Category / Cost Benefit Analysis

Cost Benefit Analysis is so bad we need more of it January 9, 2014 at 5:35 pm

John C. Coates says:

quantified CBA on those rules [in the Dodd Frank Act and elsewhere in financial regulation] amounts to no more than “guesstimation,” entailing (a) causal inferences that are unreliable under standard regulatory conditions; (b) use of problematic data, and/or (c) the same kind of contestable, assumptionsensitive macroeconomic and/or political modeling used to make monetary policy.

This is entirely fair. Coates however makes too much of this, claiming that

While CBA… is a useful conceptual framework, and quantified CBA a worthy long-term research goal, it is not capable of disciplining regulatory analysis [of financial rules] in its current state.

Let me explain why. Any cost benefit analysis of significant financial regulation is plagued with difficulty: not only is it hard to know what both sides are, there is also the significant difficulty that the industry will change in likely unpredictable ways to any regulation. With the best will in the world, it is impossible to quantify either costs or benefits accurately.

However, agencies and others should still conduct CBA. There are a number of reasons for this. First, building a CBA models focusses the mind and brings up hitherto unforeseen issues. Even if you throw away the output, it is still worth doing.

Second, a good CBA model will not produce simple cost and benefit analysis, but ranges of estimates, probability fan charts, or similar. This encourages the modeller to be more honest about model risk and often highlights the fact that, for many policy proposals, they are not certain to work. That doesn’t mean that you shouldn’t enact them, but rather that you should be alert to the possibility of failure, and ready to change policy if the evolving evidence indicates that you should.

Finally, both sides of an argument can and should do CBA. This would focus the discussion on those aspects of the problem that the two sides disagree on, and hence provide a hopefully small set of questions whose answers determine the efficacy of the proposal, or which suggest modifications to it. Wouldn’t it be great if instead of the industry going up in front of a judge and saying ‘the agency didn’t do a CBA, so you should stop them enacting the rule’, both sides instead went up with their own detailed models, and were forced to justify their differing appraisals of a policy proposal?

Cost benefit fail December 6, 2013 at 11:34 am

From the Guardian:

The bill for cleaning up the huge Sellafield nuclear plant in Cumbria will rise even higher than its current estimated level of £70bn as operators struggle to assess the full scale of the task, according to sources close to the project.

It is the season to be generous so I will merely point out that this was entirely predictable (and predicted), and that it serves as a useful lesson about the risks of making long term infrastructure decisions on the basis of cost benefit analysis where both sides are subject to oodles of model risk.

Performativity in policy June 10, 2013 at 8:32 am

I am buried in final book proofs – when your title is listed on the publisher’s website with a publication date less than six weeks away, you know that it is urgent – but I wanted to at least point to an insightful old post of Chris Dillow’s. He discusses how the ideological environment in which policy is formulated affects its outcome.

the “neoliberal” turn in politics has two adverse effects:

  1. If you believe markets know best and that centralized information-gathering is bound to be a deeply flawed process, then you’ll invest less effort in it, or be sceptical of the product of doing so. Cost-benefit analyses will then be founded upon flimsier evidence, or won’t carry much weight even if it is.
  2. The increased belief in consumer sovereignty and decline in faith that “the man in Whitehall knows best” (to which “Nudge” economics is the counter-reaction) has devalued expertise. If politics is about giving voters what they want, you don’t need experts and evidence, but just pollsters and market researchers.

In these senses, “neoliberalism” has had some performative effects upon policy.

This is clearly right. There’s no such thing as an ‘objective’ cost benefit analysis, however hard you (or aren’t) trying to produce one. Politics can’t help but colour any policy making process — which is one of the reasons that it is so important.

Update. It occurs to me that there is a variant of the Sapir-Whorf hypothesis here: instead of `the structure of your languages affects your cognition’ we have `your politics affects which policies you can implement’.

What regime should you charge for capital under? January 19, 2012 at 7:42 am

Dealbreaker picks up on some interesting comments from Goldman’s Viniar about allocating regulatory capital to businesses:

As far as how we’re charging the desks, that’s a little bit of a complicated question. And we’re working through that now, and it — there’s no one-size-fits-all yet. And we have to be careful. As you know, Basel III does not kick in for quite a while, and quite a bit of what we do is very short dated. And so we don’t want to charge desks on a Basel III basis, have them turn down profitable opportunities that would be long gone from our balance sheet long before Basel III ever kicks in. So we’re really taking into consideration the tenor of what we do and trying to figure out what capital regime we’re going to be under. And it’s still — I would say, we’re going through a transition process here.

This makes sense. If you do a one year trade now, Basel III won’t touch it, so charging for Basel III capital is crazy. But if you do a twenty year trade, it probably will be affected by whatever ends up being implemented. Goldman being a US firm has less certainty here than many, as the US is notoriously slow at implemented Basel Accords, and quite likely when it does get around to doing something to implement a subtly different set of rules. So somehow a US bank like Goldman has to design a regulatory capital allocation mechanism that doesn’t discourage short term trades that are profitable under the current rules, but also doesn’t load up the balance sheet with long term ones that have an unattractive ROE under whatever the US version of Basel III ends up being. Tricky.

Discounting in the presence of rate uncertainty July 28, 2011 at 6:21 am

We all know how to discount future cashflows – they teach you that in Econ 101. But what do you do if you aren’t certain of the rate at which to discount? Mark Buchanan, in a fascinating blog post discussing work by Farmer and Geanakoplos (HT Naked Capitalism) answers the question. While you do what most people would expect (OK, most people with a quant background), namely take the probability-weighted average over paths of the effective discount factor on each path, what you end up with is more surprising. According to Farmer and Geanakoplos, in this setting discount factors follow a power law:

D(T) = (1 + aT)^-b

where a and b are constants.

The crucial observation is that this falls off much slower than the usual exp(-rT), and hence typically gives much more value to cashflows in the distant future. If one wanted to be hyperbolic about this (yes, yes, pun intended), then one would say that the cure for short termism is simply to use the right discounting function.

Paradigm hunting December 3, 2009 at 3:12 pm

Like most things which create careers and make money, science isn’t what it claims to be.

It claims to be objective; validated by experiment; unbiased. Of course it isn’t because that takes far too much time. Usually the cranks are exactly that. So it would be an awful waste to test their claims or otherwise take them seriously. Similarly the promotions are in the hot topics, the topics that are getting published in the big journals. Stick with those, stick with the orthodoxy, and you have a career. This is entirely rational: paradigm changing science comes along infrequently, and it is a very good working assumption that any given anomalous result is a screw up rather than a harbinger of a dramatic new theory. Moreover, scientists are people: they have rivalries, jealousies, and such like too.

Scientists, then, for entirely practical and understandable reasons, don’t do science very objectively. And mostly that does not matter. A really good idea will win out eventually, albeit possibly after its creator has died. Some middling good ideas never make it, but the loss is not huge given the increase in efficiency that seeming-crank-avoidance brings. It’s OK, really, most of the time.

(Much of the landscape here has been surveyed by sociologists of science, such as Pierre Bourdieu. Donald MacKenzie has a nice take in the LRB here.)

Unfortunately, as Daniel Henninger points out in the WSJ, when politics enters the picture, things become rather less OK. I don’t agree with much of the Henninger article. However, his basic point – that the failure of scientists at the East Anglia Climate Research Unit to act the way scientists are supposed to act has caused great damage to the image of science – is sound. And it is a great pity.

First, it is worth saying that most people’s emails, if widely published, would cause some embarrassment. It is no surprise that things are no different for scientists.

Second, as we have seen in several cases recently, politics asks too much from science. Or at least politicians do. The real answer to many, perhaps most scientific questions is we don’t know. Experts give advice based on best guesses. This is particularly the case with climate models: like models in many other areas, they are approximations. We think that they work. There is good evidence that the work in some domains. But we are using them well beyond the area that we are really comfortable with. That means that there is model risk. So yes, climate change might not be as bad as our best guess – and it might be worse. It might happen sooner or later than we think. The balance of risk versus cost strongly suggests doing something now, and something pretty drastic. But we can no more know for sure that this is the right thing to do than we can know for sure that the sun won’t explode tomorrow.

What we need desperately is more evidence based politics. This requires three things:

  • Carefully gathering evidence, and using the best available theory to analyse it;
  • Forming policy on the basis of that analysis;
  • Ongoing review, including changing your mind if the evidence and/or the theory changes.

Politicians find that last part particularly hard as it can involve loss of face. But what would you rather have, someone trying to do the right thing, while acknowledging that they might be wrong about what that thing is, or someone who has blind faith in their decisions whatever the evidence?

Strike me down October 8, 2009 at 10:30 pm

The British postal system is a mess. It does not work very well in places thanks to chronic under funding. Queues in post offices are often long, especially in cities; too much post is lost; and rural post offices are being closed. To make matters even worse, a nationwide postal strike is threatened.

A large part of the problem is that attempts have been made to make the Royal Mail efficient. Royal Mail management have tried to squeeze more and more work from the average postie. These are people with physically demanding jobs working unsocial hours. They should be treated like third world donkeys, loaded with ever more work. Instead the funding for the Royal Mail needs to be significantly increased, if need be by increasing the cost of post and banning competition. Who needs competition in postal delivery anyway? What is needed is an efficient postal service that serves everyone. If doing that is only possible with a state subsidy, then so be it. The societal benefits of a working postal system are more than sufficient to justify a subsidy. Far better that than a plethora of companies competing for Amazon’s business but no one able to get a letter from Lands End to John O’Groats overnight.

Pounds per pixel May 23, 2009 at 9:27 am

I had cause recently to muse on the rather variable cost of a pixel. It’s like this.

Pentax has a new digital camera out. It’s called the K-7, it is apparently quite nice, and the body will cost roughly £1,200. It will produce images with 15 million pixels. This is fairly typical for a good quality digital SLR.

Now consider the large format camera I bought the other day. It cost £200, and it will take 5×4 film. Even a medium quality flat bed scanner can produce a three hundred million pixel scan from a 5×4 negative. Lenses for the LF camera are roughly the same price as high end digital lenses – a Rodenstock Apo Sironar S 150mm is comparable in price to the Pentax 31mm limited. So I am getting a pixel for 0.000067p, vs. 0.008p for the digital photographer, a factor of over 100 better.

Now of course digital is free once you have the camera, and large format isn’t. But the £1,000 I have saved will buy quite a big pile of Fuji Velvia 5×4. Sometimes old technology is cheaper and better than new…

Hoicked from the comments May 19, 2009 at 5:58 am

In a comment on the non-classical cost benefit analysis post of a few days ago (a title, I think you will agree, of gigantic pretention), Dave said:

I agree with your conclusions: that uncertainty and moral hazard can make CBA unreliable and sometimes it is better to rely on qualitative objectives.

But I disagree with your applying these to systemic risk. Firstly, with systemic risk it is the “worst-case scenario” that is important. If regulators had used the great depression as the worst case scenario, they wouldn’t have been far wrong.

Often, though, the worst case scenario can be hard to identify. The worst case scenario in much of finance for instance is that all claims are worthless and all liabilities come due immediately. We might as well all go home if that comes true, and barricade the doors. ‘Plausible’ worst cases have a nasty habit of turning out to be too optimistic: wasn’t it David Viniar from Goldman who said that 2008 was much worse than the most pessimistic scenario they looked at?

Secondly, I can’t see how systemic risk regulation would cause bankers to take greater risks. So, I don’t see where moral hazard fits in.

Fair enough – bankers are not people riding bikes. (Quite literally, usually – Wall Street tends to view cycling to work as only marginally less strange than coming by elephant.) So probably bankers did not take more risk because they were regulated. Some of them did, however, take as much as they could subject to regulation, because that was the way to maximise returns to shareholders.

Thirdly, how do you take a “moral” position on systemic risk? I don’t think this gets you very far.

Well, I think that the key idea of Anglo-Saxon capitalism – that the first and only duty of a firm is to its shareholders – is simply immoral. Of course, like any ethical judgement, you can disagree with that. But I also think, and I’d like to think that I can prove, that a system that has a wider burden of responsibilities, including a responsibility to the financial system, would be less likely to go into crisis, cost the taxpayer less over the cycle, and deliver slower but less volatile growth.

Finally, the main impact of systemic risk regulation would be to encourage smaller banking/trading institutions. I would think that this a good thing in itself. And I disagree with James Kwak that “countercylical measures in a boom dampen economic growth”. Surely the opposite is true (in the long run).

Absolutely. We need a lot of small banks, not a small number of large ones. The hard part is how we get to there from here.

Sound words on defence spending May 16, 2009 at 6:36 am

Lewis Page writes sharply and well on defence procurement. He’s a sample:

defence manufacture brings us a measly billion or two in exports each year – and our arms industry requires the great bulk of the £15Bn defence materiel budget in spending to win us this rather paltry amount of trade.

Put that way, the claim that we need our massive – per capita larger than any other EU state – defence budget to support exports is clearly ridiculous. Does this spending provide credible independent capability? Page says no, and gives detailed examples:

the Prime Minister can fire his American-made Trident missiles without asking Washington frst. But he cannot expect his supposedly ‘Britsh’ or ‘European’ systems to keep operatng through a normal-length war if US support is cut of. No, seriously. The Eurofghter contains so much US equipment that American consent is required for us to export it to Saudi Arabia, for goodness’ sake. EADS tells us openly that “the A400M will beneft from use of American content”. The command system for the Nimrod is being made by Boeing. The Future Lynx uses American engines.

On a day when the shameful truth of defence procurment – that British soldiers are dying because we can’t get them the kit they need – is once more emphasised, it is time to face the truth. Defence spending isn’t just absurdly high in the UK: despite that, it does not give the ordinary soldier, sailor and flyer what they need and deserve.

If you want to subsidise exports, then support the most efficient exporters. They are not defence companies. If you want capable weapons systems, then buy the best ones that you can afford*. And if you want to send men out to fight, then you have a moral obligation to kit them out properly: that imperitive over-rides any possible national interest in a particular manufacturer or procurement process. We don’t just need to cut defence spending: we need to spend smarter and more ethically.

*Subject of course to acceptable ‘will they support it’ risk. One might like to consider for a moment in this context whether the Sukhoi-30 is a better bet for the RAF than the Eurofighter…

Update. A correspondant with considerable knowledge of the defence industry points out that even when UK defence companies can meet a procurement objective, they are more expensive than their civil equivalents because they cannot meet the same timescales and margins. A combination of the shelter provided by captive defence spending and the overhead (both in cost and in putting off some staff) of security means that they simply are not lean and mean enough. If you want a van, go to Ford or Toyota or Renault – don’t go to someone who makes tanks.

Non-classical Cost Benefit Analysis May 15, 2009 at 6:05 am

Remember Schroedinger’s cat? Poor moggy is trapped in a box with a radio active isotope. The isotope decays randomly. Let’s say that there is half a chance of detecting a beta particle using a detector inside the box during some time interval. If the particle is detected, then poison gas is released and the cat dies. If not, it lives.

This setup is usually used to explain superposition of states: basically until you open the box, the cat is in the superposed state ‘dead and alive’. You force it to be one or the other by observing it.

I want to use it to talk about something else, though – cost/benefit analysis. If you like cats, then you will want to save moggy. But there is a cost to opening the box early, a pound say. If you judge the worth of a cat as more than two pounds, then you’d spend the pound and guarantee that the cat is safe. In general, ‘classical’ cost benefit analysis says that if a bad event has cost x and probability p, then it is worth spending px to prevent the bad thing.

Concretely this is usually expressed with less likely events: a certain kind of brake failure on your car is a one in a million event, and the average cost of an accident if your brakes fail is ten thousand pounds, so it is only worth spending a penny to prevent the problem.

This classical cost benefit analysis makes two big assumptions. First it assumes that the bad events are independent and identically distributed. In many applications, this is not true: making the system safer sometimes encourages people to take more risk (and not fixing an obvious safety issue makes them more careful). There is good evidence for this from the development of ABS brakes, amongst other things: they didn’t make cars nearly as much safer as the developers hoped, since drivers absorbed the safety margin by driving more aggressively.

In the cat experiment, you can think of this as moggy learning (perhaps by cat telepathy) that if it gets between the isotope and the detector, the particle is less likely to be detected, and hence it is more likely to live. This changes p from 1/2 to 1/3, say, and now your pound is only worth spending if you think a cat’s life is worth three pounds.

The second major problem is that your estimate of the probability of failure for small p, is likely to be wrong. Your estimate of the cost, x, might be wrong too. As James Kwak says:

imagine that the government had considered the idea of systemic risk regulation five years ago. It would have cost money; it would have created new disclosure requirements for banks and possibly hedge funds; it would have required countercyclical measures in a boom that would dampen economic growth. Those are the costs of regulation. And how would anyone have estimated the benefits? No one would have estimated the scenario we face today – trillions of dollars of asset writedowns, 3.3% contraction in the U.S. economy and counting, even more severe damage elsewhere in the world economy. And as a result, the regulation would have died.

… it’s a mistake to think that all policies can be boiled down to cost-benefit calculations when one side of the equation is difficult or impossible to measure accurately, and the last thing we need today is more economics-based overconfidence.

In other words, cost benefit analysis is all very well if you can measure the costs, the benefits, and their probability distribution accurately. But if you can’t, as in the costs of financial regulation vs. its benefits, then you shouldn’t use spurious theory to try to justify the decision you wanted anyway. If you don’t know the probability of the particle being detected, you simply have to fall back on an ethical judgement: killing cats is wrong.

Office decorations January 24, 2009 at 8:32 am

Note to CEOs everywhere. No one, not your shareholders, not your staff, not your clients, thinks you deserve a $87,000 rug. Buying one shows a spectacular failure of judgment. Buy something cheap and inoffensive instead. But don’t go too far.

Decorations

Update. Thain is paying the $1.2M back, according to a letter leaked to FT Alphaville. Good on him.

What are the armed forces for, exactly? December 31, 2008 at 9:28 am

Yesterday’s news from the National Archive that Britain’s ability to defend itself against an attack from the Soviet Union was so diminished in the late 1970s that the prime minister exclaimed: “Heaven help us if there is a war!” spurs me to write a post I’ve been mulling for a while on the armed forces.

The first thing to say is that we should be grateful to those who risk their lives for all our sakes; we should equip them properly; and we should grant them generous rights after their service is complete. The saga of the gurkhas does us no credit at all, for instance: no service person should have to live in penury after a career in the military.

Let us be clear, though, about what the armed forces are for. If necessary, they kill people. Of course we hope that the ability to do it makes actually doing it unnecessary. But sometimes those fond hopes are unjustified. So no one should join without an absolute unquestioning willingness to kill if ordered to do so. That is what the armed forces are for.

All power structures generate their own dynamics, their own justifications. Ones with a long history carry a lot of baggage, too. Thus we have the fiction that the armed forces are commanded by the Queen, when in fact they do the bidding of the government. We have traditions — many Victorian inventions — designed to emphasise the importance of the military. Good tourist-attracting heritage though some of these may be, but they also support some convenient myths. Perhaps if we remembered that the military are funded by taxes we might be a little less tolerant of their parades, their lavish messes, their Saville Row tailored uniforms, and their expeditions. State school teachers don’t get junkets to the Antarctic: why do the Army?

It is the toys that really bother me though. The boats and the planes, the missiles and (especially) the nukes. Just as Wall Street had a whole industry dedicated to justifying unjustifiable executive compensation, so the `defence’ (by which we often of course mean `attack’) sector has a whole industry devoted to persuading governments to buy weapon systems they do not need. Admirals like shiny new boats, nukes enhance the virility of defence ministers. So we spend tens of billions without effective scrutiny yet keep universities in poverty, schools with leaky roofs, and nurses on indefensibly low salaries.

We can’t afford to go on this way, especially in the present climate. Let’s cancel the Trident replacement now. Let’s stop spending money on high tech goodies for the top brass, and equip the men on the front line with the armour they need instead.

We also need to eliminate the culture that allowed bullying at Deepcut and Catterick. The armed forces are civil servants too. Let’s treat them as what they are: valued public sector workers who are not above scrutiny. A pound spent on subsidising the port in the officer’s mess is a pound not spent on education or health. Battle honours dating back hundreds of years are no excuse for a culture that destroys some people today. As Rahm Emanuel says, You never want a serious crisis to go to waste. Perhaps with shrinking tax revenues and an end to our presence in Iraq we can try to produce a military that is efficient, appropriately funded, fit for purpose and fit to be part of a modern democracy.

Christmas Post December 24, 2008 at 7:46 am

I shall be away for a few days from today, so this is the last post for a little while. And, perhaps aptly, it is about the Royal Mail.

I have to say first that I cordially loathe the Royal Mail. Deliveries in my area have one of the highest loss rates in the country, and they are among the least timely. Post offices in central London are almost always horribly crowded, Christmas or not. As an organisation, at least as I experience it, the Royal Mail is broken.

However I don’t think the answer is to part privatise it or shut it down. And I recognise that Post Offices outside London often offer services that are important to communities, services that it is hard to put a profit or loss figure on, but which we would miss if they were gone. The arguments in favour of privatisation too often measure what is easy to measure and ignore everything else. (Jackie Ashley makes a version of this argument in the Guardian here.) And if we can spare tens of billions for the systemically important banking system in the UK, surely we can spare a billion or two for the socially important postal system. Let’s admit that we need the Royal Mail and see what good we can do with it. (Jon Crudas has an idea here.) But above all let’s not use biased analysis based on discredited economics to destroy a national institution that is useful and valuable and could be quite a lot better.

The shocking non-call December 16, 2008 at 1:43 pm

A deeply scary event for the capital instrument market occurred today. Deutsche did not exercise a call on a lower Tier 2 instrument, the 3.875% sub notes of 2004/2014. From their press release:

Deutsche Bank has decided not to exercise its early redemption option to call the Notes at par because replacement costs would be more expensive than the existing EURIBOR +88 bps step-up coupon. Accordingly, the Notes’ early redemption provision at the option of the issuer is not in-the-money.

The entire capital instrument market is based on the principle that banks will call their sub notes at the earliest opportunity – most investors calculate duration on that basis, and few people calculate an option adjusted spread, viewing the option not to call as reputationally too dangerous to exercise. The world has changed: expect the prices of these things to plummet. It will also become significantly more expensive for banks or insurers to issue hybrid capital instruments. This is really really not good.

What do we want from the banking system? October 12, 2008 at 10:15 am

A few desiderata, to assist in the reform process.

Safety, at least for retail deposits. People want to know that their money is safe and available at short notice.

Availability of credit at a fair price. It should be possible for all, individuals and corporates, to borrow at a spread that reflects the risk (in both directions – not too high nor too low). Financial institutions can make profit in this process, but that profit should not be unreasonably high. Therefore we need some measure of competition in lending.

Return requires risk, and that risk should sit with the risk taker alone. If you want a higher return than government bonds, it should be perfectly clear that you are taking a risk to get that return, and hence if things turn sour, you and you alone should bear the consequences of that decision*. Risk takers should not be allowed to take risk in ways that endanger more than themselves – low altitude parachute jumps over uninhabited desert are OK; driving at 100 mph in built up areas is not.

Ummm, I am sure there is more, but aren’t those the most important things? Right now I am a bit like the financial system — suffering and not working very well — thanks to a nasty coldy flu thing. I hope my recovery will be easier and faster than finance’s. And certainly I hope less radical surgery will be required.

* That extra 1% return on an Icelandic bank account came with a risk. Live with it.

Risk and climate change policy August 13, 2008 at 11:48 am

Just before I went away Paul Krugman posted on the economics of catastrophe, and I have been meaning to follow up for a while. Krugman picks up on some research by Marty Weitzman looking at the distribution of outcomes of climate change. The basic idea is to look at the uncertainties and hence come up not just with a single prediction of the path of global average temperatures, but a path of distributions. There is a lot of model risk in this analysis – it is bad enough predicting financial distributions were we do at least have a lot of high frequency data – however the results are interesting. Krugman says:

Marty surveys the existing climate models, and suggests that they give about a 1% probability to truly catastrophic change, say a 20-degree centigrade rise in average temperature.

Twenty degrees would be game over. Even if it is only 0.01% chance, this is an outcome worth hedging. Clearly then it is not just the expected temperature change that we should be concerned with, it is the variance of that change, or more accurately the upside tail of the distribution. As Krugman says, mobilizing people to protect against low probability but catastrophic outcomes is crucial. Hedging far from the money is cheap, but you do actually have to buy those options.

Uncertainty and strategy May 27, 2008 at 11:11 am

A key issue in strategy is uncertainty in the outcome. Unlike financial return distributions, where we at least have some data to go on, and some models (albeit ones which struggle with autocorrelation, fat tails, and regime changes) there isn’t much data on corporate strategy because each situation is different. I can’t try the same acquisition a hundred times over to get a sense of the distribution of returns or, as Keynes said:

Our knowledge of the factors which govern the yield of an investment some years hence is usually very slight and often negligible

Usually people don’t let that worry them too much not least because the downside is bounded at zero: often you cannot lose more than you put in. But there is one area where is glaringly obvious that a consideration of uncertainty is important because the returns are so volatile and possibly highly negative – nuclear power. Today we heard, entirely predictably, that:

[The] cost of cleaning up the UK’s ageing nuclear facilities, including some described as “dangerous”, looks set to rise above £73bn

In fact we have no reason to believe that nuclear fission has net positive value. The costs of building it, running it and cleaning it up may well exceed, perhaps by an order of magnitude, the value of the power generated. As France’s nuclear safety watchdog has ordered EDF to halt work temporarily at its flagship new generation nuclear power station and half a million people were hit by unscheduled power cuts after seven power stations, including Sizewell B in Suffolk, unexpectedly stopped working within hours of each other perhaps the policy makers might like to reconsider their push for a new generation of nuclear power stations.

Update. WTF? Gordon Brown has said the UK needs to increase its nuclear power capacity – raising the prospect of plants being built in new locations. As Sting didn’t write, every little thing he does is hurried, ill-advised, and foolish.

Towards a quantitative hedonics April 8, 2008 at 7:11 am

It is possible to support the general theme of a body of work without thinking any particular part of it is interesting or successful. Susannah Clapp captures the phenomenon nicely in a Guardian review of the play Contains Violence at the Riverside studios. Here the audience sit on the roof of the theatre and observe the action in adjacent buildings through binoculars.

In Contains Violence the spectators aren’t in the same building as the actors. You make up your own long-shots and close-ups, using their binoculars to zoom in and out at will; the headphones, which are designed to lock you into the action (you hear not just conversation but the slosh of water, the ring of a phone, the crackle of paper, the clink of a keyboard), also protect you from the sound of other audience members and from street noise. You are, weirdly, much further away from the actors than usual but aurally much closer up. Beneath the imaginary acts of violence, as in a dreamlike backdrop, buses pass by silently, pedestrians bustle, and ambulances speed to real emergencies. Occasionally, a non-actor – a cleaner or late worker – gets snarled up accidentally in the action.

So far, so illuminating: this inside-outsideness sets you up to look quite differently at your surroundings – which is not something The Importance of Being Earnest will usually help you do. But the exciting stuff has actually all happened before the show begins: this is a concept, an occasion, not a drama. Contains Violence has contrived the most thrilling of settings, but it doesn’t manage to convey a real story or any richness of expression.

In other words, great idea, poor use of it. I feel the same way about quantitative hedonics. The idea of trying to use rigourous (OK, quasi-rigourous) economics to argue about happiness without all the usual moral biases or imposition of arbitrary utility functions is a good one. Most of the work in the area, however, disappoints. A good example is given by Jeremy Waldon in his review of Sunstein’s Worse Case Scenarios in the LRB:

[Sunstein] is reluctant to abandon a method of measuring losses by how much people would pay to avoid them, even though it is hopelessly flawed by the fact that poor people would pay less simply because they have less. (We measure the value of a life by asking how much people would pay to avoid its loss, under various scenarios. Now, as a matter of fact, a poor person will not pay $100,000 to avoid a 10 per cent chance of death from cancer, because the poor person has no access to $100,000; so a poor person’s life must be worth less than a million dollars; and so it is not clear how the government can justify imposing taxes for a scheme that spends many millions of dollars to avoid this sort of hazard. That’s the sort of argument this book is inclined to defend.)

On this basis preventing jeering at polo matches is a much more important aim than giving clean water to sub-Saharan Africa since polo players are wealthy and will certainly pay a lot to increase their comfort slightly, whereas the citizens of sub-Saharan Africa are mostly (in dollars a day terms) very poor. So Waldon has a point: cash only works as a measure if we are comparing the happiness of people with roughly the same amount of disposable income. Even percentage of disposable income does not mean much to people who don’t have any. So how can we compare two regulations or two pieces of charity or whatever rigourously in terms of their outcomes? That, it seems to me, is an important question for quantitative hedonics.

Why do we keep playing the protectorate game? December 31, 2007 at 8:13 am

The crown dependencies are possessions of the British Crown: the Isle of Man, Jersey and Guernsey are the principal dependencies. The British Government is solely responsible for defense and international representation of the dependencies, although each island has responsibility for its own customs and immigration. All ‘insular’ legislation has to receive the approval of the ‘Queen in Council’, in effect, the Privy Council in London, with a UK minister being the Privy Councillor with responsibility for the Crown dependencies.

Acts of the British Parliament do not usually apply to the Channel Islands and the Isle of Man, unless explicitly stated, and even this is increasingly rare. When deemed advisable, Acts of Parliament may be extended to the Islands by means of an ‘Order in Council’, although normally the agreement of the dependency administrations would be sought first.

(This summary and the following one filleted from wikipedia [1] [2] as a prelude to the discussion that follows.)

In addition (and constitutionally distinct) there are the British Overseas Territories. These fourteen territories – including Bermuda, the British Virgin Islands and the Cayman Islands – are under UK sovereignty, but they are not part of the United Kingdom itself.

Each Overseas Territory has its own legal system independent of the United Kingdom. The legal system is generally based on English common law, with some distinctions for local circumstances. Each territory has its own Attorney General and court system. Defense of the Overseas Territories is the responsibility of the UK. Neither the overseas territories nor the crown dependencies are full members of the EU.

More or less anything to do with the constitutional affairs of these little bits of land is complicated by history, precedent, residual monarchism and colonialism, and the lack of political will for change. None of that however is reason to simply accept the status quo. Between them the dependencies and territories account for many of the world’s tax havens. Their financial systems deprive the UK Exchequer of billions of tax revenue, probably hundreds of billions. They encourage tax avoidance, facilitate money laundering, and contribute little in return beyond the occasional friendly harbour for the Royal Navy. Yet we provide these islands with defense and a variety of forms of aid. That is simply illogical. It is clearly not in UK interests to support the dependencies and territories, especially given the other calls on the defense budget and the fact that this budget is smaller than it could be thanks to the tax arbitrage opportunities these very same islands provide. If they want the shield of the UK military and the UK AAA rating then they should pay UK tax. If they don’t want to do that then we should cut the tax havens loose without a second thought.

Both practically and legally the UK has the apparatus to enforce a decision on the protectors and dependencies. Some will doubtless prefer to remain British – and in that case we should extend full citizenship and EU membership to them in exchange for their tax revenue: examples here might well include the islands with less developed financial systems such as the Falkland Islands, the Pitcairn Islands and South Georgia. Others such as Jersey or Bermuda may well decide to go it alone. But in that case they should be treated as any other foreign country, their populace denied UK citizenship, and UK citizens living there treated as foreign domiciled. All in all it is high time we applied some cost/benefit analysis to our constitutional arrangements.