Thursday, 25 November 2010

The dreaded Could of the economist

Robert Peston inadvertently highlights a common journalistic trap today - a trap laid for them by a frequent and annoying habit of economists.

David Walker, author of last year's Walker Review on bank governancehas written in the FT that:
"[A]ny attempt to require banded disclosure for UK banks in isolation would be commercially sensitive vis à vis their non-disclosing competitors elsewhere. It could also stimulate higher executive turnover, and (as a perverse unintended consequence) lead to higher remuneration as a defensive retention measure." [emphasis mine]
What exactly do "could" and "would" mean in this context? They have a very specific meaning in economist rhetoric.

Would means: is guaranteed to have the following effect on an unobservable variable. Note that Walker can confidently state that this is "commercially sensitive" because there's no way to measure, confirm or deny whether that is the case.

Could means: creates an incentive for an observable change, but nobody knows how strong an incentive. So, the unobservable variable of commercial sensitivity might encourage people to move jobs - but it could be such a small factor compared to everything else that there would be actual effect in the real world. As soon as the change becomes observable (higher executive turnover) then the language has to shift to "could" instead of "would".

Here is the problem: conventional economic theory makes it quite clear in which direction an incentive points, but has no way to determine how strong the incentive is. So we can agree that disclosure creates some incentive towards increased turnover, and therefore some incentive for higher pay - but it may be incredibly weak. On the other hand, disclosure also creates some incentive towards public shame, and therefore some incentive for lower pay! But equally, we don't know which one is stronger, or whether either of them is actually strong enough to make any difference to the decision of any real person.

So, economic theory cannot tell us what will happen in this case. Hence, economists use could to indicate that something might happen, but without giving any practical guidance to its likelihood. Only empirical data or a deeper theory can illuminate this, and rhetorical economics generally stops before getting to that.

In this case, as often happens, Walker chooses which coulds he wants to highlight, and journalists inadvertently translate could into would in their interpretation. In this case Peston himself hasn't fallen into the trap, but David Cameron has. Or more likely, Cameron has selectively used the coulds that suit him, so he can justify a politically convenient policy.

And David Walker? Well, he hasn't really changed his mind - his FT article repeats a point already made in his report, suggesting the UK should pressure other countries to implement their own rules at the same time as the UK does. But by using the economist's ubiquitous could - which is logically and intellectually respectable but rhetorically dangerous - he runs the risk that less subtle readers will take his potential, maybe weak, maybe counterbalanced, incentive effects and run away with them, over the horizon into convenient deregulation.

Update: I was going to say that the biggest could in economics is probably the effect of income tax on productivity and hours worked - higher taxes could have a disincentive effect, but nobody really knows. And they could indeed have a positive incentive on work through income effects...but nobody really knows. No sooner do I publish the post than I see Karl Smith correctly highlighting this as the main difference between Paul Krugman and Greg Mankiw - both eminently respectable economists who agree on textbook economic theory (if not on which textbook to read it in) but virulently disagree on most politically sensitive subjects. The deadly Could is at the core of this disagreement.

2 comments:

Min said...

Leigh Caldwell: "Here is the problem: conventional economic theory makes it quite clear in which direction an incentive points, but has no way to determine how strong the incentive is. So we can agree that disclosure creates some incentive towards increased turnover, and therefore some incentive for higher pay - but it may be incredibly weak. On the other hand, disclosure also creates some incentive towards public shame, and therefore some incentive for lower pay! But equally, we don't know which one is stronger, or whether either of them is actually strong enough to make any difference to the decision of any real person."

Well, in what you quoted, there was no mention that the result could be lower pay.

Leigh Caldwell: "So, economic theory cannot tell us what will happen in this case. Hence, economists use could to indicate that something might happen, but without giving any practical guidance to its likelihood. Only empirical data or a deeper theory can illuminate this, and rhetorical economics generally stops before getting to that.

"In this case, as often happens, Walker chooses which coulds he wants to highlight, and journalists inadvertently translate could into would in their interpretation. In this case Peston himself hasn't fallen into the trap"

I would not call the interpretation of the journalists inadvertent. (As an American, I am somewhat surprised that British journalists would not question the "could". Your journalists are so much better than ours. :)) Out of all the possibilities, the expert has focused on this one. By the rules of the game, he is not supposed to hoodwink us. (For that we have politicians. ;)) He should have a good reason for the focus. Perhaps it is because it is likely. Perhaps it is a warning.

In this context, one of an "attempt to require banded disclosure" (of executive compensation?), it sounds like a warning, especially as he talks of a "perverse unintended consequence". (BTW, Walker may have misspoken slightly. I think that he mean that disclosure might increase executive turnover, not that attempts to require disclosure might increase it, although that is possible. If so, his reference to "attempts" suggests that he does not like the idea. He is distancing himself from it.)

Anyway, despite his possible bias, I give Walker a pass on this one. I think that he was giving a warning, as when your mother says, "You could poke your eye out."

Min said...

Leigh Caldwell: "So we can agree that disclosure creates some incentive towards increased turnover, and therefore some incentive for higher pay - but it may be incredibly weak. On the other hand, disclosure also creates some incentive towards public shame, and therefore some incentive for lower pay! But equally, we don't know which one is stronger, or whether either of them is actually strong enough to make any difference to the decision of any real person."

Well, in what you quoted, there was no mention that the result could be lower pay.

Leigh Caldwell: "Hence, economists use could to indicate that something might happen, but without giving any practical guidance to its likelihood. . .

"In this case, as often happens, Walker chooses which coulds he wants to highlight, and journalists inadvertently translate could into would in their interpretation."

I would not call the interpretation of the journalists inadvertent. (As an American, I am somewhat surprised that British journalists would not question the "could". Your journalists are so much better than ours. :)) Out of all the possibilities, the expert has focused on this one. By the rules of the game, he is not supposed to hoodwink us. (For that we have politicians. ;)) He should have a good reason for the focus. Perhaps it is because it is likely. Perhaps it is a warning.

In this context, one of an "attempt to require banded disclosure" (of executive compensation?), it sounds like a warning, especially as he talks of a "perverse unintended consequence".

BTW, Walker may have misspoken slightly. I think that he mean that disclosure might increase executive turnover, not that attempts to require disclosure might increase it, although that is possible. If so, his reference to "attempts" suggests that he does not like the idea. He is distancing himself from it.

Anyway, despite his possible bias, I give Walker a pass on this one. I think that he was giving a warning, as when your mother says, "You could poke your eye out."