Stumbling and Mumbling

Important decisions

Norm commends this post by Brownie. But there’s one passage in it that really sticks in my craw:

When I hear people whose most important decisions each day are what to play on the iPod lecturing the country’s most senior policeman about the rules of engagement for suicide bombers, telling him how his men are “executioners” (these being the officers who ran towards, not away from, a man they suspected of being half a second from committing mass-murder), I want to be sick.

Now, if Brownie wants to criticize these people for their lack of empathy or their belief that the decision is a simple one, I'm with him.

What worries me, though, is that note of contempt for people who don’t take important decisions, and – by implication – the belief that we should respect senior policemen for having to take them.

This is wholly wrong. People who take important decisions – be they ordinary rozzers, top cops, cabinet ministers or chief executives – are selected not (just?) for their decision-taking ability, but for their ambition, their desire to impose their will upon the rest of us.

It’s not as if there is an open, national exam in classical and Bayesian statistics and cognitive psychology, with important decision-making roles being assigned to the people with the best scores, is it?

In a society in which decisions are taken, often in secret, by a self-selected group of ambitious mediocrities, our presumption should be hostility to that group.

iPod players should not be scorned for this presumption, still less for the fact that they cannot take important decisions because of the lack of direct democracy in this country. And, insofar as some of them don’t have any ambition to control others, they deserve our praise, not our scorn.

Now, I hope I’m reading too much into this passage. I hope Brownie doesn’t mean to scorn the powerless and praise the powerful. Because if he does, it’s a pretty lamentable attitude for someone on the “left” to have.

And another thing. Deciding what to play on your iPod is an important decision. And if it’s not Jolie Holland’s Catalpa, it’s the wrong one.

Are companies sufficiently accountable?

John Lewis's latest weekly sales figures were released today. The important thing about these is not what they show, but the very fact that they exist at all. They highlight a paradox - that the UK company that is most transparent and up-to-date about its operating performance is a worker co-op, not  a publicly quoted one. AFAIK, no UK-quoted firm issues weekly sales numbers.
Why don't they? A few years ago, they could have claimed it was costly to compile them.  But this is no longer the case. Bloomsbury Publishing reported within hours that the latest Harry Potter book sold 2,009,524 copies in the UK within 24 hours of its release. If they can be that timely and transparent about their best-seller, they can do the same for their entire catalogue.
One reason why firms might be reluctant to issue weekly figures is that to do so would increase share price volatility. But this argument is lame. For one thing, it's not obvious that it should. Sure, irrational investors might over-react to noisy data. But on the other hand, more data should increase the accuracy of the valuation of companies.
No. I suspect the main reason firms don't issue weekly data is that they just don't want the scrutiny. They want to hide from shareholders. And shareholders let them do so.
This raises a really big issue. Is the stock market really the most efficient means of controlling company bosses? The difference between their lack of disclosure and John Lewis's openness - allied to Waitrose's good numbers - suggests it might not be. Indeed, quoted firms seem to be stuck in the dark ages of secrecy and inadequate accountability. As Joseph Fuller has said:

For a remarkably innovative economy, very little innovation has occurred in the fundamental form of structuring and running public enterprises over the last 100 years or so. Most of the attention of policymakers, academics and business executives has focused on 'perfecting' the form of public corporation. But, in doing so, they have lsot track of its original purpose, and that it remains plagued by structural problems, particularly the agency problem.

So, here are my questions. What type of company ownership structure does maximize efficiency (however you wnat to define it)? Under what conditions is the traditional stock-market quoted firm the optimal ownership structure? Are these conditions becoming more or less common?
The work of Luigi Zingales and Shann Turnbull, among others, might help answer these.

A challenge to the "Left"

William Vallicella asks of the US Left: “Take away their blind oppositionalism and their venom and what is left?” And he quotes Orwell:

The mentality of the English left-wing intelligentsia can be studied in half a dozen weekly and monthly papers. The immediately striking thing about all these papers is their generally negative querulous attitude, their complete lack at all times of any constructive suggestion.

It pains me to say so, but this is a good shot, isn’t it?

So, here’s my challenge for the Left (and I include myself in this). Forget, for the moment, Iraq. What positive proposals do have to improve the condition of the working class, or any oppressed group, in the western world?*

Here’s one of my modest contributions. And this guy and his links offer inspiration. And in a just and rational world Stephen Marglin, Herbert Gintis, Sam Bowles and John Roemer would get a lot more attention than they do.

So, come on, what else have you/we on the Left got? Or are you all just bleeding hearts and big gobs?

* I take for granted that we support massive increases, and other improvements, in foreign aid.

Why is journalism so bad?

Medialens (via Chicken Yogurt) asks a good question, but answers it badly:

Why is the media, for all its high-tech sophistication, wealth and power, so bland, so empty, so dull? The answer is that its capacity for sincerity and truth is fundamentally compromised by the profit motive at its heart. What can a system based on unrestrained greed possibly have to say about a world crucified by greed?

This answer is too glib. The problem with the dead tree industry lies in the culture of journalism itself, rather than in the corruption of the profit motive.

A few years ago, I applied for the job of foreign exchange writer on a national.

“What qualifies you for this job?” asked a friendly interviewer. I told them about my masters in economics, and my years of experience as a City economist.

“We’re not interested in that”, replied another interviewer. “We want flower show journalism – someone who gets the basic facts right, writes well and files on time.”

Even if I'd been offered the job, it would have been less valuable than lesson I learned.

There are (at least) four other aspects of journalistic culture which militate towards a conservative blandness:

1. People enter journalism straight from university. Very few – there are illustrious exceptions - turn to journalism after a professional career. This means journalists have an exaggerated faith in “experts.” They don’t realize a large chunk of professional “expertise” lies in the ability to disguise one’s ignorance. When I speak to people who know me as an economist, conversations are very different from those I have with people who regard me as a journalist. One consists in a discussion of areas of uncertainty. The other is a list of quotes.

2. Journalists are obsessed with status. The biggest shock I had on moving from the City to journalism was just how hierarchic it was; writers, senior writers, deputy editors, editors, publishers (I’ve never worked out what they do) and so on – and these titles meant something. At the Daily Mail a few years ago (things might have changed), pretty much everyone was obsessed with brackets; if your job title had brackets, you were making it. A former editor of mine once referred to my “career”, and was genuinely surprised when I didn’t know what she was talking about.

This status obsession has two effects. It means journalists would rather get a quick interview with a “senior figure” rather than a junior one who might know more. And it leads to an appeal - which is as anti-democratic as it is anti-rational - to authority and credibility rather than to the inherent merits of an argument. To take the example immediately to hand, here's the Times today: “The research, published by the prestigious National Institute of Economic and Social Research…” Why would “prestigious” matter here?

3. Journalism is about the striking anecdote, human interest and the “quote”; questions are often asked to elicit good soundbites rather than to get information.

This means the standard ways in which social scientists think about the world – statistical inference and mechanisms of unintended consequences – are ignored.

4. Journalists are not trained to think clearly. So cognitive biases are epidemic. Every paper every day contains at least one example of: the representative heuristic; the hindsight bias, overconfidence in our limited knowledge; the salience effect; or the fundamental attribution error; I’ll come back to this.

It’s here, though, that we get a reason why the dead tree industry exists. Pretty much no-one is actually educated to think clearly – insofar as I do so at all (which is doubtful) it’s because I read Kahneman, Tversky, Dawes and Gigerenzer in my spare time - and rationality doesn’t come naturally to us. The upshot is that there’s little demand for high intellectual standards, as the best bloggers’ visitor stats corroborate. So maybe the profit motive does lead to bad journalism after all. But it’s not the fundamental cause of it.

Terrorism, irrationality and natural selection

Could terrorism have emerged through natural selection?  This question arose whilst reading this paper by Georg Kirchsteiger and colleagues, published in this month's Economic Journal.
They considered the endowment effect - the habit people have of valuing goods highly simply because they possess them. It means the (minimum) money people are willing to accept to part with a good can be much higher than the (maximum) amount they are willing to pay for it; there's more about the effect here (pdf).
(This matters because it buggers up the Coase theorem and a lot of cost-benefit analysis, but these are other stories).
Kirchsteiger and colleagues show that the endowment effect might have emerged through natural selection.
This is because our over-valuing what we have strengthens our bargaining position by creating a credible   threat that we will walk away from negotiations*. They show that, under certain conditions, the benefit of this - getting some good deals - exceeds the loss it causes, which is that some mutually benefical trades don't happen.
Now, if stronger bargainers are more likely to survive in conditions of scarcity, natural selection will favour them over weaker bargainers. Selection, then, works in favour of people who have an endowment effect.
Indeed, increased effectiveness at bargaining might not be the only way in which there's selection in favour of the endowment effect. This effect can also cause people to be overly willing to fight to defend what they have. If potential aggressors know this, they will be less likely to predate upon people with strong endowment effects, which allows them to survive and multiply more than those less willing to fight to defend their property.
Where does terrorism fit in here? Simple. The endowment effect is not the only apparent irrationality that strengthens man's bargaining power and hence probability of survival. Another bargaining tool is to make extreme and strong demands, and threaten to make no concessions. If natural selection favours this tactic, as it favours the endowment effect (and the analogy seems close to me), then it favours extremists. And if more extremists are thrown up by evolution, so will be more terrorists.
Evolution isn't the same as progress.
* You might object that bargainers might merely pretend to have the endowment effect. However, this pretence isn't always credible; the best way to make a credible threat is to believe it yourself.

Why the yield curve matters

Alan Greenspan and the Conference Board could both be wrong, according to a paper in the latest Economic Journal.
Mr Greenspan recently told the Joint Economic Committee that the yield curve is not a foolproof indicator of a downturn (pdf). And the Conference Board last week rejigged its index of leading indicators to give the curve less prominence.
If they're right, we shouldn't worry that the current flatness in the curve points to a sharp slowdown.
However a paper by Arturo Estrella (pdf) shows that there are good reasons why the yield curve should predict economic activity. If he's right, we can add a fourth reason to James D. Hamilton's list of reasons why the Fed shouldn't raise rates aggressively.
Mr Estrella shows that the ability of the yield curve to predict output is the natural result of  a standard macroeconomic model  with rational expectations and reasonable monetary policy reactions. Under a Taylor rule - whereby short rates are determined by the output gap and inflation alone, the yield curve should be a powerful forecaster of output. And if monetary policy is used solely to stabilize output, shows Mr Estrella, the yield curve will be the best possible forecaster of output.
The intuition here is that if everyone sees a recession coming, bond markets will anticipate lower short rates and lower future inflation, as the recession lowers inflation. That will drive long yields down more than short rates (as these do not fall in response to future inflation.) The result will be a yield curve inversion and a subsequent recession.
However, under a regime of strict inflation targeting, bond markets know what future inflation will be, so long yields won't move so much. In this regime, the yield curve will be a worse predictor of output than in a regime where monetary policy is used to stabilize output. This, shows Mr Estrella, is why the yield curve has become a less good predictor of output since 1987 - because since then, the Fed has given more weight to inflation targeting relative to output stabilization.
This summary does horrible violence to the subtlety of  Mr Estrella's paper. The question it helps us answer is: how can the yield curve now not be pointing to a slowdown? Mr Estrella's paper suggests three possibilities:
1. The Fed is engaging in stricter inflation targeting (and less output targeting) than it has in the past.
2. Expectations are not rational, in some say.
3. The term premium is falling for rational reasons; Mr Estrella abstracts from this issue.
Whatever your answer to this question, please don't invoke foreign official buying of US Treasuries because this has fallen off recently at the same time as the curve has flattened; in the 12 months to May, official buying of Treasuries was $117bn, compared to $193.7bn in the 12 months to May 2004.

Life expectancy and over-confidence

In this post, I cited research showing that our denial of our mortality can cause us to save too much. Today, though, the IPPR says that "the public do not accept the fact that life expectancy is increasing and mistrust government, the financial services industry and employers on the subject of pensions."
Obviously, anyone who isn't a complete cretin distrusts government, the financial services industry and employers. But is it really the case that the public don't accept that life expectancy is increasing?
No doubt, this is what they told the IPPR's focus groups. But it's a key law of economics - and indeed life - that we should judge people by what they do, not what they say. And there's one killer fact about behaviour which suggests people are more likely to over-estimate their  longevity than under-estimate it. It's that they leave enormous bequests. In 2001-02 (the latest year for which we have figures) the 267,027 people who left estates had £40.6 billion of assets (pdf). That's an average of almost £152,000. Only 37,670 (of those with estates) left less than £10,000.
This means tens of thousands of people are dying before their money runs out. Which is evidence of either an enormous desire to leave their money to their kids, or that they died before they expected to.
So, maybe people are over-confident about their longevity, whatever they say.

What are we worth?

"The total value of the UK at the end of 2004 was £5.8 trillion", says National Statistics (pdf).
This is plain wrong.
To see why, remember that GDP last year was £1.19 trillion, and will be over £1.2 trillion this year. If our total capital assets are just £5.8 trillion, this means we'll earn a return on them of over 20 per cent.  That's absurdly high, especially considering that £3.4 trillion of this £5.8 trillion consists of a consumer good, housing, most of which yields little direct income.
What's missing from this estimate is the economy's biggest asset - its human capital. Last year wages were £648.7bn. We can think of this as the income yielded by our asset, human capital. If we assume, heroically, that the yield is 5 per cent, then our human capital stands at £13 trillion.
Add this to our £5.8 trillion and the UK is worth £18.8 trillion. That's over £300,000 per person.

Bugger Baghdad

Right, confession time – I’m not interested in foreign affairs. Mention Iraq, Israel, or Korea to me, and the chances are I’ll switch off. I find apparently minor economic affairs, such as the cross-section of equity returns or the interest-elasticity of consumer spending, much more interesting than what’s happening in Iraq or Palestine.

Don’t get me wrong. I think anti-Semitism, suicide bombing and Robert Mugabe are wholly bad things. But these are straightforward moral views, held by all decent people. There’s no intellectual meat in them. My reaction to most of the posts and comments at Harry’s Place or Oliver Kamm is: just put in a sock in it, will you.

This is not Little Englanderism. There are good reasons why I’m not interested in foreign affairs. One problem stems from Arrow’s impossibility theorem; I just don’t know how to ascribe intentions or agency to groups such as “Israelis” or “Sunnis.” Another is that many of the standard tools of economics just don’t apply (though there are big exceptions). For example, economists have some great theories about property rights – but it’s hard to see how these bear upon the question of the occupied territories.

A bigger problem, though, is that no-one agrees on the basic facts. Make a factual claim about economics and we can usually verify or reject it. With the empirics roughly agreed upon, we can then get on with the interesting stuff about explanation and statistical inference.

In foreign matters, though, we often can’t do this. Take a simple question: how many people have been killed in the Iraq war? Is it around 25,000 as Iraq Body Count claims, almost 100,000 on the Lancet estimate, or just too difficult to count, as the UK and US governments claim?

If the basic facts aren’t known, what role can reasoned analysis play?

None. What passes for debate is merely the exchange of prejudice. Take Iraq Body Count’s estimate that around 25,000 civilians have died in the conflict. Of the several ways of reacting to this, here are two reasonable possibilities:

“25,000 is a bigger cost than I’d expected. Given that my estimate of the benefit of removing Saddam from power is less than this, maybe I shouldn’t have supported the war.”

“25,000 is less than I’d expected. Maybe therefore my opposition to the war was wrong.”

I doubt that one person in 10,000 had either of these thoughts. A bastardized form of Bayesianism seems to apply; the facts are so weak that they never change anyone’s priors.

When the “facts” are so disputed that they carry little weight, two unpleasant consequences follow:

1. Group identification. When George Galloway recently wanted to discredit a claim made by MEMRI, he thought it sufficient to say that they were Israelis. In logic, of course, this was no argument whatsoever; claims are either true or false, regardless of who makes them. But many seemed to think it adequate. This is what happens when people are incapable of assessing facts for themselves; they trust (or not) groups with whom they have a tribal loyalty (or not.)

You might object that Galloway is just a moronic rabble-rouser. That’s my point. Why should I take an interest in issues where someone like him is taken seriously?

2. Extremism. One of the under-rated virtues of the stock market is that it’s a device for eliminating extremism. The facts often undermine the beliefs of even the most successful investor, with the result that we learn to hold our views lightly, and to be open to contrary opinions. In foreign affairs, however, the facts are too weak to have this moderating effect.

I’d be more than usually grateful if anyone could change my mind here. But until you can, I’ll be happier with issues that come with standard errors and covariances attached.

An exception: I am interested in the question of how much we should help sub-Saharan Africa, but that's because this raises interesting questions such as: does aid work? and what obligations to we have to the poor?

More freakonomics

Here's a strong contender for the best sentence written in economic research this year:

Repressing minor reminders of mortality is always beneficial: it results in a first-order reduction in fear, but only a second order utility loss from regular consumption.

It's from Wojciech Kopczuk and Joel Slemrod's paper, Denial of death and economic behavior. They show that our denial of death can lead us to save too much. That's a great corrective to the self-serving tosh of the pension fund industry which says we're saving too little.  Or at least it would be if it weren't offset by another  mechanism - which is that people who anticipate denying their mortality as they get older save too little, in anticipation of saving too much in later life.
This is not the only NBER paper this week to develop Freakonomics. There's also   "Crime, punishment and myopia" (pdf) by  David S Lee and Justin McCrary.  They've conducted a natural experiment to see whether longer prison sentences deter crime.
Over-18s are treated as adults and get longer sentences than under-18s who commit the same crime. So, they say, you'd expect criminality to fall once people pass their 18th birthday, because - at the margin and ceteris paribus- the offence that was worth the risk when you were 17 is no longer worth it when you are 18.
However, they found that the fall in criminality after peoples' 18th birthday was tiny. This suggests the price elasticity of the demand to commit crime is low. Which means, they say, that "lengthening periods of incarceration has limited value as a deterrent."
There is a case for longer prison sentences. But it's (partly) that the social costs of so-called minor crimes are high, rather than that prison is a deterrent.