Stumbling and Mumbling

Ideology in economics

Much as I admire both protagaonists, the debate between Simon and Jo on the role of ideology in economics left me cold. I’m not interested in whether economics is mainstream or heterodox.

To see my point, let’s take an example from outside macro – the capital asset pricing model. This is an elegant, internally consistent and well micro-founded theory.

And it’s wrong. In particular, we’ve known since the first tests of it that low-risk stocks do better than they should. This is weird: theory tells us there should be a trade-off between risk and return, but the facts tell us otherwise.

Herein, for me, lies the essence of economics – the collision between theories and facts.

There’s a parallel here between the CAPM and (some?) RBC models. Both are theoretically elegant. And both fail to survive contact with the real world. Just as the great performance of defensives undermines the CAPM, so the existence of involuntary unemployment rejects RBC theories: the unemployed are significantly less happy than those in work – and in fact unhappier than the divorced or disabled.

But why is the CAPM wrong? There are some nice theories (pdf). But I want to draw your attention to a recent paper by Michael Ungehauer and Martin Weber at the University of Mannheim which I think is a model of good economics.

They show that a key assumption of the CAPM is wrong. The CAPM assumes that investors measure market risk by beta, the covariance of a stock with the market. But Ungehauer and Weber show that people don’t measure risk this way. Instead, they assess correlations by using a simple counting heuristic: how often does a stock co-move with the market? This leads to different measures of risk, because it underweights the importance of large price moves.

They established this first by experiments. Then they applied their theory to US data. And they found that if stocks’ riskiness is measured by the frequency of co-movement with the market, there is indeed a trade-off between risk and return. It’s just that, contrary to the CAPM, risk isn’t measured by beta.

In this sense, there’s another analogy between the CAPM and RBC theory. The CAPM says that agents’ view of risk is determined by beta; RBC theory says their view of the future is determined by rational expectations. For me, both claims must be tested against the facts.

I appreciate that I might just be expressing a personal taste here, but I don’t give a toss whether a theory is elegant or not, or mainstream or not. For me, what matters is: does it fit the facts? And: does it work? My response to elegant theories is often like that of Andrew Tyrie to Boris Johnson: “This is all very interesting, Boris. Except none of it is really true, is it?”

Now, you might find this surprising. We Marxists are supposed to be spittle-flecked ideologues, and yet here I am demanding facts and utility.

But of course, there’s no paradox at all. As a Marxist, I have no skin in the game of whether the CAPM or efficient theory is right or not: such matters are orthogonal to my concerns qua Marxist. And in fact even if Robert Lucas’s main points were right – that business cycles are an optimum response to technology shocks with little welfare cost – a lot of Marxism would survive. Such claims are consistent with the notion that capitalism is exploitative and alienating and leads to unacceptable inequalities of wealth and power.

It’s sometimes said that Marxism brings ideology into economics. For me, though, it takes it out.

On the doctrine of signatures

In pre-modern times, people believed in the doctrine of signatures. This was the idea that the cure for an ailment must resemble the ailment itself. So, for example, eyewort was used as a remedy for vision problems and toothwort for toothache because the flowers of those plants resembled eyes and teeth. As Thomas Gilovich and Kenneth Savitsky write:

Historically, people have often assumed that the symptoms of a disease should resemble either its cause or its cure (or both). In ancient Chinese medicine, for example, people with vision problems were fed ground bat in the (typically) mistaken belief that bats have particularly keen vision and that some of this ability might be transferred to the recipient (p685 of this big pdf).

There was just one problem with this – it was wrong.

However, although modern medicine has corrected this error, we still see it in economic policy. What Gilovich calls the “like goes with like” dominates popular attitudes to economic policy. For example:

 - American voters who believe cheap imports have depressed domestic wages support the introduction of tariffs.

 - People who believe (mostly wrongly) that immigration has depressed wages favour immigration controls.

 - Leftists support higher minimum wages as a solution to low pay.

 - People blame the Bank of England for low interest rates rather than global secular stagnation or tight fiscal policy.

 In these cases we see a modern version of the doctrine of signatures – the belief that the cure must resemble the ailment. So higher import prices are the solution to cheap imports; higher minimum wages the solution to low pay; monetary rather than fiscal policy is to blame for low interest rates, and so on.

And just as the doctrine of signatures was wrong in medicine, so it is in economics. Even if tariffs or minimum wages would do some good, there are better alternatives. To the extent that immigration or cheap imports raise inequality, a better solution might be more redistributive tax and benefit policy. And it’s better to help the low paid by increasing demand for labour through expansionary macro policy and by increasing their bargaining power than by minimum wages or immigration controls.

So, why don’t people appreciate this sufficiently? It’s not just the lousy lying media that’s to blame. It’s because the same representativeness heuristic that underpinned belief in the doctrine of signatures is also at work here: people believe that effects must resemble causes. They are, David Leiser and Zeev Kril have shown, bad at connecting economic phenomena. Instead, says Leiser, public attitudes to the economy are shaped by a “good begets good” heuristic (pdf) – the idea that good things have good effects. That’s very similar to the “like goes with like” heuristic described by Gilovich and Savitsky.

I fear, however, that this is a case where diagnosis is easier than cure. It’s easy to see that popular attitudes to the economy are mistaken, but much less easy to see how they might be corrected, especially when so many people have an interest in not correcting them. It took the medical profession centuries to rid itself of the doctrine of signatures. It might take as long for public attitudes to economic policy to improve.

Tariffs vs exchange rates

The apparent popularity of Donald Trump’s demand for protectionism raises a question: why haven’t exchange rates done the job they were supposed to?

I ask because one justification of floating exchange rates back in the 1970s was that they would render protectionism redundant. If a country ran a trade deficit, the thinking went, its exchange rate would fall, thus improving its competitiveness and pricing its workers back into jobs. As one of my old textbooks put it:

If the exchange rate is free continually to equilibriate the balance of payments, a country’s policy-makers should not have recourse to protectionist devices for balance of payments reasons: the freeing of exchange rates should usher in a period of more liberal trade (Ronald MacDonald, Floating Exchange Rates, p4)

For a long time, this looked valid: trade barriers have indeed fallen since the 70s. So, why is there now a call for tariffs rather than for exchange rate adjustment?

You might think the answer is simple: China has fixed its exchange rate to keep it artificially low and therefore its exports cheap.

But this isn’t entirely true. China has fixed its nominal exchange rate. But because it has had higher inflation than elsewhere, its real exchange rate has risen a lot – by over 40% in the last ten years according to BIS estimates.

You might think that even this appreciation hasn’t been sufficient: perhaps the US’s status as a reserve currency under the “Bretton Woods II” system has sustained demand for dollars and so prevented the US dollar falling as much as it should.

Maybe – although this overlooks the fact that the US’s lack of competitiveness because of high wages is greatly offset by the advantage it enjoys of cheaper energy.  

But perhaps there’s another reason. Maybe exchange rates don’t equilibriate the balance of payments after all. Let’s suppose China were to greatly revalue its currency? Would more expensive Chinese exports thereby improve the lot of US workers? Yale’s Ray Fair has used his econometric model to answer this. His finding is that:

The net effect of the yuan appreciation on U.S. output and employment is close to zero—in fact slightly negative. (p194 of this pdf)

There are two reasons for this. One is that a rise in the yuan would cut China’s output generally, and this would reduce US exports. The other is that dearer Chinese imports would raise the prices faced by US consumers, thus reducing their real incomes. These factors offset the tendency for a dearer yuan to make US goods more competitive.

This suggests that there might be a grain of truth in the call for tariffs, insofar as exchange rate adjustments don’t work.

But of course, only a grain. There are many better ways of helping unskilled workers: looser macro policy, welfare reform, a jobs guarantee and so on. Such policies have the added virtue of protecting such workers from the myriad (and I think greater) other threats to their livelihoods.

Rather than say this to endorse Trump, I do so to attack the mainstream. The presumption that free markets and floating exchange rates would protect workers from cheap imports might well have been wrong, and it distracted attention from the need for policy interventions to help the (minority of) workers hurt by them. In this sense, Trump’s victory represents a failure of centrist policy-making.

Ed Balls & modern "politics"

Ed Balls’ performances on Strictly Come Dancing shed more light upon politics than is generally appreciated.

What I mean is that Balls the politician was presented as an unsympathetic figure. “Bruiser” and “bully” were common descriptions, and his coining the phrase “post-neoclassical endogenous growth theory” gave the impression of being a pointy-headed technocrat. He embodied the Oxbridge elite that is supposedly out of touch with the common man.

And yet on Strictly his performances have been “a rare delight to brighten our weeks”. He’s charming, popular and funny: we’ve been laughing with him, not just at him.

Which poses the question: how can there be such a massive difference between Balls the politician and Balls the dancer?

It’s tempting to blame the media. After all, the same journalists who painted so unsympathetic portrait of Balls also made a public schoolboy who doesn’t listen to music or watch TV into a man of the people, and a serial liar and friend of a criminal into a loveable buffoon. The BBC, of course, has been complicit in this misrepresentation, and remains so: just listen to how John Humphrys usually aggressive interview technique deserted him this morning (2’09” in) when faced with a Trump crony.

But perhaps there’s something else. Balls the politician made a terrible mistake. It’s the same error Ed Miliband is making when he calls upon the left to “rebuild with deep thinking”. This mistake is to take politics seriously.

Doing so has two costs. One is that being serious commits you to some principles and a vague commitment to the truth as you perceive it. This puts you out of touch with ordinary voters with your truth conflicts with theirs, and makes you inflexible. By contrast, the Tories lack of interest in ideas allowed them to shift from being a party of the metropolitan elite to appearing as a sort of Ukip-lite. And it enabled Trump to tell his voters what they wanted to hear, regardless of whether he can or will enact his promises.

The other cost is that it means you come across badly on TV. If you prepare well for interviews and try to make serious points, you’ll look humourless and out of touch. The Johnson cheeky chappie approach works better.

Political success is achieved today by treating public life as a game, as a jolly jape. Taking it seriously destines you to failure.

Again, the BBC is complicit in this. It invited Marine Le Pen onto the Marr show not out of a deep interest in French politics but because it knows that fascism sells. It booked Le Pen rather than Alain Juppe (the favourite to be next president) because it thought it would be “good TV”. And it rewards politicians like Johnson who play along with this aim.

The idea that the BBC’s politics output is high-minded is nonsense. It is part of the entertainment business just like Strictly is. The difference is that Strictly is good entertainment.

On Burkean Marxism

“We are afraid to put men to live and trade each on his own private stock of reason; because we suspect that this stock in each man is small, and that the individuals would do better to avail themselves of the general bank and capital of nations and of ages.” Commenters on a recent post of mine have pointed out that my awareness of individuals’ limited cognition echoes that famous claim of Edmund Burke, and wonder how a Marxist can express such a sentiment.

The question’s a good one. Anyone who doesn’t feel the force of Burke’s point is a bumptious prat who knows nothing of history, politics or psychology. If Burke and Marx are incompatible, that’s bad for Marx.

But are they incompatible? Perhaps not.

First, a distinction. We Marxists are fighting both defensive battles (against inequality and reaction) and offensive ones. In the defensive battles, we are and have been certainly on the side of Burke whilst the right is against him. For example, Harry Braverman’s account of deskilling by Taylorite management is a defence of traditional craft knowledge against a form of rationalism. Our support of coal mining communities against the Thatcherite attack in the 1980s was a defence of Burkean small platoons against sophists and calculators. And our resistance to the managerialist-neoliberal attempt to revolutionize universities is a Burkean defence of tradition against arrogant know-alls.

In these respects, Marxists are the Burkeans and neoliberals and Tories have been the anti-Burkeans.

There’s more. One reason why I’m a Marxist is that I doubt that capitalism can be greatly improved by moderate reforms. That arises from a Burkean scepticism about rationalist scheming.

Which runs into the question: isn’t communism the most hubristic rationalist scheme of all? Isn’t there therefore a flat contradiction between Marx and Burke?

Not necessarily. Except for a few policy proposals in the Communist Manifesto (some of which were subsequently enacted) Marx notoriously did not provide a blueprint for a communist society and was rude about those who did. Instead, he wrote:

We do not anticipate the world dogmatically, but rather wish to find the new world through the criticism of the old…We do not confront the world in a doctrinaire way with a new principle: Here is the truth, kneel down before it! We develop new principles for the world out of the world’s own principles.

Burke wrote that “the individual is foolish, but the species is wise” – a claim we now know to be true only under special conditions. You can read those words of Marx as seeing the process of socialism as an attempt to unlock the wisdom of the species.

Many leftists today think of the transition to socialism in these terms. Erik Olin Wright has written (pdf) of “interstitial transformation” – building and then expanding socialistic institutions. In this spirit Paul Mason has written:

Capitalism, it turns out, will not be abolished by forced-march techniques. It will be abolished by creating something more dynamic that exists, at first, almost unseen within the old system, but which will break through, reshaping the economy around new values and behaviours.

In this sense, the transition to socialism will be a modest process of trial and error. That’s consistent with a Burkean scepticism about our ability to foresee what will work.

There’s something else. A big gripe Marxists have with capitalism is that it is a system of domination; in the workplace and in politics, only a few have effective power. By contrast, under communism such domination will cease; communism is a society “in which the free development of each is the condition for the free development of all.” In this sense, communism replaces the rule of foolish individuals with that of the wise species. It therefore facilitates Burkeanism in a way which capitalism cannot.

Of course, Burkean epistemology has often been used as a tool of reaction and conservatism. But it needn’t be so.

Is globalization to blame?

Donald Trump’s victory is being seen as a backlash against globalization. For me, this poses the question: to what extent is globalization to blame for the decline in many workers’ real incomes?

The answer, I suspect, is: not much. These papers by Ann Harrison and colleagues (pdf) and Jonathan Haskel and colleagues (pdf) show that it is very hard to link declining US real wages to increased openness to trade. Equally, it is unproven (to say the least) whether increased immigration has contributed to falling wages: George Borjas’s claim that it is has has been sharply challenged (pdf).

Common sense should also make us doubt whether globalization is to blame.

For one thing, cheap imports should help workers. If you’re spending $5 on a Chinese T-shirt rather than $10 on a US-made one, you’ve got $5 more to spend on other things. That should increase demand and jobs. And insofar as it cuts inflation, cheaper imports should allow real interest rates to fall – which should increase economic activity and jobs. And this is not to mention that globalization has probably cut interest rates in another way since the 1990s, thanks to the Asian savings glut.

Such doubts about the adverse effects of globalization are reinforced by casual empiricism. The pace of globalization – measured by growth in world trade - has slowed markedly since the financial crisis. But US real wages, until very recently, haven’t improved. This tells us that other things might have depressed wages of ordinary Americans.

What might these be? Here are seven other suspects (there might well be more), some of which date back years and some of which are more recent:

 - The decline of trades unions. This has increased inequality not just by depressing workers’ pay (pdf), but by increasing bosses' pay by weakening one constraint upon their rent-seeking.

 - Financialization. For example, increased corporate debt, especially in the 80s and 90s incentivized firms to cut costs aggressively. Englebert Stockhammer estimates (pdf) that this was a more important factor in depressing the share of wages in GDP than globalization.

 - Skill-biased technical change (pdf). Since the 1980s, new innovations have increased demand for skilled workers rather than for unskilled ones.

 - Power-biased technical change. Innovations such as CCTV, containerization and computerized tills have given managers more direct oversight of less-skilled workers, which has removed the efficiency wage element of their pay.

 - Lower minimum wages. The real value of the US minimum wage is 20% lower now than it was in the 1970s.

 - A meaner welfare state. In incentivizing people to find work, cuts in welfare benefits have reduced wages by increasing labour supply and weakened workers’ bargaining power by worsening their non-work options.

 - The productivity slowdown. In the last five years’ labour productivity has grown by just 0.7% per year, compared to 2% per year in the 30 years before the 2008 crisis.

 All this poses a paradox. Although the economic evidence suggests that globalization is, at most, only one of many contributors to the declining fortunes of middle America, it has dominated the political debate to the exclusion of those other factors. Why might this be? At least part of the answer is that it suits some people very well for foreigners to get the blame rather than for inequality and the health of capitalism to come under scrutiny.

Does character matter?

Trump’s election victory has been regarded as a defeat for pollsters and the liberal elite. But there’s another group who should worry about it – HR managers. This is because Trump’s presidency is a big and public test of a hypothesis: of whether past character predicts job performance.

Imagine you were hiring a senior manager. The following candidate pitches up. He has no directly relevant past experience: Trump has never held elected office. He has little understanding of what the position entails; Trump’s grasp of the constitution is shaky. His past business management has resulted in several bankruptcies and unpaid debts. He has confessed to sexual harassment. And this is not to mention the narcissism and sociopathy.

Many HR managers would tell us they wouldn’t let such a candidate through the door.

Which poses the questions. How, then, can Trump be anything other than a disaster as president? If he isn’t wouldn’t this suggest that all the effort spent screening candidates is a waste of time and money? Why not just pick them at random? (I suspect the median American is of better character than Trump).

The answer to this lies in the possibility that Trump’s character might not be a complete liability, in at least three ways:

 - In a president, being representative of the people, who themselves are ignorant and prejudiced, is desirable. There’s something in the Bill Stone theory of democracy.

 - There are checks and balances. Not only are there constitutional constraints on what the president can do, but the president also has access to the best advice, if he wants it. Mervyn King said that being Governor of the Bank of England “is actually the easiest job I’ve ever done…you’ve got tremendous support.” Whilst this isn’t entirely true of the presidency – he’ll find lots of opposition! – he can have a strong support network to smooth out the impact of his character flaws.  

 - Policy matters more than character. If Trump can invest well in infrastructure and simplify the tax code whilst his promises on protectionism and immigration control get diluted, he might not be an unmitigated catastrophe.

Psychologists believe there is only a weak link at best between measurable personality traits and job performance. And the fundamental attribution error cautions us that we often over-rate the importance of personality and under-rate that of the environment. Let’s hope Trump’s opponents are making this mistake.

Now, I must caveat this. A big part of why character matters is that it might help predict how a man responds to surprises. If we’re lucky, the surprises a Trump administration gets will not highlight his flaws. (If were’ not…)

 Nevertheless, there is an important question here that applies far beyond Trump: how far does character matter? Mightn’t policy and circumstance matter more? Can personality be restrained or enhanced by institutions?

The answers, of course, differ from time to time, place to place and job to job. It is insofar as such differences exist that a successful-ish Trump presidency would not invalidate traditional hiring practices. But then again, plenty of narcissists and psychopaths do become CEOs. So perhaps the American electorate isn’t so different from HR bosses after all.

My Trump fear

There’s one man whose work seems to be vindicated this morning – that of Ben Friedman. Back in 2005 he wrote (pdf):

Economic growth—meaning a rising standard of living for the clear majority of citizens—more often than not fosters greater opportunity, tolerance of diversity, social mobility, commitment to fairness, and dedication to democracy…But when living standards stagnate or decline, most societies make little if any progress toward any of these goals, and in all too many instances they plainly retrogress.

The election of Donald Trump seems to confirm this theory. It is perhaps the most morbid symptom of secular stagnation.

Now, I appreciate there’s some resistance to this idea. A Gallup poll has found that Trump’s supporters are reasonably well-off – albeit not as much so as the finding that his supporters in the primaries have an average household income of $72,000 would suggest. And Ezra Klein points out that Trump supporters (like Brexit voters) tend to live in areas of low immigration.

Such facts, though, are consistent with Jason Brennan’s theory that voters are sociotropic: they vote not in their personal interest but in the national interest as they perceive it. And as Simon says, these perceptions are distorted by media lies.

Those lies, though, contain a germ of truth – that median incomes have been stagnating for years. Although they have picked up recently, they are still below their late 90s levels*. Trump has exploited the anxiety that this stagnation has generated – for the country if not so much for his individual voters' pocketbooks.

Which brings me to my fear. What if Trump proves unable to reverse this stagnation? What if protectionism (and the fears thereof that might depress business investment) and tough immigration controls depress incomes by more than looser fiscal policy raises them? Or what if the forces of secular stagnation simply keep income growth down?  

It would be nice to think that, in such an event, voters would infer that closed borders are the wrong way to reverse stagnation and that more liberal egalitarian methods must be tried instead and so there’ll be a backlash against Trump.

This, though, is naïve. When people are confronted by evidence that contradicts their beliefs, they often do not revise those beliefs but instead double down on them and become more dogmatic: this is the backfire effect or asymmetric Bayesianism. Picture the scene in 2020:

Fact: the US economy has performed poorly.

Response: “This only shows that we haven’t done enough to protect the economy from cheap foreign competition or to reduce immigration. We need to get tougher.”

This, surely, is more likely to be the response of Fox News than an admission of failure. As Max says:

Trump might satisfy some of his base (as Tory Brexit will satisfy to some extent the ‘left behind’ in this country) but nothing will ever satisfy the true believers, because while we can do more to stimulate domestic industry and control immigration we cannot reverse time or socially engineer a lost country. There will be more bitterness, more resentment, more backlash.

Normally, political partisans hope that their opponents fail in office. Such a hope should be resisted. A successful Trump presidency might be as unpleasant as it is unlikely. But I fear that a failed one would be worse.  

* The recent pick-up is consistent with Friedman’s thesis, if it is long periods of growth or the lack thereof that influences ideology rather than shorter-term fluctuations.

The opportunity cost of Brexit

There’s one possible effect of Brexit that I suspect hasn’t had the consideration it merits – the opportunity cost.

What I mean is that all of us – politicians, journalists and regular folk – have limited attention and mental resources. Attention devoted to Brexit is therefore attention that’s taken away from other matters. And given that state capacity is also limited, if our best civil servants are working on Brexit (which is an if) then they are not focusing on other policies. Brexit steals cognitive bandwidth.

For example, in a better world, we’d devote our political attention to overcoming secular stagnation, welfare reform, combating inequalities of power and income, improving workers’ rights and so on. As it is, attention is focused on trade deals, our relationship with the single market, countless treaty renegotiations and so on – all of which are efforts merely to avoid losses, something which could have been more simply achieved by a Remain vote. Rather than turn our attention to progress, we’re wearing ourselves out trying to avoid regress.

Brexit distorts the policy agenda in other ways. For example, industrial policy should be concerned with increasing productivity and innovation. But in fact, it’s focused upon limiting the damage of Brexit, perhaps by offering handouts to favoured big firms whilst letting smaller ones swivel in the wind.

And then there’s the question of the values promoted by the Brexit debate. Brexit fuels nativism and even perhaps mercantilism, whilst the policies it squeezes out would focus instead upon more enlightened ideals such as liberty and equality.

All this, however, poses the question: is there really an opportunity cost here at all? Might there instead be an opportunity benefit?

All the above assumes that we are on a kind of policy production possibility frontier, so that Brexit means less good policies or administration elsewhere. But what if we are in fact well inside the frontier? Then Brexit – far from being a barrier to good policy elsewhere – might actually help it.

For example, had we not had Brexit Cameron and Osborne would still be in office so we’d be stuck with fiscal austerity. As it is, their departure has created space for a “reset” of policy. If Johnson and Fox were not tied up with Brexit negotiations, they’d probably find some ways to damage our polity. And a government whose energies and political capital weren’t sapped by Brexit might well have even more ability to hurt the worst off.

Which brings me to a paradox. We lefties can be quite relaxed about the opportunity cost of Brexit. Yes, Brexit is regrettable, but it has the silver lining of distracting the Tories from doing damage elsewhere. Tory supporters, however, have no such comfort. They should regard Brexit as a distraction of government energy which could be well-employed elsewhere. In this sense, it is intelligent Tories who should most regret Brexit.  

Knowledge vs rationality

One question posed by Jason Brennan’s Against Democracy is: who should be the epistocrats?

Ideally, of course, they would be informed and rational. But these are two different things. Which means we have four categories of people* as my diagram summarizes.

In the top left we have the informed and rational. These are proper experts (who might, of course, be only a subset of those who appear to be expert). But here’s a problem: there are no general purpose experts. Some of you might think I’m tolerably rational and informed about a few economic issues, but I’m ignorant about foreign and legal affairs – just as experts on those might know little about economics. This is a problem, as people who are rational and informed on some matters can be as daft as a brush in other contexts.

In the opposite corner we have the ignorant and irrational. Perhaps the most dangerous of these are those prone to the Dunning-Kruger effect: those who don’t realize that they are ignorant.

It is, however, the other corners that interest me. In the top-right we have the informed but irrational. These include some people whose perhaps genuine expertise in one field emboldens them to consider themselves more general experts; think of dinner party bores and some guests on the BBC's moron-yak shows.

But there’s another group in this category: people who are befuddled by their own knowledge. Take two examples from investing. Even financially literate and intelligent retail investors make expensive mistakes, such as trading too much or investing in poorly-performing high-charging funds. And even quite short runs of good returns can make investors “dizzy with success”: their good performance emboldens them to take too much risk. In such cases, moderate knowledge creates an illusion of knowledge and overconfidence.

This can happen in politics. Thatcher’s successes (by her own lights) in the 80s led her to introduce the poll tax, which destroyed the Tories in Scotland for a generation and contributed to her losing her job. And Blair’s successful interventions in Kosovo and Sierra Leone led him to think he could repeat the trick in Iraq.

In the opposite corner from these, we have those who are rational but ignorant. Exemplars of this include Charlie Munger and Warren Buffett. One of their strengths is that they know their “circle of competence” and try not to stray outside it. This means they avoid lots of businesses which they don’t understand but stick to principles they know that work – namely, using (pdf) their insurance float to take cheap geared positions in defensive stocks, a trick retail investors can only half-emulate.

Another example of rationality and ignorance is the Brainard principle – the idea that, faced with uncertainty one should do less than one otherwise would. Although this is associated with monetary policy it has wider relevance. For example, if I were conducting foreign policy I would set an extremely high bar for engaging in military action. Such a rule would risk not intervening in cases where one could do good. But it would avoid catastrophic engagements.

The general idea here is that the rational but ignorant stick to rules which require inaction in many circumstances.

This brings me to a problem with epistocracy: what if true experts are scarce? One danger is that if you call some people “epistocrats” they’ll believe they are experts when they are not and so commit the errors that arise from overconfidence.

Personally – given the choice in a second-best world - I’d prefer rulers to be rational but ignorant than informed but irrational. But this poses the question: do we have the rules and institutions that best mitigate the problems that arise when informed rationality is absent?

* Of course, there isn’t a sharp divide between rational and irrational or between the informed and ignorant: we lie on a spectrum between the two. I’m simplifying.

Against Democracy: a review

Should everybody have a right to drive? Most of you would say not. Some people are incompetent, reckless or drunk drivers who endanger others. They should be kept off the road for everyone’s safety.

Jason Brennan’s argument in Against Democracy is that what’s true of driving is also true of voting. Some voters are so irrational and ill-informed that their preferences endanger the rest of us. Just as we have a right to be protected from bad drivers, so we should be protected from bad voters. He favours epistocracy – rule of the knowledgeable – over democracy.

I find his argument only half-convincing. He’s strong at showing just how badly informed voters are. He’s also good at undermining the conventional arguments for a right to vote. For example, because your vote almost certainly won’t affect the outcome of an election, you lose no power by being denied a vote. Nor are your rights of self-expression limited: you can express yourselves in countless other ways.

What’s more, he says, political expression often brings out the worst in us. He cites Shanto Iyengar and Sean Westwood’s research (pdf) which shows extreme polarization between Democrats and Republicans, but a moment spent watching Question Time would also vindicate him.

Nor, he says, would unequal voting rights undermine equality of status. For example, I might know more about economic policy than my plumber. But this doesn’t and shouldn’t mean I’m a better person than him, any more than his superior knowledge of plumbing makes him my superior. Brennan says:

We should stop viewing the right to vote as a badge of equal status and instead regard it as having no more symbolic power than a hunting or plumbing licence.

Brennan is also unworried by the possibility that an unequal franchise would give more votes to (say) richer white men than to black women. For one thing, he says, if this is the case it’s the product of past injustices and is an argument for rectifying those.

I’m unsure of this. Certainly, the fact that gender, class and racial injustices have persisted for decades after women, workers and blacks have had the vote suggests that universal suffrage isn’t sufficient to achieve justice. But might it be necessary? Brennan thinks not. He argues that people don’t vote in their self-interest, so under-represented groups would be protected by others. I'd prefer stronger safeguards.

Where Brennan is persuasive, I think, is in arguing that our right to competent government is stronger than a right to vote. As he says:

Just as it would be wrong to force me to go under the knife of an incompetent surgeon or sail with an incompetent ship captain, it seems wrong to force me to submit to the decisions of incompetent voters.

However, I have two big gripes with his theory.

One is that he seems vague about the form of epistocracy.

One possibility he suggests is that voters should set ends and informed politicians should choose means, as a man might tell a ship’s captain his destination but allow him to choose how to get there. For me, this doesn’t work. What if the ends are unattainable? And is there a distinction between ends and means? For example, is Brexit an end in itself or is it a means?

Another possibility is that bad candidates whom the voters choose can be vetoed by an “epistocratic council.” This seems impractical. Can you imagine what would happen if Trump were to be elected president but an “elite” were to prevent him taking office?

Merely raising this question highlights a virtue of democracy which Brennan under-rates: it is a way of keeping the peace by placating the mob.

We might, however, read Brennan in a different way. Our actually-existing democracies have in fact always had epistocratic elements. In a parliamentary democracy our elected representatives should exercise superior judgment on our behalf. (And if they don't, that's because epistocracy doesn't go far enough). And independent institutions – such as central banks and the judiciary – help to prevent bad choices. One can read Brennan as a defence of these epistocratic institutions against referenda and populist sentiments. And this makes his book so very valuable now.

"The will of the people"

Brexiters’ reactions to the High Court’s ruling that parliament must vote before the government invokes Article 50 give us a clearer idea of what they meant by “taking back control.”

Dominic Raab says the ruling is “a plain attempt to block Brexit by people who are out of touch with the country.” Nigel Farage speaks of “betrayal” – and just look at some of the comments he attracts. And Suzanne Evans says:

How dare these activist judges attempt to overturn our will? It's a power grab & undermines democracy. Time we had the right to sack them.

“Taking back control”, it seems, means that the will of the people – as they interpret it – must not be constrained by the judiciary or parliamentary scrutiny. Evans’ demand to sack judges should be seen in the context of opposition to the independent Bank of England and the demand that Remain “traitors” be “silenced”. They are totalitarian demands to quash opposition or independent scrutiny.

This runs into several problems. One is that they just aren’t true. As Jolyon points out, a parliamentary debate will actually plug a democratic deficit by revealing what Brexit means.

Also, the Brexiters’s whines are unBritish. They are alien to our traditions and constitution, which recognise the independence of the judiciary and that it is parliament that is sovereign, not the “will of the people”. The High Court’s ruling was an assertion of “the fundamental constitutional principles of the sovereignty of parliament.”

I’d add that the Brexiters are also anti-Thatcherite, as she was opposed to referenda. In 1975 she said:

Our system, which has been copied all over the world, is one of representative Government under which those who have not time to look into every detail of this or that Bill choose people who are honourable and with whose opinions they are in harmony to discuss these matters. That has been our system of Government for many years, representative Government in which the representatives consider and discuss all the points in detail. In a popular vote, the voter expresses an individual opinion. In a representative institution, the representative would be expected to consider the interests of minorities and see how the separate measure fitted into the whole. I believe that if we have a referendum system, minorities would not receive anything like such a fair deal as they have under the existing system.

Which brings us to a paradox. Since Thatcher said that, there’s been mounting evidence that voters are ill-informed – not just about the EU but about everything - and irrational: they are prone to more cognitive biases than you can shake a stick at. Yes, there are conditions under which crowds can be wise, but these are only occasionally satisfied.

You’d expect, therefore, to see less respect now for the “will of the people” and a greater valuation of the separation of powers and of forms of rational deliberation which parliament can – albeit only very occasionally – provide. Thatcher’s position should therefore be stronger now than it was then.

So why isn’t it?

The answer, I fear, lies in a deterioration in the British character. Many of us (and not just Brexiters) have become narcissistic over-entitled fanatics. Like spoiled children, they scream and scream “I want, I want”, oblivious to the fact that such wants require rational scrutiny.

This is not an environment in which serious politics is possible.  

Socially influenced preferences

This morning, Jo Michell tweeted:

Preferences are mostly socially determined. i.e. the opposite of what the textbooks say.

In a general sense this is trivially true. No middle-aged Victorian gentleman wanted a Martin guitar or Brennan B2 as one of their 21^st century counterparts does.

However, we have lots of finer-grained evidence on this point.

Some of it comes from investment decisions. Common sense, and standard financial advice, says that these should depend upon individuals’ taste for risk. But there’s more to it than this.

Some experiments by Matteo Ploner and colleagues established this*. They offered subjects choices among bets, and found that when the subjects were told what the average choice of others was, they moved towards that choice.

This experiment has external validity. Hans Hvide and Per Ostberg show that people own similar shares to their colleagues, and when they change job, they buy shares similar to those owned by new colleagues. This isn’t because their colleagues know something they don’t: such shares do not out-perform. Other research suggests that herding is more common with investors who have suffered recent losses, suggesting that doubts about one’s own competence lead people to follow the crowd. In a similar vein, Ben Jacobsen and colleagues show that peer effects are a bigger influence upon asset allocation decisions than individuals’ personal circumstances.

We also have evidence that consumption decisions are partly socially determined. US research suggests there is a “keeping up with the Jones” motive. And some nice Dutch research shows that when someone wins a car in a lottery, his neighbours are disproportionately likely to buy new cars for themselves.

We have plenty more evidence. Experiments suggest that the choice of how hard to work is influenced by peers. So too are decisions about one’s health – people are more likely to be obese if friends and neighbours are. And so too are educational choices such as what (pdf), where (pdf) and how much (pdf) to study.

What are the mechanisms here? One possibility is that people just want to fit in. Another is that our  perceptions of what’s true are shaped by others. The latter, however, can badly mislead us: Solomon Asch’s study found that people’s decisions about a trivially obvious question – the length of different lines – can be influenced by others. This paper (pdf) suggests that both mechanisms can be important.

In saying all this, I don’t intend to say that our preferences are wholly or even, as Jo claims, “mostly” socially determined: in Asch’s experiments, only a minority of subjects either always or never conformed.

Nevertheless, the evidence is sufficient to suggest that people’s choices might not reflect their best interests. And this brings into doubt not just conventional welfare economics but also some justifications for democracy.  

* I know some of you have doubts about the relevance and replicability of experiments. But in this context they have a great virtue, of allowing us to overcome the problem that people acting similarly might be due to a “like attracts like” effect rather than a pure peer effect.

On the counting heuristic

Simon asks for a sense of proportion about the allegations of Hillary Clinton’s misuse of emails:

The media obsesses over whether Clinton might have sent an email containing confidential information from her personal account while secretary of state, and also wonders about whether Trump tells lies, pays any taxes, bribes officials and assaults women. Anyone who reads these stories can see that there is no equivalence here. But anyone who just reads the headlines would be tempted to think otherwise.

There might be a more widespread cognitive bias at work here. We can call it the counting heuristic – a tendency to judge things by frequency rather than impact. Here are three examples:

 - A lovely paper by Michael Ungehauer and Martin Weber shows that people evaluate correlations between asset returns simply by looking at the frequency of co-movement. This can lead them to under-estimate correlations by putting too little weight upon a few large moves. But in risk management it is these moves that matter: a stock that falls only slightly when markets slump is worth having. Neglecting this causes defensive stocks to be under-priced.

 - In the mid-00s, a long run of stable returns led banks to presume that mortgage derivatives were relatively safe. They therefore under-estimated tail risk – the small chance of disaster. Investors and corporate managers can under-estimate the importance of low-frequency, high-impact events in non-financial firms too.

 - The peak-end rule tells us that we look back more fondly upon a nasty experience if it is followed by discomfort than if it suddenly ends. For example, colonoscopy patients who had the scope left in for a few minutes at the end of the procedure evaluated their experience as less unpleasant than those who had it immediately removed. In this way, the duration of an experience can mislead us as to its impact.

These experiences all imply that a steady drip-drip of minor allegations such as those against Clinton can weigh more heavily in people’s minds than more serious allegations – just as the drip-drip of small co-movements distracts people from important large co-movements, or frequent small returns distract people from the risk of big losses, or a frequent discomfort can cause them to misremember real pain.

One simple question should help us combat the bias generated by the counting heuristic. Just as the first question you must ask of any statistic is: is that a lot or a little? So we must always ask of any news story: so what?

Size matters. For example, the countless stories about Clinton’s misuse of emails (which might be exaggerated by the error of correlation neglect) pose the question: is a neglect of bureaucratic protocols really more serious than tax-dodging and sexual assault?

This over-weighting of frequency and under-weighting of impact has also infected UK politics. Here are four examples:

 - In the 2015 election campaign there were numerous stories about the “cost” of Labour’s policies. Such stories generally failed to point out that these costs were much smaller than the cost of Tory austerity.

 - The frequency of stories about benefit fraud obscures the fact that the “cost” of such fraud is in fact low – and in fact, is often a transfer from tax-payers to companies or landlords.

 - Tory attacks on the Bank of England pose (but do not answer) the question: even if we grant that there have been monetary policy errors, how big are these relative to the cost of fiscal policy errors or Brexit?

 - The tabloids’ fuss about some migrants falsely claiming to be children raises the question: so what if we let into the country a few 20-something refugees?

My point here should be a trivial one – that quantification matters. However, the interaction of a vicious media with cognitive biases means that even trivial points get neglected in politics.

Selecting for fanaticism

I’ve long thought that the problem with politics isn’t just what people believe but also the fanaticism and dogmatism with which they believe it. Tory attacks upon Mark Carney illustrate this fact.

Let’s face it, these are motivated in large part not by the technicalities of monetary policy but by Carney’s warnings before the referendum that Brexit would unsettle the economy. In this sense, they are part of the same mindset that demands that Remainers be lock up as traitors: they are an attempt to silence dissent. That’s a symptom not just of the right’s hatred of freedom, but of fanaticism and hysteria – of a belief in one’s cause which is stronger than the evidence warrants.

But of course, fanaticism is not confined to the right. It can be found across the political spectrum - even, I suspect, among people who are sane and reasonable in other respects.

Which brings me to my problem – political institutions (including of course the media) select for fanatics. I’m thinking here of (at least) four different mechanisms:

 - Fanatics are more likely to contribute a lot to pressure groups and parties, thus raising the salience of their pet beliefs. Anti-immigrationers have Migration Watch. Those of us sympathetic to open borders have no equivalently powerful organization, perhaps because we are less willing to pay big money for it.

 - The BBC is more likely to invite partisans onto its discussion programmes rather than those who are more sensible or who see both sides. For example, we hear a lot from the Taxpayers Alliance relative to more sensible economists, and heard rather more from Farage during the Brexit campaign than from more reasonable Brexiters such as Andrew Lilico.

 - Fanatics are more willing to lie to support their cause and – with the BBC being impartial between truth and lie – this gives them an edge.

 - Fanatics are often articulate about their cause, because they have so much practice in repeating it and because it’s easy to be fluent if you rarely use the word “but”. Because people are apt to take overconfident people at their word, this gives them a plausibility they don’t warrant.

If we had rational political institutions, these biases would go the opposite way: fanaticism would be selected against, not for.

For example, one virtue of demand-revealing referenda is that people must say how much they are willing to pay to back a cause. Although the law of large numbers makes it unlikely that people really would have to stump up, such a process forces people to ask: how much do I support this cause? And it would also bring proportion to debates. Imagine if, during the Brexit referendum Evan Davis had been able to ask (say) Farage: “OK, how much are you willing to pay to leave the EU?”

Also, good institutions of deliberative democracy would select against irrational and over-stated arguments, and in favour of more correct ones.

And a BBC that took seriously its mission to inform as well as entertain would banish fanatics from its airwaves in favour of reasonable people.

But of course, we are miles away from such institutions – which means that politics is disfigured by a hysteria we see in few other walks of life.