A sideways look at economics

You may recall my beaming mood in my last blog post, courtesy of schools remaining open during lockdown? It didn’t last. Home-schooling was back in less than a week, and I was again guzzling down the latest vintage of Chateau Sour Grapes by the bucket-load. However, with schools due to reopen in about 220 hours – not that I’m counting – I will not bore you with a therapeutic rant. Instead, I am going to pass on my tip to surviving lockdown and home-schooling, which is to put in place a network of small pleasurable experiences, that can nudge our expectations about life away from the ‘low’ setting they have been stuck on for so long.

The deep, melancholic, yet warm embrace of Johnny Cash’s voice kicked off this process for me, as these lyrics echoed around the house[1]:

You can stand me up at the gates of Hell
But I won’t back down

Gonna stand my ground, won’t be turned around
And I’ll keep this world from draggin’ me down
Gonna stand my ground and I won’t back down.

The song came on a couple of weekends ago in the depths of the winter gloom, with Christmas holidays a distant memory and the lockdown tunnel stretching endlessly ahead. The music gave me a jolt, producing an endorphin boost that transformed my attitude to the ordinary game of Monopoly that I was about to embark on with the family.

My daughter, Juliette (or Juji, Juj, Ana, Sweety Monster and at least another 15 nicknames) asserted in non-negotiable terms, and somewhat worryingly, that she was going to be the Bank. My wife, Christine (lots of nicknames here too, but let’s keep these private), was a reluctant participant in the game after having previously been trashed by my son’s odds-defying luck. My son, Gabriele (or Gabri, Gabi, Gabs, Pitch and at least another 15 nicknames) was rubbing his hands at the prospect of getting one over both adults in the house yet again. As for me, I would rather have watched football, but my son’s smug glee and those lyrics triggered my childish and competitive side.

My resounding win released another small, pleasurable high. I needed to win – for educational purposes, obviously. It was one of those critical moments for an economist parent who wants to preserve a shred of credibility. Anyone who has spent more than ten minutes on a video call with me knows that my kids have a regular habit of checking on their father. It is a gesture motivated less by concern for my well-being, I believe, than by curiosity about what the hell I talk about all day – a curiosity that I often share. You can imagine the awkwardness of losing at Monopoly and then having to explain what a monopoly is to an eight-year-old. They would be as engaged in the conversation as someone who had invested his entire family wealth in Bitcoin at $1000 and been able to retire early on the proceeds, listening to some finance expert trashing cryptocurrencies. This time however, after my resounding victory, the pedagogical message hit satisfyingly home.

Indeed, the post-game frustration visible on my son’s face was a reminder to be humble in victory and to tone down the customary winning parade of showering in Monopoly cash (which Juji, the Bank, seemed to enjoy). I went over and congratulated Gabri on a hard-fought game and told both kids that if Gabs had not made one simple mistake, I would have been certain to succumb to his legendary luck. His rookie mistake, I went to explain, was to be complacent and judge his winning odds to be high based on his large cash pile, rather than on his less conspicuous asset base. ‘Cash is trash’ quickly became the mantra of the evening, as pillow fights started to mix with the flying banknotes. Worried that things were getting out of hand and that one of the kids might grab my phone and place all the family savings on GameStop shares, I elaborated a little more.  In fact, I spent the rest of the afternoon imparting a first, half-serious lesson on investment, touching on the difference between zero-sum situations versus investing for growth. I won’t hide a surge in pride when Gabi steered the conversation firmly towards incentives, a particular fascination of mine. During the game, I had made him a series of progressively less fair offers as my grip on the board tightened. The idea that a fair deal is often conditional on the situation faced and dictated by relative bargaining powers had clearly left a mark.

With disarming innocence, he asked me ‘Are monopolies then a good thing?’, partly to make sure that we had not just indulged in an unsavoury activity, and partly to check his understanding of what I had explained. I gave him a typical economist’s ‘It depends’ answer, about striking a balance between providing the right incentives for growth and innovation, and preserving consumer choices. He probed further, with ‘Can you give me an example of a monopoly?’ And here I realised that it is actually quite difficult to come up with examples that an eight-year-old can relate to these days. Telephone companies, utilities and transport are either no longer technically true monopolies or too abstract. The Internet Explorer story didn’t ring a bell with Gabi, though at least he could relate to the idea of being forced to use only one browser. As I was racking my brains for a better example, he interjected with ‘Like Amazon, maybe, then?’ I gently rebuffed the idea, suggesting that we have choices other than Amazon – despite the evidence of the pile of empty delivery boxes littering the hallway. Curious about his thought processes, I asked him why he came to that conclusion. He then started reciting what could have passed for an exceptionally cogent Reddit FOMO thread, listing how his consumerist universe was very narrowly dominated by Google, Amazon and Netflix (plus Lego and Harry Potter).

I found contrasting my son’s reality with my own childhood experience quite fascinating. My universe as an eight-year old was bombarded by a much broader set of brands vying for my attention. Neither parents nor kids were unambiguously better off from this greater competition, but we were certainly aware of it. Indeed, my parents would curtail access to the TV to avoid the aggravation that came from the relentless advertising that would inevitably get us obsessed with some toy. Even I would have much preferred to do away with the adverts, so that I could binge uninterrupted on Japanese animation. Today, companies can observe our behaviours, and have no need to scream at us. The result is that our life risks being monopolised by fewer brands (theoretically not ideal from an economic standpoint) without us even noticing that it’s going on until we stop and think about it.

As Johnny Cash, the kids and the monopoly lessons faded into the evening, I thought about this conversation with my son. It became clear that the difference between my experience and that of my kids was fully accounted for by technology and the progressive dominance of network effects, as predicted by Metcalfe’s Law. This Law states that the value of a network increases with the power of the number of its users, while the costs increase only linearly with the number of users. For example, a network that has 10 users and subsequently doubles to 20 will see its cost double, but its value quadrupled (20^2 vs 10^2). The effects of Metcalfe’s Law are ubiquitous.

In economics, it has potentially far-reaching effects on how monopolies are both defined and contrasted. It predicts huge first mover advantages, implicit barriers to entry, novel systemic vulnerabilities and winner-takes-all outcomes. It has massive implications for inflation and growth and their joint relationship. In finance, it is used to justify loftier valuations for companies generating revenues through network dynamics, relative to more traditional ones. It also makes risk-return trade-offs more binary, it incentivises lottery ticket behaviours and potentially raises the frequency of sharp bouts of market volatility. In geopolitics, it provides the strategic framework for the spread of propaganda and disinformation dynamics. Fathom has always exploited network effects, since its early days focusing on providing clients with an integrated offering across macroeconomics, financial markets and geopolitics, rather than restricting itself to any single one. More recently, we have also started to embed network effects directly in our tools, models and projects – such as the Financial Vulnerability Indicator – to incorporate contagion and non-linear dynamics.

Metcalfe’s Law is an integral part of what makes us human too. The synapses in our brains obey this principle, guaranteeing an extraordinary adaptability and the capacity to find the most diverse and creative association of ideas (as this blog entry probably demonstrates). A recent psychology article also argues that the size of our broadest network matters for our well-being.  The direct feedback and network effects that accrue from positive, low level interactions, such as a smile or a quick bar chat with strangers, significantly enhance our welfare.

The COVID pandemic may offer eerie parallels with Tennessee Williams’s play ‘A Streetcar Named Desire’, where Blanche’s internment at a mental institution curtails her ability to continue depending ‘on the kindness of strangers’. One cold winter afternoon spent playing Monopoly, surrounded by laughter, love and random musings, and with the right tune playing in the background, certainly felt like the remedy for the current lack of social interactions. Harnessing the network of small pleasures surrounding us will stand us all in good stead for the great comeback. Strangers, you’d better be ready.

[1] Before you say anything: I’m aware that it’s a Tom Petty song, but the Johnny Cash cover is just better in every way, as well as more apt to the mood of the moment