The curse of politicians' illusory superiority

In 1995 a 44-year-old man called McArthur Wheeler set out to rob two banks in Pittsburgh. In preparation for the crime he smeared his face with lemon juice.

Wheeler's bizarre logic was that since lemon juice can be used as a kind of invisible ink on paper, the liquid would also render his face invisible to the banks' security cameras.

After the robbery police retrieved the surveillance tape and gave it to a local news channel. Wheeler was duly identified and then arrested. During his interrogation Wheeler was confused over how his cunning plan to avoid detection had failed. "But I wore the juice," he reportedly mumbled.

Wheeler's delusions over his own competence as a criminal inspired two US psychologists, David Dunning and Justin Kruger, to run some experiments on undergraduates at Cornell University in New York. They asked students a series of technical questions on grammar and logic and asked them to estimate their scores and also estimate their rank relative to their peers.

The results suggested that some students who performed badly not only considered themselves to have done well - but also believed themselves more competent than those who performed considerably better.

Thus was established the "Dunning-Kruger effect": the cognitive bias of illusory superiority. People who rate their talents highly sometimes just don't grasp how incompetent they truly are.

"This is more work than in my previous life," Donald Trump told reporters from Reuters last week in an interview to mark 100 days of predictable fiasco from the property tycoon's White House. "I thought it would be easier. This is actually more work." Or as the former Apprentice personality might have put it: "But I wore the juice."

One does not have to look far in politics to find the Dunning-Kruger effect. David Cameron was once asked why he wanted to be prime minister and replied: "Because I think I'd be rather good at it." Before the 2015 general election he solemnly warned that Britain faced an "inescapable choice - stability and strong Government with me, or chaos with Ed Miliband".

Surveying the chaotic British political scene in 2017 many have begun to question whether this was an entirely accurate prognostication. But not Cameron. Speaking in Bangkok last week Cameron said he thought he did a "reasonable job" as Prime Minister, despite his humiliating resignation last year in the wake of the Brexit vote. And he apparently has no regrets about his decision to hold that vote. "The lack of a referendum was poisoning British politics and so I put that right," he concluded. In Cameron's mind the lemon juice apparently worked a treat.

In February 2016 the Conservative MP David Davis airily stated that there was "no reason" Britain could not conclude entirely new free trade agreements with its biggest foreign markets "within two years". Trade experts regard that as catastrophically ignorant of the technical difficulties involved in constructing such complex deals. But now that the two-year Article 50 European Union divorce proceedings have been triggered and Davis is the minister for Brexit he has an opportunity to prove himself correct. Let's hope the lemon juice is operational.

It gets worse. Research from scientists at the University of California suggests over-confidence is often taken as a signal by others of actual competence. So Trump and Cameron's electoral success may have reflected a view among the public that they must have known what they were doing precisely because they told us so forcefully. Ditto the super-confident Brexiteers like Davis.

Such cognitive biases may not only explain why we sometimes have such inadequate political leaders but also why we have such chronically unequal societies. The flip-side of unmerited over-confidence can be unmerited under confidence. And experiments by the behavioural economist Jeffrey Butler have found that when individuals are randomly assigned high and low pay in cognitive ability tasks those who are luckier often became more confident and competitive, while the unlucky tend to grow demoralised and to inaccurately underrate the relative ability.

Perhaps this research offers a clue as to why bright and diligent kids born into disadvantage so often fail to fulfil their potential while the most prestigious jobs and political power so often seem to be monopolised by the thrusting and grotesquely over-confident sons of privilege. Or to put it another way: why the lemons rise to the top.

Capping energy tariffs won't lead us down the road to Venezuelan-style ruin

The North Norfolk radio personality Alan Partridge once threatened to switch to a different petrol station because he felt the fuel on sale at his usual forecourt was "a bit obvious… a bit petrolly". But normal people don't care where they get their energy from so long as it's a good value. No one prefers the gas supplied by EDF to that from Centrica. The electricity from SSE doesn't work any better than npower's version. The only real source of competition in the retail energy market is price.

The same applies to current account banking. The days when we would take pleasure from visiting an avuncular bank manager for a useful chat about our personal finances are, for better or worse, over. The limit of what most of us demand nowadays is a half respectable interest rate, a non-extortionate overdraft charge and, if we're in a particularly demanding mood, a functioning website.

We're often told that the magic of competition in a free market drives prices down and the quality of services up. But while generally true, it's not universally so. If a seller knows more than the buyer about the product, ostensibly free markets can deliver some glaringly unsatisfactory outcomes.

The economist John Kay has written about "competitive misinformation" in markets such as retail energy where this kind of information asymmetry exists. The contracts offered by energy firms are nigh on impossible for the typical customer to understand. The same is usually true of the small print that outlines banks' overdraft charges.

The complexity is intentional. It is designed to extract fat profits from the less savvy. The seller knows more than the buyer. The result is customer confusion and inertia. Half of us have been with our bank for more than a decade and only three per cent switch each year. Around two thirds of energy customers never switch and end up on the costly "standard variable" tariff.

And this inertia is a major source of profit for an oligopoly in both industries; the big four in banking and the big six in energy. The Competition & Markets Authority concluded last year that the latter "enjoy a position of unilateral market power over their inactive customer base", earning them excess profits of £1.4bn a year. The CMA says banks cream off around £1.2bn a year from unarranged overdraft charges.

When companies sell essentially the same product at different prices to different customers it's usually the rich who tend to pay more: think of first class train or plane tickets. But in energy and banking it's often the poor, elderly and least clued-up that end up being penalised. Their loss is the gain of those who do switch, claim the oligopolies.

But even active customers still suffer notoriously poor levels of service in both banking and energy. When a bank's website crashes all customers are in the same boat. When a large energy company messes up its billing system no one is immune from the fallout.

One response to failing markets is to try to level out the informational playing field. This could be done by giving the least savvy customers more information through easy-to-use tariff or fee comparison websites, or by compelling providers to periodically remind customers that they might be able to switch to better deals.

Another response is to jump-start competition by breaking up the oligopoly of providers in the hope that this will encourage a larger number of smaller providers to focus on customer service and more transparent pricing in order to grow their respective market shares.

But the first route hasn't worked so far (although some still insist the breakthrough just need the right technology). And politicians and regulators have consistently balked at the second option, seeing structural reform of this nature as being too logistically and legally challenging.

So now we're circling a third option: capping prices. Proposals to cap standard variable tariffs relative to better deals are being worked up for the Conservative manifesto, and the Labour MP Rachel Reeves is campaigning to limit bank overdraft fees.

It's a gross error to assume that all markets are alike and always work perfectly. These economic forms are only valuable for the welfare their deliver; they are not an end in themselves. Structural reforms would probably be more effective and less prone to damaging political opportunism than price capping. But in already heavily regulated sectors such as retail banking and household energy provision it would be hysterical to suggest, as some free market fundamentalists do, that caps are the slippery slope to ruinous Venezuelan-style socialism.

Fundamentalist critics might care to consider a different risk: the discrediting of the many parts of the free market system that are working well from a chronic failure to fix those salient sectors that manifestly are not.

Why are we so ignorant about who is and isn’t rich? Blame psychological bias and misinformation

'When Austin Powers' nemesis Dr Evil came out of deep freeze and held the world to ransom he hilariously imagined that one million dollars was a lot of money. The response to the suggestion of shadow Chancellor John McDonnell last week that those earning an annual salary of more than £70,000 makes one rich has prompted similar guffaws.

Doesn't he know how much it costs to buy a house in London these days? Doesn't he know how expensive private school fees are? Honestly, how out of touch can you get? Of course, as many have pointed out, it's not McDonnell who is out of touch.

The most recent data from HMRC shows that the median average pre-tax income is around £22,400. An income of more than £70,000 a year will actually put you in the top five per cent of all UK earners. When Ed Miliband proposed a "mansion tax" on properties valued at more than £2m in 2015, right wing newspapers exploded with fury, screaming about how that this would lay waste to middle England.

In fact, it would have affected around 100,000 homes, less than half a per cent of the total UK residential dwelling stock. The average house price today, by the way, is around £220,000. And wealth is a far more unequally distributed than income, with the luckiest tenth owning almost half of all the assets.

Rich is like the inverse of "middle class". In Britain, everyone seems to think of themselves as middle class, whether they're earning hundreds of thousands of pounds a year or taking home barely more than the minimum wage. Being middle class (preferably the "hard working" variety) is a badge of honour. But people are extraordinarily reticent about allowing themselves to be labelled rich. Many would sooner present themselves in the Daily Mail offices as a Brexit saboteur.

Is this simply because people don't want to pay more tax and fear that admitting wealth will invite a raid from opportunistic politicians? Up to a point. But another big influence is reference point psychology.

People don't have a mental snapshot of the national distribution of income or assets in their heads when they consider the question of whether or not they are "rich" or "well off". They answer an easier question instead: where do they feel themselves to be relative to their peer group and relative to their own expectations? 

This helps explain why research shows people from all over the income distribution have a tendency to place themselves in the middle of the pack when asked to guess. We all know some people who are doing better than us and some who are doing worse.

Even the indisputably prosperous are prone to this. Consider the FTSE 100 chief executive who is awarded a compensation package of £4m a year. Rich? Not when you consider that the boss of an American company earns five times as much. What about the investment banker who extracts a bonus worth tens of millions of pounds from his employer? Well off? Not compared to that banker's hedge fund or private equity friends who might earn ten times as much. And so on right up to the billionaire classes.

But this psychology can be found well down the pay scale too, even among those who earn below £70,000. As HL Mencken put it, wealth is "any income that is at least one hundred dollars more a year than the income of one's wife's sister's husband".

So where does this fiesta of unscientific relativity leave tax policy? In a dire state is the answer. Most public finance experts, at least those who are not employed by the super-rich to evangelise for tax cuts, now agree that residential property in the UK is inefficiently and unfairly taxed. But it's proven impossible to reform the system in a more equitable direction because the bulk of the public can be so easily misled by politicians and the partisan media into believing that they personally will feel the pain.

The consequence is that residential wealth, which has risen substantially in recent decades, is under-taxed relative to income, which impedes our national productivity growth and encourages us to plough our savings into property, leaving us perpetually prone to a dangerous orgy of housing speculation. If we are ever to escape from this doom loop of public ignorance, dysfunctional policymaking and financial instability, the first step out will probably be an acknowledgement of the source of the problem: misinformation and right wing propaganda.

When political commentators react like scalded cats to the very suggestion that someone on more than three times the average income could be labelled well off, there is a problem. When we are inundated with chin-stroking discussions in the broadcast media (even among public broadcasters like the BBC) about who can fairly be considered rich, that tells us something important and troubling about whose financial interests the essential channels of information in our society are, directly or indirectly, serving. And it's not those who really are in the middle.

The treatment of David Dao by United Airlines is a lesson in the economics of air travel

"Economics tutors should thank United Airlines. The hapless company has furnished them with a perfectly intuitive case study in the power of financial incentives.

Was the right answer to a lack of volunteers to be bumped from the overcapacity Chicago to Louisville flight last week to select one at random and then drag the unfortunate victim kicking and screaming from his seat when he refused to accept? Or was it, as many have suggested, to increase the compensation offer until someone willingly came forward? 

The sharp fall in the share price of United's parent company following the avalanche of bad publicity generated by the brutal treatment of Dr David Dao (captured on other passengers' smart phones) provides a clear answer. Talk about a false economy.

United's gross misjudgement on this occasion seems to have been the fruit of a bad general policy. As the Wall Street Journal has pointed out, other US airlines with higher overbooking rates have fewer "involuntary removals" than United. Why? It seems the answer is that they offer more generous incentives to encourage passengers to volunteer to be bumped. Volunteers receive gift cards rather than travel vouchers with the same airline. They may have the same nominal value but passengers, naturally, prefer the greater choice that comes with gift cards.

But there's still something of an economic mystery lingering in the background. How, it's been asked, could an airline ever be so out of touch as to consider treating one of its passengers like United treated Mr Dao, even before the heavies of the Chicago airport police were summoned? And how could the company's chief executive, Oscar Munoz, have been so catastrophically cloth-eared as to (at least initially) defend the removal and even blame Dao for not vacating his seat with good grace? Doesn't United grasp that treating its customers well is the very reason it exists? 

Well, only up to a point. Economics tutors might also consider a lesson in the economic incentives of the airline as well as of the passengers. Airlines make surprisingly little money from the regular passengers who fill the back of their planes. Around two-thirds of their revenue is estimated to come from a minority of business and first-class customers, with their flatbeds, generous legroom and other perks.

On short-haul flights there are also vanishingly small profit margins per passenger. This is the fundamental reason for the famously unsentimental treatment of passengers by the likes of Ryanair. Such budget carriers also make much fatter margins from selling expensive snacks on the flight, which is the reason why stewards are often more engrossed in their trolley-rolling duties than ensuring the comfort of passengers.

Intense competition is forcing more prestigious carriers in the same direction. British Airways has provoked outrage with its decision to cut complimentary meals on short-haul flights and to sell Marks & Spencer sandwiches instead. It may even do the same for long-haul soon. But it's hardly surprising that the customer experience of non-premium passengers is neglected given they are so unprofitable.

Airlines compete on price rather than service nowadays. Most of us don't fly frequently enough for customer loyalty to be a major concern for airline management (although United might be testing that proposition).

It's not all bad news. Since deregulation in the 1980s and the advent of internet booking airline consumers have benefited enormously in many ways. Prices have tumbled in real terms and the number of routes has risen. But the regular customer experience has, for most of us, gone in the opposite direction.

The problem is that we labour under a cognitive dissonance, retaining a mental image of air travel as something for which one might wear a suit and tie and be served a three-course meal. But today flying is more like travelling by cross-country bus rather than stepping onto the deck of a luxury cruise ship. Or, if it's a cruise ship, most of us are locked in steerage. The image of Dao being dragged down the aisle of a United Airlines plane may finally start to align public perceptions with that reality."

A decade after the banking crisis, Barclays proves little has changed in the City

"There was a period of remorse and apology for banks. I think that period needs to be over." The words of the Barclays chief executive Bob Diamond in front of the House of Commons' Treasury Committee in 2011 bear repeating. Let's briefly summarise what has occurred to Barclays since that statement of defiance, that instruction for us all to move on.

In 2012 the bank was fined £290m by US and UK regulators for rigging the Libor interest rate for profit between 2005 and 2008 - something that prompted the board of Barclays to fire Diamond (although only under pressure from the Bank of England). In 2013, Barclays was fined $453m in the US for manipulating electricity prices in California. In 2014 there was a £26m penalty in the UK for a Barclays trader rigging the gold fix price.

This was followed in 2015 with a fine of £284m, the largest UK financial penalty in history, after Barclays traders were shown to have illicitly manipulated foreign exchange markets between 2008 and 2013. The same year Barclays was fined £72.3m for failings on money laundering controls in 2011 and 2012.

And now we learn that the current Barclays chief executive, Jes Staley, last year attempted to unmask an internal whistleblower - despite being explicitly informed that this was not permissible (for obvious reasons). Regulators are investigating.

By coincidence, a recording from 2008 unearthed by the BBC also today shows a Barclays manager telling a junior to massage his Libor submission during the financial crisis, claiming these instructions came from the Bank of England - something that the Bank has repeatedly denied.

This is very unlikely to be the end of it. An investigation by the Serious Fraud Office into Barclays' 2008 emergency fund raising is due to conclude by the end of next month, amid claims the bank illegally lent $3bn to the Qatar sovereign wealth fund which was then used to buy its own shares. Barclays has failed to cooperate with the SFO, refusing to voluntarily disclose documents.

Barclays is also being taken to court by the US Department of Justice for allegedly misselling mortgage bonds in America prior to the financial crisis - something for which it could well ultimately face a multibillion dollar fine. Unusually, Barclays is fighting the DoJ. In addition, there are ongoing investigations and court cases - all exhaustively catalogued in the bank's 2016 annual report - into claims of rigging of markets in precious metals, plus more money laundering allegations and a host of other alleged misdemeanours.

An end of apologies? An end of remorse? You must be joking. The Archbishop of York last week claimed that Cadbury's omitting Easter from the name of its annual egg hunt was like spitting on the grave of its Quaker founder. Perhaps, if his blood pressure will withstand it, John Sentamu should consider how the Quaker founders of Barclays would react to what has become of their own once-reputable institution.

Some things have certainly changed in banking in the past decade. There is more regulatory box-ticking, plenty of additional compliance officers, lots of fine speeches about ethics. But for all the comforting words about a new ethos of responsibility, Staley's actions raise questions about whether the culture at the top of these institutions has really been transformed in the way we're led to believe.

Four ex-employees of Barclays were sent to jail last year for rigging Libor. But no bank has lost its licence. None of the senior executives who presided over a rotten culture of fraud have been barred from the financial services industry, let alone prosecuted. Bob "no more remorse" Diamond is now back in the City of London with his investment vehicle recently acquiring a small stockbroker.

"Without penalising the perpetrators and their seniors we will not get better behaviour," concludes Robert Jenkins, a former Bank of England policy maker. The internal governance mechanisms of banks still look far from adequate. John McFarlane, the chair of Barclay's board (which has said Staley retains its "unanimous confidence" despite his whistleblower witch hunt), last year complained about the size of the fines levied on Barclays, blaming them for the fact that the bank had been forced to cut its dividend to shareholders.

"The societal cost of excessive penalties is very real," McFarlane lamented. Perhaps it would have been more honest of him to have echoed Diamond and simply said that the period of fines for proven wrongdoing by Barclays needs to be over.

Higher wages could help solve our economic woes

Which comes first: the chicken or the egg? Productivity growth or wage increases? Most economists generally assume that the chicken of productivity growth comes before the egg of workers' wage hikes. In this mental model, productivity (the amount of output that the economy produces per hour of labour) rises thanks to technological advances or more efficient ways of working. This boosts firms' revenues and profit margins. Companies are then able to pay their workers more and everyone is better off.

The general view of most policymakers and analysts is that if firms, in aggregate, increase workers' wages before there has been an increase in national productivity, the result will simply be a damaging burst of economy-wide inflation as too much money chases too few goods and services.

This is the kind of description of the way the world works that one can find from economic authorities such as the Bank of England and the Office for Budget Responsibility. This is why there's so much emphasis given to policies and schemes designed to increase our economy's productive potential. "Raising productivity is essential for the high-wage, high-skill economy that will deliver higher living standards for working people," is how the Chancellor Philip Hammond summed it up last year.

But is this story entirely right? What if wage increases for workers did not always need to follow productivity growth, but could precede it, perhaps even cause it? What if the egg came before the chicken? Some fascinating research posted on the Bank of England's Bank Underground blog by Alex Tuckett last week provides some evidence that wage-led productivity growth may indeed be a possibility.

Tuckett takes a dive into the data of wage growth and output growth in each broad industrial sector of the UK economy. "A careful analysis of the sectoral data suggests that the relationship between productivity and wages is not simple, and that causality may run in both directions," he concludes.

This is an important finding given the UK's current economic condition. Productivity growth has collapsed since the financial crisis. So has wage growth. Real average wages in the UK still languish some five per cent below their level in 2008 (despite the overall growth of GDP in that time). And the Brexit-related slump in the pound has pushed up inflation, meaning real wages are falling once again. On the basis of the OBR's projections, we are on course for the weakest decade of real wage growth since the Battle of Trafalgar.

Under the dominant economic story, the collapse of productivity growth is the fundamental reason wages are on the floor and to rectify the latter productivity needs first to be fixed. Attempts to bypass this are often criticised as counterproductive. In his summer 2015 Budget George Osborne mandated a chunky hike in the minimum wage. This drew the disapproval of many economists who argued that low wages for those at the bottom reflect their low personal productivity and that significantly increasing their wages by government diktat will merely increase unemployment.

But if the chicken follows the egg, perhaps wage increases will prompt higher productivity in firms that employ low-wage labour. Perhaps, in order to protect their profit margins, managements will be spurred into increasing the efficiency of their operations. Perhaps they will invest in more capital equipment to enable their workforce to produce more per hour of their time. Think of a hand car wash installing automatic equipment but retaining the same amount of staff, retraining them to operate the new machinery, and doing more business. This would make minimum wage increases positive for productivity.

And perhaps this is true on a macroeconomic level too. Simon Wren-Lewis of Oxford University has hypothesised that there exists a significant "innovation gap" in the economy, which has built up since the financial crisis due to pessimism about future levels of consumer demand (made worse by George Osborne's deep capital expenditure cuts after 2010). "Most firms…[could be] using out-of-date production techniques which are too labour intensive," Wren-Lewis suggests.

If output and wages were given a positive shock, by government fiscal stimulus for instance, perhaps the overall productive capacity growth rate of the economy would rise in response because some companies would be prompted to step up their capital investment and also research and development programmes.

And this investment might create positive spill-overs. Economists in the US have reasoned along similar lines, suggesting that aggregate supply could be dragged up by stronger aggregate demand.

Economic history strongly suggests that, in the long-run, productivity growth does indeed determine wage growth. And the idea that doubling everyone's pay overnight would double our productivity is obviously fanciful. Yet it's not mad to suspect that looser government fiscal policy and higher wages for workers could help shake us out of our almost decade-long economic funk.

And after many years of productivity growth forecast disappointments it's surely time we took the respectable hypothesis of wage-led and aggregate demand-led productivity growth more seriously - and that economic policymakers summoned up the courage to put it to the test.