Tim Harford The Undercover Economist

Articles published in October, 2011

Malthus’s ghost and baby number 7bn

“In five days, world population is projected to reach 7 billion.” – UN Population Fund, October 26

There will be 7bn of us come Halloween? You’re kidding.

Someone at the UNPFA has a sense of humour, it seems. This is a terrifying prospect to some and cheery for others, while most of us find it irrelevant. Halloween seems appropriate.

This is a statistical projection, and statistical projections don’t have a sense of humour.

But they do have margins of error. The UNPFA doesn’t even know whether the seven billionth person will be born in 2011. Even the UK is currently relying on 10-year old census data. There are places in the world where the data are decades old and we’re just guessing at the population. Still, such celebrations – if they are celebrations – do pass the time.

Time does fly, doesn’t it? When I was at school I was told there were only 5bn people in the world.

In the mid 1980s, there were only 5bn. The world’s six billionth person – officially Adnan Nevic of Sarajevo, although of course we have no idea who it really is – is only about 12 years old.

Each new billion comes more swiftly than the last one – it’s pretty worrying.

Actually, population growth has been slowing. It grew by a third between 1960 and 1974 – from 3bn to 4bn – but it’s taken more than 21 years to grow by a third from about 5bn to 7bn. The UN has a projection – the “low fertility” scenario – where the world population briefly tops 8bn then starts falling.

So Malthus was wrong?

Even Robert Malthus realised that there was such a thing as birth control. His more excitable successors, such as Paul Ehrlich, author in 1968 of The Population Bomb, have been fairly thoroughly rebutted by subsequent events. Dan Gardner, author of the fascinating Future Babble, summarises Ehrlich’s three scenarios for the 1980s as “everybody dies” (starvation-triggered nuclear war), “every third human dies” (starvation-triggered virus) and in the optimistic scenario “a billion people still die of starvation”.

Poor Ehrlich. Maybe next decade … What about Malthus?

He’s harder to judge: his most famous argument is actually rather abstract. He argued that unchecked population growth is exponential: 2, 4, 8, 16, 32, 64. Progress in agricultural production can only be arithmetic at best: 10, 20, 30, 40, 50, 60. Eventually, the exponential always catches up and overtakes the arithmetic progress. Sooner or later, then, the population bumps up against our ability to feed everyone.

And mass starvation ensues.

That’s possible. More likely is that the availability of food keeps limits to population growth. In a “Malthusian economy” living standards never improve beyond subsistence, no matter how much technological progress there is, because population always keeps pace with the growth of the economy.

Which is nonsense, of course.

Which is a surprisingly good description of human existence until, roughly, 1798, which is when Malthus’s famous Essay on the Principle of Population was published. Calorie intake of rural labourers in England seems to have been somewhat less than it is in primitive hunter-gatherer societies today. Happily for humanity but unfortunately for Malthus subsequent developments were a big surprise: agricultural productivity dramatically surged ahead of population.

Does that mean we’re all fine?

It means “so far, so good”. Some experts think that natural resource scarcity has to catch up with us eventually. A more optimistic school of thought argues that large populations mean more good ideas to go around. We’ll innovate at an ever-faster rate and solve whatever energy, resource or environmental problems come our way. The optimists have been right for a couple of hundred years.

Nothing to worry about, then.

Not quite. The modern Malthusians were looking very foolish in the 1990s: the price of skilled labour was rising inexorably and the price of most commodities, notably oil, was low. But in recent years there’s been a distinct rise in these prices. Perhaps this is a temporary thing: the rising prices could spur energy-saving innovations. Or perhaps Malthus’s ghost will come back to haunt us, even if not this Halloween. It’s hard to say: population growth is a funny thing. Malthus himself had three children – but no grandchildren.

Also published at ft.com.

Can you be a little less specific?

Game theorists are beginning to produce rational models of deliberate vagueness

Seinfeld’s George Costanza was once invited “up for coffee” at the end of a romantic evening, and refused: caffeine would keep him awake, he explained to his perplexed date. Later, aghast, he realised: “coffee doesn’t mean coffee! Coffee means sex!”

Well, indeed – but few people, if they are wise, will baldly suggest the sex. A little ambiguity is called for. Now game theorists – masters of the mathematisation of human interaction – are beginning to produce rational models of deliberate vagueness.

Andreas Blume and Oliver Board, two economists at the University of Pittsburgh, offer up just such a model. They point out that perhaps it is too much trouble to be specific, as with a business contract offering a fee plus “reasonable expenses”. This isn’t always the reason. “Coffee” has two syllables, “sex” has only one, and surely George’s date could have made her intentions plainer without much effort.

Perhaps it’s just a matter of social norms: it would have been shocking for George’s naughty-but-nice date to ask him to sleep with her, so instead she hinted that an attempt at seduction might not be rebuffed.

But there is often a logic behind such norms – for example, the opportunity to tweak the message depending on how it is received. If George seemed taken aback by the invitation for “coffee”, his lady friend would have retained plausible deniability. If he seemed interested but hesitant, she could have clarified the message by slipping into something more comfortable.

Alan Greenspan, the mumbling maestro of mixed messages, played the markets with one vague declaration after another, each one a nudge – but not a shove – in the direction he preferred.

The Blume-Board paper lurks on the boundary between philosophy and mathematics – and, ironically, it is extremely precise about what “vagueness” means. A working paper from the economists Florian Ederer, Richard Holden and Margaret Meyer has a more practical bent, examining the boss who finds it useful to be vague about performance bonuses.

The scenario here is one of an employer who cares about two tasks and an agent who finds it easier to do only one of them. Imagine a journalist who must both write words and spell them correctly: the boss needs both of these jobs done well, within reason: a mass of spelling mistakes is no use and neither is a tiny number of correctly spelled words.

The challenge is to design appropriate performance pay for the job, and the difficulty is, there are two types of journalist: those who find it easy to churn out reams of copy, and those who find it easy to spell correctly. The boss doesn’t know which type of journalist she is hiring. It would be easy to demand the impossible, and find no takers for the job; or to pay over the odds; or to hire a journalist but then inadvertently give him an incentive to neglect half the job.

In some important cases, say Ederer, Holden and Meyer, the boss will want to be deliberately ambiguous about what sort of performance will be rewarded. Will the bigger reward go to the careful speller or to the hasty typist? One type of ambiguous contract has the boss tossing a coin and rewarding either one type of achievement or the other. An alternative contract – a variant of “you cut the cake and then I’ll choose” – allows the boss to choose one of two performance metrics after she has seen what kind of performance has actually been produced.

There’s a cost to all this ambiguity, of course: it’s risky for the journalist, who must then be compensated. Nevertheless this can be a price worth paying.

We’re used to thinking of ambiguity as a flaw in contracts, agreements and management styles. But when your boss gives you vague directions or bases your performance bonus on inconsistent and ever-changing criteria, perhaps there’s method in the madness.

Also published at ft.com.

Why we should all trim our antlers

Robert Frank’s ‘The Darwin Economy’ argues that there are markets in which we would be better off if we agree to throttle back

In a hundred years, if professional economists are polled to identify the founder of their discipline, the majority will name Charles Darwin, rather than Adam Smith as they would today.”

This prediction, made in a recent speech in Oxford by the American economist Professor Robert Frank, has a certain symmetry about it: after all, Darwin’s theory of evolution was inspired by the economist, Thomas Malthus.

Frank has a particular Darwinian insight in mind: the idea that contra Smith’s “invisible hand”, individuals competing can produce results that are bad for society as a whole.

Consider the vast antlers of the north American bull elk: they’re the result of sexual selection balanced by other selective pressures. Elks with big antlers win fights with other elks, and mate with multiple females. However, they also get hunted down and killed by packs of wolves. Elks as a whole would be better off if they could all agree to shrink their antlers by a factor of four or five: the males with the biggest antlers would still get the girls, while only the wolves could object to faster, more agile bull elks. Sadly for the elks and happily for the wolves, that’s not how sexual selection works.

In a new book, The Darwin Economy, Robert Frank sees elk antlers everywhere he looks in modern society. For example, when parents bid up the price of houses near good schools, they’re engaging in a wasteful arms race: children as a whole will be no better educated as a result, but vast sums are devoted to the quest for the right school district. My flashy car makes you less satisfied with your own; if I take ladies out to the opera and Michelin-starred restaurants, other men will no longer succeed by offering scampi and chips at the Romford dog track. In short, says Frank, my spending harms you as surely as I would harm others by standing up at a concert and forcing everybody behind me to stand up in turn.

Sometimes this dynamic is the result of envy; at other times it is genuine competition for scarce resources, such as beautiful partners or elite university places.

Elks cannot reach an agreement to trim their antlers, but humans can, and Professor Frank advocates a steeply progressive consumption tax to serve this purpose. In effect, the tax would be an income tax with an exemption for savings, encouraging investment but discouraging spending sprees. Frank argues that it should be progressive because the wasteful economic arms races are at their most grotesque at high consumption levels.

I think Frank’s analysis is impressive, original and thoughtful. But one need not invoke elk antlers to justify progressive taxation. And I part company with Frank on two points.

First, I am unconvinced that such arms races are quite as common as he feels. For instance, new antibiotics or cancer treatments are “luxury” goods in the technical sense that rich societies spend a greater proportion of their income on healthcare. Is this really just a race for status, for the coolest chemotherapy treatment? Frank thinks that “luxury” goods tend also to be positional, status goods – but such medical treatments seem to me to be an increasingly important counterexample.

Frank also sidesteps the idea that markets themselves can be structured to eliminate the arms race. For example, parents can scramble to buy property near an existing good school, or they can fund a new school – at least in principle. In the second case, new resources are mobilised and more children get a good education. Can education really be nothing but the anthropic equivalent of elk antlers or peacock tails?

Frank is right to remind us that there are markets in which we’d all be better off if we could collectively agree to throttle back. But he may have been too quick to assume that such markets are beyond reform.

Also published at ft.com.

Wolfson’s prize is impossible to win

“Lord Wolfson, a prominent eurosceptic . . . is offering £250,000 to the person who comes up with the best plan for winding up the euro in an orderly way. The Wolfson Economics Prize . . . will be the second-largest cash prize for an academic economics after the Nobel Prize.” – Financial Times, October 19

Cheap at the price.

Very cheap. The European financial stability facility has €440bn to disburse, and it’s a sign of the eurozone’s woes that this is widely regarded as far too puny.

Let’s hope somebody wins it, then.

I doubt that will happen. Lord Wolfson is offering a prize for turning an omelette back into its constituent parts.

I like omelettes.

So do I, but the eurozone is currently lacking in light, fluffy deliciousness. Hence the talk – and not just from millionaire eurosceptics – of a break-up.

Will that help?

If Greece somehow managed to leave the eurozone in a tidy fashion, that would help up to a point. Many of Europe’s peripheral countries, including Spain, Italy and Greece, have a growth problem for which a neat euro exit could be a cure. Their wages and prices are too high relative to those in Germany and so they’re struggling to grow. Wages and prices can of course fall, but that is a slow, painful and politically fraught process. If they had an independent currency, they could devalue and the growth problem would disappear.

Great. Well, that’s sorted then.

You’re forgetting about the omelette. In any case, the eurozone has two other problems that are distinct from slow growth in southern Europe. The first is that Greece’s government simply cannot repay the money it has borrowed, while some other eurozone countries are struggling with their own financing for various reasons. The second problem is that many of Europe’s banks lack – or are widely thought to lack – the financial cushion necessary to cope with this level of sovereign debt distress. A euro-exit, no matter how neatly done, will not solve either problem.

If Greece or Spain left the euro and devalued the peseta or the drachma, their pre-existing euro-debts wouldn’t shrink. In fact, relative to the devaluing economy, they would grow. One of the questions Lord Wolfson’s prize winner is supposed to answer is what happens to euro-debts after an exit – especially if, for instance, a Greek citizen has borrowed in euros from a German bank. There is no easy answer to that, as well he knows.

Is that why an orderly exit from the eurozone is so difficult?

It’s one reason. Another is the transition itself. Think about what’s going to happen if Greece leaves the euro: a bank account with €10,000 in is suddenly going to have 10,000 drachmas in. A salary of €800 a month will become 800 drachmas a month.

Seems simple enough.

But then the drachma will immediately collapse. Your 10,000 drachma bank account will be worth, say, only €3,000. And that means you’d have been much better off if you had moved your cash to a bank account in Germany, or converted it into euro notes.

When the Greeks figure this out, won’t they start rushing to move money out of the country?

I think the Greeks are ahead of you on this one.

They can’t have moved everything out of Greece.

No, and if Greece does leave the eurozone the flight of euros is going to have to be stemmed. Banks will have to close, international transfers shut down, perhaps the country’s borders will even have to be closed to prevent suitcases of euros being carried across.

Sounds painful but temporary.

Perhaps – but the next problem is that if Greece leaves, anyone with euros in Spain or Portugal or Italy is going to start asking whether those countries are next. Euros in Spain will be worth less than euros in Germany. At that point a fear of a euro break-up could become a self-fulfilling prophecy.

Looks like this will be a difficult prize to win.

Yes. Lord Wolfson has made his point, in a way.

In another way, it is odd to complain that a euro-exit would be messy and difficult. That is the nature of adopting a single currency: if it could be dissolved on a whim, it wouldn’t have any value or significance in the first place. As with a marriage, the binding commitment is pretty central to the whole idea.

So Lord Wolfson’s money is safe!

Yes. If only that were true for the rest of us.

Also published at ft.com.

Innovation works in mysterious ways

‘I’m surrounded by technology that looks good and works well because others followed where Apple led’

Was it salesmanship or engineering? Creativity or ruthlessness? Or was Steve Jobs simply gifted with vision and impeccable taste? Whatever the true source of his success, there was more than a touch of genius about Jobs. Even his side project, Pixar, was an astounding achievement. His first love, Apple, he built from nothing and then dragged back from the brink to make it the most valuable company in the world. No wonder so many of us felt sad at the news of his passing: surely he had more to offer.

I spend my life in front of a computer, and that life is better because of what Steve Jobs created. But here’s the strange thing: I’ve never owned an Apple product for longer than the two weeks it took to give up and send it back. (Apple’s customer returns department is impeccable, by the way.) My Macbook Air? Glorious hardware, but fussy software and a counterintuitive interface. My iPad? Beautiful – but also heavy, not too fond of wireless, and refused even to turn on until I did some most impertinent things to my Windows laptop.

Apple never made a penny from me. Why, then, do I say that Steve Jobs improved my life? It’s because I am surrounded by technology that looks good and works well because others followed where Apple led. Without Apple’s refinement and popularisation of the WIMP environment (window, icon, menu and pointer), how long would we have waited for a graphic interface from Microsoft – and how awful might it have been? It’s hard to imagine Bill Gates would have shown much interest in fonts without Apple’s beautiful typography. Beyond desktop computers, there’s a similar story to tell: I own an Android phone that owes more than a passing debt to the iPhone; I’m still waiting to own a Windows machine to rival the Mac Air; and every tablet in the world bows to the iPad.

To an economist the lesson is obvious: innovative profits are imperfectly appropriable. In more user-friendly language: when an entrepreneur bakes a cake, he only gets to keep a thin slice for himself. This is worrying if it discourages innovation, and in some industries innovators may be discouraged by the prospect that they must take big risks and sink big costs while society sits back and hopes to reap the benefits. Yet in the computer industry, plenty of entrepreneurs seem happy to take risks for the prospect of a thin slice of the social benefits.

A discussion paper published in 2004 by the economist William Nordhaus attempts to establish exactly how thin that slice is. Nordhaus reckons that innovators capture a “minuscule” 2.2 per cent of the total social benefit of their innovations. The other 97.8 per cent goes to consumers, partly because competitors soon catch on, and partly because no company, even a monopolist, can charge each consumer a price reflecting her individual willingness to pay.

Professor Nordhaus’s estimate can be regarded as, at best, an educated guess, partly because Nordhaus is only able to focus on innovations which lead to lower production costs and thus lower prices. If that’s the metric, developments such as the world wide web or penicillin barely register. Still, I think it’s safe to say that both Tim Berners-Lee (the web) and Alexander Fleming (penicillin) reaped far less than 2.2 per cent of the total value to society of their insights.

Was Jobs an exception? Chris Dillow of the Investor’s Chronicle, who called my attention to the Nordhaus paper, reckons that Jobs’s gift for branding and design helped Apple retain an unusually large slice of the innovator’s cake. Perhaps that’s true. Apple’s shareholders have certainly enjoyed a profitable few years. But the greater benefit has flowed to customers – and not only the customers of Apple.

Also published at ft.com.

Debt crisis? Let’s just call it quits

We keep hearing about a eurozone debt crisis. But who owes the money? And to whom?

The simple answer is that a lot of people owe a lot of money to a lot of other people and it’s all rather messy and difficult.

If we all owe the debt to each other, can’t we just wipe the slate clean?

If you owed £100 ($158) to me and I owed £100 to you, we could agree to shake hands and call it quits. But even then there would be complications. You might have promised to give me £100 by tomorrow while I promised you £100 by Christmas 2015. Those two promises don’t quite cancel out, especially if both of us urgently need the £100 on Monday morning.

Why would we owe each other money like that?

We wouldn’t. But governments and companies do issue IOUs called bonds. The bonds have set time frames and are traded, so that kind of scenario isn’t fanciful. Anyway, the point is, it’s messy. And it’s not the case that all the debt cancels out: some people and institutions are net creditors and some are net debtors.

“Neither a borrower nor a lender be.” – Polonius

Polonius was a sententious fool. There are plenty of reasons to be a borrower or a lender. Cash is a claim on goods and services, and if you have cash but don’t need the goods and services right now – say, you are a middle-aged person looking ahead to retirement – then it makes sense to be a lender. A young person, however, could perfectly prudently borrow to pay for a home or an education. All this talk of wiping the slate clean sounds very tempting if you’ve just borrowed money to buy a house; it’s less tempting if you’ve spent your life saving and suddenly your savings disappear as part of a slate-wiping project.

We aren’t talking about little old ladies. Or are we?

Only indirectly: most government debt is owed by states to large institutions such as pension funds, insurance companies or other governments. Pension funds and insurers are natural creditors as they have cash now that they don’t need.

Now we’re getting somewhere.

Perhaps. The Office for National Statistics says, for example, that the three key holders of UK government gilts (basically, bonds) are pension funds and insurers, foreigners and banks. That list includes the Bank of England, which has bought a lot of UK government debt and is planning to buy more. The three sectors hold about 30 per cent each of UK gilts.

And what about Greece?

Greek debt has increasingly been taken on by national and multilateral institutions. Barclays Capital has published estimates of Greece’s largest creditors and at the top of the list is the European Union, the Greek state pension fund, the IMF and the National Bank of Greece. Foreign private banks are further down the list, although as Dexia proved last week, even a thin slice of Greek government debt can be enough to poison a bank.

Are banks particularly vulnerable, then?

You have to ask? Yes, they are, and this is why the “clean slate” view is so unrealistic. If you have a pension pot of £100,000 and 10 per cent of it is invested in Greek government bonds, then if the Greek government defaults completely you’re going to lose £10,000, 10 per cent. That’s annoying, but the loss is not magnified. But if your bank has 10 per cent of its investments in Greek government bonds, then when Greece defaults, your bank could be close to bankruptcy. Other lenders will refuse to do business with your bank for fear of losing their money. You will – if you are wise – put your current account somewhere else. The bank will be at best a lame duck, desperately cancelling overdrafts and refusing mortgages as it scrambles to stay afloat. The damage could be much more than the original loss.

Gosh. If only banks had been properly reformed before this crisis hit.

No kidding. Although that wouldn’t have been easy – effectively we were looking to redesign the financial ship while it was still out in a storm, taking on water.

If the debt was repaid, wouldn’t somebody be sitting on a pile of cash?

I’m not sure I’d accept the idea that some international man of mystery (George Soros? Auric Goldfinger?) would end up with all the cash. But yes, if all the debt was paid back creditors would be sitting on trillions. But what use would that be? Creditors are creditors because they have money they don’t immediately need. If all the debt was suddenly repaid, creditors would immediately be looking for alternative investments.

Also published at ft.com.

Mr Prime Minister, we like our credit cards

“The prime minister was forced to change a passage in his original speech which appeared to call on people to pay off their debts instead of spending money.”

What’s wrong with telling people to pay off their credit cards?

Nothing. Paying off your credit card is a marvellous idea. Credit cards are magnificently expensive if you start letting the balance accumulate.

Surely they’re not that bad?

It’s all about compound interest, the most powerful force in the universe, as Albert Einstein probably didn’t famously declare. Compound interest can be overhyped, usually by people trying to sell us pensions. Yet compound interest of 20 per cent a year – which some credit card companies would regard as modest – is the kind of return that puts you in the same league as Warren Buffett. You don’t really want to be offering your credit card company Buffett-style returns.

Why was David Cameron planning to offer personal finance advice?

I don’t think he intended the advice to be taken quite too literally; surely he just wanted to echo the government’s baffling mantra that it is going to pay off the nation’s credit card.

Is it?

No, it’s just slowing down the rate at which the nation’s credit card balance is increasing. In any case, the metaphor is daft, because the government is borrowing money very cheaply – about 0.5 per cent a year for a two-year loan, and 2.25 per cent for a 10-year loan.

So why did the prime minister change his speech at the last minute?

There’s a school of thought out there that suddenly having every consumer in the country close his or her wallet might not be terribly good for the economy.

Aha, this is the famous paradox of thrift?

Not quite. The paradox of thrift is the idea that when we all try to pay off our debts, in fact we end up more indebted than ever.

Huh?

It’s a more extreme version of your idea: if everyone stops spending and starts trying to save, the economy might be so damaged that incomes fall faster than spending, and borrowing increases.

Wow. Can that happen?

It’s not impossible. But it’s worth examining the idea. It seems counterintuitive and bizarre that collectively we could cause a recession by trying to be prudent with our cash. But after the idea has been explained it becomes difficult to shake it off: the cause of all economic problems suddenly seems to be pessimism and the solution is for everyone to go shopping. But there are problems with that view.

Well, yes, we can’t keep racking up ever larger debts, can we?

Not as an increasing proportion of overall income, no, we can’t. But beyond the sheer mathematical impossibility of an economy fuelled by increasing debt-gross domestic product ratios, there’s a more subtle objection. Is it really true that an economy collapses when consumer spending collapses?

Of course! What else do you expect to happen?

If prices are flexible and resources can be redeployed, then business investment should replace consumer spending. Businesses will find that it’s cheap to borrow, buy land and machinery, and cheap to hire workers – in fact, they would find that it was an excellent time to invest to take advantage of the coming boom. And the boom would come: it would be investment-led rather than consumption-led.

So everyone should pay off their credit cards?

Well, maybe a little bit, yes. The case for doing so becomes all the stronger when you consider that the UK is an open economy. In a closed economy, my spending is your salary. But in an open economy, part of my spending is Johnny Foreigner’s salary. As any politician will tell you, foreigners don’t vote.

In reality it takes time for prices to adjust and time for resources to be redeployed, so it would be a disaster if everyone tried to pay off their debts overnight. The shift from consumption to investment can’t happen instantly, so in an Augustinian spirit we must hope for the Lord to make us frugal, but not yet.

Which brings us back to the initial point: it would have been a bad idea for Mr Cameron to tell the nation to stop spending, wouldn’t it?

No, because no one listens to a word the prime minister says. But if Jonathan Ross or Simon Cowell had told us to stop shopping, that would have been a disaster.

Also published at ft.com.

Confusion at a price

The UK energy secretary wants to reform the way suppliers charge customers. But his plans seem unlikely to give a dramatically better deal

Are we living in a confusopoly? You know what I mean: trying to figure out whether it’s cheaper to use one phone company’s “Armadillo Everyday 500” tariff or another’s “Supersava B”, with a special concessionary price for the first 15 minutes of the 25-year contract. (The term confusopoly was, I believe, first coined by Scott Adams, the creator of “Dilbert”.) Chris Huhne, the UK energy secretary, fears the confusopoly in energy prices, and in a speech last month, he announced his plans to do something about it.

Huhne has a point: we know that a well-functioning, competitive market is a good way to get prices down. If such a market is feasible it’s far more likely to deliver good results than regulatory diktats, with all their inevitable loopholes and unintended consequences. Yet if consumers are confused about prices then competition is unlikely to produce such glorious results.

But the story is – surprise, surprise – not quite as simple as Huhne suggested in his conference speech. There are two separate issues here: people feel that it’s a hassle to switch suppliers, and they are uncertain about whether they’d be better off if they did.

The first problem, switching costs, is less serious than it seems. Paul Klemperer, an economics professor at Oxford University, says that switching costs need not be bad for consumers or particularly good for companies. In a market with switching costs, what every company wants is a fat share of captive customers to exploit. But how to acquire those customers? The obvious solution is to offer fantastic deals, attract the suckers, and then gouge them for all they’re worth. (This is why your phone company will happily give you a £500 phone “free”; nobody has yet offered me a free laptop computer.) The early bargains partially – and sometimes fully – compensate for the later price gouging.

Perhaps we should not worry too much, as long as the introductory bargains are generous enough. I wonder what to make of the fact that Huhne has branded them “predatory pricing” and declared that the bargains will stop. I fear it will be hard to implement that policy sensibly. For instance, Michael Waterson of the University of Warwick reckons that a recent effort by the energy regulator to stop some kinds of predatory pricing simply backfired: the deals dried up but lower everyday prices did not materialise.

The second problem, confusion pricing, seems to be the curse of our age. There is certainly reason to worry: I’ve written in this column before about the research of the economists Catherine Waddams Price and Chris Wilson, who studied customers who had overcome whatever switching costs they faced and were determined to find a cheaper electricity supplier. Most people missed the lion’s share of the savings they might have achieved, and a quarter managed to make themselves worse off.

And yet, and yet. Eugenio Miravete of the University of Texas at Austin studies what he calls “foggy pricing” and reckons that competition is a pretty good antidote to the fog: new entrants typically have an incentive to offer simple prices to cut through the confusions, while incumbents do not retaliate by complicating their own offers.

I do sympathise with Huhne’s concerns and am sure he’s on to something. But his reforms seem unlikely to give us a dramatically better deal. According to VaasaETT, a global energy think-tank, energy prices in London are among the lowest of all major European cities. Low energy taxes are part of the reason – something Huhne might want to address if he is as serious as he claims about energy efficiency and climate change. But my casual inspection of VaasaETT’s figures suggests that low taxes do not explain the entire price discount. The confusopoly hasn’t quite got the better of us yet.

Also published at ft.com.

A ‘Robin Hood’ tax is no way to redistribute

“José Manuel Barroso, European Commission president, has proposed a tax on financial transactions to help rebuild public finances across the bloc, calling it a matter of fairness.”

What’s this all about?

The idea is that every time money changes hands in the City, the state takes a sliver. No one in the City really notices, the tax revenue is huge and the government’s financial problems are solved. Even better, the tax reduces speculation and so makes the banking system safer.

Wow. Sounds great!

Doesn’t it, though?

What’s the catch?

There’s no catch.

Really?

Don’t be daft. Of course there’s a catch. Imagine a non-financial transaction tax: every time anyone receives a payment, they must pay £5. No big deal if you’re selling a house but quite a big deal if you’re selling a packet of chewing gum.

But the FTT is a percentage, isn’t it?

True, this isn’t a precise analogy to the FTT, but it’s worth exploring. My tax would discourage small transactions while the FTT would discourage short-term transactions. The obvious response to my tax would be to pool transactions: you’d want to be paid quarterly rather than weekly. You’d do big shopping trips, not impulse buys. Similarly the FTT encourages – say – lending $1m for a year rather than for a day, 365 times.

Either tax discourages certain transactions.

For James Tobin, the late Nobel laureate economist who first proposed the tax, that was the whole point. He expected short-term deals to dry up, so the tax was a bad source of revenue. But he thought that this would enhance financial stability.

Would it?

Maybe, but probably not. Certainly it would have done nothing to prevent the current crisis. Most of the patchy empirical evidence – collated by the Institute of Development Studies – suggests that as transactions evaporate, volatility increases. Purchases get lumpier and people only trade in response to large price movements – besides trying to avoid the tax with accounting tricks: imagine transactions being lumped together, netted off, moved offshore or removed from exchanges. If I had to pay a £1 tax on every real-world transaction, the first thing I’d want to do is set up some kind of slate with my corner shop so that we only “transacted” every three months, even if I popped in for milk and a copy of the FT every morning. Traders could get very cute about this, and none of that is likely to make the financial system robust and stable.

Still, it’s a tiny tax that would raise a huge amount of money, isn’t it?

Tiny or huge? Make up your mind. If you’re trading the same stuff backwards and forwards a hundred times a day and the government takes 0.01 per cent of each trade, then you’ve lost about 1 per cent in a day. That’s not tiny. Mr Barroso reckons he could raise €55bn a year, which is very roughly 10 per cent of global banking profits.

And the problem that is that the banks are too weak to pay.

No. The problem is the banks aren’t likely to be the ones who pay the tax. If it was a tax on bank profits it would hit bank shareholders, such as governments and pension funds.

But it’s not a tax on profits, it’s a tax on transactions, and we have no idea who will end up paying it. Tax incidence is tricky: some taxes can be passed on to customers, others will end up hitting shareholders. It’s reasonable to assume that in the end the FTT would be mildly progressive – assuming the tax doesn’t just drive huge chunks of the financial sector offshore.

Is that likely?

Moving trades from London to New York is hardly beyond the scope of human ingenuity. Curiously, the European Commission itself reckons the tax will destroy derivatives trading in the European Union, reducing it by at least two thirds and possibly by nine tenths, and lowering GDP by 1.75 per cent, or more than €200bn.

Gosh.

At least Mr Barroso isn’t planning to invade Poland.

But I thought this tax was also called a Robin Hood tax – rob from the rich, give to the poor?

We do have other ways to take money from the rich and give it to the poor – income tax, capital gains tax, that sort of thing. We could even tax banking profits or bankers’ pay directly.

But the FTT is a baffling way to try to redistribute, and Tobin didn’t endorse that use of the tax. And Robin Hood himself was a determined campaigner against erratic taxation.

Also published at ft.com.

The honest truth about kickbacks

It may be better to get 10 per cent of a booming economy than 100 per cent of a stagnating one

An old joke: a bureaucrat from Sani Abacha’s Nigeria visits a bureaucrat in Suharto’s Indonesia and is impressed that his Indonesian counterpart lives in a nice house and drives a Mercedes. “Do you see that road? Ten per cent,” the Indonesian explains.

A couple of years later the visit is reciprocated. Suharto’s man finds the Nigerian civil servant in a palace with a pair of Ferraris. “Do you see that road?” says the Nigerian, gesturing at virgin rainforest. “One hundred per cent.”

There is more to the joke than meets the eye, of course: Indonesia managed to combine severe corruption with many years of strong growth, while Nigeria stagnated over a similar period. Corruption matters, but so does the type of corruption.

And here is a conundrum. Technocrats have long offered economic policy advice to powerful people in developing countries, yet powerful people may have much more to gain by ignoring the advice and lining their own pockets. The problem is so severe it is a wonder that economies ever develop at all. But the situation is not hopeless, because contrary to the joke, it may be better to get 10 per cent of a booming economy than 100 per cent of a stagnating one.

A new working paper from Michael U. Klein of the Frankfurt School of Finance and Management argues that if elites profit from corruption and control the levers of policy, we should ask ourselves what sort of policy advice might appeal to a corrupt bureaucrat while still being sound economics?

Consider the traditional form of corruption: paying bribes in exchange for favourable treatment. This may be harder than it looks, even in a society where corruption is common: one must still find corrupt partners, establish a deal, and secretly enforce it.

Klein, who studied Nigeria in the 1980s, gives some baffling examples of behaviour that may have been designed to drive away the honest and leave only the corrupt. In one case, the boss of an engineering company arranged to meet the managing director of a large public enterprise after many requests and much waiting. When finally brought into the managing director’s office, he found his counterpart facing the wall. Four hours passed; the only sound was that of a radio playing. Then the managing director turned and a deal was struck.

The waste involved in arranging, monitoring and enforcing corrupt deals can be immense – Klein has found that transaction costs of large projects rise from 3 per cent to at least 10 per cent in “complicated” environments. Prosecutions for corruption can be tough to pull off, says Klein, because big Nigerian firms had no accounts in the late 1970s. (There was also a national tradition of fires breaking out in accounting departments.) All this is dreadfully damaging for growth.

What might work better, while still satisfying the avarice of a country’s elite? One idea would be for elites to hold direct stakes in commercial firms. But the result would still look like a mafia town: too much emphasis on squashing competition and not enough on meeting the needs of customers.

Perhaps this is why export markets have proved such an important element in the success of many Asian economies: domestic markets may be sewn up in corrupt deals, but the government can still insist on export success as a precondition for political favours. Only productive firms are allowed to join the corrupt club – with export markets a good test of genuine productivity. For a case study, consider decades of South Korean growth.

Perhaps there is a touch of fatalism about all this. Eventually one would hope for a world where corruption is very rare. While we’re waiting for that, it’s worth asking how even a corrupt economy can achieve growth.

Also published at ft.com.

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