Articles published in September, 2009

First published in Business Life, April 2009
Next time you’re at a computer, try typing “QWERTY”. You shouldn’t have too much trouble finding the keys: QWERTY, with minor international variations, is the universal standard for English keyboards.
An economist is the kind of person who thinks it’s worth asking if we got it wrong. Is QWERTY a good way of arranging the keys on a keyboard, or is it a historical accident that slows us all down? There’s more at stake than typing speeds. Whenever different standards collide – Mac versus PC, VHS versus Betamax, Blu-Ray versus HD-DVD, eBay versus QXL – economists worry that we might become “locked in” to an inferior standard when it attains a critical mass of users.
That’s certainly the received wisdom about QWERTY. Typewriters were originally fragile mechanical constructions, and it’s often said that the QWERTY keyboard was designed to slow down typists in the hope of preventing keyboard jams. In the computer age such jams are no problem, and slowing down typists simply seems perverse. But who wants to be the first to retrain himself to use a better, faster keyboard – and then struggle every time he moves employers or tries to use an Internet café? There are better ways to arrange the keys – such as the “Dvorak” keyboard, which, according to wartime trials by the US Navy, was so fast that typists could recoup the time and trouble of retraining within just ten days. If only we could all agree to make the leap at the same time, we could be plugging Dvorak keyboards into our computers and be reaping the benefits within a fortnight.
Not everyone buys the story of QWERTY lock-in. The American economists Stan Liebowitz and Stephen Margolis call it “The Fable of the Keys” – pointing out that the evidence for Dvorak’s superiority is sketchy. (That Navy test? Conducted by a certain Lieutenant Commander August Dvorak, who owned the patent…) For Liebowitz and Margolis, network lock-in is an interesting theoretical possibility, but in practice they argue that people find a way to move to the new standard.
An intriguing new experiment supports that idea. Tanjim Hossain and John Morgan recruited Hong Kong students and paid them money if they were successfully able to coordinate on the same “platform” – an abstract representation of the choice between standards such as a Blu-Ray or an HD-DVD. What really mattered was to choose the most popular platform, and the students did that – but they also managed to coordinate a move to the higher-quality choice, even if they had started off on the low-quality platform.
Oh, and when you do type QWERTY, you’ll discover that while the keys are easy to find, they’re hard to hit because they’re so close together. Perhaps putting common letters on opposite sides of the keyboard wasn’t such a stupid idea after all?

To my astonishment, my talk at LSE next Tuesday is already a sell out.  But never fear. I am also giving a talk on “The Consolations of Economics” at Cass Business School in the City – please register before you go along – on Wednesday 14th October. The day after, I am speaking at One Alfred Place but it is not yet clear whether the speech is open to the public (an excellent reason to become a member, shurely). Finally, I’m giving a sermon on Frugality just before Christmas: 13 December at Conway Hall, under the auspices of the School of Life. Do please come along.

In all cases, the inspiration for the talks will be “Dear Undercover Economist“, my new book.

My daughters (average age: four) have a serious credibility problem. “Daddy, if you read just one more story, then we’ll go to sleep.” “Mummy, if you give me a snack now, I promise I’ll eat up all my dinner.” You know what, my darlings? We just don’t believe you, so there’ll be no extra story and no snack.

Such troubles are not solely the preserve of little girls. Managers promise performance bonuses, workers do not believe them, and so the hoped-for performance does not materialise. Governments promise to keep a lid on inflation, nobody takes them seriously, and that is one of the reasons the lid comes off.

These problems have solutions. Most adults build up enough of a reputation for honesty that their promises tend to be believed. Politicians delegate inflation management to central banks, which – despite recent travails – are both more credible and more successful inflation-busters.

Yet when it comes to climate change, few people are talking about time inconsistency. They should be. I can find no reason to take seriously any government promises on the subject.

The British government has set a binding carbon emissions target for 2050. It is safe to speculate that the present cabinet will be out of office by then. Meanwhile, the government levies a reduced rate of tax on domestic heating and neither new nuclear power stations nor renewable energy look well placed to meet the UK’s short-term energy needs.

The EU has an emissions trading scheme, and a good idea it is, too. But its reputation took a knock when the price of emissions permits collapsed in 2007 because member states had flooded the market with them. Current allocations are tighter, but the farce could well be repeated in five or 10 years.

In the US, the credibility of carbon restrictions is weaker still, because people sceptical of the idea that humans cause global warming remain politically influential. And globally, the Kyoto regime expires in 2012. It has, as yet, no successor. Why should we believe that words today will mean action tomorrow? Indeed, why should we believe that action tomorrow will not be undermined by backtracking the day after that?

All this matters because anyone planning to build an energy-efficient office block, a wind farm or a nuclear power station will want to know that the project will not suddenly be undermined by a government U-turn.

One possible solution, mentioned last year in this column, is to create the climate change equivalent of a central bank. An “energy policy committee” could, like the monetary policy committee, use a narrow range of policy tools to meet targets set by parliament. Or like the UK Statistics Authority, it could act as an independent watchdog.

But ad hoc solutions are also possible. The government could auction off long-term carbon price contracts, in effect selling insurance (to the highest bidder) against the prospect that the carbon price collapses. Dieter Helm and Cameron Hepburn, two economists at Oxford University, have proposed an idea along these lines.

Another proposal, by the economists Warwick McKibbin and Peter Wilcoxen, is more informal: governments should auction off long-term permits to emit carbon dioxide – a ton a year, forever, or at least for decades. The owners of these assets would then constitute a lobby group for high and stable carbon prices. There is something Frankensteinian about the idea of manufacturing a pro-carbon-tax lobby group, but it’s a clever solution. For now, I am more concerned at how few people seem to recognise the nature of the carbon credibility problem.

Also published at ft.com.

Dear Economist,
I am an economics student sharing a house with two other students and there is an issue with keeping the kitchen clean. I thought that a grim punishment strategy would maintain a system of alternate cleaners. But my threat to “punish” by refusing to clean indefinitely is not seen as credible by my housemates as I value a clean kitchen more than they do. What to do?
Tom, Gloucestershire

Dear Tom,

I counsel against “grim” as a strategy. As you know, “grim” describes a strategy of punishing unwelcome behaviour with everlasting, implacable revenge. In most circumstances, your own included, this is bluff. It’s not hard to imagine the bluster: “Right! I mean it this time. This really is your last warning.”

There is a more serious problem. You are treating the issue as some kind of public-goods game or prisoner’s dilemma, in which everyone has an incentive to act selfishly while hoping that others will do the spade work. But this is a student household. Not only is “spade work” likely to be an accurate description of what it will take to clean the kitchen, but your housemates may be entirely indifferent to how clean the place is. Many of these men will, later in life, inhabit bachelor pads with kitchens just as filthy, which suggests that we are not really talking about a collective action problem at all.

If you could persuade them to care about the kitchen at all, your best bet might be to persuade them to contribute to hiring a cleaner, rather than to contribute to cleaning up themselves. Behavioural economics suggests that people are much more reluctant to cheat if hard cash is involved. But how to make them care in the first place? Perhaps you might speculate about why no young female students ever come to stay. Point out that while women enjoy culture as part of a night out, they do not wish to find it growing in the fridge.

Also published at ft.com.

I have a guest post up on the Freakonomics blog, taking readers’ questions. Here’s a sample:

Q. If a reasonably intelligent young person today is looking to make as big a contribution to society as possible, is he or she better off making a small impact on something very large (like federal policy) or picking one particular problem and spending a lifetime attacking it (like curing a disease or improving public education in a country or even city)? — Matt

The answer, with several others, is here.

Behavioural economics, the application of psychological insights to economic theories and problems, has been growing in influence for decades. But with the publication of Richard Thaler and Cass Sunstein’s Nudge, it seems to have struck policy primetime – and as with many once-good ideas, it has mutated. I recently attended a meeting at one government department at which the conversation rarely strayed from the question of how the latest marketing tricks could be used to get citizens to behave as the nanny state preferred.

At a seminar for the UK’s government economic service on applying behavioural economics to public policy, I therefore expected to be the lone voice of caution – especially since fellow panellists included Dan Goldstein, a psychologist, and Pete Lunn, author of Basic Instincts, a popularisation of behavioural ideas. I was wrong: while everyone was impressed with the potential contribution of psychology and neuroscience to economics, they all seemed queasy about how quickly behavioural economics has appeared as a policy panacea.

Lunn began by displaying Poggendorff’s optical illusion, in which a diagonal line passes behind a vertical block, creating the impression of two separate but parallel lines. Thaler and Sunstein have a similar optical illusion at the beginning of chapter one of Nudge. Their point: the human brain has evolved to take short cuts in the way it processes information, short cuts that sometimes lead us astray. Hence, sometimes we could use a little help in nudging us towards the correct decision when we make mistakes.

Lunn may be a champion for behavioural economics, but he is also originally a neuroscientist specialising in optical processing. And he makes a telling objection: we don’t yet know why Poggendorff’s illusion fools us. Are we so confident that we want the government to furnish us with spectacles that nudge the line straight, when we don’t know why it looked crooked in the first place?

Dan Goldstein’s caveats came from the sharp end of policy design. He has been studying the question of default options in policy and business. When you order from Amazon, should the default be express shipping or standard shipping? Should Amazon refuse to post your books until you express a preference?

For a business, the choice is not straightforward, even if the aim – to maximise profit without alienating customers – is simple. For a government, the decision should be harder still. Goldstein points out that 12 per cent of Germans and 99.98 per cent of Austrians are registered organ donors. Germans have to opt in to the donor scheme, Austrians have to opt out. The implication: few people really have a strong preference as to whether to be an organ donor or not, so they stay where they’re put.

The response to this is not obvious. Perhaps the government should use the default to maximise organ donations. A more cautious approach would be to try to figure out what people would prefer if they could be persuaded to give it some proper thought. One indication comes from research by Goldstein and Eric Johnson: in an experiment on organ donation, people forced to choose one way or the other acted like people who were placed in the donor pool by default. In this particular case, maximising the donor pool and doing what people really want seems to be much the same thing. Other cases will be less clear-cut.

Much of this was implicit in Thaler and Sunstein’s original – less sexy, less concise – concept of “libertarian paternalism”. The monosyllabic version has been debased in policy circles; it now needs a firm nudge back again.

Also published at ft.com.

Dear Economist,
Samantha, my PA, is so very unreliable. For example, she failed to pass on your invitation to feature as a responding correspondent in your recent “Dear Undercover Economist” plug article. However, she does have a fantastic pair of, er … feet. Should I fire her?
Bob Casablanca

Dear Mr Casablanca,

Much depends on your line of business. In Mel Brooks’s masterpiece, The Producers, the crooked Broadway magnate Max Bialystock hires a blonde bombshell, Ulla, whose secretarial skills consist solely of the ability to pick up the telephone and intone, “Bialystock unt Bloom, Good tag por day.” She can, however, dance. Bialystock is happy enough, which is understandable given that the sole aim of his production is to go bankrupt.

It is unlikely that you share Bialystock’s aims, but if you work for a large organisation, you may share his contempt for his shareholders. Your PA’s incompetence largely disadvantages them, while her aesthetic appeal – which an economist might call a “non-pecuniary benefit” – is enjoyed by you alone.

Naturally you have to ensure that your PA’s failings are not so disastrous as to damage your own career, but that should be manageable, especially if you continue blaming her whenever something goes wrong.

If you own a large stake in the business, the trade-off is more painful. Samantha will be costing you money. I cannot advise you as to the right course of action, since I don’t know how much money you have, how much you want, and how “fantastic” she really is. I would simply note that you can always look for other options. You could hire a second PA to work in parallel with Samantha. Or you could seek out a PA who offers the best of everything. It cannot be impossible to find an assistant who is both effective and attractive.

Also published at ft.com.

In the late 18th century, Johann Gottlieb Beckmann, a Saxon forester, hit upon the idea of systematically surveying Saxony’s forests. He dispatched trained surveyors into a tract of woodland to hammer nails into every tree. Each man carried nails of five different colours, enabling them to grade trees by size. When every tree was marked and the men emerged, Beckmann counted the coloured nails left over to calculate the exploitable resources.

Efforts to measure what goes on in the economy have a chequered history. The political scientist James C. Scott, who unearthed the example of Beckmann, points out that forest planners tried to conform to Beckmann’s theories, spacing with architectural precision trees of the same breed and age. The resulting forests were vulnerable to high winds and to disease.

Sir William Petty, an adviser to Oliver Cromwell, produced the first estimate of Britain’s national income, which he put at £40m a year back in 1664. But Petty’s surveys also made it easier for the English to exploit Ireland. William the First’s Domesday book is both a historical treasure and the tool of a conqueror.

It is no wonder Sir John Cowperthwaite, the laissez-faire financial secretary of Hong Kong in the 1960s, refused to calculate economic statistics for the colony. He thought they would only encourage bureaucratic meddling from London.

With all this in mind, it is perhaps not surprising that economic indicators continue to generate heat as well as light. This week, the World Bank and the International Finance Corporation published their annual “Doing Business” report, which surveys the time and expense involved in performing simple business procedures such as incorporating a medium-sized enterprise.

The report’s authors – some are former colleagues of mine – draw conscious parallels between their attempts to collect microeconomic data and the much more established macroeconomic indicators such as inflation and unemployment rates.

Doing Business is beginning to be incorporated in academic research and it is probably a modest spur to reform efforts. One of the merits of its data is that for any given regulatory obstacle in a country, it is easy to see which neighbouring country is doing better, and whether there are any relatively simple changes that would help.

Not everyone is happy, though. Arvind Panagariya, professor of economics at Columbia University, has called for the indicators to be scrapped. “When firms are entering a market with a horizon of several decades, does it matter whether it costs $500 rather than $5,000 and takes 20 rather than 200 days to start the business?” he wrote last summer in India’s Economic Times newspaper. But that is an odd complaint; not every business is a corporate titan, and even corporate titans like to operate in an economic ecosystem of smaller suppliers.

Doing Business statistics sometimes show a different picture to that painted by statistics on foreign investment and economic growth. Critics claim this shows that they are irrelevant; supporters that the data provide information not captured elsewhere.

In response to criticism, the World Bank is distancing itself from the suggestion that “less regulation” equals “better regulation”. Fair enough – but the report’s most important finding is that the world’s most regulated economies are not the likes of Germany and Japan, but the Central African Republic and the Democratic Republic of Congo. Hong Kong stands at number three in the world. Even Sir John Cowperthwaite might have given these statistics his grudging acceptance.

Also published at ft.com.

Dear Economist,
Suppose we plot my preference curve for a man as units of “good boy” traits (thoughtfulness, caring, emotional support) versus “bad boy” traits (adventurousness, sexual attractiveness). My boyfriend, whom I’ve been dating for a year, would come up very high on the former and low on the latter. This situation was fine for me before, but now I’m having a hard time being attracted to him and I wonder if I want to continue the relationship. Has my preference curve simply shifted more in favour of the “bad boy” traits? I know the one year is a sunk cost, but I’m reluctant to give up so easily on such a nice man.
Beatrice

Dear Beatrice,

It is a pleasure to receive a letter that packs so much consumer choice theory into so little space – although I sense a creeping confusion in your question. You speak of a preference curve expressing a trade-off between good boy and bad boy traits. (By the way, I recommend the term “indifference curve”, both because it is technically more precise, and because it makes you sound sexy and unavailable.) Yet you do not specify your budget constraint. You act as if you can have a thoughtful boyfriend or a sexy boyfriend, but not both. I wonder why you think this is true. Perhaps you should hang around with economists more.

Let us take your problem at face value, though, and assume that you cannot simply find a man who has it all. If so, the problem you describe is familiar enough: that of diminishing returns. Only little children want to eat their favourite food for every meal, or listen to the same story again and again. For most of us, variety is the spice of life. So dump your boyfriend and find a rogue. Date him for a year. It is bound to end in tears, and then you can find yourself another ugly, tedious – yet thoughtful – man. They are not in short supply.

Also published in ft.com.

It occurs to me that despite various hints and publicity elsewhere, I have not actually announced the fact on ths blog that my new book, “Dear Undercover Economist”, is now out in English and Spanish. Other languages to follow! Details about the book on the Dear Undercover Economist page…

First published in the Sunday Times, 9 August 2009

Spend less time with your children. Don’t underestimate the benefits of a divorce. Never serve dog food at a dinner party. These are some of the unexpected revelations to have emerged from an unlikely combination: happiness, and economists.
You might think that the “dismal science” has done enough damage for now. Economists have hardly emerged from the banking crisis with their reputations enhanced. But forecasting financial meltdown was never going to be easy, so perhaps it is best of economists stick to simpler questions, such as “how can we be happy?”
A growing number of economists have been attempting to answer this question. Not only are the statistical tools of economics surprisingly well-suited to unlock the secrets of happiness, but the research topic is good box office, too… and these are economists we’re talking about.
Some of the results sound as though they come from hippies rather than economists. For instance, economic growth does not seem to make the citizens of a rich country such as the UK any happier. A good job too, considering the current prospects of any economic growth seem slim.
Other discoveries are less intuitive. For instance the economists Andrew Oswald and Nattavudh Powdthavee has discovered that teenagers and the elderly are actually rather happy. “Your late 30s are the most unhappy period of your life,” Oswald cheerfully tells me. Thanks, Professor, from a grateful 35-year-old. Read the rest of this entry »

Published in The Globe and Mail in Canada, and ABC Unleashed in Australia:

Think of the ideal advice columnist, duty-bound to help correspondents with their problems at home, at work, and in love. What kind of person comes to mind? Caring? Honest? Wise? Whatever your answer, I’m guessing it didn’t involve the phrase “professionally trained economist”. Whatever: here I am, the only economist in the world to run a problem page – “Dear Economist” in the Financial Times – dedicated to making my readers’ personal lives better.

I’ll admit that it is not immediately obvious what an economist might have to say about parenting, the intricacies of etiquette or the dark arts of seduction. Even at our best, we economists seem too perfect, too rational, to understand mere human weaknesses. You might as well consult Mr Spock for dating advice as ask an economist. And at our worst, we appear hopelessly naïve, emotionally tone-deaf, and bordering on the sociopathic.

And let us be honest, at times my advice column persona has lived up to that caricature. When a woman wrote to me confessing that she enjoyed the dating game but was afraid she might leave it too late to settle down, I didn’t offer a sympathetic ear, but a handy explanation of the theory of optimal experiments. When a dinner party guest wondered how much he should spend on wine, I reached straight for the Journal of Wine Economics. Every advice columnist needs a persona, and for “Dear Economist” it was blunt, rude, and rather fond of the latest economic research.

As “Dear Economist”, I was never supposed to offer good advice. The whole thing was a joke, with a predicted shelf-life of about six months. Six years later, my inbox is still full of readers’ queries, and I am still handing out advice. Hopefully it still makes my readers laugh. But – and here’s the strange thing – I am starting to wonder whether some of it is actually pretty good advice, too.

There is something about the cold eye of economics that lends itself, quite unexpectedly, to the advice-column format. Economic theories are ruthlessly reductive, cutting away complexity to reveal some hidden truth. If we’re honest, most advice columns are reductive, too. And economists have an advantage over most advice columnists, because we have access to the most bizarre (and yet carefully peer-reviewed) research, based on the latest data.

Some of it falls under the category of “nice to know”. Imagine: your marriage isn’t working out and you’re seriously considering divorce. What should you do? Well, research from the British economist Andrew Oswald helpfully points out that most people tend to be happier a year or two after their divorce than immediately before it. (This is not true for bereavement, by the way.) So perhaps you should go ahead.

Some of it we can file under “can’t make it up”. The American Association of Wine Economists just published an informative research paper entitled, “Can people distinguish pâté from dog food?”. Sadly, they can: even if puréed to look like chicken-liver pâté and served chilled with a parsley garnish, dog food tastes terrible. A shame, but useful to know if you were thinking of cutting corners at your next dinner party.

And some of it? Well, some of it turns out to be important. One young man wrote to me to ask if he should switch high schools. He provided a long list of good reasons to switch but was still hesitating. I diagnosed “the endowment effect”, a tendency to stick with the devil you know that is well known to economists, and told him to switch. He did, he then got into Cambridge University, and recently wrote to me to thank him for changing his life. (Better yet: he’s studying economics. A bright future awaits him explaining to lonely singletons how to compose attractive internet dating ads, as I have done.)

Nowadays, I don’t mock the life-changing power of economics. I reckon it’s as good as any other source of personal advice, and funnier than most. I’ve even taken economic advice myself: the timing of my (successful) marriage proposal was calculated using an option valuation formula. My poor wife, you might think. But it’s a triumph for economics.

And there’s one more reason to applaud the use of economic theory in personal problem-solving: it’s less dangerous than using it to run banks.

Dear Economist,
I send the FT the Polymath crossword solution on a fairly regular basis, but I notice that a greater than expected number of winners hail from overseas. Would I have a better chance of winning were I to send the solution to my friends in Sweden for them to post in an envelope with a foreign stamp?
Tony Waldron, UK

Dear Mr Waldron,

You are not the only one to notice that Johnny Foreigner appears to win with alarming regularity. Still, we must be statistical.

You say that a “greater than expected number of winners hail from overseas”. But you do not say what you expect. The British make up about 1 per cent of the world population. Accordingly, there should be a British victor approximately 1 per cent of the time, or once every two years, on average. I believe the British victory rate is higher than this.

Another basis for forming our expectations is to look at subscribers. Many UK-resident FT subscribers fail to realise that they are outnumbered by overseas subscribers. If the British won Polymath half the time, this would be “more than expected”. The informal estimate of the Polymath team is that the proportion of foreign winners is roughly in line with the proportion of foreign subscribers.

After discussion with the Polymath administrator, I have concluded that her method for picking winners is reasonably random. However, she takes no extravagant precautions to ensure this is so. Perhaps foreign stamps do attract her magpie-gaze.

Even so, you must weigh the fractional additional chance of winning against the time and expense of routing your entry via Sweden. Surely the costs outweigh the benefits, unless you are motivated chiefly by the glory of having your name published in the Financial Times. If so, I believe I have solved your problem.

Also published at ft.com.

When the planes hit the twin towers eight years ago this week, I wasn’t a journalist at all, but a business economist living in London. It was my job to look at what was happening to the economy and figure out what it might imply and what might happen next. Alongside the shock experienced by anyone watching the television coverage, I felt bewilderment. It seemed that the sheer physical destruction and the deaths of so many highly skilled people would have to disrupt the running of the US economy – one of Osama bin Laden’s declared objectives. But with no close precedents, it was hard to say by how much.

Early estimates suggested that the economic cost alone might be grievous. The International Monetary Fund’s World Economic Outlook, published three months after the attacks, thought that losses to the US economy could total $75bn. Others thought the economic damage would be greater. Robert E. Looney, a professor at the Naval Postgraduate School, estimated in 2002 that direct costs exceeded $27bn but the effect of the disruption might total $500bn. A study by the New York City Comptroller’s Office estimated that the city alone would lose a cumulative $58bn between 2001 and 2004 as a result of the attacks.

Some attempts to untangle the question were ingenious. Alberto Abadie of Harvard and Sofia Dermisi of Roosevelt University looked not at New York but at Chicago to estimate one consequence of the attacks. Chicago, after all, suffered no damage and enjoyed no reconstruction boom. But as the home of the Sears Tower, the tallest building in the US, Chicago might have suffered a psychological blow as a possible target for a future attack. Sure enough, vacancy rates in and near the Sears Tower and two other famous Chicago skyscrapers rose sharply relative to rates elsewhere in the city.

With the luxury of hindsight, a new issue of Peace Economics, Peace Science and Public Policy attempts to work out the economic impact of the September 11 attacks, publishing a range of studies that approach the problem from two directions. One approach is to look at the entire economy and try to figure out what damage was done by the attacks – no easy task given the fact that the dotcom bubble had been deflating and the economy was entering recession at about the time the terrorists struck. The other approach is narrower, looking at – for example – the impact on New York City rents and wages.

Both approaches struggle to deal with the echoes of the attack. Air travel suffered, for instance, but teleconferencing, holidays at home and road transport might well have prospered. Then there is the problem of the policy response: President Bush quickly pledged $20bn to rebuild New York City. That reconstruction spending would act as a counterweight to the attack. No wonder the journal’s editors write of “unscrambling the eggs”.

Reading the full range of studies, I have concluded that the direct physical effects of such a horrific attack had been smaller than most people expected. Perhaps $25bn of buildings were destroyed; the lifetime wages of the victims would have been about $10bn, which is a crude way of calculating the narrow economic impact of a mass murder. But beyond that, there seem to have been few immediate economic consequences for New York City. The additional costs to the country as a whole were largely psychological: job losses because of a loss of confidence, for instance. There is a reason such acts are called terrorism.

The polity of the US was placed under severe strain by al-Qaeda’s attack. Its economy was more resilient than most observers expected.

Also published at ft.com.