Tim Harford The Undercover Economist

Articles published in July, 2008

A spot of car trouble

I pay someone to clean my car three times a week. He usually does a good job of it. However, I often travel and as soon as I’m gone, the cleaner stops work. So I always come back to a dirty car.
I pay him even when I’m not around. Shouldn’t he at least clean the car the day before he knows I will return, thus pretending to have been cleaning it regularly?
DT, Bahrain

Dear DT,

I can think of three explanations for this behaviour. Either the cleaner is too stupid to realise he should be skiving more subtly, or he thinks you are too stupid to notice, or he does not care if you notice.

If he is stupid, or he thinks you are stupid – don’t ask which – the solution is easy: say you’ve noticed that the car is dirty and ask him to clean it before you return.

If he does not care, that means he can try to get an equally good job elsewhere. Since the current job comes with frequent paid holidays, that is unlikely – unless you are being especially stingy.

I suggest sharper incentives. Tell him you’ll pay him a bonus if you return to a clean car. Frankly, since you are paying him to clean an unused car, incessantly, and he isn’t doing it, any change is likely to be an improvement.

Also published at ft.com, subscription free.

26th of July, 2008Dear EconomistComments off

The cost of curbs on immigration

Humans don’t take kindly to outsiders: history is heaped with the corpses of those who were lynched, bayoneted or gassed because of their race, religion or nationality. Even within the relatively civilised sphere of economic relations, there is plenty of room for discrimination. People earn less because of their race or their sex, even in the richest countries in the world.

For example, according to a recent summary by the economists Michael Clemens, Claudio Montenegro and Lant Pritchett, white men earn 27 per cent more in the US than white women. That figure compares the hourly wage of full-time workers with similar qualifications and experience. Again making best efforts to compare like with like, the economists found that white men earn 7 per cent more than black men in the US. Look back to 1939, and the like-with-like wage premium for whites in the US was 60 per cent. In modern Pakistan, meanwhile, men earn three times as much as equally qualified women. None of these numbers is trivial: most are appalling.

It is even possible – although perhaps only an economist would think it pertinent – to calculate the implicit wage loss suffered by US slaves. Several economists have attempted to do this by comparing the “compensation” – food, clothes, shelter and perhaps some medical care – received by slaves with how much one slave-owner would pay another to rent a slave. Of course, low wages were hardly the chief reason that slavery was an atrocity. Yet had slaves earned for their labour what slave-owners paid each other for it, the wage would have been three or four times higher than the basic subsistence owners saw fit to provide.

There is a huge gap between what slaves would have earned in a free labour market and what in fact they were forced to accept. But the gap is dwarfed by the difference between what a Nigerian-born, Nigerian-educated man could earn in the formal sector in Nigeria, and what he could earn if allowed to work in a rich country – more than eight times as much. Nigeria is an extreme example, but there are many other countries in which all that would be needed to quadruple or quintuple a person’s income would be permission to work in a rich country. Restrictions on immigration cause a greater loss of wages than racial and sexual discrimination – and perhaps greater even than slavery. This is what Clemens and his colleagues call “the great discrimination”.

This is unquestionably a research paper with an agenda: Lant Pritchett is a vocal advocate of more liberal immigration rules. Despite the agenda, I see no reason to doubt the numbers. Migrants from very poor countries see huge leaps in wages if allowed to move to wealthy countries – that much is obvious. The question is whether voters in wealthy countries feel morally obliged to take those gains into account. So far, they don’t.

Economists have a habit of poking these sore points. Steven Landsburg, author of The Armchair Economist, secured notoriety four years ago by labelling the vice-presidential candidate John Edwards a “xenophobe”, arguing that his protectionism arbitrarily privileged Americans over foreigners and was no better than arbitrarily privileging whites over blacks. Few non-economists see things that way.

Economists have always tended to be blind to distinctions of race, sex and nationality. In 1849, Thomas Carlyle branded economics “the dismal science” for its insistence that a market wage set by supply and demand was superior to slavery and what Carlyle called the “beneficent whip”. His view is now rightly branded abhorrent.

I have no idea how immigration barriers will be viewed by our descendants. But it is worth reflecting, if only for a moment, on the costs they impose on those trapped on the other side.

Also published at ft.com, subscription free.

Bargains that aren’t

First published: Parade Magazine, 13 July 2008

Not everything that seems like a bargain will really end up saving you money. Luckily, behavioral economists are finding the gimmicks and tricks that regularly lure us to spend more. Read this—and don’t get caught!

ANYTHING YOU BUY ON CREDIT
Putting a purchase on a credit card with a zero interest rate may seem like a good deal, but you’re less likely to shop frugally when you’re using it—or any kind of credit card. MIT researchers Drazen Prelec and Duncan Simester ran an experiment in which two groups of subjects were allowed to bid on tickets to sporting events. One group had to pay in cash within 24 hours, the other with a credit card. The credit-card group offered much more for the tickets—and more than twice as much for a sold-out game. Other studies suggest that people who pay with plastic spend more and tend to forget how much they spent. Learn More

20th of July, 2008HighlightsOther WritingComments off

An economist who put a premium on truth: Obituary of Leonid Hurwicz

Financial Times comment, 19 July 2008
Leonid Hurwicz, the economist who last year became the oldest person ever to win a Nobel prize, helped transform economic thinking in the second half of the 20th century.
For years economists had been passionately debating the rival merits of state planning versus free markets. In both systems, people had incentives to lie to bureaucratic planners or to employers about their interests, their skills or their circumstances. “Leo”, who has died at the age of 90, founded the field of “mechanism design”, a new way of thinking which focused on giving people incentives to tell the truth and to do so in a way that would benefit society as a whole.
His mechanism design idea has applications in a range of practical areas, from the design of computer networks and voting systems to arbitration rules.
The debate between state planning and free markets must have seemed far from academic to Hurwicz. His parents were Polish Jews who fled the Kaiser’s invading army, going to Moscow, where Hurwicz was born in 1917. They returned to Poland in a horse-drawn wagon to escape the Bolsheviks when he was two. Learn More

19th of July, 2008Other WritingComments off

Greenhouse gas

I take small steps to reduce my carbon footprint (I walk, recycle etc) and attempt to influence others by spreading awareness of climate change. However, a friend recently accused me of being a hypocrite because of my contribution to carbon emissions when I fly for my holidays. I admit I do not weigh the damage done to the environment when planning my breaks, and am not ready to forgo them. How do I preach green without breaching the walk-the-talk philosophy?
An apparent pseudo-treehugger

Dear Treehugger,

You are in good company. Most of the developed world’s governments have been spouting about climate change, without adopting policies that have noticeably prevented the growth of carbon emissions.

But hypocrisy does not strike me as the issue here. In fact, you are refreshingly honest – you say you do not know the impact of your travel, and would not change if you did.

The problem, rather, is that most people are equally as ignorant and as self-centred as you. Few humans are capable of making serious sacrifices for the unborn grandchildren of total strangers, which is the basic selling point of voluntary action on climate change.

That leaves us with two alternative policies: hope that people chivvy each other into action, or hope that governments swap some of their taxes on labour and capital for taxes on carbon. I am not holding my breath for either.

Also published at ft.com, subscription free.

19th of July, 2008Dear EconomistComments off

At last, a sensible way to measure poverty

Seebohm Rowntree was the son of the wealthy Quaker businessman Joseph Rowntree, but acutely aware of the poverty that surrounded him in late-Victorian York. In 1899 he set himself the task of defining a “poverty line” by working out how much it would cost to supply basic food, housing and clothes. Anyone who couldn’t afford to buy those basics – including a helping of pease pudding with bacon on Sunday – was below the poverty line.

The idea of a poverty line has stayed with us, but the candidates have multiplied. The World Bank has two poverty lines: a dollar a day and two dollars a day (strictly, those are 1985 dollars adjusted for inflation). In the US, the poverty line is $29.58 a day for a single adult under the age of 65. All these are absolute income standards, just as Rowntree’s was.

Eurostat, the European Union’s statistics agency, takes a different approach: it defines the poverty line as 60 per cent of each nation’s median income. (The median income is the income of the person in the middle of the income distribution.)

This has an unfortunate consequence: poverty is permanent. If everyone in Europe woke up tomorrow to find themselves twice as rich, European poverty rates would not budge. That is indefensible. Such “poverty” lines measure inequality, not poverty, and they do so clumsily.

On the other hand, absolute standards of poverty are creepy, reliant as they are on expert definitions of a nutritionally balanced diet. (Rowntree was a Victorian philanthropist, so we’re willing to make allowances.) The US definition dates back to early 1963 and the efforts of a Social Security Administration researcher called Mollie Orshansky. Lacking decent statistics, she based her poverty line on government nutritional advice. It was a decent estimate given the limited resources of the time, yet the threshold has changed only to take account of inflation.

So, the US definition of poverty is stuck in the 1960s. Had Seebohm Rowntree been working for the US government, perhaps it would now have a poverty standard based on the price of pease pudding, and which assumed that electricity and indoor plumbing were luxuries. This cannot be right.

Adam Smith put his finger on the problem back in 1776. In The Wealth of Nations, he wrote: “A linen shirt, for example, is, strictly speaking, not a necessity of life. The Greeks and Romans lived, I suppose, very comfortably though they had no linen. But in the present times, through the greater part of Europe, a creditable day-labourer would be ashamed to appear in public without a linen shirt …”

Smith’s point is not that poverty is relative, but that it is a social construction. A person can lack the money necessary to participate in society. Whatever Eurostat may say, people don’t become poor just because the median citizen receives a pay rise, but they may become poor if something they cannot afford – such as an internet connection – becomes viewed as a social essential.

That is why a new unofficial poverty threshold, published this month by – appropriately – the Joseph Rowntree Foundation, makes more sense than it at first appears. The standard was set by focus groups working out what was and was not necessary “to participate in society”.

The results are frugal – there is a budget of £40 every two years to buy a suit, for instance – but they were always bound to be controversial. The list of essentials includes a self-catering holiday, a mobile phone and enough booze to get drunk twice a month.

But the new threshold’s apparent weakness – its subjectivity – is in fact its strength. Poverty is not relative and it cannot be objectively determined by an expert. Adam Smith understood that very well.

Also published at ft.com, subscription free.

Part-time parenting

I am the mother of two young children, and extremely grateful to my own parents for looking after them for a few hours now and then. My problem is that they stuff the kids with chocolates, crisps and ice cream. This is not good for the children, their behaviour and my own efforts to feed them something nutritious. Why do the grandparents have such a different philosophy, and can I do anything to change their thinking?
F.M., Cumbria

Dear F.M.,

The symptoms are familiar, but you have misdiagnosed the cause. Your parents do not have a different philosophy; they have different incentives. As you surmise, the costs of the junk-food strategy are mostly long-term: the children become fat, their teeth rot and they refuse to eat more wholesome fare.

In contrast, the benefits – delighted smiles, grateful kisses, compliant silence – are all short-term. Their strategy is perfectly rational for temporary carers.

Rather than reasoning with your parents, you must change their incentives. Unfortunately, this is not easy. You could try to bribe your parents, but threats will be useless because they are doing you a favour.

Perhaps your best bet is to try to arrange for longer bouts of childcare. Your parents will have a fresh perspective on the merits of carrots after trying to put a three-year-old to bed in the midst of a sugar high.

Also published at ft.com, subscription free.

12th of July, 2008Dear EconomistComments off

Why the world needs more speculators

When the economy is in turmoil, no one is demonised more than the speculator. First, we are told, speculators have driven up the price of oil, condemning us to expensive heating and motoring. Then, they have driven down the price of bank shares, dealing vicious blows to the City’s noblest banks. All of this, we are supposed to believe, is immensely profitable and highly destabilising.

With one exception – that I’ll come to – I am not persuaded. I struggle to understand how speculation is supposed to be both profitable and destabilising, all at once. Profitable speculation requires buying low and selling high. Destabilising speculation requires the opposite: short-selling shares in a trough, thus deepening the trough, and betting that frothy shares will become frothier. In other words, destabilising speculation means selling low and buying high. If that is a recipe for profit, I am missing something.

Profitable speculators, in contrast, are veritable philanthropists. When they think oil is going to become more expensive, they buy and hoard oil, or they buy oil futures, encouraging others to buy and hoard. This raises oil prices when they are relatively cheap, and lowers them later when they are relatively expensive. (The corollary, incidentally, is that if central banks lose money when “stabilising” the currency, stabilisation is precisely what they failed to achieve.)

True, when speculators make mistakes, that is destabilising. But in the case of oil prices, it’s hard to see that speculators are playing much of a role. For one thing, inventories don’t seem to be rising; if the inventory data is correct, consumers were burning all that $145 oil.

For another, speculation and prices don’t seem to be closely correlated. BP’s recent Statistical Review of World Energy points out that while few speculators have been betting on a spike in the price of heating oil, its price has soared even more rapidly than the crude-oil price. More striking, speculators have been betting that natural gas prices will slump. Natural gas prices haven’t.

If the intellectual case against speculators is weak, one can always fall back on the emotional one. Short-sellers are a particularly easy target: their hope that prices will fall hardly seems constructive. It is not much of a stretch to move from abhorrence at the idea of short-selling to the implausible conclusion that it is the short-sellers who are dragging down prices. As the great investment writer Fred Schwed Jr commented: “Only the thoughtful ask, ‘What is happening to us?’ The popular cry is, ‘Who is doing this to us?’ and its satisfying sequel – ‘Just let me get my hands on him!’”

In some rare cases, the short-seller really is the one causing the problem. For example, it might be possible to sell a retail bank’s shares short, start unfounded rumours about the bank’s liquidity and cause a run on the bank, making the rumours self-justifying, destroying a valuable asset and making money into the bargain. We should never feel comfortable about short-sellers who also (independently of their short-selling) possess the power to destroy – be they rumour-mongers, board members, or just a sportsman backing himself to lose.

This is the exception mentioned earlier. But I can’t help feeling that the “sell-short, start rumour, make a killing” strategy is more easily planned than executed.

No, the world needs more speculators, especially of the short-selling variety. There is nothing inherently wonderful about inflated prices, but it is not easy to bet that prices will fall. More short-sellers in the dotcom bubble of the late 1990s, and the housing bubbles of the past few years, would have added a welcome dose of stability and sanity. Alas, there were not enough short-sellers – and given the amount of money they were losing at the time, the only people complaining about them were their impoverished families.

Also published at ft.com, subscription free.

Storytime split

My husband and I both have fairly demanding jobs, and we also have two children under the age of five. Bedtime is sometimes fulfilling, but more often exhausting and aggravating. Most of the work – especially the stories and the staring at the ceiling waiting for the children to fall asleep – is best done alone. So how should we share the chore?

Taking it in turns seems obvious, but what about when one partner is particularly tired already? Should we be holding an auction or something?
Sophie Jamieson

Dear Sophie,

Your problem is surprisingly subtle. Simply taking turns is inefficient, since that may mean the wearier party being faced with the chore. But a more discretionary system of side-payments is complex, and may be corrupted if one of you feigns mentalhealthdrugs.com exhaustion when in fact you simply fancy a glass of wine and a bit of TV.

Such situations are common. For example, a price-fixing cartel faces a trade-off between rigid profit-sharing rules and complex schemes to trade market share. The general problem has been analysed in the formidably mathematical research of Professor Susan Athey. She finds that less efficient but simpler schemes often – but not always – pay off. So you should indeed take turns, and if that is occasionally sub-optimal, tough luck.

Please note that Athey also has two children under the age of five.

Also published at ft.com, subscription free.

5th of July, 2008Dear EconomistComments off

Why small prizes make it easier to win

We’ve known for a century that laboratory rats choke under pressure. Back in 1908, two researchers, Robert Yerkes and John Dodson, repeatedly placed rats in a cage and gave them a choice between two pathways. Each time, one of the pathways was lined with black card and delivered an electric shock; the other pathway was lined with white card and was safe.

Yerkes and Dodson varied the intensity of the shock: some rats always got a ferocious zap, other rats always got a mild buzz. The rats which learned quickest were the ones receiving neither mild shocks nor strong shocks, but shocks somewhere in the middle. When the “incentive” to learn was too big, the effect was counterproductive.

So much for rats. Is the same true of humans offered financial incentives? To answer the question, four economists, Dan Ariely, Uri Gneezy, George Loewenstein and Nina Mazar, decamped to rural India to conduct an experiment. They knew that when the experiment’s volunteers were very poor, it would be easier to pay them enough money to make heads spin and hands shake.

The researchers paid bonuses if the volunteers were able to complete assorted mental and physical challenges. The tasks varied from physical ones, such as throwing balls at a target, to concentration-based challenges, such as bashing away on Simon, a toy from the late 1970s that requires the player to memorise sequences of colours.

Just as with Yerkes’ and Dodson’s rats, the participants were offered low, medium and high incentives. Some of the participants stood to win up to a day’s income, others about two weeks’ income, and those with most to gain could, in theory, have scooped about six months’ income. But they didn’t: instead, they choked under the pressure.

Those on low or medium incentives managed to win just over 35 per cent of the available money, while those on the highest incentives cracked, winning less than 20 per cent. (If hell was designed by behavioural economists, sinners would be forced to play Simon for their souls.)

However, one does not need to torment Indian villagers to observe choking under pressure; it is much more fun to torment professional footballers. The torture of choice is the penalty shoot-out, now widely used as a tiebreaker in the most important games, including the most recent Champions League and World Cup finals.

In a penalty shoot-out, each team takes it in turn to try to score a goal from the penalty spot. There might well be additional pressure on the second team, because most penalty attempts are successful, and so the second team tends to be trying to catch up rather than draw ahead.

Between 1970 and 2003, the team which went first was chosen randomly. Since 2003, a coin-toss has given one captain the chance to choose whether to go first or second. That rule change gave two economists, Jose Apesteguia and Ignacio Palacios-Huerta, an opportunity to investigate pressure in a seriously high-stakes environment.

They found that before 2003, the team lucky enough to be forced to go first won more than 60 per cent of the time. This is a huge advantage, and professionals are well aware of it. Since the rule change, most captains have chosen to go first when given the option.

Yet there are exceptions. The Italian team recently lost a penalty shoot-out to the Spanish after their captain, Gianluigi Buffon, won the toss and chose to go second. He might have had a different perspective: as the team’s goalkeeper, when his team-mates shot second, he was able to go first. Whatever the reason, the choice backfired, as history would have suggested.

Professors Apesteguia and Palacios-Huerta are delighted with the result. Presumably this is because it is a powerful vindication of their research, and not because they are Spanish.

Also published at ft.com, subscription free.

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