Chris Dillow's Blog, page 129

Heterogeneity

One of the big questions in macroeconomic forecasting now is: what's going to happen to business investment? For me, this highlights the importance of thinking about heterogeneity rather than representative agents.

On the one hand are those who believe increasing confidence and high replacement demand will cause a big rise in capital spending: the Bank of England seems to side with these. On the other are those, like the guys at Fathom Consulting, who fear that credit constraints will hold it back; this weeks figures showed that bank lending to non-financial firms fell again in January.

Here is where heterogeneity comes in. Profitable investment opportunities aren't distributed evenly across firms; some have them, some don't - which is why some thrive and others fail. If these opportunities are concentrated among credit-constrained firms then investment will be weak. But if they are concentrated among cash-rich firms - and non-financial firms are sitting on £284.8bn of UK sterling bank deposits - then investment could rise a lot.

You might object that only a few firms are credit-constrained; the last CBI survey found only 4% of manufacturers saying that an inability to raise external finance limits their investment. But this is a survey of existing firms; it's quite plausible that potential new firms are more constrained.

You might also object that capital markets should solve this problem, because credit-constrained firms (or potential start-ups) can sell to cash-rich firms. But two things make this only an imperfect solution: asymmetric information and commitment problems. There's a big difference between having a good idea and persuading conservative men in suits to buy it. And working for others, especially in a bureaucratic culture, might drain one of the energy required to make such a project work.

Heterogeneity, then, matters. Here are three other ways it does:

1. If an adverse demand shock hits cash-rich firms and households, the effects might be more modest than if it hits highly-indebted ones, where it might trigger a cascade of bankruptcies.

2. Paul Geroski and Paul Gregg found that in the 1989-91 recession, the worst-hit 10% of firms accounted for 80% of the drop in sales and 85% of the cut in employment. This tells us that recessions are about what happens in a minority of firms.

3. Right now, household debt, at £1.4 trillion, is equivalent to 1.3x disposable income. But the distribution of this matters. An economy in which everyone had debt of 1.3x income - equivalent to a mortgage of around £30,000 for a household on median income - would be a different thing from one in which two-thirds had no debt and one-third debt of almost 4x income.

And here's the thing. We know much less about the heterogeneity of firms and households than we do about aggregates and averages. It could be that the latter helps to give us a pretense of knowledge, rather than real knowledge.

Another thing: Yes, I know all this should be familiar to Austrians who have always been sceptical about macro aggregates. But it bears repeating.

Equality, growth & policy

Some new IMF research (pdf) finds that "more unequal societies have slower and more fragile economic growth". Readers of Sam Bowles - and everyone should be - won't be surprised by this. But could it be that there's a mechanism here that is being overlooked - namely that egalitarianism helps to promote growth-enhancing policies?

Take immigration. There's decent evidence that immigration can foster economic growth by raising (pdf) innovation and productivity. Why, then, are people so hostile to it? One reason might be that they feel uncomfortable at icky foreigners talking funny. But another reason might be that they don't feel that the economic research is right. There could be three reasons for this, all arising from inequality:

1. Immigration is, as James Morris says, a "vortex issue; it it sucks in concerns about housing, wages, benefits, jobs, public services." However, if we had a more egalitarian society in which there were more and better social housing and public services, these concerns would be allayed, and so hostility to immigration would be less.

2. Trust. Voters don't trust those politicians and experts who point out the economic benefits of migration; it's no accident that populist anti-immigrant parties often pose as anti-establishment too. However, as Eric Uslaner has shown (pdf), distrust is a product of inequality; one reason people distrust politicians and experts is that they are "others". It's possible, therefore that more equality would, eventually, foster more trust in the experts who point to the benefits of migration.

3. In a class-divided society, the benefits of migration (or at least the immediate and obvious ones) accrue to the rich, in the form of cheap labour and Filipina servants, whilst the poor feel the costs. An egalitarian society, by contrast, would spread the benefits more widely. In an economy of worker coops and full employment, workers would respond to immigration less by thinking "he's taking my job" and more by "he's freeing me up to do more productive stuff."

In these ways, equality can facilitate growth by making it more likely that a growth-enhancing policy will be adopted.

I suspect the point widens. Egalitarian societies might be more likely to favour globalization and free trade, insofar as the benefits are distributed more evenly, and they are less likely to oppose technical change or creative destruction which (temporarily?) destroys jobs: Luddites, remember, only smash other people's machines.

I say all this as a response to Tim Worstall. If you really want classical liberal policies that foster growth - such as open(ish) borders, free trade and the creative destruction of market forces - you might need some form of equality as a precondition for them.

The triumph of "good persons"

It's not often that an essay on W.H Auden reminds one of Alan Pardew, but this one did:

By refusing to claim moral or personal authority, Auden placed himself firmly on one side of an argument...
On one side are those who, like Auden, sense the furies hidden in themselves, evils they hope never to unleash, but which, they sometimes perceive, add force to their ordinary angers and resentments, especially those angers they prefer to think are righteous. On the other side are those who can say of themselves without irony, “I am a good person,” who perceive great evils only in other, evil people.

The reaction to Mr Pardew's headbutt - an endless stream of denunciations on 6-0-6, for example - seemed to come solely from the "good persons", people who seem to have never given into the temptation to twat someone.

This reaction, I suspect, is indicative of our wider culture. A couple of years ago, MPs' expenses triggered a moral panic which made one think that politicians were the only people who had ever put their hand in the till or inflated their expenses. And everyone seems to call footballers and bankers "greedy", as if they would turn down a pay rise themselves.

Auden's moral self-awareness seems a small minority position today. And few people seem to try to put themselves into another's shoes before condemning him. Instead, popular culture is dominated by the self-righteous brothers. Like those 20-stone lard-buckets who call Frank Lampard "fat", many of us are swift to condemn others when we have greater faults ourselves.

I suspect hostility to immigration fits into this category. Often, the "debate" is framed in terms of how we feel "uncomfortable" about immigration, which ignores the question: what would you do if the only chance you had to make a decent life for yourself meant you had to move hundreds of miles from home?

Why, then, is public discourse dominated by "good persons"?

It could be just a selection effect; those of passionate intensity make the most noise, whilst the morally conflicted or nuanced stay quiet.

But something else might be a work - a constellation of cultural changes.

One piece of this puzzle might be the decline of religion, or at least of a respectable face of it - the face that says we all have original sin and that only he who is without sin should cast the first stone.  More broadly - as Alasdair Macintyre has described - we have lost the tradition of moral inquiry with the result that moral judgments have become mere emotivist spasms. This manifests itself in the absence of serious ethical debates; the Moral Maze is more like the Jeremy Kyle show than the Brains Trust.

Perhaps, also, there's an element of neoliberal performativity here too. A culture of consumer sovereignty, in which the customer or voter is king, can become one in which everyone feels entitled to judge others, without self-reflection.

Whatever the cause - or perhaps it was ever thus - there seems to me a big element of narcissism in what passes for moral judgments. I'm tempted to deprecate this. But then, if I were free of narcissism myself, I wouldn't have a blog would I?  

Happiness, age & class

Jackart speaks for England here:

The fact is, for most people, the best time of your life is 15-25.

Happiness research corroborates this. On average, happiness does indeed fall after one's teens and early 20s.

One reason for this is that in one's youth one has high expectations, and as these are missed, one becomes melancholic. As J says:

the fact you're not PM, decorated war hero, racing driver, star of stage and screen, or billionaire entrepreneur you set out to be, is a itch at the back of your mind.

But there's good news here. The research also shows that happiness rises after one's mid 40s - in the UK by more than can be explained by rising incomes. This could be because by then we adapt to our position, so our relative failure in life no longer troubles us.

For me, this raises three issues.

One is the status of adaptive preferences. Insofar as 50-somethings have reduced their desires to match their circumstances they might seem happy, but is this really a good thing? Isn't there is instead something sad about contenting oneself with little?

Secondly - and perhaps contradicting the above - doesn't this show the importance to well-being of real freedom? I'm on the upward part of the U curve. A big reason for this is that I'm free. A combination of wealth and modest tastes means I'm mostly freed from desire; I'm freeish from worries about work and presenteeism; free from having people dependent on me; free from giving a toss what others think; and can look forward to even more freedom when I retire in a few years. (It could be that, as Oxford's greatest graduate sang, "freedom's just another word for nothing left to lose.") One reason those younger than me are unhappier is that - as J implies - they have less freedom.

Thirdly, isn't there a class aspect here?

I mean this in two senses. One is that if your health has been broken by hard manual work, one might not enjoy an upward leg in happiness later in life.

Also, I suspect a big difference between J and me is our class backgrounds. J says: "I had enough money from loans, parental indulgence, holiday jobs and the TA to do more or less whatever I wanted." This was not my experience. My youth was instead a mostly joyless and sexless life of work. Chalet girls never threw themselves at me, partly because I couldn't afford skiing holidays.

In this sense, though, I'm lucky. I look back at my youth not with Bridesheadian nostalgia but with relief at having escaped. What's more, coming from a poor background gave me low expectations: whereas J regrets not becoming a billionaire entrepreneur, I rejoice in not having to worry about the leccy bill.

My point here, though, is not about iniquities of class, but merely to note that our satisfaction, or not, with life is something we inherit from our parents. None of us is a self-made person.

Another thing: Jackart is entirely right to say UKIP is a contemptible party of by and for stupid, angry people.

Equality: the Ron Atkinson effect

Igor Toronyi-Lalic points out that the proportion of workers in the City who are from ethnic minorities is five times that in the arts, and says:

The evil scumbags who work in the City appear to be doing a better job at being modern and liberal than the state-subsidised art world.

Why? One reason, as Simon says, is a selection effect; Indians tend to study numerate subjects, which disposes them to enter finance rather than the arts.

But there's another reason - the Ron Atkinson effect. In the 70s, pro football was overwhelmingly white. Then BFR selected the "three degrees" - Batson, Regis and Cunningham - which paved the way for an influx of black players into top sides.

BFR did not do this because he had advanced, liberal opinions; we later learned that he didn't. He did it because players of the calibre of Regis and Cunningham were so good they improved his team greatly.W hen racism met the desire to win games, racism lost.

This illustrates a point made by Gary Becker back in 1957. He pointed out that competition was the enemy of discrimination and monopoly its friend. A company that refused to hire blacks or women even if they were good workers would lose out to firms that did hire them. And subsequent research has proved him right. For example, studies have found that when US banks became exposed to more competition in the 80s and 90s, gender (pdf) and racial (pdf) pay gaps narrowed.

This helps explain the difference between the arts and banking. Granted, banks as an industry are massively (pdf) subsidized. But within the bubble there's competition between banks. And in many banking jobs, there's a clear measure of performance; does the guy make money or not? Competition and the ease of measuring performance combine to make banks want to hire the best person they can, regardless of colour.

By contrast, there's less competition between arts groups and less clarity of measuring performance*. This gives arts companies more room to prefer the second-rate white guy - a breed of whom the world has never had a shortage - over the better black.

Now, you might think all I've said here is standard pro-market stuff. But there's an implication for the left. We don't achieve equality merely by having politically correct liberals in positions of power (especially if such"liberals" are merely self-righteous hypocritical little pricks). We achieve it by having the right institutions and mechanisms. Structure matters more than agency.

* I'm talking matters of degree here; it is possible for duffers with political skills to do OK in banking, but it's probably tougher.

Libertarians & Marxism

Bryan Caplan says:

The view that money has a major effect on happiness is ideologically convenient for me.  But it goes against first-hand experience, the wisdom of the ages, and the rightly interpreted empirical evidence.  So to hell with ideological convenience.

I find this admirable, but puzzling. A libertarian surely doesn't need a view on which goods (other than freedom) makes us happy. All he needs is a framework in which people are free to pursue whatever ends we want - whether those ends be money or whatever. As Robert Nozick wrote:

Utopia will consist of utopias, of many different and divergent communities in which people lead different kinds of lives under different institutions.

I fear, though, that there's a reason why libertarians might find it convenient to think that money makes us happy. It's because actually-existing capitalism does not give us Nozick's Utopia, which means there's a tension between supporting liberty and supporting capitalism. If, however, you think that money gives us happiness, then this tension weakens.

Here's what I mean. Capitalism has totalitarian tendencies, in the sense that it squeezes out (other) utopias. For example:

 - Most of don't have outside options; we can't live off our savings or inheritances or on our smallholding. We are therefore compelled by circumstance to enter into capitalist relations to earn our living. This curtails our freedom to pursue other lifestyles, such as a love of arts and music or caring for others.

 - Capitalism requires a big and cheap labour supply. It is therefore antagonistic to policies which might give us real freedom to opt out of the labour force, such as a basic income.

 - Capitalist employment relations can be oppressive and alienating.

 - As Richard Sennett has suggested, flexible capitalism can undermine stable communities.

 - Capitalism contains a deskilling process not only in the workplace, but also in leisure skills; commodification tends to crowd out traditional skills such as music and cookery.

 - Capitalism prioritizes the goods of effectiveness (money and power) over those of excellence. This creates a society of "trampling, crushing, elbowing, and treading on each other's heels", which many of us would prefer not to live in.

These tendencies are awkward for a right-libertarian wanting to defend actually-existing capitalism. So, what can he do? One line of attack is to say - with much justification  - that capitalism has provided more freedom (both formal and substantial) for more people than any hitherto-existing form of society. But this runs into the Marxian objection that a post-capitalist society could do even better.

This leaves Bryan's instinctive answer. If you believe that money makes us happy, then you can argue that, in depriving us of alternative lifestyles but delivering the physical goods, capitalism isn't really imposing much of a loss upon us, because it's giving us what makes us happy, what we'd choose anyway.

There is, though, a third option here. It's to recognize that capitalism and real freedom aren't wholly compatible, and to look for economic institutions - of which a basic income is one - which better promote freedom. Libertarianism and Marxism have much in common.

On happiness inequality

Do we need policies to reduce inequality, or should we simply allow economic growth to do so? This is the question posed by a recent paper by Andrew Clark and colleagues. They find that, in the UK and elsewhere, economic growth reduces inequality of happiness.

This isn't simply because it reduces the amount of abject misery. Growth also reduces the number of people who say they are very happy. This might be because wealth increases our options and hence the opportunity cost of our preferred choice. For example, work isn't too bad if it gets you out of a joyless slum, but it can be a misery if it keeps you off the golf course or guitar.

This finding is awkward for the left. If we believe that what matters most is people's well-being, it suggests that the most important inequality should be addressed not by redistribution by simply by promoting growth.

So, what answers might the left have to this? I can think of three:

1. Policies to promote growth require redistribution, to the extent that wealth inequalities are an obstacle to growth. This is the thinking behind wage-led growth and the asset redistribution ideas of Sam Bowles.

2. If people adapt their desires to their circumstances, or if other cognitives biases reconcile them to inequality, they might be content with injustice, but this would not necessarily legitimate the system: we would consider slavery wrong even if all slaves were content. As Amartya Sen said:

Consider a very deprived person who is poor, exploited, overworked, and ill, but who has been made satisfied with his lot by social conditioning (through,say, religion, or political propaganda, or cultural pressure).Can we possibly believe that he is doing well just because he is happy and satisfied? (The Standard of Living (pdf), p12)

3. Inequality can matter for non-welfarist reasons - for example to the extent that it undermines equality of respect or the democratic system.

Personally, I think these are good answers. But Clark's paper should force leftists to think more about why inequality matters. 

How not to write about stock markets

Ha-Joon Chang's claim that stock markets are "heading for trouble" depresses me. I had hoped that stock market punditry had moved beyond some guy's opinion.

What I mean is that a sensible view on the prospects for markets can take one of two forms - and I confess to being ambivalent between them.

The first one is that markets are complex emergent processes which are inherently impossible to predict. On this view, we just can't say where they're heading. All we can do is have a vague idea of expected returns and the standard deviation around them.

In this context, Chang misses the point here:

No one is offering a new narrative justifying the new bubbles because, well, there isn't any plausible story.

Such narratives are not only impossible - we can't foresee the future - but pernicious, because they give a false sense of security. All you need to justify the current level of share prices is a basic  bit of economic theory - that risky assets must offer higher expected returns than safe ones, so equities should be expected to rise. Granted, this theory is questionable. But Chang doesn't question it.

The second line of attack is to look for evidence of predictability in returns. My favourite indicator here is foreign buying of US equities*. When this is high, it's a sign that global investors are irrationally exuberant and so shares are heading for a fall. Last year, though, foreigners were net sellers, which points to good returns this year.

Again, though, Chang presents no evidence here. In fact, he ducks a chance to present some. He says:

Share prices are high mainly because of the huge amount of money sloshing around thanks to quantitative easing.

However, the Fed is only likely to withdraw QE if the economic outlook improves, which poses the question: could it be that the stock market will gain more from better growth than it loses from less loose monetary policy? I've suggested that the answer is: yes. Please, show me evidence I might be wrong - because Chang doesn't.

Now, I don't say this to say stock markets will definitely rise - as if anyone gives a toss about my opinion. In fact, I guarantee that they'll fall some time.

Instead, my point is that discussions of the market should be scientific: is there evidence of predictability or not? What they should not be is just some guy's judgement. This is especially true because we know that such judgments are prone to countless cognitive biases. I fear that one here is wishful thinking. The left wants to believe that finance will get its comeuppance, and the wish generates the belief. But we can, and should, try to do better than this.    

* The regression equation in my chart is: annual change in All-share index = 20.72 - 0.188 x foreign buying of US equities, $bn in the previous 12 months. R-squared = 45% since Jan 1996, standard error = 12pp. And no, this is not just in-sample fitting.

Moralizing inequality

I complained yesterday about the non-Marxist left's tendency to commit the fundamental attribution error - the habit of over-emphasizing individuals' traits and under-emphasizing situational forces. We saw another example of this habit at the weekend, when Crystal Palace fans reacted to Wayne Rooney's new £300,000 per week contract with chants of "you fat greedy bastard."

Sadly, Mr Rooney did not respond in the manner of one of his celebrated predecessors. But he should have, because the chant is wrong. Mr Rooney is not getting £300,000 a week because he is unusually greedy: in the improbable event of being offered such money, who among us would turn it down? He is getting it because he is unusually powerful - a power which is not entirely due merely to his exceptional skill.

Palace fans, then, are committing the fundamental attribution error - they are blaming Rooney's salary upon his personal character rather than upon his situation.

Although Palace fans are - with the odd exception - not famous for their powers of thought, this error is a common one: "greedy bankers" is a cliche, "overly powerful bankers", whilst true, is not.  

It is also a pernicious error. It functions to moralize inequality; the rich are rich because they are greedy whilst the poor are poor because they are lazy.

What this effaces is the fact that inequalities in capitalism* are instead the result of inequalities of power - a power which rests in part upon ideology. Moralizing inequality tends to blind us to this fact. It creates the illusion that capitalism would be acceptable if only those at the top were better people, when in fact the faults in capitalism are structural and not due to the flaws of passing individuals.

Granted, there might well be differences in character between rich and poor. But these might be not the cause of inequality, but the result of it. As someone once wrote:

The difference of natural talents in different men is, in reality, much less than we are aware of; and the very different genius which appears to distinguish men of different professions, when grown up to maturity, is not upon many occasions so much the cause, as the effect of the division of labour. The difference between the most dissimilar characters, between a philosopher and a common street porter, for example, seems to arise not so much from nature, as from habit, custom, and education. When they came into the world, and for the first six or eight years of their existence, they were perhaps, very much alike

Who said that? Adam Smith, that's who. Palace fans, and other moralizers about inequality aren't therefore merely anti-Marxist, but anti-Smithian as well.  

* I mean actually-existing capitalism, not the utopia that exists only in the minds of sillier libertarians.

Bonnie Tyler syndrome

Trouble in Venezuela has led to some rightists sneering at Owen Jones for supporting the socialist government. Such partisan point-scoring, however, hides an interesting question: what is the origin of Owen's mistake, assuming it to have been one?

The thing is that he is certainly not the first leftie to have put his hopes into a regime that turned out to be disappointing. We've seen the same thing in Beethoven's support for Napoleon; the Webbs' admiration of the Soviet Union; 1960s students chanting "Ho, Ho Ho Chi Minh; "radicals" wearing Che Guevara T-shirts; and Polly Toynbee's lust for Gordon the Viking. We might call this the Bonnie Tyler syndrome: holding out for a hero, a superman to sweep me off my feet, a white knight upon a fiery steed.

Several cognitive biases contribute to this urge for heroic leaders. One is simple wishful thinking. We want to think socialist government can succeed, and the wish is father to the belief. Another is "my enemy's enemy is my friend" syndrome: opponents of the US imperialism can easily find supporters in the western left.

These two biases are, of course, not confined to the left. Wishful thinking is ubiquitous, and "my enemy's enemy" led Tories to support or at least be silent about apartheid.

But there's another bias at work here. The thing is that centralized power tends to be misused, as Lord Acton famously pointed out. In supporting men from Napoleon to Chavez lefties have overweighted the ability of some exceptional individuals to resist the corrupting influence of unequal power relations*. This is a particular form of the fundamental attribution error, the tendency to overweight the role of individual agency and underweight situational factors.   

Marx's writings - as opposed to some of his followers! - provide an antidote to this. Successful socialism, he thought, requires a particular level of development, one in which it was technically feasible for workers to control the economy themselves:

New superior relations of production never replace older ones before the material conditions for their existence have matured within the framework of the old society.

Unless this condition is met, a revolution will be too premature to succeed:

Development of productive forces...is an absolutely necessary practical premise [for communism] because without it want is merely made general, and with destitution the struggle for necessities and all the old filthy business would necessarily be reproduced.

In this context, the urge for political heroes is anti-Marxist, because it is a search for great men rather than the right socio-technical conditions. Owen's mistake, then, isn't that he's a leftist, but that he is not a Marxist.

* I'm thinking here not just of moral but also intellectual corruption - the tendency of authoritarian structures to cause those in power to live (pdf) in "purely imaginary worlds."