Osborne: he\’s going to be Chancellor in a few months and it\’s not going to be pretty

Osborne teams up with Richard Thaler: latest exponent of the drear conviction that we\’re all little idiot baa lambs and have to be driven into behaving properly. You know, managed, prodded, but all for our own good of course.

But perhaps most significantly, the crisis has finally put to rest the assumption, which underpinned Labour\’s entire system of financial regulation, that individual behaviour is always entirely rational…

Who has ever said that individual behaviour is entirely rational? That we attempt to be so, that we attempt to reach our desired goals in the best manners available to us given the information about the world that we have plus the inevitable imperfect information about the future, sure….but the leap to perfect rationality from that is something of a straw man.

and that market prices always reflect intrinsic values.

What? What in buggery are \”intrinsic values\”? If we\’re all the way back to Thomas Aquinas and \”true value\” then we\’re about to march off a very steep cliff. For there isn\’t and aren\’t any such things. The value of something depends upon the value of everything else: we cannot say that 1 kg of gold is worth $12,000, or x tonnes of wheat, or y tonnes of fresh water or z numbers of smiling babies, without having some idea of the relative values of fresh water and smiling babies. Which in turn depend upon the state of knowledge (medical knowledge tells us what our forefathers did not know, that unfresh water leads to definitely not smiling and in fact dead babies) and the state of technology (how much effort do we have to put into freshening water to get smiling babies?) and indeed where we are at any one time (less effort if we\’re by a clear mountain stream, more if we\’re on a boat out in the ocean).

Values are thus relative, always, all the time, not intrinsic.

We can just about side step this and go for a much weaker meaning of \”intrinsic\” which is \”what people think these values are\” but then by definition market prices are the average of what everyone does think these values are.

So we\’re not off to a good start here.

A classic example is the way that Gordon Brown\’s tax credits system was initially designed. Obviously, we are in favour of tax credits, but when the system was first introduced it was assumed that people would promptly inform HM Revenue and Customs of any change in their income. That must have seemed so plausible on a spreadsheet on the then chancellor of the exchequer\’s desk. But of course, as it turned out, people don\’t quite behave like figures on a Treasury spreadsheet, and as a result billions of pounds were lost on overpayments.

So if we recognise that people do not always act rationally, what does this mean for public policy?

Eh? What is irrational about keeping overpayments to you? At least once (and I think more than that) they\’ve been written off. So this behaviour is in fact entirely rational. You might have to pay the money back, you might not. So hang on to it and wait and see. You can\’t be worse off by doing so and you might be better off by doing so. This is rational action, not irrational.

That Osborne and Thaler (and of course Brown himself) cannot see that this is rational behaviour really rather bites at the arse of the idea that politicians are going to be more rational than we are now doesn\’t it?

They then maunder off into behavioural economics which is a very different thing.

So if we recognise that people do not always act rationally, what does this mean for public policy? This is where behavioural economics and social psychology – an academic field that has already garnered Nobel prizes for the likes of Daniel Kahneman – comes in. These disciplines are enabling us to develop a new approach to policymaking, based on empirical evidence about how people really behave.

Here is one example. Over the past decade, the UK government has spent billions of pounds trying to encourage households to become more energy efficient. These efforts have largely failed, but it doesn\’t have to be like this. In Sacramento, an energy company has harnessed the insights of behavioural science, and prints information on energy bills that allows households to compare their energy use with similar homes. This simple change led to a fall in overall energy consumption as homes using more energy than their neighbours quickly adjusted their behaviour to fit in with the norm.

In what way does this undermine the thought that people at least attmept to behave rationally? What you\’ve just done there is increase the information available to people, OK, great. But you\’re then still depending upon them acting upon that information in a rational manner, aren\’t you? You\’ve again undermined your assumption of irrational behaviour: indeed, the very success of this scheme obliterates that assumption as with new information people are acting upon it rationally.

Jebus, if this is how the Shadow Cabinet thinks then we\’re fucked, aren\’t we?

Behavioural economics is all very well (\”Hey, wow, you mean that\’s the way people actually behave?\”) but none of it leads on to the idea that people aren\’t rational within the bubble of their own desires and the information available to them. Nor to anything quite so medieval  as \”intrinsic values\”.

And most certainly not to the idea that the bloke who\’s good at kissing babies in Tatton is more rational than we are when faced with our choices about our lives.

18 comments on “Osborne: he\’s going to be Chancellor in a few months and it\’s not going to be pretty

  1. what a dog’s breakfast they’ve made of it … it’s perfectly possible for markets to be severely dysfunctional when every participant is actually rationally, from their point of view (in the presence of information asymmetries, principal agent problems, etc. etc.) so why aren’t they asking what are the public policy implications of that?

    The word rational is too loosely defined – one could say it’s rational to avoid flying if you have an irrational fear of flying… so is that person rational or not? In the sense of economics, there are some formal definitions of rationality, but you can still put whatever you like in the utility function (I hate flying) and you can argue about whether other-regarding behaviour is rational or not, whether having a high subjective discount rate is rational or not (can one have an irrationally high discount rate?) I think arguing about whether people are rational or not can be a bit of a blind alley. I think you need to start with “if you assume people’s objectives are this, then are they acting rationally … but people too often get muddled up arguing about whether people’s objectives are rational.

  2. I think they mean “market prices” to be short-term or even immediate prices/values and “intrinsic values” means some long or hold-to-term price/value. but I agree it’s dangerous nonsense for the reasons you give.

  3. A further problem with tax credits- those in receipt tend to have very variable hours, and therefor incomes. They also tend to be less organised than the average- that’s partly why they need help. So the system depends on these people reporting a change in income every week, so that they can have their benefits reduced against their own best interests. Remember these people are relatively poor, so an extra pound is worth more to them than it would be to me. It also depends on government clerks, who are themselves near to minimum wage, processing this information both quickly and accurately- highly unlikely given their incentives.

  4. “Obviously, we are in favour of tax credits”.

    That statement alone should disqualify George from every being given the keys to No11. Tax credits are a hellishly complex, inefficient and unconservative way to take people’s money and then give some of it back to some of them.

    There have to be better ways to organisae the tax system that help the poorest that don’t involve armies of bureaucrats to phuque it up on a regular basis.

  5. Oh come on, we all know that when someone in government talks about “rational behaviour” they really mean “behaviour that I approve of”.

  6. Politicians, and presumably civil servants (as they draft the laws the politicians think up), are under strange illusions as to what rational behaviour is.

    They think that if they want us to do X instead of Y, and provide laws and penalties to stop us doing Y, we will all stop doing Y. Everything in the garden will be lovely.

    They forget that almost inevitably at the same time they are introducing a new charge or tax on something that was previously allowed for free.

    For example the change in Waste Management rules about 10 years ago, was accompanied by the Landfill tax, thereby making it more expensive to dispose of waste. Surprise, surprise people refused to pay the new landfill charges and instead dumped stuff in hedgerows and gateways all around towns. I suffered with a plethora of abandoned cars on my farm, until the China effect took hold and scrap metal prices rose and gave a scrap car some value.

    To a politician such illegal behaviour would be ‘irrational’, to anyone with a bit of experience of human nature, entirely predictable.

    Its the classic socialist idea – trying to fit people into society’s mould, rather than taking human nature into account when organising society.

  7. I think you’ve got this one very wrong, Tim (for once).

    Thaler’s point is that, for various reasons, people behave irrationally even with ALL of information. One aspect is that we are highly influenced by our peers.

    So, for example, in a bubble the fact that ‘everyone’ is investing in a Ponzi creates a desire to get involved too.

    The quoted example of the energy company only works because each household’s energy usage is compared their neighbours’. The desire to ‘conform to the norm’, rather than the fact and figures, drives the behaviour to save energy. (This goes both ways, so households with low average consumption will actually INCREASE energy usage).

    The irrationality applies to politicians too (you are right in that they will undoubtably cock it up), but big idea behind Thaler’s “Paternal Liberalism” is that dictats from ‘those who think they know better’ should be nudges rather than prescriptions and that they should always be a get-out clause.

  8. Tim this is not news we known that ‘nudge’ theory has been part of Conservative thinking for long time . I am not sure what your point is to be honest.Government wants to encourage socially good behaviour without being authoritarian . Whats the problem with that ?
    Your understanding Tax credits leaves something to be desired .People , as everyone but you knows , did not over claim because they meant to or put themselves into difficulties by any process amenably to rational examination , they did so by accident
    This is because in the US where the scheme worked at low levels their is a culture of being self sufficient and filing returns at all income levels . Such a thing was unknown in this country and faced with mountainous forms people cocked up. In other words it was working against the grain
    Now I am really looking forward top hearing you rational explanation of that exceedingly common real life phenomenon , bollixing it up ?

    Building cathedrals over generations , screwing the whole company before you will give in into management , working when you would obviously be better off on benefits …. rational ? Nope , I do not recognise this machine man you have created at all.

    Your problem is what you perceive as an attack on the market as the fount of all wisdom . I don`t think from George Osborne that is the right interpretation but morer generally if you want him to be talking turkey about cuts then have a look at the way the Polls react . He is in a tight spot .They need a mandate but they have to be elected and its very close
    We do not need pro Brown show boating at this point so stop it or face my wrath if not a sound thrashing.

  9. Mary:

    I plead ignorance of just whoever this Thaler might be but he (or she) is clearly an idiot, a propagandist, or perhaps, both.

    That people are influenced by their “peers” is not at issue. (“Peers” is a word used in describing those with influence on one, so is more or less “circular” in that regard.) It might be correct to say that people were “normalizing” their usage
    as that usage approached average. It might even be said, with some justice, that each one (as well as the entire group) was “optimizing” their “comfort/cost index” or were “maximizing” either their “utility index,” their “comfort/peer approval” index, depending on which particular aspect of their individual psyches the good doctor might wish to focus as the spirit moved him (I don’t say “or her” because only “hims” are ever quite so stuipid!).
    .

  10. Underlying this whole thing is a much more awful error by Osborne than any mistakes about rationality. You will note the unspoken but completely accepted notion that the role of government is to encourage people to behave better. The discussion is all about what is the best way to get people to do the “right” thing. The example used, of the energy saving in Sacramento, illustrates this very well. For goodness’ sake, these people are supposed to be our servants not our masters. The main political question of our time is how we prevent people like Osborne interfering in our lives.

  11. Yup good summary, I’d agree with all the comments above (especially The Remittance Man), apart from Mary and Newmania.

    My new theory is that ALL people behave ENTIRELY rationally AT ALL TIMES (within the constraints of the very limited information and mass-brainwashing to which they are subjected – people would behave differently if they knew more, but would not necessarily be any happier for it), except when voting for their next government, strangely enough, which is when all commonsense goes out of the window.

  12. If Osbourne wants to examine the true effectsof ‘Behavioural Economics’, then he doesn’t want to start with the argument about people behaving rationally, but with the argument that government interference creates perverse incentives.

    The tax credit system which he wants to keep, actively encourages fraud. An unmarried couple with a child, earning around £25K p.a. recieve about £40 pcm, until they inform the government that they are no longer in a relationship but are now house sharing as they cannot afford to leave the property. They then recieve £400pcm.

    Where government interferes in such a way with such perverse incentives, they encourage normally honest people to behave in a dishonest way.

    But he wants to keep tax credits.

  13. Mark Wadsworth:

    It’s by no means a new theory but–welcome (to the Austrian School) anyway. As we see it, “rational,” as you and I use it, is a “technical” term in Economics–signifying exactly that which its name implies. Like many other words, common usage is not quite so circumscribed (nor need it be–custom is what determines) which means, unfortunately, that in using the word in ordinary discourse, it’s denotation is modified (for at least several reasons), sometimes deliberately but, usually, unconsciously and without polemic intent.

    For us Austrians, behavior need not be rational: there are reflexes and automatisms included in the term “behavior”; but even these can, to some extent, be “rationalized” (as when we stop breathing when diving underwater or in an unpleasant atmoshere, refrain somewhat from “blinking,” or repress a cough or sneeze), which simply means to be chosen (for action) from among other possible alternatives.

    Human are able to say many, many things–some even beyond their own capacity (or the capacity of any human) to understand (springing to mind immediately are words such as “omnipotent” and “omniscient,” both quite beyond our capacity
    to even define satifactorily) and quite frequently employ such words in discussions where a more circumscribed definition is necessary. In such wise, all “action” (which necessitates choice from among alternatives) is “rational,” whether ill-considered in the view of another person or even the same person under different circumstances or merely at a different time.

    Economics, as a body of knowledge and understanding, is entirely a product of “thinking”
    (or what is usually referred to as “deduction”) and cannot be aided nor enlarged by experience nor by the use of calculations, graphs, models, etc. (though all of these, of course, including experience, may well be used to illustrate and, sometimes–tho’ not often)–to simplify concepts).

    The reason that Economics (like Mathematics) is deductive, rather than inductive (as are the material sciences) is not because the deductive is a superior method; rather, it is because it is the only method: the process it employs is the same as that (thinking and acting) which it is sought to study and understand. And, because each logical step in an economic analysis or theory is related to previous steps by a chain of logically and definitionally irrefutable equivalencies, no “experience” can ever invalidate a properly-drawn economic theorem.

    The fundamental tool of the material sciences, induction, is not a different way of thinking than the deductive (which is the only way the mind “works”) but is, rather, a subset of the deductive. Where deduction says that A =B + C, it also recognizes that, if C=D+E+F, then it is also true that A =B+D+E+F and there can be no objection for substituting the latermost for the first; if what we call “science” is intent on learning the effect of variance in the magnitude of “F” on the magnitude of “A,” it resorts to the “experimental method,” whereby the values of B, D, and E are held constant by “laboratory” methods, while the magnitude of F is varied (and the effect on A measured). But nothing of the original (A=B+C) has changed.

    The problem in applying calculations (and, thus, cardinal numbers) to economic study is, quite simply, that there are not only no constant relationships–but no constants whatsoever. Changes occur constantly in every dimension and for immeasurable (and some unknown or new) reasons which, themselves, cannot be measured (no matter how quantifiable: ten dollars “mean” quite different things depending on the particular markets being studied or even in the very same market at different times (whether in the trading session or the century).

    I tried to keep it simple. But, if one wants to understand, it is necessary to read Von Mises; then, nobody who hires economists will hire you as an economist (because you will be an economist!). But, at least you’ll understand.

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