Stumbling and Mumbling

Society & markets

Tim suggests that CoE-supported credit unions might not be so able to undercut Wonga. This raises an important point which Conservatives such as Jesse Norman have made - that markets are embedded in society.

Imagine two polar opposite societies. In one, individuals are isolated and anonymous. In the other, they are part of a dense social network of friends, family and colleagues.

In the latter, credit unions and Roscas have a great chance of success. The very fact that lenders already know potential borrowers mean there is no extra cost of screening loan applicants; friends and family can vouch for lenders and guarantee their loans; and borrowers are less likely to renege on a loan if it means betraying frinds and acquaintances and the social ostracism that'll result. By contrast, in an atomistic society, they do not have these advantages and so payday lenders, with their economies of scale, are more likely to thrive.

In truth, you don't have to imagine this at all. It's how microfinance works. Here's Banerjee and Duflo:

Microfinance institutions (MFIs) rely on their ability to keep a close check on the customer, but they do so in part by involving other borrowers who happen to know the customer. The typical MFI contract involves loans to a group of borrowers who are liable for each others' loans and hence have a reason to try and make sure that the others repay. Some organizations expect the borrowers to know each other when they come to borrow, whereas others bring them together by making them come to weekly meetings. The very act of meeting together every week helps clinets know each other better and become more willing to help out a group member. (Poor Economics p166-7)

This is of course by no means the only example in which social structures shape markets. It's trivially true that our peers affect our career choices, and they might even affect fund managers' performance by facilitating insider dealing. But there are many other examples:

 - Low-trust societies are likely to see big markets in security firms and CCTV cameras, but thinner markets in goods and services where asymmetric information is important.

 - Societies with healthy social networks might have lower unemployment rates, because friendship networks help job-finding and so reduce frictional unemployment.

 - Social norms affect the size of markets. Gambling, for example, was a backstreet industry when it was frowned upon, but has become big business since the norm against gambling has weakened.

 - The decline of workers' solidarity and trades unions has led to a more active market in managers, and to higher CEO pay, but also to the decline of working men's clubs.  

All this said, it doesn't necessarily follow that "society" comes before markets. It can be, as Marx said, that both are influenced by technology. For example, the arrival of labour-saving household devices allowed women to enter the labour force, which has shaped labour and product markets in several ways. And it's also the case that markets shape society; a society in which everything is for sale will have different social norms from one where markets are restricted.

And herein lies a danger. The neoliberal priority of individuals over community networks can be performative; it doesn't just describe the world, but shapes it too.  Having given us a society of isolated individuals, neoliberalism also gives Wonga more chance of out-competing credit unions.  

Minimizing misery

The ONS's latest survey of well-being raises a question put in a recent paper by Orsolya Lelkes: should government policy aim at maximizing happiness, or rather at minimizing misery?

She argues for the latter. A good reason for this is that whilst happiness is in large part an idiosyncratic thing, unhappiness is more closely correlated with social conditions, most notably unemployment. For example, today's figures show that the unemployed are almost four times as likely to have low well-being as those in work.

Such a view should be close to consensus. It's consistent with the Rawlsian position that we should maximize the position of worst-off groups. And it's consistent with our concern to protect human rights and prevent crime; crime and rights violations inflict great misery, which is to be avoided.

We might add that liberals of all sorts should prefer minimizing misery to maximizing happiness. It's better that governments focus upon a few social evils than act as a nanny busybodying itself with every detail of our everyday lives; even if libertarian paternalism isn't an oxymoron, it can very quickly lose its libertarianism.

Of course, it would be daft to think governments can eliminate misery - I'm not sure they can or should do much to reduce divorce for example. But there are some things a government concerned to minimize misery would give a higher priority to:-

- Full employment.

- A greater concern with improving poor mental health (pdf).

- Better healthcare generally. Today's figures show that those in bad health are often very unhappy - more so even than the disabled.

- Poverty reduction. This follows from simple diminishing returns; giving £1 to the very poor does more to increase happiness than giving £1 to the rich.

- Racial integration. Black people are almost twice as likely to be very unhappy as whites; Chinese and Indians, though, are less likely to be unahppy.

Curmudgeons might reply at this point that governments should stick to their traditional task of trying to promote prosperity.

But is there a conflict between minimizing misery and raising GDP growth? I'm not sure. For one thing, it could be that long-run growth is much less malleable by conventional policies than thought. And for another, happier people are more productive, more likely to trust others and - being more optimistic - more likely to look for work if they don't have it. In these senses, it could be that policies that aim to minimize misery end up, obliquely, raising GDP.

Whether such policies are feasible under managerialist capitalism is, however, another matter. 

Overconfidence in politics

One of the best-attested cognitive biases - which has effects in boardrooms (pdf) and stock markets - is overconfidence. A new paper (pdf) by Pietro Ortoleva and Erik Snowberg shows that it also has political effects.

They estimated the overconfidence of almost 3000 American voters by asking them what the latest unemployment and inflation rates were, and getting them to say how confident they were of these numbers. They then found that overconfidence on this measure was strongly correlated with ideological extremism, especially on the right. What's more, such overconfidence and extremism were both correlated with the propensity to vote.

In this sense, the shrill partisanship of American politics is rooted in a cognitive bias.

But here's the puzzle. There should in theory be a negative correlation between confidence and extremism; note the tagline of my blog. People should think: "most people don't hold my views; it's possible therefore that they know something I don't". But this view is the minority one. Why?

One reason lies in the asymmetric Bayesianism proposed by Glaeser and Sunstein; we are more sceptical about information that disconfirms our priors than that which corroborates them.

Another reason, say Ortleva and Snowberg, is that "it is very dicult to persuade overcondent citizens that their prior is incorrect as they will tend to attribute contradictory information to others' biases." (I might be guilty of this!).

I'd add that these mechanisms are supported by two others.

One is that politicians are themselves overconfident; you wouldn't enter a career as precarious as politics if you weren't. Leaders thus tend to buttress their followers' confidence (at least in public).

Secondly, in politics, the cost of being wrong might be large for society, but it is small for the individual. Those equity investor who thinks a £5 share is worth £10 will, sometimes, learn the hard way not to be so overconfident.But political partisans don't bear a personal cost for being wrong.

At risk of being epically self-unaware, this corroborates one of my priors - that overconfidence, far from being selected against, can actually be magnified by politics.

Bosses, power & ideology

Fraser Nelson attempts to defend the 1%. I have problems with this. He writes:

If a banker could be found to make RBS so successful that it could be sold at a £20 billion profit for the taxpayer, would they be begrudged, say, a £20 million pay-packet?

This begs the question, in the proper sense of the phrase. In practice, it is impossible to find such a banker. The belief to the contrary reflects several cognitive biases and ideological positions, such as:

 - An underweighting of Hayek's scepticism about the possibility of managing complex organizations in which knowledge is inherently dispersed:

 - An ignorance of the role of organizational capital. Boris Groysberg has shown (pdf) that managerial "talent" is not portable. What determines the success of a hire is not the individual's skill, but rather the match between his skill and experience and the organization's needs.

 - An underweighting of environmental factors, one of which is luck. For example, the best hope of RBS's share price rising is that not so much that good management turns the company around but rather that investors become more risk-tolerant and the risk of a financial crisis recedes, so that its share price rises. This point widens. The market can occasionally sustain poorly-run companies, at leat for long enough for their CEOs to take out millions.

In this sense, demand for managers - and hence their pay - is inflated by the fundamental attribution error and pot hoc ergo propter hoc fallacy which combine to create a faith in "strong leaders" who can transform organizations. And as padeophile priests know, if people have faith in you, you can get away with anything. Bosses can therefore extort millions for mediocre or even disastrous performance.

Fraser's question-begging continues:

Had Fred Goodwin’s mania at RBS been spotted earlier and he had been paid £2 million to go quietly, it would have been money well spent.

But it wasn't spotted. And there's a reason why it wasn't. Management skill is not like sporting or musical skill; it cannot be observed directly by outsiders. We have therefore a problem of asymmetric information. This too gives bosses power, especially as it is combined with the aforementioned biases. And money flows to power.

The market for managers, therefore, is one that's rigged by ideology and information failure. 

But does this matter? After all, the market sometimes rewards mediocre musicians or writers so why should we worry if it rewards bad bosses?

One reason is that bosses don't just get money but power, as politicians and the media defer to them. Another reason is that faith in leaders has an enervating effect. If we're looking to leaders (in business or politics), we are apt to lose the ability to take control of our own affairs; this is the converse of Tocqueville's point, that the virtue of democracy is that it "spreads throughout the body social a restless activity, superabundant force, and energy never found elsewhere."

Now, you might think I'm making leftist points here. I'm not sure. For one thing, New Labour was cringeingly deferential towards bosses. And for another, many rightists should, in principle, support what I say. Hayekians should be sceptical of central organization; no rightist should support market failures; and boss culture militates against good Thatcherite virtues of self-reliance. Why then, should the right be so supportive of bosses? It surely can't be because they simply want to defend inequality, can it?

Another thing: I wish Fraser wouldn't repeat that silly trope about to the top 1% paying so much income tax. If inequality is high enough, the rich can pay a disproportionate amount of tax even if the tax system is regressive.

The transition to socialism

It's a sign of our strange times that not only is the Bank of England more radical than many on the left but also the Archbishop of Canterbury shows more sign of thinking about how to abolish capitalism than many on the left.

His promise to try to compete Wonga out of existence can be seen as part of what Erik Olin Wright calls (pdf) an "interstitial transformation" - the creation of non-capitalist forms of organization in the interstices of capitalism which, if they can expand, could eventually marginalize capitalism itself. So, for example, credit unions and Roscas might eventually grow at the expense of banks (especially if the latter's state subsidy is withdrawn); farmers' markets and even allotments nibble away at supermarkets; the internet is undermining the media and music industries.And so on. These are examples of everyday decommodification.

You might object that this such yogurt-knitting self-indulgence is no immediate threat to capitalism. This ignores two things. First, existing leftist strategies of sanctimonious posturing, talking amongst themselves and hoping for a government with "political will" is no threat to capitalism either. Secondly, small changes can beget bigger ones, for example:

 - If the capitalist media were to go out of business, one source of pro-capitalist ideology would disappear.

 - If people can organize themselves into credit unions and other forms of community activism, it would unleash an energy and appetite for self-determination that could challenge capitalism in other areas. If people can organize some of their affairs collectively, why should they be content to let bosses organize them in others?

 - The growth of non-capitalistic organizations would help shift the Overton window, by demonstrating that alternatives to capitalism are feasible.

But it's not just self-organization that can help here. So too might reasonably modest government policies. For example, some reasonably small tweaks could change universal credit into a citizens' basic income. This would give people the real freedom to choose to work or not. In response to that, firms would have to offer less exploitative conditions, and perhaps even ownership stakes in an attempt to retain workers. That's a stepping stone to socialism.

Or increasing public sector workers' control over their workplace - say by putting services out to tenders from coops - would increase the amount of self-organization and hence set the ball rolling towards socialism.

Now, these are only a few examples. More imaginative and knowledgeable folk than me could no doubt think of others. My point here is that lefties should consider the interplay between policies, institutions, norms and culture. It's possible that some small changes in policies and institutions can eventually have big effects, to the extent that they encourage the growth of anti-capitalistic norms.

The transition from feudalism to capitalism did not generally happen because peasants protested in the streets, nor because they found a government with the "political will" to overthrow feudalism. It happened because a sequence of smallish individual actions - often without consciousness of their full effects - meant that, eventually, people found better things to do than obey feudal lords. Perhaps the transition from capitalism will occur in a similar way.  

"Unsustainable" economic activity

Allister Heath wants more "good" GDP growth:

Good growth is sustainable in the strict sense of the world: it is the kind of activity that would continue in the absence of subsidies and if the cost of money rose again to properly reflect the supply and demand of funds, long-term output expansion, expected inflation and other risks.

This, though, under-rates the benefits of "unsustainable" economic activity. I'm not just thinking of the trivial fact that a temporary income is better than none, but of other mechanisms:

 - Temporary booms can leave positive legacies, as Daniel Gross has pointed out; they can leave us with a useful infrastructure of railways, broadband connections and (sometimes) housing that we wouldn't otherwise have.

 - Even "bad" businesses can be useful learning experiences, which equip entrepreneurs to go onto success. Thomas Edison said: "I have not failed. I've just found 10,000 ways that won't work."

 - Apparently "bad" businesses might become good ones, if there are learning by doing effects. "Fake it till you make it" isn't a great business strategy, but it's a possible one.

 - Temporary spells of employment can improve workers' skills and working habits and so make them productive later, thus avoiding hysteresis effects whereby the temporarily unemployed can become permanently deskilled.

But there's another issue here. How can we distinguish between "artificial" economic activity created by loose monetary policy and that arising from over-optimism, bad business plans or plain bad luck? In normal times there is a massive amount of creative destruction; on one estimate (pdf), the UK economy created and destroyed around 50,000 jobs each week between 1997 and 2007. How can we tell how many of the 50,000 jobs created are "sustainable"?   

You might think we can't, until after they've disappeared: as Warren Buffett said, it's only when the tide goes out that you can see who's been swimming naked. But even this won't do. In their study of the 1990-91 recession Paul Gregg and Paul Geroski point out that there was little correlation between firms' pre-recessionary efficiency and their vulnerability to recession. There is, they say, a "large random component" affecting who gets hurt in a recession. The best way to ensure that firms are efficient is to ensure vigorous competition, not to hit them with occasional recessions.

Worrying about "sustainable" or "unsustainable" economic activity is, therefore, pointless. We can't distinguish the two, and it doesn't matter.

I say all this to raise a paradox. Mr Heath is generally seen as a man of the right, whilst I'm a Marxist. But it's Mr Heath who looks like a Guardianista fretting about "good" and "bad" activity whilst the Marxist is reminding him of the virtues of tumultuous market activity.

This is, of course, not simply a matter of his and my idiosyncracies. If you're looking for people who believe in old-style central planning, you'll find them among CEOs who think they can manage sprawling multinationals from a head office, and among fund managers who think - contrary to most facts - that they can spot good investments better than the market. We Marxists, however, have learned from our mistakes and are interested in ways of decentralizing economic activity. A belief in central planning these days is to be found in boardrooms and in fund managers' offices  more than on the thoughtful left.

In defence of high house prices

Graeme Leach of the Institute of Directors says the government's Help to Buy scheme is "very dangerous". Viewed from most perspectives, he's right. It's surely a bad idea for the state to help overpriced assets become even more overpriced.

From one perspective, however, it does make sense. High house prices help to increase the supply of labour.

Let's look at this from a Keynesian perspective. In 1930, Keynes forecast (pdf) that by 2030 real incomes per capita would be four to eight times their 1930 level. A point may soon be reached, he said, when our absolute needs are satisfied, "in the sense that we prefer to devote our further energies to non-economic purposes." He thought the working week would drop to just 15 hours.

This forecast has been half right: real incomes are now 4.5 times 1930's level. But it has been half wrong; the average working week is twice Keynes's forecast. Why?

One reason, of several, is that housing costs have risen. In 1930, these comprised just 9.5% of consumer spending. Today, they comprise 25.8%*. Our absolute need to live somewhere is keeping our noses to the grindstone.

Let's put this another way. Imagine we had a massive housebuilding boom which reduced house prices and rental costs to reasonable levels. It would then be possible for people of above-average earning ability to downshift or even completely retire after a few years. This would be especially true to the extent that, for some important goods such as music, we are close to a post-scarcity society. 

The complaint that Anne McIntosh recently made about GPs - that they are scarce because many women work part-time - would be one that would be repeated across the economy. Skill shortages would bid up wages and squeeze profits.

What's more, there'd be an adverse selection effect. If we could afford to downshift in our 30s or 40s, who would choose not to do so? It'd be the narcissists (pdf) and psychopaths who gain satisfaction from occupying positions of economic power. Sure, these already are already (pdf) disproportionately prominent in boardrooms: I suspect one contributor to the banking crisis was that less money-motivated types left the industry having earned enough. But imagine how much worse things would be if their more balanced colleagues left the business.

In a sense, I agree with David Boyle:

People are less free when they have to pay half their income in housing costs or more, less in control of their lives and much less able to follow the career and life path that thrills them most...
I don't want my children eking out a living in indentured servitude to their landlord, in a job they loathe but need just to pay the rent.

However - and here Marxists disagree with liberals - the purpose of capitalist economic activity is not to increase our real freedom, but to increase profits. High and stable** house prices, insofar as they facilitate indentured servitude, achieve just this.

* I'm comparing table 24 of Feinstein's Statistical Tables of National Income, Expenditure and Output of the U. K.: 1855 - 1965 to table E1 of this pdf.

** That word "stable" matters. Rising house prices can depress the labour supply by permitting some people to retire on their capital gains. 

Identity & punishment

Can experimental economics shed light upon the Trayvon Martin case? I ask because of a recent paper by Jeffrey Butler and colleagues.

They got people to play a simple dictator game, in which one subject was given some money to divide between himself and a partner. Third parties were invited to watch and to choose to punish the dictator if he made what they thought was an unfair division.

They found that, on average, observers chose to punish unfair offers even when they had to pay for doing so. This is a routine finding; we have a taste for fairness and are willing to pay for that taste.

But here's the thing. Observers were then split into two groups, depending on whether they drew a blue or red chip from a bag. They then found that observers were keener to punish unfair decisions by dicators from the "other" group. Whereas observers were willing to pay 33 cents to fine a dictator €1 if he was in their group and made an unfair offer to a group member, they paid 47 cents if the dictator was in the other group and treated one of the observers' group unfairly. That's a 40% difference.

We are, then, much more willing to punish members of the "out-group" for an offence than we are to punish members of our own group. You can easily imagine an evolutionary reason for this; moral norms evolved to protect the group, especially from predation by outsiders.

This is where the Martin case enters. Blacks and liberals regard Zimmerman (perhaps wrongly, but no matter) as one of the out-group and are therefore keener to punish him than those who regard him as one of "them". There is of course nothing new in this. It's consistent with a vast range of behaviour, from the horrible to the trivial:

 - Demagogues who want to commit genocide first take steps to establish their victims as an out-group, and a threatening one at that.

 - In the deep south, blacks were lynched for things that wouldn't have been crimes at all had a white person done them.

 - The attempt to distinguish between strivers and skivers is a means of legitimating welfare cuts not just because it tries to paint skivers as undeserving, but because it paints them as an out-group, who can be punished harshly.

 - One reason why MPs' expenses created such a furore - when such behaviour had been going on for ages - was that they had grown distant from the public, who thus regarded them as outsiders and so were keener to punish them.

All this is consistent with the idea that social capital has a dark side (pdf) - a desire to hurt outsiders. As Charles says: "Social solidarity, tradition and community (all good) can end up being defensive and fearful of 'otherness' (bad)."

But there's second message. Professor Butler created social divisions in the weakest and most trivial way possible - by simply drawing chips. If divisions formed in this way can be sufficiently strong to generate significant differences in willingness to punish, isn't it likely that real-life social and ethnic divisions can be easily deepened by ideology, rhetoric and other cues? And mightn't such divisions have some terrible effects?

Peter Barlow: a study in behavioural finance

It's my convinced belief that there's more good economics in Corrie than there is in "serious" current affairs TV. Peter Barlow's impending loss of his bookie's shop reinforces this view.

His behaviour demonstrates three findings in behavioural economics.

1. When he started to lose money, Peter took reckless risks in an attempt to break even. This is an example of prospect theory at work - the tendency for people to gamble in an effort to recoup their losses.As Kahneman and Tversky wrote in their classic paper (pdf): "a person who has not made peace with his losses is likely to accept gambles that would be unacceptable to him otherwise."

2. Faced with the prospect of paying out on a 58-1 accumulator, Peter failed to lay off the bet. This is an example of ignoring tail risk - the small chance of big losses.

3. One reason he ignored such a probability was that he wanted Rob to lose: "Not only did I want to beat him, I wanted to beat him with one hand tied behind my back." His judgment of probability was coloured by motivated reasoning.

However, Peter's mistakes are not isolated ones. They are quite common in the financial world:

 - "Breakevenitis" is one reason for the disposition effect - the failure to ditch losing investments. This lack of selling pressure is one reason why the negative leg of momentum investing has so often paid off; it causes prices of losing stocks to be too high, with the result that they drift down later.

 - The ignorance of tail risk - the small danger of default, of of liquidity drying up or of counterparties failing to pay - was one factor (pdf) behind banks' failures in 2008. 

 - Libertarians who bought bitcoins above $100, gold bugs who bought gold above $1400 and the various inflationistas who are looking silly now are all sitting on losses caused by motivated reasoning - a wish that the world will conform to their political beliefs. Some neat experiments by Guy Mayraz have shown how easy it is for investment opinions to be shaped by wishful thinking.

Now, here's the thing. Peter has little education and a dubious grasp on his rationality; Rob calls him "a dry drunk who could spin out of control any second" and The World's Most Perfect Woman says he's driven by "macho pride."  And yet allegedly sophisticated "skilled" professional investors make the same mistakes he does.

Evil Tories?

Sunny Hundal has caused a stir by calling right-wingers "evil." For me, this raises a distinction between the Marxist and non-Marxist left: whereas the non-Marxist left often claim a moral superiority over the right - see Comment is Free, passim, if you can bear to - Marxists do not.

For us, the problem isn't that Tories are bad, or liars or stupid. Sure, some are - but a glance at Simon Danczuk, Liam Byrne or Siobhan McDonagh will remind us that Tories hardly have a monopoly here. Instead, for Marxists, immorality is an attribute not so much of individual agents but of the capitalist system itself.

Take, for example, exploitation and bad pay. These, said Marx, don't happen because individual capitalists are evil or greedy, but because competition forces working conditions down:

Capital is reckless of the health or length of life of the labourer, unless under compulsion from society…But looking at things as a whole, all this does not, indeed, depend on the good or ill will of the individual capitalist. Free competition brings out the inherent laws of capitalist production, in the shape of external coercive laws having power over every individual capitalist.(Capital vol I ch 10 pt 5)

From this perspective, the problem with Tories isn't that they lack a moral code, but rather the opposite - they put too much weight upon morality, and fail to see that this agency is circumscribed by capitalism itself. Take two examples.

 - Jesse Norman wants bosses to be public spirited rather than pure profit maximizers. But this ignores the fact that the firm that pays lots of taxes and decent wages will suffer a competitive disadvantage against those that don't. Depending upon how finely the wheels of competition grind, this might not be possible. It also ignores the fact that the neoliberal ideology that sustains capitalism is performative; it instils in bosses a moral norm against paying taxes or decent wages.

 - Tories want the unemployed to look for work, to have a work ethic. But this ignores the fact that, in a world of chronic excess supply of labour, workshyness is a rational response. "Bad ethics" of low expectations and helplessness are an effect, not a cause. What Banerjee and Duflo wrote of the global poor is true, mutatis mutandis, of the UK's poor:

In the same way that the poor may save less than the middle class because they know that their savings will not be enough to reach a consumption goal they are really looking forward to, they may not invest as much (not only money but also emotions and intellectual energy) in their businesses because they already know that they can't make a real difference (Poor Economics, p224)

You might object here that Tories are "evil" in that austerity is doing real damage. True. But this omits two points. First, they are not pursuing austerity because they want to hurt people, but because they believe it will do good; this is an intellectual error, not a moral failing.

Secondly, austerity is not the only - or even main - cause of our woes. Capitalism was ailing well before Osborne became Chancellor. In this sense, talk of "evil" Tories does capitalism a favour, by deflecting attention away from its systemic shortcomings.