Some major contagions have nothing to do with you-know-what

It’s a long weekend so, though we’re barred from enjoying it in the usual way, let’s at least forget the V-word. How about a quiz?

Let’s say the government is preparing for the outbreak of an unusual disease (no, not that kind of disease) that, should we take no action, is expected to kill 600 people. The government could act to combat the disease in either of two ways.

If program A is adopted, 200 people will be saved. If program B is adopted, there’s a one-third chance that 600 people will be saved, and a two-thirds chance that no one will be saved. Which one would you choose?

If you chose A, congradulations. You’re in good company. When this psychology experiment is run, about 72 per cent of subjects favour A and only 28 per cent favour B.

But then the government consults the epidemiologists. Their advice is: forget A and B, and consider program C or program D. If C is adopted, 400 people will die. If program D is adopted, there’s a one-third chance no one will die and a two-thirds chance that 600 will die. Which one would you choose?

If you chose D, more applause. In laboratory experiments, that’s what 78 per cent of subjects choose, leaving only 22 per cent choosing C.

But if you look at the four options again you find that program A and program C are the same. Under A, 200 out of 600 are saved; under C, 400 out of 600 die. It’s just that A highlights the positive, whereas C highlights the negative.

That 72 per cent of subjects favoured A, but only 22 per cent favoured C tells that most of us instinctively favour the safer, more certain outcome. Program B, remember, contained a two-thirds chance that no one would be saved. This instinctive preference confirms economists’ conventional assumption that most people are “risk-averse”.

But a closer look also reveals that program B and program D are the same. Program B offers a one-third chance that 600 people will be saved and a two-thirds chance that no one will be saved, whereas program D offers a one-third chance no one will die and a two-thirds chance that 600 will die.

(If you can’t see that, remember that, in probability theory, the expected outcome is the possible outcome multiplied by the probability of it happening. So B is ⅓(600) + ⅔(0) = 200. And D is ⅓(600) + ⅔(0) = 200.)

But if options B and D are the same thing expressed in different ways, how come the experiments show only 28 per cent of subjects choosing B, but 78 per cent choosing D? It’s because, relative to option C, which offered only the certainty that 400 people would die, option D offered a one-third chance that no one would die, and most subjects thought that was a risk worth taking.

This shows that, while it’s generally true that most people are risk-averse, as conventional economics assumes, a more powerful human characteristic – which conventional economics ignores – is that most of us are “loss-averse”.

A key insight of behavioural economics is that we hate losing something much more than we love gaining something of the same value. So much so that, surprisingly, we’re willing to run risks to avoid any loss.

If you hadn’t noticed, when you look closely you see that all four options offered the same “expected value”: 200 people saved, 400 lost. If everyone had realised this at the time, they should have been equally divided between the options.

Why were we so sure that A and C were much more attractive that B and D? Well, one possibility is that most of us aren’t much good at maths. But the more important explanation is that we are heavily influenced by the way a proposition is presented to us – by the way it’s “framed”, as psychologists say. The same proposition can be packaged in a way we find attractive or repellent.

This, too, is a truth that conventional economics knows nothing of, but behavioural economics – the school of economic thought that uses psychology to throw light on economic issues – has brought to economists’ attention.

Putting it differently, the choices we make are heavily influenced by the context in which we make them. This is one of the key arguments advanced by Robert Frank, an economics professor at Cornell University, is his new book, Under the Influence.

Frank notes that standard economic theory says the spending decisions we make depend only on our incomes and relative prices. People’s assessments of their needs and wants are assumed to be completely independent of the spending decisions of others around them.

But this too is where the assumptions of standard theory are unrealistic. In real life, the things we buy and do are often heavily influenced by the “context” of what our friends are buying and doing.

We wear the clothes we think are fashionable, and we judge what’s fashionable by what our friends are wearing. The best way to predict whether a young person will take up smoking is whether their friends smoke.

We have an impulse to conform – which is stronger than we often realise. That’s why we can’t resist buying toilet paper when others are grabbing it, or selling our shares when others are quitting the market.

Psychologists call this phenomenon “behavioural contagion” – our tendency to mimic the behaviour of others. When some things start to become popular, they often become very popular. Same if they start becoming unpopular.

Frank notes that our tendency to copy what others are doing can have positive consequences (as when people exercise more because their friends are doing it) or negative consequences (as when we drink heavily because the people we live with are).

He argues that economists ought to be more conscious of behavioural contagion because of the opportunities they present for governments to use taxation to encourage us to make better choices.

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The local school is in decline, reducing social cohesion

I love living in my suburb. I shop locally, just so I can run across friends and neighbours on a Saturday morning, and be greeted with a smile – even a name – by shopkeepers who know me.

I figure the best ways to get to know people in your suburb is to own a dog – you get to talk to other dog-owners as you stand around in the local park – and send your kids to the local school. You can't help getting to know the other parents in your kids' classes.

But all that was some years ago, and times change. The local school isn't the institution it used to be.

Perhaps it won't surprise you to be told that, over the years, our capital cities have become more stratified, with a greater tendency for better-off people to live in better-off suburbs – the ones with water and views and, these days, those closest to the centre – and for the less well-off to live in less well-off suburbs far from the centre.

This is most true of Sydney, then Melbourne – which is catching up with Sydney in size – but less true of the other capitals.

But maybe this will surprise: something similar is happening to our schools, particularly secondary schools.

We have a widening divide between the schools attended by the offspring of better-educated, better-off parents, and those attended by, well, the not so well educated and paid.

This is happening partly in consequence of the increasing stratification of suburbs, but also because of the education policies pursued by federal and state governments.

Unlike almost all other rich economies, Australia runs three school systems rather than one.

This array has tempted us to treat school as though it was a market, where government, Catholic and independent schools compete for youthful customers, thus providing parents with greater choice and obliging government schools to lift their game.

John Howard was big on choice. Julia Gillard left Howard's pro-choice funding arrangements running until Labor's last year, while emphasising competition between schools.

She introduced the NAPLAN testing of literacy and numeracy and, to ensure parents were well-informed before making their choice, she introduced the My School website, loaded with detailed information about every school.

We got a lot of choice, but no improvement in measured performance. Moral: schools aren't a market.

One benefit, however, is that researchers can collate the My School data to give us a much clearer picture of what's happening to our schools. Leaders in this research are two retired high school principals, Chris Bonnor and Bernie Shepherd.

Everyone knows there's been a decades-long drift of students from government to non-government schools.

What our not-so-retired principals have discovered, however, is that this has masked a big shift from schools with low socio-educational advantage to those with high socio-educational advantage. (A school's socio-educational advantage is rated largely according to the socio-economic status of its students.)

My School shows that, over the five years to 2015, average enrolments at all schools grew by more than five students a year. But enrolments at schools with high socio-educational advantage grew by an average of 11 students a year, whereas enrolments at disadvantaged schools grew by just more than one student a year.

When choosing schools, many of us think of a hierarchy of excellence – in teaching and results – running from government to Catholic to independent. But that's just what you see on the packet. (Echoed by the prices of the packets.)

Studies estimate that 78 per cent of the variance in the performance of schools is explained by differences in their socio-educational advantage – that is, by the socio-economic status of their students.

Independent schools tend to get good exam results because most of their students come from well-educated families. Catholic schools get better results than you might expect because the days when their classrooms were full of working class kids are long gone.

You'd expect this to mean public schools increasingly full of disadvantaged kids getting poor results. True, but they retain a higher proportion of advantaged students than you'd expect.

Why? Partly because public schools in posh suburbs still have lots of smart kids, but mainly because – particularly in Sydney and, to a lesser extent, Melbourne – state authorities have responded to the demand for greater "choice" by creating more selective schools.

But this means greater stratification on the basis of socio-economic status even within the government system, coming at the expense of disadvantaged government schools.

Choice, however, isn't available to all parents. To have a choice you need either brains or money (which usually comes with brains attached).

The vogue for choice has also allowed greater stratification of students on the basis of religion. These days, Jewish kids go to Jewish schools, Muslim kids go to Muslim schools and Baptist and Pentecostal kids go to "Christian" schools.

Trouble is, high socio-educational advantage schools aren't always located in high-status suburbs. So these days, a lot more traffic congestion is caused by a lot more students and parents travelling longer distances to and from school.

Leading to the decline of the local school. Less than a third of schools now have an enrolment that resembles the people in their local area.

Sounds a great way to reduce the nation's social cohesion.

What did the rich kid say to the poor kid? Nothing. They never met.

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CAN OLD ECONOMISTS LEARN NEW TRICKS?

Public Lecture in Economic and Social Policy, University of Wollongong, Friday, October 19, 2007

I could today say something terribly polite and complimentary about economics, but instead I want to keep you awake by saying something a little thought provoking and challenging to the economic orthodoxy, influenced by some of the reading Ive been doing lately, particularly a most interesting book by Avner Offer, a professor of economic history at Oxford, called The Challenge of Affluence.

As many of you know, the overriding goal of conventional economics – specifically, microeconomics – is to help the community deal with the problem of scarcity – the fact that the physical resources available to us are finite, whereas our wants are infinite. Theres any amount of goods and services wed like to consume, but the wherewithal to produce those goods and services is strictly limited. So micro economists see their role as to advise the community on ways to stretch those limited resources further, to help us get more bang for our buck. This explains economists obsession with efficiency, because its by using resources more efficiently that we can stretch them further. Economists seek to promote more efficiency in the sense of greater economy in the use of resources, the reduction of waste and the discovery of better ways to do things, but also in the sense of more efficiently allocating resources to that particular combination of goods and services the community values most highly. If you think about the push for microeconomic reform that weve seen economists successfully urging on governments for the past 25 years, its been all about using increased efficiency to raise the communitys material standard of living.

But Offer and others have advanced an interesting proposition: that the developed market economies attack on the problem of scarcity over the time since the industrial revolution has been so remarkably successful that weve actually defeated the problem of scarcity and replaced it with a different problem, the problem of abundance. Now, technically, for an economist to say that a resource is scarce is merely to say that it can only be obtained by paying a price, that its not so abundantly available as to be free. Clearly, in that technical sense, the problem of scarcity is still with us.

But, in the broader sense, its hard to deny that the citizens of the developed world live lives of great abundance. Our material standard of living has doubled or trebled since 1950 and has multiplied many times over since the start of the industrial revolution in the mid-1700s. No one in the developed world is fighting for subsistence; even the relatively poor among us are doing well compared with the poor of Asia or Africa; we satisfied our basic needs for food, clothing and shelter a mighty long time ago; our real incomes grow by a percent or two almost every year, and each year we move a little higher on the hog. Our greater affluence can be seen in our ability to limit the size of our families, in the growth in the size and opulence of our homes, the fancy foreign cars we drive, our clothes, the private schools we send our children to, the restaurants we eat in and the plasma TVs, DVDs, video recorders, personal computers, mobile phones, stereo systems, movie cameras, play stations and myriad other gadgets our homes teem with.

How has this unprecedented and widespread affluence come about? Its the product of the success of the market system and even of the sound advice of the economists in identifying ways to fine-tune that system. But above all its the product of all the technological advance – the invention and innovation – the capitalist system is so good at encouraging. Malthuss dismal prediction in the late 1700s that the growth in the population would outrun the growth in food production was soon disproved.

It's therefore reasonable to say that, when we look around us, what we see is not scarcity but abundance. This is something to be celebrated. But, as with everything in life, no blessing is unalloyed. Every good thing has its drawbacks and difficulties. The first and most obvious problem with abundance is the damage the huge expansion in human activity – most of it economic activity – is doing to the natural environment. For millennia, the environment was so vast and economic activity so limited that it was easy to see the environment and the economy as completely divorced. Air and water and fish in the sea were in such abundance that economic analysis could class them as free goods and promptly ignore them. By now, however, the huge expansion in economic activity has started to overwhelm the environment. We see that everywhere around us: air pollution in cities, widespread over-fishing and the destruction of species, waste discharges leading to the degradation of waterways and beaches, the damage caused by European farming methods, the near drying up of some of our river systems, the opening of the hole in the ozone layer and, of course, global warming. All these environmental concerns are the product of the abundance of human and economic activity, a concern that didnt exist when our major concern was scarcity – our then limited success in overcoming natures impediments to the satisfaction of wants.

The next but less obvious problem with abundance is that it exacerbates humankinds difficulty achieving self-control. Thanks to their assumption of rationality, this is a problem that simply doesnt register on the conventional economists radar. You and I are assumed to know exactly what we want, to always want whats in our best interests, to have a clear idea of what the future holds, to have no difficulty balancing short-term benefits against long-term costs, and to have an iron will in being able to choose and stick to what we judge to be best for us in the long run.

In truth – and as the psychologists have demonstrated – humans have a big problem with self-control. Consider the simple example Offer quotes of the student trying to decide whether to go out tonight and have fun with her friends, or to stay home and study. To make the right decision, she must know her own preferences, and how they rank; must be confident that if she chooses to go out, she will not regret it tomorrow morning. She must know the payoffs for academic distinction, that she will like them, that she will be around to have them, that the world will have a use for her skills, that her vision of the future will not change, that some completely unforeseen factor or event will not sideline her prudent choice. In short, were always facing choices where the benefits are clear and immediate, whereas the costs are uncertain and distant. The greatest problem is our willpower to defer gratification, but its compounded by uncertainty about our own preferences and about what the future holds.

Problems of self-control are ubiquitous to daily life. The one were most conscious of these days is the temptation to eat too much. But there are many more: to get too little exercise, to smoke, to drink too much, to watch too much television, to gamble too much, to shop too much, to save too little and put too much on your credit card, to work too much at the expense of your family and other relationships.

The more stuff we have – the fewer among us whose main problem remains satisfying our basic needs – the more problems of self-control emerge as our dominant concern. But theres a deeper point: humans have never been good at self-control, but as long as we were poor and resources were scarce, our self-control problem was naturally held in check. Its when things become abundant, when we can afford to indulge so many more of our whims, when we have a huge range of things or activities to choose from, that self-control problems become more prevalent and we have trouble making ourselves choose those options that are best for us in the longer term, not just immediately gratifying.

Its worth asking a question economists dont ask because their model assumes it away: why do humans have such trouble controlling their emotional urges and behaving in a more thoughtful, far-sighted way? I think the answer lies in our evolution, specifically in the way our brains have evolved. Our brains evolved to cope with the problem of scarcity, not abundance. The older, more primitive part of our brain – the part that deals with the fight or flight response, for instance – has evolved to make an instantaneous, emotional response to cues without waiting for more information or for more evaluation of options. Its the newer, more cerebral part of our brain that cuts in later with a more careful analysis of the choices and the longer-term implications. This is the neurological dimension of the problem of abundance and it explains why its common for psychologists and others to speak of humans as having two selves: our present-self and our future-self. This is the essence of the self-control problem: finding ways to allow our future-self to have more wins over our present-self.

The highly topical and worrying problem of obesity provides an excellent example of the way the move from scarcity to abundance has exacerbated self-control problems. Humans evolved in conditions where nutrition was scarce. Our brains are therefore hardwired to eat everything that comes our way while weve got the chance, and theyre are surprisingly poor at signalling to us when weve had enough. For as long as food remained scarce – that is, relatively expensive – and work remained highly physical, there wasnt a problem. But as we triumphed over scarcity the former natural balance was lost. Technological advances in the growing, transport, storage, preservation and cooking of food greatly reduced its cost to consumers. As humans have become more time-poor, weve seen an explosion in inexpensive fast food, all of it cunningly laced with those three ingredients our brains were evolved to crave: fat, sugar and salt. Then, on the output side, weve seen technological advance strip the physical labour first out of work and then out of leisure. We dont play sport, we watch it being played and these days we dont even go to the effort of travelling to the grounds.

There's a third aspect to the problems of abundance: the increased resources devoted to the socially pointless pursuit of social status through consumption. When we have long passed the point where our basic needs for food, clothing and shelter are being satisfied, but our real incomes continue to grow by a couple of percent a year, we have to find something to do with the extra money. Partly, we spend it on superior goods – goods you want more of as you get richer – such as health and education. Thats fine. But a fair bit of the extra income is spent on positional goods – goods whose purchase is designed to demonstrate to the world our superior position in the pecking order. Everyone needs a car, but that need can be met quite adequately by a 10-year-old Toyota. When we feel we must buy a new car every few years, or when we buy an expensive imported European car, the extra we pay is commonly motivated by a conscious or unconscious desire to impress people and so constitutes a positional good. The fields in which we can use our spending to demonstrate our high social status are legion: the size, opulence and desirable location of our homes is probably the most significant instance, but theres also the clothes we wear, the clothes we put on our children, the restaurants we visit, the cars we drive, the schools we send our kids to and much else. The point here is that, from the viewpoint of the community rather than the individual, the pursuit of status is a zero-sum game: the gains of those individuals who manage to advance themselves in the pecking order are offset by the loss of status suffered by those they pass. Thus a perpetual status arms-race is socially pointless. From the perspective of society, a lot of resources are simply wasted.

So thats the case for believing that, at this late stage in our development, the problem of scarcity has been superseded by the problem abundance. This has happened without the economics profession noticing. And should the profession fail to take notice, it will go on urging on our political leaders policies that make things worse rather than better. If Im right then the economists hitherto single-minded pursuit of efficiency is inadequate at best and damaging at worst. Economists will need to add more strings to their bow, learn some new tricks. But which new tricks?

The first point to make is that, while economists have a major – perhaps the major – contribution to make in fashioning policies to reduce the conflict between economic activity and the natural environment, this is the exception to the new rule: here, their conventional approach of using greater efficiency to fight scarcity remains appropriate. The trick is that, while its the abundance of economic activity and greenhouse gas emissions that are doing so much damage to the environment, its still best to define the problem as the scarcity of water and the scarcity of low-emission-intensive goods and services. Internalising the externalities to the prices of goods and services by means of economic instruments such as pollution taxes and tradable permit schemes is the best way to achieve environmental goals with minimum economic disruption.

In the main, however, to contribute to solving the problem of abundance economists need to learn the new trick of helping people cope with their self-control problems. People know they have trouble controlling themselves, trouble allowing their future-selves to dominate their present-selves and so avoid myopic choices. The way they do this is by developing commitment strategies and commitment devices. Economists must, first, understand the need for and accept the legitimacy of commitment devices and, second, become expert in the development of such devices. This will require a small revolution in their thinking.

Commitment devices come at three levels. First, the restrictions individuals choose to impose on their own behaviour. Second, the restrictions the members of groups choose to impose on themselves by submission to group norms of acceptable behaviour. Third, the restrictions governments impose on us to remove temptation from our paths. Economists will have trouble coming to terms with each of the three levels. With self-imposed commitment devices, conventionally trained economists are tempted to regard them as irrational behaviour. I may try to limit my consumption of ice cream by keeping only one small serve in the fridge. Should I want to eat more than Ive pre-decided should be my daily limit, I have to go the shop and get it. Technically, this behaviour is inefficient and irrational: its cheaper and easier to by ice cream in bigger quantities.

With group-imposed behavioural norms, conventional economists often arent conscious of their existence or dont appreciate their value until some economic upheaval destroys them. Increased competitive pressures, for instance, can cause a breakdown in professional standards of behaviour towards clients.

With government-imposed restrictions, conventional economists assumption that individuals behave rationally – that is, always in their own best interests – leads them to disapprove of many government interventions. How could governments know better than individuals what was in those individuals best interests? Why not leave people free to choose for themselves? Short answer: because individuals know they have trouble controlling themselves and would appreciate government taking temptation out of their way. In practice, we see any amount of often quite punitive government intervention aimed at protecting both the individual and the community from the consequences of speeding on the road, excessive drinking, smoking, air and water pollution, drug use, gambling, usury and much else. Its notable that most of these impositions on our freedom were introduced without great opposition and today are quite uncontroversial. Prohibition of smoking in pubs is a recent example. Why do we accept these restrictions so readily? Because we – and the politicians who impose them – know they help us control our more myopic selves.

If economists are to help the community deal with the problem of abundance by assisting us to control ourselves theyll need to develop greater awareness and respect for group behavioural norms and also see the value the rest of us see in government-imposed solutions to our self-control difficulties. There is probably scope for a lot more carefully judged intervention, appalling though that may sound to libertarians. One obvious candidate, relevant to the obesity epidemic and more, is greater controls over advertising. Will the day come when economists are designing and advocating such interventions rather than opposing them? Psychologists know something economists dont: that rather than it taking a change in attitudes to bring about a change in behaviour, if you can use intervention to force a change in behaviour, people will then change their attitudes to fit.

As well as such coercive interventions there are less intrusive ways governments and others can change behaviour merely by changing the way choices are framed. For instance, in encouraging employees to join voluntary saving schemes, automatically enrolling them but permitting them to opt out will be far more successful than inviting them to opt in. Economists can master these behavioural tricks.

The remaining domain of self-control for us to consider is individuals imposing their own commitment devices on themselves. In his book Mindless Eating, the Cornell psychologist Brian Wansink writes that the 19th century has been called the Century of Hygiene and the 20th century the Century of Medicine. This century, he predicts, will be the Century of Behavioural Change.

Changing your personal behaviour isnt easy, but it is possible. It involves adopting better habits, which eventually become part of our unconscious selves and so become lasting. In The Happiness Hypothesis, the psychologist Jonathan Haidt says that trying to control yourself is like riding an elephant. The elephant has a mind of its own and cant just be ordered to obey. It can, however, be carefully trained and cajoled into more desirable ways.

There is work to be done here in researching the use of personal commitment devices and in educating the public about the usefulness of this approach and the effectiveness of particular devices. It maybe that this is more a role for psychologists than economists, but that really brings me to the pointy end of this lecture: will economists simply go on fighting the last war – the war against scarcity in which efficiency is the sole objective – or can they learn new tricks and help us cope with the new problem of abundance, a problem where the solutions often involve some loss of efficiency? If they cant, they may find their dominance in the provision of public policy advice being usurped by interlopers from the newer science of psychology.


AUSTRALIA’S POLITICAL AND ECONOMIC OUTLOOK 2008

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