jamesz

Economists tackle ‘the surge’

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Economists like to claim that their discipline is about providing tools for analysis, not answers to ready-made problems. OK, so they’re hardly alone in that but Dani Rodrik links an interesting paper by Michael Greenstone that walks the walk. Greenstone

…shows how data from world financial markets can be used to shed light on the central question of whether the Surge has increased or diminished the prospect of today’s Iraq surviving into the future. In particular, I examine the price of Iraqi state bonds, which the Iraqi government is currently servicing, on world financial markets. After the Surge, there was a sharp decline in the price of those bonds, relative to alternative bonds. This decline signals a 40% increase in the market’s expectation that Iraq will default. This finding suggests that, to date, the Surge is failing to pave the way toward a stable Iraq and may in fact be undermining it.

I really like how he uses modern economic and econometric techniques to tackle important public policy issues. However, we shouldn’t rely too heavily on the wisdom of the market in evaluating the effectiveness of the surge. While the aggregation of information that occurs in market pricing might be a better indicator than anecdotal evidence, ‘The Market’ doesn’t have superpowers that grant it access to information nobody else has. Many of the decision makers in that market likely have little more access to information about the surge than you or I. Aggregation tends to dampen the influence of extreme views but it doesn’t guarantee accuracy.

jamesz

Risky regulation in the dairy industry

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An article on Stuff reports that the government is choosing to do nothing about a potentially dangerous protein found in most milk produced by NZ cows. Apparently it would be very damaging to the NZ dairy industry to act on the rather uncertain scientific evidence, so the Food Safety Authority is downplaying the situation. The nutrition expert who wrote a report for the NZFSA says, “it does raise the whole question about how well… the question of uncertainty is dealt with by the authority” and partially attributes the problem to “government risk aversion com[ing] into play.” Risk aversion is well known to economists and is exhibited by most people; however, the government here is not exhibiting risk aversion at all.

What the government is doing is avoiding certain costs in favour of maintaining the dairy industry’s profits with a huge cloud of uncertainty sitting over them. Doing something about the protein now would be costly but would avoid any future risk of adverse scientific results hurting our exports. Doing nothing exposes the industry to the entire risk of such results. Why would the government act in such an apparently risk-seeking fashion? The answer comes from the field of behavioural economics and, in particular, prospect theory.

This theory was proposed by Daniel Kahneman and Amos Tversky to explain two observations pertinent to the NZFSA’s actions: loss aversion and risk seeking behaviour for losses. Loss aversion describes how people feel the pain of a loss far more keenly than the happiness of a gain of equal size. Tversky and Kahneman also found that, while people are risk averse for gains, they are risk seeking for losses. They will be willing to take huge risks in an attempt to avoid making any sort of loss. Taking these factors in to account perfectly explains the NZFSA’s behaviour: they are more than willing to take on the risk of future damage to NZ’s dairy industry in order to avoid the guaranteed losses of taking action now. Whether this is in the best interests of the country or the dairy is quite another matter as the comments in the article make clear.

Matt Nolan

The rational Chimpanzee

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So according to a recent study, Chimpanzees play the ultimatum game more ‘rationally’ than humans (hat tip Marginal Revolution).

For those who don’t know, the ultimatum game goes like this. There are two players, and a sum of money that can be split between them (say $1). The first player gives decides on how this dollar should be divided between the two of them. Given this division the second player decides whether to accept this division or reject it. If the second player accepts they divide the dollar, if the second player rejects the offer they both get nothing.

If both players only value the amount of money they get then the first player will set up the division so they give player two only an infinitesimally small amount. However, when humans play the game we find that they divide the dollar up quite evenly. Furthermore, we find that when people divide the dollar up very unevenly, the offer is rejected, even though that means player two misses out on some money.

When they say that Chimps play a more rational game than humans, they mean that chimps behave in the way closer to what we would expect if the agents involved only valued money. All this really tells us is that humans value concepts like fairness at a higher rate than chimps do. Hardly a surprising result.

However, this does make a good point for economists to take on board. Humans obviously do value fairness,. Part of this is instinct, and part of this is institutional. By institutional, I mean that it is a preference we have developed as a result of the society we live in. Although economists are happy to abstract from ideas like this, when we apply economic theory it is important not to forget about the social norms that people also value.

But more importantly, the social norms that are created through the application of economic ideas may eventually change the preferences of the individuals in society. Fairness is useful as it helps reinforce co-operation in situations where a prisoners dilemma occurs. If analysts introduce policy that undermines fairness, or in some way degrades the social norm of fairness, then the socially optimal co-operative result becomes more difficult to achieve. Even more fundamentally, how does the change in preferences influence the way individuals value things, could the loss of fairness as a social norm leave people feeling more upset ceteris paribus? I think this is what sociologists have been telling economists for a while.

Ultimately, I accept the idea that social norms are important in determining preferences, but academic economists have good reason for not looking at them. Academic economists want to focus on thing they feel that they can objectively measure, so that their work does not become value laden. Defining preferences is not value neutral, and so is steered away from in academic work (except maybe in Evolutionary game theory? Not that I would know 😉 ). However, economists that want to apply their ideas to reality must realise that societies affect on preferences is non-trival. This makes the questions of how a given policy will impact on preferences more difficult.

Matt Nolan

Nationalism, the All Blacks, and the 2007 World Cup

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Now remember, I hate nationalism. However, when I wrote this I found I was being strangely defensive of New Zealand. This made me realise that nationalism is just something that happens to people, often people aren’t explicitly trying to be nationalistic, society is just influencing the persons preferences in such a way that they become biased towards that nation.

After the recent loss by the All Blacks, a psychologist said that this was a ‘blow to the Kiwi tribe”. This idea has been criticised here, and in an update here. In the first criticisim the author says that he doesn’t feel like it’s the end of the world, therefore the psychologist is wrong. He seems to think that this influence on society may have existed 30 years ago, but not now. The second criticisim is from an author here. I agree with their article, that people mis-use statistics in order to make up stories.

Now I agree with the criticism raised by the second author (of course 😉 ), it seems strange to make such sweeping statements of national identity without evidence. However, at some level I think that the psychologist may have a point, albeit an obvious and not particularly enlightening one.

The psychologist is saying that there is a group that sees themselves as New Zealanders, and this group also feels very strongly about rugby. I agree that there are large numbers of people that do not associate themselves with this, however this group does exist. Furthermore, the importance of rugby to ‘New Zealanders’ is often placed on TV, taught in schools, and for someone who is brought up in NZ it does form part of the way that they identify the society that surrounds them.

In some sense, an individual’s preferences are partially endogenously defined by the society they grew up in. So even though a person makes choices based on their preferences, their preferences are a function of the way society is shaped. In this case a social event that occurs when an individual makes a utility maximising decision can influence the choice both by influencing the structure of the game or by changing the individuals’ preferences. Examples of this are:

  1. The values of the group you associate with are included directly in your own preferences. So when the NZ rugby team loses you as you feel like part of the team that did the losing.
  2. Although you do not have a preference over which team would win, you still want to function well in society. If you expect that an All Black loss changes the utility function and choices of other agents in the game, then you will respond by changing your behaviour

The first case is an example of when society defines an individual’s preferences. The second case is an example of when an individual will change their behaviour based on the belief of how other agents will react.

The idea of a ‘blow to the kiwi tribe’ relies on the fact that some individuals will take the result of the All Blacks game in the first sort of way. The loss of a rugby game must influence some New Zealanders preference set. Once we know that the loss of a game can influence the preference set of part of a given group, there is a case for other agents to change their behaviour as a result of the event, since the event will affect their expectations of the choice made by other agents. Ultimately, for there to be a ‘blow to the kiwi tribe’ the social event must provide a negative payoff from the part of an individuals preferences that are determined by society. I am not sure that the new social equilibrium post game must provide less ‘welfare’ than the pre-game social equilibrium, however I suspect in most cases it will be.

I prefer soccer to rugby by a mile, but I still felt hurt when the All Blacks were knocked out. As a result, on a personal level I can understand where this result the psychologist was discussing comes from. However, as the second author implied, it is sort of silly to make blanket statements without any evidence, especially when the above problem is likely to be full of assumptions that require us to assume cardinal utility! As a result, I don’t think it is appropriate to go from how the All Black loss affected me to how the All Black loss has influenced society.  This is the mistake the psychologist seems to have made.

jamesz

Left-wing libertarians?

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Leftie liberals tend to be in favour of government intervention in markets. They tend to claim it prevents abuse of market power by powerful firms. However, these self-proclaimed left wing economists write that

[l]abour-market flexibility, deregulation of the service industry, pension reforms and greater competition in university funding is not anti-equality. Such reforms … tend to increase productivity by basing rewards on merit rather than on being an insider. Pursuing pro-market reforms does not imply facing a trade-off between efficiency and social justice. In this sense, pro-market policies are “left wing”.

I think that they are confusing deregulation and competition. Here on this blog we are in favour of efficient competitive markets, yet often advocate regulation. The problem we see is that many markets do not generate much competition. Perhaps there are natural barriers to entry, or perhaps an incumbent has the market power to deter others from entering. In either case deregulation does not lead naturally to greater competition and one wouldn’t necessarily expect increases in efficiency when the government left the market to its own devices.

However, one can’t conclude that a market will do better when regulated simply because it is not perfectly competitive. As Alesina and Giavazzi point out, there can be perverse incentives created by government regulation that run contrary to the goals of the intervention:

The young are hired with temporary contracts which offer no social security … When the contract expires, the employer opts not to renew it, so as not to run the risk of having to convert temporary hires into permanent employees

Such cautionary examples should stop us from jumping on a bandwagon either in favour of, or opposing, regulatory intervention. There is no bullet that will solve an economy’s problems or it would have been done long ago. It is rarely possible to solve a difficult problem using sweeping generalisations as many politicians and ideologues would like to do.

Robbie Allan

All Blacks’ loss to France: Bad for families, good for the economy?

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It’s commonly believed in many countries domestic violence spikes following a loss in a major sports event. It’s easy to see why “facts” like this spread easily: they seem to stand to reason (we tend to be upset when our favourite team loses, and most people are more prone to violence when they’re upset), as well as being an implicit criticism of our obsession with sports. The problem is, these “facts” are often false.

In the US a few years ago a story did the news circuit about domestic violence increasing following Superbowl Sunday. While it’s a good story, on examination the facts seem to have been largely manufactured, and the contention is not supported by academic evidence.

In 2003 a similar story did the rounds here, originating from a study commissioned by the National Collective of Independent Women’s Refuges, and already the idea is being dragged out again as pundits of all colours weigh in on the effect of the All Blacks’ loss on the national psyche.

I haven’t been able to track down a copy of the NCIWR report, so I can’t comment on its relevance, but anecdotal evidence alone that domestic violence goes up after an All Blacks game isn’t enough. This is because All Blacks games tend to happen on the weekend, and it’s possible that domestic violence always goes up on weekends anyway. Moreover, domestic violence will fluctuate randomly from week to week, so to suggest that the All Blacks are having an effect on domestic violence, we need to be able to prove that the any increase in incidents (after adjusting day of the week, and any other known factors) is more than can be explained by random variation.

The fact is that most of the data that we see is influenced by many factors, so show that a one-off occurrence has an effect, we need to make the necessary adjustments for other known influences.

In the same way, the most recent Molesworth and Featherston newsletter goes out on a limb when it claims: “New Zealand has been dumped out of the world cup four times now. Each time, our economy has accelerated in the following quarter. We have won the world cup once – in 1987, immediately before the stockmarket crashed.”

While they’re being flippant, we can’t automatically conclude that the All Blacks are helping the New Zealand economy because the World Cup tends to be held right before Christmas, when the economy peaks anyway.

It’s often said that “there are lies, damned lies, and statistics”. Statistics aren’t bad in and of themselves, but they can be bad when they’re used wrongly. I’d prefer it if we acknowledged that there are “lies, damned lies, and bad statistics”.

 

Update: The Dom doesn’t fail to deliver: http://www.stuff.co.nz/4229264a10.html