Sunday, May 17, 2009

What determines whether we have successful lives?

Your chances of success in life depend on your intelligence, your family background and your temperament, don’t they? Yes, to some extent. But over the last few days I have read about research findings which suggest that beyond a threshold IQ doesn’t make much difference, the important aspects of family background are only superficially related to wealth and the predictive importance of childhood temperament tends to diminish over time.

In “Outliers” Malcolm Gladwell tells the story of research conducted by Lewis Terman who identified 1,470 Californian children with very high IQs (over 130) in the 1920s. Terman believed initially that members of this group were destined to be among the future elite of the U.S. When they grew up, however, the majority had careers that could only be considered ordinary. It turns out that the relationship between IQ and success works only up to a point. Additional points of IQ beyond about 120 (remember the population average equals 100) don’t seem to have much impact on success.

Further analysis divided these genius subjects into three groups and looked for reasons for differences between the achievements of the most successful and least successful groups. The main difference seemed to be that the most successful performers came from the middle and upper class – the most successful group contained almost none of the children from the lowest socioeconomic class. Later in his book Gladwell points to evidence which suggests that the link to socioeconomic class has little to do with things that are directly associated with wealth or even with the quality of schooling. Research by Karl Alexander shows, for example, that the main difference between reading scores between elementary school children emerge during the summer vacation period while they are not at school. The wealthier parents tend to cultivate the interests of their children in reading etc. even during the summer vacation period. The difference seems to have more to do with culture than with income.

Gladwell’s main point is that it is impossible for superstars in any field to look down from their lofty perches and say with truthfulness, “I did this all by myself”. Gladwell argues: “They are the products of history and community, of opportunity and legacy. Their success is not exceptional or mysterious. ... The outlier, in the end, is not an outlier at all” (p 285).

Something else I have read recently that relates to the determinants of successful lives is Joshua Wolf Shenk’s article “What Makes Us Happy” (The Atlantic Online, June 2009). Shenk’s article discusses George Vaillant’s research, based on the Harvard Study of Adult Development. This study of healthy, well-adjusted Harvard students began in 1937 and followed its subjects for more than 70 years. As with Terman’s study, the leading researcher originally involved in the Harvard study thought he would be studying a group of people who would have successful lives. Many did in fact achieve dramatic success, but by age 50 almost a third of the subjects had at one time or another met Vaillant’s criteria for mental illness.

One of Vaillant’s findings is that the predictive importance of childhood temperament diminishes over time: shy, anxious kids tend to do poorly in young adulthood, but by age 70 they are just as likely as the outgoing kids to be happy and well. One of the factors that he found to predict healthy aging is “employing mature adaptations” to life’s troubles. Mature adaptations include altruism, humour, anticipation (planning for future discomfort) and delaying attention to an impulse or conflict. The second most important factor that he found to predict healthy aging was the quality of relationships, including with siblings, friends and mentors.

Will Wilkinson comments on his blog: “What I liked so much about this essay, and about Vaillant, is the recognition that the complexity of human psychology, the complexity of coping and adapting to the challenges life throws up, makes relationships or “social aptitude” no simple thing.” I agree.

This brings me back to Gladwell’s book. One of the things from “Outliers” that will stick in my mind is Gladwell’s account of the Roseto mystery. In brief, in the 1950s the inhabitants of Roseto (Pennsylvania), whose ancestors came from a town of the same name in Italy, had a very low incidence of heart disease and their death rate from all causes was 30 to 35 percent lower than expected. Researchers ruled out all the obvious causes such as diet, exercise, genes and location. Their explanation was that Rosetans had created a powerful, protective social structure capable of insulating them from the pressures of the modern world. In Gladwell’s words, it was about “the mysterious and magical benefits of people stopping to talk to one another on the street and of having three generations under one roof” (p 10).

This is very interesting and very complex. I find myself reacting in three different ways. First, in statistical terms “outliers” are chance events; before getting too excited about sociological implications we should establish whether there is evidence that other communities which share similar characteristics to Roseto in the 1950s have similar health outcomes. Second, leaving aside the “mysterious and magical” factors, the most useful place to look for an explanation would be in the links between happiness (emotional health) and physical health. Third, perhaps it is time I had a closer look at the research findings behind those headlines a few months ago which claimed that scientists now have evidence that happiness is contagious.

Friday, May 15, 2009

Where will the productivity growth come from?

In the Australian federal budget delivered earlier this week, forward estimates of revenue and spending were based on Treasury projections of economic growth rates in excess of 4 percent coming out of the current recession. This projection has attracted attention because the projected growth rates are higher than those experienced in Australia during recent boom years.

It seems reasonable to me to suppose that growth rates might be somewhat above trend when an economy comes out of a recession. An economy that is not limited by capacity constraints obviously has potential to grow more rapidly than one approaching full employment.

However, the Treasury’s optimism about future economic growth prospects in Australia seems to me to sit oddly with their more guarded views about prospects for the world economy. In discussing the outlook for the world economy Treasury states: “Even when growth returns, the recession will leave a legacy of significant policy challenges across the world. The extraordinary measures being taken to combat the current crisis will have to be unwound carefully.” Governments will not find it easy to unwind these extraordinary measures. This means that commodity exporting countries like Australia should expect the world economy to give them a fairly bumpy ride in the years ahead.

Why is Treasury so optimistic about Australia’s growth prospects? The Treasury forecasters base their optimism on the growth rates experienced in Australia following recessions in the 1980s and 1990s. Their projected growth rate is about the same as that following the 1990s recession.

Even if it is reasonable to expect world economic growth in the 2010s to be as robust as in the 1990s, is it reasonable to expect that Australia’s productivity growth in the 2010s to be as high as in the 1990s? The 1990s was a period in which multifactor productivity growth in Australia was more than double the rate experienced in recent years. High rates of productivity growth in the 1990s stemmed to a large extent from productivity improvements in the services sector, which were associated with micro-economic reforms (neo-liberalism in the terminology favoured by Australia’s current Prime Minister).

Where will comparable productivity improvements come from during the 2010s? Perhaps the government has plans for extensive microeconomic reforms that it has yet to announce. But I wouldn’t bet on it!

Tuesday, May 12, 2009

How much prudential regulation do we need?

It was a few weeks since I had seen Jim, so I made the mistake of asking him what he had been doing. He replied that he had been thinking about bankruptcy.

I said that I didn’t know his financial situation was that bad. Jim replied that he wasn’t having too much trouble paying his own bills at this stage, but he had been thinking about bankruptcy as an institution and about the role of government in bankruptcy. While he was saying that I was thinking that Jim was not the kind of person who would ever have too much trouble paying his bills. I heard him ask: “What do you think about bankruptcy?”

I said that I thought modern bankruptcy laws that wiped the slate clean when debtors had no hope of meeting their obligations were a huge advance on traditional practices such as virtual enslavement or imprisonment of people who could not pay their debts. I added that in my view there had to be a role for government in this process because you can’t allow people to hire muscle to pressure people to pay their debts. Since we have to rely ultimately on the coercive power of government to enforce contracts then we have to rely on government to devise rules about the conditions under which contracts cannot be enforced.

Jim nodded. He then asked: “What do you think about limited liability?” I said that I thought the contribution of limited liability to economic growth was often overstated because liability insurance could have arisen to serve a similar purpose in enabling individual investors to limit their liability when in investing in companies. I added, however, that I couldn’t see a problem in the owners of a firm declaring that their liability was limited to the amounts they had invested. In my view transparency is the important issue: people who lend money to the firm or provide good on credit should be aware that if the firm goes bust the liability of the owners is limited.

Jim said: “Hmm, so you are saying that if I form a company to engage in speculation there should be no limit on the amount of debt that the company can incur? Are you saying that I should be allowed to gamble with other people’s money secure in the knowledge that if the gamble doesn’t pay off then my own liability is limited to the extent of my own investment in the company?” I insisted that transparency was the important issue. If people are prepared to take the risks involved in lending money to speculators, good luck to them.

Jim said: “People who take those risks need all the luck they can get. What about systemic risks? It is one thing to accept that a few people will lose their life savings whenever some highly leveraged property speculator goes bust, but isn’t it something quite different when confidence in the whole financial system is threatened because of excessive leverage in major financial institutions?” I did my best to put the argument that the current financial crisis arose at the end of last year because central banks in major economies hadn’t established a credible commitment to maintaining a stable rate of nominal GDP growth. I suggested that the best way to deal with the deleveraging and associated decline in the velocity of circulation would have been by maintaining a monetary policy that would promote expectations of a stable rate of growth in nominal GDP.

I could see Jim’s eyes glaze over as I spoke. He said: “If you were making government policy decisions in the aftermath of the current financial crisis wouldn’t you be looking to see what could be done to avoid re-emergence of systemic risk in major financial institutions? I had to admit that if I was making government policy decisions I would probably be looking for policy levers relating to capital adequacy and things like that.

Jim said: “Ah, you sound just like one of those neo-socialists who advocates more financial regulation in order to save the capitalist system. Rather than interfering in the financial management of healthy companies, wouldn’t it be better for governments to focus on improving laws to minimize the adverse effects on the wider economy that can occur when some companies become insolvent. For example, why can’t the ownership of insolvent companies be quickly transferred to creditors?”

Jim seems to like asking me questions that I can’t answer.

Sunday, May 3, 2009

Is money a message as well as a medium?

Money is the medium of exchange as well as the unit of account and store of value. As the medium of exchange money makes life easy because we don’t have to spend a lot of time trying to find someone who is prepared to trade the goods we want to buy for the goods we want to sell. I have never been able to understand what Marshal McLuhan was talking about when he said “the medium is the message”, but the question I want to consider is whether we behave differently when we have money on our minds.

The idea that people may behave differently when they have money on their minds has a long history. Everyone has heard the biblical claim: “the love of money is the root of all evil”. What does this mean? This is not really an assertion that it is evil to collect coins, is it? It seems to me that the statement was not really about money at all but about the love of the worldly goods that money can buy.

The question of whether people behave differently when they have money on their minds also comes up in discussing when it is or is not appropriate to attempt to motivate other people using money. Tyler Cowen, for example, has used several parables to discuss this question, including the dirty dishes parable. Is paying one of your children a good way to ensure that the dishes are washed? Probably not. Children may feel less obligation to do their share of family chores if a voluntary exchange relationship is established in which the parent becomes an employer providing money in exchange for work, rather than a family leader “who is due some amount of obedience in his or her own right” (“Discover your Inner Economist”, p 14).

Is the payment of money intrinsic to this parable? I think that many economists would tend to say that the parable would apply in the same way if the child is paid in kind, e.g. in tickets to rock concerts, rather than in money. In the minds of many economists the issue would appear to be whether strict reciprocity is appropriate to the circumstances rather than about the method of payment that is used. Economists often say that money is a veil.

However, I am not sure that many parents would rule out all forms of bartering as being inappropriate as a means of motivating a child to do his or her share of family chores. It seems to me that bartering could be appropriate if it is about the things that parents do for their children that are beyond what might be generally considered to be the core responsibilities of a parent. For example, like many other parents, while my kids were in their teens I used a substantial part of my leisure time providing an unpaid taxi service to ferry them and their friends to and from various sporting and entertainment activities. Would it be inappropriate for a parent to suggest to a child that it would be unfair to expect provision of such services unless he or she does an appropriate share of family chores without having to be constantly reminded?

This raises the question of whether responses to provision of incentives have more to do with perceptions of the appropriateness of particular incentives than with concepts such as the strictness of reciprocity or the money value of the incentives provided. There is some evidence that actions that merely remind people of money can have a significant effect on behavior. For example, Kathleen Vohs, Nicole Meade and Miranda Goode report an experiment in which participants were primed by sitting at a desk facing posters showing various denominations of currency or posters showing either a seascape or a flower garden. The participants were then presented with a nine-item questionnaire in which each question asked them to choose between two leisure activities – an experience that only one person could enjoy and an experience that two or more people could enjoy together. Participants primed with the money poster tended to chose more individually focused experiences. The authors report similar results for eight other experiments (‘The psychological consequences of money’, Science, 318 (5802), 2006).

So what if responses to incentives are strongly influenced by perceptions of the form in which the incentive is provided and the language used when the offer is made? The most obvious implication is that a lot of care is required in selecting incentives that are perceived to be appropriate and in presenting them in an appropriate way to achieve the desired effect. There are quite different implications in relation to prevention of corruption. The ethics of accepting a bribe do not change merely because the incentive offered is more subtle than a bundle of notes in a brown paper bag.