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

Let’s be blunt: criticism works

‘If Amazon encourages its staff to be straight with each other about what should be fixed, so much the better’

Last month’s Amazon exposé in The New York Times evidently touched a white-collar nerve. Jodi Kantor and David Streitfeld described what might euphemistically be called an “intense” culture at Amazon’s headquarters in a feature article that promptly became the most commented-on story in the newspaper’s website’s history. As Kantor and Streitfeld told it, Amazon reduces grown men to tears and comes down hard on staff whose performance is compromised by distractions such as stillborn children, dying parents or simply having a family. Not for the first time, The Onion was 15 years ahead of the story with a December 2000 headline that bleakly satirised a certain management style: “There’s No ‘My Kid Has Cancer’ In Team.”

Mixed in with the grim anecdotes was a tale of a bracingly honest culture of criticism and self-criticism. (Rival firms, we are told, have been hiring Amazon workers after they’ve quit in exasperation, but are worried that these new hires may have become such aggressive “Amholes” that they won’t fit in anywhere else.)

At Amazon, performance reviews seem alarmingly blunt. One worker’s boss reeled off a litany of unachieved goals and inadequate skills. As the stunned recipient steeled himself to be fired, he was astonished when his superior announced, “Congratulations, you’re being promoted,” and gave him a hug.

It is important to distinguish between a lack of compassion and a lack of tact. It’s astonishing how often we pass up the chance to give or receive useful advice. If Amazon encourages its staff to be straight with each other about what should be fixed, so much the better.

We call workplace comments “feedback”. This is an ironic word to borrow from engineering, because while feedback in a physical system is automatic, with a clear link between cause and effect, feedback in a corporate environment is fraught with emotion and there is rarely a clear link between what was done and what is said about it.

The story of the Amazon worker who thought he was about to be fired is instructive. A list of goals not yet accomplished and skills that need improving is actually useful. Yet we’re so accustomed to receiving uninformative compliments — well done, good job — that a specific list sounds like grounds for dismissal.

Consider the contrast between a corporate manager and a sports coach. The manager usually wants to placate workers and avoid awkward confrontations. As a result, comments will be pleasant but too woolly to be of much use. The sports coach is likely to be far more specific: maintain lane discipline; straighten your wrist; do fewer repetitions with heavier weights. Being positive or negative is beside the point. What matters is concrete advice about how to do better.

A similar problem besets meetings. On the surface these group discussions aim at reaching a good decision but people may care more about getting along. People who like each other may find it harder to have sensible conversations about hard topics.

In the mid-1990s, Brooke Harrington, a sociologist, made a study of Californian investment clubs, where people joined together to research possible stock-market investments, debate their merits and invest as a collective enterprise. (The results were published in a book, Pop Finance.) Harrington found a striking distinction between clubs that brought together friends and those with no such social ties.

The clubs made up of strangers made much better investment decisions and, as a fly on the wall, Harrington could see why. These clubs had open disagreements about which investments to make; tough decisions were put to a vote; people who did shoddy research were called on it. All rather Amazonian. The friendlier clubs had a very different dynamic, because here people were more concerned with staying friends than with making good investments. Making good decisions often requires social awkwardness. People who are confused must be corrected. People who are free-riding must be criticised. Disagreements must be hashed out. The friendly groups often simply postponed hard decisions or passed over good opportunities because they would require someone to say out loud that someone else was wrong.

None of this should be a blanket defence of Amazon’s workplace culture — which if the New York Times exposé is to be believed, sounds dreadful. Nor does it excuse being rude. But the problem is that honest criticism is so rare that it is often misinterpreted as rudeness.

In some contexts, letting politeness trump criticism can be fatal. From the operating theatre to the aeroplane cockpit, skilled professionals are being taught techniques such as “graded assertiveness” — or how to gently but firmly make your boss realise he is about to kill someone by mistake.

Scientists have wrestled with a similar challenge. As the great statistician Ronald Fisher once drily commented, “A scientific career is peculiar . . . its raison d’être is the increase of natural knowledge. Occasionally, therefore, an increase of natural knowledge occurs. But this is tactless, and feelings are hurt . . . it is inevitable that views previously expounded are shown to be either obsolete or false . . . some undoubtedly take it hard.”

Nobody likes to be told that they are wrong. But if there’s one thing worse than someone telling you that you are wrong, it’s no one telling you that you are wrong.

Written for and first published at ft.com.

Undercover Economist

Meet the Flop Pickers

‘If savvy consumers can help predict a product’s success, might there not be consumers whose clammy embrace spells its death?’

Spare a thought for the poor darlings who run your typical transnational, fast-moving, consumer goods company. They invest millions launching an exciting new product (Colgate ready meals, say, or Cosmopolitan brand yoghurt. Or Crystal Pepsi: it sounded like a Class A drug, it looked like water and it tasted pretty much like any other kind of Pepsi. How could it fail?) They give the product to focus groups, who like it. They trial it in a few select stores, and it sells well. Their retail partners are convinced. Then the product is launched to global fanfare, and the ungrateful customers refuse to buy it.

It is no secret that many new products fail. Naturally, companies are on the lookout for ways to identify failures earlier in the process, before they have sunk too much time and money into a product that will eventually collapse. If you’re going to flop, it’s better if you can do it quietly in the changing rooms rather than from the highest diving board with camera bulbs flashing.

Back in the mid-1980s, Eric von Hippel, a management professor, suggested working with what he called “lead” customers — people with more advanced or specialised needs whose demands might predict where the market could be heading. Today’s military technology is tomorrow’s household appliance; today’s professional imaging software is tomorrow’s smartphone app. In the innovative industries that interested von Hippel, paying attention to lead customers would produce great ideas for the mass market.

In more everyday sectors, lead customers might instead be fashionistas whose choices were copied by others. Or lead customers might simply be cutting-edge consumers of music, or coffee, or gluten-free cakes, who are always one step ahead of where the herd is already going. In any case, the strategy for a business is clear: identify these lead customers if you can, and pay attention to what they do and say.

Von Hippel and co-authors wrote in the Harvard Business Review in 1999 that “all processes designed to generate ideas for products begin with information collected from users. What separates companies is the kind of information they collect and from whom they collect it”.

What they meant was that companies should consider the ideas of lead customers, rather than gathering a group of John and Jane Does and showing them a product prototype. But lead customers aren’t the only unusual people who might be worth paying attention to.

If savvy influential consumers can help predict a product’s success, might it not be that there are consumers whose clammy embrace spells death for a product? It’s a counter-intuitive idea at first but, on further reflection, there’s a touch of genius about it.

Let’s say that some chap — let’s call him “Herb Inger” — simply adored Clairol’s Touch of Yogurt shampoo. He couldn’t get enough of Frito-Lay’s lemonade (nothing says “thirst-quenching” like salty potato chips, after all). He snapped up Bic’s range of disposable underpants. Knowing this, you get hold of Herb and you let him try out your new product, a zesty Cayenne Pepper eyewash. He loves it. Now you know all you need to know. The product is doomed, and you can quietly kill it while it is still small enough to drown in your bathtub.

A cute idea in theory — does it work in practice? Apparently so. Management professors Eric Anderson, Song Lin, Duncan Simester and Catherine Tucker have studied people, such as Herb, whom they call “Harbingers of Failure”. (Their paper by that name is forthcoming in the Journal of Marketing Research.) They used a data set from a chain of more than 100 convenience stores. The data covered more than 100,000 customers with loyalty cards, more than 10 million transactions and nearly 10,000 new products. Forty per cent of those products were no longer stocked after three years, and were defined as “flops”.

. . .

The harbinger customers are those who buy lots of flops and, in particular, those who buy flops and then go back for more, repeatedly buying the same unpopular product. It turns out that having identified these flop-loving customers, you can get a good idea of future failures by watching whatever they buy next. This is interesting: in principle there’s no reason why a customer who loves an unpopular flavour of soft drink would be more likely to also love an unpopular brand of shampoo.

In practice, however, the data show a class of people with an eclectic taste in products that others dislike.

Anderson and his colleagues reckon that their results are robust within the particular context of the convenience store data. Whether the technique could also be used for films and books, or computers and tablets, remains to be seen. But it’s already a good example of the kind of patterns that emerge from much larger and more detailed data sets than ones traditionally available to social scientists.

A final question is whether you can spot Harbingers of Failure without access to their shopping habits, purely from demographic information. The answer seems to be no. Harbingers of Failure are much like the rest of us. The only difference is that they love the products that we hate.

Written for and first published at ft.com.

Undercover Economist

When it comes to banking, can we have too much of a good thing?

In 1980, the econometrician David Hendry (now Sir David) investigated a key economic question: what causes inflation? Hendry looked to the data for insight. He speculated that a particular variable, X, was largely responsible. He assembled data on variable X, performed a few deft mathematical tweaks and compared his transformed X with the path of consumer prices in the UK. Graphing the result showed an astonishingly close fit.
The only snag: X was cumulative rainfall. Since consumer prices and cumulative rainfall both rise over time, Hendry had an excellent platform for finding his spurious correlation. Statistical sleight of hand did the rest.
Hendry wanted to demonstrate just how easy it was to produce plausible nonsense by misusing the tools of statistics. “It is meaningless to talk about ‘confirming’ theories when spurious results are so easily obtained,” he wrote.
All this is by way of preamble, because a hot topic in economics at the moment is the role of finance in the health of the economy. For many years, economists have tended to believe that a larger financial sector tends to be good news for economic growth, with statistical evidence to back this up.
It won’t surprise anyone to hear that this belief is now viewed with some scepticism, and the statistical studies now back up the scepticism too. Several recent research papers have found that finance can be bad for economic growth.
Given this statistical volte-face, Hendry’s conjuring trick comes to mind. Are our statistical studies simply serving as decoration for our existing prejudices?
A recent note by William Cline of the Peterson Institute for International Economics worries that new anti-finance research rests on a statistical illusion. Rich countries tend to grow more slowly than poorer ones. But rich countries also have larger banking sectors. A naive analysis, then, would show that large banking sectors are correlated with slower growth. But, points out Cline, the same statistical methods show that doctors are bad for growth and that telephones are bad for growth and even that research and development technicians are bad for growth. In reality, all that is being shown is that being rich already is bad for further growth.
Cline makes a good point but a narrow one. It’s not particularly helpful to analyse banking like salt in cooking or water on your vegetable patch, and conclude that “some is good, too much is bad”. Unlike salt and water, banking services are complex and diverse. There’s a difference between a mortgage, a payday loan, life insurance, a credit derivative, a venture capital investment and an equity tracker fund. They’re all financial services, though.
More persuasive analyses of the relationship between finance and growth are asking not just whether finance can grow too big to be helpful but what kind of finance, and why.
In two working papers for DNB, the Dutch central bank, Christiane Kneer explores the idea that the trouble with banking is that it sucks talent away from the rest of the economy. Kneer looked at the process of banking deregulation state by state in the US and found that banks hired skilled individuals away from manufacturing, where labour productivity fell. If Kneer is right, too much finance is bad for growth because the banks are gobbling up too many of the smartest workers.
Another possibility, explored by economists Stephen Cecchetti and Enisse Kharroubi, is that large banking sectors aren’t doing their classic textbook job of funding the most productive investments. Instead, they like to lend money to organisations that already have collateral. Mortgages make attractive loans for this reason. Loans to a business that already owns an office block or an oil refinery are also tempting. But lending to a business with more intangible assets, such as an R&D department or a set of strong consumer relationships, is less attractive. Perhaps it is no surprise when Cecchetti and Kharroubi find that larger banking sectors are correlated with slower growth in R&D-intensive parts of the economy. But it is not encouraging.
. . .
Such research reminds us that we shouldn’t simply bash “banking” or “finance” in some generic way, blaming the banks for anything from the weather to the struggles of bees. We need to look at the details of what the financial services industry is doing, and whether financial regulations are protecting society or making things worse.
The truth is that we desperately need a strong banking sector. This entire research literature on finance and growth was originally kicked off by development economists who had observed that poor countries struggled to develop if they didn’t have decent banks. Thorsten Beck, an economist at Cass Business School, first started studying the effects of finance when he worked at the World Bank. “I didn’t care about the UK or the Netherlands. I cared about Kenya, Chile and Brazil.”
Without a strong and sizeable banking sector to lend money to businesses, it is very hard for a poor country to grow. It may well be that we have more finance sloshing around the economy than we can use. That is a big problem — but it is also a first-world problem.

Undercover Economist

London’s turning . . . 

‘London’s excruciating price tag is not just a vulnerability but also a sign of success’

What is happening to London? Is the city devouring itself, its street life disappearing as flat-pack apartment blocks metastasise in once-healthy neighbourhoods? Or are we simply witnessing a process of regeneration and renewal? Rohan Silva, a former adviser to David Cameron, recently told architecture magazine Dezeen that London might lose its creative class because of high rents. In The Observer, Rowan Moore wrote that London “was suffering a form of entropy whereby anything distinctive is converted into property value”.

It is natural that journalists find this an urgent topic: surely the gap between the price of a typical London house and the salary of a typical London journalist has never been higher. But the topic is genuinely puzzling, because London’s excruciating price tag is not just a vulnerability but also a sign of success. It is hard to see how the city can be written off when so many people are willing to pay such extraordinary sums to live there.

It’s worth dismissing some disaster scenarios. Many people fret that the infamous apartments of One Hyde Park stand for the future of London: joyless, unaffordable and empty most of the time. But London is not going to become a gigantic holiday park full of second homes for billionaires — there simply aren’t enough billionaires out there to turn a city of more than eight million souls into the equivalent of a weekend hideaway in Cornwall.

Another concern is that international investors will snap up new-build apartments as investments, then leave them empty. But rental property is a much better investment when one actually rents it out, so this makes sense only if one accepts that most international investors are insane.

Nor has London abandoned its social housing sector either — not yet. About a quarter of London’s households live in social rented housing, and many more than that in inner London. The prevalence of social housing has been falling since the 1980s — but slowly. Social housing is still on offer to almost a million households.

The vision of London as a ghost town can be disproved in an instant by the experience of actually being in London. Try to get on the Tube at Clapham Common at 8am, then tell me that London’s problem is underpopulation.

“London’s population is going up,” says Professor Christine Whitehead of the London School of Economics. “And there’s no indication that the new population is the wrong mix.”

“Mix” is an important word here. More than 50 years ago, in The Death and Life of Great American Cities, Jane Jacobs emphasised the merits of variety in city life. If a neighbourhood had a mix of homes, offices, factories, shops and nightlife, then the streets would be interesting, well used and, therefore, safe for many hours a day. More rigorous zoning might look tidy on a city map but would leave streets (and shops) unusably overcrowded at some times and deadly boring at others. Tedious and perhaps dangerous, such a neighbourhood would be fragile. Jacobs also advocated a mix of different industries so that ideas could spread from one to another. Her most famous example was Ida Rosenthal’s invention of the bra after working not in lingerie but in dressmaking.

Fundamental to all this, wrote Jacobs, was a mix of old and new buildings. Leaving aside unusual cases such as Venice, cities need a mix of higher-rent buildings and more decrepit low-rent buildings, because such buildings house different kinds of activity. Experimental projects, in particular, need somewhere cheap — the Silicon Valley garage, perhaps, or the east London warehouse. “Old ideas can sometimes use new buildings,” Jacobs wrote. “New ideas must use old buildings.”

This is London’s challenge: if only hedge-fund millionaires can afford to live there, then even the hedge-fund millionaires will not wish to. Artists, start-up hopefuls and hipster baristas need not only low-rent places to live but low-rent places to work. If London loses such places, then it will indeed lose its creative edge.

Still, London does not yet seem to be short of hipster baristas. Whitehead says: “I’ve heard that argument once a decade for the past 50 years.” It may yet come true — but so far, so good.

The trouble with creative destruction is that it is always easier to see what is being lost than what is being gained. Notting Hill seems pretty dull to me these days but Clapton Pond is on fine form: brothels have been replaced by bars; murderous dives have been replaced by gastropubs; fried-chicken joints have been replaced by coffee shops. The mix is changing but it’s still a mix, and it’s not obvious that the new mix is disastrous.

What would be disastrous would be if the lot were bulldozed to make way for apartment blocks in which nobody wanted to live because there was nothing to do outside. We must guard against the encroachment of such residential deserts, yet they remain rare in London. The city is, of course, a playground for the super-rich. But, for now, it remains much more than that.

Written for and first published at ft.com.

Undercover Economist

How to level the playing field

‘It costs something like a billion quid to turn a bottom-half Premier League club into one of the best teams in Europe’

They have dominated their national football league, winning 17 times in the past 50 years, far more than any rival. Indeed, only 10 other teams have managed to win the league at all since 1965. Can you guess the club?

You might be thinking Real Madrid — but no, Real have won 21 times in the past half century and Barcelona are not so far behind. Juventus would be a better guess — they have won 19 titles in the past 50 years, with rivals AC Milan boasting 10. Manchester United have 14, just ahead of Liverpool with 12.

But no. I am thinking of Havnar Bóltfelag. Affectionately known as HB, they are the Real Madrid of the Faroe Islands. The club is 111 years old — just a couple of years younger than Real — and just as dominant, albeit on a smaller stage. If Havnar Bóltfelag were ever to play Real, the entire population of the Faroe Islands could rattle around inside Real’s Bernabéu stadium with room to spare for some home fans.

The curious thing is that most European football leagues show a similar pattern of dominance. As sports economist Stefan Szymanski explains in his book Money and Football, looking at just the distribution of wins — typically 18-22 for the leading team over the past 50 years, and 11 or 12 champions in total — it is hard to tell the European leagues apart.

There are some exceptions (the French and Irish leagues have been more competitive, and the Scottish and Dutch leagues less so) but the regularity is striking. That might seem surprising given that the average revenue per top-tier club in England, Germany, Spain and Italy is more than $100m, while that in the Faroe Islands and Luxembourg is less than $1m. And, in case you were wondering, Luxembourg fits the pattern perfectly. The Real Madrid of Luxembourg (or should that be the Havnar Bóltfelag of Luxembourg?) is Jeunesse Esch, also just over a century old. It has won 20 titles in the past 50 years.

So what explains this widespread pattern in which one or two teams tend to dominate? Not the cost of fielding 11 players, certainly. As Szymanski points out, there are plenty of football teams around. Running a football club does not demand scale, like a mobile phone network or a nuclear power station. It’s more like running a soft drinks company: anyone can do it at any scale but Coca-Cola somehow manages to be the biggest around. (Coincidentally, Coca-Cola’s global market share is the same as Real Madrid’s share of the past 50 La Liga titles and Pepsi’s is the same as Barcelona’s.)

Here is a hypothetical question that might shed some light: why don’t Havnar Bóltfelag borrow some money and hire superstars such as Lionel Messi and Cristiano Ronaldo? Let’s assume that a sufficiently gullible bank could be found — the nearest banking centres, Reykjavik and Edinburgh, suggest that anything is possible.

The answer is that Havnar Bóltfelag is not the best place to showcase the talents of the world’s most expensive players. Partly this is a question of geography. But partly HB’s problem is its reputation: it doesn’t have one. Until the club had more name recognition, good players would be reluctant to join, and would have to be given extra financial incentives. Sponsors would feel the same. And while football spectators do like to watch big names playing attractive football, they are also loyal to their old clubs. Even if Real Madrid and Barcelona were somehow to become feeder clubs for Havnar Bóltfelag, it would take a while for their support to ebb and HB’s to grow.

Now apply the same logic to smaller clubs in large leagues, and the reason for big club dominance starts to become clear. Clubs such as Rayo Vallecano in Madrid or West Ham in London face no geographical handicap in challenging Real Madrid or Chelsea. But they would have to pay over the odds to attract players, staff and fans while simultaneously earning less from advertisers and global TV rights.

It is possible to bridge this brand-name gap if you are willing to lose enough money. “It costs something like a billion quid to turn a club from a bottom-half Premier League team to one of the best teams in Europe,” says Szymanski. Manchester City, Chelsea and Paris Saint-Germain have been transformed into top-flight clubs. They are all now in a position to make money — or at least, to lose no more money than any other top club — but nobody expects their owners to recoup the cost of that transition, at least not through the business of football.

The clubs with a large fan base, long history and global name recognition are the clubs with the most to gain from spending a lot trying to win football matches. For anyone else to challenge them requires very deep pockets. That is why winners keep winning.

But should we care about this sporting dominance? Szymanski points out that European football with its lopsided leagues has far outgrown American sports, which are carefully engineered to ensure competitive balance. Apparently, the global army of fans of Real Madrid, Manchester United and Bayern Munich don’t mind if they win a lot.

Written for and first published at ft.com.

Undercover Economist

Worming our way to the truth

‘Why does such a large policy push need to be based on a handful of clinical trials?’

It was one of the most influential economics studies to have been published in the past 20 years, with a simple title, “Worms”. Now, its findings are being questioned in an exchange that somehow manages to be encouraging and frustrating all at once. Development economics is growing up, and getting acne.

The authors of “Worms”, economists Edward Miguel and Michael Kremer, studied a deworming project in an area of western Kenya where parasitic intestinal worms were a serious problem in 1998. The project was a “cluster randomisation”, meaning that the treatment for worms was randomised between entire schools rather than between children within each school.

Miguel and Kremer concluded three things from the randomised trial. First, deworming treatments produced not just health benefits but educational ones, because healthier children were able to attend school and flourish while in class. Second, the treatments were cracking value for money. Third, there were useful spillovers: when a school full of children was treated for worms, the parasites became less prevalent, so infection rates in nearby schools also fell.

The “Worms” study was influential in two very different ways. Activists began to campaign for wider use of deworming treatments, with some success. Development economists drew a separate lesson: that running randomised trials was an excellent way to figure out what worked.

In this, they were following in the footsteps of epidemiologists. Yet it is the epidemiologists who are now asking the awkward questions. Alexander Aiken and three colleagues from the London School of Hygiene and Tropical Medicine have just published a pair of articles in the International Journal of Epidemiology that examine the “Worms” experiment, test it for robustness and find it wanting.

Their first article follows the original methodology closely and uncovers some programming errors. Most are trivial but one of them calls into question the key claim that deworming produces spillover benefits. Their second article uses epidemiological methods rather than the statistical techniques preferred by economists. It raises the concern that the central “Worms” findings may be something of a fluke.

Everyone agrees that there were some errors in the original paper; such errors aren’t uncommon. There’s agreement, too, that it’s very useful to go back and check classic study results. All sides of the debate praise each other for being open and collegial with their work.

But on the key questions, there is little common ground. Miguel and Kremer stoutly defend their findings, arguing that the epidemiologists have gone through extraordinary statistical contortions to make the results disappear. Other development economists support them. After reviewing the controversy, Berk Ozler of the World Bank says: “I find the findings of the original study more robust than I did before.”

Yet epidemiologists are uneasy. The respected Cochrane Collaboration, an independent network of health researchers, has published a review of deworming evidence, which concludes that many deworming studies are of poor quality and produce rather weak evidence of benefits.

What explains this difference of views? Partly this is a clash of academic best practices. Consider the treatment of spillover effects. To Miguel and Kremer, these were the whole point of the cluster study. Aiken, however, says that an epidemiologist is trained to think of such effects as “contamination” — an undesirable source of statistical noise. Miguel believes this may explain some of the disagreement. The epidemiologists fret about the statistical headaches the spillovers cause, while the economists are enthused by the prospect that these spillovers will help improve childhood health and education.

Another cultural difference is this: epidemiologists have long been able to run rigorous trials but, with big money sometimes at stake, they have had to defend the integrity of those trials against the possibility of bias. They place a high value on double-blind methodologies, where neither subjects nor researchers know who has received the treatment and who is in the control group.

Economists, by contrast, are used to having to make the best of noisier data. Consider a century-old intervention, when John D Rockefeller funded a programme of hookworm eradication county by county across the American south. A few years ago, the economist Hoyt Bleakley teased apart census data from the early 20th century to show that this programme had led to big gains in schooling and in income. To an economist, that is clever work. To an epidemiologist, it’s a curiosity and of limited scientific value.

As you might expect, my sympathies lie with the economists. I suspect that the effects that Miguel and Kremer found are quite real, even if their methods do not quite match the customs of epidemiologists. But the bigger question is why so large a policy push needs to be based on a handful of clinical trials. It is absolutely right that we check existing work to see if it stands up to scrutiny but more useful still is to run more trials, producing more information about how, where and why deworming treatments work or do not work.

This debate is a sign that development policy wonks are now serious about rigorous evidence. That’s good news. Better news will be when there are so many strong studies that none of them will be indispensable, and nobody will need to care much about what exactly happened in western Kenya in 1998.

Written for and first published at ft.com.

Undercover Economist

The rewards for working hard are too big for Keynes’s vision

The economist was right in that we are better off but at the cost of our free time

Working long hours pays off in monetary terms, but it means there is less time for pursuits

If John Maynard Keynes is looking down upon me now — he might make a good guardian angel for economists — then he is wondering why I am writing this column instead of lounging by the pool.

“Three hours a day is quite enough,” he pronounced in his 1930 essay Economic Possibilities for our Grandchildren. The essay offers two famous speculations: that people in 2030 will be eight times better off than people in 1930; and that as a result we will all be working 15-hour weeks and wondering how to fill our time.

Keynes was half right. Barring some catastrophe in the next 15 years, his rosy-seeming forecasts of global growth will be an underestimate. The three-hour workday, however, remains elusive. (Keynes was childless, but NPR’s Planet Money show recently tracked down his sister’s grandchildren and asked them if they were working just 15 hours a week. They were not.)

So where did Keynes go wrong? Two answers immediately spring to mind — one noble, and one less so. The noble answer is that we rather like some kinds of work. We enjoy spending time with our colleagues, intellectual stimulation or the feeling of a job well done. The ignoble answer is that we work hard because there is no end to our desire to outspend each other.

Keynes considered both of these possibilities, but perhaps he did not take them seriously enough. He would not have been able to anticipate more recent research suggesting that the experience of being unemployed is miserable out of all proportion to its direct effect on income.

Perhaps Keynes also failed to appreciate that there is more to keeping up with the Joneses than conspicuous consumption. We want to live in pleasant areas with good schools and easy access to dynamic employers. As a result, we find ourselves in ferocious competition for a limited supply of desirable houses.

There are subtler explanations for Keynes’s error. As the late Gary Becker observed in an essay with Luis Rayo, Keynes may have been led astray by contemplating the leisured elite of the 1920s. The income flowing to the “1 per cent” was not much different back then, but they owned much more of the wealth. A gentleman in 1920s Bloomsbury drawing income from capital was just as wealthy as a partner at a 21st-century New York law firm billing at a vast hourly rate. Yet it is no mystery that the gentleman spent his time at the club while the lawyer is working her socks off.

A few years ago, the economists Mark Aguiar and Erik Hurst published a survey of how American work and leisure had evolved between 1965 and 2005. Both men and women had more leisure time — although nothing like as much as Keynes had expected. But some people defied this trend. The best educated and the highest earners, both men and women, had less free time than ever. Starting in the mid 1980s, this elite began to drop everything and work ­furiously.

Perhaps the real story, then, is that we are trying to keep up not with the Joneses but with our work colleagues. By pulling the longest hours and taking the least leave, we climb the corporate ladder. It may be no coincidence that the collapse in leisure time began in the 1980s, at a time when inequality at the top of that ladder was surging. The rewards for working hardest are large.

We are still 15 years away from the world that Keynes imagined. If we are to live up to his laid-back expectations, much will have to change. We’ll need plentiful access to nice schools and neighbourhoods, and less of a rat-race culture in the office.

That sounds welcome. But perhaps the fundamental truth is that many of us enjoy working hard on something that feels worthwhile, or aspire to such work. John Maynard Keynes was a wealthy man, but that did not stop him working himself to death.

Written for and first published at ft.com.

Undercover Economist

It’s tough turning ideas into gold

‘If innovators make no money at all, they will end up creating for the love of creation rather than for any financial reward’

Alchemy, the ancient art of turning base metals into precious ones, was built on more than one misapprehension. The obvious error is that it is impossible to turn lead into gold. (Not quite impossible, actually. Chemistry will not do the job but a particle accelerator will, although not cheaply. In 1980, researchers bombarded the faintly lead-like metal bismuth and created a few atoms of gold. The cost was a less-than-economical rate of one quadrillion dollars an ounce.)

But there is a subtler mistake — not a scientific one but a matter of economics. “The alchemist fallacy” is the belief that once a simple method is found for turning lead into gold, gold will continue to be precious. We don’t have to rely on economic theory to refute this conclusion, because we have a fascinating case study of a close parallel.

Twenty-six million years ago, some cataclysmic event in the Eastern Sahara raised the temperature of silica sand to well over 1,000 degrees. The result was a large deposit of a lustrous material the colour of a lemon’s flesh. A fragment of this precious stuff was used to make jewellery for Tutankhamun’s tomb. (The story is well told in Steven Johnson’s book How We Got to Now.) The substance could be quarried but not manufactured.

While alchemists never figured out how to turn lead into gold, other craftsmen did develop a process with much the same economic implications. They worked out how to transform silica sand, one of the most common materials on earth, into the beautiful, versatile material we know as glass. It has an astonishing variety of uses from fibre optics to microscopes to aeroplane fuselages. But while gold remains highly prized, glass is now so cheap that we use it as disposable packaging for water.

When it was possible to restrict access to the secret of glassmaking, the guardians of that knowledge profited. Venetian glassmakers were clustered together on the island of Murano, where sparks from the furnaces would not endanger Venice itself. Venice had less success in preventing the secrets of glassmaking from spreading. Despite being forbidden on pain of death to leave the state of Venice, some of Murano’s glassmakers sought fortunes elsewhere. The wealth that could be earned as a glassmaking monopolist in some distant city must have been worth the risk.

That is the way of new ideas: they have a tendency to spread. Business partners will fall out and set up as rivals. Employees will leave to establish their own businesses. Time-honoured techniques such as industrial espionage or reverse engineering will be deployed. Sometimes innovators are happy to give their ideas away for nothing, whether for noble reasons or commercial ones. But it is very hard to stop ideas spreading entirely.

A few years ago, the economist William Nordhaus tried to estimate just how fallacious the alchemist fallacy is — how much of the social gains from innovation does the innovator manage to keep hold of? If the answer is anywhere near 100 per cent — even 50 per cent — then there is no fallacy at all. But if the answer is near zero, then innovations are swiftly copied, benefiting competitors and above all consumers.

Nordhaus was writing in the wake of the dotcom bubble, and pointed out that the valuations of “new economy” companies could be justified only if they were able to retain about 90 per cent of their value to society. This is a slice of the pie to make the most powerful and sophisticated monopolist dream. Nordhaus, pointing to the rapid demise of many dotcom firms and the tight margins of others, reckoned that the proportion was rather lower than that.

Looking at data from the United States between 1948 and 2001, Nordhaus estimated that corporations were able to keep about 3.7 per cent of the social value of their innovations. The remaining 96.3 per cent went to everyone else, mostly to consumers.

Nordhaus’s estimate is uncertain but has the ring of truth about it. Even a company such as Apple, which has a gift for holding on to a good proportion of the returns from innovation, has seen its iPad, iPhone and MacBook Air relentlessly chased down by competitors.

All this raises a question: should we wish that the innovator’s profit share was higher or lower? There is a balance to be struck. When innovators keep too much money, the benefit of using or recombining new ideas spreads too slowly. But if innovators make no money at all, then they will end up creating for the love of creation rather than for any financial reward. That may be fine for pop songs and poetry but less so for nuclear fusion or an HIV vaccine. Costly research programmes will not be funded.

The right balance depends on the innovation in question, and how expensive it is to develop. We probably need better incentives to create some new medicines. Yet our intellectual property system gives too much protection to ideas that would have been created anyway, such as simple software, business methods and Mickey Mouse. It is no surprise that the Venetian doges tried to keep the glassmakers in Murano. We should be grateful that they failed.

Written for and first published at ft.com.

Undercover Economist

Why wishful thinking doesn’t work

‘Careless nudges are no more welcome in public policy than at a domino-toppling event’

Three years ago, the University of Vermont in Burlington began to experiment with a few nudges towards a healthy, sustainable lifestyle. First, in 2012, campus outlets and the company operating the vending machines were required to make sure that at least 30 per cent of the drinks on offer were wholesome stuff such as vegetable juice, low-fat milk and water. A few months later, selling bottled water on campus was banned outright. The aim, pushed hard by student campaigners, was to encourage students to fill reusable bottles with tap water instead.

So, how did the Vermont experiment go? A study by Elizabeth Berman and Rachel Johnson (of the University’s own Department of Nutrition and Food Sciences) was recently published in the American Journal of Public Health. The researchers found that “per capita shipments of bottles, calories, sugars and added sugars increased significantly when bottled water was removed . . . As bottled water sales dropped to zero, sales of sugar-free beverages and sugar-sweetened beverages increased.”

In other words, the policy backfired with both barrels. Students didn’t switch to tap water, they switched to the likes of Coke and Diet Coke instead. All this would be just an amusing curiosity — one more example of student campaigners who are all heart and no brains — if it weren’t for the fact that more mature policy makers often commit similar blunders on much broader canvases. We would do well to learn some lessons from the University of Vermont’s experience.

The first lesson is that when it comes to saving the planet, people focus on what they can see. Type “environmental impact of concrete” into a search engine and you are likely to see a page filled with scholarly analysis pointing out that the impact is very large indeed, because cement production releases vast volumes of carbon dioxide. Type “environmental impact of bottled water” instead and your search results will be packed with campaigning groups seeking to persuade you to change your ways.

This is understandable: I can’t do much about concrete but I can stop drinking bottled water. But being a logical target for campaigners is not the same as being a logical target for policy action.

The second lesson is that we often struggle to deal with multiple goals. The University of Vermont wanted to reduce the flow of plastic water bottles to landfill but also wanted to encourage students to be healthy. There’s a clear conflict between these goals. Water is as healthy a drink as you can find, yet that was exactly what the University of Vermont was banning from vending machines. Wishful thinking provides a resolution — if everyone just drank tap water then there would be no problem. But wishful thinking is not an excuse for setting no priorities.

We see this sharply in the debate over nuclear power. We want to reduce the greenhouse gas emissions that result from burning fossil fuels. We also want to avoid radioactive waste and the risk of radiation leaks. In response to a genuine policy dilemma, politicians have tended to plump for wishful thinking every time, typically involving wind turbines.

The third lesson is that the much-vaunted notion of “nudging” doesn’t always help navigate a complicated policy maze. Nudging means using default options, information design and similar techniques to achieve policy goals. It can be very successful. But careless nudges are no more welcome in public policy than at a domino-toppling event. If you pick a questionable target (bottled water) and fudge a key policy dilemma (the environment vs health) then nudging isn’t going to solve your problems.

So what can be done? One approach is to try to reach policy goals with the help of market signals. The classic example of this is a carbon tax, levied on fossil fuels to reflect their carbon-dioxide emissions. The advantage of this approach is that it encourages everybody at any stage of production or consumption to take actions that reduce emissions, because those actions will save them money. A truck manufacturer might develop a cleaner engine, a logistics company might find a more efficient delivery algorithm, and the final consumer might decide to consume a little less.

The idea of using the price system to solve environmental problems is widely accepted by economists but, alas, it finds itself stranded in the policy doldrums. Ponder this: the Pope recently argued that climate change was a grave problem but he opposed market-based responses. Meanwhile the US Republican party likes market-based responses but isn’t so convinced about climate change.

One other advantage of using environmental taxes is that people can decide on their own priorities. A lot of what we do has consequences for the planet — including breathing — and so part of the problem we face is deciding what is worth doing anyway.

Perhaps it is time for a confession. I am writing this column on the hottest July day recorded in British history. At my left hand is a glass of chilled sparkling water, and next to the glass is a plastic bottle to top it up. If there had been a tax on that bottle, it is a tax I would willingly have paid.

Written for and first published at ft.com.

Undercover Economist

In search of the perfect match

‘One algorithm had to cope with pairs of romantically attached doctors who wanted two job offers in the same city’

When it comes to finding the perfect match, nobody wants to be left on the shelf but the Arunta — a polygamous aboriginal tribe from the area around Alice Springs — used to take things to extremes. As described by anthropologists in the 1920s, the father of a newborn Arunta boy would get together with the father of a newborn girl to arrange a future marriage. The betrothal was not between the two babies, of course — that would be leaving things far too late. Instead, the engagement was between the baby boy and the first daughter that the baby girl had when she became a mother herself.

This astonishing process is called “market unravelling”, and it is not limited to the Arunta. As described in Alvin Roth’s new book, Who Gets What — and Why, hospitals make early offers to untried junior doctors. Law firms make early offers to law student freshers. Oxford and Cambridge make offers many months before the students in question sit their exams.

This is not a sensible situation because if everybody could agree to wait, then more information would emerge, allowing more compatible matches. Yet there is an incentive to break ranks and make early “exploding” offers. If those time-limited offers are any good, then students will often accept them rather than take the risk of waiting. The logic of the situation pulls these early offers ever earlier, sometimes absurdly so. Everybody loses but no individual can change things.

One response is to agree a rule banning early offers. That is what the US National Association for Law Placement did in the 1980s: it ruled that any job offer made to a first-semester law student had to remain open until the end of that semester. It wasn’t long before the lawyers had found the loophole: mediocre offers paired with massive time-limited signing bonuses.

Another possibility is to use a central clearing house. That is what the Boston school system did. Parents listed at least three schools in order of preference, and the clearing house put every child into their first choice school where possible. Any schools with spare places would then admit students who’d listed the school as second choice, then third choice, and so on. Four out of five students got their first choice, yet parents hated the system. Why?

The problem was that parents had just one shot at a good school. Popular schools filled instantly, making second choices almost irrelevant. Parents who didn’t understand the game might apply for several popular schools and get nothing. Those who understood the problem found themselves second-guessing the clearing house, using their precious first choice on a compromise school rather than the high-risk approach of saying what they truly wanted. The system produced cynical, alienated parents.

The problem is easier to describe than to solve. But there is a way to fix unravelling markets: call Alvin Roth. An engineer by training — albeit one with a Nobel Memorial Prize in economics — Roth designs markets with an engineer’s practical mentality. With his colleagues, Roth has designed stable clearing houses for doctors, fixed the school application systems in Boston and in New York City, and even created kidney donation networks.

At the heart of many well-functioning clearing houses is something called the deferred acceptance algorithm. The algorithm begins with the following input: each student submits a list of their preferred schools, from first choice to last, and each school submits a ranked list of their preferred students. Armed with these rankings, a computer can swiftly handle the rest. First, each school provisionally fills its places with the top students on its list; then each student provisionally accepts the best offer she has received and rejects the others; each school then extends further offers to fill the spaces that these rejections opened up. The process continues (inside the computer) with each student keeping only the best offer received so far, and with each school working down the list of students and making fresh offers as the rejections come in.

There are two important features of the deferred acceptance algorithm. The first is that people can safely tell the truth about their favourite schools — there is no disadvantage to aiming high. The second is that the algorithm’s allocation is stable. There will never be a pair of school and student who wish they were matched to each other but whom the algorithm sent elsewhere. This matters because if such pairs exist, they have an incentive to strike side deals, undermining the whole system.

The deferred acceptance algorithm is just the start of a successful market design, because details matter. In New York City, there are different application procedures for certain specialised schools. When assigning hospital residencies, the US National Resident Matching Program needed to cope with pairs of romantically attached doctors who wanted two job offers in the same city. These complexities sometimes mean there is no perfect matching algorithm, and the challenge is to find a system that is good enough to work.

Economists such as Alvin Roth are like engineers or doctors. They cannot settle for understanding a system in theory; they must solve practical problems too. It’s a hopeful direction for economics — and an essential one, if economists aren’t to be left on the shelf themselves.

Also published at ft.com.

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