Category Archives: finance

The ‘Bad Version’ and How to Tax the Rich

A ‘bad ver­sion’ is a tech­nique used by tele­vi­sion writers to inspire cre­ativ­ity when exper­i­en­cing a cre­at­ive block. The tech­nique involves writ­ing a pur­pose­fully awful sec­tion of plot as a way of help­ing the writer find cre­ativ­ity and, even­tu­ally, the ideal solu­tion: it’s a way of “nudging your ima­gin­a­tion to some­place bet­ter”.

In The Wall Street Journ­al, Scott Adams offers some “ima­gined solu­tions for the gov­ern­ment’s fisc­al dilemma” – bad ver­sions of ways to incentiv­ising the rich to will­fully pay more tax. Those incent­ives:

  • Time: Any­one who pays taxes at a rate above some set amount gets to use the car pool lane without a pas­sen­ger. Or per­haps the rich are allowed to park in han­di­capped-only spaces.
  • Grat­it­ude: The gov­ern­ment makes it a con­di­tion that any­one apply­ing for social ser­vices has to write a per­son­al thank-you note to a nearby rich per­son […] It’s easy to hate the gen­er­ic over­spend­ing of the gov­ern­ment. It’s harder to begrudge med­ic­al care to someone who thanks you per­son­ally.
  • Incent­ives: Sup­pose the tax code is redesigned so that the rich only pay taxes to fund social ser­vices, such as health care and social secur­ity. This gives the rich an incent­ive to find ways to reduce the need for those ser­vices.
    Mean­while, the middle class would be in charge of fund­ing the mil­it­ary. That feels right. The coun­try gen­er­ally does­n’t go to war unless the middle-class major­ity is on board.
  • Shared Pain: I doubt that the rich will agree to high­er taxes until some ser­i­ous budget cut­ting is hap­pen­ing at the same time. That makes the sac­ri­fice seem shared. […] Change the debate from arguing about which pro­grams and how much to cut, and instead to do what the private sec­tor has been doing for dec­ades: Pull a ran­dom yet round num­ber out of your ear, let’s say a 10% cut, just for argu­ment’s sake, and apply it across the board. No excep­tions.
  • Power: Give the rich two votes apiece in any elec­tion. That’s double the power of oth­er cit­izens. But don’t worry that it will dis­tort elec­tion res­ults. There aren’t that many rich people, and they are some­what divided in their opin­ions, just like the rest of the world.

First Offers and Aggressive Offers: Optimal Negotiating Tactics

When nego­ti­at­ing ensure that you make the first offer and make sure it’s an aggress­ive one: this is almost always the optim­al nego­ti­ation strategy. That’s the con­clu­sion from a study look­ing at nego­ti­ation tac­tics and the anchor­ing effect (from the same research­ers that dis­covered the optim­al start­ing prices for nego­ti­ations and auc­tions).

One of the research­ers gives a good over­view of the study’s find­ings in an art­icle for Har­vard Busi­ness School’s Work­ing Know­ledge that provides suc­cinc­t nego­ti­ation tac­tics and reas­ons for why you should make the first offer. Top­iccs include: when you should not make the first offer, how to counter first offers, how to con­struct a reasonable—yet aggressive—offer, how to pro­tect your­self from the effects of anchor­ing, and more.

Some key points worth con­sid­er­ing (in no par­tic­u­lar order):

We might expect experts to be immune to the anchor­ing effect. Real estate agents, for example, should be able to res­ist the anchor­ing effects of a prop­er­ty’s list price because of their pre­sumed skill at estim­at­ing prop­erty val­ues. Test­ing this the­ory, [it is clear that] anchors affect the judg­ment of even those who think they are immune to such influ­ence. But why?

Every item under nego­ti­ation (wheth­er it’s a com­pany or a car) has both pos­it­ive and neg­at­ive qualities—qualities that sug­gest a high­er price and qual­it­ies that sug­gest a lower price. High anchors select­ively dir­ect our atten­tion toward an item’s pos­it­ive attrib­utes; low anchors dir­ect our atten­tion to its flaws. […]

The prob­ab­il­ity of mak­ing a first offer is related to one’s con­fid­ence and sense of con­trol at the bar­gain­ing table. Those who lack power, either due to a nego­ti­ation’s struc­ture or a lack of avail­able altern­at­ives, are less inclined to make a first offer. Power and con­fid­ence res­ult in bet­ter out­comes because they lead nego­ti­at­ors to make the first offer. In addi­tion, the amount of the first offer affects the out­come, with more aggress­ive or extreme first offers lead­ing to a bet­ter out­come for the per­son who made the offer. Ini­tial offers bet­ter pre­dict final set­tle­ment prices than sub­sequent con­ces­sion­ary beha­vi­ors do.

There is one situ­ation in which mak­ing the first offer is not to your advant­age: when the oth­er side has much more inform­a­tion than you do about the item to be nego­ti­ated or about the rel­ev­ant mar­ket or industry. […]

How extreme should your first offer be? My own research sug­gests that first offers should be quite aggress­ive but not absurdly so. Many nego­ti­at­ors fear that an aggress­ive first offer will scare or annoy the oth­er side and per­haps even cause him to walk away in dis­gust. How­ever, research shows that this fear is typ­ic­ally exag­ger­ated. In fact, most nego­ti­at­ors make first offers that are not aggress­ive enough.


The Drinkers’ Bonus: Alcohol Intake and Increased Earnings

Drink­ing alco­hol – and the increased social cap­it­al that it leads to – may not just be respons­ible for a pos­sible increase in life span; it may increase your earn­ings, too.

In an ana­lys­is of both the Gen­er­al Social Sur­vey and the pub­lished lit­er­at­ure, research­ers for the Reas­on Found­a­tion show that alco­hol drink­ers earn, on aver­age, 10% more than abstain­ers (pdf). This is known as the drink­ers’ bonus.

Recent stud­ies indic­ate that drink­ing and indi­vidu­al earn­ings are pos­it­ively cor­rel­ated. Instead of earn­ing less money than non­drink­ers, drink­ers earn more. One explan­a­tion is that drink­ing improves phys­ic­al health, which in turn affects earn­ings (Hamilton and Hamilton, 1997). We con­tend that there is an eco­nom­ic explan­a­tion. […]

Drink­ers typ­ic­ally tend to be more social than abstain­ers. As Cook (1991) explained, drink­ing is a social activ­ity, and one reas­on people drink is to be soci­able. In the med­ic­al lit­er­at­ure, Skog (1980) showed that mod­er­ate drink­ers have the strongest social networks. Fur­ther­more, Lei­f­man et al. (1995) doc­u­mented a neg­at­ive rela­tion­ship between social integ­ra­tion and abstin­ence. Wheth­er abstain­ers choose not to be as social or wheth­er organ­izers of social occa­sions involving drink­ing exclude abstain­ers is unclear. Abstain­ers may prefer to inter­act with oth­er abstain­ers or less social people. Altern­ately, abstain­ers might not be invited to social gath­er­ings, work-related or otherwise, because drink­ers con­sider abstain­ers dull.

Corcor­an et al. (1980), Mont­gomery (1991), and Put­nam (2000) each made con­vin­cing cases that social net­works are import­ant for find­ing jobs and earn­ing pro­mo­tions. Mont­gomery (1991) explained that com­pan­ies prefer acquaint­ances of employ­ees because employ­ees screen poten­tial can­did­ates and thereby reduce the cost of search. Approx­im­ately half the work­ers sur­veyed in the Pan­el Study of Income Dynam­ics found their job through friends or rel­at­ives, and one-third repor­ted help from acquaint­ances in obtain­ing their job (Corcor­an et al., 1980). There­fore, a per­son with more con­tacts will have more labor mar­ket options (Burt, 1997). Gran­ovet­ter (1995) sug­ges­ted that a large quant­ity of weak ties or friends-of-friends may be most import­ant to gar­ner­ing the best job offers.

Thus, if social drink­ing enables great­er social net­works, it will also increase earn­ings. In terms of search the­ory: the more one drinks, the more people one knows, and the more people one knows, the lower the mar­gin­al costs of search.

The study is packed full of excel­lent ref­er­ences to pub­lished stud­ies (as you can tell from the above excerpt), so I sug­gest read­ing the access­ible (and very short!) report. It’s also worth not­ing foot­notes four and five, describ­ing how this is just like all invest­ments in cap­it­al, in that an optim­al level exists: “you must drink more than 21 drinks per week to earn as little as a non-drink­er”.

via @phila_lawyer

Against Behavioural Economics and Irrationality

Prais­ing Maurice Allais as the fath­er of beha­vi­our­al eco­nom­ics rather than Kahne­man and Tver­sky,  John Kay intro­duces us to some of Allais’ ideas while sim­ul­tan­eously provid­ing one of the finest argu­ments against the simplist­ic view of beha­vi­our­al eco­nom­ics as the study of irra­tion­al­ity:

The skill of piecing togeth­er sense from frag­men­ted and inac­cur­ate inform­a­tion is a cent­ral attrib­ute of human intel­li­gence. Lit­er­al inter­pret­a­tion, and insens­it­iv­ity to con­text, are not marks of ration­al­ity but men­tal disorders. […]

The [beha­vi­our­al eco­nom­ics] exper­i­menter­’s trick is to con­struct an arti­fi­cial situ­ation in which nor­mally sens­ible beha­viour gives what he thinks is the wrong res­ult. The “mis­take” is detec­ted in a mean­ing­less prob­lem designed solely to eli­cit the “mis­take”. […]

Allais was less con­cerned to show that our beha­viour was irra­tion­al than to argue that the premises of ration­al­ity itself were irrational. […]

Allais’ most fam­ous exper­i­ment showed that we often treat very high prob­ab­il­it­ies very dif­fer­ently from cer­tain­ties, although “ration­al” indi­vidu­als would regard them as almost the same thing. But very high prob­ab­il­it­ies often are dif­fer­ent from cer­tain­ties: very high prob­ab­il­it­ies are usu­ally derived from cal­cu­la­tions whose rel­ev­ance and valid­ity are them­selves uncer­tain. […]

Irra­tion­al­ity lies not in fail­ing to con­form to some pre­con­ceived notion of how we should behave, but in per­sist­ing with a course of action that does not work. Some­times in mod­ern eco­nom­ics and polit­ic­al life, there is a big dif­fer­ence.

The example Kay uses is a bit glib but does serve its purpose.That last para­graph, how­ever, is the crux of it all. As you may have guessed, this is the Allais that designed the Allais para­dox – an exper­i­ment in beha­vi­our­al eco­nom­ics that shows the above won­der­fully.

Building a Brand In a Recession

The recent reces­sion saw sales of con­doms, guns and burg­lar alarms soar. This is because, when fear enters our mind in terms of los­ing our job or of not being able to pay bills, we focus on two of our most basic drives: fear and sex.

The key to selling and build­ing a brand dur­ing fin­an­cial crises, there­fore, is simple: man­age fear. Under­stand how it works and how it affects pur­chas­ing beha­viour. This advice on brand-build­ing dur­ing a reces­sion comes from Mar­tin Lind­strom, ex-advert­ising agency exec­ut­ive, author of Buy­ology, and one of TIME’s 100 Most Influ­en­tial People in the World, 2009.

First, there’s always good news in bad times. A stand­ard approach in this situ­ation is to address con­sumers’ prob­lems. And people always have prob­lems. The fact is we rarely know what we want, but we have no trouble point­ing out our dif­fi­culties. For example, no one knew they wanted an airbag, but every­one agreed they wanted safer cars.

It’s there­fore import­ant to ask your­self what sort of prob­lems are con­sumers facing dur­ing this eco­nom­ic reces­sion? There are many. […] Con­vert prob­lems into assets for your brand.

Second, add a prac­tic­al dimen­sion to an irra­tion­al decision. No mat­ter how much money you may have in the bank, or how secure your employ­ment may be, it’s now fash­ion­able to save your money and buy everything at a dis­count. What can a brand own­er do? Par­tic­u­larly in light of the fact that a dis­coun­ted brand typ­ic­ally takes sev­en years to recov­er!

The answer is simple. Add a prac­tic­al dimen­sion to the equa­tion. […]

Third, you have to sys­tem­at­ic­ally remove fear. Hyundai did it. And a stream of new banks are doing it. Both have suc­ceeded in identi­fy­ing why con­sumers are reluct­ant to spend. Once this is under­stood, then you can har­ness it and build a bet­ter product by address­ing the fear and find­ing a way to elim­in­ate it. Your sales may be down. But do you know why? People are cer­tainly buy­ing less, and explan­a­tions like, “Well, there’s a reces­sion going on out there,” are not help­ful. What’s import­ant is to under­stand the fun­da­ment­al role of fear, and then turn it around to strengthen your brand. Some of the world’s most endur­ing gro­cery brands were built on the back of the Great Depres­sion. Each one turned the threat into an oppor­tun­ity.