Stumbling and Mumbling

Rachel Riley & suboptimal choice

In the day job, I advise people to do a crossword before taking important financial decisions, because experiments suggest that a task which increases mental alertness can help people make more far-sighted choices.

I was going to recommend that people watch Countdown instead - but then I (quickly) realized that looking at Rachel Riley can stimulate more than the mind. And such stimuli can worsen financial decision-making. Testosterone leads to increased risk-taking, which can lead to financial crashes. More generally, experimental evidence (pdf) shows that higher levels of excitement can lead to price bubbles and hence crashes.

It is no coincidence that in the spring a young man's fancy lightly turns to thoughts of love and that "sell in May" is a great investment strategy. Better weather - which usually comes in the spring - tends to get us happier and more excited, and this raises share prices to levels which are often unsustainable. When shares rose, my first boss used to say "the market's got the horn." He was more right than he knew.

This is not the only example of how we can be influenced to make poor decisions. Here are two others:

 - Researchers have found that creating an upmarket atmosphere in a restaurant - by playing classical music rather than Britney Spears - causes people to spend more. This corroborates Robert Frank's fear, that conspicuous consumption, in also creating a sense of affluence, can cause other people to spend more than they otherwise would.

 - Women can be primed to act girly. For example, when they go to a mixed-sex school they are more likely to make low-paying "feminine" career choices and to shy away from competition than if they attend single-sex establishments.

There's a common theme here. Our choices can be influenced by contexts and stimuli in ways of which we are not fully aware. As a result, our preferences might not best serve our interests. And if this is true for investment, spending and career choices, might it not also be true in other realms, such as politics?

Entrenching inequality

Does inequality feed on itself? Some recent experiments by Jeffrey Butler suggests the answer is: yes.

He got subjects to play an urn-guessing game. They were presented with two urns, one with with mostly red balls and another with mostly white, and were asked to guess which of two urns the experimenter was using, based upon seeing one ball drawn. Subjects were split randomly into two groups, one being better paid than the other.

Both the low-paid and high-paid groups got roughly the same amount of guesses right.However, when they were asked: are you a better or worse than average guesser? things changed. Whereas 85% of the high-paid group said they were better than average, only 60% of the low-paid group did. Butler says:

Inequality undermines the confidence of the disadvantaged and boosts the confidence of the advantaged.

This confidence is not just idle talk. In other experiments, Butler found that more confident subjects were more likely to choose to enter winner-take-all tournaments, thus increasing their chances of big payoffs later.

This implies that initially arbitrary inequality can become persistent, because it reduces the desire of the worst-off to compete.(This is, of course, only one of several routes in which this can happen).

It's easy to see that this might have real-world applications.It's consistent with Afro-Caribbean boys doing poorly at school; with working class kids being loath to apply to Oxbridge; and with women not applying for top jobs. It's also consistent with some of the unemployed not wanting to work: why apply for jobs if you'll only be knocked back?

This implies that a popular explanation for inequality might be no explanation at all. It's sometimes claimed that the successful are successful because they worked hard and the unemployed are unemployed because they are lazy. But this research suggests the causality might be reversed. Maybe successful people work hard because prior good luck has led them to think that work pays, whilst others are lazy because bad luck has reduced their confidence. In other words, it could be that the preferences which rightists believe to be the cause of inequality are in fact the effect of it.

We know from research in personal finance that preferences for risk are partly endogenous; people who have experienced recession (pdf) or the death of a child are more risk averse than others. Wouldn't it be remarkable if risk appetite was the only endogenous preference? If ambition and appetite for work are also endogenous, then a moralistic defence of inequality becomes less tenable.

Scrounging: how big an issue?

George Osborne wants benefit claimants to "do the right thing" and move into work. This, though, might not make very much difference to the economy.

The first question is: how many claimants don't want to work? As a rough pass, let's assume it is the number of unemployed who report very high subjective well-being; 9 or 10 on the ONS's 0-10 scale. 16.3% of the unemployed do so, which equates to 411,000 people.

Now, this could be an over-estimate, as it includes people who naturally have a sunny disposition, and folk who are happy because they expect to get work soon. But let's run with this.

Let's assume that all these could find full-time work at the national minimum wage. Let's assume too that employers are just waiting to hire so many (humour me). These folk would then earn £11885 a year; £6.19 for 40 hours a week and 48 weeks a year. £11885 multiplied by 411,000 gives us £4885m. Of course, employers would make a profit by employing these people. Let's assume that the ratio of profits to wages for these folk is the same as it is in the whole economy, at 37% (table D of this pdf); I'm ignoring diminishing returns here. This gives us £1807m of profits.

Add the two together and we have £6.69bn. This is 0.43% of annual GDP.

Of course, this is worth having. But it's not a massive sum. It's less than one quarter's of ordinary GDP growth.

Let's put this is context. If non-oil GDP had grown by just 1.5% a year since 2007Q4, the economy would be 9.6% bigger than it actually is. Scroungers and layabouts, then, cost the economy about one-twentieth as much as the recession has.

Of course, this is just the back of a beermat estimate and not a hard fact. You could get it higher if you assume there are more "scroungers" or if you assume that they could get higher wage work. Personally, I find these improbable - though I'll concede that Mick Philpott's intelligence and honesty would have equipped him well for a successful banking career.

You could increase my estimate in some other ways. You could claim that there would be powerful multiplier effects from "scroungers" moving into work. But it would be odd for defenders of fiscal austerity to suddenly discover big multipliers.

Or you could argue that low-wage workers are complements to higher-wage ones, so that the latter's earnings would rise as the former increase in numbers. But it would also be odd for supporters of immigration controls to suddenly adopt one of the economic arguments for open borders.

However, you cut it, then, the cost to the economy of layabouts - in terms of GDP foregone - is small.

There's a message here for left and right.

For the right, it's just plain wrong to think that "scrounging" is a serious macroeconomic issue. You might think it a moral failing. But don't confuse macroeconomics and morals.

For the left, you don't need to pretend that all benefit claimants are saintly victims in order to deny that scrounging is a serious economic issue. Even if we concede that there are tens of thousands of such scroungers, we can still maintain that getting them into work is not a top priority. A much bigger priority should be creating jobs for those who do want to work. 

Money hopes

Today's economic news has been mostly bad, with the Bank reporting (pdf) falls in mortgage approvals and non-financial companies' borrowing, and purchasing managers saying that manufacturing output fell last month. But there's one sign of hope. It's that non-financial companies' UK sterling bank deposits have risen quite sharply. They're up by 7.8% year-on-year, the biggest annual rise since December 2007.

My chart shows why this matters. There's a good correlation between companies' M4 growth (inflation-adjusted) and GDP growth. The best lag is two quarters, with money growth leading output growth.Eyeball econometrics - an under-rated discipline - suggests there's little sign of this relationship having broken down recently.

This relationship suggests that, at worst, the risk of serious recession is fading and, at best, that we're heading for recovery.

The obvious reason for such a link is simply that companies build up cash with the intention of spending it on capital or labour. If they were simply pessimistic about their prospects, they would not hold cash but rather hand it back to their owners.

There are, though, two caveats here. One is that the relationship between corporate M4 and GDP is stronger on the downside than upside; money predicts recessions better than booms. The other is that companies might be hoarding cash for precautionary reasons. The fear that credit lines might be withdrawn in future is causing them to have big bank balances as protection against this.

Two things, however, make me suspect these are no more than caveats:

1. Today's BCC survey shows a small rise in investment intentions, corroborating the message of M4.

2. There's recently been a decline in companies' financial surplus and a rise in PE ratios. Both are consistent with a pick-up in growth expectations and hence in the motive to invest.

The good news, then, is that the economy might be about to recover. The great news is that this might - only might - mean that the economy's long-term problem of a dearth of monetizable investment opportunities could be receding. The bad news is that, if the recovery does come, the Tories will claim this as vindication of its austerity policies.

Don't blame PPE

Many tweeters have been laying into Oxford PPEists. Faisal Islam says they are "to blame for most UK problems", and the Renegade Economist says "PPE at Oxford University has had a disastrous effect."

Being a PPEist myself, I'm flattered to think I have such influence, but I don't think this is right, for three reasons.

1. It's not obvious what pernicious beliefs are instilled by PPE. The syllabus is so diverse that it can't convey a united body of knowledge and ideology; it's possible for two PPEists not to study a single common course after their first year. What is it that Nick Cohen, Seamus Milne, Toby Young, Ann Widdecombe, David Cameron and I have in common*? And Oxford certainly doesn't endorse right-wing ideology. Corpuscules and Balliolites in the mid-80s tutors and lecturers' included Andrew Glyn, Steven Lukes, Wendy Carlin and David Soskice, none of whom were famed for supporting neoliberalism or austerity - a tradition followed by Simon Wren Lewis**.

2. A PPE degree is like fame or wealth - it doesn't create character, so much as reveal it. Granted, PPEists include a lot of rum characters. But this could be a simple selection effect. The most able and ambitious young people who are interested in politics are disproportionately likely to do PPE at Oxford, and they are disproportionately likely to go onto careers in politics. There will therefore be a huge proportion of Oxford PPEists in politics. But this might not have anything to do with PPE causing people to become MPs and ministers.

3. The belief that PPE is responsible for neoliberal politics attributes too much power to politicians' agency and not enough to power structures. The fact is that we live in a post-democratic age (to use a phrase of another former PPE tutor) in which politics is shaped by the power and ideology of capital. These constraints influence politicians' behaviour much more than does their educational background.

* Self-opinionated arrogance, you might say. Whether this is because of selection (such qualities equipped us well for the admission interviews) or causality is, however, unclear.

** One could argue that PPE tutors have or had a leftist bias, but this is not the allegation being levelled on Twitter now.

In (half) defence of New Labour

Hopi hopes that New Labour will rise from the dead. I half-hope he's right. New Labour was not just empty slogans, infighting and invading Iraq. It was a serious supply-side economic project - an attempt to answer big problems. For example:

- The emphasis upon education, including Sure Start, was intended to address the fact that demand for lower and middlingly-skilled workers was falling, whilst that for more skilled ones is rising.

- Brown's attempt to provide a stable policy framework - for example through Bank of England indepedence - was intended to reduce some of the uncertainty that businesses face, and thus stimulate investment.

- Public sector reform was intended to ensure that taxpayers get more bangs for their buck.

I would rate New Labour a failure. It had far too much faith in managerialism and not enough in bottom-up workers control, and thus was blind to the damage done by arrogant management. It under-estimated the importance of the dearth of investment opportunities in the west and thus over-estimated the underlying vigour of capitalism. And public sector reform requires a more delicate touch than some New Labourites imagine, to ensure that the right incentives are created without impairing the knightly (pdf) motives of public sector workers.

Nevertheless, its policies were not wholly without good intellectual (pdf) foundations. And the questions it raised are still important: what to do about falling demand for less skilled workers? How to raise investment? How to raise public sector productivity?

Like Hopi, I fear that the left's opposition to austerity is distracting it from the fact that there must be more to economic policy than just Keynesianism. Yes, New Labour got the answers wrong. But it got the questions right. The problem is, a lot of the left aren't even asking those questions.

Miliband's message

I tweeted last night, to the consternation of some, that David Miliband is one the the nicest blokes I've met. I did so for three reasons, other than that it's true.

First, to counter a couple of common cognitive biases. One is a form of the halo effect - the idea that because someone has bad politics, he is a bad person. This is just wrong. Sometimes (often) bad people do good things, and good ones bad things. The other is a form of outcome bias. Peter Oborne describes David as "greedy", but he never struck me as that at all. Just because someome is rich does not mean they are greedy. They might instead be just lucky, in the right place at the right time.

Secondly, and relatedly, I want to counter a common conception of politics, especially on the left. It's what I've called the Bonnie Tyler syndrome, of holding out for a hero - the idea that our political objectives can be achieved if only we could be governed by the right people. But this is not true. It ignores the power of capitalism to perpetuate itself, for example because it generates ideologies that favour inequality, and because capitalists' control over investment decisions gives them control over the economy. And it ignores the fact that even quite senior politicians have less influence than is attributed to them; as I've said, office doesn't just corrupt, it enslaves.

We pay too much attention to the character of politicians, and not enough to the power structures and ideologies that constrain them.

Remember - David did have radicalish instincts. In 1994, for example, he described inequality as "shocking" and pointed out that "capitalist economies contain basic inequalities of power."

Thirdly, I did not mean "nice" entirely as a compliment. One fault of agreeable people is their tendency to trust others too much, perhaps because they wrongly project their own decency onto them. I fear this tendency led David to become too trusting of Blair.

The message of David's career, then, is that good instincts, decency and intelligence are not enough for a politician to change society. It is an old joke that Ralph Miliband thought that socialism couldn't be achieved by parliamentary means, and his sons are proving him right. But there's an element of truth in this.

Why is the middle squeezed?

Hopi points to the paradox that whilst some of the left is talking more stridently, actual trades union militancy, as measured by strikes, is very low. A new paper highlights this disjunct between the political and industrial spheres.

Martina Bisello shows that there has in recent years been a job polarization; employment has grown in both well-paid and badly-paid jobs at the expense of middling occupations. She attributes this to the IT revolution which, along with other technical changes, has had three effects:

- it has displaced routine white-collar clerical workers.

- it has increased demand top-level employees who analyze and manage data.

- in permitting direct control of many manual workers, it has reduced the efficiency wages these receive, and this relative wage fall has helped sustain demand for such employees.

I recommend the work of Peter Skott and Frederick Guy on power-biased technical change in this context.

Granted, this process hasn't all been bad for middle-income earners, as many, like Joan Harris a generation earlier, have moved up the occupational ladder. Nevertheless, it suggests that the squeeze on middle incomes has a basis not just in the macroeconomics of stubborn inflation, but in changes in the technical-industrial base.

This fact, however, is scrupulously ignored by the Labour leadership, which thinks of the "squeezed middle" as a purely political rather than industrial problem. To paraphrase Marx, Labour inhabits the "very Eden of the innate rights of man" that is the sphere of commodity exchange, and never troubles itself to consider the "hidden abode of production". The industrial and the political realms are thus separated.This surely represents a triumph of the Thatcherism which asserted "management's right to manage".

And herein lies my concern. Marx was surely correct to point out that a strategy that never inquires into the hidden abode of production is unlikely to succeed intellectually. So can it succeed politically?

Immigration & irrationalism

Britain has an immigration problem - but not of the sort generally supposed.

Let's be clear. The facts show that immigrants are a net fiscal benefit rather than a cost, and that immigration is, except for a small negative effect at the bottom end, a net positive for wages (pdf) and for economic growth (pdf).

Economically speaking, then, immigration is (net) a good thing.

So, what's the problem? It's that the public just don't believe the economic evidence. I don't think this is simply because they hold economists in low esteem: the man on the Clapham omnibus does not devote his waking hours to thinking "that Jonathan Portes talks some shite." Rather, I suspect the problem is a more general one - that irrationalism plays a big role in human affairs.

There's an analogy with the MMR scare of a few years ago. The idea that immigration is an economic problem is like the belief that the MMR vaccine causes autism. Both views are founded upon a mix of anecdote and the post hoc ergo propter hoc fallacy: "my son got the jab and then was diagnosed with autism"; "a lot of Latvians arrived in town and my son now can't find a job." And in both cases, scientific evidence is weak against vivid anecdotes and well-organized campaigning.

You only have to listen to 6-0-6 to know that opinion and evidence coincide only accidentally. The belief that migrants are a drain on the economy is like the popularity of Boris Johnson, homeopathy or conspiracy theories.  

It would be easy - and right - to complain that politicians and the media amplify such irrationalism rather than challenge it.

But there's a caveat here.Irrationalism is not wholly unreasonable.Yes, the belief that immigration is doing serious economic damage is wrong, as it lacks a good evidence base. But an uneasy feeling that change can have unforeseeable effects isn't so stupid, being rooted in a reasonable conservative disposition - and in the fact that, as Diane says, there's much we don't know about the effects of immigration.

One way to combat this instinct, as I've said, is to remind people that immigration is nothing new and is part of our "island story."

But there's something else. We know from financial markets that risk aversion rises in bad times, and falls in good. This is one reason why, as Ben Friedman has shown, people become more intolerant in recessions - it's because downturns cause them to see the downside of change, openness and diversity more than the upside. Perhaps, then, an economic recovery would soften attitudes to immigration - although it'll take more than this to convert people to the case for free migration.

Marriage & wages

Bryan Caplan says the marriage premium (pdf) - the well-established fact that married men tend to earn much more than single ones - is due in large part to causality. Being married, he says, causes men to earn more, rather than there being selection effects, whereby men who are attractive marriage prospects are also attractive to employers. Several things make me agree with him.

- Introspection. I strongly suspect that if I'd been married, I would have earned more. This is partly because a wife might have inspired me to overcome my distaste for job search, and partly because having someone to provide for would have caused me to move along the wage/job dissatisfaction indifference curve. It's also plausible that a wife can nag a man to get a job.

- The marriage premium is bigger for straight men than gays (pdf). This is not obviously consistent with selection effects; if it were the case that the same things that make a man attractive to an employer also make him marriageable, shouldn’t this effect be as powerful for gays as straights? It is, however, consistent with a causal effect. Having a wife frees a man from housework, thus allowing him to focus on his job, and gives him a chance of having children for whom he must provide.

- Top baseball players earn more if they are married. Again, this is inconsistent with selection effects; most such men are surely highly marriageable. But it is consistent with a causal role. Maybe employers discriminate in favour of married men, believing them to be more reliable. Or maybe a wife emboldens a man to take a more aggressive stance in wage bargaining.

- Even a study which favours the selection hypothesis finds that there's a causal effect at the lower part of the wage distribution.

However, on the other hand, something else leads me to favour the selection effect. It comes from happiness research. There's good evidence that married people, on average, are happier than singletons. However, Andrew Clark has shown that the effect on happiness of marriage fades away quite quickly. How can we reconcile these facts?

Simple. Happier people are more likely to be married; who wants to marry a miseryguts? Marriage doesn't cause happiness, but it selects for it.

And here's the thing. There's evidence (pdf) that happier people earn more (pdf) than less happy ones.

Perhaps, therefore, the positive link between marriage and wages (for men) isn't wholly causal, but reflects the fact that happiness increases both wages and marriage chances.

If all this sounds like an abstruse issue of labour economics, it shouldn't. There's an ideological undertow here. Bryan thinks that poverty (in the US) is due to individual bad behaviour, and so changing behaviour "get married!" is a route out of poverty. His interlocutors, however, disagree.

However, we must avoid the trap of motivated reasoning. The marriage premium is causal or not, whether you want it to be or not. I suspect that some of it is causal. But this doesn't mean I have to accept that poverty is simply due to individuals' failings.