Chris Dillow's Blog, page 196

Organizational stupidity

One of the great curiosities of the UK economy is that productivity has stagnated. Output per hour has fallen in the last four years and has grown by only 1.1% a year over the last 10 years.
This is curious because it seems to contradict the principle of learning by doing. I spend about 10 hours a week playing guitar, and I've gotten much better in the last four years. Why, then, have the 900 million-plus hours per week we devote to work not yielded productivity improvements?
Here's a theory - which I'll overstate for expositional reasons. It's that companies are institutionally stupid. They are incapable of learning.
Three pieces of evidence are consistent with this:
- 90% of the growth in total factor productivity in UK manufacturing in the 1980s came from plants entering and exiting (pdf) the market, rather than from incumbents improving productivity.
- The statistical distribution of corporate deaths is very similar to that of species' extinction. This, says Paul Ormerod, suggests (pdf) that "firms have very limited capacities to acquire knowledge about the true impact of their strategies."
-  Alex Coad has found that corporate growth is largely random and unpredictable. This is consistent with the possibility that there is no "corporate intelligence" that leads to growth (Or it could be that such intelligence is uncorrelated with observable variables - but why?)
But why don't firms improve with practice in the way that individuals' musical or sporting performance improves? Here are four possible differences:
1. Within firms, there's no mechanism for translating individuals' learning, or incremental knowledge, into corporate knowledge. As Hayek said, hierarchies are terrible at using fragmentary, tacit, dispersed knowledge.
2. Job turnover means that job-specific human capital gets lost.
3. Bosses are selected for overconfidence. But overconfidence militates against learning.
4. In companies, the feedback that's necessary for improvement gets warped by adverse incentives or ego involvement. If I play a phrase or chord badly, my ears tell me to practice it more. But if a company gets some adverse feedback - falling sales, say - no-one has an incentive or desire to say "I screwed up: I'd better improve." And formal efforts to generate feedback, such as performance reviews, often backfire.
What I'm saying is  what every methodological individualist knows: companies are not individuals writ large. The differences between them can mitigate against learning by doing.
And herein lies the cost of the banking crisis. Because productivity growth comes from entry and exit rather than firms' learning on the job, anything that retards the entry process - such as a lack of finance - will retard aggregate productivity growth, and hence economic growth.
Another thing: What's true of firms is probably true of other organizations such as government departments. Organizational stupidity might well contribute to Baumol's cost disease.

Cognitive biases in football

Cognitive biases are everywhere - in stock markets, boardrooms (pdf), politics and even songs.It should, then, be no surprise that they also affect football punditry.
I'm thinking here of four biases:
1.Misperceiving randomness. There's always a chance that a team will suffer from bad luck: its opponents' finishing will be unusually brilliant; refs and linesmen will make bad decisions* against it; or usually good players will make bad errors. These random events will sometimes bunch together - that's the nature of randomness. If they come in one game, the team will get a hiding. If they come over a few successive games, it could suffer a losing streak.
But the pundits won't appreciate this. Instead, we'll hear about the club losing form, or being in crisis or decline. But in fact, what might have happened is just an "accident."
2. Hindsight bias. Results colour our attitude to teams' performance. If a team wins, we naturally think it played well and this can distract us from its shortcomings. For example, Manyoo's victory over Chelsea covered up the fact that they conceded 20 shots. Had things gone a little differently - better finishing by Chelsea or two of United's goals being ruled offside, this would have led the pundits to question the quality of their young defenders.As it is, they escape scrutiny from the media (though not, I suspect, Sir Alex).
3. The availability effect. Some aspects of the game are more noticeable, mentally available, than others, and so they attract an attention disproportionate to their importance.
The stupidest example of this is when retards criticise managers for not being more passionate on the touchline. But this is just the 2% of a managers' working week that is the most salient.
A more subtle form is that set pieces are more salient than many aspects of open play, such as the transition from possession to non-possession. This means that if a team is poor at defending set pieces, it'll get a reputation for bad defending even if its overall defence is good.You'd never guess from all the howling that,last season, Arsenal had the fourth-best defensive record in the league despite: having no goalkeeper for half the season; missing their best defender for most of it; not parking the bus in front of the goal;and being the victim of some appalling officiating.
4. Confirmation bias. Once people have an idea, they find evidence to corroborate it.So, having gotten the idea that Arsenal can't defend, they overweight evidence for this, an underweight evidence to the contrary. This is all the more likely to happen if it combines with point 1.
The counterpart of this bias is that people don't admit they were wrong.12 months ago, everyone said Arsenal needed to buy a new keeper. Wenger thought differently. And when Szczesny made that save against Udinese, did Wenger's critics recant and say that, maybe, they are wrong on other things as well? No.
Now, although fans and pundits commit these errors, coaches rarely do. As Arsene says, "We must not completely believe what people say when it goes well or badly." This isn't because they are better educated in statistics than their critics - though Arsene is - but rather because rationality often arises from practice, so those better practiced in football make fewer intellectual errors about it.This means that coaches don't over-react to good or bad streaks. They "take positives" from a defeat not (just) out of the self-serving bias but because there often are such positives. And they sometimes - though rarely in public - describe a winning performance as "disgraceful."
And yet, despite all this, fans and journalists continue to criticize coaches who have vastly more knowledge and expertise than they do. Which is, surely, an example of the Dunning-Kruger effect.
* I'm assuming refs' bad decisions are random. This is not obvious.

The final crisis of capitalism?

Are we seeing the final crisis (pdf) of capitalism? What I mean is that Marx envisaged that the end of capitalism would see four features, all of which are in place now.
1. The rate of profit would fall, reducing the motive to invest and producing slower growth and bigger recessions.
Although observed, past profit rates are high, companies' reluctance to invest and the low valuations on shares suggest that bosses and shareholders anticipate very low future profit rates.
2. Low returns on real assets would lead to speculative bubbles and swindles and hence financial crises.
To some extent, the banking and euro area debt crises are the results of the dearth of real investment opportunities arising from the fall in (expected) profits. This lack of investment, combined with high Asian savings drove bond yields down. That led to the growth of mortgage securities, as banks tried to synthesize securities to meet demand for them, and encouraged governments to borrow. In this way, the seeds of the financial crises were sown by the fundamental crisis of real profitability.
3. Increased inequality would exacerbate economies' propensity for crises, by creating a mass of people too poor to buy the goods which capitalism produced.
This has not quite happened. But, as IMF research has argued, inequality has had a very similar destabilizing effect. It led to the build-up of debt which contributed to the banking crisis.
4. By its end, capitalism would cease to be a means for developing the economy's productive forces and become instead a barrier to their development. As Marx put it:

At a certain stage of development, the material productive forces of society come into conflict with the existing relations of production…From forms of development of the productive forces these relations turn into their fetters. Then begins an era of social revolution.

This too fits capitalism today. Capitalists invest only if it is profitable to do so. When returns to investment were monetizable, this meant that capitalism was indeed a form for developing the productive forces. But returns have become less monetizable, and so capitalists are now less willing to invest. I mean this in several ways:
- Investment is no longer about building big factories and using capital-intensivity as a barrier to entry and hence form of monetizability; this is done in Asia rather than the west. Instead, investment here is more closely tied to innovation. But capitalists have always had trouble appropriating the returns to innovation, and so are - now they have wised up to this - are reluctant to undertake it.
- Some/many investments (such as in green technologies?) have higher social returns than private returns. But capitalists don't invest merely because social returns are high.
- Technology and changing social norms mean that many capitalist investments in the media are no longer monetizable.
Insofar as there are potentially useful investments which are capitalists are not undertaking because they are not profitable, then capitalism is indeed a fetter on the development of productive forces.
Now, of course, the death of capitalism has been hailed many times before. But I suspect that this crisis differs from that of the 30s and 70s.
In the 30s, profits were depressed by weak aggregate demand, something which could be cured. In the 70s, they were depressed by labour militancy, and when this was killed, capitalists' desire to invest was rekindled.
But the problem now is deeper than then. Capitalism has lost its underlying oomph; investment was low, remember, even before the recession. And this suggests that its vitality cannot be restored by policy measures, be they Keynesian ("boost demand") or Thatcherite ("attack workers").
Herein, though, lies the problem. Even if capitalism is dying - and I say if - there is no-one to kill it off; Marx's prediction that the working class would become a powerful agent of change was wrong. And there is no well worked-out vision of an alternative.  Gramsci's words fit the bill:

The old is dying and the new cannot be born; in this interregnum a great variety of morbid symptoms appear.

How bonuses backfire

There's growing evidence that high-powered financial incentives such as big bonuses can backfire. This can be because they crowd out intrinsic motivations (pdf) and creativity; or because they encourage free-riding; or because they lead to choking; or because people fear their work will be only imperfectly monitored and so won't get a payoff even if they work hard.
There might, though, be another possible reason for bonuses to fail, as a new paper points out.
Bonuses, the researchers say, have an ambiguous effect. On the one hand, there's the standard effect (subject to the above caveats) of inducing more effort. On the other hand, though, there's an informational effect. If the boss knows more than workers about the job, a big bonus will be interpreted as a signal that the job is very difficult. And this can, the researchers show, have big effects in reducing effort, as workers figure that there's no point busting a gut in a losing cause.
What I wonder, though, is how applicable this mechanism is to the real world. I suspect it might not be. One reason for this is that the criteria that trigger bonuses might not be tightly defined. Instead, bonuses might be just a loose form of profit-sharing, in which case their signal is diluted.
Another reason, though, lies in selection effects.
Although rational people might be deterred from taking on a job with a big bonus, overconfident ones might not be. They'll figure: "This is a tough job, but I've got the skills to do it." This gives us another way in which some firms might actually select for overconfidence.
Also, this paper draws the information asymmetry very sharply; principals have information, agents don't. In practice, though, this might not always be the case. Agents might instead find ways of cooking the books in order to appear to hit their targets. In this way, bonuses might select for unethical workers; I don't know if this happened in the case of Kweku Adoboli, but he fits the story.
Whatever. The point here is simply that the notion that bonuses have unambiguously good incentive effects is, surely, plain wrong. Sometimes, they work and sometimes they don't. And this means that a common justification for inequality is greatly flawed. 

Europe's morality crisis

Everyone says Europe has a debt crisis. But does it not instead have a morality crisis?
What I mean is that, technically speaking, there are lots of possible solutions to the problem, such as some mix of:
- Eurobonds, either actual or synthetic, accompanied by limits upon governments' ability to borrow.
- Recapitalizing the banks so they can withstand the inevitable write-down of PIGS' debt.
- A debt-equity swap
- A German fiscal expansion
- Full-blown quantitative easing, perhaps via changes to the SMP.
(I do not include a breakup of the euro as a solution because it's not; it would only be a massive default).
The thing is, this range of options is pretty impressive compared to those available in most political and economic crises. Of course, they all have costs, but not technically insuperable ones.
Instead, the obstacle is morality. All these options - except fiscal expansion which is only part of the solution anyway - impose costs upon northern European taxpayers. Which prompts the sort of questions posed by Clemens Wergin of Die Welt: why should German tax-payers support Greek tax-dodgers? Why should bankers who have made bad loans be bailed out?
In short, there's moral resistance, founded in part upon natural justice and in part upon the protestant bourgeois belief that hard work and prudence should be rewarded and fecklessness punished.
I say this is moral resistance rather than self-interest for a simple reason. Tax-paying Germans will lose money even if policy-makers do nothing. A Greek default, and contagion losses on other PIGS' bonds, will lead to a banking crisis and to recession in southern Europe which clobbers the German economy.
Whatever happens, Germans lose. The question is whether they lose by doing nothing or by formally supporting banks and/or PIGS. Insofar as there is resistance to the latter, it is founded on morality - a desire to punish sinners - rather than narrow self-interest.
Herein, I think, lies the cause of the markets' annoyance at Europe's lack of leadership. If you regard the crisis as a merely technical one, you'll see lots of possible fixes - or at least improvements on the status quo - and will therefore be frustrated that these aren't being pursued.  What you miss is that moral aspect.
This, though, merely raises a more general point about politics - that there is not only often a clash between moralists and technocrats, but a mutual incomprehension between them.

When consultation fails

Responsible policy-makers should consult widely before reaching their decisions. This is trivial. It is also wrong, according to new research. A neat experiment at Nottingham University shows how consultation can be counter-productive.
They got subjects to say whether a couple of paintings were by Paul Klee or Wassily Kandinsky. The subjects were split into two groups. One group comprised individuals making their own decisions. The other comprised individuals who were assigned to teams of six and allowed to consult team members.
And members of the teams did worse. Whereas only 29% of individuals got both paintings wrong, a whopping 51% of team members did so - twice as many as you'd expect by chance.
There was, however, no significant difference in the proportions getting both questions right: 38% of individuals versus 36% of team members.
Consultation, then, increases the chances of a bad decision, without improving the chances of a good one. What's more, people don't realize this; most said that they found the consultation process helpful.
The reason for this is that people are misled into giving wrong answers by team members who are irrationally over-confident, because these send out more (false) competence cues. "Individuals who know little are swayed by those who know less" say the researchers. (This is more true for women than men, but let's not go there.)
There is, though, a crucial thing about this result.
It all hinges upon whether the answer to a question is demonstrable or not. If it is demonstrable, then an expert who knows the answer can prove that he does so by using logic or evidence, and non-experts will defer to him. Consultation will then work, simply by virtue of bringing expertise into play.
But some knowledge is non-demonstrable. The expert might be able to distinguish between Klee and Kandinsky, but he'll find it harder to demonstrate his expertise to laymen than, say, a mathematician will be able to demonstrate that he knows the solution to an equation. And where knowledge is non-demonstrable, people might follow false experts.
This, I fear, might have widespread implications. Juries, for example, are asked to find a non-demonstrable answer.
It suggests that public consultation exercises must be carefully designed - or least they should, insofar as the object of them is to reach the correct decision, which might not always be the case.

Our illiberal culture

One of the most unpleasant aspects of the last Labour government was the illiberalism that saw it create over 4000 new criminal offences. However, it's becoming clear that, in this regard, Labour was merely reflecting a censoriousness culture. Take these examples:
- two men were jailed for four years for (unsuccessfully) using Facebook to try to incite a riot.
- The London Philharmonic Orchestra has suspended some musicians for merely writing a letter
- a man has been imprisoned for trolling.
To these cases we might add the disproportionately hostile reaction to Johann Hari's activities. His sins were small compared to the crimes of, say, serial drunk-driving or being Toby Young, and perhaps indicative of a troubled mind rather than malevolence. And if you don't like his journalism, the solution is not to make a fuss, but to not buy the Independent - a feat which 99.7% of the British people perform each day.
What interests me is: why is there this intolerance? I suspect there are three separate things.
One is technophobia. From Mary Shelley writing about the frightening power of electricity to people sheltering from wi-fi in West Virginia, some people have been scared by the power of new technology. Judges, who have never been comfortable with modernity, merely continue this pattern. In believing Facebook to have occult powers, they treat its misusers far more harshly than they would idiots making comparable remarks in the pub.
Another thing, which applies to the Hari case, is a mix of tribalism and envy. Rightists celebrate the embarrassment of an opponent, whilst Leftists - bizarrely - envy Hari his job.  Both lead to a loss of perspective.
There is, though, something else which links all these cases. They corroborate my fear that we have lost the conservative disposition - the recognition that the crooked timber of humanity does bad and silly things and that we should tolerate this. In its stead is the belief that people should conform to an ideal of buttoned-up, restrained respectability. So the LPO expects - contrary to centuries of evidence - musical ability to coexist with sensible political opinions; judges expect that Facebook users will not be hotheads; and the Twitterati convinces itself that columnists should somehow have standards higher than those of mere shills. And when reality hits these silly ideas, the response is an outrage comparable to that of Victorian ladies whose delicate sensibilities have been offended.
And in all this, toleration and liberty are lost.