Sunday, 2 June 2013

Saving Economics from the Economists (Ballito Mag)


“Saving Economics from the Economists” is the thought provoking title of a recently published article in the Harvard Business Review (Dec. 2012), written by the 1991 Nobel Prize winner in Economics, Ronald Coase – now an impressive 101 years old. Coase remarks that Economics as currently presented in textbooks and taught in the classroom does not have much to do with business management and still less with entrepreneurship, which is at the heart of a market economy. The degree to which economics is isolated from the ordinary business of life is extraordinary and unfortunate. Coase points out that this was not always the case as the father of modern economics, Adam Smith, envisioned it as the study of the nature and causes of the wealth of nations, with his seminal work, “The Wealth of Nations”, which every Economics 101 student will know about, widely read by businessmen at the time. Coase calls for a reengagement of the study of economics with the economy and to re-orientate this field of study to the study of man as he is and the economic system as it actually exists. The blockbuster titles “Freakonomics” and equally successful sequel “Super Freakonomics” by Levitt and Dubner, therefore came as a breath of fresh air for those thirsting after applied economics, as they set out to explain wacky real life questions such as why drug dealers live with their mothers, how your name can affect how well you do in life and what estate agents have in common with the Ku Klux Klan. I am always interested when estate agents are used as a group to study and the revelations provided by Levitt and Dubner explain why as a seller it is so important to have your estate agent’s goals aligned with your own. The best way I know how to achieve this is through the use of a sole mandate.

The emergence of capitalism in its hybrid forms as a means of organizing labour, capital, information and innovation in China, India, Africa and South America provides economists with unprecedented opportunities to study how a market economy gains its resilience in societies with such diversities. The recent BRICS (Brazil, Russia, India, China and South Africa) annual conference held in Durban and hosted in Zimbali for part of its duration, brought to the Dolphin Coast the reality of the importance these newly developed economies exert on a global platform. South Africa has seen its proportion of gold production to world output plummet but remains a key producer of platinum (together with Russia). South Africa also remains a strategic gateway for doing business in large parts of Africa, and with Africa now being the fastest growing continent as measured by GDP growth according to the Economist magazine, this provides opportunities for us. As Africa becomes wealthier, we can expect more and more African nationals to invest in residential property within South Africa. We have already witnessed this with the proportion of foreign African investors now making up 20% of all foreign residential property purchases. I would expect this figure to double over the next five years. Did you know that the single biggest investment to date in a residential property along the Dolphin Coast was made by a Zimbabwean national? My estimate is R200m for the land and existing buildings (confirmed) and R200m (conservatively but unconfirmed) for capital improvements to date. I would challenge anybody in South Africa to show me another single residential home with a cost value (not asking price) of R400m.

The protection of property ownership rights and the information communicated by prices are fundamental to the operation of the market for real estate in an economy. The pricing of any good or service is an interesting concept as at most price levels there will be some people who see greater value offered than the asking price, and who would tend to buy the good or service while others will see the price as higher than the value provided, and therefore typically elect not to buy the good or service. An outstanding book by William Poundstone, called “Priceless. The myth of fair value”, interrogates this hidden psychology of value. He comes to the conclusion that prices are a collective hallucination and that what matters is not the absolute price of anything but only the relative price. This field of study is called behavioural decision theory and draws on our knowledge of psychology and economics to explain how pricing of anything directly affects the value we associate with it. Poundstone explains the idea of “anchoring” the value we ascribe to a product where it is priced at a certain level and then discounted repeatedly to create a sense of relative value as we psychologically create a benchmark in our minds using the original asking price. In a property market the asking prices of other similar properties provide an opportunity for “anchoring” or creating this benchmark. Over-priced properties make other similar properties seem like excellent value and therefore help estate agents to actually sell the other property. Properties that have been significantly discounted relative to their original asking price also create a sense of value at the revised pricing, which often results in a sale.  

(Author: Andreas Wassenaar, published in The Ballito Mag, June 2013)

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