Thursday, December 27, 2012

Are voluntary contracts always mutually beneficial?



In a Crooked Timber post about cyborgs, Chris Bertram writes:
I expect someone will be along to explain how...contracts [requiring employees to get cyborg modifications] would be win-win.
Matt Yglesias drops by in the comments to write:
It seems pretty obvious how they would be win-win: They’d be agreed to voluntarily by two mentally competent adults.
Actually, this is a common misconception, so I thought I'd write a quick post to correct it. Basic Econ 101 does not imply that voluntary contracts are mutually beneficial to the people who enter into them.

The misconception springs from some solid intuition. In general, people who are free to do what they want, do do what they want. Maybe sometimes they don't realize what they want, or are subject to compulsions like addiction, but in general, free people only make deals that they want to make.

BUT, it doesn't follow that contracts are mutually beneficial. The reason is that there is uncertainty in the world.

Suppose that there's a deal that has a 60% chance of being to my benefit, and a 40% chance of being to my loss (assume equal benefit and loss here, just for simplicity). If I'm a rational person, and not too risk-averse, I would do that deal. But that still leaves a 40% chance that I'll lose out on the deal.

This is what's known as the difference between ex ante and ex post. Econ 101 says that people only make deals that are to their benefit ex ante. But that still leaves a lot of room for people to lose out ex post. And ex post is more important, since it's the real thing that actually happens to people, whereas ex ante is just what we guess will happen. (As a commenter points out, insurance contracts are a really good illustration of this principle. Would you buy health insurance if you knew you weren't going to have any health problems? Would your insurer sell you insurance if they knew you were going to get sick?)

Of course, all this doesn't mean the government needs to step in and stop people from taking risks. It just means that you can't infer outcomes from people's decisions.

Now just for fun, and because I don't like writing short blog posts, let's move out of the Econ 101 world, and introduce two advanced concepts: 1) asymmetric information, and 2) Knightian Uncertainty.

In a world of asymmetric information, one party to a deal may know something that the other party doesn't. For example, suppose you and I are considering making the deal in the above example. You think that the deal gives you a 60% chance of benefiting and a 40% chance of losing out. So, by your best guess, this deal is worth it ex ante. And so you're willing to do the deal.

But suppose I have information you don't (of which you are entirely unaware). Suppose I know that in reality, you have only a 30% chance of benefiting from the deal and a 70% chance of losing out. If you know what I knew, you'd never agree to the deal.

Now, if we could do 100 such deals, you'd eventually realize that I systematically had better information than you, and you'd become wary and stop making deals with me (as in George Akerlof's "lemons" model of asymmetric information). But in the real world, conditions are changing all the time - today I might have information you don't, and you might have information I don't. Thus, not only is there asymmetric information, but there's uncertainty (called "Knightian Uncertainty" after Frank Knight) about how likely it is that there's asymmetric information.

This allows people to be swindled again and again, as new kinds of asymmetric info keep popping up and falling into different hands. The swindlers may change, but the swindling will never stop, no matter how rational people are or how much experience they get. This is the basis of what George Akerlof calls "Phishing for Phools".

This is why we might want the government to step in and force people to divulge their private information. Econ 101 does say that better information all around can't possibly worsen the outcome of deals. I know of no "economic efficiency" argument for allowing people to try to swindle other people.

Anyway, bottom line: Even in a perfectly rational, perfectly free world, voluntary contracts are not always  mutually beneficial to the people who enter the contracts. And in a realistic, ever-changing, uncertain world, some kinds of contracts might be mutually beneficial less than 50% of the time. (Of course, if you allow for people to be irrational and unfree, things get even worse. And this post doesn't even mention things like externalities, which throw a further wrench into the system.)

68 comments:

  1. Anonymous7:06 PM

    Actually from a policy perspective only ex ante can be important, because you cannot know the ex post.

    ReplyDelete
    Replies
    1. No, that's not right! If you think that for some reason people are taking a socially suboptimal amount of risk, then ex post matters.

      For example, you might want to implement limited liability to make entrepreneurs more risk-tolerant.

      Or you might want to implement macroprudential regulation to reduce systemic risk.

      Both of these examples involve externalities (which I didn't cover in the post). But you might also think that people are addicted to risk (e.g. gambling), and you might act paternalistically to reduce their risk-taking for their own good.

      Delete
  2. The Libertarians will argue that employers should be allowed to make sexual favors a condition of employment.

    ReplyDelete
    Replies
    1. Yeah, Noah really misses the point here. Matt's argument applies just as well to "I'll hire you if you sleep with me" and Noah's counter argument doesn't apply in that circumstance, putting aside the possibility of herpes.

      Delete
    2. Well, addressing that side of the argument requires analyzing the nature of soft coercion, which really isn't something economics has much to say about.

      Delete
    3. But does he? Is this not a problem of asymmetric information?

      What if you simply asked employers to publicly announce if they have such hiring practices? Would any financier take a stake or lend funds to a company that hires people according to such standards? Would a good emploee ever seek employment in such a company? Would a customer do business with such a company? For any employer to do so would amount to professional suicide, unless of course they are in the porn industry!

      Delete
    4. Its more than asymmetric information. It is asymmetric power. Of course it can be argued that the option the employee has chosen is beneficial to them - it is beneficial to have an income and if getting a job is the only way one can get an income then granting sexual favours or accepting implants is less bad than starving and having ones family starve. This fundamental inequality points to the core fallacies in economic theory.

      Delete
    5. This fundamental inequality points to the core fallacies in economic theory.

      Just out of curiosity, what do you think is the fallacy?

      Delete
    6. Alternz,

      economic theory simply states that power will be asymmetric only if the employee has no other similar job options. For this to be true the employee's skills must be such that no one will hire them at the desirable wage based on only economic criteria. Theory also states that prohibiting voluntary sexual favors will, everything else being equal, make that person worse off. Moreover, my post simply pointed out that rather than prohibiting a voluntary exchange you can achieve the same outcome by requiring disclosure of information on hiring practices. So I join Noah in asking, where is the fallacy in that?

      Delete
  3. Anonymous7:11 PM

    Sweet. Back to the economics.. and a much better post.

    From "Anonymous" of one and a half hours ago, on your prev post.
    x

    ReplyDelete
  4. Does bounded rationality figure into this, or is it folded into one of the other factors? (I'm not an economist--sorry if this is a dumb question.)

    ReplyDelete
    Replies
    1. It does add an additional wrinkle. What kind of wrinkle depends heavily on just how the rationality is bounded.

      Delete
    2. I should have realized. I was thinking in terms of resources (time, "computation", etc.), but I suppose that's too abstract.

      Delete
    3. If computation is constrained by something like available glucose or time, then ignorance of risks can get worse.

      But when you start working in a bounded rationality framework, you've now got the possibility people are using ad hoc decision heuristics, social norms, etc which may be kid-tested and mother-approved by other mechanisms, like evolutionary selection.

      So limited computation, if you stay in a strictly forward-looking, Bayesian rational world where people are calculating expected utility, exacerbates information problems -- but only in terms of calculating expected payoffs.

      In a broader bounded rationality view, calculating expected payoffs on every margin probably isn't that important, as long as costs and benefits got weighed at *some* point in a decision's history. As in -- at some point a critical mass of people decided it was a good thing to hold doors open and not let them slam in stranger's faces. And that social convention persists regardless whether anyone thinks about it.

      Delete
    4. The computational bounds of rationality are, I think, important in many practical consumer situations.

      Marketing types invest a good deal of company money to ferret out small biases in people's decision making that advantage the company, like which shelf is the best for dish soap, how big should shopping carts be. For each individual consumer there is 'rational inattention' calculating exactly how much to put in your grocery cart may not be worth the time and effort, but the aggregate of those decisions for the company is very valuable to the grocer.

      I think of it like the Richard Pryor character in Super Man III skimming the rounded off pennies from the payroll.

      Delete
  5. To anyone other than an economist, this topic is non-controversial and the answer is no. That is why there are laws against enforcing contracts for illegal activities, contracts induced by fraud and contracts with minors, and a number of other exceptions to enforceability. Experience again trumps theory -- and with good reason given human nature.

    More fundamental is the question of whether the teleological assumption (in the general form -- I'm not talking about creationism) is accepted or not -- i.e., the agent/actor knows what he wants today and knows today what he will want tomorrow. Since it implies that people do not ever change in their desires and can predict their own futures with certainty, it appears to be easily falsified.

    ReplyDelete
    Replies
    1. More astounding erudition from critics of economics, reciting commonplace issues dealt with in major economics journals as if you've radically undermined the discipline.

      Delete
    2. If we ignore the "Libertarian" dogma that all voluntary contracts ARE de facto mutually beneficial, or should be presumed to be so, thereby eliminating any justifiable need for any kind of govt "referee" between contracting parties.

      I have read Rothbard on privatizing Congress, Courts, etc. with private "legislator corporations", and with everyone buying private "police company" contracts and going to resolve disputes in competing private "justice court companies".

      Granted, our existing "democratic" aka "republican" models which presume that a "public purpose" exists, are hardly devoid of politics and bias towards POWER (generally), but I can't imagine how people buying "police contracts" and "justice contracts" (or insurance) at Nordstroms and discount contractual services via Walmart could produce better "free market" outcomes, using various market incentives.

      What happens when two different parties' private police companies have competing agendas? May the strongest win? This seems to amount to high-tech sophisticated "warlordism" in a bad kind of anarchy.

      Yet THIS KING OF THINKING lies behind much of commonplace Neo-Classical Economics.

      Delete
    3. That's right Graham, ignore the issue completely and just tell yourself that all critics of economics are ignorant as the economy crumbles around you.

      Economists: lol.

      Delete
  6. "The very fact that an exchange takes place is proof that there must necessarily be profit in it for both the contracting parties; otherwise it would not be made. Hence, every exchange represents two gains for humanity." - Étienne Bonnot de Condillac

    There's demonstrated preference, revealed preference, stated preference and Bryan Caplan's Consumer Satisfaction Standard

    It was the Austrians, specifically Hayek, who gets credit for arguing that it was absurd for you positivists to assume perfect information. Nobody is omniscient...we all only have partial knowledge.

    But I don't quite grasp how somebody can truly grasp the significance of partial knowledge and still lean away from exit towards conceit.

    Somebody fools me twice...shame on me for not exiting. If the government fools me twice...if it forces me pay for things that do not even come close to matching my preferences...if there isn't a convenient exit...then shame on me...cause it's all my fault for not being a more effective communicator.

    The market works because, if I share my partial knowledge with you and suggest that you to buy and read Scroogenomics...then you have the freedom to act or not act on the partial knowledge that you just gained. If I tell you that the DoD is spending your taxes on things that you ethically or economically object to...then you don't have the freedom to act on the partial knowledge that you just gained...you don't have the freedom to give your taxes to another government organization instead.

    I've decided that I'm going to start referring to "planned economies" as "non sequitur economies". Why do we want a non sequitur economy in the public sector? What would you estimate the deadweight loss to be?

    ReplyDelete
    Replies
    1. "Hence, every exchange represents two gains for humanity." - Étienne Bonnot de Condillac
      --------------------

      Reminds me of Neoliberalism: origins, theory, definition by Paul Treanor.

      If Adam Smith returned and saw the more extreme aspects of neoliberalism, he would probably find them bizarre. Nevertheless, they derive from the ideas of early liberalism.

      The belief in the market, in market forces, has separated from the factual production of goods and services. It has become an end in itself, and this is one reason to speak of neoliberalism and not of liberalism.

      A general characteristic of neoliberalism is the desire to intensify and expand the market, by increasing the number, frequency, repeatability, and formalisation of transactions.

      The ultimate (unreachable) goal of neoliberalism is a universe where every action of every being is a market transaction, conducted in competition with every other being and influencing every other transaction, with transactions occurring in an infinitely short time, and repeated at an infinitely fast rate.

      It is no surprise that extreme forms of neoliberalism, and especially cyberliberalism, overlap with semi-religious beliefs in the interconnectedness of the cosmos.

      Delete
  7. Anonymous9:20 PM

    Apropos of nothing else, I'd love to know how you came by the choice of accompanying image.

    ReplyDelete
    Replies
    1. See if you can figure it out! Nerd points if you do.

      Delete
    2. So I guess it is the Transformer "Swindle"

      "Capitalist first, Decepticon second, Swindle is a con-man, an opportunist, a hustler—or as he would put it, an entrepreneur. Unlike his fellow Combaticons, he considers the Autobot-Decepticon war to be merely an opportunity for networking, cutting deals, and making profit. He's an expert on all manner of weaponry and their market prices, and he prides himself on being able to sell anything to pretty much anybody. All he needs is a smile.

      Swindle can combine with the other Combaticons to form Bruticus.
      It's... it's not my fault, Megatron! This greed is built into my personality component!Swindle, after selling the other Combaticons's remains"

      Delete
    3. Absalon wins the Nerd Points.

      Delete
    4. Absalon wins the Nerd Points.

      You like me, you really like me...

      Delete
  8. Anonymous11:49 PM

    You said in your conclusion:
    "Anyway, bottom line: Even in a perfectly rational, perfectly free world, voluntary contracts are not always mutually beneficial to the people who enter the contracts."

    I think by "mutually beneficial" you mean ex post mutually beneficial, right?

    Can you please give an example of an insurance contract which is *ex post mutually beneficial* to all parties who voluntarily enter that contact ex ante?

    Thank you

    ReplyDelete
    Replies
    1. I think by "mutually beneficial" you mean ex post mutually beneficial, right?

      Well, see the second part of the post...it depends on conditions in the world.

      Can you please give an example of an insurance contract which is *ex post mutually beneficial* to all parties who voluntarily enter that contact ex ante?

      Hmm, that is a subtle question...

      How about auto insurance? If I hadn't bought it, I wouldn't have been allowed to drive...

      Delete
    2. Anonymous3:53 AM

      No. Don't cheat! You said in "perfectly free and rational world". By that you should be able to come up with a textbook example in which blank is true. So, suppose you are allowed to drive even without insurance. Tell me an example of an insurance contract that every party will want to buy ex post.

      I will tell you the answer: there is none! Almost by definition of insurance. Which means a person receives x if event a happens.

      Something is wrong with your argument in this post. And it has nothing to do the asymmetric information and all that. It is much more basic than that: your criteria of mutually beneficial is not well defined. There is no contract that satisfy it!:) by construction.

      Delete
    3. I will tell you the answer: there is none! Almost by definition of insurance. Which means a person receives x if event a happens.

      Well, maybe so. That is certainly my first instinct - "insurance" means an ex-post zero-sum bet. But does it? I'll try and think of an intuitive counterexample.

      Something is wrong with your argument in this post...your criteria of mutually beneficial is not well defined. There is no contract that satisfy it!:) by construction.

      No, that's not right. First of all, "mutually beneficial" IS well-defined. Second of all, there definitely ARE contracts that are mutually beneficial under perfect information; to see this, just take any perfect-information example from intro micro. You have two left shoes, I have two right shoes, I trade you a left shoe for a right shoe and now we can both wear shoes. Simple.

      Delete
    4. Anonymous4:14 AM

      That is not insurance. Ex ante and ex post are identical in your shoe example.

      Ex post mutually beneficial is not well defined. Just think about it for a minute and you will understand why.

      Delete
    5. You wrote:

      There is no contract that satisfy it!:) by construction.

      Nowhere in that statement is the word "insurance"...

      Ex post mutually beneficial is not well defined. Just think about it for a minute and you will understand why.

      Hmm, maybe I've thought about it for more than a moment, and maybe you're wrong...think carefully... ;-)

      Delete
    6. Anonymous6:28 AM

      No, he is right. In general, ex-post welfare is not well-defined. A simple example for illustration. Suppose a simple Arrow-Debreu economy with two states of the world. There is an asset which pays well in one state and in another state of the world, the buyer has to pay. There are also two agents who have different subjective probabilities about the outcomes, i.e. the first agent thinks that the probability of the good state is 95% and the second agent thinks that the probability is 90%. Should the government allow the trade in the asset? If it is allowed, should it be somehow regulated by somehow weighing the outcome? The problem is that the true probabilities of the outcome are not known and hence nobody knows how to weigh the outcome ex-ante.

      For a description of the difference betweem ex-ante and ex-post welfare see Hammond (1981).

      Delete
    7. cyborg VI1:37 PM

      nicely put puto---

      Suppose a simple Arrow-Debreu economy with two states of the world. There is an asset which pays well in one state and in another state of the world, the buyer has to pay. There are also two agents who have different subjective probabilities about the outcomes, i.e. the first agent thinks that the probability of the good state is 95% and the second agent thinks that the probability is 90%. Should the government allow the trade in the asset? If it is allowed, should it be somehow regulated by somehow weighing the outcome? The problem is that the true probabilities of the outcome are not known and hence nobody knows how to weigh the outcome ex-ante.

      For a description of the difference betweem ex-ante and ex-post welfare see Hammond (1981).

      Delete
    8. Phil Koop4:15 PM

      I think it is a little early in the discussion for you guys to start high-fiving each other. This line of argument carries more than a whiff of fallacy of composition.

      I am a casino. I sell insurance against certain outcomes on a roulette wheel, say. So the outcome eventuates and I have to pay the policy claim. Why am I supposed to be sad, ex-post? If did not pay this claim I would not have been able to sell all the other roulette policies. I am perfectly happy to pay out billions of dollars in claims so long as I am raking in billions more in premiums. Only if the gambler has some illicit edge - the information asymmetry that Noah explicitly excluded - would I be unhappy.

      Will you claim that although I am happy overall, I cannot be happy about the particular policy that I had to pay? Even that is not obviously true. Do I not want to advertize? To be seen to be paying out some claims to encourage the others?

      Delete
    9. No, he is right. In general, ex-post welfare is not well-defined.

      No, he's not right, ex post welfare is well-defined, as long as you can define Bernoulli utilities. If you can define the utility of any outcome, ex post welfare is just the welfare of the outcome that actually happens.

      Your example shows that ex ante welfare isn't well-defined, because of heterogeneous beliefs. That is true. That is why, in my post, I say that "ex post is more important".

      Delete
    10. Anonymous5:10 PM

      I am the 11:49PM anonymous,

      The way you argue is very confusing. You first talk about "mutually beneficial" and by that you mean voluntary participation in trade (yes, or no?). Then you claim that "ex post mutually beneficial" is the right concept to study because of uncertainty. The moment you bring uncertainty you are talking about insurance contracts (hence your show example is irrelevant).

      Then you desperately attempt to come up with an example in which there is uncertainty AND outcome is "ex post mutually beneficial". You didn't realized this is impossible by definition (and you still stubbornly refuse to accept that).

      Now, all of the sudden you talk about welfare? Who talked about welfare? Off course ex post welfare is well defined. That is not what we are talking about here.

      You claimed I am wrong and you have thought about it more than a minute. OK, prove me wrong. Give me a simple textbook example (as you claim in the post) of insurance contract (a contract with uncertainty) in which all parties are better off ex ante and ex post.
      And don't cheat. I don't want any left show-right shoe and no aggregate uncertainty/growth. I want pure insurance contract without friction, with rationality and free trade. Just like you claimed.

      Thank you very much, good luck and happy new year!:)

      Delete
    11. The way you argue is very confusing.

      Sorry...were we arguing?

      You first talk about "mutually beneficial" and by that you mean voluntary participation in trade (yes, or no?).

      No! The whole point of this post is that these are distinct concepts.

      hence your show example is irrelevant

      No, because you made a more general statement without the word "insurance". Apparently you misspoke.

      Then you desperately attempt to come up with an example

      No, nowhere did I evince "desperation". That is merely a case of you inserting fun words into your comments for purposes about which I can only conjecture.

      It is trivially easy to come up with an example in which there is uncertainty and in which the outcome is mutually beneficial ex post. Here is such an example:
      There are 2 future states of the world, A and B, each with 50% probability. In state A, I will receive two left shoes and you will receive two right shoes. In state B, I will receive two right shoes and you will receive two left shoes. You and I agree to a contract in which, contingent upon the realization of state A, I will trade you a left shoe for a right shoe, and contingent upon the realization of state B, I will trade you a right shoe for a left shoe. This contract must be mutually beneficial ex post, because in every future state of the world, both of us will be better off, in utility terms, relative to the counterfactual in which no contract was made.

      See how that works? :-)

      You didn't realized this is impossible by definition (and you still stubbornly refuse to accept that).

      Ohhhh, I guess you were wrong, weren't you? ;-)

      And don't cheat. I don't want any left show-right shoe and no aggregate uncertainty/growth. I want pure insurance contract without friction, with rationality and free trade. Just like you claimed.

      So, I'm not sure why you demand that I don't use shoes as an example; this seems an arbitrary demand, so I will ignore it. If you like, substitute the word "gloves" for shoes.

      The example I gave has uncertainty, but no aggregate uncertainty, since the future number of shoes (or, if you prefer, "gloves") is certain.

      I am not sure what you mean by "growth".

      Maybe you're just having trouble phrasing your question. I think you are. Maybe you had better go back and think more deeply about what you mean. You seem to be claiming that all contracts under uncertainty are zero-sum ex post. That claim is false. If you define an "insurance contract" as a contract that is zero-sum ex post, then the claim that all "insurance contracts" are zero-sum ex post is trivially true. But in that case there are many contracts under uncertainty that are not "insurance contracts" by your definition, such as the example I gave above.

      You really just need to think more carefully about what you say, and focus less on trying to be a dick. You're OK at being a dick, but not good enough that I'd advise you to make a career out of it.

      Delete
    12. I don't mean to use profanity here, but NOAM CHOMSKY points out from a non-economist perspective that while we pretend we exist in some mythological "free market" world with near-optimal transparency and information, in reality Big Corp and Marketing overwhelmingly operates with the main purposes being concealment, emotional triggers, and deception offered to buyers, with more powerful parties generally winning.

      That buyers sometimes see beyond or through deceptions is not justification.

      Not that we should have expectations that full transparency is achievable, but we should not engage in public policy and "lassez-faire" fantasy economic discussions AS IF it's achievable and exists, and promotes "maximum freedom" ... only in Neo-Liberal Libertopia.

      Delete
    13. Anonymous12:20 PM

      My take is that Noah is very much correct that contracts may not be mutually beneficial due to asymmetric information. Insurance is just a very bad example to use to prove that point. A mutually beneficial ex-post outcome is hard to imagine in general insurance contract framework since there is always a winner and loser (at the level of the individual contract).

      The fact that insurance contracts aren't a great example shouldn't undermine the intended point. To say that all voluntarily entered contracts are always mutually beneficial is to deny that swindles, scams, and cons exist. Obviously, that's quite silly.

      Delete
    14. Actually, insurance is a case in which the government generally decides it has an interest in making people conclude conclude contracts that they wouldn't otherwise conclude, i.e. the government acts to force people to limit their idiosyncratic risk.

      Delete
  9. Anonymous2:56 AM

    "Econ 101 does say that better information all around can't possibly worsen the outcome of deals."

    Not necessarily. There's obvious reasons why we economists default to this state of mind (lack of information is a friction, less frictions -> better), but it's not unambiguous. The main one I think of is this great paper by Grubb and Osborne where they show that consumer inattention is actually better from a consumer welfare perspective than full information, because firms price differently when they know their buyers are better informed: http://www.mit.edu/~mgrubb/GrubbOsborne.pdf (It's also a good case study of the kind of contract that can be ex ante beneficial, but ex post harmful if you have incorrect beliefs about yourself)

    By the way, I think health insurance is the wrong example here. When you buy health insurance, it is technically only a 1 year commitment, but most people change plans pretty infrequently. So even if you buy insurance and then go a year without using it, you might discount that loss because you expect to utilize the full value of the plan over a long horizon (or, alternatively, you're risk-averse/loss-averse enough that being insured against catastrophic risk gives you some relief, even if the chance of that risk is miniscule)

    ReplyDelete
    Replies
    1. Hey, you're right, but notice I said "Econ 101"! Rational inattention is an awesome idea but it is definitely not Econ 101.

      Delete
    2. Anonymous11:27 AM

      Oh, I misinterpreted that as a statement of "even Econ 101 students know this," which is something that I've seen other economists say.

      Delete
  10. What about unequal bargaining power? Couldn't a series of agreements made under conditions of unequal bargaining power create real inequalities or even make a party worse off? I'm thinking of the labor market or winner's curse phenomena.

    ReplyDelete
    Replies
    1. The question then becomes, "worse off than what?"

      Delete
    2. The question then becomes, "worse off than what?"

      That is precisely the question, and I can think of two ways one might ask it:

      1. Are you worse off taking this contract than if you don't get the job and the company finds someone more desperate who will work under those terms?

      2. Are you worse off taking this contract than if it were not permitted/accepted/possible for employers to make this kind of requirement and the company offered different terms?

      You and Matt are approaching this from the standpoint of #1, whereas I believe Chris Bertram is thinking about question #2. And question #2 is the more relevant one when you're considering the effect that cyborg technology will have on society and the economy.

      Delete
    3. You're right...Bertram is probably thinking about externalities, which are a whole 'nother kettle of fish...

      Delete
    4. Anonymous2:07 AM

      #2 isn't about externalities. It's about 'worse off than what' for the weaker party. Eric raises the possible answer: worse off than some minimum ethical or legal standard that exists to protect the weaker party to a bargain. Deals that are volutary but fall below a minimum standard for one party are not 'mutually beneficial' on the view implied by 2.

      Delete
    5. Anonymous12:32 PM

      To say it another way, it would be helpful to clarify the counterfactual.

      I've been held up at gunpoint and handed over my wallet. Handing over my wallet was better than being shot, but not better than not being robbed at all. To say whether or not agreeing to hand over my wallet was "better," even ex-post, depends entirely on which counterfactual I'm comparing the outcome to, one where I wasn't robbed at all, or one where I got shot.

      Are we comparing the cyborg contract to a world where no such contracts are permitted, or one where if I say no, someone else could say yes?

      Delete
  11. Marcus Walker5:22 AM

    Re unequal bargaining power: even assuming complete & fully shared information, it can leave one party worse off than they were before the exchange, but less badly off than that party would have been had they refused the exchange. Such a deal could be "exploitative".

    Say you badly need a job before you lose your home & health care, but all that's available is one of those "contracts [requiring employees to get cyborg modifications]" which you're not at all happy about. Signing up would be "voluntary" in a trivial Yglesian sense. But in an important sense, you had no choice.

    Your new employer could demand such terms precisely because they know your only alternative is unpalatable. It's only one step away from the employer coercing you to sign by threatening to inflict adverse consequences themselves if you don't. The difference between "voluntary" and "coercive" is then reduced to: who inflicts the consequences of refusing the deal - your 'partner', or a third party?

    ReplyDelete
  12. Marcus Walker5:42 AM

    ...nb the reality of unequal bargaining power is an important reason why many countries have minimum wages & other labor regulations: because voluntary exchanges between heavily unequal parties can be 'beneficial' to the weaker party only in the sense of making them worse off by less than had they said 'no'.

    ReplyDelete
  13. If the scenario was that a person could get a implant and a higher wage, or keep his old wage, your post would make sense - but I think you are missing the point.

    ReplyDelete
    Replies
    1. Marcus Walker7:03 AM

      How so?

      The words 'voluntary' and 'beneficial' are both problematic, but Yglesias's quote treats them as simple. That's an additional problem with his view, on top of the points Noah makes.

      Delete
  14. Marcus Walker7:09 AM

    @Nemi: the choice in my thought experiment is (same wage + implant) or loss of livelihood, not (higher wage + implant) or same wage.

    ReplyDelete
  15. Mutually beneficial, at least economically, ex post:

    I buy a 20-year term life policy at time t that pays $500K on my death, $500K being what my family would need PVed to compensate it economically for my death. Premia are set on the assumption that I have x% chance of dying (pooled risk), returns on my payments will be y% (presumably y<0) and stays there for the next (20-n) years.

    Over time (standard Life Cycle Theory), my earning potential declines. The likelihood that I will be able to make PV$500K drops--say, "an economic upheaval" occurs, and real wages drop in my field (ignore for the moment professions that disappear, e.g., hot type setter)--faster than "expected."

    At 19 years and 7 months--just after the last premium has been paid--I die.

    My family receives $500K, which is more than I would have made going forward. The insurance company received all my payments and received a greater return than they expected, while their pooled expectations remain unchanged. (I'm holding that variable constant for convenience, not the reality that it is likely to decline over time.)

    It's a win-win all around, both ex post and ex ante.

    ReplyDelete
  16. P.S. The above assumes, of course, that the return available to a large investor (the insurance company) is greater than the return that is available to me.

    This may vary from Econ 101, which is geared toward pretending everyone has dynastic wealth from the start, but it is reality.

    ReplyDelete
  17. One way in which a contract could be rational ex ante for one of the parties to that contract is if its expected value is negative, but greater than the expected value of any alternative action you could perform instead. Suppose you only have have three alternatives: not making a contract, making contract A or making contract B. And suppose the expected values of the alternatives are -1000, -100 and -10 respectively. Then it is indeed rational to make contract B. I don't think we would say contract B is beneficial simpliciter: in this case you have no beneficial alternative. Contract B is only relatively beneficial.

    ReplyDelete
    Replies
    1. Right. If you define "beneficial" relative to the state of the world in which no contract was made, B is still beneficial.

      Delete
    2. Marcus Walker2:00 AM

      Under that definition, 'your money or your life' offers a mutually beneficial deal.

      Delete
    3. Ummm, the title of the post contains the word "voluntary". It is there for a reason!

      Delete
    4. Marcus Walker10:11 AM

      The sub-issue here is the definition of 'beneficial', not 'voluntary'. The former must be defined independently of the latter, or else the answer to the blog's main question becomes circular.

      Delete
    5. It is beneficial if you end up better off after than contract than you were before the contract. It is voluntary if there is no coercion invlolved. This seems to me pretty clear, but in any case, it would mean that the other party has not control over your state of the world.

      Example: An employment contract is voluntary because your employer has no influence on your reality if your refuse to accept the contract. You will be no worse off than you would have been if you never met them. Clearly, your example does not meet the definition of voluntary, since coercion is involved.

      Delete
  18. As one of a bazillion examples, look at how many people voluntarily destroy their lives, just as they're getting started, signing contracts for private student loans that mean inescapable lifetime indentured servitude. For more on this see:

    http://richardhserlin.blogspot.com/2009/06/what-we-do-to-our-kids-19-and-it-can.html

    ReplyDelete
  19. STILL waiting for the financial sector to grow into that "perfectly rational, perfectly free world." But alas, in this imperfect universe, our masters are often parties to deals they know WAY more about than the party that's buying what the banks are selling...

    ReplyDelete
  20. Pickle Surprise10:57 PM

    In professional sports voluntary trades occur all the time, but mutually beneficial trades are so rare that they are regarded as monumental strokes of luck.

    ReplyDelete
  21. Uncertainty isn't the only reason that voluntary contracts can make one of the parties worse off. I have in mind a scenario like the leader-follower model of a duopoly. Strictly speaking, there doesn't need to be an explicit, legally binding contract involved (which would be prohibited by the Sherman Act), but in fact if not in law, the arrangement is basically a type of contract. The point is that by knowing that he is the weaker power in a duopoly, the duopolist is made worse off. The reason is bargaining power: the follower cannot credibly threaten to compete with the leader in the duopoly. Indeed, adding uncertainty can actually make the follower better off.

    ReplyDelete
  22. Anonymous5:39 PM

    Noah, can you give a specific example? I doubt it.

    I'm amazed at how economists talk about contracts ignoring there is a very specific meaning in law that addresses all these issues.

    It spreads misinformation to economics students and the public to ignore this and just make up your own fuzzy meanings.

    Can you explain what the difference is in common law between a promise, exchange, bond, agreement or contract? Most economists I know can't.

    ReplyDelete