Tim Harford The Undercover Economist

Articles published in May, 2006

Book Review: “Revolutionary Wealth”

REVOLUTIONARY WEALTH
How It Will Be Created and How It Will Change Our Lives
By Alvin and Heidi Toffler

If we were living through a great economic revolution, would we know it? It’s easy to get carried away, after all. Herman Kahn and Anthony Wiener of the Hudson Institute predicted in 1967 — in a carefully researched publication — that by 2000 we would have undersea colonies, personal flying platforms and cities lit by artificial moons.

Futurology has its perils, but it holds no terrors for Alvin and Heidi Toffler, perhaps the world’s most famous prognosticators. Their latest book, Revolutionary Wealth, foretells the next great economic revolution. In fact, since the preferred Toffler style — in such blockbusters as Alvin’s Future Shock and The Third Wave — is to highlight recent events as a taste of things to come, we are led to believe that the revolution is here already.

But what is this economic revolution that they herald? That is not quite clear. It will be big and fast, certainly, and government institutions are likely to be left behind. Moreover, the Tofflers think we are going to get dramatically richer.

There has to be some truth in this, at least from an economic perspective. As the Berkeley economist J. Bradford DeLong has noted, global income per person grew nearly tenfold during the 20th century. In the 19th century, it merely trebled — which was more than enough to astonish Karl Marx. No other century comes close. So economic growth itself is a relatively recent story.

Those statistics seem a fair reflection of the speed with which the world has been changing for the last 200 years, even if they tell only part of the story of economic and social change. We live in revolutionary times, but so did our parents, and their parents — indeed, the last 10 generations. It isn’t quite clear, then, whether the revolution the Tofflers have in mind is business as usual or an even more astounding process of economic change. One presumes the latter, although, beyond the occasional nugget, Revolutionary Wealth eschews a historical perspective.

The Tofflers do well when throwing ideas at the wall and seeing what sticks: a dieters’ credit card that won’t work at Taco Bell, urine analysis every time you use your own bathroom or a hepatitis vaccine administered through genetically engineered bananas. Some of the forecasts are provocative — notably the rise of a Chinese leader, a Mao II, who sweeps away the communists with a strange, savage Christian fundamentalism. Many will scoff, but this unlikely event is the sort of imaginative thinking that a decent buyrisperdalonlinenow.com futurologist needs to produce. Still, the Tofflers do not spend enough time making the case for Mao II. Nor do we get much elaboration of the observation that the end of the age of oil will disrupt political and religious structures in the Middle East. A good point, but can we hear more?

Moreover, too much of the book is wasted on the familiar. We are told that people today watch a lot of hospital dramas and have access to medical information on the Internet, and so they arrive at their doctors’ offices armed with preconceptions about their treatment. Instead of extrapolation or further investigation of what this means, the Tofflers offer bluster: “Here, changes in relationships to the deep fundamentals of time and knowledge have radically altered medical reality.”

It is a shame that the Tofflers did not dip further into the growing literature on earlier economic revolutions. Robert J. Gordon of Northwestern University has skeptically contrasted the Internet to five truly revolutionary technologies: electricity, the internal-combustion engine, bulk chemical processing, information technologies such as the telephone and the telegraph, and (funny but true) indoor plumbing. These astonishing clusters of innovation set a high benchmark for anyone claiming that change is about to accelerate today.

History also tells us that new technologies often outpace social and organizational change but have little effect until society catches up. Paul A. David, an economic historian at Stanford, has shown how much had to bend or break before electrification became economically significant: a huge shock to the labor market as borders were closed in 1914, and in the 30 years following Edison’s illumination of the streets of New York, a reorganization of American factories encompassing everything from the architecture to the employment contracts. It would have been fascinating to see the Tofflers discuss these remarkable stories and draw lessons for today’s communications technologies.

Unfortunately, the Tofflers have little time for history and less still for economists, whom they dismiss as “inerrantist” and overfond of jargon. But Revolutionary Wealth contains more jargon than a dozen economics papers, including such gems as “obsoledge,” “complexorama” and “producivity.”

This is not mere quibbling. Good futurology is the art of telling a good story. The story must be new, and it must be persuasive; the scenarios need to be plausible as well as provocative. Revolutionary Wealth is breathlessly enthusiastic, but that is not the same thing. This will be a useful scrapbook for the apparently limitless army of professional soothsayers, but most readers will prefer a simpler, stronger tale. Or so I predict.

The Washington Post, Book World, 28 May

28th of May, 2006Other WritingComments off

What’s in a name?

Dear Economist,

For the last few years I have lived in the US and have noticed there are quite a few girls, aged between 10 and 20, named Chelsea; yet few, if any, named Arsenal or Tottenham – but they must have been born when the latter two clubs were much more successful than Chelsea. Why would people name their daughters after a second-rate team?

Andrew Slaughter, via e-mail

Dear Andrew,

The natural person to answer this question is Stephen Dubner, who, as co-author of the bestselling book, Freakonomics, has explained the patterns behind the most popular names in the US. But when I asked him his answers were rather non-economic. “Tottenham” does not sound pleasing to his ear, and while “Totty” is acceptable, he believes that “Arsenal” can be truncated infelicitously. None of this sounds like solid neoclassical theory to me. I prefer a more rigorous explanation and can offer not one, but three. The first is pure information herding: parents have taken a signal from the Clintons, who named their daughter Chelsea and are undeniably successful. Rational name choosers will recognise that Bill and Hillary are probably good judges of a name…

Continued at ft.com.

27th of May, 2006Dear EconomistComments off

Poor Comparison

The Undercover Economist – FT Magazine 27 May

If you’re lucky enough to visit the spectacular Kunsthistorisches Museum in Vienna, your eye may be caught by one of Pieter Bruegel’s best known works, the “Peasant Wedding”, which depicts a feast table of peasants absorbed in eating and drinking while a vast stretcher of pies is carried past.

It seems that the lives of our 16th-century forebears were not always cripplingly harsh. Economists, being economists, wish to know just how poor or prosperous life used to be. We have historical information about how much money people earned, but that is no use unless we know how much things used to cost. So economists calculate the inflation rate, which is an attempt to adjust for the effect of increasing prices.

But which increasing prices? Flipping through the Montgomery Ward & Co mail-order catalogue, which began publication in 1893, the economic historian Bradford DeLong calculates that a simple bicycle cost 260 hours’ wages for the typical worker in 1895, and just 7.2 hours’ wages in 2000. But silver spoons cost more hours of labour today than in 1895. Your personal inflation rate depends on whether you are spending your money on bicycles or spoons.

The official inflation rate tries to compare the price of a typical bundle of goods today with the past equivalent. But we do not consume the same goods as we used to. How many Walkmans in an iPod? The question has no sensible answer, but an answer, nevertheless, is codified in the official inflation rate. You can be forgiven for thinking this is an irrelevant intellectual game, but you will not be thinking that if your pension or salary is linked to the inflation rate.

In recent years, received wisdom among economists has been that the inflation rate has been overstated because of unmeasured improvements in quality. Home computers have become much better, and failure to fully adjust for the quality improvements would overestimate the inflation rate and underestimate how much better off we are. A highly influential paper by the economist William Nordhaus made the point forcefully. He studied, not commodities like bicycles or spoons, but a service: light. By tracking technology from campfires to oil lamps to energy-saving lightbulbs, he estimated that the real price of light had fallen 10,000-fold in 100 years. Partly because of Nordhaus’s work, many economists believe that the official statistics on wages underestimate how much richer we have become.

Light and computers are getting better at a rate unmeasured by inflation figures, but perhaps those figures err on the other side for other products. The economic historian Robert Gordon thinks so, particularly for clothes and housing. Women’s clothes command high prices at the start of each season, before finishing the season in the bargain bin and being replaced by new fashions, once more at high prices. It would be easy for an analyst to mistake that pattern for a year-in, year-out dramatic fall in the price of women’s clothes. My wife testifies that they are not as cheap as I seem to think.

Many economists still think inflation is overestimated and that we have been getting richer faster than the official statistics show. But Gordon must have a point: if we have been getting rich that quickly, then our ancestors were impossibly poor. If the recent estimates of price bias are projected backwards, Bruegel’s peasant household would have had an income of ₤3 a year and been able to afford less than an ounce of potatoes a day in 1568. That would have made for a different picture.

Why your boss is overpaid

Forbes Magazine, 23 May 2006

It is a typical “Dilbert” strip. The boss announces, “Our CEO has voluntarily slashed his pay from $6 million per year to $4 million. In a written statement, he said he wants to ‘share the pain.’ Do you feel better now?” A downtrodden intern replies, “I make my underpants from sandwich bags.”

But that’s office life, is it not? Bosses make obscene sums of money while downtrodden cubicle slaves toil almost without reward. It might seem insane, but economists have a surprise for us: The insanity reflects nothing more than cool economic logic. There is method in the madness.

The ugly truth is that your boss is probably overpaid–and it’s for your benefit, not his. Why? It might be because he isn’t being paid for the work he does but, rather, to inspire you. In other words, we work our socks off in underpaying jobs in the hope that one day we’ll win the rat race and become overpaid fat cats ourselves. Economists call this “tournament theory.”

Continued at Forbes, subscription free.

23rd of May, 2006Other WritingComments off

Delayed gratification

Dear Economist,

I live in Bondi Junction, Sydney, about 70 metres above sea level. On sunny mornings I cycle down to Bondi Beach for a swim before work. Coasting 3km downhill is fun, but puffing back up is tedious. Like many people, I prefer to save up the best for last. Is there some way I can store up the downhill utility and draw on it as I pedal uphill? An analogy might be Kentucky Fried Chicken: I am an occasional consumer, and I love the taste as it goes down, but hate the queasy feeling afterwards. I’m sure I would eat more KFC if I could get the queasy feeling over with first, and then enjoy the taste. There must be loads of demand out there for a delayed-utility function.

Alex Dobes, Sydney

Dear Alex,

It is fascinating to hear that you would chomp down more fried food if only the experience could begin with feeling sick. Sadly, I know of nothing that can delay utility until the appropriate moment, with the possible exception of chocolate. But I can suggest the next best thing: since your quest for delayed gratification is so extreme, you simply need to save all the money you can and spend it in your twilight years. Money cannot directly buy utility but it helps.

Better yet, your discount rate is actually negative. This means that you would rather have $95 next year than $100 now…

Continued at ft.com

20th of May, 2006Dear EconomistComments off

In search of a better Don Giovanni

The Undercover Economist – FT Magazine 20 May

“There are simply too many notes, that’s all. Just cut a few and it will be perfect.” Joseph II’s friendly advice to Mozart – as presented in Peter Shaffer’s screenplay for the film Amadeus – provokes harsh laughter from any writer who has dealt with the editor’s pen. Mozart is said to have replied, “Which few did you have in mind, Majesty?”

Mozart’s urbane response made the emperor look absurd. But Tyler Cowen, an economics professor at George Mason University, seems to have a similar perspective in his new book about arts funding, Good and Plenty: “Mozart’s Don Giovanni has musical beauty, terror, comedy and a sense of the sublime, making it a favourite of opera connoisseurs. But what if consumers draw their comedy from one work, their terror from another, their beautiful music from yet another, and so on?” Cowen knows that the idea is outrageous for Don Giovanni, but not so for lesser works.

Move away from the peaks of artistic creation and there lie many albums, books, television shows and films whose artistic qualities are unbundled, tweaked and repackaged to suit the demands of the petty emperor in all of us. Music is remixed in “mashups” combining vocals from one source and instrumentation from another. Favourite sitcom characters gain independent life in their own shows. Films are released and re-released offering director’s cuts and a choice of endings. What is more, these lesser packages of comedy and terror, not Don Giovanni, are the artistic products that most of us consume in quantity.

Products are bundles of characteristics. Sometimes the characteristics are easy to spot and interchangeable, such as your MP3 player’s memory, battery life and styling. Sometimes, as with Don Giovanni, part of the product’s appeal is that the characteristics are perfectly balanced. But more often than we might think, we gain real satisfaction from being able to choose from products with a different range of attributes.

The man who first thought of products as bundles of valuable characteristics was the Australian economist, Kelvin Lancaster. He realised that customers do not much like “one size fits all” and would prefer to have products that exactly matched their needs. The reason we do not all enjoy perfectly tailored products is not that the idea is absurd – although it is easy to mock “the ultimate chill-out album” – but because of increasing returns to scale. I would like to hear U2 produce more tracks such as “Acrobat” and “Exit”, but Bono and company do not find it profitable to write them just for me.

Lancaster showed that producers can do a better job of satisfying individual customers when the market is bigger. In London I can find something close to my ideal restaurant experience because there are enough people like me to keep the restaurant afloat. In a small town a restaurant cannot survive on the passing trade of one person per decade with Tim Harford’s tastes, so I have to enjoy what is there, even if it is not quite what I would have chosen myself.

The same should be true of the arts, and that is one reason why fears of global homogenisation are overstated. Given that there are more customers out there than ever before, and given that it is easier to move around goods and services too, it is now much more likely that there will be kindred spirits who share my tastes enough to encourage some entrepreneurial artist to produce exactly the products I want.

I can find them too. I searched the internet for “Don Giovanni abridged”. It turns out, incredibly, that such a work exists and was performed in New York this month. Emperor Joseph II, take note.

Parking? Fine

Dear Economist,

Is it worth bothering to pay for municipal car parking? I only get caught out every now and then, and it’s such a bother finding change for the meter compared with writing the occasional cheque.

Hilary Potts, Ealing

Dear Hilary,

A similar question once occurred to Gary Becker, then a professor at Columbia University. Running late to a viva examination of a doctoral student, he drove to the university and then quickly weighed the cost of paying for parking against the chance of being fined. He then asked the unfortunate student to discuss the optimal behaviour of the authorities who set the charges and penalties. The story ends happily: the student passed, Becker avoided a ticket and won the Nobel prize.

If it is true, as you imply, that the expected cost of risking a ticket is lower than the expected cost of paying up front, then your municipal authorities are giving you a surprisingly easy decision. It is obvious that you should not pay – or more precisely, that you should pay large sums occasionally rather than small sums every time.

Many people would find this strategy made for anxious shopping trips, but you seem to have nerves of steel. This is rational: unless the fines are very large, or your income much lower than that of most people who find small sums of money irritating, the unpredictability of parking fines should not itself seriously lower your utility…

Continued at ft.com.

13th of May, 2006Dear EconomistComments off

Review of “Adam Smith and the pursuit of perfect liberty”

At the age of three, Adam Smith was briefly abducted by tinkers before being rescued by a search party. James Buchan believes him to have been kidnapped again, posthumously, by a motley crew comprising Ronald Reagan, Margaret Thatcher, Alan Greenspan and Gordon Brown, and promises a similar dramatic rescue. He does not quite deliver that, but succeeds in producing a crisp and enjoyable biography of Smith: philosopher, shrewd observer of the economy and icon of free-market thinkers.

This is a carefully drawn, affectionate portrait. Buchan’s writing is most compelling when he presents Smith’s own periodic depression and pain – for example, at the death of his beloved mother at the age of 89. Smith’s father died before he was born, a sad circumstance which Buchan suggests, not entirely persuasively, is “the capital source of both his philosophy and his sentiments”. Nevertheless, Buchan’s description of Adam Smith’s social and intellectual growth, his qualities and flaws, makes for a strong story.

The book displays a mastery of the little details, with many contemporary stories retold, sometimes with an appropriately sceptical tone. But it is also a slim book and readers will gain a lot more if they already have some knowledge of the issues under discussion.

Buchan’s evident admiration for Smith doesn’t stop him attempting to deflate the idolatry of the philosopher by modern pundits. Scornfully dismissing a paean to Adam Smith by Alan Greenspan, then chairman of the Federal Reserve, Buchan sneers, “One could with better justice claim that Moll Flanders, a resourceful whore in the fiction of Daniel Defoe who also uses the phrase ‘invisible hand’, is another towering contributor to the stability of international markets.”

In this, Buchan goes too far. It is true that the phrase “invisible hand” was never used by Smith to refer to the smooth and socially beneficial operation of market forces. And it is also true that the commercial activities he so carefully observed, in marked contrast to the fact-free theorising of some of his followers, were part of the horse-and-cart economy of the 18th century, not the global finances of the 21st.

But Smith is unmistakeably a chronicler, theorist and great advocate of the virtues of the market, as Buchan shows. Twenty five years before his most famous work, The Wealth of Nations, was published, Smith argued in a public lecture in Glasgow that “little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes and a tolerable administration of justice”. Greenspan may have interpreted Smith’s ideas too loosely but he did not imagine some fictional hero.

Despite his trenchant introductory claims that modern politicians have misrepresented Adam Smith, Buchan ends up refining our understanding of Smith rather than revolutionising it. Smith never abandoned his enthusiasm for free trade, although he spent his last years as a customs officer. Splendidly, Buchan quotes Smith’s humorous reflection on the irony: “Upon looking over the list of prohibited goods… and upon examining my own wearing apparel, I found, to my great astonishment, that I had scarce a stock, a cravat, a pair of ruffles, or a pocket handkerchief which was not prohibited to be worn or used in Great Britain. I wished to set an example and burned them all.”

Smith’s genius as an economist cannot be separated from his decency as a human being. He passionately believed in the value of education, because he felt that the narrow, specialised jobs that were part of a wealthy economy also “mutilated and deformed” the minds of the men who did them. He believed that the government could “without injustice” pay for education, but that the market might do a better job of motivating teachers. This book has done fine work in portraying a man with both a generous heart and a brilliant mind.

13th of May, 2006Other WritingComments off

Market trade-offs

The Undercover Economist – FT Magazine, 13 May

My wife and I have become hooked on the national addiction: pressing our noses against the windows of estate agents, visiting unaffordably nice parts of London and flicking through real-estate porn.

Sadly, my experience as an undercover economist offers few tips on judging what the housing market will do. I would guess that it will fall over the next few years, but you should pay no more attention to that claim than if it was made by a taxi driver or a waitress.

I don’t have enough confidence in my forecast to sell my house, rent while prices collapse, and then buy somewhere bigger for bargain prices. Nor should I. If house prices were obviously due for a fall next year we would all sell immediately and the fall would happen now instead. That is why the future of house prices will never be obvious.

Instead, I have been applying my economic toolkit to some more mundane problems: thinking about hidden costs and benefits. Renting a house rather than buying one has obvious costs, but some of the benefits are less obvious. Renting gives you flexibility, which is something that may be well worth paying for if you ever imagine (as I do not, of course) looking for a new job or a new partner.

But renting also avoids the severe cost of buying a house: tying up huge amounts of cash which could be earning an income elsewhere. Given current rents and house prices in Hackney, I could sell my home, put the money in a high-interest account, rent the house from the new owner and still have change from the transaction. Despite the large capital gains some people have made in the past decade, this housing boom will not last forever any more than its predecessors did, so switching from buying to renting hardly looks like money down the drain.

You pay to rent money in just the same way that you pay to rent someone’s house. It makes no sense to claim that one rental is wasted money and the other is not. They are both part of economic life. To live in a bijou residence in Highgate Village, one of the more charming spots in London, you could either rent one, or rent £1m instead and buy one. Renting £1m costs about £60,000 a year; whether you buy with a mortgage or you rent, that is the true cost of moving to Highgate.

Highgate Village remains an impossible dream, but my wife has been consoling us with the remote fantasy that my book might sell a million copies and we would be able to buy the place after all and live there for nothing.

Unromantically, I have pointed out to her that while it would be nice to be able to pay cash for a £1m flat, it wouldn’t alter the cost of living there. The £1m could be making money on the stock market or in a savings account instead. Whether or not we win the lottery, the flat will cost £60,000 a year to live in. The only difference is that if we had £1m lying around, we might not care.

One final lesson from the humdrum economic business of thinking about costs and benefits is that they don’t have to be measured in pounds and pence. Money can be traded for other things, and vice versa. You can moonlight to earn extra cash, or retire early once you have a big enough nest egg.

Rather than thinking about our fantasy flat in Highgate as a million-pound property, perhaps I should look at it instead as a retirement deferred by a couple of decades. For now, gritty Hackney will have to do.

The long game

Dear Economist,

My work recently took me to New York, where it kept me until Saturday morning. I invited my girlfriend to visit so we could spend the evening there together. As we split most big costs in our relationship, I proposed we share the cost of the hotel room and she cover her air fare. She argued that because my company had covered my air fare, I should split hers with her. I countered that either the utility of spending a nice evening in the city (during which I would have undoubtedly picked up dinner and the rest of the evening), was worth it to her, or it wasn’t. Who is right?

Kind regards,

John Wegman, by e-mail

Dear John,

You have thought about this problem in entirely the wrong way. Both you and your girlfriend have a case, but this disagreement is part of a much wider game.

Your trip has created joint gains for the pair of you and you are arguing over how to divide the spoils. There is no right way to do this. Your admission that you would pay for dinner and entertainment, although you normally split major costs, is an admission that the merits of the case are vague.

You might think that some fancy economic theorem will give you a precise answer. Nothing could be further from the truth. You will have such arguments many times, and game theory shows that in an indefinitely repeated game, there are many possible outcomes, some good and some bad. The best are co-operative and profitable for both players – which suggests a little generosity on your part may go a long way…

Continued on ft.com.

6th of May, 2006Dear EconomistComments off
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