Paste your Google Webmaster Tools verification code here

Does Miliband understand the importance of incentives?

Does Miliband understand the importance of incentives?

Ed Miliband has long had a problem with voters not perceiving him as “normal”. His famous struggle with a bacon sandwich in some ways says it all. But at a much more important level, he seems to have little or no empathy with one of the most fundamental of human motivations. The most profound insight of economics is that people respond to incentives. When incentives change, behaviour also changes. This certainly does not exclude other motives, such as altruism, but incentives are key to understanding how people make decisions. It is this which Miliband appears unable to grasp.

Consider the political situation in Scotland. A rampant SNP threatens many Labour seats. Yet despite the pleadings of his colleagues, Miliband finds it very difficult to rule out forming a coalition with the Nationalists after the election. In these circumstances, the incentives facing a Labour-inclined voter North of the Border are clear. Voting SNP promises a potentially powerful bloc in Parliament to press the case for extracting even more money from the English. And at the same time, you could still get a Labour government via the coalition route. For all except the truly faithful Labour supporter, incentives in Scotland point to voting SNP.

Pensions are another area where neither Miliband nor his political mentor Gordon Brown have shown the slightest sign of understanding the effect of incentives. Miliband proudly proclaims that he will finance a reduction in tuition fees by reducing the tax advantages of putting money into a personal pension scheme. One of Brown’s first acts as chancellor in 1997 was to abolish the tax relief pension funds earned on dividends from stock market investments. This crippled many final salary pension schemes. Pension pots are an irresistible lure for politicians with profligate spending aims. But at a time when life expectancy is rising sharply, it is an act of profound economic illiteracy to reduce the incentive for people to put money away for retirement.

Miliband played a prominent role in the last Labour government, first as a key adviser and fixer for Brown, and then as an MP and member of the Cabinet. Brown was at first an excellent chancellor, keeping us out of the euro and maintaining fiscal probity. But he soon went in for a massive increase in public spending, with entirely predictable results. Workers in the public sector were portrayed as angels, selflessly serving the nation. But they proved only too human, just like the rest of us. They responded to incentives.

The incentive to take advantage of the increases in public spending was strong. The outcome was a huge increase in the pay of the public sector relative to that of the private, even more attractive gold plated pension schemes, shiny new offices, more staff, and endless re-gradings and promotions. Most of the rise in public spending did not go into improving service provision. Instead, it went into subsidising the private consumption of those employed in the public sector.

Like it or not, responding to incentives is a very deep-rooted aspect of human behaviour.

As Published in City AM on Wednesday 11th March

Image: Ed Miliband and Fabian Hamilton by Bob Peters licensed under CC BY 2.0

Read More

Crocodile tears for the poor

Crocodile tears for the poor

INEQUALITY is now a buzzword in Britain. Scarcely a week goes by without a new publication by an academic or journalist lamenting the levels of poverty facing swathes of the population. They are bolstered by a complicit metropolitan liberal elite, who shed crocodile tears for the poor, while ruminating on the current situation.

Unfortunately, much of the work coming out of universities can hardly be described as scientific. Rather, it could be described as “advocacy research”. In other words, research that is carried out with the intention of providing evidence and arguments that can be used to support a particular cause or position. And too often, the taxpayer is left financing such activity.

However, a new book on poverty, Breadline Britain, deserves to be taken more seriously. The authors, economist Stewart Lansley and academic Joanna Mack, wrote the first version in 1983 when they were producers at ITV’s current events programme, Weekend World. Over the next three decades, they continued to collaborate on the topic.

Lansley and Mack make the startling claim that one in three households now suffer from poverty. Their method of calculating this figure is intriguing. Instead of wrestling with intricate statistical methods, they simply go out and ask ordinary people what they consider to be the basic necessities for a decent standard of living. On this basis, the percentage of households lacking three or more of the items listed has risen from 14 per cent in 1983 to 30 per cent now.

Of course, like any measure of relative poverty, it is open to the valid criticism that in material terms the poor are far better off than they were. But it does serve as a useful reminder of the different qualities of life which are on offer in the UK today.

A key point in the book is that poverty is far from being confined to those on benefits. A rising proportion of the poor are in work. The authors cite the usual suspects of zero hour contracts and the spread of low pay. But there is one fundamental driver of these changes in labour markets which they do not face up to – namely, mass immigration.

Under New Labour, Britain’s borders were effectively opened completely. While the party was in power, immigration added more than 3m to our population. At the time, we were invited to believe that this would have no effect on real wages. Equally, we were assured that immigration was vital in combatting the effects of an ageing society. Critics such as Bob Rowthorn, then head of the Cambridge economics faculty, were pilloried for making the obvious point that immigrants themselves get older.

Unsurprisingly, the increased supply of labour has driven down real wage rates at the lower end of the market. And the imperatives of politics means that benefit levels have had to follow suit.

If Lansley and Mack are right, as the inequality debate persists, we must acknowledge the part that the liberal elite’s advocacy of mass immigration over the past two decades has played in impoverishing the indigenous working class.

As published in City AM, Wednesday 18th February 2015

Image: Bread by Matt Burns licensed under CC BY 2.0

Read More

Birthday parties and the NHS: We Need More Markets

Birthday parties and the NHS: We Need More Markets

Many outrageous things happened around the world during the course of last week. But, judging by both the level of popular interest in the story and reaction to it, the most heinous was the decision of a mother to send an invoice to the parents of a boy who did not turn up to her son’s birthday treat. A demand for £15.95 was slipped into his schoolbag after he missed the outing to a local ski centre.

The adverse sentiments seem to be partly based on the feeling that it was inappropriate to introduce the principles of markets – a price was charged – into purely social relationships. Hostility to markets is a very widespread phenomenon. Many people get apoplectic at the idea of markets being introduced into the NHS. It was actually the post-war Labour government which began the process in 1951, charging for teeth and spectacles. But why let facts get in the way of a faith? Firms which fill gaps in the market by providing loans to high credit risk individuals are regularly pilloried for the rates of interest which they charge.

But the whole history of progress is based upon the gradual spread of markets across the range of human activities. In the distant mists of pre-history, humans were organised into tiny, self-sufficient groups in which markets were unknown. As the American anthropologist and best-selling author Jared Diamond points out in his latest book, The World Until Yesterday, life was pretty unpleasant. Nasty, brutish and short, as a famous philosopher once said.

Diamond has a wealth of evidence from areas like New Guinea, where primitive forms of human social structures survived almost until the present day. Contact with other small bands of people was largely based upon the principles of rape, pillage and murder. Strangers were intensely feared and liable to be killed on the spot.

As a species, it took us many thousands of years to start to work out that, in order to benefit from what other groups could produce, it was better to use markets and trade rather than invade and loot. In modern times, societies which have tried to suppress markets, like Stalin’s Soviet Union, Mao’s China and contemporary North Korea, have merely perpetuated grinding poverty for the masses. On a much less serious note, Ed Miliband’s pledge to buck the market and freeze energy prices has just left him looking foolish.

The real problem with the birthday party was that the bill was sent after the event, without prior consent of the participants. Places on the trip were limited, and telling people in advance that no shows would be charged would have been an efficient way to ration scarce resources. Otherwise, the only sanction would be social disapproval. And social norms are always open to exploitation by free riders. An example is in the NHS, where a modest charge to visit a GP would go a long way to reducing pressures on surgeries. Most people behave reasonably, but a minority abuse the system. We need more markets, not less.

As published in City AM on Wednesday 28th January 2015

Image: Birthday Cake by Will Clayton licensed under CC BY 2.0. 

Read More

What the Emily Thornberry saga tells us about macroeconomic policy

It has been a wretched week for Emily Thornberry. The high-flying MP for Islington was sacked as Shadow Attorney General, and widely pilloried in both social media and conventional newsprint for tweeting a picture of a white van and England flags in Strood. Yet the saga tells us more about perception, about the narrative which emerges around a story, than about the objective reality of the event itself.
One of Thornberry’s defences was that she had grown up on a council estate, and so was very familiar with the world of the working class. She had indeed successfully presented a image of herself within the Labour Party of having a humble background. This was no disadvantage in her rise, in the so-called People’s Party, to a position of being a close ally of its Leader. However, her Wikipedia entry paints a subtly different picture. Her father was a successful academic, who went on to become United Nations Assistant Secretary General. Her mother was a teacher and Mayor of their local town. Image triumphed over reality.
Her misdemeanour is an even more striking example of the importance of perception. It was a week in which the England football team had played and won two matches. Imagine if Nigel Farage had tweeted an image of the now famous white van and the three national flags draped over the house. Suppose further that the former stockbroker had posted the identical comment ‘I’ve never seen anything like it in my life’. Now, we will never know for certain what his reception would have been. But it seems plausible that it would have been seen as a eulogy to patriotism and to the success of our boys on the field. Instead, Thornberry was ridiculed as a patronising snob. Exactly the same actual event, completely different consequences.
The impact of macroeconomic policy shares this same characteristic. The narrative which evolves around an event is even more important than the facts. It was a great coup by David Cameron and George Osborne in the aftermath of the 2010 General Election to succeed in presenting the government as being financially prudent.
It is even more impressive that the markets still believe them. On coming to power over four years ago, the government projected that borrowing in the current financial year, 2014/15, would be just under £40 billion. It is on track to be around £100 billion. What is more, over the first seven months of this financial year, borrowing is even higher than it was in 2013/14. The increase is not great, £3.7 billion according to the Office for National Statistics, but it is still up, not down. The stock of outstanding government debt sits at around 80 per cent of GDP, a figure similar to that of Spain
Against this, the government suffers politically for what is believed to be its austerity programme, one which scarcely exists in reality. The increasing importance of perception and narrative confound the attempts by mainstream economics to build mechanistic models of the economy.

As published in City AM on Wednesday 26th November 2014

Read More

Can Nanny make you stop drinking?

The National Institute for Health and Care Excellence (NICE) has been the butt of much ridicule over the past week.  A pill designed to reduce alcohol consumption among problem drinkers will be made available across the NHS.  But the concept of problem drinkers is so wide that it embraces people who enjoy a couple of modest glasses of wine a day.  Indeed, the treatment is not really aimed at serious alcoholics who knock back litres of vodka with meths chasers.

There are now vast swathes of behaviour which Western governments attempt to modify.  The government has its so-called ‘nudge’ unit dedicated to precisely this end.  Obesity, smoking, the amount of exercise people take, voting registration, recycling, energy consumption are some of the examples.  On the latter, it is not just the amount but the mix.  Hectored for years that diesel fuel was morally superior to petrol, some unfortunates followed the advice and switched their cars to diesel. They now find themselves on the receiving end of a volte face on the matter by the bureaucracy.

There is a literature in top ranking economics journals on the impact of such interventions.  In general, there is a short term effect which gives the policy makers what they want, but gradually, the reactions become muted and people revert to their old patterns.  There are exceptions, but most of these attempts to change behaviour fail.

An interesting paper in the latest American Economic Review by Hunt Allcott and Todd Rogers shows the enormous efforts which are needed to alter the decisions which people make in the long term.  In the United States, nearly 100 utilities hire a company called Opower to send home energy reports every month to millions of households.  Households receive information on personal energy use, social comparisons and energy efficiency information.

The real interest in the Opower work is that some of the programmes were set up as controlled scientific experiments.  Allcott and Rogers examine three of the longest running ones, which started in the late 2000s.  Highly sophisticated metering devices were installed.  Households, from a very large sample, were selected at random to receive the information.  And after two years, some of those getting the reports were randomly assigned to have them stopped.  This way, both post-intervention persistence and the incremental effects of continued treatment can be measured.

Unsurprisingly, there is an immediate reduction in energy consumption after receipt of the first report, though this impact decays rapidly.  In households discontinued after two years, the subsequent decline is much lower.   The sheer frequency of the reports does seem to alter behaviour.   But there are further reductions in energy consumption in households who continue to receive the information, suggesting that people take a very long time to completely change their habits.

In the UK, attitudes towards wearing seat belts and drink driving did eventually change, but it took a very long time.  Short-term trendy campaigns to ‘nudge’ behaviour are just not going to work.  Governments have to be in it for the long haul.

As published in City AM on Tuesday 7th October

Read More

Open Data: Britain leads the world

The UK economy is doing well. Even so, it is not often that we are placed unequivocally at the top of a world ranking of any kind.  But a team of economists led by Nicholas Gruen of Lateral Economics in Melbourne has done just that. In their recent report on the economic potential created by the concept of open data, it turns out that the UK government has been leading the world.  On the Open Data Index, we score 100 compared to America’s 93.  There is then a big gap to the next group, Australia, Canada and Germany, placed in the high 60s.

Open data is the idea that certain data should be freely available for everyone to use as they wish, without restriction.  So what?  Well, scaling some previous work carried by the McKinsey Global Institute, Gruen and his team estimate that open data has the potential to increase output in the G20 economies by no less than $13 trillion over the next five years.  This could even be a substantial underestimate.  The feedback loops between data provision and the value created by open analysis are strong.

Open data comes in many forms.  Public sector information, such as outcomes in the health service or the spending of local councils is an important example.  The ability of people to access and analyse this data creates pressure for improvement in the provision of public services.  A GP who routinely prescribes expensive branded medicines rather than the generic products which are just as good, can be identified.  A council with a very expensive refuse collection service or with large numbers of highly paid bureaucrats, can be exposed.

Research or science data which is publicly funded is an area where much more can be done.  About twenty years ago, a leading American economics journal attempted to replicate the results of influential articles on applied monetary economics.  Some had had a direct and powerful impact on policy.  Most of the results could not be repeated, some dramatically so.  But the effort involved in discovering this was huge.  Now, if the data were placed on the web and made freely available, a graduate student could do the work in a couple of days.  The replication of results is something which is all too often lacking in academic work, especially in the social sciences.  Open data makes it much easier to carry out, and so reduces the chances of shaky, or even outright bogus, results surviving.

As the economy and society become more knowledge-based, data are core assets, creating value in their own right and driving social and economic innovation, growth and development.  Open data is yet another example of the vast potential for innovation which has been created by the technology of the internet.  Just as with the steam engine in the 18th century, genuinely revolutionary technologies may take many years to reveal their full economic impact.  Fashionable worries about the slowing down of innovation are completely misplaced.  And Britain stands to be a major beneficiary.

As published in City AM on Monday 7th July

Read More