Reforming unemployment insurance

People rarely stop to think about just how bizarre our unemployment insurance system actually is. Imagine if automobile insurance worked as follows. After an accident, the insurance company paid you $400 dollars for each week that your car was out of commission, up to 26 weeks.

That system would obviously encourage people to delay repairing the car. This is why insurance companies pay the insured a lump sum, right after the accident. I’ve long advocated the same system for unemployment insurance, in order to reduce work disincentives.

Instead, the disincentive to work was actually increased by the UI reforms in the recent CARES Act. Some of the changes may have been beneficial, such as extending UI to independent contractors. But it’s hard to justify paying people who don’t work more than they received on their previous job, even during times when jobs are hard to come by.

A new study by Attila Lindner and Balázs Reizer suggests that paying UI as a lump sum after the “accident” of job loss could be a win-win proposition.  Here’s the abstract:

We estimate the effect of front-loading unemployment benefit payments on nonemployment duration and reemployment wages. Exploiting a sharp change in the path of benefits for those who claimed unemployment benefits after November 1, 2005 in Hungary, we show that nonemployment duration fell by two weeks, while reemployment wages rose by 1.4 percent as a result of front-loading. We show that these behavioral responses were large enough to offset the mechanical cost increase of the unemployment insurance. We argue that our results indicate that benefit front-loading was a Pareto improving policy reform as both unemployed and employed workers were made better off.

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UK fact of the day

#COVID19 mortality in UK hospital patients has been falling steadily from >6% in March to ~1% now, with similar trends elsewhere. The reasons behind this pattern remain unclear, but #COVID19 Infection Fatality Rates will likely have to be revised downward. https://tinyurl.com/ybnlmkdz That is from Francis Balloux.  And again here is the source link.  And please […]

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Cost and the Agony of Choice

I recently had cause to re-read part of James Buchanan’s Cost and Choice, which remains one of the most important treatments of the idea of cost in the history of economics. Chapter 3 of the book is the core of his argument and it lays out an important distinction that is often overlooked in other treatments of cost.

 

Buchanan starts with a methodological distinction between what he calls the “predictive theory” of orthodox economics and the “more general theory of choice.” In a move that can be found elsewhere in his work, Buchanan understands the predictive theory to be the equilibrium models that populate much of formal economics. Those are based on two key assumptions. First, humans are homo economicus, concerned with maximizing utility or profits. Second, they have all of the relevant knowledge necessary to engage in that maximization process. That is, meaningful uncertainty is absent.

If all of the conditions of the predictive theory hold, we can, indeed, predict what people will do facing a particular set of data. As Buchanan notes, in this world, “Individuals do not choose; they behave predictably in response to objectively measurable changes in their environment.” Another way to put this is that if an actor is assumed to maximize utility and that person knows all that is necessary to fill in their utility function, what they will “do” is not a choice. It is simply implied by the maximization assumption combined with those particular data. As we teach in intro, when you know your cost curves and your revenue curves, and are assumed to maximize profits, you don’t “choose” the price and output combination in any meaningful sense of the word. That combination is the logical implication of the location of those curves. Utility and profit maximizers in the predictive theory stand there and can do no other.

The simplest way to see the distinction between the predictive theory and the more general theory of choice is a bit of introspection. When real humans actually make choices, we feel the “agony of choice” that is utterly absent from the predictive theory. Which entrée should I order at the restaurant? Which college should I attend? Which medical treatment should I adopt? All of these choices involve an internal struggle over assessing the costs and benefits and thinking through alternatives, and imagining future regret. The discomfort we experience when facing genuine choice is the result of conflicting goals we might have and the structural uncertainty that is the human condition. Those are all absent in the predictive theory where there are no alternatives to the outcome implied by the data given the maximization and knowledge assumptions.

In the more general theory of choice, human actors are not assumed to only care about pecuniary concerns and they face genuine uncertainty about the future. As Buchanan puts it, in the predictive theory, “cost is reckoned in a commodity dimension” while in the theory of choice it is “reckoned in a utility dimension.” The assumptions of orthodox theory allow us to attach a financial or physical dimension to our understanding of cost, as represented by the marginal cost curves of basic microeconomics. But once we put those assumptions aside, we can only understand cost in utility terms.

This is where Buchanan’s core contribution comes in. What does cost look like in a world where people have multiple goals and are dealing with true uncertainty? Cost in such a world is the actor’s “own evaluation of the enjoyment or utility that he anticipates having to forego as a result of selection among alternative courses of action.” (I would note that it would be more precise to say “want satisfaction” rather than “enjoyment or utility,” especially if “utility” is understood in hedonic terms.) He lays out six implications of what he calls the “choice-bound conception of cost:”

  1. Most importantly, cost must be borne exclusively by the decision-maker; it is not possible for cost to be shifted to or imposed on others.
  2. Cost is subjective; it exists in the mind of the decision-maker and nowhere else.
  3. Cost is based on anticipations; it is necessarily a forward-looking or ex ante concept.
  4. Cost can never be realized because of the fact of choice itself: that which is given up cannot be enjoyed.
  5. Cost cannot be measured by someone other than the decision-maker because there is no way that subjective experience can be directly observed.
  6. Finally, cost can be dated at the moment of decision or choice.

 

I don’t want to walk through each of these, as I’ve covered many of them in a previous contribution. What I do want to note is that all of these implications derive from the absence of homo economicus and the presence of real uncertainty. This combination makes cost subjective and anticipation-driven. We don’t know for sure whether the steak will be better than the salmon, or whether standard drugs will be better than chemotherapy. Cost is the hurdle we must get over in order to choose. We have to decide that the want we anticipate satisfying by one option is more valuable than what we anticipate from the next best option. That process of weighing those anticipated outcomes is the agony of choice, and it is what is absent from the predictive theory and the standard neoclassical models that emerge from it.

Standard theory might allow us to make predictions about behavior, given its assumptions, but it fails us as a way to understand choice.

Another way to see Buchanan’s contribution is to think in terms of the Austrian idea of discovery and markets as processes of social learning. In the predictive model, there is nothing to discover and there can be no regret. Behavior is implied by the assumptions and the data, and the maximizing combination is always chosen. There is nothing to learn. In the theory of choice, we are always in a process of discovering whether or not the various options in front of us can satisfy our wants in the ways we anticipate. If we choose the steak and it’s not very good, we have learned something for next time we eat at that restaurant. We can experience regret and it can inform future decision making. We learn from our choices and we improve ourselves in the process.

The relationship between cost and real choice Buchanan outlines in his description of the general theory of choice depicts humans who are much closer to the kind of people who inhabit the world of the humanities, and especially the creative arts. They are richly understood humans who experience that agony of choice and face uncertainty about the future. And they are humans who are capable of regret, learning, and improvement. In his essay “Natural and Artifactual Man,” Buchanan writes that “Man wants liberty to become the man he wants to become.” This is a description of the choosing person who inhabits the general theory of choice. The automaton in the predictive theory cannot be understood in those terms.

Whatever the value of the predictive theory, and it certainly has value as a preliminary exercise for understanding economic relationships, it cannot help us to understand genuine choice in a world of uncertainty. And it therefore cannot help us understand the very human experience of the agony of choice, the regret of error, and the joy of learning.

 

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CfP: “International Capital Flows and Financial Globalisation”

From Trinity College Dublin: CALL FOR PAPERS IM-TCD half-day workshop on: International Capital Flows and Financial Globalisation Date: December 17th, 2020 Venue: Zoom This half-day virtual workshop will include four papers featuring the latest research advancements in international capital flows and financial globalisation, from empirical and theoretical perspectives. Examples of relevant research areas include: New […]

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Tuesday assorted links

1. Training the professional auctioneer, good story. 2. New economic history podcast. 3. Predictive performance of the IHME model: doesn’t beat the baseline forecast. 4. Early June case spikes from four different cities with four different reopening regimes.  Hmm. 5. Why hasn’t coronavirus been worse in Haiti? 6. MR readership much higher than TLS readership.  […]

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Induction into Intellectual Culture

Are you a reader who can socialize with dead people? One who engages in the form of reading that enables interaction with people who have been dead a long time? In this episode, EconTalk host Russ Roberts and philosopher Agnes Callard consider the state of humanities education, the lifelong benefits of the study of philosophy, and how college can be where some (many?) young people are inducted into intellectual culture and truly learn the art of reading and discourse.

Callard’s enthusiasm emanates, and might make you reach for a dusty copy of Plato’s Dialogues. She would want you to invite some friends to join in a shared experience. Let us know what you think about the power of philosophy and its relevance to how we think about the great questions of our human experience.

 

 

1- How does Callard differentiate the field of philosophy from science in regard to external standards for progress?  Are there other fields for which the consensus standard is a questionable way to measure the “established truths”?

 

2- Roberts and Callard view changes in humanity over the past centuries differently. While Roberts believes we have progressed little in coping with the complexity of our consciousness and becoming virtuous, Callard suggests that the idea of human rights first articulated by Immanuel Kant as the idea of human dignity is the ultimate philosophical human achievement. With whom do you side, and why?

 

3- Roberts voices concern over the philosophy of utilitarianism and our tendency toward the idea of a calculus of societal well-being.  What evidence does Callard give that “wanting the most good happenings” is an area of philosophy that is currently being worked on? What are other examples of such principled decision-making?

 

4- Roberts calls the description below by Callard both poignant and tragic. Is it also hopeful? Explain.

“So, maybe you tell yourself a different story, like a story about how it’s all about the search and the searching, ‘Live the search and that’s actually valuable.’ And, that–that story, that pretense–that you told yourself is how you get yourself to do this impossible thing, which is searching for something that you maybe can’t get within your lifetime.”

 

5- University education is desired by more people and universities are becoming more integrated into society. What do you think of the description of college as a “finishing school” or “starting school”, and how do you imagine universities in 200 years?

 

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