Big Sky Ideas: Key summaries and waymarkers

Showing posts with label Key summaries and waymarkers. Show all posts

Tuesday, January 1, 2013

The Importance of Stocks and Depreciaton

We're looking at Double Entry: How the Merchants of Venice Created Modern Finance by Jane Gleeson-White, starting here. Book-keeping evolved into accounting as outside investors needed assurance that dividends were paid out of actual income, not capital.

Railways and factories also wore out, however, which led to another important concept: capital stock and depreciation.

The advent of the corporation raised several other key accounting issues; for example, how to calculate the declining values—due to wear and tear—of large investments in machinery, rails, rolling stock (or railway vehicles), and so on. This problem gave rise to the concept of depreciation.

It took a long time for accountants to come to terms with depreciation and properly accounting for assets. And this is still a problem, she says, when it comes to the environment since many assets are free.

This is because until recently economists have assumed that natural resources are so plentiful that any loss of them is insignificant, not worth counting. They assumed that natural resources like water, soil, forests and air were free gifts of nature.

But just as the nineteenth-century railway entrepreneurs had to learn that human-made capital—rails and machinery—wears out and must be depreciated, so some economists are beginning to understand that nature’s capital is also subject to wear and tear and depletion. Cambridge University’s Professor Sir Partha Dasgupta is one economist who is critical of the GNP and its use to judge the progress or otherwise of nations. He argues, ‘as so many economists have already done, that GNP’s main weakness lies in the fact that it is insensitive to the depreciation of capital assets’. And from an environmental point of view, this is critical.

The Modern Economy is about Stocks

This is no doubt true. But she perhaps over-emphasises environmental gaps to the exclusion of other social assets like trust or quality of life.

The larger point is we are often too focused on flows rather than stocks, including the depreciation of assets (stocks meaning an amount, like a stock of wheat, rather than an equity share like the stock exchange.) This is a basic economic distinction we often forget. As Dasgupta says, we need to be sensitive to the depreciation of capital assets.

We are much better at being conscious of flows of income rather than the valuable stock of assets which produces that income. Yet many of the great economic challenges of our era have more to do with stocks than flows of income. Many or our capital assets, such as the knowledge required to build an Intel processor or the song "Hey Jude" do not depreciate in the traditional way. They may have to be re-learned or passed on, but they do not wear out.

So what happens when the stock of our valuable assets, properly defined, gets disproportionately much larger than money income flows? In many ways, our prime objective should be to increase the stock of assets. Income and distribution are secondary factors , especially of many of the benefits flowing from those assets are free. Some of our political thought gripes towards this, especially those who think capitalism should be left unfettered to create wealth which government can then redistribute. But that often confuses income with value.

We will come back to this point another time.

Finally, Gleeson-White emphasizes again how the numbers may often conceal deeper uncertainties.

Even accounting’s most fundamental concepts and practices, such as income measurement and asset valuation, are based on uncertainties. Accountants still cannot agree on how to define income, the measurement of which remains one of the intractable problems in financial accounting theory and practice. The valuation of assets only becomes more complex and more fiercely debated as modern global corporate structures and financial instruments become increasingly labyrinthine, and income measurement, the key to determining profits and therefore dividends, is inextricably linked to this contentious, chimerical practice of asset valuation. Nor is the crucial measurement of costs an objective process: costs are also highly contestable figures and may result as much from the collusion or rivalries of firms as from any other actuality. Accrual (or corporate) accounting—the need to allocate revenues and expenses between accounting periods and to value assets and liabilities at the end of an accounting period—raises problems which have never been solved and are probably incapable of solution. Numbers can be negotiated to make management look good. In effect, ‘accounts are used to justify decisions and to excuse mistakes’.

She concludes

In an era of international capital, when our wealth is more than ever tied up in its fortunes, and at a time when corporations, governments and financial institutions are demonstrating their fallibility on a global scale, it is essential that we are aware of the somewhat arbitrary laws of account that govern them—especially because it is in the labyrinthine workings of our accounting systems that value itself is assigned. It seems that if we want to bring our infinitely voracious consumerism into line with the resources of our finite planet, we must consider giving our planet a value that the market can recognise and account for, assign a monetary value to the oceans, air, forests, rivers, wildernesses. • Delete this highlight

(My bold). In the end, we come back to the problem of economic value. There have been many major shifts in perception of costs and decisions and stocks and accountability and depreciation. Together, they make up the modern economy.

It is time for another major shift, to cope with intangibles and abundance and our reliance on those abundant stocks. Value should not be defined by arbitrary default.

Monday, November 12, 2012

Aristotle and the beginning of the Western tradition

With the election still reverberating in the air, it's a good time to get some longer perspective. I read Aristotle's The Politics (Classics) a few weeks so, but haven't talked about it yet. It is going to take at least a week to go through all the ramifications of this book.

Why read something two thousand years old?

Let me explain first of all how I was led to this. I started off this blog asking what had gone wrong with the economy. The answer, as I've gradually come to think, is we have a set of institutions and practices which are designed for scarcity, the oldest problem of mankind. But the basic things of life are now superabundant, at least in the West. We have more material stuff than we know what to do with. Our problem is not starvation, but obesity.

So we have solved the "economic problem", as Keynes called it. As we become more and more efficient and productive, the amount of labor devoted to the exchange economy - services as well as manufacturing - is plunging, just as agriculural employment did before in the nineteenth century. The economy is sputtering as a result.

Mainstream economists are confident that demand will simply shift to newer goods and services. But the nature of our wants and preferences are changing. Most mainstream economists are oblivious to this, because they take tastes and preferences as exogenous. The discipline ignores changing preferences by definition. It is a profound blind spot.

Many of the other things we want in life are changing, as we ascend what Maslow called the hierarchy of needs. The issue is that the things we increasingly want more of are not easily packaged and sold as excluable, non-rivalrous goods and services. They are not as suited to be as easily sold in the market, or delivered by the welfare state. It is difficult to establish clear property rights. (Ask the music or newspaper industries). Alternatively, as technology advances, the marginal cost of so many new goods and services is so low that (as in Facebook, or Google, or Flickr, or other paragons of the new economy) it is easier to give them away to the consumer.

Most of the value in the economy is now intangible, but we have been slow to catch up with the consequences. Mainstream economists are wrong to assume that new jobs will always be created to replace old ones, even though that has been true for the last two centuries.

I have become frustrated with our general lack of answers for what we do with the economy once many of the things we want are not material or easily tradable - such as connection, enjoyment, security, love and relationships, meaning and purpose. These are the things we turn to once we have enough shelter and food and security.

In other words, we need to take a much deeper look at what makes people flourish; not just what simply ensures survival, because flourishing has to be the objective of the economy from now on. And that means it is sensible to take a step back and look at long-run answers to this question, and older conceptions of human nature.

This is all the more important because most of our political theory has ignored this question for two hundred years, as the idea of ends or the "good life" have been sidelined. Liberal political theory - and I mean here liberal in the broad sense, which covers most of the current political spectrum - has as a matter of conscious intention no sense of what flourishing means or what our ends should be. Instead, it asks how people can minimally coexist together in a largely neutral state. In other words, it focuses almost entirely on the referee rather than asking what game we are playing, and what our goals are.

So, among other things, I was riveted by this book : After Virtue, by Alisdair McIntyre. He argues our ethical theory has become incoherent because we lost the much older tradition in the West, dating back to Aristotle, which is based on the virtues. That tradition places much more emphasis on character and judgement than impartiality, and it seeks the "golden mean" and ways to avoid excess rather than universal rules.

I read Aristolte's Nicomachean Ethics. There has also been a revival of interest in virtue ethics in contemporary philosophical circles. It has even reached some brave mavericks in the economics profession, such as Deirdre McCloskey's magnificent books.

I think many of our most intractable current political disputes arise because we argue over distribution without any reference to the virtues or actual flourishing. The left thinks equal distribution is enough. The right tends to want some standards of behavior or work ethic, but finds it hard to articulate this in liberal or libertarian terms. So it falls back on "the market". Our basic economic and political issue is what "fairness" means.

The Politics

This is why I wanted to read Aristotle's other major book, The Politics. Right at the dawn of the western tradition, he discusses what a society focused on virtue and flourishing and the Good Life ought to look like in practice. Part of the fascination is he is, of course, one of the foundational thinkers of the West, one of the most brilliant thinkers who ever lived. As an educator, he profoundly influenced the next two thousand years of history, including the Islamic world via Avicenna and the medieval Chirstian world via Aquinas. In practical terms, he tutored the most brilliantly successful conqueror in history, Alexander the Great, as well, so he is not simply an ivory-tower theoretical hermot. He taught in post-democratic Athens, but was eventually forced to flee by the mob who were hostile to Macedonian non-citizens like himself.

So we have a pragmatic voice of wisdom from a world which had grappled with many of our issues of freedom, leisure and democracy, but which is absolutely disintersted about our own political divisions. Aristotle lived two millenia before America was even discovered.

We will start off with what he says about household management, oikonomia - the origins of our word for economics.

Thursday, November 8, 2012

Blaming a whale (and narrative) for defeat

From a David Brooks exchange with Gail Collins in the NYT:

David: This might be a good time for Republicans to redouble their commitment to the reality-based community. Did you see Byron York's reporting from inside the Romney campaign? They apparently had this giant computer model called Orca - named after a whale because it was bigger than anything the Democrats could imagine. It processed huge amounts of data and late in the day was still projecting a Romney victory until its head exploded. Garbage in. Garbage out.

Gail: The Republican Orca - stop me before I fall into a great pile of Moby Dick analogies.

I think that some people are a little transfixed by Nate Silver's accurate projection of the election, despite, as I've noted, his own much more self-awade mature grasp of the limits of models.

I think this is at root a particular problem with journalism.

Or, to put it more precisely, it is a problem with narrative. Human beings have a hardwired fascination with stories, probably dating from sitting around fires in the savannah fifty thousand years ago. It is often the prime way we transmit culture and values and pointers for behavior we should admire.

But stories can be too trite, and this is where journalism becomes very hedgehog-like sometimes. It is all to easy to link stories into an appealing broader narrative, to instinctively frame things in a way which makes for an entertaining read. Stories are much more interesting than data. Once you go looking for "stories", as opposed to drier mechanical reporting of facts, you introduce potential blindspots. Things can fit all too neatly into narrative buckets.

Journalism thrives on stories. Journalists are paid to look for them, rather than dry, ambiguous, complicated truth in isolation.

We've also seen that hedgehogs typically get more media attention, because big striking claims typically make better tv or better stories. Hedgehogs want an audience for their "one big thing." Journalists want a story, And "triumph of models" is itself a good story.

Of course, at the same time as the fivethirtyeight model did well, the Romney and other models performed badly. But why let that get in the way of a good story?

Self-awareness

This is the real explanation of Silver's greater success here. It is not so much a data-driven approach, as using the data to confront your presuppositions. That is why he does better than most journalists and opinion pundits.

It is not, as the story linked above puts it, simply a matter of primitive punditry against spanking new "data driven rationality".

The scientific method is at root about testing hypotheses, not mining data. You test a prediction or explanation against reality, and you revise your views if necessary based on the outcome. You can selectively use data to confirm all kinds of things if you are not careful. So you need to have a falsifiable hypothesis, a situation where at least in principle you may be forced to revise your view.

There's nothing in narrative that compels you to change your view, because you can always add a twist in the story. Indeed, most good stories will have the hero endure many setbacks and misunderstandings before being proved right in the end.

Even in science, as Thomas Kuhn famously pointed out in The Structure of Scientific Revolutions, conflicting data is often left aside as a "puzzle" or "anomaly" in periods of normal science until there is a sudden change of awareness: I.e. the "paradigm shift" which has become so overused a term it is almost a clichė. Even in the hard sciences, it can take a generation for data to settle arguments one way or another. Theories can sprout dozens of ad-hoc adjustments.

So data can be part of this process of self-awareness. But in a world where we have a blizzard of often conflicting and imperfect data, it may equally reinforce entrenched views.

Romney's big Moby Dick model was probably highly sophisticated, but likely being used to mine data more efficiently, not testing against reality.

Innumerate journalists may regard the statistical models as some sort of new semi-deity, partly because they don't understand it, or the many ways in which statistics can be used to obscure. (There is a famous book called How to Lie with Statistics).

But the real message is not statistics as some kind of new rational technique which guarantees prophetic success. Instead, it is self-awareness.

You need devices to help you retain self-awareness, to see things as they really are instead of ever-more elaborate stories or models. And humans typically find that very hard to do. I've got a few more things to say about Silver's book in that light.

Tuesday, November 6, 2012

Maps, not models, by Mapper

We're looking at Nate Silver's The Signal and the Noise: Why So Many Predictions Fail-but Some Don't, starting here.

There's one stray reference in the book, which caught my eye, because I've been interested for over a decade in the difference between maps and models as ways to understand the world. I call myself Mapper on this blog for a reason.

Silver says:

The Finnish scientist Hanna Kokko likens building a statistical or predictive model to drawing a map. It needs to contain enough detail to be helpful and do an honest job of representing the underlying landscape—you don’t want to leave out large cities, prominent rivers and mountain ranges, or major highways. Too much detail, however, can be overwhelming to the traveler, causing him to lose his way. As we saw in chapter 5 these problems are not purely aesthetic. Needlessly complicated models may fit the noise in a problem rather than the signal, doing a poor job of replicating its underlying structure and causing predictions to be worse. But how much detail is too much—or too little? Cartography takes a lifetime to master and combines elements of both art and science. It probably goes too far to describe model building as an art form, but it does require a lot of judgment. Ideally, however, questions like Kokko’s can be answered empirically. Is the model working? If not, it might be time for a different level of resolution.

I hadn't head of Kokko before, but I thought this was interesting. The reason I find the topic so fascinating is that I have sat many times in meetings with senior economic officials - or even more often, their more academic staff - who argue that to think clearly about a situation you need a model in your head, if only to ensure consistency. For most economists, this tends to be linked to some version of Milton Friedman's as-if methodology, which says that the test of a model is not the realism of its assumptions, but the accuracy of its predictions. Simplification and abstraction from reality is what constitutes explanation, and anything else is mere muddle.

Of course, this automatically counts out the value of studying history, which has been largely excluded from the mainstream of education in the discipline for fifty years (despite some good work). Mathematical models have reigned supreme. Optimization subject to constraints is the center of thinking. It is far narrower than even "theory", as it imposes essentially aesthetic constraints on what a theory should be, I.e. mathematically elegant.

It also is dangerously overreliant on consistency. You need to be consistent to be fully rational in your choices, of course, in a narrow sense. But consistency is no guarantee of truth. You can be consistently wrong. And many actual problems are about reconciling different objectives or opposing views. Compromise in this sense is bound to be somewhat inconsistent with someone's basic principles. It is also real life.

However, the most important point is the economic modeling perspective is also a very naive way to think about useful abstraction. A map is an abstraction too, but it tends to be much more useful for most purposes than a mathematical model. Many policy problems are in fact much more like "how to get from A to B" than " maximize X subject to Y".

In particular, maps are much more focused on specific purposes. If I want to get from New York to Albany, I look at a standard road atlas or Google maps. If I want to see where shale gas deposits may lie, I want a geological map of New York State. If I want to sail up the Hudson to Albany, I want a chart which shows sandbanks and shoals and traffic lanes in the river.

In other words, purpose is much more intrinsically present in a map than a mathematical model using aggregate economic statistics or optimization assumptions.

Add to that, as Kokko says, the scale and resolution which are inherent to maps. You abstract away what you don't need. He is right here, but both Silver and Kokko are wrong in a larger sense. The point is not that there is an art to building models so they are , by analogy, a little more like maps with a correct level of detail. It is that maps and models are wholly different ways to understand reality.

Maps are much more suited to seeing risks. The kind of generalized abstraction in a model will not help you avoid the specific rock which is just below the surface as you enter harbor, but the right chart will. A map will show you the massive mountain chain or desert or unfordable river in your way. It will show the paths and cliffs and hazards. A model won't.

So thinking in terms of surveying a specific landscape for specific important features for a specific purpose is just as disciplined an intellectual exercise as developing an abstract model to predict, and much more useful. It can also be a much better predictor of some kinds of problem (eg how long it will take to get to Albany.)

Maps help you see what is actually there, rather than "explain" it in some ultimate universal way. We most often don't need a general theory of roads. We just want to find our way home. Models will predict, but maps will show you the right way. If you want to climb a mountain you are better off bringing a topo map than an abstract mathematical model of paths.

Silver's book is all about prediction, but the more general human problem in decision-making is which way do I go? What is the right direction? Where are the hazards? We need maps more than universalized explanations in most situations. We need a survey of the actual landscape with a particular purpose in mind.

Ways of seeing what is really there are the main way we will develop and make progress. Too much modelling often prevents us from doing that, by distracting people towards the mathematically elegant and tractable, the thin universal rather than the thick description of specifics, and the quantifiable and obvious rather than the danger that lurks in the details.

Friday, September 28, 2012

Excellence versus equality

G and I were discussing a book a few days ago which surveyed debates in the 1950s and 1960s about the purpose and role of universities. One prominent view was that the university should be a center of excellence. But this sat uneasily with the egalitarian drift of society. So others argued that the university should somehow uplift surrounding communities, even if it meant open admissions and less attention to academic standards.

I was immediately interested in this, because excellence is largely a translation of the Greek word arête. So this links directly to the idea of virtue ethics which I've talked so much about.

It is a profound problem. How do you reconcile equality and excellence? I think there have been two main problems with this debate.

The corruption of excellence

First, excellence has often been corrupted, and that has made us deeply suspicious of the concept. Nobility frequently been anything but noble. In the wake of the First World War, the legitimacy of many of the traditional virtues (and the social classes which justified themselves in relation to them) collapsed. The senseless carnage of the trenches in the end undermined a whole way of life, of deference and tradition and hierarchy.

The original definition of aristocracy was "rule by the best". Instead, the European aristocracy, which centuries before grew from its claim to military excellence and skill, had turned into a entitled, overprivileged and often stupid bastion of unearned wealth. In the trenches, lions turned out to be led by donkeys.

We saw last week that the same applied elsewhere. The Chinese scholar-officials turned inward and rigid.

The Bloomsbury Generation saw "eminent Victorians" as hidebound and stuffy and hypocritical. Western society turned more egalitarian. The Second World War and Cold War were fought for democracy, versus forms of totalitarianism. There was another leap in egailtarian consciousness in the sixties, which ramified into the new social movements like feminism and gay rights.

Curiously, a new university-educated meritocratic elite gradually rose over the same period. A brand-name degree still had legitimacy as a marker of excellence, at least in the job market. So did achievements like winning an Olympic gold medal.

But on the whole, there is now no consensus on what excellence is any more. Indeed, it isn't part of the conversation in the liberal tradition, which, as we've often discussed, focuses on autonomy and impartial rules.

The life cycle of organizations

Much of the problem arises because Excellence does not last. G and I often discussed how workplaces have a tendency to turn rancid over time. Organizations have a life cycle. They start off creative and fresh, and a little crazy. They then stabilize, get a bit of adult supervision, and if they are lucky, they succeed and grow. But over time bureaucracy and rigidity also grow, strangling the culture. Good people get frustrated and leave. Time servers and assholes remain. The vitality ebbs away. The organization cannot adapt or change. And eventually it dies.

The number of organizations that survive even fifty years is remarkably small.

The average lifespan of a company listed in the S&P 500 index of leading US companies has decreased by more than 50 years in the last century, from 67 years in the 1920s to just 15 years today, according to Professor Richard Foster from Yale University.

In fact, the mystery is how some organizations survive for much longer. Institutions like the Catholic Church have often faced crises and reform movements and internal rot.

So what does this mean? Excellence is always in trouble. It is not self-sustaining. It is always beset by hypocrisy and corruption and rigidity. It is more like evolutionary fitness - literally so on the original Aristotelian definiton, which sees it as fitness for a particular purpose. Few species last any length of time either.

It can also be very hard to discern excellence in many fields. Who has a brilliant business idea or leadership skills? Hundreds of startups fail for every Google or Apple that succeeds. Initial excellence has a tendency to turn into monopoly (such as Microsoft's efforts in the 1990s). Initial political change has a tendency to turn into predation and an exclusionary parasitic elite.

But that does not mean some conception of excellence is valueless. It just means it has to be open to challenge and discussion. It needs checks and balances and renewal. It needs some way to get rid of the rot and the timeservers.

By happy accident, insofar as our economy works, it is because it has found ways to do this, at least for a conception of excellence as a combination of profitability and political preferment. It does not do so for the original Greek ideal of eudaimonia, or flourishing. And that is the basic problem with the economic system.

Maybe it is like a different version of Newton's First Law. That states, of course, that an object continues in its current state of motion unless acted on by a resultant exterior force. Instead, excellence tends to steadily decline unless acted upon by a positive external force.

Actually, that sounds more like the second law of thermodynamics. Entropy is always increasing. Life is the process which resists entropy, by increasing order and harmony in some localized spots. Excellence is much the same, a process that resists the deterioration of everything into a featureless soup of atoms in empty space.

Equality and dignity

That brings us to the second problem, equality. The debates here are old and familiar, especially the distinction between equality of opportunity and equality of outcome. The right prefers the first, the left inclines to the second.

Instead, I think our basic problem with equality is a tendency for the idea of equality of dignity - a highly important idea - to seep out of bounds into much larger demands for equality of respect. And that is incompatible with any idea of excellence. It isn't primarily a difference of economic outcomes that matters now, so much as status outcomes.

People deserve a certain basic dignity and respect simply as a human being - an idea which took the world a long time to arrive at. But should that extend to equal dignity and respect, regardless of what they do?

Take the phrase "second class citizen". It is used as a debate-killer, an automatic wrong. So people argue released felons should not be treated as second-class citizens. Amnestied illegal aliens should not be treated as second-class citizens.

The problem is this strips away any other possibiliies for society apart from power and money and celebrity. Yes, it is a noble idea to give everybody an aura of abstract equality and dignity, regardless of actual reality. The serial killer does have in a sense the same abstracty humanity as the cancer researcher or the startup pioneer. But it is also a sort of religious belief that has sucked the life out of dignity and excellence as well. Should we not say that in some senses the cancer researcher at her workbench is better than the serial killer in his prison cell? That will make many people uneasy. But it may be a necessary unease.

The problem is we have become so distrustful of any claim to merit which would justify claims to excellence. That is, perhaps, a legacy of the Cold War arguments for democracy, the fanfare for the common man. Democracy tends to erode the legitimacy of any other claims. We saw that "democracy" was ironically seen as the worst political system for most of recorded history, until the French Revolution. As Mitt Romney may discover, few people wil fight for economic liberty. But they will fight for equal dignity.

The great value of democracy, at least when it is embedded in the culture of a society, is that it has a tendency to resist the corruption of elites. Status distinctions tend to entrench a parastic layer above society. But equal dignity is often so patently unrealistic in practice it is also a difficult basis for legitimacy. Democracy can suffer from the corruption of the electorate.

So here is the difficulty. Claims for automatic equality undermine virtue. Some form of excellence - virtue - is necessary for societies to flourish. Too much equality at the expense of excellence produces, ultimately, the poltiical gridlock, overloaded fiscal burdens, bloated pension exposures and the financial crises we see around us.

This leads to the older discussion about the cultural contradictions of capitalism, as Daniel Bell put it, or the related ideas that the Protestant or bourgeois Ethic, for example, was necessary to the growth of capitalism. That's a topic for another post.

In essence, though, without some kind of active debate about virtue or excellence, society will have much less of it.

Saturday, September 1, 2012

Books Index 2

I wrote a post of links to books I talked about from the beginning of the blog in July 2011 back in February. I've found it pretty useful just for my own purposes. So here is another list of books I've talked about from the end of February (2012) until today. The image links to Amazon and the text links to the relevant post. Most recent is first.