The Undercover Economist — Tim Harford

The Undercover EconomistThe Undercover Economist is full of useful explanations of many orthodox economic concepts. It explains why free markets are so powerful and what economic efficiency means. It also contains the most accessible explanation of the subprime mortgage crisis as I have ever read. But when all you have is a hammer, everything looks like a nail. For Mr Harford, like many others, markets are that hammer. He does a decent job of trying to address possible difficulties with market-based solutions, but he ignores some fundamental problems.

Economists call free markets “efficient”. This just means that nobody can be made better off without also making somebody else worse off. For example, 10 billionaires having all the money while a million paupers starve to death could be an efficient system, since we can’t give a crust of bread to a pauper without making a billionaire worse off (by the price of a crust of bread). Obviously, this sort of efficiency doesn’t say anything about whether the economy is at all desirable. Hartford briefly points out that we tend to value things like fairness too.

But after that very brief mention, he goes on as if it’s really efficiency that we should be striving for. He says we choose to believe “cosy white lies” when we do things like raise taxes to subsidise elderly people’s home heating so they don’t freeze to death in winter. But his own example seems to show that efficiency itself is the lie. It’s not efficiency that we need to pursue — it’s fairness. Economic efficiency is worthless unless it helps us be more fair.

And this is not a political statement. Politics and morality don’t come into it until we ask what fairness actually is: maybe it’s fair for CEOs to make 1000 times as much as janitors, or for rich people’s children to be rich too, or for lazy, stupid people and their families to starve. Economic efficiency is a subordinate goal at best, but Harford spends his whole book letting the “efficient” tail wag the dog.

An even more fundamental problem comes with his often-repeated assertion that free markets are efficient. While this is true in simplistic mathematical models of perfect economies, it’s not true of the real world. So after his useful description of the concept of economic efficiency, the rest of the book contains a lot of economic techniques and policies that are based not on the true assumption that idealised free markets are efficient, but on the false assumption that actual, real-world markets are efficient. Since this assumption is false, his arguments are not sound. This doesn’t mean his policies won’t work, but it does mean they need a lot more justification that just appealing to fictitious efficient markets.

Overall there is an underlying assumption that people are “econs”, who always value goods, time, human life, etc. rationally and consistently. This is clearly false (see for example Thinking Fast and Slow for umpteen counterexamples) yet throughout the book Harford asserts that people know the truth about their costs and benefits, and that they always act in their own best interests. Of course they don’t; and this explains a lot of the world’s health and social problems, which free markets by themselves are not going to solve.

The book discusses market-based systems for providing public health care. A major problem is having to decide how to spend a limited health budget. How do we choose between a teenager’s hearing and an old man’s hip? In the UK the National Health Service chooses treatments based on Quality-Adjusted Life years (QUALY), which can result in controversial allocations of funding. Harford prefers the Singaporean solution of universal free insurance, allowing people to choose the treatment they want. The high-excess insurance is backed by compulsory saving, so presumably the poorest people will still face financial hardship. Harford thinks that this system avoids the need to worry about QUALY. He’s wrong. All it does is move the responsibility of evaluating treatments from government-sponsored experts to worried sick people. He might suggest that people will make better decisions about their own healthcare than bureaucrats, but it’s not clear that having better incentives will automatically result in better decisions. It’s the paradox of choice all over again.

There is a school of political thought that seeks to ensure people take personal responsibility over their lives. This seems reasonable. But some see it as an all-or-nothing choice: either we have the nanny state, deciding everything, regulating everything and sliding into a failing planned economy or we are in the brave frontier of self-made men and women, doing everything themselves with no meddling government. Surely a better approach would be for us to take personal responsibility for the interesting stuff, and leave the mundane stuff to government

Harford seems to favour full free trade within and among countries. But the path to full free trade is very uncertain and painful, and nobody knows what the destination will be like and whether it will be better than now. For example, full free trade would have to include free trade in labour, which means free migration. This is a typical example of seizing something that is easy to measure (economic “efficiency”), and trying to optimise it, rather than realising that we don’t yet understand how to optimise human wellbeing.

There’s a lot of good and interesting stuff in this book. As I said, Harford’s explanation of the US subprime loan crisis of 2008 is the clearest I have yet seen. And in the epilogue to one chapter he admits:

There is much more to life than what gets measured in accounts. Even economists know that.

Unfortunately that crucial fact isn’t reflected in the rest of the book.

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