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 creates opportunities for rivals to hire women, and make the same goods at lower cost. This is 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.

HT:  MarginalRevolution.com 

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 http://trialandstderror.com/  "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 athttp://trialandstderror.com/ but not copied without permission from Froeb luke.froeb@vanderbilt.edu.

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

REPOST: Management matters

in exactly the way that economists would predict, both across countries:

Income differences between rich and poor countries remain staggering, and these inequalities are in good part due to unexplained productivity gaps , ..., US productivity is more than 30 times larger than some sub-Saharan African countries. In practical terms, this means it would take a Liberian worker a month to produce what an American worker makes in a day, even if they had access to the same capital equipment and materials.

and across firms within a country:

This huge productivity spread between countries is mirrored by large productivity differences within countries. Output per worker is four times as great, and TFP twice as large, for the top 10% of US establishments compared to the bottom 10%, even within a narrowly defined industry like cement or cardboard box production (Syverson 2011). And such cross-firm differences appear even greater for developing countries (Hsieh and Klenow 2009).

A new survey relates these differences to management practices:
we rated companies on their use of 18 practices, ranging from poor to non-existent at the low end (for example, “performance measures tracked do not indicate directly if overall business objectives are being met”) to very sophisticated at the high end (“performance is continuously tracked and communicated, both formally and informally, to all staff using a range of visual management tools”)...
The large, persistent gaps in basic managerial practices that we document are associated with large, persistent differences in firm performance. Better-managed firms are more productive, grow at a faster pace, and are less likely to die. 

HT: marginalrevolution.com

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.