I was directed to this article on the New York Times website by A2 student Annie Huang. In October this year, a truck dumped 8 million coins (see photo) in front of the Swiss Parliament along with 125,000 signatures in support of a minimum monthly wage. The coins represented the citizens of Switzerland, and the petition was enough to trigger a referendum, voting on whether Swiss citizens should receive a monthly minimum income of $2,800, no questions asked. Each Swiss person would recieve this money from the government no matter what age they are, if employed or unemployed.
Although this seems rather radical there are some interesting points made as to why it has been proposed. The proposal is the work of German Enno Schmidt who is a leader of the basic-income movement. Here are some of the reasons:
* Basic income would provide dignity and security to those underemployed and unemployed
* Empower the labour force to work they want to, rather than just getting by
* Basic income through the tax code would be fairer than band aid programmes such as benefits, housing allowances, child benefits etc.
* The one basic income would replace and reduce welfare bureaucracy that is apparent with numerous welfare schemes
* Reduce poverty and increases social mobility
Research has shown that where the basic income has been implemented not only did poverty disappear but secondary school completion rates increases, hospitalisation went down and the community values started to change.
However there are some strong arguments against:
* The cost is too great
* It creates a disincentive to work
* The basic income might be enough to live on but at a very low standard
With the record earnings in the corporate sector but still no increase in the living standards of many, guaranteed incomes have resurfaced. Millions of workers have had no real increase in earnings since the late 1980’s. Below is an extract from the article:
The advocacy group Low Pay Is Not OK posted a phone call, recorded by a 10-year McDonald’s veteran, Nancy Salgado, when she contacted the company’s “McResource” help line. The operator told Salgado that she could qualify for food stamps and home heating assistance, while also suggesting some area food banks — impressively, she knew to recommend these services without even asking about Salgado’s wage ($8.25 an hour), though she was aware Salgado worked full time. The company earned $5.5 billion in net profits last year, and appears to take for granted that many of its employees will be on the dole. New York Times – 12th November 2013
‘The True Cost’ is a documentary film exploring the impact of the global clothing industry on people and the planet. While the price of clothing has been decreasing for decades, human rights and environmental costs have grown dramatically. It is the goal of this film to make those costs vividly clear as we explore how we got here, the damage being done, and the hope filled prospect of choosing a different future.
We have taken a first step in creating the teaser and building a growing team of experts around the world. We are now raising this money to begin full production on the final film. Funds will go to principal photography and the post-production process.
The film will feature interviews with top industry leaders from the international clothing industry, illuminating this complex dilemma. In addition to these professionals, the audience will get to see the human side of the issue as we take cameras around the world to capture the lives of the people affected by these issues every day. More than just underscoring the problem, this is an effort to highlight real solutions that we can all take part in. The road we are on is not sustainable, but there is an opportunity here; a defining moment in history for us to set a new precedent for the future we will create.
Recently John Cassidy in the New Yorker wrote a piece about Alan Greenspan’s new book “The Map and the Territory: Risk, Human Nature, and the Future of Forecasting” in which Greenspan admits to flaws in the neo-classical model that people and financial institutions act in their own self-interest. He has finally come round to admitting that people’s actions are often driven by “Animal Spirits” (originates from Keynes) and rather than behaving like calculators they respond to fear, greed, euphoria, and impatience. He identified 10 traits which he calls “Inbred Propensities”. It seems that during his tenure as Fed Chairman Greeenspan rarely mentioned Keynes although he studied it at Columbia University in the 1950’s. As John Cassidy points out by the time he met Ayan Rand he was of the neo-classical orthodox. The article is worth a look – plenty of good debate.
Remember the difference between the two schools of thought
Many thanks to A2 student Annie Huang for this article by Aditya Chakrabortty in The Guardian Newspaper. It discusses the fact that most major degrees in economics still focus on the neoclassical ideology and associates humans as perfectly rational walking calculators working out their utility for each purchase. The main model of consumer behaviour assumes that we never buy anything until we’ve calculated the impact on, for example, our retirement fund, and we’re so good at maths we use interest rates to compute our pleasure, over time, after buying something. He mentions the movie documentary “Inside Job” which showed how some of the best minds at American universities had been paid by Big Finance to produce research helping Big Finance. He tells the story of an economics lecturer being asked by students to discuss the Global Financial Crisis.
“US economist Philip Mirowski recounts how a colleague at his university was asked by students in spring 2009 to talk about the crisis. The world was apparently collapsing around them, and what better forum to discuss this in than a macroeconomics class. The response? “The students were curtly informed that it wasn’t on the syllabus, and there was nothing about it in the assigned textbook, and the instructor therefore did not wish to diverge from the set lesson plan. And he didn’t. In the 1970s at Cambridge “There were big debates, and students would study politics, the history of economic thought.” And now? “Nothing. No debates, no politics or history of economic thought and the courses are nearly all maths.”
Click below for the full article.
Also have a look at this video from the New Economics Foundation – again it debates the value of mathematical models and neoclassical theory. Does the market actually reach equilibrium? I like Steve Keen’s comment – “the pirate obsession of Economics – they love X marks the spot”. It also includes Joseph Stiglitz, Gillian Tett, David Tuckett, Stephen Kinsella, John Kay, David Weinstein, and Dirk Bezemer.
PBS Newshour Economics correspondent Paul Solman talks to Robert Reich about “Inequality for All,” a documentary about the former labour secretary’s personal crusade to explain to Americans why everyone should care about the nation’s growing economic disparity and divisiveness. Here is part of the interview in which Reich states what is bad about inequality.
Well it’s a bad thing in two regards, even if you don’t particularly worry about issues of fairness or public morality. It’s bad, number one, because no economy can continue to function when the vast middle class and everybody else don’t have enough purchasing power to buy what the economy is capable of producing without going deeper and deeper into debt. Seventy percent of the entire economy is basically consumer spending. And if consumers don’t have the wherewithal to spend because all the money’s going to the top, and the people at the top only spend a very small fraction of what they earn, then the economy is almost inevitably destined to slow.
Since the GFC in 2008 the world seems a happier place to be than it was before the event. This is according to a Ipsos a research company which completed a poll of 19,000 adults in 24 countries. However the term happiness is self-reported and the term means different things to different people. According to The Economist two conclusions have emerged from the data:
1. Large, fast-growing emerging markets do not share share rich industrialised pessimism. The happy countries got even happier – Turkey, Mexico, and India. Incidently even considering the tsunami and the nuclear accidents Japan’s ‘very happy’ category increased.
2. Happiness levels tend to rise with wealth and then plateau – The Easterlin Paradox. This usually happens when a country’s national income per head reaches around $25,000 per annum. But the highest levels of reported happiness are in the poor and middle income countries – Indonesia, India, and Mexico. In rich countries the levels range from 28% in Australia to 13% in Italy and 11% in Spain. Most Europeans are gloomier than the world average.
Levels of income seem to be inversely related to happiness and one can see that happiness depends on a lot more than material welfare. One just has to look at the Bangladeshi cricket supporters in the recent test with the Black Caps. Plenty of happy faces with an average income of $1,883 per annum and ranked 151 by the World Bank.
Here is another piece from Martin Luk that was published in the recent edition of “The King’s Echo”.
Barry Schwartz, in his TED talk “The Paradox of Choice”, talks about the “official dogma of all western industrial societies”. This is the common belief that by maximising one’s choice, we are maximising their freedom, and therefore their welfare. However, Schwartz gives some reasons why this may not be true, and this article aims to highlight these.
Firstly, here is a clear, intuitive example of how choice may not necessary be a good thing. A doctor offers X amount of treatment options to the patient, and allows the patient to choose. The patient has choice, but he/she would most likely lack the knowledge and physical state of mind to make the best decision. Obviously, it should be better if the doctor, with all their experience and knowledge, makes the decision, even though it restricts the patient’s choice.
One of the main reasons why freedom can do more harm than good, is that it paradoxically causes paralysis in decision-making. When people have a lot of freedom, they have to spend time and effort considering the many options and making a decision. We have so much freedom in our college lives, that I think all of us will inevitably have endless questions racing through our minds, such as “Should I be studying or relaxing? What subjects should I take next year? Do I go to community service or football training? Should I text this girl or not?” These rather futile, yet difficult decisions make us indecisive, slow, and permanently pre-occupied in our lives, all thanks to the “problem” of having a bit too much freedom.
However, there are some more subtle cognitive effects that come with more freedom. First, it is very easy to imagine that there was a better choice than the one that you had chosen. If a girl chooses a certain lipstick among the many thousands there are at Smith & Caughey’s, and finds out that she doesn’t like it, then it is easy for her to think that there was a better option in the store somewhere that she didn’t choose –despite the fact that there may not be. Even if her choice was very good, it isn’t hard for her to imagine that there was an even better alternative. This causes us to regret our own decisions (even if the option we took was the best choice), and this can seriously damage how satisfied we are with something. And with more freedom, comes more capacity to imagine that the grass is greener on the other side.
Those who take economics may also be familiar with the term “opportunity cost”. This simply means the alternatives that you have to give up, in order to go with one option. For example, by going on Facebook, your opportunity cost could be studying, or going out with your friends, eating, or gaming. As you can clearly see, the more freedom of choice you have, the more you can do at any point in time: leading to higher opportunity costs. More freedom = more things you are going to miss out on by doing something. What this means, is that the attractiveness of the alternatives you reject can subtract from your satisfaction from doing something, even if that thing is very enjoyable and fun.
Finally, in this “choice-full” world of today, people are bound to choose an option that is almost perfect. Schwartz talks about how there only used to be one kind of jeans that you could buy, compared to the many different colours, fabric, fit, and size that you can buy today. He claims that by being able to buy such near-perfect jeans, you have such high expectations for the next pair that you can’t be completely satisfied. He jokes: “the secret to happiness is low expectations.” I find this to be true to a certain extent.
However, I have left the most damaging part of freedom to last. Putting it simply: “Everything is because of you.” If we live in a world of little choice, and you don’t feel happy about something, then you can blame others and the world around you (it isn’t your fault that you can’t get what you want). However, if we live in a world full of choices, then you only have yourself to blame if you are not satisfied with what you have. There is no excuse for failure, as the right alternative would have probably been out there somewhere, but it would have been you who failed to choose the right one. Schwartz points to the rise in clinical depression in the industrial world in the last generation, and I agree with him in saying that more choice has played a large factor in this.
In all, excess freedom may allow us to perform better in general, but it will leave us feeling worse off emotionally. Some choice is better than none, but more choice may not necessarily be better than some choice. There is some tipping point where increased amounts of freedom may begin to have the adverse effects that I have talked about above. In this world of today, we may have just passed that.
Below is an article written by King’s College Year 11 student Martin Luk which was published in the student magazine “The King’s Echo”. He makes some excellent points in this exciting area of Behavioural Economics – thanks Martin.
This may sound like a stupid question. Are you in control of your own decisions? Of course, you say. How can you not be?
Well, in reality, we only think we are in control of our own decisions. We think we are intelligent enough to pick the best option. However, in one of his TED talks, behavioral economist Dan Ariely turns this belief on its head. He talks about real-life experiments that show: We aren’t in control of our own decisions. How can that be?
1) The way some questionnaires are laid out can heavily influence our decision (Johnson and Goldstein)
The graph shows the percentage of people in each country that were interested in donating their organs. The bizarre thing is, is that there is a clear division between countries where the vast majority are willing to donate, and those where the vast majority aren’t. And if you look even closer, you can see that countries of very similar culture (Germany and Austria, Denmark and Sweden) can be on different sides of that division. What could be going on?
The countries in white (low participation) have a survey form which looks like this:
☐ – Check the box if you want to donate your organs.
The countries in grey (high participation) have a survey form which looks like this:
☐ – Check the box if you don’t want to donate your organs.
The people in the white countries don’t tick the box, and they don’t donate. The people in the grey countries also don’t tick the box, but this time, they end up donating. That’s it. What this shows, is that decisions like these don’t actually reside fully in us. While it appears like we have the freedom to choose the best option, the person designing the form pretty much decides what we choose. This fact that we are just under the illusion of making a decision might be hard to believe, as we have such a strong feeling that we are in control. However, the simple reasoning is that the decision is so complex that we don’t know what to do. As a result, we don’t really care about it, and just pick the default: what was already chosen for us.
2) The importance of pointless options
This was an advertisement from The Economist a few years ago. At first glance, the second option seems pointless. Why would anyone choose only to have the print subscription, when you could have the print & web subscription at the same price?
Ariely gave this to 100 MIT (Massachusetts Institute of Technology) students, and surely enough, most people chose option 3, the combo deal. Obviously, nobody chose option 2. However, if nobody chose option 2, then it should be taken off, right? Once Ariely had done this, more people opted for option 1 than option 3. If he were The Economist, he would have lost money.
Why? The “useless” option in the middle was actually far from useless, as it made the third option looked like a really good deal. As a consequence, people chose the third option. Again, this is an example of a scenario where we don’t actually know our preferences that well, and we are susceptible to all these influences.
3) Who you should take when on a date
It is a common belief that when we see someone, we can immediately tell whether we are physically attracted to them or not. However, an experiment done with real people (although graphic images and fake names are used here) proves otherwise.
Some people were shown a picture of Tom, and a picture of Jerry, and were asked, “Who do you want to date? Tom or Jerry?” However, half of the people were also shown an uglier (photoshopped) version of Jerry, and the other half were shown an uglier version of Tom. Did ugly Jerry and ugly Tom help their more attractive brothers? Oh yes. When ugly Jerry was around, Jerry was popular. When ugly Tom was around, Tom was popular.
So next time when you’re going on a date, you want to take a slightly uglier version of yourself. Similar, but slightly uglier. And you know how other people think about you if they ask you to tag along.
I’m only joking.
On a broader level, what these three experiments show is that, us humans have some cognitive limitations when it comes to decision-making. We may believe that we are fully in control of our own decisions, but as you have clearly seen, we might have less control than we think. If this isn’t shocking enough, consider how this changes our notion of freedom. How are we meant to be free if we aren’t even in control of what we choose? Can we ever overcome these limitations? Can we ever become truly “free”?
No business, however great or strong or wealthy it may be at present, can exist on unethical means, or in total disregards to its social concern, for very long. Resorting to unethical behaviour or disregarding social welfare is like calling for its own doom. Thus business needs, in its own interest, to remain ethical and socially responsible. As V.B. Dys in “The Social Relevance of Business ” had stated
“As a Statement of purpose, maximising of profit is not only unsatisfying, it is not even accurate. A more realistic statement has to be more complicated. The corporation is a creation of society whose purpose is the production and distribution of needed if the whole is to be accurate: you cannot drop one element without doing violence to facts.”
Business needs to remain ethical for its own good. Unethical actions and decisions may yield results only in the very short run. For the long existence and sustained profitability of the firm, business is required to conduct itself ethically and to run activities on ethical lines. Doing so would lay a strong foundation for the business for continued and sustained existence. All over the world, again and again, it has been demonstrated that it is only ethical organisations that have continued to survive and grow, whereas unethical ones have shown results only as flash in the pan, quickly growing and even more quickly dying and forgotten.
Business needs to function as responsible corporate citizens of the country. It is that organ of the society that creates wealth for the country. Hence, business can play a very significant role in the modernisation and development of the country, if it chooses to do so. But this will first require it to come out from its narrow mentality and even narrower goals and motives. However behavioural economists have found that many businesspeople don’t behave in this type of profit-maximising manner in times of crisis – e.g a water shortage means businesses could charge more. If they do, consumers remember and retaliate down the road.
As consumers start to develop a preference for ethical brands, e.g.. Fair Trade Coffee, create a market for such coffee. Firms are therefore pressured to shift toward supplying what consumers want. This is even the case if the firm’s management don’t care how or where the coffee is sourced. Changing consumer preferences force firms to change their ways. Even at higher prices consumers are often willing to pay a premium for ‘ethical’ products or the products of socially responsible firms. Being more expensive doesn’t necessarily mean the company will go out of business if consumers have a preference for ethical products. Higher-priced ethical firms remain highly successful under these circumstances. Instead of being protected by tariffs or subsidies, they’re protected by the preference of consumers. Below is graph that I got from Stephen Hickson who presented at the NZCETA conference this year. Notice the changes in the Fair Trade price of coffee especially from 2011. Commodity prices can fluctuate wildly, and isolated, poor growers are often unable to take advantage of the sophisticated financial instruments employed by buyers to lower risk and volatility. The Fair Trade floor price gives farmers market information, financial stability, and access to credit. But as Stephen Hickson pointed out:
But that of course is not what people think… most people think when they buy FT coffee it is about the extra they pay going to the farmer (in fact not paying any extra would seem odd to some).
Recently came across the The United Nations General Assembly second annual World Happiness Report, measuring happiness and well-being in countries around the world to help guide public policy. Denmark topped the list of the happiest nations, ousting last year’s winner, Iceland. Denmark was followed by Norway, Switzerland, the Netherlands, and Sweden – New Zealand comes in at 13th place. Below is an extract and a graph showing the happiness ranking.
In an impoverished society, the focused quest for material gain as conventionally measured typically makes a lot of sense. Higher household income (or higher Gross National Product per capita) generally signifies an improvement in the life conditions of the poor. The poor suffer from dire deprivations of various kinds: lack of adequate food supplies, remunerative jobs, access to health care, safe homes, safe water and sanitation, and educational opportunities. As incomes rise from very low levels, human well-being improves. Not surprisingly, the poor report a rising satisfaction with their lives as their meager incomes increase. Even small gains in a household’s income can result in a child’s survival, the end of hunger pangs, improved nutrition, better learning opportunities, safe childbirth, and prospects for ongoing improvements and opportunities in schooling, job training, and gainful employment.
The paradox that Easterlin noted in the U.S. was that at any particular time richer individuals are happier than poorer ones, but over time the society did not become happier as it became richer. One reason is that individuals compare themselves to others. They are happier when they are higher on the social (or income) ladder. Yet when everybody rises together, relative status remains unchanged. A second obvious reason is that the gains have not been evenly shared, but have gone disproportionately to those at the top of the income and education distribution. A third is that other societal factors – insecurity, loss of social trust, a declining confidence in government – have counteracted any benefits felt from the higher incomes. A fourth reason is adaptation: individuals may experience an initial jump in happiness when their income rises but then at least partly return to earlier levels as they adapt to their new higher income.
These phenomena put a clear limit on the extent to which rich countries can become happier through the simple device of economic growth. In fact, there are still other general reasons to doubt the formula of ever- rising GNP per person as the route to happiness. While higher income may raise happiness to some extent, the quest for higher income may actually reduce one’s happiness. In other words, it may be nice to have more money but not so nice to crave it. Psychologists have found repeatedly that individuals who put a high premium on higher incomes generally are less happy and more vulnerable to other psychological ills than individuals who do not crave higher incomes. Aristotle and the Buddha advised humanity to follow a middle path between asceticism on the one side and craving material goods on the other.
A further huge problem is the persistent creation of new material “wants” through the incessant advertising of products using powerful imagery and other means of persuasion. Since the imagery is ubiquitous on all of our digital devices, the stream of advertising is more relentless than ever before. Advertising is now a business of around $500 billion per year. Its goal is to overcome satiety by creating wants and longings where none previously existed. Advertisers and marketers do this in part by preying on psychological weaknesses and unconscious urges. Cigarettes, caffeine, sugar, and trans-fats all cause cravings if not outright addictions. Fashions are sold through increasingly explicit sexual imagery. Product lines are generally sold by associating the products with high social status rather than with real needs.
Here is a short clip from the movie Samsara which is enlightening. Overconsumption is a situation where resource use has outpaced the sustainable capacity of the ecosystem. A prolonged pattern of overconsumption leads to inevitable environmental degradation and the eventual loss of resource bases. This six minute video will open your eyes to a world normally hidden from cameras. A hard hitting dose of perspective of what unsustainable demand looks like. To get more information on the movie go to their website – Samsara.
This week James Surowiecki in The New Yorker addressed the issue of the bumper lobster harvests but the high prices of lobster in restaurants. In the state of Maine, on the east coast of the US, lobsters off the boat were selling for US$6 / pound in 2005 in contrast to today where the wholesale price is as low as US$2.20. Therefore why have the prices in restaurants stayed high when you consider the wholesale price?
One logical reason is that ff there is a bad harvest and prices rise, restaurants might find it hard to sell expensive lobster to customers who have got used to it being cheaper.
Lobster is more like a luxury good than a commodity and therefore has a range of psychological factors:
1. High lobster prices became an important image on the menu – studies have shown that people enjoy cheaper wine when they do blind taste tests. If lobster was priced like chicken people wouldn’t enjoy it as much.
2. Customers often correlate price with quality. As the majority are not aware of what is happening on the lobster wholesale market they could presume that the quality of your lobster is not as good as your competitors – low price creates suspicion.
3. By making lobster expensive it make other items on the menu look more reasonably priced. A classic experiment described by Itamar Simonson and Amos Tversky showed that if you asked people to choose between a mid-priced microwave oven and a lower-priced one sales of the products were roughly split. But adding a higher-priced oven to the mix increased sales of the mid-priced product by forty per cent—the mere presence of a more expensive option made the moderate one look like a better buy. So any restaurant that cuts lobster prices significantly runs the risk of making that sesame-crusted tuna look too pricey.
4. Finally. although there is a lot of competition amongst restaurants very few customers would pick restaurants on the price of lobster.
Although U.S. GDP has grown over the last 35 years, average happiness has not. According to researchers at the University of California at Berkeley, the reason may lie in growing economic inequality. Paul Solman of PBS reports as part of his Making Sense of Financial News. Some good references to the book ‘The Spirit Level’ and an interview with Robert Frank of Economic Naturalist fame and the Darwin Economy.
Another article from EcoNZ@Otago on infographics and heuristics.
Many scientists (including economists) rely heavily on empirical analysis in their research. Overwhelming the public with statistics can be a big turn-off. Journalists and economists have introduced infographics to their writing whcih combine data with visual appeal (via artwork and design).
In doing so, scientists can take advantage of a variety of ‘mental shortcuts’ (or heuristics) used by the general public to identify patterns, to assign meaning to information, and to retain knowledge. This leads into the area of Behavioural Economics.
The basic idea of behavioural economics is that decisions tend to be biased because they are based on heuristics (decision-making shortcuts). The problem isn’t so much that people’s choices don’t reveal their wants and desires, but that their wants and desires are often biased and error prone.
Visualisations contain particular characteristics, known as preattentive attributes, which the human brain can interpret very quickly. Colour, for example, can be used to draw attention or isolate outliers (see Figure 1). Colour can also transmit meaning.Think of the daily weather map as an example: cool regions are coloured blue and warm regions are coloured red. As people associate these colours with cold and hot temperature, viewers can get a sense of what the weather will be like by just looking at the map and not noticing the exact temperatures. Size and placement can be used to establish significance, with larger, central, and forward objects indicating more importance (see Figure 2). Symbols can be used to form visual narratives or metaphors which can give viewers hints as to the meaning behind the images (see Figure 3). By combining visual elements with textual explanations, meaningful and memorable messages can be disseminated faster than with text alone.
In the March edition of the University of Otago publication EcoNZ@Otago there was a good article on ‘Prosumers’.
In markets, firms produce goods and services and consumers buy them (see Figure 1). This is the underlying set-up embodied in many economic models. Most of the time, the buyer-seller dichotomy is an accurate representation of market activity. Since the early 1990s, however, another paradigm has emerged. The advent of the internet has allowed some industries to assign a stronger role in the production of goods and services to those who purchase them (see Figure 2). Consumers are becoming prosumers and firms are benefiting (immensely) by consumer-led marketing and design.
A key feature of prosumers is that they are not paid for the work that they do. Every time you post a review about a product online, for example, you are either doing marketing for the firm (in the case of good reviews) or providing them with information about their product’s shortcomings which they can use to improve their wares (i.e. quality control, in the case of bad reviews). The firm pays you nothing for this. In some cases, prosumers work for the firm without even knowing it. Some websites monitor the buying activities of other users so they can suggest products to you based on the goods in your shopping cart. By simply buying online, you help the firm cross-sell products to others in the future.
But there is an even stronger role in the production process for prosumers! Occasionally, prosumers will take it upon themselves to build products from scratch and share them with other prosumers (see Figure 3). One example of this is the production of open-source software. In the 1980s, such software was made available under General Public Licensing (also known as copylefting), a licensing procedure developed by the Free Software Foundation. Anyone is allowed to use and modify copylefted software under the conditions that: (1) they do not attempt to impose licensing restrictions on others, and (2) all enhancements to the code are licensed on the same terms.This means that any programmer who makes alterations to the code can claim ‘bragging rights’ for their work, but they cannot charge others to use it.
On New Zealand’s TVONE last night the current affairs programme “Sunday” ran a segment on the booming property market in Auckland. There were some interesting interviews with real estate people plus economists – namely BNZ Chief Economist Tony Alexander and New Zealand Institute of Economic Research (NZIER) Principal Economist Shamubeel Eaqub. The economists were a lot more rational in their thoughts as to buying a house – for example:
* Have you actually done the sums?
* Can you afford to repay the mortgage if there is a 3% interest rate increase?
* We could see a US style housing collapse.
* Auctions are a good example of buying on emotion with all the hype.
Loads of behavioural economics in the programme. You should be able to see the following:
Herding – People tend to follow the herd, especially information is uncertain, incomplete, and asymmetric (some people are more informed than others).
Relative Positioning – is a concern people have regarding their own economic and social status relative to other people.
Overconfidence – is a belief, fed by emotions, that you can predict movements better than you actually can. When you’re overconfident, you’re not as smart as you think you are.
Institutional Failure – Investment decisions that can be bad for society but good for the individual can be a product of the institutional environment. If decision makers face little or no downside risk when making very risky decisions, they’ll take those risks.
Here is the link to the programme – “Sunday – Going, Going, Going”
Whilst away on hockey tour in Malaysia I was able to avail myself of the ‘The Straits Times’ newspaper which is published in Singapore. One article that particularly caught my attention was that concerning the creativity of algorithms. Most are oblivious to their creativity yet highly sophisticated algorithms have created music based on the works of great artists but in a style that is personalised and therefore indicative of you the individual. They are also replacing writers – Professor Phil Parker of the Insead Business School in Paris has published more than a million reports on Amazon in just a couple of years. Using a proprietary algorithm that produces a report in 10 – 20 minutes instead of about 4 weeks. The algorithm pulls information from the web, performs econometric analyses, creates tables, formats the report and publishes it as a Word document. Professor Parker has also developed algorithms to produce poems, videos and video games.
Although we could question the efficacy of algorithms on intangible dimensions such as “soul’ and “depth”, one area where they trounce human beings is stock trading. With up to 75% of trades on Wall Street done using computer programmes it is no wonder that algorithms execute trade at lightening speed and carry out numerous transactions every second. On the NYSE the average round-trip transaction time is 600 microseconds. To put into perspective if you blinked it takes you 300 milliseconds to complete the action – during that time NYSE executed 500 trades. This desire to improve efficiency in the market has led to extremely low costs of trading and very high stock liquidity. However it has also produced huge swings in stock prices. On 6th May 2010 – know as the ‘Flash Crash’ – the DJIA fell 9% in minutes but then recovered most of that loss in the subsequent few minutes.
The landscape of society was always made up by this uneasy relationship between nature and man. But now there is this third co-evolutionary force – Algorithms – and we will have to understand them as nature and in a way they are. Kevin Slavin Ted Talk
One of the first topics in the Behavioural Economics course that I am teaching is Prospect Theory. Of critical importance to behavioural economists is the fact that people are frequently subject to cognitive illusions (errors in understanding reality based on how information is presented or framed and how our brain processes information) causing errors and biases in decision making. Moreover these events are typically not one-time occurrences: People fail to learn appropriately from their mistakes, which is a product of not abiding by conventional economics behaviour norms. Nobel Laureate Daniel Kahneman and Amos Tversky referred to this as errors and biases approach. Prospect theory was developed as descriptive theory of certain aspects of average decision-making behaviour. Conventional economics can’t describe, explain, or predict choice behaviour. Emotions are a key driver of a person’s behaviour. People have been shown to be loss averse, generally appearing to dislike losing something roughly twice as much as they like gaining it. Such a phenomenon has been shown in a number of experimental studies in a broad range of contexts. Loss aversion can be explained by prospect theory , which states that an individual’s value function (whether for money or otherwise) is concave for gains but convex for losses. In other words, people are more sensitive to losses compared to gains of similar magnitude.
This is illustrated in the graph. The reference point in the diagram is the current position of the individual concerned. Gains and losses are evaluated with reference to this neutral reference point. The value function takes an asymmetric S-shape because marginal value (or sensitivity) declines as absolute gains and losses increase in size. A dollar lost more than outweighs a dollar gained. In conventional economics, gains and losses are treated equally – a dollar lost simply cancels out a dollar gained.
Many people pay special attention to reference points when income or wealth increases or decreases. What counts isn’t total income or wealth but the relative changes in income and wealth – this is why the negative and positive dimensions of the value function are drawn from a reference point. In conventional economics, what people are most concerned about is the endpoint or total amount of income or wealth. But from the perspective of prospect theory, many people are happier if their income increase by 10% from a lower level of income than 2% from a much higher level of income. If my income goes up by 10% from $1,000 to $1,100, I’ll be happier than if my income goes up 2% from $10,000 to $10,200. Of course in conventional economics, your emotions don’t introduce concerns about reference points that may override your desire to increase your absolute level of income.
A lot of behavioural economics textbooks look at the role of anchoring in our decision making processes. The anchoring effect is a type of framing where the appraisal of options is affected by an original starting value (or anchor). This is despite the anchor being arbitrarily chosen. For example, when asked to value the same property after being given different anchor values, real estate agents gave valuations that were significantly correlated with the arbitrary anchors provided.
With regards to the seizures of ships by Somali pirates, economists have had a particular interest in the negotiations that have taken place especially as the market has been generally free of government intervention. Research has shown that by sending consistent (cheap-talk) signals about their type (“sophisticated pirate” / “poor owner”), each side hopes to negotiate a better outcome but have reason to speed up the negotiation process:
Pirate - the hostages (and themselves) need to be fed
Crew – cargo might be perishable and the vessel is not in use therefore not making money.
However higher past ransoms are positively associated with subsequent ransom amounts – higher ransom amounts pass on a negative externality on future victims. This finding has policy implications for governments considering becoming involved in ransom negotiations. For instance, under political pressure to recover hostages, the Spanish government paid 1.2 million USD in 2008 for release of the Playa del Bakio, more than twice the previous record amount for a fishing vessel – source: Barrgh-gaining with Somali Pirates, 2012 by Olaf J. de Groot, Matthew D. Rablen and Anja Shortland. Therefore a floor price (see graph) has been set for future negotiations and it is a point of anchoring for the the pirates. Also from this paper is a graph (see below) that shows the duration of hijack and the ransom paid in US$m – there is a lack of correlation although the authors suggest that there is insufficient observations in this analysis.
The authors of the paper conclude by saying:
ransoms might be lowered by making rich ship-owners more patient by, for instance, by governments providing emergency loan guarantees to cover the running cost of the hijack, or compensating ship-owners for loss of hire, while offering
significant financial compensation to the crew.
Here is a great documentary on behavioural economics from PBS – features Richard Thaler – University of Chicago and co-author of Nudge, Gary Becker Univerisity of Chicago, Jennifer Lerner – Harvard – social psychologist. The main model of consumer behaviour assumes that we never buy anything until we’ve calculated the impact on, for example, our retirement fund, and we’re so good at maths we use interest rates to compute our pleasure, over time, after buying something.
At the centre of all the rational models lies an unflinching belief in free markets. The idea is to keep regulation and government interference to a minimum, in both the every day consumer market and in the giant money markets of Wall Street. Rational economists believe that the increase in wealth, worldwide, over the last 30 years, is a triumph for free markets.
With the GFC, the rift in economics widens between the rationalists and the behaviouralists. So which side is right? Are we rational about money, or do our emotions and psychology play a much bigger role than previously realized?
The programme features loads of experiments:
$20 auction. People bid for the $20 but the second highest bidder receives nothing and pays the amount of the losing bid. See what happens.
Answer this question
a) Would you prefer $100 in a year’s time or $102 in a year one day?
b) Would you prefer $100 right now or $102 tomorrow?