The experimental government: what works best?

In order to highlight the significance of a more experimental and empirical approach to public policy, UK Nudge Unit leader David Halpern suggested the notion of experimental government in 2015. The relevance of the experimental government can be noted in Halpern’s words:

Governments, public bodies and businesses regularly make changes to what they do. Sometimes these changes are very extensive, such as when welfare systems are reformed, school curricula are overhauled, or professional guidelines are changed. No doubt those behind the changes think they are for the best. But without systematic testing, this is often little more than an educated guest. To me, this preparedness to make a change affecting millions of people, without testing it is potentially far more unacceptable than the alternative of running trials that affect a small number of people before imposing the change to everyone.

The randomized controlled trials (RCTs) are at the heart of figuring out “what works best” in public policy after using tests as a routine policy and practice. As a result, while governments could gradually determine the measures that actually operate, policymakers could manage the outcomes of studies that could be deemed more or less efficient

Considering the controversies around the institutional sterility of the RTCs and the laboratory environment, one of the main questions at stake is: why we cannot transport the results of RCTs to policy contexts?

Deaton and Cartwright (2016) pointed out that there are misunderstandings around what the RCTs can really do. For them, the induction technique does not guarantee that appropriate causal factors are taken into account across sample groups in any specified RCT. Therefore, the results of the process of inference might be wrong. Indeed, the results of RCTs can be challenged ex post, after examining the composition of the control group and the factors considered in the experimental setting.

Deaton and Cartwright also dismissed the transportation of RCT results to other contexts since the causality of the results is always context-dependent. The decision-making process in experimental environments therefore relies on contextual factors that may be different elsewhere. Therefore, empirical economics does not provide a credible basis for economic theory and policy by relying on inductive investigation techniques that can never be completely transported across time and space

Moreover, economists Steven D. Levitt and John A. List (2007) highlighted that human behaviour in RCTs can be affected by the selection of the individuals, the context, the evaluation of actions by others, and ethical issues. Then, the findings in a laboratory setting may overestimate or underestimate the outcomes of real life interactions.

In other words, if an intervention “works” and makes people better off in the laboratory, there is no guarantee that this intervention will actually do so in the real-world. As a matter of fact, RCTs run the risk of considering worthless casual relationships as causalities in the attempt to theorize on economic issues. In short, without understanding why the effects work on society, the results of the RTCs cannot be transferred and the normative results of economic studies are challenged.

From a critical point of view, Michel Foucault (1981) emphasized that human beings are trapped in practices of domination that affect their subjectivities in the context of historical social relations, practices and institutions. His philosophical contribution calls for a reflection on both history and mechanisms of power to build economic theories and policies.

Indeed, in economics while considered as a social science, “what works” in the laboratory does not necessarily work in the real-world.

 

References

Deaton, A. and Cartwright, N. (2016). Understanding and misunderstanding randomized controlled trials. NBER Working Paper No. 22595.

Foucault, M. (1981). As Palavras e as Coisas (The Words and the Things). Coleção Tópicos. São Paulo: Martins Fontes.

Halpern, D. (2015). Inside the Nudge Unit: How Small Changes Can Make a Big Difference. London: WH Allen.

Levitt, S. D. and List, J. A. (2007). What do laboratory experiments measuring social preferences reveal about the real world? Journal of Economic Perspectives, 21 (2): 153–174.

Madi, M.A.C (2019). The Dark side of Nudges. London: Routledge.

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GOING DIGITAL. The next WEA Conference

The advent of digital economy creates new challenges for businesses, workers, and policymakers. Moreover, business prospects for artificial intelligence and machine learning are evolving quickly. These technologies have transforming implications for all industries, businesses of all sizes, and societies. The digitalization of economic activities calls for a deep reflection on the forces that will shape the future of the global economy.

The objective of this conference, led by Prof. Maria Alejandra Madi and Dr. Malgorzata Dereniowska, is to discuss recent contributions to the understanding of digital economy and its consequences for business trends and labour challenges. The conference also focuses on bridging the gap between different economic theoretical approaches and the practical applications of artificial intelligence and machine learning.

The Conference calls for a focused reflection on the benefits and risks of the high-tech revolution is an important element of shaping sustainable business and just labor. Related topics include law, ethics, safety, and governance.

Topics include (but are not limited to):

1. The gig economy and recent economic theoretical approaches: advances and challenges.
2. Internet of Things in retrospect and today.
3. Machine learning: integration of people and machine learning in online systems.
4. Consumer transactions and Big Analytics.
5. Time Series Data & Data for Prediction in Economics.
6. Business Transformations though Internet of Things and Artificial Intelligence.
7. Impact of artificial intelligence on business and society: automation of jobs and the future of job creation
8. Artificial intelligence for manufacturing: today and tomorrow.
9. Disruptive innovation and transforming industries: telecom, finance, and travel/transportation, logistics, etc.
10. Machine learning and eco-challenges.
11. E-government, e-democracy and e-justice.
12. Ethical and legal issues of artificial intelligence technology and its applications.
13. Digital economy and economic inequality.
14. The impact of the digital economy on competition and economic growth.

We welcome submissions from scholars working in economics, law, political science, psychology, philosophy, and sociology.

We also welcome contributions from business executives responsible for AI initiatives, heads of innovation, data scientists, data analysts, staticians, AI consultants and service providers, and students.

 

KEY DATES

Papers submission: October 20^th 2019.

Welcome

Discussion Forum: November 11^th – December 9^th 2019.

 

CONTACT

Maria Alejandra Madi alejandra_madi@yahoo.com.br

Małgorzata Dereniowska malgorzata.dereniowska@gmail.com

 

 

On NAIRU and NAIBER

Throughout the last decades, the nominal interest rate became the dominant monetary policy instrument. Looking backward, the early 1980s proved to be a transition period in terms of monetary policy. After the monetarist experiences of Thatcher and Reagan, there was a pragmatic shift from the supply of the monetary base to the interest rate as monetary policy instrument. The recognition that the control of the monetary base could not only impose extreme volatility to the interest rate but also deeply affect the whole economy challenged, in fact, the previously stable empirical relationship between money supply, demand for money, prices, and income supported by Milton Friedman.

At the theoretical level, the so-called “New Consensus in Macroeconomics” favoured the short-term interest rate as the policy instrument in conjunction with inflation targeting. The new-Keynesian so-called “Taylor rule” has increasingly turned out to be adopted by central banks to manage the interest rate as the policy instrument. In this policy approach, the central bank, mainly through open market operations, sets the short-term interest rate in order to adjust its level in response to changes in inflation and output. In a framework of capital account openness, however, the autonomy of monetary policy, aimed to stabilize prices, subordinates the fiscal budget.

After the global financial crisis, academic economists and policy makers have actively participated in the debate on monetary policy. After the bail-outs, central banks in the US and European Union focused on lender-of-last-resort program extensions and dealt with multiple challenges: how to prevent a recessionary downturn, how to avoid asset and credit bubbles and inflationary pressures. The unprecedented actions of the Federal Reserve, European Central Bank and the Bank of England, for example, suggest the need to rethink the traditional scope of the lender of last resort. The scope of the recent central banks’ interventions has been expanded in order to include not only the provision of liquidity as lender of last resort, but also to include the expansion of repurchase agreements as buyer of last resort and the supply of liquidity to specific markets  as market maker of last resort.

The modern Keynesian literature emphasizes that, even if increasing the current money supply has no effect, monetary policy is far from ineffective at zero interest rates. What is important, however, is not the current money supply but managing expectations about the future nominal and real interest rates. Thus, recent research indicates that monetary policy is far from being ineffective at zero bound levels, but it worked mainly through expectations. So far, the key-issue is how very low or negative interest rates translate into improved growth rates since austerity programs are biased towards entrenching mass unemployment and introducing anti-social structural reforms.

The debate about the appropriate policies to achieve economic growth has been recently fuelled by the advocates of the MMT (Modern Monetary Theory). According to Warren Mosler, for instance, the mainstream version of fiscal responsibility is based on false premises. In his view, MMT provides new guidelines for the fiscal position for governments since the role of   fiscal policy is to ensure there is no spending gap. Fiscal interventions, through direct government spending and/or a tax cut to increase private disposable income, aim to create demand and provide enough jobs for all the workers who desire to work. Therefore, a zero spending gap occurs when the level of national income is a full employment

Against the Non-Accelerating Inflation Rate of Unemployment (NAIRU) that refers to the concept of full employment irrespective of how many workers are unemployed or underemployed, the MMT advocates propose the NAIBER – the Non-Accelerating Inflation Buffer Employment Ratio. The concept of NAIBER, designed by the economists Bill Mitchell and Warren Mosler, is associated to the idea of a Job Guarantee programme managed by the government in order to hire unemployed workers as an employer of last resort (ELR). Beyond negative rates and quantitative easing, MMT specifies a new discipline for the fiscal policy: if the goal is full employment and price stability, then the full-employment fiscal deficit condition has to be met.

Although the idea of ELR is not new, the current debate on price stability  considers the creation of jobs at the center of policy making.  Against mainstream economics, it is urgent to develop alternatives to face the social challenges of unemployment, underemployment, informality and poverty at large scale.

The neoliberal governance of the self: a clarification

My last post on Behavioural Economics arose some interesting questions about the rationality of the neoliberal governance of the self and its relation to the current research about psychology and cognitive theories. (https://rwer.wordpress.com/2019/03/20/beyond-behavioral-economics-the-self-governance-of-nudging/#comment-150149)

The neoliberal governance of self-care (or neoliberal governance of the self) relies on Dual Process Cognitive Theories (DPTs), especially the one elaborated by Daniel Kahneman. According to him, the distinction between Econs and Humans rejects the concept of homo oeconomicus of the neoclassical theory.  The human brain functions in ways that refer to a distinction between two kinds of thinking: automatic  and reflective (rational), and Kahneman called these ways of thinking System 1 and System 2, respectively. His Dual Process Cognitive Theory tries to explain why human beings actually systematically deviate from rational decisions.

Considering the normativity perspective in behavioural economics, nudges are social norms that  aim to foster “better” choices, “happiness” and freedom of choice. Nowadays, nudges are part of the neoliberal governance. As Thaler and Sunstein say: nudges are everywhere.

The political rationality of neoliberalism is that the strategy of rendering individual subjects “responsible” entails shifting to them the responsibility for social risks such as illness, unemployment, retirement plans, etc.. Therefore, there is a call for “personal responsibility” and “self-care”.  In other words, the political rationality of neoliberalism calls for  the relevance of System 2. However, on behalf of the human cognitive biases, people need a helping hand of the government to be rational and exercise self-control.

It is worth remembering Cass Sunstein and  Richard Thaler´s words:

Equipped with an understanding of behavioral findings of bounded rationality and bounded self-control, libertarian paternalists should attempt to steer people’s choices in welfare-promoting directions without eliminating freedom of choice. It is also possible to show how a libertarian paternalist might select among the possible options and to assess how much choice to offer.

Indeed, the understanding of the Libertarian Paternalism of Thaler and Sunstein  involves implicit forms of power and processes of subjectivation.

Beyond behavioral economics: the self-governance of nudging

Looking back, after the Second World War, new theoretical and applied work in economics fostered empirical techniques that included structural estimation, the development of input-output methods and linear programming. Among the theoretical advances, the Keynesian revolution, the mathematical modeling of the business cycle, game theory, dynamic modeling, new models of consumer behavior and general equilibrium analysis can be highlighted.

What is significant about these changes is that, as theoretical and empirical work became more formal and mathematical, the conceptions of economic theory and of its relationship to various types of applied work changed. “Measurement without theory”, as Rutledge Vining explained, means that empirical work was needed in order to discover the appropriate theory. The ensuing debates were dominated by this view, that also included Milton Friedman’s contribution that turned out to be one of the most widely read methodological essays in economics.

By the 1970s, mainstream economics was centered on mathematical modeling of maximizing agents and econometric models were widely spread in applied work. Consequenlty, economics was becoming more methodologically homogeneous despite the protests from heterodox economists. In this setting, new theories for specific fields in economics were developed. As Backhouse and Cherrier claimed, there has been a process of unification and fragmentation in economics.  

Some of the new theories fostered a renewed understanding of economic behavior, bringing in imperfect information or psychological evidence. In this context, behavioral economics rejected the commonly accepted model of rational choice. In order to demonstrate the existence of cognitive biases, behavioral economists rely on empirical data, collected through designed experiments, surveys and field studies. Beyond the belief in positive analysis, behavioral economics developed normative recommendations to make people “happier” as the result of government interventions (nudge) that can help people change their behaviors and act more rationally. This normative program has been called Libertarian Paternalism by Richard Thaler and Cass Sunstein.

However, behavioral economists have not abandoned the ideal of rationality in economics. According to Stefan Heidl, psychology is treated as a mere add-on to mainstream economics and, therefore, behavioral economics faces the same methodological limitations.

In accordance with the same line of thought, Leonard adds: ‘The irony is that behavioral economics, having attacked homo oeconomicus as an empirically false description of human choice, now proposes, in the name of paternalism, to enshrine the very same fellow as the image of what people should want to be. Or, more precisely, what paternalists want people to be’.

Taking in account the spread of behavioral public policies in contemporary research and economics education, the relevant concern is related to the implicit political and social processes at stake.

In our view, the dominant ideology underlying behavioural public policies is the self-governance of nudging that reflects a neoliberalization of everyday life.

 

 

References

Backhouse, R.  and Cherrier, B. (2014). Becoming Applied: The Transformation of Economics After 1970. Department of Economics Discussion Paper 14-11. University of Birmingham.

Heidel, S. (2014) Philosophical Problems of Behavioural Economics.  PhD dissertation University of Bonn.

Leonard, T. C. (2008). Review of “Richard H. Thaler, Cass R. Sunstein, Nudge: Improving decisions about health, wealth, and happiness”. Constitutional Political Economy, 19 (4): 356-360

Friedman, M.  (1953). The Methodology of Positive Economics. In Essays in Positive Economics. Chicago: University of Chicago Press. pp. 3-43.

Vining, R.  (1949). Methodological issues in quantitative economics: Koopmans on the choice of variables to be studied and of methods of measurement, The Review of Economic and Statistics, 21 (2): 77- 86.

 

 

Karl Polanyi and social justice

In the introductory note to the book Trade and Market, Polanyi invites the readers to re-examine the notion of the “economy” since many people think that the only way of organizing the livelihoods of men is the market economy. In his own words:

‘What is to be done, though, when it appears that some economies have operated on altogether different principles, showing a widespread use of money, and far-flung trading activities, yet no evidence of markets or gain made on buying or selling? It is then that we must re-examine our notions of the economy.’ (Polanyi et al, 1957: xvii).

In order to develop an alternative notion of the “economy”, Polanyi proposed a new theoretical approach to explain the place and role of human beings in social and economic systems. He addressed that men value those material goods that serve the end to promote protection and social standing. As a result, in his approach, social matters  turn out to be anthropological ones and the role of history is highly relevant. As  Polanyi wrote:

“But a purposeful use of the past may help us to meet our present over concern with economic matters and to achieve a level of human integration, that comprises the economy, without being absorbed in it” (Polanyi et al., 1957: xviii). 

Indeed, while considering different historical references, Polanyi provided a guide to examine the non-market economies and claimed that empirical observations reveal economic life in archaic and primitive economies to be entirely different from that assumed by formal economic analysis (Polanyi et al, 1975: 243-44). Against the methodological approach to economics based on assumptions, premisses and deductive reasoning, Polanyi proposed the method of economic anthropology that depends upon principles of economic behavior that are induced from empirical observation.

From the empirical evidence of economic life in ancient times and primitive economies, Polanyi explained the concepts of reciprocity and redistribution. The reciprocity principle implied that there was an unspoken agreement in society and on its behalf people produced goods and services that could be redistributed according to their needs among all who contributed according to their abilities to the common welfare. Their motivation to produce and share was not the economic motive, but the fear of losing the social status and prestige.

Although Polanyi addressed that ancient and primitive economies had market places, they were not market economies. In this scenario, daily local markets were merely exchange places operating within the broad system of reciprocity. Local craft and provision markets were isolated by the local authorities from the long distance ones (ports of trade) that only sold items which could not be provided within the local system of reciprocity (Polanyi et al., 1957).

In the nineteenth century, however, Polanyi noted that the emergence of a market economy pushed to the side the old economic and social systems based on reciprocity and redistribution.  Since then, the new market economy has been characterized as an economic system controlled by prices that determine what, how and how much is produced and how is distributed.  As Polanyi explained, the decisions about production and distribution are guided by the economic motive and they do not aim at achieving common welfare. Indeed, as he highlighted in The Great Transformation, the process of social change created by the market economy might lead to the emergence of poverty on a large scale.

Karl Polanyi described the desolation, dehumanization and degradation of human lives as necessary steps for the emergence and expansion of the labor market in a market economy:

 “Before the process had advanced very far, the labor­ing people had been crowded together in new places of desolation, the so-called industrial towns of England; the country folk had been de­humanized into slum dwellers; the family was on the road to perdition; and large parts of the country were rapidly disappearing under the slack and scrap heaps vomited forth from the “satanic mills.” Writers of all views and parties, conservatives and liberals, capitalists and social­ists invariably referred to social conditions under the Industrial Revo­lution as a veritable abyss of human degradation” (Polanyi, 1944: 41).

Polanyi’s analysis also enhanced a critique of some well-known economists and public men such as Townsend, Malthus, Ricardo, Bentham and Burke who considered that the provision of extensive relief to the poor by the government (such as the Poor Laws in England) would negatively affect the rate of economic growth.

Polanyi decisively condemned the hunger of workers as the only way to increase the levels of production in a market economy. In fact, Polanyi addressed that the “iron” laws governing a competitive market economy are not human laws.  It is worth recalling his own words:

“The true significance of the tormenting problem of poverty now stood revealed: economic society was subjected to laws which were not human laws.” (Polanyi, 1944: 131).

 

References

POLANYI, K. (1944) The Great Transformation: The Political and Economic Origins of Our Time, New York: Rinehart.

 

POLANYI, K. (1977) The Livelihood of Man, New York: Academic Press

 

POLANYI, K., ARENSBERG,. H. and PEARSON, H. W. (eds.) (1957) Trade and Market in the Early Empires: Economies in History and Theory, Glencoe, Illinois: The Free Press.

 

POLANYI-LEVITT, K. (ed.) (1990) The Life and Work of Karl Polanyi, Montreal: Black Rose Books.

 

Pension funds and the search for alternative assets

A decade after the 2008 global crisis, some key trends can be highlighted: a) There has been a shift to defined contribution (DC) pension plans, b) The increasing role of alternative assets, such as private equity, among pension assets.

Many governments in OCDE countries have been committed to structural reforms in labour markets and pension plans. As a result, the current era of austerity has deep impacts on the diversification of types of pension plans. According to a 2018 OCDE  report, in a mandatory pension plan, a) employers setup a plan for their employees, b) employees contribute to a state funded pension scheme or c) employees contribute a private pension fund of their choice.  In a quasi-mandatory, employers need to setup a pension plan as a result of labour agreements. In some OCDE countries, there are automatic enrolment programs at the national level where employees have the option to opt out of the plan under certain conditions.

In this setting, a recent PwC report warned that government-incentivized or government-mandated retirement plans turns out to privilege the use of defined contribution (DC) pension plans -such as the United States. In a defined contribution (DC) pension plan the employer, the employee or both make contributions on a regular basis in individual accounts. As  matter of fact, after the global crisis, the traditional occupational defined benefit (DB) pension plans have been losing ground in many countries, such as Australia, Iceland, Israel, the Netherlands, Mexico, New Zealand, Sweden and the United States. Besides, the increase in life expectancy result in longer periods of benefit payments to retirees for DB pension funds for a given retirement age (OECD, 2017).

The shift to occupational defined contribution (DC) plans seemed to be associated with pension underfunding. In this setting, lower discount rates used to value liabilities (as a result of quantitative easing policies) have been important factors to rethink the financial sustainability of pension funds. Indeed, the continuity of liquidity-driven monetary policies and a decline in the long-term interest rates have affected not only the expectations on profitability of pension funds, particularly in those portfolios where income-fixed assets predominate, but also the valuation of liabilities. In this scenario, the portfolio performance has been stimulating the search for alternative assets.

Table 1 shows the evolution of contributions and benefits in DB plans as of 2017. Many factors drove the evolution the funding ration and the asset- liability management of DB pension plans: a) low interest rates, b) composition of assets, c) number of members and wages, d) benefits paid, e) age structure of members, f) aggregate price level.

 

Table 1.  DB pension plans: contributions and benefits in OECD selected countries, 2017, in %

OECD Countries	Contributions	Benefits
New Zealand	18.3	-23.3
Iceland	9.6	-13.0
Norway	8.4	-3.6
Switzerland	8.3	-5.0
Germany	7.7	-5.0
Spain	5.6	-7.9
Canada	5.2	-5.4
Portugal	4.6	-3.3
Indonesia	4.6	-8.3
Belgium	4.0	-2.8
Netherlands	3.9	-3.3
Namibia	3.8	-3.0
Guyana	3.3	-2.6
Finland	2.5	-3.5
Denmark	1.6	-3.5
Costa Rica	0.5	-7.4

Source: OECD

Ten years after the global crisis, the funding ratio of occupation defined benefit (DB) pension plans was below their pre-financial crisis levels in most of the OECD reporting countries. However, in Iceland, Indonesia, Mexico, the United Kingdom and the United State the funding ratio had already been below 100% for several years. Therefore, one of the main issue at stake is the path of evolution of benefits and contributions in different types of pension plans and how this evolution may affect the financial sustainability of pension funds.

Considering this background, pension funds´ managers have been searching for alternative investments outside of traditional stocks and bonds. The 2017 Preqin Alternative Assets Performance Monitor also highlights that pension funds (public 30%, private 15%) are increasingly allocating more of their assets to PE today. In truth, between 2008 and 2017, most of pension funds (public and private of all sizes) in developed markets had expanded their allocations to alternative asset classes from 7.2% of assets under management in 2008 to 11.8% in 2017. In emerging markets, on average, pension funds increased their alternative investments from 0.97% in 2008 to 6.6% in 2017. In the past 10 years, pension funds reported median net returns in their private equity allocations ranging between 7.5% and 11.5%. These returns have been above those obtained for fixed income, listed equity, hedge funds and even real estate assets.

Alternative investments like private equity assets might prove to be controversial choices for pension funds because of the PE governance historically focused on the extraction of short-term returns in private companies. At the heart of our argument is that the capital accumulation process involves social relations driven by profit and competition. As the private equity investors´ motive is not growth per se, but value extraction, the social losses in terms of unemployment, working conditions, workers´ rights and income distribution could be relevant.