Tuesday, March 29, 2011

The Information: A History, a Theory, a Flood

Freeman Dyson writes an interesting and provocative review of the new book by Gleick in the New York Review of Books, 3/10/11.

Gleick begins his book with a chapter titled "Drums That Talk". Dyson reviews this chapter and concludes:

"The story of the drum language illustrates the central dogma of information theory. The central dogma says, “Meaning is irrelevant.” Information is independent of the meaning that it expresses, and of the language used to express it. Information is an abstract concept, which can be embodied equally well in human speech or in writing or in drumbeats. All that is needed to transfer information from one language to another is a coding system. A coding system may be simple or complicated. If the code is simple, as it is for the drum language with its two tones, a given amount of information requires a longer message. If the code is complicated, as it is for spoken language, the same amount of information can be conveyed in a shorter message."

After two historical examples of rapid communication in Africa and France, "the rest of Gleick’s book is about the modern development of information technology. The modern history is dominated by two Americans, Samuel Morse and Claude Shannon. Samuel Morse was the inventor of Morse Code. He was also one of the pioneers who built a telegraph system using electricity conducted through wires instead of optical pointers deployed on towers. Morse launched his electric telegraph in 1838 and perfected the code in 1844. His code used short and long pulses of electric current to represent letters of the alphabet."

"Claude Shannon was the founding father of information theory. For a hundred years after the electric telegraph, other communication systems such as the telephone, radio, and television were invented and developed by engineers without any need for higher mathematics. Then Shannon supplied the theory to understand all of these systems together, defining information as an abstract quantity inherent in a telephone message or a television picture. Shannon brought higher mathematics into the game."

Dyson writes, "According to Gleick, the impact of information on human affairs came in three installments: first the history, the thousands of years during which people created and exchanged information without the concept of measuring it; second the theory, first formulated by Shannon; third the flood, in which we now live."

The reviewer writes a wonderful description of science:

"The information flood has also brought enormous benefits to science. The public has a distorted view of science, because children are taught in school that science is a collection of firmly established truths. In fact, science is not a collection of truths. It is a continuing exploration of mysteries. Wherever we go exploring in the world around us, we find mysteries. Our planet is covered by continents and oceans whose origin we cannot explain. Our atmosphere is constantly stirred by poorly understood disturbances that we call weather and climate. The visible matter in the universe is outweighed by a much larger quantity of dark invisible matter that we do not understand at all. The origin of life is a total mystery, and so is the existence of human consciousness. We have no clear idea how the electrical discharges occurring in nerve cells in our brains are connected with our feelings and desires and actions.

Even physics, the most exact and most firmly established branch of science, is still full of mysteries. We do not know how much of Shannon’s theory of information will remain valid when quantum devices replace classical electric circuits as the carriers of information. Quantum devices may be made of single atoms or microscopic magnetic circuits. All that we know for sure is that they can theoretically do certain jobs that are beyond the reach of classical devices. Quantum computing is still an unexplored mystery on the frontier of information theory. Science is the sum total of a great multitude of mysteries. It is an unending argument between a great multitude of voices. It resembles Wikipedia much more than it resembles the Encyclopaedia Britannica."

Dyson describes this flood of information in the context of evolution:

"The explosive growth of information in our human society is a part of the slower growth of ordered structures in the evolution of life as a whole. Life has for billions of years been evolving with organisms and ecosystems embodying increasing amounts of information. The evolution of life is a part of the evolution of the universe, which also evolves with increasing amounts of information embodied in ordered structures, galaxies and stars and planetary systems. In the living and in the nonliving world, we see a growth of order, starting from the featureless and uniform gas of the early universe and producing the magnificent diversity of weird objects that we see in the sky and in the rain forest. Everywhere around us, wherever we look, we see evidence of increasing order and increasing information. The technology arising from Shannon’s discoveries is only a local acceleration of the natural growth of information."

Dyson closes his review with some thoughts about the future:

"The vision of the future as an infinite playground, with an unending sequence of mysteries to be understood by an unending sequence of players exploring an unending supply of information, is a glorious vision for scientists. Scientists find the vision attractive, since it gives them a purpose for their existence and an unending supply of jobs. The vision is less attractive to artists and writers and ordinary people. Ordinary people are more interested in friends and family than in science. Ordinary people may not welcome a future spent swimming in an unending flood of information. A darker view of the information-dominated universe was described in a famous story, “The Library of Babel,” by Jorge Luis Borges in 1941.3 Borges imagined his library, with an infinite array of books and shelves and mirrors, as a metaphor for the universe.

Gleick’s book has an epilogue entitled “The Return of Meaning,” expressing the concerns of people who feel alienated from the prevailing scientific culture. The enormous success of information theory came from Shannon’s decision to separate information from meaning. His central dogma, “Meaning is irrelevant,” declared that information could be handled with greater freedom if it was treated as a mathematical abstraction independent of meaning. The consequence of this freedom is the flood of information in which we are drowning. The immense size of modern databases gives us a feeling of meaninglessness. Information in such quantities reminds us of Borges’s library extending infinitely in all directions. It is our task as humans to bring meaning back into this wasteland. As finite creatures who think and feel, we can create islands of meaning in the sea of information. Gleick ends his book with Borges’s image of the human condition:

We walk the corridors, searching the shelves and rearranging them, looking for lines of meaning amid leagues of cacophony and incoherence, reading the history of the past and of the future, collecting our thoughts and collecting the thoughts of others, and every so often glimpsing mirrors, in which we may recognize creatures of the information."

The Information: A History, a Theory, a Flood
by James Gleick

World Wide Mind

Excerpts from the book by Michael Chorost that were published on Seed Magazine:

"...technology advances by integrating. That is, when one system improves, it spurs improvement in other systems so they can keep up. When those systems improve, they in turn spur the first system to improve. The systems become increasingly dependent on each other. Their futures become mutually bound.

Take, for example, desktop computers and the software that runs them. Better computers let software engineers write bigger programs. Bigger programs create a demand for better computers. The computer manufacturers are happy to oblige, and the cycle starts all over again. A push is matched by a pull, which evokes a new push. That push-pull dynamic has rammed innovation into overdrive. For example, it took between 1900 and 1990 to develop computers that could perform one million instructions per second (MIPS) per thousand dollars. In 2005, computer manufacturers added an additional MIPS per thousand dollars to their computers every five hours.

A push-pull dynamic is hobbled, though, when one system can’t improve as fast as the other. The Internet is improving very fast. The human body improves very slowly. Our hands evolved to grip spears and plows, and so can type only so many emails in a day. Our senses evolved to monitor a largely unchanging savannah for friends and predators, and so can pay attention to only a handful of events at a time. To be sure, some human attributes like IQ appear to have risen in the twentieth century, but the rate of increase is much slower than technology’s. There is no Moore’s Law for human beings.

This mismatch between humans and the Internet imposes inherent limits on how much either can improve. This is unfortunate, because they are a natural match for a push-pull dynamic driving each other upward. Their strengths are complementary. The Internet is fast, while humans are slow; capacious, while humans are forgetful. Conversely, humans are self-aware while the Internet isn’t, and humans can interact with the physical world while the Internet can’t. But they also have aligned strengths: they are both intensely networked, intensely communicative entities."

There appear to be two solutions to this conundrum - either we integrate computers and communication technologies into humans to increase individual capacity (cyborgs) or we integrate everyone into one thinking organism exponentially increasing our capacity. I personally opt for the later over the former. The former leads possibility of the Singularity does not seem at attractive future. Beside, the later integration will force us to grow our social and spiritual skills in order to peacefully collaborate worldwide.

While I have not read Chorost's book, he seems to favor the latter option as well for he writes:

"To be sure, the Internet is a human invention reflecting human choices and values. However, it often looks as if it is a separate species with an internal logic of its own. The 1987 stock market crash has been blamed on program trading—computers that started selling frantically because every other computer was selling. The ceaseless war between viruses and antivirus programs looks eerily like the workings of a biological ecosystem. However, even if one posits that the Internet is comparable to a biological species, it’s obvious that it’s not very intelligent. It has primitive ways of “sensing” and “reacting,” but it has no self-awareness and no ability to formulate its own goals. Nor, as I argue later, could it ever reach such a state on its own. It could, however, be the backbone of a sophisticated new organism if physically integrated with humanity. The Internet would become a new nervous system for humanity, and humanity would become a new body and executive brain for the Internet."

Read more excerpts here.

His ideas are closely related to de Chardin's concept of the noogenesis. Read more about that concept here.

In either case, we are creating more complexity.

World Wide Mind: The Coming Integration of Humanity, Machines, and the Internet
, Michael Chorost, Free Press, 2011

Michael Chorost is a technology theorist with an unusual perspective: his body is the future. In 2001 he went completely deaf and had a computer implanted in his head to let him hear again. This transformative experience inspired his first book, Rebuilt: How Becoming Part Computer Made Me More Human, in which he wrote about how mastering his new ear, a cochlear implant, enabled him to enhance his creative potential as a human being. Dr. Chorost earned his B.A. at Brown University and studied computer programming, Renaissance drama, and cultural theory on the way to his Ph.D. at UT-Austin. He doesn’t draw sharp lines between programming, science, writing, and art; to him, these are all profoundly creative human endeavors.

Monday, March 21, 2011

The Big Short: Inside the Doomsday Machine

Felix Salmon in writing a review in Barnes and Noble Review of The Big Short[1] stated, “The Big Short is not the story of the crisis, as the crisis is commonly understood. The failure of Lehman brothers and of Fannie Mae and Freddie Mac; the stock-market crash; the bail-out of Detroit; the fevered all-nighters pulled at Treasury and the New York Fed; the fears that the entire global financial system was on the brink of collapse -- little if any of that is in this book.

Instead, Lewis has found a different story -- one which he started mining for a spectacular cover story in the December 2007 issue of Portfolio magazine, and which has culminated in this book, over two years later. It's the story of what used to be called the "subprime crisis" before it metastasized into something much larger and more dangerous than that. And it's also, like all Michael Lewis tales, a human story, which takes us deep inside unique characters like Steve Eisman and Mike Burry.

On the face of it, there's almost nothing sympathetic about these men. Their social skills are all but nonexistent; they live in a world of arcane financial analysis which might as well be a different planet for all that it has any bearing on the way that most of us live our lives; and they made their outsize profits by wagering hundreds of millions of dollars on the proposition that Americans across the country would end up being thrown out of their homes after they found themselves unable to make their mortgage payments.

What these men did was not "socially useless," to quote the chairman of the UK's Financial Services Authority, Lord Turner. It was worse than that: it was actively harmful, since they provided the fuel which kept the subprime mortgage furnace burning even when the country was running out of new junk mortgages to write.”

This is a well written story that every thinking person needs to read. We have been on a journey for a number of years that has now taken us to the position that we have two economies – the real economy and the financial economy. Coupled with that we have discovered that procedural innovations (changes in the way people interact with people) is a lot easier that product or process innovations. As a result a lot of the creative talent and innovative energy has been devoted to innovations in financial instruments so complex that they have become WMDs (weapons of mass deception). Not only did they deceive the general public, but their peers and themselves as well.

Lewis has a quote at the beginning of the book that touches on the blind faith almost everyone had in these financial instruments:

The most difficult subjects can be explained to the most slow-witted man if he has not formed any idea of them already; but the simplest thing cannot be made clear to the most intelligent man if he is firmly persuaded that he knows already, without a shadow of doubt, what is laid before him.

-Leo Tolstoy, 1897

The unbelievable size of the transactions and greed lead inexorably towards the tragedy it was born to be. Unfortunately, the game was rigged, the ones who perpetrated the deception walked away with tens of millions of dollars while the rest of us paid. And the people who paid dearest were those who defaulted on their mortgages and lost their homes.

Quoting Salmon, the book “is that rarest of beasts in a world drowning in financial-crisis books: a new book which actually breaks news. For instance, Lewis uncovers what could possibly be the single greatest trade that any Wall Street banker ever made: in December 2006 and January 2007, Deutsche's Greg Lippmann paid an insurance premium of 0.28 percentage points to take out insurance on $4 billion of triple-A-rated bonds from Morgan Stanley's Howie Hubler. Less than a year later, that $11 million bet paid off to the tune of a whopping $3.7 billion. I'll save you the math: that's an annual return of more than 33,000%.

There's lots more where that came from: this is an assiduously-reported and beautifully-written book. There aren't many reasons to be happy about the global financial crisis, but here's one: that it brought Michael Lewis back to his roots, to produce what is probably the single best piece of financial journalism ever written.”

Here are a few excerpts from the book:

Whatever Eisman was meant to be doing got pushed to one side. His job became a single-minded crusade against the Household Finance Corporation. He alerted newspaper reporters, he called up magazine writers, he became friendly with the Association of Community Organizations for Reform Now (ACORN), which must be the first time a guy from a Wall Street hedge fund exhibited such interest in an organization devoted to guarding the interests of the poor. He repeatedly pestered the office of the attorney general of the state of Washington. He was incredulous to learn that the attorney general had investigated Household and then been prevented, by a state judge, from releasing the results of his investigation. Eisman obtained a copy; its contents confirmed his worst suspicions. "I would say to the guy in the attorney general's office, 'Why aren't you arresting people?' He'd say, 'They're a powerful company. If they're gone, who would make subprime loans in the state of Washington?' I said, 'Believe me, there will be a train full of people coming to lend money.'"

Really, it was a federal issue. Household was peddling these deceptive mortgages all over the country. Yet the federal government failed to act. Instead, at the end of 2002, Household settled a class action suit out of court and agreed to pay a $484 million fine distributed to twelve states. The following year it sold itself, and its giant portfolio of subprime loans, for $15.5 billion to the British financial conglomerate the HSBC Group.

Eisman was genuinely shocked. "It never entered my mind that this could possibly happen," he said. "This wasn't just another company -this was the biggest company by far making subprime loans. And it was engaged in just blatant fraud. They should have taken the CEO out and hung him up by his fucking testicles. Instead they sold the company and the CEO made a hundred million dollars. And I thought, Whoa! That one didn't end the way it should have." His pessimism toward high finance was becoming tinged with political ideas. "That's when I started to see the social implications," he said. "If you are going to start a regulatory regime from scratch, you'd design it to protect middle- and lower-middle-income people, because the opportunity for them to get ripped off was so high. Instead what we had was a regime where those were the people who were protected the least."

What prepared him to see what was happening in the mortgage bond market, Paulson said, was a career of searching for overvalued bonds to bet against. "I loved the concept of shorting a bond because your downside was limited," he told me. "It's an asymmetrical bet." He was shocked how much easier and cheaper it was to buy a credit default swap[2] than it was to sell short an actual cash bond-even though they represented exactly the same bet. "I did half a billion. They said, 'Would you like to do a billion?' And I said, 'Why am I pussyfooting around?' It took two or three days to place twenty-five billion." Paulson had never encountered a market in which an investor could sell short 25 billion dollars' worth of a stock or bond without causing its price to move, even crash. "And we could have done fifty billion, if we'd wanted to."

What struck them powerfully was how cheaply the models allowed a person to speculate on situations that were likely to end in one of two dramatic ways. If, in the next year, a stock was going to be worth nothing or $100 a share, it was silly for anyone to sell a year-long option to buy the stock at $50 a share for $3. Yet the market often did something just like that. The model used by Wall Street to price trillions of dollars' worth of derivatives thought of the financial world as an orderly, continuous process. But the world was not continuous; it changed discontinuously, and often by accident.

Event-driven investing: That was the name they either coined or stole for what they were doing. That made it sound a lot less fun than it was. One day Charlie found himself intrigued by the market for ethanol futures. He didn't know much about ethanol, but he could see that it enjoyed a U.S. government subsidy of 50 cents a gallon, and so was supposed to trade at a 50-cent-a-gallon premium to gasoline, and always had. In early 2005, when he became interested, it traded, briefly, at a 50-cent discount to gas. He didn't know why and never found out; instead, Charlie bought two rail cars' worth of ethanol futures, and made headlines in Ethanol Today, a magazine of whose existence he was previously unaware. To the intense irritation of Cornwall's broker, they wound up having to accept rail cars filled with ethanol in some stockyard in Chicago-to make a sum of money that struck the broker as absurdly small. "The administrative complexity of what we were doing was out of proportion to our assets," said Charlie. "People who were our size didn't trade across asset classes."

A guy from a rating agency on whom Charlie tested Cornwall's investment thesis looked at him strangely and asked, "Are you sure you guys know what you're doing?" The market insiders didn't agree with them, but they didn't offer persuasive counter-arguments. Their main argument, in defense of subprime CDOs, was that "the CDO buyer will never go away." Their main argument, in defense of the underlying loans, was that, in their short history, they had never defaulted in meaningful amounts. Above the roulette tables, screens listed the results of the most recent twenty spins of the wheel. Gamblers would see that it had come up black the past eight spins, marvel at the improbability, and feel in their bones that the tiny silver ball was now more likely to land on red. That was the reason the casino bothered to list the wheel's most recent spins: to help gamblers to delude themselves. To give people the false confidence they needed to lay their chips on a roulette table. The entire food chain of intermediaries in the subprime mortgage market was duping itself with the same trick, using the foreshortened, statistically meaningless past to predict the future.

"No," said Eisman. "It's a zero. There is zero probability that your default rate will be five percent." The losses on subprime loans would be far, far greater. Before the guy could reply, Eisman's cell phone rang. Rather than shut it down, Eisman reached in his pocket and answered it. "Excuse me," he said, standing up. "But I need to take this call." And with that, he walked out of the speech. The caller was his wife.

"It wasn't important at all," she says with a sigh. "I was a prop." After that something must have come over Eisman, for he stopped looking for a fight and started looking for higher understanding. He walked around the Las Vegas casino incredulous at the spectacle before him: seven thousand people, all of whom seemed delighted with the world as they found it. A society with deep, troubling economic problems had rigged itself to disguise those problems, and the chief beneficiaries of the deceit were its financial middlemen. How could this be?

It was in Las Vegas that Eisman and his associates' attitude toward the U.S. bond market hardened into something like its final shape. As Vinny put it, "That was the moment when we said, 'Holy shit, this isn't just credit. This is a fictitious Ponzi scheme.'" In Vegas the question lingering at the back of their minds ceased to be, Do these bond market people know something we do not? It was replaced by, Do they deserve merely to be fired, or should they be put in jail? Are they delusional, or do they know what they're doing? Danny thought that the vast majority of the people in the industry were blinded by their interests and failed to see the risks they had created. Vinny, always darker, said, "There were more morons than crooks, but the crooks were higher up." The rating agencies were about as low as you could go and still be in the industry, and the people who worked for them really did not seem to know just how badly they had been gamed by big Wall Street firms.

Don’t be surprised if you see this book as a movie. (His earlier book The Blind Side was made into a movie.)It would make a compelling one, and I hope that that happens. This message needs to be understood by a larger audience than the ones willing to read this great book.

By the way, although the book never mentions this, at the core issues resides our friend complexity. But that’s another story.

The Big Short: Inside the Doomsday Machine, Michael Lewis, Norton, 2010, 291pp

[1] In finance, short selling (also known as shorting or going short) is the practice of selling assets, usually securities, that have been borrowed from a third party (usually a broker) with the intention of buying identical assets back at a later date to return to the lender. Wikipedia

[2] A credit default swap (CDS) can almost be thought of as a form of insurance. If a borrower of money does not repay her loan, she "defaults." If a lender has purchased a CDS on that loan from an insurance company, the lender can then use the default as a credit to swap it in exchange for a repayment from an insurance company. However, one does not need to be the lender to profit from this situation. Anyone (usually called a speculator) can purchase a CDS. Wikipedia

The True Believer: Thoughts on the Nature of Mass Movements

For a down-loadable version of this article, click here.

Eric Hoffer published this book in 1951 (There have been 23 editions published.) after studying and reflecting on the mass movements of his recent past. Even though this book is 60 years old, it is perhaps more relevant now than it ever was. In America we have become irreconcilably polarized on a number of factors important to our future. His thoughts provide some insight on this issue.
And, its application to the issue of fanatical, radical fundamentalism internationally is quite obvious. While the book definitely has structure and a narrative, it is primarily a series of thoughts in 125 sections. As the book’s title suggests, it is about two things – the true believer and mass movements.

In the Introduction Hoffer describes his book. “This book concerns itself chiefly with the active, revivalist phase of mass movements. This phase is dominated by the true believer-the man of fanatical faith who is ready to sacrifice his life for a holy cause-and an attempt is made to trace his genesis and outline his nature. As an aid in this effort, use is made of a working hypothesis. Starting out from the fact that the frustrated predominate among the early adherents of all mass movements and that they usually join of their own accord, it is assumed: 1) that frustration of itself, without any proselytizing prompting from the outside, can generate most of the peculiar characteristics of the true believer; 2) that an effective technique of conversion consists basically in the inculcation and fixation of proclivities and responses indigenous to the frustrated mind.”

Hoffer[1] does not take an exclusively negative view of true believers and the mass movements they begin.

Before the beginning of the book, Hoffer quotes Blaise Pascal from his book Pensées:

Man would fain[2] be great and sees that he is little; would fain be happy and sees that he is miserable; would fain be perfect and sees that he is full of imperfections; would fain be the object of the love and esteem of men, and sees that his faults merit only their aversion and contempt. The embarrassment wherein he finds himself produces in him the most unjust and criminal passions imaginable, for he conceives a mortal hatred against that truth which blames him and convinces him of his faults.

This quote provides a pretty good summary of Hoffer’s description of a true believer. This discontent with the self is not limited to any economic strata. Shakespeare even has King Richard express this in his play Richard III:

"Now is the winter of our discontent" are the opening words of the play and lay the groundwork for the portrait of Richard as a discontented man who is unhappy in a world that hates him. Later he describes himself as "Deformed, unfinished, sent before his time into this breathing world, scarce half made up". This deformity, which has now been shown to have been exaggerated or even deliberately faked in portraits of Richard, is given as the source of his supposed evil doings. He says that as he "cannot prove a lover" he is "determined to be a villain".

Hoffer writes, “There is in us a tendency to locate the shaping forces of our existence outside ourselves. Success and failure are unavoidably related in our minds with the state of things around us. Hence it is that people with a sense of fulfillment think it a good world and would like to conserve it as it is, while the frustrated favor radical change. The tendency to look for all causes outside ourselves persists even when it is clear that our state of being is the product of personal qualities such as ability, character, appearance, health and so on. "If anything ail a man," says Thoreau, "so that he does not perform his functions, if he have a pain in his bowels even ... he forthwith sets about reforming-the world."

It is understandable that those who fail should incline to blame the world for their failure. The remarkable thing is that the successful, too, however much they pride themselves on their foresight, fortitude, thrift and other "sterling qualities," are at bottom convinced that their success is the result of a fortuitous combination of circumstances[3]. The self-confidence of even the consistently successful is never absolute. They are never sure that they know all the ingredients which go into the making of their success. The outside world seems to them a precariously balanced mechanism, and so long as it ticks in their favor they are afraid to tinker with it. Thus the resistance to change and the ardent desire for it spring from the same conviction, and the one can be as vehement as the other.”

Read complete article.

The True Believer: Thoughts on the Nature of Mass Movements

Eric Hoffer, Harper and Row, 1951, 177pp

[1] “The book passes no judgments, and expresses no preferences. It merely tries to explain; and the explanations-all of them theories-are in the nature of suggestions and arguments even when they are stated in what seems a categorical tone. I can do no better than quote Montaigne: "All I say is by way of discourse, and nothing by way of advice. I should not speak so boldly if it were my due to be believed”."

[2] Archaic willingly; gladly

[3] Given what we now know about complex systems, this statement is probably true.

Tuesday, March 15, 2011

Design Fiction

I heard Bruce Sterling briefly speak last night at Plutopia 2011, SXSW in Austin about "design fiction". It's an intriguing concept, a concept that is searching for its meaning. Sterling has blogged on the subject.

Sterling quotes Dr. Stuart Candy's definition of design fiction. “Design fiction has emerged as a pre-eminent tool for designing, challenging and understanding speculative future realities. However, design fiction aims to make the extraordinary ordinary. It merges the elastic creativity of science fiction with everyday matter of fact reality. Furthermore, in using current media conventions as a way to express ideas about the future, design fiction is able to twist reality and trick us into accepting the fantastic as possibility.

“This process seems to afford us a moment in which we can reframe our expectations of reality. Consequently, it alters our conditional assumptions and stories we are using to define our future…”

Jullian Bleeker, Near Future Laboratory, blogged a definition of design fiction. "Design Fiction is making things that tell stories. It’s like science-fiction in that the stories bring into focus certain matters-of-concern, such as how life is lived, questioning how technology is used and its implications, speculating bout the course of events; all of the unique abilities of science-fiction to incite imagination-filling conversations about alternative futures. It’s about reading P.K. Dick as a systems administrator, or Bruce Sterling as a software design manual. It’s meant to encourage truly undisciplined approaches to making and circulating culture by ignoring disciplines that have invested so much in erecting boundaries between pragmatics and imagination

When you trace the knots that link science, fact and fiction you see the fascinating crosstalk between and amongst ideas and their materialization. In the tracing you see the simultaneous knowledge-making activities, speculating and pondering and realizing that things are made only by force of the imagination. In the midst of the tangle, one begins to see that fact and fiction are productively indistinguishable.

Design is about the future in a way similar to science fiction. It probes imaginatively and materializes ideas, the way science fiction materializes ideas, oftentimes through stories. What are the ways that all of these things — these canonical ways of making and remaking and imagining the world — can come together in a productive way, without hiding the details and without worrying about the nonsense of strict disciplinary boundaries?"

Tuesday, March 1, 2011

The Myth of the Laffer Curve

How many times in the last several months have you heard the mantra: If you reduce the tax rate, the economy will grow and we’ll get more tax revenue?

That mantra is based on the Laffer Curve, an economic thought experiment named after Arthur Laffer. The thought experiment is based on the following assumptions:
  • If the tax rate is 0%, then the government will get no revenue.
  • If the tax rate is 100%, the economy will collapse as there will be no incentive for private industry, and the government will get no revenue.
  • Between these two end points there is a tax rate that will maximize the governments’ revenue. This is usually represented as a parabola as shown below.

Let’s consider the assumptions:

  • Zero tax rate does not necessarily mean zero income. Many people freely give to charities and other organizations – money, time, products, services.
  • 100% tax rate does not necessarily mean that there will be no federal government revenue. There are at least two ways that this could occur. Exemptions and deductions would allow corporations and individuals to live well under a 100% tax rate. (President Roosevelt increased the tax rate on the wealthy to 91%, in order to curb greed, and the economy grew.) In many totalitarian governments, all the money goes to the government, and an economy still exists.
  • The shape of the curve defies reason. A parabola with a single peak is probably the most unlikely shape of the relationship, if one even exists. If there is a cause and effect relationship between tax rate and government revenue, it is probably much more complicated.

Even if one accepts the curve, in order for the mantra to be true, the U.S. would have to be operating on the right hand side of the curve. There’s no data to assume that that is true. Attempts to gather data in support of the Laffer Curve are very controversial because there is no simple model of an economy, and because we can’t achieve ceteris paribus1. (We can’t make all things equal between the various states of the economy we want to compare.)

Here’s one example of an attempt discussed by Mark Thoma in Economist’s View:

He first shows a curve created by Kevin Hassett, American Enterprise Institute, in order to prove that tax cuts will generate revenue for the government.

First comparing all these different economies is flawed because we cannot assume that all other conditions are the same across all the economies. Secondly, as Thoma points out, the curve “fitting” the data was forced to look like the theoretical Laffer Curve in order to make the political point.

Thoma suggests that a more reasonable fit to the data is as shown below:

As a matter of fact, there’s no data at all to support the Laffer Curve.

It is pretty clear now that a modern economy is a complex system, and as a result, attempts to find casual relationship between the two parameters is futile. The economy is likely a complex system in a non equilibrium critical state. It would not surprise me at all to find chaotic regions in relationships like these.

1 Ceteris paribus or caeteris paribus is a Latin phrase, literally translated as "with other things the same," or "all other things being equal or held constant." It is an example of an ablative absolute and is commonly rendered in English as "all other things being equal." A prediction, or a statement about causal or logical connections between two states of affairs, is qualified by ceteris paribus in order to acknowledge, and to rule out, the possibility of other factors that could override the relationship between the antecedent and the consequent.