Statements and Revelations

In a post a few weeks ago (here) I mentioned that economists generally aren’t very much interested in what people have to say. You won’t find many economic researchers engaged in constructing focus groups, and asking people for their opinions on the labour market, the state of the financial system, or why they think the government (or they themselves) can’t balance a budget. Usually instead, economists collect data about what people bought, what they were paid as wages or who they voted for.  When I mentioned this previously, I also said that there were very good reasons for this. As I have attempted to explain before, economics is not the study of money; it is the study of the efficient allocation of scarce resources; from a single household to the whole country. How each individual allocates these resources in his/her life is based on his/her individual preferences, subject to his/her budget constraint.

The thing about preferences however, is that they can be very elusive, even to the individual themselves. You don’t really know how the cash in your wallet is going to be spent. If you were asked, you would possibly think of food shopping or other basic survival necessities. This is how we like to think of ourselves, as functioning people surviving in (and possibly even contributing to) society. Most likely that money won’t be spent on standard food shopping, most likely it will be spent on something stupid like a magazine, luxury baked goods or five beers. What we have here is the difference between a stated preference and a revealed preference. The stated preference was for the food, but through your actions your revealed preferences are for basically everything else. As mentioned in a few previous posts, social sciences don’t really tell you anything you don’t know intuitively, and the lesson here is that there is a fundamental difference between what we say and what we do. In neo-classical economics, only revealed preferences are taken into account, as what people do is far more relevant to the efficient allocation of resources than what they say.


In order to study these revealed preferences, some kind of medium is needed in order to isolate the talking from the action. Nothing suggests a preference for something as much as willingly spending money on it, so therefore we have a logical area to research: the free market. In simple economic theory, buying something is taken as a revealed preference for that item. Each purchase in a market economy is a signal, revealing preference after preference. Supply and demand for each product interact in accordance with these revealed preferences, setting the prices, setting trends and defining what is available for consumption in the economy as a whole. In essence, money is used to quantify what we really want in life, based on signals we give to people who make the products we buy. This is one of the reasons why the concept of money is so important in economics. This might seem very depressing, and not many will want to believe it, but in social sciences simplicity is the key. The free market is the one medium where all members of society must interact at one point or another, and is thus the best way possible to quantify these revealed preferences. Asking people what they want would probably not yield the same quality of results.

This is not that people are generally dishonest or liars, it is just that sometimes we want something we say to represent who we are. In May 2010, the UK media were going crazy as polls they conducted indicated that the Liberal Democrats would storm into power, based on positive reaction to Nick Clegg in election debates. The LibDems did well in the election, and went on to form a coalition government, but the difference between the media polls and the actual results were incomparable. In between the debates and the election, newspapers such as The Guardian randomly asked people on the street who they were going to vote for. Most voters in a two-party system are sick to death of the usual suspects up for election, and Clegg was something new, something exciting, so they answered for him. Actually voting is another matter entirely, as most don’t want to waste a vote on a third-party candidate when they know that one of the usual suspects will win. Really all that the individuals who were polled were doing was trying to impress a stranger, the stranger who was polling them. Nick Clegg and the LibDems were exciting and different, and so were the people answering the poll questions. In 2008, John McCain thought he had a chance in the election despite the massive deficits he suffered in opinion polls, as he was advised (with good reason) that people favoured Obama in polls as they didn’t want the polltaker to think he/she was a racist. In the US, the overestimation in polling numbers for minority candidates is so prevelant that it even has a name, The Bradley Effect.

What we say and what we do are very different things. The things we say are our direct outlet to show the world what kind of person we think we are. Everyone has an image of themselves, and we are not all aware of it. We just suffer from a kind of existential crisis every time someone asks us what we think about something. What do I think? Who am I? Who do I want to be? Who is this person? Do they like me? With friends and people we know well, this is different of course.  With strangers, most people will want to portray the best possible image of themselves. It is the difference between public thoughts and private thoughts. You are more likely to reveal your true self to your close friends. You won’t pretend to like opera, you might confess that your designer bag is a fake, and you just might let it slip that you actually do think Justin Beiber is a great musician. Most people have things like this that they will only tell to close friends, and would never reveal to someone they just met. In economics, we try to take all of this this into account. I have been told on good authority that the word “idiot” comes from the Ancient Greek word for “private person”, and what we can take from all of this is that in private, we are all really idiots. We just don’t want many people to know about it since that, in itself, would be a revelation.


Cause, Effect and Captain Hindsight

For the past few weeks I have been reading Thinking: Fast and Slow by Daniel Kahneman, a Nobel Prize Winning Economist/psychologist. While every few pages contain a revelation that will blow your mind (sorry), what has interested me most is the research he has done on cause and effect, and the human minds understanding of this process. We see a broken window; we see a group of children dressed for a sporting activity on a field of glass nearby staring at it, mouths open, frozen to the spot. The brain subconsciously puts all this together in a story in the mind: the kids were playing some game; the ball (or whatever) spun wildly into the window, and broke it. More than likely this is the case, but of course many other things could have broken that window. This is a simple example, and the brain is very good at instantaneously locating the cause of a simple event like this that has just occurred, as it was necessary at an evolutionary level. You hear a tree branch crack in the forest: something caused this, it more than likely is not something good. At the very least, stop moving until you know more.

These non-complex examples are usually very explainable by simple cause-and-effect, but human society has evolved a lot faster than the human brain, and our minds on a daily basis must comprehend events that have multiple interweaving causes. These could be major societal events such as the Arab Spring or the Summer of Love. Kahneman argues that above all else, when explaining the past the human mind seeks confidence in coherence. Coherence means how well the explanation fits in to the event it describes, while confidence refers to whether this explanation tells the best story of what it describes. There is nothing new here, but what Kahneman showed through years of experiments is that the human mind is completely untrustworthy at determining which of these causal explanations is the best. In fact, all of his research points to the conclusion that confidence in coherence (the way we explain major events) works best when we have hardly any information about the event. We want the simple story, like the kids breaking the window. We know nothing about what was happening on the other side of the window, or indeed in front of it, but the automatic hypothesis fits very well. With more complex events like the fall of the Soviet Union, experts see the event and look back, then pick and choose the most coherent explanation of what caused this. To skip to the end, the logical conclusion of Kahneman’s argument is that social events cannot be explained by cause-and-effect at all. They are explained by hindsight.

Everything makes sense in hindsight. Watching news coverage of the BP Oil spill in May 2010, one would think that everyone working at BP was completely incompetent, that from what they did, an oil spill of magnitude was absolutely inevitable. Reports claim that they didn’t have enough people working, their safety checks should have been more frequent, a backup valve to the backup valve should have been installed (thank you, Captain Hindsight). So the BP Oil Spill was down to human error, which was easily avoidable, but due to these errors the spill was absolutely inevitable. This is a coherent story given to us by the media, in order for us to make sense of a very complex and somewhat random event that occurred, and could have occurred on any oil rig anywhere in the world. It makes sense to us in hindsight: we can study exactly what went wrong, and who was to blame, but beforehand if a statistician were to work out the probability of such a sequence of events occurring, the odds would be astronomical. We were all told a story of cause-and-effect, and it is reassuring to think that disasters are preventable and predictable, but really all that was learned from this event was how to somewhat minimise the effects of an oil spill at the BP Oil Rig Deepwater Horizon that must occur no later than 10pm on April 20, 2010. This story is much more comforting than the realisation that most things in this world are completely out of our control.

Another famous piece of hindsight was the revelation that in summer 2001, George W. Bush was given a briefing report, warning of a terrorist attack on US soil in the near future.  This brings out the Captain Hindsight in everyone, I think. “What if he had just acted on this intelligence?”. In the academic study of history, this is known as contingency, and it is very closely related to hindsight. Contingency is all about the “what ifs?” of history. What if you could kill Hitler when he was a child? What if Franz Ferdinand was not shot in Sarajevo? What if Columbus never crossed the Atlantic Ocean? It is fascinating for us to think that major world events could be prevented simply by altering the actions of one individual actor. Historians call this the “Great Man Theory”, the idea that one person can change the course of history. We were all taught this version of history in school because it is the simplest way to explain complex social movements and events. A great man did something, it had an effect, and that was what happened. This is certainly a lot easier than explaining dynastic politics in various regions of an empire, combined with rising social pressure as a result of food scarcity due to a bad winter, one year. What is interesting about historians is that unlike the social sciences, they make no attempt to use what they have learned from one event in order to explain another, or to predict what may happen. They alone accept that they are but documenters of hindsight.


I was reading about Kahneman’s research on cause-and-effect last Friday, and then I got thinking. In the case of an event of which there is limited evidence, then every coherent causal explanation of this event is as valid as another. I had a gap in my memory from the previous weekend, and all to show for it was a lost phone, a receipt, and a bottle of Fanta. Based on this evidence, I constructed a coherent (to myself, anyway) story which I have more confidence in than any other I have been presented with. Therefore, in essence, my previous post was a tribute to the possibilities of an active consciousness in interpreting the causes of past events. That, and a fitting eulogy to my fallen friend; the black HTC with the cracked screen. There is nothing sinister behind the simplification of disasters, both natural and man-made, as well as the linearisation of historical events. Perhaps none of us would watch a news report that had no underlying story, with no villain, hero or outcome. It would be too unnerving to watch such a thing, as how could we get back to our day afterwards? Seeing disaster after disaster with no answers anywhere how to prevent any of them from happening. Coherence helps, but it’s our devout confidence in them that needs to be balanced.

The Search for a Match

When I tell people that I am doing a PhD in economics, but that my topic has nothing to do with money, I always get a lot of questioning looks. Surely my dissertation should be on bond prices and government deficits during and after the crisis. Similarly, when I explain that my research topic is about discrimination, I am always asked to explain what this has to do with economics. I should be out consoling sad women and living with gypsies in France in order to better understand their hardships. The thing is, what most people out there think of as economics, is really just finance. Finance is a sub-discipline of economics, and its most influential aspect, but that is not all there is. Economics is the study of scarcity and efficiency. It is a way of looking at the world by seeking and questioning the most efficient allocation of scarce resources. These resources can be anything: fuel, people, time and of course money. The method doesn’t change, just the input resource.  My sub-discipline is Labour Economics, which is a market for people in (or out of) employment. For the past year I have been looking into using search theory as a means of analysing discrimination in the labour market. This post does not explain my research, it simply acts as an example to portray how economists view the world.

Search Theory is relatively very new on the academic scene, dating back only as far as the late 1970s. Even in this short time period, it has replaced a classical economic theory dating back centuries. Previously, the unemployment rate was defined as comprising entirely of people who do not want to work: the long term unemployed or unemployable. If someone wants to work, they get a job.  If a worker loses her job, she is instantly sucked up by another unfilled job to retain balance. Anyone who has ever been unemployed can see the fallacy here; finding a job takes time, lots of unemployed people really want a job. (Economists don’t really listen to what people say, and for good reasons, but I will write about that some other day). However the classical way was convenient and it “worked” (ie it satisfied their existing beliefs), so there was no real motivation in changing it. Then along came search theory. Some people in America finally came up with a way to model this search process and explain its necessary period of unemployment, so that changed everything. In introductory economics classes you will know this as Frictional Unemployment, the “frictional” indicating that the unemployment is simply because of movement, not between physical spaces, but between conditions in the labour market: the movement from being employed to unemployed, for example. But back to search theory.


You have to imagine a deserted island in the middle of the ocean. There are two brainless, mute idiots wandering around this island, each unaware of the presence of the other. Their only goal is to find another person.  What methods does each use to explore the area? How long do they keep searching? Do they both have the same motivation to search? These questions are the essence of search theory, and also a good metaphor for unemployment: the two people represent an employer and an employee, the island being the job market. Not just unemployment though, we can apply that to almost anything where two agents are searching for each other. Search theory is also used to analyse the search for a mate. Go back to the questions at the beginning of this paragraph; have they ever gone through your head during an extended period of singledom? Sometimes it may feel like you are running around on a desert island, with no way to find someone, and with no proof that any person is actually there. So you run around looking, mindlessly. As time goes by, your standards may drop, similar to how your demanded wage will drop as your duration of unemployment goes on. You may think of giving up, but you keep going, because that is what you want. Eventually you meet another person, a Match.

So you have finally met someone who is interested, this is good. But soon you realise you don’t like what they have to offer. You take into account everything that you need, everything that they have and think that you can do better. At around this time you will realise there are many other people wandering around the island (anyone who has ever been unemployed for a few months will understand this instantly: once it rains, it pours), and you can do better. So, reject the first match, keep going. Soon after, you meet another match and everything here looks good, let the negotiations begin. Remember above where I inferred that the two idiots on the island might not necessarily have the same interest and motivation in solving this match? This comes into play here, as it is all about bargaining power. Before the match is official there is a bargaining process, and rarely are the two parties on an equal footing. You are all thinking now that in my examples, the employer and the woman are in better bargaining positions. Well, it all depends on the person on the other side. You bargain now, and you can save yourself years of complaining that you aren’t getting paid enough for the work you do, or the control he/she has over the relationship. In search theory this is called the ‘Match Surplus’, which has to be shared between both parties. It is important, and before you get involved in any sort of match you should really think of how much of it you want and more importantly, deserve.

This is all very random however, and unlike the real world. In the real world we do not wander aimlessly around an island, for this would be an extremely inefficient search process. There are places to go and engage in this sort of searching and matching, free from the abundant solved matches on display everywhere. It is only the very desperate person who goes from door to door asking for work, similarly as it is only the over-eager (or Italian) man who tries to pick up girls at supermarkets. The solutions for the jobseeker analogy are newspaper classifieds, websites etc, this is obvious. What is more interesting is the latter example of the relationship search. The solution here is the bar, and it is studied intensely in certain fields of economics as it is the purest and most accessible example of a Two-Sided Market. In a two-sided market, the product offered by a firm is simply a platform where two distinct types of users can meet each other in a risk-free environment. Most non-Latin countries frown upon men approaching women in public, however in bars this is seen as normal behaviour. In economics, a bar doesn’t sell alcohol or music or ambiance, it sells men and women to each other. Ever noticed that some weeknights many bars or nightclubs charge men an entry fee, but let women in for free? They are assuming the bar will fill up with women, then the men outside will pay a premium due to the relative scarcity of men inside. If you think you go to a club for the music and atmosphere, but end up meeting a mate there, that bar has sold you the type of person you want to meet, who has similar interests to you. Otherwise you would have been wandering mindlessly around the island looking for each other.

Of course, life is a lot more complex than this. The main joke in economics is that we do it with models. Everything is simplified, modelled, and then analysed accordingly. A model is supposed to be something perfect, something that works out and does not leave any unanswered questions. All of this is impossible. The main thing is that in economics, the world is full of resources that have to be allocated efficiently. These models and metaphors don’t solve everything, but they can be used as a springboard to better understand these complex systems. And don’t think for a second that I have spent the past year learning what I have written here, for in order to consider myself an economist, every point I made above has to be expressed mathematically. This is actually the most important lesson when you come into contact with all the Social Sciences: everything we tell you is obvious, we just tell it back to you in a complicated, albeit extremely organised way.

Benchmarking the Newsroom

Aaron Sorkin’s HBO show The Newsroom deals with the aftermath of a Jerry Maguire-esque epiphany (here) by the formerly vanilla cable news anchor Will McAvoy (Jeff Daniels), leading him to go on a mission to bring intelligent, informed news to the American people. Anyone who has seen The Newsroom will, after a while, feel like they are watching a story set in a world of fantasy and idealism rather than the real world in which newsrooms actually operate. Audience numbers and corporate pressures to protect business partners are ignored as the staff of this newsroom go about their business of saving America. The show has been heavily criticised for this, as well as the patently liberal agenda visible in every plot point. Sorkin is way past the point where he can make a claim to be non-partisan. This is the man who created President Jed Bartlett in The West Wing, one of the most liberal characters in TV history.

The Newsroom however goes far past what Sorkin attempted with The West Wing, and any show that has gone before it: it is set in the real world, reporting real news. While President Bartlett weighed the consequences of battling genocide in Equatorial Kundu and dragging his country into a war protecting Kazakhstan from the crosshairs of Russia and China, Will McAvoy is reporting news from mid-2010 through fall 2011. Actual news stories, from the BP Oil Spill to Osama Bin-Laden via the Arab Spring and the News of the World phone tapping scandal. Actual news footage from his ‘competitors’ at CNN, FOX, MSNBC and others are shown to contrast with what our liberal newsroom staff think should be done. After a few episodes, it sunk in that what  Sorkin is doing in The Newsroom: he’s benchmarking the news. Continue reading