Preferences are logically prior to incentive structures

If we want to say “it is immoral to try and influence people’s preferences because [insert boringly stupid Rawlsian reason here]”, then we should just say that, not pretend that the problem is far harder to solve than it actually is because we’ve restricted ourselves to assuming that everyone’s preference relation is purely self-interested and we just have to fix incentives to counter that.

On my list of “Opinions I currently hold”, number six reads as follows:

While “improve incentive structures” is a good way to improve outcomes, it has obvious limits if everyone is particularly immoral, so “improve people” is both an inescapable goal and also an almost domain-independent Pareto improvement

A friend recently commented that this was very oblique, so this is a short post intended to elucidate what I mean.

A generic slide from an economics course on preference relations.

Let’s consider a classic economic incentive problem: the principal–agent problem. I restate it here as follows. A principal desires that some certain outcome be achieved (e.g. a shareholder desires that the stock of a company increase in value), so they delegate their authority to an agent, who acts on their behalf (e.g. the shareholder delegates authority to the CEO). But the agent may have incentives that fail to align with the principal’s (e.g. the CEO may have an incentive to increase their own salary past some optimum point, which would not be in the interests of the company but would be in the interests of the CEO), so the principal has to put some place of checks and balances in place to ensure that the agent’s incentives align with the principal’s incentives.

The principal–agent problem is trivially “solvable” if we just define the agent’s preference relation to be the same as the principal’s preference relation: no checks and balances will be needed, since the agent will by construction always act in the interests of the principal. In order for us therefore to arrive at a principal–agent “problem” that we solve by incentives, we must assume their preference relations don’t align. In other words, preferences are (clearly) logically prior to incentive structures. The principal–agent problem, externality analysis, game theory, and indeed any other way of modelling decisions using preference relations can by definition tell us nothing about how such preferences are formed or what types of preferences exist in the real world, because these problems always assume some preference relation and then work from there.

I do not believe I have said anything interesting or insightful in the above, and yet the above is seemingly forgotten in almost all discussions about incentive structures. For instance, large numbers of economic problems become trivially solvable if we assume that we can change people’s preferences to (e.g.) incorporate externalities into their own preferences. Political science as a discipline largely falls away if you assume you have some means of ensuring that only people of moral integrity ever run for office. The constant refrains among replication-crisis commentators that “we must reform the incentives” seems to assume you could never reform people’s preferences to achieve the same effect. To belabour the point here, all of these discussions take preferences as given and then discuss how to fix incentive structures to ensure outcomes, but it’s very rare that anyone gives a reason to take preferences as given and not to consider the possibility that we could get people to have different preferences.

The reason this silence on preference formation is so bizarre is because preferences clearly are malleable and varied—literally all wills are potential principal–agent problems, and yet many executors execute wills to the letter because they want to uphold the wishes of the deceased! And if we wanted to study how and why these preference relations develop, and what we might want to do to ensure that people’s preferences are a bit less dodgy, there are whole sub-disciplines that study preference formation (in psychology, sociology, anthropology, philosophy, etc.)! If we want to say “it is immoral to try and influence people’s preferences because [insert boringly stupid Rawlsian reason here]”, then we should just say that, not pretend that the problem is far harder to solve than it actually is because we’ve restricted ourselves to assuming that everyone’s preference relation is purely self-interested and we just have to fix incentives to counter that.

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Review of Economics in Two Lessons

In short, this is a deeply inadequate economics primer that the “uninitiated” should probably not read, least those who already sympathise with Quiggin’s policy prescriptions. If you want a “balanced” economics primer, you’d be better off starting any of the many better options (suggestions down the bottom).

Reposted from Goodreads here.

In short, this is a deeply inadequate economics primer that the “uninitiated” should probably not read, least those who already sympathise with Quiggin’s policy prescriptions. If you want a “balanced” economics primer, you’d be better off starting any of the many better options (suggestions down the bottom).

In discussions I have with well-meaning friends who have not formally studied economics, I often find myself coming to a point where I’ll say something like “But obviously a firm will not employ a worker if the hourly revenues generated by that worker are exceeded by the wage of that worker”, the friend will give me a blank look, and I will promptly remember that I have no good economics primer to lend to them. To remedy this situation, I purchased Quiggin’s Economics in Two Lessons and its predecessor, Henry Hazlitt’s Economics in One Lesson, since I was concerned that, even though Hazlitt is the classic and substantially shorter than Quiggin, Economics in One Lesson might be unbalanced. On that basis, I wanted a “back-up”, albeit one with less renown or conciseness. After having read both, I am astounded to say the dead opposite: despite my broadly centre-left policy views, I found Hazlitt to do exactly what an economics primer should do (dispel common economic falsehoods that echo around the mediascape and introduce its readers to the “economic way of thinking” with minimum bias) and Quiggin to do exactly what an economics primer shouldn’t do (heavily reinforce a specific policy prescription without giving a sufficient grounding to enable readers to discern for themselves which economic statements in the mediascape are still equivocal and which are assuredly false).

Quiggin isn’t entirely accurate in what kind of book he’s trying to write, and he doesn’t portray his opponents with any degree of fairness, and the combination of those two would lead someone with no economic background deeply astray.

What do I mean by “he isn’t accurate in what kind of book he’s trying to write”? Well, to explain by way of contrast, Hazlitt is very clear about what his book will accomplish:

This book is an analysis of economic fallacies that are at last so prevalent that they have almost become a new orthodoxy… When analyzing fallacies, I have thought it still less advisable to mention particular names than in giving credit. To do so would have required special justice to each writer criticized, with exact quotations, account taken of the particular emphasis he places on this point or that, the qualifications he makes, his personal ambiguities, inconsistencies, and so on. I hope, therefore, that no one will be too disappointed at the absence of such names as Karl Max, Thorstein Veblen, Major Douglas, Lord Keynes, Professor Alvin Hansen and others in these pages. The object of this book is not to expose the special errors of particular writers, but economic errors in their most frequent, widespread, or influential form. Fallacies, when they have reached the popular stage, become anonymous anyway. The subtleties or obscurities to be found in the authors most responsible for propagating them are washed off. A doctrine becomes simplified; the sophism that may have been buried in a network of qualifications, ambiguities or mathematical equations stands clear. I hope I shall not be accused of injustice on the ground, therefore, that a fashionable doctrine in the form in which I have presented it is not precisely the doctrine as it has been formulated by Lord Keynes or some other special author. It is the beliefs which politically influential groups hold and which governments act upon that we are interested in here, no the historical origins of those beliefs. (p.7-11, emphasis mine)

This last sentence is especially salient, as it means that Hazlitt is free to criticise economics as it is crudely discussed in the press and in politics without necessarily arguing that such crudeness is endemic to an entire school and without attacking specific individuals where Hazlitt believes such an attack is unwarranted. Quiggin makes no such qualification, and in attacking “One Lesson” economists (his term for “laissez-faire” or “free-market”), he tars with the same brush everyone from corporate lobbyists through to well-meaning academic economists who are simply sceptical of government power. As a result, Quiggin jumps between views that almost all laissez-faire economists would genuinely hold (e.g. “governments will generally be less efficient than private enterprise in implementing the same project”) and views that virtually none of them would hold (e.g. “all people are literally Homo economicus”). He spends most of the book therefore attacking a straw man and therefore pleasantly avoiding having to respond to the best criticisms of the laissez-faire group. An example of the ridiculousness this leads him to is best exemplified in his repeated claims that “One-Lesson” economists have apparently failed to study what would constitute basic components of any undergraduate economics major:

The difference between One Lesson and Two Lesson economists is neatly reflected in the theory of welfare economics. One Lesson economists read the theory as far as the First Fundamental Theorem [of Welfare Economics] and then close the book, satisfied that they have discovered everything they need to know. They ignore the more important and interesting Second Theorem and fail to recognise that the allocation of property rights is the critical factor in determining which of the infinite range of possible market equilibrium outcomes is realised. (p.148)

What?! Like, by all means, I’m sure some poorly read conservative politicians genuinely think that “free markets always without exception lead to efficient prices”, but anyone who actually knows what the First Fundamental Theorem of Welfare Economics is would absolutely know what the Second Fundamental Theorem is! They’re generally presented in the same lecture in a second- or third-year microeconomics course!

Again, Hazlitt can get away with his more polemical style because he’s clear in predominantly attacking lobbyists, and he’s very clear when he’s attacking a specific economist whose specific view he doesn’t like. Quiggin just seems to genuinely believe that everyone to the right of Elizabeth Warren is genuinely motivated by cartoonish stupidity and selfishness.

On that point, this book contains a simply astonishing amount of ad hominem. Economists like Hayek are respected by modern laissez-faire economists, but they’re not held as infallible prophets whose works are scripture — the only people who act like that are politicians and lobbyists (again, this is the danger of attacking all your intellectual opponents with the same brush). In spite of this, Quiggin devotes an astounding amount of time irrelevantly attacking historical economists as people. A few choice selections:

The idea of opportunity cost was brought into the mainstream of economics by Austrian and Austrian-influenced economists, most notably F.A. Hayek, Ludwig von Mises, and Lionel Robbins. Unfortunately, all three were dogmatic One Lesson economists, who stripped von Wieser’s idea of its egalitarian implications. (p.27)

Before explaining this [Pareto-efficiency], it’s important to understand Pareto’s broader body of thought, one that led him in the end to support the fascist regime of Benito Mussolini. (p.145)

Over time, however, the view that many, perhaps most, labor markets are monopolistic has gained ground, at least among those economists open to empirical evidence. (p.186, emphasis mine)

Again, to those who know nothing about economists, maybe these seem like relevant points, but if you do know anything, they clearly aren’t! If you don’t know anything about Hayek, maybe it seems reasonable to decry him as an dogmatic “amoral free-marketeer” (as opposed to someone who certainly saw a substantial role for government, though in certain circumscribed spheres, and someone who cared deeply about the welfare of all). If you don’t really know what Pareto-optimality is, maybe the fascist connections of Vilfredo Pareto seem relevant (even though they’re clearly not, since Pareto-optimality can be introduced as a bland technical definition, and in the first instance is introduced in virtually all economics courses in the context of “you want to exhaust all possible Pareto-optimal options first since nobody is worse off, though clearly the distribution of wealth matters a lot too”). If you don’t know the literature, maybe it seems like there is an overwhelming empirical consensus that labor markets are all monopolistic, meaning minimum wages can be introduced without penalty (even though this isn’t unequivocal, as is demonstrated by the Seattle minimum wage study). This is a big problem with Quiggin’s book: because this is an introductory text, most readers won’t know enough to differentiate between his genuine argument and his polemic. These ad-hominem attacks are virtually all presented in advance of the dissection of the authors’ key ideas, if the key ideas are presented at all, which reinforces Quiggin’s contention that “One Lesson” economists are all evil corporatist trolls but hardly helps a reader to know truth.

In addition to all of this, Quiggin seems more keenly motivated in some sections by self-aggrandisement than by a desire to educate, which makes his already polemical and scattered work even more polemical and scattered. For instance, he has a bad habit of needlessly giving etymologies or original-language equivalents even when it adds nothing:

The same cannot be said of Friedrich von Wieser, the Austrian economist who coined the term “opportunity cost” (Opportunitätskosten in German)… (p.26)

A similar mix of private and common property is found in an apartment complex organized as a condominium (the term is derived from the Latin for “shared property”). (p.104)

The term “monopoly” means “one seller” (from Greek). (p.177)

He spends a large section of the book poorly outlining the science of climate change, even though a.) this will clearly convince nobody who was not already convinced, b.) it substantially lengthens an already lengthy section on negative externalities where the simple acid rain example would have served perfectly adequately, and c.) it seems to be there mostly so that he can accuse One Lesson economists of being climate deniers, which is clearly not universally or even mostly true (there are obviously many economists who are merely sceptical of the capacity of the government to remedy the problem rather than being sceptical of the underlying science). Even outside the self-aggrandisement, his polemic results in his giving sloppy definitions that would certainly confuse an uninformed reader (for instance, he defines a public good as something that “must be supplied equally to the entire population”, which a.) confuses the normative and descriptive uses of “must” for someone who doesn’t know he’s speaking descriptively b.) would confuse a reader new to economics since “public education” appears by this definition to be a public good).

In short, I don’t know whom this book would actually help. Hazlitt provides a good defence against really bad lobbyist arguments if that’s what you want out of an economics primer. Something like Economics Rules by Dani Rodrik provides a relatively accessible introduction to how academic economics could be better (hint: he doesn’t just accuse them all of being “One Lesson”). Someone like Tim Harford in The Undercover Economist does as good a job of explaining economic intuition and opportunity cost without diverting into ideological and misrepresentative tirades. If you want a good critical introduction, go for John Kay’s “The Truth About Markets”. Put this book down. Get something better.