Economist Quick Quotes

Economists are quick to speak of ‘market failure’, and rightly so, but a greater threat comes from ‘government failure’.

The Poverty Tour provided the opportunity to meet many people who had been living paycheck to paycheck even before the economic downturn. To so quickly slide from the great middle into the underworld of the poor validated our suspicions that perhaps these citizens never really were bona fide, middle class Americans. Indeed, some economists assert that the middle class evaporated decades ago.

We reach the point of diminishing marginal predictive returns for knowledge disconcertingly quickly,” Tetlock writes. “In this age of academic hyperspecialization, there is no reason for supposing that contributors to top journals—distinguished political scientists, area study specialists, economists, and so on—are any better than journalists or attentive readers of The New York Times in ‘reading’ emerging situations.” The

A quick quiz. What do the following events have in common? The war in Iraq. The Exxon Valdez oil spill. The rise in America’s prison population. The answer: They all contribute to our nation’s gross national product, or what’s now referred to as gross domestic product, or GDP, and therefore all are considered “good,” at least in the dismal eyes of economists.

The economist Steven Radelet has pointed out that “the improvements in health among the global poor in the last few decades are so large and widespread that they rank among the greatest achievements in human history. Rarely has the basic well-being of so many people around the world improved so substantially, so quickly. Yet few people are even aware that it is happening.”13

All of us believe you belong here,” I’d said to the Elizabeth Garrett Anderson girls as they sat, many of them looking a little awestruck, in the Gothic old-world dining hall at Oxford, surrounded by university professors and students who’d come out for the day to mentor them. I said something similar anytime we had kids visit the White House—teens we invited from the Standing Rock Sioux Reservation; children from local schools who showed up to work in the garden; high schoolers who came for our career days and workshops in fashion, music, and poetry; even kids I only got to give a quick but emphatic hug to in a rope line. The message was always the same. You belong. You matter. I think highly of you. An economist from a British university would later put out a study that looked at the test performances of Elizabeth Garrett Anderson students, finding that their overall scores jumped significantly after I’d started connecting with them—the equivalent of moving from a C average to an A. Any credit for improvement really belonged to the girls, their teachers, and the daily work they did together, but it also affirmed the idea that kids will invest more when they feel they’re being invested in. I understood that there was power in showing children my regard.

There are clearly many ways to more equitably share the wealth that lies beneath our feet. Ostrom was quick to point out, however, that there is no panacea for managing land and its resources well: neither the market, the commons nor the state alone can provide an infallible blueprint. Approaches to distributive land design must fit the people and the place, and may well work best when they combine all three of these approaches to provisioning.44

argues the evolutionary psychologist Gerd Gigerenzer: we have survived and thrived not despite our cognitive biases but because of them. These so-called biases are the underpinnings of our heuristics, the unconscious mental shortcuts we take every time we use a ‘rule of thumb’ to make decisions. Over millennia, the human brain has evolved to rely on quick decision-making tools in a fast-moving and uncertain world, and in many contexts those heuristics lead us to make better decisions than exact calculations would do.

Economists are quick to speak of ‘market failure’, and rightly so, but a greater threat comes from ‘government failure‘. Because it is a monopoly, government brings inefficiency and stagnation to most things it runs; government agencies pursue the inflation of their budgets rather than the service of their customers; pressure groups form an unholy alliance with agencies to extract more money from taxpayers for their members. Yet despite all this, most clever people still call for government to run more things and assume that if it did so, it would somehow be more perfect, more selfless, next time.

In 2017, Greg Duncan, the education economist, along with psychologist Drew Bailey and colleagues, reviewed sixty-seven early childhood education programs meant to boost academic achievement. Programs like Head Start did give a head start, but academically that was about it. The researchers found a pervasive “fadeout” effect, where a temporary academic advantage quickly diminished and often completely vanished. On a graph, it looks eerily like the kind that show future elite athletes catching up to their peers who got a head start in deliberate practice. A reason for this, the researchers concluded, is that early childhood education programs teach “closed” skills that can be acquired quickly with repetition of procedures, but that everyone will pick up at some point anyway. The fadeout was not a disappearance of skill so much as the rest of the world catching up. The motor-skill equivalent would be teaching a kid to walk a little early. Everyone is going to learn it anyway, and while it might be temporarily impressive, there is no evidence that rushing it matters.

The nudge movement spawned by Thaler and Sunstein has been spectacularly successful around the globe. A 2017 review in the Economist described how policy makers were beginning to embrace insights from behavioral science: In 2009 Barack Obama appointed Mr Sunstein as head of the White House’s Office of Information and Regulatory Affairs. The following year Mr Thaler advised Britain’s government when it established BIT, which quickly became known as the “nudge unit”. If BIT did not save the government at least ten times its running cost (£500,000 a year), it was to be shut down after two years. Not only did BIT stay open, saving about 20 times its running cost, but it marked the start of a global trend. Now many governments are turning to nudges to save money and do better. In 2014 the White House opened the Social and Behavioural Sciences Team. A report that year by Mark Whitehead of Aberystwyth University counted 51 countries in which “centrally directed policy initiatives” were influenced by behavioural sciences. Nonprofit organisations such as Ideas42, set up in 2008 at Harvard University, help run dozens of nudge-style trials and programmes around the world. In 2015 the World Bank set up a group that is now applying behavioural sciences in 52 poor countries. The UN is turning to nudging to help hit the “sustainable development goals”, a list of targets it has set for 2030.32

In opting for large scale, Korean state planners got much of what they bargained for. Korean companies today compete globally with the Americans and Japanese in highly capital-intensive sectors like semiconductors, aerospace, consumer electronics, and automobiles, where they are far ahead of most Taiwanese or Hong Kong companies. Unlike Southeast Asia, the Koreans have moved into these sectors not primarily through joint ventures where the foreign partner has provided a turnkey assembly plant but through their own indigenous organizations. So successful have the Koreans been that many Japanese companies feel relentlessly dogged by Korean competitors in areas like semiconductors and steel. The chief advantage that large-scale chaebol organizations would appear to provide is the ability of the group to enter new industries and to ramp up to efficient production quickly through the exploitation of economies of scope.70 Does this mean, then, that cultural factors like social capital and spontaneous sociability are not, in the end, all that important, since a state can intervene to fill the gap left by culture? The answer is no, for several reasons. In the first place, not every state is culturally competent to run as effective an industrial policy as Korea is. The massive subsidies and benefits handed out to Korean corporations over the years could instead have led to enormous abuse, corruption, and misallocation of investment funds. Had President Park and his economic bureaucrats been subject to political pressures to do what was expedient rather than what they believed was economically beneficial, if they had not been as export oriented, or if they had simply been more consumption oriented and corrupt, Korea today would probably look much more like the Philippines. The Korean economic and political scene was in fact closer to that of the Philippines under Syngman Rhee in the 1950s. Park Chung Hee, for all his faults, led a disciplined and spartan personal lifestyle and had a clear vision of where he wanted the country to go economically. He played favorites and tolerated a considerable degree of corruption, but all within reasonable bounds by the standards of other developing countries. He did not waste money personally and kept the business elite from putting their resources into Swiss villas and long vacations on the Riviera.71 Park was a dictator who established a nasty authoritarian political system, but as an economic leader he did much better. The same power over the economy in different hands could have led to disaster. There are other economic drawbacks to state promotion of large-scale industry. The most common critique made by market-oriented economists is that because the investment was government rather than market driven, South Korea has acquired a series of white elephant industries such as shipbuilding, petrochemicals, and heavy manufacturing. In an age that rewards downsizing and nimbleness, the Koreans have created a series of centralized and inflexible corporations that will gradually lose their low-wage competitive edge. Some cite Taiwan’s somewhat higher overall rate of economic growth in the postwar period as evidence of the superior efficiency of a smaller, more competitive industrial structure.

But when Stigler was put in front of the TV cameras, lights blazing, and asked about supply-side economics, the iconoclastic economist opined that “it’s a gimmick, or, if you wish, a slogan.” Ouch. That didn’t help Ronald Reagan. I presume it didn’t help George Stigler either, who was quickly hustled off stage.

The nature of capital was a major debate issue at the turn of the twentieth century because economist wanted to know how quickly the economy could adjust and recover from a depression. If capital were homogeneous and highly liquid, then the adjustment process should not take long and the economy could soon be back on its feet. But if capital were heterogeneous and not easily transferable to other uses, then the adjustment process could take much longer and it might take years for a nation to recover from a depression

But there's a bigger lesson that I would like to draw from this experiment—and in fact from all that I have said in the preceding chapters. Standard economics assumes that we are rational—that we know all the pertinent information about our decisions, that we can calculate the value of the different options we face, and that we are cognitively unhindered in weighing the ramifications of each potential choice. The result is that we are presumed to be making logical and sensible decisions. And even if we make a wrong decision from time to time, the standard economics perspective suggests that we will quickly learn from our mistakes either on our own or with the help of “market forces.” On the basis of these assumptions, economists draw far-reaching conclusions about everything from shopping trends to law to public policy. But, as the results presented in this book (and others) show, we are all far less rational in our decision making than standard economic theory assumes. Our irrational behaviors are neither random nor senseless—they are systematic and predictable. We all make the same types of mistakes over and over, because of the basic wiring of our brains. So wouldn't it make sense to modify standard economics and move away from naive psychology, which often fails the tests of reason, introspection, and—most important—empirical scrutiny? Wouldn't economics make a lot more sense if it were based on how people actually behave, instead of how they should behave? As I said in the Introduction, that simple idea is the basis of behavioral economics, an emerging field focused on the (quite intuitive) idea that people do not always behave rationally and that they often make mistakes in their decisions.

Being able to figure out quickly what works and what doesn’t can mean the difference between survival and extinction.” —Hal Varian, Google Chief Economist “If you double the number of experiments you do per year you’re going to double your inventiveness.” —Jeff Bezos, CEO of Amazon

Purina’s exposure to the hog business was not limited at all. The volatile markets exposed that fact. In 1998, the US hog market experienced a shock comparable to the stock market crash of 1929—a market convulsion that obliterated all the rules everyone thought applied to the business. The root of the problem could be traced to the very industrialization that created Purina Mills’ feed business in the first place. Now that hogs were raised on factory farms, the supply of animals was enormous and inflexible. Farmers were raising herds of tens or even hundreds of thousands of pigs. When prices started to fall, these industrial farms couldn’t adapt quickly. They had mortgage payments to meet on the big pig houses, and they needed to keep production high. Factory farms were a machine that wasn’t easily turned off. The flow of pigs continued into the slaughterhouses, and prices fell even further. Then everything spun out of control. Hog prices plummeted, sucking the entire business into the ground almost instantly. The price of hogs fell from about 53 cents per pound to 10 cents per pound in a matter of months. When adjusted for inflation, this was the lowest price for pigs in US history. It cost far more to raise a pig than the animal was worth. Purina Mills should have been insulated against this crisis. It only sold feed, not the hogs themselves. But with its decision in 1997 to start buying baby hogs, Purina had exposed itself to the risk of falling pork prices. Dean Watson began to discover just how large that exposure was. As one farm economist put it at the time, the rational number of hogs to own in 1998 was zero. Purina discovered this fact quickly. It bought baby hogs, and turned around to sell them to the farmers. But there were no buyers. The farmers refused to take them. “The people who we were supposed to be selling the pigs to were basically saying: ‘Sue me.’ The people we had bought the pigs from were saying: ‘You’re not getting out of my contract or I am suing you,’ ” Watson said. “All of this ownership risk that I was assured didn’t exist started to just come out of the woodwork.

Ross’s “arbitrage pricing theory” and Rosenberg’s “bionic betas” posited that the returns of any financial security are the result of several systematic factors. Although seemingly stating the obvious, this was a seminal moment in the move toward a more vibrant understanding of markets. The eclectic Rosenberg was even put on the cover of Institutional Investor in May 1978, the bald, mustachioed man depicted as a giant meditating guru with flowers in his hair, worshipped by a gathering of besuited portfolio managers. The headline was “Who Is Barr Rosenberg? And What the Hell Is He Talking About?”8 What he was talking about was how academics were beginning to classify stocks according to not just their industry or their geography, but their financial characteristics. And some of these characteristics might actually prove to deliver better long-term returns than the broader stock market. In 1973, Sanjoy Basu, a finance professor at McMaster University in Ontario, published a paper that indicated that companies with low stock prices relative to their earnings did better than the efficient-markets hypothesis would suggest. Essentially, he showed that the value investing principles espoused by Benjamin Graham in the 1930s—which revolved around buying cheap, out-of-favor stocks trading below their intrinsic worth—was a durable investment factor. By systematically buying all cheap stocks, investors could in theory beat the broader market over time. Then Banz showed the same for small caps, another big moment in the evolution of factor investing. Follow-up studies on smaller stocks in Japan and the UK showed similar results, so in 1986 DFA launched dedicated small-cap funds for those two markets as well. In the early 1990s, finance professors Narasimhan Jegadeesh and Sheridan Titman published a paper indicating that simply surfing market momentum—in practice buying stocks that were already bouncing and selling those that were sliding—could also produce market-beating returns.9 The reasons for these apparent anomalies divide academics. Efficient-markets disciples stipulate that they are the compensation investors receive for taking extra risks. Value stocks, for example, are often found in beaten-up, unpopular, and shunned companies, such as boring industrial conglomerates in the middle of the dotcom bubble. While they can underperform for long stretches, eventually their underlying worth shines through and rewards investors who kept the faith. Small stocks do well largely because small companies are more likely to fail than bigger ones. Behavioral economists, on the other hand, argue that factors tend to be the product of our irrational human biases. For example, just like how we buy pricey lottery tickets for the infinitesimal chance of big wins, investors tend to overpay for fast-growing, glamorous stocks, and unfairly shun duller, steadier ones. Smaller stocks do well because we are illogically drawn to names we know well. The momentum factor, on the other hand, works because investors initially underreact to news but overreact in the long run, or often sell winners too quickly and hang on to bad bets for far longer than is advisable.

Another important question is to ask why the problem your new organization is addressing has not been solved already, or won’t be solved in the future. Ask yourself: Why hasn’t this problem been solved by markets? Why hasn’t this problem been solved by the state? Why hasn’t this problem already been solved by philanthropy? In many cases, the answers to these questions will suggest that the problem is very difficult to solve, in which case it may not be the most effective problem to focus on. In other cases, the answers might suggest that you really can make good progress on the problem. If the beneficiaries of your action don’t participate fully in markets and aren’t governed by a well-functioning state, then there is a clear need for philanthropy. For example, we should expect the interests of future people to be systematically underrepresented because they don’t participate in present-day markets or elections. For-profit entrepreneurship can be even more compelling as an option than nonprofit entrepreneurship. Though it generally will be more difficult to focus your activities on the most important social problem within for-profit entrepreneurship, there is a much greater potential to grow quickly, and there is the additional benefit of larger earnings that can be used for good purposes later on in life. Economists also suggest that innovative entrepreneurship is undersupplied by the market.

When we have an experience—hearing a particular sonata, making love with a particular person, watching the sun set from a particular window of a particular room—on successive occasions, we quickly begin to adapt to it, and the experience yields less pleasure each time. Psychologists call this habituation, economists call it declining marginal utility, and the rest of us call it marriage.

The situation was similar in the Soviet Union, with industry playing the role of sugar in the Caribbean. Industrial growth in the Soviet Union was further facilitated because its technology was so backward relative to what was available in Europe and the United States, so large gains could be reaped by reallocating resources to the industrial sector, even if all this was done inefficiently and by force. Before 1928 most Russians lived in the countryside. The technology used by peasants was primitive, and there were few incentives to be productive. Indeed, the last vestiges of Russian feudalism were eradicated only shortly before the First World War. There was thus huge unrealized economic potential from reallocating this labor from agriculture to industry. Stalinist industrialization was one brutal way of unlocking this potential. By fiat, Stalin moved these very poorly used resources into industry, where they could be employed more productively, even if industry itself was very inefficiently organized relative to what could have been achieved. In fact, between 1928 and 1960 national income grew at 6 percent a year, probably the most rapid spurt of economic growth in history up until then. This quick economic growth was not created by technological change, but by reallocating labor and by capital accumulation through the creation of new tools and factories. Growth was so rapid that it took in generations of Westerners, not just Lincoln Steffens. It took in the Central Intelligence Agency of the United States. It even took in the Soviet Union’s own leaders, such as Nikita Khrushchev, who famously boasted in a speech to Western diplomats in 1956 that “we will bury you [the West].” As late as 1977, a leading academic textbook by an English economist argued that Soviet-style economies were superior to capitalist ones in terms of economic growth, providing full employment and price stability and even in producing people with altruistic motivation. Poor old Western capitalism did better only at providing political freedom. Indeed, the most widely used university textbook in economics, written by Nobel Prize–winner Paul Samuelson, repeatedly predicted the coming economic dominance of the Soviet Union. In the 1961 edition, Samuelson predicted that Soviet national income would overtake that of the United States possibly by 1984, but probably by 1997. In the 1980 edition there was little change in the analysis, though the two dates were delayed to 2002 and 2012. Though the policies of Stalin and subsequent Soviet leaders could produce rapid economic growth, they could not do so in a sustained way. By the 1970s, economic growth had all but stopped. The most important lesson is that extractive institutions cannot generate sustained technological change for two reasons: the lack of economic incentives and resistance by the elites. In addition, once all the very inefficiently used resources had been reallocated to industry, there were few economic gains to be had by fiat. Then the Soviet system hit a roadblock, with lack of innovation and poor economic incentives preventing any further progress. The only area in which the Soviets did manage to sustain some innovation was through enormous efforts in military and aerospace technology. As a result they managed to put the first dog, Leika, and the first man, Yuri Gagarin, in space. They also left the world the AK-47 as one of their legacies. Gosplan was the supposedly all-powerful planning agency in charge of the central planning of the Soviet economy.

Interestingly, [Kevin] Anderson says that when he presents his radical findings in climate circles, the core facts are rarely disputed. What he hears most often are confessions from colleagues that they have simply given up hope of meeting the 2 degree temperature target, precisely because reaching it would require such a profound challenge to economic growth. “This position is shared by many senior scientists and economists advising government,” Anderson reports. In other words, changing the earth’s climate in ways that will be chaotic and disastrous is easier to accept than the prospect of changing the fundamental, growth-based, profit-seeking logic of capitalism. We probably shouldn’t be surprised that some climate scientists are a little spooked by the radical implications of their own research. Most of them were quietly measuring ice cores, running global climate models, and studying ocean acidification, only to discover, as Australian climate expert and author Clive Hamilton puts it, that in breaking the news of the depth of our collective climate failure, they “were unwittingly destabilizing the political and social order.” Nonetheless, that order has now been destabilized, which means that the rest of us are going to have to quickly figure out how to turn “managed degrowth” into something that looks a lot less like the Great Depression and a lot more like what some innovative economic thinkers have taken to calling “The Great Transition.

those who happen to have the right talents-should be economists and statesmen, and that all economists and statesmen should be Christians, and that their whole efforts in politics and economics should be directed 'Do as you would be done by' into action. If that happened and if we others were really ready to take it, then we should find the Christian solution for our own social problems pretty quickly.

In any case, Locke argued that we all have a natural set of property rights and can happily go about our business trading with each other and creating all sorts of prosperity. Only much later do we get together and form governments in order to eliminate certain “inconveniences” associated with the state of nature. This sets up the basic contrasts: economy = natural; government = artificial. The impact of this type of thinking can be truly disastrous. No one knows this better than economic planners in Eastern Europe, who were unlucky enough to ask a bunch of American economists for advice on how to make the transition from communism to capitalism. Naturally, the Americans had no experience in these matters, but they did have an overarching ideology that stipulated that markets are nothing more than the expression of our natural “propensity to truck and barter.” So their advice to the East Europeans was quite simple— don’t do anything. Just destroy all your existing public institutions and markets will magically pop up and take their place. Nothing could be easier. Any country foolish enough to take this advice quickly found that when it scaled back the government’s role, what it wound up with was rampant criminality, not orderly markets.

Addiction If some scientists believe that “if-then” motivators and other extrinsic rewards resemble prescription drugs that carry potentially dangerous side effects, others believe they’re more like illegal drugs that foster a deeper and more pernicious dependency. According to these scholars, cash rewards and shiny trophies can provide a delicious jolt of pleasure at first, but the feeling soon dissipates—and to keep it alive, the recipient requires ever larger and more frequent doses. The Russian economist Anton Suvorov has constructed an elaborate econometric model to demonstrate this effect, configured around what’s called “principal-agent theory.” Think of the principal as the motivator—the employer, the teacher, the parent. Think of the agent as the motivatee—the employee, the student, the child. A principal essentially tries to get the agent to do what the principal wants, while the agent balances his own interests with whatever the principal is offering. Using a blizzard of complicated equations that test a variety of scenarios between principal and agent, Suvorov has reached conclusions that make intuitive sense to any parent who’s tried to get her kids to empty the garbage. By offering a reward, a principal signals to the agent that the task is undesirable. (If the task were desirable, the agent wouldn’t need a prod.) But that initial signal, and the reward that goes with it, forces the principal onto a path that’s difficult to leave. Offer too small a reward and the agent won’t comply. But offer a reward that’s enticing enough to get the agent to act the first time, and the principal “is doomed to give it again in the second.” There’s no going back. Pay your son to take out the trash—and you’ve pretty much guaranteed the kid will never do it again for free. What’s more, once the initial money buzz tapers off, you’ll likely have to increase the payment to continue compliance. As Suvorov explains, “Rewards are addictive in that once offered, a contingent reward makes an agent expect it whenever a similar task is faced, which in turn compels the principal to use rewards over and over again.” And before long, the existing reward may no longer suffice. It will quickly feel less like a bonus and more like the status quo—which then forces the principal to offer larger rewards to achieve the same effect.

questions Those taking a new leadership role should ask: How is your industry changing and, in particular, how are your customers’ expectations evolving? What are the global developments (for example, increased migration, urbanisation or proliferation of mobile communications) that could benefit, threaten or generally alter the way that you do business? What are the political, economic, social, technological, legislative or environmental trends that could affect your business? What situation best describes the challenges and opportunities faced by the business? Is this clearly and widely recognised? What specific challenges are likely to be encountered? How can they be addressed? What are the major opportunities and what action is needed to realise them? Are there quick wins or low-hanging fruit that can be secured? What are the greatest risks, threats and potential pitfalls? How will these be avoided or overcome? What are the expectations of stakeholders? Are these expectations realistic – do they need adjusting? What should be the priorities?

First, reframe the purpose of taxes to help build social consensus for the kind of higher-tax, higher-returns public sector that has been a proven success in many Scandinavian countries. And remember, the verbal framing expert George Lakoff advises to choose your words wisely: don’t oppose tax relief—talk about tax justice. Likewise, the notion of public spending is often used by those who oppose it to evoke a never-ending outlay. Public investment, on the other hand, focuses on the public goods—such as high-quality schools and effective public transport—that underpin collective well-being.57 Second, end the extraordinary injustice of tax loopholes, offshore havens, profit shifting and special exemptions that allow many of the world’s richest people and largest corporations—from Amazon to Zara—to pay negligible tax in the countries in which they live and do business. At least $18.5 trillion is hidden by wealthy individuals in tax havens worldwide, representing an annual loss of more than $156 billion in tax revenue, a sum that could end extreme income poverty twice over.58 At the same time, transnational corporations shift around $660 billion of their profits each year to near-zero tax jurisdictions such as the Netherlands, Ireland, Bermuda and Luxembourg.59 The Global Alliance for Tax Justice is among those focused on tackling this, campaigning worldwide for greater corporate transparency and accountability, fair international tax rules, and progressive national tax systems.60 Third, shifting both personal and corporate taxation away from taxing income streams and towards taxing accumulated wealth—such as real estate and financial assets—will diminish the role played by a growing GDP in ensuring sufficient tax revenue. Of course progressive tax reforms such as these can quickly encounter pushback from the corporate lobby, along with claims of state incompetence and corruption. This only reinforces the importance of strong civic engagement in promoting and defending political democracies that can hold the state to account.

conducted by the UK’s Behavioural Insights Team. The goal of the experiment was to see whether taxpayers who owed money could be nudged to pay off their debts more quickly. The results were analyzed by team member Michael Hallsworth in collaboration with three academic economists. The subjects (who did not know they were part of an experiment) were taxpayers, such as business owners, who had income that was not subject to the withholding tax and had not paid in full. Several different letters were tried and compared to a control letter just reminding people of how much money they owed.

What can I actually do?” asked the British economist E. F. Schumacher in his 1973 book Small Is Beautiful, in the face of intractable tentacles of industry. “In the excitement over the unfolding of his scientific and technical powers,” he wrote, “modern man has built a system of production that ravishes nature and a type of society that mutilates man.” Meanwhile, the wealthy were stripping the world of its cheap fuels at such a quick rate that poor countries would never get a fair share.

Economist Paul Rosenstein-Rodan has pointed to the “tremble factor” in understanding human motivation. “In the building practices of ancient Rome, when scaffolding was removed from a completed Roman arch, the Roman engineer stood beneath. If the arch came crashing down, he was the first to know. Thus his concern for the quality of the arch was intensely personal, and it is not surprising that so many Roman arches have survived.” Why should investing be any different? Money managers who invested their own assets in parallel with clients would quickly abandon their relative-performance orientation.

Capitalism and Freedom stuck it to the Man years before doing so became trendy. Expecting “the usual espousal of big government and the welfare state that all intelligent people—especially intelligent economists—are known to support,” an audience at Haverford College jolted awake when Friedman laid down theses from the book. “The speaker attacked almost every institution dear to the modern liberal, among them socialized medicine, public housing, foreign aid, large government agencies and farm price supports,” reported the student newspaper. Campus liberals rallied to counterattack, only to be overwhelmed “by a bevy of facts and quick retorts.”34 The Friedmans rejected the idealism of Kennedy liberalism. At the same time, their provocative, anti-establishment proposals foreshadowed another rising mood of the decade.

after thousands of generations in an immediate-return environment, our brains evolved to prefer quick payoffs to long-term ones.16 Behavioral economists refer to this tendency as time inconsistency. That is, the way your brain evaluates rewards is inconsistent across time.fn2 You value the present more than the future. Usually, this tendency serves us well. A reward that is certain right now is typically worth more than one that is merely possible in the future. But occasionally, our bias toward instant gratification causes problems.

As these students quickly discover, our beliefs about economic growth are almost religious: personal in nature, political in consequence, privately held and little discussed.

Leave aside for a moment the catch that billions of people lack the money needed to express their wants and needs in the marketplace, and that many of the things we most value are not for sale. Economic theory is quick—too quick—in asserting that the price people are willing to pay for a product or service is a good enough marketplace proxy for calculating their utility gained. Add to this the apparently reasonable assumption that consumers always prefer more to less, and it is a short step to concluding that continual income growth (and therefore output growth) is a decent proxy for ever-improving human welfare. And with that, the cuckoo has hatched.

Suppose that the perpetrators of the crime planned to, and did, impose a military dictatorship that killed thousands and tortured tens of thousands. Suppose the new dictatorship established, with the support of the criminals, an international terror center that helped install similar torture-and-terror states elsewhere, and, as the icing on the cake, brought in a team of economists—call them “the Kandahar Boys”—who quickly drove the economy into one of the worst depressions in its history. That, plainly, would have been a lot worse than 9/11. As we all should know, this is not a thought experiment. It happened. I am, of course, referring to what in Latin America is often called “the first 9/11”: September 11, 1973,

Think of Eric Clapton on that Saturday evening as a repentant sinner who is literally on the road to salvation, like the hero of Pilgrim’s Progress, the seventeenth-century allegory. Suppose that he, too, is journeying toward a Celestial City. While traveling through the open countryside, he can see the city’s far-off golden spires and keeps heading in their direction. This evening he looks ahead and notices a pub, strategically situated at a bend in the road so that it’s directly in front of travelers. From this distance it looks like a small building, and he still keeps his eyes fixed on the grander spires of the Celestial City in the background. But as Eric the Pilgrim approaches the pub, it looms larger, and when he arrives, the building completely blocks his view. He can no longer see the golden spires in the distance. Suddenly the Celestial City seems much less important than this one little building. And thus, verily, our pilgrim’s progress endeth with him passed out on the pub’s floor. That’s the result of hyperbolic discounting: We can ignore temptations when they’re not immediately available, but once they’re right in front of us we lose perspective and forget our distant goals. George Ainslie, a renowned psychiatrist and behavioral economist with the Department of Veterans Affairs, worked out the mathematics of this foible by using some clever variations of the familiar experiments testing long-term and short-term rewards. For instance, if you won a lottery with a choice of prizes, would you prefer $100 to be paid six years from today, or $200 to be paid nine years from today? Most people will choose the $200. But what if the choice were between $100 today and $200 three years from today? A rational discounter would apply the same logic and conclude once again that the extra money is worth the wait, but most people will instead demand the quick $100. Our judgment is so distorted by the temptation of immediate cash that we irrationally

Using data collected directly from firms, economists at the Federal Reserve and Harvard Business School found that volatility in publicly traded firms’ sales growth rates and profit-to-sales ratios has increased dramatically since 1970—and that the increased volatility is reflected directly in the wages of workers within the year. In other words, firms seem to be reacting more quickly to changes in the business environment by increasing or cutting what they are paying their existing workers (not by layoffs or new hires). This connection is most pronounced in the service sector and for low-wage workers.

Among life's cruelest truths is this one: Wonderful things are especially wonderful the first time they happen, but their wonderfulness wanes with repetition. Just compare the first and last time your child said "Mama" or your partner said "I love you" and you'll know exactly what I mean. When we have an experience _ hearing a particular sonata, making love with a particular person, watching the sun set from a particular window of a particular room on successive occasions, we quickly begin to adapt to it, and the experience yields less pleasure each time. Psychologists call this habituation, economists call it declining marginal utility, and the rest of us call it marriage.

Despite being the most protectionist country in the world throughout the 19th century and right up to the 1920s, the US was also the fastest growing economy. The eminent Swiss economic historian, Paul Bairoch, points out that there is no evidence that the only significant reduciton of protectionism in the US economy (between 1846 and 1861) had any noticeable positive impact on the country's rate of economic growth. SOme free trade economists argue that the US grew quickly during this period despite protectionism, because it had so many other favourable conditions for growth, particularly its abundant natural resources, large domestic market and high literacy rate. The force of the counter-argument is diminished by the fact that, as we shall see, many other countries with few of those conditions also grew rapidly behind protective barriers. Germany, Sweden, France, Finland, Austria, Japan, Taiwan, and Korea come to mind.

Most free trade economists would accept that there are winners and losers from trade liberalization but argue that their existence cannot be an argument against trade liberalization. Trade liberalization brings overall gains. As the winners gain more than what is lost by the losers, the winners can make up all the latters' losses and still have something left for themselves. This is known as the 'compensation principle'-if the winners from an economic change can fully compensate the losers and still have something left, the change is worth making. The first problem with this line of argument is that trade liberalization does not necessarily bring overall gain. Even if there are winners from the process, their gains may not be as large as the losses suffered by the losers-for example, when trade liberalization reduces the growth rate or even make the economy shrink, as has happened in many developing countries in the past two decades. Moreover, even if the winners gain more than the losers lose, the compensation is not automatically made through the workings of the market, which means that some people will be worse off than before. Trade liberalization will benefit everyone only when the displaced workers can get better (or at least equally good) jobs quickly, and when the discharged machines can be re-shaped into new machines-which is rarely.

Examine the value function in this figure at the origin, where both curves begin. Notice that the loss function is steeper than the gain function: it decreases more quickly than the gain function goes up. Roughly speaking, losses hurt about twice as much as gains make you feel good. This feature of the value function left me flabbergasted. There, in that picture, was the endowment effect. If I take away Professor Rosett’s bottle of wine, he will feel it as a loss equivalent to twice the gain he would feel if he acquired a bottle; that is why he would never buy a bottle worth the same market price as one in his cellar. The fact that a loss hurts more than an equivalent gain gives pleasure is called loss aversion. It has become the single most powerful tool in the behavioral economist’s arsenal. So, we experience life in terms of changes, we feel diminishing sensitivity to both gains and losses, and losses sting more than equivalently-sized gains feel good. That is a lot of wisdom in one image. Little did I know that I would be playing around with that graph for the rest of my career.

The relationship between government institutions and economic growth prompted a clever and intriguing study. Economists Daron Acemoglu, Simon Johnson, and James Robinson hypothesized that the economic success of developing countries that were formerly colonized has been affected by the quality of the institutions that their colonizers left behind.6 The European powers adopted different colonization policies in different parts of the world, depending on how hospitable the area was to settlement. In places where Europeans could settle without serious hardship, such as the United States, the colonizers created institutions that have had a positive and long-lasting effect on economic growth. In places where Europeans could not easily settle because of a high mortality rate from disease, such as the Congo, the colonizers simply focused on taking as much wealth home as quickly as possible, creating what the authors refer to as “extractive states.” The study examined sixty-four ex-colonies and found that as much as three-quarters of the difference in their current wealth can be explained by differences in the quality of their government institutions. In turn, the quality of those government institutions is explained, at least in part, by the original settlement pattern.