Tim Harford The Undercover Economist
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Undercover Economist

Why tax systems are trickier than Martian algebra

Only radical restructuring has a chance of creating fair taxation, writes Tim Harford

Tax is a divisive subject but everyone seems to agree on one point: taxes are too complicated and should be simpler. Unfortunately, tax systems did not receive the memo.

In the UK only a few years ago, almost everyone in work used to be taxed at a marginal rate of either 31 per cent or 41 per cent, depending on how much they earned. (If Brits do not recognise those numbers, it is because the UK has two cumulative systems of income tax, one of which goes by the code name of “national insurance”.)

The system is trickier today than Martian algebra. Paul Johnson of the Institute for Fiscal studies points out that, over different levels of income, a non-working spouse with two children will be taxed at marginal rates of 12 per cent, 32 per cent, infinity, 42 per cent, 60 per cent, 42 per cent, 60 per cent, 42 per cent and 47 per cent. You might ask what kind of muppet designed a tax schedule like that, and one answer would be George Osborne, chancellor of the exchequer, and Alistair Darling, his predecessor – the last two men to be in charge of the UK tax system.

Another answer would be that this is just the sort of thing that happens without diligent maintenance. Window frames rot. Iron structures rust. Tax systems become complex.

Having nine different marginal tax rates is an ugly sign that things are not well. There are others. Cereal bars attract value added tax at 20 per cent but flapjacks enjoy a zero rate; vegetable chips are tax-free if the vegetable in question is not a potato; dried fruit is subject to VAT unless destined for a cake. On a gingerbread man, chocolate icing attracts a substantial VAT liability unless the icing constitutes the eyes. There are more things in tax accounting, Horatio, than are dreamt of in your philosophy.

If a tax break for unfrosted gingerbread seems uniquely British in its eccentricity, it is not. Officials in New York state have been obliged to rule on the tax status of burritos. (Legally they are sandwiches and attract sales tax of 8 per cent.) Or consider Pillow Pets, a stuffed toy/ pillow whose slogan – “It’s a pillow, it’s a pet, it’s a Pillow Pet” – poses a dilemma for US Customs. For the purposes of levying a tariff, is it a pillow? Or is it a tariff-free toy pet?

Then there are tax subsidies for agricultural land in places such as Florida. Agricultural land is no easier to define than a flapjack or a sandwich. Rent a cow, let it graze on your garden or vacant lot; if that is not agriculture, what is?

All this matters not just because the rules are hard to understand and expensive to obey but also because taxes shape our behaviour. The “camelback” houses of late 19th century New Orleans, with a hump of two storeys at the rear and a long single-storey snout stretching to the street, were tax-efficient because property taxes were levied based on the number of storeys at the front of the house. Abba’s outlandish outfits are reported to have been inspired by tax rules: they were tax-deductible only if they were too outré to be worn anywhere other than on stage.

These are trivial examples of tax-efficient charm but the same principle can be harnessed for a far greater good: a carbon tax to shift our energy system towards low-carbon fuels. Well-designed taxes can raise revenue while rewarding green behaviour.

Meanwhile complex, illogical taxes raise less revenue while rewarding clever accountants. There has been outrage over celebrity tax-dodging in the UK but the tax avoidance schemes usually involve a government attempt to provide a tax incentive for the British film industry or some other hobbyhorse.

What is behind such insanities? Partly, absurd loopholes exist because special interest groups demand them; hence the subsidies for land with cows on it. Partly, voters are given the tax systems they deserve because we sympathise with highly vocal losers whenever a loophole is closed and we fall for simple tricks that hide taxes behind a veil of complication.

The UK’s two-tier income tax system is a good example. Basic income tax rates have tended to fall over time, while national insurance rates have tended to rise. True income tax rates for the typical worker are similar to those of 35 years ago but they seem much lower. The sleight of hand is politically convenient but increases complexity, creates unfairness and opens opportunities for tax avoidance.

It is tempting, then, to call for a radical simplification, for taxes simple enough to write on the back of a postcard. But this ignores the third reason that taxes are complex, which is that fair taxation is a genuinely complex business. This year’s piecemeal reform efforts become next year’s loopholes.

Only radical, systemic reform has much chance of success – and it may be less elegant than some reformers hope. A per-person “poll tax” was introduced in the UK 25 years ago, and promptly ended the premiership of Margaret Thatcher. It was undoubtedly simple – but in taxation, as in life, simplicity is not the only virtue.

Also published at ft.com.

Undercover Economist

What tech jerks can teach us

Added to the familiar gallery of corporate monsters are those making money from parasitic smartphone apps

Fat cat bankers swimming in taxpayer subsidies. Oil barons battening on indigenous peoples. Corrupt media moguls poisoning politics. To the familiar gallery of corporate monsters, a new horror has been added: tech jerks making money through parasitic smartphone apps.

The term #JerkTech was minted recently, complete with hashtag, by Josh Constine, a San Francisco-based writer for the technology website TechCrunch. Constine pointed at ReservationHop, which aimed to make reservations at popular restaurants, then sell the reservations on to eager diners; and at MonkeyParking, which allowed people parked in a public parking space to auction it off when they left. (San Francisco’s city attorney had already sent MonkeyParking a cease-and-desist letter threatening substantial fines to users.)

There are several other examples, and it seems that the world was waiting for the word JerkTech, which spread as fast as the latest internet meme – and nothing spreads faster. Before long, both MonkeyParking and ReservationHop announced a pause for reflection.

The outrage was as much a reflection of Silicon Valley’s tarnished image as about these particular business models. Stories have circulated about a misogynistic “brogrammer” culture in some tech firms, while protesters in San Francisco have objected to Google sending free buses to the city to pick up employees, thus driving up rents. Constine himself made the link between JerkTech apps and contemptible behaviour elsewhere. As with bankers, oilmen and newspaper proprietors, the debate is emotionally charged by the broader sense that technology companies may not have our best interests at heart.

At the risk of injecting a dose of logic into the debate, it seems worth asking what exactly is objectionable about JerkTech apps themselves.

What are the common features? First, commodification: they sell or take commission on the sale of something that previously wasn’t a commodity at all: a reservation to eat at a popular restaurant; the opportunity to park in a public space. These things have always been valuable but they’ve been hard to buy and sell.

This is an odd complaint. Trading something such as sex, or a kidney for transplant, might be said to change the nature of what is being traded. But a restaurant meal is already a commercial transaction. Although one restaurateur has complained that such apps are wrong because “hospitality has no price”, all the restaurants I know do expect me to pay for the food at some stage. It’s odd to insist that the reservation itself occupies a separate, almost spiritual domain.

A second complaint is that such apps rob the poor (the government, a small business, the everyday consumer) and give to the rich (people who are willing to pay a premium). This objection is also odd. Genuinely poor people rarely own cars, and being willing to pay $5 to find an otherwise-free parking space hardly requires you to be a billionaire. None of the people hoping to secure a reservation at a Michelin-starred restaurant is poverty-stricken.

The critics are on stronger ground when they point out that JerkTech firms are appropriating someone else’s property. A driver has the right to park on the street but she does not own the space that will be vacated when she moves on. A restaurant reservation service might make a reservation under a false name (“Dick Jerkson”, suggests Constine) then sell the details to a customer who will actually show up and buy a meal. If the reservation is unsold the restaurant will lose out but the JerkTech start-up faces no loss. Most reservations are made on a trust-based system, and restaurants always run the risk that this trust will be abused. But JerkTech can exploit that trust on an unprecedented scale.

This is more than an argument about propriety: JerkTech might also have consequences. Restaurants might have to demand a credit card from customers, or proof of ID. Parking JerkTech encourages people to park in the street, simply waiting for a bid to move their car. San Francisco’s city attorney alleged that one JerkTech company was planning to pay people by the hour to occupy parking spaces for resale at the right price. This is close to extortion.

. . .

And yet: when a market is being “disrupted”, that is sometimes a sign that the status quo is rotten. Scarce restaurant reservations could sensibly be sold. That is exactly what a few restaurants do – for example, Alinea in Chicago. It would be no surprise to see tech start-ups emerge to help restaurants do exactly that.

As for parking, many cities waste this scarce resource by underpricing it. Instead of paying money into the public purse, drivers pay in wasted time. Their quest for parking spaces burns fuel and causes congestion.

Two lessons emerge from JerkTech: scarce public resources shouldn’t be given away for free to all comers; and simple technology can make it easier to match scarce resources with people who need those resources. Westminster Council, in London, is rolling out a smartphone app that will help drivers find vacant parking spaces and pay for them. If JerkTech can make a market work, there’s probably a JerkTech-free way to make that market work too.

Also published at ft.com.

Undercover Economist

Crime prevention: where’s the evidence?

It may seem mind-bendingly obvious but we need to test and evaluate ideas

How do we keep young people away from a life of gangs and violent crime? You can see one answer if you fire up YouTube and type “Scared Straight” into it. You’ll have the pleasure of seeing muscular prisoners bully terrified teenagers while police officers stand by and watch. It’s an American reality TV show called Beyond Scared Straight and it’s into its seventh season.

Before Beyond Scared Straight there was Scared Straight. It was a 1978 documentary about a crime prevention programme of the same name, in which teenagers spent a day inside a prison being frightened by the inmates. The film was presented by Peter Falk at the height of his fame as Columbo, and it won an Oscar for best documentary. Its producer-director, Arnold Shapiro, went on to make the US version of Big Brother and Beyond Scared Straight.

The Scared Straight approach is popular as TV, and seems popular as public policy. But while Scared Straight was a success as a documentary, Scared Straight is a failure as a policy. We know this because, on seven occasions, administrators have allowed the programme to be evaluated rigorously using a controlled trial. Some troubled teens experienced the joys of Scared Straight while others did not, allowing a fair test of the programme’s results.

These seven rigorous evaluations form the foundation of a review of Scared Straight (and similar interventions) by the Cochrane Collaboration. The review concludes that “programmes such as Scared Straight increase delinquency relative to doing nothing at all to similar youths. Given these results, we cannot recommend this programme as a crime prevention strategy.”

If there is a question mark over a programme’s effectiveness then we need to make sure we’re not wasting effort, or even causing harm without meaning to. We should routinely test ideas, and adapt them if they’re not working. If that might seem a mind-bendingly obvious idea, let’s compare it with how programmes are evaluated in reality.

Consider Your Life You Choose (YLYC), a programme involving magistrates, police and prison officers which began in Ealing, west London, and which aims to reach 11- to 12-year-olds and steer them away from a life of crime. It hasn’t yet been rigorously evaluated.

Oddly, media reports seem to wish that YLYC was like Scared Straight, even though Scared Straight does not work. A recent headline in the London Evening Standard described YLYC as “Schoolchildren in north London taught lessons on life behind bars: Children put in handcuffs and prison van in anti-gang drive.” The article was accompanied by cheesy photographs of 11-year-olds in … well, handcuffs and a prison van.

Despite the Evening Standard’s enthusiasm for such photos, YLYC bears a blessedly superficial resemblance to Scared Straight – it’s delivered in schools, not prisons. Pam Ullstein, the YLYC project leader, says the handcuffs and van may “provide some entertainment” but are not the point of the programme. Good.

So YLYC might indeed work, and it might not. It would be wonderful to find out. Time for an evaluation?

Alas, the government’s leading authority on the matter, Damian Green – who this week lost his post as the Minister for Police and Criminal Justice – seemed to think no evaluation was needed. “Official figures demonstrate that it really is having an impact,” he said of YLYC in a speech in March.

I asked the Ministry of Justice what Green had in mind when he said this. I was directed to a page on the YLYC website itself, in which a police sergeant observes that in Ealing, youth convictions have fallen sharply in recent years. (Oddly, the web page also features Ealing’s Conservative MP, Angie Bray, praising YLYC with exactly the same words as Green: “Official figures demonstrate that it really is having an impact.”)

. . .

The fall in crime is good news, and perhaps that’s what Green and Bray mean by “official figures”. Yet youth convictions have also been falling sharply in England as a whole, so perhaps it’s a coincidence. If we are to have serious evidence on YLYC – or any other programme – we need rigorous evaluations, not a nod towards “official figures” of passing relevance.

The sociology of this is fascinating: we have an unproven programme that politicians are happy to praise and that a newspaper admires for its faint resemblance to a proven failure.

None of this is a criticism of YLYC, which may indeed be effective. We’re fortunate that people want to set up programmes such as YLYC and volunteer to support them. But we don’t want them to waste their time, so we should provide help in figuring out whether what they do actually works.

The good news is that help is available. There’s Project Oracle, for example, a new London-focused outfit that aims to support programme providers in gathering useful evidence about what’s working, while also educating the people who commission such programmes that it’s important to ask for evidence. Professor Georgie Parry-Crooke, co-director of the project, tells me that an evaluation of the effectiveness of Project Oracle itself is on the cards. That’s all to the good: reality TV is no basis for figuring out what works and what doesn’t. The evidence revolution will not be televised.

Also published at ft.com.

Undercover Economist

Underperforming on performance

State education in Britain consists not of families choosing the best schools but of good schools choosing the best families

What is the collective noun for indicators of public service performance? A thicket? A fudge? Whatever it may be, the British government has announced yet another league table, this time packed with indicators of public safety in English National Health Service hospitals.

Logging on to the NHS Choices website, I discover my local hospital is “among the worst” as far as “infection control and cleanliness” are concerned. The website adds that all “Care Quality Commission national standards” have been met. This is baffling. The hospital is filthy yet meets all care quality standards? Maybe the collective noun should be “a contradiction of indicators”.

“I think we’re getting a bit overwhelmed now with these packages of indicators,” says John Appleby, chief economist of the King’s Fund, a healthcare think-tank. “As a patient, I wouldn’t know what to make of these at all.”

If they are merely useless and confusing, that’s one thing. But some indicators in the past have caused serious collateral damage. Consider two examples from either side of the Atlantic.

In the UK in the late 1990s, Tony Blair’s government set a range of targets for how quickly ambulances should respond to emergency calls. In an “immediately life-threatening” case in an urban area, first responders should arrive within eight minutes, three-quarters of the time. The target swiftly backfired. By 2003 the data were showing odd patterns – for one ambulance service, more than 900 calls were recorded as having been met in seven minutes and 59 seconds, with just a handful met in eight minutes. The definition of “immediately life-threatening” mysteriously varied by a factor of five from one ambulance service to the next. Crews were split and given bikes or small cars, allowing a lone paramedic on a bike to hit a target, even if he couldn’t take you to hospital.

In the US, “report cards” provide data on the performance of cardiac surgeons and cardiac wards. David Dranove, Daniel Kessler, Mark McClellan and Mark Satterthwaite, four economists who studied the report cards, found a most unwelcome consequence: doctors resisted operating on the severely ill and favoured surgery for patients who might not even need it. A healthy patient is a strong candidate to thrive after heart surgery, no?

None of this should surprise. There are three ways to improve your score on any performance metric: first, actually improve performance; second, focus on ways to look good on the metric in question; third, cheat.

That said, surely performance metrics can sometimes identify and encourage what’s best in public service. What might help is a sense of who is supposed to use these metrics, and how they might react.

Gwyn Bevan of the London School of Economics suggests four models of public service. In “trust and altruism”, noble doctors and teachers always do their best, and indicators help them do their jobs. In “targets and terror”, public servants are assumed to be selfish, whipped into shape by a central government with a dashboard of performance data. In the “quasi-market” system, the indicators are provided to the public, who act as consumers and choose their preferred school or hospital. Finally, “name and shame” uses league tables to humiliate losers and lionise winners.

None of these four systems is obviously absurd, so what does the evidence suggest? Devolution in the UK provides an interesting natural experiment. The Welsh government abolished school league tables and the Scottish government eschewed targets for hospital waiting times. In both cases, researchers from Bristol University and elsewhere showed that the English system worked better. This supports “name and shame” (for schools) and “targets and terror” (for hospitals). It is bad news for the “trust and altruism” model.

We know that true markets often work well but there are question marks over the effectiveness of “quasi-markets” for education and healthcare. The British state education system consists not of families choosing the best schools but of good schools choosing the best families, while bad schools chug along without going out of business. Americans may be savvy consumers of cars or phones but appear to pay little attention to publicly available evidence on the quality of hospital care.

“Name and shame” is the idea that indicators work not because they inform bureaucratic overseers, nor because they help consumers pick the best services, but simply because nobody wants the embarrassment of propping up the bottom of a league table. It seems a crude approach but an influential research paper by Judith Hibbard, Jean Stockard and Martin Tusler found evidence that “name and shame” might work.

Hibbard and her colleagues studied how Wisconsin hospitals reacted to a report on quality of care. Some of the hospitals were included in a widely disseminated quality evaluation. Others, chosen at random, received a confidential report on their own performance – the ideal approach for a world of “trust and altruism”. A third group of hospitals received no report at all.

Hibbard’s research suggested that Wisconsin healthcare did not function as a regular market. Poorly performing hospitals were not afraid of losing market share, and rightly so. But they did make substantial efforts to improve, nonetheless – citing a concern for their reputation.

Perhaps we have that collective noun after all: it’s an “embarrassment of indicators”.

Also published at ft.com.

Undercover Economist

All aboard the volatility express

Should we treat low volatility as a portent of disaster, or as a sign that the world economy is finally on the right track?

For years this newspaper has been reporting financial markets as a rollercoaster. It was refreshing, then, to find the summer ushered in with a series of stories about how low volatility had become by early June. Yet the general tone in the financial press has been far from soothing. “It’s quiet . . . too quiet”, goes the refrain, followed by the pointed observation that the last time volatility was so low, it was just before the financial crisis began.

There is a commonsense alternative to the idea that this must be the calm before the storm: it’s that no news is good news. So which view is right? Should we treat low volatility as an eerie portent of disaster in the making, or as a sign that the world economy is finally on the right track?

The answer to the question depends on whether we look at financial markets, or at the real economy of goods and services, production and investment.

From a financial perspective, low volatility should indeed make us nervous. That’s the lesson of the late Hyman Minsky. Minsky was once neglected but, since the financial crisis, we are all Minskyites now. Your bluffer’s guide to Minsky is that when things are going well, people become complacent and take too many risks – in particular, the classic leverage risk of borrowing to invest. Calm breeds complacency. Stability is destabilising.

If this all seems a little hysterical right now, perhaps it is – but there are plenty of reasons to worry. US first-quarter growth was disappointing. China’s property market is in trouble. Geopolitics from Iraq to Crimea look shocking. The soothingly low financial volatility of early June looks surreal.

But what happens to the rest of the economy when all is calm? Nick Bloom, a British economist working at Stanford University, has a useful recent research paper on “Fluctuations in Uncertainty” in which he tries to unpick the relationship between economic turbulence and economic trouble.

In 1921, the economist Frank Knight influentially defined risk as the unknown outcome of a known probability distribution such as the toss of a coin or the spin of a roulette wheel; uncertainty, by contrast, was where the probabilities weren’t known at all. Risk is a convenient, tractable concept but uncertainty is a more realistic benchmark for dealing with most economic problems.

Bloom turns to a variety of proxy indicators of both risk and uncertainty: the VIX index, which is a market-based indicator derived from traders’ bets on volatility over the following 30 days; disagreements between economic forecasters; forecasters’ own expressions of uncertainty; newspaper mentions of the word “uncertain” or “uncertainty” and “economy” or “economics”. In all cases, these measures are higher during recessions, although the measured spike in uncertainty is usually when the recession itself is well under way, so this is not much help as a forecasting tool.

What about more fine-grained measures of uncertainty? Bloom looks at the spread between the fastest-growing and fastest-shrinking firms in each industry, and the dispersion between fast-expanding and fast-contracting manufacturing plants in the US.

No matter what the indicator, the story is similar: low volatility, low uncertainty and low dispersion are what happens in good economic times. Recessions are high-volatility, high-uncertainty and high-dispersion events. Low levels of uncertainty may breed complacency but they are also what the economy seems to need. Bloom speculates that, in a vicious circle, uncertainty is both a cause and a consequence of recessions.

. . .

There are some good theoretical reasons why growth goes hand in hand with low levels of uncertainty. Consider a company making a hard-to-reverse decision such as hiring a new permanent member of staff or buying a new factory. If the company was confident of modest growth, it should take the plunge, invest and expand. But if the forecast of modest growth is very uncertain, and growth might be exhilarating or disastrous, then why not wait and find out? If conditions turn out to be right, the factory can always be built later; the worker can always be hired tomorrow.

That makes investment sound like an emotional business but the reasoning above is a matter of pure logic. A computer or a Vulcan would recommend the “wait and see” approach as profit-maximising. Of course, when everybody is waiting, all they will see is further economic depression.

Emotion also matters, of course. Andrew Eggers and Alexander Fouirnaies, two political scientists at the London School of Economics, recently published a working paper titled “Red Zero, Black Zero”, which looked at what happened when growth figures were either fractionally above or fractionally below zero. The difference is of no direct economic consequence in its own right but triggers very different media stories. Eggers and Fouirnaies find that companies don’t worry over the distinction, but consumers do.

All this suggests that low volatility really is good news. It may be seductively dangerous for financial markets. Yet it is what both consumers and producers need to get things back on track. I hope it is no longer necessary to point out that what is worrying for market-watchers is not necessarily bad news for the rest of us.

Also published at ft.com.

Undercover Economist

Let’s play economics-by-metaphor

The patient was seriously ill. Dr Balls advised antibiotics but Dr Osborne argued it was a virus

“A riddle wrapped inside a mystery inside an enigma.” That was Winston Churchill’s view of Russia one month after the outbreak of the second world war in Europe. It was also Andy Haldane’s view of the British economy in a speech given in Scarborough on June 18. Coming from the Bank of England’s new chief economist, this seems an alarming parallel, although all Haldane meant to say was that the situation was hard to read.

Haldane, who has long given the Bank’s most thought-provoking speeches, is fond of a literary flourish – indeed, his Scarborough speech was an extended metaphor on cricket, with the uncertain prospects of the economy compared to a well-bowled cricket ball. Should the Bank respond like England’s veteran batsman Ian Bell (take the initiative, front foot forward) or like newcomer Joe Root (wait for things to become clearer, acting at the last possible moment) or, for that matter, like the long-retired Geoff Boycott (commit to a relentlessly defensive strategy regardless of circumstances)?

The context for this – although Haldane did not say it – is that his boss, Mark Carney, has abruptly shifted his stance. Carney spent the first few months of his tenure committing to low interest rates, and is suddenly warning that rates will rise sooner than anyone expects. Geoff Boycott, after fending off ball after ball, has suddenly started trying to slog everything over the members’ pavilion.

Some international readers will be none the wiser after all these cricketing similes but I’ve decided that the game of economics-by-metaphor is lots of fun, and have been pondering what the best metaphor might be for the puzzling state of the UK economy.

Haldane’s evocation of Churchill prompts me to compare the UK in 1939 with the UK in 2008. The man in charge when it all began fumbled some things badly but got no credit for good decisions in an impossible bind. The bank bailouts were like Dunkirk – a heroic, improvised, last-gasp tactic that laid some foundations for future success, while conceding that everything up to that point had basically been a catastrophe. Then came grinding dogmatism, often incompetently managed, which postponed the long slog. Eventually a victory of sorts was won thanks to the industrial power of the US; the bloodied UK was never quite the same again. (This analogy gives David Cameron the role of Winston Churchill but no parallel is ever exact.)

But what of the UK today? The image that comes to mind is of an overconfident City wide boy on gardening leave, waiting for his next well-paid job. He’s feeling flush because his flat in gentrifying Hackney has doubled in value. He’s spending liberally on home improvements, on restaurant meals, on cocaine and Polish lap-dancers. (The Office for National Statistics will now be recording this activity as part of GDP.) Above all, he’s buying nice stuff from abroad. There is lots of activity for the low-paid service sector and for importers but whether our City boy will actually get another real job soon is an open question.

Perhaps instead we should view the British economy as a fractious marriage. Hubby is English; swaggering and self-obsessed, he keeps telling his Scottish wife she’s beautiful and that they’re great together. Yet he never takes her seriously or listens to a word she says. She yearns to get away from him but she’s afraid to leave. Her single friends in Iceland and Ireland have had some tough times but at least they have their identity and self-respect. He’s cocky and has convinced himself that she’s never going to leave him, yet she may well walk out a few months before Christmas. Any divorce is going to be hellish because their financial affairs are all tangled up together. He’s probably going to get angry, resentful and drunk, and, before you know it, he’ll say something he regrets to his neighbours Angela and François. Give him five years and he’ll quit the neighbourhood entirely to spend the following decade in his vest and underpants, obsessed with whatever’s on Sky.

. . .

Then there’s the question of who takes the credit for what is, undoubtedly, a far stronger recovery than anyone expected a couple of years ago. Here a medical metaphor may suffice.

For a long time the patient was seriously ill. Dr Ed Balls advised a short course of mild antibiotics, on the grounds that a long course of strong antibiotics would be too expensive. Dr George Osborne argued that the patient was suffering from a virus and antibiotics would simply be wasteful and ineffective. No reliable diagnosis being available, the two men yelled at each other across the hospital bed, with Dr Osborne’s assistants periodically walking in, slapping the patient and yelling at him not to be such a malingerer. Now that the patient has staggered out of the hospital and is self-medicating on espresso, Dr Osborne argues that Dr Balls has been exposed as a fraudulent quack.

Each man will be hoping to run the economy after next year’s election, so British voters may decide to give them both the metaphor they deserve, good and hard.

Also published at ft.com.

Undercover Economist

A good economic bet

Pundits who make wagers may look grubby but at least they are accepting a cost for failure

Two economists disagree about the state of the economy. That’s not terribly surprising; you can insert your own joke here. Refreshingly, they’ve decided to put money on the table: instead of spouting hot air, they have made a bet. Bravo. More public intellectuals should follow suit.

Jonathan Portes is director of a UK think-tank, the National Institute for Economic and Social Research. Andrew Lilico runs Europe Economics, a consulting firm. Portes thinks that there’s plenty of spare capacity in the British economy, and that even as economic growth picks up, inflation will remain modest. Lilico disagrees. The men have staked £1,000 – inflation-adjusted, naturally.

The bet says (roughly) that once economic growth tops 2 per cent in the UK, inflation will exceed 5 per cent within 18 months. Economic growth has indeed picked up, so the bet is on and the clock is ticking. By October 2015 we should have a winner.

There is a long-running debate about whether this sort of wager is to be welcomed. Alex Tabarrok, an economics professor at George Mason University, is all in favour. “A bet is a tax on bull****,” he wrote after statistical journalist Nate Silver offered a wager on the results of the 2012 presidential election, with profits to go to charity. The New York Times public editor, Margaret Sullivan, disagreed. Silver was writing for the newspaper back then, and Sullivan declared it was “inappropriate” for journalists to be publicly wagering that their opinions were well founded.

Who’s right? Sullivan’s main argument against Silver’s wager was that it created the “appearance” of a conflict of interest. Albeit indirectly, Silver stood to profit from a victory for the Democratic Party, if only by avoiding having to make a charitable donation. Suddenly he was no longer disinterested. This is a shallow foundation for the case against public wagers.

And there are strong counter-arguments. Pundits who make wagers may look grubby but at least they are accepting a cost for failure. A more subtle advantage is that betting encourages forecasts that are specific and quantifiable.

This matters, because too many forecasts are both vague and consequence-free. A pundit can shoot his mouth off about what will happen in the future and nobody much cares. If the forecast should happen to come true, the pundit can revisit his words and claim to have predicted the financial crisis, the fall of the Berlin Wall or whatever. What’s more, many forecasts are hazy enough, especially on timing, to make them impossible to falsify.

Making a wager helps correct both these problems. A forecast that is specific enough to bet on is also specific enough to come true, or to fail. And for any wager, there is at least one person with an incentive to keep track of what happened.

The most famous bet about economics is that between Paul Ehrlich, ecologist, doomsayer and author of the massive 1968 bestseller The Population Bomb, and Julian Simon, an economist most famous because he persuaded Ehrlich to bet with him. Ehrlich believed that overpopulation would cause disaster and widespread scarcity. Billions would die, developed countries would disintegrate, India was beyond saving. Simon thought that people would find substitutes for scarce resources and that things would be fine.

The bet, however, needed to revolve around something specific. It was that the price of five metals would rise between 1980 and 1990 as scarcity continued to bite. Instead prices fell, dramatically. Ehrlich lost the bet. In some ways, this story shows the value of the wager. Because the bet was specific, we now know that Ehrlich was wrong and Simon, who died in 1998, was right.

Yet the tale of the Ehrlich-Simon bet is not entirely reassuring. The very fact that the bet was so specific means that long after Simon won, the argument continues to rage about whose worldview was truly correct. I have never met an environmentalist who was convinced by Simon’s victory that technology will save the world. And I have encountered many conservatives who seem to believe that because Paul Ehrlich was wrong about the price of metals in the 1980s, all environmentalists are wrong about everything.

Paul Sabin, a historian who wrote a book about the bet, argues that the affair brought more heat than light. He reports that Ehrlich took his loss with poor grace, sending Simon a cheque with no cover note. And Ehrlich seems unrepentant. In a recent interview with NPR’s Planet Money show, he said of the late Simon, “It’s hard to be more wrong… he knew absolutely nothing about anything important.”

This pigheadedness is disheartening but unsurprising. Perhaps the wager pushed each side into stubborn tribalism and encouraged a reductive view of complex affairs.

Yet on balance, the world needs more wagers between pundits. The alternative is intolerable: a world full of confident forecasts that nobody ever bothers to verify. The betting man must be thoughtful and specific or his wallet will suffer the consequences. We should all be quicker to ask ourselves before we open our mouths: would I be willing to bet on this?

Also published at ft.com.

Undercover Economist

There’s more to life than money

Too often the debate over public policy becomes a toy argument, dressed up as the grown-up version

Scottish voters are in the middle of an unseemly bidding war. With the referendum for independence scheduled for September, Scotland’s first minister Alex Salmond is trying to tempt the Scots by promising that they will each be £1,000 a year better off after independence. From London, the UK Treasury has a better offer: it forecasts a dividend of £1,400 per Scot per year if Scotland stays part of the United Kingdom.

As it happens, the big difference between the two forecasts is that the Scottish government forecasts that productivity growth will be 0.3 percentage points higher each year in an independent Scotland. (That is a lot.) A smaller difference is that while both forecasts assign most North Sea oil revenue to Scotland, the UK Treasury is pessimistic about the value of the dwindling resource.

But the weaselly details of all this need not delay us. It’s astonishing that instead of being wooed by romantic ideals expressed with passion, Scots are being promised cash. The debate over the future of the country is being conducted in a style worthy of a clearance sale at a furniture showroom. One can only imagine what politicians are like on a date – presumably they pull out a roll of banknotes and haggle over the hourly rate.

You might ask why an economist, of all people, is shocked by such behaviour. I think the reason is that it’s a superficial impersonation of what economics really is. My two-year-old son happily imitates mum and dad at the stove, but while a knee-high plastic kitchen range may look like the real deal to him, it is not. Too often the debate over public policy becomes a toy argument, dressed up to resemble the grown-up version with financial forecasts serving as the sparkly accessories.

Stated plainly, the Scottish government’s case is that an independent Scotland would enjoy high economic growth thanks to better economic policies. Any costs would be swamped by the benefits of this growth. That is not an absurd claim, although not everyone will find it persuasive. Economic numbers could, in principle, serve as a sanity check – but that is not why the numbers are there. Instead, they’re designed to divert scrutiny away from the plausibility of the underlying argument.

Scottish independence is one of countless examples of toy-oven economic analysis. Consider the old standby that some illnesses – diabetes, dementia, breast cancer – cost “the economy” billions of pounds per year. For example, the Alzheimer’s Society reports that dementia “costs the UK over £23bn a year” – a statement that could mean all sorts of things. Yale’s Rudd Center says that “obesity-related direct and indirect economic costs exceed $100bn annually”, which makes a bit more sense.

In the UK the cliché is that some disease is problematic because it costs the National Health Service money, as if an instant cure for all cancers is desirable largely because it would allow us to stop paying salaries to the radiologists.

There is certainly merit in conducting a cost-benefit analysis of medical treatments. If we understand how well they work and how severe are the symptoms they alleviate, we can set priorities. But something has gone wrong when we say that the problem with a heart attack is that it will be an expensive nuisance for the ambulance service.

Where did we go astray? Three sensible propositions from economics have somehow been crumpled into a mess of public relations and politics.

The first is that opportunity costs matter. Time, money and attention that are poured into something cannot also be lavished on something else. For this reason it’s good to get a sense of how much a proposal is likely to cost and what the benefits might be. But the cost-benefit figures often convey a sense of certitude that is absurd: they are only as solid as the assumptions and forecasts that go into them.

The second proposition is about reducing everything to money. It follows from the first: if you are going to compare the costs and benefits of different things, you need some common unit of measurement. This unit doesn’t have to be money. It is just as true for the UK Treasury to say that independence will cost every Scot the equivalent of one knickerbocker glory a fortnight. But money is a more convenient yardstick than an ice-cream sundae.

The third proposition is that it’s worth paying special attention to spillover costs and benefits. In arguing over HS2, the fantastically controversial proposal to build a faster railway line between London and Manchester, people speculated over the value to passengers of a faster journey. Economics suggests that’s the last thing we should fret about, because passengers can make those benefits known by buying tickets. It’s the costs and benefits for those who don’t buy tickets that need more scrutiny.

Costs and benefits matter, money is a handy measuring rod, and spillovers deserve special attention. These three principles should be respected – but that does not mean the way to make good policy is to stick a price tag on everything.

Also published at ft.com.

Undercover Economist

The four lessons of happynomics

‘Happiness is surely important, but the case for letting economists loose on the subject is less clear’

The discipline of happynomics (or to give it an academically respectable title, “the economics of subjective well-being”) is booming. Respected economists have joined the field, from Lord Layard in the UK to White House appointees such as Alan Krueger and Betsey Stevenson. Several have been charmed in by Daniel Kahneman, a widely admired psychologist with a Nobel Memorial Prize in economics.

Happiness is surely important, but the case for letting economists loose on the subject is less clear. So are happyconomists discovering things that will put a song in your heart and a smile on your face? Perhaps. After reading a stack of books about the economics of happiness, and seeking advice from some of the researchers involved, allow me to present four tips for happiness from the dismal science.

Number one: don’t be distracted by the obvious. When buying a new car, it’s natural to imagine yourself thrilling to its acceleration. When buying a new house, it’s only human to ponder the pleasure of hosting guests at a summer barbecue on the patio. But such thoughts fall prey to what psychologists call “the focusing illusion”. Most of our time will be spent neither throwing summer parties nor overtaking lorries. Yet we’re swayed by these attractions because we’re focusing on them just at the moment that we decide.

The focusing illusion was splendidly captured by a pair of questions asked of college students by researcher Norbert Schwartz and others: “How happy are you?” and “How many dates did you have last month?” The research team discovered that people having a lot of dates also say they’re feeling very happy – but only if asked about the dates first. If the happiness question comes first, there’s a far smaller correlation between the answers. Those students asked initially about their love lives continued to think about them when pondering their happiness. Otherwise they might have been worrying about money, career or exams.

The focusing illusion lies in wait for us whenever we make a decision. Nattavudh “Nick” Powdthavee, an economist and author of The Happiness Equation, says that we have to try to “look beyond what’s salient about an experience”. Don’t just think about the obvious when making decisions; think about how day-to-day life is likely to change as a result – if it changes at all.

The second piece of advice is to pay attention selectively. It turns out that we grow accustomed to some conditions, happy or unhappy, but not to all.

The study which sparked the idea that we can get used to almost anything was published by Philip Brickman, Dan Coates and Ronnie Janoff-Bulman in 1978. It compared the happiness of paraplegic and quadriplegic accident victims to that of lottery winners – and discovered that the disabled people were scarcely less happy than the millionaires. Apparently we can bounce back from some awful experiences. (It is sad and troubling that a few years after making this discovery, Brickman killed himself.)

But how exactly is this apparent process of habituation supposed to work? Here’s where happiness economics has the long-run data to help. Consider bereavement: we cope by paying less attention as time goes by. A friend said to me, months after my mother and his father had both died, “You don’t get any less sad when you think about them but you think about them less often.”

The same is true, alas, for the nice things in life: we begin to take them for granted too. But there are experiences – unemployment is one of them; an unhappy marriage another – that depress us for as long as they last. What those experiences seem to have in common is the ability to hold our attention. Commuting, although shorter and less serious, is a classic case – annoying but also stimulating enough that we keep noticing the annoyance.

This suggests that we should look for the opposite of commuting: positive new experiences that are engaging enough to keep being noticed. In this case “count your blessings” is perfect advice.

Third, try nudging yourself to happiness with the techniques of behavioural economics. Paul Dolan, another economist and the author of the forthcoming Happiness by Design, advocates doing some preparation to make it easier to do what brings us joy. If you wish to read more, for example, set your browser home page to a book review site, leave books lying around your house and make a commitment to visit a literary festival. Make the new habit easy to do and hard to ignore.

Finally we must keep a sense of what’s possible. I asked Daniel Kahneman himself for his advice, and he made some evidence-based suggestions about the importance of friends and family. But he also pointed out that much of our happiness seems genetically predetermined. It’s possible to give good advice, he said, but “we shouldn’t expect a depressive person to suddenly become extroverted and leaping with joy”. In happiness, as in life, we economists must know our limits.

Also published at ft.com.

Undercover Economist

An astonishing record – of complete failure

‘In 2008, the consensus from forecasters was that not a single economy would fall into recession in 2009’

In the 2001 issue of the International Journal of Forecasting, an economist from the International Monetary Fund, Prakash Loungani, published a survey of the accuracy of economic forecasts throughout the 1990s. He reached two conclusions. The first was that forecasts are all much the same. There was little to choose between those produced by the IMF and the World Bank, and those from private sector forecasters. The second conclusion was that the predictive record of economists was terrible. Loungani wrote: “The record of failure to predict recessions is virtually unblemished.”

Now Loungani, with a colleague, Hites Ahir, has returned to the topic in the wake of the economic crisis. The record of failure remains impressive. There were 77 countries under consideration, and 49 of them were in recession in 2009. Economists – as reflected in the averages published in a report called Consensus Forecasts – had not called a single one of these recessions by April 2008.

This is extraordinary. Bear in mind that this is not the famous complaint from the Queen that nobody saw the financial crisis coming. The crisis was firmly established when these forecasts were made. The Financial Times had been writing exhaustively about the “credit crunch” since the previous summer. Northern Rock had been nationalised in the UK and Bear Stearns had collapsed in the US. It did not take a genius to see that trouble was on the way for the wider economy.

More astonishing still, when Loungani extends the deadline for forecasting a recession to September 2008, the consensus remained that not a single economy would fall into recession in 2009. Making up for lost time and satisfying the premise of an old joke, by September of 2009, the year in which the recessions actually occurred, the consensus predicted 54 out of 49 of them – that is, five more than there were. And, as an encore, there were 15 recessions in 2012. None were foreseen in the spring of 2011 and only two were predicted by September 2011.

Predictions from multinational organisations such as the IMF and the Organisation for Economic Co-operation and Development have remained very similar to the private sector consensus – similarly bad, that is.

We should not blame economics alone for our inability to peer into the future of a complex world. In 2005, Philip Tetlock, a psychologist, published a landmark work with the title Expert Political Judgement. Tetlock found that throughout the 1980s and 1990s, political and geopolitical forecasts had been scarcely better than guesswork. It made little difference whether the forecaster was an academic, journalist or diplomat, a historian or a political scientist. Forecasting is difficult, it turns out. (Supply your own punchline.) As for Tetlock, he is currently conducting a follow-up study to see whether forecasting practices can be saved.

Why are forecasts so poor? The chief explanation is that the economy is complicated and we don’t understand it well enough to make forecasts. We don’t even fully understand recent economic history.

Ben Chu, economics editor of The Independent, recently took a look at the UK recession of the 1990s in the light of two decades of data revisions. From the vantage point of 1995, the economy in late 1992 was slightly smaller than the economy in early 1988. But today’s best guess is that the economy of late 1992 was almost 6 per cent larger than in early 1988. The Office for National Statistics has substantially revised its view.

Not only is it difficult to forecast the future, then – forecasting the past isn’t straightforward either. What chance does any prognosticator have?

A second explanation for forecasting’s fallibility is that there is little incentive to do better. The kind of institutional chief economist whose pronouncement makes it into Consensus Forecasts will stick to the middle of the road. Most countries, most of the time, are not in recession, so a safe strategy is never to forecast one. Of course there are the mavericks who receive media attention for making provocative predictions and are lionised when they are right. Their incentives are different but it is unclear that their overall track record is any better.

The obvious conclusion is that forecasts should not be taken seriously. There is not a lot of point asking an economist to tell you what will happen to the economy next year – nobody knows. It is still a source of constant wonder to me that the demand for forecasts – in economics and elsewhere – remains undiminished.

John Maynard Keynes famously looked forward to a day when “economists could manage to get themselves thought of as humble, competent people, on a level with dentists”.

It’s a nice piece of self-deprecation, but it’s also an analogy worth exploring. We don’t expect a dentist to be able to forecast the pattern of tooth decay. We expect that she will offer good practical advice on dental health and intervene to fix problems when they occur. We should demand much the same from economists: proven advice about how to keep the economy working well and solutions when the economy malfunctions. And economists should bear in mind that no self-respecting dentist would be caught dead forecasting when your teeth will fall out.

Also published at ft.com.

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Tim Harford is an author, columnist for the Financial Times and presenter of Radio 4's "More or Less".
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