The Pygmalion Syndrome

Several readers have asked why I haven’t posted for a while. Rather than admit simply that I had nothing to say, I claimed to be busy with class notes and my draft manuscripts. I was aroused to pen this when I heard a babble head doll on a business program going on about the need to accelerate management change in US industry. This brought back memories of the golden age of change management during my consulting days. The note is drawn in part from the draft chapter on Nature vs. Nurture that Jim and I are working on for the business economics book.

The Pygmalion Syndrome describes change management theories and related efforts to create designer corporations. Formal change management efforts rarely succeed and often destroy more value than they create. These efforts are typically the product of management hubris, a shallow understanding of the evolutionary co-development of organizations with their environment, and a lack of respect for the learning and experience embodied in a firm’s routines. Routines comprise the practices and know-how that define how the firm converts inputs into something of value that it offers to the market. A firm, especially an established firm, is the result of an evolutionary process of adaptation and environmental adoption. The firm’s routines, which environmental economists Nelson and Winter liken to genes because they are replicable, persistent, and selectable define the firm and the products that it offers to the environment for selection. It is the routines that make the product possible that are selected; just as it is the cheetah’s genes that make it faster than some gazelles, not the speed per se, that are selected. In this sense, the firm has been changing from birth and has survived because the environment has selected its routines from among the many rival offerings. This is a joint process involving both nurture and nature; man nurtures a firm or set of routines by seeking advantage relative to rivals and alignment with the environment or nature which makes the final decision.

One of management’s most important jobs is of course to guide the creation and adaptation of routines to align better with the environment. The problems come when management tries to impose a design (complex of routines) dramatically different from the existing structure of routine and out of harmony with the environment. These are often vanity organization designs intended to shape the firm to reflect better the chief executive’s tastes or pretentions. The failures that result are yet more evidence of man’s limits in dealing imperiously with natural forces of which we have a long literary history from which to learn. In Ovid’s Metamorphoses (Transformations), the sculptor Pygmalion fell in love with the statue of a beautiful woman that he had carved of pure white ivory. In his effort to change the statue into his lover, Pygmalion violated just about every community standard of decency by fondling, kissing, dressing, undressing, and taking his statue to bed with him only to be frustrated by her cold inanimate nature. Fortunately goddesses are endowed with change management skills denied us mortals and Venus solved Pygmalion’s problem by granting life to the statue who then married Pygmalion and bore him a son. Now that’s transformational change that even Gary Hamel could believe in! George Bernard Shaw’s version of the story, Pygmalion, involves a pompous phonetics professor, Henry Higgins, as the change manager who transforms Eliza Doolittle, a Cockney flower girl, into a faux Duchess. Eliza however retains her essential character; she asserts herself and rebels against Henry’s clinical approach to her by threatening to leave and marry another. Henry then realizes how shallow are his changes to Eliza but how profound her affect on him has been. In the play’s later musical stage and movie adaptation, My Fair Lady, the story line is very similar but when the professor accepts finally Eliza’s natural character he recognizes his love for her more emphatically than in Shaw’s original version (“I’ve Grown Accustomed to Her Face”), prompting her to return and it seems likely that they will, like Ovid’s original pair, marry. Shaw had it right; most of the changes that can be applied in an ordinary change management program are superficial. BP was never “Beyond Petroleum” and its sunny solar logo and green posturing couldn’t offset its failure to create more effective operational routines consistent with producing in a still unfamiliar deepwater environment.

Kafka’s most famous novel, usually titled in English as Metamorphosis, shares its title with Ovid’s poem but has a very different story line than either Metamorphoses or Pygmalion. Gregor Samsa, a traveling salesman, wakes up one morning at home and finds that he has been transformed into a giant insect. His family is at first alarmed by his new form but eventually they become resigned and then resentful and finally happy when he dies. Samsa’s failed transformation is consistent with the evolutionary evidence that most biological mutations result in less fit organisms and quickly die out. This is consistent also with the experience of most change management programs. Efforts to transform utilities into energy services companies typically created overweight creatures that didn’t fit their environment.

Business change is evolutionary and its speed is determined within the system. Revolutionary rates of change rarely if ever occur because almost all of the change is incremental and internal to the system. The rare but dramatic changes in biological evolution such as the asteroid that probably lead to the extinction of the dinosaurs have no useful parallel in business or economic evolution. The rate of business change is governed primarily by two factors: the entrepreneurial capacity of the firms involved and the environmental selection process. The environment comprises all of the rival firms, their customers, and the collateral social and political systems that influence selection. Environmental selection operates by sorting and sifting through the variety of products and routines submitted by firms; it can select only from what is offered. Entrepreneurs seek continually to offer new products and routines for evaluation and, hopefully, selection. Individual entrepreneurs are human and thus limited in the variety that they can offer the environment but so long as there are many entrepreneurs there is a good chance that some will offer a product and routines aligned with the environment’s characteristics. The sort of unprecedented and accelerated change proclaimed by Hamel and others to be disruptive is the product of the system and not some external threat to it. (It’s also not nearly as unprecedented as he makes out – consider electricity or, before that, steam power.) Some firms will fail to adapt but unless some succeed, positive change can’t occur.

Submitted by Bob

Hogwarts School of Economics

Few are aware of the influence wielded by the Hogwarts School of Economics. This is probably because, as our president has observed, we Muggles neither pay attention nor understand what is going on. Like their counterparts at the college for wizards, the Hogwarts economics faculty and its graduates have mastered an impressive array of spells and charms. By relying on magic, Hogwarts economics eliminates the awkward operation of a primitive (i.e. market) economy, in particular the troublesome need for trade-offs. In an effort to increase awareness of the new economics, I’ve collected a few recent examples of the more powerful economics curses, spells, and charms rendered in the original J.K. Rowling Latinized terminology.

Lay manus, Lay manus, Lay still bro’ ! Spell created in 2008 by then-Treasury Secretary and Wizard Henry Paulson whose early training as a Christian Scientist and later experience as CEO at Goldman Sachs prepared him to accept and to accelerate the divinely ordered demise of the Muggle bank Lehman Brothers. This spell was cast heroically to enforce financial discipline and to repudiate the Too-Big-to-Fail mantra of the Big Bankers (aka Lord Voldemort and his Death Eaters) and thus ushered in a world of stable financial systems. Oh, wait…

Goldmine Sackus. Used to transform a hideously profitable investment bank into an obnoxious bank holding company and hence eligible for a government helping hand of somewhere around $15 billion dollars. The spell was created by holding up a magic mirror while chanting the Lay-manus, Lay-manus curse (see above) thus inverting it and thereby ushering in a world of stable financial systems. Coincidentally, it too was cast by Wizard Henry Paulson (see above).

Windy Milly Dilly. A powerful spell that blows money from the pockets of Muggle taxpayers to those of rent seeking weasels such as Jeffrey Imelt, CEO of Grasping Electric. Imelt distilled, so to speak, this spell from a predecessor, Ethanolis described below.

Ethanolis Alcoholis! An enhanced version of the prohibition-era spell, Bootlegitas, in which corn is transformed into cash through the intermediate production of alcohol. Only today it is performed using much larger stills coupled with the innovative mutation of Revenuers from tax collectors into subsidy payers. This spell has been effective in raising grain and food prices while lowering water tables without the embarrassing jail sentences and fines associated with earlier price-fixing efforts by the Wizards of ADM. Bootlegitas at least gave us NASCAR.

Cialis Stimulatus. Cast using the incantation, “When the Time is Right, Will You Be Shovel Ready?” as uttered by Woolly-Minded Witch of the West at the request of Wizards Obama and Geithner who have shoveled out, so to speak, $800 billion to find out. Guaranteed to increase economic dysfunction by inducing naked couples to hold hands while inexplicably reclining in separate bathtubs. The symbolism is obvious to every Congressman.

Hire, Hire, Pants on Fire! A novel spell suggested by rent-seeking weasel Jeffrey Imelt (see above) in a recent speech to the unenlightened Muggles of the Chamber of Commerce in which he urged them to get over their concerns about the course of the government and the economy and just go out and hire someone. GE has done its part by releasing 40,000 of their own employees since 2008 thus making them available to the timid souls at the Chamber.

Affordibullous Healthus Carus. A truly breathtaking spell cast by the Woolly-Minded Witch of the West, Wizards Obama and Reid, and managed by Wizard Sibelius, this spell transforms 14 per cent of the national economy into one large, centrally administered bureaucracy staffed by trolls who worked formerly at the Ministry of Magic. This spell builds on the previous experience and success at the Post Office, Amtrak, The Bureau of Indian Affairs, the Bureau of Land Management, and other noteworthy institutions.

Quanticus Easibus (aka QE1, QE2, QE3…) Cast by Grand Wizard Bernanke to cause the miraculous creation of prosperity simply by buying private securities and injecting even more money into the economy, thus maintaining near zero rates of interest, lowering yields on private securities, and producing little or no new investment. Imported from Japan where, due to the local habit of speaking Japanese, it was known as economic Hara-Kari, and successfully contributed to the “lost decade.” It is the credit creation equivalent of building speculative ball fields in Iowa cornfields.

Debtus Ceiling Relievus. More a ritual than a spell or curse; it is modeled on the 12-step program for recovering alcoholics with the only difference being that participants never pass through the denial step. As a result, the government predicts that the world as we know it will end on August 3rd.

French kissus. Jim, my co-blogger, brought this new charm to my attention. University of Texas professor and Wizard wannabe James Galbraith has suggested that unemployment could be significantly reduced if the government would encourage more people to retire early and take social security, perhaps by lowering the eligibility age or offering a buy out. Something similar has already been implemented in France so we know it has to be a good idea.

Posted by Bob

Whither Oil Prices?

Every time there is an oil price spike as there is today, two things happen. First, various government agencies launch investigations to see if there has been something nefarious going on.  Second, despite the clamor for more drilling in the US, it is said that doing so won’t affect oil prices today.  This is always used as the argument to allow the rabid environmentalists to continue to keep the most likely places to find oil off limits.  The first is a silly waste of time.  Not once has manipulation of the markets been discovered.  The second deserves closer scrutiny, though.

Let’s say that is autumn and the wheat crop is in for the year.  You have bought it all up with the intent of releasing it into the market in such a manner as to maximize your profits.  With interest rates being positive the most will be released in the first month and the least in the final month before the next harvest.  (I’m assuming that there isn’t any seasonal variation in the consumption of wheat.  If there was the amounts would be adjusted accordingly.  Ignoring it doesn’t change the qualitative results, though.)  But now something terrible happens.  The Argentine and Australian wheat harvests are expected to their best ever.  They will have sufficient quantities to sell into the US market.  This wheat will come onto the US market in six months.

Clearly, you won’t be able to sell the wheat you had planned to sell in months 7 – 12 for as much as you had planned.  What to do?  Being rational, you will want to increase the quantities you sell in the first six months, even though it will result in a lower price.  You will do this because it will enable you to maximize your profits (which will now be lower than they had been expected to be before the bumper crops elsewhere) under the new price-quantity combinations that are expected to prevail.  Note that while the Argentine and Australian crops haven’t arrived yet the implications of their impact on prices have been factored into the plans of the holder of the US wheat.  The rational response is to recognize that the inventory is now less valuable and the needs to be sold sooner even though it means receiving a lower price.

Wherever you see (U)S wheat replace it with OPEC oil.  Wherever you see Argentine and Australian wheat replace it with US oil.  The analysis is exactly the same.  If the government allowed our oil firms to explore in the currently off-limits areas where we know there is plenty of oil, the current price of oil would decrease.  It would do so as OPEC realized that its inventories of oil are now less valuable than they were before.  In order to maximize their profits they will supply more oil into the world markets today.  This is a critical insight.  The expectation of more oil (or wheat) will cause the current price to fall from what it would have been.

The lower price of oil will be an enormous increase in the discretionary incomes of Americans, far greater than any targeted tax reduction would be.  It would reduce our Balance of Payments deficit.  It would employ, at rather handsome wages, many people.  It would reduce the incomes of some of the most unstable and mischievous regimes on the planet.  It is difficult to see why our political leaders continue to allow a small but vocal minority negatively impact our lives.

Posted by Jim

Stick With The Needle

Dr. Andrew Wakefield is an entrepreneur. In 1987 he patented a measles vaccine that faced a major impediment to success; the existing combination mumps, measles and rubella (MMR) vaccine dominated the market. So in 1988 Wakefield, with research support from equally entrepreneurial personal injury lawyers, published an article in the prestigious medical journal The Lancet that suggested that the MMR vaccine might be responsible for autism in young children. The problem was that Wakefield made up the data; there were only twelve children in the study (several of whom were offspring of litigious parents searching for confirmation of their suspicions of the vaccine), and the invasive procedures performed on the children were never cleared by an ethics board. Following a sensational news conference announcing Wakefield’s results, many concerned and frightened parents refused to vaccinate their children, exposing them to serious disease. Other researchers were unable to replicate Wakefield’s finding and no other scientists could find evidence that the vaccines were in any way linked to autism. Nevertheless, U.K. vaccination rates plunged below the levels necessary to contain the diseases and measles, a disease once on its way to eradication, reappeared and some children died. Resistance to vaccination spread to the U.S. and other countries and soon they too were reporting outbreaks of measles.

In 2004, due largely to the work of journalist Brian Deer (http://briandeer.com/solved/bmj-enterocolitis.htm), the fraudulent nature of the work, and the enormous sums paid Wakefield to support the litigation were widely publicized. Thereupon 10 of the original 13 co-authors redacted their names from the Lancet article. Prime Minister Tony Blair also spoke out for the efficacy of vaccination. Incredibly, The Lancet’s editor, Dr. Richard Horton, while conceding some irregularities and concerns, refused to retract the article. Publicity about Deer’s 2004 findings led to a rebound in vaccination rates but many parents remained fearful. Deer continued his research, unearthing, among many disturbing things, that about $780 thousand dollars paid to Wakefield came from The Legal Services Commission a publicly funded agency intended to help poor people gain access to legal aid that was hijacked by anti-vaccine activists to underwrite phony research and testimony. After losing his position at the Royal Free Hospital in 2001 Wakefield absconded to the U.S. and Florida’s International Child Resource Development Center, purveyors of dubious autism testing and treatment products, and was soon appointed to a $280,000 position at the oddly named Thoughtful House in Austin, Texas. Dr. Horton and The Lancet continued to defend the original article but a competing publication, The British Medical Journal, published and endorsed Deer’s findings. Finally in 2010, 12 years after the fraud, a British medical panel found that Wakefield’s work was dishonest, unethical, and displayed a “profound callousness” to the suffering of children affected by his work. The only double-blind factor in the fraud, The Lancet, finally retracted the article in 2010.

This is a story about a meme, those gene-like messages that biologist Richard Dawkins defined to explain the propogation and persitence of ideas. Memes, like viruses, are typically very simple creatures that rely on hijacking their hosts’ resources to reproduce and proliferate. The “vaccines cause autism” meme is short, memorable, and easily transmitted. Once a population is infected it is very hard to extinguish a bad meme. Many memes are not antigens in the sense of automatically stimulating our intellectual immune system. Treatment and removal of bad memes usually requires sustained action, either preventive inoculation in the form of expertise or exposure to compelling new information. Unfortunately, while the meme linking the vaccine to autism spread rapidly and widely, the meme refuting the fraud has moved relatively slowly and encountered stiff resistance from the original meme’s dupes and dupesters. Some believers have even threatened the people who exposed the fraud and others have sued to discourage efforts to discredit the false story. Wakefield’s fraud is but an example, although a dangerous one, of the proliferation of false or corrupt memes; in many cases made through the Internet. We call some of them “urban myths” or “legends” and everyone occasionally receives a few in their email.

Why do so many succeed in entering and lodging in the popular mind? To paraphrase the Irish philosopher Edmund Burke, “All that is necessary for the triumph of ignorance is that good men learn nothing.” The promotion of gratuitous self-esteem, the postmodern notion that facts are mutable social constructs, and increasingly common exposure to diluted forms of higher education supports spread of ignorance. As biologist Peter Medawar has observed, many people are educated well beyond their capacity for critical thinking.

Take Jenny McCarthy, former Playboy model, college drop-out, actress in a slew of tacky shows and movies, including being typecast in The Stupids, and a curiously influential autism activist who has helped spread and defend the “vaccines cause autism” meme. Let us grant Ms. McCarthy that having an autistic child, as she does, is a serious blow but it is no excuse for imperiling the children of impressionable and equally ignorant parents by discouraging vaccinations. Ms. McCarthy has remained steadfast in her support of Dr. Wakefield and, like others in the anti-vaccine industry, has sought to launch a new meme that Brian Deer is part of a drug company conspiracy to protect their investment in dangerous vaccines and other drugs.

What have we learned from this sorry episode? The story of the MMR vaccine meme is instructive in a number of ways. Robert Goldberg, author of Tabloid Medicine, How the Internet is Being Used to Hijack Medical Science for Fear and Profit, applies the findings of behavioral economists, Daniel Kahneman and Amos Tversky, that we are not very good at evaluating risks, particularly long term risks. I think that is a very useful insight that explains our vulnerability to fraudsters but we need also to look more broadly to the systems and institutions we create that facilitate the fraudsters.

• A fair number of memes are intentionally generated by self-interested people, lawyers in this case and many others, but they often find channels among self-promoting celebrities, gullible journalists, and guilt-addled citizens. Activists are continually looking for new targets.
• Corroborating experts can always be found, Wakefield in this case, but highly credentialed people have profited in many dubious frauds upon the public. Courts have been extraordinarily lax in testing and policing credentials.
• Tax-supported programs intended to provide legal support to poor and uneducated people (such as The Legal Services Commission in the U.K. or poverty law programs in the U.S.) are vulnerable to hijacking by self-interested parties, often lawyers. Whatever their initial mission, they exist to challenge the establishment and to sue, and so they do. These groups face no market discipline and measure success in suits and claims filed.
• Corrupt memes, such as the Rosenbergs’ innocence, the U.S. government’s advance knowledge of Pearl Harbor, and the MMR vaccine hoax, often spawn vested interests that promote their distribution and resist their eradication – often for years. These people can be vicious in defense of their franchise to exploit their ignorant supporters. Tevi Troy, a former deputy secretary of HHS, reports in a recent Weekly Standard book review that Dr. Paul Offit, a legitimate vaccine expert, has been repeatedly harassed and sued, called a terrorist, prostitute, and devil. No one seems to have used similar tactics with Ms. McCarthy.
• Official and media bodies are often slow to respond and often ineffective in battling false memes. Independent efforts such as Brian Deer, are often more effective but face the threats mentioned above as well as the institutional agendas of seemingly reputable actors. The Lancet, under Dr. Horton, protected the seed meme for twelve years, in part for Horton’s left-wing political agenda which included prostituting the once-great journal with articles of extravagantly biased estimates of Iraq war casualties intended to erode support for the campaign.

The story of vaccines tells us a lot about the public system of health regulation and reminds us that incentives matter. Why we are surprised when initially well-intentioned institutions support the efforts of evil people is another issue.

Posted by Bob

Guile on the Nile

Probably no nation is so constantly reminded that its best days are behind it than is Egypt. Tourists from around the world marvel at the extraordinary monuments, some over 4600 years old, erected by the people who lived and prospered on the shores of the Nile. The ancient Egyptians were not only accomplished builders and engineers but they developed an expressive form of writing, papyrus to write on, a reasonable calendar, and pioneered effective techniques in medicine and surgery. What have Egyptians accomplished since? Between Cleopatra and Omar Sharif the Egyptians haven’t played a leading role in much of anything.

We have been told for years that the Arab “street” was seething with hatred for western, especially American, thought and culture. In the past few weeks we have discovered that the people who actually go out in the street seem to share a lot of our values and wish we supported them instead of their government. We learned much the same thing last year when the Persian street tried to overthrow a stolen election but, shamefully, we watched as the mullahs crushed them. The government that condoned voter intimidation by the New Black Panthers extended the same courtesy to the Revolutionary Guards. We did a little better this time, although in truth, the Egyptian demonstrators neither looked to us nor relied on us. They seem to have been inspired by the earlier Tunisian uprising that booted out the long serving Ben Ali.

Most revolutions, including our own, are caused by economic forces, often related to foodstuffs. The Tunisian revolution was sparked by a frustrated and humiliated young vegetable vendor, Mohamed Bouazizi, who operated an unlicensed cart in the town of Sidi Bouzid. After a policewoman confiscated his cart and produce, slapped him, and spit on him, he attempted to complain to the municipal authorities who denied him an audience. As anyone who has ever dealt with the Registry of Motor Vehicles can appreciate, a frustrated Bouazizi then set fire to himself and, subsequently, to the political power structure of his country. Bouazizi’s despair and choice of death is symbolic of the economic stasis that has frustrated the aspirations of Muslims, especially Arab Muslims, since the end of their golden age 700 years ago. A lot of reasons are given for the decline of the Muslim Arab world but one is surely excessive government regulation and limitations on people’s economic lives. Some reports indicated that Bouazizi had tried unsuccessfully for five years to get the permits required for his vegetable stand.

Most of the discussion following the revolts has understandably focused on the political outlooks for the two countries. But the success of both will depend on creating effective and growing economies. Unshackling the Egyptian economy will be extraordinarily difficult; some like the Wall Street Journal’s Daniel Henninger think it nearly impossible. Tunisia looks to have the better chance. Tunisia is more economically liberal than is Egypt. Tunisia, one of the more liberal economic environments in the Arab world, ranks 55th on the World Bank’s index of ease of doing business. Egypt, the largest Arab country, ranks 94th. In perceived corruption, the Egyptians rank 98th while the Tunisians are only 59th. With respect to property rights, a decent proxy for economic freedom, Tunisia is tied for 40th, Egypt trails far behind tied for 73rd. Perhaps the most comprehensive rankings, the World Economic Forum’s Global Competitive Rankings place Tunisia 32nd and Egypt 81st. Every one of the restrictions, regulations, and impediments to a competitive market economy has an entrenched beneficiary who will fight to preserve his favored position. The Egyptian army, seen by many as the guarantor of political liberalization, has extensive interests in the economy; some estimate its holdings at 20 to 30 percent of the nation’s productive assets. Good luck getting them to part with it. Half the population is under 24 and most are unemployed or under-employed.

What can the Egyptians do to get their people usefully employed? Apart from the Nile and a little bit of oil, Egypt doesn’t have many natural resources. They have a lot of tolerably literate people and not much else. One possibility, suggested by Egyptian Keynesians, is to build some more pyramids; there is a precedent and constructing each would employ tens of thousands of people for decades. But the country already has about 140 of the things and its not clear that anyone even knows how to build one anymore. The Mexican option, sneaking across the U.S. border, is not practical since few Egyptians speak Spanish, which has become a requirement for getting an entry-level job in many parts of the U.S. The Greeks, a once-great people who retired early, were able to lie their way into the subsidizing arms of the E.U. but it’s unlikely the Europeans would fall for that again; they won’t even admit Turkey, a Muslim country with a real economy. Most of the rich nearby Muslim countries are either furiously trying to develop indoor golf courses and ski runs or buying off their own restless populations.

There is one nearby country that has a vibrant economy, a flair for developing innovative products, but a relatively small and expensive labor force and so might be interested in investing in Egypt and outsourcing production. That country has even fewer natural resources than Egypt but has a per-capita income six times as great. Many of that country’s citizens can even trace their ancestry to Egypt. Of course, they parted ways on very bad terms about 3000 years ago.

Posted by Bob

That’s Why They Play the Games

Figures often beguile me, particularly when I have the arranging of them myself; in which case the remark attributed to Disraeli would often apply with justice and force: ‘There are three kinds of lies: lies, damned lies and statistics’.” Mark Twain(1)

Felix Hernandez, the workhorse ace of the hapless Seattle Mariners, was awarded the 2010 American League Cy Young Award despite having, at 13-12, by far the worst winning percentage among the candidate starting pitchers and the lowest number of wins by a starter in the history of the award. Hernandez won a lot easier on the ballot box than on the mound, collecting 21 of the 28 first place votes cast by baseball writers. The election set off a debate about the purpose of the award and the appropriate bases for selecting the winner. Many traditionalists, while acknowledging Felix’ enormous talent, are uncomfortable declaring that a barely .500 pitcher is the best in the league. Others, many of them in the sabermetric community, are trumpeting the selection as a triumph of scientific analysis.

For our purposes, I will accept the notion that the Cy Young Awards are intended to honor the best pitchers in each league and will concede also that the voters honorably and conscientiously seek to interpret the candidates’ records to determine who is best. I do think they have become overly mesmerized by the sabermetricians’ efforts to distill the pure essence of individual performances.

Historically, our definition of best pitcher emphasized the number of wins credited to the pitcher. For context, I have reproduced below the ESPN Cy Young Predictor developed by Bill James and Rob Neyer, based on a statistical analysis of past winners(2). As you can see, Hernandez tied or led all of the leading starting pitchers in every major category except won-lost record.

The N-J formula projected the Yankees’ CC Sabathia the winner followed closely by Tampa Bay’s David Price with Hernandez a distant sixth. I am not endorsing the N-J predictions, but I am using them because their research reflects the historical pattern of voting and is reasonably representative of the type of calculations, explicit or implicit, that most of us fans perform when determining our favorites for the award. My preferred candidates were David Price and John Lester. (I do not consider relievers valid Cy Young candidates so I never examined the three listed by N-J.) My impression based on listening to sports radio and TV was that Sabathia was the leading choice among commentators. So I was more than mildly surprised when Hernandez won by a landslide.

The N-J formula is the weighted sum of various statistics: Cy Young Points (CYP) = ((5*Innings Pitched/9)-Earned Runs) + (Strike Outs/12) + (Saves*2.5) + Shutouts + ((Wins*6)-(Losses*2)) + VB. (3)

Wins are the single most important factor in the N-J formula with a multiplier of 6 while innings pitched (divided by nine) is next with a multiplier of 5. Wins seem to have been the least important factor to the Cy Young voters. Using the N-J formula, had Hernandez been able to convert four of his losses to wins (17-8) he would have gained 32 points and passed Sabathia. Three conversions of losses to wins (16-9) and he would have passed Price and been only 3 points behind CC. Either a three or four game swing would put have put Hernandez in the same general range as that of Tim Lincecum who won the 2009 NL award with a 15-7 record and Zach Greinke, the winner of 2009 AL edition for a 16-8 season. But 13-12? To the extent that N-J captures accurately the historical consensus weighting of performance factors – what would justify such a large departure from traditional patterns? If Felix had been 12-13 with otherwise identical statistics, would the voters have still given Felix the reward? I can’t prove it, but I suspect that a losing record for a starting pitcher would be a non-starter. But, if we accept, as many do, the superiority of the granular statistics over the won-lost record, why not so award a losing pitcher?

The voters seem to have concluded that Hernandez should be judged only on, as an AP writer said, “things he could fully command.”(4) So voters discounted (ignored) his won-loss results and focused on the other measures with ERA, innings pitched and strikeouts weighted most heavily. The sabermetric community is reported to have emphasized Wins Over Replacement Player (WARP), a measure of calculated wins relative to those credited to a player of slightly below average major league quality, often a triple-A player of the sort likely to be called up to replace a player (pitcher in this case).

I love to compare and debate player statistics as much as anyone but I do want to point out something that is too often neglected – baseball statistics don’t really measure individual performance. The pitcher has total command over absolutely none of the factors measured by statistics though his influence is relatively greater in some areas than others. For example, the pitcher is relatively more responsible for his strikeout and walk numbers than for his won-lost record. In this sense, emphasis on granular statistics such as ERA can provide some insight into the relative performance of pitchers.

No one will be able ever to develop a perfect measure of a player’s contribution to his team’s success. Not because of the fact that teams win or lose together, as your old coach told you (although he was correct) and not because it is a difficult analytical challenge but because it is logically and mathematically impossible. This is because a baseball team is engaged in what economists call joint or cooperative production and it is impossible to determine precisely the marginal value of an individual team-member in a joint production setting.

Pitchers are the most obvious examples of joint production of outs and runs. Baseball is fairly unique in that outputs are produced jointly by the defense and offense. A hit or an out is produced jointly by the batter and the pitcher and, in most cases, his fielders(5). In fact, in the early days of the game the pitcher’s explicit function was to put the ball in play by throwing it “for the bat” and then later to throw either above or below the belt as directed by the batter. Today, some batter-pitcher combinations are more “efficient” at producing hits (to the chagrin of the pitcher) and thus the manager is interested in the historical rates of success his batters have had against that day’s opposing pitcher.

The team’s final output is a win or a loss. Wins or losses are the result of the intermediate products called runs and outs. These final and intermediate outputs are produced jointly by the team members whose efforts comprise the team production function. Any team production function involves at least two inputs and is not separable into the sum of two input functions. In other words the output of team members is not additive and this has serious implications for estimating functional relationships. This point, made by Armen A. Alchian and Harold Demsetz in 1972 is not a trivial or esoteric technicality but a fundamental basis of our modern understanding of the nature of firms and the role of managers.

Alchian and Demsetz observed further, “In team production, marginal products of cooperative team members are not so directly and separably (i.e. cheaply) observable. What a team offers to the market can be taken as the marginal product of the team but not of the team members (emphasis added). Clues to each input’s productivity can be secured by observing the behavior of individual inputs…” The impossibility of perfect measures of individual performance and contribution in a team setting is the primary reason that human managers are important; judgment based on experience and observation is a necessary ingredient.

Team or joint output whether it be runs or wins cannot be attributed precisely to the efforts of the individual team members. The fact that the batting order matters is evidence of the joint nature of producing runs. The manager seeks the batting order that maximizes the joint production of his hitters. Therefore responsibility for output or runs is shared. Branch Rickey recognized long ago that runs batted in (RBI) could be a very misleading measure of individual contribution because it depends greatly on the success of the preceding batters.

Statisticians and sabermetricians using regression analysis must assume the separability (additivity) of the baseball production functions. (Even non-linear regression is really a set of linear regressions covering portions of the observed data.) The typical multivariate regression formula seeks to explain the dependent variable, Y, as the weighted sum of the independent variables, xi, where the weights or coefficients, Bi, represent the proportional influence of each independent variable plus a residual.  If the underlying function is not additive then the use of a linear or additive regression technique introduces bias into the estimate. The severity of the bias depends on the underlying form of the production function. Another layer of distortion or bias comes about when sabermetricians use regression coefficients to build composite models such as Wins Above Replacement Player. The true WARP (if such a thing exists) is almost certainly non-linear and so constructing a linear representation of it using biased coefficients based on linear representations of other non-linear functions seems capable of introducing serious distortions into the analysis. I am not saying that the modern statistics are not useful; many are intriguing but all contain a measure of distortion and their use involves some bias and it cannot be said they are necessarily more objective than some of the old stand-bys.

My other, and in many ways more important, concerns about discounting wins and losses are that the pitcher often contributes to a team’s wins in ways that are not evident even with the most granular of statistics. Winning a ball game in the major leagues is very hard, winning around twenty games is extremely hard and to do so a pitcher must overcome a number of specific moments or threats where a single pitch can have significant consequences. Some pitchers seem to make those pitches when they most need to and so win more games than do pitchers with similar skills and statistics. Pitchers’ effort is somewhat elastic; a pitcher with a big lead will tend to bear down less than one in a tight game. This is rational; the return on full effort adjusted for the cost of potential injury or arm fatigue is not as high with a five run lead as with a one run lead and a man on second. This is true of games as well, a pitcher who can win late in the season with a postseason spot on the line or in the postseason with a title on the line has often to perform at a higher level to overcome the extra intensity of his opposition at those times. Those wins, in my opinion, reveal more about the pitcher than do wins earlier in the year. But if we discount all wins as “being beyond the control of the pitcher” we sacrifice that value and information. So, until we have a rigorous and unbiased model of the baseball production function and means of imputing personal performances into that model, I think we should continue to give a lot of consideration to the actual results of games played.

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Posted by Bob

Footnotes (for the appearance of scientific rigor):

1.There is some evidence that Twain misattributed the origin of the line to Disraeli, see http://www.twainquotes.com/Statistics.html where Courtney and perhaps Carlyle are suggested as possible antecedents.

2.The Neyer-James model seeks to predict the award winner based on historical evidence and patterns; it does not necessarily reflect either observer’s own judgment as to who should win.

3.Saves almost always accrue only to relief pitchers. The VB term is a bonus to reflect the historical tendency to recognize pitchers from league-leading teams but did not come into play this year.

4.Felix Hernandez wins AL Cy Young, November 18, 2010 http://sports.espn.go.com/mlb/news/story?id=5820623

5.The catcher is involved in the sense he is necessary for the pitcher to perform his part of the process so it would be reasonable to say a hit involves 3 players. An out, whether by strikeout, force-out, throw-out or caught fly, involves at least three players. Other forms of out, such as pick-offs, usually involve three or more players to produce.

To Extend or Not to Extend

As I write (Nov. 30, 2010) the Congress is about to start debating whether or not to extend all of the Bush era tax cuts or just a subset of them in order to deal with the deficit.  The Republicans want all of the current tax rates to be continued indefinitely, that is, until a real overhaul of the tax code could be tackled.  They appear to be willing to settle for a minimum of a two year extension.  The Democrats, led by President Obama, want the current rates continued except for those making over $250,000.  Senator Chuck Schumer, of NY, put forth the option to extend the rates for everyone making under $1,000,000.  The public, that is, us, prefer to extend them for everyone.

 

The reasoning underlying the Democrats views’ is suspect at best.  Obama says we can’t afford them, and it will only affect 2% of the taxpayers.  These 2% pay about 45% of all income taxes; the bottom 50% pay 3.5%.  Looked at another way the top 2% are paying 13 times as much as the bottom 50%.  As it stands the top 2% are certainly contributing heroically to funding the government.  Let’s look at the charge that we can’t afford not to raise the rates.  As is usual in government, when one is trying to make a point the cost/savings for multiple years are given because it balloons the figure.  We can’t “afford” maintaining the current rates for everyone else either, on their reasoning.   One factor, and it is a big one, that the Dems have overlooked is that those in the top bracket aren’t going to sit there to be shorn.  They will alter their behavior and reduce their taxable income.  In effect, the increased tax revenue will be less than estimated, by a long shot.  Further, in their efforts to reduce taxable income these individuals will spend resources to avoid taxes rather than devoting those resources to growing output.

 

We have the spectacle of columnist, Froma Harrop, shrilly saying  that;

“And what business is it of the chairmen — Erskine Bowles, a Democrat, and former Wyoming Sen. Alan Simpson, a Republican — to set an arbitrary (and low) maximum percentage on the tax revenue relative to gross domestic product that our society is allowed to collect? Their job is to find ways to bring down deficits. Period.”

She then goes on to say,

“For all the talk of the painful, painful(!) sacrifices needed to achieve the chairmen’s goal of reducing the federal deficit by $4 trillion through 2020, one thing should be kept in mind: Simply ending all the George W. Bush tax cuts would do the same thing. No one starved in the Clinton era. In fact, people did darn well then. That’s something for Democrats to think about now, before Republicans take over the House and start the fiscal voodoo dance all over again.”

You can’t make this stuff up.  I’m always amused by liberals/ progressives belief that 50.1% of us should be able to tell the other 49.9% what to do when it suits them.  The Bill of Rights were enacted precisely because the Founders recognized that the likes of Ms. Harrop were lurking out there.  Survey after survey shows that most Americans, 70% or more, believe that an individual’s total (State, Local, and Federal) tax burden shouldn’t exceed 25%.  These results hold for every subgroup out there .  Well, almost all.  I’m sure that the polls don’t have subgroups for: clergy (of any denomination); college English professors; carping liberal columnists; or unionized government employees.  These would demand expropriation of all income from those who made more than they did.  This is typically their definition of “the rich”.

 

Turning to Ms. Harrop’s comparison with the 1990s.  It is a totally inappropriate comparison.   Ms. Harrop confuses correlation with causation. To start with, the economy was still in the glow of the Reagan years.  The benefits of increased investment were still accruing.  Lawrence Meyers, who Clinton appointed to the Federal Reserve Board, had an economic consulting firm that analyzed the Clinton tax increases.  Their conclusion was that the economy grew slower and total taxes collected were lower than they otherwise would have been.  So, in fact, the Clinton higher tax rates weren’t a boon to the economy.  They didn’t appear to be a bad thing because of other decisions that were being made.  The two most important were the election of the Republican majorities in 1994 that slowed the growth of government spending and the slashing of the capital gains tax rate, against Clinton’s wishes, by the way.  These two events, against the backdrop of the Reagan growth agenda of the 1980s more than swamped the negative effects of the Clinton tax increases.

 

Sen. Schumer defends his proposal by falling back on the most naïve version of Keynesian economics.  He still believes in the concept of the marginal propensity to consume out of current income, fifty some years after Milton Friedman showed that people consume out of permanent income.  He seems to believe that if we just put more money into the pockets of people with high average propensities to consume the economy will grow.  Two problems with that: first, most obviously, we have been doing that for two years and have nothing to show for it; and second, what is being discussed by the Congress is not a tax cut but the prevention of a tax increase, which even Schumer realizes would be a disaster.

 

The Republicans push for maintaining the current taxes for everyone reflects the understanding that investment and job creation come from those making more than $250,000.  From a supply-side approach, the response to incentives is very disproportionately from the higher income small businessmen and other entrepreneurs.   Lowering marginal tax rates typically doesn’t cause a bank clerk, say, to increase their level of economic activity while it will to a business owner, or potential business owner.

 

Obama’s attitude was put on display during the campaign when he responded to Joe the Plumber, saying that he was for redistribution.  Raising rates for the so-called rich (m any two income families in NYC would fall into this definition of rich) appeals to his political orthodoxy which trumps his obligation create an environment in which the economy can grow.

 

When the dust settles where will we be?  I expect that the tax rates for all will be extended for at least two years and as a quid pro quo, unemployment benefits will also be extended for another 26 weeks. It is important to keep in mind that this will only prevent things from getting worse than they are.  In order for the economy to gain real traction, the plethora of mandates and regulations spewing out of the Executive branch must stop and many need to be repealed.  Simply put, regulations have the same effect as taxes but don’t get run through the government income statement.  The EPA, Health and Human Services, and the Dept. of the Interior are loose cannons that are circumscribing our daily lives to our detriment.  The Health Care bill needs to be rescinded and begun anew.  The financial reform legislation, another unread 2000+ page monstrosity, needs to be put in abeyance while cooler heads revisit every provision.   The energy drilling moratoria across the country need to be reassessed.

 

The vote on the tax rates will give a clear picture if the Congress got the message that the “Tea Party” sent on November 2.  If they didn’t the message , be prepared for another housecleaning in 2012.

 

posted by Jim