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

Friday, October 1, 2010

Evaluating investments: theory vs. practice

Let’s say you or your company is deciding whether to make some sort of new investment. How do you go about deciding whether it makes sense? The typical advice from economics / finance professors is to perform some sort of net present value (NPV) analysis. Project all of the proposed cash flows from the project, properly discount future cash flows to reflect the fact that a dollar received in the future is worth less than a dollar received today, and calculate the net. If the NPV is positive, you’ve got yourself a good investment. Live long and prosper.

Despite the masses of MBAs bludgeoned with the importance of NPV analysis over the years, other techniques remain in practice. In a very interesting paper that appeared in the Journal of Financial Economics, two Duke professors examined how real CFOs make decisions and found that over half of surveyed CFOs used the payback period as a technique to evaluate projects. Interesting because, as any first year MBA who has completed core Finance can tell you, the payback period technique can lead to incorrect decisions.

Theory sure is nice, but practice is often very different.

[I should add a few caveats related to NPV analysis. First, it’s not entirely clear what discount rate you should use – the standard story from finance is to use your weighted average cost of capital, but not everyone agrees on how this should be calculated. Second, real options theory would argue that simple NPV analysis misses some critical values flowing from the option nature of projects.]

Indifference Principle - TV Commercial Edition

The US Senate is considering banning TV commercials being broadcast noticeably louder than programming. How would the broadcasters react? Well, why are commercials so loud anyway? I am pretty sure it is because most viewers are like me and often leave the room during commercials for small errands. Higher volume allows advertisers to better reach their audiences in the kitchen (or maybe even the bathroom). If the volume restriction means that they will reach a smaller fraction of their audience, then TV advertising is not as valuable to them and they will not be willing to pay as much for a given commercial. Broadcasters who rely on this advertising to underwrite the program production costs will likely respond with 1) less investment in program quality or 2) more advertising per program.

I do not know what the correct policy is. I know that I find the higher volume annoying and I reach for the mute button more often now than before. But I am not sure that I would prefer more but quieter ads or lower production values.