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!  MarginalRevolution.com has a nice post about the "Optometry Racket:"
In every other country in which I’ve lived, ...you 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

Which organizational forms can best adapt to change?

One of the themes in this blog is that it is not necessarily the strongest firms that survive, but the most adaptable.  Kodak once dominated the film industry but now it is bankrupt.  How did this happen?

Part of the fault lies with Kodak's centralized structure which was slow to react to the expiration of its patents, and the advent of digital photography.  Colby Chandler, former CEO of Kodak, admitted as much at the 1984 annual meeting:
Like many companies, we are not used to working in an environment where there is rapid technological transfer from laboratory to the marketplace. But we know that will be important in our future.
In 1984, in the hopes of encouraging innovation, Kodak decentralized decision making to 17 different business units with profit and loss responsibility.  However, the decentralized decision making was not accompanied by incentive pay.  Instead, small bonuses were doled out by officious bureaucrats, according to office politics. 

As a result, Kodak continued its slow decline, and in 1993 the board of directors fired its CEO for not holding its managers accountable for failure.  This year, Kodak entered bankruptcy.

The moral of the story seems clear to me:   decentralized decision making is better for adapting to technological change, but only if accompanied by strong incentive pay.  This may be the reason that much of certain types of innovation is done by small firms:  owner/operators have the strongest incentives to perform. 

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

A novel way to screen using the felony box

A student told me how his company used the felony box (previous posts) to screen out bad applicants
Being a felon did not rule you out from being hired to work for my company.  Instead, we used the box to see if the job applicant was truthful about their felony past.  We did not hire those who (i) had a felony record and didn’t disclose it; or (ii) lied when filling out the explanation of the charges.  
However, we did hire those who disclosed truthfully (except for certain crimes), and found them to be good employees.

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. 

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

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

Friday, November 30, 2018

Sunday, November 17, 2019

Using credit history to price car insurance

In 2007, the FTC's Bureau of Economics just relased their FACTA study, which concludes that:
  1. Credit scores effectively predict ... the total cost of [auto insurance] claims.
  2. Credit scores permit insurers to evaluate risk with greater accuracy, which may make them more willing to offer insurance to higher-risk consumers ... . [note: this is why you can call up GEICO, let them look at your credit report, and get an auto insurance quote over the phone].
  3. ..as a group, African-Americans and Hispanics tend to have lower scores than non-Hispanic whites and Asians.
  4. ...scores effectively predict risk of claims within racial and ethnic groups.
  5. The Commission could not develop an alternative scoring model that would continue to predict risk effectively, yet decrease the differences in scores among racial and ethnic groups.
So even though credit scores help insurance companies price insurance more accurately, point 3 implies that some groups pay more, on average, than others. The policy issue behind the study is whether the government ought to ban the use of credit history for anything but making loans. As point 4 implies, banning the use of credit scores would result in higher prices for good drivers, regardless of their race or ethnicity.

Theory tells us that in states which ban the use of credit scores to price insurance (California and Massassachusetts) insurance companies would find it more costly to distinguish high from low risks, so they may lump them together (called "pooling"), and price insurance at the average risk. Or they may be concerned that only high risks would be willing to buy high-priced insurance (what economists call "adverse selection") and price high or, if price controls prevent high prices, exit the market.

I would be curious if any of our readers know of novel uses of credit scores as a screening mechanism, or if they have developed better predictors (point 5) in a particular application, like pricing insurance or screening job applicants.

Friday, November 15, 2019

Time to Experiment with Price Transparency in Health care

For ten years, Vanderbilt students have heard about two airport gas stations who refuse to post prices.  When travelers stop to fill up, they see a price on the pump that is $2/gallon higher than in the rest of Orlando.  Because few travelers will risk missing a flight to shop for a better deal, there is no pressure on the stations to reduce their outrageous prices.

Our students are amused by the story until they try to complete their first assignment, “find the price for any health care service.”  The assignment is among the most difficult of the semester.  Students learn just how hard it is to shop in an industry that accounts for 18% of the economy.  And just like the gas stations in Orlando, when there is no shopping, there is no competition. 

Ironically, health plans are now giving consumers an incentive to shop.  The average healthcare deductible for the employed population has risen 300% since 2006 to $1573.  On the public exchanges, deductibles are roughly twice that amount.  Now that consumers finally have the incentive to shop, let’s give them the ability. 

Mandating price transparency would make shopping easier, and the resulting price competition could save us billions.  Within the same market, for the exact same service, like a chest x-ray, it is not uncommon for real prices—not the fictitious “charges” that no one pays—to vary by over 400%.  If shopping created enough competition to drive prices down to the lowest of these, we would be able to realize the promise of expanded care through lower prices.   

But there is a tradeoff:  forcing price disclosure could reduce competition between providers to get into payer (insurance company) networks.  The intuition (it is not precise enough to call it a theory) is that if a provider can keep its prices secret, it is more likely to offer discounts to payers. 

Admittedly, losing these discounts is a risk, but even if it happened, the effects of losing payer-provider competition (10-20% from estimated merger price effects) are an order of magnitude smaller than observed price variation within a market.  The potential gain from increasing competition for consumers seems likely to outweigh any potential loss in competition among providers to get into payer networks. 

It's time to experiment.   

  • On the final rule covering hospitals, facilities will have two obligations. First, they will have to provide insurer-specific negotiated rates in a computer-readable file.
  • Second, hospitals will have to post negotiated charges online for 300 specific services that patients typically shop around for. Seventy of those services, including vaginal birth, colonoscopy, and joint-replacement surgery, are stipulated in the rule, according to senior administration officials. Hospitals can select the other 230 services they post online.
UPDATE:  Paper on Transparency and Negotiated Prices
...information on purchasing by peer hospitals leads to reductions in the prices hospitals negotiate for supplies. ...Within coronary stents, reductions are concentrated among hospitals previously paying relatively high prices and for brands purchased in large volumes, and are consistent with resolving asymmetric information problems.

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.

HT:  MarginalRevolution.com

Thursday, November 7, 2019

What is the cost of marriage?

To an economist, the cost of an activity is what you give up to pursue it.

In the year following a divorce, women's living standards fall by 27 percent while men's living standards rise by 10 percent.
Steven Landsburg's classic column on Why Men Pay To Stay Married argues that the difference is a compensating differential, the "price" that men pay to women to compensate them for the relatively unpleasant job of marriage.

If men stay in marriages that cost them a lot of money, that just proves they really like being married. They're getting something they value, and they're paying for it.

When I first read this 8 years ago, I thought it was funny. Now, after 19 years of marriage, I wonder why the price is so low.

The costs of fighting inequality


Following up on an earlier post, Why are there so few unicorns in Europe?Bloomberg suggests an answer straight out of Chapter 1:  the EU limits on incentive pay, particularly on stock options, make it difficult for innovators to align the incentives of employees with the profitability goals of the company:

"...when you’re not highly profitable, you have to incentivize employees on the promise of the upside.”  

Onerous rules and taxation make this difficult to do.  Examples of EU limits on incentive pay:
  • The Dutch capped bonuses for bankers, money managers, and other financial professionals at 20% of base salaries. 
  •  Entrepreneurs must navigate onerous tax rates and restrictions that often make equity sharing and options more trouble than they’re worth. 
  • When employees in Germany exercise options, they have to pay income tax on the difference between the fair market value and the strike price, that runs from 14% to 47.5%. They also pay a 25% capital-gains tax on additional profits when they sell their shares.
In contrast, American employees typically pay a 0% to 20% rate on capital gains when options are redeemed, ...

Chatterbug's COO, sums it up: “I wish we had the same system as the U.S.,” she says. “But they don’t want us to get rich in Germany.”

HT:  Gus B.

ADDENDUM:  when I ask my EU colleagues about the disparity, they point to other factors as well, like bankruptcy codes that discourage risk-taking.

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.

HT:  ZeroHedge.com

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.

HT:  MarginalRevolution.com

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