People respond to incentives, so if you want something done, reach for your wallet.That’s what you’d expect an economist to say, but it is a belief that infuriates many commentators.
I will concede that offering cash is not always productive. In the days when I was young, free and single, I was never tempted to try to seduce cute girls at parties by slipping them a couple of crisp twenties. (Perhaps I should have done it. It is not as if my hit rate on an unpaid basis was particularly good either.)
Yet many policy wonks believe not just that there are some things that money can’t buy, but that cash incentives are counterproductive and even morally corrosive. The touchstone of this school of thought is Richard Titmuss’s book The Gift Relationship, published in 1970.Titmuss’s most memorable and influential claim was that the British system of voluntary blood donation led to better outcomes – healthier blood, supplied in a more timely fashion – than the American system of paying blood donors.
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As an economics student, I look to impress my girlfriend on a budget, and I know I am not alone. When it comes to choosing the wine to have with dinner, on the rare occasion that I get to take my girlfriend out, I avoid going for the cheapest bottle, as this makes me look, er, cheap. So instead I go for the second-cheapest bottle. But now I hear that restaurants, having cottoned on to people like me, ensure the second-cheapest bottle is highly profitable, overpriced plonk. My best response now is to go for the third-cheapest bottle, at least until everyone else does the same. Or is it? Based on price alone, what is the best bottle to buy?
You assume that the price of the wine and its quality can be neatly separated out. This seems reasonable, but is wrong. Price changes the very experience of quality. Neuro-economists have found, for instance, that while placebo painkillers work, they work best if the subject thinks they are expensive. Energy drinks give you less energy if you buy them at a discount. (Yes, really.) And of course, wine tastes better if you believe that it is expensive.
One possibility is to conceal the price of wine from your girlfriend and tell her you’re buying the expensive stuff when in fact you are buying the house red. This is a white lie: many people prefer the taste of cheap wine in blind tastings, and by claiming it is expensive you will quite genuinely improve the way she thinks it tastes.
If your girlfriend knows nothing about wine, this will work. If she knows more than you about wine – which seems likely – then why not invite her to choose? You’ll get a better bottle. And if she blithely splashes your money around, console yourself: you will have learnt a lesson about her that would have been even more costly to learn later.
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via Marginal Revolution and with an astonished round of applause for Russ Roberts and and John Papola. No prizes for guessing where Russ’s sympathies lie, but quite, quite brilliant.
I have had a sneak preview of John Kay’s Obliquity. I cannot recommend it too highly as a wise and creative study of the secrets of success in business, politics and life. Loyal readers of John’s column will recognise some of the examples but the argument is superbly put together. John argues that in a complex world one cannot simply identify a goal and plan your route towards it. Success must be groped towards gradually and with much correction of error.
As a result, I have had no time to read Eric Lonergan’s Money, positively reviewed by The Economist.
On October 13 2008 – a public holiday in the US – the Treasury Secretary of the day, Henry “Hank” Paulson, summoned bank bosses to a meeting and made them an offer they couldn’t refuse: $125bn of taxpayers’ money in exchange for equity in nine US banks. Some banks, such as Citigroup and JP Morgan, received as much as $25bn each. The Treasury also guaranteed new issues of bank debt. It was a bail-out of enormous value to bank shareholders and bondholders, so it can hardly be a surprise that the Obama administration is planning to try to get the money back with some kind of levy.
But how much did the banks benefit from Hank Paulson’s “gift”? Did the policy have the desired effect? If so, why? All these questions are answered in research carried out by Pietro Veronesi and Luigi Zingales, economists at the University of Chicago, updated last month. One fascinating conclusion is that Paulson, a former chief executive of Goldman Sachs, may have missed a huge money-making opportunity.
The plan apparently stabilised the financial system in the short run; in the long run, it may have the opposite effect by encouraging some future generation of bankers to take more risks. Both these effects are impossible to quantify.
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The betting markets reckon Elin Nordgren will shortly divorce Tiger Woods. Considering the experiences of the wives of Shane Warne and Bill Clinton, that seems hasty. Shane Warne’s wife tolerated his scandals for years before divorcing him. Australian cricketers do not make as much money as global golf stars, hence, the probability of her receiving a large alimony was low. It would have been rational for someone in her position to try to salvage the marriage and lay aside their emotions. Hillary Clinton had a much lower probability of political success as a divorcee.
I think we should look at economic rather than emotional reasons for divorce. Have I discovered a new canon in marital economics?
Your theory goes well beyond Ray Fair’s “Theory of Extramarital Affairs”, published in the Journal of Political Economy. Still, you need to clarify your reasoning a little. You contrast Shane Warne’s earnings with those of Tiger Woods, which suggests you have in mind some kind of income effect, where the richer the husband, the more likely the wife is to divorce him. This has the merit of being a falsifiable theory, but I am not sure it is true.
Such cases belong instead to the theory of the firm. When two units of production – Hillary and Bill, say – are worth more together than they are separately, we call them “complementary assets”, and there is a strong reason to keep them together. If one of the units of production is sleeping with a pancake waitress, then that is a reason to separate them. It’s all a question of how annoying the affairs are versus how strong the complementarities are. Hillary and Bill are highly complementary assets; this is less obvious for Nordgren and Woods. As for a general theory, there is plenty of data out there – a research project for a diligent student of economics such as yourself?
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The last episode of this series of More or Less airs on Radio 4 at 1.30 GMT today.
This week, we parse the unemployment numbers and ask why they haven’t risen as fast or as far as expected; Chris Bowlby asks whether we should pay so much attention to age benchmarks such as 18, 50 or 65 – I wonder if he is worried about something? We also ask what the midpoint of the last century was, and we discover celebrity ichyometry.
Mark Easton, BBC Home Editor, presents a fascinating essay on the history of political statistics. And we will also be discussing whether it’s possible to “keep libel laws out of science“, with libel expert Duncan Lamont, and science writer (and libel-court survivor) Ben Goldacre.
The program website is here, or you can subscribe to the podcast, or send us your ideas for investigations: email@example.com.
I have thoroughly enjoyed the opportunity to read Hamish McRae’s What Works, a series of case studies of successful businesses, organisations, institutions, cities, and policies. It’s very wide ranging and I suspect McRae may already be regretting the inclusion of Dubai, but in fairness each case study includes a sober reflection on “what could go wrong”. There is a lovely balance of reporting and analysis here.
As a result, I have not had time to read much of Phil Villarreal’s Secrets of a Stingy Scoundrel. Basically a humorous collection of ways to cheat others or save money; often in poor taste, but inventive.
Andrew Exum, aka Abu Muqawama, comments on my weekend column on Afghanistan:
Difficulties aside, most U.S. Army and Marine Corps officers are not trained as social anthropologists or ethnographers. Economics, though, is more accessible. It is, at the most basic level, the science of decision-making. How people make decisions and what incentives drive them to make decisions (or not make decisions) is a question we can all ask and, again, a useful framework for thinking about the conflict environment in Afghanistan.
Why not saunter over and join the conversation at his blog, too? A different clientele to FT readers.
Bob Hahn and Peter Passell write:
In the beginning, economists touted emissions taxes and cap-and-trade systems as efficient, market-friendly methods for reducing pollution. The idea: put a price on pollution equal to the damage it caused or decide what level of emissions was acceptable to society as a whole, and then let businesses decide how to minimize the cost. The two approaches – put a price on emissions or put a limit their total quantity — were thought to be equivalent means to the same end.
Then came Martin Weitzman, a very clever economist from Harvard, who showed decades ago that the choice between the price and quantity approaches mattered a lot when policymakers weren’t certain what the costs and/or benefits of pollution control would be. And now Round Three: In a recent, provocative piece [Download Here], David Weisbach of the University of Chicago questions Weitzman’s conclusions. He concludes that the optimal approach may change if you make the (realistic) assumption that policymakers can alter course in response to new information.
And then there’s another factor to consider: the systems can be designed to look a lot like each other. For example, a cap-and-trade system with a “safety valve,’’ which effectively limits the maximum market price of emissions permits, in many respects mimics the impact of an emissions tax.
So where does that leave us on climate change policy? The key is not to get lost in the trees – any market-based system that rewards people and businesses for emitting less carbon would be a big step forward.
Quite so. Here is my attempt to say much the same thing.
Hahn and Passell have a new website and blog, Regulation2Point0.com. I strongly expect that it will be worth following.