Shorten's New Year's resolution: practice what I preach

People are always complaining that our politicians – on both sides – are "out of touch". They're too high and mighty to understand the things that are annoying ordinary people in ordinary life.

This is a big part of the reason almost one person in four voted for a minor party in last year's election. The political establishment just doesn't get it.

But one of our pollies does claim to have got the message. Wading through all the usual guff in the start-of-the-year speech Bill Shorten gave last week, I came upon a passage so surprising I thought it worth recording.

"Restoring ... faith in the system is the threshold challenge for politics today. Rusted-on supporters and deep tribal loyalties are not what they once were," he said.

"There is one certainty in 2017: people are disengaged from politics and they're distrustful of politicians.

"To many Australians the political system is broken – and more than a few don't trust us to fix it.

"I say 'us' because virtually everyone in this room [at the National Press Club] is considered part of the problem, part of the political class.

"Rightly or wrongly, fairly or unfairly, we are seen as members of the same insider club, letting down the rest of Australia.

"This sense of alienation isn't a local curiosity – it's a global phenomenon. Strong enough to take Britain out of Europe – and put Donald Trump in the White House.

"And in these unusual times, politics-as-usual doesn't cut it any more.

"Yes, we are an adversarial democracy, built on the clash of ideas – I honour that. My job, as Leader of the Opposition, is to oppose what I believe is wrong. My job ... is to put positive ideas forward.

"But this year I am going to remind myself as often as possible: people first, politics last. I can't guarantee I'll always get that right – but I'm certainly going to try.

"Because Australians are sick to their core of the petty schoolyard bickering, he-said she-said, the tit-for-tat.

"They're not opposed to genuine debate about the future – but they are over the smallness of so much of the national political conversation ...

"Mind you, that counts for nothing if [scandals over politicians' expense claims make] people think we are acting in our own interests, instead of theirs."

Wow. But this column is no free ad for Team Shorten. I wanted to record it because it was so true, but also to help the man stick to his New Year's resolution.

Actually, it shouldn't surprise that Shorten "gets" all that. Our politicians aren't "out of touch" because that's why their parties (and sometimes, we taxpayers) spend thousands every year conducting focus groups with ordinary voters.

I bet that some of the phrases Shorten used were lifted straight from Labor's market research. Someone in the group blurts out some pithy opinion, everyone else says "Yeah, that's right!" and the researcher writes it down for future use.

As the "political class" knows, the punters love having their own opinions fed back to them. I'd also bet that both parties' rival researchers tell them much the same things about what voters like and dislike.

But if the pollies know how much we hate the way they carry on, why do they keep doing it?

Because some of the things they do still work, even though we hate them. Because they want to win the next election at all cost, and so are willing to do things that bring them immediate advantage, even though they add to the long-term fouling of the collective political nest.

Because many of the unconvincing things they say are intended to shore up the faith of the party faithful, not persuade the rest of us.

Because both sides are afraid that if they're the first to stop behaving badly, the other side will wipe the floor with them. Economists call this a "collective action problem", which can only be fixed by some outside authority imposing a solution on both sides.

Back to Shorten's resolution. It would certainly be a big change to Labor's behaviour since its success at last year's election left Malcolm Turnbull with such a tiny majority.

Labor has followed a sneaky strategy of giving the appearance of co-operation and positivity while quietly seizing opportunities to frustrate the government's program, making it look impotent and unstable.

To keep same-sex marriage alive as an issue for the next election, it has blocked Turnbull's plebiscite, using the excuse that the gay community wanted to avoid the risk of an abusive debate.

Were it less self-interested it would have advised gays that few great social advances come without pain, and that failing to take advantage of the public's present mood of approval risked having to wait many years for what they want so badly.

Just to make life hard for the government, Labor has ignored its principles and sided with Liberal dissidents and rich superannuants claiming Turnbull's super reforms were "retrospective" and sided with asset-rich oldies opposing Turnbull's reform of the age pension means test.

And now, it seems, Labor's preparing to side with elite private schools objecting to the government redirecting some of their lolly to more needy students.

What were you saying about voters being sick of rival politicians playing tit-for-tat, Bill?

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Competition does have its drawbacks

Competition is billed by economists as a wonderful thing, the invisible restrainer of a capitalist economy and essential to ensuring consumers get a good deal.

But many economists aren't as conscious as they should be that competition has costs as well as benefits.

It's true, of course, that monopoly is usually a terrible thing, allowing arrogant, inflexible behaviour on the part of producers, with little pressure on them to keep prices down or to provide much choice. Dealing with government departments shows you what monopolies are like.

Economists tend to assume the more competition the better and that customers can never get too much choice. But this shows how – despite their loud protestations to the contrary – their thinking is excessively influenced by their most basic, least realistic model of "perfect competition".

Psychological experiments show that when shoppers face too much choice, they tend to avoid making a decision. That's because the information they need to make informed choices isn't freely available and because the human mind hasn't evolved to be good at choosing between more than two items with differing characteristics.

Many real-world markets are characterised by oligopoly: a few large firms accounting for most of the sales. Oligopolies make economic sense because they're needed to fully exploit economies of scale (which are assumed away under perfect competition). So, in reality, competition and scale economies are in conflict.

In oligopolies and even in markets with a relatively large number of producers, competition is blunted by product differentiation, much of which is cosmetic. As with most advertising, product differentiation is intended to induce consumers to make decisions on an emotional rather than rational basis.

Phoney differentiation is also intended to frustrate rational comparison. It's not by chance that it's almost impossible to compare mobile phone contracts.

When economists speak of competition, they're usually thinking of competition on price. But though oligopolists watch their competitors like hawks, they much prefer to avoid price competition, competing rather via advertising, marketing, packaging and other differentiation.

Mackay's Law of competition states that the key to competition is to focus on the customer, not your competitor. But this is what oligopolists don't do.

In the real world – including the media – competitor-oriented competition is rife. This robs customers of genuine choice. It's a form of risk aversion: if I do the same as my competitor, I minimise the risk of him beating me.

It's what, in Harold Hotelling's classic example, prompts two ice-cream sellers to be back-to-back in the middle of the beach, regardless of whether some other positioning would serve customers better. It explains why business economists' forecasts tend to cluster, usually around the official forecast.

In his book The Darwin Economy, Robert Frank, of Cornell University, argues that lefties tend to see inadequate competition as the most prevalent form of market failure, whereas it's actually "collective action problems".

A collective action problem arises when the players in a market realise they're doing something mutually destructive, but no one's game to stop doing it for fear of being creamed by their competitors.

Usually in commercial markets the only answer is for the government to intervene and impose a solution on all players; for which they're grateful.

However, that's no help to our political parties, which have got themselves locked in a game of ever-declining standards of behaviour they don't know how to escape from. It's collective action problems that make it so easy for the politicians to manipulate the media.

The advocates of federalism believe it's good to have the states free to be different and competing against each other. In reality, the competition is mainly negative. The states compete to attract foreign investors with special tax concessions and the foreigners play them off against each other.

In the early 1970s, the McMahon government transferred its payroll tax to the states to give them the "growth tax" they needed to cover their growing spending. In the decades since then, they've done little but compete with the others by raising their tax-free thresholds and cutting their rates.

The huge increase in federal grants to private schools over recent decades was justified as increasing parents' choice and imposing competitive pressure on public schools. There's little evidence it's worked, nor much even that it's held down private school fees.

Similarly, Julia Gillard's My School website, with all its information about the academic performance of particular schools, intended to increase competition between them, has failed to produce any increase in the proportion of students achieving national minimum standards in reading, writing and numeracy over the five years to 2014.

Depending on circumstances, competition can make things better or worse – or little different.

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Herd behaviour, fashion and status seeking

Think for more than a moment about the causes of the global financial crisis - the fallout from which is still hurting the US and Europe - and you realise herd behaviour had a lot to do with it.

People paid extraordinarily high prices for houses because they felt they were trailing the Joneses. Brokers sold unsound mortgages because they had to keep up with rival brokers. Funds managers - remunerated according to their relative performance against other managers - traded shares with the same motive.

So, the study of herd behaviour must be a pretty important part of economics, right? Wrong. Between 1970 and the onset of the crisis only nine out of 11,500 articles in three esteemed economic journals discussed herd behaviour. And when they did discuss it they usually viewed it as "informational learning" - learning what I should do from your behaviour. If you hear a fire bell and see people running for the exit, you don't inquire further, you just join them.

Yeah, sure. That explains it. Fortunately, one economist who's taken a great interest in herding is Professor Andrew Oswald, of the University of Warwick, in Britain, and the IZA research institute, in Bonn. Oswald spoke about herd behaviour and keeping up with the Joneses at a conference this week to celebrate the contribution of Professor Ian McDonald, of Melbourne University.

Unlike his peers, Oswald has spent his career crossing the boundaries between economics and the other social sciences. Now he's forging links with the physical sciences and is on the board of editors of the journal Science.

On herding, Oswald took his lead from a seminal zoological paper written in 1971. "Before that article, the standard theory in biology was that herds had some inexplicable communitarian instinct," Oswald says. But the article argued that an animal clusters with others because its relative position is what matters. When you're being threatened by a predator, clustering with others reduces the chance it will pick you as its prey.

What has this to do with humans? Just our preoccupation with our position relative to others. Our desire to be in fashion - to wear what our peers are wearing - is motivated subconsciously by our strong desire to keep up.

And falling back worries us because it involves dropping down the status ladder. So, our often demonstrated desire to do what other people are doing seems to show a deep, though unconscious, concern to defend or advance our status (or rank) relative to others.

Economists have long been suspicious of survey evidence, of asking people what they think about things or why they do things. It's too subjective; how can you be sure they're telling you the truth? This is one of the profession's reservations about the study of happiness (of which Oswald has been a leader among economists).

So, Oswald has been interested in finding more objective ways to measure feelings such as happiness. When I compare your rating of your satisfaction with life with your spouse's or your friend's rating of your satisfaction, do they line up? (Yes, they do.)

He's done a lot of work using the British medical profession's system for rating people's mental health, rather than just asking people how they feel about their lives.

Another approach is to use magnetic resonance imaging (MRI scanning) to see what happens inside people's brains when they have certain feelings or encounter certain ideas.

Yet another approach Oswald is pursuing is the use of "biomarkers": can changes in a person's physiology - their heart rate or blood pressure, say - tell us about what they're thinking and feeling?

Oswald quotes the results of a study by German economists who put pairs of people in adjacent brain scanners and asked them puzzle questions, with money rewards for correct answers. They found that outperforming the other guy had a positive effect on the reward-related parts of the brain. People compare themselves with others and enjoy feeling they're winning.

You reckon that's pretty obvious? Not to an economist. Their standard model assumes away all interpersonal comparison. My likes and dislikes ("preferences") are unaffected by other people's preferences and never change over time.

Raise my income by $10 and my satisfaction ("utility") increases. Raise my income by

$20 and there's a commensurately greater increase in my utility. Raise my income by

$10 while you increase my mate's income by $20 and I won't mind a bit.

Actually, we know from happiness research that relative income (how my income compares with yours) has a big effect on how satisfied people feel with their lives.

Oswald asks whether our satisfaction from social status accelerates or decelerates as we increase in status. That is, does our pursuit of status bring increasing marginal utility or decreasing marginal utility?

This question is still being researched empirically. Oswald quotes the case of top tennis players. The gain in utility from going from being third in the world to second is likely to be much bigger than the gain from going from eighth to seventh.

But increasing marginal utility is probably limited to the very top of the status ladder, with diminishing utility applying to most of us.

We know, for instance, that though people with high incomes are happier than those with low incomes successive increases in income buy progressively smaller and smaller increases in satisfaction with life.

Another thing we know is that the rising average real incomes the developed economies have achieved over the decades haven't led to any increase in average levels of satisfaction.

This raises what Oswald calls a "disturbing possibility". "Maybe modern society is stuck," he says. "Individually, we chase higher income and 'rank', but for society as a whole this cannot be achieved."

Here's another worry: "Herd behaviour is often very natural and individually rational. But it has the potential to be disastrous for the group," he says.

"When rewards depend on your relative position it will routinely be dangerous to question whether the whole group's activity is flawed, and be rational simply to compete hard within the rules that govern success."

In the dotcom bubble a decade ago - where the shares of internet companies that had never made a dollar of profit traded for ever more ridiculous prices - those analysts who said it made no sense got fired.

"In financial markets, people are now routinely rewarded in a way that depends on their relative performance" - whether they're in the top quartile, second quartile or whatever. "That's dangerous," he concludes.

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A little regulation brings out the best for all of us

Ask economists who is the father of economics and almost all of them will say Adam Smith. But a new book makes the amazing claim the true father is Charles Darwin. And if you ask economists the question in 100 years' time, that's what they'll say.

The book is The Darwin Economy, by Robert Frank, professor of economics at Cornell University.

Smith was the Scottish moral philosopher, who published his most famous work, The Wealth of Nations, on the eve of the industrial revolution in 1776 (just a few years after Captain Cook visited Botany Bay).

Among all his insights about how the economy works, the one for which he gets most credit is the "invisible hand". This is the notion that impersonal market forces channel the behaviour of greedy individuals to produce the greatest good for all.

Why does a business owner go to the trouble of designing a new product that consumers are likely to find appealing? Why does he invest such effort to revamp his production process to reduce costs? Simply to make more money - as many people realised before Smith.

What they didn't see was the response those actions would provoke from rival business owners, and how the ensuing dynamic - the invisible hand - would produce outcomes very different from those intended, Frank says.

If one producer comes up with a cheaper way of manufacturing a product, he can cut his price slightly and steal market share from his rivals. In the short run, his profits soar, just as he'd hoped. But the loss of market share by rival firms gives their owners a powerful incentive to mimic the original innovation.

And once the innovation spreads industry-wide, the resulting competition drives the product's price down to a level just sufficient to cover the new, lower production costs. The ultimate beneficiaries of all this are consumers, who enjoy steadily improved products at ever-lower prices.

There's much truth to this and it does much to explain why the market system has raised our material standard of living so far over the past 200 years.

So why does Frank then think economists will come to see Darwin as the true father of economics rather than Smith? Because Darwin's study of the natural world led him to a deeper insight about the often flawed nature of competition.

Although Smith was careful not to claim it, many economists (and many libertarians) have taken his invisible hand to mean that regulation of markets is unnecessary and undesirable because unbridled market forces can take care of things quite nicely on their own.

In fact, Smith was well aware that unregulated markets didn't always produce the best outcomes. For the most part, however, he imagined market failure to be the result of inadequate competition. Firms would find some way to nobble their competitors and overcharge their customers.

Critics on the left have long focused on anti-competitive behaviour as the key to understanding why markets fail. But they (and Smith) are missing an important point.

"Darwin's view of the competitive process was fundamentally different," Frank says. "His observations persuaded him that the interests of individual animals were often profoundly in conflict with the broader interests of their own species."

Consider the outsized antlers of bull elk. These antlers function as weapons not against predators but in the competition among bulls for females. Since the bull with the biggest antlers gets to mate with the females, while the others don't, the process of natural selections has given male elk ever-bigger antlers.

But big antlers are a big disadvantage when elk are being preyed on, making them more likely to be killed and eaten by wolves. So what's in the interests of the individual bull is actually contrary to the interests of the group.

While no individual bull would want to be disadvantaged by having smaller antlers than the others, all the bulls would be better off if all of them had the width of their antlers narrowed by, say, half a metre (which would leave the relative size of their antlers unchanged).

You can tell the same story about peacocks' tails, huge elephant seals and many other animals that compete to be the sexual top dog. They all suffer a "collective action problem" - they're locked in a kind of arms race from which no individual can escape, even though all individuals realise how costly the race is. The only solution to the individuals' problem is for the animals - human animals - to act collectively. For them all to agree on a truce - a strategic arms limitation treaty, so to speak - or for some external authority, such as a government, to impose a solution on all of them. All would benefit from such an imposition so, contrary to the assumption of the libertarians, all are likely to welcome it.

The Nobel-prize-winning American economist, Thomas Schelling, quotes the case of ice-hockey players. When helmet-wearing is voluntary, no one is prepared to suffer the small competitive disadvantage of wearing one. But, since helmets do increase safety, all players would vote to make them compulsory.

Frank argues that for competition to give rise to collective action problems - wasteful arms races, if you like - is more the rule than the exception. Why? Because in many important areas of life, performance is "graded on the curve". It's not your absolute score that matters, it's your relative score - that is, where you rank in the comp.

"The dependence of reward on rank eliminates any presumption of harmony between individual and collective interests," Franks says, "and with it, the foundation of the libertarian's case for a completely unfettered market system."

Frank says since individual humans' reproductive success has always depended first and foremost on "relative resource holdings" - which males look the best physical specimens and the best providers; which females look the best child-bearers and homemakers - it would be astonishing if the evolved brain didn't care deeply about relative position.

Hence the tendency as we become ever-more affluent for a growing share of our income to be spent on "positional goods" - that is goods or services which, as well as doing whatever it is they are supposed to do, also signal to the world by their expensiveness our superior position in the pecking order.

Frank concludes that the real reason we regulate markets is to protect ourselves from the consequences of excessive competition.

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