Tag Archives: economics

What is inflation: the purchasing power cookie monster

Credit: Pixabay.

Imagine you receive a large, tasty-looking chocolate-chip cookie as a gift. Giddy, you place it in the pantry for safekeeping so you can enjoy it later. One day, you get the munchies and decide to finally revel in the chocolate-chip delight when you notice something terrible: it’s been bitten off.

You gobble the cookie whole — or at least what’s left of it. It is still delicious, but you can’t help feeling bitter at the fact that you could have had more of the cookie had you decided to eat it when you first put your hands on it, right then and there. You also feel angry at the unruly perpetrator. Yeah, you know who it was — the inflation monster strikes again!

What is inflation

In any free-market economy, prices for goods and services are never fixed for a long time. Some prices rise while others fall, depending on the influence of various market forces along with monetary and fiscal policies. However, whenever one speaks of an increase in prices for a broad range of goods and services, not just individual items, this is called inflation.

Not just any goods or services — inflation typically refers to the rise in prices for goods and services that are regarded as essential or in common use. These include food, housing, clothing, public transit, consumer staples, electronics, etc. Inflation is always relative to previous prices, which is why it is measured in percentages.

For instance, an inflation rate of 5% per year means that if your grocery shopping and recurrent bills cost you $100 today, it would have cost you about only $95 a year ago. The same basket of shopping will cost you $105 in a year’s time. If inflation stays at 5% for ten years, this same shopping will cost you $163.

When prices move in reverse (decrease), economists refer to this phenomenon as ‘deflation’.

So, inflation is a time when the buying power of money in terms of goods and services is reduced, while deflation is a time when the buying power of money in terms of goods and services increases.

What are the effects of inflation

Inflation causes prices to rise, affecting purchasing power. During inflation, the same amount of money that bought you goods and services a year ago, now buys less of them. In other words, inflation chips away at your purchasing power.

In fact, when inflation is extreme — a phenomenon called ‘hyperinflation’ where the monthly inflation rate exceeds 50% — money that used to buy you something is now worthless. In some cases, that wad of cash may be worth less than the paper it is printed on.

Look no further than Venezuela for a prime example of how inflation can ruin a country’s economy and the livelihoods of its people. In 2018, Venezuela experienced an inflation of 130,060%, which is equivalent to saying 130,060 US dollars would offer the same purchasing power as one US dollar after only a year.

The situation is so ridiculous in Venezuela, that stores don’t even label prices. What’s the use when prices can change by the hour?

To make matters worse, Venezuela has been experiencing hyperinflation for years, reflecting the country’s poor economy that has shrunk by half in a span of five years.

However, inflation in most countries isn’t nearly that bad. In the United States, the annual inflation rate in the last two decades has typically been around 2% to 4%.

Of course, that’s not to say that the U.S. hasn’t seen its fair share of bloating inflation. In this modern history, the country has seen its highest inflation rates during World Wars I and II, as well as more relatively recently in the 1970s.

In response to double-digit inflation from the 1970s, which didn’t end until the early 1980s, the central bank raised interest rates to 20%, leaving many Americans priced out of new cars and homes.

You can see how inflation rates evolved in the United States in the two diagrams below, starting from 1913 until 2014. Diagram A shows the level of prices in the Consumer Price Index, where ‘100’ is defined as the average level of prices that existed from 1982 to 1984. Diagram B shows the annual percentage changes in the CPI over time, which corresponds with the inflation rate.

OpenStaxCollege, CC BY 4.0.

What causes inflation

The price for any goods or services in a free market is heavily dependent on supply and demand — and money is no different. When the central bank prints more money, each dollar bill tends to become less valuable.

However, this doesn’t necessarily mean that printing more money will drive prices up. There’s also a demand side, so if there are more goods and services offered on the market, there will be more demand for cash. It is this dance between demand and supply for cash that drives prices up or down, creating inflation or deflation.

This is why some economists are in favor of small annual inflation rates, arguing that it drives consumer spending, thus fueling the economy. In fact, the Federal Reserve is actually targeting certain inflation rates with its monetary policy, rather than making efforts to reduce it.

On the flip side, inflation discourages savings, which can motivate individuals to engage in riskier investments to increase or even maintain their wealth. For this reason, some economists claim that inflation benefits only a minority of businesses and individuals at the expense of the majority.

The types of inflation

Inflation means the same thing anywhere: prices go up. However, not all inflation is triggered in the same way, which is why economists have identified several types of inflation.

Demand-pull inflation occurs when consumers demand more goods and services than there are available. Imagine you run a factory that just released the sleekest electric vehicle on the market. People are throwing money at you, but despite your staff’s best effort, with production ramped to the max, you can’t meet demand. Since demand is huge relative to supply, the price for the product goes up accordingly.

Cost-push inflation is also a result of more demand than supply, with the key difference being that supply is affected by production costs. In line with our previous example, imagine that China — who is the world’s most important supplier of rare earth minerals — suddenly rose prices on their end. Better yet, imagine that the U.S. government slaps an extra tariff on imports of these resources from China. In any case, the result is the same, the production cost rises, and prices must go up to preserve the bottom line.

The two examples are the most common types of inflation. Less frequent types of inflation include hyperinflation (out of control inflation), pricing power inflation (when a company that has a monopoly raises prices simply because they can and consumers don’t have an alternative), sectoral inflation (rising prices confined to a single industry), and stagflation (rising inflation and unemployment despite slow economic growth).

Is inflation inherently bad? Not always. In fact, a bit of inflation is actually welcome sometimes

The very idea of money losing its value over time seems awful. Who on Earth wants their money to be worth less? But there are instances when inflation can help the economy, thereby boosting purchasing power.

When there are more dollars in circulation, people spend more, driving demand for goods and services. More demand tends to (but certainly not always) boost production in order to meet the additional demand.

According to famed British economist John Maynard Keynes, at least some inflation is required to stave off the Paradox of Thrift — the idea that consumers will hold off purchases to wait for a better deal, which reduces aggregate demand, leading to less production, unemployment, and a generally poor economy.

Inflation is also great for debtors, who can repay loans with money that is less valuable than at the time of borrowing. Obviously, this encourages peoples and businesses to borrow or lend, which again increases spending.

This last point is also why many governments are very fond of ‘good’ inflation. The world’s number one debtor is the United States government, its debt amounting to $25.7 trillion as of May 27, 2020. Having some inflation eases the burden of this massive debt.

In other words, high inflation is very bad, but so is low inflation. For the U.S. Federal Reserve, a 2% inflation rate hits the sweet spot.

This shows that inflation is not necessarily a catastrophe (unless you live in Venezuela). Instead, inflation is actually part of modern monetary policy and is actively pursued by most states in the developed world.

How inflation is measured

In the U.S., the rate of inflation is tracked using the consumer price index. The index is the average price of a basket of goods and services that are in common demand. Its year-to-year change corresponds to the annual inflation rate.

This index, however, is an average value. So, although the inflation rate might be 2%, some goods and services might have actually risen above or fallen below that value.

Below is an example of an annual ‘basket’ of goods and services consumed by households. The difference in pricing over the years can tell us the rate of inflation.

Bottom line: inflation is defined as the rate of change in pricing for a broad range of goods and services in demand by households. A little inflation is healthy for the economy, but too much of it can slow down the economy and increase unemployment. This is why monetary policy (printing money, setting interest rates) is a very delicate balancing game.

As long as your cookie also keeps growing, the inflation monster isn’t that scary at all.

manufacturing

Industrialization pays less dividends: when manufacturing jobs shift abroad, their share peak at a lower level than in the previous country

Manufacturing is becoming less and less lucrative for countries looking to develop their economies. According to one of the most comprehensive studies in the field, the market forces of a globalized economy have made it more difficult for rich countries to compete in the global market and for poor countries to become rich by industrializing.

manufacturing

Credit: Pixabay.

One of the biggest takeaways of the study was that once manufacturing shifts abroad, say steel milling from the United States to India, the per-capita income (or job market share) will peak at a lower level than in the previous country. This implies that any politically-centered policy to bring back manufacturing jobs in rich countries, such as Trump’s recently proposed trade tariffs, are doomed to fail in the long-run.

The research led by Aashish Mehta, a University of California Santa Barbara associate professor in the Department of Global Studies, analyzed a dataset of manufacturing employment in 63 countries from 1970 to 2010, representing 82 percent of the world’s population in 2010.

The path countries have taken towards industrialization looks more or less like this: At first, there’s a low share of manufacturing jobs, but as the economy gains of industrialization accrue, more manufacturing jobs become available. However, once income rises, so do wages. At one point, it becomes more lucrative to move away from high-paying jobs, either replacing them with machinery, moving operations abroad where wages are lower, or both. These global forces allow developing countries to become industrialized and catch up — the traditional way of becoming rich themselves. However, the share of manufacturing jobs in the new country peaks at a lower level than in the previous country, the researchers wrote in the Cambridge Journal of Economics.

“While the original OECD countries peaked with over 30 percent of their jobs in factories, today’s industrializers seem to be peaking at around 12 to 14 percent,” Mehta told Jim Logan for The Current.  “We also showed that the per-capita income level at which this decline sets in has fallen over time. These findings suggested to us that the path to riches through industrialization had narrowed considerably.

“This was worrying,” he continued. “We had to know why it happens and, particularly in an era of climate change, we had to know whether there are alternative pathways to national prosperity.”

Mehta and colleagues found that although individual countries are deindustrializing early and at lower shares, the number of manufacturing jobs is generally the same. Manufacturing jobs tend to flow from richer countries to poor countries, where the workforce is less skilled and automatization not that widespread. So, it takes more people in a developing country to replace one manufacturing job lost by the industrialized country.

“If you took half the manufacturing jobs out of Europe, let’s say manufacturing employment comes crashing down from 30 percent to 15 percent. And you took all those jobs and you put them in China or India. The fraction of Chinese or Indian workers working in factories would go up very little, because there are so many of them. But globally, no factory jobs would be lost,” Mehta explained.

In today’s context, the research suggests that it will prove extremely difficult for the U.S. to compete for manufacturing jobs. Besides having a cheaper labor force and opening up trade (China is a great example), developing countries have also invested heavily in infrastructure but also education. Mehta notes that this has not been the case in the U.S. in recent decades. For instance, very few people in the United States are trained how to operate a machine relative to the country’s population. Today, developing countries are more adapted and able to support manufacturing in ways that the U.S. cannot.

Foragers farmers fossil fuels.

Book Review: ‘Foragers, Farmers, and Fossil Fuels: How Human Values Evolve’

Foragers farmers fossil fuels.

 

“Foragers, Farmers, and Fossil Fuels: How Human Values Evolve”
By Ian Morris
Princeton University Press, 400pp | Buy on Amazon

What we consider as ‘right’ or ‘just’ isn’t set in stone — far from it. In Foragers, Farmers, and Fossil Fuels, Stanford University’s Willard Professor of Classics Ian Morris weaves together several strands of science, most notably history, anthropology, archeology, and biology, to show how our values change to meet a single overriding human need: energy.

Do you think your boss should be considered better than you in the eyes of the law? Is it ok to stab someone over an insult? Or for your country’s military to shell some other country back to the stone age just because they’re ‘the enemy’? Do leaders get their mandate from the people, from god, or is power something to be taken by force? Is it ok to own people? Should women tend to home and family only, or can they pick their own way in life?

Your answers and the answers of someone living in the stone age, the dark age, or even somebody from a Mad-Men-esque 1960’s USA wouldn’t look the same. In fact, your answers and the answers of someone else living today in a different place likely won’t be the same.

Values derive from culture

They’ll be different because a lot of disparate factors weigh in on how we think about these issues. For simplicity’s sake, we’ll bundle all of them up under the umbrella-term of ‘culture’, taken to mean “the ideas, customs, and social behavior of a particular people or society.” I know what you’ll answer in broad lines because I can take a look at Google Analytics and see that most of you come from developed, industrialized countries which (for the most part) are quite secular and have solid education systems. That makes most of you quite WEIRD — western, educated, industrialized, rich, and democratic.

As we’re all so very weird, our cultures tend to differ a bit on the surface (we speak different languages and each have our own national dessert, for example). The really deep stuff, however — the frameworks on which our cultures revolve —  these tend to align pretty well (we see equality as good, violence as being bad, to name a few). In other words, we’re a bit different but we all share a core of identical values. Kind of like Christmass time, when everybody has very similar trees but decorates them differently, WEIRD cultures are variations on the same pattern.

It’s not the only pattern out there by any means, but it’s one of the (surprisingly) few that seem to work. Drawing on his own experience of culture shock working as an anthropologist and archaeologist in non-WEIRD countries, Professor Morris mixes in a bird’s eye view of history with biology and helpings from other fields of science to show how the dominant source of energy a society draws on forces them to clump into one of three cultural patterns — hunter-gatherers, farmers (which he names Agraria), and fossil-fuel users (Industria).

Energy dictates culture

In broad lines, Morris looks at culture as a society’s way to adapt to sources of energy capture. The better adapted they become, the bigger the slice of available energy they can extract, and the better equipped they will be to displace other cultures — be them on the same developmental level or not. This process can have ramifications in seemingly unrelated ways we go about our lives.

To get an idea of how Morris attacks the issue, let’s take a very narrow look at Chapter 2, where he talks about prehistoric and current hunter-gatherer cultural patterns. Morris shows how they “share a striking set of egalitarian values,” and overall “take an extremely negative view of political and economic hierarchy, but accept fairly mild forms of gender hierarchy and recognize that there is a time and place for violence.”

This cultural pattern stems from a society which extracts energy from its surroundings without exercising any “deliberate alterations of the gene pool of harvested resources.” Since everything was harvested from the wild and there was no way to store it, there was a general expectation to share food with the group. Certain manufactured goods did have an owner, but because people had to move around to survive, accumulating wealth beyond trinkets or tools to pass on was basically impossible, and organized government was impractical. Finally, gender roles only went as far as biological constraints — men were better tailored to hunt, so they were the ones that hunted, for example. But the work of a male hunter or a female gatherer were equally important to assuring a family’s or group’s caloric needs were met — as such, society had equal expectations and provided almost the same level of freedom and the same rights for everyone, regardless of sex. There was one area, however, where foragers weren’t so egalitarian:

“Abused wives regularly walk away from their husbands without much fuss or criticism [in foraging societies],” Morris writes, something which would be unthinkable in the coming Agraria.

“Forager equalitarianism partially breaks down, though, when it comes to gender hierarchy. Social scientists continue to argue why men normally hold the upper hand in foarger societies. After all, […] biology seems to have dealt women better cards. Sperm are abundant […] and therefore cheap, while eggs are scarce […] and therefore expensive. Women ought to be able to demand all kinds of services from men in return for access to their eggs,” Morris explains in another paragraph. “To some extent, this does happen,” he adds, noting that male foragers participate “substantially more in childrearing than […] our closest genetic neighbours.”

But political or economic authority is something they can almost never demand from the males. This, Morris writes, is because “semen is not the only thing male foragers are selling.”

“Because [males] are also the main providers of violence, women need to bargain for protection; because men are the main hunters, women need to bargain for meat; and because hunting often trains men to cooperate and trust one another, individual women often find themselves negotiating with cartels of men,” he explains.

This is only a sliver of a chapter. You can expect to see this sort of in-depth commentary of how energy capture dictates the shape of societies across the span of time throughout the 400-page book. I don’t want to spoil the rest of it, since it really is an enjoyable read so I’ll give you the immensely-summed-up version:

Farmers / Agraria exercise some genetic modifications in other species (domestication), tolerate huge political, economic, and gender hierarchies, and are somewhat tolerant of violence (but less than foragers). Fossil-fuelers / Industria was made possible by an “energy bonanza,” and are very intolerant of political hierarchies, gender hierarchy, and violence, but are somewhat tolerant of economic hierarchies (less than Agrarians).

These sets of values ‘stuck’ because they maximised societies’ ability to harvest energy at each developmental level. Societies which could draw on more energy could impose themselves on others (through technology, culture, economy, warfare), eventually displacing them or making these other societies adopt the same values in an effort to compete.

Should I read it?

Definitely. Morris’ is a very Darwinian take on culture, and he links this underlying principle with cultural forms in a very pleasant style that hits the delicate balance of staying comprehensive without being boring, accessible without feeling dumbed down.

The theory is not without its shortcomings, and the book even has four chapters devoted to very smart people (University of Exter professor emeritus of classics and ancient history Richard Seaford, former Sterling Professor of History at Yale University Jonathan D. Spence, Harvard University Professor of Philosophy Christine Korsgaard, and The Handmaiden’s Tale’s own Margaret Atwood) slicing the theory and bashing it about for all its flaws. Which I very much do appreciate, as in Morris’ own words, debates “raise all kinds of questions that I would not have thought of by myself.” Questions which the author does not leave unanswered.

All in all, it’s a book I couldn’t more warmly recommend. I’ve been putting off this review for weeks now, simply because I liked it so much, I wanted to make sure I do it some tiny bit of justice. It’s the product of a lifetime’s personal experience, mixed with a vast body of research, then distilled through the hand of a gifted wordsmith. It’s a book that will help you understand how values — and with them, the world we know today — came to be, and how they evolved through time. It’ll give you a new pair of (not always rose-tinted) glasses through which to view human cultures, whether you’re in your home neighborhood or vacationing halfway across the world.

But most of all, Foragers, Farmers, and Fossil Fuels will show you that apart from a few biologically “hardwired” ones it’s the daily churn of society, not some ultimate authority or moral compass, that dictates our values — that’s a very liberating realization. It means we’re free to decide for ourselves which are important, which are not, and what we should strive for to change our society for the better. Especially now that new sources of energy are knocking at our door.

The 2016 Nobel Prize in economics awarded to duo of contract theoreticians

The 2016 Nobel Prize for economics goes to UK-born Oliver Hart from Harvard University and Finland-born Bengt Holmström from MIT for their work on contract theory. The duo has covered issues ranging from employer-employee contracts to public-private partnerships and executive pay. Their work has helped improve the design of contracts, which hold together modern economies.

The committee said the prize reflected the pair’s role in advancing contract theory as “fertile field of basic research” and their subsequent work, which many regard as the foundation on which many policies and institutions were created. The Royal Swedish Academy of Sciences called their work the key to understanding how real-life institutions and contracts sustain modern economies.

“Society’s many contractual relationships include those between shareholders and top executive management, an insurance company and car owners, or a public authority and its suppliers. As such relationships typically entail conflicts of interest, contracts must be properly designed to ensure that the parties take mutually beneficial decisions,” the Royal Swedish Academy of Sciences said.

“This year’s laureates have developed contract theory – a comprehensive framework for analysing many diverse issues in contractual design, like performance-based pay for top executives, deductibles and co-pays in insurance, and the privatisation of public-sector activities.”

Hart focused on contract theory. In his view, contracts work as instruction manuals, but they were incomplete. His assessment of the US prison system, showing that the pressure to cut costs was so great it led to unacceptable drops in quality, found that the issue stems from “incomplete contracts”. As these agreements can’t specify what needs be done in every case, they should say how decisions should be taken.

“His research provides us with theoretical tools for studying questions such as which kinds of companies should merge, the proper mix of debt and equity financing, and which institutions such as schools or prisons ought to be privately or publicly owned,” the Royal Swedish Academy of Sciences, which awarded the prize, said in a news release, referring to Dr. Hart.

Holmström’s work has focused on employment contracts, reaching into issues such as executive pay. In the news conference that marked the award, he was asked what the thought of the huge bonuses awarded under modern contracts.

“My personal view is they are too complicated today,” he said.

Where a company wants its employers to act as if they have a stake in the winnings — working hard, minding costs but also taking calculated risks — employees don’t. They want to be paid as much as possible, for as long as possible, while not working harder than needed, and assessing performance becomes difficult. So Holmström showed that companies should pay employees following the broadest possible evaluation of his or her performance.

He said one big part of this is to set aside a portion of compensation. If an employee is efficient and the company profits, this bonus can be increased. If not, it can be reduced. He also said that companies should tie pay to the share price of other firms in the industry — it wouldn’t make sense to reward or punish executives for fluctuations tied to broader economic factors. And, companies are increasingly opting for this kind of deferred payment, particularly for executives, Dr. Holmstrom noted with satisfaction Monday morning.

 

 

The science of why you should buy experiences, not things

The science of happiness is still a youthful and controversial field, but one thing seems to be clear: there’s only so much money and comfort can bring.

Economic growth doesn’t translate to happiness. Sure, people in developed countries often tend to be happier than those in developing countries, but generally speaking money doesn’t bring more happiness – it just brings less sadness. Moving on to a personal level, the things you own don’t define your happiness, and researchers like Thomas Gilovich, Professor of Psychology at Cornell University are trying to convince people of this.

“One of the enemies of happiness is adaptation,” says Dr. Thomas Gilovich, a psychology professor at Cornell University who has been studying the question of money and happiness for over two decades. “We buy things to make us happy, and we succeed. But only for a while. New things are exciting to us at first, but then we adapt to them.”

The reasoning is apparently simple: let’s say you can choose between taking a vacation you’ve always wanted versus buying a new, better laptop. The vacation will last only a week, while you’ll enjoy the laptop for years. So apparently, it makes much more sense to buy the laptop. But according to recent research, that reasoning is completely wrong.

It’s not about the money

Gilovich suggests not focusing on the new iPhone, or a BMW or a nicer couch – instead, we should be going to more art galleries, theater shows, traveling and learning new skills.

His findings are highly consistent with modern research, and especially with the Easterlin Paradox. The Easterlin paradox is a key concept in happiness economics. Named for the economist Richard Easterlin, who discussed it in his highly influential book in 1974, the paradox states that while within a given country people with higher incomes were more likely to report being happy, this would not hold at a national level, creating an apparent paradox. He reported that happiness does not correlate with GDP and Gilovich believes he knows why. Along with colleague Amit Kumar, Easterlin published a review which demonstrated that “experiential purchases (such as vacations, concerts, and meals out) tend to bring more lasting happiness than material purchases.” They found this was because “Compared to possessions, experiences are less prone to hedonic adaptation“.

“Our experiences are a bigger part of ourselves than our material goods,” says Gilovich. “You can really like your material stuff. You can even think that part of your identity is connected to those things, but nonetheless they remain separate from you. In contrast, your experiences really are part of you. We are the sum total of our experiences.”

Another aspect that contributes to this factor is comparison to others. A study conducted by researchers Ryan Howell and Graham Hill found that we’re much more likely to negatively compare our possessions to those of others, but that doesn’t really happen for experiences. As it turns out, we cherish our experiences quite deeply.

“The tendency of keeping up with the Joneses tends to be more pronounced for material goods than for experiential purchases,” says Gilovich. “It certainly bothers us if we’re on a vacation and see people staying in a better hotel or flying first class. But it doesn’t produce as much envy as when we’re outgunned on material goods.”

So the conclusion is simple: pick up that pottery class. Go for that vacation you need so badly. Heck, meet up with your friends for a beer more often – those are the experiences that will ultimately contribute to your happiness.

jackie-chan-illuminati.0.0

Are some people pro-social because they don’t know how to selfishly help themselves?

Utilitarian economics says each person ought to seek to maximize personal gains, either by acting completely selfishly or by being seemingly altruistic only to personally benefit by sharing the spoils of the group. Studies that track this sort of behaviour seem to be at odds. Some find that humans indeed seek to maximize their profits, while others find that humans are altruistic — forgoing maximum profit for the benefit of the group as a whole. A new study by Oxford researchers suggests that we all would like to maximize our profits, it’s just that some simply don’t understand the rules of the game. In other words, they act altruistic because they don’t know how to be selfish, which in effect doesn’t make them altruistic at all.

jackie-chan-illuminati.0.0

Some people just don’t get it.

The researchers write that economics experiments made so far divide humans into two paradigms: fairminded cooperators that act for the good of the group and selfish “free riders” that exploit the altruism of others. These thinking is modeled by the results of games study participants played in which those who cooperate share the group’s prize pool, but at a personal cost. More precisely, studies account for two types of people: 50% being conditional cooperators, who approximately match the contributions of their groupmates, and about 25% being free riders who sacrifice nothing. People in fall in the 25 percent range either contribute more or less the same every time (the unconditional contributors — do they care?) or people who express complex behaviour that can’t be described broadly.

What we can gather from this is that people are generally pro-social. But there’s another explanation, the Oxford researchers reckon: people are confused and don’t know how to play ‘the game’. The game of life? Maybe.

The team organized a public-goods game in the same way as those that have been previously used to measure if there are distinct social types. Individuals were grouped in four, and each given 20 monetary units (MUs) that they can either keep for themselves or partially/fully contribute to a group project. The sum of the contributions was multiplied by 1.6 MU and shared equally among the members. Therefore, for each 1 MU contributed, a person lost 0.4 MU. The maximum profit one would gain is thus by contributing nothing, nil, zero MU.

Researchers explained the rules and possible outcomes of the game to the participants in person, on paper and on a computer screen. Here’s where the catch was though. First, participants were told they will be play with computers only. This was explicitly stated beforehand. So, joining the group will be three computers that were programmed to play randomly. No human would gain from their contributions. If they chose to cooperate, they would lose money. There is no logical reason for them to contribute. But the findings were striking.

“We found that when playing with computers, individuals can be divided into the same behavioral types that have previously been observed when playing with humans (34) (Fig. 1). Specifically, we found that 21% (n = 15) are noncooperators (free riders) who contribute 0 MU, irrespective of the computer contribution, and 50% (n = 36) are conditional cooperators, who contribute more
when the computer contributes more (1–6). These conditional cooperators are adjusting their behavior in response to the computer’s contribution, even though they have been told that their contributions will not benefit others and despite the fact that the income-maximizing strategy does not depend on how much the computer contributes. The remaining 29% (21) of players exhibited some other pattern”

Next, the participants played the same game — this time with human players. The researchers sought to predict the outcomes of the games based on results in the previous experiment with computers. Before they could proceed playing one of the six series of games, each player had to click yes to a popup saying: “I understand I am now playing with real people.”

The findings suggest that people don’t know how to play the game, and all of these public-good studies that suggest most people are willing to cooperate do not, in fact, reflect underlying social preferences. Switching to human opponents did not alter the initial results.

. Play with computers predicts play with humans and conditional cooperators misunderstand the game. Image: PNAS

. Play with computers predicts play with humans and conditional cooperators
misunderstand the game. Image: PNAS

“We also found that how individuals conditioned their behavior on their beliefs about the behavior of their groupmates did not differ in response to whether they were playing with computers or
humans,” the researchers conclude in the paper published in PNAS.

“Overall, our results show that individuals behave in the same way, irrespective of whether they are playing computers or humans, even when controlling for beliefs. Therefore, the previously
observed differences in human behavior do not need to be explained by variation in the extent to which individuals care about fairness or the welfare of others.”

Rich but not happier — why economic growth doesn’t always translate to happiness

It’s easy to assume that with economic gain comes happiness — we live in capitalism, after all. But science comes to prove us all wrong yet again, and shows that the link between economics and happiness is much more complicated that we thought. Research shows that getting a promotion or a salary raise can increase a person’s satisfaction and give an emotional boost, but only for a short while. Not even something as huge as winning the lottery doesn’t make a permanent change to people’s overall life satisfaction. Money can’t buy happiness, it seems.

And just as a person’s happiness is a result of more than just money, a country’s economic growth doesn’t directly translate into happier citizens — this is known as the Easterlin paradox, after economist Richard Easterlin, the one who observed and documented the phenomena in 1974.

So money can’t buy happiness for countries either, ok, cool. Only that for some…It totally does.

Image via davidruyet.wordpress

What gives!?

Critics have pointed out that in several countries — Italy, Denmark, Luxembourg for example — citizens’ happiness has increased in tandem with the local economy. But for the United States it hasn’t — the Easterlin paradox still applies here: major economic gains over the past 40 years have not led to an overall increase in national happiness. So why does that happen?

Well, psychological scientists Shigehiro Oishi from the University of Virginia and Selin Kesebir from London’s Business School think they may have found the reason why some countries show the paradox and others don’t: income inequality.

“Economic growth is typically not shared equally across segments of society and often results in increased income inequality,” the researchers explain. So, although a country’s GDP may be rapidly expanding, only relatively few people are actually benefiting from this economic prosperity.

The two tested their hypothesis, and their findings were published in the journal Psychological Science.

“Our analyses demonstrate that once one considers income inequality, the Easterlin paradox is not so paradoxical anymore,” the researchers write.

Drawing on data pertaining to economic growth, income inequality and reported happiness levels from 34 countries, Oishi and Kesebir found “support for the idea that the Easterlin paradox can be explained by the toxic effects of income inequality.” They started by mining data from the World Database of Happiness, looking at 16 developed countries in Europe and Asia that had at least 10 years of data available between 1959-2006. They correlated this with the countries’ GDP, taken from the World Development Indicators online database, and calculated income inequality for each, using the Gini index.

“For a nation’s life satisfaction to increase, producing more wealth is not sufficient. The fair distribution of the added wealth may critically determine whether life satisfaction will rise on the whole,” they write.

They found that changes in income equality was a better explanation for happiness better than GDP per capita alone. In years with high income equality, economic growth entailed an increase in general life satisfaction. In years with economic prosperity but large gaps in income equality there was no increase in a population’s happiness.

“What was surprising was that happiness levels did not change from 1947 when GDP per capita was $13,407 (in current dollars) to 1970 when GDP per capita rose to $22,996,” the authors explain. “On the basis of our findings, it is safe to say that if income and happiness go together, it is when income is distributed evenly.”

A second set of data was collected from the Latinobarómetro, a representative public opinion survey conducted annually in 18 Latin American countries and Spain. In both sets of analyses, the researchers found a significant interaction between GDP per capita and the Gini coefficient; citizens’ life satisfaction, on average, was lower in years of greater income inequality.

“Considering the recent trend of growing income inequality in many parts of the world, our findings suggest that more instances of the Easterlin paradox will be observed, with economic growth not necessarily increasing the happiness of a country’s citizens,” Oishi and Kesebir conclude.

Rhode island rape reports compared with three similar states. The vertical line in the timeline is when people took notice of the prostitution loophole. Image: NBER

When Rhode Island accidentally legalized prostitution rapes and STDs dramatically fell

prostitution

In the 1980s, concerned that the state statute on prostitution was too broad and could potentially infringe on First Amendment freedoms, lawmakers in Rhode Island decided to make it more explicit by cutting some articles. They went a bit too far, though, and accidentally removed the section defining the act itself as a crime. It wasn’t until 2003 that courts found that they couldn’t prosecute people for prostitution related felonies. Six years later, legislators corrected the law, but during this time it was found that public health and safety improved dramatically. Namely, gonorrhea among women declined by 39 percent, and the number of rapes reported to police in the state declined by 31 percent.

The economics of legalized prostitution

Rhode island rape reports compared with three similar states. The vertical line in the timeline is when people took notice of the prostitution loophole. Image: NBER

Rhode island rape reports compared with three similar states. The vertical line in the timeline is when people took notice of the prostitution loophole. Image: NBER

The study was reported by Baylor University’s Scott Cunningham and Manisha Shah of the University of California, Los Angeles and provides the first quantitative evidence that legalizing prostitution, even if by accident, can reduce violence against women and prevalence of sexually transmitted diseases. The study’s findings suggest that legalizing prostitution is the best course of action to minimize the risks to society, but some critics argue that prostitution is inherently violent, legal or not, and should be punished in consequence. The debate is whether prostitutes themselves are criminals or victims to pimps and sex traffickers.

The authors, being economists, did not touch on these issues and only focused on reporting data. They found, for instance, that most prostitutes were white and Asian women and that their asking prices fell compared to the black market. It’s important to mention that streetwalking, pimping and trafficking, remained illegal. As such, until the law condemning prostitution as a felony was revised, sex workers were operating their services from home and advertising on the internet.

Some 824 rapes that would have been otherwise reported to police were prevented or 31% less than when prostitution was banned. This sharp decline surprised the scientists involved in the study, but even after running through the date using three separate statistical they found that their results were still valid.

“The human costs are so big, if this is in fact a very real causal effect,” Cunningham said. “I think we have convinced ourselves that we have done everything we can do rule out alternative explanations.”

Debate

Other voices are less convinced. Melissa Farley, a feminist, psychologist and trenchant critic of prostitution, are too detached from what’s going on in the real world that the data fails to account for the fact that prostitutes will continue to be the victims of abuse, whether they operate under pimps or johns. She argues that legalizing prostitution would make it dead easy for traffickers to operate unobstructed and lead to an explosion of sex trafficking and exploitation that could ruin countless lives. A study made in Europe lends credence to her claims.

“Women in prostitution generally describe it as paid rape. That’s what if feels like to them,” said Farley, who feels the study embodies a “reactionary worldview.”

One of the main arguments is that once with rising demand for commercial sex, supply must also follow suit. But is demand actually growing or is it transferred from the black market – where anything can happen? Advocates that call for legalizing the oldest prostitution of the world believe such a counter status quo move will vastly improve working conditions and protect sex workers. Prostitutes could then call the police if they’re abused by a client – something unthinkable at this point – or force the client to wear a condom.

Ronald Weitzer, a sociologist at George Washington University, also argues that a transparent sex market would actually reduce the financial incentive for organized crime. “When something is prohibited, it allows organized crime to gain a foothold,” he said, comparing the sex market to the markets for alcohol during Prohibition or for marijuana and other drugs today.

There are already several countries in the world where prostitution is either legal or decriminalized, like Netherlands and Germany or the state of the Nevada in the US. Each, however, has its own form of regulation. Canada and Israel are currently considering reforms of their own, but this doesn’t make things less debatable in the US or other more conservative, at least publicly, countries.

ZME readers, what’s your take?  As always, please direct your comments below.

Poverty

Poverty puts ‘tax’ on cognition — financial strain causes drop in IQ as large as 10 points

=Poverty posses long-lasting social, emotional and, least not forget, cognitive perils. A recent study found that people under financial strain have a hard time focusing on anything else other than their day-to-day strides, seriously affecting their cognitive abilities. The researchers, led by noted Harvard economist Sendhil Mullainathan, found that people affected by poverty scored as much as ten points lower than they had prior or post entering poverty.

“Our results suggest that when you’re poor, money is not the only thing in short supply; cognitive capacity is also stretched thin,” Mullainathan explained. “That’s not to say that poor people are less intelligent than others. What we show is that the same person experiencing poverty suffers a cognitive deficit as opposed to when they’re not experiencing poverty. It’s also wrong to suggest that someone’s cognitive capacity has gotten smaller because they’re poor. In fact, what happens is that your effective capacity gets smaller: Because you have all these other things on your mind, you have less mind to give to everything else.”

“Imagine you’re sitting in front of a computer, and it’s just incredibly slow,” he continued. “But then you realize that it’s working in the background to play a huge video that’s downloading. It’s not that the computer is slow, it’s that it’s doing something else, so it seems slow to you. I think that’s the heart of what we’re trying to say.”

The idea that poverty induces stress is far from being new, almost everybody is aware of this, and those who have been or are still experiencing poverty know this better than anyone. The implications of the findings are far-reaching, however, because they show a different side to the age long theory that says the social-economic discrepancies between the poor and the rich are due to environmental considerations. It’s not just that – the poor are effectively getting their cognitive bandwidth taxed, deepening the class gap. Something that policymakers should pay particular attention to.

Poor income, poor mental power

Mullainathan reached these conclusions after he studied two dramatically different groups, from almost all perspectives (social, economic, ethnic) –  shoppers at a New Jersey mall and sugar cane farmers in rural India.

When approaching the first group, Mullainathan further divided it into two. Before proceeding with standard IQ and impulse control tests, he asked the first half of the group only “what would they do if their car broke down, and the repair cost $1,500.” The question was meant to surface at a subconscious level their own, personal financial strains. Just thinking about it made a whole lot of difference in their scoring abilities for some people, namely the poor.

“For the poor, because these monetary concerns are just below the surface, the question brings them to the top,” Mullainathan said. “The result was, for that group, the gap between the rich and the poor goes up, in both IQ and impulse control. There was no gap in the other group, but ask them anything that makes them think about money and you see this result.”

The second group represents a more versatile testing medium. Sugar cane farmers experience invariable wealth throughout the year. The farmers only get paid once a year, after harvest when they’re relatively rich. As their funds diminish throughout the year, they experience a poorer and poorer lifestyle peaking at one month before harvest.

“The month after the harvest, they’re pretty rich, but the month before — when the money has run out — they’re pretty poor,” Mullainathan said. “What we did is look at the same people the month before and the month after the harvest, and what we see is that IQ goes up, cognitive control, or errors, goes way down, and response times go way down.

“The effect here is about two-thirds of the size of the effect found in the mall study — it’s at least nine or 10 IQ points, just between these months,” Mullainathan added. “Between these two studies, you both see the mechanism at work, and you see that, in the real world, these effects are enormous.”

Of note is a different study, independent from the current study, which ZME Science featured a while ago. Then, I wrote how Martha Farah, the founding director for Penn’s Center for Neuroscience and Society, found a direct link between poverty and stunting of brain development in children. Though her findings are still preliminary, they are more alarming than the current study featured in this piece. While Mullainathan’s study subjects aren’t less intelligent, just overloaded and flooded, Farah’s subjects experience permanent brain deficiencies. Something well worth considering, again, when discussing the far-reaching implications of poverty.

Calming the mind by isolating poverty

With this in mind, the research proposes policymakers to address these issues by directing efforts meant to isolate periods of acute poverty. As an example, the researchers mention the growing issue U.S. parents face with the cost and availability of childcare.

“One of the major challenges for low-income individuals in the U.S. is having to juggle and find child care,” he said. “That’s a big cognitive load. Seamlessly solving the child-care problem would not just allow people to go to work, it would actually increase their IQ. Rather than simply looking at these challenges as a lack of money very broadly, if we could break it up and simply target the biggest concerns and deal with them, we might begin to solve other problems as well.”

Journal reference: Poverty Impedes Cognitive Function, Anandi Mani, Sendhil Mullainathan, Eldar Shafir, and Jiaying Zhao, Science 30 August 2013, Vol. 341 no. 6149 pp. 969-970, DOI: 10.1126/science.1244172

Prisoner's Dilemma

When the “prisoner’s dillema” is played with real prisoners: unexpected results

The prisoner’s dilemma is one of the most famous paradigms and at the same time one of the most discussed case studies in both economics and psychology introductory classes. Basically, two prisoners are each isolated from one another and are presented with two choices: either they turn the other in (sabotage) or remain silent (cooperate). Now, from here on it varies, but let’s say if one of the paired prisoners testifies, and their partner remains silent, the partner gets three years and the “rat” goes free. If both testify, both get two years. If both stay silent, both get only one year.

Now, game theory states that in such a confrontation betrayal is the dominant strategy since it offers the a slightly higher payoff in a simultaneous game. Economists refer to this as the “Nash equilibrium” after the Nobel Prize recipient John Nash and feature film subject in the Oscar winning biopic “A Beautiful Mind”.

Truth is, this game has been played loads of times before, and apparently game theory’s right: betrayal is the dominant outcome. But not necessarily and not always. For instance, one of the most interesting renditions of the paradigms was made using two study groups: one made out of students and the other out of actual inmates. The study was performed by  two University of Hamburg economists who wanted to analyze the behavioral differences between the two. The outcome was unexpected, to say the least.

Trust or not: the prisoner’s dilemma

A group of prisoners in Lower Saxony’s primary women’s prison was selected to play the same game as another separate group made out of students, through both simultaneous and sequential versions of the game. Naturally, no prison terms cuts could be made so as rewards money was offered to students, while the equivalent in coffee and cigarettes were offered to the inmates.

The researchers found for the simultaneous game, only 37% of students cooperated, while inmates cooperated 56% of the time.

On a pair basis, only 13% of student pairs managed to get the best mutual outcome and cooperate, whereas 30% of prisoners do.

In the sequential game, far more students (63%) cooperated, so the mutual cooperation rate skyrockets to 39%, whereas for prisoners, it remains about the same.  It’s worth noting, though, that the simultaneous game requires far more blind trust from both parties, and the prisoners were far more keen on showing trust first than the students.

Now, everybody assumed that prisoners, seeing how they’re living in a jagged and stressful environment, will defect in larger proportions than the students. The opposite occurred however and while the payoffs weren’t that great (an actual prison sentence reduction would have most likely rendered different results) the paper, published in the Journal of Economic Behavior and Organization, demonstrates that inmates aren’t that calculated and untrusting as society is quick to label them the moment they set foot in a correctional facility.

Good looking people more money

Beautiful people earn $250,000 extra on average

Good looking people more moneyIt’s generally known that people of above-average physical looks are at a greater social advantage than people of average or sub-average appearance. Beautiful people are known to be more successful, happier and more financially fulfilled. Regarding the last part, there’s always been a controversy regarding the economics behind this kind of superficial advantage.

Renowned economist Daniel Hamermesh of University of Texas at Austin, decided to explore the concept and provide an insightful view upon the correlation between one’s physical appearance and income in his recently published book, Beauty Pays.

“In economic terms, beauty is scarce. People distinguish themselves and pay attention to beauty,” Hamermesh says. “Most of us want to look better so we can make more money. Companies realize that hiring better-looking people helps in various ways. In every market, whether it’s jobs or marriage, beauty matters.”

In the most comprehensive study of its kind to date, Hamermesh gathered and correlated date from both his own research and that of numerous other scientists to paint an accurate picture of the economics behind beauty. Beauty is indeed in the eye of the beholder, however much of the populace can generally agree upon what can be considered attractive.

After stabilizing the countless factors to the closest nominal denominator, like studying people of similar background and education, but of different physical appearances, Hamermesh was able to assert some palpable claims. He found that the best-looking one-third of the population makes 5 percent more money than average-looking people and 10 to 12 percent more than the worst-looking people. This doesn’t mean that better looking people automatically get a bigger salary, but just a direct consequence of the fact that beautiful people have an easier time scoring better paying jobs or advancing up the social ladder. Connections quite probably represent the most important asset in the business environment and a good looking individual will generally manage to do better social-wise.

One of the economist’s leading claim, and maybe most evidence to the financial contribution physical appearance has, is that the best looking people earn an extra $250,000, on average, during their careers than the least attractive people and are more likely to remain employed, get promoted, and even secure loans.

Surprisingly enough, beauty affects the earnings of men in the labor market more than women, since apparently women have more options outside the workforce. Beautiful women are statistically known to marry high earning men, an economic factor which contributes to the documented trend that good-looking people are happier.

This doesn’t mean however that people of average or sub-average appearance are miserable or don’t succeed in life, Hamermesh says.

“Take advantage of other things: brains, brawn, personality,” he says. “This is the economic theory of ‘comparative advantage.’ You work off the things you’re good at and if looks isn’t one of them, you try to de-stress that.”

I bought an Adam Sandler for 7 monkey dollars.

How scientists taught monkeys the concept of money. Not long after, the first prostitute monkey appeared

You may have thought things like currency or money are concepts known solely to humans. While it’s true some animals might have a sense of ownership, trading resources and the likes haven’t been observed in any other species besides Homo sapiens. However, in 2005, an economist/psychologist duo from Yale University managed to teach seven capuchin monkeys how to use money. The study went into some unexpected territory not long after.

Monkey Business

Gotta pay the rent tomorrow on the cage. Still a few monkey dollars short.

“Gotta pay the rent tomorrow on the cage. Still a few monkey dollars short.”

“The capuchin has a small brain, and it’s pretty much focused on food and sex,” said Keith Chen, a Yale economist who along with Laurie Santos, a psychologist, are the two researchers who have had made the study. ”You should really think of a capuchin as a bottomless stomach of want,” Chen says. ”You can feed them marshmallows all day, they’ll throw up and then come back for more.”

It’s exactly these selfish desires that they tried to exploit and experiment with great success after teaching capuchins to buy grapes, apples, and Jell-O. The economist wanted to study the incentives that motivated specimens to behave in a way, while the psychologist analyzed the behavior itself.

Chen’s monkey correlations to human economics go from further back when he was a Harvard graduate, and additionally shows some more interesting facts. At Harvard, he worked with Marc Hauser, a psychologist, on a project which studied altruistic behaviors in cotton-top tamarin.

At first, they put two monkeys in different cages, each with a lever. When the lever was pulled, the neighboring monkey would receive food. If not altruism, it was still a form of cooperation that was put to the test — the typical tamarin pulled the lever about 40 percent of the time.

The most interesting part came after the researchers introduced new behaviors. Now, they trained a monkey to always pull the lever (mindless altruist), and another to never pull it (ego-monkey). The two were then inserted into the game with other monkeys.

At first, the mindless altruist was pulling the lever every time, never missing a chance to deliver food, while the other tamarins responded in the same way 50 percent of the time. The other monkeys soon understood, though, that the mindless altruist was just pulling the lever anyway, regardless of whether it was reciprocated or not – their response then dropped to 30 percent of the time.

The ego-monkey was exposed to the harshest treatment, as expected — very harshly. “[The other tamarins] would just go nuts,” Chen recalls when she was introduced to other monkeys. ”They’d throw their feces at the wall, walk into the corner and sit on their hands, kind of sulk.

I bought an Adam Sandler for 7 monkey dollars.

“I bought an Adam Sandler for 7 monkey dollars.”

When Chen and Santos first started their study, they didn’t have a particular goal in mind. It was just as simple as giving a monkey a dollar and see what would happen, which was exactly the case. Instead of the dollar, however, a silver disc with a hole in its center was employed as a means of currency for the capuchins.

It took several months of training for the capuchins to learn that they could exchange such a token for fruit. After they understood this, each monkey was given 12 tokens to decide on how to spend it on food valued at different prices.

Researchers observed that the monkeys could even budget. Researchers then changed the market and put Jell-O at a lower price, to see if monkeys would buy fewer grapes and more Jell-O. They acted exactly like the current laws of economics dictate for humans as well.

They then taught them how to gamble, and saw they made the same irrational decisions a human gambler would make as well. The data generated by the capuchin monkeys, Chen says, ”make them statistically indistinguishable from most stock-market investors.”

The capuchin monkeys understood money, not only used it

But did the capuchins truly understood the value of money or did they just behave mindlessly to receive food? One of the researchers cut circular slices of cucumber, similar to the discs that were handed out to the capuchin as money, and fed them to the monkeys instead of their usual cube-like shape.

One of the monkeys took a slice, chewed a bit on it, and then immediately went to one of the researchers to see if she could buy something tastier with it.

There was stealing too. Not a single monkey saved any of the tokens, but most of them tried to subtract a few more tokens when they were handed out.

The monkeys were given tokens one at a time, which were inserted in a separate chamber from that of their living quarters, but on one occasion everything sprung into chaos when a capuchin tried to make a run for it with a tray filled with tokens. The chaos was intense. That was a tough time for researchers.

Something else happened then too. Grasping the notion of currency simply means you understand that you can exchange money for goods and services. Well, one of the researchers, during the chaotic episode mentioned earlier, observed how one of the monkeys exchanged money with another for sex. After the act was over, the monkey which was paid immediately used it to buy a grape…

There you have it folks, sounds familiar? In almost all aspects, capuchins manage to understand money and use it in a manner not too different from a plain old homo sapiens. The study, titled “How Basic Are Behavioral Biases? Evidence From Capuchin Monkey Trading Behavior“, can be read here.