Tim Harford's Blog, page 115

A ‘simple rule’ about migrants and benefits

Clues to the UK’s woes lurk in its own backyard, writes Tim Harford

‘Iain Duncan Smith, the work and pensions secretary . . . said the number of EU migrants claiming benefits in Britain had reached a “crisis” and confirmed the government was “looking at what we can do” to limit new arrivals’ access to welfare’

FT.com, March 6

Never a man to waste a good crisis, that IDS fellow.



Or manufacture one. Mr Duncan Smith’s declaration hits all the right notes for a Conservative politician: the welfare scroungers are picking our pockets; there are too many foreigners around; and it’s all the fault of the EU. But behind the mood music there isn’t a lot of substance. We don’t know for sure how many EU migrants claim benefits but Mr Duncan Smith’s Department for Work and Pensions did publish a fascinating estimate in January 2012.

Which found?

The DWP looked at people who were of working age, and who were not UK citizens at the time they applied for a national insurance number. They found that in February 2011, 6.6 per cent of such people were claiming a working age benefit such as jobseeker’s allowance.



That must be hundreds of thousands of people, though.

Over a third of a million people, yes. But 93.4 per cent of the working-age immigrant population are not claiming working-age benefits. This ratio compares very favourably indeed with the homegrown working-age population: 16.6 per cent of us were claiming working-age benefits. Is this really what an immigrant benefit crisis looks like?

But Mr Duncan Smith particularly drew attention to immigrants from the EU.

I don’t know why. The DWP’s own figures show that EU accession countries hardly figure in the list of benefit claimants, who are much more likely to come from India, Pakistan, Somalia or Bangladesh. There are a lot of Poles in the country but they only come seventh on the list of benefit-claiming immigrants.

But immigrants also use public resources such as care in the National Health Service or school places.

And they pay for them too. An analysis by University of College London’s Centre for Research and Analysis of Migration, published in July 2009, found that immigrants from the EU8 accession countries had been net contributors to the public purse in every year since May 2004, when these central and eastern European states joined the EU. Given that the UK population as a whole had been draining the public purse by running a deficit, this is an impressive achievement.



But the situation might change when Romanians and Bulgarians are allowed to work here next year.

Lots of things might happen. Forecasts on this question have been very poor in the past. Official forecasts of how many immigrants might show up when the borders were opened to eastern Europe in 2004 were dramatic underestimates. But despite this unexpected immigration bulge, things have been fine. I mean, the country has gone to the dogs since 2004, but it’s hard to make a case that the Poles themselves caused any trouble.

Unless Gordon Brown has a Polish grandmother?

Or George Osborne. Or Fred Goodwin. Or Sir Mervyn King. Whoever you want to blame for the state we’re in, it needs a peculiarly xenophobic mindset to point the finger at immigration, even if it did happen on a far greater scale than anyone expected.

Social cohesion has to be an issue. I see Ed Miliband wants to ensure that people speak English. No wonder: the 2011 census found a million households in England and Wales that speak no English.

So a number of commentators claimed – for instance Jackie Ashley in the Guardian. The census actually found something different: 1m households where English or Welsh was not the first language. But that doesn’t tell us anything about whether English was spoken well, poorly or not at all.

The Labour leader wants a ‘simple rule’: to make sure people who work in the public sector, face to face with the public, can speak English.

Does this country really hire lots of public sector workers who are unable to function because they can’t speak English? If we do, that’s a sign of a serious problem and one that will not be fixed by the sticking plaster of Mr Miliband’s “simple rule”. The British economy and public finances are in a bad state. If our borders had been closed to eastern Europe in 2004 they would be worse.

Also published at ft.com.

A theorem fit to terrify bankers

Bankers have tended to argue that too much equity means that banks will make fewer loans at higher rates. M&M shows us that this argument is wrong in theory

Looking down the list of winners of the Nobel memorial prize in economics, two names are causing bankers across the world to break into a cold sweat. They are Franco Modigliani (laureate in 1985) and Merton H. Miller (laureate in 1990). Both men have been dead for years but their most important idea lives on with the undignified name of M&M.

M&M refers to an important-seeming decision for any company: how much should it be funded by borrowing, and how much through raising money by issuing shares or retaining profits? Some companies, famously Apple, have no debt to speak of. Others, including any bank you can name, raise most of their resources by borrowing rather than issuing shares.

I say “important-seeming”, because M&M, the Modigliani-Miller theorem, is an elegant proof that under certain circumstances the debt/equity mix of a company’s funding doesn’t actually affect its value at all.

Imagine a company called Papple. It has issued 100 shares, each a claim on 1 per cent of Papple’s future profits. Papple has big plans, which it could fund by issuing 100 new shares, making each old share worth only 0.5 per cent of Papple’s profits. Alternatively, Papple could borrow money, leaving each shareholder with the right to 1 per cent of Papple’s profits, but pushing shareholders to the back of a queue behind the company’s creditors. That second option is riskier, but more profitable for shareholders if the expansion plan works. If the plan fails and the debt can’t be serviced, Papple will be bankrupt.

It seems a fraught decision, but M&M says that it doesn’t matter what Papple does, because investors in the company can always hedge their bets if Papple seems too risky, or borrow money to buy extra Papple shares if they feel that Papple is too boring an investment without such leverage.

M&M requires assumptions that never hold, of course. But the core of the argument is rock solid: companies which take on debt expose their shareholders to higher rewards and higher risks; the shareholders can take steps to offset these risks at the cost of giving up some rewards; the whole decision is less important for the company’s value than you might think.

But this neat little textbook theorem turns out to be very weighty indeed for the question of bank regulation, a cause championed in a new book by Anat Admati and Martin Hellwig, The Bankers’ New Clothes. Regulators want banks to fund themselves more through equity and less through debt. Bankers are reluctant.

M&M applies to banks, too, but with a twist. Banks that get into financial trouble cause systemic damage, so even if M&M applies from the point of view of investors, society would prefer less debt and more equity. But bank investors want the opposite, because the “too big to fail” subsidy means that shareholders enjoy successful gambles while creditors are bailed out if things go wrong. This subsidy means that debt-laden banks are more valuable to investors. If M&M holds, the taxpayers’ loss is the bankers’ gain.

Bankers have tended to argue that equity is scarce and expensive and too much equity means that banks will make fewer loans at higher rates. M&M shows us that this argument is wrong in theory.

In practice, M&M roughly holds: as leverage falls, equity becomes substantially cheaper. Banks are tempted to take on more leverage not because debt is efficient but because debt is the route to an implicit government subsidy.

Banks should be obliged to use more equity funding – or in the misleading jargon of the industry, to “hold more capital”. But equity is not “held”. It’s perfectly good money, provided on flexible terms. It can be lent to businesses and homebuyers just like debt – and with far more resilient results.

Also published at ft.com.

A way to burn a hole in Britain’s pocket

Negative rates might tackle the liquidity trap but they are unlikely to be introduced, says Tim Harford

‘In evidence to the Commons Treasury committee, Paul Tucker [deputy governor of the Bank of England] raised the possibility of imposing negative interest rates on a portion of banking reserves, effectively charging banks rent to hold money at the BoE, but stressed that any action was not imminent.’

FT.com, February 26

It’s about time the banks got a taste of their own medicine. They’ve been borrowing my money and charging me for the privilege, one way or another, for years.

Oh, stop moaning. This isn’t the Parable of the Horrid Banker. Mr Tucker has floated this idea – very hypothetically, I should add – not because it would punish the banks but because it might encourage them to lend money to the likes of you and me. The BoE has been creating money enthusiastically with the hope that people may spend it. Yet nervous bankers have undone much of this effort because they are hesitant to lend. Negative interest rates on the reserves held at the BoE could nudge them into expanding their ambitions.

Ultimately, then, this is all about getting lending and spending going again. Wasn’t that what quantitative easing was all about? What’s wrong with the economy if printing squillions of pounds can’t persuade people to spend?

It is awkward, I agree. But it’s not entirely unexpected. There’s this thing called a “liquidity trap”, which sounds like the sort of thing that a Bond villain would unveil in a monologue but instead describes the situation where people (or companies, or banks) would rather stick their cash under a mattress than spend it. If the central bank prints money and hands it out we just sock that cash away too.

Surely a central bank with the ability to create infinite quantities of money should be able to do something about that?

That seems right, and we’re not in a pure liquidity trap: people will spend money. They just need a lot of prodding. The BoE has created about £6,000 a person and spent it on UK government bonds. There is surely some amount of money – £60,000 a person? £60m? £60bn? – at which people will be tempted to spend, or someone in whose pocket the money will burn a hole.

And then inflation will take off.

It might, but the thinking is that before it does, inventories will fly off the shelves, laid-off workers will find jobs again and the economy will recover. And at that point the BoE can hoover up the cash again, as long as it hasn’t done something silly such as write off all that government debt.



But printing literally trillions of pounds might be difficult to undo – is this why there’s this talk of negative interest rates instead?

Yes. If the economy is in some kind of liquidity trap, or slowed down by a few liquidity potholes, then the bank might look for more elegant ways to get people spending than what Ben Bernanke, the US Federal Reserve chairman, once approvingly called “the logic of the printing press”. Negative interest rates on bank reserves are one approach. Another is to threaten that even if inflation is difficult to produce, once the BoE has found some at the back of the kitchen cupboard, the British public will get that inflation good and hard for years to come.

Why on earth would a central bank want to promise to create inflation?

It’s that liquidity trap thing again. If the economy is in a slump, then people may hold on to whatever cash they can lay their hands on and this behaviour will simply prolong the slump. But if the BoE threatens to create enough inflation to evaporate our savings, and if we believe the threat, then we will spend money and that should get the economy moving again.

So why doesn’t the BoE threaten a decade of double-digit inflation?

The Monetary Policy Committee has a mandate to hit an inflation target, so such promises are probably illegal. George Osborne may in private be urging the MPC to create inflation, but the chancellor has not dared to change the inflation target. And without a change in mandate, central bankers who threaten to create inflation are like soft parents who threaten to withhold TV time. Nobody believes a word of it and so the threat has no effect. Central bankers are reduced instead to musing idly about ideas that won’t happen – such as introducing negative interest rates.

Also published at ft.com.

Can an app make us behave better?

Basic scientific research paired with user-oriented design thinking makes for a powerful alliance

Everyone’s talking about a new iPhone app, Mailbox. It uses simple swiped gestures to archive email, or postpone it, or send it to a “to do” list. Mailbox users can quickly highlight their entire inbox and instruct it to come back “tomorrow”. If you have an iPhone, you’re probably already in the queue for the app.

What’s intriguing about Mailbox is that it is basically a redesigned front-end for Gmail; it adds very little actual functionality to Gmail but it strongly nudges us in particular directions, making it easy for us to handle our email in the way we should have been handling it anyway. The word “should” is intriguing: I’ve strong opinions about how to handle email. Mailbox also has strong opinions, unlike the bland “do with me as you will” of most email clients.

Modern software is fascinating because of the rapidly evolving way in which software designers try to make complex tools intuitive to use. The results are patchy but, at their best, rather brilliant. And the way in which the best software is created is fascinating, too: it’s a potent blend of thoughtful design with constant experimentation. The design gurus brainstorm and create; the experimenters see what works. In fact, this process – supported by the relentless improvement of our silicon infrastructure – has become so successful that when somebody says “technology”, we immediately think of computers and phones, rather than aeroplanes, vaccines or nuclear reactors.

Perhaps it is no surprise that “behavioural design” is becoming a buzz-phrase. Nick Chater, professor of behavioural science at Warwick Business School, argues that the combination of basic scientific research with user-oriented design thinking is a powerful one. Behavioural scientists in the fields of psychology and economics are producing reams of research about human behaviour, and designers have the skill and experience to turn those insights into products and services that make our lives happier or safer.

One new home for such collaboration is the Behavioural Design Lab, a joint venture between Warwick Business School and the Design Council. Another is Ideas42, a Massachusetts-based “design lab” established by economists and behavioural scientists. (The “42” is a Douglas Adams reference: we need to improve the questions we’re asking before we can find useful answers.)

A new policy paper by Saugato Datta and Sendhil Mullainathan of Ideas42, published by the Center for Global Development, uses the example of fertiliser use to illustrate behavioural design. African farmers use much less fertiliser than one might expect and suffer low yields. The natural explanations for this situation are that the fertiliser is unaffordable (solution: subsidy) or that it’s less useful than agronomists might think (solution: agronomists should back off) or that the farmers don’t understand the benefits (solution: education).

But behavioural economics suggests another possibility, which is that the farmers want to use the fertiliser but, being human, are tempted to fritter away their cash and can’t afford the fertiliser when they need it. One possible design solution is to offer commitment savings accounts to allow farmers to lock their cash away. When this idea was tested in Malawi, the farmers signed up with alacrity and fertiliser use increased sharply. Subsidising free home delivery of fertiliser also works very well, much more than a price discount of equivalent value.

These are design options, making it easy to do what we hope is the right thing. Free home delivery of fertiliser is an opinionated subsidy, just as surely as Mailbox is an opinionated Gmail interface. And when we combine the slick influence of design-based thinking with a humble willingness to test, learn and adapt, we have a powerful alliance.

Also published at ft.com.

Wave the jazz hands and hope for the best

Politicians hope that voters are clueless about tax, writes Tim Harford

‘Ed Miliband … put the wealthy on notice that a future Labour government would squeeze the rich with a £2bn tax on expensive homes to fund a revival of the 10p starting rate of income tax, axed by Gordon Brown’

FT.com, February 14

A Valentine’s day massacre for the rich, eh?



More like an ill-judged romance with an old flame. Mr Miliband’s 10p proposal repeats an error committed by Denis Healey in 1978, Norman Lamont in 1992 and Gordon Brown in 1999. It’s a pretty basic howler but what’s more interesting is that politicians are so determined to learn nothing from history.

First tell me why it’s a bad idea.



My colleague John Kay explained this elegantly on Wednesday, but in a nutshell there are two problems. One is that many people earning low incomes are not poor; they are, for instance, the second earner in a two-income household. It’s the benefits system, not the tax system, that is designed to take this into account. Even more fundamentally – it’s a matter of simple arithmetic – it is always more advantageous to people with lower incomes to increase the personal allowance, rather than introduce a new low-rate tax band. Raising the personal allowance is simpler and more progressive than introducing a 10p tax band, while the surest way to reach the needy is through benefits reform.

So why is the 10p tax band so hard to kill?



It’s possible that Mr Miliband hasn’t given a moment’s thought to how taxes actually work. It’s more likely that Mr Miliband reckons voters haven’t given a moment’s thought to how taxes actually work. And Mr Miliband may be right. The way tax policy is conducted in this country is farcical – a point made in an exasperated policy brief issued this week by the Institute for Fiscal Studies.

Ah, the IFS! The nation’s favourite Budget-kibitzers.



I wonder if the IFS isn’t fed up of playing that role. Everybody likes to see it pick apart the details of the latest Budget or Autumn Statement. But when it published a grand treatise on tax reform, “Tax by Design”, a few years ago, nobody cared. This is a symptom of a serious political malaise. The tax system should be just that – a system, with interlocking parts working together to achieve an overall goal. Instead the tax system is a labyrinth for ordinary users, a money factory for the tax advice industry and a stocking full of miscellaneous goodies for successive chancellors of the exchequer. Twice a year, whoever is chancellor has to produce some tempting giveaways, all calculated for their political effect, while desperately clawing back the revenue as he hopes nobody is looking.

So what’s the solution?



Politically, I have no idea. But economically, it’s easy to point out some basic features of a sensible tax system. Some are obvious: keep it simple, for instance, and avoid perverse incentives. But what is less obvious is the tax system needs to be considered in its entirety. At the moment each change to taxation is served up by a hopeful chancellor, jazz hands waving as he waits for applause. The change is then picked apart as though the rest of the tax system did not exist.

For example?



Take the withdrawal of child benefit from households with a high earner. The measure was messy and has been costly to prosperous, fecund people of a certain age while leaving many other prosperous people untouched. The changes were justified on the grounds that they were progressive, and indeed they were. But whether an individual tax is progressive or not is not the point: the question is whether the system as a whole is progressive. We want – and can have – a tax system which is fair, provides reasonable incentives (discouraging smoking and carbon emissions while encouraging education and pension saving) and yet is not too Byzantine. But to make each individual tax meet these standards in isolation is unnecessary, absurd and impossible.

And yet having each tax examined in isolation is the inevitable consequence of chancellor’s twice-yearly party pieces.



Yes. Intriguingly politicians do now try to link one tax with another – as Mr Miliband has done, promising to pay for his unwise 10p tax band with a tax on expensive property. But these pairings are arbitrary and cosmetic. Assembling a coherent system seems to be beyond the wit of today’s politicians, and as long as we all treat each Budget as a bullet-point list of grabs and giveaways, we will deserve the scrappy tax system we have.

Also published at ft.com.

Changing channels: why TV has had to adapt

Technological change has swept through broadcasting as surely as it has through music and newspapers

What does Strictly Come Dancing have in common with Mad Men? Not a lot, you might think – and before hearing Joshua Gans speak recently at a seminar on broadcasting, I would have agreed with you. I now think otherwise.

Technological change has swept through broadcasting just as surely as it has through music and newspapers. In the case of broadcasting, however, the process has been more gradual. In the 1970s, British television was funded either by advertising or by the licence fee, and whatever you watched, you watched when it was broadcast. Both these facts changed long before most of us had heard of the internet.

The two technology-based changes have been the emergence of subscription-only channels, and the development of time-shifting technologies to allow TV to be consumed on demand. First there was video but now we can watch the television on the internet, and pause or fast-forward with digital recorders.

Gans, an economist at the University of Toronto and the author of Information Wants to Be Shared, argued that time-shifting in particular was doing interesting things to the economics of broadcasting. First, consider advertising revenue: time-shifting makes it easy to avoid adverts, which undermines the traditional ad-funded model. However, there are some events that most people demand to watch live: sporting events, of course, but also talent shows and reality TV. These are events that our friends and colleagues will talk about and if you don’t watch live, you will miss out. Such programmes remain attractive to advertisers.

Gans argues that a great deal of information has a social context: we want to recommend what’s good and we need to hear recommendations to figure out what to watch. One only need contemplate “Gangnam Style” or Fifty Shades of Grey to see that this is true, but the story is older and more subtle then we tend to acknowledge.

Ponder the resurgence of complex, almost Dickensian story arcs in the unexpected form of the television series. From The Sopranos to Lost, 24 to Breaking Bad, over the past decade or so, the extended, sophisticated narrative has come to a TV near you. Previously only soap operas would attempt such a sprawling form, and then only on the understanding that anyone could switch on at any time and grasp what was happening. The idea of putting on a series that becomes baffling to occasional viewers was regarded as commercial suicide.

But while time-shifting technology has pushed ad-funded television towards live events, it has also provided a foundation for complex storylines. Thanks to DVDs and digital recorders, people can catch up on what they’ve missed. Because the intricate plots are addictive, they are a natural fit with DVD box sets or cable TV.

Game of Thrones or Mad Men rely on social networks just as surely as Britain’s Got Talent does, but in a different way: if the first three episodes were amazing, word will spread and people who initially missed out will catch up. In the first case, the social pressure to watch live is used to foil the ad-skipping time-shifters. In the second case, it’s time-shifting that makes it possible for word of mouth to build.

Some formats sit uneasily with either model. A standalone documentary or sitcom offers neither the addictiveness of the extended series, nor the immediacy of sport or reality TV. The golden age of the sitcom is, perhaps, behind us. And it did not escape my notice that the kind of news coverage that really matters – thoughtful, analytical, investigative – also fits poorly. Perhaps in the future all TV news will take the form of either epic narrative documentaries, or helicopter chases.

Also published at ft.com.

Don’t blame Ofcom if the 4G price isn’t right

It’s almost 13 years since the UK government raised £22.5bn in one of the biggest auctions of all time, for the right to use radio spectrum for 3G mobile phone services. The next big thing, 4G, has been auctioned for around a 10th of that price, and a third less than the sum the Treasury had pencilled in. What went wrong?

Some say that’s the wrong question: several telecoms analysts claim that the low prices will result in a better deal for consumers, which makes me wonder if they have their wires crossed. Consumer prices are determined by competitive pressure and the marginal cost of supplying services, not by one-off upfront costs. That’s the theory, anyway. For a change, theory and reality are in step: despite the stratospheric price that phone companies paid for the 3G licences, mobile phone services in the UK are cheap.

The lower than expected 4G auction price, then, is bad news for the taxpayer, good news for shareholders, and irrelevant to consumers. And it can’t be a huge shock, because estimates for the 3G auction revenue were even more inaccurate, even if the surprise there was a pleasant one. If we had known what the auction price was going to be, we wouldn’t have needed an auction. The whole point of the auction is to reveal how much bidders want the prize, and to charge them accordingly.

But could Ofcom have designed the auction better? Not obviously so. Good auction design is not magic: it’s about preventing cheating and attracting serious bidders. The 3G auction designers had an opportunity to raise silly money during a bubble, and they did not squander that opportunity. The 4G auction designers lacked the same good fortune, and the merger of two major competitors, T-Mobile and Orange, will not have helped.

The 4G auction, a fancy thing called a “combinatorial clock”, split the available spectrum into bite-sized chunks, each with its own price. Bidders revealed which chunks they wanted at prevailing prices, and prices for the most-demanded chunks rose quickly. Rather than dropping out entirely, the major bidders gradually shrank their demands until everyone could be accommodated. Collusion can never be ruled out in such auctions, but a plausible explanation for the lowish price is the simplest one: bidders simply decided that they could curtail their ambitions if it meant saving money.

First published at ft.com.

The lesson from Poundland: work pays

The UK government is in a muddle over employment schemes, says Tim Harford

‘Ministers are trying to get back-to-work schemes on track after a university graduate won a court ruling that making her work for no pay at a Poundland store was unlawful.’



Financial Times, February 13

A blow struck for human rights against forced labour!



Hardly. That sort of talk was dismissed by an earlier court ruling. Cait Reilly had argued that the European Convention on Human Rights forbids “forced or compulsory labour”. The back-to-work scheme does not say “work in Poundland or go to prison”, but “work in Poundland or have your benefits withdrawn”. The courts felt there was a difference. (The Department for Work and Pensions tried hard to lose the case by referring to some of these schemes as “mandatory work activity”.)

So why are we hearing that the government lost the case?



The new ruling comes from the appeal court, which agrees that nobody’s human rights have been violated, but argues that the regulations underpinning these schemes are too vague. The government has responded with new rules. Let’s see how it works out. An interesting question is whether such schemes are a good idea.

How would you propose to produce an answer?



I don’t need to. The DWP has an answer for the Community Action Programme, which is the obligatory six-month work placement that was the scheme experienced by Ms Reilly’s joint appellant, Jamie Wilson. The CAP was subjected to the fairest evaluation available, a randomised controlled trial. It concluded CAP participants were no more likely to find a job than the control group. Perhaps the CAP could be regarded as a success in other ways, but a failure to help people find jobs is hardly an endorsement.

What would you suggest instead?



This is where the data speak volumes. Take the Future Jobs Fund, for example. It had similar aims to the CAP – to give six months’ work experience – but it worked differently, by subsidising employers who gave young people a job that pays at least the minimum wage. The subsidy lasted for six months, and a lot of the jobs disappeared when the subsidy did. Yet a DWP evaluation showed impressive effects, with participants more likely to have a job 18 months after their subsidised work had ended. The cost-benefit analysis of the FJF was favourable, too. Perhaps it was more effective than the CAP because the FJF jobs were, well, real jobs, with pay for the employee and a cost to the employer.

And the Future Jobs Fund was, presumably, legal?



Who cares? It was scrapped before the evaluation had been completed – the prime minister told the BBC it was “one of the most ineffective job schemes there’s been”.

Awkward.



Yes. It is ironic that this is one of the few areas where the government is carrying out rigorous tests of what works, and yet few people seem interested in what those tests discover.

There’s a moral issue here: we can’t allow people to mooch around on benefits without looking for a job.



Agreed, and that seemed to be what was behind the mandatory work activity. But the DWP seemed confused. The MWA was used to remind disengaged benefit claimants that job-seeking is a serious business, and yet official policy was that it was never to be used as a threat.

So it was some kind of punishment that could neither be introduced after a warning, nor introduced with no warning?



No wonder the courts thought it was too vague. But on the “mooching” point, Jobcentres can always threaten to withdraw benefits. Workfare schemes can’t be justified as a threat, then, only as a way to help people find jobs. The evidence they do doesn’t look encouraging. Intriguingly, the government’s Behavioural Insight Team has been running a trial with a Jobcentre in Essex, where the advisers on the ground floor use the old approaches and the advisers on the first floor use a new approach, and jobseekers are randomly assigned to the two floors.

What are the new approaches?



First, to streamline form-filling so that advisers can use the first meeting to talk about jobseeking strategies. Second, to discuss specific jobseeking actions over the coming weeks. Third, some touchy-feely stuff about expressive writing. The trial suggests this combination of approaches is effective. In fact the whole thing looks so successful that it can only be a matter of time before the programme is cancelled.

Also published at ft.com.

Why short-sellers get short shrift

These ‘men without bowels’ are more likely to be the prompt discoverers of bad news than the inventors of it

No economist could remain unmoved by the brouhaha that has engulfed Herbalife, the nutritional supplements company. The sponsors of football teams such as Barcelona and LA Galaxy, it sells diet drinks and protein bars through a network of small distributors, many of whom recruit, train and supply further distributors. This may be an intelligent way of selling the product through word-of-mouth. But doubters wonder whether Herbalife isn’t too reliant on distributors filling their spare bedrooms with protein shakes, which they hope to sell at a profit by recruiting yet more distributors.

In May last year, a hedge fund manager called David Einhorn asked a few pointed questions on a Herbalife investor conference call, wondering how many final customers Herbalife actually had. Herbalife’s share price promptly fell by a fifth. Einhorn has a reputation as a savvy sceptic, and had made a very public bet against Lehman Brothers a few months before the company imploded. Another short-seller, Bill Ackman, recently took a large short position, and then argued at great length that Herbalife was a pyramid scheme. Herbalife denies this vigorously.

It’s not just Herbalife’s reputation that is at stake here: it’s that of short-selling, a practice that has been controversial since 1610, when it was banned, after somebody tried to short the Dutch East India Company.

The emotional case against short-selling was caricatured perfectly in Fred Schwed’s classic book, Where Are the Customers’ Yachts? “At the very moment we were buying that stock, hopefully and constructively, looking forward and upward toward better things, those fellows, men without bowels, were selling it and they didn’t even have it to sell!”

Short-sellers seem bad because they’re hoping for bad things to happen. Now this is true but irrelevant – unless the short-sellers cause the bad things to happen in the Wall Street equivalent of an insurance job. This has always seemed a risk for banks, because banks depend on the confidence of their funders. If it became widely believed that a particular bank would collapse tomorrow, the bank would collapse today. Perhaps short-sellers could destroy a bank, and profit from its destruction, simply by convincing others that the bank was doomed. Perhaps.

It’s even less clear that short-sellers can cause permanent harm by saying cruel things about a strong company. Herbalife should be at little risk – unless it really is a pyramid scheme, in which case a lack of confidence in its business model could become self-fulfilling. But while Ackman’s criticism did dent the company’s share price, the shares quickly recovered and it was higher at the start of this year than it had been two years previously.

Economists have long suspected that short-sellers are more likely to be the prompt discoverers of bad news than the inventors of it. And we now have some data. After the collapse of Lehman Brothers, many countries restricted short-selling – but at different times and for different classes of shares. Two economists, Alessandro Beber and Marco Pagano, used the variation produced by this patchwork response to filter out the impact of the bans. They concluded that the bans made stocks less liquid, slowed down the price discovery process and, mostly, failed to buoy prices.

In short, the bans were counter-productive. Several other pre-crisis studies reached similar conclusions.

Short-sellers have a powerful argument in their defence: who else has an incentive to spend millions of dollars uncovering frauds and letting the air out of bubbles? We could have done with more early scepticism of Enron and Bernie Madoff, of Wall Street, mortgage-backed securities and the dotcom mania. The “men without bowels” should be allowed to continue their dread work.

Also published at ft.com.

The astonishing life of Bill Phillips

This is the latest video from the recording of my my radio series, “Pop Up Economics“. (Alternative link to watch.)