Lest this sound like an impossible paragraph, let me hasten to follow it by one in plain English. To this end, I will point first to Princeton economics professor Uwe Reinhardt’s very recent posting in the Economix blog of the New York Times. Please do read it before continuing to read this post.

In this very good piece, Professor Reinhardt points out how often the term “efficiency” is trotted out to make audiences feel that the economist speaker/writer addressing them is making an objective, scientific claim. Not so fast! Efficiency, in the technical sense of economics (“Pareto efficiency”), means that a state of affairs prevails in the economy so that there is no feasible change that will improve the welfare of at least one person while harming no one.

Think about it for a second; it sounds appealing, at first. Why not aim to extinguish the “welfare waste” that inefficient states possess?

But it is not so easy. Nobel laureate Amartya K. Sen has classic criticisms (see his Nobel lecture, page 198 and onwards, or look up his 1977 classic paper, “Rational Fools”) of efficiency. (He is not the only one, but he is quite probably the most respected scholar, among economists, who has such criticisms.) The Rational Fools paper, if memory serves me right, is the one that pointed out that the state of affairs in which Roman Emperor Nero would have been prevented from having Rome set afire as a background to his lyre playing, would entail a loss of welfare for Nero (never mind that it would improve the welfare of thousands of Roman citizens) and therefore it would not be an improvement in efficiency over the historical state of affairs, in which Nero did enjoy performing his ode while Rome burned. Pretty much every person’s sense of fairness would find this repugnant, which points out one particular, often glaring, way that economic efficiency hides a strong value judgment, that says “don’t you dare hurt anyone, no matter privileged, to help any number of people, however non-privileged or deserving”.

Worse still, economists are blithely using “efficiency” to justify all sorts of policy suggestions, and as a benchmark in countless papers. I hope this post has helped at least one consumer of writings of economists become more critical of this practice.

For a bit more about this, please check out my writing on public economic on this page.

Overall, the promotion of interesting stories in preference to accurate ones is always in the immediate economic self-interest of the promoter. It’s interesting stories, not accurate ones, that pump up ratings for Beck and Limbaugh.  But it’s also interesting stories that bring readers to The Huffington Post and to Maureen Dowd’s column, and it’s interesting stories that sell copies of Freakonomics and Super Freakonomics.  In this respect, Levitt and Dubner are exactly like Beck and Limbaugh.

We might call this the Pundit’s Dilemma — a game, like the Prisoner’s Dilemma, in which the player’s best move always seems to be to take the low road, and in which the aggregate welfare of the community always seems fated to fall. And this isn’t just a game for pundits. Scientists face similar choices every day, in deciding whether to over-sell their results, or for that matter to manufacture results for optimal appeal.

In the end, scientists usually over-interpret only a little, and rarely cheat, because the penalties for being caught are extreme.  As a result, in an iterated version of the game, it’s generally better to play it fairly straight.  Pundits (and regular journalists) also play an iterated version of this game — but empirical observation suggests that the penalties for many forms of bad behavior are too small and uncertain to have much effect. Certainly, the reputational effects of mere sensationalism and exaggeration seem to be negligible.

Mark Thoma says, among other things, this, in the post that brought Liberman’s post to my attention:

I’m not sure I know the answer to that, but I suspect it has something to do with increased competition among media companies for eyeballs and ears combined with an agency problem that causes information organizations to maximize something other than the output of credible information (maximizing profit may not be the same as maximizing the output of factual, useful information).

Though this type of behavior was always present in the media, it seems to have gotten much worse with the proliferation of cable channels and other media as information technology developed beyond the old fashioned antennas on roofs receiving analog signals. I don’t want to go back to the days where we had an oligopolistic structure for the provision of news (especially on network TV), competitive markets are much better, but there seems to be a divergence between what is optimal for the firm and what is socially optimal due to the agency problem.

Some people have argued that there are big externalities to good and bad reporting, and therefore that “some kind of tax credit scheme for non-entertainment news reporting might enhance societal efficiency and welfare.” That might help to change incentives, but I’m not sure it solves the fundamental agency problem. There must be reputation effects that matter to the firm, some way of making the firms pay a cost for bad pundit behavior. But that is up to the public at large, people must reward good behavior and penalize bad, it is not something the government can control. I suppose we could try something like British libel laws to partially address this, but looking at the UK press does not convince me that this solves the problem.

So I don’t know what the answer is.

I would not want to jump in and say that I know what the answer is. However, it is clear that there is a mechanism design question here. The economist’s knee-jerk reaction to this would be “if the consumers of information are more interested in being entertained than informed, then it is efficient to provide them entertainment as long as the marginal cost of entertaining each one of them meets her/his marginal willingness to pay”. As Thoma notes, it is noted that reporting has external effects. These would seem to push us in the direction of amending the rule for social optimality and looking for ways to align pundits’ incentives to what efficiency would require.

But if the majority of the audience want to be entertained and not informed, shouldn’t we economists, as children of the Enlightenment, bow to the consumers’, our multitudinous Kings’, desires? To take the idea that bad reporting carries negative externalities seriously, one has to take seriously the possibility that people express preferences for the wrong things, things that will in the long term, collectively conspire to harm them. Is this only because of the word “collectively” and so only a question of externalities, one step removed? I think that there is more “irrationality” to consumers than that. We need to come to grips, as we consider mechanism design, with “irrational consumers”. The misnamed “behavioral economics” (all economics is behavioral) field has some valuable ideas here. It seems to me economic theorists of the mechanism-design bent, should adopt these ideas and do their formalizing magic with them to reach some results. After all, no lesser theorist than Leonid Hurwicz made a foray into “irrational” agents all the way back in the 1980s.

Remark: I always place “irrational” and “rational” within quotation marks. Given what I know of game theory, including Binmore’s work on the application of Goedel’s Theorem on games played by automata, and games such as the Prisoners’ Dilemma and the Centipede, I feel I have no way of even pretending that I know what “rational behavior” really ought to mean in the case of individuals interacting in a game. Worse, in the context of consumer not knowing “what’s good for them”, we have an additional level of “irrationality” which seems to resolve to time inconsistency in the behavior of a single person. This post being long enough, I have to leave further development on my thoughts on these points to another post.

Most economists think that they are building cranes that suspend important theoretical structures from a base that is firmly grounded in first principles. In fact, they almost always invoke a skyhook, some unexplained result without which the entire structure collapses. Elinor Ostrom won the Nobel Prize in Economics because she works from the ground up, building a crane that can support the full range of economic behavior.

When I started studying economics in graduate school, the standard operating procedure was to introduce both technology and rules as skyhooks. If we assumed a particular set of rules and technologies, as though they descended from the sky, then we economists could describe what people would do. Sometimes we compared different sets of rules that a “social planner” might impose but we never said anything about how actual rules were adopted. Crucially, we never even bothered to check that people would actually follow the rules we imposed.

…

Economists who have become addicted to skyhooks, who think that they are doing deep theory but are really just assuming their conclusions, find it hard to even understand what it would mean to make the rules that humans follow the object of scientific inquiry. If we fail to explore rules in greater depth, economists will have little to say about the most pressing issues facing humans today – how to improve the quality of bad rules that cause needless waste, harm, and suffering.