WSJ article about gas prices

[bobman0330]

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The Rational Herd
November 23, 2005; Page A17

A handy idea for making sense of the modern world is the idea of an "availability cascade." It employs economics to explain how people come to hold faddish beliefs, even when those beliefs are at odds with other beliefs they hold or information they possess.

You can see this dynamic in Washington's lowbrow burlesque over gasoline prices. The idea is also known as rational herding. Senators in the recent grilling of energy CEOs couldn't have made it plainer that they were flinging charges of manipulation not because they believed them but because they believed their constituents believe them. Senators also let it be known they were perfectly prepared to enact unwise policies rather than argue with constituent misperceptions.

Said Republican Pete Domenici: "Polls show that our people have a growing suspicion that the oil companies are taking unfair advantage of the current market conditions to line their coffers with excess profits . . . My constituents think that somebody rigs these prices, that in the process somebody is getting ripped off."

Said Democrat Byron Dorgan, explaining why he was forced to introduce a bill confiscating the "windfall" profits of oil companies: "A consumer says to us, 'You know, Mr. and Mrs. Politician, what I see are big economic interests getting rich here.'"

This hand-washing is the essence of childishness but the political class is far from the helpless sock puppet of an ignorant or misinformed public. The same voters, in any poll, would happily affirm that the world is running out of oil, that the supply is controlled by unreliable foreigners. Yet let gasoline rise to $3.00 a gallon, and suddenly they believe that only the ruthless profiteering of oil companies stands between them and cheap and abundant gasoline.

The public doesn't adopt beliefs directly at odds with its other beliefs without help. In the latest instance, help came from state attorneys general who, at the first sign of a spiking gas prices, ran to the nearest TV cameras and proclaimed crackdowns on price gouging. It came from the media and politicians declaiming against Exxon's quarterly profit of $10 billion as aberrant and suspicious -- never mind that at 10% of sales, Exxon's profit margin was hardly out of line with those of other industries.

'Availability cascade" is a term coined by Cass Sunstein and Timur Kuran in an important 1999 Stanford Law Review article. Their work follows distinguished prior work on informational cascades (when people knowing little about an issue take their cue from others) and reputational cascades (involving the rational incentive to go along with the crowd). All owe a debt to the Nobel Prize-winning work of Daniel Kahneman and Amos Tversky, who coined the term "availability bias" for people's willingness to judge the odds of a given event occurring based on how readily an example comes to mind.

The key is to remember that acquiring information is costly and that people look for shortcuts. Imagine a situation in which gifts are being distributed in red and blue boxes. You don't know what the boxes contain but everyone in line is asking for a red box. Therefore, you ask for a red box too, assuming they must know something you don't and because you want to appear "in the know" too.

This is rational herding. Now consider that everyone was thinking just like you, and that the chain began only because a prominent individual was seen picking a red box.

Put aside the reliance on jargon: That even intelligent people are capable of holding passionate views on matters to which they have given little thought or study is hardly a revelation. A plausible explanation indeed is that such people model their beliefs on the apparent beliefs of others whom they presume to be better informed.

Though the authors focused in their original article on environmental scares (and cited the presence of "availability entrepreneurs" who try to advance their agendas by inciting public misperceptions), their reasoning is widely applicable. After all, what was the collective estimate of the world's intelligence agencies about Saddam's WMD but an informational cascade? And, with rather more deliberation, what are Democrats now trying to create but an availability cascade for the belief that the Bush administration "lied" about Saddam's capabilities and intentions?

Messrs. Kuran and Sunstein used their Stanford article to suggest formal mechanisms to slow availability cascades that "spread empirically baseless information" and create "formidable political pressure in support of wasteful or counterproductive regulations." Among their ideas were creating a respected website to retail accurate risk information and greater reliance on formal risk-benefit analysis and peer review in the legislative and regulatory process.

Pierre Lemeiux, an economist at the University of Quebec who has also explored the practical implications of this work, points to cascade theory as reinforcing the classical case for protecting unpopular speech and cultivating the checks and balances of a decentralized state.

The danger of public herding in the media age is obvious but it can be overstated. Informational cascades are inherently fragile -- because they're based on slight information, thus ripe to be reversed when better information becomes available. It's the "reputational cascades" -- in which influential members of the public adopt positions based on fear of unpopularity or career damage -- and the resulting unnatural unanimity among elites that poses the real danger. So the senators rushing to enact punitive attacks on oil companies -- and blaming public opinion for making them do it -- let themselves off the hook too easily.

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[tylerdurden]

If oil companies can so easily "manipulate" prices to produce these "windfall" profits, why the hell did they wait so long to do it? Shouldn't their shareholders sue them for dereliction when they failed to show any profits for such long periods?