Sunday 27 September 2009

Intermezzo: Writing about economics in another (more exotic?) language

I guess most of you have heard of Nikkei, which is known for the stock market index Nikkei 225 (it's like a Japanese version of FTSE100). Nikkei is actually a Japanese newspaper that sells 3 million copies (= three times as many as FT, incidentally) every weekday. It has a daily column on research in economics, and recently I wrote eight short pieces on "economics of communication" for the column, of course in Japanese.

It was a challenging but interesting experience. I am a native speaker of Japanese (and highly non-native speaker of English as some of you may know) so in principle it should be easier for me to write in Japanese. But I found it really hard. I think there are two reasons for it. The first is that I didn't know much of the Japanese economics jargon because my serious economics training was almost all in English. The second, which is related but much more serious, is that there are no Japanese translations for many terms in the first place. Let me give two (of many) examples.

To begin with, a half of what I wrote was about (the game theoretic analysis of) "cheap talk" but even now I still don't know how to translate it. Because it's a short phrase, I spelled the English pronunciation with Japanese characters like "chiipu toku", and fortunately the column editor liked the sound. It may well have been the very first time the term "chiipu toku" ever appeared in Japanese mass media.

The other half was about "verifiable disclosure", but again no translation for this term seemed to exist. It would be too long and awkward if I spelled the sound, so I really had to come up with a translation. There is a nice established Japanese translation for "disclosure" but there are a few equally good candidates for the word "verifiable" in that context. So I chose one that sounded best to myself. If my translation of "verifiable disclosure" becomes commonly used in Japan (at least among academics), then I should get credit for it!

Wednesday 23 September 2009

How/If Economists Got the Crisis All Wrong

Financial Crisis brought down not only the banks but led to questions on whether economists are to blame for all this mess. Below are two very different views of whether Economists are at fault for the crisis in a highly politically charged essays from a Nobel Laureat and a Professor of Economics at Princeton University Paul Krugman and a Professor of Economics at the University of Chicago Booth School of Business John Cochrane.

On September 2, 2009 PAUL KRUGMAN in an article How Did Economists Get It So Wrong? wrote:
"It’s hard to believe now, but not long ago economists were congratulating themselves over the success of their field. Those successes — or so they believed — were both theoretical and practical, leading to a golden era for the profession... Last year, everything came apart. Few economists saw our current crisis coming, but this predictive failure was the least of the field’s problems. More important was the profession’s blindness to the very possibility of catastrophic failures in a market economy."

Krugman then goes on to answer "What happened to the economics profession? And where does it go from here?" questions, and concludes that

"It’s much harder to say where the economics profession goes from here. But what’s almost certain is that economists will have to learn to live with messiness. That is, they will have to acknowledge the importance of irrational and often unpredictable behavior, face up to the often idiosyncratic imperfections of markets and accept that an elegant economic “theory of everything” is a long way off. In practical terms, this will translate into more cautious policy advice — and a reduced willingness to dismantle economic safeguards in the faith that markets will solve all problems." (to read more click here)


John Cochrane responded to Paul Krugman's accusations on September 11th, 2009 saying that

"Paul Krugman has no interesting ideas whatsoever about what caused our current financial and economic problems, what policies might have prevented it, or what might help us in the future, and he has no contact with people who do. “Irrationality” and “spend like a drunken sailor” are pretty superficial compared to all the fascinating things economists are writing about it these days."
he goes on to say:

"Again, what is the alternative? Does Krugman really think we can make progress on his – and my – agenda for economic and financial research — understanding frictions, imperfect markets, complex human behavior, institutional rigidities – by reverting to a literary style of exposition, and abandoning the attempt to compare theories quantitatively against data? Against the worldwide tide of quantification in all fields of human endeavor (read “Moneyball”) is there any real hope that this will work in economics?

No, the problem is that we don’t have enough math. Math in economics serves to keep the logic straight, to make sure that the “then” really does follow the “if,” which it so frequently does not if you just write prose. The challenge is how hard it is to write down explicit artificial economies with these ingredients, actually solve them, in order to see what makes them tick. Frictions are just bloody hard with the mathematical tools we have now." if you wan to read more click here.

Tuesday 22 September 2009

Selfish basterds: On rationality in Economics (I)

In this series of entries, I would like to reflect on the assumption of rationality in Economics. By using my personal experience and some elements from economic theory, I will discuss the common misconceptions on Economics, economists and rationality. Today, I will start with some personal anecdotes.

In my MSc dissertation, I worked with a model of coalition formation in which individuals differed in resources and abilities and could get together in order to produce output. Over and over again, I found that in the equilibrium of that model the more able agents formed groups with other able agents and that the group structure was ordered in that way. I say that I got that result over and over again because I found it outrageous so I checked and rechecked my computations. I did not like the fact that MY model yielded a hierarchical world in which people ended up merging with people similar to them and the less able and less rich got excluded. The fact was that I was letting my personal ideas obscure my economic thinking.

A few years later, I was a recently appointed lecturer at the University of Edinburgh and I was about to run my first economic experiment. As part of the process, I had to find subjects. I resorted to traditional methods like posters, showing up at the beginnning of lectures and distributing flyers across George Square. Students mostly liked the idea of being paid £10 for an hour of their time so the experience of chatting them up was pleasant. However, I remember vividly the visceral reaction of one female student. When I told her that we were looking for people to participate in research in Economics she answered "I hate Economics, I don't want to have anything to do with it. It's hideous."

Since last year, I have taught game theory on the MSc on Carbon Management that we run jointly with the Business School and Geosciences. I performed a simple classroom experiment in which students in the course played a public good game. They had to decide whether to contribute towards a public fund or not. Individual payoffs (I actually paid them in cash) increase with the number of contributors if you contribute too, but they increase even faster if you remain out. In equilibrium everybody should free-ride. Most students were shocked to find that, indeed, very few of them contributed. They thought that the world, and even themselves, was different. But once they felt the power of incentives, they were the first ones in leaving moral self-images aside.

Last Spring, I gave a workshop on economic experiments to students interested in the topic. I reported one experiment ("The Competitive Advantage of Sanctioning Institutions," O. Gürerk, B. Irlenbusch and B. Rockenbach, Science, 2006), in which subjects had to choose whether to play the game above or another version in which after contributions decisions are made, they could punish others at a cost. As you can expect, contributions are typically much higher in the latter case. I asked the audience which game they thought that subjects selected more often in the first round of the experiment. They all answered "the one with punishments". They were dismayed to find that it was actually in the other way around and that contributions were very low. I asked one student why she answered in the way she did. She replied "because that is how I would like the world to be, a world where people are nice".

So the moral of this first post is the following: Don't let your good feelings mix up with your Economics. Otherwise you will not be doing a good service to yourself nor to the world.

Only if you are ready to abandon your prejudices and your self-image as a saint, then you can continue reading.

(to be continued)

Friday 18 September 2009

Gary Becker speaks up for the Chicago School

My colleague Martin Fransman sends me this interview with the Nobel Laureate in Economics Gary Becker for the FT. In this interview, Becker vehemently defends the positions of the Chicago School and the validity of free markets. His argument seems to have two parts:

  1. The crisis occurred because economists still do not understand financial instruments well enough. In other words, Economics as a science is not advanced enough to deal with such issues, pretty much in the same way as medieval medicine was not ready to fight viruses or used leeches to cure diseases.
  2. The regulated know much better what to do than the regulator. The crisis should be solved by economic agents and not by the state because, paraphrasing Churchill's dictum on democracy, free markets are the worst economic system, except for all those other forms that have been tried from time to time.

You can watch the video here.

What do you think?

Wednesday 16 September 2009

A message from Lord Kitchener


The original here. You better do what he says!

Monday 14 September 2009

Who guards the investors?

In The Republic, Plato required his king-philosopher to have neither material possessions nor a family that he could favour. He also trusted law enforcement to a caste of guards. He was thus very aware of the problem of incentives. He also confronted the natural question that such idea begged, an idea that Alan Moore explored centuries later in his graphic novel Watchmen: Quis custodiet ipsos custodes? Who would guard the guards? Plato’s answer was that it was necessary that the guards should be highly moral and spirited individuals, able to look beyond their own material interests and able to sacrifice for their fellow citizens (compare that to Moore’s answer!). In the end, despite his advanced economic thinking, Plato placed moral behaviour at the top of the social pyramid he constructed, and gave it the role of that mythical “key stone” that it is said to support the structure of every gothic cathedral.


To a large extent, this dichotomy in Plato’s thinking reflects the two types of proposals made after the recent financial crisis: On the one hand, measures aimed at improving regulations and constructing better incentive schemes and, on the other hand, the calls to a more moral approach to business, to an ethical regeneration of the economic sphere, that allegedly would ameliorate the rampant greed that reigns in international markets.


But unless human nature had changed dramatically in the last two hundred years, I am afraid that these calls to a moral renaissance will be empty. In his wonderful book The Passions and The Interests, Albert O. Hirschman showed how capitalism, and thus greed, emerged precisely from the total failure of traditional moral systems, of those ethical principles based on religion or a shared national destiny; a failure that precipitated the religious and nationalist conflicts of the XVI and XVII centuries. As a solution, Adam Smith wanted to design a “theology without God”, whose centre would be occupied by a governing principle that humans would feel naturally inclined to follow without any appeal to supernatural powers. That force was self-interest. That force was greed. To illustrate this I will use the example I always give to my students: suppose you are a person that belongs to an ethnic or religious minority. You are walking down the street and suddenly a bunch of people from a rival ethnic or religious group start chasing you with very threatening intentions. If suddenly you started throwing £20 notes behind you, this people would immediately stop chasing your and start collecting the bank notes. Self-interest is a very powerful force, capable of overriding other forces of moral or ethical nature.


All this suggests that moral calls to businessmen, investors and bankers will prove useless. The stakes are so big, there is so much money to be made in international financial markets that there will be always someone ready to bend these principles. At the same time, regulation has proved ineffective in preventing these behaviours or at least that these behaviours meet monetary success. The only way out of this catch-22 situation is to acknowledge -the sooner the better- that the game between the regulator and the economic agents is a rat race, a fight in which the beast of self-interest that Adam Smith unleashed will always look for ways to break the chains that Leviathan wants to put on it.

Sunday 6 September 2009

More reflections on the state of economics

This is going to run for a while. Channel 4 had an item on its news programme on whether economics has failed, including appearances by Bob Lucas (Chicago, defensive) and Robert Skidelsky (critical). There is a video of Gary Becker defending Chicago economics and the market on the FT website, interviewed by Martin Wolf. Becker's view is that the issue was the various mortgage derivative products were fine on their own for spreading risks, but no one understood the systemic risks associated with them. Markets are still the best thing we have, though not perfect. better than government in any case. Finally, there is a long piece in the NY Times from Paul Krugman. Chicago economists were quite prescient for getting in their defence first, as Krugman is not particularly charitable. The Krugman piece is pretty much a regurgitation of his previously blogged opinions (see earlier postings on this site for many of these). Nevertheless it gives an interesting view on the development of macroeconomics and financial economics over the last hundred years or so. It also includes a version of the Capitol Hill babysitting circle story, just about the best illustration of how Keynesian economics works (see his excellent book, Peddling Prosperity, for more detail). Nevertheless there are a couple of issues that seem to be confused: the question of whether the economics profession should have predicted this crisis is logically distinct from whether your approach allows for such crises to occur. Prediciting crises, almost by definition, is very tough and it would be surprising if this could be done consistently.

Friday 4 September 2009

Cricket stats

More or Less from the BBC (hosted by Tim Harford, the undercover economist) is an excellent source of interesting items on statistics. Last week's programme had an item on misleading statistics from the recent Ashes test series. Here's another one, in my opinion, arising from the last test match of the Ashes series:
Almost all commentators regarded Australia's target of 546 to win in their second innings as virtually impossible to achieve. The argument is simply that the previous highest winning total in the fourth innings was 418 (W.Indies vs Australia in 2003). However I believe this is largely a statistical artifact. To register a high winning fourth innings score certain things must hold simultaneously. First, obviously, the target must be big. Secondly, there must be enough time to get the runs. I strongly suspect that the conjunction of these two events is pretty rare (especially when the target is set by the other side, who arguably should not set gettable targets).
It would be interesting to know how many times there has been a target of say over 500 and more than two days left to play (as we just had at the Oval). Confirmation that this is unusual comes from looking at highest fourth innings totals: 17 of the highest 30 in test cricket have occurred since 2000 (8 of these since 2008). Until recently teams scored at a much lower rate than we see these days---there simply wasn't time in a 5 day game to be set a huge target within 3 days if teams score at say 250 a day (when there was no time limit England got to 654 for 5 in Durban before they had to catch a boat back home). Technology and the one-day game seem to have increased scoring rates, so 350 in a day is not unusual. So it is not surprising that few large scores were posted until recently. The point is that at the oval, there was plenty of time and the wicket wasn't that bad. I don't think the records were very relevant. Ricky Ponting made it clear afterwards that he and Mike Hussey were having no problems batting. Arguably it was only the two crucial runouts that turned the game.