Category: Behavioural Econ

A fable of Eunuchs, Praetorians, and University funding cuts.

Imagine yourself to be in the mythical Land of Beyond where you need minions to do a dirty job that men with honour would refuse to do. A classic trick in this situation is to pick people despised by the rest of society who are thus dependent on protection and will simply do what is asked for.

The Chinese emperors hit upon this truth when they started to surround themselves with eunuchs, despised by the rest of Chinese society and thus fiercely loyal to their protector, the Emperor. The roman emperors, similarly, made a habit of surrounding themselves with freed slaved who were despised by other Romans, as well as by a dedicated palace guard (the Praetorians) who were the only militia allowed in the vicinity of Rome.

The European colonialists too used this basic ‘dirty dozen’ technique when it came to keeping a large population in check with minimal own presence, particularly in Africa, by elevating some small despised group (ethnic or religious minorities) as the preferred club from whom the senior administrators came. This small favoured group would get personal benefits (riches and influence) but in return they would do whatever the colonizers wanted.

To see the relevance of this for university cuts in the Land of Beyond, you first need to step back a level and imagine yourself to be the Vice Chancellor of a second-rate university that brings in, say, a billion ‘Beyond’ dollars a year out of which some 300 million is money you dont really need to generate that 1 billion. It is ‘potential profit’ if you like.

Now, your first thought will of course be to give as much of this money to yourself as you can. That is not so easy though: in Beyond, universities are non-profit organisations nominally run by senates and full of academics who like to monitor and criticise you. You would never get away with giving yourself multi-million dollar salaries and huge offices if academics are really watching your every step.

So in order to get more of the profit, you need to subdue two groups, the academics and the senate. You subdue the academics by keeping them busy with ‘compliance’ and having a lot of systems in place to punish them if they become pesky. You thus include in your rules that anything that harms the reputation of the university is a sacking offence. You put yourself at the top of the committees that decide on professorial promotions and academic bonuses so that you are their direct boss. You appoint hundreds of administrators to monitor the media, teaching, and student-related activities of the academics with the purpose of keeping them quiet and punishing them when they get out of line.
You subdue the senate by overloading them with information (for which you need again more administrators) and by keeping them happy with luxuries and gifts. Over time, you attempt to get control of the mechanism via which new members get to be in these senates.

Now, the essential problem you face in this as a VC is how to ensure that the people helping you with your take-over plans are somewhat loyal to you rather than to something as silly as the goals of the university or academia or even to the needs of Beyond. It is loyalty to yourself that you need in order to eventually be able to get away with giving yourself huge amounts of money.

You remember your history lessons and realise that what you need is a set of eunuchs: people despised by the academics in your organisation who will thus have the same incentive as you have to subdue the academics and grab as much of the university resources as possible.

What are the equivalent of eunuchs in universities? Why, non-academics of course! Better still, non-academics whom you give academic titles for they will be even more despised! Hence you pick the most efficient bullies you can find, call them all professor and put them in charge of the divisions that subdue the academics and that send mountains of information to the university senate to ensure they will just go along with whatever you happen to ask of them at the end of some sumptuous occasion.

Due to your brilliance and foresight, the trick works like a charm and you find yourself earning well over a million, with several huge offices, and in a position to bargain for even more kick-backs from outsiders who want to use parts of the university for their own end (property developers and the like).

Now imagine yourself in the layer yet higher: you are now an ambitious paymaster in the Capital of Beyond, someone who nurtures a reputation for being able to get things done even if they might not really be in Beyond’s best interests. You too have a control problem for you want all kinds of things from universities. You would like the universities to keep the population happy by churning out cheap degrees to domestics. You also want universities to sell visas to smart oversees students by means of high fees for almost no education (cross-subsidising those domestics). Basically, you want universities to abide by whatever fancy drifts into the head of your current minister.

The control problem you have as a ‘wheeling and dealing’ senior civil servant in Beyond is again those pesky academics: they are self-righteous, not all that interested in your opinion or even your money, and wouldn’t easily go along with these plans. They might well flatly refuse to sell visas to foreigners because they would baulk at short-changing the education given to those foreigners. Indeed, they would probably laugh in your face if you suggested that universities should fall in line with, say, your wish to have a campus in the middle of nowhere just because it is a marginal constituency.

Just imagine what confident academics would do if you told them to cut their budget by 900 million! Why, they might do something as bold and brash as to honestly tell their students that there are no funds to properly educate them. Imagine the political fallout of such honesty by a bunch of self-righteous academics who won’t simply do your bidding! No no, it is quite clear to you that the last people you want leading universities are academics. You want leaders who know what you really mean when you talk about ‘university accountability’, ‘stakeholder management’, ‘strategic visions’ and ‘preparing for the future’.

So the senior Beyond bureaucrat too finds herself in the situation of needing eunuchs in charge of universities. You don’t mind if they get some private benefits out of the arrangement as long as they do your bidding and not rock the boat politically.

Now think a step higher again and consider why Beyond might have fixers at the top of the ministries …..

 

Are there unhelpful mathematical models of economic phenomena?

Take your bog-standard first-year economics story of why money (sea shells, coins, notes, bank statements) exist. Money, you will be told, is a means of exchange, a store of value, and a unit of accounting, thoughts going back to David Hume (18th century) and earlier.

When explaining the idea of exchange to students you say things like ‘you can’t exchange a hundredth of a sheep for a loaf of bread so you want something to represent the value of a hundredth of a sheep, and in any case it’s a long slog to the market carrying a sheep around’.

When explaining the idea of a store of value you say things like ‘You would like to be able to consume things when you are old without working when you are old. That means you need to save up wealth in the form of something that doesn’t perish. Sheep perish, gold does not’; and when explaining the unit of value idea you say things like ‘we all think of the value of things in terms of a numeraire, such as that milk costs 1 dollar per liter and flour 2 dollars a kilo. None of us think in terms of 1 liter of milk being worth half a kilo of flour. Given many different products, it is more convenient to think of the value of each of them in terms of something you can compare across these goods. Money performs that role and you will find that even when the unit of money changes (such as moves from the Deutschmark to the Euro) that people will continue to calculate everything back in terms of the old money for many years’.
Simple stories, no? And most students will ‘get the point’ of each of these three stories. They will see the difficulties of exchange with lumpy goods that cannot easily be stored and exchanged, and they will see the point of being able to save up for a later date and that requires some form of storable money.

Simple though these arguments are, you will be hard-pressed to find mathematical models of them that anyone would recognise as remotely capturing these verbal arguments. It tells you something about the limits of mathematical models to think through why recognisable models of money do not exist. So bear with me as I take you through the actual difficulties of modelling money and how those difficulties end up as unhelpful advise from theoretical economists to policy makers.Think of the actual difficulties involved in modelling the story of money as a medium of exchange. Before even thinking about money, you have to start from a model with exchange. This means you need to model the production of more than one good and you must build in a reason, like comparative advantage, why individuals do not simply produce all the goods they need by themselves. For realism you would want the goods to be lumpy, perishable, and to require long-term investments. After all, sheep herding and crop-growing do not happen overnight and neither sheep nor apples can meaningfully be stored for very long or exchanged in halves.
You immediately hit your first mathematical snag right there: if production is lumpy (you can’t produce half-apples), then you won’t get the simple outcome that someone will spend all his time on what he is best at. An individual could optimally spend his time by producing one sheep and two apples even though he has a comparative advantage in sheep, simply because he can’t make exactly two sheep. If you want lumpiness in your model, you thus would have to solve the problem of how a person would optimally allocate a fixed amount of time over lumpy investment projects. This is known in the Operations Research literature as the knap-sack problem (in which you need to decide which lumpy goods to put into a knapsack of particular size) and it is known to be an ‘NP-hard’ problem. Simply put, you know of such problems that there is a single optimal solution but it may take a long time to actually find it. Solving just that knapsack problem for a single individual is already something that may take a computer years if you choose the bundle of potential goods to be large enough, and there will be cases in which you will find that even with comparative advantage the sheep herders may grow enough apples to not need exchange.
How do you solve that snag, which incidentally arises in all models of production? The reality is that you don’t because solving just that one leaves you with a model in which you can solve little else and in which you are not assured of any real impetus for exchange. Hence you ‘simplify reality’. You thus presume that there is no such thing as a lumpy good and that people spend their time producing a ‘continuous’ amount of goods, say, 3.271 sheep or 14.231 apples. Without lumpiness, people will specialise in making one thing and have a reason to trade. Note that you thus have already given up on describing the most intuitive reasons for having money around: you can no longer meaningfully talk about the difficulties of exchanging a hundredth of a sheep for half an apple since you now have presumed a world in which you produce sheep in hundredths and apples in halves.
Moving on, the next modelling problem you hit is that it must be the case that different individuals happen to want what the other produces, a ‘coincidence of wants’. Indeed, you want some kind of place (a market) where people come to exchange what they have produced. In model-land you must answer every counter-factual. You must thus have a reason why traders would use money instead of giving each other credit or just exchanging bundles of good (since goods are now not lumpy, you can just go to the market with your 2/3 sheep and exchange it in one big free-for-all for all the goods you need). Such thoughts may sound absurd to you, but working them through has occupied really good mathematicians for years. It is in fact nigh impossible to solve models in which people do not know exactly beforehand what will happen in a market.

You see, as soon as you say that a person does not know beforehand what other people have produced and at what prices they might trade, you are in the world of limited information and in the world where it is possible that people make mistakes (go to the market empty handed, produce the wrong things, etc.). You are then in the business of having to specify how people form expectations about what others would do and what prices they would trade at.

You are then also in the business of working out whether there are perhaps multiple equilibria (i.e. different configurations of the whole economy) and the issue of how people who don’t know each other could actually coordinate on a particular configuration. You then for instance have to contend with the possibility that nobody shows up at the market because they expect nobody else to show up. You have to contend with the possibility that you get the wrong prices, under which there is no specialisation at all.

You have to contend with the problem that the only people to show up wouldn’t want to trade with each other because they have produced the same thing and you have to figure out how a group of people would actually arrive at a price (or prices). Each of these sub-problems is considered exceptionally hard by theorists: only under very specific mathematical assumptions can you be absolutely guaranteed that the problems above do not occur.
Hence, what do you do? Well, again, the reality is that you assume away all these problems. You simply make those assumptions that guarantee you that everyone who produces something is ‘magically’ matched up with someone else who has something they want to trade with. Also, you now presume the existence of some kind of all-powerful benevolent entity, say god. You need such an entity to do away with elements in your model you cannot model but need anyway, such as how prices arise before any exchange takes place (if prices change during exchange one gets into exceptionally complicated dynamics where you need to start talking about the expectations that people have of possible price paths). So you invent a god that takes care of such issues. God, in his first incarnation as a Walrasian auctioneer, announces the prices at which everyone is willing to trade, whereby everyone believes god and acts accordingly. God, now in his second role as a benevolent and completely trusted government, then also provides a means of exchange that is not perishable, i.e. money.

Usually, a third sleight of hand is needed to get a workable model and that is to have a situation in which there is no such thing as a mistake because there is no such thing as expectations that are incorrect. This of course basically presumes away the original problem you were starting out to model, but that is an almost inevitable casualty of the wish to have a tractable economic model.

What kind of models of money do we end up with? To my taste, the best that mathematicians have come up with is the story that some sheep producers have a craving for eating apples in the night, but they are themselves just innately incapable of producing apples and their sheep always die at the end of the day (i.e. they must be eaten before the end of the day. New ones are only born at the start of the next day). This means that the sheep herder must sell his sheep during the day to the apple maker whilst buying the apples during the night (apples also perish at the end of each half day so he can’t trade during the day). In a modelling sense, that ensures you the ‘coincidence of wants’ you need to have a role for exchange and ensures that sheep herders and apple farmers cannot just trade their produce. By assuming that they not trust each other, but that they do trust the provider of money, you ensure that they do not just trade promises but use money for their trades. Within this kind of basic set-up you can even introduce monetary policy in the form of allowing god to hand out more money to specific groups or to reduce the value of the money in circulation. Whole ‘policy edifices’ have been built upon the basic structure of sheep herders having cravings for apples in the night. For those who are interested, I am talking about the model by Lagos and Wright (2005) and the many extensions on their basic idea.
Now, anyone in his right mind would laugh out loud at the story above as it comes nowhere close to the historical stories told about why we have money and what its role is in the economy: big historical problems in the emergence of money concerned the fact that there was no trusted government, and the value of money had a lot to do with the actual costs of information and transportation, costs that the story talked about above had to assume away. Yet the story of apples and sheep above, believe it or not, is one of the dominant stories told in ‘micro-founded’ monetary economics. It is in that kind of model-economy that they talk about money, credit, banks, regulation, etc. If it weren’t for the fact that it is deemed cutting-edge research, you would have to cry.
I hope you will take my word for it that the problems of generating models in which money exists because of savings and as a numeraire good are equally hard to set up and hence such models don’t exist at all as far as I know.
The value of the actual models of money are mainly as proof of concept, i.e. that you can think of a micro-model in which money emerges and where you can base the emergence of money on at least one of the underlying micro-motivations you think are important for the existence of money (the advantage of having a more varied consumption bundle). It is not the model you would have wanted but at least you can have it in the back of your mind as an example of the micro-mechanisms that are relevant.
The problem with the monetary model talked about above is that it fits so poorly. It hardly fits the many historical examples we know of the emergence of money, nor does it capture the problems we face today when thinking about money markets (trust in the institutions, the incentive problems inside organisations, the investment problem). Hence it is singularly unsuitable to use as a mental laboratory for the policy problems of today, or even as a descriptive model of the actual roles of money in our economy.

The problem of poor fit carries over to unhelpful advise: despite the fact that it is such a poor fit to reality, it is the only ‘game in town’ when it comes to micro-models of money. A most unfortunate and destructive phenomenon then appears, which is that the only game in town becomes the truth to a whole set of people making their careers on the back of it.

All the potential advantages of models become a disadvantage when a poorly-fitting model is taken too seriously. One potential advantage of models is that they can be the codification of previous knowledge and as such a good model is a quick way of conveying a lot of knowledge to the next generation who don’t have to learn what reasons went into the construction of the model in the first place.

This now becomes a disadvantage: the new generation that looks to write papers ‘on money’ need know nothing about the history of money or its uses today but only need know the dominant model, which turns into a disadvantage because that new generation will come up with twists and extensions of something that is innately unsuitable to answer any interesting question. Yet that new generation will be blissfully ignorant of the uselessness of what they are doing because they, unlike the originators of the first models on money, will lack the historical database in their heads of what actually goes on. They are simply proving their worth by being more acquainted with the mathematical ins and outs of these models than anyone else and that is what supplies them their daily dinner, not whether the model is useful to anyone else.

Another potential advantage of a good model is that you can make consistent statements instead of waffling on incoherently. One real advantage of model-land is that it is fairly easy to spot someone who is not capable of understanding models. This advantage also becomes a disadvantage in a model that fits poorly because you will see a great proliferation of consistent statements that are based on poor abstractions of real phenomena. You might term this the proliferation of ‘precisely wrong’ statements.

And it is a cop-out to say that these precisely wrong statements are not intended to be taken literally: despite being mere models, the adherents deliberately use words that convey its supposed usefulness, such as monetary policy, government, banks, etc. The pretense of usefulness pervades each paper and each grant proposal using these models. Worse still, that modelling community is a group with a big incentive to pretend that the assumptions made for convenience are ‘actually true’, i.e. it is a constituency of individuals with an incentive to presume there is no such thing as transaction costs or a trust problem when it comes to money. When such people become important they will poo poo those who make different assumptions and force them to first invest in their models. In short, a poor model that is taken seriously becomes a part of the problem.

Would you also have the same problems if monetary economics were mainly based on a set of historical case studies and an awareness of the problems faced today by economic actors? Unlikely, because you then at least have set up an ultimate goal of the discipline, which is to understand how the world came to be as it is and to help economic actors shape their world to their advantage, i.e. you are grounding your discipline in historical reality and real world problems. Having said this, one should not be blind to the disadvantage of a more verbal discipline though. The disadvantage is that when knowledge consists of a collection of examples and lessons, there is more room for the wafflers of this world to ply their trade, and there are millions of eager wafflers around.

Are there any good economic models you might ask? I believe there are and my prime example would be Industrial Organisation models of competition and market interaction. These are the Cournot models, Stackleberg models, models of complementary investments in vertical markets, oligopoly models, models of the internet as a platform, etc. The nice thing about these models is that the motivations they presume of their actors (pure greed) are pretty well spot-on and that it is not that hard in reality to see what kind of market interaction is happening, i.e. which of the I/O models to use.

Though it is hard to measure for a statistician, it is not so hard to spot as a human whether, say, the oil companies are engaging in collusion or not. It is not hard to spot a cartel, or the basic information structure of a market, nor is it hard to spot the structure of investment complementarities. In short, I/O models can do a remarkably good job of describing the particular aspects of reality one can optimally intervene in, which is of course why they are so central to the work of regulation authorities and why, for instance, auction design on the internet is done by mathematically schooled geeks. They need to know nothing of the history of auctions to nevertheless be damned good designers of auctions as long as they understand the models and have learned to spot the market patterns around them.

There are thus good models out there and the groups of disconnected geeks working on extending them are, often to their own surprise, doing something useful with their lives. We wouldn’t want to go back to waffling in those areas. The problem is thus not the existence of mathematical models per se, but rather that there are aspects of economic reality where the best we can do is a bad model.

Is money the only area where we can do no better than bad models that are worse than useless when they are taken seriously? Alas, no. What goes for money goes for many economic phenomena. To have an economic model where growth is driven by specialisation (which is what most historical economists believed was the engine of growth) has so far been beyond us, which is why we have ended up with these ridiculous representative agent models. What the pragmatists believe is true about specialisation can’t be modelled by the best minds in math econ land (this is not to say there are no models of specialisation, simply none that get close to illuminating the path-dependence, trust, and institutions that sustain it). Satisfactory ‘des-equilibrium’ models of recessions also simply don’t exist. Models of human behaviour drawing upon more than two of the known ‘irrationalities in our make-up’ are also too hard to solve. The list goes on and on: if one insists on consistent mathematical theorising from ‘micro-foundations’, nearly all of the big drivers of economic growth and economic institutions are beyond our ability to model even remotely realistically.

Mathematical models are hence in many areas a problem because they fit poorly but nevertheless live a life of their own, taking up valuable mental time of smart people, leading individuals to think about the wrong problems, leading people to think in terms of the wrong assumptions, motivating statisticians to measure the wrong things, and divorcing their discipline from reality.

Suppose you believe all this, but nevertheless want to make progress in disciplines by doing proper science, differentiating yourself from the wafflers. What is ‘proper science’ in an area where we cannot make much mathematical headway and hence where we can be reasonably certain that every grand story we tell (in maths or in words) has inconsistent parts to it? That’s the subject of a future blog….

Is Catholicism in rude health?

Looking at the newspapers you’d think Catholicism is having a hard time with philandering priests and cover-ups of their doings being found out on a weekly basis. Dutch and German newspapers kept track for a while of the regional frequencies of new cases of sexual misconduct allegations. You might think Catholicism is getting its long-awaited come-uppance. Nothing is further from the truth however: Catholicism is in rude health.

There are now around 1.3 billion adherents making Catholicism the largest religion on the planet and the largest branch on the tree of Christianity that appears to hold about 2.1 billion adherents. Its strongholds in Latin America and Southern Africa are looking rock-solid, and conversion rates in the new centres of Asia (China, Thailand, Vietnam, Indonesia, etc.) are looking very healthy indeed. The Christian World Database hence proudly announced Christianity was the world’s fastest growing religion in 2006 and in terms of numbers, Catholicism is by far the biggest and probably fastest growing of the Christian faiths.

What is interesting about Catholicism is that it seems to have lost its footing in its traditional stronghold, Southern and Western Europe. The area where all the popes came from, where all the old cathedrals are, where nearly all the alternative branches of Christianity originated, is now more secular than ever. Europe now has to import monks from Latin America and Africa to fill up its most prestigious and old monasteries (such as the one in Poblet, Spain). Things are so bad for Catholicism in Europe that in April 2009, the Archbishop of Vienna proclaimed that “The time of Christianity in Europe is coming to an end”. It is of course partially this retreat of the power of the Catholic church that allows all the skeletons to emerge from the cupboard. It is striking how few scandals come to the surface in places like Brazil and Nigeria compared to the almost massive ‘coming out’ currently seen in Europe.

It is this light that one should see the choices of the Roman Catholic church regarding the marriage of priests, the use of condoms, the rights of gays, etc.: policy choices in those realms are simply no longer aimed at pleasing or controlling the faithful in Europe (including Australia), but are now aimed at keeping and expanding the appeal of the church in Africa and Asia. And it is apparently working. Whatever Germans, French, Italian, American, and Australian Catholics think about the appropriate meaning of Christianity and the celibacy rules for priests is simply not of great importance anymore because the international market for new souls is elsewhere.

It is, speaking as a pure outsider to these religious games, very interesting to see how successful the CatholicChristian message is amongst the Chinese in Australia, Singapore, Hong Kong, and even in China itself. Universities witness a lot of action in this regard: you can see young Chinese female converters lining up to peddle the Catholic message amongst the recent student migrants in Sydney, Melbourne, and Brisbane. Reportedly, almost 40% of university graduates in Singapore are now Christian. Statistics for conversions in China are hard to get in that estimates of the current stock range from about 15 million self-identified Christians in the latest Census to 40 million in the CIA-factbook to 140 million in unsubstantiated estimates by particular Christian organisations (see Wikipedia). Yet, even the mid-stream estimate of 4% is quite a bit up from 50 years ago so it does appear that the Chinese are ripe for the taking in terms of religiosity. It certainly looks that way amongst Chinese students in Australia. And Christianity seems to be the religion-du-jour amongst that immense market. The main competitor to Christianity, Islam, seems to me to have no chance at all with the Chinese, partially because almost zero Chinese students study in Islamic countries, partially because the West is far richer and hence far more appealing than the Middle East, and finally because Christianity starts from a far stronger base within China (except with particular minorities but not amongst the main Han-Chinese population).

I personally expect China to become more Christian, as the control of the state becomes less and the uncertainty of capitalist life makes the urban middle classes receptive to the Christian promise of a loving god and an eternal life. Whether the Chinese go for Catholicism or one of the alternatives amongst the Christian pantheon is harder to know.

What is ‘face’?

I have been part of a research group looking into Chinese migration for about 5 years now (see rumici.anu.edu.au/), and the main cultural difference one has to get used to as a Westerner in interactions with the East is the notion of ‘face’. This Asian cultural trait has been written about for centuries, but I haven’t found a definition that makes sense to an economist used to the language of game theory and utility functions. So let’s look at ‘face’ from an economic perspective, allowing me to make statements on where it comes from and what will happen to it.

To set the scene, consider some examples of the way in which ‘face’ pervades everyday life in China, Japan, and much of South-East Asia. For one, the boss never gets contradicted directly and no-one tells a boss that he is wrong, even if behind his back things are done completely differently and everyone believes him to be wrong. It would thus be quite common for people to congratulate a boss about a decision he did not in fact take. Connected to this, decisions and opinions are obscured in secret codes. By this I mean that it is never said that ‘we dont care about this so we are not going to do it’ but rather the whole topic is avoided or some technical difficulty is fabricated to avoid a negative decision on something. You will thus be hard pressed to hear ‘no, we will not allow you to do X’ but instead will be told ‘we are still working on how to measure X’.

And loss of face is serious business for as soon as you are publicly contradicted and told you are useless, it means that no-one will protect you, help you, or trade with you. Losing face is thus being shut out from a community, which of course explains why keeping up face is a life-and-death thing for many people in Asian societies, even today.

Face thus means people are not directly contradicted; opinions and preferences are hardly ever asked for directly, but instead are inferred; and there is a whole language known to insiders via which to convey actual opinions and coordinate responses.

If you think about this from a game-theoretical perspective you might first naively think that ‘face’ is about people’s beliefs as to how good (or useful or important, etc.) that you are. To have face would then mean people believe you to be virtuous, valuable, important, etc.

This clearly does not fit most examples of face though: it is perfectly possible that someone has face and yet nothing he or she says gets done. What people hence actually think about you does not prevent you from having a ‘face’. As long as efforts are made to hide the truth from you, one still has ‘face’. Hence face is not just about beliefs.

Face is more about the willingness of others to go along with pretending you are good, important, useful, etc. It is only when that pretense becomes unsustainable that one has lost face.

Yet this as a definition is not useful enough because it begs the question why it would matter what others are willing to pretend about you. With well-defined property rights, it matters not what other people think about you since that in no way influences the trades and decisions you can make.

I would therefore venture that the rub behind the whole concept of face is imperfect property rights. With imperfect property rights, it becomes a matter of fluid group opinion as to what you actually own and what you dont. ‘Face’ is then connected to those implicit property rights. The willingness of others to go along with your ‘face’ then signals the degree to which they still respect your property rights and the moment you lose face is the moment all others can rob you of whatever you possess with social impunity.

Translated to a game-theoretical context, this means one should think of ‘face’ as the degree to which others see you as partaking of the social norm upholding a particular allocation of property rights. Their willingness to go along with your face is then nothing less but a social vote as to whether you are still in the club or not. This in turn relies upon a social game in which the accepted rule is that if any two (or more) people deny each other their face then social voting continues until either face is restored or face is lost completely, leading to a re-allocation of the property rights of the loser. Note that what is actually believed about anyone does not matter.

This kind of conception of face has many important implications. For one, it is clear that something like this is more likely to arise in economic systems where most property rights are ill-defined, such as in large bureaucracies where nominally all is owned by the collective (or the emperor who leads the collective) but where limitations of span of control imply that cliques can actually appropriate things for themselves though only to the degree they cover each other’s backs. This of course explains the importance of face for a country like China that has so long had a bureaucracy. It also fits the ‘all who remain in the clique have to stick up for each other’ aspect of face and why someone who has lost face must be killed or in some other way neutralised since there is an outside world who can be alerted to the degree to which these implicit property rights violate the official ones.

Yet, also in more primitive cultures that lack well-established property rights (understood here as allocations that can only be undone by voluntary trades), the same general idea would hold to some extent though one then more normally would call it ‘honour’, and indeed there is an anthropological literature saying that pastoralists (who dont have official lists of who owns what) are big on honour.

The second and perhaps more important implication is that ‘face’ should lose its meaning and value when an economy becomes more monetised and based on formal property rights. Hence the industrial revolution taking place in China right now should be strongly eroding the whole notion of face, at least within the business community. And indeed, if you meet an outspoken Chinese person who says what he wants and tells you what he thinks, it is most likely someone from the business community.

The third, and most worrying implication is that something like face should inevitably start to arise in any major organisation that survives for a long time, since it is in large organisations that property rights become less perfect. Hence the Western world, which has seen greatly expanding government bureaucracies in the last few centuries and where there are relatively large long-lived private enterprises with major span-of-control problems over what all the managers do should see an increase in the importance of face. Whilst ‘face’ thus becomes less important in the East, it is probably on the rise here……

Thoughts on “Thinking, fast and slow”

I couldn’t resist buying a copy of Daniel Kahneman’s best-seller when returning from holidays. Several friends and colleagues told me it was a great book; it got great reviews; and Kahneman’s journal articles are invariably a good read, so I was curious.

Its general message is simple and intuitively appealing: Kahneman argues that people use two distinct systems to make decisions, a fast one and a slow one. System 1, the fast one, is intuitive and essentially consists of heuristics, such as when we without much thought finish the nursery rhyme ‘Mary had a little…’. The answer ‘lamb’ is what occurs to us from our associative memory. The heuristic to follow that impulse gives the right answer in most cases but can be lead astray by phrases like ‘Ork, ork, ork, soup is eaten with a …’. Less innocuous examples of these heuristics and how they can lead to sub-optimal outcomes are to distrust the unfamiliar, to remember mainly the most intense and the last aspect of an experience (the ‘peak-end rule’), to value something more after possessing it than before possessing it (the ‘endowment effect’) and to judge the probability of an event by how easily examples can come to mind.

System 2, the slow way to make decisions, is more deliberative and involves an individual understanding a situation, involving many different experiences and outside data. System 2 is what many economists would call ‘rational’ whilst System 1 is ‘not so rational’, though Kahneman wants his cake and eat it by saying that System 1 challenges the universality of the rational economic agent model whilst nevertheless not wanting to say that the rational model is wrong. ‘Sort of wrong sometimes’ seems to be his final verdict.

Let me below explore two issues that I have not seen in the reviews of this book. The first is on whether or not his main dichotomy is going to be taken up by economics or social science in the longer-run. The second, related point, is where I think this kind of ‘rationality or not’ debate is leading to. Both issues involve a more careful look at whether the distinction between System 1 and 2 really is all that valid and thus the question of what Kahneman ultimately has achieved, which in turn will center on the usefulness of the rational economic man paradigm.

Continue reading “Thoughts on “Thinking, fast and slow””

Happiness over lifetimes

In a recent study withTony Beatton (QUT), I looked at how happiness changes by age. For the freely downloadable working paper version, see here.

What got me into this issue is the dominance of the “U-shape” story in the economic literature on happiness. The dominant story is that we get miserable in mid-life as the stresses of life are piled onto us and then get happier again the closer we get to death. It didnt seem right, either from the point of view of raw data nor intuitively, so we set to work. The main findings of our study can be summarised by the graph below, where you can see the way happiness changes over the lifetime in Australia, the UK and Germany for a representative individual starting at a 7 on a 0-10 scale.

This Graph summarises data from over 50,000 individuals in Australia, the UK, and Germany, followed over more than 10 years. It turns out that individuals are happiest early into retirement years (65-75) and at their most miserable close to death (80-90), with relatively little changing in the years before retirement. Our interpretation is that individuals older than 65 no longer have unrealistic expectations of what their life will be like and simply enjoy reasonable health and wealth, leading to a marked surge in happiness. As their health starts to deteriorate after 75, their happiness plunges.

In particular: Continue reading “Happiness over lifetimes”

Qantas needs to end its war on customers

Last year when I travelled back to Australia I had nothing but praise for Qantas and the Australian aviation system in general. I wrote about it at Harvard Business Review. This time around they lost much of that goodwill. This was not because things had changed with respect to quality that I wrote about. Instead, it was about their own foolish and self-destructive ways of dealing with customers.

The story was this. In planning our annual family trip back to Australia I was invited to the Annual Leadership Retreat hosted by the Australian Davos Foundation. This is held at Hayman Island and seemed like a great opportunity. Unfortunately, when I was planning our trip and purchasing airline tickets, it was still undecided how much attending the conference might cost. As it turned out, and as is common with many fares to Australia, you can add some legs to the trip at no additional cost. Given that, I agreed with the conference organisers to book the trip with a leg to and from Hamilton Island (as a gateway to Hayman) and, should it prove to costly, I would just abandon that leg of the trip. And as it turned out, it was too costly (this is an event for the 0.1%!) and so I had to do just that.

Now, in all this, I was using what I will term ‘naive rationality.’ I had figured that because it would save Qantas money I could freely dispose of that additional leg without issues. I would not get any money back, of course, but Qantas could sell the five seats to someone else. The rationality part was that this was a ‘win-win’ for both parties.

But it was the ‘naive’ bit that caught me. I rang Qantas to cancel the leg. The person on the phone informed me that it would cost $100 per person to change the booking right at the start. So we were already going to be charged $500 for not taking a flight! But they weren’t done yet. They informed me that because this was part of a package, we would have to look for a new fare for the whole trip from Canada at the same or a higher price. The cheapest alternative would cost us an additional $500 per person. So that was $3000 just to not take a flight.

Suffice it to say, I was outraged and let them know it. Yes, I knew that on a discounted fare, ticket changes would incur penalties but naively I thought that was for changes in the timing of flights not abandonment. After all, if we had just book a flight to and from Hamilton Island, we would not be charged more to cancel it. But because it was a part of an international fare Qantas wanted to take advantage of that and extract more from us.

Of course, I wasn’t going to pay that. So I suggested that I would simply not take the flight. We wouldn’t show. They then informed me that the rest of the trip would be cancelled and we would be stranded in Australia. This is a classic hold-up problem.

Now, had I been unethical, I could have just turned up to the flight with a child I claimed to have an infectious disease and seen what happened then. If they forced us on I guess I would have had to inform everyone else on the flight, right? But I wasn’t unethical.

Instead, I rang Qantas head office and shouted at someone until they put me through to some manager who could do something realistic. That happened but the best they could do was charge us $80 per person for the change. As it turned out, that would allow us to cancel the flight but also make other changes as well so we made a tweak elsewhere. That was more reasonable but they continued to insist the payment would have to be made just to cancel the leg regardless of other changes. Most consumers would not have known they could do that and would have just been forced to deal with the ‘standard operating policy.’

Now you may be thinking. Well, this is just price discrimination and airlines do that. It is true that they are clear on how discounted tickets translate into changes in your booking and that is fine as a way of charging people different amounts. But this particular charge was not like that. First, it was only a penalty because I was consuming a set of linked trips from Qantas. Had it just been that one trip they could not do it. So it was specifically designed to extract more rents from international visitors. Second, it is a penalty to punish those who engaged in errors. In that way it is like bill shock from mobile carriers to ISPs. It is a tax on the naive. That makes it all at a different level.

But there is more to it than that. When Qantas gets all legalistic with things that are zero cost to it, it is engaged in a war on customers. They are saying “you think you got a discount from us but we gotcha back.” Moreover, they force their employees to explain their exploitative behaviour. The souls of the phone operator and manager were being destroyed over the whole interaction. If you have a policy you cannot explain, you are harming your own workers and corporate culture.

Finally, as I already noted, this is a policy targeting international visitors. In the current environment, Australia needs visitors and Qantas is acting against those interests. This is unbecoming of an airline that purports to special treatment and protection from competition as it is the national carrier.

Politicians need to examine these behaviours closely. They are as destructive as complex mobile phone plans and bank charges that tax less sophisticated consumers. And they put employees in untenable positions trying to deal with customers in the frontline of the corporation’s war. This seems pretty unAustralian to me.

PS. I wrote my concerns to Qantas three weeks ago hoping for a reply and received none.

My two cents on Golden Balls

Since everyone is talking about it, here is my two cents on the above ‘Golden Balls’ video.

Let’s suppose that the guy on the left is choosing column and the guy on the right is choosing row. (The first payoff in each cell in the following game is the right guy’s payoff).

Here is the original game.

It has three (pure strategy) Nash equilibria: (Steal, Steal), (Split, Steal) and (Steal, Split). So it is not a traditional prisoner’s dilemma which has one unique equilibrium (Steal, Steal).

Now the left guy’s strategy is to change the payoffs. Specifically, he does so by offering a contract in one cell where he plays steal and the other plays split. That generates a new game.

 

 

Notice that there are now only one pure strategy Nash equilibrium. It is just that one of these cells a split like solution. This change occurs because, I suspect, the contract is enforceable because it was a clear offer and acceptance. However, it will likely have some details associated with it and so I have reduced the left guy’s payoff by c to account for those transaction costs. If c = 0, then the (Split, Steal) option is a Nash equilibrium again.

The point is that (Split, Split) — the thing that was actually played is not a Nash equilibrium. A real strategic innovation would be to ensure that. But what is more, unless you believe c = 0, then (Split, Steal) isn’t a Nash equilibrium either.

Now the left guy had recognised that (a) there were three Nash equilibria and (b) by committing to steal so openly he may have pushed the other person to take the split choice as it would make them look better. The point is that, if this is a real innovation, then this game show is dead. But it isn’t sustainable so it will live on nicely.

[Updated: due to early morning thinking error]

The market for term papers

The Chronicle has just published a first person account by ‘Ed Dante’, someone who writes term papers for a living: http://chronicle.com/article/article-content/125329/. It is well worth a look. I don’t support the practice, but it exists.

Three things crossed my mind after reading the article. Firstly, there must surely be a market failure happening here. Otherwise, Ed Dante should be earning more than the $66,000 per year that he claims is his income. This is especially given the amount of work he described doing and the potential value of his work to his clients. I suspect it is because he is aiming at highly customized pieces, so students may be reluctant to refer their friends and classmates to him as potential customers, just in case they end up with suspiciously similar essays.

Secondly, it confirms for me that libraries are in trouble. Apparently he relied mainly upon Google Scholar and Wikipedia but has never once been to a library since starting his job. Are you thinking what I’m thinking? If I were a Librarian, this present a good business opportunity as library resources could be complementary. In fact, scrolling through the comments, I saw one by “p_s_nym” that said “I do the same thing… I work for an internet company (while doing my day job as a librarian! Unfettered access to library materials is a great boon, and I can kill two birds with one stone).”

Thirdly (and yes, as an educator I am a bit concerned), it seems the solution here is one that already exists and is the age old one: exams. Term papers are fine to some extent, but this is what you get if you put too much weight on them. If the term paper contributes only a fraction of the students’ overall grades, it reduces the incentive to cheat. Besides, one can correlate the student’s exam performance with their term paper, and to some extent this acts as a way to smoke out the cheaters: it is hard to imagine that the girl who wrote that email (“did u get the sorce I send?”) would be able to write complete, coherent sentences in an examination under controlled conditions. So, looking for divergence in the scores as well as the writing styles between the exam and the term paper would be a useful thing to do.

Are there better solutions out there? Maybe I’ll set that as a term paper question for my students and see what their paper writers come up with.

Bait and Switch

News from Singapore this week made it all over the internet. A group of five diners were charged S$1224 (AUD1039) for a steamed fish at the new Resorts World casino. They had earlier ordered a different fish (which was presumably less expensive) but the waiter suggested a substitute without identifying the price. The diners later complained and received a 15% discount. But there are lots of people complaining online that the fish usually costs $6 per 100grams instead of the $60 per 100g charged by the restaurant.

It may sound a bit harsh, but in my opinion the diners exhibited a lack of bargaining skills. I would have refused to pay any more than for whatever fish it was the substitute for, after all it was the restaurant’s fault for running out of stock. It is also evident that the restaurant manager needs to do an MBA. It is a failure in marketing if people are complaining about your firm’s prices based on the cost of the raw materials used. My former MBA students would have learnt that in a well-run restaurant, customers would be happy to pay for the skills of its chefs, quality of the dining experience, and the ambiance. After all, if you’ve dropped by a high-end restaurant in Japan and eaten fugu (poisonous pufferfish), a price like US$100-200 per head is not unreasonable.

Singapore, June 30, 2010- THEY feasted on a fish named sultan – and were made to pay a king’s ransom for it. Well, not quite a king’s ransom, but a whopping $1,224 for that single steamed fish dish. And the bill left a sour aftertaste. The diner, who only wanted to be known as Mr Liu, 35, had taken his four friends to Resorts World Sentosa’s (RWS) Feng Shui Inn restaurant on June 12. The group had initially wanted marble goby, better known locally as soon hock, but the waiter said there was no stock for the fish. The waiter suggested the white sultan fish instead. The group agreed, without asking how much the dish would cost. They were stunned when the bill arrived. The single sultan fish, which weighed 1.8kg, set them back by $1,224. Source: http://soshiok.com/article/12333

ps: remember to ask the price before ordering at a restaurant.