Archive for March, 2010

The Role of Measurement in Reducing Transaction Costs and Creating Efficient Markets for Externalities

March 31, 2010

Coase (1960, 1990) suggests that well-defined property rights drive transaction costs down, and so could, in principle, overcome the market frictions introduced by externalities. Because transaction costs are usually not negligible, they make the initial allocation of property rights a crucial factor in market efficiency. It is generally accepted that property rights should then be assigned to those able to realize the greatest value from them, that the nature of the firm is contingent on its capacities to reduce transaction costs relative to their costs outside of the firm, and that a legitimate role for government is in facilitating efficient corrections of misallocated resources via laws and agencies that reduce transaction costs.

Most of the complex discussions involving these issues, broadly referred to as consequences of the Coase Theorem, take place in the context of extensive assumptions about the nature of capital and capitalism (McChesney, 2006; Cooter, 2000; also many others). Most problematic among these assumptions are those involving a short-term focus on financial bottom lines. No mention is made of sustainable long-term profitability’s dependence on trusting relationships with healthy, motivated workforces and communities living in clean and pleasant environments. The fact that everyone owns, has shares in, and wants to maximize the value of the local stock of social and natural capital goes unrecognized, as is the fact that everyone has the right to increase the value of, and/or contract out, shares of their human capital.

But examples of externality problems rarely put due emphasis on the maximization of social welfare. Even in McChesney’s (2006) third example, in which the cost of a government solution is added, rights are not defined to maximize the social welfare, even though the social value of the pollution abatement is included as a hypothetical factor in all the examples. Where the steel mill and the laundry both have owners and/or stockholders who are financially rewarded or penalized in the short term by the freedom to pollute or by the restriction on pollution, the value associated with the maximization of social welfare is vaguely defined. Its costs and benefits are realized in an aggregate way that shows up only indirectly in anyone’s accounting spreadsheets, as health care costs increase or decrease, as employee recruitment and retention becomes more difficult or easier, as community trust and loyalty spills over into appreciation or lawsuits.

To define rights in a way that would lead to the greatest potential for the maximization of social welfare from the start, we need only think of what it means for markets to function efficiently and apply those considerations to the ownership of human, social, and natural capital. Transaction costs are most fundamentally affected by information on the identification, volume, and quality of what is traded (Barzel, 1982, Benham & Benham, 2000). Common product definitions, universal uniform metrics, and reliable quality indicators make or break markets by the way they clarify or obscure property rights.

For example, it is one thing to own a vineyard in the Margaux terrain producing 20,000 cases (12 bottles of 0.75 liters each) of premier cru 1990 vintage wine, and quite another to own a hospital in New Orleans producing gains of 37.2 units expressed in ordinal health status survey scores of unknown reliability and cross-instrument convertability. Superior value is unmistakable in the widely recognized identity of the Margaux estate, the immediately understood measure of volume, and the well-known quality attached to the premier cru designation and the 1990 year. There is a literal transparency in the measure of quantity, in that each bottle of wine could be shown to contain the same 0.75 liters, no matter where in the world it is measured, no matter who measures it, and no matter which particular instrument of volume measurement is employed. The French and international oenology communities go to great lengths, via their standards associations and in collaborations facilitated by the international Treaty of the Meter, to ensure the global recognition of the value of Margaux wines.

The identity, amount, and quality of the hospital’s health status gain score is quite obscure, however. What exactly is being referred to as a change in health status? Is it a reduction in symptoms associated with a specific disease or condition? Or is it a change in physical or emotional functionality? What is the unit being counted? How much change in health status does a unit stand for? How does this amount of change compare with the changes produced by other health care providers? Is it more or less, and what immediate and long term value is obtained per dollar spent?

Fortunately, over 20 years of research shows that health status surveys, and many other kinds of tests, surveys, and assessments, often can be calibrated to measure in constant linear units (Bezruczko, 2005; Bond & Fox, 2007; Fisher & Wright, 1994), and appear to have the potential to support universally uniform reference standard metrics (Fisher, 1997a, 1997b, 1998, 2000; Fisher, Eubanks, & Marier, 1997; Fisher, Harvey, & Kilgore, 1995; Fisher, Harvey, Taylor, Kilgore, & Kelly, 1995). The opportunities before us in health care, in education, in human and environmental resource management, and in other areas are directly analogous to the historical births of many markets, such as the transformation of the London coal trade effected in the 1830s (Velkar, 2008) the origins of the electrical industry in the 1870s (Hunt, 1994; Schaffer, 1992), or the establishment of standard time in 1883 and the subsequent distribution and sale of uniform time units by astronomic observatories (Bartky, 2000), and the use of the clock in the regulation of the work day.

Capital is made fungible when its monetary expressions can be summed across properties owned, when it can be divided into shares for sale to investors, and when its value can be transparently and efficiently represented via some form of currency or instrument recognized and accepted at any point across a network of linked agencies, such as trading centers, banks, courts, laboratories, etc. (Ashworth, 2004; Barzel, 1982; De Soto, 2000; Latour, 1987, p. 223; Fisher, 2002). The unification of measurements and standardization of quantitative expressions facilitate common product definitions, lower transaction costs, and market transparency by enabling more precise determinations of property rights—who owns what, how much of it, and of what quality.

Probabilistic models for calibrating and equating ability tests, attitude surveys, and performance assessments (Rasch, 1960; Wright, 1977, 1999; Andrich, 1988) offer a scientific basis for rigorous, practical, and convenient methods of unifying the measurement of human, social, and natural capital (Fisher, 2002, 2005, 2007, 2009, 2010). One way in which governments could, then, perform their optimal role would be to introduce laws and institutions focused on reducing living capital transaction costs, as would occur via the expansion of the Treaty of the Meter to include uniform standards for the measurement of the various forms of human, social, and natural capital.

The origins of the metric system (SI) were explicitly framed in terms of a mutual conformity between universal rights for all people and universal standards of measurement (Alder, 2002, p. 3). The question we face today is, what might a metric system for human, social, and natural capital imply for the co-production of new scientific, economic and social orders? In particular, how might business practices be made more just, sustainable, and profitable through the better management of intangible assets? How and when will we as individuals be able to represent our hireability, promotability, retainability, and productivity in terms recognized and accepted as far and wide as the terms for expressing time, distance, weight, and temperature are? Can universal human rights to equal opportunities be realized in the absence of fair and comparable metrics for representing abilities, health, performance, and credibility? Will we get ahead of this issue and proactively develop the systems we need, or will we need to be driven to action by yet another new crisis?  We hold the keys to our liberation.

References

Alder, K. (2002). The measure of all things: The seven-year odyssey and hidden error that transformed the world. New York: The Free Press.

Andrich, D. (1988). Rasch models for measurement. (Vols. series no. 07-068). Sage University Paper Series on Quantitative Applications in the Social Sciences). Beverly Hills, California: Sage Publications.

Ashworth, W. J. (2004, 19 November). Metrology and the state: Science, revenue, and commerce. Science, 306(5700), 1314-7.

Bartky, I. R. (2000). Selling the true time: Nineteenth-century timekeeping in America. Stanford: Stanford University Press.

Barzel, Y. (1982). Measurement costs and the organization of markets. Journal of Law and Economics, 25, 27-48.

Benham, A., & Benham, L. (2000). Measuring the costs of exchange. In C. Ménard (Ed.), Institutions, contracts and organizations: Perspectives from new institutional economics (pp. 367-375). Cheltenham, UK: Edward Elgar.

Bezruczko, N. (Ed.). (2005). Rasch measurement in health sciences. Maple Grove, MN: JAM Press.

Bond, T., & Fox, C. (2007). Applying the Rasch model: Fundamental measurement in the human sciences, 2d edition. Mahwah, New Jersey: Lawrence Erlbaum Associates.

Coase, R. (1960, October). The problem of social cost. Journal of Law and Economics, 3, 1-44.

Coase, R. (1990). The firm, the market, and the law. Chicago, Illinois: University of Chicago Press.

Cooter, R. D. (2000). Law from order: Economic development and the jurisprudence of social norms. In M. Olson & S. Kahkonen (Eds.), A not-so-dismal science: A broader view of economies and societies (pp. 228-244). New York: Oxford University Press.

De Soto, H. (2000). The mystery of capital: Why capitalism triumphs in the West and fails everywhere else. New York: Basic Books.

Dohrn-van Rossum, G. (1996). History of the hour: Clocks and modern temporal orders. Chicago, Illinois: University of Chicago Press.

Fisher, W. P., Jr. (1997a). Physical disability construct convergence across instruments: Towards a universal metric. Journal of Outcome Measurement, 1(2), 87-113.

Fisher, W. P., Jr. (1997b, June). What scale-free measurement means to health outcomes research. Physical Medicine & Rehabilitation State of the Art Reviews, 11(2), 357-373.

Fisher, W. P., Jr. (1998). A research program for accountable and patient-centered health status measures. Journal of Outcome Measurement, 2(3), 222-239.

Fisher, W. P., Jr. (1999). Foundations for health status metrology: The stability of MOS SF-36 PF-10 calibrations across samples. Journal of the Louisiana State Medical Society, 151(11), 566-578.

Fisher, W. P., Jr. (2000). Objectivity in psychosocial measurement: What, why, how. Journal of Outcome Measurement, 4(2), 527-563 [http://www.livingcapitalmetrics.com/images/WP_Fisher_Jr_2000.pdf].

Fisher, W. P., Jr. (2002, Spring). “The Mystery of Capital” and the human sciences. Rasch Measurement Transactions, 15(4), 854 [http://www.rasch.org/rmt/rmt154j.htm].

Fisher, W. P., Jr. (2005). Daredevil barnstorming to the tipping point: New aspirations for the human sciences. Journal of Applied Measurement, 6(3), 173-9 [http://www.livingcapitalmetrics.com/images/FisherJAM05.pdf].

Fisher, W. P., Jr. (2007, Summer). Living capital metrics. Rasch Measurement Transactions, 21(1), 1092-3 [http://www.rasch.org/rmt/rmt211.pdf].

Fisher, W. P., Jr. (2009, November). Invariance and traceability for measures of human, social, and natural capital: Theory and application. Measurement (Elsevier), 42(9), 1278-1287.

Fisher, W. P., Jr. (2010). Bringing human, social, and natural capital to life: Practical consequences and opportunities. Journal of Applied Measurement, 11, in press [http://www.livingcapitalmetrics.com/images/BringingHSN_FisherARMII.pdf].

Fisher, W. P., Jr., Eubanks, R. L., & Marier, R. L. (1997). Equating the MOS SF36 and the LSU HSI physical functioning scales. Journal of Outcome Measurement, 1(4), 329-362.

Fisher, W. P., Jr., Harvey, R. F., & Kilgore, K. M. (1995). New developments in functional assessment: Probabilistic models for gold standards. NeuroRehabilitation, 5(1), 3-25.

Fisher, W. P., Jr., Harvey, R. F., Taylor, P., Kilgore, K. M., & Kelly, C. K. (1995, February). Rehabits: A common language of functional assessment. Archives of Physical Medicine and Rehabilitation, 76(2), 113-122.

Fisher, W. P., Jr., & Wright, B. D. (1994). Introduction to probabilistic conjoint measurement theory and applications (W. P. Fisher, Jr., & B. D. Wright eds.) [Special issue]. International Journal of Educational Research, 21(6), 559-568.

Hunt, B. J. (1994). The ohm is where the art is: British telegraph engineers and the development of electrical standards. Osiris: A Research Journal Devoted to the History of Science and Its Cultural Influences, 9, 48-63.

McChesney, F. S. (2006, Winter). Coase, Demsetz, and the unending externality debate. Cato Journal, 26(1), 179-200.

Rasch, G. (1960). Probabilistic models for some intelligence and attainment tests (Reprint, with Foreword and Afterword by B. D. Wright, Chicago: University of Chicago Press, 1980). Copenhagen, Denmark: Danmarks Paedogogiske Institut.

Schaffer, S. (1992). Late Victorian metrology and its instrumentation: A manufactory of Ohms. In R. Bud & S. E. Cozzens (Eds.), Invisible connections: Instruments, institutions, and science (pp. 23-56). Bellingham, WA: SPIE Optical Engineering Press.

Velkar, A. (2008, 4 April). Caveat Emptor: Abolishing public measurements, standardizing quantities, and enhancing market transparency in the London coal trade c1830. Enterprise and Society, http://es.oxfordjournals.org/cgi/content/abstract/khn003v1.

Wright, B. D. (1977). Solving measurement problems with the Rasch model. Journal of Educational Measurement, 14(2), 97-116 [http://www.rasch.org/memo42.htm].

Wright, B. D. (1999). Fundamental measurement for psychology. In S. E. Embretson & S. L. Hershberger (Eds.), The new rules of measurement: What every educator and psychologist should know (pp. 65-104 [http://www.rasch.org/memo64.htm]). Hillsdale, New Jersey: Lawrence Erlbaum Associates.

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Considering comments on the prior blog post…

March 22, 2010

I received some interesting comments on the prior blog post here, which is on the way we might manage our individually-owned forms of intangible assets in the future.

One comment that caught me off-guard had to do with what it would mean for a health capital account balance, for instance, to be overdrawn, as though the negative number would have profound existential effects! Of course, the introduction of negative numbers in the 19th century, and of zero before them, provoked similar kinds of fears and ridicule as to the complete meaninglessness of counting up increasing amounts less than nothing!

But any kind of bank account might be overdrawn, just as so many of our natural and social capital accounts are today, even though the entries in these accounts are not recorded in the same currencies, when they are in fact recorded at all.

The other comment that caught me unawares contended that the multiplication of all the different forms of capital requiring accounting was a pointless increase in paperwork. The commenter specifically likened it to an Orwellian doublespeak that claims a reduction in costs and increase in efficiency while in fact increasing costs and decreasing efficiency.

And so today’s existing systems for measuring and managing the inputs, outputs, and outcomes of education and health care, for instance, are somehow as good as it gets? Individual producers and consumers of the services provided in health care and education have all the information they need to make informed decisions about quality and value? Our diverse welters of uncontrolled and incommensurable metrics for measuring and managing literacy, numeracy, and health status are sufficient to the tasks of bringing the economics of education and health care under control? Nothing of substantial value could be obtained if all reading tests measured in a common, scientifically-established unit scaled from the earliest facility with reading to the most complex treatises of law, psychology, and philosophy? It would not behoove us to take explicit ownership of exactly how much human, social, and natural capital we as individuals possess as we try to exchange it and increase it on the market for monetary gain?

Maybe so, maybe so. Perhaps what we’ve got is as good as it gets. I don’t think so, though. It seems to me that two of the ultimate logical consequences of models facilitating the objective measurement of individual abilities, attitudes, and behaviors are metric systems for each of the various forms of intangible assets, and systems relating each individual’s measured values with monetary values in a comprehensive management, accounting and econometric framework.

It has long been held by economists that the model of land, labor, and manufactured capitals that are destroyed and transformed into profit and waste needs to be replaced. Fungible representations of natural, social, human, and manufactured capital fit the bill for comprehensive models that recycle all assets back into the system, and that redefine profit as the removal of waste. This is the role objective measurement is destined to fulfill, at every level from the individual to national accounts of well being.

For a description of how improved measurement fits into the context of the new four-capitals economic models, see https://livingcapitalmetrics.wordpress.com/2010/01/13/reinventing-capitalism/. These issues are also taken up in my 2008 Measurement article, and in a forthcoming Journal of Applied Measurement article.

Quite apart from any consideration of my living capital accounts report, I would love to hear where you think it all leads. I mean, what do you think will happen when everyone everywhere has immediate and universal access to a validated uniform measure of their literacy, numeracy, health status, etc.? When the patterns of income, expenditure, career growth, etc. associated with those metrics become available, entrepreneurs will be breaking down the doors to capitalize on them.

Yes, there are thousands of technical details to work out, and a host of moral implications. Yes, privacy and confidentiality will certainly be major issues. The issues will play out in ever new ways the old problems of forced socialization vs rampant alienating individualism, in the evolving context of ever more powerful technical means. How will the costs and benefits be balanced? How can we reap the benefits of feeling part of a larger whole in which we can see ourselves in everyone else without feeling smothered by a too-close conformity with an externally-imposed order?

My own opinion is that we use the balance scale as a symbol of justice for a reason. We define our moral status by our capacity for fair dealing. Measurement models that integrate individual patterns of variation with population-level structures are a medium for extending democratic principles to new levels of life, liberty, and the pursuit of happiness. For more on this theme, see my blog entry at https://livingcapitalmetrics.wordpress.com/2010/01/14/temple-pillars/.

Assignment from Wired’s Predict What’s Next page: “Imagine the Future of Medical Bills”

March 20, 2010

William P. Fisher, Jr.

william@livingcapitalmetrics.com
New Orleans, Louisiana
20 March 2010

Consider the following, formulated in response to Wired magazine’s 18.04 request for ideas on the future of medical bills, for possible use on the Predict What’s Next page. For background on the concepts presented here, see previous posts in this blog, such as https://livingcapitalmetrics.wordpress.com/2010/01/13/reinventing-capitalism/.

Visualize an online image of a Maiuetic Renaissance Bank’s Monthly Living Capital Stock, Investment, and Income Report. The report is shown projected as a vertical plane in the space above an old antique desk. Credits and debits to and from Mary Smith’s health capital account are listed, along with similar information on all of her capital accounts. Lying on the desk is a personalized MRB Living Capital Credit/Debit card, evidently somehow projecting the report from the eyes of Mary’s holographic image on it.

The report shows headings and entries for Mary Smith’s various capital accounts:

  • liquid (cash, checking and savings),
  • property (home, car, boat, rental, investments, etc.),
  • social capital (trust, honesty, commitment, loyalty, community building, etc.) credits/debits:
    • personal,
    • community’s,
    • employer’s,
    • regional,
    • national;
  • human capital:
    • literacy credits (shown in Lexiles; http://www.lexile.com),
    • numeracy credits (shown in Quantiles; http://www.quantiles.com),
    • occupational credits (hireability, promotability, retainability, productivity),
    • health credits/debits (genetic, cognitive reasoning, physical function, emotional function, chronic disease management status, etc.); and
  • natural capital:
    • carbon credits/debits,
    • local and global air, water, ecological diversity, and environmental quality share values.

Example social capital credits/debits shown in the report might include volunteering to build houses in N’Awlins Ninth Ward, tutoring fifth-graders in math, jury duty, voting, writing letters to congress, or charitable donations (credits), on the one hand, or library fines, a parking ticket, unmaintained property, etc. (debits), on the other.

Natural capital credits might be increased or decreased depending on new efficiencies obtained in electrical grid or in power generation, a newly installed solar panel, or by a recent major industrial accident, environmental disaster, hurricane, etc.

Mary’s share of the current value of the overall Genuine National Product, or Happiness Index, is broken out by each major form of capital (liquid, property, social, human, natural).

The monetary values of credits are shown at the going market rates, alongside the changes from last month, last year, and three years ago.

One entry could be a deferred income and property tax amount, given a social capital investment level above a recommended minimum. Another entry would show new profit potentials expressed in proportions of investments wasted due to inefficiencies, with suggestions for how these can be reduced, and with time to investment recovery and amount of new social capital generated also indicated.

The health capital portion of the report is broken out in a magnified overlay. Mary’s physical and emotional function measures are shown by an arrow pointing at a level on a vertical ruler. Other arrows point at the average levels for people her age (globally, nationally, regionally, and locally), for women and women of different ages, living in different countries/cities, etc.

Mary’s diabetes-specific chronic disease management metric is shown at a high level, indicating her success in using diet and exercise to control her condition. Her life expectancy and lifetime earning potentials are shown, alongside comparable values for others.

Recent clinical visits for preventative diabetes and dental care would be shown as debits against one account and as an investment in her health capital account. The debits might be paid out of a sale of shares of stock from her quite high social or natural capital accounts, or from credits transferred from those to her checking account.

Cost of declining function in the next ten years, given typical aging patterns, shown as lower rates of new capital investment in her stock and lower ROIs.

Cost of maintaining or improving function, in terms of required investments of time and resources in exercise, equipment, etc. balanced against constant rate of new investments and ROI.

Also shown:

A footnote could read: Given your recent completion of post-baccalaureate courses in political economy and advanced living capital finance, your increased stocks of literacy, numeracy, and occupational capital qualify you for a promotion or new positions currently compensated at annual rates 17.7% higher than your current one. Watch for tweets and beams from new investors interested in your rising stock!

A warning box: We all pay when dead capital lies unleveragable in currencies expressed in ordinal or otherwise nonstandard metrics! Visit http://www.CapitalResuscitationServices.com today to convert your unaccredited capital currencies into recognized value. (Not responsible for fraudulent misrepresentations of value should your credits prove incommensurable or counterfeit. Always check your vendor’s social capital valuations before investing in any stock offering. Go to http://www.Rasch.org for accredited capital metrics equating information, courses, texts, and consultants.)

Ad: Click here to put your occupational capital stock on the market now! Employers are bidding $$$, ¥¥¥ and €€€ on others at your valuation level!

Ad: You are only 110 Lexiles away from a literacy capital stock level on which others receive 23% higher investment returns! Enroll at BobsOnlineLiteracyCapitalBoosters.com now for your increased income tomorrow! (Past performance is not a guarantee of future results. Your returns may vary. Click here to see Bob’s current social capital valuations.)

Bottom line: Think global, act local! It is up to you to represent your shares in the global marketplace. Only you can demand the improvements you seek by shifting and/or intensifying your investments. Do so whenever you are dissatisfied with your own, your global and local business partners’, your community’s, your employer’s, your region’s, or your nation’s stock valuations.

For background on the concepts involved in this scenario, see:

Fisher, W. P., Jr. (2002, Spring). “The Mystery of Capital” and the human sciences. Rasch Measurement Transactions, 15(4), 854 [http://www.rasch.org/rmt/rmt154j.htm].

Fisher, W. P., Jr. (2005). Daredevil barnstorming to the tipping point: New aspirations for the human sciences. Journal of Applied Measurement, 6(3), 173-9 [http://www.livingcapitalmetrics.com/images/FisherJAM05.pdf].

Fisher, W. P., Jr. (2007, Summer). Living capital metrics. Rasch Measurement Transactions, 21(1), 1092-3 [http://www.rasch.org/rmt/rmt211.pdf].

Fisher, W. P., Jr. (2009, November). Invariance and traceability for measures of human, social, and natural capital: Theory and application. Measurement (Elsevier), 42(9), 1278-1287.

Fisher, W. P.. Jr. (2009). NIST Critical national need idea White Paper: metrological infrastructure for human, social, and natural capital (Tech. Rep. No. http://www.livingcapitalmetrics.com/images/FisherNISTWhitePaper2.pdf). New Orleans: http://www.LivingCapitalMetrics.com.

Fisher, W. P., Jr. (2010). Bringing human, social, and natural capital to life: Practical consequences and opportunities. Journal of Applied Measurement, 11, in press [http://www.livingcapitalmetrics.com/images/BringingHSN_FisherARMII.pdf].

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