Tuesday, 1 September 2009

Behavioural links and comments 2009-09-01

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 may include the idea of monitoring an interest rate as a substitute for understanding the whole breadth of monetary variables in an economy; making simplifying assumptions about people to avoid dealing with their full range of personal attributes; using the price of a product as a proxy for the more complex variable of quality; or counting up to 5 portions of fruit and veg so you don't need to work out your detailed nutritional input for every meal.

The intriguing point here is that those who choose to, or attempt to, multitask more turn out to be worse at it than those who don't. Perhaps then, multitasking is a compensating mechanism for the inability to design good single-variable heuristics.

Keiichiro Kobayashi proposes a new macroeconomics which includes financial intermediaries as an entity in the model. The traditional approach treats the savings, investment and consumption of consumers as the fundamentals, and assumes the finance markets are a completely transparent mechanism which simply transmits price signals and resources around the world. I absolutely agree with this impetus, though I'd ideally like to expand the approach to provide a different treatment for different kinds of firms: those servicing consumers directly, those servicing other businesses, and a further classification based on the types of knowledge they add or the cognitive approach they take.

The finance markets, after all, are a way to overcome cognitive limits of the kind I outlined a few paragraphs ago. Because I don't have the capacity to monitor six billion people's demand for money, steel or cars, or their supply of oil, labour or savings, I rely on a network of intermediaries to do it for me. In a world of rational agents with no limits on their ability to process information, most financial firms would not exist. But our world is sufficiently far from that ideal that the sector can employ one in thirty people just to mediate between us.

As for Benjamin Friedman's related question of "is it worth it?" you simply have to ask: if I didn't have this sector out there, equalising prices and moving capital around, would I be more than three percent worse off? Personally I have no doubt that I would.

Expanding the question to include business services in general makes it more interesting. Around 30% of the British economy is financial and business services which are not directly consumed by individuals. Does the existence of advertising, consultancy, lawyers, accountants, software professionals, recruitment agencies, graphic designers and insurance companies as well as the banking and finance sector make us all collectively 50% richer than we'd otherwise be? My instinct says yes: but I would love to be able to prove it. I hope that a mixed macro and microeconomic model will be able to answer this, and many other, questions.

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