Tim Harford The Undercover Economist

Articles published in January, 2006

Ideas are nice really

Dear Economist,
Governments like to promote innovation. But ever greater innovation means ever greater use of resources, disposability of goods, consumer spending and (one surmises) social envy. Is there a case for suppressing innovation?
Marion Hancock, by e-mail

Dear Marion,

There are two ways to raise purchasing power: investment or innovation. Investment means buying big machines so that each worker operates more equipment. It is hard to see how this is more environmentally friendly than innovation. It is also self-limiting: all the investment budget goes on replacing worn-out machines.

By contrast, innovative ideas consume no resources at all. They are particularly useful when there are many people on the planet, because everyone can benefit from a piece of software, a better design for the mousetrap or the theory of germs. Not everyone can benefit from my electric hand drill.

Nor do innovative products use more resources. Today’s expensive consumer products are tiny, or do not physically exist at all – for example, the 4,000 issues of The New Yorker that my wife gave me for Christmas are stored digitally.

It is true that if I was poor enough then I would have received no magazines, digital or otherwise. So perhaps you are not really in favour of suppressing innovation but of ending economic growth entirely. This has proved possible – for example, in Mao’s China or the dying days of the Soviet Union. Environmental Eden did not result.

At least an end to innovation might (you surmise) return us to the envy-free days when my great grandmother might have been your great grandfather’s scullery maid.

But I don’t wish to find out.

Also published at ft.com.

28th of January, 2006Dear EconomistComments off

What really counts

The Undercover Economist – FT Magazine, 28 January 2006

An extended version of this article was published by Slate, 4 February.

My second-favourite character from Sesame Street was always The Count. Avid viewers will recall that The Count loves to count, punctuating his counting with a throaty Transylvanian chuckle. Laughing aside, I’ve noticed a similar tendency in economists. We spent decades perfecting the theoretical tools and the software to gather and analyse noisy data in a messy world. Most of the data were produced by laborious counting of the most obvious things: goods sold, prices, people out of work. Now the tools are so good and so simple to use, and data so easy to gather and disseminate, it’s hard to resist the temptation not to count, well, something different.

A nice exponent of this is Chicago-based economist David Galenson, who recently demonstrated that Picasso was by far the greatest artist of the 20th century. Galenson’s method is simplicity itself: round up every art history textbook of the past 15 years, and see whose art is reproduced most frequently. Picasso, with 395 illustrations in 33 textbooks, scores nearly as many as his three closest rivals (Matisse, Duchamp and Mondrian) put together.

Galenson is out on a limb with this particular piece of counting, but his work highlights the features of more mainstream counting projects. First, it’s infuriating. An economist pronounces Picasso the greatest artist of the 20th century on the basis of leafing through picture books: what could be more irritating?

Second, it’s also annoyingly reasonable. Galenson is not counting something stupid, like the number of colours Picasso used. He’s counting something meaningful, which is how frequently experts felt inclined – or compelled – to exhibit Picasso’s art in canonical textbooks. The process of counting is reductive but not foolishly so. It is a simple and transparent quantification of other people’s qualitative judgments.

Third, the counting is the start, not the end. What really interests Galenson is when artists reach their peak. His method allows him to show, for example, that the artists who made conceptual leaps (Johns, Picasso, Duchamp, Warhol) peaked far earlier than so-called “experimental” artists for whom practice made perfect (Kandinsky, Rothko, Mondrian). Johns was 25 when he produced his most-reproduced pieces. Mondrian was 71.

Galenson’s counting isn’t going to change the world, but other projects may. Former colleagues at the World Bank have been counting away: how many official signatures does a farmer in the Central African Republic need to obtain before he’s able to get his bananas on a ship bound for America or Europe – 38. How many official procedures must a businessman in Lagos go through in order to legally buy a warehouse – 21.

This kind of counting – done with the help of several thousand local lawyers and public officials – shares common ground with Galenson’s work. It transforms a qualitative impression (”Nigerian bureaucracy is painful”) into a quantitative fact; it does so through the intermediation of experts, and uses a perfectly transparent process.

It’s also rather more useful. Galenson won’t tell you how to be the next Picasso, but the World Bank report, Doing Business in 2006, can show Central African Republic officials which 37 of the 38 signatures are surplus to requirements in Germany.

Meanwhile, Doing Business in 2006 is, by far, the World Bank publication most mentioned in press reports. I know that, because somebody counted.

The economics of bad breath

Dear Economist,
My dentist tells me that I should floss, but what do you think?
William Henderson, Virginia

Dear William,

You may be misremembering John Maynard Keynes’ famous wish that economists should aspire to be thought of “as humble, competent people on a level with dentists”.

I don’t think Keynes ever believed that economists should become dentists. Fortunately for you, Bryan Caplan, an economist at George Mason University, thinks otherwise.

Professor Caplan’s dentist, like yours, is quick to list the benefits of flossing in rather vague terms. No doubt the benefits are real. But are they greater than the costs? Flossing is tedious, uncomfortable and undignified. You can quantify the costs of a lifetime of flossing for yourself: I suggest that you ask your dentist to quantify the benefits before you make a decision.

Professor Caplan’s dentist didn’t seem to understand the question, so Caplan turned to the scientific journal Nature for enlightenment.

It turns out that dentistry itself may not be as useful as Keynes believed: regular dental checkups are likely to give you no more than five extra teeth when you’re 75 – assuming you live that long. This is a modest and distant reward for a lifetime of being drilled.

Of course, this column shouldn’t be mistaken for informed medical advice. Neither Caplan nor I know a thing about dentistry. But I believe that if economists make a bit of an effort to understand dental health and hygiene, the dentists should meet us half way and produce that cost-benefit analysis.

You may think this is missing the point: flossing also helps to produce more kissable breath. Perhaps most economists feel that bad breath is the least of our worries.

Also published at ft.com.

21st of January, 2006Dear EconomistComments off

The world’s rudest barman

The Undercover Economist – FT Magazine, 21 January 2006

An extended version of this piece is available at Slate.

I don’t want to complain, but my favourite lunchtime haunt has the rudest barman I’ve ever encountered – and I don’t think it’s an accident. The restaurant is famous for its superb, sophisticated Italian cooking and it prices accordingly. A romantic meal for two costs about $150, plus the price of your selection from a wine list of biblical proportions. Even if you pick the cheapest main course for lunch and sip water, this frugal meal for one will set you back $15.

Or, you could sit at the bar or on one of the tables in the bar area. The food is still superb: you can fill up on rich, soft pork meatballs nestling on pillows of light polenta for about $8. The veal ragu is rich but you don’t have to be, because this perfect spaghetti is half the price of a pasta dish in the main restaurant.

It sounds too good to be true, and I’m afraid there is a catch. To get to the food, you have to get past the barman who takes your orders, a man more Bond villain than bon vivant. To walk into that bar is to laugh in the face of fear. The barman welcomes me in with all the warmth of a Transylvanian butler in a B-movie. He drops menus on my table with a sneer. He repeatedly ignores my attempts to order. As he walks past, my companion whispers that he picked up his tattoos in a Russian prison. I think she’s having me on, but I can’t be sure.

It’s possible, of course, that this man is in the wrong job by accident, and when the restaurant owner reads this column and works out that it’s about his restaurant, “Igor” will be fired. I’m not convinced. I think Igor is all part of the plan. One food critic described a previous bartender as acting like she’d just returned from a tax audit. “Venomous” is obviously in the job description.

Why would a restaurant deliberately sabotage the dining experience? A restaurant with a good reputation and a brilliant chef acquires some degree of power to name its prices. With that power comes the temptation to try to separate out customers and charge a high price to the expense-account lobbyists and a cheaper price to me and my friends. A nice idea, but trying to charge different prices for the same product is not easy. Something must be done to keep the lobbyists in the full-priced restaurant, and that something is Igor.

This sounds odd, but it’s not really so unusual. Think of Adobe’s Photoshop Elements, a product that is often described as a stripped-down version of the image processing software, Photoshop. It doesn’t cost Adobe any more to ship a Photoshop CD than to ship an Elements CD, and stripping out those extra features was surely an additional expense. Intel introduced two versions of the old 486 computer chip; the cheaper one was the expensive version with some extra work done on the chip to slow it down.

Consider, too, multipacks in supermarkets. A manufacturer produces a gigantic pack of 12 three-litre bottles of lemonade at a price: it must hire a packaging company to bundle them together. As with Intel and Adobe, the inferior product costs more to produce. The payoff is simple: it enables retailers to target price increases on shoppers who prefer something easier to carry, even if it is more expensive.

One day I shall have an expense account, and I shall dine in the main restaurant where, no doubt, the maitre d’ looks like Pierce Brosnan and sylph-like waitresses will give me massages. Until then, I will eat great food at low prices, and Igor will keep the lobbyists away.

What’s in it for us then? – A book review

by Daron Acemoglu and James A. Robinson
Cambridge University Press £25, 540 pages

The birth of British democracy was protracted, as the ruling classes slowly allowed the voting franchise to expand. In 1832 the first reform act increased the electorate from about 8 per cent of the population to 15 per cent; several further reform acts continued the process, and it was completed with near-universal suffrage in 1928. While the concessions were gradual, designed to stave off reform rather than hasten democracy, they all moved in the same direction.

Argentine democracy, by contrast, flickered on and off throughout the 20th century. Something resembling universal male suffrage was introduced in 1916 but was rendered irrelevant by coups in 1930, 1943, 1955, 1966 and 1976.

Non-democracies also differ from each other. Singapore’s dictatorship has delivered such riches that popular opposition is half-hearted; whereas South Africa’s apartheid regime was tempted into ever-greater acts of repression.

With these four cases, Daron Acemoglu of the Massachusetts Institute of Technology and James Robinson of Harvard begin an ambitious attempt to explain the different paths that democracies and non-democracies can take when viewed in retrospect: steady progress as in Britain; oscillation in Argentina; stable, high-performance dictatorship in Singapore or the repressive apartheid regime. What they produce is an abstract model that will infuriate historians but deserves their attention.

The authors are distinguished economists: Acemoglu recently won the John Bates Clark medal, a decoration rarer than the Nobel prize in economics (it’s awarded every two years, and never to multiple recipients). Acemoglu’s immediate predecessor was Steven Levitt, co-author of the best-selling book Freakonomics. Anyone expecting Acemoglu to produce something similarly crowd-pleasing will be disappointed. Acemoglu teamed up not with a professional writer but with a long-standing academic collaborator, and produced a book that will be impenetrable to the layman. Nevertheless, I expect Economic Origins of Dictatorship and Democracy to be highly influential.

Acemoglu and Robinson model the struggle for democracy as a piece of game theory – a strategic contest between a small number of players. Social classes are collapsed into individuals: the basic model is a two-player struggle between the “elite” player and the “citizens” player. The players are rational, foresighted, take each other’s responses into account and are motivated by economic interest rather than ideology.

Game theory is an ostentatiously spartan tool for analysing mass historical movements. Intra-group conflicts and distinctions between different types of democracy are swept aside.

Acemoglu and Robinson know they are simplifying aggressively: they often use the phrase “Occam’s Razor”, meaning that by shaving away superficial historical details, they will expose the underlying structure of the emergence of democracy. I think it’s worth suspending disbelief to see where the model goes – but historians and political scientists may be less patient with its reductionism.

Acemoglu and Robinson say the fundamental problem they expose is how rebellious citizens turn temporary opportunity into permanent advantage. The citizens have revolted, leaving the fields, taking the elites and their standing armies by surprise, and seizing the moment: how can they use their fleeting power to secure lasting concessions for the future? Faced with an imminent revolution, the elites will offer to change their ways. But since a revolutionary movement can’t be sustained forever, how can the citizens be sure the elites will deliver once they have picked up their ploughshares once again?

Viewed from the other side, how can the elites offer credible concessions to a temporary insurrection? The initial temptation is not to bother. For example, in 1905, mutiny on the Battleship Potemkin helped simmering discontent in Russia to boil over. Tsar Nicholas II published the October Manifesto, granting freedom of speech and association, guaranteeing no imprisonment without trial, and establishing an elected legislative body, the Duma. The revolutionary threat cooled, and Nicholas II promptly changed his mind, disbanding the Duma in less than three months.

Twelve years later, the revolutionaries were less interested in compromise.

Acemoglu and Robinson’s formulation reminded me of an old game theorist’s story, the kidnapper’s dilemma. The hostage is taken; the kidnappers have temporary power. But how to swap the hostage for the ransom, or for safe passage? A Woody Allen routine once captured the inherent difficulty of the negotiations: “The FBI surround the house. ‘Throw the kid out,’ they say, ‘give us your guns, and come out with your hands up.’ The kidnappers say, ‘We’ll throw the kid out, but let us keep our guns, and get to our car.’ The FBI say, ‘Throw the kid out, we’ll let you get to your car, but give us your guns.’ The kidnappers say, ‘We’ll throw the kid out, but let us keep our guns – we don’t have to get to our car.’ The FBI say, ‘Keep the kid.’”

Acemoglu and Robinson argue that for the elites as well as the FBI, the answer to this dilemma is to give up the kid. That is, the elites can irrevocably hand over some power to the masses by creating democratic institutions. By doing so they dissipate the threat of revolution and keep some power for themselves, too. The concession is more credible than offering a change in policy (such as bigger welfare payments or lower taxes) because policies are easily changed but democratic institutions are not easily disbanded. Because the concession is more credible, it is also more effective: by making such concessions the elites avoid revolution.

That, then, is the story of how democracy emerges: it’s a way of committing to reforms when the likely alternative is the guillotine or the firing squad. But what about those cases when democracy does not emerge, or does not last? Or the revolutionary forces ignore concessions from the elites and seize power in a civil war, perhaps destroying much of what they sought to control in the process. Or some general decides that a coup is in order after democracy appears to have developed. Or the elites decide that they would rather repress rebellions with ever-greater violence than concede anything.

Acemoglu and Robinson argue that these scenarios tend to hinge on predictable factors. For example, the elites will concede democracy more readily if they have less reason to fear severely redistributive taxes. Land is especially easy to tax, so landed gentry will oppose democracy more violently than industrialists would. Other important determinants include the level of inequality, the ease with which civil society organises itself, and the frequency of economic crises. In practice, this is a model that may prove helpful in explaining long-term patterns of emerging democracies; it will not serve as a handbook for today’s nation builders.

The thesis is compellingly inventive. It has to be: Acemoglu and Robinson do not back it up with empirical work. Their case studies are sparsely distributed in the book, and designed only to illustrate its argument. This is a surprise, because both writers, with Simon Johnson of MIT, have done breathtakingly inventive empirical studies of economics and political institutions.

The use of game theory is not wholly satisfying, either. Social or economic classes do not act in unison. Acemoglu and Robinson recognise this – indeed, the fact that citizens cannot organise a rebellion on a whim is the pivotal point of the argument. But the flexible assumption that a social class can sometimes be treated as a single decision maker, and sometimes cannot, is a worrying weak link in the chain of reasoning.

Despite these imperfections and their highly technical models, Acemoglu and Robinson will deservedly win an audience. Students of economics will study this text as much for its methodical exposition and academic proofs as for its conclusions. They will find the effort well worthwhile.

21st of January, 2006Other WritingComments off

My best friend’s wedding

Dear Economist,
I’m planning to take a sabbatical to travel around the world with my partner for eight months. But we have a dilemma: should we cut our trip short after four months and return to England for a best friend’s wedding? It would mean that we would miss out on New Zealand (and four more months off work) – but maybe it would be worse to miss the wedding?
Paula Marvin, London

Dear Paula,

Your choice would be simple if one of these plans was Pareto-superior to the other.

A Pareto-superior plan is one that makes at least one person better off and, critically, makes nobody worse off.

I can only presume that your best friend would prefer you to attend her wedding, while it’s perfectly obvious that your partner would rather cavort in the antipodes for another four months. There is no way to make one of them better off without making the other worse off, so unfortunately, neither option is Pareto-superior.

How, then, are you to choose?

I recommend the Hicks-Kaldor compensation test. If you could (in principle) offer your best friend enough cash to assuage her feelings for your absence, and still feel that you were ahead on the deal, then the Hicks-Kaldor test is satisfied and you should stay the course for eight months.

Fortunately, you do not actually need to bribe your friend to excuse you from the wedding – which is good news, since the bribe might be misinterpreted. All you need to know is that four months of fun and frolics together for you and your partner is worth more than the fleeting pleasure your friend will get at noticing you amid the crowds at her wedding. Put like that, your choice is obvious.

Also published at ft.com.

14th of January, 2006Dear EconomistComments off

London is cheaper than Washington DC after all

The Undercover Economist – FT Magazine, 14 January 2006

After two years as a roving freelance columnist, I am leaving Washington DC and returning, at last, to Albion’s shores to work for the Financial Times. But how much should I be paid? In moments of delirium I imagine that the FT will invite me to name my own salary, at which point I shall magnanimously refuse to take advantage. But that daydream brings out the Undercover Economist in me: what salary would be fair? Washington DC isn’t cheap, but London is notoriously expensive. The question, “How much more expensive?”, makes less sense than you might think. You can compare the price of particular goods – Budweiser and Coors are cheaper in DC than in London. But I don’t drink Budweiser or Coors, so what does it matter? A sensible price comparison would have to look at the things that I do buy.
This is hard. In London I drink good English beer, but good English beer is expensive in DC so I drink less of it. Decent red wine is cheap enough, so I have that instead. DC offers several places where you can get a good restaurant lunch for the equivalent of £5, so I often eat out for lunch. It would be expensive for me to maintain the habit in London, but I won’t, and that’s no coincidence. It’s impossible to separate what things cost from whether I buy them.
Still, if I am to work out a fair salary I could ask how much it would cost me in London to buy the things I bought in Washington DC. This is guaranteed to deliver a fat relocation allowance: the things I paid for in Washington DC, such as a central-city apartment, would cost the earth in London.
There’s another point to consider. Even living in Hackney I would be less than an hour away from the shopping and the arts of one of the world’s great cities. To get quickly from DC to the heart of one of the world’s great cities requires a helicopter trip to Manhattan. All this assumes that I would not adjust my lifestyle to take advantage of the different prices and opportunities available, and so overestimates the cost of the move.
When relocation consultants estimate the cost of living, they miss out the important stuff. As far as our imperfect methods can tell, the high prices in more expensive American cities outweigh the higher wages paid there. In other words, despite his dollar wealth, the typical inhabitant of New York is poorer in material goods than the typical inhabitant of Kansas City. What does that show? The fact that anyone is willing to live in New York rather than Kansas, despite relative poverty, shows that New York is full of pleasures that relocation consultants’ checklists cannot measure.
Economics has no trouble admitting that the best things in life are free: for us, the greatest joy of moving to London will be the fun of friends and family. They do not charge for the entertainment they provide.
So which is the cheaper city? I would rather have $50,000 (£28,360) in London than $50,000 in Washington DC. So for me, the cost of living in London is lower – not the cost of buying something on a consultant’s clipboard, but the cost of living happily.
Oscar Wilde’s description of cynics – people who know “the price of everything and the value of nothing” – is now applied to economists. The truth is stranger: I don’t know the price of living in London rather than Washington, but the value is clear enough. Perhaps I should ask for a pay cut.

When Fantasy becomes Reality – a book review

SYNTHETIC WORLDS: The Business and Culture of Online Games
by Edward Castronova
University of Chicago Press $29, 344 pages

Review: Financial Times, 14 January 2006

“This book claims to take a serious look at online computer games. You are actually reading it,” begins Edward Castronova in Synthetic Worlds. “If you are a serious, hardheaded person like me, you must be feeling a bit strange.” Quite. Castronova, an economist as well as a games enthusiast, is well aware of the need both to explain his subject, and to justify his choice of it. Although both explanation and justification are laborious (one suspects Castronova also found them so) they are worth the effort. Synthetic worlds – that is, silly online games about wizards and goblins – are an idle pastime no longer.
In an online role-playing game, the computer displays a three-dimensional world to explore, presenting babbling streams and ice-tipped crags in glorious fidelity. The game can be anything from a fantasy styled after The Lord of the Rings, to a journey in a spaceship across a galaxy. Exploring the same world are several thousand other people, each also playing as a wizard or alien. The longer you play and the more imaginary equipment you acquire, the more the game will allow you to do: with a better spaceship, you can move faster around the synthetic world and overcome more of its dangers.
Online role-playing games are part online chatroom, part special-effects extravaganza and part game of let’s pretend. If they were merely that, they might be intriguing but hardly worth scholarly analysis. Where the surprise comes – and the economists start to pay attention – is when games players spend real cash to gain virtual items. If I want a head start in Star Wars Galaxies, for example, I can visit eBay, or a specialist website such as ige.com, and buy a Jedi Knight character (today’s price $686).
That seems a lot of money for an asset that exists only inside a game, but perhaps it’s not so remarkable. Admittedly, the Jedi doesn’t physically exist, but neither does Darth Vader, and that didn’t stop me paying money to watch the Star Wars films. The Jedi will give its user a smoother, more enjoyable game experience, a bit like owning a better tennis racquet.
More interesting is the fact that the Jedi Knight is both consumed and produced inside a synthetic world. In principle the company that hosts the game can manufacture advanced characters at almost no cost. In practice, game owners have resisted the temptation to allow people to buy advancement because many players think it spoils their fun. (Imagine if I started bribing other players with real money during a game of monopoly.) The result: advanced characters are produced the hard way, by playing long hours in the tedious early stages of the game. This is labour intensive and, predictably, has been outsourced to China. Synthetic worlds have also exhibited inflation, the spontaneous emergence of market institutions and fraud.
Many observers believe that online games are like real economies. In Synthetic Worlds, Castronova demonstrates that he knows better: online games are real economies. People devote time and skill to producing things that other people value, such as Jedi Knights. That’s supply and demand: an economy. The aliens and the light sabres aren’t real, but the human effort and the human desires are. It becomes easier to realise this when the synthetic economies spill out into the corporeal one – when grand wizards are bought and sold on eBay or Romanian entrepreneurs supervise workshops of virtual gold-miners.
One synthetic world, Second Life, offers no game-play as such but sells virtual real-estate that users can build almost anything on. One real-estate maven, “Anshe Chung”, a Chinese teacher based in Germany, is reported to make $150,000 a year buying, improving and reselling virtual homes in Second Life. Others have businesses designing virtual clothes or selling virtual advertising. “Tringo”, a game-within-a-game that was created and made popular within Second Life, was bought from its creators by Nintendo and released for the GameBoy console. (Tringo’s programmers, not the Second Life hosts, owned the intellectual property.)
At this point it is possible to take the discussion in almost any direction, and Castronova tries many. He has an eclectic approach to research – some amateur sociology, a spot of anthropology, some national income accounting with liberal use of the back of the envelope. The research occasionally seems a little flaky, but it’s well ahead of the gushings of consultants and media pundits. Meanwhile, Castronova’s grab-bag of methodologies works fine for exploring unmapped territory.
When will synthetic worlds become economies worth reckoning with? They are already real, and are the fastest-growing economies in the world. But they are small: all the synthetic economies put together, with about 10 million players, are about the size of Bosnia and Herzegovina. It’s possible to compute an hourly wage in a synthetic world, how much one could make seeking gold in a synthetic world and selling it for cash on eBay. The answer is small but not minuscule: enough to attract the Chinese and perhaps some teenagers, but less than you can earn working at Starbucks. “Anshe Chung” may make $150,000 a year but such a salary would hardly be news if earned in the corporeal world.
All this will change, as Castronova argues convincingly. More players will spend more time in synthetic worlds as the technology becomes easier to use, more enjoyable and cheaper. Not only will more people spend more time in synthetic worlds, but it seems likely that the economies of the worlds will become more interesting.
Today’s synthetic economies are dull, even if the games are not. A popular game of the moment, World of Warcraft, has an economy largely based on killing monsters, taking their gold, and spending the money to acquire better weapons and armour. There is no technological progress, little gain from specialisation, and no opportunity to invest in capital stock (castles, for example, are created by game designers, not enterprising players). Second Life, which allows people to build almost anything, is more fertile territory, but remains small relative to the simpler games. For me, the interesting moment will come when – if? – a world with the popular appeal of Warcraft or Star Wars Galaxies allows entrepreneurial players to invest and invent.
Castronova asks questions most readers will never have thought of: what will autocratic governments do with synthetic worlds? Can governments emerge inside synthetic worlds? What will happen when a government tries to shut down an addictive world, and can’t because it’s hosted on decentralised computers – much as music files are illegally copied today? His answers are not always convincing but the questions themselves are enough.
Meanwhile, Castronova has “gone native” – entranced by the distant lands he set off to explore. Rather than puffing a tedious subject full of hot air, he is a giddy enthusiast desperately trying to sound sober. In a book that often managed to provoke the expert while informing the novice, that is a winning enough combination.

14th of January, 2006Other WritingComments off

The prices are wrong

Dear Economist,
I am a pensioner and I am wondering if you can explain why my personal recent experience of inflation is so different from the official statistics. Retail price inflation is 2.5 per cent up on last year, but my domestic heating oil bills have doubled, petrol prices have shot up, mortgage and other interest rates are up by 25 per cent, labour rates for tradesmen have gone up etc. I would say that I am paying out 10 per cent a year more to maintain the same standard of living.
Peter McIlwraith, West Sussex

Dear Mr McIlwraith,

The Office for National Statistics regards your consumption patterns, as a pensioner, as sufficiently whacky as to deserve deliberate omission from the retail price index (RPI).

I wouldn’t worry that you’re missing out too much, though. The RPI has never borne much relation to the standard of living, for three reasons.

First, falling prices are only included in the RPI once they’ve fallen enough that people are paying them. Computers have been falling in price since the 1940s, but only the more recent falls have been included in the RPI because ordinary people didn’t buy computers in 1955.

Second, the goods counted in the RPI are always changing. In the 1970s, entertainment meant hula-hooping. Now it’s an Xbox.

I am not sure how many hula-hoops make an Xbox. Neither is anyone else.

Third, and most importantly, quality improvements are very hard to capture. The price of medical care is rising, for instance, but life expectancy has risen too – it was below 50 years in the first half of the 20th century. The invention of antibiotics and vaccinations cannot really be captured in measures of inflation but, thanks to those developments, you’re alive and complaining today.

Also published at ft.com.

7th of January, 2006Dear EconomistComments off

Surviving the sales

The Undercover Economist – FT Magazine, 7 January 2006

If you’re reading this, you’ve survived the New Year sales, an organised riot arranged annually for fun and profit. In the US, there is a similar tradition of giveaways the Friday after Thanksgiving, and similar chaos as the stores open. The furniture store Ikea has added extra exhilaration to the sales experience – you may recall that ambulances were required after an opening-night sale at a London store nearly a year ago, and there have been worse incidents, including an Ikea opening in Saudi Arabia in 2004 in which three people died.

These queues and crushes create a bizarre situation where no amount of price-cutting will make customers better off. To see why, imagine that you have two choices on sales day: the first is to go hunting for a bargain; the alternative is to stay at home eating turkey sandwiches.

But imagine, too, that after a thorough brainwash with sherry and old Bond movies, you’re thinking along the same lines as everyone else. You’d be tempted by a price cut of 25 per cent as long as you didn’t have to queue more than half an hour to get into the shops and get hold of your bargain. But since everyone thinks similarly to you, a price cut of 25 per cent will attract punters only if the queue is no more than half an hour long. If it looks like growing longer, people will stick to the turkey sandwiches.

What if the offer is half price? Perhaps you’d line up for an hour. But so would everyone else. More people will arrive until the line is an hour long and the sandwiches beckon once more. In fact, the shop could be giving away its merchandise along with free lottery tickets and a kiss from Brad Pitt, but the more attractive the prize at the end of the line, the more effort everyone will expend to get it.

Reality is more complicated, of course. People have to guess how long the queues will be, and some of them will end up queuing while wishing they’d never left home. And some people like bargains more than others, which means that some people will show up pleased and surprised that the queue isn’t even longer. But the story remains essentially the same: life is not greatly improved, no matter how great the bargains become, because the crowds will build to offset the bargains perfectly. You will always be torn between going shopping and turkey sandwiches.

If this was merely a tale of a cheap pair of shoes at Harvey Nichols, we could leave the story here as a theoretical curiosity, because we don’t care whether department stores are able to give money away effectively or not.

But we do care, very much, about other efforts by governments and by charities to give money away. Governments provide roads and they become congested, to the extent where the average driver would be just as well off paying £5 and halving his commute time. They provide a few good schools, and the benefits flow not to anxious parents but to the local homeowners who can sell them expensive houses. And everyone is familiar with the concern that giving money to beggars makes begging a less unattractive occupation. In all of these cases tremendous amounts of money are spent but the beneficiaries are scarcely better off, if at all.

This is one reason – there are others – why subsidised services have so often proved to be disappointments. Retailers may occasionally abandon the idea of charging real money for their wares, but the scrums they create when they do offer discounts make us appreciate that prices are often worth paying.