Monthly Archives: July 2008

I think the conversation going on at the Creative Capitalism blog is interesting. I was pleased to be asked to join in.

Bill Gates put a lot of emphasis on “recognition” as a “market-based incentive.” I think that’s worth examining closely. Many contributors has argued about whether it’s legitimate for a company’s managers to divert resources to social ends – with Steven Landsburg, and the spirit of Milton Friedman, at the heart of the debate. But there’s another question here: would this work? Will the quest for a good corporate name actually provoke the behaviour we’d like to see?

By Tim Harford

In his Davos speech, Bill Gates sketched out several ways in which capitalism might better serve the poor.

One is that corporations should just get smarter at finding profit opportunities “at the bottom of the pyramid.” No harm in that, but at Michael Kinsley and Warren Buffet both point out in their discussion, we’d expect most of the available market opportunities to be filled already.

Another is that governments should take a role in providing incentives to help the poor. One direct way to do that is to establish prizes or quasi-prizes for companies that develop vaccines for diseases of the poor. (I discussed that development in a feature for the Financial Times magazine in January.) Another is to use aid money to purchase services for the poor – so-called “output-based aid.” And there are other possibilities too, although the example Gates gives, of rewarding philanthropic pharmaceutical firms with priority drug approval on another product, raises more questions about the waste involved in the US drug approval system than about creative capitalism.

But Gates put most emphasis on “recognition” as a “market-based incentive.” I think that’s worth examining closely. Many contributors has argued about whether it’s legitimate for a company’s managers to divert resources to social ends – with Steven Landsburg, and the spirit of Milton Friedman, at the heart of the debate. But there’s another question here: would this work? Will the quest for a good corporate name actually provoke the behaviour we’d like to see?

I am not sure. Think about how the quest for recognition might work as a “market-based incentive.” Corporations would hope that by doing good things, or avoiding bad behaviour, they’d win loyalty from employees, business from customers and suppliers, or cheaper funding from socially responsible investors. If the cost of doing the right thing is less than the reputational benefit, well, that’s a successful market-based incentive to be a good corporate citizen.

Great. But when would it work?

First, firms must be long-lasting and patient enough to make the investment in good behaviour up front, in anticipation of a reputational reward.

Second, the rewards for good behaviour or punishments for bad behaviour must be easy to inflict. It is easy to boycott a particular brand of gasoline or to buy a cool RED product. It is a bigger deal to resign from a company on ethical grounds.

Third, it must be easy to spot good behaviour and bad behaviour. Firms must realise that their actions really will have consequences for their reputation, consequences that can’t be duplicated with a nice advertising campaign.

Fourth, the company’s potential reputation must be worth more than the expense of doing the right thing.

Recognition works as a market-based incentive when these four conditions are met, and I’m just not convinced that that will happen often enough.

Think about successful reputational campaigns and you start to realise how exceptional they are. Following bad publicity about sweatshops, Nike is now regarded by many as a leader on labour standards. But Nike, which is basically a marketing outfit, finds it fairly cheap to respect these standards and very beneficial to do so. What have less prominent sportswear brands been doing? Who cares? Nike put resources into setting up collaborative bodies for responsible behaviour, but many less famous competitors declined to join. So this is a “recognition” incentive which has been a success only in a very narrow way.

Product RED is a terrific idea, but again, cheap to implement and reliant on a few very brand-conscious firms, for whom recognition is very important.

Contrast such efforts with the mid-1990s campaign to get Shell out of Nigeria, then run by the dictator Sani Abacha. Shell cares about recognition, for sure, but no reputational damage was ever likely to outweigh the cost of halting oil production in Nigeria. It is no surprise that Shell stayed and took the bad publicity on the chin.

Other companies who produce commodities, intermediate goods or non-branded products – memory chips, copper, rice – are unlikely to be seriously affected by reputational concerns.

My final worry about recognition is that we do not always recognise behaviour that will truly help the poor. A simple example: a friend of mine recently bought shoes made in Italy rather than shoes made in Romania, specifically because she was worried (in a rather vague way) about encouraging sweatshop labour. That’s a valid concern, but clumsily expressed. I worry that most of us, being simple human beings, will also clumsily express our desires to make the world a better place, as shareholders, customers or employees. If I’m right, recognition will be an even blunter tool.

I share with Bill Gates the conviction that capitalism has a huge role to play in helping the poor. But I am not convinced that the recognition mechanism is what will make that happen.

I wrote a longer (but still brief) note on this subject with Michael Klein, Chief Economist of the International Finance Corporation. The note is available here.

I’m taking some holiday over the next few weeks, and when not taking holiday I’ll be writing furiously to cover for my colleagues who are also taking holiday. Posting will be less frequent – sorry – but I’ll try to get a couple of posts a week up here, and my two Saturday columns will also be posted here, as usual.

Humans don’t take kindly to outsiders: history is heaped with the corpses of those who were lynched, bayoneted or gassed because of their race, religion or nationality. Even within the relatively civilised sphere of economic relations, there is plenty of room for discrimination. People earn less because of their race or their sex, even in the richest countries in the world.

For example, according to a recent summary by the economists Michael Clemens, Claudio Montenegro and Lant Pritchett, white men earn 27 per cent more in the US than white women. That figure compares the hourly wage of full-time workers with similar qualifications and experience. Again making best efforts to compare like with like, the economists found that white men earn 7 per cent more than black men in the US. Look back to 1939, and the like-with-like wage premium for whites in the US was 60 per cent. In modern Pakistan, meanwhile, men earn three times as much as equally qualified women. None of these numbers is trivial: most are appalling.

 The remainder of this column can be read here. Please post comments below.

I pay someone to clean my car three times a week. He usually does a good job of it. However, I often travel and as soon as I’m gone, the cleaner stops work. So I always come back to a dirty car.
I pay him even when I’m not around. Shouldn’t he at least clean the car the day before he knows I will return, thus pretending to have been cleaning it regularly?
DT, Bahrain

Dear DT,

I can think of three explanations for this behaviour. Either the cleaner is too stupid to realise he should be skiving more subtly, or he thinks you are too stupid to notice, or he does not care if you notice.

If he is stupid, or he thinks you are stupid – don’t ask which – the solution is easy: say you’ve noticed that the car is dirty and ask him to clean it before you return.

If he does not care, that means he can try to get an equally good job elsewhere. Since the current job comes with frequent paid holidays, that is unlikely – unless you are being especially stingy.

I suggest sharper incentives. Tell him you’ll pay him a bonus if you return to a clean car. Frankly, since you are paying him to clean an unused car, incessantly, and he isn’t doing it, any change is likely to be an improvement.

Questions to economist@ft.com

I met a fellow called Tim Kruger this week, who was keen to tell me about his idea for a process to suck carbon dioxide out of the atmosphere. (NB: Kruger and I both used to work for Shell, and Shell has also provided some seed money to him.)

Here’s the thinking:

    * First, you heat limestone to a very high temperature, until it breaks down into lime and carbon dioxide.
* Then you put the lime into the sea, where it reacts with carbon dioxide dissolved in the seawater.

The important point is that when you put lime into seawater it absorbs almost twice as much carbon dioxide as is produced by the breaking down of the limestone in the first place.

This has the effect of reducing the amount of carbon dioxide in the atmosphere. It also helps to prevent ocean acidification, another problem caused by the increase in the amount of carbon dioxide in the atmosphere.

If done on a large enough scale it would be possible to reduce carbon dioxide levels back to what they were before the Industrial Revolution.

Apparently, the pure CO2 produced in stage 1 is potentially a useful product – unlike the emissions from burning fossil fuels. And although the process is hugely energy-intensive, Kruger hopes to use “stranded energy” – flared natural gas, solar energy in desert regions, and other situations where energy is available but too far from civilisation to be much use.

Will it work? My natural scepticism says not: too many weak links in the chain. But it’s not absolutely impossible.

Why am I mentioning it? Two reasons:

1) It is always worth remembering that CO2 emission-reduction is not the only possible way to deal with climate change. This is a problem that will play out over the next century, and over the next century, our technology is likely to advance along the way. (But not necessarily in a helpful direction, unless we have a credible price on carbon emissions.)

2) I’m also intrigued by Kruger’s “anti-patent” space. He’s trying to mimic the open source software model for a non-software project. Reckon that part of the idea might work and/or catch on? I’ve no idea.

Other nutty-sounding methods for taking carbon dioxide out of the atmosphere are here.

Andrew Dilnot (my predecessor on More or Less) and Michael Blastland report. The summary:

1) House prices are up

2) Employment rate is high

3) Inflation is down

4) Lower earnings are good

5) We’re living longer

Not convinced? See the full story here.

I’m late to the party, but a pokerbot beat some decent human players earlier this month. This is not a huge surprise: when I visited the artificial-intelligence version of the World Series of Poker in Las Vegas in 2005, it seemed likely that this was coming. It will take a little more time to be sure, though: there is a great deal of variance in poker. (Steve Levitt has more on that point – always interesting.)

This is interesting:

A Norfolk headteacher has said there have been no exclusions from his school since he started rewarding pupils with chocolate for good behaviour. Dr Andrew Sheppard began the scheme in 2005, since when exclusion days at Redcastle Furze Primary in Thetford have dropped from 65 a year to zero…

In September 2005, Dr Sheppard pledged to give all 240 pupils a bar of chocolate if they made it to the half time break without any exclusions. The scheme proved so successful it was extended term by term. Since then discos, picnics and Easter eggs have been handed out.

Genius. But:

The School Food Trust said it would be better to use healthy food as a reward.

Oh dear.

Financial Times comment, 19 July 2008
Leonid Hurwicz, the economist who last year became the oldest person ever to win a Nobel prize, helped transform economic thinking in the second half of the 20th century.
For years economists had been passionately debating the rival merits of state planning versus free markets. In both systems, people had incentives to lie to bureaucratic planners or to employers about their interests, their skills or their circumstances. “Leo”, who has died at the age of 90, founded the field of “mechanism design”, a new way of thinking which focused on giving people incentives to tell the truth and to do so in a way that would benefit society as a whole.
His mechanism design idea has applications in a range of practical areas, from the design of computer networks and voting systems to arbitration rules.
The debate between state planning and free markets must have seemed far from academic to Hurwicz. His parents were Polish Jews who fled the Kaiser’s invading army, going to Moscow, where Hurwicz was born in 1917. They returned to Poland in a horse-drawn wagon to escape the Bolsheviks when he was two.

Seebohm Rowntree was the son of the wealthy Quaker businessman Joseph Rowntree, but acutely aware of the poverty that surrounded him in late-Victorian York. In 1899 he set himself the task of defining a “poverty line” by working out how much it would cost to supply basic food, housing and clothes. Anyone who couldn’t afford to buy those basics – including a helping of pease pudding with bacon on Sunday – was below the poverty line.

The idea of a poverty line has stayed with us, but the candidates have multiplied. The World Bank has two poverty lines: a dollar a day and two dollars a day (strictly, those are 1985 dollars adjusted for inflation). In the US, the poverty line is $29.58 a day for a single adult under the age of 65. All these are absolute income standards, just as Rowntree’s was.

Eurostat, the European Union’s statistics agency, takes a different approach: it defines the poverty line as 60 per cent of each nation’s median income. (The median income is the income of the person in the middle of the income distribution.)

This has an unfortunate consequence: poverty is permanent. If everyone in Europe woke up tomorrow to find themselves twice as rich, European poverty rates would not budge. That is indefensible. Such “poverty” lines measure inequality, not poverty, and they do so clumsily.

The remainder of this column can be read here. Please post comments below.

The Undercover Economist: a guide

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