Saturday, March 21, 2020

Scaling Standards

By Michael Abramowicz - March 21, 2020 at 03:13PM

In two recent posts, I blogged about the proposal from my article, Random Selection for Scaling Standards, With Applications to Climate Change, but in the blog posts, I used COVID-19 ventilator production as an example instead of the climate change examples from the article. This highlights that the proposal is quite general, a technique for distributing money to claimants when there may exist many factors that ought to interact to determine how much each should receive. Usually, in these circumstances, we depend on rules, even if the best rules that we can craft are crude approximations that ignore many relevant considerations.

I promised to return with answers to commonly asked questions. I'll start, though, with a brief recap, but using a different application, also related to the current pandemic, to illustrate the core idea behind the proposal. Suppose that the government wishes to distribute $500 billion to the American people. The simplest way would be to send fixed payments to all Americans; if we later decide that some received too much, we could always increase taxes on some groups later. But let's suppose that we genuinely wanted to distribute payments in proportion to need. There are many factors arguably relevant to assessing need: how much someone's income declined (if at all), how much of this decline was attributable to COVID-19, how much of a nest egg someone had, whether the person was capable of obtaining some other job, whether the person faces eviction, where this person lives, and so on. Meanwhile, people might disagree about which factors are most relevant or even about which way they cut. If Congress and the President cannot come to an incompletely theorized agreement about these issues, we are likely to end up either with a crude solution (like fixed payments) or no solution at all.

Ex post decisionmaking might seem impossible in this context. We certainly do not want a bureaucracy to process claims from every American through individualized hearings, however informal. That is too much work and would lead to too much inconsistency. We could, however, imagine that a governmental panel (perhaps meeting a few years into the future) could make ex post retrospective assessments of the needs of a small number of claimants, randomly selected. With only a small number of cases to consider, the panel could take into account a wide range of factors. Of course, we can't wait for this to occur before people receive their checks, and we also might worry that the panel will make some idiosyncratic decisions. Still, we might think that objective consensus predictions today of what such a panel would decide on average will be about right. The question then becomes how can we make sure that people are paid quickly based on expectations of what this panel would decide.

One approach (not my proposal, but still in its spirit) might be for the government to select some number companies (say, 100), each assigned a randomly allocated small percentage of the American people. Each would then be able to distribute funds according to whatever criteria it sees fit. In a few years, the government panel would use its ex post assessments to rate each of these companies on its performance, distributing some much smaller amount of money (say, 1%, or $5 billion). Companies that performed well according to the panel would receive more money; companies that performed badly would receive little (or might even need to pay money to add to the $5 billion being distributed to the other companies). These companies would thus have incentives to ask of claimants questions that it thinks will be relevant to the government ex post and to determine the weight to which to assign to different answers. I believe that such a proposal would lead to funds being distributed in a more tailored and thoughtful way than a solution like fixed amounts for each citizen. That might well be worth the reward money distributed to these companies. Still, there are some challenges, such as determining how many companies to authorize, how to regulate those companies to ensure that they do not accept bribes or have conflicts, and so on.

My proposal is simpler. The government simply commits to distributing the entire $500 (or $505) billion to the holders of claims from a small number of randomly selected Americans, say 100, in proportion to the ex post valuation of their needs. That is, each citizen would be able to sell his or her right to a claim to an intermediary. The intermediaries would have incentives to pay more for claims that they expect would on average receive more money on average ex post. Intermediaries would likely build diversified portfolios of claims. Competition among intermediaries would cause them to bid up the prices they would offer to claimants. The article explains that we might have some regulations to enhance competitiveness and reduce the possibility of discrimination. But the strength of the proposal is that it allows the government to distribute money with a minimal decisionmaking and regulatory burden while still ensuring that a wide range of factors are considered. It is especially useful in an emergency where it just is not possible for the government to scale up a bureaucracy in a short amount of time.

With this application spelled out, I will return to some questions asked or hinted at in responses to my previous blog post.

Don't the usual objections to government spending apply? Sure. There is a deadweight loss of taxation. My proposal simply assumes that the government should be spending money for the relevant purpose, whether on new ventilators or to help people get by in a crisis. It addresses how the government can distribute money to many claimants, some with stronger claims on the money than others, when it is difficult to craft ex ante rules. In a hypothetical world without externalities and perfectly efficient markets, we would not need this system. Similarly, I am not making a claim that I have found the best thing to spend money on (although ventilators seem to me to be quite cost-effective now).

Isn't this just a lottery, where completely undeserving people might receive the funds? This is a lottery for the intermediaries, not for the ultimate claimants, who receive money from the intermediaries in exchange for their claims before the lottery takes place. The money that the government distributes is distributed to intermediaries in proportion to their measured need, so claimants with claims that are expected to be more valuable will receive more from intermediaries. One might worry about completely frivolous claims–for example, that many who haven't even built ventilators might file claims on the ventilator fund–but the ex post panel would be likely to rate their contributions at close to zero. So intermediaries won't pay much for those claims. Moreover, if one worries that a high percentage of the ex post claims might be frivolous, one can address that by requiring an intermediary to add a certain amount of money into the fund for each claim to be eligible for the lottery.

Should claims be selected proportional to dollar expenditure? No, that shouldn't be necessary so long as we use the mechanism above for eliminating frivolous claims. It would be possible to have such a mechanism, but if claim A has twice the chance of claim B of being selected, then, if both in fact are selected, the social welfare evaluation of claim A should be divided by two before allocating the fund proportionately.

Isn't there too much risk for intermediaries? This is a major issue considered in depth in the paper, so I won't discuss it much here. The risk that intermediaries face can be divided into two sorts: risk associated with the random selection and risk associated with uncertainty about government decisionmaking. The first type of risk can be costlessly insured away (I explain how the government can offer insurance on random selection at actuarially fair rates), and the second type of risk is not so different from many types of risk absorbed through capital markets.

What if the ex post decisionmaking is corrupt? One might worry that someone on the panel would give a high valuation for a claim owned by an intermediary that either bribes the ex post decisionmaker or, say, that employs a friend of the ex post decisionmaker. These are legitimate dangers, but this can be addressed with anti-corruption and recusal rules. In general, judicial decisionmaking is less susceptible to special interests and corruption than other forms of decisionmaking. Meanwhile, even if some corruption did occur ex post, it would affect the ultimate claimants only if intermediaries could predict ex ante which claims would corruptly receive high valuations.

Won't people try to scam the system? Sure, but that explains why the system is so simple. (The system may seem unusual, but it is much simpler than any existing administrative programs.) The best scam idea that any commenter had was to submit huge numbers of claims in the hope that each would be worth a few pennies, but the approach described above of charging a fee per application addresses that. It's hard to scam a system where you need to convince someone to buy your claim from you. Of course, claimants may try to commit fraud to deceive intermediaries (an issue discussed in depth in the paper), but the intermediaries at least have incentives to try to identify such fraud and won't spend much money on claims that they are skeptical of.

Don't we need to have experience with the system before using it? Certainly, it would make sense to implement a system like this on a small scale before expanding it. Starting with $500 billion at stake might be a mistake. But one virtue of the system is that it's easy to scale up without greatly increasing the need for government employees, as the number of claims to be randomly selected can stay fixed.

How do we know a market will form? If the government has credibly committed to giving away $500 billion, private interests can be expected to spend close to that amount trying to get that money, particularly if the cost of entry into the market is low. This is basic rent seeking theory, but here the rent seeking is largely socially valuable. Of course, private firms might wonder how much investment other firms have made. One can require that intermediaries make periodic disclosures about how much they have spent on claims, so that intermediaries can gauge the total size of the market easily.

What if the ex post decisionmakers don't have a proven track record? All that matters is that they get the right result in expectation. If there is a chance that a claim might be adjudicated a thousand dollars too high or a thousand dollars too low, those possibilities cancel out, and the claimants will receive the right amount from the intermediaries.

What if the ex post decisionmakers are especially political? Ideally, the ex post decisionmakers won't be chosen until years after the intermediaries have bought up all claims. That way, at the time the intermediaries buy up claims, they won't know what political party and which officials will be in control. It's possible that ex post decisionmakers may behave differently based on political party, but, once again, that roughly cancels out in expectation. And because the ex post decisionmakers will only be affecting how intermediaries are compensated, rather than on what priorities the money will be spent, the decisionmaking might be lower salience and less political.

What is the difference between this and grants? Grants are given ex ante, so if the grant makers have some systematic biases, that will affect grants. Moreover, a grant mechanism can't scale to millions of potential claims without creating a huge bureaucracy.

Does this provide sufficient accountability? If one believes that accountability is the most important thing, one might prefer to just allow the President to distribute the money as he likes. My view is that it's better to reduce the role of political considerations in this process. Ex post, retrospective analyses are less likely to be politicized.

Does the fund need to be fixed? Not necessarily. We could make the fund dependent on some ex post measure of social benefit—for example, lives or QALYs saved by additional ventilator production. The fixed fund, however, minimizes the risk that the government, having induced production, will effectively refuse to pay up by rating contributions artificially low. If there is a sufficiently good process for measuring social welfare benefits ex post, a fixed fund is not necessary.

Many of the above questions are addressed in some form in the article, as are many other questions that might have been raised. Thanks to all commenters for their contributions.

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