THE UNDERCOVER ECONOMIST This page intentionally left blank THE UNDERCOVER ECONOMIST Exposing Why The Rich Are Rich, The Poor Are Poor— And Why You Can Never Buy A Decent Used Car! Tim Harford 2006 Oxford University Press, Inc., publishes works that further Oxford University’s objective of excellence in research, scholarship, and education. Oxford New York Auckland Cape Town Dar es Salaam Hong Kong Karachi Kuala Lumpur Madrid Melbourne Mexico City Nairobi New Delhi Shanghai Taipei Toronto With offices in Argentina Austria Brazil Chile Czech Republic France Greece Guatemala Hungary Italy Japan Poland Portugal Singapore South Korea Switzerland Thailand Turkey Ukraine Vietnam Copyright © 2006 by Tim Harford Published by Oxford University Press, Inc. 198 Madison Avenue, New York, New York, 10016 www.oup.com Oxford is a registered trademark of Oxford University Press All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior permission of Oxford University Press. Library of Congress Cataloging-in-Publication Data Harford, Tim, 1973– The undercover economist / Tim Harford. p. cm. ISBN-13: 978-0-19-518977-3 ISBN-10: 0-19-518977-9 1. Economic history, 1990– 2. Economics. 3. Consumer education. I. Title. HC59.15.H35 2005 330.9'0511—dc22 2005010297 1 3 5 7 9 8 6 4 2 Printed in the United States of America on acid-free paper To Deborah Harford, Fran Monks, and Stella Harford—family . past, present, and future. This page intentionally left blank Acknowledgments Peter Sinclair got me into economics; Tony Courakis, Simon Cowan, Stan Fischer, Bob Garhart, Paul Klemperer, Brendan McElroy, Elinor Ostrom, Hyun Shin, Bill Sjostrom, and many others helped me along the way. I am grateful to them all. At Shell, Ged Davis let me work part-time while I produced the first draft of the book. I was flattered by his reluctance and grateful for his support. Other colleagues at Shell were inspira- tional, especially Betty-Sue Flowers, Anupam Khanna, Cho Khong, Michael Klein, Doug McKay, and John Robinson. At the Financial Times, Pilita Clark, Andy Davis, Chris Giles, Andrew Gowers, John Kay, John Willman, and Martin Wolf gave me opportunities and then made sure I didn’t waste them. At the World Bank, Michael Klein and Suzanne Smith are wonderful colleagues and every day with them is an education. David Bodanis, Felicity Bryan, Penny Dablin, Moore Flannery, Juri Gabriel, Mark Henstridge, Diana Jackson, Oliver Johnson, John Kay, Cho Khong, Paul Klemperer, Stephen McGroarty, Doug McKay, Fran Monks, Dave Morris, Rafael Ramirez, Jillian Reilly, John Robinson, Tim Savin, Martin Wolf, and Andrew Wright improved the book with their comments. Sally Holloway, my agent, has been superb. Tim Bartlett and Kate Hamill at Oxford University Press infuriated me with their precision and insight—I have been very lucky to work with them. • vii • ACKNOWLEDGMENTS Most importantly, emotional support came from Diana Jack- son, my wife Fran Monks, “Uncle” Dave Morris, and Jillian Reilly. Above all I have to thank Andrew Wright, a genius, without whom the book could never have been finished, and David Bodanis, an inspiration, without whom it would never have been started. • viii • Contents Introduction 1 ONE Who Pays for Your Coffee? 5 TWO What Supermarkets Don’t Want You to Know 31 THREE Perfect Markets and the “World of Truth” 61 FOUR Crosstown Traffic 79 FIVE The Inside Story 109 SIX Rational Insanity 137 SEVEN The Men Who Knew the Value of Nothing 155 • ix • CONTENTS EIGHT Why Poor Countries Are Poor 177 NINE Beer, Fries, and Globalization 201 TEN How China Grew Rich 231 Notes 253 Index 263 • x • CHAPTER TITLE THE UNDERCOVER ECONOMIST • xi • This page intentionally left blank INTRODUCTION Introduction I would like to thank you for buying this book, but if you’re any- thing like me you haven’t bought it at all. Instead, you’ve carried it into the bookstore café and even now are sipping a cappuccino in comfort while you decide whether it’s worth your money. This is a book about how economists view the world. In fact, there might be an economist sitting near you right now. You might not spot him—a normal person looking at an economist wouldn’t notice anything remarkable. But normal people look remarkable in the eyes of economists. What is the economist seeing? What could he tell you, if you cared to ask? And why should you care? You may think you’re enjoying a frothy cappuccino, but the economist sees you—and the cappuccino—as players in an intri- cate game of signals and negotiations, contests of strength and battles of wits. The game is for high stakes: some of the people who worked to get that coffee in front of you made a lot of money, some of them made very little, and some of them are after the money in your pocket right now. The economist can tell you who will get what, how, and why. My hope is that by the time you finish this book, you’ll be able to see the same things. But please buy it first, before the store manager throws you out. Your coffee is intriguing to the economist for another reason: he doesn’t know how to make a cappuccino, and he knows that • 1 • THE UNDERCOVER ECONOMIST nobody else does either. Who, after all, could boast of being able to grow, pick, roast, and blend coffee, raise and milk cows, roll steel and mold plastics and assemble them into an espresso ma- chine, and, finally, shape ceramics into a cute mug? Your cappuccino reflects the outcome of a system of staggering com- plexity. There isn’t a single person in the world who could pro- duce what it takes to make a cappuccino. The economist knows that the cappuccino is the product of an incredible team effort. Not only that, there is nobody in charge of the team. Economist Paul Seabright reminds us of the pleas of the Soviet official trying to comprehend the western system: “Tell me . who is in charge of the supply of bread to the population of London?” The question is comical, but the answer—nobody— is dizzying. When the economist drags his attention away from your cof- fee and looks around the bookstore, the organizational challenges are even greater. The complexity of the system that made the store possible defies easy description: think of the accumulated centuries of design and development, from the paper upon which the books are printed to the spotlights that illuminate the shelves to the software that keeps track of the stock, not to mention the everyday miracles of organization through which the books are printed, bound, stored, delivered, stacked, and sold. The system works remarkably well. When you bought this book—you have bought this book by now, haven’t you?—you probably did so without having to give instructions to the book- store to order it for you. Perhaps you did not even know when you left your home this morning that you were going to buy it. Yet by some magic, dozens of people took the actions necessary to fulfill your unpredictable desires: me, my editors, marketers, proofreaders, printers, paper manufacturers, ink suppliers, and many others. The economist can explain how such a system works, how companies will try to exploit it, and what you as a customer can do to fight back. Now the Undercover Economist is gazing out of the window at the traffic jam outside. To some people, the jam is merely an • 2 • INTRODUCTION irritating fact of life. To the economist, there is a story to tell about the contrast between the chaos of the traffic and the smooth running of the bookshop. We can learn something from the book- store that will help us avoid traffic jams. While economists are constantly thinking about the things going on around them, they are not limited to discussing local matters. If you cared to engage one in conversation you might talk about the difference between bookshops in the developed world and libraries in Cameroon, which have eager readers but no books. You might point out that the gap between the world’s rich countries and the world’s poor countries is huge and appall- ing. The economist would share your sense of injustice—but he could also tell you why rich countries are rich and poor countries are poor, and what might be done about it. Perhaps the Undercover Economist seems like a know-it-all, but he reflects the broad ambition of economics to understand people: as individuals, as partners, as competitors, and as mem- bers of the vast social organizations we call “economies.” This breadth of interest is reflected in the eclectic tastes of the Nobel Prize committee. Since 1990, the Nobel Prize in Eco- nomics has only occasionally been awarded for advances in the obviously “economic” things, such as the theory of exchange rates or business cycles. More often, it has been awarded for insights less obviously connected with what you might have thought was economics: human development, psychology, history, voting, law, and even esoteric discoveries such as why you can’t buy a decent secondhand car. My aim in this book is to help you see the world like an econo- mist. I will tell you nothing about exchange rates or business cycles, but I will unlock the mystery of secondhand cars. We’ll look at the big issues, such as how China is lifting a million people a month out of poverty, and the little ones, such as how to avoid paying too much money in the supermarket.