Double standards are everywhere in economic policy – welcome to the world of Bubblethink. Alan Shipman explains
To illustrate: Britain’s bankers must be spared any cap on bonuses, otherwise they will not work hard enough, and the economic mess they created in 2008 will take longer to fix (see this). But Britain’s low-income households must have a cap imposed on their benefits, otherwise they will not work hard enough, and the economic downturn inflicted on them in 2008 will take longer to escape (see this). So if you’re already getting a very good salary, your best incentive is the promise of additional pay, which must be allowed to rise to more than twice that salary. Whereas if you’re struggling along on the minimum, your best incentive is to receive even less (and give up the spare room if you want to avoid a further reduction). It’s a variation in the age-old principle that tax cuts for the rich will boost the economy by encouraging effort and enterprise – while pay and benefit cuts for the poor will achieve exactly the same.
This logic troubles an increasing number of observers, notably the new Archbishop of Canterbury. But as well as pre-dating Orwell’s dystopia, it puts in a Biblical appearance – usually characterised as the Matthew Effect, but actually put most succinctly by Mark (4:25): “For he that hath, to him shall be given: and he that hath not, from him shall be taken even that which he hath.”
Another example: the growth of payday lending is a bad thing, because it leads to some of the most deprived households paying the highest interest rates on runaway debts. But the growth of employment to record levels since 2010 is a good thing, signalling the success of present economic strategy even though national output has fallen in the meantime. Payday lending has grown because more households are working for incomes that don’t cover their basic costs – and that’s because a rise in employment against a backdrop of falling output can only mean a fall in productivity and pay. But politicians, reassured by their economic advisers, don’t notice the contradiction.
Huhne and Pryce: a heroic experiment
Economists’ messages may be enduring, but their strategies change with the times. Once criticised for armchair theorising, they now come under fire for armchair empiricism – making ‘investigations’ entirely by crunching data on computers, and never actually stepping into the world they seek to characterise and control. To refute this, two prominent economists recently ditched their heroic assumptions to stage a heroic experiment, testing the predictions of a famous theorem at great personal cost.
The Prisoners’ Dilemma depicts two criminal suspects who, arrested and separately questioned, have the option of confessing to a crime or pleading innocence and blaming their partner. If both co-operate (confess), both can walk free. But if one co-operates (confesses) and the other contests the charge, the co-operator is severely punished while the contestor gets off lightly. The inevitable outcome – theoretically – is that both deny the charge, and both get heavy sentences.
Economists claim an insight into strategy games that ordinary people lack. So when two of the country’s best-known played this game, they inevitably chose strategies different from those that get the worst-case outcome. One of them confessed on the day of the trial, leaving other to contest the charge alone. The result: both got an identical sentence (see Chris Huhne and Vicky Pryce both jailed for eight months), judged alarmingly heavy by their economist friends – who must also be bemoaning the judge’s refusal to read the game-theory account of the Dilemma.
Bubblethink came alive in the immediate aftermath of the sentencing, as the estranged defendants’ allies condemned the injustice and waste involved in jailing a former cabinet minister and former head of the Government Economic Service. Some have even suggested that big fines and community service would have been a more appropriate punishment. The arguments are eloquently put. But they are notably are not extended to many others, comparably convicted of perverting the course of justice, for whom prison is judged a necessary corrective, and attempts to buy their way out of it would be viewed as outrageous.
Dramatic comebacks from this case are not ruled out, despite the frustrated game-play. Vicky Pryce remains one of Europe’s leading economists, whose work on improving the quality of government economic data will likely outweigh any damage to the justice system in the longer term. And Chris Huhne is no stranger to improbable role reversals, having previously moved from writing leaders for the Guardian to running a Credit Rating Agency.
As he switches from HMG to HMP, one of Huhne’s own contributions to Bubblethink is worth remembering. As Energy Secretary, he sat in a cabinet that roundly condemned the ‘casino capitalism’ that nearly destroyed the public finances. But he also devised a financing plan for Britain’s new nuclear power stations based on ‘Contracts for Difference’ a highly popular gambling device among that casino’s professional players, because it lets them take profitable bets on the movement of asset prices without having to buy and sell the asset. These Contracts are supposed to offer private power companies enough guaranteed income to build the new plants privately, without letting them profit from energy shortages and price spikes at public expense.
Two years on, the firms are still arguing over the terms, and Britain’s energy regulator has warned of possible power cuts from 2015 because of coal-fired closures and delays in installing the new reactors. A technique borrowed from the City that almost switched the economy off is now in danger of turning the whole country’s lights off. Economists are agreed that incentives matter, but still struggling to design the right ones.
Alan Shipman 13 March 2013
Alan Shipman is a lecturer in Economics at the Open University. He is responsible for the modules You and your money:personal finance in context and Personal investment in an uncertain world, part of the foundation degree in Financial Services.
The views expressed in this post, as in all posts on Society Matters, are the views of the author, not The Open University.
Cartoon by Catherine Pain