Steven Randy Waldman elaborates on some ideas that I set out in response to his initial post.
service providers in these industries are themselves uncertain of the value they are able to provide. Yet providers work hard to hide and downplay their uncertainty. Politicians pushing new programs offer authoritative projections of brilliant outcomes, although many initiatives fail once the lights of the bill-signing fade. Healthcare, finance, and education are built around credentials and prestige, despite questionable correlations between these tokens and value provided. Healthcare, finance, and educational institutions market themselves hard, portraying themselves as professional, competent, and above all, effective. These claims are not certain to be lies: High competence might sit within the wide confidence intervals that would surround a fair evaluation. But successful institutions do, and must, misrepresent those confidence intervals (to others, and sometimes to themselves).
There is more worth reading. In effect, Waldman is that these are professions that select for hubris and an activist mindset. If you are cautious and self-doubting, you have to act otherwise if you want people to believe you are a good school administrator, doctor, political leader, or finance professional. (See also Rescued from the Comments, which provides some hard evidence for what we are talking about.)
I would say that it is not the fault of the people in these professions that they select for hubris. The problem is ultimately that consumers prefer confidence. In some sense, what consumers are paying for is hope. That late-stage medical procedure represents hope. For overcoming disadvantages with which people are born, education represents hope. For getting rich without having to work hard or save obsessively, money managers offer hope. And do I even need to say that people look to politicians to supply hope?
Waldman concludes,
Forecasts that they will dominate, or prescriptions that we should specialize in these sectors to exploit alleged comparative advantage, should be greeted unenthusiastically
Phrases like “Hope springs eternal” or “the triumph of hope over experience” come to mind.
READER COMMENTS
Gaspard
Feb 20 2011 at 12:05pm
This all describes lawyers pretty accurately too, and before that, the clergy.
GU
Feb 20 2011 at 1:53pm
This not as true as you may believe. The large, prestigious law firms that serve corporate/financial clients are supervised by a team of lawyers, many of whom used to work at the firms that represent their current employer. The rise of these “corporate counsel” has resulted in the trimming of much useless fat from large law practice. And anyway, at least for corporate and tax practices, the results are pretty easy to observe. Admittedly this is more difficult for commercial litigation.
Sure, the average rube who is hiring a divorce lawyer that graduated from Western Idaho A&M Law School has no way to judge the value-added by hiring the lawyer (compared to pro se representation). But even not very skilled lawyers do a better job than most intelligent people at legal representation because of (1) experience, and (2) most people don’t have enough time to manage their legal problems on their own.
Finally, it should be noted that law school is designed to crush the egos of law students. Few leave unscathed in this respect. I don’t think that is the case with business school (and probably not med school either).
Philo
Feb 20 2011 at 2:03pm
Waldman acknowledges that “government, education, health care, and finance” are necessary industries, even though “the quality of [the] work [done in them] is difficult to evaluate, by practitioners or by outsiders, ex ante or ex post.” This amounts to acknowledging that, whatever the difficulties of evaluation in particular cases, these industries do more good than harm. Then why shake your head and cluck-cluck about these fields, and “greet unenthusiastically” the news that Americans enjoy comparative advantage in them?
Sure, it would be nice if evaluation were easy and clear-cut. But it’s not; why does Waldman find it so hard to accept that?
Various
Feb 20 2011 at 3:05pm
Well sure, consumers in these service areas pay up for “hope” and also for “risk aversion”. Just look at the commercials the major brokerage firms run during golf tournaments projecting their supposed expertise, risk aversion and integrity.
What these service lines all share is a large does of ignorance on the part of the general public, and, in many cases, ignorance among those who are supposedly well educated. The only way out of this is to have the general public become progressively more educated on the subjects of healthcare, education and finance. I think this will eventually happen, but will be in fits and starts over the next century. Our educational institutions are hopelessly outdated to help the general populace gain a reasonable understanding of these subjects. But, I think WE ARE making progress on this front. In particular, I think that the increased decentralization of the media and communication (e.g., the internet, blogs like yours, cell phones, texting, cable TV, etc.) serves as an informal educational forum for the populace. I bump into a larger percentage of people who I would consider financially sophisticated, and I attribute much of this to the increased decentralization and proliferation of information outside of the formal education systems. In particular, I would guess that the percentage of the population that is relatively financially sophisticated is roughly double what it was 25 years ago.
Steve Waldman
Feb 20 2011 at 6:42pm
Philo — One word: corruption.
These industries are necessary to a degree, but they are deeply vulnerable to corruption. Societies, I think, are best off trying as much as possible to keep the parts of these industries that are deeply inevaluable (which isn’t very everything — we’ve plenty of good information about setting broken bones) small relative to the rest of their economies, or they risk finding themselves where I think we already are: with a lot of notional money flows whose connection to meaningful value is tenuous, poor capital allocation decisions, a sclerotic real economy, and a politically destabilizing legitimacy gap.
An economy in which these industries account for 10% GDP is likely to be much better capable of making smart, market-based decisions than one in which these industries account for 50% of GDP.
And the “comparative advantage” argument is generally spurious, or at best inevaluable. Does the US have a comparative in advantage in providing value-generating “sophisticated” financial services, or is the US financial sector’s great skill in extracting and redistributing rents? Both might look like “comparative advantage” in terms of an ability to attract custom. Do you want to bet our economy on the question? I sure don’t.
Philo
Feb 20 2011 at 10:41pm
Undeniably, consumers are ignorant. But the medical, financial, etc., sectors of the economy will continue to grow only if consumers believe they are (probably) getting value for what they spend in these sectors. And in general who knows better than the consumer himself whether he is getting his money’s worth? (Government and, to some extent, education are special cases, because the services are not freely purchased by consumers.) Calling for medicine and finance to shrink is rejecting consumer sovereignty–unconvincingly, as it seems to me.
Shangwen
Feb 20 2011 at 10:49pm
Philo, I agree with the basic concepts in Arnold and Steve’s posts. The problem is not that evaluation is difficult and imprecise; there are few people who expect them to be. I work partly as a health economist in a health care system, and most of what I do is attempt to get a grip on the relationship between activities, effectiveness, outcomes, and costs, and encourage others to get a grip on it. It is totally unrealistic to expect that there will be some precise evaluation, but that doesn’t matter because the primary struggle is getting any reliable and consistent evaluation in the system. You would think that healthcare–which markets itself as hyper-scientific–would embrace such things, but reliable improvement measures such as Statistical Process Control and even a humble, 5-minute Bayesian probability analysis are rare indeed, and generally unpopular when proposed.
I do not think that people who work in healthcare and education are inherently venal individuals, but I do believe that the incentives in those systems encourage more venality than they would exercise in their personal lives. That is where I agree with Steve. I wouldn’t call it corruption, but the fact is that (a) anyone who turns down free money is a fool, (b) we all naturally believe that we know what we are doing and can get it right, whatever “it” is, and (c) no one wants to end a good thing. A+B+C is not a dangerous thing if you win the bingo pot or luck out on the trivia question in a bet. But it is very dangerous thing if that combination of thinking is subsidized, overvalued, overpriced, politically protected, and 16% of GDP.
@ Various, I envy but cannot share your optimism about consumer education. Improvements in information dispersal have been going on for a long time, but the larger literature on information aversion, and my own experience on the real level of interest in patient self-education tells me that this is mostly a waste of money.
Joe Cushing
Feb 21 2011 at 9:44am
Two years ago, I finished a masters degree in finance. All throughout the program, we used mathematical formulas to calculate the value of individual assets and whole companies. In most of the earlier classes, we were given data and had to chose which formula to plug the data into. I began to have a nagging question, where does this data come from to plug into these formulas? In later classes, we found out–we take a guess. We look at what happened in the past and guess what will happen in the future. Then we take those guessed values and calculate what the are worth today. At fist I began to despair. I spent 3 years learning how to make a guess. Finance felt like a sham. Then I realized that although the value of any income producing asset is based on a guess of what it will bring in the future, my training has taught me how to make the best guess possible. I think it’s better to know how to make a good guess . There are lots of reasonable assumptions you can make in a forecast. It’s important to know that guessing is what you are doing. Without good guesses, there is no way to know how much to pay for anything.
Greg
Feb 23 2011 at 10:15am
Who are you going to rely on to educate you about the financial industry? The financial industry itself?
This is part of the problem with the privatization of everything, especially education. When all of this is made a commodity to sell, there will always be unhealthy forces which end up being able to influence the outcomes to their advantage. Financial services end up buying the means which educates us about financial services.
The most disturbing example of this is the privatization of prisons systems. The judge in Pennsylvania that was sending kids to the juvenile detention centers on trumped up “charges” because he was benefitting financially from the owners of the detention center. How could we EVER think it was a good idea to make incarceration a product to be profited off of? How could anyone not see where this would lead?
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