Network and Inequality

And now our sociologist friend, Roby shows us that inequality can be a manifestation more of network effect than of prejudice (or discrimination for that matter)...

-- Manager

Network and Inequality
by Roby

An asset-management company has this problem:

The business of asset-management companies is to attract rich individuals to give up their money so they can be managed by these companies. The sales people rely on their own social networks to access these high net worth individuals; and they are compensated based on how much money they can bring to the company.

A problem arises when there is an allegation that the company implements a disriminatory practice in its compensation structure. The company has several Blacks in its sales group and their earnings are consistently lower than their White counterparts. Thus, the company is accused of discrimination, and furthermore this case has been exemplified as a discrimination practice that is rampant in the corporate world and responsible for the high income inequality
between Blacks and Whites.

The argument here is that discrimination - with respect to racial prejudice in this case - is the main cause of inequality.

If we take a closer look, however, we will find out that those Black employee come from lower Social Economic Status (SES) than their White colleagues. Since SES affects one's social network greatly (rich people know more rich people than poor people and vice versa), interactions between people within the same SES groups are more likely than interactions across SES groups.

What happen is that the compensation (incentive) structure only reveals the underlying social structure. Therefore, in this case, the inequality stems as a network effect; not as a form of discrimination.

There are two important points here. First, inequality can be a network effect that has less to do with individual prejudice or preference. Second, it is important to pay serious attention to the
relevant social structure in designing an incentive structure since disregarding social structure completely can lead to unintended and undesired consequences as illustrated in this case.

The science of interaction

Our guest blogger, Tirta, raises the issue on the individual vs. collective behavior, and the importance of taking the distinction into account.

- Manager

The science of interaction
by Tirta

I have the following issue with Milton Friedman's dictum that economic assumptions are only as good as the predictions they make.

The dictum implies that in any economic model, what really happens in individual minds doesn't really matter, as long as the collective phenomenon of interest can be predicted. In fact, one of the criticisms against the recent interest in behavioral economics is that at the aggregate level, there's no such thing as irrationality. Individuals may be irrational, but society as a whole is rational – as shown by the success of rational models in their predictions of many collective actions.

Now this is all fine, if there is only one explanation behind each phenomenon of interest. But what if the phenomenon of interest can be predicted by two differing models built upon two dissociable assumptions behind the action of the individual – one being more psychologically realistic than the other? Should we choose the simpler assumption (i.e. homo economicus) for the sake of neat predictions? Or should we pick the more realistic one (e.g. homo behavioral-economicus, homo neuro-economicus) at the expense of perhaps less clear and less fruitful predictions?

I think there is a danger in the tendency to prefer simple and neat models to complex and more complicated ones. Parsimony as a scientific criterion doesn't always apply, at least when it comes to explaining how the human mind works. A century of psychological explorations have shown that the human mind and brain are necessarily complicated and, as far as reality goes, cannot be further simplified.

So it seems that we are left with either making good-collective predictions based on bad-individual assumptions, or making bad-collective predictions based on good-individual assumptions.

Can we make good-collective predictions based on good-individual assumptions?

In principle yes, and I think the key lies in understanding how the actions of individuals result in collective phenomena. The more we understand about the science of interaction, the less we have to rely on making unrealistic assumptions about individuals, while at the same time maintaining our accuracy in predicting the emergence of collective actions.

Now I personally don't know how far we've come with the science of interaction. But I sense that, if anything, the end result of understanding how different individuals interact with one another in collective settings would be better and more fruitful economic predictions.

The Making of Good Espresso --and Economic Growth

What is a good shot of Espresso? Here is the standard.

The ideal espresso (according to the Instituto Nazionale Espresso Italiano) is a 25ml beverage extracted from around 7g of finely ground coffee, using water at a temperature of 88C, passing through the grains at a pressure of 9 bar. See, dead easy. It should be thick-textured, having emulsified many of the oils, retain most of the volatile aromas and flavours of the bean and be capped with a thick colloidal foam layer - "crema" - reddish, creamy and flecked.

It's taken from a nice writing in The Guardian on 'the God-shot'--the nickname for a perfect home espresso. That article, somehow, reminds me the pursuit of, well, economic growth. We have pretty much had a good idea what espresso economic growth is, and a good deal on the mechanics. At least theoretically.

We know how seductive the crema economic growth is, too, that in Robert Lucas' words in 1988: once one starts to think about them, it is hard to think about anything else.

Yet, when it comes into policy making, the problem is:

Each one of those factors is minutely variable, potentially causing thinness, bitterness, under- or overextraction or - the ultimate humiliation - a thin or patchy crema.

Faux Jazz and Pareto Improvement

In his feature on Java Jazz (in Bahasa Indonesia), Bre Redana of Kompas wrote that people came to see something he called the ersatz jazz --or the not-so-really jazz, the likes of James Ingram and Babyface. Reading it, you could not avoid a glint of satire and his mock to Jakarta lifestyle.

My take: if those ersatz jazz make Jakarta urbanites willing to pay hundreds of thousand IDR so that the organizing committee could pay Joshua Redman (as in 2007) and Wynton Marsalis (probably in 2009) to play, bring them on.

Imagine in the next year Java Jazz, those people crowd into, say, Rihanna's stage, and the jazz addicts enjoy The Lincoln Center Jazz Orchestra in less crowded, thus more pleasant, performance. Better yet, if the former pay additional special rate, while the latter regular.

In economics term, it's called a Pareto improvement.

From the Manager

Hi, I'm back (hi, Rizal). Yes, it's been a while since my last post. I guess I was having a blogger's block. Or I have been curious about Facebook. Or in a state of confusion brought by so many political comedies recently (there is no way you can't avoid them: they're all over the media, TV, and even in talks between friends and coffee addicts here -- mostly about Bank Indonesia, BLBI and noisy DPR).

Fortunately, an actress turned politician has saved me from further gloom. She just accused and sued a former rival of using fake university diploma. The latter beat the former in a governor race. Both are pretty. But our actress seems to think that it's impossible to have two legally pretty politicians with university degree. Oh boy.

I'll go hibernate again.

Friday Rant

Spring break's here. What spring break? Central Bank governor election started to look embarrassing (Aco ridiculed it in his own blog. He wants a Rogoff's tough guy type --who has little sympathy on unemployment and real sector). Bear Stearns went collapsed (who's next?). The Manager (this cafe's manager) went AWOL. Oil price hits 110 USD.

The upside: I still enjoy my heavy intake of coffee and the upbeat of Trioscape jazz album --an underrated gem. And it seems that the KPK (anti corruption squad) works.

Of Leader and Grassroots Participation

Here is the teaser:

“...found big changes in growth when autocratic leaders die in office—both positive and negative, but no substantial change when democratic leaders died in office......(T)hat individual leaders can play crucial roles in shaping the growth of nations,”

and (in Indonesia)

“increasing government audits reduced missing expenditures, as measured by discrepancies between official project costs and an independent engineer’s estimate of costs, by eight percentage points. By contrast, increasing grassroots participation in monitoring had little average impact…. Overall, the results suggest that traditional top-down monitoring can play an important role in reducing corruption.”

Who do you think found that (rather unpopular) evidence?

Yes, it's Ben Olken, one of the rising stars in economics.

On Psycho-economics (2)

Our psychologist friend Tirta continues on his post about the amalgamation of psychology and economics. Enjoy. -- Manager

On Psycho-economics (2)
by Tirta

A while ago I wrote about my worry with psycho-economics. I felt that the field was taking off a bit too early, because we psychologists still don't know much about how the decision-making mind really works. In my grim view, to fill the decision-making literature with neuro-laden jargons and colorful brain images may be nothing more than a showcase of unsubstantiated excitements.

An example I mentioned at the time was that of the economist Roland Fryer, who has been involved in a project to help New York students get better grades. I argued that Fryer was right to tackle the problem using the incentive approach, and that we need not worry too much about the psychological side of the issues – given how little we know about what happens in the students' brains when they study in schools. So I took it that as long as you have the right incentive, you would produce students with better grades.

I would now like to tweak my previous stance, as a result of reading two articles in the past few days.

The first one was about Fryer and his New York student project. He and his team had come up with an incentive: mobile phones. Students who do well in tests will be rewarded with mobile phones – which are to be used for school-related purposes (teachers would text their students about exams and homework, for instance). Now there are many objections to this mobile-phone approach, but I personally prefer to wait and see for some future data as to assess whether this particular incentive works.

The second one was about the psychologist and neuroscientist Stanislas Dehaene, whose research is about what he called 'the number sense'. He has produced groundbreaking work covering the many aspects of how the human and non-human brains deal with numbers: from the crude task of making an estimate that we share with other species (for example, which one is bigger: 2 or 8?) to the most sophisticated number manipulations only a handful of fortunate souls can do (fancy notions like the Poincare conjecture sounds fit here – although I honestly know nothing about this mathematical proposition).

One practical implication of Dehaene's work is that when it comes to mathematical reasoning as taught in schools, the brain has a pre-wired starting point: the number module. (Evolutionary psychologists believe that the brain is naturally designed with built-in modules, one of which is the number module). So mathematics teachers don't work with blank slates, they instead work with the number sense. Let's take the simplest example of counting.

Today the world is built upon the base-ten Arabic (some say Indian) numerals. Some languages, like English and Indonesian, are not completely compatible with this base-ten form: there are words that are cumbersome to pronounce and came out of nowhere, like 'eleven' or 'sebelas'. Chinese words for numbers, in contrast, are efficient to say and perfectly compatible with the Arabic numeral system. This is why Chinese four-year olds can count up to 40, while their American counterparts find it hard to get to 15; and why the average Chen can hold up to 9-digit in his memory, while the average Joe's capacity is limited to 7-digit. Dehaene's work is full of insights like this.

Now surely there are jargons and brain pictures filling up the number sense literature, but I think they are substantiated. We psychologists apparently know a bit about how the mathematical mind works, and we should be able to redesign how mathematics is taught in schools -- to make it more aligned with the nature of the number sense.

So yes, incentives do matter, and perhaps the mobile-phone approach will bring you better grades. (After all, the brain also operates with an incentive module). But paying more attention to the number sense might help the falling grades too, and make learning more fun even if Fryer runs out of mobile phones.

Alas, No Easy Answer

Ap, in his reply to Ben of Indonesia Anonymus, wonders:

"What's interesting was how it (US, my word) overtook Europe only less than two centuries....(w)hat's interesting was why the Europeans who conquered the world, not vice versa (or why not the Chinese)"

It's an elusive quest indeed to explain what was going on --let alone, what will be going on next. But here is some thoughts on institution, based on my limited reading.

Why China and Middle East before Europe? Geography, said Jared Diamond.

Why Europe got industrial revolution? Culture, said David Landes. Culture embedded in evolutionary biology (or demography), argued Gregory Clark. And perhaps economic institutions (a.k.a private property right and market), said Acemoglu et.al (in pdf).

Why US and later Asian Tigers? The same Acemoglu's economic institutions.

Who's next and why? We don't know (Rodrik and Easterly position).

Do you have any idea?

The Western's Wealth

So we don't think that the western's virtue is George W. Bush, or for that matter Paris Hilton. But I guess it is fair to say that the western has been having a great wealth of knowledge, making technological progress, and taking the lead in term of economic income.

The question is why Europe, the western?

David Landes asserts that in Europe the knowledge accumulation, and its subsequent peak of industrial revolution, had been characterized by the growing autonomy of intellectual inquiry, development of (scientific) method (including verification method and common language), and routinization of research and diffusion.

All came from not-so-noble reasons. Autonomy from dogmatic religious authority emerged from the patronage of science from political rulers pursuing pragmatic aim, that is, advantage over rival. Development of scientific method and research routinization was spurred by fame motive and contest for priority.