(Ain’t) Misbehaving

Despite having read plenty of the behavioural economics books, of course I had to read Misbehaving: The Making of Behavioural Economics by Richard Thaler, one of the first people to introduce and then popularise (through Nudge in particular) the introduction of psychological empiricism into economics. Nor do I regret it. It is a very good read. Although it goes over much familiar territory, it’s very interesting to read Thaler’s account of how a highly resistant discipline became accepting and then positively enthusiastic about behavioural models. Too enthusiastic – but more on that later.

Misbehaving combines a broadly chronological account of Thaler’s career and work with a highly accessible explanation of what behavioural economics is, how it differs from the previously conventional kind, and the evidence from psychology about how people make decisions. The book starts by explaining why economists had adopted an unrealistic model of rational choice, and why it made economics so powerful: “That power derives from the fact that economics has a unified, core theory from which nearly everything follows.” Certainly early resistance to ‘behavioural’ assumptions tended to be that these derived from an ad hoc list of patterns of choice with no theory behind them, never mind that rational choice is ad hoc with respect to the facts. This seems to be hard for some economists still to accept perhaps because – as Thaler recounts – economists make choices far more often in conformity with their own models than do other groups of people. Misbehaving tells of a survey conducted among wine connoisseurs designed to explore how people regard sunk costs and opportunity costs, in which the people who gave the ‘correct’ answer were economists.

The book has lots of examples that will be useful to people teaching behavioural economics, including classroom experiments. I also very much enjoyed all the anecdotes, like the story of a vigorous debate with Richard Posner at a conference on law and economics, or a session on behavioural finance that had smoke coming out of Merton Miller’s ears. Resistance among distinguished economics professors who had built their glittering careers on rational choice models is, of course, entirely rational. Less rational, more human, was the behaviour of a group of University of Chicago economics faculty in selecting their offices in a brand new building.

Behavioural economics is now one of the most popular areas of the subject, and seminars on behavioural papers are packed. Sometimes it seems pretty much everyone I know has a new paper applying behavioural insights to their own sub-field. Perhaps this is just me being contrarian, but the new embrace by economists makes me uneasy. This is not just because of the well-known debate about paternalism (as discussed by Gilles St Paul in The Tyranny of Utility or Julian LeGrand and Bill New in Government Paternalism: Nanny State of helpful Friend?) It is because the sight of economists delighting in a new tool to engineer society is alarming – it’s the same old reductionism in more fashionable clothes. I happened to read this morning this essay by historian Ian Beacock on Arnold Toynbee. This quotation jumped out: “We’ve begun to treat vexing social and political dilemmas as simple design flaws, mistakes to be rectified through a technocratic combination of data science and gadgetry.”

I’m 100% in favour of empiricism. Why would you not do ‘what works’? But the behavioural rules of thumb are in danger of being seen as a new policy gadget.

  

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Conventional wisdom on cities. Not.

The subtitle of Urban Economics and Urban Policy, by Paul Cheshire, Max Nathan and Henry Overman, is “Challenging conventional policy wisdom.” This surprised me: these are eminent economists and Henry Overman runs the newish government-funded What Works Centre for Local Economic Growth, with a specific policy advice remit. In what way are these authors ‘challengers’?

Luckily, the final chapter of this excellent book answers that question. The conventional wisdom consists of the kind of “place-based” policies so much loved by local governments over the decades. The book: “Argues that focusing public expenditure on ‘turning around’ the economies of declining places has had little success; and specifically, many policy interventions have had little economic effect.” It argues that the evaluation of disparities between places should anyway take account of cost differences as well as nominal wages, and should consider too non-wage and non-monetary amenities. But in any case, disparities between people are more important than geographic ones – people, not places – although people do sort themselves with similar people into specific locations. Thus the skills of individuals matter – places don’t have skills – so the challenge is attracting and retaining the individuals. Or, conversely, enabling people to move away from declining places.

A separate, powerful strand of argument concerns housing supply and land use in general. The book argues that land-use is an under-appreciated factor in differences in urban performance. This is tied in to the argument that decline must be made possible: “We would argue for a greater focus on encouraging labour market activity and removing barriers to mobility. In practice, this will require a better understanding of the three-way interaction between the benefit system and the housing and labour markets, and the expansion of housing supply and reduction of costs of living in relatively successful places.”

The book does have a brief chapter on the city devolution process under way now in the UK, but it’s fair to say that the authors are unimpressed by the standard range of urban policies – ‘cluster’ policies, infrastructure investment, area-based initiatives and so on. While sharing their sentiment about some of the guff produced about localism (and there’s a lot of it), I think they are too sceptical about the potential. Consider for example the argument made in Chapter 8 that infrastructure investment does not deliver on regional ‘rebalancing’ and could be counterproductive; and look at the map below showing the way the UK’s motorways were planned (discovered courtesy of Tom Cheshire, @chesh):

All motorways lead to London

The railways post-Beeching cuts have the same radial pattern around London, as do the big internet pipes. Is it really any surprise at all that the UK is such an unusually capital city-centric economy?

This is a terrific book that summarises the state of economic knowledge about urban economies but – as it also acknowledges – there is much we don’t understand. Why do some declining places in fact achieve a turnaround? Why do people not leave poor locations even when they apparently can? Why do policy makers insist on trying over and over again things that don’t work? Answers will surely involve neighbouring social sciences as well as economics. The momentum toward city devolution in the UK, limited as it is, mean that these are pressing questions, and a lot of people will be piling in to offer answers. Although I don’t share the policy scepticism to the degree it is expressed here, Urban Economics and Urban Policy provides an invaluable foundation for the debate ahead.

The information economy

I very much enjoyed reading Cesar Hidalgo’s Why Information Grows: The evolution of order, from atoms to economies. It’s a very original perspective on the process of secular economic growth, bringing together not only several strands of the economics literature – growth theory, institutional economics, social capital etc – but also physics, biology and information theory. So it’s certainly ambitious, and I found it largely persuasive.

Hidalgo’s first point is that we are misled by thinking of the information economy as ‘weightless’ (a term I think I coined, or at least popularised, in my 1996 book The Weightless World) into forgetting that information is nevertheless physical. “Information is not a thing; rather, it is the arrangement of physical things. It is physical order.” He links the order of the economy to the order of the universe that can exist in pockets despite entropy. Economic order comes about through information embodied in things (‘crystallised imagination’) and in the way people organise themselves to apply knowledge and know-how. The first section is rather poetic. Hidalgo describes a tree as a computer powered by sunlight. “A tree processes the information that is available in its environment.” He describes a colleague at MIT who lost both his legs to frostbite while mountaineering, and built his own prosthetics: “He is walking on solidified pieces of his own imagination.”

The book goes on to consider products imported and exported by countries in terms of ‘crystallised imagination’, which requires “an enormous amount of knowledge and know-how.” Knowledge is the set of instructions – a book describing how to play a guitar – and know-how is the practical experience enabling application – the process of learning and practising playing to produce lovely music. Hidalgo introduces the concept of a ‘personbyte’ – the limit to the knowledge and know-how that can be embodied in one individual. For an economy to go beyond that requires collective organisation. He argues against the normal economic argument that economic development is the process of acquiring the ability to consumer more goods and services. “Economic development is based not on the ability of a pocket of the economy to consumer but on the ability of people to turn their dreams into reality.” (This part doesn’t wholly convince me – it’s an appealing case but surely consumption matters too.)

The book then turns to the idea of the economy as a social and technological system for amplifying knowledge and know-how, and looks at institutional economics and the role of social capital in growth in this context. Conveying know-how is difficult, and becoming more so as time goes by and the economy becomes more diverse and complex. The “computational capacity” of the economy needs to grow, but it is constrained by the ability for knowledge and know-how to be embodied in networks of people – hence the value of trust, as it makes that easier.

Hidalgo’s work on the Atlas of Economic Complexity enters here: there is a strong positive correlation between a complexity index and long term growth (over 10 years). The falling cost of communications and the emergence of standards have increased the number of long-distance market links (instead of transactions within single firms), and this know-how transfer is made far easier by high trust, which enables larger networks. Low trust economies are often characterised by more family firms and rely more on the state to spread knowledge and know-how through its support for industries.

There is a very nice analogy of the economy as a jigsaw. “Moving a complex industry is like trying to move a jigsaw puzzle from one table to another. The more pieces in the puzzle, the harder it will be to move it, as the puzzle falls apart when we fail to move all the pieces at the same time.” It is easier to move just a few pieces to another table that already has part of the puzzle in place. Thus economies mostly grow out from their earlier set of products, which embody the know-how they already have – they already have some of the pieces. The description of this process would very much appeal to evolutionary economists.

A final point that very much intrigues me is measuring growth. Hidalgo makes the same point as the final chapter of my GDP book, that in adding things up in terms of their monetary value we are not capturing the value of diversity: three spoons are not as valuable as a knife, fork and spoon. He says that using market price denomination to aggregate implicitly assumes there is friction-free trading; but this is often not possible, especially with stock variables. He advocates looking at the disaggregated economy via input-output tables.  “The mix of products exported by a region’s industries represents a fingerprint of its productive capacities that does not suppress the identity of the economic elements involved.”

So a highly recommended read for anyone interested in economic growth and development. The insistence on the embodied-ness of knowledge and know-how is surely correct, and also a useful corrective to overly-abstract accounts of economic development, including quite a lot of the newer institutional literature (as Morten Jerven argues, this often amounts to the advice to poorer countries to “be more like Denmark”, ignoring the trajectory from here to there). It’s also a pleasure to read such a well-written economics book; from now on I’ll be envisioning the economy in terms of crystals of imagination.

Railways and plutocrats

This is a bit off-topic i.e. isn’t an economics book, but I enjoyed Iain Sinclair’s latest, London Overground: A Day’s Walk around the Ginger Line. It’s an absolutely characteristic dyspeptic take on what’s happening in the unfashionable parts of London, the places linked by the tarted-up, more-or-less linked-up overground rail lines where Londoners can afford to live, if they’re lucky, pushed ever-further out by the tide of foreign plutocrat money drowning the housing market, leaving swathes of the city deserted because of the absentee landlords.

Sinclair’s work is an acquired taste but I love it. This is not one of his best – not up to London Orbital standard –  but it does feature one of my favourite things, a Victorian-built railway. Sinclair writes of the “functional elegance of Victorian arches” – indeed. And then there’s the anger, the anger, about the money: “Dirty money was never so bright, so blatant. So protected by the politics of no-nothing quiescence.” This week the Chancellor of the Exchequer said we should stop the banker-bashing; but I’m with the Governor of the Bank of England, saying there had been ‘ethical drift’, and the time really has come for the money people to regain their social licence to operate.

On The Economy of Machinery

On The Economy of Machinery and Manufactures by Charles Babbage was published in 1832. I discovered it courtesy of Sydney Padua’s The Thrilling Adventures of Lovelace and Babbage, not having known Babbage had written at all about political economy.

It’s a marvellous book. Babbage clearly had a joyous, expansive interest in everything. The first half describes and discusses all kinds of innovations in manufacturing – how machines work, what different industries have been introducing, and a long chapter on different types of copying, from copperplate printing to mass production techniques making copies of manufactured items.

The second half turns to questions of political economy and it is fascinating to see how Babbage links his observations about actual businesses that he visits – clearly, very many of them – and the price lists he sees, and the machines he has seen built – with analytical principles. He describes the importance of fixed costs and increasing returns to scale; the importance of asymmetric information in explaining many phenomena in business; the way large productivity gains depend on a reorganisation of production, but may be left untapped unless there is enough pressure from competitors because old techniques are still profitable; the phenomenon of geographic clustering for exactly the reasons Alfred Marshall more famously set out his 1890 Principles of Economics; and the sheer restless dynamism of the industrial economy. He even has thoughts about the relationship between automation and jobs.

All in all, it adds up to a very modern-seeming view of how the economy operates. Although of course it would have seemed very old-fashioned to 20th century economics, having no equations, no steady state equilibrium, no machinery of assumptions and axioms.

I love Babbage’s detailed empiricism. He is overjoyed by the potential of the division of labour, and takes Adam Smith’s example of pin manufacture. He visits pin makers of all kinds and describes the 10 stages of pin making in some detail. He tells us whether tasks are mainly done by men, women or children, and what their typical wages are. He describes the tools used and how they work. He also has a detailed account of pin making from half a century earlier. He can put a figure on the productivity gain from the division of labour!

It turns out Babbage wrote a fair bit of economics. I might move on to another of his works.