Improving our dismal public schools with the dismal science

Misbehaving: The Making of Behavioral Economics, by Richard Thaler, has some potentially practical advice for improving our schools:

A good example of a domain where field experiments run by economists are having an impact is education. Economists do not have a theory for how to maximize what children learn in school (aside from the obviously false one that all for-profit schools are already using the best methods). One overly simplistic idea is that we can improve student performance just by giving financial incentives to parents, teachers, or kids. Unfortunately, there is little evidence that such incentives are effective, but nuances matter. For example, one intriguing finding by Roland Fryer suggests that rewarding students for inputs (such as doing their homework) rather than outputs (such as their grades) is effective. I find this result intuitively appealing because the students most in need do not know how to become better students. It makes sense to reward them for doing things that educators believe are effective. Another interesting result comes directly from the behavioral economics playbook. The team of Fryer, John List, Steven Levitt, and Sally Sadoff has found that the framing of a bonus to teachers makes a big difference. Teachers who are given a bonus at the beginning of the school year that must be returned if they fail to meet some target improve the performance of their students significantly more than teachers who are offered an end-of-year bonus contingent on meeting the same goals. A third positive result even further from the traditional tool kit of financial incentives comes from a recent randomized control trial conducted in the U.K., using the increasingly popular and low-cost method of text reminders. This intervention involved sending texts to half the parents in some school in advance of a major math test to let them know that their child had a test coming up in five days, then in three days, then in one day. The researchers call this approach “pre-informing.” The other half of parents did not receive the texts. The pre-informing texts increased student performance on the math test by the equivalent of one additional month of schooling, and students in the bottom quartile benefited most. These children gained the equivalent of two additional months of schooling, relative to the control group. Afterward, both parents and students said they wanted to stick with the program, showing that they appreciated being nudged. This program also belies the frequent claim, unsupported by any evidence, that nudges must be secret to be effective.

Imagine the outcry if teachers got money at the beginning of the school year, spent it on vacations, recreational marijuana, etc., and then some of them had to give the money back at the end of the year due to evidence that their students hadn’t learned much!

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Behavioral economics says we can beat the market

Misbehaving: The Making of Behavioral Economics, by Richard Thaler, is an interesting history of this new-ish subfield from the inside. It also contains some potentially useful guidance for investors!

Thaler points out that the rational beings on which the theories of Econ 101 rest do not exist in the real world. None of us make rational purchase decisions, for example. Aggregating a huge group of irrational people does not make our decisions somehow more rational:

the premises on which economic theory rests are flawed. First, the optimization problems that ordinary people confront are often too hard for them to solve, or even come close to solving. Even a trip to a decent-sized grocery store offers a shopper millions of combinations of items that are within the family’s budget. Does the family really choose the best one? And, of course, we face many much harder problems than a trip to the store, such as choosing a career, mortgage, or spouse. Given the failure rates we observe in all of these domains, it would be hard to defend the view that all such choices are optimal.

The book contains a good introduction to all of the big issues in behavioral economics, e.g., that people are loss-averse and also that they demand fairness (which is why we must all vote a Warren-Sanders ticket for president!).

Perceptions of fairness also help explain a long-standing puzzle in economics: in recessions, why don’t wages fall enough to keep everyone employed? In a land of Econs, when the economy goes into a recession and firms face a drop in the demand for their goods and services, their first reaction would not be to simply lay off employees. The theory of equilibrium says that when the demand for something falls, in this case labor, prices should also fall enough for supply to equal demand. So we would expect to see that firms would reduce wages when the economy tanks, allowing them to also cut the price of their products and still make a profit. But this is not what we see: wages and salaries appear to be sticky. When a recession hits, either wages do not fall at all or they fall too little to keep everyone employed. Why? One partial explanation for this fact is that cutting wages makes workers so angry that firms find it better to keep pay levels fixed and just lay off surplus employees (who are then not around to complain). It turns out, however, that with the help of some inflation, it is possible to reduce “real” wages (that is, adjusted for inflation) with much less pushback from workers.

Speaking of fairness, note that Uber has eliminated its “surge pricing” annotation. When the price is higher than usual, customers see a higher quoted price, not a screaming “surge pricing” banner. Restaurants and theaters would rather have a long waiting list than charge a market-clearing price. A chef is quoted as saying that he didn’t want to charge so much that customers would leave feeling that they’d been overcharged.

Stock markets are irrational and predictably irrational as far as Thaler and colleagues are concerned. Companies shouldn’t pay taxable dividends, for example, when they can buy back shares and compensate investors with a higher stock price:

Shefrin and Statman’s answer relied on a combination of self-control and mental accounting. The notion was that some shareholders—retirees, for instance—like the idea of getting inflows that are mentally categorized as “income” so that they don’t feel bad spending that money to live on. In a rational world, this makes no sense. A retired Econ could buy shares in companies that do not pay dividends, sell off a portion of his stock holdings periodically, and live off of those proceeds while paying less in taxes. But there is a long-standing notion that it is prudent to spend the income and leave the principal alone, and this idea was particularly prevalent in the generation of retirees around in 1985, all of whom had lived through the Great Depression.*

Gambling on the ponies is irrational. Betting on the even-money favorite will return 90 cents on the dollar. Betting on the longshot will return 14 cents and the returns get worse at the end of the day. Surely professionals investors are not as dumb as folks who gamble at the track? Thaler summarizes research suggesting that investors are actually just as dumb!

Thaler says that the equity premium (excess returns of stocks compared to bonds) is higher than it should be, even after economists pointed out that the equity premium is too high. The idea that professional investors are irrational is an old one, going back at least to Keynes:

Keynes thought markets were more “efficient,” to use the modern word, in an earlier period at the beginning of the twentieth century when managers owned most of the shares in a company and knew what the company was worth. He believed that as shares became more widely dispersed, “the element of real knowledge in the valuation of investments by those who own them or contemplate purchasing them . . . seriously declined.” … Keynes was also skeptical that professional money managers would serve the role of the “smart money” that EMH defenders rely upon to keep markets efficient. Rather, he thought that the pros were more likely to ride a wave of irrational exuberance than to fight it. One reason is that it is risky to be a contrarian. “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”

The simple “value investing” idea put forward by Benjamin Graham, i.e., buy stocks with a low P/E ratio, continued to work 50 years after its conception:

It was not so much that anyone had refuted Graham’s claim that value investing worked; it was more that the efficient market theory of the 1970s said that value investing couldn’t work. But it did. Late that decade, accounting professor Sanjoy Basu published a thoroughly competent study of value investing that fully supported Graham’s strategy. However, in order to get such papers published at the time, one had to offer abject apologies for the results. Here is how Basu ended his paper: “In conclusion, the behavior of security prices over the fourteen-year period studied is, perhaps, not completely described by the efficient market hypothesis.”

Both the best companies and the worst tend to revert to the mean:

Finding evidence of mean reversion would constitute a clear violation of the EMH. So we decided to see if we could find that evidence. Our study was simple. We would take all the stocks listed on the New York Stock Exchange (which, at that time, had nearly all of the largest companies) and rank their performance over some time period long enough to allow investors to get overly optimistic or pessimistic about some company, say three to five years. We would call the best performing stocks “Winners” and the worst performers “Losers.” Then we would take a group of the biggest Winners and Losers (say the most extreme thirty-five stocks) and compare their performance going forward. If markets were efficient, we should expect the two portfolios to do equally well. After all, according to the EMH, the past cannot predict the future. But if our overreaction hypothesis were correct, Losers would outperform Winners. Such a finding would accomplish two things. First, we would have used psychology to predict a new anomaly. Second, we would be offering support for what we called “generalized overreaction.” Unlike the Kahneman and Tversky experiment in which subjects were overreacting to measures of sense of humor when predicting GPA, we were not specifying what investors were overreacting to. We were just assuming that by driving the price of some stock up or down enough to make it one of the biggest winners or losers over a period of several years, investors were likely to be overreacting to something. The results strongly supported our hypothesis. We tested for overreaction in various ways, but as long as the period we looked back at to create the portfolios was long enough, say three years, then the Loser portfolio did better than the Winner portfolio. Much better. For example, in one test we used five years of performance to form the Winner and Loser portfolios and then calculated the returns of each portfolio over the following five years, compared to the overall market. Over the five-year period after we formed our portfolios, the Losers outperformed the market by about 30% while the Winners did worse than the market by about 10%.

Can the non-behavioral economists fix this? No! says Thaler.

The efficient market hypothesis could be reconciled with our results if the Loser stocks had high betas and thus were risky according to the CAPM, and the Winner stocks had low betas, meaning they were less risky. … By whatever measure one used, “value stocks” outperformed “growth stocks,” and to the consternation of EMH advocates, the value stocks were also less risky, as measured by beta.

The practical advice from the book is to buy value stocks and small cap stocks. A portfolio of “blue chip” large cap stocks would be almost certain to underperform in the long run (see GE!).

Can we get good advice for day-to-day trades from economists? Nobel laureate Paul Krugman predicted a dramatic and persistent stock market depression after the Trumpenfuhrer was sent to the Reichstag in November 2016. Nobel laureate Bob Shiller predicted a stock market crash in 1996, according to Thaler. The S&P 500 was 1,050 when they sounded the doom horn. The stock market did crash starting in 2000. It fell from 2,100… to about 1,150. In other words, if you’d gone short in 1996 and then perfectly timed the bottom of the stock market in 2002 you still would have lost money (plus another 3 percent per year in dividends that you’d have had to pay out). Thaler credits Shiller with prescience and says he was too early, but does not point out that Shiller was actually wrong based on the numbers.

Real estate seems to be one of the most irrational of all markets.

My conclusion: the price is often wrong, and sometimes very wrong. Furthermore, when prices diverge from fundamental value by such wide margins, the misallocation of resources can be quite big. For example, in the United States, where home prices were rising at a national level, some regions experienced especially rapid price increases and historically high price-to-rental ratios. Had both homeowners and lenders been Econs, they would have noticed these warning signals and realized that a fall in home prices was becoming increasingly likely. Instead, surveys by Shiller showed that these were the regions in which expectations about the future appreciation of home prices were the most optimistic. Instead of expecting mean reversion, people were acting as if what goes up must go up even more. Moreover, rational lenders would have made the requirements for getting a mortgage stricter under such circumstances, but just the opposite happened. Mortgages were offered with little or no down payment required, and scant attention was paid to the creditworthiness of the borrowers. These “liar loans” fueled the booms, and policy-makers took no action to intervene.

In other words, it seems likely that the short trade that made John Paulson a multi-billionaire will work during the next bubble.

A fun corner of the book is a discussion of office allocation in a new building for the economists at University of Chicago:

Two other rules of interest: offices could not be traded and, after one senior faculty member inquired, the deans emphatically ruled out the possibility of buying an earlier draft pick from a colleague. This ruling, and the fact that the school decided not to simply auction off the draft picks, reveals that even at the University of Chicago Booth School of Business—where many favor an open market in babies and organs—some objects are simply too sacred to sell in the marketplace: faculty

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Knee replacement in Mexico

It has long amazed me that the typical non-emergency medical intervention for an American does not start with a plane flight to a country in which medicine can be done efficiently.

“A Mexican Hospital, an American Surgeon, and a $5,000 Check (Yes, a Check)” (nytimes) is a story about a knee replacement that happens in the way that Econ 101 would suggest:

The hospital costs of the American medical system are so high that it made financial sense for both a highly trained orthopedist from Milwaukee and a patient from Mississippi to leave the country and meet at an upscale private Mexican hospital for the surgery.

Ms. Ferguson gets her health coverage through her husband’s employer, Ashley Furniture Industries. The cost to Ashley was less than half of what a knee replacement in the United States would have been. That’s why its employees and dependents who use this option have no out-of-pocket co-pays or deductibles for the procedure; in fact, they receive a $5,000 payment from the company, and all their travel costs are covered.

Dr. Parisi, who spent less than 24 hours in Cancún, was paid $2,700, or three times what he would have received from Medicare, the largest single payer of hospital costs in the United States. Private insurers often base their reimbursement rates on what Medicare pays.

Interesting, but it raises more questions than it answers, e.g., why aren’t all knee replacements done in a country where knee replacements can be done efficiently?

[Separately, note that the NYT informs us that Mexico is too dangerous for a caravan of Hondurans to dwell, which is why they need to continue across the southern border of the U.S. and claim asylum. But, on the other hand, the same newspaper tells us that Mexico is sufficiently safe and organized to serve as a meeting place for American surgeons and privately insured patients.]

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Hotel life in Seattle, minimum wage $16/hour


The Seattle Office of Labor Standards (OLS) announces that the 2019 minimum wage for all large employers (employing more than 500 workers worldwide) will be $16.00 per hour. In past years, there was a two-tier system under which large employers that contributed toward individual medical benefits paid a lower minimum wage than those that did not. This two-tier system ends in 2019. Also, beginning on January 1, 2019, small employers (with 500 or fewer employees) must pay at least $15.00 per hour.

From the Hyatt Regency, in a confirmation email:


The “housekeeping every other day” message was regarding a $300+/night stay.

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Americans can’t afford to live in America: heartland edition

“America’s Housing Affordability Crisis Spreads to the Heartland” (Bloomberg) says that Americans with ordinary jobs can’t afford to buy houses or apartments all across the U.S.

“Financial Crisis Yields a Generation of Renters” (WSJ) notes that the median age of a home buyer is 46, the oldest ever recorded and homeownership rates for younger Americans “have fallen sharply.” The article notes “Home prices have outpaced wage gains.” Costs are up by 21 percent (after adjusting for the inflation that the government tells us does not exist) while income is up only 2 percent (2000-2017).

Related, from :

I talked with a guy recently who is involved in a $1.5 billion project to create 2,700 “affordable” apartments here in the Charlestown section of Boston (story). That’s $555,555 per apartment (less than 1,000 square feet on average) on land provided for free (city already has a housing project on the same footprint). Presumably these will be higher quality than whatever was built in Halifax in 1918.

[Note: poor people who are selected by the housing ministry to move into one of these apartments would actually be rich almost anywhere else in the world if they could only get their hands on the $555,555 capital cost as a direct grant instead of as an in-kind service! If they could also get their hands on the monthly operating cost and combine that with interest on the $555,555 they would be able to enjoy, without working, a middle class or better lifestyle in many of the world’s beach destinations.

How about folks who work at the median wage? That’s about $23/hour in Massachusetts (BLS) or $46,000 per year. NerdWallet says that someone earning this much in MA can afford a $258,500 house if he or she has saved $60,000 for a down payment, has a top credit score, and spends $0/month on food and other non-housing expenses. Zillow says $274,416 on a nationwide basis. So a dual-income couple in which both partners earn the median wage wouldn’t be able to afford one of these units without a taxpayer subsidy, even if landed were free and the unit were sold at zero-profit construction cost. The U.S. has apparently become a society in which Americans can’t afford to live like Americans!

But the caravans of folks streaming over the southern border and claiming asylum will surely be able to do better?

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Crazy cheap solar power plant

“World’s Largest Solar Power Plant Switched On” (Forbes):

The $870 million project was the result of a competitive tender process that will see electricity from the site sold to the Emirates Water and Electricity Company (EWEC) for around 2.4 cents per kWh, a record at the time of the auction and a record for any completed solar project. It was built by the Indian firm Sterling & Wilson with nearly 3000 people working on site during the peak of activity.

Can this be right? These profit-driven folks can recover their $870 million by selling power at 2.4 cents/kWh? That’s more or less free (the average cost in the U.S. to consumers is about 13 cents/kWh, which of course includes distribution).

Most parts of the U.S. are not as sunny as the UAE, but some parts are. Could we build a monster plant like this in Arizona or Nevada and run the power back to the cloudy East Coast? A friend who used to run a mutual fund that invested in this area said, “It would be a no-brainer economically to run a DC high voltage line from wind farms in Oklahoma to New York City. You could shut down every fossil fuel power plant in New York. But the U.S. power grid is fragmented and the people who stand to benefit from that have enough politicians in their pockets to keep it fragmented. So you’ll never see that power line built.”

Vaguely related: This investor considers Jeff Immelt to be the most incompetent executive in recent American business history. “GE actually made windmills so they knew that the price was going to drop below that of coal-fired power plants,” he said. “Yet still, GE bought Alstom, which has been disastrous. Even if the market for fossil fuel plants had held up, GE was locking itself into French labor, which any rational businessperson would seek to avoid. It is fair to say that the folks at Alstom were a lot smarter than anyone at GE.”

For the rest of the world, where they aren’t as plagued by cronyism in power transmission as we are, will it be time to go nuts with electricity (cars, planes, heat pumps, etc.)?

Also, does this mean we don’t have to worry about about climate change and CO2? Who is going to bother burning fossil fuels for any reason if they can get electricity for 2.4 cents/kWh plus reasonable transmission fees? (Aviation? Just turn the electricity into hydrogen and then run your electric motors off a fuel cell!) We were terrified in the 1970s about burying ourselves in nuclear waste. Then it turned out that we couldn’t operate nuclear plants economically, so the amount of waste generated was much smaller than anticipated (we just burned natural gas and dumped out CO2 instead!).

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Is Irish GDP misleading?

Based on GDP per capita, Ireland is substantially better off than the U.S. It is ahead of Switzerland and Norway, though not within sight of Singapore or Qatar.

Yet the observed lifestyle in Ireland does not seem lavish or gold-plated as it does in Switzerland. A “national road” (comparable to a state highway in the U.S.) will be the width of a North Carolina dentist’s driveway. There is no shoulder and a dirt embankment or hedge will be flush to the edge of the pavement, which is also the edge of the travel lane (see “no shoulder”). Houses are smaller than in the U.S. and systems for central and water heating, etc., seem to be more primitive (one huge plus: no mosquitoes and therefore no screens on the windows!). Public transport infrastructure is better than the U.S., but nowhere near the Russian standard (commuter rail every 15 minutes!). The country does not seem to live any wealthier than southern England, for example.

Costs for labor-intensive items, such as car or aircraft maintenance, are comparable to what people pay in the U.S. and much lower than in Switzerland. Hotels and restaurant prices are also reasonable, especially when you consider that taxes and service are included.

I spoke with several Irish guys who are frequent travelers to the U.S. They think that Ireland is a better country overall, especially for young people, due to the fact that citizens come out of university debt-free and into a strong job market. So they aren’t impressed with our infrastructure, apparently. Thanks to the cold/wet climate, nearly everyone in Ireland can afford to live close to the ocean. Oceanfront property prices are approximately 1/10th of what one might pay in Florida, for example, despite the fact that the Irish property will typically be high enough above sea level (on the rocky shore) to survive quite a bit of sea level rise. (Below, a statue in Cobh that commemorates the first person to immigrate to the U.S. through Ellis Island, but when the future was plainly brighter for a young person in the U.S.)

Our government investigators are the best (look at how the Mueller investigation, in only two years, figured out that older Americans were paying younger Americans to have sex and that Americans sought to avoid paying tax!) so I hesitate to doubt the CIA’s published GDP numbers. However, the facts on the ground don’t seem consistent with the higher-than-Switzerland purported GDP-per-capita.

The Financial Times seemed to agree with this back in 2016: “Multinationals obscure real state of Ireland’s economy; Bloated GDP data blamed on difficulty of measuring their activity.”

The good news is that, whatever the actual level of GDP per capita, Ireland is growing nicely, though property prices are not yet back to their peaks (a real estate developer told me that prices for completed structures, as opposed to undeveloped land, are now roughly where they were at the 2008 peak, but that’s in nominal dollars, not inflation-adjusted).

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Would it make sense for cities to hire homeless relocation concierges?

From the Los Angeles Times, “Councilmen weigh legal action, saying other cities are pushing homeless into L.A.”:

Councilmen Mike Bonin and Joe Buscaino called Wednesday for City Atty. Mike Feuer to explore “legal steps” that L.A. could use to compel those cities to comply with a federal court decision on homelessness and sidewalk camping in Boise, Idaho. The proposal, they said, would stop nearby cities from pushing homeless people into L.A. city boundaries.

The U.S. 9th Circuit Court of Appeals ruled last year that homeless individuals may not be held criminally responsible for sleeping on government property when no alternative shelter is available.

Bonin, whose council district touches Santa Monica, Culver City and El Segundo, said he believes many cities in the region are not complying with that decision.

“Instead of allowing people to sleep on their sidewalks, they are encouraging people, or compelling people, to move to the city of Los Angeles to do that,” he said.

I’ve occasionally wondered in these pages why people who are homeless in a place with a cold and/or wet climate, e.g., Seattle, do not relocate to Santa Monica. Readers have put forward various theories about the challenges faced by the homeless. The LA Times article shows that at least some cities are eager to see homeless residents move to other places (but they also want to provide sanctuary to undocumented low-skill immigrants?).

Would it make sense for cities to hire concierges for their homeless populations? The concierge El Segundo, for example, would organize luxury bus tours of nearby California cities, would know the best places to camp out and receive services in each of those places, etc. Instead of an arms race of hostility, seeing which city can make life miserable for the homeless, try to facilitate their moves.

[The article also contains a comparison of homeless to trash that, had Donald Trump made it, would have been newsworthy:

Councilman Jose Huizar and several colleagues called for increased enforcement, fines and rewards, along with the expansion of a program that allows homeless and formerly homeless individuals to work on cleanup crews.

“I have long said that downtown Los Angeles needs an emergency, triage-like response when it comes to addressing homelessness,” Huizar said in a statement. “But that is also true for the amount of trash that is illegally dumped on our streets.”


Readers: What do you think? Cities already provide a lot of services to the homeless. Why not a concierge to help with moving?

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Don’t hire American college graduates (says Harvard Business School)

“Dismissed by Degrees; How degree inflation is undermining U.S. competitiveness and hurting America’s middle class” (Harvard Business School) is a 2017 report recently brought to my attention by a reader.

It is worth reading because it corroborates the minimal improvement in skills described in books such as Academically Adrift (my review). Today’s typical college graduate doesn’t perform much better on tests of general research/thinking/writing than he or she did on finishing high school. HBS:

The results of our survey were consistent across
many industries—employers pay more, often
significantly more, for college graduates to do jobs
also filled by non-degree holders without getting
any material improvement in productivity.

Results vary by major, but our funding and investment in college educations is, unlike Chile’s, not conditional on major.


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Evil corporations put profits before human life

One of my virtuous neighbors was talking about evil corporations that prioritize profit over human life, not making products as safe as possible.

Of course I had to agree that this was, shall we say, Deplorable.

I asked “What about our own town?” We don’t have Danish-style bike infrastructure, in which a curb separates an automobile road from a bike lane and a second curb separates the bike lane from the pedestrian sidewalk. A cyclist was killed in our town recently, an accident that wouldn’t have happened with a Danish-style system.

I then pointed out that we have several busy roads through town that aren’t divided, thus inviting a deadly head-on collision. Since we do not want to put a price tag on human life, wouldn’t it make sense to raise property taxes sufficiently to widen these roads and insert a concrete divider in the middle?

Had he stood up at town meeting (at which recently the good townsfolk voted to spend $110 million on a new school for about 440 town-resident K-8 students) to demand these initiatives for safer roads?

The corporate critic was horrified at these ideas: “That would cost a fortune,” he said, “to acquire the strips of land and build the barriers. It would never make sense.”

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