Thursday, 31 December 2009

Heidegger versus God

Found by Google Alerts on a blog called "Christians in Context":
Let me sketch one point this book defends. Heidegger argued that modern technology in its very essence is radically differentiated from pre-modern technology. He calls pre-modern technology technique, and goes on to explore what this newly-arrived word 'technology' actually signifies. To risk oversimplification, here is what technology means: it is the interpenetrating of knowing and making, the co-penetration of science and art, which for the modern world means that our science is inescapably 'folded' not just toward increasing information (i.e. describing the world, its causalities, etc) but also increasing power over the world.
I never knew this was in Heidegger - but a followup search shows me that it's a phrase commonly ascribed to him (presumably in translation). Anyway, it perfectly encapsulates why I named this blog.

My first reading of the paragraph above was that it is entirely positive - a paean to technology. But the article goes on to argue against this view of technology, because the writer (Ian Clausen) believes it places humanity above the world created by God. While I entirely disagree with him, it's a fascinating viewpoint. Pascal's wager comes to mind: if I have to choose between Heidegger and God, I'm not sure I've picked the right side.

Tuesday, 29 December 2009

The economics zeitgeist, 27 December 2009


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.

Sunday, 27 December 2009

Old Bridge Inn pictures

If you get the email version of this blog you might not have seen the pictures with yesterday's review of the Old Bridge Inn. Do go back and have a look at them if not.

Saturday, 26 December 2009

Christmas at the Old Bridge

I spent Christmas Day with family at the Old Bridge Inn in Aviemore, in the most beautiful, spectacular snowfall I've ever seen in this country.

Aviemore is a mountainside town on the River Spey (home of many of Scotland's malt whiskies) with skiing and snowboarding in the Cairngorm mountains in winter, and rafting in summer. I haven't been joining in the all-action activities (my comparative advantage is definitely in the intellectual rather than physical factor of production, which reminds us that comparative advantage can accrue purely from an inability in one attribute with no compensating capability in another).

But if I can't ski, I can at least appreciate beauty. The whole landscape is covered with a thick, pristine blanket of snow, the sky is blue and the sunlight makes the world shine like a diamond.




Best of all is the Old Bridge Inn. A warm corner in the midst of the snow, with lovely, comfortable rooms, a log fire in the bar, amazing cooking from Stevie Matson and great hospitality from Owen Caldwell*, Kim Plimley and Gordon Reilly. We had a great meal on Christmas Eve - the famous venison with blue cheese dumplings competed with my roast halibut with artichoke puree for best main course (the tartiflette is definitely hyper-comfort food and can cure any frozen limb) - accompanied by some lovely arrangements from local singer and guitarist Rachel Sermanni. Then a wander around outside, up to the local railway station which looked as flawless as an illustration from Thomas the Tank Engine, in a thick covering of snow and silence. The peaceful quiet of windless snowfall is a deeply calming experience. Back into the bar for a closing-time round of drinks with local friends and visitors.




On Christmas morning a short exchange of presents and then a procession through to the bar for Cava and Christmas lunch. This time my choice of smoked venison with madeira and plum sauce was slightly more divine than the almost-traditional Christmas three-bird roast (turkey, pheasant, goose) with trimmings. I got a taste of the monkfish later and nearly wished I'd had that. I'll have to go back.

As the evening came in and the bar closed, two of the owners' families gathered round for quieter drinks and no Christmas TV at all. The snow started to fall again outside and a stunning couple of days came to a gradual slowdown with the first night off for staff and management in twelve days.

A relatively early night then up in time to see the sun rise - if you've never seen blue skies and golden sunlight pouring down on a pristine snowfall you haven't lived. I saw a heron, pheasants and - I think - an osprey all in flight on the river within an hour.




So was anything not perfect? One of our keys got stuck in the bedroom door for a while, and at one point someone was sitting in front of the fire and blocking the heat a bit. The accommodation is bunkhouse-style but absolutely at the top end of that range (each room is ensuite and well appointed); you can save money by sharing a room, but my advice is to book your own private room, which is still excellent value. If there was anything else missing I can't remember what it was.

If you're exploring the north of Scotland I can't think of a better base. And if you're within a hundred miles or so, the cooking alone makes it worth the visit, not to mention the music, the banter, the malts and the snowboarding. Maybe I'll get some lessons next time.


* Disclaimer: Owen, one of the owners, is my brother! But everything I said is still true. Even having known him for nearly thirty years, I was stunned at what a spectacular experience it was.





Old Bridge Inn Facebook group for latest updates.

Odd accounting from the Telegraph

From this article (h/t Marginal Revolution):
The top 100 authors dominate sales. As The Bookseller has explained, some 100,000 titles are published every year, but these authors account for £1 in every £6 spent on books and a fifth of revenue.
 What does the Telegraph think is the difference between "revenue" and "£ spent on books"?

Thursday, 24 December 2009

$800 billion = $800 billion. Coincidence?

Scott Sumner thinks it's just a coincidence that the increase in excess bank reserves in the US is almost exactly the same as the amount of the government's discretionary fiscal stimulus - $800 billion.

And yet, the increase in the Bank of England's balance sheet through quantitative easing so far - £180 billion or so - is also the same as the UK government's budget deficit this year. Doesn't it make you wonder?

Now it's true that there is no necessary link between the two. In "normal" times, government borrowing and central bank easing are not necessarily correlated - quite the reverse, in many cases. Public borrowing is generally inflationary; so a monetary authority with a constant inflation target is likely to counteract that by raising interest rates or otherwise reducing the money supply.

However, now is different. Inflation and growth are exactly what we need, and the fiscal and monetary authorities are acting together to try to create them.

You could look at these numbers as being simply a fair division of labour: the central bank is doing half the job, and the government the other half. But there is no reason why they should divide this job 50-50. There's something missing in this explanation.

And, as it happens, there's a perfectly good reason why they should be the same.

The fact is that, despite the assumptions many people make about capital markets, most real investors do not move their money around very fast. There is a lot of inertia in most markets. Investors who were long on gilts or Treasuries in 2007 are still long now. Mutual fund investors who held equities are likely to - mostly - still hold them now. It isn't that easy for governments to create $1 trillion of new demand for bonds; and equally, it isn't that easy for a central bank to find $1 trillion of unwanted assets to buy - without taking big risks on buying up risky "toxic" assets.

This makes it very natural that, to avoid too much disruption in markets, central banks would print just about enough money to buy the unexpected surge of government bonds. There needn't be any overt coordination to make this work: price signals are enough. As governments borrow more, long-term rates go up, risking a collapse in business investment; the central bank buys long-term debt to counter this and reduce the chance of deflation.

In the longer run, markets can absorb these greater amounts of debt. Commercial banks may issue their own paper to buy some of it, pension funds will buy it as more people retire, and if not then its price will fall until somebody is willing to take it off the central banks' hands. But it all takes time, because behaviour has inertia.

This is also why all that extra money is not finding its way into business lending. Net lending to business in both the US and UK continues to fall. No doubt it's falling more slowly than before, but there's all sorts of inertia both in the infrastructure of the commercial banking sector and within businesses which leads to slow uptake of the funds that are available.

Nick Rowe's theory of loan officers is one way to explain this; another is the Austrian "recalculation" model, in which it takes time to redeploy resources from one sector to another.

My preferred view is that it's about information and uncertainty. Two years ago, banks and investors "knew" what was a good way to lend money and make a relatively high and safe return. Loans to build buy-to-let properties, loans to private equity companies to buy retailers and utilities, property-secured loans to individuals of low credit quality. Those are no longer regarded as good prospects, so lenders are cautious about making new loans until they have discovered what's worth investing in.

Thus bank reserves stay in reserve and the increased household savings rate goes into government bonds. Maybe, as Scott suggests, a penalty interest rate or expected inflation would encourage lending, but I suspect it will take more than that. The real shortage now is information - information about which businesses banks can lend to and still expect to get their money back.

But information is powerful for one key reason: it has huge positive externalities. A successful investment has a powerful side-effect: it adds to the stock of reliable knowledge about which types of business are a good investment. This extra knowledge can be used by anyone in the economy to make a similar investment, multiplying the impact on the economy many-fold.

The conclusion: government should sponsor loans to a diverse range of businesses, on a randomised basis, with a commitment to publish the results. Industries whose loans produce a return will attract private lending or investment. We don't yet know what the next decade's dotcom or buy-to-let opportunity will be. But if we discover it, a wave of new investment will be unleashed, providing a destination for savings and more importantly a new long-term income stream for the economy.

Unfortunately these "experimental investments" will take time, and we won't know definitively for some time which ones are successful. But the investments in themselves will contribute to fiscal stimulus, data will start to accumulate immediately, and even within a few months those externalities will start to materialise.

Could this be part of the Bank of England's mysterious "Plan B"?

Tuesday, 22 December 2009

My BBC World/News 24 items today

I was on BBC World this morning to discuss the latest UK GDP figures and why the UK is the last major economy still in recession (hoping to get a clip to upload later). Here is a summary of my views, some of which I got across in the interview. Any of these could be an article in themselves, but there isn't much time to discuss them on an hourly business news update!

  1. Our recession has been worse mainly because we are dependent on the financial sector. We did very well out of this before the recession, but having reached a higher peak we had further to fall.
  2. However, employment figures have been relatively very healthy, meaning that the pain of the recession has been less than it could have been. Also, fiscal and monetary action have mitigated the risk of a deeper depression.
  3. We are now gradually edging out of recession but there is a risk that tax rises and government spending cuts will put a brake on growth. To combat this, continued aggressive monetary policy is needed. Because interest rates are about as low as they can go, three things are needed:


    • more quantitative easing
    • more work on transmission within the finance sector, to get the extra money to actually take effect in the economy
    • clear expectation setting, the one thing Scott Sumner and Paul Krugman agree on


  4. Fiscal policy has a short-term impact, monetary policy medium-term, and real investment and consumption choices finally take over in the long term
  5. The unusually high household savings rate of recent months could slow growth as well, unless it finds its way into investment. That's the big economic question in the longer term.
  6. Therefore the key question is: can government or central bank policy help to create more investment? It can invest directly itself, in education or infrastructure, but the key policy goal has to be to remove barriers to productive investment as far as possible.
Update: BBC News 24 also interviewed me about this and I made sure to emphasise how crucial it is that the Bank of England set clear expectations about the strength of their future monetary policy. Price level targeting or NGDP level targeting (as opposed to targeting of growth rates) are an important part of this - see the Scott Sumner link above for more detailed thoughts on this.

    Sunday, 20 December 2009

    The economics zeitgeist, 20 December 2009


    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.

    The words moving up and down the chart are listed here. Key words this week: policy and banks up, Fed back up after a fall last week, inflation up 340 places and Bernanke up 415. Falls in sales, emissions and spending. But the most poignant entry on the list is a new name at position 272: Samuelson.

    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.

    Saturday, 19 December 2009

    What I said on the radio

    They asked me about November's record budget deficit of £20.3 billion, about which George Osborne has said that "Gordon Brown is maxing out the nation's credit card".

    My response, briefly:

    • Sometimes it's appropriate to run up your credit card to tide yourself over a problem - the recession definitely qualifies. Government spending is a pretty mainstream response to help mitigate an economic downturn.
    • Spending cuts and tax rises might make a small difference, but the thing that will really cover the debt is economic growth. The UK's tax take is especially countercyclical and will rise sharply when GDP growth and profitability return.
    • The return of VAT to 17.5% in twelve days will make some impact in itself (raising about £12 billion), but might be more valuable as a credibility device: the government showing investors and markets that they are serious about getting the deficit under control.
    If you're interested, the recording is here.

    Friday, 18 December 2009

    Radio Five this afternoon

    I'm on Radio Five Live at 5.45 today talking about the public sector borrowing requirement, whether it's a necessary response to the recession, and how the country is going to pay it back.

    Update later when I listen back to what I end up saying...

    Thursday, 17 December 2009

    Red wine, blue wine

    Just a link for Thursday.

    From the Daily Telegraph, wine tastes better in blue- or red-lit rooms. At least in Germany. [Original paper here is quite well-written and reveals some interesting details]

    According to the newspaper reports, the psychologist who ran the study (Dr Daniel Oberfeld-Twistel) thinks the explanation is that the light puts people in a better mood. But the paper cites another study showing that in fMRI tests:
    Whenever colors and odors were presented together that subjectively constituted a good match in the eyes of the observer, activity in the orbitofrontal cortex and in the insular cortex was observed
    Now we all know to be cynical about fMRI tests, but it seems reasonable to draw the very broad conclusion that there is some cognitive basis for this effect. I am inclined to believe that - like most behavioural wine effects - it originates in a self-fulfilling calculation of the expected "value" of the wine and is a cognitive rather than a mood effect. Indeed, the paper says a little later:
    The complexity of the color-odor interaction may be founded in the fact that the process appears to be located at higher cognitive processing stages.
    However, my view is somewhat challenged by the fact that the experiment used opaque black wine glasses to eliminate the direct effect of the light on the wine's colour.

    It's certainly possible that a cognitive "value" decision could be influenced by lighting, though I would expect the effect to be weaker than the impact of the colour of the wine itself.

    One experiment was run in a winery and two others in a lab; the effect seemed to be clearer and stronger in the winery. If cognitive factors are involved this does not seem surprising, because value judgments would be influenced by assumptions about the quality of the winery as well as the product itself.

    The authors mention a different cognitive effect, which is that blue light makes people more alert and thus affects cognitive processing. I guess that might be true too, but the paper is sceptical about it and so am I.

    It would be interesting to test the emotional/mood hypothesis by affecting mood with sound instead of colour. I think the effect of sound on mood is much stronger than that of colour, but as far as I'm aware there is no known effect of sound on subjective perception of taste.

    Wednesday, 16 December 2009

    Taxes versus mandatory offsets

    Consumerology reports a study by David Hardisty, Eric Johnson and Elke Weber at Columbia which randomly offered participants various choices between different pricing options for airline tickets. The main distinction was between a surcharge described as a "carbon tax" and an identical charge described as a "carbon offset".

    The tax was unpopular - no real surprise. But when people were asked if they supported making the carbon offset mandatory - which is of course exactly equivalent - the response was highly favourable (around 2 points more positive on a scale from -3 to +3).

    Not only was the "mandatory offset" more popular, but it was regarded identically by Democrats and Republicans. The tax, on the other hand, was strongly disliked by Republicans while Democrats made no distinction between taxes and mandatory offsets. Thus the entire effect appears to be due to Republicans' attitudes to tax.

    This is an example of a well-known cognitive bias called 'framing'. The paper's purpose is to study the cognitive processes that generate the framing effect, and the authors find evidence that it arises partly from the order in which advantages and disadvantages are evaluated by a subject.

    The original paper is here and contains lots of other interesting details including:
    • Only 46% of Republicans were willing and able to follow the instructions of one study which asked them to list the advantages (if any) of carbon taxes before the disadvantages (the reverse of the "natural" order). 100% followed the instructions when asked to list the disadvantages first. Democrats and Independents generally followed the instructions in both cases.
    • When this natural order was reversed - even for those Republicans who did not follow instructions - the framing effect was eliminated!

    Tuesday, 15 December 2009

    Sentences to ponder, Samuelson edition

    From Mario Rizzo in ThinkMarkets, objecting to Samuelson's mathematical formalisation of economics:
    I believe that the profession has, because of the formalistic direction in which it has traveled, more than its share of idiot savants.
    Perhaps that's so. I guess Rizzo would prefer to adopt the model of some other social sciences, which are quite satisfied with ordinary idiots.

    The significance of Paul Samuelson


    The screenshot on the left - taken within a few hours of the announcement of his death - illustrates quite simply the huge impact Paul Samuelson made on the economics profession throughout the last seventy years.

    As his New York Times obituary says, he was never as well known by the public as Keynes or Friedman - and had less direct political impact - but he almost forged a whole profession with his establishment of mathematical analysis as the way to do economics [Update: my mistake, the observation was actually in this Justin Fox article]

    This interview with Conor Clarke reveals that his incisiveness and charm was unimpaired right up to this summer. Read it for a flavour of his ideas and personality, but read the obit to learn the scope of his influence. [Update: Marginal Revolution links to another excellent interview, this one from John Cassidy]

    (A curious side note: both of these items mention in passing, but with some admiration, that Samuelson became wealthy from his textbook. This phenomenon will not be unfamiliar to readers of Greg Mankiw, whose beautiful home was also featured in a Lifestyles-of-the-Rich-and-Famous-style profile in the Harvard magazine. Do we expect our economists to prove their credibility by being rich, in the way we expect our environmentalists to drive electric cars?)

    I must confess that while I knew of his influence on the teaching (and thus practice) of economics through his seminal textbook, I was not aware of the degree to which his theorems laid the foundations for so much of today's economic mainstream. Some, such as his influence on the efficient markets hypothesis and the Black-Scholes theorem, are still controversial (although Samuelson never took the idea seriously in the way that Lucas or his followers did). But his modelling of Keynesian liquidity traps, the impact of wage or tax changes on labour, the relative effects of trade on different groups, definitions of public goods and analysis of macroeconomic stability and the business cycle have all been adopted so deeply into the economic psyche that one treats them as established truths, forgetting that somebody had to invent them once.

    But arching over all these was his creation of economics as a mathematical discipline, and the establishment of maximisation and equilibrium as its two fundamental principles. How could one man - in his PhD thesis, no less - revolutionise a field like this? Perhaps he gave economists the self-confidence to use the mathematical tools they were nervous of; perhaps he showed them such power and elegance in his proofs that narrative economics was immediately recognised as trite and weak; or maybe, in true economic style, he provided a new generation of economists with the technology to outcompete the old.

    And although mathematical virtuosity has been criticised in some of the economic soul-searching of the last two years, and some would like to sideline it in favour of narrative treatments and economic history, that would be a mistake. Mathematics is what has given economics its power in the last century; and we need more of it, not less.

    From the Cassidy interview:

    "Lionel Robbins gave an address saying this math stuff is just a passing fad. I was all of twenty-eight, but I thought, 'Poor fellow, he just doesn't realize that he's missing the train.' That was just a bad understanding of the dynamics of the profession. Math is a problem for everybody in the profession and it has been for years. We all say, math should be used just up to the point that I have used it, and no more...I always say to our graduate students when they are leaving: 'As a graduate student at a top-notch university, you tend to lose touch with reality. You have been engaged in puzzle solving and learning a new language. When you emerge, you may tend to think you have been asleep for several years.' The paradox is that the best people in practical terms are the Jim Tobins, the Bob Solows - the guys who are awfully good at the technical stuff as well."

    Samuelson's revolution goes beyond economics. It has set out an ambition for all of social science, and hints at a project on the scale and scope of the Enlightenment and the scientific revolution of the 18th century: the full and rich understanding of human society and progress. As we remember his life and contribution, let us make sure that revolution continues.

    Monday, 14 December 2009

    The economics zeitgeist, 13 December 2009


    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.

    The words moving up and down the chart are listed here. Key words this week: climate, oil, debt, Copenhagen and deficit up; big falls in Fed, interest, credit and demand.

    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.

    Saturday, 12 December 2009

    Behavioural finance working group: part 1

    The lack of postings in recent days has been partly due to attending a conference: "Behavioural perspectives on the financial crisis" at Cass Business School (no relation to Cass Sunstein).

    It turned out not to be quite as billed. An interesting selection of short research presentations but barely any mention of the crisis at all.

    Highlights of the first day included:

    Addressing the psychology of financial markets: a good qualitative insight from David Tuckett, a psychologist from UCL, into the psychological factors which affect finance. He identified a very intriguing difference between finance markets and other markets: which I'd express as saying that finance markets have no referent. Other markets involve real assets which are traded, and which provide real and direct utility. Financial markets provide no direct utility feedback from a purchase - investors hold an asset whose only utility is from its (unpredictable) future value. Thus emotional factors take the place of real ones in how we relate to the market. This can disrupt the diminishing returns dynamic which helps establish stable equilibria; instead, it creates reflexivity, self-fulfilling prophesies and volatility.

    Stories matter: the Effect of News in a Laboratory Asset Market: by Sudeep Ghosh from Hong Kong Polytechnic University. This research measured the difference between providing investors with facts, and providing them with stories that explain the facts. It turns out that stories affect behaviour more than facts do; and bid-ask spreads are higher when investors receive stories. Interestingly the stories were designed (as far as possible) to contain no additional information, but simply a narrative structure to make the facts somehow more understandable. The cognitive factors behind this are not clear, but it's certainly an interesting area to explore.

    A very energetic and charming presentation from Steven Jordan about the international evidence for long-term reversals. Not my area at all, but an honourable mention for being funny, hyperactive and managing to go through his material at twice the speed of anyone else yet still running out of time.

    And finally the keynote speech from Werner de Bondt: Investor sentiment and financial stability. A good survey of the crisis from a behavioural point of view. I felt he didn't quite demonstrate convincingly that psychology was at the source of the crisis, though he gave lots of good illustrations and is a highly articulate presenter. Very similar in style to Richard Thaler - with whom he has worked closely for the last thirty years, so perhaps not too surprising. He has a plausible descriptive model of bubbles: that they originate in psychology and become inflated through short-term rational mechanisms, then become subject to herd behaviour before bursting at some unpredictable point.

    I'll post more shortly about the second day of the conference and link to my notes on the various talks.

    Tuesday, 8 December 2009

    Facebook Pecha Kucha

    I presented a mini-Pecha Kucha at the Association for Qualitative Research last night.

    Great fun and lots of interesting people. I hadn't done a Pecha Kucha before, though it turns out my last BRX presentation was similar in style to a few of the presentations on the night.

    You can download my slides here - though I'd be fascinated to hear if it makes any sense whatsoever to you without the narrative.

    There should be a video of the event at some point soon for my three diehard fans to watch online.

    Sunday, 6 December 2009

    The economics zeitgeist, 6 December 2009


    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.

    The words moving up and down the chart are listed here. Key words this week: people, jobsunemployment, pay and Bernanke up; energy, data and markets down.

    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.

    Saturday, 5 December 2009

    Behavioural economics links

    Notes and some videos on what sounds like a brilliant course at Edge last year on behavioural economics, with Thaler, Kahneman and Mullainathan as speakers - and just look at the attendees!

    Thoughts from Felix Salmon (also click through to the more detailed Wine Economics article he references) about one of my favourite subjects: how cognitive biases influence our willingness-to-pay for wine.

    Useful comments from Charles Goodhart in the FT about the money multiplier - I suggest you read this as preparation for an article I'm writing on self-fulfilling expectations and the money supply.

    Mark Thoma's link to Paul de Grauwe's paper, "Top-down versus bottom-up macroeconomics" [PDF] which says some powerful things about limitations on knowledge and the consequences for rational expectations theory.

    And Steve Randy Waldman's Interfluidity blog has moved - updated link in the right-hand column and here.

    Thursday, 3 December 2009

    Bankers' bonuses: two solutions

    What issue has such purchase on the public imagination that it - at least in the UK - just keeps coming back, again and again, as people's top concern about the financial crisis and the recession?

    Of course, it's the bonuses paid to bank employees.

    The psychology of this conversation is revealing. Nobody really notices if RBS makes £6 billion in profits. But when one RBS employee gets a $10 million bonus - that's about 1/1000th of the amount - suddenly it's a big deal. We can relate much better to (relatively) small numbers with people attached to them than we do to huge figures.

    Clearly the government has a political problem: it doesn't want to be seen to be allowing high bonuses to be paid when the public has paid for the banks to be rescued.

    But it also has a commercial problem: the rescue is a sunk cost, and the bonuses are part of the bank's strategy to incentivise future behaviour. If RBS doesn't pay any bonuses, perhaps their top people will leave and the value of the public's 84% stake in RBS will be diminished. And if (say) Barclays doesn't pay bonuses, perhaps their people will leave, damaging the government's future tax revenues from Barclays' profits and their executives' pay.

    But why is it that the market outcome is to pay such high bonuses? Surely finance is a competitive marketplace and some of these high returns should be competed away?

    Unfortunately not. The fact is that there are two constraints on supply in finance, both of which push up prices and pay. The first is that there are not really that many financial institutions, and in each individual marketplace there tend to be only two or three dominant ones because of powerful network effects. This is not enough to create real price competition, so investment banks' profits can be very high even in a recession.

    The second constraint is on staff. Entry into the financial sector is closely guarded, as are the knowledge and contacts of those already working there. A fall in demand and thus in revenues (such as last year's) is greeted with layoffs in preference to pay cuts, keeping supply tight.

    So banks have high profits because there are few of them; and employees get to capture a lot of these profits in bonuses because there are few of them too.

    The clear solution to these problems, then, is to increase supply. In a working market, the shareholders of the banks would be insisting on this themselves. No private company wants to have its costs pushed up by a labour shortage. But the finance sector, more than most industries, is controlled by those who work in it. The executives of the banks themselves hold much of the equity in most investment banks - and the outside shareholders are mainly other financial institutions, whose employees' interests in restricting supply are just the same as those of the banks.

    Through its control of RBS, the government - as a shareholder - can set out to change this. It should recruit thousands of new people - there are plenty out there - and create a competitive labour market for skilled finance professionals. In the medium term, this would enable RBS shareholders to capture a much higher share of profits relative to those going to highly-paid traders, boosting the value of the government's shares.

    In the long term, it would encourage a more competitive market among banks themselves, reducing their profits and increasing the surplus available to the rest of the economy.

    That still leaves the short term. Here is the second solution, which deals with that.

    Two major sources of RBS's profits this year are: the combination of cheap money from central banks, and tight credit conditions enabling the bank to charge high interest on loans; and its underwriting and dealing commissions on huge issuance of government debt.

    Both of these are essentially a subsidy from the public sector. It would be economically legitimate for RBS to pay a proper price for these public services - whether through a high rate of tax on profits, or a specific levy. This could equally be considered as a price on the externality that banks impose on the public through their implicit government guarantees. The Treasury will not want to hurt RBS's capital position, so it could exempt, or reduce tax on, the portion of profits which are set aside as permanent capital not for the immediate benefit of shareholders (or employees).

    By reducing the retained profits available to the banking sector, this action would reduce the available pool of money for bonuses in a way that fairly reflects the costs that the banking sector has imposed on the rest of us.

    Would it affect employees' beliefs about the future in such a way as to cause a bunch of people to leave the company? That's not clear, but it should at least be made clear that these taxes or levies are a temporary measure to recapitalise and restore stability to the sector to provide the basis for future growth. Once the market is competitive enough, there will be no need to continue this scheme anyway.

    In short: competition, and pricing of externalities, will restore balance to the banking sector and let it play its proper social role at a reasonable cost. Nothing too controversial about that, as any economist would agree.

    Update: A commenter on Robert Peston's blog points out a typical job posting for one of the mid-to-high end investment banking positions. I thought the following "requirement" was very revealing:
    You must be extremely professional and polished in person and be able to gain the commitment and trust of your existing client relationships who will want to work with you again if you were to move to a new opportunity. Individuals who apply must be well connected and have very good money generating contacts.
    Difficult-to-replicate skills and knowledge? Mm-hmm.

    Update 2: Chris Dillow proposes an alternative approach: instead of rewarding bankers when they do well, kill them when they do badly. Feel free to form your own opinions on that.

    Wednesday, 2 December 2009

    Applications of behavioural economics part 1a: anchoring

    In the East End of Glasgow, as you head from the Tollbooth towards Celtic Park, you'll come across a curiosity out of the 19th century. The Barras is a huge flea market - the biggest in Europe - where everything from second-hand clothes and books to discount electronics and records of doubtful provenance are sold.

    And the people selling them are some of the most effective salespeople in the country.

    Let's wait by the stall of a chap called Glasgow Harry (why he's called Glasgow Harry when he works in Glasgow is another story). We're among forty or fifty people waiting expectantly for the show to start.

    Harry pulls out a radio cassette player (this was quite a few years ago) and starts the pitch. "Now who wants one of these wee stoaters?" [You'll have to imagine the Glaswegian accent] "Latest Japanese technology, double cassette deck, AM/FM, lasts about forty hours on the battery." Elucidation of many more features follows.

    And now the key moment...we wait agog, breath bated, to hear what it is going to cost us.

    "Now in a shop this'd cost you two hundred quid. I'm not asking that. I don't have their overheads. I'm not even going to ask for a hundred and thirty." Great! A bargain already. "I was selling them last week for a hundred and twenty but I won't even start there. I'm going to save time and start straight in at a hundred and five. They won't last long at that price so get your order in now."

    There's always someone who jumps straight in and pays it. Accomplice or sucker? We'll probably never know. But then after a bit more banter the price comes down a little.

    "OK, who wants it for a hundred? There's only eight of them left...and this is the last of them, I cleared out the warehouse this morning." Maybe someone else bites, maybe not.

    "All right, nobody wants it? Fine. I'm moving onto this set of plates."

    And that is that...for about ten minutes. It's good theatre, so most of the audience stick around. Then, inevitable, back comes the radio cassette machine again.

    "Right, we had these on last week at 120. Sold two of them just now at 105. Now I don't want to cart them away with me again, so who's ready to take them at 95? You, madam? Excellent, here you go. Anyone else? It's got a one-year guarantee. OK, how about this - I'll throw in the batteries for the next two buyers. Six of these'll cost you £12, I've got a dozen of them spare so how about that?" Probably gets a couple more purchases out of that.

    "Right, the batteries are gone so I'll cut the price to £90 - final offer. Anyone? You sir, good, please pay my assistant over there. Who's left?"

    If you wait around long enough the price comes down to £60 and the last person to jump gets an excellent bargain - £60 for a £200 piece of hardware. Not a bad deal, eh?

    Except of course that the things only cost Harry £20 each in the first place.

    Nobody standing around the stall knows the "real" value because nobody has the ability to do a price comparison on the same product. Instead, Harry has anchored his audience. Anchoring is when you become mentally attached to a specific value, and subconsciously start to believe that is an appropriate value for the product. Even though you wouldn't say it consciously, you use it as a reference point and it influences the price you are willing to pay.

    Harry isn't anchoring his buyers to the £200 price, because no-one really believes in that. But as soon as you give any serious consideration to buying at some particular price, you're caught. The first time you consider buying, even if you decide against it, that becomes your reference price.

    So if you nearly went for the £105 offer, anything cheaper looks like a bargain and you become more and more likely to buy it. If you waited for £90 before deciding against it, then £80 looks like a pretty good deal and £60 is an absolute steal.

    Ultimately Harry always gets rid of all his merchandise - nowhere near his original "asking" price, but at a huge profit.


    Even experts can easily be caught by this effect.

    A few weeks ago Rory Cellan-Jones (@ruskin147) auctioned a phone on Twitter to raise money for charity.

    I needed a new phone, so I put in a speculative bid for £50 to see if I might win it. It was a new Google Android phone (the HTC Hero) so I thought it would be a decent handset, and probably worth more than £50 to me. I would be eligible for a new phone anyway by renewing my contract, so I would be buying flexibility of contract rather than the features of the phone as such. Even if it turned out not to bring me £50 of benefit, it was a good cause.

    After I placed my first bid, a quick Google search showed me the retail price of the phone: around £380! Much more than I'd expected.

    Suddenly I decided it would make sense to place a higher bid. My estimated value of the phone to me was strongly influenced by seeing the retail price. I bid £105, and then as the auction continued, my bids reached the dizzy heights of £245 before someone else won it for £280.

    This for a phone I was originally willing to pay £50 for!

    I hadn't learned anything new about the features of the phone, or reconsidered how useful it would be to me. I'd simply found out that some random shop charges a high price for it, and suddenly my willingness-to-pay jumped up accordingly.

    And I'm supposed to know how this stuff works. If I can be influenced into behaving like this, what hope does a random shopper have?

    Not much, if they are buying a bottle of wine. Most people don't have a clear idea of what any specific bottle of wine is going to taste like before they buy it. Instead, they treat the price of the wine as a signal for its quality.

    This means that retailers can, to a large extent, set their own profit margins. It's easy to demonstrate how.

    Show your friend a nice bottle of wine. Ask them to write down which day of the month they were born - a number from 1 to 31 - and put a £ sign in front of it, turning it into an amount of money. Now ask them to write down whether they would pay that amount for the wine.

    As soon as they make the decision - whether the answer is yes or no - the damage is done. They have anchored themselves to that price.

    Now ask them how much they would pay for the wine in a shop. If their birthday is at the end of the month - so they are anchored to a price £20 or above - they will, on average, be willing to pay significantly more for the wine than someone who was born on the 5th, and is anchored to the £5 price.

    On average, people who were born in the second half of the month will pay 25% more for the same bottle of wine than those born in the first half. If you want to save some money, change your birthday.

    The second part of this chapter will outline the cognitive theory behind how anchoring works. And after that, a guide for salespeople on how to apply anchoring in your own business.

    Tuesday, 1 December 2009

    The "Feck the French" strategy

    Ireland has a problem. It is at risk of getting into some terrible debt.

    Its fiscal deficit has soared this year to about 14% of GDP, more than almost any other country, and on current path its debt is forecast to reach 126% of GDP by 2016.

    This is mainly due to a collapse of over a tenth in Irish GDP during the recession - which, under the informal definition, qualifies as a full depression in Ireland. What is to be done?

    The government is willing to take fairly drastic steps to cut its deficit, even though the economic recovery is still tentative (as a very export-oriented economy, Ireland can afford countercyclical fiscal policy better than most nations). But can the government carry its citizens with it?

    An Economist article last week offers a clue.

    Take a look at the chart at the top of the article. Ireland's figures look bad, but it has an advantage: it starts from a reasonable public debt position. On this projection, in 2011 Irish public debt will be 96% of GDP while other countries - let's say, for example, France - will have high debt too, with lower deficits but from a higher starting point.

    Ireland wants to cut another 4 billion euros from its budget, and is likely to require public sector wage cuts to achieve it. No government can easily cut the wages of its civil service without inflation or a major public emergency - and Ireland, tied to the euro and (relatively) at peace, can't easily achieve either.

    So what stirring message - assuming he doesn't declare war on the Isle of Man - could Brian Cowen broadcast to create that shared public spirit of self-sacrifice? Circumstance provides an answer.

    The tactic? A joint national project to keep Ireland's national debt below the level of France's - subjecting France to the ignominy of lining up as top euro-area debtors with Greece, Italy and Portugal, three other countries rather better at winning football matches than running their economies. Just the thing.

    It's called the "Feck the French" strategy and I suspect the Irish people would be only too happy to participate. They might even get a sympathy interest rate cut from the ECB.