Articles published in March, 2007

Guntur, in south-east India, is a city short of money but not of entrepreneurs. Stroll through the main thoroughfare of the largest slum at nine in the morning and outside every sixth house you will pass a woman sitting behind a kerosene stove, ready to prepare dosa for passers-by with a rupee to spare. An hour later, each woman will be on to her next job. One earns cash by sewing fancy beads on to cheap, plain saris. Others are labourers, rubbish collectors or pickle-makers.

The scene is described by two MIT economics professors, Abhijit Banerjee and Esther Duflo, in a recent article, ”The Economic Lives of the Poor”. They set themselves the task of explaining how very poor people make money, and how they spend it.

The ”very poor” are those who live on less than a dollar a day. The benchmark – a rare piece of brilliant marketing from the World Bank – is both more generous and more frugal than it seems. Generous, because the benchmark dates from 1985 and has been adjusted since to take account of inflation in each country and is generally now more than a dollar a day. But frugal because the dollar is adjusted for purchasing power. In other words, a Kenyan farmer might have 50 cents a day to spend but still not count as ”very poor” because 50 cents in Kenya buys more than a dollar would in the US. However you look at it, a dollar a day is a tiny income.

Perhaps surprisingly, even the poorest find the resources to let their hair down. Banerjee and Duflo, looking at economic surveys of the very poor in 13 countries, conclude that about a third of household income is spent on stuff other than food. The alternatives to simply trying to consume more calories include tobacco, alcohol, weddings, funerals and religious festivals. Radios and televisions are also popular. Looking at food spending itself, although the very poor do focus on the cheapest grain – millet – they also spend on wheat, rice and even sugar.

Even the very poor seem to have some consumer power. For example, in the countries where free public schools are especially bad, some parents are scraping together the resources to send the children to private schools. The teachers may be largely unskilled themselves, but at least they show up.

The same is true for healthcare. A pair of World Bank economists, Jishnu Das and Jeffrey Hammer, examined the quality of public and private healthcare in Delhi. They found that while publicly employed doctors tended to be far better qualified than the private doctors, the private doctors tried much harder, spending more time, asking more questions and examining patients more carefully. Competition works – even for the poor.

It would work better yet if the poor were less destitute. One of the problems is that so much of this entrepreneurial activity is carried out on too tiny a scale to make much cash. Scaling up would be more efficient, but requires capital equipment. That’s hard to come by in a world where bank loans are scarce and cash savings are at risk from inflation and theft. It would be better, too, if it were easy to set up a legal business. According to the World Bank’s ”Doing Business” reports, the poorest countries often boast red tape that means it takes months and costs a small fortune to set up in business.

But do not despair entirely. In 1981, 40 per cent of the world’s people lived on less than a dollar a day, according to Shaohua Chen and Martin Ravallion of the World Bank. The figure plummeted to 21 per cent by 2001, and may be around 15 per cent by 2015. We can hope.

First published at ft.com.

Dear Economist,

I’m looking for ”the one”. Is he out there?

Yours,
Ruth, Barcelona

Dear Ruth,

It might help if we understand which elements of marriage are common to many potential husbands, and which are unique to ”the one”.

First, marriage offers economies of scale in production, particularly production of children. Husband and wife can each specialise in different skills, according to their comparative advantage. I fail to see why you cannot realise these economies of scale with almost anyone. Second, there are economies of scale in consumption. One garden will do, so will one kitchen.

The real question, then, is whether you can stand the person you marry enough to enjoy these efficiencies. Here, economics had little to say until a recent breakthrough by the economists Michele Belot and Marco Francesconi. They examined data from a speed-dating company, and discovered, unsurprisingly, that women like tall, rich, well-educated men. Men like slim, educated women who do not smoke.

The more intriguing finding emerged when pickings were scarce. Women ”ticked” about 10 per cent of men as worthy of further investigation, regardless of the quality of a particular crop. If the men were short and poor, then the women lowered their standards, and still picked 10 per cent. The men, too, abandoned unrealistic ambitions. They ”ticked” about a quarter of the women, regardless of quality. This happened even though each could have a complimentary speed date another time if he or she found no one they liked.

My conclusion: even when there is little to be lost from maintaining standards, people are very quick to lower them. My advice: do likewise.

First published in Business Life magazine, November 2007

I remember Saturday evenings when I was a boy, curled up in a towel after bath time to watch game shows such as “The Price is Right”. Little did I know it, but those Saturday evenings were preparing me for life as an economist.
Economists have theories about how people behave, but those theories are hard to test in the muddle of the real world. And laboratory experiments may be no better, because the stakes are too trivial to see how people act under pressure.
That is where the game shows come in. Like real life, game shows are often played for high stakes. But like the laboratory, the rules are simple and the experiment is repeated over and over again.
In one early piece of game show research, economists Jonathan Berk, Eric Hughson and Kirk Vandezande showed that contestants in “The Price is Right” made transparent mistakes but learned from them.
Four contestants would in turn name a price for some household object such as a toaster. The contestant who got closest to, but not over, the correct retail price would win. The other contestants would get another chance.
If you’re smarter than the average contestant you’ll see that the fourth person to bid has an advantage. Since you want to be closest, but not too high, the best strategy is to guess just one pound higher than one of the other contestants (or zero, if you think they’re all too high). Not many contestants did this, but once somebody figured it out, the others were more likely to use the tactic in later rounds.
The economics of quiz shows hit the big time with Steven Levitt, now famous as the co-author of Freakonomics. Levitt tried to understand what was behind discrimination in the job market: did people simply dislike ethnic minorities or the elderly? Or did they believe them to be less competent?
For the answer, he looked to “The Weakest Link”, in which contestants vote for other contestants to be excluded. The best approach is to vote off weak players early on, because they’re costing everyone money – but later, to vote off strong players, because they are the most dangerous competition.
Levitt showed that elderly players tended to be voted off at any stage, suggesting a pure dislike for them. Hispanic players were likely to be voted off early but kept on later in the game, implying that other contestants thought they weren’t very smart.
The game show boom in economics is still going. I’m aware of eight economists who’ve studied “Deal or No Deal”. If only I’d been thinking like an economist when I was younger, I could have beaten them all to it.

I’ve been shortlisted for “Best Communicator” at the Business Journalist of the Year awards. Last year’s winner was the wonderful Evan Davis (who has a new blog). This year’s winner may well be the equally wonderful Hamish McRae. I’ll just enjoy being on the shortlist for now.

Dear Economist,

I’m a referee at the local basketball association. In one of the teams is a fantastic looking woman. She is distractingly beautiful, but also prone to committing fouls, often collecting the maximum of five fouls and being forced to be substituted.

Upon receiving her fifth foul, she nearly always walks to the bench, furiously removes her singlet and sits around for the remainder of the game in her sports bra. This brings the two male referees great utility.

However, it is costly to call for each of those five fouls. No referee wants the gorgeous girl to be angry with him, as we all hold on to the slim possibility that our stars may align one day.

Grasping this slim hope, sometimes each referee will avoid making 50-50 calls in the hope that his partner will. If both officials think this way too often, then she stays on court and so do her clothes. What to do?

Thanks in advance,
David

Answer at ft.com, subscription free.

Britain has long favoured an odd school system whereby well-to-do parents buy an education at the better state schools by giving money to homeowners who live near those schools, rather than by giving the money to the schools themselves. This is not very satisfactory, and there are two logical responses. One is to let the parents give the money to the schools. The other is to prevent people from buying a place at a good school through the housing market, and instead assign places from a much wider area using a lottery. This bold new experiment is about to be tried in Brighton and Hove.

Some parents are understandably livid: they paid for a service (albeit indirectly) and suddenly discover it’s being handed out like a raffle prize. Their houses will probably lose value. Little Jeremy may not even go to that wonderful school at all. But Brighton’s dispossessed parents are also worried by the same thing that worries parents all over the country: that if their school allows too many of the ”wrong” type of children in the door, Little Jeremy’s performance will suffer.

What these parents are worrying about is what an economist would call a ”peer effect”. Peer effects are what happen when you hang around in the wrong company. Yet the evidence for their existence is slimmer than the nation’s parents assume.

The difficulty is this. If Jeremy hangs around with the ”right” kids and does well, why? The obvious explanation is that he did well because his peers were a good influence on him, but it is just as plausible to suggest that he chose those peers, or had those peers chosen, because he was one of the ”right” kids, too. Does John Terry play great football because he is surrounded by great footballers, or is he surrounded by great footballers because he plays great football?

Clever researchers can disentangle some of these effects…

Continued at ft.com, subscription free.

Dear Economist,

I cannot help being fair when giving presents or rewards, even though I may actually want to give differently or the recipients may in fact deserve differently. I only differentiate between groups (my children, my nephews and nieces, my friends etc), but not within each group. Not wanting to show favouritism or cause rivalry, I give a present of equal value to every member of a group.

Were businesses to follow my example such “incentives” would no longer serve as a motivating tool. But then, this could also mean no ill feelings or disharmony, right?

Aidida Rosenstock, Germany

Answer at ft.com, subscription free.

Britain’s bank customers are in the throes of a most un-British uprising. They have discovered that writing to their bank to demand the repayment of excessive overdraft charges is both fun and profitable. There is nothing wrong with this behaviour, but it is selfish. I’m writing this column in an effort to make us more public-spirited in our attempts to claw money away from our favourite faceless corporations.

A scenario in which thousands – perhaps millions – of customers can successfully claim back money is unusual, the result of a regulator’s decree. But the basic situation is very common indeed. Customers have bought into a product line or ongoing service, in this case a bank account, and have decided they’re no longer happy with the way the service is provided. They decide, however, that switching to a competitor is too much trouble.

Lots of products display what economists call ”switching costs”: your mobile phone network; the supermarket whose layout you’ve mastered; a brand of car you know how to drive; your trusty PC – or should that be your trusty Mac? Sometimes the ”switching cost” is financial, but often it’s simply a matter of inconvenience.

The rational response of any business whose customers won’t switch is to exploit them. If you have a small market share you need to attract future victims by offering fantastic prices. Once you have a large market share you should milk it. Best of all is to combine the large market share and the growth by sucking customers in with a tempting initial offer.

This all sounds familiar to me….

Continued at ft.com, subscription free.

After a rather odd delay, the hardback-paperback hybrid of Undercover Economist is available from Amazon.co.uk. Its the size of a hardback but with a soft cover. The small-format paperback is due in May.
Meanwhile the North American paperback is on the bestseller lists in the US and Canada too!

In last week’s column, I fretted about the workers of Treorchy, South Wales, who have lost their jobs as Burberry’s shirt-making plant is closing. Unfortunately, they are not alone. Any small community with a lot vested in a single industry is vulnerable to any number of shifts in the economic landscape, whether caused by domestic or foreign competition, management blunders or technological change.

Even big cities can struggle if they overspecialise. Liverpool and Manchester are examples. Birmingham, on the other hand, has always been a city bustling away making everything and nothing in particular. As the late author Jane Jacobs once pointed out, Birmingham was thought highly inefficient compared with the specialised mills of Manchester, but when the downturn came Manchester was devastated and Birmingham kept on chugging along.

Looking to the US, one might ask why people still live in Detroit, which has suffered for so long? Why not move to Chicago or New York? People originally moved to places such as Treorchy because there was coal to be mined. Now that the mines have closed – and the Burberry factory, too – why do they stay?

One reason is that community ties matter. Many people like to stay near where they were born. But many others would like to seek new opportunities – even, dare I say it, new experiences. My father moved the family to four different locations across England in pursuit of work. I’ve also moved several times to find the right job, and only occasionally regretted it.

But emotional ties are not the only ones that bind…

Continued at ft.com, subscription free.

Dear Economist,

I’ve fallen in love with my best friend. Whenever we go out, we have the best of times but for a reason I seem to unable to comprehend, she has not clearly indicated that she feels the same for me as I do for her. I see a risk of alienating her as a friend if I tell her how I feel for her. Quite an exposure in my view.
Any suggestions?
F, Austria

Answer at ft.com, subscription free.

FT Comment, 5 March 2007

For most of us, the most important contract we will ever enter into is marriage. It is a shame that nobody really seems to know what the contract says, and for obvious reasons it is considered poor form to ask.

These issues will be richly illustrated this week when the latest big-money divorce case reaches the UK Court of Appeal. The multi-millionaire insurance underwriter John Charman is arguing that his ex-wife Beverley, to whom he was married for 30 years, should receive £20m ($39m) rather than the £48m he has been ordered to pay her.

With children grown and provided-for, £20m is more than Mrs Charman needs but £48m is substantially less than half of the assets built up during the marriage. In this sometimes-yawning gulf between an equal division and what the poorer spouse needs lies the zone of uncertainty in which divorce lawyers are gambolling, while politicians avoid the subject.

The judges are trying to make sense of it all as they go along. That is a shame. Their decisions do not simply affect the unhappy couple in front of them, but the incentives of others. It is often said that if divorce is a blank cheque for the poorer spouse, the rich will fear marriage with the less wealthy altogether. But it is also true that if divorcees expect no extra money as a result of their partner’s entrepreneurial efforts they will offer lacklustre support. Mr Charman has complained that his wife hesitated to let him use their home as collateral for a big business loan. Perhaps she realised that she might not enjoy all the rewards if the gamble paid off.

Every divorce is different. Should the length of the marriage matter? Or the extent to which the wealth was accumulated before the marriage began? Or who filed for the divorce?

It is possible to make a reasonable argument for many different positions and Mr Charman claims that he has paid lawyers on both sides of the argument almost £5m to do just that. But while it is hard for ordinary mortals to suppress their schadenfreude when the super-rich go through messy divorces, this uncertainty is unnecessary and counter-productive for us all.

Marriage is a market. There is a supply, there is a demand. Markets work better when contracts work too. Economists know perfectly well that one of the many reasons why marriage has always been popular is that it is economically efficient. It is based on the division of labour, Adam Smith’s pin factory and all that. One man straightens the pin, another whitens it. The Chinese make the fridges, the Americans make the software that designs them. So, too, in a traditional marriage: one spouse brings home the bacon, the other cooks it. It is a joint effort, an efficient one – and one under serious threat if the contract is ambiguous.

Life is full of arguments about who should get what. Contracts are a wonderful way to help solve them. There are arguments for “he gets it all” and there are arguments for “she gets it all”, but I do not find any of them nearly so compelling as those for “both get whatever they agreed to when the marriage began”.

Unfortunately, the British courts do not recognise pre-nuptial agreements. Perhaps engaged couples are presumed incapable of making big decisions.

But that is a strange position. The ideal time to think about divorce is before the marriage. At that stage, each should enjoy a similarly powerful negotiating position. If the man feels he is in a stronger position, why is he settling for the woman in front of him? Paul McCartney presumably felt the equal of Heather Mills when they were married. If he felt superior, perhaps he should have married Madonna instead.

A good pre-nuptial agreement should be able to specify one of the many reasonable ways in which things will be resolved if the marriage does not work out. If she is a financial powerhouse and he is a toy boy, marriage need not be beyond them: the pre-nup can fix compensation arrangements, by the hour if necessary. It is not romantic but neither is a messy divorce.

I will admit that it might be tricky to draw up a sensible pre-nuptial agreement. The government could at least supply us with a choice of three: equal division, fair needs, or everyone for him or herself. I can see all three possibilities having some takers. There should be no default option. Couples should have to choose. If they are not willing to discuss these awkward questions before they commit to a “lifetime” together, what responsible government would recognise their marriage?

I’ve been reading an early copy of Tyler Cowen’s hugely enjoyable “Discover Your Inner Economist“. Full of small steps towards a much better life. Here’s Tyler in an art gallery:

In every room ask yourself which picture you would take home — if you could take just one — and why. This forces us to keep thinking critically about the displays. If the alarm system was shut down and the guards went away, should I carry home the Cezanne, the Manet, or the Renoir?

And on self-deceit:

How many of us would enjoy hearing a two-hour debate — Oxford style with formal rules — on the relative prominence of our virtues and flaws? Let’s say – just to be generous – that the “Virtue” side would win the debate.

Marvellous. He doesn’t get it all right, though:

A pure “hard to get” strategy fails to satisfy what signaling theorists call – forgive the nerdspeak – “a separating equilibrium.” In other words, it does not sort (or “separate”) the winners from the losers. “Hard to get” is too easy for the losers to mimic… I’ve played “hard to get” with Salma Hayek for years, yet this reticence paid few dividends, not even a courtesy email or party invitation.

No, Tyler. “Hard to get” isn’t a signal, it’s a screen. When Salma finally turns up on your doorstep, you’ll know for sure that she’s serious about you.

My eye has been caught recently by the contrast between two stories the FT has been covering. Burberry, the luxury goods manufacturer, is to close a factory near Treorchy, South Wales, and expand production in Spain and China where rents and salaries are lower. This decision has drawn condemnation from everyone from the local MP to Charlotte Church. In other news, Glasgow has been persuading companies such as JP Morgan to move jobs away from London. Two of Glasgow’s attractions are said to be, well, lower rents and lower salaries.

One of these stories is widely regarded as good news, and the other as a disaster. But the motives of Burberry and JPMorgan seem very similar: they are profitable businesses, aiming to stay profitable. The effects look similar too. Some people in the poorer of the areas (China is poorer than Wales, Glasgow is poorer than London) will get better jobs. Some people in the richer areas will lose theirs. Prices will adjust too: the richer areas will become just a tiny bit more affordable. When the new jobs go to Glaswegians, all this appears to be acceptable, but when the new jobs go to foreigners it is regarded as appalling.

The queue of celebrities eager to hitch themselves to the Burberry backlash seem to have entirely missed the xenophobia inherent in their views, but that is the risk of allowing the debate on globalisation to be carried out by Charlotte Church and Sir Tom Jones. Yet more sensible observers also seem a little confused. Several people have complained that when jobs move from Britain to lower-wage countries, this just goes to show the need for stronger global regulations, even a global government to protect exploited workers in both Wales and in China.

But a lack of appropriate regulations doesn’t seem to be the problem in this case…

Continued at ft.com, subscription free.

Dear Economist,

Why should I wash my car? It will be dirty again tomorrow!
Regards,
Chris Smith,
Hampshire

Answer at ft.com, subscription free.

Why aren’t African-Americans achieving all that they could? American blacks are twice as likely to be in poverty as non-blacks, according to the U.S. Census Bureau, and they make nearly $5,000 a year less, on average. What exactly is standing in their way? That’s not an easy question, but some compelling and controversial answers are coming from an unexpected source: economics.

Economists who studied racial inequality were once viewed with skepticism, even by other economists. In the 1970s, Glenn Loury’s Ph.D. classmates at the Massachusetts Institute of Technology joked that his economics thesis began: “This dissertation is concerned with the economics of racism. I define racism as a single-valued, continuous mapping….”

The joke is now on them, as economists have dug up insight after insight in the field. Now Loury’s young co-author, Harvard’s Roland Fryer, is attracting attention for his study of “acting white,” where black kids who work hard at school are said to be ostracized by their peers. Despite a lot of talk about the problem–Barack Obama raised it in his famous speech to the Democratic National Convention–some academic researchers weren’t convinced that it existed…

The full article is on the Forbes site, subscription-free.