Tim Harford The Undercover Economist

Undercover EconomistUndercover Economist

My weekly column in the Financial Times on Saturdays, explaining the economic ideas around us every day. This column was inspired by my book and began in 2005.

Undercover Economist

Even in Trump’s White House, chaos has its limits

Written for and first published in the Financial Times on 23 March 2018.

“So many people have been leaving the White House. It’s actually been really exciting and invigorating,” said Donald Trump earlier this month. “I like turnover. I like chaos. It really is good.” It is not clear whether he was joking — the remark was made during a light-hearted dinner speech — but, for Mr Trump’s sake, one hopes he meant it.

The past month has seen the resignation of his communications director Hope Hicks, the downgrading of his son-in-law Jared Kushner’s security clearance, the resignation of his senior economic adviser Gary Cohn, the sacking-by-tweet of the secretary of state Rex Tillerson, the escorting-out-of-the-building of his aide John McEntee, the firing of Andrew McCabe, deputy director of the FBI – and now HR McMaster has gone too.

Along the way Mr Trump has railed against the investigations of special counsel Robert Mueller. Chaos reigns.

It remains unclear how much method there is in all this madness, but there may be more than we think. Mr Trump does not drink, but his leadership style is reminiscent of “drunken boxing” — a style of martial arts associated with staggering around unpredictably until your opponent lets his guard down, whereupon you pop him in the mouth.

The disadvantage of chaos is that it is destabilising; the advantage is that it may destabilise your foes more than you. About four decades ago the US military strategist John Boyd (UK) (US) gave a series of influential talks about this idea. Boyd, whose admirers included senior Republican Dick Cheney and management guru Tom Peters, argued for rapid, confusing manoeuvres, improvised if need be, with the aim of disorienting the enemy. Create enough chaos and you could completely paralyse your foe. If the chaos made life uncomfortable for your own side, no matter. Synchronisation, said Boyd, was not for organisations, but for watches.

This messy, improvised approach to tactics is not entirely new. Sun Tzu, the near-mythical author of The Art of War, declared that “quickness is the essence of war”, but also advised being “without ascertainable shape”. This sounds like the incessant, incomprehensible activity of the Trump White House.

It also sounds like the campaign for the UK to leave the EU in 2016. The Brexiters seemed hamstrung by the fact that they ran two mutually suspicious campaigns — Leave.EU and Vote Leave. “It wasn’t one of my adverts,” said Nigel Farage about Vote Leave’s bus, while Boris Johnson said Mr Farage’s inflammatory poster about refugees was “not my campaign” and “not my politics”. This left the Leave campaign, as Sun Tzu advised, “without ascertainable shape”, so voters picked which ever message resonated, while the Remain campaign did not know where to look. Dominic Cummings, of Vote Leave, later said a united Leave campaign would have been easily defeated.

On the battlefield, the master of messy improvisation was the German general Erwin Rommel. He championed swift, energetic action, even if it left his own men scrambling to figure out what was happening. “I have a feeling that things are in a mess,” lamented one Berlin-based general of Rommel’s north Africa campaign in 1941. They were, but for many months the chaos took a worse toll on the British than the Germans.

The same fast-paced seizing of opportunities has worked for some businesses. In the early years of Amazon, Jeff Bezos was clear that he needed to get ahead of rivals such as Barnes & Noble and Toys R Us, even if it meant chaos within Amazon. A more methodical start-up would have been caught and crushed. “It’s a messy process,” Mr Bezos told his biographer, Brad Stone (UK) (US), but there was simply no time to be meticulous. A visitor to an Amazon warehouse in the run-up to Christmas in 1999 would have said the company was a shambles, but the chaos paid off. Amazon bled money but shipped on time, while rivals have been struggling to catch up ever since.

Of course the more ponderous forces of planning and organisation may reassert themselves in the end. Mr Trump has an uncanny ability to dominate the news cycle, change the subject whenever he wants, and turn the spotlight away from his critics and towards himself. This was a huge asset during the election campaign but is a mixed blessing in government.

Facebook’s old mantra, “move fast and break things”, suddenly looks less clever. Mark Zuckerberg must now explain exactly what he has broken.

The Brexiters are running into the limits of the improvisation, ambiguity and self-contradiction that worked so brilliantly as a campaigning strategy, and indeed as a way of managing their own divisions. On a playing field criss-crossed by technical and legal details, EU negotiator Michel Barnier’s ploddingly careful preparation now seems to be paying dividends.

Even the unpredictable Rommel was eventually defeated, by Bernard Montgomery’s cautious and meticulously planned application of force at El Alamein. Montgomery was in no hurry as he assembled everything he needed. Mr Trump may have noticed that Robert Mueller is displaying the same patience.

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Stephen Hawking’s restless scientific curiosity pulled us all in

A few months ago, my teenage daughter and I went to see a lecture by Stephen Hawking at Oxford’s Mathematical Institute. The event had been postponed once because he was unwell; I worried that his body might finally give out, albeit five decades later than doctors had expected. Yet a new date was set and Hawking duly arrived, as if from another world, to deliver a spellbinding talk in his distinctive synthetic voice.

I had given a lecture myself at the same venue earlier, striking a pessimistic tone: it was easy to pollute the stream of conversation about science and statistics, I said, and simply intoning the facts would not dispel misinformation. Hawking, who died this week, went some way to restoring my hope. He showed that it was possible to communicate difficult ideas, if you went about it in the right way.

What was his secret? He acknowledged that his disability attracted the spotlight, but there was much more going on than the spectacle of a brilliant mind in a malfunctioning body.

First, he did not patronise his audience: presenting the most complicated ideas was a sign that he respected our intelligence. If we did not grasp everything, we would still be better off for having tried.

“I know the book is difficult,” he commented after his A Brief History of Time (UK) (US) had become a bestseller. “It does not matter too much if people can’t follow all the arguments. They can still get the flavour of the intellectual quest.”

That instinct was right. His talk demanded concentration. Most of it was beyond my daughter. Much of it was beyond me. Then Hawking would crack a joke about hairy black holes, and the audience would all be back on the same page, laughing, and ready for another attempt to scale the intellectual heights.

Second, he was immensely curious. “My goal is simple, “ he said. “It is a complete understanding of the universe, why it is as it is and why it exists at all.”

That sort of curiosity is contagious. It makes us want to join his hunt for answers, rather than passively receiving (or rejecting) information from an expert who claims to know them already.

The third quality followed from the first two: unlike some public intellectuals, Hawking was not very interested in conflict for the sake of it. The economist Paul Krugman and the biologist Richard Dawkins are instructive contrasts to Hawking: both are brilliant communicators, but they often present their ideas as a battle between good and evil, wisdom and stupidity.

When you have a noble cause it can be tempting to pursue it in an antagonistic way: Economy, a charity that aims to improve economics literacy, has been fundraising with an endorsement from writer George Monbiot saying that economists are “a pox on the planet”.

These insults seem to work, at first. If you call out your opponents as fools, knaves, or even transmissible diseases, you enthuse your own supporters. But you will win few new converts when every issue becomes a matter of tribal loyalty.

We humans are social creatures. Given a choice between being right on a partisan question (abortion, guns, Brexit, globalisation, climate change) and having mistaken views that our friends and neighbours support, we would rather be wrong and stay in the tribe. This becomes clear in surveys of views on climate change: college-educated Republicans and Democrats are further apart on the topic than those who are less educated.

If our goal is to persuade, the curiosity-driven approach works better than the conflict-driven one: the evidence suggests that curious people are less subject to the temptations of partisanship. When the national conversation becomes polarised, we need to encourage curiosity about how things work rather than them-and-us tribalism.

Hawking, of course, did have robust political views. He criticised the UK health secretary Jeremy Hunt for cherry-picking evidence on the National Health Service and spoke out against Brexit. But after the referendum went the other way, he continued to argue in favour of mutual understanding and solving problems together, rather than dismissing voters as ignorant.

If experts want to persuade us to wrap our minds around a complex issue, they need to get us to abandon our cynicism towards unwelcome information. It does no harm to be the most recognisable scientist on the planet, but Hawking also understood that insults do not work. Instead, he treated us with respect and fired our enthusiasm.

Towards the end of his lecture, after a difficult discussion of quantum effects near the boundary of a black hole, Hawking offered a simpler idea: “If you feel you are in a black hole, don’t give up. There is a way out.”

It was a message any teenager could hold on to. I sat next to my daughter and thought about how Hawking had lived such a rich life under the burden of an apparently unbeatable illness.

We have been told that people have had enough of experts. That is true for some experts. It wasn’t true for Stephen Hawking.

 

 

Written for and first published in the Financial Times on 16 March 2018.

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A clever nudge to improve diversity

In the introduction to my book, The Undercover Economist, I invite readers to imagine that, as they leaf through the pages, there’s an economist sitting nearby. Because he’s an economist, he sees things — hidden patterns, curious puzzles — that they might not notice. The book had been out for a decade when a young economist wrote to me. She had a simple question: why was my undercover economist a “he”?

I was reminded of the question this week by the musician David Byrne’s embarrassment. Mr Byrne, formerly of Talking Heads, has just realised that his new album is a string of collaborations with men. He apologised for being “part of the problem”.

It is easy for white men in a white man’s world to do this sort of thing without malice — almost by default. Sometimes we need a nudge to do better. Frances McDormand has just such a nudge in mind. Accepting her second Oscar for best actress on Sunday, she invited every female nominee in the room to stand up. “Look around, ladies and gentlemen, because we all have stories to tell and projects we need financed,” she said. Adding a final enigmatic phrase: “inclusion rider”.

Inclusion rider? The idea was proposed a couple of years ago by media researcher Stacy Smith. Ms Smith observed that minor characters could easily be demographically representative of a film’s setting — which is likely to mean more women, more ethnic minorities and more disabled actors on screen. An A-List celebrity could simply insist on this requirement — an inclusion rider — in his or her contract.

This is a clever nudge. A straightforward demand for “more diversity”, however reasonable, can be evaded. A black Superman or female Gandalf apparently feels too bold for some studio executives. But the inclusion rider clause is specific and straightforward to satisfy; nobody is going to die in a ditch to make sure that straight white men get all the bit-part roles. Off-screen jobs could be covered, too. And it’s easy to imagine Hollywood A-listers throwing their weight around on this point.

There is no doubt that Hollywood movies fail any reasonable test of being demographically representative. The most famous test — imperfect but instructive — is named after cartoonist Alison Bechdel. To pass, a movie must contain two women, who talk to each other about something other than a man. A low bar, it might seem, but a surprising number of movies fail.

Despite some prominent examples of more diverse casting (the recent superhero movies Wonder Woman and Black Panther and the Oscar-winning Moonlight, which ironically fails the Bechdel test) it is not obvious that the situation is improving. Even online reviews are dominated by male reviewers.

We shouldn’t blame Hollywood alone for this. Data scientist Ben Blatt, author of Nabokov’s Favourite Word Is Mauve (UK) (US) conducted a computer-aided analysis both of recent fiction bestsellers and classics of the literary canon. One simple test: how often does the word “he” appear, relative to the word “she”?

In The Hobbit (US) (UK), JRR Tolkien’s adventure story that contains a variety of fairytale protagonists, none of them with wombs, the word “he” is used 1,900 times. The word “she” appears only once, referring to Bilbo’s mother. That is an outlier, but Mr Blatt found that many male novelists wrote about a world in which the opposite sex barely existed. This was far less true for female authors.

The economics profession has a particular problem when it comes to diversity, according to research by economists Amanda Bayer and Cecilia Elena Rouse. In the US, more than 50 per cent of both bachelor’s and doctoral “Stem” degrees — science, technology, engineering and mathematics — are now awarded to women. But, in economics, the proportion is just 30 per cent and shows no sign of improvement. Economics is also behind the curve in including some ethnic minorities.

To the extent this reflects discrimination, or a hostile environment for women, that is a disgrace. And if it is purely, or even partially, that young women don’t find economics appealing, we economists should be asking why not. A monoculture in academia is unfair, and it leads to blind spots, like the significance of unpaid housework.

One recent study is a nice reminder that a more inclusive environment can pay dividends. The Norwegian Defence Research Establishment randomly assigned female recruits into mostly male squads of six. During eight weeks of boot camp, the squad members trained together and shared a single dormitory. The experiment markedly shifted the attitudes of the men, with substantial increases in their evaluation of mixed-gender teams, and more egalitarian views on women and housework. “Gender stereotypes are malleable and can be altered by integrating,” noted the economists who ran the experiment.

There is a vast difference between an eight-week boot camp and the experience of watching a movie or reading a book that reflects our diversity. Still, we make what progress we can. I shall follow the topic of inclusion riders with interest. And the mysterious protagonist of The Undercover Economist? That street-smart enigma is now a “she”.
Written for and first published in the Financial Times on 9 March 2018.

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How referendums break democracies

The Dutch parliament have just agreed to abolish advisory referendums. I don’t blame them. I did not much care for the result of the latest referendum that was held in the UK, so I confess to disliking referendums with the fervour of a sore loser.

The winners no doubt feel more cheerful about the idea but even they may agree with this: the campaigning process was corrosive, and the consequences for the health of British politics have been even worse.

This scepticism might be seen as kicking democracy when it is down. The Pew Research Center found last year that 17 per cent of Americans think military rule would be a good idea, while 22 per cent favoured a strong leader “without interference from parliament or the courts”. The numbers in the UK were fairly similar.

Most of us still believe in democracy, but even its staunchest supporters will admit that it has its flaws. The most obvious of these is that we voters pay little attention to the issues. Consider Jeremy Corbyn’s recent shift; his opposition Labour party now advocates the UK leaving the EU but remaining in the (or “a”) customs union — not to be confused with the single market. This has been roundly agreed to be a significant change in the political landscape. But the now-momentous-seeming distinction between the customs union, the EU and the European single market was obscure to all but the wonkiest of wonks until a couple of years ago (myself included). It surely remains obscure to most voters today.

I do not mean this as a criticism of the voters. Why should we pay attention? We have other things to do. A decade ago, economist Bryan Caplan’s book The Myth of the Rational Voter (UK) (US) argued that it made sense for us to express our misconceptions, prejudices and tribal loyalties at the ballot box, since doing so was almost costless.

A voter thinking of popping to the polls and then trying out a new pizzeria would be perfectly rational in checking out TripAdvisor, rather than the party manifestos. This is because her vote will almost certainly not make any difference to her life, but her choice of restaurant almost certainly will. We vote because we see it as a civic duty, or a way of being part of something bigger than ourselves. Few people go to the polls under the illusion that they will be casting the deciding vote.

If voters are not paying close attention, then what might we expect from a referendum? The psychologist and Nobel laureate Daniel Kahneman, in Thinking, Fast and Slow (UK) (US), writes, “When faced with a difficult question, we often answer an easier one instead, usually without noticing the substitution.”

The difficult question in a referendum might be, “Should the UK remain in the EU?”; the easier substitution is, “Do I like the way this country is going?”

Another simple heuristic is this: “If one of the options was awful, they wouldn’t be asking, would they?” Except that in the UK’s referendum on EU membership, for reasons of short-sighted political expediency, they did ask.

Of course, any democratic system is weakened by the fact that voters are not paying close attention. But representative democracy provides a line of defence against voter ignorance, by asking us to elect someone to make considered choices on our behalf.

I can’t fix a blocked drain, so I ask a plumber to do it for me. I am not sure whether that blotch on my cheekbone is malignant, so I ask a doctor. And I am, truth be told, a bit vague about the difference between the European Court of Justice and the European Court of Human Rights, which is why I elect an MP who can call on the advice of civil servants and the House of Commons library on my behalf.

I may make the same knee-jerk, tribal decision in an election as in a referendum, but at least I will be assisted by my recognition of longstanding party brands. Just as we recognise brands like Apple, Coke and HSBC, most voters know the difference between Conservative and Labour, or Republican and Democrat. We vote for people who seem to share our instincts and trust them to handle the details.

These brands have another advantage: they provide their owners some modest incentive to tell the truth and keep their promises. The shortlived campaigns that coalesce to fight referendums have no such constraints.

That points to one other disadvantage of a referendum: there is nobody to hold to account after the result. Theresa May campaigned for Remain. Three-quarters of MPs were for Remain. So if the result of the exit process goes badly, who can be blamed? Not them — and we’re certainly not going to blame ourselves. The buck stops nowhere.

No voter can master every issue, and few voters try. Any democratic system must cope with that. Referendums, instead, invite us to ignore the question, give the snake-oil peddlers an edge, concentrate our ignorance into a tightly focused beam, and hold nobody accountable for results. They magnify the vulnerabilities of our democracies and diminish their defences. The Dutch are wise to avoid them.

 

Written for and first published in the Financial Times on 2 March 2018.

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Zombie companies walk among us

For vampires, the weakness is garlic. For werewolves, it’s a silver bullet. And for zombies? Perhaps a rise in interest rates will do the trick. Economists have worried about “zombie companies” for decades. Timothy Taylor, editor of the Journal of Economic Perspectives, has followed a trail of references back to 1989, noting sightings of these zombies in Japan from the 1990s, and more recently in China.

The fundamental concern is that there are companies which should be dead, yet continue to lumber on, ruining things for everyone. It’s a vivid metaphor — perhaps a little too vivid — and it is likely to be tested over the months and years to come if, as almost everyone expects, central banks continue to raise interest rates back to what veterans might describe as “normal”.

Claudio Borio of the Bank for International Settlements recently gave a speech in which he worried about the tendency of low interest rates to sustain zombie companies. Mr Borio has consistently been concerned about the distorting effects of low interest rates, but the zombie element of his argument adds a new twist.

Researchers at both the BIS and the OECD, the club of wealthy nations, have found evidence that low interest rates seem conducive to the existence of zombies, which they define as older companies that don’t make enough money to service their debts. As interest rates have fallen around the world, such zombies have become more prevalent and have also shown more endurance.

On average, across the US, Japan, Australia and western Europe, the proportion of firms that are zombies has risen fivefold since 1987, from 2 to 10 per cent. The zombies walk among us.

Why should we worry? One obvious answer is that zombies absorb resources. If a zombie retailer occupies a space on the high street, that makes it harder and more expensive for a start-up or a successful competitor to move in. The same goes for any resource from advertising space to electricity, and of course it goes for staff, too.

We would usually expect a thriving company to be able to outbid the walking dead for anything necessary, from a finance director to a unit in an industrial estate. But the status quo always has a certain power, and in some cases, the zombie might be at an unfair advantage.

Consider a zombie bank, propped up by a government guarantee but basically insolvent. Gambling on resurrection, it tries to expand by offering high rates to depositors and cheap loans to creditors. In the late 1980s, Joseph Stiglitz — later to win a Nobel memorial prize in economics — proposed a “Gresham’s law” of savings-and-loan associations based on this tendency: bad associations crowd out good ones.

More recently, the collapse of Carillion, a large British outsourcing and construction firm, showed a similar dynamic. The more Carillion struggled, the more desperate it became to win new business — which meant aggressive bids in competitive auctions, dooming Carillion while starving competitors of business.

Having written an entire book about the importance of failure, I am naturally sympathetic to Mr Borio’s argument. Modern economies have a low failure rate — probably too low.

Still, one should not be too cavalier about this point. To ordinary ears, bankruptcy sounds unambiguously bad. If you spend too much time thinking about zombie firms and economic dynamism, bankruptcy starts to sound unambiguously good.

Cut down those zombies and let highly productive new firms grow in the rich soil, fertilised by those zombie corpses, sounds like — forgive the play on words — a no-brainer.

But should we really be so pleased that so many of the UK’s coal mines, or the auto suppliers of Detroit, have been successfully killed off? If nothing has replaced them, there is nothing to celebrate.

One of the lessons of recent economic research by economists David Autor, David Dorn and Gordon Hanson has been that productive new firms do not necessarily spring up as we might have hoped. Mr Autor and his colleagues have, in a series of influential papers, tracked local areas subject to the sudden shock of competition from imported Chinese products. Their conclusion: recovery is neither quick nor automatic.

Nor is it always easy for laid-off workers to stroll into fresh jobs: if you have worked for several years stitching soft toys, then the obvious next step when the toy factory lays you off is to start stitching shirts or trousers instead. Unfortunately, that is also the obvious next move for the importers, or the robots.

We can make a long list of policies that might help new productive firms to get started and expand: education, infrastructure, flexible regulations, small-business finance and so on. There is some evidence in favour of these policies, but no checklist can guarantee results.

Still, that is where to focus our attention as the zombies start to expire. The easier it is to start a new idea, the more hard-nosed we can be about killing off the old ones. It is necessary that the zombies must die, but that cannot be where the story ends.

Written for and first published in the Financial Times on 23 Feb 2018.

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Oxfam, #MeToo and the psychology of outrage

This week I overheard someone describing Oxfam as “all a bit Jimmy Savile”. When the UK’s most prominent development charity finds itself being compared to the UK’s most infamous sex offender, it’s safe to say that Oxfam has had a bad week.

The allegations are certainly disturbing: that senior Oxfam staff made liberal use of prostitutes in the wake of the catastrophic Haiti earthquake of 2010 — a crime, as well as an abuse of trust — and that Oxfam quietly showed them the door rather than take a blow to its reputation. The blow has landed now, and it is a heavy one. (Oxfam denies there was any cover-up.)

This is hardly the first wave of outrage to break. Before Oxfam there was the Presidents Club dinner — a men-only fundraiser at which waitresses were treated as sex objects. One FT investigation and the organisation was closed within hours.

There was Harvey Weinstein and the emergence of the #MeToo movement from niche to mainstream. There was the UK parliamentary expenses scandal. Then there are campaigns to take Cecil Rhodes’s statue off an Oxford college, and — from a different political direction — campaigns to ban transgender people from using the public bathroom they prefer.

Where does the outrage come from, and why does it seem to emerge so suddenly? Media reporting is often a trigger, but for every hard-hitting investigation that unleashes a sustained storm, a dozen squalls blow over swiftly.

One clue comes from a large research study of jury-style deliberations, conducted by psychologists Daniel Kahneman and David Schkade, along with Cass Sunstein, who has recently been exploring the dynamics of outrage. (Mr Sunstein was a senior official in the Obama administration, co-author with Richard Thaler of Nudge and is a legal scholar at Harvard Law School.)

This study looked at debates over punitive damage awards against corporations. When individual jurors felt a corporate crime was outrageous, the group displayed a “severity shift”. The group’s verdict could be more severe than any individual’s initial impression. The jurors egged each other on.

But juries could also display a “leniency shift”; if individuals thought the crime was trivial the jury as a whole would often feel even less worried. Sometimes we don’t know how to feel until we see how other people feel. We are, rightly, much more relaxed about gay cabinet ministers than we used to be, and this is partly because everyone sees that everyone else feels there is nothing shameful about it.

The severity shift and the leniency shift contribute to outrage being unpredictable. Our initial impressions are reinforced once we see what other people think.

But not all of these shifts are in favour of progressive causes. One experiment — conducted by economists Leonardo Bursztyn, Georgy Egorov, and Stefano Fiorin — examined people’s willingness to support an apparently xenophobic organisation. In 2016, people often wanted anonymity before they were willing to back the xenophobes.

US president Donald Trump changed that. When people were reminded that Mr Trump was leading in the polls in their state, anonymity no longer mattered. When the experiment was rerun after his election victory, the result was the same: some people were xenophobes and some were not, but in the Trump era, nobody kept their xenophobia in the closet.

The force of these jolts to public opinion is amplified by several other factors. Over the past year, it has become safer to speak out about sexual harassment, but it has also become riskier to make light of it. This reinforces the trend.

And the sudden salience of an issue may bring further problems to light. One woman tells her story of sexual assault at the hands of a famous man, and other women come forward to say that he’s done the same thing to them.

Or, since everyone is now concerned about sexual exploitation by Oxfam staff in Haiti, where else has this happened? How often? Journalists ask questions that could not have been asked a decade ago. Regulators open investigations. Other charities scramble to get ahead of the story.

The self-reinforcing dynamics mean that unpredictability is a feature of the outrage system. They also suggest that we need to learn two lessons.

The first is that we should ask ourselves, is there anything that happens in my profession, industry or community that is taken for granted, but that the wider world might view with sudden outrage? The in-crowd may lure each other into viewing transgressions with a leniency-shifted forgiveness. When everyone else pays attention, the leniency shift may flip to a severity shift.

The second is to beware tribalism. Outrage may be unpredictable, but once it has grown it is easy to manipulate for political ends, whether noble or reprehensible. Surrounded as we are with people who share our sense of outrage, it is easy to wonder why some other group just doesn’t seem to feel the same way.

Righteous outrage is a powerful weapon, and one that has smashed many barriers of injustice. We should pull the trigger of that weapon with care, not with abandon.

Written for and first published in the Financial Times on 16 February 2018.

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A sloth’s guide to surviving market volatility

This piece was published on 9 February 2018, about the rollercoaster ride of the stock market that week. The fact that it’s published with a month’s delay feels particularly appropriate, given the article’s argument. – TH

What happened in the markets this week? That depends on how often you were looking. It was a brutal Monday — the S&P 500 was down more than 4 per cent, the worst day on the market for more than six years.

Tuesday continued the rout — at least at first. But anyone who had paused for a leisurely coffee on the way to the office might have wondered what all the fuss was about: by 9.25am on Tuesday morning, New York time, the S&P 500 was up 2 per cent from the opening plunge. After various adventures, Tuesday ended up the best day in more than a year.

Twenty-five minutes for coffee is a very long time in the life of a high-frequency trading algorithm, with trades timestamped with an accuracy of one-ten-thousandth of a second. A casual investor, though, can blink and miss it.

A few months ago, my wife asked me for advice about where to invest some money on behalf of her family. I was concerned that stocks seemed rather expensive and advised caution. My words of warning rang true this week, when it has felt like a time to be cautious — but the truth is that over a six-month timescale my advice cost her money.

Most investors should operate closer to that six-month timescale than to the frenetic fast-twitch world in which a coffee break lasts an eternity. Given the choice between investing fast or slow, the slower the better.

This is partly for the sake of sanity. The concept of “loss aversion” was developed by two founding figures in behavioural economics, Daniel Kahneman and Amos Tversky. Their experiments showed that we tend to find a modest loss roughly twice as painful as an equivalent gain. (Ponder the annoyance of losing £10 against the pleasure of finding £10 and you may agree.)

If you check the market every day, you will find it is down very nearly as often as it is up, and the pain of the downs will tend to outweigh the joy of the ups. But if you check less frequently you will have more reason to smile: unlike good days, good years are almost three times more likely than bad ones. Slow investing feels better.

Slow investing may also be more lucrative, at least for those of us who lack the technology to compete at the microsecond level. One laboratory study — by Mr Kahneman, Tversky, Alan Schwartz and last year’s Nobel laureate economist Richard Thaler — invited participants to make investment allocation decisions over 200 “turns”, each meant to simulate a few weeks of real investment. Some were allowed to reallocate every turn after observing what had just happened. Others had to wait and decide whether to reallocate after seeing the accumulated return over either eight or 40 turns, simulating months or years without peeking at the portfolio.

Those who were forced to evaluate and decide at a slow pace were — like real investors — less likely to witness losses. As a result, they were not intimidated by short-term fluctuations. They chose less conservative investments and could expect bigger profits.

Research into the behaviour of real-world investors has reached similar conclusions. One study, by Brad Barber and Terrance Odean, looked at the investments of 65,000 ordinary retail investors in the early 1990s, a time of sharply rising markets. Messrs Barber and Odean found that the less retail investors traded, the better able they were to keep up with the market as a whole. Active traders underperformed by six percentage points a year because trading costs eroded their profits. Lazy investors made more money.

There may be a broader lesson in this. Sometimes we have a clearer view of the world when we stand back from it. In 1965, two Norwegian sociologists, Johan Galtung and Mari Holmboe Ruge, pointed out that the speed of the news cycle affects what we see as news: “To single out one murder during a battle where there is one person killed every minute would make little sense.”

A newspaper that was published once every 50 years — an idea proposed by Max Roser, an economist at Oxford university — might give us a much clearer perspective of what has gone right and wrong since 1968 than a stack of daily papers. The latest headlines: the world population growth rate has roughly halved and continues to fall. In 1968, nearly one in five children died before their fifth birthday; the rate is now lower than one in 20. Annual carbon-dioxide emissions have nearly tripled. Meanwhile the financial page reports that, over the past 50 years, the S&P 500 has delivered a total post-inflation return averaging almost 6 per cent per year — a 17-fold gain.

Perhaps we slow investors should adopt a mascot. I suggest the sloth. Hanging upside-down, moving at a few metres a minute, is much like trading infrequently: it saves the costs of doing things more quickly. Sloths take almost two months fully to digest each meal — which is handy, given that they eat mildly toxic leaves that would poison them if absorbed too quickly.

Investors are reminded, all too often, that the financial world is lush with toxic get-rich quick products. A slower approach to finance makes market movements a great deal more digestible.

 

 

Written for and first published in the Financial Times on 9 February 2018.

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

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Undercover Economist

Like great coffee, good ideas take time to percolate

Monmouth Coffee opened on Monmouth Street in London in 1978. It serves wonderful coffee and the queues often stretch out of the door. That is what makes what happened next so surprising.

What happened next was: nothing. Monmouth had few imitators, either upmarket or downmarket. Starbucks did not arrive in London for another 20 years. A handful of gourmet cafés serving New Zealand-style coffee only began to open in 2005. They’re very good, although I still prefer Monmouth. It’s now possible to get good coffee in several spots in London, but it is hardly ubiquitous. It is even more elusive outside the capital.

This is a puzzle. Monmouth may not be a global titan like Starbucks, but it appears to be a highly successful business: the coffee is priced confidently and it is popular. So why has such an obviously good idea been so slow to spread?

Even if you don’t much care about London’s coffee scene, this is an important question. William Gibson, science fiction author, observed that the future is already here — it’s just not evenly distributed. In that respect, it is much like good coffee. Economics agrees with Mr Gibson — which is fortunate, since he is little short of a prophet.

The data show that just because good ideas emerge does not mean that they spread quickly. Researchers at the OECD have concluded that within most sectors (for example, coal mining or food retail) there is a large and rising gap in productivity between the typical business and the 100 leading companies in the sector. The leading businesses are nearly 15 times more productive per worker, and almost five times more productive even after adjusting for their use of capital such as buildings, computers and machinery.

These are not small gaps. If there were some way to help good ideas to spread more quickly, more people would have good coffee and much else besides. One natural approach is for a laggard company to seek advice — perhaps from management consultants. A decade ago, economists at Berkeley, Stanford and the World Bank conducted a randomised trial in which the bank paid for some textile factories in Mumbai to receive consulting advice from a global company. These factories tended to have utterly chaotic systems, so help with modern inventory management made a big difference. The factories saw their productivity transformed.

More recently, those economists revisited the experiment. How much of the good advice had lasted? Had any of it spread? There was good news and bad news. The good news was that within companies that owned several factories, some of the good ideas first used in a single factory had been adopted across the company. But the bad news was that these proven management processes had not been copied by rival businesses.

This is a reminder of how slow good ideas can be to spread, even when they are straightforward to grasp. In his classic textbook, The Diffusion of Innovations (UK) (US), Everett Rogers points out that many inventions have to cross a cultural divide: the person preaching the good idea is often quite different to the person being preached to. Rogers would probably not have been surprised to see that “not invented here” was a barrier to good practice spreading in the Mumbai textile industry.

So good advice can work, but even good advice wears off. And we can all be resistant to new ideas. The status quo is comfortable, especially for the people who get to call the shots.

An extreme example of resistance to change lies behind the quip that “science advances one funeral at a time”, based on an observation from the physicist Max Planck. A team of economists has studied the evidence from data on academic citations, and found that Planck seems to have been right: the premature death of a star scientist opens up his or her field to productive contributions from outsiders in other domains. People can be so slow to change their minds that we literally have to wait for them to die.

There is an analogy in the marketplace: sometimes old businesses have to die before productivity improves, although that can mean desperate hardship for the workers involved. But sometimes bracing competition does not kill companies, but makes them stronger.

For example, when iron ore producers in the Great Lakes region found themselves exposed to cheap competition from Brazil in the 1980s, the century-old industry faced a crisis. The response — as tracked by economist James Schmitz Jr — was a dramatic surge in productivity, unleashed by changes in work practices. Other economists have found similar responses to trade shocks elsewhere.

And for all the talk of relentless change, there is evidence that US industry is becoming less dynamic: there are fewer shocks, and companies respond less to them. The OECD research, too, suggests that the productivity laggards tend to be further behind in markets that are over-regulated or otherwise shielded from competition.

All too often, we don’t pick up good ideas willingly. We grasp for them, in desperation, only when we have no choice.

Written for and first published in the Financial Times on 2 February 2018.

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

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Undercover Economist

Should the government try to maximise happiness?

“Money can’t buy me love,” sang The Beatles, although it is doubtful that this was a rigorous empirical claim. Still, nobody disputes that there’s more to life than money and a new book, The Origins of Happiness (UK) (US) argues that happiness should be a guide to government policy.

Two years ago this would have been part of the zeitgeist: one of Barack Obama’s senior advisers, the economist Alan Krueger, was a noted expert in “subjective wellbeing” (happiness to you and me), while former UK prime minister David Cameron also championed the idea. It now seems strangely out of step with the times: whatever you think is driving Britain’s current PM Theresa May or US president Donald Trump, it seems unlikely to be surveys of life satisfaction.

Still, it is easy to sympathise with Thomas Jefferson’s remark, shortly after he stepped down as US president, that “The care of human life & happiness, & not their destruction, is the first & only legitimate object of good government.”

The question is what that means for government policy — and whether the academic study of wellbeing can help. The five authors of The Origins of Happiness, including Professor Richard Layard of the London School of Economics, focus on answers to the question “Overall, how satisfied are you with your life these days?” on a scale of 0-10.

It’s not an absurd question, but if a group of academics proposed reforming a nation’s economic institutions and industrial strategy on the basis of answers to the question, “Overall, how rich do you think you are these days, on a scale of 0-10?” we might reasonably object that our evidence base was too fuzzy to provide much guidance.

Nor is it clear whether someone moving from three to four on the scale is enjoying the same boost to happiness as someone moving from seven to eight. And what does “10” really mean? Is it literally impossible to become happier from there — or, Spinal Tap-style, should there be room to go up to 11?

These questions might trouble only the philosophers, except that Lord Layard and his co-authors write of a “revolution in policymaking” based on findings such as “an extra year of education directly raises your own happiness by 0.03 points on average throughout life”. This suggests a confident policy swagger that I confess to lacking myself.

Still, a meagre kind of knowledge is better than no knowledge at all, and it would be wilful to ignore what people tell us about how they are feeling. So what do we learn?

First, we have a love-hate relationship with our jobs. We know from panel data (interviewing the same people more than once over time) that being unemployed is miserable and stays miserable for many years. This is a good argument in favour of policies that promote low unemployment — something Japan, Germany, the UK and the US have managed to do, and France, Italy and Spain have not.

But while unemployment is depressing, work itself is no paradise. Self-employed people are happier than employed people by the same margin that unemployed people are less happy. And Mr Krueger and Nobel laureate psychologist Daniel Kahneman have shown that of all the day-to-day activities we engage in, commuting and work are the least enjoyable — while of all the people we spend time with, colleagues are bad and bosses are worse.

The answer, of course, is more jobs, and better jobs, please. And for that matter, it seems that more time in satisfying romantic relationships would also help — but I prefer to leave the government out of that.

Lord Layard and his colleagues argue in general for evaluating government spending using “a method of cost-effectiveness in which the benefits are measured in units of happiness”. Some policies — such as providing ready-mix concrete floors to poor households in Mexico — pass this test easily. Others do not.

Lord Layard has long been an advocate of devoting more resources to treatment for depression and anxiety. He is right. Even a modest success rate would go a long way here. But beyond that, much depends on the capacity of government to deliver what matters. Better schools, we’re told, improve the emotional wellbeing of children, which is an excellent investment in happiness. Fine, but nobody is in favour of worse schools and the researchers confess to knowing very little about what features of a school are correlated with happy pupils.

There is much in the idea of an activist happiness policy to amuse or horrify anyone with laissez-faire instincts. But to the extent that we think governments can sometimes bodge their way into bettering the human condition, there’s a case to look at what people say makes them happy with their lives.

As a cautionary note, however, I offer Adam Smith’s warning against the person who “seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chessboard”. Whether a politician seeks to maximise national income or national happiness, Smith’s critique rings just as true.

Written for and first published in the Financial Times on 26 January 2018.

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

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Undercover Economist

The case for ending Amazon’s dominance

It should not be difficult to love Amazon. To consumers, it offers choice and convenience. Countless internet ventures have relied on its cheap, flexible cloud computing services to start and scale up. Amazon makes titans such as Walmart work hard for their revenue, offers a shopping search engine that is Google’s only serious rival, raises the bar for television networks and sells tablet computers at a price to make Apple loyalists stop and think.

Amazon is also giving the US economy what it needs. Two economists, Germán Gutiérrez and Thomas Philippon, have argued that corporate America is underinvesting. One reason is that companies are impatiently funnelling cash to investors and executives rather than take a long-term view.

If that is a worrisome state of affairs — and it should be — then Amazon is the shining counterexample. The online retailer’s strategy is driven not by short-term profit but by investment, innovation and growth. If only there were a few more companies like Amazon, capitalism would be in a happier spot.

But there’s the rub: there aren’t more companies like it. It’s unique, and an increasingly terrifying force in online commerce. Should regulators act? If so, how? It’s worth first disposing of a bad argument: that Amazon must be challenged because it makes life miserable for its competitors, some of which are plucky mom-and-pop operations. However emotionally appealing this might seem, it should not be the business of regulators to prop up such businesses.

Regulators have a tendency to slip into the role of protecting incumbents with surprising ease. Marc Levinson’s history of container shipping, The Box (UK) (US), describes Malcom McLean — the entrepreneur behind containerisation, a risk-taking visionary reminiscent of Amazon’s founder Jeff Bezos. When McLean tried to expand his operations, one of his largest obstacles was the Interstate Commerce Commission in the US, which regulated US railways from 1887 and interstate trucking from 1935.

The ICC, writes Mr Levinson, had to approve each new route, every new commodity and any new price schedule. When McLean wanted to start a trucking route at a low price, he had to hire lawyers and argue his case at the ICC, while his competitors protested bitterly — “unfair and destructive”, said the railways. He did not always get his way.

Antitrust authorities should not be in the business of making life easy for incumbents. What, then, should they do? There are two schools of thought. One is to focus on consumers’ interest in quality, variety and price. This has been the standard approach in US antitrust policy for several decades. Since Amazon makes slim profits and charges low prices, it raises few antitrust questions.

The alternative view — which harks back to an earlier era of antitrust during which Standard Oil and later AT&T were broken up — argues that competition is inherently good even if it is hard to quantify a benefit to consumers and that society should be wary of large or dominant companies even if their behaviour seems benign. The collapse of companies from Lehman Brothers to construction services business Carillion reminds us that size can be a problem when a company is weak as well as when it is strong.

The narrowing in antitrust thinking is described by Lina Khan in a much-read article, “Amazon’s Antitrust Paradox”. Ms Khan berates modern antitrust thinking for its “hostility to false positives”, arguing that it has become incapable of saying anything insightful about modern tech companies.

Unlike Ms Khan, I share modern antitrust’s hostility to false positives; there is a real cost to cumbersome and unnecessary meddling in a dynamic and rapidly-evolving marketplace. Donald Trump’s history of publicly attacking Mr Bezos is worth pondering too: do we really want the US government to have more discretion as to who is targeted, and why? We should not wish to return to a world in which a plucky new competitor must beg regulators — over the objections of incumbents — for permission to cut prices. We should be grateful that Mr Bezos did not face in the 1990s the regulatory obstacles that Malcom McLean dodged in the 1950s.

Yet for all this, I am deeply uneasy about Amazon’s apparently unassailable position in online retail. Yes, customers are being well served at the moment. Yet the company has acquired formidable entrenched advantages, from the information about customers and the suppliers who sell through it, to the bargaining power it has over delivery companies, to the vast network of warehouses. Those advantages were earned, but they can also be abused.

Antitrust authorities face a difficult balancing act. Regulate Amazon and you may snuff out the innovation that we all say we want more of. Punish it for success and you send a strange message to entrepreneurs and investors. Ignore it and you risk leaving vital services in the hands of an invincible monopolist.

There are no easy options, but it is time to look for a way to split Amazon into two independent companies, each with the strength to grow and invest. If Amazon is such a wonderful company, wouldn’t two Amazons be even better?

 
Written for and first published in the Financial Times on 19 January 2018.

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

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