Two cheers for technocracy

Who needs experts? The minimum wage was once an example of the triumph of technocracy, where decisions are delegated to experts to depoliticise them.

The Low Pay Commission was set up to balance competing priorities – increasing wages without creating too much unemployment. If you were a moderate who thought the minimum wage was a good way of boosting low wages, but recognised that it might also create unemployment, the LPC gave you a middle ground position. (For what it’s worth, I’m an extremist.)

That technocratic settlement also allowed politicians to, basically, safeguard against an ignorant public. By delegating decisions like this to experts, bad but politically popular policies could be avoided. Relatively well-informed politicians could avoid having to propose bad policies by depoliticising them.

Other examples of this include NICE’s responsibility for deciding which drugs the NHS should and shouldn’t provide, and the Browne Review that recommended student fees, which had cross-bench support. The old idea that “you can’t talk about immigration” comes from an informal version of this – everyone in power knew that people’s fears about the economics of immigration were bogus, so they were basically ignored.

But that technocratic settlement now looks dead. Labour has now made a specified increase to the minimum wage part of its electoral platform, following George Osborne’s lead earlier this year. That means that voters will have to choose not just between two rival theories about the minimum wage, but two competing sets of evidence about whether £7/hour or £8/hour is better, given a wage/unemployment trade-off.

Whether voters are self-interested or altruistic doesn’t really matter. A self-interested low wage worker would still need to know if a minimum wage increase would threaten her job; an altruistic voter would similarly need to know a lot about the economics of the minimum wage and the UK’s labour market to make a judgement about what level it should be.

And of course the minimum wage is just one of dozens, if not hundreds, of questions that political parties offer different answers to that voters have to make a judgement about.

In practice this does not happen. Voters are very uninformed about basic facts of politics, and are almost entirely ignorant about economics, which almost everyone would agree would be necessary to make the correct judgement about something like what the minimum wage level should be (even if they didn’t agree on which theories and evidence was relevant). Even the use of rules-of-thumb such as listening to a particular newspaper or think tank (ha) will suffer from the same problems.

Voters, then, face a nearly impossible task. Assuming they are bright, well-intentioned, and believed that it was important for them to cast their vote for the party that would have the best policies, they would have to amass an enormous amount of information to make the right decision on all the questions they, in voting, have to answer.

So voters are trapped. They cannot know what minimum wage rate is best any more than they can know what drugs the NHS should pay for. They are, empirically, very unaware of basic facts, but they would find it hard to overcome that even if they wanted to.

Does democracy make us free? Maybe, but it’s the freedom of a deaf-blind man – we can choose whatever policy we want, without any idea about what those policies will actually do. So, if the alternative is more direct democracy like this, maybe technocracy isn’t so bad.

Switching mobile networks is easier than switching governments

Unlike lots of people on the right, I like Owen Jones. He’s good natured and often challenges orthodoxy on his own side, and he’s a thought-provoking writer. 

Having said that, I usually disagree with what he writes on economics. His Guardian piece this week, which called for the nationalisation of the UK’s mobile network operators, was a good example. It’s tempting to dismiss it as clickbait, but it represents a train of thought that is increasing in popularity. And if nothing else it may shift the Overton Window.

Jones starts by pointing out that nationalisation of big industries is very popular among the public at large. “While our political overlords are besotted with Milton Friedman, the public seem to be lodged somewhere between John Maynard Keynes and Karl Marx.” 

A fair point. He might also have noted that the public disagrees with him about lots of other things: the obvious example is hanging, where the public is somewhere between Roger Helmer and Oswald Mosley, but there’s also immigration, which 55% of people want reduced ‘a lot’ (and another 21% want reduced ‘a little’). The Great British public thinks the benefits system is too generous by a 2-to-1 margin, and think that ‘politicians need to do more to reduce the amount of money paid out in benefits’ by a 3-to-1 margin. And so on. On these issues, and presumably many others, I assume Jones thinks the public needs further persuasion.

It isn’t necessarily that the public really is bloodthirsty or xenophobic or anti-poor or quasi-Marxist; it’s that the public is extremely uninformed about most things. How could you judge whether we needed more or less immigration if you thought we had more than twice as much immigration as we actually do? How could you judge whether the railroads should be nationalised or not if you did not know that passenger numbers had doubled since privatization, after decades of decline under the state?

Jones claims that mobile phone networks are an inefficient natural monopoly, without any real reasons given. This claim is untrue. The UK has four competing mobile networks (Vodafone, O2, Three and EE, which was formed by a merger by T-Mobile and Orange) and dozens of aftermarket “mobile virtual network operators” that lease wireless spectrum from those four networks (GiffGaff and Tesco Mobile are two popular examples). None of these networks are unusually profitable and all spend enormous amounts on marketing. Try spending a day in a city without seeing at least one advert for each company. This is not the behaviour of monopolistic industry!

(There are a couple of other frustrating errors in the piece. For instance, a typical £32-a-month 24-month contract can get you an iPhone worth £550, not a device worth £200 as Jones claims.)

Yes, signal blackspots are annoying. (Take it from someone who spent his teenage life having to walk into the garden to send a text message.) And mobile networks’ customer service really does suck sometimes! But Jones is comparing reality with an ideal where resources are infinite. Since resources are not infinite, we have to have some way of deciding what imperfections are tolerable. 

For example, as annoying as blackspots are, the optimal amount of coverage is obviously less than 100%. The phone networks reckon they cover around 99% of the population, and as frustrating as it is when you’re in that last 1%, the marginal costs rise dramatically when you try to cover that last 1%. We could cover them at great cost, meaning that we have less money to spend on other important things elsewhere. The question is one of priorities.

Ultimately, the important question that Jones does not answer (or ask) is, compared to what? Private sector firms might be irritating sometimes. Unless you can show that nationalised firms would be less irritating and better overall, that doesn’t tell us anything about what we should do. 

There are lots of examples of nationalised firms that were absolutely terrible. Tim remembers waiting three months for a landline when the GPO ran the phones; and then there is the huge drop-off in rail passenger numbers under British Rail, followed by an equally huge recovery after privatisation:

GBR_rail_passenegers_by_year

The fact that the state funded some of the scientific research that led to the iPhone doesn’t mean that we’d have better phones if we nationalised Apple. (It might be a case for state funding for scientific research that is released into the public domain, though.) As Tim says, “The State can be just as good as the market at invention, the creation of really cool new technologies. But it’s terrible compared to the market at innovation, the getting of that new technology into peoples’ hands so that they can do cool and interesting new things with it.” 

Economies of scale exist, as Jones suggests, but so do diseconomies of scale. Firms can be too big. And when you have a single network (whether it’s privately or publicly owned), customers lose all ability to ‘exit’ a firm that is giving them a bad service, so the only recourse they have is at the ballot box. 

Which brings us back to the first problem with Jones’s piece: politics is a complicated business about which we know little. If we don’t like what we’ve got, we have to hope that a majority of other voters agrees with us – and even if we’re right, they may not be informed enough to agree with us. 

It’s a lot easier to switch mobile phone providers than it is to switch governments. Ultimately, it’s that pluralism and freedom of exit that drives improvements in markets, and tends to make governments relatively bad at doing things. For all the mobile network industry’s problems, the question is: compared to what?

When ignorance trumps incentives

When something bad happens it is often helpful to think about why it has happened in two ways: did someone have a reason to make it happen, or did it happen by accident? This can also be expressed in a slightly different way: were incentives to blame, or ignorance? Jeffrey Friedman and Wladimir Kraus have made a compelling argument that ignorance explains more about the world than we often realize, using the 2008 financial crisis as an example. This post is an attempt to summarise their argument.

Economists often remind us that incentives matter. Indeed this is sometimes said to be the cornerstone of ‘the economic way of thinking’. Russ Roberts gives the example of death rates on British ships bringing convicts to Australia in the 18th Century – rather than attempting to raise ship captains’ awareness of the badness of letting their passengers die, the government gave captains a bonus for every convict that walked off their ship. This was very effective.

Clearly this way of thinking can be very powerful. It is the foundation of the price system, which is the mechanism that markets use to allocate resources effectively in a world where information is dispersed: if demand for pizza rises, the price of pizza rises, giving cooks and restaurant owners an incentive to sell more pizza. It helps to explain why some people stay on welfare payments for long periods of time: the welfare money they lose when they go into work represents a significant disincentive to work. Or, if you offer something like a bailout to businesses that go bust, you reduce the incentive for them to act prudently to avoid going bust.

This last example is what is known as moral hazard. And it is a popular and compelling explanation for the 2008 financial crisis. Banks expected to be bailed out if they went bust, so they acted more recklessly than they would if they thought they would be on the line for their mistakes.

However, Friedman and Kraus argue that this popular and compelling explanation may in fact be wrong. A good way of testing it would be to compare how the bankers involved in making bad decisions acted where perverse incentives applied, and how they acted where perverse incentives did not apply.

One strong piece of evidence against the incentives narrative is that bankers seem to have acted the same way with their personal investments as they did with their business investments.

Many bankers lost a lot of money personally in the crisis because their personal portfolios were not ‘bailed out’ in the same way that their banks were. If we are to treat the ‘incentives story’ as a falsifiable proposition (as all claims about the world should be treated), this might be a fairly strong reason to disregard it.

This may be where ignorance comes in. If bankers acted the way they did because they were unaware of the risks they were taking, then we would expect their private and business investments to be pretty similar.

However, it is strange that so many bankers seemed to make the same mistake. We know that they were not acting in a neutral environment: as Friedman and Kraus have shown, regulations like the Basel accords and the US’s recourse rule directed banks to prefer mortgage debt to business debt. Other regulations directed banks to rely on the risk judgments of three specific ratings agencies, giving those agencies protection from competition.

(On the ratings agencies point, astonishingly, it seems that nobody realized that these agencies were basically protected from competition. Both bankers and regulators assumed they were being subjected to market forces, leading to everyone trusting them a lot more than they would if they knew they were dealing with protected monopolies.)

These regulations were designed to make banks act prudently: the regulators had no incentive to make banks act badly. It seems possible that they did not realize the error of their ways until it was too late. Perhaps regulatory ignorance was to blame.

It is important to stress that the regulators should not be blamed personally. They probably made the best choice they could have made given the information available to them. Rather it is the position they found themselves in that seems to have been to blame. If a single bank (or even a handful) makes a mistake, that bank will suffer but the whole sector probably won’t. It is only when a whole sector of a market (or almost all that market) makes an error that we should worry. (Incidentally, as shaky as the housing and financial sectors were, the real trouble did not begin until monetary policy tightened unexpectedly, as Scott Sumner outlined at our recent Adam Smith Lecture.)

Given ignorance, we should expect errors to take place. Because regulation necessarily applies to everyone in a market, a regulatory error affects everyone.  That may be the fundamental problem with regulation, and a reason to have a strong ‘prima facie’ objection to regulation. It is better to have one hundred firms making one hundred different mistakes that happen at different times and in different ways to one hundred firms making one single mistake that happens at the same time for everyone.

None of this implies any special knowledge on the part of firms. Indeed regulators may be much more expert than the firms they are regulating, but the danger of a collective error would still give us a reason to generally object to regulation in principle, no matter how sensible it may seem.

Politics makes us ‘stupid’ because the world is complex

Ezra Klein has launched his new site, Vox.com, with an essay on ‘how politics makes us stupid’.

The piece is provocative, and Klein uses some interesting examples. Most striking is the study that shows that people’s maths skills get worse when the problem they’re dealing with has a political element and goes against their political instincts. (Klein seems to have slightly misunderstood the study he’s written about, but his basic point stands.)

The basic claim is that people engage in ‘motivated reasoning’ when they think about politics – in other words, they think in order to justify what they already believe, not in order to discover the truth. This, he suggests, is because the politically-engaged people get more loyalty to their ‘tribe’ than they lose by being wrong.

This ‘identity-protective cognition’, as he calls it, makes sense – a pundit who decides that the other side is right about some particular political issue (Klein uses global warming as an example) has a lot to lose in terms of status within the group they’re part of, and little to gain by being right.

Klein says that this has become worse as political parties have become more ideologically uniform and ideological ecosystems, like think tanks, blogs, media, more expansive. Not only is there the external cost of being wrong, but admitting to yourself that you’ve been wrong for a long time is quite difficult too, especially if you’re politically engaged and some of your sense of self is tied up with your beliefs. You could call this ‘rational ignorance’.

Even though that might seem plausible, I think he is assuming too much and is wrong about some of the phenomena he identifies. I’d like to suggest an alternative understanding of political ignorance that, I think, explains more and assumes less.

I think Klein’s fundamental error is to assume that the truth – or, at least, his mode of truth-seeking – is obvious. Basically, he starts off from the position that most people could reasonably see the light if they wanted to. If that’s right, then it could follow that incentive to disbelieve the truth. And “identity-protective cognition” is an interesting way of understanding that.

But suppose truth is not obvious – that we’re ignorant not because we want to be but because, in Keynes’s words, “we simply do not know!”. In contrast to the rational ignorance Klein is discussing, this kind of ignorance comes about because life is complex. The existence of this kind of ignorance is what allows people to disagree without either being willfully ‘dumb’.

To demonstrate his case, Klein uses examples of ideological dogmatism that are based on rejection of the hard sciences. Here he is assuming that a reasonable default position must be to believe in the usefulness of science, so anyone who deviates from that by disbelieving some scientific point must have an incentive to do so. But if they are simply unaware of the fact that science is usually a good way of learning things, them ignoring scientific consensus is simply a mistake.

Klein may see it as being obvious that science is great. But he has probably spent a lot more time thinking about it than most people – for many, rightly or wrongly, the jury is still out on science, as a great man once said. Error, not group loyalty, may be a simpler explanation for people’s refusal to accept what seems to be a well-established truth.

If the truth is difficult to determine, people who have an interest in politics need some way of sorting the truth from the information they can access. Since there is a huge amount of conflicting data and theory in nearly every area of policy (whether garbage or not), people need some way of sorting the wheat from the chaff.

That’s where an ideology comes in. An ideology, I suggest, is a type of ‘web of belief’ that allows people to use what they already believe to be true to sort relevant and true new information from irrelevant and untrue information. As Jeffrey Friedman puts it, ideology “provides pegs on which to hang the political facts of which non-ideologues tend to be so shockingly ignorant”.

This fits with the fact that ideologues are usually a lot more informed than non-ideologues, an important fact that, so far as I can tell, Klein ignores.

Klein’s view is that political ideology ‘makes us stupid’, but ‘closed-minded’ is probably a more accurate term. The vast majority of the public is shockingly ignorant of basic political facts, with the informational ‘elite’ also happening to be the more closed-minded. The alternative to closed-mindedness may simply be to be extremely uninformed.

This matters because the things Klein blames for politics making us stupid – ‘gerrymandering, big money, and congressional dysfunction’ – are mostly irrelevant if the view I’ve outlined here is correct. In a complex world where the truth is hard to discover, even the purest politics would make us stupid.

This implies a much more fundamental problem with the democratic process than Klein suggests. The trade-off between ignorance and dogmatism may be unavoidable in politics, making a well-functioning deliberative democracy virtually impossible to achieve. This may imply that less cognitively-demanding ways of making decisions, like markets, may be even more valuable than we realise.

Why we’re hoping the wisdom of crowds can beat Mark Carney

Today we’ve launched two betting markets to try to use the ‘wisdom of crowds’ to beat government economic forecasters. Here’s the press release we sent out:

The Bank of England’s economic forecasts have been wrong again and again. To counter this, the free market Adam Smith Institute is today (Wednesday 28th August) launching two betting markets where members of the public can bet on UK inflation and unemployment rates, taking the government’s experts on at their own game. The markets are designed to aggregate individual predictions about the economy’s prospects to use the ‘wisdom of crowds’ to beat the predictions of government experts.

The launch coincides with Mark Carney’s first major speech as governor of the Bank of England and follows his announcement earlier this month that the Bank will consider both inflation and unemployment when deciding monetary policy.

The markets (which will be run by bookmaker Paddy Power and can be accessed here) offer these odds:

UK Inflation on 1st June 2015
7/1 – 2% or Less
3/1 – 2.01 – 3.00%
9/4 – 3.01 – 4.00%
5/2 – 4.01 – 5.00%
7/2 – 5% or Greater

UK Unemployment rate on 1st June 2015       
9/2 – 5% or Less
3/1 – 5.01 – 6.00%
15/8 – 6.01 – 7.00 %
5/2 – 7.00- 8.00%
5/1 – 8% or Greater

Bookmaker odds tend to be far more reliable than expert opinions about sports, politics and the Eurovision Song Contest, because betters have a strong financial incentive to bet in a dispassionate way and betting markets collect the judgments of thousands of different people, eliminating individual biases.

Even if no single member of the public can beat the experts, collecting the local knowledge of thousands of people in betting markets allows for a much broader set of data points, weighted according to the strength of people’s beliefs. The Office for Budget Responsibility already collects around two-dozen expert predictions, but this is nothing like the kind of volume needed for the ‘wisdom of crowds’ effect to take place.

These markets follow the CIA’s attempts to use betting markets to anticipate geopolitical crises, which were short-lived because of public objections. In future, the Adam Smith Institute will use these markets to compare betters’ judgments about the direction of the economy to those of government forecasters.

Sam Bowman, Research Director of the Adam Smith Institute, said: “No individual can know enough about the economy to make a really reliable prediction about it. By combining the local knowledge of thousands of people, betting markets can outpredict any panel of experts. If these markets catch on, the government should consider outsourcing all of its forecasts to prediction markets instead of expert forecasters.”

Rory Scott from Paddy Power said “Mr Carney – forget your fancy financial models; let’s see where the great British public put their pound instead. Failing that, perhaps the solution to topping up the Bank of England coffers is to take advantage of Paddy Power’s 7/1 for inflation to be 2% lower come June 1st 2015.”