Since You Asked

Love is blind, unless you’re an economist

Did you have a good Valentine’s day?
Very good indeed, thank you. After all I am married, and also an economist.

Neither of those attributes immediately points to an enjoyment of Valentine’s day.
Au contraire, many people find Valentine’s day miserable. Single adults have their noses rubbed in cloying faux-romanticism; insecure teenagers count their Valentine cards; dating couples feel under pressure to produce romantic gestures on a day when such gestures ring hollow. It is really only the married people who can view the whole festival with equanimity.

Equanimity is one thing, pleasure is another. Why would you derive joy from other people’s misery?
I have been perusing the happy-nomics literature and apparently I am supposed to feel happy when those around me have less money than I. I am trying to shed my textbook economic rationality and join the human race, and apparently the way this is done is to enjoy invidious situations. I am not sure why.

You may have got the wrong end of the stick. And you have not explained why economists are well-equipped to enjoy Valentine’s day.
My friend, we are masters of the arts of love.

You make it sound as though Keynes’s General Theory should be filed alongside The Joy of Sex and the Kama Sutra.
Well, Keynes’s contemporary Joseph Schumpeter was fond of saying that he had vowed to be the greatest economist in the world, the greatest horseman in Austria, and the greatest lover in Vienna … and that things were not going well with the horses.

Very droll.
Schumpeter is not the only romance expert in the economics profession. Take Hugo Mialon, who just recently published, in Economic Inquiry, “The Economics of Faking Ecstasy”.

Sounds useful.
It isn’t, really, although it’s clever.

Clever but useless? Sounds like, oh, every economics paper ever published.
Touché. But Michèle Belot and Marco Francesconi’s article, “Can Anyone Be ‘The’ One?” is economics you can use, at least if you go speed-dating.

Tell me more.
Belot and Francesconi’s research is based on data supplied from the UK’s largest speed dating agency, based on many hundreds of fleeting conversations, a treasure-trove of information about who wants a second date with whom. To cut to the chase, you are more likely to find a romantic partner if you are a well-educated non-smoker. If you are a man, it helps to be tall and rich. If you are a woman, it helps to be slim.

You’re not exactly shattering stereotypes here.
Perhaps so, but it is good to find out what the data really say. Belot and Francesconi also discovered that dating success is relative to the attractiveness of the other people in the room. In other words, if you want to succeed at speed dating, bring a short ugly friend with you.

All duly noted, but speed dating is a bit of a fad, isn’t it? Surely the real action is online.
Economists have also been studying internet dating. Dan Ariely, a psychologist, alongside a pair of economist colleagues, once published a splendid analysis of what works in online dating by scraping information off dating websites.

Lying, I would imagine, is the way forward.
Well, yes, lying does work – albeit that Ariely and his colleagues aren’t able to see how the dates themselves pan out, merely whether a particular ad is garnering attention. But the they did discover that the typical user of online dating websites claims to be richer, slimmer, blonder and prettier than the rest of the population. It’s a Lake Woebegon world, online dating.

Any practical advice from Ariely?
Posting a photograph is a very good idea. No matter how hideous you might think you are, people will draw regrettable conclusions if you do not supply a picture. Ariely argues that online dating is poorly designed, in any case, because it relies on matching database-friendly categories of “interests”. Actually finding out whether someone is a good match would be much more easily done if, for instance, the dating website showed each of you some conversation pieces – music, art, stories, jokes – and encouraged you share your reactions with each other online. Why not show this article to the next person you date and see what he or she makes of it?

Also published at ft.com.

Nudge, nudge. Think, think. Say no more …

I hear the Nudge unit is in the news again …

I am waiting for the government to establish a Dig in the Ribs unit. Maybe even a Slap and Tickle unit, who knows?

Don’t be silly. Remind me what Nudge is again?

It started as a concept, “libertarian paternalism”, advanced by two American academics, Richard Thaler and Cass Sunstein. The idea was that the government could help people to help themselves without violating their liberty – for instance, by assuming they would like to make pension contributions unless otherwise stated. Then it became a book and the concept got a bit broader and a bit vaguer and more generally about the use of psychology and behavioural economics in policymaking. Then “Nudge” became a fashionable label to be slapped on any policy in search of a headline. Finally, David Cameron set up the Behavioural Insight Team – aka the Nudge unit – to do more research on the subject. The Cabinet Office published some of their findings this week.

This sounds an unpromising pedigree …

Well, the idea of using a popular economics book as a branding exercise certainly smacks of superficiality. But the idea of doing actual experiments to improve policy is a good one and, perhaps surprisingly, that’s what the Behavioural Insight team has been doing.

Why are you surprised?

I am surprised – pleasantly surprised – because these experiments risk failure and take time, neither of which are qualities calculated to endear them to politicians. The Nudge unit has managed to get around this by conducting some experiments on a large scale and examining short-term questions, such as whether people will respond to a letter about tax. This makes it possible to produce results very quickly.

For example?

Let’s say somebody has been fined in court but has not paid. You could send in the bailiffs. Or you could send a text message explaining that if the fine isn’t paid quickly, the bailiffs will be on their way. The Behavioural Insight team and the courts service ran a randomised trial, sending no text message to some people and a variety of text messages to others to see which approach works best. It turns out that text messages are highly effective and even more effective is a text message that mentions the miscreant’s name. The difference between no message and a personalised message is that instead of one in 20 people immediately paying up, one in three people do. That adds up to 150,000 occasions on which the bailiffs need not be called in.

This doesn’t sound like rocket science …

No, and it’s not brain surgery either. But it does appear to work. Sometimes these effects are mind-numbingly obvious. For instance, a letter sent by HM Revenue and Customs to chase up tax from doctors was vastly more effective after being written in a straightforward way with the key messages and request for action at the top of the letter. It was just as effective as an alternative that shoehorned in many fancy behavioural insights.

Why do we need these experiments at all, then?

There are a couple of reasons. The first is that human psychology is full of surprises. The report from the Cabinet Office contains no jaw-dropping discoveries but it does show that some sensible-sounding interventions have no effect, while others have very large effects. The second reason is that credible experiments tell a powerful story. I am told that the phone is ringing off the hook at the Behavioural Insight team office – government departments are queueing up to get some of that Nudgey goodness.

Nice for them, but I thought Nudge was all about persuading us to go to the gym

That has been its reputation, but so far the focus has been persuading people to pay taxes and fines and get a driving licence. A lot of the details are, frankly, pedestrian. But if core functions of government can be conducted more effectively the stakes are far from trivial. These experiments suggest that they can.

Do the experiments really stack up?

Most of them are work in progress. But while the Cabinet Office has obviously rushed to publish early results, they don’t look like a botched job. In an ideal world we’d get peer review, a registry of experiments and eventually systematic reviews. For now, I think we should be grateful that somebody is bothering to ask what works.

Also published at ft.com.

Everyone’s a critic now – or are they?

‘The ASA has banned TripAdvisor UK from claiming or implying that “all the reviews that appeared on the website were from real travellers, or were honest, real or trusted” on its UK site’

Financial Times, February 1

The ASA?

The Advertising Standards Authority. They don’t like the fact that TripAdvisor, a company that operates websites providing travel advice, has been claiming that reviews on its UK site are written by real people.

Who else might they be written by?

Well, they could be written by automated software. Or by real people who are nevertheless not genuine customers – for example, the owner of the restaurant in question, or the owner of the restaurant across the street from the restaurant in question. Or they could be written by customers who have been offered bribes. It may well be that such abuses are rare – TripAdvisor is at pains to assert that they have various safeguards. Still, it cannot prove that dishonest or fake reviews are impossible, hence the ASA ruling.

But it’s not really news that people do dubious things online, is it?

No. And online reviews aren’t new either. But they seem to have been more of a sore point on TripAdvisor than reviews on Amazon or ratings on Ebay. Partly it’s about the stakes: from the customer’s point of view, buying a substandard romantic novel is trivial, whereas a ruined weekend tryst in Paris is a minor tragedy. It’s also about the possibility of malicious reviews. I could post grim reviews of Freakonomics and Outliers in the hope of boosting my own book sales, I suppose, but even if my reviews were taken seriously it is not clear I would benefit. On the other hand, if I ran a gastropub in a picturesque village with a single rival, it’s fairly clear that I might benefit if I could persuade potential visitors that my rival left a trail of disgusted customers in its wake. So both the customers who read reviews on TripAdvisor and the businesses being reviewed have a lot to lose if the review system is corrupt.

Full of sound and fury, signifying nothing?

Signifying $4.4bn, if TripAdvisor’s market capitalisation is anything to go by. And people do take online reviews about as seriously as they deserve to be taken.

How seriously is that?

The limited evidence we have suggests that people are drawing quite sensible inferences from the reviews they read. Ebay auctions have been studied by the economist David Reiley and a number of his colleagues. Reiley finds that positive ratings for a seller push up the prices she receives, but that the effect is small and not statistically significant. On the other hand, negative ratings have a much larger and statistically significant effect in depressing prices. This makes sense: sellers might go to some lengths to round up friends (or “sock-puppets” – online aliases that they control) and ask them to post positive ratings. But who bothers to post negative Ebay ratings for the sheer joy of it? Negative ratings are also rarer and so might be regarded as more informative.

Seller ratings aren’t the same as reviews.

No, but we also have evidence on Amazon reviews, thanks to work by Judith Chevalier and Dina Mayzlin. They compared books for sale on the Amazon and Barnes & Noble websites, observing both the reviews and the relative popularity of any given title on each site. This is a nice statistical tool. Obviously one would expect good books to earn good reviews and lots of sales, but when a book has particularly notable reviews on one site, Chevalier and Mayzlin were able to use that fact to track the effect of the reviews on the book’s sales.

And?

It’s a similar story to that which David Reiley found on Ebay: reviews can affect sales, for good or ill, but negative reviews have a much greater impact.

Wouldn’t it be better if reviewers themselves were properly identified?

This does happen – for instance Amazon can use credit card details to verify the identity of a reviewer, should that reviewer want to be identified. Social networks such as Facebook and Google Plus prevent anonymity and have tried to prevent pseudonyms too. The advantages of this are obvious as far as the likes of TripAdvisor are concerned – so too are the advantages to, for instance, the Chinese police. An alternative is to allow users of a website to review the reviewers. But who reviews the reviewers of the reviewers? Apparently it’s reviewers all the way down.

Also published at ft.com.

No growth, but the LSE is looking for it

‘Official data showed the UK economy contracted slightly in the last quarter of 2011’

– Financial Times, January 25

Is that a surprise?

Not particularly. The economy was expected to shrink and the provisional data show that it shrank a tiny bit more than expected.

Does that mean we are officially back in recession?

There is no official definition of a recession and, in any case, who cares? Whether the economy is shrinking slowly or growing slowly is neither here nor there – given that technology is developing and the British population is growing, “positive growth” is both an arbitrary hurdle and a low one.

So growth doesn’t matter?

Of course growth matters. Unemployment is at its highest level since the mid-1990s. Government debt is growing very fast. A nice surge in economic growth would go a long way towards solving the country’s problems right now. Apart from the direct reduction in human misery that more jobs would bring, growth would also reduce the deficit.

Any sign of that surge?

No. You can get a good sense of how serious the situation is by comparing today’s slump with the slumps of yesteryear – the National Institute of Economic and Social Research has a handy graph. Measured from the peak of gross domestic product, the recessions of the early 1990s and early 1970s reduced output by no more than 4 per cent and the economy recovered to the pre-crisis peak in about three years. Even the recession of the early 1980s troughed at 6 per cent below the peak, and output took four years to recover. The current recession troughed at 7 per cent and four years on, output is 4 per cent below the peak and going nowhere. Today’s crisis is arguably graver than the situation in the 1930s. Given another year of this kind of growth it will be inarguably worse.

So what is to be done?

Good question. The London School of Economics has just launched a “Growth Commission” to look into how to boost the economy. The first two guest speakers were academic economists with a heavyweight record in policymaking: Larry Summers, former US Treasury secretary, and Steve Nickell, a member of the UK’s Office for Budget Responsibility.

What did they say?

Mr Nickell pointed out that many such growth reports have been written in recent years and the commissioners might care to read them in the hope of picking up some useful ideas.

Laconic.

Yes.

But is long-term growth relevant? In the long run we’ll all be dead.

Mr Summers argued that the longer and deeper the recession, the more damage will be done to long-term growth prospects. Workers will become disheartened and rusty, buildings and machines will fall into disrepair and, in general, opportunities to sow the seeds of future growth will be missed. He argued for measures to boost aggregate demand, which presumably means printing more money, lowering taxes, raising state spending, or perhaps all three. Mr Nickell did not comment, except to point out that this is ground well trodden elsewhere.

That’s true enough. So what about the long term – is it time to boost manufacturing?

High-tech manufacturing is fashionable, but it is unlikely to drive much economic growth because the sector is too small. Nor is it a source of jobs: as Mr Summers pointed out, even China seems to have been shedding manufacturing jobs over the last couple of decades. Perhaps the data deceive here, but the Chinese manufacturing boom seems to be more about increasing output per worker than employing more workers. If the Chinese can’t generate jobs through manufacturing I am not sure we should be expecting too much from that strategy.

Any good news to report?

I think so. Mr Nickell pointed out that the quality of UK management is demonstrably poor. David Brent is alive and well, and managing offices all over the country.

Why is that good news?

Because it is probably easier to fix than our Victorian infrastructure or the fact that half the workforce is under-skilled compared with our European neighbours. In any case, it feels reassuring to blame our troubles on bumbling bosses rather than on more intractable causes. It’s always satisfying to blame the management – and even more so when blame is justified.

Also published at ft.com.

Are you saying John Lewis isn’t perfect?

I hear that Nick Clegg has called for a “John Lewis economy”. Who could be against a John Lewis economy?

Indeed! All right-thinking people love John Lewis. It all starts with your wedding list and the love affair just goes on and on. My daughter told me she wanted to be the little boy from the adverts who can’t wait to give his parents their Christmas gifts.

How did she see the advert? You don’t even have a television.

Her primary school showed it to her. That’s how blandly all-conquering John Lewis has become: their advertisements are used in school assemblies. And don’t get me started on Waitrose!

I know – I discovered that those nice Padrón peppers are also available from Ocado. Amazing!

It is. Nick Clegg is clearly on to a winning policy here.

Quite so. What is there to dislike about a vision of Britain that awoke from sweet dreams under crisp Egyptian cotton sheets to sweep aside Tesco, Ikea and Primark, replacing them with John Lewis and Waitrose?

Nothing. But I suspect that Mr Clegg is more taken by the idea of widespread profit-sharing and share ownership.

That makes sense. John Lewis is owned by a trust for the benefit of its employees, John Lewis is profitable and John Lewis shops sell nice things.

Yes, but what we have here is an “n of 1” problem: just because these things are true about John Lewis does not mean they always go hand in hand. ExxonMobil is profitable but it is not owned by an employee trust and it is not usually regarded as a purveyor of nice things.

But surely it’s a good thing for employees to own shares in the companies they work for.

You might want to ask the former staff of Lehman Brothers and Enron about that. I’m sure it’s great if you get in on the ground floor of Microsoft or Apple, but the logic of employee share ownership is not so clear. The more shares an employee owns in a company, the more risk she is exposed to: she already accepts the risk that in hard times the company may sack her, cancel her perks or cut her salary. On top of that she is supposed to pin the value of her savings to the company share price?

Yes, if it will motivate her to work hard for the company.

If it does it will not be because of any financial logic. If you were exposed to just 0.1 per cent of the risk and reward of a £1bn company, you’d be facing a £1m risk – a 10 per cent drop in the share price would hit you by £100,000. And yet you would still enjoy only 0.1 per cent of any gains you created for the company, which is surely not enough to discourage you from stealing paper clips. There is a trade-off between providing proper incentives and exposing workers to excessive risks. I don’t think shares or share options provide a happy medium between the two.

Are you saying that employee-owned companies perform poorly?

No, I’m not aware of any evidence for that. A study by Alec Bryson and Richard Freeman of the Centre for Economic Performance at the London School of Economics found that employee ownership was positively correlated with productivity; it was also positively correlated with other measures of performance-pay and worker autonomy. What exactly causes what is a nice question, but there’s certainly little evidence of harm. Mr Bryson and Mr Freeman also surveyed other studies and conclude that none found any negative impacts of employee share ownership and some found positive effects. In any case, the theoretical case for the popular alternative – companies with highly dispersed shareholders – is also rather troubling. Adam Smith predicted that “negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company”. None of these things works in theory; whether they work in practice is another question.

So what’s wrong with supporting employee share ownership?

Nothing. The government already does with various tax incentives, and more than 60 per cent of workers have access to share-ownership or other profit-sharing schemes. Mr Clegg might consider whether it could be easier to convert existing companies into employee-owned co-operatives, because the economy is unlikely to be damaged by greater diversity of organisational forms.

Sounds sensible but bland.

What do you expect from a man who has just invented a very British version of motherhood and apple pie?

Also published at ft.com.

The unlikely boons of longer train journeys

‘The benefits to passengers from the high-speed link are overstated … there is an assumption that all the time that business travellers spend on a train is wasted … this is a somewhat questionable proposition.’

Financial Times, January 11

So the High Speed Two rail link was approved?

It was indeed. The London-Birmingham link will be ready as early as 2026. Then there may be an extension linking Birmingham to Manchester and Leeds. We’ll only have to wait until 2033 for that.

The cost-benefit analysis says the project is good value for money.

Yes, according to HS2 Ltd, a company that was established to make the business case for high-speed rail. Of course, other things might be better value for money. HS2 Ltd, using Treasury assumptions, discounts future costs and benefits at a discount rate of 3.5 per cent for 30 years, and then 3 per cent. If the government borrowed £10bn at the current 10-year interest rate of about 2.1 per cent and kept rolling it over before paying it back in 60 years, the eventual repayment would be almost £35bn. But the present discounted cost would be just £150m – a massive benefit/cost ratio. If playing by the cost-benefit analysis rules, just borrowing cash and doing nothing is a winning strategy.

You’re just messing around with the numbers.

I am, and you can mess around with a lot of numbers if you are making these calculations over a 60-year timescale. I wouldn’t pay too much attention to HS2 Ltd’s forecasts, or those of their opponents.

But it’s not just about forecasts – it’s about the value of time saved because of a faster journey, right?

That’s true. The high-speed link would save about 40 minutes on a journey from London to Birmingham. How much that is worth is an interesting question.

If you have a morning meeting it might mean an extra 40 minutes in bed.

It might indeed, which is priceless. HS2 Ltd told me that they use numbers from the Department for Transport. The DfT apparently values leisure time at about £6 an hour – this, intriguingly, implies that the UK government’s official position is that anyone under the age of 21 is wasting their time earning the young person’s minimum wage and would be wise to chillax in front of the Nintendo.

What about business travel?

Well, business travel is valued at £50 an hour. Unless the business travel in question is commuting, in which case it’s £7 an hour.

What?

Doesn’t make a bit of sense to me, either. Perhaps the idea is that commuting is eating into your leisure time, which is almost valueless apparently, whereas business travel is eating into your employer’s time, which is precious indeed. Complain to the DfT if you don’t like it.

And surely business travellers will often be able to work on trains, with laptops and smartphones.

Personally I find I often get more done on the train than anywhere else – bar an aeroplane, of course – because I’m not distracted by Twitter or videos of amusing cat antics.

That rather implies that you don’t otherwise make good use of your time.

It’s not clear any of us are that good at managing our time. Economist Alan Krueger and psychologist Daniel Kahneman studied people’s emotions while participating in various activities. Their subjects – women in Texas, in this case – most enjoyed praying and “intimate relations”, but these activities were not chiefly how they spent their days.

I’m confused. Are you implying that users of High Speed Two should be having sex on the train?

Who is to say what social mores will govern our behaviour by the time the line is finished? But I think we can agree that if rail travellers occupied themselves in this fashion then shorter journey times would not necessarily be a tremendous boon.

I’m not sure this is a helpful line of inquiry. What did Kahneman and Krueger discover about how people feel while on business travel?

Business travel wasn’t a category that was reported, but the morning commute, it turns out, is the most miserable of all commonly reported uses of time. You might think that shortening commutes would be very valuable, then – but the DfT hasn’t received that memo.

And how much of this column did you write on the train?

All of it.

Also published at ft.com.

Pocket money will endure even in 2012

“Families with children are shouldering a disproportionate burden.” – Katherine Rake, chief executive of the Family and Parenting Institute

“Dad”

“Yes, my dear?”

“I heard that austerity was affecting families with children more severely than other groups.”

“I didn’t see much evidence of that over Christmas. You ate your own weight in Toblerone. I must have words with Father Christmas about all that sugar and fat.”

“Dad stop joking around, this is serious! It’s the Institute for Fiscal Studies. You always say they’re very serious people.”

“So they are, my love, although I always find them slightly less serious when they get tangled up in macroeconomic forecasts. The trouble is that the Today programme can’t get enough of forecast stories. ‘Central bank makes forecast! Financial institution makes forecast!’ But these forecasts never pan out because the macro-forecasting business is a mug’s game. The BBC might as well report Mystic Meg’s forecast and have done with it.”

“Dad. Have you actually read this report?”

“I have indeed. Very worrying. Relative child poverty rates to rise to 26.6 per cent by 2015. That’s for a family with three children; for a family with two children, relative child poverty rates will rise to just 18.5 per cent. If only we’d had this forecast earlier, your mother and I could have been more careful – but it’s too late to send your baby brother back now.”

“I don’t even want to think about that, Dad. Is a relative child poverty rate of 26.6 per cent bad?”

“I am not sure. It shows the percentage of households living on less than 60 per cent of the income of the household in the middle of the income distribution, so it’s a measure of inequality. I don’t think many people think it’s good news that the number is rising.”

“What about absolute poverty rates?”

“Well, the report shows something it calls absolute poverty rates. They’re rising too, although as far as I can see they’re really relative relative poverty rates.”

“What?”

“They’re poverty rates relative to what the relative poverty line was in 2010-11, rather than relative to what the relative poverty line will be in 2015-16 – according to the macroeconomic forecast, which will be wrong as all such forecasts are.”

“But don’t larger families need higher incomes?”

“Aha, all these numbers have adjusted for that. The IFS assumes that £100 for a childless couple is like £67 for a single adult, or £120 for a couple with a young child, or £186 for a couple with two teenagers and a toddler. It’s called equivilisation.”

“That makes my head spin, Dad.”

“It is complicated, isn’t it? That won’t stop politicians and media pundits confidently citing the numbers as though they were inescapable and simple truths about the universe.”

“But Dad, you’re still ducking the key issue – are families bearing the brunt of austerity?”

“You make it sound so harsh. In fact, we’re getting off lightly. Between the start of 2011 and the spring of 2014, the IFS reckons that a typical household will lose a little less than 4 per cent of net income thanks to tax and benefit changes. Those losses are concentrated among the poorest third and the richest 10 per cent, so I’m not sure why everyone keeps banging on about the squeezed middle.”

“Median voter theorem, Dad, you explained it to me on New Year’s Eve.”

“Of course. Now, where was I? Ah yes: an average loss of 4 per cent, but less than 2 per cent for pensioners and just under 6 per cent for families with children.”

“But that means families are losing more than anyone else!”

“I guess it does. But on the bright side: one day you’ll be a pensioner and you can get the Conservative party to fight to preserve every privilege you’ve got.”

“Somehow I don’t think it will work out that way.”

“Hmm, you may be right. But anyway, things aren’t so bad: the government has been running a deficit of 12 per cent of national income. Surely the obvious base case is that everyone ends up 12 per cent poorer after that particular gravy train runs out of steam.”

“You’re oversimplifying.”

“You were complaining that I was making your head spin a minute ago. But yes, I am oversimplifying. And you’re right: most people will pay more tax and take home stingier benefits, and families with children will suffer most of all. Happy now?”

“Yes, thanks. By the way, isn’t Saturday morning time for pocket money?”

Also published at ft.com.

Can Spam ever be better than gold?

“Can you eat gold? No. You can eat and barter Spam”

– Nouriel Roubini, economist, Dec 14 2011

An intriguing remark, that.

It calls to mind one of the jokes that was circulating during the post-Lehman panic of 2008: “Normally the pessimists buy gold; these days, the optimists are buying gold and the pessimists are buying bottled water and bullets.”

Prof Roubini is one of the pessimists?

He is famous for his apocalyptic economic forecasts, the gist of which has been borne out in the past four years. This isn’t the first time he’s pointed to the logic of canned goods in the worst of economic times.

Well, he’s right: you can’t eat gold.

That was a problem for King Midas, but I think that’s a distraction. You can’t eat bank statements or share certificates. I think what Prof Roubini is really suggesting is that gold isn’t necessarily the best financial investment.

And is it?

Forecasting is for the likes of Prof Roubini. All I can do is point you to past performance and make the observation that it’s no guarantee of future performance. Over the past 40 years or so, the value of gold has been negatively correlated with the value of other assets, making it useful for diversification. Gold was subject to a speculative bubble in the late 1970s and, after adjusting for US inflation, reached a long-standing peak in 1980. Gold proceeded to be an abysmal investment for the rest of the century, but has been booming again more recently. Despite a recent slump, gold has still outperformed the US stock market over the past decade. But what does that tell you, unless you have a time machine?

Surely you can say something about fundamentals?

Not really. When it comes to bonds you can make judgments about inflation and the probability of the money being repaid; with shares, it’s helpful to look at corporate profits. Gold has some industrial and cosmetic uses, but its value to gold investors is that there will always be another investor willing to buy. Because the value of gold is almost entirely tied to future investors’ willingness to buy it, strictly speaking, gold has been in an investment bubble for the past 3,000 or 4,000 years. But there’s the rub: if the bubble has lasted as long as civilisation itself, “bubble” is hardly a derogatory term.

Why do people get so excited about gold?

There’s a particular economic philosophy at work here – the view that government-issued paper money cannot be trustworthy and that currencies should be firmly backed by gold. Presumably the gold enthusiasts have never encountered the Bundesbank. Philip Coggan, author of Paper Promises, points out that there has long been a conflict of interest between creditors, who like their money as sound as possible – making a gold standard attractive – and debtors, who prefer more flexibility. A bit of inflation makes debts less burdensome; what you feel about that depends on whether you’re a borrower or a lender.

So the gold standard helps prevent inflation?

It does. But it also has serious disadvantages. In the early 20th century, currencies were tied to the gold standard, which brought some price stability at the cost of making it impossible to prevent the Great Depression. Now most economists argue that it’s an advantage to have a flexible currency – after all, if tying the lira to the euro has caused so much trouble, imagine if the euro itself was tied to the dollar and the dollar was still pegged to the contents of Fort Knox.

So gold is sometimes a good investment but rarely a good macroeconomic foundation?

That’s my view, and I think I’m in the majority of economists – for what that’s worth these days.

And what about Spam?

Well, Spam is an intriguing prospect. A good currency is fungible, homogenous, non-perishable and easy to carry around. Spam ranks high on the non-perishability stakes, and it’s also homogenous. Notwithstanding the existence of “Spam Hot And Spicy”, most people are likely to take the view that Spam is Spam. It’s not to everyone’s taste, though. Have you considered Mars Bars instead?

Mars Bars?

Nico Colchester, the great Financial Times journalist, once studied the remarkable price stability of Mars Bars. Cocoa, sugar, vegetable fats and milk solids are all valuable commodities and a Mars Bar offers you diversification in a handy ingot form. Prof Roubini might wish to investigate.

Also published at ft.com.

Is payday lending really wrong?

“About half of US states have clamped down on payday loans by capping interest rates, or restricting them in ways that make them less profitable… Faced with a hostile home market, several US companies have hit upon the same solution: to set up shop in Britain.”

That doesn’t sound good.

Oh, I don’t know. Haven’t we been wringing our hands about a “credit crunch” for the past four years? At least somebody has stepped into the market. Payday lending is said by one analyst to be up from £100m in 2004 to £1.7bn in 2010. But that’s modest compared with over £55bn of outstanding credit card debt or more than £200bn of consumer credit – which includes everything from a credit card to paying in instalments for a new sofa. Bank lending is down sharply; consumer credit is up slightly after a big dip; only payday loans are showing strong growth.

You’re being facetious: payday loans are offered at extortionate rates.

I am being facetious – mostly. And yes, payday loans are at extortionate rates. Say you borrow £100 for a month and have to pay £125 at the end of the month. That’s an interest rate of 25 per cent a month, which compounds to about 1350 per cent a year.

This sort of thing is disgusting. Payday loans should just be banned.

Many people think that. An alternative is to cap the interest rate at something like 30 per cent, which would allow most store cards and credit cards but destroy the business model of payday loans. But aren’t we being a little bit hasty? This product tends to be discussed as though it’s something like heroin: profitable but corrosive. Isn’t it worth considering that payday loans are a valuable service, used by people in full control of their senses?

That’s ridiculous.

It’s not ridiculous at all. Consider the fuss that people now make about microcredit – small loans, often at interest rates well above 50 per cent a year that are said to help the very poorest families manage their finances and even become entrepreneurs. That’s a story that many people are happy to accept without examining the evidence, while at the same time condemning payday loans, which appear to be a similar product. Are you sure you’re not just reflecting a prejudice that credit-starved Bangladeshis are heroic would-be entrepreneurs while credit-starved westerners must be trailer trash?

Are you claiming that it is rational to take an interest rate of 1350 per cent?

Of course it could be, the question is whether it is rational in practice. Consider the founding story of microcredit – the moment in 1976 when Muhammad Yunus lent less than a dollar each to 42 rural craftswomen. Those women had previously made baskets and chairs, funded by a village moneylender at a rate of 10 per cent a day, which by my calculations is an annual rate of over 100,000 trillion per cent. I am not aware that anybody argues the women were irrational: until Mr Yunus came along they had no options but to take out the loan each morning to buy materials.

So what’s the evidence?

It’s mixed. For example, the economists Dean Karlan and Jonathan Zinman persuaded a South African consumer finance company providing loans for a few months at an interest rate of 200 per cent, to run an experiment randomising loan approvals for marginal applicants who would otherwise have been rejected. To Mr Karlan’s surprise, the borrowers who were randomly approved for loans did better than those who didn’t get the cash. The reason seems to be that those borrowers used the loans to pay essential bills – fixing a bike, buying clothes – that helped them keep their jobs. But another study by Mr Zinman and Scott Carrell, which paid a lot of attention to disentangling correlation and causation, found that in states where US Air Force personnel had access to payday loans, the combat-readiness of the Air Force suffered. There are reasons to be concerned about these loans, but we shouldn’t assume that they are never put to good use.

Why don’t banks enter this market? Surely competition would drive down rates.

The banks do compete in this market, albeit indirectly, by allowing people “unauthorised” overdrafts and charging them through the nose for them. The truth is that an unauthorised overdraft can be even more expensive than a payday loan. I am not sure that the banks would like to compete in this market more overtly: the current situation seems to suit them rather well.

Also published at ft.com.

You’re wrong – we are all wealth creators

“We will set public sector pay awards at an average of 1 per cent for each of the two years after the pay freeze ends . . . while I accept that a 1 per cent average rise is tough, it is also fair to those who work to pay the taxes that will fund it.”

The chancellor’s autumn statement

“Did you hear about that 1 per cent pay rise?”

“I did. Tough but fair, if you ask me.”

“Why’s that?”

“Well, we in the private sector have to work to pay for you in the public sector. It’s only fair that you show some restraint.”

“Well, ‘show some restraint’ is not quite the phrase, is it? It’s not as if I’m choosing my own pay. You must be confusing me with the chief executive of a major PLC. No need for me to show any restraint; George Osborne is quite capable of showing restraint on my behalf, thank you very much.”

“Good job he is, too. I’m paying for your salary.”

“Is this the ‘hard-working private sector funds the bloated public sector’ line?”

“Funny you should mention that, I guess it is.”

“I’ve never understood that. I’ll admit that you pay for my salary, but I pay for your salary too.”

“How’s that?”

“You work in sales for a mobile phone company. I work as a teacher.”

“Yes, my taxes pay for your salary.”

“But my mobile phone bill pays for your salary. If the government nationalised Vodafone – stranger things have happened – and privatised the school system, my taxes would be paying for your salary while my employer would be sending you a bill for my teaching of your children. But we’d still be paying each other. This is a modern economy. Everybody pays for everybody else’s salary, except the subsistence farmers and survivalists, who look after themselves.”

“But…”

“Look, communism didn’t collapse because there wasn’t any private sector to pay for the public sector. It collapsed because the incentives were thoroughly screwed up. There’s no logical reason why an economy couldn’t be 100 per cent public sector. You’re making it sound like that’s impossible as a matter of simple arithmetic.”

“Still, communism is hardly an advertisement for the public sector, is it? The private sector creates wealth.”

“No, individual technologists, managers, scientists and entrepreneurs create wealth. Their natural home might well be the private sector but there’s no logical reason why they can’t be employed in the public sector. Tim Berners-Lee invented the World Wide Web while he was working in the public sector.”

“He’s not exactly representative of the public sector.”

“Sure, but Steve Jobs isn’t exactly representative of the private sector either. There are remarkable individuals who do remarkable things, and I’m happy to acknowledge that the private sector is usually the place where those remarkable things have space to grow. But the private sector as a whole is doing something more pedestrian: it’s providing goods and services. And so is the public sector. To suggest that some of these goods and services count as ‘creating wealth’ and others don’t, purely because some are paid for out of taxes and others are paid for in the marketplace, doesn’t make any sense.”

“Still, Osborne was right: we need to make savings. Public sector workers have to do their bit.”

“That’s a fallacious line of reasoning: it assumes that the public sector workers of yesterday are going to be the same people as the public sector workers of tomorrow, after several years of chipping away at their real incomes. They might not be. I might decide to become a mobile phone salesman instead of an economics teacher.”

“The way this conversation is going I wish you’d made that choice a while ago.”

“The question is where you want the best people. Trimming public sector wages might harm current public sector workers, or it might just persuade them to seek new pastures, to be replaced by over-promoted junior staff – or mobile phone salesmen who were sacked because of a sudden influx of better-qualified people who could do their job. It may well be reasonable for Osborne to squeeze public sector pay, but if he does, private sector workers will suffer consequences too. Sometimes when he says that we’re all in this together, he’s right – if only by accident.”

Also published at ft.com.