The contractual view of marriage

One of my former students asked me to write up the contractual view of marriage that I teach in my classes.  Here it is:

POST INVESTMENT HOLDUP ROUTINE (I deliver this after I describe the problem of post investment hold-up and how vertical integration can re-establish the incentive of parties to make relationship specific investments)

When I got engaged, my fiance and I had to go through pre-marital counseling with a priest, and he asked us why we wanted to get married.

I said “Long-term relationships induce higher levels of relationship-specific investment.”

The priest looked as if he didn’t understand, so I said “you know, the kind of investments that differentiate a marriage from a series of meaningless spot-market transactions.”

On our first anniversary, my wife gave me a card declaring that “her relationship-specific investment was earning an abnormally high rate of return.”

Regulating Everclear Sales in Iowa

The state of Iowa is considering increased regulation of the sale of Everclear, a 151-proof alcohol popular with college students (the 190-proof version of Everclear is illegal to sell in a number of states according to Wikipedea). The consideration follows a recent hazing incident in which a Drake University student nearly died with a blood alcohol level of 0.5 (Wow!)

So what do you think is happening to current sales of Everclear in Iowa? They're going up.

Lord Keynes on the State of the Union

The political pressure for deficit reduction is also seen as an anti-stimulus by some economists, suggesting a difficult trade off (jobs vs. deficits). So here is President Obama's policy solution:

Over the weekend, Obama endorsed legislation that would set up a bipartisan budget commission, to make recommendations on tax hikes and spending cuts later this year. One appeal of this approach is that it offers the promise of deficit reduction, while postponing any hard decisions until the economy is on more solid ground — or at least until after the November election.

How would Lord Keynes view this policy?

Organized public works, at home and abroad, may be the right cure for a chronic tendency to a deficiency of effective demand. But they are not capable of sufficiently rapid organisation (and above all cannot be reversed or undone at a later date), to be the most serviceable instrument for the prevention of the trade cycle.

UPDATE: The recently announced spending freeze seems too small to make much difference, but some economists are worried.

Prominent economist Brad DeLong of the University of California at Berkeley took to his blog to express fear that Obama was repeating the missteps of President Hebert Hoover, widely blamed in academic circles for not aggressively trying to fight the forces that caused the worldwide economic collapse that lasted from 1929 until the start of the World War II.

Privatizing liquor sales in Virginia

Only the market can stop a populist politician

The Washington Post is following the economic problems caused by the socialist political model in Venezuela:

During the past two weeks, just before and after the earthquake outside Port-au-Prince, the following happened: Chávez was forced to devalue the Venezuelan currency, and impose and then revoke massive power cuts in the Venezuelan capitalas the country reeled from recession, double-digit inflation and the possible collapse of the national power grid.

Despite the recovery in oil prices, the Venezuelan economy is deep in recession and continues to sink even as the rest of Latin America recovers. Economists guess inflation could rise to 60 percent in the coming months. Meanwhile, due to a drought, the country is threatened with the shutdown of a hydroelectric plant that supplies 70 percent of its electricity. And Chávez's failure to invest in new plants means there is no backup. There is also the crime epidemic -- homicides have tripled since Chávez took office, making Caracas one of the world's most dangerous cities. At a recent baseball game a sign in the crowd read: "3 Strikes-Lights-Water-Insecurity/President You Struck Out."

Outsourcing and the Pinewood Derby

If you have heard of the Boy Scouts or Cub Scouts, you've probably heard of the Pinewood Derby. It's one of the major events of the year for Cub Scouts, and it involves model wooden cars racing down a sloped track of around 30 feet. According to Wikipedia, "Cub Scouts, with the help of parents, build their own cars from wood, usually from kits containing a block of pine, plastic wheels and metal axles."

Having attended my first Pinewood Derby this past weekend, I can tell you that economic principles are alive and well in the world of Pinewood Derby. Obviously, not every Cub Scout (even with the help of parents) is going to be particularly skilled in building a car from a wooden block and other spare parts. So, what do you do when someone else can do a job better or more cheaply than you? Outsource! I was impressed to learn of the number of companies offering plans, supplies, and even completed cars to potential racers (just do a Google search on "Pinewood derby"). I think the Cub Scouts should offer an economics badge to Scouts who show the most proficiency in outsourcing production of their cars.

The cancer is growing

Lead article in the Economist:

“The question that we ask today”, said Barack Obama in his inaugural address, “is not whether our government is too big or too small, but whether it works.” This is clearly naive: with deficits soaring, nobody can afford to ignore the size of government. Mr Obama’s appeal for pragmatism has some value: conservative attempts to roll back government regulations have led to disaster in the finance industry. But left-wing attempts to defend entitlements and public-sector privileges willy-nilly will condemn the state to collapse under its own weight. Policymakers will not be able to give a serious answer to Mr Obama’s question of whether “government works” without first asking themselves some more fundamental questions about what the state should be doing and what it should be leaving well alone.

But why do we have to pay the public employees so much?

The problem is likely to get worse:

The United Nations points out that the proportion of the world’s population that is over 60 will rise from 11% today to 22% in 2050. The situation is especially dire in the developed world: in 2050 one in three people in the rich world will be pensioners, and one in ten will be over 80.

Denmark: high taxes, big social safety net, but all the talent has left the country

Interesting two part podcast on Denmark, which at first glance seems to defy the usual tradeoff:  higher taxes (63% income tax) may make it easier to take care of everyone (four years of unemployment insurance), but all the really productive people have left the country. 

• First Part:  Denmark utopia
  
• Second Part:  Tax me please
  

Why are homeowners reluctant to walk away from underwater mortgages?

Especially in states like Arizona and California, where mortgages are nonrecourse loans, which cost more because they are easier to walk away from ($800 for each $100,000 borrowed).

Morality aside, there are other factors deterring “strategic defaults,” whether in recourse or nonrecourse states. These include the economic and emotional costs of giving up one’s home and moving, the perceived social stigma of defaulting, and a serious hit to a borrower’s credit rating. Still, if they added up these costs, many households might find them to be far less than the cost of paying off an underwater mortgage.

An important implication is that we could be facing another wave of foreclosures, spurred less by spells of unemployment and more by strategic thinking. Research shows that bankruptcies and foreclosures are “contagious.” People are less likely to think it’s immoral to walk away from their home if they know others who have done so. And if enough people do it, the stigma begins to erode.

Other people's money

President Obama recognizes moral hazard:

Phony populism aside, yesterday Mr. Obama introduced his first serious idea into the debate on reforming the financial system. In calling for an end to proprietary trading at firms with a federal safety net, the President showed that he now understands an important principle: Risk-taking in the capital markets is incompatible with a taxpayer guarantee.

Now, if we could only get him to recognize the same problem in health care.

Pub Owners Support Minimum Alcohol Prices

The Economist reports on the UK's consideration of introducing a minimum price for alcohol. Not surprisingly, the idea is supported by medical associations and the police. The policy is also supported by pub owners, which initially seems a bit odd. The explanation: prices in pubs are already above the proposed minimum price, so the floor would only affect sales made in competing outlets like grocery stores.

Using Behavioral Economics to motivate workers

If you are going to adopt incentive compensation, try the following.  Instead of promising workers increased pay for performance, tell them that they have been "provisionally" awarded a bonus, but that the bonus will be taken away if they do not perform.  As predicted by prospect theory,

The fear of loss was a better motivator than the prospect of gain (which worked too, but less well). And the difference persisted over time: the results were not simply a consequence of workers’ misunderstanding of the system. Economists have always been advocates of using carrots and sticks. But they may not have emphasised appearances enough. Carrots, this research suggests, may work better if they can somehow be made to look like sticks.

Democrat's Senate futures take big dive

On Intrade, prices of Coakley futures fell to $0.45.

UPDATE:  now at $0.30.

More on Increasing Organ Donations

Around 100,000 people in the United States are currently on waiting lists for organ donation. In today's WSJ, Alex Tabarrok discusses ways different countries around the world are tackling the organ donor shortage.

More Evidence for the EMH?

Lusha, a chimpanzee in a Moscow circus, outperformed 94% of the country's investment funds over the last year.

Somebody better give Lusha a huge bonus or the circus might not be able to retain her talent.
(HT: NYT Economix blog)

Support for the EMH from the Most Unlikely Place

Understandably, faith in the Efficient Market Hypothesis (EMH) has wavered recently due to a spate of bursting bubbles. This has rekindled the EMH debate loosely defined as between Chicago and Harvard. But Harvard's "elite" repeatedly guessing wrong about market swings - and billions of dollars wrong - may be the best recent evidence in support of the EMH.

Information and Prices

Soybean farmers in the Indian state of Madhya Pradesh sell their products in open auctions to intermediaries, who then re-sell to food processing companies. Because each market tended to have only a few intermediaries, it was relatively easy for them to collude to pay lower prices. The farmers had little access to prices being paid by the food processing companies or by intermediaries in other markets.

So what happened when internet kiosks that show prices in nearby markets were introduced into the markets? Prices went up (around 1.7% on average) - here's (pdf) a presentation by the study author and an article from the Economist.

What wasn't entirely clear to me was the incentives of the kiosk provider. The kiosks were provided by one of the food processing companies. Part of the motivation seemed to be to bypass the intermediaries but that doesn't really explain provision of the kiosks with nearby market prices.

Endogenous Propoerty Rights - Gnarly Dude

I wish I thought of this - "Quality and the Commons: The Surf Gangs of California." Growing up in So Cal, it was always clear that non-locals had better steer clear of the best surf spots when the waves were up. I was not a surfer, but half of my high school water polo team was. When the surf was up, we could not have a decent practice because they all ditched school to go surf. Since we were inland a few miles, they were non-locals and would come back with stories of the fights they got into with the locals. Of course, this notion was succinctly summed up in Oingo Boingo's My Beach" and My Wave" decades ago.

Its the incentives, stupid.

Almost everyone knows that health care costs decrease when patient co-pays go up.  So why is IBM  eliminating them?

Big Blue has gone whole hog in eliminating primary care co-pays for most of its 115,000 U.S. employees. And notwithstanding the company's concern for employee health, it's betting that the action will yield positive numbers on its employee health insurance balance sheet.

Maybe they are doubling down on their investments in wellness programs. If theirs works as claimed, it would be the first.

The primary care copay waive is in character for IBM. It invested $79 million in wellness programs between 2004 and 2007, saving about $191 million in health-related costs, according to an announcement. It has also participated in patient-centered medical home initiatives. And it has been covering preventive care at 100% since 2006.

Expected inflation rising

From Laffer Associates:

Taxes destroy wealth

It is interesting that the Republican challenger to Ted Kennedy's senate seat is using clips of Ted's brother, JFK, to tout his 1962 tax cuts.  Every Senate Republican, including Barry Goldwater, voted against the 1962 tax cuts.

Adjusting to risk

A new paper  finds that after they get sick, insured people re-balance their portfolios in the obvious way.

We find that insured individuals are significantly likely to divest from risky asset holdings in response to a decline in health while the risky asset accounts of uninsured individuals demonstrate no correlation with health status when controlling for variables such as income, age, and out-of-pocket medical expenses.

The finding is somewhat counter-intuitive because one would think that health risk is bigger for uninsured individuals.

Venezuela devalues the Bolivar

As a consequence, producers are helped, but consumers are hurt as import prices increase.  If the votes do not punish Chavez, the markets will:

"It was a Black Friday, tinted red," said sales executive Diana Sevillana in reference to the crimson color of Chavez's socialist party. She stood in a line of 30 people outside an electrical goods store in a middle class neighborhood.

The socialist Chavez believes the state should have a weighty role in managing the economy. During his 11 years in office he has nationalized most heavy industry, and business and finance are tightly regulated.

The devaluation is politically risky but means every dollar of oil revenue puts more bolivars in government coffers. That allows Chavez to lavish cash on social projects and fund salary increases ahead of parliamentary elections in September.

Is China the next bubble to burst?

Why is the recovery so mild?

Because of the uncertainty that goes along with it:

In terms of discouraging a rapid recovery, other government proposals created greater uncertainty and risk for businesses and investors. These include plans to increase greatly marginal tax rates for higher incomes. In addition, discussions at the Copenhagen conference and by the president to impose high taxes on carbon dioxide emissions must surely discourage investments in refineries, power plants, factories and other businesses that are big emitters of greenhouse gases.

Congressional "reforms" of the American health delivery system have gone through dozens of versions. The separate bills passed by the House and Senate worry small businesses, in particular. They fear their labor costs will increase because of mandates to spend much more on health insurance for their employees. The resulting reluctance of small businesses to invest, expand and hire harms households as well, because it slows the creation of new jobs and the growth of labor incomes.

Consumers vs. voters

Why voters are likely to make worse decisions than consumers:

One underappreciated fact about the experimental and survey evidence relied on by advocates of the new paternalism is that it models voter decision-making far more closely than market decisions. Unlike market participants, voters have little or no incentive to either acquire information about the issues they decide, or to analyze the information they do have in an unbiased fashion.

The Heat is on in Iceland

The amazing story of Iceland's boom and then bust is the lead story in the new chapter on trade, bubbles, and market making in the second edition of the text. The saga continues.

As part of the boom, Icelandic banks offered very attractive interest rates to foreign depositors in the UK and the Netherlands through Icesave accounts. When the bust came, the foreign governments ended up picking up the guarantees on the deposits. And, they want their money back.

As part of the bailout negotiations, the Icelandic government had agreed to repay the UK and the Netherlands for the amount of the guarantees (which come to about $17,000 per citizen in Iceland - ouch!), and its parliament recently passed a bill authorizing the re-payments. Yesterday, however, President Olafur Ragnar Grimsson vetoed the bill, which about 70% of the population reportedly opposes.

Optimal Toll Pricing?

Tolls on the New York Thruways are 5% higher today, the second increase over the last year. According to Thruway Authority officials, the increase was necessary because of a decline in traffic. The logic here might sound a little goofy on initial read: "we raised price last year and traffic went down, so let's raise price again." But, what we don't know is what the effect has been on revenue. If demand for use of the tollway is fairly inelastic (I would guess that it probably is), raising price and decreasing quantity would lead to higher revenue.

Happy new decade

From Calculated Risk:

There has been zero net job creation since December 1999. ... Middle-income households made less in 2008, when adjusted for inflation, than they did in 1999 ... And the net worth of American households ... has also declined when adjusted for inflation ...

Mathematica Demonstration project

Mathematica is a high level computer language that simplifies programming the kind of models that economists use.  They have a big library of programs that can illustrate the effects of models, like bubbles.