Economics – Jeremiah Stanghini

Quick Thoughts: Planning Fallacy, Sci-Fi, Gendered Language, and Scarcity/Excess

As I look to breathe some life back into writing, I thought I’d take a quick peek at some of the “drafts” I had saved from when I used to write regularly. Fortunately, there aren’t too many there. In the interest of trying to start fresh, I thought I’d do a quick post addressing some of these ideas kind of in the same way that Wikipedia has stubs.

Planning Fallacy: Many years ago, I wrote about the planning fallacy as part of my series on cognitive biases (i.e. how to make decision better). Something I didn’t talk about in that post was the difference between a 7-day and 5-day workweek. Let me explain. For those that go to university, everyday is eligible for a “work” day (i.e. homework). Many things are due on Monday morning and rather than push to complete something on Friday afternoon (or night?), students will often be writing things on Sunday night. Not only am I drawing on my experience as a student, but I’ve been teaching for the last 7+ years and I can say with authority, if I give students a full week (7 days) to complete an assignment and make an assignment due at 1159p on Sunday night, 50%+ of the class will complete that assignment sometime on Sunday. I’m digressing a bit from the point. So, we get used to this “7-day workweek” to complete things. When we move into the work world, that “week” shifts from 7 days to 5 days (and even less in cases of holidays or even less than that if you take into account mandatory meetings, etc.). So, when someone estimates how much time they’ll have to complete a work product, they’re used to (primacy effect?) how they were estimating when they were a student and don’t take into account the ‘truncated’ week.

Science Fiction, Humans, and Aliens: In those sci-fi movies that have some form of alien (i.e. non-human), often times, there’ll be a scene where the humans are kept in a cage. It made me think about how humans keep some animals in cages (i.e. zoo). Maybe to a different species, we (humans) would be treated in the same way we treat animals.

Gendered Language: There was a journal article from a few years ago that caught my eye. Here’s a bit of the abstract:

The language used to describe concepts influences individuals’ cognition, affect, and behavior. A striking example comes from research on gendered language, or words that denote individuals’ gender (e.g., she, woman, daughter). Gendered language contributes to gender biases by making gender salient, treating gender as a binary category, and causing stereotypic views of gender.

Like I said yesterday, if you’ve been following me for any sort of time, this bit about our words having an effect on us shoudn’t come as a surprise. However, this journal article is strong evidence to keep in your pocket if you need to point to something evidence-based in a discussion.

The Problem of Excess: Another good journal article that I’ve been saving for over 5 (!) years. /facepalm. I still remember my first grad school economics course and the professor was explaining the fundamental principle that underlines economics — scarcity. I wanted to raise my hand and disagree on the merits, but it didn’t seem appropriate. I can see and understand how scarcity came to be the dominant theory of the day, but a part of my being just feels that that interpretation is… near-sighted. Seeing this journal article a few years after that class highlighted a different perspective. Here’s a bit of the abstract:

This article argues for a new branch of theory based not on presumptions of scarcity—which are the foundational presumptions of most existing social theory—but on those of excess. […] It then considers and rejects the idea that excess of one thing is simply scarcity of another. It discusses the mechanisms by which excess creates problems, noting three such mechanisms at the individual level (paralysis, habituation, and value contextuality) and two further mechanisms (disruption and misinheritance) at the social level. […] It closes with some brief illustrations of how familiar questions can be recast from terms of scarcity into terms of excess.

Enjoy your weekend!

The Quest for a Life of Leisure: Prisoner’s Dilemma in Food Production

In a conversation about “vegan food in the workplace,” I heard a thoughtful comment that reminded me of the Prisoner’s Dilemma. Before I paraphrase the comment, here’s a quick video to refresh your memory on the Prisoner’s Dilemma:

So, now that we have a better understanding of the Prisoner’s Dilemma, let’s get back to the comment. Essentially, the person was making the argument that large-scale commercial agriculture and farming is unsustainable, harmful to plants, and harmful to animals. The person was making the point that this problem stemmed from the business models/practices required to sustain them (and not the animals/plants themselves). Further to the person’s point, they explained that we also play a part in this by the way we purchase food. Regardless of whether we buy local, wild-caught food or buy large-scale commercialized food, there’s still an impact on the environment.

Upon hearing this comment, the first thing I thought of was the Prisoner’s Dilemma. Let me explain. There’s a demand for food. Consequently, businesses will satisfy that demand by supplying food. [Econ 101, amirite?] But how businesses satisfy that demand is where things get tricky. They could do so in a number of ways, but let’s simplify it into two: large-scale commercial agricultural production or small-scale local farming. If businesses were to focus on small-scale local farming, they’d be supplying food for the town (or maybe the town and some neighbouring towns). Businesses that focus on large-scale commercial agricultural production aren’t supplying food for a town, they’re supplying food for a country or – countries.

The two-by-two that I see here is that if businesses “cooperated,” they’d be supplying food for the local town(s) and “everyone” would be satisfied (consumers get food, businesses make money, environment is ‘harmed’ as little as possible, etc.). The possible hitch here is that businesses see an opportunity to make more money, so they scale up production into a major agricultural conglomerate (i.e. food for countries). That’s not to imply that this is “bad,” just that the opportunity exists and many businesses seek to seize it. In so doing, that provokes other businesses to do the same – the businesses are “betraying” each other, leading to externalities borne out by things like the environment. [NOTE: I’m aware that this example is very oversimplified and does not represent the state of food in all countries, especially where food shortages exist.]

The irony of the race-to-the-bottom is that, often times, the people running these businesses are all in it for the same thing:

An American businessman was standing at the pier of a small coastal Mexican village when a small boat with just one fisherman docked. Inside the small boat were several large yellowfin tuna. The American complimented the Mexican on the quality of his fish.

“How long it took you to catch them?” The American asked.

“Only a little while.” The Mexican replied.

“Why don’t you stay out longer and catch more fish?” The American then asked.

“I have enough to support my family’s immediate needs.” The Mexican said.

“But,” The American then asked, “What do you do with the rest of your time?”

The Mexican fisherman said, “I sleep late, fish a little, play with my children, take a siesta with my wife, Maria, stroll into the village each evening where I sip wine and play guitar with my amigos, I have a full and busy life, senor.”

The American scoffed, “I am a Harvard MBA and could help you. You should spend more time fishing and with the proceeds you buy a bigger boat, and with the proceeds from the bigger boat you could buy several boats, eventually you would have a fleet of fishing boats.”

“Instead of selling your catch to a middleman you would sell directly to the consumers, eventually opening your own can factory. You would control the product, processing and distribution. You would need to leave this small coastal fishing village and move to Mexico City, then LA and eventually NYC where you will run your expanding enterprise.”

The Mexican fisherman asked, “But senor, how long will this all take?”

To which the American replied, “15-20 years.”

“But what then, senor?”

The American laughed and said, “That’s the best part. When the time is right you would announce an IPO (Initial Public Offering) and sell your company stock to the public and become very rich, you would make millions.”

“Millions, senor? Then what?”

The American said slowly, “Then you would retire. Move to a small coastal fishing village where you would sleep late, fish a little, play with your kids, take a siesta with your wife, stroll to the village in the evenings where you could sip wine and play your guitar with your amigos…”

And maybe that life of leisure is closer than we think or, maybe, as the above parable suggests, we had that lifestyle before we “betrayed” each other in the Prisoner’s Dilemma. In an article I read recently in The Atlantic [Emphasis Added]:

The Ju/’hoansi [of Namibia] not only managed to feed themselves better than many in the industrialized world, but that they did so on the basis of only around two hours foraging a day, and cheerfully spent the rest of their time on more leisurely pursuits such as napping, playing games, and making art.

[…]

Over time, a more sophisticated picture of the Ju/’hoansi’s affluence emerged—one I saw firsthand living in southern Africa for 25 years and one I describe in my recent book. The Ju/’hoansi had an unyielding confidence in the providence of their environment and in their knowledge of how to exploit it. This meant that the Ju/’hoansi, like other hunter-gatherers, focused almost myopically on the short term—if the environment always supplied food and materials and the seasons were broadly predictable, what point was there in worrying about the future? This confidence also meant that the Ju/’hoansi did not store food for more than a few days and only expended energy on securing just enough to meet their immediate needs.

The Ju/’hoansi shared their food with one another according to a set of social prescriptions that ensured pretty much everyone, including the young, old, or disabled, got a share. As a result the Ju/’hoansi were also thoroughly egalitarian, mercilessly ribbing anyone that developed delusions of grandeur and seeing no point in accumulating wealth or formalizing systems of exchange.

NOTE: This was cross-posted.

Do New Stadiums Lead to an Increase in Business?

Unless you’re familiar with the literature in this arena (no pun intended) or you know about Betteridge’s law of headlines, the title of this post is actually still an unresolved question for you. Well, I won’t delay the inevitable: according to research published earlier this year, the answer is no — new stadiums do no lead to an increase in business.

There are two things I want to talk about as it relates to this research. The first is Richard Florida. If this area is an interest of yours, there’s a good chance that you’ve come across him. Florida has been a professor for the last 20+ years and has written extensively on cities. Here’s a post I found from him within the last year that talks about the very thing that the journal article discussed:

The overwhelming conclusion of decades of economic research on the subject is that using public funds to subsidize wealthy sports franchises makes zero economic sense and is a giant waste of taxpayer money. A wide array of studies have shown that professional teams add virtually no income to local economies. In fact, some of them find that large subsidies actually have a negative effect, taking money out of the local economy. Aside from the jobs generated by actually building the stadium, most jobs inside the stadium—selling food and beer or working at team concessions—are low-paying temp jobs. It’s even worse for football stadiums, which are used for games at most a dozen times a year, and maybe a few more times for concerts or large events. Public economic development dollars can be put to much better use on things besides subsidizing sports teams and their wealthy owners.

Ultimately, the burden of public subsides falls disproportionately on small cities that are the least able to bear the cost. For example, a $200 million public subsidy for a new stadium ends up costing a small city like Santa Clara roughly $1,650 per resident, compared to just $50 a person for L.A. And, of course, teams in bigger cities, with their bigger markets and more revenue, often do not need subsidies at all.

The reason I raise Florida’s name is because I was surprised that I didn’t see his name mentioned in the journal article. To be fair, I don’t think that Florida has done any primary research in this domain, but I would have thought that even in the opening introduction or literature review that there may have been some reference to Florida’s constant discussion of literature like this.

Anyhow, the second thing I wanted to talk about is something that might not be measurable. Well, it might not be measurable in a simple way. As a former amateur athlete, I have a special place in my heart for sports. Certainly, there are plenty of things that one could classify as “wrong” about sports, but part of me still wants to defend it/them and I’ll be upfront: that might be part of what’s going on with this section of this post.

Something I didn’t see in the article (and probably something I wouldn’t expect to find in any well-written article) is a measure of (or discussion of?) the positive externalities that result from a city’s team winning the championship or even the spillover effects from the possible positive externalities. Now that’s a tortured sentence. I’m talking about how the residents of a city feel after their team wins the championship (in a given sport). Naturally, not everyone would be watching (or care), but for those that are fans of the team that wins, there would certainly be elevated levels of joy and happiness immediately following the victory. If there were studies done on this, I suspect that there might be comparisons to those who have won the lottery in that a couple of months after, lottery winners return to a similar level of satisfaction/happiness that they had prior to the lottery win.

I wonder, though, could we measure the economic gains for a city from this positive externality and the resulting spillover effect (in this case, let’s say the spillover effect would be the “pay it forward”-ness of joy from the fans of the team to the non-fans that the fans will be interacting with in the weeks following the city’s team’s victory). Even if there is a tangible effect that can be measured, I’m sure that any reasonable cost-benefit analysis would still conclude that a new stadium isn’t worth it for a city.

Harger, K., Humphreys, B., & Ross, A. (2016). Do New Sports Facilities Attract New Businesses? Journal of Sports Economics, 17 (5), 483-500 DOI: 10.1177/1527002516641168

How To Be a Better Person: Awe Yourself

Research published earlier this year seems to indicate that when we’re “awed,” we’re more likely to engage in prosocial or altrusitic behaviour. The researchers conducted five different studies:

Individuals higher in dispositional tendencies to experience awe exhibited more generosity in an economic game (Study 1). Experimentally inducing awe caused individuals to endorse more ethical decisions (Study 2), to be more generous to a stranger (Study 3), and to report more prosocial values (Study 4). A naturalistic induction of awe in which participants looked up at a grove of towering trees led to increased helpfulness, greater ethicality, and decreased entitlement (Study 5).

There’s so much to unpack in these findings. Experiencing awe can make us more generous, more ethical, more altruistic, more helpful, and less entitled. These findings have implications for a number of areas, not the least of which, is essentially, creating a roadmap for how to be a better person.

As someone who often trumpets the importance of perspective, I was pleased to read the following from the discussion section:

It would seem, as hypothesized, that awe leads to more prosocial tendencies by broadening the individual’s perspective to include entities vaster and more powerful than oneself and diminishing the salience of the individual self.

So, maybe instead of writing articles highlighting different perspectives, I should be writing fiction (or articles) that allow you to experience a sense of awe?

In thinking about the findings of this research, I’d be very interested to see how it plays out in the Prisoner’s Dilemma. I imagine that the results would probably still hold, but it’d be great to have confirmation of that. Furthermore, I’d be interested to see how economists would incorporate this into our understanding of the “rational actor.” If we’re experiencing awe and, as a result, becoming more prosocial, it would — theoretically — begin to wreak havoc on the idea that we’re acting rationally (as it takes a laboured interpretation of the rational actor to include prosocial behaviour).

Just for good measure, here’s a second picture that I hope allows you to feel a sense of awe.

Piff PK, Dietze P, Feinberg M, Stancato DM, & Keltner D (2015). Awe, the small self, and prosocial behavior. Journal of personality and social psychology, 108 (6), 883-99 PMID: 25984788

Tyler Cowen Convinced Me to Stop Eating Dessert

It’s been a couple of months since my last post, but with the academic semester waning, I should have a bit more time to get a few things written and posted here in the next month. Several weeks ago, I came across a post from a colleague, Tyler Cowen, who wrote about desserts. From Cowen:

Let me stress there are two different propositions:

1. “I don’t like desserts.”

2. “I don’t like desserts (with economist’s hat on).”

I meant mainly the latter, although I do also find many desserts overrated.

In any case, the sugar and calories “shadow price” of most desserts is pretty high. I’d rather consume my health sins in other ways, and so relative to their actual net prices I find few desserts are worth it.

The green pepper is a food which as a human I like a small amount but as an economist I like a great deal.

I read this post, as luck would have it, a few days before I got the flu. When I get sick, I usually eat ice cream. While I know that’s very counterintuitive and probably contraindicated, for me, so far in this life, eating ice cream has done the trick in making me feel better and nursing me back to health quickly. I suppose it also helps that I don’t often get sick and so the eating of ice cream when I’m sick doesn’t have much of an effect on my health (or at least I like to think that it doesn’t). So this time, upon falling ill, I decided I wasn’t going to eat ice cream and upon regaining my health, I kicked desserts altogether.

This was a big move for me as I’m known to have a sweet tooth for Ben & Jerry’s (coffee coffee buzz buzz buzz, in particular). On a side note, I wonder if this decision would have been harder if my favourite kind of ice cream were sold in Ottawa. The closest thing I can get to my favourite flavour of Ben & Jerry’s is Coffee ~~Heath~~ Toffee Bar Crunch. Anyway, so even though Cowen didn’t write a treatise on the matter, the simple yet eloquent argument about the negative effect that dessert has on a nation’s health and the effect that this can have in so many other areas, made me want to give up dessert.

It’s been over a month since I’ve given up dessert and while I’ve certainly thought about “cheating” and having something here or there, I’ve held strong to my conviction.

At this point, I should also add that I expanded my “no desserts” decision to sugar, in general. I’ve made a conscious decision to try and select foods that don’t have any (or very little!) sugar in them. For instance, did you know that some organic saltines (!) have sugar (evaporate cane juice, but still) in them? Or, some organic crackers, in general? A more obvious choice in cutting out sugar comes from trips to Starbucks. My drink of choice used to be vanilla lattes or caramel macchiato’s, but what do you think is in those flavour shots? Back to americano’s or cappuccino’s for me.

At some point, I do imagine that I will begin to eat “dessert” again, but there’s something that I’ll want to remember if/when I do decide to eat dessert again — just because I’m served a plate of dessert doesn’t mean I have to eat a plate of dessert.

There’s a story that I remember being told about Kate Hudson. I tried to find it just now, but Hudson recently mentioned something about a story in France that has similar keywords to the search I ran and so I’m not able to find it. It may or may not be true, but let’s just say that it is. When Hudson was young, her mother (Goldie Hawn), taught her an important lesson when it came to dessert: only take one bite. That is, when you’re served a piece of pie or a piece of cake, it’s not necessary to eat the entire piece. Instead, just take one bite of the dessert to “enjoy” the taste of the dessert and let that be it.

So, if/when I go back to eating dessert, my plan is to just take one bite and then push my plate forward.

Is There a Way to Broadcast Ideology Without it Colouring Opinion?

There was a good article in the New York Times this past weekend from a professor of economics at Harvard, N. Greg Mankiw. He talked about how when economist give advice on policies, they’re also giving advice as political philosophers. While this should come as no surprise to anyone, I think it’s good that it’s being discussed.

What’s more interesting to me, though, is how we can offer opinions or advice on matters as experts, while at the same time disclosing our inherent bias to a given political philosophy. And if we do this, does that then colour the way the opinion is received? Most folks would say that of course it is going to colour the way the opinion is received, but maybe it wouldn’t. Regardless, I think it’s necessary to disclose biases, especially when it comes to making policy advice.

The problem here is that people aren’t always aware that they have a given bias towards one political philosophy over the other. While I’m relatively sure that I lean towards the “left” of the political spectrum when it comes to social issues, where I fall upon the political spectrum when it comes to other matters can vary by issue. This is part of the reason why I encourage folks to take the time and read through some of the more notable philosophers.

I suppose the idea of signaling also comes into play on this matter. That is, if someone has a more conservative viewpoint on health policy and they support a more liberal policy, does that change the way other conservatives view the policy? Does it change the way liberals view the policy? Should it?

There are lots of questions, but no easy answers. As someone who’s steeped in biases in judgment and decision-making, I’m not sure which way would be best, but I’m glad that — at a minimum — it’s being discussed.

Could There Be No Poor Countries in 20 Years? Bill Gates Thinks So

This is probably one of my favourite headlines I’ve had to write so far this year, especially on the heels of yesterday’s post about less than 100 people having more wealth than half of the world. In the Bill and Melinda Gates’ Foundation annual letter, Bill Gates is optimistic, to say the least:

I am optimistic enough about this that I am willing to make a prediction. By 2035, there will be almost no poor countries left in the world. (I mean by our current definition of poor.) Almost all countries will be what we now call lower-middle income or richer. Countries will learn from their most productive neighbors and benefit from innovations like new vaccines, better seeds, and the digital revolution. Their labor forces, buoyed by expanded education, will attract new investments.

By current definition of poor, Gates clarifies that he means that, “almost no country will be as poor as any of the 35 countries that the World Bank classifies as low-income today, even after adjusting for inflation.”

WOW!

Can you imagine a world where this happens? And Gates thinks that this could happen by 2035 — that’s 20 years from now! Twenty years!

A few months ago, I wrote a post considering what might be my generation’s version of racism:

I’ve spent a lot of time talking about my generation in comparison to generations past, but the true purpose of this post is a juxtaposition of the generations to come. As I said, it seems that past generations had a harder time than mine digesting the mix of cultures. For kids growing up today (in certain countries), it’s abundantly clear that there are people who look different from them and it’s just normal to grow up and be friends with people like this. My question, what is it that my generation will have a hard time with that future generations will see as natural?

Maybe a tangential answer to that question is poverty. Maybe in my lifetime, poverty (as we know it) will be eradicated. That’s certainly a wild idea given the current state of the world, but I for one would be thrilled to see this come to pass as I imagine others would be. With that being said, I could see how some folks might not be as accepting of this change and that’s not to say that they wouldn’t want poverty to be forever changed, but just that they might be a little less comfortable with the change.

As an example, let’s use technology. Generations before mine had technology that was quite different from what we use today. That is, the invention of TV was amazing. Now today, we can watch TV on a device that we can carry around in our pocket. Some folks from past generations are amazed by this and might still have a hard time adjusting to this reality.

That’s how I’m trying to superimpose the possibility of the eradication of poverty for my generation. Some folks might have a hard time adjusting to this reality. Regardless of the comfortability of some folks with this potential reality, I think it’s great that the Gates’ have wrote a letter helping to debunk some of the myths in developmental economics:

Poor countries are doomed to stay poor.
Foreign aid is a big waste.
Saving lives leads to overpopulation.

I definitely recommend checking out the whole letter, which you can read here.

The Cross-Section of Social Entrepreneurship and Externalities: Social Entrepreneurship and Externalities, Part 4

In the first post in this series, we looked at the definition of social entrepreneurship. In the second post in this series, we looked at the definition of externalities. In the third post, we looked at some solutions to externalities. In today’s post, the last in this series, we’ll look at the cross-section of social entrepreneurship and externalities and wrap up the paper.

The Cross-Section of Social Entrepreneurship and Externalities

Let’s revisit our definitions of social entrepreneurship and externalities. Social entrepreneurship is the application of innovative solutions to society’s most pressing social problems in the form of massive wide-scale change, usually to the system. Externalities are a cost/benefit experienced by someone who is not a party to the transaction. Just by looking at those two definitions, my first inclination is that externalities are absolutely essential to the understanding of social entrepreneurship. Given that many of society’s most pressing social problems – in some people’s minds – can be traced back to a transaction that resulted in the negative externality, it’s hard to imagine how externalities wouldn’t be essential to the understanding of social entrepreneurship. With that being said, let’s look at some examples where these two concepts meet.

The current Director of the Skoll Center for Social Entrepreneurship, Pamela Hartigan, recently wrote a book chapter entitled, “Creating Blueprints for Business in the 21^st Century: Social Entrepreneurship Shows the Way.” In it, she talks about the specific role of social entrepreneurs in the economic ecosystem. “Economic literature often pays much less attention to the role of positive externalities than it does to negative externalities. In so doing, it neglects the primary drivers of social entrepreneurial action.”[1] Hartigan goes on to say that neglected positive externalities should be a main focus of social entrepreneurship. A really good example of this is Wikipedia, which was created by Jimmy Wales (who is also an Ashoka Fellow). Based on that citation alone, one would have to think that externalities are part of the understanding of social entrepreneurship, but let’s see if there are others.

A paper written by a professor at INSEAD, which is consistently one of the top business schools in the world, called A Positive Theory of Social Entrepreneurship offers some more insights into neglected positive externalities. In fact, the author’s first proposition states that, “addressing problems involving neglected positive externalities is the distinctive domain of action of social entrepreneurship.”[2] It looks like Santos and Hartigan share similar viewpoints in that neglected positive externalities are a key to social entrepreneurship. These two examples make it pretty clear that neglected positive externalities feature in the field of social entrepreneurship. Let’s move onto different examples to see if any other key points arise.

If you recall, one of the solutions to externalities had to do with the internalization of the externalities. There’s a book chapter entitled, “The NYC Watershed agreement: sustainable development and social entrepreneurship,” written by Joan Hoffman. In it, she addresses some of the challenges that are faced by those in watershed collaborations (combination of economic and environmental goals). “The economic concept of externalities, or impacts of market transactions on third parties, can be extended to describe the need for social entrepreneurs . . . The new organizations fostered by social entrepreneurs are designed to internalize consideration of these externalities.”[3] It turns out that social entrepreneurs, if not by intention at least by accident, are directly addressing problems of externalities through some of the solutions that have been proposed by economists and academics.

In answering our question about whether externalities are essential to the understanding of social entrepreneurship, we have inadvertently answered the second question: are economic theories of externalities used in the professional understanding of social entrepreneurship? In this last reference, we saw that not only was there a reference to an economic theory of externalities, but there was a reference to a solution of externalities (as offered by economic theory). As a result, I think it is safe to say, “yes” to both questions.

Closing Thoughts

In this paper, we have explored definitions of social entrepreneurship and externalities. We have explored some of the muddiness around both of these definitions. We have taken a closer look at some of the different kinds of externalities (positive, negative, positional, etc.). We have looked at some of the proposed economic solutions to externalities. Then, we looked at the cross-section of externalities and social entrepreneurship. We dove deeper into the intersection of these two concepts to find that at the heart of social entrepreneurship is an inclination to solve some of the externalities facing the planet. Lastly, we were able to answer, “yes” to the two main questions of this paper: “Are externalities essential to the understanding of social entrepreneurship?” and “Are the economic theories of externalities used in the professional understanding of social entrepreneurship?”

In closing, I wanted to revisit one of the ideas put forth by Barnett and Yandle in their paper, The End of the Externality Revolution.[4] Specifically, I want to address their idea that there aren’t any externalities – only inefficiencies. As someone who has had very little training in economics, but a great deal of training in some of the other social sciences, I can appreciate this reframing of externalities. In fact, I think it is appropriate to repackage our understanding of externalities as part of the “main” function of the transaction. In calling them inefficiencies, I don’t think that Barnett and Yandle are doing this. I think both names – externalities and inefficiencies – are not entirely representative of the true state of affairs. In doing research for this paper, I came across a quote that I think captures the essence of what I’m trying to say. It was written in the aftermath of the financial collapse of 2008,[5] [emphasis mine]:

The good news is that I think the economic system we will build next will be one in which environmental and social costs will no longer be externalities; costs that get pushed off the balance sheet. The cost of doing business to the planet . . . will now be factored in.

[1] Lopez-Claros, A. (2010). The innovation for development report 2010-2011: Innovation as a driver of productivity and economic growth. New York: Palgrave Macmillan.

[2] Santos, F. M. (2009). A positive theory of social entrepreneurship. Social Innovation Centre: Working Papers, 1-51.

[3] Perrini, F. (2006). The new social entrepreneurship: What awaits social entrepreneurial ventures? Northampton, MA: Edward Elgar Publishing Limited.

[4] Barnett, A. H., & Yandle, B. (2009). The end of the externality revolution. Social Philosophy and Policy, 26(2), 130-150.

[5] Jones, K. (2009). When more mission equals more money: The more a business focuses on its social mission, the more revenue it will generate. Stanford Social Innovation Review.

If you liked this paper/series, you might want to check out some of the other papers/series I’ve posted.

Defining Externalities: Social Entrepreneurship and Externalities, Part 2

In the first post in this series, we looked at the definition of social entrepreneurship. In this post, we’ll look at the definition of externalities. Before we get into the post, I wanted to let you know that when I copied part of the paper into this post, the footnotes reset and started at 1. However, as we know from yesterday’s post the first footnote from Pigou is actually footnote #10.

Defining Externalities

The process for defining externalities is as muddled as the process for defining social entrepreneurship. Since the term ‘externalities’ came first,[1] it might be more accurate to say that the process for defining social entrepreneurship is as muddled as the process for defining externalities. The first appearance of a definition of externalities comes in the early 1900s from Pigou,[2] a British economist, who comes from the field of ‘welfare economics,’ which focused on maximizing the well being of society. The general understanding of externalities hasn’t changed too much since then, leaving us with the following definition: “An externality is a cost or benefit that is experienced by someone who is not a party to the transaction that produced it.”[3]

This definition of externalities leaves us with the possibility for positive (benefit) externalities or negative (cost) externalities. An example of a negative externality could be the pollution to the air (or water) caused by a factory. An example of a positive externality could be the honey caused by the natural process of bees. Those two examples of positive/negative externalities are simple ones, but there are many more. Some cite traffic congestion as a negative externality[4] and some cite immunization as a positive externality.[5] The concept of externalities came out of economic theory and as such, we can highlight (through economic theory) some of the results that come from negative/positive externalities. “Negative externalities cause overproduction of the good in a competitive market, while positive externalities cause underproduction of the good in a competitive market, in both cases leading to a deadweight loss.”[6]

There is another kind of externality: positional externalities. “A positional externality occurs when new purchases alter the relevant context within which an existing positional good is evaluated.”[7] An example of this could be said to be when a job candidate starts to wear really expensive suits. The side effect of this is that other job candidates don’t make as good an impression upon the interviewer. From the perspective of the other candidates, it would be most beneficial to go out and purchase expensive suits, so as to make a favorable impression on the interviewers. “But this outcome may be inefficient, since when all spend more, each candidate’s probability of success remains unchanged.”[8] The last kind of externality of this similar vein (positive, negative, and positional) is a network externality. This is also referred to as a network effect and is most often seen in technology. Think about your cell phone. The value of your cell phone is somewhat dependent upon the number of other people [network] who also have cell phones. There is a further way to distinguish between different kinds of externalities: ‘internal’ and ‘external’ externalities.[9] Internal externalities are those externalities that are external to the contractual relationship, but internal to those parties within the contract. External externalities are those externalities that are external to both the contractual relationship and the parties within the contract.

At this point, we have talked about the various kinds of externalities (positive, negative, positional, network, internal, and external). To solidify the understanding of externalities, I’d like to provide an example of the creation of externalities by externalities:[10]

Jacksonville, Florida requires apartment complexes to provide 1.75 parking spaces per one-bedroom apartment – despite the fact that 16% of Jacksonville’s renter households even own one [sic] car . . . Most American cities require office buildings to provide four parking spaces per 1000 square feet of office space. Because four parking spaces consume about 1200 square feet of space, this means that a commercial landlord must allocate the majority of his land to parking.

Minimum parking requirements reduce population and job density, because land that is used for parking cannot be used for housing or commerce. Residents of low-density areas tend to be highly dependent on automobiles for most daily tasks, because they are less likely to live within walking distance of public transit and other amenities.

Minimum parking requirements indirectly discourage walking, by encouraging landowners to surround their building with parking. Where shops and offices are surrounded by a sea of parking, they are unpleasant places for pedestrians, because pedestrians must waste time walking through parking lots and risk their lives dodging automobiles . . .

By increasing the number of parking lots, minimum parking requirements may increase pollution from stormwater runoff. Rainstorms cause stormwater to fall on parking lots, collect metal, oil and other pollutants lying on the ground, and then run off into nearby waters, thus making those waters dirtier and more dangerous.

As one can see, this never-ending string of externalities seems to keep going. All of this stems from the initial action of a policy seemingly trying to do well by its citizens. Now that we have talked about some of the different kinds of externalities and explored a concrete example of how externalities can quickly multiply, let’s look at some of the proposed solutions to these externalities. But just before we move into the description of some of the solutions to externalities, I thought it a good place to add a note from Coase, who is often part of the conversation of externalities: “The traditional approach [to externalities] has tended to obscure the nature of the choice that has to be made. The question is commonly thought of as one in which A inflicts harm on B and what has to be decided is; how should we restrain A? But this is wrong . . . The real question that has to be decided is: should A be allowed to harm B or should B be allowed to harm A?”[11] Coase is absolutely right in his critique of the framing of the question. Even in today’s discussion (Coase wrote this in the 1960s) about externalities, rarely is the question framed in the way that Coase has suggested.

Note: when we next pick-up this series, we’ll look at some solutions to externalities.

[1] Pigou, A. C. (1920). The economics of welfare. London: Macmillan and Co.

[2] Ibid.

[3] http://www.csun.edu/~dgw61315/L&Elect2.pdf

[4] Bento, A., Kaffine, D., Roth, K., & Zaragoza, M. (2011). The unintended consequences of regulation in the presence of competing externalities: Evidence from the transportation sector. Yale Center for Business and the Environment.

[5] Simpson, B. P. (2007). An economic, political, and philosophical analysis of externalities. Reason Papers, 29(1), 123-140.

[6] Gruber, J. (2010). Public finance and public policy (3rd ed.). New York: Worth Publishers.

[7] Frank, R. H. (2003). Are positional externalities different from other externalities? The Brookings Institution.

[8] Ibid.

[9] Buchanan, J. B., & Vanberg, V. J. (1988). The politicization of market failure, Public Choice Society Meetings.

[10] Lewyn, M. (2010). What would Coase do? (About parking regulation). Fordham Environmental Law Review, 22(1), 89-118.

[11] Coase, R. H. (1960). The problem of social cost. The Journal of Law and Economics, 3(1), 1-44.

Ignore Sunk Costs: List of Biases in Judgment and Decision-Making, Part 1

It can be really fun to write a series of posts on a particular topic. By my count, I’ve done this at least seven times so far. Today, I’d like to start what I hope will be an oft-read series on biases in judgment and decision-making (to some, cognitive biases). Because of my background in psychology and my interest in decision-making, I thought it would be wise to share with you the things that I’ve learned either through the classes I’ve taken (the classes I’ve taught!) or the research I’ve read. With each bias, my goal is to explain the bias and offer some possible avenues for not falling into the trap of the bias. Today, we start with one of the big ones: the sunk cost fallacy.

Sunk costs are those costs that have already happened and can’t be recovered. For instance, let’s say you buy an apple and bite into it. The money you used to buy that apple can’t be recovered — it’s a sunk cost. Now let’s say the apple doesn’t taste very good (maybe it’s inorganic). You might say, ‘well, I’ve already paid for the apple, so I might as well eat it.’ NO! That’s the sunk cost fallacy! Just because you’ve already bought the apple and paid for it, doesn’t mean you have to eat it. If it tastes bad, by golly, don’t eat it!

That’s a rather basic example of the sunk cost fallacy, so let’s look at one that might seem a bit more applicable. Sunk costs often come into the fray when they’re contrasted with future costs. Let’s say you’ve bought a subscription to a newspaper or a magazine. Because of your subscription, you get a discount when it’s time to renew your subscription. Now, let’s say that in that year of your subscription, you discovered that there was another newspaper/magazine that you preferred (maybe The Economist?). When it comes time to renew your subscription, you look at the two options to either subscribe to The Economist or continuing with your other subscription. You find out that the discounted price for your current newspaper/magazine will be the same price as The Economist. You say to yourself, “well, I’ve already subscribed to this newspaper and spent so much money on it, so I might as well keep subscribing to it.” NO! That’s the sunk cost fallacy. The money you’ve spent on the subscription for the other newspaper/magazine can’t be recovered! You can’t get it back. As a result, it shouldn’t affect the decision you make now about whether to choose it or The Economist.

There’s one more quick example that I want to highlight: war. From a paper by a professor at Princeton:

The United States has invested much in attempting to achieve its objectives. In addition to the many millions of dollars that have been spent, many thousands of lives have been lost, and an even greater number of lives have been irreparably damaged. If the United States withdraws from Vietnam without achieving its objectives, then all of these undeniably significant sacrifices would be wasted. [Emphasis added]

Pay particular attention to that last sentence. That is the sunk cost fallacy in action.

Ways for Avoiding the Sunk Cost Fallacy

So, now that we’ve looked at the sunk cost fallacy, how can we avoid it? Well, the first step in avoiding the sunk cost fallacy is recognizing it. Hopefully, the above examples have given you an idea of how this bias can arise. There are a two other ways I want to highlight that you can use to avoid this trap.

1) What am I assuming?

The crux of the sunk cost fallacy is based on an assumption. That is, you’re assuming that because you’ve already spent money on X, that you should keep spending money on X. If you look at what it is that you’re assuming about a situation, you just might find that you’re about to step into the sunk cost trap.

2) Are there alternatives?

Related to the above example is alternatives. You’re not bound to a decision because you’ve made a similar decision in the past. Just because you bought the ticket to go to the movie, if another activity presents itself as more enticing, you’re allowed to choose that one instead. In fact, if when you sit down to watch the movie, it’s bad, you’re allowed to get up and walk out. Don’t fall into the sunk cost trap thinking that you have to stay because you paid for it. There are any number of things you could be doing: going for a walk, calling an old friend, etc.