The Undercover Economist – Tim Harford

I can’t say enough about this book. It simply amazes me how Tim takes everyday things in our lives (supermarkets, insurance, environment) and uncovers the hidden economics in all of them. It further amazes me how much of an impact an economist and his policies can have in affecting our day to day lives. Their deeper understanding of the workings of the world is indeed something to covet.

I wish I could remember all I have read in this book. But given history screams harsh judgements about my retention capacity, here’s my attempt at boosting it by writing in my own words what I read.

I liked his presentation of Economist Kenneth Arrow’s work: “All efficient outcomes can be achieved using a competitive market, by adjusting the starting position”. He calls it the head-start theorem.

Markets are like races. They force industries and people to perform: produce goods that are needed, produce them in the most efficient way, allow competition to drive prices such that they reflect their value as perceived by people. In some sense, they are like a running race where everyone is doing their best. While this is desirable, it can leave fairness off the table sometimes.. What if we have weak runners? Is it ok for them to always lose? Arrow’s work says we need not. His solution is to not interfere with the race, but rather rearrange the starting blocks.

Lets look at the example he gives. But first some background. Government have taxes at their disposal to raise money to provide the services they do. Now they could have a blanket rate for everything but they have to be clever than that. Taxes affect prices which in turn affect consumer choices. Thus, it would make sense to have higher taxes on goods to which consumers are less price sensitive. That way, the sales stay as they are and government gets the tax it wants. Consider domestic fuel. People find it hard to cut down on fuel consumption. Government can use this information to impose heavy tax on fuels hoping this would not affect people’s choice much. Another aspect to consider is environmental consequences. A way we can make people pay for their choice to affect the environment (by using more fuel) is to tax it more.

So far so good. But this also means, anyone who can’t afford heating will face a harsh winter. Tim points that many seniors die due to inadequate heating in Britain every year. If we were to apply Arrow’s work to this problem, we would leave the taxation on domestic fuel as is. Instead government could support the elderly with their heating bills. This is akin to giving a weak runner a head start in a race.

His discussion about health insurance is interesting. Insurance is a curious case for markets to solve given the lack of information. Insurance companies face a formidable task: they need to decide premiums based on imperfect information. Who/how many of insurees will fall sick? If they charge too less premium they will go bust because of claims. If they charge too much, they will drive away healthy insurees who will opt out; further driving premiums higher and getting into a vicious cycle leaving many uninsured.

He looks at both private (US) and state provided (Britain) health insurance and points out flaws in them. A private and voluntary policy like in US will make people opt out, if their resources need to be employed elsewhere (food/clothing). If only people who fall sick take insurance, this will drive up the premiums and force more people out of insurance coverage. State provided health insurance is good but as evident with Britain’s example the system is overcrowded where patient’s face long waits. Furthermore, it takes away the choice of treatment out of a patient’s hand: the doctor decides what the treatment is. You either take that or you get nothing.

Here the author gives an example system (employed in Singapore) which tends to work slightly better than the above options. This involves giving maximum responsibility and choice to patients. They chose their treatments and pay for most of their medical bills. Government /insurers step in only for catastrophic(expensive) bills and to aid the poor. This system mandates having a savings account dedicated to health (reduced taxes will put money in this account, government will help poor by contributing to this account). People pay for most of their medical bills using this account and only the largest bills (rare) is where the insurance steps in.

Finally, loved his line: “Want a bargain? Don’t try to find a cheap store. Try to shop cheaply.”