Tim Harford The Undercover Economist
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Undercover Economist

Women (still) don’t win prizes

‘Something about the culture of UK schools is nudging young women away from economics’

It’s no secret that women have long faced an uphill battle both to achieve success and be recognised for that success. The Nobel Prizes tell the story as well as anything: 860 people have been awarded prizes (including the unofficial Nobel Memorial Prize in economics) but only 5 per cent of them were women. The imbalance is worse still in stereotypically male subjects: only six Nobels for physics or chemistry have been awarded to women, fewer than 2 per cent of the total. Marie Curie won two of them; her daughter Irène won another.

Economics is another subject with a masculine reputation. It does not seem to be a happier hunting ground. The economics prize in memory of Alfred Nobel was launched in 1969 but it wasn’t until 2009 that Elinor Ostrom became the only woman so far to win it. “I won’t be the last,” was her characteristically practical comment.

Ostrom won the Nobel in economics despite not being an economist — her application to study for a PhD was turned away by UCLA’s economics department because she didn’t have the maths. “I had been advised as a girl against taking any courses beyond algebra and geometry in high school,” she commented. This particular piece of sexism ultimately worked in her favour: she became a political scientist instead and ended up approaching economic problems from a fresh perspective.

Curie faced a more immediate form of discrimination: in 1903 the Nobel physics committee planned to award the prize to her husband Pierre and to Henri Becquerel, overlooking Marie’s central role in studying radiation. Pierre insisted that his wife should receive the credit that she deserved. Not every husband of a brilliant wife has been quite so enlightened.

The two stories show the range of possibilities for discrimination to occur. Ostrom’s career path was shaped by negative stereotypes more than 60 years before she eventually won her prize; Curie nearly had the prize snatched away at the moment of triumph.

These are old wounds, and we have made a great deal of progress since then. But gender imbalances remain. In the US, the National Science Foundation’s survey of earned doctorates is not a bad place to look for the state of play. In 2012 women earned 46 per cent of all doctorates, up from 32 per cent three decades earlier. No great cause for alarm there. And women heavily outnumber men in social sciences such as psychology, sociology and anthropology.

Yet economics is a different beast: more than two-thirds of economics doctorates are awarded to men. (There is a similar story to tell in physics, chemistry, computing and engineering.) Since nobody under the age of 50 has won the Nobel Prize in economics, one can expect this imbalance in economics PhDs today to ripple through the upper echelons of the profession for many years to come.

There are also hopeful signs. The proportion of economics doctorates earned by women has been growing. The John Bates Clark medal, a prestigious award for economists under the age of 40, was exclusively male until Susan Athey won in 2007, but two other women have won the award since then. That is a sharp shift.

Is the lesson that all we need to do to attract more women to economics is wait? That is doubtful. In the UK, the proportion of undergraduate economists who are women is 27 per cent and falling. This isn’t a problem that will fix itself. So what can be done? The answer to that question depends on where we think the source of the imbalance lies — are we facing Marie Curie’s problem, or Lin Ostrom’s, or something else?

The school environment seems as significant today as it was for Ostrom. A recent study by Mirco Tonin and Jackie Wahba of the University of Southampton examines enrolment in undergraduate economics degrees in the UK. The gender imbalance in successful applicants is much more pronounced among UK applicants than those applying to UK universities from overseas. That suggests that something about the culture of UK schools is nudging young women away from economics.

. . .

That something may well be mathematics. This subject, a vital foundation for economics, is studied by more boys than girls at A-Level. Such a gender gap in advanced high-school mathematics disappeared in the United States 20 years ago.

As for women who already have their PhDs and are looking for careers in academia, the situation in the US is not entirely encouraging. A recent detailed study by a team of economists and psychologists (Stephen Ceci, Donna Ginther, Shulamit Kahn and Wendy Williams) looked at women in US academic sciences and concluded that while “gender discrimination was an important cause of women’s under-representation in scientific academic careers, this claim has continued to be invoked after it has ceased being a valid cause of women’s under-representation”. The playing field, they suggest, is much more level than it once was; a modern Marie Curie wouldn’t need her husband to fight her corner.

But Ceci and colleagues note an exception — one maths-intensive subject at which well-qualified and productive women somehow find it hard to win academic promotions. It’s economics. For some reason, the dismal science remains heavy with the scent of testosterone.

Written for and first published at ft.com.

Undercover Economist

The Christmas card network

‘It is not clear new technologies are expanding our number of genuine friends’

Is the Christmas card obsolete? I suppose the answer depends on what function you think the Christmas card is intended to serve, if any at all. Surely it is no longer intended to convey information. Email and social networks do a more efficient job, and including a Christmas newsletter or family photograph (I do both) will earn you only scorn from any self-respecting British snob.

Some believe that the Christmas card list, where we keep track of old favours and slights, is a sort of passive-aggressive vendetta. There is truth in this. Late in 1974, two sociologists, Phillip Kunz and Michael Woolcott, posted more than 500 Christmas cards to people they did not know. Some of them were “high status” cards, using expensive materials and signed “Dr and Mrs Phillip Kunz”. Others were from “Phillip and Joyce Kunz” or used cheaper stationery or both.

The Kunz family received, along with a complaint from the police, some rather touching replies: “Dear Joyce and Phil, Received your Christmas card and was good to hear from you. I will have to do some explaining to you. Your last name did not register at first . . . Please forgive me for being so stupid for not knowing your last name. We are fine and hope you are well. We miss your father. They were such grand friends.”

But what is most striking is that more than 100 strangers felt obliged to send a signed card in response. That is the power of reciprocity. (Response rates were particularly high if “Dr Kunz” had written on a fancy card to a working-class household. That is the power of status.)

If this is what Christmas cards are all about — mindless reciprocal obligation coupled with some social climbing — then I think we can all agree on two things: we could do without them; and we’ll never be rid of them. Thomas Schelling, a winner of the Nobel Memorial Prize for Economics, once advocated a bankruptcy procedure — wiping clean the list of people to whom we “owe” a Christmas card. If only.

But perhaps the Christmas card also serves other purposes. Consider the exchange, “How do you do?”, “How do you do?” This is phatic communication. It conveys no detailed information but it acknowledges others and implies that there is nothing much to report. “I’m OK, and you’re OK, and lines of communication are open if that changes.”

A Facebook “poke” could achieve the same thing at much lower cost. But perhaps the expense and the hassle is part of the point. If someone invites you for dinner and you say “thank you” as you leave, you may still wish to follow up with a thank-you note to show that you have enough invested in the relationship to take the trouble. If relationships weren’t hard work, they would not be relationships.

There’s a thing called the “social brain” hypothesis: it states that humans evolved large and energy-intensive brains not to do hard sums or design clever tools but because they needed them to navigate the complexities of dealing with other people. Back in 1992, Robin Dunbar — an anthropologist and psychologist now based at the University of Oxford — published a fascinating addendum to that idea. Dunbar had been looking at the social group size and the brain size of different primates, and found that primate species with larger neocortices had grooming relationships with larger social groups. Extrapolating to humans, he produced what has become known as Dunbar’s Number. If our brains are any guide, we’re built to handle a social network of about 150 people.

Dunbar’s Number is both more uncertain and more complex than popular presentations would have you believe. Dunbar himself argues that social networks are nested, following rough powers of three: five people to whom we might turn for substantial emotional or financial support in a moment of true crisis; 15 intimate friends; 50 friends; 150 rather casual friends, and so on.

Social networking tools let us reach more people, more quickly, and in some detail if we so choose. I can reach 90,000 followers on Twitter but — how can I put this tactfully? — they are not my friends. These new technologies are a great convenience but it is not clear that they are allowing us to expand the number of genuine friends that we have. A recent study by Bruno Gonçalves, Nicola Perra and Alessandro Vespignani examined 25 million conversations between Twitter users, and found that the network with whom people might actually have several reciprocal conversations was between 100 and 200 — Dunbar’s number again. As for close friends, women engage in two-way communication with around six people on Facebook; men with just four.

Much like primate grooming, a Christmas card requires effort, time and expense. An up-to-date Christmas list requires some thought about who matters to you, for reasons noble or ignoble. And a few years ago, two researchers carefully examined how big Christmas cards lists tended to be, once allowing for the fact that a single card could reach several members of a household. The researchers were Russell Hill and Robin Dunbar. And the number of people reached by a typical British Christmas card list? 154.

Written for and first published at ft.com.

Undercover Economist

Learn from the losers

Kickended is important. It reminds us that the world is biased in systematic ways

Can there be an easier way to raise some cash than through Kickstarter? The crowdfunding website enjoyed a breakthrough moment in 2012 when the Pebble, an early smartwatch, raised over $10m. But then a few months ago, a mere picnic cooler raised an extraordinary $13m. Admittedly, the Coolest cooler is the Swiss army knife of cool boxes. It has a built-in USB charger, cocktail blender and loudspeakers. The thundering herd of financial backers for this project made it the biggest Kickstarter campaign to date, as well as being a sure sign that end times are upon us.

And who could forget this summer’s Kickstarter appeal from a fellow by the name of Zack “Danger” Brown? Brown turned to Kickstarter for $10 to make some potato salad; and he raised $55,492 in what must be one of history’s most lucrative expressions of hipster irony.

I’m sure I’m not the only person to ponder launching an exciting project on Kickstarter before settling back to count the money. Dean Augustin may have had the same idea back in 2011; he sought $12,000 to produce a documentary about John F Kennedy. Jonathan Reiter’s “BizzFit” looked to raise $35,000 to create an algorithmic matching service for employers and employees. This October, two brothers in Syracuse, New York, launched a Kickstarter campaign in the hope of being paid $400 to film themselves terrifying their neighbours at Halloween. These disparate campaigns have one thing in common: they received not a single penny of support. Not one of these people was able to persuade friends, colleagues or even their parents to kick in so much as a cent.

My inspiration for these tales of Kickstarter failure is Silvio Lorusso, an artist and designer based in Venice. Lorusso’s website, Kickended, searches Kickstarter for all the projects that have received absolutely no funding. (There are plenty: about 10 per cent of Kickstarter projects go nowhere at all, and only 40 per cent raise enough money to hit their funding targets.)

Kickended performs an important service. It reminds us that what we see around us is not representative of the world; it is biased in systematic ways. Normally, when we talk of bias we think of a conscious ideological slant. But many biases are simple and unconscious. I have never read a media report or blog post about a typical, representative Kickstarter campaign – but I heard a lot about the Pebble watch, the Coolest cooler and potato salad. If I didn’t know better, I might form unrealistic expectations about what running a Kickstarter campaign might achieve.

This isn’t just about Kickstarter. Such bias is everywhere. Most of the books people read are bestsellers – but most books are not bestsellers. And most book projects do not become books at all. There’s a similar story to tell about music, films and business ventures in general.

Academic papers are more likely to be published if they find new, interesting and positive results. If an individual researcher retained only the striking data points, we would call it fraud. But when an academic community as a whole retains only the striking results, we call it “publication bias” and we have tremendous difficulty in preventing it. Its impact on our understanding of the truth may be no less serious.

Now let’s think about the fact that the average London bus has only 17 people riding on it. How could that possibly be? Whenever I get on a bus, it’s packed. But consider a bus that runs into London with 68 people at rush hour, then makes three journeys empty. Every single passenger has witnessed a crammed bus, but the average occupancy was 17. Nobody has ever been a passenger on a bus with no passengers but such buses exist. Most people ride the trains when they are full and go to the shops when they are busy. A restaurant may seem popular to its typical customers because it is buzzing when they are there; to the owners and staff, things may look very different.

. . .

In 1943, the American statistician Abraham Wald was asked to advise the US air force on how to reinforce their planes. Only a limited weight of armour plating was feasible, and the proposal on the table was to reinforce the wings, the centre of the fuselage, and the tail. Why? Because bombers were returning from missions riddled with bullet holes in those areas.

Wald explained that this would be a mistake. What the air force had discovered was that when planes were hit in the wings, tail or central fuselage, they made it home. Where, asked Wald, were the planes that had been hit in other areas? They never returned. Wald suggested reinforcing the planes wherever the surviving planes had been unscathed instead.

It’s natural to look at life’s winners – often they become winners in the first place because they’re interesting to look at. That’s why Kickended gives us an important lesson. If we don’t look at life’s losers too, we may end up putting our time, money, attention or even armour plating in entirely the wrong place.

Written for and first published at ft.com.

Marginalia

Economics commentator of the Year

Yesterday I was named Economics Commentator of the Year. That feels jolly grown up, especially given the splendid people on the short-list and the list of previous winners. I’ll enjoy it, though! (A list of other comment award winners is here.)

26th of November, 2014MarginaliaComments off
Undercover Economist

Why a house-price bubble means trouble

A housing boom is the economic equivalent of a tapeworm infection

Buying a house is not just a big deal, it’s the biggest. Marriage and children may bring more happiness – or misery, if you’re unlucky – but few of us will ever sign a bigger cheque than the one that buys that big pile of bricks, mortar and dry rot.

It would be nice to report that buyers and sellers are paragons of rationality, and the housing market itself a well-oiled machine that makes a sterling contribution to the working of the broader economy. None of that is true. House buyers are delusional, the housing market is broken and a housing boom is the economic equivalent of a tapeworm infection.

As a sample of the madness, consider the popular concept of “affordability”. This idea is pushed by the UK’s Financial Conduct Authority and seems simple common sense: affordability asks whether potential buyers have enough income to meet their mortgage repayments. That question is reasonable, of course – but it is only a first step, because it ignores inflation.

To see the problem, contrast today’s low-inflation economies with the high inflation of the 1970s and 1980s. Back then, paying off your mortgage was a sprint: a few years during which prices and wages were increasing in double digits, while you struggled with mortgage rates of 10 per cent and more. After five years of that, inflation had eroded the value of the debt and mortgage repayments shrank dramatically in real terms.

Today, a mortgage is a marathon. Interest rates are low, so repayments seem affordable. Yet with inflation low and wages stagnant, they’ll never become more affordable. Low inflation means that a 30-year mortgage really is a 30-year mortgage rather than five years of hell followed by an extended payment holiday. The previous generation’s rules of thumb no longer apply.

Because you are a sophisticated reader of the Financial Times you have, no doubt, figured all this out for yourself. Most house buyers have not. Nor are they being warned. I checked a couple of the most prominent online “affordability” calculators. Inflation simply wasn’t mentioned, even though in the long run it will affect affordability more than anything else.

This isn’t the only behavioural oddity when it comes to housing markets. Another problem is what psychologists call “loss aversion” – a disproportionate anxiety about losing money relative to an arbitrary baseline. I’ve written before about a study of the Boston housing crash two decades ago, conducted by David Genesove and Christopher Mayer. They found that people who bought early and saw prices rise and then fall were realistic in the price they demanded when selling up. People who had bought late and risked losing money tended to make aggressive price demands and failed to find buyers. Rather than feeling they had lost the game, they preferred not to play at all.

The housing market also interacts with the wider economy in strange ways. A study by Indraneel Chakraborty, Itay Goldstein and Andrew MacKinlay concludes that booming housing markets attract bankers like jam attracts flies, sucking money away from commercial and industrial loans. Why back a company when you can lend somebody half a million to buy a house that is rapidly appreciating in value? Housing booms therefore mean less investment by companies.

. . .

House prices have even driven the most famous economic finding of recent years: Thomas Piketty’s conclusion (in joint work with Gabriel Zucman) that “capital is back” in developed economies. Piketty and Zucman have found that relative to income, the total value of capital such as farmland, factories, office buildings and housing is returning to the dizzy levels of the late 19th century.

But as Piketty and Zucman point out, this trend is almost entirely thanks to a boom in the price of houses. Much depends, then, on whether the boom in house prices is a sentiment-driven bubble or reflects some real shift in value. One way to shed light on this question is to ask whether rents in developed countries have boomed in the same way as prices. They haven’t: research by Etienne Wasmer and three of his colleagues at Sciences Po shows that if we measure the value of houses using rents, there’s no boom in the capital stock.

The housing market then, is prone to bubbles and bouts of greed and denial, is shaped by financial rules of thumb that no longer apply, and sucks the life out of the economy. It even muddies the waters of the great economic debate of our time, about the economic significance of capital.

One final question, then: is it all a bubble? That is too deep a question for me but there is an intriguing new study by three German economists, Katharina Knoll, Moritz Schularick and Thomas Steger. They have constructed house-price indices over 14 developed economies since 1870. The pattern is striking: about 50 years ago, real prices started to climb inexorably and at an increasing rate. If this is a bubble, it’s been inflating for two generations.

At least dinner-party guests across London will continue to have something to bore each other about. Not that anybody will be able to afford a dining room.

Written for and first published at ft.com.

Undercover Economist

Finance and the jelly bean problem

‘What else might influence portfolio returns? There is literally no limit to the number of variables’

Discomfiting news: most of those financial strategies that claim to beat the market don’t. Even more surprising, many of the financial research papers that claim to have found patterns in financial markets haven’t.

Don’t take my word for it: this is the conclusion of three US-based academics, Campbell Harvey, Yan Liu and Heqing Zhu. What is particularly striking about the way they’ve lobbed a hand grenade into the finance research literature is that Campbell Harvey isn’t some heterodox radical. He’s the former editor of the leading journal in the field, The Journal of Finance.

What’s going on?

Much financial research attempts to figure out what explains the investment returns on financial portfolios. At a first pass, returns follow a random-walk hypothesis. This insight is a century old and we owe it to the mathematician Louis Bachelier. The basic reasoning is that any successful forecast of price movements would be self-defeating: if it was obvious the price would rise tomorrow, then the price would instead rise today. Therefore, there can be no successful forecast of price movements.

A second pass at the problem, courtesy of several researchers in the 1960s, gives us the capital asset pricing model: riskier portfolios will probably offer higher returns. And it seems that they do.

Then, in 1992, Eugene Fama (more recently a Nobel Memorial Prize winner) and Kenneth French found that the returns on a portfolio of shares were explained by three factors: exposure to the market as a whole, exposure to small company stocks, and exposure to “value stocks”.

This is progress of sorts – but it’s also a can of worms. What else might influence portfolio returns? There is literally no limit to the number of different variables that could be examined, because variables can always be transformed or combined with each other, for instance as ratios or rates of change.

In principle, economic logic might limit the number of combinations to be examined – but in practice both academics and quantitatively minded investment managers have been known to throw in all sorts of possibilities just to see what happens. Why not, for example, use the cube of the market capitalisation of the shares? There’s no economic logic behind that variable – at least, none that I can see – but that hasn’t stopped the quants stirring such things into the mix.

The issue here is what we might call the “jelly bean problem”, after a cartoon by nerd hero Randall Munroe. The cartoon shows scientists testing whether jelly beans cause acne, applying a commonly used statistical test. The test is to assume that jelly beans don’t cause acne, then rethink that assumption if the observed correlation between jelly beans and acne has less than a 5 per cent probability of occurring by chance. The scientists test purple, brown, pink, blue, teal, salmon, red, turquoise, magenta, yellow, grey, tan, cyan, green, mauve, beige, lilac, black, peach and orange jelly beans. It turns out that the green ones are correlated with acne!

This is, of course, no way to perform a statistical analysis. If 20 statistical patterns are analysed and there’s no genuine causal relationship in any of them, we’d still expect one of them to look strikingly correlated. (How strikingly? Well, about 19-1 against.)

The finance literature has looked at far more than 20 possibilities. Harvey, Liu and Zhu scrutinise 316 different factors that have been explored by a selection of reputable research studies, of which 296 are statistically significant by conventional standards. That’s just a subset of the factors that have been examined in minor journals, or not published at all because the results were too boring.

For example, a paper might try to explain stock market returns as a function of media coverage of companies; of corporate debt; of momentum in previous returns; or of the volume of trades.

With 316 factors – and probably many more – under investigation, using a 5 per cent significance standard is absurd. Harvey and his colleagues suggest that after trying to correct for the jelly bean problem (more technically known as the multiple-comparisons problem), more than half the 296 statistically significant variables might have to be discarded. They suggest higher and more discerning statistical hurdles in future, not to mention a more explicit role for variables with some theory behind them, rather than variables that have happened to stick after the entire statistical fruit salad has been hurled at the wall.

None of this should astonish us. In 2005 an epidemiologist called John Ioannidis published a research paper that has become famous. It has the self-explanatory title “Why Most Published Research Findings Are False”. The reason is partly the multiple comparisons problem, and partly publication bias: a tendency on the part of researchers and journal editors alike to publish surprising findings and leave dull ones to languish in desk drawers.

Harvey and his colleagues have shown that the Ioannidis critique applies in the finance research literature too. No doubt it applies far more strongly in the advertisements we’re shown for financial products. We should have always been on the lookout for intriguing patterns in the data. But if we’re not careful, our analysis will produce plenty of flukes. And in finance, flukes are just as marketable as the truth.

Written for and first published at ft.com.

Undercover Economist

A passport to privilege

Class matters far less than it used to in the 19th century. Citizenship matters far more

I’ve been a lucky boy. I could start with the “boy” fact. We men enjoy all sorts of privileges, many of them quite subtle these days, but well worth having. I’m white. I’m an Oxford graduate and I am the son of Oxbridge graduates. All those are things that I have in common with my fellow columnist Simon Kuper, who recently admitted that he didn’t feel he’d earned his vantage point “on the lower slopes of the establishment”.

I don’t feel able to comment objectively on that, although we could ask another colleague, Gillian Tett. She’s female and – in a particularly cruel twist – she wasn’t educated at Oxford but at Cambridge. That’s real diversity right there.

All these accidents of birth are important. But there’s a more important one: citizenship. Gillian, Simon and I are all British citizens. Financially speaking, this is a greater privilege than all the others combined.

Imagine lining up everyone in the world from the poorest to the richest, each standing beside a pile of money that represents his or her annual income. The world is a very unequal place: those in the top 1 per cent have vastly more than those in the bottom 1 per cent – you need about $35,000 after taxes to make that cut-off and be one of the 70 million richest people in the world. If that seems low, it’s $140,000 after taxes for a family of four – and it is also about 100 times more than the world’s poorest people have.

What determines who is at the richer end of that curve is, mostly, living in a rich country. Branko Milanovic, a visiting presidential professor at City University New York and author of The Haves and the Have-Nots, calculates that about 80 per cent of global inequality is the result of inequality between rich nations and poor nations. Only 20 per cent is the result of inequality between rich and poor within nations. The Oxford thing matters, of course. But what matters much more is that I was born in England rather than Bangladesh or Uganda. (Just to complicate matters, Simon Kuper was born in Uganda. He may refer to himself as “default man” but his life defies easy categorisation.)

That might seem obvious but it’s often ignored in the conversations we have about inequality. And things used to be very different. In 1820, the UK had about three times the per capita income of countries such as China and India, and perhaps four times that of the poorest countries. The gap between rich countries and the rest has since grown. Today the US has about five times the per capita income of China, 10 times that of India and 50 times that of the poorest countries. (These gaps could be made to look even bigger by not adjusting for lower prices in China and India.) Being a citizen of the US, the EU or Japan is an extraordinary economic privilege, one of a dramatically different scale than in the 19th century.

Privilege back then used to be far more about class than nationality. Consider the early 19th century world of Jane Austen’s Pride and Prejudice. Elizabeth Bennet’s financial future depends totally on her social position and, therefore, if and whom she marries. Elizabeth’s family’s income is £430 per capita. She can increase that more than tenfold by marrying Mr Darcy and snagging half of his £10,000 a year (this income, by the way, put Mr Darcy in the top 0.1 per cent of earners). But if her father dies before she marries, Elizabeth may end up with £40 a year, still twice the average income in England.

Milanovic shows that when we swap in data from 2004, all the gaps shrink dramatically. Mr Darcy’s income as one of the 0.1 per cent is £400,000; Elizabeth Bennet’s fallback is £23,000 a year. Marriage in the early 19th century would have increased her income more than 100 times; in the early 21st century, the ratio has shrunk to 17 times.

This is a curious state of affairs. Class matters far less than it used to in the 19th century. Citizenship matters far more. Yet when we worry about inequality, it’s not citizenship that obsesses us. Thomas Piketty’s famous book, Capital in the 21st Century, consciously echoes Karl Marx. Click over to the “Top Incomes Database”, a wonderful resource produced by Piketty, Tony Atkinson and others, and you’ll need to specify which country you’d like to analyse. The entire project accepts the nation state as the unit of analysis.

Meanwhile, many people want to limit migration – the single easiest way for poor people to improve their life chances – and view growth in India and China not as dramatic progress in reducing both poverty and global inequality, but as a sinister development.

It would be unfair to say that Simon Kuper and Thomas Piketty have missed the point. Domestic inequality does matter. It matters because we have political institutions capable of addressing it. It matters because it’s obvious from day to day. And it matters because over the past few decades domestic inequality has started to grow again, just as global inequality has started to shrink.

But as I check off my list of privileges, I won’t forget the biggest of them all: my passport.

Also published at ft.com.

Undercover Economist

Trading places – with a rat

Financial price data are converted into music, the music is played to a rat, then the rat guesses whether the price will fall or rise

Eighty-five years ago, a young psychologist called BF Skinner developed what is technically called an operant conditioning chamber but is more famously known as a Skinner box, designed to contain and train laboratory animals. The simplest version rewards a rat for pressing a lever. More complex devices can play sounds, display lights and even deliver electric shocks, although Skinner himself preferred to use rewards rather than punishments.

The Skinner box acquired an unpleasant reputation: rumours circulated that Skinner raised one of his own daughters in one, that she lost her mind, that she sued him and that she killed herself before reaching middle age. None of this is true. One explanation for the rumours is that Skinner did design an air-conditioned crib for his daughter and described it with fancy technical terms such as “apparatus”. But perhaps the false ideas circulated because Skinner’s ideas of modifying behaviour with rewards in a carefully controlled environment seemed somehow manipulative and threatening. These days, of course, we call behaviour modification “nudging” and it is perfectly respectable.

I thought of all this when I discovered RatTraders.com, a website offering, in its own words, “a professional service to the financial industry; rats are being trained to become superior traders in the financial markets.”

RatTraders displays photographs and short films of rats in Skinner boxes. As the website explains, “RATTRADERS rats can be trained exclusively for any financial market segment. They outperform most human traders and represent a much more economic solution for your trading desk.”

The brains behind the project is Michael Marcovici, who has a double life: he’s both a conceptual artist and an offbeat investment guru. So is RatTraders a work of art or a business proposition? The basic conceit is that financial price data are converted into 20 seconds of piano music, the music is played to a rat, and then the rat guesses whether to bet that the price will then fall or rise. If the rat is successful, it receives food; if not, a mild shock. After weeks of training, the site says, the best rats outperform most humans.
Rat graph illustration by Harry Haysom for Undercover Economist©Harry Haysom

In an online video, Marcovici deadpans to a “reporter” that “rats are much better at this because you can train a rat on a very specific thing. It will not be distracted.” The interviewer asks how much it would cost to buy one of these elite rats. “It’s hard to put a price tag on a rat. A rat will not help. Rat trading is a system,” responds Marcovici. But he adds that even the full service would be “just a fragment of what a human trader will cost”.

Just when the viewer’s credibility is strained to breaking point, Marcovici announces that investment banks have already installed trading floors full of rats in boxes. His ultimate business vision, he says, is that rats will also be trained to do marketing and general management. The comic timing is impressive. And it’s a piece of art with a message that does not need underlining.

Marcovici says that all this began as a joke. But after he had bought some rats and built a rather beautiful Skinner box, his girlfriend urged him not to get rid of the rats but to see if they actually could learn to trade gold, oil and foreign exchange. Most of them couldn’t but after five months a few of the rats were pretty good – better than tossing a coin, anyway, which is a tougher benchmark than you might think.

So should we start employing rats as traders? The idea is not totally absurd. Ben Vermaercke of the University of Leuven recently published a paper with four colleagues titled “More complex brains are not always better”. They showed that rats were better than humans at distinguishing certain kinds of striped patterns from others – the humans, it was hypothesised, were thinking too hard rather than relying on instinctive pattern recognition.

Perhaps a properly controlled scientific experiment would also find that rats make excellent foreign exchange traders. I doubt it. If rats really can make money after being played a sonified snippet of recent price history, that suggests a basic inefficiency in financial markets. If price movements were predictable in such an elementary way then profit-seeking traders, human or murine, should exploit the pattern and thereby change it. (If there are patterns in market prices, they are not simple.)

RatTraders is five years old but the project has recently enjoyed a fresh burst of media attention. Marcovici tells me that several small hedge funds promptly got in touch with him to find out more. Did he really expect serious interest in financially savvy rats?

“Yes, yes. Honestly I did,” he says. “I’ve been involved with the financial industry for some time and people try anything.”

Fair enough. Greed is a powerful motivator for humans and rats alike. But it is not always a great investment strategy. Some people wanted to believe the worst about BF Skinner. If there seems to be money to be made, others will gladly believe the best about trader rats.

Also published at ft.com.

Undercover Economist

Why are recessions so depressing?

Happiness is around six times more sensitive to economic growth when that ‘growth’ is negative

Have we missed the true cost of the Great Recession of 2008 and 2009? That seems a strange question: the financial crisis, the deep recession that followed and slow growth for many years after seem like the defining economic events of a generation – and it’s not as if we’ve been ignoring them.

But perhaps we haven’t taken the recession nearly seriously enough. That’s the conclusion of Jan-Emmanuel De Neve, an economist at University College London and the London School of Economics. De Neve says that the “untold story” of the recession is its psychological cost. In plain language: recessions make us very sad.

It might seem obvious that recessions are disheartening experiences. It’s not, for the simple reason that the link between economic growth and happiness is itself not obvious.

The opening salvo in a long intellectual battle was fired by Richard Easterlin, an economist who, back in 1974, found that richer people in any society tended to be more satisfied with their lives, and yet richer societies showed no tendency to be happier than poorer ones. Thus was born the “Easterlin paradox”: money buys happiness within a society but money does not make society as a whole happier.

There are several ways of accounting for this finding. One is to say that it’s wrong: that data on life satisfaction weren’t very good in 1974 and now we know better. Recent research by Betsey Stevenson and Justin Wolfers finds that there is no paradox: richer societies are indeed happier. A second response is that it all depends on what you mean by “happiness”. Angus Deaton, an economist, and Daniel Kahneman, a psychologist who won the Nobel memorial prize in economics, have found that income is better at buying some forms of happiness than others. People in rich societies say they are more satisfied with their lives but that does not mean that from day to day they will be in a better mood. A third explanation, favoured by many Easterlin fans, is to say that what Easterlin showed is that we live in a rat race: what makes us happy isn’t money but feeling richer than our neighbours. It’s a race not everyone can win.

This is the backdrop against which De Neve and five of his colleagues began to investigate the impact of recessions on our wellbeing. When you look at surveys of life satisfaction, people in rich countries typically rate their satisfaction at 6.5 or 7 out of 10. The answers are stable, barely changing as economies grow. One might expect that the impact of a recession – of the economy shrinking – would be similarly hard to detect in surveys of life satisfaction.

But a couple of years ago, De Neve was sitting in the Brussels office of Gallup, the polling company, reviewing the latest data on life satisfaction with colleagues. Something strange had happened: Greece and Portugal had disappeared.

On closer inspection it turned out the researchers couldn’t find Greece and Portugal on a graph because they had dropped out of a cluster of EU countries and were suddenly reporting life satisfaction of around 5 or 5.5, on a par with Afghanistan. Greece and Portugal had both suffered severe contractions but not so severe as to put their incomes anywhere near that of Afghanistan. So what had happened?

De Neve and his colleagues believe that the impact of economic growth on happiness is highly lopsided. Their statistical analysis is based on several large international data sets surveying life satisfaction, and finds that happiness is around six times more sensitive to economic growth when that “growth” is negative. If you have six years in which the economy grows a couple of per cent a year, followed by one year when the economy shrinks by 2 per cent, the economy itself will have made substantial progress but the wellbeing of citizens will not.

This is just one research paper but it chimes with a 2003 study by Wolfers, another expert in the economics of happiness. Wolfers found when macroeconomic indicators such as inflation or unemployment were volatile, that volatility was associated with lower life satisfaction.

What might explain the disproportionate impact of recessions on happiness? There’s a longstanding finding in psychology that losses are more keenly felt than gains so maybe that’s the answer.

Yet loss aversion is not the only explanation for why recessions seem to depress us. Another is that recessions are associated with an increase in uncertainty. Uncertainty is unsettling in its own right – and it is also attention-grabbing. When the economy is growing, we take that for granted. A recession, with lay-offs, bailouts, bankruptcies and emergency budgets, is far more noticeable.

Perhaps the connection between the economy and wellbeing is simple: when the economy is doing something that we notice, it affects how we feel – and recessions have a habit of calling themselves to our attention. This suggests a new happiness paradox. Even though we may have underestimated the psychological costs of the recession, those costs would be less if only we’d stop talking about it.

Also published at ft.com.

Other Writing

Why pilot schemes help ideas take flight

There’s huge value in experiments that help us decide whether to go big or go home

Here’s a little puzzle. You’re offered the chance to participate in two high-risk business ventures. Each costs £11,000. Each will be worth £1m if all goes well. Each has just a 1 per cent chance of success. The mystery is that the ventures have very different expected pay-offs.

One of these opportunities is a poor investment: it costs £11,000 to get an expected payout of £10,000, which is 1 per cent of a million. Unless you take enormous pleasure in gambling, the venture makes no sense.

Strangely, the other opportunity, while still risky, is an excellent bet. With the same cost and the same chance of success, how could that be?

Here’s the subtle difference. This attractive alternative project has two stages. The first is a pilot, costing £1,000. The pilot has a 90 per cent chance of failing, which would end the whole project. If the pilot succeeds, scaling up will cost a further £10,000, and there will be a 10 per cent chance of a million-pound payday.

This two-stage structure changes everything. While the total cost is still £11,000 and the chance of success is still 1 per cent, the option to get out after a failed pilot is invaluable. Nine times out of 10, the pilot will save you from wasting £10,000 – which means that while the simple project offers an expected loss of £1,000, the two-stage project has an expected profit of £8,000.

In a real project, nobody could ever be sure about the probability of success or its rewards. But the idea behind this example is very real: there’s huge value in experiments that help us decide whether to go big or go home.

We can see this effect in data from the venture capital industry. One study looked at companies backed by US venture capitalists (VCs) between 1986 and 1997, comparing them with a sample of companies chosen randomly to be the same age, size and from the same industry. (These results were published in this summer’s Journal of Economic Perspectives in an article titled “Entrepreneurship as Experimentation”.)

By 2007, only a quarter of the VC-backed firms had survived, while one-third of the comparison group was still in business. However, the surviving VC-backed firms were big successes, employing more than five times as many people as the surviving comparison firms. We can’t tell from this data whether the VCs are creating winners or merely spotting them in advance but we can see that big successes on an aggregate scale are entwined with a very high failure rate.

The option to conduct a cheap test run can be very valuable. It’s easy to lose sight of quite how valuable. Aza Raskin, who was lead designer for the Firefox browser, cites the late Paul MacCready as his inspiration on this point. MacCready was one of the great aeronautical engineers, and his most famous achievement was to build the Gossamer Condor and the Gossamer Albatross, human-powered planes that tore up the record books in the late 1970s.

One of MacCready’s key ideas was to develop a plane that could swiftly be rebuilt after a crash. Each test flight revealed fresh information, MacCready figured, but human-powered planes are so feather-light that each test flight also damages the plane. The most important thing a designer could do was to build a plane that could be rebuilt within days or even hours after a crash – rather than weeks or months. Once the problem of fast, cheap experimentation was solved, everything else followed.

Some professions have internalised this lesson. Architects use scale models to shed light on how a completed building might look and feel. A nicely made model can take days of work to complete but that is not much compared with the cost of the building itself.

Politicians don’t find it so easy. A new policy is hardly a new policy at all unless it can be unveiled in a blaze of glory, preferably as a well-timed surprise. That hardly suits the MacCready approach. Imagine the conference speech: “We’re announcing a new array of quick-and-dirty experiments with the welfare state. We’ll be iterating rapidly after each new blunder and heart-rending tabloid anecdote.”

A subtler problem is that projects need a certain scale before powerful decision makers will take them seriously.

“The transaction costs involved in setting up any aid project are so great that most donors don’t want to consider a project spending less than £20m,” says Owen Barder, director for Europe at the Center for Global Development, a think-tank. I suspect that the same insight applies far beyond the aid industry. Governments and large corporations can find it’s such a hassle to get anything up and running that the big stakeholders don’t want to be bothered with anything small.

That is a shame. The real leverage of a pilot scheme is that although it is cheap, it could have much larger consequences. The experiment itself may seem too small to bother with; the lesson it teaches is not.

Also published at ft.com.

21st of October, 2014Other WritingComments off
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Tim Harford is an author, columnist for the Financial Times and presenter of Radio 4's "More or Less".
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