Tim Harford The Undercover Economist

Undercover EconomistUndercover Economist

My weekly column in the FT Magazine on Saturday’s, explaining the economic ideas around us every day. This column was inspired by my book and began in 2005.

Undercover Economist

Hidden truths behind China’s smokescreen

‘When countries become richer, do they pollute their environment more or less?’

The pictures from Beijing tell their own story: pollution there is catastrophic. Bad news for residents, and awkward for me too. Just over a decade ago, I wrote a book, The Undercover Economist, which among many other things cheerfully asserted that particulate air pollution in urban China was sharply falling as the country grew richer. It’s a claim I believed at the time (based on well-regarded research in the 2002 Journal of Economic Perspectives) but with each new report of smog over China, I felt a nagging sense that I had led readers astray. I figured it was time to do some more research and to set the record straight.

There is a broader question here. When countries become richer, do they pollute their environment more or less? For a while it seemed obvious that pollution and riches went hand in hand: industrialised nations spewed out more of everything.

But then the leading countries began to crack down on pollution. London no longer suffers from smog. The European Union reduced sulphur dioxide emissions by more than 80 per cent between 1990 and 2011. At the same time, the United States has reduced atmospheric lead by 98 per cent.

In the early 1990s, Princeton economists Gene Grossman and Alan Krueger coined the phrase “environmental Kuznets curve” to stand for the idea that as countries become richer, their emissions first rise but then fall, as richer citizens demand cleaner air from the governments they elect and the companies from whom they buy. There’s some evidence that this is true but it’s hard to interpret that evidence. An optimistic view is that countries reduce pollution with or without economic growth because they can use clean technologies developed elsewhere. If true, China may be able to clean up its air faster than we’d expect.

A grimmer possibility is that the richer countries aren’t really reducing pollution — they are exporting it, by banning dirty factories at home while happily buying from dirty factories abroad. On this view, China is unlikely to be able to clean its air any time soon.

How serious a problem is offshoring pollution? It’s not trivial. In 2007, Joseph Aldy of Harvard’s Kennedy School published research showing clear evidence of this pollution-export effect within the US. Richer states seemed to be emitting less carbon dioxide per person as their economies grew. Alas, Aldy concluded that the effect could be explained entirely by the rich having bought their electricity from poorer states rather than generating it at home. A more recent study (Peters, Minx, Weber and Edenhofer 2011) estimated that by 2008, developed countries were net importers from developing countries of goods whose production represented about 1.6 billion tonnes of carbon dioxide emissions, roughly 5 per cent of the global emissions total. No prizes for guessing that much of this energy-intensive manufacturing is taking place in China, alongside the production of steel, cement and coal-fired electricity for domestic use.

The dreadful air quality in Beijing, then, is no mystery. First, China is not yet rich, so it may be on the wrong side of the environmental Kuznets curve anyway, the side where pollution has not yet begun to fall. Second, China is not a democracy, and that will partially dampen the power of its citizens to demand cleaner air. Third, China is a major exporter of manufactured goods.

But as I stood ready to pen my correction, I realised something: I didn’t actually have a time series for air pollution in urban China. I could see that things were bad but not what the trend was.

“The challenge with particulates is that we keep changing what we want to measure and regulate,” Aldy told me. Researchers now track PM2.5, very fine particles thought to be particularly hazardous to health; but, in 1985, when my original data series began, nobody was collecting PM2.5 data.

So how much worse have things got in China? I called Jostein Nygard of the World Bank, who has been working on Chinese air pollution issues for more than two decades, and I was surprised at his response: in many ways, China’s urban air quality has improved.

Sulphur dioxide is down and coarser particulate matter is also down since good records began in 2000 — a fact that is explained by Chinese efforts to install sulphur scrubbers and to move large pollution sources away from the cities. “You could see the air quality improving through the 1980s and 1990s and to the 2000s,” says Nygard. PM2.5 is very bad, he says — but not necessarily worse than 10 years ago, and serious efforts are now under way to track it and reduce it.

To my surprise, not quite a correction at all, then. But if local air pollution in China is actually on an improving track, how come we see so many stories about pollution in China? One reason, of course, is that the situation remains serious. Another is that the Chinese government itself seems to be using smog alerts as a way to send a message to local power brokers that clean air is a priority. But there is also the question of what counts as news: sudden outbreaks of smog are newsworthy. Slow, steady progress is not.

Written for and first published at ft.com.

Undercover Economist

How fighting for a prize knocks down its value

‘If many people have patience to queue for scarce (and underpriced) tickets, the value on offer will be consumed by the race to grab it’

I was recently told about an airstrip near a banknote-printing facility. Every day, planes take off, bursting with cash. It used to be that if you stood in a certain field near the airstrip, you could catch the dollars as they drifted gently to the ground, or scoop armfuls of them up from the soil. On average, $1m a day fluttered down.

Word soon got around. Before long, the field was packed with bill-catchers, racing and shoulder-charging each other to get the cash. People started to bring butterfly nets. The skies were thick with quadcopters darting around to snatch the money at altitude.

If you’re wondering where this field might be, don’t. It exists only in the imagination of Stanford economist Mike Ostrovsky, reported in Al Roth’s book Who Gets What and Why. But if the field did exist, you’d have to be a hardy soul to venture there. If $1m a day was known to be at stake, the ferocious quadcopter scramble would escalate until it cost almost $1m a day to run. If it didn’t, then people would have a strong incentive to keep buying drones until it did.

Economists call such arms races the “dissipation of economic rents”. They’re frustrating, because value is being frittered away in the competition to secure them. Think of the queue around the block for scarce (and evidently underpriced) concert tickets or the riots over cheap merchandise that occasionally break out during discount sales. If a few people are particularly patient, or muscular, or skilled at piloting drones, then they will keep at least some of the value; if many people have similar patience, strength or skill then the entire value on offer will be consumed by the race to grab it.

(The airfield tussle is particularly wasteful because real resources are being devoted to grabbing banknotes that could easily and cheaply be replaced. But even if the planes were dropping something valuable, such as saffron or USB drives, the process would mean that value was wasted.)

Another example is the business of high-frequency trading in financial markets, in which algorithms try to outwit or outpace each other as they scramble for trades in a contest that is over in less than an eye-blink. Some traders have invested in microwave networks, which are faster than fibre optics, to gain edges of less than a thousandth of a second as they respond in New York to news from Chicago. The parallel with the money-field is clear enough — and, unlike the field, high-frequency traders do exist.

A microwave link to save a few microseconds is in much the same category as a faster dollar-grabbing drone, or turning up earlier for a better place in the queue at an Oxford Street store. There is a value to having a liquid market for financial assets, one in which you can quickly find some buyers to compete for whatever you might be selling. But high-frequency trading adds little to market liquidity in times of crisis; the microwave link, like the drone, adds no value to society as a whole.

Can anything be done about such rent-dissipating behaviour? One approach is to tax it. We could levy a fee on standing in queues, or on microwave transmitters, or on stock market transactions themselves. If people who queue for scarce concert tickets are all taxed $5 an hour while they queue, then the lines will be shorter. The cost of the tax should roughly be offset by the reduced waiting time, so the queueing crowd is no worse off; the government, on the other hand, has acquired revenue from nowhere. This is a rare free lunch.

Taxing transactions is also a possibility, although a more problematic one. Much of the difficulty comes not from transactions themselves but from “quote stuffing”, where high-frequency traders make and withdraw thousands of bids, probing for information without actually making transactions. And charging for quote-stuffing might not help either. Three Canadian researchers (Katya Malinova, Andreas Park and Ryan Riordan) studied the impact of a regulatory change where traders were charged for quotes, not just trades; they found that quote volume fell sharply. But the bid-ask spread, a measure of market inefficiency, rose nearly 10 per cent. And while a transaction tax or quote tax would discourage some forms of high-frequency trading, it seems to me that the incentive to build microwave links between Chicago and New York would still exist.

So an alternative is to redesign the market to make it work better. In the case of queues for tickets, charging more for the original tickets would help, and the seller could hold an auction to set the perfect price. Financial markets could also be improved by introducing an auction once a second, batching together all the offers that have been submitted during that second. That would be fast enough for any reasonable purpose — and would remove the need to spend all this money on microwave relays.

Auctions are no more of a panacea than markets themselves, but they can help. Markets do not always organise themselves. A well-designed auction can mean less effort wasted in the fight to get to the front of the queue.

Written for and first published at ft.com.

Undercover Economist

The price of being female

‘Gender-based mark-ups may not be an economy-wide phenomenon. But they seem to exist for certain products’

Does a dollar in my pocket buy more than a dollar in my wife’s? It seems so, according to a report released just before Christmas by New York City’s Department of Consumer Affairs, which was much covered in the US media. The DCA report found that men often paid less for clothes and items such as razor blades and shampoo. Even boys’ toys are cheaper than those aimed at girls. The report led with a striking example from a department store website: while a red “My 1st Scooter Sport” costs $24.99, a pink “My 1st Scooter Girls Sparkle” is twice as much. Beneath the paint job, the products appear to be identical — surely glitter cannot be that expensive?

The sparkly scooter was sold at an astonishing mark-up but it’s not a typical case. The DCA report looked at 22 bikes and scooters, finding that on average the product aimed at girls or women cost 6 per cent more. Across 800 products, the DCA found that while men sometimes paid more than women, on average women faced prices that were 7 per cent higher. Relative to profit margins this is still a large price difference but it’s a long way shy of 100 per cent.

What should we make of this? One response is that perhaps the price gap isn’t really there or at least not in any systematic way. Perhaps the DCA unwittingly cherry-picked examples. (Sports cars and hi-fi systems were not included.) Whether or not systematic gender-based pricing is widespread, it will always be easy to find examples that look sexist.

Still, other research has reached similar conclusions. For example, a study published in Gender Issues in 2011 by Megan Duesterhaus and others found that “gendered price disparities are not as widespread as . . . journalists have previously reported but it does appear that women pay more for certain goods (deodorant), services in hair salons (haircuts), and dry-cleaning of shirts”.

In the hope of getting a truly comprehensive overview, I spoke to the UK’s Office for National Statistics, which systematically collects price data to calculate inflation measures. Unfortunately, the ONS data aren’t designed to shed light on this question; they often do not distinguish between male and female products and services. The job of inflation indices, after all, is not to detect discrimination but to follow price changes over time.

So it is hard to be sure that gender-based mark-ups are an economy-wide phenomenon. But they may be. And they certainly seem to exist for particular kinds of product. Why? No single theory will suffice. Car insurers and nightclub owners both want to charge more to men, but not for the same reason.

Broadly, there are two types of explanation. One is that higher prices reflect higher costs. Maybe men’s haircuts typically require less time and skill than women’s haircuts. It’s said that women’s blouses cost more to clean and iron at a dry-cleaner’s because they are delicate and need to be pressed by hand. Still: why not charge by the hour to provide a haircut? Or charge for hand-pressed clothes, regardless of gender? Restaurants do not charge men more on the grounds that they usually eat more; instead, they charge by the dish. I can only speculate as to why hairdressers act differently.

The alternative explanation is that companies are making fatter margins on women’s products and services. Economists call this “price discrimination”, and it would suggest that women pay more than men if and when they are less sensitive to prices. Perhaps manufacturers and retailers have found that if they try to raise the price of razor blades or shampoo, men will shop elsewhere or skimp on the product, while women will willingly pay the higher price.

This female insensitivity to price — if it really exists — might be driven by all kinds of things. Perhaps women tend to be busier and have less time to shop around. Or perhaps they care more about quality when it comes to deodorant or shampoo, whereas men just want something cheap.

 . . . 

But even if women are potentially willing to pay extortionate rates for certain kinds of goods, it doesn’t mean that companies can exploit that willingness. A lot of the businesses most regularly accused of sexist pricing — hairdressers, dry cleaners and nail salons — operate in the face of almost unlimited potential competition. If all of them are operating on razor-thin margins for men and fat margins for women, shouldn’t they be desperately trying to win female customers away from each other? This competitive pressure will constrain attempts to discriminate on price. It is the big brands — such as Ferrari, Hermès and perhaps Gillette — who have the power to charge different mark-ups to different customers.

As soon as a company acquires some market power, it will try to give spendthrift customers an opportunity to display their spendthriftiness by offering costly variants on basic products. Publishers ask double for a book with hard covers; coffee chains charge a lot for squirting flavoured syrup in your latte. We can hardly be surprised if some of these special variants look pink and sparkly. And as consumers, male or female, our only resort is to keep searching for the products without those frills, literal or otherwise.

Written for and first published at ft.com.

Undercover Economist

Why predictions are a lot like Pringles

‘Nobody thinks that there’s any great virtue in forecasts but we find them hard to resist’

In mid-December, Phil McNulty, the BBC’s chief football writer, offered us his predictions for the rest of the English Premier League season. My interest in football is limited but I found McNulty’s efforts fascinating. Even the most sceptical about football can learn a great deal from the episode.

A brief piece of context for those sceptics. Chelsea, the champions, had just played Leicester City, a team that had been relegation favourites just a few months before. Leicester won the game. This result would have been surprising had it not been set against the even more surprising pattern of the season. Champions Chelsea had slumped towards the bottom of the league after producing an unprecedentedly appalling run of form; Leicester, meanwhile, were top of the table. Nobody was shocked to see them vanquish Chelsea but it felt like a significant moment nonetheless.

What of McNulty? At the beginning of the season, he had predicted that Chelsea would be champions again, while Leicester would finish in the bottom three and be relegated from the Premier League. Both of those outcomes are now inconceivable. After admitting that his initial prediction had been about as wrong as it is possible to be, McNulty proposed a new set of predictions.

Those predictions were . . . but wait. Why on earth should you care? McNulty knows a great deal about football — far more than I do — but he had conclusively proved that he can’t see into the future. And yet he felt bold enough to offer another forecast, which many sports fans read with great interest.

This is a common pattern in football and beyond: pundits make forecasts, their audience consume those forecasts with relish, the forecasts are proved wrong, nobody is very surprised, and the cycle begins again. Why?

Part of the explanation is wishful thinking: we like to believe that the world runs on rails, and to trust in experts who claim to have decoded the timetable and can therefore explain what is going to happen, when, and why. Forecasters with a record of some success — such as data-driven political and sports analyst Nate Silver — soon find themselves saddled with unrealistic expectations.

Silver correctly predicted the fine details of the 2012 presidential election but he is happy to admit three things: that US elections are data-rich environments and much more predictable than most; that he had some luck; and that the bar for forecasting success had been set very low by partisan pundits much more interested in cheerleading than accuracy.

Sure enough, when Silver and his colleague Ben Lauderdale tried to predict last year’s UK election result, their performance was woeful. This was partly because the seat-by-seat polling data are far less detailed than in the US and partly because Silver’s good luck didn’t last.

We would be wise to have more realistic expectations, even of careful data-driven forecasters such as Silver. But perhaps our expectations are irrelevant. Even when we know that the forecasts are useless, when the pundits have no track record, when the events in question have always been unpredictable (the stock market; geopolitical shocks; recessions), we remain hungry for opinions about the future.

The truth is that forecasts are like Pringles — nobody thinks that there’s any great virtue in them but, offered with the fleeting pleasure of consuming them, we find it hard to resist. I am not sure quite why this should be so, but I have a couple of theories.

Possibility one is that the moment we hear a forecast, we imagine it happening. It then becomes a believable outcome and one that is easy to call to mind in the future. The scenario that we imagine looms large in our minds; other scenarios, equally plausible, fade to the background. As a result, we can be sceptical of forecasts in general yet still hooked by a particular one.

I notice this tendency in myself whenever I hear someone opining on the stock market. As an abstract proposition I think that it’s almost impossible to predict what the stock market will do. But the moment someone starts to tell me a story about what will happen to it, I’m hypnotised.

Possibility two is that forecasts offer us a lazy way to understand a complex world. The background to the conflict in Syria is complicated. So is Chinese politics. So, too, is the evolution of the Japanese economy. Trying to understand what is going on in any of these places requires an investment of time and attention that most of us are not willing to make. Wise heads at this newspaper could explain the intricacies to you or to me for hours yet barely have begun to do the topic justice.

But a forecast? That’s different. A forecast about what will happen in Syria, China or Japan is a simple way to convey a fleeting sense of understanding. The forecast will probably be wrong. But at the instant it is consumed, it gratifies. As I say, a lot like Pringles.

Written for and first published at ft.com.

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Undercover Economist

The cost of overconfidence

‘Some companies base their business models on our tendency to overestimate our willpower’

So, how are those resolutions going? Given that the new year has scarcely begun, there is some chance that your will remains as firm as it was on New Year’s Eve: the cigarettes have not been smoked, the white wine has not been guzzled and you actually went to the gym. As we all know, however, a year is a long time to stay strong.

Companies know it too, and some base their entire business model on our tendency to overestimate our willpower, our memory or our ability to navigate small print so devious that it would make Rumpelstiltskin blush.

The most egregious example — popular in the US, blessedly less so in the UK — is the mail-in rebate, where a manufacturer or retailer will offer a discount but only after the customer fills in a form, attaches a receipt and mails the paperwork off with fingers crossed. There are a number of advantages to this — it may allow the manufacturer to gain information about customers, and produces a flattering cash flow — but surely the main reason companies use mail-in rebates is that they know some people aren’t as disciplined and organised as they think.

Scott Adams, as so often, nailed the issue in a Dilbert comic strip. Dogbert offers a product for sale for $1,000,029 with a $1,000,000 rebate. And since “all we need is one person to forget to mail in the rebate forms”, Dogbert suggests targeting “the lazy rich”.

While the mail-in rebate is a particularly naked case of exploiting inattentive consumers, there are subtler examples, such as magazine subscriptions with free trial periods followed by auto-renewals.

More subtle still are pricing schemes that exploit consumers. In a recent analysis of overconfident consumers, economist Michael D Grubb highlights the “three-part tariff”. A one-part tariff would be, for example, 2p per minute to make phone calls. A two-part tariff might be £10 a month, plus 1p a minute to make phone calls. And a three-part tariff? A tenner a month with 200 minutes of free calls, plus 10p a minute to make phone calls after the 200 minutes have been used.

The three-part tariff will be reassuringly familiar to anyone with a mobile phone contract. But look at it there on the page. It’s ridiculous, is it not? It is hard to imagine any company deploying such a convoluted offering for a product whose consumption was obvious, such as petrol — “£10 a month to use our petrol stations, the first 50 litres of petrol to be supplied at cost price, and then £5 a litre thereafter.” There are legitimate business justifications for a three-part tariff but the likeliest story is that phone companies think we are fallible. Most of us don’t have a firm grasp either of how much we talk on average or of how variable that average is. As a result, many of us pay these punitive charges more often than we expect.

At least mobile phone carriers offer an honest service behind their manipulative pricing structures. I am not sure the same can be said of bookmakers, casinos and lotteries. Some of their customers have a clear-headed view of their chances of winning — just as some customers mail back their rebates or accurately forecast their phone calls — but many must overestimate their skill or underestimate the odds against them.

Yet I wonder if any business model is more dependent on the excessive optimism of its customers than gyms that offer ongoing memberships. In a famous research paper, “Paying Not to Go to the Gym”, economists Stefano DellaVigna and Ulrike Malmendier studied almost 8,000 gym members, with data on their attendance record and on the contracts they had agreed with the gym.

There were three contractual options: pay per visit, pay monthly on an automatically renewed contract, or pay annually on a contract that is not automatically renewed. DellaVigna and Malmendier found a number of patterns that are most naturally explained by the hypothesis that we consumers are naive, weak-willed fools.

● Eighty per cent of pay-monthly customers would have paid less — often much less — had they simply paid per visit. Likely explanation: we don’t go to the gym as much as we think we will.

● Pay-monthly customers pay more than the annual customers, because they retain an option to cancel, yet these customers, in fact, tend to stay members for longer. Explanation: we think flexibility is valuable but don’t realise how lazy we are in the face of auto-renewal.

● The people who get the worst value from the gym (highest per-visit cost) also take the longest to cancel (gap between final visit and cancellation). Explanation: people who are idiots about one thing are idiots about other things too.

Taking money to provide facilities to people who do not use them is a tempting business. But gym companies must still compete with each other for our custom, even if that competitive dynamic is dysfunctional.

So, take heart: if you are a customer who mails in her rebates, who carefully rations mobile phone use or who goes to the gym five times a week, then you are likely to get an excellent deal, cross-subsidised by other customers.

And you are just such a person, aren’t you? Of course you are.

Written for and first published at ft.com

Undercover Economist

An economist’s dreams of a fairer gig economy

We should decide what the state should provide and how generously, writes Tim Harford

It has never been easier to find little jobs for little payments. If you are being paid through Amazon’s Mechanical Turk to tag people’s photos or being hired to put up shelves via TaskRabbit, who needs a real job? For enthusiasts, these micro-jobs mean sticking two fingers up to the Man and rejecting wage-slavery in favour of freedom. For pessimists, they are precarious ways to earn a living that offer no pension or health insurance. Welcome to the “gig economy”, a phrase that evokes both the romantic ideals and the grinding poverty of life as a journeyman musician.

The app-based gig economy is still small. Perhaps one in 200 American workers rely on it for their main source of income; nobody is really sure. Yet it seems likely to grow, and, as it grows, so will a question: does the way we link social protections to jobs make sense?

Details vary but most advanced countries have a list of goodies that must be provided by employers rather than the government or the individual. In the UK a full-time worker is entitled to 28 days of paid leave. In the US the default provider of health insurance is your employer. In many countries, employees cannot be sacked without long notice periods and a decent pension is the preserve of people with a decent job. As for freelancers, they may enjoy flexibility and independence and sometimes even a good living — but as far as social protections go, they are on their own.

It is easy to understand the politics of this: pensions, healthcare and paid holidays are expensive, and asking employers to pick up the bill obscures their true cost. But the emergence of companies such as Uber is changing the calculus. Are Uber drivers employees or not?

Uber maintains that they are not. That seems defensible: a driver can switch the app on or off at any time, or work for a competitor such as Lyft on a whim. Few employees who acted in this way would be employed for very long.

Then again, does a driver who puts in 60 or 70 hours a week providing Uber-assigned rides according to Uber-determined rules and rates not deserve some sort of security? Some authorities think so: the company has lost a number of rulings in California as judges and arbitrators have found that, in certain cases, Uber drivers are employees.

Such judgments are likely to vary from case to case and place to place, and the uncertainty helps nobody bar the lawyers. Alan Krueger, former chairman of President Barack Obama’s Council of Economic Advisers, draws a parallel with the emergence of the workers’ compensation system a century ago. Sensible rules were agreed, he says, once lawsuits over industrial accidents became expensive and unpredictable.

But what should the new rules be? Mr Krueger’s approach is to adapt the status quo by extending some employment benefits to gig economy workers. He and his co-author, Seth Harris, recently proposed a third category of “independent workers”, neither pure freelancers nor pure employees. They receive “all the benefits that employees get”, Mr Krueger told me, “except for the ones that don’t make sense”.

As the global economy heals, a brave new world is emerging for workers in which more temporary jobs are being created — especially for the young

For example, if Uber drivers enjoyed the status of independent workers, they could form or join a union, and be protected under anti-discrimination laws. Uber, for its part, might offer pensions, health insurance and other products that its drivers could find attractive without fear this would lead the courts to rule that it was an employer. But independent workers would not receive paid holiday or protection from dismissal.

The Harris-Krueger proposal is based on the idea that the current package of employment rights in the US is attractive, and that America would be a better place if it was available as widely as possible. In the eurozone, where double-digit unemployment seems to be customary, it is hard to see how most protections could be applied to independent workers — and harder still to see why that would be a progressive step.

So here is a far more radical approach: we should end the policy of trying to offload the welfare state to corporations. It is a policy that hides the costs of these benefits, and ensures that they are unevenly distributed. Instead we should take a hard look at that list of goodies: healthcare, pensions, income for people who are not working. Then we should decide what the state should provide and how generously. To my mind, there is a strong argument that the state should provide all of these things, to everyone, at a very basic level. What the state will not provide, individuals must pay for themselves — or seek employers who provide these benefits as an attraction rather than a legal obligation. Call it libertarianism with a safety net.

No doubt this is just an economists’ pipe dream. Even the far tamer Harris- Krueger ideas seem unlikely to gain political traction any time soon. That is a shame. While traditional jobs suit most of us, the gig economy is perfect for some people and some circumstances. It would be a shame if our welfare state and labour laws failed to catch up.

Written for and first published at ft.com.

Undercover Economist

In praise of Scrooge

‘Scrooge didn’t waste his money on extravagances for people whose desires he didn’t really understand’

Ebenezer Scrooge is underrated. Literature’s most notorious misanthrope gets no respect from anyone. He’s a miser, a bully and a sociopath. Only with the most strenuous pleading from three supernatural mentors does he embrace the spirit of Christmas and, in so doing, join the human race. Dickens’s story is viewed as a journey of redemption; I am not so sure.

In his original, miserly form, Scrooge actually gives us much to admire. He was a model of inadvertent benevolence. He earned vast sums and avoided spending so much as a farthing if he could help it. The economic implication of this? Regardless of Scrooge’s motives, because he spent little, everyone else enjoyed more, as surely as if Scrooge had divided his fortune and sent a few coins to everyone in the country. As the economist Steven Landsburg once wrote: “There is nobody more generous than the miser — the man who could deplete the world’s resources but chooses not to.”

This isn’t an intuitive proposition but it is true. Scrooge reminds me of Bill Drummond and Jimmy Cauty, formerly of successful dance band The KLF, who in the summer of 1994 filmed themselves burning 20,000 £50 notes — £1m — on an island in the Inner Hebrides. People who wouldn’t have batted an eyelid if Drummond and Cauty had blown the cash on fast cars and drugs were outraged at the waste. As the Ghost of Christmas Yet To Come might have pointed out, the money could have been spent on a worthy cause. On a chat show, in front of a jeering audience, Drummond explained that “burning that money doesn’t mean there’s any less loaves of bread in the world, any less apples, any less anything. The only thing that’s less, is a pile of paper.”

Drummond was quite right. He had a claim on £1m worth of goods and services and by burning the money, he didn’t destroy those goods and services — he merely relinquished his claim and let others enjoy them instead. The likely economic effect is that everything in the country became a tiny bit cheaper. If the Bank of England had worried about the (minuscule) fall in the money supply, it could have printed replacement banknotes for a couple of grand.

Scrooge’s self-denial had a similar effect: he could have splashed his money around buying houses and sweets and anything else Victorian London might offer but, in doing so, he would have denied those pleasures to others. In a deep recession, one might be concerned that Scrooge was failing to support aggregate demand but in normal economic times the effect of his skinflintery was to ensure that everyone else was able to enjoy a little more.

Ah, but we might claim: it is the thought that counts, and Scrooge thought of nothing but workhouses and humbug and himself. True. But are the rest of us really any better? We engage in a seasonal fit of generosity but generosity is not the same as empathy — as thinking deeply about what someone else might want.

Loyal readers will know that 22 years ago, Joel Waldfogel, an economist, wrote an article titled The Deadweight Loss of Christmas, in which he quantified something we all instinctively know: a lot of the presents that people give and receive aren’t terribly well chosen. We spend money on things that people don’t really like — and thereby we waste energy, material resources and labour that could have been far better deployed making something people did want.

More recent research by psychologists — notably Gabrielle Adams and Francis Flynn of Stanford, and Harvard’s Francesca Gino — has revealed a startling lack of self-awareness in our gift giving. A few of their results:

● Gift givers believe that spontaneous gifts are as welcome as those on a wish list, while wish list gifts seem charmless and impersonal. Recipients feel otherwise — they have no problem being given something from a list, and often lament the poor choices when people venture away from it.

● People feel awkward giving money yet are perfectly happy to receive it.

● Gift givers think more expensive presents are appreciated more yet gift recipients don’t care about the expense either way.

It is hard for us to grasp the discrepancy between how we see the world when giving gifts and when receiving them. Recipients may appreciate cash or presents from a list and not fuss too much about expensive gifts; gift givers, in contrast, imagine that the ideal present is an expensive surprise. It isn’t. All this suggests we should probably be spending less on presents, and thinking a lot more about the presents we do buy.

Which brings us back to Scrooge himself. When he finally did decide to embrace the conventional spirit of Christmas, he didn’t waste his money on demonstrative extravagances for people whose desires he didn’t really understand. Instead, he gave three superb gifts. First, a prize turkey that he knew — thanks to a ghostly premonition — was much needed by the Cratchit family. Second, the gift of his time and attention, playing games and making merry with his nephew. Finally, he gave Bob Cratchit the greatest Christmas gift of all: a pay rise.

As I say: underrated.

Written for and first published at ft.com.

Undercover Economist

Economics: still a job for the boys?

‘There are two or three male undergraduate economists for every female undergraduate economist in the US. That is not good’

The world’s most powerful economist is a woman — but chair of the Federal Reserve Janet Yellen doesn’t have a great deal of female company at the economic top table. Christine Lagarde runs the International Monetary Fund, it is true — although she is a lawyer. But the president of the European Central Bank has never been a woman, nor the president of the German Bundesbank, nor the governor of the Bank of England. The US Treasury secretary has never been a woman, nor has the UK chancellor of the exchequer, nor the president of the World Bank.

To some extent this reflects the well-known fact that women are under-represented in positions of power. But beyond that it suggests that economics itself is a curiously male-dominated discipline. There has still only been one female winner of the Nobel Memorial Prize in Economic Sciences: Elinor Ostrom in 2009 (she shared the prize with Oliver E Williamson), and she was not a mainstream economist herself.

Quite why economics is so testosterone-laden is unclear. The situation at the top of the profession now is partly a reflection of the state of economics education decades ago. Ostrom’s desire to study economics was set back by the fact that she was discouraged from studying mathematics at school because she was a girl. We cannot travel back in time to give her a more enlightened maths teacher.

In the younger echelons of the profession there is more cause for cheer. The John Bates Clark medal, for example, is awarded to economists based in America under the age of 40; it is a prestigious award and in many cases a precursor to the Nobel Prize. Until 2007 it had been an exclusively male preserve but it has since been won by three women.

Another hopeful development is the blossoming of psychological realism in economics, in the form of behavioural economics. Behavioural economics doesn’t have all the answers but it is certainly asking some good questions. Since psychology is as popular among female undergraduates as economics is unpopular, it seems plausible that behavioural economics will make the dismal science more appealing to women.

Perhaps we should simply wait, then, and the women will break through? That seems doubtful. The American Economic Association publishes a regular newsletter from the “Committee on the Status of Women in the Economics Profession”, and two summers ago the newsletter pondered a depressing trend — or rather a depressing lack of a trend.

“The fraction of all bachelor of arts candidates majoring in economics has not budged much over the past decade,” wrote Cecilia Conrad of the MacArthur Foundation, co-editor of the newsletter. There are two or three male undergraduate economists for every female undergraduate economist. That is not good — but at least the ratio isn’t getting worse. In the UK, the ratio is similar but has shown a marked decline between 2002 and 2013. The basic explanation is lack of demand: too few women wish to study economics.

Tempting as it might be to blame the financial crisis for this trend, the sharpest movement occurred a decade ago, before the crisis hit. The downward trend in the percentage of women enrolled in UK undergraduate economics courses has continued since then but much more slowly.

One possible explanation is that unconscious sexism is depriving young women of role models in the profession. Justin Wolfers, an economist and New York Times contributor, recently complained that when journalists wrote about economics research with both male and female authors, journalists routinely quoted the man or cited the paper as though the man were the senior author.

(My own confession: I once committed the same sin in demoting Wolfers’ co-author Betsey Stevenson when she should have been cited first. And another confession: one indignant reviewer on Amazon pointed out that my first book, The Undercover Economist, habitually uses “he”, “his” and “him” in situations where female pronouns would have been perfectly proper. These days I try to do better.)

Unconscious sexism is hardly the exclusive preserve of economics, though, so what else is going on? Diane Coyle, an economist and FT contributor, wonders if mathematics is the problem, since girls are less likely than boys to study mathematics at A-level. She recently sounded a call to arms on her blog: “Girls, women, brush up on the maths a bit if you need to, but above all come and study economics!”

I can’t disagree with that but we cannot just blame imbalances in mathematics. A recent study by Mirco Tonin and Jackie Wahba of the University of Southampton found that even among A-level maths students, girls were less likely than boys to choose economics. And in the United States, where economics degrees are just as male-dominated as in the UK, girls have long since achieved gender parity in advanced high-school maths.

The sad truth is that economics just does not seem to be terribly attractive to young women. That is a shame, and it has financial consequences, since economics graduates tend to be well paid. But the real loss is to economics. If we cannot make the subject relevant to half the world, we have a problem.

Written for and first published at ft.com.

Undercover Economist

The window tax — an open and shut case

‘People respond in profound ways to tax incentives. They adjust their behaviour to avoid tax’

The adage ‘free as air’ has become obsolete by Act of Parliament,” thundered Charles Dickens in 1850. “Neither air nor light have been free since the imposition of the window tax. We are obliged to pay for what nature lavishly supplies to all, at so much per window per year; and the poor who cannot afford the expense are stinted in two of the most urgent necessities of life.”

Dickens prevailed: the window tax, which had been levied in England since 1696, was abolished within a year. But the curious story of the tax, explored recently by Wallace Oates and Robert Schwab in the Journal of Economic Perspectives, holds lessons for us today.

The details of the tax varied across the centuries but with the broad theme that the more windows your house had, the more tax you had to pay. At first glance, the tax seems clever, even brilliant. Rich people had larger houses, and so paid more tax. Windows are easy to count from outside the premises, so the tax was easy to assess. Poor people didn’t own large houses, so they weren’t affected by the tax. And the number of windows in a house doesn’t change, so the tax was impossible to avoid.

Wrong, wrong, wrong.

The tax was probably progressive but not nearly as progressive as it might seem. Many poor people did live in large houses — as servants or in tenement blocks. They suffered from the tax, as we shall see. Adam Smith himself, in The Wealth of Nations (1776), nailed the other problem with the idea that the tax was paid only by the rich: “A house of £10 rent in the country may have more windows than a house of £500 rent in London.”

A more fundamental error is the idea that architecture doesn’t respond to tax incentives. When William Pitt tripled the tax in 1797, thousands of windows were bricked or boarded up almost overnight. Later, the president of the society of carpenters in London told Parliament that almost every homeowner on Compton Street had approached him to reduce the number of windows. A new apartment building in Edinburgh was designed with an entire second floor filled with windowless bedrooms.

When Dickens complained that the poor were being denied light and air, he wasn’t speaking figuratively. Poor people did not have to pay the tax out of their own pockets but their landlords did, and the poor dwelt in stuffy darkness as a result.

After 1747, the window tax followed a strange structure. Houses with fewer than 10 windows paid no window tax; those with 10-14 windows paid six pence per window per year. As a result, the cost of having a 10th window was that you also had to pay tax on the other nine. Tax wonks call such discontinuities “notches”, and there were further notches at 15 and 20 windows.

If these notches seem absurd to you, modern governments don’t seem to have a problem with them. Stamp duty, a tax on property transactions in England and Wales, contained notches until last year, and the UK income tax system recently acquired a new notch: a transferable tax allowance for married couples, worth more than £200, evaporates abruptly if one of the couple strays into a higher tax bracket, even by a single pound. All of this distorts our behaviour.

Nonsensical as the notches are, they help economists to see the effect of the tax. In the recent study, Oates and Schwab combed through tax records from the mid-1700s. They found that nearly 50 per cent of the total number of houses had the tax-efficient totals of nine, 14 or 19 windows — an intelligent response to a foolish tax. People who bricked up a couple of windows to bring the total down to nine were inconvenienced by the tax, yet the Treasury earned no revenue from them. Most taxes will produce some of this sort of waste but the window tax was particularly egregious.

If it seems strange that tax policy could shape the architecture of a country, consider New Orleans’s distinctive camelback houses, one storey high at the front (the part of the home that’s taxable) but with two storeys at the back — a tax-efficient architectural style.

And ponder the research of economists Joshua Gans and Andrew Leigh, who noted that twice as many births were recorded in Australia on July 1 2004 than on June 30 2004. Why? The July babies were eligible for a “baby bonus” of A$3,000 and the June babies were not. Gans and Leigh even found that many Australians delayed their deaths — or perhaps the moment their deaths were recorded — long enough to escape inheritance tax when it was abolished on July 1 1979. If our births and deaths respond to tax incentives, it shouldn’t be surprising that a few windows might be bricked up.

There is a useful lesson to be learnt from the window tax: it is that people will respond in quite profound ways to tax incentives. That is why economists often call, more in hope than expectation, for a tax on carbon emissions. People would adjust their behaviour to avoid the tax, which is exactly what we need.

But perhaps a more realistic lesson is this: it’s perfectly possible for a bad tax to last for 155 years.

Written for and first published at ft.com.

Undercover Economist

Eyes on the innovation prize

‘Coming up with something new is for suckers; smart people sit back and rip off the idea later’

In 1737, a self-taught clockmaker from Yorkshire astonished the great scientists of London by solving the most pressing technological problem of the day: how to determine the longitude of a ship at sea. The conventional wisdom was that some kind of astronomical method would be needed. Other inventors suggested crackpot schemes that involved casting magic spells or ringing the world with a circle of outposts that would mark the time with cannon fire.

John Harrison’s solution — simple in principle, fiendishly hard to execute — was to build an accurate clock, one that despite fluctuating temperatures and rolling ocean swells, could show the time at Greenwich while anywhere in the world. Harrison and countless other creative minds were focused on the longitude problem by a £20,000 prize for the person who solved it, several million pounds in today’s money.

Why was the prize necessary? Because ideas are hard to develop and easy to imitate. Harrison’s clocks could, with effort, have been reverse engineered. An astronomical method for finding longitude could have been copied with ease. Inventing something new is for suckers; smart people sit back and rip off the idea later. One way to give non-suckers an incentive to research new ideas, then, is an innovation prize — that is, a substantial cash reward for solving a well-defined problem. (Retrospective awards such as the Nobel Prize are different.)

For decades after Harrison’s triumph, prizes were a well-established approach to the problem of encouraging innovation. Then they fell out of favour, with policymakers instead encouraging innovation with a mix of upfront research grants and patent protection. Now, however, prizes are making a comeback. The most eye-catching examples have been in the private sector: the $1m Netflix prize for improved personalisation of film recommendations or the $10m Ansari X prize for private space flight. Last year Nesta, a UK-based charity for the promotion of innovation, launched a “new longitude prize” of £10m for an improved test for bacterial infections, marking the anniversary of the original prize’s founding in 1714.

But the big money potential is in the public sector. In 2007, several governments (and the Gates Foundation) promised a $1.5bn prize for a vaccine for pneumococcal meningitis. The prize, called an “advanced market commitment”, is structured as a dose-by-dose subsidy rather than one giant cheque. It is being paid out and millions of children have already been vaccinated. Much bigger commitments are possible: before US senator Bernie Sanders began his run for the presidency, he introduced two Senate bills that would have provided almost $100bn a year as medical innovation prizes.

But why are innovation prizes attractive, when the existing system of grants and patents seems to have served us reasonably well so far?

Research grants may be too conservative, favouring establishment figures working on unambitious projects, and rewarding process rather than results. Such conservatism is not inevitable but it goes with the territory. An innovation prize seems more meritocratic and, since it pays only for results, the prizes can set radical goals.

Patents are particularly problematic, since they encourage the development of something that anyone can use — a new idea — with the perverse reward of restricting access to that idea. That is a trade-off that is easily bungled, with patents that last too long, are too broad, too easy to secure and too difficult to challenge.

Even a well-crafted patent system depends on there being a ready market for the innovation in question. Few people will pay much for a malaria vaccine but it would be socially very valuable, as would a new class of antibiotics. A prize can easily reward long-term social priorities such as these; a patent cannot.

But there is a danger of expecting too much from prizes. If we are to scrap patents entirely, prizes would be far too narrow a replacement. (Who would have sponsored a prize “for inventing the internet”? Not all innovations exist to solve precooked problems such as finding longitude.) If we use patents and prizes in parallel, however, there’s a self-selection problem: inventors with truly valuable ideas apply for patents, while those with dross apply for prizes. A new working paper from economic historian Zorina Khan points out that Royal Society of Arts prizes in the 19th century suffered from exactly such adverse selection.

Khan also observes that many celebrated historical innovation prizes were actually mired in controversy, with prizes awarded for unoriginal or ineffective ideas, or denied to the deserving. It’s easy to point to a few success stories but there are plenty of those for patents and grants too.

For my money the patent system urgently needs reform, with patents that are harder to earn and easier to challenge. Innovation prizes definitely have their place, especially where markets for a socially valuable innovation may not exist. But we do a good idea no favours by overselling it. We should also probably stop going on about the Longitude Prize or at least we should admit what Nesta’s new prize website does not: that Harrison’s invention was rewarded with decades of suspicion and controversy. The Board of Longitude, the government body set up to administer the prize, questioned both the accuracy of his clocks and whether they could be replicated. Harrison did receive numerous payments for his efforts — but neither he nor anyone else ever won the Longitude Prize.

Written for and first published at ft.com.

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