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Heavy-handed Westminster diktats have eroded trust — now only localised Covid policy can restore it

Heavy-handed Westminster diktats have eroded trust — now only localised Covid policy can restore it

Last month, the official group of scientific advisers — SAGE — warned the government that only a quarter of those who need to self-isolate due to coronavirus symptoms were in fact doing so.

This illustrates a concept which is of great practical importance: namely the conflict between individual and collective rationality.

Consider Margaret Ferrier, an SNP MP (who has since had the whip removed) who travelled by train from London to Scotland despite knowing she had tested positive for Covid-19. Better for her personally to be at home in Glasgow than stuck in a London hotel for a week, but worse for society as a whole as she risked spreading the virus to everyone on the train with her.

The textbook model of economics neatly sidesteps this potential problem. It sets up an idealised situation in which there is no conflict between individual and collective rationality.  The task is then to discover what assumptions about behaviour are needed to be compatible with such an outcome.

It is a very challenging question, and several of the early Nobel Prizes in economics were awarded for work in this area.

Economics itself has moved on in recent decades and pays much more attention to the potential rift between what is good for the individual and what is good for society.

One of the most influential thinkers in this area is Elinor Ostrom who received the Nobel prize in economics only three years before her death in 2012. Her work is very relevant in the Covid crisis.

Her doctoral dissertation was on how farmers and others in Southern California solved the problem of water management in their local area. For individuals with favourable locations, it was rational to grab as much water as they could. But collectively, this was a bad outcome. Others would be short of water.

The key feature of Ostrom’s work was to show that individuals were capable by their own actions of avoiding conflicts of individual and collective rationality. It was not necessary to have a heavy-handed regulator trying to impose a solution from above.

Like the Nobel laureates before her, she basically worked out what assumptions were needed for this to happen.

An essential element is that those involved must have some feeling of being part of a group. Further, disruptive and self-serving behaviour should be speedily identified and punished, in ways which are seen to be fair within the group. People also need to feel a sense of ownership of any restrictions which are asked of them.

When Boris Johnson announced lockdown on 23 March, in effect the nation was the group. For a period, most people behaved with proper regard to others.

The subsequent maze of complex and often contradictory diktats issued by health bureaucrats and politicians since then has eroded much of this trust.

Countries such as Germany which had locally based Covid strategies from the outset have fared much better than the centrally planned attempts in the UK, in part because they have been able to maintain this trust and sense of community.

At long last, the UK government shows signs of being willing to trust local authorities to do what is best for their area — in the form of local lockdown rules. They may still get it wrong, but local autonomy on Covid policy at least gives the chance of restoring the trust which is essential to any successful strategy.

As published in City AM Wednesday 14th October 2020
Image: icsilviu via Pixabay
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For richer or for poorer? The economic case for marriage is worth remembering

For richer or for poorer? The economic case for marriage is worth remembering

An important piece of social news emerged last week. According to the Office for National Statistics, the divorce rate in 2018 fell to its lowest level for nearly 50 years.

The overall trend is clear and well-established. The divorce rate rose steadily from the late 1950s, with sharp rises immediately following the Divorce Act of 1969, to the early 1990s.

Since then, with minor blips, the rate has fallen. It now stands at just over half the level of its 1993 peak.

Economic theory has a lot to say about marriage and divorce.

This may be surprising to many. But economists believe that the theory’s basic model, that of someone making a rational choice from the alternatives on offer in any given situation, is universal in its application. The institution of marriage is a key social phenomenon, and so the rational choice model ought to be able to give an explanation as to why it exists.

The Chicago economist Gary Becker received the Nobel prize in 1992 for his pioneering work in this area. Essentially, the participants in a marriage reap what economists see as the gains from trade. One partner goes to work and earns money, and the other raises children and does housework. By each concentrating on the activity which he or she does better than the other, both parties benefit.

Implicitly, Becker took as the social background to his theory the institutional structure of marriage and the family as it existed in the Midwest of the USA in the 1950s. Gender roles have certainly evolved since then, but his basic insights remain valid.

A much more general theory of marriage is linked with the work of economists such as Bob Rowthorn, former head of the Cambridge economics department.

In this approach, marriage is seen as an institution for providing couples with the confidence to make long-term investments in their relationship. The basic theme is that marriage should be seen as an institution for creating trust between individuals in the sphere of family life.

Given this emphasis on both trust and the long term, it is curious that many metropolitan liberals, not least Supreme Court justice Lady Hale when she headed the family courts, appear to see marriage as no better than any other form of family structure.

The empirical evidence overwhelmingly supports the special value of marriage for the individuals concerned, for their children, and for society. Indeed, there are few hypotheses in the social sciences which receive such clear confirmation from serious research.

For example, most children grow up to be useful and well-adjusted members of society regardless of family structure. But the incidence of crime and mental illness among children whose parents have divorced, while low as a proportion of all such children, is much higher than it is among those whose parents remain married.

The falls in the divorce rate can be seen as rational learning by the generation who were children themselves when divorce was at its peak. They see the costs imposed on them. And society as a whole will reap the benefits in years to come.

As published in City AM Wednesday 4th December 2019 
Image: Wedding Rings via Piqsels licensed for use CC0 1.0
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Labour’s rejection of conventional economic theory ignores important insights

Labour’s rejection of conventional economic theory ignores important insights

One of the first tasks facing whoever becomes chancellor after the General Election will be choosing the next governor of the Bank of England.

Getting to make this choice would be a key step in the plans of Labour’s shadow chancellor John McDonnell to shake up the Bank of England, but his radicalism is not simply a matter of practical policies. McDonnell appears to want a new intellectual approach at the central bank and across government, one not based on existing economic theory.

Many people on the left, such as McDonnell, have criticised austerity ever since the financial crisis of the late 2000s. They often believe this to be a criticism of conventional economic theory.

But these are two different things. They are not the same. It is certainly possible to construct a coherent critique of austerity purely on the basis of standard theory.

Economists disagree on the matter because of different interpretations of the empirical evidence, rather than on the basic theory.

However, Labour’s election manifesto appears to want to ditch the most powerful insight of the whole of economic theory. Namely, that people react to changes in the incentives which they face. If incentives change, behaviour changes.

For example, even the most dedicated critic of economics will slow down when approaching a speed camera if they are exceeding the speed limit. On the open road, there is a chance of being stopped by the police, but it is very small. Yet the probability of incurring a penalty rises sharply in the presence of a speed camera. And so behaviour changes — the driver slows down.

We can apply this insight to taxation. Already, the top one per cent of earners in the UK pay well over 30 per cent of all income tax, according to calculations by the Institute of Fiscal Studies.

Before tax, to be in the top one per cent you have to earn at least £166,000 a year. After tax, the figure falls to £111,000. So these individuals — just over 300,000 of them — are already handing over one third of their income to HMRC.

We know from Labour’s manifesto that McDonnell wants to raise many billions more in tax from the top five per cent of earners.

Much of this would potentially fall on the top one per cent, where the money is really concentrated. But this would require these taxpayers to stand still and wait to be plucked like so many golden geese. Economic theory, supported by a vast amount of empirical evidence, suggests that this just would not happen.

he same ignorance of fundamental, well-supported economic theory is seen in Labour’s policy on corporation tax. The proposal is to raise the rate from 19 to 26 per cent.

The basic problem here is that if the tax rate changes, the behaviour of a company will change.

The company may hold down wages. It may not take on extra staff, or even get rid of existing employees. It may cut dividends, so that pension funds and the income of pensioners is reduced. Or it may slash investment, so that the workers in the firms which supply to the company will suffer.

Instead of jettisoning economic theory, Labour should learn from its most powerful insights.

As published in City AM Wednesday 27th November 2019 
Image: John McDonnell by Sophie Brown via Wikimedia licensed for use  CC BY-SA 4.0
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What kind of person crosses the Nevada desert to investigate UFO conspiracies?

What kind of person crosses the Nevada desert to investigate UFO conspiracies?

Area 51 is a mysterious place.

Located deep in the Nevada desert, it is home to highly classified US military operations. Rumours abound that it harbours secrets about extraterrestrial life.

In June, a podcaster released an interview with someone who claims to have studied flying saucers in Area 51. The video spread like wildfire on the internet.

A proposal for an event took shape, labelled “Storm Area 51, They Can’t Stop All of US”. The idea was for large numbers to gather on 20 September in a couple of tiny Nevadan towns next to Area 51. The security defences would be overwhelmed. Citizens could then see for themselves the aliens being kept secret by the military-industrial complex.

Around two million individuals pledged on Facebook to attend. Estimates vary, but it seems that in reality only some 2,000 turned up in the nearby towns. Of these, a mere 200 or so actually arrived at the security fences which guard the area. No one tried to cut or climb over the barriers.

The event has subsequently attracted a great deal of ridicule in both the mainstream and social media. But it usefully illustrates two important principles in economic theory.

The first is the so-called free rider problem. It occurs when some individuals fail to contribute their fair share to the cost of a shared product or services.

An everyday example is that of a shared kitchen space in an office block. Provided enough people are willing to keep it clean, there is an incentive for others to free-ride and enjoy the clean kitchen without doing anything themselves.

The problem is that where free riders exist, the product or service in question tends to be under-produced. In the kitchen example, the supply of people willing to clean may drop off.

Exactly the same thing took place outside Area 51. Everyone wanted the razor wire fences to be cut, so they could consume the “product” of entering the site to see if it contained aliens. But not enough – in fact no one at all – was willing to cut the wire and incur the potential cost of being shot.

The event also illustrates the importance of revealed rather than stated preference.

Economists traditionally attach little weight to surveys in which people are asked hypothetical questions about what they might do or pay in different situations. These constitute stated preferences.

Instead, economists prefer to infer preferences from the actions people actually take. If you always buy Pepsi rather than Coke, you have revealed your preference between the two.

Pressing a button to say you “like” something merely states your preferences.  The cost of doing this is virtually zero. Revealing preferences may involve substantial costs, such as travelling to the Nevada desert.

This fundamental point is being lost in many of the reactions of decision-makers to events on social media. Far too much importance is being attached to actions which are almost costless.

The UFO buffs of Area 51 have done a public service by providing a clear example of this principle, and of evidence that “likes” do not necessarily equal action.

As published in City AM Wednesday 2nd October 2019
Image: Area 51 by RJA1988 from Pixabay
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Modern Monetary Theory? More like Magic Money Tree

Modern Monetary Theory? More like Magic Money Tree
As the Brexit process unfolds, the possibility of a Corbyn government has become much more tangible. Last month, John McDonnell, the shadow chancellor, wrote to the Treasury to say that in power he would require them to “widen the range of economic theories and approaches in which its officials and those in the rest of the government are trained”. In principle, this would be a good thing. Machine learning algorithms, for example, have been shown beyond doubt to be more powerful than the traditional economists’ tool of econometrics for analysing data. Standard economic theory is not as good as cultural evolution theory at understanding how search engines, reputation systems, and social media affect the decisions we make and the news we read. Somehow, however, one feels that this is not the retraining which McDonnell has in mind. The fashionable idea among left-wing economists is something called “Modern Monetary Theory” (MMT). In the US, the rising Democrat star Alexandria Ocasio-Cortez appears to be keen on it, believing that it could finance her Green New Deal as well as an immense raft of social programmes and welfare benefits. A key part of MMT asserts that governments who control their own currency can finance any level of spending simply by printing more money. Countries in the Eurozone, for example, cannot do this, because the European Central Bank controls how much money can be created – but the UK can. A sharp increase in public largesse almost always creates an increase in the public sector deficit, which is the difference between spending and the income that the government gets from taxes. The conventional way of financing the deficit is by issuing bonds. This both creates a stream of interest payments to the lenders, and at some point – depending on the date of maturity – have to be repaid. MMT asserts that printing money instead removes these constraints. Money created by the government never needs to be repaid. For example, £10 notes carry the phrase “I promise to pay the bearer on demand the sum of 10 pounds”. If you take it to the cashier’s desk in the Bank of England, they will do just that – they will give you another £10 note instead. Also, money carries no interest. In technical terms, we might think of money as a “zero coupon perpetual bond”, although I have never seen MMT theorists refer to it in this way. In one way, MMT is completely true. Countries like the US and the UK can finance government deficits by printing money rather than issuing bonds. Indeed, there are genuine arguments to be had about the appropriate mix of the two. Where the theory falls down, however, is not recognising the adverse consequences of creating too much money. The economic history of the world is replete with examples of how this just creates inflation, from Roman emperors to the latest example, Venezuela. MMT ought to be renamed the Magic Money Tree. The Bank of England is running a competition for whose face should be on the £50 note. For MMT theorists, the answer is obvious: old magic grandad himself, Jeremy Corbyn.
As published in City AM Wednesday 10th April 2019
Image: Jeremy Corbyn by Chris McAndrew via Wikimedia is licensed under CC BY 3.0
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From Northern Rock to lunch tables, no one is immune from the herd mentality

From Northern Rock to lunch tables, no one is immune from the herd mentality

The Bank of England and Federal Reserve held a two-day conference last week in London on big data and machine learning. All very interesting stuff.

There was an intriguing vignette as we emerged from the conference room for the frugal lunch on the first day.

Straight ahead was a table with sandwiches, fruit and the like. Most participants made for this, so many that a long queue soon formed, stretching well out of the room. But a sharp right instead brought you to a smaller table, with identical food. The wait was very much shorter.

This illustrates important aspects of modern economic theory.

In fashion markets and on the internet, for example, products or sites can rapidly become popular for reasons not connected to their inherent qualities. They become more popular simply because they are already popular. People start to follow the crowd rather than rely on their own judgment.

The same thing can be observed in bubbles in financial and property markets. An extreme example was seen in the case of Northern Rock in the run-up to the financial crisis in 2008. The bank did in fact have enough assets to pay its liabilities. But it experienced a short-term liquidity problem and approached the government for support.

The news leaked, and within 24 hours huge queues formed outside the branches as people scrambled to get their money out. The longer the queue, the bigger it became. The result was the first bank failure in the UK for 150 years.

This herd-like behaviour seems irrational. But an important paper by Sushil Bikhchandani and colleagues in the top-ranked Journal of Political Economy 25 years ago showed that it was perfectly compatible with the economic concept of rationality.

Suppose you have to make a decision, like the table to go to in order to pick up lunch. You might have some private information about the options. In addition, there is some public information available to all.

If enough people have chosen and have already given more weight to the public information, it will seem like it is more accurate than your own. So you are likely to give more weight to it when you choose.

This is exactly what happened at the central bank event. The first few people coming out of the conference used private information, and made for the table they could see. Others behind them could only see people getting lunch, and simply followed them. They used the public information about where lunch was available.

Those in the long queue had imperfect information, another key concept in economic theory. They were outside the room and could not see the other table in the opposite corner.

I considered approaching people in the queue to sell them information to shorten their wait. But it is a bit tricky to value information – yet another important issue in modern economics. As soon as I mentioned it, they would easily guess there was another table and find it themselves.

The conference itself was fascinating. But it was certainly gratifying to see economists behave as rational herders.

As published in City AM Wednesday 5th December 2018

Image: Northern Rock by Alex Gunningham via Wikimedia under CC BY-SA 2.0
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