Tag Archives: economics

Why the Prediction Market Failed to Predict the Supreme Court

There is a very interesting piece in the New York Times today by David Leonhardt on the apparent backlash against prediction markets such as Intrade and Betfair. In principle, these markets make predictions by aggregating the disparate information of many independent bettors who offer prices for a particular outcome. Prediction markets have enjoyed a fair amount of success in recent elections. The University of Iowa has even set up an influenza prediction market.  But prediction markets are hardly perfect and have had some pretty big recent failures. It turns out that Intrade failed in a pretty spectacular manner to predict the outcome of the recent Supreme Court ruling about the constitutionality of the Affordable Care Act. Leonhardt suggests that some of the failures of online prediction markets is attributable to relatively small number of people who actually trade on the market:

But the crowd was not everywhere wise. For one thing, many of the betting pools on Intrade and Betfair attract relatively few traders, in part because using them legally is cumbersome. (No, I do not know from experience.) The thinness of these markets can cause them to adjust too slowly to new information.

This may have been an issue with the ACA decision but the primary problem with the incorrect prediction is that the crowd doesn’t actually know much about the workings of the very closed social network that is the United States Supreme Court. Writes Leonhardt:

And there is this: If the circle of people who possess information is small enough — as with the selection of a vice president or pope or, arguably, a decision by the Supreme Court — the crowds may not have much wisdom to impart. ‘There is a class of markets that I think are basically pointless,’ says Justin Wolfers, an economist whose research on prediction markets, much of it with Eric Zitzewitz of Dartmouth, has made him mostly a fan of them. ‘There is no widely available public information.’

This point gets at a larger critique of market-based solutions to problems suggested by my Stanford colleague Mark Granovetter over 25 years ago (Granovetter 1985). This is the problem of embeddedness. The idea of embeddedness was anticipated by the work of substantivist economist Karl Polanyi, but Granovetter really laid out the details. Granovetter writes (1985: 487): “A fruitful analysis of human action requires us to avoid the atomization implicit in the theoretical extremes of under- and oversocialized conceptions [of human action]. Actors do not behave or decide as atoms outside a social context, nor do they adhere slavishly to a script written for them by the particular intersection of social categories that they happen to occupy. Their attempts at purposive action are instead embedded in concrete, ongoing systems of social relations.” Atomization is independent bettors making decisions about the price they are willing to pay for a certain outcome.

The argument for embeddedness emerges in Granovetter’s paper from the problem of trust in markets. Where does trust come from in competitive markets? The fundamental problem here regards the micro-foudnations of markets where “the alleged discipline of competitive markets cannot be called on to mitigate deceit, so the classical problem of how it can be that daily economic life is not riddled with mistrust and malfeasance has resurfaced.” (p. 488). The obvious solution to this is that actors choose to deal with alters whom they trust and that the most effect way to develop trust is to have prior dealings with an alter.

Granovetter’s embeddedness theory is a modest one. He notes that, unlike the alternative models, his “makes no sweeping (and thus unlikely) predictions of universal order or disorder but rather assumes that the details of social structure will determine which is found.” (p. 493)

These ideas about the careful analysis of social structure and networks of interlocking relationships are fundamental for understanding when the crowd will be wise and when it will not. They are also essential for developing effective development interventions and, for that matter, making markets work for the public good in general.  The theory of embeddedness allows for the possibility that markets can work but if we are to understand when they work and when they don’t, we need to think about social structure as more than just a bit of friction in an ideal market and take its measurement more seriously. People are not ideal gases. (Dirty little secret: most gases are not ideal gases). This gets at some problems that I have been thinking about a lot recently relating to the implications of additive, observational noise vs. process noise and its implications for prediction of multi-species epidemics, but that must wait for another post…

 

 

Guess What: Food Prices Still Near All-Time Highs

The FAO Food Price Index (FPI) remains at near record-highs, and this at a time when record droughts and calamitous famine threaten the Horn of Africa. Using the latest data from the FAO FPI page, I plot here the FPI time series from 1990-2011.

fpi-ts-1990-2011-1

World food prices are high and have remained so since the beginning of this year, though there have been some pretty dramatic swings between 2008 and now.  There is some argument that the real problem for poverty alleviation is actually price volatility and not high prices per se.  However, a recent paper in Foreign Affairs by Barrett and Bellemare argues that the problem for the world’s poor is really high prices (a more complete working paper can be found here). I find their arguments quite persuasive. Among these, the authors wryly note “Perhaps not coincidentally, [commentators’ and politicians’] emphasis on tempering price volatility favors the same large farmers who already enjoy tremendous financial support from G-20 governments.”

Stanford Migration and Adaptation Workshop

Information on our NICHD-funded April formal demography workshop on migration and adaptation is now posted on the website Stanford Center for Population Research (SCPR, pronounced “scooper”).  SCPR is itself hosted by Stanford’s Institute for Research in the Social Sciences (IRiSS), which is also the umbrella organization for the Methods of Analysis Program in the Social Sciences (MAPSS), a program that I currently direct. We will be having this little shindig at the new IRiSS facility on Alta Road, a lovely location on the hill behind Stanford’s main campus, quite near the Center for Advanced Study in the Behavioral Sciences. All of these workshops have been terrific, but I am particularly excited about this one because it brings together so many of the threads of work going on right here at Stanford on human ecology, demography, and the biophysical environment.  Much of this work is facilitated by the Woods Institute for the Environment, where I and a number of the other Stanford-based speakers sit.

As a quick teaser of the kind of work that we will discuss, I want to draw people’s attention to two papers by Stanford faculty participating in the workshop that are just out this week.  Eric Lambin has a paper (which also happens to be his inaugural paper in PNAS as a member of the NAS) on the interactions between globalization, land use, and future land scarcity. I saw a talk on this last week and it was terrific. Lambin and co-author Patrick Meyfroidt argue that there are four socio-economic mechanisms (displacement, rebound, cascade, and remittance effects) that are amplified by by the process of economic globalization and that can accelerate land conversion. David Lobell has a new paper out today in Nature Climate Change in which he and his co-authors capitalize on a treasure-trove of historical agricultural trials in Africa to measure the impact of warming on maize production.  They find that approximately 65% of areas will experience a decline in productivity with a one-degree rise in global temperature if rain patterns are optimal.  If rain is sub-optimal, as is likely to be the case, then every site would experience reduced productivity.  This supports David’s contention that the effects on agricultural productivity of temperature increase from global climate change can not be understood except in the context of changes in rainfall as well.

Potential students who are interested in studying these issues at Stanford have a number of options.  If anthropology is your thing, we have a Ph.D. focus area in Ecology and Environment within the Department of Anthropology.  Bill Durham, Lisa Curran, Rebecca Bird, Douglas Bird, and I all teach in this area. Another option, for the more interdisciplinarily inclined, is E-IPER.  This is a topic I will have to take up in more detail in a later post since I actually have to do some work organizing our workshop now!

Food Prices Continue to Rise

Newly released data by FAO show that food prices continued to rise, up 3.4% from the last month of 2010. This is yet another record high. Here is a plot based on the FAO data (click to enlarge):

fpi-ts-1990-2011

An article in today’s New York Times attributes much of the rise in price to uncertainty over coming harvests. It also notes the four main factors that contribute to increased price: weather, higher demand (from larger population size and greater demand for meat and dairy), smaller yields, and the diversion of food crops to biofuels.

An Alternate Course Load for the Game of Life

In a recent editorial in the New York Times, Harvard economist and former chairman of the Council of Economic Advisers, N. Gregory Mankiw provides some answers to the question “what kind of foundation is needed to understand and be prepared for the modern economy?”  Presumably, what he means by “modern economy” is life after college.  Professor Mankiw suggests that students of all ages learn something about the following subjects: economics, statistics, finance, and psychology.  I read this with interest and doing so made me think of my own list, which is rather different than the one offered by Mankiw. I will take up the instrumental challenge, making a list of subjects that I think will be useful in an instrumental sense — i.e., in helping graduates become successful in the world of the twenty-first century. In no way do I mean to suggest that students can not be successful if they don’t follow this plan for, like Mankiw, I agree that students should ignore advice as they see fit. Education is about discovery as much as anything and there is much to one’s education that transcends instrumentality — going to college is not simply about preparing people to enter “the modern economy,” even if it is a necessary predicate for success in it.

People should probably know something about economics.  However, I’m not convinced that what most undergraduate students are taught in their introductory economics classes is the most useful thing to learn. Contemporary economics is taught as an axiomatic discipline.  That is, a few foundational axioms (i.e., a set of primitive assumptions that are not proved but considered self-evident and necessary) are presented and from these, theorems can be derived.  Theorems can then be logically proven by recourse to axioms or other already-proven theorems. Note that this is not about explaining the world around us.  It is really an exercise in rigorously defining normative rules for how people should behave and what the consequences of such behavior would be, even if actual people don’t follow such prescriptions. Professor Mankiw has written a widely used textbook in Introductory Economics. In the first chapter of this book, we see this axiomatic approach on full display.  We are told not unreasonable things like “People Face Trade-Offs” or “The Cost of Something is What You Give Up to Get It” or “Rational People Think at the Margin.” I couldn’t agree more with the idea that people face trade-offs, but I nonetheless think there are an awful lot of problematic aspects to these axioms.  Consider the following paragraph (p. 5)

Another trade-off society faces is between efficiency and equality. Efficiency means that society is getting the maximum benefits from its scarce resources. Equality means that those benefits are distributed uniformly among society’s members. In other words, efficiency refers to the size of the economic pie, and equality refers to how the pie is divided into individual slices.

Terms like “efficiency” and “maximum benefits” are presented as unproblematic, as is the idea that there is a necessary trade-off between efficiency and equality.  Because it is an axiom, apparently contemporary economic theory allows no possibility for equality in efficient systems. Inequality is naturalized and thereby legitimized. It seems to me that this should be an empirical question, not an axiom. In his recent book, The Bounds of Reason: Game Theory and the Unification of the Behavioral Sciences, Herb Gintis provides a very interesting discussion of the differences between two highly formalized (i.e., mathematical) disciplines, physics and economics.  Gintis notes, “By contrast [to the graduate text in quantum mechanics], the microeconomics text, despite its beauty, did not contain a single fact in the whole thousand page volume. Rather, the authors build economic theory in axiomatic fashion, making assumptions on the basis of their intuitive plausibility, their incorporation of the ‘stylized facts’ of everyday life, or their appeal to the principles of rational thought.”

If one is going to learn economics, “the study of how society manages its scarce resources” — and I do believe people should — I think one should (1) learn about how  resources are actually managed by real people and real institutions and (2) learn some theory that focuses on strategic interaction.  A strategic interaction occurs when the best choice a person can make depends upon what others are doing (and vice-versa). The formal analysis of strategic interactions is done with game theory, a field typically taught in economics classes but also found in political science, biology, and, yes, even anthropology. Alas, this is generally considered an advanced topic, so you’ll have to go through all the axiomatic nonsense to get to the really interesting stuff.

OK, that was a bit longer than I anticipated. Whew.  On to the other things to learn…

Learn something about sociology. Everyone could benefit by understanding how social structures, power relations, and human stocks and flows shape the socially possible. Understanding that social structure and power asymmetries constrain (or enable) what we can do and even what we think is powerful and lets us ask important questions not only about our society but of those of the people with whom we sign international treaties, or engage in trade, or wage war. Some of the critical questions that sociology helps us ask include: who benefits by making inequality axiomatic? Does the best qualified person always get the job? Is teen pregnancy necessarily irrational? Do your economic prospects depend on how many people were born the same year as you were? How does taste reflect on one’s position in society?

People should definitely learn some statistics. Here, Professor Mankiw and I are in complete agreement.

Learn about people other than those just like you. The fact that we live in an increasingly global world is rapidly becoming the trite fodder of welcome-to-college speeches by presidents, deans, and other dignitaries. Of course, just because it’s trite doesn’t make it any less true, and despite the best efforts of homogenizing American popular and consumer culture, not everyone thinks or speaks like us or has the same customs or same religion or system of laws or healing or politics. I know; it’s strange. One might learn about other people in an anthropology class, say, but there are certainly other options. If anthropology is the chosen route, I would recommend that one choose carefully, making certain that the readings for any candidate anthropology class be made up of ethnographies and not books on continental philosophy. Come to grips with some of the spectacular diversity that characterizes our species. You will be better prepared to live in the world of the twenty-first century.

Take a biology class. If the twentieth century was the century of physics, the twenty-first century is going to be the century of biology.  We have already witnessed a revolution in molecular biology that began around the middle of the twentieth century and continued to accelerate throughout its last decades and into the twenty-first. Genetics is creeping into lots of things our parents would not have even imagined: criminology, law, ethics. Our decisions about our own health and that of our loved ones’ will increasingly be informed by molecular genetic information. People should probably know a thing or two about DNA. I shudder at popular representations of forensic science and worry about a society that believes what it sees on CSI somehow represents reality. I happen to think that when one takes biology, one should also learn something about organisms, but this isn’t always an option if one is going to also learn about DNA.

Finally, learn to write.  Talk about comparative advantage! I am continually blown away by poor preparation that even elite students receive in written English. If you can express ideas in writing clearly and engagingly, you have a skill that will carry you far. Write as much as you possibly can.  Learn to edit. I think editing is half the problem with elite students — they write things at the last minute and expect them to be brilliant.  Doesn’t work that way. Writing is hard work and well written texts are always well edited.

On Human Rationality

Oh, how this bugs me.  I think behavioral economics is a great thing.  However, the language that is used to discuss behavioral economics — and specifically, the types of problems it addresses — is hugely problematic. There is this pervasive idea, largely arising from economics, that because people do not behave according to the predictions of some narrow pecuniary incentive structure, they are somehow not rational.  Rebecca Bird and I recently wrote a brief essay in which we bemoaned this perspective, noting particularly in the case of indigenous peoples, the diagnosis of irrationality is the ticket to paternalism, allowing “marginalized people to be further marginalized and fail to reap the benefits of even well-intentioned [development] projects.”  In many traditional social contexts, pecuniary rewards may trade-off with social prestige.  People could be hyper-rational in their optimization of social capital and fail utterly to meet the bar for narrow-sense economic rationality.

This is all I have time for right now, but there is more to come (both scholarly a paper and probably more blog posts).

The Continuing Food Crisis

The 2008 Report of the Millennium Development Goals is out today. Seeing this, along with this editorial piece by The Age‘s economics editor, Tim Colebatch, drives home the key point that the world food crisis is far from over.  High food prices may drive 100 million more people into extreme poverty this year, eroding the substantial progress that has been achieved in the eradication of extreme poverty since the MDG were instituted.

34% of US Corn Harvest To Be Used for Ethanol

Despite the flooding in Iowa earlier this summer, the US is set to harvest its second largest corn crop ever.  Good news for the price of food for hungry people?  Not really, the USDA expects that 34% of the total corn crop will be used to make ethanol for biofuel. They project a price of $5-6 per bushel for the coming year, up from $4.25 for 2007/08. I can’t help but think that making fuel for SUVs out of food when there are still many poor, hungry people in the world is a bad idea.  But what do I know?