The Elusive Quest for Best Practice

(foreword: I am actually thinking of moving to medium.com. Their comment in line function is quite appealing. I really hope to get more critisisms or comments. so I also published this on medium)

People love to find a best practice. Who can blame them? After all, we are confronted with so many problems, and they give us a headache. Wouldn't it be great if we can follow some best practice and solve all these problems, or at least mostly solve the problems?

Problems

In public policy, we see the problem of corruption and bad policy. Wouldn't it be nice if there is a system that could guarantee the public policy serves the people?

In banking, we see reckless moral hazard. Wouldn't it be nice if we bind all fund managers to some best practice and manage money soundly?

In research, we see the problem of careless or even fraudulent statistical analysis, and the ensuing non-credible results. Wouldn't it be great if we can whip researchers all into some best methodology, and take the 'con' out of everything?

Fake Solutions

In public policy, we were sold ideologies like democracy and Washington Censuns. We point to successful cases and ignore failed attempts, and say democracy can cure every country except those who cannot be cured. (borrowing from doctors before the start of Randomized control trials) Or we say, ahh, those are not real democracies, these and that. But face it, democracy is not a pancea. The Dupont story and Flint Water Scandal should give us pause: in a well-run society, discovering and exposing such deeds should not be so difficult. Or consider this, Ohio regulators rubberstamped the merger between Aetna and Humana (two of the biggest US health insurance company) and kept the decision secret for more than a month.

In banking, we are sold all kinds of ideas: capital requirements, Bessel II, Bessel II, triple A....The 2007 financial crisis speaks to their limits (or absurdity)

In research, we were sold ideas like instrumental variable, natural experiment, propensity score matching. These made us feel like we are in the land of Asymptopia (see Leamer's paper), where we churn out more non-sense, just in more complicated forms.

Problems with Best Practice

I used to think that looking for best practice is a fool's errand.  Now, it feel it results more from laziness than stupidity. Intellectual laziness. It is the kind of wishful thinking that one can rest sound and tight, and never need to do anything, if one can find the best practice. But you never will.

Sometimes the best practice does not exist. Though people or countries may have similar symptoms, the underlying disease differ. What jump-started western economies (free market) could leave late-comers in a resource curse, while the opposite (industrial policy) actually enable Japan, South Korea, and others to leap ahead. Just as Dani Rodrik pointed out: Diagnostics before prescription.

More fundamentally, the problem with best practice is that it is a static concept: there is something set in stone. It might work well for handling physical objects, like atoms, or chemicals, but it won't work for people. People find work-arounds and adapt to new circumstances (this idea is at least as old as Lucas critique, but deplorably, economists (including Lucas himself) address this critique with a best practice: rational expectation framework).

Starting with some best practice is great. The problem is most people stop there. It is only a starting point, and is no substitute for real work, like constantly monitoring and continuous problem solving. It is not enough to let people vote, it is paramount to stay vigilant against any forces that stealthily swap the democratic spirit for democratic form. 

"Yes, there are all sorts of problems with best practice, but, what is the alternative?" people ask, "Doesn't is prevent the worse from happening?" Maybe, but at a cost. It gives us a false sense of security, complacency or even over-confidence; it encourages us to join a wild party celebrating "the Great Moderation" without realizing the boat is sinking. We might improve a little bit, but also swept the remaining mess under the rug of best practice. 

It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so. 

The lesser evil paves the way for the greater evil.

Running for Life

When I see all those researchers thoughtlessly implementing Inverse Probability Weighting (IPW) or carrying out a structural estimate, and present their results as credible. I cannot help thinking to myself it is another triple-A rated Credit Default Swap being sold. I should scramble for life.

Empethetic Sociapath

Check out Financial Times' latest read on Net Neutrality:

Net neutrality: Strife in the fast lane

The main idea is that the Internet Service Providers (ISP) abuse their monopolistic power and hence created the digital divide which is described by FT as

the gulf between those who have access to the internet and those who do not – has become one of the flashpoints in the fierce battle over US broadband policy.

While this is an important issue, it is sad, almost disheartening that this becomes the focus. Politicians take this issue as their goal: "Mr Obama has often spoken of his desire to close the gap between the digital haves and have-nots". It seems to them as long as we can close this gap, it is all good.

Nothing could be farther from the truth.

Those ISP are monopolies in their respective markets. They abuse their monopoly power.  The so-called digital divide is merely one symptom of such abuse. A good policy should aim at the root of the problem instead of working at one symptom, which is typical of what politicians do. Abusing its monopoly power, ISP like Comcast has charged unreasonable price for all internet users, and most of us simply surrender and pay the price. For the unlucky ones, they simply chose not to. In an economic sense, those who purchased internet suffered more from having a monopoly than those who simply could not afford internet (Econ 101).

However, empathy drives people to the visible inequality, the digital divide, and completely blind to those who suffer in silence. Empathy, with the help of media, turns the have-nots and haves head on, when they are in fact both suffering from the common enemy---monopolistic ISP. These leads to myopic policy agenda as the one put forth by Mr. Obama. The true evil lies in the damn monopoly, and we need to kill it. Period. Give reasonable price to everyone, not just the poor.

Ominously, Comcast is taking advantage of the public empathy-oriented judgement, and is pre-empting legislative moves:

Comcast does offer a much cheaper plan – $9.95 a month – for families with children on free or cut-price school meals...

This seems like a great benevolent move, if our mind revolves around the stupid and narrow goal of closing the digital divide. In fact, this is what economists would call "price-discrimination"---charging everyone his willingness to pay, a typical move by monopolist. If you look at it, Comcast does not lose a dime in this "charity move". In fact, it collects money. The key to realize that internet service has very low marginal cost, almost zero, as long as it is within capacity limit (By the way, ISP like Comcast has deliberately limited its capacity to blackmail Content Providers like Netflix to build its fast lane with ISP) . Thus, offering this plan is like hitting two birds with one stone. First, Comcast sells more products at near zero marginal cost, with relatively low margin; Note that those who can afford internet service still pay the unreasonable price due to the design of this offer. Second, this is a great public relation move, especially for the empathetic crowd. This will probably takes the steam out of further regulatory moves.

Comcast is a complete empathetic socialpath---it understands how the public psychology works, and uses to its advantage, bringing hard to all in the name of charity.

If one has any doubt that the ISPs in US are destructive monopolies, check out the following two graphs---high price, low quality--typical of monopolies. ISPs have wielded their monopolistic power for too long, causing economic loss to all of us.



We are fighting a losing war. The public is diverted by empathy to the stupid digital divide. The regulatory agency is captured---Tom Wheeler, FCC's democratic chairman, lobbied for the cable and wireless industry before entering FCC via this "revolving door". Established Internet companies are more ambivalent. For one thing, lack of net neutrality means they might get blackmailed away some of their profits. On the other hand, that probably means, they could build fast lane to forestall any start-up intent on rising to their position. In this age of technological convergence, such preemption is certainly valuable. One could see that as long as ISP do not get too greedy, big Internet companies will be more than happy to pay a tribute to let ISP to serve as a guard against any innovative "disruptor".  In fact, google has been silent about the issue since 2006, and even when it broke its silence, it is more of a lukewarm support for net neutrality. I am not optimistic how long the current conflict between internet companies and ISP will genuinely last. We the paying consumers? Who cares? Those future innovators? LOL

How Seriously should We Take Economic Policy Analysis 1?

The short answer is: not much. We can take the qualitative analysis quite seriously, but in many areas, the quantitative results are far from as trust-worthy as most would like you to believe.

There are many reasons, and I have intended to blog about this for a long time, but I will only discuss one issue briefly.

In economic analysis, we do something called welfare analysis---that is we find the utility function for individuals, and then we find their utility under different policies.

The problem lies in finding the utility function. We know there is no way utility function is parametrically identified, thus, we need to assume a functional form for the utility and for that functional form, we fit the data. Almost surely (that is with probability 1), we will be using the wrong functional form and the utility function we claim to identify is a very crude approximation within that functional form. As it turns out the welfare calculation could be very sensitive to that. There is one paper that finds that the welfare improvements is infinity!! The authors admirably kept the results and explained that it is due to their functional form assumption and continued with other functional forms. I could imagine in other studies authors would just delete crazy results from the paper and pretend nothing happened.

The problem continues. For welfare calculation, we want an "experience utility", that is how people actually feel. However, we can only back out what I call "decision utility", that is agents behave as if they are maximizing their "decision utility". Unless we assume that agents do maximize their experience utility, there is no reason to believe that these two would coincide. In fact, the study of behavioral economics point to many problems. Any inconsistency problems or cognitive bias would break the link, and they exist.

Let me give another example. We all know about business cycle--that is the boom and bust, recessions. We kind of feel there is a big cost to it, and it would be quite desirable if we can eliminate it. In fact, it is so desirable that we will be willing to pay an insurance fee to eliminate it or protect ourselves completely from it. But if we apply a standard welfare calculation, an upper estimate of the welfare cost of business cycle is 1/5 of 1 percent. An individual with average consumption of \$50,000 would be willing to pay \$100 to eliminate fluctuations. This is still a very small amount compared to the implications of long run growth on income. Most economists feel this is weird, but that is what is spit out. I think this does point to the limitation of our standard welfare analysis. Perhaps, some habbit formation adjustments would give more plausible answers.

Thus, the utility function we get needs to be taken with a grain of salt and so does the policy recommendation.

What does this imply?

It does NOT imply we should stop doing welfare analysis in economics. We need to and we need to expand the scope. But we need to be careful in interpreting our results and realize the error margin is larger than it looks. I always think of the wisdom of Ariel Pakes:"A decision needs to be made in real time. This is not perfect, but this is the best we can do." On the other hand, I would not shoot for any drastic policy changes that promises a slight/moderate welfare improvements on paper.