Tim Harford The Undercover Economist

Articles published in February, 2013

Wave the jazz hands and hope for the best

Politicians hope that voters are clueless about tax, writes Tim Harford

‘Ed Miliband … put the wealthy on notice that a future Labour government would squeeze the rich with a £2bn tax on expensive homes to fund a revival of the 10p starting rate of income tax, axed by Gordon Brown’
FT.com, February 14

A Valentine’s day massacre for the rich, eh?

More like an ill-judged romance with an old flame. Mr Miliband’s 10p proposal repeats an error committed by Denis Healey in 1978, Norman Lamont in 1992 and Gordon Brown in 1999. It’s a pretty basic howler but what’s more interesting is that politicians are so determined to learn nothing from history.

First tell me why it’s a bad idea.

My colleague John Kay explained this elegantly on Wednesday, but in a nutshell there are two problems. One is that many people earning low incomes are not poor; they are, for instance, the second earner in a two-income household. It’s the benefits system, not the tax system, that is designed to take this into account. Even more fundamentally – it’s a matter of simple arithmetic – it is always more advantageous to people with lower incomes to increase the personal allowance, rather than introduce a new low-rate tax band. Raising the personal allowance is simpler and more progressive than introducing a 10p tax band, while the surest way to reach the needy is through benefits reform.

So why is the 10p tax band so hard to kill?

It’s possible that Mr Miliband hasn’t given a moment’s thought to how taxes actually work. It’s more likely that Mr Miliband reckons voters haven’t given a moment’s thought to how taxes actually work. And Mr Miliband may be right. The way tax policy is conducted in this country is farcical – a point made in an exasperated policy brief issued this week by the Institute for Fiscal Studies.

Ah, the IFS! The nation’s favourite Budget-kibitzers.

I wonder if the IFS isn’t fed up of playing that role. Everybody likes to see it pick apart the details of the latest Budget or Autumn Statement. But when it published a grand treatise on tax reform, “Tax by Design”, a few years ago, nobody cared. This is a symptom of a serious political malaise. The tax system should be just that – a system, with interlocking parts working together to achieve an overall goal. Instead the tax system is a labyrinth for ordinary users, a money factory for the tax advice industry and a stocking full of miscellaneous goodies for successive chancellors of the exchequer. Twice a year, whoever is chancellor has to produce some tempting giveaways, all calculated for their political effect, while desperately clawing back the revenue as he hopes nobody is looking.

So what’s the solution?

Politically, I have no idea. But economically, it’s easy to point out some basic features of a sensible tax system. Some are obvious: keep it simple, for instance, and avoid perverse incentives. But what is less obvious is the tax system needs to be considered in its entirety. At the moment each change to taxation is served up by a hopeful chancellor, jazz hands waving as he waits for applause. The change is then picked apart as though the rest of the tax system did not exist.

For example?

Take the withdrawal of child benefit from households with a high earner. The measure was messy and has been costly to prosperous, fecund people of a certain age while leaving many other prosperous people untouched. The changes were justified on the grounds that they were progressive, and indeed they were. But whether an individual tax is progressive or not is not the point: the question is whether the system as a whole is progressive. We want – and can have – a tax system which is fair, provides reasonable incentives (discouraging smoking and carbon emissions while encouraging education and pension saving) and yet is not too Byzantine. But to make each individual tax meet these standards in isolation is unnecessary, absurd and impossible.

And yet having each tax examined in isolation is the inevitable consequence of chancellor’s twice-yearly party pieces.

Yes. Intriguingly politicians do now try to link one tax with another – as Mr Miliband has done, promising to pay for his unwise 10p tax band with a tax on expensive property. But these pairings are arbitrary and cosmetic. Assembling a coherent system seems to be beyond the wit of today’s politicians, and as long as we all treat each Budget as a bullet-point list of grabs and giveaways, we will deserve the scrappy tax system we have.

Also published at ft.com.

Changing channels: why TV has had to adapt

Technological change has swept through broadcasting as surely as it has through music and newspapers

What does Strictly Come Dancing have in common with Mad Men? Not a lot, you might think – and before hearing Joshua Gans speak recently at a seminar on broadcasting, I would have agreed with you. I now think otherwise.

Technological change has swept through broadcasting just as surely as it has through music and newspapers. In the case of broadcasting, however, the process has been more gradual. In the 1970s, British television was funded either by advertising or by the licence fee, and whatever you watched, you watched when it was broadcast. Both these facts changed long before most of us had heard of the internet.

The two technology-based changes have been the emergence of subscription-only channels, and the development of time-shifting technologies to allow TV to be consumed on demand. First there was video but now we can watch the television on the internet, and pause or fast-forward with digital recorders.

Gans, an economist at the University of Toronto and the author of Information Wants to Be Shared, argued that time-shifting in particular was doing interesting things to the economics of broadcasting. First, consider advertising revenue: time-shifting makes it easy to avoid adverts, which undermines the traditional ad-funded model. However, there are some events that most people demand to watch live: sporting events, of course, but also talent shows and reality TV. These are events that our friends and colleagues will talk about and if you don’t watch live, you will miss out. Such programmes remain attractive to advertisers.

Gans argues that a great deal of information has a social context: we want to recommend what’s good and we need to hear recommendations to figure out what to watch. One only need contemplate “Gangnam Style” or Fifty Shades of Grey to see that this is true, but the story is older and more subtle then we tend to acknowledge.

Ponder the resurgence of complex, almost Dickensian story arcs in the unexpected form of the television series. From The Sopranos to Lost, 24 to Breaking Bad, over the past decade or so, the extended, sophisticated narrative has come to a TV near you. Previously only soap operas would attempt such a sprawling form, and then only on the understanding that anyone could switch on at any time and grasp what was happening. The idea of putting on a series that becomes baffling to occasional viewers was regarded as commercial suicide.

But while time-shifting technology has pushed ad-funded television towards live events, it has also provided a foundation for complex storylines. Thanks to DVDs and digital recorders, people can catch up on what they’ve missed. Because the intricate plots are addictive, they are a natural fit with DVD box sets or cable TV.

Game of Thrones or Mad Men rely on social networks just as surely as Britain’s Got Talent does, but in a different way: if the first three episodes were amazing, word will spread and people who initially missed out will catch up. In the first case, the social pressure to watch live is used to foil the ad-skipping time-shifters. In the second case, it’s time-shifting that makes it possible for word of mouth to build.

Some formats sit uneasily with either model. A standalone documentary or sitcom offers neither the addictiveness of the extended series, nor the immediacy of sport or reality TV. The golden age of the sitcom is, perhaps, behind us. And it did not escape my notice that the kind of news coverage that really matters – thoughtful, analytical, investigative – also fits poorly. Perhaps in the future all TV news will take the form of either epic narrative documentaries, or helicopter chases.

Also published at ft.com.

Don’t blame Ofcom if the 4G price isn’t right

It’s almost 13 years since the UK government raised £22.5bn in one of the biggest auctions of all time, for the right to use radio spectrum for 3G mobile phone services. The next big thing, 4G, has been auctioned for around a 10th of that price, and a third less than the sum the Treasury had pencilled in. What went wrong?
Some say that’s the wrong question: several telecoms analysts claim that the low prices will result in a better deal for consumers, which makes me wonder if they have their wires crossed. Consumer prices are determined by competitive pressure and the marginal cost of supplying services, not by one-off upfront costs. That’s the theory, anyway. For a change, theory and reality are in step: despite the stratospheric price that phone companies paid for the 3G licences, mobile phone services in the UK are cheap.
The lower than expected 4G auction price, then, is bad news for the taxpayer, good news for shareholders, and irrelevant to consumers. And it can’t be a huge shock, because estimates for the 3G auction revenue were even more inaccurate, even if the surprise there was a pleasant one. If we had known what the auction price was going to be, we wouldn’t have needed an auction. The whole point of the auction is to reveal how much bidders want the prize, and to charge them accordingly.
But could Ofcom have designed the auction better? Not obviously so. Good auction design is not magic: it’s about preventing cheating and attracting serious bidders. The 3G auction designers had an opportunity to raise silly money during a bubble, and they did not squander that opportunity. The 4G auction designers lacked the same good fortune, and the merger of two major competitors, T-Mobile and Orange, will not have helped.
The 4G auction, a fancy thing called a “combinatorial clock”, split the available spectrum into bite-sized chunks, each with its own price. Bidders revealed which chunks they wanted at prevailing prices, and prices for the most-demanded chunks rose quickly. Rather than dropping out entirely, the major bidders gradually shrank their demands until everyone could be accommodated. Collusion can never be ruled out in such auctions, but a plausible explanation for the lowish price is the simplest one: bidders simply decided that they could curtail their ambitions if it meant saving money.

First published at ft.com.

The lesson from Poundland: work pays

The UK government is in a muddle over employment schemes, says Tim Harford

‘Ministers are trying to get back-to-work schemes on track after a university graduate won a court ruling that making her work for no pay at a Poundland store was unlawful.’

Financial Times, February 13

A blow struck for human rights against forced labour!

Hardly. That sort of talk was dismissed by an earlier court ruling. Cait Reilly had argued that the European Convention on Human Rights forbids “forced or compulsory labour”. The back-to-work scheme does not say “work in Poundland or go to prison”, but “work in Poundland or have your benefits withdrawn”. The courts felt there was a difference. (The Department for Work and Pensions tried hard to lose the case by referring to some of these schemes as “mandatory work activity”.)

So why are we hearing that the government lost the case?

The new ruling comes from the appeal court, which agrees that nobody’s human rights have been violated, but argues that the regulations underpinning these schemes are too vague. The government has responded with new rules. Let’s see how it works out. An interesting question is whether such schemes are a good idea.

How would you propose to produce an answer?

I don’t need to. The DWP has an answer for the Community Action Programme, which is the obligatory six-month work placement that was the scheme experienced by Ms Reilly’s joint appellant, Jamie Wilson. The CAP was subjected to the fairest evaluation available, a randomised controlled trial. It concluded CAP participants were no more likely to find a job than the control group. Perhaps the CAP could be regarded as a success in other ways, but a failure to help people find jobs is hardly an endorsement.

What would you suggest instead?

This is where the data speak volumes. Take the Future Jobs Fund, for example. It had similar aims to the CAP – to give six months’ work experience – but it worked differently, by subsidising employers who gave young people a job that pays at least the minimum wage. The subsidy lasted for six months, and a lot of the jobs disappeared when the subsidy did. Yet a DWP evaluation showed impressive effects, with participants more likely to have a job 18 months after their subsidised work had ended. The cost-benefit analysis of the FJF was favourable, too. Perhaps it was more effective than the CAP because the FJF jobs were, well, real jobs, with pay for the employee and a cost to the employer.

And the Future Jobs Fund was, presumably, legal?

Who cares? It was scrapped before the evaluation had been completed – the prime minister told the BBC it was “one of the most ineffective job schemes there’s been”.

Awkward.

Yes. It is ironic that this is one of the few areas where the government is carrying out rigorous tests of what works, and yet few people seem interested in what those tests discover.

There’s a moral issue here: we can’t allow people to mooch around on benefits without looking for a job.

Agreed, and that seemed to be what was behind the mandatory work activity. But the DWP seemed confused. The MWA was used to remind disengaged benefit claimants that job-seeking is a serious business, and yet official policy was that it was never to be used as a threat.

So it was some kind of punishment that could neither be introduced after a warning, nor introduced with no warning?

No wonder the courts thought it was too vague. But on the “mooching” point, Jobcentres can always threaten to withdraw benefits. Workfare schemes can’t be justified as a threat, then, only as a way to help people find jobs. The evidence they do doesn’t look encouraging. Intriguingly, the government’s Behavioural Insight Team has been running a trial with a Jobcentre in Essex, where the advisers on the ground floor use the old approaches and the advisers on the first floor use a new approach, and jobseekers are randomly assigned to the two floors.

What are the new approaches?

First, to streamline form-filling so that advisers can use the first meeting to talk about jobseeking strategies. Second, to discuss specific jobseeking actions over the coming weeks. Third, some touchy-feely stuff about expressive writing. The trial suggests this combination of approaches is effective. In fact the whole thing looks so successful that it can only be a matter of time before the programme is cancelled.

Also published at ft.com.

Why short-sellers get short shrift

These ‘men without bowels’ are more likely to be the prompt discoverers of bad news than the inventors of it

No economist could remain unmoved by the brouhaha that has engulfed Herbalife, the nutritional supplements company. The sponsors of football teams such as Barcelona and LA Galaxy, it sells diet drinks and protein bars through a network of small distributors, many of whom recruit, train and supply further distributors. This may be an intelligent way of selling the product through word-of-mouth. But doubters wonder whether Herbalife isn’t too reliant on distributors filling their spare bedrooms with protein shakes, which they hope to sell at a profit by recruiting yet more distributors.

In May last year, a hedge fund manager called David Einhorn asked a few pointed questions on a Herbalife investor conference call, wondering how many final customers Herbalife actually had. Herbalife’s share price promptly fell by a fifth. Einhorn has a reputation as a savvy sceptic, and had made a very public bet against Lehman Brothers a few months before the company imploded. Another short-seller, Bill Ackman, recently took a large short position, and then argued at great length that Herbalife was a pyramid scheme. Herbalife denies this vigorously.

It’s not just Herbalife’s reputation that is at stake here: it’s that of short-selling, a practice that has been controversial since 1610, when it was banned, after somebody tried to short the Dutch East India Company.

The emotional case against short-selling was caricatured perfectly in Fred Schwed’s classic book, Where Are the Customers’ Yachts? “At the very moment we were buying that stock, hopefully and constructively, looking forward and upward toward better things, those fellows, men without bowels, were selling it and they didn’t even have it to sell!”

Short-sellers seem bad because they’re hoping for bad things to happen. Now this is true but irrelevant – unless the short-sellers cause the bad things to happen in the Wall Street equivalent of an insurance job. This has always seemed a risk for banks, because banks depend on the confidence of their funders. If it became widely believed that a particular bank would collapse tomorrow, the bank would collapse today. Perhaps short-sellers could destroy a bank, and profit from its destruction, simply by convincing others that the bank was doomed. Perhaps.

It’s even less clear that short-sellers can cause permanent harm by saying cruel things about a strong company. Herbalife should be at little risk – unless it really is a pyramid scheme, in which case a lack of confidence in its business model could become self-fulfilling. But while Ackman’s criticism did dent the company’s share price, the shares quickly recovered and it was higher at the start of this year than it had been two years previously.

Economists have long suspected that short-sellers are more likely to be the prompt discoverers of bad news than the inventors of it. And we now have some data. After the collapse of Lehman Brothers, many countries restricted short-selling – but at different times and for different classes of shares. Two economists, Alessandro Beber and Marco Pagano, used the variation produced by this patchwork response to filter out the impact of the bans. They concluded that the bans made stocks less liquid, slowed down the price discovery process and, mostly, failed to buoy prices.

In short, the bans were counter-productive. Several other pre-crisis studies reached similar conclusions.

Short-sellers have a powerful argument in their defence: who else has an incentive to spend millions of dollars uncovering frauds and letting the air out of bubbles? We could have done with more early scepticism of Enron and Bernie Madoff, of Wall Street, mortgage-backed securities and the dotcom mania. The “men without bowels” should be allowed to continue their dread work.

Also published at ft.com.

The astonishing life of Bill Phillips

This is the latest video from the recording of my my radio series, “Pop Up Economics“. (Alternative link to watch.)


Raising the stakes on life’s big choices

Using a coin-flipping website, an experiment aims to investigate how people make the most important decisions

A few minutes ago, I made up my mind to toss a coin to decide whether or not to leave my wife. It was Steve Levitt’s idea.

I should explain that Levitt, an economist most famous for co-writing Freakonomics, would regard that coin toss as noise in his data. In collaboration with John List, a fellow professor at the University of Chicago, Levitt is offering the blessed release of the coin to people everywhere who cannot decide whether to quit their jobs, leave their partners, have children, move cities, quit drinking or even get tattoos. It’s all in the name of social science.

Here’s how the research project works. If you’re having trouble with one of life’s big choices, you sign up at FreakonomicsExperiments.com, choose your dilemma, fill in a short survey, promise to abide by the coin’s decision, and the website will flip the coin for you. Later, the research team will email a survey to ask whether you followed the coin’s advice and how things are working out.

It’s tempting to treat the whole thing as a joke or a publicity stunt (the website is, after all, lavishly branded). But Levitt maintains that the research intent is serious, and I am inclined to agree.

Here’s the problem for social scientists everywhere: we just don’t know much about how people make big decisions. We can analyse everyday behaviour, but that means simply observing correlations with little idea of what might be causing what. Or we can bring people into the psychology lab, but laboratories are artificial environments. Laboratory experiments tend to involve small decisions for small stakes. Sometimes they involve hypothetical decisions for no stakes at all. Levitt’s colleague, John List, has been a pioneer in developing field experiments with more realistic contexts, but even then it is hard to study the really big choices in life.

Hence, the Freakonomics coin-toss website. Levitt hopes to find people who are genuinely undecided – the “marginal” decision makers – and, as he asks, not unreasonably, “who could be more marginal than the kind of person who comes to a website to flip a coin to try to decide whether to leave his wife or not?” If Levitt and List do attract the genuinely undecided, they will be able to observe genuine causation in action: was asking for a raise the right decision or not?

You might reasonably wonder what could be learnt, even if Levitt and List do get enough people to toss the coin and follow through. But there are natural hypotheses worth testing. Do we believe the grass is always greener? Or do we prefer the devil we know?

Levitt is bullish about the project. After I admitted I couldn’t make up my mind whether to take it seriously or not, he reckoned that if the website attracted a decent number of serious users it would be “some of the best research I have ever done”. It would certainly be an original angle on an important set of problems. I asked Levitt if he’d ever read The Dice Man, but he hadn’t heard of it. Luke Rhinehart’s shocking novel is about a man who frees himself from social convention by submitting to the will of the die. (Should he rape his next-door neighbour? The die says yes.)

Feeling unnervingly like The Dice Man myself, then, I logged on to FreakonomicsExperiments.com to find out whether to leave my wife. I am, admittedly, exactly the wrong experimental subject because I have quite firm opinions on the pros and cons of the decision, but I wanted to see how the process worked. I filled in a few quick questions about our ages, races, marital history, children, stepchildren, household income; then I had to tick some boxes and write a couple of sentences reflecting on why I was considering leaving my wife and how the prospect made me feel.

And then I tossed the coin.

Also published at ft.com.

A terrific windfall for the big spenders

Kuwait’s debt plan illustrates oil’s mixed blessings, says Tim Harford

‘Kuwait is considering plans for a $6bn consumer debt write-off that would be the latest mass official bailout of Gulf citizens who have broken the region’s harsh debt laws and sometimes ended up in jail.’

Financial Times, February 7

I know George Osborne likes to talk about paying off the nation’s credit card, but this is something else.

It’s a bit more literal. It may not happen, though: much the same plan was tabled three years ago and it went nowhere. That said, some Gulf states do seem to have their share of spendthrifts. One bank official in the United Arab Emirates complained that “many people don’t know how to use the credit card . . . They treat it as free money.”

If the government swoops in and pays off the bill then treating it as free money seems a sensible approach. It’s unfair on people who saved money instead of spending it.

Yes, it’s a dreadful way of dealing with consumer debt. You can see such bailouts sow the seeds for future problems. Not that we can feel too smug in the UK. If you want to talk about moral hazard and bailouts, just look at the banking system of the western world. And if you want to fret about savers being penalised while borrowers are coddled, quantitative easing and the Funding for Lending scheme are pretty effective at that. Kuwait might be talking about rescuing its debtors; in the UK, it’s the official policy of the fiscal and monetary authorities.

Can we just get back to chuckling at foreigners? That feels a little more comforting.

The Gulf states do have a tricky problem, it must be said. All that oil and gas isn’t necessarily an advantage. Economists and political scientists even talk about the “resource curse” – the idea that striking oil might do more harm than good.

Why would that be?

There are various theories. One is that the oil exports cause the exchange rate to appreciate, and that makes it unprofitable to develop alternative export industries. If a country’s exporters begin making bicycles, they may learn to make cars. If they do some software outsourcing, that may develop into a large industry. But if the country’s main export is oil, it’s going to be hard to learn to do much except spend the cash.

Doesn’t sound too bad.

No – until the oil runs out or the oil price collapses, and you have no plan B. And even while the oil money flows in, it may be unevenly distributed and corrosive to the political system – which is a second reason why oil may be bad news. It’s a great prize for an unelected ruler, a wonderful help to anyone who wants to stay in power. You get economies built on patronage – or worse, corruption – rather than economies in which entrepreneurs are rewarded.

Is there an alternative, then? Norway seems to be doing just fine.

Norway has the world’s largest sovereign wealth fund – more than $650bn, according to the SWF Institute. Such funds are very sensible, like everything else in Norway. They spread the resource windfall out over a longer period, rather than just blowing the cash on a single generation. If the money is invested outside the country, they also prevent the woes of exchange rate appreciation. Unfortunately simply deciding to have an SWF is no guarantee of good sense. The fund’s controllers must resist the temptation to build record-breaking skyscrapers in the middle of low-rent deserts – or indeed, the temptation to pay off everybody’s credit cards every few years. No doubt this is easy if you happen to be Norway.

Is there an alternative to the alternative?

Another possibility is to take the oil revenue, divide it up equally and pay the cash into each citizen’s bank account every year. If the government needs revenue it must then tax the citizens and develop an accountable tax-collecting civil service. The system is more transparent. Citizens may even be more sensible with the money than the government is. For instance, during the coffee price surge of the late 1970s, most African governments grabbed the windfall revenues through taxation, if they did not already own the coffee industry outright. The revenues were rarely well spent. But in Kenya, the money stayed in the private sector and coffee farmers saved the money, having deduced that coffee prices wouldn’t stay high forever.

Sounds great.

Quite so, and I am sure ruling families across the Gulf will implement this policy shortly after the turkeys vote “yes” in the great Christmas referendum.

Also published at ft.com.

9th of February, 2013Since You AskedComments off

The Asch Conformity Experiment

This is a classic and well worth your time.

Pop-Up Economics, Pulp-O-Mized

Pulp-O-Mizer_Cover_Image

The Pulp-O-Mizer. More about Pop-Up Economics.

 

7th of February, 2013MarginaliaRadioComments off
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