The Undercover Economist
by Tim Harford
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Book Reviews of The Undercover Economist
Book Review: Macro 1 as it should be
Summary: 4 Stars
Who pays for your coffee? With this simple yet mistaken (think about it!) question, Tim Harford introduces David Ricardo's theory of economic rent. Using the coffee stands at London's Waterloo station, he shows how the rents of the best locations are governed by the worst, the marginal sites at which the price can just cover the cost of production. `Undercover' does not imply illegality and danger, just a man going about his everyday business with a few extra intellectual tools.
Fortunately, the chapter titles make more sense after the first. `What Supermarkets Don't Want You to Know' illustrates price discrimination, `Perfect Markets and the "World of Truth"' how a perfectly competitive market could bring about efficient outcomes, and `Crosstown Traffic' and `The Inside Story' how externalities and asymmetric information spoil this story. `Rational Insanity' is an apt a description as any of herding in financial markets, while `The Men Who Knew the Value of Nothing' is not a description of mad economists selling rain forests and small children but an excursion into game theory via the trials and tribulations of radio spectrum auctions. `Why Poor Countries Are Poor', `Beer, Chips and Globalisation' and `How China Grew Rich' are more standard applications of comparative advantage and Olsen's stationary bandit theory.
The opinions and policy prescriptions are unsurprising for a Financial Times columnist -- free trade is good, environmental and fair trade activists are often misguided, tradable permits and taxes are the best way to solve pollution and congestion. (Unfortunately, Bastiat's quip about throwing rocks in your own harbour is attributed to Joan Robinson, which surely has them both spinning in their graves.) Yet while Harford exhibits flashes of unjustified dogmatism -- `trade barriers will always do more harm than good' and holding up South Korea as a shining example of free trade -- his views are generally more nuanced, separating goods trade and direct investment from financial openness in his discussion on globalization, and praising China's pursuit of gradual reforms and `growing out of the plan', rather than fire-sale privatization Russian style.
It is a great strength of the book that it starts with monopolistic competition -- firms with some price setting power, but still constrained by rivals, rather than the pedagogically more common (but empirically less so) extremes of pure natural monopoly or perfect competition. Yet the full implications of this pervasive market structure are not fully appreciated. The unavoidable dilemma whenever there is some fixed cost and marginal costs do not increase with output is that the efficient, marginal cost price loses money, while any increase in price is inefficient. Successful price discrimination may determine whether the product exists at all, not just whether the quantity provided is marginally more or less efficient. This dilemma is never squarely faced, unlike the problems posed by externalities and imperfect information. In `Perfect Markets' it is simply stated that marginal cost price is efficient. This could not be applied in most industries without a vast system of subsidies and restrictions on entry.
Aside from fixed costs, one of the very few areas of basic microeconomics neglected by Harford is the classification of goods based on rivalry and excludability. This may be asking too much of a work that, after all, does not claim to be a textbook. Yet claiming that `the basic rules for making money in the high-tech business are not so different from the rules for train operators or coffee bars' is not convincing. The combination of low rivalry in the intellectual property and low excludability thanks to easy piracy makes the software, pharmaceutical and music industries more different than he admits, and less susceptible to even a second-best market solution. Similarly, lumping police and schools together when considering government versus private provision is rather crude.
One piece of terminology is also unfortunate. As if the word `monopoly' is to be avoided at any cost, `scarcity power' is used instead, which indiscriminately covers cases of natural scarcity such as good crop land, differences in the efficiency of organizations (which are rather confusingly also called `natural'), contrived monopolies through government regulation or criminal violence, and skills that are in short supply.
Yet with these reservations, The Undercover Economist is still superb. In a market where introductory textbooks are growing ever larger, more colourful, and more expensive, the author has taken some of the most important ideas in economics, made them as simple as they can be (but no simpler), and related them to examples that are real, relevant and interesting. All in around 250 pages with 5 simple black and white graphs.
-Originally published in Agenda 13(3), 2006.
Book Review: Somewhat spotty; Decent overall
Summary: 3 Stars
There was a lot overlap between this book and Steven Landsburg's "Armchair Economist" (discussion of why popcorn costs more at the movies, etc)
The good points, one by one:
1. Harford does a slightly better job of detailing differential pricing systems than Landsburg. Not only is the treatment of differential pricing better, but there is also a more clear treatment of why scarcity creates value. Rather than defining "The Indifference Principle" (Landsburg), Harford just simply stated the principle in a much more straightforward way.
2. This was a cool mishmash of a lot of unrelated ideas, but it didn't quite catch on in the same way that "Freakonomics" did. Perhaps this is because the author chose to do too much pontificating and less work on the facts.
3. There is a thorough demolition of a lot of misconceptions about free trade, and even a brief exposition of Abba Lerner's proof that a tax on imports is exactly equivalent to a tax on exports of the same amount. There was also something for the enviro-nutbags that demonstrates that there is no clear relationship between economic growth and pollution.
4. The discussion of Pareto optimality, rent seeking and random walks is particularly clear and accessible. Alan Greenspan covered the topic in "The Age of Turbulence," but it was less clear than this author's exposition.
5. There were interesting details presented in the special case of African idiocy. He revisited Bill Easterly's take on "Misadventures in the Tropics" as to why distorted incentives can explain a lot of Africa's misfortune.
6. The fact that he spent more time with actual case studies (without making this read like a book of statistics) is a significant positive point in the book.
7. The best chapter in the book is the one about PRACTICAL APPLICATIONS of game theory with REAL LIFE EXAMPLES. (Economists often get so carried away with building their models, that they forget that there is an empirical component necessary to know how good the model is. This chapter was a step in the right direction.)
The bad points:
1. His discussion of American health care is extremely foolish. There are many reasons that healthcare there is so expensive, and third party payments (insurance companies) are only a part of the problem. There are licensing restrictions and excessively long training periods that excessively limit on who can be a physician (this would have been a good addition to his comments on scarcity). There are also laws that don't allow prices to be posted in clear view in hospitals (which would have fit well into his chapter on information asymmetry). But with his long tirade against US healthcare, it was clear that he *just didn't know what he was talking about.*
2. Because of the weakness of the arguments about the US healthcare system, it is not clear how much of the rest of the book contained specious arguments. For example: The Lerner proof is something that was presented as just that. But a brief examination of some other sources shows that there are conditions under with the Lerner "proof" breaks down-- and these cases were not dealt with AT ALL by the author.
3. There was also omission of relevant facts. For instance: Switzerland is a country that has a private health care system (and private insurance) and its costs are lower than those of the United States (as a percentage of GDP), and this was omitted because it would run contrary to his PRIVATE INSURANCE BAD NATIONAL HEALTHCARE GOOD argument. In addition: There was NO exposition of what led him to assert that the quality of care in one place was better than another. (Exactly was so much better about Canadian health care than US? And how much better?)
4. There were also lots of misconceptions about China. There are LOTS of questions about the efficiency of Chinese investment. Japan was also a country that invested huge sums of money at diminishing returns, and it proved very messy to clean up. If he wanted to use a stellar example of capitalism at work, this was not the best one that he could have chosen.
Book Review: The Economist as Detective
Summary: 4 Stars
Ever since the surprise success of "Freakonomics", a flood of economics books for the general public have been published, all trying to cash on the success of that peculiar best seller. According to the principles explained in Tim Harford's book, that is probably a mistake: profits come from scarcity - so further books about `the economics of everyday life' face diminishing returns. And yet, Harford offers several explanations as to why such books may continue to be published: one is that if everyone thinks that economics books are going to be best sellers, an editor who wouldn't publish economics books may lose her job. I'm merely speculating, of course, but this is what happened (with dotcom stocks instead of econ books) to Tony Dye, chief executive of Phillips & Drew (pp. 135-137).
Tim Harford's stuff, though, is worth reading. A regular contributor to slate.com and the financial times, Harford has the gift of explaining complicated economic ideas in accessible language.
Although the comparison to "Freakonomics" is made prominently by the book's cover (which in my version includes an endorsement from Freakonomist Steven Levitt himself, as well as a description as the "elder sibling" of Freakonomics by `The Economist'), `The Undercover Economist' is the better economics book. Freakonomics, after all, doesn't teach too much economics: beyond emphasizing that "people respond to incentives" (an important message, for sure) it answers such questions as whether Sumo wrestlers cheat (They do) and what name should you give your child (It doesn't matter). Harford, on the other hand, explains such valuable economic concepts as rent seeking, externalities and asymmetrical information, and does so in a language that suits both academics and laypeople, with fun examples and a little history of economic though to boot. What more can you ask for in a popular book?
For those with a little knowledge of economics (I have an undergraduate degree in Business Economics) much of it will be familiar. And yet there are enough interesting tidbits that don't make it into your average introductory economics textbook. The chapters about the stock exchange and the application of game theory for auctions were both informative, thought provoking, and fun to read.
For me, the great revelation was the discussion of the environmental effects of globalization. I admit that I have long considered environmental damage to be the most credible counter argument to economic benefits of trade; But Tim Harford makes a good case that that ain't so. "Races to the Bottom" in which countries compete for the worse environmental regulations are unlikely, Harford argues - the advantage in producing "dirtily" is simply not big enough. Rather, Harford shows that protectionism leads to over production, and thus to pollution. And yet, Harford acknowledges that economic growth as such does hurt the environment. And therefore the dilemma of environmentalism or growth is not entirely imaginary - just exaggerated.
There are times when Harford does not raise his opponent's best arguments. In the chapter on free trade, Harford does not discuss various theories of Path Dependencies and learning curve. In the chapter of poverty, he hardly discusses the effects of the environment on economic growth (a major issue in Jeffrey Sachs'The End of Poverty: Economic Possibilities for Our Time), or the questionable legacy of western imperialism. I'm not saying that these are irrefutable objections - quite the contrary - but Harford doesn't quite do them justice.
Still, Harford's book is well written, entertaining, and informative. It targets the economically challenge but has something to offer to all readers, no matter how economically astute.
Book Review: An excellent treatment of everyday economics
Summary: 5 Stars
I must begin by saying that I liked this book very much. Not to cut suspense, since the review is obviously favorable all along, but just to set a positive tone for the start.
On the surface, "The Undercover Economist" is just another popular economics book, of the kind that is quite common lately (Freakonomics is one example that immediately comes to mind). However, once you finish reading it (paying attention all the way, of course), you realize it presents some relatively deep ideas, explaining them very thoroughly and logically connected pieces from different aspects of economics.
The book begins by a thorough overview of supply and demand, providing simple and befitting examples, both from real life and imaginary. Next, it treats the topic of price targeting (also called "differential pricing") - with really a huge assortment of examples from diverse fields. Then, it explains about free markets and what's good about them.
The connection of market freedom to "finding the truth" is enlightening, and becomes even more so while reading further. The author then moves to more macro-economic topics, discussing globalization and the economic situation in third world countries, such as Cameroon. Finally, he concludes the book with a thorough treatment of the changes in the Chinese economy in the past 30 years. This is the best part of the book, in which all the concepts presented in previous sections come together to explain why the communist system prevailing in China before 1976 failed, and why the gradual freeing of its economy in the years that passed since succeeded on a magnificent scale.
Here are another few topics that I found interesting, in no particular order:
* Why is wine always very expensive in restaurants ? Because one of the big costs in a restaurant is table space. Restaurants would therefore like to charge customers for dawdling, but because they can't do that, they charge higher prices for products that tend to be consumed in longer meals, like wine, appetizers and desserts.
* The story of how the Environmental Protection Agency (EPA) in the USA reduced sulfur pollution problems in the 1990s by cleverly issuing "pollution permits" that factories could buy. This way, the "truth" was exposed - the real costs of pollution reducing equipment to companies.
* Did you ever think about what an "efficient economy" means. Simple. If we can point to a change that could make at least one person better off, and nobody worse off, we (economists) say that the current situation is inefficient. This simple explanation is much deeper than it first appears, as it sets one of the basic rules of free markets - in an efficient market, everyone lives on the margins (excepts of one having scarcity power). If some field is too profitable, more competitors will enter it.
* There is an excellent treatment of the problems with the USA's current health care system that's worth reading, not only for Americans.
* When we bash dictatorships in third world countries, we must keep in mind that not all dictatorships are equally bad. In fact, stable dictatorships damage their country's economy much less than unstable ones. This is because stable dictators expect to stay in power for a long time, and hence don't have an interest to rob the economy too much, because that will reduce from their future profits. Unstable dictators, OTOH, are the worst kind - they just come to power, steal as much as possible and disappear. The author cleverly compared stable dictatorships to biological viruses, that have over time evolved not to kill the host body, but rather to use it in order to feed and reproduce to other bodies.
As I mentioned, I really liked this book. In fact, I think it's one of the best popular-economics books I've ever read. It is very highly recommended.
Book Review: An extraordinary primer on the basics of economics written for the general public: Tim Harford is the Carl Sagan of economics
Summary: 5 Stars
Mr. Harford is a renowned economist and a gifted writer and communicator, who successfully achieved in this short and well written book the difficult task of explaining to the general public the complexities of key economic principles in very simple terms. However, do not be confused, this book, though equally entertaining, is no Freakonomics [Revised and Expanded]: A Rogue Economist Explores the Hidden Side of Everything. The author's 2008 book, The Logic of Life: The Rational Economics of an Irrational World, is actually more Freakonomics style.
Have you heard of price elasticity and price signals, scarcity power, market failures, marginal cost, externalities, asymmetric and imperfect information, moral hazard, stock prices and random walk, and game theory?
Mr. Harford manages to explain the concepts behind this jargon in simple words with everyday life examples, allowing you to understand why the production cost of the cheapest oil fields in Saudi Arabia and Kuwait is just around $2 a barrel but we ended paying $50 (or up to $140 last year); why we pay $3 for a cappuccino but coffee growers in the third world just get a few cents for each cup; the rationale behind congestion pricing (the entire Chapter 4 is devoted to this controversial policy and how it also applies for curbing pollution); the economic reasons behind the failures of the US health insurance system; and the predictability of the stock market (the current financial crises proves Harford's point, who wrote about the "rational fools" in March 2005, and within the context of the dot-com bubble). In general terms, the first seven chapters provide the reader an opportunity to grasp key concepts and principles in the field of microeconomics.
The three last chapters of the book take a different approach as the book turns more into the territory of macroeconomics, exploring equally interesting and up-to-date issues regarding economic growth, international trade, competition, the theory of comparative advantage, and of course, globalization. The reader is introduced to these concepts with a chapter on Cameroon, used as a case study to explain the reasons for poor countries being poor, and highlighting the role corruption, weak institutions, and trade barriers. The last chapter in contrast, presents how China was able to achieve explosive growth rates during the last three decades, growing faster than any country in history, rising from Mao's disastrous economic experiments through the power of market and prices. Chapter 9 is a must read, as he discusses the main issues regarding globalization in a nutshell. Here Mr. Harford courageously debunks several myths regarding the alleged negative environmental impacts and other associated evils of globalization. Not surprisingly he wisely chose the examples of Cameroon and China to support his point of view.
This book comes very handy for the layman especially during these days of global economic crisis. I have a background on economics, and I do highly recommend it for anyone planning or having second thoughts about studying economics, the book will provide you with quite a general picture of what economics is really about. I also recommend it for those citizens interested in understanding a bit more about key economic principles, its everyday application, and who do not want to be easily fooled by politicians, interest groups, the media, nor even by many of the so-called "experts" and "gurus". The world would be a better place if every voter in the planet could grasp the basic concepts presented in this book.