Horsemeat Economics

horse-meat-420x210

The British (and now Europe-wide) scandal of corporations selling horse meat as beef is emblematic of many of the problems with big, unwieldy systems.

The similarity between horse meat and subprime has already been noted in a Financial Times editorial:

The food industry has long known that processed meat is susceptible to fraud. While it is relatively easy to verify whole cuts of meat taken from a carcass, this is not the case for the bits left behind. These are gathered up and shipped out to thousands of outlets for processing into lower-value products. In Britain, monitoring this industry is left to local authorities and the retailers themselves.

Yet this surveillance has become virtually impossible in the modern world of food production. Consumers want ever lower prices. But food margins are already wafer thin. The drive to cut costs has sent retailers scouting for cheaper suppliers in far-flung parts of the world. Supply chains have become vast and unwieldy. And internet tenders drive prices down even further.

This has brought big benefits to consumers who until recently enjoyed consistently falling prices. But in a disturbing parallel to the financial sector’s subprime crisis, the growing distance between supermarkets and their suppliers has also opened the door to fraud on a scale that as yet can only be guessed at. The meat used in these products now travels across multiple borders and through myriad companies. Regulators do not have the resources to keep up. Only those who buy the processed products and sell them under their own brands can apply the pressure that will limit chances for fraud.

Just as with subprime, complicated, impersonal systems have bred fraud. Once upon a time, banks were impelled to lend responsibly, because if they did not their balance sheets would become filled with trash, and they would face bankruptcy. Then they discovered that they could pull a ruse — lend irresponsibly, and pass off the risk to someone else. Purchasers of subprime mortgage-backed securities thought they were buying a AAA grade product, as that is what ratings agencies passed them off as being. But it turns out they were just buying unsustainable trash. It is, of course, possible that the subprime crisis could have been avoided had the price of oil and other commodities not risen so steeply and precipitously, squeezing consumers’ budgets.

crisis-economy-commodity-instability-will-hit-china-and-india-who-remain-import-dependent

But sooner or later, the banks’ irresponsibility would have come home to roost, and the ruse would have collapsed. If it hadn’t been ballooning commodities prices, it would have been something else.

Similarly, in an equally sprawling and disconnected system — the global food supply chain — anonymity has bred irresponsibility once again. Retailers claim to have been misled. Meat processors and food manufacturers claim to have been misled too. But somewhere along the line, someone is lying. Someone, at some point decided that horse was a cheaper alternative to beef, someone tested it for taste, to affirm that it would be taken as an acceptable substitute. And someone decided that horse would enter the food chain, and that consumers could be fooled into thinking that it was beef. Would that be possible with a local butcher? Would it be possible for unwanted substances to penetrate the food chain if the supply chain was much shorter?

Maybe, but there are strong disincentives. With a shorter supply chain, it is not so easy to pass off the blame to someone else. If a local British butcher decides to substitute horse for beef, it would be more easily discoverable than if a sprawling multinational — whose abattoirs are located in Romania or Cyprus, but its customers in Britain, Spain, France and Italy — decided to do so. British abattoir workers would know, and might dissent. Butchers would be able to tell the difference, and most would have a serious problem with deceiving customers who they see face to face. A supermarket that sells meals packaged in plastic containers by other companies, has no such problem with deception. Customers don’t ever get to meet the person who butchered or cooked or shipped their ready meal. This provides a barrier of anonymity. There is no immediate embarrassment in deception carried out at distance. Simply, anonymity makes deception easier, and big, complex systems create anonymity.

In 2010, The Telegraph reported on some empirical research supporting this idea:

There is a growing body of research to support the logically obvious idea that humans become increasingly dishonest as cheating becomes easier:

From finding a £50 note on the floor to being accidentally given the answers to test questions, even normally honest people can suddenly become dishonest, it found.

But they will only cheat if it does not involve any work, said the academic study for the journal Psychological and Personality Science.

In an experiment on 84 students, researchers set up a trial involving a maths test on a computer, without telling them the reasons why they were doing it.

Half the students were warned the system was not working properly. If they pressed the space bar on the keyboard the answers would come up.

The other half were told that if they did not press the enter key immediately after seeing the question, then the answer would come up.

Overall, few cheated at all. But those who did not have to press a key to cheat were almost TEN times as likely to do so, said the researchers from the University of Toronto.

They said it was because pressing a key was like ‘intentionally’ trying to cheat while those who didn’t acted as if they were cheating by accident, so they did not feel they were making an immoral choice.

In a second test, the volunteers were tested on their willingness to help a fellow student with a disability complete an exam paper.

Half were told the way to volunteer was to follow an online link, the other half simply had to click ‘yes’ or ‘no’ on the screen.

Those who had to follow the link were five times less likely to volunteer to help, because it was easier for them to get out of it than the others who had a clear choice to make.

Study author Rimma Teper said: “People are more likely to cheat and make immoral decisions when their transgressions don’t involve an explicit action.”

I am coming to believe very strongly that as this century continues, and as systemic interconnectivity and complexity increases, we will see many more horse meat and subprime style scandals exploiting the anonymity of big systems.

Meanwhile, those who do not wish to be exposed to such counterparty risk will avoid such complexity like the plague.

About these ads

Not Rational Utility Maximisers

One cornerstone of neoclassical economic thought is the assumption in microeconomics (and microfounded macroeconomics) that humans behave as “rational utility maximisers”.

Yet this assumption is increasingly outdated. Empirical findings in behavioural economics show that the neoclassical assumption of utility maximisation has very little basis in reality.

First, it is crucial to define what we mean by utility maximisation. Paul Samuelson, one of the grandfathers of the neoclassical New Keynesian school defined consumer rationality as follows:

• Completeness — Given any 2 bundles of commodities A & B , the consumer can decide whether he prefers A to B (A≻B), B to A (B≻A), or is indifferent between them (B≈A).

• Transitivity — If (A≻B) and (B≻C) then (A≻C).

• Non-satiation — More is preferred to less.

• Convexity — Marginal utility falls as consumption of any good rises.

This definition remains dominant in neoclassical economics today.

Sippel (1997) tested whether consumers really adhered to these four rules. He gave his student test subjects a budget, and a set of eight priced commodities to spend their budget on:

UtilityMaximisation

This was repeated ten times, with ten different budget and price combinations. Sippel found that 11 out of 12 of his test subjects’ behaviour failed to meet Samuelson’s criteria for rational utility maximisation. Sippel repeated the experiment later with thirty test subjects, finding that 22 out of 30 did not meet Samuelson’s criteria. Sippel concluded:

We conclude that the evidence for the utility maximisation hypothesis is at best mixed. While there are subjects who appear to be optimising, the majority of them do not.

It is interesting that some individuals obey the rules set out by Samuelson, and that some don’t. Human behaviour is highly variable from individual to individual. If the hypothesis of utility maximisation is right about a subset of individuals, but wrong about much of the general population, then this underlines the variability of human behaviour. And different circumstances call for different decision-making frameworks — some individuals may act like rational utility maximisers under some sets of circumstances and not others. This is really an area that deserves much, much more empirical study.

The evidence so far suggests that humans are complex animals whose decisions are multi-dimensional. This could be because our brains have evolved to use different neuro-circuitry for different decisions. According to the behavioural economist Daniel McFadden:

Our brains seem to operate like committees, assigning some tasks to the limbic system, others to the frontal system. The “switchboard” does not seem to achieve complete, consistent communication between different parts of the brain. Pleasure and pain are experienced in the limbic system, but not on one fixed “utility” or “self-interest” scale. Pleasure and pain have distinct neural pathways, and these pathways adapt quickly to homeostasis, with sensation coming from changes rather than levels. Overall, presumably as a product of evolution, our brains are organized well enough to keep us alive, fed, reproducing, and responsive to but not overwhelmed by sensation, but they are not hedonometers.

All of this points to the idea that microeconomics needs a new framework based on neurological and behavioural evidence, not decades-old assumptions that are unsupported by empirical evidence.