Stumbling and Mumbling

Rennard's lesson

The Rennard affair sends an important message about politics - one which will be ignored.

So far, the allegations against him seem mild. We're not talking Jimmy Savile or Julian Assange here, but the sort of tiresome groper which any woman with a backbone has long learnt to cope with.

Except that is, for one thing. His main accuser, Susan, says:

I possibly could have knocked my chances of any future success within the party by having said no...
This is a man with an almighty amount of power. At the time he held the purse-strings for any winnable seat, and he could choose which were the starred seats and advise other federal bodies which should be the starred seats.So this was a man who could control your future.

The issue here, then, is not sex, nor crime, but power.If these allegations are correct, it vindicates Lord Acton's famous saying:

Power tends to corrupt, and absolute power corrupts absolutely. Great men are almost always bad men, even when they exercise influence and not authority, still more when you superadd the tendency or the certainty of corruption by authority.

This isn't always a wholly bad thing. One message of Lincoln is that even decent men must sometimes use unpleasant means to achieve worthy ends. But it does pose the question: wouldn't it be remarkable if the only way in which politicians abuse power is to try and get their leg over?

There's another question here. Why was Susan, and presumably women like her, at all surprised by this? It's surely astonishingly naive to think that power will be clean and decent.

One possibility is that they were prone to the optimism bias that afflicts most people entering politics. Another is that they were blinded by tribalism; the misuse of power is something "their side" does, not "ours". This fails to see that the division that matters is not between parties, but between the powerful and the powerless.

Herein, then, lies the big message of the Rennard affair. It's not just about how power can be subtly but insidiously abused, but about how people can try to enter politics whilst being oblivious to this.

I don't expect this message to be noticed, because real power consists in being able to disguise the fact that it is being exercised.The lesson of this affair will not be learned.

Happiness vs options

Since it was proposed in the 1970s, many economists have been sceptical of the Easterlin paradox, the claim that rising GDP doesn't increase happiness. Some of the scepticism - which Easterlin himself still rejects - is based upon the data, although this still seems to show that happiness increases only slightly with incomes. I suspect, though, that it is also motivated by a discomfort at the apparent implication of the paradox, which is that aggregate incomes don't (much) increase happiness because, as researchers such as Sheena Iyengar and Christopher Hsee has suggested, the increased choice that comes with higher incomes either demotivates (pdf) folk or causes them to choose badly (pdf).

However, a new paper by Katherine Guthrie and Jan Sokolowsky point out that this implication need not be true.They show that increased wealth and choice might not increase happiness even if people are rational utility maximizers.

Imagine a cinema opens in a dull town. Some people choose to go, others don't. Those who go experience an increase in utility - they would not go otherwise - whilst those who don't experience the same utility as before. Surely, then, happiness has increased.

Not necessarily. Utility is not the same as happiness. Cinema-goers might feel discontent or guilt if they feel they should be working or looking after the children instead. And non-goers might also feel unhappier at work because they think: "I could be at the pictures instead." Guthrie and Sokolow say: "An expanding choice set offers opportunity to increase one's utility, but it also evokes rising discontentment."

We don't, therefore, need to assume people are irrational to believe in the Easterlin paradox - the mere fact that they are aware of opportunity costs can do so.

This theory is consistent with (at least) five findings of happiness research:

- Well-paid workers aren't happier in their work than lower-paid ones. This is odd because better-paid jobs are generally nicer. One explanation is that well-paid people have more valuable alternatives; a job that gets you off a crime-ridden housing estate might be no bad thing, but one that gets you away from the golf course is.

- American women have become less happy (pdf) over time. This might be precisely because their options have increased. The career woman feels bad about leaving her kids, whilst the home-maker regrets abandoning her career, whereas Betty Drapers in the 60s never had this choice and so never suffered the higher opportunity cost of not working.

- Well-being declines in middle-age. This could be because we 40-somethings have more options than younger or older folk, and so are more discomforted by having to give them up.

- Commuters are unhappy. This is because they're aware they could be either at home or drinking with workmates.

- Happiness comes from "flow" - losing ourselves in an activity. One reason for this is that when we immerse ourselves in something, we lose awareness of the other things we might be doing, whereas when we are less engaged (for example when watching TV) we are aware of those opportunity costs.

Perhaps, then, the Easterlin paradox - even if it is true - is entirely consistent with rational utility maximization.

Chesterton, & inflation

You can now buy the complete works of G.K.Chesterton for £1.97. A few years ago, they would probably have cost hundreds of pounds and lots of effort. I say this as a counterweight to the Telegraph's claim (via) that the cost of everyday goods has "rocketed" since 1982.

True, many such goods have. So much so, in fact, that in some cases they've outstripped wages. Back in 1982, the average pre-tax weekly wage would have bought 148 pints of lager. Today, it buys 146.

And yet the works of Chesterton aren't wholly atypical either. Back in 1982 no money would have bought you a Playstation or iPod. Their prices have fallen from infinity to affordable - that's an infinite rate of deflation. And things we paid for back then, such as some newspapers and music, are now free. Again, massive deflation.

All this should seem trivial. But it has some under-rated implications.

First, such huge changes in relative prices make it impossible to calculate long-run inflation rates accurately. There's no such thing as a "true" inflation rate. How do you compare the prices of goods that exist today with the prices of goods that didn't exist 30 years ago?

Paradoxically - given that he's considered the father of macroeconomics - Maynard Keynes was more aware of this than this followers.The concept of a general price level, he wrote, is "vague and non-quantitative" and  "very unsatisfactory for the purposes of a causal analysis": "two incommensurable collections of miscellaneous objects cannot in themselves provide the material for a quantitative analysis."

Secondly, insofar as people think about the general price level, the availability heuristic can lead them to over-estimate its rate of increase. We buy beer, food and petrol every week and so their price rises loom large in our mind. But we buy  books and gadgets only occasionally and so their deflation rate is less salient. This could generate a bias to exaggerate overall inflation.

Thirdly, the general price level is that faced by an average consumer. But many of us aren't average. If you spend less than average on deflation-prone goods, and more on those whose prices rise over time, the cost of living for you might rise more than CPI inflation rates would suggest. For this reason, it is possible - only possible, as there are other factors at play (pdf) - that uprating welfare benefits in line with the CPI represents, in effect, a cut in benefit in real terms.

Fourthly, the fact that the price of technology has collapsed relative to (say) beer over the last 30 years is not just a technical fact about relative prices, but a cause of social change; people respond to incentives, remember. Some of this change might be good - if, say, video games have reduced crime. Other aspects of it, however, might be more ambiguous. I fear (this is just a hypothesis) the decline of pub-going and rise of social networking might be contributing to a hollowing out of the social sphere, in which weak ties - those between neighbours - weaken whilst stronger ties (those between like-minded folk) strengthen. In this sense, worrying about the precise inflation rate is missing the point of what price changes do.

Trend growth

Moody's decision to cut the government's credit rating because of "continuing weakness in the UK's medium-term growth outlook" will, no doubt, focus attention upon the need to raise our trend growth rate.

Doing so, however, might be very tricky.

To see my point, start from the fact that the economy shrank slightly last year. Does this mean our economy is in trend decline? Probably not. More likely, 2012 was just an unusually bad year. But even if we take many years together, it's quite possible that we'll over-sample bad years (or good) and so get a biased measure of trend growth. To reflect this problem, we should measure the standard error of growth. In its simplest form, we do so simply by dividing the standard deviation of growth rates in our sample by the square root of the number of years*.

My chart does this for each 20-year period since 1831; I'm using Bank of England data, updated by the ONS. The two lines show trend growth plus and minus one standard error. Roughly speaking, we can be two-thirds confident that trend growth in any 20-year period was somewhere between these two lines.

Which brings me to the point. Once we allow for this standard error, trend growth doesn't change much. In fact, except for a period to the mid-30s (which covered the post-war slump and Great Depression), it's quite possible that trend growth has never moved much from around 2%.

In other words, whether we have free markets, post-war social democracy or post-Thatcherite neoliberalism, trend growth might be much the same. Neither Victorian virtues of thrift and hard work (and hypocrisy) nor "dependency culture" much affected growth.

I'm not doing anything odd or original here. I'm just making the same point in time-series form as John Landon-Lane and Peter Robertson did in cross-country form when they concluded:

There are few, if any, feasible policies available that have a significant effect on long run growth rates.

It is possible that this is due to luck. Maybe good microeconomic policies have been swamped by bad macroeconomic times and vice versa. Perhaps the interventionist policies of the post-war era were bad for growth, but this was offset by an unusually favourable macro climate, whilst Thatcherite deregulation might have raised growth were it not that bad macro policy gave us two recessions.

Nevertheless, the data suggest that we should be very sceptical of the chances of improving our trend growth rate. Of course, many of the policies recommended by the LSE's Growth Commission - such as better education and infrastructure - are good ideas.But history suggests they are unlikely to have a noticeable effect upon trend growth.

* This method assumes that the observations are independent of each other. This isn't quite true in these data, as the serial correlation between annual growth rates since 1831 has been 0.28. I don't think this overturns my basic point.

The irrational virtue of stubbornness

Arsene Wenger and George Osborne don't seem to have much in common - only one of them has a qualification in economics - but they do. Both this week expressed a will to stay the course despite criticism. Osborne says that Moody's downgrade merely "redoubles" his determination to stay with his plan, and Wenger says he has never for "one second" considered resigning.

Such stubbornness is, of course, common in many walks of life. It is often the product of many cognitive biases, such as:

1. Bayesian conservatism. Both Wenger and Osborne have strong priors that they are right, and they regard evidence to the contrary as sufficiently noisy that it  can be disregarded.

2.Ego involvement.For either man to step down would be a recognition not merely that a set of intellectual propositions is wrong, but that they themselves are not the men they thought they were - not the great Chancellor or great coach.

3. Gratification of enemies. An acknowledgement of error would be a victory for things they hate - Ed Balls in Osborne's case and financial doping in Wenger's. It's one thing to admit error in oneself; it's another to surrender to a loathsome foe.

4. Wishful thinking and overconfidence. It's surprisingly easy to believe things will turn out to one's advantage, especially if you think you're right anyway. So Osbone thinks business confidence will pick up because of low interest rates, and Wenger thinks his players will improve and that he can find new players to strengthen the squad.

It seems, then, as if Wenger and Osborne have much in common. Except for one thing - Wenger is a genius and Osborne, well, might not be. The difference, I suspect, lies in point 1. Wenger's prior that he knows best is founded upon things like: the fact that he's the only coach in 130 years to have taken a team through a whole top-division season unbeaten; the fact that no team that cost less to assemble has finished above Arsenal; and that he has turned countless players from unknowns to world stars. Osborne's prior is somewhat less well-founded.

Yes, Wenger might be biased. But sometimes, cognitive biases are a good thing, as they give us the strength to stick with a correct course in the face of adversity. The author who gives up after a few publishers reject her work, the businessman who gives up after a bank turns him down or sale falls through, and the musician who gives up after a few bad gigs might be behaving rationally. But rationality is not necessarily the road to success. As Richard Nisbet and Lee Ross wrote in Human Inference: Strategies and Shortcomings of Social Judgement, one of the earliest books on cognitive biases:

We probably would have few novelists, actors or scientists if all potential aspirants to these careers took action based on a normatively justifiable probability of success. We might also have few new products, new medical procedures, new political movements or new scientific theories.

If it weren't for the benefits of the biases that generate stubbornness, then, we'd have little art, music, business or science - and we'd probably be living under a Nazi dictatorship.

We should not, then, criticize Osborne for being stubborn. Stubbornness can be a virtue. The problem instead is that he's simply wrong.

Policy failure, no economic damage

Sometimes, even abject policy failure doesn't make much material difference. This is the paradox of the UK government's loss of its AAA credit rating.

Economically speaking, this won't make much difference. As I wrote recently:

Markets are relaxed about the possibility that rating agencies might soon cut the government's credit rating from its present AAA grade. Such a prospect, says Sam Hill at RBC Capital Markets, "is priced in".

And Reuters reports:

Charles Diebel, a fixed income strategist at Lloyds, was sanguine about the impact of the downgrade on gilts, as U.S. and French debt was not badly affected when these countries lost their triple-A ratings.
"This has been speculated as inevitable and is most likely largely in the market. I would expect only very limited damage to the gilt curve and to sterling. Historically, losing your AAA is actually a bond bullish event," he said.

There's a simple reason for this. Ratings agencies don't usually tell investors anything they don't know already, and on the odd occasions when they do, they are  often wrong. There's no new news about the public finances in Moody's statement.

The truth is, of course, that the government's creditworthiness is impeccable, simply because - even if the worst comes to the worst - the Bank of England can print as much money as is necessary to buy gilts. There is, therefore, no chance of the government ever having to default on its obligations to borrowers, unless it chooses to do so.

However, even if you think all the above is wrong and that credit ratings matter, they still don't matter much.

The best measure of what an AAA rating is worth comes from the US municipal bond market. Here, a one-notch rating cut adds 0.23 percentage points to five-year yields.

But this is puny. If we use the Bank of England's estimate (pdf) of the effect of the first £200bn of QE as a guide - it estimates that this reduced gilt yields by a percentage point - an extra £50bn of QE would offset the impact of the downgrade.

However you look at it, then, the economic effect of Moody's move is insignificant.

Instead, it matters only for party political purposes. "We will maintain Britain's AAA credit rating" said Osborne in his Mais lecture in February 2010. "We will safeguard Britain’s credit rating" promised the Tory manifesto (pdf). In this sense, Moody's move represents a failure of policy.

Sometimes, though, policies can be so silly that their failure doesn't much matter.

Encouraging irrationality

Most people agree that rational behaviour is a good thing, which should be encouraged through education or, if necessary, nudging. However, a new paper by Daniel Pi challenges this. In some contexts, he says, we'd benefit if we were less rational.

Take crime. The rational person weighs the benefit of mugging someone - the financial reward and the buzz of the violence netted off against the feeling of guilt afterwards - against the cost; the probability of being caught multiplied by the punishment.

But we don't really want people to think so rationally because it would lead them to actually mug someone occasionally. It would be better if they had the heuristic "don't mug people." Such a heuristic is, however, irrational in the narrow economistic sense, as it would cause people to reject occasionally profitable actions.

The best policy, then, says Mr Pi, is not to debias people, as nudgeists would like, but to bias them - to encourage the spread of the "don't commit crime" heuristic which, whilst irrational for (some) individuals is socially beneficial.

There's an analogy here with the theory of the second best (pdf). This says that if there is a market failure, welfare can sometimes be increased by moving further away from optimality rather than by moving towards it.In similar fashion, moving away from rationality might enhance aggregate welfare.

This issue might be acute in the field of corporate tax. Companies apply economic rationality in considering how to minimize their taxes, but many people think that such behaviour is detrimental to aggregate welfare. If you agree with such folk - which is another issue - the question then arises of how to increase tax morale, to inculcate a "pay fair tax" heuristic. There are (at least) three possibilities:

- Customer boycotts. These operate on the rational cost-benefit calculus of whether to pay tax, but also help foster the "pay tax heuristic" by encouraging a "doing well by doing good" ethic.

- Arrest and punish high-profile tax-dodgers. This can deter crime through the availability effect; people over-estimate the probability of events they can easily see and recall.

- Introduce an element of arbitrariness into the probability of detection and punishment. If people can't calculate the probability of getting caught and punished, they'll decide to err on the safe side.

These last two can be applied to crime generally.But they run into the objection that it's normally desireable that the law be applied equally and predictably. This, though, just repackages the paradox we began with. Part of the case for having clear and consistent laws is that they permit individuals to make rational plans. If, however, those rational plans are harmful to others, then perhaps rationality is not to be encouraged.

Jobless danger for wages

The MSM reports that yesterday's figures show that unemployment fell to just over 2.5 million. This greatly understates the true level of joblessness.

The figures also show that there are 2.32 million who are economically inactive but who would like a job. Adding these to the official unemployment count gives us a total of over 4.8 million who are not working but would like to. That's 12% of the working age population.

One common objection to this calculation is that the inactive's claim that they would like to work is just an idle preference.Such people haven't actively sought work in the last four weeks and/or are unavailable to start in the next two; if they were, they'd be measured as unemployed.

However, other figures yesterday - on labour market flows - show that this objection is false. They show that, in Q4, 423,000 "inactive" people became employed. That's equivalent to 18.1% of all the inactive who'd like a job. By comparison, 595,000 moved from unemployment to work - 23.7% of all the unemployed.What's more, of the 871,000 who lost their jobs in Q4, more moved into inactivity than unemployment (453,000 vs 418,000).

These numbers tell us that, for practical purposes, the distinction between "unemployed" and "inactive" is blurred. In practice, there's not much difference between being "inactive" and being unemployed.

You might wonder how it can be that so many people can find work if they are not actively seeking it. I suspect much hinges on the vagueness of "actively". Consider two people. One distributes his CVs to firms speculatively. The other asks family and friends to listen out for vacancies. You might think the former is "actively seeking" work whilst the latter isn't. But given the importance of social networks for getting jobs, the latter could have as good a chance of finding work as the former.

My point here is not just that the official figures greatly understate employment. There's worse, shown in my chart.It plots the unemployment plus inactivity rate since 1993 (when data began) against real wages four quarters later*.It's a variant of the wage curve (pdf).

This shows that, between 1993Q2 and 2007Q4, there was a humungous negative correlation between the two - of minus 0.94. A greater excess supply of labour led to lower real wages, and less excess supply to higher ones. That's Econ 101.

However, since the recession began, the wage curve seems to have shifted rightwards. The excess supply of labour has not depressed real wages as much as you'd expect. In fact, if the 1993-2007 relationship had continued to hold, real wages would now be almost 20% lower than they actually are.

In this sense, the puzzle is not: why have real wages been squeezed? It's: why have they not fallen much more?

And herein lies a danger. If the wage curve does return to its 1993-2007 pattern, real wages could fall a lot. I don't know how likely this is. But you could interpret the fact that real wages have fallen recently at the same time as the jobless rate has also fallen as a sign that this risk might be materializing.

Perhaps, then, the downward pressures on real wages are much greater than generally thought.

* I define real wages as total compensation of employees, divided by the number of employees, deflated by the CPI.

Happiness, work & productivity

"A happy worker is a productive worker". This might seem like a vomitorious cliche, but some experiments at the University of Warwick suggest that it's true.

Economists paid people to solve some tedious maths problems. They found that subjects who were shown a short comedy film beforehand solved significantly more problems than those shown a neutral film. And subjects who had suffered a recent bereavement solved fewer. "Happiness makes people more productive" they conclude.

This suggests that firms wanting to raise productivity should want their workers to be happy.

But this is not the case. Zoe Williams describes how big employers treat their low-paid workers with contempt and suspicion. And a great new paper by Alex Bryson and George MacKerron shows how even well-paid workers are unhappy whilst they're working. Using mappiness to measure people's momentary happiness, they found that work was associated with lower happiness than all but one of 40 various activities - the exception is being ill in bad. Work makes us even unhappier than queuing or commuting, and is as bad for our happiness as drinking or pursuing hobbies is good*.

This is not true merely for low-paid work. If anything, the opposite; lower paid workers are less unhappy at work, perhaps because they realize they need the money more, or perhaps because they get less happiness from leisure**.

This poses the question: if happiness raises productivity, why don't employers try harder to prevent people being miserable at work? There are, at least, three competing possibilities:

1. It's not technically feasible. High productivity requires a detailed division of labour, but this naturally creates jobs which people find frustrating. As Ray Fisman and Tim Sullivan point out in The Org, some companies' attempts to foster teamwork and camaraderie just fail.

2.Employers fail to see the benefits of obliquity. Making workers happy is an oblique way of increasing efficiency. Monitoring them closely to ensure they meet targets is the direct way. And bosses have a cognitive bias - a form of the representativeness heuristic - in favour of direct methods.

3. Employers aren't interested in productivity, but in profits.And experimental evidence corroborates what we know - that many employers prefer methods which are profitable but inefficient in aggregate to ones which are efficient but less profitable.  

* Sex makes people happiest - even, apparently, if they do it whilst using their phones. 

** This evidence is consistent with the well-known fact that the unemployed are, on average, less happy than those in work, as workers are happier when they are not working.

Politics as stepping-stone

James Purnell, former Work & Pensions Secretary is going to become the BBC's "director of strategy and digital" on a a salary of £295,000 - and no doubt worth every penny. This suggests we should change the way we think of Westminster politics.

Purnell is continuing a trend for quite young people to leave politics for more lucrative work: Ruth Kelly, John Hutton, David Miliband (perhaps temporarily) and even Tony Blair. Whereas politics used to be something one undertook after gaining experience in other careers, it is now a stepping stone, something youngish people do as a means to bigger money*.

Such a path is understandable. Politics offers someone of average-to-decent ability a chance to manage multi-billion pound budgets at a younger age than they'd often get in ordinary business. Sure, they might not accomplish much whilst they are in government. But as Marko Tervio has shown, employers often prefer the mediocrity with a track record to the potential star without, so "Secretary of State for Work & Pensions" looks better on the CV than a string of competently-done junior management jobs.

Once we we regard politics as a means whereby 30- and 40-somethings gain experience before going onto better things, then several things follow:

1. We should be more forgiving of mistakes in both policy and execution. These guys are only learning their craft, so mistakes are inevitable. Politics is youth team football, not the Premier League. Sure, they're making mistakes with our money, but hey-ho.

2.Political reporting - in the sense of who's up, who's down - is not important, any more than is the matter of who becomes deputy assistant marketing director at Amalgamated Aerosoles. Of course, policy matters, as do questions of values about how we are governed. But individual ministers don't matter; they're just passing through.

3. We should expect politics to be biased towards crony capitalism and managerialist ideology not because these are goods way of running the country, but because they are ways in which ministers increase their chances of getting lucrative work later.

* Actually, the distinction isn't so sharp. It was quite common in the 50s for men to become MPs in their early 30s, and ministers have often taken directorships after leaving politics - although many of these were sinecures to subsidize retirement rather than, as now, a career advancement.