Articles published in October, 2008

Where economics meets neuroscience

From BBC Online.

Is a stock market bubble a medical condition?
You might well have thought so, had you taken a walk around a trading floor and looked at the behaviour of traders at the height of the dotcom bubble in 2000.
“They were displaying classic symptoms of mania,” says John Coates, recalling his time as the manager of a New York trading floor.
“They were overconfident, they had racing thoughts, they had diminished need for sleep and heightened sexual appetite.”
But Dr Coates no longer works on Wall Street.
He is now one of a small but growing number of “neuroeconomists” – researchers who study the brain, hormones and nervous system in search of an explanation of our behaviour as investors and shoppers.
Neuroeconomics is a new discipline that fuses economics and neuroscience, and its practitioners are people who think that everyday phrases such as “impulse buy”, “business brain” and “bull market” are more than just figures of speech. Learn More

It might be a brainwave, but what on earth does it mean?

This morning, I had a remarkable experience: I strolled into a delicatessen and bought some delicious Stilton. What made the shopping trip unusual was that I was wearing a brain scanner while I did it.

My costume consisted of an electroencephalograph (EEG) cap, which looks like a polka-dot shower cap with wires plugged into it; a pair of wrap-around glasses with a tiny video camera attached; a clothes peg on one finger to measure my heart rate; two other finger monitors that functioned like a lie-detector; a thermometer patch on a fourth finger; and a satchel to hold a computer gathering the data.

Most of these devices, or their equivalent, can be hidden under clothes or baseball caps so that the wearer looks as if they are sporting only shades and an iPod, but in my case the boffins hadn’t bothered, and so I entered the deli looking like an extra from a 1970s episode of Doctor Who.

This was all part of my efforts to understand ”neuroeconomics”, a new, controversial and eclectic marriage between economics, marketing and various branches of physiology and brain science. With very different aims, economists and marketers are attempting to tap into the dramatic advances in our understanding of the brain that have taken place over the past 15 years. Their tools encompass mood-altering drugs, tests for hormone levels, animal studies and fMRI scans (which use immobile scanners to measure blood flows deep inside the brain).

“Neuromarketing” is the simplest application, and the one in which I was participating. David Lewis, a neurophysiologist at The Mind Lab, a spin-off from the University of Sussex, showed me how the physiological readings could be viewed alongside output from my camera to provide a simple but – presumably – useful demonstration of what really grabbed my attention in the deli. Among Lewis’s findings are that eating chocolate is more exciting than snogging (at least, snogging in an electrical shower cap while surrounded by men with clipboards) and that, subconsciously, young men are more interested in trainers than in the wares on display in an Ann Summers sex shop.

While the possible applications for marketers are obvious enough, such trials are hardly unlocking the deepest secrets of thought. It remains to be seen whether neuroscience has much to contribute to economics itself, a subject that has long focused on the decisions people make, without relying on any particular theory of how they make them. It is also hard to point to anything terribly interesting that the neuroeconomists have discovered, although neuroeconomics may contribute more as time goes by.

Neuroeconomics may provide more shape to the older and more famous field of behavioural economics. A mixture of economics and psychology, behavioural economics has used laboratory experiments to expose a bewildering number of exceptions to the traditional economic theory of rational choice. At present, though, there is little pattern to what the behavioural economists are observing, and it’s possible that a greater understanding of how the brain works might help to provide one.

Yet neuroscience might also help reinforce the traditionalists. Wolfram Schultz, a neuroscientist at Cambridge who studies how the brain processes risk and reward, says that just as the brain registers sensations such as sight, he can now see it registering rewards. There was no reason to expect that the mathematically convenient economists’ fantasy of “utility” had any real analogue in the brain – but it seems that it might after all. There’s a thought.

Also published at ft.com.

Why did a neighbour get my car clamped?

At the apartment block where I used to I live, I once parked in another tenant’s car bay for a brief period. The tenant called the wheel clampers and landed me with a $120 (£69) fine, despite the fact he doesn’t have a car and there were 30 spare car bays, and despite knowing that the car belonged to me. Up to that point I had had no run-ins with this person.

The tenant gained nothing from this except my bad opinion, and I was $120 worse off. Why did he not either ignore my car, or come up and knock on my door and say: “Look, I’ve got these people on the phone who will clamp your wheels unless you persuade me otherwise.” He could have had a few bottles of beer out of it. But he didn’t. So what was the rational reason behind his action?
Jeremy Cook

Dear Jeremy,

You are right to be puzzled. Clearly, this neighbour did not maximise the value of his bargaining position in the narrow situation you describe. Still, I think there is a certain logic to what happened.

Game theory is the economist’s tool of choice to analyse what happens when two or more people have to negotiate, co-operate, compete or otherwise engage with each other. The essence of game theory is that each side would expect the other side to anticipate and respond to his likely actions.

Game theory shows that there are times when irrationality (real or feigned) is a highly effective strategy. Someone who seems impervious to logic is someone who also gets his own way a lot. Consider, for example, toddlers, terrorists, bosses, dogs and the late Charles de Gaulle.

Your neighbour may have calculated that by demonstrating a willingness to punish you for no immediate personal gain, he will gain in the long term anyway. Irrational perhaps, but rationally irrational.

Also published at ft.com.

Forbes: Why do markets create bubbles?

The idea that ordinary people have a tendency to be caught up in investment manias is a powerful one, thanks in part to Charles Mackay, author in 1841 of the evergreen book Extraordinary Popular Delusions and the Madness of Crowds. Mackay’s most memorable example was the notorious Dutch tulip bubble of 1637, in which–absurdity!–tulip bulbs changed hands for the price of a house. Learn More

Business Life: Mackerel economics

First published: Business Life Magazine, August 2008

You’ll all have heard the old proverb, “Give a man a fish and you feed him for a day. Teach him how to fish and you feed him for a lifetime.” But what happens if you give him a mobile phone?
The economist Robert Jensen has been trying to find out. For over a decade, development types have been debating the idea that new technologies such as mobile phones and email might prove to be important tools for helping poor countries grow richer. It all sounds plausible enough, but the challenge has been to prove it. After all, the sceptical case – that the priority for economic development has to be basics such as vaccines, schools, roads and electricity – is fairly persuasive.
Jensen studied Kerala, in India, whose 400 miles of coastal waters provides the livelihood for a million fishermen, and whose beaches host over 100 local fish markets. In the mid-1990s, this was an industry characterised by waste and shocking uncertainty for buyers and sellers alike.
A detailed data-set collected by Jensen tells the story. One Tuesday in January 1997, for example, fishermen were arriving at the Bagdara market to find that buyers had already purchased all the fish they could possibly want. The excess fish had to be dumped or given away for free, since they were perishable. But within 10 miles, at the markets both north and south of Bagdara, fish were scarce and prices were high; buyers were giving up and going home in disgust.
Buyers and sellers were not able to meet up because they had no way of finding each other. And the next week, exactly the same thing happened – except that the gluts and shortages were located at different markets, the result of the whimsy of the mackerel shoals.
Jensen – who collected his data each week for years – was able to see clearly what happened when the mobile phone masts came to Kerala, erected one at a time along the coast. Although they were not aimed at fishermen, the signals ranged many miles out to sea, allowing fishing boats to call the markets and find the best prices.
If I were to show you the graph of fish prices, you would instantly be able to point to the moment at which the masts were switched on in each region. The graph, which has been jumping around like the ECG of a patient with a heart-attack, sudden flatlines as the prices across different markets equalise. At that point, prices fall but fishing boat profits rise, and spoilage of fish becomes a thing of the past.
When Jensen’s research was published late last year, it was a minor triumph for economic analysis: the moment at which the stories about the magic of technology became something more than fishermen’s tall tales.

Econopoly

Comparisons between today’s financial crisis and the 1930s are looking less strained by the day. So what better to lighten the tension than to revive everybody’s favourite Depression-era board game, Monopoly? Learn More

Can you help me to wake up earlier?

I struggle to wake up in the morning although I sleep, on average, seven and a half hours. As I do have a flexible timetable, I arrive at work at 10am. I would like to start at 9am, but my laziness makes it impossible.

Do you have any advice?
Ruth

Dear Ruth,

Your guide here must be the Nobel laureate Thomas Schelling. Schelling’s expertise as a game theorist was honed by his experiences as a cold war strategist – he advised John F. Kennedy during the Berlin crisis.

Schelling realised that the same bargaining and bluffing techniques that worked against Nikita Khrushchev might also work in an individual’s struggle with herself, to quit smoking, diet or get out of bed in the morning. He called the idea “egonomics”.

Your predicament is a contest between two competitors, Evening Ruth and Morning Ruth. Evening Ruth has fine ideas about an early start, but her late nights impose costs on Morning Ruth, who then stays in bed.

One option is to tie Morning Ruth’s hands, just as Odysseus ordered his sailors to tie him to the mast. Evening Ruth might buy one of those motorised alarm clocks that falls off the dresser and scuttles under the bed, beeping loudly.

An alternative is to recruit a third player. The British government handed over control of interest rates to the Bank of England. Similarly, ask an early-bird friend to call every morning.

Odder still, Evening Ruth could enlist Bad Cop Ruth to punish Morning Ruth for lie-ins by, say, denying her(self) television privileges. Bizarre as it may seem to turn one person’s decision into a three-way inner struggle, Schelling avers that this technique works.

One final point. Your letter was evidently composed by Evening Ruth. Are you sure that Morning Ruth’s preferences are so mistaken?

Also published at ft.com.

Why extortion is a hard game to master

In March 1959, a promising young Harvard economist delivered a lecture in Boston on “The Theory and Practice of Blackmail”, drawing on the then-young branch of economics and mathematics called “game theory”. Strictly speaking, his subject wasn’t just blackmail – the threat to reveal damaging information in order to get what you want – but the broader practice of extortion or coercion.

The lecturer emphasised a central problem in coercion, which is to make the victim believe that if he or she refuses to be coerced, the threat will be carried out anyway. That is not straightforward, but it is possible. For instance, in December 1958, a “little old lady” walked into a bank, placed a glass of colourless liquid on the counter and passed a note to the teller.

“I have acid in a glass, and if you don’t give me what I want I’ll splash it on you,” said the note. It continued, “I have two men in here. I’ll throw the acid in your face and somebody will get shot. Hurry. Put all the fives, tens and twenties in this bag.”

What would you have done in the teller’s shoes? A quick-thinking teller might well have thought that it was safe to refuse, because the lady’s best option would then be to pick up the glass and walk out in search of another bank. She would have nothing to gain from hurling the acid except a longer prison sentence. Yet the teller handed over a bag full of money. It was, after all, not his.

Other bank robbers of the day enjoyed similar success. One convinced a teller that a comb in his waistband was a gun. Another walked away with $5,000, quite a sum in 1958, after brandishing what looked like a grenade; surely he cannot have intended to blow himself up. A third robber managed two hold-ups armed only with a polite note. The little old lady herself was arrested on a second heist and found to be equipped with a glass of tap water.

One lesson is that bank tellers have little to lose by complying, which is why banks started introducing locks, alarms, cameras and other systems that could not be overridden by staff. Another lesson is that small doubts over the rationality of the coercer can go a long way in enforcing a threat. After all, if grandma walks into the bank and starts trying to extort money, she’s already demonstrated herself to be a little out of the ordinary.

Blackmail proper is a more difficult threat to make credible. Richard Posner, a pioneer on the frontier between law and economics, has pointed out the basic difficulty: unless the blackmail victim is himself a criminal, he has the powerful counter-threat of a complaint to the police. If the victim’s secret is revealed, he has nothing to lose by then reporting the crime. If the victim goes to the police immediately, the blackmailer cannot reveal the secret without risking a longer sentence. Small wonder that blackmail seems to be a rare crime.

An epilogue: the economist who gave his 1959 lecture on blackmail later ended up with more practical experience of it than anybody would want. His name is Daniel Ellsberg. After his early contributions to economics, he became far more famous as the military analyst who risked a life sentence for espionage after leaking the Pentagon Papers to the press in 1971 in the hope of obstructing the Vietnam war. It was a memorable instance of blackmail’s heroic twin, whistleblowing.

The Watergate burglars then broke into the office of Ellsberg’s psychiatrist, perhaps with the hope of obtaining blackmail material. That burglary was one reason why the Ellsberg trial collapsed. Blackmail is a difficult business – but even back in 1959, Ellsberg had known that very well.

Also published at ft.com.

Wild Swimming

FT Magazine, 18 October 2008

In the car on the way to the Lake District, my friend Mark calls. He’s a doctor.

I tell him that I’m planning on going for a leisurely swim in one of the lakes.

“Be careful not to die,” he says helpfully. Learn More

Krugman wins Nobel for trade theory

The Financial Times, 14 October 2008

The Nobel economics prize was awarded yesterday to Paul Krugman, one of the great popularisers of economic ideas and a trenchant critic of the Bush administration. However, the prize was awarded for work done almost three decades ago in developing what is known as “new trade theory” and “new economic geography”.

Earlier trade theories suggested that a country would trade with partners that were different – rich would trade with poor, and capital-intensive would trade with labour-intensive. In practice, rich countries tend to trade with other rich countries. Learn More