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Epistemological tidbits

December 7, 2015

Paul Krugman’s review of Robert Reich’s Saving Capitalism is worth reading just as example of how economists compare different explanations of current trends. Consider:

Conventional supply-and-demand analysis says that raising the minimum wage should reduce employment, but as Reich notes, we now have a number of what amount to controlled experiments, in which employment in counties whose states have hiked the minimum wage can be compared with employment in neighboring counties across the state line. And there is no hint in the data of the supposed negative employment effect. Why not? One leading hypothesis is that firms employing low-wage workers—such as fast-food chains—have significant monopsony power in the labor market; that is, they are the principal purchasers of low-wage labor in a particular job market. And a monopsonist facing a price floor doesn’t necessarily buy less.

Unlike the politicized rhetoric that insists the conventional analysis is handed down on stone tablets, the reasoning above is based on observed data and considers alternate explanations. Even if it is wrong, it is the kind of reasoning that can be wrong in a useful way. As opposed to those wed to one model, who aren’t even wrong.

John Cogburn’s bullshit tests for Continental philosophy is fun reading for those of us who dabble around that.

In a sense, cat bonds return insurance to the original underwriter model at the start of Lloyd’s. Perhaps there should be a fund that looks for financially or causally coupled possible catastrophes and buys groups of such bonds that are less likely to fail together than if their trigger events were independent. The epistemological issue lies in characterizing a catastrophic trigger event, for example, an earthquake near Istanbul:

For instance, the weighting of the different seismological monitoring stations in Bosphorus 1 Re Ltd. reflects, one must presume, the relative magnitude of TCIP’s financial exposure in each zone: higher weightings in the formula would appear to correlate with a higher-density of higher-value insurance obligations…

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