The Undercover Economist
by Tim Harford
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Book Summary Information
Author: Tim HarfordEdition: Paperback
Audio: English (Unknown); English (Original Language); English (Published)
Published: 2007-01-30
ISBN: 0345494016
Number of pages: 265
Publisher: Random House Trade Paperbacks
Book Reviews of The Undercover Economist
Book Review: Insight on Problems, Less on Solutions
Summary: 4 Stars
Among the issues addressed in this insightful book are health care and personal investing, two key topics for most individuals. His analysis is penetrating but unfortunately his economist's rationality seems to have obscured for him the limits of economic models in real world complexities.
Harford describes the U.S. health care system as suffering primarily from an information problem. He claims a major problem is the inability of insurance companies to reliably know the level of risk of those who get insurance which causes them to raise rates higher than they should be. That in turn drives away low risk persons who rightly believe that premiums are excessive. So the remaining folks to be insured are higher risk which causes premiums to rise even more. The insurance companies then also spend a good deal of money on underwriting risk (though apparently not very effectively) and massaging the claim and payment system to maximize profits. This leaves a patchwork system of coverage that is inefficient and expensive.
He proposes that we adopt the system in Singapore that focuses solutions on the precise problem of market inefficiency caused by inadequate information. The problem of lack of affordability is addressed by subsidizing directly the cost of insurance for the low income, not setting up a separate insurance system for them. Even better is to "tackle the general system of poverty" that prevents them from affording many needed services, not just health care.
The British system is flawed by limited choice and rationing by government. Harford claims that it is the lack of key information that "destroys the insurance market" for medical care. He would greatly enhance consumer information about disease and providers and then make most costs the direct responsibility of the consumer without any insurance. That would give them the incentive to become well-informed and apply the information gained to purchase just the care they really need and want. Insurance would be reserved for "catastrophic" costs that are largely unpredictable and (in most cases) out of the control of the individual (e.g cancer). [Harford recognizes that some major health problems are the result of voluntary behavior, e.g. smoking, but figures that "moral hazard" cannot be entirely avoided.]
These considerations dictate private health savings accounts (which currently exists for the self-employed). Some tax incentive would be available for all for basic expenses and the contributions would be mandatory. Presumably premiums for the catastrophic coverage would also be mandatory.
There are several problems with Harford's solution. In an ideal world, you could create a much better market for health care services where government's role could be minimized. One major problem Harford ignores is the impracticality (despite the theoretical desirability) of each person mastering and managing their own health care and costs. The truth is that medical treatment and costs are complex areas that even highly educated people have trouble mastering. Even if they have the skills to do so, the efficiency of each person trying to do so is a problem. Then there is the question of where we draw the line on "catastrophic" expenses and "normal" expenses and how much of the burden we make people bear. These problems exist in any system, but they don't disappear by any means with Harford's plan. The mandatory savings plan could appear to operate like Social Security, assuring a basic minimum of care. But if the savings were not managed well, an individual could still end up with inadequate savings to cover "normal' expenses at a point when they had no other income to do so. In Social Security, the individual cannot dissipate his pension through bad management because the government doesn't let him. Likewise, it would prove impractical to leave people without any medical support despite their own mismanagement.
Most people would rather have "experts" manage their health care and costs in exchange for assuring a reasonable standard of care over their lifetime. A parallel can be seen in the self-directed retirement industry (401K's and IRAs) where most people don't want to take primary responsibility for the complex task of investing their savings but are willing to pay others to manage it. And here, increasingly, there is a trend for government and employers to limit fees and set up reasonable "default" programs that serve most people with the option of greater flexibility for those who wish to accept greater risk.
Harford's system may work well in Singapore where there is a more homogenous population and uniform system of providers. But until and unless there are very much improved information systems and clear, beneficial options for people to choose from, then stronger governmental intervention is a necessary trade-off for health security for the vast majority of Americans. At the point I can go to a reliable website and easily compare cost and quality of services and providers for my health care needs, then I would be far more willing to assume greater individual responsibility for negotiating my own health care contracts with providers. Until then I will have to rely on the health insurance companies to use their market power to negotiate more reasonable costs and my employer or the government to protect me from daunting, if not catastrophic, costs and failures of coverage. Unfortunately, these safeguards are not available to many and have proved inadequate to rein in soaring costs. So greater government intervention is necessary, not less.
Unlike in the world of economists' models, in the real world of ordinary people dealing with increasingly complex systems in every aspect of their lives, most would bargain for the protection of simpler, safer choices on essential matters of personal security - health care and retirement income. Options yes, but not bewildering complexity that can be easily exploited by vendors to hide poor value and excessive costs.
Harford on the stock market. This chapter is a helpful and perceptive primer in explaining the "random walk" theory of stock prices. The current price contains all the information (expert and otherwise) that is known to all investors. For the most part, there are very few avenues to exploit to find significantly under- or over-valued stocks (as distinct from factors generally applicable to the market as a whole - such as interest rates and return on competitive investments like bonds, and growth expectations for the economy as a whole). Thus variations in individual stock prices are driven by unanticipated events or "news" that is essentially random and unpredictable. Analysts have long shown that high-priced growth stocks are much more vulnerable to random bad news because so much good news is already incorporated into the price; whereas, low-priced "value" stocks typically have more upside because mostly bad news has been incorporated into their price.
Fundamentally, stocks are likely to return to the mean of their long term trend of selling for about 16 times annual earnings, or a return of between 6 and 7%, though as the 1990's showed, leading into the dot.com bubble, the P/E ratio can buck the trend for much longer than might be expected. He also shows how investment theories such as being the "first to market" or being in the forefront of a new technology fail to take account of the toll of competition over time leaving many leading companies as mediocre investments which is still better than many of their competitors which go bust.
The only reliable basis for outsized growth and profits is "scarcity power" which can come from some unique capability: a powerful brand in a conservative market; control of a standard like Microsoft; superior expertise like GE, or (so far) technical and marketing superiority like Google.
The next chapter addresses game theory and its application to economics. It ranges from a discussion of poker to auctions for telecom spectrum rights. It illustrates splendidly what Harford does not significantly acknowledge in the earlier chapter on health care - that economic models often fail to account for the messy human factors that inhibit purely rational decision-making from prevailing. In poker, the great John von Neumann, theorized that there was a winning strategy in tending to bluff with large bets on weak hands, but of course not predictably. But there are so many uncertain factors regarding the strategies or lack thereof of other players, that no consistently winning strategy can be worked out through game theory. The more variables one tries to factor in the more complex the analysis becomes so that few people can understand and apply it. The tale of auctioning radio spectrum illustrates the point. Early auctions were failures because the designers failed to adequately understand how their system could be gamed by the bidders. A later auction in Britain revealed that bidders could be induced to pay far more than they or the government anticipated when using different rules. In each case, even sophisticated players could end up being surprised and harmed when the game is complex. That is precisely why leaving great uncertainty and unequal bargaining power to play in issues of fundamental personal security does not make sense as a matter of policy.
Summary of The Undercover Economist
?The economy [isn?t] a bunch of rather dull statistics with names like GDP (gross domestic product),? notes Tim Harford, columnist and regular guest on NPR?s Marketplace, ?economics is about who gets what and why.? In this acclaimed and riveting book?part exposé, part user?s manual?the astute and entertaining columnist from the Financial Times demystifies the ways in which money works in the world. From why the coffee in your cup costs so much to why efficiency is not necessarily the answer to ensuring a fair society, from improving health care to curing crosstown traffic?all the dirty little secrets of dollars and cents are delightfully revealed by The Undercover Economist.?A rare specimen: a book on economics that will enthrall its readers . . . It brings the power of economics to life.?
?Steven D. Levitt, coauthor of Freakonomics
?A playful guide to the economics of everyday life, and as such is something of an elder sibling to Steven Levitt?s wild child, the hugely successful Freakonomics.?
?The Economist
?A tour de force . . . If you need to be convinced of the everrelevant and fascinating nature of economics, read this insightful and witty book.?
?Jagdish Bhagwati, author of In Defense of Globalization
?This is a book to savor.?
?The New York Times
?Harford writes like a dream. From his book I found out why there?s a Starbucks on every corner [and] how not to get duped in an auction. Reading The Undercover Economist is like spending an ordinary day wearing X-ray goggles.?
?David Bodanis, author of Electric Universe
?Much wit and wisdom.?
?The Houston Chronicle
From Publishers Weekly
Nattily packaged-the cover sports a Roy Lichtensteinesque image of an economist in Dick Tracy garb-and cleverly written, this book applies basic economic theory to such modern phenomena as Starbucks' pricing system and Microsoft's stock values. While the concepts explored are those encountered in Microeconomics 101, Harford gracefully explains abstruse ideas like pricing along the demand curve and game theory using real world examples without relying on graphs or jargon. The book addresses free market economic theory, but Harford is not a complete apologist for capitalism; he shows how companies from Amazon.com to Whole Foods to Starbucks have gouged consumers through guerrilla pricing techniques and explains the high rents in London (it has more to do with agriculture than one might think). Harford comes down soft on Chinese sweatshops, acknowledging "conditions in factories are terrible," but "sweatshops are better than the horrors that came before them, and a step on the road to something better." Perhaps, but Harford doesn't question whether communism or a capitalist-style industrial revolution are the only two choices available in modern economies. That aside, the book is unequaled in its accessibility and ability to show how free market economic forces affect readers' day-to-day.
Copyright © Reed Business Information, a division of Reed Elsevier Inc. All rights reserved.
From Bookmarks Magazine
Harford exposes the dark underbelly of capitalism in Undercover Economist. Compared with Steven Levitt?s and Stephen J. Dubner?s popular Freakonomics (*** July/Aug 2005), the book uses simple, playful examples (written in plain English) to elucidate complex economic theories. Critics agree that the book will grip readers interested in understanding free-market forces but disagree about Harford?s approach. Some thought the author mastered the small ideas while keeping in sight the larger context of globalization; others faulted Harford for failing to criticize certain economic theories and to ground his arguments in political, organizational structures. Either way, his case studies?some entertaining, others indicative of times to come?will make you think twice about that cup of coffee.
Copyright © 2004 Phillips & Nelson Media, Inc.
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