Illustration by Ingram Pinn

First published at  FT Comment on 4 August 2010

FT Comment, 21 July 2010

Illustration by Ingram Pinn

It says a lot about the talents of John Maynard Keynes – and just as much about the shortcomings of modern macroeconomics – that when the financial crisis struck, policymakers instinctively reached not for their fancy models, but for the Keynesian idea of fiscal stimulus. These pages have been filled with eminent thinkers arguing over whether it is time to bring the stimulus to an end.

Perhaps we should turn the question around: if stimulus were to be the solution, what would be the problem? The problem would be that too many of us wanted to save money or pay off debts; that is, we wanted others to pay for our services but weren’t so keen on paying for theirs right now. Simple arithmetic suggests this would leave slack in the economy. In addition, the problem would be that businesses, pessimistic about prospects for recovery, didn’t harness all the spare savings floating around and plough them into new investment projects. The slack would stay slack, possibly for a long time. If that was the problem then government stimulus would be the solution.

And the above paragraph doesn’t seem to be a bad description of the US or UK economy, which suggests the case for stimulus is strong. True, the patience of the bond markets is surely not boundless (and say what you like about kowtowing to the markets, if we’d like them to lend us money we have good reason to care whether they are willing to lend it). And there already is an awful lot of stimulus spending going on right now, so it’s not absurd to suggest we could get by with less as the economy bounces back. I realise that I am sitting on the fence here, but it’s part of my new maxim, which is never to stand in the middle of a fight between Paul Krugman and Niall Ferguson.

Continued at ft.com

FT Comment, 18 March 2010

I don’t recall it myself, but like most babies born in 1973, I apparently slept face down in my cot. This was the standard advice, made famous by Benjamin Spock in 1948. We now know that for many unlucky families, this well-meaning advice was fatal. According to research published in 2005, putting babies to sleep on their fronts has led to about 60,000 cot deaths.

The story is a favourite of Sir Iain Chalmers, a campaigner for better standards of evidence in medicine and beyond. Because it is possible to do so much unwitting harm in medicine, many medical interventions are now subjected to a randomised controlled trial. Austin Bradford Hill performed the first properly controlled clinical trial in 1948, although he had predecessors, including James Lind, who used a randomised trial to show that citrus fruit prevented scurvy. There’s even a controlled trial in the Bible (Daniel 1:8). Such trials have proved the effectiveness of countless treatments, and the dangers of countless others.

Continued on ft.com

From a series of 10 ideas for business, FT Magazine

Failure has always been a fundamental part of a market economy. When markets work, they do so because new ideas are constantly being tried out. Most fail. Those that succeed cause older ideas to fail instead. In the US, about 10 per cent of businesses disappears each year. This is an awkward insight – but trial and error could be starting to take its rightful place as a business technique, rather than the dirty little secret of capitalism.

There are some hopeful signs. Stefan Thomke of Harvard Business School has argued that advances in computation have made it possible to experiment on new products as a matter of course, trying many things and expecting many failures. It is now easy, for example, to experiment with changes in the layout of a website, showing different configurations to different visitors and tracking results in real time. Google, meanwhile, routinely launches new products with a “beta” label on them. And academic superstars such as Steven Levitt, co-author of Freakonomics, have been teaching executive courses in business experimentation.

We are also starting to learn more about the psychology of learning from mistakes. Richard Thaler, the behavioural economist behind Nudge, coined the phrase “hedonic editing” to describe our habit of lumping small losses together with larger gains in order to mask the pain of the loss. Sugar-coating is human, but it’s also a recipe for failing to learn from failure. Thaler, with colleagues, even studied the behaviour of contestants on Deal or No Deal. He discovered that people who had made unlucky choices then started to take reckless risks, which often compounded the error.

It’s hard to learn from failure if it briefly robs us of our judgment. As we start to understand why trial and error is so painful a process, we may be able to use it more constructively. The financial crisis has made us aware that a system that cannot tolerate a bit of failure is a dangerous one. The idea that an institution was “too big to fail” used to sound reassuring. Not any more.

FT Comment – 25 February 2010

We are sometimes admonished: “Don’t shoot the messenger.” Since there is rarely a logical reason to shoot messengers, such advice should not be needed. But it is, because bad news hurts, and organisations find it difficult to deliver such news to the person in charge.

Andrew Rawnsley’s account of Gordon Brown’s premiership has received attention for its claims that Mr Brown was abusive and physically threatening to his staff, grabbing lapels, stabbing upholstery with his pen and causing his advisers to cower for fear of violence. If true, that is disturbing – but few people will have found it surprising. High-status men sometimes do abuse that status.

I am worried not so much that Mr Brown may be beastly, but that he is cutting himself off from good advice. Mr Rawnsley describes Mr Brown’s fateful decision to pull back from a widely trailed snap election in late 2007. His inner circle waited until he was out of the room before agreeing that such a course would be disastrous. When the prime minister reconvened the meeting, however, this was not conveyed: “No one expressed a clear view. No one wanted responsibility for the decision.”

This is a more significant anecdote than any tale of flying spittle. Any leader needs frank advice, and the biggest obstacle to receiving it is often the leader himself. Even a polite and level-headed boss will be tempted to cut naysayers out of the loop. Knowing this, sensible juniors will avoid expressing criticism or grim tidings if at all possible.

“If you deliver bad news, you’re disempowering yourself,” says Professor David Sims of Cass Business School. “You’re less likely to be listened to in the future.” For some ambitious subordinates, this is a far worse fate than the threat of being thumped.

A new reality television show, Undercover Boss – which has migrated to the US after airing on Britain’s Channel 4 last summer – tries to tap into the dissonance between bosses and front-line staff by filming as a senior executive works incognito in the trenches. It is a delicious premise.

When bosses must don a disguise to learn about how their organisations really work, trouble is in store. Read the rest of this entry »

First published in Business Life, May 2009

Office life may not be a game, but it is a tournament. Economists use the word “tournament” to describe situations where the winner – or a few winners – walk off with the rewards. A race to develop a patent for a new drug is a tournament. Fund managers scoop the lion’s share of customers by beating the market, rather than delivering objectively excellent returns.  And many offices promote or pay bonuses to those who outperform their peers. Sometimes the competition is subtle and implicit, at other times brashly celebrated – but it’s all a tournament.
Tournament pay makes sense from the point of view of employers, and goes some way to explaining the frustrations of office life. (Some key predictions of tournament theory: when there is more luck involved, bonuses have to be bigger to have a motivational effect; bosses need to be paid vast and largely unearned bonuses to motivate their underlings; and when the incentives are sharp enough, workers will deliberately sabotage each other. Is it all starting to make sense?) But one interesting question is hard to answer: how does tournament pay affect the risks that people take? This is a tough question because it is generally hard to observe risk-taking directly.
Two economists, Christos Genakos of Cambridge and Mario Pagliero of Turin, have discovered an exception: professional weight-lifting contests. Because weightlifters announce in advance the weight they will attempt, it’s possible to observe people taking risks by lifting heavier weights. With data from 17 years of competition, the researchers are also able to track individual weightlifters across time and see whether they behave differently in different situations.
They conclude that more prestigious tournaments, such as the Olympic games, encourage more risk-taking. They also conclude that people take more risks when close to but outside a medal position. Tournament leaders play it safe, and so do those completely out of contention. Competitors lying in sixth place are most likely to go for broke.
This finding is a lot more potent given the context of a banking crisis which is blamed in part on a bonus culture that encouraged bankers to take too many risks. While popular anger is focused on the sheer scale of bankers’ bonuses, many economists are concerned that naïvely-designed bonuses may have contributed to the crisis.
As Genakos and Pagliero comment, “tournaments can be too successful in encouraging risk-taking… while this may be ideal in sport, in which suspense and extraordinary performances are what the spectators want, it may not be so desirable in firms”. Ouch.

This Christmas, will you buy your loved ones presents that they may not like? Or will you slip them some cash instead? Neither option has much appeal. A gift of money, unless to a much younger relative, looks lazy and even patronising. Yet many people are incompetent present-buyers: Read the rest of this entry »

First published in Business Life, April 2009

Deciding how much to charge customers is a crucial decision for most businesses, and many devote huge effort to complex pricing schemes. Not all, though: some businesses turn the whole task over to customers. “Pay what you want” seems to be a new business fashion – but is it taking customer sovereignty too far? And is the model sustainable?
Pay what you want has two clever features. The novelty attracts customers and publicity, too. And affluent or price-insensitive customers tend to pay more. Any well-run business will try to offer low prices only to customers who demand them, not to every customer; pay what you want might achieve the same result without the fuss.
The Achilles heel of pay what you want is, of course, blindingly obvious: what if people don’t want to pay anything at all? No wonder the model has caught on in two very specific contexts: digital goods such as music files, software or blogs; and cafés or restaurants. With digital goods, the cost of providing an extra copy is close to zero, and collecting real money is difficult thanks to piracy and a customer base that is used to getting what it wants without paying. Inviting contributions is better than nothing. In a café, customers are used to tipping staff and find it hard to accept service from a smiling waitress and then pay little or nothing. Honour – or guilt – can be a powerful motivator. So can social norms: Americans, well used to tipping, were reported to have paid much more than others when invited to pay what they wanted to download Radiohead’s album “In Rainbows”.
My concern is that when the novelty wears off, pay what you want will collapse as a model, at least for restaurants and cafés. Not only will the free publicity ebb away, but there is every reason to suppose that customers will start to exploit the offer. The economists John List and Uri Gneezy have carried out an experiment that sheds light on this tendency. They hired temps to perform various tasks, and paid some of them well above the hourly wage that had been agreed. The question was whether the workers would put in extra effort out of guilt or simple gratitude. The answer: yes, but the effect wore off in a matter of hours. Selfish exploitation of the generous wage became the norm by lunchtime on day one. I suppose if the same thing happens to restaurant owners, they can always install a cash register.

Superfreakonomics: Global Cooling, Patriotic Prostitutes and Why Suicide Bombers Should Buy Life Insurance
By Steven D. Levitt and Stephen J. Dubner
Allen Lane £20, 288 pages

For fans of the multimillion-selling pop-economics book, Freakonomics, all that needs to be said is that the sequel’s title is an accurate description. This book is a lot like Freakonomics, but better.
The original, a runaway hit, had its genesis in Stephen Dubner’s masterful New York Times Magazine profile of “rogue economist” Steven Levitt. “Rogue” may be stretching it a bit, because Levitt is, in fact, a garlanded and hugely influential professor at the University of Chicago.
He has applied his statistical techniques, now much emulated, to unconventional topics such as the link between abortion laws and crime, or whether sumo wrestlers cheat (they do, he concludes). The 2005 book that resulted was wide-ranging, fascinating and above all, likeable – however, it showed signs of haste, and it was never clear whether it was supposed to be a book by Steven Levitt or about him.
Book cover of ‘SuperFreakonomics’ by Steven D Levitt and Stephen J DubnerSuperFreakonomics offers much the same range and amiability, but is more polished. The book’s chapters cover prostitution; data analysis in healthcare and counter-terrorism; altruism; innovation; and geo-engineering. The reader may not guess the central topic from the chapter titles or the opening pages, however, which betray a fondness for springing surprises and putting twists in the storytelling.
Detours are all part of the style; an afternoon reading SuperFreakonomics is like one of those thrilling and occasionally frustrating conversations where ideas tumble out so quickly that they keep interrupting each other. In short, the book’s organisation is deliberately on the freaky side, but if you simply resolve to read it from cover to cover you are guaranteed a good time.
My favourite chapter describes the research of John List, a colleague of Levitt’s, as he zaps some of the most famous results in behavioural economics. In the “dictator” game, well-known in economic circles, player A is given $10 by the experimenter and told they can keep it all. Alternatively they can give some to anonymous player B. Many players do, indeed, hand over money, a finding that troubles conventional economic theory.
List thinks many researchers have embraced this finding too easily, however. “What is puzzling”, he comments, “is that neither I nor any of my family of friends (or their families and friends) have ever received an anonymous envelope stuffed with cash”. The lab experiments, in which large numbers of students display a preference for sending cash to anonymous strangers, need to be questioned more closely. Yet List showed that with small modifications to the dictator game, experimental subjects could be persuaded not only to curb their generosity, but to confiscate cash from others.
There is much more here, and all is told with verve and care. Levitt and Dubner have a gift for explaining precisely how a researcher discovers something. Their epilogue, on Keith Chen’s attempts to introduce currency to a monkey society, is a model of how to tell a gripping story of scientific research without compromising on accuracy.
The most eye-catching chapters in the book are the first, on prostitution, and the last, on global warming. The chapter on prostitution flits from academic research into street prostitution, carried out by Levitt and sociologist Sudhir Venkatesh, to an engaging profile of a high-end escort and various digressions into the economics of gender and other topics.
One of these asides provides the book’s best moment: when the authors demonstrate that a prostitute gets more money through the use of a pimp than a homeowner gets through the use of a realtor, or estate agent. The financial impact of a pimp is greater than that of a realtor, “Or, for those who prefer their conclusions rendered mathematically, PIMPACT > RIMPACT.”
Those with a prurient curiosity (I am guilty), will find some of the descriptions of what prostitutes do all day rather coy. Those with an interest in the economic angle (guilty, again), will find some questions unanswered.
“The real puzzle isn’t why someone like Allie becomes a prostitute, but rather why more women don’t choose this career,” Levitt and Dubner write. Do tell, thinks the reader, but they don’t, even though literature on the puzzle does exist. The leading research on the question is written by two women, not two men, a fact that some people will find relevant.
The analysis of street prostitution is based on careful academic work. The account of high-end prostitution is merely a journalistic profile of a single successful and intelligent woman. But Levitt and Dubner seem to have decided that while data-driven discoveries are generally wonderful, you can have too much of a good thing.
The authors claim to prefer data to “individual anecdote”, but part of the secret of their success is that they like a good story more than anyone.
As for the final chapter on global warming, it is a striking discussion of geo-engineering, surveying various schemes for cooling down the planet rather than trying to prevent climate change by cutting carbon emissions. This is a strong story, but it is also one-sided, portraying the geo-engineers as brilliant iconoclasts, dismissing the objections to geo-engineering as the knee-jerk reaction of the unreflective, and failing to convey the views of a single credible geo-engineering sceptic. A well-deserved swipe at Al Gore does not really count.
According to this chapter, the only reason everyone is making so much fuss about carbon dioxide is that they’ve never heard of geo-engineering, or are the kind of stubborn Luddites who think technology never solved anything. I have some sympathy with that view but the section nevertheless needed more balance.
In the end, a book such as SuperFreakonomics stands or falls on its entertainment value. And on that count, there’s no doubt: it’s a page-turner.
More revealing, though, was that I’d folded over at least a dozen pages, resolving to go back, follow up the references, and find out more. This is a book with plenty of style; underneath the dazzle, there is substance too.

First published at ft.com.