Tim Harford's Blog, page 117

What price a top state school?

The best things in life may be free, but buying a house in the vicinity of the best things in life is expensive

How much do parents value a safe environment, green spaces and a good education for their children? Such things are priceless – except that, of course, they are not. The best things in life may be free, but buying a house in the vicinity of the best things in life is expensive.

Economic researchers use house prices like a movie jewel-thief uses an aerosol spray. The aerosol isn’t important by itself, but it reveals the otherwise invisible laser beams that will trigger the alarm. The house prices aren’t necessarily of much direct interest, but indirectly they reveal our willingness to pay for anything from a neighbourhood free of known sex offenders to the more familiar example of a popular school.

In principle this is easy. Compare the market price of two otherwise identical houses, one of which enjoys the amenity in question (a nice view, a quiet street, access to an excellent school) while the other does not. In practice, houses are rarely identical, and all sorts of valuable amenities from good schools to good neighbours to low crime are likely to be jumbled up together.

Researchers have relied on a variety of statistical techniques to get round this problem. At first they used what are called “control variables”, a mathematical attempt to adjust for the fact that a proper like-for-like comparison is impossible. More recently they have focused on administrative boundaries, where one side of a street is in a school’s catchment area while the other side is not.

“A link between better schools and higher house prices is one of the most stable empirical regularities worldwide,” writes the economist Steve Gibbons in Centrepiece, a magazine published by the LSE’s Centre for Economic Performance. His colleague Stephen Machin has published a more academic review of the literature, reaching much the same conclusion: the ability to send your children to one of the best schools rather than one of the worst will add 15 to 20 per cent to the value of your home. (Internationally, estimates range from about 5 per cent to 40 per cent.)

Relative to private school this is pretty good value: it corresponds to around £20,000 or so. [EDIT: Apologies, this should have been £28,000, with UK average house price of £160,000. Not sure what I was thinking. Then again, interest rates of 5 per cent are on the high side so the £1000 a year figure remains in the right ballpark. Thanks to all who pointed out the error.] Since one would presumably get this money back eventually, when selling the house, the real cost is just the extra interest on a larger mortgage (or the foregone opportunity to earn interest on savings). At interest rates of 5 per cent, that is £1,000 a year for the right to send every child in your family to a nice school, an order of magnitude less than the cost of privately schooling a single child.

One obvious question is what parents actually think they’re paying for here – the quality of the schooling, or the chance to choose their child’s peer group? The answer seems to be both, in roughly equal measure. School regulators focus on “valued added” measures – the underlying quality of what the school provides – but parents are probably right to care about who is in their child’s peer group, too.

What conclusions should we draw? The first is that while the chattering classes talk endlessly about schools and school admissions, willingness to pay to live near a good school is smaller than I would have expected. No doubt there is a lot of variation here: some people don’t care at all and others care desperately. Still, it is surprising that willingness to pay is so low.

The second conclusion is that while £1,000 a year isn’t an enormous amount, it’s a large sum relative to how much we spend on state schooling – about £6,000 per child in England. More to the point, of that £1,000-a -year willingness to pay for good schools, the school system receives not a penny. There must be a better way.

Also published at ft.com.

The Indiana Jones of Economics

This is an edited version (five minutes rather than thirteen) of my talk on the amazing life of Bill Phillips.

It’s part of the pop-up economics series – listen out at 8.45pm GMT, Radio 4, for the story of of two Nobel laureates – a doctor and an economist – who revolutionised transplant surgery. Podcast and other details here.

How to support innovations that matter

That was the topic of the first episode of “Pop Up Economics“, and here’s the video!

The Bundesbank takes back its doughnuts

In repatriating its gold, the German central bank shows it doesn’t trust foreigners

‘Germany’s central bank is planning to shift 54,000 gold bars worth €27bn from Paris and New York to its base in Frankfurt, one of the biggest publicly announced shipments of the precious metal on record.’

Financial Times, January 16

What’s the thinking behind that?



There is no thinking behind that. This is gold we’re talking about, so we’re entering the asylum.

Really? Gold has been a pretty good investment over the past 10 years.



It’s been an excellent investment. But there’s no logic behind the gold bubble.

Bubble? That’s a controversial word to use. How do you know the gold price will collapse?



I don’t mean the gold price will collapse. When I say “bubble”, I’m thinking of a more technical category: gold is a bubble because its investment value isn’t connected to the stream of income it produces. Housing produces rent. Bonds produce interest payments. Shares produce dividends, or at least the prospect. But gold doesn’t produce any income stream, and its value as jewellery or for industrial uses is inconsequential. Gold merely offers the prospect of resale to somebody who also wants to hold gold. Therefore it is a bubble. It may remain an excellent investment: any bubble that has persisted for 4,000 years has to be pretty resilient.

There are plenty of good reasons to expect the gold price to rise – most notably that central banks are printing money by the hundreds of billions.



Whatever. If we actually get some decent inflation – and it has been conspicuous by its absence in much of the developed world – then of course the price of anything denominated in the inflating currency will rise. For example, the price of balloons should rise.

But this is all a distraction. The point is not that Germany is buying up gold but that it’s physically moving the gold it already has. So something else is going on.



Indeed. To change the subject for a moment, did I ever tell you about the Island of Yap?

Yap!



There’s no need to snap. Be polite and you might learn something. Yap is in Micronesia in the West Pacific. Its coins, the rai, look like stone doughnuts. Some are fairly portable, the size of actual doughnuts, but others weigh as much as a couple of cars. The process of producing these things, 250 miles across the sea in the quarries of Palau, used to be a gigantic effort – a Victorian naturalist witnessed a tenth of Yap’s adult male population digging these things out of the ground and sailing them back to Yap.

Gosh. Couldn’t they have been more profitably employed producing something with practical value?



Tell me again that gold isn’t a bubble.

I see your point. But I’m curious – how did the Yap islanders use a 4-tonne coin? It sounds like something dreamed up by Douglas Adams.



You’re thinking of the Triganic pu. In Adams’s fertile imagination, this was worth eight ningis – but as the ningi was a rubber coin 6,800 miles long on each side no one ever got enough together to own a pu.

Couldn’t you just have accumulated credit for the eight ningis in a bank account?



No, the banks didn’t want to bother with small change. But you have the solution to the islanders’ problem here. They didn’t actually move the 4-tonne coins around, they just gave each other credit. If we lived on Yap and you paid me for something – say, land or a dowry – with a huge coin, everyone would simply agree the coin in question had a new owner. It would remain the one leaning against the tree behind the garden shed. But when once it had been yours, now it would be mine. The islanders even used a coin at the bottom of the ocean as money. It sank in a storm on the way back from Palau but everyone knew whose it was.



That’s absolutely insane.

Now you’re thinking like the Bundesbank. Most of the world’s gold is in vaults with labels on it: “That’s Auric Goldfinger’s gold”; “That’s the Bundesbank’s gold”. Usually, when it is bought and sold, we just change the labels. You and the Bundesbank think differently. The Germans are behaving like a Yap islander who actually wants to move the 4-tonne stone doughnut to his own back garden.

Socially awkward.

Quite. The message is simple: the Bundesbank doesn’t really trust foreigners. Diplomatically, that will ruffle some feathers. But it is a sentiment that will reassure many Germans.

Also published at ft.com.

Lessons for pirates – from tax collectors

A government official and a bandit both redistribute resources, but an official does so far more efficiently

Here’s a question to puzzle the libertarians among you: what’s the difference between the government tax collector and a plundering bandit? One reasonable answer is that the tax collector, as the representative of a democratically elected government, has the same democratic legitimacy. A more utopian response is that the tax collector, unlike the bandit, serves the greater good. A third answer is that the tax collector is constrained by pre-agreed rules. (British parliamentarians seem not to accept this idea, preferring to haul multinational corporations over the coals for not making an appropriate “contribution”, irrespective of the legal position.)

I am not sure that determined libertarians would be convinced by any of these distinctions. But here’s a fourth that might carry some weight: both the tax collector and the bandit redistribute resources, but the tax collector does so far more efficiently.

It was the economist Mancur Olson who most insightfully explored the similarities and differences between a tax-collecting government and a bandit in his book, Power and Prosperity. Olson should have been 81 this week – and possibly would have a Nobel memorial prize in economics to his name – but an early death, 15 years ago, meant that Power and Prosperity was his last work.

Consider two different types of bandit, suggested Olson: the roving bandit, who wanders around pillaging wherever he can; and the stationary bandit, who builds a castle and settles down to exploit a particular area. At first glance, one might think that a stationary bandit is the greater curse, because he’s always around. But not so: roving bandits are more dangerous because they have no reason to hold back. A roving bandit will take everything and leave you dead. The stationary bandit wants to come back and take more next week, and so will ensure you have the resources to keep going about your business.

Because you have everything to fear from the roving bandit, you are likely to take your own steps to avoid him – to hide, to place locks and alarms on everything, or to hire a group of seven samurai to protect you. Meanwhile, anticipating your counter-measures, the roving bandit will also spend resources on his counter-counter-measures. The cost of such arms races can be vast.

The quintessential roving bandit is the pirate – so what is the cost of piracy? A recent working paper by Tim Besley, Thiemo Fetzer and Hannes Mueller tries to evaluate the costs of piracy off the coast of Somalia by examining the rise and fall of shipping costs alongside the ebb and flow of pirate attacks.

Besley and his colleagues reckon that costs of between $900m and $3.6bn were incurred in 2010 as a result either of pirate attacks, or efforts to deter or evade such attacks. Meanwhile the pirates took home just $120m over the same period. Now that $120m does seem to have had some beneficial effects on the pirates’ home ports, according to Anja Shortland, an economist at Brunel University. But piracy is an expensive way to get $120m into the hands of anybody.

There are signs that Somali piracy is on the wane, at least for now. But Somalia remains the poster child for a failed state. And a good working definition of a failed state is one that lacks a decent, long-lived stationary bandit. After all, once a stationary bandit feels secure in his tenure (“long live the king!”) he may do more than show restraint in his plunder: he may begin to invest in the prosperity of the region he dominates, building bridges, establishing a police force and drawing up laws. To maintain his power base he will have to hand out favours and ensure that prosperity is reasonably widespread.

Eventually, the banditocracy becomes a democracy. And a democracy simply cannot afford revenue-raising efforts as wasteful as Somalia’s pirates.

Also published at ft.com.

Pop-Up Economics – new radio series

I’m delighted  to announce the arrival of “Pop Up Economics”, my new radio series for the BBC. I’m proud of it and I think my producers have made it sound exciting and very different.

The show is all about storytelling – and the stories are of remarkable lives or surprising ideas in economics. We’ll learn about the impromptu engineering genius Bill Phillips, the cold war guru Thomas Schelling, and life-saving market designer Al Roth. We’ll discover how the geeks took over poker, and what happened to them.

And the series begins with the innovation lessons from the London Olympics – or as we’ve called it, “Hot Pants vs. the Knockout Mouse”.

Here’s the free podcast page (or search on iTunes) and here is the series homepage. Please spread the word. First broadcast is tonight, 8.45pm GMT, BBC Radio 4.

What really powers innovation: high wages

Why did the industrial revolution take off in the UK rather than in China?

Five hundred years ago, the world’s richest countries – the western European states – were only twice as wealthy, per person, as the poorest – a modest gap, roughly comparable to that between modern-day Switzerland and Portugal. By the start of the industrial revolution, two centuries ago, the ratio of per-capita incomes had become three to one. It is now 20 or 30 to one; if you look at the very richest and poorest it is far greater than that.

These facts deserve an explanation. Not only do such inequalities define the economy of the modern world, they also present a puzzle. If the basic story here is that rich countries have better technology, it should be fairly easy for poor countries to grow quickly by copying that technology. China is proving the truth of this, but such dramatic catch-up growth has been unusual in the past two centuries.

Perhaps for this reason, economists have tended to point instead to the importance of institutions such as well-functioning courts, or governments able to levy reasonable taxes and spend the money on infrastructure.

But maybe the answer is technology, after all. The economic historian Robert Allen has been studying why the industrial revolution took off in the UK rather than, say, China. Allen waves aside cultural and institutional explanations and focuses instead on economic incentives.

Consider, for example, the fact that while the UK was developing the spinning jenny, British potters were using wasteful bronze-age kiln technology. China, meanwhile, was building highly sophisticated kiln systems to circulate hot air and maximise the energy efficiency of the process. Who had the more innovative culture? For Bob Allen, the question misses the point. Both countries were developing new technologies, but in response to different economic incentives.

At the dawn of the industrial revolution, labour was expensive in the UK, and energy in the form of coal was uniquely cheap. This was less true in continental Europe and the reverse was true in China and India, with cheap labour and expensive energy. British wages were high thanks to the success of the British trading empire. Chinese inventors looked for ways to save energy. British inventors looked for ways to save labour, because the payoff for replacing muscle power with steam power was obvious.

According to Bob Allen’s calculations, had a French entrepreneur been presented with easy-assemble instructions for the spinning jenny in 1780, it would scarcely have been worth building it. In India, it would have been a definite loss-maker. But in the UK, the annual rate of return was almost 40 per cent. So much for the genius of British engineering: it wasn’t that nobody else could develop labour-saving machines, it was that nobody else needed them.

This is a persuasive explanation for the location of the industrial revolution, but it is also a solution to the puzzle with which this column began, because Bob Allen’s view of innovation points towards a self-reinforcing spiral. High wages lead to investment in labour-saving technology; that investment means that each worker will be operating more powerful equipment and producing more; this process in turn raises the productivity of labour and tends to raise wages. The incentive to innovate further only continues.

As Allen observes, China and India were not agricultural economies that for centuries failed to develop a manufacturing sector; they were low-wage manufacturers whose domestic industries were gutted by competition from highly automated British industry. Those countries that did manage to get back on even terms with the UK did so with activist industrial policy and trade tariffs to protect their infant industry. It was not a strategy that the British allowed their Imperial possessions to pursue.

Also published at ft.com.

Why platinum is fool’s gold

In the context of a small round coin, the stakes are surprisingly high, writes Tim Harford

What’s all this I hear about a trillion-dollar platinum coin?



It’s brilliant, isn’t it? Here’s the background. The US Congress has, over the years, voted to collect less in taxes than it has decided to spend. In order to carry out Congress’s instructions the US Treasury has to borrow extra money. The Treasury’s power to do that is limited by a debt ceiling, and it’s likely to run out of cash shortly after Valentine’s day.



So who has the authority to raise the debt ceiling, and thus enable the Treasury to carry out Congress’s instructions?



Oh, that’s easy. Congress does.



Wait – so in February we’ll find out whether Congress will allow the Treasury to obey Congress or not?

We will indeed.



I suppose this is how checks and balances work.

Checks and balances are one thing, but this is about the US government’s right to punch itself repeatedly in the face. If Congress doesn’t allow the Treasury to obey Congress then the US might even be forced to default on its debt obligations, which would be less of a punch in the face and more a baseball bat swung firmly into the groin of the world economy. I suspect that somehow the administration will find a way to stave off such a default, which would – unlike the inaptly-titled “fiscal cliff” – be a sudden and near-catastrophic event.



Unless there was . . . A TRILLION DOLLAR PLATINUM COIN!

Yes, unless that. Actually there are various ways in which the US Treasury might find an escape hatch through the debt ceiling, but coin seignorage is by far the most eye-catching. A law passed back in 1997 gives the US Treasury secretary the authority to mint platinum commemorative coins in any denomination. And coins aren’t government bonds, so they don’t count against the debt ceiling and the Treasury could simply pay for Congress’s spending programmes with the trillion-dollar coin. Or less comically, a big pile of hundred million dollar coins.



I now have so many questions I don’t know where to start. Like – where would the Treasury get a trillion dollars’ worth of platinum?

It doesn’t need to, any more than the Federal Reserve is obliged to put a hundred dollars’ worth of paper and rag into every hundred dollar bill. A small coin with “One Trillion Dollars” stamped on it will do.



And the face of Dr Evil, little finger cocked to mouth, I suppose?

Tim Geithner, the Treasury secretary, can choose any design he wants but we can all see that Dr Evil would be the only reasonable choice.



A bit unwieldy, though?

The Treasury could deposit the coin with the Federal Reserve. The Federal Reserve would then credit a trillion dollars to the Treasury’s bank account, and the Treasury would start spending the money in the traditional fashion.



Wouldn’t that be catastrophically inflationary?

The Fed should ensure that it isn’t. The value of notes and coins in circulation is $2.6tn, so an extra trillion would be a big deal. But currency in circulation can vary hugely without necessarily causing inflation – it depends what else is going on in the financial system. In this case, as the Treasury spent the trillion dollars, the Fed could sell a trillion dollars’ worth of US government bonds, absorbing the extra currency.



So the overall effect would be an extra trillion dollars of bonds in private hands, exactly as though the Treasury had borrowed money in the first place?

Yes. The economics of this are surprisingly tame. It’s the politics that are up for grabs, and there are really two questions here. The tactical issue is who would look stupider – Republicans in Congress for using the debt ceiling to prevent the Treasury carrying out Congress’s instructions, or the Obama administration for responding to that threat by using a trillion-dollar coin. It’s a variant on the old philosophical paradox: the infinitely ridiculous force meets the infinitely ludicrous obstacle.



Is there a real policy judgment to be made, too?

Yes. It’s whether America’s economic reputation would be more damaged by another debt-ceiling crisis, or by the executive seizing the authority to create new money. Very sensibly, the administration is trying to rise above the whole argument.



So there won’t be a trillion- dollar coin?

I strongly doubt it. But then again, Tim Geithner is expected to step down soon. Someone should check his pockets on the way out.

Also published at ft.com.

How to nurture innovations that matter – Tim Harford live at Wired 2012

Here’s my talk at Wired late last year. It was a really fun event. Enjoy!

Click here to view the embedded video.

(Note, incidentally, that Matt Parker has now moved from cycling to rugby.)

 

2013: The year I plan to fail

We pass up excellent opportunities to make larger gains, purely because we are desperate to avoid small losses. But doing so might be to our disadvantage

As I write these words, I am already contemplating my New Year’s resolutions, and my attempts to use the toolkit of behavioural economics grow ever more intricate. This year the enemy is “loss aversion”, a phenomenon identified by the psychologists Daniel Kahneman (a Nobel laureate) and the late Amos Tversky.

Loss aversion sounds like an odd label, because it might seem perfectly reasonable to be averse to losses. Technically speaking, loss aversion is something more than that: it is a disproportionate anxiety about losses. When we pass up excellent opportunities to make larger gains, purely because we are desperate to avoid small losses, that is loss aversion at work.

And it is rarely wise, since the difference between “losses” and “gains” is often rather arbitrary – a benchmark that is easily manipulated.

(Naturally it is in the interests of casinos to make you think you’re gambling with the house’s money, so that everything feels like a possible gain, because that will make you more willing to take risks. In contrast, expect insurance salesmen to emphasise the status quo that must be protected against loss.)

Loss aversion might seem to have little to do with New Year resolutions, but I think it does. My resolution this year is to risk more small losses. The world is full of overpriced insurance or insurance supplements, designed to remove the risks of having to replace a cracked mobile phone or a dented bumper. But as a paid-up member of the economics profession, I’ve avoided such nonsense for years, so this doesn’t make for a good new resolution.

But there are other small losses, which we are tempted to avoid to our disadvantage. These are the little experiments in life: going to the party where we might meet someone interesting; the new class we were thinking of taking up; the hobby we wanted to try out. Peter Sims’ book Little Bets is full of examples in the work habits of successful creative people, from architects to stand-up comics.

So I’ll be trying something new each month in 2013, and I’ll be fighting loss aversion all the way. I have a few plans. I’d like to write a short story, organise an intellectual salon, hire a personal trainer, learn to program and bake chocolate cake.

Now you may have heard such wheezes before, but this is a little different. The whole point is that I don’t really expect much of this to work out. The personal trainer will probably be a waste of money; the salon is likely to be awkward and disappointing; I have no need to program and nobody is ever going to publish my short story.

As for baking, I did try to learn to bake bread last year, visiting my brother-in-law’s bakery beside Oxenholme railway station. I had fun – but I have never found the time to bake anything at home.

This is the point: none of these losses will amount to a hill of beans. I expect to waste a few hours and a few quid. I don’t expect to regret any of it, because none of this is really supposed to pan out. Some of these projects will remain firmly on the drawing board for the entire year. It simply does not matter because these losses are all small. And you never know: one of these days, one of these projects may turn out to be hugely fulfilling. That will justify all the failed experiments along the way.

Loss aversion grips many organisations. Far too often, new ideas are turned down because they will probably fail, without seriously asking whether the small chance of meaningful success might outweigh an inexpensive failure – even if that failure is highly likely.

Most resolutions are things we decide to do because we’re convinced they will be to our benefit. My aim is to do things that I suspect will fail.

Also published at ft.com.