The Geography of Thought

nisbett_coverThe Geography of Thought from Richard Nisbett shows that East Asia and the West have had different systems of thought, including perception, assumptions about the nature of the world, and thinking processes, for thousands of years. Ancient Greek philosophers were “analytic” — objects and people are separated from their environment, categorized, and reasoned about using logical rules. Psychological experiments show the same is true of ordinary Westerners today. Ancient Chinese philosophers and ordinary East Asians today share a “holistic” orientation — perceiving and thinking about objects in relation to their environments and reasoning dialectically (focusing on contradictions, change and relationships), trying to find the Middle Way between opposing propositions. Differences in thought stem from differences in social practices, with the West being individualistic and the East collectivist.

There are strong social-psychological differences between East Asians as a group and people of European culture as a group. East Asians live in an interdependent world in which the self is part of a larger whole. Westerners live in a world in which the self is a unitary free agent. Easterners value success and achievement mostly because they reflect well on the groups they belong to, whereas Westerners value these things because they are badges of personal merit. Easterners value fitting in and engage in self-criticism to make sure they do so. Westerners value individuality and strive to make themselves look good. Easterners are more sensitive to the feelings of others and aim for interpersonal harmony. Westerners are more concerned with knowing themselves and are prepared to sacrifice harmony for fairness. Easterners are more willing to accept hierarchy and group control, whereas Westerners prefer equality and personal development. Asians are more likely to avoid controversy and debate.

Nisbett discusses a range of studies that underwrite these differences.  Asians detect more elements in an environment, whereas Westerners tend to focus on the dominant object (left figure).  Westerners are more likely to classify the cow and chicken together (focus on object classification), whereas Asians group the cow with the grass (focus on relationship).

 

These differences already characterized differences between the Greeks and ancient Chinese. Greeks focused on agency, logic, individual objects and decontextualization. Confucianism and Taoism stressed complexity, constant change, harmony, interpersonal relations and relations of objects with their environment. Children’s education plays a role in perpetuating these differences, as well as differences in the structure of languages.

The preference of Westerners for classifying objects and of Chinese for seeing relationships is reflected in their languages. East Asian languages are highly contextual with words having different meanings depending on their context. East Asian children learn verbs as easily or more easily as nouns, in contrast to Western children.

A preference for logic with Westerners may sound contradictory to the superior achievements of East Asians in international maths and science tests. Nisbett gives following explanations:

1. East Asians don’t have trouble with understanding logical principles, but are less likely to use them in daily life.
2. The Asian superiority is quite recent, with traditional Chinese and Japanese culture focusing on arts, literature and music
3. Asian teacher training is better, with more continuous teacher professional development and fewer teaching hours for Asian teachers
4. Asian students work harder than their Western counterparts, partly due to a stronger belief that success is the result of hard work (growth mindset), rather than innate ability (fixed mindset)

Additionally, there are two major advantages of Asian cognition: first, Asians see more of a given scene or context than Westerners do and, secondly, the holistic, dialectic, Middle Way approach to problems. IQ tests that are used across cultures should therefore not use words. Advantages of the Western cognition are more openness to debate and peer review and less respect for hierarchy.

Globalisation causes a convergence of Eastern and Western values. Eastern parents enroll their children in debate camps and Westerners discover the virtues of Eastern philosophies. Nevertheless, differences are likely to remain for a while.

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The Globalization Paradox

Rodrik is a globalization skeptic in the line of Ha Joon Chang. He is not against globalization, but put the mantra of free markets into perspective. Rodrik spends a considerable part of his book on the history of globalization. He focuses on 2 periods of strong globalization.  The first one, between 1820 and the First World War, the increase in global trade was based on imperialist policies, thereby forcing other countries to open their markets and accept unfavorable trade treaties (globalization by gunboat), and on the gold standard, which works fine as long as you don’t have a democracy to prevent the painful internal devaluations that are needed from time to time.  The globalization drive after the second world war was based on the Bretton-Woods system and the General Agreement on Tariffs and Trade (GATT) within a multilateral world order, guaranteed by the US (dollar-exchange standard).  These are the precursors to the World Trade Organisation (WTO), founded in 1995, but are based on different premises. Bretton-Woods and GATT respect the primacy of the nation-state limiting the reach of globalization where it creates conflicts with nation states.  In contrast, the WTO aims towards hyperglobalization, even when it has negative consequences for nation states (e.g,, agriculture, food regulations, financial services) or undermines democratic decision-making within nation states.  Recent economic success stories such as China and South Korea are due more to playing by the Bretton-Woods rules than WTO rules, relying on export subsidies, import tariffs and weak enforcement of intellectual property laws.

Rodrik sees a fundamental trilemma between globalization, nation states and democracy.  You can have two, any two, but not all three. If you want globalization and democracy, you need global institutions, undermining the nation-state.  If you want nation states and democracy, you can’t have deep globalization, as this requires global rules and creates the enormous capital flows that can undermine domestic economies.


Rodrik’s trilemma helps to gain insight in many current politics.  Globalisation causes a power shift to the supranational level, often to non-democratic institutions (IMF, ECB, multinational companies, WTO).  At the same time, many challenges remain deeply national, such as ageing populations, social safety, migration, inequality as a result of winner-takes-all markets.  International mobility of goods and finance makes that nations tend to engage in races to the bottom (lowering taxes, standards) to attract investment and capital. Currently, globalisation and nation states seem to have the upper hand, eroding democracy.  The power of electorates to significantly influence key economic and social decisions has become very limited, such is the disciplining force of international markets.  The rise of populist parties and Brexit are consequences of this democratic erosion.  Rodrik does not consider global democratic institutions realistic and therefore pleads for returning to nation states more power to set their economic and social policies within a set of global “traffic rules”, such as keeping trade imbalances in check. This would require scattering some sand in the wheels of international finance, like a financial transactions tax.

For developing countries, the situation is even more dire. Globalization has a tendency to “freeze” a country’s role in the international division of labor. In a globalized world, countries that live from exporting resources have little incentives to diversify and invest in representative institutions and education level of their population. Secondly, within the WTO system, many industrial policies that were used by developed countries are no longer allowed, such as protection of domestic industries, export subsidies, capital controls, currency devaluations and weak enforcement of intellectual property.  Rodrik reminds us of the fact that the USA and the UK were notable protectionists until their industries were strong enough to stand on their own feet.  Thirdly, manufacturing as a powerful driver of economic development for low-income countries may have run its course.

Manufacturing became a powerful driver of economic development for low-income countries for three reasons. First, it was relatively easy to absorb technology from abroad and generate high-productivity jobs. Second, manufacturing jobs did not require highly skill: farmers could be turned into production workers in factories with little investment in additional training. And, third, manufacturing demand was not constrained by low domestic incomes: production could expand through exports. But manufacturing has become increasingly skill-intensive which has made it very difficult for newcomers to break into world markets for manufacturing.

Exodus: Costs and Benefits of Mass Migration

exodusExodus discusses the costs and benefits of mass migration.  Paul Collier (author of “The Bottom Billion”) looks at migration from the viewpoint of the migrants, the population of the receiving country and the population of the country of origin.  Most people about migration argue either that it is good or bad. They address the wrong question, says Mr Collier. The right one is: how much more migration would be beneficial, and to whom?

Collier identifies 3 factors that determine the migration rate: the width of the income gap (which he sees as a temporay distortion during which prosperity is not yet globalised), the income level in the country of origin and the size of the diaspora (and the absorption rate).  The second factor implies that migration might increase when a country of origin becomes richer, as more people are able to afford the trip.  The absorption rate is the speed with which migrations adopt the norms of the host society.  The rate tends to decrease with the size of the migrant community in a country, as new arrivals have fewer incentives to adopt norms of the host country when there is already a large diaspora network.  Therefore, initiatives (language programmes, geographical spreading, apprenticeship programmes) that help to increase the absorption rate are useful, as they can sustain a higher migration rate.  Such policies explain why the US has a higher absorption rate than France.
Migration makes migrants better off. If it did not, they would go home. Those who move from poor countries to rich ones quickly start earning rich-country wages, which may be ten times more than they could have earned back home. “Their productivity rockets upwards,” says Mr Collier, because they are “escaping from countries with dysfunctional social models”.  This is crucial. Most rich countries are rich because they are well organised, and poor countries are poor because they are not. Nationalism has positive aspects as it enables people to cooperate beyond the family or clan level and to redistribute resources.  Cooperation requires trust and easily breaks down (e.g. free riders) .  As other did (Acemoglu and Robinson), he points to the importance of inclusive (rather than extractive) institutions and trust in the development of a country.  High-trust societies have the institutions and norms that enable development.  France is richer than Nigeria because its social model is superior.  A factory worker in Nigeria produces less than he would in France because the society around him is dysfunctional: the power keeps failing, spare parts do not arrive on time and managers “are busy battling bribe-hungry bureaucrats”. When a rich country lets in immigrants, it is extending to them the benefits of good governance and the rule of law.
What of the countries that receive immigrants? Mr Collier argues that they have benefited from past immigration, but will probably suffer if it continues unchecked.  Continued mass immigration threatens the cultural cohesion of rich countries.  There is a trade-off between positive effects of cultural variety (no real demographic positive effects) and negative effects on social cohesion, but these effects play with different groups in society.  The young, affluent middle classes are the big beneficiaries of variety. In contrast, those people on benefits like social housing or welfare, whether because they are unemployed or pensioners, experience most competition from immigrants and are the most vulnerable to the weakening of cohesion.  Collier refers to the work of Robert Putnam in the US who showed how immigration lead to a decrease of trust, not only between indigenous population and immigrants, but also among the indigenous population (“hunkering down”).  This has effects on people’s willingness to support welfare policies.  A shared sense of identity is a condition for social redistribution.  People need to see people who need state welfare as themselves minus the good luck.
Finally, Mr Collier looks at the effect of emigration on poor countries. Up to a point, it makes them better off, dispelling notions of “brain drains”. Emigrants send good ideas and hard currency home. The prospect of emigration prompts locals to study hard and learn useful skills; many then stay behind and enrich the domestic talent pool instead. But if too many educated people leave, poor countries are worse off. Big emerging markets such as China, India and Brazil benefit from emigration, but the smallest and poorest nations do not: Haiti, for example, has lost 85% of its educated people.

 Collier is quite pessimistic, but it is hard not to see the recent surge in populism and anti-immigration policies as a vindication of his warnings.  As Milanovic did, he suggests looking into ways to give immigrants a special statute (e.g. higher taxes, temporary residency, limited access to social welfare).  These policies might seem discriminatory or harsh, Collier writes, they might be better than the current situation, both for the countries of origin and for the countries of destination.

Global Inequality – Branko Milanovic

Global inequality is composed of inequality between countries and inequality within countries.  We can describe inequality within countries by “Kuznets waves”.  Inequality first rises as a country grows richer and when it has achieved a certain income level, inequality gradually decreases.  The theory fails to explain though why inequality has risen in developed countries since 1990, notably in the US, but also in Europe.  Milanovic introduces the concept of Kuznets cycles, rather than waves.  Benign and malign forces drive inequality up or down. High inequality is unsustainable and creates the seeds for destructive events that reduce it, but in their wake also destroy much else.
Forces that push inequality up are:
  • higher returns on capital than labour (Piketty factor)
  • high incomes from labour and capital are increasingly concentrated in the same peoplez
  • technological innovation that favours the rich (capital rents, higher wage dispersion)
  • decreasing power of unions (due to changing labour markets)
  • high availability of labour (opening up of China, India and USSR in 1990s)
  • increasing scalability and emergence of more winner-takes-all markets (e.g. education)
  • capture of political process (democracy) and media by the rich
  • monopolisation of sectors
Forces that reduce inequality are (malign or benign)
  • investment in public education
  • redistribution of wealth through progressive taxes or social programmes
  • wars, epidemics and natural disasters (World Wars or the Plague in medieval times)
  • scarcity of labour (can be reduced by immigration)
  • technological innovation that favours the poor (speculative)
Although inequality has been rising in developed countries, at the global level it has been decreasing for quite some time.  This is mainly due to the rise of China and, to a lesser extent, other Asian countries (India, Indonesia, Vietnam, Thailand).  This has come mainly at the expense of the lower middle class in Western countries.  The figure below shows how the 99th percentile (global plutocrats) and 50th-60th percentile (upper middle class in Asia) has done well during the last 20 years, whereas the 80th-90th percentile saw its income stagnating.  He notes that, as China grows richer, it will in the near future contribute to global inequality, rather than being a reducing force.

Lower inequality between countries reduces the “citizenship rent”, the importance of where one is born for whether will be rich or not. This does not mean that the “lottery of birth” becomes less important, as social mobility within countries has been decreasing.  However, in our (Western) discourse about rising inequality, it is important to note that on a global level, inequality is actually going down.  The decrease is mainly due to the rise of Asia, Africa is not contributing at all.
Milanovic discusses some of the consequences of high inequality.  On migration, which he sees as an inevitable consequence of globalization, he advocates (as Collier does) for limited access to citizenship rights (temporary worker status, higher taxes) to compensate for their higher productivity as a result of migration and access to a superior social model.  On politics, he sees plutocracy (the US option) and populism (the EU option) as consequences of high inequality and the reduced size of the middle class. A smaller middle class results in lower support for public services such as health and education and more attention for internal security and defense.  The slide away from democracy is masked by shifting attention to issues such as nationalism and identity and by overestimating social mobility.  He refers to the work of Jan Tinbergen who showed how returns on education are highest in poor countries, where few people have access to higher education.  In developed countries, access to education is widespread, the return decreases, but connections and sheer luck determine who gets access to well-paying jobs.
Milanovic present an impressive range of data and charts to make his case.  It is not an optimistic book, as he doesn’t see many benign forces that are strong enough to reduce inequality, especially in the US.

The Information

the-information-gleickWhat is Information? Is it inseparably connected to our human condition? How will the exponentially growing flow of information affect our societies?  How is the exploding amount of information affecting us as people, our societies, our democracies? When The Economist talks about post-truth society, how much of this trend is related to the failure of fact-checking, increasing polarity and fragmentation of media and the distrust of ‘experts’?  The Information starts with a reference to Borges’ Library of Babel:

The Library of Babel contains all books, in all languages.  Yet no knowledge can be discovered here, precisely because all knowledge is there, shelved side by side with all falsehood.  In the mirrored galeries, on the countless shelves, can be found everything and nothing.  There can be no more perfect case of information glut. We make our own storehouses.  The persistence of infomation, the difficulty of forgettting, so characteristic of our time, accretes confusion. (p. 373)

In The Information, James Gleick takes the reader on a historical world tour to trace the origins of our ‘Information Society’, basically an old term that keeps on being reinvented. It’s a sweeping and monumental tour that takes us from African drumming over alphabets, the beginnings of science, mathematical codes, data, electronics to the spooky world of quantum physics.  He shows how information has always been central to who we are as humans. He points to foreshadowings from the current information age such as the origin of the word “network” in the 19th century and how “computers” were people before they were machines.

shannonThe core figure in the book is Claude Shannon. In 1948 he invented information theory by making a mathematical theory out of something that doesn’t seem mathematical. He was the first one to use the word ‘bit’ as a measure of information. Until then nobody would have though to measure information in units, like meters or kilograms. He showed how all human creations such as words, music and visual images are all related in the way that can be captured by bits. It’s amazing that this unifying idea of information that has transformed our societies was only conceptualized less than 70 years ago.

It’s Shannon whose fingerprints are on every electronic device we own, every computer screen we gaze into, every means of digital communication. He’s one of these people who so transform the world that, after the transformation, the old world is forgotten.” That old world, Gleick said, treated information as “vague and unimportant,” as something to be relegated to “an information desk at the library.” The new world, Shannon’s world, exalted information; information was everywhere. (New Yorker)
At its most fundamental, information is a binary choice.  A bit of information is one yes-or-no choice. This is a very powerful concept that has made a lot of modern technology possible. By this technical definition, all information has a certain value, regardless of the content of the message.  A message might take 1.000 bits and contain complete nonsense. This shows how information is at the same time empowering, but also desiccating. Information is everywhere, but as a result, we find it increasingly hard to find meaning.  Has the easy accessibility of ‘facts’ diminished the value we assign to it?
Despite the progress in producing and storing information, we have remained human in our ability to filter and process information. Gleick gives the example of his own writing process:
The tools at my disposal now compared to just 10 years ago are extraordinary. A sentence that once might have required a day of library work now might require no more than a few minutes on the Internet. That is a good thing. Information is everywhere, and facts are astoundingly accessible. But it’s also a challenge because authors today must pay more attention than ever to where we add value. And I can tell you this, the value we add is not in the few minutes of work it takes to dig up some factoid, because any reader can now dig up the same factoid in the same few minutes.
It’s interesting because this feeling of the precariousness of information is everywhere. We think information is so fragile, that if we don’t grab it and store it someplace, we’ll forget it and we’ll never have it again. The reality is that information is more persistent and robust now than it’s ever been in human history. Our ancestors, far more than us, needed to worry about how fragile information was and how easily it could vanish. When the library of Alexandria burned, most of the plays of Sophocles were lost, never to be seen again. Now, we preserve knowledge with an almost infinite ability.
Redundancy is a key characteristic of natural information networks. As Taleb taught us, decentralized networks are much more resilient than centralized structures.  Every natural language has redundancy built in. This is why people can understand text riddled with errors or missing letters and why they can understand conversation in a noisy room.  The best example of a natural information network may be life’s genetic make-up:
“DNA is the quintessential information molecule, the most advanced message processor at the cellular level—an alphabet and a code, 6 billion bits to form a human being.” “When the genetic code was solved, in the early 1960s, it turned out to be full of redundancy. Some codons are redundant; some actually serve as start signals and stop signals. The redundancy serves exactly the purpose that an information theorist would expect. It provides tolerance for errors.”
 Technological innovation has always sparked anxiety. Gleick quotes Plato’s Socrates that the invention of writing “will produce forgetfulness in the minds of those who learn to use it, because they will not practice their memory.” (p.30) Mc Luhan recognized in 1962 the dawn of the information age.  He predicted the confusions and indecisions the new era would bring and wrote about a ‘global knowing’.  Thirty years before H.G. Wells wrote about a World Brain, a widespread world intelligence, taking the form of a network.  Wells saw this network as a gigantic decentralized encyclopedia, managed by a small group of ‘people of authority’. The network would rule the world in a ‘post-democratic’ world order.
Gleick writes that we’re still only at the start of the Information Age. Some effects on us and on our societies will only become apparent in the coming decades. Will the internet continue to evolve into a world brain or will it splinter into various parts. Will the atomisation of our media into countless echo chambers continue and what kind of society will it lead us into?
The library will endure; it is the universe. As for us, everything has not been written; we are not turning into phantoms. We walk the corridors, searching the shelves and rearranging them, looking for lines of meaning amid leagues of cacophony and incoherence, reading the history of the past and of the future, collecting our thoughts and collecting the thoughts of others, and every so often glimpsing mirrors, in which we recognize creatures of the information. (p.426)

The Euro Crisis and its Aftermath (Jean Pisani-Ferry)

$_35Until 2013, Pisani-Ferry was the director of Bruegel, a think-tank.  In his book Jean Pisani-Ferry recalls the story of the euro from “the day it ceased being boring” and explores the underlying causes of the euro crisis.

The introduction of the euro was intended to create a forefront for more political and economic harmonisation among the adopting countries.  However, in the mid-2000s, it became gradually clear that national economies were diverging rather than converging.  Northern European economies like Germany were doing penance, running surpluses and accumulating savings, while countries in Southern Europe (incl. Ireland) went through a period of euphoria and saw consumption and debt rising.

After the introduction of the euro, these countries experienced a ‘golden decade’. They experienced a strong drop in interest rates, which reduced their debt burden and opened credit floodgates.  Resulting increases in wages and prices created higher inflation than in the northern countries.  Interest rates were the same across the Eurozone, but prices of nontradable goods and services such as houses and restaurant meals were not.  As a result, inflation rates were also not the same and the real cost of credit (the difference between the interest and the inflation rates) was much lower in the southern countries and Ireland.  In Spain, poor households bought houses they could hardly afford, helped by the now infamous cajas, the regional savings banks, creating their own version of the subprime crisis.

Then, on 16 October 2009 the euro stopped being boring.  That day, Greek prime minster George Papandreou confessed that Greek debt and deficit numbers were much worse than reported.  Investors suddenly realised that Greek debt was more risky than German debt and the spread between the two rose to 4%.  Greece revealed the incompleteness of the European construction and the strong disagreements about how to complete its architecture.

The negative feedback loop between banks and their sovereigns (countries) became apparent, the so-called ‘doom loop’.  Why is this relation problematic? Banks usually have large portfolios of debt issued by their countries.  At the same time, they depend on their sovereign for assistance in case things turn sour.  When investors doubt a country’s guarantee to save its banks, these banks can see their capital flows come to a sudden stop.

An example. The Spanish state was borrowing from the Spanish commercial banks which, in turn, borrowed from the Spanish central bank, which, in turn, borrowed from the ECB.  Meanwhile, private money flowing out from Spain was being deposited with German (or other northern European) banks, which, in turn, deposited it with the Bundesbank, which in turn lent it to the ECB.  The European system of central banks had become a sort of gigantic artificial heart that pumped back into southern Europe money flowing out from it in search of northern safety (p.145).

“Banks may be European (or global) in life, but they remain national in death.”

This explains why Ireland, with a debt-to-GDP ratio of only 25% got into problems. Its banking system was 8 times the size of its GDP.  Similarly, Spain’s problem was not a fiscal one, having low debt and running current account surpluses.  Its problem was that Spanish banks accumulated lots of loans that became non-performing when real estate prices plunged.  Add to this that the housing boom in Spain created a very unbalanced economy in which the non-tradable sector had expanded beyond reason at the cost of the tradable-goods sector.

Overall, debt levels and deficits in the Eurozone are much lower than those in the US or Japan.  What makes Eurozone debt vulnerable (less internal debt), faces a grim long-term demographic outlook (low fertility rates and not enough migration) and faces a lack of competitiveness (in the south).

Pisani-Ferry describes how Eurozone leaders throughout the crisis devised piecemeal solutions that were time and time again overtaken by reality.

The introduction of a common currency removed external devaluations as a way to inflate away debt and restore competitiveness as a tool from the toolbox. Milton Friedman compared devaluating a currency with daylight saving time.  It’s much easier to change time than to ask everyone to change their habits. In the same way, when a currency is overvalued, it is easier to devalue the exchange rate than to modify all wages and prices individually. By entering the Eurozone, member countries gave up this popular weapon, leaving them only the painful option of internal devaluation.

Much has been achieved since the outbreak of the euro crisis.  Under massive market pressure and by overcoming deep divisions, countries have agreed on new rules and created new institutions.  These solutions increased the power of the European institutions.  For example, the Commission received an ex-ante near-veto on national budget plans, including automatic sanctions for sinners. However, as economic prospects have improved, the political sentiment has clearly deteriorated.  Politics lag behind economics, which in turn, lag behind market developments.

On the other hand, solutions so far have only been found under the pressure of urgency and in an attempt to avoid the worst.  In Pisani-Ferry’s words, Europe has consistently displayed a strong sense of survival, but it has equally consistently failed to display a sense of common purpose (p.175).  The sense of survival comes from a realisation that a unified Europe is the only chance for Europe’s nations to remain significant actors in the world economy and to contribute to the shaping of global rules. The main challenge of European policy makers is to chart the road to continued relevance and to convince European citizens that it is the right road to take.

So far, solutions for the Eurozone crisis (financial firewall, fiscal treaty, building blocks of banking union) have much of an adhocracy.  Decisions on policy moves were not taken on the ground whether they would improve outcomes, but whether they were needed to avert disaster, like house owners only contemplating repairs when the house is about to collapse.

For Pisani-Ferry, a sustainable solution to deal with all the following aspects:

  1. The ECB’s inflation mandate of an average inflation rate across the Eurozone close to 2% implies a higher inflation rate in Northern Europe for several years.  During the first 12 years of the Euro, inflation rates were higher in Southern Europe.  The correction process has started for wages, but prices lag behind in the South because of the high cost of credit and the fact that many sectors are not open to competition.  A side effect of low interest rates is that non-functioning firms still get access to cheap credit, preventing the process of creative destruction, which would reduce supply, allowing others to raise prices, resulting in inflation.
  2. The EU’s budget comprises 1% of its total GDP and negotiated (and fixed) for periods of 7 years. This leaves little room for flexibility.
  3. For the dollar, US Treasuries are the safe assets.  For the Eurozone, 10-year German government bonds (‘Bunds’) are the de facto safe assets. This is an advantage (‘rent’) for Germany, as it can borrow money at lower rates than other countries. Because of this privilege, Germany should take up special responsibilities such as acting as an insurer for the whole Eurozone or sharing this rent with other countries through issuing Eurobonds.
  4. Gradual acknowledgement of reality of unsustainability of Greek debt, acceptance of debt restructuring and design of systematic way of dealing with debt crises.
  5. Acceptance of ECB as a lender of last resort.
  6. Strengthen the democratic character of the EU.  Germans, for example, are particularly underrepresented in the parliament in comparison to citizens from smaller countries.
  7. Governance reform.  The most important one.

“The euro area is not equipped with a government, but with a series of partial powers.  The ECB has decision-making capacity in its important, but limited domain (it makes full use of it).  The Commission has been given a defined mandate of oversight of national policies (it generally fulfils it) and a broader mission to chart a way through the policy challenges (it sometimes fulfil it and sometimes forgets it). Berlin exercises leadership (or not).  Paris tries to balance it (effectually or not).  Bratislava or Helsinki insists on specific points that are close to their hearts (and generally push through a minor concession).  Rome matters when the prime minister has stature (not always the case).  And the president of the Eurogroup chairs the meetings of finance ministers (and does little more).  Europe’s governance is reminiscent of Blaise Pascal’s definition of the universe: a sphere, the centre of which is everywhere…” But unlike Pascal’s universe, few observers, if any, see the hand of God in its design” (pp.165-166)

Currency unification has led European states to an unknown territory in which national borders are less defined as they used to be.  The euro has created a community of fate.  The EU and the Euro zone need a common vision on their future.

Basically, there are two models for the Eurozone:

  • An agglomeration model that accepts concentration of activities in certain areas, for example manufacturing in northern Europe.  This model comes with mobility of labour, portable social rights, acceptance of national current account deficits and surpluses and a full banking union.
  • A rebalancing model that focuses on limiting differences among countries.  This comes with attempts to southern re-industrialisation. This is the logic of the Structural Funds.

The agglomeration model is economically more efficient.  Not every country is good at everything and the agglomeration model stimulates countries to specialise.  However, this model is likely to lead to wider (but not necessarily permanent) disparities in GDP/person and would require euro-area-wide taxation and transfer systems. Also, the agglomeration model requires a stronger political community, something which still needs to materialize, if it ever will.

A permanent solution for the Eurozone’s travails would need to answer fundamental questions about the union:

  1. Are countries and their citizens prepared to embrace a degree of labour, product and capital market integration that is needed for a monetary union to function?  Current discussions about the scaling back the Schengen union and the rise of extreme right suggest not.
  2. Are countries and their citizens ready for a fundamental redefinition of the fiscal framework that would create a predictable regime for state insolvency and introduce a degree of risk-sharing through the partial mutualisation of sovereign liabilities?
  3. Is the euro area willing to accept a degree of contingent redistribution across countries or even individuals in order to help smooth adjustment within a monetary union, for example through a common budget or through contingent transfer mechanisms?
  4. Is the euro area for institutional reform that would equip it with effective decision-making capacities (and budget) within it fields of competence?

In a democracy, power should be limited, but not weak (Tommasso Padoa-Schioppa)

Pisani-Ferry’s book tremendously helps to put the Euro crisis into perspective.  It enables the reader to understand the causes and the responses. In my case, it helped to change my opinion that the crisis was not so much (only) a consequence of southern (mainly Greek) profligacy, but a result of economic imbalances resulting from an incomplete monetary and fiscal union.

Thinking, Fast and Slow: the marvels and flaws of intuitive thinking

Intelligent gossip at the water cooler.  That’s the ultimate goal for Daniel Kahneman, author of the widely praised Thinking, Fast and Slow and recipient of the Nobel Prize in Economics.  cover Thinking fast slowPeople are not rational, but rather not-quite-rational human beings, their behaviour driven by two inner “agents”:  system 1 and system 2.  System 1 acts automatically and quickly, works with little or no effort and without any sense of voluntary control.  Unfortunately, it isn’t particularly strong in logic and statistics.  System 2 corresponds with who we think we are.  It is responsible for our effortful mental activities and can override the intuitive conclusions from system 1.  People are prone to cognitive biases and faulty decision-making, because system 1 kicks in before the more rational and logical system 2 is engaged.

“Although System 2 believes itself to be where the action is, the automatic System 1 is the hero of this book.”

Most of the time, we rely on the mental shortcuts of our system 1.  It is inexhaustible, unlike the limited capacity of system 2.  Paying attention can actually be taken quite literally.  Ego Depletion not only occurs through mental effort, but also through emotional temptations.  Kahneman recalls  the Oreo Experiment where 4-year old children’s ability to resist the immediate temptation for one Oreo biscuit for a two Oreos after 10 minutes turned out to strongly predict later success in life.

In the book, Kahneman vividly describes a wide range of systematic errors in our judgements and choices.  Rather than rational beings, our judgements and choices are affected by a whole variety of biases and fallacies.  An important characteristic of our system 1 is basing decisions on information that we see or that is immediately available. “What you see, is all there is” (WYSIATI).  It explains availability bias, the tendency to overweigh personal experiences, dramatic events (plane crashes!) and things that attract media coverage.  WYSIATI explains priming and halo effects.  The halo effect is our tendency to give a disproportionately high weight to first impressions such as a handsome and confident speaker.  The effect of recent exposure to information on our judgement is the priming effect.  It explains how  volunteers walk more slowly down a corridor after seeing words related to old age, or fare better in general-knowledge tests after writing down the attributes of a typical professor.  Anchoring is a form of priming explains why it’s a bad idea to let the salesman set the starting price when bargaining.  Overconfidence is another manifestation of WYSIATI.   When we estimate a quantity, we rely on information that comes to mind, neglect what we don’t know and construct a coherent story in which our estimate makes sense.  90% of car drivers think they are better than average.  We also focus on what we want and can do, neglecting the plans and skills of others.  Add to this the fact that uncertainty is not socially acceptable for a “professional”.  Another way our lazy System 1 operates is through substitution.  It replaces a target question with a heuristic question.  “How happy are you in life?” becomes “What is my mood right now?”

kahneman2

Our system 1 is pretty bad in statistics, especially in calculating probabilities.  The Law of Small Numbers refers to our tendency to ignore that small samples are much more likely to generate extreme outcomes.  It explains our bias to pay more attention to content than its reliability (sample sizes are rarely mentioned).  Another example is base rate neglect (planning fallacy).  A good example is that people, when given a person’s character description that resembles a librarian, are likely to think that that person will be a librarian, rather than a teacher, without accounting for the fact that there are much more teachers than librarians.  Base rate neglect means that we often exaggerate intuitive impressions of diagnosticity, rather than sticking close to the base rate.  Another example is confuse the probably with the plausible.  Our associate machinery likes to construct plausible stories from past events, rather than admitting it was all just a coincidence.  Adding detail to a description makes it more plausible, but less probable.  Upon reading a description of a woman called Linda, subjects rated it more likely that Linda was a bank teller who is active in the feminist movement than that Linda was a bank teller.

I am particularly fond of this example [the Linda problem] because I know that the [conjoint] statement is least probable, yet a little homunculus in my head continues to jump up and down, shouting at me—“but she can’t just be a bank teller; read the description.” source

Stephen Jay Gould

Our unwillingness to deduce the particular from the general is only matched by our willingness to infer the general from the particular.  Whether it’s about helping people in need or stock picking, when confronted with statistics, people are very reluctant to accept them, claiming they are different.   Conversely, coherence bias makes that people are very quick to draw general conclusions from events that happen in their neighbourhood.  WYSIATI!

People who claim to rely on their intuition are using their System 1.  People who are powerful (or made believe that they’re powerful), knowledgeable novices, in a good mood and have had a few successes are more likely to rely on their intuition.  Intuition makes only sense in a predictable environment and where skills are learnable through prolonged practice and lots of feedback.  Chess is an example.  Stock picking is not a good example, as it’s a low validity environment.  When asked for his favourite formula by Edge, Kahneman chose:

Success = talent + luck

Great success = little more talent + a lot more luck

We tend to overestimate talent and underestimate the role of luck.  Regression to the mean explains why highly intelligent women will marry less intelligent men and why winners of the ‘Golden Ball’ are likely to perform worse the year after.  A great achievement or misfortune is due to luck more than anything else and is unlikely to be repeated the year after.  Nassim Taleb speaks about the illusion of validity, the tendency to create ‘stories’ that ‘make sense’.

Prospect theory (for which Kahneman was awarded the Nobel) shows how choices we make are based on utilities rather than expected values. We respond stronger to losses than to gains (most people twice as strong).  prospect theoryEndowment effects make that the coffee mug we get for free, becomes more valuable once we have it.  It shows how we overweight (or completely neglect) unlikely events (possibility effects) and how a small probability of no success reduces its utility value disproportionally.  We are risk averse for our gains and risk seeking for our losses.  This explains how we keep buying lottery tickets and how insurance companies make profits.  In stock trading, we tend to sell winners and keep losers.  Often, it’s better to cut your losses, rather than waiting and hoping for breaking-even.  The best way to deal with our fallacies in low validity environments is to rely on formulas, standardized factual questions and to avoid inventing ‘broken legs’ (exceptions to your rules).

If that’s not enough, our memory, upon we base our decisions, suffers from quirks such as duration neglect and peak-end rule.  These were strikingly illustrated in one of Kahneman’s more harrowing experiments. Two groups of patients were to undergo painful colonoscopies. The patients in Group A got the normal procedure. So did the patients in Group B, except a few extra minutes of mild discomfort were added after the end of the examination. Which group suffered more? Well, Group B endured all the pain that Group A did, and then some. But since the prolonging of Group B’s colonoscopies meant that the procedure ended less painfully, the patients in this group retrospectively minded it less.

As with colonoscopies, so is it with life. It is the remembering self that calls the shots, not the experiencing self. Our memory of our vacations is determined by the peak-end rule, not by how fun (or miserable) it actually was moment by moment.

“Odd as it may seem, I am my remembering self, and the experiencing self, who does my livinkahnemang, is like a stranger to me.”

Are we really so hopeless? We can’t turn off our system 1 and Kahneman acknowledges that he’s just as prone to its pitfalls as anyone else.   However, being aware of biases and fallacies helps to recognise situations where it’s a good idea to sit down and involve your system 2.  There are some useful techniques as well.  Before taking an important decision, it’s a good idea to organise a pre-mortem meeting, a thought experiment where participants imagine they are a year into the future and implemented the plan as presented.  However, the outcome was a disaster and participants write a brief history of that disaster.  Pre-mortems help to legitimise doubt and encourage even supporters of the decision to search for possible threats.

Findings of behavioural economics find their way into policy and our daily life.  Both the UK and the US have
a government unit dedicated to applying its principles into policy making.  It helps explaining why personal stories trump numbers in global development and why education should focus on educating learners to be disciplined thinkers with knowledge of decision-making skills and principles of probability, choice theory and statistics.

Everyone should read Thinking, Fast and Slow.  It’s an astonishingly rich book: lucid, profound, full of intellectual surprises and self-help value.