Tim Harford The Undercover Economist

Articles published in February, 2008

Business Life: Psst! Want to buy a kidney?

First published in Business  Life magazine, September 2008

Basic economics says that when supply can’t keep up with demand, raising the price will solve the problem. It sounds sensible – but what if we’re talking about a market for live human organs? Economic logic doesn’t seem to be much use, because the mere idea that patients might pay others to donate organs is offensive to most people.
Our attitude to an organ market might change eventually; attitudes sometimes do. Life insurance, for example, was considered ghoulish until about a hundred years ago, because it is a bet about when you’re going to die. Now it is not only acceptable, but regarded as something any family breadwinner should do.
But whatever some economists might wish, there is no prospect of a legal market for live kidney donations any time soon. One economist, Al Roth of Harvard, has therefore taken a more pragmatic approach to the problem. He realised that there is an untapped resource: many people on the waiting list for a kidney have a friend or relative willing to make the donation, but unable to do so because the pair are biologically incompatible.
Professor Roth realised that while it is not socially acceptable to offer money for a kidney, it is acceptable to offer a kidney for another kidney. And so he looked for ways to match pairs of donations, with the aim of making the transplants more compatible. My friend donates to you; your friend donates to me, and both transplant operations are more likely to be successful.
Such “paired kidney donation” is an example of a “matching market”, and Roth is the world’s leading expert on matching markets. He has spent much of his career designing them; for instance, matching student doctors with a favourite list of training hospitals with training hospitals, which have a favourite list of students. That turns out to be a simple problem – until you realise that many student doctors are in relationships with other student doctors, and the system will be rejected if it splits up these couples.
Matching markets for kidneys can also be technically demanding. For example, an altruistic donor who declares herself willing to donate to anyone can trigger a little avalanche of transplants on a kidney exchange – but only if the exchange is well-designed.
Al Roth, with fellow economists Tayfun Sonmez and Utku Unver, designed a kidney exchange programme with the help of surgeons in New England. And it’s working: over 30 transplants had taken place by the summer of 2008. The UK has now changed its own laws to permit paired donations, and the first transplant took place late in 2007. Economists are saving lives – sounds strange, doesn’t it?

28th of February, 2008Other WritingComments off

Firework fear

Dear Economist,
Occasionally, I buy and launch my own fireworks, generating cheerful positive externalities. Sadly, some amateur launchings end in tragedy – and there is frequent talk of a private firework ban. What is the economically efficient way of dealing with those negative externalities?
Jens Frolich Holte, Norway

Dear Jens,

If you’ve diagnosed the problem correctly, we can reach for a textbook solution. In a market with zero transaction costs, Coase theorem tells us that your neighbours could, in principle, pay you to hold firework displays, or not to, depending on their enjoyment of the spectacle or fear of injury.

More likely, we would need to approximate the Coasian solution with an externality tax on fireworks (to reflect the risks) or a subsidy (to reflect the benefits). But I am not sure you have correctly identified the positive and negative externalities here.

Unless you are shooting the fireworks down the street, most of the risk is surely borne by you and your friends, who’ve chosen to enjoy the display at close range.

There is no negative externality there: they’ve knowingly taken the risk.

On the positive externality side, I doubt that more distant neighbours enjoy the show as much as you think, not knowing when it is going to start. And they may be aggravated by the noise.

On balance, where are the externalities?

We should focus instead on encouraging more responsible use of fireworks. If your firework display hurts an innocent, you should be liable. An appropriate level of likely damages will encourage you to take exactly the right amount of care with your displays.

Also published at ft.com, subscription free.

23rd of February, 2008Dear EconomistComments off

The choice isn’t yours

The choice isn’t yours

Review by Tim Harford

Predictably Irrational: The Hidden Forces that Shape Our Decisions

By Dan Ariely
HarperCollins £14.99, 304 pages
FT bookshop price: £11.99

Not long ago three professors, Daniel Ariely, Elie Ofek and Marco Bertini, set up a stall to hand out free cups of coffee at the Massachusetts Institute of Technology (MIT). In exchange, they asked patrons to tell them whether they liked the roast.

Ariely and his colleagues set up a table of condiments – milk and sugar, but also obscure offerings such as cloves and orange peel. Nobody ever sampled the unusual options, but they turned out to matter a great deal. Some days, the cloves and orange peel were presented in glass containers on a brushed-metal tray, on other days they were dumped in Styrofoam cups with hand-scrawled labels. The presentation of the “condiments-not-taken” turned out to make a big difference as to how MIT students thought the coffee tasted.

This is a typical anecdote from Ariely’s book, Predictably Irrational: inventive, lovingly described, verging on the trivial, and yet something I immediately wanted not only to tell people about but to try myself. In future, I vowed, I would be sure to present wine in a carafe, and dinner on fancy plates.

Ariely’s book is an accessible account of his own research programme, drawing occasionally on the insights of others. His aim is to show that our choices – usually, but not always, in commercial settings – are irrational but predictable. He does this by conducting psychological experiments, sometimes carried out in the laboratory, often in more real settings.

The book has a lot to recommend it. Ariely is a more than capable storyteller, and he sticks close to his own research so his writing is full of colour and detail. He also has a knack for conveying the rigour of the experiments without brandishing too many technicalities. And although he is pursuing a consistent theme throughout, there is a fresh insight in every chapter.

I could scarcely imagine a better introduction to “behavioural economics”, a discipline of growing influence that sits on the boundary between economics and psychology. But opinions differ among economists as to whether behavioural economics seriously challenges the long-held basic assumption of economics that we make rational choices, or whether it merely illuminates some fascinating but relatively minor human foibles.

Ariely’s research shows that our perceptions of a good deal can be hugely influenced by marketing tricks; that sexual arousal changes the way we make decisions, and that we are not good at anticipating this; that we can be confused by the fear of losing options; that the placebo effect is partially dependent on our perception of price. There is much else of interest. And there is plenty there for the economic traditionalists – I am one of them – to chew on.

Yet a question remains over how much we can generalise from these experiments. I have long been persuaded that the evidence shows we are fundamentally rational creatures when it comes to most of the decisions that really matter. Predictably Irrational did not change my mind about that, partly because it tended to steer clear of the bigger questions.

That may have been wise. When Ariely attempts to generalise from his experiments, his conclusions are far less satisfactory than the clever experiments themselves. One example is his work on sexual arousal: having painted a memorable picture of undergraduates answering survey questions while masturbating over a laptop encased in cling-film, he recommends first that teenagers should carry condoms, and second that they should steer clear of situations where they may become aroused. Wise advice, perhaps, but something of a stretch from the experiment itself.

Another example is his work on how choices confuse us. Again, this is based on a laptop experiment. Ariely explains that when his subjects were paid pennies to click on computer icons, they clicked – irrationally – on unprofitable icons, because doing so kept (useless) options open. That suggests a broader message, but when Ariely draws conclusions about how we should choose careers, or boyfriends, he is putting more weight on his own experiment than it can bear.

Fortunately, Ariely does not spill too much ink on heroic conclusions, preferring to describe with charm his relentlessly creative experiments. For anyone interested in marketing – either as practitioner or victim – this is unmissable reading. Other readers will be engaged and looking forward to a sequel. If only more researchers could write like this, the world would be a better place.

Also published at ft.com.

23rd of February, 2008Other WritingComments off

It’s the way they sell ’em

Here’s what I like about insurance: you pay the insurers money when you do not desperately need it, and then the insurers pay you money just when you need it most.

Curiously, this is not what other people seem to like about insurance. Most people do not try to arrange for insurance payments to arrive when they will need them most. Instead, they arrange for insurance payments to arrive after bad luck.

If your house has just burnt down, “when you need money most” amounts to the same thing as “after bad luck”. But what if your son has just been accepted by Eton, and his older sister by Harvard? That is when the money would be useful, but we are temperamentally more inclined to insure against the tragic death of a child. It goes against the grain to insure against “good news”.

Meanwhile, we pay through the nose to insure a mobile phone – the loss of which is bad luck, but hardly a life event that suddenly makes money more valuable.

In contrast, we do not buy insurance against living until the age of 95 – a “good luck” event that goes hand in hand with a huge need for extra money. Insurance against longevity is easy to obtain: it’s called a “life annuity” – sometimes just an “annuity” – an investment product that pays you an income as long as you live. If you die young, you lose money on the deal; but who cares?

Yet we seem to dislike annuities. They barely exist in the US. In the UK, they are compulsory for those who want tax relief on their pension savings. Still, we buy them kicking and screaming.

Quite why we have such an aversion to annuities is not clear. True, money spent on an annuity is not available as a lump sum on a rainy day. Annuities are also expensive: after all, insurers must fear that only vegan teetotallers will buy them. But the truth is that our reluctance even to dabble in annuities is almost certainly irrational. So what quirk of human nature is standing in our way, and what might insurers (and governments) do to nudge us in a more sensible direction?

One indication comes from new research by four economists, Jeffrey Brown, Jeffrey Kling, Sendhil Mullainathan and Marian Wrobel. Using an internet-based survey, they presented respondents with a series of comparisons between pairs of fictitious retirees who had made different decisions about funding their retirement.

The survey asked who had made the better choice. Brown and his colleagues found that whether their respondents favoured those with the annuities depended entirely on how the question was presented.

Annuity purchases look attractive when described as sources of spending.

For instance, when told that “Mr Red can spend $650 each month for as long as he lives in addition to social security.

When he dies, there will be no more payments…” respondents preferred Mr Red’s choice (implicitly, an annuity) to Mr Gray’s savings account, which was flexible but would run out of money at age 85 if he spent $650 a month.

But when described as investments, annuities suddenly became unpopular.

Few fancied Mr Red’s decision when told that he had invested “$100,000 in an account which earns $650 each month for as long as he lives. He can only withdraw the earnings he receives, not the invested money. When he dies, the earnings will stop and his investment will be worth nothing.”

The two Mr Reds, of course, chose exactly the same product described in a slightly different way.

The lesson: don’t focus on what rate of return an annuity produces. Just think about what you can spend if you buy one.

Also published at ft.com, subscription free.

The Economist reviews The Logic of Life

Here’s a sample:

The book surveys shelf after shelf of the economics literature but in such skilful hands it does not feel like a dutiful trip to the library. Economists are often too beguiled by elegant theories, but Mr Harford wisely confines himself to ideas that have been carefully tested against real life. Only thorough research could discern that residents of high-rise buildings are more likely to be victims of crime, because stacked tenants make for poor monitors of the surrounding streets. Even the excellent chapter on game theory has a practical hero: the card player, Chris “Jesus” Ferguson, who applied its lessons to win the poker world championship in 2000.
Mr Harford, who works at the Financial Times, is an amiable guide for the non-specialist reader, neither too lofty nor dumbed-down. The book’s tone is breezy, but his command of the subject is such that even a well-schooled economist will discover much that is new.

The whole thing is here; I’m collecting reviews here.

22nd of February, 2008MarginaliaComments off

Virtual virtues

Nurses leave Nigeria and come to the UK, hoping for a better career. Farmers leave Mexico to work in construction or catering in the US. Such migrants can have a profound impact on the economy, as well as the society and politics both of the country they leave and the country to which they move. Social scientists, naturally, take an interest.

But one economist, Edward Castronova of Indiana University, studies an unusual kind of migration. Unhappy with your job as a Starbucks barista? Why not become a starship captain instead? Impossible if you stay in the country of your birth, but simplicity itself if, instead, you emigrate to an online fantasy world.

In such worlds, players usually pay a monthly fee for the right to explore richly detailed three-dimensional landscapes inhabited by dragons or aliens or, in some cases, punks and strippers. They are also populated by other players – guess who plays the strippers. If a player spends enough time there, perhaps he has migrated.

You might protest that is not migration at all, and you’d be right in all sorts of ways. But Castronova thinks it is relevant nonetheless, and he may be right too.

Half-joking but curious, his studies began with a survey he conducted in 2001 among regular players of an online game, Everquest. He asked about how much they played, as well as their real and fantasy careers. A third spent more time in the Everquest world than they did working for pay (and the average respondent worked a 40-hour week). One fifth regarded themselves as residents of the Everquest world, and a similar proportion said they would spend all their time in Everquest, if only that were possible.

By itself, that means little. But it should set us thinking. There is no doubt that these games have a modest but real and growing economic significance. People spend time and effort inside the game, creating or obtaining items that other players value. Virtual currency can be traded for dollars, and performing mundane tasks inside a computer game can even provide an income that is attractive to Chinese and eastern European students. Paying real dollars for an in-game item sounds silly, but no more than paying for a new mobile phone ringtone, which is also a digital product of purely aesthetic value. Time is spent, fun is had, money is spent, economic value is added.

As many more people log on and spend time having fun in a synthetic economy, will that really change the mundane world, as Castronova argues in a new book, Exodus to the Virtual World? Is the phenomenon any different from, say, poker – which is also a game in which time is spent, fun is had, and money changes hands?

If there turns out to be a difference it will be because synthetic worlds offer us an alternative vision of how society might work. These are places in which alter-egos live and die, fall in love, and develop careers and alliances. Their politics are very different from those to which we are accustomed.

Most synthetic worlds, for instance, celebrate their huge inequalities. Some characters are helpless and penniless, others are near gods, and every facet of the game’s interface will scream the distinction at you. But nobody minds, because the game is seen as fair. Everyone starts from the bottom and works their way up without state intervention, a libertarian’s dream. Yet other facets of the game are centrally controlled with great care: tremendous effort goes into offering equal opportunity to all players.

Castronova believes that compelling, increasingly popular and radically new experiences in synthetic worlds will start to change the nature of politics “back home”. That remains to be seen. But I find the idea faintly encouraging: a little healthy competition never did anyone any harm.

Also published at ft.com, subscription free.

Mortgage maths

Dear Economist,
I gave my sister a 30 per cent share of my mortgage when buying a new house two years ago so she could get on the property ladder. In return, she gave me some money towards the deposit on the house – about 20 per cent of the total put down. Given my larger share of the investment and commitment, should I get a greater proportion of the equity than my 70 per cent share, if and when we sell?
Ben

Dear Ben,

It is astonishing that you have entered into this enormously valuable contract without agreeing terms, but perhaps I should not be surprised – your letter suggests that you are unable even to think clearly.

You do not “give” someone a share of a mortgage any more than you “give” them a share of your restaurant bill.

If all you mean is that you gave her 30 per cent equity in exchange for a deposit, stick to the deal.

But I think you mean that your sister paid 20 per cent of your deposit and 30 per cent of your mortgage and has received nothing in return so far. You, on the other hand, have had your living costs subsidised and your risks in the property market hedged. Thanks to a housing bubble, your joint investment has paid off and you would now like to cream off some additional upside. Had there been a slump – widely forecast when you bought the house – would you be offering to bear more than 70 per cent of the loss?

There is no well-defined outcome from your befuddled arrangement, but it would be reasonable for your sister to enjoy more of the upside.

She took on nothing but risk, while you lived on the cheap. Family values, indeed.

Also published at ft.com, subscription free.

16th of February, 2008Dear EconomistComments off

Start making sense

Family Harford has just put in an offer for the house next door, to hoots of scorn from my colleagues, who know me as a bear among bears. It is true that the London housing market seems (who knows?) to be in the final stages of its biggest-ever bubble. But there are special circumstances involved here, one of which is that no rational economic actor disobeys an order from his wife.

My discomfort at having to make an offer put me to thinking that we often bungle our housing decisions. I am ever the champion of economic rationality, but even I would admit that there are exceptions. Buying a house is a rare event and the stakes are mind-bendingly high. Calamity is, therefore, always possible.

Most people do not seem to see the cost of a house in the same way that they see other prices. House prices are simply viewed through the lens of monthly repayments that either can or cannot be afforded. We spend time and money insuring ourselves against some losses, such as a malfunctioning washing-machine; yet the value of the house we own (or the cost of the house we might someday want to buy) fluctuates by far more, perhaps on a daily basis. Nobody cares, nobody hedges the value of their homes – although it is not hard to do so – and nobody seems to compare the price to any meaningful alternative, such as retiring 15 years early.

We also become irrationally possessive, and not only of our homes. The behavioural economist Dan Ariely – author of an excellent new book, Predictably Irrational – once demonstrated this possessiveness with a clever experiment.

He observed that tickets to see the top basketball games at Duke University are absurdly scarce. Students who want them must queue for weeks (they form teams and take turns). Even then, there is a lottery for tickets. Some win and some lose.

Winners and losers alike queue devotedly and are chosen at random. The only difference is that winners, by chance, hold tickets in their hot little hands. And yet when Ariely phoned the losers offering to sell tickets, they tended to offer around $175. Winners simply wouldn’t sell to him for anything close: their typical asking price was $2,400.

People are even less willing to sell if that means realising a loss. Research by Terrance O’Dean, a professor of finance, suggests that stock-market investors tend to sell shares that have made money and keep poor performers, even though tax efficiency suggests the opposite strategy.

The tendency is called “loss aversion”; people hold on to poor investments grimly, hoping for a turnaround.

“If you can get attached to a stock, imagine how attached you can be to your house,” Professor Ariely told me in a telephone interview.

Other research suggests that high stakes can befuddle the brain. Ariely and his colleagues once offered payments of up to six months’ salary to Indian peasants who could successfully complete certain mental or physical tasks. Modest stakes motivated excellence; super-high stakes simply caused nerves.

Sadly, none of this helps Family Harford very much. We’d like to buy the house next door, but if others offer irrationally exuberant bids, we won’t get it. Nor will we be able to pick it up cheaply after the bubble bursts. In principle that should be easy to do. In practice, that would mean somebody selling at a loss, a rare phenomenon.

And so, if we want the house next door, we must buy it now – even if it means outbidding irrational bidders. It’s a tough job being the sole voice of reason in a crazy world, but somebody has to do it.

Also published at ft.com.

Truly Lovelorn

Dear Economist,
I am 17 years old and my school only recently became coeducational. The other sixth-form students are almost all male, like me. I feel that the school does not meet my romantic needs and that I will never know true love while at school. In fact, I’m not having much luck at finding any love at all. Please can you help, or even just offer some hope?
Yours, truly lovelorn,
Student K, Bedford

Dear Student K,

You are right. The sixth form does not meet your romantic needs. Even if the boys only mildly outnumbered the girls – say, 55 to 45 – then assuming everyone paired off in the traditional fashion, there would be 10 boys left out, hormones raging, willing to offer the girls a better deal in one way or another. Sensible girls know how to exploit this healthy competition in their favour.

Still, as you grow older, your time will come. In cities across the developed world, dating-age women outnumber dating-age men. (Economist Lena Edlund argues that women have more to gain from city life than men.)

The excess supply of datable women and the resulting dating disadvantage forces women into bursts of self-improvement, which may explain why they tend to be better dressed and better educated than men. Research by economists Kerwin Charles and Ming Luoh finds a similar effect when many otherwise-marriageable men end up in prison. It does not take much to tip a dating market out of equilibrium, and your plight seems particularly extreme.

Yet take heart. At your age I was in an even worse situation, at an all-boys school. All seemed lost, until I discovered that the girls’ school opposite was willing to look for some gains from trade.

Also published at ft.com.

9th of February, 2008Dear EconomistComments off

Business Life: Money can’t buy love

First published in Business Life Magazine, October 2007.

“I don’t care too much for money, money can’t buy me love.” A great tune, but don’t believe everything you’re told by The Beatles. Money can buy you love, and it can buy you happiness as well.
The economist Lena Edlund (whose own greatest hits include an economic “Theory of Prostitution”) finds that wherever the men are rich, the women are plentiful. Women outnumber men in the cities of almost every developed country, which is why the girls from “Sex and the City” were always grumbling that all the good men are taken. In Edlund’s home country, Sweden, the towns with the highest average male income are the towns with the largest proportion of women aged 25-34. Still think that money doesn’t buy love?
More direct evidence comes from internet dating, where economists have shown that men who claim a high income get more “clicks” than their poorer – or more honest – rivals.
These findings probably won’t surprise the cynics, but economists have also been investigating the link between money and happiness. The conventional wisdom is that money doesn’t buy happiness. The truth is a little more subtle.
It is true that the citizens of countries like the US, the UK and Denmark claim to be no happier than their parents did in 1980 or their grandparents in 1950, despite being much richer. But in every country, in any given year, richer people also claim to be happier. Money isn’t everything, though: divorce, unemployment or ill-health are far more depressing than mere poverty.
“Happiness economics” is a booming field at the moment, but even its proponents would concede that findings are at an early stage. One promising approach is led by Daniel Kahneman, a psychologist who shared the Nobel prize in economics in 2002, and the economist Alan Krueger, both at Princeton University. Rather than just asking people how they feel about life in general – the survey approach which has produced most of the happiness data reported in the press – they ask a smaller group of subjects to think about specific episodes during the previous day, and how they felt.
This approach has yielded some surprises: praying is enjoyable, spending time with your children is not. It is no surprise to discover that having sex is lots of fun.And if Lena Edlund is right, that sort of fun isn’t cheap.

8th of February, 2008Other WritingComments off
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