Buoyant Economies

On the psychology of economic incompetence  

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In Norman Dixon’s book entitled “On the Psychology of Military Incompetence” he describes how military generals disregard the facts and make decisions that result in disasters.  For example, he considers how the “highly intelligent” General Percival failed to act in time to protect Singapore against the advancing Japanese force.  “Even the Japanese were staggered . . . by the ease, speed and enormity of their success.”

The human attributes that Dixon identifies in military leaders that lead to military disasters can exist in any profession, including economists.  Dixon’s thesis can best be summed up in the following statement:

the greater the impact of new information the more strenuously will it be resisted.  There are several reasons for this dangerous conservatism.  ‘New’ information has, by definition, high information content, and therefore:

·        firstly it will require greater processing capacity;

·        secondly it threatens a return to an earlier state of gnawing uncertainty; and

·        thirdly it confronts the decision maker with the nasty thought that he may have been wrong. 

No wonder he tends to turn a blind eye!

I will quote an example that Dixon uses but modified to make it more relevant for economists. 

Acquiring knowledge involves the reduction of ignorance through the acquisition of facts, but ignorance is rarely absolute and its reduction rarely total.  Hence reducing ignorance can be regarded as reducing uncertainty about a given state of affairs.  It follows that an unlikely or unexpected fact contains more information (i.e., reduces more uncertainty than one which is expected.  But an unexpected fact is less readily absorbed than one which was expected.  If this is less than crystal clear, consider the following example, cast in a suitably economic policy context.  The message in this case consists of an analytical report which states: “There is no evidence to support the theory that the fiscal deficit is directly responsible for the current account deficit.”

Now this report, factually so simple, contains amounts of information which differ greatly from one senior economic policy advisor to another.  To senior economic advisor "A" who already expected that there was no relationship between the two deficits, it conveys very little; it merely confirms a hypothesis which he already held.  In fact he has developed policies that are based on this understanding and the report, when it came, was largely redundant.

In the case of senior economic advisor "B", however, the same report was quite unexpected.  He had relied on the twin deficits theory to justify his policies.  So little had he anticipated that the report was charged with information.  It gave him plenty to occupy his mind and much to do.

Finally we have senior economic advisor "C", for which the report was so totally unexpected that he chose to ignore it, with disastrous results.  It conflicted with his preconceptions.  It clashed with his wishes.  It emanated, so he thought, from an unreliable source.  Since the mind was closed to its inception, he found plenty of reasons for refusing to believe it.  Its information-content was just too high for his channel of limited capacity.

One particularly hazardous aspect of the relationship between information and the decision process concerns the revising of decisions.  It seems that having gradually (and perhaps painfully) accumulated information in support of a decision, people become loath to accept contrary evidence. Yet in economics, the consequences can be more disastrous than in military battles. 

For example, Churchill appreciated the value of the English pound following World War I.  This led to high unemployment in the United Kingdom.  Although he later realised it was a mistake, he refused to reverse his decision. 

One country that appeared to have a senior economic advisor of type B is the Philippines.  The Central Bank of the Philippines has acted to change their monetary policies once they were aware of the relationship between commercial bank credit and the current account deficit under a closed floating exchange rate system.  They once had large current account deficits but now have current account surpluses.     


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