Economics

about.me Follow me on Facebook Follow me on Goodreads Follow me on Twitter

Read: Phishing for Phools

Phishing for Phools leaves me with a rather ambivalent feeling. Some parts I like and found interesting, in other parts Akerlof and Shiller seem to just state the obvious, and in the remaining parts they offer interpretations that I cannot agree with. The particular mix that equates legal and illegal actions, welfare enhancing activities and plain fraud seriously subtract from the (entertaining) value of their little book.

I like their discussion of finance and fraud. (They are not the first to offer such an account.) And I agree that “greed” (that is not really a bad thing in it self), the (bad) design of incentives, and the lack of proper regulation to ensure well functioning markets in the presence of information asymmetries are all contributing to the problems we have observed.

Also their discussion of the misaligned incentives in the pharma industry is not controversial. Others have, of course, beaten that horse before. Bad Science / Bad Pharma by Ben Goldacre come to mind. Recommending better regulation to reduce the problems caused by information asymmetries here is not a controversial issue.

The voter’s rational ignorance and the influence of special interest groups are also ultimately linked to information asymmetries. In contrast to the authors who seem to like to regulate lobbying more I do not believe that more and stricter regulation will necessarily lead to a better outcome of the political decision making process. It may reduce some waste, resources spent on lobbying may find better uses somewhere else. It will not change anything about he voter’s ignorance.

Though there is nothing really new up to here – the authors admit that their book may not offer anything new except for their interpretation – these parts are both instructive and, yes, entertaining.

Finally, the moment Akerlof and Shiller talk about Phishing for Phools that is not linked to information asymmetries (that moment actually comes first in their book) I cannot agree with them. The provision of goods in convenient ways and places is not a bad. Yes, ceteris paribus I like to live healthy. But if I buy donuts the trade-off between the immediate satisfaction of my needs and wants and the long run effects of that satisfaction is decided. By me. I do not need any paternalistic restrictions of my choice set. Educate me but do not tell what to do or take my choices away.

I really do not like how the entrepreneur who provides a valuable service to his customers is placed on the same level as the con man and the financial fraudster, or even the price discriminating used car sales person.

Tags: 

Read: How do you know?

Seemingly irrational behavior or rather bounded rationality is the result of bounded cognitive abilities, bounded willpower, bounded self-interest, and - yes - bounded knowledge. Russell Hardin offers an account of the consequences of - fully rational - limited knowledge, an economics of ordinary knowledge. The question is what extent of knowledge in terms of quantity and quality can we expect from an ordinary person.

Rational ignorance permeates all domains of our daily lives and not just public policy and politics. To illustrate his point, maybe even delineating an extreme, Hardin singles out religious belief. Believes are just one instance of knowledge by authority that lie at the core of an economics of ordinary knowledge. No one can gain expert knowledge in everything and hence has to take many bits and pieces of knowledge at face value from an authoritative source. What is an authoritative source and who is an authority from the perspective of an ordinary person then may limit the quality of knowledge, the extent of its objective truth. Hardin discusses the tension between science and religion, the individual and communal incentives to believe, sincerity, fundamentalism, and extremism. He draws a very bleak picture of society.

Even though Hardin acknowledges the existence of limits on cognitive abilities, will-power, and self-interest his analysis only drops the assumption of perfect knowledge, he is able to explain many seemingly irrational patterns in our behavior. His ordinary person still tries to maximize their utility and decides that obtaining more and better knowledge may not be worth its cost. People remain rational ignorant. Yet, already this small deviation from the standard economic analysis of decisions, choices under uncertainty and in strategic interactions seems sufficient to explain seemingly irrational, i. e. objectively sub-optimal, behavior.

Adding the further bounds to our abilities is not likely to improve the quality of our decisions and welfare. So yes, Hardin draws a very bleak picture indeed.

Read: Happy Money

So, after Stuffocation I wanted to get a bit more on (and closer to) the original research. Dunn and Norton’s Happy Money was supposed to fill that role as “Better Spending” is at the core of their research.

I had too high expectations.

The book is rather small, but not brief. There is a lot of unnecessary padding, irrelevant anecdotes, and personal back story. Hence, they say a lot less than they actually write.

Since most of the results presented in their book I already knew, Happy Money has added very little. Out of the 5 chapters that discuss the research only two offered something new. Articles on “Buy Experiences”, “Make It a Treat”, and “Buy Time” had already made it to my desk. And, unfortunately, the book did not offer anything worthwhile compared to these articles.

The chapters on the ideas that one should rather “Pay Now, Consume Later” and “Invest in Others” were more interesting. “Pay Now, Consume Later” follows directly from the concept of “pain of paying” and the peak-end effect. If there is no “pain (of paying)” at the end of the consumption experience the experience is more enjoyable, makes one happier. Getting happier by “Invest(ing) in Others” seems a bit like conventional wisdom. There is, however, a substantial amount of research on this. It took me a while to make the connection to the altruism and warm glow literature. They do not refer to any of the relevant economics artciles in this area (like James Andreoni’s A Theory of Warm-Glow Giving from the 1990) but only cite very recent articles in psychology. They do, however, refer to the Waldfogel paper on the Deadweight Loss of Christmas, the economic inefficiency of gift giving to show how myopic, narrow-minded, and thus incomplete the economic analysis of gift giving is. Consequently, they neglect all, almost all, the relevant research in (behavioral) economics, published in economics journals, and thus irrelevant to psychologists. While, of course, perfectly justifiable, I perceived this rather mono-disciplinary approach as annoying. Given the title Happy Money I expected rather a fusion of the different fields of economics and psychology.

What else annoyed me?

The authors feel it is necessary to explicitly tell their readers that they are professors at highly reputed universities and that they publish in highly reputed academic journals and that their friends are also professors at universities of the highest reputation. They were the rising stars, they were the people who will change the world. They are the authority on the book’s topic. You do not need to look any further.

And finally, in the last chapter they explain how government should make the world a better place by just applying all the principles discussed in the book, to cast them into a law and make them a guide for government action. Their recommendations are plain paternalistic policies. Given the heated debate about freedom preserving libertarian paternalism, nudging, these restricting, purely paternalistic policies that would force happiness upon the feeble-minded citizen who does not know what is good for him were a big surprise.

Read: Stuffocation

A downside of reading ebooks is that you cannot briefly skim the whole book to get an idea about its content, the argument the author wants to make. Yes, the table of contents can still give a clue about this. Yet, somehow with an ebook it is less likely that I will consult the table of contents (again) once I have “turned” the pages.

Hence, while reading Suffocation (as an ebook) I often wondered why the author would now discuss things like the Streisand effect, or whether he sees a future in our society for whatever he was discussing at the moment.

Wallman builds his argument slowly, carefully. Yet, without telling his reader the big picture up front. Only after a chapter, at the end of it, or even only after several chapters, it becomes clear what Wallman wants to say, why he tells what he just told, what the purpose of all the (anecdotal) evidence is. At the end, everything is obvious.

Wallman identifies a problem: Stuffocation. Materialism in the sense of buying (too much) stuff, conspicuous consumption. After the all the unclutter and simplify-your-life books and articles that seem legion nowadays he does not need to spend too much time and effort to make and explain this point. He then discusses three potential solutions: minimalism, regression to simple living, and medium chill (a result of satisficing with rather modest aspirations). They all ain’t it.

So, he identifies a common core and a less anti-materialist solution to Stuffocation, all the stuff that clutters our homes and makes us miserable, that seems more likely to catch on. Experientialism, conspicuous spending not on lots and lots stuff but lots and lots of memories (and some high-quality stuff that helps to have a great experience).

All in all, this conclusion does not seem to be very controversial. Or original. Psychologists like Gilovich and Dunn arrived at the conclusion that spending money on experiences is making people happier than spending money on consumer goods much earlier. On the other hand, Wallman asks (and answers) whether this shift in spending on goods to experiences would be viable, whether people would change their behavior in large numbers to have a lasting effect on the economy. Of course, the anecdotal pieces of evidence still hint a the current stage of this idea’s dissemination and adoption: It’s still very, very early. Right now, experientialism seems something that is mostly for the financially (very) well off. Though, of course, these may be exactly the people who feel the most “stuffocated”, who have reached the end of material scarcity, and for whom time has become the ultimate scarce resource.

So, despite all the shortcomings there were a few parts of the book and ideas for which I am happy to have read Stuffocation.

For instance, I was surprised to find a(n interesting) discussion of the economic concept of GDP in the book. While Wallman’s perspective seems to be rather anti-business (“captains of consciousness”) he quite correctly points out: (only) what gets measured gets managed. Hence as long as there is no widely accepted replacement (or at least complement) for GDP that captures well-being the progress of society will be measured as the increase of the monetary value of the goods and services produced and sold and not as the increase in its citizens’ well-being, their quality of life.

And, Wallman gave a nice summary of why conspicuous spending on experiences is better in the sense of likely to make people happier than conspicuous spending on stuff. With stuff, it is almost always easy to rank what is the better (as a proxy the more expensive) thing. With experiences the cost may not serve anymore as a proxy for the quality: a “cheap” experience may still be great. Hence, there is less of a feeling of being behind, less pressure to upgrade and spend more.

Read: Misbehaving

Thaler’s Misbehaving is a personal account of the development of modern behavioral economics. It is not the history of behavioral economics. It is a (part of the) history of behavioral economics. Thaler is a contemporary witness, and at the same time one of the major figures in modern behavioral economics.

I like Misbehaving for (at least) two reasons.

First, Thaler establishes very early and often reinforces later that standard economic [consumer / decision] theory, rational choice theory is a normative theory. It describes how people should behave if they were to optimize their utility. It (often) does not describe what they really do. Rational choice theory is based on mathematical axioms, not true human behavior. For many purposes, this is absolutely fine. In many contexts, the observed aggregate behavior is driven more by the institution than the individual. For describing human decision making, for predicting an individual’s choices it is not. This is where we need a positive, descriptive theory.

Human cognition is bounded. Full rationality (in its mathematical definition) is, therefore, impossible. Bounded rationality is the best we can hope for. And this is the core of behavioral economics.

Without a pre-existing unifying model to compete with the dominant Rational Choice Theory research had to start with identifying “anomalies.” Thaler did exactly this. He reports many of the initial hostilities and criticisms against his heretics, the abandoning of the dominant doctrine. Sometimes he also reports a researcher’s conversion as a result to economics becoming a more empirical science. Nevertheless, still today some colleagues, and even colleagues among the experimental economists, would start to defend Rational Choice and Expected Utility Theory even if I just described it as a normative and not a positive theory.

The still standard normative economic theory approach can serve many purposes well and is often easier than more realistic approaches. As-if utility maximization has its purpose. Yet, as the sole policy analysis tool it may lead to the wrong conclusions and should, therefore, be augmented with the many insights we have gained from neighboring fields and the empirical economic research of the decision maker. A recommendation that, obviously, also Thaler advocates and has already helped to implement on several occasions.

Second, somewhere in the middle of the book Thaler alerts,

Tempering expectations about the magnitude of the sizes of effects that will be obtained is important because the success of […some nudges…] can create the false impression that it is easy to design small changes that will have big impacts. It is not.
It is also crucial to understand that many improvements may superficially appear to be quite small: a 1 or 2% change in some outcome. That should not be a reason to scoff, especially if the intervention is essentially costless. […] A 2% increase in the effectiveness of some program may not sound like a big deal, but when the stakes are in billions of dollars, small percentage changes add up. As one United States senator famously remarked, “A billion here, a billion there, pretty soon you’re talking about real money.”

I believe this statement is more important than its place in the book and its extent of the discussion in the book implies.

In the laboratory, we are used to large effects. Experiments are often designed such as to generate as large an effect as possible. Even though the lab is the real world with real world incentives and real world decision makers, decisions outside the lab are made in a context that matters, after a series of other different decisions that matter, by more heterogeneous decision makers what matters, too. This is not just additional noise. These factors need to be investigated as well. Yet, this means that an effect in the field of maybe 2% when standard theory would predict none is huge.

Of course, this also has implications for research. Experimental results obtained under “clean” conditions with small samples in the laboratory will not always translate to similar effects outside the laboratory. The small samples imply that statistical significant effects may be over-estimated. The “clean” lab environment may lack moderating factors. Hence, large-scale field studies will become more and more important as the basis for evidence-based policies. We have already begun to see this.

Read: How Markets Work

After a few a little bit more radical, heterodox critiques of current (textbook) economics Prasch’s “How Markets Work” is rather orthodox. It still deviates from the standard introductory textbook treatment of markets in the sense that it does not blindly follow The (competitive) Market is best doctrine that advocates the market institution as the easy solution to many problems – if only the market was unregulated. Yet, the critique focuses rather on the unreflected application of the perfectly competitive commodity market model to goods and services that do not fit into the standard commodity category.

Hence, Prasch discusses the peculiar deviations of specific markets that render the standard textbook toy model inapplicable. He discusses e. g. financial asset markets that are characterized by positive feedback loops instead of negative feedback loops and that are therefore not necessarily self-stabilizing and labor markets that feature non-monotonic supply curves that bend backwards, forwards, and backwards again and may have four different equilibria, two stable and two unstable one, at different levels of wages. He also touches upon the issue of prices, values, and incommensurability. There are contexts in which the orthodox utility framework seems not to apply, where the choice problem cannot easily be represented by a scalar utility model.

Overall, Prasch’s “How Markets Work” is utterly unspectacular, non-revolutionary, orthodox, and just well thought-out. The didactic approach, starting with a discussion of property rights, is impeccable. As an added benefit the book is easily accessible also for the uninitiated and mostly non-technical as even the number of graphs is kept at a minimum. It may be a good supplementary reading for any introductory (micro-) economics course covering the analysis of demand and supply.

Pages