Naked Economics by Wheelan, Charles (best books to read .TXT) 📗

did not understand the concept of investment diversification. (If you don’t know what that means either, you will after reading Chapter 7.) Based on her research, Professor Lusardi has concluded that “financial illiteracy” is widespread.15

These are not merely esoteric fun facts that pipe-smoking academics like to kick around in the faculty lounge. Bad decisions can have bad outcomes—for all of us. The global financial crisis arguably has its roots in irrational behavior. One of our behavioral “rules of thumb” as humans is to see patterns in what is really randomness; as a result, we assume that whatever is happening now will continue to happen in the future, even when data, probability, or basic analysis suggest the contrary. A coin that comes up heads four times in a row is “lucky” a basketball player who has hit three shots in a row has a “hot hand.”

A team of cognitive psychologists made one of the enduring contributions to this field by disproving the “hot hand” in basketball using NBA data and by conducting experiments with the Cornell varsity men’s and women’s basketball teams. (This is the rare academic paper that includes interviews with the Philadelphia 76ers.) Ninety-one percent of basketball fans believe that a player has “a better chance of making a shot after having just made his last two or three shots than he does after having just missed his last two or three shots.” In fact, there is no evidence that a player’s chances of making a shot are greater after making a previous shot—not with field goals for the 76ers, not with free throws for the Boston Celtics, and not when Cornell players shot baskets as part of a controlled experiment.16

Basketball fans are surprised by that—just as many homeowners were surprised in 2006 when real estate prices stopped going up. Lots of people had borrowed a lot of money on the assumption that what goes up must keep going up; the result has been a wave of foreclosures with devastating ripple effects throughout the global economy—which is a heck of a lot more significant than eating too many cashews. Chapter 3 discusses what, if anything, public policy ought to do about our irrational tendencies.

As John F. Kennedy famously remarked, “Life is not fair.” Neither is capitalism in some important respects. Is it a good system?

I will argue that a market economy is to economics what democracy is to government: a decent, if flawed, choice among many bad alternatives. Markets are consistent with our views of individual liberty. We may disagree over whether or not the government should compel us to wear motorcycle helmets, but most of us agree that the state should not tell us where to live, what to do for a living, or how to spend our money. True, there is no way to rationalize spending money on a birthday cake for my dog when the same money could have vaccinated several African children. But any system that forces me to spend money on vaccines instead of doggy birthday cakes can only be held together by oppression. The communist governments of the twentieth century controlled their economies by controlling their citizens’ lives. They often wrecked both in the process. During the twentieth century, communist governments killed some 100 million of their own people in peacetime, either by repression or by famine.

Markets are consistent with human nature and therefore wildly successful at motivating us to reach our potential. I am writing this book because I love to write. I am writing this book because I believe that economics will be interesting to lay readers. And I am writing this book because I really want a summer home in New Hampshire. We work harder when we benefit directly from our work, and that hard work often yields significant social gains.

Last and most important, we can and should use government to modify markets in all kinds of ways. The economic battle of the twentieth century was between capitalism and communism. Capitalism won. Even my leftist brother-in-law does not believe in collective farming or government-owned steel mills (though he did once say that he would like to see a health care system modeled after the U.S. Post Office). On the other hand, reasonable people can disagree sharply over when and how the government should involve itself in a market economy or what kind of safety net we should offer to those whom capitalism treats badly. The economic battles of the twenty-first century will be over how unfettered our markets should be.

CHAPTER 2

Incentives Matter:

Why you might be able to save your face by cutting off your nose (if you are a black rhinoceros)

The black rhinoceros is one of the most endangered species on the planet. Some 4,000 of them roam southern Africa, down from about 65,000 in 1970. This is an ecological disaster in the making. It is also a situation in which basic economics can tell us why the species is in such trouble—and perhaps even what we can do about it.

Why do people kill black rhinos? For the same reason they sell drugs or cheat on their taxes. Because they can make a lot of money relative to the risk of getting caught. In many Asian countries, the horn of the black rhino is believed to be a powerful aphrodisiac and fever reducer. It is also used to make the handles on traditional Yemenese daggers. As a result, a single rhino horn can fetch $30,000 on the black market—a princely sum in countries where per capita income is around $1,000 a year and falling. In other words, the black rhino is worth far more dead than alive to the people of impoverished southern Africa.

Sadly, this is a market that does not naturally correct itself. Unlike automobiles or personal computers, firms can’t produce new black rhinos as they see the supply dwindling. Indeed, quite the opposite force is at work; as the black rhino becomes more and more imperiled, the black market