Analogy by Poker: Income Inequality, pt. III
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There’s one player who hasn’t been mentioned, the House.  He truly sets the rules of the game.  He’s not involved in just trying to turn a profit, but to make sure that the game keeps going. And let’s expand the game: it’s not just one table, it’s 500 of them.  There are only 5 or 6 Whales, but they’re each playing simultaneously at multiple tables, so there’s one Whale at every table.  What’s more, the Whales have one private table, where they’re betting only with each other.

At that private table, even a couple of the Whales got into trouble.  They were passing around IOU’s from the players at the smaller tables, and trading many multiples of what they actually had.  When it came time to pay, they couldn’t collect from all of the players they’re busting out at the smaller tables, and so they couldn’t pay their own IOU’s. They go to the House.  The House gives them some more credit – a few chips to stay liquid in the Whale game while they wait to earn the money back from the smaller games (where they have such a built-in edge).  Eventually they do get liquid again, and they pay back the House.

The players at the smaller table?  They’re wondering why they don’t get the same deal.  Of course, if any single one of them gives up and leaves, it’s not going to bring down the entire room, so the House disregards them.  But collectively, they can say “What the fuck, you bailed out the Whales, why can’t we get a little help?  If we bust out, our only option is to go deeper into debt, and on such lousy terms that it keeps us from ever having any hope of getting ahead.”  That’s OWS.

The house, obviously, is the government.  There are a lot of things that the house can do. For one, they can recognize that the blinds are way too high, so they can alter the way the chips are valued.  Keep the blinds at $1000, but let’s make all of the chips you have worth 10x as much.  Now you have $10k, and the Whale has $5 Million. You have better risks (because the blinds are comparatively lower, but they’re lower for everyone). You past debts to the Whale? Well, they’re still what they were – but you have a better shot at paying them off.

This is what the effect inflation would have on our situation right now.

OK, maybe that’s not the perfect solution.  Let’s try something else.

Some of their tables are falling apart – so the House offers a deal to a bunch of the guys who are busted out of the game “build us some new tables, and we’ll give you $20,000 in chips to play. That’s what the stimulus is.  Paying for things you need anyway, at a time when the influx of chips will help the game.

Heck, some players are busted out but because they had to borrow so much to play in the first place, they can’t ever get to a point where they don’t owe more than they have. The House says “Tell you what.  I’m going to talk to the Whale, and we’re going to tell him that you’ll give him a fraction of what you owe, and he wipes the slate clean.”  This is Bankruptcy – an option that’s increasingly being taken off the table in real life (ie. non-dischargeable student loan debt, or credit card debt with the 2004 bankruptcy reforms.)

 

Now, to see where the criticisms of OWS are coming from, let’s add one more player to these game, we’ll call him the fish. He started playing ages ago. He sat down to the table with $1500, and the blinds were only $30, maybe there was a whale at the table, but it was a lot smaller at the time, and the rules didn’t favor the whale as greatly. Maybe he played a low risk strategy, maybe he got lucky. Most of the people he started with are gone (he assumes it’s because he’s better than them, most of us can recognize that that may not be entirely the case, but we’ll even grant that).

So now he’s sitting there with a sizable pile in front of him.  The blinds have increased over time, to $1000, but he’s managed to increase his stake to something along the lines of $10,000, and only owes $2000 of that to the $500,000 whale sitting at the head of the table.  Everyone else?  They’re kids just joining the game, with $2000 each, all borrowed from the Whale, and almost guaranteed to go belly up within the next few hands.

He’s sneering at the new kids, as though they’re doing something wrong “I managed to survive, and I had less money than they did when I started, they should just make things better for themselves like I did.” It’s a particularly ironic statement, because it fails to appreciate just how close the fish is to being busted himself.  He sees a qualitative difference between himself and the new crop of players, confusing survivorship bias with skill. He thinks he’s closer to the whale than he is to the new guys, and sympathizes with him, when he’s about 2 unlucky decisions from being knocked out as well.  If you can’t see the sucker at the table, it’s probably you.

Most of the criticisms I see of OWS are along the same lines – “Just don’t make bad decisions in the first place and you wouldn’t have to worry.”  The problem with these criticisms is the source. Even just 20 years ago, the costs of entry were different – education, housing, etc.  Tuition has skyrocketed, and at the same time, there has been a push to reduce government grants and scholarships, so that students are increasingly dependent upon loans. You have to borrow just to get in to the game, giving up your winnings before you even start. In our example, this is the equivalent of raising the blinds faster than the participants can account for with their own bankroll, and the criticisms are mostly coming from people who played with much lower blind bets, or got lucky cards on the few times that they’ve had to bet. The critics myopically see their own situation, and can’t imagine that the risks and odds for someone else may have been substantially different.

What’s happening at OWS is that you have a large segment of society that has been participating in this unfair game, and they’re pointing out that it’s not working. That it is designed such that the winners will continue to win, and everyone else has bad odds – even the fish who are mocking them.

No, I don’t believe that all of the participants understand all of the rules of the game stacked against them, they just see the fundamental unfairness.  But those who are sneeringly dismissing them understand even less – because not only do they not appreciate the rules of the game, they haven’t been screwed over by those rules, so they remain blind to the unfairness – whether passively naïve, or willfully dense, it’s the same outcome.

Analogy by Poker: Income Inequality, pt. II

There are a lot of aspects of economics and our current situation that can be illustrated with this poker analogy, it’s quite versatile.

Where we left off, when you have the wealth concentrated, the stakes get raised but there’s not enough “liquidity” to enable the smaller players to participate on merit. It’s fundamentally a flawed, unfair game. But if you have no choice but to play it, you have to accept its terms. When you have such a flawed game, there are ways around it. One, is that the whale can extend credit to people as they bust out.  “I’ll give you $1,000 more.  If you win, I get 40% of that, but if you lose, you still owe me the $1000.”  This is primarily what happened in the past ten years. As income inequality increased, you have substantial segments of society unable to participate economically without borrowing.  This isn’t actually a solution, it just papers over the problem. It provides the liquidity necessary to play the game, but it actually ends up increasing the concentration of wealth in the “whale” not only is he winning money at the table, but he’s earning interest on the money that he’s loaned you. And you reach a point where the whale is owed far greater value than the amount of money in play – that’s a bubble, and eventually, the credit stops, because there is no incentive or ability to continue to lend.

There are legitimate questions as to how the whale earned his bankroll in the first place. Because he has so much of a stake, he’s the single most important player, and he gets to set the rules.  Especially once everybody owes him most of their bankroll – “If you don’t do what I want, I’m going to call in everything I’m owed, and shut down the game. So you can’t possibly win it all back.” By setting the rules of the game, he’s been exempt from posting his own blinds. Sure, he “wins” hands fair and square, but over time, his bankroll isn’t being whittled away by being forced to be when the odds aren’t in his favor, or forced to bet more just to keep what he’s already risked.

Let’s just say that after a time, as people bust out, new people join the game. The bank changes the rules yet again – “you can’t bring your own chips, you have to accept a loan from me to even sit at the table.”

So what you see is a player who already has more than everyone else, able to shield himself from his own losses, keeping all of his own winnings, while forcing other players to be held accountable for their losses, without realizing all of the upside of their winnings.  He’s winning by the rules, but only because the rules favor him.

This is what OWS is calling out.  They are sitting down at a table at which they can’t win.

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Analogy by Poker: Income Inequality

One of the great things about economics is when you’re able to build a simplistic model that illustrates a real problem. One of my favorites is one that Paul Krugman uses quite often, about the DC Baby sitter’s collective, which shows the effects of a demand recession in pretty accurate detail, but on a small scale.

I’ve been trying to come up with one that illustrates the issue with income inequality, and I think I’ve managed to do so. It uses one of my favorite pastimes to boot, poker. Since people have been saying that Wall Street is just a casino for the past couple of years, it seems like now is an apt time.

Now, let’s pretend that we’re sitting down to play no-limit Texas hold’em. Just to explain the basics of the game, for our purposes, we only need to focus on the betting. If you’ve played before, you can skip ahead.
You have ten seats at the table. Every hand, 2 people are forced to put up mandatory bets, the small blind, and the big blind. This rotates with each hand, so that eventually everybody will have to play a hand with this disadvantage.

The big blind is the minimum you have to bet to play that hand, and the small blind is half of that (so that the small blind still has to put in MORE money if he wants to have a chance of winning, but if he declines to play, he loses without even having that chance). Everybody else? They can choose freely whether or not to risk anything on that given hand. What’s more is that someone else can raise the initial bet, forcing even the big blind to have to put in more money just to play the game. Then, as you see more cards, there is additional betting, so you have to keep putting money in, until the cost of continuing is no longer commensurate with the potential your cards have of winning.

Part of the game is just luck. Indeed any one hand is determined by the luck of what cards you have in front of you. Part of the game is risk assessment over time, recognizing good risks and bad risks. But a large part of the game is also how much money you have in front of you in the first place. If you have a large stack of chips, and nobody else does, you can force them to take bad risks, which costs you little, but has the potential to bankrupt them. In short, the more hands you get to play, the more skill affects the outcome. The more risks you’re forced to take, the more it’s random chance and luck.

So let’s play this out with some numbers to see how it works and complete the analogy.

If you’re going to play a sensible game, everyone usually starts with roughly the same amount of chips, and the bets you have to make (the blinds) are relatively small fractions of that. Say everyone starts with $1500, and the big blind is $30. Even if you fold every hand, you get to see over 300 hands, which allows you to make decisions based on your cards, rather than desperation. This gives everyone a chance – there is going to be luck involved, but you have many opportunities to make good decisions, and over time, the better players will end up winning, not just the person who has the best cards.

Now let’s say that the blinds are structured much differently. Instead of $15/$30, we’re going to say that they are $250/$500, but everyone still has the same number of chips, $1500. In that case, everyone has the same likelihood of winning, but more of it is attributable to luck. If you only have $1500, and you have to make $750 in mandatory bets every 10 hands (once as the big blind, once as the small blind), you’re going to have to just hope you get really good cards when it matters, but a lot of it is out of your control. Hopefully you understand why.

Let’s add another wrinkle. Not everybody starts with the same amount of money, because there have been games going on for years. So when you sit down, some people only have $1000, some have $4000. If the minimum bets are small ($30), even the people with the $1000 have some chance of persisting for a while. He may feel increased pressure because the guys with $4000 can take more risks than he can, but smart decision making can minimize that advantage. If they start to go up, say, back to the $250/$500 range, it’s going to change the risk tolerance for all parties, but for those with the fewest chips, it removes more decision-making from their hands faster. They’re forced to act by circumstances where someone with even just a few more chips can wait for a better hand.

Now let’s add another specific player. A whale sits down at the table. He has $500,000 in chips in front of him. We’ve raised the blinds to $1000/$500. Everyone else? They have somewhere between $1000 and $2000. Because the blinds are so high relative to their stacks, they have, at most, 10 opportunities to make a choice, but really quickly they’re going to be forced to just risk everything they have on their cards, whatever those cards may be. The whale? He can lose over and over again, because he can keep playing with his deep stack. Unless someone gets really lucky, he can force people into bad decisions repeatedly, and play every hand in his favor until he has everybody’s money. With such a sizable advantage, he can do so very quickly. But here’s the thing. In that case, even if the blinds are low ($15/$30), the Whale can just raise to the maximum every time, because it’s trivial for him, whereas it forces everyone else to make crucial decisions as to their very existence, with imperfect information, and with a very real likelihood of getting it wrong – even if just because of random chance). Everyone else is forced to make bad decisions.

That’s the basics of income inequality. You have a small fraction of the players in the game with exceptional leverage, who already have more than everyone else, but because of their position, are able to extract even more without taking the same sort of risks as the rest of the table.

Libertarianism v. corporatism

From Radley Balko:

Sunday Discussion: Should We Abolish the Limited Liability Corporation?

We libertarians are regularly accused of being corporatists, despite a wealth of evidence to the contrary. But what are the arguments in favor of keeping the legal protections that define corporations?

This is one area where the breakdown between strict adherence to libertarian principles and reality suffer a disconnect, but I applaud Radley for raising the question (though Murray Rothbard has touched on this as well in “Power and Market”) But recognizing the “problems that stem from shielding government actors from any real repercussion for their actions” while also confessing that with respect to corporations it is “outside (his) area of expertise” seems to raise the question of whether you’ve truly thought through all of the problems, and its why libertarianism to me always seems to have decided on an answer, and retrofits the argument to support it.

The idea of personal responsibility being a limiting factor on one’s actions is necessary for many of the supposed benefits of libertarianism to work (ie. the function of the invisible hand in laissez faire economics). The problem with this is a divergence of interests between the individual actors that compose a corporation, and the corporation itself. If the individuals are shielded from liability, that personal responsibility disappears.

The problem, of course, is that you are throwing the baby out with the bathwater. Modern society requires complexity and scale. Individual proprietorships simply can’t engage in the level of activity necessary for any sort of large scale efficiency. This complexity may have drawbacks, but large scale coordination has real benefits as well.

Strict adherence to principles would require the (counterproductive) elimination of limited liability protections for shareholders. But partial adherence to principles – recognizing the form, but not allowing for regulation of action – is counterproductive as well. A pragmatic approach recognizes that there are advantages to allowing limited liability, but with those advantages must come restrictions. Either in the form of regulation, or by subjecting them to actors of comparable strength.

The natural libertarian aversion to regulation always seems to kick in, but it shouldn’t – limited liability structures are an artificial construct. Regulation of an artificial construct is simply setting the rules of the game: it is about recognizing the limits of a granted power, not curbing an existing right and liberty. Recognizing that police or other government actors go beyond utility in their actions is not the same as advocating for elimination of police altogether, but I see the same dynamic in libertarian discussions over and over in other contexts. In this case, libertarianism leads to one of two solutions: eliminate corporations (limited liability is a government intervention) or allow them to run rampant (no regulation!), where the answer is really in the middle, and that to me highlights the inadequacy of thinking in terms of strict principles when the real world is infinitely too complex to comply with them.

On the flip side, the idea of a comparable actor arises when discussing unions. I understand the drawbacks to unions, but contextualize them by comparing them to corporate structures. One must do away with both, or neither. But to gut unions while leaving corporations unbound seems to me the worst of both worlds.

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The spectrum

I have to start out with the basics. Defined terms. Liberal. Conservative. Not the vilified terms that they’ve become now, but what do they mean in a vacuum.

At its most basic, liberalism is about using rational thought to create positive changes in society by modifying the rules and framework under which we all live. It’s forward looking, and positive. Optimistic about the results of change.

Conservatism is about recognizing that there are limits to your ability to plan these changes. Either through unforeseen consequences, or through ineffectiveness, and that one shouldn’t disrupt the current order too much. It relies on tradition, and the idea that one must be careful about breaking things when advocating for change.

Viewed like this, there is nothing inherently wrong with either position. There are things that can be fixed in any society, and things that shouldn’t be. There is an inherent tension between both positions, but, optimally, they should work in conjunction. Liberals advocating for change, conservatives keeping them honest.

The problems arise when one side veers too far. Either advocating reckless change, or challenging everything, and preventing any improvement whatsoever.

That’s the situation we find ourselves in now.

But it’s been remarkably one sided. Watching the current political situation in the US, it seems to me that we have one side, the left, which is a mix of liberal and conservative. Incremental change and caution.

The other side, the right, is camped out in both extremes, a mix of reactionary and radical. Any solution offered by the left is demonized as the end of the world (Health reform, Financial reform), and the solutions offered by the right involve tearing down existing structures (Social Security, Medicare, progressive taxation).

The prism through which I view politics is no longer right v. left, it’s extremist v. moderate.  Those who call themselves “Conservatives,” are anything but. As a political unit, they have collected at the poles, but I guess my question for now is simply “why?”

 

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The beginning…

I still haven’t quite figured out the entirety of what this project is going to be, but that’s what the blog is for.

I’ve spent most of the past year pondering the state of politics today, and the more I do, the more I circle back to the decrepit state of the Conservative Movement. I’ve spent a lot of energy trying to convince myself otherwise, for two reasons.

One, I fear greatly that this is the result of confirmation bias – I’ve spent most of my life self-identifying as liberal, and naturally some small part of myself always wants to “win.” I know at heart that this is irrational, if one is chiefly concerned with how best to govern our country, it shouldn’t matter whether those in charge are Democrat or Republican, just that they are operating the levers of power in a competent manner with the best interest of the nation at heart.

Two, I believe very strongly in many so-called conservative principles. But beyond that, I believe just as strongly that alternate viewpoints are valuable – necessary even – to prevent the excesses of one ideology from running rampant and undermining even noble goals.  To that end, an effective conservative movement based on – and operating on – principle with intellectual honesty is something that we all have a vested interest in.

The problem is that I don’t believe that the Conservative Movement is anything but cynical and opportunistic. That it has become intellectually corrupt has been an ongoing meme through-out the political blogosphere, but I don’t feel like anyone has truly addressed the root causes of this corruption. That doesn’t let the current Left off the hook, but the problems with the left at the moment are qualitatively different. Of course, that’s all interconnected, and will all be part of what I plan on exploring.

Let’s see how this turns out.

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