Tim Harford's Next Book
By Arnold Kling
Is called The Logic of Life. I hated the introduction. At one point, Harford writes,
Might there not be such a thing as a rational blowjob?
I don’t think of myself as a prude, but I wound up muttering to myself about economists who think that sex is a good choice for a topic. Might there not be such a thing as diminishing returns and comparative advantage? I want the next pop economics book to be entitled The Undercover Economist Discovers that No More Sex Equals Safer Freakonomics.
It really was not until the fourth chapter that I started to like the book.That chapter is about CEO pay. He explains Lazear’s tournament theory this way:
The more luck is involved in work, the larger the pay gaps need to be between the winners and the losers if the tournament is to motivate anyone.
You might think, as an owner, that the more your manager’s results depend on luck the less you want to reward the manager according to performance. But the problem is that if the manager’s effort has little effect on performance (because it’s mostly luck), then the manager only has incentive to work hard if the reward for good performance is large.
I have a very different approach to compensation. I think that the key is to change compensation schemes frequently. The reason is that any scheme can be gamed, and the longer you wait to change any given scheme, the more effectively the participants will have gamed it. That is one reason I think that “Pay for Performance,” the newest miracle cure for health care costs, will fail miserably. The doctors will be able to run circles around the bureaucrats. In the U.K., they already have–all of a sudden, 91 percent of doctors were receiving bonuses for being above average.
I think that the more Washington tries to regulate CEO pay, the more it will create a disconnect between pay and performance. Regulation will inhibit companies from frequently changing their incentive systems, and that will give CEO’s more time to game them.
I also really like Harford’s seventh chapter, called “The World is Spiky.” He describes the thinking of Robert Lucas, Ed Glaeser and others on cities. One important point is that you can meet more interesting people in a big, vibrant city. If your skills and interests are such that they can benefit from proximity to a variety of people, it is worth paying higher rent to live in a city. Conversely, if a city is dying, then the only reason to live there is to take advantage of the cheap excess housing stock.
Let me propose a subversive variation on that theory. Suppose that it really pays to be around rich people. Then as New York gets expensive, it selects richer people, and consequently it is more desirable to live there. Meanwhile, as Detroit gets poorer, it selects mostly poor people, and consequently it is less desirable to live there. This is a lot like my theory of college tuitions–the higher they go, the more that colleges wind up selecting rich people as students, and the more desirable the colleges become for people who want their kids to go to school with other affluent kids. Note that in this “segregation equilibrium” costs (rents in rich cities, tuitions in elite colleges) can rise to ridiculous levels, because the demand curves are upward sloping.
I also really liked the last two chapters, on institutional economics. I agree with much of the work that Harford cites, but not all of it. He describes the theory of Acemoglu and Robinson on endogenous democratization.
There are two players in the “game”: the rich elites, who take the role of potential kidnap victim; and the poor masses, who take the role of potential kidnapper. The masses want different economic policies from the elites…If they are sufficiently indignant and are able to get themselves organized, the masses can rise up and demand greater democratic rights…new policies are not credible but new institutions might be.
I don’t think much of this theory. For one thing, it assumes that the masses and the elites each homogeneous groups. It does not explain how free-rider problems are resolved within those groups.
My model of the world has multiple elites and multiple masses. The elites compete to manipulate masses. The competition tends to favor broadening the electorate. It pays to be on the side of supporting votes for women, votes for blacks, votes for 18-20 year-olds, votes for illegal immigrants…I mean, I am very pro-immigrant, but drivers’ licenses for illegal immigrants? That one does not even pass the laugh test. Still, I can see where it makes sense in political terms–you expect these folks are eventually going to be given amnesty, so you want their votes.
UPDATE: The UK experience was 91 percent compliance, not 91 percent above average. But the general point still stands. The UK system paid a lot of money for what even the proponents suspect was relatively little change in actual performance, with lots of gaming (e.g., some doctors making “exceptions” of 15 percent of paitents or more).