Sunday, 30 November 2008
Saturday, 29 November 2008
Wednesday, 26 November 2008
Tuesday, 25 November 2008
- They may feel that they are spending just enough to survive, and are saving less than they want to. The marginal value of saving one more dollar is higher than that of spending it. In theory, this would only happen if they are exactly on the cusp of a marginal change in relative utility between saving and spending - otherwise they would have already redistributed some income into saving.
- They may have established spending habits which they have not thought about for a while - having risen, Peter-principle-like, to consume the majority of their income - and a discontinuous boost in income gives them a prompt to evaluate afresh what they will do with it. Like a new year's resolution, they may succumb to virtue and save the money.
- They may already be borrowing in order to spend at their desired level; and rather than spending the new money, they pay off part of a credit card balance.
- They may feel under pressure because of high debt, and are looking for opportunities to pay some of it off.
- They may be expecting a future fall in income and wish to protect themselves against it.
- They might feel they are saving the right amount already and the rebate is a discretionary boost. This could happen, say, if savings rates are high. The rebate is like a little lottery win - and few would argue that people don't spend when they win the lottery.
- Similarly, they may have confidence that things will remain stable for them, and additional saving is not needed - in which case there is no reason not to spend the extra income.
- Their income may have fallen, so the rebate partially replaces lost income - enabling them to spend at previous levels for at least one more month.
- They may simply want some goods or services more than they want the security of having higher savings. In particular, there could be some specific item which has been out of reach but can be afforded now.
- They may be expecting a future rise in income, in which case the confidence of increased future saving may permit the gratification of buying something now.
- Is there any established or habitual behaviour which is suppressed by recent changes - if so, they may want to return to it.
- Is there a strong expectation of the future - such as fear or optimism?
- Target it at those whose incomes are stable
- Target it at those who expect their income to increase - for example young people or graduating students
- Alternatively, provide it for long enough that the stimulus itself becomes an expected long-term income increase
- Or, make it automatically adjust to increasing income - the classic "automatic stabiliser"
- Target it at those who have been saving "enough" already or those who show no inclination to save
- Aim it at those who have cut their spending recently - we have enough evidence from supermarket loyalty cards to get some understanding of this
- Package it in such a way that it is least likely to disrupt existing saving habits - for example by a VAT reduction, which does not put a readily-saveable lump sum in anyone's pocket but still leaves us with more money to spend
- Provide it in a way that is consistent with easy spending decisions - for example subsidising products to make them more attractive, or by giving out $5 bills in bars which sell drinks for $5
- Ensuring borrowing is available if people want it
- Doing what you can to change the public conversation, perhaps by providing the right kind of message alongside the policy change; increasing expectations is as important as increasing the cash in your pocket
Roubini’s paper from 8th February makes an intriguing point. In his list of reasons why the Fed cannot save us this time, the final one is that the entire system is in “a crisis of financial globalisation and securitisation” and so a recession cannot be prevented within the current framework. The implication is that quantitative policy actions will not solve the problem, but systemic reform or qualitative changes are required.
While the actions proposed by Sachs and Wolf seem reasonable and well thought out, it is unclear that they will be convincing to market participants. This argument is borne out when we look at the situation from the angle of behaviour and incentives instead of just the figures.
Decision-making behaviour is in theory guided by what people believe the future will hold, not what happened in the past. Of course if they believe the future is going to be like the past, they will use past evidence to make future decisions. Future economic performance is in turn driven by the decisions people make now.
And so, for any policy intervention to work, it is crucial that it be a credible break with the past. Whether the policy is genuinely different is sometimes less important than whether people believe it is.
This is why the fiscal rules of Gordon Brown in 1997 and, before that, the Maastricht rules of 1992 were successful. They gave people a reason to believe that the future would be different, and to take actions accordingly. As it happens, Roubini himself wrote a paper on these rules in 1992 – co-authored with Willem Buiter – suggesting that the debt condition of the Maastricht rules (public debt to be under 60% of GDP, fiscal deficit to be under 3%) should be suspended in the runup to EMU. Whatever the merits of the rules themselves, their believability is the most important issue.
As John Kay’s column of 3 September said, “The appearance of prudence, not prudence itself, was sought and rewarded”.
What support is there for this viewpoint? First is the evidence that, in recent months, no matter what level of liquidity and fiscal stimulus has been announced, the economy has not responded as intended. Perhaps interbank rates are finally coming down, but the taps in the real economy have not opened yet.
Second, we see the totemic importance in the public narrative of redefining the rules. Alistair Darling avoided proposing new fiscal rules for the UK in his Mais speech of 29th October, but there is clear pressure to produce them [this response was written some time before the PBR]. Gordon Brown’s article in the Telegraph last weekend also started to hint at new rules for guiding the behaviour of the market in general, and commentators across both economic and mainstream publications are hunting for new frameworks for all sorts of things.
Third, we can refer to behavioural theory and what we might call the “boiling frog” principle. Quantitative, continuous adjustments tend not to change the behaviour of real agents (as opposed to imaginary, rational economic agents) significantly – the mental cost of changing is greater than the incremental pressure created by the adjustment. A discontinuous change in policy is more likely to cause people to re-evaluate their positions and change their behaviour than simply an increase in the numbers. This is supported both by recent brain research and also by plausible models of bounded rationality.
What kinds of discontinuous actions therefore might have greatest credibility? Those which have an external rationale which discourages further change. For example, if the UK’s fiscal rules are to be rewritten, it would seem more credible to adopt the Maastricht rules (60% debt and 3% deficits) than to choose an arbitrary 55% debt target or 4% deficit rule. By conforming to an existing mental anchor, the resetting of expectations becomes more believable. It also allows for a credible transition period – which may well be needed in the UK, which would probably run 5-7% deficits for a couple of years on the way to the 60% limit.
Future frameworks which people can believe in also go a long way to mitigating the trauma of a collapse in the old framework. If large parts of a “mountain of private debt” do end up defaulting, the damage to economic relationships and confidence will be extreme if there is a vacuum of expectations. Firms and consumers will have no guide for the future except for the memory of the violated promises of past borrowers. However if a new economic model has been defined, and defined credibly, it is much easier to accept pain in the present day – a write-down of current assets – without destroying the incentives for future economic activity.
What form that economic model might take is a subject for another day, but I suspect Nouriel Roubini may have some suggestions.
Monday, 24 November 2008
- Creating extra work for accountants and software developers. This would be the first change in VAT since 1991, and the economy is a lot more complex and automated than it was then. My own programmers are on standby to update and check all our clients' systems if the change goes ahead. We are hoping to have a few days' or weeks' notice of the change so that we have time to do this. Accountants, similarly, will have some extra work to check that their clients have changed the rate they apply and correctly dealt with invoices which might straddle the effective date of the change.
- Administrative overhead for retailers. There will be work for retailers in changing prices - and particularly in reconsidering non-granular price points such as £1.99 or £5. Many retailers may not reduce prices but will increase profit margins instead. The retail sector has been under a lot of pressure so there will be strong temptation to hold at least some prices. No doubt consumer bodies will be active in monitoring these prices so it will be interesting to see how the fights play out. Perhaps this will make pricing a more visible issue in the public realm.
- Reduced cash float for most businesses. On balance, companies hold their net VAT receipts for about ten weeks after collecting it from their clients and before paying it over to the government. A typical service business turning over £1 million and spending £200,000 on taxable items will currently collect £140,000 a year in VAT, holding an average of £28,000 as cash float. The size of float will vary from about £11,000 to £46,000 over the course of a quarter, meaning that £11,000 is a permanent interest-free loan from the government. If VAT is cut to 15%, the average float will reduce to about £24,000 and the permanent component to £9,500. In an environment where credit to companies is being cut back, this may make an appreciable if small impact. The amount of the effect on average float is only 0.5% of value add, so this will not be critical for most businesses, but it doesn't help.
- Subsidy for ex-EU businesses buying services in the UK. Most businesses are VAT-neutral so their own finances will not be directly affected by this change. The three types of entity which actually pay VAT are consumers, microbusinesses under the VAT threshold, and non-EU companies. Occasionally we have sold software services to a US or Canadian company, and if the service is provided in the UK, they pay VAT on it. They will now pay less.
|BBC (Nick Robinson) |
|1% of GDP (£15bn) fiscal boost: deferring tax rises on cars, small business and income tax; tax cuts for the lower paid; bring forward government spending|
|BBC (Robert Peston) |
|Deferred VAT rise to 22.5% in a couple of years|
|VAT reduced to 15%||Big tax cuts on low paid, rises on high earners; extra tax on bonuses|
|Sunday Times |
|2.5% VAT cut; extend £120 income tax rebate; defer road tax and corporation tax rises; three months grace on repossessions; increase public capital spending; expand SFLGS||Increase support for manufacturing|
|Sunday Telegraph |
|2.5% VAT cut; reduce empty buildings tax|
|Income tax increase to 45% over £150,000; public spending cuts outside education and health; temporary VAT cut to 15%||Fiscal boost is important; Tories' insistence on funding the tax cuts is risky|
|Daily Telegraph |
|2.5% VAT cut; NI reduction; defer small company corporation tax rise; reduction in motoring taxes; public spending increase||Increase income tax allowances; possibly reduce stamp duty; reduce corporation tax from 28% to 25%|
|2.5% VAT cut; future increase in income tax on £150,000 earners; give businesses more time to pay tax||Lower interest rates; controls on borrowing to reduce debt in the economy|
Clearly the VAT cut is the main consensus and is expected to be introduced almost immediately, and to last for a year. Other actions have either been leaked consistently or the papers are all following each other and reporting the same things. But there is a bit of diversity in the opinion pages, with some insisting that redistribution is important, others wanting private debt discouraged, and some bemoaning the running of deficits in general.
Monday, 17 November 2008
To answer this we must go further back and ask why there are even any groups of people to be led. The simple answer is that is what works. Specialisation of roles emerged long before Henry Ford and Adam Smith - as soon as hunter-gatherers settled in villages and discovered agriculture, there were some people out in the fields digging, some people making tools or clothes, some raising children and others inventing the wheel.
Specialised roles are more efficient because people have different talents and, with practice, can get good at one thing. They can use the tools appropriate to the job and stay in one place to carry it out. And when you have specialised roles, you need a team. Whoever is making the clothes still needs food to eat, and if they are not growing it themselves they must cooperate with someone who is.
So groups of cooperating people emerged. This is what we now call a team - a group of people cooperating - working together - to deliver results.
And now we are ready to answer our question: why do leaders arise?
To achieve the greatest results, a team must act with purpose. This means that it has a goal in mind and that its actions are to further that goal. It may be as simple as "produce more wheat" but it's likely that a more specific goal (specialisation again) will be more successful. The more directed the purpose of the team, the greater its results will be. There is competition in everything, so those teams which achieve the greatest results are those which survive.
A team which has the purpose of build the biggest retail company in the world or win the Bedfordshire Sunday hockey league knows what it's there for, and can design actions to succeed in that goal. A team whose purpose is paint and recarpet the office before Monday morning may not know the strategic objective of its work, but it's pretty clear what has to be done.
A purpose is an expression of what-we-want or what-we-are-going-to-do. In both cases it is a product of human motivation, and the fundamental source of motivation is the internal consciousness of a single human mind. The motivations of multiple people in teams must be somehow aligned, in order that they stay together. But the purpose of a team is most consistent and focused when it is declared out of the motivation of a single person.
That, in its most essential form, is the leader: the person who declares the purpose of the team and somehow makes its actions consistent with that purpose.
This is not to say that teams cannot arise organically and manage themselves. But this takes a lot of willpower and subtlety, so it is not the most common or stable form for a team. Other things being equal, most teams will have leaders.
Leaders arise for another reason, and that is because they can. All people are biologically set up to benefit from having power over others. Therefore, it's natural to want to be a leader, and if the social structure allows for leaders, they will arise. That motivation does not directly serve the team and is not what causes the team to produce results, but it does influence who ends up as the leader of a team.
And it also exists symbiotically with the nature of teams; people need leaders to deliver the best results, and leaders need people to lead for their own fulfillment.
This, then, is the answer to Why do people lead people? Or is it? There is another reason - and that is to make a contribution. Leaders contribute to their followers both through the results that they help the team produce - and by the sense of purpose that they offer to the individuals in the group. Participating in a powerful goal which challenges you, while learning from those you work with, is an amazing growth experience which gives you new abilities to achieve results in the future. These psychological rewards are as important as material rewards, especially in a society where material need is not the main driver for most people. Offering leadership to others, as a contribution which helps them to achieve those rewards, is a great motivation in itself.
In both roles, then - leader and follower - there is a base biological motive and a separate psychological fulfillment which is gained from participating in the team. These two motives are not independent but they are distinct. And leadership outside of a subsistence environment requires delivering to both motivations.
The importance of this relationship in human society is immense. Think of the passions aroused by the leadership of football teams or of political parties. The crew and captain of the Argo or the soldiers and general in Napoleon's army are archetypal examples of human interaction. So an understanding of the mechanisms and patterns of leadership is crucial to operating successfully in society.
Thus, finally, to the heart of this article: How do people lead people? By now you know the answer. In the most successful groups, people lead people:
- By articulating an purpose
- By guiding people's behaviour to be consistent with the purpose
- By ensuring that each team member achieves the personal rewards that make it worthwhile for them to participate
Friday, 14 November 2008
Barclays management preferred to accept a private £2.8bn investment from the Qatar and Abu Dhabi states, rather than take UK taxpayers' money, to the apparent detriment of existing shareholders. Peston suggests (in an earlier post which he links to in this one) that the reason may be that top Barclays management want to preserve their freedom to pay big salaries and bonuses to themselves (and each other).
Without addressing the accuracy of this suggestion, as I have no data either way, economic theory does shed some light on how this could happen. Assume for now that the facts are as Robert Peston says.
Classical theory says that firms act in their own interest (equivalently, the interests of their shareholders). In this case, that would mean taking the Treasury's money.
However, the agency problem, based on the fact that firms are not controlled by their shareholders but by professional managers, says that these managers will act in their own interests instead of that of the owners. Apart from the question of fairness, this also presents a problem for the proper workings of the economy because it means capital will not be allocated efficiently.
This is well-known, and so there are some defenses against it. With most major decisions such as a capital dilution, the shareholders have to vote on the proposal. Thus there is a vote on 24th November to determine whether it should go ahead.
However, this is where bounded rationality comes in. Because of the psychological phenomenon of anchoring, and the resulting question of credibility, it becomes critical for an organisation to follow through on what it says. In a purely rational world, any firm could re-evaluate at any time the expected utility of any decision, and change its mind.
But in real life, people become attached to ideas which have been decided or announced; and so to back down on anything may cause a crisis of confidence. Particularly in the financial markets, which rely so heavily on trust - it's no accident that credit and credibility have the same root - and where trust is in such short supply right now.
This has two consequences. One is that shareholders are being urged to recognise the danger of voting against the deal. Even though they are being mistreated, if they reject the proposal the value of the bank will be substantially damaged and they will lose out even more.
The other is that the Treasury has its own face to save, and is no longer likely to offer Barclays money on the same terms that were available a few weeks ago - because the original proposal itself cast a shadow on the Treasury's cash and thus on the other banks which have accepted it.
So because of anchoring, Barclays shareholders and British taxpayers are both potentially stuck with a deal which is in the interest of neither. Barclays management and the Qatari and Abu Dhabi royal families will do OK, though.
There are game-theoretic explanations for this behaviour which are distinct from the idea of anchoring. Both concepts - game theory and anchoring - are likely to be a factor, and it would certainly be interesting to explore whether the psychological phenomenon is what gives rise to the game theory solution; or indeed whether game theory explains why our psychology evolved this way.
Thursday, 6 November 2008
Although efficient markets is an appealing idea and can be proved in a world of 'homo economicus', the world has not been demonstrated convincingly to behave as the theory predicts.
A suggestion as to why this may be. The traditional hypothesis says that markets are influenced only by news, which by definition is unpredictable. The apparent phenomenon of 'sentiment' seems to contradict this - sentiment surely drives the market (in both directions) beyond whatever rational level is implied by news events.
I would suggest a modification to the hypothesis: instead of being driven just by unpredictable news, markets are driven by a sentiment which is also unpredictable.
Chaos theory gives us one plausible explanation for how this could arise; the interactions between thousands of interdependent agents who influence each other in ways too complex to be analysed. Sentiment in this sense is hard to model with classical economics because there is no effective price signal to communicate between people in the market. Sentiment does not necessarily obey self-correcting equilibrium laws and find an appropriate balance point.
And so, sentiment - even though not necessarily driven by exogenous events - is still unpredictable and so cannot be factored into market prices. Thus, the efficient markets hypothesis still has the implications for investment strategy that Tim indicates: past performance does not indicate the future; don't pick stocks; and don't time the market.
But perhaps the reason it has been hard to demonstrate is that researches are looking only at news as an influencer. If they also looked at events which are not news, but are also non-predictable within a linear equilibrium model, perhaps the truth of this hypothesis would be more clearly visible.
Wednesday, 5 November 2008
- Iowa: Obama
- New Mexico: Obama
- Pennsylvania: Obana
- Ohio: Obama
- Virginia: Obama
- Colorado: Obama
1. Go to the polling booth
DRINKING INSTRUCTIONS (everyone else - Americans also allowed):
Obtain one bottle of Kentucky bourbon (try and find one with a red neck). If you don't drink bourbon (you elitist), a bottle of "Mac"allan will do; if you don't like whisky at all, you can drink cachaca as it is made from sugar (Mc)cane.
You then need six bottles of champagne or Cava (preferably with blue labels and not "too European"). Make paper caps for them, marked: Virginia, Pennsylvania, Ohio, Florida, Missouri, North Carolina. If you feel especially confident (and thirsty) you can add bottles for Georgia, Indiana and North Dakota (if you're an Obama fan) or Colorado, New Mexico and New Hampshire (if you're a McCain fan). These are known as the 'swig states'.
Whenever a swig state is declared officially - or if the result is called by the TV channel you're watching - it's time to have a drink. If Obama won the state, open the champagne and drink it before the next result comes in. If it went to McCain, take a shot of bourbon. If you need to plan your drinking time, here are the closing hours for the swing states:
Indiana: 11.00 GMT (6.00 EST)
Georgia: 12.00 GMT (7.00 EST)
Virginia: 12.00 GMT (7.00 EST)
Florida: 12.00 GMT (7.00 EST)
New Hampshire: 12.00 GMT (7.00 EST)
Ohio: 12.30 GMT (7.30 EST)
North Carolina: 12.30 GMT (7.30 EST)
Pennsylvania: 01.00 GMT (8.00 EST)
Missouri: 01.00 GMT (8.00 EST)
Colorado: 02.00 GMT (9.00 EST)
New Mexico: 02.00 GMT (9.00 EST)
North Dakota: 03.00 GMT (10.00 EST)
Set aside four Nurofens marked Iowa, Nevada, Arizona and Montana. By the time Colorado and New Mexico close (2am GMT or 9pm EST) you should be fairly drunk, and when Iowa and Nevada come in an hour later you will need the Nurofens. If Obama is having a good night you'll be mainly high on champagne; if McCain has pulled off a comeback you can cry into the bourbon.
For extra credit, if:
- you hear the phrase "served his country with honour" - stand up with your right hand on your heart and have a shot of Stolichnaya
- Hillary Clinton's face is shown - eat a New York bagel
- Joe the Plumber is quoted - have a Budweiser
- George Bush appears on screen - eat a pretzel (carefully)
- someone says "credit crunch" - have a coke (no, the drink)
- Sarah Palin and 2012 are mentioned in the same sentence - drink something red
- anyone calls Obama by his middle name - have a soft drink
- Joe Biden sends you an email asking for $5 - spend it on an extra drink instead
And save a whole bottle of red whine for the concession speech.
Finally, if you're feeling suicidal:
- take a drink every time the phrase "too close to call" is mentioned
Whatever the result, you will wake up with a hangover which may last up to four years. And if you buy your Cava at Aldi (or your bourbon at Walmart), at least you should have some change left over. I hear they may be looking for some of that in Washington soon.