Peer effects matter for consumer spending. A new paper finds that "the consumption decisions of U.S. households are to a large extent driven by upwardly directed interpersonal comparisons." That is, we spend more if our neighbours are living it large.
This is not a new finding. It corroborates Robert Frank's theory of "expenditure cascades", evidence from the effects of the Dutch postcode lottery, and the large literature on the importance of peer effects.
This means Boris Johnson had a point when he said (pdf) that keeping up with the Joneses is a "valuable spur to economic activity." But it also supports those who blame the crisis (partly) upon inequality: people's efforts to emulate the spending of the rich led to them becoming over-borrowed.
But there's an angle here that is under-appreciated. Peer effects help explain why economic forecasting is a mug's game.
The argument for forecasting is that, across millions of people, individuals' whims cancel out. If this is so, the law of large numbers means we can ignore the crooked timber of humanity and think of a representative consumer responding predictably to changes in wealth, interest rates and such like.
But if peer effects are important, the law of large numbers no longer holds. If I buy a new car (I just have), my neighbours could so so as well. If so, my spendthrift urge ceases to be idiosyncratic. Instead, it's possible that whims can "go viral."
Now, you might object that, in practice, macroeconomic forecast errors are rarely due mainly to mispredictions of consumer spending relative to incomes. However, peer effects might also apply to corporate spending decisions. One reason for this is that, because bosses talk to each other at conferences, clubs and suchlike, firms' animal spirits are as likely to be at least as infectious as households'. Also, there's a business case for peer effects to hold; if a rival invests in cost-cutting equipment, you have to do so or else be competed out of business.
My point here is simple, and unoriginal - though not recognized by the swinish multitude which thinks economists should be in the forecasting game. It's that the economy cannot be treated as if it comprised merely a "representative" consumer or firm, but rather that interactions between agents matter and these mean that the economy is a complex emergent process which renders forecast errors all but inevitable. For this reason, we should not take seriously whatever forecasts the OBR makes on Thursday.
The idea of 'peer' spending is another one of those things where a multitude of other variables comes into play, which make the theory almost redundant. Therefore abstraction in this case is problematic.
But if we were to abstract, any theory of 'peer' must be at a general level, it cannot be individualised. One individual cannot cause a trend, unless maybe it is a celebrity, which is where advertising comes into the equation. The 'great peer' is on the TV screen.
The things that cause spend reductions and spend spikes are not to be found in 'peer' theory.
I would say that society today (in the UK at least) is more consumer conscious than it was 30 years ago, that was created by design, it didn't happen by accident.
Posted by: Deviation From The Mean | December 03, 2013 at 05:35 PM
Bosses travel in herds. I used to dread one chap who after a conference would return with a raft of damnfool ideas.
There is an entire industry devoted to flogging old wine in new bottles. Remember PERT and CPA, then we got Management by Objectives, BPR, Matrix Management and Six Sigma to name but a few. As they used to say of academics 'take something very simple - and make it very hard'. But really the whole process is about drumming up razzamataz, raising FUD in the chairperson's mind and moving cash from one pocket to another - was ever thus.
Another sales angle is the necessity for firms to 'appear up-to-date' with the latest gizmos - otherwise bright people will see their careers stagnating and thus quit and move on. All makes work and drives the wheels round and round. As for the OBR and Osbo, just a small part of the same game.
Posted by: rogerh | December 04, 2013 at 07:32 AM
Very interesting to compare this with the millenium bridge wobble.
Standard practice was to assume lateral loading (as feet are not central there is a tiny sideways push as we walk from each foot to keep us moving in a straght line)all even out and their effect is small. However, as the bridge reacted, it altered the behaviour of the people on the bridge: making more people walk in step and thus excite the bridge further. Only when people felt uncomfortable did this stop.
Would be interesting if the modelling concept that came out of the research into the bridge could help in modelling peer effects. Some areas of activity will act like "normal" bridges others like "wobbly" ones.
http://www2.eng.cam.ac.uk/~den/ICSV9_06.htm
http://dx.doi.org/10.1061/(ASCE)1084-0702(2001)6:6(412)
Posted by: Mark C | December 04, 2013 at 03:51 PM