Tim Harford The Undercover Economist

Articles published in July, 2006

Multiple choice

The Undercover Economist – FT Magazine

Israel’s strategy for dealing with Hizbollah has been called “tenfold deterrence”: any attack will be met with a far more forceful counterattack. Unfortunately both for Israelis and Lebanese, the strategy did not deter Hizbollah’s missiles.

It might seem strange for an economist to offer even these obvious opinions on military strategy, but economists have been armchair generals since the development in the 1940s of game theory by John Von Neumann, a mathematician, and Oskar Morgenstern, an economist. Game theory is the study of situations where each side’s actions influence and are influenced by the other side’s actions. Since the second world war, game theorists have pondered strategy, deterrence and Armageddon.

Game theory’s power to summarise complex situations in a simple model is sometimes too seductive. The two most overinterpreted ideas in game theory are related to deterrence: the prisoner’s dilemma and the strategy sometimes believed to “solve” the dilemma, tit for tat.

The prisoner’s dilemma was popularised by a simple story. Two men are captured by the police and separately offered the same plea-bargain: “If you confess and he doesn’t, you walk free; if you both confess, you’ll both get five years; if neither of you confess, you’ll both get one year; if he confesses and you don’t, you’ll get 20 years.” Rational prisoners will confess, wishing there was a way to commit each other to silence. Game theorists have known since the 1950s that when the prisoner’s dilemma is repeated indefinitely, more co-operative strategies can flourish. This insight was independently rediscovered and made famous by Robert Axelrod, a political scientist who organised a computerised tournament in which competitors submitted simple programs to play the prisoner’s dilemma. The champion was “tit for tat”, which begins by co-operating with its fellow prisoner (staying silent) but punishes a squealer by confessing on the next turn. Axelrod argued that “tit for tat” was successful because it was easy to interpret, hard to exploit, began co-operatively and quickly forgave transgressions by returning to co-operation. It has proved a magical myth: that you should speak softly and carry a big stick, that “an eye for an eye” can produce co-operation in unpromising situations. Axelrod’s idea was repeated in a horde of popular science books.

But “tit for tat” is just a little too much of a poster child. The repeated prisoner’s dilemma is a poor description of real world situations. It didn’t describe the cold war, when a nuclear exchange was a one-off game if ever there was one. It doesn’t describe the asymmetric struggle between Israel on one hand and multiple decision makers – Lebanon? Hizbollah? – on the other.

Most importantly, the “prisoner’s dilemma” is merely a two-player game. Game theorists such as Ken Binmore, a professor at University College London, say this is a crucial omission. Most social arrangements stand or fail with the help of third parties. The crisis in Lebanon will be no exception.

In any case, “tit for tat” is not quite as successful as conventional wisdom would have you believe. A team from Southampton University kicked “tit for tat” off the top spot in a re-run of Axelrod’s tournament by entering a collection of team players who colluded with each other. Another successful strategy is “tat for tit”, which first tries to exploit the other person and plays nicely only if that doesn’t work. Another winning approach is even more depressing, punishing cheats with eternal vengeance. It is known simply as “grim”.

Commercial breakdown

Dear Economist,

During the World Cup, I was struck that everyone I know prefers the BBC’s football coverage to ITV’s, because the BBC carries no commercials. Yet ITV continues to win the rights to cover international matches. Assuming this is the majority view, is it a market failure that customers’ preferences are not coming first – and what can we do about it?

Suman Ziaullah, by email

Dear Suman,

No doubt you would prefer advertisers to subsidise your viewing without you going to the bother of watching their advertisements. I am afraid this is how the world works, although as other couch-potatoes watch the commercials, you can free-ride on that subsidy and pick up a good novel whenever the ads for cars come on.

The market failure, in fact, is not the one you think. The real problem is that television broadcasting is imperfectly competitive. In an ideal world you would be able to choose between thousands of perfectly tailored packages of programmes, pay as you watched, and also be able to accept a discount in exchange for sitting through the advertisements.

You may have boundless choices when it comes to choosing a restaurant meal or a book, but television broadcasters have to offer more standardised packages. You must simply accept whatever package comes closest to what you would prefer, even if the BBC’s top pundits are not part of it…

Continued on ft.com

29th of July, 2006Dear EconomistComments off

A capital idea

The Undercover Economist – FT Magazine 22 July

My father used to ride to work in a colleague’s car. I distinctly remember as a child pressing my nose against the sitting-room window and forlornly watching him standing by the roadside. He did not usually have to wait more than a couple of minutes before he was picked up and driven 15 miles to the big city. Neither of us realised that he was using a mysterious economic asset, “social capital”.

Social capital is important but elusive. It is an attempt by social scientists to expand the traditional list of economic assets beyond physical capital, such as computers or roads; and human capital, that is you and me and whatever tricks we’ve learned along the way. Economists have attempted to account for why, in the words of P.J. O’Rourke, “some parts of the Earth prosper and others suck”. But as long as those attempts have simply measured the roads and counted the number of IT graduates, they have failed. Social capital is supposed to explain why, and social scientists, including economists, embraced the concept with enthusiasm.

Francis Fukuyama published Trust, explaining how trusting societies were richer. Robert Putnam offered Making Democracy Work, noting that in southern Italy, it didn’t. He then followed up with Bowling Alone, a study of the decline of everything from voting to bowling leagues.

All this is the realm of social capital, but it is a slippery concept. Some kinds of social capital might be rather destructive: the old school-tie network, or patron-client relationships. Social capital will sometimes be a zero-sum game: if I enjoy high status, that is social capital for me, but an improvement in my status will often reduce yours.

Even “good” social capital is hard to measure. One popular way to gauge trust is to ask people whether they think other people can be trusted. Unfortunately, this is a terrible measure of whether people do actually trust each other. Research by economist Ed Glaeser and his colleagues suggested that people who are “trusting” according to the surveys do not actually trust others in simple laboratory experiments. They are, however, more trustworthy. Another popular measure of social capital is the turnout at elections, but it’s not at all obvious that voting and social capital are the same thing. It would be much better to measure an activity that cannot happen without social capital.

And so we return to car-pooling. It is not a bad measure of a certain kind of social capital: car-pooling does not work without trust. Can you trust your fellow travellers not to be late, drive badly, or murder you? Whatever it is, social capital would seem to help you get a lift. Economists Kerwin Charles and Patrick Kline have just published a paper about car-pooling and social capital, and there’s a twist. Charles and Kline want to understand how the local racial mix affects social capital. They predict that, for instance, African-Americans will find it easier to car-pool if they live in an area with lots of other African-American, following a battery of tedious but handy statistical tests, this is exactly what they find.

They also find that not all racial differences present the same barrier to car-pooling. Asians who are a minority in a chiefly white area car-pool more than Asians who are a minority in a chiefly African-American area. African-Americans and Hispanics seem to find it similarly easy to get along. But neither whites in a largely African-American area nor African-Americans in a largely white area tend to car-pool. There is such a thing as social capital, and if you live in an area full of people with the same colour skin as you, it seems you will enjoy more of it.

The consolations of economics

Dear Economist,

I am being divorced. Since I will have less disposable income – due to higher living costs plus alimony – and since I want to stay married, must I conclude that I will be permanently worse off?

Gerard Nichols

Maastricht, Holland

Dear Gerard,

Commiserations, it certainly doesn’t look good. If it’s any consolation, I can think of five Nobel laureates in economics with helpful suggestions.

It is probably best to start by measuring your “permanent income”, the term Milton Friedman used to describe average income over your lifetime. Your future permanent income, in monetary terms, does seem to have fallen, although Friedman’s analysis argues that you should spread the misery over the rest of your life, rather than taking a big depressing hit all at once.

Gary Becker analyses the non-monetary returns to marriage. These are positive for you but clearly negative for your wife. Ronald Coase’s ideas suggest the opportunity for negotiation: it might be that you like the marriage more than your wife dislikes it. If so you could pay her to stay married to you.

Failing that, you should look on the bright side…

Continued on ft.com

22nd of July, 2006Dear EconomistComments off

Green Taxes and Posturing Politicians

Financial Times, Comment

Ken Livingstone, London’s mayor, last week caused consternation among the Chelsea tractor set by appearing to threaten a punitive rate of congestion charge, Pounds 25 instead of the current Pounds 8. Cue cheers from the tree-hugging community and an equally passionate response from the 4×4 lobby. One columnist – and there are no prizes for guessing which newspaper she writes for – complained in all seriousness that she needed her 4×4 to attend shooting and fishing events at weekends, and if Red Ken had his way then she would have to leave London altogether.
That alone makes me want to tax the shirts off 4×4 drivers. I hate the things – I am a cyclist, I have a young child with a head at bull-bar height and I am as worried as anyone else about the planet. These are needlessly wasteful vehicles and there is a growing body of evidence that they make drivers feel so safe as to encourage more reckless driving. But Mr Livingstone’s proposal is idiotic.
We economists might seem to make unlikely environmentalists but most of us are passionate supporters of so-called green taxes. The idea of a green tax is simple: when the market does not reflect the true social costs of some activity, be it switching on the air conditioning or driving into London at rush hour, the government can make society better off by imposing a tax that reflects that social cost. The problem with the mayor’s new-look congestion charge is equally simple: it is not a green tax.
Real green taxes are not populist stunts. They are levied on activities that cause problems, and they reflect the size of those problems. Almost everyone recognises that whatever the benefits of driving around in a car, drivers also impose costs on each other and on the rest of us. Cars run people over, clog up the roads and spew pollution.
What is less widely recognised is that some of these antisocial costs are much bigger than others. Congestion and accidents, between them, generate almost all the costs of road transport. According to a report into “food miles” commissioned by the Department for Environment, Food and Rural Affairs, people who drive cars to pick up shopping inflict a cost of more than Pounds 3.6bn on society. Of this, 70 per cent is congestion and 26 per cent is attributable to accidents. Just 1 per cent is because of the contribution of cars to climate change – and that is a figure using a fairly high estimate of Pounds 70 for the cost of a tonne of carbon. European businesses pay one-quarter of that for carbon emissions permits under the Kyoto-inspired emissions trading scheme.
Climate change is a big problem but cars are only part of that problem. Accidents and congestion are serious too: cars kill more than 3,000 people a year, while climate change will have to get very bad indeed before it affects the life of a typical British citizen as much as do traffic jams. Local air pollution is also a minor problem in comparison, and it is chiefly caused by older vehicles not the brand-new urban tanks that so outrage the less thoughtful kind of environmentalist.
The brilliance of the current congestion charge, crude as it is, is its focus on congestion, by far the most serious problem caused by London’s drivers. The new proposal would tax disproportionately the heaviest emitters of carbon dioxide, but since the typical driver’s contribution to congestion is 50 times more serious than his or her contribution to climate change, the smug Prius driver – currently exempt – should pay almost as much as the sociopath in his BMW X5. The X5 driver already pays more fuel duty, while the Prius can run over your toddler or force you to measure out your life in traffic queues as much as any other car.
Officially, a BMW X5 emits 307g of CO per kilometre; a Prius, 104g. Drive 5km around London in the X5 under the proposed new congestion charge regime and you would pay an extra charge of Pounds 25 for just one additional kilogram of emissions – or Pounds 25,000 per tonne of CO. Buy a carbon permit for your cement- manufacturing business and it will cost you about Pounds 7 per tonne of carbon dioxide.
If we really cared about the planet we would recognise that CO is CO. It does not matter where it comes from: it is all harmful.
This is where economists seem to part company with knee-jerk environmentalists, including Mr Livingstone. For an economist, the whole point of a green tax is that while we know what we want – lower carbon emissions, fewer accidents, less congestion – we do not know the best way to get there. We cannot afford to stop all pollution: remember that we produce CO simply by breathing. The aim is to stop the low-priority activities and not the high-value ones. And the judge of what is really important should be each individual, not a posturing politician. The green tax should send the same signal to each individual. They can decide for themselves whether or not those shooting and fishing weekends are worth the price.

21st of July, 2006Other WritingComments off

Creating something from nothing

Dear Economist,

How do you turn “f*** all” into “something”?

Tim Renshaw, painter, West Norwood

Dear Tim,

I am sure this is not a purely abstract question. You believe that you have no valuable assets and you would like to accumulate some. That is natural enough.

The first thing to recognise is that not all capital is tangible. It is nice to have a cool million in a Swiss bank account, or a fancy apartment in Belgravia, but there is also such a thing as “human capital”. That constitutes the skill or simply the muscle-power to generate an income. Most people have some, including you – unless you are an extraordinarily bad painter.

So, you should use your human capital to begin the process of accumulation – that is, get off your painterly backside and get a job, then put some of the money aside.

Alternatively, you could get some kind of training to build up your human capital and thus your earning power. This may be the best way forward, because human capital investments typically have a higher return than financial investments.

This strategy might combine well with a second possibility: arrange for a transfer from someone else. Despite appearances to the contrary, education in this country is still somewhat subsidised. Going on a subsidised course is a bit like having the government contribute to your savings account…

on ft.com

15th of July, 2006Dear EconomistComments off

Schoolboy error

My school used to offer two varieties of food. There was canteen food, which was inedible, and there were chocolate bars from the tuck shop. For two years, I had four chocolate bars for lunch every day.

These days schools are trying to outlaw the unhealthy options, but some markets are irrepressible. William Guntrip is a 13-year-old boy whose Northamptonshire school banished vending machines and tuck shop food in favour of nutritious offerings at the canteen. Guntrip spotted a market opportunity and has been buying soft drinks and sweets and reselling them in his school playground. The school is trying to stop him and claims that most students are happy with the new regime, although if that was true then Guntrip wouldn’t be making £50 a day.

Suppressing a market is a bit like squeezing a balloon – the trade will usually pop up somewhere else. The Soviet Union was full of markets. The factory in north Vladivostok would be allocated too much sheet metal but not enough coal. The factory in south Vladivostok had the reverse problem. Both factory managers would ask for extra resources but in the command-and-control system the incentive was to ask for more of everything, with little hope of success. So the managers would quietly, and illegally, do a deal with each other. Professional expediters would be sent out to barter for scarce inputs and the informal market reached a high level of sophistication.

According to the iconoclastic economist Mancur Olson, there were seven levels of Soviet disapproval of these markets, from black through grey to off-white. In China in the early 1980s, the government officially sanctioned this sort of side trade as part of the process of moving from a planned economy to a market one. Nowadays we realise it is insanity to suppress markets for coal and steel, but we are still tempted to try the trick on the markets for sex, drugs, rhino horn, football tickets and, apparently, Mars bars.

These efforts usually fail. Football tickets for big events such as the World Cup or the FA Cup are a bit like Soviet coal. They are supplied in a non-market system or sold at below-market value for political or ideological reasons. Although touts perform a social service by getting tickets to those who value them most, nobody likes them because they are bearers of bad news: these events are popular, supply is limited and consequently the price is high. Markets are good at telling us this sort of truth, and the ticket agency Ticketmaster is starting to use online auctions to beat the touts at their own game.

Markets for prostitutes and for rhino horn are suppressed for a different reason: they are thought to be bad for prostitutes and rhinos, respectively. That is obviously true for individual rhinos and is true for unwilling prostitutes too, but just banning something does not prevent it from happening. Julian Morris, now director of International Policy Network, a free-market think-tank, studied the rhino ban and concluded that it had reduced rhino numbers by discouraging sustainable management of rhino herds in southern Africa, while doing nothing to prevent poaching in east Africa.

Heroin is banned because the government believes heroin users do not make sensible decisions about it. Toblerones are banned because Guntrip’s school believes the same is true of pupils. The bans will almost certainly cut consumption – their main aim – but the side-effects can be serious. In any case, all these are examples of what Olson called “irrepressible markets”. Most irrepressible markets – such as those for tickets and Soviet coal – should not be stifled because they help the world go round. The rest should not be stifled because they cannot be.

First published at ft.com

Leaving your money to the cat

Dear Economist,

I have a two-year-old daughter. I am thinking of making contributions into her tax-free “Child Trust Fund” accounts to help with university fees or a deposit on her first home. The trouble is that under the rules of the scheme, the money becomes my daughter’s on her 18th birthday. There will be nothing I can do to prevent her blowing the cash on boyfriends, fast cars and fancy holidays. What can you advise?

Yours sincerely,

Timothy Molinari, Hackney

Dear Timothy,

You’re clearly a man who likes to think ahead, as well as being a control freak. You could, therefore, look for other ways to invest money and give out the cash on your own terms. That would mean you would pay more tax or more fees, or perhaps both. But the fundamental truth is that such schemes will not prevent your daughter from living the high life if she wants to.

What you have failed to realise is that with cash from Daddy safely tucked into a trust fund to be accessed at age 21 or 25 or even 30, your daughter can take the documentation to any bank and take out a loan at once.

What, then, to do? The obvious approach is to leave your money to Battersea Dogs & Cats Home and make it perfectly clear to your daughter and her bank manager that this is what you have done…

Continued at ft.com

8th of July, 2006Dear EconomistComments off

If the price is right

The Undercover Economist – FT Magazine 8 July

If you want to be rich, you can try to set up a brilliantly successful company. Or you can steal money. Trans-parency International, the corruption watchdog, has estimated that Mohamed Suharto embezzled up to $35bn when he was Indonesia’s president, a figure that is in the same league as the entrepreneurial fortunes of Bill Gates and Warren Buffett. On a humbler scale, we all face the same choice. We can try to earn money by doing something useful, or we can try to steal or extort it from other people. A society where most people are doing something useful has a good chance of being rich; a society full of corruption will be poor.

That is a glib enough explanation of wealth and poverty, but what causes corruption? Many economists believe that corruption is a response to perverse incentives. For example, in Indonesia it takes an average of 151 days to legally establish a small business, according to the World Bank’s “Doing Business” database. This is a large incentive to pay bribes or keep a business unregistered. It is not surprising that there is a strong correlation between red tape and corruption. In general, the harder it is to make money legally the more tempting it will be to do so illegally, and if people are not punished for stealing they will be more likely to steal.

The view that incentives are paramount suggests that if you take a person from a poor, corrupt economy and move him to a richer, less corrupt economy, he will live up to the new system. William Lewis, founding director of the McKinsey Global Institute, points out that illiterate Mexican workers on building sites in Houston are as productive as any construction worker. The Mexicans are perfectly capable of living up to the potential of the American system.

An alternative view, popular among the common-sense crowd, is that corruption is a problem in Indonesia because Indonesians are crooks by nature; poor countries are poor because they are full of people who are lazy or stupid or dishonest. I disagree out of faith, rather than because the evidence is compelling. But then, what evidence could there be? You would need to take people from every culture, put them somewhere where they could ignore the law with impunity, and see who cheated and who was honest.

That sounds like a tall order for any research strategy, but the economists Ray Fisman and Edward Miguel have realised that diplomats in New York city were, in fact, the perfect guinea pigs. Diplomatic immunity meant that parking tickets issued to diplomats could not be enforced, and so parking legally was essentially a matter of personal ethics.

Fisman and Miguel found support for the common-sense view. Countries with corrupt systems, as measured by Transparency International, also sent diplomats who parked illegally. From 1997-2005, the Scandinavians committed only 12 unpaid parking violations, and most of them were by a single criminal mastermind from Finland. Chad and Bangladesh, regularly at the top of corruption tables, produced more than 2,500 violations between them. Perhaps poor countries are poor because they are full of corrupt people, after all.

It’s a very clever piece of work, but I will not be abandoning my faith in economic incentives just yet. In 2002, New York city was given much greater power to punish deadbeat diplomats: cars were towed, permits suspended, and fines collected from the relevant foreign aid budget. Unpaid violations immediately fell 90 per cent. When it comes to parking violations, personal morality matters, but incentives matter more.

Is a wife valuable property?

Dear Economist,

I live in a strange European Union country where one of our members of parliament declared his wife, who is a housewife, an economic asset in the wealth statement required by parliament. Was he right to do so? Was he fair towards his wife, who is also a human being?

Miroslaw Wasilewski
Warsaw, Poland

Dear Mr Wasilewski,

You raise two questions: the first is whether a housewife can be an economic asset. The answer, surely, is yes. An economic asset is defined by its ability to produce a valuable flow of services. These could be financial (a portfolio of shares) or physical (a car) or both (a house).

Presumably your man in Warsaw derives both financial and non-financial benefits from his wife. Even if she does not earn monetary income, her unpaid labour reduces his financial outgoings – a financial benefit. If she is nice to have around the house then that is a non-financial benefit too.

But is this definition fair to the wife? There is no contradiction between being valuable and being human. So the question is whether this valuable human being should be regarded as property. I don’t see a problem in that. Property is something to be cherished…

Continued on ft.com

1st of July, 2006Dear EconomistComments off


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