Opaque fragile systems/institutions dominate.

by saliency1 min read11th Jun 201216 comments

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Opaque fragile systems/institutions dominate.

“Out of the crooked timber of humanity no straight thing was ever made.”

All systems compete against each other for users.  I believe opaque fragile systems dominate transparent robust systems.  First I believe individuals choose shrouded systems more tightly bounding their rationality.  Second I believe even when individuals know a system is fragile they believe they will not be victim to its fragility; the greater fools will be.

First sophisticated consumers like price discrimination while myopic consumers are ignorant they are being discriminated against or unwilling to commit the time needed to exploit the system.  Information asymmetry is a feature of the system not a bug.

See “Shrouded Attributes, Consumer Myopia, and Information Suppression in Competitive Markets” http://aida.wss.yale.edu/~shiller/behmacro/2003-11/gabaix-laibson.pdf for more detail.

Second sophisticated individuals, even when they perceive the system to be fragile, often subscribe to the the greater fool theory.  They feel they will win out over the greater fools, but they do not understand how tightly bound their rationality has become due to the layers upon layers of shrouding.  The myopics of course are largely ignorant of the risks.

This is a very pessimistic view that offers no solution to the problem of system fragility.  I think though most solutions to fragility only create larger equally fragile systems.

 

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What do you mean by "system"?

If you look at the history of retail, transparently priced stores, with price tags on items, having been winning out convincingly over the previous system of "always haggle" in most domains. Is that outside the scope of your claim, or have I misunderstood you?

In the first world people haggle by cutting coupons out of the newspaper. This is a form of price discrimination. It is also non-transparent pricing. Coupons also add to the asymmetry of information, ect,ect.

I would argue just the opposite, that we are way past our peak of transparent pricing and as time passes you will see a more byzantine maze develop.

As far as retail goes JC Penney recently failed in such a strategy be transparent.

http://redtape.msnbc.msn.com/_news/2012/05/25/11864178-fair-and-square-pricing-thatll-never-work-jc-penney-we-like-being-shafted

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P.S. "You are trying to submit too fast. try again in 3 minutes." - Is this really needed?

"You are trying to submit too fast. try again in 3 minutes." - Is this really needed?

Judging by the quality of your posts and comments, it's working perfectly.

Part of the problem is that while non-transparent pricing may or may not be self-sustaining (Gabaix--Laibson is not wholly convincing on this point), price discrimination is unambiguously so because it serves a useful economic function, namely defraying intra-marginal costs (including fixed costs and normal profit) in the most effective and least burdensome way. Cutting coupons is a comparatively efficient way of signaling that one is a highly price-sensitive customer and should not bear a significant share of these intra-marginal costs. The JC Penney strategy was affected by a similar issue in that they got rid of most of their discount sales, which also attracted highly price-sensitive folks.

First thank you for the thoughtful response. This is more what I was hoping for when I posted... I don't agree with you signaling story but it is something I would not have considered.

"price discrimination" I don't think this is at all a story of signaling. I think it is a story of information/time costs.

My stories: If my wife picks up the circular at the store entrence and tells me that if I rip out this page an hand it to the cashier I will save a buck I do so. Most people don't do their health savings accounts or mail into NYC to have their metro cards mailed to them so they can save a few bucks by deducting the cost. Do you think most people pay more taxes then they need to because they are signaling? Tell me your signaling story.

To the paper being convincing. Be specific. I bet that your story will involve agents who can not defect or some external structure which alters incentives. My story is very close to that of the paper. That people who care "sophisticated" will prefer systems in which they can obtain an advantage.

I'm expanding the strict definition of price discrimination by including taxes ect but believe they are the same. By doing so I think it can be seen that price discrimination is a supply and demand side. In addition I would argue that because I am talking about systems that it is an emergent phenomena. Agents within a system shroud. Does your car mechanic or IT guy tell you the exact truth or do they pad things just a little. Do teammates working on a project ever slack but make it look like they are doing work?

Do you think most people pay more taxes then they need to because they are signaling?

No; I think they are trading off compliance costs vs. the risk of paying more taxes than they owe. But it's not clear that the price discrimination story is applicable here.

To the paper being convincing. Be specific.

Basically, the problem with Gabaix--Laibson is that its "myopic" consumers are persistently biased in addition to having bounded rationality. They persistently expect to be charged less e.g. for the hotel stay than they actually are. A boundedly rational consumer would expect to be overcharged for some addons, even if she dosn't know in advance what the marked-up addons will be or whether she can avoid the surplus charge (unlike Gabaix--Laibson's sophisticated consumers). This may or may not change her response to efforts at more "transparent" pricing.

That people who care "sophisticated" will prefer systems in which they can obtain an advantage.

Yes, this is fairly obvious. But this also implies that naïve folks will avoid these same systems. In general, it will pay for sophisticated folks to credibly refrain from using such systems, unless the system provides further benefits (say, effective price discrimination).

Does your car mechanic or IT guy tell you the exact truth or do they pad things just a little. Do teammates working on a project ever slack but make it look like they are doing work?

This is an asymmetrical information problem. People expect that a car mechanic will pad costs if she can get away with it; so they try to establish norms under which more info is provided, or else the practice is deterred directly.

"compliance costs vs. the risk of paying more taxes" -- This is why I use health savings accounts and commuter plans as an example.

"myopic" consumers -- There really are no individual consumers there are transactions. Myopic transactions perhaps would be a better description. On aggregate we have lots of myopic transactions. (bounded rationality) To answer you question -- I agree with you second part on myopic's but don't see how it is a problem for G&L. Sophisticateds are the ones driving the evolution of the system.

made article more clear by adding /institution.

Institutions is still unclear. Retail stores can be said to be 'institutions' depending on your context.

All systems: A cities zoning board. The network of mortgage back securities. A large firm.

In all individual agents have incentive to shroud and prefer subscribing to a shrouded systems so as to extract rents.

I think "fragile" is a poor choice of a word.

Thanks for the comment. I use fragile because I am rifting off, and a bit against, what I expect is Taleb's idea for his new book antifragility.

Such usage is bad for readers who don't pay attention to Taleb. Such usage might be good for readers who do pay attention to him, but only if they (a) realize that's what you're talking about and (b) agree with your guess.

Anyhow, you used other words, so I understood what you were talking about.

I have a few problems with this theory.

First is that the boundary between "sophisticated" and "myopic" consumers is not only artificial, it is either patently false or non-falsifiable. You could only verify a consumer as sophisticated/myopic based on whether they favored price discrimination and transparency. But it is almost trivially true that nearly all consumers will sometimes favor these institutions and sometimes not, so "sophisticated" and "myopic" don't neatly divide agents. You could, alternatively, say that it is activity and not the individual agents that the kinds apply to, but then you could divide any set of agents that way, regardless of how they were composed or what activities they took, which would not be enough to use the kinds to establish trends. This same criticism can be leveled against "fragile/non-fragile" systems/institutions.

Second, it's not clear how this sort of division is useful. As you point out, it offers no solution to the problem it poses. While it can be true that some problems may be beyond solution by current means, our means includes our current knowledge of the problem. A well-developed theory of sophisticated/myopic consumers and how they relate to institutions would give you some idea of what would be needed to make a system less fragile or consumers more sophisticated, even if those means were currently impractical. For instance, if system size (in terms of people, dollars, influence, or some other metric) were the issue, it would be fair to posit that making smaller systems would make them less fragile. (I picked size only because you mention it specifically.) But this theory seems to directly suppose that this is just the way things are.

This sounds like a just-so story with no data to back it up.