A five part series on behavioral economics

This week’s posts were going to be about podcasts that I listen to, but I’ll push that out to next week.

I and a colleague of mine at the Gokhale Institute (which is where I work) are running a five day seminar at the Institute on behavioral economics. This one is for undergraduate students only, but based on how this one turns out, we might do a couple more through the year. But for that reason, I figured we might take a look at behavioral economics is, and explore work being done in this area, and why it matters.

In this post, I’ll give you an overview of behavioral economics, and in the five subsequent posts that follow, I’ll detail what we spoke about in each session.

First things first: behavioral economics really is a tautology, because economics is the study of choice, and we make our choices given what we know and given what we feel.

The trouble is, modern economic theory (most, but not all of it) would tend to say that what we feel ought not to matter, and in fact doesn’t actually matter in the real world. Except we’ve all demolished a big fat bowl of ice-cream because we’re feeling blue, the diet be damned. We’ve all bought items on sale on Amazon, when we clearly had no need for them. And we’ve all chosen to play a game on the phone over completing a task at hand, and hang the consequences. I could go on (and not just where individuals are concerned, but firms and governments too!), but you get the picture.

We’re all predictably irrational.

In a sense, behavioral economics is about the first word in that link. As a social scientist, it’s not much use to say that we’re irrational. That’s akin to saying that there’s nothing that we can say, do or predict about the choices that all of us make.

But predictably  irrational? Ah, how exactly? If our irrationality can actually be modeled, then perhaps we could understand how and why we make the choices we do. Even better, maybe we could push people towards eating more salads and less ice-cream. Although you should note that there are some people in my tribe who don’t necessarily think this to be a good idea.

Still, the study of

a) whether we think “rationally” or not, and…

b) if not, then can we think systematically about how we are “irrational” and why…

c) and can we use our findings from this exercise to make people, institutions and therefore societies behave differently (and hopefully better)…

…is the study of behavioral economics.

And the five day version (duly expanded) of this is what Savita Kulkarni and I will be talking about at Gokhale Institute over the course of the next five days. And I’ll keep you guys updated as we go along.

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Staring into the abyss: A review of To the Brink and Back, by Jairam Ramesh

A while back, I read a book by Sanjaya Baru, famous nowadays for having penned the book “The Accidental Prime Minister”. While that book was certainly more topical, his other book, the one I am referring to right now, is far more interesting. The title of the book is , quite simply, “1991”, and the subtitle is “How P.V. Narasimha Rao Made History”.

The reason I bring that book up right now is because Mr. Baru begins his book by speaking about how, while at an event  at a university near Delhi, he asked students about the importance of the year 1991, and some levity aside, many people didn’t have a clue. Things became, he goes on to mention, slightly better when he asked the same question to a slightly older age group, and many people mentioned the reforms of 1991. What those reforms were, and who was responsible for them is a story, Mr. Baru says in the introduction to his book, many people are not aware of. Given the subtitle of his book, it is clear who the protagonist is – and further evidence in favour of his argument is to be found in the book that is the subject of this blog post: “To the Brink and Back: India’s 1991 Story”, by Jairam Ramesh.

The book (a very short one) is Mr. Ramesh’s recollections of those tumultuous three months or so, when, as he so memorably puts it, history was put in motion. I often say in classes I teach that India gained her political independence in 1947, and started to gain her economic independence in 1991. The first half of that statement is a fact, and the second half is false, too true or not true enough depending on where you stand on the spectrum of economic ideology. But no matter where you find yourself on that spectrum, what is indisputably true is the fact that 1991 was a turning point for the Indian economy.

Having read both books, and some others besides, on the events of 1991, here is my simple list of why 1991 was so important:

  1. A lot of people today don’t know, or don’t want to know this, but there was, for quite a few people, a choice to be made. “To default or not to default” was an actual dilemma for some, and reading about those times makes it clear that the former option was certainly on the table. It is our great good fortune that the people in charge, and the then finance minister in particular, did not view it as a dilemma – India simply would not default. That in itself was a signal to us and the rest of the world – and the importance of that signal cannot be overstated. Put another way, the economist took a political stance that had truly far reaching economic consequences.
  2. India finally became competitive in the global markets, because of the devaluation of her currency. A strong currency is often taken to be a proxy for a strong nation, but nothing could be farther from the truth. If you chart India’s exchange rate movements (vis-a-vis the dollar, say) against her GDP growth rate, you can see this quite clearly. That devaluation mattered, it truly mattered. Ask Infy. And as the book makes clear, getting people to agree with this decision wasn’t all that easy.
  3. This point is the most important of the lot: our industrial policy changed on the morning of the budget. Yes, Manmohan Singh presented that budget, but the far more important announcement was about our industrial policy changing – for the better, at long, long last. This includes changes in the MRTP (Monopolies and Restrictive Trade Practices)Act, changes to the way foreign firms could invest in India, and changes in what kind of licences would be needed to produce, well, almost anything. And much else besides, I should add – but the point that one should understand is that the shackles were taken off where India’s producers were concerned.

There is, please understand, much more to the reforms of 1991, and most of it is contained in the book. But to me, the book is important because it makes a point about a political decision that had far reaching economic ramifications: India would honour her debt, no matter what the cost, and no matter what changes needed to be made to her industrial policy. This (political) commitment to do the right thing has had (economic) consequences that we are benefiting from today and beyond.

The book speaks about who did what before, during and after the three months of June, July and August 1991, and credit is given and withheld in various cases by Mr. Ramesh. See, for instance, his repudiation of Yashwant Sinha’s claims to have been the true father of the whole reforms story.

I’m not so interested in who did what though – reading the book to understand what happened, and how it happened is a fascinating lesson in the art of political economy. The chapter on the roll back of the increase in urea pricing, for example, is a great for understanding how to push what you want through – you can almost see Cialdini nodding in approval.

Is the book written for the layperson who knows nothing of economics? I will not pretend that it will be easy going, but I will say this: you will appreciate the importance of 1991 far more at the end of it. And as a citizen of India, four hours or so is a worthwhile price to pay to understand how we got to be where we are.

Choices, Costs, Horizons and Incentives

Economics, many people think, is about money and finance. Nothing could be farther from the truth.

Which is not to say that economics is not about money and finance – it is about that as well, but you’d be doing economics (and yourself) a disservice if you thought that economics was only about money (and finance).

A larger, more general framework for thinking about economics is to realize that it is about four things that I mentioned in yesterday’s post: choices, incentives, costs and horizons. Of the four, perhaps the one that is most misunderstood is incentives. Yes, incentives can be, and very often are, monetary in nature – but very often is not always.

Tyler Cowen puts it well in his book “Discover Your Inner Economist”:

The central concept of economics is not money but rather incentives. Quite simply, an incentive is anything that motivates human behaviour, or encourages an individual to make one decision rather than another. An incentive can be money, but it can also be a tip, a smile, or an act of praise.

Something that acts as a push for us to do (or not do!) something is all an incentive is – and if you get incentives right, you can get people (including yourself) to do what you want them to.

IMG_20180428_213957393_LL
Not all incentives need be monetary

Incentives, and the way we interpret them, are what help us choose, and that’s the second key concept in economics: it’s a matter of being incentivized to make a particular choice, out of all the alternatives available. Quite often, though, understanding the set of choices itself can become tricky.

Think about this little puzzle (adapted from a truly wonderful book called “Thinking Strategically: The Competitive Edge in Business”, by Avinash Dixit and Barry Nalebuff):

Amar, Akbar and Anthony are three friends who, having quarreled, have decided to settle that quarrel with a shootout. They stand at the three vertices of a triangle, and decide to take turns shooting at each other, one bullet per attempt, until only one person is left standing. Amar will go first, he can shoot at either Akbar or Anthony. Assuming Akbar survives, he’ll go second, and he can shoot at either Amar or Anthony, assuming Anthony is alive, and Anthony will go third. And on and on it will go, in this order, until only one person is alive. Amar is a lousy shot – he shoots with only 10% accuracy. Akbar is pretty good, he’s working with 80% accuracy, while Anthony is just plain lethal – fully 100% accurate.

Now, Amar hires you as a consultant and asks, whom should I shoot?

What would your answer be?

It turns out that Amar’s best option is to shoot in the air (because even if you succeed in killing whoever you aim at, the survivor is left with only Amar to aim at).

The point is: any well informed decision needs two things to begin with: a clear idea of all the choices available, and a clear idea of the incentives involved (“I hate Akbar! I want to kill him!” may be a great incentive, but a higher probability of staying alive is surely the better incentive).

And this applies to everything in life: one helping of desserts or two? (Hint: how about none?). Only one more YouTube video before I get back to completing this blog post, or ten? (How about re-reading “Thinking Strategically” instead?)

The trouble is, our brain isn’t always the best at interpreting incentives correctly, which brings us to the third key concept in economics: horizons. Or, if you have had enough nerd talk for one day, we could also call it the instant gratification monkey problem. Call it what you will, the problem is that we tend to prioritize choices that payoff in the short run, but create problems in the long run. If you’ve ever had that last “one for the road” drink, or ended up actually eating that second dessert (and who hasn’t?), you don’t really need an explanation for this. We tend to choose those options that payoff over the short horizon, and ignore the long term consequences.

And in retrospect, that pounding headache the next morning is really not worth it, or to put it another way, the cost is too high.

Costs are not just monetary in nature, of course, and hangovers are a great way to explain this. You don’t pay any money the next day, but nobody who has experienced one would argue that hangovers are in any way cheap. Worse, costs are almost always a little higher than you think.

The price of the party the night before isn’t just the morning after, but it is also the fact that you could have spent the last evening reading a book, watching a movie, going out for a drive – anything but the party. Not only do you not get to watch that movie (the opportunity cost, as we economists call it), but you also have the goblins drumming away inside your head.

Choices, incentives, horizons and costs.

The truly tricky thing, and this is what makes economics such a worthy endeavour, is that each of these four aren’t understood by all of us in a rational, objective manner. Our brain processes each of these for us in ways that are subject to the way we are raised, the environment in which we are raised, our emotional state at the time of making decisions, and much else besides. Our decision making, predicated on these four concepts, is gloriously uncertain, fickle and inconsistent.

But it is exactly this that makes studying economics such a lot of fun.

Choices, Not Prices: A Review of Where India Goes

There are four simple words that underpin the art of thinking like an economist: Costs, Incentives, Horizons and Choices. (They’re important enough to merit being capitalized, and are also important enough to deserve an acronym as well – CHIC).

It might surprise you that prices don’t make the list, but (realized) prices arise as an outcome of trade, and trade can’t happen unless you have some sort of framework in your head about your costs, incentives, horizons and choices.

Today, I’m going to post my thoughts (and notes) on a book that will help you understand why choices matter, and why prices are secondary.

Diane Coffey and Dean Spears have co-authored this book, titled “Where India Goes”. As the title suggests the book is about defecation, and as most of us are aware, India goes in the open.

Not all of us, of course – but a sizeable number do – this much has been in the news for quite a while now. But how many people, exactly? Or if not exactly, how many people, approximately, defecate in the open? Nobody knows, it turns out, for sure. And that’s because we are aiming to eliminate open defecation “without monitoring this simple statistic”.

All Indian governments, I should add, lest this turn into a politically charged debate, have been reluctant to collect this data, let alone share it, because the disquieting truth is that open defecation in India isn’t a matter of people not having access to latrines – people want to defecate in the open.

As Alex Tabarrok mentions in his review of the book, the problem isn’t one of lack of access per se:

Latrines are not expensive. Many people in countries poorer than India build their own latrines. If access is not the problem then building latrines may not be the solution. Indeed, India’s campaign(s) to build latrines have been far less successful than one might imagine based on the access theory. Quite often latrines are built and not used. Sometimes this is due to poor construction or location but often perfectly serviceable latrines are simply not used as latrines. In fact, surveys indicate that 40 per cent of households that have a working latrine also have at least one person who regularly defecates in the open (Coffey and Spears 2017).

The problem isn’t prices – if you have a latrine already, the price is essentially free. The problem is choice.

open defecation is not an activity that most people are ‘forced’ into due to lack of latrines, but rather one that most household decision makers chose over using the kinds of affordable latrines that would need to be emptied manually.

And the reason this choice is made is twofold. One, it is actually perceived as being healthier: respondents to a survey conducted by the authors have said that going out to defecate is a way to get some clean air (in the process of walking to the location where you’ll actually defecate), the walk aids digestion, and for at least some women, it is a way to get out of the house for a bit.

And second, if it is a pit latrine (which is overwhelmingly likely in rural India), who’ll clean the pit?

But the vast majority of people we talked with said that they could not even conceive of emptying a latrine pit themselves. Priya, a woman living in peri-urban Sitapur who belonged to a lower, but not a Dalit, caste, explained why: We cannot empty [the latrine pit] ourselves. We call a Bhangi even if something gets clogged in the latrine … How can we empty it ourselves? It is disgusting, so a Bhangi must come to clean it … We are Hindus, so how can we clean it? [If we do], how will we worship afterwards? If money were an issue we would take a loan for it; we would have to find some way to get it emptied. This work can only be done by people who inherit this occupation. They are Bhangis, they have been created [by God] for this work.

Caste, it turns out, is an important reason behind people choosing to “go” in the open. People do not want to clean out their pit latrines because it is seen as being “ritually polluting”.

And which is why the latest scheme to reduce/eliminate open defecation is going to fail, like all of its predecessors. It’s not because we aren’t throwing enough money at the problem (we are), but we are throwing it at the wrong target. The problem isn’t the lack of infrastructure, it’s the lack of desire to use said infrastructure. This in spite of overwhelming evidence about the problems caused by open defecation, which Coffey and Spears explain admirably by a mixture of anecdotes and clear eyed data.

Children in India are shorter than children in Africa; children in West Bengal are shorter than equally poor children in Bangladesh; and babies born to Hindu households in India are more likely to die than babies born to Muslim households. Each of these inequalities can be hoped to eventually diminish as open defecation is eliminated everywhere; each reflects a difference in the pace of somebody’s switching to latrine use.

The 5th, 6th and 7th chapters do an admirable job of capturing the consequences of open defecation – but the true surprises (and therefore the worth) of the book are in the first section itself: open defecation is not because of a lack of access to latrines, it is because of a lack of desire to use them.

As Rose George puts it in her TED talk on much the same issue, open defecation is a software problem, rather than a hardware problem. But the attention being paid to this problem, ever since successive Indian governments have started tackling it, is scant:

Yet, existing health and community workers have little reason to take up the task of convincing people to use latrines when they will not be compensated for doing so. And despite the fact that sanitation experts agree that the government should put greater emphasis on behaviour change than latrine construction, the government has not allocated funds to hire a staff for this purpose. Behaviour change is nobody’s job. It is no wonder, then, that the programme guidelines never precisely specify who will do this work. The language carefully avoids sentences with human subjects: ‘emphasis is to be placed’; ‘behavior change communication should focus’; ‘delivery mechanisms would be adopted’.

Open defecation then, “Where India Goes” shows us, is a problem caused not by a deficit of funds, is a problem with extremely serious repercussions (in terms of health, income earning capacity, cognitive development and all-round economic well-being), and is a problem with a cure that nobody wants to be responsible for.

It will go away over time, but the longer it takes, the higher will be the percentage of deaths caused by it.

The last word is best left, perhaps, to the authors themselves:

The Millennium Development Goals of the first decade of the new millennium vowed to ‘make poverty history’. That fits better on a T-shirt than ‘possibly accelerate the existing slow decline of open defecation in rural India’, especially if we take the space on the back of the shirt to explain that rural Indians will probably eventually make open defecation history anyway, if everybody waits long enough. But it matters enormously how long the wait would be. It is not too late to substantially reduce the harm that open defecation will cause before it runs its course.

 

Understanding the Importance of GDP Growth

What is GDP all about? Why is it so very important, and why do economists spend so much time in tracking it? As we discussed in an earlier post, the GDP growth rate is one way of understanding how much more we produced in a given period compared to the last one.

So more is always good, right?

Well… not quite.

It’s a question I struggle to answer in the context of GDP growth, because yes, growth is good, but with qualifiers. It’s a little bit like saying that speed is good where a car is concerned, but too much of it can be quite disastrous.

And in a book that I have started reading recently, I came across a way of thinking about GDP growth in India that I quite liked:

In this book, I define the objective of India’s economic development as rapid, inclusive, stable and sustainable growth of national income, within a political framework of liberal democracy

(emphasis in original)

The book in question is “India’s Long Road” by Vijay Joshi, with the subtitle being “The Search for Prosperity”. Vijay Joshi has done all kinds of awesome sauce things over a long and distinguished career, and a 500 word limit will not begin to do justice to his many accomplishments. Suffice it to say that reading this book is well worth your time if you are interested in India’s growth story.

But to go back to the quote above: the author is saying, as is everybody else, that growth is important, indeed crucial, from an Indian context. That’s the rapid part. However, we also need to make sure that the growth is inclusive. Which means it’s not just important to bake a larger cake, but it is also important to make sure that every gets a slice (and preferably, as equal a slice as possible). There are many ways to accomplish this, and we don’t always do a perfect job in this regard but here’s the most important bit: we have to bake a larger cake first! Distributing a very small cake equally isn’t the point.

Stable implies growth that happens in steady fashion, not haphazardly, not in fits and starts. Put another way, steady growth over a decade is better than rapid growth for the first five years and no growth for the other five. Listen closely, and you can hear the sound of every RBI governor alive nodding his head ever so vigorously.

Sustainable would mean environmentally friendly. That’s a separate book in and of itself, but what we want is a rapidly growing country that has breathable air, drinkable water and arable land 100 years from now. Some might say that’s a contradiction in terms, but we won’t wake that particular beast just yet.

And the last bit? …within the framework of liberal democracy is treated as being almost axiomatic by Vijay Joshi, and in my opinion, rightly so. Sure, we grow slower as a consequence of our choice of a liberal democracy, but if that’s the price for political freedom, it is certainly worth it.

But I’d much rather that we work towards achieving rapid, stable, sustainable and inclusive economic growth within the framework of a liberal democracy, than achieving rapid GDP growth.

It’s a longer definition, but a better target.