Tim Harford The Undercover Economist

Articles published in September, 2011

Patenting the Ponzi: the extraordinary growth of Ponzi schemes

“Two world poker champions and other leaders of one of the largest internet card gaming sites turned the company into a massive Ponzi scheme, wrongly taking out more than $440m from player accounts, US officials alleged on Tuesday.”

Office of Charles Ponzi & Sons:

“Mr Ponzi, have you seen what the US Justice Department is saying about this poker website?”

(Sighs) “Don’t tell me, Massimo: they say it’s a Ponzi scheme?”

“You’ve got it in one, Mr Ponzi.”

“This is outrageous! Call my lawyer! Who do these bastards think they are? I am Charles Ponzi! The Ponzi scheme is my creation!”

“I don’t think Full Tilt Poker are planning to infringe on the trademark.”

“I’m not worried about Full Tilt Poker. I’m upset about these sanctimonious asses who keep saying Ponzi, Ponzi, Ponzi and they know nothing! If a company goes bankrupt but the managers get paid, it’s a Ponzi scheme. Internet bubble companies are a Ponzi scheme. If it’s a government policy they don’t like, it’s a Ponzi scheme. Where does it stop? Some kid steals baseball cards from a candy store and it’s a Ponzi scheme? They think I’m a shoplifter or something? What do they say the poker website did anyway?”

“Well, the US Justice Department says that some of the company directors paid themselves handsomely while they were struggling to take in money from new players.”

“Why were they struggling to take in money?”

“Because the US government was trying to make online poker and all related transactions illegal.”

“Oh well. It doesn’t matter to me if they did it or not. What these clowns at the US Justice Department are describing is not a proper Ponzi scheme at all. A proper, classic, elegant Ponzi scheme is an investment offer that pays investors high returns. You know this.”

“I know this, Mr Ponzi.”

“You know this. The high returns attract new investors – and often the old investors keep their money in too. As long as the money coming in from new investors is enough to cover the occasional investor who cashes out – and of course the dividends taken out by the scheme’s creator – then all is well. It is a thing of beauty.”

“It certainly is, Mr Ponzi.”

“If these guys looted the cash register while their company was going bankrupt, that’s not worthy of the great name of Ponzi. I’ll sue the prosecutors for tarnishing my brand name.”

“And Mr Perry.”

“Who?”

“Governor Rick Perry. He’s running for president.”

“What about him?”

“He said that social security was a Ponzi scheme.”

“He said what? Who the hell does he think he is?”

“I think he thinks he’s the next president of the United States.”

“Well screw him! I’m Charles Ponzi! Social security isn’t a Ponzi scheme! It’s just a welfare payment that’s going to be more expensive because of demographic change.”

“I understand, boss. But – well, isn’t it a little bit of a Ponzi scheme? I mean, it depends on each generation being larger than the previous one.”

“Crap! It does not depend on that at all. Sure, it’s cheaper if there are lots of young people around. But social security is perfectly affordable with a bit more tax or a slightly lower pay-out. It’s nothing like a Ponzi scheme. With some adaptations it could run forever. But a good, audacious Ponzi scheme can become unsustainable in months.”

“Shall we sue Mr Madoff too, then, sir?”

“No, no. Bernie is fine, Bernie carried off a proper Ponzi scheme. He sure kept it going for a long time. I cannot complain. I wish we had trademarked the Ponzi name, but I cannot blame Bernie for that.”

“That’s very big of you, Mr Ponzi.”

“I suppose I should not be too upset. The more people carelessly talk about Ponzi schemes, the more confused everybody becomes. It will become easier and easier to operate a real Ponzi scheme. So everything is not so bad.”

“You look tired, sir. Let’s get some pizza and relax.”

“A good idea, Massimo! I have some vouchers from this internet thing, Groupon. It seems the local pizzeria is offering some great deals.”

“Ah. Mr Ponzi?”

“Yes?”

“Have you heard what some people are saying about Groupon?”

“My lawyer, Massimo! My lawyer at once!”

Also published at ft.com.

New ways with old numbers

Academics are always being asked to demonstrate the “impact” of their research. (Is it like being hit by a rogue cyclist? Or is it more like a pile-driver, or even an asteroid strike?) But while it is not unreasonable to ask whether a particular piece of academic research is useful, the difficulties in answering the question are extraordinary.

The quality of a piece of research is subjective, and using measures such as the number of peer-reviewed articles published simply outsources the subjective judgment to somebody else. But there is a deeper problem: in a complex world, it is impossible for anyone to judge what the significance of a research breakthrough might eventually be.

Nowhere is this more true than in the field of mathematics. The most famous example is the development of imaginary numbers. The very name conveys the supposed uselessness of the concept. Square the imaginary unit, i, and you get minus one. Baffling.

Imaginary numbers were regarded with great scepticism after they were developed in Bologna in the 16th century as the logical solution to an abstract problem. Eventually, however, they turned out to be essential for, among other applications, electrical engineering – hardly something that could have been imagined by their creators.

So are imaginary numbers typical of the unexpected bounties of pure mathematics – or an unrepresentative poster child? Two recent commentators have tried to expand the number of examples. Professor Caroline Series of the University of Warwick devoted a recent presidential lecture at the British Science Festival to this topic, focusing on the applications of non-Euclidian geometry.

When Euclid originally laid down the axioms of his geometric system 23 centuries ago, one of them seemed less than obvious. For 2,000 years mathematicians tried to derive the “fifth postulate” – equivalent to the claim that the internal angles of a triangle add up to 180 degrees – from more basic building blocks, and failed. Eventually it transpired that the axiom was optional. Consistent systems of geometry were possible in which the internal angles of triangles summed to more than 180 degrees, or even to fewer.

Surfaces on which the sum of angles in a triangle is less than 180 degrees look like leaves of kale. Prof Series points out that the development of kale-like geometric systems, called hyperbolic geometry, initially seemed a curiosity but made possible Einstein’s theory of special relativity. Now, says Prof Series, hyperbolic geometry promises to advance our understanding of the way complex networks such as the internet behave and grow.

Peter Rowlett, a maths educator and historian, recently gathered further examples together in the journal Nature. The “sphere packing problem” – beginning with the conjecture that grocers have found the most efficient way to stack oranges – has been an open area of research for four centuries, but in the 1970s a solution for eight-dimensional “spheres” was used to design efficient modems. This meant that internet access no longer required specialised cables.

Quaternions, which extend imaginary numbers into a further dimension, began to be developed by William Hamilton in Dublin in 1843. They were eclipsed by matrix algebra, before being rediscovered as indispensable for generating 3D computer graphics efficiently. Rowlett’s contributors offered several other examples.

Cost-benefit analysis has its place. But the benefits of academic research can pop up in such unexpected ways, sometimes immediately and sometimes after centuries. We should not set too much store by any bureaucrat’s analysis of “academic impact”.

Also published at ft.com.

Don’t fear the migrant

Should we seek to keep the citizens of poor nations trapped in their countries of birth for the good of their fellow citizens?

I have been mourning the loss of a dear family friend: a doctor, trained in West Bengal, who then emigrated to Birmingham and worked all her life in Britain. She died, surrounded by her family, back in Kolkata. The choices she made would probably have been impossible today: the National Health Service now has a code of practice banning recruitment from around 150 developing countries – almost all of them. It also bans recruitment from West Bengal.

It is sad that in all the fuss about immigration, few commentators take the viewpoint of the emigrant, although every immigrant is also an emigrant. (Even in the scholarly economics literature the word “immigration” is four times as frequent as the word “emigration”.) The reason is obvious enough: we view migration by considering what we have to gain, rather than what the migrants might gain.

What the migrants might gain is, of course, a great deal. Migrants receive far higher wages than they would back home. It is possible that migrants are particularly energetic people who would have earned well anywhere – but this effect is probably not the main explanation for the gap between wages at home and abroad. Economists who have studied situations where the right to migrate is assigned by lottery have found little difference between the wages of those who lose the lottery and those who do not apply.

A recent survey by the economist Michael Clemens, of the Center for Global Development, points out that although the question is largely ignored, any reasonable estimate of the economic gains from freer migration would dwarf that of the gains from, say, freer trade – if we include the welfare of the migrants themselves. Clemens points out that allowing some migration from disaster-hit countries such as Haiti or Somalia would be a far more effective way to alleviate poverty than many conventional aid programs.

Clemens has, alas, attracted the attention of white supremacists, but even people with impeccable bleeding-heart-liberal credentials worry about emigration because of the “brain drain” – the harm assumed to be done to poor countries as their doctors, engineers and entrepreneurs abandon them for cushy careers in the west. It is for this reason that the NHS has its recruitment ban.

I am not convinced. Should we seek to keep the citizens of poor nations trapped in their countries of birth for the good of their fellow citizens? Nobody would, for a moment, consider banning ambitious Mancunians or Glaswegians from working in London, purely on the principle that they might do more good in their back home. Outrageous infringements of liberty seem to be acceptable only when applied to foreigners. (Another analogy, inspired by Clemens: would we happily discuss working mothers under the heading of “the love drain”? I hope not.)

The real effects of the brain drain have also been poorly thought through by most of us. The economist Oded Stark points out that if western countries assiduously recruit doctors and engineers from poor countries on comparatively vast salaries, that is a strong incentive to train as a doctor or engineer. The result may be more doctors and engineers in poor countries, even after the migrants have left. And there is some evidence that this is indeed the case. (Robert Guest, the author of a forthcoming book on international migration, points out more nurses leave the Philippines each year than any other country, and yet the Philippines retain more nurses per head than Austria.)

The striking conclusion of Michael Clemens’s research paper is that we know far too little about the effects of emigration. In particular, we have little idea how much emigration is socially, politically and economically possible. But I strongly suspect our fear of the immigrant is hugely overblown. My friend did not just put a few extra pounds in her pocket by moving to the UK: she enriched the lives of her many British friends. We shall miss her.

Also published at ft.com.

Rogue accidents, and banging more shins

Another rogue trader?

Apparently so. The Swiss bank UBS says it has lost $2bn down the back of a sofa somewhere – or more specifically, that it suspects one of its traders did so in unauthorised trading.

An unauthorised loss of $2bn. Are there any authorised losses of $2bn?

Where have you been for the last four years? UBS “authorised” losses of €50bn during the subprime crisis.

In that case, what’s $2bn between friends?

It’s all about banging shins.

Banging shins?

Bear with me. A while ago I interviewed the psychologist James Reason, who specialises in human error and how human error contributes to accidents – oil rigs that explode, trains that crash, ferries that capsize, that sort of thing.

He used to give talks to banks about preventing accidents but, he told me, “they thought it was all about banging shins”. Then, he said, they realised what a risk really was when Nick Leeson came along.

The original rogue trader?

If you like. Mr Leeson wasn’t the first rogue trader – that was arguably William Pullinger, who in the late 1850s pilfered £263,000 in his role as chief cashier of Union Bank and played with the money on the London Stock Exchange. He wasn’t even the one who lost the most money. What sticks in the mind is that Mr Leeson managed to destroy, single-handedly, a 233-year-old bank. Admittedly, in the light of the past few years that no longer seems quite such an achievement, but it probably took some doing.

But Nick Leeson didn’t lose money “by accident”.

That depends on what you mean by an accident. Prof Reason has been using Mr Leeson as a case study in preventing “organisational accidents”. Once you start looking at these issues from an industrial safety perspective, you realise that whether a particular disaster was caused by honest error or deliberate malfeasance is not necessarily the most interesting question.

It’s the question that determines whether someone goes to prison.

Well, yes it is. Mr Leeson was sentenced to more than six years. But some illegal acts have minor consequences and some legal acts have tragic results. Some “accidents” involve serious wrongdoing – carelessness, sloppiness, poor procedures – but that does not make them less of an accident.

This sounds like tortured logic to me.

It shouldn’t. The point is that a system www.buyingphenterminenow.com with a poor safety culture, slapdash attitude to checks and balances, and pressure to get results quickly will be vulnerable to things going wrong. The eventual trigger may be fraudulent or innocent, but preventing disaster means changing the system. Consider the sinking of the Herald of Free Enterprise, a catastrophe that killed almost 200 people. The ferry’s owners had already lost a ferry in a collision five years earlier; the ferry lacked indicator lights to tell the captain that the bow doors were closed; the ferry was overloaded and its bow was pointing downwards; the man in charge of closing the doors was asleep; crew were under pressure to depart in a hurry. It’s facile to blame the tragedy on any single action. The system itself was unsafe.

So this is why it matters if a UBS trader lost $2bn?

Yes – it suggests an accident-prone system. Now, perhaps UBS has superb risk controls and through great ill-fortune fell victim to a terribly determined and sophisticated fraudster. But you could forgive investors if they ask questions.

Still, a $2bn loss for UBS is a $2bn gain for somebody else. It’s a zero-sum game. Who cares?

By that reasoning, if I steal your car, who cares? You lose a car, I gain a car. But most of us would not wish to live in a world which was indifferent to such events. It’s not just the morality of the thing, but also the prospect of such activities forces you to take costly actions – buying a car alarm, investing in off-street parking – and makes you anxious. Similarly, there are costs in a world where banks cannot keep a leash on their traders. In the financial system, even apparently zero-sum bets can have severe negative consequences if they drag a bank into or close to bankruptcy: when Lehman Brothers collapsed, it wasn’t just a problem for its investors.

Is UBS going to collapse?

Certainly not because of a single $2bn loss. The bank has a capital cushion of about $50bn; investors have therefore lost about 4 per cent of their stake as a result of the trades – that’s a bad day, but most bank shareholders have had worse.

Also published at ft.com.

Laffer curves and the logic of the 50p rate

“What do you make of the idea of a 50p tax rate on top earners, then?”

“What do you mean, ‘the idea’? It’s here. It’s happening. Look around you! It’s the reality we have to deal with, not the idea.”

“Come on, Charlie. It’s not as if you have to deal with the “reality” of the 50p rate, is it? Not on your salary.”

“It’s not about salary, mate. It’s about entrepreneurialism. The 50p tax rate discourages entrepreneurial spirits.”

“Not if your entrepreneurial spirit doesn’t pull in 150 grand a year, it doesn’t. And there’s no chance of that.”

“Not any more, there isn’t. But that’s because my entrepreneurial spirit has been deflated by the 50p rate. I was planning to become a millionaire this year, but I decided it wasn’t worth my while. It’s exactly this kind of thing that those 20 economists were worried about when they wrote to the FT this week. The 50p rate should be scrapped. It’s damaging the country.”

“I suppose that’s possible. I don’t doubt your story for a second, but I wonder how many people are in the same boat. And the government needs money – if not from the richest, then from somebody less able to pay.”

“Does the 50p rate make money?”

“I’ve looked it up. The Treasury reckons the 50p rate will earn £2.7bn a year in revenue, which is something like £40-£50 a person per year.”

“That doesn’t sound a lot.”

“Fifty pounds is better than a poke in the eye. If the Treasury doesn’t raise it from the rich it will have to raise it from somebody else. But the estimate is very uncertain because of what the Treasury calls a ‘behavioural response’.”

“What’s that?”

“Could be pure fraud: tax evasion. Or people like you, deciding to remain lowly wage slaves because of the disincentive effect of the 50p rate. Or people using legitimate accounting dodges, delaying collection of dividends, relocating to Dubai, that kind of thing.”

“How big is the behavioural response?”

“We don’t know yet, some of it we’ll probably never know. But I saw some numbers suggesting that the behavioural response would wipe out two-thirds of revenue. The 50p rate would have raised £7.8bn if not for the behavioural response.”

“But people keep saying that the Institute for Fiscal Studies reckons the 50p rate could actually lose money.”

“The IFS said it might lose money, not that it would.”

“But what about the Laughter curve?”

“The Laffer curve?”

“Same thing.”

“Interesting you should ask. The idea behind the Laffer curve is that if the tax rate is zero then revenue is zero and if the tax rate is 100 per cent then revenue is also zero, and if the tax rate is somewhere in the middle then revenue is positive.”

“Doesn’t sound that profound.”

“It’s not that profound. Logically, there are tax rates so high that cutting them actually raises revenue.”

“Such as the 50p rate.”

“Well, maybe. In some circles the Laffer curve is now simply a claim that whatever the tax rate is, if you cut it then you’ll raise revenue. Which is daft.”

“Well, maybe – but 50 per cent is a pretty high tax rate in my book. And there’s national insurance and VAT on top. The real tax rate on the top earners is probably over 60 per cent.”

“Yes – which as far as anyone can tell is pretty close to the top of the Laffer curve. In other words, it’s close to being the optimum for raising revenue. Not that we really know for sure.”

“Optimum? What are you talking about?”

“Calm down – I just mean that the 50p rate, that is about a 60 per cent marginal tax rate on the top earners, is probably close to the rate that raises the maximum amount for the Treasury. It doesn’t mean it’s a good rate. It means that after you account for all the fraud, the discouraged entrepreneurs, the tax exiles and the money paid to accountants, the Treasury is still keeping a pound or so out of every three pounds it tried to collect with the 50p rate.”

“That doesn’t seem ideal.”

“It doesn’t. Now there are some people who don’t care if the Treasury raises nothing at all, as long as the rich are inconvenienced. And others will look at that and say it’s a lot of fuss for not a lot of revenue and so it’s probably not worth the risk of discouraging entrepreneurs. That’s true even though that risk is probably not very big, yourself excepted of course.”

“Are there really people who think that?”

“Right now? No, nobody. At the moment most of us are happy if the rich get it in the trousers. I’d wait a couple of years to become a millionaire, if I were you.”

Also published at ft.com.

Look out for No. 1

In the late 1990s, eurozone wannabes squeezed and stretched to meet the criteria for accession, including low inflation and government deficits, and moderate levels of debt. The criteria were somewhat irksome, especially for an economy such as Greece, but nevertheless the Greeks seemed to comply.

Eventually, it became clear that the Greek numbers did not quite add up. Eurostat, the European statistics agency, has complained about “widespread misreporting of deficit and debt data” from the Greek authorities. In 2006, eyebrows were raised when Greece’s GDP jumped 25 per cent overnight thanks to a statistical revision that sought to incorporate prostitution and money laundering, among other industries. In late 2009, the incoming prime minister announced that the deficit was more like 12.5 per cent of GDP than 3.7 per cent.

Had its economic statistics been more rigorously reported, it seems unlikely that Greece would have made it into the eurozone. But could the anomalies have been spotted at the time? Perhaps so.

I’ve written about Benford’s Law before: it’s a statistical regularity that often occurs in “real” data but not in manipulated numbers. Now four researchers have published a paper using Benford’s Law to examine Greek macroeconomic data. (Perhaps the origin of the paper should not be a surprise: it’s by Bernhard Rauch, Max Göttsche, Gernot Brähler and Stefan Engel, and it’s published in the German Economic Review.)

Benford’s Law was discovered in 1881 by the astronomer Simon Newcomb, and then again by Frank Benford, a physicist at General Electric, in 1938. The law is a curious one: it predicts the frequency of the first digits of a collection of numbers. For example, measure the lengths of the world’s rivers, and see how many of the digits begin with “one” (184 miles; 1,543 miles) versus “three” (3,022 miles) or “nine” (985 miles). Newcomb and Benford discovered that the first digit is usually a “one” – fully 30 per cent of the time, over six times more common than an initial “nine”. And the result is true whether one counts the numbers on the front page of The New York Times or leafs through baseball statistics.

Nobody seems sure why so much data has the Benford distribution. We do know that exponential growth produces it. To move from a GDP of one billion Flainian Pobble Beads (a unit of currency in The Hitchhiker’s Guide to the Galaxy) to two billion Flainian Pobble Beads requires cumulative growth of 100 per cent, which will take a while. But to move from a GDP of 9 billion to 10 billion Flainian Pobble Beads requires only 10 per cent growth. Benford distributions are, uniquely, scale-invariant – in other words, if one measures GDP in dollars instead of Pobble Beads, the Benford property remains.

Manipulated data often fail to satisfy Benford’s Law. A manager who must submit receipts for expenses over £20 may end up filing claims for lots of £18 and £19 expenses – and the data will then contain too many ones, eights and nines. A forensic accountant can easily check this, and while not an infallible check (fraudster Bernard Madoff filed Benford-compatible monthly returns), it’s an indicator of possible trouble.

Which brings us back to the data Greece submitted to the European statistics agency. According to Rauch and his colleagues, Greek data are further from the Benford distribution than that of any other European Union member state. Romania, Latvia and Belgium also have abnormally distributed data, while Portugal, Italy and Spain have a clean bill of health.

Would a Benford-style analysis have helped spot Greece’s problems? In principle, yes. In practice, one wonders whether politics would have trumped statistics. A shame: according to Benford’s Law, Greece’s data were particularly odd in 2000, just before it joined the euro.

Also published at ft.com.

The politics of cheap cider and single malt

“Dad, aren’t monks supposed to be holy people?”

“So they say, my love.”

“Then why are monks trying to make the Scots do bad things?”

“This isn’t about Buckfast Tonic Wine, is it?”

“I saw someone on the television saying that there were these monks in Devon and they were making this special wine that made people naughty, and then sending it to Scotland.”

“That does sound rather unsavoury, doesn’t it? What did the person on the TV suggest doing about it?”

“He was saying that Scotland was going to introduce a minimum price on alcohol.”

“Very interesting. Could you pass me that bottle of whisky? I need a top-up.”

“But will a minimum price work? Will it stop Scottish people drinking tonic wine?”

“It certainly won’t stop them drinking Buckfast Tonic Wine, since – unless I am mistaken – the price of Buckie is above the minimum price. But even if we simply banned Buckfast, other sweet alcoholic beverages are available. There’s always rum and Coke – unless they’re going to ban rum. Or I suppose they could ban Coke instead. It seems unlikely.”

“Dad, if the minimum price is lower than the price of the drink that everyone says is causing the problem, then surely it won’t change anything.”

“That’s not true. It will change a few things. It will raise the price of the cheapest drinks. I’m no longer the expert I once was about cheap cider, but I reckon the price would more than double. And nicer drinks may get more expensive too. If paint-stripper must legally be priced at £12 a bottle, the price of a decent single malt may rise, too. And I am almost sure it will raise the profit margins of supermarkets. If they actually got together and agreed to charge a minimum price for alcohol they might end up in prison. They must think it’s awfully decent of the politicians to make it obligatory for them to raise prices rather than obligatory for them not to.”

“Can’t the politicians make all alcohol more expensive?”

“They can: they can tax it. They already tax it a lot and they can tax it some more. If they tax the value, then the price of everything will rise in proportion. If they tax the alcohol content then the cheaper, stronger drinks will become more expensive, relative to the original price.”

“Why don’t they do that?”

“There are a couple of reasons. One is that people don’t like the idea of the government getting their money. They’d rather have a minimum price than a tax. Of course this means the money going to the supermarkets rather than being available to reduce deficits, cut taxes or fund public spending, but there it is. The other reason is that it would work too well: it would increase the price of the drinks that voters buy, and especially the price of drinks that journalists buy. This creates bad publicity.”

“But don’t voters buy cheap drinks too?”

“Have you studied Venn diagrams at school?”

“We did them last term.”

“Let me just speculate – without evidence – that the set of voters does not hugely overlap with the set of people who regularly buy two litres of cider for £1.50. But lots of people buy drink in general, so this would be a tax on lots of people. Politicians often levy taxes on lots of people but they try to avoid crowing about it when they do. As the cliché has it, this would be a tax on the vast majority of responsible drinkers.”

“Are responsible drinkers in the vast majority in Scotland, Dad?”

“I don’t know. Casual observation suggests they are not even in a slim majority in England.”

“What I don’t understand is why a price increase would change anything – after all, we’re already talking about alcoholics and irresponsible drinkers, aren’t we?”

“I’m surprised you know what an alcoholic is.”

“I assumed it was like a chocoholic, only with whisky.”

“Your deductive powers are admirable. But even alcoholics, and chocoholics, respond to incentives. There’s a study from the 1980s by the economists Philip Cook and George Tauchen which found that when taxes on alcohol rose in some US jurisdictions, you could track the fall in liver disease in the local hospitals. And there are other academic studies which find that demand for addictive products such as gambling and cigarettes even responds to prospective price increases – the addicts realise their habit is about to become expensive and try to quit before that happens.”

“Gosh. Scottish drinkers may already be cutting back.”

“All the more for me, then.”

Also published at ft.com.

Green lights for red-light districts

When men are in transit, and so less likely to be interested in marriage, it should be no surprise that sex takes off in the spot market

The sex workers of Tampa, Florida, and Charlotte, North Carolina, can get ready for a spike in business at the end of next summer: the Republican and Democratic National Conventions, respectively, are coming to town. In the last electoral cycle, the political jamborees were held in Denver and Minneapolis – and there seems to have been a coincidental surge in the local market for sex.

The economists Scott Cunningham and Todd Kendall discovered this by examining advertisements in the “adult services” section on Craigslist, the online ad service. (Craigslist has since closed down this section.)

Using postings in Seattle and Philadelphia as a control group – these cities did not have almost 50,000 visitors descending on them for a few days – the economists estimated that advertisements selling sexual services increased by 29-44 per cent in Minneapolis during the Republican visit and 47-77 per cent in Denver when the Democrats arrived. I’m not going to make jokes about oversexed politicians, largely because the majority of visitors appear to have been journalists.

Perhaps we should not be surprised that when a large number of people drop into town, many of them men, local sex workers see an opportunity to do business. Tourists worry less about being spotted by a neighbour or a colleague. And to the extent that some men may be weighing up the relative attractions of paying for sex versus looking for a wife or girlfriend, being in a city far from home makes looking for a girlfriend relatively less tempting.

It may seem alarmingly cold to view men as weighing up the costs and the benefits of finding a wife versus hiring a prostitute – and just as stark to view women as making the same decision in reverse – but the idea is not mine. Almost a decade ago, two economists, Lena Edlund of Columbia University and Evelyn Korn of the University of Marburg, published an article, “A Theory of Prostitution”, which modelled exactly these decisions. One of their purposes was to explain why sex workers can earn so much money. The abstract begins with a puzzle: “Prostitution is low-skill, labour intensive, female and well paid.” The economists suggested a “marriage market explanation” as the reason why. If marriage can provide women with an important source of income, “it follows that prostitution must pay better than other jobs to compensate for the opportunity cost of forgone marriage market earnings”.

When men are in transit, and so less likely to be interested in marriage, it should be no surprise that sex takes off in the spot market. In their study, Edlund and Korn cited mining camps, military bases, 19th-century American frontier towns and sex industries driven by a surplus of men in African cities. In short, there is nothing special about American political conventions. What might be more surprising is the idea that some women dip into the sex industry very occasionally. In an unpublished paper, Steve Levitt and Sudhir Venkatesh gather data on street prostitutes in Chicago, a different segment of the market from those advertising on Craigslist. Levitt and Venkatesh find that on the Fourth of July holiday demand rose by 60 per cent and prices by 30 per cent. This price increase proved sufficient to tempt some women into sex work for one day of the year.

All this is fascinating from an economic point of view: the market for sex is a market like any other. But some of it is also worrying. Both the mobile buyers of sex and the workers who sell it have long been identified as vectors for sexually transmitted infections. Levitt and Venkatesh find that in the street transactions they analyse, condoms are rarely used. Perhaps those Craigslist advertisements Cunningham and Kendall found were facilitating safer sexual encounters. Let us hope so.

Also published at ft.com.

Elsewhere

  • 1 Twitter
  • 2 Flickr
  • 3 RSS
  • 4 YouTube
  • 5 Podcasts
  • 6 Facebook

Books

  • Fifty Inventions That Shaped the Modern Economy
  • Messy
  • The Undercover Economist Strikes Back
  • Adapt
  • Dear Undercover Economist
  • The Logic of Life
  • The Undercover Economist

Tim’s Tweets

Search by Keyword

Free Email Updates

Enter your email address to receive notifications of new articles by email (you can unsubscribe at any time).

Join 152,667 other subscribers

Do NOT follow this link or you will be banned from the site!