Posted by: Ananish Chaudhuri
(A version of this blog appeared in Section C2 of the Dominion Post on Thursday, May 21, 2009.)
Recently, the Chief Executive of Air New Zealand announced a freeze on wage increases and said his goal was "to do everything I can to minimise the risk of job losses…". Freezing wages is a way of containing costs. The implication here is that if costs keep rising and freezing wages don’t do the trick then the next – inevitable- step is to lay off workers.
A pertinent question to ask in this context is this: why not cut wages across the board rather than lay off some people? In January of this year Radio New Zealand reported that some business leaders including the Chief Executive of Business New Zealand were calling for a freeze in the minimum wage. In February, Business New Zealand, in its recommendations to the jobs summit, suggested that cutting the hourly wage rate should be considered as one of the options for preventing job losses. Even if the wage is only frozen rather than cut, as long as increases in the minimum wage do not keep pace with rising prices, then the net effect is to reduce the “real” wages of workers because with rising prices their wages are worth less than before. In fact, during recessions one often hears calls for cuts in the minimum wage, or even doing away with it completely. The argument is that the presence of the minimum wage prevents employers, faced with falling revenues, from lowering wages to get the cost-savings they need to justify maintaining their workforces. Under this view, unemployment must increase because the minimum wage blocks the needed adjustments in costs.
However the fact remains that all over the world employers tend to show a strong preference for laying off workers rather than cutting wages. So why is this? If the primary aim is to save on costs, then pay-cuts across the board for all workers might actually save more money than laying off an unfortunate few, especially given that laid off workers often get severance pay.
Based on hundreds of interviews with managers at a variety of firms in the north-eastern United States, Truman Bewley of Yale University found that the managers of most enterprises were reluctant to enact a reduction in wages even though, given the extensive unemployment, they could then pick up new workers willing to work for less. But in fact top management is extremely reluctant to enact wages cuts and the main reason they gave for this is that such cuts hurt morale and therefore reduce workers’ productivity.
OK, wage cuts hurt in the wallet, but what is the link with morale more generally? Morale has a number of different components including identifying with the firm and its objectives as well as a mood that is conducive to good work. Psychologists say that most of us engage in what is called “anchoring”, whereby our current wages become a reference point for us to measure future developments against. Furthermore, most of us are “loss averse” in that a $10 loss makes us more than twice as unhappy as a $10 gain makes us happy. Therefore, pay-cuts are psychologically painful. Workers are used to receiving regular pay increases as a reward for good work and loyalty and so interpret a pay cut as an affront and a breach of implicit reciprocity. The morale of existing employees is hurt by pay cuts because of an insult effect. This explains how a general cut in pay can indeed lead to serious losses in productivity via its detrimental effect on worker morale.
There are two other factors at work here as well. First, pay-cuts can often lead to a problem of “adverse selection” whereby a general cut in pay may lead to the most productive members of the firm leaving, resulting in a much greater than proportional fall in productivity. In this case the savings from lower wages are outweighed by the resulting loss in productivity. The second factor has to do with the concept of “efficiency wages”. In a variety of jobs monitoring workers is difficult and the cost to the firm from workers shirking is high. In such cases, firms routinely pay workers more than the minimum amount that they have to pay. This higher pay is certainly desirable but workers also understand that being fired from the job now comes with the potentially high penalty of having to settle for an alternative that pays much less. Efficiency wages have the effect of fostering loyalty on the part of the employee and therefore reducing the possibility of workers shirking or even leaving. Firms paying efficiency wages are always reluctant to cut wages even in the face of pervasive unemployment, because of its detrimental effect on worker loyalty and productivity.
General pay cuts hurt everybody and can cause lasting resentment and loss of morale. Layoffs affect morale as well but that effect seems relatively short-lived since the laid-off workers are no longer around. This implies that with jobs where workers are hard to monitor including jobs in customer service or information systems or jobs that require close cooperation among groups of workers, we would not expect to see any pronounced cuts in wages. To the extent workers use the minimum wage as an anchor, cuts in this wage may have a tremendously detrimental effect on morale and may not have any impact on job losses in any case.
Wednesday, May 20, 2009
Tuesday, May 19, 2009
Creating Optimistic Beliefs Key to Tackling Global Recession
Posted by: Ananish Chaudhuri
(A version of this blog appeared as a "Viewpoint" article in the University of Auckland News on Friday, May 15, 2009.)
During this on-going economic crisis, a number of commentators have urged consumers to keep spending. Except, it’s not that simple. An individual consumer increasing spending makes no difference to the recession. What is required is for all consumers to increase consumption simultaneously. As a consumer, I might clearly understand that we can make a difference if we increase consumption, but how do I know if others will actually increase their consumption if I do so?
A wide variety of economic situations require coordinated action on the part of individuals or groups in order to achieve a successful outcome. Economists refer to these as ‘co-ordination problems’ and they arise, for instance, in any industry engaged in team production along an assembly line such as in steel mills and automobile factories.
Even if everyone works at speed, just one individual or group lagging behind is needed to slow down production significantly to the detriment of everyone else. This may not seem like a large problem, but in reality getting a large group of individuals to successfully coordinate their actions often poses a difficult challenge for many organisations.
While coordination failures at individual organisations may only be of passing interest, when they apply to the economy as a whole, all of us are affected. Economic recessions are to a large extent an outcome of wide-spread pessimism among businesses and individuals, rather than the result of inherent systemic problems. Creating appropriately optimistic beliefs is a key to addressing such crises.
One fundamental problem in deep recessions is that the economy gets caught in an under-employment trap...a situation where no firm wishes to expand production unless it can be assured that others will do the same - yet not doing so leads to an outcome that is worse for everyone concerned. The crux of the issue here is that taking a risky action makes sense if - and only if - everyone matches that action. If they don’t, then the individual or firm taking that risk is worse off and makes no difference.
Such a lack of coordination can also lead to a run on banks if depositors lose faith and rush to withdraw their money, even though everyone is better off if they keep their money where it is. Such loss of faith, which often tends to be self-fulfilling, can have devastating financial consequences.
Along with Andrew Schotter of New York University and Barry Sopher of Rutgers University, I recently used economic decision-making experiments to understand whether it was possible for groups to “talk” themselves out of such an under-employment trap. To do so we developed an innovative ‘inter-generational’ paradigm in which one group of players - after playing the game - could leave advice for their successors. This continued for a number of generations.
We found that allowing one group to pass advice to the next could indeed create the optimistic beliefs that led to coordination on the risky action, but with a twist. When the advice was private and given from one participant to his immediate successor, this advice tended to be pessimistic, suggesting following the least risky course of action.
In order for the advice to make a difference it needed to be public and common knowledge, in the sense that everyone in the group must get the same advice and must also know that everyone else has got the same advice. So if a political leader makes a public announcement heard by everyone, and everyone knows that everyone else has heard it, then a necessary condition has been met for successful coordination.
We conclude that getting a message to coordinate was not enough; each person must be convinced that others have received the same message and interpreted it in similar ways. A shared comprehension of the message is absolutely crucial to solving such coordination problems. Thus, in combating our financial crises, we really need to think of innovative actions or social processes that generate optimistic beliefs. This, in turn, suggests that economic stimuli packages might need to be accompanied by exhortative messages that clearly highlight the aims of these packages and are designed to reduce consumer pessimism.
These results appear in the January 2009 issue of the Economic Journal, which is published by the Royal Economic Society and is a leading international scholarly journal in economics.
In the context of the current crisis, an example of such a commonly perceived public announcement might be the one made by the British government early on of a plan for major equity injections into British banks, backed up by guarantees on bank debt that should get lending among banks going again. This may have gone a long way towards calming jittery financial markets.
The recent “jaw-boning” by Alan Bollard about banks passing on rate cuts to consumers and companies keeping prices down should also help. Another example of this is the recent announcement by the US Federal Reserve that not only was it cutting interest rates, but aiming to keep it at that level for the foreseeable future. In this regard, New Zealand may be well situated, given the population’s generally high trust in the government and other social institutions which makes public pronouncements more credible.
(A version of this blog appeared as a "Viewpoint" article in the University of Auckland News on Friday, May 15, 2009.)
During this on-going economic crisis, a number of commentators have urged consumers to keep spending. Except, it’s not that simple. An individual consumer increasing spending makes no difference to the recession. What is required is for all consumers to increase consumption simultaneously. As a consumer, I might clearly understand that we can make a difference if we increase consumption, but how do I know if others will actually increase their consumption if I do so?
A wide variety of economic situations require coordinated action on the part of individuals or groups in order to achieve a successful outcome. Economists refer to these as ‘co-ordination problems’ and they arise, for instance, in any industry engaged in team production along an assembly line such as in steel mills and automobile factories.
Even if everyone works at speed, just one individual or group lagging behind is needed to slow down production significantly to the detriment of everyone else. This may not seem like a large problem, but in reality getting a large group of individuals to successfully coordinate their actions often poses a difficult challenge for many organisations.
While coordination failures at individual organisations may only be of passing interest, when they apply to the economy as a whole, all of us are affected. Economic recessions are to a large extent an outcome of wide-spread pessimism among businesses and individuals, rather than the result of inherent systemic problems. Creating appropriately optimistic beliefs is a key to addressing such crises.
One fundamental problem in deep recessions is that the economy gets caught in an under-employment trap...a situation where no firm wishes to expand production unless it can be assured that others will do the same - yet not doing so leads to an outcome that is worse for everyone concerned. The crux of the issue here is that taking a risky action makes sense if - and only if - everyone matches that action. If they don’t, then the individual or firm taking that risk is worse off and makes no difference.
Such a lack of coordination can also lead to a run on banks if depositors lose faith and rush to withdraw their money, even though everyone is better off if they keep their money where it is. Such loss of faith, which often tends to be self-fulfilling, can have devastating financial consequences.
Along with Andrew Schotter of New York University and Barry Sopher of Rutgers University, I recently used economic decision-making experiments to understand whether it was possible for groups to “talk” themselves out of such an under-employment trap. To do so we developed an innovative ‘inter-generational’ paradigm in which one group of players - after playing the game - could leave advice for their successors. This continued for a number of generations.
We found that allowing one group to pass advice to the next could indeed create the optimistic beliefs that led to coordination on the risky action, but with a twist. When the advice was private and given from one participant to his immediate successor, this advice tended to be pessimistic, suggesting following the least risky course of action.
In order for the advice to make a difference it needed to be public and common knowledge, in the sense that everyone in the group must get the same advice and must also know that everyone else has got the same advice. So if a political leader makes a public announcement heard by everyone, and everyone knows that everyone else has heard it, then a necessary condition has been met for successful coordination.
We conclude that getting a message to coordinate was not enough; each person must be convinced that others have received the same message and interpreted it in similar ways. A shared comprehension of the message is absolutely crucial to solving such coordination problems. Thus, in combating our financial crises, we really need to think of innovative actions or social processes that generate optimistic beliefs. This, in turn, suggests that economic stimuli packages might need to be accompanied by exhortative messages that clearly highlight the aims of these packages and are designed to reduce consumer pessimism.
These results appear in the January 2009 issue of the Economic Journal, which is published by the Royal Economic Society and is a leading international scholarly journal in economics.
In the context of the current crisis, an example of such a commonly perceived public announcement might be the one made by the British government early on of a plan for major equity injections into British banks, backed up by guarantees on bank debt that should get lending among banks going again. This may have gone a long way towards calming jittery financial markets.
The recent “jaw-boning” by Alan Bollard about banks passing on rate cuts to consumers and companies keeping prices down should also help. Another example of this is the recent announcement by the US Federal Reserve that not only was it cutting interest rates, but aiming to keep it at that level for the foreseeable future. In this regard, New Zealand may be well situated, given the population’s generally high trust in the government and other social institutions which makes public pronouncements more credible.
Do Three Strikes Laws deter Violent Crime?
Posted by: Ananish Chaudhuri
It is not clear that National’s support for enhanced punishment of repeat offenders under a ‘three strikes and you’re out’ legislation is based on a careful sifting of the available evidence and deliberation. If the aim is to reduce violent crime, then such mandatory sentencing may not be an effective way of achieving that.
In the United States - where Washington and Wisconsin were the first states to adopt a ‘three strikes’ law in 1993 - the State that has systematically and strictly enforced the ‘three strikes’ statute is California. California has used the law broadly to cover pretty much all felonies.
California has also allowed limited judicial discretion preventing judges from circumventing the law in those cases where its application seemed uncalled for, such as for non-violent felonies. As of 2000, more than 40,000 offenders have been sentenced under the ‘three strikes’ legislation in California. No other State has even reached 1000.
Armed with those statistics, you have to ask...does the law work in preventing violent felonies? Surprisingly, there is very little evidence to answer this in the affirmative. A 1994 study commissioned by the Rand Corporation found huge costs and limited deterence from this law change requiring mandatory sentencing for a third offence.
In an article published in the Stanford Law and Policy Review in 1999, Mike Males and Dan Macallair compared California counties with ‘strict’ versus ‘lax’ enforcement of the law, and concluded that counties that strictly enforced the enhanced sentencing guidelines saw negligible effects on crime rates.
Thomas Marvell and Carlisle Moody’s 2000 article, published in the Journal of Legal Studies - a leading scholarly journal - undertook a cross-state analysis and found that ‘three strikes’ laws have little effect on overall crime rates. Moreover, a recent study by Radha Iyenger of Harvard University suggested that ‘three strikes’ laws may have a wholly unintended consequence of increasing the incidence of violent crime.
Using data from California, Iyenger reported both good and bad news. She found that ‘three strikes’ legislation reduced participation in criminal activity by 20 percent for second-strike eligible offenders and by almost a third for third-strike eligible offenders. But, because the California law is non-discriminatory in that a wide variety of felonies will attract the ‘three strikes’ penalty, Iyenger found that criminals were much more prone to committing more violent crimes as their third-strike offence.
The rationale is not difficult to understand. If you do participate in a third-strike eligible criminal act, then it no longer matters much whether you commit a violent felony or a non-violent felony, because in either case you would be looking at a mandatory 25 years-to-life sentence. There is no strong incentive to avoid violence in the course of committing a third offense.
California’s Proposition 184, which brought the ‘three strikes’ law into existence, was approved by more than 70% of the State’s voters. Yet, in 2004, opponents of the law put a measure on the ballot – Proposition 66 – that would have required the triggering third offense to be a serious or violent crime. This proposition was defeated narrowly by a 53% to 47% margin, demonstrating widespread dissatisfaction with the way the law is applied.
Following the defeat of Proposition 66, the District Attorney of Los Angeles County has now taken up a drive to soften the law, an effort that is supported by the Sheriff of Los Angeles County and the police chief of Los Angeles.
Under the proposed revision, a criminal would typically be subject to the mandatory ‘three strikes’ law only if the third strike is for violent or serious felony, although in some cases the mandatory sentence may apply for a minor felony such as drug possession or petty theft only if that particular criminal has already been convicted of a serious felony in the past.
But in many cases, where the third offense is a relatively minor felony, this will not attract the mandatory sentence under the ‘three strikes’ law. This revision then will also reinstate a measure of judicial discretion that was missing from Proposition 184.
It is obvious that California, the one State that has applied the ‘three strikes’ law most systematically, is now questioning its effectiveness. Under the circumstances, one would hope that the National Party would engage in much greater consultation before implementing such a drastic change in current sentencing guidelines, especially in light of the fact that New Zealand already has relatively high rates of incarceration per capita.
There must be other more innovative ways of dealing with recidivist offenders than borrowing a policy from the United States which does not seem to have worked in the first place. Is there any particular reason to believe that it will work any better here in New Zealand?
It is not clear that National’s support for enhanced punishment of repeat offenders under a ‘three strikes and you’re out’ legislation is based on a careful sifting of the available evidence and deliberation. If the aim is to reduce violent crime, then such mandatory sentencing may not be an effective way of achieving that.
In the United States - where Washington and Wisconsin were the first states to adopt a ‘three strikes’ law in 1993 - the State that has systematically and strictly enforced the ‘three strikes’ statute is California. California has used the law broadly to cover pretty much all felonies.
California has also allowed limited judicial discretion preventing judges from circumventing the law in those cases where its application seemed uncalled for, such as for non-violent felonies. As of 2000, more than 40,000 offenders have been sentenced under the ‘three strikes’ legislation in California. No other State has even reached 1000.
Armed with those statistics, you have to ask...does the law work in preventing violent felonies? Surprisingly, there is very little evidence to answer this in the affirmative. A 1994 study commissioned by the Rand Corporation found huge costs and limited deterence from this law change requiring mandatory sentencing for a third offence.
In an article published in the Stanford Law and Policy Review in 1999, Mike Males and Dan Macallair compared California counties with ‘strict’ versus ‘lax’ enforcement of the law, and concluded that counties that strictly enforced the enhanced sentencing guidelines saw negligible effects on crime rates.
Thomas Marvell and Carlisle Moody’s 2000 article, published in the Journal of Legal Studies - a leading scholarly journal - undertook a cross-state analysis and found that ‘three strikes’ laws have little effect on overall crime rates. Moreover, a recent study by Radha Iyenger of Harvard University suggested that ‘three strikes’ laws may have a wholly unintended consequence of increasing the incidence of violent crime.
Using data from California, Iyenger reported both good and bad news. She found that ‘three strikes’ legislation reduced participation in criminal activity by 20 percent for second-strike eligible offenders and by almost a third for third-strike eligible offenders. But, because the California law is non-discriminatory in that a wide variety of felonies will attract the ‘three strikes’ penalty, Iyenger found that criminals were much more prone to committing more violent crimes as their third-strike offence.
The rationale is not difficult to understand. If you do participate in a third-strike eligible criminal act, then it no longer matters much whether you commit a violent felony or a non-violent felony, because in either case you would be looking at a mandatory 25 years-to-life sentence. There is no strong incentive to avoid violence in the course of committing a third offense.
California’s Proposition 184, which brought the ‘three strikes’ law into existence, was approved by more than 70% of the State’s voters. Yet, in 2004, opponents of the law put a measure on the ballot – Proposition 66 – that would have required the triggering third offense to be a serious or violent crime. This proposition was defeated narrowly by a 53% to 47% margin, demonstrating widespread dissatisfaction with the way the law is applied.
Following the defeat of Proposition 66, the District Attorney of Los Angeles County has now taken up a drive to soften the law, an effort that is supported by the Sheriff of Los Angeles County and the police chief of Los Angeles.
Under the proposed revision, a criminal would typically be subject to the mandatory ‘three strikes’ law only if the third strike is for violent or serious felony, although in some cases the mandatory sentence may apply for a minor felony such as drug possession or petty theft only if that particular criminal has already been convicted of a serious felony in the past.
But in many cases, where the third offense is a relatively minor felony, this will not attract the mandatory sentence under the ‘three strikes’ law. This revision then will also reinstate a measure of judicial discretion that was missing from Proposition 184.
It is obvious that California, the one State that has applied the ‘three strikes’ law most systematically, is now questioning its effectiveness. Under the circumstances, one would hope that the National Party would engage in much greater consultation before implementing such a drastic change in current sentencing guidelines, especially in light of the fact that New Zealand already has relatively high rates of incarceration per capita.
There must be other more innovative ways of dealing with recidivist offenders than borrowing a policy from the United States which does not seem to have worked in the first place. Is there any particular reason to believe that it will work any better here in New Zealand?
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