Inequality, mental models, and counterfactuals

09/09/2013 § 4 Comments

In the recent book Inequality: A New Zealand Crisis, Jonathan Boston has a really useful chapter. It probably should have started the book as a way of laying some intellectual groundwork, instead of being Chapter 5. It raises the same point as Matt Nolan does at TVHE, quoting Amartya Sen, but with more detail. Here’s Boston:

As highlighted in this chapter, there is almost universal acceptance that equality matters. Yet there is no consensus on what kind of equality should be championed.

And here’s Nolan:

 Everyone, especially those who are more extreme in any given “political dimension” cares about equality of something – and the underlying reason why there are trade-offs stems from (as Sen discusses in the book) the heterogeneity of individuals!

Boston tries to cope with the different equality targets in two ways. First, he says that some equalities are more important than others, arguing that there is an inequality of equalities. With this, I believe he steps right back from his initial understanding — that reasonable people may reasonably disagree. Secondly, he suggests a certain pragmatism, or specific egalitarianism. While this seems attractive, it papers over the real conflict amongst theories of egalitarianisms with a poorly defined set of concrete goals.

In doing this, Boston shows how hard it really is to have evidence-based policies. When it comes time to make a decision, we have to take values and preferences into account. A particular set of evidence can be made to suit a range of policies, once you introduce different values. I’ve not read Peter Gluckman’s new report on evidence-based policies (pdf), but the reporting I’ve seen suggests that it is insufficiently attuned to this problem.

There is a second problem less well understood. When we make judgements about inequality, we are using mental models of social systems to create counterfactuals. For example, if one says, ‘they wouldn’t be poor if they weren’t lazy’, there is a mental model of society that underpins the judgement. That model has a weighting on ‘effort’, as well as weightings on other things like ‘education’, ‘social network’, ‘ethnicity’, ‘gender’, and more. The ‘effort’ weighting is sufficiently large to counteract any negatives from the other factors. We could, through interviews and surveys, estimate the parameters that people apply to those factors.

We all have these models. They are all wrong. I say that with conviction because ‘all models are wrong.’ They are always partial — they have missing variables — and the parameters are estimated from a sample of observations rather than the population. So, in my interpretation of my experience, it may be that ‘effort’ is sufficient to make a person not-poor. That doesn’t make it so, either for my experience (which suffers from observer error) or for the wider world.

In economic analysis, counterfactuals are hard to construct. You have to decide which factors are important and how important and over what time. If I’m being cynical, I might say that the counterfactual is the most important part of any cost-benefit analysis, and it is literally something we just make up. With data and evidence, mind you. But we make it up just the same.

How much harder is it, then, to understand the counterfactuals that people create from poorly-specified mental models of complex social systems?

More evidence would help, so it’s good to see Gluckman encouraging the government to find and use more. The findings will rarely be conclusive, however, as evidenced by Boston’s discussion of equality.

Inequality: I’m not yet convinced

29/07/2013 § 4 Comments

I have started the book Inequality: A New Zealand Crisis. It’s slow going but want to start teasing out my reactions, so I’ll review it piecemeal. Today, we’ll look at Part One, the introduction. My apologies at the start — this is long and somewhat rambling.

The reason it is slow going is that I’m having to weigh up each sentence. I think there are logical flaws, so the book doesn’t carry me along. I’m sure some readers will enjoy the outrage and devour the book — I’m not one of them.

A major premise of the introduction is that we are all worse off when inequality increases. They rely on Wilkinson and Pickett’s The Spirit Level for this argument, even reproducing a figure from the book (see here for my take on that book).  But they know themselves that this isn’t true. On page 17, we are told

We are all worse off for having wide income gaps in New Zealand.

On page 16, by contrast, the argument is

in countries with large concentrations of income, the wealthy can use their power to argue for policies that further their interests rather than those of the economy as a whole.

When you put these two statements together, the argument is that the wealthy are working against their own interests by arguing for policies that favour their interests. Obviously, this is illogical.

I also think it’s a tactical mistake. People working to lessen inequality are trying to get other people on board, to make equality politically popular. They are doing this by saying that equality is in everyone’s benefit. But this is simply not true, and obscures the fight they have on their hands.

(There is a similar retrospective argument going on over slavery in the United States during this sesquicentennial of the Civil War. One side says that slaveowners could have been bought out and everyone would have been better off. The other side argues that this wouldn’t have been possible.)

A second issue is that equality/inequality is a muddled concept throughout the Introduction. It seems to stand in for ‘things we don’t like’ rather than having an independent definition. This was quite striking with the second personal profile in the book. It’s a profile of a family with mum, dad and four children. They moved from Auckland to Whanganui, then mum lost her job and things got tight. But ‘tight’ is a relative term. For example, the family can afford some after-school activities but not all of them. Is that deprivation or not? Most important, though, is the notion of choice:

But even though she’d almost certainly get work in Auckland, Kristine doesn’t regret the move to Whanganui. ‘Being down here enables us to do so many more things for the children. We get a far better lifestyle here, with far more time together as a family.’

So how is this inequality? This family is choosing non-monetary rewards over monetary rewards and dealing with the consequences of that choice. They know they have other options and choose not to exercise them.

Another issue is that the statistical basis for the arguments is not consistent. Sometimes, the talk is of personal income, which includes all the superannuitants. We are told, for example, that 30% of individuals have incomes less than $15,000. In the very next paragraph, we move to a discussion of household incomes, which look much less dire (decile 1, single person, no children: $16,600 or less). Further on, the discussion moves to disposable incomes (after tax) for single households, but figures for the top 1% of those earners are given as pre-tax amounts because of data constraints. In essence, the number of people at the low end is inflated, and the incomes at the high end are inflated. It would have been better to work harder at a consistent measure of income to present a fair picture of the situation.

This kind of ‘worst case’ picture doesn’t stop with the incomes figures. For example, we are told that

this country has a relatively small earnings advantage to those with degrees.

As it happens, I know a little about this topic. The footnote (ftnt 66!) to the statement correct notes that the OECD has measured returns to tertiary education. However, that includes not only degrees but also sub-degree qualifications. The composition of New Zealand tertiary education (comparatively more sub-degree qualifications than other OECD countries) drags down our average return.

This statement about a small earnings advantage also shows the incoherence of the whole introduction. In a relatively equal society, we should have low returns to increased education. The premium should cover the time spent out of the workforce but not much else. Just because someone didn’t get an education is no reason for them to be disadvantaged in the workplace.

If this strikes you as a silly argument, that’s because you are thinking about productivity and economic efficiency. Clearly, the book recognises that some inequality is okay (degree holders should make more money), but too much is not. What I want is a clear statement about where they think that line is, and how they propose to measure it.

Book report: The Death of Economics

30/01/2012 Comments Off on Book report: The Death of Economics

Used book stores are odd. It is hard to get really good books, because people hold onto them. So, you get middling books, textbooks, and very common books. The economics section is usually quite grim: a volume of Galbraith, a 4th edition of Samuelson, and Atlas Shrugged.

It was in such a shop that I found The Death of Economics by Paul Ormerod. I’d heard his name in relation to Butterfly Economics, so I gave it a shot.

Here’s the quick summary: Ormerod overstates his case. A lot. The book is internally inconsistent, because he uses economic research to show that economic research is mistaken about economics. It is also inconsistent with the external world. My exhibit: yesterday’s FT blog by Martin Wolf. He describes a panel discussion on ‘The Future of Economics’, in which four very senior economists had criticisms and suggestions that were nearly identical to Ormerod’s. Maybe economics has an amazing capacity for renewal and reinvention, so that Ormerod’s criticisms of 20 years ago are now the received wisdom. Or, possibly, the situation was not so dire as he suggested in 1994. Neither explanation suggests a dying discipline.

On to the details. The first half of the book criticises mainstream economics, following a well-worn path. Classical economists were better because they were philosophers and political economists. The marginalists took a wrong turn by adopting a physics model for economics. In the 20th century, the focus on mathematical prowess turned economics inward and away from real life. In particular, the fiction of the rational individual has led us astray.

This is a selective reading of economics. As Ormerod himself explains, there have been many disagreements throughout these different eras. He counters the dangerous mainstream of economics by citing…other economists! For example, while discussing the problems with general equilibrium theory, he relies on work by von Neumann, Arrow, Lipsey, and Lancaster. Economic research doesn’t appear as blinkered as he would have us believe.

The second half of the book proposes new ideas, focusing on determinants of unemployment. There is some interesting stuff here. For example, he has graphs that suggest the rates of unemployment and inflation have a more consistent relationship than the levels. He also runs through some work on attractor points and the Lotka-Volterra system. His point is that an economy cycles around an equilibrium relationship between unemployment and inflation, but the specific equilibrium point can be shifted by external forces or social preferences.

In effect, Ormerod is saying that he has a better model. He favours a different set of variables (rates rather than levels) and a different mathematical expression (attractor points rather than linear regressions). Structurally, though, his argument is basic economics. A mathematical equation, properly specified, can describe human behaviour.

The last chapter reveals Ormerod’s real confusion. He forgets that economics comes in two flavours, micro and macro. Macro examines economy-wide indicators; its behavioural foundation can be rather thin. Micro is about rationality and its limits and what they imply. There have been attempts to bring them together, but the Grand Theory still escapes us. And this is, perhaps, his real criticism of economics:

Over the course of time, the system possesses many potential solution paths. Any actual path which is observed, from the myriad potential paths which could have been followed, will not correspond, except by the purest of coincidences, to the one which would have been chosen by the globally optimal maximising behaviour of ‘rational’ individuals. (p. 209)

Perhaps this is just a book of its time, 1994. Rational expectations theory hadn’t lived up to its promise in the 1980s. Unemployment was rising in Europe, Japan was in trouble, the US growth was low. Economists had new things to explain.

Perhaps, too, the biggest issue with the book is its title. Economics, even the mainstream general equilibrium theory Ormerod so heavily criticises, has not died. But then, Some Suggestions for Improving Economic Theory probably wouldn’t have sold as many copies.

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