Stumbling and Mumbling

Democracy, liberty & minarets

In an earlier post, I wrote: “There’s a conflict between liberty and democracy.” The Swiss decision to ban minarets illustrates this perfectly.
Let’s be clear here. This move is, as Norm says, “a grossly illiberal measure”. It is, quite simply, an infringement of an individual’s property rights. Libertarians should be appalled - and if they are not, then they are not really libertarian.
However, Left Outside is, I think, entirely wrong to call the move “spectacularly undemocratic.” If we define democracy as the will of the majority, then it is perfectly democratic.
We have, therefore, a simple conflict of fundamental values, a vindication of Isaiah Berlin:

The notion of the perfect whole, the ultimate solution, in which all the good things co-exist, seems to me not merely unattainable - that is a truism - but conceptually incoherent…Some among the great goods cannot live together. That is a conceptual truth. We are doomed to choose, and every choice may entail an irreparable loss. (“The pursuit of the ideal", p11 in The Proper Study of Mankind)

The question is: is there anything that can be done to mitigate this trade-off?*
One possibility which I favour is to use demand-revealing referenda. If people had to stake their own money - even though the risk of loss is actually small - they would be less ready to vote to reduce others’ liberty. They’d figure: a minaret does me no harm, so why should I pay to stop them being built?
Another possibility, though, is  education. Are there ways of educating people to respect freedom more - perhaps by making them aware of the cognitive biases that can stoke up the demand for state regulation?
In the absence of such answers, the beauty of the Swiss decision is that it forces us to address a question I’ve posed - but not answered! - several times here: what is the value of democracy, given that it can yield poor substantive outcomes? What, for that matter, is the value of liberty?
Paul has recently tried to answer the first question by pointing out that democracy is not just the will of the majority, but also a value in itself, one that expresses the fundamental equality of persons.
The trouble is, though, that the Swiss decision actually violates this principle, as it is anti-egalitarian - it says that Muslims should have fewer rights than others, in that they should be less free to put up religious buildings than others.
We are, then, left with a nice puzzle: how to argue for the value of liberty and democracy, rather than merely assert them.
* Note that a bill of rights would not solve this problem at all, as it merely prioritizes liberty over democracy.

2010 vs 1981

2010 will not be 1981 - in the sense that it‘s unlikely that a tightening of fiscal policy will be accompanied by economic recovery. That’s the message of today’s figures.
First, a reminder of the history. In his 1981 Budget Geoffrey Howe tightened fiscal policy despite the recession. 364 economists (pdf) wrote to the Times warning that this would “deepen the depression.”  But in fact the economy subsequently recovered.
So, could those economists criticizing today’s Tory plans be making a similar mistake?
Maybe not, because there’s (at least) one humungous difference, which is where today’s figures come in.
In 1980-81, the government removed restrictions on bank lending, such as the “corset”, reserve asset requirements and informal qualitative controls on personal lending. The lifting of these controls unleashed an  enormous - unexpectedly so - pent-up demand for loans. So consumer credit growth (and mortgage lending) boomed.
Household borrowing therefore offset government saving, with the result that domestic demand recovered.
But things are different now. Today’s figures show that consumer credit is falling - households’ non-mortgage debt fell by 0.1% in the year to October.
Of course, it’s possible that this fall will be reversed next year, if consumer confidence improves or if banks become more willing to lend. But even so, there’s a huge contrast to 1981 in one respect. Back then, personal debt was equivalent to 18% of annual after-tax income. Today, it’s equivalent to 118.9%. On the most optimistic reading, this means there’s vastly less pent-up demand for debt. On the more pessimistic reading, it means consumer debt might continue to fall. And if households and governments both attempt to reduce debt, we can wave goodbye to the recovery.
However, you cut it, the chances of a fiscal tightening being accompanied by economic recovery are lower now than they were in 1981.
This doesn’t mean they are negligible - just that Tories can’t use 1981’s precedent as a justification for a fiscal squeeze.
* My chart shows the M4 measure of consumer credit, which is slightly different from the one in the Bank’s lending to individuals series, as this has a longer history. I’ve deflated this by RPIX inflation.

Taxes, incentives & the long-run

Tim and Richard are debating that old question, would higher taxes on the rich, as demanded by Compass (pdf), actually raise tax revenue, or would the rich emigrate, work less or fiddle their taxes with the result that less income would be raised?
Economic theory is absolutely no help here, as there are two competing effects. The income effect predicts that higher taxes might lead people to work harder, in order to maintain their post-tax incomes. The substitution effect says that if work becomes less remunerative, we’d do less of it and spend more time with the guitar or golf clubs.
It is an entirely empirical question as to which one dominates - in other words, as to where the Laffer curve is.
Here, though, is the problem - the empirics are also uncertain. Take, for example a recent paper (pdf) from IFS economists. It says:

If the richest 1% see a 1% fall in the proportion of each additional pound of earnings that is left after tax, then the income they report will rise by less than half that - only 0.46%. Although a tentative estimate, this suggests that the government would maximise the revenue it collects by imposing an overall marginal rate on the highest earners of 56.6%, very close to the 53.0% currently charged.

Victory to Tim, you might think.
No. For one thing, as they say, the estimate is tentative. Allowing for this gives us another interpretation. This is that the revenue-maximizing top tax rate is 95% likely to be in the range 45-75%. This encompasses Tim’s and Richard’s views.
And it could be that Richard is nearer the truth. The IFS’s estimate is for the top 1%. But these are those most likely to respond  to higher taxes by reducing labour supply. The well-paid hedge fund manager can relocate to Bermuda. The CEO can stop work and take up some non-executive directorships. And guys who have made a few million can afford to retire.
However, those lower down the top decile - the ones Richard wants to tax more - have fewer such options. They might be tied to work. Remember, an income as low as just over £46,000 gets you into the top decile (table 14 of this pdf) - and you can‘t retire on your savings from that.
Indeed, other IFS evidence (pdf) suggests that, for male workers in general, “hours of work are almost completely irresponsive to changes in work incentives.”
So, am I siding with Richard? Not entirely. Here, I’ll invoke one of my favourite rules of thumb, namely:

Elasticities are smaller than expected in the short-run, but larger expected in the long-run.

To see what I mean, put yourself in the shoes of someone on, say, £100,000 a year facing Richard’s higher tax. He might well figure: “I’ve got an ex-wife and kids to support: I’ve got to keep  earning. And I’m not qualified to do anything else anyway. But I hear that some senior partners are thinking of retiring now they have to pay more tax. If I work hard, I might be able to get one of the jobs they leave.” 
But now, think of a university student. He figures: “I was toying with the idea of going into the City. But why should I work 80 hour weeks in a dullish job to hand over most of my money to the government? I’ll do a less well-paid job that I enjoy instead.“
Now, in the short-run - which might be many years - the £100,000 a year man’s response is the most important one. But in the very long-run - decades - it’s the student’s response that determines our macroeconomic fate.
What I’m getting at here is a point made by Assar Lindbeck (pdf, p323) - that the short-run response to incentives can be dampened by habits, social norms and other path dependencies. It is only as these fade away, over decades, that the full effect of disincentives is felt.

Identity vs behaviour

What is the link between personal identity and behaviour? Two recent episodes pose this question. One is the death of Bill Barker, the PC who died during Cumbria’s floods. Was his death the act of a heroic character, or was he - as Matthew Parris asks - merely an ordinarily decent man who just happened to be in a dangerous place?
The other is Thierry Henry’s handball against Ireland. Did he do this because his character is that of a cheat? Or did he do it because he’s an ordinary guy who found himself in a position where there was an overwhelming incentive to act dishonestly?*
A recent paper sheds some light upon this issue.  Researchers got some students to play a simple dictator game - giving them some money and letting them choose how much, if any, of the cash to share with others. They found several things.
First, there was a wide range of choices of how much money to give away, with some keeping all and others giving away half. Even among a narrow demographic - Mexican biology students - there is therefore considerable heterogeneity of behaviour.
Secondly, there’s a big difference between what people thought they should do and what they actually did. Most thought they should give half away. But only a few did so. Social norms, it seems, aren’t that powerful. 
Thirdly,  the link between what the students did and how they think of their own identity is tenuous. Yes, subjects who say they believe in fairness tended to give away a similar large sum. But those who thought of themselves as selfish of charitable gave very differing amounts. Self-perceptions of character, then, are only weakly correlated with behaviour. Perhaps talk about one’s own personality is cheap talk, which signifies little about actual behaviour.
The authors conclude:

Several contradictions arise that oblige us to be cautious when attributing identities to people and attempting to explain economic conduct in terms of these identities.

If this is true even in the simplest laboratory experiments, how much more true will it be in the complex world?
This is, I think, consistent with the notion that the fundamental attribution error is indeed common: we often over-estimate the importance of “character“ as a determinant of behaviour, and under-rate situational forces.
There is, though, a political aspect here. If identity - be it identifying with religion or ethnicity - has only weak influence upon behaviour, mightn’t the identity politics of the non-Marxist left be over-emphasised, or even plain wrong?  
* Or was he, as I suspect, inflicting the wrath of God upon the Irish people as punishment for giving us Jedward?

Some new happiness research

Here are three new papers on happiness research.
First, German research finds that there’s a strong day of the week effect upon happiness. People are much less happy on Sundays than other days; they side with Billie Holiday rather than Fats Domino.
You might think this is because people dread having to go to work on Monday. Not so. Even the unemployed are less happy on a Sunday than other days. Instead, the Sunday effect seems especially strong for married people, rather than singles - so strong, in fact that the difference in a married person’s happiness between Sunday and other days is over one-third the difference in happiness between the employed and jobless, which is universally found to be huge. Maybe familiarity breeds contempt. Although marriage raises well-being, sustained exposure to one’s partner - or children - does not.
Secondly, other German research (pdf) sheds light upon  the finding that happiness is U-shaped in age, bottoming out around one’s 40s.
The authors suggest this is because people’s failed investments become apparent in mid-life. 40-somethings are more likely to be divorced; those who are unemployed suffer more; even quite successful people realize that they’ll not get to the top of their career ladder; children reduce parents’ well-being; and, as Marianne Faithfull sang, we learn that we'll never fulfill our dreams.
Thirdly, Italian researchers think they’ve found an explanation for the Easterlin paradox. It lies in social capital. Nations which have suffered big falls in this - as measured (or proxied?) by membership of voluntary organizations - have seen happiness fall.
There is, I suspect, a common theme here - that people don’t predict what will make them happy at all well. Having children and investing in careers rather than in social networks doesn’t make us happy, and yet we do it in our 20s and 30s, only to be miserable later.

Was fiscal policy too tight in the boom?

In a letter to the FT, Martin Weale writes:

Fiscal policy should be run on the principle of saving up for the next crisis and our government should have saved the revenues associated with the financial boom and a buoyant housing market.

Is this true? I ask for two reasons. One is simply that our lax fiscal policy in the boom doesn’t seem to have limited the scope for counter-cyclical policy in the downturn. It’s not the case that Darling could have ran a more expansionary policy this year, if only he wasn’t starting from a position of higher-than-desired debt. If fiscal policy has been insufficiently expansionary, it’s because the government has spent less than planned, not because its hands have been tied by the high debt caused by borrowing too much in the earlier 00s.
Nor is it true that gilt yields now are so high as to crowd out private investment - which would be the case if the build-up of public debt in the boom years were a serious problem.
My second reason is that one could argue that fiscal policy, in the western world, was too tight in the boom years, not too loose.
The thinking here is arises from one common view of the origins of the crisis. In the 00s, the Asian savings glut caused high demand for western AAA-rated assets: government and agency bonds. Mortgage securitization was one trick banks used to satisfy this demand. The result was a housing boom and slump and bank default.
But what if governments had responded to the glut by running bigger deficits, and increasing the supply of government bonds? This might have crowded out mortgage securitization and the housing boom, thus preventing the subsequent bust. And/or, if you like, anticipations of higher taxes caused by looser fiscal policy might have deterred people from taking on high mortgage debt.
In this sense, we might have achieved better macroeconomic stabilization if governments around the world had borrowed more in good times.
Now, I don’t know if I believe this. But surely, if you take crowding out hypotheses seriously, you should at least think it plausible.

Immigration: two new papers

Via the NBER come two new papers on the effect on immigration.
First, Giovanni Peri shows (pdf), from looking across US states, that migrants are good for the economy:

We present three main findings, two of which are quite new in this literature. First, we confirm that immigrants do not crowd-out employment of (or hours worked by) natives but simply add to total employment. Second, we find that they increase total factor productivity significantly and, third, that such efficiency gains are unskilled-biased—larger, that is, for less educated workers.

This happens because migration improves the division of labour. Unskilled migrants go into manual work, which frees up natives to work in “communication-intensive” jobs (call centres).
Now, a standard response to findings such as these is that opposition to immigration isn’t founded upon economic effects, but upon concerns for social cohesion. A paper (pdf) by Christian Dustmann from CReAM and colleagues looks at this. They find that there’s a correlation between people’s attitudes to the economic effects of immigration and their attitudes towards its effects upon what they call “compositional amenities” - the value one places upon a common language, ethnic homogeneity and suchlike. However, it seems that differences in people’s opinion of immigration are driven more by concerns about compositional effects than economic ones.
For me, this raises two questions. First, should a desire for compositional amenity have any weight in a free society? For example, I would - I think - prefer it if others shared my religious beliefs (mild atheism). But I don’t think this preference should be embodied in policy.
Second, are concerns about compositional amenities rational? One clue that they might not be lies in the finding that they are especially pronounced among the less educated.
Of course, in a democracy irrational and illiberal preferences have as much weight as rational ones. Which, for some of us, is another argument against democracy.

Labour's anti-Keynesianism

Is the government spending too little? I know it sounds a silly question, but it’s the one raised by today’s public finance numbers.
My table shows what I mean. I’ve taken it from page 3 of today’s press release (pdf) and table 2.8 of the Budget 2009 supplementary material (pdf).
This shows that, so far this financial year, central government borrowing is running ahead of forecast. The Budget forecast a 73.9% rise in net borrowing from 2008-09 to 2009-10, but comparing this year so far with the same period last year, borrowing is up by 115.7%.
However, this is happening because revenues are running below forecast; receipts have dropped 10.1% against a forecast for the whole year of a 7.2% fall.
By contrast, spending has grown less than expected. If we exclude social benefits and interest, it’s risen just 7.2% against a forecast rise of 8.3%. This is the same rate it grew between 2002-03 and 2006-07, when the economy was growing nicely.
If spending for the whole year is to reach its Budget forecast, then it will have to grow by 9.8% in November-March compared to the same period last year. But it’s generally thought that the economy will be recovering then.
This means the government is practising a form of anti-Keynesianism. The biggest rise in spending will come as the economy is growing, rather than when it was shrinking.
Yes, it cut VAT in a Keynesian fashion. And the automatic stabilizers have done what they should. But when it comes to discretionary spending, the government has been anything but Keynesian.

Scroogenomics: a review

Joel Waldfogel’s Scroogenomics provides the academic justification for the campaign to cancel Christmas. The gist of his argument will be familiar to anyone who knows his now-notorious paper, The Deadweight Loss of Christmas (pdf). Quite simply, we are worse at buying for other people than we are at buying for ourselves. As a result, each dollar spent on someone else generates less value than a dollar we spend on ourselves - about 18 per cent, estimates Waldfogel. With Americans spending about $66bn a year on Christmas gifts, this implies an annual destruction of around $12bn of wealth - just under 0.1 per cent of GDP.
One reason for this destruction, says Waldfogel, is misaligned incentives. When we get some revolting jumper our response is not “why did you get me this crap?” but a smile and a thank you. As a result, bad gift givers don’t get the feedback  that would cause them to improve their performance.
However, not all gifts do destroy value. Waldfogel estimates that around one-third of them actually increase value, with gifts from “significant others” being, on average, likely to do so; it is gifts from aunts and grand-parents that are most wasteful. This happens because partners know our tastes and sometimes have better knowledge than we do of the products out there, so they might buy us a book or CD that we come to love.
Herein, though, lies a problem with Waldfogel’s thesis. There might be another reason why gifts add value, which a narrow instrumentally rationalist perspective misses.  Gifts aren’t just physical products, but ways of cementing social ties - of saying “I’m thinking of you”. For this reason, exchanges of gifts seem to be a widespread feature of all societies.
This ties in with a response that Sara Solnick and David Hemenway made (pdf) to Waldfogel’s original article. They found that gifts up the generations - from children to parents and grandparents - could add enormous value, in large part because of their function as love tokens.
It is, though, not just social capital that gifts create. They also create memory capital. The thing is, we quickly forget bad gifts  but remember good ones forever. We all, I hope,  fondly remember playing with some great pressies we got as children; for me it was Subbuteo - the floodlights were handy in power cuts. Would we have such happy memories if we’d received the more efficient gift of money?
For me, then, the value of Waldfogel’s little book is that it tests the limits of how far instrumental rationality can go. In many areas, it should go further than it does. But perhaps Christmas is a step too far.

Bayes theorem: an application to Afghanistan

I said yesterday that MPs should know their Bayes’ theorem. To see its usefulness, let’s apply it to the question: do the deaths of British troops show that the mission in Afghanistan is failing?
Bayes’ theorem lets us answer this if we know just two numbers (well, actually four, but two are just one minus the others).
First, what did you think was the probability of success in Afghanistan before the mission began? This is the prior probability, which we’ll call Ps. The probability of failure, Pf, is one minus this.
Second, what is the probability that we’d see the number of deaths we have, if the mission were succeeding? Call this Pd|s. One minus this gives us Pd|f.
Let’s pin some numbers on this. Let’s call Ps 0.8. I guess this is the sort of number the government had in mind when the mission began. It can’t be much lower, because no-one would send troops to war without a high probability of success. But it can’t be much higher, because that would be over-confident, given that the British and Russian empires both failed to control Afghanistan.
Our second question is trickier. It could be that the mission was always going to be bloody, and in fact we’ve had fewer casualties than expected. On this view, Pd|s is high, and the deaths are no evidence of mission failure - in fact, the opposite. On the other hand, there was a vague hope that troops would “leave without firing a shot.” From this perspective, Pd|s is low, and the deaths are evidence of mission failure.
Let’s split the difference, and call Pd|s 0.5 so Pd|f is 0.5.
Now let’s take Bayes’ theorem to derive a number for the probability of the mission succeeding, in light of the casualities we‘ve suffered. This is Ps|d, the posterior probability:
            Ps|d = (Pd|s x Ps)/[(Pd|s x Ps) x (Pd|f x Pf)]
Plug the numbers into this, and we get:
            Ps|d = (0.5x0.8)/[(0.5x0.8) + (0.5 x 0.2)] = 0.8
In other words, the posterior probability is no different from the prior. The reason for this is simple. I’ve constructed the example so that the deaths are no evidence either way. So there’s no reason for the prior probability to change.
But what if the deaths were more consistent with failure? If Pd|s were, say, 0.2 and Pd|f 0.8, then our posterior probability would be 0.5.
Now, I write this not to take a view on Afghanistan. I know as much about Afghanistan as Abu Hamza does about playing the banjo. I do so rather to show how Bayes’ Theorem can help us think about the issue. I’d stress two uses of it.
First, it forces us to ask of any piece of information: what is this evidence of? Are deaths evidence of mission failure or not? It’s in this context that we need specific military expertise.
Second, we can reverse engineer the theorem. Rather than plug numbers into it and accept the answer, we can use it to ask: what numbers give us a high probability of success? How plausible are they? Again, military expertise can illuminate here.
Note that I am not saying that Bayes’ theorem is sufficient. It can’t define “success”. Nor can it tell us whether the success is worth the costs. It is, though, surely an important part of how to analyse the issue. And yet - in public at least - politicians do not think this way. They did not tell us Ps or Pd|s (or even ranges thereof) before the mission began. Nor do they tell us now. We can all think of reasons for this omission. But are they really satisfactory?