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The politics of infrastructure

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Cape Town railway historic

What type of infrastructure would be best for South Africa’s future? The answer, of course, depends on your point of view. If you live and work in Gauteng, your answer might well be to expand the Gautrain network. Or if you reside in Cape Town, you might prefer investments in desalinization plants. Your occupation may also be relevant. If you’re a miner, you are unlikely to support the expansion of renewable energies. A trained software engineer? Well, you’re likely to support large investments in telecommunications infrastructure.

An important – but often underappreciated – role of government is to choose the type of infrastructure that is destined to shape the country’s future development path. This choice is never neutral though: for every decision, there are winners and losers. Choose to build a new coal-fired power plant? That will benefit coal mine owners and workers, while the users of electricity, were the costs of alternative sources to fall rapidly, will pay. Choose to build a high-speed train network across the country (a hyperloop, perhaps!), then users of this network, likely to be high- or middle-income South Africans, will benefit, while long-distance bus services, taxi operators and rental cars will pay. The government’s job, in theory at least, is to choose the projects that will maximize the benefits and minimize the costs.

But things are never that simple. A research paper that will soon appear in the European Review of Economic History, written by Alfonso Herranz-Loncan and myself, investigate the infrastructure in the Cape Colony built during the second half of the nineteenth century. Before the discovery of diamonds in 1867, the few railways that existed (in and around Cape Town) were privately-owned and largely unprofitable. But the discovery of diamonds and the rush to the mines meant the demand for fast, affordable inland transport increased exponentially. The Cape government had to react.

They did. They bought the few existing lines, and then began to the process of connecting Cape Town to Kimberley, finally achieved in 1885. The connection to the booming diamond region brought huge economic benefits: we estimate that the railway may account for 22-25 percent of the increase in income per capita in the Cape during the diamond-mining period (1873-1905). This is a massive share for a single investment and a clear indicator of the transformative power of railways during the first era of globalisation.

But these benefits were not equally shared by everyone. Surprisingly, the government itself earned a meager 3.7% average return on its capital. Had a private firm built the railways, far fewer branch lines would probably have been built. As Stellenbosch PhD student Abel Gwaindepi now shows, the government incurred huge debt to build this infrastructure, and although the government did benefit through customs duties and other tariffs, the main beneficiaries were the owners of the diamond fields. The railway link between Cape Town and Kimberley could now transport the machinery and foodstuffs required to feed the growing Kimberley population. Western Cape wheat farmers, who supplied the mines with food, was another group of beneficiaries. It is not entirely coincidental that it was also these two groups – mine owners and Western Cape farmers – who had formed a political alliance in Cape parliament.

Of course, it was not only mine owners and Cape farmers that benefited. As detailed reports of passengers show, Cape Colony residents from all walks of life used the railways. But, ultimately, it was tax payers who had to foot the debt that were incurred, and often these tax payers were spread across the entire colony (far from the direct benefits of the railways) – and after unification in 1910, the rest of the country. And the location of the railways meant that those with less political influence – like Basotho farmers, who were of course producing wheat much closer to the diamond fields – lost out. Here is one missionary report from 1886, the year after the railway line was completed: ‘Basutoland, we must admit, is a poor country… Last year’s abundant harvest has found no outlet for, since the building of the railway, colonial, and foreign wheat have competed disastrously with the local produce.’

The nineteenth-century Cape railways contributed significantly to economic growth, but it inadvertently also had distributional consequences: some benefited more than others, and some even suffered as a result of its construction.

The lessons for today? Politics shapes the type of infrastructure that’s built. And infrastructure shapes the direction of economic development. So the key question is this: Are we building the type of infrastructure that will put South Africa on a path of broad-based economic development, or is the choice of infrastructure determined by the self-interest of those with decision-making power, much like Cecil John Rhodes and his cronies during the late nineteenth-century?

Put differently, when we choose a new power-generating facility or national air carrier or telecommunications license, do we consider the benefits for society as a whole or the benefits for a specific interest group?

*An edited version of this first appeared in Finweek magazine of 5 October 2017.


Policy uncertainty is killing investment in what matters

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Much has already been said about South Africa’s inefficient public sector. Not only has the public sector wage bill escalated beyond the realms of the sustainable, but this has come at almost zero public sector productivity growth. In other words, we are paying more for government to do less. Add to that the poor performances of state-owned enterprises like Eskom, the SABC and most notoriously, South African Airways, and it seems that there is little more that the South African government can do to hurt the prospects for economic growth.

But there is. A new NBER working paper, published by Jose Maria Barrero, Nicholas Bloom and Ian Wright, uses new data on about 4000 US firms to investigate the sources of uncertainty in the US economy. They first distinguish between short-term and long-term uncertainty, identifying the factors that cause each type of uncertainty. They then ask how each type of uncertainty affect firms’ behaviour.

Short-term uncertainty, they find, is caused by oil price volatility. In contrast, economic variables like the oil price has less of an effect on long-term uncertainty where political risk, like policy uncertainty, has a much larger effect. The important result is that short-term and long-term uncertainty have different consequences for firm behaviour. Short-term uncertainty affects employment; long-term uncertainty affects investment in research and development.

If we assume this is true for South Africa too, how would it play out? Volatility of several macroeconomic variables, like the oil price and exchange rate, cause higher short-term uncertainty. This would likely make firms unwilling to hire new workers, or make managers unwilling to offer higher wages. These are the consequences economic commentators typically cite when referring to an unstable macroeconomic environment.

But employment and wages are not the only variables affected by uncertainty. One of the key indicators of a thriving economy is businesses’ willingness to invest in research and development. Take R&D as a percentage of GDP, shown in the Figure below. There is large variation in the share that countries spend on research and development: Israel and South Korea, for example, spend more than 4% of their GDP on R&D. South Africa spend less than 0.8%. (This figure almost reached 0.9% in the 2006-2008 period, a period not surprisingly correlated with high growth rates.)


There is a strong positive correlation between countries that grow fast and those that invest in research and development. South Africa, unfortunately, significantly lags those countries at the technological frontier. It is important, though, to understand why this is the case. It is not only government that invests in R&D; in fact, more than half of all R&D investment in South Africa comes from the private sector.

So what will encourage businesses to invest more in R&D? Well, according to Barrero, Bloom and Wright, political risk and policy uncertainty is the biggest determinant of private sector investment in R&D. In a political environment with little policy coherence, business are unlikely to make investments where the returns can only be realized in the long-run. Even if the possible returns are substantial, a rational investment response to a murky policy environment would be to sit back and see what happens. Lower investment in R&D means falling further behind international competitors.

There are some in the South African government who realise this. Minister of Science and Technology, Naledi Pandor, has committed to doubling R&D expenditure as a percentage of GDP by 2020. This is commendable, but in the current budgetary environment, unlikely to get the support from the Minister of Finance. Other initiatives to get the private sector investing in R&D, like a refundable tax credit that will benefit small businesses, have not been implemented.

These problems are not unique to South Africa. As the authors argue: ‘Our findings are significant in the wake of recent events like Britain’s vote to leave the European Union and Donald Trump’s assumption of the US Presidency, which have generated considerable uncertainty over future economic policy around the world. As we have shown, such policy uncertainty is particularly linked with long-run uncertainty and in turn with low rates of investment and R&D that can have significant consequences for the global economic outlook in years to come.’

R&D is the bedrock of future prosperity. Political risk that leads to policy uncertainty hurts not only economic growth and employment creation, but also deters firms from investing in the one thing that can create prosperity for all. If the ruling party is serious about its slogan, it better start by enacting more coherent economic policy.

*An edited version of this first appeared in Finweek magazine of 21 September 2017.

Why #DataMustFall

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ZimBoth the Independent Communications Authority of South Africa (Icasa) and the Competition Commission are concerned about South Africa’s high data costs. It is about time. Of the 48 African countries ranked by for the first quarter of 2017, South Africa was the 22nd most expensive in which to buy 1GB data. All of South Africa’s main competitors on the continent, including Egypt (1st), Ghana (4th), Nigeria (8th) and Kenya (15th) ranked higher. Our poorest neighbour – Mozambique – ranked second, with US$ 2.27 for 1GB in contrast to our US$7.49.

Consumers have known this for some time. Last year, radio personality Thabo “Tbo Touch” Molefe started a Twitter campaign – #DataMustFall – that went viral. He was subsequently invited to address the parliamentary Portfolio Committee on Telecommunications and Postal Services about the high cost of broadband in South Africa. Said Molefe at the time: “The power of data gives access to education, mentorship, skills training, financial assistance, job searching and recruit.”

Molefe is correct. There is now ample evidence globally to show that internet access at affordable prices is correlated to better job market opportunities. This is especially true in South Africa, where the employment rate is seven percentage points higher in areas connected to the internet than those with no connection. The problem is that economists have struggled to show that this relationship is causal: areas with internet connectivity usually have all the other amenities that are associated with better job market prospects. It then becomes an empirical question of how to separate the effect of internet connectivity from things like education, infrastructure and wealth that also affect job market prospects?

A new NBER Working Paper by Jonas Hjort of Columbia University and Jonas Poulson of Harvard University offers an answer. The two authors exploit the gradual arrival of 10 submarine Internet cables from Europe in cities on Africa’s coast in the late 2000s and early 2010s to identify whether the higher speeds and cheaper data costs created new jobs. First, they show that the arrival of the cables did, in fact, increase average internet speeds and the expansion of the network. They then compare the changes in employment patterns in cities and towns with a bigger versus a smaller increase in access to fast Internet. “In each of three different datasets that together cover 12 African countries with a combined population of roughly half a billion people, we find a significant relative increase—of 4.2 to 10 percent—in the employment rate in connected areas when fast Internet becomes available.” Just as Molefe said: faster and cheaper internet creates jobs!

As with any economic change, there are both winners and losers. Hjort and Poulson show that the faster, cheaper internet reduces employment in unskilled jobs, but “enables a bigger increase in employment in higher-skill occupations”. In other words, just as automation does in the developed world, faster internet in Africa results in a change in the type of skills required. One might expect the consequence to be deeper levels of inequality. Not true, says the authors, especially in South Africa. Faster, cheaper internet enables South African workers of low and intermediate educational attainment “to shift into higher-skill jobs to a greater extent than highly educated workers”. The net effect is that fast internet lowers employment inequality across the educational attainment range in South Africa.

So what types of jobs were created by the arrival of the submarine cables? The authors find that “new and new types” of jobs were created via the “extensive margin” (meaning: new users) and “intensive margin” (meaning: different use of the internet by existing users). Using detailed firm level data, they show that, in South Africa, new firms are established, notably in sectors that benefit from ICT. In Ethiopia, by contrast, existing firms improve their productivity. In other African countries like Ghana, Kenya and Nigeria, firms with access to the faster, cheaper internet export much more, perhaps, the authors suggest, because “website communication with clients become easier”.

Technology is not just a threat to job creation – it is also an opportunity. But as the #DataMustFall movement has shown, fast internet access remains a mirage for most South Africans. That is hopefully changing. Non-profits, like Project Isizwe, want to facilitate the roll-out of free WiFi in public spaces in low income communities, as it is already doing in Tshwane. Similar initiatives are following in South Africa’s other metros. Both Google and Facebook are designing new technologies that could revolutionise connectivity for in rural areas.

Consumers are rightfully angry about the high cost of data in South Africa. Yet it is local entrepreneurs and their employees that should be most upset. As Hjort and Paulson show, cheap data will create more firms and more, better-paying jobs. “Employment responses of the magnitude we document indicate that building fast Internet infrastructure may be among the currently feasible policy options with the greatest employment-creating potential in Africa.”

Fast and cheap internet is probably the simplest way to alleviate South Africa’s high unemployment conundrum. Policy-makers should take note.

*An edited version of this first appeared in Finweek magazine of 24 August 2017.

Written by Johan Fourie

August 30, 2017 at 10:56

How do we build a prosperous, decolonized South Africa?

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I recently attended an academic conference at the University of the Free State on the topic ‘Decolonizing Africa’. Much of the debate was, understandably, about the past: about the lingering effects of the (Atlantic) slave trade, European colonization that included the imposition of largely artificial borders, and the post-colonial failures of independent Africa. But at the final keynote, delivered by Prof Alois Mlambo of the University of Pretoria, the discussion turned to the future. How do we build a prosperous, decolonized South Africa?

One unescapably emotive topic is land reform. The expropriation and dispossession of land in South Africa is the root, many agreed, of the severe levels of inequality that plague the region. But how to correct this past injustice was not so easy; in the audience, too, were several Zimbabwean scholars quite critical of that country’s land reform programme. Over lunch, one Zimbabwean student told me the tragic story of his grandfather, a former farm worker on a white farm turned successful tobacco farmer after land reform, only to lose his land because he was considered ‘too successful’ by the ruling ZANU-PF party. The farm is now dormant.

Getting land reform right is fraught with difficulty. Not everyone that suffered land expropriation wants to return to farming – by far the largest number of recipients of successful land claims in South Africa choose the cash instead of the land. (This is often ignored by politicians and commentators when simply taking the hectares transferred as measure of land reform success.)  And even when recipients choose to return to the land, they often struggle to support themselves because of the small size of land allocated, or a lack of capital investment, or a lack of technical or management skills. There are also political consequences: because land recipients, like those in Zimbabwe, often do not receive title deed to the land they are given, they become ensnared by the political party that gave them the land. Why do people still vote for ZANU-PF despite the state of the economy? Because they worry a vote for the opposition means that they might lose their land. Most worryingly, it is often the original farm workers who lose the most, like the Zimbabwean student’s grandfather.

This is not to say that some form of wealth redistribution is not imperative. But whereas land (and the minerals it contained) was clearly the most productive resource when it was expropriated in the nineteenth century (which is the reason it was expropriated), a valid question is whether it still is the most productive. Of course, people value land not only for its economic uses: there are a myriad of historic, cultural and religious reasons why the land of your ancestors are treasured. But as a redistributive policy aimed at creating a more equitable society, is land reform the best way to create prosperity for those who suffered historical injustice?

Think of the fastest growing companies globally: which of them still rely predominantly on land ownership? AirBnB is a great example: it is the world’s largest accommodation service, without owning any property! For AirBnB and the myriad other unicorns that have created incredible wealth for their founders and shareholders, it is not land or physical property that creates wealth, but science and technology. (Even farmers know this: that is why they are investing in science to improve their crops and in technology to mechanize production.)

In the twenty-first century, land is what you buy with your wealth, and not the reason for your wealth. A quip about Stellenbosch wine farmers summarize this well: How do you make R1 million farming in Stellenbosch? You spend R2 million.

Prof Mlambo remarked that India and China, both with a history of colonisation, is not growing at above 5% because they have redistributed land. They have prospered because they embraced science and technology. Consider this: in the 2015/2016 academic year, 328,547 Chinese students studied in the United States; only 1,813 South African students did. (If you account for population size, 7 times more Chinese than South Africans students study in the US.) Take South Korea, a country with roughly the same population size as South Africa: 61,007 South Koreans traveled to study in the US in 2015/2016, 33 times more than South Africa.

So how would a redistribution policy look that takes science and technology seriously? I don’t have the answers, but here are some suggestions. Most of us would agree that education is key, but the South African education system has not made much progress in the last decade and it is unlikely to do so in the next. Redistribution must start at the first year of life. Publicly funded but privately run nurseries will remove the gap between the rich and poor that has already emerged when kids arrive at school. For primary and secondary education, a voucher system that incentivize private schools for the poor is an option. At tertiary level, we need more and better-funded universities, notably in science and technology. (It would help to send more of our smartest students abroad to study at the frontiers of science – they will return with new ideas and networks to propel our industries forward.) Visas for and recruitment of skilled immigrants can boost research and entrepreneurship. Improve free wifi access and invest in renewable energies. The private sector, because that is where most innovation occur, can be incentivized through appropriate legislation to offer shares to workers – or to those living in communities where they operate. There are a myriad of innovative possibilities.

If Zimbabwe has taught us anything, it is that politics may triumph over economic logic. Land reform in Zimbabwe was not an economic strategy in as much as it was a strategy to keep the ruling party in power. It has had severe economic consequences, as anyone visiting Zimbabwe today can attest. The real radical economic transformations of our age – just in my lifetime, the Chinese has managed to reduce the share of people living in absolute poverty from 88% to less than 2% – have not come from redistributing an unproductive twenty-first century resource. It has instead been the result of investments in science and technology. Any attempt to redistribute with the purpose of building a more prosperous society should take this as the point of departure.

*An edited version of this first appeared in Finweek magazine of 29 June 2017.

We are shopping less, but buying more

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One of the things I realised soon after marriage, is that my wife and I share different strategies when it comes to grocery shopping. I like to stock up, buying bulk on the cheap, while she prefers to visit the store more frequently, acquiring only what is necessary for the next few days. This of course means that we never run out of canned beans, but often out of milk.

Such choices are at the heart of economics. Understanding how, why and when a buyer chooses a product or service is often the difference between a thriving and failing business. That is why every successful firm, from banks to health insurance to mobile communications companies, spend considerable resources these days analysing ‘Big Data’ to understand and ‘nudge’ the behaviour of their customers.

Even general retail, a sector often caricatured as unaffected by technological change, now has to adjust to the new technological possibilities, like sensing technologies that track the movement of customers as they browse a store. Not only can technology help retailers to optimise store lay-out, but, with a little leap of the imagination, they can have advertising that can recommend new products when a new customer walks past based on the content of their previous purchases, of their existing basket or of the purchases of their friends that is connected to them on social media. (Imagine buying shampoo, and being prompted: Your friend, Herman, purchased Organics in this store five days ago.) And then there is a plethora of other technologies that are likely to revolutionise the shopper’s experience, from mobile payments (in South Africa: wiCode or SnapScan), to digital receipts (another South African upstart: Pocketslip), to online shopping.

There is no doubt that these new technologies will shape the way we make decisions about what, how and where to buy our groceries, but technology is not the only thing that affects our spending behaviour. A new NBER Working Paper by three authors affiliated to US universities, identifies an interesting trend in the US over the last four decades: the rise of spending inequality, or a widening gap between how much different households spend when they go shopping.

We usually measure inequality by comparing peoples’ incomes. But presumably we are also interested in how people spend their incomes: are there huge differences between how much some households spend vis-à-vis others, and do these differences change over time? In fact, it seems like this is indeed the case: the difference in household spending patterns in the US seem to be on the increase. Some families seem to be spending a lot more than others.

One suggestion for the rise in income inequality is the impact of technology. But this is where the authors find an interesting result: the reason for the rise in spending inequality, they argue, is not because of growing differences in consumption caused by greater levels of income inequality (i.e. the rich still consume more than the poor, but this gap is not increasing), but instead because Americans go shopping less frequently. They explain it as follows: if a household starts buying groceries once a month instead of once a week, their consumption may not change (they stockpile to smooth their consumption), but the measured spending inequality will change because some households in surveys will appear as if they spend a lot, while others will appear as if they spend nothing. This difference was less dramatic when households went shopping every week, and so it appears as if inequality is on the rise.

Using various datasets, the authors find two distinct trends to support this theory: first, the number of shopping trips that Americans make has been steadily falling since 1980. In contrast, the average expenditure per trip has been steadily rising. Americans are making fewer, but larger, shopping trips on average. Second, the quantity of goods Americans buy have been rising, while the amount of time spent shopping has declined. All of this, the authors conclude, points to higher levels of stockpiling by Americans.

What explains this changing behaviour? Surprisingly, it is not technology innovation, which is often considered the source of most disruption. Instead, the authors show, the increasing stockpiling is a result of the emergence of warehouse stores, like Costco, that sell larger quantities of goods at lower unit prices. “As these stores have expanded throughout the country since the 1980s, it has become easier for households to stock up in ways that were not feasible in the past, consistent with the decreased frequency of shopping that we observe.”

Technological improvements like mobile payments, digital receipts and online shopping is aimed at reducing transaction costs, making it easier and cheaper for consumers to do their grocery shopping. Such lower costs should result in a higher frequency of shopping. And yet, the trends, at least for the US, point in exactly the opposite direction: fewer visits to the supermarket, with consumers preferring to buy in bulk and on the cheap.

Perhaps South African consumers behave differently. Perhaps the digital revolution will reverse these trends quickly; once your fridge can order canned beans automatically from the local supermarket when supplies run low, we won’t need to buy in bulk. But any retailer worth their salt would do well to be aware that the promise of technology can often overshadow deeper forces pulling in the other direction. Technology reduces transaction costs, but the benefits of buying bulk seem to outweigh the costs. Now to convince my wife.

*An edited version of this first appeared in Finweek magazine of 18 May.

Written by Johan Fourie

June 13, 2017 at 05:48

Four high-growth scenarios for Africa

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Can African countries sustain the relatively high growth rates they attained since 2000? At the start of 2017, putting aside the newsworthy political shifts and the fear of many that the developing world has entered a ‘secular stagnation’, this remains the most vexing question for those of us on the African continent.

It is not a question with an easy answer. The stellar economic performance of several African countries has created an ‘Africa rising’ narrative where further progress – and catch-up to the developed world – seems inevitable. A more pessimistic counternarrative argues that this growth, from a low base, is largely the result of favourable commodity prices and Chinese investment. Both narratives had, unfortunately, made little use of either economic theory or history.

Enter Dani Rodrik, professor of International Political Economy at the John F. Kennedy School of Government at Harvard University, who tackles this question in a new paper in the Journal of African Economies. He first shows that many African economies have indeed improved since 2000, but that many, including Senegal, the DRC, the Ivory Coast and Zambia, remain on levels below those immediately following colonialism (around 1960). The second fact he establishes is that the rapid growth of the last dozen years has not lead to a large structural transformation of the economy. Whereas rapid growth in south-east Asian economies during the late twentieth century resulted in the growth of manufacturing, a more productive activity than subsistence farming, high growth rates in Africa have not had any effect on the relative size of manufacturing. In fact, in many countries, the size of the manufacturing sector has actually declined since 1975.

Rodrik attributes these changes not so much to factors unique to Africa – like a poor business climate or weak institutions or bad geography – but to a global trend of deindustrialisation. Even Vietnam, a country which has recently experienced rapid growth, has not seen much growth in manufacturing.  And Latin American countries, which have decidedly better institutions than three decades ago, have also not seen much growth in manufacturing. Technological change – the move to automation, for example – is one likely reason.

So despite high growth rates, African countries have not industrialised – and, in fact, may have even begun to deindustrialise. This is why Rodrik is pessimistic about Africa’s future growth prospects. He nevertheless concludes by considering potential scenarios in which Africa can indeed sustain high growth, and identifies four possibilities: 1) To revive manufacturing and industrialise, 2) To generate agricultural-led growth, 3) To generate service-led growth and 4) To generate natural resource-led growth.

Let’s start with agriculture. Although many African countries have a lot of potential to expand their agricultural sectors, productivity in the agricultural sector remains low. Many farmers are subsistence producers, with low economies of scale. Such a scenario will require a reversal in the current trend away from agriculture. A recent study by Diao, Harttgen and McMillan show clearly how the share of agriculture is falling, particularly as women older than 25 are moving to the cities and into manufacturing and services. This trend seems irreversible, even if changes to technology (like seed varieties or market access opportunities) or institutions (like private property) are made, which means that an agricultural-led high growth scenario seems highly unlikely.

A natural resource-led strategy also seems unlikely for most African countries. Yes, most countries on the continent are well-endowed with resources, but the problems of the Natural Resource Curse and Dutch Disease are well known. It may be an option for some small economies, like Botswana has shown, but one has to question to what extent it can be sustainable beyond a certain level of income.

A third option is to reverse the trend of deindustrialisation. Because a growing manufacturing base seems to be, at least if we consider past examples of industrialisation, the only way to increase labour productivity over a sustained period of time, this is the option preferred by many development agencies. Yet there are many obstacles in the way of a thriving manufacturing sector, including poor infrastructure (transport and power in particular), red tape and corruption, low levels of human capital, and political and legal risk. But as explained earlier, Rodrik believes that even if these (very difficult) barriers can be overcome, it is not clear that manufacturing will return. The Fourth Industrial Revolution may completely alter the nature of manufacturing away from absorbing unskilled labour to capital and knowledge-intensive production. As I’ve said before, it is dangerous to follow a twentieth-century blueprint when production technologies are so different.

That leaves us with one scenario: services-led growth. Services have traditionally not acted as an ‘escalator sector’ as Rodrik explains. The problem is that services typically require high-skilled labourers, one thing that is in short supply in a developing economy. Rodrik does acknowledge, though, that the past will not necessarily look like the future. “Perhaps Africa will be the breeding ground of new technologies that will revolutionise services for broad masses, and do so in a way that creates high-wage jobs for all. Perhaps; but it is too early to be confident about the likelihood of this scenario.”

I don’t see an alternative, though. Yes, some countries, like Mozambique or Tanzania, will be able to expand their agricultural sectors – but higher productivity will probably mean larger farms with fewer workers. A few small countries will be able to benefit from natural resources – from diamonds to rare minerals like tantalum (used in cellphones and laptops); oil-producing countries will struggle, though, as the cost of renewable energies keeps falling. And some coastal countries may even develop their manufacturing sectors, like Ethiopia and South Africa. But for most of Africa, services offer the only reprieve from low productivity, low-wage jobs. From semi-skilled jobs like call-centres and virtual au pairs (apparently the next big thing) to professional services like accountants and designers and programmers, digital technologies must help leapfrog the barriers of poor infrastructure, bad geography and weak institutions. If it cannot, Dani Rodrik’s pessimistic vision of Africa’s future is likely to come true.

*An edited version of this first appeared in Finweek magazine of 26 January.

How Uber makes the world a better place

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The first thing students are taught in any introductory microeconomics course is that the price of something, let’s say chauffeur services, and the quantity of it that consumers want is depicted by a negative-sloping demand curve. The difference between what consumers are willing to pay for a chauffeur ride (the demand curve) and what the chauffeur asks (the market price), is what is known as the consumer surplus. The bigger the consumer surplus, the better for society.

But even though the idea of consumer surplus is used in many applications, measuring it has always been problematic. That is because, in the real world, demand and supply move together, and it is therefore difficult to establish the exact shape of a demand curve.

That was, until Uber. A team of economists (including Steven Levitt of Freakonomics fame) recently published an NBER Working Paper that uses almost 50 million UberX ‘consumer sessions’ to identify a demand curve for taxi services, and then calculate the consumer surplus that these services generate. A ‘consumer session’ is basically when someone logs onto the UberX app and requests the price for a proposed trip. The consumer either accepts the price and wait for an Uber driver to pick them up, or they don’t, and find alternative transport.

What makes Uber unique is that its prices vary according to demand (for its services) and supply (the availability of drivers). This unfortunately also means that it is not possible to simply calculate a demand curve when the price increases by 10%, because the increase might be the result not of greater demand by consumers for Uber trips, but of lower supply (having fewer drivers on the route). The research team use a clever trick to get around this. Say the algorithm predicts that the price must increase by 1.249. This is then rounded down to 1.2 for the consumer. Other times the algorithm suggests the price must increase by 1.251, but the app then rounds this up to 1.3. It is this discrete difference when the price is essentially the same which the authors exploit using regression discontinuity analysis.

uber_advertIf this sounds very geeky, the results are worth the wait. First, the authors find that demand is quite inelastic (around 0.5). This means that if prices increase by 10%, demand will only fall by 5%. Second, they compute the dollar value of consumer surplus in Chicago, Los Angeles, New York and San Francisco to be roughly $2.8 billion annually. This is more than six times Uber’s revenue in those cities. Put another way, for each $1 spent on an UberX ride at the lowest price, the authors estimate that the consumer ‘receives’ $1.57 in extra surplus. In short, Uber generates massive benefits for society-at-large.

Why does Uber generate so much consumer surplus compared to normal taxi operators? Another NBER Working Paper, written by Judd Cramer and Alan Krueger, suggests that it is because of the higher capacity utilisation rate of Uber drivers: “UberX drivers spend a significantly higher fraction of their time, and drive a substantially higher share of miles, with a passenger in their car than do taxi drivers.” There are four reasons for this. First, Uber’s better matching technology (an app that anyone can download on their phones). Second, the larger scale of Uber’s usage in comparison to taxi companies. Third, highly inefficient taxi regulations which limit the number of routes or time periods taxi drivers can operate. Fourth, Uber’s flexible labour supply model and pricing model which match supply with demand.

South African regulators have had varied responses to Uber’s entrance in the local market. There has been opposition from the taxi industry, sometimes violent. Proponents of Uber, on the other hand, often highlight the entrepreneurial and job-creating opportunities the service creates.

What this research shows, though, is that Uber’s main benefit is the massive surplus it generates for consumers. According to the Levitt research team, one day’s worth of consumer surplus in the four US cities they analyse is worth about $18 million. “If Uber were to unexpectedly disappear for a day, that is how much consumers would lose in surplus.”

Aside from this consumer surplus, Uber services create many positive externalities, from lower congestion and pollution levels to semi-skilled employment to, perhaps more tenuously, greater social interaction and cohesion – I’ve had some fascinating conversations with Uber drivers, and know of one driver that was offered a scholarship by a client. But, most importantly, when regulators and policy-makers debate the pros and cons of Uber and other such services that will almost certainly appear in the next few years, it is worth remembering one of the basic principles of introductory economics: the immense benefits society derives from the additional consumer surplus.

*An edited version of this first appeared in Finweek magazine of 20 October.

Written by Johan Fourie

November 23, 2016 at 08:56