Monday, December 9, 2019

Find the problem before you own it

All of these companies could have benefitted from the advice of Chapter 19, "Anticipate adverse selection."  
  • in 2016, Marriott acquired Starwood for $13.6 billion, unaware that Starwood's reservation system had been attacked which exposed personal data of nearly 500 million of its customers.
  • In 2017, Verizon discounted its original $4.8 billion purchase price of Yahoo by $350 million after it learned--post­ acquisition--of the latter's data breach exposures. 
  •  In 2016, Abbott announced the acquisition of St. Jude Medical, a medical device manufacturer based in Minnesota, only to learn of a hacking risk in 500,000 of St. Jude's pacemakers a year later in 2017. Abbott ending up recalling the devices.    
BOTTOM LINE:  when purchasing an item of unknown value (you don't know whether a target acquisition has hidden liability associated with data breaches), anticipate that the target may have better information than the acquirer which would make the target more likely to sell because the target knows it is not worth what the acquirer has offered.  Acquirers should "find the problem before they own it." (HBR Article)

Evidence that acquirers are anticipating adverse selection:  After the EU adopted stricter liability associated with data breachers in the form of GDPR, venture capitalists were less likely to invest in startups or and a number of deals fell apart:
  • One study estimated that venture capital invested in EU startups fell by as much as 50 percent due to GDPR implementation. (NBER)
  • “55% of respondents said they had worked on deals that fell apart because of concerns about a target company’s data protection policies and compliance with GDPR” (WSJ)
HT:  Danny Sokol &

Tuesday, December 3, 2019

Paying People to Lie: The Truth about Corporate Budgeting

Michael Jensen's timeless classic is available here.  In it he describes how stock market analysts set earnings expectations for a company's stock.  Since the CEO is paid in stock options which will decline in value if earnings fall short of analysts' expectations, the CEO wants to ensure that each division makes enough money to meet analysts' expectations.  In consultation with division managers, she turns analysts' earnings expectations into performance metrics, with each division manager's bonus tied to meeting her division's share of company earnings. 

With these incentives, each division manager has an incentive to understate (or lie about) how much her division can earn.  As a result, the negotiated division budgets need not reflect what managers actually know.   Important decisions are then made based on based on budgets constructed from lies.

Fortunately, there is an easy fix:
 [by]...changing the way organizations pay people. In particular to stop this highly counterproductive behavior we must stop using budgets or targets in the compensation formulas and promotion systems for employees and managers. This means taking all kinks, discontinuities and non-linearities out of the pay-for-performance profile of each employee and manager. Such purely linear compensation formulas provide no incentives to lie, or to withhold and distort information, or to game the system.
With a linear compensation scheme, there is no incentive to understate how much a division will earn.  And with better information, better decisions are made:

I believe that solving the problems could easily result in large productivity and value increases - sometimes as much as 50 to 100% improvements in productivity.

Sunday, December 1, 2019

Sales "bunching" and high-powered commission rates

Ian Larkin studies the use of "high powered" quarterly sales commissions, used by virtually every firm that sells software. A typical incentive compensation scheme (as a function of sales) is highly convex: a sales person earns 2% if she sells $100,000 worth of software; 5% if $500,000; 8% if $1,000,000, ..., up to 25% if $8,000,000.

Ian finds that these high-powered (convex) compensation schedules give sales people an incentive to "bunch" sales into the same quarter. Just as convex production costs can be reduced by "smoothing", i.e., holding inventories to buffer sales shocks, so too can convex commissions be increased by "bunching" sales into the same quarter, the opposite of "smoothing."

Using proprietary data from a large vendor he finds that 75% of sales are occur on the last day of the quarter; and 5% of sales occur on the first day of the quarter, as sales people give discounts to customers to accelerate or delay purchases. These discounts cost the firm about 7% of revenue, which is about the same amount that it pays out in sales commissions.

The 7% revenue loss suggests that there is a way to make both firm and its salespeople better off: adopt linear commission schemes to eliminate the incentive to "bunch," and split the 7% savings between the firm and its sales people in the form of higher commission rates.

When asked why they use these costly incentive compensation schemes, managers say only that they need them to retain their "superstar" sales people. But surely there is a better way to retain superstars, isn't there? As always, I would like to hear from readers on whether they think this would work.

Saturday, November 30, 2019

What is the best way to increase demand for your service?

Get the government to make it illegal not to buy! has a nice post about the "Optometry Racket:"
In every other country in which I’ve lived, can simply walk into an optician’s store and ask an employee to give you an eye test, likely free of charge. If you already know your strength, you can just tell them what you want..—no doctor’s prescription necessary. ...
 The excuse for the law is that eye exams can discover other problems. ... [But] the requirement to get a medical exam from an optometrist who has spent a minimum of seven years in higher education ... creates unreasonable costs—and unjustifiable suffering….

Here is an issue that everyone but Optometrists would support:  put Americans in charge of their own vision care, and abolish mandatory eye exams!

Wednesday, November 27, 2019

Taxes & transfers redistribute income

IN the graph above, the share of income earned by the top 1% is plotted against time.  Based on pre-tax income, it looks as if the share has doubled.  But this does not take account of our progressive tax system and government transfer payments, like Medicaid, (bottom line).  The after-tax and after-transfer shares of the richest look pretty flat.  

HT:  Greg Mankiw

Thursday, November 21, 2019

Incentives matter: physicians perform fewer surgeries on smokers

The move towards fixed fees, and away from fee-for-service, has given physicians an incentive to get their patients as healthy as possible before surgery, so that there are fewer complications.  Under a fixed fee system, e.g., $20,000 for a joint replacement, the surgeon makes less money if there are complications.
“A year from now, I’ll probably be at a point where I would require all my patients to stop smoking,” Spector said. “Currently, I evaluate it on a case-by-case basis. Over time, we’re going to feel comfortable being a little more stringent with our patients about these modifiable risks.” 
Edwards said he finds many patients “don’t take it well at first” when he advises them to quit smoking or lose weight. But many of them thank him later.

Wednesday, November 20, 2019

Moral hazard in parachuting

What happens when you make parachuting safer? 

People take more risks!
HT: Benjamin W.

Tuesday, November 19, 2019

Holiday book recommendations (add your own in the comments)

This year's book recommendations are below, in the order I would recommend them.  Click on the links for my blog posts that reference the book. 

Shoe Dog
An Economist Walks into a Brothel
Rising Strong (squishy, but good)

Last year's recommendations are copied below--the first two are highly recommended. 

Friday, November 30, 2018

Thursday, November 14, 2019

Sapiens, a brief history of humankind (2015)

The scope of the book Sapiens is extraordinary.  From the birth of our species, about 150,000 years ago until about 70,000 years ago, we were just another unremarkable "Great Ape."  Then about 70,000 years ago, we went through what Harari calls the "Cognitive Revolution," and we began to
...behave in far more ingenious ways than before, ... and we spread rapidly across the planet. About 11,000 years ago we enter on the agricultural revolution, converting in increasing numbers from foraging (hunting and gathering) to farming. The "scientific revolution" begins about 500 years ago. It triggers the industrial revolution, about 250 years ago, which triggers in turn the information revolution, about 50 years ago, which triggers the biotechnological revolution, which is still wet behind the ears. Harari suspects that the biotechnological revolution signals the end of sapiens: we will be replaced by bioengineered post-humans, "amortal" cyborgs, capable of living forever.  [Guardian Book review

Harari's grand vision is compelling, and his writing is engaging and fast moving.  So fast, in fact, that when you take time to dissect and critique what he is saying, you will find much with which to disagree.  For example, I would have had capitalism and religion playing a much bigger role in our history.  But this kind of conflict leads to growth, and after reading the book, I think I have a much better understanding of how we got here and, maybe, where we are going.

The book exhausted me, and I am reading some fiction before I go to the next two books in his trilogy.

Harari meditates for two hours every day, and goes on a 60-day silent retreat each year.  He attributes his extraordinary productivity (three books in three years) to this practice:

... It's so difficult, especially when you deal with long-term history, to get bogged down in the small details or to be distracted by a million different tiny stories and concerns. It's so difficult to keep reminding yourself what is really the most important thing that has happened in history or what is the most important thing that is happening now in the world. The discipline to have this focus I really got from the meditation.

This was enough to get me back to my paltry 15-minute prayer discipline.

Tuesday, November 12, 2019

Is this collusion?

We report, you decide:
If you are looking for an interesting case to discuss with your classes, I recommend to you the Commission’s complaint against Valassis.  The product at issue in the case was free-standing inserts – the booklets of coupons that come in Sunday newspapers. Historically, two companies each had about half the market – Valassis and News America Marketing, a subsidiary of NewsCorp. According to the complaint, in June 2001, Valassis raised its prices by 5%. When News America did not follow suit, it gained market share.

With News America sticking to its old prices, Valassis decided in February 2002 to abandon its attempts to raise prices and instead to try to regain its lost market share. From February 2002 until the middle of 2004, a price war ensued, with prices dropping more than 15% from those that prevailed in June 2001. At that point, the complaint alleges, Valassis decided to give up on recovering its market share and instead decided to raise prices. It did not, however, want to repeat the experience of raising prices without having News America follow suit. As a result (again, according to the complaint), Valassis decided to communicate its plans during a stock analyst conference call. In that call, the CEO announced 1) that it was raising its prices, 2) that it would not cut prices in order to attract News America’s customers, 3) that it would cut prices to whatever it had to in order to retain its existing customers, and 4) it would only stick with its strategy if News America made it clear that it was not going to try to take Valassis’s existing customers. It even provided details about specific outstanding pricing offers. The text of the conference call is available as Exhibit A to the Commission’s complaint in the case. I suggest you take a look at it and consider using it as case material in your courses.

Monday, November 11, 2019

Does a sense of fairness make us better bargainers?

Most ultimatum games, in which one player makes a take-it-or-leave-it offer to another, result 60-40 splits.  This occurs because the player making the offer knows that their offers will be rejected if seen as too "unfair." Some hypothesize that this notion of fairness makes us better bargainers so there might be some evolutionary basis for passing on a sense of fairness.

See how monkeys behave when they get an unfair payoff.

Friday, November 8, 2019

The benefits of being WEIRD (Western, Educated, Industrialized, Rich, Democratic)

Reputation and trust can solve a lot of business problems, like post-investment hold-up or free riding. It turns out that WEIRDo's (about 12% of the planet) have been successful, in part, because they manage to build and maintain reputations and trust more easily than others. 

 WEIRDos are more individualistic and independent, less conformist and obedient, more likely to favor “impersonal prosociality” — the idea that one set of moral rules should govern how you treat everyone, from the most distant stranger to your nearest kin. This seems normal to them, but in a global context, WEIRD people really are extremely weird. And as modernity erodes the last vestiges of traditionalism, they are probably getting WEIRDer and weirder by the day.  
 …More specifically, Western Christianity; the number of years that one’s ancestors were exposed to the medieval Catholic Church correlates pretty nicely with things like social trust, creativity and willingness to do things like donate blood — and correlates negatively with traits such as nepotism.

The world abounds in spurious correlations, of course. But the authors of “The Church, intensive kinship, and global psychological variation” propose a very plausible mechanism: the Catholic Church’s extreme obsession with incest, which isn’t found in the Eastern Orthodox branch. The church kept banning marriages between more and more distant relations, up to sixth cousins, which smashed the tight kin-based networks common to agricultural cultures.


Wednesday, November 6, 2019

Is predatory pricing profitable?

Predatory pricing is rare, at least in the US, because it is an investment that rarely pays off.  After an incumbent firm drives an entrant out of the market by pricing low (and deliberately losing money), the incumbent must be able to recoup the lost money by raising price--without attracting more entry--when the entrant exits the industry.

Perhaps the best examples of predatory pricing come from the airline industry, when the Department of Justice brought several cases in the 1990's.
Probably our best known airline predation investigation involved Northwest's response to Reno Air's entry into the Reno-Minneapolis city-pair in 1993. Not only did Northwest institute service of its own on this route that it had previously abandoned, it also opened a new mini-hub in Reno that overlaid much of Reno Air's own operation. Our investigation was well under way when the matter was resolved because, with the intervention of the Department of Transportation, Northwest decided to abandon its overlay of Reno Air's hub operation.

See here why these cases are so hard to win.
In other words, the government needs to prove that the low fares and extra flights would prove financially ruinous if continued indefinitely. To make the argument stick, the government will have to prove that American could reasonably expect to recover its losses after Vanguard or Sun Jet exits the market by raising fares -- confident that its high fares would not attract another round of upstarts.

RELATED:  DOJ loses predatory pricing case against American Airlines

Tuesday, November 5, 2019

What happens if we reduce drug prices by 70%?

Senator Warren's proposed policy fails a benefit-cost test:

Between 1982 and 2015, for example, the US saw the launch of 719 new drugs, the most of any country in the sample; Israel had about half as many launches. By looking at the resultant change in each country between mortality and disease, Lichtenberg calculated that the years of life lost before the age of 85 in 2013 would have been 2.16 times as high if no new drugs had been launched after 1981. For a subset of 22 countries with more full data, the number of life-years gained in 2013 from drugs launched after 1981 was 148.7 million.

Monday, November 4, 2019

How does Google auction ads?

Note the analogy to second price auctions--the highest rejected bid determines the price.  Because advertisers do not pay what they bid, they are willing to bid their values.

Fight in the Eurozone about negative interest rates

New EU Bank Head Christine Lagarde, pushing for lower interest rates and a weaker euro, said "We Should Be Happier To Have A Job Than To Have Savings," appealing to voters as producers, not consumers.

Lagarde's direct attempt at shaming Europe's fiscal conservatives was nothing short of shocking: normally ECB officials avoid naming individual countries in public statements, because their mandate is to act in the interests of the eurozone as a whole. But when Lagarde made her speech she had not yet officially taken over at the Frankfurt-based institution — she succeeds Mario Draghi on Friday.

We somehow doubt this "explanation" will fly with the German population, which sees itself as funding peripheral Europe's profligate ways for the past decade, even as it benefited from the weak euro to supercharge the German export machine.

Lower interest rates weaken the Euro because fewer people want to keep savings in euros at such low rates (they sell euros and, e.g., buy dollars to invest in the US), and more people want to borrow in euros (the carry trade), change euros to, e.g., dollars to invest in the US.  This weakens the euro relative to the dollar, which increases employment in the EU via an increase in export demand.  But EU consumers are hurt by higher import prices.


Sunday, November 3, 2019

Switzerland vs Sweden

NY Times on Sweden:
Die-hard admirers of Scandinavian socialism overlook the change of heart in countries such as Sweden, where heavy government spending led to the financial crises of the 1990s. Sweden responded by cutting the top income tax rate from nearly 90 percent to as low as 50 percent. Public spending fell from near 70 percent of G.D.P. to 50 percent. Growth revived, as the largest Scandinavian economy started to look more like Switzerland, streamlining government and leaving business more room to grow.

Same article on Switzerland:
Capitalist to its core, Switzerland imposes lighter taxes on individuals, consumers and corporations than the Scandinavian countries do. In 2018 its top income tax rate was the lowest in Western Europe at 36 percent, well below the Scandinavian average of 52 percent. Government spending amounts to a third of gross domestic product, compared with half in Scandinavia. And Switzerland is more open to trade, with a share of global exports around double that of any Scandinavian economy.


Friday, November 1, 2019

Never start a land war in Asia (or a price war)

Competition has brought pizza prices down to $0.75/slice in a midtown Manhatten, with a predictable response:

... [One of the competitors] Eli Halali made it clear that 75 cents was a temporary price point. He said he could not make money at that level and eventually would return to $1. He said that if Bombay/6 Ave. Pizza went back to $1, he would as well.

This public statement seems like what the FTC called an "invitation to collude" in its suit against Vlassis who made a similar offer to end a price war with News America:

If News America continued to compete for Valassis customers and market share, then Valassis would return to its previous pricing strategy, and the price war would resume.

..., Valassis made the foregoing proposal with the intent to facilitate collusion and without a legitimate business purpose. ... Valassis’ statements described with precision the terms of its invitation to collude to News America. If the invitation had been accepted by News America, the result likely would have been higher FSI prices and reduced output

FSI refers to newspaper inserts, the product in question.

HT: Greg Mankiw

Tuesday, October 29, 2019

Hard to Find Good Hitman

Outsourcing is fraught with perils. You give up some control over product quality and your supplier has different incentives. That is what happened when the Chinese businessman, Tan Youhui, sought to take out a competitor, Wei Mou. Not having the requisite skill set himself, he hired a hitman. But the hitman outsourced it to another hitman for half the contract value. Who then outsourced it again. Who then outsourced it again. Eventually, the fifth in the chain became incensed at how much the value of the contract had fallen, which eventually led to the police finding out about the plot.

Privately funded, Randomized Control Trials for policy

Results from the first four RCT's funded by Arnold Ventures.

Here are the results for charter schools:
The study found that students who won a KIPP middle school admissions lottery were 6 percentage points more likely to enroll in a four-year college than students who lost the lottery (47% of lottery winners enrolled vs. 41% of lottery losers). We view this finding as highly suggestive but not yet strong evidence of an effect because it did not quite reach statistical significance (p=0.085). The study also found a 4 percentage point increase in the rate of persistence through the first two years of a four-year college (30% vs. 26%), but this finding was not statistically significant and so is preliminary and not reliable (p=0.23). These effects of winning a KIPP lottery (i.e., the “intention-to-treat” effects) are the primary study findings based on the researchers’ pre-registered analysis plan.

However, only 68% of students who won a KIPP lottery actually enrolled in a KIPP school. In an exploratory analysis, the study found that the effect on these 68% (i.e., the “treatment-on-treated” effect) was a 9 percentage point increase in enrollment in a four-year college and a 6 percentage point increase in persistence. The enrollment effect approached statistical significance (p=0.085); the persistence effect did not. [2]

I am left wondering whether this effect is biased due to the presence of competition, e.g., there is some evidence that public schools get better when a competing charter schools opens up.  If so, control group students who went to a public school that also gets better, would bias the estimated effect towards zero.   

HT:  David S.

Monday, October 28, 2019

How many economists does it take to eliminate discrimination against women?

None--the market will do it. If enough employers indulge a taste for discrimination (animus based) against women, this can creates opportunities for rivals to hire women, and make the same goods at lower cost. This seems to be happening in South Korea where US firms are hiring over-qualified, and under-employed Korean women:

Jordan Siegel of Harvard Business School reports that foreign multinationals are recruiting large numbers of educated Korean women...., lifting the proportion of a firm’s managers who are female by ten percentage points raises its return on assets by one percentage point...

In contrast to animus based discrimination, statistical discrimination is profitable.

Sunday, October 27, 2019

Why is PG&E shutting down power in California?

The incentives are clear:  to avoid liability from fires caused by its power lines.
PG&E filed for bankruptcy in January after amassing tens of billions of dollars in liability related to two dozen wildfires in recent years. As speculation grew that its equipment might be the cause of the Kincade Fire, its stock price plummeted about 30 percent on Friday to $5.08, a small fraction of its 52-week high of $49.42.

Liability laws are designed to give potential wrongdoers (tortfeasors) incentives to take appropriate care (by investing in safety measures), so that they do not cause too much harm to others.  However, shutting down power causes just as much harm to some consumers as the risk of fire.

A better solution would be to invest more in infrastructure, but PG&E is a regulated monopoly, which means that prices are set by the state.  OK, what are the incentives of the regulators?
the Office of Ratepayer Advocates ... has typically argued against maintenance and safety expenditures, so that rates can be kept low.

OK, now that we understand the problem, run it through the problem solving algorithm of Chapter 1:
  1. Who made the bad decision?  PG&E shuts down its power grid to avoid lawsuits rather than investing in better infrastructure that can withstand high winds.
  2. Do they have enough info to make a good decision?  Yes
  3. Do they have the incentive to do so?  No.  The price regulator wants to keep prices low by preventing PG&E from making costly safety investments that would justify a rate increase.  
Post a better solution in the comments.


UPDATE:  Ted Nordhaus' Twitter Thread

Thursday, October 24, 2019

What isn't for sale? vs. The Market as God

From the Atlantic, What isn't for Sale? lamenting the "commoditization" of society, and calling for a debate about markets:

A debate about the moral limits of markets would enable us to decide, as a society, where markets serve the public good and where they do not belong.

Note the hubris of the framing, as if society can decide what is best for all of us, rather than letting each of us decide for ourselves.

BOTTOM LINE:  This older Atlantic article is much more fun, The Market as God.

HT:  the loyal opposition

Tuesday, October 22, 2019

Sunday, October 20, 2019

Share buybacks move money to higher-valued uses.

Testimony from colleague Craig Lewis (5 minute testimony) who was Chief Economist at the SEC for 3 years:

Why did the Airbus 380 fail?

Above, I show how Airbus "won" the game of chicken between Airbus and Boeing by seizing the first-mover advantage, and began building a jumbo jet, which deterred Boeing from building its own jumbo jet. 

Here is the rest of the story from two students:

The A380 was designed to fly point-to-point (bypassing hubs) with more people but less frequently (it was suppose to disrupt the hub-and-spoke model). This Forbes article supports the idea that this strategy was not as profitable as the existing hub-and-spoke model nor did it serve what the market actually wanted – more frequent routes with more options. On a side note, it looks like there was a lot of political pressure by EU political leaders for AirBus to build the A380 (can anyone say jobs program).

I also think it’s interesting that at the same time AirBus was pursuing the jumbo A380, Boeing was actually planning the phase out of the 747 by replacing it with the existing 777 fleet (a smaller more efficient aircraft that can still handle transoceanic routes) which can still operate within the domestic and international hub-and-spoke model.

If this is true, perhaps Boeing actually wanted AirBus to build the A380 and sink a bunch of money in a project that Boeing felt was doomed to fail because they already knew the 747 jumbo jet didn’t work well within the more profitable hub-and-spoke model. The more I think about this, I don’t think Boeing would have built a larger jet regardless of what AirBus did. I think they were planning to go the opposite way all along.
Quotes from the Forbes article:
“…news reports followed the company line that the A380 was designed to disrupt the airline industry’s hub-and-spoke model of airline operations…”

“…the A380 program will be remembered as a massive money loser. It did, however, achieve its political masters’ goal of employing lots of European aerospace workers and keeping the Continent relevant in the high tech aviation manufacturing world.”

“….But given the power of hubs to collect hundreds and hundreds of travelers a day to funnel into multiple profit-making hubs, airlines weren’t about to abandon that successful operating style….. High frequency service aboard multiple mid-size planes was the model that they believed would continue to produce the most revenue and profits because it better fit what travelers actually wanted – lots of access and relatively low prices – than limited access service on one big plane each day in each market. The economic power of the hub was too obvious for airlines to throw it all away in pursuit of Airbus’ grand vision of a mega-plane flying once a day on major international routes.”
HT:  Sam and Rick

Tuesday, October 15, 2019

3 Randomista's win Nobel prize in economics

...for using Randomized Control Trials to figure out which policies work and which do not. 
Here are some blog posts on information from randomized control trials:

Below is a Ted Talk from one of the winners (I suspect that it would be profitable for business to run more randomized control trials, e.g., to estimate the effects of advertising campaigns.

Why are 600,000 waiting for apartments in Stockholm?

Good article from Economist on how rent control destroys wealth by preventing housing from moving to higher valued uses:
Rent controls are a textbook example of a well-intentioned policy that does not work. They deter the supply of good-quality rental housing. With rents capped, building new homes becomes less profitable. Even maintaining existing properties is discouraged because landlords see no return for their investment. Renters stay put in crumbling properties because controls often reset when tenants change. Who occupies housing ends up bearing little relation to who can make best use of it (ie, workers well-suited to local job opportunities). The mismatch reduces economy-wide productivity. The longer a tenant stays put, the bigger the disparity between the market rent and his payments, sharpening the incentive not to move.

... It is unrealistic to expect politicians to ignore voters’ demands. But the danger is that one abuse of power is replaced by another as renters, just like NIMBY's, campaign for regulations to lock newcomers out of the market. Although today’s residents might benefit from capped rent increases, outsiders, faced with less supply and fewer opportunities, will suffer. Just ask the 636,000 people who were queuing at the end of 2018 for a diminishing stock of rental housing in rent-controlled Stockholm. There, the average waiting-time to find a long-term tenancy is ten years and black-market rentals have begun to thrive. Rent control harms almost everyone eventually because the housing stock deteriorates.

Thursday, October 10, 2019

Learn regression simply

·         PEDAGOGY: The program  "inverts" the problem of teaching regression by asking students to create data by clicking on an (x, y) graph to achieve a given outcome, like a statistically significant regression line. An early version of this program was used to teach Justice Dept. attorneys enough about regression to allow them to cross-examine rival experts.

·         © 2019, Luke M. Froeb & Keyuan Jiang. The program may be freely used at but not copied without permission from Froeb

Tuesday, October 8, 2019

Conneticut's slow job growth

is likely caused by taxes and regulations that prevent assets from moving to higher valued uses:

  • ...the governor raised taxes on Connecticut residents by about $1.7 billion over two years, mostly in the form of various new sales taxes. 
  • [the governor] “refinanced” pension payments to state employees. The agreement with the unions doesn’t reform the system but shorts contributions by $2 billion through 2032, only to increase the taxpayer’s obligation by $5 billion from then until 2047. 
  • a 6.5 percent pay increase for state troopers and an 11 percent increase for assistant attorneys general.  
  • a $15 statewide minimum wage and workers will be hit with a new 0.5 percent payroll tax to fund a mandatory paid-leave program.

Monday, October 7, 2019

What could possibly go wrong?

In August the knights of the Business Roundtable announced that they are putting “stakeholders” ahead of shareholders as their primary business purpose.

Senator Warren sent the Roundtable a letter saying that she "expects" them to "live up to their promises" by endorsing her bill to change the way that capitalism works:

...Every company with revenue of more than $1 billion would have to obtain a new federal charter, in contrast to the current system of state charters.
Instead of serving the interests of the shareholders who own the company, CEOs and directors would have to serve some combination of “the workforce,” “customers,” “the local and global environment” and “community and societal factors.” 

UPDATE:  Why An Elizabeth Warren Presidency May Not Be Catastrophic For The Market

Wednesday, October 2, 2019

How did Blockbuster's CEO solve the double marginalization problem?

Hal Varian's (Chief Economist at Google) tells the story of Blockbuster (a video "rentailer") and its distributors who suffered from "double marginalization" or "the double markup problem." In other words, competition between firms selling complementary products results in a price that is too high and output that is too low:
Consider, for example, video tape rental industry. Prior to 1998, distributors sold video tapes to rental outlets, which proceeded to rent them to end consumers. The tapes sold for around $60 apiece, far in excess of marginal cost. The rental stores, naturally enough, economized on their purchase, leading to queues for popular movies.

The old contractual form suffered from double marginalization, which resulted in video rental prices that were too high and output that was too low.

The Blockbuster CEO recognized this as a problem and proposed a solution:

In 1998 the industry came up with a new contractual form: studios provided video tapes to rental stores for a price between zero and $8, and then split revenue for rentals, with the store receiving between 40 and 60 percent of rental revenues.

Although the stores marginal revenue was cut in half, the marginal cost of a video went down by about 90%.  As a result,

.. these contracts increased revenue of both studios and rental outlets by about 7 percent and consumers benefitted substantially. Clearly, the revenue sharing arrangement offered a superior contractual form over the system used prior to 1998.

 This arrangement is subject of course to verification of the downstream revenue by the upstream distributor.  New "smart" cash registers at Blockbuster made this possible:

The interesting thing about this revenue-sharing arrangement is that it was made possible only because of computerized record keeping. The cash registers at Blockbuster were intelligent enough to record each rental title and send in an auditable report to the central offices. This allowed all parties in the transaction to verify that revenues were being shared in the agreed-upon way. The fact that the transaction was computer mediated allowed the firms to contract on aspects of the transaction that were previously unobservable, thereby increasing efficiency. 

More of Hal Varian's insights about economics (there are some good stories here) can be found in his popular columns.  He is most famous to MBA's for saying that "marketing is the new finance," urging the Quants, who used to go into finance, go into marketing instead.

HT:  Vlad Mares

Tuesday, October 1, 2019

NY Times should read Chapter 9

Former student John Tamny wrote a nice essay critiquing a NY Times critique of capitalism:
...Wu’s assertions about U.S. corporations wholly focused on profit without regard to “employees, suppliers, customers, and the communities to which they belong” would have meaning if he could produce evidence that the best get that way while running roughshod over the aforementioned. 

John is implicitly referring to the compensating differentials of Chapter 9 (which he has read). Remember that a mobile asset has to be indifferent about where it is used.  Workers will move to the better company, and the migration will continue until wages adjust so that employees are just indifferent between the two.  In this new equilibrium, workers will be compensated with higher wages for working at the bad company.

Labor markets punish companies that mistreat workers by making them pay for their mistreatment.

Monday, September 30, 2019

REPOST: Screening out the "social" entrepreneurs

Funding early stage ventures presents a HUGE adverse selection problem:  How do capitalists find the twenty-something entrepreneur committed to making money for his or her investors, and screen out those who want to be entrepreneurs because it supports their lifestyle?  Here are four different ways:
  •  Mr Hommels employs a subtle test of character. During a chat about funding, he deliberately changes the subject. “The cool entrepreneur will immediately get back to the topic and not be a social talker,” he reckons. “The good ones are more focused.”
  • Mr Lobato’s test is more direct. “I get edgy and unpleasant,” he says. “I want to see what their reaction is. For them, I’m a means to an end. It shouldn’t matter how unpleasant I get. I want to see that they behave rationally and understand they need to get what they need to succeed.”
  • Danny Rimer, a partner at Index Ventures, a global tech fund, says an obvious turn off is an entrepreneur keen to discuss a quick “exit”. He doesn’t want to hear how they plan to sell out to Google or Facebook within a couple of years. Instead, he wants to hear how their company will be around for another decade.
  • And sometimes, obnoxious overconfidence has the karmic effect it deserves. “I had a pitch from an entrepreneur once,” Mr Rimer recalls. “She said: ‘I am the American dream.’ That was a tell-tale sign.”

Thursday, September 26, 2019

REPOST: New Harmony and the results of socialism

Each year, I begin teaching capitalism to our executive MBA's at the conference center in historic New Harmony, site of a failed socialist experiment.  The irony is funny (other posts on the topic seem convincing), but it is important to remember our history, lest we repeat it.
The term “socialism” was coined by followers of Robert Owen (1771-1858), whom Karl Marx would label a “utopian socialist.” In 1825 Owen founded New Harmony, an Indiana commune, to demonstrate the superiority of what was first called the “social system.” The same year, Owen explained his experiment to a joint session of Congress attended by Supreme Court justices, President James Monroe and President-elect John Quincy Adams. Although Owen poured his fortune into it, New Harmony collapsed in disarray and recrimination within two years.

Owen’s son Robert Dale Owen salvaged the community by implementing what he called “a policy the very reverse” of socialism: “giving each respectable citizen every facility and encouragement to become (what every adult ought to be) a landed proprietor.”

Undeterred, others founded some 40 to 50 similar communes during the 19th century, and all collapsed quickly. New Harmony’s two years proved to be their median lifespan.

Most telling is that the one socialist experiment which succeeded was abandoned because its people realized, collectively, that they could be much better off on on their own.
Successful socialism has been created in only one place on earth, the kibbutzim of Israel. They were democratic and egalitarian; sharing possessions, meals, even child rearing. But once the Jewish state was securely on its feet, kibbutzniks chose to switch to private enterprise. Socialism, they learned to their surprise, was not a happy way to live.