Knowing and Making

My panel on behavioural economics from earlier this year is now available at WorldBytes . Thanks to The Lantern Group for spotting this before I did. If you look hard enough you may spot missmarketcrash in the audience.

This week's word cloud from the economics blogs. I generate a new cloud every Sunday, so please subscribe using the RSS or email box on the right and you'll get a message every week with the new cloud. I summarise around four hundred blogs through their RSS feeds. Thanks in particular to the Palgrave Econolog who have an excellent database of economics blogs; I have also added a number of blogs that are not on their list. Contact me if you'd like to make sure yours is included too. I use Wordle to generate the image, the ROME RSS reader to download the RSS feeds, and Java software from Inon to process the data. You can also see the Java version in the Wordle gallery . If anyone would like a copy of the underlying data used to generate these clouds, or if you would like to see a version with consistent colour and typeface to make week-to-week comparison easier, please get in touch.

Tyler at MR has been asking recently whether the structure of bankers' pay caused (or contributed to) the financial crisis. Matt Yglesias also has something to say about it (via the above link). I agree with the general skepticism about this - it is a bit too easy as an explanation. Limited liability on the other hand is definitely a contributor - shareholders' interests are actually almost the same as those of employees: take lots of risk as the upside is much higher than the downside. If a bank makes $100 billion, shareholders and employees get to share it out. If it loses $100 billion, shareholders lose their whole stake, employees lose a large part of theirs, but creditors are likely to lose many times more. Or if the creditors in question are insured depositors, the taxpayer loses out instead. Ultimately, banks manage much more of their depositors' and other lenders' money than shareholders' money. So this had some impact on risk-taking. But I am starting to c...

The Economist has a Global Public Debt Clock on their site now, along similar lines to the American and Irish debt clocks but monitoring the total public debt of the whole world. But lots of people are concerned by the buildup of private, consumer and corporate, debt as well as debt incurred by governments. So, inspired by previous conversations with Nick Rowe , I decided to extend it to show the net total of ALL debt in the world - public and private. The clock will automatically update to the correct figures in real time. Here it is - enjoy:

Frydman and Goldberg (authors of Imperfect Knowledge Economics , which I still must get around to reading) are in the Economists' Forum with the sexily titled article "An economics of magical thinking". They believe that nobody can predict economic crises and that swings in asset prices are natural. Because all knowledge is intrinsically uncertain, and nobody has access to it all, the market cannot find a "true" price for assets. So far I agree. But the next part of the argument is suspect: Behavioural economists have uncovered much evidence that market participants do not act like conventional economists would predict “rational individuals” to act. But, instead of jettisoning the bogus standard of rationality underlying those predictions, behavioral economists have clung to it... The behavioural view suggests that swings in asset prices serve no useful social function. If the state could somehow eliminate them through a large intervention, or ban irrational pl...

The OFT has just fined a bunch of building companies £129 million for "cover pricing", which is described as "the practice of submitting an artificially high bid for a contract which you do not intend to win". But, I thought, companies do that all the time. If a client comes to me with a project that I don't want to do for £20k, I may well be willing to do it for £50k. So I put in £50k, fully expecting not to win, but if I do, then great. Hearing the vague explanation on the BBC this morning, I figured there must be something more to it. This article from Contract Journal explains it better. The issue is not actually the high prices as such. It's the fact that there's collusion between suppliers, ensuring there is no real competition for the tender. As CJ says: What is cover pricing? Cover pricing is when a contractor bids for a job with no intention of winning the tender. For example, Company A has been invited to tender by a client, but for various r...

Everyone is looking for new macroeconomic models these days. Paul Krugman's recent article has been a prompt for a reopening of intense discussion on the matter. It seems that there are two major classes of proposal emerging: those based on cognitive/behavioural insights, and those which incorporate financial firms as part of the model instead of just assuming they transparently pass demand and money around the economy. Financial models include " New Models for a New Challenge ", Cecchetti, Disyatat and Kohler's proposal (via Mark Thoma - though a number of the comments on his posting point back towards the behavioural option). Another is Kobayashi's , which I may have mentioned before. I've explored the behavioural models more in past columns but I hadn't noticed this conference in Australia which looks to have had some interesting presentations. Krugman hints at behavioural explanations in his commentary but has not yet suggested a model incorporating ...

Apart from Alchian and Allen, Tyler Cowen is the only economist mentioned in the Wikipedia entry for the Alchian-Allen theorem . Is this because he is the pre-eminent commentator on that theorem in the contemporary economics world? Or just because he has a popular blog? This post won't answer that question, but it is prompted by Tyler's thoughts on the theorem in his book , and in an interesting Econtalk podcast with Russ Roberts . The theorem states that if a fixed unit cost is added to the prices of all products in a set, relative consumption will shift towards the most expensive one. Or more simply: high shipping costs lead to higher quality goods. The classic example is apples. In Somerset (arguably the apple capital of Britain, for readers unfamiliar with its many joys ) let's imagine a juicy, hand-picked, top quality Pink Lady apple costs £0.10; while a tasteless, mass-produced Golden Delicious costs £0.02. That's a fifth of the price! Local consumers of apples w...

This week's word cloud from the economics blogs. I generate a new cloud every Sunday, so please subscribe using the RSS or email box on the right and you'll get a message every week with the new cloud. I summarise around four hundred blogs through their RSS feeds. Thanks in particular to the Palgrave Econolog who have an excellent database of economics blogs; I have also added a number of blogs that are not on their list. Contact me if you'd like to make sure yours is included too. I use Wordle to generate the image, the ROME RSS reader to download the RSS feeds, and Java software from Inon to process the data. You can also see the Java version in the Wordle gallery . If anyone would like a copy of the underlying data used to generate these clouds, or if you would like to see a version with consistent colour and typeface to make week-to-week comparison easier, please get in touch.

The Office of Fair Trading is conducting a market study on advertising and pricing . This is of interest to me because one of my company's services is advising clients on how to structure their prices. Finding the right price structure is in the interests of both supplier and consumer; although pricing can look like a straight zero-sum game where any gain by the supplier is a loss to the consumer, this is not at all true in general. Thanks to the OFT for pointing out the study to me. The authors have requested comments on what its scope should be; I have made the following submission: Consumers' experienced utility of a good is not always predictable in advance, and pricing can be a key factor in several situations relating to this. Purchases can broadly be classified into four types: In the first type , consumers have a good prior understanding of the utility they can expect to gain. This is the type of purchase dealt with by rational choice theory. Many of the pricing practi...

Dan Ariely has done some really interesting experiments about how to induce honesty or dishonesty. He thinks the results are a sad fact about human nature, but I don't take that view. For me, it's just more insight into how humans behave - which helps give us the power to improve. The Wall Street Journal has a couple of examples of businesses using behavioural economics to influence their customers' behaviour. Revealingly, these examples are mostly of the 'Nudge' type - an electricity company helping customers to reduce energy use, or a pharmacy enrolling more customers in home-delivery services to help the customer save money. This isn't what's relevant to most businesses, though. The third example is much more apposite - an insurance firm using (cognitive) behavioural insights to upsell more supplementary services. Much harder for this company to pretend it's just trying to help its customers out - but much more honest for them to put their story in ...

Is Lloyds, as Robert Peston suggests , really acting on the instructions of its shareholders in trying to withdraw from GAPS (the Government Asset Protection Scheme)? Or is it, as seems more likely, trying to give its management more power? The EU and Treasury intervention that he refers to will restrict the freedom of Lloyds executives to hang onto the empire they've built; and incidentally, to set their own pay and credit policies. Selling off the Halifax branches might well be in the interest of Lloyds shareholders if not in the interests of the board. What's more: if the government does wish to make more credit available to UK businesses and consumers, one way to do it is to make sure banks have lots of capital available to support lending. If Lloyds really can raise £20 billion of new capital, wouldn't it be better if that can support £100 billion of new lending, rather than just replacing the GAPS scheme without increasing loan capacity at all? With the economy in th...

A slightly misnamed book, as its subject matter is New Labour's progress on social policy goals, not economics. But, like most policy debates today, it's taken from an old Keynes quotation, so I guess that's OK. The author, Stein Ringen, led a debate at the RSA this week. The core thesis of the book is that the Labour government which took power in 1997 was well-intentioned, sincere, competent, visionary and had the economic wind at its back - but still achieved almost nothing in its four key social goals: health, education, reduction of crime and poverty. Ringen suggests that this failure arises from a built-in conservatism in the British constitution and political system. Because of centralisation of power in the prime minister's and chancellor's offices, there is nowhere in the political process to conduct a well-informed critical debate. Because of politicians' inability to "mobilise the effort of millions" towards new ideas, all policy becomes te...

If you didn't see the Italian Grand Prix on Sunday and you're still planning to watch it, look away now. But really . It's been three days. So for those who didn't see it and are not planning to watch it, think about this question. Should the order in which drivers are placed affect the aggregate happiness of all fans? (Assume for now that all drivers and teams have the same number of fans.) Surely not, right? No matter whether Rubens Barrichello wins or Robert Kubica does, people will be - on average - equally happy. There's a certain utility gained from your driver coming first, a lower amount for coming second, third, and so on. The total utility gained by all fans is the sum of U(first) + U(second) ... + U(20th), and the only difference is the distribution of happiness between people. And yet. On Sunday, Lewis Hamilton was running in third place and ready to get on the podium. He entered the last lap a couple of seconds behind Jenson Button and trying to catch...

Mark Thoma posts an interesting article from EurekAlert about some Caltech research. The researchers set out to solve the free rider problem by measuring people's real valuation of public goods. The classic problem with public goods is that if you ask people what the service is worth, they have an incentive to lowball their answer. I may claim that a new railway line, or the NHS, is worth only £10 a year to me. That way, I am likely to pay lower fees or taxes for it, and since I think that lots of other people will put a higher value on it, the government will build the railway and keep funding the NHS regardless of my feelings. It's the same dynamic as in the tragedy of the commons; no matter what I do, the behaviour of all the other people will determine whether the good is provided. My action won't make any real difference to the outcome, so I may as well act selfishly. The consequence, however, is that if everyone claims to put a low value on the outcome, the governme...

This week's word cloud from the economics blogs. I generate a new cloud every Sunday, so please subscribe using the RSS or email box on the right and you'll get a message every week with the new cloud. I summarise around four hundred blogs through their RSS feeds. Thanks in particular to the Palgrave Econolog who have an excellent database of economics blogs; I have also added a number of blogs that are not on their list. Contact me if you'd like to make sure yours is included too. I use Wordle to generate the image, the ROME RSS reader to download the RSS feeds, and Java software from Inon to process the data. You can also see the Java version in the Wordle gallery . If anyone would like a copy of the underlying data used to generate these clouds, or if you would like to see a version with consistent colour and typeface to make week-to-week comparison easier, please get in touch.

I intended to mention this little tussle between Felix Salmon and John Carney a couple of weeks ago. As it happens, it's provoked an idea on a solution to the eternal problem of bankers' pay. Carney points out that we don't actually want traders to take the minimum possible risk in all circumstances. If they did, they would never make any returns at all. Instead, we want them to take the right level of risk...at the scale of the whole economy, this is the socially optimal level; at the scale of an individual company, it's the optimal level of risk for shareholder value. He says that without guaranteed bonuses, traders will take less risk than shareholders want them to, because they will need to retain some amount of guaranteed upside to pay their mortgages. Felix's argument against this is interesting, because he doesn't quibble with the theory. As various people have pointed out, because shareholders have limited liability, they have an incentive to get th...

Sam Robbins and I attended a fascinating workshop yesterday at the OFT , titled Trust In Markets . It covered three areas: the nature of trust and its importance in economic exchange; trust and the law; and how trust is manifested in some specific industry sectors (online marketplaces and finance). I'm especially interested in trust as an economic concept. Clearly trust is an absolute prerequisite for many kinds of economic systems to even function. Any system in which transactions are not instantaneous; anything where the quality and nature of the product is not fully known in advance of purchase; and any financial system where credit is offered - will operate smoothly only if parties broadly trust each other. The crowning theory of microeconomics, the Arrow-Debreu theorem, can only work where futures markets are available - and futures markets can only work if parties know that their contracts will be honoured over time. Sometimes trust can be replaced, in the short term at leas...

This week's word cloud from the economics blogs. I generate a new cloud every Sunday, so please subscribe using the RSS or email box on the right and you'll get a message every week with the new cloud. I summarise around four hundred blogs through their RSS feeds. Thanks in particular to the Palgrave Econolog who have an excellent database of economics blogs; I have also added a number of blogs that are not on their list. Contact me if you'd like to make sure yours is included too. I use Wordle to generate the image, the ROME RSS reader to download the RSS feeds, and Java software from Inon to process the data. You can also see the Java version in the Wordle gallery . If anyone would like a copy of the underlying data used to generate these clouds, or if you would like to see a version with consistent colour and typeface to make week-to-week comparison easier, please get in touch.

The Geary behavioural blog explores some research from Garth Brooks into time discounting and uncertain preferences. Who knew he had a second career in economics? But he evidently does: Garth has proved his credentials as a behavioural economist by not writing down an actual model for his theories; instead, he just tells an anecdote and we're meant to make our own inferences. He'd fit in just fine in J.Econ.Psych. Multitaskers are bad at... multitasking, according to the BBC . In my own model of the mind, this is one of the key factors that accounts for much of the behaviour we see in experiments. In complex situations, to rationally optimise for the ideal outcome requires us to near-simultaneously adjust and monitor several different variables. In reality cognitive limits prevent us from doing this, so we either miss opportunities to optimise, or we use heuristics which combine multiple variables into one (and that can only be an approximation). In this context, heuristics m...