Bankruptcy reform and the time-inconsistency problem - Division of Labor

Lawrence H. White writes

Now read Paul Krugman on the new bankruptcy reform bill. It never crosses Krugman’s mind that easy resort to bankruptcy impedes a borrower’s ability to credibly commit to repaying, and therefore makes it harder for the Joneses of the world to borrow in the first place. (We all gain, for the same reason, from a constitutional ban against governments relieving debtors of their debts.)

White reminds us that the concept that he is employing is time inconsistency: while you as a successful borrower may like to go bankrupt, but you as a potential borrower want to want to be able to commit to repaying the loan -- in order to get the loan.

Last year Kydland and Prescott won the Nobel Memorial Prize in Economic Science largely for their article on the problem of “time-inconsistency”. Centuries ago Homer had already illustrated the idea: Ulysses gained by having his crew bind him to the mast, so that he could hear the Sirens without giving into the temptation to steer the boat in their direction (and thereby crash on the rocks).

Before Kydland and Prescott were wet behind the ears (well, maybe not that long along) an earlier economist, R. H. Strotz, produced an absolutely gorgeous piece of work, his "Myopia and Inconsistency in Dynamic Utility Maximization," which appeared in Review of Economic Studies in 1956. Strotz opens with this quotation:

but you must bind me hard and fast, so that I cannot stir from the spot where you will stand me . . . and if I beg you to release me, you must tighten and add to my bonds." - The Odyssey.

The problem Strotz addresses is different from the one White is highlighting. Strotz is interested in the problem of making plans today, knowing that we will not be willing to carry out those plans is the future - even if the bargain is merely with ourselves. Thus individuals come up with solutions to this problem. Or the market responds to the demand for solutions. He gives this nice example:

It is customary for the United States Army to offer voluntary enlistees a furlough starting with the date of enlistment. This practice is not needed to enable a man to put his affairs in order - he can do that first and then enlist - but it does serve as an enticement to those who want the paternalism ("security") of the army, but do not want it right now.

Thus, I want to exercise, but the only way I can get myself to do it is to make a specific commitment with Larry: a weekly run on Mondays mornings at 6:45 starting from the Cleanco bus stop. I've not made that commitment this year.

But I have lost 9 pounds since January 29th. How did I do it? I gave up my car. I have not been to the grocery store since then. Instead of replacing the larder with enticing food, I am left with progressive less and less enticing food. (I eat the good stuff first of course.) I didn't lose any weight the first two weeks, but now the pounds are melting off.

I call it the Strozian diet. It works.