Archive for June, 2010

Complex Decisions

Most real-world business decisions are considerably more complex than the examples presented by academics in decision theory and game theory. What makes some decisions more complex than others? Here I list some features, not all of which are present in all decision situations.

  • The problems are not posed in a form amenable to classical decision theory.

    Decision theory requires the decision-maker to know what are his or her action-options, what are the consequences of these, what are the uncertain events which may influence these consequences, and what are the probabilities of these uncertain events (and to know all these matters in advance of the decision). Yet, for many real-world decisions, this knowledge is either absent, or may only be known in some vague, intuitive, way. The drug thalidomide, for example, was tested thoroughly before it was sold commercially – on male and female human subjects, adults and children. The only group not to be tested were pregnant women, which were, unfortunately, the main group for which the drug had serious side effects. These side effects were consequences which had not been imagined before the decision to launch was made. Decision theory does not tell us how to identify the possible consequences of some decision, so what use is it in real decision-making?

  • There are fundamental domain uncertainties.

    None of us knows the future. Even with considerable investment in market research, future demand for new products may not be known because potential customers themselves do not know with any certainty what their future demand will be. Moreover, in many cases, we don’t know the past either. I have had many experiences where participants in a business venture have disagreed profoundly about the causes of failure, or even success, and so have taken very different lessons from the experience.

  • Decisions may be unique (non-repeated).

    It is hard to draw on past experience when something is being done for the first time. This does not stop people trying, and so decision-making by metaphor or by anecdote is an important feature of real-world decision-making, even though mostly ignored by decision theorists.

  • There may be multiple stakeholders and participants to the decision.

    In developing a business plan for a global satellite network, for example, a decision-maker would need to take account of the views of a handful of competitors, tens of major investors, scores of minor investors, approximately two hundred national and international telecommunications regulators, a similar number of national company law authorities, scores of upstream suppliers (eg equipment manufacturers), hundreds of employees, hundreds of downstream service wholesalers, thousands of downstream retailers, thousands or millions of shareholders (if listed publicly), and millions of potential customers. To ignore or oppose the views of any of these stakeholders could doom the business to failure. As it happens, Game Theory isn’t much use with this number and complexity of participants. Moreover, despite the view commonly held in academia, most large Western corporations operate with a form of democracy. (If opinions of intelligent, capable staff are regularly over-ridden, these staff will simply leave, so competition ensures democracy. In addition, good managers know that decisions unsupported by their staff will often be executed poorly, so success of a decision may depend on the extent to which staff believe it has been reached fairly.) Accordingly, all major decisions are decided by groups or teams, not at the sole discretion of an individual. Decision theorists, it seems to me, have paid insufficient attention to group decisions: We hear lots about Bayesian decision theory, but where, for example, is the Bayesian theory of combining subjective probability assessments?

  • Domain knowledge may be incomplete and distributed across these stakeholders.
  • Beliefs, goals and preferences of the stakeholders may be diverse and conflicting.
  • Beliefs, goals and preferences of stakeholders, the probabilities of events and the consequences of decisions, may be determined endogenously, as part of the decision process itself.

    For instance, economists use the term network goods to refer to a good where one person’s utility depends on the utility of others. A fax machine is an example, since being the sole owner of fax is of little value to a consumer. Thus, a rational consumer would determine his or her preferences for such a good only AFTER learning the preferences of others. In other words, rational preferences are determined only in the course of the decision process, not beforehand.Having considerable experience in marketing, I contend that ALL goods and services have a network-good component. Even so-called commodities, such as natural resources or telecommunications bandwidth, have demand which is subject to fashion and peer pressure. You can’t get fired for buying IBM, was the old saying. And an important function of advertising is to allow potential consumers to infer the likely preferences of other consumers, so that they can then determine their own preferences. If the advertisement appeals to people like me, or people to whom I aspire to be like, then I can infer that those others are likely to prefer the product being advertized, and thus I can determine my own preferences for it. Similarly, if the advertisement appeals to people I don’t aspire to be like, then I can infer that I won’t be subject to peer pressure or fashion trends, and can determine my preferences accordingly.

    This is commonsense to marketers, even if heretical to many economists.

  • The decision-maker may not fully understand what actions are possible until he or she begins to execute.
  • Some actions may change the decision-making landscape, particularly in domains where there are many interacting participants.

    A bold announcement by a company to launch a new product, for example, may induce competitors to follow and so increase (or decrease) the chances of success. For many goods, an ecosystem of critical size may be required for success, and bold initiatives may act to create (or destroy) such ecosystems.

  • Measures of success may be absent, conflicting or vague.
  • The consequences of actions, including their success or failure, may depend on the quality of execution, which in turn may depend on attitudes and actions of people not making the decision.

    Most business strategies are executed by people other than those who developed or decided the strategy. If the people undertaking the execution are not fully committed to the strategy, they generally have many ways to undermine or subvert it. In military domains, the so-called Powell Doctrine, named after former US Secretary of State Colin Powell, says that foreign military actions undertaken by a democracy may only be successful if these actions have majority public support. (I have written on this topic before.)

  • As a corollary of the previous feature, success of an action may require extensive and continuing dialog with relevant stakeholders, before, during and after its execution.

    This is not news to anyone in business.

  • Success may require pre-commitments before a decision is finally taken.

    In the 1990s, many telecommunications companies bid for national telecoms licences in foreign countries. Often, an important criterion used by the Governments awarding these licences was how quickly each potential operator could launch commercial service. To ensure that they could launch service quickly, some bidders resorted to making purchase commitments with suppliers and even installing equipment ahead of knowing the outcome of a bid, and even ahead, in at least one case I know, of deciding whether or not to bid.

  • The consequences of decisions may be slow to realize.

    Satellite mobile communications networks have typically taken ten years from serious inception to launch of service.  The oil industry usually works on 50+ year cycles for major investment projects.  BP is currently suffering the consequence in the Gulf of Mexico of what appears to be a decades-long culture which de-emphasized safety and adequate contingency planning.

  • Decision-makers may influence the consequences of decisions and/or the measures of success.
  • Intelligent participants may model each other in reaching a decision, what I term reflexivity.

    As a consequence, participants are not only reacting to events in their environment, they are anticipating events and the reactions and anticipations of other participants, and acting proactively to these anticipated events and reactions. Traditional decision theory ignores this. Following Nash, traditional game theory has modeled the outcomes of one such reasoning process, but not the processes themselves. Evolutionary game theory may prove useful for modeling these reasoning processes, although assuming a sequence of identical, repeated interactions does not strike me as an immediate way to model a process of reflexivity. This problem still awaits its Nash.

In my experience, classical decision theory and game theory do not handle these features very well; in some cases, indeed, not at all.  I contend that a new theory of complex decisions is necessary to cope with decision domains having these features.

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Gingery Australian politics

Australia has a new Prime Minister, the very competent Julia Gillard.   She is the first Australian PM not to have been born in Australia since 1923.   Gillard was born in Wales, and is Australia’s second ethnically-Welsh PM.  The first, Billy Hughes, was born in London, but grew up in Wales speaking Welsh as his mother tongue (as did his  contemporary, David Lloyd-George).   No other country, apart from Britain and Australia, has had a Welsh prime minister, and Australia has now had two.   Clearly being Welsh is no bar to political success in Australia.  A greater obstacle might be hair-colour:  I believe Ms Gillard is Australia’s first red-headed prime minister.

Australia has had one other PM born in England (Joseph Cook), two born in Scotland (George Reid, Andrew Fisher) and one born in Chile (Chris Watson, although he thought he had been born in New Zealand).  It should be noted that, despite Australia’s historical links with Britain, the Australian High Court has ruled that Britain is a foreign power under the Australian Constitution, which prohibits members of parliament being citizens of foreign powers.

Australia’s very first PM, Edmund Barton, was born in Australia, indeed in the inner-city suburb of Glebe,  Sydney.  A person living in Glebe would now find themselves represented by women at every level of government:

Lord Mayor of the City of Sydney:  Clover Moore

Member of the New South Wales Legislative Assembly for the Electorate of Balmain:  Verity Firth

Deputy Premier of NSW: Carmel Tebbutt

Premier of NSW: Kristina Keneally

Governor of NSW:  Marie Bashir

Member of the Commonwealth House of Representatives for the Federal Division of Sydney: Tanya Plibersek

Prime Minister:  Julia Gillard

Governor-General of Australia:  Quentin Bryce

Queen of Australia and Head of State:  Queen Elizabeth II.

And in this list, the Premier of NSW, Kristina Keneally was born in the USA, while Marie Bashir is of Lebanese descent and Tanya Plibersek of Slovenian.

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Silicon millenarianism

Here we go again! We have another blogger predicting the end of the office.   Funny how it’s almost always bloggers and journalists and thinktank-swimmers doing this – always people whose work, most of the time, is by themselves, and who therefore fail to understand the nature of actual work in modern organizations.   As I’ve argued before, workplace interactions are primarily about the co-ordination of actions and the assessment of people’s intentions concerning these actions, not (or not merely) about sharing information.  Why did Barack Obama summon the Chairman and CEO of BP to the Oval Office earlier this week?  Why was the CEO also called to testify before Congress?   Why didn’t the President or the Congressional Committee simply place a conference call?  Because it is very difficult, perhaps even impossible, to accurately assess another person’s intentions without immediate physical proximity and face-to-face interaction with said person.

If all you are doing is writing a blog or researching a story, perhaps you don’t ever appreciate this fact about work.  But anyone tasked with doing something other than writing knows it.   Seth Goodin thinks that within 10 years TV programs about office work will seem to be “quaint antiques”.  I bet him they will not at all.  Moreover, I bet the people in those offices will still be using paper, still having meetings, and still talking by the water-cooler.   In fact, while you’re placing my bets, put me down for 100 years, not 10.




Hey, Economics! Meet Politics!

Economists are fond of simplistic generalizations, which they refer to as “laws” (in imitation of Physics, itself showing its links to Theology), or as stylized facts.   Most such are, at best, default conclusions, since there are always exceptions.  Here are several, linked in a chain of inferences:

  • A successful single European currency requires a single European monetary policy.
  • A successful single European monetary policy requires a single European fiscal policy.
  • A successful single European fiscal policy requires fiscal transfers from one part of the European Union to another.
  • Fiscal transfers from one part of the European Union to another can only be undertaken over the long term by European institutions having democratic legitimacy.
  • To achieve democratic legitimacy for European institutions, the nations of Europe will require full political union.

This is not a new argument.  I first heard it put by Zambian economist Chiselebwe Ng’andwe in a paper read to a meeting of the African Association of Political Science in Salisbury (later Harare), Zimbabwe, in May 1981, talking about regional economic unions in Africa.   In today’s Guardian, Simon Jenkins refers back to a book about European integration by Larry Seidentop, published in 2000, which apparently makes a similar case about Europe.  Here is Ng’andwe in 1981:

Central banks play a pivotal role in the harmonization of fiscal, monetary and general economic policies.  Hence, separate central banks make it difficult to harmonize even those policy areas where joint arrangements exist such as a common tariff.

The Central bank is such an important institution for economic policy control that a joint central bank [in an economic union of states] needs total political harmony to function.  The necessary political harmony is not possible without political union.  Hence, a joint central bank and its potential benefits are simply not possible in a grouping of political[ly] independent states.  If one state wants some specific monetary policy to deal with an internal problem, a joint central bank will [op]pose some problems [policies?] unless the desired action is completely consistent with the economic and (or) political mood of the other countries.  The loss of some territorial capacity for fiscal and monetary manoeuvre entailed by a joint central bank may involve a greater loss in territorial economic growth than the territorial gain from joint economic actions. This possibility of net economic loss does not augur well for a joint central bank.  But even more important to the territorial political leaders is the loss of control over the key instruments of economic policy.  This loss can create frustrations in the internal economic and political policies of individual countries.

 . . .

Another signifance of joint policy instruments lie in the capacity of these instruments to reduce imbalances in the distribution of economic benefits.   .  .  .  Even in the U.S.A. where there is practically no government industrial and commercial activities, the availability of common fiscal and monetary policies enable[s] the central government to redistribute income throughout the federal states.

This redistribution may not be enough to remove inequalities completely, but it does remove the rough edges from any regional economic imbalances.”  (pp. 13-14)

Why is this argument not, then, widely understood?  Is it that some ideas are too comprehensible – in other words, apparently lacking in complexity or subtlety – to be understood by intelligent people? Or is that the political forces which benefit from the non-democratic European status quo are so strong as to prevent the adoption of democratic structures, and to muzzle the arguments for them?  As I recall, Ng’andwe’s talk was received very coldly by his audience, most of whom were keen on economic unions (between African countries), while maintaining national sovereignty in all other respects.

References:

Chiselebwe Ng’andwe [1981]:  Problems of Economic Integration in Africa.  Paper presented to the Fourth Bi-Annual Meeting of the African Association of Political Science (AAPS 1981).  Salisbury, Zimbabwe:  23-27 May 1981.

Larry Seidentop [2000]:  Democracy in Europe.  London, UK: Penguin.

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Verligte Economics

Nobel  laureate economist, Paul Krugman, has a blogpost summarizing his (and some of Brad DeLong’s) arguments against imposing fiscal austerity in the short-term.   I realize that the verkrampte wing of the economic commentariat seem to be in the majority at present, so unfortunately the wise good sense of Krugman and DeLong seems unlikely to prevail.  But I want to note their arguments for the record so that, 2 or 5 years from now, when we are again (or still) in recession, we can look back and weep.

So, one more time: here’s an attempt to put together some key arguments about why the rush to fiscal austerity is deeply misguided.

Let me start with the budget arithmetic, borrowing an approach from Brad DeLong. Consider the long-run budget implications for the United States of spending $1 trillion on stimulus at a time when the economy is suffering from severe unemployment.

That sounds like a lot of money. But the US Treasury can currently issue long-term inflation-protected securities at an interest rate of 1.75%. So the long-term cost of servicing an extra trillion dollars of borrowing is $17.5 billion, or around 0.13 percent of GDP.

And bear in mind that additional stimulus would lead to at least a somewhat stronger economy, and hence higher revenues. Almost surely, the true budget cost of $1 trillion in stimulus would be less than one-tenth of one percent of GDP – not much cost to pay for generating jobs when they’re badly needed and avoiding disastrous cuts in government services.

But we can’t afford it, say the advocates of austerity. Why? Because we must impose pain to appease the markets.

There are three problems with this claim.

First, it assumes that markets are irrational – that they will be spooked by stimulus spending and/or encouraged by austerity even though the long-run budget implications of such spending and/or austerity are trivial.

Second, we’re talking about punishing the real economy to satisfy demands that markets are not, in fact, making. It’s truly amazing to see so many people urging immediate infliction of pain when the US government remains able to borrow at remarkably low interest rates, simply because Very Serious People believe, in their wisdom, that the markets might change their mind any day now.

Third, all this presumes that if the markets were to lose faith in the US government, they would be reassured by short-term fiscal austerity. The available facts suggest otherwise: markets continue to treat Ireland, which has accepted savage austerity with little resistance, as being somewhat riskier than Spain, which has accepted austerity slowly and reluctantly.

In short: the demand for immediate austerity is based on the assertion that markets will demand such austerity in the future, even though they shouldn’t, and show no sign of making any such demand now; and that if markets do lose faith in us, self-flagellation would restore that faith, even though that hasn’t actually worked anywhere else.




Spiderwoman RIP

The death has occurred of artist Louise Bourgeois, aged 98.   I can’t say I liked or appreciated her art at all, most of which I found unsettling, sinister and off-putting.   Her art did not communicate anything pleasant or subtle, at least not to me, but perhaps that was her intention, or else I was not in her target audience.   Her art was also obsessive (all those spiders, for goodness sake!) and very literal-minded (every one of them with exactly 8 legs).  Somehow we expect our artists, of all people, to have more imagination than this.    Bourgeois appears to have been true to her own vision and to her own self, but that does not mean she was someone I would want to spend any time with.

Perhaps I was not the only person repelled by her art and the personality it revealed.   In gallery Dia: Beacon, upriver from New York City,  Bourgeois’ art is placed in a small upstairs room on its own, hidden away from the other work like some Mrs Rochester of the art world.  Perhaps the curators thought her work would infect the wonderful minimalist and conceptual art for which the gallery is rightly known; her work certainly seems out of place in this gallery.  As elsewhere, I found her art there unpleasant, and a whole room full was overwhelmingly repellent.  Indeed, the one great work in that room you only see as you descend the steps to leave, and is not by her or by any artist.  In this former printing factory, the wall next to the steps is the original external red-brick factory wall, covered in some places with a white dust, and left as it presumably was when the gallery took over the building.  This subtle, spiritual wall with its geometric pattern of red bricks overlaid with random splotches of white is the only interesting or pleasant artwork in the Bourgeois room at Dia:Beacon.  It says something about Bourgeois’ art (or perhaps about my taste) that the packaging here is much better art than any of the objects inside it.

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