Behavioural economics

I just listened to another podcast featuring a debate between a devout Keynesian and a devout Hayekian about whether or not the U.S. stimulus worked or was large enough or even if we can know if it worked.  They lightly skimmed over the issue of how and where the stimulus money was spent – mainly that it wasn’t targeted to areas with the highest unemployment or to the sectors that – it could be argued – where demand was the slackest.    For example, there was money for research, to extend unemployment benefits, to support public sector wages (a sector with rock bottom unemployment already) while there was relatively litte for sectors like manufacturing (where unemployment is high).  They both kind of agreed there was a fear of ‘moral hazard’ where targeting the money to areas that most needed it would be rewarding bad behaviour (like rewarding excessive public spending in California or a housing bubble in Nevada).

Once again, it struck me listening to this how little economists think about economic development as a specific activity.  Economists think a lot about macroeconomics – price levels, GDP, inflation, etc. and even microeconomics – cost/price, scale, scope, etc. but I don’t know that too many of them are trained to understand how firms make locational decisions – at a tangible level in a world of unknowns and relationships.  

We almost need a kind of behavioural economics at the firm and industry level.    This may exist and I just haven’t seen much of it but ultimately I think this is important.    I also think we need to foster more understanding of this stuff at a provincial level – in a place like NB – which is part of a national economy and has very porous borders for both people and capital.

For example, the two of my biggest criticisms of the Graham tax cut were:

a) there didn’t seem to be real good thinking about how this generic idea (tax cuts stimulates economic growth) applies at a provincial level – particularly a small place like NB; and

b) the tax cuts were given disporportionately to folks who didn’t need them – in the sense they weren’t going to leave New Brunswick because of high tax rates.  I already put forward this notion but to reiterate if you look at the folks with in the top quartiles of income – they are in large part public servants, doctors, lawyers, engineers, accountants, consultants, etc. – all that generate their livelihood here in New Brunswick – entirely.  So the argument they will leave or not come because of high taxes is virtually irrelevant because the work is here – if a lawyer leaves because of high taxes – another one will fill the gap.  Same with public servants, engineers, etc.

It’s not quite that simple but at a theoretical level I think this should have been taken into consideration.  

Now it could be that governments think they will be stimulating the economy by cutting the taxes of those in upper income levels but as I have shown much of that spending will be on goods and services where the value is added elsewhere (TVs in Korea for example) whereas government spending – overwhelmingly – adds its value in the provincial economy (nurses salaries, for example). 

This is further compounded by the fact – as I pointed out – that companies with national and international markets are not only taxed in New Brunswick.   They are taxed based on a complex formula based on where they generate revenue and where they have operations.  For example, a firm in New Brunswick that exports all its product to Ontario will probably have a higher tax burden in Ontario than in New Brunswick.

So, if an economist tries to apply a generic model build for a national economy or a large provincial economy to New Brunswick – it is bound to falter.

This is another reason why we need to have New Brunswick or regional economists looking at these issues specifically from the New Brunswick or regional perspective. 

As for behavioural economics at the firm and industry level, I have studied Michael Porter’s work – I saw him speak twice in the past decade – and I like his stuff but even there I think we need to back off some of the hard issues and focus more on the behavioural side of decision making.

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6 Responses to Behavioural economics

  1. Pingback: Twitter Trackbacks for It’s The Economy, Stupid » Behavioural economics [davidwcampbell.com] on Topsy.com

  2. Tim says:

    Though I admire Michael Porters work, his contributions have limited application in any detailed modeling of firm behaviour. Five forces, Supply Chain, and Diamond model – all contribute to a lingua franca, but arguably do not take us much further beyond good conversation. (I am not saying the emperor has not cloths, just not the type of cloths that many people tend to indicate)

    There are a great many microeconomic models that can help us understand firm behaviour – they just don’t make for good public policy discussion – the leap from the mathematics to public discourse is just too great. Therefore, unfortunately, we will always suffer excessive coloring of the debate with opinions, and other human frailties.

  3. Tim Coates says:

    What was the podcast?

  4. Don Boudreaux of George Mason University talks with EconTalk host Russ Roberts on some of the common misunderstandings people have about prices, money, inflation and deflation. They discuss what is harmful about inflation and deflation, the importance of expectations and the implications for interest rates and financial institutions.

    http://files.libertyfund.org/econtalk/y2011/Boudreauxmisunderstanding.mp3Play

  5. Scott says:

    Instead of targeting the rich (which is a small demographic) with further tax hikes, why not try to grow that demographic through fair policy.

    Recently, south of the border, Obama made the iffy claim that “These [high-income taxpayers] are folks who are less likely to spend the money, which is why economists don’t think tax breaks for the wealthy would do much to boost the economy.” This narrative seems to stick with some folks in the middle class. However, if they were only given the facts about where most of the job growth occurs and how important this demographic is to the creation of wealth and prosperity, then I’m not sure he would be making that argument nor would people be easily buying into it.

    First off, this narrative is troubling for the very fact that it encourages a spend thrift attitude as it puts a negative spin on those that save their money for a rainy day. It’s not like saving is the pratice of the ealthy stahing away cash in pillow cases. It’s anything but, as people defer consumption so as to put away a nest egg so that they are free to invest in transactions which will result in long-term economic growth. In other words, savings are the funds available for investing in stocks, bonds and other securities that allow businesses access to the capital they need to grow. Firms use these funds to start or expand businesses and to buy machinery and other physical capital.

    And because much of the savings that can drive investment and economic growth over time comes from the relatively small fraction of individuals which you mention that are in the top income tax bracket, permitting a tax increase on high-income earners would be a significant disincentive for savings and investment. So before making that argument, these are things that we must consider.

  6. Mike E. says:

    I see your problem here being more of a question of partial equilibrium v. general equilibrium analysis. Behavioural economics has lots of great insights but I think this is a straight forward question of $s and incentives.

    For your tax example, you assume that the engineering, lawyering etc jobs could not be located elsewhere. That is not the case so if people become less/more willing to go to or to stay in a location the labour pool will grow and shrink accordingly. So will the quality of the labour you get (doctors and engineers aren’t a homogeneous lot). This in turn will affect the quantity of labour demanded. I’m not commenting on the size of the effect, but it exists. So it is misleading to assume their is an infinite supply of highly skilled labour and that the demand for it is constant.

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