September 2020 – Page 2 – The one-handed economist

Valuing tigers and humans

Shivalika writes*

The Sundarbans — the world’s largest mangrove ecosystem — is shared between India and Bangladesh. With the global mangrove biome increasingly under threat from human exploitation, how India and Bangladesh choose to manage and conserve the Sundarbans could be the difference between preserving these crucial and biodiverse habitats or letting them disappear in 100 years. But the two countries are struggling to manage this resource effectively. A necessary first step is forming a cooperative alliance to collectively manage the resource.

The Sundarbans provide many crucial ecosystem services. They are, for example, the last remaining stronghold for the endangered Royal Bengal Tiger and host several species of mangrove trees that have an intrinsic value of their own. The livelihood of roughly 3.5 million coastal residents depends on the forest. Due to climate change and resulting sea-level rise, the mangroves provide essential flood protection and reduced mortality from floods, tsunamis, and cyclones that are common in the area.

One can, by this point, draw the conclusion that the Sundarbans need to be protected, at all costs. But what are these costs exactly? It is the environmental economist’s duty to quantify the benefits of action and the costs of inaction to inform policy. One simply cannot put “all costs” into one cause.

A cost-benefit analysis is thus called for to make credible policy suggestions to the Indian and Bangladeshi governments in regard to the protection of the Sundarbans. About a quarter of the Indian Sundarbans [pdf] is currently a core protected area – allowing no human activity whatsoever. In the Bangladeshi Sundarbans, 23% of the area is declared protected.

What would the area look like if the entirety of it was protected? This policy appeals to advocates of strong sustainability or preservationists, but there are economic, social, and political consequences to consider.

Take the example of Bengal tiger protection alone. Here, there are economic costs for enforcement and monitoring, social costs because of the tiger-human conflict in the surrounding villages, and political implications of any policy that would effectively be perceived as a prioritisation of the lives of tigers over the lives of people that depend on extractive industries in the Sundarbans or have been hurt or killed by tigers. The intrinsic value of the tiger, or extrinsic value of the ecosystem of which it is a part, are the benefits of this proposed policy. And tigers are only a small part of the Sundarbans. A bigger picture analysis would need to include a host of different factors to consider and monetise.

Bottom line: These costs and benefits are, if at all possible, not easy to monetise. But even a humble attempt at doing so will add to the understanding of the complex nature of the Sundarbans, and the ever more complex consequences of any policy for their conservation.

* Please help my Environmental Economics students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Equilibrium of normal demand and supply

Book 5, Chapter 3

§1. What determines supply in the market? An individual trader considers a host of factors (p 281):

Dealers take account of the areas sown with each kind of grain, of the forwardness and weight of the crops, of the supply of things which can be used as substitutes for grain, and of the things for which grain can be used as a substitute… If it is thought that the growers of any kind of grain in any part of the world have been losing money, and are likely to sow a less area for a future harvest; it is argued that prices are likely to rise as soon as that harvest comes into sight, and its shortness is manifest to all. Anticipations of that rise exercise an influence on present sales for future delivery, and that in its turn influences cash prices.

From this, we can see how the market price depends on the mix of opinions from dealers, buyers and sellers, and how price volatility reflects differences in these opinions.

§2. The cost of producing a good depends on a mix of labor and capital costs (money paid), as well as their opportunity cost at the margin (money not paid). This formulation disagrees with Marx’s Labor Theory of Value because it evaluates capital costs not in terms of the embedded labor it took to produce that capital but in the capital’s alternative uses.

§3. The price for a good will depend on the cost of inputs needed to bring it to customers. Thus, a tree is cheap when it’s bought from the logger, but furniture made from that tree reflects the costs of transportation, transformation, design, retail rents, etc.

All market participants will change the mix of inputs as relative costs shift, to maximize profits. Thus Marshall introduces the Principle of Substitution.

§4. Most market participants watch each other, making it possible to assume a “single price” for a given good that changes with time and circumstances. The price will move up (or down) as demand exceeds (or trails) supply. Better run firms will expand faster (or contract slower) than worse run firms.

§5. The price of goods usually increases as quantity sold increases, due to the need to attract increasing quantities of inputs. Economies of scale (spending more capital to shift to larger machines) can lower costs at higher volumes, but that’s discussed later.

§6. Marshall describes “equilibrium” in price and quantity, before explaining how that equilibrium is moving more randomly than “a disturbed stone on a string returning to rest,” i.e.,

In an age of rapid change such as this, the equilibrium of normal demand and supply does not thus correspond to any distinct relation of a certain aggregate of pleasures got from the consumption of the commodity and an aggregate of efforts and sacrifices involved in producing it… We cannot foresee the future perfectly. The unexpected may happen; and the existing tendencies may be modified before they have had time to accomplish what appears now to be their full and complete work. The fact that the general conditions of life are not stationary is the source of many of the difficulties that are met with in applying economic doctrines to practical problems.

§7. Marshall gives one of his enduring metaphors for the relative importance of demand (value) versus supply (cost) in determining market equilibrium (p290):

We might as reasonably dispute whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper, as whether value is governed by utility or cost of production. It is true that when one blade is held still, and the cutting is effected by moving the other, we may say with careless brevity that the cutting is done by the second; but the statement is not strictly accurate, and is to be excused only so long as it claims to be merely a popular and not a strictly scientific account of what happens.

In the same way, when a thing already made has to be sold, the price which people will be willing to pay for it will be governed by their desire to have it, together with the amount they can afford to spend on it. Their desire to have it depends partly on the chance that, if they do not buy it, they will be able to get another thing like it at as low a price: this depends on the causes that govern the supply of it, and this again upon cost of production. But it may so happen that the stock to be sold is practically fixed. This, for instance, is the case with a fish market, in which the value of fish for the day is governed almost exclusively by the stock on the slabs in relation to the demand: and if a person chooses to take the stock for granted, and say that the price is governed by demand, his brevity may perhaps be excused so long as he does not claim strict accuracy.

…and with scissors and fish in hand, the chapter ends.

This post is part of a series in the Marshall 2020 Project, i.e., an excuse for me to read Alfred Marshall’s Principles of Economics (1890 first edition/1920 eighth edition), which dominated economic thinking until Van Neumann and Morgenstern’s Theory of Games and Economic Behaviour (1944) and Samuelson’s Foundations of Economic Analysis (1946) pivoted economics away from institutional induction and towards mathematical deduction.

Interesting stuff

It’s not so nice when “nice white families” take over a non-white school
How energy bars turned into meals
The first “good” map was made by a Greek who also (accurately) calculated the diameter of the Earth.
Working at home is forcing cultural change
Taibbi on the Trump Era that we’re sick of
Rice vs wheat: a labor, calorie and governance comparison
How settlers screwed up ecosystems in the “New” world
What does “gentrification” mean?
Singapore’s “authoritarian capitalism” doesn’t scale
Every episode in this podcast series has changed my mind on race and US history. Listen in!

H/T to TJ

Review: Bitcoin Clarity

Kiara Bickers, the author of this 2019 book, sent me a copy because I reviewed Digital Gold: Bitcoin, the Inside Story. As an economist with an interest in how bitcoin, blockchains, and crypto-assets are evolving, I agreed to look at her book.

In short, I found it insightful and interesting. I learned some useful stuff, but there were also some weaknesses.

The book is divided into four parts (conceptual reframing, analysis & knowledge, properties of the system, and synthesis & understanding), i.e., “what’s the idea, how does it work, how do people use it, and how can I get involved?” Some of these topics can get quite technical, but Bickers has a friendly tone and uses sketches to lay a foundation that readers can build on with further research.

(I’m now thinking the “bitcoin ecosystem” may now be too complex for anyone to understand.* The “crypto” ecosystem, of which bitcoin plays a small but significant part, is even more complex, confusing and chaotic.)

Here are some thoughts and highlights I noted while reading…

Part one explains bitcoin and the Blockchain (capital B, to distinguish it from many other blockchains that use similar protocols), two related ideas that depend on public key/private key cryptography. In my understanding, the blockchain records transactions linking bitcoins to various addresses that function as “safes.”

A miner is rewarded with bitcoin when they solve a math problem before other miners — all of them using special computer hardware and lots of electricity. Reward bitcoins are recorded in new blocks that also (and this is really important) record transfers of existing bitcoins among addresses. These actions mean that bitcoins, which can be divided into one million satoshis (think milli-pennies) are stored at an address until all or part of the bitcoin is ~~transferred~~ reassigned to a new address. Some addresses can be “rich” with many bitcoins but many addresses are empty. Transfers only occur when the person controlling coins at an address “signs” (cryptographically approves) a transfer to another address. Approved transfers are then bundled into new blocks that are added to the end of the Blockchain, copies of which are kept all over the world on “full nodes” (simple computers that do not use much electricity).

I learned from Bickers’s description of these steps. First, miners do the work but full nodes display the results of work, which — in the case of bitcoin — consists of a shared public ledger that shows where bitcoins are held as well as confirming when and where bitcoins are transferred. (I say “shared” in the sense that over 100,000 nodes agree have copies of the same Blockchain, which keeps the system “secure” from those who want to shut down the system or spend coins they do not have.)

Second, the combination of bitcoin+Blockchain is elegant and effective, just as many “alt coins” (or shit coins) and/or blockchains are solutions in search of problems. (Read “Blockchain, the amazing solution for almost nothing,” which is insightful, funny and cringy, and this academic analysis of the many useless projects that are burning government and enterprise cash without producing value, let alone evidence of success.)

Third, bitcoin/Blockchain are “trustless” in the sense that you can use them without needing to trust any person, organization or government.* This characteristic explains how and why people get scammed by so many alt-coins, but also why bitcoin is popular in dysfunctional countries (Turkey, Venezuela, and Zimbabwe spring to mind). Trustless doesn’t mean simple, by the way, which is why the “bitcoin industry” of consultants, speakers and services has sprung up. (Bickers offers her own advice to paying clients.)

Fourth, a lot of people think bitcoin is a terrible “payments solution” because it records a few hundred transactions every 10 minutes, rather than thousands of transactions per second, like Visa/Mastercard. This critique misses the point of the 10-minute block: to help synchronize 100,000+ copies of the Blockchain held in nodes around the world. Slow but secure is why many people see bitcoin more as digital gold (an asset) than as a digital currency.

Part two gets into some deep technical analysis, but it’s quite interesting.

I like the idea of the Blockchain as a method of “triple-entry bookkeeping” that shows where bitcoin have been subtracted (sender) and added (receiver) — the double-entry part — but also giving a global view of where all bitcoin are. (Bitcoin transactions are not anonymous but in plain view on the Blockchain; the tricky part is identifying who controls bitcoin at various addresses.)

Bickers is a fan of Austrian economists and “full” (as opposed to fractional) reserve banking, and the Blockchain’s “triple entry” nature means it’s impossible to inflate bitcoin by printing more (miners can’t get paid when they try that) or trading more (nodes prevent “double spending”), which gives bitcoin an advantage over fiat currencies that have value because governments say so. Although most of us trust US dollars or Euros, others want trustless, “sound” money as a hedge against printing new money and inflating the money supply via fractional reserves. (I keep a wad of 100 Bolivares notes as a handy reminder of how Venezuela debased its citizens’ savings. The wad of 100 notes was worth around USD2,500 in 2013, but only USD0.01 in 2018.)

The rest of Part two is technical but not unclear, covering transactions, node networks, mining and smart contracts. In that last chapter, Bickers does a pretty good job demolishing the 1,000-plus altcoins and blockchains that claim to be “trustless” but deliver scams and broken promises.

In Part three, Bickers discusses governance and decentralization, both of which exhibit robust stability under game-theoretic conditions in which many players in many roles cooperate via self-interest without creating vulnerabilities that can be taken over by insiders or outsiders.

When she turns to “the economics of money,” she falters, misinterpreting and misunderstanding comparative advantage, Smith’s interested bystander, the labor theory of value, quantitive easing, mortgage-backed securities, and service-sector inflation. I think most of these errors arise from her reading of biased, unreliable sources. Perhaps they can be fixed in edition 2.0?

Part four covers markets, hype cycles, and a healthy mindset for switching from fiat to bitcoin. These philosophical chapters draw on Bickers’s self-identity as a university drop-out pursuing a career in bitcoin. Although the discussion was useful, there were also errors in explaining the origin of “HODL”, the problem of known unknowns, and valuing growth stocks. Even so, the chapter ends with a heartfelt and welcome call to rebel against the status quo

My one-handed conclusion is that this book offers insights, explains complex ideas, and gives plenty of material to ponder. Although weakened by some preventable mistakes, I recommend it to anyone interested in bitcoin. FOUR STARS.

* 2 Nov 2020: I think it’s helpful to think of Bitcoin/Blockchain as a new (digital) species whose evolution, use and “goals” are beyond our control but important in our lives. If the 80s were the decade of the PC, 90s of the Internet/WWW, 00s of mobile phones, and 2010s of social media, then what consumer tech will dominate the 2020s? Bitcoin and crypto might be that tech.

Addendum: On bitcoin adoption: Discovering Digital Gold and Bitcoin and The American West

Feb 16: Ray Dalio and his researchers put out a great note on Bitcoin.

Apr 7 2022: Ten (useful) pieces of advice on bitcoin

Here are all my reviews.

Temporary equilibrium of demand and supply

Book 5, Chapter 2

§1. People make various trades for benefit without worrying about equilibrium, or balancing aggregates of supply and demand, which occurs when many actors repeatedly trade (semi-)commodified goods.

§2. Marshall gives the example of a corn market — a “grain” market in the US — in which buyers (with willingness to pay) and sellers (with willingness to accept) converge on an equilibrium price of 36 pence/quarter at which quantity demanded equals quantity supplied. Fluctuations around 36d occur, but they do not persist, since buyers wait out “outrageous” offers and sellers ignore “lowball” bids.

§3. Prices in commodity markets do not deviate too far from equilibrium because traders can borrow (or lend) money to smooth bumps. Prices (wages) in labor markets can vary a lot because workers go hungry if they cannot eat whereas capitalists can eat while they wait for willing workers. The implication, which Marshall elaborates in Annex F (“Barter”), is that money allows commodity markets to clear “on the margin” while labor markets (which have a barter component when one considers that workers are offering heterogeneous units of labor) have a lot of inframarginal noise due to workers getting bad deals. Gender-wage gaps, for example, can be explained by men driving harder bargains than women when negotiating their starting salaries.

Interesting stuff

Measuring the scale of coronavirus via sewage
So… the American Revolution was not about democracy but changing which leaders were in charge (and making money, especially via cotton and slavery). Related: Race and science
Why are market prices surging? A lot of money managers only get paid if client funds are “invested” (!)
A website with Trump’s new slogan (“Keep America Great”) points out how he’s broken all his promises and failed to deliver
Western “liberals” are rejecting tolerance for their subjective truth?
Lol: “Facebook apologizes to users, businesses for Apple’s monstrous efforts to protect its customers’ privacy“
Why are there 5280 feet in a mile?
The pandemic is nuking college-town economies (velocity of money case study)
Online advertising wears the emperor’s new clothes (= it’s often worthless)
Blockchain: the amazing solution for almost nothing

H/Ts to PB and BZ