Sunk Costs and The Sense of Self

My 3 year-old will scream. She will lay on the floor, thrash about, and make demands as an infant would if they could communicate and develop the motor control adequate to do so. It doesn’t matter whether she can remember the reason for her disposition – she will continue. My wife and I usually sense the situation. We could get angry and threaten punishments. Alternatively, we know that no amount of reasoning and attempts at persuasion will convert our daughter’s behavior into the sweet, desirable sort. We have found that smothering her with love works best. And when the demands of other children prevent such single-minded attention, we at least try to act lovingly toward her.

My wife is quite beside herself. Why is this happening? (Truth be told, it’s all my fault. It’s in the genes.) Sometimes we see the momentary consideration of a calmer world in our daughter’s face. Then, she rejects it like there is no goodness left in the world. To be clear: I see my daughter know that she can stop her comprehensive riot and instead enjoy some other activity, then definitively decline the opportunity. She has cognitive dissonance.

My child is not crazy. One might say that she is irrational. The entirety of her behavior up to that point is a sunk cost. She could just stop the outburst and feel better. But she doesn’t. Why the heck doesn’t she?

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The Role of Prices in an Emergency, Winter Storm Edition

When natural disasters and other emergencies strike, two things are certain. First, many essential goods will run out of stock at stores. Second, economists will complain that if only prices would rise in response to the increase in demand, shortages could be avoided.

Let’s take the current winter storm passing through much of the center of the nation, importantly including the southern US where both individuals and governments are unprepared for major winter storms. Here is a sign up at Home Depot in Arkansas:

I can verify that many people in Arkansas don’t have snow shovels. I’ve seen folks using dust pans and leaf rakes to try and clear their driveway. This video is a few years old, but I have no doubt that someone in Arkansas right now is strapping a widescreen TV box to their lawn tractor to clear snow.

So why no snow shovels in Arkansas at Home Depot? The common answer: it doesn’t snow much here, so the stores don’t stock many, and then when it does snow everyone rushes out to buy them.

Simple enough, but the economist says: WRONG! The reason Home Depot doesn’t have any snow shovels in Arkansas is because they didn’t raise the price. Why do economists insist on this?

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The Massive SolarWinds Hack: A Work of Art

With all the uproar around the election in December, the news of the SolarWinds data breach did not get the attention it deserved. Some well-resourced foreign organization, almost certainly in Russia, succeeded in infiltrating the data systems of an astounding 18,000 or more U.S. organizations. These included major federal agencies such as the Pentagon, the Department of Homeland Security, the State Department, the Department of Energy, the National Nuclear Security Administration, and the Treasury, and other big targets like Microsoft, Cisco, Intel, and Deloitte, and organizations like the California Department of State Hospitals, and Kent State University. Security watchdogs run out of adjectives (“11 out of 10”) in characterizing the magnitude of this hack.

At the same time, security experts cannot help admiring the sheer artistry of this exploit. Hackers themselves often view their codes as a work of art. According to one cybersecurity expert, “Programmers and hackers like to sign their work like artists…So they sign that code in various ways. Often, they’ll leave their initials or they’ll try to be cute and put some sort of cryptic message.” So how was this hack accomplished?

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You’ll Never Walk Alone…to the Moon🚀?

As a dedicated supporter of Tottenham Hotspur Football Club, it is with much shame that I have referenced the anthem of Liverpool FC, but the sentiment implied by their club slogan is a powerful one.* To promise someone they will never have to suffer the torments of loneliness is to promise them a lifetime of riches. When we soft, vulnerable human beings find a source of community and support, we are loathe to give it up. Which is to say the promise of membership and threat of banishment are powerful means of solving collective action problems.

The promise of forever walking within columns of lockstep compatriots is a big part of why Gamestop (GME) went to the moon 🚀🚀🚀, but also why it came back down to earth. As Scott noted in his post, the story of the last, and most meteoric, stage of the Gamestop saga was the “short-squeeze”– short-sellers suddenly desperate to cover their positions found themselves needing more shares than existed, while the “unsophisticated” gamblers of r/wallstreetbets refused to sell their shares. Specifically, the large, but uncoordinated institutional short-position holders all pursued their independent self-interest, while the seemingly disaggregated redditors managed to solve their collective action problem. Which raises what, to me, is the most interesting question of the whole saga: if coordinating a short-squeeze is so lucrative, why doesn’t it happen more often? Put another way, why were a large number of strangers able to coordinate a complex financial gambit rarely pulled off by sophisticated institutional investors?


The answer, in part, is that they weren’t strangers. They may be anonymous to one another, absent recognition or connection in real life (IRL aka meatspace), but that doesn’t make them strangers. These men and women had built a community so deep they had their own (often incredibly offensive) language. Their own jokes. They had a culture and sources of status, going so far as to create their own within-group celebrities. And, absent any visible coordination, that culture had evolved in this moment toward a single idea: hold the stock. They were playing a massive prisoner’s dilemma game with each other. Can you form a group for the express purpose of creating a short-squeeze? Probably not – the very action of creating an identity around profit from financial speculation belies the prospect of building an identity valued more than pure profit by its members. That’s the rub – if you want to pull off a massive collective financial action, you’re going to have to build a group of people interested in financial collective action that nonetheless values the identity of the group above the profits of collective financial action. That’s what makes this Planet Money podcast about Gamestop so special– more than anyone anyone else, they seemed to understand that the absurdist emoji usage and language, the elaborate memes, the actual freaking sea-shanties, those weren’t just color for the story, they were the story. Hedge funds weren’t losing tens (hundreds?) of millions of dollars in a zero sum game to a bunch of idiots obsessed with chicken tender-centric memes and sea shanties. They were losing a millions of dollars in a zero sum game because of the memes and sea shanties.

https://blog.methodsconsultants.com/posts/the-prisoners-dilemma/

Put succinctly, at every stage leading up to and during the short-squeeze, each and every holder of Gamestock shares would have been better “defecting” on their r\wallstreetbets comrades-in-arms. Yes, the group is better off if everyone holds, but everyone knows the incentives faced by everyone else, which creates a seemingly irresistible economic gravity of self-interest (defect, defect). So how do we solve these collective action problems? Well, first and foremost, we change the payoffs. That’s what we do in successful families, mafias, and religious groups. It’s what we fail to do in our misfiring coups, cooperatives, and communes.

Yes, your bank account balance will increment upwards if you defect and sell your stock. But that also means you’re no longer a true Son of Gondor. Sure, no one else on the subreddit knows it, but you’ll know it. You’ll know it in your cold, lonely, traitorous heart. Sure, you can use the words and participate in the jokes, but will you ever know the same sense of fellow-feeling within the community as you knew before. That’s a real cost. Is it worth cashing in $5000 in profit a week early, especially knowing it might be worth more next week? Remember – the benefit of group identity doesn’t have to be greater than the profit at hand, it only has to be greater than the risk holding the stock bears for your future profit. Combined with a little motivated reasoning, and it quickly becomes clear how a community, formed independent of profit-via-collective-action, now suddenly becomes an engine of pro-social decision-making sufficient to create an existential threat to any institution over-leveraged on a short position.

The same payoff matrix, however, also demonstrates that a short-squeeze built around a group identity is living on borrowed time. With every short position that gets closed out, the price climbs both higher and closer to its (actually) inevitable peak. There are a finite number of short positions, and there is a finite number of days their share lenders will allow them to hold out, all of which mean a peak will be reached, after that point the price will begin to rapidly decline. Which all means that as the price rises the risk to holding also rises, both of which are increasing the opportunity costs of holding the stock, shifting the payoffs back to a classic Prisoner’s Dilemma. Sure, your group identity might be worth $5K, or even $50K, but there’s a point at which anonymous community is dominated by the prospect of material wealth. I’m not saying you can buy true friends, but eventually you can buy something that offers a close substitute for anonymous friends. Or an island.


*I mean, I personally believe “To Dare is to Do” is a far smarter and sexier slogan.

Charities will pick up used stuff but not businesses

There are reality TV shows dedicated to the spectacle of Americans drowning in their own material goods. What a year to be alive. Household income is rising around the world, as will clutter issues.

For now, I’m abstracting away from irrational hoarders. Lots of people have items that they would happily sell at a small price if only a buyer would come to their home. I see people posting items for sale all the time online, with the condition that the buyer come to them. (Most of these items are “used”, but some are brand new in the box.)

Why is there not a truck circling every American neighborhood offering to haul away unwanted stuff in exchange for a small payment?

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Economics of Romance

In the immortal words of Haddaway, “What is love?” Despite being in bed all of Tuesday, and not being up-to-the-task of teaching Wednesday, I mustered enough energy to talk with the Economics Club at FSU about the “Economics of Romance”.

In that talk, I started with some good economics jokes — some of which can be found here. Skipped some really bad economics pick-up lines, and waxed about the dangers of thinking at the margin in a world that thinks about levels. For example, the next time your spouse asks whether the presentation you’re writing is more important than them …. well, don’t try to explain marginal thinking to them.

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Age-Old Dads

Do you know how old you are?

I’m 33. Specifically, I’m 33 years, 29 days old. I don’t know the time of day that I was born, but my mom probably remembers within a couple of hours. My dad did not keep track of my age. Growing up, it was normal for him to take me to a sports registration event and need to ask me for plenty of my details in order to complete the paperwork.

Do you know the age of your children? Is it normal for parents to lose track? Or is it just the dads?  …Or just my dad? I have no idea what is typical.

But I do have some decent evidence that, had my dad lived in 1850, he would not have been such an anomaly. Consider exhibit A: A histogram of US ages in 1850. The population was only about 23 million at the time and we have the age for about 19 million of those people. So the graph is relatively representative (IPUMS census data).

Do you notice anything weird about the graph?

That’s the question I asked my Western Economic History class.

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Broad Base, Low Rates: Every US State Fails on Good Sales Tax Principles

In a previous post, I contrasted the income and property taxes, but I left out the other important tax: the retail sales tax. So let’s rectify that omission.

The retail sales tax is like the “Little Engine that Could,” delivering a steady stream of revenue to governments, while mostly staying out of the passionate debates surrounding the income and sales taxes. About 23% of state and local tax revenue comes from general sales taxes in the US, roughly equal to income taxes, and if you include selective sales taxes it’s slightly larger than the property tax share.

But there’s a problem with sales tax. The sales tax “base,” basically the extent of economic activity that the base covers, has been shrinking. A lot. As Jared Walczak has recently written, in just the past 20 years the “breadth” of the sales tax (how much of the potential base it covers) has fallen from about 50% to 30%.

As Walczak also notes, there are seven or so broadly agreed on principles of sales taxes, but I would say there are two primary ones (the first two on his list):

  1. An ideal sales tax is imposed on all final consumption, both goods and services.
  2. An ideal sales tax exempts all intermediate transactions (business inputs) to avoid tax pyramiding.

But US states violate these two principles in various ways, leading to (oddly enough) a tax base that is simultaneously too narrow and too wide. Why is this?

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Why Short Selling Is a Good Thing for the Stock Market and Investors Large and Small

We noted earlier the hubbub over a hive of little investors on Reddit outfoxing some big Wall Street firms who had made massive short bets on the stock of GameStop. Some of the narrative around this event has painted short selling as a secret, evil practice only available for the big guys. But none of that is true.

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