A business plan built on screening out bad risks

If you can find a way to signal that you are a safe driver, you should be able to get better rates.  Here is how Progressive screens out bad drivers:

You, the consumer, agree to allow Progressive to install a monitor that plugs into your car's onboard diagnostic system. Progressive then monitors how you drive: how far, how fast, how many hard brakes and so on. If Progressive likes what it sees, you can get your bill knocked down by as much as 30% after 30 days. Six months later, you mail the device back and have the opportunity to lock in the discount — permanently. If, on the other hand, Progressive puts you in the naughty category, sorry, no discount.

HT: Micah

Which governments can get out of the way of growth?

John Cochrane reminds us to keep our eyes on the prize:

In the long run, nothing else matters. GDP buys you health, advancement of the disadvantaged, social programs, international security, and climate if you are so inclined. Without GDP, you get less of all.  Economic policy should have one central goal -- get productivity growing again, or (in my view) get out of the way of its growth. This is the one little hope that has not been let out of the policy Pandora's box, focused on everything else right now.

Macroeconomists classify two basic types of growth:  

• More inputs (labor, capital) lead to more output (GDP)
• Technological progress (Total Factor Productivity) increases output for the same level of input.

Here is a graph of the Total Factor Productivity in the US

And here is the change in Total Factor Productivity across countries.  

We have blogged about the dearth of unicorns in the EU,

   

Total Factor Productivity seems to be telling the same story.

Will Resale Price Maintenance Return?

[Orignally posted 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 suing retailers who sell merchandise on eBay at a discount.

tit-for-tat in the New Congress

In a repeated prisoners' dilemma, [play coauthor Mike Shor's online game against 5 different players], the best strategies exhibit the following characteristics: 

• Be nice--no first strikes 
• Be provokable--retailiate immediately if your rival cheats 
• Be forgiving--don't punish cheating too much 
• Be clear--make sure your rival can interpret your moves 
• Dont be envious--focus on only your slice of the profit pie

Tit-for-tat is the winning strategy (examples)

The WSJ reports that new Republican House Speaker is doing exactly what the previous Democratic House Speaker did, in order to deter future abuses of power:

Republicans believe that if they don’t play tit-for-tat like this, Democrats will feel empowered to keep escalating. Maybe if Democrats get the same ill treatment, the GOP thinks, Democrats will revert to better form the next time they’re in the majority.

Of course, this works only in an evenly divided Congress. If one party gains the majority for a long time, it need not fear retaliation.

Play the repeated prisoners' dilemma

By playing against one of five types you learn how to sustain cooperation:

1. Be nice--no first strikes
2. Be provokable--retailiate immediately if your rival cheats
3. Be forgiving
4. Be clear--make sure your rival can interpret your moves
5. Dont be envious--focus only on your slice of the profit pie

HT: Jordan

When are between group differences evidence of discrimination?

WSJ: Disparity doesn't necessarily imply Racism 

To measure the effects of discrimination, one has to rule out skills, education, or other factors that could explain between-group differences. 

To understand this, go to LearnRegression.com and click on the "Differences between groups" page.  Then click on the X,Y graph to create data that shows two things:  (i) a  statistically significant mean difference in Y for the blue and black groups:And (ii):  once we account for the differences in X, the between-group differences lose statistical significance:

 

The author finds the same pattern in data for "unemployment, teen pregnancy, incarceration and other outcomes."

The solution isn’t to look away from discrimination. It does exist. But we also can’t point at every gap in outcomes and instantly conclude it’s racism. Prejudice must be measured rigorously. Statistically. Disparity doesn’t necessarily imply racism. 

Housing bubbles in Australia, Canada, and Sweden?

The Economist:

House prices are now starting to fall after years of vertiginous growth. And it is overheated markets, overheated markets, like those in Australia, Canada and Sweden, that are facing some of the sharpest drops. A mortgage binge fuelled by rock-bottom interest rates has left each country with enormous quantities of household debt. As a share of disposable income, such debt sits at 185% in Canada, 202% in Australia and 203% in Sweden. By contrast, debt levels have shrunk in countries that bore the brunt of the last crash, including America, Ireland and Spain (see chart).

ver·tig·i·nous: /vərˈtijənəs/ adjective, causing vertigo, especially by being extremely high or steep.

Mercedes "crimps" its electric vehicles

Mercedes is degrading the acceleration of some electric vehicle models in order to offer two products, at different prices, to appeal to high and low value consumers.  Classic indirect price discrimination:

Mercedes-Benz is the latest auto manufacturer to unveil a subscription fee to unlock perks, such as the ability to boost acceleration. 

The $1,200 yearly subscription is called "Acceleration Increase" and can be found on Mercedes' online store. 

"COMING SOON - Accelerate more powerfully: increase the torque and maximum output of your Mercedes-EQ," reads the description on the online store. It's available for all upcoming EQ electric models that will "improvement in acceleration of 0.8 to 1.0 seconds (0-60 MPH)."

Similar to what Tesla's does with range (Tesla "Crimping?")

Tesla "Crimping?"

Alex Tabarrok over at Marginal Revolution thinks Tesla may have unwittingly committed a marketing faux pas. As Hurricane Irma bears down, they expedited an over-the-Internet update to the cars' software to extended battery life.

Tesla owners in Florida may be grateful for this mileage boost as they escape the ravages of Irma but I suspect that some of them will be upset when they have more time to reflect. How could Tesla increase the mileage at the flick of a switch? The answer is that owners of the Tesla 60kWh version of its Model S and Model X actually have the same battery as the 75kWh vehicles but the battery has been purposely limited or “damaged” to provide only 60KWh of mileage. But why would Tesla damage its own vehicles?

The idea of offering both premium and discount versions is common, as is purposely 'damaging' the product one so as to make the discount version perform more poorly than the premium version (i.e. "Crimping").

In this case though, there may have been no deception. There is a report that owners may have opted not to pay for the better battery life.

The real meaning of Thanksgiving

Peter Klein gives us the story of the first Thanksgiving that you never learned in school:

Faced with potential starvation in the spring of 1623, the colony decided to implement a new economic system. Every family was assigned a private parcel of land. They could then keep all they grew for themselves, but now they alone were responsible for feeding themselves. While not a complete private property system, the move away from communal ownership had dramatic results.

 This year I am giving thanks for private property. 

 Related:  Good short video on the how private property saved the Pilgrims, China and Vietnam from our friends at MarginalRevolution University

Netflix's decentralized organizational form

https://jobs.netflix.com/culture

1. encourage independent decision-making by employees
2. share information openly, broadly, and deliberately
3. are extraordinarily candid with each other
4. keep only our highly effective people
5. avoid rules

We can put this "culture" into the taxonomy of our textbook (decision rights, performance metrics, reward schemes):

1. Decision rights are decentralized (employees have tremendous freedom)
• There are virtually no spending controls or contract signing controls. Each employee is expected to seek advice and perspective as appropriate. “Use good judgment” is our core precept.
• Our policy for travel, entertainment, gifts, and other expenses is 5 words long: “act in Netflix’s best interest.” We also avoid the compliance departments that most companies have to enforce their policies.
• Our vacation policy is “take vacation.” We don’t have any rules or forms around how many weeks per year. Frankly, we intermix work and personal time quite a bit, doing email at odd hours, taking off weekday afternoons for kids’ games, etc. Our leaders make sure they set good examples by taking vacations, often coming back with fresh ideas, and encourage the rest of the team to do the same.
• Our parental leave policy is: “take care of your baby and yourself.” New parents generally take 4-8 months.
• Each employee chooses each year how much of their compensation they want in salary versus stock options. You can choose all cash, all options, or whatever combination suits you. You choose how much risk and upside you want. These 10-year stock options are fully-vested and you keep them even if you leave Netflix.


2. Subjective performance metrics designed to identify the highest performer
• We focus on managers’ judgment through the “keeper test” for each of their people: if one of the members of the team was thinking of leaving for another firm, would the manager try hard to keep them from leaving? Those who do not pass the keeper test (i.e. their manager would not fight to keep them) are promptly and respectfully given a generous severance package so we can find someone for that position that makes us an even better dream team.


3. Rewards are set at the highest level (including a "risk premium" to compensate employees for the risk of getting fired)
• To help us attract and retain stunning colleagues, we pay employees at the top of their personal market. We make a good-faith estimate of the highest compensation each employee could make at peer firms, and pay them that maximum. Typically, we calibrate to market once a year. We do not think of these as “raises” and there is no raise pool to divide up. The market for talent is what it is. We avoid the model of “2% raise for adequate, 4% raise for great”. Some employees’ market value will rapidly rise (due both to their performance and to a shortage of talent in their areas) while other employees may be flat year-to-year, despite doing great work. At all times, we aim to pay all of our people at the top of their personal market.

I love this interview question

 

Tell me a time when you went around your manager to make a decision. Why did you do it, and what was the outcome?

The question is so good because the answer reveals so much. 

• If you has never done this, does it mean that you are not very experienced, or that you are a corporate sheep, going along to get along. 
• If you have done this, does it mean that you are following your own agenda rather than trying to implement your company's strategy.  

Using the idea of incentive alignment,(make sure employees have enough information to make good decisions and the incentive to do so), it becomes clear what a good answer might be:

I have gone, and would go, around my manager if I thought I had better information than she did. But if I thought she had considered my point of view, I would defer to her judgement, as she may be trying to achieve goals or have concerns that do not occur to me.   

From Amazon (link)

11/22: Is the stock market over-valued?

Price of a stock is supposed to go close to its value in the long run. But how does one determine value? We have talked about Shiller's P/E ratio. From your Finance class, you know that the "value" of a stock is its discounted future earnings. But cannot observe future earnings, so Shiller used a moving average of past earnings and found that stock prices seem to revert to about 17 times earnings.

The current Shiller P.E Ratio for the S&P 500 is 39.89. Last month the ratio was at 38.68, and a year ago was at 34.51. In fact, the ratio is now at its highest level in the last 20 years.

Another value metric is the total capitalization of the stock market relative to GDP (From Zerohedge).  

How higher interest rates bring down inflation.

 

The above graph shows a sharp drop in mortgage applications (to buy houses).  This is how the Federal Reserve is trying to reduce inflation:  by raising interest rates, they reduce demand for capital spending, e.g., equipment, cars, and houses, where you typically borrow to make the purchase. 

As demand for goods and services falls, their prices start falling as well.  From CalculatedRisk.com

Recently we've seen used car prices down over 10% and framing lumber prices down 33% 

Currently inflation is running close to 9%, and many expect the Fed to keep raising interest rates until the rate of annual price increases drops to around 2%. 

WSJ: EU Doubles Down on Big Government

WSJ reports:

Unlike during the financial crisis, the eurozone crisis and the pandemic, free-spending governments are on a collision course with the [European Central Bank], which has raised interest rates at its fastest-ever pace to cool inflation. The eurozone’s inflation rate rose to 10.7% in October, a fresh high, while price growth in the U.S. slowed to 8.2% in September.

...The IMF last month urged Europe to cut state spending to support central banks in the fight against inflation

As interest rates go up, firms' cost of capital increases, and fewer investments are made, e.g., in capital equipment, in houses, cars. As spending decreases, incomes also decrease because one person's spending is another's income (this is the "Keynesian Multiplier" in your Macroeconomics class).

Benefits of inflation?

The only other time in US history that our debt/GDP ratio was as high as it is today was after WWII (link).  High inflation in the following three years (8.5%, 14.4%, and 7.7%, link) reduced the real amount (in deflated dollars) that we had to pay back. Lenders (debt holders) lost, but borrowers (the US govt) won.

HT:  Cramer

Bidenomics: US turning into France

 You know the President's in trouble when the left-leaning Economist goes off on him:

Joe Biden’s colossal economic stimulus in early 2021 first set inflation on its feverish trajectory, before Russia’s invasion of Ukraine sent prices spiralling further. Voters may soon punish him for it, among other perceived excesses....

Mr Biden has signed three landmark bills, on infrastructure, semiconductors and the environment, which together contain plans to spend $1.7trn. With his executive actions, these amount to full-blown industrial policy. The result is unlike anything seen since Congress threw its weight behind America’s car- and chipmakers in the 1980s. The government will dole out $180bn in subsidies and tax credits to local firms over the next five years. At 0.7% of gdp, that is more than supposedly dirigiste France.

Dirigisme: an approach to economic development emphasizing the positive role of state intervention. The term dirigisme is derived from the French word diriger (“to direct”), which signifies the control of economic activity by the state.

Bank strategies are changing in response to Fed Policy

Wells Fargo, the bank most reliant on Home Mortgages is laying off employees:

The ranks of mortgage loan officers, who mainly earn commissions from closing deals, is expected to drop to under 2,000 from more than 4,000 at the start of the year, according to one of the people. Many salespeople haven’t closed a single loan in recent weeks, this person said. 

And changing strategy:

Among the six biggest U.S. banks, Wells Fargo has historically been the most reliant on mortgages. But that has begun to change under CEO Charlie Scharf, who has said that the bank is looking to shrink the business and focus primarily on serving existing customers.

What happens next in Russia?

From The Economist:

questions that weigh heavily these days on the minds of the Russian elite, its bureaucrats and businessmen, as they observe the Ukrainian army advancing, talented people fleeing Russia and the West refusing to back down in the face of Vladimir Putin’s energy and nuclear blackmail. “There is a lot of swearing and angry talk in Moscow restaurants and kitchens,” one member of the elite says. “Everyone has realised that Putin has blundered and is losing.”

To fill this power vacuum, those who provide support to President Putin's regime may soon re-focus their energies (and armies) on fighting for power in a post-Putin world. 

This is analogous to what happens in a prisoners' dilemma: self interest (struggling for power in a post-Putin world) trumps group interest (supporting Putin's regime).