Tim Harford The Undercover Economist

Articles published in November, 2007

Business Life: Jam Tomorrow

First published in Business Life Magazine, June 2007

Whoever would have thought the world contained so many types of jam? Even my local corner shop offers thirty-five varieties. A supermarket offers hundreds. The choice can be dizzying.

Some social scientists argue that this sort of choice is actually a bad thing because these choices are stressful without being useful. Certainly, when my wife asks me to run an errand for her and buy some unfamiliar product, stress is exactly what I feel.

More formal studies back up those instincts. Psychologists Mark Lepper and Sheena Iyengar set up a jam tasting stall in a posh supermarket in California. Sometimes they offered six varieties of jam, at other times 24 flavours. The bigger display attracted more customers but very few of them actually bought jam. The display that offered less choice made many more sales.

Fascinating research, but I don’t get as worried about this as the psychologists do. They perhaps forget that the choice between Robertson’s Jam and Wilkin and Son’s Jam might seem irrelevant to the customer, but it’s not irrelevant to Robertson, nor Wilkin and Son. We are often offered an apparently-pointless choice between two equally good products, not appreciating that they are only good because we have been offered the choice.

I am less concerned about the proliferation of choice in supermarkets – which, after all, we usually take in our stride – and more about what those choices sometimes do to prices. The differences between innumerable products are a great way of charging some customers more, because more varieties allow supermarkets more options for carefully-aimed prices.

And surprisingly, sometimes choice does not foster competition at all. When a few large companies pour forth a huge variety of brands, some economists believe that this is an attempt to stake out territory and keep out new competitors.

The resulting variety is still useful, especially if you have unusual tastes or needs (my corner shop offers four jams for diabetics). Yet there is clearly a cost. The more types of jam there are, the more expensive each one is likely to get, because of higher production, marketing and distribution costs. Is it worth it?

The most famous analysis of such a situation says “no”. In the 1970s, economist Richard Schmalensee devoted himself to the other side of the breakfast table, and argued that the American cereal market was full of unnecessary brands. That meant, said Schmalensee, that prices were higher than they needed to be. But such studies are expensive to conduct, so whether this is true today, and for other products, is something we can only guess. It is all worth pondering over breakfast – perhaps just a grapefruit and a cup of coffee?

28th of November, 2007Other WritingComments off

Pot of Gold

Dear Economist
British rock band Radiohead have come up with a radical price model for their new album In Rainbows: it is available for digital download and customers decide the price themselves. Could you elaborate on the economic principles at play? I chose to pay £5 out of love for original and creative content, but I admit that my behaviour is absurd from any rational choice model.
Stig, Copenhagen

Dear Stig,

This is just an electronic tip jar, and people’s payments are governed by a desire to feel generous – or at least, to avoid looking stingy. That desire is enough to persuade almost everyone to tip at a restaurant, but what about online? Less so, it seems.

According to one internet consulting firm, almost two-thirds of those who downloaded the album paid nothing, and those who did pay didn’t pay much – less than £3 on average. That makes sense: much easier to leave no tip when you don’t have to look the waitress in the eye, and Radiohead make more than your waitress anyway.

If the figures are accurate, the band seems to have made £500,000 or less from downloads in just three weeks; their traditionally priced CDs probably made the band 10 times more, at least. But it is too early to say whether this scheme was profit-maximising, especially since Radiohead have criticised these estimates.

There is more to this than direct revenue, of course. The stunt also brought free press for a band widely thought to be past its prime. That trick will not work again, and future electronic tip jars seem likely to be emptier.

I can’t say whether your payment was rational. I strongly suspect that this business model, in the long term, is not.

First published at ft.com.

24th of November, 2007Dear EconomistComments off

Same difference

“Life’s not fair,” my parents always used to say. Bill Gates and the Mexican business magnate Carlos Slim each have fortunes of about $60bn, according to the rich-list boffins at Forbes. A 10 per cent return on that lot would produce a $6bn income, or about $200 a second. That is, very roughly, about what an American makes in a day or an Ethiopian makes in nine months. Small wonder that income inequality is a hot topic.

But reliable numbers on inequality are hard to find. Even in the US, there is no agreement over what is going on. Look across the globe, and the data problems are far more acute. The most commonly reported scare statistic compares the richest country with the poorest. But this method overlooks the fact that about 2.5 billion poor people live in rapidly growing India and China. A better, but more demanding approach summarises inequality both across countries and within countries. Such efforts suggest no strong recent trends in global income inequality, either up or down.

Those efforts have been led by Branko Milanovic of the World Bank. But now – with fellow economists Peter Lindert and Jeffrey Williamson – he has produced a more surprising result. He has found that income distribution within a modern society is much the same as income distribution in imperial Rome, or England and Wales at the time of the glorious revolution. It’s not that there is no variation at all, but that modern societies are as different from each other as from ancient societies.

For example, imperial Rome’s income distribution looks like that of the modern US; China in 1880, like Sweden today, was rather equal; England in 1688 was more unequal than imperial Rome, but modern Brazil is worse still.

This is unexpected, not least because modern societies have the potential to be far more unequal than anything the Romans could have dreamed of. That’s because the richer a society is, the more unequal it could be without its working class starving to death. Prehistoric societies were, by necessity, fairly equal: there wasn’t enough societal wealth to make anybody very rich.

Modern Tanzania seems more equal than modern America, but Milanovic and his colleagues point out that it is as unequal as it could possibly be without mass starvation. The Democratic Republic of Congo is about as unequal as the US, but that is far more than the country can stand – hence the enormous loss of life through war, malnutrition and disease.

The US, as the richest society in history, is therefore potentially the most unequal in history. The US population could be kept alive for the cost of about $100bn a year.

If the elites had total control, that would leave another $13,800bn (the rest of US GDP) a year to distribute among friends of the president – almost enough to give a sum equal to Bill Gates’s lifetime wealth to a new crony each working day.

But the US is not remotely this exploitative, no matter what you may feel the next time you buy a copy of Windows.

In the newly coined jargon, it has a low “inequality extraction ratio”, meaning that the poor have much more than it would take to keep them alive.

That is faint praise for the US, perhaps. But it is interesting to observe that while modern societies are rich enough to be much more unequal than their predecessors, they show similar patterns of income inequality. Perhaps – I am speculating wildly – human societies have some hard-wired tolerance for inequality?

But one conclusion is less speculative. It is no coincidence that richer societies are less exploitative of their own citizens (have a lower “inequality extraction ratio”) than poorer ones.

That is because severe exploitation guarantees poverty.

First published at ft.com.

Your number’s up

One thing you can rely on economists to generate is a big bunch of numbers. For that, you can blame a man named William Petty. He developed the first national income accounts, concluding in 1664 that English national income was £40m.

We rely on numbers like those calculated by Petty to help make policy decisions.

First came GDP and inflation, now a plethora of statistics on everything from income distribution to the number of days it takes to start a legal business. We rely on them for policy decisions, and usually we take it for granted that the data actually mean something.

That is an assumption worth questioning. Fraud or simple incompetence might be distorting some economic or accounting data. It would be nice to have a way to check, but it is often impossible to do so directly. So an alternative is to look for patterns in the data that might indicate that something is amiss.

One such pattern is Benford’s Law, first noted by the astronomer Simon Newcomb in 1881, and then independently by the physicist Frank Benford in 1938. The story is that each man had noticed that the early pages of books of logarithm tables were dirtier, suggesting that people tended to look up the log of numbers whose first digit was one – such as 11, 134 or 17,650. Benford then showed that whether he looked at the populations of small towns or all the numbers collected from an issue of the Reader’s Digest, numbers whose first digit was one cropped up 30 per cent of the time.

Benford’s Law does not apply to every set of numbers – for example, it does not apply to post codes or national insurance numbers, which are assigned by bureaucratic processes. But all sorts of “natural” processes should produce Benford data. And since the units in which many quantities are measured are arbitrary (grams or ounces, miles or millimetres, dollars or yen) then converting to a different unit of measurement preserves Benford’s law.

As an example, think about an economy that is growing from an initial value of $10bn. It must grow by 100 per cent before the first digit changes, to $20bn. Then it need only grow by 50 per cent to reach the next digit at $30bn, which is likely to happen more quickly. To grow from $90bn to $100bn requires just over 10 per cent growth; but then to change the first digit back to two, at $200bn, requires that the stock grow by 100 per cent again. That sort of story suggests why Benford data may be common, although quite why Benford’s Law holds so widely is not yet settled.

Regardless, the pattern is a useful test of the plausibility of data. In the early 1970s, Hal Varian, now chief economist at Google, argued that if economic data satisfied Benford’s Law on the way into an economic model but not on the way out, it was worth taking a second look at the model itself.

And Mark Nigrini, an accountancy professor, found fame in the 1990s by using Benford’s Law to discover accounting scams, frauds and tax dodges, such as inventing invoices that were just under some threshold for managerial approval.

John Nye and Charles Moul, two economists at Washington University in St Louis, have now checked some basic macroeconomic statistics using Benford’s Law. They find that OECD statistics fit the law quite well, suggesting that GDP data should follow Benford. But African GDP data do not fit. It is not possible to say whether the anomaly is due to fraud or underfunded statistical offices. But it is a reminder that some data should come with a health warning.

First published at ft.com.

Lunch with the FT: Andrew Dilnot

Andrew DilnotAs I enter the porter’s lodge at St Hugh’s College, Oxford, I fleetingly reflect that I may be about to receive an intimidating tutorial from the college principal, Andrew Dilnot. It is not that the economist has a stern reputation, but today’s circumstances are unusual. He recently stepped down from presenting More or Less, a BBC Radio 4 series about numbers in the news. I have been recruited as the new presenter, and am ready to be patronised – or worse.

I needn’t have worried: as he strides into the lodge in a pale brown linen suit and blue tie, Dilnot’s smile is genuine enough, and as we walk together through north Oxford’s leafy residential streets, he is more eager to identify shared acquaintances in the world of economics than to lecture me on the art of radio presenting. Learn More

Alimony advice

Dear Economist,
My wife and I have separated. Naturally our relationship is not great, but it’s OK. Now divorce proceedings have started and we will be dividing up our assets. Should I hire a lawyer? I am not convinced that it is worth the expense.
Seth, via e-mail

Dear Seth,

You have obviously grasped that this is a zero-sum game with two to four players. The assets will be divided between you, your soon-to-be-ex wife, and any lawyers the two of you bring on board.

I can sympathise with your suspicion that the lawyer is money down the drain.

It is worth considering the scant evidence available.

The Austrian economist Martin Halla has collected data from divorce proceedings in his home country, and he finds a curious pattern. Husbands end up paying the smallest alimony when no lawyers are involved. If the husband hires a lawyer, but his wife does not, the alimony payment rises (and then there are fees to be paid, too). If the wife hires a lawyer, or the couple hires a joint lawyer, the husband forks out still more. Worst case scenario for hubby is if both sides hire their own lawyer. On top of that the proceedings are longer and more expensive.

Interpret that result with caution, because it is not clear whether the lawyers cause poor settlements for husbands, or whether husbands hire lawyers when things look grim. Still, the pattern that Halla discovered does bolster your scepticism.

In the absence of better information, then, Halla’s research suggests that you have a dominant strategy, meaning one that is best no matter what your wife does. That strategy is not to hire a lawyer. And for goodness sake, don’t let your wife see any research from Martin Halla.

First published at ft.com.

17th of November, 2007Dear EconomistComments off

Forbes: Frequent Flier Food

I have a new piece up at Forbes:

…the most reasonable judgment is that flying fresh food around the planet carries an environmental cost of no more than a few cents per meal. That sounds astonishing, but perhaps it shouldn’t be. Those Chilean grapes aren’t flying first class: They’re packed tight to save money, which incidentally saves on pollution. The most wasteful part of the journey is when you and I hop in our cars and drive to the shops and back with a bag of potato chips in the trunk of the car.

You can read the whole thing here; the Forbes piece also contains links to the research.

Business Life: The economics of dating

First published in Business Life magazine, May 2007

Do you believe that there is one special person out there, someone who is the perfect match for you? If so, perhaps you should flip to a different page, because your hopes and dreams are about to be scrutinised by the most unlikely researchers: economists.
The economics profession’s standard excuse for poking around in matters of the heart is the close connection between family stability and economic success. The truth is probably a bit different: where once economists only had data on inflation and unemployment, now they have data on dating. Which would you rather study?
Speed date evenings are one of the best sources of this new data. If you’ve ever been on a date that was obviously a disaster from the first three minutes, you’ll understand the attraction of speed dating; on a speed date, you only meet each person for three minutes anyway. At the end of the evening you tell the organisers which people you liked, they later connect mutually-attracted couples.
Economists have realised that speed dates provide the sort of data about who likes whom that you would normally only acquire with binoculars, years of research and a great lawyer. Two researchers, Michèle Belot and Marco Francesconi, persuaded speed dating companies to share their data. Belot and Francesconi recently published their research with the intriguing title, “Can anyone be The One?” The answer, I’m afraid, is “just about anyone, yes.”
They studied 3600 people at 84 speed dating events. They were able to see who went to which event, and who liked whom. Some of the findings weren’t surprising: women seem to be choosier, proposing a match half as often as men. It will shock nobody to hear that tall men, slim women, non-smokers and professionals received more offers.
But what might raise the odd eyebrow is the discovery that speed-daters systematically change their standards depending on who shows up for the speed date. Although women prefer tall men rather than short men, on evenings where nobody is over six feet, the short guys have a lot more luck. Most people prefer an educated partner, but they will propose to school drop-outs if the PhDs stay away.
If people really were looking for a partner of a particular type, we would expect them to respond to the absence of such people by heading home with a disappointed shrug and hoping for better luck at the next speed date. Instead, people respond to slim pickings by lowering their standards. So if you really believe there’s just one special person out there for you, you’re more patient than the rest of us.

13th of November, 2007Other WritingComments off

Jol-ly hard luck

Dear Economist,
Were Tottenham right to sack Martin Jol?
A Spurs fan

Dear Spurs fan,

Let me explain to the unconverted that Martin Jol was the manager of Tottenham Hotspur, the second-most successful football club in north London. Jol inspired good results in the past, but the club’s recent performance has been poor.

Were Tottenham wrong to sack him? Many lament the rapid turnover of football managers, and note that the two most successful premiership sides, Manchester United and Arsenal, have the longest-serving managers. But how do the numbers stack up?

Christopher Hope is an economist at Cambridge University specialising in the costs of sacking football managers (and the costs of climate change). He estimates that when a manager is replaced, the typical team loses more than 10 league points from the disruption, equivalent to three wins and a draw. The cost of paying off the manager’s contract means less money to pay players and so a further modest points loss.

Nevertheless, Hope’s analysis recommends that clubs should sack their managers more often. He has concluded that the following algorithm would improve the performance of premiership clubs. Any new manager should have an eight-match honeymoon, during which time he is safe from sacking. After that, his average results should stay above a miserly 0.74 point per game; that average should be weighted to put about half the emphasis on the most recent five games.

Jol averaged 1.57 points per game last season, but just 0.7 points this season and 0.6 points in his last five games.

I believe Hope would have sacked him. But what would I care? I’m an Arsenal fan.

Published at ft.com.

10th of November, 2007Dear EconomistComments off

Your vote doesn’t count

Talk about a baptism of fire: my first experience with a televised panel debate put me up against Tony Benn, a leftist former cabinet minister famous – in part – as perhaps the most formidable debater in the country.

“You’re going to get killed,” said my wife, ever supportive. And rhetorically, perhaps I was – he masterfully trotted out his favourite sound bites, regardless of whether they pertained to the question or not.

This was almost two years ago, and one of Benn’s sound bites has had me thinking ever since. He pointed out that “in a democracy, everybody gets a vote. In the market, the poor and the homeless don’t get a vote.” Ergo, government provision of, well, anything, is preferable to leaving it to the market.

But the concept of a “vote” is meaningless when it comes to the market. If Benn’s claim means anything at all, surely it means this: that a poor person has more influence over the service he or she receives from the government than over the service he or she receives from the market. That claim means something, but it is also hard to sustain.

I am not making an argument about the miracle of the market, but about the limits of politics. Democracy has many virtues, but giving influence to the individual voter is not one of them. Notoriously, an individual’s vote makes no difference to anything. According to the British election watcher David Boothroyd, in 24 general elections since 1918, each spanning hundreds of parliamentary constituencies (most recently, 646), there has only ever been one valid election where your vote could have made a difference: A.J. Flint was elected as Labour MP for Ilkeston in 1931 by just two votes. (The other two-vote victory, in 1997, was declared void.) Even in 1931, the Ilkeston swing voter would not have influenced government policy: the Tories won about three times as many seats as all the other parties put together.

In the US, there is a similar story: the closest presidential race in history, Bush-Gore in 2000, still had a margin of more than 500 votes in Florida.

So my vote gives me no power to influence the government. That might explain the cavalier behaviour of government agencies. I’ve twice received government threats over my presumed late payment of tax. In one case the tax was paid in good time but that didn’t deter them; in the other, I asked for a statement of all tax owed, paid it, and then heard nothing until the court summons a year later. (Their statement had been wrong, so I’d paid the wrong amount of tax – but tell that to the judge.) Never was there an apology – not even the regretful tone that most good corporate bureaucracies are capable of producing if they have to.

These big corporate bureaucracies are equally capable of stuffing things up, of course. The difference is that when they do, you can usually have them grovelling, because they know that you can take your business elsewhere. Most of us do not enjoy the luxury of choosing which tax bureaucracy to do business with. (Those who do, tend to secure favourable results.)

It is true, as Tony Benn would no doubt claim, that a billionaire’s threat to take his business elsewhere carries more weight than a poor person’s does. But businesses still cater to the poor, and do not want to lose customers, even poor ones. And the poorest participants in a market society have more influence over what they receive as consumers than they do as voters. The government could nationalise Tesco, and rich and poor alike would get the same level of individualised service: not much.

Published at ft.com.

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