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Because I didn’t want to register with the UK government site on which Leigh Caldwell posted his ideas for behavioral analysis in the structure and deployment of services, I’ll comment here.
The rationale for Leigh’s wild and irresponsible proposals*:
While some behavioural interventions are being explored through the Cabinet Office’s Behavioural Insight Team (with some success) these tend to be relatively simple adjustments to framing of specific choices available to citizens. A deeper re-examination of the economic assumptions used in public service contracting and forecasting could lead to real improvements in outcomes and efficiency.
Some specific sectors that Leigh targets:
- Health care, where behavioral modelling of the consumption of health services may lead to more efficient deployment and use of resources.
- Education, where behavioral analysis could help bring incentives and signalling in line with cost savings in order to reduce spending while maintaining quality.
- Welfare and social security, where structuring incentives could help raise people out of poverty by building productivity, and encouraging formation of savings. Thus, reducing dependence on the state in the long run.
Now, I’m only a smidgen a behavior economist (having read varied works from the Santa Fe institute), but I’ve always been at least cautiously optimistic about the prospect of what Richard Thaler refers to as “libertarian paternalism“. Leigh is a crazy lefty*, but I trust that he believes in choice, and understands that choice is often not the problem in and of itself. Choice sets often are given various cognitive biases. Thus, choice architecture can preserve the ability of the individual to make a choice, but incentivize choices that are in the best interest of the decision maker.
I’m not too familiar with the first two categories Leigh lists, but I am broadly familiar with the third (which is the most “popular”). There are several ways in which the government could better structure incentives to produce superior long-run results, but I want to focus on one real-world example. The Oportunidades program,
an the anti-poverty program in Mexico. The program is centered around providing cash transfers that are linked to incentive goals:
Oportunidades is the principal anti-poverty program of the Mexican government. (The original name of the program was Progresa; the name was changed in 2002.) Oportunidades focuses on helping poor families in rural and urban communities invest in human capital—improving the education, health, and nutrition of their children—leading to the long-term improvement of their economic future and the consequent reduction of poverty in Mexico. By providing cash transfers to households (linked to regular school attendance and health clinic visits), the program also fulfills the aim of alleviating current poverty.
The Oportunidades program has by many measures been very successful in reducing extreme poverty in Mexico. In the long run, these types of behavioral-influenced programs can lead to considerable long-run gain in productivity, health, and personal finance.
I think that the British government would do well to invest in research of this type. While I doubt that behavioral economics will revolutionize the field of economics as a whole (at least until highly useful simulations are commonplace, right now we have variants of sugarscape and the game of life/prisoner’s dilemma), behavioral analysis can be extremely useful at the margin.
*Just kidding. I consider Leigh a good friend.
“If the coin be locked up in chests, it is the same thing with regard to prices, as if it were annihilated.” David Hume — Of Money
As I had stated before, as a matter of simple accounting, you make the math work out fairly easily to where consumption would have to fall a cumulative total of $84 million dollars. But introduce savings vehicles, which you can not assume away. How is this idle money being horded? There are a quite a few options, I’ll detail three:
Money Market Account: What if our idle millionaire holds his money in an MMA, earning (say) the 10yr Treasury rate of interest, which is then reinvested in Treasuries? The IRS takes his money, and the government spends it on goods and services. Does this reduce consumption future consumption while not affecting idle millionaire’s position? Yes-ish, but only to the extent that the risk-free real interest rate rises, and causes a fall in investment. You could get to a wash in this situation, though…if the government is investing the money at a higher ROI (i.e. it takes the money and invests in a project that cures all cancers with a single pill*).
An Index Fund: Now say our idle millionaire has his money in broad index fund, earing the average rate of return (5%), which is then reinvested back into the fund. The IRS takes his $84 million, and spends it. What the IRS has done here is to reduce the long-run stock of capital in the economy by some amount. IF the government can find a higher ROI than the entire basket of companies that idle millionaire held, then in the long run, there is no fall in consumption. However, that is a tall order, and unlikely to happen. Thus, I falls, and over a period C falls by ~G. Giving an answer that could be close to Landsburg’s result. This is because at the margin S ≘ I.
Mattress: Finally, lets say that our idle millionaire stuffs his mattress full of $84 million. His preference for sleeping on mattresses full of money non-withstanding, what our millionaire has done is reduce the stock of currency. This is the assumption that leads to the phrase “money is not wealth”. Indeed, money is not wealth! But the key is that our guy has already reduced long-run consumption by at least $84 million! This is because S ≠ I in this scenario. Hume explains this in the above quote. So, say the IRS steals his money, and simply keeps it in the mattress for IRS agent Joe to sleep on during lunch? The net effect is nothing happens, because consumption has already been reduced. What if the government spends it on stocks of a company which immediately goes bankrupt? Then society has lost. But if the government simply transfers $1 to 84 million people, then consumption will rise by…~$84 million.
However, this is not optimal. The optimal solution, given that the monetary authority is aware of our guy’s mattress, is to increase the money supply by $84 million. As Leigh Caldwell said in a Twitter conversation (the question was “What Would [Scott] Sumner Do?”):
@leighblue: well, I think he’d say that first the Fed should be printing a new $84m if it knows about the mattress; to be withdrawn when the guy takes his money out of the mattress. NGDP futures in theory would make this happen automatically.
In the real world, our millionaire, Mr. Kendrick, probably owns a basket of assets that includes Treasuries, stocks, corporate bonds, real assets, and currency. In the real world, the government may be hard pressed to tax Mr. Kendrick in a way that is welfare enhancing in the aggregate (even at less than full employment). Not saying that it couldn’t, just saying that it would be uphill battle.
P.S. I still firmly stand behind my “club goods” critique of this problem, although I’m assuming that Landsburg would disagree.
P.P.S. You can object that I’m overestimating the investment efficiency of the private sector over the public sector.
P.P.P.S. You’ll notice that I used investment above quite liberally. It is extremely hard to think of situations where the government is strictly consuming income, besides deadweight loss of transfer. It is also very hard to think of situations where individuals are strictly consuming income, which is a technical point that caused Garett Jones a lot of flack recently. Hence, money does not equal wealth.
The FINAL P.S. (I swear!): Paul Krugman posted a rebuttal to Landsburg’s problem that I think is misunderstood by many looking for contradictions (including my favorite blogger). PK’s hypothetical model assumes that government > no government. So if G is at 0, then any other state of affairs is welfare enhancing. Take your stand on the political spectrum on this one (mine is far to the…I guess right?…from Krugman’s, if you were wondering), but this is the model. The idea is that C (and I) in a world without a financed government would be drastically lower than C (and I) in a world where government steals Kendrick’s money, so by taxing Kendrick, the government (as an institution) is providing a higher level of C (and I) and would otherwise prevail under a situation where G = 0.
Extreme, I know. But the point is that government starts from the disadvantage of a priori deadweight loss. More realistically, you could say that government takes $84 million and invests in a technology which is capable of educating children and young adults much more efficiently than our current arrangement. As an aside, in this scenario, the Treasury issuing $84 million in new Treasury notes, and the Fed buying them with $84 million in newly minted currency would make this situation a wash.
Everyone knows – or thinks they know – that prices such as £1.99, £5.99 or £9.99 are optimal price points for retail goods. Customers read the first digit first, and the last two are ignored – or at least, they have much less cognitive impact. In general, consumers were thought to put a subjective value estimate of about ten per cent less on an item priced at £3.99, than one at £4.00.
This has been a fairly robust result in the past, and is intuitive for a number of reasons, “but WAIT!” say Leigh:
[And] the results were a surprise. At first we thought that the effect we have discovered was just a previously unnoticed artefact, hidden by the fact that no proper experiment has been published before. But after further exploration, we think it is also an effect of changing consumer preferences. As customers become more aware of marketing tactics and more cynical about any communication from companies, their psychology and behaviour inevitably changes.
So, to the results. The summary points are:
- Prices ending in .99 no longer have any advantage in consumer value perception, and do not lead to higher sales.
- The optimal penny value varies by country. In the United States, it is .01. So, instead of $3.99, companies should charge $4.01. In European countries, the optimal price point is different for different product categories, but there is a peak at .04 for many products. So, British or European retailers currently charging, say, £0.99 should increase the price to £1.04.
- By switching in this way to a “dollar-plus” price instead of “dollar-minus”, retailers can increase sales volume by an average of 8% and increase profit margins by 1-3% (depending on the exact price point).
- Consumers, when presented with the new price point, report an increased level of trust and affinity with the brands of the retailer and manufacturer. We believe this arises from the “honesty signal” that comes from abandoning a discredited and manipulative sales practice.
This is indeed very interesting, and I eagerly await reading the full study (which Leigh is offering as a pre-print!). Head over to Leigh’s blog for more rather counter-intuitive findings from his new research!
Update: If not a bit late, April fools!