Product Description

“The economy [isn’t] a bunch of rather dull statistics with names like GDP (gross domestic product),” notes Tim Harford, columnist and regular guest on NPR’s Marketplace, “economics is about who gets what and why.” In this acclaimed and riveting book–part exposé, part user’s manual–the astute and entertaining columnist from the Financial Times demystifies the ways in which money works in the world. From why the coffee in your cup costs so much to why efficiency is not necessarily the answer to ensuring a fair society, from improving health care to curing crosstown traffic–all the dirty little secrets of dollars and cents are delightfully revealed by The Undercover Economist.

“A rare specimen: a book on economics that will enthrall its readers . . . It brings the power of economics to life.”
–Steven D. Levitt, coauthor of Freakonomics

“A playful guide to the economics of everyday life, and as such is something of an elder sibling to Steven Levitt’s wild child, the hugely successful Freakonomics.”
–The Economist

“A tour de force . . . If you need to be convinced of the everrelevant and fascinating nature of economics, read this insightful and witty book.”
–Jagdish Bhagwati, author of In Defense of Globalization

“This is a book to savor.”
–The New York Times

“Harford writes like a dream. From his book I found out why there’s a Starbucks on every corner [and] how not to get duped in an auction. Reading The Undercover Economist is like spending an ordinary day wearing X-ray goggles.”
–David Bodanis, author of Electric Universe

“Much wit and wisdom.”
–The Houston Chronicle
From Publishers Weekly
Nattily packaged-the cover sports a Roy Lichtensteinesque image of an economist in Dick Tracy garb-and cleverly written, this book applies basic economic theory to such modern phenomena as Starbucks' pricing system and Microsoft's stock values. While the concepts explored are those encountered in Microeconomics 101, Harford gracefully explains abstruse ideas like pricing along the demand curve and game theory using real world examples without relying on graphs or jargon. The book addresses free market economic theory, but Harford is not a complete apologist for capitalism; he shows how companies from Amazon.com to Whole Foods to Starbucks have gouged consumers through guerrilla pricing techniques and explains the high rents in London (it has more to do with agriculture than one might think). Harford comes down soft on Chinese sweatshops, acknowledging "conditions in factories are terrible," but "sweatshops are better than the horrors that came before them, and a step on the road to something better." Perhaps, but Harford doesn't question whether communism or a capitalist-style industrial revolution are the only two choices available in modern economies. That aside, the book is unequaled in its accessibility and ability to show how free market economic forces affect readers' day-to-day.
Copyright © Reed Business Information, a division of Reed Elsevier Inc. All rights reserved.
From Bookmarks Magazine
Harford exposes the dark underbelly of capitalism in Undercover Economist. Compared with Steven Levitt’s and Stephen J. Dubner’s popular Freakonomics (*** July/Aug 2005), the book uses simple, playful examples (written in plain English) to elucidate complex economic theories. Critics agree that the book will grip readers interested in understanding free-market forces but disagree about Harford’s approach. Some thought the author mastered the small ideas while keeping in sight the larger context of globalization; others faulted Harford for failing to criticize certain economic theories and to ground his arguments in political, organizational structures. Either way, his case studies—some entertaining, others indicative of times to come—will make you think twice about that cup of coffee.
Copyright © 2004 Phillips & Nelson Media, Inc.

Product Details

• Amazon Sales Rank: #5045 in Books
• Published on: 2007-01-30
• Released on: 2007-01-30
• Number of items: 1
• Binding: Paperback
• 288 pages

Review
"Required reading."
—Steven Levitt, author of Freakonomics

"A playful guide to the economics of everyday life, and as such. . . something of an elder sibling to Steven Levitt’s wild child, the hugely successful Freakonomics."
—The Economist

"A book to savor."
—The New York Times

"The Undercover Economist is a book you must pick up if you want a fresh perspective on how basic ideas in economics can help in answering the most complex and perplexing questions about the world around us."
—Business Today


“[Harford] is in every sense consumer-friendly. His chapters come in bite-size sections, with wacky sub-headings. His style is breezy and no-nonsense. . . . The Undercover Economist is part primer, part consciousness raiser, part self-help manual.” --Times Literary Supplement

"Anyone mystified by how the world works will benefit from this book – especially anyone confused about why good intentions don’t, necessarily, translate into good results."
—The Daily Telegraph (UK)

"Harford writes like a dream – and is also one of the leading economic thinkers of his generation. From his book I found out why there’s a Starbucks on every corner, what Bob Geldof needs to learn to make development aid work properly, and how not to get duped in an auction. Reading The Undercover Economist is like spending an ordinary day wearing X-ray goggles."
—David Bodanis, author of E=mc2 and Electric Universe

"Popular economics is not an oxymoron, and here is the proof. This book, by the Financial Times columnist Tim Harford, is as lively and witty an introduction to the supposedly 'dismal science' as you are likely to read."
—The Times

About the Author
Tim Harford is an editorial writer at the Financial Times, where he also writes the newspaper’s “Dear Economist” column and “The Undercover Economist” column, which also appears in Slate. He lives in London.

Excerpt. © Reprinted by permission. All rights reserved.
One

Who Pays for Your Coffee?

The long commute on public transportation is a commonplace experience of life in major cities around the world, whether you live in New York, Tokyo, Antwerp, or Prague. Commuting dispiritingly combines the universal and the particular. The particular, because each commuter is a rat in his own unique maze: timing the run from the shower to the station turnstiles; learning the timetables and the correct end of the platform to speed up the transfer between different trains; trading off the disadvantages of standing room only on the first train home against a seat on the last one. Yet commutes also produce common patterns—bottlenecks and rush hours—that are exploited by entrepreneurs the world over. My commute in Washington, D.C., is not the same as yours in London, New York, or Hong Kong, but it will look surprisingly familiar.

Farragut West is the Metro station ideally positioned to serve the World Bank, International Monetary Fund, and even the White House. Every morning, sleep-deprived, irritable travelers surface from Farragut West into the International Square plaza, and they are not easily turned aside from their paths. They want to get out of the noise and bustle, around the shuffling tourists, and to their desks just slightly before their bosses. They do not welcome detours. But there is a place of peace and bounty that can tempt them to tarry for a couple of minutes. In this oasis, rare delights are served with smiles by attractive and exotic men and women—today, a charming barista whose name badge reads “Maria.” I am thinking, of course, of Starbucks. The café is placed, inescapably, at the exit to International Square. This is no quirk of Farragut West: the first storefront you will pass on your way out of the nearby Farragut North Metro is—another Starbucks. You find such conveniently located coffee shops all over the planet and catering to the same desperate commuters. The coffee shop within ten yards of the exit from Washington’s Dupont Circle Metro station is called Cosi. New York’s Penn Station boasts Seattle Coffee Roasters just by the exit to Eighth Avenue. Commuters through Shinjuku Station, Tokyo, can enjoy a Starbucks without leaving the station concourse. In London’s Waterloo station, it is the AMT kiosk that guards the exit onto the south bank of the Thames.

At $2.55 a tall cappuccino from Starbucks is hardly cheap. But of course, I can afford it. Like many of the people stopping at that café, I earn the price of that coffee every few minutes. None of us care to waste our time trying to save a few pennies by searching out a cheaper coffee at 8:30 in the morning. There is a huge demand for the most convenient coffee possible—in Waterloo Station, for example, seventy-four million people pass through each year. That makes the location of the coffee bar crucial.

The position of the Starbucks café at Farragut West is advantageous, not just because it’s located on an efficient route from the platforms to the station exit, but because there are no other coffee bars on that route. It’s hardly a surprise that they do a roaring trade.

If you buy as much coffee as I do you may have come to the conclusion that somebody is getting filthy rich out of all this. If the occasional gripes in the newspapers are correct, the coffee in that cappuccino costs pennies. Of course, the newspapers don’t tell us the whole story: there’s milk, electricity, cost of the paper cups—and the cost of paying Maria to smile at grouchy customers all day long. But after you add all that up you still get something a lot less than the price of a cup of coffee. According to economics professor Brian McManus, markups on coffee are around 150 percent—it costs forty cents to make a one-dollar cup of drip coffee and costs less than a dollar for a small latte, which sells for $2.55. So somebody is making a lot of money. Who?

You might think that the obvious candidate is Howard Schultz, the owner of Starbucks. But the answer isn’t as simple as that. The main reason that Starbucks can ask $2.55 for a cappuccino is that there isn’t a shop next door charging $2.00. So why is nobody next door undercutting Starbucks? Without wishing to dismiss the achievements of Mr. Schultz, cappuccinos are not in fact complicated products. There is no shortage of drinkable cappuccinos (sadly, there is no shortage of undrinkable cappuccinos either). It doesn’t take much to buy some coffee machines and a counter, build up a brand with a bit of adver- tising and some free samples, and hire decent staff. Even Maria is replaceable.

The truth is that Starbucks’ most significant advantage is its location on the desire line of thousands of commuters. There are a few sweet spots for coffee bars—by station exits or busy street corners. Starbucks and its rivals have snapped them up. If Starbucks really did have the hypnotic hold over its customers that critics complain about, it would hardly need to spend so much effort getting people to trip over its cafés. The nice margin that Starbucks makes on their cappuccinos is due neither to the quality of the coffee nor to the staff: it’s location, location, location.

But who controls the location? Look ahead to the negotiations for the new rental agreement. The landlord at International Square will not only be talking to Starbucks but to other chains like Cosi and Caribou Coffee, and D.C.’s local companies: Java House, Swing’s, Capitol Grounds, and Teaism. The landlord can sign an agreement with each one of them or can sign an exclusive agreement with only one. She’ll quickly find that nobody is very eager to pay much for a space next to ten other coffee bars, and so she will get the most advantage out of the exclusive agreement.

In trying to work out who is going to make all the money, simply remember that there are at least half a dozen competing companies on one side of the negotiating table and on the other side is a landlord who owns a single prime coffee-bar site. By playing them off against each other, the landlord should be able to dictate the terms and force one of them to pay rent, which consumes almost all their expected profits. The successful company will expect some profit but not much: if the rent looks low enough to leave a substantial profit, another coffee bar will be happy to pay a little extra for the site. There is an unlimited number of potential coffee bars and a limited number of attractive sites—and that means the landlords have the upper hand.

This is pure armchair reasoning. It’s reasonable to ask if all of this is actually true. After I explained to a long-suffering friend (over coffee) all of the principles involved, she asked me whether I could prove it. I admitted that it was just a theory—as Sherlock Holmes might say, a piece of “observation and deduction,” based on clues available to all of us. A couple of weeks later she sent me an article from the Financial Times, which relied on industry experts who had access to the accounts of coffee companies. The article began, “Few companies are making any money” and concluded that one of the main problems was “the high costs of running retail outlets in prime locations with significant passing trade.” Reading accounts is dull; economic detective work is the easy way to get to the same conclusion.

Strength from scarcity

Browsing through the old economics books on the shelf at home, I dug out the first analysis of twenty-first-century coffee bars. Published in 1817, it explains not just the modern coffee bar but much of the modern world itself. Its author, David Ricardo, had already made himself a multimillionaire (in today’s money) as a stockbroker, and was later to become a Member of Parliament. But Ricardo was also an enthusiastic economist, who longed to understand what had happened to Britain’s economy during the then-recent Napoleonic wars: the price of wheat had rocketed, and so had rents on agricultural land. Ricardo wanted to know why.

The easiest way to understand Ricardo’s analysis is to use one of his own examples. Imagine a wild frontier with few settlers but plenty of fertile meadow available for growing crops. One day an aspiring young farmer, Axel, walks into town and offers to pay rent for the right to grow crops on an acre of good meadow. Everyone agrees how much grain an acre of meadow will produce, but they cannot decide how much rent Axel should pay. Because there is no shortage of land lying fallow, competing landlords will not be able to charge a high rent . . . or any significant rent at all. Each landlord would rather collect a small rent than no rent at all, and so each will undercut his rivals until Axel is able to start farming for very little rent—just enough to compensate for the landlord’s trouble.

The first lesson here is that the person in possession of the desired resource—the landlord in this case—does not always have as much power as one would assume. And the story doesn’t specify whether Axel is very poor or has a roll of cash in the false heel of his walking boot, because it doesn’t make any difference to the rent. Bargaining strength comes through scarcity: settlers are scarce and meadows are not, so landlords have no bargaining power.

That means that if relative scarcity shifts from one person to another, bargaining shifts as well. If over the years many immigrants follow in Axel’s footsteps, the amount of spare meadowland will shrink until there is none left. As long as there is any, competition between landlords who have not attracted any tenants will keep rents very low. One day, however, an aspiring farmer will walk into town—let’s call him Bob—and will find that there is no spare fertile land. The alternative, farming on inferior but abundant scrubland, is not attractive. So Bob will offer to pay good money...

Customer Reviews

Somewhat spotty; Decent overall
There was a lot overlap between this book and Steven Landsburg's "Armchair Economist" (discussion of why popcorn costs more at the movies, etc)

The good points, one by one:

1. Harford does a slightly better job of detailing differential pricing systems than Landsburg. Not only is the treatment of differential pricing better, but there is also a more clear treatment of why scarcity creates value. Rather than defining "The Indifference Principle" (Landsburg), Harford just simply stated the principle in a much more straightforward way.

2. This was a cool mishmash of a lot of unrelated ideas, but it didn't quite catch on in the same way that "Freakonomics" did. Perhaps this is because the author chose to do too much pontificating and less work on the facts.

3. There is a thorough demolition of a lot of misconceptions about free trade, and even a brief exposition of Abba Lerner's proof that a tax on imports is exactly equivalent to a tax on exports of the same amount. There was also something for the enviro-nutbags that demonstrates that there is no clear relationship between economic growth and pollution.

4. The discussion of Pareto optimality, rent seeking and random walks is particularly clear and accessible. Alan Greenspan covered the topic in "The Age of Turbulence," but it was less clear than this author's exposition.

5. There were interesting details presented in the special case of African idiocy. He revisited Bill Easterly's take on "Misadventures in the Tropics" as to why distorted incentives can explain a lot of Africa's misfortune.

6. The fact that he spent more time with actual case studies (without making this read like a book of statistics) is a significant positive point in the book.

7. The best chapter in the book is the one about PRACTICAL APPLICATIONS of game theory with REAL LIFE EXAMPLES. (Economists often get so carried away with building their models, that they forget that there is an empirical component necessary to know how good the model is. This chapter was a step in the right direction.)

The bad points:

1. His discussion of American health care is extremely foolish. There are many reasons that healthcare there is so expensive, and third party payments (insurance companies) are only a part of the problem. There are licensing restrictions and excessively long training periods that excessively limit on who can be a physician (this would have been a good addition to his comments on scarcity). There are also laws that don't allow prices to be posted in clear view in hospitals (which would have fit well into his chapter on information asymmetry). But with his long tirade against US healthcare, it was clear that he *just didn't know what he was talking about.*

2. Because of the weakness of the arguments about the US healthcare system, it is not clear how much of the rest of the book contained specious arguments. For example: The Lerner proof is something that was presented as just that. But a brief examination of some other sources shows that there are conditions under with the Lerner "proof" breaks down-- and these cases were not dealt with AT ALL by the author.

3. There was also omission of relevant facts. For instance: Switzerland is a country that has a private health care system (and private insurance) and its costs are lower than those of the United States (as a percentage of GDP), and this was omitted because it would run contrary to his PRIVATE INSURANCE BAD NATIONAL HEALTHCARE GOOD argument. In addition: There was NO exposition of what led him to assert that the quality of care in one place was better than another. (Exactly was so much better about Canadian health care than US? And how much better?)

4. There were also lots of misconceptions about China. There are LOTS of questions about the efficiency of Chinese investment. Japan was also a country that invested huge sums of money at diminishing returns, and it proved very messy to clean up. If he wanted to use a stellar example of capitalism at work, this was not the best one that he could have chosen.

Insight on Problems, Less on Solutions
Among the issues addressed in this insightful book are health care and personal investing, two key topics for most individuals. His analysis is penetrating but unfortunately his economist's rationality seems to have obscured for him the limits of economic models in real world complexities.

Harford describes the U.S. health care system as suffering primarily from an information problem. He claims a major problem is the inability of insurance companies to reliably know the level of risk of those who get insurance which causes them to raise rates higher than they should be. That in turn drives away low risk persons who rightly believe that premiums are excessive. So the remaining folks to be insured are higher risk which causes premiums to rise even more. The insurance companies then also spend a good deal of money on underwriting risk (though apparently not very effectively) and massaging the claim and payment system to maximize profits. This leaves a patchwork system of coverage that is inefficient and expensive.

He proposes that we adopt the system in Singapore that focuses solutions on the precise problem of market inefficiency caused by inadequate information. The problem of lack of affordability is addressed by subsidizing directly the cost of insurance for the low income, not setting up a separate insurance system for them. Even better is to "tackle the general system of poverty" that prevents them from affording many needed services, not just health care.

The British system is flawed by limited choice and rationing by government. Harford claims that it is the lack of key information that "destroys the insurance market" for medical care. He would greatly enhance consumer information about disease and providers and then make most costs the direct responsibility of the consumer without any insurance. That would give them the incentive to become well-informed and apply the information gained to purchase just the care they really need and want. Insurance would be reserved for "catastrophic" costs that are largely unpredictable and (in most cases) out of the control of the individual (e.g cancer). [Harford recognizes that some major health problems are the result of voluntary behavior, e.g. smoking, but figures that "moral hazard" cannot be entirely avoided.]

These considerations dictate private health savings accounts (which currently exists for the self-employed). Some tax incentive would be available for all for basic expenses and the contributions would be mandatory. Presumably premiums for the catastrophic coverage would also be mandatory.

There are several problems with Harford's solution. In an ideal world, you could create a much better market for health care services where government's role could be minimized. One major problem Harford ignores is the impracticality (despite the theoretical desirability) of each person mastering and managing their own health care and costs. The truth is that medical treatment and costs are complex areas that even highly educated people have trouble mastering. Even if they have the skills to do so, the efficiency of each person trying to do so is a problem. Then there is the question of where we draw the line on "catastrophic" expenses and "normal" expenses and how much of the burden we make people bear. These problems exist in any system, but they don't disappear by any means with Harford's plan. The mandatory savings plan could appear to operate like Social Security, assuring a basic minimum of care. But if the savings were not managed well, an individual could still end up with inadequate savings to cover "normal' expenses at a point when they had no other income to do so. In Social Security, the individual cannot dissipate his pension through bad management because the government doesn't let him. Likewise, it would prove impractical to leave people without any medical support despite their own mismanagement.

Most people would rather have "experts" manage their health care and costs in exchange for assuring a reasonable standard of care over their lifetime. A parallel can be seen in the self-directed retirement industry (401K's and IRAs) where most people don't want to take primary responsibility for the complex task of investing their savings but are willing to pay others to manage it. And here, increasingly, there is a trend for government and employers to limit fees and set up reasonable "default" programs that serve most people with the option of greater flexibility for those who wish to accept greater risk.

Harford's system may work well in Singapore where there is a more homogenous population and uniform system of providers. But until and unless there are very much improved information systems and clear, beneficial options for people to choose from, then stronger governmental intervention is a necessary trade-off for health security for the vast majority of Americans. At the point I can go to a reliable website and easily compare cost and quality of services and providers for my health care needs, then I would be far more willing to assume greater individual responsibility for negotiating my own health care contracts with providers. Until then I will have to rely on the health insurance companies to use their market power to negotiate more reasonable costs and my employer or the government to protect me from daunting, if not catastrophic, costs and failures of coverage. Unfortunately, these safeguards are not available to many and have proved inadequate to rein in soaring costs. So greater government intervention is necessary, not less.

Unlike in the world of economists' models, in the real world of ordinary people dealing with increasingly complex systems in every aspect of their lives, most would bargain for the protection of simpler, safer choices on essential matters of personal security - health care and retirement income. Options yes, but not bewildering complexity that can be easily exploited by vendors to hide poor value and excessive costs.

Harford on the stock market. This chapter is a helpful and perceptive primer in explaining the "random walk" theory of stock prices. The current price contains all the information (expert and otherwise) that is known to all investors. For the most part, there are very few avenues to exploit to find significantly under- or over-valued stocks (as distinct from factors generally applicable to the market as a whole - such as interest rates and return on competitive investments like bonds, and growth expectations for the economy as a whole). Thus variations in individual stock prices are driven by unanticipated events or "news" that is essentially random and unpredictable. Analysts have long shown that high-priced growth stocks are much more vulnerable to random bad news because so much good news is already incorporated into the price; whereas, low-priced "value" stocks typically have more upside because mostly bad news has been incorporated into their price.

Fundamentally, stocks are likely to return to the mean of their long term trend of selling for about 16 times annual earnings, or a return of between 6 and 7%, though as the 1990's showed, leading into the dot.com bubble, the P/E ratio can buck the trend for much longer than might be expected. He also shows how investment theories such as being the "first to market" or being in the forefront of a new technology fail to take account of the toll of competition over time leaving many leading companies as mediocre investments which is still better than many of their competitors which go bust.

The only reliable basis for outsized growth and profits is "scarcity power" which can come from some unique capability: a powerful brand in a conservative market; control of a standard like Microsoft; superior expertise like GE, or (so far) technical and marketing superiority like Google.

The next chapter addresses game theory and its application to economics. It ranges from a discussion of poker to auctions for telecom spectrum rights. It illustrates splendidly what Harford does not significantly acknowledge in the earlier chapter on health care - that economic models often fail to account for the messy human factors that inhibit purely rational decision-making from prevailing. In poker, the great John von Neumann, theorized that there was a winning strategy in tending to bluff with large bets on weak hands, but of course not predictably. But there are so many uncertain factors regarding the strategies or lack thereof of other players, that no consistently winning strategy can be worked out through game theory. The more variables one tries to factor in the more complex the analysis becomes so that few people can understand and apply it. The tale of auctioning radio spectrum illustrates the point. Early auctions were failures because the designers failed to adequately understand how their system could be gamed by the bidders. A later auction in Britain revealed that bidders could be induced to pay far more than they or the government anticipated when using different rules. In each case, even sophisticated players could end up being surprised and harmed when the game is complex. That is precisely why leaving great uncertainty and unequal bargaining power to play in issues of fundamental personal security does not make sense as a matter of policy.

A great primer on economic theory and policy ...
The more I read about the strain developing countries are placing on natural resources and global food supplies, the more interested I have become in economic theory and policies. Unfortunately, my knowledge of such is limited to basic introductory courses in college. For that reason, I am glad I picked up this book; it has answered many of my questions and has shed light on many interesting topics for future reading!

Mr. Hartford uses the first few chapters to introduce fundamental concepts such as supply and demand, scarcity, marginal costs, market efficiency, externality charges, and price targeting.

However, the fun doesn't stop there! Mr. Hartford then uses those concepts to explain a broad array of interesting topics: these topics include the health insurance industry, the stock market, auctions, free trade and globalization, tariffs and taxes, subsidies, pollution, government corruption, poverty, and China.

I must say that I am very impressed with this book. It wasn't too hard of a read, but it does make you think. In fact, in the later more advanced chapters, I often found myself going back and re-reading certain sections. Still, I enjoyed the book and found his writing style to be very good and easily digestible.

I really enjoyed the last chapter, which goes into great depth explaining how China has grown as a country and as a future economic powerhouse.