Saturday, January 30, 2010

Its the Math, Stupid

Remember that slogan from Bill Clinto's first campaign? "Its the economy, stupid". That was James Carville at his most brilliant.

In real life, not the silly drone of political campaigns, "Its the Math, stupid".

Everything, and I mean EVERYTHING, can lend itself to mathematical analysis to great effect. Everything from the melody of a symphony to the beauty of a woman's face can be expressed, and understood, mathematically. So too can we predict outcomes of government policy.

Perverse Incentives and a Government Doomed to Collapse
(January 14, 2010)

We form and fund governments to solve problems. So what do we do when government devolves to a tangle of perverse incentives?
As I worked through the Survival+ critique of the status quo, it struck me that the built-in incentives in any system are far more powerful predictors than the ideology used to justify the system.

Foir example, the sickcare system (a.k.a. "healthcare") in the U.S. is doomed for a very simple reason: the incentives are all perverse. Care providers make more money by billing for needless or even harmful tests, procedures and medications, patients have no incentive to maintain their health or choose lower-cost care options (nobody even knows how much care costs before "buying" it), and the government systems (Medicare and Medicaid) are fundamentally open-ended--if you qualify, then we pay all your bills, no questions asked (hey, we only glance at 3% of the bills presented, 97% we pay automatically).

Construct a system with these perverse incentives and it is doomed to implode as everyone piles in to exploit the windfall. It's really not that hard to understand.

Another causal factor I cover in Survival+ is the concept of marginal returns. Let's start with the idea that government of any size, shape or form is formed to solve problems inherent to the human condition: the tribe in the next valley is starting to come over and steal our food, if we let this continue we will starve to death, etc.

In areas without government, or with government which does not view this as a problem it is tasked with solving, disabled people who can't work are either beggars on the street or they are cared for at home by their families.

In the U.S. and other wealthy post-industrial economies, government has come to accept disabled citizens as its responsibility.

So government establishes a program to aid disabled citizens who can no longer work (or no longer work in standard settings, for whatever reason: physical or mental disabilities or perhaps a mix of both). Let's say 40 pages of regulations and guidelines are written to define who qualifies and how the stipend/aid is distributed.

Since humans seek to exploit any and all windfalls, then "free money" programs are big targets for exploitation via fraud. So another 400 pages of guidelines are written to set up auditing, tighten the qualification process, enable appeals from those turned down, and so forth.

Since we live in a legalist society, then various legal claims and lawsuits are filed regarding the guidelines, and soon it takes 4,000 pages to cover all the exemptions, exceptions and refinements needed to clarify exclusions and various types of aid for different populations of disabled citizens.

Over time, new administrators seek to make their mark by improving service, and more legal challenges result in more refinements. Eventually the full body of documentation guiding the program reaches 40,000 pages, and the costs of operating the program exceeds the benefit of having such a massive body of rules and regulations.

At some point, the program is so rigid and costly than any budget cuts are not just "unfair" but "impossible." Or the cost of litigating the cuts exceeds the savings, and so on. This is the threshold of marginal returns. Put another way: it now costs $10 to "save" $1.

Without conscious design, the system becomes riddled with and then ruled by perverse incentives as various "fixes" incentivize ways to get around the barriers to windfall exploitation. Since the program is open-ended (an "entitlement"), then there is no feedback loop to limit expansion and complexity.

The system is now doomed to inevitable implosion/collapse.

In private enterprise, the company either goes bankrupt or enters a brutal downsizing/ reorganization which essentially throws over the entire status quo.

With government, that is impossible because the status quo is heavily defended by politically potent protected fiefdoms with asymmetric stakes in the game of preserving their share of the tax revenues (and the funds borrowed by government).

Got it? IMHO, that is the most succinct explanation for the surety of the disastrous outcomes destined to come from our "political progressives" and their insane social policies.

No matter what "feel good" status you might get, the outcome is ineluctable, and these programs will inevitably cause far more damage than they might temporarily alleviate, not that you can tell this to a "true believer" to any great effect...

The again, these were the folks that studied humanities in order to avoid Math... with predictable results. Government is run by lawyers (wordsmiths), also with predictable results.


bureaucrat said...

I'd like to remind everyone that, on the Federal side anyway, there are indeed tens of thousands of regulations with hundreds of thousands of words. However, that does NOT mean that they apply to everyone in every situation. 98% of regulations apply to the 2% of the U.S. population with VERY special circumstances (and even fewer businesses). Just because you have 40,000 pages of regulations does not imply that you have to enforce all of them (at huge, backbreaking cost) all the time. In the Federal govt. we have the CFR -- the Code of Federal Regulations. I've seen books and books of them. However, I never read them. I'm human. I want to do my job in the simplest, fastest manner just like everyone else. Almost everything I've learned in 20 years was verbally from another employee, not from reading regulations.

You all can see this is your own lives ... 90,000+ pages of IRS regulations, almost all of which apply to no one. 2/3rds of Americans essentially file the 1040EZ (2 pages). The majority of Americans don't even need H&R Block. The are just scared into thinking they do, cause they don't want to look stupid by not taking advantage of some tax break (a break that probably doesn't even exist).

Private sector businesses may have 500+ page rulebooks as well. Have any of you ever had to refer to them more than even once a year? Fear by paperwork. :)

Anonymous said...

Speaking of mathematically challenged, it is interesting just how FAST the USA has gotten used to trillion dollar deficits... nothing to see here- just another multi- trillion $$ deficit.

Anonymous said...

'Since humans seek to exploit any and all windfalls,' indicates that Mr. Smith might want to study logic, since he has the math thing down so well.
That statement is equal to the one that claims Mr. Market acts rationally all the time and is composed exclusively of rational actors.
We all know how true that is.

Greg T. Jeffers said...

Dear anon 11:09am:

Who says those statements ARE equal?

The "Efficient Market Hypothesis" is just that - a hypothesis... as is Mr. Smith's assertion, which cannot be proved or disproved...

Yet, if you took a poll of some sort, say 100 random students studying philosophy at our top universities... well, my bet is that a plurality would agree with Mr. Smith...

It would then follow that you somehow disagree with Mr. Smith's assertion, despite overwhelming evidence to the contrary (we have reams of data going back many years regarding "disability" compensation, with all of the data SUPPORTING (while not PROVING) Mr. Smith's assertion.

But that would not matter to a "true believer", now would it? True believers do not need to any analysis, do not need to make assertions to be peer reviewed and defended... because they already KNOW.

Sorry, but your grasp of "logic" in this instance appears to be flimsy, indeed.

Feel free to expound.

Greg T. Jeffers said...


I must say I am surprised at you... you are an engineer for pete's sake!

Paretto's Law of the "Trivial Many and the Critical Few" apply to Regulator and Regulated, too... and all you done is point out the that "Trivial Many" are, in fact, trivial.

That does not buttress an argument against Smith's excellent points.

Donal Lang said...

I agree. This rule of 'perverse incentives' applies to any public program. For example, if the police were really good at their jobs, they'd solve all crime and be out of a job. If locking up criminals in prisons worked, we wouldn't need so many prisons.

There is an inbuilt incentive for policement to ENCOURAGE crime and prisons NOT to 'cure' criminals!

The real cure for this is payment by results. Policemen and prison guards should be paid a low basic wage, and a bonus on how many crimes they solve and how many criminals don't re-offend.
Similarly hospitals paid for people they cure with deductions for repeat occurences of the disease. Same with drug companies.

In addition the staff share the financial pain if they get sued, and maybe even 'share' negative of the overheads.

Then there's politicians and bankers and .... Hmmm, I could get into this!

Donal Lang said...

There is also the natural movement for societies to increase complexity; no-one makes things simpler, everyone adds a layer of detail. Almost every invention, research project, law, regulation, dissertation, clever financial product(?!), service job, management layer, add complexity.

Eventually the layers of complexity exceed the production/carrying capacity and the system collapses.

Like any moment now!

Greg T. Jeffers said...


Excellent points all... not that I have a solution...

bureaucrat said...

Just pointing out from first-hand experience that the over-regulated, over-ruled, over-budget, over-invasive, over-scary and over-threatening governing bodies in this country is a red herring. :) It's not the government that wants you scared. People like being scared -- all the time.

Anonymous said...


Do the math. You rely on this "just one more day" theory of survival. Somehow you truly believe that getting by just one more day is not that hard, and should always be possible, assuring the future. Be warned, that's exactly what Greenspan and Geithner and maybe Volcker believed that they could do with the credit bubble.

Private debt started growing faster than the GDP in 1974. They KNEW THEN that this was a problem, but decided that it was easier and more politically expedient to continue to ease credit to keep the bubble growing for just one more day than to pop it early and with much less harm. First, interest rates were reduced over time. When they could not be reduced much further, more populations had to be included in the housing market. Ever wonder why 85% of the American people oppose illegal immigration but it has had unstoppable bi-partisan support in Washington? Prop up housing! Then, after the supply of qualified (financially) borrowers was exhausted came the sub-prime loans and liar's loans and loans to anybody with a pulse. Eventually, the ability to extend things just one more day was exhausted. The credit bubble was run out for 35 years, but still the day of reckoning came.

Ever hear about the straw that broke the camel's back?

Seems to me that Mr. Smith is dead on.


Coal Guy

bureaucrat said...

I will get thru today, and likely the next day, and the next day ... The only thing we have to fear is debt overhang and prices for things going up, and even then, people having to sacrifice their plasma TVs, Mexican vacations, $75,000 Hummers, enough clothes to wear something new every day, and multiple trips to Brazzaz, where you get all you can eat salad bar and Brazilian meats for $50 a dinner, sacrificing that would not be a human tragedy. :)