Behavioral Political Economy

I was interested to read "Behavioral Political Economy: A Survey" by Jan Schnellenbach and Christian Schubert. (HT marginal revolution's irresistible links.)

Context: I have long been puzzled at the high correlation between behavioral economics and interventionism.

People do dumb things, in somewhat predictable ways. It follows that super-rational aliens or divine guidance could make better choices for people than they often make for themselves. But how does it follow that the bureaucracy of the United States Federal Government can coerce better choices for people than they can make for themselves?

For if psychology teaches us anything, it is that people in groups do even dumber things than people do as individuals -- groupthink, social pressure, politics, and so on -- and that people do even dumber things when they are insulated from competition than when their decisions are subject to ruthless competition.

So on logical grounds, I would have thought that behavioral economists would be libertarians. Where are the behavioral Stigler, Buchanan, Tullock, etc.?  The case for free markets never was that markets are perfect. It has always been that  government meddling is  worse. And behavioral economics -- the application of psychology to economics -- seems like a great tool for understanding why governments do so badly. It might also inform us how they might work better; why some branches of government and some governments work better than others.

This nice paper got my attention, since the paper says that's starting to happen.

...Assuming cognitive biases to be present in the market, but not in politics, behavioral economists often call for government to intervene in a “benevolent” way. Recently, however, political economists have started to apply behavioral economics insights to the study of political processes, thereby re-establishing a unified methodology. This paper surveys the current state of the emerging field of “Behavioral Political Economy”

I came away horribly disappointed. Not with the paper, but with the state of the literature that the authors ably summarize.


I notice a lot of theory rather than fact. Stigler and company were deeply empirical.  That theory seems focused almost entirely on individual perceptual and decision-making biases, rather than how people in groups produce bad decisions.

On "theory," you can see where we're going with

We distinguish between a “weak” and a “strong” variant of BPE. The former merely alters specific auxiliary assumptions on either agents’ cognitive capacities or the content of their utility functions, by arguing, for example, that voters not only care about political outcomes, but also about their “citizen duty” when going to the polls, or that they care about other aspects that seem irrelevant from an orthodox instrumental standpoint, like a candidate’s looks... The “strong” variant of BPE goes beyond this and attempts to actually explain (rather than just postulate) motivational and other psychologically informed extensions to the standard model. For instance, it may try to examine the mental processes causing differences in agents’ susceptibility to certain biases

In particular, the first substantive section is

2. Voter preferences and voter behavior

which deals with the age old question, why do people bother to vote? Some of the answers

compliance with social norms..costs of moral behavior...utility gained by expressing one’s opinions...direct democracy appears to provide voters with procedural benefits by letting them participate in the decision-making process, independent of altering results in their favor...voters may overestimate the  probability of their personal vote being decisive...

This little quote suggests some of the character of the enterprise

...expressive utility is by now probably the most widely accepted element of BPE. Hamlin and Jennings (2011) define the “expressive” aspects of voting behavior as reflecting benefits from the act of voting that neither derive from its instrumental nor from its consumptive value, but from its symbolic or representational aspect: not from the act, but from its meaning”

The review covered not one salient fact, other the fact that people vote at all. They are all apparently highly complex ex-post stories. How would one even tell these theories apart?

I was expecting (hoping?) for things like, "XYZ study the FAA's perplexing inability to write rules allowing commercial use of drones, analyzing meeting schedules, showing that PDQ's theories of small group dynamics account for the pattern of indecision,'' or "ABC study data collection by Federal Agencies and how the agencies use control of the data to influence academics to write articles supportive of the agency's goals."  I was hoping even for some good stories of how bureuacratic decisions, lobbying results, bill writing, or anything political/economic can be understood by psychology -- or anything else. Alas, no.

After just one section, it's back to people are dumb, so omniscient bureaucrats should manipulate them (not the authors, to be clear, but the literature they are surveying)

3 Policy-makers ...

3.1 What should politicians do? ..

...attempts to derive policy implications from an explicitly “behavioral” model of how citizens respond to policies. Bolton and Ockenfels (2012) suggest an approach they call “behavioral economic engineering” that tries to integrate such ideas. Harstad and Selten (2015) also model citizens as responding to policies in a non-optimizing way: They are guided instead by “lower-dimensional” rules of thumb that are much easier to apply. The authors argue, quite convincingly [?], that policymakers should take these observations into account, as many important policy recommendations go awry when inadequately modeling citizens as homines oeconomici.

Yes, but we were supposed to be here to see what recommendations go awry when inadequately modeling bureacrats and politicians as homines oeconomici, not as deus-ex-machina, or pater familias.

Another little quote to alert you to the prose style you're going to have to master if you want to take up this topic.

Other approaches extend the process-oriented perspective. ...a theory of economic policy-making should take into account how politicians and citizens interpret political problems.... social communication constructs the beliefs in which concrete policy-measures are rooted.... A theory of economic policy would then need to be open to explanatory approaches from social psychology and sociology, which help to understand how common beliefs are formed and dispersed.

Again, and again, things we ought to listen to in order to construct new theories. Please could we try to study a single fact?

Finally I seemed to find what I was looking for

4. Bureaucrats, regulators, and lobbyists

And

While there is a very broad literature on how bureaucrats should efficiently regulate the actions of individuals suffering from choice imperfections, [!] so far there is very little research on the biases that regulators themselves may be subject to (see however Kuenhanss et al. 2015 and Tasic 2011 for a first survey). 

Aha! But the hoped-for research isn't there. For example,

 Guided by re-election concerns, they [politiicans] will choose to regulate those risks that are perceived to be particularly salient by the general public at a given point in time, which may direct regulatory resources away from other, objectively more pressing but less salient risks (Jolls et al. 1998)....

regulators face a trade-off between, on the one hand, maximizing social welfare, and, on the other hand, serving their career concerns by following the politicians’ demands. 

That is not terribly deep to put it mildly.

I was hoping for solutions, empirical evaluation guided by theory of what larger frameworks produce better outcomes. Alas what we get is

The authors suggest some institutional remedies that could alleviate the problems of bias in bureaucracies. An example is “de-biasing” by assigning a team within the bureaucracy to play the role of advocatus diaboli, and thereby make sure to get all arguments on the table. Another proposal is to incentivize bureaucrats by making parts of their rewards dependent on long-term outcomes

Madison and Hamilton on separation of powers this is not. (And a great example of my least favorite verb voice, the regulatory passive. "To incentivize." Who is going to do this "incentivizing" please?)

I had some hope finally for

5. Applying BPE: Two examples 

But no. The two examples are

5.1. Libertarian Paternalism..as popularized by Thaler & Sunstein (2008)

Back to Gruberism.

5.2. The Long-Term Effects of the Welfare State 

A suggestion that "social norms" can mollify the disincentives of the Welfare State.

The conclusion is ringing. Once again, bravo to  Schnellenbach and  Schubert:

We have also seen that what makes political behavior a particularly suitable candidate for applying insights from psychology is the fact that it exhibits incentive structures that differ markedly from those prevailing in the marketplace: Behind the veil of insignificance, people are essentially free to pursue any kind of non-standard goals. [Amen!]

But,

... BPE models still often display an asymmetry with regard to their basic assumptions, when, for example, “behavioral” voters are modeled as interacting with perfectly rational policy-makers or lobbyists. There is a danger here to introduce a new dichotomy in behavioral assumptions without much concern for the empirical evidence.

Indeed.

The opportunity for deeply empirical, behavioral public-choice economics, studying how individual and group psychology helps us to understand government failures. And hopefully, to craft instutitonal structures that will lead to better outcomes.

Why not? Perhaps, to indulge in a little behavioral ex-post story telling of my own, a behavioral Stigler would be hated equally by the public choice school, which uses rational-actor economics, and by behavioral economists, who seem, in this wide-ranging review, to remain overwhelmed by dumb-voters-in-need-of-our-enlightened-guidance dirigisme.

Writing compactly

A correspondent sends a suggested edit of a part of my writing tips for PhD students

With markup

Keep it short

Keep the paper as short as possible. Be concise. Every word must count. As you edit the paper ask yourself constantly, “can I make the same my point in less space?” and “Do Must I really have to say this?” Final papers should be no more than  under 40 pages, drafts should beshorter. (Do as I say, not as I do!) Shorter is better.

 

Clean: 

Keep it short

Be concise. Every word must count. As you edit, ask yourself, “can I make my point in less space?” and “must say this?” Final papers should be under 40 pages, drafts shorter.  Shorter is better.

Well, I did say "do as I say, don't do as I do!" 

Segregated Cash Accounts

An important little item from the just released minutes of the October Federal Open Market Committee meeting will be interesting to people who follow monetary policy and financial reform issues.

Finally, the manager reported on potential arrangements that would allow depository institutions to pledge funds held in a segregated account at the Federal Reserve as collateral in borrowing transactions with private creditors and would provide an additional supplementary tool during policy normalization; the manager noted possible next steps that the staff could potentially undertake to investigate the issues related to such arrangements.

A slide presentation by the New York Fed's Jamie McAndrews explains it.

The simple version, as I understand it, seems like great news. Basically, a company can deposit money at a bank, and the bank turns around and invests that money in interest-paying reserves at the Fed. Unlike regular deposits, which you lose if the bank goes under, (these deposits are much bigger than the insured limit) the depositor has a collateral claim to the reserves at the Fed.

This is then exactly 100% reserve, bankruptcy-remote, "narrow banking" deposits.  I argued for these in "toward a run-free financial system" as a substitute for all the run-prone shadow-banking that fell apart in the financial crisis. (No, this isn't going to siphon money away from bank lending, as the Fed buys Treasuries to issue reserves. The volume of bank lending stays the same.)


A second function of such deposits is that, like the new repo facility, it's going to help the Fed to raise rates. When the Fed wants to raise rates it will pay more interest on reserves. The question is, will banks pass that interest on to depositors? If they were competitive they would, but that's not so obvious. If large depostitors can access interest-bearing reserves through the repo program, or now through this narrow-banking program, it's likely to more quickly transmit the interest on reserves to the wider economy.


 

Dusty corners of the market

Thursday and Friday I attended the NBER Asset Pricing conference. As usual it was full of interesting papers and sharp discussion. Program here.

A bloggable insight: Itamar Drechsler, and Qingyi F. Drechsler "The Shorting Premium and Asset Pricing Anomalies." They carefully found the cost to short-sell stocks.

Here's their Table 5. F0 are all the easy to short stocks. F3 are the hardest to short stocks. They construct long-short anomaly portfolios in each group. "F 0 Mom" for example is the average monthly return of past winners minus that of past losers, among the easy to short stocks. Now compare the F0 row to the F3 row. The anomaly returns only work in the hard-to-short portfolios.

The second panel shows  Fama-French alphas, which are better measured. The sample is alas small. But the result is cool.

The implication is that a lot of anomalies exist only in hard to trade stocks. There is a lot more in the paper, of course.

Table 5: Anomaly Returns Conditional on Shorting Fees

We divide the short-fee deciles from Table 2 into four buckets. Deciles 1-8, the low-fee stocks, are placed into the F0 bucket. Deciles 9 and 10, the intermediate- and high-fee stocks, are divided into three equal-sized buckets, F1 to F3, based on shorting fee, with F3 containing the highest fee stocks. We then sort the stocks within each bucket into portfolios based on the anomaly characteristic and let the bucket's long-short anomaly return be given by the di erence between the returns of the extreme portfolios. Due to the larger number of stocks in the F0 bucket, we sort it into deciles based on the anomaly characteristic, while F1 to F3 are sorted into terciles. Panel A reports the monthly anomaly long-short returns for each anomaly and bucket. Panel B reports the corresponding FF4 alphas. Panel C reports the FF4 + CME alphas. The sample period is January 2004 to December 2013.

(From Table 4 caption) The anomalies are: value-growth (B=M), momentum (mom), idiosyncratic volatility (ivol), composite equity issuance (cei), nancial distress (distress), max return (maxret), net share issuance (nsi), and gross pro tability (gprof). The sample is January 2004 to December 2013.

Inequality at WSJ

"What the Inequality Warriors Really Want" a Wall Street Journal oped on inequality. It's a much edited version of my evolving "Why and How we Care About Inequality" essay. Any writers will appreciate the pain that cutting so much caused.

As usual I can't post the whole thing for 30 days, but you might find the WSJ short version interesting, especially if you couldn't slog through the whole thing. Their comments might be fun too.

Guilds

The Syndics of the Drapers' Guild by Rembrandt, 1662.

I enjoyed Sheilagh Ogilvie's The Economics of Guilds in the latest Journal of Economic Perspectives. Bottom line:

..the behavior of guilds can best be understood as being aimed at securing rents for guild members; guilds then transferred a share of these rents to political elites in return for granting and enforcing the legal privileges that enabled guilds to engage in rent extraction. 

The paper nicely works through all the standard pro-guild and pro-regulation arguments. If you just replace "Guild" with "regulatory agency" it sounds pretty fresh.

Did guilds provide contract enforcement, security in weak states, property right protections not otherwise available? No.

Overall, the empirical findings suggest that impersonal exchange in medieval and early modern Europe was sustained not by particularized arrangements such as guild jurisdictions or interguild reprisals, but by generalized institutions: private business practices backed up by public-order municipal or state institutions, which were open to all traders, not just members of privileged guilds.

Did guilds improve quality, protecting the unwary consumer?

..guilds typically penalized their members’ quality violations too mildly to deter them (Homer 2002; Forbes 2002; Ogilvie 2005). Customers often described guild quality controls as inadequate, and wholesale merchants added their own quality inspections at point of purchase. As one German guild inspector declared in 1660, “the cloth-sealing takes place very badly, and when one says anything about it, one incurs great enmity” (as quoted in Ogilvie 2004a, p. 295). Guild inspectors lacked the incentive to develop the skills and deploy the effort necessary to detect low-quality work beyond superficial features (such as size), which were readily apparent to wholesale merchants and consumers anyway (Ogilvie 2005; Boldorf 2009)...

Guilds were certainly often active in regulating quality. But there is little empirical support for the idea that they were efficient institutions for solving information asymmetries between producers and consumers.

Uber stars vs. taxicab regulators, circa 1350.

Did guilds provide better training and certification?

While craft guilds often made apprenticeship and journeymanship compulsory— at least on paper—the extent of actual training sheds bleak light on the incentives of monopolistic professional associations with regard to human capital investment. Contemporaries often complained that guilds failed to penalize neglectful masters of apprentices, issued certificates to apprentices without examination, or granted mastership without training or examination to masters’ relatives and well-off youths who paid for “privileges” (La Force 1965; Kaplan 1981; Horn 2006).

Black-market “interlopers” who failed to obtain guild training—often, as in the case of women and Jews, because guilds excluded them—were vigorously opposed by guilds precisely because they had skills indistinguishable from those of guild members and were willingly hired by customers (Wiesner 2000; Ogilvie 2003, 2004b, 2007a; Hafter 2007; van den Heuvel 2007).

A good reminder that modern union's behavior - quick exclusion of minorities for example -- goes back a long way.

Technology? Did guilds, as professional organizations, help to spread information about new techniques?

How did guilds affect technological innovation? The most visible way in which guilds interacted with new techniques was when, as often happened, they opposed them. Many guild members thought there was a limited lump of labor to go around. Innovations that squeezed more output from existing inputs would flood markets  depress prices, and put guild masters out of work. As one fourteenth-century Catalan intellectual put it, “If a shoemaker comes along with new tools and makes 70 shoes in a day where others make 20 . . . that would be the ruin of 100 or 200 shoemakers.”

A lot of 20th century economists, commentators, politicians and "policy-makers" apparently believe the same thing.

Continuing,

Leiden distinguished itself from other cities by limiting or altogether banning textile guilds, yet its flourishing industries were at the forefront of technological innovation, introducing hundreds of new fabrics and a vast array of innovative methods and devices between 1580 and 1797 (Ogilvie 2007a; Davids 2008; Lis and Soly 2008). Within England, the mechanical innovations of the Industrial Revolution were introduced not in the guilded “borough” towns but in fast-growing centers such as Birmingham, Manchester, Leeds, Halifax, Sheffield, and Wolverhampton, which had no guilds (Clark and Slack 1976; Coleman 1977; Pollard 1997). 

Why did guilds die out?  Early in the paper, Ogilvie mentions competition from the unguilded countryside and abroad.  "Globalization" and competition do their work.  In the last section,

... current scholarship suggests a complex of factors that created a new equilibrium in which both the political authorities and the owners of industrial and commercial businesses gradually discovered they could do better for themselves by departing from the particularist path and beginning to use more generalized institutional mechanisms. These factors included stronger representative institutions (parliaments) that increasingly constrained how rulers could raise revenues and grant privileges to special interest-groups; a more highly diversified urban system in which towns did not act in concert, but rather competed and limited each other’s ability to secure privileges from the public authorities; a more variegated social structure including prosperous, articulate, and politically influential individuals who wanted to practice trade and industry and objected to its being monopolized by members of exclusive organizations; and governments that gradually made taxation more generalized and developed markets for public borrowing, reducing the attractiveness of short-term fiscal expedients such as selling privileges to special-interest groups (de Vries 1976; Lindberg 2008, 2010; Mokyr 2009; Ogilvie 2011; Gelderblom 2013; Ogilvie and Carus 2014).

A nice ending

The historical findings on guilds thus provide strong support for the view that institutions arise and survive for centuries not because they are efficient but because they serve the distributional interests of powerful groups. 

The trade of competition-stifling regulation for political support continues. The question is how many centuries will it take now, and what similar political and economic forces will undermine it.

Update:

In this (Nov 18) morning's Cato News Summary,

 According to a front-page analysis from Robert Pear of the New York Times (11/18, A1, Subscription Publication, 9.9M), titled “Health Law Turns Obama And Insurers Into Allies,” Obama “is depending more than ever on the insurance companies that five years ago he accused of padding profits and canceling coverage for the sick.” Pear says that since the passage of the Affordable Care Act, “the relationship between the Obama administration and insurers has evolved into a powerful, mutually beneficial partnership that has been a boon to the nation’s largest private health plans and led to a profitable surge in their Medicaid enrollment.” 

Who is afraid of a little deflation?

Who is afraid of a little deflation? Wall Street Journal Op-Ed.

Fears of "tipping" into deflation are overblown. I poke a little fun at sticky wages, Fed headroom, deflation-induced defaults and the long-predicted Keynesian deflationary spiral that never seems to happen, and the doom and gloom language from the ECB, IMF and other worriers who just happen to (of course) want to spend trillions to fix this latest "biggest economic problem."

One point that went by a little too quickly in the interest of space: Deflation can be a symptom of bad things. The issue is whether deflation is by itself a bad thing, and causes further damage.

Also, I should have been clearer on a big bottom line: we don't need huge "infrastructure" projects just to save us from deflation.  

They ask me not to post the whole thing for 30 days, so those of you without WSJ access will just have to google or wait breathlessly.

Update: Ed Leamer wrote a great similar piece for Economists' Voice a while back "Deflation Dread Disorder; 'The CPI is Falling!'"  In addition to a better title, he's got a cool Godzilla reference and picture.