Monday, April 15, 2013

Review of The Undercover Economist by Tim Harford

Why is coffee so expensive on train stations? Which type of illegal activity gives the best profit? What are the benefits and the downsides of free markets? Is natinal health insurance good or bad? Should you feel bad when purchasing products made in countries where workers do not enjoy the same rights as in your own country?

In The Undercover Economist Tim Harford deals with these as well as other economic issues that we encounter on a daily basis, often without being aware of it. The book is generally easy to understand and have a subtle humorous tone which keeps you engaged. Like almost all economist (that I have encountered anyway), Harford favors a more or less free market. Whether this should be seen as a bias or if this is because free markets are intrinsically good is a question I cannot answer. In any case the book is definitely pro free market which may be a dealbreaker for some potential readers.

Harford begins by introducing the concept of scarcity power. He claims that the scarcity of a product or any type of asset will determine the price of that asset. In the case of a coffee stand on a busy London train station the price can get very high indeed which ultimately results in high coffee prices. In my mind scarcity is simply part of the supply and demand equation. If the supply is very small, and demand very high prices will be high. Perhaps there is something I do not understand...

Harford moves on to discuss the implications of this principle in the society. For instance, if you own a maffia, one of the most lucrative paths to take is to start a legit business and then threaten competition to increase scarcity power (reduce supply). With the competition gone you can charge what you want and make a nice profit.

One of the most interesting things I learned from this book was that sales, rebates, special prizes for students and seniors, class seating on trains and airplanes etc, are often just ways for a business to charge customers as much as they are willing to pay for any particular product. A coffee stand may earn a profit by selling coffee quite cheap but would of course like people with a lot of money to pay as much as possible. To get rich people to pay allot while not scaring off poor people or students you can offer large cups or alternative types of coffee such as coffee mocha coco bozo with cream, ice cream etc etc. Such fancy product are really not much more expensive to produce but you can charge much more for it (and if you check out the prizes at your local cafe this is exactly what they do).

Similarly if you own an airline company it makes sense to have different types of seating because then you can charge insane amounts of money for a little bit more leg space and a little better service which many people are willing to pay to feel just a little bit more special. To increase the gap you can also consciously make standard seating slightly uncomfortable.

While being a free market proponent Harford acknowledges that markets can run into trouble. For example, the insurance industry is very susceptible to the problem of imperfect information. If people only get insurance once they are sick, or if insurance companies only offer insurance to those who are completely healthy and have a tiny risk of getitng sick, then the market will not work. As Tim puts it, insurance industry is dependent on mutual ignorance. In the case of health insurance one practical solution is to have universal health insurance, which erases these issues. The only problem with this is that people are likely to consume more health care than they really need...

Harford also offers an analysis of what makes poor countries poor. The short answer is high tariffs (which reduces trade with the rest of the world), and corruption. These two factors can be particularly detrimental in small countries which are extremely dependent on international trade. There is nothing preventing poor countries from developing into richer countries and there are in fact many examples of such a transition. One particularly striking example which is discussed in the book is South Korea which used to have many “sweat shops” where working conditionins were poor compared to the rest of the world. However, because they could offer cheap products they achieved impressive growth and a rapid switch from an agricultural to a manufacture economy. Today, South Korea is a highly technological society with a high standard of living and sweat shops have moved to other countries, because today there are better jobs available to Koreans. Harford makes it clear that boycotting a county’s products because their workers do not have the same job security or pay as our own workers does not help that country, even though it people think they are doing a good deed.

To illustrate what freer markets can achieve Harford looks to China, a country which has seen an improbable economic growth in recent decades. As a result of this development, 300 million people have been lifted out of poverty in China. This number is so high that it is difficult to comprehend what it really stands for. When a natural disasters kills tens of thousands of people it is also easy to lose sight of the fact that every person is an individual with his or her own personality, feelings, food preferences, etc etc. Similarly when hearing that that 300 million people have been lifted out of poverty it means a very significant improvement in the lives of these individuals and that is something worth remembering!

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