[FoRK] On why high IQ fails us - the Freakonomics of peak oil, and horse breeding, Manhattan style

Simon Wistow simon
Tue Aug 30 02:29:17 PDT 2005


http://jameshowardkunstler.typepad.com/clusterfuck_nation/2005/08/hurricane_guest.html

ON WHY HIGH IQ FAILS US, THE FREAKONOMICS OF PEAK OIL, AND HORSE 
BREEDING, MANHATTAN STYLE

by Dmitry Podborits

Part One

I find myself in a very strange situation. Everywhere I look I see very 
smart people expressing confident opinions about some future 
developments of various large and small-scale financial and economic 
phenomena. One might assume that these opinions should somehow filter 
into various decision making processes for for various kinds of 
analytical, strategic and tactical thinking. Therefore, one might hope 
that the opinions expressed by the smartest people with the most 
confidence are the most informed, balanced and rational.

However, often I observe the opposite trend: the smarter the people are, 
the less they are interested in the world around them and the more 
confident their opinions become. Under these conditions, high IQ becomes 
almost a handicap. It is almost as if a storm would be forecast and a 
person would be warned to seek shelter, and his response would be  
"Don't try to scare me  I am too smart to seek shelter. I am confident 
in my ability to always outsmart the storm".

You would think that his level of confidence would be correlated with 
the information the person has about the severity of the coming storm. 
But no, the person is not even interested in the storm. He cheerfully 
observes that he has little understanding of storms in general and has 
not even bothered to look into the information gathered by others about 
this particular approaching storm. He is not interested in these things. 
This, however, does not affect the confidence of his opinion or forecast 
which (the confidence) is based solely on understanding himself as a 
smart, high-IQ person. And this is something that is hard to argue with  
yes, he is smart, "high IQ" is written all over his forehead. 
Nevertheless, you almost wish he wasn't, since high IQ makes him more 
vulnerable, not less, and his forecast more flawed.

One can speculate on the origins of this paradox. There is a 
well-researched phenomenon in evolutionary biology called Zahavi's 
handicap principle, which establishes that certain types of animal 
morphology and behavior evolve precisely because they reduce the 
animal's fitness and penalize its chance for survival. A peacock's tail 
is an obvious example. One can observe that a peacock's tail is almost 
"deliberately designed" to introduce a higher cost for survival for the 
host animal and therefore to communicate to others (including predators 
and potential mates) that the peacock-carrier of the larger tail is the 
animal with superior genes.

I propose that a very smart person deliberately ignoring reality and 
expressing extremely shallow opinions with extreme confidence based on 
no thinking at all behaves much like a peacock advertising to predators 
his costly tail. The message that he broadcasts is basically this: "Look 
at me -- I am so obviously smart that I can deliberately make extremely 
dumb statements with a very high degree of confidence; it takes a really 
high-IQ person to totally ignore reality and still be this confident in 
his forecast".

Under these circumstances, the worst possible thing someone on the 
receiving end of an "opinion" can do is to assume that smarter people 
express more informed, more based-on-reality, and more rational 
opinions. I cannot warn people strongly enough: beware of smart people 
expressing confident opinions or forecasts.

A case in point  a recent series of commentaries on the topic of "Peak 
Oil" by two eminent economists (and self-described "rogue" economists) 
who wrote an award-winning and best-selling book, Freakonomics. The 
book, which I greatly enjoyed (in the audio version) discusses various 
phenomena traditionally viewed outside the realm of economics from the 
classical economics standpoint. The book is well-written, insightful, 
makes a number of interesting observations and very quickly appeared on 
multiple bestseller lists.

I'd like to note, however, that the self-definition of the Freakonomics' 
authors as "rogue" economists is largely misleading. The success of the 
book is based on the application of the known patterns of human behavior 
-- the chief of which is the generalization that "people respond to 
incentives" -- to the analysis of human dynamics nontraditional to the 
economics at large, such as illicit drug dealing and abortion. 
Obviously, if one can talk about "the economics of Hollywood" and "the 
economics of healthcare", one can also talk about the economics of 
crack-cocaine, because in all cases it is ultimately the human behavior 
that underlines all of these dynamics. In this sense, the authors are 
not really "rogue" economists, as they do not undermine any of the 
reigning economic principles; they embrace them and apply them to the 
areas of human behavior unfamiliar to the economics as practices by the 
"economic establishment" (if there is such an institution).

The problem starts, however, when the "freakonomists" begin to 
obnoxiously profess that since some dynamics can be understood within 
the context of human behavioral patterns, then all dynamics can be 
understood with human behavioral patterns.

One such dynamic of supreme importance centers around the Peak Oil 
phenomena that has finally entered into the mainstream of public debate, 
as evidenced by the Peter Maass' article in New York Times magazine. Jim 
Kunstler criticized Maass' article last week for being wishy-washy about 
the issue of Peak Oil; to his criticism I would add that Maass in the 
article dedicated in part to the research by Matt Simmons noncritically 
repeats the official Saudi number for total recoverable Saudi oil 
reserves as 260 billion barrels (the claim never substantiated in public 
statements by field-by-field breakdown by Saudi Aramco or the Saudi 
government), while analyses abound by Simmons, Campbell, McKillop and 
other authoritative industry observers claiming that the official number 
has no basis in reality.

Nevertheless, I believe that the Maass' article is a valuable and 
welcome development since it increases, not decreases the overall public 
understanding of the Peak Oil phenomenon.

Freakonomists, however, confidently claim that the Peak Oil will be a 
non-event. In the leading commentary on the topic in the authors' blog, 
titled "Peak Oil: welcome to the new media's version of shark attacks," 
and then in the follow-up commentary, they ridicule the PO phenomena as 
a media-fabricated frenzy and portray the people analyzing this topic as 
a new incarnation of obscure alchemist tinkerers -- charmingly 
ridiculous in their doomed determination, but harmless.

On what basis? After all, the freakonomists cheerfully state that "I 
don't know much about world oil reserves. I'm not even necessarily 
arguing with their facts about how much the output from existing oil 
fields is going to decline, or that world demand for oil is increasing. 
But these changes in supply and demand are slow and gradual -- a few 
percent each year."

Well, this is how they describe their worldview:

"What most of these doomsday scenarios have gotten wrong is the
fundamental idea of economics: people respond to incentives. If the
price of a good goes up, people demand less of it, the companies that
make it figure out how to make more of it, and everyone tries to
figure out how to produce substitutes for it. Add to that the march of
technological innovation (like the green revolution, birth control,
etc.). The end result: markets figure out how to deal with problems of
supply and demand.

Which is exactly the situation with oil right now. I don't know much
about world oil reserves. I'm not even necessarily arguing with their
facts about how much the output from existing oil fields is going to
decline, or that world demand for oil is increasing. But these changes
in supply and demand are slow and gradual -- a few percent each year.
Markets have a way with dealing with situations like this: prices rise
a little bit. That is not a catastrophe, it is a message that some
things that used to be worth doing at low oil prices are no longer
worth doing. Some people will switch from SUVs to hybrids, for
instance. Maybe we'll be willing to build some nuclear power plants,
or it will become worth it to put solar panels on more houses."

And finally, the last nail in the coffin of these pesky Peak Oil 
doomsayers:

"As [Maass] notes, high prices lead people to develop substitutes.
Which is exactly why we don't need to panic over peak oil in the first 
place."

The scariest thing for me here is not the flimsiness and the stupidity 
of the rebuttal, but the CONFIDENCE and the LACK OF INTEREST IN THE 
REALITIES OF THE WORLD that they are pronounced with. Even scarier,
however, is that these commentators are smart people with high IQ, 
regarded throughout the world as authorities in economics. When these 
two talk, many listen.

Of course people respond to incentives! Of course markets will attempt 
(as they have been attempting for a long time, without success) to find 
substitutes within the same basic economic structure.

However, is there a physical law stating that an adequate substitute, 
fitting into any existing infrastructure and cost structure, and 
satisfying the needs of any living arrangement, has to exist? I wish the 
freakonomists were there with me during my various travels -- from 
Mexico to Greece to Alaska -- where I saw communities of various scales 
abandoned and in ruins because the populace couldn't find at sufficient 
cost and quantities the resources they have come to depend upon, from 
water to arable soil to fish in the sea to mineable minerals. What if 
the vast literature dedicated to discussing the inadequacy of all 
currently known putative replacements for cheap oil has a point?

So, if we are not lucky enough to find a sufficient replacement for 
cheap oil, what will our response be? How will we, so to speak, respond 
to incentives?

Well, as Kunstler euphemistically puts it, "we will have to make other 
arrangements." This will basically mean that the society will change its 
very fabric and structure in response to the post-cheap oil 
circumstances.

The structure of the "new arrangements" arrangement may be, however, 
very unfamiliar from the point of view of "the world as we know it" -- a 
Maass' term that the freakonomists disagree with. I also think that a 
better term would be "the world as we practice it".

For example, one of the "responses to incentives" can be described as 
"making do with less", as in malnutrition or starvation.

Another response under the same circumstances can be described as "going 
to war".

Yet another response can be described as "mass migration away from the 
areas that have become uninhabitable, into the still habitable areas 
whose longtime residents would not be too happy to share their own 
resources with the newcomers".

And yet another response could be described as "reorganizing the economy 
around local food production".

Of course, there could be still other arrangements including elements of 
several or all of the previous four, plus some other yet unmentioned. 
However, they all would reflect "the new equilibrium" of the post-cheap 
oil world.

If someone can show me that a perfect market and even a lessaiz fair 
economy cannot respond to incentives along these lines, I would be very 
interested. I think that a big mistake that the freakonomists make even 
in their "pure economic," i.e. maximally abstract, nonspecific and 
detached-from-reality considerations when they dismiss any changes, is 
that they equate the notion of a market economy with the notion of a 
growing economy, and also with a consumer economy. These, however, are 
not the same things. A market economy, for example, can remain such even 
while becoming, under post-cheap oil circumstances, a contracting or 
imploding economy. How this scenario would correspond to the notion of 
the consumer economy I would leave as an exercise to the esteemed 
freakonomists.

Furthermore. I have carefully looked at the economic side of the 
argument and have not found any substantiation of the claim that "the 
changes in supply and demand would be slow and gradual  a few percent 
per year." I don't see how even against the backdrop of a perfect market 
economy, say, Ghawar's production cannot collapse fairly quickly due to 
geological maturity and overinjection of seawater, as Simmons suggests. 
I don't see how the same cannot happen with any other of the currently 
producing fields, or several fields at once at some point in the fairly 
near future. What cutting-edge economic thinking precludes, for example, 
the oil province of Saudi Arabia to start declining at the rate of, say, 
North Sea or Alaska's North Slope?

The authors claim:

"If oil prices rise, consumers of oil will be (a little) worse off.
But, we are talking about needing to cut demand by a few percent a
year. That doesn't mean putting windmills on cars, it means cutting
out a few low value trips. It doesn't mean abandoning North Dakota, it
means keeping the thermostat a degree or two cooler in the winter."

It appears to me that the authors somehow missed in their analysis that 
the decline of, say, 5% per year in consumption of fossil fuels (against 
the backdrop of, say, 1% of overall population growth due to demographic 
reasons and mass migration away from the areas hit the hardest) would 
translate into a roughly 50% of fossil fuel usage reduction after 10 
years. That's the core of the PO argument with which the authors "are 
not necessarily arguing with" -- that past peak, the oil production will 
continue to fall, as it will take ever-increasing heroic expenses to 
keep it flat, and any successes in keeping it flat will be necessarily 
temporary.

So, in a dozen of years in this scenario -- probably still within the 
economic life time of a brand new Hummer H2, which has by then recently 
descended from a factory conveyer somewhere in the state of Michigan on 
the day the oil has peaked (that day will be known only post factum, of 
course), purchased through an employee incentives discount and financed 
on credit, the owner will have to cut a nonessential 50% of his overall 
driving, keep the thermostata mere 25 or 30 degrees lower and face doing 
more of the same in subsequent years, all without abandoning North 
Dakota, or making any other lifestyle changes.

One could comment that the "freakonomists" seem to have gone pretty far 
in life for people exhibiting the kind of thinking (as well as the level 
of confidence in their own thinking) that they demonstrate. This 
observation helps matters very little, though. It is not the shallowness 
of their analysis, total lack of interest to the underlying realities, 
and a 15 second attention span -- it is how widely and noncritically 
such views are accepted that I find most disturbing here.

Part Two

On a more general ground, it is interesting to revisit the earlier made 
point that when supply/demand imbalances occur, the structure of the 
society changes in response. This goes very contrary to the central 
dogma of "freakonomics" (which is really traditional economics in 
disguise), that as supply/demand imbalances occur, mysterious market 
forces "make sure" that the adequate substitute is found, irrespective 
of the laws of physics, chemistry and geology.

Basically, this means that the structure of any observed society (that 
is not in a state of flux or discontinuity) reflects the balance between 
supply and demand of all critical commodities, existing in that society.

It also means that when new types of products, services and commodities 
become available through, say, geological discoveries or the efforts of 
inventors and innovators, or opening of the new trade routes, the demand 
for them does not occur immediately, but only builds up gradually and 
with much effort and large energy expenditures (witness, for example, 
the enormous expense companies go through in order to get their product 
accepted in the market), because such penetration of the new product 
into society essentially means restructuring the society around the 
newly available product.

This is illustrated by the history of penetration of absolutely 
indispensable items into the current North American living arrangement 
such as automobiles, computers, mobile phones and commercial airliners. 
Take away any one of them (much less several of them), and the structure 
of the society will change dramatically. However, when these items were 
introduced, they did not get incorporated into the then-existing living 
arrangement immediately and without effort. When they finally gained 
widely acceptence, they forced change, or restructuring, of then-existed 
living arrangement.

There is an observable diminishing returns effect here: further 
innovations do not create demand for new products if the new products do 
not "knock out" already established products occupying the same niche in 
the existing living arrangement. Thus, a person who was forced to buy a 
new computer (maybe even reluctantly) when the societal structure 
changed around him so much that the computerless life no longer 
adequately worked, may have less incentive to upgrade, even if the new 
computer, on its own, is overall better, cheaper and shinier.

In this light, maybe certain utterances commonly ridiculed as 
shortsighted may be viewed more charitably in the new context. Take, for 
example, the famous pronouncement of a top IBM executive circa 1950 that 
in the entire world there is market for maybe five computers. That 
statement reflected the realities of the living arrangement of the time, 
that's all. Yes, it is an absurd statement from today's standpoint 
because it would take tremendous changes in the societal structure to 
have computers as ubiquitous as we observe them today. However, it is 
extremely hard even for a very smart person immersed in the daily 
realities of his busy life to imagine, let alone anticipate, the changes 
in the societal structure that are lying ahead.

It may be just as difficult for some to imagine the extent and the 
direction of the societal changes that will result from the 
supply/demand imbalance (from today's arrangement's standpoint) in the 
energy supply. This is another notion that freakonomists ridicule 
without realizing how vulnerable and superficial their criticism looks.

For example, is it possible that in the post-Peak Oil world the price 
for oil would decline? Yes, of course it is possible -- without even 
finding the adequate substitute for oil. For example, disappearance of 
commercial airlines from the historic scene and inability of air travel 
for most people would make it possible (for a while).

Now, a society without air travel would be a differently structured 
society, wouldn't it? It would solidly fall within the "other 
arrangement" notion. There go a lot of things currently taken for 
granted, such as high mobility, tourism, globalization, and so on. But 
yes, it is possible -- within the context of a perfect market economy. I 
would even venture to assert that it is far more probable than finding 
an adequate substitute for oil. This kind of a change would fit well 
within the currently understood natural laws scheme.

Is it difficult to imagine a world where some of the ingredients for 
something like affordable air travel might not be adequately available, 
and it would have never, so to speak, taken off? Wouldn't our current 
necessities deemed indispensable today in the easy air travel world seem 
strange and foreign to people inhabiting that, alternative, living 
arrangement?

The "efficient markets" religion is so pervasive that people who make 
pronouncements in the spirit of the freakonomists do not even stop to 
look around them and think what they are really saying. Where does it 
come from that a perfect market society has to satisfy every human need?

Well, here is an example of a market society which is still relatively 
very wealthy: the United States circa 2005. And here is a basic need 
which even an economist would not dare to dispute: adequate health care 
for its population. In this society with about 40 million medically 
uninsured (some of which resort to pulling out their own decaying teeth 
with pliers, as Malcolm Gladwell reports in The New Yorker), and with 
the medical care and insurance industries virtually in the crosshairs of 
the economic "science", how can this market aberration be possible?

Clearly, this need in healthcare can be satisfied under some other 
living arrangement, as evidenced by countries where we do not observe 
such a large contingent without medical care. No laws of physics, 
chemistry and geology would need, most likely, to be changed for that; 
maybe only something in the public psychology and the currently existing 
system of priorities and values. What makes people think that under 
dramatic increases in the cost of energy, much reduced mobility, etc. 
other life support systems in the currently arranged society (such as, 
for example, food production and distribution, law enforcement, finance, 
government services, etc.) will perform better than the healthcare 
performs currently?

Finally, I'd like to observe the following seeming paradox from the 
"efficient markets will satisfy every need" standpoint.

I note that many of the residents of Manhattan, as a segment of the US 
population, are doing better financially than the average, and have more 
discretionary income. Some of these well-off Manhattanites happen to be 
economists, and some happen to like horses at the same time.

As it presently stands, horse breeding is generally incompatible with 
the life in Manhattan. Therefore, the stables in which the economists' 
keep their horses are typically located far from Manhattan, in places 
like Long Island, New Jersey and Upstate New York. This circumstance 
creates, I would assume, a major inconvenience for the economists who 
visit their hooved friends during the weekends (consider the stress of 
long distance driving, tunnel tolls, road rage, harassment by truck 
drivers and other unpleasant circumstances).

It would have therefore followed from the efficient market principle 
that the economists would be willing to pay extra, if someone figured 
out a way, or a substitute, that would allow them to keep horses right 
there, in Manhattan and avoid the inconveniences.

It is possible that someone already tinkered with, say, breeding smaller 
and smaller horses to fit a Manhattanite's lifestyle, but such 
substitutes didn't take off, probably because they wouldn't provide the 
potential clientele with the adequate horse experience. So, this way or 
another, the current economists' living arrangement for those of them 
who combine both horses and Manhattan in their lives has been 
restructured around certain inconveniences. The inconveniences, it 
appears, are here to stay.

I wonder, how this discrepancy might be explained by the freakonomics 
worldview.

_________________________________
Dmitry Podborits was born and grew up in Odessa, (then the USSR). He 
immigrated to the US in 1991.  He specializes in analytical software for 
interest rate derivatives  and works in a major investment bank in New 
York City.



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