The Incentives of Dynamic Systems

Sometimes it seems like the cold war never ended.

 

The western world is ostensibly a free-market democracy, and yet you could be forgiven for thinking otherwise. Corporations are universally reviled, sometimes with hilarious results. The socialist running for US president is widely beloved, while the business owner is a public joke. Academia and the more elite publications will, behind closed doors, admit they thought the former СССР had some good ideas. Despite what it says in our history books, this memetic conflict is still ongoing.

I don’t care so much about what name we give to Moloch. I’m much more interested in the things people say, the ways they behave when engaging in this cosmic struggle. It’s quite curious.

Despite our political squabbles, most people generally hold the same object-level beliefs. Our ideas regarding morality are largely the same. Murder is bad. Love is good. Don’t hurt other people. That sort of thing. At the end of the day, this is why we all do the things we do. Further, it’s not too difficult to judge whether something achieves these goals or not. While it’s hard to really predict the long term effects a given policy will have on society, we can all generally agree on which systems work and which systems fail. So why do we disagree so viciously on politics when we agree on the goals and have objective ways to measure them?

The big clue to me was when I started to notice, in the US anyway, that someone’s professed party often doesn’t do the things you would expect it to do from first principles. Republican ‘pro-business’ policies often give preferential treatment to certain businesses at the expense of others. Democrat social policies have a strange tendency to backfire on the poor and reward the upper-middle class. It’s almost as if people value Being A Democrat (Republican) more than they value actually achieving Democrat (Republican) goals.

When you see an obvious contradiction, and nobody else seems bothered by it, that’s a clue to look deeper. Many people are better at understanding than communicating. Perhaps something illegible is going on. Maybe a deeper cause drives this difference, and all we see is the bad explanation.


For all people’s opinions on social policy, they’re shockingly bad at systems thinking. People think, “X will solve our problems,” and go about trying to do X. What they fail to realize is that systems are dynamic and chaotic. If you do X to a system, the system will react. If your path to X is “do X until it’s done”, the system will push back, and you’ll never get anywhere. You can’t do X directly. You have to figure out something else, something that leads to X. If you aim where X is, you will miss. You have to aim at where X will be.

The key to all of this is incentives. Incentives matter. Anything you do to society will only change it today. But if you change the incentives, you will forevermore change what society will do in the future. There are implicit incentives in all our decisions. It seems people rarely give them the attention they deserve. But it’s interesting to look at the incentives that fall out of different policies, and ponder what they might mean.

As I said before, communism, capitalism, I don’t find this argument interesting. But the incentives that fall out of communism and capitalism in practice, these are fascinating. We have all these ideas in our heads, from society, from the media, about what these mean, but the incentives tell a different story. Following the incentives, the fundamental difference between the two is central planning. The naïve intuition might frame this as redistribution, but that’s not quite correct. There are ways to redistribute wealth in a decentralized fashion, but communism never implements itself that way.

Communism is fundamentally central planning. The core idea of communism is that we can identify coordination failures in systems, and if we could avoid them it would be better. Avoiding them necessitates an overseer, who can supervise and step in when necessary. This overseer is necessarily centralized.

Capitalism (or, more precisely, free markets) is fundamentally decentralization. The core idea of free markets is that by empowering a million people to make a million decisions for themselves, their incentives for success and against failure are stronger, and the diversity of experimentation will generate more and better solutions over time. This system does not work when a single director ultimately makes decisions.


As an illustration, consider the medical industry. Well, the medical industry in the US is a horrendously bad example of a free market, so consider the relatively free case of nonessential surgeries at private clinics.

I’ve lived in the US for many years, and I am a Canadian citizen. I have ample experience with both medical systems. The difference is a useful illustration of my point.

Consider knee replacement surgery. This surgery is nonessential, nobody will die without knee replacements, but it is significant for quality of life. In the US, if I need a knee replacement, I will go to a clinic, make an appointment, have the surgery next week, and a month later receive a bill for fifty thousand dollars. In Canada, I will go to my doctor, get on a waiting list, wait at least six months, have my surgery, and pay fifty bucks for some painkillers. The reason why medical care is astronomical in the US is well documented, but what’s up with Canada? Why does it take so long? The difference is in the incentives created by the US’s markets and Canada’s socialism.

In the US, a million people who need knee replacement are each able to weigh the costs and benefits of surgery, and make the right decision for themselves on whether or not to go under the knife. In Canada, this decision is ultimately delegated down to a central agency. Instead of a million people making a million decisions, one person (or committee) is making one million decisions on behalf of one million people.

This is an unmanageable burden. One person can’t do the work of a million people. That’s why most modern communistic proposals imagine massive computer systems to take on this burden. Failing that, the only way to manage this burden is to turn a million illegible decision processes into one simple, scalable bureaucratic policy.

A result of this is that the policy necessarily must be one-size-fits-all. Sure, it can be complicated, with exceptions carved out for this, that, or the other group. But the exceptions are still based on relatively simple factors such as demographic group membership. The process can’t mold itself to fit an individual’s needs. And it can’t react in real-time to shifting conditions in the environment. It’s restricted to a predefined set of procedures to be used in different contingencies

Additionally, the central authority’s ability to make the correct policies is limited. A central authority can’t possibly know what a million people want better than they do. It must accept trade-offs. The most common one is legibility. Earlier I mentioned that people often understand better than they communicate. The central planner’s policies can only be based on what people can communicate. They must engage in some streetlight sociology.


The end result is that communistic policies treat the systems they apply to as static systems, out of necessity. In the socialized healthcare of Canada, the central health agency is given a budget and told to optimize given that budget. The amount of resources they can bring to bear on the problem is ultimately fixed; all they can do is use them wisely. If a million people want knee replacements, and we can only afford 200,000 a year, a hell of a lot of people are going to be on wait lists.

In the free, decentralized system of the US, this doesn’t happen. The system is dynamic and open. It readily exchanges resources with the outside world. More people wanting knee replacements doesn’t stretch a fixed budget; it makes more resources available! Alternatively, as the price rises, more people are able to decide for themselves that it’s not worth the cost, and drop out of the pool of waiting patients. Nobody needs to preemptively put themselves on a wait list.

The tradeoff is cost. It sounds optimistic when I say “more resources available to provide more knee replacements,” but remember, resources means money. More knee replacements means that more money gets spent, in total. It is more expensive, in total. The budgetary mindset of the central planner allows them to aggressively drive down the price of the surgery, at the expense of other, non-monetary factors (opportunity cost, time, quality of service). In the US, no such compromise on service quality takes place; you simply spend more money instead.

It’s this difference in mindset, I think, that is at the heart of the deep political differences between socialists and free marketeers. If you’ll let me engage in a bit of armchair evolutionary psychology for a moment, consider the following. In situations where the pool of resources is fixed, the budgetary mindset makes sense. There is no chance the pool of resources will grow, so having a central authority allocate the resource makes sense. The alternative would be waste and instability in the service of a goal that we’ve already hypothesized is impossible.

On the other hand, very few resources are truly fixed, and rarely are they permanently so. In many cases, taking the central allocation approach is unnecessary, and retards the experimentation and diversity the leads to growing the resources you have.

It’s plausible that both types of situations were common throughout human history. In times of famine, where no more food would be available until after winter, the strict central management of resources is critical. At the confluence of two rivers, a trading post represents a place where you can grow the pool of a critical resource, at the expense of a less important one.

Perhaps, over time, evolution thought it valuable to fixate genes that bias people towards both mindsets, with the optimal one for any given situation ultimately dominating the memetic landscape.

Perhaps we all agree on what our goals should be. Perhaps we all are good at judging when we’ve succeeded or failed. But perhaps we’re all afflicted with genetic blindspots, and coming together to solve society’s problems involves overcoming the bug-ridden software that evolution has armed us with. Capitalism, communism, the flavour of the system doesn’t matter. What matters is that the incentives are aligned to best achieve the goals we all agree we should reach.

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About Simon Penner

Injecting compassion and humanity into political discussion. Disagreements welcome, but you must be kind and charitable.
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13 Responses to The Incentives of Dynamic Systems

  1. LapsedPacifist says:

    If communism = centralization, what about deliberate attempts to effect decentralization of communist/socialist systems, such as market socialism? Consider post 1974 Yugoslavia, say. Flawed though it was, it did everything possible to decentralize all decision making it could.

    Note that I’m not attempting to say that this is necessarily a _good_ solution, but it is not centralized.

    Like

    • Simon Penner says:

      I’m always happy to hear about experiments with new systems, especially when the experimentation is motivated by pragmatism and need instead of top-down ideology

      Like

  2. Simon Penner says:

    An alternative idea that I didn’t edit enough to make the blog post is the way we pay for university education.

    On one extreme, we can maximize decentralization, where every individual student is fully responsible for the costs, benefits, and decisions of their degree. The other extreme is a fully subsidized system where the government centrally provisions all education. (Obviously this is a continuum and you can mix and match the system as appropriate).

    Many people like the idea of partially or fully subsidized university, but they don’t appreciate the tradeoffs. As soon as someone other than the student is signing the cheques, you have moved the ultimate decision making authority from the million students into a more central location.

    When students make their decisions fully on their own, each student’s decision can best reflect their needs and desires, as those students are each very aware of their own lives. As soon as you centralize this process (by having someone else pay for it), you’ve moved part of the deciding.

    At that point, you’re making smaller amounts of people have to do the same amount of deciding, and they need to make things easier on themselves just as a manner of practicality. Maybe they develop blanket rules like “everyone gets what they want”. Maybe they develop demographic guidelines like “the first x% of people from each group get in”. Maybe they specify a fixed number of slots available and give them away first come first serve. Each of these systems has their own costs and benefits, and any may be the right tradeoff for a given goal. But all of these systems necessarily have the cost “the decision process is less flexible for any individual student”.

    I frequently wonder why people don’t seem to recognize this as the problem that it is. I suspect the Typical Mind Fallacy is a large factor. Essentially, the people advocating for more central control in any given scenario believe that the resulting decision process will be the same as their personal process, and can’t imagine that others would prefer a different decision or a different process

    Liked by 1 person

    • nidefatt says:

      I’ve been reading this site since what’s his name from Popehat came over. The downside is that this is a bunch of intellectual puffery. The upside is that I have grown slowly convinced that you are intelligent people. So. Good on you.

      I will give you another example. I am a public defender in Idaho, where public defense has been decentralized. Counties, rather than the state, are to maintain constitutionally proficient offices or contract with locals. The have failed- the ACLU sued and got a decision that is the epitome of how dumb are judges are- that the judiciary has no say over constitutionally acceptable defense and it is up to the legislature and executive. Seriously, that happened.

      Of course, what the ACLU and various organizations want is centralized control. The state has created an agency to do this, this agency is headed by a seven person panel of which two are from the legislature, one is chosen by our Chief Justice, and four by the governor. Of those four, one is from our state appellate public defender, and one “must have defense attorney experience.”

      The current panel is pushing for power. The public defenders in Boise are backing this push, believing it will be for the best. I am situated far outside of Boise, and my office fights its battles with the local county on an almost daily basis. But we know our enemy and we keep fighting. Now, Boise want to join in with coercive power over both our attorneys, and purse strings. When I told attorneys in Boise I thought this situation was not palatable, they were… far from pleased. And generally their response was to look at those two attorneys they like on the panel now. No thought as to the future. No concerns about what could happen. One of them even said that the commission would have no power over attorneys, despite how the laws they were pushing for were written, as if they weren’t lawyers suddenly.

      This intellectual dishonesty is the kind of thing I think you’re describing. But here, we have a situation where its a choice of where to place control of a government function, and just as you describe, otherwise intelligent people are pushing for central authority because they believe, despite years of being disappointed by our state government (which is one of the least defense friendly on earth and we all know it) that this commission will think like them and give them what they want.

      That’s how bad it really is.

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  3. Felix says:

    I think there’s a basic flaw in this argument. You say, “The budgetary mindset of the central planner allows them to aggressively drive down the price of the surgery, at the expense of other, non-monetary factors (opportunity cost, time, quality of service). In the US, no such compromise on service quality takes place; you simply spend more money instead.”

    I don’t buy this. You take it for granted that central planning reduces costs while free markets don’t. Everything I have seen says just the opposite — free markets provide great incentive to reduce costs and become more efficient, while central planners don’t know what costs really are and have no incentives to reduce them.

    My experience with statists also leads me to believe that their primary concern is not managing systems, but establish control structures with them in charge, then washing their hands of any responsibility by putting bureaucrats in charge while they go find fresh uncontrolled pastures.

    You say, “In situations where the pool of resources is fixed, the budgetary mindset makes sense.” But isn’t one of the basic tenets of economy all about the scarcity of resources? Just as peak oil has never happened, in spite of alarmist predictions, because increased prices increase the incentives to find more oil, so does increased demand for knee replacements increase the incentives for finding better and cheaper ways of replacing knees. Your typical bureaucrat has no such incentives; in fact, they seem to only want to increase their budget and bureaucracy, and efficiency is the wrong answer for them.

    Or maybe I missed the point. That’s always a possibility…..

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    • RoseMallow says:

      I’m going to have to disagree with you on…most of that.

      In the centralized system, the organization has a goal and a budget. They need to make the knee operation cheap enough to fit within the budget, otherwise they have failed at their goal. If the bureaucracy is set up right, it probably has some pretty solid incentives to make sure the costs are low enough.

      In the free market variant, the incentive is to maximize profits, not minimize costs. The company wants to minimize their own costs, while charging as much as they can get away with. Competition will probably drive that down some, but it will still cost the consumer significantly more than the actual price of producing the product in most cases.

      The article also directly addresses the fact that resources and demand won’t stay consistent, and talks about how that means that no matter how well set up the bureaucracy is, it won’t really be able to adjust properly to changes in the market, or be specialized enough to deal with all of the individual cases.

      Or maybe I missed the point of your comment. There’s always that possibility…

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    • Dave says:

      “I don’t buy this. You take it for granted that central planning reduces costs while free markets don’t. Everything I have seen says just the opposite — free markets provide great incentive to reduce costs and become more efficient, while central planners don’t know what costs really are and have no incentives to reduce them.”

      I don’t disagree with you in concept, but I think it’s too simplified for the situation of knee replacements.

      It sounds like you’re assuming that there are minimal externalities of getting a knee replacement, that there’s enough information flow for consumers to make a knowledgeable purchasing decision, and that the knee replacement surgeries are fungible enough that one is a replacement for another.

      I’m not sure that any of these assumptions are valid enough to drive competition sufficiently. In an ideal world, the suppliers would be competing on cost, and what you note is correct.

      Today, it’s hard for consumers to understand the OOP cost to the surgery, hard to compare the value and features from one provider to another, and very hard to measure the benefit of improved knee function.

      Additionally, as RoseMallow points out, the profit motive drives hospitals to reduce costs and improve their profitability, while maintaining product differentiation to sustain their price.

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    • Tim! says:

      We hit peak oil in the US in 1970, almost exactly as predicted: https://en.wikipedia.org/wiki/Peak_oil#/media/File:Hubbert_Upper-Bound_Peak_1956.png

      Yes, increased incentives post-peak added new sources to the list and created a new peak that we have not yet hit. OTOH, we’re still discovering the externalities of extracting from these new sources, and those externalities are not being accounted for in pricing. Oil is a finite resource on a historic time scale and we will eventually run out of new sources.

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  4. vendorx says:

    If this is the case then why does Germany surpass the US when it comes to wait times?

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  5. Jason K. says:

    The economics in this piece is poor. Under some situations, increased demand begets increased costs, but not most. You have to have a situation where the supply is insufficient, inelastic, and not have enough gains from economies of scale. Yes, you may see a temporary uptick, but that usually leads to more entrants into the market or efforts to expand supply, which pushes prices back down to equilibrium.

    Centralization generally doesn’t decrease costs, it just hides them. Your outlay for the knee surgery may have only been 6 months and painkillers, but that doesn’t mean that was the true cost of the surgery. The hospital, the doctor, and the bureaucracy still got paid. Essentially what has happened is that you have a nationalized insurance where people pay based on income (taxes) and inconvenience (wait times).

    It is true that in theory, a perfectly managed monopoly is the most economically efficient, however that is a bit like saying that in theory you can go back in time by traveling faster than light. There is a nigh insurmountable gap between theoretical potential and practical ability. The reality is that in the vast majority of situations, centralization increases costs because you now have to provide all the same services as before plus add paying all the bureaucrats (at a minimum).

    Incentives do matter. The bureaucrats’ incentives are inherently disconnected from everyone else in the process, which is at the core as to why centralization does not work. The irony of talking about not seeing past action to reaction and then arguing for centralization is rich indeed.

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    • Simon Penner says:

      If you think I was arguing _for_ centralization, I’ll have to come back and edit this for clarity. This was not at all my intention.

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  6. The concept of dynamical systems theory has its origins in Newtonian mechanics . There, as in other natural sciences and engineering disciplines, the evolution rule of dynamical systems is given implicitly by a relation that gives the state of the system only a short time into the future.

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  7. Joscha Bach says:

    Sure, it is all about incentives. But it seems that your example is not working very well. In the US, I cannot shop around for medication, surgery etc., because the market is not free. Entry in the market as a provider is heavily regulated, too, with a lot of gate keeping mechanisms, resulting in oligopolies. Consumers in the market are largely not buyers, and are instead insulated from the purchasing process through their insurances, which pass the price on as an aggregate. As a result, providers charge higher prices than anywhere else in the world, which on a societal level is hugely ineffective. (Medical costs are among the primary reasons for personal insolvency, and people without adequate insurance coverage often seem to resort to kitchen table surgery.) For a relatively free market, look to India.

    If the US had a free health care market, you would probably see much lower prices than in Canada, since central planning has usually fewer incentives to bring down cost than direct competition. This is not to say that free markets are always preferable. In the absence of working competition, their natural incentive is too provide the shabbiest service they can get away with, while extracting the largest overhead they can get away with. This is why privatized utilities tend not to work.

    Also note that markets often benefit from the economics of scale. Getting a new treatment past the FDA is expensive. As a result, providers have to make decisions for millions, too. It is not clear that MBAs are automatically better at these decisions than scientists.

    In many situations, even ideal market decisions lead to sub-optimal resource allocation outcomes because of path effects. As a result, we give up perfectly livable cities like Detroit, and exclude significant parts of the population from both production and consumption. Overcoming such problems will probably require a certain amount of centralized control.

    Note that the socialist countries of the Warsaw pact had never implemented any feedback systems like Chile intended in 1973 (right before the US got Pinochet to stop such silly experiments). Instead, they used 5 year plans, dreamt up by remote authorities that came to their positions through the Peter principle, based on stale demand data, and without meaningful incentives for innovation or even for keeping to the targets.

    Also note that large corporations tend not to implement market economies within their own structure, because they see this as wasteful. Instead, they use centralized planning.

    The above is not meant as an endorsement for a particular set of solutions, but as a response to your arguments.

    Like

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