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Paul Ormerod: May 2012

Tuesday, 22 May 2012

Political map of London is like America: strong geographic segregation

Thomas Schelling is a brilliant American polymath, who deservedly won the Nobel Prize in economics in 2005.  One of his most remarkable insights is about segregation in cities, which he published as long ago as 1971.

The residential pattern of American cities tends to be pretty sharply divided on ethnic grounds.  The population of many areas is often overwhelmingly drawn from a single ethnic group.  There are white neighbourhoods, black neighbourhoods, as so forth, in which there are very few members of other ethnic groups.

An obvious implication of this seems to be that there is strong racial prejudice in the US, that many people actively prefer to live amongst people of their own ethnicity.

Schelling showed that strong segregation at the level of the city as a whole can arise even when individuals have only a very weak preference in favour of being surrounded by people of their own ethnic group.  There is a big, often highly mathematical, scientific literature on this in the four decades since Schelling made his discovery.  But his basic finding still remains valid.  Very weak individual preferences often translate into apparently very strong ones at the city-wide level.

His work was all the more remarkable given that personal computers had not been invented. Schelling obtained his results using coins on graph paper.  He placed pennies and nickels in different patterns on the "board" and then moving them one by one if they were in an "unhappy" situation.

Source: Guardian newspaper

The first preferences in the 2012 London Mayoral election are a remarkable example of city-wide segregation. They give the impression of a city which is sharply divided in its political allegiances and outlook.

Of course, many factors determine electoral outcomes. And the chart is not implying that people select their place of residence according to its political preferences. But, certainly, there is a self-reinforcing aspect to this process, which Schelling did not incorporate into his original model. The underlying maths of these models came much later.

The overall culture of a locality is an important determinant of an individual’s political preference. Many wealthy left-wingers, for example, choose to live in the Labour areas immediately north of the river in the centre of the city. They do so because of the local culture, which in turn reinforces their own opinions and voting habits. So we have a Schelling-type process underpinning the electoral map, overlaid with the kind of self-reinforcing feedbacks which pervade modern life.

A very American outcome in Europe’s leading city!

Tuesday, 8 May 2012

Compulsion or Co-operation: Curbing Executive Pay

Andrew Moss, who has been in charge of Aviva since 2007, has become the third chief executive to quit amid increasing shareholder discontent in recent weeks, following David Brennan at AstraZeneca and Trinity Mirror’s Sly Bailey. Just what is going on with the public limited company, one of the great inventions of capitalism?

It has provided a flexible legal framework for dynamic activity and innovation for centuries. The structure really took hold and boomed in the late 19th century, when the first truly global, multi-national enterprises emerged. And it continues to be by far the most important building block of the Western economic system, which has delivered prosperity beyond the wildest dreams of previous generations.

For most of its existence, the joint stock company has operated without its validity being queried in the wider political economy domain. In the decades of rapid growth which followed the Second World War, for example, executives were well remunerated. But there was a general feeling that everyone was benefiting from the rise in prosperity.

But since the 1980s, there has been growing criticism of the way in which the corporate system operates. Many readers will recall the public vilification of one Cedric Brown, the hapless chief executive of the newly privatised British Gas. His ‘crime’ was to be paid the unheard of sum of £400,000 a year. Today, even allowing for inflation, most chief executives appear to require many times this amount simply to get out of bed.

The present crisis of public confidence in the institution of the public limited liability company was of course triggered by the financial collapse of the late 2000s. It is not just that confidence has been eroded. Outright rage has risen dramatically, with the protests often taking the form of demonstrations against capitalism itself.

The public appears to accept huge rewards when they appear merited. Footballers, film stars, rock musicians, the founders of Facebook and Google – very few seem to begrudge them what the Labour Party’s old Clause Four used to call, in its quaint way, ‘the full fruits of their industry’.

The real concern is of course what appear to be massive rewards for failure, combined with hostility to the enormous gap which has emerged between the rewards of the board and the remuneration of the rest of the workforce.

One response to the problem is what by now has become the knee jerk reaction of what we might call the interventionist class. The politicians and public sector bureaucrats who believe that rules can be devised to solve any problem. And preferably rules which are administered by themselves or by their peers in specially created agencies, replete with ever-rising numbers of support staff and gold plated pensions.

The alternative relies on a view of the world which is the complete antithesis of that of the would-be central planner. Just like the natural world, our social and economic systems are at heart evolutionary. They do not stand still. Behaviour changes, often in unpredictable ways, and at unexpected speed.

Much of our behaviour is increasingly driven not by the calculations of Economic Person, rationally weighing up the pros and cons of all the alternatives, pondering in splendid isolation. Instead, we act by copying, by imitating the behaviour of our peers. The principle is very familiar in the world of popular fashion. Remember Crocs? Shoes with holes in. Suitable perhaps for Arizona or Adelaide, but hardly for rainy Seattle or Scotland. Yet they swept the market. Once they became fashionable, people wanted them simply because others had them.

Copying or imitation exists at far more elevated levels. In the 1990s, it became fashionable to have an independent central bank. Yet it is hard to argue that the Bank of England, granted independence by Gordon Brown and Ed Balls, has covered itself in glory. And the European Central Bank was not exactly on the qui vive both before and during the financial crisis. The choice was hardly justifiable on so-called rational criteria.

We have seen exactly the same principle of copying operating in the shareholder revolts against what is often pure looting of the company by senior executives. James Caynes, for example, the chairman and chief executive of Bear Stearns, was paid $40 million cash between 2004 and 2006 and made millions more by selling his shares. He presided over the destruction of virtually the whole value of the shares in the bank during 2007. Many more have followed in his wake.

Yet it is only now that shareholders are exercising their power and calling companies to account. Their actions show the basic, fundamental strength of capitalism, its endless capacity to renew and recreate itself. But they also show the inherent unpredictability of the modern economy, the great difficulty of predicting the tipping point, when the consensus moves decisively in a new direction, almost regardless of ‘objective’ reality.

We have passed the tipping point. The fashion is for shareholders to become even more active, to devise new ways of holding executives to account for their performance and remuneration. More regulation, more red tape is the last thing that we need right now.

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