Tim Harford The Undercover Economist

Articles published in March, 2012

Sex, shopping and the statistics of happiness

“How satisfied are you with your life these days?”

Beg pardon?

On a scale of 0-10. I’m reading a question from this new Office for National Statistics report on happiness. Here’s another one: “How happy did you feel yesterday?” On a scale of 0-10.

This isn’t that economics-of-happiness nonsense is it?

It is indeed. Hm. “How anxious did you feel yesterday?”

On a scale of 0-10?

Yup.

I wasn’t feeling anxious yesterday but I am now, thank you for asking. How many questions are you planning to throw at me?

Only four. This is the last one. “To what extent do you feel the things you do in your life are worthwhile?”

Right. And the answers are supposed to revolutionise economic policy and pave the way for an alternative to gross domestic product as a measure of national wellbeing? I won’t hold my breath.

I think you’re expecting a bit much. You haven’t even answered the questions yet.

I don’t mean my answers specifically. I mean, our answers in general, however many people they’ve asked.

Eighty thousand.

Eighty thousand, fine. They’ve spent however many millions of pounds going around the country asking 80,000 people if they felt happy yesterday. This is supposed to be some transformative statistical exercise, right? Let me ask you a question: to what extent do you feel the things the government is doing to measure happiness are worthwhile?

On a scale of 0-10?

Oh, shut up.

I’d give it about a 4 out of 10. I suspect it will be only faintly useful but I also suspect the cost of doing this is modest. Remember, the ONS went to a huge amount of time and trouble to interview a suitable sample of 80,000 people but they were going to do it anyway. Adding an extra four questions can’t have broken the bank.

What have we learnt, then, from this cheap and cheerful exercise?

Not a lot, yet, because so far the ONS hasn’t produced a detailed statistical analysis. We know that Londoners are the most anxious people in the country and that the Northern Irish are the most satisfied with their lives by the three measures on offer. Women are more content than men. The middle-aged are less happy, more anxious and less likely to consider their existence worthwhile.

Is any of this a surprise?

I didn’t know the Northern Irish were so delighted with life, but previous work on life satisfaction has counselled against being middle-aged or male, so this isn’t new.

What else do we already know about happiness, other than money not buying it?

Actually, one thing we do know about happiness is that money does buy it. Take any society and the rich will be happier than the poor; they will be more likely to rate their lives as “going very well” .

I was sure the happiness research said money doesn’t buy happiness.

You’re thinking of the Easterlin Paradox. The economist Richard Easterlin, in the 1970s, couldn’t find evidence that societies as a whole got richer as they got happier. But the reason this is a paradox is because richer individuals do tend to be happier than poorer ones. The societal half of the Easterlin Paradox is a matter of active debate right now .

Thanks to David Cameron and the ONS.

Well, right now it’s thanks to surveys being conducted by the likes of Gallup. But I can imagine the ONS effort will come in handy eventually .

But you obviously feel the ONS could do better.

I’d like to see deeper questions along the lines of those asked by Alan Krueger and Daniel Kahneman.

Those names sound familiar.

One is the chairman of Barack Obama’s Council of Economic Advisers. The other has a Nobel Prize for economics. But before Mr Krueger’s political appointment, he and Mr Kahneman were using an approach that produces a lot more detail about the kinds of activities that make people unhappy, such as commuting or going to meetings.

I see. Any gems from this line of research?

Sex is fun, shopping is annoying and people like lunch and spending time with other people . And it’s been nice spending time with you. Aren’t you happy we talked?

Also published at ft.com.

The not-so-sweet smell of odious debt

A proposal that declares obligations of a particular regime non-transferable frees innocent people from indenture not of their making

“He that dies pays all debts,” says Stephano in The Tempest. Evidently he did not have sovereign debt in mind, which survives the demise of almost any government. Lucas Papademos would not get far with a declaration that, since Greece’s national debt had been accumulated by previous prime ministers, he had no obligation to pay it. That is not the way things are done: each government is liable for the deeds of its predecessors.

Usually this makes good sense, if only for the practical reason that without this principle of governmental succession, democracies would find it almost impossible to borrow money.

Yet the implications can be disturbing. Germany completed its reparation payments for the first world war in 2010. In South Africa in 1994, Nelson Mandela’s incoming government faced a debt burden of $23bn, in part courtesy of apartheid-era spending on the soldiers and police necessary to support the regime. Saddam Hussein bequeathed unpayable debts to Iraq.

For this reason, legal experts (for instance Lee Buchheit et al in the Duke Law Journal 2006) have pondered various doctrines of war debt, odious debt and hostile debt, under which certain kinds of debt – or perhaps all debts to certain kinds of government – might be written off. In 2008, the government of Ecuador did this unilaterally.

The trouble is that defining odious debt is contentious. Many governments that inherit odious debts pay them, figuring that the reputational benefits of doing so outweigh the costs (Mandela’s government is an example). Other governments may simply use the “odious debt” excuse to screw creditors, raising the cost of borrowing for governments in future – Ecuador’s default is cited as an example of this.

But there is an alternative. The idea was proposed by the economists Michael Kremer and Seema Jayachandran and has been taken up by the Center for Global Development, a think tank. The proposal is that the international community would declare that all future contracts with a particular regime would be non-transferable. Lend money to President Assad after such a declaration, and you can kiss goodbye to it if he is toppled; sign an oil-production sharing agreement with him at your own risk. (In practice, it is the US and UK, as hosts to most sovereign debt markets and courts, who would wield the biggest influence in such a declaration.)

This is an elegant idea. By drawing a clear line between existing debt, which is to be respected, and all future debt, which will be regarded as odious, it reassures creditors lending to the governments of poor countries. It frees innocent people from debts not of their making. And, cleverly, it undermines odious regimes by making it hard for them to promise credibly that they will repay their creditors.

Regular trade sanctions offer rich rewards to maverick states or private sector smugglers who circumvent them. An odious debt declaration is a kind of sanction that offers only headaches to the moneymen who might prefer to keep lending.

In truth, Damascus is already a pariah and has very little public debt, so this proposal is not relevant to Syria. But there are cases where the idea would have bite. Franco Tudjman’s government in Croatia, for instance, was cut off by the IMF in 1997, but turned to private creditors and almost quadrupled its borrowing that year. An odious debt declaration would have given those borrowers the creditors pause for thought.

Imposing sanctions of any kind is a policy with uncertain results. Yet a pre-emptive declaration of odious debt should at the very least make it harder for corrupt or repressive governments to borrow money. More to the point, it would mean that future generations were freed from the burden of loans that should never have been made.

Also published at ft.com.

The real estate rollercoaster as an actual rollercoaster

I saw this a few years back, and the data stop in 2006, but in many ways I think it works better that way. This is US data, and we know how the story ended in the US. In the UK I think we’d still find ourselves near the top, but what do I know?

Certainty over tax rules is overrated

‘The UK government is so shocked by a bank breaking a promise not to exploit a legal tax loophole that it is introducing retroactive legislation to block it.’

Is that a good idea?

What an unusual question! Most people I’ve spoken to feel the same way about retroactively taxing Barclays as they do about eating oysters – opinion is divided as to whether the concept is wonderful or nauseating and no conscious thought is required.

Yes, yes, we all know you economists are intellectually superior. Answer the question.

The immediate effect – assuming the whole affair doesn’t run through the courts for several years – is to transfer money to ordinary citizens from the employees and shareholders of Barclays. I would guess that this is moving money from richer people to poorer people although I haven’t seen data on that question.

Hurrah for that!

Perhaps. There are more straightforward ways to redistribute but let’s give it a hurrah for the sake of argument. The second-order effect is that banks and perhaps others may expect to pay more tax in future if they stay in the UK, or come to the UK. Some may leave, or decide never to set up here. The long-term effects of this are hard to fathom: businesses like to claim they are very footloose but not all are.

But so far these are just standard arguments for and against raising taxes. What about the retrospective action? Surely that sets an important precedent.

It’s not the first time it’s happened. A famous example is the case of Robert Huitson, a consultant who managed to route his tax affairs through the Isle of Man in such a way as to reduce his tax rate to less than four per cent. This was all legal until the Finance Act of 2008 retroactively outlawed the arrangement. Suddenly Mr Huitson’s legal tax avoidance was declared illegal tax evasion and the taxman promptly asked for more than £100,000 in back taxes. When Mr Huitson went to the High Court, he lost his case. Some 2,500 other tax-avoiders suddenly became tax-evaders, too.

I’m not sure how I feel about that. It seems harsh to retroactively change the rules. On the other hand, why should a well-paid person expect to get away with paying so little tax?

You’ve switched into oyster-eater mode.

Oh, shut up.

The High Court ruled that Mr Huitson’s human rights hadn’t been violated because the government had taken reasonable steps to balance his interests against the public good. In short, it wasn’t just an arbitrary confiscation of his property. But there is disquiet about this kind of thing from commentators, tax professionals and business leaders. The tax expert Professor Anne Redston said after the Huitson case that “as citizens, we have a right to know the legal position before making up our minds.” Jill Kirby, the Conservative Home columnist, called the Barclays affair a “tax grab” that would “lead to uncertainty”.

This creation of uncertainty is a key problem, isn’t it?

Everybody from Adam Smith on seems to think so. I am not so sure. Usually, uncertainty over tax is a problem. Entrepreneurs may be discouraged by the thought that the fruits of their risk-taking and hard work might arbitrarily be confiscated. Similar issues apply to people making any long-term plans. And, of course, frequent tax changes can have these harmful effects even if they are not retroactive.

But few people seem to have recognised that if the entrepreneurial activity in question is avoiding tax through artificial loopholes, it might be a very good idea to generate some uncertainty and give pause for thought. After all, customs officers prefer to search suitcases for heroin in an unpredictable fashion rather than giving advance warning.

That’s very different: heroin is illegal and the uncertainty is about whether you will get caught. We’re talking about uncertainty about whether the activity itself is illegal.

To a jurisprude, I am sure there is all the difference in the world. But I’m just a humble economist and from a pragmatic point of view the two scenarios are quite similar. I am not so worried about retroactive legal changes as such. The real damage would be caused if the authorities were wielding power arbitrarily and picking favourites. In the case of Mr Huitson, the High Court decided that they were not.

Also published at ft.com.

Boomtime for trying to fathom the bust

Economists from MIT and Yale attempt to untangle a crisis that has already lasted longer than the first world war

What is the best description of Gavrilo Princip’s notorious act, almost 98 years ago? “Moved his finger.” “Murdered the Archduke.” “Started the Great War.” “Ruined the 20th century.” None of them quite captures what happened, and the story of the war that followed can be – and has been – told in many different ways.

It is with something of this spirit that the economists Andrew Lo of MIT and Gary Gorton and Andrew Metrick of Yale attempt to untangle a financial crisis that has already lasted longer than that war. They do so in a pair of articles in this month’s Journal of Economic Literature.

Lo reviews 21 books about the crisis, 11 by academics, one by the former US Treasury Secretary Hank Paulson, and nine by journalists, including my colleague Gillian Tett. Gorton and Metrick take on 16 more technical pieces of research. Do they get any closer to the bottom of this complicated affair? A little, but the sheer variety of sources demonstrates the difficulty of the task – as does Lo’s decision to evoke Akira Kurosawa’s 1950 film Rashomon, an exploration of the shifting nature of truth. Unlike Kurosawa, though, all three academics believe that the truth can be uncovered with enough care.

One of the central questions concerns the nature of the initial credit crunch, in which financial institutions suddenly struggled to roll over short-term loans, or “repo” agreements that functioned very much like loans. Why?

One explanation is that repo markets suffered the wholesale version of an old-fashioned bank run; while banks had suffered real losses, the panic was out of all proportion to those losses. Instead, it was a self-fulfilling situation: quite rationally, nobody wants to be at the back of the queue when a bank run breaks out.

The alternative account is that the “originate-to-distribute” business model under which companies made loans, repackaged the loans and sold them on to others, was fundamentally flawed. It led to a catastrophic decline in lending standards, with both borrowers and lenders agreeing loans that were careless at best and fraudulent at worst.

Gorton – who developed risk models for American International Group, which was later bailed out by the US Federal Reserve – has been a proponent of the “bank run” view. With Metrick, he surveys research papers studying the panics. In the asset-backed commercial paper (ABCP) markets, it is possible to track many different “bank runs” – events when lenders refused to refinance maturing loans for particular bundles of assets. While these runs were often connected to fundamentals, in the initial credit crunch of August 2007, many runs broke out apparently at random. This, say Gorton and Metrick, was a panic phase of the crisis. It explains why trouble kept breaking out in parts of the financial system that were unrelated to the subprime mortgage sector that was the initial source of trouble. Lo is only partly persuaded by this – self-fulfilling panic had a role to play, he says, but that hardly puts the originate-to-distribute model in the clear.

Lo takes the time to debunk several pieces of received wisdom: that bankers were being paid to take excessive risks; that the efficient markets hypothesis led investors astray; and that in 2004 the SEC changed its rules and excessive leverage at banks was the result. All sensible claims, says Lo – but contradicted by the facts.

Not all is lost in the fog of war, though. As Gorton and Metrick point out, the institutional details of the crisis may be new and intricate, but its macroeconomic pattern – in particular, the housing bubble that preceded the crisis – is very familiar. The really striking thing about the crisis is not its familiar shape, but its gigantic scale.

Also published at ft.com.

My favourite quotes about failure

In celebration of the publication of Adapt in paperback in the UK, I’ve put together my favourite quotes about failure and adaptation. Enjoy!

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