Chris Dillow's Blog, page 159

Costly discrimination

It's long been said that discrimination entails a waste of talent as able people are prevented from making full use of their skills. A new paper (pdf) tries to quantify this by looking at the effects of the decline in racial and gender discrimination in the US since the 60s. It says:

Changes in occupational barriers facing blacks and women can explain 15 to 20 percent of aggregate wage growth between 1960 and 2008. Furthermore, essentially all of the gain is driven by the movement of women into high-skilled occupations.

Discrimination, then, has significant macroeconomic effects.

This matters, not just because there (might?) still be discrimination against women and ethnic minorities, but because gender and racial discrimination isn't the only souce of a misallocation of talent. The authors say:

We suspect that barriers facing children from less affluent families and regions have worsened in the last few decades. If so, this could explain both the adverse trends in aggregate productivity and the fortunes of less-skilled Americans over the last decades.

Not just Americans, of course.Class barriers are high in the UK too.

And there are other forms of misallocation of talent, such as poor careers advice at school and university, and the systematically bad hiring practices that favour yes-men, the irrational or known mediocrities over unknown potential stars.

Perhaps, therefore, human resources policies have more significant macroeconomic effects than generally supposed.

The state as risk manager

Here are three related things:

1. The government is not implementing the Dilnot report, even though uncertainty about the likelihood and cost of needing care in old age makes it impossible for people to plan their finances sensibly.

2. There's widespread hostility to welfare benefits. A TUC survey (pdf) found that 42% of people think them too high, whilst only 18% think them too low. This suggests there's little demand for insurance against unemployment risk, despite the fact that this risk is high, even in decent economic times.

3. Although a plurality of voters (pdf) thinks fiscal austerity is bad for the economy, only 42% think the spending cuts are too deep and a majority think they are necessary. This suggests the public's appetite for counter-cyclical fiscal policy is smaller than that of many (most?) mainstream macroeconomists.

There's a common theme here. All point to government and/or voters having little desire that the state help provide insurance against big risks that the private sector does not insure us against. This is despite the fact that the correction of market failure is a legitimate function of government - though of course left and right differ on the extent of such failure.

Why is there so little demand? There are three possibilities:

1. People are risk-tolerant, so that - as Robert Lucas suggested (pdf) - the welfare costs of aggregate fluctuations are trivial.In the trade-off between risk and incentives, people prefer a position nearer the latter.

I'm not sure about this. Low stock market participation, and demand for poor-value insurance products such as PPI, extended warranties and (I suspect) pet insurance suggests people are risk-averse in some domains.

2.The government (not just in the UK) doesn't understand that the role of the state is to solve problems of collective action, to do what the private sector cannot do. Politicians prefer to patronize the (poor) obese and waffle about vision and destiny than take genuinely hard choices to improve people's security and well-being.

3. Popular thinking about risk is horribly contaminated by cognitive biases. Wishful thinking stops us appreciating the danger of redundancy or dementia, sheer ignorance causes folk to over-estimate the generosity of welfare benefits, and that damned "good housekeeping" metaphor stops them thinking seriously about macroeconomic policy.

Unless reason (1) is the sole factor - which is improbable - the point here is depressing. There are powerful obstacles to the state being used for what it should be for - a means of pooling risks in the face of market failure. Which, in an odd sense, vindicates the anti-statist position that for every market  failure, there's also a government failure.

Inequality's effects

Paul Krugman and Joe Stiglitz have been debating the role inequality has played in contributing to the US's weak recovery. As chance would have it, three new papers suggest that Stiglitz is right to worry about its effects.

First, Roland Benabou and Jean Tirole model how competition for "talent" can damage companies and the economy, by diverting workers' efforts from important but hard-to-measure jobs and over-incentivizing the easily measured aspects of performance:

Highly competitive labor markets make it difficult for employers to strike the proper balance between the bene…fits and costs of high-powered incentives. The result is a  �bonus culture� that takes over the workplace, generating distorted decisions and signi…cant efficiency losses, particularly in the long run.

It takes no imagination to apply this to banks and CEOs' pay generally.

Secondly, some laboratory experiments with asset markets have found that short-term bonuses can contribute to larger and longer price bubbles. This is consistent with the theory that big bonuses (and hence inequality) contributed to the crash by inflating the bubble in mortgage derivatives.

Thirdly, Eckhard Hein suggests that the high-powered incentives that contributed to rising inequality:

[have] imposed short-termism on management. This meant a decrease in management’s “animal spirits” with respect to real investment in capital stock and long-run growth of the firm, and an increase in the preference for financial investment, generating high profits in the short run.

These three mechanisms are very different from the underconsumptionist theory of which Krugman is, I suspect rightly, sceptical. But inequality doesn't just affect economic performance through macroeconomic channels. It does so through microeconomic firm-specific ones, and through "cultural" mechanisms, such as, in Benabou and Tirole's model, eroding non-monitorable work ethics.  

In suggesting this, however, I don't want to suggest that rising inequality matters only for its effects upon economic performance. Even if its effects were benign - which is darned hard to show - leftists would still have social and ethical objections to it.

Dreamers vs sceptics

Commenters on a previous post say I'm spreading defeatism. Britmouse says I'm a professional sceptic. This raises a queer paradox. As a Marxist and extremist, shouldn't I be the utopian dreamer whilst centrists are the pragmatic realists?

No. In fact, the opposite is the case. My Marxism and my scepticism are the same thing. I fear that capitalism is inconsistent with full employment, except under conditions that don't now exist, and capitalist ideology excludes from the Overton window radical policies such as a seriously redistributive tax and benefit system, a genuine jobs guarantee or worker ownership. As a result, prospects for improving workers' living standards are limited.

Of course, this is not to say they are non-existent; a sensible fiscal policy would do some good. My suspicion, though, is that there are tight constraints on what centre-left politics can achieve.

This, though, seems to be precisely what the non-Marxist left reject.I fear there's a danger that they are exaggerating the benefits of Ballsian fiscal policy, corporate tax compliance, a living wage or job subsidies.

In this sense, it's the centre-left who are the utopian dreamers, and we Marxists who are the realists.

This shouldn't be surprising. Political activists, and especially career politicians, are selected for the optimism bias; you don't go to all those dull meetings unless you think (conventional) politics can achieve a lot.

And it's not just mainstream politicians who are the dreamers whilst I'm the sceptic. Stock-pickers who think they can beat the market and CEOs who think they can successfully control ther fate of huge organizations are just like centre-left politicians, exaggerating what they can achieve in the face of powerful and complex market forces.

Now, I might be doing the soft left a disservice here. Perhaps there's a glass half-full/half empty issue, with me stressing the emptiness and the soft left the fullness. But if this is so, I wish they'd be more candid about the fact that poverty, unemployment and inequality (of power as well as wealth) will remain even after they have enacted their favoured policies.

As it is, the question "what can politics achieve in a capitalist economy?" is rarely posed, let alone answered, by the centre-left. And until it is, they are likely to remain Isobel Crawley-type figures - perhaps doing a little good, but not challenging basic socio-economic inequalities, and leaving poverty and their own privilege largely unchanged. 

Kirsty Soames & self-fulfilling fear

Yet again, Corrie has reminded us of an interesting idea in the social sciences - that of self-fulfilling fear. Kirsty's jealous paranoia that Tyrone would cheat on her drove him into Fiz's welcoming clutches, and so her fear, which was initially ungrounded, proved correct.

How common is this self-fulfilling fear? It can certainly happen at an individual level. If a man freezes with terror when confronted with danger, his fears might well be prove to realized whereas they wouldn't be if he kept a clear head.

It can happen at a social level too. Oliver Burkemann describes some examples, such as airports' counterproductive obsession with security. Stereotype threat predicts that people we view with fear - outsiders, "hoodies" and so on - might come to behave in a more threatening way. And Jon Elster quotes Nisbett and Cohen's description of violence in honour cultures:

The knowledge that the other person may be armed and may begin acting violently may lead to preemptive first strikes. Once conflicts escalate, a man may be more apt to take a first strike as a matter of self-protection before he himself gets shot. At a cultural level, the occurrence of hundreds of these violent self-fulfilling prophecies creates a milieu where the threat of violence keeps individuals vigilant.

In economics, there are two big ways in which self-fulfilling fear occurs.

One is liquidity panics. If traders fear that an asset will become illiquid, they'll not buy it, thus creating the illiquidity they feared. This contributed (pdf) to the financial crisis. 

  

Secondly, corporate investment decisions are driven in (large) part by animal spirits; the notion that bosses are rational is an ideological fiction used to justify a claim to power and wealth. And if enough bosses fear recession, they'll cut spending and so bring about what they feared. This is in part what FDR had in mind when he said "the only thing we have to fear is fear itself—nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance."

I suspect, though, that both of these are cases where fear exacerbates downturns rather than acts as a pure exogenous cause; there's usually some reason for traders to fear a loss of liquidity or bosses a downturn.

However, there (at least) two mechanisms acting against self-fulfilling fear, causing it to go into reverse.

One lies in the concept of trust cycles. If everyone is distrustful and fearful of each other, the man who can successfully signal his trustworthiness gains a big competitive advantage; he can borrow cheaper or win new business. As others emulate his success, so trustworthiness spreads and fear declines.

Secondly, when bosses and investors become fearful, they often become overly so. This means that low share prices and weak capital spending lead to rising prices and better economic activity, which helps to reverse their pessimism.

In these ways, self-fulfilling fear leads to cyclical behaviour rather than a permanent slough of despond. 

I say all this for two reasons. One is to demonstrate Elster's point that the social sciences are about mechanisms. Some mechanisms cause beliefs to be self-fulfulling, but others act against this tendency. The job of the social sciences is to understand such mechanisms, not to make prophecies.

Secondly, this weakens the link between being rational and being right. Kirsty's belief that Tyrone was cheating on her was initially irrational, but it turned out to be correct. In a similar way, traders who short an asset and make money might not be rational, but merely the first to panic. Wealth is not evidence of rationality.

Doubts about wage-led growth

In his Ralph Miliband lecture, Len McCluskey said unions "first job is to organise workers and secure a better deal for them at work." However, I'm not sure this is anything like sufficient to provide the alternative to our current crisis-ridden capitalism.

Let's assume - heroically - that unions do find the strength to push for higher wages. Would this boost the economy?

History suggests it could. In the 50s and 60s, a degree of wage militancy was compatible with full employment and decent economic growth. But I doubt that those circumstances apply today, for two big reasons.

First, high wages are quite consistent with full employment and high investment as long as those wages are returned to capitalists in the form of higher consumer spending. If this happens, capitalists will tolerate a squeeze on profit margins because they will anticipate that low margins will be accompanied by high sales volumes, and thus a decent return on capital.

But I'm not sure that higher wages would be returned in this way. For one thing, they might leach overseas in the form of spending on imports. And for another, if households use their extra incomes to pay off debt or student loans, then consumer spending won't rise as much as wages rise. That'll be a net loss to capital, and hence cause a fall in profit rates.

It's no accident that the post-war settlement was sustainable as long as the household savings ratio stayed low, but eventually fell apart in the 1970s as savings propensities increased.

Secondly, capitalists increased their investment significantly in the 1950s and 60s, thus contributing to high aggregate demand and full employment, even though profit rates were declining; investment rose 5.3% a year between 1948 and 1973. But there were two reasons for this, both of which are obviously absent now:

- The 1930s slump and the war created, in R.C.O Matthews words, "a very substantial arrears of investment opportunities." Today, by contrast, there's a dearth of such opportunities.

- In the 50s and 60s, most people thought governments had the will and know-how to maintain aggregate demand at a high level. They agreed with Tony Crosland's claim in the The Future of Socialism that "Demand has proved to be malleable, and in a broadly predictable manner, by fiscal policy." This reduced the fear of downturns, thus increasing the motive to invest. Again, though, this factor is absent now.

I fear, therefore, that McCluskey's call for greater workers' power will not give us wage-led growth.

This, however, is not to dismiss his lecture. He rightly quotes Ralph Miliband approvingly: "All concepts of politics, of whatever kind, are about conflict──how to contain it, or abolish it.” If class conflict cannot much improve workers 'living standards, the alternative is abolish such conflict. Sadly, however, this form of "one nation" politics is not yet a practical option.

Incentives & creativity

"Incentives matter" is a cliche. But is it true? One new paper suggests not. German researchers got subjects to find words from a set of letters - a task requiring some creativity and inventiveness - and found that their ability to do so was barely affected at all by whether they were paid a flat fee, by results or by giving a prize to the better solvers. They concluded:

Neither on the aggregate nor on the individual level do we find effects of incentives on performance.

This is consistent with a claim made by Daniel Pink - that financial incentives can actually be bad for creativity:

For more right-brained undertakings - those that demand flexible problem-solving, inventiveness or conceptual understanding - contingent rewards can be dangerous. Rewarded subjects often have a harder time seeing the periphery and crafting original solutions. (Drive, p 46)

Research by Theresa Amabile, summarised here (pdf), corroborates this.

All this, though, runs into a question. Tim Harford and Robert Allen say that the industrial revolution - the burst of creativity that most transformed human life - occured in Britain because of incentives; high wages gave inventors an incentive to look for labour-saving machines. How can we reconcile this with the laboratory evidence that incentives don't spur creativity? I suspect there are two ways.

One is that attention (pdf) is a scarce resource, and incentives act to draw our attention to problems. So, for example, England's high wages in the 18th century drew attention towards the question of how to save labour costs, in a way that didn't happen in lower-wage nations.

Secondly, there's a selection effect. Incentives might not motivate a given group of people to be creative, but they might change the composition of that group, by - at the margin - attracting some able people to the task*.

My point here is that there's a big difference between believing that incentives matter and actually designing an effective incentive scheme. Instead, incentives matter through elusive, long-term and hard-to-manage channels, and are often unintended consequences. After all, nobody actually consciously designed the structure of incentives that gave us the industrial revolution.

* I'm not sure how strong this is. Do many potentially great musicians or artists really give up their creative careers because they believe there's not much money in them? Or is it only the would-be second-raters who do so?

Ideology as cognitive bias

In this paper (pdf), Jon Wiseman makes an important point:

Once control of the state was in principle democratized by the ballot box, the fortunes of the elite came to depend solely upon controlling ideology.

This reminds me of Steven Lukes' "third dimension" of power; rulers can exercise power not only by direct action or by keeping some things off the agenda, but by shaping ideology so that the oppressed come to regard their oppression as legitimate and unquestionable.

But how do the elite achieve this trick? Sometimes, the left verges towards conspiracy theory here, by believing that our rulers have the organizational skill to hoodwink people through the mass media.

This, though, needn't be the case. There are numerous cognitive biases which dispose people towards "neoliberal ideology."

1. The optimism bias leads people to over-estimate their future earnings, which biases them against wanting higher (pdf) taxes on top incomes.

2. The self-serving bias leads people to exaggerate the extent to which they are responsible for their own success, and thus biases them to believe that they "deserve" their incomes and hence resist paying tax.

3.These two biases also depress demand for unemployment insurance, as folk believe (until they get the heave-ho) that if they work hard they'll keep their jobs.

4. The just world illusion causes people to rationalize injustice, for example by blaming the victim.  

5. The status quo bias causes us to prefer the devil we know, thus biasing people against radical change (not that this is on offer!)

6. The fundamental attribution error causes people to over-rate the importance of human agency relative to environmental factors, and so believe that huge pay for bosses is justifed.

7.The same error can also stop people recognizing that - via a mix of priming, stereotype threat and the Pygmalion effect - inequalities of outcome generate inequalities in behaviour. We might therefore attribute income inequality to differences in intelligence or industry, when in truth those differences are the result of inequality in income and power, not the cause.

Now, I don't say this to either deny a role for hoodwinking or to claim that "neoliberal ideology" is all bull. Instead, I do so merely to suggest that the ideology that benefits the elite is supported, in part, by cognitive biases. 

Marxism & freedom

There's a point implicit in a recent post of mine that should be elaborated. It's that Marxism and freedom are not only compatible - contrary to what the small sample of historical experience suggests - but that freedom actually requires Marxism.

I say this in part because there's a strong libertarian strand within Marxism. Jon Elster, one of Marx's best interpreters, has written that Marx "condemned capitalism mainly because it frustrated human development and self-actualization."

For Marx, the ideal society was one in which "the free development of each is the condition for the free development of all." This is a society that not only abolishes wage slavery, but which is hostile to, among other things, gender essentialism and transphobia.

Also, we must remember that there's a sharp distinction between the Marxist and non-Marxist left. Marxism is not about lifestyle politics. It doesn't think that a priority of government should be to tell workers what to eat or how much to save. Indeed, because Marxists believe that bosses are exploiters, they are sceptical of managerialists' claims to know what's good for us - because such claims to superior knowledge are an ideological cover for a claim to power.

Nor - unlike soft leftists such as Murphy and Toynbee - do Marxists think that Britain is a family with the wrong members in control, and all would be well if only people of courage, intellect and integrity were in government. (The fact that this has so rarely happened doesn't seem to trouble the soft left).

Instead, the Marxist view of the state - as a "committee for managing the common affairs of the whole bourgeoisie" - is much closer to James Buchanan's public choice theory than it is to the soft left's notion of the state as a tool for improving the lot of workers.

So much for the compatibility between Marxism and freedom. Why do I say the latter needs the former?

It's because right libertarians have something in common with soft leftists such as Toynbee, in that they seem to think it sufficient for good government that people merely come round to their way of thinking. Marxists, however, know that this is not sufficient. They see that big illiberal government arises from capitalism.

One reason is that a lot of the motives for restricting freedom arise from capitalism. If you're on the right, you can interpret demands for living wages and employment regulations as a way in which workers demand protection from excessive exploitation. If you're on the left, you can regard illiberal impulses such as hostility to immigrants, transsexuals or the disabled as the product of an ideology that is generated by capitalism.

A second reason is that, in a market economy, the state is like everything else, there to be bought. The upshot is that, as I've said, crony capitalism is the only feasible capitalism.

For these reasons, freedom requires not just that people wise up, but that the basic power relations which generate unfreedom be abolished. As Marx wrote:

When, in the course of development, class distinctions have disappeared, and all production has been concentrated in the hands of a vast association of the whole nation, the public power will lose its political character.

You might object that this is improbable. True. But this doesn't invalidate Marxism, but merely tells us that real freedom is improbable.

The markets paradox

A new paper (pdf) by Nick Bloom and colleagues shows that there is "substantial dispersion" in the quality of management across US manufacturing establishments, which confirms earlier research. This raises a paradox.

The very fact that many poorly-run firms stay in business shows that market forces do not strongly and swiftly select against inefficiency.

Bloom's is not the only evidence we have here. Alex Coad's survey of corporate growth around the world found that firm growth is a "fundamentally random process" which is largely unrelated to past productivity or financial performance. Geroski and Gregg found that it was almost impossible to predict from past performance which firms got into difficulty in the 1990s recession. "Market selection criteria may be rather myopic" they concluded. And Bjorn-Christopher Witte has shown that market forces can sometimes actually select in favour of stupidity; they favoured irrational trend-followers in the tech bubble and risk-seeking banks in the mid-00s, for example.

All this suggests that markets do not select in favour of efficient firms nor against poorly-run ones as rigorously as free market fanatics would have us believe.

Which brings me to the paradox. Despite all this, it seems clear that freeish markets are responsible for large chunks of productivity growth (pdf) - though the best natural experiment we have on this (the division of Korea) tells us that lots of emphasis (pdf) should be placed upon the "ish".

How, then, is it possible that market selection works so imperfectly and yet markets are key to prosperity?

There are (at least) two possibilities. One is that central planning of whole economies or of companies is so terribly inefficient (beyond a certain point) that even imperfect markets are a big improvement.

The other is that markets are not merely a technology but also a culture. As Gregory Clark and Deirdre McCloskey have argued, markets encourage - over time - the cultivation of "bourgeois virtues" such as hard work and prudence which themselves encourage growth. This helps explain why shock therapies of immediate transitions to market economies have had indifferent results.