Saturday, July 28, 2012

Two Chinese Sayings

And two economic reflections
Recently, I've been traveling in Hubei, visiting family, and enjoying inland China (without much Internet or economics blogging). In some conversations, two sayings popped up that reminded me of two core economic concepts: the efficient market hypothesis and the danger of prediction. First, the EMH:
"People can't judge goods; money judges goods"
A serious problem with shopping in inland China is that it's extremely hard to judge the quality of goods. Some of the greatest examples are clothing shops. How do you judge which clothes is better than others?
One strategy is to go with certain branded clothing, but it's difficult to tell if they're the actual brand. However, this isn't always reliable because it's hard to tell if the product is fake or real. Remember, this is the land of China, where I-Pad advertising schemes are ripped off to sell smaller "U-Pad" (you-Pad) educational tablets; clothes are even easier to replicate. Clothes are also problematic because there's a serious asymmetric information problem. Only the tailor can know if the cloth will start fraying or if the color will bleed out. Traditional solutions for this "used-car problem", such as risk-free returns, don't function well because it's tough to know if the seller actually recognizes returns. As a result, sometimes the only judge of quality is to make sure that the store looks large enough to signal a rich company, and to make sure the price of the clothes is high enough to signal high quality. Thus, the quote. Buyers may not have the ability to recognize good clothes from bad, but money, the price of the good, certainly does not discriminate.
A second quote:
"Those who drown are all swimmers"
The theory behind the quote is that because only swimmers have the confidence to step into dangerous waters, the ones who drown are almost always swimmers. Those who cannot swim take extra precautions, and thus are less likely to end up among the drowned. The forecasting analog would be "those who are surprised are all forecasters".
This is one of the central problems of forecasting; you always run the risk of being blindsided, and when the decision is high-stakes, the danger is even higher. When planning a picnic with your significant other, the forecasting of whether it will rain (hopefully) is not an extremistan decision; whether it rains or not, the result should be mild. However, when working with highly leveraged financial products, the danger of prediction becomes more apparent. While you are most likely right; the danger of being wrong can be a bit too much to bear. Don't use prediction to form the basis of a fragile decision, a decision that can be fundamentally altered by landing on the wrong side of uncertainty. Because of this, I'm skeptical of prediction markets to truly estimate probabilities. Even if they are as good as, if not better, than professional forecasters, they're still no replacement for robust preparations. No matter how good of a swimmer you think you may be, it might still be good to take a lifeboat when the waters get rough.


  1. It's been a while since I've heard a good Chinese saying. Both seem to indicate the limits of our knowledge. It's not that we know nothing. It's that we must always be aware that our knowledge, momore often than not, will only be partial and incomplete, and there we face uncertainty.

  2. It seems that we live in an age of human hubris not primarily because we've forgotten old proverbs that warn us against it, but mainly because of the irresistible force of increasing temptation due to the scale of modern societies and economies. I fear that even if we had growing appreciation of the dangers of hubris, it will still be overwhelmed by the even faster growing incentives for engaging in hubris, both in the markets and in politics.

    I suspect humanity will always be behind the curve, 'in some sense', in learning about the dangers of hubris 'this time around' -- i.e., there will never be enough lifeboats. In what sense? Or, 'enough' from whose perspective? Lifeboats for just 1% of world population today might seem quite insufficient from the perspective of us the living, but might be viewed rather differently by those of our distant descendants. Assuming there will be some (no point in being pessimistic).