Andrew Leigh

My Wryside economics segment on Life Matters this morning discussed Eli Berman’s work on the economics of terrorism. If you’d like to listen to it, you can find it here.

Today, an anonymous guest post (from someone with an ANU connection) ponders airline pricing.

A recent article in the SMH reports that from February 1, Air France and KLM will begin charging obese passengers 75% of the cost of a second seat if they cannot fit into one seat. This story re-ignited an interesting question I’ve had regarding airline tickets. I have always been perplexed by the issue of pricing after a trip to the Middle East.

After spending far too much money on carpets in the souks, I arrived at the check-in counter at the airport to be told that my ticket only allowed 25kg of baggage and that my recent acquisitions had sent me 5kg over. If I wanted to take them with me, I had to pay the surcharge. The exact amount escapes me, but I was told it was to cover the cost of transporting the extra weight.

What puzzled me about the explanation was that standing at the next check-in counter was a sizable chap (possibly around 110kg) with 25kg of luggage. He wasn’t charged excess since his luggage was on the allowable limit, but if the price of a ticket represents the cost of transporting weight; your weight, surely his net impact on the overall weight of the plane is far greater? (I’m an average male, 175cm tall and weighing around 78kg). With my luggage, my total weight on the plane was 108kg, much less than the 145kg of my fellow passenger.

Simple flight dynamics says that the heavier the plane, the more fuel it will use to fly. Presumably, most other costs of operating an aircraft are fixed (salaries for crew, catering, landing and docking levies, lease payments on the aircraft), which leaves fuel. If the largest variable cost of running a plane is determined by the fuel used to transport the overall weight (plane, passengers and luggage) of the aircraft at takeoff, surely the current pricing mechanism for airline tickets is economically inefficient?

Wouldn’t it be far more efficient to charge people based on their total weight impact on the plane (i.e. body weight plus baggage)? That way, slim travellers with little luggage do not subsidise heavier people with large amount of baggage.

Any theories as to whether the suggestion of our anonymous poster could – well – fly?

(xposted @ Core Economics)

New Yorker writer John Cassidy has posted on his website a 1996 interview with the late Paul Samuelson. My favourite snippet concerns the use of mathematics in economics.

I asked Samuelson whether mathematics was now too important in economics.

Rather than answering the question directly, he talked about a lecture he attended in the nineteen-thirties by Lionel Robbins, a well-known professor at the London School of Economics. “Lionel Robbins gave an address saying this math stuff is just a passing fad. I was all of twenty-eight, but I thought, ‘Poor fellow, he just doesn’t realize that he’s missing the train.’ That was just a bad understanding of the dynamics of the profession. Math is a problem for everybody in the profession and it has been for years. We all say, math should be used just up to the point that I have used it, and no more…I always say to our graduate students when they are leaving: ‘As a graduate student at a top-notch university, you tend to lose touch with reality. You have been engaged in puzzle solving and learning a new language. When you emerge, you may tend to think you have been asleep for several years.’ The paradox is that the best people in practical terms are the Jim Tobins, the Bob Solows—the guys who are awfully good at the technical stuff as well.” Samuelson also brought up his colleague Modigliani, whose parking space he may have been occupying, noting “he has done more for Italy than pizza,” and the prevalence of technically adept M.I.T. graduates in the Clinton administration. (They included Lawrence Summers, Joseph Stiglitz, and Laura Tyson.)

“Like herpes, math is here to stay,” he said. “It takes strong math to defeat misleading math. For example, ordinary least squares”—a standard statistical method—“is misleading. It takes more mathematics than ordinary least squares to understand three-stage least squares, co-integration, or unit roots, all of which are improvements on ordinary least squares. But it does lead to a communication problem. The number of people who can communicate effectively, like Paul Krugman, is very small.

As anyone who has read SuperFreakonomics would’ve seen, Steven Levitt (along with and John List) appears to be on a quest to reach into the chest of laboratory experiments and rip out its beating heart. Their latest two papers are below (gated links, sorry).

What Happens in the Field Stays in the Field: Exploring Whether Professionals Play Minimax in Laboratory Experiments 
Steven Levitt, John List and David Reiley
The minimax argument represents game theory in its most elegant form: simple but with stark predictions. Although some of these predictions have been met with reasonable success in the field, experimental data have generally not provided results close to the theoretical predictions. In a striking study, Palacios-Huerta and Volij (2007) present evidence that potentially resolves this puzzle: both amateur and professional soccer players play nearly exact minimax strategies in laboratory experiments. In this paper, we establish important bounds on these results by examining the behavior of four distinct subject pools: college students, bridge professionals, world-class poker players, who have vast experience with high-stakes randomization in card games, and American professional soccer players. In contrast to Palacios-Huerta and Volijs results, we find little evidence that real-world experience transfers to the lab in these games–indeed, similar to previous experimental results, all four subject pools provide choices that are generally not close to minimax predictions. We use two additional pieces of evidence to explore why professionals do not perform well in the lab: (1) complementary experimental treatments that pit professionals against preprogrammed computers, and (2) post-experiment questionnaires. The most likely explanation is that these professionals are unable to transfer their skills at randomization from the familiar context of the field to the unfamiliar context of the lab.

Checkmate: Exploring Backward Induction Among Chess Players
Steven Levitt, John List and Sally Sadoff
Although backward induction is a cornerstone of game theory, most laboratory experiments have found that agents are not able to successfully backward induct. Much of this evidence, however, is generated using the Centipede game, which is ill-suited for testing the theory. In this study, we analyze the play of world class chess players both in the centipede game and in another class of games – Race to 100 games – that are pure tests of backward induction. We find that world class chess players behave like student subjects in the centipede game, virtually never playing the backward induction equilibrium In the race to 100 games, in contrast, we find that many chess players properly backward induct. Consistent with our claim that the Centipede game is not a useful test of backward induction, we find no systematic within-subject relationship between choices in the centipede game and performance in pure backward induction games.

This follows on from List’s famous 2007 JPE paper (On the Interpretation of Giving in Dictator Games), which found that a simple modification to the dictator game (allowing the player to take money as well as share it) drastically altered the results. As List stated in the conclusion to that paper:

A recent surge of research in economics uses the laboratory as a tool to measure preferences. One stylized fact from this literature is that a majority of agents in standard dictator games pass a portion of their funds to an anonymous agent, and the amount is nontrivial—roughly 20 percent of the endowment. Utility theories that invoke social preferences have been forwarded to explain such data patterns. One puzzling feature of everyday life, however, is that even though scores of students around the world have outwardly exhibited their preferences for equality in laboratory experiments by sending anonymous cash gifts to anonymous souls (in some cases not even knowing that such a soul actually exists), why is it rare to find such data patterns in the extra-lab world?

My own take on this literature is that for experimental economists, there is probably more to be learned from economics games that don’t use computers. If you want to learn about teams, put people around a table. If you want to learn about trust, let them speak to their partner. If you want to learn about giving, put the cash in their hands first. The less that the game resembles real life, the less we are likely to be able to learn from it.

I spoke yesterday in a plenary session at The Australian Sociological Association’s annual conference at ANU. The session was on ‘Economics and Sociology’, and I shared the stage with RSSS Director David Marsh and TASA President Michael Gilding (who I know because of the fascinating work he has done on wealth holdings). There were of course the usual anti-economics jokes (economics is about how people make choices, sociology is about how people have no choices), and anti-sociology jokes (economists are told that if they’re good, they’ll be reincarnated as physicists, and if they’re bad, they’ll be reincarnated as sociologists).

I spoke about how I see the two disciplines, what I’ve learned from sociology in my own research, and what the two disciplines might learn from one another. In case it’s of interest, here are my slides. The Q&A session was terrific fun, though it made me realise that I’ve forgotten almost everything I ever knew about Marxist economics. I’m also not sure everyone was convinced when I argued that Stevenson and Wolfers had shown that the Easterlin Paradox didn’t exist, and that economic growth was on balance pretty good for wellbeing.

My happiness workshop yesterday certainly raised my life satisfaction – and hopefully that of the attendees as well. If you missed it, the papers of Betsey Stevenson and Justin Wolfers are available on their websites. Paul Frijters’ paper should soon be on his site. ABC Fora filmed the workshop for their Big Ideas series, so selected excerpts will air on ABC1 early next year, at which point they’ll also post the full video on their website (I’ll link to it then).

I couldn’t resist running a small survey of attendees at the conference, asking the same 0 to 10 life satisfaction that appears in the 2007 HILDA survey, plus two simple demographics: gender and occupation (economist/non-economist).

The headline finding is that those who attend a happiness conference (mean=7.7) are a smidgin less happy than the typical Australian (mean=7.9). If you want to be happy, don’t delve into happiness research…

It also appears that among attendees, economists (mean=7.8) are happier than non-economists (mean=7.6). (So much for the ‘dismal science’?) The economists’ answers were also markedly more dispersed – perhaps my colleagues trying to give me some extra variation.

And among attendees to my conference, there was no difference in average happiness between men and women (both means=7.7).

This contrasts with HILDA data, which has consistently found Australian women to be happier than Australian men.

Feel free to email me if you’d like to play around with the data.

Is there a more ecumenical Nobel than the economics prize? First, it goes to a psychologist – now to a political scientist.

Shiller may be going to far to call this  “part of the merging of the social sciences”. But it’s good to see economics sharing the love (and money).

QUT’s Professor Paul Frijters has received the 2009 Young Economist Award from the Economic Society of Australia. It’s a biennial award, with the first receipient (in 2007) being Joshua Gans.

Paul’s award is richly deserved. He works on a vast array of topics, running the gamut from labour economics to development economics to econometrics. Paul works with amazing speed (he told me yesterday that he typically aims to write his first paper drafts in a single sitting), and has a CV that’s the envy of just about every economist in the country.

Paul is also the guy you want in seminars, whether as an audience member asking tough questions with typical Dutch directness; or as a presenter combining substance, anecdotes, theory, and methodology.

And as well as doing research on social capital, he believes in it. Practically every day at ANU, he would walk the corridor at noon, knocking on doors and shouting ‘the lunch train is leaving!’. We’ve missed him greatly since he left in 2006 for the humid shores of the Brisbane River.

I had to fly back from the Australian Conference of Economists yesterday just before Paul gave his presentation, but fortunately he’s posted the powerpoint and a background paper on his website. He chose to focus on a major research project that he is involved with, looking at rural-urban migration in China (perhaps the largest mass migration in history).

Congratulations, Paul.

Bloomberg news has a profile of one of Chile’s finance minister, Andres Velasco. He was my microeconomics lecturer when he taught at Harvard in 2001. A unique guy.

Thousands of government workers marched on downtown Santiago last November, burning an effigy of Chilean Finance Minister Andres Velasco and calling him “disgusting” as a strike for higher wages paralyzed public services.

Five months later, polls show that Velasco is President Michelle Bachelet’s most popular minister. During a three-year copper boom he and central bank President Jose De Gregorio set aside $48.6 billion, more than 30 percent of the country’s gross domestic product, that he is now using for tax cuts, subsidies and cash handouts to poor families. …

Velasco, who runs 30 miles (48.3 kilometers) a week, is the son and grandson of national politicians. He received his higher education while living in the U.S. after Augusto Pinochet’s military dictatorship exiled his father from Chile in 1976 for criticizing the regime. Velasco earned a bachelor’s degree in philosophy and economics in 1982 and a master’s in international relations in 1984 at Yale University in New Haven, Connecticut, according to his resume. He received a doctorate in economics from Columbia University in New York in 1989.

His publications include two books on free trade, and two romance novels.

(HT: David Lynch)

My friend Justin Wolfers has been appointed a co-editor of the Brookings Papers on Economic Activity. This strikes me as a particularly good fit. Justin’s signature style is an applied economics paper that presents a pastiche of evidence – ranging across different time periods, different surveys, and sometimes even different countries. As a reader, it’s much more persuasive to me when an author can show that his or her results are robust to these kinds of shifts, and don’t merely hold up in one dataset, one time period, and a single country. His recent coauthored work on the death penalty, happiness and income, macroderivatives, and prediction markets are just a few examples. Along with the Journal of Economic Perspectives, BPEA has traditionally been an outlet for precisely this sort of a wide-ranging paper. Let’s hope that Justin manages to generate more of them during his tenure.

With resource prices rising far faster than expected, my AFR op-ed today discusses the arguments for and against a windfall profits tax on mining companies. Full text over the fold.

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A post by Harry Clarke bemoans the fact that policies regulating alcohol often fail to apply simple benefit-cost analysis. This got me thinking about some of the other issues upon which I’d like to see a little more rigorous benefit-cost thinking, and a little less off-the-cuff moralising.

• Road safety. At many Canberra intersections, a red turn arrow prevents right turns when the road is clear. My guess is that if we weighed up the cost (thousands of hours of lost time per year) against the benefits (fewer accidents), we would probably find that that former exceeded the latter. In other words, I think Canberra has a sub-optimal number of traffic accidents. 
• Pornography in Indigenous communities. A bipartisan movement has pushed to reduce the amount of porn available in remote NT communities. But this will only help reduce sexual violence if pornography is a complement for violence rather than a substitute. What little evidence exists seems to favour the substitute theory rather than the complement theory. In other words, perhaps the costs of this policy outweigh the benefits (and I’m ignoring any benefits to the porn buyer).
• Regulation of prediction markets. Since most policy regulation is concerned about the cost of problem gambling, the information benefits of prediction markets are often ignored. So we end up with a situation where Australian betting agencies cannot run markets on (for example) the unemployment rate a year from now. Justin Wolfers and I highlighted this issue last year, and a team of 22 economists has just done the same in a recent issue of Science magazine.

Of course, there’s an easy alternative to weighing costs and benefits. As usual Stephen Colbert puts the case best:

ladies and gentlemen of the press corps, Madame First Lady, Mr. President, my name is Stephen Colbert and tonight it’s my privilege to celebrate this president. We’re not so different, he and I. We get it. We’re not brainiacs on the nerd patrol. We’re not members of the factinista. We go straight from the gut, right sir? That’s where the truth lies, right down here in the gut. Do you know you have more nerve endings in your gut than you have in your head? You can look it up.

According to a new paper by Amanda Goodall, Lawrence Kahn, and Andrew Oswald, the answer is yes.

We measure the success of National Basketball Association (NBA) teams between 1996 and 2004, and then attempt to work back to the underlying causes. We have information on 15,040 regular season games for 219 coach-season observations, for which we compute winning percentages; in addition, we study post-season playoff success for these coaches. Perhaps unsurprisingly, a main explanatory factor is the quality of the group of players. But, less predictably, there seem also to be clear effects from the nature of a team s coach. Teams perform substantially better if led by a coach who was, in his day, an outstanding player.

They also cite evidence that this holds in a context with direct relevance to me: university management.

Goodall finds a positive cross-section correlation between the scholarly quality of presidents and the academic excellence of their institutions, and some evidence, for a set of British universities, that those led by highly cited scholars show improved performance over the ensuing decade.

So if your boss is incapable of doing your job, perhaps he or she isn’t much chop as a manager.

The Productivity Commission has just posted on its website the proceedings of a 2007 roundtable on behavioural economics. The most provocative piece is by QUT’s Paul Frijters (who mistakenly gets a UQ designation), discussing Eldar Shafir’s opening keynote. Frijters’ discussion (which starts on p35 of the PDF) is a neat summary of the problems involved in applying behavioural economic research to policy. A few snippets:

After presenting his list of anomalies and giving us nice anecdotal research to make it indeed entirely plausible that these all exist and are important for real-life decisions by people of flesh and blood, Shafir attempts to draw some policy conclusions. Shafir’s policy conclusions are a little weak, it has to be said. His paper is full of the usual ‘we should take into account’ and ‘we may also need to reconsider’ and ‘policy should be carefully crafted’, but he essentially leaves it up to the reader to work out what any item on the list means for policy advisers. Indeed, he gives no real suggestions for new policies, but rather mentions policies that were enacted in an era preceding ‘anomaly economics’, presumably as evidence that ‘anomaly economics’ has a point. …

Implicit in Shafir’s piece is that it is actually possible to think through the consequences of these anomalies for policies. This requires their integration into the current economic policy toolkit of Homo Economicus, and policy directed at correcting market failures. Shafir himself does not undertake to do this, but explicitly calls for it to happen.

It is not just Shafir who can not integrate them. To my knowledge, no-one in this literature has even been remotely able to incorporate a multiple of items on The List into actual modelling or into a blurred overall vision of human choice behaviour. We still cannot do what the classical economists thought too hard to attempt.

If even the leading authors in this field cannot integrate the lessons of the anomalies into mainstream policy advice (and even his list is far shorter than the full one), it should be clear that it is going to be extraordinarily difficult to do. Indeed, I think we should simply admit that it is not going to happen: we are stuck with a fairly unorganised and large set of anomalies which we are never going to be able fully to integrate into a theory that does justice to each of them. Unless we are prepared to simplify The List into a couple of much simpler rules of thumb, it is just too hard to come up with a framework that really makes intellectual sense.

My economics group – in the Research School of Social Sciences at the Australian National University – is seeking PhD students. Here’s a one-page flyer, and a more detailed document about our program.

In the weekend AFR, Dierdre Macken has an article on the steady expansion of economic research into non-traditional areas (or as she calls the phenomenon, ’Everythingonomics’). The article profiles Justin Wolfers, Tim Harford, and yours truly; and also has some commentary from Australian Sociological Association president Michael Gilding.

Betsey Stevenson and Justin Wolfers have a new paper out that debunks the Easterlin Paradox. It’s a classic Stevenson-Wolfers style “throw all the data we can find at the problem” paper, and it concludes that (a) rich people are happier than poor people; (b) richer countries are happier than poorer countries; and (c) as countries get richer, their people become happier. Over the next few days, Justin is blogging about the paper at Freakonomics – his first post is here.

My AFR oped today is on randomised policy trials, with a particular discussion of what I think is the most fascinating randomised trial now in place in Australia – the Head Injury Retrieval Trial. I’m grateful to commenter Mark, who first drew HIRT to my attention, to Nicholas Gruen for comments on an earlier draft, and to Alan Garner for taking the time to talk with me about it. Full text over the fold.

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I spoke today at the Melbourne Institute’s conference on the topic of labour supply and labour shortages. For anyone who’s interested, here’s my powerpoint. I shared the stage with Judith Sloan, Jeff Lawrence, Heather Ridout and Guyonne Kalb, which made for a fun panel.

Incidentally, the lunchtime speaker was Brendan Nelson, whose introduction (presumably drafted by his office) referred to his various achievements in particular portfolios. The one that caught my attention was that getting the defence budget increased was touted as one of the successes of his time as defence minister. I couldn’t help wondering whether he would have made the same claim if he had been social security minister.

Several studies have looked at the impact of the French 35 hour week law on economic output (my recollection is that most find little impact). Now another study has looked at its effect on social capital. Its conclusion? Not much impact. Which leaves me thinking that perhaps someone should look at what’s happened to French TV watching patterns over this period.

The Effect of Hours of Work on Social Interaction 
Henry Saffer, Karine Lamiraud
Over time, increases in hours of work per capita have created the intuitively plausible notion that there is less time available to pursue social interactions.  The specific question addressed in this paper is the effect of hours of work on social interaction.  This is a difficult empirical question since omitted factors could increase both hours of work and social interaction.  The approach taken in this paper utilizes an exogenous decline in hours of work in France due to a new employment law.  The results clearly show that the employment law reduced hours of work but there is no evidence that the extra hours went to increased social interactions. Although hours of work are not an important determinant of social interaction, human capital is found to be important.  The effect of human capital, as measured by education and age, is positive for membership groups but negative for visiting relatives and friends.  Also, contrary to expectations, there are no important differences in the determinants of social interaction by gender, marital status or parent status. Finally, a comparison between France and the US show that the response to human capital and other variables are much the same in both nations. 

Steve Levitt and John List, writing about behavioural economics in Science:

Most of this research eschews a narrow conception of rationality, while continuing to embrace precisely stated assumptions that produce a constrained optimization problem. A less “scientific,” and in our view less productive line of research in this area approaches the problem from the opposite direction: Observing an unexpected pattern of behavior (e.g., lower stock markets on rainy days in New York City), one looks for a psychological theory consistent with that behavior (in this case, seasonal affective disorder). Given the wide array of psychological explanations from which to choose, however, a researcher undertaking such a task has virtually unlimited freedom to explain any observed behavior ex post facto.

Perhaps the greatest challenge facing behavioral economics is demonstrating its applicability in the real world. In nearly every instance, the strongest empirical evidence in favor of behavioral anomalies emerges from the lab. Yet, there are many reasons to suspect that these laboratory findings might fail to generalize to real markets. We have recently discussed several factors, ranging from the properties of the situation–such as the nature and extent of scrutiny–to individual expectations and the type of actor involved. For example, the competitive nature of markets encourages individualistic behavior and selects for participants with those tendencies. Compared to lab behavior, therefore, the combination of market forces and experience might lessen the importance of these qualities in everyday markets.

Recognizing the limits of laboratory experiments, researchers have turned to “field experiments” to test behavioral models. Field experiments maintain true randomization, but are carried out in natural environments, typically without any knowledge on the part of the participant that their behavior is being scrutinized. Consequently, field experiments avoid many of the important obstacles to generalizability faced by lab experiments.

Following in the footsteps of the Economic Society of Australia, which last year instituted a biennial medal for the best Australian economist under the age of 40 (and gave the inaugural prize to Joshua Gans), the Italians have decided to do the same. But while the Australian prize has a residency requirement, the Italian one does not (this is the country with diaspora representation in the Senate, after all). And in a country whose stage flair is renowned, the winner delivers a public lecture.

The Italians have chosen UC Berkeley economist Enrico Moretti (1 JPE, 2 AERs, 3 QJEs, 3 ReStats), who will give his lecture in July. I’m hoping that the Australian organisers can follow suit and give Joshua a keynote slot at the Annual Conference of Economists in Sept/Oct.

My oped today is on bulls, bears and efficient markets. Full text over the fold.

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Joshua Gans has recently proposed that bank account numbers should be portable, just like mobile phone numbers. I was initially sceptical, but his FAQ neatly addressed most of the concerns that I had. (See also a writeup in the Canberra Times from Peter Martin.)