Book Review
In lucid language, Tim Harford brings forth to the reader the multifarious linkages that bind the global economic system. Over the course of ten chapters, Harford brings home an account of economic activity and highlights linkages between economics, human development, psychology and similar esoteric discoveries.
Harford commences his journey as an ‘undercover economist’ by observing how Starbucks Coffee shops are strategically placed at the exits of metro stations. Harford observes that while the retail price of a cup of coffee is far in excess of the actual cost of producing one, most of the premium goes the way of the agencies that rent premium spaces to coffee vendors. This brings forth the concept that ‘bargaining strength comes from scarcity’. Such scarcity could be natural or an artificial construct, and Harford offers the example of the Green Belt around London that drives property prices up in London to emphasizing the need to discern between protectionist and artificial scarcity.
Having established the concept of scarcity, Harford considers how establishments that sit on prime and scarce property manage to draw out the maximum revenue from paying customers. In a bid to avoid the thrifty customers from walking away at the sight of higher prices, businesses typically throw in conscience salving monikers like ‘fair trade’ coffee that promises to plough back more revenue to the coffee grower in order to lure the richer customers into paying more for similar fare. By the same token, establishments attempt to arrive at price sensitivity by targeting groups willing to pay higher prices, or by ‘price targeting’ individuals cavalier enough not to bother about the price. Ultimately, the price a consumer pays for a product is related to his price insensitivity and even laziness as related to walking an extra mile to a similar but cheaper store.
Harford next examines the concept of perfect markets, and explains how in an ideal world, the choice of consumers would be linked in a complex maze by markets to all associated upstream and downstream products and prices, creating ‘truth’ and transparency in the system. In contrast, nonmarket systems like the police services and public schools are inefficient and belie the requirements of the public. Taxes destroy the information that perfect markets carry. Kenneth Arrow solved the dilemma about inefficient taxes by advocating a ‘head start’ option of rearranging the starting blocks or interfering with the race, and then letting the markets decide on the best outcome. This is seen as a strong antidote to the inefficiencies created by taxes.
Harford thereafter focuses on ‘externalities’, the side effects of any market movement. He uses the example of traffic jams and pollution faced by pedestrians. While cars may have paid up-front taxes, they have no incentive to make lesser trips to town. Harford recommends ‘externality charges’ as a solution to be levied based on situations and context. Harford points out situations where externalities need not be charged and negotiations are preferred to taxation.
The efficiency of markets is compromised by insider information. Through a series of examples, covering used car markets, the kind of furniture offered in rented houses and meals in tourist spots, Harford proves that availability of insider information to one side results in ‘asymmetric information’ (Harford 113), and runs counter to the interests of the buyers and sellers equally. Transposing the logic to the insurance industry, it is evident that the insurance market runs on ignorance; the more the information about the likely onset of disease, the less the incentive for insurance companies to provide insurance to people likely to fall ill at reasonable premiums. The way out, as proposed by Michael Spence, is for the informed side to send suitable signals indicating genuine intent. Joseph Stiglitz provides the solution for the uninformed side- to provide self-targeting offers for the other side to commit to profiles fitting their predilections. Harford uses the ‘peaches and lemons’ analogy to explain how the US insurance market is the most expensive in the world. He suggests a two-part ‘keyhole’ solution- access to information and choice to the consumer. He also advocates a system of forced savings out of taxes deductible to individuals, to be put into a health savings account- a system that has reasonable chances of success.
On the subject of the stock market, Harford observes that rationality on the part of investors in the markets creates a totally obverse consequence of irrationality in market prices. He provides the reader with a broad understanding of fundamental analysis of the markets, which is based on an assessment of the future prospects of companies. He gives sound advice when he recommends prospective investors in the stock market to be alive to be aware of the signals the market is heading and to value companies that have unique capabilities.
Focusing on the challenge in divining the value in an auction, Harford determines the common thread to be hidden information; this forms the basis of game theory, and provides the context behind the challenges faced by governments when auctioning frequency bands to telecommunications companies. Harford recounts the case of the successful UK spectrum auction, which underlined the power of deriving strength from scarcity, as the government created only five licenses to bid for.
Harford examines the law of increasing returns in the context of developing countries; with the infusion of capital and technology, these countries would give a larger bang for the buck as they leveraged their resources, and therefore had a chance of catching up with the developed countries. However, this model did not apply to the vast multitude of poor countries that seemed to get poorer with time. The problem facing these poor countries is an inefficient use of resources, mired in corruption, waste and oppressive regulation on the part of the government. An allied aspect that Harford highlights is that society needs the right kind of incentives to remain progressive. Political will and integration in the world economy are seen as likely solutions to push poor countries out of the mired conditions restraining them from progress.
Harford next focuses on the advantages of globalization and the stresses caused by global competition. He uses the example of cheap Chinese goods and the ‘anti dumping’ laws put in place by countries in response, and argues that such barriers to trade harm the global economy. Instead, countries should strive to produce what they do best, and rely on a system of equitable exports and imports for the global economy to function for the benefit of all. Harford proves that global trade does not lead to environmental degradation, and broad-based development is the only way that poor countries could catch up economically.
Finally, Harford provides the example of China as a lesson for developing and poor countries to emulate. He recounts the abject poverty that existed in China in 1949. Mao’s Great Leap Forward as a solution was an unparalleled disaster. Under Deng, incentives for production and efficiency triggered growth. Chinese investment in infrastructure, paved the way for expansion. Deng ensured a gradual unshackling of the economy to retain stability, and integrated China with the world to leverage the Chinese advantage of cheap labor and manufacturing. The wealth that was initially concentrated along the Chinese coasts is now seeping inland, giving reason to believe in the long-term success of the Chinese economy.
In the course of ten chapters, Harford has lucidly explained the nuts and bolts behind myriad economic developments. For the reasons behind the success of boutique coffee shops in strategic locations, the targeting of the economy-blind customer by supermarkets, Harford expands the reader’s understanding to grasp the concept of true markets, the dangers of insider information and how to surmount them. He delves into the challenges in price discovery before throwing light on the global economy and what poor countries can do to catch up. The biggest takeaway for the reader from the book is not the various chapters in themselves, but Harford’s approach to view every aspect of human interaction and society through the lens of economic simplicity, so as to draw answers to the most fundamental questions confronting mankind.
Work Cited
Harford, Tim. The Undercover Economist: Exposing Why the Rich are Rich, the Poor are Poor- And Why You Can never Buy a Decent Used Car! New York: Oxford University Press, 2006. Print.
