Undercover Economist

The not-so-sweet smell of odious debt

A proposal that declares obligations of a particular regime non-transferable frees innocent people from indenture not of their making

“He that dies pays all debts,” says Stephano in The Tempest. Evidently he did not have sovereign debt in mind, which survives the demise of almost any government. Lucas Papademos would not get far with a declaration that, since Greece’s national debt had been accumulated by previous prime ministers, he had no obligation to pay it. That is not the way things are done: each government is liable for the deeds of its predecessors.

Usually this makes good sense, if only for the practical reason that without this principle of governmental succession, democracies would find it almost impossible to borrow money.

Yet the implications can be disturbing. Germany completed its reparation payments for the first world war in 2010. In South Africa in 1994, Nelson Mandela’s incoming government faced a debt burden of $23bn, in part courtesy of apartheid-era spending on the soldiers and police necessary to support the regime. Saddam Hussein bequeathed unpayable debts to Iraq.

For this reason, legal experts (for instance Lee Buchheit et al in the Duke Law Journal 2006) have pondered various doctrines of war debt, odious debt and hostile debt, under which certain kinds of debt – or perhaps all debts to certain kinds of government – might be written off. In 2008, the government of Ecuador did this unilaterally.

The trouble is that defining odious debt is contentious. Many governments that inherit odious debts pay them, figuring that the reputational benefits of doing so outweigh the costs (Mandela’s government is an example). Other governments may simply use the “odious debt” excuse to screw creditors, raising the cost of borrowing for governments in future – Ecuador’s default is cited as an example of this.

But there is an alternative. The idea was proposed by the economists Michael Kremer and Seema Jayachandran and has been taken up by the Center for Global Development, a think tank. The proposal is that the international community would declare that all future contracts with a particular regime would be non-transferable. Lend money to President Assad after such a declaration, and you can kiss goodbye to it if he is toppled; sign an oil-production sharing agreement with him at your own risk. (In practice, it is the US and UK, as hosts to most sovereign debt markets and courts, who would wield the biggest influence in such a declaration.)

This is an elegant idea. By drawing a clear line between existing debt, which is to be respected, and all future debt, which will be regarded as odious, it reassures creditors lending to the governments of poor countries. It frees innocent people from debts not of their making. And, cleverly, it undermines odious regimes by making it hard for them to promise credibly that they will repay their creditors.

Regular trade sanctions offer rich rewards to maverick states or private sector smugglers who circumvent them. An odious debt declaration is a kind of sanction that offers only headaches to the moneymen who might prefer to keep lending.

In truth, Damascus is already a pariah and has very little public debt, so this proposal is not relevant to Syria. But there are cases where the idea would have bite. Franco Tudjman’s government in Croatia, for instance, was cut off by the IMF in 1997, but turned to private creditors and almost quadrupled its borrowing that year. An odious debt declaration would have given those borrowers the creditors pause for thought.

Imposing sanctions of any kind is a policy with uncertain results. Yet a pre-emptive declaration of odious debt should at the very least make it harder for corrupt or repressive governments to borrow money. More to the point, it would mean that future generations were freed from the burden of loans that should never have been made.

Also published at ft.com.

Boomtime for trying to fathom the bust

Economists from MIT and Yale attempt to untangle a crisis that has already lasted longer than the first world war

What is the best description of Gavrilo Princip’s notorious act, almost 98 years ago? “Moved his finger.” “Murdered the Archduke.” “Started the Great War.” “Ruined the 20th century.” None of them quite captures what happened, and the story of the war that followed can be – and has been – told in many different ways.

It is with something of this spirit that the economists Andrew Lo of MIT and Gary Gorton and Andrew Metrick of Yale attempt to untangle a financial crisis that has already lasted longer than that war. They do so in a pair of articles in this month’s Journal of Economic Literature.

Lo reviews 21 books about the crisis, 11 by academics, one by the former US Treasury Secretary Hank Paulson, and nine by journalists, including my colleague Gillian Tett. Gorton and Metrick take on 16 more technical pieces of research. Do they get any closer to the bottom of this complicated affair? A little, but the sheer variety of sources demonstrates the difficulty of the task – as does Lo’s decision to evoke Akira Kurosawa’s 1950 film Rashomon, an exploration of the shifting nature of truth. Unlike Kurosawa, though, all three academics believe that the truth can be uncovered with enough care.

One of the central questions concerns the nature of the initial credit crunch, in which financial institutions suddenly struggled to roll over short-term loans, or “repo” agreements that functioned very much like loans. Why?

One explanation is that repo markets suffered the wholesale version of an old-fashioned bank run; while banks had suffered real losses, the panic was out of all proportion to those losses. Instead, it was a self-fulfilling situation: quite rationally, nobody wants to be at the back of the queue when a bank run breaks out.

The alternative account is that the “originate-to-distribute” business model under which companies made loans, repackaged the loans and sold them on to others, was fundamentally flawed. It led to a catastrophic decline in lending standards, with both borrowers and lenders agreeing loans that were careless at best and fraudulent at worst.

Gorton – who developed risk models for American International Group, which was later bailed out by the US Federal Reserve – has been a proponent of the “bank run” view. With Metrick, he surveys research papers studying the panics. In the asset-backed commercial paper (ABCP) markets, it is possible to track many different “bank runs” – events when lenders refused to refinance maturing loans for particular bundles of assets. While these runs were often connected to fundamentals, in the initial credit crunch of August 2007, many runs broke out apparently at random. This, say Gorton and Metrick, was a panic phase of the crisis. It explains why trouble kept breaking out in parts of the financial system that were unrelated to the subprime mortgage sector that was the initial source of trouble. Lo is only partly persuaded by this – self-fulfilling panic had a role to play, he says, but that hardly puts the originate-to-distribute model in the clear.

Lo takes the time to debunk several pieces of received wisdom: that bankers were being paid to take excessive risks; that the efficient markets hypothesis led investors astray; and that in 2004 the SEC changed its rules and excessive leverage at banks was the result. All sensible claims, says Lo – but contradicted by the facts.

Not all is lost in the fog of war, though. As Gorton and Metrick point out, the institutional details of the crisis may be new and intricate, but its macroeconomic pattern – in particular, the housing bubble that preceded the crisis – is very familiar. The really striking thing about the crisis is not its familiar shape, but its gigantic scale.

Also published at ft.com.

A problem shared is one quickly solved

Promoting cross-disciplinary research need not require a mysterious blend of social-networking tools and funky collaborative architectural spaces

Andrew Exum, a senior fellow at the Center for a New American Security in Washington DC, recently blogged about the question of military intervention in Syria. It wasn’t about the pros and cons but about the difficulties in weighing up this kind of decision: “Regional specialists rarely understand military capabilities and options well enough to make an argument for or against, and those who understand military capabilities and options rarely understand the regional dynamics well enough to make an argument for or against.”

This problem is hardly limited to military affairs. One reason the financial sector grew so grotesquely vulnerable just before the crisis was that the knowledge required to spot trouble brewing was distributed across different kinds of people – accountants, psychologists, economists, lawyers, politicians, practitioners and others – who had no reason to talk to each other.

In academia, the challenge of encouraging interdisciplinary research is at least recognised as a problem. The advancing frontier of scientific knowledge forces most researchers to specialise in ever narrower fields and, as a result, collaboration between these silos is essential. I recently visited the Oxford Martin School, a seven-year-old initiative designed to foster cross-disciplinary projects at the University of Oxford. I talked to the school’s director, Ian Goldin, about the challenges of breaking down academic silos.

He thinks these silos are mostly artificial. Academic journals are largely specialised rather than interdisciplinary and official funding bodies shy away from interdisciplinary projects. The result is that academics with interdisciplinary interests have few ways to fund the research and few credible outlets for publishing the results. The Martin School has funding, but most of the researchers are either junior, with some freedom to experiment, or professors so senior they no longer need to worry about their publication record. The mid-career academics are missing. It is nice to hear the tenure system sometimes produces the hoped-for courage and independence, but not so nice that there is no career track for interdisciplinary researchers.

Can we learn anything from the Martin School approach? One lesson is that an important problem can be a great focus for interdisciplinary work. “Problems tend to be interdisciplinary,” Goldin comments. To examine an issue such as migration or the spread of infectious diseases is to create a natural focus for separate specialists to find common ground.

That is all very well for slow-burning problems. Unfortunately, many problems surface without warning and demand action immediately. Syria is, arguably, a case in point. So was the collapse of Lehman Brothers. If there are no pre-existing lines of cross-silo communication at the moment of crisis, it is asking a lot for them to be established in time to share knowledge usefully.

If problems are one focal point for collaboration, tools can be another. An example: systems needed to deal with the gigantic data sets generated in finance, astronomy and oceanography. Such tools naturally bring together computer scientists and the statisticians, economists and scientists who might use the data. Goldin points to “crowdsourcing” as a second example of a cross-disciplinary tool, complexity science as a third and (optimistically, I feel) practical ethics as a fourth.

Perhaps the real lesson is that promoting cross-disciplinary research need not require a mysterious blend of social-networking tools and funky collaborative architectural spaces. All that is sometimes required is a shared problem, or a shared set of tools, and, above all, the money to pay for the job to be done.

Also published at ft.com.

Could we live without cash?

Like euthanasia, proposals to do away with physical currency could remain controversial for a long time to come

I’ve just started to give my daughters pocket money, and it’s fascinating to see how they deal with it – not the income, that is, but the physical cash itself. The younger Miss Harford hasn’t figured out that by tradition, the five [doh!] seven-sided coins are worth half as much as the stubby fat ones. (The swaps that her clued-up older sister proposes have to be monitored with some care.) She has also failed to gain any visceral appreciation of the fact that these metal discs can be used to obtain sweets and toys, useful things. She is fascinated by the coins as objects in their own right.

The visceral appreciation for cash will presumably arrive. Cash, it seems, does strange things to us. Ask people to count money and then subject them to pain, and they are more resistant than a control group who have been asked merely to count pieces of paper. Cash is also a social anaesthetic. In another cash- or paper-counting study, experimental subjects were asked to play “catch” in a group comprised of stooges. They never received the ball. The cash counters were less likely to feel socially excluded. Huge bonuses for bankers are both the cause of, and the cure for, their public humiliation.

Physical cash also makes us cautious relative to spending money on credit cards. Drazen Prelec and Duncan Simester, behavioural economists at MIT, ran an experiment in which two groups of subjects were allowed to bid on tickets to sporting events. One group had to pay in cash within 24 hours, the other had to pay with a credit card. The cash buyers offered substantially less – in the case of the best tickets, less than half as much.

Then there is the idea that cash makes us honest. Dan Ariely, author of Predictably Irrational, has found that people are reluctant to cheat in order to win physical cash, but will gladly cheat in order to win poker chips that can immediately be redeemed for cash. (In a less compelling study Ariely placed either six-packs of Coke or plates with six $1 bills in student dorm refrigerators. The Cokes vanished quickly and the cash remained – perhaps because your first instinct after finding cash in a refrigerator is that you are entering the “twilight zone”.)

All this and more came to mind on reading David Wolman’s new book, The End of Money. Wolman spent a year largely living without physical money, using a variety of electronic payment methods instead, and he thinks it would be a good idea if the rest of us did likewise.

After a while, Wolman’s cash-free lifestyle begins to look like a compulsive disorder. Offered bills, he would “flick them away like mosquitoes”, imagining “the stepped on, sweat-drenched, and hyper-handled life cycle of that cash”.

To his credit, Wolman also reports that cash is highly unlikely to be much of a vector for disease. A more telling complaint is its use for crime. For all the fuss we make about online transactions and credit card fraud, the simple anonymity of cash makes it irresistible for all manner of illicit business.

Wolman is worried about the $100 bill and simply cannot fathom why Europe has a €500 note – allowing a cigarette packet to contain €20,000. Law-abiding citizens would surely find it more convenient to load cash on to a chip contained in a card, a watch or – most likely – a mobile phone. Mobile phones could easily zap cash to each other, when friends want to split a restaurant bill or repay a small debt.

We probably do not appreciate the huge costs of defending cash from thieves and counterfeiters, and Wolman makes a brave case for the idea that “killing currency wouldn’t be a trauma; it’d be euthanasia”. Like euthanasia itself, I suspect that proposals to do away with physical currency will remain controversial for a long time to come.

Also published at ft.com.

How do you strip down the state?

Government cuts are shrinking the state, but gauging its size in the first place is hardly straightforward

Love this government or hate it, the consensus is that it is rolling back the state with a vengeance. Supporters agree with David Cameron’s pre-election diagnosis: “it is more government that got us into this mess.” Sceptics accuse the coalition of unnecessary cuts, fuelled by an ideologically driven love of small government.

All of which made me wonder: how big is the British state? It’s not a straightforward question. One could consider measures of regulation, or public sector employment. Then there are tax revenues, which since the mid 1990s have never been less than 36 per cent of national income, and never more than 39 per cent.

An alternative is to look at government spending. I prefer this as a measure of the size of the state, because – barring a default – all spending must eventually be paid for by taxes (or inflation). By this measure, the state is much bigger: total managed expenditure is more than 46 per cent of national income this tax year.

What’s more, according to “Green Budget 2012”, recently published by the Institute for Fiscal Studies, expenditure would have stayed near that level indefinitely without action. That action was pencilled in by then-Chancellor Alistair Darling as the impact of the recession became clear, and has since been amplified by George Osborne. The coalition’s austerity measures – four-fifths of which are spending cuts rather than tax increases – will eventually push spending back below 40 per cent of national income, which is where it was for most of the time that Gordon Brown was chancellor of the exchequer.

So assuming Osborne gets spending back down to 40 per cent of national income, would he have succeeded in producing a small state?

That spending includes pensions and benefits – in other words, redistributing money to the unemployed, the retired and the fecund from childless people with well-paid jobs. Then there’s free healthcare, free education, the army, the police, the courts, and infrastructure such as roads.

This is a lot. Is it worth £40 of every £100 that you earn? You can be the judge of that. Many people would regard it as good value for money. But it certainly does not look like a vision of a stripped-back, “night-watchman” state to me. If the austerity is motivated by libertarian ideology, true libertarians will be unimpressed with the results.

This is not to say the austerity is timid. Many economists would prefer more of the spending cuts to be deferred for a year or two until the economy is stronger (that said, according to the IFS, the cuts are not well advanced: 12 per cent down and 88 per cent to go). And spending 40 per cent of GDP will feel like a smaller state in 2015 than it did in 2003 or 1995. This is because, thanks to an ageing population and a rapidly growing national debt, the cost of providing pensions, paying interest and funding the National Health Service will all rise substantially.

Is there an alternative? A Labour government would have cut more slowly and perhaps would have cut less, but it is hard to imagine closing the deficit through tax increases alone – that would require tax revenues as a percentage of national income to rise by about a quarter. Imagine VAT up to 25 per cent, income tax up to 25, 50 and 65.5 per cent, and 14p on the price of petrol, and you get a rough-and-ready idea of what sort of taxes might be needed. Such taxes could be paid, but would be a huge departure from how we have grown accustomed to organising our society.

There are good reasons to object both to the timing and the details of the spending cuts. But the idea that they will produce anything like a stripped-down state looks far-fetched.

Also published at ft.com.

Five steps to an organised inbox

Here are a few microeconomic analysis-tested tips to get your email under control:

I always liked Keynes’s view that it would be splendid if “economists could manage to get themselves thought of as humble, competent people on a level with dentists”. Time, then, to apply the power of microeconomic analysis to the important practical task of getting your email under control.

Step one: take advantage of free disposal. Simple textbook economic problems assume that you can never have too much of a good thing – at worst, you can always throw away the stuff you don’t want. We economists call this the assumption of “free disposal”. Of course, free disposal does not apply if you’re talking about visiting relatives, a tatty sofa or a breeding population of yoghurt pots at the back of the fridge. It is remarkably easy, however, to get rid of email: all that is needed is the “will to delete” – ideally the deletion should be swift and without remorse.

Step two: take a data-driven approach. A long-running question is whether you should organise your email into folders or not. Over the past couple of decades, our computer filing systems have trained us to think in terms of folders, but an alternative is to find old email by searching for it – or even just scroll through a big fat unsorted inbox. Steve Whittaker, a computer scientist at IBM Research, with four colleagues, has conducted a study to figure out the effectiveness of these different approaches. It’s called “Am I wasting my time organising email?” and the conclusion is “yes, you are”.

Searching for email tends to be quicker and no less reliable than filing it. I’d suggest that if you must file, choose something simple – for example, a file called “Not Done Yet” and a file called “Archive”. That should handle most contingencies. This conclusion is interesting but so too is the research method: look at what people do, quantify how effective it is, and let the data speak.

Step three: invest wisely. A complex file structure may be a wasted investment, but other up-front efforts can pay dividends in the long run. About two months ago, I began to be quite fastidious about hitting “unsubscribe”, or blocking people who sent unsolicited junk. Without wishing to tempt fate, I think I am winning this battle – the inbox is beginning to look almost human, filling up at a genteel pace with genuine email from friends and acquaintances rather than mailing lists and unknown publicists. On most email programmes such filters are very simple and quick to set up; at first they might seem more trouble than they are worth, but trust me, they can pay dividends.

Step four: remember that, in extremis, bankruptcy can be your friend. From time to time individuals or companies can find themselves in a situation where the shadows of the past are simply unmanageable. We’ve found it helpful to introduce procedures for bankruptcy, whereby a line can be drawn under unpayable debts and everybody involved can figure out where they stand. Email bankruptcy can work for you, too.

Simply craft a short email explaining that you have become overwhelmed by your email and are not going to respond, and inviting them to send the email again if it’s really important. Email bankruptcy, like real bankruptcy, is probably not as much fun as it sounds – and easier for arty types and high-status individuals. But for some people, it beats the alternative.

Step five: never forget opportunity cost. Opportunity cost is the idea that what you’re paying for something – anything – is whatever you have to give up in order to get it. Email has a cost: every hour spent wading through the inbox is an hour that isn’t being spent doing something more useful, such as reading a book, relaxing with the family or even writing a handy column about how to manage your email.

Also published at ft.com.

The tricky business of measuring growth

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

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

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

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

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

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

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

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

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

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

Also published at ft.com.

Why have house prices stayed so high?

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

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

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

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

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

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

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

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

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

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

Also published at ft.com.

Can the minimum wage create jobs?

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

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

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

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

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

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

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

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

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

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

Also published at ft.com.

To tweet or not to tweet?

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

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

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

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

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

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

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

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

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

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

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

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

Also published at ft.com.