Paste your Google Webmaster Tools verification code here

Comparison sites are forcing businesses and economists to rethink price theories

Comparison sites are forcing businesses and economists to rethink price theories

The competition and Markets Authority (CMA) published a report about Price comparison sites at the end of last month. They seem simple enough, but these straightforward sites raise interesting issues for economics.

Overall, the CMA was pretty positive about the DCTs – digital comparison tools, to give them their Sunday best name. The conclusion was that “they make it easier for people to shop around, and improve competition – which is a spur to lower prices, higher quality, innovation and efficiency”.

DCTs offer two main benefits. First, they save time and effort for people by making searches and comparisons easier. Second, they make suppliers compete harder to provide lower prices and better choices to consumers. In short, they bring the real world closer to the perfectly informed consumers and perfectly competing firms in the ideal world of economic theory.

But even in this market, there is an issue which goes right to the heart of much of the information which can be accessed through the internet: how do we know whether we can trust it?

The main problem is that the comparison sites typically provide their services free of charge to consumers. They make money by charging a commission to suppliers.

This creates an incentive for a DCT to promote those suppliers which pay it the most commission. An effective way of doing this on the internet is by the order in which the information on the various suppliers is presented.

It is not that DCTs deliberately provide misleading information, or even that a site leaves off a major supplier which does not pay the particular website enough. But they can put those that pay the most at the top of the list.

Notoriously with Google searches, people rarely click through to anything which is not in the top three results of the search.

Allegedly, 60 per cent of the time, only the site which comes at the very top of is accessed.

Obviously on a DCT, consumers are likely to look at more. That is the whole point of using the site. But although the CMA does not provide hard data on this, it expresses a clear concern about the ways in which the sites rank the suppliers.

How the DCTs themselves set their prices raises a more general question for economics. The basic rule, described in the textbooks since time immemorial, is to set price equal to marginal cost – in other words, at the point where the revenue from one extra sale equals the cost of producing that extra item.

The standard assumption made in teaching generations of students their introductory course to economics is that as the level of output increases, marginal cost first of all falls but eventually rises.

But on the internet, once the site is set up, the cost of dealing with an extra user is effectively zero. The time-hallowed formula of economics is a recipe for bankruptcy.

The internet is forcing companies to innovate in their pricing strategies. And it is forcing economists to rethink some of their theories.

As published in City AM Wednesday 18th October 2017

Image: Man and Laptop by Pexels is licensed under CC by 0.0
Read More

Behavioural economics has had its Nobel moment, but take it with a pinch of salt

Behavioural economics has received the ultimate accolade.

Richard Thaler of the University of Chicago Business School has been awarded the Nobel Prize in economics for his work in this area.

Economics over the past 20 to 30 years has become far more empirical. Leading academic journals do still carry purely theoretical articles, but far less than they once did.

This shift towards the empirical takes two forms. Major advances have taken place in the heavy duty statistical theory of analysing large scale databases containing information on individuals and their decisions. This was recognised when James Heckman and Daniel McFadden were awarded the Nobel Prize in 2000.

Behavioural economics is much less technical. In any given situation, the decision which a purely rational person would take is identified. We then look how people actually behave, and see if there are any deviations from the rational way of doing things.

Perhaps the main finding of behavioural economics is so-called prospect theory, first set out nearly 40 years ago by Daniel Kahneman. In essence, prospect theory says that people dislike making losses more than they like making gains of the same amount.

Another important discovery is that, when weighing up how to value future costs and benefits, people often place much more weight on the present and very immediate future than standard economic theory assumes. Last month I wrote about how this helps to explain the reluctance of electorates to deal with climate change.

These two results are backed by large amounts of evidence obtained in a range of different contexts. So now they are being integrated into economic theory.

But many economists are altogether less sure about much of the rest of behavioural economics. One of the issues is that it often gives the impression of being rather ad hoc. No reason is given as to why people in one situation appear to behave rationally, but in another they do not. Very few guidelines have emerged as to when we can expect to see deviations from rationality.

Another issue is that many economists are prepared to accept that non-rational behaviour might be observed at a point in time. But in a reasonably stable situation, people will learn over time to be rational.

Behavioural economics is not just about advancing knowledge on the workings of the economy. Policy-makers have become interested.

Cass Sunstein, Thaler’s colleague, served in the Obama administration as head of the Office of Information and Regulatory Affairs. David Cameron set up the so-called “Nudge Unit” in his government based on Thaler’s ideas. Thaler claimed 10 years ago that a “nudge” could lead to “better investments for everyone, more savings for retirement, less obesity, more charitable giving, a cleaner planet, and an improved educational system”. In his 2016 book Misbehaving, he has backed off the extravagance of these claims.

Still, whatever the doubts and qualifications, behavioural economics has made a big impact. An economist can no longer be said to have a good training if he or she is not familiar with its main themes.

As published in City AM Wednesday 11th October 2017

Image: Richard Thaler by Chatham House is licensed under CC by 2.0
Read More

From Korea to Germany, experiments with socialism show markets always win

From Korea to Germany, experiments with socialism show markets always win

A red-hot topic in economics is randomised controlled trials (RCT). Esther Duflo, the MIT academic who has really driven this idea, has surely put herself in pole position for a Nobel Prize at some point.

The idea of RCTs has been imported from medicine.One group of people are selected at random to be subject to a particular policy, and the outcomes in this set are compared to the rest of the population, which are not.

The studies have been almost exclusively carried out in developing countries. Evaluating RCTs often involves some subtle statistical points, but they are a powerful way of identifying what really works. Their policy impact has already been substantial.

Over 200m people worldwide have been reached by the scaling up of programmes evaluated by the J-PAL network, in which Duflo is the leading light. The RCT studies themselves are carried out on a small scale, evaluating very particular policies. If they succeed, they can be expanded. Examples include encouraging the take-up of school-based deworming, chlorine dispensers for safe water, and free insecticidal bed nets.

A closely related concept is known as a natural experiment. This is when we observe two contrasting policies which have been carried out in the past, either at the same time on different populations or at different times on the same one.

The policies in this case have not been deliberately designed as part of an experiment. They have been introduced as part of the political process.

But good natural experiments can be just as informative as RCTs. Indeed, they can reach the parts which RCTs cannot get to, because we can observe natural experiments which have taken place on very large scales.

By far the most important of these is the series of natural experiments on the performance of market-oriented economies compared to their centrally planned socialist rivals.

The current tensions highlight the differences between North and South Korea. In the 1950s, the latter had living standards similar to African countries. Now, they are at Western levels.

Other countries which were poor in the mid-twentieth century and which have adopted the principles of market-oriented economics have also prospered.

The fall of the Berlin Wall at the end of the 1980s brought into sharp focus the contrast between East and West Germany. The Trabant was a popular car in the East, but it was of such poor quality that its value dropped to almost zero as soon as Western cars could be imported.

The major economic contest of the twentieth century was between the US and the Soviet Union, won easily by America.

India and China practised different forms of socialism until the late 1980s. The Chinese was the most extreme – resulting, for example, in the deaths of at least 60m people in the self-induced famines around 1960. After adopting market principles, both countries have flourished.

The outcomes of these major natural experiments are decisive. Belief in socialism in 2017 is equivalent to believing the sun goes round the Earth.

As published in City AM Wednesday 4th October 2017

Image: For God’s Sake by Ninian Reid is licensed under CC by 2.0
Read More

The demise of Germany’s Social Democrats reflects the challenge for all liberal parties

The demise of Germany’s Social Democrats reflects the challenge for all liberal parties

The German elections on Sunday went pretty much according to the polls. Another victory for Chancellor Merkel.

Much of the commentary has focussed on the success of the far-right Alternative fur Deutschland (AfD) party. One of its leading candidates eulogised the German armed forces during the Second World War – a topic even more sensitive topic there than it is here.

The AfD took nearly 13 per cent of the vote and 94 seats in the Bundestag. This puts them within striking distance of the Social Democrats (SPD). The SPD share of the vote collapsed to just over 20 per cent, barely half the support it attracted only a decade ago.

The Social Democrats – the German equivalent of Labour in the UK – were annihilated not just in areas like Bavaria where traditional centre-right parties have always been strong. They lost very heavily in the old East Germany, where the AfD secured its highest level of support.

It is no accident that the rise of the AfD and the fall of the SPD go hand in hand.

A popular myth among the liberal elite in Britain is that our country has an exceptionally high level of inequality compared to the rest of Europe. This far from being the case.

The same forces which have widened inequality here have operated in Germany, in some ways even more powerfully.

The opening up of Eastern Europe in the early 1990s has had a strong effect. Employers soon realised that economies such as Poland and the Czech Republic possessed educated labour forces, whose productivity potential had been suppressed by the gross inefficiencies inherent in planned economies. German companies opened up new production plants in the old Soviet bloc countries in Europe rather than at home.

This has been combined with the impact of both globalisation and mass immigration.

The effect on wage rates of this increase in competition in the labour market has been dramatic. Christian Dustmann at UCL has examined the evolution of wage rates in the former West Germany.

The fifteenth percentile of the wage distribution is the level at which only 15 per cent of wages are lower. In West Germany, at the fifteenth percentile, real wages have fallen almost continuously since the mid-1990s.

At the fiftieth percentile, where half get more and half get less, the reduction has been less sharp. But the fall had set in by the early 2000s.

At the eighty-fifth percentile, we see the mirror image of the fifteenth: real wages grew strongly, reaping the benefits of the recovery of the economy.

In the states of the old East Germany, the problems are even worse.

The sharp rise in inequality is a key reason for the collapse in support for the social democratic parties across Europe. Their traditional voters have been the ones who have been hit the most by static or falling real incomes. They have not been defended by social democrat parties, which now represent the interests of the public sector urban professional classes.

The fact that Jeremy Corbyn’s Labour did not suffer the same fate as Germany’s SDP is a clear indictment of the Conservative campaign in the election.

As published in City AM Wednesday 27th September 2017

Image: Martin Schultz by Olaf Kosinsky is licensed under CC by 3.0
Read More

Rochdale Hornets End of Season Dinner

Paul_Hornets Rugby

I have supported Rochdale Hornets, the Rugby League team of my home town, for many years.

I continue to enjoy my association with the team as President, and it was with pleasure I attended the annual Hornets End of Season Dinner on Friday.

Pictured with me is Rob Massam, who received the the Top Try Scorer Award for crossing the line 18 times! Rob, the ‘tank on the flank’, plays not in the forwards but on the wing, yet he towers over me and is twice as broad!

Read the full story here.

Read More

Full employment in Britain has lowered productivity instead of increasing wages

Full employment in Britain has lowered productivity instead of increasing wages

The UK jobs market is booming, as the latest ONS figures show. Unemployment is at its lowest for over 40 years. A record 32.1 million people are in employment, a rise of over 3 million since the financial crisis.

Apart from in a few scattered pockets, Britain is at full employment. Usually in such circumstances, wages would start to outpace inflation. Labour shortages would lead employers to start bidding for workers, who would themselves feel more confident about demanding pay increases.

Perhaps this is starting to happen, with the TUC voting for a campaign to raise public sector wages by 5 per cent.

But a combination of immigration and a concerted government campaign to get people off benefits means that the supply of labour has risen sharply. This holds down the price of labour, the wage, in the bottom half of the labour market.

Instead, full employment manifests itself in different ways. A few anecdotes might illustrate the key points.

I recently bought a new phone, which has proved to have an intermittent fault. The Richmond branch of EE advertises both on the internet and on its doors that it opens at 9.30am. I turned up at 9.40 to find the place in darkness. I went to another EE branch, where a listless young woman informed me that she could not replace it. I asked what she could do. She replied that she could take it in for repair, but that this “would take three weeks”. I left, and she slumped back to her stupor.

Later that day, I went to see someone at a leading London university. The department receptionist asked if I had the extension number. When I said I was rather hoping he might have it, he responded that he probably did, but that it would be “hard to find”. We looked at each other in silence. Then a light bulb came on in his mind. He winked at me, and pronounced “I’ll take you up there”.

These experiences are not confined to the dynamic capital city. A few weeks ago, I visited the maths department at Durham and left my glasses behind. They offered to post them guaranteed next day delivery. I tracked the parcel on the Royal Mail website. 39 hours later, it had arrived at the Newcastle sorting centre, all of 15 miles away.

These examples of appalling service arise for two reasons. First, the very high demand for labour means that some people now in jobs are scarcely able to perform work at all. Second, many low paid workers realise they can easily get another job, so why bother making an effort in your current one?

Here is part of the answer to the so-called productivity puzzle. During the recovery from a recession, productivity, output per worker, usually rises quickly. But it has been flat.

Whether due to limited ability or a lack of incentive, the output of some workers taken on in the jobs boom is close to zero. And this drags the average down.

As published in City AM Wednesday 20th September 2017

Image: Fatigue by Shanghai is licensed under CC by 3.0
Read More