The
Undercover Economist is a
book that explains economic principles to the general public, in much
the same way that Chaos
explains chaos theory to the general public. Harford does
this by
taking everyday examples and examining why things are this way and who
is benefiting. However, this is not a book about
business.
If anything, it is a book of society and public policy, as Harford
spends much of the book examining the effect of economic policy on
countries, and why some countries grow richer and others grow poorer.
The first principle of the book is that economic benefits only go to
owners of scarce resource. Hartford uses the example of
Starbucks. Money is transferred from caffeine-craving
consumers
to Starbucks because Starbucks has a scarce resource:
conveniently located coffee. However, anyone can set up a
coffee
shop (so it really is not too scarce of a resource), which means that
Starbucks needs to outbid people for conveniently located store
sites. This raises the rental cost and means that Starbucks
has
less profit. Since coffee is not really a scarce resource,
most
of the benefit goes to the landowner, not the coffee vendor (or, for
that matter, the coffee growers).
This leads into the second economic principle, which is that the
important part of the economy is what happens at the margins, the
just-barely-productive sections. Hartford illustrates with an
example from David Ricardo, an early nineteenth-century economist who
discovered the principle. If there is a large area of
undeveloped
land, people willing to farm the land can rent the land for very little
(lots of land producing no income, few farmers). As more
farmers
come, the land price increases until farmers start renting land that is
less good. The price of the good land is relative to the
price of
the marginal land.
Economists view a perfect market, that is, a market where everyone pays
exactly the price that they are willing to for a particular good or
service, as ideal. (By "ideal" they mean "benefits everyone
the
most.") If it were not ideal, then people would pay less, or
choose something different. It follows, then, that pricing is
very important in economics. In fact, a seller will want
everyone
to pay exactly the maximum price that they are willing. Of
course, you cannot just ask buyers what they are willing to buy, so
there are various strategies to get buyers to divulge that
information: having different qualities of the same item at
different prices, different quantities, different "specialness" (e.g.
"organic"), etc.
Unfortunately, sometimes the price does not correctly reflect the
cost. The cost of driving a car is not just the car plus the
gas. It is also the fact that you are using space on the road
(leading to more traffic jams) and polluting the atmosphere.
If
this is not included in the price, then it is each person's best
interest to take a car trip, leading to pollution and traffic
jams. The solution is an externality charge, which is
basically
someone (the government) increasing the price to reflect the real
cost. London instituted a per-trip charge through a certain
area,
which resulted in a quick and dramatic traffic drop. The
marginal
cost of a trip to the local grocery store was originally close to zero,
so everyone drove. Now it was larger, so more people chose to
walk or bike.
Also, sometimes the market cannot set a correct price because of lack
of information. Health insurance is expensive because the
people
that think they are likely to get sick are the ones who will buy
insurance, but they insurance company has less information on whether
the person will get sick that the person does. You could have
the
government provide health care, but there is never enough money to go
around, so you have to choose who gets what treatment; since
there is not a good way of doing this, you get situations like in the
U.K. where if you are going blind in both eyes, you can only get one
eye treated (and not at all if you are going blind in just one
eye). The solution to this sort of problem is keyhole
economics. Identify what the scarcities are, allow both
parties
to get equal information, and let markets take care of the rest.
One example of using price to convey information and accurately
describe value is the auction of the U.K. 3G wireless
spectrum.
The bids were viewable by all parties, but once you stopped bidding,
you were out. The other company's bids gave you an idea of
how
valuable the market was going to be.
There is a bit of a shift in direction at this point and the rest of
the book discusses world trade. One of the major topics is
why
poor countries are poor. The standard models suggest that if
poor
countries develop their resources that have actual scarcity they will
eventually become rich. Japan and South Korea are good
examples
of this. However, some countries, like Cameroon, have
actually
become poorer. The difference is that Cameroon has a dictator
whose goal is to stay in power and have the country provide for his
personal fortune. If that were all, then the country should
still
get richer, because it would be in his interest for the country to have
more for him to steal. However, he can only remain dictator
with
the help of many other people, so he needs to provide an atmosphere
where they are better off with him than without. So he
tolerates
a culture of corruption. In order to maximize the opportunity
for
bribes there is a tremendous bureaucracy involved with
anything.
As a result, it is enormously expensive to set up a business, not
practical to try to collect from customers who do not pay, and the
general economic climate is miserable. To make matters worse,
since no one has any incentive to invest anything, children are not
effectively taught and the national infrastructure has fallen apart,
making the country even poorer. Fixing the problem would be
relatively simple: enforce laws that are necessary for the
proper
function of business and remove bureaucracy. The markets will
fix
the rest. Unfortunately, this cannot happen because of the
dictator.
China, on the other hand, has been a remarkable story of being an
economic success. Mao pretty much ruined the country partly
through stupid choices, and partly because the system gave no incentive
for individuals to improve it. Deng Xiaoping gradually
introduced
reforms that gave individuals incentive to improve the system, starting
with two small areas of the country. Although China's
business
climate was not suitable for business, it worked because the economic
areas were so small that laws that did not work were quickly
replaced. And although China's laws were insufficient,
because of
close family connections with Hong Kong and Taiwan, investments were
able to be made because family connections provided the necessary trust
that the laws did not promote.
Harford also discusses how world trade benefits everyone.
Although it is possible for some countries to be self-sufficient, it is
more economically efficient (i.e. people are richer) if each country
produces what it is good at producing and trades with the
rest.
Simply put, if you are not doing what you are best at, clearly you are
wasting time doing something inefficiently; if you had stuck
to
doing what you are best at, you could convert that previous
inefficiency into wealth through trading. Thus trade is good,
and
inhibitors to trade (tariffs) are bad. David Friedman
illustrates
this principle by talking about Detroit car manufacturers and Iowa car
growers. Detroit manufactures cars from steel; Iowa
grows
corn and ships it to a factory called "Japan" which turns it into
cars. Tariffs on imports benefit Iowa car growers.
Basically a tax on imports is equivalent to a tax on exports.
It also turns out that world trade is not ecologically
harmful.
Companys go to poor countries for cheap labor, not to
pollute.
Generally companies build the same plant everywhere in the world
because it is more efficient that way. In fact, if anything,
world trade imports pollution to rich countries, because they are the
countries that have the skilled labor to produce things using
concentrated chemicals. World trade is also not harmful to
workers. Workers in the poor countries go to the sweatshops
voluntarily; as bad as conditions are in the sweatshop, they
are
even worse outside the sweatshop, or workers would not choose to come
there!
The
Undercover Economist is a
easily understandable introduction to economics. The examples
that Harford uses are interesting and relevant and the astute reader
should be able to apply them to similar situations elsewhere.
A
number of these examples debunk commonly held ideas: high
prices
imply price gouging (they do not if there is real scarcity), trade
hurts the economy, government control is good, workers in poor
countries are being harmed by sweatshops. He also follows the
theory to its conclusions in public policy, which is helpful since the
public debate rarely includes relevant theory.
His delight in perfect markets seems to me to be a little like the joke
about physicists that ends with "assume a spherical cow."
Cows
are not spherical and markets are not perfect. So somewhere
the
theory is going to break down rather badly, but he does not discuss
when economics fail. Business schools like to teach a
"efficient
market" theory, which says that the stock market perfectly values
companies. Clearly this is not the case or we would not have
.com
bubbles or Warren Buffett
investors who beat the market for
decades. The implication of "efficient markets" is that
Warren
Buffett cannot exist (he cannot reliably beat the market if the market
truly values companies appropriately), but he does. The
"efficient market" is so similar to the economists perfect markets that
either the business schools did not understand the limitations of
perfect market theory and inappropriately applied it, or economic
theory has some substantial limitations that economists do not admit.
That said, this is a good introduction to economics and an interesting
analysis of situations all readers are likely to be familiar with and
the examples nicely illustrate, or rather, motivate, the principles, so
the book will be useful to any reader unfamiliar or only partly
familiar with economics.
Review: 8.5
A little
simplistic,
but good for the target audience. Good principles, good
examples. I'm a little unconvinced that this will be a 100
year
book, perhaps because although the principles are timeless, the
examples are firmly locked in the early twenty-first century.
Copyright
© 2006 by Geoffrey
Prewett