Tim Harford The Undercover Economist

Articles published in March, 2005

Addicted to economics

Dear Economist,
My son has become addicted to economics. The more diligently I confiscate his economics books, the more he steals from my purse. I’m determined that he should grow up to be normal, frequenting the pub like everyone else. What should I do?
— Stymied in Stratford

Dear Stymied,
You tell a sad story, but one that can be analysed using the theory of rational addiction developed by economists such as George Stigler, Gary Becker and Kevin Murphy.
Addictive goods and activities have some interesting properties. First, addictiveness itself: the pleasure produced by consumption is higher if past consumption has been high. In other words, the more heroin, alcohol or neoclassical growth theory the addict has consumed, the less bearable it will be to abstain now.
Second, past consumption will also have a direct bearing on the addict’s happiness. Typically, we think of negative addictions: past consumption of crack makes for a miserable junkie today. But positive addictions are possible too. A progressive addiction to yoga or to reading may make for a happier and happier person. I am addicted to my wife – so far, with unambiguously positive results.
Your son’s addiction is probably a positive one, which will make him ever more fulfilled. But even if it is a negative addiction, you must remember that rational addicts are utility maximisers. He may have been driven to addiction by circumstances – a desire to escape an over-controlling parent, for instance – but trying to frustrate his desires will make him more miserable.

What could be more heart-rending than to see a true passion for economics crushed by an economically illiterate parent?

I must urge you to stop your ill-advised policy of prohibition and adopt the more enlightened approach of laissez-faire.

First published on ft.com.

26th of March, 2005Dear EconomistComments off

FT Comment: Free lunches always leave a bad taste

It may seem easy to give things away, but it is not. The more attractive the gift, the more damage people will do to themselves, and each other, trying to get hold of it.
If that idea seems counterintuitive, it is nevertheless true, as the managers of Ikea, the furniture giant, can testify. They opened a new London store recently, offering opening night discounts of nearly 90 per cent on a limited number of leather sofas. The store closed 40 minutes later after 6,000 people tried to force their way through the doors; several had to be taken to hospital.
The press immediately blamed either the boorish stupidity of the British public or the hypnotic influence of the wily Swedes. But the ill-tempered scenes are not unique to Britain: at the grand opening of Jeddah’s Ikea last summer, two people died in the crowds queuing to get hold of $150 vouchers. Nor are these incidents the result of some quasi-religious shopping frenzy. The curse of the free lunch is at work.
If I were to announce that next Tuesday I would stand in Times Square handing out $100 notes, the result would be pure social waste, even if New Yorkers inexplicably decided to form an orderly queue. That queue would get longer and longer until latecomers decided that it was not worth camping out all night to get $100.
The man at the back of the queue would be spending $99 worth of his time to get hold of $100. In other words, it would cost me $100 to give this man a net gain of $1 – and on top of that I would have to worry about potential casualties. If instead I were to hand out $200 to each expectant New Yorker instead, the problem would get worse, not better.
This scenario may seem far-fetched, but the world is full of attempts to give money away. For obvious reasons, the generous donors are usually not companies such as Ikea, but governments.
Many of us are involved in a situation analogous to the queue in Times Square twice a day, when we commute. Almost everywhere, governments have decided that roads should be free or heavily subsidised – much like a leather sofa on opening night at Ikea. Since everybody gets to use a valuable product for free, the resulting congestion and road rage should hardly come as a surprise. The “free” roads of the big cities of every developed country in the world are choked with cars, and bumper-to-bumper traffic is already a problem in many cities in the developing world.
London is a partial exception, after Transport for London, the government agency in charge, decided to stop the free lunches. With rather more wisdom than the management of Ikea, it levied a “congestion charge” of £5 on any driver wishing to cross central London. In doing so, TfL demonstrated the inefficiency of road use up to that point: although traffic levels only fell by 15 per cent, delays caused by congestion decreased by nearly one-third.
Motorists are not the only ones suffering from the curse of the free lunch. It also torments parents trying to place their children in the limited number of high-quality “free” schools. They pay for the right to attend those particular schools not by having to queue, but through the housing market: the better the local school, the higher the property values. At least these payments, unlike the cost of queues or traffic congestion, are transfers from buyer to seller rather than pure waste. Yet it would be more sensible if the money were spent on better schools instead.
Government policies to subsidise important services such as roads and education usually make no more sense than Ikea inadvertently organising an opening-night riot. Sometimes the benefits are dispersed by overcrowding, as happens in the case of the roads. In other cases, as with education, the benefits are simply misdirected, going not to poor parents but to homeowners selling property close to good schools.
This is not to say that subsidies must be abolished. With real political leadership, it is possible to direct them fairly accurately at the poor. In many instances, the right way to do this would be for the government to let competing companies charge what the market will bear, and give cash or vouchers only to those who cannot afford the fees. Such schemes are transparent and trust the poor to make their own decisions; political elites therefore view them with suspicion. The free lunch remains popular, partly because it can be aimed at favoured constituencies, and partly because queues are simply seen as a sign that we need more subsidies for more roads and more schools, not fewer. It is time we started paying our own bills.

24th of March, 2005Other WritingComments off

Grants or Loans: Development finance and incentive effects

By Michael Klein and Tim Harford

Some people think the best way to give aid is through grants. Others advocate aid embedded in subsidized loans. Mostly, incentive effects on donors and recipients are ignored in this debate. But grants and loans carry different incentives and in some settings can be complementary. Donors should offer a wider menu of options, including ongoing forgiveness of loans, unbundled subsidies, and loans combined with output-based grants. Donor agency staff should be rewarded for outcomes, not volume of funds out the door.
http://rru.worldbank.org/PublicPolicyJournal/Summary.aspx?id=287

Part of the series on the future of the aid industry: http://rru.worldbank.org/Themes/AidEffectiveness/

24th of March, 2005Other WritingComments off

Schrodinger’s lottery ticket

Dear Economist,
My lottery ticket, the physicist Erwin Schrodinger tells me, is the winning ticket up until the moment of observation. Thus from Saturday evening through to Sunday morning, when I check my numbers, I am a millionaire. How do I best capitalise on this newfound wealth?
— Joseph Kelly, Carlisle

Dear Mr Kelly,
Regrettably, anyone wishing to securitise the indeterminate winnings and pay you accordingly is likely to insist on observing the ticket, thus ruining an interesting prospect.
In general, lottery tickets have a very low expected value because the chance of winning a million pounds is much less than one in a million. You may take those odds anyway because you love risk. To be consistent, you should cancel your house insurance and enjoy the thrilling possibility that it may one day burn to the ground.
Still, it is possible to buy lottery tickets with a positive expected value, according to finance professor William Ziemba. In many lotteries, jackpots are shared when people have the same numbers, so your expected winnings increase if you pick unpopular numbers (historically these include 32, 39 and 40 – which are never chosen by people who choose birthdays as numbers).
Unfortunately even if you play all over the world you should not expect to win for several thousand years. A faster way to win, while guaranteeing excitement, is to choose six numbers but not buy a ticket. The expected value of this gamble is usually positive, while the nail-biting thrill of watching the draw and praying that the numbers don’t come up has to be experienced to be believed.

Luck helps too. Professor Ziemba reports that one winner chose the number 48 because he “dreamed of the number seven for seven nights in a row, and since seven times seven is 48…”

First published on ft.com.

19th of March, 2005Dear EconomistComments off

Humbert Humbert confesses

Dear Economist,

I seem to have a thing about young girls. I will not see 40 again, and while my friends (the female ones, admittedly) insist that I should be dating sophisticated thirtysomething women with the aim of settling down, I find myself attracted to wild, volatile hellraisers. There has been Kristen, 18, catwalk model; Irene, 22, Swedish law student; Janine, 20, French heiress and, most recently, Fleur, 23, polo player (my God). My friends tell me my later years will be lonely, barren and desperate. Is it worth it?
— H. Humbert, London

Dear Mr Humbert,
Contrary to popular belief, economists have an optimistic disposition. We believe that when individuals are free to choose, they find life is full of mutually beneficial interactions, such as the ones you and Fleur enjoy. We also believe that just because something is fun doesn’t mean it cannot last.

The contrary view – the view your friends hold – is that you need to drop Fleur like a hot potato and find yourself a member of the Bridget Jones generation. There are two possible reasons. First, perhaps women, like wine, improve with age. Your friends may believe this but when it comes to your happiness, your own preferences must be sovereign. Second, perhaps it is worth giving up your playboy lifestyle now to avoid loneliness later.

But I believe that your friends are giving you bad advice because they are jealous. Given that you are already successfully dating people half your age, why will this suddenly stop? Even if your hellraisers grow tired of you, you may then find that single women of a certain age are a renewable resource. But the most important reason for advising you to stick to girls is my own conscience: I am not sure the sophisticated women of the world could bear to experience your charms just yet.

First published on ft.com.

12th of March, 2005Dear EconomistComments off

Rational procreation

Dear Economist,
My husband and I have a son and we’re thinking of having one or two more children. But how many, do you think?

— Emma Travers, York

Dear Emma,
When optimising your investment in children, it’s erroneous to consider quantity without thinking of quality. The most famous economist to make this mistake was Malthus: he predicted that whenever household incomes rose, families would expand to consume the new resources.

Malthus did not anticipate advances in contraception, which make it much more likely that people like you can have exactly the number of children they desire. An equally important error – if a more subtle one – was his failure to appreciate that as incomes rise, parents can increase their investment in children not just by having more, but by spending more time and money on each child.

In the analysis of the Nobel laureate Gary Becker, you can increase the quality of your children as well as their quantity, for example by investing in their education. Becker understood that children can be analysed in the same way as other durable consumer goods, such as cars.

Nobody would make Malthus’s mistake by assuming that millionaires buy dozens of cheap cars. We all realise that a more typical response to rising income is to replace the Skoda with a Mercedes. It is hard to give you more specific advice without knowing more about your situation, but if you appreciate that your choice is between two high-quality children and three lower-quality children, things may become clearer in your mind.

Some people protest that children cannot be traded off against other consumer durables, or even analysed in the same way. Perhaps. But it’s interesting to note how many of these people have few children but nice cars.

First published on ft.com.

5th of March, 2005Dear EconomistComments off

The Future of Aid: Scenarios

The ‘Future of Aid‘ project continues with two short scenarios.
The Undergrowth presents a world where booming remittances and private investment, put to innovative uses, eclipse a slow-moving official aid industry.
The Big Push describes an alternative in which the official industry goes through a revolution in reaction to falls in the number of people in severe poverty and the growing ability of poor countries to borrow from the market.

Other short papers on the Future of Aid page discuss the implications of growing competition in the aid industry, and what we know about the performance of donors (not enough).

2nd of March, 2005Other WritingComments off

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