How much do mergers raise price?

The answer--about seven percent for a 3-to-2 merger-- comes from a natural experiment constructed from prices of rental cars at different airports.

Table 6.―Predictions from Natural Experiments Compared with Benchmarks

Number of Firms	Increase in HHI	Predicted Market-Wide Average Percentage Price Increase
		Our Prediction	Cournot Benchmark	Bertrand Benchmark
2	.500	16.1	20.0	12.0/15.6
3	.222	7.1	8.9	4.9/5.4
4	.125	4.0	5.0	2.7/2.7
5	.080	2.6	3.2	1.6/1.7

Each row in the table above shows how the estimated merger effects relate to the predicted merger effects from standard theoretical merger models (Cournot and Bertrand).  So for example, the first row denotes a 2-to-1 merger (2 firms going to 1, or merger to monopoly) which leads to a 16.1% price increase.  The second row is our aforementioned 3-to-2 merger which leads to a 7.1% price increase.

Because the estimated effects are close to those from the models, the authors interpret their results as lending "some support to reliance on model-based tools for predicting merger effects." 

DISCLAIMER:  I am one of the authors.

Before you start a war against poverty, ...

..., gather  information to help figure out how to win.

The folks at MarginalRevolution University have a nice set of short videos on poverty.  My favorites are on the value of randomized control trials. 

• Randomized Controlled Trials, Part One
• Randomized Controlled Trials, Part Two

Vertical Relationships for Google

As Google enters new areas, occupiers of that space worry about Google's referrals within that space. Over at Marketplace, coauthor Luke Froeb weighs in on the potential FTC settlement with Google:

“I can’t believe that Google would accept a remedy that would slow things down or not get consumers what they wanted,” Froeb says.

Also, if you have not heard yet, Luke has reconsidered his opposition toward government subsidies of broadcasting ;-)

Are Software patents a tax on innovation?

Another good episode from Planet Money that is making me rethink my opposition to government subsidies to NPR.  Highlights a hold-up problem with software patents:

Big companies that should be focused on inventing the next great thing are instead spending billions of dollars buying up patents and suing each other. Small companies have to worry that someone with some random patent is going to sue them and shut them down.

This is why Southern Europe is a mess

This episode from Planet Money almost made me forget my opposition to government subsidies for NPR.  It is the story of one manager's struggle to reduce absenteeism in his pasta plant in Southern Italy. 

Despite good reporting of the facts, it was amazing to me how the reporters managed to miss the elephant in the room--Italy's labor laws.  

Barbie discrimination

Magician Barbie costs $12.99 but Doctor Barbie costs $32.99. Emily Ostler does a great job explaining why over at Slate. Essentially, its indirect price discrimination. While most families value professional role models for girls, wealthier families are willing to pay more than poorer families to provide one.

Hat tip: Martin Gaynor

REPOST: consult an economist before buying a wedding dress

When Stephanie (her name has been changed to avoid embarrassment) went shopping for a wedding and bridesmaid dresses, she found valuable advice from an unusual source, Chapter 23 of her favorite economics text.  And it was not about sleeve options, figure flattery, or bustles.

She was puzzled that over half of the stores that sell wedding dresses do not permit photos, and do not have tags in the dresses that would identify the manufacturer and style type.  

These retail stores want to prevent customers from "free riding" on their fitting and display services:

I just spoke with someone who had all her bridesmaids sized in the store only to go online and buy them from a discount site. I would assume many of the brides are doing this as well.

Note that this is not just a problem for the store, but also a problem for the dress manufacturer: if stores cannot prevent free-riding, they will invest less in point-of-sales fitting services, and dress sales will suffer.  See our earlier post about golf club manufacturer PING, who faced a similar problem,

The discount retailers were advising consumers to visit a full-service retailer to request a custom-fitting session, and then bring the specifications for custom-made clubs back to the discounter. PING could control this kind of opportunistic behavior only by dropping dealers, a very costly option.

PING wanted to set a minimum retail price (called "retail price maintenance") to address the problem.  The minimum price meant that discount retailers could not undercut full service retailers.  The antitrust laws prevented this until the Supreme Court changed the case law.

For the wedding dresses, the no-photos policy created a problem for Stephanie because she wanted to photograph her bridesmaids in each of the dresses to make sure that they choose the best dresses for the wedding. So she chose to purchase from a large retail chain, like J. Crew, BCBG, Ann Taylor, or Nordstrom’s because they had solved the free riding problem, using exclusives, where only one chain carries the style.

For an economic analysis of resale price maintenance, see the amicii brief of 24 antitrust economists (I am one of the 24.)

UPDATE:  Amazon just made free riding a lot easier.

Bargaining: President vs. Congress

Robert Frank (game theorist) has a column in the NY Times applying John Nash's non-strategic (Chapter 16) or axiomatic theory of bargaining to the standoff between Congress and the President. He correctly notes that it is the alternatives to agreement that determine the terms of agreement, and tells a funny story of Warner Brothers bargaining with Tony Bennett to sing the closing song in their hit comedy, "Analyze This."

With the film almost completed — and with Mr. Bennett already an integral part of the plot — the studio finally got around to approaching the crooner with an offer of $15,000 to sing “I’ve Got the World on a String” in the movie’s closing scene. But as Danny Bennett, the singer’s son and business manager, later explained, the executives made a fatal mistake by not scheduling this conversation sooner: “Hey, they shot the whole film around Tony being the end gag and they’re offering me $15,000?”

It would have cost the studio a lot more than $15,000 to rewrite the script and get someone else to do it (the alternative to reaching agreement), which gave Mr. Bennett a lot of bargaining power.  The studio eventually paid him $200,000.

The rest of Professor Frank's analysis depends on his assumption that going over the fiscal cliff would hurt Republicans more than Democrats. If he is right, then his prediction is that the Republicans will cave on the issue of tax rates, will likely come true.

But lower tax rates is the one theme that has united Republicans, at least since the Presidency of Reagan, so I am not sure they can give this up without severe damage to the party. If so, this alternative may be even worse for Republicans which would predict that they would hold fast to their insistence on closing tax loop holes (making for a "flatter" more efficient tax), rather than raising rates.

Why are rich Chinese Leaving the country?

It looks like 70%!of the rich are emigrating

When the rich pin the hope of their children’s education and retirement on other countries, it means that they have a pessimistic view regarding the improvement of their country’s education and social security. When people flee a country just to protect their assets, it’s further proof that they do not hold too much hope for the country’s rule of law.

So what should the government do to reverse this talent exodus?

If (China can)...improve public services, accelerate the process of the rule of the law and put an end to corruption as fast as possible, China will become a pleasant country to live in. And then, I’m convinced that the rush to exile by the rich will come to a halt

.

REPOST: Will resale price maintenance return?

In 2007, the Supreme Court removed the blanket prohibition against retail price agreements between manufacturers and retailers. PING (the golf club manufacturer) submitted an amicus brief in the case that detailed how difficult it is to prevent discount retailers from free riding on the custom fitting services of full service retailers. The discount retailers were advising consumers to visit a full-service retailer to request a custom-fitting session, and then bring the specifications for custom-made clubs back to the discounter. PING could control this kind of opportunistic behavior only by dropping dealers, a very costly option. [For an economic analysis of resale price maintenance, see the amicii brief of 24 antitrust economists--full disclosure: I am one of the 24].

Now PING has another option, minimum resale price maintenance. The federal legality of these agreements will now be determined under a rule of reason. However, it is likely that those states more inclined towards regulation, like California and New York, will try to "repeal" the Supreme Court decision with state legislation, setting up a conflict between state and federal antitrust laws.

This just in: some manufacturers are suuing retailers who sell merchandise on eBay at a discount.

Bargaining stalemate between Hostess and its Union

It appears that Hostess has a credible threat to shut down unless the Union makes concessions.

Hostess, based in Irving, Texas, has already reached a contract agreement with its largest union, the International Brotherhood of Teamsters. But thousands of members in its second-biggest union went on strike late last week after rejecting in September a contract offer that cut wages and benefits. Officials for the Bakery, Confectionery, Tobacco Workers and Grain Millers International Union say the company stopped contributing to workers’ pensions last year.

But listen to the video below, and hear the fears of the Bakers Union, that if they make a concession to Hostess, other companies would want similar concessions.

Visit NBCNews.com for breaking news, world news, and news about the economy

Why do Brits drink more than Yanks?

England has a drinking problem:

Since 1990, teenage alcohol consumption has doubled. Since World War II, alcohol intake for the population as a whole has doubled, with a third of that increase occurring since just 1995. The United Kingdom has very high rates of binge and heavy drinking, with the average Brit consuming the equivalent of nearly ten liters of pure ethanol per year.

It’s apparent in their hospitals, where since the 1970s rates of cirrhosis and other liver diseases among the middle-aged have increased by eightfold for men and sevenfold for women. And it’s apparent in their streets, where the carousing, violent “lager lout” is as much a symbol of modern Britain as Adele, Andy Murray, and the London Eye.

The US, is in much better (?) shape:

A third of the country does not drink, and teenage drinking is at a historic low. The rate of alcohol use among seniors in high school has fallen 25 percentage points since 1980. Glassing is something that happens in movies, not at the corner bar. 

Part of the difference is the inefficient 3-tiered distribution system in the US, which is not only much less efficient at delivering beer to consumers, but also results in so-called "triple marginalization," each stage of the vertical supply chain takes its own markup, with the result that the final price is much higher than would be charged by a vertically integrated producer-distributor-retailer.

...most states, requires that the alcohol industry be organized according to the so-called three-tier system. The idea is that brewers and distillers, the first tier, have to distribute their product through independent wholesalers, the second tier. And wholesalers, in turn, have to sell only to retailers, the third tier, and not directly to the public. By deliberately hindering economies of scale and protecting middlemen in the booze business, America’s system of regulation was designed to be willfully inefficient, thereby making the cost of producing, distributing, and retailing alcohol higher than it would otherwise be.

Why are cows leaving California?

It is not because of high taxes or unfunded pension liabilities.  Rather it is due to the low regulated prices that cheese producers get to pay. 

Some 100 California dairy farmers are shutting their doors this year, according to the Milk Producers Council, a group representing dairy farmers.

Those of you who read this blog know that markets would fix the problem, leading to higher prices which would reduce demand from processors and increase supply from dairies.  However, in California, they are using regulators, courts, and the legislature, rather than markets, to set prices:

Last week, four groups representing dairy farmers ... filed a lawsuit in August against Karen Ross, the secretary of the California Department of Food and Agriculture, which sets the price that cheese makers pay for milk.

But dont worry, help is on the way.  Last month, Ms. Ross "assembled a task force of producers and processors to study the issue."

I eagerly await their report. 

Why are takeover premia so big?

Its all about the Benjamins:

Here is a really simplified example. Suppose you are a large company generating $1B in revenue, and you have a market cap of $5B. You want to build an important new product that your CTO estimates will increase your revenue 10%. At a 5-1 price-to-revenue ratio, a 10% boost in revenue means a $500M boost in market cap. So you are willing to spend something less than $500M to have that product.

Why shortages appear

Blame prices that are not allowed to adjust:

Hit by a cascade of complaints from consumers, the New York Attorney General’s Office launched a probe on Monday into price gouging in the state in the wake of Hurricane Sandy.

The complaints centered on gas-price hikes but also include reports of jacked-up prices on everything from emergency supplies like generators to higher hotel rates and loftier prices for food and water.

 “Our office has zero tolerance for price gouging," NY Attorney General Eric Schneiderman said in a statement. "We are actively investigating hundreds of complaints we've received from consumers of businesses preying on victims of Hurricane Sandy, and will do everything we can to stop unscrupulous individuals from taking advantage of New Yorkers trying to rebuild their lives."

Not only do higher prices cause shortages to disappear (by encouraging conservation on the demand side, and increases in supply), but they also give consumers and firms an profit motive to find ways to alleviate shortages in the future. 

Halloween Candy Markets

Know the rules of Halloween candy trading

What happens when States incur too much debt?

The NY Times takes a look at Illinois:

For years, Illinois has racked up billions in public debt to plug budget holes, pay overdue bills, and put money into its mismanaged pension funds. And for the people who live there, this has resulted in decrepit commuter trains and buses, thousands of unsound bridges, 200 hazardous dams and one of the most inequitable public school systems in America.

Stossel on subsidizing risks

The video illustrates a couple of ideas:

1. From Chapter 2:  subsidies destroy wealth, in this case, by encouraging activities whose cost is bigger than their benefit. 
2. And from Chapter 20:  If you make things safer, people take more risks. 

Aussies Find Cosmetics Firm Guilty of RPM

The Australian Competition and Consumer Commission (ACCC) has clamped down on so-called "resale price maintenance" (RPM) by Eternal Beauty Products. In this case, the cosmetics maker pressured online retailers to either sell goods at certain prices or risk being cut off altogether. Most countries have had some sort of anti-RPM law on the books. At first blush, it seems quite obvious that that a manufacturer requiring a retailer to set higher prices must not be in the public interest. Until, you ask a simple question, "Why would manufacturers do this?"

1. If the manufacturer was a monopolist, it might be a way of getting higher final prices. But, why not simply raise the wholesale price? Given the wholesale price, the manufacturer should want as low a retail price as possible to sell as many units as possible. Anyway, in this this case, like most, the manufacturer was one of many competitors.
2. If the industry was oligopolistic, the manufacturers may be collectively using retailers to enforce higher prices. This could be a way to reduce rivalry. But then all cosmetic firms would be party to the deal and they would have to impose price restraints on all retail channels. This appears to have been far from the case.
3. If the product was new or differentiated and the target market was poorly informed about the product's characteristics relative to competitors, the manufacturer may want to encourage point-of-sale (POS) services. Retail sales associates may be uniquely positioned to demonstrate why this product might be preferred. But this imposes costs on the retailers who perform these POS services. They may be willing to do so for a higher margin. But not if some online retailer offers the same product without the POS services at a discount. Customers will may make an initial purchase with the full service retailer and then shift orders to the cheaper online vendor. In this case, no retailer will be willing to offer the POS services and suffer the free-riding by online discounters. Without POS services, the product fails. To counter this, the manufacturer bans discounting by setting a minimum retail price that includes enough of a margin that retailers want to offer the POS services. In this theory of RPM, customers benefit from small manufacturers bringing new and innovative products to the market. Too bad the ACCC got in the way.

Group Incentives: Teacher pay

An interesting application of group incentives was examined in a new working paper by Scott A. Imberman and Michael Lovenheim called "Incentive Strength and Teacher Productivity: Evidence from a Group-Based Teacher Incentive Pay System." The incentive scheme was for groups of teachers teaching the same subject within a grade and school. One problem with group incentives is free-riding. But different teacher assignments means that the incentive can be stronger for teachers who are responsible for the outcomes of more of the students. So, as a teacher's share of students in a particular school, grade, and subject combination, the incentives get stronger. From their abstract:

We find that student achievement improves when a teacher becomes responsible for more students post program implementation: mean effects are between 0.01 and 0.02 standard deviations for a 10 percentage point increase in share for math, English and social studies, although mean science estimates are small and are not statistically significant. 

While these effects seem small, they are bigger than are found in many previous studies. So, if the incentive dissipates for larger groups, why use group incentive rather than measuring performance at the individual level? I can think of a few reasons (and maybe you can think of more):

1. Individual incentive would lead teachers to try to "cherry-pick" students. These could just be the better students if raw test average is the performance measure or those thought to be able to improve the most if change in score is the metric.
2. To better sort students into classes. Students differ in abilities as well as other characteristics (e.g. unruly versus well-mannered). Some teachers are better with one type of student than another (e.g., former drill sergeant). The group of teachers all benefit from better matching students to teachers.
3. Spillovers within a group. Teachers have heterogeneous abilities and no one likes to be 'corrected' by a colleague. But now there is a stronger incentive for the better teachers to share their methods with those who can improve.
4. Demonstration effects across teacher groups. Other groups of teachers can observe the successful groups and learn.

 So it might be worth weaker group incentives so as to address these issues.

Using patient satisfaction as a performance metric

One of the biggest problem with the US medical system is cost:  every time you put a patient in front of a provider, the provider does stuff.  Sometimes it is what we want the provider to do; many times it is not.  See our earlier blog post:  What do tonsilectomies have in common with auto repair?

The problem, of course is the incentives:  our fee-for-service payment scheme rewards physicians and hospitals for doing stuff to patients, regardless of whether it is the cost-effective thing to do. 

To try and fix the problem, the government is evaluating hospital performance using patient satisfaction scores.  The Wall St. Journal has a funny piece about its obvious shortcomings:

"Donna Barnett, a senior nurse at Grady [Hospital], cites a patient who had a hemorrhagic stroke and recovered swiftly enough to walk out of the hospital about a week later. On the survey the patient complained that meals were served cold and gave Grady low scores. 'It makes you want to throw your hands up,' said Ms. Barnett."

When Vanderbilt asked patients what they wanted, it was easy and free parking, which explains the valet parking and unsightly parking structures all over campus.  Patients didn't seem to care too much about the quality of care, and not at all about the cost because other people (you and I) pay for their care. 

And lets not forget the placebo effect, which means that patients are not satisfied unless providers do something to them.  

Arbs attack the presidential betting markets

There are several political betting markets: Intrade; Iowa Electronic Market, Betfair, Paddy Power, and, Predictwise.com, which averages Intrade, Iowa and Betfair in real time.

What happens when the market prices diverge?  The arbs start betting:

PS: So right now it's October 4, 2012 at 12:50 pm EST. President Obama's got 66 percent odds [of winning the election] on Intrade, 69 percent on Iowa and 73 percent on Betfair. If you were trying to make money right now, what do you do?

AJG: Well, I would if I could -- Betfair is locked for U.S. persons -- sell President Obama's contracts on Betfair and buy President Obama's contracts on Intrade, and wait, because eventually the prices on these two contracts would have to converge. They just predict the same event happening, so they will have to be worth the same once the event happens or doesn't. So come November 6th, both of these contracts will expire at the same value, but because I sold one high and I bought the other one low, I will pocket the 8 points difference between the 2 contracts.

HT:  Merle Hazard

When is inequality bad?

The lead article in the Economist purports to be about income inequality.  It starts out with the reasonable proposition:

... some measure of inequality is good for an economy. It sharpens incentives to work hard and take risks; it rewards the talented innovators who drive economic progress. Free-traders have always accepted that the more global a market, the greater the rewards will be for the winners. 

But then it argues that inequality has reached a stage where it can be inefficient and bad for growth:

That is most obvious in the emerging world. In China credit is siphoned to state-owned enterprises and well-connected insiders; the elite also gain from a string of monopolies. In Russia the oligarchs’ wealth has even less to do with entrepreneurialism. In India, too often, the same is true.

In the rich world the cronyism is better-hidden. One reason why Wall Street accounts for a disproportionate share of the wealthy is the implicit subsidy given to too-big-to-fail banks. From doctors to lawyers, many high-paying professions are full of unnecessary restrictive practices. And then there is the most unfair transfer of all—misdirected welfare spending. Social spending is often less about helping the poor than giving goodies to the relatively wealthy. In America the housing subsidy to the richest fifth (through mortgage-interest relief) is four times the amount spent on public housing for the poorest fifth.

 These examples are strategies employed by firms and individuals to manipulate government policy to their own advantage, which readers of this blog will recognize as examples of "make the rules or your rivals will." 

If this is the problem, I am not sure why the Economist proposes income re-distribution to address it.  Why not attack the problem directly by eliminating too-big-to-fail subsidies, regulatory barriers to entry, and misdirected welfare spending.

 HT:  Cassie

Theatre of the Absurde: banning achievement in France

France's socialist president wants to ban homework in school:

He doesn’t think it is fair that some kids get help from their parents at home while children who come from disadvantaged families don’t. It’s an issue that goes well beyond France, and has been part of the reason that some Americans oppose homework too.

This concern for equality has been satirized by Kurt Vonnegut in his story, Harrison Bergeron:

...In that brave new world, the government forced each individual to wear "handicaps" to offset any advantage he had, so everyone could be truly and fully equal. Beautiful people had to wear ugly masks to hide their good looks. The strong had to wear compensating weights to slow them down. Graceful dancers were burdened with bags of bird shot. Those with above-average intelligence had to wear government transmitters in their ears that would emit sharp noises every 20 seconds, shattering their thoughts "to keep them…from taking unfair advantage of their brains."

I have nothing to add, except to remind people that the story does not have a happy ending,  Harrison breaks free of his device and performs a beautiful dance, the likes of which had never been seen before.  But then, the Handicapper General, Diana Moon Glampers shoots Harrison and his partner, and equality is restored.

HT:  JC

Taxes destroy wealth: France's capital gains tax rises to 62.5%

French businesses are outraged at a proposal by the government to raise the capital gains taxation rate from 34.5% to 62.2%.  This compares with 21% in Spain, 26.4% in Germany and 28% in Britain.

...the Socialist government of François Hollande has yet to understand the “extreme gravity” of the crisis.  ...the policies border on economic illiteracy: “The idea of aligning taxes on capital with those on wages is a profound economic error. It is scandalous that the French have been left in such economic ignorance for years.”

Here is the analysis behind the outrage.  The new tax rate raises the cost of capital (the return you have to promise investors in order to get them to invest in France) by a factor of 1.74.  Suppose, for example, investors were willing to invest in a project that returns 10% under the lower tax rate.  Under the higher tax rate, the same project would now have to earn 17.4% in order to get the investors to invest.  From chapter five, we know that a higher cost of capital means that fewer investment projects will be undertaken (because they have a lower NPV). 

So, the Socialist (deontological) justification for higher taxes is that they re-distribute money from those who have it (rich investors) to those who don't (poor non-investors).

The Capitalist (consequentialist) critique of higher capital gains taxes is that they raise the cost of capital, which reduces investment, which makes us all poorer.

As Winston Churchill said:   

The inherent vice of capitalism is the unequal sharing of blessings. The inherent virtue of Socialism is the equal sharing of miseries.

Unwritten Clauses in Vertical Relationship Contracts

Burger King's supply chain contracts probably do not have an explicit clause that state that dairy suppliers must treat their cows humanely, but it seems as though there is an implicit clause. An animal activist group went undercover at Bettencourt Dairies to video employees beating, kicking, and jumping on cows. A perhaps unanticipated result is that representatives from Burger King said the company had temporarily suspended Bettencourt Dairies LLC. from its suppliers.

This raises a couple of contracting issues:

1. Burger King, as a mass retailer, suffers a reputation loss if customers believe Burger King is indifferent to these issues. They could suffer real losses if this keeps enough customers away. Bettencourt Dairies does not deal with final consumers to the same extent and may not suffer a similar loss.This leads to a possible conflict in acceptable business practices, or at least the diligence with which firms are expected to monitor employees for violations.
2. I could be wrong, but this is probably not an eventuality that negotiators thought they would have to include in the supplier contract. (How would one determine the level of severity that leads to a breach?) Contracts cannot cover all possible contingencies. Knowing this, buyers in the relationship try to include some all-encompassing clause to cover the unanticipated. However, this leaves suppliers open to possible holdup opportunities. Suppliers do not want to be left exposed to the possibility that their customer will claim a breach of contract in order to take advantage of them.

A good contract must balance all of these concerns.

Do increases in energy efficiency increase energy use?

On the one hand increased efficiency reduces the amount of energy needed to power current consumption levels; on the other, it makes energy consumption cheaper, so people consume more.  Energy consumption can go up or down. 

You can model this as an increase in the supply curve.  Price goes down, quantity demanded increases.

The New Yorker has a nice essay on what they call The Efficiency Dilemma:

The problem with efficiency gains is that we inevitably reinvest them in additional consumption. Paving roads reduces rolling friction, thereby boosting miles per gallon, but it also makes distant destinations seem closer, thereby enabling people to live in sprawling, energy-gobbling subdivisions far from where they work and shop.

HT:  Hoyt

Perceptions of Priority Paying

BBC Magazine has a nice story on various recent implementations of schemes to charge extra for patrons to go to the head of the line. It is easy to recognize that these are merely attempts to price discriminate. But the theme of the article is how it affects the perceptions of those opting not to pay.

"What it does is it creates what I call the politics of envy. It separates the haves and the have-nots," he says.

"We've always prided ourselves on not being so stratified. Our founding fathers never had this idea of, 'I got mine, now you go get yours'. That's not anywhere in the constitution, the bill of rights, the declaration of independence. But that's what this creates."

In these cases, the lost profits from serving the 'have-nots' may swamp the gains from serving the 'haves.'

TN Governor gets a "D"

From CATO:

Bill Haslam is a former businessman and mayor of Knoxville. As governor, his best fiscal move so far is to repeal Tennessee’s inheritance tax. Haslam says that the tax is prompting “a whole lot of people” to leave the state because “it’s cheaper to die in Florida.”114 Haslam originally called for an increase in the exemption amount, but he ultimately agreed to a full phase-out of the inheritance tax over three years. Haslam also signed a small cut in the sales tax on groceries. Balancing out those tax cuts, Haslam approved an increase in the state’s hospital tax from 3.5 to 4.5 percent of hospital net income. Haslam has also been leading the charge to increase taxes on Internet sales.115 State general fund spending rose about 14 percent during Haslam’s first year in office, which was a key factor in the governor’s low grade.

In Gov. Haslam's defence, his low grade is a consequence of his response to the perverse incentives set up by the Medicaid matching grants, that pay $2 for every $1 of state money.  We have blogged about this before:

Sunday, February 7, 2010

Tax us, please!

If you ever wonder why the government keeps growing when most people want it to shrink, look no further than Tennessee's Medicaid program, "TennCare."  Tennessee is facing a budget short fall, and the usual reaction would be to cut back spending.  In fact, the Governor has proposed steep cuts in funding, which would cut revenue to the state's hospitals who provide services to TennCare patients. 

The state hospitals have come up with a clever alternate plan.  Instead of cutting back TennCare spending, they want to increase it, financed by a tax on the state's hospitals.

Because the Federal government matches spending (with $2 for every dollar spent on TennCare), the taxes paid by the hospitals would be more than offset with increased revenue coming to TennCare from the federal government:

Regulatory "backdoors": act quickly, ask questions later

One of the recurrent themes of this blog is that firms use regulation strategically, summed up by the maxim, "make the rules or your rivals will." 

When they do, it is sometimes possible to circumvent regulatory barriers with what are known as "hacks" or "back doors."  

Nextel was one of the all-time great regulatory hacks. In the late 80s and early 90s, the FCC’s rules banned more than two cellular operators per city. As Nextel’s cofounder said, “the FCC thought a wireless duopoly was the perfect market structure”. Nextel (called Fleet Call at the time) circumvented these rules by acquiring local (e.g. taxi, pizza truck) dispatch radio companies, which they then connected to create a nationwide (non-dispatch) cell phone service.

 Predictably, the incumbent cellular companies responded tried to block Nextel's entry, arguing that  Nextel’s service would interfere with public safety frequencies and would be too expensive. Uncharacteristically, the regulators (the FCC) decided to let Nextel keep operating:

Nextel grew to become a top five US cellular operators before it was acquired by Sprint in 2004 for $35B. Their service turned out to be cost-competitive, high quality, and safe. The only thing endangered were the incumbents’ profits.

HT:  Lamar

Mexican gas is a substitute for San Diego gas

The main idea behind purchasing power parity is that similar goods--in the absence of trade barriers or transportation costs--should have the same price, when expressed in the same currency units.  Trade is the force that links these prices together.  But sometimes, "trade" means that the consumers, rather than the goods, move to the lower priced country.  Gas prices in the San Diego near $5, consumers are driving across the border to fill up with Mexican gas for only $3.30

"I don't buy gas in the U.S. anymore I'll buy it in Mexico," said one Chula Vista resident.

This driver, who identified himself only as “Joe,” has a Hummer, an Expedition, an Excursion and a BMW so he says he has no choice but to find the cheapest gas.

HT:  Matthew

AA Pilots Up the Ante

Sheila Heen, from Harvard Law School, discussed a possible slow down by American Airlines pilots as a negotiating tool on Marketplace this morning.

...the pilots' tactics may be working, "the pilots are actually doing a reasonably good job of bringing other players into the negotiation by saying, 'look, other people here are on our side, and those other people also have decision making power because they can choose to fly with someone else.'"

Toward the end she points out that each side is testing the other's BATNA (Best Alternative To A Negotiated Agreement). Our Managerial Economics students will recognize this as their 'disagreement value.' If you know what this is, you know how much you can expect to take away from the negotiations.

Vertical not-quite-integration in medical care

The NY Times has a good story about the opportunity created by the closing of the old St Vincent's hospital in Manhattan.  Rushing to fill the void are retail clinics, affiliated with bigger medical centers:

Without building a hospital, one large chain, Continuum Health Partners, is establishing a beachhead in Chelsea and the Village by connecting with outpatient clinics, trying to dominate the market and create a feeder network for its hospitals in other neighborhoods. It is joining forces not just with traditional clinics but also with newer experiments like doctors working out of drugstores. A competitor, NYU Langone Medical Center, is expanding its physician practices downtown, and like Continuum, it has hired dozens of stranded St. Vincent’s doctors.

The integration will reduce costs if it is cheaper to see patients in a clinic than in an emergency room or physician's office.  Regardless, the vertical relationship benefits both the retail clinic and the hospital:

The hospital system checks doctors’ credentials and provides — and bills for — laboratory, radiology and imaging services prescribed by the [retail] doctors. The system also gets a potential trove of patients referred by the clinics. The [retail] clinics earn the cachet of being associated with major hospitals, and as with other affiliated practices, the [retail] patients are given expedited access to Continuum specialists and direct access to hospital admission if needed.

Libertarian experiment in Honduras

Honduras is experimenting with limited government:

Small government and free-market capitalism are about to get put to the test in Honduras, where the government has agreed to let an investment group build an experimental city with no taxes on income, capital gains or sales.

Proponents say the tiny, as-yet unnamed town will become a Central American beacon of job creation and investment, by combining secure property rights with minimal government interference. 

“Once we provide a sound legal system within which to do business, the whole job creation machine – the miracle of capitalism – will get going,”

Is "organic" sustainable?

Elsewhere we have argued that some of the arguments for organic food are anything but sustainable. Now we get estimates of the opportunity cost of locally grown organic food:

Studies show somewhere between a 20 and 50 percent decline in yield per acre from organic methods. So, is the environment better served by more land being used for farming, and less land left to nature? Conventional agriculture has given society both more food and more land, in the form of rainforests not farmed, the millions of acres in the United States which were once farmed and are now returning to the wild, or the 35 million acres taken from production in the last 30 years and planted to native grasses in the American Midwest and West.

The entire essay is well written, and funny.

HT:  Germain

Electronic Medical Records boost hospital bills

The potential benefits of electronic medical records (EMR's) induced the Obama Administration to provide billions of dollars for physicians and hospitals to use them.  The result is new kind of irony:  instead of lower costs, EMR's are instead making it easier for hospitals and physicians to bill more for their services, whether or not they provide additional care:

The share of highest-paying claims at Baptist Hospital in Nashville climbed 82 percent in 2010, the year after it began using a software system for its emergency room records.

So if you make it easier to bill, you get more billing.  Who could have predicted this?

HT:  Don Marron

You might be a libertarian if ...

You can think more clearly than others:

Perhaps more intriguingly, when libertarians reacted to moral dilemmas and in other tests, they displayed less emotion, less empathy and less disgust than either conservatives or liberals. They appeared to use "cold" calculation to reach utilitarian conclusions about whether (for instance) to save lives by sacrificing fewer lives. They reached correct, rather than intuitive, answers to math and logic problems, and they enjoyed "effortful and thoughtful cognitive tasks" more than others do. 

The researchers found that libertarians had the most "masculine" psychological profile, while liberals had the most feminine, and these results held up even when they examined each gender separately, which "may explain why libertarianism appeals to men more than women." 

All Americans value liberty, but libertarians seem to value it more. For social conservatives, liberty is often a means to the end of rolling back the welfare state, with its lax morals and redistributive taxation, so liberty can be infringed in the bedroom. For liberals, liberty is a way to extend rights to groups perceived to be oppressed, so liberty can be infringed in the boardroom. But for libertarians, liberty is an end in itself, trumping all other moral values.

Repost: avoid bureaucratese

There is a temptation, especially when you have nothing substantive to say, to write in the passive voice, using big words, and ponderous prose.  If you notice these tendencies in yourself, you are probably OK.  But if you don't, you may be speaking in what Alfred Kahn calls "bureaucratese." 

 

Although Kahn is most remembered for deregulating the airlines industry, Vanderbilt students know him through his essay,My War Against Bureaucratese," the gobbledygook written by government bureaucrats designed to hide what they are really doing.  Here are a few of his most salient points:

• “Every time you’re tempted to use ‘herein’ or ‘hereinabout’ or ‘hereinunder’ or, similarly, ‘therein,’ thereinabove’ or ‘thereinunder,” and the corresponding variants, try ‘here’ or ‘there’ or ‘above’ or ‘below,’ and see if it doesn’t make just as much sense.”
• “The passive voice is wildly overused in government writing. Typically its purpose is to conceal information. One is less likely to be jailed if one says, ‘He was hit by a stone,’ than if he says, ‘I hit him with a stone.’ The active voice is far more forthright, direct, humane.”
• The use of ‘presently’ to mean ‘now’ is another pomposity. If you mean ‘now,’ why don’t you say ‘now’?
• “Why use ‘regarding’ or ‘concerning’ or ‘with regard to’ when the simple word ‘about’ would do just as well? Unless you’re trying to impress somebody. But are you sure you want to impress anybody who would be impressed by such circumlocutions?
• “Outreach makes me upchuck.” Sometimes the demands of pomposity and dynamism converge—as in using “input” as a verb, “specifics” for “details” and constantly “implementing” things and “addressing issues.”

Professor Kahn began this war as part of his successful effort to deregulate the airline industry. He is the hero of Thomas McCraw's Pulitzer Prize Winning book Prophets of Regulation. Interestingly, the villain of the book is Louis Brandeis for his role in creating the FTC.

Former colleague Mike Shor's MBA Writer puts phrases from student memos together to generate sentences that sound all too familiar.

To proactively manage profit, our key initiative objective pushes the envelope toward systematized reciprocal capability.

Enabling continuity, enterprise optimization accelerates the movement towards third-generation contingencies.

Incentive Compensation Can Be Too Strong

A recent NY Times article reports that about 1,000 of the elderly in Shaoyang, have been deputized to enforce minor nuisance laws. They have been given the authority to ticket citizens who litter, spit in public or park illegally. Except that they get to pocket 80% of the fines collected from the tickets they issue. What would we expect to happen to enforcement?

That's right, violations have been found where perhaps none occurred:

A convenience store clerk reached by phone described how the newly empowered urban management officials have been pouncing on motorcyclists stopped at red lights, summons books at the ready. “Many of us depend on motorcycles to get around, but they’re now giving us tickets for not wearing a helmet, for not having insurance, or for not carrying our licenses,” complained the clerk, who would give only her surname, Li. “None of us dare drive our motorcycles anymore — it’s just too risky.”

What I expected, but has not been reported yet, is the settling of old grudges by trumping up violations against some neighbor who won't "toe the line." Or worse, extorting payments from the neighbor so as to avoid ticketing - an ersatz senior citizen protection racket.

From the policy perspective, the choice seems to be between imperfect under-enforcement of the laws and imperfect over-enforcement.

Zhang Yue, a downtown shop owner, acknowledged that city streets have become increasingly chaotic but suggested that the government reconsider its experiment. “People in this city have no respect for the law, making the traffic situation really terrifying,” he said, “but this crackdown is going very far, perhaps too far, in the other direction.” 

Hat tip: Angus

10 college majors most likely to end up in retail

The majors are ranked according to how likely their graduates end up working in retail, measured against the national average.

1. Anthropology Likelihood of working retail: 2.1 times average

2. Fine Arts Likelihood of working retail: 1.8 times average

3. Film and Photography Likelihood of working retail: 2.6 times average

4. Philosophy and Religious Studies Likelihood of working retail: 2.0 times average

5. Graphic Design Likelihood of working retail: 0.6 times average

6. Studio Arts Likelihood of working retail: 2.3 times average

7. Liberal Arts Likelihood of working retail: 1.8 times average

8. Drama and Theater Arts Likelihood of working retail: 2.1 times average

9. Sociology Likelihood of working retail: 1.4 times average

10. English Likelihood of working retail: 1.4 times average

The list illustrates the idea of selection bias. If we randomly assigned students to majors, then we could conclude that the difference in outcomes was due to the major that they chose. However, students select majors, so it is difficult to infer causality from this correlation.  It could be that students who are likely to end up in retail are choosing these majors.

If causality is running the other way (from choice of retail to the major), then forcing your sons and daughters out of these majors would not necessarily improve their employment outcomes.

The truth is likely somewhere in between (both selection bias and causality explain the data), but that is only my opinion.  To prove this, you have to do a lot more work. 

Why are so many donated kidneys discarded?

In the past, we have blogged about our inefficient kidney matching system:  almost 100,000 people are waiting for kidneys, only about 20,000 receive kidneys. 

Now we learn that physicians throw away about 2000 usable kidneys.  One of the reasons is the government's performance evaluation metric:  If the number of failures exceeds expected levels by 50 percent, transplant programs are put on watch list, and then decertified if they dont improve.  This incentive encourages physicians to reject all but the best organs for transplant:

“When you’re looking at organs on the margins, if you’ve had a couple of bad outcomes recently you say, ‘Well, why should I do this?’ ” said Dr. Lloyd E. Ratner, direct of renal and pancreatic transplantation at NewYork-Presbyterian/Columbia hospital. “You can always find a reason to turn organs down. It’s this whole cascade that winds up with people being denied care or with reduced access to care.” 

After the University of Toledo was cited, a transplant surgeon cut back to about 60 transplants a year from 100, becoming far choosier about the organs and recipients he accepted. 

The one-year transplant survival rate rose to 96 percent from 88 percent, but Dr. Rees still bristles at the trade-off. “Which serves America better?” he asked. “A program doing 100 kidneys and 88 percent of them are working, or a program that does 60 kidneys and 59 of them are working? It’s rationing health care under the guise of quality, and it’s a tragedy that we are throwing away perfectly good organs.”

Someone, please, let these people use a market. 

Why are there so few tenured professors?

Virginia Postrel remarks on the decline in tenured professors in academia:

About 30 percent of faculty members are either tenured or on the tenure track, compared with about 57 percent in 1975. The rest are “contingent faculty”: About 19 percent work full time, usually on contracts lasting one to three years, and more than half work part time. (These figures omit graduate students who also teach classes.) Along with a lack of job security, contingent faculty members receive lower pay and fewer, or no, benefits. They frequently don’t have offices and may not even get library cards. 

Why the change?  Tenure makes it very difficult for academia to respond, and adapt to a changing external environment.  And there are few industries changing as rapidly as academia (see past posts:  Failing to Educate,  How should universities respond to rising costs, declining demand, and the emergence of cheap alternatives?, Making Research more Relevant, Irony: do business schools practice what they preach?, Incentive pay for professors, Agents vs. principals: the strange case of Dartmouth, Dartmouth governance, again).

Competition favors lower cost organizational forms, so it is not surprising that we see a decline in its use. 

Market for Online Class Takers

Like many universities, mine is gearing up for online courses in a big way. Our administrators see this as an untapped revenue stream. The faculty worry about diluting the value of the degree. How do you know that the one enrolled in the course is the one doing the work and taking the exam? With "WeTakeYourClass," it just got harder. From their website:

We know why you came here

 You are struggling with your online classes or homework and you want someone to do it for you. We can handle almost any subject and customer service is a priority. Our company culture revolves around making sure you feel safe and satisfied knowing that your work is being done by an expert within your specified deadline. We are here to serve you around the clock by email, live chat, and phone. For all of your academic needs, WeTakeYourClass wants to be the one you turn to time and time again.

Signing up is simple:

1) Fill out the Get a Quote Form or speak to a representative about your assignment

2) Receive a price to complete the class or assignment and come to an agreement

3) If its an online assignment, we will complete it for you and send an invoice when its done. If its an offline assignment we will send an invoice and once its paid, we will complete your work and send it to you within the deadline.

HT: Mark Perry at Carpe Diem

On Uncertain Ground

Insightful, well written summary of the economic forces that will shape business strategy in the coming years, by Howard Marks, chairman of Oaktree.

The essay touches on a number of themes in our textbook.  The first is that firms seem to be waiting until the political and economic uncertainty (Chapter 17) is resolved before they invest:

...In contrast to the preceding 28 years of pro-business and pro-free market administrations under Presidents Reagan, Bush, Clinton and Bush, today many business people detect antipathy – or, at minimum, indifference – on the part of the Obama administration, in which the private sector is little represented.  In addition, there is uncertainty and anxiety regarding the outlook for the economy, regulation and taxes.  All of these things have deterred expansion.

The second theme is the role of compensating risk differentials (chapter 9).  Given that a lot of the uncertainty is political in nature, investors have adopted so-called "macro" strategies, to buy risky securities when they perceive the political risk is about to be resolved:

This has given rise to so-called “risk-on, risk-off” investing, consisting of investors’ attempts to profit by increasing their risk exposure when they expect favorable macro developments, and decreasing it when they foresee unfavorable developments.  Since macro events determine most of the results, it’s on the macro that investors believe they should spend their time.

Finally, there is a really good description of the formation of the financial asset bubble:

In the 1980s and ’90s, everything went right.  Economic growth was strong.  Companies thrived.  There were great gains in productivity and technology.  Profits rose dramatically.  Interest rates declined.  Inflation was quiescent.  Equities soared.  Houses and 401k accounts appreciated, producing a positive “wealth effect.”  The world was largely at peace.  All of this contributed to positive psychology, feeding back to further spur economic strength in a classic virtuous circle.  Was this a period in which favorable outcomes were entirely dependable, or just one in which the underlying processes met up with good luck, producing favorable outcomes?  And if the latter, were the results better than people should have expected to continue? 

Regardless, people did extrapolate them.  When stocks returned 20% a year in the 1990s, rather than the normal 10%, investors ratcheted up their return expectations for the subsequent years, and with them their allocations to equities.  Everyone knows that if you reach into a bag containing both black and white balls and pull out ten white ones in a row, the probability has increased that the next one will be black [PROFESSOR NOTE:  The author is using the statistical metaphor, sampling without replacement, that you cannot keep drawing white balls out of a hat, to explain his belief that the downside risk is bigger.  This is not the only one he could have used.  Regression towards the mean suggests that high returns in one period are "outliers" and we should not expect them to continue].  But in the investment world, events like that serve to convince people that there are only white balls – favorable outcomes – in the bag.  That’s part of the illogical, emotional thinking that makes for bull markets and bubbles.  So by the time the late 1990s rolled around, many investors had concluded that the world was a benign place in which profits were inevitable.  That is, that there was little risk or uncertainty.

And its aftermath, deleveraging:

Few debtors can tap the capital markets today to the same extent they could five or ten years ago.  In a radical turn of events, lenders now appear to care about borrowers’ ability to repay, and they find some of their customers less than creditworthy.  Since almost no borrowers actually have the ability to pay off their debts, this has led to credit difficulties ranging from home foreclosures, to municipal bankruptcies in the U.S., to debt crises in peripheral Europe. 

American consumers seem to have concluded that they should owe less (or have found that they can’t borrow as much).  For whatever reason, the savings rate has risen, suggesting a decline in the propensity to spend all one makes and more.  All around the world, there’s movement on the part of borrowers – sometimes voluntary and sometimes involuntary – toward austerity (reducing the excess of spending over incomes) or even delevering (spending less than you make and using the surplus to pay down debt). 

Do teachers deserve to make 31% less than everyone else?

The graph from NY Times Economix blog shows that middle school teachers in the US earn about 69 percent of the salary of a average college-educated worker in the United States. The comparable figure is 82 percent in the rest of the developed world:

So tell me: Given the opportunity costs of becoming a teacher instead of using your college degree to enter another, more remunerative field, are the psychic rewards of teaching great enough to convince America’s best and brightest to become educators?

Perverse incentives in TN state funded investment

The state is auditing the its venture capital fund, which awards $20 Million ($25 M in future tax credits are worth about $20 M today), and then asks fund managers to invest  in early stage ventures.  After the investment pays out, the state and the managers split whatever remains. 

Proponents of the program say it was an innovative attempt to steer venture capital toward economic development priorities like health care, bioscience, music and other sectors. As the Business Journal reports today, some Republicans are questioning the program’s job creation so far and want to evaluate other aspects of its financial performance.

Any audit should first understand the incentives.  To do this, lets run through some scenarios.  This is what is called a "sensitivity analysis."

 Compare the (very approximate) terms of a typical Venture Capitalist (VC) to those of TNInvestco under the following scenarios:

• Scenario A:  Good Scenario (Invest $20 million, sell investments for $50 million)
• TNinvestco gets $25 million, State gets $25 million
• Typical VC gets $6 million, investor gets $44 million


• Scenario B:  Break-even Scenario (Invest $20 million, sell investments for $20 million)
• TNInvestco gets $10 million, State gets $10 million
• Typical VC gets zilch, investor gets $20 million


• Scenario C:  Worse-case Scenario (Invest $20 million, sell investments for $10 million)
•  TNInvestco gets $5 million, State gets $5 million
• Typical VC gets zilch, investor gets $10 million

The key thing to note is that the typical VC is makes nothing (other than management fees) unless a fund makes money for investors.  This serves to align the fund manager's incentives with the profitability goals of the fund investors.

In contrast, a TNInvestco fund manager makes a substantial amount unless the fund is a total failure.  

Bottom line, TNInvestco creates incentives for the managers to not lose money, as opposed to the high level of risk taking that is typical to venture capital.  One would expect safer investments. 

Stay tuned for what the audit uncovers.