Elsewhere

This is for a foreign language publication and it’s aimed at people not all that up on economics. Thus the detail is a bit sketchy:

Richard Thaler has won the 2017 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel – also known as the Economics Nobel. There is no controversy over the award to him – he’s widely thought of as being a thoroughly deserving recipient. There is a little pondering over the when of the prize though, some think he should have been noted in 2002, with Daniel Kahnemann, or perhaps 4 years ago with Robert Shiller. For all three have been working at the same basic problem we have within economics, when is it that we do actually work as the textbooks assume and when don’t we? This is more generally known as behavioural economics, the teasing out of what really are, instead of what are assumed to be, human reactions to stimuli.
This being, of course, what we’re trying to do in the whole field – what is it that humans do? Once we know that, and the way that they respond to changes in the incentives they face, then we can at least to begin to design methods to aid in a better world.
One outcome of Thaler’s work, something discussed in his best selling book with Cass Sunstein, “Nudge,” is that we can get people to save more for their retirement simply by assuming that they will. In more detail, Thaler’s work shows that we value what we’ve got rather more than we do what we might get. That is, $1 we have is worth more to us than $1, or perhaps even $2, that is on offer – this is known as the “endowment effect.” This feeds through into a possible overvaluation of the status quo in many situations.
At which point, we know that we want people to save for their retirements – excellent, so, how do we encourage this? We could imagine tax breaks for saving, a law stating that you must save (the UK does the first, Singapore the second) and so on. Thaler has pointed out the implications of that status quo bias. As and when people are signed up by their employer for pensions savings schemes, the default option could be the maximum permissible savings amount. People are more likely to take the choice their offered rather than change it. Just this, this little insight alone, is said to have led to some $30 billion more of pensions savings among Americans.
At the heart of the work though there is a great point being made. Market economics makes an assumption of rationality, something which itself comes in two flavours. The first being that people are just consistent. If they prefer A to B and B to C then they will also prefer A to C. The second is that people are rational calculating machines who zero in on the optimal strategy to gain their desires given their constraints. The first is held to be generally true, the second only at times. Thaler, along with other behavioural economists, has shown that neither are always true. However, as is so often true the interesting part is in trying to work out why the irrationality.
Some early parts of Thaler’s work concentrate upon the ultimatum game. In this there are two participants in the experiment, one is given $100 and told to split it, however they wish, with the second. The second can accept or reject the offer. Rejection means that neither keeps any cash, acceptance that the split happens. Logic would indicate that a 99/1 split should be accepted, a free dollar is after all a free dollar. That isn’t what happens though, splits of less than 70/30 are routinely rejected.
At which point we want to explain this and the usual idea is that humans have some innate sense of fairness. One that’s so strong that they will reject “unfair” offers at costs to themselves in order to punish that perceived unfairness. This does indeed seem to be true among American undergraduates who were the experimental subjects.
This result did not survive testing in other societies though. We now have a pretty good evidence base that resolutely non-market economies will accept just about any split, market economies will reject ones perceived as unfair. Which leaves our mystification just that one level deeper – do markets create that punishment against unfairness or are they a precondition for them?
In this instance we’re seeing something that doesn’t appear rational yet, upon deeper examination, it becomes entirely rational at that deeper level. Other parts of Thaler’s work talk about “limited rationality” which is where people do things that really aren’t rational in either of our two meanings. One of his examples here is a fund called “Cuba.” That’s the trading name for it, it doesn’t have any assets in Cuba itself, nothing to do with the place, that’s just the 4 letter acronym it’s known by. For years it bumbled along at the usual 10 to 15% discount to net assets that a closed end fund normally trades at – then it leapt to a 70% premium to that asset value. What? The trigger event was the US stating that it would open up a little more to trade with Cuba. The island that is, the place the fund has nothing to do with.
This change in price is clearly irrational and if it was something that persisted for a day or two we could just mark it down as a mistake brought on perhaps by bad information. But it persisted for months. Even financial markets – which Thaler and most others would agree are the most rational of our markets – aren’t really all that rational therefore.
The implication of this, one that Thaler pushes himself, is that we should therefore nudge people into making better, more rational, decisions. Sometimes this is obvious enough, greater savings for retirement probably are a good thing as above. However, the idea does run into a logical problem, which is that if people are irrational who is going to be the rational nudger? Of course, as with Kip’s Law (“the central planner always, but always, envisions himself as being the one doing the planning”) there’s no shortage of people who claim to be more rational than the rest of us. But given the way politics works it’s not in fact a given that those who are will be the people giving the nudges. A casual glance around the world shows that.
One of the joys of Thaler’s work is that it isn’t heavily mathematical and in fact, it’s all rather obvious. Except it’s obvious in a non-obvious manner. Once he’s explained a matter – two examples being why people like it when you take away the cashew nuts they’re enjoying eating, or how men will improve their aim when you stencil a fly on a urinal – then yes, it’s obvious! But before it was pointed out it wasn’t obvious at all.
What we really want to know of course is what is the deeper significance of all of this? Preventing bathroom messes, getting people to save, these are good and useful things but hardly about to set the world alight. That importance being that the standard microeconomics does indeed assume “Homo Economicus,” that we’re rationally reacting to stimuli and opportunities all the time. Thaler, along with colleagues, is pointing out that human beings simply don’t work that way all the time. But the important part of this observation is the “not all the time” part.
We are not in a binary situation here. It is not true that humans are irrational, thus must be told what to do. We’ve tried those planned economies and societies and we know they don’t work. It is also not true that humans are rational, always and all the time, so the unregulated world of varied fantasists also will not work. What we actually want to know is when is it that people are doing that irrationality and perhaps should be nudged or regulated out of it, when are they doing just fine and can be left alone?
The correct answer here is unknown as yet but in my opinion will come from something closely related to Thaler’s behavioural economics. Which is the result of the Prisoner’s Dilemma, an experiment in game theory. Two prisoners, if they both keep silent then they will both get a short prison sentence. If they both tell on the other then both will get a medium one. If one keeps silent and the other tells then silence earns a long sentence, informing freedom. What’s the best strategy for the prisoners?
This is still argued about when it’s a one time event. But when it happens over multiple iterations then the optimal strategy is clear, cooperation, or tit for tat. I’ll do this time whatever you did last time – inform or stay silent. At which point we’ve the beginnings of a useful structure.
Thaler tells us, proves to us, that we’re sometimes to often irrational. Regulation, nudges, can improve matters when we are – but what we want to know is, when are we? As the results of the two games, Ultimatum and Prisoner show, the answer is different in situations with multiple iterations, many interactions. Punishing people into fairness is part of – perhaps cause, possibly result – the market economy that so enriches, it’s worth it. Cooperation, tit for tat works over time. At which point a useful rule of thumb can be constructed.
Where we do things regularly then we’re probably acting rationally. We buy bread often enough that an unfair seller will quickly lose custom and be driven out of the market. We buy pensions usually only once in a lifetime, we’re far more likely to be irrational at that point. Thus we can leave the regular activities to humans to solve, regulation is needed more with the irregular.
Note that the conclusion is mine, not Thaler’s. His great contribution though is to get us to the point where we can even consider the point. People are not as rational as the standard theory assumes, we must therefore consider where, when and why people are irrational and what we plan to do about it.

35 thoughts on “Elsewhere”

  1. You’re so right about decisions done regularly will lead peeps to be good at them. It’s part of the modern human problem that the things that are very important to get right they don’t get much practice at e.g. house and spouse.

  2. “Respectfully sir you are wrong – the correct answer to any problem is moar tax and some controller telling you what to do.”

    which sums up the reason Richard Thaler receives a nobel and DICK potatohead is forced to run a blog so he gets the praise he thinks he’s due from a bunch of fanbois. Thaler takes into account human nature where mr potatohead thinks he can override human nature because he’s right and everyone else is wrong.

  3. I didn’t think Kahnemann properly grasped that rejecting the 99/1 split _is_ rational. The only exception is if you’re only playing the game once with that person maybe you take it (explains why lawyers and estate agents are so rich), but for an iterative game it’s in your long-term interest to punish greed.

    Within a society it might also be rational to reject the split for a one-time game (puts the scoundrel off pulling the stunt on others in future), something Kahnemann did touch on. Contract law stops you doing that in practice with lawyers and estate agents.

  4. Ah, good old Herzfeld Caribbean Basin Fund.

    “The island that is, the place the fund has nothing to do with.”

    This isn’t, strictly, true. And never was. Why do you think they picked the bloody ticker symbol in the first place?

    Though I don’t think it really changes anything in the article.

  5. If you publish this anywhere in English please let me know. I have a friend of the “economics is bullshit because it assumes all people are all rational all the time” (coupled with the assumption that all economic rationality is about acquiring money) who desperately needs to read it.

  6. Thanks for info, Tim. Very interesting.

    I can see why this would be an interesting and useful area of economics. My problem with it, though, is political. Thaler and Sunstein called it ‘libertarian paternalism’. If ever there were an oxymoron, that’s it. I remain to be convinced that governments should even be trying to influence their citizens’ decisions. But than I am a libertarian. Admittedly, if they are going to do it, this sounds the least bad way to go, as citizens can at least opt out.

  7. Yeah, but if he goes through my comments here he will think I’m even more of an antisocialist fascist nazi evil capitalist oppressor conservative republican selfish greedy libertarian Trump fanboy than he already does!

  8. So people get.better at.thimgs after practice?
    The problem I see is who do we trust to advise us on those matters we lack the opportunity to practice? Pensions, education, etc.

  9. The holy grail of socialism is that human nature is replaced by a dull obedience to the state without losing the spark of innovation.

    Hasn’t happened yet. Never will.

  10. Sunstein is a sly dictatorial cunt who, if memory serves, was an influence on Camoron (and thus prob the Fish Faced BluLabour Cow also).

    He needs a public and permanent neck-stretching.

    Thaler is a chum of his and likely is in need of the same permanent arrogance cure. Perhaps they could award him another Nobel and combine the two ceremonies.

  11. Philip Scott Thomas

    Mr Ecks –

    Sunstein is a sly dictatorial cunt who, if memory serves, was an influence on Camoron…

    Your memory serves. Cameron’s government took up Sunstein’s ideas wholesale and set up the Nudge Unit.

  12. Mr Ecks,
    Can you give us a rough estimate of the population of the UK once your purge is finished?

  13. Can we send this Noble 23 years back in time?

    Perhaps then maybe my econ101 professor might not have been quite as big of an idiot. Probably not though. The class shouldn’t have been called econ101. How to beg for VC funds would have been far more appropriate.

  14. The nudge unit are responsible for those irritating HMRC letters about how “Most people pay their taxes on time, but we’ve noticed you haven’t”

    I have sent letters to HMRC on behalf of clients which include phrases such as “most organisations try to get things right first time”.

    But my nudges seem to be having fuck all impact.

  15. @Bloke in Germany, October 10, 2017 at 2:12 pm

    Yeah, but if he goes through my comments here he will think I’m even more of an antisocialist fascist nazi evil capitalist oppressor conservative republican selfish greedy libertarian Trump fanboy than he already does!

    Copy and paste article on pastebin. Then tell your friend someone sent you the pastebin link.

    PS “he will think” – isn’t that how you think about us?

  16. “PS “he will think” – isn’t that how you think about us?”

    No, I don’t actually, but that’s kinda my point. I’m definitely on the left side of the Worstallian Commentariat but my mate has the fault a lot of people do, which is to see other people in binary terms. Especially when it comes to politics.

  17. I think the nuts story is about providing pre-dinner nibbles. If they’re there, most people will fill up on them, but if you remove them, they’re actually relieved that they will retain their appetite for the food that’s to come.

    It’s an analogy for some economic position, but I’ve forgotten which one!

  18. “Where we do things regularly then we’re probably acting rationally.”
    As we say in sales, its better to sell to a client than win a client.

    If there is the chance of trading again, the incentive is to not take advantage of someone’s ignorance.

  19. This little example of Herzfeld; I didn’t realise that Thaler had made such a big deal of the thing, mainly here;

    https://poseidon01.ssrn.com/delivery.php?ID=998105006000067127072106124096096121053040051018055094125101002098095096071066125123041031008002042043044094083124026122020084025010021006031082095019115099073037084086093121091113005007105025124111090125001021017102108069084103088112066070119090&EXT=pdf;

    Which is fine, apart from the minor problem that it is in fact almost complete bollocks.

    So, from Thaler’s piece, you say;

    “For years it bumbled along at the usual 10 to 15% discount to net assets that a closed end fund normally trades at – then it leapt to a 70% premium to that asset value. What? The trigger event was the US stating that it would open up a little more to trade with Cuba. The island that is, the place the fund has nothing to do with.
    This change in price is clearly irrational…”

    The change in price is completely rational.

    Herzfeld Caribbean Basin Fund, prospectus September 2015

    (https://seekingalpha.com/filing/2578191)

    “Our investment objective is long-term capital appreciation. To achieve our objective, we invest in issuers that are likely, in the Adviser’s view, to benefit from economic, political, structural and technological developments in the countries in the Caribbean Basin, which include, among others, Cuba, Jamaica, Trinidad and Tobago, the Bahamas…”

    Slightly further on, in the same paragraph…

    “At such time as it becomes legally permissible for U.S. entities to invest directly in Cuba, the Fund will consider such investments”

    The text in the first quote above also appears in the annual report for 2006.
    (https://docs.wixstatic.com/ugd/7ba5b8_c0466f1128554478b840f956b4956ddf.pdf)

    From the notes to the December 1999 R&A;

    “$165,000 principal, 4.5%, 1977 Republic of Cuba bonds purchased for $63,038. The bonds are listed on the New York Stock Exchange and had been trading in default since 1960. A “regulatory halt” on trading was imposed by the New York Stock Exchange in July, 1995.”

    It’s a shame that the annual reports don’t really go much further back on-line, as quite early on in the fund’s life, the directors report’s contain discussions about the major holding in Florida East Coast Railroad/Industries, just south of 25% of net assets by 2001, and the anticipated impact that a relaxation of the embargo would have on that investment.

    But, then the 2002 semi-annual also has nice premium/discount chart from the fund’s inception; which shows a consistent premium for the first two years, peaking at 60%-ish around the latter half of 1995, then dropping to a consistent discount from June 1996, but that discount ranges from about 0 to 20%, then hits a premium of ~25% late 1999.

    Helms Burton passed in March 1996.

    Quite why Thaler makes the statements about the fund looks a bit odd, since he wrote a bloody good paper in 1990 about discounts and premiums, Investor Sentiment and the Closed End Funds Puzzle;

    https://dash.harvard.edu/bitstream/handle/1/27693394/w3465.pdf?sequence=1

    Which largely talks about investor sentiment or noise traders, in particular, what he calls “differential clienteles”, but also is a quite handy round up of other theories about discounts and premiums. And guess who, amongst others, is acknowledged for providing data? Thomas Herzfeld.

    What’s really good about Thaler’s 1990 paper is the point that investors in closed-end funds tend to be smaller (ie, retail) and thus not to be significant investors in the funds’ underlying assets; they’re really too small to capture the discount by going long the fund and short the underlying, as the rest of the market won’t even notice the short. With regard to Herzfeld, total net assets are only ~$46m, and it is pretty much the only vehicle available to smaller investors that provides access to the declared strategy; it would cost too much to replicate it.

    There’s one other fund around from the mid-Nineties to the early 2000s that has the same characteristics, and displayed the same premium-discount moves; Templeton Vietnam.

  20. The bread vs mortgages thing is the argument I’ve been using for years. If you buy a dodgy loaf, that’s a quid or so you’ve wasted and a day or so’s food, you chuck it out and on the experience of buying several thousand loaves of bread decide how to replace it or to replace the supplier. If you buy a dodgy mortgage that’sa commitment of many multiples of your annual income, you tend to have zero experience to guide you, or perhaps experience from two recessions ago.

    Extending it, there’s the anonymous supplier problem that justifies regulation, which is how I approached taxi licensing. With Hackneys where the passenger has zero quality control over the product, you get whatever random product happens to drive past you as you wave at it, and that random product has zero causal link to any of the other random products. And also why Hackneys are jusifiably regulated harder than private hire, ‘cos private hire must go through a booking office and must be recorded, so there is an identifiable product for the consumer to gain experience from and advise future purchasing decisions.

  21. re this Ultimatum Game thing. I don’t think maket/non-market economies explain it. More likely relative wealth. £1 to me really isn’t worth much, I probably ‘waste’ at least that much every day, I can afford to reject the offer. On the other hand if I had nothing then that £1 would be worth a lots more, and being poor I probably would be respectful of any charity or patronage offered.

  22. “Mr Ecks,
    Can you give us a rough estimate of the population of the UK once your purge is finished?”

    Once again Biggie I am obliged to point out to you, as to so many others, that the purge merely removes leftists from the taxpayers tit –not from existence. I am not a socialist and thus do not support or endorse, let alone practice, mass murder.

    I do speak of hanging the Sunsteins of the world and–were I say PM– I would be tempted to do so. However Sunstein is not a UK citizen even so I would be content to have him ( should he ever be foolish enough to visit the UK under my Premiership) picked up at the airport, taken to nick, worked over, charged with “assaulting Officers while trying to escape” etc , followed by a rapid Home Office decision to expel and a humiliating handcuffed “perp walk” for Mr Sunstein back to the plane and away.

    I think that such a “nudge” might at least give the cunt pause for thought next time he is coming up with plans for the better organising of other people’s lives.

    Indeed there would be a great many International leftists and general tyranny fans who would be ill-advised to visit these shores during any time I spent as PM. The entire procedure detailed above has the potential to become a well-oiled machine. Arrive, arrest, beat, charge, expel, walk and flyaway. Perhaps even Drunker and Verstadt themselves might receive a taste of British hospitality.

    As for your original question Biggie I am sure that the population of the UK post-Purge will be many, many times the native German population ( and indeed the entire Native population of the Continent) once Mer-Cow and her EU friends have finished with you.

    Better get that gun.

  23. Dear Mr Worstall

    “We now have a pretty good evidence base that resolutely non-market economies will accept just about any split, market economies will reject ones perceived as unfair.”

    Assuming the relative wealth of both parties is about the same, there is no need to invoke a ‘sense of fairness’ in market economies when mutual self-interest – the driver of said economies and Adam Smith’s ‘hidden hand’ – is sufficient. It is in the giver’s self-interest to ensure that his offer will not be declined. At $99-$1, the giver has much more to lose than the recipient. Step downwards until the relative gain/loss becomes more equal and two thirds/one third seems about right. There is little advantage to the recipient to press for an equal split, though that would, of course, be ‘fairest’ of all.

    Step forward the SWJ, who will rationalise thus: ‘my need is greater than your’s therefore you will accept this paltry thaler while I keep the rest for my needs. No, don’t thank me, your acceptance is thanks enough.’

    DP

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