Monthly Archives: February 2009

Performance pay is a tricky business. If you hired me as a hedge fund manager and paid me “2 and 20” – a 2 per cent management fee, plus 20 per cent of any gains – then I’d be tempted to take your money to a roulette table and put it all on black. If I won, I’d get to keep 20 per cent of the gains. If I lost – well, I would have been sure to deduct the management fee first.

If I were instead aiming to top a league table of investment managers, worse awaits. This time, instead of betting on black, perhaps I’d put the money on lucky number seven. If the rewards go to the most successful investment managers, then I need to go for broke – especially since “broke” is more likely to describe my investors than me.

All this is an exaggeration, of course, but discussions of bankers’ bonuses are haunted by visions of this kind of perverse “compensation” scheme. (Annoyingly, we use the word “compensation” as though bankers were being awarded damages after the trauma of executive life.) The popular view of bankers’ bonuses is simple enough: they never deserved to be paid millions anyway, and the fact that they seem to have blown up the world’s economy proves it.

The remainder of the article can be read here. Please post comments below.

Here in India – as in most other parts of the world – there is an assumption that all politicians are corrupt. As such, politics is not the first career choice for most individuals. However, if all politicians are indeed corrupt, wouldn’t that mean that all politicians benefit more than the rest of us? Therefore, shouldn’t the rational choice be that more people join politics? And would “competition” reduce corruption?
Chirag Panjikar, India

Dear Chirag,

You are clearly thinking along the right lines, but the details can be more subtle. I asked Mikhail Drugov, an expert on the economics of corruption from Oxford University, for advice. One of his observations is that politicians may not necessarily make more money from a corrupt system. If, for example, you wish to exploit a political position for personal gain, you may find that to obtain the position, you must pay a substantial bribe to some other politician. On balance, even the most venal political neophyte may decide it is easier to make money by getting a proper job.

Competition may reduce bribes: as the economist Robert Klitgaard famously commented: “Corruption equals monopoly minus accountability plus discretion.” It’s hard to charge a bribe if the official in the next office will perform the same service for less.

But competition does not always reduce corruption. The number of bribes required may rise, even as the size of the bribes falls. And corruption can secure illegitimate services as easily as legitimate ones. Should we be pleased if it becomes cheaper to obtain a driving licence when one cannot actually drive?

When competition does reduce corruption, it is very good news. In such cases, the most feared phrase in politics should be “bipartisan agreement” – for which read “cartel”.

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The Logic of LifeA little bird tells me that the paperback of The Logic of Life is now on the front table in Borders in the UK. Official publication date is Thursday 5th March, but don’t feel you have to wait! Do please consider buying a copy.

Peter Passell has a new website and a new book (Where To Put Your Money NOW) which I’ve not seen yet. Here he opines on Afghanistan:

What to do? It’s easier to check off what won’t work. Crop eradication by high-altitude spraying is both a logistical nightmare and a surefire way to alienate rural residents. Crop substitution is a joke. Paying current farmers not to grow opium would simply lead other farmers to go into the business – and there’s no end of remote land available to raise the flowers. Buying the crop and either using it to make medicinal morphine or simply destroying it is equally problematic. As long as there’s a demand for illicit opium, there will always be a place in Afghanistan to grow it.
Hardly anyone wants to hear that the war in Afghanistan is effectively unwinnable as long as opium is plentiful.

That’s based on an article by Robert Mooney in the Milken Institute Review – which Peter edits. And I’m going to go and check out Peter’s book – and Mooney’s article.

I have started playing the national lottery in an attempt to resolve my worsening financial situation. While I am aware of the improbability of winning, I was wondering if I would improve my chances by sticking with the same numbers rather than using the randomly generated “quick pick”?
Peter, Canada

Dear Peter,

You seem to have a rather charming scenario in mind, with you playing the role of a little lost child, and the lottery machine playing the role of parent, diligently searching for you. This is called a “rendezvous problem”, and, in general, you would be better off staying where you are and letting the lottery machine find you.

With almost 14 million combinations to try, this would take, on average, seven million attempts – about 67,000 years if you play twice a week. Success would be guaranteed after 135,000 years. If you choose your numbers at random, however, success is never guaranteed, and tame mathematicians tell me that the average time to strike lucky is also longer – perhaps 100,000 years or so.

But whether you can shave 35,000 years off is beside the point. The lottery machine is not trying to find your number. It has no memory of previous combinations, and is equally (un)likely to pick any of the 14 million. Pick at random, write down your birthday … it makes no difference to your chance of winning – although if you write down unusual numbers, it will minimise the likelihood that if you win, you’ll have to share your prize.

In case you are not a long-time reader, I will repeat my advice as to how to enjoy the thrill of the lottery without the fool’s bet. Choose your numbers, but don’t buy a ticket. You’ll win almost every week – the fear that your number might actually come up is an adrenaline rush to beat them all.

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No wonder the Financial Times is making a fuss about the downturn: our readers are suffering more than most. That, at least, is my conclusion after reading the research of two economists from America’s Northwestern University, Jonathan Parker and Annette Vissing-Jorgensen. Drawing on US data, they found that the biggest spenders are those whose spending fluctuates a lot. The consumption rates of the top 10 per cent of households fluctuate 10 times more than those of the majority – the bottom 80 per cent of households. So a fall in overall consumption is a blip for most people, but a slump for those near the top. (We’re not just talking about Russian oligarchs here: spending of just over twice the average is enough to place you in the top 10 per cent.)

Other economists – again, in the US – have made similar discoveries. Shane Jensen and Stephen Shore examined the oft-made claim that household income (an indicator of spending) is more volatile in modern times. They found that this is actually only true for the rich: the proportion of US national income earned by the rich surged ahead in the booms of the 1980s, 1990s and 2000s, but stuttered or even fell in the recessions that separated them.

My aim is not to sympathise with the well-off: while no doubt it stings to take the kids out of private school or to sell the sports car at a loss, most people never enjoyed such privileges in the first place. But this research highlights a truth often forgotten in the hand-wringing about the downturn: everyone has their own experience of a recession. Some do badly and others do very well indeed. The gloomy averages we usually see reported fail to convey that range of experience.

The remainder of the article can be read here. Please post comments below.

The credit crisis has provided a series of unpleasant lessons about the importance of financial services. The first lesson was about credit: we began to realise that it would not always be possible to extend our overdrafts or refinance our mortgages cheaply. The second lesson, as queues formed outside Northern Rock, was about savings: there is no iron law of economics that says that the money in your savings account is 100 per cent safe. Last September, those of us still peeping through our fingers at the financial news learnt a third lesson, about the payment system itself: it began to be conceivable that you might write a cheque and the cheque would bounce, not because you lacked the funds to honour it but because your bank did.

The same lessons are being learnt in a different context, that of financial services for the very poor. In the 1970s, pioneers in Latin America and Bangladesh – most famously Muhammad Yunus of Grameen Bank – demonstrated the importance of affordable credit for the poor, and discovered that poor borrowers could reliably repay loans. The early experiments grew into a worldwide microcredit movement.

But just as we were rudely reminded that there is more to our banking system than cheap mortgages, so microcredit experts have been realising that there is more to microfinance than loans for the poor: savings, insurance and payment systems matter too.

The remainder of the article can be read here. Please post comments below.

I have a great boyfriend. We’ve been together for five years, have a son and are planning more kids. I have a good job which I would like to continue doing and that pays OK. My boyfriend earns a lot more money than me and we have a very comfortable lifestyle. We are both in our early thirties but I am worried that after three kids and 10 years with me, he’ll run off with a younger woman. Should I marry him?

C.M., France

Dear C.M.,

Economists have gathered evidence from speed dating and internet dating, and found that it supports the conventional wisdom: men like young women and women like rich men. Clearly, you have reason to be nervous.

I keep re-reading your letter and I cannot work out whether you regard the risk of desertion as a reason to get married or a reason not to. No matter: a spot of game theory, which economists use to understand how rational people interact with each other, may help you here. You have three options: dump him now; stay with him but do not get married; or get married now. Ten years later he will respond by staying with you or leaving you for the nanny.

Dumping him seems odd: you already have a child together, you enjoy the relationship, and dumping him will not change the unpleasant logic of evolutionary psychology, which puts you at an increasing disadvantage as you both grow older. Staying with him seems more sensible, but if he does run off you will have limited negotiating power. Marrying him seems best of all: the legal contract, in most jurisdictions, protects you against this sort of behaviour. You cannot prevent him leaving you, but you can make it an expensive proposition for him if it happens.

Do I hear the distant sound of wedding bells? Happy Valentine’s Day.

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Price-sensitive lovers of economics books may want to know that the paperback of “The Logic of Life” is now out in the US. (In the UK, one more month to wait.) You can buy it here; you can read discerning reviews from the New York Times, the Economist, and many others here – people of taste, all.

The book has been interpreted as the antithesis of Nudge or Predictably Irrational, an anti-behavioural-economics book, but it isn’t really that. It’s really a product of my love affair with economics, showing how it can usefully be applied to crime, marriage, poker and much else. Thumbing through the pages of the paperback reminds me how much I loved writing the book, so I’m glad that the collected book reviewers of America enjoyed reading it.

I work with an international bank, but have recently been laid off. Fortunately, I have managed to land myself another job in this very tough job market (yes, in India too!).

The catch is that my current employer is offering me a severance package of around 20 months pay – but only if I stick around for six more weeks, while the other company wants me to join as soon as possible.

One option gives me a pile of hard cash, but uncertainty and the stigma of unemployment. The other option is a secure and cushy job. And, another thing: India does not have any unemployment benefits.

P.M., India

Dear P.M.,

I’m not surprised you’re tempted by the severance package, especially with two companies fighting over who employs you for the next six weeks – a great boost to your ego.

Still, I’d urge you not to get too confident. An economics PhD student at MIT, Johannes Spinnewijn, recently published a research paper showing that most unemployed people are too cocky about their prospects of finding a new job. On average, they expect seven weeks of unemployment, but eventually endure 23 weeks. And this is using data from the mid-1990s, not recession years. Be warned, then: don’t let overconfidence lure you into undervaluing the guarantee of a good job.

A better approach would be to negotiate a compromise. Surely there is a way to secure the new job without losing all the severance pay – perhaps involving part-time work for both companies for the next two months.

If you do decide to turn down the new job and look again with severance pay in hand, look very hard indeed. Spinnewijn’s research shows that job-seekers tend to harbour another misperception: that an energetic job search does not pay dividends. They are wrong.

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Tim Harford’s blog

This blog is no longer updated but it remains open as an archive.

Tim, also known as the Undercover Economist, writes about the economics of everyday life.