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A tip for Dominic Cummings: Don’t hire anyone who fails to grasp the power of incentives

A tip for Dominic Cummings: Don’t hire anyone who fails to grasp the power of incentives

The job advert issued by Dominic Cummings for people to work in government has attracted a wide range of comments. One particular focus has been on the sorts of skills he is looking for.

Computer science, forecasting, artificial intelligence, causality theory — all these topics excite his interest. Cummings advocates a small selection of scientific papers with which applicants should be familiar. He believes that humanities graduates are unlikely to be aware of them.

The papers are indeed quite challenging mathematically. Even the smartest arts graduate might struggle to cope with their content simply because of the language — maths — in which they are written.

The implication is that those with expertise in the humanities need not apply. Indeed, economics is conspicuous by its absence from the now notorious reading list.

I can empathise with his focus on the hard sciences. But economics does have one very powerful, general insight into behaviour that Cummings should heed. In fact, everyone — whether working in the civil service, think tanks or university social science departments — should be familiar with it.

It is, quite simply, that agents respond to incentives. When the set of incentives faced by an individual, a company, or a government changes, behaviour changes too. Different decisions are made as a result.

Two snippets of recent news, chosen almost at random, can illustrate the power of the concept.

Beggars have started to travel from Glasgow to Carlisle to ply their trade. In Scotland, the penalty for aggressive begging is up to a year in jail and a £5,000 fine. In England, it is only a £1,000 fine. These facts are sufficient to explain why Carlisle has become more attractive.

On a note that will be more relevant to most people, more than a million people a month now fail to turn up for GP appointments. From June to November last year, a record 7.8m patients did not attend.

This bad behaviour imposes extra costs on the NHS and makes it more difficult for people who really need to see a GP to get appointments.

A simple solution is to charge for visits to the GP surgery. It would not eliminate the problem, but it would make a big difference.  Once having paid, people would be much more likely to turn up.

Any proposal to introduce charges in the NHS causes the left to froth at the mouth. The standard argument is that charges would deter poor people from accessing healthcare.

It does not seem to do so in countries such as Ireland and Sweden. Both charge people to see their doctors. The impact is mitigated in the former by an annual cap on charges, and in the latter low-income people can visit for free. Other EU countries have similar schemes — in France, the principle of health services is pay upfront, get reimbursed later.

It is not necessary to believe that people act in a completely rational way all the time. They obviously don’t. But incentives work. Empirical examples of the principle can be found every day, in every situation.

A simple, sensibly designed set of incentives is worth a tonne of regulation. A clear understanding of this principle should be the key thing Cummings considers when hiring a new set of government “weirdos” to shake up the civil service.

As published in City AM Wednesday 15th January 2020
Image: Trending Topics via Flickr licensed for use CC BY 2.0
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Creepy micromanagement won’t drive productivity — try trusting staff instead

Creepy micromanagement won’t drive productivity — try trusting staff instead

Calling all employers: what was in your Christmas stocking? Did you find the latest gadget designed to enhance productivity?

The innovative device, featured in the media during the festive season, is a toilet with a downward sloping seat. The company which makes it, StandardToilet, has conducted extensive tests. A slope of 13 degrees is exactly the right tilt to make workers feel miserable without causing any lasting pain.

This way, it is alleged, staff will spend less time on the lavatory and more on their work. Output per worker will rise.

The very slow growth in productivity, the shorthand word for “output per worker”, was a defining feature of the past decade. Typically, productivity in the UK grows by around two per cent a year. During the latest decade, annual growth was barely above zero, at 0.3 per cent a year.

Higher productivity growth means that real wages can increase faster. Bigger pay packets mean more tax receipts for the government, so spending on public services can also rise.

Clearly, productivity growth needs to be boosted. But contrary to the claims, devices such as the sloping toilet may be one of the problems rather than the solution.

Recent years have seen a surge in technical innovations designed to control in ever more detail the tasks which workers perform. This is particularly the case at the lower end of the pay scale — think of warehouse jobs, delivery services and the like.

This ultra-micromanagement of time is intended to increase productivity. Its side effects include high employee turnover, resentment, and sheer bloody mindedness.

Why bother to make even the slightest bit more effort than your contract specifies under such conditions? Especially when, with the UK at full employment, you can walk into an equally crap job just down the road the very next day.

Nobel laureate George Akerlof addressed these issues in a famous paper 40 years ago entitled “Labor Contracts as Partial Gift Exchange”.

It was stimulated by a study which found that a group of women in a low-level, routine job exceeded the minimum work standards of the firm by an average of 15 per cent. This could not be explained by the standard economic theory of rational behaviour.

A key point for Akerlof was that the women did not work in isolation from each other. They interacted. He argued that, through these interactions, the workers acquired sentiment both for each other and for the firm. As a result, a situation developed which depended on the “norms” of gift exchange.

On the workers’ side, the “gift” given was work in excess of the minimum work standard. On the company’s side, the “gift” was wages in excess of what these women could receive if they left their current jobs.

The new tools of time and task micromanagement do the opposite. They are counter-productive, ensuring that virtually no employee will do more than the absolute minimum required by the contract. Why not try fur-lined, heated lavatory seats instead?

As published in City AM Wednesday 8th January 2020
Image: Bored office workers via Pxhere licensed for use CC0 1.0
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Supply and demand at work, or just good bargaining? The reality behind CEO pay

Supply and demand at work, or just good bargaining? The reality behind CEO pay

A report published by Deloitte a couple of weeks ago will have enhanced the feeling of holiday wellbeing for many people.

The median annual pay for bosses of FTSE 100 companies fell in 2018 to £3.4m, compared to £4m in 2017.

This is the lowest level since 2014, when the UK brought in rules which require firms to report a single figure for chief executive pay.

Criticism of the remuneration of top corporate executives has been growing strongly for some time. In June, for example, the shareholders of Netflix voted down – albeit by a very narrow margin – the firm’s executive officer compensation plan.

Netflix grew from nothing in 1997 to a current value of around $150bn, and over the last four years its share price has almost trebled. But shareholders still did not like the chief executive’s proposed package.

Top executives may feel rather aggrieved at this mounting unease over their “emoluments” – a much more suitable word for these grandiose packages.

After all, does not basic economics provide a sound justification for their pay? In the textbooks, prices are set by the interaction of supply and demand. If something is in short supply, such as the skills of executives, the price will be bid up.

Remarkably, a more sophisticated version of this argument is advanced by some leading members of the economics profession.

Greg Mankiw, a top Harvard economist, is one of the biggest cheerleaders. Technological change, he argues, usually increases the demand for skilled labour. As such, unless society is able to educate and train people so that the supply of skilled labour increases at least as much as the demand, the earnings of skilled workers will rise relative to the rest of the labour force.

Technology is further invoked by some to justify the pay of those at the top. Because of a truly dramatic increase in the level of connectivity in society, highly talented individuals have been able to leverage their talents across global markets and capture rewards that would have been unimaginable in earlier times.

This is certainly the case with stars of popular culture and sport. A hundred years ago, for example, the only people who could have any direct experience of Manchester United playing football live were those present in the stadium during the game. Now, the team can be watched by literally billions around the world, using a variety of delivery channels, and the players reap huge amounts as a result.

However, it is not at all apparent that the same argument applies to corporate executives.

The huge growth in business schools in recent decades, for example, has presumably led to a substantial increase in the supply of people capable of filling top executive roles.

The fact is that, in many situations, there is an inherent indeterminacy around a price – or a pay package – when it is being set. The Oxford economist Francis Edgeworth argued over a century ago that “in pure economics there is only one theorem, but that it is a very difficult one: the theory of bargain”.

Corporate executives have certainly exhibited great bargaining skills in recent decades. But it seems that, at last, their bluff is being called.

As published in City AM Wednesday 28th August 2019
Image: Handshake via pxhere licensed under CC0 1.0
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Retailers beware, the online shopping revolution isn’t going anywhere

Retailers beware, the online shopping revolution isn’t going anywhere

Another week, another retailer biting the dust. The baked potato specialist Spudulike has closed all 37 of its branches, with a loss of nearly 300 jobs.

Shopping centres are undergoing a sudden and dramatic squeeze, with many retailers only able to stay in business if granted a dramatic rent reduction.

Last week, Intu Properties, owners of the prestigious Lakeside and Trafford centres, announced a loss of £840m pre-tax. Net rental income fell by 18 per cent in the first half of this year.

Local authorities have become big owners of shopping centres to try to revive their town centres. But in most cases, the council taxpayer is taking a big hit. Shropshire Council, for example, bought three shopping centres in Shrewsbury early last year.

Their value has since fallen by over 20 per cent. The main reason is well known: more and more consumers are switching to the internet.

The latest estimates from the Office for National Statistics show that online sales now account for 18 per cent of all retail sales – and this is rising rapidly. In the year to October 2018, online sales grew 12.6 per cent. The only sector resisting the internet revolution is food, where the growth in online was only 1.8 per cent. The internet itself has been around long enough for a whole generation to have grown up unable to imagine life without it.

What is new is the surge in retail online activity in the past few years. The potential has been there for some time, but it is only now having a real impact. Why should this be?

Some 50 years ago, a larger-than-life Texan business school academic, Frank Bass, offered an explanation. He formulated a simple differential equation – and in differential equation terms it certainly is simple – which describes how new products get adopted in a population.

Bass made millions from his discovery, and it is still widely used in marketing circles today.

The basic idea is that people adopting a new product – in this case, shopping on the internet – can be classified into two groups. A fairly small set are innovators, those who are willing to experiment with something new. Most people are imitators, who wait and see how the innovators get on.

The speed of adoption, if it happens at all, of any new product is determined by the interactions between the two types of consumer and the degree to which they are willing to innovate or imitate.

Remarkably, given its simplicity, the model gives a very good account of the growth of a whole range of products.

In the early stages of a new product, growth is always slow. Almost all those buying are innovators. Then, suddenly, a critical point is reached. The imitators start to swarm in and growth becomes rapid.

Modern network theory offers a more sophisticated approach, but it is still essentially based on the motivations described by Bass.

Either way, the future for both retail and shopping centres looks bleak, unless they themselves find some dramatic way to innovate and alter their offer.

As published in City AM Wednesday 7th August 2019
Image: Empty High Street via Geograph licensed under CC BY-SA 2.0
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It’s not cutting-edge AI we should fear, but mediocre automation

It’s not cutting-edge AI we should fear, but mediocre automation
If there were a betting market in future winners of the Nobel prize in economics, MIT’s Daniel Acemoglu would be at pretty short odds. His highly innovative work has already won him a string of prizes. So his research is always worth following – especially when he challenges the conventional wisdom, as in his paper in the latest issue of the Journal of Economic Perspectives. Economists are usually optimistic about the impact of new technology. The innovation itself destroys jobs – the Luddite riots in the early nineteenth century, for example, were in direct response to the displacement of skilled handloom weavers by the new machinery in textile factories. But this, along with all subsequent waves of innovation, enabled goods and services to be produced more cheaply. As a result, the spending power of everybody else in the economy increased, and new jobs were created. Mass production in factories during the industrial revolution was of course a phenomenon without precedent in the history of the world. Other completely revolutionary technologies followed, such as the railways and electricity.  The rapid advance of robots and artificial intelligence seems to be the latest example of a transformative new technology. Acemoglu argues that it is not these “brilliant” (as he puts it) technologies which threaten jobs and wages. These enable things to be produced much more cheaply than before, substantially boosting real incomes elsewhere in the economy. Then new kinds of goods and services can be created as a result of the increase in spending power. Rather, the risk to overall employment and living standards comes from the introduction of “so-so technologies”, which generate only small productivity improvements. Examples of so-so technologies include automated customer service, which has displaced human service representatives. It is, however, generally deemed to be low-quality, and thus unlikely to have led to large productivity gains. The cost of your bank charges or your supermarket shop have not exactly been reduced much by the introduction of automated answering systems or self-service check-outs. But jobs have been lost as a result. Acemoglu suggests a key reason why modern economies have, as he puts it in the jargon, “moved along this [particular] innovation possibilities frontier”. In the US and also here in the UK, the tax system has evolved in ways which subsidise the use of equipment and penalise the use of labour through payroll taxes such as our employers’ national insurance contributions. Interestingly, he also points the finger at the big tech companies. Their business model is based on automation and small workforces. The impact of innovative technology which destroys particular jobs needs to be counterbalanced by innovation elsewhere, which creates new tasks, new jobs which no one had previously thought of. We have had some, such as software and app development and database design, but nowhere near enough. Governments need to rethink the tax system as it applies to investment and employment. And they need to rebuild support for long-term innovation, which gives more scope to invent completely new jobs.
As published in City AM Wednesday 8th May 2019
Image: Self Checkout by Ben Schumin via Wikimedia is licensed under CC-BY 2.0
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Want to tackle the scourge of fake reviews? The market can help with that

Want to tackle the scourge of fake reviews? The market can help with that
The internet has led to a massive increase in the amount of information available. Often, this is a good thing. For example, shopping around to find the cheapest price for something has become far easier. But it can have its downsides. A report last week from the consumer magazine Which highlighted one such disadvantage. An investigation claimed that the review system on parts of Amazon was being undermined by fake five-star reviews. The magazine analysed the listings of hundreds of popular tech products in 14 online categories, such as headphones and smartwatches. Researchers sorted the headphone reviews, for example, by the average scores of the brands. The first page of results – those with the highest scores – consisted almost entirely of little-known brands, with nearly 90 per cent of the reviews from unverified buyers. In other words, there was no evidence that the reviewer had ever bought the item in the first place. Companies like Amazon are well aware of these potential problems. They take steps to try to guard against them. A flurry of very good posts for a less well-known brand is one of the classic footprints which enable fake reviews to be identified. But Which suggested that the volume and variety of fake reviews was so large that the defences are currently being overwhelmed. A similar problem arose almost from the very start of email, when spam first appeared. Ever since then, a complicated evolutionary game has been played between the spammers and the spam filters. It is a game because spam wins if it gets through, and the filters win if it does not. It is evolutionary because both sides are constantly adjusting their strategies. The filters seem gradually to be getting the better of it, though I am currently being plagued by emails from China offering to sell me plastic moulds. The fake review – and more generally the fake news – problem has not been an issue for quite as long, but concern over it is growing. The instinct of many people is to reach for the law, and in particular to regulate. Set up a body, staff it with bureaucrats who of course have the public interest at heart, and the problem will be solved, goes the logic. The European Commission is a strong proponent of this approach. But there are already some good illustrations of the private sector reducing what economists describe as “reputation systems failures”. For example, a 2017 paper by Andrey Fradkin and colleagues at the MIT School of Management analysed experiments by Airbnb. A particularly successful one appears to be that of the simultaneous review: both the buyer and seller post their reviews, and only then are they allowed to see what was written about them. Not all consumers give feedback. Many who have a bad experience do not bother to rate the seller or product – they just stop buying from the platform. Platform providers therefore have a strong incentive to verify posts and encourage real reviews, perhaps using monetary payments to reduce selection bias. Just as we didn’t need to regulate against spam, given time, markets will find solutions to what is currently a pressing problem.
As published in City AM Wednesday 24th April 2019
Image: Online shopping by Maxpixel is licensed under CC0 1.0
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