Sorting out short-termism

Reforming finance and corporate governance have been a bit of a theme in my recent reading. There was John Kay’s outstanding [amazon_link id=”1781254435″ target=”_blank” ]Other People’s Money[/amazon_link], which I reviewed here a few days ago. I’ve read the proof copy of Adair Turner’s impressive new book, [amazon_link id=”0691169640″ target=”_blank” ]Between Debt and the Devil[/amazon_link], although am not allowed to post a review until it’s out in November.

[amazon_image id=”1781254435″ link=”true” target=”_blank” size=”medium” ]Other People’s Money: Masters of the Universe or Servants of the People?[/amazon_image]  [amazon_image id=”0691169640″ link=”true” target=”_blank” size=”medium” ]Between Debt and the Devil: Money, Credit, and Fixing Global Finance[/amazon_image]

Meanwhile, I’ve read a short new book by Laurie Fitzjohn-Sykes, formerly a City analyst and now working for the think tank Tomorrow’s Company. It’s called [amazon_link id=”1845408349″ target=”_blank” ]Playing the Long Game: How to Save the West from Short Termism[/amazon_link], and is well worth a read.

[amazon_image id=”1845408349″ link=”true” target=”_blank” size=”medium” ]Playing the Long Game: How to Save the West from Short-Termism (Societas)[/amazon_image]

The book starts with a vignette of the annual general meeting of Softbank in Japan, in which Masayashi Son gave a 2 hour speech setting out his 30 year and 300 year vision. He must be doing something right. Softbank’s latest product, Pepper the companion robot, has sold out its first two batches of 1000 within a minute of launch.

Pepper, the robot Softbank proposes as your companion - photographed by Rory Cellan-Jones at Innorobo this year

Pepper, the robot Softbank proposes as your companion – photographed by Rory Cellan-Jones at Innorobo this year

The author contrasts this of course with the quarterly results obsession in UK and US business, with the under-investment in the west compared with Asia, and stockmarket churn. It touches on one issue I think is highly damaging, the link between executive remuneration and share prices – as does Andrew Smithers in his excellent book [amazon_link id=”B00EMVHKR4″ target=”_blank” ]The Road to Recovery[/amazon_link].

[amazon_image id=”B00EMVHKR4″ link=”true” target=”_blank” size=”medium” ]The Road to Recovery: How and Why Economic Policy Must Change[/amazon_image]

Fitzjohn-Sykes’ conclusions focus on exactly the need to change management incentives through corporate governance reform and taxation of the damaging pay structures. He also recommends using the tax system to link fund managers’ pay to the long term performance of their funds rather than quarterly outperformance, and introducing minimum stock holding periods for pension funds. In such a short book these recommendations are short on detail but surely in the right territory. Interestingly, he advocates requiring all market research to be conducted by 3rd parties – this focus on the problem of sell-side research is worth considering, along with putting the spotlight on the fund management industry as well as the investment banks and the companies themselves.

At 115 pages, this book is a concise introduction to the short-termism problem, and I’m sure some of the solutions it advocates will prove necessary. However, the problem is well-known and many people have suggested reforms; the question remains why they have so little political traction?

Economics made fun

Yes, really. [amazon_link id=”1138902675″ target=”_blank” ]Economics Made Fun: Philosophy of Pop Economics[/amazon_link] edited by N Emrah Aydinonat and Jack Vromen is a collection of essays (previously published in the Journal of Economic Methodology) exploring the phenomenon of popular economics books. I have a short chapter in it, and along with Robert Frank represent the defenders of popularising economics.

[amazon_image id=”1138902675″ link=”true” target=”_blank” size=”medium” ]Economics Made Fun: Philosophy of the pop-economics[/amazon_image]

It’s fair to say most of the other contributors are critical, largely because they don’t like the version of economics that is being popularised. I’m not wild about all of it myself, particularly the [amazon_link id=”0141019018″ target=”_blank” ]Freakonomics [/amazon_link]version, which is often broader quantitative social science rather than economics, and does do Chicago-style economic imperialism/reductionism to the exclusion of all else.

In his essay Emrah Aydinonat also argues that the genre over-simplifies the research on which it’s based to a misleading extent, using the example of Peltzman’s research on the effect of compulsory seatbelts. The ‘fun’ version is that seatbelts encourage more reckless driving so might not save lives. Aydinonat suggests that a reading of the Peltzman paper indicates that this conclusion requires strong assumptions and rests on flawed data – it is a controversial paper.

This is interesting, but popularising necessarily requires simplification. I think the Peltzman example is a useful way to flag up the fact that regulations can and often do change behaviour, although of course it should be used carefully. And I don’t think many [amazon_link id=”0141030089″ target=”_blank” ]Freakonimists[/amazon_link] actually argue for abolishing seat belt laws, so they implicitly recognise this.

Anyway, as a populariser, I found [amazon_link id=”1138902675″ target=”_blank” ]these essays[/amazon_link] a bracing read; they won’t stop me trying to communicate economic research to the wider public. (And of course lots of thoroughly mainstream academic economists look down on popularising too!)

As social scientists, and particularly influential in public policy, it’s our responsibility to do so.

Designing markets

One of the (many) things I like about market design is the name. It’s a reminder that markets are social institutions too, and that there is a wide spectrum of ways of organising the allocation of resources. So often only the two extremes are discussed: ‘free’ markets (dependent only on property law and contract enforcement – oh, and social norms and culture, and infrastructure, and standards and…. but I digress); and ‘the state’ (with its benign and omniscient ability to analyse market failures and tell people what to do so they are fixed…. oh, wait).

Al Roth’s new book describing his career’s worth of market design, culminating in his Nobel prize with Lloyd Shapley, is a truly excellent overview of the subject. [amazon_link id=”000752076X” target=”_blank” ]Who Gets What and Why: the hidden world of matchmaking and market design[/amazon_link] is a very clear and non-technical description of what can cause markets to malfunction, and how to make them do a better job of matching up supply and demand. It includes the work for which he is most famous, on designing an exchange  to enable the matching of kidney donors and recipients, where no money changes hands in the market-like process.

[amazon_image id=”000752076X” link=”true” target=”_blank” size=”medium” ]Who Gets What – And Why: The Hidden World of Matchmaking and Market Design[/amazon_image]

The first section is a warm-up describing the pervasiveness and importance of markets, and some of the problems market design addresses. The second and third sections are the meat in the sandwich. Roth first of all explains why some markets will collapse, with many examples. The fundamental need is for a ‘thick’ market with plenty of buyers and sellers, in which people have enough time to make their decision, but neither the need nor the opportunity to act strategically. The problems are therefore: incentives to jump the gun ahead of most people in the market – which causes everyone to try & do so once somebody does; trades that occur too fast so people on the slower side of the market cannot make good decisions; rules that cause people to have to devise strategies other than expressing their true preferences; and ‘goldilocks’ communications between participants, not too fast/frequent and not too slow. The following section sets out market design solutions to each kind of problem.

For example, the ‘too soon’ problem featured in the market for first jobs for junior doctors in the US, as 2nd tier hospitals would make earlier and earlier binding and exploding offers to medical students – exploding meaning the candidate had as little as half an hour to say yes before the offer expired. They wanted to make sure they had the best students, but the good students faced the dilemma of a sure job versus the chance of a job at a competitive but better hospital. Attempts to reform the system always foundered on a lack of trust between hospitals. The solution was the famous ‘deferred acceptance’ algorithm run by a central clearing house: it ensures offers can be held until it is clear each student will not get a better one. Every hospital and every student gets their best possible match given everyone’s preferences.

The ‘too fast’ example is high frequency trading, where the millisecond speed means the market is actually thin at each moment. The proposed solution – not yet adopted by regulators – is to insist that all trades occur together once every second.

Matching students to schools is the example of a system that forced strategic behaviour under the old rules in New York and Boston, where Roth’s solutions have been implemented. Parents had to decide disguise their real preferences to reflect the fact that certain schools would only take pupils who had put them as first choice, and that some were so popular that the 2nd or 3rd choice had to reflect a realistic ‘insurance’ option. The deferred acceptance algorithm, with adjustments to reflect policies such as a sibling rule, was again the solution, making it safe to express true preferences.

The later chapters of the book cover other issues, among them signalling, and repugnant markets. Roth also emphasises two important factors: the role of culture in shaping how markets work (gastroenterologists vs orthopedic surgeons have sufficiently different professional cultures that their matching markets needed to be set up differently); and the need to work alongside politicians who might not take every bit of the economists’ advice. The context changes too, calling for redesigns – for example, the medical student matching market needed to be updated when more couples started looking for jobs in the same city.

[amazon_link id=”000752076X” target=”_blank” ]Who Gets What and Why[/amazon_link] has jumped to near the top of my list of books to recommend to students and non-economists to help explain (a) what a lot of economists actually do when they get involved in public policy and (b) why the standard political debate about ‘free markets versus government intervention’ is so utterly inadequate and misleading. Highly recommended.