Wednesday, October 12, 2011

In praise of "slavery" or Why education should be equity financed

As an avowed free market libertarian, I am, in general, opposed to Government intervention in the economy. Conceptually, an intervention can be justified only if the nature of the problem is a "market failure" , or if a "public good" has to be provided. Even in such cases, the intervention is justified if and only if the proposed intervention solves the identified problem without inducing unintended collateral damage.

Hence whenever any Government intervention is proposed the tests that I use are a) Is there a market failure? b) If not, are there gaps in financial markets that prevent the market from functioning and then c) Is the cost-benefit evaluation of the intervention better than laissez faire?

The reason I think about financial markets separately is that a well functioning financial market is an unstated assumption in free market theory. Markets for "real goods" can be hampered if people are not able to make intertemporal trade-offs (e.g., borrow money to start a company and then repay it later) or manage risk (e.g., insurance for different "states of the world"- investments may dry up if people think that a single event can wipe out their money)

Having laid out the conceptual framework let me get to a specific example: Recently when I contested the case for Government intervention in education by a friend, he asked me how I would view the problem? Without Government intervention (either by being the provider of free/subsidized education or being the payor by schemes such as school vouchers or Government mandated low interest rate education loans), wouldn't the market for education just collapse- perpetuating poverty since the poor will not have access to education?

The argument seems sound: While education is not a public good in the economic sense (since it is definitely excludable, though it is somewhat non-rival), for a poor person, the benefits of being educated are clear, but how would he ever raise the money to pay the fee?

Is there a gap in financial markets to provide the same? Why have student loans not solved the problem?

For that take a project finance view to education (that is, consider that educating a person is a project. An applicant comes to you (a financier) and asks you for money to finance his education. How would you view this proposal in purely financial terms?). What are the characteristics of this project in financial terms:

1. The payoff is real, but variable: Education definitely leads to an increased economic payoff to the beneficiary (i.e. the applicant). However the degree of benefit is highly variable (see the high distribution of income among all people that you attended school with). Hence the financial requirement is for risk capital, since the financier has to be willing to live with variable payoffs.

2. The payoff is deferred: The returns to education typically accrue after a time gap (for school education the gap is considerable- maybe as high as 15-25 years). Hence the financial requirement is for patient capital, the financier should be willing to defer his expectation on when his money would be returned

Hence from a project finance standpoint, the financier needs to provide patient risk capital. In finance, the capital that has this characteristic is not debt (that is loans) but equity. Equity implies taking a risk, and being content with getting the payback much later. But in equity, when the investment does payoff, you get a much higher return (unlike debt where the returns are fixed)

The missing gap in financial markets is that you cannot buy equity in people (such contracts are generally not allowed in law). If I could sell a part of myself (in financial terms) I may be able to raise the money needed for education.

Markets would arise where we could trade shares in people. Just as in financial markets for companies you have equity investors at various stages of financing, based on their own risk appetites and expertise (for example, angel investors for startups, venture capitalists for fledgling companies, private equity firms for different stages of growth, and the capital markets for more mature companies) we would have various investor profiles for investing in people too.

For example I may make a bet that out of 500 schoolchildren in a village in Bihar,my assessment is that at least 2-3 people may end up as high income earners. If I invest by taking a stake (say 50%) in each of them and pay for their school fees, they will owe me 50% of their income in perpetuity.

The crucial point here is that many investments may fail, but the successes could be so huge so as to justify the investments across the entire portfolio (just as VC and PE firms do with companies).

Such an investor, would at a later stage, offload some of his stake in specific people, to later stage investors. Financial aggregators would warehouse risk across multiple investments (for example, I will create a scrip tha is an aggregation across 10,000 IIT students which I will trade; this may raise the money to finance their MS/MBA in the US in top schools), just as mutual funds and other funds do for companies.

In industries of a "superstar" nature, such contracts actually exist! In an industry like book publishing, or music, the distribution of incomes is very high- successful people earn huge amounts (like  Lady Gaga or a writer like J.K. Rowling), unsuccessful ones end up with no money. Music companies or book publishers typically take up "rights", that is a percentage of the revenue from the sales of the book/ album. This is a equity like contract.

But such a contract would not be possible for the person's earnings as a whole- which is why they don;t exist for other industries.

Look forward to the day when such an innovation would be allowed!

Tuesday, October 11, 2011

Arthashastra and Antibiotics: Alternative approaches to disease control

The latest news in the public health sphere in India is the fear of a new antibiotic-resistant "superbug"- namely the NDM-1 gene

In many ways, this is the latest illustration of how we may need to try alternative approaches to the field of communicable disease control.

First, the context: "Superbugs" are newly evolved species of bacteria that are antibiotic-resistant. To defeat the menace of superbugs, we need to understand what fundamentally leads them to arise.

The answer is antibiotics itself! In essence. the mechanism is as follows: "Simple" forms of bacteria infect us, and if their effects are malign (not all bacteria are harmful to human beings), we seek to treat them with antibiotics.

The use of these antibiotics effectively causes the evolution of superbugs.

Now, it so happens that the rate of bacterial evolution is high. The "rate" of evolution is governed by 2 things- how often an organism mutates (scientists still do not understand what governs this) and how efficient natural selection is in weeding out "bad" mutations ("Bad" here refers only to the ability of the mutated organism to survive and reproduce, not to its effects on other organisms)

We don't have control on the first mechanism (that is, the rate of mutation)- it so happens that bacteria mutate really fast. But in using antibiotics, we are ensuring that "weak" or "bad" mutations are weeded out even more efficiently.  In other words, we are helping the superbugs develop faster!

Another way to explain this is to say that our use of antibiotics makes bacteria "want" to develop antibiotic-resistant forms (this is the shorthand that we often use, which is misleading since evolution has no agency, or purpose- it just is. But using this shorthand helps us understand the phenomenon better)

This is an arms race that we are condemned to lose- for example, the rampant use of methicilin  to treat staph infections led to the rise of MRSA (methicilin resistant staph infection), the use of vancomycin to treat MRSA then has led to the the evolution of VRSA (vancomycin resistant staph). We are chasing a moving target, one that moves much faster than we can.

But then, what choice do we have? Clearly, the answer cannot be to leave bacterial infections untreated.

An alternative approach is to actually help the evolution of less malign bacteria- to come to some kind of mutual accommodation with bacteria rather than look to vanquish them.

Let me use a concept from Kautilya's Arthashastra (the seminal text on the use of pragmatic realpolitik to achieve one's strategic goals) to illustrate the point.

In Arthashastra, Kautilya delineates 4 ways to deal with any adversary- "sama" (use of logic or argument), "dama" (gift, bribery or blandishment), "bheda" (sow dissension or confusion) and "danda" (use of force)

Fundamentally, our way of dealing with bacterial disease control is "danda"- destroy the adversary with force.

Now, that is a smart strategy only if the power asymmetry is disproportionately in your favor, and the costs of using force are low.

This is clearly not the case with the use of antibiotics.

So why not try an alternative approach- one inspired by "dama"? Can we bribe our way towards more benign forms of bacteria?

One radical approach in disease control (pioneered by the evolutionary biologist Paul Ewald) actually is looking to do that.

The basic concept to understand is on how diseases spread. Some diseases, like a common cold, are deliberately not virulent- the reason is that by not debilitating you severely, it can keep you up and moving, sneezing all the way so that you can infect other people (translation: help it survive and reproduce). Other diseases such as African sleeping sickness or malaria are virulent since by incapacitating us it increases the probability of its own spread (since the mosquitoes that spread it from one host to another can get to you easier if you are pushed to the brink of death and are unable to move).

So in many ways, the degree of virulence of a disease is determined by the modes of transmission.

Hence, if we were to attack not the disease directly, but the modes of transmissions, we can effectively bribe the infections towards lower virulence.

For example if we spend our medical research money, not on developing antibiotics, but on cleaning water supply or on providing mosquito nets, there is evolutionary pressure on the infectious agents to move towards lower virulence, since for their own spread they need us to be moving around. History also suggests this- when cholera outbreaks spread from Peru to Ecuador (where the water supply was poorly protected), the bacteria became more virulent; when it moved to Chile (where the water supply was much better protected), it became less virulent since it needed people to be alive and mobile, in order for it to spread. (Source: Survival of the Sickest by Sharon Moalem)

Effectively this is a policy of accommodation with the infectious agents- we will not fight you, we will cooperate with you to help you spread, but you need to make your effect on us more benign! By bribing them thus, we may have a far better chance at survival.

I was thinking about this also when I was watching the movie "Contagion". Communicable disease control is really hard- the movie brought out the point not only of the large scale destruction that a single "Black swan" (low probability, high impact) event can bring about, but also that even after a "cure" is discovered, the time to market is so high due to the stringent requirements on testing by the FDA, as also the scale of production and distribution required.

We need multiple approaches to deal with this problem, and the wisdom from the Arthashastra of how deal with adversaries may have useful pointers on what kind of approach we may consider!

Tuesday, March 15, 2011

Stocks and flows: Why Larry Summers is right...but should be ignored

It's not often that I write in favor of an avowed Keynesian. But much of the criticism of Summers on his remarks about the economic impact of the earthquake that has caused severe destruction in Japan is based on stuff that he simply did not say (put it down as a case of "What you read, and what you don't read! :). 

Here's what he said: 

Monday, March 14, 2011

The Black Swan: Technique, transcendence and the artistic endeavour

Jai Arjun Singh (Jabberwock) had a very interesting post on the parallels between "The Black Swan" and "The King's Speech" .

Here are my own unstructured thoughts on the Black Swan, which I personally loved:
  • More than anything else, for me the movie was about the nature of the artistic endeavor itself. When I was at IIM, I remember that during a lecture, in a very interesting diversion, my strategy professor was telling us about how artists differ from "normal" people in that they get "obsessed". What is but a fleeting glance, an ephemeral emotion for us, becomes the center of their attention, something they get fixated with (think of the indulgent detail with which the Impressionist painters would bring their subjects, drawn from everyday images, to life). In the Black Swan the extent of this obsession is amplified for dramatic effect, but at the core, like all good works of art, it conveys a deep insight: of how the nature of the artistic endeavor is inherently obsessive
  • Secondly, the movie brings out one theme of art that is of particular interest to me, what I call the interplay between "Technique" and "Transcendence". Could truly beautiful art arise out of following rigid rules? Isn't there something inherently contradictory about being "creative" and being rule-bound? Not really. In Douglas Hofstadter's works, he vividly illustrates how it is false to think of these two as a dichotomy; that technique, when properly employed would be in aid of the transcendent nature of art. Creativity arises in how rules are employed not necessarily in flouting them. The requirements of meter for poetry, for following the note patterns of a raga in Indian classical music, of techniques in editing and camera work in cinema, enhance and aid the creativity, rather than hinder it. However, while technique aids creativity,  art cannot be explained by invoking technique alone. A reductionist view of art, in terms of the technique used to create it, would not capture it wholly. That "extra" dimension, which is so difficult to describe, but easy to perceive when it is present, is "transcendence". In the Black Swan too, the limitation of Nina as an artist is the same, flawless technique, but lacking that transcendent quality to take it beyond technique alone. As a theme, I think this interplay between technique and transcendence is on of the most fascinating aspects to bring out in any work about art, and the Black Swan does it very well.
  • Every work of art is an idea. One of the things that I judge a work of art by is if this form of art was the most appropriate vehicle to convey the idea that the artist wanted to share. Every type of art has its own distinctive property- cinema's is the "moving image", paintings are about an arrested image, music is about emotion in sound, and a novel is a complex meditation on the human condition, where the artist has the luxury of discarding the constraints of both space and time , while cinema is bound by it. A movie length of 1 minute, has to take 1 minute to show, it is a real-time medium. Movies cover a longer time span by "cheating", by not showing something that transpired. With a novel, on the other hand, the writer can spend several pages just describing what happened in a fleeting second. There is no requirement to stay married to the actual time (or even space) of the real world, while cinema has to stay very close to it( the most cinema can do is "slow-mo" cameras for time, zooming for space, but that is far less rich than the lens that a writer can use. The greatest writers use this distinctive quality of cinema very well. Good writers always use this aspect of the novel well, the most celebrated example in the modern novel would be James Joyce's Ulysses, even later writers like Ian McEwan (one of my favorites from the current crop) meditate about a single instant of time or a focal point in space, and with rich and vivid description invite the reader to experience it more wholly than we even do on real life. A novel is the writer's way of making the reader experience the full force of his obsessive fixation of what would otherwise be an ephemeral experience. In fact, I think this is why most movies made from books fail to impress. the clich├ęd explanation that is parroted is that with a book you could imagine the visuals yourself, while a movie does not allow that, but that does not satisfy me for several reasons: a) How much time do we really spend visualizing what we are reading about? b) I see no reason to assume that my imagination would always necessarily lead to a more vivid visual than that of a director and c) If that were the case, everything should be a book, movies will always be an inferior medium! Rather I think it is because the nature of a particular story or idea required all the tools that only a novel could provide, and that the inherent limitations of cinema for that particular purpose, is what prevents the movie from having the same impact as the book. Similarly, cinema has its own distinctive advantages (multiple perspectives, moving images etc.), and a great movie could choose to use them. It is for that reason that a movie like say, The Shawshank Redemption, while being very entertaining a truly awesome movie, would never be something that I cite as the best cinema, because the nature of that story idea would better be served by a novel rather than a movie. It is a lengthy meditation of a prisoner's  journey and of the nature of liberty and confinement- the protagonist's undying quest for liberty and the patient and persistent way in which he pursues it, the sense of community that the prisoners develop even among themselves, and how releasing a prisoner after prolonged confinement makes him an alien in the outside world, with the prison being where he is free and the outside world being where he is confined etc.! Hence you will notice that the movie has to pause several times for expository dialogue. Don't get me wrong, it is an awesome movie (I even list it among my favorites), but it might have worked even better as a book. The Black swan, on the other hand, needed to be a movie. To convey how her obsession leads to madness, it required the viewer to shift perspectives from the "empathetic stance"- perceiving the world from the standpoint of the  ballerina and what she was experiencing to the "voyeuristic stance" - viewing it as an outsider. The dramatic effect and emotional arc of the movie requires the viewer to toggle between these stances continually. To achieve that in a book requires a clumsy shift from a first person narrative (when we need to experience it from the POV of Natalie Portman) to a non-participant third person omniscient narrative voice (for the voyeuristic stance) which would be much more forced and unnatural. In a movie, on  the other hand, it is achieved by the simple device of changing the camera angle!- pointed at Natalie Portman (for the voyeuristic stance), or placed the way she would view it (for the empathetic stance)! Also, the nature of the story, as a ballerina's work, her technique and the need to transcend technique, needed visual storytelling. Hence, I liked Black Swan, not just because it was a well made movie, but also since to be everything that it could have been, it HAD to be a movie
  • Lastly, one shout out for the performances, but more crucially for the casting.  An excellent performance requires good acting, but is not only about acting. The physicality of the actor in bringing out the personality of the character is also very important (as an aside, this again, is something movies can do far more efficiently than books do; if a character such as that of Natalie Portman in the Black Swan needs to be shown as vulnerable and frigid, juxtaposed with the vivacious, sexy and mysterious character of Mila Kunis, the mere casting of the frail Natalie Portman, and the sultry looking Mila Kunis accomplishes that far netter than reams of description in a novel). The pale faced Natalie Portman as the metaphorical "White Swan" and the dark skinned, alluring Mila Kunis as the "Black Swan" was pitch perfect casting. And no portrays vulnerability better than Natalie Portman anyways.
All in all, an outstanding movie!

Thursday, March 10, 2011

Why dictators should study Game Theory!

One of the (over)hyped features of the revolutions in the Arab world has been the role played by social media. Several articles have outlined how social media have made spreading information much faster, which has helped mobilize people to protest against the regimes. This is particularly important since these countries do not have an independent "regular" media.

However, overcoming the "coordination" problem is just one of the 2 problems that an individual faces in deciding to protest against the regime. For an individual to decide rationally that he can protest he needs to overcome 2 problems of information asymmetry

1. The "coordination" problem: Where and when the protests will be held
2. The "common knowledge for confidence" problem: For me, as a rational individual, to decide to protest, I need to know there are several other protesters. The reasoning is simple, if I am going to be one among only a handful of protesters then the dictatorship would crush the protest ruthlessly. If on the other hand I am among half a million protesters the dictatorship would be unable to do so.

Note that every individual faces the same issue. Hence what is required for a successful protest is that I know there are other protesters, and that they know the same. They should know, that I know, that they also want to protest and I should know that they know the same. Hence there should a "common knowledge" about the desire to protest for me to be able to have the confidence to protests myself. 

The role of social media is actually as important in overcoming the latter, as the former problem. When I post about the protest on Twitter or Facebook, and someone "Likes" or Retweets my message, we automatically have common knowledge.

The answer, if you are Mubarak, seems intuitive, shut down social media! However, with a little game theory you can show that this would actually be counterproductive! (the Game Theory blog "Cheap Talk" showed this well in their post However they have not talked about the former problem, and how shutting down social media would affect that )

The reasoning is as follows. The regime would not shut down social media unless their assessment was that the protests could be large-scale. But this is precisely the information that i as an individual protester seek!- whether the protests are going to be large-scale or not (and that everybody else is aware of the same!), because that is when it is rational for me to protest too! In other words, the regime has successfully consolidated all the private signals of protest, into one big public signal. Hence, paradoxically, the act of shutting down social media makes its role even more efficient in terms of overcoming the "common knowledge for confidence" problem- everyone instantly knows that everyone else is keen to protest and that they all know the same!

But, hang on, would it still not achieve the purpose of preventing the protesters from overcoming the coordination problem (the first problem outlined above)? Granted, they all now have the confidence to protest, but in the absence of social media, how would they know when and where to go? In which case, isn't shutting down social media still effective?

The answer is No, and it is due to a concept called "focal points" (which was first popularized by Malcolm Gladwell).

Consider this thought experiment: If I told you that you were supposed to meet someone in Paris the next day. I do not tell you the time or the place. The only thing that you know is that the other person has the same information. What would you do? Most people would decide to go to the Eiffel Tower at 12 noon. This is because when we have to solve coordination problems in the absence of information there are some "default" solutions that we inexorably converge towards, as we expect others to arrive at the same default solution.

Hence, when social media is shutdown, and I know there is no way to communicate with my legion of fellow protesters (I know it is a legion now by the regime's act of shutting down social media), I will protest in the famous focal point-  namely, Tahrir Square at 12 PM!

Note, that again the act of the dictatorship has been counterproductive- it ensures that every single protester converges upon the focal point, where it might have been that they would have been more dispersed otherwise!

S the act of shutting down social media helps the protesters solve both the coordination problem and the common knowledge for confidence problem, more efficiently, and optimally, than they otherwise would have!

But what should the government have done? Not doing anything would have still led the protesters to solve the problem using social media.

There were 2 options to consider. One is that given that the protesters would necessarily converge upon the focal point, to focus only on preventing people from getting there e.g., in blocking key arterial roads to Tahrir Square.

The other option is to use misinformation. Just as bad money drives good money out of circulation ( Gresham's law), bad information would drive good information out of circulation, if the Government had used social media to spread rumors about the size and nature of protests, and confused people with multiple and contradictory views of where protests would occur, that might have helped. this is however difficult to pull off since people typically automatically have a quality filter in social media networks (since you decide whom to follow or friend).

The collapse of these repressive regimes was inevitable, but by their ham handed actions driven by lack of knowledge of Game Theory, they hastened their own demise. Cheers to that!