Book: Naked Economics by Charles Wheelan Five stars out of five.
A few months ago, I wrote a post on how game theory has led to a variety of counterintuitive results. People apparently find that kind of thing extremely interesting—that post accounts for about a quarter of all traffic in this website’s six year history. At some point, I am going to write a book on the subject. I’m still probably a couple years away from actually doing that. But to prepare, I’ve made a list of pop-economics books to read through to get an understanding of what makes them tick and why they were so successful. Naked Economics is the first of my list.
Why Naked Economics? Purely by chance, I saw a thread on Reddit a couple months ago about the nefarious reason that stores often offer you a free meal if you do not receive a receipt with your purchase. Do you think the store owner is being generous and trying to make sure you receive the best possible service? Hell no. They are worried that the cashier is going to pocket the cash. The offer effectively employs the customer as an extra pair of watchful eyes. This deters the cashier from stealing. The owner has successfully retained his rightful share of the money, and it didn’t cost him a dime.
And that Reddit post? It was a picture of the page from Naked Economics explaining this. I immediately put the book in my queue.
Yes, my queue. I borrowed the book from the University of Rochester’s library. Someone already had it on loan, so I had to recall it. Soon after I checked it out, it was recalled again. It’s apparently that popular. I’m now stuck writing this review without actually having the book on me, but I digress.
Anyway, Naked Economics is a layman’s introduction to micro and macroeconomics. There is no math. That’s a good thing to promote a greater understanding from a wider audience. It’s a bad thing because it will lead people who don’t understand economics to falsely believe they do. To wit, one of the top reviewer comment on Amazon as I write this says that the reviewer uses it as his textbook for his economics class. That’s pure silliness. This is not notNOT a textbook. At all.
Rather, Naked Economics is an infomercial for why people should study economics. It contains insightful analysis of critical social, political, and economic phenomenon from recent times. Why is mackerel used as currency in some prisons? In the book. Why did our economy melt down in 2008? In the book. Why are insurance markets such a problem? In the book. Why is dirty money (that is, physically unclean money) not worth anything in India? In the book. Why is it hard for developing countries to retain intelligent workers? In the book.
So if you like understanding why the social world works the way it does, you can’t ask for a better start than Naked Economics. That’s why I’m giving it five stars. But please don’t read this book and think that you know economics as a result.
Suppose two generals each have two choices: attack or defend. The decisions are simultaneous and private. Military strategy favors the offensive, so both really want the other guy to defend while he attacks and really does not want to defend while the other guy attacks. On the other hand, war is extremely bloody. Both generals agree that mutual defense is better than mutual aggression. What should we expect the generals to do?
Intuitively, you might think that mutual defense is a reasonable outcome since peace is an agreeable outcome. However, this fails to appreciate individual incentives. If one general knows the other will play defensively, he should take advantage of his rival’s cooperation and attack. As a result, mutual aggression is the only sustainable outcome. But war is worse for both parties. This is the tragedy known as the prisoner’s dilemma: both parties end up in a mutually despised outcome but cannot commit to the better result due to their selfish individual incentives.
The prisoner’s dilemma has been around since the 1950s. For the next three decades or so, game theorists speculated that repeated interaction could solve the cooperation problem. Perhaps war favors the aggressor, but only a slight degree. If so, the generals could agree to maintain the peace as long as the other guy did. But the moment one slips up, the generals will fight all-out war. The threat of a painful breakdown in peace might incentivize the generals to never start conflict, even if a surprise attack might yield short-term benefits.
However, the cooperative solution remained elusive…until Robert Axelrod’s The Evolution of Cooperation. For a three sentence summary, Axelrod shows that these generals can adopt a “grim trigger” strategy and credibly promise infinite punishment in the future to enforce cooperation in the present. Thus, even bitter rivals can maintain friendly relations over the long term. In essence, we can rationally expect cooperative relationships in even the worst of environments.
Despite how I glossed over all of the intricacies of the repeated prisoner’s dilemma, The Evolution of Cooperation is a must-read for that result alone. But the book is so much more. I first picked it up during my junior year of college. I hadn’t taken a math class in five years, and the grade in that class was a C. Yet, despite the sophistication of the argument, I understood exactly what was going on. Axelrod’s exposition of formal theory in this book is quite simply the best you will ever see.
The fourth chapter is nothing short of awesome. Axelrod takes cooperation to the limit in his study of the “live and let live” trench warfare system during World War I. For a significant chunk of the war, troops spent most of their time deliberately shooting to miss their enemies in the opposing trench. While shooting and killing an enemy soldier provided a marginal gain should a battle take place, said act of shooting risked sparking a larger battle which would cause great causalities on both sides. Thus, for the sake of self-preservation, armies avoided fighting. This culminated in the famous Christmas Truce, in which the troops actually got out of their trenches and began fraternizing with the so-called enemies. (In that vain, you should watch Joyeux Noel if you have not already.)
If there is one issue with the book, it is the emphasis on tit-for-tat. Tit-for-tat is a less aggressive way of responding to your opponent’s aggression than grim trigger; rather than punishing forever, you merely punish at the next available opportunity. Axelrod correctly identifies a bunch of nice properties of tit-for-tat, especially how well it plays nice with others. However, as every modern game theorist knows, tit-for-tat is not subgame perfect and thus is extremely questionable on theoretical grounds. Of course, we would not have found out about that had this book not existed, so this just further solidifies how important The Evolution of Cooperation is.
In sum, go out and buy it. The book has applications to game theory, economics, political science, sociology, evolutionary biology, and psychology. If you are reading this blog, you likely have an interest in one or more of those fields, so you should pick it up.
Disclaimer: I either read this book because it just won the Lepgold Prize or because Goemans will be grading my comprehensive exam in a week.[1] I will let you decide which is true.
Personally, I study unitary actor explanations for war. The unitary actor assumption treats a state as though it were a single entity; there are no presidents, there are no parliaments, there are no people, and there are no revolutionaries. These are clearly strong assumptions, but they are useful and justifiable.[2]
War is quite puzzling from the unitary actor perspective. After all, war is costly to both sides because it destroys stuff. Why can’t we just implement the would-be results of war without actually fighting? In this manner, both states are better off since they get what they would get from fighting but without having to pay those costs. This is war’s inefficiency puzzle.[3]
Chiozza and Goemans start with this puzzle and then break out of the unitary actor framework by looking at leaders’ incentives, which has become a popular trend among recent scholarship. Presidents and dictators control their countries’ armies at least to some degree, but the “costs” they pay for fighting may not be the same as the costs that their citizens pay. We normally think of this as being beneficial to the leaders–citizens do the actual fighting (and dying) while the leaders sit back at home and wait for the favorable results. In contrast, Chiozza and Goemans care about what happens to the leaders after war ends, especially when things go badly. Do they retire? Do they go to prison? Into exile? Die? Presumably, the expected fate of the leader weighs heavily on his decision to fight, which in turn changes our expectation on when wars ought to break out.
Specifically, Chiozza and Goemans identify two new causal mechanisms for variation between war and peace: fighting for survival and peace through instability.[4] Let’s start with fighting for survival. Imagine I am the repressive Dictator of Virgon, and I am expecting to face domestic upheaval in the near future due to a food shortage. If the domestic uprising is successful, I expect to lose my head–I have been a brutal dictator for the last ten years. Thus, I have two choices: sit back and let the revolution happen or start a dispute with neighboring Aerilon. If I start the fight against Aerilon, I can send some of the military leaders most capable of plotting a coup against me to the front lines. If the war goes incredibly wrong and they die, I am little safer because I am short a few more coup plotters. If the war goes well, suddenly I am a military genius and everyone loves me. Or the war causes the citizens to finish their rebellion. In the first two situations, I am much better off because I am alive. In the third situation, I’m dead–but, hey, I was going to die anyway. So what the hell. I might as well fight.
This has the flavor of traditional diversionary war, so it is worth noting their emphasis on the role of truncated punishment in the theory. Imagine instead that I were the President of Canceron. We are a fledgling democracy. My power is somewhat stable but not as firm as the U.S. President’s is. I face plenty of domestic opposition, some from within the government and some from within the military. Suppose I am facing that same food shortage. Again, I can choose to attack Aerilon or not. If I don’t, it is quite likely that one of my political rivals will oust me. But we are a fledgling democracy with some rule of law, so I will go back and live a nice retirement on my ten-acre estate. But fighting is much riskier. Yes, I might be successful and save my presidency. But I could also spark further domestic upheaval from my own military. And if they launch a coup to overthrow me…well, I might just lose my head. So I decide to leave Aerilon be. This is Chiozza and Goemans’ peace through instability mechanism; I avoid wars because I prefer taking a lovely retirement with certainty to a gamble between remaining president and dying.
We can attribute the difference in outcomes due to the truncated punishment. The Dictator of Virgon has nothing to lose. His punishment (dying) can’t get any worse, so he willing to fight the war. The President of Canceron, on the other hand, is not. His possible outcomes is not truncated. Fighting can make things much worse–his outcome can switch from retirement to death. Hence he’s not fighting the war.
That, in a nutshell, is the argument. The authors spend chapters three and four empirically investigating the link between war and war outcomes to leader fate. The empirics are accessible to readers without much statistical background, so that is a huge plus. The fifth chapter then qualitatively looks at leader transition and war in Central America from 1840-1918. They find that their theory explains the outbreak of a good portion–though not all–wars during that period. Credit Chiozza and Goemans for being honest here. A single theory will never explain all wars, since wars happen for a variety of reasons. I too often read material that wants to explain everything, which is laughable. Chiozza and Goemans instead make an honest effort and do not unnecessarily oversell their theory.
Finally, I offer two practical reasons to read the book. First, it is just over 200 pages. The writing is succinct, clear of extraneous information[5], and you can easily read it in half a day.[6] It can also be had on Amazon Kindle for about $15, which is remarkably cheap for an academic book that only came out a year ago. Go check it out.
[1] You may then wonder whether I actually believe this book deserves five stars–after all, if I truly thought this book was terrible, I have incentive to misrepresent. However, rest assured that I think it is good. After all, if it were bad, I could have just written no review. But by writing a review, I face potential audience costs from readers who pick up this book because of me and then think it is terrible. Thus, the audience costs make my signal credible. Game theory at work, qed.
[2] See the following video:
[3] See the following video:
[4] Technically, they split fighting for survival into two categories, but I will gloss over it for the sake of time.
[5] Fine, there is extraneous information, but it is in the form of humorous anecdotes, so that makes it okay.
[6] Unfortunately for Goemans, my comprehensive exam will not be succinct. At all. And my dissertation? Well, let’s not go there…
Let me start by start by saying that this book is actually four stars or zero stars, depending on the audience. This is true for most books, though, so I err on the positive side.
Let’s start with the reasons you should not read this book. You might read the title and think “Gee, I have always wanted to learn about bargaining theory” and therefore decide to read the book. Bad move. This book is completely inaccessible. In the introduction, the author says that the reader only needs a decent understanding of subgame perfect equilibrium to get a lot out of it. This is a gross underestimate–you need at least a full year of game theory to get anything substantial out of the book and two years if you really want to understand it. Even then you will probably scratch your head from time to time. (In the conclusion, the author also says the book “has centered on some basic, elementary, models.” I found that quite humorous.)
The phrase “death by notation” comes to mind as you read this. The author says he intends the book for graduate level economists, and it shows. Variables are often defined once and then never interpreted a second time during a proof. You will often find yourself going back to try to figure out what all of the notation means. (This is a problem for just about all game theory texts, though, which is why I stick to mostly English in my textbook.)
The book also lacks adequate illustrations and figures. Game trees and strategic form matrices help readers understand the flow of the interaction. Figures here are rare and are often baffling. Without them, you will be left to look back at the notation, which has its own problems. (Like before, lack of sufficient illustration is a problem for just about all game theory texts.)
On a personal level, the author spent way too much time discussing the Nash bargaining solution. Personally, I find the Nash bargaining solution to be uninteresting except at the very basic level. Your mileage may vary. And, if you are like me, then you can just skip those sections like I did. So I can’t really fault it for this.
Despite all that, you should read this if you are interested in bargaining and have a good understanding of game theory. I don’t know of any books that are more thorough than it. I originally picked it up for some background on my risk aversion and sports contracts paper, and it was extremely useful. The author covers just about every type of bargaining game you will find in the literature with many variations of each model. So if you want to learn about bargaining, you should spend a few hours reading through it.
For practical purposes, chapter four (bargaining with risk of breakdown), chapter seven (bargaining over bargaining), and chapter nine (incomplete information) are the most useful. Four and seven probably have the most interesting application possibilities. I might reread the seventh chapter again at some point and think about how to relate it to international relations. We seem to have a lot of bargaining models in IR without much discussion of why bargaining protocols should take one particular form and not another. Perhaps this will lead to some publishable research.
I leave you with the following takeaway point: if you follow my work, you would probably enjoy reading this book, and it may qualify as required reading for you; if you found this page by randomly searching the internet for reviews of the book, you should think twice.
A few weeks ago, a fellow grad student told me about a book that uses game theory to discuss prison life. That book ended up being Games Prisoners Play: The Tragicomic Worlds of Polish Prison by Marek Kaminski. Kaminski ran an illegal Solidarity publishing house during the communist era in Poland. He got caught and spent a few months in jail. Many years later, he became a political science professor at UC Irvine and wrote the book based off the first-hand research he compiled while in jail.
Kaminski’s thesis is straightforward: although prison life looks silly to the outsider, prisoners’ seemingly illogical behavior is perfectly rational once you understand their strategic constraints. The discussion is thorough, beginning with the prison’s ruling class and its secret language before moving to topics like prison sex and strategic ailment. (That’s ailment, as in faking sickness or inducing real sickness, not alignment as I kept misreading.) He intersperses bizarre (but perfectly logical tales) of prison life. Be sure not to skip the postscript, which describes the interesting dilemma of the Polish Robin Hood, a legendary anti-communist thief who became paralyzed. The prison’s ruling class had a lively debate whether it was permissible to help the man use a bedpan. Normally, that would be a major no-no. But is an exception appropriate in the case of such a prison hero? (Yes.)
Throughout, Kaminski relays important points by drawing simple game theoretical models. These are probably more useful to the lay reader, as Kaminski’s the informal logic was sufficient for me. The one exception is his discussion of costly signaling, where game theory proves its value. Unfortunately (and fortunately), Kaminski leaves out any classic examples of the prisoner’s dilemma despite the obviousness of the joke.
Formal theory or no formal theory, bringing rational choice theory to the world of prisons proved worthwhile. It’s the best sociology book I have ever read, hands down. Five stars out of five.
William Spaniel 