Statistics is actually really cool (and why you probably didn't like it before)

I think one of my favorite ways to procrastinate is to pick an activity that is remotely related to the thing I should be doing and then just go with that (despite it not really being what I should be doing). In this spirit, I decided to read “Naked Statistics” by Charles Wheelan instead of preparing for my Econometrics exam. 

Did I learn something? Yes. 
Did I learn something for my Econometrics exam? Probably not really.

Wheelan’s “Naked Economics” was the first book I read about economics. After being accepted to university I thought I should read something about economics since I’ve never done it before and thank Bernie Sanders, did I pick up that book. In his “naked” books Charles Wheelan takes seemingly boring or dismal topics and turns them into a disney-land-like experience (I may be slightly exaggerating) by explaining the intuition behind all those formulas and models that haunted you the days before an exam, something usually missing from your standard 101 university module. My statistics class at university was a bunch of formulas that I tried to remember and apply to the type of questions I thought were going to come up. Looking back, I think this is what I did with most of my math modules all throughout high school and now university. Sadly, most math teachers this far didn’t care to explain why we use a certain formula or even what it means, leaving students bored and disinterested with the topic.

Fast forward to the first weeks of this semester and me doing econometrics, which is basically a cross-over of economics and statistics. What we’ve done this far is applying the abstract concepts and formulas from statistics to real-life scenarios. Through this process it became clear to me what all that stats-stuff was for and why I needed to understand it. Apparently, questions about the gender wage gap, the relationship between education and wages, and more can be approached with those random-seeming formulas I crammed into my head the days before the statistics exam. Who would have thought?

Especially statistics play such an important role in our life that it’s a shame they have such a bad reputation. Whether it’s reading about some crazy connection between getting up at 4 am and being more successful, being confronted with some headline about increasing crime rates because of immigration or having to listen to a family member at Christmas about the success rate of a new diet, statistics can help interpret these “findings” with caution and be wary about the next outrageous headline. Debates would be much more informed if people couldn’t just quote any statistic that was intentionally designed to support an argument and get away with it, and the media, too, would have to live up to higher standards if people demanded statistical information to presented appropriately. Yet, I completely relate to anyone feeling discouraged by what they’ve learned about statistics at school because they didn’t understand it. Staring at letters and numbers in a formula and for the love of Ruth Bader Ginsburg not being able to make sense of them is a sure way to make you feel stupid. Teachers should make more of an effort to communicate the intuition behind those formulas instead of just expecting students to understand them. After all, the math is forgotten the minute the exam ends, but the intuition stays. Furthermore, it takes me two seconds to look up a formula on the internet. I doubt anyone will ever ask me on the spot to calculate the standard error of a regression I performed, whereas understanding and being able to communicate the information conveyed in that formula is a more useful skill.

Until the entire education system changes, because I have written this blog post, I recommend reading “Naked Statistics”[1] and learning something valuable in a truly entertaining way (because Wheelan is not only good at explaining he’s also a great writer). 

The only thing I didn’t like about the book is that I wish it hadn’t been written so I could have written it.

[1] Charles Wheelan should pay me for promoting this book

Price Power

Whilst procrastinating this Christmas and accompanying my mum to Costco to (search for tasters) help with the Christmas shopping, my mum pointed out a large bottle of vanilla essence and told me to write about this for my next blog post. The point of interest about this bottle of vanilla essence ( apart from being the biggest bottle of vanilla essence I'd seen available for personal use) was the price. More specifically, the price compared to the last time my mum purchased this bottle of vanilla essence. She had paid no more than £7 in the past for the same product that now cost £29.99.

In fact, this problem is not just an example of a price hike from Costco. Indeed I remembered over the summer on the rare occasion I would venture onto Facebook I was met with videos warning me that my vanilla ice cream eating days may soon be over, largely the result of crop destruction in Madagascar, the primary producer of the very fragile Vanilla plant. By March 2018, Vanilla was worth more than silver.

How does this happen? This vanilla catastrophe is a great indicator of the power of prices. Prices, as championed in an article from my first year of economics study, are so important because 'prices contain information.' The information provided by prices shows us that certain resources (the more expensive ones) are scarce. Prices also illustrate the relative scarcity of resources. In the case of vanilla, the price hikes are largely due to crop uncertainty resultant from environmental irregularities hindering harvest. This small case study of a relatively trivial product thus provides important illustrations of how climate change can and will impact the consumer. Apart from the devastating impact of increased occurrences of natural disasters on locals and the displacement of an estimated 300 million people, consumption patterns will be forced to change as crops become more scarce and unable to survive in new climate conditions. These rising prices should be taken as a warning and a reminder of the real impacts climate change can hold for everyone regardless of whether their country will 'escape' the brunt of environmental change. If we act proactively, work to reduce human impact on the environment and continue to lobby government action then maybe, just maybe we can save the vanilla ice cream, as well as the planet.

Orwell and Behavioural Economics

Although my detector for gendered language and stereotypical gender roles burst into flames due to overload while reading Orwell’s classic “1984,” I finally finished the book this week (I have started Animal Farm now, which is far better already). One of the concepts in Orwell’s dystopia is “doublethink”. It means something like holding two contrary beliefs at the same time and genuinely believing in both of them. It seems contradictory, but this paradox is the essence of the word. Doublethink is believing in A=B and A=C and holding that they are both true, and being oblivious to the contradiction. Orwell explains this in the book over what feels like 30 pages, alternatively check out this link from the urban dictionary.

So, what does this have to do with economics? As I was reading about doublethink I was thinking about how this relates to Kahneman’s Two System Approach. Daniel Kahneman, who wrote the book “Thinking fast, and slow” (2012) and won the Nobel Prize in Economics in 2002, summarizes many years of psychological (and economic) research by describing two systems that operate in our mind (let it be noted that “Dual Process Theory” was a thing even before Kahneman). System 1 is our go-to person, we rely on it for our day to day decisions, it operates automatically, makes quick decisions, and in doing so heavily relies on heuristics (rules of thumb). When someone asks us how we’re doing, we don’t actually “think” before we answer, instead System 1 provides us with a quick reply. System 2, on the other hand, does the hard, analytic work. It’s active when we are trying to calculate 376*19 (2+2, on the other hand, would be a task for System 1) or when we reason about things.
This behavioral approach is comparatively new to economics - a discipline that hasn’t been updated since 1790 - but it can somewhat explain doublethink.

Standard economic theory thinks of humans as rational beings, we know that A=B and A=C can’t be true, it assumes we reason about all our decisions and come to the logical conclusion. Under this theory, something like doublethink could not exist, simply because it would be illogical to hold two contradictory beliefs. However, although maybe not as pronounced as in “1984”, some examples come to mind. My roommate explained to us why he wants us to transfer him the money into his bank account instead of giving him cash; because cash would feel like it’s already spent. Rational human being–wise this doesn’t make any sense, whether I give him the £7 in cash or make a Paypal transfer shouldn’t matter, because the amount of money is the same either way. On the other hand, I understand what he means, I’d much rather have my money in my bank account, the little cash I do hold I don’t really count when I whine about how little money I have (noting here that I am German, so I always carry a little cash with me, it’s a German thing). In this case, we doublethink; while being completely aware that 7=7 regardless whether it’s cash or a transfer, we feel like the cash somehow “doesn’t count” as much.

Admittedly, this is not as extreme as the examples in “1984”, but I am sure many of us can think about others (or maybe ourselves) holding contrary beliefs and not truly recognizing the paradox. If you can think of some, start a discussion in the comment section! 

Human Capital: an Overview

For the past week, I have been engaged in an impressive marathon of crammed revision for my very first Mandarin written assessment. When I first considered including this credited course within my second year university timetable, my rose tinted visions of fluency goaded me forward, hopeful that the  inclusion of a Mandarin course on my curriculum vitae would help me stand out from the rest in my applications for internships, as well as broadening my skills on a more personal level. This phenomenon is by no means new, many of my peers engage in the same thought processes, constant reminders of how competitive the graduate job market can be spurs on students to challenge themselves beyond their mandated curriculum. The golden ticket that we are all seeking has helpfully been given a name within economics; human capital. Claudia Goldin, professor of economics at Harvard, defines human capital as 'the stock of skills that the labour force possesses.' Simply put, human capital encapsulates the broad spectrum of knowledge, personal attributes, skills etc that contribute to each unit of labour's (each person's) capacity to produce economic value.
Increasingly, investment into education within workplaces is seen to have tangible consequences for a company's bottom line. This would seem logical, labour is a factor of production necessary to carry out tasks that generate an income, and investment in improving education and capability suited to a particular job should see improvements in productivity and efficiency. Moreover, dedicating time and resources towards betterment of employees can often enhance feelings of job satisfaction as well as retention as employees feel they are a valued element within the company; the fact that 44% of employees highlight lack of opportunities for development as a major area of stress in the workplace illustrates that human capital holds value for employees as well as the employer.

Recognising education as an investment can also hold important consequences and opportunities beyond a traditional economic lens. Viewing education as a driver of growth can increase accessibility to opportunities. Incorporation of human capital into mainstream development economics and shift of consensus to incorporate expanded access to education and skill based learning broadens the recommendations being proposed for development plans. This in turn holds the potential to narrow employment gaps between men and women, even if for more growth oriented motivations as opposed to altruistic social intervention.

Criticism has been articulated surrounding how much human capital does actually contribute towards enhanced employability. Michael Spence and Joseph Stiglitz have posited an alternative; signalling theory. This stream of thought challenges assertions that education in itself contributes to human capital, rather workers with greater access or ability are signalling to employers by virtue of the institutions they go to and education they receive. A classic example would be the status associated with graduating from Oxford or Cambridge, even if the content of the degree itself may not directly correlate with job specific knowledge.

Furthermore, the flip side to the championing of human capital should not be overlooked. The reality is that human capital is not just related to investment in those already employed or policy recommendations for developing countries; as alluded to above with my endeavours into broadening my CV, increased recognition of the value of human capital increases the demand for extra skills that may complement your chosen career. This encouragement to constantly be better can go beyond a helpful motivation. A hyper-competitive jobs market seeking infinitely well rounded employees does take a toll. The Netflix documentary 'Take Your Pills' considers the rise in 'study drugs' such as Adderall, intended to treat ADHD, a trend symptomatic of increased academic expectation and anxiety. A 2014 study found that 20% of college students in America report abusing prescription drugs compared to 14% of students not in college. By 2017 the initial figure of 20% had increased to 30%. In the UK use of 'smart drugs' has increased from 5% in 2015 to 23% just two years later. Such a perception amongst students that in order to achieve certain grades they need focus beyond their standard capacity should give pause for thought. When considered alongside rising reports of low mental health well-being in universities (with 1 in 3 students experiencing depression and 1 in 10 struggling with a diagnosable mental illness) it would appear worthy of investigation to consider the impact this holds. This is not to say that engaging in extracurricular activities and striving to be the best you can be academically is not important and healthy for development, however self-evaluation of our individual capacities should not be sacrificed for this end. Because ultimately, 'labour' should be more than just the value it can produce, and a fostering of self expression beyond pure competition and calculation is essential for the creation of a happier workforce.
Anyway, time to get back to my Mandarin...

Climate Change and the Discount Rate

The world we live in today is extremely connected, not only across the globe but also through generations, so that the decisions we make today affect our future lives as well as the ones of the generations after us. The most obvious example that comes to mind is the environment, our behaviour today has serious implications on how (and maybe even if) future generations can live. Completely ignoring here that there are people still disputing the role of humanity in climate change, in many cases, economists have to figure out how to incorporate this intergenerational connection into their analysis. This is where discounting enters the stage.

Many of you have maybe heard the ominous term “cost-benefit analysis” before, which basically means when you are trying to decide whether to go ahead with a project or not, add up all the costs and benefits, and proceed if the benefits outweigh the costs. That sounds easy enough, but when it comes to actually doing it there are some obstacles in the way. One of these obstacles is exactly what I’ve been talking about, how do we value costs and benefits that accrue not today, but maybe five, or ten, or even a hundred years in the future? The standard argument goes that consumption today is valued higher than consumption in the future, for two reasons; time preference and elasticity of the marginal utility of consumption.

The first reason – time preference – stems from the idea that we prefer consumption now rather than in the future. Eating the chocolate bar right now gives me more utility (~happiness) than waiting excruciating 24 hours and eating the chocolate bar tomorrow.  This has something to do with our preference for certainty, there is some uncertainty attached to my waiting a day to eat the chocolate bar; one of my roommates could eat it, I could lose it, or maybe I somehow develop an allergy to chocolate within the next day. These scenarios are more or less likely, but regardless of that, I don’t have to deal with any of these uncertainties if I eat the chocolate right now.

The second reason economists assume that consumption today should be valued in higher monetary terms than consumption in the future is that we will be richer in the future, so total costs that might seem high today will appear smaller the richer we get. This is based on the – reasonable – assumption that income will keep rising like it has been over the past few decades. The richer we get, the less we care about an additional unit of wealth – this is the concept of diminishing marginal utility. I value an extra £10 higher when I’m broke than when I just got a pay-check.

These two assumptions flow into what is called the discount rate, which is a factor by which we multiply all benefits and costs that accrue in the future and thereby convert them into their present value – what we would value them today. As per usual in economics, this is a simplification of reality, these assumptions don’t claim to hold for every individual at every point in time, but rather reflect an average trend for society.

This type of simplification is necessary and often useful, but in the context of environmental cost-benefit analysis, I have been struggling to wrap my head around this. When we are talking about climate change, surely, the costs of climate change, or conversely, the benefits of reducing emissions for example, are worth as much today as they are in the future.
The problem here lies with the conversion of everything (and I mean literally everything) into monetary terms. Even environmental goods such as a lake, a park or a wetland are tagged with monetary values so they can be included in the cost benefit analysis. Take a project to build an office building where there was a green space before. If you were to do a cost benefit analysis you would add up everything that is already in monetary terms such as costs for construction, materials, labour, etc. and benefits in terms of jobs created, additional revenue and so on. But you’d also identify costs and benefits that are not expressed in monetary terms such as the utility people get from the green space, what the green space does for air quality, disutility from traffic jams because people have to get to work at the same time and are all going to that office building and so on.

The environment is generally something that isn’t traded in a market place so economists had to come up with fancy ways of transforming the utility we get from environmental resources into monetary terms to include it into cost benefit analysis. Of course, there are objections to doing this based on the idea that you just simply can’t put a price on nature and yes, in an ideal world people would automatically value and respect the environment, but sadly we live in a capitalist society. While it is difficult to put a price on environmental goods, environmental valuation is a step of integrating something important (the environment) into a system that is flawed but already there.

It is a matter of fact that we communicate value in prices and to me, environmental valuation is a necessary evil in getting people to care about the environment. And for single, specific, projects this works out fine, but when we are talking about climate change the combination of environmental valuation and discounting dilutes the costs of non-action too much. The effects of climate change transcend borders and generations, it is an accumulation of many projects rather than a single, defined, undertaking. Environmental valuation is incredibly difficult, because there are some things you could never replace with any amount of money in the world, and a functioning ecosystem is an example of that. So already in the first stage of cost benefit analysis on climate change, we’d undervalue the environment, because environmental valuation simply cannot capture everything. When we then apply a discount rate that suggests that future generations will value these benefits lesser (or conversely can better deal with the costs), we undervalue our ecosystem even more.

Admittedly idealistic, I think the environment shouldn’t be discounted, because the uncertainty connected to climate change makes it difficult to determine the exact breaking point after which the apocalypse starts and the earth has finally had enough, and to be honest, I’d rather cut back on consumption, redefine the prices we put on goods such as water and meat, and overvalue the environment (you know, “just to be safe”) than discount and leave the next generation with even less than we have now.