Articles published in November, 2005

Fast Company have a piece on the boom in economics books, including a brief interview with yours truly (as well as the relevation that SuperFreakonomics is on the way…).

Meanwhile, The San Diego Union Tribune’s reviewer damns all economists, economcs and economics books. It is comforting that he concedes that I have

produced an engaging, fast-paced, well-written and witty volume that affords the reader a quick, and in many ways useful, insight into the ways in which modern economics dissects and interprets many contemporary issues. His summaries of abstruse economic ideas, such as the concept of “moral hazard” in insurance markets and the notion of market “externalities,” are clear and well informed.

In the Agora’s reviewer says:

If you read only one pop economics book this year, The Undercover Economist should be it. Harford, a columnist for the Financial Times among other distinctions, has written a book that could almost serve as a textbook for an Economics 101 course. But it’s emphatically not dry or dull. Instead, what Harford has done is convey the excitement, the power, and the often counter-intuitive results of economic thought. In so doing, he has written more or less the economic equivalent to The Selfish Gene.

Finally, one blogger thinks my Undercover Economist columns from the Financial Times magazine (also published here) are extracts from the book. Not so – they’re all brand new stuff.

Patri Friedman, the high-stakes-poker-playing-anarchist, has a big interview with me up at Catallarchy. Thanks, Patri!

In other news, Amazon have sold out of copies of ‘The Undercover Economist‘. I am assured they’ll be offering 24-hour shipping again any day now.

Dear Economist,
For cultural reasons I am probably going to have an arranged marriage. This will mean that I won’t have an opportunity to cohabit first to find out how well things would work. I would have to take a decision that is more rational than emotional. There are a lot of things that I would like in a woman, but hardly anyone has it all. What can you advise?
Josh Gopal, by e-mail

Dear Josh,

When we elect members of parliament, we are the “principals” and they are the “agents” who, supposedly, represent us. Similarly, when shareholders elect a board of directors to maximise shareholder value, the directors are their agents. Those directors will hire managers to do their bidding; again, the managers are the agents.

Think for a moment: are principals ever happy with what their agents get up to? You can understand why economists speak of something called the “principal-agent problem”.

Your parents are acting as your agents in this case, as they scout out a limited field of possible wives. How are you to encourage them to see your point of view?

The best way forward is probably to pay them by results. Perhaps your parents should post a bond of £100,000, to be repaid at the rate of £5,000 a year plus interest as long as you and your beloved remain hitched. If you and your wife end up divorced, you keep the remaining money.

Of course, your parents may be asking themselves what is in it for them. You may find that you are the one who has to post the performance bond, and will get your money back only if they choose poorly. Your parents will also fret that you will connive a divorce just to lay your hands on the cash. Nobody said this was going to be easy.

Also published at ft.com.

The Undercover Economist – FT Magazine, 26 November 2005

The Harford family would like to hear the patter of tiny feet in stereo, but we discovered the first time around that having a baby is not cheap. So, in between practising, we have been looking into the possibilities of getting someone else to make a financial contribution.

As our first baby was born in the US, we’ve had an opportunity to compare and contrast. In Britain, employers pay for six months of maternity leave and reclaim the money from the government. In the US, on the other hand, the mother pays. With no legal right to maternity pay, many women scrape together some paid time off using their holiday and sick-leave entitlement instead.

That doesn’t sound like such a good deal to us. If we stayed in the US, nobody would be paying my wife to stay away from the labour force and she might emulate her American peers, who tend to return to work very quickly and outsource the baby’s care.

Yet look a little deeper into the economics of it all, and the British system may not be such a sweet deal for new families. If we settled back in Britain and we wanted those tasty maternity benefits, we would have to persuade some employer that my wife wasn’t going to be using them. American mothers seem to have a friendlier relationship with their bosses, even looking forward to telling their colleagues that they’re in the family way. “My boss was so pleased, he gave me a big hug,” said one of our baby circle. Why shouldn’t he be pleased? She took less time off work this year than I did.

British mothers-to-be dread the day that they will be forced to “break the news” to their employers, and no wonder. Even though British maternity leave is subsidised by the government, the employer bears a heavy burden. Good employees are always paid less than they’re worth (when this is not true, the employees don’t stay employed for long) and the cost of an employee disappearing for six months is often much more than the cost of paying her.

Of course, the effects do not stop there. I said “the employer bears a heavy burden” but the smart employer will work hard to shift the burden elsewhere by avoiding women who seem likely to have children or by paying them less than they would otherwise get, to compensate for the risk. Fertile-looking women have to outperform their peers.

There is an alternative, but it would be insane: my wife could start her own business. That might make sense if employers were able to shift the full cost of maternity leave on to mothers, but they will always spread the burden on to other women and perhaps beyond. This makes employment more attractive for anyone who plans to get pregnant and less attractive for everyone else. Broody Brits should flock to employers and shun self-employment, where they have to face the full costs of their disruption to business. It seems that they do. In the UK fewer than one in six small businesses are majority-owned by women; in the US very nearly half of private businesses have women owning at least half of the company. The American system has its costs but it has benefits too.

Female entrepreneurs are rare in Britain because it takes an unusually independent spirit to turn your back on the blandishments of paid maternity leave, and start both a business and a family. Of course, this is exactly what my wife has done. It looks like we can forget about asking anyone else to pick up the tab.

For reasons explained here, I have the first ever signed copy of the million-selling Freakonomics in my possession. I’m selling it on eBay and will donate the proceeds to Steve Levitt’s preferred charity, ‘Smile Train’. Go and bid… it’s for a good cause, and it could be worth a fortune in years to come!

Update: Sold for $610, and Steve Levitt has thrown in another $610 of his own money. That’s a lot of smiles…

Dear Economist,

“Pascal’s wager” states that even if it is unlikely that God exists, it is rational to believe in his existence, since disbelief risks infinite unhappiness for eternity.

But even if hell exists, its torments are likely to be so intense as to have a high discount rate. Although any individual moment in hell might be infinitely painful, the sheer intensity should lower the expectation that such pain might continue through eternity. Multiply that by the low probability of the existence of a deity that actually operates as hypothesised and the future expected value of both heavenly bliss and hellish torment should converge close to zero. Doesn’t Epicurus make more sense than Pascal?

Karthik Sankaran, New York

Dear Karthik,

Infinity doesn’t work like that. Pascal’s wager does not depend on the eternal duration of reward and punishment. A moment in heaven is infinitely pleasurable, so even if heaven lasts no longer than that, that moment outweighs a lifetime of Epicurean pleasures.

Even if you believe the probability that God exists is tiny, a tiny chance of a moment of infinite bliss outweighs a lifetime of large but finite bliss.

Perhaps you think that Pascal’s wager displays flawed logic. But wait. The economist Alex Tabarrok points out that if there is even a tiny chance that Pascal is right, a tiny chance of a tiny chance of a second of infinite bliss is still infinitely valuable.

Now, if you give me all your money, I’ll intercede with God on your behalf and increase your chance of going to heaven. Of course, there is only a tiny chance that my intercession will help, but a tiny chance of infinite bliss is, again, infinitely valuable.

Please send your cheque via the FT, and quickly please – I’ve already given Professor Tabarrok all my cash.

The Undercover Economist – FT Magazine, 19 November 2005

My wife can buy cheaper car insurance than I can because she’s a woman and, fairly obviously, I am not. Is this sexual discrimination? Some people would claim that wrongful discrimination is treating somebody differently because they are a member of an identifiable group – a woman, for example, or a black person. That is a sensitive definition but not a useful one. I spent more time in my 20s pursuing girlfriends than boyfriends, and I must admit that this bias was everything to do with the fact that the girls were all members of an identifiable group.

In any case, it can be discriminatory to treat two people identically. Women are, on average, safer drivers and cheaper customers for insurance companies. If they were offered the same insurance rates as men, that would be discrimination.

This suggests a plausible way of working out whether discrimination is going on: if a company’s management is willing to give up profits to exercise a prejudice, then the discrimination is real. An insurance company that offered equal rates to men and women would be leaving money on the table, because if the company cut rates to female customers it could attract extra, profitable business.

If companies are discriminating against employees or customers from some minority group, only the most profitable members of that group will be tolerated: customers who pay well over the odds and employees who are extraordinarily productive or who agree to work for very low wages.

Once you start thinking like this, you realise that certain kinds of discrimination are likely to cause more damage than others. Corporate discrimination is surprisingly ineffective, because it is so tempting to gain a competitive advantage by swallowing your prejudices. Victims of discrimination make attractive customers and employees, since they are offered high prices and low wages elsewhere. A business with a profit margin of 5 per cent and a wage bill of 20 per cent of revenues could double its profits if it could lower its wage bill by a quarter. A chief executive who staffed his business with cheaper workers from downtrodden minorities would look like a financial genius.

That suggests that prejudice on the part of managers would have to be very severe to have a big impact. Discrimination from the public, on the other hand, can be crippling. If customers don’t want to be served by women or ethnic minorities, you will struggle to make money ignoring them.

All prejudice is shameful, but some prejudices are more harmful than others. Under apartheid, where the minority whites could not simply isolate their economy from the blacks, the average white South African was paying dearly for the deep prejudice in his society. This helps to explain why the system collapsed. In the US, in contrast, whites outnumber blacks nearly 10 to one. The economic cost to whites of discriminating against blacks is tiny. But as a small, poor minority suffering from discrimination, blacks suffer a heavy economic price even from mild prejudice.

Free markets tend to work against discrimination. After Rosa Parks sparked the boycott of public buses in Montgomery, entrepreneurs stepped in to offer cheap rides in cabs, despite the city council’s efforts to fix a price floor. The city pressured local insurers not to cover cars used in car pools. That bullying was ignored by Lloyd’s of London, which no doubt saw a profit opportunity.

Closer to home, car insurers didn’t need training in gender sensitivity to offer women a cheaper deal. All this is encouraging. Less encouraging is that 50 years after the Montgomery boycott, much milder prejudices than those defied by Rosa Parks can continue to wreak such high economic costs on minorities. The economics of discrimination sometimes spread a little poison a long way.

News from ‘The Undercover Economist’ this week:

The AEI-Brookings joint center was kind enough to sponsor a launch of ‘The Undercover Economist’ on Wednesday 9th November, and the video is now available here (top right). If addicted to internet video you can also see me on WCNC, giving advice on cheaper shopping.

Several reviews this week, too.

The Washington Post believes the book is “A good Christmas gift for that college student who’s been avoiding economics — or, even better, for that economics prof who hasn’t come up with an interesting enough curriculum.” They thought I talked about coffee too much, though.

The Wall Street Journal’s reviewer loved the book so much he forgot the title… “‘The Underground Economist’ distinguishes itself from the pack with a lively and insightful discourse on global poverty and what can be done about it.”

The Houston Chronicle liked the book too: “Harford takes the basic underlying ideas of economics to demonstrate how they can be applied to every aspect of the world. Seems like a stretch, but Harford shoehorns in many freewheeling discussions with much wit and wisdom.”

Dear Economist,
Around South America hundreds of children have held their hands out to me and I’ve ignored many and felt terrible. But my £1 can be worth six of their currency – will I still go to heaven?
Yours sincerely
Natalie Chalk, by e-mail

Dear Natalie,

You would be astonished how difficult it is to give money away properly. Because there are few good jobs in poor countries, the understandable generosity of relatively wealthy visitors risks turning begging into a comparatively attractive profession – which is a self-defeating process.

Imagine that a poor farmer can make £1 a day, and a beggar can make £5 a day. Who would be a farmer? Farmers will leave the fields to beg until five times as many beggars are chasing the same tourists, returns collapse to a £1 a day, and the rest of the farmers continue farming. Similar reasoning applies to where families send their children: to the fields, to school or to the streets? For the same reason, guides and taxi drivers will wait hours or days for the single lucrative tourist. This doesn’t do anyone any good.

It’s true that begging often carries a stigma. Perhaps farmers would rather farm for £1 than beg for £2. Unfortunately, this is no better: your money is still doing nothing more than compensating beggars for the stigma of begging.

This process of “rent-dissipation” is not limited to beggars. For instance, the net benefit of being crushed but getting cheap goodies in the New Year sales should be roughly zero – otherwise more people would be there in the scrum.

You will only help if you can hand out money without encouraging people to chase those handouts. When you work out how to do that, your place in heaven is assured.

Also published at ft.com.

The Undercover Economist – FT Magazine, 12 November 2005

The other day I was hurrying to lunch on somebody else’s expense account at a very nice Washington restaurant, The Oval Room. I began to fret that clad in my weathered racing green leather coat, I had as much chance of talking my way into the White House across the street as getting past the maitre’d without a jacket and tie.

Summoning up indignation in advance, I angrily asked myself why anyone would turn away the guest of a paying customer. Scruffs pay the bill the same as anyone else, so isn’t the dress code of jacket and tie commercial suicide?

Actually, the smart restaurateur, armed with the swift feedback of market forces, does what governments tend to find rather difficult: balance the competing interests of different people. Some people will pay to eat a meal surrounded by the smart set. Other people will pay to eat a meal without having to dress up. The restaurateur gets to decide whose wishes count – the snobs or the slobs.

If he is wise, the restaurateur sets the rules to reflect the willingness to pay on each side. If the slob crowd is willing to pay more to remain underdressed, either because it is large or because it is militantly scruffy, the restaurateur respects that wish if he wants to stay in business. If the snobs are richer, more numerous or more impassioned about the issue, the restaurateur should swing the other way instead.

Dress codes are rare in modern restaurants, because few people care enough to pay to have them enforced. But dress codes are very common in nightclubs, because the main thing that a nightclub offers is the company of others. It is worth much more to go to a club filled with sexy people. The demand is evidently sufficient to compensate club owners for the loss of revenue from the dowdy.

Restaurateurs, diners, club owners and clubbers do not need the assistance of governments to help them work all this out. A law that insisted on jackets and ties in restaurants, or defended the rights of clubbers to wear cardigans and running shoes, would be a terrible law. A law that made jackets optional in restaurants but smart shoes compulsory in clubs would be better, but unnecessary at best.

Entrepreneurs, unlike governments, produce rules that are well-attuned to the will of the masses. Even better, the market satisfies niche demands. If you really want to eat lunch surrounded by suits, or to wear running shoes to a club, then you will find someone willing to provide that service. The law, by necessity, prescribes that one size fits all.

All of this makes it very clear that when governments ban smoking in restaurants, bars or clubs, the law is an ass. Entrepreneurs are just as capable of providing a smoke-free bar as providing a cardigan-free club, and will supply a variety of options to match demand.

If customers want smoke-free bars they will – and do – pay for them. My desire for a smoke-free environment is stronger than my desire for a cardigan-free club, but it is different in degree, not different in kind. If bar staff prefer a smokeless working environment then managers (and through them, customers) will have to pay them more to work in a polluted one. The scarcity of smoke-free bars is not an indication of the need for a smoking ban, but an indication of how much such a ban will inconvenience the ordinary punter.

Personally, I trust the market to provide a variety of solutions to suit all needs. When I reached The Oval Room, beloved of Washington’s top power-brokers, they allowed me and my leather coat in without batting an eyelid.

Here’s a brief interview from NPR Boston’s ‘Here and Now‘.

RadioEconomics is hosting a second podcast (the first is an interview) of me reading the introduction to The Undercover Economist. Short and – I hope – sweet.

Dear Economist,
My boyfriend is always encouraging me to save money or put it in a pension. (We are both in our early 30s.) I say any day could be your last, and you shouldn’t feel guilty about splashing out. Who’s right?
Yours sincerely,
Rebecca Marr, Sheffield

Dear Rebecca,

You are right, of course. Your boyfriend appears, at first glance, to be more rational.

After all, you are both likely to live for several decades to come. Your plan to spend everything you have and more as soon as possible seems a certain recipe for a penurious old age. Indeed it is.

But your boyfriend’s idea is worse. He risks saving too much. Better to die in debt than a millionaire: he can’t take it with him. He might claim that he will optimise his consumption patterns so as to avoid leaving too much money behind, but this is naive. The economists Wojciech Kopczuk and Joel Slemrod argue that people tend to deny the possibility of their own mortality, which explains why they tend not to make wills or buy enough life insurance. (Personally, I feel that people don’t buy life insurance because they realise it’s a bizarre bet that you can win only by dying young.) Because people like your boyfriend refuse to stare directly at death, they end up compulsively saving for a future they will not live to see.

Your plan is a compromise. You know that in 20 years you are likely to be saving too much, so you remove that temptation from your future self by spending all the money now. Even better would be to find ways to commit to optimal spending throughout your lifetime, but this is not easy. Perhaps you could start with a lifetime’s subscription to the Financial Times?

Also published at ft.com.

The Undercover Economist – FT Magazine, 5 November 2005

Few costs infuriate the modern consumer more than the price at the pump. Type “fuel price riots” into Google for a list of fatal incidents from Yemen to Indonesia. US pundits have been raging against “price gouging” in the wake of Hurricane Katrina’s damage to the energy infrastructure, while in Britain a fuel protest never seems far away. There are plenty of reasons why oil prices should be high at the moment: record world economic growth, disappointing exploration results, disruptions in Venezuela, Nigeria and Iraq, and a Gulf of Mexico full of storm-damaged drilling rigs. But motorists may wonder why the price of petrol leaps up so quickly when the crude oil it comes from was sold when the price was much lower.

It can take weeks or months for oil to get from the fields beneath the Gulf of Mexico into an SUV’s petrol tank. So while crude oil prices have risen, and with them the wholesale price of refined gasoline, the underground tanks at petrol stations have been full of cheaper petrol bought earlier. Yet the price at the pump has risen quickly. It’s infuriating to be paying tomorrow’s high prices today. Surely this is price-gouging?

Not so fast. If petrol stations were able to raise prices on a whim, they wouldn’t need to wait for a hurricane. After all, retailers don’t just price-gouge in emergencies; they price-gouge every day to the maximum extent of their powers. Fortunately, their powers are extremely limited and in fact the only time retailers can put prices up immediately is when high prices are obviously looming.

Imagine a world where wholesale gasoline prices are increasing but prices at the pump don’t rise immediately. You and I would want to fill up immediately with cheaper petrol. But service stations would have little interest in selling us this cheap petrol, because pump prices are going to rise in a couple of days. The owners of independent stations might regard this as the perfect time to close for the weekend and check out the sights in Blackpool. Why sell cheaply, if their petrol inventory is about to climb 10 per cent in value?

In a world of eager buyers and reluctant sellers, it is no wonder that price increases do not, in fact, wait for the arrival of the expensive petrol in the storage tanks.

The thoughtful motorist might be satisfied with this explanation, until they ponder the conundrum a few weeks later: crude prices and wholesale petrol prices start to fall, but pump prices do not. Petrol prices seem to follow “rocket and feather” behaviour: up quickly and down slowly. This is puzzling. The reverse argument should apply: retailers want to get the expensive petrol sold before the cheap petrol arrives, while motorists, anticipating the fall, should hold off on buying. (There are limits to this, of course: you can only hold off until the gauge starts showing empty.)

So if prices stay high, isn’t this yet more evidence of price gouging? Again, not so fast. The petrol retailers are not to blame – we lazy consumers are. Why? Because if we were prepared to look around more for lower prices, we would pay less. As Matthew Lewis, a young economist at Ohio State University, has pointed out, drivers who see a petrol station with a higher price than the previous week may drive past and look for a better deal. But checking prices is a hassle; customers who see a petrol station with lower prices are unlikely to bother searching further. This means that rising prices encourage competition, but falling prices do not. That makes sense. If you get a clean bill of health from your doctor you are unlikely to ask for a second opinion.

So next time you find yourself emptying your wallet to fill up, don’t blame the petrol station owner. Not unless you’re prepared to spend another half hour looking for a cheaper price.

Financial Times Magazine, 5 November

Why things cost what they cost
Gumshoe economics

Nov 3rd 2005
From The Economist print edition

MOST economists are nine-to-fivers. Calculating rationalists during the working day, they are much like the rest of us when they are at home with their boots off. But Tim Harford, who works at the World Bank and writes a regular newspaper column, never seems to take off his boots at all. He sees the fingerprints of supply and demand everywhere he looks: at work and at play, sipping coffee, shopping for groceries, even playing poker with friends.
His new book, “The Undercover Economist”, is a playful guide to the economics of everyday life, and as such is something of an elder sibling to Steven Levitt’s wild child, the hugely successful “Freakonomics”, which came out earlier this year.
While Mr Levitt wanders freely among sumo wrestlers, game-show contestants and other inhabitants of the outer fringes of economics, Mr Harford takes care of the home turf—scarcity, competition, taxes and trade. He is happy to learn from his elders, which is all to the good. The best stuff is not always the latest stuff, after all. As far back as 1817, David Ricardo explained why the best farmland often makes money for the landlord, not the farmer. And his analysis serves perfectly well to explain why today’s coffee companies don’t make much money from a high-priced latte in Waterloo railway station.
That said, Mr Harford does not take himself too seriously. He is at his best illuminating the economics of small things. He rehearses some of the familiar arguments in favour of globalisation and mounts a spirited defence of competitive markets, on the grounds that they discover the “truth” about our wants, and how much it costs to meet them. (Taxes, which make some things more costly than they truly are, in order to make other things cheaper, are a kind of “lie”, he says, though often a white one.) He also makes some impish forays into charged issues, such as environmentalism, which he thinks too important to be left to the moralists. But in general, as befits a covert operative, his tone is quizzical and low-key, rather than bombastic and judgmental.
For anyone schooled in blackboard economics, “The Undercover Economist” succeeds in taking the chalkdust out of the subject. But does it also serve the reader who has no economics at all? The difficulty is to avoid talking over readers’ heads, without talking down to them either. It is a trick Mr Harford carries off well, for the most part, though he can sometimes seem almost too anxious to entertain. The best detective stories are usually told straight.

I’ve always been a fan of The Motley Fool so was delighted when they asked to interview me about the investment lessons from The Undercover Economist. Read Undercover Investment Tips at the Motley Fool, or in my favourites section.