Tim Harford The Undercover Economist

Articles published in 2009

Can you put a price on being nice?

Dear Economist,
There seem to be economic benefits for a society where people are law-abiding, trustworthy, caring and generally nice. You get less cheating, and where you feel you can trust people, you can enter into business dealings with more confidence. Has anyone calculated the economic value of people being nice? And could a government invest in people being nice? If so, what would be the return on that investment?
James Atkins

Dear James,

Even economists would recognise that niceness is valuable for its own sake. But you are right, it is also good for the economy. Steve Knack, an economist who specialises in governance, trust and social capital (translation: niceness) once told me that, taking a broad definition of trust, it would explain the difference between the per capita income of the US and Somalia. That is, niceness and its cousins are worth about 99.5 per cent of US national income.

There are limits, though. When people trust each other, they become vulnerable to cheats. A recent paper by economists Jeff Butler, Paola Giuliano and Luigi Guiso finds that for an individual, there’s an optimal level of trust in others. Too little and you’re over-conservative, missing opportunities; too much and you get screwed. The effects are large, similar to the difference between going to college or not.

It is not clear how a government might encourage people to be nicer, but one famous economic study does suggest a way: Ray Fisman and Ted Miguel looked at the behaviour of diplomats in New York. The Scandinavians committed 12 unpaid parking violations between them; diplomats from Chad and Bangladesh notched up over 2,500. But when the city was given more power to punish offenders, all the diplomats cleaned up their act – niceness is best supported by legal incentives.

Also published at ft.com.

19th of December, 2009Dear EconomistComments off

It’s not what you know, but who you know and where they are

Alfred Marshall didn’t have to wait for Silicon Valley to evolve before concluding that some places are hubs of intangible knowledge. In 1890, the renowned Cambridge economist opined that “great are the advantages which people following the same skilled trade get from near neighbourhood to one another. The mysteries of the trade become no mysteries; but are as it were in the air … if one man starts a new idea, it is taken up by others and combined with suggestions of their own; and thus it becomes the source of further new ideas.” Marshall knew that where you live and work affects what you learn and what you earn. One question that economists have struggled to answer, though, is exactly how and between whom knowledge spreads.

Marshall emphasised the spread of ideas between similar companies, but there are other plausible possibilities. Jane Jacobs, author of The Death and Life of Great American Cities, was more excited by the spread of ideas across industries, citing examples from the invention of the bra by Ida Rosenthal to the development of Scotch tape by 3M, originally a mining company.

More mundane forces could also be at work: maybe innovative cities are innovative because, with so many jobs and so many workers, it is easier for each worker to find the perfect job. City-dwellers may become smarter just because they are surrounded by some well-educated people.

I recently rediscovered an interesting working paper published in 2005 by Shihe Fu, then at Boston College but now working in Southwestern University in China. Fu used very detailed data from the 1990 Massachusetts census in an effort to track knowledge “in the air”; specifically, he looked at wages, block by block, and tried to work out whether he could find evidence of knowledge spillovers traced out by patterns of higher wages.

Recall the four possible hypotheses: knowledge spreads within industries; ideas are generated when different industries rub together; people learn from being around lots of smart people; or people benefit from the density of a labour market, which helps them find the perfect job.

Fu found evidence that all are true, but intriguingly, they operate at different distances and on different professions. For example, wages tend to be high near densely occupied blocks, but tail off within a mile or two. But Jacobs-style benefits from diversity raise wages at a distance of nine miles and more. Managers benefit from all four types of urban spillover, while hi-tech workers particularly benefit from the spread of ideas described by Marshall and Jacobs. Artists thrive on the pure diversity that Jacobs celebrated.

The big question hanging over Shihe Fu’s research, it seems to me, is that the data supporting it are nearly 20 years old. Have e-mail and social networking changed the way that knowledge flows through cities? It seems that they must have, but quite how is far from obvious. After all, enhanced communications technology could simply concentrate wealth and innovation in fewer, world-dominating hubs.

My reading of the evidence is that technology has not killed distance – at least, not as far as the spread of ideas goes. Research in 2007 by Charles King, a political scientist, and two economists, Neil Gandal and Marshall Van Alstyne, found that e-mail’s real value seemed to be communicating with colleagues in the same office. And two years ago I described research at Google – not exactly a technological dinosaur – which found that the best predictor of who knew what was where they sat. For all the wonders of the internet age, location is as important as ever.

Also published at ft.com.

Rebooting Britain: encourage failure (Wired)

“Dare to Fail” was a week-long course taught by a Peter Cook character, the football manager Alan Latchley – a man whose chief contribution to the beautiful game was to get his team to stand on each others’ shoulders, backs to the opposition, in an attempt to block the goalmouth.

Politics is supposed to inspire satire, not the other way round – but I think the government needs to take a leaf out of Alan Latchley’s book. Failure is inescapable in a complex world, and the more governments are in denial of that fact, the more they will cling to bad ideas.

Take a look at the private sector: most businesses fail eventually, and ten per cent of companies disappear every year. The most dynamic sectors, such as computing, see the baton handed over again and again, from Transitron to Intel, IBM to Microsoft to Google. Figuring out what consumers want, and the best way to give it to them, is a challenge that requires a great deal of trial and error. The economic growth of wealthy countries has emerged from this process of evolution, with more successful ideas growing from the ashes of disaster.

In principle, why shouldn’t ten per cent of government policies also disappear as “failures” every year, to be replaced by something better? Whether it’s a drive to reduce hospital infections or to persuade people to recycle, a new literacy scheme in the classroom or a new regime for rehabilitating offenders, most policies can be rigorously evaluated, copied if they work and culled if they don’t. If private-sector performance is anything to go by, about half of all such policies are likely to be duds. And that’s just fine – as long as the duds aren’t allowed to live forever.

The obstacle is politics: if failure is so common, no sensible politician really wants to take such pains to discover it. Alan Latchley claimed that the other side of failure was success. Quite by accident, he was right. Good policies will often be right by accident, too.

First published in Wired.

Should I take my own great leap forward?

Dear Economist,
I was recently given notice that my position will be eliminated at the end of the month. My employer is offering two months’ severance.
I’m thinking about changing industries, from finance to clean tech, and moving from the US to Europe. I’m in my late twenties, single, and able to relocate – something less likely to be the case after my next position.
Making such a drastic change may prove difficult and take longer than two months. On the other hand, I can stay here and take a job in the same industry relatively quickly. Should I go big and risk a long unemployment or play it safe and take a job now?

Dear Jeremy,

“Behavioural economics” work on the boundary between psychology and economics offers relevant insights here. Unfortunately, it provides two entirely contradictory messages.

On one hand, you may be suffering from “hyperbolic discounting” – a tendency to weigh immediate costs too heavily and ignore longer-term benefits. You have three or four decades ahead of you, and yet you are focusing on a few weeks’ unemployment.

On the other hand, economist Johannes Spinnewijn has discovered that job-searchers tend to be far too optimistic about their chances of finding a new job quickly. So you are probably underestimating the risks at the same time as you focus too much upon them.

So let me put aside the contradictions of behavioural economics and rely instead on economic history. Experience suggests that grand transformative projects – Mao’s Great Leap Forward, the UK’s nuclear power “jackpot” – end in disaster. A gradual approach is better. Your own plan is to switch industries and continents from a precarious position on the dole. Would it really be impossible to reach your dream career step by step instead?

Also published at ft.com.

12th of December, 2009Dear EconomistComments off

What the wealth of nations is really built upon

It is an old question: why are some countries rich and others poor? Sir Partha Dasgupta, a hugely accomplished economist, born in Dhaka and educated in Delhi and Cambridge, is as well qualified as anyone to come up with an answer – which he did, delivering this year’s Royal Economic Society public lecture.

Dasgupta began by inviting his audience, many of whom were A-level students, to consider the lives of two girls – Becky, an American, and Desta, an Ethiopian.

Becky lives in a country with a gross domestic product per head of $46,000, life expectancy of 78 years and near-universal adult literacy. GDP per head in Desta’s country is $780; life expectancy is 53 years, adult literacy 36 per cent, and most women spend about 15 years bearing or taking care of children, with average fertility of more than five live births per woman.

Familiar as this sort of data is, the numbers never fail to shock. As Dasgupta pointed out, Ethiopia is not notably richer than it was 5,000 years ago. Why?

Economists haven’t been short of answers. Rich countries have more physical capital – better roads, bigger buildings, more machines. They also have more human capital – their citizens are better educated and trained, and healthier. And they have more technological capital, with more scientists, more advanced technology and more intellectual property.

But these are symptoms of something deeper. After all, as China is now demonstrating, it is possible to expand all three types of capital at speed. Many poor countries don’t. Why not?

The fashionable answer is that rich countries have better institutions. It sounds profound, but nobody really agrees on what it means. Dasgupta pointed out that in a variety of circumstances – from buying fresh-seeming food at a supermarket to getting married, from walking the streets in safety to writing a country’s constitution – we need to be able to rely on other people to play their part in a deal that may be explicit but is often entirely implicit. And he devoted much of his lecture to answering the question of when we can expect other people to keep to these agreements and quasi-agreements.

Relying on game theory analysis, Dasgupta reached two conclusions. The first is that stable societies – that is, where cheats can be found and punished, if only by a refusal to do business with them in future – are a precondition for successful institutions. If every interaction is a one-off, co-operation is impossible, and all those wonderful investments in machinery, education and innovation will simply never happen.

The second conclusion was that co-operation is extremely fragile. Dasgupta’s game theory suggested that even a successful, co-operative society is always at risk of breaking down. “It is easier to destroy institutions than to build them,” he argued, and cited the Watts riots and the decline of many pre-modern civilisations. The credit crisis is, arguably, another example.

If true, this is very disturbing: it suggests that we should perhaps spend less effort thinking about how to develop poor countries, and more effort holding together our own fragile societies.

I was not totally convinced. Perhaps I am complacent, but the past 200 years of economic history contain far more examples of poor countries becoming rich than of rich countries becoming poor.

As Sir Partha patiently explained his algebra to a gaggle of admiring schoolchildren, I was left with more questions than answers about why we trust each other and our institutions, and how such trust is created and destroyed. That, I think, was exactly his aim.

Also published at ft.com.

Perhaps microfinance isn’t such a big deal after all

Last December, I showed some unwitting prescience by worrying about a backlash against microfinance, the practice of providing small loans – or perhaps savings products or insurance – to poor people. I fretted that there was little compelling evidence that it worked.

A year later, the evidence is arriving and the backlash has begun. The Boston Globe published an article in September, subtitled, “Billions of dollars and a Nobel Prize later, it looks like ‘microlending’ doesn’t actually do much to fight poverty.” Other media have weighed in on all sides, with The Wall Street Journal concerned about a microcredit bubble. What is going on?

Three important randomised controlled trials were unveiled this year. In one, economists Dean Karlan and Jonathan Zinman persuaded a lender in Manila to tweak a credit-scoring computer program so that it randomly awarded or denied loans to marginal borrowers. The results were disappointing, considering that an earlier Karlan-Zinman study of a consumer-finance lender in South Africa had shown more substantial benefits from microcredit, despite annual interest rates of 200 per cent. In Manila, male-owned businesses tended to become more profitable after a loan, and female-owned businesses did not. This runs counter to a strong focus on women in the microfinance culture. The loans produced no improvement in diet or income about 18 months down the line.

A second trial, by Abhijit Banerjee and three other MIT economists, studied a more traditional scheme in India, which lent to groups of women. Spandana, a leading microfinance operator, agreed to randomise the way it entered the Hyderabad market. The company chose 104 suitable areas of the city but at first only marketed loans in 52 of them. Again, the results were modest. Households seemed to use the loans to buy more expensive goods and then cut back on everyday spending to repay the loan, but income did not rise, nor were there improvements in health or women’s empowerment. Business owners did manage to improve profits. The time horizon, again, was less than two years.

A third trial, of a micro-savings scheme in rural Kenya, was more encouraging. Economists Pascaline Dupas and Jonathan Robinson found that the savings accounts were popular among women and helped them save, invest in businesses, spend more and cope with bad luck. All this was despite the fact that the accounts paid no interest and charged hefty withdrawal fees.

Microfinance fans should not feel too defensive about these mildly positive results, especially when microfinance itself has passed a market test by growing very rapidly, often without subsidies. All such trials are context-specific and have other limits: the Manila study targeted marginal borrowers, while in the Hyderabad study, Spandana was not the only microfinance lender in town.

The reason for the backlash is obvious: microfinance was supposed not just to be a useful financial product, but to emancipate women, create millions of entrepreneurs and get rid of stubborn stains on your collar. Such claims were always going to be difficult to justify – even if donors tend to lap them up in the search for the next development panacea.

David Roodman, a microfinance expert at the Center for Global Development, sums it up well: “Suppose microfinance is not having much average impact on poverty, but is giving millions of people a modicum of greater control over their lives … is that so bad?” Other serious studies are in the pipeline. If microfinance is to thrive under the microscope, perhaps its practitioners should establish more realistic expectations.

Also published at ft.com.

Did Thierry’s head inform his hand?

Dear Economist,
With regard to the controversial goal that has shattered Irish World Cup hopes, how would an economist have chosen to control the ball in Thierry Henry’s position? Given that the rewards so greatly exceed the risks, would it have made any economic sense not to handle the ball? Is this a form of moral hazard?
Rich Stevenson, Oxford

Dear Rich,

Allow me to answer the questions in reverse order. Moral hazard describes a situation where a decision-maker takes unwarranted risks because he or she has been provided with some kind of safety net. Examples include people who insure their cars and then don’t park securely, or financial traders who gamble because they get bonuses for profitable trades, but no real penalty for losing money. Thierry Henry committed a deliberate handball and set up the winning goal for France. I cannot quite see the parallel with moral hazard.

As for the risks and rewards, I think you are extremely confused. You say that the rewards exceed the risks, but we must ask to whom those risks and rewards accrue.

Henry has been selfless. The rewards of his cheating go largely to his team-mates, who get to go to the World Cup with their names unblemished, and to fans of French football, once they get over the embarrassment – which they will. Henry himself faced all the risks. He might have been cautioned or sent off, but surely the far greater risk was what happened: only the TV cameras noticed the handball and a great striker’s reputation was tarnished. His subsequent pronouncements of guilt, shame and remorse have hardly put matters right.

So, what would an economist have done? The answer is absolutely clear: economists would never cheat in front of the camera. Their fans and team-mates might be frustrated with them, but their sponsors would be delighted.

Also published at ft.com.

5th of December, 2009Dear EconomistComments off

Business Life: Gift Cards

This Christmas, will you buy your loved ones presents that they may not like? Or will you slip them some cash instead? Neither option has much appeal. A gift of money, unless to a much younger relative, looks lazy and even patronising. Yet many people are incompetent present-buyers: Learn More

1st of December, 2009Other WritingComments off

Should I stay single in Italy – or come home?

Dear Economist,
I’m a 32-year-old American woman; I moved to Italy about five years ago and later applied for a master’s programme at an Italian university. Average earnings for my BA in political science are low, so I wasn’t missing out on much.
My problems are two-fold: first, dating. Italy has the second-oldest population in the world. Seeing a single thirtysomething is like finding a unicorn. Eliminate men who live with their mothers, are chain-smokers, or are shorter than me, and I’m in a convent.
Second, my Italian university has decided to reverse its previous decision to accept my American degree. I am being forced to re-earn an Italian BA, which could take a further year.
I’d hate to turn down another degree, but can I handle another year’s worth of pasta and enforced singledom?
My current plan includes going to San Francisco upon my return, though I do have the choice of a semi-permanent job with Nike in the middle of nowhere. Or I could stay in Italy; but if I spend another year single, according to my mother, I will die alone.
Crying in my cappuccino

Dear Crying,

You appear to be committed to staying in a country whose food, bureaucracy and dating scene do not suit you. Your judgment has been clouded by the sunk-cost fallacy: you hoped to get a master’s degree, great food and an Italian paramour. Things didn’t work out and you have wasted five years. You’re only human if you want to waste another year or two, but you’re making a mistake. Go home.

As for your career, forget cash: the happiness literature suggests that a happy relationship and secure job are far more important. San Francisco is not famed for its excess of single straight men, but the demographics of the middle of nowhere are excellent, with many eligible bachelors. Your new life awaits.

Also published at ft.com.

28th of November, 2009Dear EconomistComments off

Political ill wind blows a hole in the climate change debate

My sunny disposition is wavering as the Copenhagen summit on climate change approaches. I believe that the governments of the world have taken the wrong approach to the problem – and if they had taken a different tack 12 years ago in Kyoto, we would be much closer to dealing credibly with climate change.

The complexities are dizzying, so it may help to be reductive for a moment. The governments of the world are focusing on reducing the quantity of greenhouse gases emitted, through cap-and-trade programmes; they should instead be focusing on increasing the price polluters must pay for emissions. The incentives provided by the two approaches are similar. Both will lead to a higher carbon price and lower emissions, and both could be tweaked over time to produce much the same trajectory of lower emissions. Either system would work well from an economic perspective.

Yet politically speaking, cap-and-trade – where an agreed cap on the level of pollution permitted in a region is set, within which companies can trade those permits between themselves so long as the cap is not exceeded – has long been regarded as the easier sell. I am not convinced it deserves that reputation. There are already several technically successful cap-and-trade schemes, but none requiring anything like the political compromises now necessary. The Kyoto protocol, a quantity-based agreement on emissions, effectively died in the US long before George W. Bush became president, took eight years to come into force and could not meaningfully accommodate China, India, Indonesia or Brazil. This is hardly auspicious.

The trouble with cap-and-trade is that countries must agree how to divide the allocation of permits. This has proved troublesome when emissions targets were assigned relative to a 1990 baseline. Rapid growth in the US economy suddenly made its allocation look stingy, while the Russian allocation looked absurdly lax following the economy’s collapse in the early 1990s. It should not have been a surprise that some economies would grow faster or slower than predicted.

Gabrielle Walker and Sir David King, in their otherwise superb book on climate change, The Hot Topic, assert the conventional wisdom that cap-and-trade is politically more achievable. This statement is somewhat undermined as they start to describe the political prerequisites for such a deal, which include agreement on a global emissions cap (a hugely contentious question) and the distribution of emissions rights among countries.

There is a form of carbon tax that would be far simpler – and would not, contrary to Walker and King’s implication, be levied by the World Bank. G20 members would agree to impose a broad-based carbon tax on their own economies. The tax would be levied by national governments and spent as they saw fit. Precise harmonisation would be unnecessary. The taxes would simply need to be broadly in line, with a commitment to keep them that way.

Cameron Hepburn, co-editor of The Economics and Politics of Climate Change, points out that quantity regulation puts knotty issues of distribution and compensation at the heart of the international negotiations. Harmonised carbon taxes put these questions to one side. They could be – and would have to be – discussed separately. Perhaps a carbon tax is the wrong approach, and it is all for the best that the whole sorry mess will be on the table at Copenhagen. That is the path the world’s governments have chosen. I sincerely hope that they are right.

Also published at ft.com.