The Folly of Wellbeing in Public Policy

The idea that Government policy should focus more on promoting wellbeing has been gaining support. Proponents of this view argue that happiness indicators have stagnated over decades because, they argue, governments have paid too much attention to maximizing a materially-based measure of economic welfare, Gross Domestic Product, rather than a more holistic indicator based on happiness.  This premise is clearly false.   Economics has undoubtedly been important in post-war political life, but it has not always been a decisive factor in determining the outcome of elections. Clinton’s Party lost the election in 2000 despite years of prosperity, Margaret Thatcher led the tories to re-election in 1983 despite the 1980-82 recession, and Tony Blair overwhelmingly defeated the Conservatives in 1997 after several years of strong economic growth. The fact is politicians do exhibit concerns over a wide range of issues where GDP is not the immediate focus.  For instance immigration and crime are two very live issues that no serious politician can afford to ignore. Yes, economics and economic policy matters to voters, but so do other issues, and it is wholly misleading to suggest that policy is focused solely on the maximization of GDP.    GDP as a concept has been criticized as it does not capture wider social and environmental costs and benefits within a society.  But the simple fact is that GDP was never intended to include them in the first place.  The purpose was to measure the value of the output of an economy, as far as possible using market based prices to do so. The question of measuring non-market output is conceptually different to that of happiness and well-being, but it is often confused with them in practice.  Namely:  Should we, and if so how, extend the concept of GDP to include more ‘non-market’ factors?   A wide range of adjustments to the basic measure of GDP have been suggested, such as weighting income by the degree of inequality, deducting the value of ‘bads’ such as time spent commuting, valuing work in the house, and so on.    However, the wellbeing movement goes far beyond tinkering with what is and what is not included in GDP. It suggests replacing it altogether with a measure which purports to describe not the material prosperity of a population, but its happiness.   Surveys on the levels of happiness reported by individuals have been carried out over a few decades in most Western countries. In general there is no apparent trend to be found, either up or down. Over the same period, average material standards of living (GDP per head) have shown a clear upward trend. This seems to support the old maxim ‘money does not buy you happiness’! The fact that measured happiness has not increased over decades is viewed by some commentators as indicating a flaw in our society which must be corrected through government intervention.  Indeed the lack of correlation between happiness and GDP is indicative of a similar non-trend across many other variables: expenditure, life expectancy, racial and gender inequality.  This suggests that attempting to improve the human lot through any policy – not just through pursuing economic growth - is entirely futile. Alternatively, we could conclude that happiness data over time shows little movement because it does not have much meaning.   When happiness is measured, people are asked to register their level of happiness on a scale of n categories (e.g. 1 = ‘not happy’, 2 = ‘fairly happy’ or 3 = ‘very happy’). Discrete categories mean that people have to undergo large discrete change in their happiness in order for this to be registered by the indicator so noticeable changes in average happiness can only come about through substantial numbers of people moving category. Furthermore the happiness data can exhibit no indefinite trend; in answering a survey in which levels of happiness are measured on an n-point scale, the data is therefore bounded between one and n. In contrast, at least as it is presently defined, real GNP can exhibit no upper bound.    More subtle recent work is in fact suggesting that there is a clear and positive connection between life satisfaction and income, and that there appears to be no cut-off point to this.  In a paper published in 2010 in the Proceedings of the National Academy of Science Daniel Kahneman and Angus Deaton distinguished two aspects of well-being.  First, life satisfaction, defined as the thoughts which people have about their life when they think about it.  Second, emotional well-being, which refers to the emotional quality of an individual’s everyday experience, the frequency and intensity of emotions such as joy, anger, sadness. The results of Khaneman and Deaton are striking.  Life satisfaction is unequivocally related in a positive way to income, but emotional well-being is not. In these recent studies, GDP does therefore appear to continue to have wider value as an indicator of a successful society, over and above its direct purpose of measuring material prosperity.   Despite such recent developments happiness advocates continue to insist that a single measure of happiness should be the only way of evaluating policy and progress. The problem is not merely that this lobby wants to replace GDP with a happiness index, it is the belief that by measuring happiness, it then becomes subject to prediction and control by policy makers. Of course, the fact that economics has made little or no progress in its ability to predict and control the macro economy might be seen to suggest that same fate awaits the happiness index and its devotees.  It is simply not possible to obtain systematically reliable predictions of aggregate happiness indices, any more than it is for GDP. We cannot predict with accuracy the next shake of a true dice, and neither can we do so for happiness.    Indeed, government attempts to increase measured happiness, rather than making life better for us, may well actually do the opposite: create arbitrary objectives which divert civil service. energies from core responsibilities; give many people the message that happiness emanates from national policy rather than our own efforts; and create pressure for Government to appear to increase an indicator which has never before shifted systematically in response to any policy or socio-economic change.   These are exactly the mistakes of the target-driven mentality which has come to pervade the British public sector.  We should learn from these rather than replicate them.   By Paul Ormerod. Read Paul’s full chapter on the subject in the recent IEA publication …and the Pursuit of Happiness available here.

Recessions as Collective Action Problems

In a blog on Keynes and Hayek I mentioned that I viewed recessions as collective action problems. In this blog I want to expand on what I mean by this because it makes all the difference for economic policy. It also contextualises our conventional demand management approaches, namely fiscal and monetary policy.

To build up the hypothesis, it is necessary to dip our toes in to a number of fields of study. But let us start with some empirical evidence and build the conceptual framework from there.
In his study of decision-making in the financial system, set out in his book Minding the Markets, Prof. David Tuckett from UCL interviewed 50 investment managers and analysed how they made decisions under conditions of uncertainty. Here I will take Prof. Tuckett’s conclusions and apply them to the phenomenon of recessions.

Prof. Tuckett explained how investment managers used narratives to help them make sense of the past, present and future. The amount and complexity of the information and the high degree of uncertainty they have to deal with can be staggering. So they develop narratives – mostly sub-consciously – to form what seems to be a cohesive pattern of understanding. This is also true of people in everyday life.
This is very different to conventional economics where “rational expectations” dominate. In this conventional approach, people are typically fully informed, have a particular (unchanging) model of how the economy works, and use these to determine their expectation of some variable in some fully predictable future.
By contrast, in reality people use narratives – again, subconsciously most of the time – in complex environments and these narratives can include some expectation of the future. People also typically have a sub-set of the information required to make decisions in their daily lives and, in complex social systems, the future is inherently uncertain.

Narratives form an important part of our framing of some situation or object but that is not to say they displace conscious analyses of the economy. The two are not mutually exclusive: narrative formation can involve a complex interplay of the conscious and sub-conscious aspects of the brain.
Narratives are also formed in part through social interaction. We listen to what others have to say: they influence us and we influence them, both at the same time. This important point means we are compelled to think of social systems as “Complex” (meant in the formal, Complexity theory sense), with people continuously interacting and co-evolving. The concepts of emergence and global cascades are useful for understanding how narratives are “exchanged”, how they spread, and how a particular narrative might become a “consensus” view among a group of people.

With these micro and system-wide points in mind, my argument is that recessions come about when a dominant narrative emerges within society, leading to behaviour that is consistent with a recession subsequently arising. If people believe a recession is likely, or imminent, they tend to behave “prudently” with respect to both consumption and investment. An important point is that the narrative of a recession and how people respond to that narrative make a recession both inevitable and self-fulfilling. In more technical language, there is “time-consistency” between the narrative-expectation and people’s behaviour.
An important difference between a recession narrative, which leads to a recession, and traditional theory is that in the latter, an economy is typically expected to gravitate toward some future full-employment equilibrium. For example, the models used by central banks (the terribly-named Dynamic Stochastic General Equilibrium models) normally show economies necessarily recovering following a recession. But if the consensus narrative is one of recession, and remains there, it is plausible that an economy can remain in that state, i.e. a “depression” narrative could emerge, reinforcing the slump. Alternatively put, a depression could be viewed as a sub-optimal equilibrium in a complex system.

I refer to recessions and depressions as collective action problems because they arise out of the collective action of agents in the system, operating in a way that is consistent with self-interest but which result in outcomes that are detrimental to all. An analogy is the Prisoner’s Dilemma game in game theory. As is famously known, the outcome in the Prisoner’s Dilemma is sub-optimal for both prisoners. If they could collude (a form of collective action), they could achieve a different outcome that is preferable for both. But this outcome is contingent upon the collusion being viewed as credible by both prisoners: some mechanism is required.

Now let’s turn to the policy implications of treating a recession as a collective action problem. In traditional macroeconomics, the mechanisms used to mitigate recessions (fiscal and monetary policy) are viewed as managing the overall level of demand in the economy. But if the narrative approach above is accurate, are these traditional tools of demand management sufficient for bringing about a recovery? Not necessarily.
What is crucial is the impact these policies will have on people’s narratives about the economy, not only their impact on “aggregate demand”. How these changed narratives influence individuals’ behaviour is another important question. A key point is that the overall impact of people’s changing narratives concerning an economy can dwarf demand management policies. A second key point is that narratives seem to be formed through an emergent process, which means prediction and control are highly problematic.
It is for this reason that I am sceptical of orthodox Keynesian approaches that imply a mechanistic view of the economy, whereby people adjust – deterministically – to macro management policies. Narrative formation is much more complex than that. Indeed, my colleague Paul Ormerod noted in November that the US appeared to be enjoying an expansionary fiscal contraction. This is possible if narratives change in favour of a recovery, leading to recovery-consistent behaviour by individuals, despite a fiscal contraction.
However – and this is a big however – demand management policies can and do influence narratives. But they should be viewed as one of a complex set of influences on how people view the economy, including its future.

UK GDP Growth (Source: ONS)

Before concluding, it is worth noting that these points relate to the fiscal policy debates of 2008-2010. During those debates the conventional Keynesian and Conservative perspectives were wheeled out. Keynesians said the fiscal deficit had to be expanded to counter a contraction in private demand; and Conservatives emphasised prudence to inspire “confidence”. A narrative-based framing shows that the Conservative perspective was not as unreasonable as Keynesians argued: we can re-state “confidence” through a narrative framing in stating that a prudent approach might inspire a shift away from a recession narrative to something more optimistic. But there is also a reasonable argument that a fiscal expansion might have inspired a recovery narrative. We will never know. What is clear is that we need to understand better how narratives emerge and perpetuate and how they can be influenced, including (if at all) by governments.
To conclude, I suspect that to those people not trained in conventional economics, this all sounds blindingly obvious. I would like to think that is because I started with a look at research based on empirical evidence, albeit based on the world of finance; and because I mixed this evidence with appropriate and cutting edge concepts from the new field of Complexity theory. But a lot more work needs to be done to deepen this framework, including by the academic community.

By Greg Fisher, Managing Director of Synthesis - associates of Volterra

HS2 gets Traction

Justine Greening has announced this week that HS2 will go ahead – which is enormously welcome. It is still surprising how many people have fallen for the proposition that is will be an expensive white elephant. Even the leader writers of the Financial Times have been captured by the Nimbys and the naysayers.
The fact remains that the long distance rail system is creaking at the seams. The West Coast Main Line is one of the busiest railways in Europe and managing its maintenance, even after its refurbishment, is a nightmare. The southern end, with massive commuter use, already needs more capacity. So we don’t just need HS2 to meet projected growth – we need it here and now.
Running infrastructure too close to capacity is risky, just as we see at Heathrow. This has to operate at 98% capacity, so that the slightest thing that goes wrong means lengthy trouble and hours to get the system back into normal running.
But the extra capacity will generate additional benefits. Accessibility is crucial to modern economies. With globalisation and the fact that cities are the focus of growth, intercity connectivity will be a key element in maintaining the UK’s economic performance. Our work for the Core Cities has shown that city centre growth will both generate and be generated by extra trips.

Bridget Rosewell

Minsky Mania: a Raincheck

The American economist Hyman Minsky is currently very fashionable, especially amongst those who are sympathetic to the idea of more government intervention in the economy.
Minsky argued that financial crises were an inevitable feature of capitalism, unless governments stepped in through regulation and central bank action.
He hypothesised that in prosperous times, when the corporate cash position became strong, exuberance developed which translated into a speculative bubble in asset and property markets. Private sector debt rose as borrowing increased to fuel the speculation, and at the ‘Minsky moment’ a crisis would occur. Following this, banks tighten credit, and even companies which are fundamentally sound may be driven out of business because of an unwillingness to roll over debt.
His theory is very seductive in the light of the experience since 2007.
But the theory does not explain why, over the past 80 years, we have only had two major financial crises, the early 1930s and the recent one from 2007. It is the dog which has not barked which causes fundamental problems for the hypothesis as it stands.
For example, in the United States, private sector debt relative to the size of the economy reached a peak of 2.1 in 1932. From a low point of only 0.4 in 1945, it rose almost without interruption to a new peak of nearly 2.2 in 2001. But there was no crisis. It reached 2.6 in 2006, much higher than its peak in the 1930s Great Depression. But again, no crisis.
The Minsky story is good at telling us after the event what happened in a crisis. It does not tell us why crises do not happen, even when the objective facts suggest they should.

Paul Ormerod