Links and (not-so) brief comments on Krugman, behaviour and long-termism
Any of these links could have made a blog posting of its own, but instead why not help yourself to a high-density nutritious snack selection of random commentary?
- During the first lecture of Paul Krugman's London visit last month he commented that the economy might be "stabilising". The stockmarket leapt a hundred points (giving rise to much hilarity on the second and third evenings). This perceptive writer points out a similar occasion in 1929 when someone "of no great note" called Roger Babson made a comment that the market was due to crash. At which point it duly crashed - for the next twenty-five years.
Now a little later in the Robbins lectures Paul Krugman reviewed a history of not the 1929 but the 1873 depression - and how the economy recovered from that, in the absence of the modern era's gifts of Keynesian stimulus and World War II. Nothing to do with the earlier comments...except for one little thing...
- An interesting behavioural marketing tactic from Hyundai. Instead of offering a $2000 immediate rebate (a typical sales incentive for buyers in a quiet market) they offer a $333 per month rebate for six months. This is a structure which normally works well when you're taking the customer's money, but when giving it back it feels counterintuitive. The Nudge blog points out that the normal $2000 rebate doesn't show up in the customer's pocket as cash, but is simply deducted from the price of the car - reducing the psychological appeal of the windfall. I would also suggest that getting six separate small rewards provides more utility than one big one. And finally, it has the straightforward appeal of novelty. Everyone's used to cashback offers and probably incorporate them into the price calculation - but this one is something new and therefore more likely to catch the attention of buyers on the hunt for a good deal.
- Readers of Will Hutton in the last decade may remember his leadership of the charge for "more long-term investment" and the characterisation of British business as being too focused on short-term returns - what Rachel Elnaugh describes as "microwaving the business for profits". Stephanie Flanders expresses her surprise that George Osborne of all people has now joined the campaign. It's certainly an intuitively appealing argument - it fits with our natural morality tale of "saving good, profit-taking bad". And I have even supported it myself in a Walker Review submission. But is it actually right?
The theory is linked with an argument I'm going to discuss in more detail later, which is that the British economy is too focused on financial engineering and not on long-term R&D into "real production". I am inclined to disagree with that thesis, so why do I feel that long-term investment is somehow better than short-term?
In perfectly efficient, liquid markets, short-term and long-term investment are little different. If you want to invest for the short term you should be able to cash out your investment after six months by selling it to someone else - with an appropriate increase in net present value and change in risk profile. However, in reality markets are not that liquid or efficient, and you often need to be willing to stick with a long-term investment if you're going to make one.
Banks are meant to be able to transform long-term lending into short-term liquidity - but that transmission mechanism doesn't seem to be working very well in the last twelve months. Was private equity making long-term investments when lots of credit was available in 2007? Not much - lots of companies with existing strong cash flows were purchased, but this doesn't count as net new investment because the previous owners of the companies were simultaneously disinvesting. There were a few debt-financed commercial property investments, but we didn't see a lot of business growth financed with debt.
Then again, debt is not very suitable as long-term risk capital - the long term is too unpredictable, especially in the modern economy, and debt cannot realistically bear the interest rates required to compensate for that risk. So there is a place for new equity capital instead; but this doesn't seem to have happened either: the number of IPOs even in 2006-07 never recovered to the levels of 1999. There was plenty of investment in China but not much in the UK or the US. But then, perhaps China was where the opportunities were. I think this needs more analysis before we assume the platitudes are right.
And I'm hearing Peter Mandelson on Newsnight now, saying that "people are furious about risk-taking" so perhaps long-termism is still not quite ready to come back.
- A nice note from Dani Rodrik: Blame the economists, not economics. The current period has been described as "a golden age of economics" by Paul Krugman - which may sound like a bad joke to those who blame economists for the crisis. But that blame - much of it self-administered by the profession - is exactly what has stimulated the current exciting debates within it. Behavioural economics is one field which has definitely benefited, but macroeconomics as a whole is going through some exciting contortions, as are agency theory, development economics, labour economics and above all the theory of finance. While subjects like behavioural theory have gained some currency in the last couple of years, they were regarded mostly as toy subjects; now they are establishing a place at the centre of mainstream economics. The next ten years in the profession will benefit hugely from current turmoil. I hope it's worth the price.