Other Writing

From a series of 10 ideas for business, FT Magazine

Failure has always been a fundamental part of a market economy. When markets work, they do so because new ideas are constantly being tried out. Most fail. Those that succeed cause older ideas to fail instead. In the US, about 10 per cent of businesses disappears each year. This is an awkward insight – but trial and error could be starting to take its rightful place as a business technique, rather than the dirty little secret of capitalism.

There are some hopeful signs. Stefan Thomke of Harvard Business School has argued that advances in computation have made it possible to experiment on new products as a matter of course, trying many things and expecting many failures. It is now easy, for example, to experiment with changes in the layout of a website, showing different configurations to different visitors and tracking results in real time. Google, meanwhile, routinely launches new products with a “beta” label on them. And academic superstars such as Steven Levitt, co-author of Freakonomics, have been teaching executive courses in business experimentation.

We are also starting to learn more about the psychology of learning from mistakes. Richard Thaler, the behavioural economist behind Nudge, coined the phrase “hedonic editing” to describe our habit of lumping small losses together with larger gains in order to mask the pain of the loss. Sugar-coating is human, but it’s also a recipe for failing to learn from failure. Thaler, with colleagues, even studied the behaviour of contestants on Deal or No Deal. He discovered that people who had made unlucky choices then started to take reckless risks, which often compounded the error.

It’s hard to learn from failure if it briefly robs us of our judgment. As we start to understand why trial and error is so painful a process, we may be able to use it more constructively. The financial crisis has made us aware that a system that cannot tolerate a bit of failure is a dangerous one. The idea that an institution was “too big to fail” used to sound reassuring. Not any more.

FT Comment – 25 February 2010

We are sometimes admonished: “Don’t shoot the messenger.” Since there is rarely a logical reason to shoot messengers, such advice should not be needed. But it is, because bad news hurts, and organisations find it difficult to deliver such news to the person in charge.

Andrew Rawnsley’s account of Gordon Brown’s premiership has received attention for its claims that Mr Brown was abusive and physically threatening to his staff, grabbing lapels, stabbing upholstery with his pen and causing his advisers to cower for fear of violence. If true, that is disturbing – but few people will have found it surprising. High-status men sometimes do abuse that status.

I am worried not so much that Mr Brown may be beastly, but that he is cutting himself off from good advice. Mr Rawnsley describes Mr Brown’s fateful decision to pull back from a widely trailed snap election in late 2007. His inner circle waited until he was out of the room before agreeing that such a course would be disastrous. When the prime minister reconvened the meeting, however, this was not conveyed: “No one expressed a clear view. No one wanted responsibility for the decision.”

This is a more significant anecdote than any tale of flying spittle. Any leader needs frank advice, and the biggest obstacle to receiving it is often the leader himself. Even a polite and level-headed boss will be tempted to cut naysayers out of the loop. Knowing this, sensible juniors will avoid expressing criticism or grim tidings if at all possible.

“If you deliver bad news, you’re disempowering yourself,” says Professor David Sims of Cass Business School. “You’re less likely to be listened to in the future.” For some ambitious subordinates, this is a far worse fate than the threat of being thumped.

A new reality television show, Undercover Boss – which has migrated to the US after airing on Britain’s Channel 4 last summer – tries to tap into the dissonance between bosses and front-line staff by filming as a senior executive works incognito in the trenches. It is a delicious premise.

When bosses must don a disguise to learn about how their organisations really work, trouble is in store. Read the rest of this entry »

First published in Business Life, May 2009

Office life may not be a game, but it is a tournament. Economists use the word “tournament” to describe situations where the winner – or a few winners – walk off with the rewards. A race to develop a patent for a new drug is a tournament. Fund managers scoop the lion’s share of customers by beating the market, rather than delivering objectively excellent returns.  And many offices promote or pay bonuses to those who outperform their peers. Sometimes the competition is subtle and implicit, at other times brashly celebrated – but it’s all a tournament.
Tournament pay makes sense from the point of view of employers, and goes some way to explaining the frustrations of office life. (Some key predictions of tournament theory: when there is more luck involved, bonuses have to be bigger to have a motivational effect; bosses need to be paid vast and largely unearned bonuses to motivate their underlings; and when the incentives are sharp enough, workers will deliberately sabotage each other. Is it all starting to make sense?) But one interesting question is hard to answer: how does tournament pay affect the risks that people take? This is a tough question because it is generally hard to observe risk-taking directly.
Two economists, Christos Genakos of Cambridge and Mario Pagliero of Turin, have discovered an exception: professional weight-lifting contests. Because weightlifters announce in advance the weight they will attempt, it’s possible to observe people taking risks by lifting heavier weights. With data from 17 years of competition, the researchers are also able to track individual weightlifters across time and see whether they behave differently in different situations.
They conclude that more prestigious tournaments, such as the Olympic games, encourage more risk-taking. They also conclude that people take more risks when close to but outside a medal position. Tournament leaders play it safe, and so do those completely out of contention. Competitors lying in sixth place are most likely to go for broke.
This finding is a lot more potent given the context of a banking crisis which is blamed in part on a bonus culture that encouraged bankers to take too many risks. While popular anger is focused on the sheer scale of bankers’ bonuses, many economists are concerned that naïvely-designed bonuses may have contributed to the crisis.
As Genakos and Pagliero comment, “tournaments can be too successful in encouraging risk-taking… while this may be ideal in sport, in which suspense and extraordinary performances are what the spectators want, it may not be so desirable in firms”. Ouch.

This Christmas, will you buy your loved ones presents that they may not like? Or will you slip them some cash instead? Neither option has much appeal. A gift of money, unless to a much younger relative, looks lazy and even patronising. Yet many people are incompetent present-buyers: Read the rest of this entry »

First published in Business Life, April 2009

Deciding how much to charge customers is a crucial decision for most businesses, and many devote huge effort to complex pricing schemes. Not all, though: some businesses turn the whole task over to customers. “Pay what you want” seems to be a new business fashion – but is it taking customer sovereignty too far? And is the model sustainable?
Pay what you want has two clever features. The novelty attracts customers and publicity, too. And affluent or price-insensitive customers tend to pay more. Any well-run business will try to offer low prices only to customers who demand them, not to every customer; pay what you want might achieve the same result without the fuss.
The Achilles heel of pay what you want is, of course, blindingly obvious: what if people don’t want to pay anything at all? No wonder the model has caught on in two very specific contexts: digital goods such as music files, software or blogs; and cafés or restaurants. With digital goods, the cost of providing an extra copy is close to zero, and collecting real money is difficult thanks to piracy and a customer base that is used to getting what it wants without paying. Inviting contributions is better than nothing. In a café, customers are used to tipping staff and find it hard to accept service from a smiling waitress and then pay little or nothing. Honour – or guilt – can be a powerful motivator. So can social norms: Americans, well used to tipping, were reported to have paid much more than others when invited to pay what they wanted to download Radiohead’s album “In Rainbows”.
My concern is that when the novelty wears off, pay what you want will collapse as a model, at least for restaurants and cafés. Not only will the free publicity ebb away, but there is every reason to suppose that customers will start to exploit the offer. The economists John List and Uri Gneezy have carried out an experiment that sheds light on this tendency. They hired temps to perform various tasks, and paid some of them well above the hourly wage that had been agreed. The question was whether the workers would put in extra effort out of guilt or simple gratitude. The answer: yes, but the effect wore off in a matter of hours. Selfish exploitation of the generous wage became the norm by lunchtime on day one. I suppose if the same thing happens to restaurant owners, they can always install a cash register.

Superfreakonomics: Global Cooling, Patriotic Prostitutes and Why Suicide Bombers Should Buy Life Insurance
By Steven D. Levitt and Stephen J. Dubner
Allen Lane £20, 288 pages

For fans of the multimillion-selling pop-economics book, Freakonomics, all that needs to be said is that the sequel’s title is an accurate description. This book is a lot like Freakonomics, but better.
The original, a runaway hit, had its genesis in Stephen Dubner’s masterful New York Times Magazine profile of “rogue economist” Steven Levitt. “Rogue” may be stretching it a bit, because Levitt is, in fact, a garlanded and hugely influential professor at the University of Chicago.
He has applied his statistical techniques, now much emulated, to unconventional topics such as the link between abortion laws and crime, or whether sumo wrestlers cheat (they do, he concludes). The 2005 book that resulted was wide-ranging, fascinating and above all, likeable – however, it showed signs of haste, and it was never clear whether it was supposed to be a book by Steven Levitt or about him.
Book cover of ‘SuperFreakonomics’ by Steven D Levitt and Stephen J DubnerSuperFreakonomics offers much the same range and amiability, but is more polished. The book’s chapters cover prostitution; data analysis in healthcare and counter-terrorism; altruism; innovation; and geo-engineering. The reader may not guess the central topic from the chapter titles or the opening pages, however, which betray a fondness for springing surprises and putting twists in the storytelling.
Detours are all part of the style; an afternoon reading SuperFreakonomics is like one of those thrilling and occasionally frustrating conversations where ideas tumble out so quickly that they keep interrupting each other. In short, the book’s organisation is deliberately on the freaky side, but if you simply resolve to read it from cover to cover you are guaranteed a good time.
My favourite chapter describes the research of John List, a colleague of Levitt’s, as he zaps some of the most famous results in behavioural economics. In the “dictator” game, well-known in economic circles, player A is given $10 by the experimenter and told they can keep it all. Alternatively they can give some to anonymous player B. Many players do, indeed, hand over money, a finding that troubles conventional economic theory.
List thinks many researchers have embraced this finding too easily, however. “What is puzzling”, he comments, “is that neither I nor any of my family of friends (or their families and friends) have ever received an anonymous envelope stuffed with cash”. The lab experiments, in which large numbers of students display a preference for sending cash to anonymous strangers, need to be questioned more closely. Yet List showed that with small modifications to the dictator game, experimental subjects could be persuaded not only to curb their generosity, but to confiscate cash from others.
There is much more here, and all is told with verve and care. Levitt and Dubner have a gift for explaining precisely how a researcher discovers something. Their epilogue, on Keith Chen’s attempts to introduce currency to a monkey society, is a model of how to tell a gripping story of scientific research without compromising on accuracy.
The most eye-catching chapters in the book are the first, on prostitution, and the last, on global warming. The chapter on prostitution flits from academic research into street prostitution, carried out by Levitt and sociologist Sudhir Venkatesh, to an engaging profile of a high-end escort and various digressions into the economics of gender and other topics.
One of these asides provides the book’s best moment: when the authors demonstrate that a prostitute gets more money through the use of a pimp than a homeowner gets through the use of a realtor, or estate agent. The financial impact of a pimp is greater than that of a realtor, “Or, for those who prefer their conclusions rendered mathematically, PIMPACT > RIMPACT.”
Those with a prurient curiosity (I am guilty), will find some of the descriptions of what prostitutes do all day rather coy. Those with an interest in the economic angle (guilty, again), will find some questions unanswered.
“The real puzzle isn’t why someone like Allie becomes a prostitute, but rather why more women don’t choose this career,” Levitt and Dubner write. Do tell, thinks the reader, but they don’t, even though literature on the puzzle does exist. The leading research on the question is written by two women, not two men, a fact that some people will find relevant.
The analysis of street prostitution is based on careful academic work. The account of high-end prostitution is merely a journalistic profile of a single successful and intelligent woman. But Levitt and Dubner seem to have decided that while data-driven discoveries are generally wonderful, you can have too much of a good thing.
The authors claim to prefer data to “individual anecdote”, but part of the secret of their success is that they like a good story more than anyone.
As for the final chapter on global warming, it is a striking discussion of geo-engineering, surveying various schemes for cooling down the planet rather than trying to prevent climate change by cutting carbon emissions. This is a strong story, but it is also one-sided, portraying the geo-engineers as brilliant iconoclasts, dismissing the objections to geo-engineering as the knee-jerk reaction of the unreflective, and failing to convey the views of a single credible geo-engineering sceptic. A well-deserved swipe at Al Gore does not really count.
According to this chapter, the only reason everyone is making so much fuss about carbon dioxide is that they’ve never heard of geo-engineering, or are the kind of stubborn Luddites who think technology never solved anything. I have some sympathy with that view but the section nevertheless needed more balance.
In the end, a book such as SuperFreakonomics stands or falls on its entertainment value. And on that count, there’s no doubt: it’s a page-turner.
More revealing, though, was that I’d folded over at least a dozen pages, resolving to go back, follow up the references, and find out more. This is a book with plenty of style; underneath the dazzle, there is substance too.

First published at ft.com.

Q&A with Malcolm Gladwell, in Waterstone’s Books Quarterly

Malcolm Gladwell uses the techniques of a fiction writer to make his ideas persuasive, as he explains to Tim Harford

What the Dog Saw, your forthcoming book, is a collection of writing for the New Yorker. You describe it as an attempt to understand the contents of other people’s minds. What do you mean?
One of the great continuing source of mystery and excitement for human beings is the understanding we reach at a very young age is that other people’s minds are different from our own, and what we think is not what the world thinks. I think in one form or another the fascination that the world looks different through the minds of others continues indefinitely. In my writing I’m often trying to put myself into the mind of someone who has some kind of specialised perspective.

My favourite article is about Million Dollar Murray: it’s both an unforgettable story and a powerful idea about the statistics of social problems. When you’re writing this kind of essay, what comes first – the story or the theory?
In that case it was the theory. I had been chatting with homelessness advocates and came across this argument they were making that it costs more to neglect homelessness than to cure it. Now it seems obvious, but it had never occurred to me. Once I had that extraordinary fact it was just a matter of finding Murray. But since almost all chronically homeless have the same problems as Murray, finding Murray was no great feat.

You’ve become famous for your public lectures. How do the lectures and the writing influence each other?
The lecture is a great laboratory for storytelling. The lessons you learn fit beautifully in your writing. I recently gave a lecture in Glasgow and it didn’t quite work; then I gave the talk in Brighton and I fixed it. There’s no way that if you’re writing you can do that. If I was writing I would just have handed in the Glasgow draft and never had a chance to improve.

To read more, follow the link.

First published in Business Life, April 2009
Next time you’re at a computer, try typing “QWERTY”. You shouldn’t have too much trouble finding the keys: QWERTY, with minor international variations, is the universal standard for English keyboards.
An economist is the kind of person who thinks it’s worth asking if we got it wrong. Is QWERTY a good way of arranging the keys on a keyboard, or is it a historical accident that slows us all down? There’s more at stake than typing speeds. Whenever different standards collide – Mac versus PC, VHS versus Betamax, Blu-Ray versus HD-DVD, eBay versus QXL – economists worry that we might become “locked in” to an inferior standard when it attains a critical mass of users.
That’s certainly the received wisdom about QWERTY. Typewriters were originally fragile mechanical constructions, and it’s often said that the QWERTY keyboard was designed to slow down typists in the hope of preventing keyboard jams. In the computer age such jams are no problem, and slowing down typists simply seems perverse. But who wants to be the first to retrain himself to use a better, faster keyboard – and then struggle every time he moves employers or tries to use an Internet café? There are better ways to arrange the keys – such as the “Dvorak” keyboard, which, according to wartime trials by the US Navy, was so fast that typists could recoup the time and trouble of retraining within just ten days. If only we could all agree to make the leap at the same time, we could be plugging Dvorak keyboards into our computers and be reaping the benefits within a fortnight.
Not everyone buys the story of QWERTY lock-in. The American economists Stan Liebowitz and Stephen Margolis call it “The Fable of the Keys” – pointing out that the evidence for Dvorak’s superiority is sketchy. (That Navy test? Conducted by a certain Lieutenant Commander August Dvorak, who owned the patent…) For Liebowitz and Margolis, network lock-in is an interesting theoretical possibility, but in practice they argue that people find a way to move to the new standard.
An intriguing new experiment supports that idea. Tanjim Hossain and John Morgan recruited Hong Kong students and paid them money if they were successfully able to coordinate on the same “platform” – an abstract representation of the choice between standards such as a Blu-Ray or an HD-DVD. What really mattered was to choose the most popular platform, and the students did that – but they also managed to coordinate a move to the higher-quality choice, even if they had started off on the low-quality platform.
Oh, and when you do type QWERTY, you’ll discover that while the keys are easy to find, they’re hard to hit because they’re so close together. Perhaps putting common letters on opposite sides of the keyboard wasn’t such a stupid idea after all?

First published in the Sunday Times, 9 August 2009

Spend less time with your children. Don’t underestimate the benefits of a divorce. Never serve dog food at a dinner party. These are some of the unexpected revelations to have emerged from an unlikely combination: happiness, and economists.
You might think that the “dismal science” has done enough damage for now. Economists have hardly emerged from the banking crisis with their reputations enhanced. But forecasting financial meltdown was never going to be easy, so perhaps it is best of economists stick to simpler questions, such as “how can we be happy?”
A growing number of economists have been attempting to answer this question. Not only are the statistical tools of economics surprisingly well-suited to unlock the secrets of happiness, but the research topic is good box office, too… and these are economists we’re talking about.
Some of the results sound as though they come from hippies rather than economists. For instance, economic growth does not seem to make the citizens of a rich country such as the UK any happier. A good job too, considering the current prospects of any economic growth seem slim.
Other discoveries are less intuitive. For instance the economists Andrew Oswald and Nattavudh Powdthavee has discovered that teenagers and the elderly are actually rather happy. “Your late 30s are the most unhappy period of your life,” Oswald cheerfully tells me. Thanks, Professor, from a grateful 35-year-old. Read the rest of this entry »

Published in The Globe and Mail in Canada, and ABC Unleashed in Australia:

Think of the ideal advice columnist, duty-bound to help correspondents with their problems at home, at work, and in love. What kind of person comes to mind? Caring? Honest? Wise? Whatever your answer, I’m guessing it didn’t involve the phrase “professionally trained economist”. Whatever: here I am, the only economist in the world to run a problem page – “Dear Economist” in the Financial Times – dedicated to making my readers’ personal lives better.

I’ll admit that it is not immediately obvious what an economist might have to say about parenting, the intricacies of etiquette or the dark arts of seduction. Even at our best, we economists seem too perfect, too rational, to understand mere human weaknesses. You might as well consult Mr Spock for dating advice as ask an economist. And at our worst, we appear hopelessly naïve, emotionally tone-deaf, and bordering on the sociopathic.

And let us be honest, at times my advice column persona has lived up to that caricature. When a woman wrote to me confessing that she enjoyed the dating game but was afraid she might leave it too late to settle down, I didn’t offer a sympathetic ear, but a handy explanation of the theory of optimal experiments. When a dinner party guest wondered how much he should spend on wine, I reached straight for the Journal of Wine Economics. Every advice columnist needs a persona, and for “Dear Economist” it was blunt, rude, and rather fond of the latest economic research.

As “Dear Economist”, I was never supposed to offer good advice. The whole thing was a joke, with a predicted shelf-life of about six months. Six years later, my inbox is still full of readers’ queries, and I am still handing out advice. Hopefully it still makes my readers laugh. But – and here’s the strange thing – I am starting to wonder whether some of it is actually pretty good advice, too.

There is something about the cold eye of economics that lends itself, quite unexpectedly, to the advice-column format. Economic theories are ruthlessly reductive, cutting away complexity to reveal some hidden truth. If we’re honest, most advice columns are reductive, too. And economists have an advantage over most advice columnists, because we have access to the most bizarre (and yet carefully peer-reviewed) research, based on the latest data.

Some of it falls under the category of “nice to know”. Imagine: your marriage isn’t working out and you’re seriously considering divorce. What should you do? Well, research from the British economist Andrew Oswald helpfully points out that most people tend to be happier a year or two after their divorce than immediately before it. (This is not true for bereavement, by the way.) So perhaps you should go ahead.

Some of it we can file under “can’t make it up”. The American Association of Wine Economists just published an informative research paper entitled, “Can people distinguish pâté from dog food?”. Sadly, they can: even if puréed to look like chicken-liver pâté and served chilled with a parsley garnish, dog food tastes terrible. A shame, but useful to know if you were thinking of cutting corners at your next dinner party.

And some of it? Well, some of it turns out to be important. One young man wrote to me to ask if he should switch high schools. He provided a long list of good reasons to switch but was still hesitating. I diagnosed “the endowment effect”, a tendency to stick with the devil you know that is well known to economists, and told him to switch. He did, he then got into Cambridge University, and recently wrote to me to thank him for changing his life. (Better yet: he’s studying economics. A bright future awaits him explaining to lonely singletons how to compose attractive internet dating ads, as I have done.)

Nowadays, I don’t mock the life-changing power of economics. I reckon it’s as good as any other source of personal advice, and funnier than most. I’ve even taken economic advice myself: the timing of my (successful) marriage proposal was calculated using an option valuation formula. My poor wife, you might think. But it’s a triumph for economics.

And there’s one more reason to applaud the use of economic theory in personal problem-solving: it’s less dangerous than using it to run banks.

First published in Business Life, March 2009
Amidst gloomy economic news, there’s always entertainment to be found seeing what gets blamed on the credit crunch. According to one British newspaper, people are seeking inexpensive ways to have fun: sales of aphrodisiacs, designer lingerie and maternity dresses are all said to be strong. My own employer, The Financial Times, reckons that physiotherapists are in demand thanks to an excess supply of stressed investment bankers.
Whether or not these tales have anything in them, they do highlight an important truth: many products, businesses and people sail through recessions completely unscathed.
This basic truth – everyone’s different – is easily forgotten amidst all the discussion of “how we behave in hard times”. Good question, but when it comes to a recession, there is no obvious “we” – there are winners and losers.
The economist Simon Burgess has been looking at a survey that tracks thousands of individuals, returning year after year to see how they’re doing. One of the surprising conclusions is that many people are tipped into poverty when unemployment rises, not because they lose their job, but for other reasons, which can include pay cuts, reduced hours, or hard times for those who own a small business. Others – those with secure jobs or pensions – do as well as ever. Individual circumstance is determined more by luck and skill than what’s going on in the broader economy.
Businesses, of course, will still want to know what the “average” consumer will do. Here, there is good news and bad news. The good news is that when consumers suffer a temporary drop in their income, they usually try to compensate by borrowing more or saving less until things pick up. So while the size of the economy falls, consumption falls less dramatically.
But the bad news is that this is no ordinary recession: it’s one that was kick-started by a banking crisis. If the banks can’t or won’t lend, consumers can’t borrow more no matter how much they may want to. That’s the theory, and history says the same thing. Looking at previous recessions across the developed world – as economists at the National Institute for Economic and Social Research have done – if a recession is also combined with a banking crisis, then consumer spending slumps.
Intriguingly, customers who want to borrow and can’t may find the next best thing is not to cut down on luxuries but to make necessities last longer. Your winter coat, shirt or socks might be due for replacement, but they can always last another month; and another; and another. Good news for sellers of needles and thread, at least.
The challenge for businesses, then, is to work out which consumers will not buy unless there’s a bargain, and who are the consumers who still have money to burn. That takes careful marketing and deft pricing. In some ways, then, business as usual.

First published in the Financial Times, 8 August 2009

Maligned and misunderstood, statisticians have at last found a spokesman: the Chinese author of a poem celebrating a life swimming in data.

“Why is it that statistics/Put a calm smile on my face?” the poet writes, responding to a morale-boosting campaign dubbed “Statistical Feelings” organised by China’s National Bureau of Statistics. “Because of statistics/ I can rearrange the stars in the skies above.”

Hmm. Slightly awkward, that one. In a week when China’s economic statistics have earned more scepticism than usual, it might not be wise to talk about astronomical manipulation.

Even the state-controlled Chinese media have admitted that 91 per cent of citizens do not believe official Chinese statistics. Statistically speaking, that may not be too bad. Another survey, published in Insight China, reckoned that 7.9 per cent of respondents think prostitutes are trustworthy. This figure seems low, but places prostitutes as the third most trusted group in China, well above politicians and scientists, let alone what China Daily describes as “the least credible category which consists of real estate developers, secretaries, agents, entertainers and directors”.

If you are following the statistical argument, Chinese statisticians are more trusted than its sex workers. Or perhaps I am relying on one of the 82 per cent of statistics invented on the spot. Or one of the 46.79842 per cent of statistics that claim an unjustifiable level of precision.

China’s official statisticians are not the only ones facing scepticism. In the UK, only 36 per cent of people believe that official figures are generally accurate. This is, however, an official figure, so 64 per cent of us would hesitate before placing much confidence in it.

“Some mock me for doing statistics/ Some loathe me and statistics”, writes China’s poet-statistician, but our relationship with statistics is more complex. We feel that no argument is complete without a gesture towards the data, yet few of us understand how they are compiled. We sense – rightly – that statistics are often abused through ignorance, or manipulated.

I am a non-statistician who deals with statistics and statisticians frequently, and in my view statisticians are unsung heroes. Statistics are essential to understanding the world, but statisticians get little credit. We accept the numbers in the news as fact, without considering the skill in producing them from small, non-representative samples.

The most striking statistical story I came across this year was that adding statistical information to a charitable appeal reduces donations. It seems that merely reading a statistic makes us meaner.

This is the kind of obstacle statisticians must overcome. So sing out, poet-statisticians of China. Bean-counters of the world, unite!

First published in Business Life, February 2009
I was recently invited onto a prestigious radio program to debate a provocative idea: perhaps we should stop giving money to charity and instead spend it on the high street to stimulate the economy. I declined.
This is one of those economic ideas that sounds plausible as long as you don’t think too hard about it. The numbers simply don’t add up. Economists are concerned that the recession may consist of a fall in economic growth from about three per cent to zero growth or below. But according to the Johns Hopkins Comparative Nonprofit Sector Project, the British give less than one per cent of their income to charity, far less than a three or four per cent drop in economic output. Economic stimulus is one thing, magic is another.
Not only is the idea daft in practice, it doesn’t even work in theory. Charities spend money too. They buy equipment, rent and maintain offices, and employ staff. There is absolutely no reason that the economy should be stimulated more by shopping than by giving money to a charity and letting the charity shop instead. (I’ll admit that some charities spend a lot of their cash overseas, but the same is true of many high street retailers, whose supplies are often produced abroad.)
Perhaps we put too much faith in the idea that all the economy needs in a recession is a bit of “stimulation”. Sadly, things are rarely so simple. Think of the government “fiscal stimulus” so much in vogue across the world as the recession tightened its grip at the end of the last year. The popular understanding of a fiscal stimulus is that the government cuts taxes, and the grateful citizenry spends the windfall.
That can indeed happen, but it is easy to forget that if government spending doesn’t change, then tax cuts today mean a rise in government borrowing and tax rises tomorrow. In other words, the government is borrowing money in our name and giving us the proceeds; but we’ll have to foot the eventual bill.
Should we really spend more under those circumstances? After all, one logical response would be for taxpayers to save the money (or use it to pay off debt) in readiness for the day when taxes rise and the government asks for the money back.
Economists call this idea “Ricardian equivalence” – an idea dating back two centuries to classical economist David Ricardo – which means that government taxes and government borrowing are roughly equivalent. The taxpayer always picks up the tab in the end.
In the credit crunch, a fiscal stimulus may work after all, for one simple reason: some consumers desperately want to borrow money but the banks won’t lend it to them. But that is not what we usually have in mind when we think of the free lunch that our governments are cooking up for us all.

First published: Parade Magazine, 10 May 2009

Not very long ago, Americans were terrible savers. In 2007, the average person put aside 60 cents of every $100, or .6% per paycheck. However, the current economic downturn has shocked us into depositing more at the bank. As of February, the personal savings rate was more than 4%. That’s a big improvement, but it’s still half of 1980s levels, when Americans routinely socked away 10% of their paychecks. Why is saving so hard? And how can we be smarter savers?

Behavioral economists—researchers who mix psychology and economics—have uncovered three reasons why people find it so difficult to save. The first is temptation: Although we often later regret it, we just can’t resist spending. The second is lack of understanding: Our brains can’t quite grasp the profitability of saving. The third is optimism: We believe that everything will work out, even if we don’t save. Read the rest of this entry »

Economic Gangsters: Corruption, Violence, and the Poverty of Nations, by Raymond Fisman and Edward Miguel, Princeton: Princeton University Press, 240 pages, $24.95

Many economists think corruption is a rational response to irrational incentives. The World Bank’s “Doing Business” database lists 40 countries, from Iraq to Ethiopia, in which legally acquiring the necessary permissions to export a single standard cargo container takes more than one month. The more difficult it is to do something legally, the larger the temptation to do it illegally. Small wonder that in developing countries, few people make more money than customs officials.

If perverse incentives create corruption, that suggests a simple solution to an age-old problem. Hence for the last decade or so the mantra of aid agencies has been “institutions matter”—even if it is not clear what humanitarians are supposed to do with this insight.

There is a popular alternative view that says corrupt countries are corrupt not because the incentives are perverse but because they’re stuffed full of crooks, born and bred. In this view, corruption is cultural, and poor countries are poor because their citizens are dishonest (or lazy, or fools).

Into this controversy strode two economists, Raymond Fisman of Columbia and Edward Miguel of Berkeley, with a 2006 research paper that was brilliant and trivial in roughly equal measure. Fisman and Miguel realized that to test the two theories about corruption, you would ideally need to pluck people from all over the world, place them into a community whose laws they could ignore with impunity, then see who cheated and who was honest.

Impossible? Not at all. The United Nations in Manhattan kindly provided guinea pigs for just such an experiment. Diplomatic immunity meant that parking tickets issued to diplomats could not be enforced. The decision to park legally or not, therefore, was a matter of each person’s conscience… Read the rest of this entry »

First published in Business Life, January 2009
What is Facebook worth? The social networking website’s apparent value has fluctuated wildly: only founded in 2004, a deal with Microsoft in October 2007 seemed to value the company at about $15 billion; by the summer of 2008, Business Week was reporting that shares were being sold privately at prices implying that Facebook was worth less than $5 billion.
Business fashions come and go. But the uncertainty over the valuations of networking sites such as Facebook and MySpace is not surprising to an economist. Networks have a curious and controversial economics.
The value of a network, presumably, is something to do with the number of connections it makes possible. It is not hard to count them. A computer whiz called Robert Metcalfe even proposed, back in 1980, what later became known as “Metcalfe’s Law”: the value of a network is proportional to the square of the number of users (or devices) on that network.
Metcalfe reasoned thus: A single fax machine is useless. A pair of fax machines can make a single connection, and there are three ways in which a trio of fax machines can talk to each other: connections between A and B, B and C, or C and A. Four machines can connect six ways and five can connect ten ways. Because each new fax machine can talk to any of the existing fax machines, each new fax machine is worth more than the last.
Metcalfe was no slouch: he invented the Ethernet standard for computer networking and then when on to become a high-tech entrepreneur and venture capitalist. But while the mathematics of Metcalfe’s law is indisputable, its economic logic is debatable. That matters, because while Metcalfe conceived of his law as applying to small Ethernet networks, it has often been uncritically applied to much larger networks – notably during the dot-com bubble.
The problem is that not every connection is equally important. The first telegraph linking Europe and the US was hugely valuable. The ability to fax the next cubicle is not.
When Microsoft bought a slice of Facebook, Facebook had about 90 million users. Four thousand trillion two-way connections were mathematically possible, but few will ever be useful.
For economists, the value of a network also depends critically on the ease with which people can switch to another network. Fifteen years ago it would have been inconceivable for everyone to scrap their fax machines and switch to a new, incompatible generation of faxes. Yet it is not so hard to imagine Facebook’s users deserting in droves for the next big thing in social networking. And a network that can be abandoned overnight is a network whose value can be destroyed overnight, too.

The Storm: The world economic crisis and what it means – Vince Cable Atlantic Books £14.99
Review by Tim Harford for Management Today

The chief treasury spokesman for the Liberal Democrats occupies a curious niche in the political landscape. At one time scorned as ‘Dr Gloom’ for his warnings of a debt crisis and a property bubble, Vince Cable has now acquired cult status. One sketch-writer depicted the ‘in-Vince-able tour’ and a crowd of screaming groupies, ‘the Vincettes’ (I should say I am something of a fan myself, having briefly worked for Cable while he was chief economist at Shell.)

Journalists bewildered by the credit crunch developed the habit of turning to Cable, not for a political soundbite but for a neutral and straightforward explanation of what had just happened. That’s exactly what The Storm offers.

The most striking fact about the book is that it is not a political tract; indeed, it betrays few traces of having been written by a politician at all. References to Cable’s political activities are fleeting and, with those excised, I’d defy anyone who does not already know Cable’s reputation to read the book and identify the author’s profession. It seems to be far more the work of an academic with a deft touch than of someone who wants to be chancellor of the exchequer.

All this is a testament to Cable’s intellect and his distaste for cheap populism. Still, at times the neutrality is so studied that one longs for a bit of political knockabout. After pointing out the odd situation whereby the poor Chinese lend money to the rich Americans, he comments: ‘The explanations for this strange phenomenon are several and tend to vary according to whom the author is seeking to blame.’ Just so, yet Cable does not presume to adjudicate. Readers seeking enlightenment about global financial imbalances should be pleased; potential Liberal Democrat voters will be none the wiser about what they’re voting for.

Where Cable espouses political views, they are a study in moderation. He worries about protectionism and anti-immigrant sentiment, and argues that we shouldn’t throw out the open-markets baby with the banking-system bathwater. He expresses these concerns in the most impersonal terms imaginable. ‘There is a middle position – broadly that of the author – which acknowledges that financial markets are subject to repeated bubbles, panics and crashes, and maintains that they should not be confused with markets in goods and services within and between countries. The worry some of us have is that legitimate arguments for re-regulating financial markets become confused with a generalised movement towards dirigisme.’

Even if Cable worries in the third person, he is right to worry. Yet lip service is paid to such views daily, by politicians of all stripes.

The Storm, then, is best judged not as polemic or manifesto but simply as a piece of analysis. The subject is the post-Lehmans world economy, from the credit crunch to the rise of China. The book is wide-ranging, informed, balanced, calm and well-paced. The logic is always clear and the explanations are cogent, even if the writing is not especially gripping. Cable has often been ahead of the curve, but publishing a book in the teeth of a fast-moving crisis does not allow him that position here. Yet his analysis seems up-to-the-minute.

Despite the time he spent sketching possible futures in Shell’s scenario team, Cable’s book is written almost entirely in the past tense. We are told what has happened so far and what experts think about it. There’s not much about what should happen and less still about what will happen, even in the final chapter entitled ‘The Future: A road map’. Such modesty is becoming, but a little disappointing.

The Storm covers the credit crunch in full, explaining what went wrong and sketching out possible remedies. This slim book also devotes about half its space to other big issues in macroeconomics today: the oil shock, food prices, the role of China and India, and the risk of a political backlash. In each case, the argument is solid and wide-ranging.

The best chapter picks apart the way oil markets work. It deftly covers the history of oil, explains the theory of ‘peak oil’ and offers reasons to be sceptical about it – and skewers the popular notion that speculators were responsible for the price spike of 2008. Right on all counts, and a superb primer for anyone wanting to understand this unglamorous but vital slice of the world economy.

This book will not surprise those who have followed the crisis closely, but it should find a receptive audience of people who feel the world economy has changed faster than they can follow, and who are willing to read carefully and think hard to figure it all out. They could do a lot worse than read The Storm.

For years, we were told that Wall Street attracted the very best. That was why American investment banks were the envy of the world; that was why stratospheric salaries and bonuses were essential. Other financial centers, such as London, fought tooth and nail to attract the same elite. They were worth it, we were told: If you pay peanuts, you get monkeys.
That argument seems hollow now, but it was always a misunderstanding of the way financial markets work–indeed, the way the whole growth miracle of capitalism works. It’s not that financial markets themselves are a sham: There are indeed very smart investment bankers in the world, and some of them help to make us all richer by providing a bridge between those who could use money and those who have money. It’s just that this is not the whole story.
The fact of the matter is: The market system does not work because of the incredibly smart people in charge. (The Soviets had some pretty smart people.) The market system works because nobody is in charge.
Even when markets surround us, we prefer to forget this. It is easier to focus on personalities, so the financial press like to talk about the leadership of great CEOs. When things go wrong, we search for fools and frauds: a Dick Fuld or worse, a Bernie Madoff. We think that the elite betrayed us or that the elite wasn’t as smart as everyone thought. Politicians–temperamentally inclined to believe in the “great man” theory of everything–tend to agree…

Continued at Forbes.com

A review of Parentonomics: An Economist Dad Looks at Parenting, by Joshua Gans

What happens when Mr Spock meets Dr Spock? The answer is Parentonomics , an autobiographical account of how an economist used his professional training in game theory to bring up his three children.

Joshua Gans describes his experiences in the labour wards, changing nappies and dealing with tantrums, spousal absences and sibling rivalry – all the while explaining what he did or did not do, the economic principles involved, and whether any of it worked as a parenting strategy.

The obvious question is whether this is supposed to be good advice or some kind of joke. There is no ambiguity in Parentonomics: Gans is not joking. Thankfully, he can be very funny. Although he is an academic – a professor at Melbourne Business School – his writing has a professional snap. While the advice is intended to be useful, readers will come to their own conclusions about that. It does at least tend to be thought-provoking.

The book may not strike a chord with those without children, but parents will wince with recognition. What distinguishes Gans’s approach is not just his regard for economics, but his disregard for social mores. Why do we frown on the idea of putting toddlers on leashes, he wonders? For parents wandering busy streets, they are brilliant; far safer than letting the child run free and far easier than incessantly holding hands. He points out that most parents end up tying their children into a pushchair instead – more restrictive than the leash, but socially more acceptable.

Another observation that brought me up short: when Gans plays his children at any game from chess to snap, he plays to win. “I see no need to coddle my children in game-playing,” he opines. “If they want that, they can go elsewhere, say, to their mother.” That seems wrong, somehow.

And yet, he observes, his children keep coming back for more, develop their own strategies to win (that is, they cheat) and get to play far more games with their father, because he is less likely to make excuses not to play.

There is much more in the same vein, from the logistical impossibilities of driving multiple children to multiple parties, to a deadpan account of how Gans got himself blacklisted at the local labour ward. He advised his wife, “I think you are broadly delusional. You need drugs and you need them now.”

At the heart of the book is the question of using and misusing incentives. Gans is unabashedly in the school of rational choice. Child No. 1 was toilet trained with the promise of jelly beans. Every member of the household received one jelly bean (or two – don’t ask). Child No. 1 would monitor the administration of rewards, standing outside the bathroom and asking whether Daddy had earned one jelly bean or two.

Sadly, jelly beans proved insufficiently motivating, so the reward was then ratcheted up to chocolate frogs. These were hugely motivating – so much so that the toddler spent literally hours on the lavatory waiting for something to emerge so that she could collect her reward. The entire system took some fine tuning.

Child No. 2 achieved a real coup when he earned a toy by emerging from his room with dry training pants every night for a week. Alas, he achieved this by changing his pants in the morning. When told this was against the rules, he simply removed his training pants and left them by the bed, wetting it but keeping the training pants bone dry, as the bonus scheme required. It’s a witty and instructive episode – and the lesson should be noted not just by parents but by anyone setting an investment banker’s bonus.

The Gans family solved the problem for Child No. 3 by outsourcing potty training to daycare. If only we could do the same for Wall Street and the City.

First published, Financial Times, Life and Arts, 18 April 2009

First published in Business Life Magazine, November 2008

I enjoy a glass of red, but I have to admit I am hardly a connoisseur: a friend once handed me a wine guide and invited me to read it prior to the next time I brought round a bottle. But now I have a secret weapon: the Journal of Wine Economics, official publication of the American Association of Wine Economists. These economists do everything economists do – only for wine. They study market share of wine producers, the impact of globalisation on wine, or the functioning of wine auctions.
There are also economists who use “behavioural economics” – that is, a hybrid of economics and psychology – to understand what we value in wine. The conclusions are intoxicating.
One of the interesting discoveries is the impact of price on the perceived quality of wine.
In a blind tasting, it turns out that most of us actually prefer to drink cheaper wine, as long as we don’t know it’s cheap wine. Oenephiles with some professional training do prefer the more expensive wines in a blind tasting, but just barely.
That might suggest that cheap wines are easily better value, but sadly life is not so simple. We usually know all too well what the stuff cost. This matters: the “neuro-economist” Antonio Rangel, with several colleagues, gave subjects wine to drink, after telling them a price tag. Although the wine never varied, the people who were told that it was expensive thought it tasted better; brainscans even revealed that their brains had a different perception of the experience of expensive wine. If only we could drink cheap wine believing that it was expensive…
The President of the American Association of Wine Economists is Orley Ashenfelter. Ashenfelter is a major figure in economics – editor of the prestigious American Economic Review for nearly two decades – but he also published what might be the most controversial analysis in wine economics, using economic forecasting techniques to assess the quality of Bordeaux wines shortly after harvest, using data on rainfall and average temperatures while the grapes were growing. If correct, the forecast would be valuable because young wines bear little or no resemblance to the mature wines that connoisseurs value so highly.
Ashenfelter recently recalled the controversy in the pages of The Economic Journal. “I decided in 1991 to predict that both the 1989 and 1990 vintages in Bordeaux were likely to be outstanding. Ironically, many professional wine writers did not concur with this prediction at the time…”
Ashenfelter’s predictions had the pros spitting blood instead of Bordeaux. And yet, “there is no virtually unanimous agreement that 1989 and 1990 are two of the outstanding vintages of the last 50 years”.
As I say, I don’t know much about wine. But I know some economists who do.

Even those addicted to alcohol drink less when costs rise, says economist Tim Harford. Because we all respond to prices – even to the point of the day we die or give birth.

If Chief Medical Officer Sir Liam Donaldson has his way, one day we will have to pay at least 50p a unit to buy booze. That’s £1.50 for a large can of strong lager. Most off-licence and supermarket booze costs less than that, so it would certainly change the cost of a drink.
But would it make any difference to hardened drinkers? Many people think not. After all, a tenner would still pay for 20 units – nearly a week’s safe drinking, or some people’s idea of a good night out.
So many people think this would punish ordinary drinkers without deterring the winos, brawlers and wife-beaters. The government won’t touch it. Conservative health spokesman Andrew Lansley says it’s an idea more to do with economics, than medicine.
The odd thing is most economists will think Sir Liam is on to something. Raise the price of drink, we figure, and people will drink less. That’s because people respond to prices in the most unlikely situations.
Margaret Mitchell commented in Gone with the Wind: “Death, taxes and childbirth! There’s never a convenient time for any of them.”
She was wrong: it turns out that death and childbirth can be, and are, rescheduled thanks to tax incentives.
Eonomists Joshua Gans and Andrew Leigh have discovered that after the Australian government announced that it would abolish inheritance tax, effective 1 July 1979, the death rate fell in late June of that year before surging in early July. Gans and Leigh reckon that half the likely taxpayers managed to escape death long enough to escape the tax too.
More cheeringly, when the Australian government announced (with six weeks notice) a “baby bonus” of about £1,250 for families of children born on or after 1 July 2004, something very strange happened in the labour wards. The number of happy events on 1 July was an all-time record, and twice as many births as on 30 June.
Whether entering this world or leaving it, people respond to financial incentives.
Even so, it’s hard to credit that problem drinkers pay much attention to the price of the next drink. Yet they do. Alcoholics respond more to high alcohol prices than moderate drinkers.
One piece of evidence, gathered by economists Philip Cook and George Tauchen, comes from medical records in the United States.
When taxes on alcohol rise, people drink less overall, but liver damage – a symptom of alcohol abuse – falls much more. That has a certain economic logic: the alcoholic consumes more booze than most of us, so responds more to its price.
Other economists have found that binge drinkers, smokers and cannabis users are all very price-sensitive. A recent University of Sheffield study came to much the same conclusion: faced with more expensive drinks, problem drinkers – who tend to be young or drink a lot, and so seek out the cheapest ways to get drunk – would change their behaviour much more than the rest of us.
Yet Sir Liam doesn’t suggest more tax on alcohol – he suggests supermarkets and off-licences put up prices and keep the profits, making it lucrative to flog cheap booze. Unable to compete on price, supermarkets could compete in other ways – for instance, offering freebies (sweets? football stickers?) with every bottle of strong cider. Making cheap booze a supermarket’s most profitable product is likely to backfire, one way or another. After all, supermarkets respond to incentives too.

First published by BBC News Magazine.

As so often, the Sage of Omaha put it best: “Nothing sedates rationality like large doses of effortless money.” These days, it is hard to disagree. Warren Buffett’s warning now looks less like a mere aphorism and more like a sharp summary of the latest research in behavioral economics. Our stone-age brains just don’t seem to be able to cope with digital-age credit products…

Continued at Forbes.com.

The news that Cambridge university is to demand A* rather than A grades at A-level has provoked yet another frenzy of concern about grade inflation – the name normally given to the process by which C grades become B grades and then A grades and, before you know it, all shall have prizes.

Grade inflation, like real inflation, seems widespread, afflicting not just UK schools but the Ivy League. Stuart Rojstaczer, who maintains GradeInflation.com, reckons that grades at US private universities have risen from an average of 2.3 out of 4.0 in the 1930s to 3.3 today. That rate of inflation, by itself, would be manageable – 22-year-olds do not need to compare grades with 92-year-olds. (Grade hyperinflation would be another matter entirely: students would have to take examinations, be awarded marks and then apply for jobs or university places within a matter of hours, before their grades were devalued.)

Alas, grade inflation is a misnomer. True grade inflation would mean each grade was equally devalued, with A grades superseded by AA, AAA and AAAA as new labels for superlative performance became necessary. One hundred per cent would become 110 per cent.

Yet examiners are reluctant to award 110 per cent and there are no AAAA grades. What we see is not inflation but a classic price distortion. Eventually all students will get A grades and they will be meaningless. A* grades are a small, belated step in the right direction.

Grade distortion is a serious affair. Students and their teachers are forced to switch to grey market transactions denominated in alternative currencies: the letter of recommendation, for example. Like most alternative currencies, these are a hassle.

Grade distortions, like price distortions, destroy information and oblige people to look in strange places for some signal amid the noise. Students are judged not on their strongest subjects – A grade, of course – but on whether they also picked up A grades in their weakest. When excellence cannot be displayed, plaudits go instead to those who deliver pat answers without stumbling – politicians in training, presumably.

The obvious solution to grade distortion is to ration grades so that no matter whether standards are high or low, only the better students can receive the top grades. Unfortunately, like any competitive system, such policies can create ill-feeling towards high-flyers, and even sabotage.

If grade rationing is unacceptable, perhaps grade distortion should be replaced with true grade inflation, freeing grades from the worldly confines of a maximum 100 per cent or A*. As long as everyone understands the game, what harm if the typical student of tomorrow is awarded an AAA grade? The rating agencies might even find a new line of business here – handing out an AAA for nicely packaged dross is something they should be able to master.

Also available at ft.com.

First published in Business Life Magazine, October 2008

Given the macho reputation of the trading floors of London and New York, headlines were guaranteed this spring when researchers at Cambridge University published their findings: the research linked the behaviour of City traders to testosterone.
The researchers studied 17 (male) traders at work for eight days, took saliva samples at 11am and 4pm – most of the day’s trading occurs between those times – and discovered that for each individual, temporarily high levels of testosterone seemed both to be a cause of and a consequence of a successful day’s trading. After a run of success, another hormone – cortisol, associated with stress – tended to build up, while an excess of testosterone provoked reckless behaviour.
It was a fun addition to the rapidly growing field of neuroeconomics, which marries economics and brain science, studying the links between how people make economic decisions and how their physiology changes while that is happening. Neuroeconomics tools include not only the saliva swab, but devices to measure skin conductivity, and, of course, brain scanners.
Neuroeconomics boosters are making big claims about the way that brain science is going to revolutionise our understanding of the way people make decisions. Better policies on pensions or alcohol dependency may result. So too, alarmingly, may more seductive advertising and marketing.
But while the field makes for irresistible newspaper copy, it remains small and controversial. Perhaps the simplest objection from most economists is: so what? Economics has always been agnostic about what goes on inside the brain: economists study what people do, and are more likely to pay attention to psychologists who discover unexpected behaviour than to pictures of brainwaves.
While caution is warranted, it is surely too soon to write off neuroeconomics entirely. The brain scanners can help to show us why someone does what they do, and that is sometimes a vital clue in explaining behaviour.
For example, one common laboratory experiment, the two-player “trust” game, has now been subjected to neuroeconomic study. Economic theory predicts that in “trust games”, a rational self-interested person would not, in fact, trust anyone. But in fact, people do seem to behave in a trusting way and are rewarded with a trustworthy response.
Economists haven’t understood whether this is because people are confused about the rules of the game, or because they are, in fact, trusting each other. The neuroeconomists give a clear explanation: players get a rush of oxytocin, a hormone associated with love and trust, and the brain area that is activated is one connected with promises and reciprocity. We are humans after all, and so this young science may just have something to contribute.

Why the NFL should replace the overtime coin toss with an auction system.

If the Super Bowl goes into overtime for the first time ever, it’s fairly certain who will be victorious: the team that wins the coin toss. In the first round of the playoffs, the Chargers beat the Colts 23-17 in OT, marching down the field for a touchdown after winning the toss. In the 14 overtime games that produced a winner this season, the coin-toss victor won 10 of the games, more than 70 percent. Since 2002, the team that’s gotten the toss has won more than 60 percent of overtime games.

Chess faces a similar problem—it’s generally regarded as an advantage to play white. But the chess world has long had a solution: Take it in turns and play a lot of games. That’s easy for the chess guys—they have all the time in the world, and more forgiving TV schedules. College football has a similar philosophy, giving each team the ball at the opponents’ 25-yard line and alternating possessions until someone breaks the tie. But the NFL’s competition committee, which pondered the overtime problem in depth in 2003, decided to stick with the status quo of “sudden death.”

With a little ingenuity, there is a way for overtime to be both fair and fast….

Continued at Slate.

First published: Business Life Magazine, August 2008

Sir William Petty, an advisor to Oliver Cromwell and a Professor of Anatomy at Oxford, seems an unlikely hero for economists. Yet nowadays his claim to fame is that he produced the first estimate of Britain’s national income, which he put at £40 million a year back in 1664, or about £4.5 billion in today’s money. The modern equivalent, UK gross domestic product (GDP), is a little larger: about £1400 billion.
Sir William was celebrated in his day, but the field he fathered, national income accounting, seems to be the most tedious in modern economics: back-office bean counting, far removed from eye-catching “Freakonomics”-style research.
Yet the bean counters have been having their revenge. New ways of gathering data have gradually been transforming our understanding of how economies grow, and even changing the way we think about what really matters when they do.
One important step was taken Alan Heston and Robert Summers, two professors from the University of Pennsylvania’s economics department. (Summers was the brother of economics demigod Paul Samuelson, and the father of Larry Summers, US Treasury Secretary under Bill Clinton.) After the World Bank neglected to take up the task, Heston and Summers collected international data on prices all over the world, allowing a meaningful comparison, like-with-like, of rich countries with poor ones. The fruits of this labour, the first Penn World Table, were published in 1986, and circulated to the profession via floppy disks. The two decades since have seen a great outpouring of studies based on the Penn data, trying to answer the question of what makes poor countries poor, and how they might get rich. One conclusion: investment in roads, factories and even education doesn’t seem to matter as much as was once thought. What matters is that rich countries manage to used these investments well.
With this in mind, the World Bank is now trying to count things that might matter for the business environment – for example, its Doing Business project, which has been running for five years, collects and broadcasts information about red tape in 178 countries, such as the number of days an entrepreneur needs to wait before legally establishing a new business. The project is intended to diagnose problems, but it is also a terrific spur to shamefaced bureaucrats.
Other statistics aim to show economic performance in a new light. The most respected is the Human Development Index, published since 1990, which emphasises literacy and health as well as economic growth, and has helped to change the focus of development agencies.
And the data gathering goes on: Nobel laureate Daniel Kahneman is trying to develop credible happiness accounts, based on time-weighted data on how people feel throughout the day. Not so much bean-counting as smile-counting – Sir William would have been astonished.

I wrote this for the Today program; scroll down and you can hear an interview with me on the subject from this morning’s show.

“I’m backing Britain…”, crooned Bruce Forsyth in 1968. “Yes I’m backing Britain/We’re all backing Britain.”
Despite Brucie’s support, the “I’m Backing Britain” campaign did not last long. The campaign’s T-shirts were even produced in Portugal. Typical, perhaps, of the difficulty of building up a head of steam in support of the national economy.
Economic patriotism was never really Britain’s thing, but it seems to be enjoying a comeback.
Dr John Sentamu, Archbishop of York, told an audience of farmers last October that he wanted a return to the “Buy British” mindset, with government support.
Last week, the environment secretary Hilary Benn also called for consumers to buy British food, also at a farming conference.
No doubt it was crowd-pleasing stuff, but it is puzzling.
After all, every time we deliberately Buy British we are also deliberately “Not Buying From Foreigners”.
In a world where racism is rightly viewed with disgust and contempt, it is a strange thing that discrimination against foreigners is regarded as acceptable, even laudable.
It is also not very smart, because there are so many more foreigners than us.
The economist Gary Becker has tried to calculate the economic costs of discrimination. What he found was common sense. When a large group and a small group discriminate against each other, it is the small group that suffers. The rest of the world could happily do without British products, but Britain cannot happily do without the rest of the world.
It is true that if a “Buy British” campaign persuaded many of us to seek out British products and turn away from imports, that would be a shot in the arm for the workers and companies who produced those products.
But here is the bad news. If foreigners find they cannot sell us their products, foreigners would also find that they had no sterling to buy exports.
For every local product that beat off foreign competition, there would be a British exporter struggling to find customers. We cannot have a world where we sell lots of products to foreigners, but we never buy anything from them.
Granted… such a world would, at least, cut down on food miles and you might think that would be good for the planet.
But not necessarily. Buying foreign products may add to food miles but it can also cut down on the need for heated greenhouses or intensive farming. In any case, international freight is very efficiently done. (No, those cut flowers from Kenya do not fly first class.)
When Hilary Benn had a different job – development secretary – he agreed with me, calling for people to buy Kenyan flowers for Valentine’s Day in 2007. He must have forgotten.
The biggest environmental cost of food transport comes, not from international shipping, but driving to and from the supermarket, often with just a couple of carrier bags in the back of the car.
Having looked closely at the evidence, I have concluded that what really reduces carbon emissions is making sure you walk or cycle to the shops.
Do not get me wrong. I am backing Britain. I am just not backing the British at the expense of foreigners, or national producers at the expense of British exporters.
But if I have not convinced you, please wait a moment before getting on the phone to Portugal to order your T-shirts.
There is already a hugely effective policy in place that will help support British firms and British workers: the collapse in the value of the pound, which makes it harder for foreigners to find buyers here and easier for British exporters to expand. It will have more impact than 1,000 “Backing Britain” campaigns.
Perhaps Brucie could sing us a song about it.

First published Business Life magazine, January 2008

Are you keeping your new year’s resolutions? If not, perhaps you should turn to economics for help.

That might seem like a strange piece of advice, because the staple of economic models, “rational economic man”, does not suffer from a nicotine habit, nor impulsively grab chocolate bars at the supermarket checkout. If the vice is worth the health cost, he indulges it; if it is not, he does not. Rational economic man needs no resolutions. Read the rest of this entry »

FT Magazine, 6 December 2008

Bob Annibale’s corner office, high up in one of London’s few real skyscrapers, overlooks the Thames and the Millennium Dome from one window, Greenwich Park and the Royal Observatory from another. It is the kind of enviable perch you’d expect Citigroup’s senior treasury risk manager to enjoy. But that is the job Annibale left three years ago; now he is Citi’s “global director of microfinance”… Read the rest of this entry »

First published in Business Life magazine, December 2007

It will not have escaped your notice that Christmas is upon us. And for gift-giving advice, why not turn to an economist?

That seems a strange recommendation, and it becomes even stranger when you consider that by far the most notorious Yuletide contribution from economists is a research paper titled “The Deadweight Loss of Christmas”, which was published in a respected economic journal back in 1993.

The author is Joel Waldfogel, described in print not long ago as a “slightly balding imp” by one of his fellow economists. But while his ongoing research into the economics of gift-giving tends to be seen as an example of the limitations of the dismal science, I believe that Professor Waldfogel’s work has been utterly misunderstood. Read the rest of this entry »

From BBC Online.

Is a stock market bubble a medical condition?
You might well have thought so, had you taken a walk around a trading floor and looked at the behaviour of traders at the height of the dotcom bubble in 2000.
“They were displaying classic symptoms of mania,” says John Coates, recalling his time as the manager of a New York trading floor.
“They were overconfident, they had racing thoughts, they had diminished need for sleep and heightened sexual appetite.”
But Dr Coates no longer works on Wall Street.
He is now one of a small but growing number of “neuroeconomists” – researchers who study the brain, hormones and nervous system in search of an explanation of our behaviour as investors and shoppers.
Neuroeconomics is a new discipline that fuses economics and neuroscience, and its practitioners are people who think that everyday phrases such as “impulse buy”, “business brain” and “bull market” are more than just figures of speech. Read the rest of this entry »

The idea that ordinary people have a tendency to be caught up in investment manias is a powerful one, thanks in part to Charles Mackay, author in 1841 of the evergreen book Extraordinary Popular Delusions and the Madness of Crowds. Mackay’s most memorable example was the notorious Dutch tulip bubble of 1637, in which–absurdity!–tulip bulbs changed hands for the price of a house. Read the rest of this entry »

First published: Business Life Magazine, August 2008

You’ll all have heard the old proverb, “Give a man a fish and you feed him for a day. Teach him how to fish and you feed him for a lifetime.” But what happens if you give him a mobile phone?
The economist Robert Jensen has been trying to find out. For over a decade, development types have been debating the idea that new technologies such as mobile phones and email might prove to be important tools for helping poor countries grow richer. It all sounds plausible enough, but the challenge has been to prove it. After all, the sceptical case – that the priority for economic development has to be basics such as vaccines, schools, roads and electricity – is fairly persuasive.
Jensen studied Kerala, in India, whose 400 miles of coastal waters provides the livelihood for a million fishermen, and whose beaches host over 100 local fish markets. In the mid-1990s, this was an industry characterised by waste and shocking uncertainty for buyers and sellers alike.
A detailed data-set collected by Jensen tells the story. One Tuesday in January 1997, for example, fishermen were arriving at the Bagdara market to find that buyers had already purchased all the fish they could possibly want. The excess fish had to be dumped or given away for free, since they were perishable. But within 10 miles, at the markets both north and south of Bagdara, fish were scarce and prices were high; buyers were giving up and going home in disgust.
Buyers and sellers were not able to meet up because they had no way of finding each other. And the next week, exactly the same thing happened – except that the gluts and shortages were located at different markets, the result of the whimsy of the mackerel shoals.
Jensen – who collected his data each week for years – was able to see clearly what happened when the mobile phone masts came to Kerala, erected one at a time along the coast. Although they were not aimed at fishermen, the signals ranged many miles out to sea, allowing fishing boats to call the markets and find the best prices.
If I were to show you the graph of fish prices, you would instantly be able to point to the moment at which the masts were switched on in each region. The graph, which has been jumping around like the ECG of a patient with a heart-attack, sudden flatlines as the prices across different markets equalise. At that point, prices fall but fishing boat profits rise, and spoilage of fish becomes a thing of the past.
When Jensen’s research was published late last year, it was a minor triumph for economic analysis: the moment at which the stories about the magic of technology became something more than fishermen’s tall tales.

Comparisons between today’s financial crisis and the 1930s are looking less strained by the day. So what better to lighten the tension than to revive everybody’s favourite Depression-era board game, Monopoly? Read the rest of this entry »

FT Magazine, 18 October 2008

In the car on the way to the Lake District, my friend Mark calls. He’s a doctor.

I tell him that I’m planning on going for a leisurely swim in one of the lakes.

“Be careful not to die,” he says helpfully. Read the rest of this entry »

The Financial Times, 14 October 2008

The Nobel economics prize was awarded yesterday to Paul Krugman, one of the great popularisers of economic ideas and a trenchant critic of the Bush administration. However, the prize was awarded for work done almost three decades ago in developing what is known as “new trade theory” and “new economic geography”.

Earlier trade theories suggested that a country would trade with partners that were different – rich would trade with poor, and capital-intensive would trade with labour-intensive. In practice, rich countries tend to trade with other rich countries. Read the rest of this entry »

I read this light-hearted essay on the Today program on the morning of 13th October.

Someone recently grumbled to me that, given the appalling state of the world’s financial system, nobody should be awarded today’s Nobel memorial prize for economics. That’s a little harsh: some economists did warn us of trouble on the horizon.
Still, Nobel-watchers think that this will not be the year that the prize is given to a man called Eugene Fama. Fama, a Professor at the University of Chicago and a long-time contender for the prize, is best known as the man who believes that financial markets are efficient. The timing would seem awkward.
I think that’s a shame. The belief that financial markets are efficient sounds like some Thatcherite creed, but it means something quite different: that the price of shares today reflects everything we currently know about their value. There are no obvious bargains, no easy forecasts, no get-rich-quick schemes. Read the rest of this entry »

First published: Business Life Magazine, June 2008

Any corporate mission statement will praise “teamwork” to the heavens. But teams packed with brilliant individuals can be staggeringly dysfunctional; that is something many of us suspect, and economists think they can measure.
Most team performance is hard to quantify, but professional sports teams are a different matter. Games are standardised and results are obvious. That may be why a curious little literature has sprung up on the economics of optimal play in sporting contests.
Economists have discovered that individual sportsmen and women play very well – not just the mechanics of executing a cover drive, but the strategic choices of serving to the forehand or backhand, striking a penalty to the left, right or straight on. Because these choices require a player to be unpredictable, while reckoning on his own strengths and the strengths of his opponent, the optimal strategy is surprisingly hard to calculate.
Nevertheless, economists Mark Walker and John Wooders studied the serve at Wimbledon, showing that Roger Federer, Maria Sharapova, and other top professionals are intuitive economists. More surprisingly, Ignacio-Palacios Huerta of the London School of Economics showed that the same was true of David Beckham and his peers at the penalty spot.
But teams do not seem to be able to tap into the same intuitive wisdom. V. Bhaskar, another economist, studied the declarations of cricket teams and concluded that they did not behave optimally. For example, both teams often agreed as to who should bat first; they couldn’t both have been right.
Meanwhile, Professor David Romer examined the decisions of American Football teams using an exhaustive analysis of play from three years’ worth of top-flight games. He found that teams were dramatically overcautious in a “fourth down” situation. At “fourth down” the team with the ball will usually kick it and win territory or points, while conceding possession. Romer showed that the riskier ploy of trying to retain possession was often a much better bet.
It is not clear why teams make bad decisions, but my guess is that the choice is muddied by wishing to avoid criticism, and trying to appease team-mates. Individual sportsmen focus only on winning.
Perhaps the current “teams are dumb, individuals are smart” consensus will be punctured by new research. Christopher Adams from – of all places – the US Federal Trade Commission, has published research arguing that NFL teams are smarter than Romer thinks. A group of management scientists based in Israel have argued that top goalkeepers would save more goals if they stood up rather than trying to guess which corner the striker would choose.
Nevertheless, for now, the economists’ view is that if you want a brilliant individual to do something stupid, you should simply put him in a team.

Not that much of a debate: Pete Lunn says it is a big deal, and I agree. (Prospect originally asked me to debate the proposition “Is behavioural economics a revolution?” and then changed the motion after the debate was finished…)

Still, we have plenty about which to disagree. An extract: Read the rest of this entry »

Armed with a jar full of coins and an attentive audience, economists have long known a reliable way to raise some beer money: offer to give the coins – or their cash value in a more convenient form – to whoever bids the most for them. The winner will almost always overbid, often by a hefty margin.
This isn’t because human beings are naturally incompetent at the task of guessing the number of coins in a jar. Most people do it rather well, and the average bid is usually a bit lower than the value of the prize. Fortunately for the auctioneer, auctions do not close with the average bid, but when all but one bidder has given up. It only takes a couple of mistaken bidders to generate a fat profit for the seller.
Economists call this “the winner’s curse”. It was discovered by three rueful petroleum engineers who had observed the tendency of oil companies to overbid for licences to drill in Alaska in the 1960s.
The winner’s curse is nothing to do with getting carried away in the heat of the moment. It simply reflects the fact that when a prize’s true value is unknown – be it a commercial property, an oil licence or a jar of coins – most bidders do not adjust for the fact that auctions select whoever has the most optimistic estimate.
Of course, getting carried away is also a risk of bidding in an auction, and thanks to a curious feature of the online auction site, eBay, it is now possible to catch people in the act of doing just that. Because eBay allows sellers to make fixed price, take-it-or-leave-it offers as well as to auction products, there is a clear symptom of irrational exuberance: whenever an auction bidder offers to pay more than he could have got through a simple search on the same website, he is clearly getting over-excited.
The economists Young Han Lee and Ulrike Malmendier recently realised this and decided to look closely at eBay auctions of a particular product, a popular board game. Over-exuberant bidding was astonishingly common: in nearly three quarters of cases they examined, the winning bidder paid more (after shipping) than he could have paid in a fixed-price sale. This is despite the fact that the quality of the auctioned goods was no higher and the reputation of the auction sellers was typically lower.
Most bidders, admittedly, were much more sensible. A small minority were responsible for bidding up the auction prices to irrational levels; that, happily for the sellers, was all that was needed.

First published, Business Life Magazine, May 2008

There is no idea so good that it cannot be spoilt by politicians, and such a fate is now befalling libertarian paternalism – recently rebranded as “nudging”. Libertarian paternalism is a conscious effort to help people make better choices without forbidding anything. It embraces anything from assuming that you would like to contribute to a company pension unless you say otherwise, to placing the doughnuts in a quieter corner of the supermarket.

The concept, courtesy of two US professors, Richard Thaler and Cass Sunstein, deserves attention because it is a thoughtful response to a deep policy problem. It has been seized instead by David Cameron’s opposition Conservative party in the UK as a free lunch, sound bite and flag of convenience all rolled into one. Read the rest of this entry »

First published: Parade Magazine, 13 July 2008

Not everything that seems like a bargain will really end up saving you money. Luckily, behavioral economists are finding the gimmicks and tricks that regularly lure us to spend more. Read this—and don’t get caught!

ANYTHING YOU BUY ON CREDIT
Putting a purchase on a credit card with a zero interest rate may seem like a good deal, but you’re less likely to shop frugally when you’re using it—or any kind of credit card. MIT researchers Drazen Prelec and Duncan Simester ran an experiment in which two groups of subjects were allowed to bid on tickets to sporting events. One group had to pay in cash within 24 hours, the other with a credit card. The credit-card group offered much more for the tickets—and more than twice as much for a sold-out game. Other studies suggest that people who pay with plastic spend more and tend to forget how much they spent. Read the rest of this entry »

Financial Times comment, 19 July 2008
Leonid Hurwicz, the economist who last year became the oldest person ever to win a Nobel prize, helped transform economic thinking in the second half of the 20th century.
For years economists had been passionately debating the rival merits of state planning versus free markets. In both systems, people had incentives to lie to bureaucratic planners or to employers about their interests, their skills or their circumstances. “Leo”, who has died at the age of 90, founded the field of “mechanism design”, a new way of thinking which focused on giving people incentives to tell the truth and to do so in a way that would benefit society as a whole.
His mechanism design idea has applications in a range of practical areas, from the design of computer networks and voting systems to arbitration rules.
The debate between state planning and free markets must have seemed far from academic to Hurwicz. His parents were Polish Jews who fled the Kaiser’s invading army, going to Moscow, where Hurwicz was born in 1917. They returned to Poland in a horse-drawn wagon to escape the Bolsheviks when he was two. Read the rest of this entry »

For us, the financial journalists, the credit squeeze is a lot of fun to write about. For you, the honest newspaper subscriber, it may not be so much fun to read about. This stagflation business – inflation and low growth all at once – is so depressing. You cannot look to the authorities for comfort. Your government blew all the cash in the good times, unless you happen to live in the Gulf or in China. Your central bank, desperately trying to sound both sympathetic and hawkish, is changing position more frequently than a presidential election candidate. Read the rest of this entry »

First published in Business Life magazine, April 2008

Are you an idiot, or not? I expect you have a view on the matter. Most economists have a view on the matter, too: the mainstream view in economics is that people behave more or less rationally.
Yet an influential minority of economists think that, at least when it comes to some kinds of decision, you are an idiot after all. They’re called “behavioural economists”; one of them, Professor Dan Ariely of MIT, recently published a book called Predictably Irrational – the title may give you a hint at what he thinks of you.
The behavioural economists are inventive and their experiments tend to be a lot of fun. But there’s another reason to study behavioural economics: its insights are already being used by expert marketers to slurp money from your pocket.
Dan Ariely gives a simple example: a subscription to a magazine. If the choice is between “Print and web” for £100 or “Web only” for £50, a lot of people will pick “Web Only”. But add a new and unattractive option of “Print only” for £100, and suddenly many people will choose “Print and web”. Nobody wants the new option, of course, but its mere existence makes “Print and web” suddenly seem like a better deal, and the marketers know it.
Another trick has been spotted by Richard Thaler of the University of Chicago, one of the founding fathers of behavioural economics. Thaler points out that we are irrationally nervous about small risks such a losing a mobile phone that would cost £50 to replace, or facing a £70 repair bill for a washing machine that breaks down. These possible losses are annoying, but relative to the larger financial risks we run (will you get a raise at work? Will the value of your home rise or fall?) they are trivial. Most of us should take them on the chin.
But that is not what happens. Instead, we buy extended warranties for washing machines or insurance for mobile phones. And because we buy them from the same person selling the washing machine or the phone, we don’t enjoy the benefit of competition. Such insurance is usually hugely overpriced. Insurance buyer, beware.
There is some good news from behavioural economics, though. Sometimes, when marketers work out a way to jack up the price, they end up improving the quality of the product as a side-effect. Overpriced products can look better, taste better – even work better, just because they are overpriced. Dan Ariely showed that, for example, when he gave people fake painkillers (actually vitamin C tablets), the painkillers were effective anyway, just as long as people thought they were expensive. Perhaps a high price is a price worth paying, after all.

First published in Business Life Magazine, March 2008

One of my favourite Dilbert cartoons begins with the pointy-haired boss asking for a revenue forecast on a project; it finishes with his subordinate screaming “Just tell me which lie to use!”
That might give a hint as to why internal corporate forecasts are often no good. It’s always hard to foretell the future, but harder still when managers are promoted on the basis of self-serving projections, or because they have successfully sat on bad news.
There is an alternative: something called a “prediction market”. Such markets enable a company’s employees to bet on, for example, whether the new flagship product will beat sales projections in the third quarter. The odds in the market should be a reality check for the official forecasts.
Consider a prediction market “ticket” that pays ten dollars if the flagship does indeed beat expectations in the third quarter, and nothing otherwise. The sales team, knowing that retailers are enthusiastic, might want to buy the ticket. The engineers, knowing the product is full of bugs, might want to sell. If the ticket trades at, say, three dollars, that means that the market’s opinion is that the sales target is only 30 per cent likely to be achieved.
A corporate prediction market allows employees to trade on the basis of their own unique information. They can do so anonymously, without fear of jeopardising their careers. And if they get it right, there is money to be made.
You might think that no company would dare to use a betting market to make forecasts, but the economists Justin Wolfers and Eric Zitzewitz have pointed to Arcelor Mittal, Chrysler, Eli Lilly, General Electric, Microsoft and others as having been publicly identified as experimenting with the idea. The first company to do so seems to have been Hewlett-Packard, during the first technology boom, and their tentative experiment did indeed outperform internal forecasts. The largest and most liquid prediction markets seem to be at Google, which has embraced the idea with gusto. Analysis by Wolfers and Zitzewitz, along with Google researcher Bo Cowgill, suggest that the markets have worked well – albeit with a bias towards overly sunny forecasts.
Google being Google, one trader wrote a software robot to do his trading for him and made money. But the traders who did best were those who had the longest tenure at the company. That might be a crumb of comfort for top managers. They may be usurped by prediction markets, but at least they can make a profit.

First published in Business Life magazine, February 2008

I recently saw a blast from the past: an independent coffee shop trying to charge an extra ten pence for a Fair Trade cappuccino. Fair Trade coffee is bought from certified coffee growers; they receive a premium, and a guaranteed minimum price. And so it might seem reasonable for a coffee shop to ask its customers to pay more for a Fair Trade cappuccino.
It isn’t, because there is very little coffee in a cappuccino – about seven grams of beans, or a quarter of an ounce. The Fair Trade premium, so important to a struggling grower in Kenya or Ecuador, is typically less than a penny when applied to such a small quantity of coffee. When a coffee shop charges ten pence extra for a Fair Trade cappuccino, the grower gets his due, but most of the mark-up is profit for the shop.
That sounds cynical, if unsurprising. But an alternative way of describing the same situation makes it seem much odder: the coffee shop is willing to slash prices and take a big hit to margins if you don’t buy fair trade coffee. Profiteering is one thing, actively working against fair trade is another. Why does it happen?
The coffee shop – like many businesses – faces a dilemma. Raise prices and it loses some customers; cut prices and it loses margins. Sometimes, however, it is possible simultaneously to raise prices to price-insensitive customers while cutting prices to the customers who are hungry for a bargain. Grown-up economists call this “price discrimination” – I call it “price targeting”.
Outside the bazaar or the used car forecourt, customers rarely accept the idea of haggling for a special price. So businesses work out their own methods of price targeting. The discount for students and pensioners? You might just as well call it a surcharge for people with a job. Kids eat for free in this family-friendly restaurant? Childless couples have cash to burn and can be offered a bit less for their money.
And in the coffee shop, fair trade coffee is a terrific marker for price-sensitivity. Anyone willing to pay ten pence extra for fair trade coffee is demonstrating that she doesn’t mind paying a bit extra.
The first rule of price targeting, though, is that it should never aggravate the customers. Economists started to point out what was happening, customers got cross, and the big chains now tend to offer fair-trade coffee without any mark-up.
That makes sense: they have plenty of other ways to identify price-insensitive customers, which is something to think about next time you pay thirty pence for a couple of marshmallows on the side.

First published in Business Life Magazine, November 2007

I remember Saturday evenings when I was a boy, curled up in a towel after bath time to watch game shows such as “The Price is Right”. Little did I know it, but those Saturday evenings were preparing me for life as an economist.
Economists have theories about how people behave, but those theories are hard to test in the muddle of the real world. And laboratory experiments may be no better, because the stakes are too trivial to see how people act under pressure.
That is where the game shows come in. Like real life, game shows are often played for high stakes. But like the laboratory, the rules are simple and the experiment is repeated over and over again.
In one early piece of game show research, economists Jonathan Berk, Eric Hughson and Kirk Vandezande showed that contestants in “The Price is Right” made transparent mistakes but learned from them.
Four contestants would in turn name a price for some household object such as a toaster. The contestant who got closest to, but not over, the correct retail price would win. The other contestants would get another chance.
If you’re smarter than the average contestant you’ll see that the fourth person to bid has an advantage. Since you want to be closest, but not too high, the best strategy is to guess just one pound higher than one of the other contestants (or zero, if you think they’re all too high). Not many contestants did this, but once somebody figured it out, the others were more likely to use the tactic in later rounds.
The economics of quiz shows hit the big time with Steven Levitt, now famous as the co-author of Freakonomics. Levitt tried to understand what was behind discrimination in the job market: did people simply dislike ethnic minorities or the elderly? Or did they believe them to be less competent?
For the answer, he looked to “The Weakest Link”, in which contestants vote for other contestants to be excluded. The best approach is to vote off weak players early on, because they’re costing everyone money – but later, to vote off strong players, because they are the most dangerous competition.
Levitt showed that elderly players tended to be voted off at any stage, suggesting a pure dislike for them. Hispanic players were likely to be voted off early but kept on later in the game, implying that other contestants thought they weren’t very smart.
The game show boom in economics is still going. I’m aware of eight economists who’ve studied “Deal or No Deal”. If only I’d been thinking like an economist when I was younger, I could have beaten them all to it.

First published in Business  Life magazine, September 2008

Basic economics says that when supply can’t keep up with demand, raising the price will solve the problem. It sounds sensible – but what if we’re talking about a market for live human organs? Economic logic doesn’t seem to be much use, because the mere idea that patients might pay others to donate organs is offensive to most people.
Our attitude to an organ market might change eventually; attitudes sometimes do. Life insurance, for example, was considered ghoulish until about a hundred years ago, because it is a bet about when you’re going to die. Now it is not only acceptable, but regarded as something any family breadwinner should do.
But whatever some economists might wish, there is no prospect of a legal market for live kidney donations any time soon. One economist, Al Roth of Harvard, has therefore taken a more pragmatic approach to the problem. He realised that there is an untapped resource: many people on the waiting list for a kidney have a friend or relative willing to make the donation, but unable to do so because the pair are biologically incompatible.
Professor Roth realised that while it is not socially acceptable to offer money for a kidney, it is acceptable to offer a kidney for another kidney. And so he looked for ways to match pairs of donations, with the aim of making the transplants more compatible. My friend donates to you; your friend donates to me, and both transplant operations are more likely to be successful.
Such “paired kidney donation” is an example of a “matching market”, and Roth is the world’s leading expert on matching markets. He has spent much of his career designing them; for instance, matching student doctors with a favourite list of training hospitals with training hospitals, which have a favourite list of students. That turns out to be a simple problem – until you realise that many student doctors are in relationships with other student doctors, and the system will be rejected if it splits up these couples.
Matching markets for kidneys can also be technically demanding. For example, an altruistic donor who declares herself willing to donate to anyone can trigger a little avalanche of transplants on a kidney exchange – but only if the exchange is well-designed.
Al Roth, with fellow economists Tayfun Sonmez and Utku Unver, designed a kidney exchange programme with the help of surgeons in New England. And it’s working: over 30 transplants had taken place by the summer of 2008. The UK has now changed its own laws to permit paired donations, and the first transplant took place late in 2007. Economists are saving lives – sounds strange, doesn’t it?

The choice isn’t yours

Review by Tim Harford

Predictably Irrational: The Hidden Forces that Shape Our Decisions
By Dan Ariely
HarperCollins £14.99, 304 pages
FT bookshop price: £11.99

Not long ago three professors, Daniel Ariely, Elie Ofek and Marco Bertini, set up a stall to hand out free cups of coffee at the Massachusetts Institute of Technology (MIT). In exchange, they asked patrons to tell them whether they liked the roast.

Ariely and his colleagues set up a table of condiments – milk and sugar, but also obscure offerings such as cloves and orange peel. Nobody ever sampled the unusual options, but they turned out to matter a great deal. Some days, the cloves and orange peel were presented in glass containers on a brushed-metal tray, on other days they were dumped in Styrofoam cups with hand-scrawled labels. The presentation of the “condiments-not-taken” turned out to make a big difference as to how MIT students thought the coffee tasted.

This is a typical anecdote from Ariely’s book, Predictably Irrational: inventive, lovingly described, verging on the trivial, and yet something I immediately wanted not only to tell people about but to try myself. In future, I vowed, I would be sure to present wine in a carafe, and dinner on fancy plates.

Ariely’s book is an accessible account of his own research programme, drawing occasionally on the insights of others. His aim is to show that our choices – usually, but not always, in commercial settings – are irrational but predictable. He does this by conducting psychological experiments, sometimes carried out in the laboratory, often in more real settings.

The book has a lot to recommend it. Ariely is a more than capable storyteller, and he sticks close to his own research so his writing is full of colour and detail. He also has a knack for conveying the rigour of the experiments without brandishing too many technicalities. And although he is pursuing a consistent theme throughout, there is a fresh insight in every chapter.

I could scarcely imagine a better introduction to “behavioural economics”, a discipline of growing influence that sits on the boundary between economics and psychology. But opinions differ among economists as to whether behavioural economics seriously challenges the long-held basic assumption of economics that we make rational choices, or whether it merely illuminates some fascinating but relatively minor human foibles.

Ariely’s research shows that our perceptions of a good deal can be hugely influenced by marketing tricks; that sexual arousal changes the way we make decisions, and that we are not good at anticipating this; that we can be confused by the fear of losing options; that the placebo effect is partially dependent on our perception of price. There is much else of interest. And there is plenty there for the economic traditionalists – I am one of them – to chew on.

Yet a question remains over how much we can generalise from these experiments. I have long been persuaded that the evidence shows we are fundamentally rational creatures when it comes to most of the decisions that really matter. Predictably Irrational did not change my mind about that, partly because it tended to steer clear of the bigger questions.

That may have been wise. When Ariely attempts to generalise from his experiments, his conclusions are far less satisfactory than the clever experiments themselves. One example is his work on sexual arousal: having painted a memorable picture of undergraduates answering survey questions while masturbating over a laptop encased in cling-film, he recommends first that teenagers should carry condoms, and second that they should steer clear of situations where they may become aroused. Wise advice, perhaps, but something of a stretch from the experiment itself.

Another example is his work on how choices confuse us. Again, this is based on a laptop experiment. Ariely explains that when his subjects were paid pennies to click on computer icons, they clicked – irrationally – on unprofitable icons, because doing so kept (useless) options open. That suggests a broader message, but when Ariely draws conclusions about how we should choose careers, or boyfriends, he is putting more weight on his own experiment than it can bear.

Fortunately, Ariely does not spill too much ink on heroic conclusions, preferring to describe with charm his relentlessly creative experiments. For anyone interested in marketing – either as practitioner or victim – this is unmissable reading. Other readers will be engaged and looking forward to a sequel. If only more researchers could write like this, the world would be a better place.

Also published at ft.com.

First published in Business Life Magazine, October 2007.

“I don’t care too much for money, money can’t buy me love.” A great tune, but don’t believe everything you’re told by The Beatles. Money can buy you love, and it can buy you happiness as well.
The economist Lena Edlund (whose own greatest hits include an economic “Theory of Prostitution”) finds that wherever the men are rich, the women are plentiful. Women outnumber men in the cities of almost every developed country, which is why the girls from “Sex and the City” were always grumbling that all the good men are taken. In Edlund’s home country, Sweden, the towns with the highest average male income are the towns with the largest proportion of women aged 25-34. Still think that money doesn’t buy love?
More direct evidence comes from internet dating, where economists have shown that men who claim a high income get more “clicks” than their poorer – or more honest – rivals.
These findings probably won’t surprise the cynics, but economists have also been investigating the link between money and happiness. The conventional wisdom is that money doesn’t buy happiness. The truth is a little more subtle.
It is true that the citizens of countries like the US, the UK and Denmark claim to be no happier than their parents did in 1980 or their grandparents in 1950, despite being much richer. But in every country, in any given year, richer people also claim to be happier. Money isn’t everything, though: divorce, unemployment or ill-health are far more depressing than mere poverty.
“Happiness economics” is a booming field at the moment, but even its proponents would concede that findings are at an early stage. One promising approach is led by Daniel Kahneman, a psychologist who shared the Nobel prize in economics in 2002, and the economist Alan Krueger, both at Princeton University. Rather than just asking people how they feel about life in general – the survey approach which has produced most of the happiness data reported in the press – they ask a smaller group of subjects to think about specific episodes during the previous day, and how they felt.
This approach has yielded some surprises: praying is enjoyable, spending time with your children is not. It is no surprise to discover that having sex is lots of fun.And if Lena Edlund is right, that sort of fun isn’t cheap.

I have a piece up at Forbes in part inspired by chapter 8 of “The Logic of Life”. It asks why governments are so determined to back losers rather than winners in industrial policy:

There’s a more sinister logic behind the pattern of government favoritism. Namely, firms in emerging, competitive industries have virtually no incentive to lobby for government hand-outs, while firms in aging, shrinking industries have the most to gain. Read the rest of this entry »

First published in Business Life magazine, September 2007

It’s been a long time since the heady days of the late 1990s, when email was enough of a novelty to carry the plot of a romantic comedy. How times have changed: email is now an essential business tool. It is also the source of frustration and controversy. Does email actually make us more productive?
It’s not obvious that it does. First, there is the avalanche of emails offering penis enlargements, stock tips and the odd million dollars from Nigeria. Then – and probably more of a waste of time – there are the interminable work discussions into which you’ve somehow been copied. They’re useless and yet you feel you can’t afford to ignore them. Finally there are the clumsy, slowly-typed miscommunications that could have been handled quickly and more smoothly face-to-face. It is all worth it?
Marshall Van Alstyne, an economist at Boston University, thinks he may have an answer. Van Alstyne and various colleagues have been conducting research based on extremely detailed data from an executive recruitment firm – including 125,000 email messages sent and received over a period of ten months. Rather than looking at simple correlations, such as “does more email mean more work gets done?”, the researchers are looking at the pattern of email networks and the completion of specific tasks.
The first surprise is that an email exchange is often more productive than a conversation, because email helps people to juggle many different tasks. That seems to be because a conversation demands that two people are focussing on the same thing at the same time. Sure, you can do your nails while talking on the phone, but beyond that you need to drop what you’re doing and surrender to someone else’s priorities. Email doesn’t make that demand: the recipient can read it when the time is right.
The second surprise is that email’s real value doesn’t seem to be in communicating with Tokyo or even with someone on the other side of London. The most productive workers are not the ones who send the most email or whose external networks are the largest: they are the ones with the largest email network inside the same firm.
It’s ironic: we are always complaining that our colleagues send us an email rather than walking ten yards and talking to us. Yet it turns out that this apparently-frustrating behaviour is precisely the most productive way to use email. Sometimes common sense and economic sense don’t point the same way.

First published in Waterstones Book Quarterly

Life often seems to defy logic. When a prostitute agrees to unprotected sex, or a teenage criminal embarks on a burglary, or a heavy drinker downs another whiskey, we seem to be a million miles from rational behaviour. None of it makes any sense – or does it?
Using some remarkably clever techniques and imaginative perspectives, a bold new breed of economists is busily demonstrating that life makes more sense than anyone would have thought. Using every clue that comes to hand, from a laboratory brain scan to the hidden patterns in old maps, they are discovering that there is a surprisingly rational basis to the seemingly irrational world around us. Read the rest of this entry »

Feature story, FT Magazine, 26 January 2008

In 1737, John Harrison, a self-taught clockmaker from Yorkshire, stunned London’s scientific establishment by presenting an idiosyncratic solution to the most important and notorious technological problem of the 18th century. He was hoping to win a then-fabulous prize of £20,000 (about £5m today) for anyone who could devise a way for a ship’s navigator to determine its longitude and therefore its position at sea. Harrison’s approach was to build a clock that would keep Greenwich time faithfully; by comparing local time (measured using the position of the sun) with the time in London, the navigator would know how far east or west the ship had sailed. The theory was sound, but given the rolling of ships and changing temperature and humidity, the leading scientists of the day – including Sir Isaac Newton – reckoned that a sufficiently accurate clock would be impossible to build. Harrison proved otherwise.

The longitude prize, sponsored by the British government, was not unique. Prizes were also offered in France for a functional water turbine, and for a method of preserving food for Napoleon’s armies. The latter prize quickly inspired the tin can, more of a blessing than food snobs might acknowledge.

But such prizes then fell out of fashion. For commercial innovations, we now rely on patents to encourage and protect innovators. Basic research is funded not by prizes but by grants.

And yet two centuries after tinned fish hit the market, the way we look for solutions has come full circle. Governments, private foundations and even corporations are rediscovering the value of offering prizes for good ideas. Rather than paying for scientific and engineering effort as they have done for the past 200 years, idea-hungry patrons are returning to the 18th century, and paying for results. Read the rest of this entry »

The Times (London) has published two nice extracts from the Logic of Life, plus me reading from the book. Read the rest of this entry »

As a columnist (which is fancy for “journalist in jammies”), I ought to personify the conventional wisdom that distance is dead: All I need to get my work done is a place to perch and a Wi-Fi signal. But if that’s true, why do I still live in London, the second-most expensive city in the world? Read the rest of this entry »

Slate is publishing two excerpts from “The Logic of Life“. Here’s the second one:

Perhaps a more positive way to express the trend is that women’s entry into high-powered careers has given them the option to get divorced if the marriage isn’t working out; and the recognition that that option is important is one of the factors encouraging women’s entry into high-powered careers.
That may sound a little abstract, but economists Betsey Stevenson and Justin Wolfers discovered a chilling example of the way that the increased availability of divorce empowered women. Read the rest of this entry »

Slate is publishing two excerpts from “The Logic of Life“. Here’s the first one:

Ever since John von Neumann’s game theory promised to help us understand love and marriage, economists have been interested in how people choose their partners and how relationships work. Read the rest of this entry »

First published in Business Life magazine, August 2007

The new football season is upon us, bringing the traditional complaints that the big clubs are getting ever richer and more successful at the expense of the fans’ enjoyment. Europe’s sports ministers are even pressing for action. Who, after all, wants to see a predictable football match?
Ironically, the European model of sport – global, very open, highly unequal – seems more American than American sport does. American sports leagues tend to be highly regulated, closed to newcomers, and redistributive. Sport does not always imitate life.
Many people intuitively feel that football should be a little more American, with more redistribution of television and gate revenues. Yet our intuition can sometimes deceive us. Both economic theory and the data suggest that an uneven sporting struggle may not be as bad for fans as many of us believe.
The assumption that people value an evenly-matched contest is challenged by the game’s statistics. Think of Arsenal’s unprecedented “invincible” season in 2003-04; the club won 84 per cent of its premier league matches and lost none. Hardly fair on Arsenal’s opponents, but every match was a sell-out. The small chance of a defeat was presumably enough to keep Arsenal’s many fans interested.
In any case, their dominance also allowed them to play great football. That is important: sports fans care about quality as well as the odd surprise.
That’s just one example, but Stefan Szymanski of Imperial College London, one of the world’s leading sports economists, has done a more rigorous analysis of attendance over 25 years at English second-tier football matches. He finds that that in seasons where inequality between the top teams and the bottom teams is higher, the audience for football is not smaller and perhaps a little larger.
That shouldn’t be too surprising: more fans turn up when their team is winning, so in seasons when the bigger teams are winning more often, average attendance should rise.
Similar reasoning suggests that some sport regulator genuinely trying to make the largest number of fans happy would favour the big teams, because the big teams have more fans.
The statistics certainly suggest that the rise of the mega-teams such as Manchester United, Barcelona, and Real Madrid has boosted global interest in the sport rather than killing it. Giant-killing feats are a good story but they disappoint millions of loyal big-club fans. Upsets are necessary but if they happen too often they would not be upsets. And if you really think that football is predictable, the bookies will be happy to take your bets on this season’s champion.

First published in Business Life magazine, July 2007

Let’s face it, we’re fat. Half of all British adults are overweight or obese, which is good news only for the manufacturers of outsize trousers. Other countries are also suffering from rising obesity. So if you wanted to propose a policy to slim down the western world, what would it be?

That depends on what you think the problem is. Trust the economists to have an opinion about that. Armed with a big box of clever statistical tools and a keen sense of the costs and benefits of anything – even a cheeseburger – they have something to say that is worth hearing.

The clever statistics are essential. After all, is a kid who spends 40 hours a week watching television fat because he’s been watching advertisements for fast food, or fat because he isn’t outside playing football? Or is he watching so much television because he was already fat and so doesn’t enjoy playing outside?

The economists Shin-Yi Chou, Inas Rashad, and Michael Grossman realised that local networks all over the United States have different patterns of fast-food advertisements. They have used this difference to show that fast-food advertising does indeed make children, especially teenagers, fatter.

Another neat piece of analysis is from Henry Overman of the London School of Economics, along with three co-authors. They look at the common complaint that sprawling suburbs make people fat because they encourage too much driving. On the face of it, that seems to be true: fat people live in the ‘burbs. But Overman’s team tracked 6000 people over time to show that the suburbs don’t cause obesity. They simply attract overweight people, while compact pedestrian-friendly cities attract the slim and fit.

Obesity even lends itself to cost-benefit analysis, and it does seem that the incentives are starting to push people away from dieting. Because of new cholesterol-busting drugs, it simply isn’t as dangerous to be fat as it once was. (Sure, it’s bad for you, but it used to be worse.) I have heard more than one economist argue that that’s a reason for the rise in obesity: since it’s not such bad news to be fat, why not eat the odd chocolate bar that once you would have resisted?

Add to that the fact that the time and expense of making unhealthy food has plummeted. The Harvard economist David Cutler, with two colleagues, points to the potato as an example. It was once boiled or thrown into stews because making chips was a chore. Thanks to industrial processing, freezing and vacuum packing, we can enjoy chips in seconds and for just a few pennies. If you really want to slim down the nation, perhaps you should forget advertising and worry about microwavable chips.

First published in Business Life Magazine, June 2007

Whoever would have thought the world contained so many types of jam? Even my local corner shop offers thirty-five varieties. A supermarket offers hundreds. The choice can be dizzying.

Some social scientists argue that this sort of choice is actually a bad thing because these choices are stressful without being useful. Certainly, when my wife asks me to run an errand for her and buy some unfamiliar product, stress is exactly what I feel.

More formal studies back up those instincts. Psychologists Mark Lepper and Sheena Iyengar set up a jam tasting stall in a posh supermarket in California. Sometimes they offered six varieties of jam, at other times 24 flavours. The bigger display attracted more customers but very few of them actually bought jam. The display that offered less choice made many more sales.

Fascinating research, but I don’t get as worried about this as the psychologists do. They perhaps forget that the choice between Robertson’s Jam and Wilkin and Son’s Jam might seem irrelevant to the customer, but it’s not irrelevant to Robertson, nor Wilkin and Son. We are often offered an apparently-pointless choice between two equally good products, not appreciating that they are only good because we have been offered the choice.

I am less concerned about the proliferation of choice in supermarkets – which, after all, we usually take in our stride – and more about what those choices sometimes do to prices. The differences between innumerable products are a great way of charging some customers more, because more varieties allow supermarkets more options for carefully-aimed prices.

And surprisingly, sometimes choice does not foster competition at all. When a few large companies pour forth a huge variety of brands, some economists believe that this is an attempt to stake out territory and keep out new competitors.

The resulting variety is still useful, especially if you have unusual tastes or needs (my corner shop offers four jams for diabetics). Yet there is clearly a cost. The more types of jam there are, the more expensive each one is likely to get, because of higher production, marketing and distribution costs. Is it worth it?

The most famous analysis of such a situation says “no”. In the 1970s, economist Richard Schmalensee devoted himself to the other side of the breakfast table, and argued that the American cereal market was full of unnecessary brands. That meant, said Schmalensee, that prices were higher than they needed to be. But such studies are expensive to conduct, so whether this is true today, and for other products, is something we can only guess. It is all worth pondering over breakfast – perhaps just a grapefruit and a cup of coffee?

As I enter the porter’s lodge at St Hugh’s College, Oxford, I fleetingly reflect that I may be about to receive an intimidating tutorial from the college principal, Andrew Dilnot. It is not that the economist has a stern reputation, but today’s circumstances are unusual. He recently stepped down from presenting More or Less, a BBC Radio 4 series about numbers in the news. I have been recruited as the new presenter, and am ready to be patronised – or worse.

I needn’t have worried: as he strides into the lodge in a pale brown linen suit and blue tie, Dilnot’s smile is genuine enough, and as we walk together through north Oxford’s leafy residential streets, he is more eager to identify shared acquaintances in the world of economics than to lecture me on the art of radio presenting. Read the rest of this entry »

I have a new piece up at Forbes:

…the most reasonable judgment is that flying fresh food around the planet carries an environmental cost of no more than a few cents per meal. That sounds astonishing, but perhaps it shouldn’t be. Those Chilean grapes aren’t flying first class: They’re packed tight to save money, which incidentally saves on pollution. The most wasteful part of the journey is when you and I hop in our cars and drive to the shops and back with a bag of potato chips in the trunk of the car.

You can read the whole thing here; the Forbes piece also contains links to the research.

First published in Business Life magazine, May 2007

Do you believe that there is one special person out there, someone who is the perfect match for you? If so, perhaps you should flip to a different page, because your hopes and dreams are about to be scrutinised by the most unlikely researchers: economists.
The economics profession’s standard excuse for poking around in matters of the heart is the close connection between family stability and economic success. The truth is probably a bit different: where once economists only had data on inflation and unemployment, now they have data on dating. Which would you rather study?
Speed date evenings are one of the best sources of this new data. If you’ve ever been on a date that was obviously a disaster from the first three minutes, you’ll understand the attraction of speed dating; on a speed date, you only meet each person for three minutes anyway. At the end of the evening you tell the organisers which people you liked, they later connect mutually-attracted couples.
Economists have realised that speed dates provide the sort of data about who likes whom that you would normally only acquire with binoculars, years of research and a great lawyer. Two researchers, Michèle Belot and Marco Francesconi, persuaded speed dating companies to share their data. Belot and Francesconi recently published their research with the intriguing title, “Can anyone be The One?” The answer, I’m afraid, is “just about anyone, yes.”
They studied 3600 people at 84 speed dating events. They were able to see who went to which event, and who liked whom. Some of the findings weren’t surprising: women seem to be choosier, proposing a match half as often as men. It will shock nobody to hear that tall men, slim women, non-smokers and professionals received more offers.
But what might raise the odd eyebrow is the discovery that speed-daters systematically change their standards depending on who shows up for the speed date. Although women prefer tall men rather than short men, on evenings where nobody is over six feet, the short guys have a lot more luck. Most people prefer an educated partner, but they will propose to school drop-outs if the PhDs stay away.
If people really were looking for a partner of a particular type, we would expect them to respond to the absence of such people by heading home with a disappointed shrug and hoping for better luck at the next speed date. Instead, people respond to slim pickings by lowering their standards. So if you really believe there’s just one special person out there for you, you’re more patient than the rest of us.

FT Comment, 27 October
An economist once dubbed “champion of choice” by The Guardian newspaper would like your employer to organise an exercise hour for you and your colleagues. Professor Julian Le Grand was once a social policy adviser who had the ear of Tony Blair.

Now he has everybody in Britain sitting up (sorry) and taking notice. Even though Prof Le Grand intends to offer an opt-out to anyone who doesn’t much care for the idea of doing a bench-press with the boss as spotter, that doesn’t make the idea appealing. Read the rest of this entry »

I have an article up at Forbes.com for part of their package on “The American Dream”. I argue that America isn’t the land of opportunity that I like to think it is:
Who could argue with the idea that America is the land of opportunity? Since the country was born, millions of desperate immigrants have fled poverty, war and oppression to become citizens of the land of the free. America’s entrepreneurial culture is famous: It’s easy to take risks, start a new business. Anyone can become the next Bill Gates.
It is one of the touchstone beliefs that makes America what it is. And as an admiring outsider–I am English, although my daughter was born in Washington, D.C.–I’ve always found it compelling.
There’s just one problem: On one very important measure, America offers less opportunity than almost any other rich country. The real lands of opportunity are places like Canada, Finland and especially Denmark.
The measure I’m using is hard to calculate but easy to understand: How much of your parents’ income rubs off on you? If your father was rich at the age of 40, how likely is it that you will be rich at the age of 40? And if he was poor, are you also doomed to poverty?

Continued on Forbes.com, subscription free.

My wife grew up in the countryside. To the extent that I have ever grown up, I did so in a series of small towns. Now we live in London and we are always dithering about whether to stay put with our young family, or move out to the countryside.

It is a decision for us, of course, but it is a decision that affects others – and is affected by the mixed signals provided by the government’s involvement in schools, infrastructure and the planning system. To the extent that governments get involved at all, they should be defending cities, strengthening their infrastructure and allowing them, within reason, to grow. In the UK and to some extent the US, they seem determined to do just the opposite.

Most people would prefer to live in cities. We know that because they currently accept a big financial penalty for doing so. Once you strip out the effect of the higher cost of living in cities – chiefly housing and tax – average city wages are lower than those in the countryside and small towns. Daniel Gross, the New York writer, recently totted up the purchasing power of the New York dollar: a mere 61 cents; and higher New York wages compensate for less than half the difference. The Harvard economist Edward Glaeser finds that a similar pattern holds across the US: real wages are lower, not higher, in the bigger cities. I don’t propose to shed a tear for New Yorkers or Londoners here, just to point out that we are not in it for the money.

Continued on ft.com, subscription free.

Mr Market has been getting a pasting from my learned FT colleagues recently. John Authers compared him to Wile E. Coyote. John Kay warned against personifying the market – but called him a silly old fool anyway.
The criticism seems reasonable enough. Credit spreads, bond prices, equities and currencies have all been dancing an insane caper. At times like this, the idea that the market is rational and efficient falls out of fashion pretty swiftly.
Mr Market is big enough to take care of himself, but I feel obliged to offer a few words in his defence. There is a danger in writing him off too casually, a temptation (to which I know Authers and Kay would not succumb) to think that if Mr Market is so demented, it would be easy to do better. But Mr Market is not as silly as you think.
We journalists are partly to blame for the market’s crazy reputation in times like these. It seems rather limp to write that the market rose 1.9 per cent, then dropped back 0.7 per cent, and nobody really knows why. It’s far easier all round to write a story explaining that the pattern was due to bullishness about growth, followed by profit-taking. It may even be useful, because it helps us remember what happened.
But such impromptu explanations are likely to sound feeble indeed when the market has a month like July – or worse, a day like “Black Monday” in October 1987. We are left to conclude that Mr Market must have lost his mind.
That is why it is irresponsible of me to be talking about “Mr Market” at all. It is an irresistible but misleading metaphor. Market moves that would surely be irrational if made by a single decision-maker can make perfect sense when made by a large group of investors. The economists Jeremy Bulow and Paul Klemperer have shown that even a market full of hyper-rational investors would suffer frenzies and crashes. The intuition behind their model is simple enough to grasp: smart investors pay attention to what other investors may know. When the market moves on no news, that move is the news: it is information about what everybody else is thinking.
This is not to say that all investors – or even most investors – are rational. It would be very surprising if they were. The field of behavioural finance, populated by a potent alliance of financial economists and psychologists, is revealing all sorts of evidence of irrational behaviour. An important example is a reluctance to sell loss-making stocks, because that would crystallise a loss.
This sort of psychological research deserves the serious attention it is getting. But it would be a mistake to believe that behavioural finance offers us an opportunity to put Mr Market on the psychiatrist’s couch. Just because some investors make these mistakes does not mean that the market as a whole will do so: there is too much incentive for the smart money to learn about the biases and try to do exactly the opposite.
Another difficulty for behavioural finance is that some of the behavioural economists’ discoveries have a tendency to evaporate when real money and real experience is on the line. John List, an economist at the University of Chicago, has shown that a well-known psychological bias against trading is not shared by experienced traders in real-life trading situations. (I’ll admit that the traders were dealing in Mickey Mouse badges and baseball memorabilia, but the discovery is instructive.) The experienced, rational traders tend to have more cash than the eager naïf, and so while many traders are irrational, Mr Market may well be sane enough.
It is, in any case, frustratingly hard to turn either psychological research or good solid common sense into a market-beating strategy. Psychologists point to “the endowment effect”, a natural and irrational urge to hold on to what we have rather than trade to something better. Yet wise heads caution against the foolishness of day trading. We can’t both be irrationally eager to trade and irrationally reluctant to do so – unless a split personality is to be added to the list of market traders’ psychological flaws.
Another example has been made famous by Nassim Nicholas Taleb, with his talk of the “black swan”.
Mr Taleb believes we should resign ourselves to the occurrence of dramatic, unexpected events. He claims to profit by betting that these black swans will arrive from time to time. That sounds wise indeed.
And yet the psychologist Philip Tetlock, who has made a life’s work out of studying the forecasting record of political experts, concludes that they have a natural tendency to imagine unlikely events and convince themselves that those unlikely events are, in fact, all too plausible. Mind-broadening techniques such as scenario planning or reading the Financial Times turn out to be embraced too readily by those who are already spotting black swans behind every clump of reeds. Are we too eager to imagine black swans, or too eager to dismiss them?
So I am convinced that human rationality is imperfect; I am far less convinced that those imperfections yet tell us anything profitable about the financial markets. If I am wrong, I urge any behavioural economists who have parlayed their ground-breaking research into stock-market millions and early retirement to get in touch.
Until then, I’ll invest in good old tracker funds and pay little attention to what happens to them in the short term. I’ll admit that Mr Market isn’t perfectly rational. But if I thought I could do better, I’d be crazy.

Last month, 20-year old David Lomas donated over half of his liver to save the life of his father, Stephen. It was an inspiring sacrifice.

There aren’t enough donors to go around, and 400 people die each year in the UK while on the waiting list for an organ transplant.

So what about a bit of basic economics here: if we want more live organ donors, shouldn’t we pay people for their trouble?

To many people, the very idea is offensive. But is our disgust reasonable, or is it costing lives?

Our notions of what should be bought and sold have changed over time.

Life insurance, for example, was considered ghoulish until the early 20th century.

Now it is regarded as something that every responsible person should buy.

Yet there are still many transactions – anything from sex to a kidney transplant – that are viewed as beautiful in the context of a loving relationship, but corrupted by a cash payment.

So what should we make of a market for organs?

Continued at news.bbc.co.uk, subscription free.

The dismal science keeps crashing through those boundaries, and I am now offering dating advice to the readers of Esquire (UK). Unfortunately they don’t have a proper website, so you’ll need to buy it if you want to read the article.

Here’s a taster:

If there’s one thing that economists understand, then it’s supply and demand. No matter how attractive a dating proposition you are, you can always put yourself in a stronger position by making sure that you’re in a place where there aren’t enough men to go around. In other words, you need to live in a seller’s market.
Carrie Bradshaw, the lead character in Sex in the City, grumbled “that there 1.3 million single men in Manhattan and 1.8 million women” but she didn’t stop to wonder why.
New York-based economist Lena Edlund (whose research includes “A Theory of Prostitution” and “Hermaphroditism: What’s not to Like?”) argues that the reason cities have an excess supply of young women is that they offer them two bites at the cherry: good jobs, and rich husbands.
In case you doubt this explanation, Edlund looked carefully at the situation in Sweden. She found that the richer the men, the larger the supply of available women in the local area. I think it’s pretty clear what is going on here. So if you want to be surrounded by unattached young women, live in an area full of wealthy guys.
Most big cities provide well-stocked hunting grounds for men but in the UK, the top locations include leafy stockbroker-belt towns in Hertfordshire (between the ages of 20-35, there are 113 women chasing every 100 men), Berwick-on-Tweed (112 young women per 100 young men) and Kensington and Chelsea (108 – and you thought all those girls on the King’s Road were shopping for shoes). Mews houses in SW6 don’t come cheap, of course, but if there’s one thing economics tells us it’s that there’s no such thing as a free lunch.

Note: if you are reading this magazine in Rutland, Oxford or Cambridge, the deck is stacked against you. And with three young guys for each girl, the Isles of Scilly have all the demographic desirability of a North Sea oil rig.

Review: More Sex is Safer Sex: The Unconventional Wisdom of Economics, by Steven Landsburg

A new book has appeared on the tottering pile of popular economics tomes on my desk, and appropriately enough it is a welcome return from the writer who laid their foundation back in 1993 with The Armchair Economist.

Steven Landsburg writes beautifully, is very smart and very creative, and I loved his new book. Some will hate it, but then Mr Landsburg won’t mind that at all: he has long taken a mischievous pride in offending sensibilities.

More Sex is Safer Sex is a collection of short essays – often based on Landsburg’s long-running column in Slate – exposing the economics deep beneath the surface of life. His opening chapter explains that if sexually reserved people slept around a bit more, we’d all be at less risk from sexually transmitted diseases, because we’d spend less time sleeping with a small number of sexually active, very risky partners. Sexual restraint, therefore, is rather like pollution, and it would be nice to find a policy to encourage less of it. Landsburg casts around for a solution but doesn’t find one that totally satisfies him, and then he’s off to the next subject, by which time both the verve of the writing and the edginess of the arguments are obvious.

Subsequent chapters cover politics (give every American an extra vote to cast in a different district, so that voters can punish pork-barrel politics), fire-fighting (let fire crews keep all the property they save, but watch out for arson-for-profit) and jury service (give jurors financial incentives to reach the right verdict, and hold a few fake trials to keep them honest)…

Continued at ft.com, subscription free.

One of the most prestigious awards in academic economics, the John Bates Clark Medal, has been awarded to Susan Athey, a professor at Harvard University. Professor Athey, 36, is the first woman to win the Clark Medal, which is awarded every two years by the American Economic Association to a leading academic economist under the age of 40. Many previous winners have gone on to receive the Nobel memorial prize in economics, but the Clark Medal is a better guide to the current cutting edge of the discipline.

Professor Athey made her reputation by reinforcing the foundations of traditional game theory, showing how businesses might respond to risk, and applying that insight to auctions, industrial structure and macroeconomics. Her econometrics – the statistical analysis of economic behaviour – was also mentioned in the prize citation.

“Susan’s work on the foundations of economic theory has been of fundamental importance, showing economists when they can have confidence in their ‘equilibrium’ theories and when they can’t.” said Paul Klemperer, Professor of Economics at Oxford. “The sheer range of her work is also impressive.”

This award is something of a return to traditional values for the AEA; recent winners have addressed more esoteric topics. Matthew Rabin (2001) studied the interaction of economics and psychology, Daron Acemoglu (2005) the economic causes of dictatorship and the effects of colonialism, and Steven Levitt’s (2003) research was idiosyncratic enough to form the basis of a best-selling book, “Freakonomics”.

Nevertheless, Professor Athey’s award is not a surprise. “Susan has been a favourite to win this prize since she left graduate school,” Professor Levitt commented.

Professor Klemperer, who first met Athey when they overlapped at Stanford University, agrees. “When she hit the job market she was obviously a star – perhaps the star of that cohort.”

She became famous in the economics profession for having been so in demand – and so unwilling to turn anybody down – that she presented her work to 25 departments.

She was also noted for her work ethic as an untenured professor, which was Stakhanovite even by the standards of her peers. One important breakthrough came on Christmas eve, when the rest of her family were all asleep.

Professor Athey has complained in the past that female economists lack role-models in a male-dominated profession. This award is a big step towards changing that.

From the ft.com

Competition, as any freshman economics student will tell you, brings down prices. It works for computers and for phone calls and for cars. Why not for hedge funds? Investors have been paying the same fees since practically the dawn of the hedge fund: a 2 percent management fee plus 20 percent of profits. Now that there are thousands of funds competing for capital, why hasn’t “2 & 20” become “1 & 10” or even “0 & 5”?

Quality is a major concern; no discounted fee will ever be deep enough to compensate for the cost of investing money with an incompetent manager. (Heart surgeons don’t tend to compete on price, either.) A hedge-fund manager who cuts his fee is signaling that he can’t persuade other investors to trust him…

Continued at New York Magazine, subscription free.

First published in Business Life magazine, November 2007

I remember Saturday evenings when I was a boy, curled up in a towel after bath time to watch game shows such as “The Price is Right”. Little did I know it, but those Saturday evenings were preparing me for life as an economist.
Economists have theories about how people behave, but those theories are hard to test in the muddle of the real world. And laboratory experiments may be no better, because the stakes are too trivial to see how people act under pressure.
That is where the game shows come in. Like real life, game shows are often played for high stakes. But like the laboratory, the rules are simple and the experiment is repeated over and over again.
In one early piece of game show research, economists Jonathan Berk, Eric Hughson and Kirk Vandezande showed that contestants in “The Price is Right” made transparent mistakes but learned from them.
Four contestants would in turn name a price for some household object such as a toaster. The contestant who got closest to, but not over, the correct retail price would win. The other contestants would get another chance.
If you’re smarter than the average contestant you’ll see that the fourth person to bid has an advantage. Since you want to be closest, but not too high, the best strategy is to guess just one pound higher than one of the other contestants (or zero, if you think they’re all too high). Not many contestants did this, but once somebody figured it out, the others were more likely to use the tactic in later rounds.
The economics of quiz shows hit the big time with Steven Levitt, now famous as the co-author of Freakonomics. Levitt tried to understand what was behind discrimination in the job market: did people simply dislike ethnic minorities or the elderly? Or did they believe them to be less competent?
For the answer, he looked to “The Weakest Link”, in which contestants vote for other contestants to be excluded. The best approach is to vote off weak players early on, because they’re costing everyone money – but later, to vote off strong players, because they are the most dangerous competition.
Levitt showed that elderly players tended to be voted off at any stage, suggesting a pure dislike for them. Hispanic players were likely to be voted off early but kept on later in the game, implying that other contestants thought they weren’t very smart.
The game show boom in economics is still going. I’m aware of eight economists who’ve studied “Deal or No Deal”. If only I’d been thinking like an economist when I was younger, I could have beaten them all to it.

FT Comment, 5 March 2007

For most of us, the most important contract we will ever enter into is marriage. It is a shame that nobody really seems to know what the contract says, and for obvious reasons it is considered poor form to ask.

These issues will be richly illustrated this week when the latest big-money divorce case reaches the UK Court of Appeal. The multi-millionaire insurance underwriter John Charman is arguing that his ex-wife Beverley, to whom he was married for 30 years, should receive £20m ($39m) rather than the £48m he has been ordered to pay her.

With children grown and provided-for, £20m is more than Mrs Charman needs but £48m is substantially less than half of the assets built up during the marriage. In this sometimes-yawning gulf between an equal division and what the poorer spouse needs lies the zone of uncertainty in which divorce lawyers are gambolling, while politicians avoid the subject.

The judges are trying to make sense of it all as they go along. That is a shame. Their decisions do not simply affect the unhappy couple in front of them, but the incentives of others. It is often said that if divorce is a blank cheque for the poorer spouse, the rich will fear marriage with the less wealthy altogether. But it is also true that if divorcees expect no extra money as a result of their partner’s entrepreneurial efforts they will offer lacklustre support. Mr Charman has complained that his wife hesitated to let him use their home as collateral for a big business loan. Perhaps she realised that she might not enjoy all the rewards if the gamble paid off.

Every divorce is different. Should the length of the marriage matter? Or the extent to which the wealth was accumulated before the marriage began? Or who filed for the divorce?

It is possible to make a reasonable argument for many different positions and Mr Charman claims that he has paid lawyers on both sides of the argument almost £5m to do just that. But while it is hard for ordinary mortals to suppress their schadenfreude when the super-rich go through messy divorces, this uncertainty is unnecessary and counter-productive for us all.

Marriage is a market. There is a supply, there is a demand. Markets work better when contracts work too. Economists know perfectly well that one of the many reasons why marriage has always been popular is that it is economically efficient. It is based on the division of labour, Adam Smith’s pin factory and all that. One man straightens the pin, another whitens it. The Chinese make the fridges, the Americans make the software that designs them. So, too, in a traditional marriage: one spouse brings home the bacon, the other cooks it. It is a joint effort, an efficient one – and one under serious threat if the contract is ambiguous.

Life is full of arguments about who should get what. Contracts are a wonderful way to help solve them. There are arguments for “he gets it all” and there are arguments for “she gets it all”, but I do not find any of them nearly so compelling as those for “both get whatever they agreed to when the marriage began”.

Unfortunately, the British courts do not recognise pre-nuptial agreements. Perhaps engaged couples are presumed incapable of making big decisions.

But that is a strange position. The ideal time to think about divorce is before the marriage. At that stage, each should enjoy a similarly powerful negotiating position. If the man feels he is in a stronger position, why is he settling for the woman in front of him? Paul McCartney presumably felt the equal of Heather Mills when they were married. If he felt superior, perhaps he should have married Madonna instead.

A good pre-nuptial agreement should be able to specify one of the many reasonable ways in which things will be resolved if the marriage does not work out. If she is a financial powerhouse and he is a toy boy, marriage need not be beyond them: the pre-nup can fix compensation arrangements, by the hour if necessary. It is not romantic but neither is a messy divorce.

I will admit that it might be tricky to draw up a sensible pre-nuptial agreement. The government could at least supply us with a choice of three: equal division, fair needs, or everyone for him or herself. I can see all three possibilities having some takers. There should be no default option. Couples should have to choose. If they are not willing to discuss these awkward questions before they commit to a “lifetime” together, what responsible government would recognise their marriage?

Why aren’t African-Americans achieving all that they could? American blacks are twice as likely to be in poverty as non-blacks, according to the U.S. Census Bureau, and they make nearly $5,000 a year less, on average. What exactly is standing in their way? That’s not an easy question, but some compelling and controversial answers are coming from an unexpected source: economics.

Economists who studied racial inequality were once viewed with skepticism, even by other economists. In the 1970s, Glenn Loury’s Ph.D. classmates at the Massachusetts Institute of Technology joked that his economics thesis began: “This dissertation is concerned with the economics of racism. I define racism as a single-valued, continuous mapping….”

The joke is now on them, as economists have dug up insight after insight in the field. Now Loury’s young co-author, Harvard’s Roland Fryer, is attracting attention for his study of “acting white,” where black kids who work hard at school are said to be ostracized by their peers. Despite a lot of talk about the problem–Barack Obama raised it in his famous speech to the Democratic National Convention–some academic researchers weren’t convinced that it existed…

The full article is on the Forbes site, subscription-free.

Those who were not paying attention could be forgiven for thinking that popular economics writing began in 2005 with the publication of the wildly successful Freakonomics. At one stage last year, Freakonomics and my own offering were exchanging first and second place on the Amazon.co.uk ratings. Nobody, I think, was more surprised than I and the “freakonomists” Steven Levitt and Stephen Dubner.

Diane Coyle did not think much of Freakonomics, which she attacked for its sensationalism, and The Soulful Science is not interested in making economics sexy. Dr Coyle has a very different ambition: she wants to make economics likeable.

Dr Coyle’s previous book, Sex, Drugs and Economics, was excellent on the economics but the title was misleading: this reader never got the sense that her heart was in the sex and drugs. In The Soulful Science, she is on more comfortable territory. Duly liberated from the need to hype up a subject that she feels needs no hyperbole, she has produced a better, more confident book.

The simple aim of The Soulful Science is to describe what economists do, how the field has changed in the past 10 years or so, and why you should care. It succeeds admirably.

The book is split into three parts: the first on economic growth, the second on human behaviour, and the third an attempt to bring the two together. The chapters are peppered with vignettes of economists – “passionate nerds”, she affectionately calls them – but at its core, each chapter is a review of the economic literature. Each chapter explains simply what the key questions are, shows the relevance of apparently esoteric debates, puts all the ideas into context and sums up neatly.

The opening chapters on growth and development are essential reading if you want to understand much of what is going on in the newspapers. If you want to understand whether there was a “new economy” in the 1990s, you need to understand how growth is measured and how previous technological innovations affected the economy. And if you want to understand the claims and counter-claims in an impassioned debate about the effectiveness of foreign aid, you should read the chapter on “How to Make Poverty History”.

We then move on to the hot topics of behavioural economics – that is, the study of how and why we do not act the way economists think we should – and the economics of happiness. Behavioural economics is a fascinating subject that could easily fill a book in its own right. Happiness economics is also intriguing, although far thinner: so far, it consists mostly of statistical correlations, asking whether people are more likely to say they are happy if they are rich, married or if the sun is shining.

Dr Coyle covers all this sympathetically but with an appropriate scepticism. Yes, happiness guru Lord Layard was happy growing up in a house with icicles on the inside of the windows, and Paradox of Choice author Barry Schwartz finds it agonising to choose between all the jeans on offer at Gap. But Dr Coyle likes designer shoes and dislikes icicles and would rather make her own choices than have Profs Layard and Schwartz decide for her.

Dr Coyle usually chooses her subjects well, picking research areas that are frequently over-embellished by others and giving them the fresh, unbiased treatment they are crying out for. But her final chapter, “Why Economics has Soul”, is less satisfying. What begins as a defence of economics turns into a laundry list of cool things that economists do. It is interesting enough but not a particularly satisfying way to conclude the book. Since the final chapter is supposed to defend the subject, perhaps it is unfair to complain that it sounds defensive. The rest of the book is defence enough.

Even if economists have been claiming that economics can be fun for many years, publishers have recently begun to pay much closer attention. The Soulful Science will not be the only popular economics book of 2007. One notable attraction is Steven Landsburg, an American economics professor who wrote the now-canonical The Armchair Economist. He will be back in April with More Sex is Safer Sex. Having seen a copy, I can confirm that Prof Landsburg seems keener to write about sex than Dr Coyle is.

The contrast in styles is striking. Dr Coyle is the “passionate nerd”, an enthusiastic teacher, convinced that a brightly presented review of contemporary economics should be accepted on its own merits. Prof Landsburg is more of a subversive figure, tempting readers to the dark side with an eagerness to contradict conventional wisdom at every step. He is keen to shock: at one point, he asks us to compare coma victim Terri Schiavo to a toaster to better comprehend his argument. Still, the devilish fun of it all is undeniable.

Dr Coyle is keen to make friends for economics and Prof Landsburg, it seems, is happy to make enemies. How encouraging that popular economics writing has matured to the point where we have the choice between these contrasting approaches. My advice would be to read both.

A revolution in the social sciences began in the 1920s, when the man Time magazine called “the best brain in the world” decided he would work out how to win at poker. John von Neumann’s quicksilver genius accelerated the development of the atomic bomb by a year, and he was one of the fathers of the computer. He also spawned dozens of stories about his prodigious mathematical ability: In one, he turned down funding for an early supercomputer designed to solve a mathematical problem–and instead came up with a solution using pencil and paper.

Von Neumann was only interested in poker because he saw it as a path toward developing a mathematics of life itself. He wanted a general theory–he called it “game theory”–that could be applied to diplomacy, war, love, evolution or business strategy. But he thought that there could be no better starting point than poker: “Real life consists of bluffing, of little tactics of deception, of asking yourself what is the other man going to think I mean to do. And that is what games are about in my theory.”

Read the rest at Forbes.com, as part of a survey on “Games”.

I found William Poundstone’s biography of Von Neumann, “Prisoner’s Dilemma“, helpful in writing this piece, but Forbes couldn’t make space for a link. Check the book out.

Imagine going to the corner store to buy a carton of milk, only to find that the refrigerator is locked. When you’ve persuaded the shopkeeper to retrieve the milk, you then end up arguing over whether you’re going to hand the money over first, or whether he is going to hand over the milk. Finally you manage to arrange an elaborate simultaneous exchange. A little taste of life in a world without trust–now imagine trying to arrange a mortgage.

Being able to trust people might seem like a pleasant luxury, but economists are starting to believe that it’s rather more important than that. Trust is about more than whether you can leave your house unlocked; it is responsible for the difference between the richest countries and the poorest.

“If you take a broad enough definition of trust, then it would explain basically all the difference between the per capita income of the United States and Somalia,” ventures Steve Knack, a senior economist at the World Bank who has been studying the economics of trust for over a decade. That suggests that trust is worth $12.4 trillion dollars a year to the U.S., which, in case you are wondering, is 99.5% of this country’s income. If you make $40,000 a year, then $200 is down to hard work and $39,800 is down to trust.

How could that be? Trust operates in all sorts of ways, from saving money that would have to be spent on security to improving the functioning of the political system. But above all, trust enables people to do business with each other. Doing business is what creates wealth.

Of course, as Mr. Knack admits, this loads a lot onto a short word. So it’s worth trying to get under the surface of trust in rich countries. Economists distinguish between the personal, informal trust that comes from being friendly with your neighbors and the impersonal, institutionalized trust that lets you give your credit card number out over the Internet.

The two types of trust are correlated with each other, because we are more willing to trust people if we feel that, ultimately, we can call the police or get a fair hearing in court.

“The reason why the U.S. is richer than Somalia is mostly not because of culture. The great thing about formal systems, when well designed, is that they make a little bit of public spirit, altruism or professionalism go a long way,” says Paul Seabright, an economics professor at the University of Toulouse.

Formal or institutionalized trust sounds cold and unpleasant, but it is just as useful as the personal variety, perhaps more so. Our parents might have enjoyed a line of credit from the friendly owner of the local grocery store. We don’t get the same personal service, but we get something much more useful–we can run a line of credit pretty much anywhere, from a hotel in Shanghai to a diner in Memphis to a supermarket in Berlin. Those places don’t actually trust us enough to lend us money, but Visa or American Express will, and that will do just as well.

This matters. Adam Smith, the father of modern economics, argued that wealth was built on the division of labor. He gave the famous example of the pin factory in which one worker drew out the pin wire, another cut the wire, a third added the pin head, a fourth sharpened the pin to a point and so on. But the pin factory achieves nothing if the workers can’t trust each other, and a modern global economy relies on a division of labor and the accompanying trust that spans the continents many times.

Seabright’s book, The Company of Strangers, makes this point with reference to the author’s shirt: “The cotton was grown in India, from seeds developed in the United States; the artificial fiber in the thread comes from Portugal and the material in the dyes from at least six other countries; the collar linings come from Brazil, and the machinery for the weaving, cutting and sewing from Germany; the shirt itself was made up in Malaysia.” It’s just a shirt, and even then it is far too complex a product to be facilitated merely by a network of people who know and trust each other personally.

Yet in a place like Somalia, personal trust is all that is available. It is a war-torn country in the horn of Africa which lacks anything we would recognize as a government, and entrepreneurs have to rely on much more local, primitive and less effective forms of trust. Somalis often rely on clans to settle disputes. That can work well if you’re arguing with someone from the same clan, but cross-clan disputes are often messy and unfairly resolved. (Anybody who thought Somalia’s poverty had to do with a lack of natural resources might take a look at resource-rich Nigeria, a country which is nearly as poor, and then at resource-poor Singapore, one of the richest countries in the world.)

That is a reminder that institutionalized trust might be even better than the touchy-feely type, which simply isn’t available to everyone. Personal trust can be benign, but it can also be embodied by the old-school-tie network, political patronage or a criminal mafia.

“Factors which increase trust in society are not necessarily a good thing, because they can increase the bonds between gang members, whose main economic success comes from extorting or coercing other people,” explains Seabright.

Trust can also be denied to ethnic minorities: the credit card companies may not be entirely blind to race, sex, color and creed, but I am willing to bet they are much closer than the local bank manager in the 1950s.

Economists Kerwin Charles and Patrick Kline have tried to put their fingers on the arbitrariness of personalized trust by looking at car pooling and race. They argue that car pooling is a good measure of trust: can you trust your fellow travelers not to be late, drive badly or murder you and leave your body in a ditch?

Charles and Kline predict that, for example, African-Americans will find it easier to car pool if they live in an area with lots of other African-Americans. The statistics seem to bear them out. Trust matters, and if you live in an area full of people who look like you, you will enjoy more of it. Perhaps the institutionalized version of trust is not so bad after all.

Meanwhile, experimental research by economists Ed Glaeser, David Laibson and Bruce Sacerdote shows that the way people trust each other simply isn’t fair. The researchers organized a “trust game.” Two students met ahead of time to size each other up socially, then they played the game. The first student could give up to fifteen dollars to the second student; the experimenters doubled the gift, and then the second student had to decide how much to give back. The game is a measure of trust because the first player has the power to double the size of the pie, but only at the risk of getting nothing back from the second player. What was striking is how much social factors such as race and status encouraged the second player to be trustworthy.

“If the first player has a sexual partner, the second player will send back 17% more than they otherwise would have done,” observes David Laibson, a professor at Harvard. Since the second player doesn’t know about the existence of a boyfriend or girlfriend, Professor Laibson thinks that it’s a proxy for charm, status and social capacity.

The second student will also send more money if the first student drinks more beer–suggesting sociability–or if he or she is of the same race. Pure status matters too. Students who have fathers with a college degree, or who don’t have to work to fund their studies, receive significantly more money.

“And America is supposed to be a classless society,” comments Professor Laibson. Trust matters, but if you really want to bask in its effects, make sure you start at the top of the heap.

First published at Forbes.com