Showing posts with label psychology. Show all posts
Showing posts with label psychology. Show all posts

Wednesday, March 20, 2013

Economists show racism alive and well in Oz

Australians aren't racist - and even if some people are, you and I certainly aren't. It's true, of course, that many of us are terribly stirred up about the arrival of so many uninvited boat people. And both sides of politics vie to be seen as harsher in their treatment of these interlopers. Then there's Julia Gillard's new-found concern about foreigners getting to the head of the jobs queue.

But this has nothing to do with racism. Gillard reassured us in the 2010 election campaign that we should say what we feel in the asylum-seeker debate without being constrained by self-censorship or political correctness.

"For people to say they're anxious about border security doesn't make them intolerant. It certainly doesn't make them a racist," she said.

It may surprise you that racial discrimination has long been a subject of study by economists - particularly American economists and particularly as people's "taste for discrimination" relates to the labour market.

Two economists from the University of Queensland, Redzo Mujcic and Professor Paul Frijters, will publish the results of a natural field experiment on Thursday in which trained "testers" of different ethnic appearance got on buses in Brisbane, discovered their travel card wouldn't work, but then asked the driver to let them to make the trip anyway.

Various testers did this more than 1500 times. Overall, the driver agreed in almost two-thirds of cases.

But whereas the success rate for testers of white appearance was 72 per cent, for testers of black appearance it was just 36 per cent.

Testers of Indian appearance were let on 51 per cent of the time, whereas those of Chinese, Japanese or Malaysian appearance were allowed to travel about as much as Caucasians were.

On average, bus drivers were 6 percentage points more likely to favour someone of the same race. Black drivers tended to be the most generous, accepting in 72 per cent of cases, compared with 54 per cent by Indian drivers and 64 per cent by Asian and white bus drivers.

If you think that's interesting, try this: to test the importance of how people were clothed, the testers were then dressed in business suits with briefcases. The success rate of whites rose by 21 percentage points and the combined rate for blacks and Indians rose to 75 per cent.

Next, the testers were dressed in military clothes. The success rate of whites rose by 25 percentage points while the combined rate for blacks and Indians rose to 85 per cent.

As a follow-up, the researchers then conducted a random survey of bus drivers at selected resting stations in Brisbane, presenting them with pictures of the same test subjects and asking the bus drivers whether they would let them on or not with an empty travel card.

Some 80 per cent of the bus drivers at resting stations indicated they would give free rides to Indian and black test subjects, even though in reality less than 50 per cent were let on.

Indeed, bus drivers said they would let on white subjects 5 percentage points less often than black subjects, whilst in reality white test subjects were favoured at least 40 percentage points more than black testers.

The main reason given for not letting someone on was it was against the rules, while the main reason to let someone on was it was no burden to do so.

It's all a bit disturbing - if not so surprising - but how do we make sense of it? And what's it got to do with economics?

Frijters, perhaps Australia's leading exponent of "behavioural" economics, is developing an economic theory of groups: the different types of groups and how and why they form. All of us feel an affinity with a range of groups. Businesses and government agencies are groups, but there can be groups within those groups; working teams as well as sporting teams. Mixed in with all this are in-groups and out-groups - people we want to associate with and people we don't.

Often we form groups so as to co-operate in achieving some goal. And groups often involve reciprocation - I do you a favour in the expectation that, when my need arises, you'll do me one.

So Frijters explains the results of his experiment in terms of group behaviour. "People with Indian or black complexions are more likely to be treated as an out-group and less worthy of help compared to Caucasians and Asians," he says.

"The reason bus drivers were more reluctant to give black and Indian help-seekers a free ride was that they did not personally relate to them."

When testers were sent to bus stops in military clothes this made them appear to be patriots, defending the same community as the bus driver. So the drivers' original out-group reaction could be overcome by in-group clothing.

The more favourable treatment of testers in business dress suggests the "aspirational groups" of the bus drivers include people richer than themselves, people with more desirable visual characteristics. That is, people the drivers regard as part of their in-group.

If all this sounds more sociological or to do with social psychology than with economics, it is. But that's the point of behavioural economics: to incorporate insights from other social sciences into economics.

And what have groups got to do with economics? That's simple: the objective of many groups is to give their members greater control over economic resources.

Frijter's new book, An Economic Theory of Greed, Love, Groups and Networks, written with Gigi Foster, will be published this month.

Can't wait.

Monday, February 4, 2013

Why voters seen the economy as in bad shape

Despite last week's excitement, Julia Gillard's early announcement of the election date is unlikely to change much. It's certainly unlikely to change many voters' perceptions on a key election issue: her ability as an economic manager.

It's long been clear from polling that the electorate doesn't regard the government as good at managing the economy.

Why this should be so is a puzzle. As Gillard rightly claimed last week: "As the global economy still splutters, unlike the rest of the world we have managed our economy so we have low inflation, low interest rates, low unemployment, solid growth, strong public finances and a triple-A rating with a stable outlook from all three of the major ratings agencies."

I've said elsewhere that part of the reason for this yawning gap between perception and reality is that many people's perception of how well the economy's being managed proceeds not from independent observation but from their political alignment. Once I know who I'm voting for I then know whether or not the economy's travelling well.

But there's another part of the explanation: the public's inability to distinguish between cyclical and structural factors. Most of the bad news we heard last year was structural in nature, meaning it changed the shape of the economy rather than its overall size, adversely affecting some parts but favourably affecting others and having little effect on most.

But such analysis is too subtle for most punters. To them, all news is cyclical: good news means the economy's on the up and up; bad news means it's going down and downer.

Add the media's inevitable predilection for trumpeting bad news, underplaying good news and totally ignoring anything that doesn't change, and structural change can't help but be perceived as an economy in trouble.

The resources boom is the classic case of structural change. It's in the process of giving us a bigger mining sector and bigger non-tradeable services sector, but a relatively smaller manufacturing sector and internationally tradeable services sector.

The mechanism that brings much of this about is the high dollar. It harms all export- and import-competing industries, but benefits everyone who buys imports (which is all of us). It marginally benefits three-quarters of our industries, which are non-tradeable (they neither export nor compete against imports) but do buy imported supplies and equipment.

Now consider the recent performance of unemployment. Over the year to December, the unemployment rate rose from 5.2 to 5.4 per cent.

Admittedly, the rate at which people of working age were participating in the labour force by holding a job or actively seeking one fell from 65.3 to 65.1 per cent. This decline in participation is probably explained mainly by some people becoming discouraged in their search for a job.

Even so, it's surprising people became a lot more worried about unemployment last year. Why did they? Because they get their impressions about the state of the labour market not from the official statistics but from stories on the TV news about people being laid off from factories.

If voters were more economically literate they'd respond to this news by thinking, "Gosh, isn't manufacturing being hit hard by the high dollar - but fortunately I don't work in manufacturing and only 8 per cent of workers do." What many actually thought was: "Gosh, maybe I could lose my job, too."

Thus was a structural problem affecting only a small part of the economy taken to be a cyclical, economy-wide problem.

It's a similar story with the much-publicised tribulations of the retailers, which arise from their need to adjust to various structural problems, such as the inevitable end to the period in which household spending grew faster than household income, and the rise of internet shopping.

With all the silly talk about "the cautious consumer" and with punters blissfully unaware that retailing accounts for only about a third of consumer spending, all the highly publicised complaints of the Gerry Harveys helped convince the public not that the retailers have their own troubles but that the economy must be going down the tube.

Then there's the contribution of the unending fuss about "debt and deficit", in which the government has been completely outfoxed by the Liberals.

Although every economically literate person knows Australia doesn't have a significant level of public debt, the opposition has had great success exploiting the public's ignorance of public finance and of just how big the economy is ($1.5 trillion a year) by quoting seemingly mind-boggling levels of gross public debt.

With much of this argy bargy being reported by political rather than economic journalists - how many times have you heard talk of "the economy's deficit"? - it's hardly surprising the public has acquired an exaggerated impression of the economic significance of the budget deficit.

Ironically, the budget deficit is a case where a cyclical (temporary) problem has been taken to be a structural (long-lasting) one.

But Labor has to accept much of the blame for this bum rap. Rather than standing up to the nonsense the Libs were talking, it took the path of least resistance, purporting to be just as manic as they were. Then came Gillard's foolhardy decision to take a mere Treasury projection of the budget outcome in three years' time and elevate it to the status of a solemn promise.

By now, the voters' majority perception that the economy's in bad shape and Labor isn't good at managing it is deeply ingrained.

Saturday, October 6, 2012

How the financial system works

It’s amazing to think the mighty, mysterious, overawing edifice of high finance - run by people much smarter and infinitely better-paid than us - is built on a pathetically simple, often fickle emotion: trust.

This is something economists and bankers understand in theory but, in their world of high-falutin’ mathematical models, keep forgetting in practice - to everyone’s cost. In this they exhibit the very human fallibility they so often assume away in their fancy calculations.

It’s also so elemental - and so humbling - they rarely talk about it. So when someone in authority spells it out for the benefit of mere mortals, it’s work taking note. An assistant governor of the Reserve Bank, Dr Guy Debelle, did so in a speech last week.

He started by explaining what banks and the financial sector do. They act as ‘intermediaries’ between savers and borrowers, taking the funds they raise from savers - through deposits, for instance - and lending them to those who wish to borrow, whether they’re businesses, governments or householders.

The financial sector is an intermediate sector, Debelle says. It’s not at the end of a production chain producing something that directly generates satisfaction. Rather, it’s a critical link along the way; the oil that keeps the economy ticking over. ‘When the oil dries up,’ he says, ‘the economic engine starts to malfunction and can ultimately grind to a halt.’

So the financial sector is different from other parts of the economy and its central role in keeping the rest of the economy functioning explains why it’s subject to considerably more government regulation and oversight than other industries (something many governments forgot in the years before the global financial crisis).

But why do we need financial intermediaries? Why don’t savers lend to borrowers directly? Mainly because of ‘asymmetric information’. This just means I know more about my affairs than you do. It’s hard for a saver to know whether the person or business to which they’re going to lend money will use the money wisely and be in a position to repay the loan when it falls due.

In contrast, a bank is practiced at making such an assessment of credit-worthiness and so can reduce (but never eliminate) the degree of asymmetry. The size of the interest rate charged by the bank should reflect its assessment of the degree risk of not being repaid.

The other main advantage of lending via intermediaries is their scope for ‘diversification’ - making a range of different loans to people or firms in different circumstances means the bank should not be overly exposed to a particular loan going bad.

So banks are able to ‘mutualise’ risk in a way individual savers can’t. ‘If there is a problem with one loan, the lender should be earning sufficient interest on the rest of its loan portfolio to cover the loss,’ Debelle says.

Now we see where trust comes into it. Largely because of the problem of asymmetric information, there has to be trust between depositors and the bank that their funds are safe. And there is trust between the bank and its borrower that the borrower has provided accurate information and will act in good faith.

Trust is needed to cover the asymmetry that remains despite the ‘due diligence’ of the depositor in assessing the riskiness of the bank and of the bank in assessing the riskiness of the borrower.

Trust is particularly important because banks engage in ‘maturity transformation’ - in the jargon, they ‘borrow short and lend long’. Banks will let you deposit your money ‘at call’ (you can withdraw it at any time) but, on the other hand, will lend this money for periods up to 30 years.

Were too many depositors to lose trust in their bank at the same time, it would not be able to call in all its loans and so would not be able to return the depositors’ money. To prevent such a thing occurring, central banks stand ready to lend to banks if they need it. The trust in these arrangements is almost always enough for them not to be needed, Debelle says.

Banks don’t always hold on their own books all the risk (debt) they’ve taken on, but use devices such as ‘securitisation’ (bundling many consumer loans into a bond, which is then sold to investors) to distribute the risk around the financial system.

This means the process of financial intermediation often has a number of links in the chain. This, in turn, means trust needs to be present at every stage in the chain. ‘One breakdown in this chain of trust between ‘counterparties’ can throw a spanner in the works of the whole process,’ he says.

Guess what? The global financial crisis can be explained as a consequence of the breakdown of trust.

The years leading up to the crisis were a period of what Debelle calls ‘lazy trust’. Things were going along fine, so too many people relaxed their due diligence. Too many borrowers were taken at their word, without checking.

‘Moreover, with long chains of intermediation involved, there was often too much distance between the ultimate holder of the risk and the source of the risk. Too many links means that details get lost or misheard. If the due diligence is necessarily incomplete by the very nature of financial transactions, then that incompleteness is likely to get magnified, the more chains there are in the transaction.

‘The due diligence gets dissipated along the chain. There is a presumption that someone further up the chain did the due diligence.’

Such behaviour was anything but rational. As Debelle concedes, ‘good times beget complacency’. ‘It does seem to be a trait of human behaviour that has been evidenced many times in financial history.’

Lazy trust evaporated. The financial system switched rapidly from complacency to deep mistrust. In particular, trust broke down between financial institutions. Knowing they had a lot of bad loans on their own books, institutions assumed the same was true of their competitors, though to an unknown extent.

Institutions stopped lending to each other, so intermediation broke down. Central banks had to step in and provide banks with the funds they needed. This is still true in Europe, and a lack of trust in the longevity of the euro has made people unwilling to lend even to some governments.

The trouble now is that trust can be quickly and easily shattered, but takes a long time to rebuild.

Wednesday, October 3, 2012

The psychological roots of morality (and politics)

Paul Keating still quotes his early mentor, Jack Lang: "In the race of life, always back self-interest - at least you know it's trying". This may be why, as treasurer, Keating so readily embraced economic rationalism. The economists' working model assumes the self-interest of the individual is the sole force that makes the world turn.

Fortunately, the latest research tells us it's not that simple.

I can't go on a sight-seeing holiday without taking a few good books for a little intellectual sustenance at the end of the day. One book I took this time was a ripper, The Righteous Mind: Why good people are divided by politics and religion, by Jonathan Haidt, a moral psychologist at the University of Virginia.

Haidt (pronounced Height) says decades of research by political scientists have concluded that self-interest is a weak predictor of voters' policy preferences.

Why? Because people care about the groups they belong to - whether they be racial, regional, religious or political. They seem to be asking themselves not "what's in it for me?" but "what's in it for my group?". Political opinions function as "badges of social membership".

Whereas the old view was that natural selection had caused us to evolve into self-seeking competitors, Haidt argues we're more accurately thought of as "homo duplex" - a creature who exists at two levels: as an individual and as part of the larger society.

Human nature is mostly selfish: our minds contain a variety of mental mechanisms that make us adept at promoting our own interests, in competition with our peers, he says. But human nature is also "groupish": our minds contain a variety of mental mechanisms that make us adept at promoting our group's interests, in competition with other groups.

"We evolved to live in groups. Our minds were designed not only to help us win the competition within our groups, but also to help us unite with those in our group to win competitions across groups," he says. "We are not saints, but we are sometimes good team players."

All this goes a long way towards explaining the psychological roots of morality. Haidt defines moral systems as interlocking sets of values, norms, practices and institutions that work together to suppress or regulate self-interest and make co-operative societies possible.

His research leads him to believe moral intuitions arise automatically and almost instantaneously in our minds, long before moral reasoning has a chance to get started. Moral reasoning is not something we do to figure out the truth. Rather, it's a skill we evolved to further our social agendas - to justify our own actions and defend the teams we belong to.

Human nature is intrinsically moral, but it's also intrinsically moralistic, critical and judgmental.

"Our righteous minds made it possible for human beings - but no other animals - to produce large co-operative groups, tribes and nations without the glue of kinship," he says. "But at the same time, our righteous minds guarantee that our co-operative groups will always be cursed by moralistic strife."

We're much more aware of other people's moral shortcomings than our own, often making us "selfish hypocrites so skilled at putting

on a show of virtue that we fool even ourselves".

Haidt says one of the hardest problems humans face is co-operation without kinship. We instinctively co-operate with people to whom we're directly related, but co-operation within wider groups carries the ever-present temptation to "free-ride" - to enjoy the benefits co-operation brings while avoiding pulling our weight.

The more people free-ride, and the more we see others failing to pull their weight, the more co-operation breaks down and we all forgo the benefits it could bring.

Haidt argues morality is, in large part, an evolved solution to the free-rider problem. We develop norms of acceptable, co-operative behaviour and find ways to sanction people who aren't co-operating.

His empirical research into the moral sentiments of people from around the world leads him to identify six dimensions to people's moral concerns. First is care/harm; we are sensitive to signs of suffering and need, and despise cruelty. Second is liberty/oppression; we resent attempts to dominate us. Third is fairness/cheating; people should be rewarded or punished in proportion to their deeds.

Then there's loyalty/betrayal; we trust and reward team players, but want to sanction those who betray the group. Next is authority/subversion; we recognise rank or status and disapprove of those not behaving properly, given their position. Finally there's sanctity/degradation; we care about what we do with our bodies and what we put into them.

Haidt believes these moral concerns are shared by people regardless of their culture, nationality or wealth. But, of course, people interpret them differently and put more weight on some than others.

Our differing moral emphases are reflected in our differing political sympathies. So the unending battle between small-L liberal and conservative policies is a manifestation of "deeply conflicting but equally heartfelt visions of the good society".

Haidt finds that small-L liberals' moral concerns are limited to just the first three dimensions: they care deeply about the harm suffered by minorities and the needs of the poor, about oppression and about fairness.

Conservatives, on the other hand, care about all six dimensions. Their most sacred value is to "preserve the institutions and traditions that sustain a moral community". So they worry also about maintaining loyalty, acceptance of authority and the sanctity of our bodies.

The conservatives' broader range of moral concerns means they understand the motivations of liberals better than liberals understand the motives of conservatives.

Haidt argues the community benefits from the ever-present tension between the two sides - each emphasises important aspects of maintaining a good society - if only we could restore a greater degree of civility between the contending parties.

Wednesday, February 22, 2012

Yes, there is more to life than happiness

Fed up with all the wrangling and speculation over who should be leading the Labor Party? Want something more substantial? How about the meaning of life - that weighty enough for you?

The question has been an object of contemplation by clerics and philosophers throughout the ages, of course, but in more recent times many psychologists and even a few economists have taken to studying it.

Psychologists' traditional focus has been on the abnormal - on relieving misery, helping people suffering from depression, alcoholism, schizophrenia, trauma and the like.

But for at least the past 30 years some psychologists and economists have been researching the nature of happiness. A spate of books has been written on the subject (including one by yours truly).

Then, about a decade ago, there sprang up among psychologists a new school known as "positive psychology", dedicated to helping the normal live more satisfying lives. The practitioners of positive psychology seemed to take over the happiness business.

The person most responsible for starting the positive psychology movement is Professor Martin Seligman, of the University of Pennsylvania. Seligman regularly works in Australia, and will speak at the Happiness and its Causes conference in Sydney next week, subtitled Life, Death and Everything. But is happiness all there is to the meaning of life? A lot of people doubt it. The spate of happiness books is now prompting a flow of anti-happiness books - including one by our own (eminently sensible) Hugh Mackay.

I think a lot of the problem lies with the word happiness. It's an eye-catching, emotive word beloved of book publishers and headline writers. But what does it actually mean? Different things to different people.

The critics interpret it very narrowly, as being perpetually in an upbeat, ho-ho-ho mood. And perhaps being a Pollyanna - looking on the bright side of everything and refusing to acknowledge problems.

If that's what happiness means it deserves to be ripped into by the critics. It's neither possible nor desirable to live like Dr Pangloss, and you could do yourself a mischief trying to.

Seligman points out that such an ideal favours those with an extroverted personality, disadvantaging the half of the population who are less expressive and more introverted.

Mackay argues that nature equipped us with the capacity to feel negative emotions - pain, sorrow, fear, even anger - for good reason.

But I've always used happiness to mean something much broader and more substantial. The seeking of pleasure and avoidance of pain is mere hedonism, and that's life without meaning.

Most of the academic study of happiness relies on surveys that ask people to rate their satisfaction with their lives on a scale of, say, one to 10. That's a bit broader, but recent research suggests people's answers to such a question are too greatly influenced by how they were feeling at the time they were asked.

Seligman has been giving the question much thought and the result of his cogitation is outlined in his latest book, Flourish. His objective is to guide the positive psychology movement away from happiness as its goal to something more encompassing, which he dubs "wellbeing".

Wellbeing, he argues, has five elements, of which only the first, "positive emotion", covers the narrow conception of happiness. He calls this "the pleasant life".

His second element is "engagement". Living the engaged life means regularly being in a state of "flow", where you become so absorbed in what you're doing you lose sense of time and consciousness of yourself.

It can involve your work or a hobby, but it requires an equal match between the challenge you face and your ability to meet that challenge. People in a state of flow realise they were happy only in retrospect.

Seligman's third element is "meaning". The meaningful life involves "belonging to and serving something that you believe is bigger than the self," he says. This is where other people first enter the picture.

"Today it is accepted without dissent that connections to other people and relationships are what give meaning and purpose to life," he says.

The fourth element is "accomplishment" - something Seligman added to his list only after a student told him his theory of what humans choose had a huge hole in it: "It omits success and mastery. People try to achieve just for winning's own sake."

Well, that's certainly the way it appears, though a leading economist researcher in this area, Andrew Oswald, of the University of Warwick, would argue that people want to win not for its own sake, but to increase their social status.

Billionaires scrabbling for their next billion aren't motivated by greed. They just want to demonstrate - to themselves and others - how good they are at playing the money game.

Anyway, Seligman now accepts that people pursue success, accomplishment, winning, achievement and mastery for their own sakes. He stresses, however, that his objective is to describe what people actually do to get wellbeing.

"Adding this element in no way endorses the achieving life or suggests that you should divert your own path to wellbeing to win more often," he says.

His fifth element is "positive relationships". When another founder of positive psychology was asked to say what it was about in two words or fewer, he replied "other people". Seligman says "other people are the best antidote to the downs of life and the single most reliable up".

No doubt, but that sounds a bit self-centred. For relationships to be "positive" they have to be two-way; you have to give as well as get. Whatever you call it - happiness, wellbeing, flourishing - it won't work if it doesn't have relationships at its core.

That's what we keep forgetting.

Saturday, April 23, 2011

Its all in the frame (behavioural economics)

It's a long weekend, so let's play a game. Tell me this: are eagles large? And, next, are cabins small? If you said yes to both, congratulations - you're right. But if you said no to both, you're not wrong. In fact, you're just as right as the others are.

Relative to other birds, eagles are large. And relative to other buildings, cabins are small. But if you compare an eagle with a cabin, eagles are small and cabins are large.

Get it? Whether eagles and cabins are large or small depends on what you're comparing them with. Or, as they say in the classics, everything's relative.

And this, believe it or not, is one of the great discoveries of cognitive psychology.

Part of that discovery is that the way we react to situations or propositions is heavily dependent on the way they're framed, as psychologists say - the way they're packaged, the context in which they're put.

We can react differently to the same proposition depending on how it's framed. A classic example: even doctors say a 90 per cent success rate for operations is more acceptable than a 10 per cent failure rate.

The people who didn't need psychologists to tell them our reactions to things are influenced by the way they're framed are advertising and marketing types. They know that draping a girl in a bikini over a sports car can help sell more of them. What's the logical link between a good-looking young woman and a motor car? There's none - but the young bucks (and ageing baby boomers) who buy sports cars can imagine one.

Although it comforts economists to kid themselves that advertising is purely informational, in truth almost all advertising is about framing - drawing unspoken links between the product you're trying to flog and some attractive situation or emotion. Their not-so-subtle message is, buy my margarine (or sliced bread) and you'll have a happy, healthy family. In the advertisers' adage, you sell the sizzle, not the steak.

But framing goes far wider than advertising. It's the reason you should be sceptical of the results interest groups quote from the opinion polls they commission. It's too easy to influence the answers you get by the way you frame the questions you ask.

And don't forget that political spin is a form of framing. It's about portraying situations or decisions in ways that reflect more favourably on the pollies involved.

Their opponents, of course, try to frame the same situations or decisions in a more negative light.

But in Practical Wisdom, a new book by two academics at Swarthmore College, near Philadelphia, Barry Schwartz and Kenneth Sharpe, they observe that stories like these have given framing a bad name that's unwarranted.

Why? Because there's no alternative to framing. That's the great discovery of cognitive psychology: just about the only way we can get our minds around anything is to compare it with something we already know about.

Years ago an editor reminded me of the classical rule of rhetoric that argument by analogy is invalid. Sorry, it turns out that the only way we learn is by comparing things we don't understand with things we do understand.

This doesn't mean every analogy-based argument is correct, of course, just that there's no other way to argue.

The term frame is itself a metaphor. Schwartz and Sharpe say it's a wonderful one because it emphasises our capacity to take the chaos of the social world around us and organise it in an understandable way.

The capacity we have to frame enables us to do one of the most important things the exercise of practical wisdom demands: discern what's relevant about a particular context or event in regard to the decision we face.


Wednesday, December 22, 2010

Take a break and we'll all be happy

Psychologists have a form of treatment for unhappy people called PAT: pleasant activity training.

It's quite simple: you make a list of the things you like doing, then do them more often. It's not as silly as it sounds. We've learnt our brains have one system that controls wanting and one that controls liking. The wanting system tends to dominate the liking system, so we often end up doing less of what we like than we'd like to.

I suspect that's true of taking holidays. A survey conducted by Professor Barbara Pocock of the University of South Australia, as part of the Australian Work and Life Index, found 57 per cent of full-time employees would prefer an extra two weeks' paid annual leave to a pay rise of 4 per cent.

So it seems we like taking holidays (and it sounds like a good idea to me). And yet there's a wealth of evidence that many of us don't take the leave we've already got. A survey conducted regularly by Roy Morgan shows that only about 70 per cent of Australians aged 14 or older intend to take at least one holiday over the next 12 months.

Another survey conducted for Reuters by a global market research company, Ipsos, found that only 47 per cent of Australians expected to use all their annual leave. This was the lowest proportion for any country bar the Japanese, on 33 per cent. By contrast, 89 per cent of the French, 77 per cent of the Brits, 75 per cent of the Germans and even 57 per cent of the Americans expect to take all their annual leave.

Australia's governments have required employers to provide their workers with paid annual leave since 1941. In 1973 it was increased to four weeks. At the time many people thought this extravagant, but it's about average. The French get six weeks, while the Finns, Norwegians and Swedes get five.

Pocock's survey shows 60 per cent of Australian employees stockpile at least some of their annual leave. And according to calculations by Roy Morgan, the stockpile has reached 117 million days.

But if people like annual leave, why don't they take it all? According to Pocock's survey, 31 per cent of full-time employees say they're too busy at work and 13 per cent say they couldn't get time off that suited them. Nine per cent say they prefer to work.

And 41 per cent say they're saving their leave for a future holiday - though I'm not sure I believe it. If it were true - if people were merely delaying their holiday-taking - unused leave wouldn't have piled up the way it has.

It may be that some young people want to combine a few years' leave for an extended overseas trip, but I think "saving for later" is just something you say when you don't get around to taking it all.

I guess it's true that, consciously or unconsciously, some employers don't encourage their workers to take their leave, especially key employees.

But is all this a problem? Why turn unused leave into another crisis? Well, a lot of employers think it is a problem, including one quite close to me. If an employee takes all her leave during the year, the business suffers an expense of 52 weeks' wages on her behalf. But if she works all year without taking leave, the expense rises to 56 weeks' wages, with the extra four weeks of untaken leave owing to her adding to the firm's liabilities. (What's more, the firm doesn't get a tax deduction until the leave's actually taken.)

In theory, insisting that everyone take their leave during the year means the firm has to employ more people. In practice, it means we all have to work a bit harder when we're not on leave to cover for those of us who are. Whistle-blowing economists call this "work intensification" - but it comes from employer penny-pinching, not from the leave itself.

Another group that sees untaken leave as a great problem is Tourism Australia, the federal government's tourism marketing body. Last year the minister, Mar'n Fer'son, launched a campaign called No Leave No Life to encourage us to take our leave and spend it in Australia, complete with commercial TV show.

Tourism Australia can think of many reasons why it's good to take your leave (and for employers to offer a "leave-friendly workplace"). Achieving work-life balance, we're told, comes with improved physical and mental well-being.

Taking your leave helps you avoid the stress of exhaustion and burnout. You get greater job satisfaction when you approach your task in a refreshed state. Taking leave helps you "rediscover your friends, your family and most importantly yourself".

The figures show we're taking more, shorter breaks rather than blowing the lot in one go. Maybe this explains why we have trouble making sure we've taken it all. There's some evidence that taking more short breaks is more re-creational (though I like to make sure of it by taking short breaks through the year and a big break at the end of it). Tourism Australia says there are so many great experiences to be had we should "take the opportunity to visit some more of Australia and gain some lasting memories as well as some great stories to share with others".

It may be advertising copy, but it does have evidence behind it. Psychologists have shown that one reason we get more satisfaction from buying experiences rather than things is the memories and stories we're left with.

Recent research also shows that much of the pleasure we gain from holidays is in thinking about them before we take them. But please don't think that's what I've been doing in this column. And if you're working through, please don't think I'm trying to make you guilty or envious. But I'm off.


Wednesday, June 16, 2010

Wanted: some belief in a leader

As I lay in bed one freezing morning lately I wished it would rain so I wouldn't have to get up and go jogging. But it's a free country - if I disliked the idea of going out into the cold so much, why didn't I just stay in bed? Because I knew if I wanted to be fit there was a small sacrifice involved. I also knew that when I make an effort I feel better than when I don't. All of us make similar decisions every day.

There's no law against wanting to have your cake and eat it - which is just as well because people do it all the time. This, I suspect, is a big part of Kevin Rudd's problem. When Tony Abbott began worrying people by branding the emissions trading scheme a great big new tax on everything and the public's enthusiasm for action on climate change began to slip, Rudd assumed we'd all be quietly relieved when he dropped the idea.

Instead, he's been amazed to discover that decision caused him to drop hugely in our esteem. Why? It's just a case of us wanting to have our cake and eat it. We wanted to worry about what the trading scheme might do to our cost of living but we also wanted action to reduce climate change.

Of course, we also wanted a leader who believed in things and would stick to his guns. A leader we could respect. A leader who, if he went on and on about something being really important, wouldn't just ditch it when the going got tough.

A big part of Rudd's problem is inexperience. As a result of that inexperience and bad advice he has seriously underestimated the electorate. He thought he could stay popular by appearing to pander to our whims.

Turns out we have no respect for a leader who merely gives us what we say we want. Somewhere inside us there is a semi-conscious understanding - probably born of our experience as children - that we need a leader who sometimes imposes on us things we don't fancy but he knows are for our own good.

The tyro politician's error is to assume success is simply about

never telling us anything we don't want to hear. That's the appearance but there's a deeper and more complex reality.

In the months before the 2007 election, Labor's focus groups detected public dissatisfaction over the rising cost of living. Rudd tried to capitalise on this disaffection by expressing great concern about the issue

and implying - without actually promising - there was something he could do about it.

This was the origin of two of the early setbacks in Rudd's term as Prime Minister, the failures of Fuel Watch and Grocery Watch, the first bits of evidence fostering the public's growing (if unfair) conviction that Rudd is all talk and no action.

Guess what? If you conduct focus groups today you'll find much dissatisfaction over the rising cost of living. It is, I suspect, an almost permanent state. The cost of living is always rising - but so too are wages and pensions. We have genuine cause for complaint only when the rise in prices is outstripping the rise in our incomes. And though that happens from time to time, over the past 10 or 15 years wages have grown a lot faster than prices.

So our unceasing complaint about the rising cost of living - always changing its focus, from the cost of petrol to interest rates to the price of electricity - is just another case of us wanting to have our cake and eat it. We wish we lived in a world where prices never rose but incomes rose as they do now. Dream on.

Our problem is not with the rising cost of living but with our efforts to keep up with the rising standard of living. We worry about every price rise because, in our unceasing attempt to keep up with the Joneses (who strive to keep up with us), we over-commit ourselves. When you spend all your income - perhaps more than your income - you always feel poor, always have trouble making ends meet, no matter how high your income.

Politicians who imagine this kind of foolish selfishness defines the electorate underrate us. We're looking for politicians who, in their concern to protect and advance our interests, demand more from us.

Rudd thinks we went cold on his emissions trading scheme because his opponents gave us an exaggerated opinion of what it would do to our cost of living. But Hugh Mackay, the noted social researcher, has a roughly opposite take: having been convinced by Rudd and others that our greenhouse gas emissions need to be reduced, we expected to be asked - even compelled - to change our behaviour.

When cities were running out of water, we had to stop using water in certain ways. Few resented this and almost all complied. The more we complied the more convinced we became of the seriousness of the problem and the need for strong action.

With climate change, however, no immediate demands were made on us. This was partly because of Rudd's misguided fear that making demands on us would make him unpopular.

Mackay makes the psychologist's point that our changes in attitude don't last unless they're quickly and strongly reinforced by a change in our actions (a truth that doesn't fit easily with economists' aversion to moralising, compulsion and even voluntary action, in favour of mere changes in prices).

Now, thanks to his great misstep in abandoning his trading scheme, Rudd lacks the moral authority to be believed even when he assures us the mining companies' claims that the resource tax would damage the economy are self-serving scaremongering.


Thursday, October 29, 2009


Talk to University of Sydney Department of Government and International Relations
October 29, 2009

Economists often suspect that Australia’s quite extensive quarantine restrictions - against apples from New Zealand, for instance - constitute a form of disguised protection. But when Alexander Downer was Minister for Foreign Affairs he was having none of that. ‘I want to assure you,’ he once said, ‘that our quarantine laws are based strictly on science - [pause] - political science.’

I wanted to say a few words about economics but, since this is a political science function, I thought I should compromise and speak about the politics of economics. It’s not hard to meld the two disciplines because, as many of you would have heard a fortnight ago, this year’s Nobel Prize in Economics was won for the first time by a woman, Elinor Ostrom, who isn’t even an economist, but a political scientist. (Her win caused Michael Jackson some chagrin, because she’d once offered him a job, which he’d turned down.) The person Ostrom shared the prize with, Oliver Williamson, is regarded as an economist, although the person who drew his work to my attention was a sociologist, and it certainly reads as if it was written by a sociologist.

Before we go any further - and in case there are any people from the hard sciences who’ve strayed into the room - I should confess that the economics Nobel isn’t a real Nobel. It wasn’t provided for in Alfred Nobel’s will - I’ve heard he didn’t have much regard for economists, though I’m sure that can’t be true - but was established just 40 years ago under the sponsorship of the Swedish central bank, and styles itself as the Swedish Riksbank Prize in Economic Sciences in memory of Alfred Nobel. That reference to ‘economic sciences’ is sus, for a start. I’m not convinced economics is a science, let alone more than one. But it certainly implies that the sponsors saw economics as a broad church.

This year’s awards - to a political scientist and an economic sociologist - come at a critical time for economics - in both senses of the word. In the wake of the global financial crisis, economics has come under considerable criticism for its failure to foresee that trouble was brewing. There’s been a lot of soul-searching within the profession, some of it quite acrimonious. In America they’ve been arguing on blogs; in Britain they’ve been sending petitions to the Queen.

A lot of the blame is going to the unrealistic assumptions on which conventional economics is based - as epitomised by the ‘efficient-markets hypothesis’ - and on the effort economists have made over the past 40 years to make their discipline more scientifically rigorous by making it more mathematical. The two criticisms are linked because the unrealistic assumptions are needed to make the equations work. In America, last year’s Nobel Laureate, Paul Krugman, concluded that ‘the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth’. In Britain, the eminent petitioners agreed with what they said were the complaints of three Nobel laureates that ‘in recent years economics has turned virtually into a branch of applied mathematics, and has been become detached from real world institutions and events’.

The annual awarding of the Nobel prize is a bit like the Melbourne Cup for economists. It generates considerable excitement among younger academic economists and, no doubt, quite a lot of covetousness among older economists - especially in America, which has taken out two-thirds of the awards so far. There’s a lot of betting on who’ll win. This year in the betting at Ladbrokes, the odds-on favourite was the same as last year: someone from the University of Chicago, Eugene Fama.

Really? Really? The man who dreamt up the efficient-markets hypothesis was the favourite to win the Nobel in the year after the GFC? There could hardly be a better illustration of the insularity of the economics profession - truly, they don’t live in our world. Fortunately, those anonymous souls who nominate and vote on the prize - including, I suspect, a disproportionate number of Swedes - are a little more politically attune.

And so, in the aftermath of the GFC, they gave the prize to a female political scientist and an economic sociologist. That’s the first noteworthy feature of the award: it wasn’t even given to real economists. Second shock: neither Laureate made a ‘formal’ contribution. Their contributions lacked the two qualities academic economists admire most: ‘elegance’ and ‘parsimony’. Meaning? They wrote their papers in words, not equations. Wow. Third shock: neither Laureate’s work fits the conventional right/left, libertarian versus interventionist dichotomy. Rather, they drew conclusions neither side would be particularly comfortable with.

Fourth shock: Elinor Ostrom’s work in particular is essentially empirical. Rather than theorising about the world on the basis of mathematically convenient assumptions, she’s spent her career doing field studies - ranging from irrigation systems in Nepal and grazing on the grasslands of Asia to lobster fisherpersons in Maine - to disprove a favourite theory of economists about the alleged ‘tragedy of the commons’. Although Ostrom’s contribution clearly concerned an economic issue, the fact she is a political scientist means few economists have heard of her - even though her 7000 citations on Google Scholar exceed the well-known Williamson’s by 40 per cent.

My daughter told me last night that, according to her psychology lecturer at this august institution, economists are psychologists dealing with bigger numbers. I would have said economists were psychologists who hadn’t read the textbook. Economics is amazingly inward looking. Economists know little about other social - or physical - sciences, bar mathematics. In particular, they know far less psychology, sociology and ecology than they should.

It seems clear to me the Nobel selectors were sending a pretty clear message to economists, about the need for them to widen their horizons, become more multidisciplinary and more empirical. Can the Nobel Prize reform economics? Well, economists believe in incentives, and it’s a pretty powerful incentive. If it doesn’t work, it won’t be surprising to see the prize going more often to those psychologists and political scientists who do the economists’ job for them.


Tuesday, June 6, 2006


Australian Institute of Management breakfast briefing
June 6, 2006

When I was asked to talk to you today I spent some time thinking of what I could talk about. I could preach a sermon on the need for more micro-economic reform, or I could urge you all to be more competitive, or argue passionately that the Government should slash the rate of tax we high income-earners pay so as to encourage us to work much harder. Well, you may have been prepared to get out of bed early to listen to me say that sort of thing - especially about how we’re all groaning under the weight of our crushing tax burden - but I wouldn’t have been prepared to get out of bed early to say it. No, the only topic that really attracted me was to say something more reflective about the nature of modern business life. Why are we doing what we’re doing and what do we imagine it proves? What’s it costing us and is it worth it? Remember that everything we do - every choice we make - has an opportunity cost, and sometimes it’s worth thinking about that cost.

We live in a hyper world. There’s nothing much that’s new about the things we do in business, it’s just that it’s all been stepped up. We’re competing a lot harder, working harder, making bigger profits and caring a lot more about the growth in profits. As managers and professionals we’re making a lot more money than we did. But why? Why is business life so much more intense than it was 10 or 20 years ago?

I think a big part of the explanation is micro-economic reform. Business people think the point of micro reform is to make Australian businesses more competitive - better able to meet the competition from imports or in export markets. But that’s not it. The point of micro reform is not so much to make us better able to meet foreign competition as to expose us to more competition in domestic markets. To that end, successive governments have floated the exchange rate, cut away the protection against competition from imports, deregulated many industries, broken up a lot of monopolies among the utilities, sold off a lot of government businesses and decentralised wage-fixing and industrial relations. So the competition is fiercer in many industries and, as a consequence, we’re all having to try harder. Part of the way we’ve felt the effect of greater competitive pressure on us is via the share market. The performance of the managers of public companies is much more closely and critically scrutinised these days by share analysts and fund managers.

But why now? Econocrats had been urging economic rationalist policies on their political masters for decades without much success. Why, starting about 25 years ago, did governments start acting on this advice? The obvious answer is the pressure of globalisation, but I think there’s a further cause. To a greater or lesser extent, all of us are - and always have been - materialist. But I believe the world is going through a period of heightened materialism. And if we look around we can find evidence of this. Consider the evidence from the American Council on Education’s annual survey of over 200,000 newly entering college students. Asked about their reasons for going to college, the proportion agreeing that an important one was ‘to make more money’ rose from half in 1971 to almost three-quarters by 1990. And the proportion believing it ‘very important or essential’ that they become ‘very well-off financially’ rose from 39 per cent in 1970 to 74 per cent in 1990. Over the same period, the proportion who began college hoping to ‘develop a meaningful philosophy of life’ slumped from 76 per cent to 43 per cent. This reversal stayed unchanged throughout the 1990s.

So why has the longstanding wish-list of economists become the dominant ideology of public life? Because it fits perfectly with the current mood of heightened materialism. Now, more than before, both sides of politics see faster economic growth and rising material living standards as the primary objective of government, and there’s no doubting that following the prescriptions of conventional economics will give you a faster rising standard of living. Economic rationalism was made to assist an era of heightened materialism.

You’ve probably noticed that I’ve become a great student of psychology in my old age. The findings of modern social psychology provide a valuable counterpoint to economic orthodoxy and have a lot of light to shed on why we are as we are and why we do as we do. Take, for instance, competition. Conventional economics smiles on competition. It’s a valuable commodity, spurring innovation and fostering productivity and efficiency, which lead to faster rising material living standards. So you can never have enough competition, but the trouble is there is never enough of it. Competition takes effort, and people won’t bother competing very hard unless you make it monetarily worth their while. So we must always be cutting taxes and improving incentives lest we encourage too little competition.

Talk to an evolutionary psychologist, however, and you get a very different perspective. Thanks to natural selection and the survival of the fittest, humans - particularly men - are naturally highly competitive. It’s been bred into us. So why do we compete? Because we can’t help ourselves. We’re a competitive animal. Civilisation tries to contain and channel our competitiveness into exams and sport and even business endeavour, so as to stop us brawling in the streets and fighting rival tribes at the drop of a hat. So whereas the conventional wisdom sees the competitive spirit as a fragile flower to be carefully nurtured, unorthodox economists such as Professor Richard Layard of LSE see it as something we’ve probably got too much of already and should avoid stirring up.

Let me tell you about some research by two female economists at Pittsburgh and Stanford. They used laboratory experiments to demonstrate that men were a lot more competitive than women - no doubt for evolutionary reasons. Given a choice between doing work for a piece rate or competing in a winner-takes-all work tournament, twice as many men as women opted for the tournament. So even if you took away all the discrimination against women in the workforce and compensated for the handicap of being the childbearing sex, you’d probably still find women underrepresented in senior management. Why? Because women are less likely to see the point of giving up so much for the dubious joys of being a boss. But why were the men so much more likely to give up the certainty of income in preference for a contest in which they won everything or nothing? In a word: overconfidence. Neither the men nor the women had any way of knowing how their work performance compared with others’. But three-quarters of men believed they were the best in the group, compared with 43 per cent of women. The thing to note about this is that, while it’s OK for three-quarters of men to be convinced they’d be the winner in the competition before the competition starts, once it’s completed you’re surely looking at a fair bit of disillusionment and dissatisfaction.

Another bit of light we can get from psychology is its reminder that humans are a social animal. Conventional economics assumes we’re rugged individualists. We do our own thing according to our personal and firmly fixed tastes and preferences, largely unaffected by the choices being made by people around us. In truth, however, we’re heavily influenced by the choices our friends and workmates make. Being animals that evolved to live and work in small bands of hunter-gatherers, we have a great desire to fit in and do what our peers are doing. We care deeply about what other people think of us and we’re always comparing ourselves with the people around us. We can see this in our children, but we can also see it in ourselves. We’re heavily influenced by fashions, we confirm to group norms of behaviour, our idea of what’s ethical is largely determined by what we believe ‘everybody’s doing’. We evolved to live in hierarchical groups, which leaves us terribly preoccupied - more preoccupied than we care to admit to ourselves - with our social status. With where we stand in our reference group. One important thing this means is that materialism is catching. If the people around us at work are getting in for their chop, we want ours. If the people we compare ourselves with are working long hours so they can afford a flash house in a well-regarded suburb, a late model imported car and private schools for the kids, we want to match them.

Economists believe in something called ‘revealed preference’ - they you find out what people really want by looking at what they do, not what they say. And no one - certainly no government - can know what I want better than I know myself. That’s because they assume me to be rational in all my decisions. But psychology demonstrates that our decisions are heavily influenced by emotional factors - often to a far greater extent than we’re conscious of. And studies by psychologists and behavioural economists show we’re often quite bad at predicting what will bring us utility -what we’ll ultimately find satisfying and be glad we chose to do. We often keep doing things we don’t actually find satisfying. Part of the reason for this is that our brains seem to have two separate systems for desire: one for wanting stuff, but a different one for actually enjoying stuff. What this means is that some of the stuff we really want and spend a lot of time pursuing, when we get it, it doesn’t give us as much satisfaction as we thought it would.

I suspect that a lot of us who are caught up in the business whirl have come to wonder about whether it’s all we imagined it to be when we started out. If not, let me give you some things to think about. First, are we doing it just for the money? Is so, is the money buying us much real satisfaction? We’ve got lots of fancy possessions, but do they bring us or our families much lasting satisfaction once the novelty wears off? How much satisfaction is there in owning a flash boat we have little time to use? Sounds like a poor consolation to me.

Are we becoming workaholics? I’ve got nothing against hard work; I do a lot myself and, contrary to the assumption of the simple economic model, the work itself can be far more satisfying than the stuff you buy with the money. I think the test is why you’re working so hard. If it’s because you love the work for its own sake, that’s fine. But if you’re doing it just for the money, or just for promotion, or you’re afraid of some sort of kick in the backside, or you’re getting away from life at home, you’ve got a problem. If we don’t like our work, but aren’t willing to shift to something we’d find more satisfying because of the lower pay or loss of status, we’ve got a problem. We’re trapped not by ‘the system’ but by our own materialism.

One qualification to the idea that long hours are OK if we love our work is that we have to take account of the implications for our spouse and family. All of us know that, at the end of the day - or even just in retirement - it’s our relations with our family that matter to us above all else. We know it, but in practice we’re always letting the urgent take priority over the important. How many of us have unhappy husbands or wives? Many of us - if only we could be honest with ourselves - are risking ending up in the divorce court. Does this sound a cheap price to pay for a successful corporate career? Then there’s our kids. They can’t divorce us, but they can reproach us when we’re old and need them more than they need us. How many of our extra hours could at least be done at home rather than the office? There’s evidence that a lot of young kids say they’d rather have their father’s company than his money.

Another thing that worries me about modern business life is the way we’re encouraged to neglect rest and recreation. Too many people don’t take all their annual leave and maybe don’t even get enough sleep. Apart from living narrow, unsatisfying lives, they’re heading for burnout. And again, money - in the form of being able to afford quickie visits to luxury resorts - is a poor substitute for time. Leisure is something we were intended to do, not buy. The idea of encouraging employees to cash out up to half their annual leave is pernicious. What people need in their lives is balance: hard work combined with satisfying play.

But do we have any choice? Is the only choice to play the competitive game full tilt or ‘downshift’ to Nimbin? Economics teaches us that life’s not about all-or-nothing choices but about finding the best trade-off between equally attractive but conflicting objectives. Many of us may feel we’ve neither the desire nor the possibility to take the seachange option. But I believe all of us have some degree of control over our lives and jobs, and there are plenty of changes we could make at the margin which would add up to a better, more balanced lifestyle. We could loosen up a bit here and a bit there - particularly if we take the amazingly liberating step of stopping worrying about our next promotion and caring less about our status and keeping up with the neighbours.

We fall into the habit of imagining that history moves in straight lines, that the trends we see happening now will keep rolling on forever. In truth, history moves like a pendulum: it keeps running one way until it gets to an extreme point, where there’s a reaction against it and it starts heading back towards the other extreme. I believe that our present era of hyper-materialism - with all its overwork, intense competition, stress and ever-quickening pace - can’t go on forever, just as double-digit profit growth can’t go on forever. Sooner or later there’ll be a reaction against it. Why? Because people will see it’s not as good as we imagined it would be.

That reaction will start not when some new radical government gets elected, but when enough individuals in the system begin modifying their own lives in small ways to make them less intense and more liveable. More relaxed and comfortable. That’s when the business world will start calming down. And a calming down is all I’d like to see - something that took us back to being no more materialist than we were in the 60s and 70s.


Monday, September 17, 2001


Talk to Treasury seminar, Canberra
September 17, 2001

I suspect that, when Martin and Ken invited me to talk to you today, their intention was to put before you a speaker you’d find a bit thought-provoking and challenging – someone who’d give you a bit of an intellectual workout. (Maybe someone you could easily dispose of before lunch.) So, to that end, I’m going to take a round-about approach to my topic of what Treasury’s role should be. I’ll be sneaking up on the topic, dividing my talk into three parts. The first part will be a bit theoretical, the second a bit philosophical and the last very down to earth. When I finally get round to talking about Treasury’s role, I’ll throw a few friendly punches in Treasury’s direction.

But let’s start with a little challenge on the theoretical side. If you’ve read my stuff over recent years you may have noticed that I’m much influenced by the insights of ‘behavioural economics’. This is a relatively new school of economic thought which is led by Richard Thaler – formerly of Cornell, but now ‘promoted’ to Chicago – and draws heavily on the work of two cognitive psychologists, Daniel Kahneman of Princeton and the late Amos Tversky of Stanford. If you’re not familiar with behavioural economics, you may have had more exposure to its sister discipline, behavioural finance, which is devoted to challenging and improving upon the efficient markets hypothesis. One of the leaders of behavioural finance is Robert Shiller of Yale, author of Irrational Exuberance.

Behavioural economics challenges two basic premises of the neoclassical model, rational choice and, under conditions of uncertainty, expected utility theory. These theories are both normative and positive – they specify not only how economic agents should act, but also how they do act. Behavioural economics subjects these theories to empirical testing, mainly by means of laboratory experiments, and finds that they fail as positive theories: they are poor predictors of how people actually behave. Let me summarise some of the key findings:

1. Money is not fungible. One dollar is not the same as another. In the minds of most people, a dollar’s value varies with circumstances. For instance, people will go out of their way to achieve a saving of $5 on the purchase of a tranny worth $25, but won’t go to the same trouble to save $5 on the purchase of a TV worth $500. People fail to treat all dollars equally because they engage in a system of metal accounting, where certain sums are allocated to certain purposes and can’t be drawn on for other purposes. They engage in this seemingly irrational behaviour because it helps them keep their total spending within their budget constraint. One key finding under the heading of fungibility is that a dollar of loss gets a higher weight than a dollar of gain.

2. People aren’t risk averse so much as loss averse. It’s true that people are risk averse when it comes to gains, but their dislike of losses is so great that many are willing to accept gambles in the hope of avoiding them.

3. People are more concerned about the change in their wealth than about its ultimate level. I offer you the choice between starting the day with $150 and suffering a loss of $50, or starting and ending the day with $100. Theory predicts you’ll be indifferent between the two but, in fact, most people would much prefer to avoid the loss by starting and ending with $100.

4. People simply can’t see why they should ignore sunk costs. This is something politicians understand much more readily than their econocrat advisers. It occurs, I suspect, because of people’s misconceived desire to avoid losses.

5. People often ignore opportunity costs. They commonly have a wide gap between willingness to pay and willingness to sell. I may not be willing to pay much for a particular item, but once I own it, you’d have to offer me a lot more before I was willing to sell it to you. This is a bias towards preserving the status quo.

6. People often fail to order their preferences consistently and have difficulty making comparisons between three or more things. As part of this, people’s choices are often influenced by the way those choices are presented to them – the way they’re ‘framed’ – which is why, for instance, we know not necessarily to believe the results of opinion polls conducted by vested interests.

What all this amounts to is an exploration of the specifics of Herbert Simon’s notion of ‘bounded rationality’. The point is not that people are wilfully irrational or capricious, but that the human mind simply has limited capacity to store and process information. We are physiologically incapable of being as coldly rational in our decision-making as the neoclassical model assumes we are. We rely on simple rules of thumb (or ‘heuristics’) which generally serve us well – they’re mentally cost-effective – but nonetheless lead us into consistent errors.

The fact that the leading proponent of this stuff has now won a chair at Chicago suggests it’s starting to gain some respectability in academic circles. My motive in drawing it to your attention is partly to give you something to think about and certainly to challenge any complacency you may have about the adequacy of the neoclassical model. The great stumbling block to the wider acceptance of the insights of behavioural economics is the difficulty in incorporating it in a mathematical model. If a truth can’t be turned into an equation then a mighty lot of academic economists would prefer not to know about it. But that’s not a good enough excuse for someone engaged in policy advising to elected politicians. Their advice needs to be tempered by the knowledge that the model’s assumption of rational choice is unrealistic and unreliable. Advisers need to understand and, where possible, anticipate the misconceptions that bind the minds of ministers and their constituents. They should appreciate the great extent to which rational responses need to be explained and justified. And it’s not enough to convince the minister; you then have to provide him with the explanations he can pass on to the public. The insights of behavioural economics are also useful in helping advisers realise when they’re pushing their luck too far – when the propositions they’re advancing are just too counterintuitive for any politician to sell.

By way of illustration, I’ve argued before that these insights do a lot to explain the political difficulties of selling tax reform. Once the politicians committed the fatal design error of making the reform of indirect taxation revenue positive rather than revenue neutral, the basic proposition they had to sell was along the lines: the net effect of the GST is to raise your cost of living by $10 a week, but don’t worry, we’re going to cut your income tax by $20 a week, so you’ll be $10 a week better off. To any economist, that sounds a pretty attractive offer. But to many voters it sounded most unattractive. Why? Because they gave the $10 of loss a higher weight than the $20 of gain.

In the outworking of the tax package, many voters believe their personal cost of living has risen by far more than the 3 per cent or so that the CPI seems to be suggesting. Behavioural economics’ exploration of the various heuristics that affect people’s thinking – such as that they find it easier to call to mind unusual or outstanding events – does much to explain why the CPI people carry around in their heads gives such radically different answers to the one the Statistician so carefully calculates.

OK, now let’s move on to the second part of my remarks, the vaguely philosophical bit. In his speech to the Fin Review’s chief finance officers’ summit in June, Martin repeated an argument often advanced by Treasury and others that the significant and sustained increase in productivity growth during the 90s can be attributed to the beneficial effects of 15 years of microeconomic reform. Though it can’t be proved, I have no difficulty accepting this argument. But it prompts what I regard as a key question: if we’re so rich, why aren’t we happy? If income per capita grew faster in the 90s than at any time since the 60s – and it did – why is there so much dissent in the ranks? Why so much support for outfits like One Nation; why so much abuse of economic rationalism, such carry-on about globalisation and such vehement criticism of national competition policy? Why do we all know that, no matter who wins the election, little further reform is likely to be undertaken?

Treasury’s standard answer – of which there were hints in Martin’s speech – comes in two parts. First, the opposition is coming from vested interests defending their privileges. Second, to the extent that this doesn’t explain the discontents of ordinary mortals not being whipped up by lobby groups, the punters are simply too dumb to understand what’s good for them. It’s usually put a bit more politely than that: the policies haven’t been ‘sold’ properly. I have to say the line that the public is woefully illiterate in economic matters – that it just can’t trace through causes and effects – doesn’t come well from economists whose advice is based on a model that assumes agents’ decision-making is relentlessly rational at all times. But, apart from that, the standard defence isn’t sufficiently convincing. It’s too self-serving, for one thing. And the line that the punters don’t know what’s good for them, so the pollies should just press on with good policies because, in due time, the results of those policies will convince people that father knew best – well, time’s run out on that argument. The benefits are in, they’re in line with the economists’ predictions, but the public’s still not happy with the outcomes.

The standard response from Treasury’s critics within the profession – from people such as Bob Gregory, let’s say – is that the reason higher income per capita hasn’t satisfied the electorate is distributional. Sure micro reform has increased national income as promised, but – not surprisingly – too much of that extra income has gone to the top 10 or 20 per cent of the distribution, and too little to the battlers. It’s no wonder the battlers are in revolt – and justifiably so. Now, you won’t be surprised to hear that I have a lot of sympathy with this standard criticism – and I’ll have more to say on it later.

But I want to give you my own, non-standard response – the philosophical bit. Bob Hawke once said something to the effect that the role of economists was to increase happiness. It struck the public – and even some economists – as a weird thing to say, but I think it’s right. I don’t see much distinction between ‘utility’, ‘satisfaction’, ‘welfare’ and ‘happiness’ (or, as the psychologists usually put it, ‘subjective well-being’). So, to me, increasing happiness is the stated objective of economics, and the question is: how well does it do in achieving that objective? As you may know, there’s a growing body of empirical literature about the relationship between income and happiness, and I believe it sheds a fair bit of light on that key question raised by the success of micro reform: if we’re so rich, why aren’t we happy?

A host of studies have shown that, though rising per-capita incomes have been associated with rising measures of subjective well-being in developing countries, in developed countries the steady rise in incomes over the past 30 or 40 years has not been associated with a measured improvement in subjective well-being. So we’ve been producing and consuming more goods and services but, contrary to the most basic assumption of economics, it doesn’t seem to have led to any increase in aggregate utility.

Why not? The literature offers various explanations. One is what Kahneman calls the ‘hedonic treadmill’. As our income rises, our expectations quickly adjust, leaving us feeling no better off. This is consistent with the findings of Richard Easterlin of USC in a recent study: ‘income growth does not . . . cause well-being to rise, either for higher or lower income persons, because it generates equivalent growth in material aspirations, and the negative effect of the latter on subjective well-being undercuts the positive effect of the former.’ People continually expect a rise in their income to make them happier, but it never does. They fail to anticipate the rise in their aspirations that comes with their higher income.

A second explanation of why higher national income fails to increase aggregate utility comes from the empirical observation that – contrary to the assumptions of the model – what people strive for is not an absolute increase in their income but a relative increase. What they’re seeking is socio-economic status – a higher place in the pecking order. So they’re keeping up with the Joneses – or rather, trying to get ahead of them. In consequence – and as Robert Frank of Cornell argues in his book Luxury Fever – the more affluent societies become, the more consumer spending is devoted to Fred Hirsch’s ‘positional goods’. If so, it’s obvious why we’re no happier: we’re engaged in a zero-sum game. Any increase in my relative income generates a negative externality for others.

If there’s anything in these arguments, they suggest that micro reform is pursuing an intermediate target – higher national income – which doesn’t lead to the ultimate objective: greater welfare. They also suggest that materialism is the great delusion – the great carrot on a stick – of our age. I suspect that when the punters carry on with arguments about how ‘people are more important than The Economy’, what they’re expressing, in their own inarticulate way, is their disillusionment with materialism.

In recent times I’ve become more conscious of the narrowness of economics. That it deals with just one, important but narrow dimension of our lives: the material. The limitations of the neoclassical model narrow it further. Like all professions, economists are highly specialised in their interests and they run the occupational risk of developing tunnel vision in the advice they give their clients. I’ve decided I don’t want to devote what remains of my career to trying to ram materialism down people’s throats. And I’ve become more conscious of my obligation as a journalistic commentator to warn my readers not to be unduly influenced by one-dimensional advice from economists – by what, to coin a phrase, is ‘partial-equilibrium analysis’. Voters have to stand up to economists in the same way an HSC student has to stand up to a French teacher who lays on the homework as though French was the only subject the student was studying. So the first thing I’d say about Treasury’s role is that, in proffering its advice, Treasury must guard against the unconscious assumption that the material objective should be maximised at the expense of all other objectives. I suspect Treasury also needs to be more conscious of the analytical limitations of its discipline.

So at last we reach the final part of my talk where I actually address the topic and say something about Treasury’s role. I’m not going to bother telling you what a great job I think you’re doing – there’d be little point in that. No, I’m going to offer some criticism. But please note this: I’m a person who earns his living by expressing his criticisms in public, but these are being offered in private. And though I’m paid to find fault, I have no reason to be anti-Treasury. In fact, I’ve always had in my makeup an instinctive sympathy for those people charged with the daunting task of holding the show together and moving it on in pursuit of the community’s betterment.

To that end, I’ve always accepted, for instance, that the Treasurer’s role is to talk up the economy – that he does so in our corporate interests, not just his own political interests. I’ve always accepted that it’s not Treasury’s role to be the first to forecast a recession, for fear of the self-fulfilling prophecy. I’ve been sympathetic to Treasury when its Budget-time forecasts have been subject to cheap shots from smart-alec business economists who enjoy the luxury of being able to change their forecasts as often as they change their underpants. (And I almost always remember to pin the forecasts on the Government rather than Treasury.)

Hitherto, I’ve always accepted the need for Treasury – and more, these days, Finance – to play the institutional role of Dr No. I think of it as the role of the cricket club treasurer. She’s facing a committee of 12, each of whom can think of fabulous ways of spending every cent in the club’s bank account – and more besides. Facing such odds, if she adopts a position of automatically opposing all spending proposals, there’s a fair chance that no more will get through than the club’s finances can stand. There’s never any shortage of people with good ideas to spend money. Every institution needs a least one person – the treasurer - who knows her role is to be a perpetual wet blanket in the interests of the institution’s longevity.

And, hitherto, I’ve always accepted the need for Treasury – and Tax, of course – to ‘protect the revenue’. If you don’t do it, who will? Well, it was my own concern to protect the revenue that helped to bring me into journalism almost 30 years ago. I was a young chartered accountant bored with auditing. I decided the only really interesting part of accounting was tax advice, but I also decided that I didn’t want to devote my life to helping the well-off avoid their responsibilities to the community. I trust you’ve seen this ‘prior’ evident in my work. I’ve often been happy to defend unpopular tax measures – I even went to the defence of the super surcharge, despite considerable reservations about its design features.

But – and now we get to the but – of late I’ve formed the view that Treasury needs to perform its roles of opposing new spending and defending the revenue with a lot more forethought, discernment and subtlety. With more guile, if you like. Let’s start with the spending side.

In Martin’s speech to the CFOs, he argued that ‘these real GDP per capita gains [from micro reform] are not just materialistic gains for the lucky few, but a real improvement in Australia’s capacity to sustain whatever economic and social improvements its people want’. I responded to that by email, and I’ll tell you my response. I said that, coming from Treasury, it was a bit rich. It was, in fact, no more than ex-post rationalisation. We both know, I said, that, first, when Treasury and other economic rationalists were urging governments to make these reforms in the first instance, they did little to urge governments to introduce (quote) ‘policies that help sections of the community adjust to change’ (unquote). In fact, Treasury hoped to be able to get away without them. Second, when other people wanted such adjustment assistance/compensation for the losers, Treasury oftentimes opposed it. The third thing we both know, I said, was that when the political shite eventually hits the fan, the pollies go behind Treasury’s back and do things that are really stupid. In which case, Treasury’s badly overplayed its hand.

Consider the case of the revolt in the bush. We’ve been through a period of at least a decade where, as a result of a range of micro reforms – from banking to railways to telephones – people have been busily dismantling a whole range of long-standing cross-subsidies in favour of RARAland. It seems to have occurred to no-one in any of the alleged co-ordinating departments that these disparate federal and state initiatives were starting to add up, and might soon provoke a counter-reaction. It occurred to no-one that there is deeply ingrained community support for the notion that the city should prop up the bush – support not just in the bush, but also in the city. When the inevitable backlash came, what did we get? We got petrified politicians running everywhere reversing policies and oiling squeaky wheels. What we didn’t have was any pre-emptive thinking by the PC or anyone else about second-best solutions. Thinking that, proceeding from the position that the public would always want some degree of subsidy for the bush, studied the costs and benefits of rival subsidies and came up with a program saying, if you insist on wasting your money, these are the least-worst subsidies to waste it on.

Martin always expected what I’d say today was that micro reform should have done more to help people adjust to change and more to redistribute the proceeds of reform from the winners to the losers. Well, I am saying it. I’m saying it’s not enough that the winners could compensate the losers; you actually have to do it. I’m also saying that if you want to know why economic rationalism and globalisation and competition policy are on the nose – and why the prospects for further reform are so dismal – you need look for no fancier answer than this. The punters have discerned that, whoever’s making a killing from micro reform, it ain’t them. And they’re right, it ain’t. The final ain’t is that they ain’t gonna take it anymore. Treasury and its fellow travellers sought to drive too hard a bargain on the opening up of our economy, and they’ve brought to whole game unstuck.

Next I want to say something about protecting the revenue. Alan Mitchell has a saying that the main task of the bureaucracy is to keep the crazy decisions to a minimum. On the tax front, I don’t think Treasury and Tax have been doing too well lately on that criterion. They seem to have been working on the theory that if you look after the pennies the pounds will look after themselves – and they seem to have come badly unstuck.

Consider the petrol excise. I assume that Treasury urged the Government to do the 1.5 cents a litre chisel on its promise to prevent petrol prices rising, and that it urged the Government to include the special GST price effect in the regular indexation of excises. These penny-pinching decisions were taken or confirmed after the price of petrol had skyrocketed and motorists’ extreme displeasure was apparent. Presumably, the logic was that, with OPEC and the Aussie dollar doing their worst, no-one would notice a little chiselling by the Government. But the Government was robbed of the ability to claim its hands were completely clean in the matter, and the motoring lobbies were incited to launch a major campaign. In the inevitable backdown, the Government not merely gave up the ill-gotten 1.5 cents a litre, it abandoned the indexation of petrol excise for good and all. That’s protecting the revenue? Well done.

Next, consider the alleged self-funded retirees. My mail says that a lot of the complaints Government backbenchers were getting about GST paperwork came not from small businesspeople complaining about the BAS, but from retirees complaining about the IAS. And why wouldn’t they? When the backdown came, you could have knocked me over with a Payment Summary – Individual Non Business when I heard Costello say that people likely to owe less than $250 a year no longer needed to complete a quarterly IAS. If having the elderly submit five returns a year to pay less than $250 isn’t administrative incompetence (ie they didn’t have to, but were allowed to think they did), it’s appalling penny-pinching. And the ultimate penalty to the revenue? The even more appalling measures to square away the self-righteous retirees in this year’s Budget – measures that are like a time-bomb ticking away as the population ages and Generation X buckles under the weight of carrying the babyboomers.

What is Treasury’s role? Well, one role is that, in its efforts to control government spending and to protect the revenue, it should avoid being too smart by half.