Econophysics

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Econophysics

Postby The Reaper » Sat Jul 17, 2010 11:45 pm UTC

http://www.physorg.com/news198239413.html
A Purdue University researcher has used "econophysics" to show that under ideal circumstances free markets promote fair salaries for workers and do not support CEO compensation practices common today.

The research presents a new perspective on 18th century economist Adam Smith's concept that an "invisible hand" drives a free market economy to a collective good.

"It is generally believed that the free market cares only about efficiency and not fairness. However, my theory shows that even though companies focus primarily on making profits and individuals are only looking out for themselves, the collective self-organizing free market dynamics, under ideal conditions, leads to fairness as an emergent property," said Venkat Venkatasubramanian, a professor of chemical engineering. "In reality, the self-correcting free market mechanisms have broken down for CEOs and other top executives in the market, but they seem to be working fine for the remaining 95 percent of employees."

Venkatasubramanian is proposing the use of statistical mechanics and econophysics concepts to gain some insights into the problem.

"This is at the intersection of physics and economics," he said. "We are generalizing concepts from statistical thermodynamics - the branch of physics that describes the behavior of gases, liquids and solids under heat - to analyze how free markets should perform ideally."

In previous work, Venkatasubramanian used the approach to determine that the 2008 salaries of the top 35 CEOs in the United States were about 129 times their ideal fair salaries - and CEOs in the Standard & Poor's 500 averaged about 50 times their fair pay - raising questions about the effectiveness of the free market to properly determine CEO pay.
In the new work, the researcher has determined that fairness is integral to a normally functioning free market economy.
Findings are detailed in a research paper that appeared in June in the online journal Entropy and is available at http://www.mdpi.com/1099-4300/12/6/1514/

A key idea in Venkatasubramanian's theory is a new interpretation of entropy, used in science to measure disorder in thermodynamics and uncertainty in information theory. He shows, however, that entropy also is a measure of fairness, an insight that seems to have been largely missed over the years, he said.

"Venkat's insight goes beyond the simple grafting of the mathematics of information theory and statistical physics onto the question of fairness of salary distributions within a free market economy," said Andrew Hirsch, a Purdue physics professor familiar with the research. "He has recast the notion of entropy into a context that has meaning and relevance for this particular problem."

Venkatasubramanian calls his new theory, "statistical teleodynamics," from the Greek telos, which means goal-driven.
"In statistical thermodynamics, we study the movement of large numbers of molecules," Venkatasubramanian said. "In economic systems, we have a large number of people moving around in a free market system, but instead of thermal energy driving the movement people are motivated by goals."

His theory describes how goal-driven "rational agents," or people, will behave in a free market economic environment under ideal conditions.

"The bottom line is that the free market does care about fairness," he said. "Clearly, the next step is to conduct more comprehensive studies of salary distributions in various organizations and sectors in order to understand in greater detail the deviations in the real world from the ideal, fairness maximizing, free market for labor."

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Re: Econophysics

Postby Glass Fractal » Sun Jul 18, 2010 12:23 am UTC

So under ideal circumstances the free market is perfect. That doesn't seem like news. Under ideal circumstances dictatorship and communism are also perfect.

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Re: Econophysics

Postby Diadem » Sun Jul 18, 2010 2:04 am UTC

That's not really what 'ideal circumstances' mean in scientific context. It means that there's no things like outside interference, or relevant factors that are not modelled, that there's no distortions etc. For example an ideal gas is a gas where the molecules themselves take up no space - so that complicated density-dependent effects do not have to be accounted for. Real life gases are to a very good approximation ideal, at lower densities. Ideal physical setups would typically include such things are frictionless infinite plains and perfect spheres and stuff like that. It's basically a phrase meaning some assumptions have been made to make the problem easier. But those assumptions should be spelled out.

In this context, it most likely means a perfect free market, no government interference at all. Other assumptions are probably that all agents are perfectly rational and a very large (possibly infinite) number of suppliers and buyers. But you'd have to read the article to see what assumptions exactly they are making.
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Re: Econophysics

Postby mmmcannibalism » Sun Jul 18, 2010 2:12 am UTC

In this context, it most likely means a perfect free market, no government interference at all. Other assumptions are probably that all agents are perfectly rational and a very large (possibly infinite) number of suppliers and buyers. But you'd have to read the article to see what assumptions exactly they are making.


The assumption of a stable(and effective) government is also needed. Free markets obviously won't work if someone can just steal your stuff.

This sounds interesting, but I'm not versed well enough in chemistry or economics to say if this sounds like it is a good study.
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Re: Econophysics

Postby The Reaper » Sun Jul 18, 2010 2:23 am UTC

re: Assumptions
According to the article:
We assume an ideal environment where the market is perfectly competitive, transaction costs are negligible, there are no externalities, and market participants have perfect information. In this ideal free market, employees are free to switch jobs and move between companies in search of better utilities. Similarly, companies are free to fire and hire employees in order to maximize their profits. We also assume that both utility and profit are strictly functions of money alone and nothing else. In addition, we do not consider the effect of taxes. We also assume that a company needs to retain all its employees in order to survive in this competitive market environment. Thus, a company will take whatever steps necessary, allowed by its constraints, to retain all its employees. Similarly, all employees need a salary to survive and that they will do whatever that is necessary, allowed by certain norms, to stay employed. We assume that neither the companies nor the employees engage in illegal practices such as fraud, collusion, and so on.
And then it goes on to say some other stuff, some of which is math, but most of which seems to be explanation of variable choices or some such. The research thing is available for download from the link.

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Re: Econophysics

Postby georgehorse » Sun Jul 18, 2010 2:44 am UTC

mmmcannibalism wrote:
In this context, it most likely means a perfect free market, no government interference at all. Other assumptions are probably that all agents are perfectly rational and a very large (possibly infinite) number of suppliers and buyers. But you'd have to read the article to see what assumptions exactly they are making.

The assumption of a stable(and effective) government is also needed. Free markets obviously won't work if someone can just steal your stuff.

This sounds interesting, but I'm not versed well enough in chemistry or economics to say if this sounds like it is a good study.

It doesn't seem that necessary given the rest of the assumptions made in the study — “We assume that neither the companies nor the employees engage in illegal practices such as fraud, collusion, and so on.” And in defense of the free market, I think the lock on my bicycle plays a big part in it not getting stolen.

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Re: Econophysics

Postby Marbas » Sun Jul 18, 2010 3:27 am UTC

Hey, that's my school!

Woo! Go Boilermakers.


There's really nothing constructive for me to say here. However, color me skeptical of this man's findings until there's time for me to actually read the paper. Though at first glance:

We also assume that a company needs to retain all its employees in order to survive in this competitive market environment. Thus, a company will take whatever steps necessary, allowed by its constraints, to retain all its employees


Doesn't really look like a reasonable assumption.
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Re: Econophysics

Postby frezik » Sun Jul 18, 2010 3:32 am UTC

We assume an ideal environment where the market is perfectly competitive, transaction costs are negligible, there are no externalities, and market participants have perfect information.


See, this is where free market folks fall down. They take a simplified situation which works just fine, then extrapolate that out to all situations.

In particular, there are definitely situations where externalities exist (like the BP spill) or everyone doesn't have perfect information (a used car salesman knows more about that car than you do, even if you take it to a mechanic for inspection). Too often, the Ayn Rand faction says that that's just the way it has to be.
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Re: Econophysics

Postby Velict » Sun Jul 18, 2010 4:08 am UTC

frezik wrote:
We assume an ideal environment where the market is perfectly competitive, transaction costs are negligible, there are no externalities, and market participants have perfect information.


See, this is where free market folks fall down. They take a simplified situation which works just fine, then extrapolate that out to all situations.

In particular, there are definitely situations where externalities exist (like the BP spill) or everyone doesn't have perfect information (a used car salesman knows more about that car than you do, even if you take it to a mechanic for inspection). Too often, the Ayn Rand faction says that that's just the way it has to be.

Mainstream economics frequently uses models that assume ideal conditions. This isn't the invention of "free market folks," and it doesn't imply that externalities don't exist or that everyone has perfect information.

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Re: Econophysics

Postby Patashu » Sun Jul 18, 2010 4:36 am UTC

If mainstream economics uses assumptions that are not approximations of the real world but outright wrong, is it not disingenuous to present conclusions using them as relevant?

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Re: Econophysics

Postby aleflamedyud » Sun Jul 18, 2010 5:01 am UTC

The Reaper wrote:re: Assumptions
According to the article:
We assume an ideal environment where the market is perfectly competitive, transaction costs are negligible, there are no externalities, and market participants have perfect information. In this ideal free market, employees are free to switch jobs and move between companies in search of better utilities. Similarly, companies are free to fire and hire employees in order to maximize their profits. We also assume that both utility and profit are strictly functions of money alone and nothing else. In addition, we do not consider the effect of taxes. We also assume that a company needs to retain all its employees in order to survive in this competitive market environment. Thus, a company will take whatever steps necessary, allowed by its constraints, to retain all its employees. Similarly, all employees need a salary to survive and that they will do whatever that is necessary, allowed by certain norms, to stay employed. We assume that neither the companies nor the employees engage in illegal practices such as fraud, collusion, and so on.
And then it goes on to say some other stuff, some of which is math, but most of which seems to be explanation of variable choices or some such. The research thing is available for download from the link.

So he makes a bunch of assumptions that, in the real world, are not true, and then uses them to make claims that are BLATANTLY untrue. At what point will economists just admit that they're playing a mathematical game or actually attempt to study the real world?
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Re: Econophysics

Postby Bubbles McCoy » Sun Jul 18, 2010 5:10 am UTC

Velict wrote:Mainstream economics frequently uses models that assume ideal conditions.

Not really? Much of economics is based around the observation of how things play out and the creation of understandable models that can be extrapolated to other cases, ideal conditions are really only important in finding effects that cause the current economy to deviate from perfect efficiency (such as quantifying and understanding transaction costs).

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Re: Econophysics

Postby TheKrikkitWars » Sun Jul 18, 2010 6:58 am UTC

aleflamedyud wrote:So he makes a bunch of assumptions that, in the real world, are not true, and then uses them to make claims that are BLATANTLY untrue. At what point will economists just admit that they're playing a mathematical game or actually attempt to study the real world?


I don't know that they're blatantly untrue, I mean none of us know what it is to live in a world with something even aproximating to a free market, we just live in a deregulated market where the companies can fuck everyone over, then run to the government to help fix the mess they've made.
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Re: Econophysics

Postby G.v.K » Sun Jul 18, 2010 8:56 am UTC

econophysics eh? nice name. plays up to the physics envy that still plauges the social sciences. in the end, though, it seems to be just another mathematician with too much time on his hands.

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Re: Econophysics

Postby Vaniver » Sun Jul 18, 2010 10:46 am UTC

G.v.K wrote:econophysics eh? nice name. plays up to the physics envy that still plauges the social sciences. in the end, though, it seems to be just another mathematician with too much time on his hands.
Actually, no. The guy who did it at my university was a physicist who found he got much better results (i.e. agreed closer with actual data) in econophysics than in regular physics.

What he was doing was looking at what an income distribution would look like in a totally random frictionless economy- with the comment to anyone unfamiliar with thermodynamics that it works to consider something nonrandom random when you look at large deterministic groups whose properties you don't know- your ignorance is on the whole equal to randomness. The result is a Boltzmann distribution; which is what the American income distribution fits almost perfectly.* It also predicted both household income distributions and individual income distributions, which are in practice rather different.

Normally, economists can't make statements about wages except relative to their product of labor. Unsurprisingly, the paper makes no claim that executive salaries are too high (way to go, science journalists!). It just presents a framework for using entropy to understand salaries, and more importantly why entropy should be expected to be useful for understanding ideal free markets.

Venkatasubramanian wrote:Given the statistical nature of our theory, the lognormal prediction is not valid for small, highly entrepreneurial, organizations where a handful of employees (e.g., the founders of a start-up, sports teams, movie actors, etc.) are demonstrably much more valuable than the others.
It's also necessary is to consider the responsibility of employees when setting their pay; a CEO is not just the best line worker at the plant. He or she is functioning on the scale of the entire company, and it is similarly to be expected that their pay would be a percentage of the entire company, assuming decisions have multiplicative effects rather than additive effects- and so we should expect a power law distribution of executive salaries that depends on the revenue of the firm, not for them to fit into the labor distribution.

*The divergence is at the very top, which follows a power law which follows S&P results, since that part of the income distribution is primarily from stock returns, not labor.
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Re: Econophysics

Postby Jessica » Sun Jul 18, 2010 4:49 pm UTC

So, I saw this just before reading this thread, and they seemed interesting together. So, I thought I'd post it.
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Re: Econophysics

Postby MartianInvader » Sun Jul 18, 2010 5:09 pm UTC

Glass Fractal wrote:So under ideal circumstances the free market is perfect. That doesn't seem like news. Under ideal circumstances dictatorship and communism are also perfect.

Despite the responses, I'm pretty sure this point still stands. Under some assumptions, the free market works. Well, assuming a benevolent, uncorruptable dictator, a dictatorship works. Assuming no greed and no corruption, communism works.

And before people start saying those are unrealistic assumptions, I'll posit that they're no more far-fetched than a zillion uncorruptable CEOs and boards of directors who put the good of the company ahead of the money in their pockets. Or the craziest assumption of all - that people are perfectly rational. Man, that one always cracks me up.
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Re: Econophysics

Postby Vaniver » Sun Jul 18, 2010 6:01 pm UTC

MartianInvader wrote:I'll posit that they're no more far-fetched than a zillion uncorruptable CEOs and boards of directors who put the good of the company ahead of the money in their pockets. Or the craziest assumption of all - that people are perfectly rational. Man, that one always cracks me up.
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What does it mean to believe in evolution? That random changes, when submitted to selection pressure, will result in decidedly non-random results, and we can predict what those results should look like.

Economics is, in many ways, the description of what commercial selection pressure looks like. If CEOs benefit themselves at the expense of the company, the company will perform worse and eventually go under. If every current CEO steals from their company at the same rate, they can all benefit from the system- but then a company with a CEO that doesn't steal will be able to out-perform them because of the savings. An example is the male-female pay gap; if you believe it's only sexism at play, and no other factors, a company that hired only women at their market rate would have a giant competitive advantage over a company that hired only men at their market rate, and would be able to gobble up their market share (and then competitors would use its model and through competition drive up the wage for women). Commercial selection pressure pushes against bias, and towards rationality.

Political selection pressure pushes in its own direction, and so obviously predictions made without considering real governments will not match results made while considering real governments.
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Re: Econophysics

Postby Aetius » Sun Jul 18, 2010 9:14 pm UTC

I think the point of the article is that real life wages for most of the work force approximate ideal wages to an acceptable degree, whereas CEO compensation is completely out of whack with an ideal model. Which makes sense, considering that when you reach those levels in a corporation, there's a much smaller sample size to work with, there is weaker oversight, personal psychology and negotiation comes into play much more heavily, as does fear of failure and corporate trend following.

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Re: Econophysics

Postby frezik » Mon Jul 19, 2010 12:33 am UTC

Velict wrote:Mainstream economics frequently uses models that assume ideal conditions. This isn't the invention of "free market folks," and it doesn't imply that externalities don't exist or that everyone has perfect information.


Starting with a model under ideal conditions is just fine. It's a good starting point for economists. My problem with the Free Market Folks is they often stop there, whereas real economists (even classical ones) will fully admit that this is a model that will need some adjustment.

aleflamedyud wrote:So he makes a bunch of assumptions that, in the real world, are not true, and then uses them to make claims that are BLATANTLY untrue. At what point will economists just admit that they're playing a mathematical game or actually attempt to study the real world?


This is the other extreme. Starting out with a model is a perfectly valid way of trying to understand things, and the conclusions are not necessarily blatantly untrue. There's no such thing as an Ideal Gas, a Carnot Engine, or an economy with entirely rational actors using perfect information. All of these are models that have direct, practical applications that work.

In short, my position is that laissez faire capitalism should be the default, but don't ignore situations where it provably fails.
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Re: Econophysics

Postby guenther » Mon Jul 19, 2010 2:16 am UTC

Jessica wrote:So, I saw this just before reading this thread, and they seemed interesting together. So, I thought I'd post it.
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Thanks for the link. I find this stuff fascinating to watch.

I also like the idea of modeling and simulating our economy as a system with physical properties. It seems like this type of work is in it's early stages, but as some point in the future I bet there will be a fundamental paradigm shift when we can reliably simulate very realistic models of real chaotic systems. Maybe something not too different from psychohistory.

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Re: Econophysics

Postby G.v.K » Mon Jul 19, 2010 3:30 am UTC

Jessica wrote:So, I saw this just before reading this thread, and they seemed interesting together. So, I thought I'd post it.
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right. so performance decreases as pay increases. our CEOs must be spectacularly incompetent then. good thing their work doesn't really have anything to do with production anyway.

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Re: Econophysics

Postby Sheikh al-Majaneen » Mon Jul 19, 2010 3:30 am UTC

Glass Fractal wrote:So under ideal circumstances the free market is perfect. That doesn't seem like news. Under ideal circumstances dictatorship and communism are also perfect.

Um, no. Under ideal circumstances, everyone will get along just fine without any need for government [interference]. After all, what's the point if circumstances are ideal?

The point of assuming ideal circumstances is to remove externalities, like fraud and natural disaster, and observe (to the best of our abilities) how the market would "behave."

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Re: Econophysics

Postby Glass Fractal » Mon Jul 19, 2010 4:10 am UTC

frezik wrote:This is the other extreme. Starting out with a model is a perfectly valid way of trying to understand things, and the conclusions are not necessarily blatantly untrue. There's no such thing as an Ideal Gas, a Carnot Engine, or an economy with entirely rational actors using perfect information. All of these are models that have direct, practical applications that work.


Would you buy a fridge from a person who insisted that there was an ideal Carnot Engine inside? Of course not, he's obviously either terrible misinformed about his product or lying to you.

Sheikh al-Majaneen wrote:
Glass Fractal wrote:So under ideal circumstances the free market is perfect. That doesn't seem like news. Under ideal circumstances dictatorship and communism are also perfect.

Um, no. Under ideal circumstances, everyone will get along just fine without any need for government [interference]. After all, what's the point if circumstances are ideal?


If I assume ideal circumstances for a dictatorship then I will find after a very deep analysis that dictatorship is perfect and the free market it doomed to failure as the peasants will inevitably tear each other to pieces in an orgy of anarchic violence.

Guess what happens if I assume circumstances that are ideal for a free market. Trust me, it's easy, you don't even need to take a single economics class to figure this one out.

Sheikh al-Majaneen wrote:The point of assuming ideal circumstances is to remove externalities, like fraud and natural disaster, and observe (to the best of our abilities) how the market would "behave."


So he's taken economics and deliberately divorced it from reality. Hooray?

Seriously, that's a reasonable starting point but it fails to tell us anything we don't already know or couldn't have figured out through the wide respected science of tautology. If he can show that his method will keeping giving the same results as more and more externalities are put back in then sure, anarchocapitalism all the way. Otherwise this whole thing is, at best, incredibly premature.

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Re: Econophysics

Postby Bubbles McCoy » Mon Jul 19, 2010 4:21 am UTC

Glass Fractal wrote:Seriously, that's a reasonable starting point but it fails to tell us anything we don't already know or couldn't have figured out through the wide respected science of tautology. If he can show that his method will keeping giving the same results as more and more externalities are put back in then sure, anarchocapitalism all the way. Otherwise this whole thing is, at best, incredibly premature.

Who are you even talking to? Did the conductor of the study or anyone in this thread even approach advocating anarchocapitalism? The researcher deliberately concluded with saying that this was done as a baseline to test for deviations and find the nature of them, not how this was a demonstration of how government is preventing more equal salaries.

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Re: Econophysics

Postby Glass Fractal » Mon Jul 19, 2010 4:30 am UTC

Bubbles McCoy wrote:
Glass Fractal wrote:Seriously, that's a reasonable starting point but it fails to tell us anything we don't already know or couldn't have figured out through the wide respected science of tautology. If he can show that his method will keeping giving the same results as more and more externalities are put back in then sure, anarchocapitalism all the way. Otherwise this whole thing is, at best, incredibly premature.

Who are you even talking to? Did the conductor of the study or anyone in this thread even approach advocating anarchocapitalism? The researcher deliberately concluded with saying that this was done as a baseline to test for deviations and find the nature of them, not how this was a demonstration of how government is preventing more equal salaries.

The anarchocapitalism thing was a joke.

And yes, you're absolutely right, I missed his last bit at the end there about going on to see how well it reflects real world statistics. Should've read the article more carefully. I'm afraid that I'm used to people in other places assuming that the market really is an ideal system.

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Re: Econophysics

Postby MartianInvader » Mon Jul 19, 2010 11:59 am UTC

Vaniver wrote:
MartianInvader wrote:I'll posit that they're no more far-fetched than a zillion uncorruptable CEOs and boards of directors who put the good of the company ahead of the money in their pockets. Or the craziest assumption of all - that people are perfectly rational. Man, that one always cracks me up.
Do you believe in evolution?

I don't believe in evolution of companies, because companies don't pass their traits on to other companies in any reliable way. All you see is companies copying each other, but corruption practices can be copied by executives just as commonly as good practices, and so there's no reason why one would be selected for over the other. For every investmentor that said, "Wow, I better not be corrupt like Madoff,", there's one saying "Wow, that Madoff had a good idea, made tons of money, and didn't get caught for years! I bet I could do that, but even better!"

Contrast that to biological evolution, where when an organism is successful, it creates an exponentially increasing number of near-copies of itself, which have those traits coded into their DNA and don't have to hire shady consultants or read the "Best practices for dummies" books.

But we digress from my main point, which was that you can make semi-reasonable assumptions and build any model to show any of dozens of systems work perfectly.

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Re: Econophysics

Postby Vaniver » Mon Jul 19, 2010 5:53 pm UTC

MartianInvader wrote:companies don't pass their traits on to other companies in any reliable way. All you see is companies copying each other
Ahem.

You're right that both good and bad practices can be copied, of course; also worth noting is that there are many levels of competition going on (between individuals, between memes, etc.), such that we can predict how much and what kinds of corruption we should expect from a policy or situation. For example, the current method many CEOs use to negotiate higher salaries is one designed to benefit them at the expense of investors, and the investor's representatives are generally unprepared to deal with that. However, as a negotiating tactic all it can do is move rewards from one party to another; it's not clear that it's actually resulting in companies that are significantly less profitable or likely to survive (and if that relationship does exist, it's not clear that higher salaries are not a proxy for something else).
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Re: Econophysics

Postby MartianInvader » Mon Jul 19, 2010 11:03 pm UTC

So... is your argument "It's not clear that companies aren't selected for traits that help investors, and therefore they are"?

As I said, traits aren't passed on in a reliable way. Traits get shuffled around, sure, but claiming that certain ones are selected for without significant backup isn't very convincing.
Let's have a fervent argument, mostly over semantics, where we all claim the burden of proof is on the other side!

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Re: Econophysics

Postby Vaniver » Tue Jul 20, 2010 4:42 am UTC

MartianInvader wrote:So... is your argument "It's not clear that companies aren't selected for traits that help investors, and therefore they are"?
It's a bit more complicated than that; it's clear that the selection pressure for capital allocation comes from investor's interests. What's not clear is whether or not CEO salaries at the current level by themselves reduce competitiveness enough to be significantly selected against, or if 'excessive' CEO salaries are a good proxy for executive mismanagement (in which case executive mismanagement is selected against, and that takes 'excessive' CEO salaries with it), or if 'excessive' CEO salaries actually increase competitiveness. My suspicion is the second is most likely, followed by no effect, followed by the first, then the last.
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Re: Econophysics

Postby Jahoclave » Tue Jul 20, 2010 5:31 pm UTC

aleflamedyud wrote:
The Reaper wrote:re: Assumptions
According to the article:
We assume an ideal environment where the market is perfectly competitive, transaction costs are negligible, there are no externalities, and market participants have perfect information. In this ideal free market, employees are free to switch jobs and move between companies in search of better utilities. Similarly, companies are free to fire and hire employees in order to maximize their profits. We also assume that both utility and profit are strictly functions of money alone and nothing else. In addition, we do not consider the effect of taxes. We also assume that a company needs to retain all its employees in order to survive in this competitive market environment. Thus, a company will take whatever steps necessary, allowed by its constraints, to retain all its employees. Similarly, all employees need a salary to survive and that they will do whatever that is necessary, allowed by certain norms, to stay employed. We assume that neither the companies nor the employees engage in illegal practices such as fraud, collusion, and so on.
And then it goes on to say some other stuff, some of which is math, but most of which seems to be explanation of variable choices or some such. The research thing is available for download from the link.

So he makes a bunch of assumptions that, in the real world, are not true, and then uses them to make claims that are BLATANTLY untrue. At what point will economists just admit that they're playing a mathematical game or actually attempt to study the real world?

Yeah, my degree is in English with a minor in history and I could tell you half those assumptions are outright bullshit that was never part of practiced market economics ever. Furthermore, the idea that a company must and will do everything to retain its labor force is such blatant bullshit ever. I'm just wondering where he figures that the corporate model of organization isn't feudal in method? Okay, so I guess the history minor is relevant there.

MartianInvader wrote:
Vaniver wrote:
MartianInvader wrote:I'll posit that they're no more far-fetched than a zillion uncorruptable CEOs and boards of directors who put the good of the company ahead of the money in their pockets. Or the craziest assumption of all - that people are perfectly rational. Man, that one always cracks me up.
Do you believe in evolution?

I don't believe in evolution of companies, because companies don't pass their traits on to other companies in any reliable way. All you see is companies copying each other, but corruption practices can be copied by executives just as commonly as good practices, and so there's no reason why one would be selected for over the other. For every investmentor that said, "Wow, I better not be corrupt like Madoff,", there's one saying "Wow, that Madoff had a good idea, made tons of money, and didn't get caught for years! I bet I could do that, but even better!"

Contrast that to biological evolution, where when an organism is successful, it creates an exponentially increasing number of near-copies of itself, which have those traits coded into their DNA and don't have to hire shady consultants or read the "Best practices for dummies" books.

But we digress from my main point, which was that you can make semi-reasonable assumptions and build any model to show any of dozens of systems work perfectly.

Quite frankly it's memetic evolution, not biological that would be more useful here anyways. It also makes more sense, and it would point out why you can't assume ideal conditions for a system because, like evolution, you're hemmed in by a starting framework of what came before. Plus, I wouldn't really say that the passing on of traits is that useful of a way to look at things unless you've got an effective selection method, which we don't.

If he's trying to create better models for the real world problems then go on ahead. The problem is people who take this and run with it as proof of capitalism uber alles.

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Re: Econophysics

Postby Kizyr » Tue Jul 20, 2010 7:14 pm UTC

Quick economist's answer regarding assumptions (because I don't have much time to go into detail).

Assumptions aren't used to say that "if assumptions X hold, then result Y will happen", but rather "if conditions X are not accounted for, or have a negligible effect, then the natural tendency is for Y to result" (and a corrollary would be "when conditions X start to break down, you may expect a deviation from Y, the extent of which will depend on said conditions and how they break down").

To distill it down, what this guy is saying is that the natural tendency is for CEO salaries to be a lot lower than they are right now, implying that the current level of CEO compensation isn't something that one can attribute to "market forces". Something else is bumping them up, and that something else is exogenous to natural free-market forces. (i.e., "the self-correcting free market mechanisms have broken down for CEOs and other top executives")

There's some standard reading that most economists are familiar with from Milton Friedman, where he uses the example of the arrangement of leaves on a tree, and an expert pool player, to illustrate how "theory" is used in an economics context. Again, if I had more time I could dig up links to those articles, but they're worth looking into if you want further reading. KF
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Re: Econophysics

Postby G.v.K » Tue Jul 20, 2010 9:59 pm UTC

Kizyr wrote:Quick economist's answer regarding assumptions (because I don't have much time to go into detail).

Assumptions aren't used to say that "if assumptions X hold, then result Y will happen", but rather "if conditions X are not accounted for, or have a negligible effect, then the natural tendency is for Y to result" (and a corrollary would be "when conditions X start to break down, you may expect a deviation from Y, the extent of which will depend on said conditions and how they break down").

To distill it down, what this guy is saying is that the natural tendency is for CEO salaries to be a lot lower than they are right now, implying that the current level of CEO compensation isn't something that one can attribute to "market forces". Something else is bumping them up, and that something else is exogenous to natural free-market forces. (i.e., "the self-correcting free market mechanisms have broken down for CEOs and other top executives")

There's some standard reading that most economists are familiar with from Milton Friedman, where he uses the example of the arrangement of leaves on a tree, and an expert pool player, to illustrate how "theory" is used in an economics context. Again, if I had more time I could dig up links to those articles, but they're worth looking into if you want further reading. KF


what exactly does the phrase 'natural tendency' mean to you?

all these 'nature' analogies confuse me, because it seems we are talking about institutions and roles which are contingent and very young in historical terms. i mean, how long have CEOs been around as a significant social demographic? 50 years? how long have obscenely high CEO salaries been around. 10 years? and now some economist wants to come along and explain this in terms of what is 'natural'? sounds weird to me.

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Re: Econophysics

Postby gmalivuk » Tue Jul 20, 2010 11:25 pm UTC

Vaniver wrote:Economics is, in many ways, the description of what commercial selection pressure looks like. If CEOs benefit themselves at the expense of the company, the company will perform worse and eventually go under. If every current CEO steals from their company at the same rate, they can all benefit from the system- but then a company with a CEO that doesn't steal will be able to out-perform them because of the savings.
Again you make a mistake akin to treating companies as if they were people. Sure, if the active unit of commercial selection were the company, then such-and-such would happen. Just like if the active unit of biological selection were the population, then certain kinds of altruism would be way more common, because that helps the population as a whole. But just as group selection fails as an explanation for selfishness vs. altruism because selfish individuals don't care about the group, company selection fails because selfish CEOs don't care about the long-term fate of the company.

If I can make more money by cutting safety margins and screwing over my consumers, or by cutting wages and screwing over my employees, or by negotiating for a higher salary and screwing over my investors, then there's no current disincentive against doing just that. Why should I care about the long-term fate of the company, when I've got my billions and my yacht and am doing just fine thank you? Consumers or employees or investors who are perfectly informed about what individuals are doing, and what the likely consequences of that are, might have the power to remove the offending individual(s) from power, and *then* we'd have selective pressures against corrupt CEOs (or other individuals in a company). But as things stand now, this isn't what happens. But even then it's selection on the individuals that make up a company.

So any theory that treats economics as commercial evolution driven by company selection is making a hugely incorrect assumption.
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Re: Econophysics

Postby Iceman » Tue Jul 20, 2010 11:48 pm UTC

Problem with people criticising CEO pay is always an issue of people just not understanding how much better at things some people are than others, and the leverage the can be achieved from that.

Whenever you are talking about the top people in anything...Athletics, Intelligence, Military Strategy, Politics etc... the top few people are so far above the next closest that you can throw all the rules out the window.

A a CEO who is 2% better than the next closest person can result in GE's market cap increasing by $50 Billion, and their compensation is going to reflect that, whether it seems fair or not.
A CEO's salary tends to track the size of the company they run, which tracks the leverage their position has, which makes total sense.

And if you don't believe a single person truly can influence the value that much over the others, go look at Apple stock when the market thought he was dying and the day they found out he wasn't.

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Re: Econophysics

Postby Bubbles McCoy » Tue Jul 20, 2010 11:53 pm UTC

Gmal wrote:Again you make a mistake akin to treating companies as if they were people. Sure, if the active unit of commercial selection were the company, then such-and-such would happen. Just like if the active unit of biological selection were the population, then certain kinds of altruism would be way more common, because that helps the population as a whole. But just as group selection fails as an explanation for selfishness vs. altruism because selfish individuals don't care about the group, company selection fails because selfish CEOs don't care about the long-term fate of the company.


Believing that "active units of selection" can only exist within human minds is making an equally incorrect assumption. A company can set up its own defense mechanisms against corrupt executives and the like; a business is not fully beholden to the desires of the CEO. Investors can modify salaries along clever stock option schemes or base performance on longer running initiatives than quarterly profits, forcing the CEO to look beyond simplistic and short-sighted measures akin to the ones you suggest. Investors that fail to do so will soon find themselves losing money, and their management style won't get much farther than the boardrooms overseeing their failing companies.

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Re: Econophysics

Postby G.v.K » Wed Jul 21, 2010 12:18 am UTC

Iceman wrote:And if you don't believe a single person truly can influence the value that much over the others, go look at Apple stock when the market thought he was dying and the day they found out he wasn't.


i wouldn't use a short-term market fluctuation like that as evidence. let's track the stock price in the months and years after he dies. i'll be very surprised to see any real difference. of course, we'll never be able to prove anything cos we can never compare against what the stock price would have been if he was still alive.

Iceman wrote:Problem with people criticising CEO pay is always an issue of people just not understanding how much better at things some people are than others, and the leverage the can be achieved from that.

Whenever you are talking about the top people in anything...Athletics, Intelligence, Military Strategy, Politics etc... the top few people are so far above the next closest that you can throw all the rules out the window.

A a CEO who is 2% better than the next closest person can result in GE's market cap increasing by $50 Billion, and their compensation is going to reflect that, whether it seems fair or not.
A CEO's salary tends to track the size of the company they run, which tracks the leverage their position has, which makes total sense.


maybe so, but the pay system doesn't seem to be working that way. if it did, we would expect to see the top 2% of CEOs with huge salaries compared to the rest.

i can think of several examples off the top of my head where a CEO walks in, the company tanks, and 2 years later they leave with a huge payout. from that i deduce that CEO salary is not based on merit.

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Re: Econophysics

Postby Iceman » Wed Jul 21, 2010 2:37 am UTC

G.v.K wrote:
Iceman wrote:And if you don't believe a single person truly can influence the value that much over the others, go look at Apple stock when the market thought he was dying and the day they found out he wasn't.


i wouldn't use a short-term market fluctuation like that as evidence. let's track the stock price in the months and years after he dies. i'll be very surprised to see any real difference. of course, we'll never be able to prove anything cos we can never compare against what the stock price would have been if he was still alive.


Well, again those who believe in efficient markets would say those fluctuations were accurate representations of his value, but particularly for a company like Apple, a single leader would make a very large difference if they impacted the design, timing or features of a product line, and in the case of a Steve Jobs, or a Warren Buffet, the success is very attributable to an individual.

G.v.K. wrote:
Iceman wrote:Problem with people criticising CEO pay is always an issue of people just not understanding how much better at things some people are than others, and the leverage the can be achieved from that.

Whenever you are talking about the top people in anything...Athletics, Intelligence, Military Strategy, Politics etc... the top few people are so far above the next closest that you can throw all the rules out the window.

A a CEO who is 2% better than the next closest person can result in GE's market cap increasing by $50 Billion, and their compensation is going to reflect that, whether it seems fair or not.
A CEO's salary tends to track the size of the company they run, which tracks the leverage their position has, which makes total sense.


maybe so, but the pay system doesn't seem to be working that way. if it did, we would expect to see the top 2% of CEOs with huge salaries compared to the rest.

i can think of several examples off the top of my head where a CEO walks in, the company tanks, and 2 years later they leave with a huge payout. from that i deduce that CEO salary is not based on merit.


Well, the top 2% of CEOs do make a ton more than the rest. There's Fortune 500 CEOs, but there's hundreds of thousands of CEOs in companies no where near that size who are making low 6 figure salaries.

But just like an athlete, you go off past performance and potential. The guy seems worth $13 Million/year, so you sign him for that amount..then he underperforms. Oops...
That's the risk you take. If there was no risk, they'd make $1.3 Billion, not $13 Million
You can't get them to come and then only pay them if it worked out.
The fact that a CEO can come in and the company tanks shows the impact of getting a Bad CEO.

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Re: Econophysics

Postby Vaniver » Wed Jul 21, 2010 6:20 pm UTC

G.v.K wrote:i mean, how long have CEOs been around as a significant social demographic? 50 years? how long have obscenely high CEO salaries been around. 10 years? and now some economist wants to come along and explain this in terms of what is 'natural'? sounds weird to me.
I would say CEOs have been around for, at the very least, three hundred years, and I think you can extend that back to six or seven hundred. Consider the alternative question "how long have engineers been around as a significant social demographic?" What do you mean by engineers, significant, and social demographic?

As well, executive compensations started to significantly increase in the 80s, I believe, so the problem of 'excessive' compensation has been around for about 30 years.

gmalivuk wrote:But just as group selection fails as an explanation for selfishness vs. altruism because selfish individuals don't care about the group, company selection fails because selfish CEOs don't care about the long-term fate of the company. ... So any theory that treats economics as commercial evolution driven by company selection is making a hugely incorrect assumption.
I agree that company selection alone is insufficient. Pretty much every market you add* is another source of selection (which is why competitive pressure in as many places as possible is a good thing). Venkatasubramanian is commenting on the expected level of CEO compensation from the selection of the labor market, which I think is inappropriate (or, at the very least, insufficient). I think the interaction between the capital market for companies and CEO salaries is the more relevant one to consider (or, at very least, a proper examination will include both).

*As in, capital market, consumer market, labor market, possibly a technological market, and so on.
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Re: Econophysics

Postby G.v.K » Thu Jul 22, 2010 1:00 am UTC

Vaniver wrote:
G.v.K wrote:i mean, how long have CEOs been around as a significant social demographic? 50 years? how long have obscenely high CEO salaries been around. 10 years? and now some economist wants to come along and explain this in terms of what is 'natural'? sounds weird to me.
I would say CEOs have been around for, at the very least, three hundred years, and I think you can extend that back to six or seven hundred. Consider the alternative question "how long have engineers been around as a significant social demographic?" What do you mean by engineers, significant, and social demographic?

As well, executive compensations started to significantly increase in the 80s, I believe, so the problem of 'excessive' compensation has been around for about 30 years.


what did the professor mean by 'CEOs' then? maybe he should have explained how his research also accounts for the historical analogs. presumably it should also be valid cross-culturally and historically. this is physics we're talking about, right? contingent socio-cultural facts are surely irrelevant.

personally, i would analyse the phenomena in terms of human greed, status desire and politics. that to me is the 'natural' ground for the discussion. maybe these 'surface' phenomena can be reduced to fundamental concepts in physics, but i have no idea what that would look like.


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