Undercover Economist

The tricky business of measuring growth

Two experts offer a new approach to weighing economic strength, posing many good questions about the practice.

The barrier to change is not too little caring; it is too much complexity,” Bill Gates once opined, and he was right: many problems in development cannot be solved simply by wanting solutions badly enough. And yet when it comes to one of the key development outcomes, economic growth, the problem is not too much complexity, but not enough.

Complexity plays no obvious role in mainstream economics. Under the surface of traditional accounts of economic growth there is a rather crude model: economies are a bit like loaves of bread. They are made of two or three key ingredients, and bigger loaves simply have a bit more of everything.

Compare the economy of the UK with the economy of the Democratic Republic of Congo, a country with a similar population, and the textbook will say that the UK simply has more physical capital (factories, buildings, roads) and more human capital (education, training) and perhaps even better “institutions”. Of course, everyone knows that you cannot simply turn the DRC economy into the British economy by doubling the quantities of all the ingredients. The British economy is a different and more complex kind of thing altogether.

The economist Ricardo Hausmann and the network physicist César Hidalgo have been trying to measure this complexity, and I’ve written before about their work. They argue that economies are collections of “capabilities”, building blocks that can be put together like Lego to produce different products. A trustworthy post office is a building block; so is high-speed internet; so are functional bankruptcy courts; so is a literate workforce; so is a fast lane at customs for processing perishable foodstuffs. It’s not clear how one would go about measuring all of these capabilities. Instead, Hausmann and Hidalgo measure them indirectly, tracking the shadows that they cast upon a country’s trade statistics.

Their latest work, “The Atlas of Economic Complexity”, includes analysis not just of the general method, but of the “complexity statistics” of 128 countries. Hidalgo and Hausmann show that their generic ranking of economic complexity is much better correlated with gross domestic product than traditional indicators, such as governance or educational standards. The authors seem pleased with this, but it is depressing that they are tempted to engage in such statistical arm-wrestling. Their research is far more interesting than that.

If we can measure economic complexity and find it is highly correlated with economic productivity, then the question is: how can economies become more complex, acquiring new capabilities? A couple of points suggest themselves. Modern economies require complex rules: the English version of EU law contains more than 55 million words, equivalent to about 100,000 pages. Some of this is no doubt useless, but I wonder how much. To shape such rules sensibly is no easy task.

Think of a business that wants to export cut flowers. That requires appropriate phytosanitary regulations, that fast lane at customs, quick transport links between farm and airport, laws governing irrigation and much else. Getting governments to think about all this is a tall order – especially for a business that simply will not exist until the building blocks themselves do.

The second point is linked to the first: Hidalgo and Hausmann find it is easier to develop new capabilities that have something in common with those you already have.

And what of those countries whose existing capabilities offer no obvious avenues for development? The complexity approach asks some good questions, but answers must wait.

Also published at ft.com.

Why have house prices stayed so high?

The reluctance for prices to slump may have as much to do with psychology as with conventional economics

My forecasting record on housing prices leaves something to be desired. It’s not that I missed the slump in prices: on the contrary, when making a series about economics for BBC 2 in early 2006, I tried and failed to persuade my producer and director that a house price crash was pretty much inevitable. (They disagreed and we tore up the script for that episode.)

The problem is rather that the boom was so extreme that I was sure the bust would come far sooner and be much deeper. One way to see this is to look at “real” house prices, adjusted for inflation by Nationwide. They peaked at £128,000 in 1989 (measured in today’s money); the following slump ended only six years later, after prices had fallen by almost 40 per cent. The more recent boom makes that one look puny: as early as 2002, real house prices had topped £150,000 in today’s money and I was anticipating the mother of all crashes in 2003. And 2004. And 2005, 2006 and 2007.

Real house prices are still only 20 per cent down from their peak in late 2007 despite a ridiculous boom and an economic shock almost impossible to imagine when I first started my Cassandra act.

Why have house prices stayed so stubbornly high? Partly this reflects a genuine lack of supply in a country whose dense centre of economic gravity is made yet denser by the planning restrictions of the green belt. But the reluctance to slump may have as much to do with psychology as with conventional economics.

One of the key ideas in behavioural economics is “prospect theory”. Prospect theory assumes that individuals view risky choices relative to a baseline, framing them as losses and gains. Furthermore, they care more about avoiding losses than banking gains. This is odd, because the baseline is arbitrarily defined; yet it seems to be true.

What would this mean for house prices? It would mean that people are very reluctant to sell at a loss. This means more than just trying to get as much money as possible – most sellers want that. It means being unwilling to compromise, and being willing to lose the sale, if the proposed sale price is below the not-very-meaningful level of “what I paid for it”.

If sellers do behave like this, it would mean house prices would fall only with great reluctance. In particular it would mean that sales would dry up when prices fall below a previous peak. That’s certainly true: less than half as many mortgages are being approved now than before the crisis began. There is an economic reason why volumes should dry up as prices fall: a lack of access to finance could hit both price and volume simultaneously. But the psychological explanation may be even more important.

A study conducted by the economists David Genesove and Christopher Mayer provides clear evidence for this. Genesove and Mayer looked at a housing crash in Boston in the early 1990s, and they found that sellers facing the risk of a loss priced their condominiums more aggressively, winning somewhat higher sale prices but far higher risks of not selling at all. (Genesove and Mayer also present evidence that it is nominal losses rather than real losses that matter.) The researchers also argue that liquidity constraints – it’s harder to get a mortgage in tough times – do not fully explain the patterns they discovered. Prospect theory does.

What this means for the future of the housing market is, I’m sad to say, not clear to me. My reading of the economic fundamentals is still that housing is overpriced in the UK. With housing stagnating and inflation rates likely to fall to low levels again, it may be a long time before nominal house prices exceed the peaks of 2007. And it may be a long time before homeowners make peace with their losses.

Also published at ft.com.

Can the minimum wage create jobs?

If one cannot produce enough of value to justify being paid a living wage, nothing we do to the minimum wage will help

One million unemployed young people. It had been coming for a while, but when the news broke in November that the number of 16- to 24-year-olds looking for work had reached seven figures, the number retained its power to shock.

Almost 300,000 students seeking part-time work are included in the total, and although directly comparable data are not available, the situation was almost certainly worse in the 1980s. Nevertheless, given the evidence that graduating during a recession can affect one’s earnings for far longer than the recession itself, the case for doing something looks urgent. But what?

To some, such as the Institute for Economic Affairs, the answer is simple: abolish the minimum wage. This is unlikely. Minimum wages gradually fell into disuse after Winston Churchill introduced a minimum wage system in 1909. Yet after Labour introduced a national minimum wage in 1999, grumblers have kept a low profile. David Cameron said in 2005 that it had been a success, while in 2008 George Osborne said that “Modern Conservatives acknowledge the fairness of a minimum wage.”

But that is an odd comment, because the case against the minimum wage was always that the law itself was unfair. A minimum wage forbids workers to sell their labour below a certain price, and therefore would be expected to create unemployment for low-productivity workers. Employers use machines instead.

The theoretical argument is simple and compelling. But is it true? Back in 1994 a remarkable article was published by economists David Card and Alan Krueger. They performed a statistical analysis and concluded that not only did the minimum wage not cost jobs – it might even create them. Amazing.

Extraordinary claims demand extraordinary evidence, and while many economists casually dismissed Card and Krueger, commentators on the left also seized uncritically on the results. Both attitudes are a shame because the research paper is too interesting to ignore. Card and Krueger were pioneers in using what economists call a “natural experiment”: the rise of minimum wages in New Jersey, while in neighbouring Pennsylvania they did not move. They surveyed more than 400 fast-food restaurants in New Jersey and east Pennsylvania and found no great difference between employment trends. Nor did higher-wage establishments display different employment trends to those who had to raise wages relative to the minimum. These methods broke new ground and have been much emulated.

It’s fair to say that not every statistical study has come to the same conclusion. But why might Card and Krueger be right in some cases? If employers have market power in the labour market then they might actually offer a lower wage than the balance of competitive supply and demand would produce. Some workers would rather keep looking or sign up for welfare payments, and so employment is lower at this level. Introduce a minimum wage and both wages and employment increase, while profits fall.

Of course this analysis is time and place specific. Since its introduction in the UK, the minimum wage has outpaced consumer price inflation by about 20 per cent. Even if a minimum wage can offer income for the poor without destroying jobs, it would be complacent to assume this will remain true regardless of economic conditions. The Low Pay Commission has been allowing the minimum wage for younger workers to lag behind. No wonder.

But if a young adult cannot produce enough of value to justify being paid a living wage, nothing we do to the minimum wage will help. He, the institutions which trained him and the society in which he lives, have far bigger problems.

Also published at ft.com.

To tweet or not to tweet?

Economist Justin Wolfers runs a controlled experiment to test how Twitter is affecting his productivity

I don’t normally hold with the traditional New Year’s resolution of quitting some objectionable habit – even though my favourite economist, Thomas Schelling, has written very thoughtfully on the subject. (Schelling, a brilliant game theorist and long-time smoker, used a variety of game theoretic tricks to outwit a formidable opponent – his addicted self.)

But as 2011 drew to a close, I had been wondering about my addiction to Twitter, the service that allows users to publish online short messages – grumbles, aphorisms and most often, links to recommended articles. Other users can choose to whose messages they will subscribe and unlike on fully-fledged social networks, such as Facebook, this is not necessarily a reciprocal relationship. (Facebook users have friends; Twitter users follow and have followers.) My Twitter habit has the pernicious consequence of being rather time-consuming – but it has plenty of benefits too. Should I quit? Cut down? Or should I resolve only to stop feeling guilty?

Part of the problem, I realised, is the difficulty of measuring the costs and benefits of the habit. Imagine my curiosity, then, when I noticed that the economist Justin Wolfers – a self-described Twitter cynic – had joined the club and was running an experiment to test how Twitter was affecting his productivity.

“Every morning I would flip a coin,” he explained to me. “Heads, I would sign on to Twitter, tails, I would simply tweet ‘Tails: goodbye for another day Twitter.’” It might seem strange to run an experiment with a single subject, but that all depends. If the aim is to discover the effect of Twitter on the productivity of Justin Wolfers, the experimental design looks just fine.

The challenge, of course, is to interpret the results. “I tried to be scientific,” said Wolfers, who installed software on his computer to record his use of different programmes and websites, while also using Google alerts to track whether his tweets were having much impact on web chatter. “I’m not sure I succeeded.”

Wolfers rated his productivity levels at the end of each day – revealing, and “also a total bummer” – rarely topping six out of 10. But that’s not unusual: a persistent anxiety that each day has been poorly spent is, I feel, the sign of many a productive person.

Ultimately the formal experiment broke down: “After a while, I got tired of flipping coins.” Wolfers has his data; he has never bothered to analyse it. He has decided that Twitter works for him. The informal experiment of giving Twitter a try to see how it worked out was, it seems, of far more practical use than the formal experiment of randomising days on and days off.

This makes some sense. I’ve become convinced that most of us do not experiment enough with new experiences. (The first 20 years or so of life are an exhausting but stimulating exception to this rule.) Yet few of the experiments we could be trying are conducive to a proper randomised trial.

Somehow this is a great disappointment to my inner nerd. Both Justin and I like the idea of running controlled experiments in everyday life – gut feelings can be so misleading – but he warns that to do it right takes more discipline and time than many of us might want to deploy.

Yet Justin Wolfers’s experiment has inspired an unexpected insight. The toss of a coin might not have generated data that anyone cared to use, but it had the obvious consequence of reducing the days spent on Twitter by about half.

Of course one could simply decide to spend less time on Twitter, but the arbitrary dictates of the coin have a curious power. (Yes, I have read The Dice Man.) So I do not think I’ll be quitting Twitter this year; I will be using the toss of a coin to help me cut back a little.

Also published at ft.com.

Christmas on credit

Presents for one’s children do not seem like an optional extra though many families may struggle during this holiday

One dark December evening, sometime in the early 1980s, my father sat down to have a serious chat with me. That Lego spaceship I was dreaming about for Christmas? It might never arrive. Our boiler had broken; fixing it was going to be expensive. I should not hope for too much.

Perhaps this was just a bit of smart parenting on my father’s part: perhaps I had taken to viewing a substantial Christmas present as a basic human right and he was just putting a shot across my bows. After all, I did get the Lego. (It was the Space Cruiser, set number 487, a classic that gave me many hours of pleasure. Thanks, Dad.)

Then again, perhaps we really were financially embarrassed, and perhaps my parents were not sure that an alternative source of finance would materialise. Plenty of families will be in a similar situation this Christmas. The Joseph Rowntree Foundation, which uses a thoughtful and innovative methodology to estimate the minimum income necessary to achieve a “socially acceptable” standard of living, reckons that a family of five with one breadwinner – my situation today and my father’s at the time – needs £690 a week before tax. Since 80 per cent of employees earn less than that, it is easy to see why many families require two incomes, and why many struggle at Christmas.

Yet the conversation still feels extraordinary by today’s standards. Christmas presents for your own children do not seem like an optional extra. Is this because Christmas itself has become more of a consumerist blowout than once it was? Surprisingly, the answer is no: Joel Waldfogel, author of Scroogenomics , estimates that in the US the December bulge in retail spending was far larger in the 1930s than it is today, relative to the size of the economy. The modern Christmas is not especially extravagant.

What, then, has changed during the past 30 years? The answer, surely, is the availability of credit. If I was wondering how to buy Christmas presents and fix a broken boiler – actually, both issues are on my list of things to do today – and if I lacked savings to address the issue, I would instinctively reach for a credit card. That is not the way things used to be. Waldfogel – again, using US data – estimates that in the 1930s, about a 10th of Christmas spending was financed through “Christmas clubs”, savings accounts that were easily accessible only in the run-up to Christmas.

Christmas is now financed in arrears, not in advance. Waldfogel reckons, looking at seasonally fluctuating data about credit card balances, that a third of Christmas spending has not been paid off by the end of February. This is a change in spending patterns that has developed rapidly since 1980, and, at an interest rate of 20 per cent or so, it does not come cheap.

What seems so archaic about that fatherly chat, then, is not a change in household incomes or in Christmas bingeing but in the availability of credit.

Over the past three decades we have drawn ever closer to the highly convenient world, assumed to exist in many simple economic models, in which we can effortlessly shift our spending backwards and forwards to whenever suits us. As long as total lifetime spending plus interest equals total lifetime income plus interest, no boy need ever lose out on a Lego space cruiser because of a pesky boiler repair.

Whether you are an ambitious mortgage provider, a European nation state, a first-time house buyer or just a parent without rainy-day savings, the past four years have delivered a tough lesson: access to credit is not a right, conveyed by a disinterested, omnipotent and benevolent free market. It is a privilege, granted by flesh-and-blood creditors. And it is a privilege that is both bestowed and withdrawn on a whim.

Also published at ft.com.

Screening: It’s all in the numbers

Bayesian analysis questions how we understand the notion of ‘probability’ and how we update our beliefs in light of new information

You’re a woman in her early fifties. You’re invited to a breast cancer screening unit, and you go along hoping for the all-clear. After all, 99 per cent of women your age do not have breast cancer. But … the scan is positive. The screening process catches 85 per cent of cancers. There is a chance of a false alarm, though: for 10 per cent of healthy women, the screening process wrongly points to cancer. What are the chances that you have breast cancer?

Over 50,000 British women face this awful question each year. I first encountered it – in a less alarming context – as an undergraduate economist. And I was in the audience recently when David Spiegelhalter used it as an example in his Simonyi Lecture, “Working Out the Odds (With the Help of the Reverend Bayes)”. The numbers approximately reflect the odds faced by women who go for breast cancer screening. And the answer – courtesy of the Reverend Bayes in question, who died 250 years ago – is surprising.

Bayes was concerned with how we should understand the notion of “probability”, and how we should update our beliefs in light of new information.

A Bayesian perspective on the apparently grim screening result tells us that things are not as bad as they seem. The two key pieces of information point in different directions. On the one hand, the positive scan substantially worsens the odds that you have cancer. But on the other, the odds are worsening from an extremely favourable starting point: 99 to 1 against. Even after the positive scan, you still probably don’t have cancer.

Imagine 1,000 women in your situation: 990 do not have cancer, which means we can expect 99 false positives, far more than the 10 women who do have cancer. This is why any apparent sign of cancer should be followed up with further tests in the hope of avoiding unnecessary treatments. The chance that you have cancer is 8 per cent 9 per cent – up dramatically from 1 per cent, but with plenty of room for optimism.

None of this proves screening is pointless. It can save lives, but it raises dilemmas. The UK’s breast cancer screening programme is currently under review. A systematic analysis published by the Cochrane Collaboration found that for every woman who had her life extended by early detection and treatment, there would be 10 courses of unnecessary treatment in healthy women, and more than 200 women would experience distress as the result of a false positive.

Bayesian reasoning has implications far beyond cancer screening, and we are not natural Bayesians. Daniel Kahneman, a psychologist who won the Nobel memorial prize in economics, discusses the issue in a new book, Thinking, Fast and Slow. I recently had the opportunity to quiz him in front of an audience at the Royal Institution in London. Kahneman argues that we often ignore baseline information unless it can somehow be made emotionally salient. New information – “possible cancer” – tends to monopolise our attention.

Another example: if somebody reads the Financial Times, should you conclude that they are more likely to be a quantitative analyst in an investment bank, or a public sector worker? Before you leap to conclusions, remember that there are six million public sector workers in the country. Base rates matter.

Sometimes there is no objective base rate and we must use our own judgment instead. I think homeopathy is absurd on theoretical grounds; others find it intrinsically plausible. Bayesian analysis tells us how to combine those prior beliefs – or prejudices – with whatever new evidence may come along.

Whenever you receive a piece of news that challenges your expectations, it’s tempting either to conclude that everything has changed – or that nothing has. Bayes taught us that there’s a rational path between those two extremes.

Also published at ft.com.

‘Tis not the season to be shopping

Christmas Day should be the beginning rather than the end of the festive celebrations. But commercial logic points in a different direction

I’m one of those old-fashioned types who reckons the Christmas season should begin late. I like to put the Christmas decorations up the Sunday before Christmas at the very latest, and I even enjoy working on the morning of Christmas Eve – there’s something more magically Dickensian about taking just that afternoon off and heading home with beribboned parcel, rather than taking up residence on the sofa a week beforehand. Christmas Day should be the beginning rather than the end of the festive celebrations.

Commercial logic points in a different direction. There is little profit for Selfridges or Dixons or Hamleys trying to get people in a Christmassy mood at the very last minute. Indeed, the economist Emek Basker has found that in the US, where the Christmas shopping season varies between 26 and 32 days depending on the date of Thanksgiving, longer seasons mean more overall spending (about $8 per person per extra day). Daily spending rises in November after Thanksgiving, but is just as high in December even during the most protracted shopping seasons.

The economist Joel Waldfogel, author of Scroogenomics, estimates that the extra spending on Christmas and Hanukkah in the US in 2007 was $66bn – a substantial sum, and relative to the size of the economy it is even larger in the UK.

No wonder that at this time of year, everyone hurries to publish articles about how the Christmas spending rush is good for retailers. But this is odd. Imagine how much easier life would be for retailers if that extra $66bn was spread evenly across the year.

For a hint at the inconvenience, I spoke to Derek Hayes, of Oxfordshire-based Skyline Promotions. Hayes runs the ultimate seasonal business: a British company producing firework displays. This year was particularly challenging because Bonfire Night fell at the weekend. (Wednesdays are easiest, because they spread the workload across two weekends and midweek.)

Skyline employed 42 people to run 16 firework displays on Saturday, November 5. Because most of Hayes’ staff have unrelated day jobs, the 14 displays on Friday the 4th were even more challenging. But contrast that peak of 42 workers with much of the rest of the year, when Hayes works alone. To cope this year, he called in favours from old associates who travelled from Cornwall and Leeds. He even organised a post-fireworks reunion party.

Firework displays are, of course, particularly challenging: they are extraordinarily seasonal, cannot be stored, and require skilled staff. But other businesses must cope with versions of the same challenge.

Does this matter? The economist Jeffrey Miron pointed out in The Economics of Seasonal Cycles, published more than two decades ago, that a perfectly efficient market will cope just fine: prices, wages and rents will rise at peak times to cover the very real costs of seasonal booms. Customers will either willingly pay extra, because they value the convenience of the timing, or will instead buy Christmas presents in the January sales, order cocktails during happy hour, and organise weddings on Wednesdays in October.

In practice, Miron argued, things are not quite so simple. For various reasons – some cultural, some legal – there are limits to how flexible prices and wages tend to be, and how responsive people can be in return. Some office Christmas parties are successfully moved to January, but few family Christmases are. And most schools will not applaud parents who seek a cheaper holiday by pulling their children out of class. As a result, shops will remain congested and staff harassed during Christmas, and managing inventory will be a logistical nightmare.

My Christmas decorations may be going up late in the season, but I did most of my Christmas shopping early. It was the least I could do.

Also published at ft.com.

How to stop the bogus bonus

Successful oversight is going to require more transparency about what trades are being made. But transparency is a scarce commodity

It used to be so easy to “earn” a performance bonus in financial services. Step one: agree a contract whereby you are paid if you exceed a modest benchmark with the funds you are managing. Step two: borrow money and invest it in risky assets. Step three: profit! Step three does not follow automatically, of course, if the risky asset does not pay off. But from the point of view of the fund manager and his bonus, it’s a case of “heads I win, tails the investor loses”.

It’s fairly trivial to show that such bonus schemes, if implemented naively, offer disproportionately larger bonuses for ever larger risks. We might hope that investors are too sophisticated to fall for such obvious tricks. Yet Dean Foster, a statistician at the University of Pennsylvania, and Peyton Young, of Oxford University and the Brookings Institution, were warning in the early days of the financial crisis that fund managers could hide risks in far more sophisticated ways.

The problem is, as Foster and Young show, that it is possible for an unskilled fund manager to mimic a genuinely skilled one, in the same way that an insect might mimic a leaf, or a harmless creature mimic a poisonous one.

This mimicry, too, involves three steps: first, invest all your funds in whatever benchmark you need to beat, whether it’s treasury bills or a stock market index; second, make a bet that some unlikely event will not come to pass using the invested funds as security; finally, boast of benchmark beating returns, because you’ve delivered the benchmark plus the additional money from winning the bet. Collect your performance fee. (In the unlikely event that you lost the bet and with it all your investors’ cash, simply cough awkwardly and look at your shoes.)

Rather disturbingly, Foster and Young have proved that if investors can only examine your investment returns and know nothing about your investment strategy, as a fund manager you can always make your numbers look good by taking on small risks of very bad outcomes.

These are the “black swans” made famous by Nassim Taleb: low probability, high-impact events, except that these particular swans are genetically engineered – deliberately manufactured and then hidden away, to escape at unwelcome moments.

The solution seems obvious: pay performance bonuses with a lag, perhaps in company stock, or allow “clawback” – in effect, a financial penalty rather than a bonus – if those pesky black swans do appear. But in a recent presentation, Peyton Young explained that none of these approaches really do much to help. It’s true that deferred bonuses can help evaluate performance itself over a long term, but the mimic strategies will remain available. The mimic can, for example, make a huge bet and then simply go quiet if the bet pays off, making safe, neutral investments until the bonus comes due.

Regulators, investors and senior management simply cannot judge traders and fund managers on the basis of their performance alone, no matter how good it looks – the black swans can always be bred and hidden.

Successful oversight is going to require more transparency about what trades are actually being made. And in many parts of the financial services industry, transparency is a scarce commodity.

Kweku Adoboli, the former UBS employee charged with fraud and false accounting, worked on a “Delta One” desk – and the whole point of Delta One trading is to replicate a certain pattern of returns through trading strategies that need not be disclosed.

The folly of “rewarding A while hoping for B” is – thanks to a famous article by Steven Kerr – now well known. But what about “rewarding A” without realising that in fact you are being given “C” in disguise?

Payment by results is an attractive idea, but in a world where black swans can be deliberately manufactured, results can be treacherous.

Also published at ft.com.

Music for love not money

There seems no objective justification for the idea that good music has simply dried up since file-sharing took off

“A digital vampire” – not the title of this season’s bestselling young adult novel, but an ageing rock star’s description of Apple’s online store, iTunes. In his recent John Peel lecture, the guitarist for The Who, Pete Townshend, railed against “the Aluminums” (Apple, I gather) and suggested changes to their business model that would be more supportive of musicians. He also wondered whether the modern, digitally distributed music industry could support the kind of careful listening and risk taking that the late DJ John Peel exemplified.

A reasonable response to Mr Townshend is that he could have picked more obvious targets – notably file-sharing sites and software, which facilitate outright piracy. (He did offer one sharp observation on the subject: “The word ‘sharing’ surely means giving away something you have earned, or made, or paid for?”)

It is beyond doubt that the traditional music industry is dying: high street record shops are closing their doors or stocking alternative products, and music sales have fallen by about 40 per cent during the past decade.

Digital music sales through retailers such as iTunes are manifestly failing to plug the gap from sales of physical CDs, but that is not the fault of the Aluminums.

Yet a more interesting question is how much this matters. According to Joel Waldfogel of the University of Minnesota, three-quarters of pirated music would never have been purchased anyway. In such cases the consumer gains but the producer does not lose. Alas, for the major record labels – and, perhaps, for the artists too – the one-in-four acts of piracy that do reduce sales seem to be quite enough to corrode the industry’s business model.

But, says Waldfogel, “consumers don’t care about the well-being of the recording industry. We care about the existence of good new products.” Is piracy damaging these new releases? Conventional wisdom used to be that piracy consumes itself: by damming the flow of money it causes a creative drought. Few people want to give up their day job to create music for no financial reward.

But is this true? In a new working paper, Waldfogel manfully attempts to estimate the continued flow of high-quality new music since the emergence, at the turn of the millennium, of Napster, the daddy of all file sharing services. There is no perfect way to do this, of course.

One technique is to look at lists compiled by critics of the best albums. Another approach is to look at radio air-play. Radio stations tend to be biased towards playing two things: recent music, and music that listeners are likely to enjoy. In a golden age of music one might expect radio stations to play a lot of recent releases; in a weaker creative period one would expect radio stations to play more vintage stuff. A third approach looks at albums which continue to sell well a long time after their release.

Waldfogel tries all three, and produces some intuitively sensible results: the late 1960s were the pinnacle of the past 50 years, while the 1980s were dark days indeed. Judged by the critics, the post-Napster years were unremarkable, and no worse than the 1990s. Judged by airplay data, the past decade has seen something of a renaissance in quality music. Certainly there seems no objective justification for the idea that good music has simply dried up since file-sharing took off.

Quite why this should be is a puzzle, but Waldfogel suspects it has something to do with the ease with which any band can produce and distribute music – a fact reflected in the growth of independent record labels. The money may be drying up, but the beat goes on.

Also published at ft.com.

The real cost of keeping warm

If we are to deal with climate change, the price of carbon-intensive energy is going to have to rise

With the price of domestic gas and electricity soaring, the cost of keeping warm, never off the politicians’ radar screens for long, is firmly back on the agenda. The latest wheezes to emerge from the coalition are some mild utility-bashing from the prime minister, and a “green deal” from the energy secretary, Chris Huhne, which is intended to make it easier to borrow money for energy-saving home improvements.

I may have missed it, but I am not aware of either man stating the unpalatable truth: if we are to deal both with climate change and with the security of our energy supply, the price of carbon-intensive energy – and at the moment that means energy in general – is going to have to rise.

No sign yet of any push towards that goal: domestic fuel is taxed at just one quarter of the standard VAT rate. According to a review by the Institute for Fiscal Studies, the percentage of tax revenue attributable to “green” taxes peaked at the end of the 1990s – it was less than 10 per cent then – before it began an inexorable slide. The story behind that slide is simple: the only significant “green” taxes are paid by motorists. Emissions from industrial sources, aviation and – yes – our homes have got away lightly so far. But that situation can’t last forever.

It’s clear enough why politicians don’t care to dwell on such inconvenient truths, and favour instead the kind of regulatory engineering put forward by Huhne. At least his idea addresses a genuine problem: people fear that if they move house after buying an energy-efficient boiler or double-glazed patio windows, the new occupants will reap the benefits without paying more for the house. The “green deal” leaves the home-improvement debt behind, to be repaid through utility bills.

Yet regulatory pushes are limited at best and produce bizarre consequences at worst. In the US, Corporate Average Fuel Economy standards, designed to encourage more efficient cars, have had some benefits but also two dramatic failures. They boosted the rise of the giant SUV, which was exempt from the standards that applied to regular cars. More prosaically, once the standards had been met there was no incentive to do more, and much engineering effort was devoted to making cars bigger and faster rather than more efficient.

In the UK, the “Merton Rule” – it originated in the Borough of Merton and has been widely emulated – demands that substantial new developments include the capacity to generate 10 per cent of the building’s energy needs through renewable sources, on site.

Alas, such a rule is hopelessly slack for an out-of-town supermarket – an environmental disaster because of all the driving it encourages, yet with plenty of real estate for solar panels. Meanwhile it is too challenging for a city-centre skyscraper, which is naturally a low-energy building because of its compactness and proximity to public transport.

All this explains why a carbon price has to be the centrepiece of any policy on climate change. A price on carbon acts in more subtle ways than any regulator will be able to, encouraging a switch away from coal and towards nuclear energy and renewables, encouraging energy efficiency in every choice we make, and in the last resort, encouraging us to do without products, services and activities where the energy cost is just too high.

We live in a world of seven billion people, many billions of distinct products, and countless decisions every day that have the effect of releasing carbon dioxide into the atmosphere. Without a carbon price to guide all those decisions, the cost of responding to climate change is far higher than it has to be.

Also published at ft.com.