Sunday, 24 April 2011

The economics zeitgeist, 24 April 2011


This week's word cloud from the economics blogs. I generate a new one every Sunday, so please subscribe using RSS or the 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.

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.

Thursday, 21 April 2011

AV, status quo bias and definitions

One of the arguments given against the Alternative Vote system is (as laid out in this good but rather long post) that "Under AV the person who comes second can win."

Gowers points out in the linked article that this is not true - all it means is that the person who would have come second under FPTP can win. Of course, the whole point of the referendum is that a different person could win under AV than under FPTP. The reverse argument is equally true: the person who would have come second under AV might win under FPTP.

But why does this argument have such appeal? Even AV defenders are trying to make a rational case for why it may be more democratic for "the person who came second" to win. Instead, one might expect them to challenge the premise.

The reason seems to be that the status quo bias is very strong here. People who might think they don't suffer from status quo bias (in that they have no particular desire to keep the existing voting system) may fall into it unknowingly, through the definition of the terms in the debate. It is much more intuitive to define the word "winner" in the terms of the current system, rather than the potential alternative system.

This is a particularly insidious form of bias, because it's very hard to see - spotting it requires an understanding both of the bias itself and of how strongly language and framing affects our choices. And even once you know about it, it might take a heroic level of introspection to change your mind.

Definitional bias, as we might call it, is really important in trying to persuade people to make a choice. This insight is related to the idea of linguistic relativity - the words we use shape our worldview. And our worldview, of course, affects our behaviour. But by focusing in on a single phrase like "winner" it's easy to see exactly how the phenomenon works. We start with a definition of "winner" based on our current system; we agree that the winner should have power (it's the basis of representative democracy, after all); and so we fear that a new system, where the current "winner" will not win, will somehow be less democratic. One could instead argue that we're just changing the definition of "winner" to a better one. But that's a bit too abstract for political debate.

The bias will typically appear when something that's broadly good (a democratic electoral system) is being compared with something a bit better (a democratic AV electoral system). And because there are legitimately positive things to say about the existing system, it will become very easy to present the new alternative as a threat to something positive. It is easy to assume that it's good for the person with the most first-choice votes to be elected, because that's what we currently define as "the winner". And why shouldn't the winner, er, win?

A similar phenomenon includes the bias towards established brands (most people choose Coke, so Coke must be better than [insert newly launched brand] - which neatly bypasses the circular question of why most people currently choose Coke). No doubt there are many others.

The same bias could in theory be turned against the existing system by finding things that people agree are bad about it - for instance safe seats, corrupt MPs - but the problem is that AV won't eliminate those things, it just (might) reduce them a bit. A category distinction is a much more powerful influence on decision-making than a quantitative, incremental change. Is there a definitional term which could make the case for AV obvious? Maybe "fairer voting" is the best candidate, which is indeed the phrase that the Yes campaign has chosen to focus on. But it's still not viscerally obvious that the current system is intrinsically unfair, so this argument relies on intellectual reasoning rather than gut feel.

The gut is always powerful in politics; I think that most successful political arguments are either based on the gut or on a definitional change. Is there either a gut, or a definitional, argument for AV which might be persuasive?

Sunday, 17 April 2011

The economics zeitgeist, 17 April 2011

This week's word cloud from the economics blogs. I generate a new one every Sunday, so please subscribe using RSS or the 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.

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.

Thursday, 14 April 2011

Cameron's myths and the "influx of people"

David Cameron claims in a speech today that the 2.2 million total of net immigrants from 1997-2009 is "the largest influx of people Britain has ever had".

But I was unsure, so I thought I'd check the data. 15 minutes of searching and downloading some national statistics data proved him wrong.

In fact, in the same length of period from 1946 to 1958, a net total of 2.8 million people arrived in Britain - none of whom could speak English, or had any assets, none of whom knew or followed our cultural norms, and none of whom got a job or started a business for at least a decade after arriving. Indeed the total arrivals in this period were 9.4 million, with 6.6 million people departing.

And yet nobody at the time had any problem with them - we fed, educated and housed them, and indeed they were one of the major reasons for the creation of the NHS. Today, those who are still here (nearly all of them) make an overwhelming contribution to our economy, creating much of the economy's wealth and paying a huge share of taxes.

Where is this group of newly minted British citizens? All around us. The period 1946-58 was the height of the baby boom, and those 9.4 million arrivals were newborn children. We could handle that many arrivals in the much poorer society of the 1950s, with far less infrastructure and productivity - indeed, it's inconceivable what our economy and society would be like today if they hadn't turned up. So we can certainly benefit from a few million more people now. The more people we have around us the better - let's welcome them in, help them learn the skills and language to make a contribution to our economy and cultural life, and we'll all be better off as a result.

Wednesday, 13 April 2011

Efficient taxes hypothesis

This article on pensions from the Economist made me wonder about something.

It used to be that people in the UK were compelled to buy an annuity on retirement with their pension savings. Well, almost compelled - if they took it out as cash, they'd have to pay tax on the lump sum.

So if I saved for ten years at 22% tax relief, and I then withdrew the sum, I'd have to pay 22% tax on the withdrawal.

Fair enough - the idea of pension tax relief is to encourage people to build up an income which would stop them having to draw on state benefits in retirement. If I can withdraw the cash, as if it were a standard savings plan, then the tax treatment should be the same as if I'd saved the money outside of a pension.

But could this be used to game the system?

What if today - with top tax rates at 50% - I think that the income tax rate is higher than its long-term average. Then I might save in a pension now, intending to withdraw later when tax is cut back to 40% or lower - so that I avoid paying today's 50% rate and pay the 40% rate at the time of withdrawal instead.

And conversely - if rates are cut to 33% but I don't believe it will last, I might decide not to save now (or even withdraw my pension savings early) and then wait for tax to go back up before saving again.

(I know this is a simplified picture of the complexities of pension tax treatment, but imagine it's this straightforward for now).

Now this requires predicting whether tax rates are high or low compared to their long-term average. If I were trying to do the same with oil prices, or the stockmarket, or Treasury bonds, or gold, or the Japanese yen, we'd say it was a mug's game. The efficient market hypothesis (which I broadly believe in, despite behavioural reservations) says that the market's best forecast of future prices is already built into today's price, and unless I have inside information or a really good reason to think the market is wrong, I shouldn't make investments based on my predictions of future prices.

So is it equally foolish to make predictions of future tax rates? Or, because there is no market in tax rates (except a bit of cross-border competition and arbitrage) is it possible to actually make accurate forecasts of future taxes?

Is there an efficient taxes hypothesis?

Tuesday, 12 April 2011

Start me up: StartupBritain, the Startup100 and Smarta

Startups have really been in the news for the last few weeks. We had the David Cameron-endorsed launch of StartupBritain, then Smarta launched (after a year or two in development) its Business Builder online package, the UK and US governments have both announced "Startup Visa" programmes, and tonight the prizes will be awarded to the winners of the Telegraph's Startup 100 competition.

Anyone would think there was something good about starting a new business. Governments love new businesses, because they feel like pure economic creation - new jobs, new investment, new products and services being offered in the economy, new tax revenues - and at no cost to anyone except the entrepreneur and their financial backers. Economists like them because they provide a positive externality - new ideas - which other people can benefit from as well as the entrepreneurs themselves. And customers like them because they offer new services which might not have been available before, and seem somehow charming and congenial, local and friendly, and provide opportunities for emotional affiliation which big companies often don't.

But while everyone agrees that motherhood, apple pie and business startups are full of goodness, not everyone goes along with what's being done to help them. In particular, StartupBritain has been criticised as "a government-backed link farm" among other things.

It's quite entertaining to read these debates - whether accurate or not, watching people insult each other (to be fair, the insults are only really going one way) is great fun. But is the criticism fair?

Unlike @SamEngland who wrote the above articles, I don't have a problem with the motives of the StartupBritain founders and I don't think the private sector is inferior to the public sector at helping businesses get started. Of course they want to make some money, but I am sure they also want to help businesses to start up. A more interesting question is whether the StartupBritain site is a useful way to do it.

The apparent focus of the site when it launched - £1500 of money-saving discounts off various services - probably wasn't an ideal way to start. Classical economic theory might say that reducing the financial cost of starting up will increase the number of people doing it. But in practice, those discounts will make very little difference to anyone who isn't already committed to starting a company.

In fact, the main barriers to starting up are very different to the financial barriers which are (slightly) lowered by these discounts. Our recent research into careers choices for the Department of Business, Innovation and Skills (to be published soon) indicate that the real things stopping people are more likely to be:

  1. the risk and uncertainty of leaving your current job to start up
  2. lack of knowledge of how to get a business going
  3. the complexity of most information that's available
  4. a lack of successful, accessible role models for people to copy
  5. a simple lack of understanding of where to start
Some potential solutions to each of these problems are self-evident:

  1. Encourage people to start something on a small scale in the evening or weekend
  2. Provide a simple, practical startup guide which shortcuts some of the uncertainty. Some of the straightforward things that most people don't know, not because of stupidity but because it doesn't occur to anyone to tell them: How do I raise an invoice? How do I pay my income tax? Where do I look for an office? I told a friend of mine who works in the civil service that some of our clients simply don't pay their bills, and he was astonished that such things could possibly happen. Well, they do - and new businesses could easily put some processes in place to deal with them, if they only knew how. It's easy to answer each of these questions, but without a simple guide, the uncertainty will stop a lot of people from getting started.
  3. Edited versions of - for example - HMRC or Companies House guidance on starting up. A simple step-by-step guide would cover 90% of business needs - the complexity is mostly created by the exceptions.
  4. A scheme for people to simply watch how other businesses work. Want to offer some mentoring to new startups? You could make it a complicated and time-consuming business planning and advice process, or you could just let people visit your finance department and see how they pay bills, collect debts and do their accounts. Let someone listen to your telephone sales calls or come along to a client meeting. Simple things, with no real cost to you as a mentor, but immense value to a new startup.
  5. A really simple portal which brings all these things together and takes you through the steps you need to start up.
I kind of expected StartupBritain to provide this kind of step-by-step simplified process, which may say more about my assumptions than about them. But in essence, most people have much higher cognitive barriers to starting up than financial barriers. And most of those who do have financial barriers, won't be helped much by 10% discounts.

As it happens, I think the Smarta Business Builder might close quite a few of the above gaps (Disclosure: I have no prior connection with Smarta but, having now met some of their people I'll be writing some guest blogs for them soon).

I said something like this on twitter, and @OliBarrett correctly pointed out that there's no reason StartupBritain should have been designed along these lines. But personally I believe these kind of step-by-step structures are the best way to encourage more people to start up.

One great model is the Tenner Tycoon scheme - which I only just discovered was founded by Oli himself! It addresses many of the above barriers, above all else encouraging people to simply try it out. Once someone is in the habit of thinking like an entrepreneur, many of the cognitive barriers are gone. Therefore I'm surprised that StartupBritain wasn't designed more along those lines.

I'm sure it will evolve over time. I hope that in the near future there's a site I can visit, with a big button marked "Start My Business", that will take me through step-by-step everything I need to get going. In the meantime, Smarta will provide some tools, StartupBritain some resources and ideas, Startup 100 some inspiration - and no doubt that will be enough to get some people going who wouldn't otherwise have done so. It's a start.

p.s. Inon is donating a free pricing research workshop to each of the category winners of Startup 100. I look forward to telling you about the winners, and their business models, here soon.

Sunday, 10 April 2011

The economics zeitgeist, 10 April 2011


This week's word cloud from the economics blogs. I generate a new one every Sunday, so please subscribe using RSS or the 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.

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, 3 April 2011

The economics zeitgeist, 3 April 2011


This week's word cloud from the economics blogs. I generate a new one every Sunday, so please subscribe using RSS or the 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.

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.

Friday, 1 April 2011

New research: *.99 no longer optimal for prices

The blog has been quiet for a while. I can now tell you the reason for this: I've been working on an intensive research project for the last couple of months. The Inon Pricing Research Centre has partnered with three retailers and two major consumer goods manufacturers to carry out the first detailed experimental tests of consumer responses to goods at different numeric price points.

Everyone knows - or thinks they know - that prices such as £1.99, £5.99 or £9.99 are optimal price points for retail goods. Customers read the first digit first, and the last two are ignored - or at least, they have much less cognitive impact. In general, consumers were thought to put a subjective value estimate of about ten per cent less on an item priced at £3.99, than one at £4.00.

However, despite a wide literature on behavioural economics and marketing, and a number of papers on pricing (for example this paper from Marco Bertini at London Business School), this effect has not been properly tested for years, since the advent of modern experimental economics methods. Any tests carried out by retailers in previous decades must be treated with caution - not just because they don't reflect the state of the art, but because the detailed results and methodologies have mostly been kept behind closed doors. The consumer goods industry is understandably reticent to share the results of its investigations. But we successfully persuaded several companies to participate in this new research, albeit anonymously.

And the results were a surprise. At first we thought that the effect we have discovered was just a previously unnoticed artefact, hidden by the fact that no proper experiment has been published before. But after further exploration, we think it is also an effect of changing consumer preferences. As customers become more aware of marketing tactics and more cynical about any communication from companies, their psychology and behaviour inevitably changes.

So, to the results. The summary points are:

  • Prices ending in .99 no longer have any advantage in consumer value perception, and do not lead to higher sales.
  • The optimal penny value varies by country. In the United States, it is .01. So, instead of $3.99, companies should charge $4.01. In European countries, the optimal price point is different for different product categories, but there is a peak at .04 for many products. So, British or European retailers currently charging, say, £0.99 should increase the price to £1.04.
  • By switching in this way to a "dollar-plus" price instead of "dollar-minus", retailers can increase sales volume by an average of 8% and increase profit margins by 1-3% (depending on the exact price point)
  • Consumers, when presented with the new price point, report an increased level of trust and affinity with the brands of the retailer and manufacturer. We believe this arises from the "honesty signal" that comes from abandoning a discredited and manipulative sales practice.

Retailers in the UK will be particularly relieved to see these results, as a 2% VAT rise earlier this year has been absorbed by most retailers instead of being passed onto consumers, hitting profit margins and affecting economic growth. In fact, we have now discovered, consumers are not just willing, but eager, to pay the additional cost. This is partly because of the credibility effect on the brand, and partly because it brings an associated feeling of civic pride - as consumers are able to self-signal their contribution to reducing the government deficit by paying the additional tax.

Building on this insight, we have extended the traditional economic measure of "willingness-to-pay" and developed a new, psychologically based measure, "eagerness-to-pay". We argue that these results reflect a genuine consumer preference for a higher price point, and therefore that any increases of this type should not be measured as an inflationary increase, but as a rise in consumer welfare. If adopted across the whole of the UK, this price increase would result in economic growth of approximately 1.6%.

By analogy with the established subfield of psychological research known as "reverse psychology", we propose that this aspect of consumer behaviour be explored under the banner of "reverse behavioural economics". We are exploring with UCL and other academic partners the viability of establishing a PhD scholarship in the study of reverse behavioural economics.

A paper, "How brand cynicism can lead to price sarcasm", coauthored by me, colleagues David Allen Green (@davidallengreen) and Shaa Wasmund (@shaawasmund) has been submitted to the Journal of Behavioural Finance and is expected to be published in about twelve months. Please contact me if you'd like a preprint.

This research is part of a broader programme and we expect to publish more results over the coming months. Early results suggest some intriguing conclusions. First, that TV advertising of brands reduces, not increases, consumer awareness. Second, as the retail distribution of fashion goods becomes broader, their sales volume falls, instead of increasing. And third, the most surprising result of all. The current research indicates that, under some circumstances, the demand curve slopes upwards. Simulated market experiments currently taking place in our lab, as well as examination of Web sales data, suggest that - due to network effects and the concept of "cognitive surplus" - the supply curve may in fact have shifted in the last five years, and now slopes downwards.