Tim Harford The Undercover Economist

Articles published in May, 2015

Society of Business Economists writing prize

I’m delighted to report that the Society of Business Economists has awarded me the  Rybczynski Prize for 2014-15. This is the society’s annual prize for the best economics writing of relevance to a business audience. It”s a great honour.

26th of May, 2015MarginaliaComments off

Why democratic elections are always flawed

I sometimes wonder if we expect more than we should from democracy

Most Britons are unhappy with the result of the UK general election. That is the logical conclusion, given that 63 per cent of voters cast their vote for someone other than David Cameron’s Conservatives. Nevertheless, the Conservatives surprised even themselves by winning more seats than every other party put together.

From the point of view of the losers, this state of affairs seems outrageous. It is sometimes said that splits on the left of British politics have prevented what should have been a solid leftwing majority and allowed the rightwing views of a minority to prevail. Yet the right is also split: the Conservatives and the UK Independence Party attracted more than 50 per cent of the vote between them. Leftwingers frustrated by the election result should blame the voters before they blame the voting system.

Critics of the British voting system do have a point. An analysis by Jack Blumenau and Simon Hix of the London School of Economics suggests that the disparity between votes cast and seats won has been widening for many decades, the consequence of the large number of votes now cast for smaller parties.

Since each seat is decided separately, votes cast for losing candidates simply do not count. It is possible to stack up a hefty pile of such votes while winning only a single seat — just ask Ukip’s Nigel Farage, who failed to be elected despite leading a party that attracted 3.9 million votes. The Conservatives earned about 34,000 votes per seat won, and Labour about 40,000 votes. The Scottish Nationalists needed just 26,000 votes per seat. Nick Clegg’s derided Liberal Democrats required more than 300,000 votes for each of their eight seats. Supporters of both Ukip and the Liberal Democrats might well feel disenfranchised, as might the Greens and the many Scots who voted for parties other than the SNP. Still, rules are rules and everyone knew the rules before they started to play the game.

Yet rules can be changed. And perhaps they should be. But to what? Clever schemes abound: the D’Hondt method offers something close to proportional representation while maintaining a link to local constituencies; the Borda count attempts to measure the strength of preferences; the alternative vote, AV, is designed to allow people to cast a conditional vote for whichever of several parties might find itself with a chance of winning.

AV was decisively rejected by the British in a referendum in 2011. But perhaps referendums themselves need looking at. Consider a referendum on an issue such as gay marriage. A small number of people — gay people who might wish to get married — have a tremendous interest in liberalisation. But no matter how strongly they feel, they get just a single vote each and so they have had to wait while the weakly held views of the majority slowly move in a tolerant direction.

Glen Weyl, an economist, argues that in such cases we might want to hold a referendum that allows people to express their strongly held beliefs by buying multiple votes at increasing cost: one vote costs $1; two votes cost $4; 1,000 votes cost $1m. Weyl calls this idea “quadratic voting”. It has some appealing theoretical properties but to the layperson it looks alarming. Expect to see it used in TV talent shows.

I am all in favour of improving institutions when we can but I sometimes wonder if we expect more than we should from democracy. There are two deep reasons why democratic elections are always flawed.

The first is that voters are, quite rationally, rather ignorant about politics. Sensible people vote to express themselves or out of a sense of duty, not because they harbour the illusion that it might be their vote that swings the entire election. Quite sensibly, then, people who devote hours to researching a new phone will not waste time researching which party to support.

The second reason is Nobel laureate Ken Arrow’s “impossibility theorem”, one of the most celebrated and misunderstood results in economics. Arrow’s theorem is often described as showing that there is no voting system that will reflect what society truly prefers. Arrow actually showed something more profound: that it makes little sense to speak of what “society truly prefers”. That very idea is incoherent. And those who expect that a democratic election will ever give society what it “truly prefers” will have to get used to disappointment.

Written for and first published at ft.com.

Tax: a Scandinavian solution

‘With tax, our politicians seem determined to make the process as clumsy and painful as possible’

If a politician was a surgeon, faced with the task of amputating your leg, we can well imagine how it would go. First he’d deny that he planned to amputate the leg. Then he’d pass a law making it illegal to amputate the leg. Then he’d say that he’d amputate an investment banker’s leg instead. Finally, he would blame the mess handed to him by the previous surgeon and would begin to rub away at your toes with a cheese grater.

So it is with taxes. It’s no fun paying them but public spending must be paid for somehow. Yet our politicians seem determined to make the process as clumsy, painful and disingenuous as possible.

This may be because politicians see taxes purely in political terms. They believe that the deep problem with taxes is that people do not like paying them, which is why they say, instead, that the taxes will be levied only on multinational corporations, investment bankers and tax dodgers of all stripes. Politicians placate angry voters with tax exemptions and deductions. All this is politically understandable but has the effect of making the taxes much more damaging than they need to be.

The true problem with taxes is quite different. It is that in an effort to pay less tax, people do some extraordinary things. Most obviously and controversially, they’ll adopt odd legal labels that have the effect of reducing their tax bill. Some are fiendishly complex international schemes, playing different tax treaties off against each other and generating corporate profit that each tax authority deems is someone else’s problem. Others are quite simple. All of them are unfair, and all of them generate paperwork.

A second problem, less fussed-about but probably more serious, is that people will change their behaviour rather than just the legal description of that behaviour. For example, some new mothers who want to work will stay at home rather than hire childcare out of heavily taxed income. The mother doesn’t get the career she wanted, and the taxman doesn’t get the tax revenue. Nobody wins.

Two articles in last year’s Journal of Economic Perspectives explore how governments might get more serious about raising taxes. One, by Gabriel Zucman, emphasises that the complexity and inconsistency of different tax systems allow wealthy individuals and multinational companies to exploit cross-border loopholes and avoid tax. Zucman’s calculations suggest that US companies are increasingly booking their profits in what he calls “the main tax havens”, jurisdictions that housed about 2 per cent of US corporate profits in 1984 but 18 per cent in 2013.

But one way to look at the problem of levying high taxes is to ask who has solved it. The answer: Denmark, Norway and Sweden. US tax revenue is about 25 per cent of GDP, the UK and Germany at about 35 per cent, and the Scandinavians at about 45 per cent, according to economist Henrik Jacobsen Kleven. Somehow the Scandinavians have managed to raise large sums from their citizens without destroying their economies. How?

That’s the question that Kleven sets out to answer and, of course, the answer is partly cultural. It is also partly about the comprehensive tax reporting in Scandinavia, which makes outright evasion very difficult. Norwegian tax returns are published for all to examine. (No wonder Gabriel Zucman dreams — perhaps implausibly — of a global financial registry to help track down tax dodgers.)

Not everyone will feel delighted about an all-seeing government determined to invade privacy in the name of higher taxes. But there are other elements of Scandinavian taxation that any government might want to emulate: Scandinavian countries minimise the distortions of their tax system by avoiding the bad habits of politicians in other countries.

Chief among these habits is targeting a narrow tax base. The US tax system is full of ad hoc deductions and exemptions. The UK system needlessly excludes swaths of the economy from tax. Rather than charge a 10 per cent rate of VAT on everything, the UK government charges a 20 per cent rate of VAT on roughly half of what consumers spend. The Danes have a much broader VAT base, and a higher rate too.

The simplest way to broaden the tax base is to dismantle barriers to getting a job. Scandinavian governments subsidise education, transport and care for children and the elderly, all of which help people to work who might otherwise find themselves stuck at home. As a result, even high taxes do not keep them out of the labour market.

That makes sense. If the surgeon really is going to amputate your leg, having a prosthetic replacement would be wise.

Written for and first published at ft.com.

Solve this puzzle and win a Dom Reilly bag

Tim Harford will be interviewing University of Chicago economist Richard Thaler about his new book Misbehaving on stage in London on June 10. Please visit live.ft.com/richard-thaler for more details.

In anticipation of this event, Professor Thaler is setting FT readers a challenge, revisiting a puzzle he set them once before, in 1997.

The task is simple: choose a number between 0 and 100, and supply a short justification for your choice. The winner is the person whose number is closest to two-thirds of the average of all the entries. For example, three entries are submitted: 20, 30 and 40. The average is then 30 and the winning entry is 20, being exactly two-thirds of the average.

In the event of a tie, the prize will go to the person who submits the best justification. Prof Thaler’s decision is final.

The prize for the winning entry is a luxurious weekend bag designed for the FT by Dom Reilly — lightweight, elegant and exquisitely handcrafted in brown full-grain leather with subtle FT branding.

Please send your guess and your justification to: email hidden; JavaScript is required

Competition ends May 31. T&Cs apply. ft.com/thalerconditions

The problem with sexed-up statistics

‘Statistics tell us nothing until we understand what is being counted in the first place’

Men think about sex every seven seconds. Eighty-four per cent of women are emotionally unsatisfied with their relationships. Single people in the United States have more sex than married people do. Sixty-nine per cent of people over the age of 35 have had extramarital affairs. People have 40 per cent less sex now than they did 20 years ago. Truth, or myth?

A new book by statistician David Spiegelhalter, Sex by Numbers, runs a statistical comb through our collective sex lives. His book is largely designed to teach us about sexual behaviour — who is doing what with whom and how often — but along the way he manages to impart some important statistical lessons too.

Lesson one is that statistics tell us nothing until we understand what is being counted in the first place. To ask how old people are when they start having sex, or when they stop having sex, or how many sexual partners people typically have, we need a generally agreed definition of “having sex”.

We should not take for granted that we all mean the same thing when we talk about sex. Just ask Bill Clinton, who notoriously declared “I did not have sexual relations with that woman, Miss Lewinsky.” When it later became clear that he had received oral sex from her, he apologised for giving a misleading impression but maintained that “my answers were legally accurate.”

Clinton’s carefully chosen words were in tune with the way most people used language. A survey of US college students conducted in 1991 found that only 40 per cent of them reckoned that oral sex counted as “sex”. (The US Senate implicitly reached a similar conclusion in clearing President Clinton of perjury.)

While Clinton exploited ambiguity, modern scientific surveys of sexual behaviour try to eliminate it. According to definitions used by the UK’s well-regarded National Survey of Sexual Attitudes and Lifestyles, Natsal, Clinton did have sexual relations with Miss Lewinsky.

A second lesson is that we should pay attention to whether statistical work has been done carefully or casually. Consider Time Out magazine’s finding that people have sex 10 times a month if they are in a relationship, though only five times a month if they are married. This is twice as much as more credible surveys have found. As Spiegelhalter observes, Time Out’s method can only tell us about the sexual claims of people who go out of their way to fill in sex surveys. Spiegelhalter is similarly dismissive of the “Trojan US Sex Census”, which announced that Los Angeles was the most sexually active city in America with 135 sex acts per person per year. While a great source of publicity for a manufacturer of condoms, the people who fill in Trojan’s survey don’t represent the rest of us.

Some of the most famous sex researchers are also limited by a lack of representative sampling. Alfred Kinsey found that 37 per cent of men had a homosexual experience resulting in orgasm; Shere Hite reported that 95 per cent of women experienced “emotional and psychological harassment” from their male partners. The underlying research here was politically groundbreaking but we cannot have too much confidence that these numbers are correct.

Hite, for example, distributed questionnaires through university women’s centres, abortion rights groups and other women’s groups; the response rates were less than 5 per cent, making it unclear whether respondents were typical of women as a whole. Kinsey was on the lookout for interesting sexual case histories and so sent his researchers to prisons and to bars famous for being gay meeting places. He may well have captured a broader range of sexual behaviour as a result but at the cost of a representative sample. As the great mathematician John Tukey once told Kinsey, “I would trade all your 18,000 case histories for 400 in a probability sample.” If the aim is to judge what is going on in the population as a whole, Tukey was right.

To revisit the factoids in the first paragraph: most are unproven, the results of unrepresentative surveys. The “seven seconds” claim is an urban myth and provably nonsense. But the final discovery — that we are having 40 per cent less sex — is true. According to the rigorously collected Natsal survey, heterosexually active people aged 16-44 typically had sex five times in the past month back in 1990. By 2010, the number had fallen steadily to three times. Perhaps the next Natsal survey will be able to figure out why.

Written for and first published at ft.com.

What a radical Conservative government could do

‘Scrap all mainstream benefit payments — jobseeker’s allowance, child benefit, housing benefit and even the state pension’

Last week I described Anthony Atkinson’s proposals for reducing inequality. Atkinson — a professor of economics at Nuffield College, Oxford — proposes substantially higher income tax rates for everyone earning more than £65,000, a much higher minimum wage, guaranteed public employment, an expansion of universal benefits and much else. It is the agenda one would expect of a courageous Labour party, which of course places it a long way from the agenda that the actual Labour party is proposing.

It seems only fair, then, to offer the same service to the Conservatives: on the off chance that we ever see an economically radical Tory party, what policies might I suggest they embrace?

Step one is to replace the benefit system with a more libertarian form of redistribution. Scrap all the mainstream benefit payments — for example, child benefit, jobseeker’s allowance, housing benefit, winter fuel allowance and even the state pension. Scrap the income tax allowance too. Give all long-term UK residents a taxable basic income of £8,000 a year and charge a flat 40 per cent income tax rate on every penny. The basic income can be phased in on a residency basis over 10 years, ensuring that recent immigrants pay a larger net contribution to the exchequer.

This policy targets poverty rather than inequality. It abolishes much of the bureaucracy that surrounds benefit eligibility, promotes individual responsibility and reduces the stigma of collecting money from the state. It gives everyone, rich and poor, a clear incentive to work. Compared to the current system, it redistributes to the working poor and to the highest earners — both groups of people who are likely to produce more taxable income in response. It is simple, discouraging tax avoidance. And, despite the flat headline rate, the average income tax contribution is progressive: negative for those on low incomes, 10-25 per cent for those on average incomes and approaching 40 per cent for the rich.

People with unusual needs — the severely disabled, for instance — would be helped by a multibillion-pound fund with considerable discretion to make direct cash payments or commission assistance from charities.
A second policy is to privatise the entire school system. Children would receive a £10,000 basic income in a tax-sheltered educational account controlled by parents but usable only for childcare, school or university fees. Compulsory schooling would end at the age of 14 and educational institutions would be competing to attract these pots of tax-free cash with engaging and practical training courses. Any unspent money would be taxed and handed over to the child at the age of 21.

Third, scrap the personal pension system. Both the logic for and the reputation of the existing system is in tatters. With the new flat tax and universal basic income it would also be superfluous. People can save for their retirement in more flexible Isa-style savings accounts and could be nudged into doing so by a default payroll deduction.

A fourth policy must involve the housing market. The current cluster of housing policies (“cluster” is a polite abbreviation for a more appropriate term) ensures slow growth, resentment of immigrants, a crippling housing-benefit bill, inequality growing through luck rather than hard work and innovation, and the direction of potentially productive savings into accumulating unproductive housing wealth. This is a multifunctional policy indeed.

Given that housing benefit is to be abolished by this radical government, there is an urgent need to build large numbers of houses. This would boost the economy and reduce the price of new homes. One possibility, proposed by the Centre for Policy Studies, is the establishment of “pink zones” with lighter planning regulation (the colour represents a dilution of red tape). In these zones, substantial increases in housing could be achieved by a coalition of local authorities, community groups and developers.

However the trick is pulled off, the government must create the conditions for a housing boom — 400,000 new homes a year for five years would do to begin with. It’s ambitious, but necessary after decades of insufficient building.

A final idea: look to broaden the tax base and lower tax rates. Abolishing all VAT exemptions would be a good start, and would provide substantial revenue. A carbon tax would also be well worth introducing, as would more proportionate taxation of housing wealth. The proceeds of these taxes would be needed at first to pay for the universal basic income but the aim would be to reduce universal income tax rate too. A future leftwing government could redistribute within the same framework by increasing the basic income.

That should do the trick for the first term but a Conservative government should also commit to staying in the European Union, which stands in favour of trade, business and hard money; and to leaving the National Health Service alone for a few years just to see how it performs when not being incessantly prodded by politicians.

There you have it: a smaller, less bureaucratic state, innovation in education, redistribution to the poorest, a lower but more transparent income tax to attract the rich, an economic boom on the back of much-needed home-building and affordable housing for all.

Conservative Central Office can thank me later.

Written for and first published at ft.com.

5th of May, 2015Undercover EconomistComments off

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