Articles published in October, 2005

Dear Economist,

My boyfriend and I have always practised safe sex, but now we’re talking about using just the pill rather than condoms. What concerns me is the risk of catching something. I expect my boyfriend slept with other girls before we started dating, but I feel fairly sure that he wouldn’t have done anything risky.

Am I right?

Cecilia Larson, Bristol

P.S. My boyfriend is an economist.

Dear Cecilia,

Oh dear. It was all looking so promising. Unprotected sex produces a classic negative externality. Someone who decides to have unsafe sex gets to enjoy all the pleasure but only part of the risk: if he contracts an infection, he will suffer from it himself but also risk passing it on to his future partners, and their partners’ partners. The only reason you have been using condoms at all is that you know other people haven’t bothered.

Your boyfriend knows this perfectly well. He may also know that some sexually transmitted diseases, such as chlamydia, have more serious effects in women than in men. Unsafe sex has benefits as well as risks; as an economist, he may well have decided that the personal risks are worth running.

Do not lose hope, though.

As a rational being, your boyfriend will have avoided the most unsafe practices, such as sharing needles and having unprotected intercourse with sex professionals. So your main risk is that he has had unprotected sex with a large number of ordinary women like you. But how likely is this? Such delights are likely to lie well outside his feasible consumption set: there is not usually a queue to jump into bed with economists.

Also published at ft.com.

As promised, the post below is the first installment of my new column, ‘The Undercover Economist‘. These columns are published in The Financial Times – see the column home-page here.

The Undercover Economist – FT Magazine, 29 October 2005

Woe betide the supermarket shopper trapped in a queue behind coupon-clipping Granny. As the bundle of coupons, held together with a clothes peg, rises from the handbag, and the negotiation with the checkout boy begins, you know it’s going to be a long wait.

But we should blame those coupons for more than just a few delays, and we should also be grateful to Granny for saving us from our own laziness. Granny plays a vital role in the competitive ecosystem. Unlike her richer, lazier, busier descendants, she actually looks at the price of products and bears it in mind when making her choice. The result is a more competitive retail industry, and the rest of us reap the benefits.

Imagine a town where a Tesco supermarket and a Sainsbury’s supermarket compete for the business of a young, rich, careless generation, with few grannies around to keep them on their toes. If the supermarkets offer similar goods at similar prices, local shoppers will simply split down the middle and go to whichever store is nearest. If one week Tesco offers a sale, the grannies will shuffle over there and the rest of us won’t bother. Sainsbury’s loses a handful of customers that week; Tesco gains a handful but has lower margins. Sainsbury’s managers aren’t likely to worry.

Now imagine a seaside retirement town bursting with grannies. If Sainsbury’s offers a sale around there, they’ll be flooded with bargain-hunting pensioners. Tesco, suddenly deserted, will have to respond with its own price cuts. The “silver savers” keep the supermarkets honest, while the rest of us hardly need to bother.

A little bit of extra competitive pressure can go a long way. If Tesco worries about losing customers and cuts its prices, Sainsbury’s will also want to cut prices in response. If Sainsbury’s cuts prices then Tesco will have to cut prices further. This process doesn’t feed itself forever, but in the right circumstances a few more careful shoppers can substantially cut shopping bills for everyone.

You can guess what comes next, of course: the supermarkets want Granny out of the way. As long as she is roaming the aisles and scouring the shelves for bargains, she forces them to keep their prices low. Without her they could take advantage of our laziness and vacuum the cash out of our wallets.

This is where the coupons come in. Like a whistle that only dogs can hear, the coupon is a special offer to Granny that the rest of us do not notice and scarcely understand. If the supermarkets want to fight a price war over the population of price-sensitive grannies, they can do that perfectly well with their coupons. At the same time they can keep their standard prices high. The rest of us, who were going to ignore any price war anyway, do not notice the coupons and pay through the nose. If you thought the coupon should be blamed only for long lines at the checkout, think again.

In reality, of course, the world does not divide neatly into grannies and the rest. Each of us displays a different degree of price-sensitivity; one that varies from hour to hour. The expert retailer devotes great energy to devising schemes to offer low prices to grannies and high prices to playboys, trophy wives, expense-account holders and anyone else with no sense of the value of money.

Every shopper who wanders around, carelessly waving someone else’s credit card, is softening the competitive environment for the retailers and raising prices for the rest of us. We always knew there was a reason we should hate the playboys, but we should be a little more tolerant of Granny the next time we are stuck behind her at the supermarket checkout.

Financial Times, October 29th

Amazon.com and Amazon.co.uk are now shipping ‘The Undercover Economist’.

James Reese of Radioeconomics has a half-hour ‘podcast’ interview with me about ‘The Undercover Economist’. Radioeconomics has some excellent interviews – Gary Becker, Richard Posner, and Jeff Sachs coming up. To listen to the interview itself, you need to click on the title of the post (or here).

Dear Economist,

Parents often find that some of their children turn out wealthier than others. Doting but logical parents have been seen to apportion financial help unequally in order to help the least successful of their children at the expense of the wealthier ones.
So is one is better off being lazy and a failure in life in order to maximize the potential help from one’s parents?
Yours truly,
Alexander Ross, London

Dear Mr Ross,
‘Doting but logical’ describes the parents of Robert Barro’s macroeconomic models and Gary Becker’s economic theory of the family. Such parents make sure that all children enjoy equal levels of utility, and achieve this by giving larger transfers to poorer children.

Perhaps you hope that your own parents are Barro-Becker altruists. If so, you could guarantee an increased handout by earning less. Slacking would seem to be, on the face of things, attractive. Think again.

If your parents truly are Barro-Becker altruists, they will ensure that the post-bequest utilities of all children are equalized. This simply means that everyone will get an equal share of the total wealth generated by the parents and all siblings. By slacking, you simply reduce the size of the pie that your parents will eventually divide equally.

Your only hope would be that your parents are naïve and that they will favour you, the loser, without working through the mathematics properly. What are the chances?

Most parents divide bequests equally between children, and unequal bequests are often designed to repay more devoted children. The economists Audrey Light and Kathleen McGarry analysed interviews with over 3000 mothers with at least two adult children. Just one per cent said they planned to make unequal bequests because one child had greater needs than the others. Slack off if you like, but you’re gambling on long odds.

I’ll try to restrain myself from cross-posting on my other feed, Tim Harford’s writing (http://feeds.feedburner.com/WritingByTimHarford), but I thought that Dear Economist readers would like to know that the Financial Times have published a nice big extract from my new book, The Undercover Economist.

On a sunny day in London you can purchase a cappuccino and sip away as the capsules on the Eye, the capital’s landmark Ferris wheel, rotate high above you, occasionally passing between you and the sun… one of life’s simple pleasures. Everywhere you look around the Eye you can see vendors with scarce resources, trying to exploit that scarcity. There is only one coffee bar in the immediate area, for instance. There is also a lone souvenir shop doing brisk business. But the most obvious example is the London Eye itself. It towers over the majority of London’s most famous buildings and is the world’s largest observation wheel. The scarcity power is clearly considerable, but it is not unlimited: the Eye may be unique, but it is also optional. People can always choose not to go on it.
Further along the river, the Millennium Dome is similarly unique, ‘the largest fabric structure in the world’, boasts the local authority. Yet the Dome has proved a commercial disaster because uniqueness alone wasn’t enough to persuade people to pay enough to cover the vast costs of its construction. Business with scarcity power cannot force us to pay unlimited prices for their products, but they can choose from a variety of strategies to make us pay more. It’s time for the Undercover Economist to get to work and find out more. Read the rest of this entry »

The Financial Times have published a generously-sized extract from The Undercover Economist:

On a sunny day in London you can purchase a cappuccino and sip away as the capsules on the Eye, the capital’s landmark Ferris wheel, rotate high above you, occasionally passing between you and the sun… one of life’s simple pleasures. Everywhere you look around the Eye you can see vendors with scarce resources, trying to exploit that scarcity. There is only one coffee bar in the immediate area, for instance. There is also a lone souvenir shop doing brisk business. But the most obvious example is the London Eye itself. It towers over the majority of London’s most famous buildings and is the world’s largest observation wheel. The scarcity power is clearly considerable, but it is not unlimited: the Eye may be unique, but it is also optional. People can always choose not to go on it.

Read the full extract at the Financial Times. (If it goes subscription-only, you can read it here too.)

The Undercover Economist is published in the US on 1 November.

Oxford University Press is ‘introducing its brilliant authors to the blogosphere’ at the new OUP blog. Apparently that includes me, but you can also check out Philip Pullman on Paradise Lost, and Kerry Emmanuel has a great Q&A on the links – or otherwise – between hurricanes and global warming.

Dear Economist,
Is the value of a British person’s life greater than the value of an Iraqi person’s life?
Andres Arauz, Michigan

Dear Andres,

One onlooker may find it perfectly natural that a single British death grabs headlines, while Iraqi deaths go unnoticed. Another may be horrified, believing that all human life is equally valuable. So you are raising an emotive and controversial question.

Fortunately, economic analysis removes all the controversy. You will have one view of the value of a British life and an Iraqi life, I may have another. So it helps to take the economic viewpoint: your life is worth whatever you think it’s worth, my life is worth whatever I think it’s worth. Economists respect your own opinion about your own life, and nobody else’s.

Of course, if I simply ask you what you think your life is worth, you may be tempted to exaggerate, so economists judge people based on their actions. Dangerous jobs tend to earn higher pay, while activities such as buying smoke alarms or buckling seat belts carry their own costs as well as bringing safety benefits.

Observing what people actually do makes the value of life not a theological or philosophical concept but an arithmetical one.

A typical calculation: you might pay up to $6,000 on a safer car that reduced your risk of dying by one in a thousand. Six thousand divided by one in a thousand is six million, so you are valuing your own life at about $6m. This is a typical result for residents of the US.

Researchers have tended to find lower valuations in poorer countries, which is not surprising: if I am poorer than you, I have less to spend on everything, including my own safety. That seems unfair, but the different valuation is a symptom of inequality, not its cause. I will just have to get used to it.

Also published at ft.com.

For those of you watching in RSS, you may be interested in subscribing to my other RSS feed, Tim Harford’s writing.

On 29th October, the Financial Times will begin my new column about the economics of everyday life. Watch out, too, for a sneak preview of The Undercover Economist, and profiles of Thomas Schelling and Gary Becker. I hope that Dear Economist fans will also enjoy the new column.

Feed: http://feeds.feedburner.com/WritingByTimHarford

“The most important event of the second half of the 20th century is one that didn’t happen.” With those words, Thomas Schelling marked the “stunning achievement” of 50 years without a nuclear war. No one person can claim credit, but Mr Schelling has as much claim as anyone to helping prevent Armageddon. He helped to prevent war because he understood it and explained it brilliantly to others, changing the intellectual climate, inspiring a generation of strategic thinkers and, almost incidentally, saving the young discipline of game theory from irrelevance.”The most important event of the second half of the 20th century is one that didn’t happen.” With those words, Thomas Schelling marked the “stunning achievement” of 50 years without a nuclear war. No one person can claim credit, but Mr Schelling has as much claim as anyone to helping prevent Armageddon. He helped to prevent war because he understood it and explained it brilliantly to others, changing the intellectual climate, inspiring a generation of strategic thinkers and, almost incidentally, saving the young discipline of game theory from irrelevance.

On Monday, Mr Schelling shared the Nobel Prize in Economics with the mathematician Robert Aumann. The prize is long overdue, but at the same time it is a curious reward for a man who did almost no research as such. “If you ask what he does for a living, I have to answer that he lives by his wits”, the sociologist James Coleman once remarked.

If you want to win a Nobel prize without doing technical research, Mr Schelling’s winning formula is simple: find hidden patterns or puzzles of everyday life that nobody else can see, show how they illuminate the biggest questions of the day and write it all up in the most sparkling prose.

Game theory was - before Mr Schelling - the mathematical analysis of interdependent decisions: whether a union calls a strike depends on whether the union leaders think the management will respond with a better pay offer; whether I bluff at poker depends on whether I think you are likely to call the bluff. Game theory and the atomic bomb arrived at the same time with the help of the same mathematician, John von Neumann, and the early game theorists tried to use the theory to understand nuclear war. But their analysis was weak. Von Neumann told Life magazine: “If you say why not bomb them tomorrow, I say why not today?”

Mr Schelling’s 1960 book, The Strategy of Conflict, revolutionised both strategic thinking and game theory. Mr Schelling ditched the mathematics of his peers and applied the rigorous thinking of game theory to a richer world in which the superpowers tried to understand the tacit signals behind each others’ threats and promises. He showed that even the deadliest wars involved significant elements of common interest and co-operation between foes. Indeed, the striking fact that the Cold War never became a hot one is the co-operative feat of the century.

Alfred Marshall, the great economist, advised other economists to translate their mathematics into English and illustrate with examples that are important in real life. We have largely ignored his advice, but Mr Schelling lives it. Explaining the difference between stable and unstable deterrence, he imagined a face-off in the wild west, with both men on a hair-trigger, before observing: “If both were assured of living long enough to shoot back with unimpaired aim, there would be no advantage in jumping the gun and little reason to fear that the other would try it”. Such thinking helped to change the US’s stated policy of massive retaliation for any Soviet transgression, in favour of maintaining a credible second-strike capability to discourage a surprise attack. The resulting face-off did indeed prove more stable than anyone dared hope.

Mr Schelling’s leaps of lateral thinking are so spectacular that his colleagues sometimes thought he had lost his mind. On a long flight, his doodles with noughts and crosses convinced him that extreme racial segregation often seen in modern cities could arise without extreme racial prejudice. As families try to avoid being surrounded by a different ethnic group, sharp boundaries can arise in a city full of people who are content with genuinely mixed neighbourhoods. The outcome is out of all proportion to the motives which produce it. Thirty years later, Mr Schelling’s method was being fed into powerful computers and became a cutting-edge research topic: agent-based modeling.

Nor is Mr Schelling limited to matters of grave policy: he has studied efficient ways for criminal gangs to extort money, the problem of ever-expanding Christmas-card lists and how to find a travelling companion after being separated in a strange city. That eclectic mix is inseparable from his ability to find wisdom in unusual analogies.

Mr Schelling is a great communicator of economic ideas; many would say he is the great communicator. I only wish that more economists would imitate his methods. Our only defence is that he is inimitable.

“Nattily packaged—the cover sports a Roy Lichtensteinesque image of an economist in Dick Tracy garb—and cleverly written, this book applies basic economic theory to such modern phenomena as Starbucks’ pricing system and Microsoft’s stock values. While the concepts explored are those encountered in Microeconomics 101, Harford gracefully explains abstruse ideas like pricing along the demand curve and game theory using real world examples without relying on graphs or jargon.
The book addresses free market economic theory, but Harford is not a complete apologist for capitalism; he shows how companies from Amazon.com to Whole Foods to Starbucks have gouged consumers through guerrilla pricing techniques and explains the high rents in London (it has more to do with agriculture than one might think).
Harford comes down soft on Chinese sweatshops, acknowledging “conditions in factories are terrible,” but “sweatshops are better than the horrors that came before them, and a step on the road to something better.” Perhaps, but Harford doesn’t question whether communism or a capitalist-style industrial revolution are the only two choices available in modern economies. That aside, the book is unequaled in its accessibility and ability to show how free market economic forces affect readers’ day-to-day.”

The Undercover Economist takes you from your immediate surroundings: bookstore cafe, drinking (overpriced?) coffee and looking at this hardcover (why not paperback?) book, and explains from there how quirks and failures of the market can cause your latte to cost four dollars and global problems like poverty and starvation. This is a very entertaining and enlightening book about our world from an economic perspective.

Dear Economist,

I’m a very wealthy man. It occurs to me that I might use my fortune to express my values by investing in an ethical fund. Should I?

Anonymous, New York

Dear Anonymous,

Your actions will make no difference, even if you have billions of dollars to sling around. In principle, if enough investors refuse to invest in so-called unethical companies, then such companies will face a higher cost of capital and will find it more difficult to expand their operations.

In practice, this is unlikely. As long as a substantial number of investors look only at financials, they will seek out the pariah firms (oil companies, pornographers, management consultants) whenever they become cheap. The more ethical investors shun such companies, the more attractive they look to other investors.

Your decision will probably cost you, too. You often see ethical funds arguing that they achieve better performance. This is nonsense. Even if, by a staggering coincidence, the ethical companies are the only good investments, a profit-driven fund manager could pick them and do no worse than a fastidious one. The truth is, by denying yourself options, your ethical investment returns will tend to be more volatile.

Some ethical funds did very well during the technology bubble because they held dotcom companies, which don’t cause pollution or human rights violations. Others – such as the Ave Maria Catholic Values fund – did well as the bubble deflated for the converse reason: according to financial journalist Daniel Gross, it has shunned technology firms because they offer benefits to unmarried partners of employees.

Neither result proves anything about future performance. If it did, you could equally consider the high-flying Vice Fund. It is invested in gambling, alcohol, defence, tobacco… and Microsoft.

Continued on ft.com.

Update: In the New York Times again for free, so I’ve added the full text here.

Dear Economist,
Our local council does not collect cardboard and plastics for recycling, presumably for economic reasons. Yet in our household we have felt it our moral duty to separate those items and deliver them each weekend to our local recycling centre for processing. If a centralised collection system is unworkable, does that mean our individual effort is detrimental to the global environment?
Ju-Yen Tan, west London

Dear Mr Tan,

Governments do many things that are economically wasteful and neglect to do others that would be economically efficient. So I wouldn’t take your local council’s behaviour as a guide to your own.

In fact, recycling can sometimes be financially viable even before considering the environmental benefits: companies have been profitably recycling office paper, aluminium and steel for more than 20 years. But such recycling programmes enjoy economies of scale that you do not.

As for sorting and delivering the rubbish yourself, the sad – or perhaps relieving – fact is that the case for home recycling is tenuous. It would be all very well if you walked past the plastics bank on your way to the tube station every morning, but if you are making an additional car journey to the recycling centre you are using energy, causing congestion and consuming scarce fossil fuels. The net environmental benefits of your trip are small, and may even be negative.

The economic benefits are lower. The most significant cost is the value of your time. Do not underestimate this. If you get a kick out of sorting through your rubbish, don’t let me stop you, but this has not traditionally been seen as an inspiring task. Don’t forget that the price of most commodities has been falling for decades, if not centuries, with one clear exception: the price of labour.

Also published at ft.com.