We conduct a random-assignment experiment to investigate whether positive affect impacts time preference, where time preference denotes a preference for present over future utility. Our result indicates that, compared to neutral affect, mild positive affect significantly reduces time preference over money. … Happier respondents are [also] less likely to agree with the “live for today” statement than are less happy respondents. This holds even after controlling for covariates that have been shown to be related to happiness … High cognitive load increases time preference and … individuals with greater cognitive skills, as measured by IQ tests, exhibit lower time preference. (more)

This is predicted by near-far analysis, since happy is far, and the future matters more in far mode. This matters for finance today, as whatever sets discount rates, sets prices:

“All price-dividend variation corresponds to discount-rate variation.” … When it comes to broad price aggregates, such as stocks in general or land in general, price changes basically reflect crazily-changing [discount rate] values. (more)

There are basically three things available to graduates of elite colleges that other students, no matter how hard they work, have little or no access to: elite consulting jobs, investment banking, and corporate law.

Kids from elite colleges aren’t much smarter or harder working than those from the next tier, who are cheaper to hire. But elite grads do have much more polish, shine, etc. – in a word, status. If this helps explain an elite school focus in management consulting, can it also help explain a similar focus in investment banking and corporate law?

Corporate law seems easier. If, as I suggested, our inherited sense of who will tend to win a contest in coalition politics uses certain standard status markers, then the status of one’s corporate lawyers can influence attitudes about who will win a court case. So having a high status lawyer can help get folks within an organization to support standing firm, cow lower status opponents into backing down, and influence the verdict of a judge or jury.

For investment banking, a lot of that is about getting folks with deep pockets to open their wallets to back new ventures. The more it seems that important folks associated with a venture are high status, the more others may be willing to affiliate with that venture as customers, suppliers, investors, compliant regulators, etc. So there should be a big premium on having the key person who represents a venture to potential investors be high status.

I remember Bryan Caplan once suggesting that successful real estate agents tend to be the sort of people who were popular in high school, and that house buyers (especially women) prefer to affiliate with a locally popular person as they enter a new community. Investment banking could be similar, but on higher status scale.

To me, it is easy to understand why consulting firms attract so many elite students, given the wages, prestige, and job experience they offer. And it is also easy to see why firms might pay a ton for consulting, relative to law and finance – changing your basic business strategy can conceivably add enormous value, while minor changes to contract details and financing terms have limited value.

The puzzle is why firms pay huge sums to big name consulting firms, when their advice comes from kids fresh out of college, who spend only a few months studying an industry they previous knew nothing about. How could such quick-made advice from ignorant recent grads be worth millions? Why don’t firms just ask their own internal recent college grads?

Some say that consulting firms use their access to collect data on best practices, data that other firms are eager to pay for. But while this probably contributes, I find it hard to see as the main effect.

My guess is that most intellectuals underestimate just how dysfunctional most firms are. Firms often have big obvious misallocations of resources, where lots of folks in the firm know about the problems and workable solutions. The main issue is that many highest status folks in the firm resist such changes, as they correctly see that their status will be lowered if they embrace such solutions.

The CEO often understands what needs to be done, but does not have the resources to fight this blocking coalition. But if a prestigious outside consulting firm weighs in, that can turn the status tide. Coalitions can often successfully block a CEO initiative, and yet not resist the further support of a prestigious outside consultant.

To serve this function, management consulting firms need to have the strongest prestige money can buy. They also need to be able to quickly walk around a firm, hear the different arguments, and judge where the weight of reason lies. And they need to be relatively immune to accusations of bias – that their advice follows from interests, affiliations, or commitments.

All three of these functions seem to be achieved at a low cost by hiring good-looking kids from our most prestigious schools. These are the cheapest folks you can buy with our most prestigious affiliations, they are smart enough to judge where reason lies, and they have few prior affiliations to taint them with bias. They can not only “borrow your watch to tell you the time,” but can also cow you into submission in accepting that time.

Yes the information contained in consulting advice can be obtained elsewhere at a lower cost. Firms could hire most any smart independent folks, or set up a prediction market. But alas those sources don’t have the raw strength of status to cow opponents into submission, opponents who in practice can block changes no matter what a CEO declares.

So mine is a signaling and status story (surprise surprise). The weight of status often decides outcomes, no matter what the CEOs commands, and so CEOs often need to bring out status ringers, to cow opponents into submission.

Log Nation Size v Log Rank

The threshold below which there are few nations is roughly three million people. For towns/cities this threshold scale is about three thousand, and for firms it is about three. What were such things distributed like in the past?

I recall that the US today produces few new towns, though centuries ago they formed often. So the threshold scale for towns has risen, probably due to minimum scales needed for efficient town services like electricity, sewers, etc. I’m also pretty sure that early in the farming era lots of folks lived in nations of a million or less. So the threshold scale for nations has also risen.

Before the industrial revolution, there were very few firms of any substantial scale. So during the farming era firms existed but could not have been distributed by Zipf’s law. So if firms had a power law distribution then, it must have had a much steeper power.

If we look all the way back to the forager era, then cities and nations could also not plausibly have had a Zipf distribution — there just were none of any substantial scale. So surely their size distribution also fell off faster than Zipf, as individual income does today.

Looking further back, at biology, the number of individuals per species is distributed nearly log-normally. The number of species per genera:

and the number of individuals with a given family name or ancestor:

have long been distributed via a steeper tail, with number falling as nearly the square of size:

This lower inequality comes because fluctuations in the size of genera and family names are mainly due to uncorrelated fluctuations of their members, rather than to correlated shocks that help or hurt an entire firm, city, or nation together. While this distribution holds less inequality in the short run, still over very long runs it accumulates into vast inequality. For example, most species today descend from a tiny fraction of the species alive hundreds of millions of years ago.

Putting this all together, the number of species per genera and individuals per families has long declined with size as a tail power of two. After the farming revolution, cities and nations could have correlated internal successes and larger feasible sizes, giving a thicker tail of big items. In the industry era, firms could also get very large. Today, nations, cities, and firms are all distributed with a tail power of one, above threshold scales of (three) million, thousand, and one, thresholds that have been rising with time.

My next post will discuss what these historical trends suggest about the future.

Probably the simplest and strongest argument is insurance market failure: being risk-averse, we want to insure against variations in our distant future income, but since this insurance is not available privately, governments must provide it. Why exactly this is not available privately if customers want it isn’t usually clarified. And it could be that the incentive costs of the insurance outweigh its risk-reduction benefits. But this is at least in the ballpark of a plausible institutional argument.

However, it seems to me that as a parent I wouldn’t have wanted to insure against any but the very low tail of possibilities of for my kids future income. I like the idea that one of my kids might someday be very successful or famous. And asking this of my undergrads consistently gets the same answer – very few want such insurance for their own or their kids’ future. Furthermore, parents do not much use the one clear insurance option they have – to teach their kids to share their future income with each other. Most societies used to do this, and our culture evolved away from that. So while teaching kids to share income is both personally and culturally possible, we just don’t do it.

Now you might argue that this is a signaling failure – that we would each in fact like such insurance, but dislike what our willingness to take it would say about us. But you could also tell your kids to keep this income-sharing policy a family secret, only to tell potential spouses. And once such sharing became a long family tradition then continuing it would say much less about personal features. But it seems to me that even if given the option to legally commit all their descendants to such a policy, to prevent all future signaling about it, most folks would still reject such insurance.

Thus it seems to me that most folks think the incentives costs outweigh the risk-reduction gains for such insurance, and do not want it. Thus the insurance market failure rationale for taxing the rich extra just fails.

First, firms and cities are similar in many ways. They both vary greatly in size, and can be costly for long-time associates to leave. Both tend to be “selfish” in avoiding and excluding those who do not benefit other associates, and thus tend to favor rich folks. People can relate to both kinds of units as investors, suppliers, leaders, and customers.

Second, people tend to like cities more than firms. For example, many movies are love songs to particular cities, yet few movies have cities as villains. Many movies have firms as villains, but few have firms as heroes. Sporting teams tied to cities play in huge stadiums, while teams tied to firms play in local parks.

While people tend to dislike bigger firms more than small ones, cities tend to be bigger than firms, and the biggest cities tend to be the most celebrated. People tend to resent firms more when it is more costly to leave them, yet it tends to be harder to leave cities than firms. So why are cities loved so much more?

One theory is that we related to cities less directly. If a city doesn’t hire you, you can say particular firms wouldn’t hire you. If a city won’t sell you a dress cheap, it is particular firms that wouldn’t sell it. So cities can more easily escape blame. However, a similar argument would suggest that we love shopping malls more than stores, or TV channels more than TV shows. Yet these seem weak effects, if they exist at all.

Another theory is that we often see firms as illicit dominators. We see the employer-employee relation as a dominance-submission relation, because firms give employees orders. Of course customers often give orders to firms, such as to waiters and cab drivers. But perhaps the joy of sometimes dominating does not outweigh the pain of at other times submitting. (And why are landlords seen as dominators, with renters submissives?)

Now cities do often seem to take a dominance relation to their citizens, such as via police, teachers, and rule-bound officials. But people seem to resent this dominance less. Is this because the major is democratically elected? CEOs are also usually elected, its just via one stock one vote, instead of one person one vote. Do people love cities less where local officials aren’t elected? Do people love non-profit firms as much as cities? Color me again confused.

Added 4p: Andrew Gelman says many firms are actually very popular. Alas he doesn’t have comparable data on cities.

This distribution of firms and cities seems to result from their being tolerably effective across a wide range of sizes, having long unequal lifetimes, having little net local growth, and holding a roughly fixed total number of people. In contrast, individuals have more equal lifespans, are psychologically inclined to spend more as they get richer, and have spending habits that correlate only weakly across generations. (“Rags to rags in three generations.”)

How might these change in the future? In the em era, I expect firm distributions to stay similar, but expect city and individual wealth distributions to change. I’ve talked before about how I suspect strong gains to em concentration, as they suffer less from travel congestion, leading perhaps to most being in a few dense cities. In this post, let me talk about em wealth.

Since em lifespans should be limited mainly by em wealth, em lifetimes can vary a lot more than human lifetimes, and ems can have more long-term spending consistency. While some ems will spend their wealth on more copies, others will hoard their wealth. Some may even manage to consistently reinvest most of their wealth via something like a Kelly criteria. This seems likely to make future em wealth evolution more akin to today’s firm and city evolution. I thus expect a near Zipf distribution for the high tail of em wealth.

This change in tail power should make em wealth distributions more unequal. Under a tail power of ~1.4, today’s richest person has about $75B, which is about 0.04% of the world’s $200T wealth. Under a power of ~1, the richest person might be about a hundred times richer, holding ~4% of the world’s wealth, or $7.5T.

Since a Zipf distribution has an unbounded expected value, its inequality also depends on the total population size (which follows it). The following table shows this dependence:

The “% of Richest” column says what fraction of the total wealth is held by the one richest person. The “MidW %” column shows the (smallest) fraction of the population that holds half of the total wealth. And the “MidW/ave” column shows how much richer is the mid-wealth person (for whom half of all wealth is held by richer folks) than the average person.

For a Zipf wealth distribution, as the population gets larger wealth gets more concentrated. Even so, the very richest person holds a smaller fraction of the total wealth. The same should apply to firms and cities if they retain a Zipf distribution — the firm and cities that hold most people will get larger, even though the largest firm or city would be a smaller fraction of the total.

In sum, as the population gets larger, I expect firms and cities to get larger.  And for “immortal” ems, I also expect a more unequal distribution of wealth. Even so, as population increases the very largest firms, cities, and rich folks should hold smaller fractions of their respective totals.

Added 11p 14Jan: This post has now been up for a whole day, with zero comments and one vote. Which has to be some sort of record for reader disinterest. This is especially noteworthy, given that I’m especially proud of this post, culminating several days work trying to understand something important about the future. Alas that I  sometimes bore readers, but I’m writing this blog mainly for me, so I’ll continue to write about what most interests me, even if past responses suggest readers won’t be as interested.

The number of new businesses we get seems limited by the number of folks personally wealthy enough to start new businesses. So having more really rich folks benefits everyone via innovation.

Now I learn that very rich folks are crucial not only for business starts, but also for most business investment that takes more than a year or so to payoff! Consider:

As is common in factories, [public firm] Standard [Motor Products] invests only in machinery that will earn back its cost within two years. (The Atlantic, Jan 2012, p.66)

Why look at years-to-payback instead of return on investment? A new NBER paper on private vs. public firms makes the answer clear. Unless project gains can be very clearly proven to analysts, or perhaps so small and numerous to allow averaging over them, public firms are basically incapable of taking a loss on earnings this quarter in order to make gains several years later, no matter how big those gains. CEOs are strongly tempted to instead please analysts by grabbing higher short-term quarterly earnings. So we need the very rich to make long-term investments. The details:

In 2007, private U.S. firms accounted for 54.5% of aggregate non-residential fixed investment, 67.1% of private sector employment, 57.6% of sales, and 20.6% of aggregate pre-tax profits. Nearly all of the 6 million U.S. firms are private (only 0.08% are listed), and many are small, but even among the larger firms, private firms predominate: Among those with 500 or more employees, for example, private firms
accounted for 85.6% in 2007. … 94.1% of the larger private firms in the survey have fewer than ten shareholders (most have fewer than three), and 83.2% are managed by the controlling shareholder. …

On average, private firms invest nearly 10% of total assets a year compared to only 4% among public firms. Second, private firms are 3.5 times more responsive to changes in investment opportunities than are public firms. … A plausibly exogenous tax shock … experiment reveals that private firms respond strongly to changes in investment opportunities whereas public firms barely respond at all. … IPO firms are significantly more sensitive to investment opportunities in the five years before they go public than after. …

For industries in which share prices are unresponsive to earnings news (ERC = 0), we find no significant difference in investment sensitivities between public and private firms. As ERC increases, public firms’ investment sensitivity decreases significantly while that of private firms remains unchanged. … There are significantly fewer stock market listed firms in high-ERC industries. … Investment rates decrease significantly with size among public U.S. firms …

Survey evidence …. find[s] that public-firm managers prefer investment projects with shorter time horizons in the belief that stock market investors fail to properly value longterm projects. … “The majority of managers would avoid initiating a positive NPV project if it meant falling short of the current quarter’s consensus earnings [forecast].”

It seems that the public-private margin is what matters for the effects we observe: We see no differences in investment behavior, among private firms, across different organizational structures (such as sole proprietors, partnerships, or different forms of incorporation) … . Our results are most consistent with the view that public firms’ investment decisions are affected by managerial short-termism.

Interesting that private firms have 67% of employees yet only 20% of profits. Is this mostly because owners take “profits” off the books to avoid taxes, or because owners attend more to growing firm value than to paying current earnings?

[In] a large-scale randomized field experiment in Mexico … [in '04 on] a voluntary health insurance option [=SP] … ‘high risk’ agents are, ceteris paribus, more likely to opt into SP—although the insured are not more ‘risky’ on average. That is, despite the absence of a positive raw correlation between agents’ insurance status and proxies of risk, this paper presents evidence of the systematic selection predicted by theory. In particular, individuals who rated their health as “bad or very bad” before SP became available are 6.9 percentage points more likely to sign up for SP than those in “good or very good” health (compared to an overall treatment effect of 29 percentage points).

Curiously, however, agents in the experiment sort only on pre-period medical expenditures and subjective well-being. There appears to be no selection on objective measures of health—possibly because individuals are less aware of the latter. … [Regarding] preventive care decline with insurance coverage, the effect of SP on the utilization of these services is negative and non-trivial in size. Given the positive price effect, such a decline is likely due to ex ante moral hazard. (more)

This supports the idea that medicine is less about health than health-related feelings. If medicine were more about the reassurance that comes from being taken care of medically (because medicine is a standard way for others to show that they care about us), it makes sense that we want more insurance when we feel more vulnerable to illness, but that sense of vulnerability would  have a lot more to do with the social assurances we desire than our state of health.