Paste your Google Webmaster Tools verification code here

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
Read More

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
Read More

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
Read More

At long last, economists appreciate that private debt was the catalyst for the crisis

At long last, economists appreciate that private debt was the catalyst for the crisis

This month saw the tenth anniversary of the collapse of Lehman Brothers, a collapse which precipitated one of the only two global financial crises of the past 150 years.

The late 2000s and early 1930s were the only periods in time when capitalism itself has trembled on the edge of the precipice.

It was in November 2008 that the Queen put her famous question about the crisis to the academics of the London School of Economics: “Why did nobody notice it?”

The answer is simple. In the models of the economy at the time, finance did not matter.

Mainstream economists did not notice the massive financial imbalances in the economy, because in their models, any problems that might link to these imbalances were assumed away.

To be of any use, all scientific models have to make simplifications of reality. But orthodox macroeconomics took a step too far. It assumed that the workings of the whole economy could be explained by analysing the theoretical behaviour of just a single decision maker. In the jargon, this is the “representative agent”.

The agent is a device which economists used to model the economy. It was extremely clever, and could solve hard mathematical problems – calculating how the decisions of average consumers and companies would affect the macroeconomy.

These kinds of models go by the splendid name of “dynamic stochastic general equilibrium models”, or just plain “DSGE” to their friends. But at its most basic, the problem with such economic models was that there was only one decision maker in them.

Having just two, a “creditor” and a “debtor” for example, would have helped a lot.

Over the past decade, economists have been scrambling to incorporate other financial factors into their models, such as household debt. Key contributions to this research are discussed in the latest issue of the Journal of Economic Perspectives.

Bizarre though they may seem, DSGE models now finally recognise the potential importance of household finance in causing crashes.

A particularly interesting paper in the journal is by Atif Mian of Princeton and Amir Sufi of Chicago. Their focus is considerably wider than the crisis of the late 2000s in the United States. They quote empirical studies across some 50 countries with data going back to the 1960s. They found that a rise in household debt relative to the size of the economy is a good predictor of whether GDP growth will slow down.

Rickard Nyman, a computer scientist at UCL, and I applied machine learning algorithms to data on both public and private (households and commercial companies) sector debt in both the UK and America. We find that the recession of 2008 could have been predicted in the middle of 2007.

Perhaps the most striking result is that public sector debt played little role in causing the crisis. The driving force was the very high levels of private sector debt.

A critic might say that this is simply a case of generals fighting the last war.

True, we don’t know whether a completely different nasty event lies around the corner. But at long last, economists appreciate the fundamental importance of debt and finance in Western economies.

As published in City AM Wednesday 26th September 2018

Image: Her Majesty The Queen by UK Home Office on Flickr licensed under CC-BY 2.0
Read More

Never mind who wins, the World Cup is a treasure trove for curious economists

Never mind who wins, the World Cup is a treasure trove for curious economists

Our boys make progress – and I don’t mean on Brexit.

On a visit to Glasgow last Thursday, a popular Scottish newspaper had a mock-up photo of Harry Kane lifting the cup. In massive type, the headline shrieked “This Would Be the End of the World”. Yes, it would rather put the Highland Clearances into perspective.

There is a general perception this year that the football has been more entertaining than usual. This is reflected in the fact that the average number of goals per game – 3.18 – is the highest since the 1958 finals.

The qualifiers for the last 16 generally followed the form book, with only three of them – Russia, Denmark, and Sweden – edging out teams placed above them in the FIFA rankings before the tournament started.

But the patterns in the results show once again how close many of the teams are in ability. One team has to win, though it is not obvious which one.

Germany’s own qualifying group illustrates the point. A key concept in economic theory is that of transitivity. It essentially means that preferences should be well-structured.

If I prefer product A to product B and product B to product C, the assumption is that I prefer A to C.

If we carry this over into team sports, it seems logical that if A beats B and B beats C, then A should beat C.

None of these “transitive triples”, as the jargon puts it, were observed in Group F. Mexico beat Germany, who beat Sweden. But Sweden beat Mexico. Sweden also beat South Korea, who beat Germany.

The conclusion is that the teams in this group were very evenly matched. It was largely a matter of chance rather than superior ability that Mexico and Sweden qualified.

In the round of 16, three of the eight games ended in draws and the result was by penalty shoot-out. Two of the others were decided by goals deep into injury time. And one of the quarter finals was won on penalties.

Again, the implication is that there is a great deal of randomness in the outcome. Even in England’s famous victory over Colombia, the opposition goalkeeper got his hand to the final penalty shot but could not prevent the ball entering the net. Move his hand by just a few centimetres, and he saves it.

To round off this football economics analysis, finally and frivolously, is winning the World Cup good for the economy? I looked at the eight years from 1974 when European countries won.

As a control group, I examined the US and Australia, two western economies where soccer is a minor sport. Growth in a World Cup year was higher than in the previous year seven times, and lower nine times. Growth was higher in the year after the World Cup nine times and lower seven. So the pattern here looks completely random.

In the countries which won, growth was higher in the World Cup year than the previous on four occasions, and lower on four. But in contrast to the control group, growth in the year after victory fell six times out of the eight.

Winning the World Cup is bad – or so the statistics say!

As published in City AM Wednesday 11th July 2018

Image: World Cup 2018 by RonnyK is licensed under CC-BY-0.0
Read More

There are economic lessons to learn from TfL’s hated bus announcement experiment

There are economic lessons to learn from TfL’s hated bus announcement experiment

The Transport for London (TfL) bus experiment has proved to be overwhelmingly unpopular.

Supposedly at every bus stop (but more usually once the bus has pulled away) a disembodied voice informs the passengers that the bus is about to move.

The hated announcement is being run as a trial for four weeks. TfL will then evaluate its effect on the number of accidents on the buses themselves.

A conflict between individual and collective welfare is exposed by the reactions to the experiment.

Collectively, we do not want it to continue, but individuals have little incentive to stop it in an effective way.

For example, public spirited individuals could fall down and claim that this was due to the motion of the bus. The statistics would then show an increase in accidents. Even the most obdurate bureaucracy would find it hard to persist with the experiment

The “victims” would bear costs as individuals, such as the time spent reporting it, plus the risk they might actually injure themselves. But they would create a benefit for everyone else. The voice on the buses would be switched off.

The concept of the winners compensating the losers has been a fundamental principle of economic theory for at least 100 years. It is important in public policy making, in the cost-benefit analysis which is carried out to decide whether a public infrastructure project should go ahead.

This is the rationale for the soon-to-be-abolished tolls on the Severn crossings, for example. The users benefit from a much-reduced travel time, but the non-users lose by having to pay taxes to build the bridge in the first place.

In general, the problem with implementing this in full is that the gainers are small in number relative to the losers. They tend to object vociferously to the charges levied on them, so that they rarely pay the full amount of their benefit to compensate everyone else.

With the bus scheme, the reverse is the case. Large numbers benefit from the ending of the scheme, and only the small number simulating an accident would lose.

But a public body such as TfL could hardly be expected to set up a scheme which would undermine its own experiment.

We might then ask why a market has not emerged to compensate those willing to simulate a fall. In a market, individuals could be paid the full costs they incur.

With social media, setting up such a market would be easy. But there would be two main problems.

The first is that of trust. How would participants be reassured that the relevant monies would be paid? The issue of institutional trust is a fundamental reason why markets are difficult to set up in many contexts.

There is also what economists call the free-rider problem. How many of those who dislike the voice would simply leave it to others to make the payment? There would be no coordination mechanism for ensuring that everyone paid.

Annoying though it may be, the bus experiment shows that even everyday issues often raise fundamental aspects of economic theory.

As published in City AM Wednesday 31th January 2018

Image: London Bus via Pixaby is licensed under CC by 0.0
Read More