Friday, December 31, 2010

Happy new year, start worrying now

Our grandparents are screwing our grandkids via Medicare::
... an average-wage, two-earner couple together earning $89,000 a year. Upon retiring in 2011, they would have paid $114,000 in Medicare payroll taxes during their careers. But they can expect to receive medical services -- from prescriptions to hospital care -- worth $355,000, or about three times what they put in.
And are getting screwed (slightly) via Social Security:
The same hypothetical couple retiring in 2011 will have paid $614,000 in Social Security taxes, and can expect to collect $555,000 in benefits. They will have paid about 10 percent more into the system than they're likely to get back.

Other people's money

Sunday, December 26, 2010

When you run out of money, stop paying the pensioners

Pritchard, Alabama is the canary in the coal mine:
Then Prichard did something that pension experts say they have never seen before: it stopped sending monthly pension checks to its 150 retired workers, breaking a state law requiring it to pay its promised retirement benefits in full.

Monday, December 20, 2010

Don't define the problem as the lack of your solution, ...

...unless you want to manipulate the decision makers into accepting your solution. In this case, the Democrats on the Financial Crisis Commission have decided that the crisis was caused by a lack of derivatives regulation, not a housing bubble.

I would hazard a guess that Fannie and Freddie outbid the investment banks for this Committee. In the immortal words of Deep Throat (the whistleblower from Watergate), "Follow the money."

Thursday, December 16, 2010

How to impress Goldman Sachs

One of my former Accelerator students told me about one of her college professors who brought in someone from Goldman Sachs to speak to her class. The topic of the presentation was the 360 degree performance evaluation at Goldman Sachs. Apparently, he was telling the class about how great it is and how open people are to feedback from their colleagues and how it has really improved productivity and allowed the firm to retain only the best people.

My student thought it sounded phony, so she asked him whether people's bonuses were tied to their performance evaluations. He said yes. She then asked why employees wouldn't just collude and give each other really high marks so that everyone could get a great bonus.

Some of her classmates reacted negatively, and later told her that they couldn't believe she would asked a question like that, and that it was "completely inappropriate."

But after the class ended. the speaker took her aside and told her that he has given that presentation numerous times, and she was the only student the was smart enough to look past the surface and ask such a hard question. Despite his initial enthusiasm, he conceded that she was probably right.

Wednesday, December 15, 2010

Elasticity of transportation demand with respect to service

The two biggest determinants of bus ridership are the hours of operation and the price.  Here is evidence from a natural experiment in Atlanta: the month after it cut bus hours by 10 percent and rail by 14 percent, MARTA lost a heap of riders....In October, people took 37,000 (0.5%) fewer train trips than they did in September, and 325,000 (5.6%) fewer bus trips.

Interestingly, the size of the ridership declines were smaller than the cutbacks in hours of service.  This must mean either that MARTA cut back only during the unpopular times, or that riders substituted rides during the cancelled times to rides during the remaining times.

The article says also that prices went up, so this may not be as clean of a natural experiment because two things are changing at once, so it is hard to infer which is causing the change.

Optimal ethics

Imagine that you discover that one of your employees has done something wrong, like accessing information about clients and using it in unethical, though perhaps not illegal manner.  This puts you in the familiar dilemma of a prosecutor:
  1. you can punish the employee harshly to boost morale among the "good" employees, and to deter future malfeasance; or 
  2. you can offer leniency in exchange for information from the employee that will help you design better safeguards.  
Which option should you choose?

The answer depends on whether the value of the information is bigger than the "cost" leniency, in terms of lower deterrence, or morale.

Note that, just like a prosecutor, you should expect adverse selection.  Only employees who think the leniency looks like a good option will choose it, and those are the ones who have committed more bad acts.  This is just like the adverse selection associated with plea bargaining--pleas are accepted by only those who think the plea bargain looks attractive (those with low chance of winning at trial), e.g.,

Froeb, Luke, The Adverse Selection of Cases for TrialInternational Review of Law and Economics, 13(3), (June, 1993) 317-324

Monday, December 13, 2010

WARNING: this post has nothing to do with Managerial Economics

If your music-loving friend lost all his music in a fire, what would you purchase to replace it? Here is a list compiled by Willy Stern's friends:
  • R.L. Burnside. "Come On In."
  • Bruce Spingsteen, Darkness on the Edge of Town!
  • George Thorogood and the Destroyers (first album)
  • Bob Marley, Exodus
  • The Clash, "London Calling"
  • Elvis Costello, either "My Aim Is True," "This Year's Model," "Armed Forces" or "Get Happy"
  • Miles Davis, "Kind of Blue" or "In a Silent Way"
  • Bob Dylan, "Blonde on Blonde"
  • Ella Fitzgerald, "Best of the Verve Songbooks Vol. 1"
  • Van Morrison, "Astral Weeks" or "Moondance"
  • Frank Sinatra, "Sinatra Sings for Only the Lonely" or "In the Wee Small Hours"
  • Bruce Springsteen, "Born to Run"
  • "Stax 50th Anniversary Celebration" (50 songs on 2 discs -- essential)
  • Stevie Wonder, "Innervisions"
  • Robert Earl Keane's 'Gringo Honeymoon,'
  • Lyle Lovett's 'Road to Ensenada,'
  • Jerry Jeff Walker's greatest hits
  • Screaming Blue Messiahs' 'Bikini Red.'
  • Travelling Wilburys' Vol. 1 & Vol. 3.
  • Delbert McClinton: Fortunate Few
  • Stevie Wonder: Songs in the Key of Life
  • Stevie Winwood: Back in the High Life
  • Santana: Smoot
  • Ali Farke Toure, "Talking Timbuktu"
  • Keith Jarrett, "The Koln Concerts"
  • Van Morrison, "Astral Weeks" and "Into The Music"
  • The Nitty Gritty Dirt Band, "Will The Circle Be Unbroken"
  • Al Green, "Greatest Hits"
  • The Jayhawks, "Hollywood Town Hall"
  • The Pretenders, "Greatest Hits'
  • Bonnie Raitt,"Angel From Montgomery"
  • Muddy Waters, "Hard Again"
  • Beach Boys "Endless Summer"
  • Getz/Gilberto (music by Antonio Carlos Jobim, sung by Astrud and Joao Gilberto, sax by Getz)
  • Ella & Louis (the Ella Fitzerald & Louis Armstrong recording, on Verve)
  • Solo Monk (Thelonious Monk)
  • Beach Boys "Pet Sounds"
  • The Essential Chet Atkins
  • Chopin played by Arthur Rubinstein
  • rust never sleeps - neil young & crazy horse
  • kiko - los lobos
  • anodyne - uncle tupelo
  • the essential jimmie rodgers
  • rain dogs - tom waits
  • automatic for the people - r.e.m.
  • screaming for vengeance or british steel - judas priest (in case he likes to head bang!)
  • blue horse - the be good tanyas
  • green river - creedence clearwater revival
  • within a mile of home - flogging molly
  • #1 record/radio city - big star
  • modern sounds in country and western music - ray charles
  • shepherd moons - enya
  • the velvet underground - the velvet underground
  • trace - son volt
  • pink moon - nick drake
  • a charlie brown Christmas, vince guaraldi trio
  • light of the stable, emmylou harris.
  • Junior Brown's, “Greatest hits”
  • Miles--kind of blue
  • Monk--solo
  • Beatles--white
  • Son Volt--trace
  • Lambchop--is a woman
  • sex pistols--never mind the bollocks.
  • Resphigi: Ancient Airs and Dances Suite No. 1: I. Il Conte Orlando: Balletto (Simone Molinaro) only the Los Angeles Chamber Orchestra with Neville Marriner conducting on EMI digitally remastered in 1996.
  • Richard Pryor: That Nigger's Crazy. Not really music in the strict sense, but your friend needs it.
  • O'Jays: Back Stabbers.
  • Bob Marley and the Wailers: Legend
  • Fela Kuti: Teacher Don't Teach Me Nonsense.
  • the soundtrack to coens' movie 'oh brother where art though?'
  • dandys rule ok by the dandy warhols
  • consolers of the lonely by the raconteurs
  • space wrangler by widespread panic
  • simple things by zero 7
  • Time Out-- Dave Brubeck
  • Gordon-- Bare Naked Ladies
  • Greatest Hits-- Stevie Ray Vaughn and Double Trouble
  • Lovers Rock-- Sade
  • Negotiations and Love Songs-- Paul Simon
  • Just Another Band from LA-- Frank Zappa
  • The Way It Is-- Bruce Hornsby and the Range
  • How to Dismantle and Atomic Bomb-- U2
  • Let it Bleed-- Rolling Stones
  • Hot Tuna-- Hot T
  • Ray Charles (probably a greatest hits album, but make sure it contains "America the Beautiful")
  • Charles Brown, One more for the road
  • Grateful Dead: Skull & Roses
  • Medeski Martin and Wood: Shack Man
  • Jimi Hendrix: Electric Ladyland
  • Thelonious Monk: Underground
  • Los Lobos: Colossal Head
  • PINEY WOOD BLUES -- Big Joe Williams (Delmark)
  • Forthcoming (Spring 2011) HOWLIN' WOLF 3-CD Collection (complete to 1960) (Hip-O)
  • Elvis (Sun sides)
  • Sam Cooke (Night Beat)
  • Allmans Live @ The Fillmore East
  • Nighthawks - Open All Night (hard to find, no doubt)
  • NBRQ - Stay WIth We: Best of NRBQ
  • Whiskeytown - Pneumonia
  • Subdudes - Annunciation
  • Robinella - Solace for the Lonely
  • Bruce Cockburn - Nothing But a Burning Light

Economic effect of Virginia Court ruling: adverse selection

If the ruling in Virginia stands, that the individual mandate in President Obama's Healthcare plan is unconstitutional, then only the sick people will sign up for the insurance:

what you will get is a death spiral in the insurance markets, as the healthy people wait to buy insurance until they get sick, and the cost of insurance spikes to the point where no one can afford it.

Saturday, December 11, 2010

Compensating risk differentials for prostitution are small

Past research has found that prostitutes earn about twice the weekly wage of a typical non-manual female worker and three times that of manual workers. One reason for this wage premium is the opportunity cost of foregoing marriage, though working in a foreign country reduces this cost. New research finds that Chicago street prostitutes earn roughly four times their hourly wage in other activities, but this higher wage represents relatively meager compensation for the significant risk they bear. One reason for the low compensation despite the high risk is the relatively elastic supply.

Wednesday, December 8, 2010

Lessons from Iceland: let the banks go bust

In past posts, we detailed the bursting bubble in Iceland, but it looks as if they are on the road to recovery:

Like Ireland and Greece, Iceland has taken a large dose of austerity measures to rebuild its economy. Unlike Ireland and Greece, however, Iceland allowed private banks to fail, and its currency, the krona, has declined by about 46 percent against the dollar since the start of 2008. ...

Iceland’s experience, he said, offered a lesson for the euro zone as it grappled with its own crisis: “This is the proper process. If you go through a bubble economy and you need to correct it, the answer is not to convert private debt into public debt. Rather it is to restructure the debt to the level of the assets.”

Monday, December 6, 2010

Visual display of quantitative data

We have blogged about this before, but one of the biggest improvements in the past two decades has been in the visual display of quantitative information. The video below (taken from Gapminder) dramatically illustrates how easily one can "see" relationships in data that are displayed graphically. This is part of a much larger trend, where business decisions are made better and faster, by relying on easy-to-communicate performance metrics, like those presented on business "dashboards." (example)

HT: Don Marron

Unintended Consequences - Academic Standards Edition

Even university administrators must anticipate adverse selection. My fine university is working to become even finer. The university has been able to hire more and better researchers and is experiencing very impressive enrollment growth. One metric the university wants to improve is our graduation rate. Historically we have had an embarrassingly low 52% graduation rate. Many students can get admitted to the university but do not meet higher requirements for admission to a departmental major and then drop out. To boost student retention, the university has developed a degree in generic "University Studies," a catch-all for these students, administered by University College.

How would one expect departments to react? 'Low quality' students are headaches that suck up departmental resources. We set departmental admissions criteria to avoid dealing with these students. I just came from an academic standards meeting in which two of our academic units have proposed to increase departmental admission standards (GPA in the program) even further. A justification for not doing this earlier was that it was not fair to students who have made it to their senior year by taking courses in a program and then have this coursework not count toward a degree on campus. But with "University Studies" these courses can apply to a degree. The various departments are in a race to dump their 'low quality' students into "University College."

Friday, December 3, 2010

When will AIDS prevention work?

Only when the benefits of investing in AIDS prevention (longer life) are bigger than the cost (less sex). Emily Oster presents her research on AIDS, showing that everything we know about AIDS is wrong. My favorite part of the video is when she shows that AIDS prevention efforts fail in countries with high malaria rates. In these countries, life expectancies are so low so that investment in AIDS prevention (less sex to gain a longer life) doesn't pay off (negative NPV) because you are likely to die of malaria even if you don't get AIDS.

Thursday, December 2, 2010

Price Discrimination + Yield Management + Viral Marketing

Groupons has a pretty innovative business plan. They allow firms to offer discounts to consumers who are more price sensitive, willing to take a little risk and willing to put up with a little hassle. Retailers can dump excess capacity into the system at a reduced price. The deal is only activated if enough consumers choose it. Thus, groupon users are encouraged to solicit their network of acquaintances to opt in too. This, in turn, selects consumers who might not be familiar with the product (more elastic) and they get an endorsement from a "trusted" acquaintance.

I have seen other Internet based coupon or discount sites before. Most are small shoestring operations. By combining social networking elements, this effort may become more established. At least Google thinks so.

Wednesday, December 1, 2010

What happens when you make it easier to shop?

High search costs make demand less elastic (lower prices attract fewer customers because not as many consumers can "find" lower prices) and this leads to higher prices in markets like gasoline. Products like SmartFuel (review) are designed to allow customers to search more cheaply. As products like SmartFuel bring search costs down, the market will become more competitive, and gas prices will fall.

DISCLAIMER:  The guy in the video, George Sibble, is a former student, and I have a financial interest in his company.

Practical Employee Screening

Following the previous post, I found this interesting article, "15 Google Interview Questions That Will Make You Feel Stupid" about tough interview questions by interviewers at Google. I did OK but I think I'll keep my day job.

Tuesday, November 30, 2010

Job interview tips, and mistakes

From Craig Newmark

Private property under attack in Venezuela

This is a fast moving train wreck.
Hugo Chávez, the country’s leftist president, has been on a nationalisation spree, seizing everything from steel companies and bottle makers to housing schemes. ...
Polls suggest that most Venezuelans disapprove of the nationalisations and firmly support private property. But Mr Chávez seems to be following the advice of Alan Woods, a Welsh Trotskyist who has become an informal adviser. Mr Woods, who is better known in Caracas than Cardiff, publicly urged the president to respond to his electoral setback by “accelerating the revolutionary process”, expropriating land, banks and the main industries. Venezuelans had better brace themselves for more nationalisation, scarcity and economic decline.

Incentives matter -- dump your sick employees into the govt. exchange

Marginal Revolution blogs that President Obama's health care bill gives employers incentives to offer healthcare plans that are designed to induce ONLY THE LEAST HEALTHY employees to opt for coverage on the exchange. Employers would find this profitable because:
(i) they would avoid any penalty under the "employer mandate,"
(ii) their health care costs would decrease substantially by virtue of reducing coverage and shedding high-cost employees,
(iii) high-cost employees would not be much worse off, as they could acquire coverage on the exchange with no medical underwriting or preexisting conditions.

Based on the plan designs I have seen, this looks like what employers are demanding from the insurance companies.

Incentives Matter - Professor Edition

Nice post on the Organization and Markets blog noting a recent study that looks at how professor research productivity responds to extrinsic incentives.

Monday, November 29, 2010

Save a balding, middle-aged, fat guy. taxing his health care benefits.

Colleague Larry van Horn eats poorly and doesn't exercise to illustrate the moral hazard associated with subsidized health care. Nice video of Larry interviewed on the big problems of health care

Now Larry is blogging for Forbes.

Wednesday, November 24, 2010

The real meaning of Thanksgiving

John Stossel gives us another lesson that you won't learn in high school:

When the Pilgrims first settled the Plymouth Colony, they organized their farm economy along communal lines. The goal was to share everything equally, work and produce.
They nearly all starved.
Why? When people can get the same return with a small amount of effort as with a large amount, most people will make little effort. Plymouth settlers faked illness rather than working the common property. Some even stole, despite their Puritan convictions. Total production was too meager to support the population, and famine resulted. Some ate rats, dogs, horses and cats. This went on for two years.
"So as it well appeared that famine must still ensue the next year also, if not some way prevented," wrote Gov. William Bradford in his diary. The colonists, he said, "began to think how they might raise as much corn as they could, and obtain a better crop than they had done, that they might not still thus languish in misery. At length after much debate of things, [I] (with the advice of the chiefest among them) gave way that they should set corn every man for his own particular, and in that regard trust to themselves. ... And so assigned to every family a parcel of land."
The people of Plymouth moved from socialism to private farming. The results were dramatic.
"This had very good success," Bradford wrote, "for it made all hands very industrious, so as much more corn was planted than otherwise would have been. ... By this time harvest was come, and instead of famine, now God gave them plenty, and the face of things was changed, to the rejoicing of the hearts of many. ... "

Peter Klein has some commentary, as does the revisionist NY Times:

Tuesday, November 23, 2010

Elections have consequences: it is time to reduce the deficit

The proposal from the Chairman of the deficit reduction commission has the benefit of broadening the tax base, and reducing the marginal rates.  This is a huge step in the right direction.  Our current tax system is way too inefficient.
... the chairmen of President Obama’s deficit reduction commission, have taken at hard look at these tax expenditures — and they don’t like what they see. In their draft proposal, released earlier this month, they proposed doing away with tax expenditures, which together cost the Treasury over $1 trillion a year.

Such a drastic step would allow Mr. Bowles and Mr. Simpson to move the budget toward fiscal sustainability, while simultaneously reducing all income tax rates. Under their plan, the top tax rate would fall to 23 percent from the 35 percent in today’s law (and the 39.6 percent currently advocated by Democratic leadership).

I still don't like the term "sustainability" because it can mean almost anything. However, in this context, it almost makes sense.

Monday, November 22, 2010

You cannot stop the blunders of one government program... putting another one on top of it.  Twelve minute interview of Richard Epstein, who helped me come out of the libertarian closet at the Univ. of Chicago.


Vice President Gore now thinks corn ethanol subsidies were a mistake:
"First generation ethanol I think was a mistake. The energy conversion ratios are at best very small. ...

He explained his own support for the original programme on his presidential ambitions.

"One of the reasons I made that mistake is that I paid particular attention to the farmers in my home state of Tennessee, and I had a certain fondness for the farmers in the state of Iowa because I was about to run for president."
If he had only read this blog.  Now can Senator Gore get President Obama to give up his addiction to ethanol?

---------------POST FROM TWO YEARS AGO-----------------------------

Tuesday, February 26, 2008

A tale of two senators

In this blog, we have attacked ethanol subsidies for their perverse effects (they encourage energy consumption--not conservation--and are worse for the environment), yet we have them because supporting them is the easiest way to win the Iowa caucuses. This is the traditional route that Senator Obama took through the primaries. Senator McCain took the road less traveled. From David Brooks column, "The Real McCain"
In 2000, McCain ran for president and reiterated his longstanding opposition to ethanol subsidies. Though it crippled his chances in Iowa, he argued that ethanol was a wasteful giveaway. A recent study in the journal Science has shown that when you take all impacts into consideration, ethanol consumption increases greenhouse gas emissions compared with regular gasoline. Unlike, say, Barack Obama, McCain still opposes ethanol subsidies.

DISCLOSURE: I am supporting McCain

Were Hayek and Von Mises right?

The Economist seems to think so:
A one-paragraph explanation of the Austrian theory of business cycles would run as follows. Interest rates are held at too low a level, creating a credit boom. Low financing costs persuade entrepreneurs to fund too many projects. Capital is misallocated into wasteful areas. When the bust comes the economy is stuck with the burden of excess capacity, which then takes years to clear up.

  • Were interest rates held too low? The case seems self-evident for Ireland and Spain, where the European Central Bank was setting a one-size-fits-all monetary policy. Many people would also argue that the Federal Reserve kept rates too low. Some lay the housing boom of 2003-06 at the Fed’s door,
  • Was capital misallocated? Again most people would accept that too many houses and apartments were built in Ireland and Spain, as well as individual American states like Florida and Nevada. In some places these dwellings may sit idle for a while, keeping downward pressure on property prices.
  • Economists who would not describe themselves as Austrian have reached conclusions that chime with Hayek. Carmen Reinhart and Kenneth Rogoff, in their book “This Time is Different”, argued that past financial crises have been followed by long periods of sluggish growth.

Thursday, November 18, 2010

Stocks for the long run

This article argues that diversification--buy, hold, and re-balance--is still the best way to make money.

The chart nearby illustrates how someone who invested $100,000 at the start of 2000 and, following my advice, used index funds, stayed the course and rebalanced once a year, would have seen that investment grow to $191,859 by the end of 2009. At the same time, someone buying only U.S. stocks would have seen that same investment decline to $93,717.

Wednesday, November 17, 2010

Core inflation is zero

So the cartoon mocking the Fed, a few posts ago, is not accurate on this issue.

Save the tigers eating them, a policy option that only a consequentialist could love:
Chinese tiger-breeding centers have proposed creating tiger farms to cull the animals' body parts, thereby diminishing demand for the products and lessening the chances they might be hunted in the wild. The idea has met with resistance from environmental groups.

The option value of waiting

Tuesday, November 16, 2010

Revisiting Resale Price Maintenance

We've blogged previously on the issue of resale price maintenance and the US Supreme Court's 2007 decision that removed the blanket prohibition against retail price agreements between manufacturers and retailers.

According to today's Wall Street Journal, the losing party in that case is again asking the Court to review the issue. They claim that lower courts have gone too far in applying the 2007 ruling.

Friday, November 12, 2010

Do tourists pay more than locals III?

I am currently visiting Brazil to do some work on a competition issue. My host and I had to travel to Brasilia for some meetings. We landed and he called for a taxi. While waiting, I noticed a long line of taxis waiting for clients and asked why he needed to call. It turns out you get a discount of ~20% by if you know how to order a "radiotaxi," something with which most tourists will be unfamiliar.

Can you figure out how to make money here?

Zillow estimates home values, and then compiled a list of the ten cities with the most mortgages underwater, i.e. whose housing values are less than the debt owed on the house.

  1. 80% of Las Vegas mortgages are underwater
  2. 64% of Reno mortgages are underwater
  3. 64% of Orlando mortgages are underwater
  4. 57% of Stockton mortgages are underwater
It occurred to me that these underwater mortgages keep homeowners from moving to different cities and accepting new jobs because they don't have enough money to sell their homes.  This represents an inefficiency in that homeowners are stuck in less attractive jobs (lower valued uses).  

But as we emphasize in Chapter 2, inefficiency also implies opportunity.  If you can figure out a way to move these assets to higher valued uses you can make some money.  

Wednesday, November 10, 2010

Currency wars, animated

Do Real Estate Agents Get You Higher Prices?

Not according to this study by Aviv Nevo at Northwestern and François Ortalo-Magné at Wisconsin. They compared two types of sales in Madison, Wisconsin - ones using real estate agents and ones completed through FSOB Madison. Sellers represented by real estate agents did not realize higher prices; in fact, the prices were actually a bit lower. And this is before the commission is paid.

The one apparent benefit of using a real estate agent? Homes sold through agents tended to sell faster.

Tuesday, November 9, 2010

The effects of "Quantitative Easing"

This looks like a success:
Under QE the Fed buys long-term bonds with newly created money. This lowers long-term yields and chases investors into riskier, alternative investments. The real yield on ten-year, inflation-indexed Treasury bonds has fallen from 1.05% to 0.5%, a result of relatively flat nominal yields and a rise in expected inflation. The yield on their five-year cousins is negative (see Buttonwood). Share prices are up by 14% in the same period. Lower yields make the dollar less appealing: it has duly fallen by 5% against the Japanese yen, by 9% against the euro and by 5% on a trade-weighted basis. “You can declare QE to be a success already,” says one hedge-fund economist. “Whether this translates into real activity remains a question-mark. But the question of whether the mechanism would work has been answered.”

Whether this translates into real "stimulus" is still unknown. The reduced long term real rates are...

...supposed to boost growth through three channels. First, lower real yields spur borrowing and investment. This channel is bunged up: many households cannot borrow because their homes have fallen in value and because banks are less willing to lend. But the remaining two channels remain open. Higher share prices have raised household wealth by some $1.4 trillion, which will spur some spending. And the lower dollar should help trade. American factory purchasing managers reported a sharp jump in export orders in October and a drop in imports.

Monday, November 8, 2010

Management problems at the US Department of Agriculture

Historically, government agencies with very broad authority and mandates have fared poorly, like the FTC before 1980.  After abusing its broad rule-making authority, the agency was criticized as the "national nanny" and came within one vote of being shut down.  Then Congress narrowed its authority and the agency began using benefit-cost analysis to guide its law enforcement activities (see testimony by Howard Beales, a former colleague of mine, on the history of the FTC).

Today, the US government creates agencies with narrow mandates or goals so it is easier to monitor and control the agency.  And while this does make it easier to develop performance evaluation metrics for each agency, it also creates conflicts between agencies whose narrow mandates run at cross purposes to one another.

At the absurd end of the spectrum, incentive conflicts may occur between divisions of the same agency.  This weekend, the NY Times ran a funny story about how the Department of Agriculture's Dairy Management Program was encouraging cheese consumption, while the Department of Agriculture's anti-obesity drive was encouraging the opposite
Consider the Taco Bell steak quesadilla, with cheddar, pepper jack, mozzarella and a creamy sauce. “The item used an average of eight times more cheese than other items on their menu,” the Agriculture Department said in a report, extolling Dairy Management’s work — without mentioning that the quesadilla has more than three-quarters of the daily recommended level of saturated fat and sodium.

The first job of senior management in an organization is to ensure that its divisions do NOT work at cross purposes to one another.  It seems that the Department of Agriculture would benefit from reading Chapter 22 of our texbook, "How to get Divisions to work in the Best Interests of the Organization."

Friday, November 5, 2010

The yuan is appreciating against the dollar!

If a country like China tries to peg their nominal exchange rate against the dollar, they lose control over their own money supply.  To see why, imagine that an exporter sells a flat panel TV to a US retailer.  The US retailer pays in dollars, but the exporter's costs are in yuan, so he has to exchange dollars for yuan in order to pay for the TV.

If there is a net inflow of dollars to China (there are more Chinese exporters want to sell dollars to buy yuan than there are Chinese investors who want to sell yuan to buy dollars to invest in the US), then the Chinese central bank must "print" yuan to make up the difference.  In turn, this causes Chinese inflation, which raises the price of Chinese goods.  This means that a dollar, exchanged into yuan at the official (nominal) exchange rate can buy fewer Chinese goods.

In other words, the real value of the dollar has fallen, or the Chinese yuan has appreciated in real terms.  This will make Chinese exports more expensive, and US imports to China less expensive, which should help correct the trade imbalance.

Stossel on Vanderbilt

Compensate me for bearing risk of a Greek default (II)

Thursday, November 4, 2010

Shots fired in currency war against US

With so-called "quantitative easing" (funny video), the Fed is increasing the supply of longer term loans, which will bring down US interest rates.  This, in turn, encourages foreign borrowers to borrow in US currency, trade their dollars for, e.g., Brazilian real, and then invest in Brazil.

The increased demand causes the Brazilian real to appreciate relative to the dollar which makes Brazilian exports more expensive.  This leads to reduced demand for domestic labor in Brazil.  If wages cannot fall, then you get domestic unemployment.

Predictably, foreign governments are trying to stop this from happening:
China, Brazil and Germany on Thursday criticised the Fed’s action a day earlier, and a string of east Asian central banks said they were preparing measures to defend their economies against large capital inflows.

Guido Mantega, the Brazilian finance minister who was the first to warn of a “currency war”, said: “Everybody wants the US economy to recover, but it does no good at all to just throw dollars from a helicopter.”

Wednesday, November 3, 2010

Unintended Consequences - pollution abatement edition

In 2007, new EPA regulations that mandate cleaner diesel engines took effect. The new engines reduce particle emissions by up to 98% over the previous generation and cut Nitrogen-oxide emissions in half.

But they increase the cost of trucks by $12,000, or about 10%. In addition, truckers (consumers of the new engines) expect higher maintenance costs and worse fuel mileage.

Predictably, the new regulations caused a big increase in demand for 2006 engines and trucks,
Truckers seeking to beat the price increases made 2006 a record year for truck makers. More than 373,000 big-rig trucks were built in North America, says Ken Vieth of A.C.T. Research, which follows truck sales trends. The tally easily topped the previous record of 330,000 trucks in 1999.
But next year, Vieth predicts "a production drought," with sales falling by more than 40% to 220,000 as trucking firms hold off buying to see how the new clean-diesel trucks perform. ...
The cost to truckers goes beyond new big-rig purchases, according to Moskowitz. The new fuel costs 5 cents to 10 cents more per gallon to refine and may produce lower fuel mileage. The new engines weigh more, further cutting mileage. "Over the long run, their increased costs will be passed on to the shippers and ultimately, the consumers," Moskowitz says.
Both the 2006 boom, and the 2007 bust were predictable with simple supply-demand analysis, especially since a similar regulatory change occurred in 2002.

For policy makers, this points out yet another disadvantage of acommand-and-control approach to clean air. Mandates from Washington have to be phased in, and this gives consumers an incentive to stockpile old, cheap, but dirty engines so they can use them in the future. Instead of telling producers what to produce, or consumers what to consume (by picking technologies, like ethanol, to subsidize), tax what you don't want (pollution) and let the market decide how best to reduce it.

Bottom line: How many economists does it take to screw in a light bulb? None--the market will do it.

Are US stocks over-valued?

Ask your investment advisor why stocks are above their long-run average P/E ratio.  If she obfuscates, don't trust her advice.

Supply and Demand Sugar Edition

QUESTION: Why has the price of sugar has jumped to a 30-year high?

ANSWER: Brazilian harvest has tailed off sharply, hardening expectations of a shortage.

Supply and Demand Cotton Edition

Cotton prices are up about 80% this year. Here's a chart of the "A" Index from January 2009 to October of 2010. The index is a proxy for the world price of cotton and is available here.

What's driving the price increases:
Cotton prices have been driven higher by demand from developing countries, notably China and India, where rising wealth is boosting consumption patterns. Mother Nature is also to blame, with the deadly floods in Pakistan and heavy rains in China damaging many crops and limiting cotton supply.

Monday, November 1, 2010

Small Businesses Are NOT the Engine of Job Growth

Earlier this year, while proposing a $30 Billion Small Business Lending Fund, the president said:
"This will help small banks do even more of what our economy needs – and that's ensure that small businesses are once again the engine of job growth in America."

To be fair, this has been the mantra for Republicans as well as Democrats. But it is wrong. In the most comprehensive study to date, Haltiwanger, Jarmin and Miranda use census data to conclude:
"... our main finding is that once we control for firm age there is no systematic relationship between firm size and growth."

I try to remain open to arguments that the SBA is not just another expensive boondoggle and that politicians are not just pandering to contributors and voters, but it is becoming increasingly difficult.

How do we align the incentives of government employees with the goals of taxpayers?

Not, as Michael Barone has opined, by giving labor unions the ability "to elect [their] own boss."

What would FDR have thought about this?
"The process of collective bargaining, as usually understood, cannot be transplanted into the public service," he said in the 1930s. A public employee strike, he said, "looking toward the paralysis of government by those who have sworn to support it, is unthinkable and intolerable."

...The problem is that, as Roosevelt understood, public employee unions' interests are directly the opposite of those of taxpayers. Public employee unions want government to be more expensive and government employees to be less accountable.

Thursday, October 28, 2010

Supply and Demand Lawyer Edition

What happens when the supply of new lawyers increases while the demand for new lawyers falls?

Apparently, some law school grads aren't too happy with their schools: "He is one of dozens of law students who have gone public, very public, to chastise the schools they elected to attend for leaving them older and poorer." Maybe they should require a few econ classes in order to get into law school.

Wednesday, October 27, 2010

Getting the Right Computer Engineers

Will this cartel survive?

Don Marron thinks the pact of silence will be broken because the incentive to cheat is huge:
the 33 miners agreed to a pact of silence in which none will speak about the details of the first 17 days of their ordeal. In addition, they struck an agreement to coordinate the telling of their story and to share equally the resulting profits.

In short, the Chilean miners formed a cartel. A justified and moral cartel to be sure — they deserve whatever profits they can jointly extract from their ordeal — but a cartel nonetheless.

All of which raises a natural question: Can such a cartel be successful? Or will it succumb to the perennial challenge that confronts all cartels: how to enforce a joint agreement in the face of individual temptations? A unified silence may well maximize the financial value of the story and defend the privacy of those moments that some miners do not want to share with the world. But the media circus will tempt some miners to cheat on that agreement either for monetary gain or to ensure that their individual perspective gets reported.

The key to forecasting the success of the cartel is to think about how the cartel would detect and punish cheaters. Unless they have a way to do this, I suspect it will break down.

Tuesday, October 26, 2010

Format Wars

A hot topic on this blog a few years ago was the HD-DVD / Blu-ray standards war. Here's a recent column from on 9 other format wars. If you thought the HD-DVD / Blu-ray "war" was tough, at least nobody involved in that one was electrocuting animals.

Monday, October 25, 2010

Spin zone

88% probability that the Republicans take the House; 45% for the Senate.

So say the the prediction markets:

Can we measure professor productivity?

At Texas A\&M, they are using cost/student as a performance evaluation metric. Predictably the would-be teachers' union is opposed, as are some professors (are these the low-productivity ones):
Some professors express deep concern that the focus on serving student "customers" and delivering value to taxpayers will turn public colleges into factories. They worry that it will upend the essential nature of a university, where the Milton scholar who teaches a senior seminar to five English majors is valued as much as the engineering professor who lands a million-dollar research grant.

Two approaches are emerging. In one, funding is based not on enrollment, but what students accomplish:
Details vary, but colleges typically earn points under such a system for pushing students to take science, engineering and math; for ensuring that they complete classes that they start; for improving on-time graduation rates; and for boosting more low-income students to degrees.

The other is to try to build credibility with the public by disclosing more information:
Minnesota's state college system has created an online "accountability dashboard" for each campus. Bright, gas-gauge-style graphics indicate how many students complete their degrees; how run-down (or up-to-date) facilities are; and how many graduates pass professional licensing exams.

The California State University system, using data from outside sources, posts online the median starting and mid-career salaries for graduates of each campus, as well as their average student loan debt. "Taxpayers can make a pretty good estimate of their rate of return," says Mr. Alexander, president of CSU Long Beach.

Scale Economies of Stock Exchanges

The first question to ask for any acquisition is "why does this merger create value?" In this case, the Singapore Exchange and Australian Securities Exchange hope to create a more liquid market.

The deal would create the world's fifth largest listed exchange operator. It will benefit both parties, creating a roughly US$1.9 trillion market that would pose a serious threat to other Asian exchanges in Hong Kong and Tokyo by luring away big fee-paying clients like high-frequency traders and companies seeking to raise capital in a deep, liquid market.

Saturday, October 23, 2010

Obama care reduces the incentive to work

The CBO estimates that passing Obama care increases the unemployment rate by about 0.5%:
... the legislation, on net, will reduce the amount of labor used in the economy by roughly half a percent, primarily by reducing the amount of labor that workers choose to supply.

Its effect will be biggest among older workers, who receive the biggest subsidies. However, the really bad news is the it puts our fiscal train wreck ahead of schedule:
Total spending on health care now accounts for about 15 percent of GDP, and CBO projects that it will represent more than 25 percent by 2035.

Friday, October 22, 2010

Unintended Consequences - School Accountabilily Edition

One of the unintended consequences of grading schools on student progress appears to be teacher turnover.
In 2002, Florida became one of the first states to grade schools on student progress. But the result, the study shows, was a case of “accountability shock”: in the 60 schools deemed failing, about 30 percent of the workforce left—usually for jobs at higher-rated schools nearby. (The average school nationwide might see annual turnover of about 15 percent.) Since the best teachers were among the most likely to transfer, says Northwestern University professor and study coauthor David Figlio, accountability pressure may actually reinforce the gap between educational haves and have-nots; teachers, like athletes, want to play for a winning team.

Tuesday, October 19, 2010

The Economics of Seinfeld

Linda S. Ghent and George Lesica of Eastern Illinois University and Alan Grant of Baker University have assembled a variety of clips from Seinfeld that provide examples of a variety of economic principles.

HT: Newmark's Door

Venti Merlot?

Suppose you have a brandname known worldwide for high quality beverages and restaurants on every other city-block, but they are only busy from 6am-4pm. Starbucks has considerable fixed capacity that is being wasted after, say, 4pm. To make their restaurants attractive to customers in the evenings, they are experimenting with evening beverages, namely wine and beer.
"This is in response to our customers telling us that they want more options for relaxing in our stores in the afternoon and evenings and reflects what we've learned from our "learning lab" stores (also in Seattle)," read a statement from Starbucks, "We hope to continue to learn from our experience at Olive Way and then consider bringing this concept to select stores in neighborhoods where it is relevant."

Since the fixed assets - both the brandname and restaurants - would represent common costs for both morning and evening beverages, there are likely to be economies of scope between the two.

How did Canada dig itself out of a debt hole?

in 1995 Canada was in a debt crisis as bad as Italy's today.  The government had been consuming 50% of the country's income, and debt had gone so high that the Wall St. Journal suggested that Canada had become "an honorary member of the Third World."  The editorial proved to be a wake up call, and Canada began reducing the size and scope of government.
• Paul Martin, the finance minister for the national Liberal Party, unveiled a budget in early 1995 that ... reduced program spending by 8.8% over two years ...and  federal government employment was reduced by 14%.
• While some taxes were raised (and, according to the authors, these worked against the recovery), spending cuts were 4 ½ times tax hikes. 
• Canada’s welfare system was dramatically modified, and despite accusations from the far left that the poor would suffer due to these changes, the percentage of welfare recipients fell in just a few short years from 10.7% of the population to 6.8% by 2000. 
• The tax structure was dramatically redesigned. Corporate tax rates were cut by nearly a third, taxes on corporate capital were abolished, and personal income and capital gains taxes were reduced. 
• The General Services Tax (basically a consumption tax or VAT) was instituted to pay for the tax cuts described above. 
As a result of these actions, and others, the federal budget was balanced within three years.

Monday, October 18, 2010

How do insurance companies soften competition?

By raising rivals' costs.  The Department of Justice (my former employer) sued Blue Cross, saying that their "most favored nation" raise the costs of rivals and allow Blue Cross to charge higher prices to consumers.:
Some of these contract provisions, known as “most favored nation” clauses, require hospitals to charge other insurers a specified percentage more than they charge Blue Cross — in some cases, 30 percent to 40 percent more.
Blue Cross says that these discounts lower the prices that they charge their own consumers.

Taxes destroy wealth

by reducing Greg Mankiw's incentive to work.  He compares his take home pay for taking on an "extra" edting assignment with no taxes to the take home pay he would earn after the Bush tax cuts expire:

Without any taxes, accepting that editor’s assignment would have yielded my children an extra $10,000. With taxes, it yields only $1,000. In effect, once the entire tax system is taken into account, my family’s marginal tax rate is about 90 percent. Is it any wonder that I turn down most of the money-making opportunities I am offered?

The comparison is unfair, as it compares no taxes to some taxes, but it is done to illustrate how the effect of seemingly small changes in marginal rates "compounds" the effect of taxes over the years.

Adverse selection vs. moral hazard

Back in 1992, Nobel Laureate Peter Diamond proposed a solution to the adverse selection problem in health care. The NY Times reprinted an old editorial by Professor Diamond based on an article in Econometrica :

The core of the problem is that insurance companies can pick and choose their customers. They tailor policies to attract low-risk individuals, leaving those who are -- or are about to be -- chronically ill to fend for themselves or else pay huge fees.

To solve this adverse selection problem, Professor Diamond would eliminate worker-based coverage and replace it with a government-determined risk pools:

First the government divides the entire population into many large groups. Then, the government creates a Federal Health Insurance System (HealthFed), modeled on the Federal Reserve System, ... There would be redistribution between groups and pricing of alternatives to reflect optimal social insurance principles.

But any solution to the adverse selection problem would also exacerbate the moral hazard problem, so vividly described by my colleague Larry Van Horn

I start each day with my morning “cocktail” of an ACE inhibitor, Beta blocker, and Statin - all grossly subsidized by my health plan. I pay the same monthly premium as every other employee at my workplace with a family health plan. My wages have been reduced to fund the insurance premium behind the scenes, so I never know how much was taken from me. I know the only way to get my money back is to consume the services and drugs.

To solve the moral hazard problem, make consumers face the consequences of their risky behavior, with, e.g., with polices that have big deductibles.

My take away: Democrats are concerned with adverse selection, and want to increase consumption of health care; Republicans are more focussed on moral hazard, which would reduce consumption of health care. Pick your poison.

Thursday, October 14, 2010

Where is the money going?

Money is flowing out of Institutional money market funds run by big places like State Street. They typically take cash in from institutional investors (money managers, banks, trust companies, and their money management clients) and invest in all kinds of paper that, prior to 2008 at least, was thought to be high grade, like high-grade commercial paper (which actually is high grade) and CDO crap (which was rated high grade, but was not). One plausible explanation for the outflow is that people don't trust these funds as much and so they own less of them.

What are they doing with the money instead? I suspect that its in the bank, waiting to be borrowed. Banks currently have "excess reserves" which is related to the collapse in the money multiplier in the last post. The Fed can create reserves, but if there is no demand for loans, then this wont translate into an increase in economic activity.

HT: Merle Hazard

Is the Fed out of ammo?

The money multiplier has collapsed, indicating that changes in the money supply will have a very small effect on the rest of the economy.  This is because the monetary base (what the Fed controls) is not affecting M1, the quantity of money.

HT: Merle Hazard

Tuesday, October 12, 2010

Are tax boundary problems causing market to rally?

When taxes go up, or subsidies expire, consumers adjust income or spending in response.
Just remember what happened to auto sales when the cash for clunkers program ended. Or how about new housing sales when the $8,000 tax credit ended? 

This so called "tax boundary" problem is caused by the ability of upper income taxpayers to delay or accelerate income to reduce tax liability:
People can also change the timing of when they earn and receive their income in response to government policies. According to a 2004 U.S. Treasury report, "high income taxpayers accelerated the receipt of wages and year-end bonuses from 1993 to 1992—over $15 billion—in order to avoid the effects of the anticipated increase in the top rate from 31% to 39.6%. 

So the current increase in economic activity could be caused by investors who are trying to soften the blow of the expiring Bush tax cuts, and the increase in Medicare taxes.
On or about Jan. 1, 2011, federal, state and local tax rates are scheduled to rise quite sharply. President George W. Bush's tax cuts expire on that date, meaning that the highest federal personal income tax rate will go 39.6% from 35%, the highest federal dividend tax rate pops up to 39.6% from 15%, the capital gains tax rate to 20% from 15%, and the estate tax rate to 55% from zero. 

The prospect of 2011 tax increases are also being blamed for the current increase in merger activity
Private equity firms are active in selling their portfolio companies or taking them public before an expected increase in taxes next year.

So what does this mean for 2011?
...the prospect of rising prices, higher interest rates and more regulations next year will further entice demand and supply to be shifted from 2011 into 2010. In my view, this shift of income and demand is a major reason that the economy in 2010 has appeared as strong as it has. When we pass the tax boundary of Jan. 1, 2011, my best guess is that the train goes off the tracks and we get our worst nightmare of a severe "double dip" recession.

Do tourists pay more than locals II?

Not just in India, but in Russia too. Once Again, Carpe Diem has the photo ...

and the explanation. Russian speakers are directed to one entrance while English speakers are directed to the other.

QUESTION: How do UK grocery stores soften competition?

ANSWER:  by locating in areas unlikely to face entry by a competitor:

A colleague just pointed me to a UK Competition Commission study of the UK grocery industry (summary, report).

Here is my summary (in bold) of their findings:

1.  Competition is localized:
...We conclude that one-stop shopping patterns are primarily local, with consumers rarely travelling more than 10 minutes in urban areas, and rarely more than 15 minutes elsewhere to do their main weekly shopping. We consider that on the basis of various economic criteria, five of the main parties are able to exercise power in this market, namely Asda, Morrison, Safeway, Sainsbury and Tesco. 

2.  New store locations are getting harder to find due to local zoning regulations that prevent entry outside the city center.
...significant barriers existed, such that potential competition from new entrants might not be an effective constraint on the pricing behaviour

3. The remedy is to require Competition agency approval for new store openings:
...if Asda, Morrison, Safeway, Sainsbury or Tesco wish to acquire an existing store, or build a new store, having over 1,000 sq metres (about 11,000 sq feet) of grocery retail sales area within a 15-minute drive time of one of its existing stores, or significantly to extend the grocery retailing area of an existing store, it should be required to apply to the DGFT for consent. 

I understand everything but the remedy. The regulators can prevent new entry, but they cannot force rivals to enter. The closest thing to this kind of regulation in the US is the Certificate of Need regulations preventing hospital entry in the US, which have been use to raise barriers to entry. When the FTC reviewed these laws it concluded that
States should consider the following steps to decrease barriers to entry into provider markets: Reconsider whether Certificate of Need Programs best serve their citizens’ health-care needs. On balance, the FTC and DOJ believe that such programs are not successful in containing health care costs, and they pose serious anticompetitive risks that usually outweigh their purported economic benefits.

Monday, October 11, 2010

High Frequency Trades

A 60 Minutes story last night highlighted the growth of computerized trades. Of course the warning bells were sounded.

That [speed] edge, Saluzzi [of Themis Trading LLC] claims, has made high frequency traders the new insiders on Wall Street, and he says he spots signs of predatory behavior every day. Saluzzi, who trades large blocks of stock for institutional investors, says the supercomputers are programmed to place and then cancel thousands of orders a second, trying to sniff out which way a market is moving in order to jump in ahead of big rallies and sell off before big declines. He calls them parasites who exploit a technological advantage to suck money out of the market and add no value.

Three hundred years ago, 'traditional' London exchange traders were at a disadvantage when one outfit constructed semaphore towers that reported "inside information" of which ships wre heading to harbor. Almost two hundred years ago, 'inside' shipping information was delivered to some traders in Philadelphia via telegraph reports from New York. Every advance in information technology has been associated with returns to entrepreneurs who exploit it. Those who did not, have always cried 'unfair' and 'predatory.'

Is there any social value to this trading? Ever decreasing transactions costs of trading means that trades on ever smaller bits of information become profitable. This means that prices, which are seen by all, better reflect the available information - information usually gathered by those 'insiders.'
Leibowitz [of the New York Stock Exchange] and other proponents of high frequency, high speed computer trading say it has performed a valuable function: tripling volume, reducing stock spreads and transaction costs, and providing liquidity to the markets.

"Liquidity means that if you want to buy or sell a stock you could do it right away, and you could do it at a fair price. That's what liquidity means. And without short-term traders, there is no liquidity," Manoj Narang [of Tradeworx] explained.

Sunday, October 10, 2010

Do tourists pay more than locals?

In India they do.  Mark Perry has posted a great photo depicting price discrimination on his consistently interesting blog, "Carpe Diem." Being a non-citizen raises the admission price to an Indian archaeological site tenfold.

Saturday, October 9, 2010

If you make it difficult to fire workers, then ... also make it costly to hire workers.  The Economist has a pair of articles blaming the restrictive labor laws in the EU for its high unemployment.  Spain is singled out for being particularly bad.
Spain’s rules on firing permanent staff, which are particularly tough, though recent reforms have eased them slightly. That has been good for those lucky enough to hold a permanent contract. But Spanish rules give little protection to temporary workers. So employers hired lots of them—they made up about 30% of all employees before the crisis—and fired them when the downturn arrived

Friday, October 8, 2010

The returns to education

How do we align the incentives of schools with the goals of parents?

Much of a child's educational performance is determined by factors outside of school, so measuring teacher or school performance using tests is "noisy." However, despite the difficulty of measuring student performance, each parent has a signal of whether it is working for their own kids. This is what makes vouchers so attractive as a scheme to better align the incentives of schools with the goals of parents. If parents can vote with their feet, and if money follows the parents, then schools have an incentive to do better.

Even if only a fraction of parents get a good signal, the resulting market pressure may be enough to cause improvement.

Thursday, October 7, 2010

Profiting from Pot Legalization

Business Insider has a fun little bit on how impending California marijuana legalization may affect markets and profit opportunities.
But for many companies, the legalization of weed would be a massive business opportunity. Other companies would be decimated.
My favorite is shorting firearms makers.

Wednesday, October 6, 2010

How do You Attract Better Teachers?

Uhh . . . maybe pay them more?

An article in the latest issue of the McKinsey Quarterly notes that only 23 percent of entering teachers in the United States come from the top third of their graduating class. While the following factors aren't the most highly ranked job attributes that graduates are seeking, less than 33% of top-third students agreed with the following statements about teaching:
  • I could support a family with this career

  • Offers a salary that would increase substantially over the next seven to ten years

  • Pays appropriately for the skills and effort I would bring

  • If I were to do well in this job, I would be rewarded financially

  • The job offers competitive starting salary.

Tuesday, October 5, 2010

Is "fire" a pre-existing condition?

If an insurance company must insure health risks, regardless of pre-existing conditions, then consumers have an incentive to wait until they become sick in order to buy insurance. This is what happened a few days ago, as a homeowners tried to "purchase" fire insurance as his house was burning:
OBION COUNTY, Tenn. - Imagine your home catches fire but the local fire department won't respond, then watches it burn. That's exactly what happened to a local family tonight.

A local neighborhood is furious after firefighters watched as an Obion County, Tennessee, home burned to the ground.

The homeowner, Gene Cranick, said he offered to pay whatever it would take for firefighters to put out the flames, but was told it was too late. They wouldn't do anything to stop his house from burning.

Each year, Obion County residents must pay $75 if they want fire protection from the city of South Fulton. But the Cranicks did not pay.

People who get sick, then buy health insurance is driving up the cost of insurance in Massachusetts.
The number of people who appear to be gaming the state’s health insurance system by purchasing coverage only when they are sick quadrupled from 2006 to 2008, according to a long-awaited report released yesterday from the Massachusetts Division of Insurance

Monday, October 4, 2010

How does this acquisition create value?

TPG, a large private equity group has just purchased 35% of CAA, a talent agency that manages movie stars and athletes.  It is easy to see how the acquisition benefits CAA:

What the investment will do is provide a way for the partners to value and monetize their stake, provide CAA employees a bonus payment at every level and most importantly place the agency on a stronger financial footing at a time its clients' traditional businesses -- movie, TV and music production and distribution -- are under pressure and in some cases declining owing to factors including the global economic downturn, dilution of the marketplace with the growth of new media and falling DVD sales.

What is much harder to see is how the acquisition benefits TPG. If the agency is a collection of individual agents, then each agent has to be paid their marginal value, lest they walk out the door with their clients. So the brand "CAA" doesn't carry much economic value. Furthermore, if you weaken the incentive compensation that ownership stakes for the partners implies, then they may start shirking.

If anyone can "see" what I am missing (how does this merger create value), I would love to become enlightened.

Saturday, October 2, 2010

Pirate Economics

A forthcoming article in the Journal of Economic Behavior & Organization, "Pirational Choice: The Economics of Infamous Pirate Practices," looks at the economics of pirate practices. A pdf is available on the author's web site.

This paper investigates the economics of infamous pirate practices. Two closely related economic theories—the theory of signaling and the theory of reputation building—explain these practices. First, I examine the pirate flag, “Jolly Roger,” which pirates used to signal their identity as unconstrained outlaws, enabling them to take prizes with out costly conflict. Second, I consider how pirates combined heinous torture, public displays of “madness,” and published advertisement of their friendishness to establish a reputation that prevented costly captive behaviors. Pirates’ infamous practices reduced their criminal enterprise’s costs and increased its revenues, enhancing the profitability of life “on the account”.

HT: Eric Barker and the Barking up the wrong tree blog