Stumbling and Mumbling

On hedonic adaptation

To the untutored eye the typical Gooner doesn't seem to have much in common with Peter Barlow, only one of them being a bell-end*. But he does. Both show the importance of hedonic adaptation.

What I mean is that, from one perspective, Gooners should be relatively happy with their season. Back in August, many pundits thought Arsenal would struggle to finish above S***s. Had you told them back then that they'd enter April seven points clear of S***s, nearer to second place than fifth and with a clear run to the FA Cup, most Gooners would have been reasonably content. This is especially as they are competing with a massive handicap; their three main rivals have collectively spent over £800m more than them.

But they are not so happy. One reason for this is that they've suffered some painful losses. Another is that Arsenal were for months at the top of the table, and that success raised aspirations. Rather than think "we've proved the naysayers wrong again", they think "we were going so well and now it's fallen apart. They had adapted to their good position in the winter, and so now feel miserable,

This is of course a common phenomenon in football. Many coaches have been sacked because they've improved their teams fortunes and in doing so have raised expectations to unreasonably high levels and so left themselves vulnerable to disappointment.

This is where there's a parallel with Peter Barlow. You might imagine that a man who'd copped off with the world's most perfect woman** would be pretty satisfied, especially if he's bringing as little to the table as he is.  Rather than rejoice in his luck, though, he's doing the dirty on her.

What we have in both cases are examples of hedonic adapation. We quickly become accustomed to happy circumstances, and so take them for granted and want even more - even to the point of jeopardizing what we have.

My point here is that what's true for incomes also applies to many other things, as Andrew Clark has shown.

So far, so clear. But here are two complications.

First, not everyone hedonically adapts. Many Gooners are reasonably content with their team. There's heterogeneity here.

Secondly, although such adaptation is sometimes costly - it makes us unhappy and (as Peter Barlow will discover) can lead to behaviour with costly payoffs - it also has an upside. It is the desire for more that drives economic growth and progress. If Steve Jobs had taken my attitude ther moment he'd made decent money - "sod this for a lark, I'm retiring to Rutland" - we wouldn't have the iPod or iPad.  

* We must distinguish here between the median and mean. Although the median Gooner is not a bellend, the average one is. This is because Piers Morgan scores infinity on the bellendomoter, and infinity divided by n equals infinity.

** Alison King is of course yet more evidence that all the best things in England come from Leicester and its environs.

Osborne's spending paradox

In the Times yesterday, Daniel Finkelstein pointed out that most of the squeeze on public spending has yet to happen: "The big battle is only just about to begin" he said.

He's right. OBR data show that since 2009-10, total spending spending fell by only 3.5 percentage points of GDP to 43.5%. But it's projected to drop by another 5.5 points by 2018-19. That would take the share of public spending in GDP to its lowest level since 2001-02, and lower than anything we saw in the Thatcher years.

This raises a question: why hasn't the government made more of a case for a smaller state, preferring instead to stress the need for fiscal austerity? It's failure to do so has drawn criticism from both right and left. Allister Heath has asked where Osborne's vision is, and Phil has written:

The deficit (which does need sorting) has been a policy drawbridge across which Osborne and Dave have marched a phalanx of ideologically-driven cuts to public spending.

To an economist this seems an inversion of logic. The claim "we need to cut spending to reduce the deficit" verges on the nonsensical: see Simon Wren-Lewis, passim. But the claim "a smaller share of government spending in GDP would be a good thing" is if not correct then at least more intelligent than deficit fetishism. You can point to evidence that smaller government promotes economic growth and perhaps even happiness. You could argue, McCloskey-style, that a smaller state and bigger market sector would eventually promote bourgeois virtues. And you could, following Vito Tanzi (pdf), contend that there's no link between public spending and various measures of well-being: Japan and Korea, for example, combine small states with reasonable income equality, and there are good reasons for leftists to favour a smaller state.

This poses the question: why does Osborne - and the coalition generally - use bad arguments for cutting public spending when better ones are available?

One possibility is that the UK has a social democratic culture, so explicit arguments for a smaller state won't wash: the Overton window doesn't exclude merely leftist ideas. This, though, runs into the problem that Osborne merely plans to take the share of public spending in GDP to slightly above the level it was under the first four years of Gordon Brown's chancellorship. That's hardly swivel-eyed minimal statism.

Here, then, are three other possibilities:   

 -  The secular stagnation hypothesis might be right. The private sector might have been vibrant enough to fill the space left by a shrinking public sector in the past, but it's not now.

 - Politicians have lost the ability to argue about values such as the size of the state, and prefer to hide behind pseudo-managerialist gibber about the "necessity" for cuts. An appeal to the deficit bogeyman fits this preference better than the ideal of a smaller state.

 - We can't rely upon efficiency gains to offset spending cuts. Danny calls for "relentless pressure on the public sector to provide the same services for far less money." But this pressure might fail because of counter-pressure from bureaucratic capture or Baumol's disease, or simply because of bounded managerial ability. If so, a smaller state means worse public services - and that'll take some justifying.

I'm not sure what the answer is here. But I'm pretty sure that there's a paradox here, that bad arguments for shrinking the state are preferred to less bad ones.

The tyranny of party politics

There's something I find depressing about the Tory whining about Duncan Weldon's appointment as Newsnight's economics editor. It's a sign of the tyranny of party politics.

Put it this way. Would there be so much moaning if an arts or sports reporter had leftish views? I suspect not, because arts and sports are (mostly) obviously separate from party politics. The fuss over Duncan's appointment therefore reflects a belief that economics reporting is party-politically sensitive.

Of course, this is obviously true for some aspects of economics, such as the debate about fiscal policy. But there's much, much more to economics than this small matter. Many questions can be discussed indepdendently of party politics, such as: are we really in a period of secular stagnation? Will robots take our jobs? What are the pros and cons of behavioural economics? How does evolutionary economics help illuminate social affairs? What, if anything, can we learn from happiness economics, or neuroeconomics? And so on.

The idea that someone's leftist opinions debar them from a job requiring some kind of political neutrality seems to rest upon at least deeply dubious views: that a journalist can't leave his opinions at the door and be impartial; that economics is a branch of party politics; and a narcissistic tribalism that wants to hear its own ideas echoed back to it.

It doesn't have to be like this. I've managed to spend 20 years at the IC, even though - I suspect - most readers aren't sympathetic to my Marxian views. This is because these three ideas don't apply to me; I can, mostly, hide my Marxism; much of what I write about is independent of politics; and my readers are intelligent enough to want to read something interesting rather than stale reminders of what they already believe*.

The tyranny of party politics here consists of two forms. The obvious one is the demand for "impartiality" between the main parties - or, to be more accurate, a balance between truth and falsehood.  

But there's another, more subtle tyranny. If economics is subordinated to party politics, some issues will be kept off the agenda. Neither Labour nor the Tories would be keen on an economics writer who raises thoughts such as: maybe politicians can't do anything to raise long-term economic growth; perhaps bosses pay is a reward for power rather than skill; economic forecasting is impossible so talk about fiscal policy in the next parliament is mostly otious; or perhaps there are more intelligent ways of allocating public goods than by government decree.

Ideally, we would discuss economics without having to defer to imbecilic, narrow-minded (and partly irrelevant) party politicians. And, happily, in many contexts such as this one we can. Duncan, though, has lost this freedom. I think he deserves better.

Another thing. Of course, there is a huge overlap between economics and politics: both are about who gets what and how? But the problem is that party politics is not the same as politics; the latter is about the conscious examination of power, whereas the former quite often is about obfuscating the nature of power.

* Granted, I have few readers - but this only shows that there's a sharp trade-off between quality and quantity.

Randomness in decision-making

Nobody will thank me for saying so, but I have a bit of a mancrush on Ed Smith. Yet again, he has raised a profound point in the social sciences:

Nakedly ambitious people rarely achieve their ambitions...Simplistic self-interest is not just bad PR, it is often bad strategy. It suffers from a fatal flaw: it is predictable.

This draws our attention to the fact that, in some domains, randomness is the best policy.

This is most clear - and has been formalized by game theorists - in the case of games such as rock-paper-scissors where predictability leads to defeat. In such circumstances, the optimal strategy is to randomize.

To what extent do such games exist in the real world? They're common in sport. The penalty-taker who always aims low and left will find goalkeepers quickly wising up. The batsman whose best shots are all on the legside will soon get most balls pitching outside off.

I suspect they exist in other fields. If you're negotiating with a nutter who might randomly choose violence, you might well make concessions that a more rational counterpart couldn't extract; Colonel Gadaffi stayed in power for so long in part because of this, and it seems to have worked for North Korean dictators. One reason why interviewers at Oxbridge or Google have traditionally asked candidates unpredictable questions is to test their powers of thinking on their feet. And one sign of genuine entrepreneurship is the ability to do - or blunder upon! - the unexpected, to wrongfoot rival companies.

However, randomness doesn't just work when the other player is trying to anticipate our actions. It can also work where there's environmental uncertainty.

Take a simple example. Strategy A has a 60% chance of a payoff of 3 and a 40% chance of a payoff of zero. Strategy B has a 40% chance of a payoff of 3 and a 60% chance of a payoff of zero. A is obviously the strategy with the highest expected payoff.

But it doesn't follow that it is the optimum strategy. If the payoffs are the number of descendants the members of a species has, then when that 40% chance comes up, followers of strategy A go extinct.

To maximize the chances of survival, a mixed strategy is needed. The species that randomizes will therefore survive. The one that "optimizes" does not*. This was the failure of the banking system in 2008. In trying to "optimize" banks ran the risk of extinction.

As John Kay showed, very often our goals are reached not through direct optimization, but obliquely.

And as Bruno Frey argues in a new paper, there's much to be said for using random selection in numerous contexts.

This poses the question: why, then, is randomness not used more often? And why do almost no decision-makers admit to using it, preferring instead to emphasize their "careful judgment"?

I suspect it's because we have fallen into a practice of cargo cult optimization and management. In business, politics and even in parts of our personal lives, we use the gestures and language of direct control in the hope that these suffice to achieve our aims. But sometimes, they don't.

* The scare quotes are because I want to duck the question of whether randomization is a form of rational maximization or an alternative to it. In biology, for example, mixed strategies are not consciously chosed by species but rather emerge by selection if they do so at all.

Football as financial economics

Watching the Chelsea-Arsenal game on Saturday - or at least the first 30 minutes - made me think about the parallels between football and financial economics.

In Arsenal's case, we have an odd example in sport of tail risk. Ordinarily, teams play a bit better than normal or a bit worse but performances and results are usually roughly normally distributed. Not so for Arsenal. 10% of games this season acount for 50% of goals conceded. And the 6.7% of playing time before 1.30pm accounts for 32.4% of goals shipped: as the BFG says, Arsenal don't fancy mornings.

In finance this sort of extreme negative performance is sometimes due to hitherto uncorrelated assets or strategies failing at the same time; this is how LTCM collapsed in 1998 and AIG in 2008. A similar thing happened with Arsenal. Normally, one or two players in any game will put in sub-par performances but they will be offset by others doing well. On Saturday all eleven had stinkers.

It's in this context that there's one characteristic of players that is highly prized but rarely fully acknowledged - what we might call negative betaness.

Investors value negative or zero beta assets - things that pay out well in bad times. it's the desire for these that explains: the existence of the insurance industry; the fact that deep out-of-the money put options have a positive price; and the fact that cash holdings are high even at near-zero interest rates.

Similarly in sport, a great player is someone who does well in bad times. It's unimaginable that Arsenal would have lost 6-0 with Tony Adams, because he'd have kicked them into shape.

Most of the best sides of recent years have had negative beta players - ones who didn't just play well, but played well when they needed to and got the vital goal or put in a great defensive performance when under pressure.

One thing that (for now) elevates Robin van Persie over Luis Suarez is his negative betaness. Suarez tends to do well against modest opposition but less so against big teams. But - as we saw against Olymiacos - van Persie gets goals when his team needs them. One's a high beta player, one's a low/negative beta one.

For me, one feature of a truly great player - Keane against Juventus in 1999 or Gerrard in the 2005 European Cup final - is their negative betaness, an ability to produce something when their team is desperate.

The same is true in cricket. Graeme Hick was, notoriously, a flat-track bully - a high beta player. Mike Atherton on the other hand was a negative beta player, scoring runs when they were needed.  

Coaches are forever demanding consistency - in the sense of low variance of performance. What they should also look for is negative beta. Arsenal lacked such players on Saturday.

The parallels between football and financial don't end there. One feature of stock markets, famously noted (pdf) by Robert Shiller, is their tendency to excess volatility as investors over-react to good or bad times. The same, of course, is true in football. One or two good results has that great moronfest 6-0-6 full of callers telling us their team will win the league and one or two bad ones means the manager is an idiot. In the few weeks he's been in charge of S***s, Tim Sherwood has gone from being a promisingly good manager to a lousy one, and back again.

There is, I think, a point to all this. It's easy to think of financial economics as something abstruse and technical. But it's not. As I've said before, the main ideas of financial economics are applicable to other walks of life. 

Ideology & behavioural economics

Tim Harford's brilliant essay on behavioural economics highlights an ideological bias in the way the subject is used.

What I mean is that he presents it as "a hot idea for policy makers". This underplays two things.

One is that politicians themselves might be as prone to cognitive biases as the public. Indeed, it's possible that they are selected for such biases - because the overconfident are disproportionately likely to enter politics and because irrational consumers are likely to make irrational voters. The image promoted by behavioural economics (or its users) - of rational policy-makers operating upon irrational subjects - is therefore questionable.

The other is that there's an alternative use of behavioural economics. It could serve an educational function - of telling consumers what errors people commonly make, and of warning them against them. A lot of my day job is just this.

In this latter context, the complaint some make against behavioural economics - that it is a "patchwork of sometimes-fragile psychological results" rather than general laws of behaviour - loses its force. If you're a policy-maker with a "predict and control" mentality you might want general laws. But if you just want to help others improve their decision-making, the knowledge that some/many people make a particular error in a particular context is useful enough.

Behavioural economics gives economists the chance to live up to Keynes' ideal of them, as dentists giving humble competent advice. And it's a chance they are blowing.

Now, you might reply here that it has always been so, Economics has long been pompous white men in suits speaking to other pompous white men in suits, rather than a dialogue with the public. That's true. But there's a big difference between telling politicians "people are rational maximizers so leave them alone" and telling them "people are stupid and here's how you can manipulate them."

In this context, there's both similarity and contrast between users of behavioural economics and Marxists. Both believe that ideology or cognitive biases (they're much the same) stop people pursuing their best interests. Where they differ is in how they respond to this. Marxists think people should be educated out of ideology and therefore empowered: "the emancipation of the working class must be the work of the working class itself”. Most users of behavioural economics, by contrast, see cognitive biases as just more policy tools, and thus ways of empowering rulers. But it needn't be so.

Fairness and the majority

Richard Murphy touches on an issue which, though neglected, divides political activists from many observers, and social democrats from Marxists. He says: "[when] it comes to fairness  majority opinions matter."

Now, this is true in the sense that a society whose policies and institutions violate the majority's perceptions of fairness will be an unstable one - as nation-builders often discover.

Where it is doubtful, though, is whether majority opinion decides what's fair.

There's a long tradition in ethical thinking, from the book of Exodus - "Thou shalt not follow a multitude to do evil" - to Amartya Sen (pdf) and some interpretations of intersectionality which doubts the ability of the majority to decide what's fair.

Most of us would accept these doubts in the context of other societies. We don't think the repression of women and gays is fair in Saudi Arabia, nor that it was fair in the past, merely because most people in Saudi Arabia or in early 20th century England thought them so. The statement: "slavery was fair once" would strike most of us as absurd, or at least as requiring a lot of justifying.

But why should we suspend such doubts in today's Britain? Most people - to take one example - agree with the statement: "it is fair that foreigners should be excluded from much of the UK labour market." But a few decades ago, most would have agreed with the statement: "it is fair that women should be excluded from much of the labour market." What, morally speaking, is the difference? Could it be that we see one merely because Peter Singer's "expanding circle" of concern has expanded to include women but hasn't yet expanded to include foreigners?

Let's face it, the standard of public "debate" about moral questions is not high; most claims about morality are mere emotivist spasms or expressions of narcissistic self-righteousness.

I suspect - though this might be the confirmation bias! - that recent thinking has deepened scepticism about the ability of the majority to perceive what's fair. Cognitive biases such as the just world fallacy, stereotype threat, adaptive preferences and anchoring effect help to provide popular support for inequality; John Jost calls this system justification (pdf).

It's in this context that there's a difference between Richard and me. He says:

On the welfare cap I have no doubt the majority will consider what is being proposed  to be profoundly unfair if they realise just who is affected.

But I don't much care what the majority thinks; the cap is either fair or not, regardless of what the majority think.

This difference reflects two differences between us. One is that Richard's a social democrat and I'm a Marxist. Whereas social democrats try to work within the confines of what the public considers "fair", and try to tweak those perceptions, we Marxists fear that this is a forlorn task because the power of ideology warps those perceptions.

The other is that Richard is an activist and I'm an observer. And in a democracy, success as an activist is determined by what the majority think - by whether you win elections; how often do we see politicians cite opinion polls as if they decided matters?

And this is what bothers me. Public opinion might decide what is a successful political strategy, but it is more questionable whether it should decide what is a morally right one. One of my fears about Labour politics is that this distinction is often ignored.

Ex-growth

Once upon a time, we used to think that the function of the financial system was to channel savings from households - who were savings or for a rainy day - towards companies who could invest them productively*. That world has gone, and it won't return for some time if you believe the OBR's forecasts.

These show that whereas companies are expected to run a financial surplus throughout the next five years - albeit at a declining rate - households are expected to start to run a deficit.

If the OBR is right, this means that, by the end of this decade, we'll have seen 18 years in which (except for one quarter) companies have run a higher financial balance than households.

This stands on its head the old-fashioned image of financial intermediation. This now consists of transferring corporate savings to households, to spend on housing.

Now, of course the OBR's forecasts might well be wrong; forecasts are. But they seem plausible. If we see a normal upturn the share of profits in GDP will rise, as mass unemployment continues to hold wages down. Allied to a continued (if slightly lesser) dearth of investment opportunities, this will keep retained profits higher than capital spending. Meanwhile, households could respond to that squeeze on wages by saving less.

This picture is consistent with the corporate sector having gone ex-growth. It's common for large mature companies such as Next to generate more cash than they can usefully invest. "UK plc" generally has been in this position for several years, and the OBR expects it to remain so.

Curiously - as with the productivity collapse - George Osborne failed to mention this in his speech yesterday.

But it surely is of immense significance; can an economy really prosper for long merely by building and selling houses? There are two big questions here: is there anything that could usefully be done to expand investment opportunities, or to get firms to better use the few that do exist? And/or: should we think more about the policies we need in an economy that's gone ex-growth?

I'm not sure of the answers here. But as I've said before, I wouldn't mind if our political class at least bothered to ask them.

* Yes, I know banks create money. I'm talking here about shifts of real resources.

"Subsidizing" childcare

It's fitting that Nick Clegg should have announced an increase in the state subsidy for childcare, because the policy is a sanctimonious front for something that is inegalitarian and economically illiterate.

Let's start from the fact that this subsidy must be paid for by other tax-payers. It's therefore not just a subsidy to parents, but a tax on singletons.

This is inegalitarian not just because it means that a single person on the minimum wage is subsidizing the lifestyle choice of couples on six-figure incomes. It's inegalitarian in two other ways.

First, the costs of a family don't rise proportionately with household numbers. The cliche "two can live as cheaply as one" isn't literally true, but it is partly so. This is captured by the notion of equivalence scales, which adjust household incomes for family size. Such scales tell us that a household with two adults and a young child needs an income of 1.8 times that of a singleton. But this in turn means that if two people in a couple have similar incomes - and given assortative mating many do - then the couple is better off than the singleton. Subsidizing childcare is thus regressive in many cases.

Secondly, there's reasonable evidence that marriage improves people's mental and physical well-being. This means a tax on singletons to help couples is welfare-regressive; it gives to those who have.

Why, then, do it? Simple. Couples with children have political power; politicians defer to Mumsnet, and yet many people sneer at "spinsters with cats". All we're seeing here is another example of politicians trying to give money to the powerful. Clegg's claim that this is about a "fairer society" is mere blather.

The policy is also economically illterate because it ignores two important economic ideas: fungibility and incidence.

A childcare subsidy is fungible; if parents are spending less on childcare, they've more money for something else. A lot of child benefit is spent on alcohol. The same might well be true of the childcare subsidy.

There's one sense, though, in which this isn't entirely true. Not all of the subsidy will benefit parents. This is where the concept of incidence comes in. Let's say the policy works as some hope it will, and encourages mothers (or dads) to look for work. Two things will then happen: the extra labour supply will bid down wages; and insofar as parents find work there'll be extra demand for childcare, which will tend to bid up prices of it.

Insofar as this is the case, the childcare subsidy doesn't just benefit parents, but employers and nurseries.   

There is, though, another sense in which the policy is economically illiterate. The opportunity cost of subsidizing childcare is that money could be spent on genuinely giving children the best possible start in life, by more investment in early years education, especially for kids from poor homes. Clegg has foregone this opportunity, and would rather give yummy mummies another bottle of Chardonnay.

Memories, & mechanisms

In the LRB, James Meek suggests that support for pan-Russianism is helped by generational change:

Many of the most articulate and thoughtful Russians and Ukrainians, those of middle age who knew the realities of Soviet life and later prospered in the post-Soviet world, have moved abroad, gone into a small business or been intimidated: in any case they have been taken out of the political arena.
In Russia and Russophone Ukraine the stage is left to neo-Soviet populists who propagate the false notion of the USSR as a paradisiac Russian-speaking commonwealth, benignly ruled from Moscow...If you were born after 1985 you have no remembered reality to measure against this false vision.

This hints at an interesting mechanism in the social sciences - that change can happen simply as one generation forgets what an earlier one knew. As George Santayana said, "Those who cannot remember the past are condemned to repeat it."

My favourite example of this is Andrew Newell's explanation of why the inflation/unemployment trade-off worsened in the late 60s. It was, he says, because a generation of workers who remembered the depression of the 1930s retired and were replaced by a generation that had known nothing but security and full employment and so were more emboldened to push for higher wages.

The same could be true in financial markets. It's sometimes said - in a variation on Minsky's financial instability hypothesis - that stock market bubbles occur after a generation that remembered previous crashes has retired; given short careers in the City, this happens quite often.

It's possible that a similar thing happens in attitudes to wars. It might be that the US and UK became keener on overseas adventures as memories of Vietnam and Suez faded.

The psychology behind this is Humean. Our actual lived experience gives us impressions which enter our mind with "force and violence." But the experiences of our parents and grandparents which we only hear or read about are mere ideas, which are only faint images of impressions.

So far, so good. But this is only half the story. It is also possible for the experiences even of distant generations to affect our behaviour now. For example, Germany's experience of hyper-inflation in the 1920s makes them inflation nutters today; Greeks' experience of Ottoman rule has made them disinclined to pay tax; and slavery has had a long-lasting economic and perhaps psychological impact.

Sometimes, then, historical memories fade and sometimes they linger - in both cases with material consequences.

This is not a contradiction. What we have here are two separate mechanisms through which history can cause social change - in one case because it's forgotten, in another because it's remembered if only viscerally. All of which vindicates Jon Elster:

It is sometimes said that the opposite of a profound truth is another profound truth. The social sciences offer a number of illustrations of this profound truth. They can isolate tendencies, propensities and mechanisms and show that they have implications for behaviour that are often surprising and counter-intuitive. What they are are more rarely able to do is to state necessary and sufficient conditions under which the various mechanisms are switched on. (Nuts and Bolts for the Social Sciences, p9)