Fast and slow thoughts about extended warranties

Dozing through the early business news this morning, I heard that extended warranties are back in the frame for offering consumers a bad deal (I’ll add the link when the programme is up on the iPlayer). It brought back memories. More than ten years ago (in 2002-3), I was a member of a Competition Commission inquiry into the UK extended warranties market.

For the great majority of consumers, these service or insurance contracts on domestic electrical goods are never a good deal. Appliances are well covered against malfunction by manufacturers’ warranties and UK consumer law, and often against accidental damage by normal domestic insurance policies too; and are anyway not all that prone to breaking down these days. The expected cost of repair bills or replacement is sufficiently low that most people are better off self-insuring (i.e. using their savings). A small number of cash-constrained (i.e. poor) people will benefit from paying for an extended warranty when they have the money upfront, but that’s about it.

At the time on the Competition Commission, we debated whether or not we should ban the sale of the warranties in-store. It was a close call – we decided instead to insist that stores display the warranty price alongside the price of the item so customers had a bit of time to think about it rather than (as was then the norm) being pressed to buy one when paying at the till.

With hindsight, I think we should have banned their sale in stores. Knowing what we now do about behavioural insights – especially how bad people are at assessing probabilities and expected values – would have tipped the decision, I think. The OFT looked at the market again in 2011, and the ombudsman is still saying the market isn’t working well for consumers. Oxera has a nice report about behavioural insights for these products. The right behavioural remedy it alludes to in the conclusion is probably to stop people having to decide under any pressure at all whether or not to buy one – they should do so at home, at leisure, and stores could always send them home with a form or email them a link. Maybe a copy of Kahneman’s Thinking, Fast and Slow as well?

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Eating people is wrong

A proof copy of Cormac Ó Gráda’s Eating People is Wrong (& other essays on famine, its past and its future) has arrived in the post, and it all looks terrific. I’ve skimmed the title essay, the point being that not all famines result in cannibalism, raising the question – why not? What cultural shifts or social norms might account for the different experiences concerning “one of the human race’s darkest secrets.”

The book ends with a reflection on Amartya Sen’s observation in his famous book Poverty and Famines (and again in Development as Freedom) that eliminating famine is ‘easy’, but eliminating hunger is not, and we shouldn’t pretend it is so. The task is “constrained by vested interests, by power politics, by poverty, by ignorance, by cynicism and by false analysis.”

Can’t wait to read the bits in the middle. Probably not right after our Christmas lunch.

Inequality, economics and politics – Thomas Piketty at the Bank of England

On Friday I attended an excellent conference at the Bank of England (organised by the Centre for Economic Policy Research) at which four speakers – Peter Lindert, Jaume Ventura, Orazio Attanasio and Tim Besley – gave presentations on aspects of Capital in the 21st Century, and Thomas Piketty responded to their comments and critiques. The presentations are due to go on the Bank’s website at some stage, although aren’t there yet.

Peter Lindert drew on material from his forthcoming book with Jeffrey Williamson (and also has a working paper on the Piketty book), to characterise the long-run trends in inequality as the result of ‘lucky’ historical accidents that wipe out concentrations of wealth, combined with policies that help the society stay equal. The period 1910 to the 1970s was the ‘great levelling’, due to wars, and there has subsequently been a fanning out in countries’ experience but in many cases a rise in top incomes. In this, he agrees with Piketty’s book; but disagrees with the famous ‘r>g means rising inequality’ prediction. Demography, technology and politics (mainly education and inheritance tax) – with a role for geography in the case of frontier societies – are his favoured explanations. South Korea, for example, has an inheritance tax of 50%: in principle the heirs of the ailing Lee Kun-Hee of Samsung will be due to pay £4bn in tax when he dies.

Jaume Ventura focussed on the dynamics of economic growth that might explain inequality trends: a u-shaped long-run evolution in the capital-income ratio; the changing components of wealth, with land playing a decreasing part; a not-quite-u-shaped evolution in capital-labour shares (the capital share has risen but is not back to its historic highs); and a stable return to capital of 4-5%. Like Prof Lindert, Prof Ventura does not think the model implied in Capital in the 21st Century, and the r>g inequality, stacks up. He argued that the assumptions in the book imply a world of multiple equilibria and cycles or chaotic dynamics, and also that the growth model ignores all the lessons of endogenous growth. He said: “There has been a change in the deep structure of capital in the 21st century.” Bubble-like capital gains now play a large part.

The two final papers moved on from diagnosis to solutions. Orazio Attanasio described the recent research confirming the importance of people’s early years, before the age of 3 and certainly before 10, for their lifetime earnings. Parents’ status and income is important but works through the early effects on a child’s cognitive and non-cognitive abilities. Early experiences even have epigenetic effects. He concluded that the biggest policy problem is the bottom 10% in society, not the top 1%. But also – optimistically – that individuals’ life outcomes can be changed by appropriate early interventions.Prof Attanasio also discussed the optimal level of the top tax rate – recent estimates range from 42% to 86% as the rate that would maximise revenue – to which Thomas Piketty replied that top tax rates should be seen as pollution taxes, the aim being to stop behaviour imposing an externality rather than maximising revenue. However, as 25% of UK income tax comes from the richest 1% (54% from the richest 10%), it would be a bold government that ignored tax revenues.

Tim Besley gave a fascinating talk about the political economy of inequality, referring to his most recent book with Torsten Persson, Pillars of Prosperity. He asked, does inequality undermine effective governance? In democracies there is normally thought to be a compact where the rich trade some redistribution in return for security of their property rights. But people don’t mind some kinds of high incomes – footballers vs bankers. And there is no link (looking across countries) between either top (marginal) tax rates and inequality. Quoting Lenin’s The State and Revolution, Prof Besley said there is no empirical support for the frequent claim that the median voter is decisive in political choices: “Democracy for an insignificant minority, democracy for the rich – that is the democracy of capitalist society.” He went on to show evidence that inequality limits the demands for social action, which over time reduces the capacity of the state to act – its legal capacity, fiscal capacity, and capacity to deliver public goods. Finally, he said, there is also evidence that from time to time the values of citizens shift markedly – after the war, for instance, in the overwhelming support for the NHS and welfare state. I couldn’t agree more with his final comment that there are three kinds of economics – the positive, the normative, and political economy.

When I read Capital in the 21st Century, I found it hard to work out the growth model implicit in the book, so was reassured that much cleverer economists than me found fault with them. However, as several of the speakers said, that doesn’t make it any less important a book. It has changed the public debate and climate of opinion about inequality, in large part through the long years of hard work giving us the first ever (open) data base of historical figures, the World Top Incomes Database. Jaume Ventura said his advanced macro students have to read it, along with Angus Maddison’s The World Economy: A Millennial Perspective. I was also most impressed by Prof Piketty’s openness to the critiques: “Every conclusion in the book is a temporary conclusion, and subject to discussion,” he said.

An early Xmas present…

… from my publisher is a copy of the new econometrics book by Joshua Angrist and Jorg-Steffen Pischke, Mastering Metrics: The Path From Cause to Effect.

Christmassy…..

I *love* their previous book, Mostly Harmless Econometrics, which has the most careful treatment of counterfactuals (among other things) I’ve come across. (Regular readers will know of my obsession with counterfactuals.) The new book looks awesome too. If you only buy one econometrics book, buy these two.

  

Diminishing returns to information

Although it was published three years ago, when the financial crisis was much fresher in our minds, the essays in What’s Next? unconventional wisdom on the future of the world economy (edited by David Hale and Lyric Hughes Hale) remain interesting.

Looking this morning at the chapter The Diminishing Returns of the Information Age by Mark Roeder, his two main points remain just as relevant. One is to underline the paradox that at a time when there was more information than ever about the financial markets, people in general failed to notice the huge phenomenon of the developing crisis – the signals were there and nobody paid attention. This attention deficit is something Paul Seabright has also explored.

A related point is the way certain themes or stories develop online and stick in the collective mind even if untrue. Roeder gives the example of people in the US continuing to buy unaffordable homes on sub-prime deals even after it had become very clear in 2007 that the narrative of ever-rising property prices was untrue. He links this power of certain narratives to the ‘online oligarchy’ of large news providers, increasingly keen on sensationalizing stories to grab attention, in the battle for advertising. But it is surely even more the case on social media. This is part of the tussle about ‘the right to be forgotten’ debate: falsehoods as well as truths last forever online.

Roeder ends pessimistically: “Never before have we had access to so much information, yet so little understanding of how to manage it.” Three years on, we don’t seem to have progressed any further in working out how to have understanding catch up.

As a brighter footnote, I have also read the lovely poems Dog Songs by Mary Oliver, an early Christmas gift from a friend. Here are a few lines from a poem about watching TV with her dog Ricky:

‘I’m getting a headache looking at this.
I have to bark.’ And he began.
It does no good to bark at the television
I said. I’ve tried it too. So he stopped.

Diminishing returns to barking at the TV too?