Monday, 13 September 2010

Wilkins Micawber and Charles Ponzi are two versions of Homo Economicus. Vaguely right, or precisely wrong?

Dickens's Wilkins Micawber gets a bit of a mixed press.  I'd like to examine that in the context of economics and thought it might be interesting to do that by comparing him with Charles Ponzi. I'd like to end up examining the validity in economics of discounting future value, at the individual, corporate and national level and I point out some inherent difficulties in valuing a long time into the future, difficulties around the issue of the degree of certainty we might have concerning those valuations.

First of all, all too often you see the quotation "I'd rather be vaguely right than precisely wrong" inappropriately attributed to Keynes.  This is itself vaguely right but precisely wrong.  It first appeared in print in 1920, by the Cambridge logician/philosopher Carveth Read. Read overlapped with Keynes in Cambridge, when Keynes was doing a lot of work on logic and probability.  Their shared intellectual heritage would have included Mill, Comte, Herbert Spencer, going further back to Leibniz, John Wilkins and Francis Bacon.  Read wrote this now famous line in a Cambridge world which was pre-Tractatus but post Wittgenstein waving his hot poker at Popper.  You can get a sense of the tradition Read was following in the first line of the chapter in his book which delivers the 'vaguenes' line: "Precision of thought needs precision of language for the recording of such thought and for communicating it to others".  He goes on to say:

"The terms of ordinary language fall into the same classes as those of science: they stand for things, classes of things, parts, or qualities, or activities of things; but they are far less precise in their signification. As long as popular thought is vague its language must be vague; nor is it desirable too strictly to correct the language whilst the thought is incorrigible. Much of the effect of poetry and eloquence depends upon the elasticity and indirect suggestiveness of common terms. Even in reasoning upon some subjects, it is a mistake to aim at an unattainable precision. It is better to be vaguely right than exactly wrong. In the criticism of manners, of fine art, or of literature, in politics, religion and moral philosophy, what we are anxious to say is often far from clear to ourselves; and it is better to indicate our meaning approximately, or as we feel about it, than to convey a false meaning, or to lose the warmth and colour that are the life of such reflections. It is hard to decide whether more harm has been done by sophists who take a base advantage of the vagueness of common terms, or by honest paralogists (if I may use the word) who begin by deceiving themselves with a plausible definiteness of expression, and go on to propagate their delusions amongst followers eager for systematic insight but ignorant of the limits of its possibility."

It is great to see a bit of context around the quote.  Read can write.  I hope to return to the point about spurious certainty later.  But on to Micawber now.
Perhaps his most famous quotation concerns the small (2.5%) difference between happiness and misery and I guess this fame this quote subsequently achieved has something to do with the fineness in the balance between the two outcomes.  By the way, he gets to make some other excellent economics-related utterances.  How about this "a man who labours under the pressure of pecuniary embarrassments, is, with the generality of people, at a disadvantage. That disadvantage is not diminished, when that pressure necessitates the drawing of stipendiary emoluments, before those emoluments are strictly due and payable."  He's at a disadvantage, note.  This is somewhat at odds with his other famous quote: "I have no doubt I shall, please Heaven, begin to be more beforehand with the world, and to live in a perfectly new manner, if -if, in short, anything turns up." The Collins English dictionary is a bit unfair to this character, describing him as a person who idles and trusts to fortune.  Whilst I agree with the portrayal as essentially optimistic about the financial future, I'm not sure I agree he's an idler.  He certainly borrows from his friends and has tax problems.  But he had a succession of jobs, many of which didn't work out.  Charles Ponzi too got to run a bank too for a while.  Unlike Micawber, his defining idea appears to have been an arbitrage play.  A global-macro one, no less, leveraging, as it did, the macro-economic consequences of the post-WWI inflationary waves in Europe and the USA's growing hoard of gold.  Both Micawber and Ponzi then, in a sense, had reasonable ex-ante ideas for using borrowed money to make a profit.  Both had a view on the value of assets (real or imagined) in the future and their discounted present value.  This view was optimistic (perhaps even vague).  I think it fair to say they both were possessed of 'animal spirits'.

Anatole Kaletsky, in "Capitalism 4.0" invokes Micawber's 'something will turn up' at the national level.  He challenges the accusation, often made, that our nation is selling our descendants' inheritance by pointing out that "Our grandchildren will almost certainly be much richer than we are and will have more powerful technologies at their disposal".  So, is this optimism or over-optimism? GDP at the generational scale certainly looks regularly and impressively strong, even aside from occasional recessions.  Is this optimism an implicit bet on the stability of future GDP growth?

GDP growth is a national phenomenon.  But lets imagine we found an equally low variance, long lasting positive return investment opportunity at the level of the individual investor or company.  And we could see that growth theoretically lasting multiple generations (perhaps ultimately limited by a stabilisation in population growth, or the growth in numbers of consumers of some product).  Even if you as a corporation had no intention to do anything productive with the, say, a steady 4% coming in, if you merely paid out 3.95% in distributions to investors, would that constitute a Ponzi scheme?  It may look like a bond scheme, but it isn't, since there the principal goes to a company which can productively use the money.  And is there a justification for claiming the corporate level scheme to be Ponzi while maintaining that, at a national level, it isn't a Ponzi scheme?  At the macro-economic level, is our mere observation of this GDP growth pattern a cause for optimism, or for over-optimism?
The answer to these questions depends on whether you accept a role for Knightian uncertainty as opposed solely to an operationally defined calculus of probability.  Jonathan Aldred, in his book "The Skeptical Economist" does a good job in exploring the limitations of what many economists take for granted - the application of market-driven rate discounting to future cash flows. This is part of a wider critique of the assumptions and model underlying the homogeneous economic agent known as 'Homo Economicus'.  Quantitative assessments of risk are deemed incomplete - we're more likely to become sensitive to a risk in proportion to how involuntary we consider our current situation, how unfamiliar, unfair, etc.; also, the marginal utility of money is greater for poor people.  Just because individuals are impatient for cash (Keynes's liquidity preference), are we  justified in claiming that society ought to be?

Aldred continues, attacking the blind allegiance to discounting due to its dramatic influence on capital growth.  Small changes in the load/discount rate get magnified via the logic of compounding.
Which brings me back to the point about spurious precision.  If a very long term discount rate is needed (in the order of generations), how reliable would it be?  What would its confidence intervals be set to?   Wilkins Micawber was right - something did turn up - he became a bank manager.  I wonder what kind of credit allocator he became. Perhaps he would have made  precisely the wrong decision to lend to a fictional Ponzi.