Other Writing

Nudge nudge

A behavioural economics guru gets the chance to put his ideas into practice

Simpler: The Future of Government, by Cass Sunstein, Simon & Schuster, RRP$26, 272 pages

There’s a point early on in this book where Cass Sunstein describes the distressing process of being confirmed as administrator at the Office of Information and Regulatory Affairs in Barack Obama’s White House. Everything Sunstein has said needs to be vetted and, “unfortunately for my vetters, I have written countless speeches, well over 400 articles, and a lot of books. The vetters had to sift through thousands of pages.”

We can consider ourselves fairly warned. Ideas pour out of Sunstein and on to the page – but this is not a man who has the time to step back and produce a little structure or storycraft. Simpler contains some important thoughts, written by an intelligent and experienced observer, apparently in haste. The reader is going to have to do a bit of work. This is ironic, because the book’s key message is about presenting information to ordinary people in the simplest and most useful way.

Sunstein was co-author, with Richard Thaler, of Nudge (2008), a book that aimed to show the relevance of behavioural economics to government policy. In particular, Nudge argued that the way forms are designed and default options selected, even the way cafeterias are laid out, will influence our behaviour, and that policy makers should exploit this fact to do good without spending money or infringing personal liberty. People could, by default, be enrolled in their company pension plan; efficiency labels on cars could list “gallons per 100 miles”, which by a mathematical quirk turns out to be far more informative than “miles per gallon”.

Nudge didn’t have the catchy anecdotes of Dan Ariely’s Predictably Irrational (2008), nor was it as comprehensive as Daniel Kahneman’s Thinking, Fast and Slow (2011), but because of its inventiveness and practical policy bent, it is perhaps the most influential of the recent crop of behavioural economics books.

What, then, of Simpler? If Nudge had never been written, this would be an important work, but instead Simpler feels like an echo of its predecessor. Sunstein spent time running OIRA and most of the book is Nudge shifted to the past tense: instead of writing “this would be a good idea”, Sunstein writes “we did this, and it was a good idea”.

Policies set out in Simpler include well-designed labels; treating people who take no action as though they had actively chosen some sensible default; using personal information to tailor these defaults to individual circumstances; cost-benefit analysis of new regulations; testing and piloting new policies and practices; continually re-evaluating regulations and forms; and making it easy for citizens to provide feedback on what works and what does not.

These are well worth a try. A particularly promising concept is “smart disclosure”, in which government departments and corporations allow us to download our own data in machine-readable format. I could send my mobile phone or electricity usage data to a third-party comparison website, which could tell me the perfect deal given my personal circumstances.

Yet since there is little here that was not already in Nudge, the added value of Simpler is unclear – although US political junkies may find Sunstein’s war stories engaging. What would be really useful now would be an independent analysis of how well all these “nudges” are working. Since Sunstein dreamt them up, he is not the man to tell us whether they are performing as hoped. Simplicity is a sound ambition but in a complex world we should also check for unintended consequences.

Also published at ft.com.

Budget 2013: Five ways to fix our national joke

The chancellor should start by abolishing national insurance, writes Tim Harford

In his opening words, George Osborne dismissed the idea of “easy answers to problems built up over many years”. A shame. There may be no way through our economic swamp, but there are plenty of things Mr Osborne can do to sort out the national joke our Budget process has become. Here are five.
The chancellor was keen to encourage hard work, but offered instead a national insurance exemption for small businesses that looks vulnerable to abuse.
Here’s an alternative: scrap national insurance entirely, and raise the lost revenue through income tax instead. If NI ever made any sense it was as part of a system of social insurance, designed for an age of the male full-time breadwinner, in which workers chipped into a central pot and withdrew contributions when needed. We no longer have that system.
This means that NI is just another income tax. It is an income tax levied on a narrower tax base, penalising workers and favouring those who live off capital. It is an income tax levied on a different basis and calculated in different ways, breeding cost and confusion. Mr Osborne has raised income tax allowances but NI has not kept pace. When the chancellor boasted of 2m low-paid people being taken out of tax altogether, it was untrue: almost all of them will still pay national insurance.
If NI was replaced with an equivalent but broader-based income tax, the effective tax rate on employment would fall, creating jobs and encouraging aspiring people to work harder – exactly what Mr Osborne says he wants. It would create some very vocal losers and would reveal that income tax rates are not quite as modest as they appear. That must be why neither he nor any of his predecessors has had the courage to scrap national insurance.
Mr Osborne’s second reform should be to impose value added tax on almost everything, including a VAT-like tax on financial services. VAT is an excellent tax: it is broadly based and it does not much distort decisions. VAT targets consumption rather than income, which makes it a good way to tax people’s long-term income prospects rather than their transitory income. This also encourages people to save. But VAT has so many exemptions that these benefits are frittered away. Many of these exemptions are arbitrary: children’s clothes are zero-rated but educational toys are not; Jaffa Cakes are spared VAT but chocolate biscuits attract it. The reduced rate for burning fossil fuels to heat our homes is just perverse.
The obvious objection to a broad VAT base is that it would be regressive. It would indeed be if Mr Osborne did not offset it, using income tax and benefits to cushion the blow. The Institute for Fiscal Studies believes such a reform could be introduced in such a way as to compensate pretty much everyone, while still generating £3bn of extra revenue.
Item three: Mr Osborne should scrap business rates, which are a distortion to the process of doing business, and introduce a land tax, which is not.
And for item four, the chancellor should replace council tax with a straightforward proportional tax on the value of property, a simpler and more progressive approach. He should scrap stamp duty on property: even if you gave a roomful of special advisers all year to try, they would be hard-pressed to invent a clumsier and more foolish tax.
All these ideas suggest themselves quite naturally to anyone willing to step back and survey the tax system as a whole. Most of them are explored in tremendous detail in the Mirrlees Review, published by the Institute for Fiscal Studies in 2011. The review has been quietly absorbed by Treasury officials but has made no discernible impression on the chancellor himself.
The one genuinely praiseworthy measure in Mr Osborne’s Budget – an attempt to encourage parents into work by providing tax breaks for childcare – could have emerged from a reading of the Mirrlees Review. I am willing to bet that it is a happy accident instead.
None of this is Mr Osborne’s fault alone. Successive chancellors have seized the occasion of the Budget to juggle, to conjure, to deceive and to wait for the applause. Mr Osborne’s announcement of cheaper beer, a penny off the price of a pint, was a parody of these tricks. The chancellor almost laughed as he announced the wheeze, and he knew that the newspapers would play along with the joke.
And so, a fifth and final suggestion for Mr Osborne. He should abolish the twice-yearly circus of Budget and Autumn Statement, and start thinking as seriously about his long-term strategy for tax as he thinks about his long-term strategy for re-election. It is time for William Gladstone’s famous old red box to seek its rightful place in a museum.

Originally published in the Financial Times

Don’t blame Ofcom if the 4G price isn’t right

It’s almost 13 years since the UK government raised £22.5bn in one of the biggest auctions of all time, for the right to use radio spectrum for 3G mobile phone services. The next big thing, 4G, has been auctioned for around a 10th of that price, and a third less than the sum the Treasury had pencilled in. What went wrong?
Some say that’s the wrong question: several telecoms analysts claim that the low prices will result in a better deal for consumers, which makes me wonder if they have their wires crossed. Consumer prices are determined by competitive pressure and the marginal cost of supplying services, not by one-off upfront costs. That’s the theory, anyway. For a change, theory and reality are in step: despite the stratospheric price that phone companies paid for the 3G licences, mobile phone services in the UK are cheap.
The lower than expected 4G auction price, then, is bad news for the taxpayer, good news for shareholders, and irrelevant to consumers. And it can’t be a huge shock, because estimates for the 3G auction revenue were even more inaccurate, even if the surprise there was a pleasant one. If we had known what the auction price was going to be, we wouldn’t have needed an auction. The whole point of the auction is to reveal how much bidders want the prize, and to charge them accordingly.
But could Ofcom have designed the auction better? Not obviously so. Good auction design is not magic: it’s about preventing cheating and attracting serious bidders. The 3G auction designers had an opportunity to raise silly money during a bubble, and they did not squander that opportunity. The 4G auction designers lacked the same good fortune, and the merger of two major competitors, T-Mobile and Orange, will not have helped.
The 4G auction, a fancy thing called a “combinatorial clock”, split the available spectrum into bite-sized chunks, each with its own price. Bidders revealed which chunks they wanted at prevailing prices, and prices for the most-demanded chunks rose quickly. Rather than dropping out entirely, the major bidders gradually shrank their demands until everyone could be accommodated. Collusion can never be ruled out in such auctions, but a plausible explanation for the lowish price is the simplest one: bidders simply decided that they could curtail their ambitions if it meant saving money.

First published at ft.com.

My verdict on the Autumn Statement

It may be called the Autumn Statement, but there was snow on the ground on Wednesday morning and the chancellor’s political theatre is beginning to impinge on Christmas. Before long, George Osborne will be vying for screen time with Her Majesty’s Christmas message. Instead of fighting over whether to watch an old Bond movie or a rerun of The Snowman, families will be able to argue over which of two joyless perorations to endure.
Budget speeches, and the mini-budgets that Autumn Statements have become, once involved the dispensing of little treats. No longer. Instead of stocking fillers, the chancellor is handing out the political equivalent of coal and wrinkled satsumas.The statement itself was not the only thing that was pushed back: so, too, was the date at which debt will no longer be an increasing proportion of gross domestic product. In this respect, at least, Mr Osborne is outperforming Gordon Brown. Mr Brown’s fiscal rules would simply have been stretched to accommodate changing circumstances. At least Mr Osborne has the decency to admit that he is about to break one of his fiscal rules. You can guess which one: the debt/GDP target involved a measurable quantity and a firm deadline, so of course it was vulnerable. The other fiscal rule invokes an endlessly postponed and never verifiable forecast of things to come, and you may not be surprised to hear that Mr Osborne is still “on course” to achieve it, whatever that is supposed to mean.

I would like to make a modest proposal: that the next Autumn Statement should also be endlessly postponed – or perhaps, like the 3p rise in fuel duty, endlessly postponed and then eventually cancelled. It is hard to say what the current arrangements are supposed to achieve. Two budget statements per parliament would be enough. Now we must endure something very like two budget statements per year.
Mr Osborne, walking in the footsteps of Mr Brown, has realised that you can bludgeon most audiences into depressed acquiescence if you simply intone numbers relentlessly. The deficit was falling, he assured us: 7.9 per cent last year; 6.9 per cent this year; 6.1 per cent next year. The percentages rolled on and on. Your correspondent scribbled frantically. Perhaps percentages were unhelpful? Perhaps we’d like to hear it all again expressed in billions of pounds?
The numbers continued, metronomic, merciless. He had given us numbers “with the asset purchase facility cash transfer included. When the transfer is excluded … ” Watching this was like being strapped to a comfortable chair and flogged gently with a wet sock.
“7.9 per cent” Splotch.
“7.7 per cent” Splatch.
“6.9 per cent” Splotch.
Confusion was beginning to set in. Ed Balls, who had connived in a decade of Mr Brown’s Budget speeches, was being subjected to his own medicine and flipped agitatedly through his papers. A colleague turned to me: “was that per year or across a three-year period”? I didn’t know. Nobody knew. Splotch.
Were the numbers millions or were they billions? Did anybody believe a word the chancellor was saying? Could anything make it stop? The wet sock continued. Splatch.
Mr Osborne, alas, has realised that numbers are weapons. His numbers are not very good ones but as the saying goes, quantity has a quality of its own.
When the sock-slapped fog lifted, was there anything of substance to report? Not much. The overall fiscal stance is unchanged. Mr Osborne revealed that both those who thought we should borrow more and those who thought we should borrow less were wrong. As far as the global economy was concerned, everything had changed. The only fixed point in the hurricane were the chancellor’s fiscal plans, which miraculously turned out to be perfectly judged after all.
At least, we were assured, growth is projected to be stronger in the UK than in France or Germany. Without pausing to draw breath after this boast, Mr Osborne invoked his fiscal credibility. Never mind the fact that according to the OECD’s latest forecasts, the UK government deficit next year will be twice that of France, and many times that of Germany. Growth. Fiscal credibility. Don’t think too hard about any of this.
Splotch. Splatch.

First published at FT.com

Banking goes Nuclear

Download my contribution to Wired’s “World in 2013” – absolutely free! (PDF, 2 pages – posted with permission.)

Lloyd Shapley and Alvin Roth win the Nobel memorial prize in economics

I took a particular interest in the FT leader on the subject:

The award of the Nobel memorial prize in economics to Lloyd Shapley and Alvin Roth is overdue: Mr Shapley should have shared the 1994 prize with John Nash and others, while Mr Roth has been a leading contender in recent years. The choice is a particularly good one because economists have acquired some bad habits, and Mr Roth’s example may serve to break them.
Mr Shapley is one of the key figures in co-operative game theory, which for decades looked both abstract and pointless, a poor relation to regular game theory. However, co-operative game theory is finally coming into its own in a world where computerised auctions are used to award assets or contracts in clusters. Mr Shapley has added a new page to the thick catalogue of useless ideas that turned out to be useful after all.
In contrast, the practical application of Mr Roth’s ideas has never been in doubt. Building on work by Mr Shapley and David Gale, Mr Roth designs algorithms for matching things. Mr Gale and Mr Shapley considered a whimsical problem: how to design a centralised system for allocating husbands and wives in a way that there is no possible male-female combination with a mutual desire to elope.
Mr Roth has developed this theory, but he has also put it into practice, allocating medical students to teaching hospitals and children to schools. Along the way he has resolved difficulties such as the fact that some pairs of medical students are married couples and want to live in the same city.
Most famously of all, he is part of a team that has designed kidney exchanges. If a person with kidney failure has a willing donor who is not a biological match, Mr Roth’s kidney exchange finds another pair in a similar situation – or however many pairs are necessary to find everyone a compatible organ.
Mr Roth’s work is clever and useful but he is an example to his fellow economists in other ways. While others argued that it should be legal to buy and sell organs, Mr Roth tried to understand why we find such transactions repugnant, and designed a practical alternative. He has also advocated an engineering approach to economics: rather than simply proving that something can or cannot be done, his ideas on matching ask fuzzier questions such as “will this work in most cases?” or “is this as good as we can get?”
Above all, Mr Roth has understood that if you test theory in a real-world environment, the theory will improve. So may the world itself.

Odds and ends

Review by Tim Harford

An investigation into the art of forecasting argues for a pick-and-mix approach

The Signal and the Noise: The Art and Science of Prediction, by Nate Silver, Allen Lane RRP£25/Penguin Press, RRP$27.95, 544 pages

When it comes to soothsaying, there seem to be two types of person: those who will gladly and glibly opine on anything from the chance of rain tomorrow to the chance of Mitt Romney winning the presidency, and those who think the forecasting game is all but impossible, the exclusive preserve of fools and frauds.

This state of affairs is not good enough, says Nate Silver, a statistician most celebrated for his New York Times blog, FiveThirtyEight, and its forecasts of election results in the US. While prediction is indeed a difficult affair, it is not hopeless. Thoughtful people with serious theories and mathematical nous should get involved, argues Silver in The Signal and the Noise, not only because they have a good chance of raising the bar for forecasters but because prediction is the acid test of their expertise.

Although Silver is a numbers man, and his book is seasoned with graphs, tables and the occasional equation, he advocates a pick-and-mix approach to forecasting. A statistical model may or may not beat expert judgment, and a computer may or may not out-forecast a human, but a judicious combination of approaches will generally outperform any particular method.

What works in forecasting is not always effective when it comes to writing a book. Each chapter picks a different forecasting problem, from terrorism to baseball to climate change. These individual chapters are strong, and some of them are outstanding. The analysis of the subprime crisis is as lucid as any I have read, I was hooked by his account of computer chess and the explanation of weather forecasting is a revelation.

The whole is less than the sum of the parts, alas. A chapter on poker seems to be there because Silver was once a professional poker player; the chess chapter, while brilliant, seems barely relevant. His pen portraits do not satisfy (do we care about Robert Daum, whose research is briefly cited, now that we know he is “a doctor’s doctor, with a dignified voice, a beard, and a detached sense of humor”?) and at times his efforts to document his extensive research descend into name dropping. “I was told by Tim Berners-Lee,” he writes, of some fact or other. After the first 400 pages of this kind of thing one begins to wish that Silver’s editor had been more assertive.

Despite these frustrations, there is a great deal to admire in the book. It defies easy summary but at its heart is the admonition that we should all think more like Thomas Bayes, an 18th-century minister and mathematician, nonconformist in both roles. Bayes’ theorem, published posthumously, tells us how to combine our pre-existing view of the world with new information in a rational way.

Bayes’ theorem can produce some counterintuitive results. My colleague John Kay once published a pair of columns about the classic game show “Let’s Make A Deal”, in which a grand prize lurks in one of three boxes. The contestant provisionally chooses a box; the host of the show opens a different box to reveal no prize; then the contestant must decide whether to open her chosen box, or to switch at the last minute and open the only alternative. Bayes’ theorem demonstrates quite clearly that the contestant should switch, but Kay’s postbag was testimony to the fact that few people believe this conclusion.

Silver explains Bayes’ theorem with a dark example: the attacks on the World Trade Center. When the first plane hit the tower, horrified observers instinctively updated the possibility of a terrorist attack that day from “barely thinkable” to “distinctly possible”, although at that stage an accident could not be discounted. Bayes’ theorem shows that when the second plane hit, the chance of terrorism could be updated again, from “distinctly possible” to “all but certain”.

There is no need for a mathematical analysis to tell us that, but Silver argues convincingly that Bayes’ theorem is an important reality check on our efforts to forecast the future. How, for instance, should we reconcile a large body of theory and evidence predicting global warming with the fact that there has been no warming trend over the last decade or so? Sceptics react with glee, while true believers dismiss the new information.

A better response is to use Bayes’ theorem: the lack of recent warming is evidence against recent global warming predictions, but it is weak evidence. This is because there is enough variability in global temperatures to make such an outcome unsurprising. The new information should reduce our confidence in our models of global warming – but only a little.

The same approach can be used in anything from an economic forecast to a hand of poker, and while Bayes’ theorem can be a formal affair, Bayesian reasoning also works as a rule of thumb. We tend to either dismiss new evidence, or embrace it as though nothing else matters. Bayesians try to weigh both the old hypothesis and the new evidence in a sensible way. This is good advice, and less technical than it might sound.

Despite its flaws, The Signal and the Noise is a book worth reading. It says something new in a crowded field, it is fun to read, and it’s full of facts you will remember. There is some noise here, but Silver has also produced a signal that is a pleasure to follow.

Also published at ft.com.

Leaders do not need to milk price of pint

A few years ago, José Zapatero, then prime minister of Spain, was asked the price of a cup of coffee in a television interview. His answer, a woeful underestimate, became a minor embarrassment. I know all this because shortly afterwards, he appeared at a session of Congress with my book El Economista Camuflado [The Undercover Economist] under his arm – a book that discusses extensively (some say ad nauseam) the price of a cup of coffee. I was suddenly a prop in a surreal political debate.

Thanks to Nadine Dorries the same argument has popped up closer to home: George Osborne and David Cameron are posh boys, she says, who do not know the price of a pint of milk. To accuse them of knowing nothing of lacto-economics seems odd to me. I do not know whether Mr Cameron knows the price of a pint of milk. I do know that he is posh.

I am doubtful about the idea that there is, somewhere, the Platonic ideal of a pint of milk, whose just price is known by all virtuous people but an eternal mystery to the out-of-touch. The reality, of course, is that a pint of organic Jersey milk from a Hampstead deli is likely to cost more than a quarter of a two-quart bottle from Aldi. You will pay more for a pint delivered to your doorstep than if you take the trouble to drive to the supermarket.

Beyond that, you do not need to be a Tory millionaire not to care about the price of milk. I conducted a little survey. Steering clear of soya, rice and goat’s milk, I checked the price of a single pint of ordinary semi-skimmed. It’s 49p a pint in the Marks and Spencer at the local railway station. It is also 49p a pint at the downtown Sainsbury’s. It is 49p a pint in the Tesco next door.

The financial returns to learning about milk prices seem to be limited. There are people who are so strapped for cash – or perhaps, simply curious – that they will keep track. Many others will not, but that should not disqualify them for high office.

The converse also fails to hold: knowing the price of a pint of milk is no mark of a great leader. Before carrying out my survey, I guessed that the price of a pint of milk was 50p. Perhaps Nadine Dorries thinks that I would make a cracking prime minister. I can assure her I would be a profound disappointment.

Also published at ft.com.

Enough whingeing about price gouging

‘The latest advice is that there is no need to queue at forecourts or “top up your tank” as there will not be a strike over Easter. The [energy] department is also urging motorists to stick to speed limits to conserve fuel. ’
Financial Times, April 2

Good morning. How are you?

I’m distraught. No Easter egg for me last Sunday.

You’re joking.

It’s true. My wife went to a fancy patisserie to buy one, only to discover that they’d sold out. A cheap one would have done, to be honest.

They’re all cheap now.

They are. It’s puzzling, though. If it’s fine to cut the price of eggs when demand falls, why not raise the price when demand is high? Why didn’t the patisserie put up the price of their last few eggs, rather than sell out on Maundy Thursday?

I don’t think that would have gone down well. Price gouging, don’t you know.

I’d rather think of it as dynamic pricing. I realise people use pejorative terms to describe it, but we’d all be better off if certain products varied in price a bit more.

Example?

Well, last week we discussed water and proper metering and seasonal pricing as a rational alternative to hosepipe bans. Or petrol. Remember the petrol panic a couple of weeks back, when everybody rushed out to fill up their tanks, causing queues and shortages?

You think petrol stations should have whacked an extra 20p on the price?

Of course. Think about it. There was a sudden demand for petrol because of the fear of a strike and shortages.

It was a government-engineered panic.

It was, although the point is, the demand was purely precautionary. The actual need to drive around didn’t change. Some people whose cars were empty had to queue for hours, or even go without. Those who needed petrol would have been able to get 10 litres quickly and easily at the cost of an extra couple of pounds. Meanwhile, the people who late last month were topping up their tanks because – well, why not? – would have waited for prices to fall again. The petrol stations would have provided a valuable social service by charging more, as well as making money into the bargain.

The petrol stations that did raise prices were vilified.

They were, which shows that some people don’t know what’s good for them. The idea of the “just price” has a long history but very little economic basis. There are some theoretically sophisticated stories one can tell explaining why prices tend to stick, but the truth is that in most cases we’d be better off if they moved more. The latest toys wouldn’t all sell out at Christmas, there’d be fewer hosepipe bans, you wouldn’t need a lottery to allocate Olympic event tickets and I’d have been chowing down on an Easter egg last weekend.

Life doesn’t always respect your fancy economic models.

Indeed not, and thank goodness – although the laws of supply and demand are hardly fancy. But the fuss about price gouging really does make us worse off. There are two problems with prices that don’t rise quickly enough in the face of fixed supply and high demand. First, the goods may not reach the people who want them most. Second, even the lucky customers who get the cheap product may lose out because of the non-monetary costs of getting it.

Such as?

Such as queueing for hours to get the latest iPhone or a day pass to Wimbledon, for example. Many, surely, would happily pay a little extra to sidestep these wholly avoidable costs.

If this is such a brilliant idea, why don’t we see more of it?

The simple answer is because people hate it and call it price gouging. Why people hate it is another question and one to which there is no straightforward answer. The riddle deepens because some products are routinely sold using dynamic pricing and nobody complains – for example, seats on an aircraft.

It’s not true that nobody complains. You complain about Ryanair all the time.

Yes, but that’s because of the opaque drip-pricing, the unassigned seating and the lack of customer service. It’s not about the same type of seats at different prices. I have no problem with that idea and, curiously, I’ve never heard anyone else complain about it either. But if you tried to price Wimbledon tickets like that, there would be a riot in SW19.

Why, what’s the difference?

I have no idea. But at least I was able to feast on cut-price chocolate eggs all week.

Also published at ft.com.

Following in the footsteps of Larry Brilliant

I sat down for a chat with Larry Brilliant on Wednesday at the Skoll World Forum and interviewed him about the threat of global pandemics, something I’m hoping to write a column about. But, Larry being such a remarkable character, I also wanted to ask his advice on behalf of anyone who wants to make the world a better place. Some thoughts:

It starts with ordinary people. Ordinary people do extraordinary things, and then we lionise them. We make heroes out of them. And that’s a problem, because it makes other ordinary people look at these heroes and think that they can’t achieve the same things. But that path is open to everybody. Anybody at any time.

There’s more, and you can read the full interview at How To Make a Difference.