Category: economics

Relationships and the Iterated Prisoner’s Dilemma

It was around this time last year that something snapped, and things have never been the same again. Until then, whenever she threw some tantrums, or we had some fight, I’d always give her the benefit of doubt, and unconditionally apologise, and make an effort to bring the relationship back on track. But since then, I don’t feel the same kind of sympathy for her. I don’t feel “paapa” for her like I used to , and have questioned myself several times as to why I even aoplogise, and not expect her to do that.

The optimal strategy for Iterated Prisoner’s Dilemma has been shown to be a strategy called “Tit for tat”. To explain the problem, you play a series of games against an “opponent”, and in each iteration, each of you choose to either “cooperate” or “defect”. For each combination of choices, there is a certain payoff. The payoff looks similar to this, though the exact numbers might be different. In this table, the first value refers to the first player’s payoff and the second represents the second player’s.

Player 1/ Player 2 Co-operate Defect
Co-operate 1 / 1 2 / 0
Defect 0 / 2 0.5/ 0.5

So you play this game several times, and your earnings are totalled. There was a tournament for computer programs playing this game sometime in the 1960s, where the winner was “tit for tat”. According to this strategy, you start by co-operating in the first iteration, and in every successive iteration you copy what your opponent did in the previous iteration. Notice that if both players choose this strategy, both will co-operate in perpetuity, and have identical payoffs.

Relationships can be modelled as an iterated prisoner’s dilemma. You can either choose to be nice to your partner (co-operate) for which you get a steady return, or you can choose to be nasty (defect), in which case you get a superior payoff if your partner continues to be nice. If both of you are nasty simultaneously both of you end up getting inferior payoffs (as shown by the Defect-Defect box in the above matrix).

Early on in the relationship, I was very keen to make things work and did my best to prevent it from falling into any abyss. I played the “Gandhi strategy”, where irrespective of her play, I simply co-operated. The idea there was that whenever she defected, she would feel sympathy for my co-operative position and switch back to co-operate.

So something snapped sometime around this time last year, which led me to change my strategy. I wasn’t going to be Gandhi anymore. I wasn’t going to unconditionally defect, either. I switched to playing tit-for-tat. You can see from the above table that when both players are playing tit-for-tat, you can get into a long (and extremely suboptimal) sequence of defect-defects. And that is what happened to us. We started getting into long sequences of suboptimality, when we would fight way more than what is required to sustain a relationship. Thankfully it never got so bad as to ruin the relationship.

Periodically, both of us would try to break the rut, and try to give the relationship a stimulus. We would play  the co-operate card, and given both of us were playing tit-for-tat we’d be back to normal (Co-operate – Co-operate). Soon we learnt that long defect-defect sequences are bad for both of us, so we would quickly break the strategy and co-operate and get things back on track. We weren’t playing pure tit-for-tat any more. There was a small randomness in our behaviour when we’d suddenly go crazy and defect. In the course of the year, we got formally engaged, and then we got married, and we’ve continued to play this randomized tit-for-tat strategy. And the payoffs have been a roller coaster.

Today I lost it. She randomly pulled out the defect card twice in the course of the day, and that made me go mad. While in earlier circumstances I’d wait a few iterations before I started to defect myself, something snapped today. I pulled out the defect card too. Maybe for the first time ever, I hung up on her. Do I regret it? Perhaps I do. I don’t want to get into a prolonged defect-defect sequence now.

And I hope one of us manages to give the relationship enough of a stimulus in the coming days to put us on a sustained co-operate co-operate path.

IPOs Revisited

I’ve commented earlier on this blog about investment bankers shafting companies that want to raise money from the market, by pricing the IPO too low. While a large share price appreciation on the day of listing might be “successful” from the point of view of the IPO investors, it’s anything but that from the point of view of the issuing companies.

The IPO pricing issue is in the news again now, with LinkedIn listing at close to 100% appreciation of its IPO price. The IPO was sold to investors at $45 a share, and within minutes of listing it was trading at close to $90. I haven’t really followed the trajectory of the stock after that, but assume it’s still closer to $90 than to $45.

Unlike in the Makemytrip case (maybe that got ignored since it’s an Indian company and not many commentators know about it), the LinkedIn IPO has got a lot of footage among both the mainstream media and the blogosphere. There have been views on both sides – that the i-banks shafted LinkedIn, and that this appreciation is only part of the price discovery mechanism, so it’s fair.

One of my favourite financial commentators Felix Salmon has written a rather large piece on this, in which he quotes some of the other prominent commentators also. After giving a summary of all the views, Salmon says that LinkedIn investors haven’t really lost out too much due to the way the IPO has been priced (I’ve reproduced a quote here but I’d encourage you to go read Salmon’s article in full):

But the fact is that if I own 1% of LinkedIn, and I just saw the company getting valued on the stock market at a valuation of $9 billion or so, then I’m just ecstatic that my stake is worth $90 million, and that I haven’t sold any shares below that level. The main interest that I have in an IPO like this is as a price-discovery mechanism, rather than as a cash-raising mechanism. As TED says, LinkedIn has no particular need for any cash at all, let alone $300 million; if it had an extra $200 million in the bank, earning some fraction of 1% per annum, that wouldn’t increase the value of my stake by any measurable amount, because it wouldn’t affect the share price at all.

Now, let us look at this in another way. Currently Salmon seems to be looking at it from the point of view of the client going up to the bank and saying “I want to sell 100,000 shares in my company. Sell it at the best price you can”. Intuitively, this is not how things are supposed to work. At least, if the client is sensible, he would rather go the bank and say “I want to raise 5 million dollars. Raise it by diluting my current shareholders by as little as possible”.

Now you can see why the existing shareholders can be shafted. Suppose I owned one share of LinkedIn, out of a total 100 shares outstanding. Suppose I wanted to raise 9000 rupees. The banker valued the current value at $4500, and thus priced the IPO at $45 a share, thus making me end up with 1/300 of the company.

However, in hindsight, we know that the broad market values the company at $90 a share, implying that before the IPO the company was worth $9000. If the banker had realized this, he would have sold only 100 fresh shares of the company, rather than 200. The balance sheet would have looked exactly the same as it does now, with the difference that I would have owned 1/200 of the company then, rather than 1/300 now!

1/200 and 1/300 seem like small numbers without much difference, but if you understand that the total value of LinkedIn is $9 billion (approx) and if you think about pre-IPO shareholders who held much larger stakes, you know who has been shafted.

I’m not passing a comment here on whether the bankers were devious or incompetent, but I guess in terms of clients wanting to give them future business, both are enough grounds for disqualification.

In Perpetual Transition

This post has nothing to do with Ravi Karthik’s blog. It has everything to do with Bangalore’s roads. I can’t recall a single instance in time in the last 15 years when all roads in Bangalore have been in “normal state”. Maybe ever since the KR Market flyover started, there has been one part of the city or the other that has been dug up. And the digging is only increasing. Earlier it would be a handful of places in the city that were dug up. Now, it is tough to find two points over 5 km apart such that you don’t have to take a diversion of some sort to travel between them.

The optimistic among us think that things will become better as soon as these projects get completed. However, what we forget is that there is a small but powerful section of society that survives on the city being in transition. Road-builders, bridge-builders, road-diggers, road-fillers, and all these sundry people make their living based on the premise that the city will be in perpetual transition. And given how critical income from such activities is for their survival, they resort to lobbying and paying “rents” to relevant people in the government to ensure their cash flows continue.

The problem here is one of a small concentrated set of big winners, and a large uncoordinated distributed set of small losers. And the small set of winners can successfully get together and lobby and have things their way, because the other set is too disjointed to do anything about it.

The other (and in my opinion, the bigger) problem is that thanks to lobbying, the government has a natural disposition to spend more than to spend less. And all the spending comes from taxpayer money. So you have the road projects in Bangalore that you think you don’t need. You have the free TVs and Mixies and whatnot in Tamil Nadu. And you have rice and wheat given to the (supposed) poor at rock-bottom prices. And where does the money for all this come from? Your taxes!

I hope sooner rather than later people realize that the only solution to corruption is less government. The problem, however, is that the government has no incentive to reduce its own size – for in that case the kickbacks and  rents that it (to be precise, people who are part of government) can potentially extract come down. You might institute acts like FRBM (fiscal responsibility and budget management, which seeks to put a cap on government spending) but with such a cap in space, what is the guarantee that the government will actually spend that limited money on what is necessary, and not what gives rents for its officers and employees?

Political parties may have different ideologies, and may appear to fight about every little thing. But this is one thing they agree on – that the size of the government be large – that way they all get to (in turns) have a share of the (rental) pie. This equilibrium is stable and I don’t know how we can snap out of this. And till then, our taxes will continue to flow out. And the cities will be in perpetual transition.

Libertarianism and rejection of authority

Ok so this is yet another of those self-reflective posts, where I try and rationalize why I’m the way I am. And in the process concoct a fancy theory.

I’m part of this secret society most of whose members are libertarian. I must in fact credit this society from changing my ideology from one that was broadly conservative to broadly libertarian (notice that my economic ideology hasn’t changed, only the social bit has). One thing common among most members of this society is that they are the kind of people who don’t bow to authority. They can be described as confrontationalist, or maverick,  or non-conformist. And most of them are libertarian.

I must mention that for purposes of this post, I define libertarianism as a “belief in free markets and free minds”.

In The God Delusion, Richard Dawkins writes that one of the things that makes people religious is the tendency to listen to “superiors”, “elders”, etc. He argues that this is consistent with natural selection – that back in those days where we were a “hunting ape”, if we were the type that didn’t listen to our parents, there was a greater danger that we’d fall off trees or got eaten up by lions. So us human beings are “naturally conditioned” to listen to “elders”, “superiors”, etc. Effectively, we are conditioned to take orders. Dawkins talks about how this makes us religious, but that is not relevant here.

So we grow up having this “elderly authority” at home. The “elderly authority” commands us and guides us and gives instructions, and in return provides us protection from the outside world. Soon we grow up, and don’t need that protection any more, so we don’t need to take instructions any more (if you look at taking instructions from parents as the “cost” of the protection they offer you). But then we are conditioned to taking instructions, and being controlled, and it is tough for most of us to outgrow this conditioning.

And so some people look to “society” to provide the instructions, and control you, and tell you what to do and what not to do. They end up as conservatives. Some other people, look to the government (remember that today’s “government” is a replacement for yesterday’s “king”, who was supposed to be “divine”) for instructions and control. They end up being “liberals” (quotes because traditionally liberals supported free markets; it’s only recently they’ve taken a socialist turn). It is quite interesting that a lot of “liberal” people, who profess their rejection of authority, think it is ok for the government to tell them who to do business with, and at what price.

And then there are these really masochistic people who look to both “society” and “government” to put controls on you. Think Swadeshi Jagran Manch and similar institutions.

And so what about people who actually reject the need to have a “protector” once they grow up? They don’t want to take instructions from anyone, and in return they are willing to forego protection – apart from asking from the government protection in terms of defence, foreign policy and upholding of law. Given that very few people reject authority (Dawkins’ concept), it’s very few people that end up as libertarians.

PS: Is it a coincidence that so many very good libertarian bloggers (Caplan, Tabarrok, Hanson, Cowen) are at the little-known George Mason University, and not at one of the “top-ranked” universities?

PS2: I think large corporations are not free-market in any sense. Leave aside crony capitalism. Corporations, by definition, are internally deeply socialist. I guess I’ll save that for another post.

 

On becoming a right-winger

No I’m not talking about people like David Beckham or Theo Walcott here. I’m talking about political stance. There is supposed to be this saying somewhere that goes “if you are 50 and liberal, you don’t have a head. If you are 20 and conservative you don’t have a heart” or some such. I probably first heard it some three years back, and ever since I’ve wondered why I’ve always been a right-winger in terms of my political stance. And I perhaps now have the answer.

The “social” component of rightwingery is not difficult to explain – from the ages of eight to ten, I was a member of the Rashtriya Swayamsevak Sangh (RSS). They used to have shakhas close to my house in Jayanagar, and I would go there primarily to play Kabaddi. And I don’t think it was anything to do with what they taught us there, but maybe because the seniors there campaigned for the BJP in the 1991 elections (and my parents also then supported the BJP) I became a “social right-winger”. I’ve mostly been a supporter of the BJP since then, and if I were to vote (my name mysteriously disappeared off the voter list between 2004 and 2008, and I haven’t got myself re-registered) today I’d still vote for the BJP.

I’m much less of a social conservative now than I was maybe five years ago. I can probably describe myself as centrist – a position that is inadequately represented by any Indian political party. And it is possible that my current support for the BJP is reinforced by their economic policies during their regime earlier this decade. Which brings me to the more interesting question – about why I’ve always been an economic “conservative”.

I didn’t have an answer to this till recently, but I wonder how much it had to do with the fact that 1. I don’t have any siblings,  2. I was a topper in school.

I tend to believe that the lack of siblings helped define clear property rights for me at an early age – it is easier to divide up toys and other stuff among cousins than among siblings. And when you are convinced of property rights, you are much less likely to believe in stuff like “common good” and stuff.

As for being the topper, I’m reminded of how the class would plead with the teacher to make the exams easy, or to postpone assignment deadlines. Me being the topper, however, would have none of it. I would look at situations like those to RG (IITM lingo derived from “relative grading”) the rest of my class, and would always end up campaigning in the opposite direction (this continued till I was in IIM – when I was no longer the topper – I would encourage professors to set tough papers while the then toppers would ask for easy papers – the irony!).

While others were struggling to add two digit numbers, I would be showing off my skills at adding six-digit numbers, and encouraging the teacher to move faster. I considered myself to be “elite” and thought it was beneath myself to do what the “proletariat” did – postponing assignment deadlines or going slow in class. I would not be a part of the “class struggle”. I was a “have” (and I knew about property rights) and I would fight to retain my advantage.

So one objection to this theory could be that a lot of commies are topper-types. But here, we need to make a distinction. What if they were toppers like the ones that we had in IIMs – those that would clamour for easy papers, those that would do things the done way, and do better only because they mugged more? (I never listened to anyone. for example, I considered it beneath myself to add 5 to 4 as “five in the mind and six in the hand” and counting off fingers – while my competitor for topper used to happily do that, in public). My proposition is that those that became “radicals”, and were topper-types, weren’t that radical after all when they were young. If they were, they would’ve never turned left.

Fixed Price

The problem with a lot of touristy places is that there are no fixed prices. While this means that vendors can practice effective revenue management, it also means that it is easier for them to cartelize and take the tourists for a collective ride.

I realized this during my recent trip to Sri Lanka where you need to find someone you trust to get “access” to some place. But then it is most likely that any possible intermediary is more loyal to the service provider (due to regular contact etc) than to the tourist. So the tourist ends up being screwed no matter what.

Later that night we were to figure that even the bargained prices that we paid at the wood factory were heavily inflated, and things were available for a fourth of that price (!!) at the souvenir shop attached to our hotel in Nuwara Eliya. Where else in the world do you see prices in hotel souvenir shops being significantly lower than close to the source?

So this agent business continued through the trip. We wanted to go river rafting, so we (once again) trusted our driver to find us a nice service provider. The following day we wanted to go on a boat ride up the Bentota river, and we had the (unenviable) choice of our hotel and the driver (yet again) to serve as intermediary.

What makes matters worse is that if you go without an intermediary prices are likely to be even higher. It’s as illiquid a market as you can find. But whichever intermediary you choose you are likely to end up paying much above market values. It’s not often that you find (supposedly) altruistic intermediaries such as the Gift Shop at the Grand Hotel in Nuwara Eliya.

So I wonder what drives a market from this kind of state to one where prices are fixed, and there are menus (interestingly in Sri Lanka you don’t find menus in many places. you are charged an arbitrary sum). It is unlikely to be regulation, since smart players are always a step ahead of the regulators. It has to be some market characteristic that tips the market in favour of transparency and efficiency. I’m trying to figure out what it is.

(this suddenly reminds me of a recent attempt by an investment bank to try create a private market for shares in a private technology company. Clearly the market in shares has “tipped” in favour of transparency, for the attempt hasn’t been as successful as initially imagined)

o!!!

o!!! (super) is indeed a super movie. It is so awesome in so many different dimensions, that it’s hard to capture it all in one post. I guess in this post I’ll simply stick to the economic aspect of the movie.

So basically the premise is that in 2030 India is the most powerful country in the world. Bangalore is clean and green, with whites working as chauffeurs and sweepers, with 70 pounds to the rupee, and so forth. The movie is a fairly elaborate nested story about how this transformation is brought about.  (rest of post under the fold. spoilers are there)

Continue reading “o!!!”

Idealism

So on Sunday we went to this temple on the outskirts of Bangalore where the in-laws performed Satyanarayana Pooja. There was a small number relatives there, and a large gang on unknown people (it was essentially a public function). It’s a nice temple, dedicated to Shiva, and built in the Kerala style. I think it’s still work-in-progress, and there’s stuff to be done in terms of carvings and stuff. And it’s in a nice secluded spot which adds to the peace of the place.

So the temple has this policy of “annadaana” (rice donation), where they serve lunch to everyone who visits them around lunch time. I’ve written about temple meals before, and you know I’m not a big fan of them. That aside, there was this little act of forced idealism in this temple around meal time, which I wasn’t too happy about.

So the temple doesn’t invest in professional cleaners to clean the plates (I don’t understand why temples insist on serving meals in steel plates – the same is the case in Sringeri and Horanadu also). Instead, you are supposed to wash your plate and tumbler after you’re done eating. In theory this is a fine idea – if we are giving you free food, you might as well do this small help in terms of cleaning up after you. But the problem is this creates huge incentive problems.

There is a reason that public loos are seldom clean – there is no incentive for a user to keep the loo clean for the person who uses it after them. The only way a public loo can be kept clean is by employing paid labour to clean it, where it isn’t hard to align incentives of the cleaners with cleanliness of the loo. Similarly, why would you want to make a special effort into cleaning your plate when some unknown person who you’ll probably never meet in life is going to eat out of it next?

I appreciate the idealism  but the economics simply don’t work. To put it simply – cleaner plates implies greater satisfaction among people who are there at the temple to eat, which encourages repeated visits, which results in greater donations. I’m sure the little investment in people to clean the plates can be recovered many times over in terms of increase in donation. Still, they insist on imposing ideals on people..

I’m not really going to talk about the food. However, I want to briefly mention about the pooja itself, which went on for about double the time as a normal Satyanarayana Pooja (my wife and I performed one such the day after our wedding, so I know the “standard”). The pujari (who is responsible for building the temple) put in a lot of extra fittings, and a lot of the crowd (mostly people unknown to me – it was a public event) seemed to rather enjoy it. I think there is this misplaced notion somewhere that more rituals implies more good karma.

And on a related note, I fail to understand what people mean when they say “pooje is going on well” (I’ve heard this phrase too many times to not comment on it). Does it simply mean “there have been no disasters so far during the pooje” (I can’t think of any other meaning for it)?

Teaching Sustainability

So I was at an aunt’s place last night to celebrate Diwali, and we were celebrating with fireworks. Don’t raise a stink about my carbon footprint here since that’s besides the point. Also besides the point is that I spent a long time playing on the swing in my aunt’s house and thoroughly enjoyed himself.

So the deal is that most “night fireworks” are lit with sparklers (sursurbatti in Kannada). So in order to keep the fireworks going, it is important that there is at least one burning sparkler at any point in time. Now, it is a big pain to light a sparkler directly, using something like a matchstick or a candle. The easiest way to light a sparkler is from another sparkler. I’m reminded of the technical definition of a chain-smoker, who is defined as a smoker who uses only one matchstick a day – the rest of his cigarettes being lit from other cigarettes.

Anyways the point is that in order to light fireworks “sustainably” it’s important to keep a chain of sparklers going. It is important that before a sparkler burns out, you use it to light another, and so forth. That way you end up wasting little time in terms of lighting new sparklers from candles. So it is usually the duty of an “elder” (a role that I took upon myself last night) to keep the chain of sparklers going, so that the rest can have uninterrupted fun.

So what I found last night was that my niece and nephew, in their eagerness to play with fireworks, would end up taking sparklers from my hand faster than I could build the chain. It happened way too frequently. I would have just lit a sparkler when they would take it from my hands and not return it, thus preventing me from keeping the chain going. Clearly, they didn’t know how to light fireworks “sustainably”. They prioritized immediate gain to the “loss” in terms of time wasted in lighting new sparklers.

So it was down to incentives. Whenever the chain of sparklers was broken, it was up to either me or one of my cousins to make the effort to light a new sparkler “from scratch” and start a new chain. The kids weren’t involved in this, and were oblivious of the pain that their unsustainable practices caused. And got me thinking about how I could “safely” align the kids’ incentives with sustainability.

Soon the lamps in the garden ran out of oil, and that changed the whole ball game. Now, every time the chain got broken, someone had to go into the house to light a new sparkler and restart the chain. And being one of the younger ones around, it fell to my niece to go in each time the chain was broken and get her mother to light a sparkler. The incentives had changed.

Suddenly there was change in my niece’s behaviour. She suddenly became active in terms of keeping the sparkler chain going. She never took sparklers from me when I didn’t have a spare that would keep the chain going. When she saw sparklers in my hand burning out, she would bring new sparklers to me so that I continued the chain. Her change in behaviour was sudden, and significant. Her brother, who was deemed to be too young to run in to get new sparklers lit to start new chains, however continued in his profligate ways.

So this is like one of those posts that I call as “management guru” posts. Where I tell a long-winded story to describe a simple concept. The concept here being one of sustainability, and aligning incentives. So the point is that if you want to encourage sustainable use of natural resources, users’ interests should be aligned to sustainability. They need to be punished in the short run for drawing too much.

Gift List

So over the last few days there have been several people who have met or called me and asked what gift Pinky and I want for our wedding. Hari the kid, one such caller, even suggested that we need to make a wedding wish list and put it up on our wedding website or something.

Now the thing is that gifting is a hard business. Economic research shows that the average value to the gifted is much less than the average cost to the gifter, and thus gifts create a dead weight economic loss. This, however, is compensated by the good will that the gifter earns from the gifted (if it is a good gift, that is).

When the potential gifter asks the gifted what he/she wants, the intangible value (value of a pleasant surprise minus value of unpleasant surprise, appropriately weighted by respective probabilities) is substituted by the tangible value of greater value for the gifted per rupee spent by the gifter. Also, the fact that the gifter cared to ask what the gifted wanted goes some way in compensating for the intangible value.

Anyway the question is if we should put up a gift wish list on our website. Now, one problem with that is that people might perceive us to be arrogant. After all, in this era of “no gifts/bouquets please ” (we haven’t put that on our invite cards) people might get offended at our audacity of not just asking for gifts, but also telling people what to give us. Thus there is reputational risk involved, but we can explain on the same page the collective economic benefits of the wish list, so this might be taken care of.

The bigger problem is that if we were to put up a gift list the onus is on us to come up with a list of things that we want. We need to come up with a range of things such that it fits people’s varying budgets. There should be something in the list for someone who is willing to spend a hundred rupees on our gift, and also something for someone who is willing to spend ten thousand.  So in the middle of all the other wedding work for us, we also need to decide on what we want, what we don’t want, what kind of stuff we want, and so on.

Then there is quality control. We could well put up on the wish list that we want a LCD TV, but it would sure sound too audacious to be much more specific than that. And if the gifters were to get us some LCD TV that we would ultimately end up not liking, the dead weight economic loss to all of us is huge. So we need to be specific without being arrogant, which is even more work for us.

But I think we will end up making all the effort and put up a wish list, and hopefully that will improve the collective economic condition of us and our gifters.