Airs - Ian Lance Taylor

I read about an interesting technique for people to transfer money in less developed countries. Let’s say that you live in the big city, a hundred miles away from your parents. You want to send them some money but there is no bank where they live. Recently, though, somebody in your parent’s village got a phone. What you do is buy a phone card for $10. Then you call the person with the phone and read them the numbers from the card. They give your parents $9.75, and use the numbers from the phone card to pay for their calls. The person with the phone is leasing it out to all the villagers for their calls, so he or she needs a lot of minutes.

Obviously this requires a level of trust which is only available in a relatively small society. If you cheat on the phone card by using it yourself, or if the person with the phone cheats by not paying your parents, then everybody in your parent’s village eventually finds out one way or another. This is a sufficient deterrent that I expect that few people cheat.

Money transfer is an essential part of entering the modern economy. It’s been around in the west for hundreds of years in the form of letters of credits, and probably even longer in the Islamic world. Using cell phones to bring it to the less developed world is an interesting feature of a new technology. No doubt it will be replaced fairly soon by some more formal infrastructure, probably still somehow built on top of the cell phone.

The basic idea behind capitalism as an underpinning of society is that if you give people the freedom to earn a lot of money however they please, society will tend to get better. They will get better because the best way to earn a lot of money is to sell something which lots of people want, and to sell it cheaper and/or better than everybody else. That means that people get what they want, and they get it cheaper, and so society will get better.

However, this is sort of indirect, and as we all know there are lots of other ways to make a lot of money. The one I’ve been thinking of recently is that one good way to earn a lot of money is to first convince people that they need something, and then sell it to them. This is different from the usual cheaper/better approach, which is to sell people something that they already know that they need. The idea here is to convince them that they need it, and then sell it to them.

The most obvious example is fashion. If you have a warehouse full of ostrich feathers that you want to sell, your best bet is to convince people that they will look better if they wear an ostrich feather hat. If you do that, you will become wealthy. Note that fashion is not useless, and people do gain something by buying something that makes them fashionable. The interesting trick is making the thing that you happen to have become the thing which is fashionable.

A subtler example is the notion of stuff in general. If you convince people that they need a lot of stuff, you can then make money selling it to them. This seems to the driving force behind a store like Target, for example. They have a lot of stuff, you want a lot of stuff, they will sign you up for a store credit card on the spot, life is good. Except that a lot of energy is being spent making stuff, shipping it around the planet, and eventually storing it in a landfill.

Is it possible for people to be happy with less stuff? I don’t really know. I personally am not a big buyer of stuff, other than books. I kind of enjoy walking around Target with my daughter; it’s like going to a museum of consumer goods. Of course I’m careful to tell her before we go in that we aren’t going to buy anything. But I expect I’m a bit of an outlier. It seems that many, perhaps most, people do kind of like stuff–within reason, of course.

What I wonder about is how much people like stuff inherently, and how much they like stuff because somebody has convinced them to like it. That is, is this an example of capitalism making something better, or is it an example of capitalism creating a need in order to fill it?

Almost six months later, I’ll look back at my earlier post about financial complexity. Considering the continuing troubles of the financial markets, it seems clear that I underestimated the degree of the problem. But I think I was generally correct in pointing out that the complexity of modern markets helped hide the nature of the bets that institutions were making. Many institutions thought that they had only a controlled amount of exposure to the mortgage market, only to find out that they were wrong. They had lent money to other institutions, which had made derivative bets, which were founded on the mortgage market, and problems rebounded back to institutions which thought they were acting soundly.

I believe the complexity has exceeded the ability of people to fully understand it at this point. That may be a general trend for financial markets–they naturally push the limits of complexity, limits which do increase over time as people learn more and develop better tools.

It remains to be seen how much this will affect the real economy. While it seems quite likely that the U.S. is now in a recession, it could still be a mild one. I suspect that some of the problems are facing now are really due to stagnant middle class income and increased health care costs–the ongoing issue of increasing inequality. At this stage of the business cycle, more people are vulnerable than usual, because fewer people did well when the economy was relatively strong.

But that need not be a bad thing. If few people do well when the economy is strong, it is possible that few people will do poorly when the economy is weak. Not very likely, perhaps, but possible. We’ll have to see.

A friend of mine who has been working for many years in an area that is now known as social entrepreneurship commented that there is no good economic model for it (he thinks of things like this because he went to business school).

This led me to think about economic models for charitable giving. Economists usually try to model people as rational utility maximizers: we all make decisions that we believe will make us happier. Of course this is laughably false on the face of it, though in many areas of interest to economists it works well enough. Many economic theories make a simple assumption which makes the model even worse as an approximation of reality, which is to treat money as a proxy for happiness.

Models like this don’t have a good way to handle charitable giving. They have an even harder time with major philanthropic organizations. What is Bill Gates buying with the Bill & Melinda Gates Foundation? Yet surely if homo economicus exists, Bill Gates is the type specimen.

Now, obviously I’m setting up a straw man here. Nobody really thinks that money is everything. But it’s awfully easy to make a mental slip into thinking that the simplifying assumption is the reality. A signal for this is the number of articles I see about “why do people give to charity”—as though it were some sort of weird decisions that needed to be explained (there was just such an article in last Sunday’s New York Times Magazine). Medieval Europeans would have needed no explanation. The fact that we need an explanation today is a crack in our conventional view of people–a place where the mirror we use to see the world in ourselves has broken.

According to the U.S. census, median household income in the U.S. has not changed much since 1998. The economy does continue to expand. What is happening is that the richer households are absorbing all the gains, leading to increased inequality. I’ve commented before on whether or not this matters.

I’ve now seen a couple of attempts to argue against this, on the basis that household sizes are shrinking. The argument is that when the household gets smaller, then even if the household has the same amount of money, there is more money per person.

Unfortunately, this argument is too simple. A household has fixed expenses which remain the same regardless of the number of people. One obvious fixed expense is the cost of the house itself. If the cost of housing as a proportion of household income has increased faster than the size of the household has decreased, then the argument does not hold.

It is also quite possible that the earnings-per-person of a single parent living alone has increased, while the earnings-per-person of a single parent living with children has decreased. That would maintain the same statistics, but would suggest that more children are living with fewer resources, which would seem to be undesirable.

More importantly, I think this type of argument is somewhat off-the-point. I think what matters to most people is stability of shelter, food, and health care. Stability of income is acceptable provided those prices are stable. Instability of income is rarely desirable. So the whole issue of tracking average household income seems much less interesting to me than tracking income stability for families in different economic strata.