Tim Harford The Undercover Economist

Articles published in November, 2017

Disruption can be a benefit – shame our politicians are giving us the wrong sort

“We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping,” said Richard Thaler recently. He is not alone in expressing such views, although since he had just won the Nobel memorial prize in economics, his comment understandably drew attention.

Money is loose and global economic growth is robust, yet the strength and the stability of the S&P 500 is still puzzling. This week it was the 30th anniversary of Black Monday, the largest-ever one-day crash in US stock prices, and it is eerily quiet.

One explanation of the puzzle is that markets have finally got smart: when behavioural economists turned their attention to financial markets in the 1980s, two key findings were that shares were implausibly volatile and implausibly cheap. They are now much less volatile and much less cheap; perhaps that is simply a long-awaited recognition of the way things should be. Perhaps.

An alternative view is that, while 2017 seems risky, it really isn’t. This is hard to believe. Among the obvious political risks: Donald Trump’s attempts to undermine both the North American Free Trade Agreement and the Iran nuclear deal; the rise of the far right in Germany and Austria, with Marine Le Pen waiting for President Emmanuel Macron to stumble in France; serious unrest in Spain over the Catalan independence movement; a Brexit process that seems as unclear as ever; and of course, the small-yet-conceivable chance of a nuclear war on the Korean peninsula. This is no time to panic, but it hardly seems a time for euphoria either.

There is never a good moment to create uncertainty over the prospects of a nuclear first strike. As the great Thomas Schelling once explained: “If I go downstairs to investigate a noise at night, with a gun in my hand, and find myself face to face with a burglar who has a gun in his hand, there is a danger of an outcome that neither of us desires. Even if he prefers to just leave quietly, and I wish him to, there is danger.” The danger results from mutual uncertainty over what the other person may do.

Other threats are less apocalyptic, but still have the potential to cause serious economic harm. Those who think Brexit will boost the British economy — I am not among them — have begun to acknowledge that the uncertainty is damaging. Business can no longer afford to wait for the British government to finish negotiations with itself and begin serious negotiations with the EU27.

Similar damage is likely to be done by Donald Trump’s attacks on Nafta. As the economist Nuno Limão has shown, unpredictable trade policy is itself a form of trade barrier.

And yet, despite all these political risks, the world economy might benefit from a little more disruption. Whether a more volatile stock market might usefully puncture complacency, in the real economy volatility can be an asset. We should expect old companies to fade and die, being absorbed or replaced by fresh ideas: that corporate failure is the flip side of economic vitality.

For example, a study by Kathy Fogel, Randall Morck and Bernard Yeung — published in 2008 — compiled lists of the 10 largest employers in each of 44 countries across the world. More churn in the list was a sign of a strongly growing economy, and a predictor of fast growth to come, too. The results were being driven by the extinction of corporate dinosaurs more than the rapid ascent of new stars.

The upbeat word to describe this process of success through failure is dynamism. But economic dynamism is at risk. The economist John Haltiwanger has charted a fall since the early 1980s in the rate of start-ups, business exits, job creation and job destruction. It is probably not a coincidence that low-productivity companies are able to limp on rather than disappearing.

Calm waters eventually stagnate. It is time to agitate the real economy. But how? Even acts of economic vandalism such as a train-crash Brexit can have unexpected benefits, much as Tube strikes have been shown to help some commuters discover better routes. Yet overall the costs of chaos seem likely to outweigh the benefits.

There are more positive ways to shake things up: looser planning regulations in the sclerotic UK economy, more infrastructure in much of the western world, and support for small-business finance, would all add much needed fizz to the economic system.

And the authorities could be much more assertive in challenging market power. According to the economist Luigi Zingales, federal antitrust cases in the US were five times more common between 1970 and 1999 than since the year 2000. In a world of high profits and high concentration, that passivity is hard to excuse.

I have little doubt that financial markets will rediscover the knack of panicking in due course, but the real economy may need more help. If only our politicians would stop shaking the nitro-glycerine of geopolitics, and start stirring the cocktail of market forces instead.

Written for and first published in the Financial Times on 20 October 2017.

My new book is “Fifty Inventions That Shaped The Modern Economy”. Grab yourself a copy in the US or in the UK (slightly different title) or through your local bookshop.

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Richard Thaler: How to change minds and influence people

The best thing about Thaler, what really makes him special, is that he is lazy.” So said Daniel Kahneman, winner in 2002 of the Nobel memorial prize in economics. Prof Kahneman was talking about Richard Thaler, who has emulated that achievement 15 years later. Prof Thaler’s thesis adviser, the economist Sherwin Rosen, put it differently: “We didn’t expect much of him.”

The story of how a lazy and unpromising man won a Nobel memorial prize is perhaps just as important as what he won the prize for. The Nobel announcement recognised Prof Thaler “for his contributions to behavioural economics”. But there’s another way to describe the way he reshaped economics: he persuaded a large group of successful people with a strongly held view of the world to change their minds.

What was that view? To oversimplify, it was that all of us are Spock-like rational optimisers, able to instantly trade off risk and reward, rebalance a spending plan in the face of a price change, and resist temptations such as chocolate brownies or payday loans.

Of course, no economist has ever quite believed this. But for several decades most economists believed that departures from the world of Spock were small enough, rare enough and random enough that they could be ignored. Humans weren’t quite like Spock, yet when building economic models and formulating economic policies, we could treat them as if they were.

This approach is not as absurd as it might seem. It’s flexible, powerful, and consistent. It is often close enough to reality to be useful. Prof Thaler himself told me: “If you want one unifying theory of economic behaviour, you won’t do better than the neoclassical model.”

Yet the power of the neoclassical approach made it hard to challenge. Prof Thaler wasn’t the first Nobel laureate to operate outside that paradigm — others include Maurice Allais, Herb Simon and Thomas Schelling. Yet all these men, while admired, did not manage to divert the mainstream of economic thought beyond the well-worn channel of rational optimisation. It was Prof Thaler who shifted the norms of how economics is practised, both in academia and in the policy world.

Behavioural economics is now respectable in places from the American Economic Review to the World Bank. Whether or not you think behavioural economics matters, as a feat of persuading people to change their minds this is a case worth studying. So how did he do it? We could all do with knowing, because the world is full of stubborn-minded people who need to be persuaded to change their views about important things.

Part of the story is simple persistence: Prof Thaler’s first behavioural economics paper was published in 1980; he has been banging this drum for a long time. More important was that Prof Thaler fully understood what he was criticising. It is all too easy to attack those with whom we disagree based on the haziest idea of what they think and why they think it. But he grasped perfectly why his fellow economists embraced rationality, and the arguments (good and bad) they used to defend it. Prof Thaler engaged honestly and thoughtfully with the mainstream.

His third technique was to look at the facts — not only clever statistics, but everyday facts about human existence. We find snack food hard to resist. We divide up money into separate mental accounts — rainy-day money, an entertainment budget, money for food, money for clothes. If we find a fine old bottle of port in the attic, we might refuse to sell it for hundreds of pounds, even though we would not dream of spending a three figure sum on a bottle of anything. Having secured agreement on these facts, he then moved to arguing that they might matter.

Finally, Prof Thaler engaged people’s sense of curiosity. His long running series “Anomalies”, published in the widely-read scholarly Journal of Economic Perspectives, would often begin with a puzzle — some piece of behaviour or pattern in the data that simply didn’t make sense from the mainstream point of view. He would then explore the puzzle, extend it, and consider various possible solutions.

Economists would talk about these anomalies in faculty coffee rooms. They would, at Prof Thaler’s invitation, send in their own suggestions. Rather than telling his opponents they were wrong, Prof Thaler would present a conundrum and invite everyone to discuss it together. One of his critics, the great Chicago economist Merton Miller, was reduced to complaining that Prof Thaler’s anomalies were a distraction from serious modelling because they were simply too interesting.

Which brings us back to his laziness. Prof Kahneman thought Prof Thaler’s laziness made him “special” because it meant that he could only be bothered to work on the most fascinating questions. Maybe.

But perhaps the truth is that laziness isn’t special at all. Prof Thaler realised that most of us are lazy. Most of us don’t want to think hard about our beliefs, or challenges to them. His solution was to make sure those challenges were simply too intriguing to ignore.

Written for and first published in the Financial Times on 13 Oct 2017.

My new book is “Fifty Inventions That Shaped The Modern Economy”. Grab yourself a copy in the US or in the UK (slightly different title) or through your local bookshop.

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Some podcasts you should hear

Forgive me not linking, because different people will access their podcasts in different ways, but here are a few feeds I suggest you check out:

Radio 4’s Seriously feed contains two documentaries a week, with a marvellous range of techniques. The US storytelling style is wonderful, but there’s more variety in the Seriously stable, and while it sometimes misfires or is ponderous, when it works it’s glorious. Three recent episodes worth checking out: The Edge of Life (about suicide and suicide prevention), Who’s Looking At You (quite brilliant about the effects of universal surveillance) and The Trainspotter’s Guide To Dracula, featuring Miles Jupp.

99% Invisible needs no plug from me but they’re awesome. An ear-catching recent episode discussed the universal basic income not as a piece of economic policy but as a design decision – and 99PI has got me exploring all kind of interesting topics, from barbed wire to Frank Lloyd Wright’s affordable homes.

Jon Ronson’s The Butterfly Effect is clever, curious and surprisingly moving. Series One is about the porn industry, but Ronson talks to all kinds of people and takes the story in a variety of unexpected directions. Bravo.

Just catching on is the After On podcast; free-flowing extended chats with fascinating people such as Ev Williams of Twitter, Blogger and Medium, or Chris Anderson of TED. Well worth a listen.

And finally, Radio 4’s Analysis is back and I particularly enjoyed the episode on the way the Houses of Parliament are falling apart. No, it’s not a metaphor. Except it is obviously partly a metaphor…

And finally finally, Jessica Abel’s book Out On The Wire (UK) (US) spills the beans about how great radio and podcasts are made.

Oh, and finally finally finally, you should of course listen to every episode ever made of Fifty Things That Made The Modern Economyall 52 of them. Details about the book here.

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9th of November, 2017MarginaliaComments off

Review of “The Square and The Tower” by Niall Ferguson

“The world remains a world of squares and towers,” concludes Niall Ferguson, after skipping across 500 years in about as many pages. The square — the town square, the market square — represents social networks, “the structures that human beings naturally form”. The tower represents hierarchical control and secular authority, the top-down approach to social structure.

The study of how networks compete or co-operate with each other and with hierarchies is a hot topic in the social sciences, and it is easy to see why: think of the US military versus Isis; or Russian intelligence trying to exploit the US media; or Facebook and, well, almost anything.

Yet both networks and hierarchies have been around for a long time, as Ferguson is quick to remind us in The Square and the Tower (UK) (US). Networks flourished in the years 1450 to 1790, he writes; hierarchies reasserted themselves until around 1970, and networks have been making a comeback ever since. The book is a history told with the focus on the way networks and hierarchies shaped events.

This approach is engaging but not always helpful. It is unclear that we gain much by describing Pizarro’s conquistadors and their allies as a network opposing Atahualpa’s hierarchical Inca society.

When it does work, however, it works well. German National Socialism is described as a network that then transformed itself into a crushingly powerful hierarchy. Faced with the power of the German state, the network of Jewish business interests that had loomed so large in the Nazi imagination proved helpless. “After all that had been written about the web of Jewish power,” he writes, “the only networks that really mattered were the ones that enabled emigration, and those were often simple family ties.” The analysis is illuminating, chilling and still relevant today.

While National Socialism was a network that infected a hierarchy, the Soviet infiltration of the British old boys’ club between the 1930s and the 1960s shows that hierarchies can infect networks, too.

No book written by a historian of Ferguson’s gifts is likely to disappoint, but The Square and the Tower does have one obvious weakness: it’s not at all clear that the author takes his own premise seriously. That premise, set out in the first 50 pages of the book, is that by adding the formal social science of networks to the informal descriptive practice of history, we can unlock new insights.

This union of history and social science is an exciting prospect with Ferguson in charge. But the early chapters in which he outlines the science and social science of networks are dutiful literature reviews; though he nods to network scholars such as Ronald Burt, Mark Granovetter and Duncan Watts, those names do not resurface later in the book. Ferguson cites an impressive range of social science research papers; he does not always trouble to explain technical terms as a skilled science writer might. One is left with the impression that he is happy to list every tool in the toolkit but doesn’t actually want to pick up a spanner himself.

The impression is reinforced by the way the author uses diagrams. Network diagrams always look good, whether it’s diagram 22, showing the interconnected nodes of the Bloomsbury Group (“it was . . . sexual relationships that defined the network”, we are told) or, over the page, diagram 23 depicting the evolving connections between the great powers in the late 19th century. These diagrams have been reproduced from other sources, but without sufficient labelling. Those lines mean something yet we can only guess what, unless we consult the original sources directly. The network diagrams, like the network research described early on in the book, appear to be largely decorative. That is a missed opportunity.

Yet that same flip of the page takes us from Virginia Woolf and John Maynard Keynes to a theory of the causes of the first world war outlined by none other than Henry Kissinger. There’s a joy in such leaps — from industrial networks in pre-Victorian Britain to the Taiping Rebellion, from Kissinger’s use of networked influence to how the World Economic Forum reshaped Nelson Mandela’s policy of nationalisation.

“By choice, I am more of a networks guy”, Ferguson tells us early on, and he is convincing in his claim that networks have been playing an important role for centuries. Yet at the end of his freewheeling history, he yearns for someone to take charge: “The lesson of history is that trusting in networks to run the world is a recipe for anarchy.” At best, the Illuminati take control; more likely, the Jacobins.

 

Written for and first published in the Financial Times on 11 October 2017.

My new book is “Fifty Inventions That Shaped The Modern Economy”. Grab yourself a copy in the US or in the UK (slightly different title) or through your local bookshop.

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8th of November, 2017Other WritingComments off

Monty Hall and the game show stick-or-switch conundrum

Forget Fermat’s last theorem. The most vexing challenge in mathematics just might be the Monty Hall problem. Monty Hall — born Monte Halparin — presented nearly 5,000 episodes of Let’s Make a Deal, the US game show that inspired the puzzle.

It is an onion of a conundrum; layer after layer, and guaranteed to make you cry. The puzzle is this: a contestant faces three doors. Behind one of them is a big prize such as a Cadillac. Each of the other two doors conceals a booby prize such as a goat.

The contestant chooses a door, hoping to win the grand prize. But just as the door is about to be opened, Hall steps in and halts proceedings. He opens one of the other two doors instead, revealing a goat. Then he turns to the contestant. Would they like to switch to the other closed door? Or would they prefer to stick with their original choice?

The problem was initially posed in The American Statistician in 1975, by Steve Selvin, but achieved national prominence when Marilyn vos Savant wrote about it in Parade in 1990. She suggested that it pays to switch doors. Her reward was a mailbag full of letters assuring her she was wrong — some from prominent mathematicians. John Kay’s inbox also overflowed when he addressed the problem in 2005 in the Financial Times.

What should the contestant do? Mathematically, it seems not to matter: there are two doors now, so surely they face a 50-50 proposition. And as it happens, many people prefer to stick. They have made their choice and would regret switching if it did not work out.

More careful analysis, however, reveals that the contestant should switch. One way to think of the problem is to notice that their chance of picking the grand prize was initially one in three.

Hall’s intervention does not change that, but it does guarantee that if they failed to pick the correct door initially then they will definitely get the prize by switching. Two times out of three, switching will win the prize.

A second way to think about the problem is to exaggerate the underlying process. Imagine 100 doors, but still only one grand prize. The contestant picks a door, probably not the correct one. Hall then opens 98 other doors, revealing no prize.

Should we really conclude that we have learnt nothing about the other door? The first door was picked at random but the one that Hall has left closed was selected with great care. With probability of 99 per cent, switching will win the prize.

A third way to attack the puzzle is to run an experiment. It will quickly reveal what intuition does not: the contestant should switch. In Ms vos Savant’s experience, many mathematicians changed their minds only on the basis of empirical evidence — which is revealing, since the underlying proof, using Bayes’ theorem, is not especially technical.

Some people will find these explanations persuasive, and others will not. Over the years I have concluded that there is something about the Monty Hall problem that makes it wonderfully resistant to our intuitions.

And there is a twist in the tale, too: after Ms vos Savant brought the problem to national attention, the journalist John Tierney visited Hall himself and they began to play the game repeatedly at his dining-room table, with car keys representing the grand prize and a pack of raisins serving as the goat. At first, things went as Mr Selvin and Ms vos Savant had explained: switching won the prize far more often.

Then, suddenly, things changed. At the beginning of a game, Mr Tierney pointed to one of the options. “Too bad,” said Hall, immediately. “You’ve just won a goat.”

He did not offer Mr Tierney a chance to switch. He did not always make such an offer in the game show — why should he make it now?

Hall’s change of approach turns a probability puzzle into what we might call a cheesecake bet. In the musical Guys and Dolls, Nathan Detroit offers Sky Masterson a bet that Mindy’s sells more strudel than cheesecake. Sky is sceptical, and rightly so, since Nathan already knows the answer. For much the same reason, a contestant in Let’s Make a Deal should ask themself: “If it is really such a good idea to switch, then why has Hall offered me the chance?”

I have great respect for the way Ms vos Savant faced down a posse of contemptuous mathematicians. But we must be careful not to confuse a precise mathematical description of a game for the vagaries of reality itself, something Nassim Nicholas Taleb has named the “ludic fallacy”. Rigorous mathematical thinking can be invaluable, or it can leave you blinkered and on the wrong side of a cheesecake bet.

The solution to the formal Monty Hall problem is counterintuitive and incontrovertible. But the right approach in the game show depended on what Hall himself was trying to do in offering the choice. Was he benevolent, malevolent, or simply aiming for great television?

Alas, we can no longer ask him. Hall died in September. But the Monty Hall problem will live on.

 
Written for and first published in the Financial Times on 6 October 2017.

My new book is “Fifty Inventions That Shaped The Modern Economy”. Grab yourself a copy in the US or in the UK (slightly different title) or through your local bookshop.

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