New Economist

Winning American Idol: try to be last

If you are appearing on American Idol or the X-Factor, try to be one of the last to sing. That's the conclusion from a new paper presented at a University of Westminster seminar today. Lionel Page and Katie Page look at an important topic - the evaluation of a sequential order of performances. Their paper, Biases in sequential performance evaluation, a field study on the Idol series (PDF), drew on a large dataset based on the ranking of contestants in live pop Idol shows in 8 countries (Australia, Brazil, Canada, Germany, India, Netherlands, UK, USA). That's 1,522 performances from over 165 shows. They found two main biases which influenced overall sequential performance ratings:

Our results suggest that the two mechanisms, memory and direct comparison, both play a role in the order bias. With respect to memory it appears that both primacy and recency effects are implicated when sequentially evaluating performance. Irrespective of ability, contestants who perform first are more likely to be positively evaluated than those who come in second and third positions, which provides evidence of a primacy effect. Contestants who perform in the later serial positions (particularly last position) have the largest advantage with respect to positive evaluations, implying a strong recency effect.p>

...The second bias we demonstrate is a direct comparison effect with the previous contestant. Specifically, one's performance evaluation is influenced by the evaluation of the previous contestant. If you perform after a weak contestant there is a bias such that you are more likely to be evaluated poorly than if you perform after a strong contestant. Therefore, we find evidence for an assimilation effect with respect to sequential judgments.

...Overall, we show that these two effects both operate and are important explanatory mechanisms in the evaluation of sequential performance.

Something to ponder when you go speed dating, or get a call to say you've been shortlisted for a job interview and are asked what slot you'd like.

UPDATE:

WSJ's Matt Phillips has obviously read my post, writing about the paper at the Journal's real Time Economics blog: Last Shall Be First in Idol Economics

Meet the authors...

There may be no such thing as a free lunch - but London has plenty of free public lectures. Readers living in the old dart have the opportunity to hear about two new and - by all acounts - exciting tomes.

This Wednesday evening (6 February, 6.30pm) undercover economist and FT blogger Tim Harford is giving a public lecture based on his new book The Logic of Life at the London School of Economics. Event details here. The event is free and no ticket is required, but I'd recommend turning up early, as these events fill up fast. Here is the jacket blurb for the US hardcover, published by Random House:

Life sometimes seems illogical. Individuals do strange things: take drugs, have unprotected sex, mug each other. Love seems irrational, and so does divorce. On a larger scale, life seems no fairer or easier to fathom: Why do some neighborhoods thrive and others become ghettos? Why is racism so persistent? Why is your idiot boss paid a fortune for sitting behind a mahogany altar? Thorny questions–and you might be surprised to hear the answers coming from an economist.

...In this deftly reasoned book, Harford argues that life is logical after all. Under the surface of everyday insanity, hidden incentives are at work, and Harford shows these incentives emerging in the most unlikely places. Using tools ranging from animal experiments to supercomputer simulations, an ambitious new breed of economist is trying to unlock the secrets of society. The Logic of Life is the first book to map out the astonishing insights and frustrating blind spots of this new economics in a way that anyone can enjoy.

The Logic of Life presents an X-ray image of human life, stripping away the surface to show us a picture that is revealing, enthralling, and sometimes disturbing. The stories that emerge are not about data or equations but about people: the athlete who survived a shocking murder attempt, the computer geek who beat the hard-bitten poker pros, the economist who defied Henry Kissinger and faked an invasion of Berlin, the king who tried to buy off a revolution.

Once you’ve read this quotable and addictive book, life will never look the same again.

Judging by this the LSE lecture should be a lively romp - though promising "an x-ray image of human life" seems just a tad over-hyped. I'm not really sure why the US edition is subtitled The Rational Economics of an Irrational World, but the UK edition subtitle (above) was chnaged.

Meanwhile, next Tuesday evening (12 February, 6.30pm), Columbia University sociologist Sudhir Venkatesh talks about his new book Gang Leader for a Day at the RSA. Even details here. The event is free, but you have to register online. The book has generally been well recieved (though Tyler Cowen thought it "somewhat evil"). Here is the blurb for the London launch:

Sudhir Venkatesh is a young sociologist who studied a Chicago crack-dealing gang from the inside; he captured the world’s attention when it was first described in Freakonomics. Sudhir befriended members of one of the hardest crack dealing gangs in Chicago in order to produce sociological research that the academic world had never managed to obtain before. He followed the gang (the Black Kings) for the best part of ten years and will give a frank, accessible account of what he learnt. He witnesses drive-by shootings, drug dealers, gun crime, prostitution but also a community spirit in the face of poverty and the inner workings of gang culture from the leader down to the "shorties" (foot soldiers).

UPDATE: Tim Harford informs us on his blog of Another chance to see… (London speaking events)

I was astonished when the enormous Old Theatre at the LSE was packed out at least fifteen minutes before I gave my talk on 6 Feb. Lots of people were turned away, including some for whom I’d reserved seats. I’m a bit embarassed about that, although obviously pleased that the event was popular.

But… there will be another chance to hear me talk about “The Logic of Life” at the Cass Business School on 12 March. Details are here - along with details of other talks in The Lake District, Glasgow, Oxford, Cambridge, Bristol, Singapore, Wellington and several Australian cities too. Looks like we’ll arrange a couple more London events later in the spring, too.

Rethinking free trade?

Is support for free trade losing ground amongst economists? Business Week Washington bureau chief Jane Sasseen writes of an apparent shift in mood: Economists Rethink Free Trade:

..something momentous is happening inside the church of free trade: Doubts are creeping in. We're not talking wholesale, dramatic repudiation of the theory. Economists are, however, noting that their ideas can't explain the disturbing stagnation in income that much of the middle class is experiencing. They also fear a protectionist backlash unless more is done to help those who are losing out. "Previously, you just had extremists making extravagant claims against trade," says Gary C. Hufbauer, a senior fellow at the Peterson Institute for International Economics. "Now there are broader questions being raised that would not have been asked 10 or 15 years ago.

So the next President may be consulting on trade with experts who feel a lot less confident of the old certainties than they did just a few years ago. From Alan S. Blinder, a former vice-chairman of the Federal Reserve and member of the Council of Economic Advisers in the Clinton Administration, to Dartmouth's Matthew J. Slaughter, an international economist who served on President George W. Bush's CEA, many in the profession are reevaluating the impact of globalization. They have studied the growth of low-wage work abroad and seen how high-speed telecommunications make it possible to handle more jobs offshore. Now they fear these factors are more menacing than they first thought.

No one is suggesting that trade is bad for the U.S. overall. According to estimates by the Peterson Institute and others, trade and investment liberalization over the past decades have added $500 billion to $1 trillion to annual income in the U.S.

Yet concern is rising that the gains from free trade may increasingly be going to a small group at the top. For the vast majority of Americans, Dartmouth's Slaughter points out, income growth has all but disappeared in recent years. And it's not just the low-skilled who are getting slammed. Inflation-adjusted earnings have fallen in every educational category other than the 4% who hold doctorates or professional degrees. Such numbers, Slaughter argues, suggest the share of Americans who aren't included in the gains from trade may be very big. "[That's] a very important change from earlier generations, and it should give pause to people who say they know what's going on," he says.

The IFS Green Budget: time for some prudence

The Institute for Fiscal Studies launched its IFS Green Budget 2008 at a half-day conference yesterday. A preview of the official UK Budget due mid-March, it's comprehensive and thought provoking document for anyone with an interest in the state of the UK economy or public finances. Both the full 312 page (3.9Mb) report itself and the PowerPoint presentations from yesterday's seminar are available to download online. You can also download individual chapters. The nine presentations covered:

* The economic outlook, David Miles, Morgan Stanley
* Labour's record on the public finances, Robert Chote, Carl Emmerson and Gemma Tetlow, IFS
* The public finances going forward, Robert Chote, Carl Emmerson and Gemma Tetlow, IFS
* Funding issues and debt management, David Miles and Laurence Mutkin, Morgan Stanley
* Public sector pay and pensions, Antoine Bozio and Paul Johnson, IFS
* Capital gains tax, Stuart Adam, IFS
* Taxation of foreign profits, Malcolm Gammie, Rachel Griffith and Helen Miller, IFS
* Aviation taxes, Andrew Leicester and Cormac O'Dea, IFS
* Impact of tax and benefit changes taking effect in April 2008, David Philips, IFS

The reports' authors are gloomier than Treasury officials about the outlook for tax receipts and borrowing over the next two years, given the downside risks facing the UK economy. The IFS baseline forecast scenario is not for a recession, though. They expect sub-trend growth in both 2008-09 and 2009-10, resulting in a larger budget deficit, higher public sector debt, and slower path to surplus than official forecasts. The IFS press release (PDF) puts it like this:

..we fear that tax revenues will not grow as strongly as the Treasury hopes, as the impact of the credit crunch and a weak outlook for profit growth depress Corporation Tax receipts and as weaker share and property prices reduce Stamp Duty revenues.

Under existing policies, we expect the Government to have to borrow more than £40 billion this year, next year and in 2009-10. We expect public sector net debt to hit the Government’s ceiling of 40% of national income in 2009-10 and to rise to 41.2% by 2012-13. The Government would also break its “golden rule” (to borrow only to pay for investment) over the new economic cycle, unless that cycle lasts at least a decade.

IFS Director Robert Chote argued at the conference that the government faced a "difficult call", but some action now would be "prudent". The report also reminds us that the UK’s debt remains below the OECD average,and government debt and borrowing are still both lower than when the Conservatives left office in 1997. Press coverage was predictably more critical, with most reporters focussing on the need to raise taxes. Today's FT report by Chris Giles is typical: Increase taxation by £8bn, Darling told

So precarious are the public finances that Alistair Darling should raise taxation by £8bn in the Budget even though the economy faces the risk of a brutal slowdown, says the Institute for Fiscal Studies.

A brutal slowdown? Hardly. True, Morgan Stanley's economic projections include a more pessimistic scenario in which the UK economy suffers a ‘technical recession’. But they see only a one-in-three probability of this; I would rate the chances even lower.

UPDATE:
Martin Wolf is less downbeat in his 8 February FT piece, Why a crisis is also an opportunity. He argues that "it is not that the government’s overall fiscal performance has been lamentable. It has merely been mediocre." The government must rebalance, and could benefit from depreciation: "a weaker real exchange rate is a valuable part of the economic adjustment". He concludes:

The UK economy could not continue indefinitely on its course of rising internal debt and external deficits. Equally, the government could not continue indefinitely raising the share of public spending in GDP and missing fiscal targets. These trends are now at an end. How well the necessary corrections are managed will determine how well a rebalanced economy performs in the years ahead.

Hard to disagree with that.

The mixed benefits of remittances

Recent years have seen international agencies like the World Bank and IMF extol the econmic benefits of remittances. Sending money to the folks back home boosts the incomes of developing countries and helps to offset losses fom the 'brain drain'. What's not to like?

Well, we wouldn't be economists if we weren't looking for unintended consequences. And sure enough, David Grigorian and Tigran Melkonyan have found some. Their recent IMF working paper Microeconomic Implications of Remittances in an Overlapping Generations Model with Altruism and Self-Interest studies the impact of remittances on Armenian households:

We demonstrate that when the migrant and the relative(s) cooperate to maximize the joint utility of the household, this leads to higher level of remittances as well as investment and hours worked by the relative(s). We use data from Armenia to test our predictions regarding implications of remittances flows on behavior of receiving households.

Consistent with our predictions, remittance-receiving households work fewer hours and spend less on the education of their children. While saving more, these households are not leveraging their savings to borrow from the banking system to expand their business activities. This evidence suggests that the benefits of remittances might be overstated and emphasizes the importance of measuring their impact in a general- rather than a partial-equilibrium context.

So remittances lead to households working fewer hours: "The coefficient is negative and significant and its magnitude is rather large." More surprising is the apparent negative effect on education. The authors conjecture:

The impact of remittances on education spending (column 3, Table 3) is perhaps the most controversial of our findings. The negative (and significant) coefficient here could be indicative of two things. First, it is possible that members of remittance-receiving households are likely to later migrate themselves and, therefore, not value the local education as much. Second, because their consumption patterns might be under scrutiny by the remitter, the receiving households may adjust their consumption pattern to look more conservative and be
centered around necessities (such as food and public services/utilities, and presumably not education and other types of spending that could be considered unnecessary from theremitter’s point of view). To the extent that remittances represent a large share of the receiving family’s income, for the same level of disposable income, this tendency to “simplify” the spending pattern could in fact lead to lower spending on education (in nominal terms) out of total income.

Families with remittances do accumulate more savings. While the costs of migration on households have a negative effect, it is "not large enough ..to offset the accumulation of savings due to remittances."

I would be interested to see if similar remittance effects are to found in other countries with high levels of emigration.

Growth diagnostics: the dangers of agnosticism

Why does income grow faster in some countries than others? A common empirical approach in recent growth analysis has been to adopt an 'agnostic' approach and let the data do the talking (i.e. weak priors). But a new paper by Antonio Ciccone from Barcelona's ICREA-Universitat Pompeu Fabra, and ECB economist Marek Jarocinski, question this approach. In their new ECB working paper no. 852, Determinants of economic growth: will data tell? (PDF), they show that small differences in the comparative income data can have a substantial effect on the outcomes:

As many potential explanatory variables have been suggested, these agnostic empirical approaches inevitably need to start out with a long list of variables. We show that, as a result, the growth determinants emerging from these approaches turn out to be sensitive to seemingly minor variations in international income estimates across datasets. This is because strong conclusions are drawn from small differences in the R2 of different growth regressions. Small changes in the relative fit of different models—due to Penn World Table income data revisions or methodological differences between the PWT and the World Bank income data for example—can therefore lead to substantial changes regarding growth determinants.

Their analysis clearly shows that agnostic growth regressions can be sensitive even to small data revisions. They suggest that "the available income data may be too imperfect for agnostic empirical analysis". So what to do? Stronger (and fewer) priors:

At the same time, we find that the sensitivity of growth determinants to income differences across data revisions and datasets falls considerably when priors regarding potential growth determinants become stronger. That is, the data appears good enough to differentiate among a limited number of hypotheses. Empirical models of the typical size in the literature, for example, tend to point to the same growth determinants using different versions of the PWT or the World Bank income data.

Researchers who want to continue giving equal a priori weight to all potential growth determinants in the literature, should consider shrinkage priors, explicitly incorporating priors about measurement error in the income data, or implementing Zellner’s (2002) adjustment for data quality.

The Stern report revisited

Australia's Productivity Commission today published a very useful assessment of the Stern report on climate change. The 125 page staff working paper by Rick Baker, Andrew Barker, Alan Johnston, and Michael Kohlhaas, The Stern Review: an assessment of its methodology, provides both an excellent summary and a balanced assessement of the report's analysis and recommendations. Press reports picked up on this particular connclusion:

The Review’s ‘urgent’ language can be explained by it being as much an exercise in advocacy as it is an economic analysis of climate change. It is not surprising, therefore, that reaction to it has been mixed.

Bias? To be sure. But the Commission paper remains broadly supportive of Stern's approach. They acknowledge the immense analytical challenges confronting Stern and his colleagues:

Rarely do analysts confront cost–benefit analyses with dimensions so long-term, uncertain and non-marginal. This places extraordinary strains on analytical techniques that generally have been devised for more conventional projects, and almost inevitably means that value judgements and ethical perspectives become more prominent.

The authors argue (p.xvi) that the Stern report has made an important contribution to the climate change debate:

There appears to be an emerging view that the Review has made a valuable contribution by establishing climate change as an economic issue that can be assessed through the ‘lens’ of a cost–benefit framework. Moreover, the Review team continues to engage with its critics and to expose its work (including rebuttals of critiques) to scrutiny. In some instances, its responses indicate acceptance of criticisms levelled. In this respect the Review continues to be important as a catalyst for engendering further analysis, development and refinement of the economics of climate change.

And conclude that:

Some of the criticisms of the Review are justified. The assertiveness with which some of the headline messages are delivered is not always matched by the caution attached to the evidence and analysis presented within the body of the report. And, relevant questions remain about the way the analysis was focused. It is based on a single high emissions scenario, inclines towards more pessimistic assumptions on damage costs, and adopts unconventional parameters for discount rates. These traits tend to escalate the present value of future costs and thereby elicit urgency in mitigation measures.

This is consistent with the Review authors’ apparent belief that, although catastrophic outcomes may be unlikely, the implications for future generations, were they to arise, would be so detrimental that it would be remiss to fail to give them sufficient weight. There is nothing especially wrong with this view — as one critic has conceded, the Review’s conclusions may well be proved right but for the wrong reasons. However, the Review presents itself to decision makers as yielding conclusions underpinned by conventional, rational economic analysis. In fact, the authors’ concerns about catastrophe in conjunction with their attendant ethical perspectives, permeate many stages of the analysis. More sensitivity analysis to highlight the consequences of alternative views and value judgements would have been valuable.

Anyone interested in climate change should read this paper. It is available free online.

Britain's super rich: racing away?

The latest Institute for Fiscal Studies briefing note, Racing away? Income inequality and the evolution of high incomes, focuses on the 'super-rich'. Authors Mike Brewer, Luke Sibieta and Liam Wren-Lewis define this group of 'high income individuals' as the richest 1 in every 1,000 taxpayers (i.e. the top 0.1%) The super-rich earn £350,000 or more in taxable income a year. Nine in every ten are men, and most are lawyers, City bankers and the like. The accompanying IFS press release states:

The outlook for inequality in Britain may depend more on the outlook for the stock market than on Government tax and benefit policies, a study by IFS researchers suggests today. Even though the current Government has increased taxes on people with high incomes, this has not prevented them from them racing further away from the average level of living standards across the country. In recent years, it is only in the wake of extended falls in the stock market that the incomes of the richest have fallen.

The FT's Chris Giles comments on the role played by market forces in his piece, Very rich get richer under Labour:

Highlighting a sea-change from the early post-war years when wealth often derived from land or other inherited assets, Mr Sibieta said the 21st century super-rich received 80 per cent of their incomes from an occupation - whether salaried or self-employment - rather than investments. "We are talking about the working rich rather than the idle rich," said Mr Sibieta.

But the past decade has seen rich people's income sputter as well as soar. With so many working in finance, there is a strong link between their fortunes and those of the stock market. Real incomes of top-earners grew 6.6 per cent a year on average between 1996-97 and 2001-02.

Yet in the following two years, when the stock market reached its low point, they fell on average by 2.7 per cent, before picking up again alongside equities in 2004-05. That tight correlation leads the IFS to predict that, with the rapid growth of financial markets since 2004-05, the incomes of the richest will have risen quickly in the past two years.

The data show the impact of Labour's generous funding of the public services this decade. The one group outside finance, the law or property to be well represented in the top 1 per cent of incomes works in the health sector. These were "presumably doctors and senior health service managers who have enjoyed relatively big pay increases under Labour", added Mr Sibieta.

The 'super-rich' earn 31 times average incomes: around £780,000 pre-tax income a year, of which they pay on average almost £275,000 in income tax: a tax rate of 35.3%. This is double the rate paid by the average UK taxpayer, who earns around £25,000 and pays £4,400 in tax: a rate of 17.6%.

Growth theory: Solow or Lucas?

I've just come across a new OECD economic working paper on growth theory: Solow or Lucas? Testing growth models using panel data from OECD countries. Authors Jens Arnold, Andrea Bassanini and Stefano Scarpetta test whether the growth experience of a sample of OECD countries over the past three decades is more consistent with the human-capital augmented Solow model of exogenous growth, or with an endogenous growth model à la Uzawa-Lucas with constant returns to scale to “broad” (human and physical) capital. Here's their methodology:

We exploit the different non-linear restrictions implied by these two models to discriminate between them. Using pooled cross-country time-series data, we specify our growth regression by imposing cross-country homogeneity restrictions only on  long-run  coefficients, while  letting  the  speed  of  convergence  and  short  term  dynamics  to  vary  across  countries.

Their conclusions?

The results suggest a strong effect of human capital accumulation: the estimated long-run effect on output of one additional year of education (about 6-9%) is also within the range of the estimates obtained in microeconomic analyses of the private returns  to  schooling. Our estimated speed of convergence is too fast to be compatible with the augmented Solow model, while is consistent with the Uzawa-Lucas model with constant returns to scale. This main finding is robust to several robustness tests. 

US recession risk revisited

My previous posts, Is the US heading into a recession? seems to have a caused a flurry of comments. I remain of the view that the US economy will just scrape through 2008 without one. Admittedly, the run of data since that post has hardly been encouraging, with a plunge in the ISM (signalling a likely manufacturing recession) and some very weak non-farm payroll numbers.

Richard Berner & David Greenlaw from Morgan Stanley put the case for the prosecution in their recent piece: Is Recession Now in the Price?

Incoming data suggest that tighter credit has pushed the US economy to the brink, and we reiterate our call for a mild US recession in the first half of 2008. Weak employment data and slowing in export orders reported by purchasing managers undermine the case that a healthy consumer and strong global growth would forestall a downturn. Moreover, the ongoing housing recession is deepening, declines in capital goods bookings hint that business equipment spending will contract, and inventory liquidation seems likely. ...Most of the weakness is concentrated in the first half of the year; we project the economy will contract by about ¾% annualized in the first half of 2008, compared with 0.3% last month.

I agree the weakness will be in the first half, as I argued in my post 2008: No US recession. We might even see one negative quarter; but I'd be surprised if we see two consecutive declines. And that is the standard definition of a recession. My views are closer to those of Stefan Schneider at Deutsche Bank. In today's talking point he puts forward the DB baseline:

The US economy staggers for a few quarters, but does not actually collapse. The USD recovers in line with the US economy and the pricing process on the oil market returns to “more reasonable” ranges. In this environment the emerging markets grow somewhat less than last year but still quite strongly, at roughly 6½%.

Like Deutsche, I agree most of the risk are to the downside, and I could well be proved wrong. But don't underestimate the Fed. Today's dovish comments by Ben Bernanke show a preparedness to take whatever steps are deemed necessary:

...we stand ready to take substantive additional action as needed to support growth and to provide additional insurance against downside risks.

Meanwhile, the Economist today published its's latest R-word index. While it is certainly spiking upwards, we are not in 2001-territory just yet.

The Economist's informal R-word index is also sounding alarms. Our gauge counts how many stories in the Washington Post and the New York Times use the word “recession” in a quarter. This simple formula pinpointed the start of recession in 1981 and 1990 and 2001. In the past few years the R-word index has been extremely low. It began to rise in the second half of 2007 and, measured at a quarterly rate, has soared in early 2008 (see chart). Although the number of stories is still lower than before previous recessions, the recent jump—if sustained for a quarter—is similar to that which preceded the 2001 downturn

Other pointers include the Economic Cycle Research Institute weekly index. According to an Investor's Business Daily report, we're not there yet:

"A lot of things are teetering on the edge of tipping toward a recession," said Lakshman Achuthan, managing director of the Economic Cycle Research Institute.

...The ECRI's leading U.S. index ticked higher in the latest week. But the annualized growth rate fell to -6.2%, the weakest since Nov. 16, 2001, at the end of the last recession. The index's components include housing activity, job growth, interest rates, investor confidence, money supply growth, corporate profits and productivity.

"If these downward trends in the leading indicators continue for much longer, we will end up with a recession," Achuthan said. F

Finally, what about the prediction markets? Intrade have a US recession 08 contract, where you can bet on the likelihood that there are "two successive quarters of negative real GDP growth" this year. The contracts were hovering around the 50% mark until last week. Since then they have shot up to the 60-65% mark (click on chart). Given my assessment, I should probably short the contract.