Undercover Economist

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.

Eeyore and the euro crisis

The search is on for better ways to measure systemic risk

I don’t propose to predict the next twist in the euro crisis; indeed, given the delay between my writing these magazine columns and you reading them, I’m not even going to hazard a guess as to what has recently happened. We’ve been contemplating a major systemic event: a Greek government default – and worse. A Spanish default? An Italian one? Not imminently likely, but as Eeyore once said, “think of all the possibilities … before you settle down to enjoy yourselves”.

Such events always have nasty but unpredictable consequences. In fact, the nastiness is intimately bound up with the unpredictability. A big financial loss is always likely to have further impacts: anyone holding Greek bonds suffers if the Greeks decide they won’t pay. But what if you’re applying for an overdraft to a bank that has just been burnt by the Greeks? Or applying for an overdraft to a bank that has just been burnt by a collapsing hedge fund that invested in Greece? Or a bank that has written an insurance policy – a credit default swap – on Greek bonds? The possibilities multiply: it will take us a long time if we follow Eeyore’s advice; and each successive failure can lead to further failures. Because we do not really know who is at risk, financial markets can seize up, as they did at the beginning of the credit crunch and, far more severely, when Lehman Brothers evaporated early one Monday morning in September 2008.

How should regulators deal with all this? First, they should never forget that misconceived regulatory rules have contributed in many ways to the crisis we continue to face: it’s in the nature of regulations to force black-and-white responses – as when many financial institutions are simultaneously obliged to sell a particular asset. But for those who, like me, believe the quest for better regulations is not a hopeless one, the search is on for better ways to measure systemic risk.

A number of interesting approaches to this problem have recently crossed my desk. Tobias Adrian of the Federal Reserve Bank of New York and Markus Brunnermeier of Princeton propose a tool they call “CoVaR”, or “contagion Value at Risk”. Value at Risk is a widely used but controversial risk management and regulatory tool, describing the maximum amount of money a financial institution might expect to lose over a given period of time, such as a day, with (say) 99 per cent confidence. (“What about the other 1 per cent?”, you might ask, and with good reason.) The Adrian-Brunnermeier approach calculates Value at Risk for the entire universe of financial firms, and then asks how that VaR changes if one particular entity – say, Lehman Brothers, or Portugal – finds itself in distress.

Alternative approaches look at techniques from network mapping. Francis Diebold and Kamil Yilmaz have a paper out on “network topology”. Andrew Haldane, the Bank of England’s man in charge of financial stability, with Prasanna Gai and Sujit Kapadia, is also pursuing network modelling techniques to understand how risks can spread.

Meanwhile, as regulators such as Haldane and Adrian look to abstract approaches in the hope of deeper understanding, an academic, Darrell Duffie of Stanford University, has been advocating what he calls a “10-by-10-by-10” approach, which is pleasingly pragmatic. Duffie suggests stress tests in which 10 financial firms list the impact of 10 unpleasant scenarios on 10 of their key counterparties; the process can be iterative, as each round of testing suggests new firms to include and new scenarios to try.

One can hardly complain about these efforts to understand more clearly the intricate plumbing of the financial system, but what is becoming most clear is how little we still know. So I particularly applaud one feature of Duffie’s brief working paper: more than a quarter of it is devoted to an exploration of all the ways in which his idea may fail.

Also published at ft.com.

Can you be a little less specific?

Game theorists are beginning to produce rational models of deliberate vagueness

Seinfeld’s George Costanza was once invited “up for coffee” at the end of a romantic evening, and refused: caffeine would keep him awake, he explained to his perplexed date. Later, aghast, he realised: “coffee doesn’t mean coffee! Coffee means sex!”

Well, indeed – but few people, if they are wise, will baldly suggest the sex. A little ambiguity is called for. Now game theorists – masters of the mathematisation of human interaction – are beginning to produce rational models of deliberate vagueness.

Andreas Blume and Oliver Board, two economists at the University of Pittsburgh, offer up just such a model. They point out that perhaps it is too much trouble to be specific, as with a business contract offering a fee plus “reasonable expenses”. This isn’t always the reason. “Coffee” has two syllables, “sex” has only one, and surely George’s date could have made her intentions plainer without much effort.

Perhaps it’s just a matter of social norms: it would have been shocking for George’s naughty-but-nice date to ask him to sleep with her, so instead she hinted that an attempt at seduction might not be rebuffed.

But there is often a logic behind such norms – for example, the opportunity to tweak the message depending on how it is received. If George seemed taken aback by the invitation for “coffee”, his lady friend would have retained plausible deniability. If he seemed interested but hesitant, she could have clarified the message by slipping into something more comfortable.

Alan Greenspan, the mumbling maestro of mixed messages, played the markets with one vague declaration after another, each one a nudge – but not a shove – in the direction he preferred.

The Blume-Board paper lurks on the boundary between philosophy and mathematics – and, ironically, it is extremely precise about what “vagueness” means. A working paper from the economists Florian Ederer, Richard Holden and Margaret Meyer has a more practical bent, examining the boss who finds it useful to be vague about performance bonuses.

The scenario here is one of an employer who cares about two tasks and an agent who finds it easier to do only one of them. Imagine a journalist who must both write words and spell them correctly: the boss needs both of these jobs done well, within reason: a mass of spelling mistakes is no use and neither is a tiny number of correctly spelled words.

The challenge is to design appropriate performance pay for the job, and the difficulty is, there are two types of journalist: those who find it easy to churn out reams of copy, and those who find it easy to spell correctly. The boss doesn’t know which type of journalist she is hiring. It would be easy to demand the impossible, and find no takers for the job; or to pay over the odds; or to hire a journalist but then inadvertently give him an incentive to neglect half the job.

In some important cases, say Ederer, Holden and Meyer, the boss will want to be deliberately ambiguous about what sort of performance will be rewarded. Will the bigger reward go to the careful speller or to the hasty typist? One type of ambiguous contract has the boss tossing a coin and rewarding either one type of achievement or the other. An alternative contract – a variant of “you cut the cake and then I’ll choose” – allows the boss to choose one of two performance metrics after she has seen what kind of performance has actually been produced.

There’s a cost to all this ambiguity, of course: it’s risky for the journalist, who must then be compensated. Nevertheless this can be a price worth paying.

We’re used to thinking of ambiguity as a flaw in contracts, agreements and management styles. But when your boss gives you vague directions or bases your performance bonus on inconsistent and ever-changing criteria, perhaps there’s method in the madness.

Also published at ft.com.

Why we should all trim our antlers

Robert Frank’s ‘The Darwin Economy’ argues that there are markets in which we would be better off if we agree to throttle back

In a hundred years, if professional economists are polled to identify the founder of their discipline, the majority will name Charles Darwin, rather than Adam Smith as they would today.”

This prediction, made in a recent speech in Oxford by the American economist Professor Robert Frank, has a certain symmetry about it: after all, Darwin’s theory of evolution was inspired by the economist, Thomas Malthus.

Frank has a particular Darwinian insight in mind: the idea that contra Smith’s “invisible hand”, individuals competing can produce results that are bad for society as a whole.

Consider the vast antlers of the north American bull elk: they’re the result of sexual selection balanced by other selective pressures. Elks with big antlers win fights with other elks, and mate with multiple females. However, they also get hunted down and killed by packs of wolves. Elks as a whole would be better off if they could all agree to shrink their antlers by a factor of four or five: the males with the biggest antlers would still get the girls, while only the wolves could object to faster, more agile bull elks. Sadly for the elks and happily for the wolves, that’s not how sexual selection works.

In a new book, The Darwin Economy, Robert Frank sees elk antlers everywhere he looks in modern society. For example, when parents bid up the price of houses near good schools, they’re engaging in a wasteful arms race: children as a whole will be no better educated as a result, but vast sums are devoted to the quest for the right school district. My flashy car makes you less satisfied with your own; if I take ladies out to the opera and Michelin-starred restaurants, other men will no longer succeed by offering scampi and chips at the Romford dog track. In short, says Frank, my spending harms you as surely as I would harm others by standing up at a concert and forcing everybody behind me to stand up in turn.

Sometimes this dynamic is the result of envy; at other times it is genuine competition for scarce resources, such as beautiful partners or elite university places.

Elks cannot reach an agreement to trim their antlers, but humans can, and Professor Frank advocates a steeply progressive consumption tax to serve this purpose. In effect, the tax would be an income tax with an exemption for savings, encouraging investment but discouraging spending sprees. Frank argues that it should be progressive because the wasteful economic arms races are at their most grotesque at high consumption levels.

I think Frank’s analysis is impressive, original and thoughtful. But one need not invoke elk antlers to justify progressive taxation. And I part company with Frank on two points.

First, I am unconvinced that such arms races are quite as common as he feels. For instance, new antibiotics or cancer treatments are “luxury” goods in the technical sense that rich societies spend a greater proportion of their income on healthcare. Is this really just a race for status, for the coolest chemotherapy treatment? Frank thinks that “luxury” goods tend also to be positional, status goods – but such medical treatments seem to me to be an increasingly important counterexample.

Frank also sidesteps the idea that markets themselves can be structured to eliminate the arms race. For example, parents can scramble to buy property near an existing good school, or they can fund a new school – at least in principle. In the second case, new resources are mobilised and more children get a good education. Can education really be nothing but the anthropic equivalent of elk antlers or peacock tails?

Frank is right to remind us that there are markets in which we’d all be better off if we could collectively agree to throttle back. But he may have been too quick to assume that such markets are beyond reform.

Also published at ft.com.

Innovation works in mysterious ways

‘I’m surrounded by technology that looks good and works well because others followed where Apple led’

Was it salesmanship or engineering? Creativity or ruthlessness? Or was Steve Jobs simply gifted with vision and impeccable taste? Whatever the true source of his success, there was more than a touch of genius about Jobs. Even his side project, Pixar, was an astounding achievement. His first love, Apple, he built from nothing and then dragged back from the brink to make it the most valuable company in the world. No wonder so many of us felt sad at the news of his passing: surely he had more to offer.

I spend my life in front of a computer, and that life is better because of what Steve Jobs created. But here’s the strange thing: I’ve never owned an Apple product for longer than the two weeks it took to give up and send it back. (Apple’s customer returns department is impeccable, by the way.) My Macbook Air? Glorious hardware, but fussy software and a counterintuitive interface. My iPad? Beautiful – but also heavy, not too fond of wireless, and refused even to turn on until I did some most impertinent things to my Windows laptop.

Apple never made a penny from me. Why, then, do I say that Steve Jobs improved my life? It’s because I am surrounded by technology that looks good and works well because others followed where Apple led. Without Apple’s refinement and popularisation of the WIMP environment (window, icon, menu and pointer), how long would we have waited for a graphic interface from Microsoft – and how awful might it have been? It’s hard to imagine Bill Gates would have shown much interest in fonts without Apple’s beautiful typography. Beyond desktop computers, there’s a similar story to tell: I own an Android phone that owes more than a passing debt to the iPhone; I’m still waiting to own a Windows machine to rival the Mac Air; and every tablet in the world bows to the iPad.

To an economist the lesson is obvious: innovative profits are imperfectly appropriable. In more user-friendly language: when an entrepreneur bakes a cake, he only gets to keep a thin slice for himself. This is worrying if it discourages innovation, and in some industries innovators may be discouraged by the prospect that they must take big risks and sink big costs while society sits back and hopes to reap the benefits. Yet in the computer industry, plenty of entrepreneurs seem happy to take risks for the prospect of a thin slice of the social benefits.

A discussion paper published in 2004 by the economist William Nordhaus attempts to establish exactly how thin that slice is. Nordhaus reckons that innovators capture a “minuscule” 2.2 per cent of the total social benefit of their innovations. The other 97.8 per cent goes to consumers, partly because competitors soon catch on, and partly because no company, even a monopolist, can charge each consumer a price reflecting her individual willingness to pay.

Professor Nordhaus’s estimate can be regarded as, at best, an educated guess, partly because Nordhaus is only able to focus on innovations which lead to lower production costs and thus lower prices. If that’s the metric, developments such as the world wide web or penicillin barely register. Still, I think it’s safe to say that both Tim Berners-Lee (the web) and Alexander Fleming (penicillin) reaped far less than 2.2 per cent of the total value to society of their insights.

Was Jobs an exception? Chris Dillow of the Investor’s Chronicle, who called my attention to the Nordhaus paper, reckons that Jobs’s gift for branding and design helped Apple retain an unusually large slice of the innovator’s cake. Perhaps that’s true. Apple’s shareholders have certainly enjoyed a profitable few years. But the greater benefit has flowed to customers – and not only the customers of Apple.

Also published at ft.com.

Confusion at a price

The UK energy secretary wants to reform the way suppliers charge customers. But his plans seem unlikely to give a dramatically better deal

Are we living in a confusopoly? You know what I mean: trying to figure out whether it’s cheaper to use one phone company’s “Armadillo Everyday 500” tariff or another’s “Supersava B”, with a special concessionary price for the first 15 minutes of the 25-year contract. (The term confusopoly was, I believe, first coined by Scott Adams, the creator of “Dilbert”.) Chris Huhne, the UK energy secretary, fears the confusopoly in energy prices, and in a speech last month, he announced his plans to do something about it.

Huhne has a point: we know that a well-functioning, competitive market is a good way to get prices down. If such a market is feasible it’s far more likely to deliver good results than regulatory diktats, with all their inevitable loopholes and unintended consequences. Yet if consumers are confused about prices then competition is unlikely to produce such glorious results.

But the story is – surprise, surprise – not quite as simple as Huhne suggested in his conference speech. There are two separate issues here: people feel that it’s a hassle to switch suppliers, and they are uncertain about whether they’d be better off if they did.

The first problem, switching costs, is less serious than it seems. Paul Klemperer, an economics professor at Oxford University, says that switching costs need not be bad for consumers or particularly good for companies. In a market with switching costs, what every company wants is a fat share of captive customers to exploit. But how to acquire those customers? The obvious solution is to offer fantastic deals, attract the suckers, and then gouge them for all they’re worth. (This is why your phone company will happily give you a £500 phone “free”; nobody has yet offered me a free laptop computer.) The early bargains partially – and sometimes fully – compensate for the later price gouging.

Perhaps we should not worry too much, as long as the introductory bargains are generous enough. I wonder what to make of the fact that Huhne has branded them “predatory pricing” and declared that the bargains will stop. I fear it will be hard to implement that policy sensibly. For instance, Michael Waterson of the University of Warwick reckons that a recent effort by the energy regulator to stop some kinds of predatory pricing simply backfired: the deals dried up but lower everyday prices did not materialise.

The second problem, confusion pricing, seems to be the curse of our age. There is certainly reason to worry: I’ve written in this column before about the research of the economists Catherine Waddams Price and Chris Wilson, who studied customers who had overcome whatever switching costs they faced and were determined to find a cheaper electricity supplier. Most people missed the lion’s share of the savings they might have achieved, and a quarter managed to make themselves worse off.

And yet, and yet. Eugenio Miravete of the University of Texas at Austin studies what he calls “foggy pricing” and reckons that competition is a pretty good antidote to the fog: new entrants typically have an incentive to offer simple prices to cut through the confusions, while incumbents do not retaliate by complicating their own offers.

I do sympathise with Huhne’s concerns and am sure he’s on to something. But his reforms seem unlikely to give us a dramatically better deal. According to VaasaETT, a global energy think-tank, energy prices in London are among the lowest of all major European cities. Low energy taxes are part of the reason – something Huhne might want to address if he is as serious as he claims about energy efficiency and climate change. But my casual inspection of VaasaETT’s figures suggests that low taxes do not explain the entire price discount. The confusopoly hasn’t quite got the better of us yet.

Also published at ft.com.

The honest truth about kickbacks

It may be better to get 10 per cent of a booming economy than 100 per cent of a stagnating one

An old joke: a bureaucrat from Sani Abacha’s Nigeria visits a bureaucrat in Suharto’s Indonesia and is impressed that his Indonesian counterpart lives in a nice house and drives a Mercedes. “Do you see that road? Ten per cent,” the Indonesian explains.

A couple of years later the visit is reciprocated. Suharto’s man finds the Nigerian civil servant in a palace with a pair of Ferraris. “Do you see that road?” says the Nigerian, gesturing at virgin rainforest. “One hundred per cent.”

There is more to the joke than meets the eye, of course: Indonesia managed to combine severe corruption with many years of strong growth, while Nigeria stagnated over a similar period. Corruption matters, but so does the type of corruption.

And here is a conundrum. Technocrats have long offered economic policy advice to powerful people in developing countries, yet powerful people may have much more to gain by ignoring the advice and lining their own pockets. The problem is so severe it is a wonder that economies ever develop at all. But the situation is not hopeless, because contrary to the joke, it may be better to get 10 per cent of a booming economy than 100 per cent of a stagnating one.

A new working paper from Michael U. Klein of the Frankfurt School of Finance and Management argues that if elites profit from corruption and control the levers of policy, we should ask ourselves what sort of policy advice might appeal to a corrupt bureaucrat while still being sound economics?

Consider the traditional form of corruption: paying bribes in exchange for favourable treatment. This may be harder than it looks, even in a society where corruption is common: one must still find corrupt partners, establish a deal, and secretly enforce it.

Klein, who studied Nigeria in the 1980s, gives some baffling examples of behaviour that may have been designed to drive away the honest and leave only the corrupt. In one case, the boss of an engineering company arranged to meet the managing director of a large public enterprise after many requests and much waiting. When finally brought into the managing director’s office, he found his counterpart facing the wall. Four hours passed; the only sound was that of a radio playing. Then the managing director turned and a deal was struck.

The waste involved in arranging, monitoring and enforcing corrupt deals can be immense – Klein has found that transaction costs of large projects rise from 3 per cent to at least 10 per cent in “complicated” environments. Prosecutions for corruption can be tough to pull off, says Klein, because big Nigerian firms had no accounts in the late 1970s. (There was also a national tradition of fires breaking out in accounting departments.) All this is dreadfully damaging for growth.

What might work better, while still satisfying the avarice of a country’s elite? One idea would be for elites to hold direct stakes in commercial firms. But the result would still look like a mafia town: too much emphasis on squashing competition and not enough on meeting the needs of customers.

Perhaps this is why export markets have proved such an important element in the success of many Asian economies: domestic markets may be sewn up in corrupt deals, but the government can still insist on export success as a precondition for political favours. Only productive firms are allowed to join the corrupt club – with export markets a good test of genuine productivity. For a case study, consider decades of South Korean growth.

Perhaps there is a touch of fatalism about all this. Eventually one would hope for a world where corruption is very rare. While we’re waiting for that, it’s worth asking how even a corrupt economy can achieve growth.

Also published at ft.com.

New ways with old numbers

Academics are always being asked to demonstrate the “impact” of their research. (Is it like being hit by a rogue cyclist? Or is it more like a pile-driver, or even an asteroid strike?) But while it is not unreasonable to ask whether a particular piece of academic research is useful, the difficulties in answering the question are extraordinary.

The quality of a piece of research is subjective, and using measures such as the number of peer-reviewed articles published simply outsources the subjective judgment to somebody else. But there is a deeper problem: in a complex world, it is impossible for anyone to judge what the significance of a research breakthrough might eventually be.

Nowhere is this more true than in the field of mathematics. The most famous example is the development of imaginary numbers. The very name conveys the supposed uselessness of the concept. Square the imaginary unit, i, and you get minus one. Baffling.

Imaginary numbers were regarded with great scepticism after they were developed in Bologna in the 16th century as the logical solution to an abstract problem. Eventually, however, they turned out to be essential for, among other applications, electrical engineering – hardly something that could have been imagined by their creators.

So are imaginary numbers typical of the unexpected bounties of pure mathematics – or an unrepresentative poster child? Two recent commentators have tried to expand the number of examples. Professor Caroline Series of the University of Warwick devoted a recent presidential lecture at the British Science Festival to this topic, focusing on the applications of non-Euclidian geometry.

When Euclid originally laid down the axioms of his geometric system 23 centuries ago, one of them seemed less than obvious. For 2,000 years mathematicians tried to derive the “fifth postulate” – equivalent to the claim that the internal angles of a triangle add up to 180 degrees – from more basic building blocks, and failed. Eventually it transpired that the axiom was optional. Consistent systems of geometry were possible in which the internal angles of triangles summed to more than 180 degrees, or even to fewer.

Surfaces on which the sum of angles in a triangle is less than 180 degrees look like leaves of kale. Prof Series points out that the development of kale-like geometric systems, called hyperbolic geometry, initially seemed a curiosity but made possible Einstein’s theory of special relativity. Now, says Prof Series, hyperbolic geometry promises to advance our understanding of the way complex networks such as the internet behave and grow.

Peter Rowlett, a maths educator and historian, recently gathered further examples together in the journal Nature. The “sphere packing problem” – beginning with the conjecture that grocers have found the most efficient way to stack oranges – has been an open area of research for four centuries, but in the 1970s a solution for eight-dimensional “spheres” was used to design efficient modems. This meant that internet access no longer required specialised cables.

Quaternions, which extend imaginary numbers into a further dimension, began to be developed by William Hamilton in Dublin in 1843. They were eclipsed by matrix algebra, before being rediscovered as indispensable for generating 3D computer graphics efficiently. Rowlett’s contributors offered several other examples.

Cost-benefit analysis has its place. But the benefits of academic research can pop up in such unexpected ways, sometimes immediately and sometimes after centuries. We should not set too much store by any bureaucrat’s analysis of “academic impact”.

Also published at ft.com.

Don’t fear the migrant

Should we seek to keep the citizens of poor nations trapped in their countries of birth for the good of their fellow citizens?

I have been mourning the loss of a dear family friend: a doctor, trained in West Bengal, who then emigrated to Birmingham and worked all her life in Britain. She died, surrounded by her family, back in Kolkata. The choices she made would probably have been impossible today: the National Health Service now has a code of practice banning recruitment from around 150 developing countries – almost all of them. It also bans recruitment from West Bengal.

It is sad that in all the fuss about immigration, few commentators take the viewpoint of the emigrant, although every immigrant is also an emigrant. (Even in the scholarly economics literature the word “immigration” is four times as frequent as the word “emigration”.) The reason is obvious enough: we view migration by considering what we have to gain, rather than what the migrants might gain.

What the migrants might gain is, of course, a great deal. Migrants receive far higher wages than they would back home. It is possible that migrants are particularly energetic people who would have earned well anywhere – but this effect is probably not the main explanation for the gap between wages at home and abroad. Economists who have studied situations where the right to migrate is assigned by lottery have found little difference between the wages of those who lose the lottery and those who do not apply.

A recent survey by the economist Michael Clemens, of the Center for Global Development, points out that although the question is largely ignored, any reasonable estimate of the economic gains from freer migration would dwarf that of the gains from, say, freer trade – if we include the welfare of the migrants themselves. Clemens points out that allowing some migration from disaster-hit countries such as Haiti or Somalia would be a far more effective way to alleviate poverty than many conventional aid programs.

Clemens has, alas, attracted the attention of white supremacists, but even people with impeccable bleeding-heart-liberal credentials worry about emigration because of the “brain drain” – the harm assumed to be done to poor countries as their doctors, engineers and entrepreneurs abandon them for cushy careers in the west. It is for this reason that the NHS has its recruitment ban.

I am not convinced. Should we seek to keep the citizens of poor nations trapped in their countries of birth for the good of their fellow citizens? Nobody would, for a moment, consider banning ambitious Mancunians or Glaswegians from working in London, purely on the principle that they might do more good in their back home. Outrageous infringements of liberty seem to be acceptable only when applied to foreigners. (Another analogy, inspired by Clemens: would we happily discuss working mothers under the heading of “the love drain”? I hope not.)

The real effects of the brain drain have also been poorly thought through by most of us. The economist Oded Stark points out that if western countries assiduously recruit doctors and engineers from poor countries on comparatively vast salaries, that is a strong incentive to train as a doctor or engineer. The result may be more doctors and engineers in poor countries, even after the migrants have left. And there is some evidence that this is indeed the case. (Robert Guest, the author of a forthcoming book on international migration, points out more nurses leave the Philippines each year than any other country, and yet the Philippines retain more nurses per head than Austria.)

The striking conclusion of Michael Clemens’s research paper is that we know far too little about the effects of emigration. In particular, we have little idea how much emigration is socially, politically and economically possible. But I strongly suspect our fear of the immigrant is hugely overblown. My friend did not just put a few extra pounds in her pocket by moving to the UK: she enriched the lives of her many British friends. We shall miss her.

Also published at ft.com.

Look out for No. 1

In the late 1990s, eurozone wannabes squeezed and stretched to meet the criteria for accession, including low inflation and government deficits, and moderate levels of debt. The criteria were somewhat irksome, especially for an economy such as Greece, but nevertheless the Greeks seemed to comply.

Eventually, it became clear that the Greek numbers did not quite add up. Eurostat, the European statistics agency, has complained about “widespread misreporting of deficit and debt data” from the Greek authorities. In 2006, eyebrows were raised when Greece’s GDP jumped 25 per cent overnight thanks to a statistical revision that sought to incorporate prostitution and money laundering, among other industries. In late 2009, the incoming prime minister announced that the deficit was more like 12.5 per cent of GDP than 3.7 per cent.

Had its economic statistics been more rigorously reported, it seems unlikely that Greece would have made it into the eurozone. But could the anomalies have been spotted at the time? Perhaps so.

I’ve written about Benford’s Law before: it’s a statistical regularity that often occurs in “real” data but not in manipulated numbers. Now four researchers have published a paper using Benford’s Law to examine Greek macroeconomic data. (Perhaps the origin of the paper should not be a surprise: it’s by Bernhard Rauch, Max Göttsche, Gernot Brähler and Stefan Engel, and it’s published in the German Economic Review.)

Benford’s Law was discovered in 1881 by the astronomer Simon Newcomb, and then again by Frank Benford, a physicist at General Electric, in 1938. The law is a curious one: it predicts the frequency of the first digits of a collection of numbers. For example, measure the lengths of the world’s rivers, and see how many of the digits begin with “one” (184 miles; 1,543 miles) versus “three” (3,022 miles) or “nine” (985 miles). Newcomb and Benford discovered that the first digit is usually a “one” – fully 30 per cent of the time, over six times more common than an initial “nine”. And the result is true whether one counts the numbers on the front page of The New York Times or leafs through baseball statistics.

Nobody seems sure why so much data has the Benford distribution. We do know that exponential growth produces it. To move from a GDP of one billion Flainian Pobble Beads (a unit of currency in The Hitchhiker’s Guide to the Galaxy) to two billion Flainian Pobble Beads requires cumulative growth of 100 per cent, which will take a while. But to move from a GDP of 9 billion to 10 billion Flainian Pobble Beads requires only 10 per cent growth. Benford distributions are, uniquely, scale-invariant – in other words, if one measures GDP in dollars instead of Pobble Beads, the Benford property remains.

Manipulated data often fail to satisfy Benford’s Law. A manager who must submit receipts for expenses over £20 may end up filing claims for lots of £18 and £19 expenses – and the data will then contain too many ones, eights and nines. A forensic accountant can easily check this, and while not an infallible check (fraudster Bernard Madoff filed Benford-compatible monthly returns), it’s an indicator of possible trouble.

Which brings us back to the data Greece submitted to the European statistics agency. According to Rauch and his colleagues, Greek data are further from the Benford distribution than that of any other European Union member state. Romania, Latvia and Belgium also have abnormally distributed data, while Portugal, Italy and Spain have a clean bill of health.

Would a Benford-style analysis have helped spot Greece’s problems? In principle, yes. In practice, one wonders whether politics would have trumped statistics. A shame: according to Benford’s Law, Greece’s data were particularly odd in 2000, just before it joined the euro.

Also published at ft.com.