Friday, April 4, 2014

Value Signals




Just as I was about to publish this...I noticed Noah Smith's most recent blog entry...How should Charles Koch use his power?  It's a bit of synchronicity that we're both kinda answering the same question.  So I stuck a link to his entry here so you can compare our answers.

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The other day when I searched Google images for value signals...I didn't find any images that were even vaguely similar to the images that I had in mind.  So even though the photoshopped image above is pretty crappy...it's the best one of its kind.  Well...that I know of.  It's entirely possible that searching for other terms would yield similarly "instructive" images.  If you know of any...please share them.

What's a value signal?  A value signal is anything which indicates where there's value to be found.  If it helps highlight/reveal/locate value...then it's a value signal.  Prices, profits and wages are all value signals.   So is a treasure map.

Value signals are important because they help ensure that society's limited resources are put to their most valuable uses.  If value signals are distorted...then society, as a whole, will invariably be worse off.  This is because resources will flow in less valuable directions.  When resources flow in less valuable directions...the result is far less abundance of the things that we value most.

Using the image above...let's imagine that the true value signals are as follows...

$ = rescuing a cat from a tree
$$ = stopping a bank robber
$$$ = preventing Gotham's imminent destruction

Clearly society, as a whole, would be harmed if the Joker distorted the value signals...

$$$ = rescuing a cat from a tree
$$ = stopping a bank robber
$ = preventing Gotham's imminent destruction

Batman would respond to the wrong value signal.  As a result, his valuable skills would be wasted on saving a cat rather than saving Gotham.

Perhaps this might seem pretty obvious...but if it truly was...then I wouldn't have to write about it.

So how can we try and make the sanctity of value signals more obvious to more people?  Here are some of the things that crossed my mind.  In no particular order...

Bat signal - As you can see...the bat signal (Google images) was the option that I went with.  From Wikipedia...
The Bat-Signal is a distress signal device appearing in the various interpretations of the Batman mythos. It is a specially modified Klieg searchlight with a stylized symbol of a bat attached to the light so that it projects a large Bat emblem on the sky or buildings of Gotham City. In the stories, the signal is used by the Gotham City Police Department as a method of contacting and summoning Batman to their assistance in the event of a serious crisis and as a weapon of psychological intimidation to the numerous villains of Gotham City.
Flare - A flare is another type of distress signal.  We can imagine some people lost at sea during a stormy night.  They shoot a red flare to help rescuers find them.

Three kings (wise men) - The Bible story how three kings from the East followed an exceptionally bright star to find baby Jesus.  The Google images are quite relevant to the concept of a value signal.   From Matthew 2...
9 When they had heard the king, they departed; and, lo, the star, which they saw in the east, went before them, till it came and stood over where the young child was.
10 When they saw the star, they rejoiced with exceeding great joy.
11 And when they were come into the house, they saw the young child with Mary his mother, and fell down, and worshipped him: and when they had opened their treasures, they presented unto him gifts; gold, and frankincense and myrrh.
Treasure map - Helps people find where the treasure/value is.  Entrepreneurs are treasure hunters.  As a society, we benefit when they find things that we value.  A fake treasure map is a fake value signal.  As a society we really don't benefit when entrepreneurs...

1. go on wild goose chases
2. bark up the wrong trees
3. tilt at windmills
4. leap without looking (at the correct information)

Gold rush - Prospectors hurry to the same general location because they all saw the same value signal.  The brighter the signal...the larger the rush.  People need incentives to be at the right (most valuable) place at the right (most valuable) time.

Easter Eggs - Kids make the effort to find Easter Eggs because they perceive it's worth it to do so.

Painting the target - Military term for when a laser guidance system is used to help direct a missile to its target.  Markets allow the crowd to use their dollar votes to guide resources to their most valuable uses.  As a result, consumers get the most bang for their buck.

Sirens / flashing lights - They help communicate priority...and right of way.  A path is cleared for more valuable uses of society's resources.  Flow is facilitated.

Traffic signals - A green light signals for resources to flow in a certain direction.

Can anybody think of any others?

It's imperative that we figure out how to help the crowd easily understand the harm caused by distorting value signals.  As it stands there's plenty of popular support for higher minimum wages and stronger unions.  Just like there's popular support for putting a ceiling on how much CEOs can earn.  In the past there's been popular support for lowering the cost of rent...and lowering the price of gasoline.

Consumers, as utility maximizers, clearly want to pay less money for things that they value...but they don't grasp that distorting value signals will divert resources to less valuable uses.  The logical result?  Far less abundance of the things that we value most.

If the price of gas is artificially lowered...then this prevents entrepreneurs from accurately gauging the demand for energy.  If entrepreneurs don't know exactly how much society values energy...then they can't make informed decisions as to whether they should risk making the effort to find/improve alternative forms of energy.  So in the not-so-long run...distorting the value signal will result in an inadequate and inferior supply of homogeneous energy.  The people who argued for lower gas prices are the same people who then argue that the government should subsidize alternative forms of energy.  

Raising minimum wages might seem beneficial...but the future harm is far greater than the momentary benefit.  If the minimum wage is raised...then this is a green light for unskilled labor.  More kids are incentivized to drop out of school and more people are incentivized to immigrate to the US.  This results in a surplus of unskilled labor.  Higher rates of unemployment results in more poverty.  The people who shouted for higher minimum wages are the same people who then shout that there's a greater need for government welfare.

This isn't anything new.  Bastiat wrote about it...
There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen
Yet this difference is tremendous; for it almost always happens that when the immediate consequence is favorable, the later consequences are disastrous, and vice versa. Whence it follows that the bad economist pursues a small present good that will be followed by a great evil to come, while the good economist pursues a great good to come, at the risk of a small present evil. - Frederic Bastiat, Seen vs Unseen
Adam Smith wrote about it as well.  Smith provided a very detailed description of the logical and harmful consequences of distorting value signals...
When the government, in order to remedy the inconveniences of a dearth, orders all the dealers to sell their corn at what it supposes a reasonable price, it either hinders them from bringing it to market, which may sometimes produce a famine even in the beginning of the season; or if they bring it thither, it enables the people, and thereby encourages them to consume it so fast as must necessarily produce a famine before the end of the season. The unlimited, unrestrained freedom of the corn trade, as it is the only effectual preventative of the miseries of a famine, so it is the best palliative of the inconveniences of a dearth; for the inconveniences of a real scarcity cannot be remedied, they can only be palliated. No trade deserves more the full protection of the law, and no trade requires it so much, because no trade is so much exposed to popular odium. 
In years of scarcity the inferior ranks of people impute their distress to the avarice of the corn merchant, who becomes the object of their hatred and indignation. Instead of making profit upon such occasions, therefore, he is often in danger of being utterly ruined, and of having his magazines plundered and destroyed by their violence. It is in years of scarcity, however, when prices are high, that the corn merchant expects to make his principal profit. He is generally in contract with some farmers to furnish him for a certain number of years with a certain quantity of corn at a certain price. This contract price is settled according to what is supposed to be the moderate and reasonable, that is, the ordinary or average price, which before the late years of scarcity was commonly about eight-and-twenty shillings for the quarter of wheat, and for that of other grain in proportion. In years of scarcity, therefore, the corn merchant buys a great part of his corn for the ordinary price, and sells it for a much higher. That this extraordinary profit, however, is no more than sufficient to put his trade upon a fair level with other trades, and to compensate the many losses which he sustains upon other occasions, both from the perishable nature of the commodity itself, and from the frequent and unforeseen fluctuations of its price, seems evident enough, from this single circumstance, that great fortunes are as seldom made in this as in any other trade. The popular odium, however, which attends it in years of scarcity, the only years in which it can be very profitable, renders people of character and fortune averse to enter into it. It is abandoned to an inferior set of dealers; and millers, bakers, mealmen, and meal factors, together with a number of wretched hucksters, are almost the only middle people that, in the home market, come between the grower and the consumer.   
The ancient policy of Europe, instead of discountenancing this popular odium against a trade so beneficial to the public, seems, on the contrary, to have authorized and encouraged it. - Adam Smith, Wealth of Nations
What I shared was just a small portion of Adam Smith's painstaking efforts to help people understand the importance of value signals.  Yet, more than 200 years later...it's painfully obvious that the "inferior ranks of people" still do not understand the sanctity/significance of "extraordinary profits".

Is the problem that people haven't read Adam Smith?  Or is the problem that they have read him but haven't understood him?  If the problem is the latter...then sharing relevant passages by Adam Smith will match Einstein's definition of insanity...doing the same thing over again but expecting a different outcome.

What am I doing differently?  I shared an illustration!  Look at the illustration and then read Adam Smith and then look at the illustration.  And then?  Read Adam Smith again.  And now?  Read Oskar Lange...
The system of free competition is a rather peculiar one. Its mechanism is one of fooling entrepreneurs. It requires the pursuit of maximum profit in order to function, but it destroys profits when they are actually pursued by a larger number of people. - Oskar Lange, On the Economic Theory of Socialism: Part Two
Read Smith again...
It is thus that the private interests and passions of individuals naturally dispose them to turn their stocks towards the employments which in ordinary cases are most advantageous to the society. But if from this natural preference they should turn too much of it towards those employments, the fall of profit in them and the rise of it in all others immediately dispose them to alter this faulty distribution. Without any intervention of law, therefore, the private interests and passions of men naturally lead them to divide and distribute the stock of every society among all the different employments carried on in it as nearly as possible in the proportion which is most agreeable to the interest of the whole society. - Adam Smith, Wealth of Nations
Look at the illustration again...


Read Lange again...
The system of free competition is a rather peculiar one. Its mechanism is one of fooling entrepreneurs. It requires the pursuit of maximum profit in order to function, but it destroys profits when they are actually pursued by a larger number of people. - Oskar Lange, On the Economic Theory of Socialism: Part Two
Read Smith again...
The increase of demand, besides, though in the beginning it may sometimes raise the price of goods, never fails to lower it in the run. It encourages production, and thereby increases the competition of the producers, who, in order to undersell one another, have recourse to new divisions of labour and new improvements of art which might never otherwise have been thought of. The miserable effects of which the company complained were the cheapness of consumption and the encouragement given to production, precisely the two effects which it is the great business of political Ĺ“conomy to promote. - Adam Smith, Wealth of Nations
Look at the illustration again...


Read Lange again...
The system of free competition is a rather peculiar one. Its mechanism is one of fooling entrepreneurs. It requires the pursuit of maximum profit in order to function, but it destroys profits when they are actually pursued by a larger number of people. - Oskar Lange, On the Economic Theory of Socialism: Part Two
Read Smith again...
The establishment of any new manufacture, of any new branch of commerce, or of any new practice in agriculture, is always a speculation, from which the projector promises himself extraordinary profits. These profits sometimes are very great, and sometimes, more frequently, perhaps, they are quite otherwise; but in general they bear no regular proportion to those of other old trades in the neighbourhood. If the project succeeds, they are commonly at first very high. When the trade or practice becomes thoroughly established and well known, the competition reduces them to the level of other trades. - Adam Smith, Wealth of Nations
Look at the illustration again...


Read Lange again...
The system of free competition is a rather peculiar one. Its mechanism is one of fooling entrepreneurs. It requires the pursuit of maximum profit in order to function, but it destroys profits when they are actually pursued by a larger number of people. - Oskar Lange, On the Economic Theory of Socialism: Part Two 
Read Smith again...
When by an increase in the effectual demand, the market price of some particular commodity happens to rise a good deal above the natural price, those who employ their stocks in supplying that market are generally careful to conceal this change. If it was commonly known, their great profit would tempt so many new rivals to employ their stocks in the same way, that, the effectual demand being fully supplied, the market price would soon be reduced to the natural price, and perhaps for some time even below it. If the market is at a great distance from the residence of those who supply it, they may sometimes be able to keep the secret for several years together, and may so long enjoy their extraordinary profits without any new rivals. Secrets of this kind, however, it must be acknowledged, can seldom be long kept; and the extraordinary profit can last very little longer than they are kept. - Adam Smith, Wealth of Nations
Look at the illustration again...


Read Lange again...
The system of free competition is a rather peculiar one. Its mechanism is one of fooling entrepreneurs. It requires the pursuit of maximum profit in order to function, but it destroys profits when they are actually pursued by a larger number of people. - Oskar Lange, On the Economic Theory of Socialism: Part Two 
Did you cheat?  Did you just skim and glance rather than carefully read and seriously look?   If so, then try again.

We really don't fool batman, superman and wonder woman (political correctness...sigh) by honestly signaling what our true values are.  And we certainly stand to benefit when they endeavor to save Gotham rather than rescue a cat from a tree.

On the flip side...we really don't want batman, superman and wonder woman forming a cartel.  If there's one thing that Adam Smith wrote more about than the importance of value signals...it's that producers are only too happy to use the government to limit competition.  The solution is to clarify the demand for public goods.

But producers really aren't the only ones who want a free lunch.  This means that democracy fails for the same reason that taxation must be compulsory.  In case you missed it, the solution is to clarify the demand for public goods.

10 comments:

  1. Your Lange quote refers to a theoretical ‘perfect competition’ economy. Real economies are nothing like perfect competition models. In the paper you quote, Lange says as much. Here’s the rest of your quote:

    “The system of free competition is a rather peculiar one. Its mechanism is one of fooling entrepreneurs. It requires the pursuit of maximum profit in order to function, but it destroys profits when they are actually pursued by a larger number of people. However, this game of blindman's buff with the pursuit of maximum profit is possible only as long as the size of the business unit is small and the number of entrepreneurs is consequently large. But with the growth of large-scale industry and the centralisation of financial control the pursuit of maximum profit destroys free competition. The picture would not be complete without adding that political interference in economic life is frequently used to protect profits or investments. This political intervention is also a result of the growing size of industrial and financial units. Small-scale enterprises are too small to be politically significant, but the economic power of big corporations and banking interests is too large not to have serious political consequences. As long as the maximisation of profit is the basis of all business activities it is unavoidable that industrial and financial corporations should try to use their economic power to increase profits or the value of their investments by proper State intervention. And unless the executive and legislative organs of the State are abstract metaphysical entities beyond the reach of any earthly influence, they will yield to the pressure of those powers. A return to free competition could be accomplished only by splitting up the large-scale business units to destroy their economic and political power. This could be attained only at the cost of giving up large-scale production and the great economic achievements of mass production which are associated with it. Such an artificially maintained system of free competition would have to prohibit the use of advanced technology.”

    Another quote from the Lange paper regarding perfect competition:

    the actual capitalist system is not one of perfect competition; it is one where oligopoly and monopolistic competition prevail. This adds a much more powerful argument to the economist's case for socialism. The wastes of monopolistic competition have received so much attention in recent theoretical literature that there is no need to repeat the argument here. The capitalist system is far removed from the model of a competitive economy as elaborated by economic theory. And even if it would conform to it, it would be, as we have seen, far from maximising social welfare. Only a socialist economy can fully satisfy the claim made by many economists with regard to the achievements of free competition.”

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    1. Both these quotes make a mockery of your claims regarding the "sanctity/significance of "extraordinary profits".

      Essentially you appear to believe in a cartoon perfect-competition imaginary version of the economy, which has absolutely nothing to do with real world capitalism.

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    2. "The solution is to clarify the demand for public goods"

      It only takes a little reflection to see that "clarify the demand for public goods" is simply a euphemism for disenfranchising the majority of the population whilst giving more power over public resources to the wealthiest minority. Maybe you genuinely didn't understand that before, but you don't really have that excuse any more.

      Delete
  2. In the following quote Lange contradicts your assertion that “value signals are important because they help ensure that society's limited resources are put to their most valuable uses”.

    “Only a socialist economy can distribute incomes so as to attain the maximum social welfare. In any system with private ownership of the means of production, the distribution of incomes is determined by the distribution of ownership of the ultimate productive resources. This distribution is an historical datum which originates independently of the requirements of the maximisation of social welfare. For instance, the distribution of landed property is different in countries where the big landed estates of the feudal epoch have been broken up by bourgeois and peasant revolutions than where they have been left intact. Under capitalism the distribution of the ownership of the ultimate productive resources is a very unequal one, a large part of the population owning only their labour power. Under such conditions demand price does not reflect the relative urgency of the needs of different persons and the allocation of resources determined by the demand price offered for consumer's goods is far from attaining the maximum of social welfare. While some are starving others are allowed to indulge in luxury. In a socialist society the incomes of the consumers could be determined so as to maximise the total welfare of the whole population.”

    Did you get that? In the real world, the distribution of wealth is often arbitrary. This fact renders null and void the idea that "[price] signals are important because they help ensure that society's limited resources are put to their most valuable uses. If value signals are distorted...then society, as a whole, will invariably be worse off. This is because resources will flow in less valuable directions." You are simply conflating "profitable" with "valuable". In the real world one cannot say that these necessarily mean the same thing. A different arbitrary distribution of wealth could result in very different outcomes.

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    1. In case it's not clear, I'm not advocating Lange's policy ideas, I'm simply pointing out how absurd many of your claims are.

      Delete
  3. Another thing you don't appear to be aware of is that, in the real world, most prices are not set in the way that marginalist theory predicts. Most prices are instead administered prices, or mark-up prices. As such, prices are not the sort of signals that you imagine them to be, and quantity/output changes are often more important than price changes:

    http://socialdemocracy21stcentury.blogspot.co.uk/p/there-is-mountain-of-empirical-evidence.html

    ReplyDelete
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    1. If you have so much to say about the topic...then why not start a blog?

      For example...Noah Smith said this on his blog...

      Not only that, but elected politicians can honestly say that a large group of people chose them as a representative. The Kochs can't say that.

      I had a lot to say about the topic...so I dedicated a blog entry to my reply... Modular Representation vs Monolithic Representation.

      Then I simply shared the link with him.

      If you start a blog...and post a well-researched critique of pragmatarianism...then chances are pretty good that I'll link to it and reply.

      Delete
  4. So, do you think patents are worthwhile?

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    1. oh, and I should note that Thomas Carlyle wrote at some point in favor of copyrights, arguing that he should be able to sell his works first. Considering our current knowledge of what kind of market copyrights create, though, I don't think anyone who supported them 200 years ago would have done so.

      Delete
    2. Incentives matter...so I'm going to lean towards supporting patents/copyrights.

      If somebody is guaranteed a monopoly when they develop a cure for cancer....then it stands to reason that the cure will be developed sooner rather than later.

      Delete