Tim Harford The Undercover Economist

Articles published in April, 2006

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30th of April, 2006MarginaliaComments off

Bristol in the stone age

Dear Economist,

I want to pay someone to redecorate the kitchen, rather than slave over the paint pots myself – not only because I hate DIY but also, as a professional, I want my wealth to trickle down through society. However, my husband says we should all do our own manual work so that when the oil runs out we’ll have the skills to tackle any job. What do you think?

Marion de Berker, Bristol

Dear Mrs de Berker,

You are both confused. You will not create any “trickle-down” wealth if you decide to pay a professional decorator instead of working on your kitchen in your spare time. If you do it yourself, the money you would have paid to the decorators will instead be spent on holidays, restaurants or clothes. I am not sure why you think your decorator deserves the cash, rather than the waiter or the travel agent.

Perhaps you’re afraid that if you don’t hire a decorator, the cash will be unspent for a while and nobody will benefit from receiving it.

But your restraint will free up resources for investment, and future generations will be richer.

The reason to get the decorators in is that they’ll do it better than you, and it will take less time to earn the money to pay them than to do it yourself.

Meanwhile, your husband shows signs of advanced paranoia. Send him away on a paintball weekend and have the decorators in while he’s gone…

Continued at ft.com.

29th of April, 2006Dear EconomistComments off

Silver linings

The Undercover Economist – FT Magazine 29 April

The news makes such depressing reading these days, as it always does when there’s a war on. But amid all the gloom, a small, curious part of me can’t help wondering whether our military escapades in Iraq and Afghanistan will produce any unexpected consequences for our daily economic life.

It wouldn’t be the first time that a war has transformed the economy. When Honore Blanc, a French gunsmith, produced 10,000 muskets a year for Napoleon, he made sure that any faulty pieces could be replaced by standardised components rather than the usual handmade parts. It was a simple idea but an engineering miracle – and without it, mass production would have been impossible.

The first world war provided a more indirect impetus to the process of technological change. More than 30 years after Thomas Edison lit the streets of New York City, the electric dynamo hadn’t produced the new efficient manufacturers that many had expected. Although huge steam engines had been replaced by huge electric motors, factories were still set up the old way: workers were clustered around the monstrous engines because the equipment they used was powered by drive belts, which meant it needed to be close to the source of power. The result was, the workers were arranged according to how much power their equipment needed, rather than what would lead to the most productive flow of work.

The first world war changed all that, according to economic historian Paul David. In 1914, the US government all but shut its borders to immigrants. Manufacturers focused on improving training and hiring the best workers, instead of simply drawing on a boundless supply of cheap muscle. The well-trained workers, with new contracts and new chains of command, were capable of handling new responsibilities. They operated machines using power transmitted through electric cables, not drive belts. Factory floors could be reshaped and products made more quickly, and the US economy enjoyed astonishing productivity gains.

Yet another war spurred one of the most important innovations of the past 50 years: the shipping container. In 1960, half the cost of shipping cargo from Chicago to France was the delay in handling the goods at the docks. Shipping containers cut most of those costs out, and they are fundamental to the way the world works today. Without containerisation, “Made in China” would be words we rarely read. Yet the shipping container was blocked for decades by disputes with unions, shipping cartels, and bureaucrats who regulated the routes and prices that truckers could charge for carrying containers. Change was easy to block because the status quo was sustainable.

That wasn’t true during the Vietnam war, when as early as 1965 the military build-up was being hampered by what the journalist Marc Levinson calls “the greatest logistical mess in the history of the US armed forces”. In The Box, Levinson’s new book about the shipping container, he argues that container shipping provided the answer. Once the military was sold on the idea, there were two swift consequences: a dramatic expansion of container shipping to US forces in Europe, and fleets of empty ships sailing back from Vietnam, offering cheap rates to the rapidly expanding Japanese manufacturers. The rest is history.

Interchangeable parts, electrification and containerisation collectively created the wealth we enjoy in the western world today. The wars that brought us this bounty were bloody enough, but perhaps it is some consolation to reflect that both history and the economy work in mysterious ways.

News on ‘The Undercover Economist’

Sorry about the slow updates; I have been in Ireland taking a break, along with a spot of publicity for ‘Undercover Economist‘. I returned to find the book number one on Amazon. Thanks to everyone who helped to put it there.

22nd of April, 2006MarginaliaComments off

Any colour you like, as long as it’s lemon

The Undercover Economist – FT Magazine, 22 April

I recently did something that is, in theory, most unwise: I bought a second-hand car. Since economists hate to compromise between safety and style, it was a Volvo. You’d think I would know better. The American subtitle of my book is “Why you can never buy a decent used car”.

In 1966, an assistant economics professor, George Akerlof, tried to explain why this is so in a working paper called “The Market for Lemons”. His basic insight was simple: if somebody who has plenty of experience driving a particular car is keen to sell it to you, why should you be so keen to buy it?

Akerlof showed that insight could have dramatic consequences. Buyers’ perfectly sensible fears of being ripped off could, in principle, wipe out the entire used-car market: there would be no price that a rational seller would offer that was low enough to make the sale. The deeper the discount, the more the buyer would be sure that the car was a terrible lemon.

More plausibly, only the market for cheap, shoddy used cars would survive. A person with a good car would hold on to it because he couldn’t prove it was good and so wouldn’t expect an attractive offer for it. And if the good cars aren’t put up for sale, the lemons will be what is left. This is a problem not just for buyers, but for sellers too, who wish they could be trusted.

Economists dispute whether this is actually a reasonable description of the used car market. For instance, there’s been a lively controversy as to whether pickup trucks that are sold second-hand have higher maintenance bills than pickup trucks of the same age that are not sold. (If they do, that’s evidence in favour of Akerlof’s “lemons” model.)

But that is not really the point, because used cars were just the beginning for Akerlof. His neat little paper was turned down by two top journals because they couldn’t see past the trivia of his example. He recalls that a third, the Journal of Political Economy, had a better reason for rejecting him: the paper couldn’t be true, because if it was true then economics would be turned on its head.

The Journal of Political Economy was half right. Akerlof did turn economics on its head – and eventually received the Nobel Prize for doing so – not by documenting the travails of used-car buyers and sellers, but by showing how corrosive a little bit of inside information can be to all sorts of markets. Insurance, including health insurance, is one possible casualty. Loans and mortgages too: some people simply cannot get a loan, no matter how much interest they offer to pay.

Then there’s the market for jobs. How many of your colleagues are lemons? If you’re competent but can’t prove it to your boss, you may prefer to be freelance. If other competent workers think that way, it may explain why you think your colleagues are idiots and they think the same about you.

These problems can be solved, but at a cost. Mortgage companies refuse credit to whole neighbourhoods as a way of cutting out high- risk borrowers. Employees spend years acquiring qualifications with little value other than proving that they’re smart and work hard. And used-car buyers will look for trusted sellers, even if that raises the cost of doing business. I bought my Volvo from my brother-in-law because I thought that would lower the risk of being sold a lemon.

Not only are the solutions costly, they don’t always work. My Volvo lasted less than a fortnight before the clutch burned out: a bitter little lemon after all.

The early bird

Dear Economist,

To improve my chances of getting a raise should I be the first person to walk through the office door in the morning or the last person to leave at night?

D. Clark, Seattle

Dear D. Clark,

Being first into the office is a risky business. What if you get in at 6.30am but someone else was there at 6.15am? In the winner-take- all world you envisage, you might just as well have crawled in at 10am, because there are no prizes for coming second.

Being last out of the office is, at least, predictable. You just wait until everyone else has gone, and barely a second longer. However your colleagues will realise this, so the last-out strategy may become popular, and thus expensive. Which is the easiest path to a raise?

Strange as it may seem, both competitions are a form of auction – in both cases, the bids are effort not cash, and in both cases, it’s not just the winner who has to pay. Nobel laureate William Vickrey has shown, surprisingly, that all such auctions raise the same expected revenue. Both the first-in and the last-out competition will be equally profitable for your boss and equally costly for you.

I have a word of advice and a word of caution…

Continued on ft.com.

22nd of April, 2006Dear EconomistComments off

Wrong numbers

The Undercover Economist – FT Magazine, 15 April

For nearly two months, a glossy magazine from my mobile phone company has been lying around the place. I took it with the intention of choosing a decent calling plan, but so far I’ve made little progress. Occasionally, I pick it up and thumb it listlessly but cannot get my mind around the different pricing options.

The permutations include on-peak, off-peak, in-network, out-of- network, joint accounts, “bundles” of this and that, and a variety of additional offers conditional on my signing some form of longer term contract. The choice is bewildering.

Usually, I have little sympathy with those who complain about the agony of choice. If the choice is important, such as when you buy a house, then it’s good to have the choice even between fine details. If the choice is not important, such as that between the 55,000 drinks alleged to be available at Starbucks, then few of us acquire grey hairs making it.

But the range of phone tariffs isn’t that kind of choice. All we’re being offered is a number of different prices. Unlike the choice between the Venti caramel latte and the small black coffee, the choice between “Any network anytime 200” and “Any network off-peak 1000” is not a matter of taste. There’s a correct answer and dozens of incorrect ones, and a computer armed with your bill and your company’s tariffs could work out, with hindsight, what you should have done.

With neither the computer nor the hindsight you can end up paying far more than you should. You will also struggle to discern who offers the best deals. So it’s tempting to conclude that the confusion is deliberate.

Economists had little to say about confusion pricing until recently. We find it hard to talk about the subject because the Vulcans who live in our economic models don’t get confused. However, Eugenio Miravete, an economist at the University of Pennsylvania, has been studying how humans, not Vulcans, choose between confusing calling plans. His conclusion is that customers leave little on the table. They are good at judging which calling plan will cost least, and good at switching if they guess wrong.

I wasn’t sure what to make of Miravete’s research. It is limited by the availability of detailed data, so Miravete only studied the early days of confusion pricing, when the choice was between just two calling plans. My company offers 10, plus innumerable combinations of frills and top-ups. I face much more demanding calculations than the ones Miravete studied – hence my well-thumbed magazine and no decision.

But something strange happened after I read about Professor Miravete’s intelligent, motivated subjects. I felt ashamed and was galvanised into calling my phone company. I spoke to a nice Scottish lady called Katie, who was very quickly able to tell me how much I was paying, and for what, before suggesting a couple of different tariffs that look likely to save me £10 or £15 a month. Not bad for a five-minute phone call.

The experience suggests that confusion pricing is not really about trying to entangle every customer in an impenetrable web of complex offers. Instead, it’s a very simple screening device to spot customers with money to burn. If you don’t care enough about your phone bill to ask for advice, then you can obviously afford to pay a little more.

I wondered whether my life might be made even easier, though. Couldn’t the phone company just use its computer to offer me the best deal, with hindsight, each month? “I’m afraid we can’t do that,” said Katie, rather sweetly. “I don’t know why. That is the way things have been organised for some time.”

First published at ft.com and at Slate.com

A fair day’s pay?

Dear Economist,

I’m hiring a cleaner to help around the house. I understand the going rate is GBP5 or GBP6 an hour, but that seems low. Should I offer more?

Your sincerely,

Harriet Trent, Highgate, London

Dear Harriet,

Classical economics says that you should not. If GBP5 an hour is the market-clearing rate then that is what you need to offer. You should raise the rate only if you cannot get the vacancy filled for less.

Fancier economic theories disagree. “Efficiency wage theory” suggests stinginess, but the idea is the reverse. Advertise the job at, say, GBP10 an hour and therefore reduce turnover, increase the number of applicants and perhaps boost effort from a cleaner who knows he or she has a lot to lose from dismissal. In the long run you may do better.

Recent laboratory experiments suggest a stranger notion: advertise at GBP5 an hour but then pay GBP10. Economist psychologists argue that such an unexpected bonus will induce gratitude and extra effort.

If true, traditional economics can safely be chucked out of the window. But beware putting too much weight on laboratory work, because gratitude can be short-lived…

Continued on ft.com.

15th of April, 2006Dear EconomistComments off

No such thing as a free lunch

Alas for free-riders, the Financial Times has asked me not to publish my entire columns here. The paper does, after all, have to raise the money to pay me somehow – and sadly, I don’t make the rules.

For those who cannot afford a modest subscription to the FT, do not despair. My columns are usually available subscription-free on the weekend of publication, so click through quickly! Slate also publishes half of my Undercover Economist columns, subscription-free.

Of course, you can always splash out on the US or the UK edition of my book – both heavily discounted.

Speed-date: satisfaction guaranteed

Dear Economist,

I think I’m a likeable person but I struggle to get dates. I’ve been told I give a bad first impression and just need to persuade women to get to know me a bit better. Some friends are dragging me to speed-dating but I can’t see how a series of three-minute conversations can be anything other than a disaster. How I can persuade the girls to give me a second chance?
James Atkinson, Clapham

Dear James,

Many people suffer from this problem – and not just people, but products too. Imagine a new manufacturer trying to persuade sceptical customers that a new DVD player is reliable. Nobody’s ever heard of the company name, so how do they know the DVD player isn’t going to break down after a few weeks?

The solution is for the company to offer money-back guarantees offering to replace the player or refund the customer’s money if the thing breaks within, say, three years. That gives the customer some insurance, but more importantly it’s an unmistakable signal of the manufacturer’s confidence in the product.

People who make poor-quality merchandise can’t afford to promise to fix it.

You, too, need to offer a money-back guarantee…

Continued on ft.com

8th of April, 2006Dear EconomistComments off
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