Wednesday, August 31, 2011

DOJ Blocks AT&T/T-Mobile Merger, Sprint celebrates

After much speculation, the DOJ today decided to seek to block the AT&T/T-Mobile merger. This is bad news for AT&T.

Apparently at about 11:00 AM they lost almost 4% of their value. Their merger partner, Deutsche Telecom's T-Mobile unit, didn't do so well at that time either, losing about 7% of value.

This is understandable because the merger is now more uncertain and there will be additional costs in getting the merger cleared. But can we learn anything about the impact on competitors? For Verizon, not so much (the daily return of -0.4% may mean bad news).

But Sprint shareholders received good news at about 11:00 to the tune of an almost 6% daily increase in value. This suggests that the market considers the combined AT&T/T-Mobile to be an even greater competitive threat to Sprint.

How did we get from a US subprime to an international soverign fiscal crisis?

This talk by Bill White, the chief economist at the Bank for International Settlements (the central bank for central bankers), is really acute--and scary. He starts to speak at the 16 minute mark, and his part lasts for about 15 - 20 minutes. He speaks briefly again at the 1 hr 20 min mark about moral hazard in the Q&A. Note that under White, the BIS gave wonderful warnings of the bubble while it was going on, and he's being very modest by not bragging about that.

[If the video link doesn't work, try pasting this into your browser: ]

Best thing I have heard on the crisis since Doug Holtz-Eakin's minority report.

HT: Merle Hazard

Tuesday, August 30, 2011

America's top chef uses marginal analysis

Alinea, which opened in 2005, was named the best restaurant in America by Gourmet Magazine in 2006. The restaurant's co-founder and head chef, Grant Achatz, said his 23-course meal is motivated by what any econ student would recognize as marginal analysis:

So there's something that we call the law of diminishing returns in our cooking. That's why the steak is only two ounces, because by your fifth bite you're really, you're done. You're done with that steak. You know what it's going to taste like. The actual flavor starts to deaden on the palate.

If we were to make you take 10 more bites, by the time you got to bite 15, the steak's just not that compelling anymore. So if we have a series of 23 small courses, where it's a burst of flavor on the palate, and then you move on to something completely different and then completely different, that helps us set up a more exciting meal, and it's something that is easier to kind of be compelled to go through a 23-course menu.

Friday, August 26, 2011

Would you trade our income tax for a carbon tax?

Instead of taxing something good (work), why not tax something bad (carbon)?
The province of British Columbia is celebrating Canada Day by implementing a carbon tax. The tax starts at $10 per tonne of carbon dioxide and will gradually ramp up to $30 per tonne in 2012. It is intended to be revenue neutral through reductions in business and income taxes. Further, at the national level in Canada carbon taxes do not seem to be quite the political anathema they are in America. Liberal Party leader Stephane Dion has dubbed his carbon tax proposal—similar in many respects to the BC tax—the Green Shift.
Art Laffer is on board.

Wednesday, August 24, 2011

Do food stamps stimulate the economy?

Agriculture Secretary Tom Vilsack uses Keynesian economics to justify their use: "every dollar of benefits generates $1.84 in the economy in terms of economic activity."

Robert Barro uses what he calls "regular" economics to come up with a very different answer:
In regular economics, the central ideas involve incentives as the drivers of economic activity. Additional transfers to people with earnings below designated levels motivate less work effort by reducing the reward from working.

In addition, the financing of a transfer program requires more taxes—today or in the future in the case of deficit financing. These added levies likely further reduce work effort—in this instance by taxpayers expected to finance the transfer—and also lower investment because the return after taxes is diminished.

This result does not mean that food stamps are bad, only that their benefits have to be weighed against their costs: if food stamps, or the taxes that support them, weaken the link between rewards and work, then we get less work.

QUIZ: why do hospitals and HMO's get better drug prices than drugstores?

Economist Alan Sorensen has the answer:

The superior bargaining clout of hospitals and HMOs relative to drugstores is attributable to their use of formularies, which enable them to solicit bids from competing manufacturers for an all-or-nothing contract.  Drugstores, in contrast, typically stock their shelves with all competing brands of a drug, and cannot credibly threaten to withdraw their business from a manufacturer that fails to offer a discount.

Bottom line:  the alternatives to agreement determine the terms of agreement.  In this case, the ability of hospitals and HMO's to "steer" patients to particular drugs means that the alternative to agreement is much worse for the drug manufacturer.  This makes the drug manufacturer more eager to reach agreement, which results in better prices.

Capitalism defended

Watch this short video by Jeffrey Miron

HT:  Greg Mankiw

Tuesday, August 23, 2011

Is anyone listening?

HT:  Carpe Diem

CONTEST LOSERS: design an effective ratings agency

PROBLEM:  lousy ratings

1.  WHO:  Ratings companies like Moody's offer favorable ratings
2.  INFO:  Ratings agencies have access to information that would predict poor performance, although not for Black Swan type events, which are inherently unpredictable.
3.  INCENTIVES:  Ratings agencies have an incentive to offer favorable ratings regardless of risk; otherwise they won't get chosen by the issuers.

1.  DECISION RIGHTS:  Let someone else do the ratings, like a regulator.  The failure of regulatory agencies in preventing obvious frauds, like Madoff's Ponzi scheme, suggests that this may not be such a good solution.
2.  INFO:  How do rating agencies get access to info?  Here several "private sector" solutions suggest that disclosure of information would be in the issuer's self interest, i.e., those that did not disclose or restricted access would receive less favorable ratings.  But if this is the case, why did the problem arise in the first place?
3.  INCENTIVES:  Sever the tie between the choice of a ratings agency and the payment from the issuer.  Two types of solutions fall into this category:  (i) let consumers pay (those that buy the securities that get rated); and (ii) let the ratings agency be chosen by lottery from a qualified pool (Moody's, S&P, others).  The problem with (i) is free riding, ratings are information that is easily shared, so why should I pay for it?  The problem with (ii) is shirking, i.e., what incentives to ratings agencies have to do a good job if they are chosen regardless of their performance.  Several solutions suggested customers ratings of the ratings agencies to give them an incentive to work hard.

Interestingly, no one chose litigation as a possible solution:  give the agencies a "fiduciary responsibility" to the investors that rely on them.  This would open them up to lawsuits if they acted irresponsibly.  That no one chose it underscores the difficulty that a regulator, or a litigator, would have in gathering information and determining whether the agencies were doing a good job.

BOTTOM LINE:  everyone loses.  Come by my office and pick up a consolation mug and if you want me to sign your book, bring it by.

MY SOLUTION?: get rid of the implicit guarantees that investors will be bailed out if their investments go south.  This would give them an incentive to scrutinize investments a lot more closely than they had been doing because if they don't, the market will punish them more swiftly and surely than any regulator.

Let me defend myself against the expected ridicule by posing a simple question:
QUESTION:  How many economists does it take to screw in a lightbulb?
ANSWER:  None, the market will do it.  

Friday, August 19, 2011

CONTEST: design an effective ratings agency

The primary conflict of interest at credit rating agencies is well known: The company is paid by the same issuers (banks and companies) whose securities it is supposed to objectively rate.

At Moody's, this created incentives to give Moody's clients favorable ratings, lest the clients fire Moody's and take their business to one of the other ratings agencies.

The obvious organizational design question is how to design an organization or an industry that would give more objective ratings.  Succesful entries will (i) address the conflict of interest (ii) describe how the company would get paid; and (iii) how it would get access to confidential issuer information?

The best answer (in comments below), will win a signed copy of the book (worth about $100) and a coffee mug.

Thursday, August 18, 2011

Uncertainty causes recession

In a previous post, we showed a negative correlation between the stock market and colleague Bob Whaley's "Volatility Index," VIX.

Recent research shows that volatility spikes are a good predictor of future recessions because:
  • When people are uncertain about the future, they wait and do nothing.
  • Firms do not to hire new employees, or invest in new equipment if they are uncertain about future demand.
  • Consumers do not buy a new car, a new TV, or refurnish their house if they are uncertain about their next paycheck.

The economy grinds to a halt while everyone waits.

Top 5 problem-solving mistakes by MBA's

School has started, and I just finished grading the first assignment (group HW from the end of chapter questions). The most common comments were:
“Avoid jargon” because most people misuse it. Force yourself to spell out what you mean in simple plain English. It will help your thinking and communication.

“What about the organizational design?” Figure out what is causing the problem, and then think about how to avoid the problem. A lot of papers identified a bad decision, and then suggested reversing it. But they neglected to address the issue of why the bad decision was made, and how to make sure the same mistakes wouldn’t be made in the future.

“Don’t define the problem as the lack of your solution.” For example, if the problem is “the lack of centralized purchasing,” then you are locked into a solution of “centralized purchasing.” Instead, define the problem as “high acquisition cost” and then examine “centralized purchasing” vs. “decentralized purchasing” (or some other alternative) as two solutions to the problem.

“What is the trade-off?” Every solution has costs as well as benefits. If you list only the benefits, it makes your analysis seem like an ex post rationalization of a foregone decision, rather than a careful weighing of the benefits and costs. If you spent some time thinking through the tradeoffs, show it. If not, then you should.

“Which language is this?” I write this when I get gobbledygook written in the passive voice with big words that don't mean anything. Instead write simple declarative sentences that clarify rather than obfuscate. Form is not a substitute for content.

I am looking forward to improvement on the next assignment.

Tuesday, August 16, 2011

What do US business schools and Boeing have in common?

Both have products or services sold to foreign buyers:

More middle-class Chinese professionals can afford U.S. tuition these days, said Peggy Blumenthal, senior counselor at the Institute of International Education, a nonprofit group that administers the Fulbright Scholar Program and fosters partnerships among schools world-wide. Meanwhile, American students may have more difficulty finding the funds to cover tuition given the troubled economy, she said.

A rising yuan (falling dollar) helping US exports to China, including education.

Space aliens can get us out of the recession

As part of our on-going coverage of the debate between the Keynesians and the Free Marketeers, we examine the belief that only a stimulus the size of WWII can get us out of the recession.

Monday, August 15, 2011

$4/gallon gasoline makes "chumps" out of pickup owners

Consumers are buying pickup trucks with V6 engines. This is surprising because

V8 engines are almost synonymous with pickup trucks. Only commercial fleets and people on the tightest budgets buy full-size pickups with V6 engines. All the truck-makers offer them, but usually only on low-end, stripped-down versions. Sometimes customers can get V6s only in regular-cab models with two-wheel drive — what one car-company spokesman called “the chump specification.”

But at Ford, the smaller, more economical engines are now outselling big V8s. An economist would say that this change was perfectly predictable due to the negative cross elasticity of demand for V6 engines with respect to the price of gasoline. Note that negative (positive) cross elasticity implies that two products are complements (substitutes).

Volatility is spiking: will stock prices fall?

Colleague Bob Whaley's volatility index is spiking.  It is a measure of risk, and typically as volatility increases, risk-averse investors bid down the price of risky assets, thereby increasing their expected returns.  In equilibrium, investors have to be compensated for bearing risk.  In the graph below, we see that stock prices move counter-cyclically to the volatility index.  The crash of March 2009 corresponded to a peak in the volatility index.

Tuesday, August 9, 2011

Why has new car leasing grown so dramatically?

In the early 1980s consumer leasing of new cars was almost unheard of, but now roughly one-fourth of new cars are leased. Why has new-car leasing grown so dramatically? An economist has the answer:

Buying new, and then selling a used car exposes the seller to the costs of adverse selection:  since car buyers have worse information about the quality of a used car than does the seller, buyers rationally expect that lower quality used cars will be offered for re-sale.  The result is lower prices.  So sellers suffer a low price when they go to sell a used car.

Leasing has its own problems, both adverse selection and moral hazard:
a leased unit will be inadequately maintained because there is high probability that the consumer will return the unit to the lessor at the end of the lease contract. .... moral hazard also applies to units that are purchased when new because maintenance expenditures are not reflected in the price for which used units sell on the secondhand market.  
But provisions in the leasing contract specifying that repairs be done on problems identified during routine maintenance mitigates the costs of both these problems.  In fact, leased used cars command premium prices over non-leased used cars.

The paper provides explanations for why leasing has become more popular over time:  since the proportion of problems identified during routine maintenance has risen over time, the advantage of using leasing over buying has also risen.

What is Netflix thinking?

Recently, Netflix decided to sever its streaming video and DVD-by-mail services, charging a flat fee for each that would raise prices by 60 percent. Given the success of its streaming service—which now comprises nearly a third of the country’s Internet traffic during peak hours—perhaps Netflix could be trying to "push" content providers to give their customers more streaming content. But this works only if customers value the "right now" over the "right movie."

It’s common knowledge that Netflix’s streaming offerings are patchy and unpredictable, light on new releases and heavy on catalog obscurities, and that a movie or a TV series you’re in the middle of watching can disappear overnight. But what if Netflix wants disgruntled customers? Sandoval speculates that Netflix assumes most customers will drop DVDs in favor of streaming, and studios will be faced with two choices: either make more titles available via streaming, or accept that Netflix’s customers will just watch something else. It’s already trained its members to wait four weeks, during which new movies are available to buy but not to rent, in order to expand its selection of Instant titles. So why not assume they’ll wait forever, or failing that, move on? Search for Drive Angry, and Instant helpfully suggests you watch Kick-Ass instead.

If this is right, it must be that Netflix faces less competition in the "streaming" industry than in the "DVD rental" industry.

Monday, August 8, 2011

Friday, August 5, 2011

A Children's Story for Managers

The original version of the Rainbow Fish

The updated version of the American Rainbow Fish

Hat tip Greg Mankiw

Wednesday, August 3, 2011

Is the budget deal good for the US?

The answer depends on whether you believe in Keynesian economics or not:
At the heart of these arguments is the question of whether government spending has a positive or negative multiplier, ie create more or less bang for each buck. Keynesians think the former; neoclassicists think the latter. It seems (to this blogger, at least) intuitive that the impact of a stimulus will be dependent on the initial conditions of the economy; factors such as the size of the output gap and the overall level of government debt will play a role. For example, a government will find it easier to finance a deficit if it starts from a low debt-to-GDP ratio; if it starts from 100%, its borrowing costs will rise, offsetting any fiscal stimulus. This study from the National Bureau for Economic Research illustrates the point; it says that factors like exchange rate flexibility and openness to trade play a role. It also finds that

Tuesday, August 2, 2011

Whither Red Light Cameras

The Los Angeles city counsel voted to remove red light cameras. The decision seems to be purely driven by costs to the city government.
Critics accused the council of hypocrisy, in that the American Traffic Solutions contract was spared from the boycott only because it was believed to be generating income for the city. However, a city audit of 2010 departmental budgets found the program was failing to generate the projected levels of income. In fact, amid a budget crisis, the city was found to be pumping more than $1 million into the program to keep it solvent.

At the same time the most extensive study yet indicates that red light cameras save lives.
"These findings show clearly that red light cameras offer significant safety benefits," said Troy Walden, author of the TTI study. "Most important, they help prevent the most severe and deadly type of intersection crashes."

This may a case of hidden benefits rather than hidden costs. Use of red light cameras is likely to be a cost effective way to save lives and thus make Los Angeles a more attractive place to live. Counsel members are mostly interested in budgets. Any other benefits not directly affecting the decision makers are ignored. Too bad elected officials have perverse incentives when it comes to serving their constituents.