Tuesday, May 13, 2008

How does inner freedom vary with per capita income level?

In earlier posts about inner freedom - the feeling of choice or control over the way life turns out - I have discussed some implications of the observation that humans have a passion for control of their lives (here), the correlation at a country level between inner freedom and life satisfaction (here) and the extent to which inner freedom varies with economic freedom (here).

In this post I present a chart showing how the probability of feeling in control of life varies with average income levels of countries. Data sources are the same as those used in posts referred to above.

The graph presents a similar picture to that shown in the post on inner freedom and economic freedom. The probability of inner freedom tends to rise more gradually with per capita income levels than does the probability of being satisfied with life.

Monday, May 12, 2008

Is there evidence that institutionalised transparency reduces the political power of narrow interest groups?

Recent posts by Richard Posner and Gary Becker on their blog (May 4 ) discuss US farm subsidies that apparently amount, on average, to of the order of $50,000 per farmer. Posner suggests that these subsidies are outlandish and that “their firm entrenchment in American public policy illustrates the limitations of the American democratic system”. Becker points out that the subsidies are a consequence of interest group competition that tends to favour small groups of producers (who gain substantial benefits per person) at the expense of large groups of taxpayers and consumers (whose losses are relatively small in per capita terms).

I left a couple of comments on Becker’s post, the second of which was as follows:

“... it seems to me that some political outcomes are outlandish even though they can be explained in terms of democratic politics e.g. in terms of the relative power of different pressure groups associated with differential rational ignorance and free-rider problems.
The interesting question is whether better outcomes could be achieved through institutional changes e.g. through procedures to promote greater transparency and thus reduce rational ignorance problems.”

I must confess that the question of whether transparency institutions have the capacity to reduce rational ignorance problems is something that I have thought about quite frequently over the last 35 years, having worked in such a transparency organisation for a considerable part of that time.

The latest WTO Trade Policy Review of Australia makes the following observation:

The high degree of transparency in the formulation and evaluation of Australia’s economic policies in relation to their rationale, nature, and economic effects, enhances government accountability and public debate over the merits of these policies. Hence, transparency has contributed greatly to the continued process of reform, which began in the 1980s, and in which trade liberalization, much of it unilateral, has played an important part. (WTO 2007, p. vii)

The TPRM report emphasised that the transparency function had become
institutionalised in Australia, notably through the role of the Productivity
Commission (and its predecessor organisations) as an independent review and
advisory body on microeconomic policy and regulation.

The role of the Productivity Commission and its predecessor organisations has been discussed in a recent paper by Gary Banks and Bill Carmichael, available here.

In discussing the possible relevance of the Productivity Commission as a model for other countries, Banks and Carmichael suggest that Australia’s experience demonstrates that institutionalised transparency can help promote reforms. They do not suggest, however, that institutionalised transparency is a magic wand.

“Expectations need to be tempered: transparency is unlikely to transform the policy environment overnight. Building a pro-reform constituency in government and the wider community is a gradual process. It took Australia four decades to get tariffs down and more than a decade tackling sources of underperformance in economic infrastructure services. And neither reform program is yet complete.

That said, reforms once made in Australia have tended to stick, having stronger foundations of support or acceptance within the community precisely because the basis for reform was transparent. The programs of tariff liberalisation and regulatory reform initiated under one government have generally been maintained by new governments of different political complexions”.

Banks and Carmichael conclude as follows:

“We recognise that Australia’s transparency arrangements may not suit other countries. There can be no ‘one size fits all’ approach. Arrangements in other countries must necessarily reflect their cultural and political systems, and ensure domestic ownership of national trade policy. However, finding ways of achieving the broad principles of domestic transparency in other countries’ institutional settings is an objective to which Australia’s experience lends considerable support”.

Saturday, May 10, 2008

Is inner freedom related to economic freedom?

In earlier posts about inner freedom - the feeling of choice or control over the way life turns out - I have discussed some implications of the observation that humans have a passion for control of their lives (here) and the correlation at a country level between inner freedom and life satisfaction (here).

In this post I want to consider the extent to which inner freedom varies with economic freedom i.e. the extent to which people are free to undertake economic activities without excessive government regulation or taxation.

What reasons do we have to expect that inner freedom and economic freedom might be correlated? First, it is possible that people might feel that they have greater control over their lives when they have greater freedom to engage in economic activities without government interference. Second, economic freedom provides incentives for wealth creation; and greater wealth may give people a feeling of greater control over their lives. Third, it is possible that causation may run in the other direction. When people feel in control of their lives they may feel less threatened by competition and hence less supportive of restrictions on economic freedom.

Economic freedom data used in compiling the chart below has been derived from the Fraser Institute’s Economic Freedom of the World project (here). After matching with inner freedom data (sourced from “Human Beliefs and Values” by Ronald Inglehart et al) data were available for 66 countries for the year 2000. After ranking by level of economic freedom, averages were calculated for each quintile of the percentage of people in the countries concerned who feel in control of their lives and who feel satisfied with their lives.

The chart shows that, on average, the percentages who feel in control of their lives are substantially higher in countries with high levels of economic freedom than in countries with lower levels of economic freedom. The chart suggests, however, that life satisfaction tends to rise more steeply with higher economic freedom.

Friday, May 9, 2008

Is there much difference between feeling in control of your destiny and feeling satisfied with life?

In an earlier post about inner freedom (here) I mentioned that I would look further at how closely inner freedom is correlated with life satisfaction.

One of the questions that people have been asked in the world values survey is “how much freedom of choice and control you feel you have over the way your life turns out”. They are asked to indicated this on a scale where 1 means “none at all” and 10 means “a great deal”.

In the following scatter diagram each point shows for an individual country the proportion of the population who feel they have a great deal of this inner freedom and the proportion of the population who feel satisfied with life as a whole. (Data are for 72 countries for the year 2000 and have been sourced from “Human Beliefs and Values” by Ronald Inglehart et al.)

The chart shows that there is correlation at a country level between life satisfaction and inner freedom. Countries in which a high proportion of the population feel satisfied with life as a whole tend to be the same as those in which a high proportion of the population feel a great deal of inner freedom. The correlation is obviously far from perfect, however. The percentages feeling a great deal of inner freedom in Italy, Belgium and the Netherlands, for example, were lower than would be expected on the basis of percentages feeling satisfied with life. On the other hand, the percentages feeling a great deal of inner freedom in Venezuela and Taiwan, for example, were higher than would be expected on the basis of percentages feeling satisfied with life.

I have conducted a regression analysis in order to see whether the difference between inner freedom and life satisfaction is related to various values or beliefs. The dependent variable was the percentage who feel a great deal of inner freedom and the explanatory variables were: the percentage who feel satisfied with life; the percentage who say competition is good (it stimulates people to work hard and develop new ideas); the percentage who place high importance on leisure; the percentage who say it would be good if less importance is placed on money; and the percentage who say that people should take more responsibility to provide for themselves.

Apart from life satisfaction the only variable for which the estimated coefficient was significantly different from zero was the competition variable. That result seems to me to make sense. If a high proportion of a population feel that they have a great deal of choice and control over the way their lives turn out then it stands to reason that they are more likely to feel that competition is a good thing.

Monday, May 5, 2008

Are we rational or predictably irrational?

If you ask Tim Harford, author of “The Logic of Life” (2008), he would say that we can generally be expected to make rational decisions. According to Harford, people do the things they do largely as a result of rational choices.

If you ask Dan Ariely, author of “Predictably Irrational” (2008), he would say that we are generally far less rational than we think we are. According to Ariely, while we like to think of ourselves as sitting in the driver’s seat, with ultimate control over the decisions we make, we are actually pawns in a game whose forces we largely fail to comprehend. We tend to make the same mistakes over and over because of the basic wiring of our brains.

After reading these books I felt that both authors made some good points. Is it possible that both could be right?

Harford adopts the time-honoured economic method of seeking to explain how various phenomena could be a consequence of rational individual behaviour. He refers to research studies explaining a wide variety of things in these terms that are often thought of as symptoms of irrationality. The list includes crime, addictions, divorce, provision of astronomical remuneration to some chief executives, racial segregation and the growth of large cities.

Ariely approaches the subject as a behavioral economist. His research methodology is more akin to experimental psychology than economics. He uses his experiments to illustrate that human behavior is influenced by a list of factors other than rational choice. This list includes price anchors, the power of gifts, social norms, the influence of arousal, the problem of procrastination, the tendency to over-value the things we own, the effect of expectations and the influence of ethical codes on integrity.

It seems to me to be possible for both Harford and Ariely to be right because they use different definitions of rationality. Harford’s definition of rationality is simple: rational people respond to incentives (p 8). Ariely views rationality as involving much more. In his terms, to be rational implies “that we know all the pertinent information about our decisions, that we can calculate the value of the different options we face, and that we are cognitively unhindered in weighing the ramifications of each potential choice” (p 239). Rationality involves making “logical and sensible decisions” and “if we make a wrong decision from time to time we will quickly learn from our mistakes (p 239).

That might make it possible for Harford to say that a person’s behaviour in some situation was rational whereas Ariely could say that it was predicably irrational. There is not a great deal of overlap between the things that Harford and Ariely have written about, but what they have to say about self-control in relation to spending and saving decisions can be used to illustrate this point. Harford would argue that when we have self-control problems the warring parties within us are both rational - it is just that one party is impatient and the other party is willing to wait for larger rewards in the future (pp 56 -66). Ariely implies that a person with such problems is having difficulty behaving rationally (p 122-3). Both acknowledge the potential to resolve problems by making strategic decisions e.g. placing your credit card in a glass of water in the freezer, so that you have to wait for the ice to thaw before you can use it.

The definition of rationality may have some importance to the extent that it is used as an anchor in public discussion. When we define rationality so broadly that foolish behaviour can be rational, some foolish people may think that this implies approval. Similarly, when we define rationality too narrowly some foolish people may think that the existence of irrational behaviour by individuals provides an open and shut case for more government regulation.

While adopting a broad definition of rationality, Tim Harford acknowledges that individual rationality can produce undesirable social outcomes. For the most part Dan Ariely suggests that the best way for individuals to deal with their irrational tendencies is to be aware of them. Sometimes, however, he slides quickly (too quickly in my view) from identifying irrationality to suggestions for government intervention.