Economists need to pay more attention to extraordinary delusions and the madness of crowds

“There are idiots, look around.” That was the famously tactless response, in the 1980s, from the veteran economist Larry Summers to the efficient markets hypothesis – the assumption of many financial models that people always make decisions guided by rationality and with perfect information.

Tactless Summers may have been but was he wrong? Irrational crazes are as old as human history. Charles Mackay wrote a book called Extraordinary and Popular Delusions and the Madness of Crowds as far back as 1841.

And we have plenty of modern quantitative evidence that bears out the thesis of mass misconception and confusion. A poll by the Royal Statistical Society in 2013 found that the British public think £24 in every £100 of benefits is claimed fraudulently. The true figure is 70p. Around 30 per cent of the population are perceived to be recent immigrants. The true figure is 13 per cent.

Violence is on the rise, 50 per cent believe, when in fact it has been falling for 20 years. A quarter of people think foreign aid is one of the top three largest items of Government spending when in fact it is less than 3 per cent of the total. And it’s not just Britain where serious misconceptions about the world hold sway.

According to Ipsos Mori, in France the average person believes 31 per cent of the population is Muslim. The reality is 7.5 per cent. 

And those are arguably mistakes. Even scarier are the popular conspiracy theories.

A quarter of Americans say they think the US government helped to plan the 9/11 attacks. Around 45 per cent think “millions” of illegal votes were cast in November’s presidential election. The picture of the ivory tower academic economist who assumes perfect rationality and perfect information is something of a caricature, as Summer’s well-known quip itself demonstrates.

Yet there has been a tendency among some economists to continue to assume – sometimes for the sake of convenient modelling, sometimes owing to ideology – that people are well-informed about the world around them. 

And Robert Shiller, the Nobel laureate, delivered an important lecture to the American Economic Association earlier this month urging fellow economists to start taking popular delusions much more seriously.

Shiller stressed the economic relevance of powerful “narratives”- plausible but frequently false stories which can suddenly take a hold of the imagination of a large part of the public (and more easily and rapidly than ever in this digital age of ubiquitous social media). He suggested these narratives can drive behaviour, rather than merely being shaped by it, even perhaps causing economic slumps.

“We have to consider the possibility that sometimes the dominant reason why a recession is severe is related to the prevalence and vividness of certain stories,” he suggested.

Shiller feels economists should engage in major quantitative studies of developing popular narratives through textual analysis of internet searches, online mentions, Twitter trends and by mining other sources of “big data”.

Shiller’s challenge is an unsettling one for many economists. This research agenda will doubtless give some (though certainly not all) a feeling of being unmoored from their cherished rules of thumb about the rationality of the so-called “representative agent”. And as Shiller himself acknowledges it is fiendishly hard to disentangle cause and effect when analysing narratives.

Is a popular narrative driving economic fundamentals? Or are the economic fundamentals driving the popular narrative? Did people vote for Brexit because of the power of Vote Leave’s “take back control” narrative and because they became convinced Turkey was about to join the European Union? Did Americans vote for Trump because of the force of the “Make America Great Again” slogan and conspiracy theories about Hillary Clinton’s emails? Or was it because they were economically and socially “left behind”? Narrative economics will never conclusively prove something like this. And it’s hard to see mathematically elegant “microfounded” models emerging from it.

Yet such research may well be able to hint at the right answer. And in this era of online Islamist brainwashing, Trumpian lies and propaganda, the capture of the Labour party by hard-left Corbynites, mindless health scares, fake news, Fox News, the Daily Mail, Twitter bubbles – in this digital epoch of popular delusions and the madness of crowds – the sense that something serious is going on is hard to shake.

Shiller’s challenge to economists feels like a timely one.”

This article appeared in The Independent on 22/01/17

#LarrySummers #narratives #RobertShiller

Thatcherites hailing our exit from the single market need a history lesson

Imagine going to a funeral where it turns out that most of those present never actually knew the deceased, although they were convinced they did. The thought comes to mind listening to the obsequies for Britain’s membership of the single market delivered by Theresa May yesterday.

Thatcher-worshiping Brexiteers from the Tory right are flushed with excitement at the prospect of finally “taking back control” of the British economy from meddling Brussels bureaucrats – something they are convinced leaving the single market will now permit.

Many journalists, on the other hand, highlight the single market’s tariff-abolishing benefits. Meanwhile, Theresa May says Britain will retain a high level of “access” to the single market after we’ve left. Labour’s shadow Brexit Secretary Sir Keir Starmer sternly demands it.

Yet all these reactions reflect fundamental misconceptions about what the single market actually is – and a lack of understanding of why leaving it is likely to be so harmful to the British economy.

The place to start is with some history. The single market was a significant achievement of Margaret Thatcher’s government in the 1980s – something that the sponge of amnesia has apparently wiped from the minds of her former acolytes such as Iain Duncan Smith and John Redwood.

The single market was designed, with considerable influence and impetus from London, to prise open European markets to British exporters, to level the playing field for UK firms across the Continent.

“A single market without barriers – visible or invisible – giving you direct and unhindered access to the purchasing power of over 300 million of the world’s wealthiest and most prosperous people,” was how Thatcher herself described the single market at Lancaster House in 1988 to an audience of business leaders.

What a bitter irony that, 28 years on, Theresa May has used the same mansion in St James’s as the venue to announce that Britain is walking out.

And for what? The harmonising product regulations that Brexiteers (ever since Boris Johnson first pitched up in Brussels as a bowdlerising reporter for The Daily Telegraph) ridicule and condemn as anti-democratic EU micromanagement are, in fact, designed to prevent free market-distorting discrimination by European governments.

Why is there a European directive on “jam”, defining what fruits may, and may not, be used in the condiment’s manufacture? To ensure that anything classified as jam can thereby be sold anywhere within the single market without the risk of some jumped-up local official – anywhere from Bucharest to Belfast – banning it from the supermarket shelves on the grounds that it doesn’t conform to local labelling or health and safety rules.

The new trade department recently tweeted about Britain’s “innovative jams”. That EU jam directive is a designed to help those innovative jam-makers sell their wares into a market of 500 million people (it’s grown since 1988) on our doorstep. Multiply that jam example by the size of our entire goods export sector to get a sense of the size of the benefits.

What about control? We submitted to the supremacy of the European Court of Justice because we needed a referee on trade and regulatory disputes within the single market. Was that a “loss of control”? In one respect, yes. But this was symmetric submission. Other nations agreed to abide by the ECJ rulings as well, preventing them from discriminating against British companies. In that sense we gained economic control on behalf of our exporters: control that we will now lose.

And tariffs? The single market was not really about tariffs – financial levies on imports. Any common or garden free trade agreement can abolish those. The single market was primarily about non-tariff barriers, such as local regulations and licensing rules that prevent, for instance, a British architect establishing an office in Milan because she or he does not have a local qualification. Or, conversely, that hinder a dentist who qualified in Slovakia operating in the UK.

“Insidious … differing national standards, various restrictions on the provision of services, exclusion of foreign firms from public contracts,” as Thatcher put it at Lancaster House.

And that is where the “access” argument made by Theresa May and Labour betrays a catastrophic muddle.

You’re either a member of this single market or you’re not. You have influence on the rules as a member – or you take the rules. You push for the extension and completion of the market to favour sectors you are strong in – such as services in Britain’s case – or the rest of the members concentrate on their own interests in its ongoing development.

The best you can hope for short of full membership is being in the European Economic Area, like Norway.

This means you benefit from the dismantling of non-tariff barriers, but don’t get to set the rules. If that sounds like a pointless deal, consider the fact that Norway values it sufficiently to pay annually into the EU budget in return. But in any case, Theresa May has now ruled even this out. The limit of her ambition, revealed yesterday, is a tariff-free trade deal with Europe.

Yet economists’ consensus forecasts of long-term damage to UK trade are not based on the scenario that we fail to get a free trade deal with Europe. They are based on the scenario that we are out of the single market; that our dominant services sector will not benefit from future progress in completing it. All our experience suggests this means we will export less to Europe and import less too, which means less productivity growth for the UK economy, which means lower living standards than otherwise for us all.

“Don’t it always seem to go – that you don’t know what you’ve got till it’s gone,” sang Joni Mitchell in her song “Big Yellow Taxi”. Perhaps we will realise what the single market is only when we’ve left it.

Brexiteers insist they will create a paradise of new free trade deals for Britain with the likes of America and China in the wake of Brexit which will more than compensate us for the economic damage from the loss of our membership of Thatcher’s single market. But what else was it that Joni sang? That’s right: “They paved paradise and put up a parking lot.”

This article appeared in The Independent on 17/01/17

#Brexit #MargaretThatcher #singlemarket

Why Nutella doesn’t actually give you cancer, and how to spot a health scare

What makes a good health scare? There are three essential ingredients. First, there has to be something mundane that lots of ordinary people do, and preferably enjoy doing. Second, there has to be a nasty disease, or a frightening health condition.

Third, the word “causes” must appear.

A big scare last week concerned Nutella, with reports that the processed palm oil used in the production of the hazelnut spread might cause cancer; the week before it was busy roads causing dementia; in 2015, readers might recall the scare was bacon consumption leading to bowel cancer.

The problem with such stories is not the underlying science, but that the fact that they generally do a terrible job of conveying a clear sense of the scale of the risk to the typical reader. The palm oil research is at too early a stage for any kind of quantitative headline about risks to health, but we had very specific sounding risk scale claims in relation to the dementia story. Media organisations drew attention to the finding from a Canadian study that the risk of developing dementia could be up to 12 per cent higher for those living within 50 metres of a major road.

This is known as a relative risk. Yet none of the truckload of reports referred to the absolute risk – this is the risk to anyone of contracting the disease in question over their whole lifetime, and it is essential to making sense of such stories. Making a judgement about risk without knowing the absolute risk figure is like setting out on a long and dangerous sea voyage without a compass.

The absolute risk of dementia is certainly calculable. The Canadian study observed 2.2 million people aged 55-85 over a decade. And it found that 244,000 of this sample developed dementia in that time. That implies the absolute risk of developing dementia for people over their lifetime is around 11 per cent regardless of where they live (which is in line with other studies). 

So, of 100 people, 11 will typically be afflicted. If living within 50 metres of a busy road increases the risk of dementia by up to 12 per cent, that elevates the 11 per cent absolute risk to around 12 per cent – so, of 100 people living near a busy road, around 12 will be afflicted rather than 11. 

That’s one more dementia case per hundred people who live near busy roads all their lives (possibly) attributable to air pollution. Which is not negligible, but probably sounds rather less dramatic to most people than a “12 per cent increase in risk”.

It’s important to spell this out because when people hear a relative risk figure they often, mistakenly but understandably, think they’re hearing the absolute lifetime risk. This was apparent during the 2015 bacon scare, when reports of an 18 per cent increase in the risk of contracting bowel cancer from consuming two rashers of bacon a day were widely interpreted as suggesting an almost one in five chance of getting it. 

In fact, the lifetime risk for regular bacon eaters of developing bowel cancer is seven per cent, up from six per cent for those who don’t eat it. Those are surely much more useful statistics to the vast majority of readers than the 18 per cent increase in relative risk in all the headlines. But this isn’t the only piece of context needed to make sense of such stories.

As Jen Rogers of the Royal Statistical Society has pointed out, there are bigger risk factors for dementia than living near a busy road. Smoking, for instance, is reckoned to increase the dementia risk from 11 per cent to 14 per cent and obesity to 17.5 per cent. Old people would be better advised to worry more about these harmful lifestyle factors than where they live.

Similarly, rational people who are worried about cancer should concentrate more on giving up smoking than fretting about their bacon sandwich consumption. The absolute lifetime risk of lung cancer for a man who never smoked is estimated to be about 1.5 per cent. For lifetime smokers it is 17 per cent. That’s a 1,100 per cent increase in risk by the way.

It’s important for people to be able to rank the risks they face. Whatever the palm oil research ultimately concludes, it seems unlikely Nutella will be shown to be as risky as cigarettes. This information – the size of other relevant hazards – is the map for your sea voyage through the oceans of risk assessment.

So there are three basic questions you should ask when you read the next “x gives you y” health story.

What is the absolute lifetime risk? What is the absolute risk when adjusted for the risk from the activity in question? And what are the relative risks from other relevant harmful activities? That is the information you need to decide whether or not to be alarmed.

This article appeared in The Independent on 15/01/17

#Nutella #risk #smoking