Economics focus
Looking good by doing good
Jan 15th 2009
From The Economist print edition
Rewarding people for their generosity may be counterproductive
Illustration by Jac DepczykA LARGE plaque in the foyer of Boston’s Institute for Contemporary Art (ICA), a museum housed in a dramatic glass and metal building on the harbour’s edge, identifies its most generous patrons. Visitors who stop to look will notice that some donors—including two who gave the ICA over $2.5m—have chosen not to reveal their names. Such reticence is unusual: less than 1% of private gifts to charity are anonymous. Most people (including the vast majority of the ICA’s patrons) want their good deeds to be talked about. In “Richistan”, a book on America’s new rich, Robert Frank writes of the several society publications in Florida’s Palm Beach which exist largely to publicise the charity of its well-heeled residents (at least before Bernard Madoff’s alleged Ponzi scheme left some of them with little left to give).
As it turns out, the distinction between private and public generosity is helpful in understanding what motivates people to give money to charities or donate blood, acts which are costly to the doer and primarily benefit others. Such actions are widespread, and growing. The $306 billion that Americans gave to charity in 2007 was more than triple the amount donated in 1965. And though a big chunk of this comes from plutocrats like Bill Gates and Warren Buffett, whose philanthropy has attracted much attention, modest earners also give generously of their time and money. A 2001 survey found that 89% of American households gave to charity, and that 44% of adults volunteered the equivalent of 9m full-time jobs. Tax breaks explain some of the kindness of strangers. But by no means all.
Economists, who tend to think self-interest governs most actions of man, are intrigued, and have identified several reasons to explain good deeds of this kind. Tax breaks are, of course, one of the main ones, but donors are also sometimes paid directly for their pains, and the mere thought of a thank-you letter can be enough to persuade others to cough up. Some even act out of sheer altruism. But most interesting is another explanation, which is that people do good in part because it makes them look good to those whose opinions they care about. Economists call this “image motivation”.
Dan Ariely of Duke University, Anat Bracha of Tel Aviv University, and Stephan Meier of Columbia University sought, through experiments, to test the importance of image motivation, as well as to gain insights into how different motivating factors interact. Their results, which they report in a new paper*, suggest that image motivation matters a lot, at least in the laboratory. Even more intriguingly, they find evidence that monetary incentives can actually reduce charitable giving when people are driven in part by a desire to look good in others’ eyes.
The crucial thing about charity as a means of image building is, of course, that it can work only if others know about it and think positively of the charity in question. So, the academics argue, people should give more when their actions are public.
To test this, they conducted an experiment where the number of times participants clicked an awkward combination of computer keys determined how much money was donated on their behalf to the American Red Cross. Since 92% of participants thought highly of the Red Cross, giving to it could reasonably be assumed to make people look good to their peers. People were randomly assigned to either a private group, where only the participant knew the amount of the donation, or a public group, where the participant had to stand up at the end of the session and share this information with the group. Consistent with the hypothesis that image mattered, participants exerted much greater effort in the public case: the average number of clicks, at 900, was nearly double the average of 517 clicks in the private case.
However, the academics wanted to go a step further. In this, they were influenced by the theoretical model of two economists, Roland Benabou, of Princeton University, and Jean Tirole, of Toulouse University’s Institut d’Economie Industrielle, who formalised the idea that if people do good to look good, introducing monetary or other rewards into the mix might complicate matters. An observer who sees someone getting paid for donating blood, for example, would find it hard to differentiate between the donor’s intrinsic “goodness” and his greed.
Blood money
The idea that monetary incentives could be counterproductive has been around at least since 1970, when Richard Titmuss, a British social scientist, hypothesised that paying people to donate blood would reduce the amount of blood that they gave. But Mr Ariely and his colleagues demonstrate a mechanism through which such confounding effects could operate. They presumed that the addition of a monetary incentive should have much less of an impact in public (where it muddles the image signal of an action) than in private (where the image is not important). By adding a monetary reward for participants to their experiment, the academics were able to confirm their hypothesis. In private, being paid to click increased effort from 548 clicks to 740, but in public, there was next to no effect.
The trio also raise the possibility that cleverly designed rewards could actually draw out more generosity by exploiting image motivation. Suppose, for example, that rewards were used to encourage people to support a certain cause with a minimum donation. If that cause then publicised those who were generous well beyond the minimum required of them, it would show that they were not just “in it for the money”. Behavioural economics may yet provide charities with some creative new fund-raising techniques.
*”Doing Good or Doing Well? Image Motivation and Monetary Incentives in Behaving Prosocially”, by Messrs Ariely, Bracha and Meier. Forthcoming in American Economic Review, March 2009.
Monday, January 19, 2009
Thursday, January 08, 2009
A thought on recession
The recession experienced by Prophet Yusuf a.s was caused by the drought for 7 years. May be during that time recession only happened because of natural calamities or real factors. Nowadays, mankind create the cause (i.e fragile monetary system) plus natural clamities and the real factors.
Friday, January 02, 2009
Defining depression
Economics focus
Diagnosing depression
Dec 30th 2008
From The Economist print edition
What is the difference between a recession and a depression?
THE word “depression” is popping up more often than at any time in the past 60 years, but what exactly does it mean? The popular rule of thumb for a recession is two consecutive quarters of falling GDP. America’s National Bureau of Economic Research has officially declared a recession based on a more rigorous analysis of a range of economic indicators. But there is no widely accepted definition of depression. So how severe does this current slump have to get before it warrants the “D” word?
A search on the internet suggests two principal criteria for distinguishing a depression from a recession: a decline in real GDP that exceeds 10%, or one that lasts more than three years. America’s Great Depression qualifies on both counts, with GDP falling by around 30% between 1929 and 1933. Output also fell by 13% during 1937 and 1938. The Great Depression was America’s deepest economic slump (excluding those related to wars), but at 43 months it was not the longest: that dubious honour goes to the one in 1873-79, which lasted 65 months.
Click here
Japan’s “lost decade” in the 1990s was not a depression, according to these criteria, because the largest peak-to-trough decline in real GDP was only 3.4%, over the two years to March 1999. Since the second world war, only one developed economy has suffered a drop in GDP of more than 10%: Finland’s contracted by 11% during the three years to 1993, mainly thanks to the collapse of the Soviet Union, then its biggest trading partner.
Emerging economies, however, have been much more depression-prone. Among the 25 emerging economies covered each week in the back pages of The Economist, there have been no fewer than 13 instances in the past 30 years of a decline in real GDP of more than 10%. Argentina and Poland were afflicted twice. Indonesia, Malaysia and Thailand all suffered double-digit drops in output during the Asian crisis of 1997-98, and Russia’s GDP shrank by a shocking 45% between 1990 and 1998.
The left-hand chart shows The Economist’s ranking of slumps in developed and emerging economies over the past century. It excludes those during wartime (both Germany and Japan, for example, saw output plunge by 50% or more after 1944). The depressions in Germany and France in the 1930s make it into the top 12, but not that in Britain, where GDP fell by a relatively modest 6%.
Before the 1930s all economic downturns were commonly called depressions. The term “recession” was coined later to avoid stirring up nasty memories. Even before the Great Depression, downturns were typically much deeper and longer than they are today (see right-hand chart). One reason why recessions have become milder is higher government spending. In recessions governments, unlike firms, do not slash spending and jobs, so they help to stabilise the economy; and income taxes automatically fall and unemployment benefits rise, helping to support incomes. Another reason is that in the late 19th and early 20th centuries, when countries were on the gold standard, the money supply usually shrank during recessions, exacerbating the downturn. Waves of bank failures also often made things worse.
But a recent analysis by Saul Eslake, chief economist at ANZ bank, concludes that the difference between a recession and a depression is more than simply one of size or duration. The cause of the downturn also matters. A standard recession usually follows a period of tight monetary policy, but a depression is the result of a bursting asset and credit bubble, a contraction in credit, and a decline in the general price level. In the Great Depression average prices in America fell by one-quarter, and nominal GDP ended up shrinking by almost half. America’s worst recessions before the second world war were all associated with financial panics and falling prices: in both 1893-94 and 1907-08 real GDP declined by almost 10%; in 1919-21, it fell by 13%.
The economic slumps that followed the collapse of the Soviet Union and those during the Asian crisis were not really depressions, argues Mr Eslake, because inflation increased sharply. On the other hand, Japan’s experience in the late 1990s, when nominal GDP shrank for several years, may qualify. A depression, suggests Mr Eslake, does not have to be “Great” in the 1930s sense. On his definition, depressions, like recessions, can be mild or severe.
Another important implication of this distinction between a recession and a depression is that they call for different policy responses. A recession triggered by tight monetary policy can be cured by lower interest rates, but fiscal policy tends to be less effective because of the lags involved. By contrast, in a depression caused by falling asset prices, a credit crunch and deflation, conventional monetary policy is much less potent than fiscal policy.
Yes, we have no bananas
Where does that leave us today? America’s GDP may have fallen by an annualised 6% in the fourth quarter of 2008, but most economists dismiss the likelihood of a 1930s-style depression or a repeat of Japan in the 1990s, because policymakers are unlikely to repeat the mistakes of the past. In the Great Depression, the Fed let hundreds of banks fail and the money supply shrink by one-third, while the government tried to balance its budget by cutting spending and raising taxes. America’s monetary and fiscal easing this time has been more aggressive than Japan’s in the 1990s.
However, these reassurances come from many of the same economists who said that a nationwide fall in American house prices was impossible and that financial innovation had made the financial system more resilient. Hopefully, they will be right this time. But this crisis was caused by the largest asset-price and credit bubble in history—even bigger than that in Japan in the late 1980s or America in the late 1920s. Policymakers will not make the same mistakes as in the 1930s, but they may make new ones.
In 1978 Alfred Kahn, one of Jimmy Carter’s economic advisers, was chided by the president for scaring people by warning of a looming depression. Mr Kahn, in his next speech, simply replaced the offending word, saying “We’re in danger of having the worst banana in 45 years.” America’s economy once again has a distinct whiff of bananas.
Diagnosing depression
Dec 30th 2008
From The Economist print edition
What is the difference between a recession and a depression?
THE word “depression” is popping up more often than at any time in the past 60 years, but what exactly does it mean? The popular rule of thumb for a recession is two consecutive quarters of falling GDP. America’s National Bureau of Economic Research has officially declared a recession based on a more rigorous analysis of a range of economic indicators. But there is no widely accepted definition of depression. So how severe does this current slump have to get before it warrants the “D” word?
A search on the internet suggests two principal criteria for distinguishing a depression from a recession: a decline in real GDP that exceeds 10%, or one that lasts more than three years. America’s Great Depression qualifies on both counts, with GDP falling by around 30% between 1929 and 1933. Output also fell by 13% during 1937 and 1938. The Great Depression was America’s deepest economic slump (excluding those related to wars), but at 43 months it was not the longest: that dubious honour goes to the one in 1873-79, which lasted 65 months.
Click here
Japan’s “lost decade” in the 1990s was not a depression, according to these criteria, because the largest peak-to-trough decline in real GDP was only 3.4%, over the two years to March 1999. Since the second world war, only one developed economy has suffered a drop in GDP of more than 10%: Finland’s contracted by 11% during the three years to 1993, mainly thanks to the collapse of the Soviet Union, then its biggest trading partner.
Emerging economies, however, have been much more depression-prone. Among the 25 emerging economies covered each week in the back pages of The Economist, there have been no fewer than 13 instances in the past 30 years of a decline in real GDP of more than 10%. Argentina and Poland were afflicted twice. Indonesia, Malaysia and Thailand all suffered double-digit drops in output during the Asian crisis of 1997-98, and Russia’s GDP shrank by a shocking 45% between 1990 and 1998.
The left-hand chart shows The Economist’s ranking of slumps in developed and emerging economies over the past century. It excludes those during wartime (both Germany and Japan, for example, saw output plunge by 50% or more after 1944). The depressions in Germany and France in the 1930s make it into the top 12, but not that in Britain, where GDP fell by a relatively modest 6%.
Before the 1930s all economic downturns were commonly called depressions. The term “recession” was coined later to avoid stirring up nasty memories. Even before the Great Depression, downturns were typically much deeper and longer than they are today (see right-hand chart). One reason why recessions have become milder is higher government spending. In recessions governments, unlike firms, do not slash spending and jobs, so they help to stabilise the economy; and income taxes automatically fall and unemployment benefits rise, helping to support incomes. Another reason is that in the late 19th and early 20th centuries, when countries were on the gold standard, the money supply usually shrank during recessions, exacerbating the downturn. Waves of bank failures also often made things worse.
But a recent analysis by Saul Eslake, chief economist at ANZ bank, concludes that the difference between a recession and a depression is more than simply one of size or duration. The cause of the downturn also matters. A standard recession usually follows a period of tight monetary policy, but a depression is the result of a bursting asset and credit bubble, a contraction in credit, and a decline in the general price level. In the Great Depression average prices in America fell by one-quarter, and nominal GDP ended up shrinking by almost half. America’s worst recessions before the second world war were all associated with financial panics and falling prices: in both 1893-94 and 1907-08 real GDP declined by almost 10%; in 1919-21, it fell by 13%.
The economic slumps that followed the collapse of the Soviet Union and those during the Asian crisis were not really depressions, argues Mr Eslake, because inflation increased sharply. On the other hand, Japan’s experience in the late 1990s, when nominal GDP shrank for several years, may qualify. A depression, suggests Mr Eslake, does not have to be “Great” in the 1930s sense. On his definition, depressions, like recessions, can be mild or severe.
Another important implication of this distinction between a recession and a depression is that they call for different policy responses. A recession triggered by tight monetary policy can be cured by lower interest rates, but fiscal policy tends to be less effective because of the lags involved. By contrast, in a depression caused by falling asset prices, a credit crunch and deflation, conventional monetary policy is much less potent than fiscal policy.
Yes, we have no bananas
Where does that leave us today? America’s GDP may have fallen by an annualised 6% in the fourth quarter of 2008, but most economists dismiss the likelihood of a 1930s-style depression or a repeat of Japan in the 1990s, because policymakers are unlikely to repeat the mistakes of the past. In the Great Depression, the Fed let hundreds of banks fail and the money supply shrink by one-third, while the government tried to balance its budget by cutting spending and raising taxes. America’s monetary and fiscal easing this time has been more aggressive than Japan’s in the 1990s.
However, these reassurances come from many of the same economists who said that a nationwide fall in American house prices was impossible and that financial innovation had made the financial system more resilient. Hopefully, they will be right this time. But this crisis was caused by the largest asset-price and credit bubble in history—even bigger than that in Japan in the late 1980s or America in the late 1920s. Policymakers will not make the same mistakes as in the 1930s, but they may make new ones.
In 1978 Alfred Kahn, one of Jimmy Carter’s economic advisers, was chided by the president for scaring people by warning of a looming depression. Mr Kahn, in his next speech, simply replaced the offending word, saying “We’re in danger of having the worst banana in 45 years.” America’s economy once again has a distinct whiff of bananas.
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