57 pages • 1 hour read
Tim HarfordThe Undercover Economist
Nonfiction | Book | Adult | Published in 2010A modern alternative to SparkNotes and CliffsNotes, SuperSummary offers high-quality Study Guides with detailed chapter summaries and analysis of major themes, characters, and more.
Chapters 7-8Chapter Summaries & Analyses
Chapter 7 Summary: “The Men Who Knew the Value of Nothing”
Chapter 7 introduces the fact that governments auction off the radio spectrum used by cellphone companies to run their networks. There is only so much spectrum available, so governments try to take advantage of the scarcity. They hire economists to set up the auctions, with varying results. One auction raised less than 1% of the expected price, while another raised 10 times the expected price. This task of “auctioning air” has high stakes and requires cleverness to succeed.
To introduce auctions and their economic ramifications, Harford then discusses the mathematician John von Neumann, who is often considered the “best brain in the world” (166). He is considered to have originated the field of game theory and used it to develop mathematical tools that help explain economics, biology, and even the Cold War. Game theory, in a nutshell, is “any activity in which your prediction of what another person will do affects what you decide to do” (166). Game theory encompasses poker, love, war, or bidding in an auction. For a game theorist, games are mathematical objects, not just entertainment or strategy.
Poker is relatively simple: Players conceal their cards until the final showdown, when the player with the best cards wins all the accumulated bets. To stay in the game, each player has to keep betting. However, some will give up along the way, preferring to lose what they’ve already bet rather than risk losing much more. If all the other players give up before the showdown, the winner can collect the pot without ever showing their cards. Harford says that “[poker] and the spectrum license problem are both games in Neumann’s sense” (169), and the same rules fundamentally apply to both.
The US government used game theorists to help sell spectrum rights in the late 1990s. The first sales were successful, but after a few auctions, things started to go wrong. For instance, the game theorists published the bids without rounding them to the nearest few thousand dollars. Because of this, companies started using their bids to signal to other companies which licenses they would prefer by including the area codes in the sum of the bid. This wasn’t even illegal since the auction was not designed to discourage that behavior. This led to the infamous auction that raised less than 1% of the expected price since the companies were cheating by avoiding competition. The game theorists who designed this failed auction didn’t understand that they were only controlling a piece of the game itself. The larger game was being played without their knowledge.
Game theory has another flaw: It was developed by very intelligent mathematicians who presumed that the players are “hyperrational.” This fails to accurately model how normal people actually behave. This is to say, “the more mistakes that need to be taken into account, the more complicated and less useful game theory becomes” (172). This is why theory needs to be combined with experience in order to be effective. In a spectrum auction, game theorists might behave in rational ways, but businessmen might not. Auctions do not unfold according to logic, and the game theorists have to account for that.
In order to avoid the pitfalls of earlier failed auctions, the UK government went “all out” to attract serious bidders. Bidders paid a £50 million deposit for the chance to own the first 3G phone licenses in Europe. The game theorists tested the auction design with computer simulations and mock auctions using economics students. They studied the fine print to eliminate loopholes and gave themselves the option to postpone the auction if something suspicious appeared to be happening. The auction was run like a poker game, in which bidders had to periodically submit new bids or withdraw from the auction. The bids continued to rise far past the projected earnings of £3 billion, instead rocketing up to £10 billion. Then, a month after the beginning of the auction, bidders began to drop out. This end to the auction signaled that the bidders had settled on the true price of radio spectrum. The transparent nature of the auction, which had failed for the US, succeeded for the UK. In the end, the UK government collected £29 billion from the auction.
Chapter 8 Summary: “Why Poor Countries Are Poor”
Harford says that Cameroon is a very poor country; the average citizen is eight times poorer than the average citizen of the rest of the world. Cameroon is also famous for discouraging outside visitors and tourists from entering the country. As well as being unwelcoming to outsiders, Cameroon’s government is intensely corrupt. In 2001, when the author visited, it was considered the fifth most corrupt country in the world. While traveling through Douala, the author noted the lack of infrastructure and the piecemeal, inventive ways that Cameroonian citizens make up for it. Every citizen appeared to be furiously working to support themselves, selling food or driving taxis, so Harford deduced that Cameroon’s poverty couldn’t be due to a “lack of entrepreneurial spirit” (193). Nonetheless, Cameroon was poorer in 2001 than it was in 1989—this is an economic decline not experienced by the vast majority of other countries, no matter how poor.
The president of Cameroon in 2001, Paul Biya, had been in power since 1989, and the elections that kept him in power were clearly rigged. The government structure reflects this injustice. In fact, Harford says that “much of [the] government activity appears to be designed expressly to steal money from the people of Cameroon” (197). The work of the economist Mancur Olson posited that “governments are simply bandits” who want to steal as much as possible (198). Harford uses the example of a dictator who is a bandit and plans to leave the area in one week—that dictator has no reason to leave anything for the people over whom he has power. It’s in his best interests to raze the land and take everything of value. However, if he decides that he wants to stay in the area long term and continue to steal from the people, it no longer makes sense to steal everything. He would need to leave enough resources for the people so that they could continue to create more wealth that he could then steal. A stable dictator might even be persuaded to invest in roads or bridges in order to encourage commerce and increase the wealth he might steal in the future.
In Cameroon, the self-interest and unaccountability of people in power is allowed to run unchecked, but the author cautions the reader not to think that Cameroon has more of those people than other countries. He says that “[s]elf-interested and ambitious people are in positions of power, great and small, all over the world” (207). In other countries, they are simply restrained by law, by public scrutiny, and by political opposition. Cameroon, however, has none of those checks in place.
The answer to the problem of Cameroon’s poverty can be explained by Mancur Olsen’s theory about bandits. “If a poor country has a thief for a ruler” (212), it affects the entire structure from the top down. The thief knows their position is shaky; to court allies, they allow them to steal from the people as well. Civil servants have no guarantee that their jobs will survive the government, so they control access to the essential functions of government in order to make money. The ripple effects of a self-interested leader create pockets of extra corruption in the form of soldiers demanding bribes or police officers creating impromptu road blockades to confiscate goods or demand money for passage. When the people do not trust the government to work to enrich them, they act to enrich themselves. Also, since there is no kind of meritocracy, people have no incentive to gain merit. Whatever money comes into the country from well-intentioned donors is quickly stolen by the government, which pretends to use the money for improvements.
On a basic level, the government’s economic job is to incentivize good social behavior. If it doesn’t, people will not engage in it. Options for fixing this dysfunction are simple to describe but less simple to institute. Legal reforms can be easy to implement, so that can be an effective first step. However, the global economy can offer a step up to struggling countries. High trade tariffs—roughly five times higher than the rest of the world—keep Cameroon out of the global market. This is another way for the government to squeeze cash out of their citizens, but without global trade, the entire country suffers.
In this chapter, the author also discusses the example of Nepalese irrigation systems to show “that a society [must] provide the right kind of incentives [for its people] to behave productively” (196). Nepal has a mix of modern concrete dams designed by engineers and funded by global donors as well as traditional, older systems of dams and canals using “mud and sticks” (208). While trying to understand which kind works better, the economist Elinor Ostrom found that modern dams seem to reduce the effectiveness of irrigation systems. However, modern irrigation channels and irrigation enforcement do strengthen the irrigation systems as a whole.
To explain this paradox, Harford says that existing methods of irrigation in Nepal have an inherent advantage because they are built and maintained by the same people who use them. These people have the incentive to make sure that they work. In contrast, engineers “will not starve if their dams fail” (209), so they have less of an incentive. However, the most important aspect of Ostrom’s paradox can be explained by the culture surrounding the dam and canals. Farmers living around the dam will be most concerned with the maintenance of the dam. In contrast, the farmers downstream from the dam will be more concerned with maintaining the canals than the dam. This difference of incentive is usually worked out by downstream farmers agreeing to help maintain the dam in exchange for the dam farmers coming down to help maintain the canals as well. Crucially, when a new modern dam is put in, it requires much less maintenance. The upstream farmers no longer need help to maintain the dam, so they no longer feel the need to exchange services by helping maintain the canals. Without the help of the upstream farmers, the downstream farmers cannot maintain the canals. While the technical aspects of the project were extensively studied, Ostrom deduced that “the human properties of the system” were vital to the success of the projects and had been previously ignored (211).
Chapters 7-8 Analysis
Chapters 7 and 8 explore economic and political complexities on a global scale, drawing on examples such as radio spectrum auctions and game theory, as well as Cameroon’s socio-economic challenges, to convey Olson’s “government as bandits” economic theory.
Chapter 7 emphasizes the application of game theory in economic scenarios, especially in the auctioning of spectrum rights. It explores the successes and failures of auctions, illustrating the importance of accurate models and the limitations of game theory. The embarrassing failures and overwhelming successes of different of auctions highlight the necessity for economists to carefully consider the unique needs of their own country before designing an auction, as well as considering the stumbling blocks they might face in the form of unpredictable human behavior. Corruption in Cameroon’s government connects to these themes, turning them on their heads to show how a dictator can consider the unique needs and resources of their country in order to better exploit them. Harford highlights the impact of corrupt leaders, illustrating how a self-interested ruling class can hinder economic development and perpetuate poverty. The discussion of auctions as well as governance in Cameroon underscores The Role of Incentives in Shaping Behavior. Whether in bidding for spectrum rights or running a country, individual and institutional incentives play a pivotal role in outcomes. The challenges faced by developing countries, such as Cameroon, as compared to the more nuanced issues of developed countries negotiating with corporations, are a recurrent theme.
The theme of incentives is further developed in Chapter 8 by Harford’s analysis on why well-intentioned international donations do not seem to make any positive impact in the economies of developing nations. He uses the example of Cameroon and Nepal to make his case. In Cameroon, the corrupt, undemocratic government is not incentivized to improve the lives of its citizens since the president and his minions make more of a profit from diverting these international funds to their personal coffers and pretending that they use the money for the country’s improvement. In the Nepalese example, the international organizations that build better irrigation systems for the Nepalese farmers haven’t incentivized these farmers to “behave productively.” As a result, the farmers stick to their old, comfortable ways, unwilling to make the change. These examples also highlight the miscommunication and misunderstandings between developing nations and the international aid organizations that try to help them.
Harford introduces the idea of nations involving themselves in each other’s economies and governments and then builds on this further to develop the theme of The Complexities of Global Trade. He sees that one way for Cameroon to extricate itself from poverty and corruption is for other countries to help it establish itself in global trade. Harford sees trade as a pathway to economic growth and argues that it is ethical for more developed nations to help struggling nations by giving them a trading advantage. He points out that Cameroon’s high trade tariffs and protectionist policies hinder its ability to participate in the global economy. While Harford is critical of the efforts of aid organizations to help developing nations and points to their failures, he believes that establishing developing nations as global trade partners would make better economic sense.
As in other chapters in the book, Harford conveys complex economic ideas through examples and conversational language. The use of poker as a metaphor for spectrum auctions serves as a powerful symbolic device, encapsulating the strategic and competitive nature of these economic transactions. This analogy helps simplify intricate ideas for a broader audience. It also shows the limitations of game theory, which assumes that rational players and most players are ruled by their emotions.
Harford’s conversational tone lays the groundwork for irony, especially in Chapter 8, which is titled “Why Poor Countries Are Poor.” It introduces the paradoxical situation where countries with immense potential for development struggle due to governance issues, and their poverty simply creates more poverty. The narrative structure of both chapters involves presenting real-life scenarios and outcomes. Harford narrates his experiences in Cameroon to vividly show the disastrous results of poor planning on the citizens of a nation who have no real power and are often incentivized to do little or nothing since their profits would be stolen by the government. The connection between the American telecom companies cooperating to cheat the government and the dictator Biya in Cameroon courting allies by allowing them to solicit bribes creates a troubling parallel narrative. It illustrates Harford’s point that self-interested and ambitious people are everywhere; the only things preventing them from wreaking havoc are factors like governmental regulation, laws, political opposition, and media scrutiny.
Both chapters prompt readers to contemplate the implications of economic policies. They question the assumptions underlying economic models and emphasize the need for adaptability. Harford especially advocates for legal reforms and transparency to combat corruption, and he raises questions about the role of governance in fostering economic growth.
Chapters 7 and 8 use economic theories, real-world examples, and social commentary to offer a comprehensive analysis of issues related to auctions, governance, and development challenges. The literary devices employed enrich the narrative, making complex concepts accessible while encouraging readers to critically engage with the themes presented.
