Wednesday, 19 November 2014

The ignorance epidemic and bounded rationality

This week's edition of the economist had an interesting article on the knock-on effect the Ebola outbreak is having across Africa. Safari bookings, for instance, are dramatically down on previous years. This seemingly makes no sense: the traditional safari hotspots are further away from and less connected with the effected areas than most European capitals. Through the lens of bounded rationality, however, such an 'ignorance epidemic' is much easier to explain.
       To explain, consider the Jackson family deciding where to go on holiday this year. Suppose that a safari in Tanzania is the best. Then, in the world of the economic textbook, a safari maximizes utility and the Jacksons would set off for Africa. And reality?
        Deciding where to go on holiday is undoubtedly going to be a difficult choice because of the almost limitless possibilities to choose from. So, the Jacksons are not going to maximize utility. The best they can realistically aim for is satisficing. This is the term introduced by Herbert Simon to capture the idea people search until they find a 'good enough' option. The Jacksons may decide that a holiday in Australia is good enough for them.
        Where does Ebola fit into this story? Without Ebola maybe the Jacksons would go to Africa. With Ebola they go to Australia. The crucial point to recognize is that the Jacksons don't lose much either way: in a world of satisficing Africa and Australia are pretty much as good as each other. In other words, the Jacksons don't pay for their 'ignorance'. Africans, however, will pay for the collective ignorance of families like the Jacksons. This is inefficient.
         In a recent paper with Myrna Wooders we show that such inefficiency often comes with stereotyping. Basically, the people doing the stereotyping (the Jacksons in the example) don't lose much by stereotyping. But the people who are stereotyped (Africans in the example) may lose a lot.  The standard economic model is poorly suited to picking up and analysing such things. In particular, the standard model assumes the Jacksons will eliminate bias over time. From a satisficing perspective, however, there is no incentive to do this. The bias will likely persist. 
         Such persistence of bias means that framing effects, which drive things like stereotyping, can have big consequences. It also means the general tendency within economics of wishing away framing effects and coherent arbitrariness is not good enough. Trying telling Africans whose livelihood relies on safari tourists that the 'Ebola framing' is not that important. 

Saturday, 1 November 2014

Social welfare and social preferences: Let the altruists be altruistic

I recently attended a conference session that ended with a debate on whether social preferences should be taken into account when measuring social welfare. That might not sound like a particular exciting issue but I think it's an interesting and important one. So, lets look at the issues.
         We can all agree on the idea that social welfare should guide policy. A policy can be considered good if and only if it improves social welfare. The difficulty is measuring social welfare. How can we reconcile the differing desires and preferences within a population? How can we take into account the desires and preferences of future generations who will be influenced by a policy? And so on. 
          The presence of social preferences, such as envy and altruism, muddies the waters even more as the following example illustrates. Robinson and Friday are the only people living on a desert island. Robinson is selfish and envious. Friday is altruistic and generous. You arrive with a boat full of goodies and have to decide how to distribute your cargo. What should you do?
          If your measure of social welfare takes account of social preferences then you should give all your cargo to Robinson. This keeps Robinson happy because he has no reason to be envious and it keeps Friday happy because he likes to see Robinson happy. The selfish guy gets everything! This outcome strikes many as worrying. Worrying enough that they argue social welfare should not take account of social preferences. But, I find this argument unconvincing. Here are three reasons why.
1. The Robinson, Friday example is just an example. We know that the social preferences of real people are far more subtle. For instance, overwhelming evidence  suggests that generosity is always given conditionally. In short, Friday's simply don't exist. And if Friday's don't exist then we have much less of a problem incorporating social preferences into social welfare. We can rule out the extreme kinds of preferences that people don't like and not miss anything important. 
2. The Robinson, Friday example gives a negative picture of social preferences, which is at odds with the positive view given elsewhere. Social preferences are about sharing things, rewarding those who work hard, punishing those who free-ride, cooperating for mutual benefit etc. Social preferences are almost always a good thing! So, to not take account of them seems strange. If for example, 'rich' people want 'poor' people to have a reasonable standard of living it seems strange to not take account of that when measuring the welfare benefits of a redistributive policy.
3. Social welfare is essentially about judging fairness. This means that social preferences naturally underpin any measure of social welfare. So, we allow the policy maker to have social preferences. And, we allow the economist who comes up with measures of social welfare to have social preferences. But, we don't take account the social preferences of others? That seems way too egocentric. For instance, you might consider it fair to split equally the cargo between Robinson and Friday. The problem is, neither Robinson nor Friday consider it fair! And why should your definition of fairness trump theirs?    
I think, therefore, measures of social welfare should take account of social preferences, and should take account the diversity of social preferences. But, that challenges us to improve our understanding of what fairness means to people.