Defining affordability - Pitfalls

Referring to my previous post '2025 - No no New Year's Resolutions' (https://www.dhirubhai.net/pulse/2025-new-years-resolutions-changed-perspectives-stephan-lutz-wkxsc/?trackingId=H%2BWlaCQ9SV%2BV0Jfa4d7X2A%3D%3D), I want to continue?sharing thoughts on affordability.

The issue

While the concept is easy, its application isn't. Ex-post analyses are easy though they change a lot over time. What seemed affordable just at the time of decision might turn with the distance of a couple of years or decades. An ex-ante determination of affordability people would usually or intuitively put into the camp of business administration and economists. I see an issue with an 'econometric' focus on affordability. Business Administrators (aka MBAs) and economists can tell you a lot about?it ex-post. But hardly ex-ante. This is only a prelude to more fundamental issues, and it's just as I have been trained (and majored) in both intellectually - Business Administration and Economics.

The challenge is determining affordability ex-ante to a non-reversible decision. Which are basically all decisions and actions we make as humans. Here's to the law of thermodynamics. You might reverse a decision, but relationships will have changed already. And should you have an instance where it works ... well ... then you know that it was neither a decision nor an action.

Static vs. dynamic decision making - Business administrators, economists (and quants alike), and the difference between Western Europe, the US and China

Formal economic education tells you to look at decision making (thus affordability analysis) from a rather static perspective. They don't tell you that it's static, but the approach tries to slow down the rate of change next to zero - which is also known as classic conservatism - slow down change so much that it doesn't represent a threat any more. So engineering oriented business administrators (aka MBAs) and economists - or in Germany 'BWLer' and 'VWLer' have a tendency to think that decisions should be taken only if the inherent uncertainty is minimised to the greatest?extent possible and then it needs to optimise one's outcome based on preferences to the maximum extent possible. I.e. you need to always gain more information than you have and perform a local?optimisation in an assumed steady state (conceptually). My fellows from Frankfurt School might remember the saying 'discount your expected future income (cash flow) to the present and optimise your consumption based on your preferences'.?

But that has an inherent flaw. Nothing is steady, your knowledge about the future is flawed by design, and you hardly can spell out a full set of consistent preferences for a given optimisation?task.

On the other side, you can look at decision making on a?trial-and-error-approach assuming that you have a portfolio of decisions. Some will be correct, others will be wrong (whatever this means). The earlier you decide, the better your chances are to realise gains from a - correct - decision. Compounding effect. And on the other hand, delaying a decision for too long in search of information usually has the same impact as making the wrong decision. Your competition already compounds benefits based on their early decision and thus takes you out of business.?

So decision making has a dynamic component that is determined by your timing and subsequent steps as well as your competitors actions and timing. Which is not taught and learned sufficiently if you engage in typical economic?education. And if you follow the 'static' classical approach in a rapidly changing environment, you will be out of the game faster than you think. No value of stability then.

By the way, that's why Europeans and Russians innovate (which is technical optimisation), US Americans commercialise (sorry, they have hardly invented something other than their way of life - not even nuclear fission, fusion, or computers and code has been invented there), and Chinese scale. Because it's in their mindsets based on their historic?social?memory. Europeans are engineers and intensive farmers as the continent was never rich in natural?resources and most of the time overpopulated. US Americans want to make money at all costs, and Chinese needed to manage a huge and diverse populace for aeons.

Determination of affordability - Practiced shortcuts

What does that have to do with the process of determining affordability? Actually a lot. Because societies or groups form shortcuts to determine affordability and reduce the perceived uncertainty.?Signals or symbols are determined and accepted to identify dynamics easily and provide predictability. Who is wearing what (e.g. suits or doctors' overalls) to predict competence, who is saying what how (e.g. central bank gibberish) to predict actions, who behaves in what way (e.g. politicians, managers, your crazy uncle, etc.) to derive acceptability of actions, relying on past performance and endorsements (e.g. journalism understood as fourth branch of a democratic state) to shortcut the identification what is socially or legally agreeable. In terms of debating, these all represent authoritative or analogous arguments. Psychologically, they are external versions of the type/system 1 and 2 of thinking (as per D. Kahnemann's book about thinking fast and slow). It enables one to skip the heavy burden and effort to understand and participate in the contest of logical arguments based on verifiable information.

Excursus - Types of arguments

Remember, there are four types of argument:?

1. Statement - can be but doesn't need to be true at all and even an outright lie is a statement | Has no real value as an argument or for convincing others
2. Authoritative argument - an authority (who you think needs to know and showed integrity) endorses something so you can skip checking yourself | Type/system 1 way of thinking according to Kahneman
3. Analogous argument - in a claimed similar situation something worked so it should work now again) | Type/system 1 way of thinking according to Kahneman
4. Logical argument based on verifiable information. | Type/system 2 way of thinking according to Kahneman

So where are we?

What I want to say: Most people are prone to type 1 (shortcut) thinking and thus use 2. and 3. (the intellectuals) to accelerate their decision making. Using 4. would slow them down and thus - in a stable environment - put them at a disadvantage vis-a-vis their competitors.

While it works on the surface, if your optimisation goes too far,?it finally hollows your affordability analyses?as it makes you dependent on those authorities and analogous situations.?Analogy often is a two-edged sword.? And what we see is that old authorities do not hold anymore. For doing exactly the same. They have stopped being authorities in the first place. They just have read the 'secondary literature' (something like the critique of the synopsis of a summary created by AI). Or in financial terms, some authorities have become the rating agencies that gave AAA ratings to a CDO Squared with underlyings that they didn't even look at. Which is fine as long as the bluff isn't called, and the kids don't say that the emperor is naked.?

The world is in turmoil because some old authorities and analogies don't work any more. Bluffs have been called. And too many went in 'all-in' based on blind followership of the principles of 2. and 3. They need to go back to the drawing board and think slowly themselves. No one likes it. Because it's cumbersome. And it reveals (first to ourselves) that we hardly really know anything or acted based on wrong assumptions. But we want to believe that we are great people. Way better than our neighbours or colleagues. So we look for new authorities who promise us that we can stay as we are, we just need to pay homage to them and follow some old ideas that have worked for ages. Many of us (will) do. Too fast. In the meantime, there is a fierce battle of symbols and signals which are all useless eventually. As the new ones haven't been tested and proven (they will change) and the old ones haven't been adopted/renewed yet to work again.?

And then - This Last side notes for today:

• Democracy isn't ending. It's an example of uncontested symbols. Many call for a direct democracy like in ancient Greece. Athens and Sparta had the most developed, egalitarian, and power restraining ideas of direct democracy. But you should test your assumptions. No one knows for sure, but around 300k people inhabited?the state of Athens at that time of which 100k were slaves and only 20-40k were male citizens (voters, captured by democracy). In Sparta it is assumed that around 8k Spartans (male citizens, voters, captured by the rule of law) ruled over 100k people. That means their rules applied to max?10% of the population. And those were the wealthiest, most aggressive, and mischievous ones.?
• Distinguish between rules and laws (I mean man made laws). Laws are universal and reciprocal otherwise they are rules and not laws (see Hobbs et al. on it). I.e. they apply unrelated to your status. Rules can be equally good for?ensuring order. But they work based on status. That's why there is a 'rules based order' for US Americans and not a peoples' law (V?lkerrecht) as in Germany. They speak about very different matters. Again, it's symbols and signals wrongly used.