Dear Fairfeea,

You work in marketing, so I’ll explain this slowly. If your fees are currently designed to rise steadily, and you would like them instead to stay flat, and you would also like not to raise initial fees … well, there’s only one answer: slash final-year fees and lose money.

Let’s take a step back. You say that you’d like to reflect costs. Why? Most businesses set prices to attract customers and increase profits. Costs are not directly relevant. What makes you different? And then there’s this bizarre idea of rewarding loyalty. Most companies say they reward loyalty, but it is more traditional to gouge loyal customers while chasing new ones. Don’t fall for your own propaganda.

Your existing pricing scheme works well. Parents will be nervous about whether the school will suit their children, so a cheap price year in reception is sensible. As they grow more confident and the child settles in, they will be increasingly unwilling to switch. That is why rising fees make sense. If parents are dim enough not to notice them, even better.

The only reason to change your current pricing is if you can figure out a way of concealing some of the later fees. Perhaps you could offer overpriced school trips and exam revision classes in later years – or even put a surcharge on the larger sizes of school uniform.

The only reason to reward loyalty is to create it when it does not exist. A private school will have loyal customers without your fancy pricing schemes. You should take full advantage.

Also published at ft.com.

Swoopo runs “pay-to-bid” auctions, where each bid costs you money. As a result, everyone who participates in the auction ends up paying something, and while the winner may get a bargain, all the losing bidders are out of pocket. The auction rules vary, but might specify that each new bid costs 60 cents and that each of those bids raises the price by just 12 cents.

Consider a $500 game console that sells for $240. The $240 winning bid is the 2,000th bid; Swoopo would have earned $240 for the winning bid, plus $1,200 in bid fees, for a $500 console. Sometimes bid increments are just one cent, meaning that even tiny winning bids can leave bidders collectively out of pocket.

Richard Thaler, a behavioural economist who also has a New York Times column, looked at 26 occasions on which Swoopo had simply auctioned $1,000 cheques. The average revenue was $2,452. No wonder the pitchforks are out.

When I heard of Swoopo, the first thing that sprang to my mind was not distilled evil, but an obscure piece of economics called the revenue equivalence theorem. The theorem, developed by Nobel laureate William Vickrey, shows that – given certain assumptions – all auctions can be expected to raise the same amount of cash for the seller. You can hold an open-outcry auction, or a descending-bid auction, or accept sealed bids in envelopes and charge the winner his bid, or the second-highest bid, or the third-highest bid. You can charge an entrance fee, or even insist that every single bidder forfeits his entire bid. The expected revenue, insists Vickrey, will be the same.

To get a sense of why this might be true, imagine an auction where the “evil” rule is that the winner pays twice his bid. Obviously, everyone in such an auction would simply bid half as much as they really intended to pay. The winning bid would be doubled and the final result would be no different. The revenue equivalence theorem is a more general proof of the same idea: “evil” auction rules simply encourage more cautious bidding – they don’t raise any more money.

Still, Vickrey’s theorem makes assumptions, including that of rational bids. Swoopo may attract foolish bids instead. Thaler looked at only 26 auctions, but two new research papers look at tens of thousands.

Three economists from Brigham Young University, Brennan Platt, Joseph Price and Henry Tappen, find that irrational – or perhaps simply risk-loving – bidders seem to concentrate on game consoles. The bids in other auctions look rational and are not especially lucrative.

Ned Augenblick, a doctoral student from Stanford University, has more data and is more pessimistic: he reckons that the typical Swoopo item raises about 50 per cent more revenue than its price on Amazon. This may not be a grotesque profit margin, but it is certainly handsome.

Both studies conclude that many, perhaps most, Swoopo auctions lose money, but that Swoopo makes up for this because some auctions are very profitable indeed. So perhaps Swoopo is a “hack of the human mind”. Augenblick can identify what the hack is, too: it takes advantage of what economists call the sunk cost fallacy. Bidders get sucked in, refusing to quit once they feel committed by having made a few bids.

Pure, distilled evil? I’d sooner slap that label on slot machines. But I won’t be playing Swoopo in a hurry.

Also published at ft.com.

Dear Anon,

The great Kenneth Arrow is famous for his “impossibility theorem”, which proves there is no satisfactory way to aggregate individual preferences into a group preference. I am tempted to propose my own “bathroom impossibility conjecture” – which is that the requirements you specify cannot all be simultaneously satisfied. (Let’s summarise them: the bathroom remains a right; making lessons interesting is a side-issue; neither monetary nor academic incentives are to be deployed; no input from you is to be required.)

I do have one suggestion, inspired by Roland Fryer, a Harvard professor who has been running policy pilots that offer cash to good performers at school. Since Fryer’s earlier work suggests that peer pressure explains much slacking at school, some pilots group kids into teams which succeed or fail together.

Perhaps you could group the kids into two or four teams and offer a reward – or just praise – to the team with the strongest bladders. It might work. It might also lead to accidents and mockery. I wish you luck.

Also published at ft.com.

That is history. This is not: the former mita districts are 25 per cent poorer than apparently identical districts on the other side of a boundary that ceased to mean anything 198 years ago. A long-abolished colonial system has somehow shaped the modern world.

The discovery, by a young economist at MIT named Melissa Dell, is one of many made recently which show that economic development has a long memory. Here is another example, from Daniel Berger, a PhD student at New York University: the 7° 10’ line of latitude that runs through Nigeria is geographically unremarkable and has had no administrative significance for 96 years. Nevertheless, villages just to the north of this line on a map enjoy more competent government than those just to the south.

Economists became interested in the idea that history means something when three influential research papers were published, the first in 1997. Rafael La Porta and colleagues argued that British common law provided better protection for investors than the Roman civil law tradition, and showed that former British colonies seemed to have more advanced financial markets than former French colonies. Stanley Engerman and Kenneth Sokoloff argued that Latin America had underperformed relative to Canada and the US, because it had a climate better suited to growing plantation crops such as sugar, which in turn led to exploitative institutions. And Daron Acemoglu, Simon Johnson and James Robinson showed that the reason tropical diseases are strongly correlated with underdevelopment is less for the obvious reason – that malaria is bad for the economy – and more because such diseases killed large numbers of settlers, who lacked any resistance to them. This encouraged colonial powers to grab gold, ivory and slaves rather than settling the countries and establishing decent institutions. (The Pilgrim Fathers nearly went to Guyana before thinking better of it when they realised their chances of surviving the local diseases were very low.)

Nathan Nunn, an economist at Harvard, has recently summarised the new wave of economic history. He argues that work such as Dell’s and Berger’s helps us understand not just whether history matters, but, thanks to a better handle on the channels of causation, why it matters.

Dell shows that areas outside the mita system were more likely to have large farms; the owners of such haciendas were politically influential and were able to campaign for public goods such as better roads. Berger argues that the 7° 10’ line of latitude in Nigeria is important because different systems of taxation once prevailed on either side of it. To the south, officials relied on customs duties and other taxes on trade through Nigeria’s ports. North of the line, taxes were levied on people – which meant somebody had to arrange a census and keep proper accounts. The difference in bureaucratic capability has persisted for a century.

All this suggests a fatalistic conclusion about economic development: if today’s economic outcomes are influenced by institutions shaped centuries ago, there is reason to be pessimistic that we can do much to help now. That would be going too far, because history is not the only thing that matters. But matter it does.

Also published at ft.com.

Dear Mr Golden,

Competition is only indirectly relevant. The question is how responsive an airline’s customers are to price – “own-price elasticity of demand”, in the jargon. When elasticity is low, airlines can increase prices without losing many customers. Naturally this affects the price they charge – and one explanation for elastic demand and low prices is that customers could easily shift to another airline.

Customers prefer to fly direct to their destinations, so any indirect route will tend to have to be cheap to attract custom. If competition is weak, the pricing is harder to explain, but demand can still be elastic if people would rather not fly at all than pay handsomely to fly indirectly.

The second question is why airlines charge less for more, as you describe. But from “home edition” software to electronics that have been “chipped” to slow them down, the world is full of discounted products that are more expensive to produce than their full-price counterparts. This raises costs, but if it allows companies to target price increases at those most willing to pay, it makes sense.

Also published at ft.com.

Emerging economies have to pay attention to what foreign investors think, because they typically have to borrow in dollars rather than their own currency. Life is different for countries such as the US and the UK, which have been borrowing enthusiastically in their own currencies with little sign of serious concern from the bond markets. For richer countries it is possible that Dick Cheney was right when (according to former treasury secretary Paul O’Neill) he said that “Reagan proved that deficits don’t matter.” If deficits don’t matter, one can only surmise that their natural consequence – public debt – doesn’t matter either.

We had better hope that both Cheney’s claim and Adam Smith’s rumination prove to be true, because many wealthy governments are building up debt very swiftly indeed.

According to the IMF, in the years leading up to the crisis, the gross debt to GDP ratio – which includes interest payments – was just over 40 per cent in the UK and 60 per cent in the US. This year it looks like it will exceed 80 per cent in the UK and 90 per cent in the US. By 2014, the IMF expects the UK ratio to be just under 100 per cent, and the US ratio to rise to nearly 110 per cent.

What are the likely consequences of issuing all these IOUs? A new study by Carmen Reinhart and the IMF’s former chief economist Kenneth Rogoff offers clues. Reinhart and Rogoff have been constructing an impressive database on public debt, covering 44 countries and stretching back two centuries. If the past is any guide to the future, they offer plenty of reason to be concerned.

Reinhart and Rogoff look at episodes of low, medium, high and very high indebtedness, drawing boundaries arbitrarily at public debt/GDP ratios of 30, 60 and 90 per cent. And up to a point, Dick Cheney and Adam Smith are right: there is little sign of trouble at any level of public debt up to 90 per cent of GDP. But once public debt strays into the “very high” category – which is where most rich countries are quickly heading – economic growth has tended to slump. For highly indebted rich countries, median economic growth is about 1 per cent lower than for less indebted rich countries, and mean growth is 4 per cent lower. The fact that mean growth is particularly weak indicates that for a minority of countries, high debt is a catastrophe.

The Reinhart-Rogoff study offers some cause for optimism. Most rich countries are still below the 90 per cent public debt/GDP threshold: so far, debt and deficits are a symptom of weakness, not its cause. And the high inflation feared by some commentators has not, historically, been a feature of high debt levels in rich countries.

Overall, though, the study is worrying. Although there are cases of highly indebted governments presiding over rapid growth – such as Australia and New Zealand immediately after the second world war – they look like deceptive parallels for today. High debt is to be expected after a major war, and as the economy moves to a peacetime footing, high growth is quite possible too.

But high debt in peacetime is suggestive of something rotten in the body politic. The UK government’s structural deficit is larger than the budget for the National Health Service. It will be a long slog from here.

Also published at ft.com.

Failure has always been a fundamental part of a market economy. When markets work, they do so because new ideas are constantly being tried out. Most fail. Those that succeed cause older ideas to fail instead. In the US, about 10 per cent of businesses disappears each year. This is an awkward insight – but trial and error could be starting to take its rightful place as a business technique, rather than the dirty little secret of capitalism.

There are some hopeful signs. Stefan Thomke of Harvard Business School has argued that advances in computation have made it possible to experiment on new products as a matter of course, trying many things and expecting many failures. It is now easy, for example, to experiment with changes in the layout of a website, showing different configurations to different visitors and tracking results in real time. Google, meanwhile, routinely launches new products with a “beta” label on them. And academic superstars such as Steven Levitt, co-author of Freakonomics, have been teaching executive courses in business experimentation.

We are also starting to learn more about the psychology of learning from mistakes. Richard Thaler, the behavioural economist behind Nudge, coined the phrase “hedonic editing” to describe our habit of lumping small losses together with larger gains in order to mask the pain of the loss. Sugar-coating is human, but it’s also a recipe for failing to learn from failure. Thaler, with colleagues, even studied the behaviour of contestants on Deal or No Deal. He discovered that people who had made unlucky choices then started to take reckless risks, which often compounded the error.

It’s hard to learn from failure if it briefly robs us of our judgment. As we start to understand why trial and error is so painful a process, we may be able to use it more constructively. The financial crisis has made us aware that a system that cannot tolerate a bit of failure is a dangerous one. The idea that an institution was “too big to fail” used to sound reassuring. Not any more.

We are sometimes admonished: “Don’t shoot the messenger.” Since there is rarely a logical reason to shoot messengers, such advice should not be needed. But it is, because bad news hurts, and organisations find it difficult to deliver such news to the person in charge.

Andrew Rawnsley’s account of Gordon Brown’s premiership has received attention for its claims that Mr Brown was abusive and physically threatening to his staff, grabbing lapels, stabbing upholstery with his pen and causing his advisers to cower for fear of violence. If true, that is disturbing – but few people will have found it surprising. High-status men sometimes do abuse that status.

I am worried not so much that Mr Brown may be beastly, but that he is cutting himself off from good advice. Mr Rawnsley describes Mr Brown’s fateful decision to pull back from a widely trailed snap election in late 2007. His inner circle waited until he was out of the room before agreeing that such a course would be disastrous. When the prime minister reconvened the meeting, however, this was not conveyed: “No one expressed a clear view. No one wanted responsibility for the decision.”

This is a more significant anecdote than any tale of flying spittle. Any leader needs frank advice, and the biggest obstacle to receiving it is often the leader himself. Even a polite and level-headed boss will be tempted to cut naysayers out of the loop. Knowing this, sensible juniors will avoid expressing criticism or grim tidings if at all possible.

“If you deliver bad news, you’re disempowering yourself,” says Professor David Sims of Cass Business School. “You’re less likely to be listened to in the future.” For some ambitious subordinates, this is a far worse fate than the threat of being thumped.

A new reality television show, Undercover Boss – which has migrated to the US after airing on Britain’s Channel 4 last summer – tries to tap into the dissonance between bosses and front-line staff by filming as a senior executive works incognito in the trenches. It is a delicious premise.

When bosses must don a disguise to learn about how their organisations really work, trouble is in store. One of Friedrich Hayek’s obvious-once-pointed-out observations is that society is full of local knowledge, often of a subtle nature and only fleetingly exploitable. That is one reason why decentralised market processes tend to work well. When a hierarchy has to exist, Hayek’s insight is the reason why bosses should want to receive truthful assessments of what is going on the shop floor (they don’t) and subordinates should be happy to provide them (they aren’t).

What makes matters worse for any organisation is that the same dynamic is taking place at every level. Each middle manager is a fresh obstacle to the flow of truth up a hierarchy of wastebaskets. Sensible managers try to let information flow freely, but many are happy to reinforce the barricades for their own peace of mind.

The results of barriers to communication can be catastrophic. H.R. McMaster’s influential study of decision-making during the Vietnam war, Dereliction of Duty, is packed with examples. The joint chiefs of staff were warned by their chairman, Maxwell Taylor, that Lyndon Johnson did not like “split advice”. Johnson’s defence secretary, Robert McNamara, argued that government would be ineffective if department chiefs were to “express disagreement” with the president. Not disobey, but “express disagreement”. Johnson trusted McNamara implicitly and relied too heavily on the advice of a man he praised as a “can-do fellow”. Isolating himself from dissent, the president made a series of disastrous decisions.

Both the parallels and the contrasts between Vietnam and Iraq are striking. The initial decision to invade Iraq and the appalling prosecution of the war for the first three years were made in an atmosphere in which dissent was made extremely difficult by Donald Rumsfeld and his immediate subordinates at the Pentagon. When the army’s chief of staff, General Eric Shinseki, argued just before the war that many more troops would be necessary, he was rebuked. He retired a few months later. Another general, John Abizaid, was a Middle East expert. He warned that “de-Ba’athification” would backfire and was flatly and repeatedly told that it was official policy. Mr Rumsfeld would not even let his commanders use the word “insurgent”. This Orwellianism made it much harder for army officers to rely on the appropriate doctrine: a counter-insurgency strategy.

The tactics in Iraq were initially corrected from the bottom up. One colonel established stability in the city of Tal Afar only when he engaged in a rebellion against the official strategy. His requests for additional men never made it up the chain of command to the commander in Iraq, General George Casey. He went ahead and turned around Tal Afar anyway. The name of this insurgent colonel? H.R. McMaster, who made such a close study of the top-down dysfunctionality of decision-making in Vietnam.

Most organisations cannot rely on having the equivalent of an H.R. McMaster, who had – literally – a PhD in failures of leadership. So businesses try instead to encourage bottom-up feedback with “360-degree” appraisal processes, “workout” sessions such as those introduced by Jack Welch at General Electric, or anonymous suggestion cards. Older tactics include the court jester and the devil’s advocate.

The other striking lesson of Iraq is that a change at the top can work wonders. General David Petraeus, who took command in Iraq in 2007, rightly relied on men such as H.R. McMaster to rewrite strategy. But Gen Petraeus and his boss, Mr Rumsfeld’s successor Robert Gates, had the advantage of not being the men who had made such awful decisions in the first place. Not many leaders can bear to perform their own U-turns.

Dear Tom,

I am not sure which decision you wish me to evaluate: the decision to pick your A-levels without decent advice, or the decision to pursue a mathematical subject with no mathematical talent. Neither looks smart. You have theorised on the basis of neat concepts without any real-world knowledge – in some ways, ideal preparation to be an economist.

Yet this could yet work out well for you. Ap Dijksterhuis, an economic psychologist, has studied how people make complex decisions. In one experiment he gave people fiddly hypothetical choices, giving some plenty of time to concentrate, while he distracted others before suddenly asking them to choose. He found that such complex decisions seem to be best made subconsciously.

Choosing a course to study at university is a decision with many variables. You have all but closed off economics without even thinking about it. Perhaps that’s for the best. Studying economics without maths is like studying literature when you can’t read without moving your lips – not impossible, but difficult.

As for Oxford, you could always try. Several of my classmates read philosophy, politics and economics without maths. At least one of them now calls himself an economist.

Also published at ft.com.

The tax is being backed by a large coalition of charities and fronted by Bill Nighy in a smooth marketing campaign. It’s all in a good cause. But I have been appalled by the campaign’s profound lack of curiosity as to whether this tax would be a good idea.

Start with the claim on the Robin Hood tax website that this is a “tiny tax on bankers … the people who caused this mess”. First, it’s not a tax on bankers. It’s a tax on financial transactions. And it’s not necessarily tiny, because some worthwhile financial transactions have a very large face value, and a much smaller true value. For instance, I might buy car insurance which could – if I knocked somebody down and permanently disabled them – trigger a payment of £1m. My insurance company might want to reinsure that million-pound risk, a perfectly sensible, socially useful and non-speculative transaction. But at a “tiny” tax rate of 0.05 per cent, that’s a £500 tax on a face value of £1m. It’s hard to imagine such a tax wouldn’t somehow affect my premium.

The Robin Hood tax proposes to raise several hundred billion pounds, and it will ultimately be paid not by “bankers” but by all of us, with the burden shared unpredictably. Robin Hood himself seems incurious where his arrows will strike, or at least unwilling to be specific.

The tax would certainly be attractive if, like a tax on carbon dioxide or congestion, it reduced destructive activities. But would it? James Tobin and John Maynard Keynes both proposed taxes on financial transactions and each believed that the tax would reduce financial volatility. This is possible but far from obvious, when you realise that the tax might encourage bigger, more irregular financial transactions. An analogy: if I have to pay a charge whenever I use a cash machine, I make fewer, larger withdrawals and the amount of money in my wallet fluctuates more widely. Bear in mind, too, that the most bubble-prone asset market is for housing, which is bought in very lumpy, long-term chunks.

There isn’t much evidence as to whether transaction charges reduce volatility. What there is is mixed – but perhaps leaning against the Robin Hood tax. On the French stock market, coarser “tick sizes” raise spreads and act like a tax: they increase volatility. Transaction taxes on Swedish stocks in the 1980s reduced prices and turnover but left volatility unchanged.

Banks have let us down, but the answer is to reform the banks, not tax financial transactions. (Sometimes the local bus company lets me down; I have never regarded this as an argument for a bus tax.) I’d modestly suggest a combination of stricter capital requirements, closer supervision, better bankruptcy procedures for banks and charges for the taxpayer’s underwriting of banks’ balance sheets. A tax on financial transactions doesn’t make my top 10 policy reforms. In fact, it doesn’t figure on the list at all. It’s a sideshow.

I haven’t forgotten the ultimate aim of raising money for the very poor. It’s a cause I continue to support politically and personally. But the Robin Hood campaigners have dented my confidence that they should be trusted with my cash. Money isn’t enough: we must also care about what works. Do they?

Also published at ft.com.