Stock Market Predictions: I Wish!

Sometimes I am asked to pick stocks which I do with about the same rate of success as monkey with darts. My models are about strategic interaction in situations in which negotiation is possible and so is the threat or realization of coercion, bullying, or simple pressure. A properly functioning market does not have the threat of bullying and coercion as a characteristic. Now to be sure, regulators engage in pressuring, cajoling, coaxing, and sometimes beating up the misbehaved or those alleged to be misbehaved. So, it is possible to use models like mine to forecast market movements in particular sectors that are subject to changes in regulations or government oversight. That’s mostly the domain of concerns for hedge fund managers but it is an appropriate arena for the sort of forecasting I do. Straight markets, not so much!

Maybe someone out there will be stimulated to try her or his hand at designing a stock market game. Meanwhile I hope you are enjoying the apprentice version of the game. We are working at a web version and then the downloadable will go away. It is set up anyway for limited time use — I really want to get the web version up and running.

What You Need To Know About Why Gov’t Programs Always Grow: Listen to Game Theory!

Health care reform is certainly one of the hottest policy questions around. Who wouldn’t want someone else’s help covering the costs of illness and accident? And who wouldn’t want to see less of our economy being spent on expensive treatments, doctor visits, and prescription drugs? But how can we add up to 15 percent of the population – 45 million people – to the roles of the insured and cut costs? Can there really be such huge economies of scale that by providing quality care to more people it will cost less. Seems like what people used to describe as voodoo economics back in 1980. That’s not to say cost should trump the people’s health but hey, let’s be frank about the costs as well as the benefits.

It could be true that there would be savings although the government’s independent assessors of costs don’t seem to think so. Probably that’s okay if we are all healthier but that may be a BIG IF. I am sure you have noticed that government programs often start off modestly and then swell to gigantic proportions. Let’s think a bit about this seemingly unintended consequence of legislators’ good intentions.

Often when people speak about the “unintended consequences” from government programs, for instance, what is really going on is that they didn’t work out the strategic reactions to those programs. Then, when those reactions happen, they are described as “unintended consequences.”  They may be unintended, but they are no product of happenstance. With some game theory reasoning lots of those “unintended consequences” turn out to be easily foreseen. Not to be too cynical, but I suspect that politicians sell this notion of “unintended consequences” to justify their narrow, self-interested motivations to get re-elected, even when doing so may come at great long-term social or economic costs to the rest of us. How else do we explain the fact that politicians just about always underestimate the actual costs of programs they promote? Let’s consider Medicare for a moment as illustrative of what might happen after we get some form of quasi-universal health coverage in America.

Medicare was introduced by Lyndon Johnson in 1965. It was supposed to be a small program. Today, however, it’s humungous. All the while that it grew, the cost of going to the doctor, buying medicine, and staying in a hospital has gone through the roof. Lots of folks see today’s high medical costs as the result of a loss of values by physicians, insurance companies and drug makers. While the old family doctor with his (doctors were almost always men back then) black leather case came to our homes and spent time talking to us, having a cup of coffee, and tending to our mending, today’s doctors seem to be just another breed of greedy businesspeople. And so greed becomes the explanation for the runaway costs of medical care. Few of us ever tie any part of the high cost of health care to popular programs like Medicare, let alone to ourselves.

Like with so many government programs, people quickly came to think of government-sponsored medical subsidies as something they were entitled to. They wanted more and more of it, so they demanded that Medicare cover more and more. Politicians obliged by expanding Medicare. They would have to want to commit political suicide to do otherwise. Meanwhile people keep complaining about the high cost of health care as if the two are unrelated. Somehow they think that subsidized care does not change the demand for medicine, increasing demand maybe even faster than the supply of doctors, hospitals, and pharmaceuticals can grow. The change in demand, of course, is an easily anticipated and calculated strategic response by most of us to reduced out-of-pocket costs. It’s not much different from what happens when the grocery store has a sale on steak or ice cream. Make something cheaper and more of it gets sold. The result in the case of a sale on medicine’s out-of-pocket cost is more people chasing an insufficient supply of quality medical care.

We know what happens when demand rises faster than supply: prices go up. So we have two potential sources of greater medical costs resulting from Medicare. Because of government subsidies more people can buy medical care than was true before Johnson’s program. That was the intended consequence. As planned, Medicare has encouraged greater consumption of medical care, undoubtedly a good result for us as individuals and for society as a whole. But we cannot escape the laws of economics. Higher demand, all else being equal, means higher costs. 45 million more insured Americans doesn’t seem to translate into reducing health care’s bite out of the national economy.

As Medicare’s good intended consequence kicked in, what could we expect if demand for doctors, drugs, and hospital space not only went up, but if it rose faster than their supply? Not only would the total spent on good health go up but so would the cost of individual doctor visits (along with their getting shorter to make room so that everyone could see the limited supply of physicians) and almost everything else associated with medicine. Certainly that was not Lyndon Johnson’s or the Congress’s intent, but anyone who has had Economics 101 (which, come to think of it, most of our lawyerly representatives in Congress probably have not) could work out that an out-of-pocket price reduction (via the government subsidy) would increase demand. Until supply catches up with demand, prices rise. As it is hard for supply to keep pace with demand when the range of things being subsidized continues to expand, it is hard for the growth in supply to overcome the price pressure created by more and more demand. (Does this remind you of oil prices? It should.)

Could the growth in the cost of medicine have been foreseen, even as in many instances the real – inflation-adjusted – earnings of physicians fell? Of course it could. When someone else – your neighbor, for example – pays the taxes to cover a big part of your own medical bills, you are more likely to go to the doctor, more likely to demand high-end tests, and more likely to want cutting-edge procedures to make sure you get the best care. Who, after all, doesn’t want the best care from the best doctors in the best medical facilities? None of us can be faulted for wanting good care and certainly one idea behind Medicare was to improve just such care – and it worked.

Patients may see the full cost of their care when they get their medical bill, especially if they read all the fine print, but then they also see the part that is deducted from that full cost because Medicare paid for it. Naturally, patients feel happy that they don’t have to pay the whole bill themselves. Indeed, they wonder how anyone could afford such a high bill and complain that the government must help out more. That, of course, is what creates the political pressure to expand government subsidies. Rarely do we think how much smaller the bill might be if no one were subsidized – not the patient, not the doctor, not the hospital, and not the pharmacy. Most us think the bill would be the same and thank our lucky stars that at least we are getting some help courtesy of our representatives in Congress. Each of us is right at the moment we pay our bills, but we are wrong about what the cost would look like if government subsidies didn’t exist. Would they be as low as their pre-Medicare or Medicaid prices? Surely not. There have been great strides in medical technology since the 1960s and the benefits that result are expensive, but not as expensive as the growth in medical costs.

Patients rarely stop to ask how much less their taxes would be if they didn’t pay Medicare taxes out of every paycheck, whether in sickness or in health. We forget that the average American spent about $143 on medical care in 1960 and more than $5,600 in 2003. Incomes only rose by about fifty percent (adjusted for inflation) over that same period. And few of us have an incentive to ask whether there are cheaper treatments for what ails us that are just as effective as the expensive stuff our physician – a beneficiary of Medicare spending – recommends. Even fewer of us think about all of the medical services that get provided needlessly because the direct, out of pocket cost to the consumer is relatively small. Even little things like taking ibuprofen instead of aspirin. For lots of purposes they work equally well and aspirin is generally much cheaper. Or how much fraud such a large, bureaucratic program engenders. The Government Accounting Office estimated in 1998, for example, that Medicare fraud and overcharges cost an extra $12.8 billion dollars that year. The upshot, because we think about benefits from subsidies without paying much attention to their costs, is that government programs grow rapidly as long as out-of-pocket costs are subsidized. We think about that out-of-pocket cost as all that we pay. Medical service doesn’t cost less because part of the payment is coming from a third party, it just means others are paying for you and me when we consume a service and – the part we tend easily to forget – we pay for everyone else too without being able to control how much they demand or whether they use the service prudently.

In game-theory terminology what this all means is that program growth is endogenous or, in plain English, it is a foreseeable strategic consequence of the situation that has been set up. Government offices are crowded, services are poor, and demand for programs keeps growing. All the while, our elected officials routinely grossly under-estimate what their programs will actually cost. They ignore the fact that these programs create new expectations and demands. As a result – and it is a result that could be anticipated – the programs inevitably grow, along with complaints that the service is inadequate and can be fixed only with ever more money and more growth. Meanwhile, no matter how much more effort goes in, the complaints keep on piling up; they do not diminish and no one ever seems convinced that the problems they were created to address have been fixed.

Health care seems to be a hotter political item today than it was when Lyndon Johnson gave us Medicare. Retirement benefits are a bigger issue today than when Franklin Roosevelt gave us Social Security. School policies today are a bigger issue than when public schools were being debated in the nineteenth century. Police services and prison services today seem less adequate than in the past even though we spend more, incarcerate more, and patrol the streets more than just about ever before. These are all easily anticipated – and maybe even good – consequences of public benefits. We want others to help make our lives better and we don’t mind asking them to pay more to do it – and as long as we see more benefit than cost from subsidies we will demand more of them.

Game theory compels us to try harder to foresee the consequences of our actions. It makes us think about what is endogenous – what is a strategic choice – and what is not. It draws out crystal clear differences between what we can control and what we cannot. Of course, we can think about these things without game theory, and many of us do, but we are compelled to think about such matters when we work through the strategic logic of any game situation. There’s no putting your head in the sand with game theory – you cannot ignore the strategic fallout of decisions because you simply cannot solve games without thinking through how others are expected to respond to your choices.

Thoughts on some of your comments

Thanks for the nice comments on the book and the Jon Stewart appearance. It was lots of fun — he is smart and charming as well as very witty and quick on his feet.

There is little that is secret about my algorithms, claims by the History Channel and some others notwithstanding. It is true that I make some arbitrary assumptions to turn theory in to practical use and those few practical assumptions are unpublished but then there is no reason anyone should think my arbitrary hand waves to make things work are better than those by anyone else. For my older model you can get the details from Bruce Bueno de Mesquita, Predicting Politics (Ohio State University Press, 2002) or European Community Decision Making (co-edited with Frans Stokman, Yale University Press, 1994). For my new model see the paper I gave at the International Studies Association meeting in New York in February 2009. There are lots more publications by me on the construction of the models in numerous peer reviewed journals but I think the citations above should keep any of you who are interested pretty busy.

The new model, in somewhat simplified form, is available on the Game page of this web site if you want to play with it. That’s all for now. A little later I hope to post some thoughts on health care.

Bruce

Other Stuff Hopefully of Interest

The Predictioneer’s Game is officially published tomorrow. I hope you will take a moment to buy a copy at your local bookstore or at one of the links provided at this website. You can listen to me discuss the book tonight on The Daily Show with Jon Stewart on Comedy Central and on October 19th on a CNBC special about the future of work. On October 1st, those of you in New York might stop by at the Carnegie Council where I will discuss The Predictioneer’s Game and then hold a book signing. I will have a similar program in San Francisco on October 26th at the World Affairs Council.

For those of you in the UK, I will be on BBC radio on the morning of October 19th discussing Pedictioneer — the British title.  Later that week I will give a talk at the London School of Economics. It is free and open to the public so I hope you will come to it. Check out the time and place at the LSE website. On October 20th I will give a talk at 10 Downing Street which will be available later as a podcast. And then it wil be on to Dubin for a TED-like presentation on the book.

Later today I will post an apprentice version of the model online, a version that you can download and use on your own computer. A programmer and I are still working on a web-based version and will post that as soon as we overcome some problems we have encountered. Who knows, maybe that version will be up and running today and we will provide that instead of the down-loadable version. We are doing our best!

I am looking forward to your feedback on the book after you have had a chance to read it and also on how the software is working for you. Happy predictioneering!

Bruce

Iran – An Update

Iran is much in the news so this seems like an appropriate time to bring you up to date on how I think my earlier forecast is doing and on what all the current action — missile firings, revelation of a second uranium enrichment facility, threats of greater sanctions — mean.

Back in February, I predicted that by early 2010 we would see that Iran — perhaps with concessions from the US and other international players — will develop enough weapons grade fuel to show it knows how, but that it would not go so far as to build a bomb. Let’s put that in the context of the lead international affairs story in The New York Times on September 9, 2009. Here is what the first paragraph of that story reported:

Race, Health Care and Strategic Thinking

Hi,

Sorry to have been “off the air” for a bit — this is a very busy time. Before getting into substance, I know many of you are waiting for the online access to The Predictioneer’s Game software that I promised. This has taken longer than I hoped but it is VERY close to being ready. The conversion to a web version was a bit more complicated than I thought. It should go up this week.

President Carter has raised the spectre of racism as an explanation for the sometimes harsh — maybe even mean-aspirited — opposition to President Obama’s health care proposal and lots of his other policies. I doubt racism is much of a factor but I want to present a way to think about this that reminds us that whether racism is a motivating factor or not is beside the point and adds nothing to the merits or demerits of arguments on either side of the fence. But before doing that, we would do well to remember that President Reagan was called terrible names (fascist, even Nazi) by various and sundry groups. One of the rhetorical questions at Stanford university when there was a serious prospect that Reagan’s library would be located just across from the campus was, “Would we take Hitler’s library?” I always thought the obvious answer should have been, “Yes.” A library is an invaluable educational resource. Having Hitler’s archives would have been a great asset for those trying to understand what twisted reasoning led to the holocaust. And let’s remember that President Bush was routinely described as stupid (although apparently his SAT scores were higher than Al Gore’s) and much worse and Vice President Cheney is still routinely described in the nastiest terms by those who disagree with his views. President Clinton was impeached for his personal failings (and lying to Congress about them) but I suspect most of the opposition was motivated by dislike for his policies especially since some of those who rose up against him were guilty of similar personal failings. President Roosevelt (Franklin) was called a communist. Nothing new in any of this. But I still digress.

Whether arguments against policy are motivated by racism, anti-Illinoisism, anti-anyism really is not that important. What is important is whether the content of the arguments has merit. That is, even despicable motives may still lead to smart arguments — that is the logical foundation for free speech going back to the early emergence of Britain’s parliament. We should worry less about motives — which are hard to establish — and worry more about whether the arguments for and against any policy carry weight in terms of their logic and evidence.

So if motivations are not that important why is it so common to impugn the motives of others? Let’s put on our Game Theory Goggles so we can see through the mist of motives. Attacking motives is a particularly effective strategy, just like accusing a foe of being a child molester (which does matter!).  It costs the impugner very little. Jimmy Carter is unlikely to bear much cost because of his claim that racism is behind opposition to Obama’s policies. But those who oppose the policies now anticipate that they may be tainted with a heinous label, like “racist,” and so may be more likely to self-censor.  Thus, debate quiets down, intensity of preferences becomes muted, and we, the public, lose the opportunity to hear the full range of arguments. That may serve partisan interests but it doesn’t serve We, the People very well. So let’s stop debating whether racism is behind opposition and get back to debating (civilly but forcefully) the merits of alternative health care plans and other policy proposals. Let’s finally start talking logic and evidence — what do we know and how do we know it — about health care reform instead of slinging mud and cherry picking examples to support our personal point of view.

OK, that’s my rant for the day.

Big day for Japan

Japan’s election has ended with the resounding defeat of the LDP — the party that has ruled Japan continuously (with one short interruption) since that country had its first free election in 1955 without the supervision of the victorious powers in WW II. This is really a huge step in the maturation of Japan’s democracy. Nothing improves the quality of policy more than the realization that electoral defeat follows the failure to produce good policy in a competitive political system. Now we can just keep our fingers crossed that other maturing democracies will, like Japan and Mexico just a few years ago, continue on the path to electoral defeat for the incumbent party. In thinking about places at risk, we should look to South Africa. there, following a heroic struggle for independence, the grip of the African National Congress has not yet been shaken. Of course, the voters may be happy with the job the ANC is doing (although the record is spotty) and that may be why no other party has yet won control of the national government. But as lnog as that remains true, there is a serious risk of poor econonomic and political progress and a grave danger of sliding down the path of robert Mugabe’s Zimbabwe. I sure hope not — it would be interesting to see someone out there design a data set to predict South Africa’s political future, and Japan’s too. The web model will be up very very soon so this is a good time to start thinking about issues like that to look at for the future.

Cheers,

Bruce

What’s up in Iran?

Iran’s supreme leader, Ayatollah Ali Khamenei, announced today that he had seen no convincing evidence that foreign powers were involved in the anti-government demonstrations following the June election. This is rather extraordinary for two reasons.

First, he has said this in the midst of trials alleging that protesters were part of a foreign — US and British inspired — plot against the Iranian regime. So, Khamenei’s statement — and he is after all the SUPREME LEADER — undermines the premise of many of the trials and challenges the many confessions by demonstrators and prominent figures who have been arrested. It is widely believed in the west that these confessions were coerced. We have to conclude that Khamenei has essentially admitted the truth behind that belief.

But there is a second, equally extraordinary feature to this declaration. President Obama allegedly has offered to take a tougher stance toward Iran if Netanyahu’s government in Israel will go along with preventing more settlements. Of course we do not know what back channel conversations are taking place between US and Iranian leaders and we don’t know whether the reported “get tough” offer by Obama has actually been made. Still, we can see in Khamenei’s declaration a  signal that he wants to lower the temperature and perhaps get  on track to come to a negotiated resolution of the outstanding issues between the US and Iran, most notably, of course, the nuclear issue.

Maybe I am drinking my own whiskey but this looks very promising to me. Back in February in my TED talk I predicted that Khamenei’s power was declining and I also predicted that the Iranian leadership would strike a deal with the US in which they might develop some weapons grade fuel but they would not build a bomb. Khamenei’s statement — coupled with the intensity of the demonstrations in June — is consistent with the projection that his power is on the way down (and he is trying to maneuver to slow or reverse his declining fortunes) and also is consistent with an effort to get negotiations going. Surely he would get some significant boost from reaching an agreement on the nuclear front that does not impede Iran’s demonstration that they have the know-how to build a bomb and that, as they have been claiming all along, that know-how does not mean they want to build a bomb. (Let’s hope that if and when negotiations get underway, if they are not already going full steam ahead, that the Obama foreign policy team will be careful to extract a credible, verifiable commitment from Iran to allow sufficient oversight to ensure they don’t make more than a minimal, research quantity of weapons grade fuel).

Could be a very interesting year before us!

We’re On Our Way

OK, it’s time to get started. When I read the newspaper lots of ideas jump out at me about things that could be predicted, analyzed and maybe even engineered for the better. Politicians like to say and do things that make us feel good but that don’t have a real impact. For example, after the Libyans cheered the return of the Lockerbie mass murderer, President Obama said we won’t stand by idly. Sure we will probably make some tough statements, but let’s think about what we really could do. We could boycott Libyan oil but oil is in demand and there is a world market. What we don’t buy from Libya we have to buy somewhere else and somebody else will step in and buy the Libyan oil we don’t buy. It’s not likely to have much of an impact. We could go to the UN Security Council for sanctions. Senator Schumer from New York has proposed doing just that. But there are at least two problems with this. First, to impose sanctions we will have to have unanimity among the 5 permanent members of the UNSC. It doesn’t seem all that likely that China or maybe even France will go along. It would be interesting to model that. Maybe in a week or two when I have the model up and running on the web site, someone out there can put a good data set together on this and we could see. But then, we must also realize that sanctions work best when they are threatened but not implemented. If you have to put them into use then the target has probably already concluded that the cost of the sanctions is smaller than the political costs of giving in to the sanctioners demands. Foreign policy is tough but we could model the likelihood of sanctions working after we model whether they are likely to be implemented at all. Maybe someone could build the beauty contest data set — 100 means the player in question is completely for imposing sanctions through the UNSC and 0 (zero) means absolutely opposed (with intermediaite values capturing degrees of leaning for or against) — and someone else could build a more detailed data set on positions regarding the stiffness of sanctions. Then we could anaylze both.

Bruce

Hello world!

Hello and welcome to The Predictioneer’s Game blog. I will be launching this very soon. In the meantime, keep your eyes out for a profile on the book and on me (Bruce Bueno de Mesquita) in the Sunday New York Times Magazine Section on August 16th. I will start the blog shortly after that article appears.

I’ll try to address questions about foreign policy and sometimes business from a strategic point of view, always trying to work out what motivates the actions by others as well as by ourselves. For instance, think about the imposition of economic sanctions as a foreign policy. Are sanctions more likely to work when they are threatened or after they are implemented? My answer: they will hardly ever work if they have to be implemented but they can work as a threat. I’ll explain why later. How about health care? There seem to be two conflicting objectives but the debate never seems to focus on them together. One idea is to provide universal coverage. The other is to reduce the cost of health care which currently takes up about 1/6th of the US economy and maybe more. But then it turns out — not too surprisingly — that universal coverage means higher costs, not lower costs. We must choose between better coverage for all at a cost to those already paying to be covered while making the cost a larger share of the economy or not increasing coverage and not boosting the cost to achieve universal coverage but leaving some vulnerable to the costs of illness. How might we use logic and the evidence in terms of the experience of other systems to work out what the right trade-off, if any, is between costs and benefits. Why doesn’t the debate focus on the logic and a balanced look at evidence rather than partisan points of view? How will universal, subsidized health care influence demand for care? Will it make the society healthier and more productive or will it distort the economy and reduce the average person’s quality of care? Do we have reason to believe the declarations — cheap talk in game theory terms — of the parties on either side? Is the debate just another form of negative campaigning by all sides? I hope you will think about these questions while I get this blog up and running.

In the meantime I’d welcome your thoughts on these and other subject. Maybe we can all learn something about what sanctions on Iran might do to their nuclear ambitions or what impact they might have on North Korea, or what sorts of illnesses (or prevention) a British-style system is good at and what it is bad at treatingjust to throw out some stuff to think about.

Bruce