Tim Harford The Undercover Economist

Articles published in June, 2014

A good economic bet

Pundits who make wagers may look grubby but at least they are accepting a cost for failure

Two economists disagree about the state of the economy. That’s not terribly surprising; you can insert your own joke here. Refreshingly, they’ve decided to put money on the table: instead of spouting hot air, they have made a bet. Bravo. More public intellectuals should follow suit.

Jonathan Portes is director of a UK think-tank, the National Institute for Economic and Social Research. Andrew Lilico runs Europe Economics, a consulting firm. Portes thinks that there’s plenty of spare capacity in the British economy, and that even as economic growth picks up, inflation will remain modest. Lilico disagrees. The men have staked £1,000 – inflation-adjusted, naturally.

The bet says (roughly) that once economic growth tops 2 per cent in the UK, inflation will exceed 5 per cent within 18 months. Economic growth has indeed picked up, so the bet is on and the clock is ticking. By October 2015 we should have a winner.

There is a long-running debate about whether this sort of wager is to be welcomed. Alex Tabarrok, an economics professor at George Mason University, is all in favour. “A bet is a tax on bull****,” he wrote after statistical journalist Nate Silver offered a wager on the results of the 2012 presidential election, with profits to go to charity. The New York Times public editor, Margaret Sullivan, disagreed. Silver was writing for the newspaper back then, and Sullivan declared it was “inappropriate” for journalists to be publicly wagering that their opinions were well founded.

Who’s right? Sullivan’s main argument against Silver’s wager was that it created the “appearance” of a conflict of interest. Albeit indirectly, Silver stood to profit from a victory for the Democratic Party, if only by avoiding having to make a charitable donation. Suddenly he was no longer disinterested. This is a shallow foundation for the case against public wagers.

And there are strong counter-arguments. Pundits who make wagers may look grubby but at least they are accepting a cost for failure. A more subtle advantage is that betting encourages forecasts that are specific and quantifiable.

This matters, because too many forecasts are both vague and consequence-free. A pundit can shoot his mouth off about what will happen in the future and nobody much cares. If the forecast should happen to come true, the pundit can revisit his words and claim to have predicted the financial crisis, the fall of the Berlin Wall or whatever. What’s more, many forecasts are hazy enough, especially on timing, to make them impossible to falsify.

Making a wager helps correct both these problems. A forecast that is specific enough to bet on is also specific enough to come true, or to fail. And for any wager, there is at least one person with an incentive to keep track of what happened.

The most famous bet about economics is that between Paul Ehrlich, ecologist, doomsayer and author of the massive 1968 bestseller The Population Bomb, and Julian Simon, an economist most famous because he persuaded Ehrlich to bet with him. Ehrlich believed that overpopulation would cause disaster and widespread scarcity. Billions would die, developed countries would disintegrate, India was beyond saving. Simon thought that people would find substitutes for scarce resources and that things would be fine.

The bet, however, needed to revolve around something specific. It was that the price of five metals would rise between 1980 and 1990 as scarcity continued to bite. Instead prices fell, dramatically. Ehrlich lost the bet. In some ways, this story shows the value of the wager. Because the bet was specific, we now know that Ehrlich was wrong and Simon, who died in 1998, was right.

Yet the tale of the Ehrlich-Simon bet is not entirely reassuring. The very fact that the bet was so specific means that long after Simon won, the argument continues to rage about whose worldview was truly correct. I have never met an environmentalist who was convinced by Simon’s victory that technology will save the world. And I have encountered many conservatives who seem to believe that because Paul Ehrlich was wrong about the price of metals in the 1980s, all environmentalists are wrong about everything.

Paul Sabin, a historian who wrote a book about the bet, argues that the affair brought more heat than light. He reports that Ehrlich took his loss with poor grace, sending Simon a cheque with no cover note. And Ehrlich seems unrepentant. In a recent interview with NPR’s Planet Money show, he said of the late Simon, “It’s hard to be more wrong… he knew absolutely nothing about anything important.”

This pigheadedness is disheartening but unsurprising. Perhaps the wager pushed each side into stubborn tribalism and encouraged a reductive view of complex affairs.

Yet on balance, the world needs more wagers between pundits. The alternative is intolerable: a world full of confident forecasts that nobody ever bothers to verify. The betting man must be thoughtful and specific or his wallet will suffer the consequences. We should all be quicker to ask ourselves before we open our mouths: would I be willing to bet on this?

Also published at ft.com.

There’s more to life than money

Too often the debate over public policy becomes a toy argument, dressed up as the grown-up version

Scottish voters are in the middle of an unseemly bidding war. With the referendum for independence scheduled for September, Scotland’s first minister Alex Salmond is trying to tempt the Scots by promising that they will each be £1,000 a year better off after independence. From London, the UK Treasury has a better offer: it forecasts a dividend of £1,400 per Scot per year if Scotland stays part of the United Kingdom.

As it happens, the big difference between the two forecasts is that the Scottish government forecasts that productivity growth will be 0.3 percentage points higher each year in an independent Scotland. (That is a lot.) A smaller difference is that while both forecasts assign most North Sea oil revenue to Scotland, the UK Treasury is pessimistic about the value of the dwindling resource.

But the weaselly details of all this need not delay us. It’s astonishing that instead of being wooed by romantic ideals expressed with passion, Scots are being promised cash. The debate over the future of the country is being conducted in a style worthy of a clearance sale at a furniture showroom. One can only imagine what politicians are like on a date – presumably they pull out a roll of banknotes and haggle over the hourly rate.

You might ask why an economist, of all people, is shocked by such behaviour. I think the reason is that it’s a superficial impersonation of what economics really is. My two-year-old son happily imitates mum and dad at the stove, but while a knee-high plastic kitchen range may look like the real deal to him, it is not. Too often the debate over public policy becomes a toy argument, dressed up to resemble the grown-up version with financial forecasts serving as the sparkly accessories.

Stated plainly, the Scottish government’s case is that an independent Scotland would enjoy high economic growth thanks to better economic policies. Any costs would be swamped by the benefits of this growth. That is not an absurd claim, although not everyone will find it persuasive. Economic numbers could, in principle, serve as a sanity check – but that is not why the numbers are there. Instead, they’re designed to divert scrutiny away from the plausibility of the underlying argument.

Scottish independence is one of countless examples of toy-oven economic analysis. Consider the old standby that some illnesses – diabetes, dementia, breast cancer – cost “the economy” billions of pounds per year. For example, the Alzheimer’s Society reports that dementia “costs the UK over £23bn a year” – a statement that could mean all sorts of things. Yale’s Rudd Center says that “obesity-related direct and indirect economic costs exceed $100bn annually”, which makes a bit more sense.

In the UK the cliché is that some disease is problematic because it costs the National Health Service money, as if an instant cure for all cancers is desirable largely because it would allow us to stop paying salaries to the radiologists.

There is certainly merit in conducting a cost-benefit analysis of medical treatments. If we understand how well they work and how severe are the symptoms they alleviate, we can set priorities. But something has gone wrong when we say that the problem with a heart attack is that it will be an expensive nuisance for the ambulance service.

Where did we go astray? Three sensible propositions from economics have somehow been crumpled into a mess of public relations and politics.

The first is that opportunity costs matter. Time, money and attention that are poured into something cannot also be lavished on something else. For this reason it’s good to get a sense of how much a proposal is likely to cost and what the benefits might be. But the cost-benefit figures often convey a sense of certitude that is absurd: they are only as solid as the assumptions and forecasts that go into them.

The second proposition is about reducing everything to money. It follows from the first: if you are going to compare the costs and benefits of different things, you need some common unit of measurement. This unit doesn’t have to be money. It is just as true for the UK Treasury to say that independence will cost every Scot the equivalent of one knickerbocker glory a fortnight. But money is a more convenient yardstick than an ice-cream sundae.

The third proposition is that it’s worth paying special attention to spillover costs and benefits. In arguing over HS2, the fantastically controversial proposal to build a faster railway line between London and Manchester, people speculated over the value to passengers of a faster journey. Economics suggests that’s the last thing we should fret about, because passengers can make those benefits known by buying tickets. It’s the costs and benefits for those who don’t buy tickets that need more scrutiny.

Costs and benefits matter, money is a handy measuring rod, and spillovers deserve special attention. These three principles should be respected – but that does not mean the way to make good policy is to stick a price tag on everything.

Also published at ft.com.

The four lessons of happynomics

‘Happiness is surely important, but the case for letting economists loose on the subject is less clear’

The discipline of happynomics (or to give it an academically respectable title, “the economics of subjective well-being”) is booming. Respected economists have joined the field, from Lord Layard in the UK to White House appointees such as Alan Krueger and Betsey Stevenson. Several have been charmed in by Daniel Kahneman, a widely admired psychologist with a Nobel Memorial Prize in economics.

Happiness is surely important, but the case for letting economists loose on the subject is less clear. So are happyconomists discovering things that will put a song in your heart and a smile on your face? Perhaps. After reading a stack of books about the economics of happiness, and seeking advice from some of the researchers involved, allow me to present four tips for happiness from the dismal science.

Number one: don’t be distracted by the obvious. When buying a new car, it’s natural to imagine yourself thrilling to its acceleration. When buying a new house, it’s only human to ponder the pleasure of hosting guests at a summer barbecue on the patio. But such thoughts fall prey to what psychologists call “the focusing illusion”. Most of our time will be spent neither throwing summer parties nor overtaking lorries. Yet we’re swayed by these attractions because we’re focusing on them just at the moment that we decide.

The focusing illusion was splendidly captured by a pair of questions asked of college students by researcher Norbert Schwartz and others: “How happy are you?” and “How many dates did you have last month?” The research team discovered that people having a lot of dates also say they’re feeling very happy – but only if asked about the dates first. If the happiness question comes first, there’s a far smaller correlation between the answers. Those students asked initially about their love lives continued to think about them when pondering their happiness. Otherwise they might have been worrying about money, career or exams.

The focusing illusion lies in wait for us whenever we make a decision. Nattavudh “Nick” Powdthavee, an economist and author of The Happiness Equation, says that we have to try to “look beyond what’s salient about an experience”. Don’t just think about the obvious when making decisions; think about how day-to-day life is likely to change as a result – if it changes at all.

The second piece of advice is to pay attention selectively. It turns out that we grow accustomed to some conditions, happy or unhappy, but not to all.

The study which sparked the idea that we can get used to almost anything was published by Philip Brickman, Dan Coates and Ronnie Janoff-Bulman in 1978. It compared the happiness of paraplegic and quadriplegic accident victims to that of lottery winners – and discovered that the disabled people were scarcely less happy than the millionaires. Apparently we can bounce back from some awful experiences. (It is sad and troubling that a few years after making this discovery, Brickman killed himself.)

But how exactly is this apparent process of habituation supposed to work? Here’s where happiness economics has the long-run data to help. Consider bereavement: we cope by paying less attention as time goes by. A friend said to me, months after my mother and his father had both died, “You don’t get any less sad when you think about them but you think about them less often.”

The same is true, alas, for the nice things in life: we begin to take them for granted too. But there are experiences – unemployment is one of them; an unhappy marriage another – that depress us for as long as they last. What those experiences seem to have in common is the ability to hold our attention. Commuting, although shorter and less serious, is a classic case – annoying but also stimulating enough that we keep noticing the annoyance.

This suggests that we should look for the opposite of commuting: positive new experiences that are engaging enough to keep being noticed. In this case “count your blessings” is perfect advice.

Third, try nudging yourself to happiness with the techniques of behavioural economics. Paul Dolan, another economist and the author of the forthcoming Happiness by Design, advocates doing some preparation to make it easier to do what brings us joy. If you wish to read more, for example, set your browser home page to a book review site, leave books lying around your house and make a commitment to visit a literary festival. Make the new habit easy to do and hard to ignore.

Finally we must keep a sense of what’s possible. I asked Daniel Kahneman himself for his advice, and he made some evidence-based suggestions about the importance of friends and family. But he also pointed out that much of our happiness seems genetically predetermined. It’s possible to give good advice, he said, but “we shouldn’t expect a depressive person to suddenly become extroverted and leaping with joy”. In happiness, as in life, we economists must know our limits.

Also published at ft.com.

An astonishing record – of complete failure

‘In 2008, the consensus from forecasters was that not a single economy would fall into recession in 2009’

In the 2001 issue of the International Journal of Forecasting, an economist from the International Monetary Fund, Prakash Loungani, published a survey of the accuracy of economic forecasts throughout the 1990s. He reached two conclusions. The first was that forecasts are all much the same. There was little to choose between those produced by the IMF and the World Bank, and those from private sector forecasters. The second conclusion was that the predictive record of economists was terrible. Loungani wrote: “The record of failure to predict recessions is virtually unblemished.”

Now Loungani, with a colleague, Hites Ahir, has returned to the topic in the wake of the economic crisis. The record of failure remains impressive. There were 77 countries under consideration, and 49 of them were in recession in 2009. Economists – as reflected in the averages published in a report called Consensus Forecasts – had not called a single one of these recessions by April 2008.

This is extraordinary. Bear in mind that this is not the famous complaint from the Queen that nobody saw the financial crisis coming. The crisis was firmly established when these forecasts were made. The Financial Times had been writing exhaustively about the “credit crunch” since the previous summer. Northern Rock had been nationalised in the UK and Bear Stearns had collapsed in the US. It did not take a genius to see that trouble was on the way for the wider economy.

More astonishing still, when Loungani extends the deadline for forecasting a recession to September 2008, the consensus remained that not a single economy would fall into recession in 2009. Making up for lost time and satisfying the premise of an old joke, by September of 2009, the year in which the recessions actually occurred, the consensus predicted 54 out of 49 of them – that is, five more than there were. And, as an encore, there were 15 recessions in 2012. None were foreseen in the spring of 2011 and only two were predicted by September 2011.

Predictions from multinational organisations such as the IMF and the Organisation for Economic Co-operation and Development have remained very similar to the private sector consensus – similarly bad, that is.

We should not blame economics alone for our inability to peer into the future of a complex world. In 2005, Philip Tetlock, a psychologist, published a landmark work with the title Expert Political Judgement. Tetlock found that throughout the 1980s and 1990s, political and geopolitical forecasts had been scarcely better than guesswork. It made little difference whether the forecaster was an academic, journalist or diplomat, a historian or a political scientist. Forecasting is difficult, it turns out. (Supply your own punchline.) As for Tetlock, he is currently conducting a follow-up study to see whether forecasting practices can be saved.

Why are forecasts so poor? The chief explanation is that the economy is complicated and we don’t understand it well enough to make forecasts. We don’t even fully understand recent economic history.

Ben Chu, economics editor of The Independent, recently took a look at the UK recession of the 1990s in the light of two decades of data revisions. From the vantage point of 1995, the economy in late 1992 was slightly smaller than the economy in early 1988. But today’s best guess is that the economy of late 1992 was almost 6 per cent larger than in early 1988. The Office for National Statistics has substantially revised its view.

Not only is it difficult to forecast the future, then – forecasting the past isn’t straightforward either. What chance does any prognosticator have?

A second explanation for forecasting’s fallibility is that there is little incentive to do better. The kind of institutional chief economist whose pronouncement makes it into Consensus Forecasts will stick to the middle of the road. Most countries, most of the time, are not in recession, so a safe strategy is never to forecast one. Of course there are the mavericks who receive media attention for making provocative predictions and are lionised when they are right. Their incentives are different but it is unclear that their overall track record is any better.

The obvious conclusion is that forecasts should not be taken seriously. There is not a lot of point asking an economist to tell you what will happen to the economy next year – nobody knows. It is still a source of constant wonder to me that the demand for forecasts – in economics and elsewhere – remains undiminished.

John Maynard Keynes famously looked forward to a day when “economists could manage to get themselves thought of as humble, competent people, on a level with dentists”.

It’s a nice piece of self-deprecation, but it’s also an analogy worth exploring. We don’t expect a dentist to be able to forecast the pattern of tooth decay. We expect that she will offer good practical advice on dental health and intervene to fix problems when they occur. We should demand much the same from economists: proven advice about how to keep the economy working well and solutions when the economy malfunctions. And economists should bear in mind that no self-respecting dentist would be caught dead forecasting when your teeth will fall out.

Also published at ft.com.

Don’t blame statisticians for counting the wages of sin

Officials used to size up economies like butchers size up cows, writes Tim Harford

The good news is that the UK economy is about to surge by 5 per cent. The bad news is that this surge does not actually reflect economic growth but a change in statistical definitions. And the weird news is that this is happening in part because EU statistical guidelines demand that spending on cocaine and hookers be reflected in the UK’s official statistics.

Feel free to raise one eyebrow at this point. Recall that Greece’s economy grew overnight by 25 per cent after the country’s official statisticians included sex work and illegal drugs as part of their estimates of economy activity – a move that, by an astonishing coincidence, flattered the country’s budget deficit. That was in September 2006; the story has not gone well since then.

It is certainly true that the Office for National Statistics has only the vaguest sense of what is going on in the British economy’s nether regions. (Individual statisticians with a sense of adventure may know more, of course, but their observations are unlikely to be statistically reliable.) Most recreational drugs are illegal in the UK, while sex work is on the margins of legality. One suspects that not every transaction for sex or drugs is faithfully recorded on a tax return.

The ONS has made valiant assumptions in estimating that 60,879 sex workers are each employed 1,300 times a year at an average rate of £67.16. If true, that is an industry big enough to allow every man in the country between the age of 15 and 64 to visit a sex worker every three months. We might quibble that the ONS has no idea, really, how big these black-market businesses really are. Dr Brooke Magnanti, author of The Sex Myth – and pseudonymously of various memoirs of her time as a sex worker – is not impressed with the ONS’s methodology. “Why not ask escorts themselves? It’s not as if we’re hard to find,” she has written.

She may be right – but even if the ONS does not know exactly how big the sex industry is, we can be pretty sure that the answer is not “zero”. The ONS estimates are surely an improvement on what went before.

Critics will feel this is missing the point. Why should we celebrate drugs and sex work by immortalising them in the national accounts? Are politicians now to subsidise Rizla and Durex in the hope of boosting our economy further? But such criticism is confused in a way that affects far more than this particular statistical revision.
“The critics of GDP give it too much credit. It is not the guiding star for economic policy, public morality, or anything else”

We need to understand three things about gross domestic product statistics. First, GDP itself is ineffable – an attempt to synthesise, for practical purposes, something that defies description. Second, the national accounts are not designed to give a round of applause to the good stuff and a loud raspberry to the bad stuff. They are supposed to measure economic transactions. And, third, anyone who thinks politicians try to maximise GDP has not been paying much attention to politicians.

A hundred years ago, if you had asked someone, “how is the economy doing?”, nobody would have understood what you were saying. Back then economists might have tried to track the production of coal or the number of people with jobs. Yet the idea of putting all economic transactions into one big conceptual pile and trying to measure how big the pile was – that is a newer and quite radical invention. When economists such as Simon Kuznets first tried to calculate national income back in the 1930s, they were trying to understand the malfunctions of the Great Depression, and to measure the productive potential of an economy that was gearing up for war.

This number-crunching has always had a purpose. Governments used to size up economies like a butcher sizes up a cow; suddenly they were taking measurements the way a doctor takes a pulse. William the Conqueror’s Domesday Book, the definitive record of land ownership in Norman times, was replaced with the ONS’s Blue Book of national accounts. The organisation’s new efforts are designed to figure out how much money is being earned and spent – partly for the purpose of international comparison – and it is perfectly right that this includes all voluntary transactions, even undeclared or outright illegal ones. Let others argue over whether sex work and drug taking should be prosecuted or liberalised.

This error goes back at least as far as a speech given by Robert Kennedy in March 1968. The presidential candidate pointed out that official measures of economic output include napalm, nuclear warheads, cigarette advertising and jails – but not “the beauty of our poetry or the strength of our marriages”. It is a wonderful speech but like many wonderful speeches contains a rhetorical bait-and-switch. If poetry is dying and divorce is too common, that is not the fault of the statisticians.

If politicians truly aimed to maximise GDP, George Osborne, UK chancellor of the exchequer, would never have launched an austerity drive, there would be no subsidies for renewable energy, unemployment benefits would expire quickly if they existed at all, and everybody would be clamouring to increase immigration. There is more to life than mere prosperity and there is more to prosperity than GDP growth – and much as our politicians are a woeful gaggle of incompetents, even they seem to grasp that, both in their words and in their actions.

The critics of GDP give it too much credit. It is a painstaking attempt to try to measure the total production of the economy. It is not the guiding star for economic policy, public morality, or anything else.

Sex work and mind-altering substances have been around a long time. After this statistical tweak, it cannot be long before someone starts pointing at the pimps and the pushers, and blaming their existence on the Office for National Statistics.

Also published at ft.com.

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