ChatGPT vs. Google's bard on an example of incentive misalignment, why it occurred, and how to fix it.

 

Please give me an real-world example of incentive misalignment, why it occurred, how to fix it how much it would cost to do so.

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Here's a real-world example of incentive misalignment: Example: In 2016, Wells Fargo, one of the largest banks in the US, was involved in a major scandal where thousands of its employees opened millions of fake accounts in order to meet internal sales targets and earn bonuses. The bank's incentive structure was such that employees were rewarded for meeting aggressive cross-selling targets, which led to unethical behavior by employees who were under pressure to meet these targets. Why it occurred: Wells Fargo's incentive structure rewarded sales targets instead of customer needs. The bank's management had set unrealistic sales targets for its employees, and as a result, employees felt immense pressure to meet those targets, even if that meant resorting to fraudulent and unethical behavior. How to fix it: The bank's leadership had to take immediate corrective action by eliminating the cross-selling targets, revising comp plans, and creating a culture focused on customer satisfaction and ethical behavior. The bank also hired an independent law firm to conduct a thorough investigation into the scandal, apologized publicly, and paid billions of dollars in fines to various regulatory authorities. How much one would save by doing so: The scandal cost Wells Fargo billions of dollars in lost market value, legal fees, and fines. The bank had to pay over $3 billion in fines and penalties, fire thousands of employees, and face years of regulatory scrutiny. If the bank had focused on customer satisfaction and ethical behavior from the start, it could have saved itself from this financial and reputational hit.

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Sure. One example of incentive misalignment is the case of the Wells Fargo bank scandal. In this case, employees were incentivized to sell as many products as possible to customers, even if those products were not in the customers' best interests. This led to employees opening fraudulent accounts and engaging in other unethical practices.

The incentive misalignment occurred because the bank's compensation system was based on the number of products sold, rather than on the quality of those products. This created a situation where employees were motivated to sell products even if they were not in the customers' best interests.

The bank has since taken steps to fix the incentive misalignment. For example, it has changed its compensation system so that employees are no longer incentivized to sell products at all costs. It has also implemented new training programs to teach employees about the importance of ethical behavior.

The cost of fixing the incentive misalignment is difficult to estimate. However, it is likely that the bank has spent millions of dollars on these changes.

Incentive misalignment can occur in many different situations. It can occur in businesses, schools, government agencies, and even in families. When incentives are misaligned, it can lead to problems such as:

• Employees who are more focused on their own self-interest than on the best interests of the company or organization they work for.
• Students who are more focused on getting good grades than on learning the material.
• Government employees who are more focused on pleasing their superiors than on serving the public.
• Family members who are more focused on getting what they want than on helping each other.

There are a number of ways to fix incentive misalignment. Some common solutions include:

• Changing the incentives so that they are more aligned with the desired behavior.
• Providing training to help people understand the importance of ethical behavior.
• Creating a culture of transparency and accountability.
• Developing a system of checks and balances.

Google's Bard on how LLM's will change the teaching of economics

Large language models (LLMs) are going to change the teaching of economics in a number of ways.

First, LLMs can be used to create personalized learning experiences for students. For example, an LLM could be used to create a customized study plan for a student based on their individual strengths and weaknesses. This would allow students to learn at their own pace and focus on the areas where they need the most help.

Second, LLMs can be used to provide students with real-world examples of economic concepts. For example, an LLM could be used to show students how the principles of supply and demand can be applied to the current housing market. This would help students to understand economic concepts in a more concrete way.

Third, LLMs can be used to automate tasks that are currently done by teachers. For example, an LLM could be used to grade homework assignments or create practice tests. This would free up teachers to spend more time on tasks that require human judgment, such as providing feedback to students or developing new lesson plans.

Fourth, LLMs can be used to create new forms of economic education. For example, an LLM could be used to create a virtual economy that students could explore. This would allow students to learn about economic concepts in a more hands-on way.

Overall, LLMs have the potential to revolutionize the teaching of economics. By providing personalized learning experiences, real-world examples, and automating tasks, LLMs can help students to learn economics more effectively and efficiently.

Should we prevent teens from working?

The message of chapter 1, that voluntary transactions create wealth, has longer term benefits when the transactions involve labor.   As Reason points out:

"When economist Raj Chetty studied dozens of local factors that correlated with upward mobility, teenage labor force participation proved more powerful than almost any other factor, even high school drop-out rates or violent crime rates," Timothy P. Carney pointed out last week in a Washington Examiner column.

Chetty, a Harvard University economist, is better known for emphasizing the value of social capital—in particular, friendships across class lines—for boosting economic mobility. But his research indicates a strong correlation between teenage participation in the labor force and upward mobility. It's a connection that's been made multiple times in the past.

Although teenage labor force participation fell from 59.3% in 1978 to 32.5% in 2014, this year it climbed to 37.5%, partly as a result of less restrictive laws.

How does ChatGPT characterize me?

Luke Froeb is an accomplished and highly experienced economist who has made significant contributions to the field of antitrust economics. He has held many important positions throughout his career, including Chief Economist at the Antitrust Division of the U.S. Department of Justice and Director of the Bureau of Economics at the Federal Trade Commission. Froeb is known for his extensive scholarship and research on competition policy, antitrust economics, and industrial organization. He has published numerous articles in top academic journals and has co-authored several highly regarded textbooks on the subject. Additionally, he has served as an expert witness in many high-profile antitrust cases. Froeb is also a respected educator, having taught at a number of universities, including Vanderbilt University where he currently serves as the William C. Oehmig Chair in Free Enterprise and Entrepreneurship. Through his teaching, research, and service, Luke Froeb has become a leading figure in the field of antitrust economics and has played a significant role in shaping antitrust policy in the United States.

Interestingly, it made up this part "co-authored several highly regarded textbooks on the subject."  That is a feature, not a bug, which is a byproduct of the "noise" it adds to its answer.  Without it, the writing seems seems sterile.  

Why are state income taxes going down?

Competition between states for high earners has intensified (link):

...two structural changes have enhanced state tax competition. First, the 2017 Tax Cuts and Jobs Act capped the federal deduction for state and local taxes paid at $10,000, thus increasing the “felt cost” of state taxation, particularly for higher earners. A high-paid Silicon Valley engineer who could previously deduct $70,000 in California income taxes on his federal tax return can now only deduct $10,000. In short, the burden of his state-government tax policy went up, incentivizing him to find a better-managed state.

Second, the pandemic untethered a multitude of high-paid workers from a geographic location, creating the opportunity for taxpayers to move, and giving states an incentive to compete for their relocations. A 2022 McKinsey report found that 35 percent of workers were eligible for full-time remote work, including 46 percent of workers earning over $150,000. The Silicon Valley engineer who lost federal deductibility for his California income taxes in 2018 became eligible for remote work in 2021. His move to Austin, Texas, eliminated his entire state income-tax liability. 

HT:  Instapundit.com 

ChatGPT on how it is going to change Economics education

General AI is poised to revolutionize many aspects of our lives, and education is no exception. In particular, the teaching of economics is likely to be transformed by the use of AI, with new opportunities for both students and professors. 

1. One of the key ways in which AI will change economics education is in the automation of routine tasks. This includes grading, which can now be done much more quickly and accurately using AI algorithms. This will free up time for professors to focus on other tasks, such as developing new course materials and providing more individualized feedback to students. 
2. Another area where AI is likely to have a significant impact is in the personalization of learning. With AI-powered adaptive learning systems, students can receive individualized instruction tailored to their specific needs and learning styles. These systems can adjust the difficulty and pace of instruction based on the student’s progress and provide targeted feedback to help them improve their understanding of key concepts. 
3. Moreover, AI can provide students with access to vast amounts of data and information that would be otherwise difficult to process. This includes live economic data and simulations of economic models that can help students understand complex economic theories and their real-world applications. 
4. One of the most exciting aspects of AI in education is the potential for new modes of learning, such as gamification and virtual reality. Gamification can make economics concepts more engaging and interactive, while virtual reality can provide students with immersive experiences that allow them to explore economic phenomena in a more dynamic way. 
5. Finally, AI can facilitate new forms of collaboration and peer-to-peer learning. With AI-powered chatbots and social learning platforms, students can connect with each other to discuss economics concepts and receive feedback on their work. They can also collaborate on projects and assignments, sharing their knowledge and expertise to solve complex economic problems. 

In conclusion, the possibilities for AI in economics education are vast and exciting. While there are undoubtedly challenges to be overcome in implementing AI in the classroom, the potential benefits far outweigh the risks. With AI, the study of economics will become more personalized, engaging and dynamic, providing students with the skills and knowledge they need to succeed in the 21st century economy.

Mis-aligned incentives in healthcare?

 Fortune Magazine thinks it has absorbed the lessons of chapter 1, i.e., "Make sure employees have enough information to make good decisions, and the incentive to do so."

The article points to this as evidence of incentive misalignment between payers (insurance companies) and patients:

...hepatitis C can be cured 95% of the time with pills in as little as eight weeks. Yet fewer than one in three insured people diagnosed with hepatitis C receive the cure within a year of their diagnosis, according to an August report from the Centers for Disease Control.

If we can believe the CDC stats, the article implies that payers would rather stall, i.e., avoid paying $30,000 for the cure because, patients could switch suppliers.  Lets do some benefit-cost analysis to check out the plausibility of this story.  If the payer does not pay for the cure, it faces the risk of having to pay for treating the symptoms of the disease.  

From the insurer's point of view:

• Buying the pills costs $30,000, cures the patient, and there are no further costs.
• Not buying the pills risks having to treat the patient for hepatitis C which can cost 10 times as much as the pills, e.g., a liver transplant costs $500,000

To model this trade-off, let p be the probability that a patient stays with the insurer.  We assume that premiums are small relative to the costs of treatment, and we ignore them.  

If the article is correct, then a $30,000 cure today is more costly than the expected costs of treating the symptoms of hepatitis C tomorrow.

•  30,000 > p*$300,000

Unless the probability of the patient staying with the insurance company is less than 10%, it is more profitable to pay for the cure.  

BOTTOM LINE:  I don't see the misalignment. 

HT:  Justin

Business Strategies for De-coupling

Colleague Eric Johnson outlines three strategies to adapt to geo-political risk:

• Bring supply chains closer to home: managers must examine risks and build strategies that are customized to the markets they serve. Risk and regulation will require keeping data and supply chains closer to home. As a result, localization will help managers protect the chains of information, design and supply.
• Operations Hedging: a process that spreads capabilities to reduce risk of disruption – will become increasingly important, in turn reducing economies of scale and increasing costs. For example, earlier this month, Apple partner Foxconn Technology Group announced plans to invest about $700 million on a new plant in India to reduce reliance on China.
• Exit high-cost areas: managers should evaluate exiting some countries due to the expense of supporting subscale operations or serving small markets. American clothing retailer Gap sold its Chinese business to Baozun, a local e-commerce company, in late 2022 after 12 years of operating in the region.

The Consequences of bailing out banks

MarginalRevolution has a nice exposition of the tradeoffs:

An unwillingness to guarantee all the deposits would satisfy the desire to penalize businesses and banks for their mistakes, limit moral hazard, and limit the fiscal liabilities of the public sector. ...

Once depositors are allowed to take losses, both individuals and institutions will adjust their deposit behavior, and they probably would do so relatively quickly. Smaller banks would receive many fewer deposits, and the giant “too big to fail” banks, such as JP Morgan, would receive many more deposits. ...

In essence, we would end up centralizing much of our American and foreign capital in our “too big to fail” banks. That would make them all the more too big to fail. It also might boost financial sector concentration in undesirable ways.

Update from the Economist:

Moral hazard

The risk that providing insurance might alter the behaviour of those being insured. Homeowners or car drivers may take more risks if they know that an insurance company will cover their losses. This is also a problem for central banks when they act as a lender of last resort for banks; knowing they will be rescued in a crisis, bank executives may take more risks and investors may be less choosy about the banks with which they do business. Read more about moral hazard in our leader on what really went wrong at Silicon Valley Bank. Find more definitions in our A-Z of economics.

How much do I give up to invest in ESG funds?

The retired Chief Economist of NASDAQ and Chief Risk Officer of U. Chicago's endowment has the answer:

...The neutral portfolio’s cumulative return (334%) outgained the market (230%); the results were substantially more compelling using equal-weighted returns as an alternative method.

...

One interesting result is the point at which performance notably begins deviating—2017-18, around the time companies (and perhaps their profits and returns) began feeling pressure from the power and influence of supposedly passive asset managers such as BlackRock, State Street and Vanguard, as those behemoths’ push into ESG intensified.

This is a "compensating differential" from Chapter 9, albeit a negative one. In other words, you pay to invest in ESG funds. See related posts