Simple Rules of Law

Response To: Who Likes Simple Rules?

Epistemic Status: Working through examples with varying degrees of confidence, to help us be concrete and eventually generalize.

Robin Hanson has, in his words, “some puzzles” that I will be analyzing. I’ve added letters for reference.

  • A] People are often okay with having either policy A or policy B adopted as the standard policy for all cases. But then they object greatly to a policy of randomly picking A or B in particular cases in order to find out which one works better, and then adopt it for everyone.

  • B] People don’t like speed and red-light cameras; they prefer human cops who will use discretion. On average people don’t think that speeding enforcement discretion will be used to benefit society, but 3 out of 4 expect that it will benefit them personally. More generally people seem to like a crime law system where at least a dozen different people are authorized to in effect pardon any given person accused of any given crime; most people expect to benefit personally from such discretion.

  • C] In many European nations citizens send their tax info into the government who then tells them how much tax they owe. But in the US and many other nations, too many people oppose this policy. The most vocal opponents think they benefit personally from being able to pay less than what the government would say they owe.

  • D] The British National Health Service gets a lot of criticism from choosing treatments by estimating their cost per quality-adjusted-life-year. US folks wouldn’t tolerate such a policy. Critics lobbying to get exceptional treatment say things like “one cannot assume that someone who is wheel-chair bound cannot live as or more happily. … [set] both false limits on healthcare and reducing freedom of choice. … reflects an overly utilitarian approach”

  • E] There’s long been opposition to using an official value of life parameter in deciding government policies. Juries have also severely punished firms for using such parameters to make firm decisions.

  • F] In academic departments like mine, we tell new professors that to get tenure they need to publish enough papers in good journals. But we refuse to say how many is enough or which journals count as how good. We’d keep the flexibility to make whatever decision we want at the last minute.

  • G] People who hire lawyers rarely know their track record and winning vs. losing court cases. The info is public, but so few are interested that it is rarely collected or consulted. People who hire do know the prestige of their schools and employers, and decide based on that.

  • H] When government leases its land to private parties, sometimes it uses centralized, formal mechanisms, like auctions, and sometimes it uses decentralized and informal mechanisms. People seem to intuitively prefer the latter sort of mechanism, even though the former seems to works better. In one study “auctioned leases generate 67% larger up-front payments … [and were] 44% more productive”.

  • I] People consistently invest in managed investment funds, which after the management fee consistently return less than index funds, which follow a simple clear rule. Investors seem to enjoy bragging about personal connections to people running prestigious investment funds.

  • J] When firms go public via an IPO, they typically pay a bank 7% of their value to manage the process, which is supposedly spent on lobbying others to buy. Google famously used an auction to cut that fee, but banks have succeed in squashing that rebellion. When firms try to sell themselves to other firms to acquire, they typically pay 10% if they are priced at less than $1M, 6-8% if priced $10-30M, and 2-4% if priced over $100M.

  • K] Most elite colleges decide who to admit via opaque and frequently changing criteria, criteria which allow much discretion by admissions personnel, and criteria about which some communities learn much more than others. Many elites learn to game such systems to give their kids big advantages. While some complain, the system seems stable.

  • L] In a Twitter poll, the main complaints about my fire-the-CEO decisions markets proposal are that they don’t want a simple clear mechanical process to fire CEOs, and they don’t want to explicitly say that the firm makes such choices in order to maximize profits. They instead want some people to have discretion on CEO firing, and they want firm goals to be implicit and ambiguous.

Some of these examples don’t require explanation beyond why they are bad ideas for rules. They wouldn’t work. Others would, or are even obviously correct, and require more explanation. I do think there is a enough of a pattern to be worth trying to explain. People reliably dislike the rule of law, and prefer to substitute the rule of man.

Why do people oppose the rule of law?

You can read his analysis in the original post. His main diagnosis is that people promote discretion for two reasons:

  1. They believe they are unusually smart, attractive, charismatic and well-liked, just the sort of people who tend to be favored by informal discretion.
  2. They want to signal to others that they have confidence in elites who have discretion, and that they expect to benefit from that discretion.

While I do think these are related to some of the key reasons, I do not think these point at the central things going on. Below I tackle all of these cases and their specifics. Overall I think the following are the five key stories:

  1. Goodhart’s Law. We see a lot of Regressional and Adversrial Goodhart, and also some Extremal and Causal as well. B, F, G, K and L all have large issues here.
  2. Copenhagen Interpretation of Ethics. If you put a consideration explicitly into your rule, that makes you blameworthy for interacting with it. And you’re providing all the information others need to scapegoat you not only for what you do, but what you would do in other scenarios, or why you are doing all of this. This is a factor in A, B, D, E, F, H and K all have to worry about this.
  3. Forbidden Considerations and Lawsuit Protection. We can take the danger of transparency a step further. There are things that one wants to take into consideration that are illegal to consider, or which you are considered blameworthy for considering. The number of ways one can be sued or boycotted for their decision process goes up every year.  You need a complex system in order to disguise hidden factors, and you certainly can’t put them into explicit rules. And in general, the less information others have, the less those that don’t like your decision have to justify a lawsuit or making other trouble. B, D, E, F, K and L have this in play.
  4. Power. Discretion and complexity favor those with power. If you have power, others worry that anything they do can influence decisions, granting you further power over everything in a vicious cycle. If you use a simple rule, you give up your power, including over unrelated elements. Even if you don’t have power directly over a decision, anyone with power anywhere can threaten to use that power whenever any discretion is available, so everyone with power by default favors complex discretionary rules everywhere. This shows up pretty much everywhere other than A, but is especially important in B, F, H, K and L.
  5. Theft. Complex rules are often nothing more than a method of expropriation. This is especially central in B, C, D, H, I and J.

I’ll now work through the examples. I’ll start with C, since it seems out of place, then go in Robin’s order.

Long post is long. If a case doesn’t interest you, please do skip it, and it’s fine to stop here.

C] Tax Returns

The odd policy out here is C, the failure to have the government tell citizens what it already knows about citizens’ tax returns. This results in many lost hours searching down records, and much money lost paying for tax preparation. As a commentator points out, the argument that ‘this allows one to pay less than they owe’ doesn’t actually make sense as an explanation. The government still knows what it knows, and still cross-checks that against what you say and pay. In other countries one can still choose to adjust the numbers shared with you by the government.

In theory, one could make a case similar to those I’ll make in other places, that telling people what information the government knows and doesn’t know allows people to hide anything that the government doesn’t know about. But that seems quite minor.

What’s going on here is simple regulatory capture, corruption, rent seeking and criminal theft. Robin’s link explains this explicitly. Tax preparation corporations like H&R Block are the primary drivers here, because the rules generate more business for them. There is also a secondary problem that fanatical anti-tax conservatives like that taxes annoy people.

But I’ve never heard of a regular person who thinks this policy is a good idea, and I never expect to find one. We’re not this crazy. We have a dysfunctional government.

A] Random Experiments

Robin’s explanations don’t fit case A. If you’re choosing randomly, no one can benefit from discretion. If you choose the same thing for everyone, again no one can benefit from discretion. If anything, the random system allows participants to potentially cheat or find a way around a selection they dislike, whereas a universal system makes this harder. Other things must be at work here.

This is the opposite of C, a case where people do oppose the change, but the change would be obviously good.

I call this the “too important to know” problem.

To me this is a clear case of The Copenhagen Interpretation of Ethics and Asymmetric Justice interacting with sacred values.

An experiment interacts with the problem and in particular interacts with every subject of the experiment, and with every potential intervention, in a way sufficient to render you blameworthy for not doing more, or not doing the optimal thing.

The contrast between the two cases is clear.

Without an experiment, we’re forced to make a choice between options A and B. People mostly accept that one must do their best, and potentially sacred values are up against other potentially sacred values, and one must guess and try their best.

In the cases in the study, it’s even more extreme. We’re choosing to implement A or implement B, in a place where normally one would do nothing. So we’re comparing doing something about the situation to doing nothing. It’s no surprise that ‘try to reduce infections’ comes out looking good.

With an experiment, the choice is between experimentation and non-experimentation. You are choosing to prioritize information over all the sacred values the non-objectionable choices are trading off. Even if the two choices are fully non-objectionable, choosing between them still means placing the need to gather information over the needs of the people in the experiment. 

The needs of specific people are, everywhere and always, a sacred value. Someone, a particular real person, is on the line. When put up against “information” what chance does this amorphous information have?

Copenhagen explains why it is pointless to say that the experiment is better for these patients than not running one. Asymmetric Justice explains why the benefits to future patients doesn’t make up for it.

There are other reasons, too.

People don’t like their fates coming down to coin flips. They don’t like uncertainty.

People don’t like asymmetry or inequality – if I get A and you get B, someone got the better deal, and that’s not fair.

If you choose a particular action, that provides evidence that there was a reason to choose it. So people instinctively adjust some for the fact that it was chosen. Whereas in an experiment, it’s clear you don’t know which choice is better (unless you do know and are simply out to prove it, in which case you are a monster). That doesn’t inspire confidence.

A final note is that if you look at the study in question, it suggests another important element. If you choose A, you’re blameworthy for A and for ~B, but you’re certainly not blameworthy for ~A or for B! Whereas if you choose (50% A, 50% B) then you are blameworthy for A, ~A, B and ~B, plus experimentation in general. That’s a lot of blame.

Remember Asymmetric Justice. If any element of what you do is objectionable, everything you do, together, is also objectionable. A single ‘problematic’ element ruins all.

So if we look at Figure 1 in the study, we see in case C that the objection score for the A/B test is actually below what we’d expect if we thought the chances of objecting to A and B were independent, and people were objecting to the experiment whenever they disliked either A or B (or both). In cases B and D, we see only a small additional rate of objection. It’s only in case A that we see substantial additional objection. Across the data given, it looks like this phenomenon explains about half of the increased rate of objection to the experiments.

It also looks like a lot of people explicitly cited things like ‘playing with people’s lives’ via experiment, and object to experimentation as such at least when the stakes are high.

B] Police Discretion

I do not think Robin’s story of expectation of personal benefit is the central story here, either. The correlation isn’t even that high in his poll.

If you think net harm is reduced (59%), you’re (49/59) 84% to think you’ll benefit. If you think net harm is not reduced, you are (28/41) 68% to think you’ll benefit. Given that you’d expect models to give correlated returns to the two questions – if discretion is used wisely, it should tend to benefit both most people and a typical civilian looking to avoid doing social harm, and these are Robin’s Twitter followers – I don’t think personal motivation is explaining much variance here.

The question also asking about only part of the picture. Yes, we would hope that police (and prosecutors and others in the system) would use discretion, at least in part, to arrest those who do more net social harm over those who do less net social harm.

But that’s far from the only goal of criminal justice, or of punishment. We would also hope that authorities would use discretion to accomplish other goals, as well.

Some of these goals are good. Others, not so much.

What are some other goals we might have? What are other reasons to use discretion?

I think there are five broad reasons, beyond using it to judge social harm.

  1. Discretion gives law enforcement authorities power. This power allows them to maintain and exert authority. It keeps the system running, ensures cooperation and allows them to solve cases and enforce the law.
  2. Discretion gives law enforcement authorities power and status. This power and status is a large part of the compensation we give to law enforcement.
  3. Discretion allows those with status and/or power to gain additional benefits from that status and/or power.
  4. Discretion allows us to enforce rules without having to state those rules explicitly, be able to well-specify those rules, or specify them in advance.
  5. Discretion guards against Goodhart’s Law and the gaming of the system.

To this we would add Robin’s explanations, that one might want to benefit from this directly, and/or one might want to signal support for such authorities. And the more discretion they have, the more one would want to signal one’s support – see reason 1.

A case worth grappling with can be made for or against each of these five justifications being net good. So one could argue in favor like this with arguments like (I am not endorsing these, nor do they necessarily argue for today’s American level of discretion):

  1. No one would cooperate with authorities. Every potential witness will stonewall, every defendant will fight to the end. Intimidation of witnesses would be impossible to stop. Good luck getting anyone even associated with someone doing anything shady to ever talk to the police. Cases wouldn’t get solved, enforcement would break down. Criminals would use Blackmail to take control of people and put them outside the law. Authorities’ hands would be tied and we’d be living in Batman’s Gotham.
  2. In many ways, being a cop is a pretty terrible job. Who wants to constantly have hostile and potentially dangerous interactions with criminals? Others having to ‘respect my authoritah‘ improves those interactions, and goes a long way in making up for things on many fronts.
  3. Increasing returns for status and power increase the power of incentives. We want people to do things we approve of, and strive to gain society’s approval, so we need levers to reward those who do, and punish those who don’t. We want to reward those who walk the straight and narrow track, and make good, and also those who strive and achieve. This has to balance the lure of anti-social or criminal activity, especially in poorer communities. And it has to balance the lure of inactivity, as we provide increasingly livable baskets of goods to those who opt out of status and prestige fights to play video games.
  4. If we state our rules explicitly, we are now blameworthy for every possible corner case in which those rules result in something perverse, and for every motivation or factor we state. Given that we can be condemned for each of these via Asymmetric Justice, this isn’t an option. We also need to be able to implement systems without being able to specify them and their implications in an unambiguous way. If we did go by the letter of the law, then we’re at the mercy of the mistakes of the legislature, and the law would get even more complex than it is as we attempt to codify every case, beyond the reach of any person to know how it works. Humans are much better at processing other types of complex systems. And we need ways for local areas to enforce norms and do locally appropriate things, without having their own legislatures. If the system couldn’t correct obvious errors, both Type I and Type II, then it would lose the public trust. And so on.
  5. If people know exactly what is and isn’t illegal in every case, and what the punishments are, then it will be open season for anything you didn’t make explicitly illegal. People will find technically permitted ways to do all sorts of bad things. They’ll optimize for all the wrong things. Even when they don’t, they’ll do the maximum amount of every bad thing that your system doesn’t punish enough to stop them from doing, and justify it by saying ‘it was legal’. Your laws won’t accomplish what they set out to accomplish. Any complex system dealing with the messiness of the real world needs some way to enforce the ‘spirit of the law.’ One would be shocked if extensive gaming of the system and epic Goodhart failures didn’t result from a lack of discretion.

Or, to take the opposite stances:

  1. Power corrupts. It is bad and should be minimized. The system will use its power to protect and gather more power for itself, and rule for the benefit of its members and those pulling their strings, not you. If we didn’t have discretion, we could minimize the number of laws and everyone wouldn’t need to go around afraid of authority. And people would see that authority was legitimate, and would be inclined to cooperate.
  2. Power not only corrupts, it also attracts the corrupt. If being a cop lets you help people and stand for what’s right, and gives you a good and steady paycheck, you’ll get good people. If being a cop is an otherwise crappy job where you get to force people to ‘respect my authoritah‘ and make bank with corrupt deals and spurious overtime, you’ll get exactly the people you don’t want, with exactly the authority you don’t want them to have.
  3. The last thing we want is to take the powerful (and hence corrupt) and give them even more discretion and power, and less accountability. The inevitable result is increasing amounts of scapegoating and expropriation. This is how the little guy, and the one minding their own business trying to produce, get crushed by corporations and petty tyrants of all sorts.
  4. If you can’t state what your rules are, how am I supposed to follow them? How can it be fair to punish me for violating rules you won’t tell me? This isn’t rules at all, or rule of law. It’s rule of man, rule of power begetting power. The system is increasingly rigged, and you’re destroying the records to prevent anyone from knowing that you’re rigging it.
  5. The things you’re trying to protect from being gamed are power and the powerful, which are what are going to determine what the ‘spirit of the rules’ is going to be. So the spirit becomes whatever is good for them. The point of rule of law, of particular well-specified rules, is to avoid this. Those rules are not supposed to be the only thing one cares about. Rather, the law is supposed to guard against specific bad things, and other mechanisms allowed to take care of the rest. If the law is resulting in Goodhart issues, it’s a bad law and you should change it.

The best arguments I know about against discretion have nothing to do with the social harm caused by punished actions. They are arguments for rule of law, and to guard against what those with discretion will do with that power. These effects are rather important and problematic even when the system is working as designed.

The best arguments I know about in favor of discretion also have nothing to do with the social harm caused by punished actions. They have to do with the system depending on discretion in order to be able to function, and in order to ensure cooperation. A system without discretion by default makes the spread of any local information everyone’s enemy, and provides no leverage to overcome that. If we didn’t have discretion, we would have to radically re-examine all of our laws and our entire system of enforcement, lest everything fall apart.

My model says that we currently give authorities too much discretion, and (partly) as a result have punishments that are too harsh. And also that the authorities have so much discretion partly because punishments have been made too harsh. Since discretion and large punishments give those with power more power, it would be surprising if this were not the case.

D] National Health Service

The National Health Service gets criticized constantly because it is their job to deny people health care. There is not enough money to provide what we would think of as an acceptable level of care under all circumstances, because our concept of acceptable level of care is all of the health care. In such a circumstance, there isn’t much they could do.

Using deterministic rules based on numbers is the obviously correct way to ration care. Using human discretion in each case will mean either always giving out care, since the choice is between care or no care – which is a lot of why health care costs are so high and going higher – or not always giving out care when able to do so, which will have people screaming unusually literal bloody murder.

Deterministic rules let individuals avoid blame, and allow health care budgets to be used at all. But that doesn’t mean people are going to like it. If anything, they’re going to be mad about both the rules and the fact that they don’t have a human they can either blame or try to leverage to get what they want. There’s also the issue of putting a value on human life at all, which is bad enough but clearly unavoidable.

More than that, once you explicitly say what you value by putting numbers on lives and improvements in quality of life, you’re doing something both completely necessary and completely unacceptable. The example of someone in a wheelchair is pretty great. If you don’t provide some discount in value of quality of life for physical disability, then you are saying that physical disabilities don’t decrease quality of life. Which has pretty terrible implications for a health care system trying to prevent physical disabilities. If you do say they decrease quality of life, you’re saying people with disabilities have less value. There are tons of places like this.

Another way to view this is that the only way for one to make health care decisions to ration care or otherwise sacrifice sacred values to stay on budget, without blame, is to have all those decisions be seen as out of your control and not your choice. The only known way to do that is to have a system in place, and point to that. That system then becomes a way to not interact with the system, avoiding blame. Whereas proposing or considering any other system involves interaction, and thus blame.

E] Value of Life

If you are caught making a trade-off between a sacred value (life) and a non-sacred value (money), it’s not going to go well. Of course a company doing an explicit calculation here is going to get punished, as is a government policy making an explicit comparison. Humans don’t care about the transitive property.

Thus, firms and governments, who obviously need to value risk to human life at a high but finite numerical cost, will need to do this without writing the number down explicitly in any way. This is one of the more silly things one cannot consider, that one obviously must consider. In a world where we are blameworthy (to the point of being sued for massive amounts) for doing explicit calculations that acknowledge trade-offs or important facts about the world, firms and governments are forced to make their decisions in increasingly opaque ways. One of those opaque preferences will be to favor those who rely on opaqueness and destroy records, and to get rid of anyone who is transparent about their thinking or otherwise, and keeps accurate records.

F] Tenure Requirements

Tenure is about evaluating what a potential professor would bring to the university. No matter what extent politics gets involved, this is someone you’ll have to work with for decades. After this, rule of law does attach. You won’t be able to fire them afterwards unless they violate one of a few well-defined rules – or at least, that’s how it’s supposed to work, to protect academic freedom, whether or not it does work that way. You’ll be counting on them to choose and do research, pursue funding, teach and advise, and help run the school, and be playing politics with them.

That’s a big commitment. There are lots more people who want it and are qualified on paper than there are slots we can fund. And there are a lot more things that matter than how much research one can do. Some of them are things that are illegal to consider, or would look bad if you were found to be considering them. Others simply are not research done. You can’t use a formula, because people bring unique strengths and weaknesses, and you’re facing other employers who consider these factors. Even if a simple system could afford to mostly ‘take its licks’ you would face massive adverse selection, as everyone with bad intangibles would knock at your door.

You need to hold power over the new employees, so they’ll do the work that tenured employees don’t want to do, and so they’ll care about all aspects of their job, rather than doing the bare technical minimum everywhere but research.

Then there’s the Goodhart factors on the papers directly. One must consider how the publications themselves would be gamed. If there was a threshold requirement for journal quality, the easiest journals that count would be the only place anything would be published. If you have a point system, they’d game that system, and spend considerable time doing it. If you don’t evaluate paper quality or value, they won’t care at all about those factors, focusing purely on being good enough to make it into a qualifying journal. Plus, being able to evaluate these questions yourself without an outside guide or authority will be part of the job you’re trying to get. We need to test that, too.

What you’re really testing for when you consider tenure, ideally, is not only skill but also virtue. You want someone who is naturally driven to scholarship and the academy, to drive forward towards important things. While also caring enough to do a passable job with other factors. Otherwise, once they can’t be fired, you won’t be able to get them to do anything. Testing for virtue isn’t something you can quantify. You want someone who will aim for the spirit rather than the letter, and who knows what the spirit is and cares about it intrinsically. If you judge by the letter, you’ll select for the opposite, and if you specify that explicitly, you’ll lose your signal that way as well.

I’d write this one up to power and exploitation of those lower on the totem pole, the need to test for factors that you can’t say out loud, the need to test for virtue, and the need to test for knowing what is valuable.

G] A Good Lawyer

People rightfully don’t think this number will tell us much, even now when it is not being gamed and vulnerable to Goodhart. Robin seems to be assuming that one should think that a previous win percentage should be predictive of a lawyer’s ability to win a particular case, rather than being primarily a selection effect, or a function of when they settle cases.

I doubt this is the case, even with a relatively low level of adversarial Goodhart effects.

Most lawyers or at least their firms have great flexibility in what cases they pursue and accept. They also have broad flexibility in how and when they settle those cases, as clients largely rely on lawyers to tell them when to settle. Some of them will mostly want cases that are easy wins, and settle cases that likely lose. Others, probably better lawyers for winning difficult cases, will take on more difficult cases and be willing to roll the dice rather than settle them.

I don’t even know what counts as a ‘win’ in a legal proceeding. In a civil case you strategically choose what to ask for, which might have little relation to realistic expectations for a verdict, so getting a lesser amount might or might not be a ‘win’ and any settlement might be a win or loss even if you know the terms, and often the terms are confidential.

Thus, if I was looking for a lawyer, I would continue to rely on personal recommendations, especially from lawyers I trust, rather than look at overall track records, even if those track records were easily available. I don’t think those track records are predictive. Asking questions like someone’s success in similar style cases, with richer detail in each case, seems better, but one has to pay careful attention.

If people started using win-loss records to choose lawyers, and lawyers started optimizing their win-loss records, what little information those records might have gets even less useful. You would mostly be measuring which lawyers prioritize win-loss records, by selecting winners and forcing them to verdict, while avoiding, settling or pawning off losers, and by getting onto winning teams, and so on. By manipulating the client and getting them to do what was necessary. It’s not like lawyers don’t mostly know which cases are winners. By choosing a lawyer with too good a win-loss record, you’d be getting someone who cares more about how they look in a statistic than doing what’s right for their clients, and also who has the flexibility to choose which cases they have to take.

The adverse selection here, it burns.

That’s what I’d actually expect now. Some lawyers do care a lot about their track records, they’ll have better track records, and they’re exactly who you want to avoid. I’d take anyone bragging about their win rate as a very negative sign, not a positive one.

So I don’t think this is about simple rules, or about people’s cognitive errors, or anything like that. I think Robin is just proposing a terrible measure that is not accurate, not well-defined and easily gamed, and asking why we aren’t making it available and using it.

Contrast this with evaluations of doctors or hospitals for success rates or death rates from particular surgeries. That strikes me as a much better place to implement such strategies, although they still have big problems with adversarial Goodhart if you started looking. But you can get a much better idea of what challenges are being tackled and about how hard they are, and a much better measure of the rate of success. I’d still worry a lot about doctors selecting easy cases and avoiding hard ones, both for manipulation and because of what it would do to patient care.

A general theme of simple rules is that when you reward and punish based on simple rules, one of the things you are rewarding is a willingness to prioritize maximizing for the simple rule over any other goal, including the thing you’re trying to measure. Just like any other rule you might use to reward and punish. The problem with simple rules is that they explicitly shut out one’s ability to notice such optimization and punish it, which is the natural way to keep such actions in check. Without it, you risk driving out anyone who cares about anything but themselves and gaming the system, and creating a culture where gaming the system and caring about yourself are the only virtues.

H] Land Allocations

If all you care about is the ‘productivity’ of the asset and/or the revenue raised, then of course you use an auction. Easy enough, and I think people recognize this. They don’t want that. They want a previously public asset to be used in ways the public prefers, and think that we should prefer some uses to other uses because of the externalities they create.

It seems reasonable to use the opportunity of selling previously public goods to advance public policy goals that would otherwise require confiscating private property. Private sellers will also often attach requirements to sales, or choose one buyer over another, sacrificing productivity and revenue for other factors they care about.

We can point out all we like how markets create more production and more revenue, but we can’t tell people that they should care mostly about the quantity of production and revenue instead of other things. When there are assets with large public policy implications and externalities to consider, like the spectrum, it makes sense to think about monopoly and oligopoly issues, about what use the assets will be put to by various buyers, and what we want the world to look like.

That doesn’t mean that these good factors are the primary justifications. If they were, you’d see conditional contracts and the like more often, rather than private deals. The real reason is usually that other mechanisms allow insiders to extract public resources for private gains. This is largely a story of brazen corruption and theft. But if we’re going to argue for simple rules because they maximize simple priorities, we need to also argue for why those priorities cover what we care about, or we’ll be seen as tone deaf at best, allowing the corrupt to win the argument and steal our money.

I] Investment Funds

Low fee index funds are growing increasingly popular each year, taking in more money and a greater share of assets. Their market share is so large that being included in a relevant index has a meaningful impact on share prices.

Managed funds are on the decline. Most of these funds are not especially prestigious and most people invested in them don’t brag about them, nor do they have much special faith in those running the funds. They’re just not enough on the ball to realize they’re being taken for a ride by professional thieves.

Nor do I think most people care about associating with high status hedge funds or anything like that. I don’t see it, at all.

Also, those simple rules? You can find them in active funds, too. A lot of them are pretty popular. Simple technical analysis, simple momentum, simple value rules, and so on. What counts as simple? That’s a matter of perspective. Index providers are often doing staggeringly complex things under the hood. And indexing off someone else’s work is a magician’s trick, free riding off the work of others in a way that gets dangerous if too many start relying on it.

Most regular investors who think about what they’re doing at all, know they should likely be in index-style funds, and increasingly that’s where they are. If there’s a mystery at all it’s at least contained at the high end, in hedge funds with large minimums.

One can split the remaining ‘mystery’ into two halves. One is, why do some people think there exist funds that have sufficient alpha to justify their fees? Two is, why do some people think they’ve found one of those funds?

The first mystery is simple. They’re right. There exist funds that have alpha, and predictably beat the market. The trick is finding them and getting your money in (or the even better trick is figuring out how to do it yourself). I don’t want to get into an argument over efficient markets here and won’t discuss it in the comments, but the world in which no one can beat the market doesn’t actually make any sense.

The second mystery is also simple. Marketing, winners curse, fooled by randomness and adverse selection, and the laws of markets. Of course a lot more people think they’ve found the winner than have actually found one.

This is a weird case in many ways, but my core take here is that the part of this that does belong on this list, is an example of complexity as justification for theft.

J] Selling the Company

Google is the auction company. They were uniquely qualified to run an auction and bypass the banks, and did it (as I understand it) largely because it was on brand and they’d have felt terrible doing otherwise. A more interesting case is Spotify, who recently simply let people start trading its stock without an IPO at all. Although they still paid the banks fees, which I find super weird and don’t understand. There never was a rebellion.

How do banks extract the money?

My model is something like this, coming mostly from reading Matt Levine. The banks claim that they provide essential services. They find and line up customers to buy the stock, they vouch for the stock, they price the stock properly to ensure a nice bump so everyone feels happy, they backstop things in case something goes wrong, they handle a ton of details.

What they really do are two things. Both are centered around the general spreading by banks of FUD: Fear, Uncertainty and Doubt.

First, they prevent firms from suddenly having to navigate a legally tricky and potentially risky, and potentially quite complex, world they know nothing about, where messing up could be a disaster. One does not simply sell the company or take it public, as much as it might look simple from the outside. And while the bank’s marginal costs are way, way lower than what they charge, trying to get that expertise in house in a confident way is hard.

Second, they are what people are comfortable with. You’re not blameworthy for paying the bank. It’s the null action. If you do it, no one says ‘hey they’ve robbed us all of a huge amount of money.’ Instead, they say ‘good on you for not being too greedy and trying to maximize the price while risking the company’s future.’

They’re doing this at the crucial moment when how you look is of crucial importance, when you’re about to get a huge windfall for years or a lifetime of work and give the same to everyone who helped you. When you’re spending all your energy negotiating lots of other stuff. A disruption threatens to unravel all of that. What’s a few percent in that situation? So what if you don’t price your IPO as high as you could have so that bankers can enjoy their bounce?

Banks are conspiring with the buyers to cheat the sellers out of the value of what they bring to the table. Buyers who object are threatened with ostracism and being someone no one is comfortable with, with the other side walking away from the table after buyers put in the work to get here.

Is this all guillotine-worthy highway robbery? Hell yes. Completely.

Banks (and the buyers who are their best customers and allies) are colluding with this pricing, and that’s the nicest way to put this. Again, this is theft. Complexity is introduced to allow rent seeking and theft, exploiting a moment of vulnerability.

K] College Admissions

Interesting that Robin says the system ‘appears stable.’ To me it does not seem stable. We just had a huge college admissions scandal that damaged faith in the system and a quite-well justified lawsuit against Harvard. We have the SAT promising to introduce ‘adversity scores.’ We have increasingly selective admissions eating more and more of childhood, and the rule that what can’t go on forever, won’t. This calls for some popcorn.

What’s causing the system to be complex? We see several of the answers in play here.

We see the ‘factors you can’t cite explicitly’ problem and the ‘we don’t want something we can be sued or blamed for’ here. Admissions officers are trying to pick kids who will be successful at school and in life, as well as satisfy other goals. A lot of the things that predict good outcomes in life are not things you would want to be caught dead using as a determinant in admissions even if they weren’t illegal to use in admissions. The only solution is to make the system complex and opaque, so no one can prove what you were thinking.

We also see complexity as a way for the rich and powerful to expropriate resources, in the sense that the rich and powerful and their children are likely to be more successful, and more likely to give money to the school. And of course, if the school has discretion, that gives the school power. It can extract resources and prestige from others who want to get their kids in. Employees, especially high-up ones, can extract things even without illegal bribes. Why pass that up?

We see the Goodhart’s Law and adverse selection problems. If you admit purely on the basis of a test, and the other schools admit on the basis of a range of factors, you don’t get the best test scorers unless you’re Harvard. You get the kids who are an epic fail at those other factors.

If you give kids an explicit target, they and their parents will structure their entire lives around it. They’ll do that even with a vague implicit target, as they do now. If it’s explicit, you get things like you see in China, where (according to an eyewitness who once came to dinner) many kids are pulled from school and do nothing but cram facts into their heads for the college admissions exam for years. And why shouldn’t they?

So you get kids whose real educations are crippled, who have no life experience and no joy of childhood. The only alternative is to allow a general sense of who the kid is and what they’ve done to matter. To be able to holistically judge kids and properly adjust.

As always, the more complex and hard to understand the game, the greater the expert’s advantage. The rich and powerful who understand the system and can make themselves look good will have a large edge from that. And the more we explicitly penalize them for those advantages, but not for their gaming of the system, the more we force them to game the system even harder. If you use an adversity score to set impossibly high standards for rich kids, they’re going to use every advantage they have to make up for that even more than they already do.

And of course, part of the test is seeing how you learn to game the test and what approach you take. Can you do it with grace? Do you do too much of it, not enough or the right amount?

This is all an anti-inductive arms race. The art of gaming the system is in large part the art of making it look like you’re not gaming the system, which is an argument for simpler rules. At this point, what portion of successful admissions is twisting the truth? How much is flat out lying? How much is presenting yourself in a misleading light? To what extent are we training kids from an early age to have high simulacrum levels and sacrifice their integrity? A lot. Integrity being explicitly on the test just makes it one more thing you need to learn to fake.

I hate the current situation, and the educational system in general, but I think the alternative of a simple, single written test, with the system otherwise unchanged, would be worse. But of course, we’d never let it be that simple. That’s all before the fights over how to adjust those scores for ‘adversity’ and ‘diversity,’ and how to quantify that, and the other things we’d want to factor in. Can you imagine what happens to high schools if grades don’t matter? What if grades did matter in a formulaic matter and students and teachers were forced to confront the incentives? The endless battles over what other life activities should score points, the death of any that don’t, and the twisting into point machines of those that do?

So here we have all the Goodhart problems, and the theft problems, and the power problems, and the blameworthy considerations and justifications problems and lawsuit problems with their incentive to destroy all information. The gang’s all here.

L] Fire that CEO

I love me a prediction market, but you have to do it right. Would enough people and money participate? If they did, would they have the right incentives? If both of those, would you want that to be how you make decisions?

I think the answer to the first question is yes, if you structure it right. If there are only two possibilities and one of them will happen, you can make it work.

The answer to the second question is, no.

We can consider two possibilities.

In scenario one, this acts as an advisory for the board, to help them decide what to do.

In scenario two, this is the sole thing looked at, and CEOs are fired if and only if they are judged to be bad for the stock price, or can otherwise only be fired for specific causes (e.g. if found shooting a man on Fifth Avenue or stealing millions in company funds and spending them on free to play games, you need to pull the plug without stopping to look at the market).

The problem with scenario one is that you’re trading on how much the company is worth given that the CEO was fired. That’s very different from what you think the company would be worth if we decided to fire the CEO. The scenarios where the CEO is fired are where the board is unhappy with them, which is usually because of bad things that would make us think the stock is likely to be less valuable, like the stock price having gone down or insiders knowing the CEO has done or will do hard to measure long term damage. That doesn’t mean it won’t also take into account other things like whether the CEO is paying off the board, but the correlation we’re worried about is still super high. Giving the board discretion, that market participants would expect the board to use, hopelessly muddles things.

You could try to solve that problem by having the market trade only very close in time to the board decision. You kind of have to do that anyway, to avoid having a lame duck CEO. But it still depends on a lot of private information, and the decision will still reveal a lot about the firm. So I think that realistically this won’t work.

The problem with scenario two is that you’ve taken away any ability to punish or reward the CEO for anything other than future stock prices. This effectively gives the CEO absolute power, and allows them to get away with any and all bad behavior of all kinds. Even if past behavior lowers the stock price, it only matters to the extent that it predicts future actions which would further lower the stock price. So CEOs don’t even have to care about the stock price. They only need to care about the stock price predictions in relation to each other. So the best thing the CEO can do is make getting rid of them as painful as possible. Even more than now, they want to make sure that losing them destroys the company as much as possible. Their primary jobs now are to hype themselves as much as possible to outsiders, and to spend capital manipulating these prediction markets.

Again, we’re seeing Goodhart problems, we’re seeing reinforcement of power (in this case, of the board over the CEO, so it’s a balance of power we likely welcome), and the ability to take things into consideration without needing to make them explicit or measurable, as companies both care about things they’re not legally allowed to care about and which we wouldn’t like hearing they cared about, especially explicitly, and they need to maintain confidentiality.

 

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10 Responses to Simple Rules of Law

  1. rayjuped says:

    You’re incorrect on tax returns, in a way that seems commonly held. Briefly, tax preparation is an adversarial relationship between the tax collector and the taxed. There are many possible valid tax liability calculations for an individual or entity, and we have the taxed prepare their own and construe their tax situation in the way most advantageous to them (that is in accordance with law) to avoid the obvious conflict of interest that would be caused by having the tax collecting authority do so. Learned Hand’s famous opinion: “Anyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”

    The only objections that I think make sense to the tax-preparer ecosystem are – will tax preparers lobby for a more complex tax code, and the standard libertarian objections to licensure of professions. (Note that paid tax preparers aren’t necessarily licensed accountants; I don’t recall the details but there are strata and the simplest is just applying for a tax preparer number.)

    • TheZvi says:

      I am aware of the adversarial aspect that complex situations bring to the table, and have dealt with the implications. But I don’t see how that makes holding back information and making the situation confusing a good strategy for the government side, since they can set their own rules and rates accordingly if this would somehow cost the government money to make their citizens not have to waste time.

      None of that prevents one from using an accountant or choosing how to use the data given, even if one acknowledges that an adversarial solution is correct (and it’s completely non-obvious that it is a good idea).

      Deadweight loss is bad, period.

      • rayjuped says:

        I’m not sure there’s an information asymmetry here (I won’t speak to banking or financial services regs – I’m still ignorant of banking regs, though I’ve been learning a lot lately!) – for the most part, anything reported to the IRS is reported to you as well. That is, I get W-2s and 1099s (these are types of income statements, for any readers who don’t know US tax forms) annually, and my own Schedule C (profit or loss from solo business) info hasn’t been reported to the IRS yet at tax return time, because this schedule is where I report it. This has to be the case for them to be able to mandate my filing a return – so what are they hiding from me? Maybe they’ve imposed a stealth tax by requiring taxpayers be sent

        I don’t think it’s a choice whether to make tax returns adversarial, unless one structures the tax code such that there is precisely one valid tax return per taxpayer per taxation period. If there’s a spread of valid tax amounts, then ceteris paribus the government will want to collect more tax and the taxpayer will want to pay less tax. Providing government-prepared returns as a default tilts the balance (unfairly, IMO) towards the government’s more-tax preference. Additionally, if tax returns must be prepared privately, then unreasonable onerousness of calculation is a useful political objection to complexity of the tax code. (Admittedly – this is weakened if everyone uses Turbotax. One expects tax preparers to want a more complex tax code.)

        An income tax imposes a deadweight loss on recipients of income (almost everyone); spending resources to attempt to pay less income tax may increase or decrease this, depending on the individual’s tax situation and how well effort or $ to accountants converts into tax savings (apparently, fairly well; even I, not especially rich, have saved small amounts of money at a good $/effort ratio via loss harvesting, and tax lawyers do stay in business).

      • benquo says:

        If there’s a spread of valid tax amounts, then ceteris paribus the government will want to collect more tax and the taxpayer will want to pay less tax.

        I thought Congress set tax rates, and often lowered them? “The government” isn’t an unified player here. Surely the same deliberative body that might make the change Zvi is proposing, could easily lower tax rates correspondingly to keep total burden the same.

      • benquo says:

        These objections are incoherent and involve unprincipled switching between a part of the system and the whole. Zvi is obviously right here and I’m not really sure why this kind of nonsense objection keeps popping up.

      • rayjuped says:

        I’m open to being convinced of the Danish model [1], but I’m not sure what you mean. “Government” in your quotation refers to the IRS or similarly situated state tax-collection agencies, as it does in every instance it’s mentioned; hope that helps. I don’t really see what this has to do with anything. Perhaps you advocate for a separate agency dedicated to tax preparation, which helps by providing both sides of the adversarial relationship from the public purse, like public defenders for taxes. An intriguing proposal on your part, if a departure from the Danish model discussed above.

        [1]: Going by https://skat.dk/skat.aspx?oid=2244333 – I’ve done some brief looking into this, and it seems like Denmark is the archetypal system that provides you a tax notice as a fait accompli. Per a paper I found [2], most countries that eliminate tax returns do so by having a simpler tax code that enables payroll withholding to be exact.

        [2]: http://www.ntanet.org/NTJ/50/3/ntj-v50n03p475-85-possibility-return-tax-system.pdf

      • TheZvi says:

        I agree with Benquo here that I don’t see how the objections raised here are coherent. And that I am confused by the defense, and frustrated that this is the only discussion happening here.

        Congress passes laws to set the rules that the IRS and other tax agencies use, and does so largely based on lobbying by thieves to let the thieves steal more via imposing huge time and stress costs on its victims/customers. That ‘it has to be this way’ in some form because the regulations say so, or the agency has the wrong mandates and rules, is not an answer.

        The fact that taxes impose a deadweight loss beyond costs of prep and costs of information gathering is well-known. I can say from experience that the greater the complexity of the code, the more distortionary it becomes, and the more my actions change in ways that cause increasing deadweight loss and distort markets. This in turn only increases the losses due to information access issues, which do not in turn decrease the issues from complexity except insofar that I get robbed by not having the information to defend myself.

      • rayjuped says:

        I can definitely comment on other “riddles”, though it takes more care (Law reputation actually works in real life, against all odds, and it dovetails with school admissions by way of the law school admissions process – but I don’t want to comment on it and accidentally hold myself out as an expert on inside law baseball or any sort of licensed practitioner of law, because I’m neither). I do recommend revisiting this issue when you’re inclined. Suffice it to say that it’s extremely far from obvious to me (close to being obvious in the other direction!) – maybe I’ll post in detail about it on my site.

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  3. Pingback: More Notes on Simple Rules | Don't Worry About the Vase

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