Ariely’s The Honest Truth About Dishonesty

ArielyI rate the third of Dan Ariely’s books, The Honest Truth About Dishonesty: How We Lie to Everyone – Especially Ourselves, somewhere between his first two books.

One of the strengths of Ariely’s books is that he is largely writing about his own experiments, and not simply scraping through the same barrel as every other pop behavioural science author. The Honest Truth has a smaller back catalogue of experiments to draw from than Predictably Irrational, so it sometimes meanders in the same way as The Upside of Irrationality. But the thread that ties The Honest Truth together – how and why we cheat – and Ariely’s investigations into it gave those extended riffs more substance than the story telling that filled some parts of The Upside.

The basic story of the book is that we like to see ourselves as honest, but are quite willing and able to indulge in a small amount of cheating where we can rationalise it. This amount of cheating is quite flexible based on situational factors, such as what other people are doing, and is not purely the result of a cost-benefit calculation.

The experiment that crops up again and again through the book is a task to find numbers in a series of matrices. People then shred the answers before collecting payment based on how many the completed. Most people cheat a little, possibly because they can rationalise that they could have solved more, or had almost completed the next one. Few cheat to the maximum, even when it is clear they have the opportunity to do so.

For much of the first part of the book, Ariely frames his research against the Simple Model of Rational Crime (or ‘SMORC’) – where people do a rational cost-benefit analysis as to whether to commit the crime. He shows experiments where people don’t cheat to the maximum amount when they have no chance of being caught – almost no-one says that they solved all the puzzles (amusingly, a few say they solved 20 out of 20, but no-one says 18 or 19). And most people do not increase their level of cheating when the potential gains increase.

As Ariely works through the various experiments attempting to isolate parts of the SMORC and show they don’t hold, I never felt fully satisfied. It is always possible to see how people might rationally respond in a way that thwarts the experimental design.

For example, Ariely found that changes in the stake with no change in enforcement did not result in an increase in cheating. But if I am in an environment with more money, I might assume there is more monitoring and enforcement, even if I can’t see it. However, I believe Ariely is right in arguing that the decision is not a pure cost-benefit analysis.

One of the more interesting parts of the book concerned how increasing the degrees of separation from the monetary outcome increases cheating. Having people collect tokens, which could be later exchanged for cash, increased cheating. In that light, a decision to cheat in an area such as financial services, where the ultimate cost is cash but there are many degrees of separation (e.g. manipulating an interest rate benchmark which changes the price I get on a trade which affects my profit and loss which affects the size of my bonus), might not feel like cheating at all.

As is the case when I read any behavioural science book, the part that leaves me slightly cold is that I’m not sure I can trust some of the results. The recent replication failures involving priming and ego depletion – and both phenomena feature in the book – resulted in me taking some of the results with a grain of salt. How many will stand the test of time?

The Macrogenoeconomics of Comparative Development

Oded Galor has pointed me to his forthcoming article with Quamrul Ashraf in The Journal of Economic Literature.

The Macrogenoeconomics of Comparative Development

A vibrant literature has emerged in recent years to explore the influences of human evolution and the genetic composition of populations on the comparative economic performance of societies, highlighting the roles played by the Neolithic Revolution and the prehistoric “out of Africa” migration of anatomically modern humans in generating worldwide variations in the composition of genetic traits across populations. The recent attempt by Nicholas Wade’s “A Troublesome Inheritance: Genes, Race and Human History” to expose the evolutionary origins of comparative economic development to a wider audience provides an opportunity to review this important literature in the context of his theory.

A couple of paragraphs from the introduction:

Wade advances a modified evolutionary theory of long-run economic development, based on regional variation in the intensity of positive selection of traits that are conducive to growth-enhancing institutions. His theory suggests that variation in the duration of selective pressures on genetic traits across regions form the basis of differences in social behaviors across racial groups, thereby shaping variations in the nature of institutions and, thus, the level of economic development across the globe. Although at the outset, the broad outline of this argument appears plausible and largely consistent with existing evolutionary theories of comparative development, there is currently no compelling evidence for supporting the actual mechanisms proposed by Wade. …

The two fundamental building blocks of Wade’s theory are rather speculative. In particular, his narrative relies on unsubstantiated selection mechanisms and on empirically unsupported conjectures regarding the determinants of institutional variation across societies. … Rather than subjecting his hypothesized mechanism to the scrutiny of evolutionary growth theory, Wade follows the speculative supposition of Clark (2007), merely positing that in historically densely populated regions of the world that were characterized by early statehood, there existed a class of rich elites, endowed with genetic traits (e.g., nonviolence, cooperation, and thrift) conducive to growth-enhancing institutions, whose evolutionary advantage increased the prevalence of these favorable traits in the populations of those regions over time. It is far from evident, however, that the traits emphasized by Wade necessarily generated higher incomes in a Malthusian environment and were, thus, necessarily favored by the forces of natural selection. Moreover, Wade provides no evidence on how variations across societies in their geographical setting or historical experience could have given rise to differential selective pressures on these traits and, thus, generated variation in the growth-promoting genetic makeup of their populations. Furthermore, there is currently little scientific consensus on the extent to which the key behavioral traits of nonviolence, cooperation, and thrift, as emphasized by Wade’s theory, are genetically determined.

The second building block of Wade’s theory that links genetic traits to institutions is equally speculative. In particular, there is little evidence to support the claim that the variation in institutions across societies is driven by differences in their endowment of specific genetic traits that might govern key social behaviors.

Failure to replicate: ego depletion edition

Ego depletion is the idea that we have a limited supply of willpower. As we use it through the day, we become depleted and more likely to experience a willpower failure.

There is a mountain of published experiments providing evidence of ego depletion. Meta-analyses of the studies have supported the concept. The typical trick in these experiments is to get someone to engage in an ego depleting task – such as resisting chocolate – and then you watch them cave in more quickly on a later task than those who haven’t been subject to the earlier ego depletion.

But now the evidence is looking shaky. A pre-registered replication involving 23 labs and over 2,000 subjects will be published in Psychological Science. A smaller scale attempt to replicate was also published in PLOS One. The result? If there is any effect of ego depletion, it is close to zero.

Daniel Engber at Slate has the full story. One of the interesting points is how the meta-analysis didn’t show any problems:

To figure out what went wrong, Carter reviewed the 2010 meta-analysis—the study using data from 83 studies and 198 experiments. The closer he looked at the paper, though, the less he believed in its conclusions. First, the meta-analysis included only published studies, which meant the data would be subject to a standard bias in favor of positive results. Second, it included studies with contradictory or counterintuitive measures of self-control. One study, for example, suggested that depleted subjects would give more money to charity while another said depleted subjects would spend less time helping a stranger. When he and his adviser, Michael McCullough, reanalyzed the 2010 paper’s data using state-of-the-art analytic methods, they found no effect. For a second paper published last year, Carter and McCullough completed a second meta-analysis that included different studies, including 48 experiments that had never been published. Again, they found “very little evidence” of a real effect.

Roy Baumeister, one of the founders on this work on ego depletion, provided a response to Slate. It’s typical of many responses to this growing replication ‘crisis’ in psychology – suggest that those replicating the experiments haven’t captured all the experimental nuances, or that the effect is context specific.

In his lab, Baumeister told me, the letter e task [the task used in the replication] would have been handled differently. First, he’d train his subjects to pick out all the words containing e, until that became an ingrained habit. Only then would he add the second rule, about ignoring words with e’s and nearby vowels. That version of the task requires much more self-control, he says.

Second, he’d have his subjects do the task with pen and paper, instead of on a computer. It might take more self-control, he suggested, to withhold a gross movement of the arm than to stifle a tap of the finger on a keyboard.

If the replication showed us anything, Baumeister says, it’s that the field has gotten hung up on computer-based investigations. “In the olden days there was a craft to running an experiment. You worked with people, and got them into the right psychological state and then measured the consequences. There’s a wish now to have everything be automated so it can be done quickly and easily online.” These days, he continues, there’s less and less actual behavior in the science of behavior. “It’s just sitting at a computer and doing readings.”

Engber nicely points out the consequence of this line of defence. The big idea – and you only need to read Willpower to see that Baumeister and friends sell ego depletion as a big idea – loses its power:

One of the idea’s major selling points is its flexibility: Ego depletion applied not just to experiments involving chocolate chip cookies and radishes, but to those involving word games, conversations between white people and black people, decisions on whether to purchase soap, and even the behavior of dogs. In fact, the incredible range of the effect has often been cited in its favor. How could so many studies, performed in so many different ways, have all been wrong?

Yet now we know that ego depletion might be very fragile. It might be so sensitive to how a test is run that switching from a pen and paper to a keyboard and screen would be enough to make it disappear. If that’s the case, then why should we trust all those other variations on the theme? If that’s the case, then the Big Idea has shrunk to something very small.

Personally, I don’t believe that this is a case of experimental outcomes being subject to specific experimental context. Rather, the ‘experimental context’ is the ‘garden of forking paths‘, p-hacking and publication bias.

Notes on a few books

The Advertising Effect: How to Change Behaviour by Adam Ferrier

If you’ve read a couple of behavioural economics/behavioural science books, it doesn’t take long to become bored with hearing the same experiments and examples over and over again.

Ferrier manages to largely avoid that problem. He works in advertising, so has plenty of new stories to tell, and it’s interesting to hear how advertisers go about their job (and desperately try to win the beer accounts). It also helps that Ferrier is a trained psych, so he brings a bit more psychology to the task than you typically see in the pop behavioural science literature.

That said, when The Advertising Effect does stray into those familiar studies, you start to run into the problem that many of them aren’t standing the test of time particularly well (power posing being one example).

Digital Gold: Bitcoin and the Inside Story of the Misfits and Millionaires Trying to Reinvent Money by Nathaniel Popper

Even though this book is less than a year old, it already feels like it is missing a chapter or two at the end. Still, it’s an easy and entertaining history of Bitcoin.

Mine-Field: The Dark Side of Australia’s Resources Rush by Paul Cleary

As Cleary notes, “regulation is more focused on flora and fauna than on the people affected by mining end energy developments.”

Radical Chic and Mau-Mauing the Flak Catchers by Tom Wolfe

New York society throws a party to raise funds for the Black Panthers. Many great passages – here’s one instance:

One rule is that nostalgie de la boue – i.e., the styles of romantic, raw-vital, Low Rent primitives – are good; and middle class, whether black or white, is bad. Therefore, Radical Chic invariably favors radicals who seem primitive, exotic and romantic, such as the grape workers, who are not merely radical and ‘of the soil,’ but also Latin; the Panthers, with their leather pieces, Afros, shades, and shoot-outs; and the Red Indians, who, of course, had always seemed primitive, exotic and romantic. …

Rule No. 2 was that no matter what, one should always maintain a proper address, a proper scale of interior decoration, and servants. Servants, especially, were one of the last absolute dividing lines between those truly “in Society,” New or Old, and the great scuffling mass of middle-class strivers paying up to $1,250-a-month rent or buying expensive co-ops all over the East Side. …

In the era of Radical Chic, then, what a collision course was set between the absolute need for servants—and the fact that the servant was the absolute symbol of what the new movements, black or brown, were struggling against! How absolutely urgent, then, became the search for the only way out: white servants!

Crime and Punishment by Fyodor Dostoevsky (Richard Pevear and Larissa Volokhonsky translation)

Another classic well worth reading.

Masel’s Bypass Wall Street: A Biologist’s Guide to the Rat Race

Bypass Wall StreetTyler Cowen described Joanna Masel’s Bypass Wall Street: A Biologist’s Guide to the Rat Race as “Darwin plus Fred Hirsch on positional goods as applied to finance and portfolios. Unorthodox, interesting.”

I agree with Cowen’s description of the book as unorthodox and interesting, although I was looking forward to more Darwin and more of a biological lens. As the title of the book implies, it provides a biologist’s view on savings and investment, and Masel’s background as a biologist – she is Associate Professor of Ecology & Evolutionary Biology at the University of Arizona – has likely guided her as to what arguments she is sympathetic to.

But the examination is not on the face of it from a biological perspective. Only two biological arguments directly referenced. The first is the distinction between absolute and relative competition. Relative competition can lead to wasteful arms races that are, on net, destructive of value. The second is a brief pointer to the competition between siblings for their parents’ finite attention and resources. If you asked someone to read Masel’s book and Robert Frank’s The Darwin Economy and guess who is the economist and who is the biologist, they’d likely guess their occupations the wrong way around.

A stronger influence has been some of Masel’s reading in economics. In the preface, she points to two books to which she owes an intellectual debt – Keynes’s The General Theory of Employment, Interest and Money, and Fred Hirsch’s Social Limits to Growth. Her analysis of savings and investment rests heavily on Keynes, and Hirsch’s views on positional goods provides a hook for her biological intuition that competition can be wasteful and zero sum.

The main thread of the book is the journey of “Jen” (a thinly disguised Masel?) as she decides how she should invest for her retirement. Masel builds up the analysis from near first principles and works through a set of possible investment options. She asks whether Jen should invest in stocks? Which stocks? Index funds? What are the future prospects of the stock market? If returns are unlikely to be strong, what are the other options? Is there a way to tap into areas traditionally the domain of public investment, such as health and infrastructure? What of more unorthodox options? And so on.

I won’t go into detail about where Masel lands – in some ways the most compelling part of the book is wondering just where Jen will end up – except to say that I doubt many people are going to find much guidance relevant to themselves. There are some points along Jen’s journey where I’m not convinced I agree, but they mostly relate to the finer points of what exactly savings and investment are, how it flows, and the like.

There are many moments in the book where Masel channels arguments argued in detail elsewhere – even though there is no sign that Masel has read these other sources. She shares Tyler Cowen and Robert Gordon’s view that many of the big innovations are over as part of her view that the stock market may be overvalued (although she is closer to Gordon’s pessimism). There are also many times where I could hear Robert Frank talking out of the pages, with her views on relative competition and public investment reflecting those of Frank.

On that point, the book is quite reference light – something Masel admits was deliberately done to avoid it becoming a heavily footnoted academic tome. I have some sympathy for that, but there are occasions in the book where I was longing for Masel to put up complements or counterpoints to her thinking and to discuss them.

Despite the different paths to get there, Masel often lands on conclusions that I have a lot of sympathy for. For example, she points out the crudeness of regulation defining “sophisticated” investors based on income or assets – which limits investment options for those who don’t meet the threshold. A university lecturer, who has likely forsaken material income in their career choice, does not meet the threshold despite likely being much more sophisticated than others who do.

She also mounts a strong argument for setting retirement accounts free. Today’s poor need the money now. There are many vested interests keen to keep people’s money locked in retirement accounts because of the fees they can charge. (As an aside, in Australia you can self manage your compulsory retirement savings – you can’t access them before retirement, but you have effective control on the asset allocation and who takes a cut.)

One other argument I have sympathy for is the role of education as a signal. Education can become susceptible to arms races, leading to over-investment compared to that which would optimally be obtained absent the relative competition.

To close, I will suggest a short reading list for Masel. Maybe she has already read some of these, but I expect she will find a lot of material of interest.

Gottschall’s The Storytelling Animal

storytelling-animalIn The Storytelling Animal: How Stories Make Us Human, Jonathan Gottschall asks why we live and breathe stories. We are prolific storytellers. We consume movies, novels and plays. We even create stories in our sleep.

Gottschall’s argument is that our propensity to storytelling is an evolved trait that helps us navigate problems. He likens stories to flight simulators that prepare us for problems when they arise.

Here are snippets from two chapters. First, the idea that the mind is a storyteller – an idea common in Nassim Taleb’s writings:

[W]hile Sherlock Holmes stories are good fun, it pays to notice that Holmes’s method is ridiculous.

Take the risk story Holmes concocts after glancing at Watson in the lab [at the beginning of A Study in Scarlet]. Watson is dressed in ordinary civilian clothes. What gives him “the air of a military man”? Watson is not carrying his medical bag or wearing a stethoscope around his neck. What identifies him as “a gentleman of a medical type”? And why is Holmes so sure that Watson had just returned from Afghanistan rather than from one of many other dangerous tropical garrison where Britain, at the height of its empire, stationed troops? (Let’s ignore the fact that Afghanistan is not actually in the tropical band.) …

In short, Sherlock Holmes’s usual method is to fabricate the most confident and complete explanatory stories from the most ambiguous clues. Holmes seizes on one of a hundred different interpretations of a clue and arbitrarily insists that the interpretation is correct. This then becomes the basis for a multitude of similarly improbable interpretations that all add up to a neat, ingenious, and vanishingly improbable explanatory story. …

We each have a little Sherlock Holmes in our brain. His job is to “reason backwards” from what we can observe in the present and show what orderly series of causes led to particular effects. Evolution has given us an “inner Holmes” because the world really is full of stories (intrigues, plots, alliances, relationships of cause and effect), and it pays to detect them. …

But the storytelling mind is imperfect. … The storytelling mind is allergic to uncertainty, randomness and coincidence. It is addicted to meaning. If the storytelling mind cannot find meaningful patterns in the world, it will try to impose them. In short, the storytelling mind is a factory that churns out true stories when it can, but will manufacture lies when it can’t.

The second snippet relates to the fallibility of our memories in telling stories. Memories are open to contamination, and are fictionalisations of past events rather than perfectly recollections.

In a classic experiment, Elizabeth Loftus and her colleagues gathered information from independent sources about undergraduate students’ childhoods. The psychologists then brought students into the lab and went over lists of actual events in their lives. The lists were Trojan horses that hid a single lie: When the student was five years old, the psychologists claimed, he wandered away from his parents in a mall. His parents were frightened, and so was he. Eventually an old man reunited him with his parents. At first, the students had no memory of this fictional event. But when they were later called back into the lab and asked about the mall episode, 25 percent of them said they remembered it. These students not only recalled the bare events that the researchers had supplied, but they also added many vivid details of their own.

The study was among the first of many to show how shockingly vulnerable the memory system is to contamination by suggestion.

I have several “clear” childhood memories that I suspect did not occur. That doesn’t overly worry me, but what does is my recollection of papers and books that I regularly refer to in conversation. Each time I recall the paper or book, I affect my memory of it. More than once I have gone back to the original after several years to re-read it, and realised that, even if not wrong in fact, my recollection of the tone, nuance and strength of the argument was well off.

Having pulled out two snippets of storytelling gone wrong, the book is positive about the effect of storytelling on the world. Gottschall argues that storytelling is often deeply moral, normally deals with problems of great (evolutionary) relevance to us and is a major cohering force in society. And I tend to agree.

My first biology publication

For pitching in to help my PhD supervisor on a paper, I’ve scored my first biology publication:

Sperm use economy of honeybee (Apis mellifera) queens

Authors: Boris Baer, Jason Collins, Kristiina Maalaps, Susanne P. A. den Boer

The queens of eusocial ants, bees, and wasps only mate during a very brief period early in life to acquire and store a lifetime supply of sperm. As sperm cannot be replenished, queens have to be highly economic when using stored sperm to fertilize eggs, especially in species with large and long-lived colonies. However, queen fertility has not been studied in detail, so that we have little understanding of how economic sperm use is in different species, and whether queens are able to influence their sperm use. This is surprising given that sperm use is a key factor of eusocial life, as it determines the fecundity and longevity of queens and therefore colony fitness. We quantified the number of sperm that honeybee (Apis mellifera) queens use to fertilize eggs. We examined sperm use in naturally mated queens of different ages and in queens artificially inseminated with different volumes of semen. We found that queens are remarkably efficient and only use a median of 2 sperm per egg fertilization, with decreasing sperm use in older queens. The number of sperm in storage was always a significant predictor for the number of sperm used per fertilization, indicating that queens use a constant ratio of spermathecal fluid relative to total spermathecal volume of 2.364 × 10−6 to fertilize eggs. This allowed us to calculate a lifetime fecundity for honeybee queens of around 1,500,000 fertilized eggs. Our data provide the first empirical evidence that honeybee queens do not manipulate sperm use, and fertilization failures in worker-destined eggs are therefore honest signals that workers can use to time queen replacement, which is crucial for colony performance and fitness.

Gigerenzer on system one and system two

If you have read Daniel Kahneman’s Thinking, Fast and Slow, you will be familiar with the concepts of System One and System Two. Gerd Gigerenzer is not a fan of the dichotomy, with the below passage from an interesting interview by Justin Fox (the one over N heuristic Gigerenzer refers to is the heuristic to invest your money equally across your N options):

What is system one and system two? It’s a list of dichotomies. Heuristic versus calculated rationality, unconscious versus conscious, error-prone versus always right, and so on. Usually, science starts with these vague dichotomies and works out a precise model. This is the only case I know where one progresses in the other direction. We have had, and still have, precise models of heuristics, like one over N. And at the same time, we have precise models for so-called rational decision making, which are quite different: Bayesian, Neyman-Pearson, and so on. What the system one, system two story does, it lumps all of these things into two black boxes, and it’s happy just saying it’s system one, it’s system two. It can predict nothing. It can explain after the fact almost everything. I do not consider this progress.

The alignment of heuristic and unconscious is not true. Every heuristic can be used consciously or unconsciously. The alignment between heuristic and error-prone is also not true. So, what we need is to go back to precise models and ask ourselves, when is one over N a good idea, and when not? System one, system two doesn’t even ask this. It assumes that heuristics are always bad, or always second best.

Kay’s Other People’s Money

Other Peoples MoneyJohn Kay’s Other People’s Money is generally an excellent book. Kay argues that the growth in the size of the financial system hasn’t been matched by improvements in the allocation of capital. He proposes that financial services are not as profitable as some headline numbers would suggest. And he suggests that the replacement of  those who are good at meeting clients on the 19th hole with those who were good at solving complex mathematical problems was not always a good thing – sometimes clever people are the problem, particularly in a complex environment.

I highlighted a lot of passages through the book. Here is a small selection.

First, the chapter on risk in excellent – particularly its treatment of rationality. The point in the following paragraph is in some senses obvious, but often ignored:

If you don’t behave ‘rationally’, you can be ‘Dutch-booked’ – an offensive phrase (to the Dutch – the origins of the expression seem lost in the mists of time) which means that others can devise strategies that will make money at your expense. Many economists use this argument to insist that people do behave ‘rationally’ – behaviour that does not conform to the model will be abandoned because those who engage in it lose money. I used this reasoning myself with students. But I now see it differently. People do buy lottery tickets, week after week, and they do so for reasons that seem entirely valid to them. People don’t behave – for both good and bad reasons – in line with the economic model of rationality. In consequence others do devise strategies that make money at their expense. That consequence is critical to an understanding of how financial markets operate today.

One of the most interesting threads in the books is that many of the regulatory mantras are about the financial intermediaries, not the end users. The drives for transparency and liquidity in particular come in for criticism by Kay. First, the demand for transparency is a sign of the problem:

Transparency is the mantra in the modern world of finance. But the demand for transparency in intermediation is a sign that intermediation is working badly, not a means of making it work  well. A happy motorist is one who need never look under the car bonnet. A good lawyer manages our problem; a bad lawyer responds to every issue by asking us what we want to do. When ill, we look for a recommended course of action, not a detailed description of our ailments and a list of references to relevant medical texts.

And is this demand for transparency even desirable?

The primary objective of the Securities and Exchange Commission … was to increase the quality and quantity of information available to the public. The corollary was that trading should take place on the basis of that information alone.

The idea has superficial attractions and fundamental flaws. The framework of thought is frequently described through the sporting metaphor of ‘fairness’: the ‘level playing field’ on which all players compete on equal terms. To achieve fairness, a standard template of information should be provided to everyone, whether director of a company, investment banker or day trader with a home computer. Market participants may deal, and may only deal, on the basis of that information. No trader can have better information than any other, and success depends only on skill in interpreting it – or anticipating the interpretations of others.

Of course, this ‘level playing field’ is not achievable or achieved, and would not be desirable if it were to be achieved. Yet, like the regulators of casinos, the regulators of security markets often describe ‘market integrity’ as their objective; their focus is on the efficient functioning of the market, in a narrow technical sense that is concerned with process rather than outcome. The emphasis on the preoccupations of market participants rather than the interests of market users is deeply embedded in current thinking.

The effectiveness of financial intermediation in promoting efficient capital allocation depends on the quality of the information available to market participants. Regulation whose primary purpose is to encourage trading by ensuring no trader has an informational advantage actually gets in the ways of efficient capital allocation, in principle and in practice. Effective information and monitoring are best achieved – perhaps only achieved  – in the context of a trust relationship.

And on liquidity:

The need for extreme liquidity, the capacity to trade in volume (or, at least, to trade) every millisecond, is not a need transmitted to markets from the demands of the end-users of these markets but a need, or a perceived need, created by financial market participants themselves. People who applaud traders for providing liquidity to markets are often saying little more than that trading facilitates trading – an observation which is true, but of very little general interest.

Kay also has a subtle shot at the ability of governments to use interest rates to achieve policy outcomes:

Is it desirable for government and its agencies – which have sensibly extricated themselves from the business of controlling most prices – to manipulate interest rates, with a view to managing not just the banking system but the economy as a whole? Electricity is an essential element of the national infrastructure, used by every household and business. It is possible to imagine a government trying to manage the economy by controlling the supply and price of electricity – restraining booms by limiting the availability of new power stations and new connections, or by raising the price of electricity, and tackling recessions with low electricity prices and plentiful power.

I suspect most people would share my instinctive reaction that this approach would be an extremely bad idea – that the outcome would be inefficiency in the supply and use of electricity, and instability in economic growth. Is the intuition that seems relevant to electricity not equally relevant to the financial sector?

I think it is.

And finally, on the inevitability of crises:

The organisational sociologist Charles Perrow has studied the robustness and resilience of engineering systems in different contexts, such as nuclear power stations and marine accidents. Robustness and resilience require that individual components of the system are designed to high standards. … More significantly, resilience of individual components is not always necessary, and never sufficient, to achieve system stability. Failures in complex systems are inevitable, and no one can ever be confident of anticipating the full variety of interactions that will be involved.

Engineers responsible for interactively complex systems have learned that stability and resilience requires conscious and systematic simplification, modularity, which enables failures to be contained, and redundancy, which allows failed elements to be by-passed. None of these features – simplification, modularity, redundancy – characterised the financial system as it had developed in 2008. On the contrary, financialisation had greatly increased complexity, interaction and interdependence. Redundancy – as, for example, in holding capital above the regulatory minimum – was everywhere regarded as an indicator of inefficiency, not of strength.

Thiel’s Zero to One

Zero to oneI am sympathetic to many of Peter Thiel’s arguments in Zero to One: Notes on Startups, or How to Build the Future, but this is not a book where the arguments are buttressed with evidence to convince you they are true. Below are some random observations.

Thiel argues that competition is something a company should avoid. Competition erodes profits, so you want to be a monopoly. In some ways Thiel’s argument isn’t about avoiding competition, but a recommendation to compete in different spheres – competing to find the next monopoly, wealth, status, etc. It’s a recommendation to dream big – look for 10x improvements.

Thiel puts Apple and Google in this camp – they do what they do so much better than their competitors that they are effectively monopolies. In contrast, restaurants tend not be monopolies, with profits rapidly competed away. But this brings the exceptions to mind – the restaurant chains that explode in popularity – think Starbucks. Many businesses have done very well in competitive, commodotised markets. Were they 10x improvements? Is this an ex post justification where all extraordinarily successful businesses can be explained as 10x improvements?

A thread with which I have much sympathy is Thiel’s critique of education conformity (in fact, conformity in general). Through high school the ambitious build their CV to get into a top university. They then aspire to go into law, management consulting or finance. Are they happy competing on this treadmill?

I’m close to convinced that it would be a good thing if less bright people went to law, management consulting and finance (on the last, I’m reading John Kay’s Other People’s Money). But from the perspective of the student, I’m not sure the treadmill is a bad choice. It’s a pretty good payoff. And how many people diverge from this path, dream big and fail big? If society has a dysfunctioning structure – whether created by regulation or something else – why not take advantage of it?

This argument against conformity and the recommendation to compete in new ways is also a central thread in Malcolm Gladwell’s David and Goliath.

There are some sections of the book that didn’t work for me. In a chapter “You are not a lottery ticket”, Thiel disagrees with Malcolm Gladwell’s argument that luck is central to success (found in Outliers). Thiel quotes Warren Buffet’s statement that he is a “member of the lucky sperm club”, or Bill Gates’s suggestion that he “was lucky to be born with certain skills”, which at a level must be right. As Gladwell argues, if Gates was born anywhere but the small part of the US where he was born (with certain genes etc), it wouldn’t have panned out the same for him.

The only piece of evidence Thiel throws into the debate is the existence of serial entrepreneurs who have started multiple multimillion or billion dollar businesses. “If success were mostly a matter of luck, these kinds of serial entrepreneurs probably wouldn’t exist.” Thiel effectively ignores Gladwell’s central argument.

Following this, Thiel moves to classify people’s (and whole countries’ and continents’) perspectives on the future along two spectrums – optimism/pessimism and definite/indefinite. For example, a definite optimist (in Thiel’s mind, the US before the 1980s) believes the future will be better and that you can plan how you will get there. An indefinite optimist also believes the future will be better, but doesn’t know how it will be better so they don’t plan. Rather, they try to keep their options open (e.g. the resume building Ivy League generalist).

Thiel argues for definite optimism. Those who plan and don’t believe it is all down to luck will be the ones who create the future – who go from zero to one. Is Thiel arguing for the “growth mindset” – even if much of success is innate talent through genes etc, those who pretend success is wholly due to effort and plan accordingly will do better?

The argument is interesting, but I’m not sure it’s anything more than storytelling. Are Americans today really less “definite” about the future than people in the 1960s (e.g. is there any better evidence than stories about moon landings etc.)? The argument also made me think of this paragraph from Hayek:

This is not a dispute about whether planning is to be done or not. It is a dispute as to whether planning is to be done centrally, by one authority for the whole economic system, or is to be divided among many individuals.

Is it a problem if a nation is “indefinite” and doesn’t plan if its people are “definite” planners?