Tim Harford The Undercover Economist

Articles published in November, 2012

Come and see me record a brand new radio show about economics!

I’m delighted to announce that the BBC will be broadcasting a brand new show called “Pop Up Economics” – just me telling short stories about important people and ideas in economics. You’ll laugh, you’ll cry, you’ll optimise. Come along!

The first recording is in central London, near Piccadilly Circus.

Date: Tuesday 4th December.

Time: Drinks at 18.30. Recording starts 19.15 sharp.


Please email xxx to get your e-ticket and the venue details. First come, first served!



EDIT: All gone – sorry. There’ll be another event in January. Watch this space. – TH

29th of November, 2012MarginaliaRadioSpeechesComments off

Bright idea that may end up costing more

‘Under measures put forward by Ed Davey, the energy secretary, power companies will be limited to just four main tariffs per fuel type and will have to put customers on the cheapest price available for the tariff type they choose.’

Financial Times, November 21

Will this reduce my electricity bill?

Probably, but only if the prices of inputs such as coal and gas do not rise. And it may not reduce your bill for the reason that you think.

But if companies are forced to put me on their cheapest deal, I’m going to get a better price, aren’t I?

Not necessarily. Some deals are only offered because companies know the majority of customers won’t take them up. Starbucks, for example, has long offered a “short” cappuccino without listing it on its menu. It’s a less expensive drink, enjoyed by that rare intersection of people who know about coffee yet visit Starbucks. If the company was forced to advertise this secret cappuccino, it might not offer the product at all. It’s the same with utility groups, phone companies and banks: a keenly-priced product designed to win over the cognoscenti might vanish if the company was forced to sign everyone up for it.

So you think the “lowest tariff” rule is a bad idea?

I am genuinely not sure whether it will lower prices or not. I am quite sure it will be a crowd pleaser. My phone provider, Orange, has been reassuring me for years that I was on the cheapest tariff available given my pattern of usage. When I called them recently to ask why the phone bill was so damn high, they promptly informed me that I could be on a tariff at one-third of the cost.

How did they square that circle?

More of a loophole than a circle, I should say. The sales assistant sounded delighted with himself. If Mr Davey could also make that sort of thing a flogging offence, I’d be overjoyed, even if it doesn’t lower average prices – which it may well not.

Although it suggests that companies are good at finding loopholes.

They are. There are always cashback deals, loyalty cards, “sign up, get free loft insulation” and all the rest.

But you still seem to think that prices will fall?

Probably. If prices are easier to understand then competitive pressures should be more intense. Companies may try to target the same margins as before but they might fail, if customers see who’s offering the best deals.

And they can’t figure out the best deals now?

Indeed not. A few years ago, the economists Chris Wilson and Catherine Waddams Price studied 250 customers trying to switch electricity suppliers with the aim of securing a better deal. A quarter of them made themselves worse off, and the majority failed to spot the best deal. (One genius had the option of saving £150 a year but managed to make himself worse off than if he hadn’t switched.) Ofgem, the energy regulator, recently reached a similar conclusion. So there is good reason to believe energy markets would work better if things were simpler.

Will four price tariffs still be too complex? Or, alternatively, too crude to accommodate genuine business reasons for price variations?

The economist Eugenio Miravete once studied the behaviour of customers faced with a choice of two tariffs and a single phone provider, and concluded customers were usually successful at finding the best deal. I suspect four price tariffs will be more tricky, especially when multiplied by the number of companies: customers will still have to ponder 15 or 20 different possibilities. And there’s another problem: we don’t understand our energy usage patterns. Even if our chosen company puts us on its most appropriate deal, it will be hard to figure out whether we should switch providers.

Is there an alternative?

The behavioural economist Richard Thaler has been advocating a system of “smart disclosure”, whereby energy companies would have to supply users with a computer file of their recent usage in a standard format. Customers could then upload that file to a price-comparison website and be told which company would offer the best price given their own energy patterns.

Couldn’t we just have computerised smart meters that constantly seek out the best deal?

I suspect that day is not far off. There is a catch, though: the easier customers find it to seek out the very cheapest price, the more quickly energy companies will find out that they’re being outcompeted, and the easier they will find it to raise prices in a cosy tacit cartel. Not all markets work well.

Also published at ft.com.

Still think you can beat the market?

The search for anomalies covers an almost unlimited number of potential patterns. Some of them may be real, but many emerge by chance alone

One of the most maligned ideas in economics is the efficient market hypothesis, perhaps because what is actually a rather technical statement about financial market returns is conflated with some entirely different claim about the superiority of free markets over government dirigisme.

The EMH has various forms, but in brief its message is very simple: an individual investor cannot reliably outperform financial markets. The reasoning is equally simple: money doesn’t get left around on the pavement for very long. If it was obvious that the stock market would rise tomorrow, investors would buy shares immediately and the stock market would rise today instead. Anything that could reasonably be anticipated already has been anticipated, and so markets instead respond only to genuinely unexpected news.

But the EMH has a problem: researchers keep discovering predictable patterns in the data, and such patterns amount to big piles of money being left on the sidewalk.The most famous of these is probably the “January effect”: that returns are particularly high in that month. The January effect was originally explained by investors selling shares in December for tax reasons, depressing prices. Whether or not this is true, the EMH says that other investors should stand ready to buy those cheap shares in December, and the January effect should simply not exist.

The existence of the January effect and countless other anomalies looks like a puzzle for the EMH. But it is really only a puzzle if the anomalies suggest profitable trading strategies. That will not be true if an apparent anomaly turns out to be pure coincidence. The search for stock market anomalies covers thousands of stocks, tens of thousands of daily returns, and an almost unlimited number of potential patterns to be examined. Some patterns may be real, but many emerge by chance alone.

For instance, one recent discovery is that an asset’s monthly return can be predicted by looking at the same asset’s maximum daily return during the preceding month. Did you have to read that twice? It’s a pretty obscure finding, and where there are so many such candidates to be identified as an anomaly, some will be pure coincidence.

But let’s assume that some of these patterns are real. That is a minor embarrassment for the EMH; and it becomes a major one if the anomalies persist after they have been discovered. Yet this seems doubtful. Burton Malkiel, author of A Random Walk Down Wall Street, noted in 2003 that the January effect had become a Wall Street joke, “more likely to occur on the previous Thanksgiving”. Elroy Dimson, another EMH expert, documented the reversal of a major anomaly – a tendency for shares in small companies to outperform the market – after it became known.

Strictly, such anomalies should not exist at all, but a pragmatic believer in the EMH would surely feel her faith confirmed by the observation that the anomalies turn to dust in the glare of publicity.

A new research paper by David McLean and Jeffrey Pontiff explicitly examines the idea that academic research into anomalies is a self-denying endeavour. They find some evidence of spurious patterns: if a given dataset suggests an anomaly, including subsequent data tends to erode it. But what is really striking is that after an anomaly has been published, it quickly shrinks – although it does not disappear.

The anomalies are most likely to persist when they apply to small, illiquid markets – as one might expect, because there it is harder to profit from the anomaly.

The efficient markets hypothesis is surely false. What is striking is that it is very close to being true. For the Warren Buffetts of the world, “almost true” is not true at all. For the rest of us, beating the market remains an elusive dream.

Also published at ft.com.

How Adam Smith could help the Church

‘David Cameron has welcomed Justin Welby, the former oil executive, as the next archbishop of Canterbury and spiritual leader of the world’s 77m Anglicans … Bishop Welby’s appointment had been an open secret for days.’

Financial Times, November 9

Are you still upset that you haven’t been made Archbishop of Canterbury? Or just ruing the fact that you didn’t put some money on him to get the job?

Ladbrokes had stopped taking bets by the time I got there. But yes, it’s frustrating: they give the job to this guy and everyone is going on about how useful his business experience is going to be. I just think they should have given it to an economist.

But you don’t have any experience in the church.

Neither does Justin Welby, really – he’s only been a bishop for a year.

Yes, but you haven’t been a bishop at all. You’re an atheist.

Fair enough. I still think economics has a few things to contribute to the debate.

You think economics has a few things to contribute to quantum physics, boxing and seduction. Still, go on, if you must.

I think we’ve fallen for the myth of the brilliant businessman. Not just here, but in general, the idea is that if you want a difficult job to be done, what you really need is business experience. But we’re vague about what business experience really is or what it means. Bishop Welby has business experience; Bill Gates has business experience; Bernard Madoff has business experience. It helps to dig a little deeper.

Bishop Welby was corporate treasurer at Enterprise Oil and nobody has a bad word to say about how he did the job.

Fair enough. Corporate treasurers are in charge of managing a business’s cash and investments, and that will probably come in very handy at the Church of England, but he will have to draw on other talents if he’s to reinvigorate the Church and manage the acute disagreements at the heart of the Anglican Communion.

He also has a fair bit of experience dealing with angry Nigerians.

OK, I’ll admit, he does seem very well qualified. But I still think we overestimate how much business success is down to the brilliance of business leaders, and we underestimate how much is down to chance. There’s a similar tendency at the BBC at the moment – George Entwistle obviously had to go for the sake of the organisation, but is it really coherent to blame him for not knowing that somewhere in the BBC, a story was about to emerge that hadn’t been properly checked? And do we really think his successor’s experience in selling snack food will be enormously helpful?

You think business success is down to luck.

I think there’s a lot more luck involved than we like to think. In a well-functioning market new ideas are always bubbling up to the surface. Lots of them are bad, some of them are good. When the good ideas turn into profitable businesses, we assume we’ve seen entrepreneurial genius at work, but we might just have seen a lucky spin of the roulette wheel.

I don’t see what this has to do with the Church of England.

Nothing, and that’s the problem. The Church of England doesn’t operate in a suitably competitive market.

Are you calling for the privatisation of the Church of England? You’re crazy.

I never realised that you leaned towards antidisestablishmentarianism. You should keep an open mind. A bit more competitive pressure might be good for the Church. Laurence Iannaccone, an economist who has specialised in the economics of religion, developed an idea he drew from the writings of Adam Smith: that more competitive religious marketplaces lead to more dynamic churches.

Is there any evidence?

On the face of it, yes. Protestantism in the US is extremely fragmented – there are lots and lots of small denominations – and regular church attendance is common. Canada, the Netherlands, Switzerland and Australia show similar tendencies. Denmark, Finland, Norway and Sweden have near-monopolistic churches and very low churchgoing rates. The UK is somewhere in the middle.

So you’re saying that smaller denominations try harder?

Yes, or that one way or another, compelling ideas emerge. Secularists who want the Church of England disestablished have logic on their side – but they should be careful what they wish for.

Also published at ft.com.

Education vouchers – some redeeming features

The scheme can help poor families in a commercialised school system

There are those who believe that some things, such as healthcare or the road network, are just too important to leave in the hands of the market. And there are those who believe that some things, such as food or petrol, are just too important to leave in the hands of government.

Neither side can be happy with the British school system. The state sector dominates, but quality is patchy and any pretence of egalitarianism is punctured by the many ways in which money can buy an advantage: private school, extra tuition, expensive houses in the right catchment area … Worse, none of this money goes to benefit the state-school system.

Is there a better way? One could, of course, try to negate the advantage that cash brings: this was presumably the philosophy behind Brighton and Hove’s decision in 2007 to allocate school places by lottery rather than proximity. Or more radically, we could nationalise Eton and criminalise after-hours maths tuition.

A more appealing alternative is to let the pendulum swing the other way, and privatise a large slice of the state school sector. Anyone who meets government standards could set up a school, and they could charge whatever they wanted to and make a profit if they could. This idea would embrace the willingness of many parents to spend time and money trying to obtain a good education for their kids.

We couldn’t allow the children of poor families to be cast adrift in a commercialised education system, and there are two things we could easily do to prevent that. The first is to give every family an education voucher for, say, £6,000, redeemable at any school. Poor families could get more; the current “pupil premium” for poorer children is £600, so we could add that sum, or more, to the voucher.

The second is that the government could continue to run schools, charging a fee equivalent to the voucher. Families who want exactly what they’re getting now – education both funded and provided by the government – could have it.

What possible objections could there be to this idea? Let’s consider a few. The first is that some parents couldn’t or wouldn’t spend their vouchers carefully, and their child would fall further behind her more fortunate peers. This is a risk – but competition is a powerful force, even if not everybody plays the game. People who do not bother to check prices at supermarkets will still benefit because more price-sensitive people are keeping the supermarkets honest. Similarly, schools must raise standards to attract pupils, even if not everyone responds to the improvement.

The second concern is that schools will sometimes go bankrupt, and this will cause disruption. I have two words in response: Hurricane Katrina. After Katrina devastated New Orleans, many children ended up at better schools elsewhere. A study by the economist Bruce Sacerdote revealed that despite months with no schooling at all, and appalling stress and dislocation, the children who had to move schools quickly overtook the educational achievements of the slightly older children, who had finished school before the hurricane hit. When bad schools disappear, that is probably a good thing – even for those pupils who must move.

A third concern is that the voucher system will lead to a free-for-all, with schools provided by charlatans or religious extremists.

Clearly there must be some government oversight as a backstop to competitive pressure. The Finnish educationalist Pasi Sahlberg points out that the world’s leading school systems all make educational equality a high priority. That has to give pause for thought to an enthusiast for completely unregulated voucher schemes.

Nobody can be sure what might happen if a part of the UK embraced a voucher scheme; I can’t help thinking that it is worth a try.

Also published at ft.com.

Growth or bust

If there were more corporate collapses, the economy would be a healthier place

Given the collapse of Comet last week, here’s a contrarian claim: far too many companies are staying solvent, avoiding bankruptcy and continuing to trade despite the troubled economy. If only we had a few more corporate collapses, the economy would be a healthier place.

Could this possibly be true? It’s not quite as mad as it might seem. An economy with a vibrant entrepreneurial culture, in which new companies with good ideas find it easy to raise money and reach customers, is also likely to be an economy in which slow-footed incumbents find themselves outcompeted and out of business.

To look at the same problem from a different angle, think about an economy in which banks prop up loss-making companies because of political pressure, or because foreclosure would crystallise a loss at an awkward moment for the bank, while forbearance would postpone the day of reckoning for both borrower and bank.

If such forbearance allows a fundamentally profitable company to survive temporary cash flow problems, it will be good for the economy, of course. But a persistently lossmaking company is a machine for converting equipment, business premises and the hard work of its employees into something worth less than the sum of its parts.

Jon Moulton, a corporate turnaround specialist and chairman of Better Capital, a private equity group, has been arguing that this is an accurate and worrying depiction of the economic scene today. Moulton points to the fact that in the UK, business liquidation rates averaged about 160 per 10,000 companies in the 1990s, but didn’t reach 100 even during the depths of the crisis. And Moulton told BBC Radio 4’s The Bottom Line that across Europe, countries such as Greece and Italy enjoy low bankruptcy rates while those in Germany and Norway are much higher.

That last factlet seemed so astonishing that I felt compelled to check. Moulton is quite correct. According to a report compiled by the Creditreform Economic Research Unit, Greece suffered only five insolvencies per 10,000 companies in 2011, the lowest ratio in western Europe. The three runners-up were Spain, Italy and Portugal. Germany and Norway both had bankruptcy rates well above the European average of 68 insolvencies per 10,000.

This is not conclusive. The differences will, in part, be determined by countries dealing with insolvencies in different ways and to different timescales. (Iceland’s rising bankruptcy rate is more likely to be a delayed reaction to the crisis of 2007 than a sign that things have never been worse in Reykjavik.) Different insolvency rates will also reflect the maturity of the economy: many Greek businesses were self-employed professionals, people who might simply stop trading rather than enter any formal bankruptcy procedure.

Still, the idea that corporate failure reflects economic vitality makes a good deal of sense. In a study published in the Journal of Financial Economics in 2008, Kathy Fogel, Randall Morck and Bernard Yeung compiled lists of the 10 largest employers in each of 44 countries across the world. Fogel and her colleagues found that when the membership of this elite group of companies changed frequently, the economy in question was more likely to be growing quickly.

Perhaps more impressive is the fact that churn in the top 10 list in a given year was correlated with fast growth over the subsequent decade. Even more striking, the results were being driven by the extinction of corporate dinosaurs rather than the rapid ascent of new stars. The ability to fail quickly – and without much collateral damage – is a tremendous economic asset. Just think of the companies we now think of as too big to fail.

Also published at ft.com.

Everyone can pay lip service to living wages

‘London’s “living wage” will rise by 25p to £8.55 an hour, Boris Johnson, the capital’s mayor said on Monday, as Labour was set to announce proposals to give businesses tax breaks for paying the wage.’

Financial Times, November 5

Living wage?

The minimum wage, £6.19 an hour for those 21 and over, is a legal obligation. The living wage, £8.55 an hour in London and £7.45 an hour elsewhere, is the result of a very successful publicity campaign and can count Ed Miliband and Boris Johnson among its advocates. There are no legal sanctions for paying less than the living wage, although Mr Miliband did announce plans to “name and shame” those companies who didn’t. Apparently that is helpful, because “name” rhymes with “shame”.

Why do campaigners say that you can’t live on the minimum wage?

Try living on £6.19 an hour and see how you get on.

For an economist you’re getting very high-minded all of a sudden.

I think it’s perfectly reasonable to point out that £6.19 an hour isn’t a lot of money. £8.55 an hour isn’t a lot of money, either, but a lot of people have to get by on less. Unfortunately we economists have to ask awkward questions – for instance, whether these campaigns are likely to help people without much income.

And are they?

There are two separate issues here. One is whether we should be relying on a public relations campaign instead of legislation. The second is what a good floor on wages might be.

Start with the PR.

Fine. Campaigns based on reputation have a singular advantage, which is that because compliance is voluntary, their costs are naturally kept in check. Companies value their reputations but not to the exclusion of everything else. An excessive minimum wage could put companies out of business; an excessive living wage will be ignored.

Sounds great.

It does, which is why so many politicians have paid lip service to the idea. It has something to appeal to everyone from the Marxists to the libertarians.

And it will save money for the Treasury – we’ll have to pay fewer tax credits.

The Treasury also profits when millionaires enjoy salary increases, so I am not sure why this is an interesting argument. Remember that tax credits were designed, in part, to address the following problem: some workers, perhaps because of childcare costs, need chunky wages to tempt them into the labour market, but they lack the skills to command those wages. Saying the living wage would save money on tax credits seems to just assume away that problem.

Fine. Are there any downsides to a reputation-based campaign?

It relies on companies having a reputation to protect. Not all of them do. You can boycott a restaurant chain or an airline if you don’t like what they do. Try boycotting a cement manufacturer and you’ll see that not everyone cares what you think.

But the campaign says that employers have recruited better staff by paying higher wages.

Obviously, but it’s absurd to conclude that the same thing would be true if the living wage was universally adopted. These employers reduced turnover because they offered better wages than their competitors, not because they reached some benchmark for living costs.

Perhaps we should just raise the legal minimum wage to the same level as the living wage.

Perhaps. Perhaps we should raise the legal minimum wage to a £100m an hour. I think if we did we’d find unemployment might rise. A minimum wage does two things. It will shift money from employers in an imperfectly competitive market to low-paid workers and it will induce some employers to sack workers, even if both employer and employee would prefer a deal struck at an illegally-low wage rate. There’s a case that for the good of low-paid workers, there should be no minimum wage at all. There should be one but it needs to be modest if it isn’t to cause too much unemployment.

Is there any evidence on the right level?

There’s lots, and it is mixed, but on balance it’s in favour of the idea that if you raise the cost of employing people, fewer people will be employed. It is worth bearing in mind that, for a lowly paid worker shifting from job to job, having less work available but at a high hourly rate, isn’t a bad deal. The concern has to be that certain types of people – especially young unskilled workers – will be shut out completely and denied the chance to learn on the job.

Also published at ft.com.

Banking goes Nuclear

Download my contribution to Wired’s “World in 2013” – absolutely free! (PDF, 2 pages – posted with permission.)

How to give feedback

I recently spoke at Wired 2012 and I felt it went well (video to follow, when they put it up).

Afterwards, people came up, shook my hand, patted me on the back and told me I did a great job. That felt nice, but it won’t help me to do a better job next time.

Elsewhere in the building, other people gathered in corners and grumbled about all the things I did or got wrong. (I don’t know if this happened. I assume it did. You can’t please everyone.) That didn’t help me to do a better job next time, either.

But someone did something helpful. Bruno Giussani of TED, seeing someone praise me for speaking without slides,  immediately got to the point. “You talked about the Spitfire,” he said, “But this is an international audience. Many people won’t know what you’re talking about. You should have shown just one slide: a photograph of a Spitfire. Then everyone would have understood.”

Next time I give a similar speech, I’ll be showing one slide: a photograph of a Spitfire.

It isn’t easy to get straight to the point and offer a single, focused suggestion for improvement. And the truth is, we rarely seek that kind of feedback. When we ask “what do you think?”, we’re usually looking for those confidence-boosting pats on the back. But giving such feedback – and seeking it out – is hugely important.

(On which topic, Peter Sims has an excellent book, “Little Bets“, which among many excellent topics discusses this kind of focused feedback at Pixar. Buy it for Christmas and enjoy.)

Tim Harford at the Sydney Opera House: “Make more Misstakes”

“In a complex and fast-moving world, if we want to move ahead in leaps and bounds, rather than in small steps, we need to rethink the conditions for making progress in science, business and society in a fundamental way. We need to realise there is no ‘right way’, lose our fear of failure, embrace opportunity and take risks.

We need to stop looking for leaders who can provide us with all the answers, and encourage the search for many solutions – for that is where we will find the ‘one in a hundred’ that delivers real results. We need to understand that to adapt to the challenges of the future, we must make mistakes, lots of them.”

Make more misstakes” is here – one hour. Enjoy!



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