Tim Harford The Undercover Economist

# Articles published in May, 2011

## What would Einstein make of bonds?

“Aha! A fascinating fellow. And an economist, too, in a strange way. Einstein once declared the most powerful force in the universe was compound interest.”

“Really, Dad? Ms Cartwright said that was the strong nuclear force.”

“Ms Cartwright can be awfully literal sometimes. The point is, compound interest is a tremendously powerful force for accumulating wealth. Imagine a savings account that pays 10 per cent interest per year. At the end of the first year, you’ve got £110 in that account. And then you start earning interest on the interest you’ve already accumulated: 10 per cent of £110 is £11. So at the end of the second year, you’ve got £121.”

“So you’ve earned £21 in two years? That doesn’t sound like the most powerful force in the universe to me.”

“You can also be awfully literal. I think you are spending too much time in the company of Ms Cartwright. Allow me to demonstrate.”

[Flips open computer and taps into a spreadsheet.]

“Now. This spreadsheet represents two possible financial futures for you. In this column, you begin investing £100 a year from the age of 10 until the age of 21. Then you stop investing. In this other column, you squander your pocket money and only begin investing at the age of 22, but you continue to pay £100 a year until you reach the age of 65. Now observe this remarkable thing: you earn more from investing for just those eleven years, early in life, than from more than 40 years of investing starting just a little bit later. In fact, you earn more than twice as much. Is that not a most impressive demonstration?”

“While you’re on the computer, Dad, could you check that Einstein quote on the internet? It doesn’t really sound like the kind of thing he would have said.”

“Do not allow yourself to be distracted. Let us now move on from the topic of Einstein and simply focus on the matter in hand: compound interest.”

“I understand. I suppose I should find myself a bank account paying 10 per cent interest, then. Which one would you suggest, Dad?”

[There is a pause. Father rummages around on his desk, with no apparent aim.]

“Dad, I think I heard someone say that there was a new inflation-linked certificate that paid the equivalent of 9.67 per cent interest for higher rate taxpayers. That’s almost 10 per cent.”

“Ah yes. That’s true.”

“So if I invest £100 a year in one of these certificates until I’m 21, will I then be able to stop investing completely?”

“Hm. Possibly not. These certificates actually only pay 0.5 per cent on top of the rate of inflation.”

“And is compound interest at 0.5 per cent the most powerful force in the universe?”

“Arguably not.”

“Then why say that it’s worth nearly 10 per cent to a higher-rate taxpayer?”

“Because that’s the rate of interest you’d need to earn to pick up the equivalent of the 0.5 per cent. If you earned 10 per cent, first you’d have to pay tax on that, which would bring it down to 6 per cent. Then you’d need to subtract the rate of inflation, which is more than 5 per cent.”

“It sounds to me that we should find a savings account that pays 10 per cent after tax and inflation, in order to take full advantage of the most powerful force in the universe.”

[Another pause. The aimless rummaging begins again.]

“Dad, we need a savings account paying more than 25 per cent interest. Is there one?”

“Not at the moment, dear.”

“Anything close?”

“No. Actually, the banks are grumbling that they can’t begin to compete with the 0.5 per cent interest, after tax and inflation, on offer from the government.”

“I’m not sure what your demonstration of compound interest is supposed to be teaching me, Dad. Is there any way to get a 10 per cent return?”

“You can take more risks. But the thing about this savings bond is it’s backed by the government and is therefore completely safe.”

“I see. Is that because governments always pay back their debts?”

“You are being literal-minded again.”

Also published at ft.com.

Is the iPhone made in China? The question is harder to answer than you might imagine. At first sight, the statistics seem open and shut. The Chinese make the iPhones, the Americans buy the iPhones, and the result is an increase in the US’s trade deficit with China: \$1.9bn in 2009, according to Yuqing Xing of the National Graduate Institute for Policy Studies in Tokyo, and Neal Detert of the Asian Development Bank.

Bilateral trade deficits are funny numbers at the best of times, though. Our bilateral trade deficit with China, for instance, is the total cost of all the things we buy from China, minus the total cost of all the things China buys from us. This is not necessarily an interesting figure.

To see why, imagine a world with three trading nations: Narnia, Mordor and Prydain. Narnia makes wine, Mordor makes iron and Prydain makes cloth. But the main demand for wine is in Mordor, where they are intemperate drinkers, while Prydain wants iron and the preening Narnians want cloth. Mordor will run a bilateral trade deficit with Narnia, Prydain will run one with Mordor, and yet every country might find its exports exactly balanced its imports overall.

Let’s leave Mordor’s trade deficit to one side, and return to the iPhone question. That \$1.9bn is a large number: about 1 per cent of the total US-China trade deficit. But the figure of \$1.9bn is highly misleading. Xing and Detert, after studying analysis from companies who take phones apart and report on their contents, calculate that the iPhone’s components cost about \$172.50. In contrast, the cost of assembling the components in China is around \$6.50. Apple declined to comment on these estimates, but they sound reasonable enough: when you’re talking about an iPhone, it’s hardly a surprise that the components are more expensive than the labour cost of screwing them all together.

But here’s the point: all these components are imported into China. Some come from the US, some from Germany, and many from Japan, specifically from Toshiba. The Chinese themselves add very little value to the package.

To see why this matters, assume that the Chinese currency appreciates by a hefty 25 per cent. For the \$172.50 of components bought from the likes of Japan, assembled and then exported to the US, the currency appreciation would all come out in the wash. The cost would remain \$172.50. It’s only the \$6.50 of local Chinese costs that would be affected – adding a whopping \$1.55 to the cost of the iPhone and barely shifting the US-China trade statistics.

Olaf Storbeck, economics editor of Handelsblatt in Germany, points out that policymakers’ obsession with the US-China exchange rate may be misplaced.

A similar story seems to hold for jobs. Greg Linden, Jason Dedrick and Kenneth Kramer of the University of California, Irvine, look at the jobs created by the old faithful iPod. Their study reckons that the iPod accounted for almost 41,000 jobs worldwide in 2006, and only 30 of those were in manufacturing in the US. But the iPod supported more than 6,000 engineering or other professional jobs in the US – as well as almost 8,000 lower-paid jobs in the likes of retail and distribution. Linden and his colleagues reckon that US workers earned more than two-thirds of all the wages paid to workers in the iPod value chain.

It may well be that many US workers have been hurt by the forces of globalisation. But the iPhone and iPod show why the whole business is complex. Products that are made in China may actually be rewarding producers in Japan and California, and, of course, consumers across the world. It’s a curious paradox: the more pervasive globalisation becomes, the less we understand it by looking at trade statistics.

Also published at ft.com.

## Top 10 Economists on Twitter

Twitter’s top 10 economists (17 May 2011) (previously)
@CMEGroup Chicago Mercantile Exchange 783,327 followers
@NYTimesKrugman Paul Krugman, Nobel Laureate & columnist 594,331 followers
@andrewrsorkin Andrew Ross Sorkin, NYT Dealbook 372,242 followers
@freakonomics The Freakonomics blog 331,018 followers
@WSJ_Econ Real Time economics from the Wall Street Journal 214,778 followers
@planetmoney NPR’s Planet Money 191,244 followers
@umairh Umair Haque, HBR 146,450
@Richard_Florida Richard Florida, Urbanist 122,963
@PKedrosky Paul Kedrosky, Financial commentator 120,287 followers
@nouriel Nouriel Roubini, Economic forecaster 49,501 followers

Or follow the full Top 10 at this list.

Honourable mentions:
@dambisamoyo Dambisa Moyo, Aid Sceptic 43,063 followers
@evanHD Evan Davis, formerly BBC economics editor 30,500 followers
@DavidMcW David McWilliams, Irish popular economist 32,442 followers
@jeffdsachs Jeffrey Sachs, Columbia University 25,283 followers
@FelixSalmon Felix Salmon Finance blogger, Reuters 25,190 followers
@TimHarford Tim Harford, Undercover Economist at the Financial Times, 19,323 followers (that’s me)
@Paulmasonnews Paul Mason, economics editor of BBC Newsnight 14,029 followers
@Bill_Easterly Bill Easterly, New York University 13,947 followers
@danariely Dan Ariely, Behavioural psychologist 12,393 followers
@tylercowen Tyler Cowen, curator of Marginal Revolution 9,551 followers
@DavidMWessel David Wessel Wall Street Journal’s Economics Editor 9,867 followers
@crampell Catherine Rampell, Economix Blog editor 6,755 followers
@EconEconomics Economics news from The Economist 7,725 followers
@ritholtz Barry Ritholtz, blogger 7353 followers
@DLeonhardt David Leonhardt, New York Times columnist 5,246 followers
@EconTalker Russ Roberts, econ professor and host of EconTalk 3,761 followers
@cblatts Chris Blattman, Political scientist 3,934 followers
@B_Eichengreen Barry Eichengreen, economics professor 3,423 followers
@plegrain Philippe Legrain, author 2,323 followers
@diane1859 Diane Coyle, The Enlightened Economist 2,025 followers
@AndrewSimms_NEF Andrew Simms, New Economics Foundation 1,613 followers
@dsmitheconomics David Smith, Economics editor, Sunday Times 1,444 followers
@joshgans Joshua Gans, Professor of Economics and author of Parentonomics 987 followers
@dismalscientist Tweets from Moody’s Analytics, 943 followers
@tutor2u_econ Resources for economics teachers 849 followers
@leighblue Leigh Caldwell, behavioural economist 735 followers
@OlafStorbeck Olaf Storbeck, Economics editor, Handelsblatt 560 followers

Feel free to email [undercovereconomist AT gmail] or tweet [ @timharford ] with further suggestions. I’ll update this post from time to time. Comments are open.

===

Update: Can’t incorporate them all immediately but I have received these recommendations:
@deankarlan @rodrikdani @Shanta_WB @m_clem @BBCStephanie @ayittey @gdemom @delong @l_haddad @charlesjkenny @dannyquah @andypsumner @moss_d @vijramachandran @altmandaniel @went1955 @markthoma @mattbish @jodiecongirl @jappleby123

## How to rid yourself of excess baggage – and friends

Dear Economist,
Me and my friends are a pickle. Twelve of us have agreed to go on holiday in July. Everything is sorted apart from one thing. We originally planned to take hand luggage to save money – we’re all 18 and flying budget. That seems fine – as the apartments we are going to (one of which my parents own) have almost everything we could need bar clothes.
But now certain members of the group say that 10kg of luggage simply isn’t enough, and want to pay an additional £26 for their bags. This would be fine, except that means an early check in and starting at 3.30am instead of 5.30am – unfair to the parents who have volunteered transport.
I’ve been trying to think of a fair way to impose an additional cost on these people to either discourage them or compensate everyone else. Any suggestions on how I could increase the private costs so they reflect social costs? Obviously these people are my friends, so I don’t want to be too harsh on them.
Yours,
F.M.
Dear F.M.
I am surprised your parents haven’t resolved this conundrum for you already – they seem to have laid out everything else on a plate.
No matter. I have a big bag of political philosophy right here to sort you out. Your problem is your Marxist insistence on collective burden sharing. Take a free market approach instead: if your friends Imelda Marcos and co. want to get up two hours earlier, let them. If they can persuade their parents, fine. Otherwise they can pay for the cab. The rest of you should travel seperately, enjoy the comparative lie-in, and avail yourselves of the free transport.
Oh, and if one of them suggests buying your holiday drinks in rounds – tell them to go first, and ask for champagne.

## A font of wisdom on economies of scale

A confession: I have become something of a fontophile over the past couple of months. And I don’t think it’s just me. This year’s April Fool’s Day witnessed some splendid typographical jokes. Typing “Helvetica” into Google provoked an alarming change: every letter in the search was suddenly transformed, not into the spare and elegant Swiss typeface, but into Comic Sans. (Comic Sans is a determinedly informal font loathed by almost everyone with a knowledge of typography, and unwittingly adopted by most of the rest of the human race.)

Helvetica itself was the subject of an eponymous and entertaining documentary in 2007. The message of Helvetica echoes contemporary concerns about globalisation. A single typeface, designed in 1957 in Münchenstein near Basel in Switzerland, graces the American Airlines logo, Coca-Cola adverts, the New York subway, labels in American Apparel stores, Crate and Barrel, Kawasaki, Gap, Panasonic, BMW, Jeep and even Oral B. One designer, infuriated by its ubiquity, declares in the documentary that Helvetica is the font of the Vietnam war. She’s only half joking.

Modern life tends towards standardisation. The likes of McDonald’s and Starbucks try to replicate the consumer experience, the branding, the size of the drinks cups. In such cases, economists often look for signs of “economies of scale”, a term used to describe a business operation whose average costs decline as the size of the business expands. Annoyingly, economies of scale are analytically inconvenient – if you want to build a textbook model of an industry with scale economies, the mathematics are messy – and yet Adam Smith’s famous example of the pin factory simply illustrated how fundamental economies of scale are to economic progress.

Fonts and typefaces enjoy economies of scale: once designed, they can be used again and again at low cost. Indeed this is more true than in the days when a font was hundreds of pounds of carefully sculpted metal. (Simon Garfield’s likeable book, Just My Type, includes the tale of Doves, the font that drowned. Thomas Cobden-Sanderson, the designer of Doves, did not wish his glorious font to be used by a rival after his death. Over the course of three years the septuagenarian Cobden-Sanderson destroyed the casts for the type, and then every metal letter, by consigning parcels of them into the Thames. Helvetica is immune from this fate. So, alas, is Comic Sans.)

Economies of scale underpin real-world monopolies. Could Helvetica achieve this status? Hardly. Just like most dominant companies, Helvetica is vulnerable to competition. Arial, an upstart font with the same proportions as Helvetica, was packaged with Microsoft Windows from 1992 and guaranteed instant prominence. The world’s most popular font these days is probably Calibri; it was pushed centre stage by Microsoft as recently as 2007, the year Helvetica was produced.

Contrary to popular belief, Helvetica never even wiped its rivals off the face of the New York subway. An obsessive coffee-table book by Paul Shaw documents that the Helvetica-style font that defined subway signage is in fact Standard Medium. Helvetica didn’t become the official typeface on subway signs until 1989. Standard Medium persists in corners of the subway and most people don’t notice the difference.

Economies of scale in fonts, as often in the corporate world, do not seem to stand in the way of diversity for long. There have never been so many alternatives to Helvetica, and new fonts are created at an unprecedented rate. There is always demand for the next forward-looking font. Barack Obama used a 21st century font, Gotham, for his 2008 election campaign. Evidently some people think it helped his fortunes: Gotham has now been adopted by Sarah Palin.

Also published at ft.com.

## Only Mervyn King and the tooth fairy…

‘The UK suffered the highest rate of inflation in two-and-a-half years in April’ Financial Times, May 18

“Yes, my love?”

“What’s ‘inflation’?”

“An excellent question. You will no doubt remember that when the tooth fairy came for your first tooth, she left you 50 pence. But, more recently, the going rate has been a pound. That’s inflation.”

“So, inflation is when my income goes up?”

“No, that is not the point at all. You must see it from the perspective of the tooth fairy. Inflation is when the price of goods and services rises. Your teeth are in no way increasing in value and yet their price has risen. That is inflation and it’s easy to see why so many people get jolly worried about it.”

“Well, I can see how the tooth fairy might be upset about it but if I’m selling a valuable tooth for twice the price, I’ve come out ahead. There are winners and losers. Why would society as a whole be worried about inflation?”

“You are a perceptive child. True, the doubling in price of your tooth alone cannot be regarded as inflation because, as you imply, it’s a doubling in the value of teeth relative, say, to chocolate brownies. If you are selling teeth and buying chocolate brownies – as in your case – then it is no bad thing.

“I should have said that inflation is a generalised rise in the price level, when the price of everything is rising. People may have more pounds and pennies in their bank accounts because they are being paid more for their skills but their ability to actually purchase goods and services has not increased.”

“So, when all goods and services simultaneously increase in price by the same amount over the same time period, that’s inflation?”

“Exactly so.”

“Does that ever happen?”

“No, not really. Actually what is happening is that the prices of some goods are going up, others are flat and some are falling. So the rate of inflation is the average of what is happening to all those goods.”

“That’s very interesting, Dad. Thank you.”

_______________

“Dad? I’ve been thinking. Mum buys groceries from Ocado and fancy computers with apples on them. You buy funny-looking beers from Belgium and sometimes you buy chocolates for Mum and eat them when she’s not looking. And the tooth fairy buys teeth. Don’t we all have a different rate of inflation?”

“Not according to the government. The Office for National Statistics calculates various measures of inflation and they are used to make adjustments. For instance, RPI, the retail price index, is often a bit higher than CPI, the consumer price index. But you are probably right. There are certain newspapers that enjoy finding a group of people who probably have a higher inflation rate than the nation as a whole. But what is to be done about that? I can hardly expect the Office for National Statistics to calculate my own personal inflation rate, based on what I decide to buy.”

_______________

“Dad, I’ve been thinking. You say that your personal inflation rate depends on what you decide to buy. But what does what you decide to buy depend on?”

“As an economist, my darling, I obviously pay close attention to price changes.”

“But if what you decide to buy depends on the way prices change and calculating your personal inflation rate depends on what you decide to buy, I’m confused. Aren’t we going round in circles?”

[Father rummages in fridge for expensive Belgian beer]

“You have a point, dear. If these beers get any more expensive I shall switch to Australian lager. I will have experienced inflation but precisely because of that inflation, the expensive product will no longer be something I purchase.”

“Doesn’t that make it hard to calculate inflation?”

“My dear, it makes it impossible. We can only ever have an approximation to anyone’s true inflation rate – if the concept itself makes any sense – so we have to make do with that.”

“Dad, I’m worried. Will the tooth fairy stop buying teeth if they get too expensive?”

“No, my love. The tooth fairy can create money by magic.”

“Didn’t you tell me once that only Mervyn King could do that?”

“I forgot that I said that. Yes, I overlooked the tooth fairy. But Mervyn King and the tooth fairy – they’re the only ones.”

Also published at ft.com.

## Lessons in adapting from the War in Iraq

I wrote this essay for the Freakonomics blog.

In the spring of 1980, President Jimmy Carter gave the go-ahead for a daring special-operations mission calledEagle Claw. Fifty-two American hostages had been trapped for months in Tehran under a newly hostile revolutionary government, and negotiations appeared to have broken down. The operation called for helicopters and refueling aircraft to fly into the Iranian desert at night, under the radar screen, rendezvous in the middle of nowhere, refuel, and hide during the daylight hours. The helicopters were then to fly into the heart of Tehran. Special forces were to kill or subdue resistance, liberate the hostages, and then – via another desert refueling rendezvous – escape to the USS Nimitz, an aircraft carrier off the Iranian coast. The operation suffered bad weather, bad luck – a busload of Iranian travelers blundered into the rendezvous point against all odds – and arguably bad decision-making. The mission was aborted half way through, a helicopter and a refueling aircraft crashed into each other at the rendezvous, and eight soldiers died.

The counterinsurgency specialist Andrew Exum drew my attention to the Eagle Claw failure after special forces killed Osama bin Laden: the circumstances were superficially similar but the results were very different.

“I’m thinking Tim should add our special operations forces as a case study in time for the paperback,” Exum wrote, nodding toward my book. “You cannot understand why the U.S. military was able to execute this extraordinary operation deep in the heart of Pakistan without first understanding the failures of Iran in 1980.” Learn More

17th of May, 2011Other WritingComments off

## The aeroplane that saved the world: an extract from Adapt

In 1931, the British Air Ministry sent out a demanding new specification for a fighter aircraft. It was a remarkable document for two reasons. The first was that throughout its existence the Royal Air Force had been dismissive of fighters. The conventional wisdom was that bombers could not be stopped. Instead, foreshadowing the nuclear doctrine of mutually assured destruction, the correct use of air power was widely presumed to be to build the largest possible fleet of bombers and strike any enemy with overwhelming force. The second reason was that the specification’s demands seemed almost impossible to meet. Rather than rely on known technology, the bureaucrats wanted aviation engineers to abandon their orthodoxies and produce something completely new.The immediate response was disappointing: three designs were selected for prototyping, and none of them proved to be much use. The Air Ministry briefly went so far as to consider ordering aircraft from Poland.Even more remarkable than the initial specification was the response of the ministry to this awkward failure. One of the competing firms, Supermarine, had delivered its prototype late and well below specification. But when Supermarine approached the ministry with a radical new design, an enterprising civil servant by the name of Air Commodore Henry Cave-Browne-Cave decided to bypass the regular commissioning process and order the new plane as “a most interesting experiment.” The plane was the Supermarine Spitfire.

Continued at Slate – or find out more about the book.

## The Art of Economic Complexity – New York Times Magazine

New York Times Magazine – 15 May 2011 – Graphic by CÉSAR A. HIDALGO and ALEX SIMOES

These diagrams are the early fruits of a new approach to the most important unsolved problem of the last century: how to make a rich country out of a poor one. Development economists have many theories about how the trick is done but few proven answers. A compelling solution would be useful closer to home, too: understanding the process of economic development would help us work out whether it matters that service jobs are replacing manufacturing ones or whether there is anything the government can and should do to stimulate new industries like biotechnology or green energy.
Strip away the mathematical language of economists, and conventional theories of economic growth are rather crude. Economies produce “stuff,” and if you want more stuff to come out of the process, put more stuff in (like human capital, say). Yet economies do not produce stuff so much as billions of distinct types of goods — perhaps 10 billion, according to Eric Beinhocker of the McKinsey Global Institute — ranging from size 34 dark stonewash bootcut jeans to beauty therapies involving avocado. The difference between China’s economy and that of the United States is not simply that China’s is smaller; it has a different structure entirely…

Continued on NYTimes.com

15th of May, 2011HighlightsOther WritingComments off

## How China boomed by trial and error

What is the secret of China’s success? While the US, Europe and Japan have been struggling, China’s economy has doubled in size in real terms every seven to eight years for the past three decades.

Part of the answer is simply that if a poor country gets its act together, it has the potential to grow much faster than a rich one. China was wretchedly poor in 1980 – poorer than Afghanistan or Chad, with half the per capita income of Niger or Ghana. It is far from wealthy today, with per capita income of about \$10 a day. (No westerner would envy the income of a rural Chinese peasant.) And so the potential to catch up remains large, with China’s economic clout a matter of population rather than wealth.

And yet it is impossible to dismiss China’s economic achievement so easily. So what is the recipe for growth? If I was forced to sum it up in one phrase, I’d say “trial and error”.

After Deng Xiaoping took power in the late 1970s, local experiments were tolerated, and if they worked, they were allowed to spread. The “household responsibility system”, which gave rural farmers the right to profit if they were able to generate extra crops, was used in 1 per cent of collectives in 1979 and was almost universal by 1983, largely as a result of benign neglect from Beijing.

Nor did Deng’s industrial reforms demolish the planned economy. If corporate managers could produce more than the central plan required, and if they could find a market for the surplus, they were allowed to do so. The brilliance of this idea was that it provided all the traditional free-market incentives for efficient producers to grow and find new markets – and yet the parallel market did not undermine the central plan. This itself was “frozen” in 1985, and slowly became irrelevant as the economy around it grew.

Another experiment was the establishment of special economic zones. These areas were designed to encourage foreign investment and industrial development, without requiring the entire economy to be thrown open to market forces.

The contrast with China’s earlier Maoist system could scarcely be greater. During the “Great Leap Forward” Mao personally redesigned China’s system of agriculture. Everyone had to implement Mao’s insane schemes at once, and any suggestion that his ideas were failing was ruthlessly suppressed. Tens of millions of people starved.

The Soviet Union boasted a number of failures that were less dramatic but similar in spirit. Stalin and Khrushchev demanded vast projects, and if others offered suggestions for improvement, they did so at risk of their lives. Disastrous policies could therefore last for many years.

China is far from being a free-market economy, but the Chinese system has long shared an important characteristic with more market-oriented counterparts: it has encouraged a pragmatic and diverse set of economic experiments. That is what markets themselves do when they are working well.

In his book, The Truth About Markets, John Kay says that markets offer “disciplined pluralism”. This disciplined pluralism is an important component of almost any system that solves complex problems. The term could describe biological evolution – “survival of the fittest” – and should be worn as a badge of pride by our scientific institutions. It also sums up China’s experimental approach to economic reform. (By contrast, Wall Street’s plunge into structured mortgage-backed products between 2004 and 2007 lacked both discipline and pluralism.)

Deng Xiaoping described economic reform as “crossing the river by feeling for stones”. The waters of economic change are swift-running, and perhaps China will lose its footing. But I suspect that if China does slip, it will do so because it runs into a problem that it cannot solve step by careful step.

Also published at ft.com.