Tim Harford The Undercover Economist

Articles published in November, 2013

Why women prefer fixed-price cars

‘Discrimination surely remains important, as anyone can see if they pay attention to how women are often treated in business environments’

Angela Ahrendts is about to leave Burberry; Liv Garfield is soon to run Severn Trent; the privatised Royal Mail may soon join the FTSE 100 club with Moya Greene at the top. But one thing never seems to change: there are only a handful of female chief executives of FTSE 100 companies. Why?

There is, of course, more than one force at play. Discrimination surely remains important, as anyone can see if they pay attention to how women are often treated in business environments. For those wanting a higher standard of evidence, consider a famous study by economists Claudia Goldin and Cecilia Rouse. They demonstrated that when the top US orchestras, which were dominated by men, introduced blind auditions for new members, women became several times more likely to be offered jobs.

Another obstacle to women’s achievement is motherhood. Goldin, with Lawrence Katz and Marianne Bertrand, studied alumni from Chicago’s Booth School of Business. Men and childless women have almost indistinguishable earnings; once women start having children, the gap between them and men begins to widen. (Why this might be is itself a good question.)

Another possibility is that men and women act differently in some important way. The Why Axis, by economists Uri Gneezy and John List, explores this with a series of experiments. Gneezy and List are interested in the different sexes’ appetite for competition, and performance in competitive situations.

A simple experiment requires subjects to throw a ball into a bucket. They are offered two deals: a cash bonus for every ball that hits the target or a head-to-head match, with the winner getting three times the per-ball bonus but the loser getting nothing. Gneezy found that in the US, men tended to prefer competition and women avoided it. The same was true when the research was carried out in a patriarchal tribal society – the Masai of Tanzania.

Among the Khasi of northeast India, the situation was reversed: the women liked to compete and the men did not. Why the difference? The Khasi are a matrilineal society, and one where men have fewer economic rights than women. List and Gneezy conclude that while women generally avoid competitive pressure, this tendency must be at least partially the result of socialisation because it does not apply to the Khasi.

How should we respond to this analysis? Many essentially non-competitive jobs are filled through an intensely competitive recruitment process; perhaps that’s something we can change? List and Gneezy suggest exposing girls to more competitive situations but they also put in a word for single-sex education. They are aware of the apparent contradiction.

Here’s another tangle: Gneezy and List describe one experiment in which job adverts were posted with an hourly rate. When that rate was described as “negotiable”, both sexes haggled for more pay with enthusiasm. If negotiability had not been mentioned, the men haggled anyway but the women tended not to. Women were also more likely to apply to an advert, relative to men, if the wage was “negotiable”.

Gneezy and List conclude that employers should be explicit that wages are negotiable. But they also point to evidence that women prefer to buy cars that are offered at non-negotiable prices. What should we conclude? That women are attracted by negotiable wage rates but repelled by negotiable car prices? Expect no silver bullets here.

It’s clear that we haven’t cracked the glass ceiling just yet. But no matter how intractable the subject, there’s always a place for good empirical work: let’s hope that List, Gneezy, Rouse and Goldin continue to examine what that ceiling is really made of.

Also published at ft.com.

A universal income is not such a silly idea

The concept of paying people to sit around has an upside, writes Tim Harford

‘Swiss to vote on 2,500 franc basic income for every adult.” Reuters, 4 October 2013

How much is that?

It’s about £1,700 a month – over £20,000 a year.

Payable to whom?

Everybody, or at least, every adult citizen. It’s called a “basic income” and everyone gets it, no strings attached.

You have to be joking.

We’ll have to see whether the Swiss think it’s funny or not – they are holding a referendum, which is something they do quite a lot. But the idea of a basic income suddenly seems to be back on the radar after many years of being out of fashion. The New York Times announced recently that at the cocktail parties of Berlin there is talk of little else; US policy wonks are getting excited about it too.

This sounds like some communist plot. How can anyone take seriously the idea of paying people to sit around on their backsides?

The idea is endorsed not only by experts on inequality such as Oxford’s Sir Tony Atkinson, but by the late Milton Friedman, an unlikely communist. The idea of a basic income is one that unites many left- and rightwingers while commanding very little support in the mainstream.

What on earth did Friedman see in the idea?

He saw an alternative to the current welfare state. We pay money to certain people of working age, but often only on the condition that they’re not working. Then, in an attempt to overcome the obvious problem that we’re paying people not to work, we chivvy them to get a job. Our efforts are demeaning and bureaucratic without being particularly effective. A basic income goes to all, whether they work or not.

And nobody would.

Well, maybe. If the basic income was something more modest than the Swiss campaigners have in mind – say, £75 a week, roughly the level at which the UK’s Income Support is paid – then I think most people would want to supplement that. There wouldn’t be a sudden withdrawal of benefits, so seeking part- or full-time work would be straightforward. Some advocates of a basic income see the prospect of voting with your backside as an advantage of the proposal: it would encourage employers to make low-paid jobs less uncomfortable and degrading.

Your strategy appears to be “try it and hope”.

I’m not entirely convinced of the idea myself, but I do think it should be taken more seriously than it currently is in the UK. Unlike many utopian policies, this has been tried with a set of rigorous experiments in the US in the late 1960s and 1970s. It turns out that people do work less if offered a basic income – but the effect is not dramatic by any means.

This can’t be affordable.

That depends on whether people withdraw en masse from the labour force. If most people keep working, as I would expect, the idea is less expensive than it might seem. The basic income could replace all sorts of benefits, and would also presumably replace the personal allowance for income tax. In some ways the size of the state would have to rise: some tax, such as VAT, income tax, or both, would have to raise more money. In other ways the size of the state would shrink. This is what appeals to some conservatives: Friedman believed that with a reasonable basic income for all, the welfare state as we know it would wither.

What about special cases – people with severe and expensive disabilities?

Friedman argued in Free to Choose, a book published in 1980, that such cases would be few enough that private charities would deal with them. I am not sure the modern world would accept that answer. And this does point to a general concern about basic income schemes: they look efficient and neat on paper but in reality one suspects that the complexities of the modern welfare state would fail to disappear. We would probably have exemptions for immigrants, housing allowances for Londoners, and all the rest.

I still think we’d get a country full of layabouts.

That’s the risk, I suppose. There is an alternative way to look at all this: an increasing number of economists are beginning to worry that technological change may make large numbers of people completely unemployable. In short, the robots are coming to take our jobs. These concerns have been wrong before, but perhaps this time really is different. If so, we’ll need an economic system that can cope when lots of people have no way to making a living. I wonder if everyone has a basic income in Star Trek.

Also published at ft.com.

Let’s Make More Misstakes

My talk in 2012 at the Sydney Opera House’s Festival of Dangerous Ideas is now on YouTube, which makes it easier to embed. Enjoy!

27th of November, 2013SpeechesComments off

Could Scotland handle its debt?

‘The essential problem is that an independent Scotland would struggle to deal with a debt burden that the UK as a whole finds manageable’

Everybody knows that the financial crisis has put a dent in the ambitions of Scottish nationalists. Alex Salmond’s “arc of prosperity” comparisons to Iceland and Ireland turned from inspiring to embarrassing almost overnight. It also didn’t escape anyone’s notice that the two largest banking basket cases were headquartered in Edinburgh, with titles that included “of Scotland”.

Scottish nationalists may struggle to overcome the political consequences of all this. But the crisis also created a profound economic obstacle to independence: the UK government’s large and rising debt. Westminster’s economic policies may prove too much for Holyrood to handle.

The essential problem is that an independent Scotland would struggle to deal with a debt burden that the UK as a whole finds manageable. This isn’t fair – but that’s the bond markets for you.

Exactly how much UK debt Scotland would shoulder would be negotiable, but there are estimates. One, by Angus Armstrong and Monique Ebell for the National Institute of Economic and Social Research, puts Scotland’s likely debt burden at 86 per cent of GDP in 2016/17, using Maastricht treaty definitions. This assumes Scotland acquires most of the UK’s oil and gas but only 8.4 per cent of the UK government’s debt, in line with its population. (Armstrong and Ebell outline other possibilities, many less favourable to Scotland.)

Is that 86 per cent a big number? In some ways no: it’s less than the debt/GDP ratio the continuing UK would face, and the UK has so far faced no trouble finding lenders to finance its continuing deficits.

But a realist would have to look at that debt/GDP ratio as a serious problem for Scotland, and not just because it is a world away from the 60 per cent limit customarily demanded of eurozone entrants. Scotland would be an unknown quantity to international bond investors. It would be a small economy, dependent on volatile hydrocarbon revenues, with no liquid market for sovereign bonds yet established, and no track record.

The likely consequences: higher interest payments. And with a debt/GDP ratio approaching 90 per cent and (just like the rest of the UK) a substantial ongoing deficit, high interest payments would be painful. All of this would have been a non-issue before the crisis broke.

Then there’s the transition: Scotland could not simply assume UK government debt, because bondholders have lent money to the UK government, not to Scotland. Scotland would presumably need to borrow, oh, £125bn or so – either from the rest of the UK or from the bond markets – and use it to retire its chunk of UK debt. That’s a lot of money to raise all at once, and even a small premium on that transaction would cost each Scot hundreds of pounds at a stroke.

The debt problem bears directly on a more familiar debate: what currency should an independent Scotland assume – the euro, sterling, or a Scottish currency? The euro is out of the question for now. Before the crisis, the UK’s (and Scotland’s) debt/GDP ratio was well inside eurozone accession criteria. It has roughly doubled since.

Sterling would be a tricky choice too: Scotland would have to run a contractionary fiscal policy to stabilise its debt in the face of a possibly sceptical bond market. That would be tough to do if Scotland had ceded control of monetary policy to a non-Scottish central bank (just ask the Spanish).

The most likely option is an independent Scottish currency. That would give Scotland’s government room for manoeuvre by printing money, though it would also increase the likely interest rates on Scottish debt, as investors would want compensation for the risk of a currency devaluation.

Scotland’s future debt burden is not a fatal obstacle to independence. And it is not Salmond’s fault. But it has become his problem.

Also published at ft.com.

Betting against London is tempting but no sure thing

There is far more to the British capital than hot money and hot air, writes Tim Harford

Shanghai’s Pudong district soared out of a swamp in a few short years; Dubai bloomed in a desert. London is too venerable for such sudden efflorescence, but the City is trying its best to sprout skyscrapers. The infrequent visitor cannot fail to be struck by the line of new buildings striding north from the Shard at London Bridge: the Walkie-Talkie, the Cheese-Grater, the Heron Tower, Broadgate Tower. The City’s first skyscraper, then the National Westminster Tower, was completed in 1980; it took a generation to add a second, the Gherkin. Now both are lost amid a fairground of new stunt architecture. There is more to come.

Meanwhile, the only thing Londoners themselves can discuss is the rapidly inflating price of the houses they have bought – or cannot afford to buy. The joke used to be that the typical London house was earning more than the typical London household. Today it is no longer a comic exaggeration.

To add to the air of insanity, there is talk of “lights-out London”. Rich foreigners are snapping up prime property for tens of millions of pounds, digging out multistorey basements that would shame Tolkien’s Mines of Moria, and then leaving them empty while they sail around in gigantic yachts.

It is all rather unnerving. So when Cory Doctorow, an author and blogger, recently posted the question, “How would you short London?” he seemed to be raising something vital. Shorting London property is not too hard – betting against the shares of Capital and Counties or Great Portland Estates should do the trick. (I have not yet figured out how to bet against luxury hair removal salons or overpriced steak houses.) But the deeper point is not how to short London but whether it has set such a hubristic course that nemesis is inevitable. There seems to be something feverish and surreal about London these days. The contrarian in me whispers that it will all end in tears. Will it?

It is worth teasing apart different parts of the madness. The idea of lights-out London can be dispelled by five minutes walking down Oxford Street, or a single attempt to make a tube journey between the hours of 8am and 9am. London is heaving: the shops are full, the pavements are spilling over, the streets are clogged with traffic and the public transport system is crammed. Some foreigners are buying second homes in central London but the numbers seem to be very low. Soho is in little danger of becoming a ghost town.

The skyscrapers are a separate facet of the London craze. One can quibble with the selfish, attention-grabbing architecture. Even if the Walkie-Talkie with its heat-focusing curved sides has stopped destroying nearby property, it is a bully of a building that will do London no favours.

Yet the scale of the building effort itself is less insane than it might seem. London is making up for lost time. New Yorkers would chuckle at the idea that the Heron Tower alone was plenty big enough for one decade’s worth of growth. The housing bubble looks more serious. One measure of that is the gross rental yield, which – reckons property search engine Home.co.uk – is below 3 per cent in the prime west London postcodes, and below 5 per cent in much of the rest of the capital. Those yields look like a recipe for trouble when interest rates rise – which they will.

But what do I know? I have been convinced that London’s housing is overvalued for at least a decade. The longer the boom continues, the more I doubt myself – even if the evidence of unsustainability just gets stronger.

Robert Shiller, one of this year’s Nobel memorial prizewinning economists, has long been my guide to bubble spotting. Perhaps in the hope of teasing fellow economists he has taken to treating a bubble as a condition best diagnosed with a psychiatrist’s checklist: “Sharp increases in the price of an asset like real estate or dotcom shares; great public excitement about said increases; an accompanying media frenzy …” Tick, tick, tick.

The most interesting question is the hardest to answer: is London’s innovative and cultural dynamo in danger of slowing down? Perhaps rich Russians and Saudis will live in Chelsea, their needs taken care of by armies of Poles commuting in from Bromley and Walthamstow, while French and American bankers will sleep four-hour nights in luxury flats in Canary Wharf and work flat-out the rest of the time. The entire mega-city, in this scenario, would contribute to the UK only in the way that an oilfield in the Thames Estuary would. The capital would be a plug-and-play, could-be-anywhere financial hub grafted on to a London experience theme park for visiting billionaires.

Perhaps. I am struck by how heavily this dystopian vision leans on the idea that foreigners are to blame – an idea that always seems to engender panic and shut down the critical faculties. “It’s foreign investment, buy-to-lets,” one estate agent recently told a worried Guardian columnist. But that does not mean Brits cannot live in London. They can – but often as tenants of a foreign landlord who may well have overpaid.

It is possible for a neighbourhood to become a victim of its own success. Low rents attract artists, new businesses, experimenters and risk-takers. The neighbourhood becomes cool; rents rise. Eventually only middle-aged, middle-class squares live there. (Or – gasp! – rich foreigners.) But it is hard to see this applying across an entire city. Some fret that Manhattan is becoming a bore. It still seems passably diverting to this tourist, and even if Manhattan is tedious, Brooklyn is picking up the slack. As in New York, so in London: if Shoreditch becomes too pricey for bearded hipsters making artisanal pickles, there’s always Bow or Clapton Pond.

London is too economically diverse and too socially cosmopolitan to turn into a high-rent economic desert. As Europe’s only English-speaking world city – apologies to Amsterdam, Birmingham, Dublin, Manchester and Glasgow – it is a magnet for English-learners and English-speakers from across the EU. It is a centre not only for finance and tourism but education, media, technology, food, design and the arts. It is a hub for the British and a gateway to Europe for the rest of the world. The housing bubble looks likely to burst. But there is more to London than hot money and hot air.

Also published at ft.com.

How did space become junk’s final frontier?

‘Space hasn’t been made impassable by debris just yet. There’s quite a lot of room, after all’

I don’t think I’m spoiling too many surprises when I reveal that the plot of the film Gravity, a low-orbit spectacular starring Sandra Bullock and George Clooney, involves spacecraft getting hit by space debris. It’s a less fanciful premise than it might seem: in 2009, two unmanned satellites hit each other without warning, nearly 800km above Siberia.

That collision heralded a serious problem, first flagged in 1978 by Donald Kessler, then an astrophysicist at Nasa. The concern isn’t that space debris will rain down on us here on Earth: it’s that it will stay up there in space.

The two satellites that collided, Cosmos-2251 and Iridium-33, weighed almost a ton and a half altogether. The result was at least a thousand fist-sized chunks of metal, any one of which could destroy a further satellite, and produce hundreds of further chunks. It takes time for these chunks to fall out of orbit.

What worried Kessler – and still does – was the prospect of a chain reaction. Too much debris in orbit would make it impossible to launch the satellites that have become an indispensable part of life back on Earth.

Nasa is tracking 21,000 pieces of junk 10cm across or bigger – like small cannonballs. In low Earth orbits, they are travelling at about 7km a second (25,200km/h). But space hasn’t been made impassable by debris just yet. There’s quite a lot of room up there, after all. Low Earth orbits are common but include a variety of altitudes, so objects have plenty of ways to fail to hit each other. Geosynchronous orbits, popular with communications satellites, must be exactly 42,164km from the centre of the Earth. But satellites that far out share more than 22bn sq km of space.

Still, some orbits are more crowded than others; more collisions are surely just a matter of time. That was the opinion of a 2011 report from the National Academy of Sciences, “Limiting Future Collision Risk to Spacecraft”, which argued that there is already enough junk crashing into other junk that the problem will worsen even if there are no further launches.

Deliberately moving the debris somewhere safer seems possible, but pricey. It’s expensive to tidy up a satellite – or to design one that tidies itself up – and while the benefits of doing so are widely shared, the costs are not. So the clean-up doesn’t happen.

The regulation of satellites is no simple matter: Cosmos-2251 was launched by the Russian military; Iridium-33 by a US corporation. The single largest space-junk incident was in 2007, when the Chinese military blew up a satellite just to show that it could. The regulatory authority capable of dictating to all three of those parties does not exist. (The United Nations did issue voluntary guidelines in 2010.)

Economists such as Molly Macauley of Resources for the Future, a think-tank, have been pondering this problem for some time. The obvious economic solution, recently revived by three researchers, Nodir Adilov, Peter Alexander and Brendan Cunningham, is a tax on new satellite launches. Macauley has proposed linking the level of this tax to the design of the satellite – safer designs would attract a lower charge. Another possibility is that satellite operators would put down a deposit, to be refunded once the obsolete satellite had been pushed into a safer orbit.

This is one of those all-too-common situations when it is easier for economists to announce the optimal policy than it is for politicians to implement it. As with climate change, there’s a burden to be shared here, a threat of uncertain magnitude, and plenty of opportunity for free riding.

Yet this is a far cheaper problem than climate change, with a smaller number of decision makers. It should be easier to reach an agreement on space junk than on greenhouse gases. Alas, that is a not a very encouraging comparison.

Also published at ft.com.

Swallow your contempt – Wonga is the symptom, not the problem

Disdain is no guide to regulating a socially useful sector, writes Tim Harford

I believe it was December 1980 when my father sat down with me and warned me gravely that the central heating had broken down. It would cost money to repair, money that simply could not be summoned out of thin air. I should not count on getting the toy I wanted (a Lego Space Cruiser, in case you were wondering). I considered myself duly warned.

Such a conversation is hard to imagine today. Why empty such a big bag of sadness over the head of a seven-year-old Lego fanatic? Why not, instead, log on to Wonga.com and borrow a cheeky £150, just until payday at the end of December? Wonga would charge £27.99 interest, plus a £5.50 fee – is £33.49 really too big a price to pay for the happiness of a young boy?

But the story will not end there, will it? The total repayment of £183.49 after 18 days might not sound such a lot, but it is an effective annual interest rate of almost 6,000 per cent. At 6,000 per cent a year, the money to buy a pricey toy one Christmas will balloon into a debt that could have paid for a small car by the year after – and a large house the year after that.

That would seem usury enough. But there are more serious dangers lurking for an unwitting borrower. Wonga charges £30 for late payment, substantially increasing the cost of the loan for the most vulnerable. At that point, the hapless borrower’s credit rating will start to slide, and he will find himself unable to tap into more conventional sources of credit.

It is a minor tragedy: the journey that begins by buying the toy for the much-loved child ends not long afterwards with a treacherous plunge into financial ruination.

Wonga has found itself surrounded by critics, naturally enough. Justin Welby, the Archbishop of Canterbury, announced this year that he would compete them out of existence. (That’s a tough proposition: you don’t compete with Wonga on price but by offering faster access to more convenient, less-scrutinised loans.)

A parliamentary select committee toasted representatives of the payday loan industry this week. When Ed Miliband, the Labour leader, sought a phrase to summarise all that is wrong with life in Britain under his political opponents, he settled on “the Wonga economy”. But there was worse: financial guru Martin Lewis, a man with a knack for attracting the spotlight, condemned payday loan companies for “grooming” young people with catchy advertisements on children’s television channels. When your critics borrow language that is normally reserved for sexual abusers of children, you have an image problem.

This conversation has turned into the country’s favourite pastime: a witch hunt. Little good will come of it.

Start with Wonga in particular. It is suffering the fate of many industry leaders: precisely because it is a familiar brand, critics attack it for what it symbolises more than for what it does.

In the 1990s, Nike found itself shouldering the blame for sweatshops everywhere; in the 2000s, Starbucks came to represent the oppression of coffee growers; more recently, when activists wanted to raise concerns about Chinese labour conditions, they went for Apple. This is understandable as a campaigning strategy but makes for poor policy.

Some of the specific allegations against Wonga look hysterical. Wonga is not trying to sell loans to five-year-olds. The company advertises on children’s TV, one surmises, because parents of young children are prime candidates for emergency loans. That is not pretty, but let’s call a spade a spade rather than calling it a cluster bomb.

Nor could Wonga be accused of lacking transparency. The fees, the four-figure interest rates, the late payment charges, the impact on credit ratings: everything is laid out on the website in the simplest and clearest terms imaginable.

No high-street bank comes close to this clarity, and an unauthorised overdraft may cost far more than the loan that prevents that overdraft. Outcompeted on convenience, on comprehensibility and perhaps even on price by the likes of Wonga, Britain’s banks should hang their heads in shame.

But while critics of payday lending may content themselves with attacking Wonga, its defenders cannot merely protest that it is the best of a bad lot. The real question is what to do about payday lending in general. The focus on “grooming” or deceptive terms and conditions allows us to look away from the real problem – which is that an adult can be presented with unambiguous facts about a payday loan but still do something she comes to regret.

The twist is that a payday loan can do real good, as a cash injection that helps avoid far more serious financial consequences, such as the loss of a job because the car broke down or penalty charges for failing to pay a bill on time. A randomised trial conducted in South Africa showed that this was not just a theoretical possibility. The experiment randomly approved or rejected applications for loans at an annual percentage rate of 200 per cent. Those who received one ended up better off than those rejected.

This is the problem. One person uses a payday loan to buy the suit he needs for the job interview, and gets the job; another person uses a payday loan to buy lottery tickets. I know of no law that can allow one case and forbid the other. Transparency and fair dealing is no guarantee of happy outcomes. A cap on interest rates will do no good, because for small short-term loans the interest rate is not a meaningful measure of what the loan costs.

I view the payday loan industry with disdain. I cannot imagine using it myself and would be horrified if I knew that a close friend felt the need to turn to Wonga for help. But my personal contempt for the industry, from my position of privilege, is not much of a guide to how we should regulate it.

The world is full of products that people demand yet seem harmful, from cigarettes to lottery tickets. That is not capitalism gone mad: it is simple evidence of human frailty. I sympathise with Mr Miliband’s discomfort at living in the “Wonga economy”.

But Wonga did not create modern Britain; modern Britain created Wonga.

Also published at ft.com.

What’s so scary about insider trading?

‘The awkward truth about the practice is that it’s far from clear that it should be illegal’

It was Halloween on Thursday, so let’s meet a frightening ghoul who haunts our financial markets: the insider trader. The Halloween metaphor is not mine but that of economist Donald Boudreaux, who asks if the insider trader is a genuinely dangerous monster or a comical apparition in a fright mask, fit only for the scaring of children.

Attacking insider trading has a singular advantage for regulators and journalists alike: short of swiping money from the cash register, it is the simplest financial crime to understand. The frauds perpetrated at Enron or, a generation earlier, the Equity Funding Corporation, defy any simple explanation. Insider trading – making money by trading on confidential information – is an easy sin to attack. Yet the awkward truth about the practice is that it’s far from clear that it should be illegal.

A school of thought on the libertarian wing of economics has long argued that insider trading is at worst harmless and perhaps even beneficial. The most famous proponent was the late Milton Friedman; more recently the likes of Boudreaux, a professor at George Mason University, have called for its legalisation.

The case for legalisation has several pillars; let’s consider three. First, despite intensive monitoring, it’s hard to detect and even harder to prove. Much insider trading clearly occurs without detection – why else does the share price of acquisition targets tend to rise sharply before the acquisition is announced? And people with inside information can often profit simply by not taking action when the uninformed take actions they later regret.

The second point in favour of legalised insider trading is that market prices are supposed to reflect all available information, the better to allocate capital. Insider trades simply hasten that process. This argument is not hugely persuasive on a day-to-day basis but there’s certainly a case that insiders at Enron or the Equity Funding Corporation might have exposed misdeeds sooner if they had felt able to profit by short selling the stock. (A footnote: Ray Dirks, the analyst who did a great deal to expose the Equity Funding scandal, was pursued for insider trading of Equity Funding stock before being acquitted by the US Supreme Court.)

The final defence of insider trading is that it’s a victimless crime: if you want to sell your shares in Tim Harford Corporation, and I know that record profits are about to be announced, then my swooping in to buy your shares does you no harm: you would have sold them anyway, and you received a better price because I was willing to buy.

The common sense reason to ban insider trading – that it just doesn’t seem fair – is flimsy. So is the argument that small investors won’t play the game if they feel it’s rigged: small investors are at a disadvantage, anyway, and should see that disadvantage with clear eyes.

But there are two reasons to ban insider trading that seem compelling, neither of which receive enough attention in this debate. The first is that insider trades raise the cost of being a market-maker. When secret good news is in the air, insiders will snap up stock. Market-makers will be left holding none, just as the price is rising. Conversely, insiders will dump shares on market-makers just before disaster is about to be revealed. The spreads that market-makers offer must be wide enough to reflect this risk; consequently, we all pay more because of insider trades.

The second worry is that if managers can trade easily on inside information, they have an incentive to take big risks. If you could place bets after the roulette wheel had stopped spinning, you’d spend your days down at the casino. Even if insider trading might make financial markets more efficient, it might also encourage reckless decisions in the rest of the economy. That possibility alone is enough to give me nightmares.

Also published at ft.com.

Why can’t banking be more like baking?

The last time a bread maker laid waste to the City was 1666, writes Tim Harford

“It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest.” Adam Smith, The Wealth of Nations

A tender medallion of steak, a foaming pint of bitter and a crusty roll still hot from the oven – no wonder that Adam Smith chose an alliterative trio of artisanal food providers to make his point about the benefits of capitalism. If he had chosen a junk bond salesman, a fund manager, and a quantitative analyst, wielding a Gaussian copula in an effort to price a synthetic credit derivative, his defence of the market mechanism might not have resonated down the centuries in quite the same way.

Smith’s point was a good one. We are unlikely to give our custom to butchers who poison us, brewers who serve foul beer or bakers who overcharge; food sellers find it profitable to serve decent food at reasonable prices. The system needs some oversight – hygiene inspectors, trading standards officers, the Competition Commission – but the main engine of quality is the market mechanism. People prefer cheap and delicious food to food that is pricey and tastes horrid – and that fact alone delivers more than regulators ever could.

For some reason, that does not seem to be true of financial services. No food regulator has ever described bakers as engaged in “socially useless” activity, a term Lord Turner levelled at the industry in 2009, when he was chairman of the UK’s Financial Services Authority. Mark Carney, the governor of the Bank of England, recently looked forward to the UK banking sector becoming even larger and more “vibrant”. He added that some would “recoil in horror” at the prospect, which some already have.

Surely nobody has ever recoiled in horror when a French technocrat expressed the hope that France would produce and sell lots of wine. Or when a Japanese minister wished the Japanese car industry well. There is something different – something sinister – about the financial services industry these days. So what is the difference between the baker and the banker?

The first difference is competition. This is partly about pluralism: there are lots of places to buy bread, but not so many to get a mortgage, or for that matter to underwrite an initial public offering. It is a devil of a job to set up a bank – and even harder to attract stuck-in-the-mud customers.

More fundamentally, many consumers of financial services cannot tell a good product from a bad one. The spectrum runs from payday loan customers unable to grasp quite what the loan is going to cost them, to people saving for a pension amid a fog of confusing charges, to clients of Goldman Sachs who bought into a subprime mortgage deal called Abacus 2007-AC1. (They did not realise that Abacus had been constructed with input from the Paulson & Co hedge fund, which was betting that the entire thing would implode.) It seems nobody is safe.

In a speech about the UK’s asset management industry this week, Clive Adamson of the Financial Conduct Authority quoted economist and Nobel laureate George Akerlof: “In a market plagued by asymmetries of information, the quality of goods will decrease and the market will come to be dominated by crooked sellers and gullible or desperate buyers.” Mr Adamson added that he did not mean to apply this description to UK asset managers; however it is hard to see why else he said it.

At the same event, Mr Adamson’s boss, Martin Wheatley, fired a shot across the UK asset management industry’s bows – although even trying to understand quite what Mr Wheatley is worried about will have the ordinary punter’s brain bleeding out of his ears. In a nutshell, some of the people who buy, sell and analyse shares are paying some of the people who run companies to meet up with some of the people who pick the stocks that go into the investment funds that your pension fund is buying. Mr Wheatley thinks that is OK, but the price tag for all this needs to be more transparent. (No, I don’t understand either.)

It is a safe bet that when the regulator cannot even clearly explain the commercial activities that are worrying him, the market has become too complex and opaque to deliver happy results.

If all that was wrong with finance was that customers at every level were repeatedly being ripped off, that would be one thing. But it gets worse. Income from banking is highly concentrated. When an economy – such as the UK’s – becomes highly dependent on financial services the effect can be a little like the phenomenon of “Dutch disease”, which afflicts oil-producing countries.

If a nation exports a lot of hydrocarbons, their exchange rates may appreciate, which means that it is difficult for those petro-states to compete doing anything except selling oil. As a result their manufacturing and industries decline. Similarly, it is difficult for bank-led economies to compete doing anything except selling financial services. And this matters if the employment in these sectors is slim. It would be going too far to suggest that either the City of London or Britain’s North Sea oilfields are a curse – but they are not an unadulterated economic blessing, either.

Then there is the fact that banking has a tendency to blow up, causing tremendous collateral damage. The last time a baker laid waste to the City was 1666, when one accidentally triggered the Great Fire of London; bankers seem to be able to perform the trick more frequently.

Mr Carney, and other financial regulators across the world, are forced to deal with a sector that combines the most unattractive features of the oil industry (well-paid jobs inflate the currency), the nuclear industry (occasional blow-ups and meltdowns) and the second-hand car industry (enough said).

What can be done? A wise course of action is to look for structural reforms that will make banking function a little more like baking. But there seems to be something irreducibly problematic about finance. I wonder if even Mr Carney will be able to make the market for pensions work like the market for croissants.

Also published at ft.com.


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