OVER the past few weeks, I've been reflecting on my field, and asking myself the question that every economically literate person tortures themselves with:
But is it efficient?
For those of you who have no background in Economics ,let me briefly explain what I am talking about. According to the “efficient market hypothesis” (EMH), financial markets incorporate and reflect information quickly enough that investors cannot consistently outperform the market (unless they have information not known to the market, which may raise different issues under insider trading laws). Numerous academic studies support this conclusion, particularly showing that actively managed mutual funds do not outperform the market (after accounting for expenses) in any consistent way. Accordingly, a corollary of EMH is that investors are generally better off investing in vehicles that try to replicate a broad market (such as index funds) rather than trying to use individual judgment in trying to outperform the market.
Now,a similar approach may be advisable in the field of economic punditry. Let’s presuppose that the two main goals of any aspiring economic pundit are to be (a) correct and (b) quoted. (I will leave it as an excercise for the reader to guess which one is the primary goal, which one the secondary.) It seems that a pundit who changes his or her opinions as reactions to economic events runs the same risk as an investor trying to keep up with the market: unlikely to “outperform” the market of economic pundits. The best way to ensure being correct at least some of the time may be to simply always follow a consistent approach in economic commentary. Given that the business cycle has not yet been repealed, either consistent optimism or pessimism will be correct at least some of the time. Once the commentary matches up with the business cycle, the pundit’s reputation should be made – at least enough to ensure a permanent placement on journalists’ lists of people to call for a quote to support or balance a story.
While this method should equally apply to consistent optimistic or pessimistic commentary, the competition is probably fiercer on the optimistic side (cf. the mass of stock-pushers on CNBC at any given time). A strategy of consistent pessimism is thus probably the most efficient way to achieve success in the field of economic punditry.* (But do not assess the value of this strategy based on the dismal economic news of recent weeks.)
*The best example of this strategy is probably Henry Kaufman, former senior economist at Salomon Brothers whose consistent pessimism throughout the 1970s was regularly borne out by events, thus earning him the nickname “Dr. Doom” (together with his equally pessimistic counterpart at First Boston, Albert Wojnilower, who was dubbed “Dr. Gloom”) and a permanent designation as a source of pessimistic quotes whenever one was needed to balance out a story, notwithstanding the fact that Mr. Kaufman’s pessimism was rarely borne out by events for almost two decades thereafter. More recently, Stephen Roach of Morgan Stanley rarely had a good word to say about the economy throughout the expansion of the late 1990s and the inflation of the technology bubble, and he generally has not become more optimistic since the bursting of that bubble. The heir to Messrs. Kaufman and Roach for this economic cycle may be Nouriel Roubini, whose commentary seems carefully calibrated to avoid any hint that economic disaster may be avoidable.
Thursday, May 15, 2008
Sunday, May 11, 2008
No Free Lunch
WHILE out to lunch this weekend, I noticed a note at the bottom of the menu:
“We add a 15% gratuity to every bill, you are welcome to subtract or add more”
Restaurant patrons were being defaulted into tipping with an opt-out clause. Though I found it far more offensive when I leaned that my lunch companion’s employer defaults her into charitable giving. Her firm automatically subtracts a fraction of her salary and uses the proceeds to donate to several charities of its choice. She can opt out, but most employees do not. She claims few will have the audacity to say to HR, “I don’t want to give to charity.”
We often find ourselves defaulted into many things, such as our choice of power company. But actually taking money out of our pockets by default strikes me as especially presumptuous. The default option has become popular amongst policy makers and employers to induce desirable behaviour. The 2006 US Pension Protection Act gives employers incentives to automatically enrol their employees in a pension plan. Automatic pension enrolment substantially increases participation. Most economists agree the default enrolment, when it comes to saving, is beneficial. Many people need to save more if they want a comfortable retirement. They may not save as much as they should because time inconsistent preferences, procrastination, or they just feel over-whelmed by planning for retirement. Defaulting people into a pension plan facilitates a decision in the employees’ best interest, a decision they might not otherwise make. If they feel strongly about not participating, they can easily opt out.
However, defaulting employees into charitable giving makes my libertarian sensibilities uneasy. Giving to charity is a wonderful thing and has many externalities for the firm in terms of being a stronger presence in the business and social community. Employees may even indirectly benefit from it. But there seems something, well tacky, about automatically taking money from your employees and giving it in the firm’s name.
You can argue defaulting into a pension plan serves the employees’ interest and is not completely inconsistent with their preferences. I am not sure how neatly this rational applies to philanthropy. Also opting out of charitable giving carries a social stigma, which means employees feel pressured to donate even if they don’t want to.
If there does exist a benefit to encouraging executives to donate more to charity, it would be better to have employees opt in to giving. Perhaps give employees an explicit option to donate from their pre-tax income. Employees could even choose amongst a list of causes the firm supports. This would facilitate giving and the employees and firm still reap the tax and community benefits.
Default behaviour is a strong tool. Using it to elicit any behaviour we define as desirable, be it tipping wait staff, saving, or philanthropy becomes a slippery slope. All the more reason we should use it sparingly.
“We add a 15% gratuity to every bill, you are welcome to subtract or add more”
Restaurant patrons were being defaulted into tipping with an opt-out clause. Though I found it far more offensive when I leaned that my lunch companion’s employer defaults her into charitable giving. Her firm automatically subtracts a fraction of her salary and uses the proceeds to donate to several charities of its choice. She can opt out, but most employees do not. She claims few will have the audacity to say to HR, “I don’t want to give to charity.”
We often find ourselves defaulted into many things, such as our choice of power company. But actually taking money out of our pockets by default strikes me as especially presumptuous. The default option has become popular amongst policy makers and employers to induce desirable behaviour. The 2006 US Pension Protection Act gives employers incentives to automatically enrol their employees in a pension plan. Automatic pension enrolment substantially increases participation. Most economists agree the default enrolment, when it comes to saving, is beneficial. Many people need to save more if they want a comfortable retirement. They may not save as much as they should because time inconsistent preferences, procrastination, or they just feel over-whelmed by planning for retirement. Defaulting people into a pension plan facilitates a decision in the employees’ best interest, a decision they might not otherwise make. If they feel strongly about not participating, they can easily opt out.
However, defaulting employees into charitable giving makes my libertarian sensibilities uneasy. Giving to charity is a wonderful thing and has many externalities for the firm in terms of being a stronger presence in the business and social community. Employees may even indirectly benefit from it. But there seems something, well tacky, about automatically taking money from your employees and giving it in the firm’s name.
You can argue defaulting into a pension plan serves the employees’ interest and is not completely inconsistent with their preferences. I am not sure how neatly this rational applies to philanthropy. Also opting out of charitable giving carries a social stigma, which means employees feel pressured to donate even if they don’t want to.
If there does exist a benefit to encouraging executives to donate more to charity, it would be better to have employees opt in to giving. Perhaps give employees an explicit option to donate from their pre-tax income. Employees could even choose amongst a list of causes the firm supports. This would facilitate giving and the employees and firm still reap the tax and community benefits.
Default behaviour is a strong tool. Using it to elicit any behaviour we define as desirable, be it tipping wait staff, saving, or philanthropy becomes a slippery slope. All the more reason we should use it sparingly.
Time Inconsistency Problem
I friend of mine send me this:
I RECENTLY overheard an interesting conversation between two co-workers. After a female economist returned from a sun-filled holiday a male colleague (also an economist) remarked, “You look much hotter tan.”
She thanked him, but noted the decision to tan may suffer from time inconsistency. “A tan marginally increases your attractiveness now, but you will regret it in twenty years when your skin looks like leather. One day I will look back and think: why did I bother? I looked fine tan or pale in my youth. You fool yourself tanning now and thinking you won’t care about the consequences in the future.”
He argued the value of looking your best when young is greater than the value of looking better when old. Beautiful women attract more suitors. Thus, looking great now improves a woman’s marriage prospects. The dividends of which will pay off for the rest of her life (securing the necessary botox). He suspected her discount rate is too low.
She countered as you get older the marriage market become more competitive for women, all the more reason to maintain a smooth complexion. Also vanity does not diminish as you age.
No complement between two economists goes unpunished.
I RECENTLY overheard an interesting conversation between two co-workers. After a female economist returned from a sun-filled holiday a male colleague (also an economist) remarked, “You look much hotter tan.”
She thanked him, but noted the decision to tan may suffer from time inconsistency. “A tan marginally increases your attractiveness now, but you will regret it in twenty years when your skin looks like leather. One day I will look back and think: why did I bother? I looked fine tan or pale in my youth. You fool yourself tanning now and thinking you won’t care about the consequences in the future.”
He argued the value of looking your best when young is greater than the value of looking better when old. Beautiful women attract more suitors. Thus, looking great now improves a woman’s marriage prospects. The dividends of which will pay off for the rest of her life (securing the necessary botox). He suspected her discount rate is too low.
She countered as you get older the marriage market become more competitive for women, all the more reason to maintain a smooth complexion. Also vanity does not diminish as you age.
No complement between two economists goes unpunished.
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