Tim Harford's Blog, page 116

Raising the stakes on life’s big choices

Using a coin-flipping website, an experiment aims to investigate how people make the most important decisions

A few minutes ago, I made up my mind to toss a coin to decide whether or not to leave my wife. It was Steve Levitt’s idea.

I should explain that Levitt, an economist most famous for co-writing Freakonomics, would regard that coin toss as noise in his data. In collaboration with John List, a fellow professor at the University of Chicago, Levitt is offering the blessed release of the coin to people everywhere who cannot decide whether to quit their jobs, leave their partners, have children, move cities, quit drinking or even get tattoos. It’s all in the name of social science.

Here’s how the research project works. If you’re having trouble with one of life’s big choices, you sign up at FreakonomicsExperiments.com, choose your dilemma, fill in a short survey, promise to abide by the coin’s decision, and the website will flip the coin for you. Later, the research team will email a survey to ask whether you followed the coin’s advice and how things are working out.

It’s tempting to treat the whole thing as a joke or a publicity stunt (the website is, after all, lavishly branded). But Levitt maintains that the research intent is serious, and I am inclined to agree.

Here’s the problem for social scientists everywhere: we just don’t know much about how people make big decisions. We can analyse everyday behaviour, but that means simply observing correlations with little idea of what might be causing what. Or we can bring people into the psychology lab, but laboratories are artificial environments. Laboratory experiments tend to involve small decisions for small stakes. Sometimes they involve hypothetical decisions for no stakes at all. Levitt’s colleague, John List, has been a pioneer in developing field experiments with more realistic contexts, but even then it is hard to study the really big choices in life.

Hence, the Freakonomics coin-toss website. Levitt hopes to find people who are genuinely undecided – the “marginal” decision makers – and, as he asks, not unreasonably, “who could be more marginal than the kind of person who comes to a website to flip a coin to try to decide whether to leave his wife or not?” If Levitt and List do attract the genuinely undecided, they will be able to observe genuine causation in action: was asking for a raise the right decision or not?

You might reasonably wonder what could be learnt, even if Levitt and List do get enough people to toss the coin and follow through. But there are natural hypotheses worth testing. Do we believe the grass is always greener? Or do we prefer the devil we know?

Levitt is bullish about the project. After I admitted I couldn’t make up my mind whether to take it seriously or not, he reckoned that if the website attracted a decent number of serious users it would be “some of the best research I have ever done”. It would certainly be an original angle on an important set of problems. I asked Levitt if he’d ever read The Dice Man, but he hadn’t heard of it. Luke Rhinehart’s shocking novel is about a man who frees himself from social convention by submitting to the will of the die. (Should he rape his next-door neighbour? The die says yes.)

Feeling unnervingly like The Dice Man myself, then, I logged on to FreakonomicsExperiments.com to find out whether to leave my wife. I am, admittedly, exactly the wrong experimental subject because I have quite firm opinions on the pros and cons of the decision, but I wanted to see how the process worked. I filled in a few quick questions about our ages, races, marital history, children, stepchildren, household income; then I had to tick some boxes and write a couple of sentences reflecting on why I was considering leaving my wife and how the prospect made me feel.

And then I tossed the coin.

Also published at ft.com.

A terrific windfall for the big spenders

Kuwait’s debt plan illustrates oil’s mixed blessings, says Tim Harford

‘Kuwait is considering plans for a $6bn consumer debt write-off that would be the latest mass official bailout of Gulf citizens who have broken the region’s harsh debt laws and sometimes ended up in jail.’

Financial Times, February 7

I know George Osborne likes to talk about paying off the nation’s credit card, but this is something else.



It’s a bit more literal. It may not happen, though: much the same plan was tabled three years ago and it went nowhere. That said, some Gulf states do seem to have their share of spendthrifts. One bank official in the United Arab Emirates complained that “many people don’t know how to use the credit card . . . They treat it as free money.”

If the government swoops in and pays off the bill then treating it as free money seems a sensible approach. It’s unfair on people who saved money instead of spending it.



Yes, it’s a dreadful way of dealing with consumer debt. You can see such bailouts sow the seeds for future problems. Not that we can feel too smug in the UK. If you want to talk about moral hazard and bailouts, just look at the banking system of the western world. And if you want to fret about savers being penalised while borrowers are coddled, quantitative easing and the Funding for Lending scheme are pretty effective at that. Kuwait might be talking about rescuing its debtors; in the UK, it’s the official policy of the fiscal and monetary authorities.

Can we just get back to chuckling at foreigners? That feels a little more comforting.



The Gulf states do have a tricky problem, it must be said. All that oil and gas isn’t necessarily an advantage. Economists and political scientists even talk about the “resource curse” – the idea that striking oil might do more harm than good.

Why would that be?



There are various theories. One is that the oil exports cause the exchange rate to appreciate, and that makes it unprofitable to develop alternative export industries. If a country’s exporters begin making bicycles, they may learn to make cars. If they do some software outsourcing, that may develop into a large industry. But if the country’s main export is oil, it’s going to be hard to learn to do much except spend the cash.

Doesn’t sound too bad.



No – until the oil runs out or the oil price collapses, and you have no plan B. And even while the oil money flows in, it may be unevenly distributed and corrosive to the political system – which is a second reason why oil may be bad news. It’s a great prize for an unelected ruler, a wonderful help to anyone who wants to stay in power. You get economies built on patronage – or worse, corruption – rather than economies in which entrepreneurs are rewarded.

Is there an alternative, then? Norway seems to be doing just fine.



Norway has the world’s largest sovereign wealth fund – more than $650bn, according to the SWF Institute. Such funds are very sensible, like everything else in Norway. They spread the resource windfall out over a longer period, rather than just blowing the cash on a single generation. If the money is invested outside the country, they also prevent the woes of exchange rate appreciation. Unfortunately simply deciding to have an SWF is no guarantee of good sense. The fund’s controllers must resist the temptation to build record-breaking skyscrapers in the middle of low-rent deserts – or indeed, the temptation to pay off everybody’s credit cards every few years. No doubt this is easy if you happen to be Norway.

Is there an alternative to the alternative?



Another possibility is to take the oil revenue, divide it up equally and pay the cash into each citizen’s bank account every year. If the government needs revenue it must then tax the citizens and develop an accountable tax-collecting civil service. The system is more transparent. Citizens may even be more sensible with the money than the government is. For instance, during the coffee price surge of the late 1970s, most African governments grabbed the windfall revenues through taxation, if they did not already own the coffee industry outright. The revenues were rarely well spent. But in Kenya, the money stayed in the private sector and coffee farmers saved the money, having deduced that coffee prices wouldn’t stay high forever.

Sounds great.

Quite so, and I am sure ruling families across the Gulf will implement this policy shortly after the turkeys vote “yes” in the great Christmas referendum.

Also published at ft.com.

The Asch Conformity Experiment

This is a classic and well worth your time.

Pop-Up Economics, Pulp-O-Mized

The Pulp-O-Mizer. More about Pop-Up Economics.

 

Thomas Schelling, Henry Kissinger, and Dr Strangelove

The full video of the latest episode of Pop Up Economics (free podcast here). Enjoy and please spread the world. (BBC Embed codes are proving unreliable; you can also watch here.)

Algorithm and blues

Computers have reduced the cost of buying and selling financial assets, but the gains from further speed seem unclear

In 1987, Thomas Peterffy, an options trader with a background in software, sliced a cable feeding data to his Nasdaq terminal and hacked it into the back of a computer. The result was a fully automated algorithmic trading system, in which Peterffy’s software received quotes, analysed them and executed trades without any need for human intervention.

Not long after, a senior Nasdaq official dropped by at Peterffy’s office to meet what he assumed must be a large team of traders. The official was alarmed to be shown that the entire operation comprised a Nasdaq terminal sitting alongside a single, silent computer.

From such humble beginnings, computerised trading has become very big business. High-frequency trades take place on timescales measured in microseconds – for comparison, Usain Bolt’s reaction time in the Olympic 100m final was 165,000 microseconds.

There is a variety of motives for high-speed trading. Statistical arbitrageurs look for pricing patterns that seem anomalous, and bet that the anomaly will be short-lived. Algo-sniffers try to figure out when someone is in the process of placing a big order and leap in to profit. (Algo-sniffers are likely to fall prey to algo-sniffer-sniffers, and so on ad infinitum.)

Then there are quote-stuffers, which produce and immediately withdraw offers to trade, perhaps in the hope of provoking other algorithms, or perhaps with the explicit aim of gumming up trading networks and exploiting the confusion. And the algorithmic trading game is constantly evolving.

If this sounds unnerving to you, then you have something in common with Thomas Peterffy, now a billionaire on the back of his electronic brokerage firm. Peterffy told NPR’s Planet Money team that “whether you can shave three milliseconds off the execution of an order has absolutely no social value”. It’s hard to disagree. Computers have reduced the cost of buying and selling financial assets, but the gains from further speed seem unclear, and must be set against the risks. Several recent financial “accidents”, including the May 2010 “flash crash” and the implosion of Knight Capital in August last year, attest to the hazards of high-speed trading.

But what is to be done? In a new paper, “Process, Responsibility and Myron’s Law”, the economist Paul Romer argues that we need to start paying attention to the dynamics of how new rules are developed. (“Myron’s Law” is that given enough time, any particular tax code will end up collecting zero revenue, as loopholes are discovered and exploited. Tax codes must therefore adapt. So must many other rules.)

Romer contrasts the box-ticking approach of the Occupational Safety and Health Administration – which has a detailed and somewhat contradictory rule, 1926.1052(c)(3), about the height of stair-rails – with the principles-based approach of the Federal Aviation Administration (FAA), which “simply” requires planes to be airworthy to the satisfaction of its inspectors. Romer argues that financial regulations now resemble the OHSA’s rule 1926.1052(c)(3) more closely than the FAA’s “airworthy” principle – and that this is a problem.

Peterffy’s experience is instructive: the Nasdaq official withdrew, consulted a rulebook and declared that the rules required trades to be entered via a keyboard. Peterffy’s team responded by building a robot typist, and he was allowed to continue. Box-tickers everywhere would be proud, and the actual merits of banning Peterffy did not need to trouble anyone.

The real question here is a question about process – about how new rules are developed, and who takes responsibility for the decisions made. Because as the algorithmic traders are demonstrating, even rules that work today will have to adapt tomorrow.

Also published at ft.com.

A poor excuse to rob from the rich

A financial transaction tax would at best be irrelevant to financial stability

‘The eurozone’s biggest economies would raise €30bn-€35bn from their planned levy on financial transactions, according to an expansive European Commission proposal that ensnares trades executed in London, New York or Hong Kong.’

Financial Times, January 30

That’s going to spoil your day. You’re always grumbling about new taxes.



Well, it’s no fun paying taxes. But of course, it is very nice having schools, a police force and a health service. So the question is whether this is a good tax or not.

The Robin Hood Tax campaign claims such taxes could raise hundreds of billions of pounds, fight poverty and won’t affect the ordinary public.



Really? If you believe that I have a very nice bridge you may be interested in buying.

Sarcasm is unbecoming, especially in an economist. I expect you’re going to tell me that the tax will be simply avoided?



Well, of course the tax will be somewhat avoided. All taxes are somewhat avoided. There’s even evidence sharp reductions in inheritance tax temporarily reduce the death rate, as people wait for the tax to fall before they expire. Zero tax avoidance, then, is an unfair benchmark to apply to any tax. Incompetently designed transaction taxes are easy to avoid – the poster-child of how not to do this is Sweden, for much of the 1980s. Several European countries – notably Germany – have scrapped their financial transaction taxes. But it is possible to collect revenues through determined FTTs – and ironically, given British opposition to this proposal, the world’s most successful FTT is perhaps the UK’s stamp duty reserve tax, a transaction levy on trading shares. It’s still called that because back in the day people used to stamp things.

And the stamp duty has clearly failed to extinguish share trading in the City.



But it has helped fuel the market for derivatives contracts, which don’t attract the same tax. And banks are exempt from stamp duty, even if they’re trading for their own profit. As a result, most trading in London is exempt, and the International Monetary Fund argued that by promoting trade in share-substitutes, the tax increases “financial leverage and risk”. But it’s certainly true that it is possible to levy an FTT and raise some revenue without causing the tax base to evaporate completely. But I am wondering why anyone would want to.

To reduce volatility in the financial system and to make bankers pay for the mess they’ve caused. And to end poverty.



I support your goal, but it would reflect better on development charities if they argued aid costs money but is worth it. As for reducing volatility in the financial system, that’s not clear. Let’s assume that an FTT neither drove transactions overseas nor created side-markets; it would then reduce the volume of transactions.

And thereby reduce volatility.



How? It will reduce liquidity, which in most theoretical models and most empirical studies increases short-term volatility. Admittedly that’s probably manageable. It will encourage longer-term holding of shares, which in principle increases short-term pressures on companies: locked-in investors must worry about dividends today because they can’t sell their shares purely on the basis of a company’s long-term prospects. With a small tax the effect will be tiny, but it’s still an effect in the wrong direction. The FTT should reduce flash trading by computers, which might be a good thing, although flash trading is not a European vice now. But flash trading needs direct regulatory attention – the problem at the moment seems to be quote-stuffing, in which no transaction takes place at all.

Did you not notice the gigantic financial crisis?



The crisis was the result of complex mortgage-backed assets, insurance companies writing suicidal credit default swaps and highly leveraged banks – and nothing to do with short-term share trading. The exception is the overnight repurchase market, which suffered the equivalent of bank runs and involves short-term trading. But the repo market is excluded from the new European Commission proposal. So the FTT is at best irrelevant to financial stability.

But surely you’re not saying we shouldn’t tax banks and bankers?



Of course we should. I’m with the IMF on this: the FTT is feasible but we have better options, including value added tax on financial services or taxing balance-sheet debt to reduce leverage. To invert an old saying, the FTT is the best possible tax on banks – apart from all the other ones that have been tried.

Also published at ft.com.

Economics in the office jungle

Thomas Schelling, game theory, and nuclear deterrence

Here’s a four-minute video, an extract from a forthcoming episode of Pop-up Economics – do please sign up for the free podcast! Next episode on BBC Radio 4 tonight, 8.45pm GMT.

 

Lies, damned lies and Greek statistics

Cooking the books can lead to a half-baked result

‘Greece has brought criminal charges against the official responsible for measuring the country’s debt, thereby calling into question the validity of its €172bn second bailout by the EU and International Monetary Fund.’

Financial Times, January 23

What?

Could be worse. When Andreas Georgiou, who was head of Greece’s independent statistical agency Elstat last time I looked, was first placed under investigation in late 2011, there was talk of him facing life in prison for a kind of statistical treason. As it is, he and two of his senior staff are facing charges of corruption and making false statements, with a mere five to 10 years if found guilty.

But what’s behind all this?

Mr Georgiou was brought into Elstat in 2010, and although he’s a Greek citizen he worked for the IMF for a few decades. He thus represents the global forces of technocracy. The case against Mr Georgiou is that, as Greece was negotiating a bailout from the international community, he deliberately exaggerated the country’s deficit statistics in a way that weakened its negotiating position. His motive, presumably, would have been to strengthen technocrats in the IMF and Eurostat, the EU’s statistical agency.

Not much of a motive.

Mr Georgiou says he is being prosecuted not for cooking the books but for failing to cook them. Greece’s budget deficit doubled overnight in late 2009 shortly after a new government was elected and announced that the previous deficit had been massively underreported. So there was a lot of statistical horseplay going on before Mr Georgiou showed up. It would certainly be comforting for some Greeks to believe that it was Mr Georgiou, not his predecessors, who were producing inaccurate numbers; Eurostat, however, has blessed Mr Georgiou’s figures as accurate.

Is that why he’s being prosecuted, then?

He seems to have been embroiled in full-contact office politics. One of the people accusing him, Zoe Georganta, was an Elstat board member who was sacked (along with most of the board) in 2011. Another, Nikos Logothetis, was accused by Mr Georgiou of hacking his email and has been criminally investigated. Elstat’s union has weighed in against Mr Georgiou, too. As to the merits of these accusations, your guess is as good as mine.

Gosh. Who would be a Greek statistician?

Not just Greek. The most recent issue of Significance (the Hello! magazine of the statistical community) included an interview with Graciela Bevacqua, formerly head of Argentina’s statistics institute, who complained that she had been sacked, fined and threatened with imprisonment after publishing inflation statistics that were insufficiently flattering to Argentina’s government. The same issue included a discussion of the L’Aquila earthquake verdict, in which six scientists and an Italian official were sentenced to six years imprisonment for providing “inaccurate, incomplete and contradictory information” regarding the risk of a quake that, when it occurred, killed 309 people.

But this is outrageous. Statistics should be above politics. It reminds me of the time Alabama changed the value of pi to three.

I’m afraid life will never be that simple. (For one thing, Alabama never did change the value of pi – that’s a myth.) Statistical judgments are just that: judgments. There is right and wrong in statistical practice, but typically there are also shades of grey. Walter Radermacher, Eurostat’s boss, told The New York Times that “the truth is not my business . . . statistics is about measuring against convention”. He has a point. The UK’s Office for National Statistics did not to correct a significant flaw in the way the retail price index was calculated, a decision that seems to have been motivated by a preference to overcompensate pensioners, index-linked bond investors and others for inflation.

Was the ONS right?

No, it should have corrected the RPI and published an alternative series, RPIAFU.

RPI all fudged up?

Something like that. RPIAFU would have been calculated using the old method and if the government wished to continue to benefit pensioners and bondholders at the expense of taxpayers and the purchasers of price-regulated products such as railway tickets, then fine. But the truth is that governments will often prefer statistical obfuscation as a way of achieving their goals indirectly, and statisticians will find themselves in political debates with no unambiguous, correct answer.

Also published at ft.com.