Why are quarterbacks taken so early in the draft?

 WSJ:

Since 2011, the NFL has had a rookie wage scale, which allocates relatively affordable salaries to each draft pick regardless of position. That means taking a rookie at one of the more valuable positions has the chance to generate enormous surplus value. It’s why, for instance, quarterbacks on rookie deals are so advantageous—teams can get the most from them before they re-sign on contracts that could cost upward of $50 million a year.

In other words, quarterbacks salaries are fixed further below expected value than other positions, so they generate more expected profit for the team.

Note how NFL owners negotiated with current players and came up an agreement that screwed the only people not at the table, future players (college kids).  Nice metaphor for the human condition. 

 Ironically, I am still disappointed by this kind of self-interested behavior. 

HT: Lamar

US v. Google: do complaints have to be internally consistent?

From former DOJ Economist Greg Werden: 

The governments case suggests that its exclusive deals with Apple and Mozilla to be the default search engine on their browsers “allowed Google to maintain its monopoly power [in "general search"] in violation of Section 2 of the Sherman Act.”  

However, the government's brief also suggests that Google's scale is very important, which implies that its scale economies--not its exclusive deals--that maintain Google’s dominant share. 

What does Earth Day teach us about supply?

Around the time of the first Earth Day (1970), Environmentalists were making dire predictions (via Mark Perry): 

• ...world famines of unbelievable proportions.
• some 4 billion people, including 65 million Americans, would perish in the “Great Die-Off.”
• By the year 2000, … there won’t be any more crude oil.
• Lead, zinc, tin, gold, and silver would be gone before 1990.

Why were these predictions so spectacularly wrong? 

ANSWER: If prices increase, producers find more supply or develop alternatives. For example, oil reserves are much bigger now due to technological innovations like directional drilling and shale oil extraction. 

• In 1980, Paul Ehrlich, a Stanford biologist (author of "The Population Bomb,") bet Julian Simon, a Maryland Economist, that prices of five metals (chromium, copper, nickel, tin, and tungsten) would rise due to increased demand from population growth. 
• In 1990, the prices of all five metals had fallen, and Ehrlich lost $1,000.

BOTTOM LINE:  Don't underestimate supply.  

Places like Illinois "are screwed"

The Economist: Declining fertility and declining immigration lead to:

• DEATH SPIRALS: ... the biggest problem is that, once a place starts shrinking, ... there is far more housing available than people to fill it, ... landlords and even homeowners stop maintaining their properties, ... blight spreads .. 
• TAXES PAID BY FEWER PEOPLE: as cities lose population, the cost of providing public services [mostly public pensions] tends to stay about the same. ... the result is that the remaining taxpayers must pay more simply to support the same services. 
• STATE CANNOT PAY ITS PENSIONS: Across Illinois the total burden of unfunded state and local pension liabilities is estimated to be around $210bn, or roughly four times the state’s entire annual budget.
• IL, NJ, WV, have been shrinking for awhile
• In 2021, 14 more states shrank.

McKinsey was wrong: diversity does not improve performance

Econ Journal Watch:

Combined with the erroneous reverse-causality nature of McKinsey’s tests, our inability to quasi-replicate their results suggests that ... they should not be relied on to support the view that US publicly traded firms can expect to deliver improved financial performance if they increase the racial/ethnic diversity of their executives.

Why growth matters

Making the pie bigger ("the growth agenda") means we are not fighting over a fixed pie ("zero sum fallacy"), and it guides decision making, "does this policy increase the size of the pie?"

MarginalRevolution points to a Jason Furman graph showing that a 0.5% growth rate difference between the US and Argentina over the last 120 years has lead to a per capita income in the US that is over three times as large as Argentina's [note exponential scale]

"The last refuge of a vacant liberal mind:" thinking that antitrust can cure inflation

 NYT (12/23):  

As rising inflation threatens his presidency, President Biden is turning to the federal government’s antitrust authorities to try to tame red-hot price increases that his administration believes are partly driven by a lack of corporate competition.

On Christmas 2021, the headline in the NY Times business section was "As Prices Rise, Biden Turns to Antitrust Enforcers."  Larry Summers immediately bashed the idea:

“The emerging claim that antitrust can combat inflation reflects ‘science denial,’ ” tweeted Harvard economist Lawrence Summers, a senior official in the Obama and Clinton administrations. “There are many areas like transitory inflation where serious economists differ. Antitrust as an anti-inflation strategy is not one of them.”

In the late 1970's, at Stanford, I heard John Kenneth Galbraith, the economist in charge of price controls during WWII, call the idea "the last refuge of a vacant liberal mind."  The turn of phrase was so elegant and shocking--at the time, I was a liberal--that it has stayed with me.

Online Marketplace Competiton

Amazon had been concerned with Walmart's and Target's growing presence as online marketplaces. Now Sebastian Herrera at the WSJ reports that their focus has shifted to Temu and Shein. So far, Amazon's US market share is larger than the other four combined. But these newcomers (to the US) believe that this could change. Temu's number of active users is approaching Amazon's, but Temu's revenue per user is much lower.

It is interesting how all of these firms are staking out differentiated products strategies. Walmart and Target leverage their brick & mortar stores, Shein focuses on fast fashion, Temu on deep discounts, while Amazon's logistics muscle allows it a delivery speed advantage.

Flying over Troubled Red Sea Shipping Lanes

 

Since November 2023, there have been 133 reported incidents of shipping attacks by Houthi militia in Yemen, including 14 vessels struck by missiles or drones and 18 vessels hijacked by Somali pirates. This has caused some ships to bypass the Suez Canal in favor of the Cape of Good Hope. But Paul Berger at the WSJ reports on another alternative for some shippers. Some cargo has been diverted to air freight leading to huge increases in rates.

On lanes linking the Middle East and South Asia to Europe, average spot rates rose 46% from February to March to $2.82 per kilogram, a 71% increase from last year. The average global spot rate to ship cargo by air in March rose 7% from a month earlier to $2.43 per kilogram, according to Xeneta. 

Diverse MBA teams perform worse

From "Diversity and Performance in Entrepreneurial Teams" (SSRN): 

• Among the randomly-assigned teams [of MBA students], greater diversity along the intersection of gender and race/ethnicity significantly reduced performance. 
• However, the negative effect of this diversity is alleviated ... [when teams can choose their teammates]
• ...teams with more female members perform substantially better when their faculty section leader was also female. 

Pricing the Atlantic

A WSJ article by Alexandra Bruell reports that three years ago the Atlantic magazine ran a $20 million deficit which led to layoffs. A new boss, Nick Thompson, was tasked with turning this around. Along with editorial changes toward longer investigative pieces rather than breaking news, the Atlantic raised subscription prices 50%. How did he know to do this?

Thompson’s team ran experiments to determine the best way to charge more without alienating new readers. It is offering fewer stories free and no longer discounting subscriptions. Last year, it raised prices for annual subscriptions to $80 from $60 for digital and to $90 from $70 for both print and digital.

Revenue was up 10% last year to close to $100 million and the magazine is now profitable.

What makes people happy?

Economist: Four main factors, explain happiness: 

• Age: Things go downhill from youth to middle age until they reach a nadir commonly known as the mid-life crisis. ... . [Then as people lose] ... vitality, mental sharpness and looks, they also gain what people spend their lives pursuing: happiness.
• Gender: Women, by and large, are slightly happier than men. But they are also more susceptible to depression: a fifth to a quarter of women experience depression at some point in their lives, compared with around a tenth of men. 
• Personality: Neurotic people—those who are prone to guilt, anger and anxiety—tend to be unhappy. ... Whereas neuroticism tends to make for gloomy types, extroversion does the opposite.
• Circumstances: Married, employed, childless, and richer people are happier

Spotify's Complements?

 

Anne Steele at the WSJ reports that Spotify is the leading audio-streaming platform with 600 million users and a 30% market share. Even so, it seems to be struggling. After a couple of rounds of layoffs, some false starts from expansion into podcasting, concert promotion, and audio books, it earned its first quarterly profits since 2022 in the last quarter of 2023. Competition with tech giants Apple, Amazon, and Google have kept margins low - for every dollar it earns on music streaming, it pays $0.70 in royalties.

But its tech giant competitors do not have to earn profits on streaming music. Their other services can be complementary to audio-streaming. For example, Apple would be happy if Apple Music operated at a loss so long as it helped to sell more high-margin iPhones. This is exactly what Netscape complained about in the late 1990s when Microsoft gave the Internet Explorer away for free. Netscape's revenue model was based on the sales of the browser. Microsoft's was based on sales of operating systems. So long as a free browser sold more computers with Windows already preinstalled, Microsoft was happy. How could Netscape compete with free? How can Spotify compete with subsidized competitors?

Steele hints at this problem by suggesting that Spotify could be a takeover target for companies like Microsoft, Netflix, or Tencent. These companies all have services that could be complements for music streaming. They might be willing to subsidize Spotify if doing so sells more operating systems, movies, or video games.

Keeping you from Cutting your Finger Off

The Consumer Product Safety Commission (CPSC) is considering mandating SawStop technology on future table saws. Ben Blatt at The Age does a good job of laying out the issues and providing some numbers. The technology to drop the blade out of harm's way within a few milliseconds is amazing (see video). My table saw is the scariest piece of equipment in this woodworker's shop. 

Let's see if this mandate might be worth it. The article in The Age reports that table saws cause 4,300 amputations every year, more than thousands of other products combined. Almost all of these will be fingers. Maximum workers compensation values for a lost finger range from 20 weeks of pay (a pinky) to 45 weeks (an index finger). The average carpenter's compensation is $63,149 per year or $1,214 per week. This means that if all amputations were prevented a maximum value of the savings would be $24,288-$54,648 per accident, or about $104-$234 million in aggregate. 

The Age also reports that 675,000 table saws are purchased in the US and that the CPSC estimates that the technology would add $338 to $1,210 in costs per table saw. This implies total cost increases of $228-$817 million. So the costs of the mandate are two to three times the maximum benefit.

But it is worse than this. A mandate eliminates choice. SawStop is already available on the market but only has a 2% market share. Those who value this technology can purchase it. Those who place a lower value on it can choose not to. The mandate implies that the government knows better than the 98% of practicing woodworkers and carpenters who have opted out. This little back-of-the-envelope calculation confirms my own decision not to purchase a SawStop. This may be a case for more information disclosure rather than a product mandate.

Do the Rich Pay their Fair Share of Income Taxes?

WSJ :

•  The top 1% of earners in 2021 provided 45.8% of tax revenue;  
•  the top 10% provided 75.8%; 
•  the bottom 50% provided 2.3%. 

 The obvious justification for this kind of inequality is incentives.  If we pay people who create more wealth more, we get more wealth. 

  Claude.ai: 

•  Denmark: The top 10% of income earners in Denmark pay around 28% of all Danish income tax revenue collected. However, Denmark has very high income tax rates across the board compared to the US, with even average earners paying around 36-37% in income taxes. 
•  China: vIncome inequality is high in China, with the top 10% earning around 41% of total national income as of 2015. However, taxes on high incomes in China are relatively low compared to Western nations. The top marginal income tax rate is only 45%. 
• France: the top 10% of income earners pay around 70% of all income tax revenue. 
• Germany: the top 10% pay about 55% of all income tax. 
• UK: the top 10% contribute around 60% of income tax revenue. 
• Sweden, despite high taxes overall, only around 27% of income taxes come from the top 10% of earners due to a more even income distribution. 

So while the exact percentages vary, it is common across developed nations for a relatively small percentage of top earners to contribute a disproportionately large share of total income tax revenues due to progressive tax rate structures. Denmark's flatter overall tax system leads to more evenly distributed tax contributions across incomes.

Music Backed Securities

 

Due to music streaming, many musicians can expect steady royalty streaming. The WSJ has a video that explains how this future income is increasingly being capitalized and securitized. This way, the artist has access to the cash now instead of waiting for the streams to materialize.

FTC vs. Amazon: If there is no solution (remedy), there is no problem (liability)

The FTC asked a Washington court to split its monopolization case against Amazon (earlier blog post) in two: 1. to determine whether Amazon has a monopoly (liability), and then 2. what to do about it (remedy). 

Their argument (not yet posted) likely would be that bifurcation is more efficient because if FTC loses on liability, there would be no need for a remedy trial.  But if the FTC has to litigate both at once, it would change the trial.  The FTC would have to answer the questions "what should they have done differently?"  and "why is the choice they made bad for competition?"  The burden of answering it would fall on the FTC, and its economic expert. 

For example, suppose that the FTC thinks that the source of Amazon's market power is the integration of its fulfillment network with its electronic marketplace, and proposes a remedy to force divestiture of the two.  An economic witness would be forced to admit that divested companies may not perform as well as the integrated one (See Chapters 22, 23), e.g., by creating a double markup problem, or by foregoing some other economy of integration. 

The Dept of Justice brought (I was Chief Economist then), and then lost, the ATT/TimeWarner vertical merger challenge, in part because it could not overcome this burden of proof.

SOME RELATED ACADEMIC WORK:

• Willem H. Boshoff, Luke M. Froeb, Wihan Marais, Roan J. Minnie, Steven Tschantz. Bargaining Competition and Vertical Mergers: The Problem of Model Selection, Review of Industrial Organization (SSRN). 
• Cooper, James, Luke Froeb, Daniel O'Brien, and Michael Vita, Vertical Antitrust Policy as a Problem of Inference, International Journal of Industrial Organization, 23 (2005) 639–664. (SSRN)
• Comment by Frederick Scherer (2005) 
• Comment by Ralph Winter (2005) 
• Reply by authors (2006) 
• Rejoinder by Ralph Winter (2006)

TRUTH IN BLOGGING: I have done consulting work for Amazon.

Post will be updated as information becomes available.  

Would that the EU were as fast at innovating as they are at regulating

 Link:  The European Parliament approved the AI Act, which raises the cost of European innovation.

➵ High-risk AI systems will be assessed before being put on the market and also throughout their lifecycle. People will have the right to file complaints about AI systems to designated national authorities. ➵ Generative AI, like ChatGPT, will not be classified as high-risk but will have to comply with transparency requirements and EU copyright law.

➵ Fines for non-compliance can be up to 35 million Euros or 7% of worldwide annual turnover.

Americans favor SUV's over the environment, ...

...because they are exempt from fuel economy standards:

Because making light trucks held to lower environmental standards was more profitable than building small clean cars, automakers marketed big models, including suvs, enthusiastically. They portrayed them as quintessentially American, embodying freedom, strength and adventurousness. By 2002 light trucks made up a bigger share of light-duty vehicle sales than cars. After the price shock of the 1970s, by the 1990s petrol had become cheaper in America than in other rich countries—so the cost of running a big car did not deter buyers. Such models are convenient for suburban living, and consumers see them as safe. (The Economist)

This is an example of what economists call "revealed preference."  You don't have to ask people whether they care about the environment; instead you infer their preferences from how they behave.   

It is also an example of "incentive misalignment" from Chapter 1.  If we want people to drive more fuel efficient cars, we have to stop penalizing them for doing so.  

Why did Chocolate become so expensive?

 

From The Economist:

Carla Subirana Artus explains that severe drought and diseases, driven by extreme weather, together with regulatory pressures have created the perfect storm for the cocoa industry.

In other words, supply declined.

Like Snapshot for Your Home

Progressive Insurance pioneered telematic monitoring devices to offer Pay-How-You-Drive (PHYD) insurance policies over a decade ago. Now State Farm, along with other insurance companies, is partnering with Whisker Labs to offer the Ting home monitoring system. These are WiFi-enabled sensors that plug into an outlet to detect potential electrical fires. Whisker Labs monitors these sensors in what they claim is the largest Internet of Things (IoT) network to monitor the grid. State Farm is offering these for free to its customers presumably because, once insured, customers provide too little of their own monitoring.

The Effect of M&A on Workers

New research by Arnold, Milligan, Moon and Tavakoli investigates worker outcomes from mergers in Canada. They identify three possible mechanisms: 1) workers may gain bargaining power if the firm's products have increased market power, 2) workers may lose bargaining power if the reduced number of firms confer onto them monopsony power, 3) workers who are not retained after the merger may face worse job prospects. The first two do not seem to be important.

First, we don’t find that increasing corporate competition driven by M&A is important for workers either through concentrating the market for the products the workers produce, which would in theory increase worker wages, or through concentrating the labor market, which would in theory decrease their wages. 

However, job displacements usually lead to worse worker outcomes. Which begs the question as to why they were displaced. Earnings fall most for workers with more time at the old firm and workers with higher pay. Their firm-specific human capital may not carry over. Or these are entrenched, overpaid workers that represent the inefficiency the merger was meant to eliminate.

But the efficiency impact of these M&A-driven job transitions depends on whether the higher pay at the old firm reflected higher productivity or was itself a source of inefficiency that the M&A was able to eliminate.

Hat tip: Marginal Revolution

Should restaurants let menu prices "surge?"

 When demand increases, shouldn't price be allowed to rise? (WSJ)

Dynamic pricing—charging higher rates at peak times and dropping them at slower ones—has become commonplace in industries such as e-commerce, and mobile apps have made it easier for companies to study consumers’ buying and browsing and quickly adapt. Rising costs in recent years have led more retailers to implement it.

Restaurants are experimenting with the technology as the industry looks for ways to boost sales and increase profits. Many restaurants increased menu prices as labor, food and other costs have soared since 2021. Prices for food eaten away from home in January were 30% higher than in the same month in 2019, according to Labor Department data.

If prices cannot rise shortages will develop, and profits will fall, which will reduce the number of sellers (supply), further exacerbating the shortage. 

Using procurement for political ends gives you worse prices.

Over 20 years ago, some middling economists (cite) estimated that the Small Business Set-Aside program reduced Forest Service Timber prices by 15%.  By limiting the potential pool of available bidders to only smaller lumber mills, you get less competition and worse prices.

Now San Francisco is re-learning that lesson.  In 2016, it refused to do business with companies headquartered in states that don't share San Francisco's values. As a result, project costs increased 20 percent. 

Two forces are at work:  

• Short-run reduction in competition:  just as mergers which eliminate competition raise price, so too does limiting the number of bidders.  

NOTE:  a reduction in competition in a selling auction (high bid wins, e.g., timber), price goes down; in a procurement auction (low bid wins, e.g., city services) price goes up.  

• Long-run decline in bidder quality:  winning bidders must outbid the losers, so if losing bidders from states that share San Francisco's values--like unionization--have higher costs, they are easier to outbid, so price goes up.

REASON, "Great Moments in Unintended Consequences"

The Economics of Skiing

Vail's two-part pricing (Fixed Fee + Low Daily Price) from The Economist:  

With the Epic Pass, Vail has changed the offer. Skiers can now get unlimited skiing at a whole pack of resorts cheaply, but only by committing before the season starts. The result, says Stuart Winchester, who runs the Storm Skiing Journal, an industry blog and podcast, is that for the first time in decades skiing in America is reliably profitable. But it has come at a cost to competition. “Everyone else is swimming around. Vail is buying everything,” he says.

Vail now owns 41 resorts, including more than two dozen tiny hills on the East Coast and in the Midwest, which they consider “feeder” resorts that nurture new skiers who eventually may come west. In 2018 a competing pass, the Ikon, was launched by the Alterra Mountain Company, owned by the billionaire Crown family of Chicago, which shares revenue with independent resorts. Nowadays, most of America’s biggest ski areas are on one or the other pass.

Guide to Online Econ Videos

From Marginal Revolution 

• On day one, I show video on how secure Property Rights lead to growth.  The basic idea is simple, if you give owners secure title to their property, they have an incentive to take care of it, invest in it, and move it to its highest-valued use. 
• Others I like but do not assign.  
• Data Analysis Video , note that what he calls omitted variable bias is what I term "correlation vs. causation."
• Mastering Econometrics Video.  

Gaelic Price Control

 Here is a nice video on the experience with price control in Ireland and Scotland.

 

 

Hat tip: Marginal Revolution

Compensating Differentials in the Marriage Market

Potential mates differ in what they bring to the relationship. In online dating, youth, especially for women, appears to be sought after. In a forthcoming Journal of Labor Economics article, Corine Low applies the Indifference Principle to estimate how much more income a woman must earn each year she ages to remain equally attractive. Here is the abstract.

This paper quantifies the causal negative impact of age on women’s marriage market appeal using an experiment where real online daters rate hypothetical profiles with randomly assigned ages. Truthfulness is incentivized through the experiment’s compensation: participants receive professional dating advice customized according to their ratings. The experiment shows that for every year a woman ages, she must earn $7,000 more annually to remain equally attractive to potential partners. This preference appears driven by women’s asymmetric fertility decline with age, as it is present only for men without children and who have accurate knowledge of the age-fertility trade-off.

Do Bike Vigilantes Substitute for Bike Insurance?

 

Organized bike vigilantes are emerging to recover stolen bikes. A pedagogical tool I stole from Luke (who I believe also stole it) is to explain how bicycle insurance might work, or not, in the face of adverse selection or moral hazard. Bike's are a nice example because if they are stolen, they are usually gone. Until now.

Pavlik is part of an unusual army: amateur sleuths who find stolen bikes and return them to their owners. As bike theft becomes more profitable, grassroot efforts to thwart thieves are springing up nationwide. Part wannabe detective, part vigilantes, the volunteers say recovering bikes can be strangely fun and addictive. 

Bikes becoming more expensive make them better targets for thieves but also make retrieving them more worthwhile. I suspect the coordinated vigilante effort arose because the specific insurance market did not.

Hat tip: Chris Meyer

Vitual Assistants in Retailing

 Swedish online retailer, Klarna, partnered with OpenAI to create a chat bot powered by the latest AI. The claimed results seem impressive:

• It handled two-thirds of Klarna’s customer service chats
• This is the equivalent work of 700 full-time agents
• Customer satisfaction was on par with human agents
• Repeat inquiries fell by 25%
• Customers' errands were resolved in less than 2 mins compared to 11 mins previously
  

However, this may be embellished boasting as the company may be stirring up good press over an expected IPO.

Hat tip: Marginal Revolution

Domestic migration reveals preference for {SC, DE, NC, TN, FL} over {IL, AK, HI, CA, NY},

The Life Cycle of Products

Most product's life cycle is much shorter than I had imagined. In "The Life Cycle of Products: Evidence and Implications," Argente, Lee, and Moreira analyze 100 billion unique observations at the UPC by store by week level. Among other findings, they can trace product life cycles by type of product.

Brands can span individual UPCs (A) and last longer. Novel product introductions (B) last longer. Products sell well at introduction (C) fade faster. And more durable products (D) fade faster.

The Market for Private-Label Products

There is a nice podcast on "Store-Brand Products" over at the "Economics of Everyday Things." It touches on many managerial economic concepts. There are multiple factors going into the store brands on the shelves.

1. Brand names may have excess capacity.

...some store brand products are actually made by the same companies that produce the name brand versions of those products. Take, for instance, Costco. Some of the Kirkland brand of coffee blends are made by Starbucks. Kirkland batteries? Duracell. And Kirkland diapers? Those come from Kimberly-Clark, the company that makes Huggies.

2. Brand names may be too expensive.

Bringing a store brand product to market usually starts like this: a national retailer like Albertsons has category managers who are in charge of specific kinds of goods. They might see that a certain name-brand tomato sauce is selling in big numbers, but it’s a little expensive — which means there’s an opportunity for a more affordably priced store-brand version.

3.  Private label manufacturers often explicitly reverse engineer the existing product.

Retailers ask Winland Foods to reverse engineer name-brand products and create a new version.

BERINGAUSE: We have a large R&D facility in Chicago with a large group of food scientists. And we may have customers bring us something that they want us to develop. They may say we’d like an emulation or something better than a certain pasta sauce that is out there.

4. Private label manufacturers have little bargaining power

Marketing professor Kusum Ailawadi says that private label manufacturers don’t have much bargaining power when it comes to negotiating with retailers.

AILAWADI: Because nobody knows who the supplier is — the consumer doesn’t. So the supplier doesn’t have much leverage. 

Which undergrad majors lead to under-employement?

WSJ: under-employment (lower is better)--and getting an internship helps.

Will China Generative AI catch up to US?

 NY Times thinks China's regulations make it unlikely:

When OpenAI released ChatGPT in November 2022, many Chinese firms were being hamstrung by a regulatory crackdown from Beijing that discouraged experimentation without government approval. Chinese tech companies were also burdened by censorship rules designed to manage public opinion and mute major opposition to the Chinese Communist Party.

Chinese companies with the resources to build a generative A.I. model faced a dilemma. If they created a chatbot that said the wrong thing, its makers would pay the price. And no one could be sure what might tumble out of a chatbot’s digital mouth.

Chinese tech giants were also grappling with new regulations that dictate how A.I. models could be trained. The rules limit the data sets that could be used to train A.I. models and the applications that were acceptable, and also set requirements for registering A.I. models with the government.

Deterrence in Merger Review: Likely Impacts of Recent U.S. Policy Changes

Luke M. Froeb Vanderbilt University - Owen Graduate School of Management 

 Steven Tschantz Vanderbilt University - Department of Mathematics 

 Gregory J. Werden Independent; George Mason University - Mercatus Center 

 Date Written: January 30, 2024 

We model deterrence in a multistage merger review process, potentially ending in a court proceeding. Potential merging parties sequentially decide whether to begin the process, and whether to proceed to the next stage, in the face of uncertainty about what the enforcement agency or court will do. The model is designed to explore the complex impacts of policy changes in a costly regulatory process subject to uncertainty, and in particular to elucidate the likely impact of policy changes by the two U.S. enforcement agencies. The model shows why those policy changes can be expected to succeed in deterring bad mergers but at the cost of deterring a greater number of good mergers. 

 Keywords: mergers, deterrence, antitrust, regulation 

 JEL Classification: K22, L10, L40, L50 

Froeb, Luke M. and Tschantz, Steven T. and Werden, Gregory J., Deterrence in Merger Review: Likely Impacts of Recent U.S. Policy Changes (January 30, 2024). 

Available at SSRN: https://ssrn.com/abstract=4709897 or http://dx.doi.org/10.2139/ssrn.4709897

Is ESG investing illegal?

For fund managers, it may violate their fiduciary responsibility (to maximize returns) to their shareholders.   Apparently, the legal risk is too big for JP Morgan, State Street, and BlackRock:  

Asset managers have been walking a fine legal line. GOP Attorneys General in 2022 warned that they might be violating their fiduciary obligations and antitrust laws. House Judiciary Committee Chairman Jim Jordan in December subpoenaed BlackRock and State Street Global Advisors for documents and communications related to their involvement in “collusive” agreements.

The climate alliance’s new rules would compound the legal and political jeopardy. In its withdrawal announcement, State Street said its rules “are not consistent with our independent approach to proxy voting and portfolio company engagement.” BlackRock said the rules “would raise legal considerations.”

Peter Theil's (successful Venture Capitalist) Harvard Talk, "The Diversity Myth"

 Wide ranging, mostly libertarian critique of political and economic trends in the US that touches on Chapter 1 (Incentive Alignment), Chapter 2 (Wealth Creation), and Chapter 3 (Benefit-Cost Analysis).  

• Proponents of "diversity" don't define the term, which gives Diversity Workers remarkable freedom to claim that whatever they are doing furthers the goal.  
• In-class question: how would you align the incentives of Diversity Workers with the goal of diversity?
• Positive correlation between wealth creation and inequality in the past few decades:  Theil offers his take, but does not addresses the idea that incentive alignment creates inequality, as it rewards prescient, lucky, more productive, or harder workers.
• In-class question: does incentive alignment cause inequality? 
• Justification by President Obama that his increased income taxes would cause people to work harder to make up for the lost income ("income effect") rather than substituting to more leisure/less work ("substitution effect").  
• In-class question: do higher income taxes lead to more or less work?  
• [Comment: politically, to get a policy implemented, you have to ignore any tradeoffs that might go along with it.  Economists are trained to point these out, called "unintended consequences" or "hidden costs."]
• In-class question: how would you align the incentives of venture capitalists with the goal of innovation?  HINT:  low probability of a big payoff.
• Guilty Pleasure: comparison of Senator Elizabeth Warren to a fundamentalist Protestant preacher in her lack of forgiveness or redemption. 

Don't define the problem as the lack of your solution (gun control)

The latest example comes from NPR's coverage of the shooting at the Kansas City Super bowl Parade.

That the characterization of this incident as being reflective of “weak gun laws” is ridiculous. ...Every single thing that happened here was already illegal. It is illegal for juveniles to possess handguns. It is illegal for them to carry those handguns. It is illegal for them to shoot at each other in a public place. ...

... its coverage of gun-related crime, ... is invariably marked out by a fanatical obsession with gun-control and a total lack of interest in anything else.

Don't define the problem as the lack of your solution because it locks you into a particular solution, without the careful analysis that benefit-cost analysis requires.  

Related:

• Top 5 problem-solving mistakes by MBA's
• Did too low taxes (or too high spending) cause federal deficits?
• Did lack of derivatives regulation cause the housing bubble?

Four Myths about Price Discrimination

In an earlier post, Soda Prices are Too Low for the FTC, the Biden Administration seems to be trying to turn back the clock to a time when price discrimination was viewed as bad.  Lest we repeat the mistakes of the past, it is worthwhile to remember its lessons.   

 See this 2003 talk by some middling FTC economists. Here the conclusions:  

 

BOTTOM LINE:  Determining the role that price discrimination plays in antitrust enforcement typically requires the kind of difficult and time consuming economic analysis the Biden administration is trying to avoid.

Cooper, James C. and Froeb, Luke M. and O'Brien, Daniel P. and Tschantz, Steven T., Does Price Discrimination Intensify Competition? Implications for Antitrust (2005). Antitrust Law Journal, Vol. 72, No. 2, pp. 327-373, 2005, George Mason Law & Economics Research Paper No. 14-30, Available at SSRN: https://ssrn.com/abstract=2470135

Werden, Gregory J. and Froeb, Luke M., Can the FTC Turn Back the Clock? (August 15, 2021). Antitrust Magazine Online, Oct. 2021, Available at SSRN: https://ssrn.com/abstract=3909851

The Hidden Costs of Streaking the Super Bowl

Two "streakers" interrupted the 2024 Super Bowl to attract social media followers. For the most part, this would be considered a harmless stunt.But what are the hidden costs? Most of these would be the costs to those of us watching. Only those in the stadium actually saw the stunt. TV viewers might have been more affected. Suppose it delayed the game some 5 seconds. With viewership of 123.7 million, this represents almost 20 person-years lost or, perhaps, $0.5 million in value of time lost. Perhaps we are not doing enough to deter disruptions.

Soda Prices are Too Low for the FTC

The FTC is investigating Coke and Pepsi for price discriminating. It has invoked the Robinson-Patman Act, otherwise known as the "Mom & Pop Protectionism Act." Most economists consider the act itself to stifle competition and innovation by restricting supply chain decisions. The legal profession also came around to this view such that the number of cases dwindled to zero. But, evidently, it is not dead yet.

The law, known as the Robinson-Patman Act, bars manufacturers from charging different prices to competing resellers of their products if the practice threatens to harm competition. The law is highly technical and hasn’t been enforced by the FTC in decades (emphasis added).

I can hear Dr. Frankenstein yelling, "It's alive! It's ALIVE!!!"

Demand for electric cars crashed last summer, supply is slow to adjust

  From WSJ:  

The wave of early EV adopters willing to splurge had receded, and the next round of potential customers was proving more hesitant. They had more questions about how far a car could go on a single charge, and the life expectancy of batteries. They worried about charging times, repair costs, and not having enough places to plug in, according to dealers and surveys.

With excess supply (measured as months of supply, one would expect the price to keep falling, until (Quantity Demanded)=(Quantity Supplied).

California and Washington commit the Hidden-Cost Fallacy

From MarginalRevolution: the increase in California's income tax "increased total tax revenue for California — but not nearly as much as intended. Due to departures, the state lost more than 45% of its windfall tax revenues from the policy change, and within two years the state lost more than 60% of those same revenues."

This illustrates the main idea of Chapter Three: 

Consider all costs and benefits that vary with the consequence of a decision [if you miss some that is the hidden-cost fallacy]; but only costs and benefits that vary with the consequence of a decision [if you consider irrelevant ones that is the sunk-cost fallacy].

It looks as if Washington State is making the same mistake: In 2022 they imposed a new, 7% capital gains tax on sales of stocks or bonds of more than $250,000. Soon thereafter, the state's richest man moved to Florida. 

 BOTTOM LINE: People respond to incentives [Chapter One], so make sure your state legislators read Chapter Three.

Are stocks over-valued?

 DISCLAIMER:  If I really knew, I would not be teaching school.

WSJ summarizes five valuation methodologies:

• Price/Earnings Ratio:  "Analysts are more optimistic about the profit picture for this year and project that earnings among the companies in the S&P 500 will rise roughly 11%. That could offer stocks more room to run."
• Price-to-book Ratio: "Akin to the price/earnings ratio, the price-to-book ratio divides a company’s stock price by its book value, a measure of total assets minus liabilities. ... It is less useful for tech companies because their growth prospects often aren’t captured on company balance sheets...The S&P 500 is trading at a forward price-to-book ratio of 4.15, above its 10-year average of 3.26 and its 20-year average of 2.76. In comparison, Nvidia’s price-to-book ratio is 22.48."
• Equity Risk Premium: "Comparing the trailing earnings yield with the 10-year Treasury yield shows that the S&P 500’s equity risk premium is at 0.7 percentage point, near the lowest level in about two decades. (The lower the ratio is, the more expensive stocks are.)"
• Price/Earnings Growth Ratio: "The PEG ratio is the market’s valuation of a company relative to its earnings prospects. To calculate it, divide a company’s price/earnings ratio over the past 12 months by its projected annual future earnings growth. A PEG of 1 indicates the stock’s price is in line with its growth expectations. ... The S&P 500’s current PEG ratio is 1.48, below its 10-year average of 1.49 and above its 20-year average of 1.35. Nvidia’s ratio of 0.78 makes it look cheap in comparison."
• CAPE: "At 33.4, the S&P 500’s CAPE ratio is higher than it has been more than 96% of the time since 1881, but it is still well below the prior peaks seen in the late 1990s and 2021."

We knew rent control was bad, but ...

 did not know that it could cause a financial crisis:

..what worries investors more is the NYCB’s $37 billion multi-family housing portfolio, about half of which are comprised of New York rent-regulated units.

...Why have these loans become toxic?

Blame Democrats in Albany, who in 2019 restricted landlords’ ability to raise rents to pay for renovations and “de-regulate” rent-stabilized units. ... One result is that landlords have removed rent-regulated apartments from the market and are leaving them vacant rather than spend on maintenance and improvements that they can’t recoup .... Lower anticipated future rents have also slashed property values. ... NYCB’s rent-regulated portfolio could be a ticking time bomb.

And ironically, 

Tighter supply [in the rent controlled market] has pushed up rents in the non-regulated market—one reason Manhattan’s average market-rate monthly rent has surged 30% over the last two years. 

Podcast about my Favorite Book

I was interviewed about the book on the Million Dollar Stories Podcast. It was a lot of fun but, even though I made a few mistakes (sorry Brian "Shor" McCann and my favorite word appears to be "uh").

Can Millennials Afford Houses?

I see commentary every so often about younger generations not being able to afford the houses like their parents, or grandparents, bought decades ago. These often have a generational warfare tinge to them - "Boomers destroyed the economy and now I have to live in a shack." Even after adjusting for inflation, house prices doubled between 1970 and 2020. But there have been plenty of improvements in the quality of the housing stock making new homes not comparable to parents' houses.

By today's standards Boomers' houses sucked. In 1970, one-in-six US houses had no plumbing and did not have access to public water supply, most of these relied on adjacent well water. Waste water for one-in-four houses was not connected to municipal sewage but used a septic tank or a cesspool. Heating for over a quarter was from room heaters or stoves. Three-quarters had no air conditioning. Washers were in 60% but dryers were in only 40%. These are the measures that the US Census tracked. But we also know from updated building codes that they could not handle as many electric appliances and could not withstand extreme weather as well. 

The clearest sign of progress is how crowded they were. Over the fifty years from 1970 to 2020 square footage increased 70% while the number of people living in the house fell 20%. The available data allow us to track the cost per square foot per person.

Real housing prices double (green line) but so does area per person (blue line) resulting in a nearly constant cost per area per person (red line). I infer that housing costs have not risen but housing amenities have. You could afford your grandparents' house but you probably could not find it anymore, and you probably would not want to live in it.

Apocryphal management story

When the CEO left the company, he gave his successor three envelopes to open when she encountered challenging problems.

When she ran into trouble the first time, she opened the first envelope and it said to “blame your predecessor.” She did, and the trouble passed.

When she ran into trouble again, she opened the second envelope and it said “Reorganize.” She did, and the trouble passed.

When it happened once again, she opened the last envelope and it said “Prepare three new envelopes.” 

Why restrict US exports of natural gas?

 The answer, of course, is politics:

To stop the war in Ukraine from disrupting energy markets, [Biden's] administration has overseen a big expansion in domestic fossil-fuel output. As well as being the world’s top LNG [liquified natural gas] exporter, America continues to be the biggest oil producer. That angers the climate-anxious left wing of Mr Biden’s Democratic Party. ...

But US restrictions wont help:

...the impact of the pause on global markets—and thus on global emissions, which is what matters to the climate—will be minimal. Forgone American exports will be offset by fresh supplies from Qatar, Australia and elsewhere. “I think there is an opportunity,” declared Jonathan Wilkinson, Canada’s energy minister, on January 30th.

BOTTOM LINE: President Biden's virtue signaling is worse than empty, as it is harming US producers by shifting US production to Qatar, Australia, and Canada. 

Link to Economist Article

Jan 31 - Hug An Economist Day

A much undeserved constituency finally gets some love. ;-)

Hug An Economist Day

The U.S. celebrates Hug An Economist Day on January 31 each year. Now, it’s obvious this day was meant to show your affection for economists, but we like to think it also encourages us to learn more about economics and how it affects us. Unfortunately, we don’t know much more about this day, like who initiated these celebrations or when they began. For now, this might be an unofficial holiday, but we urge you to celebrate officially and with gusto! If you’re interested in becoming an economist and pursing a degree in business, check out these business scholarships.

Hug An Economist Day Activities

1. Hug an economist

   We only recommend this with economists you really know (and are close to). If you are lucky enough to count an economist among your loved ones, go on and give them a huge hug to show your appreciation for all they do.

2. Celebrate the profession and the field

   Host an economics-themed party. Design little dollar-shaped cupcakes, dress up as famous economists, and even play economics-themed games. Monopoly, anyone?

3. Learn about economics

   Economics is used in conjunction with several other fields, including business, marketing, education, and even the environment. There are plenty of resources that make learning new economic theories and concepts fun — check out videos, presentations, and even Pinterest for ways to learn and remember new information about this field.

 

Economics of Lawsuits

The Planet Money folks did an episode on the Telephone Consumer Protection Act (TCPA) to combat spam callers. It allows spamees to sue for $500 per unwanted call. This has made it worth while for some people to actually sue and some have received sizable settlements. Defendants claim that it over deters because some people have made suing under the TCPA a business. Toward the end of the show the hosts have a pretty good sum up that describes the incentives for both parties.

HOROWITZ-GHAZI: The TCPA has turned telemarketing enforcement into a kind of market. Like, instead of having a central government agency deciding this is how much law enforcement we're going to have, the amount of enforcement goes up or down depending on the incentives. How easy is it to hunt down a company making illegal calls? How much does it cost to bring them to justice? Can you find efficiencies of scale by bringing lawsuits on behalf of millions of people all at once?

GUO: And, of course, as with any enforcement regime, the lawbreakers are also weighing their costs and benefits. Telemarketing is a multibillion-dollar business. How much can a telemarketer make on each call? How much financial risk is worth taking on to sell some vacation packages over the phone?

Incentives matter.

Does inequality make us rich?

The theory is right out of Chapters 1 and 2: incentive alignment means that those who create more wealth earn more.  

Evidence comes from the Great Depression (link):

Roughly four-fifths of the “golden age” of equality (between 1950 and 1980) owed to the Great Depression, not tax policy. This finding is hard to celebrate because it means that greater equality was achieved while everyone was getting poorer.

Evidence also comes from the decline in life-span inequality: as lifespans grow, inequality between residents of a country declines.  

Incentive alignment in Benefits Corporations

Begun in Maryland in 2012, thirty states now have Public Benefits Corporations (B-corp's) (wikipedia, seeking alpha, quora) 

• For-profit companies that can be publicly traded, but which follow other goals, like ESG. 
• B-corp managers get legal protection from shareholder suits based on low profitability, as they can claim they are pursuing ESG goals.

Chapter one identifies their fatal flaw: not only is ESG hard to measure, but it also conflicts with the pursuit of profit.  This is similar to the problems created by balanced scorecards.

Without good performance metrics,  it is hard for shareholders to tell if B-corp managers are doing a good job, so managers will pursue their own goals at shareholder expense.

Related:  ESG blog posts

US Fertility rates are below replacement (2.1)

 From MarginalRevolution:

Smoothing the Incentives of Patent Examiners

How do you address employees gaming a production quota system? In 2011, the US PTO went from patent examiners having a bi-weekly quota system to adding bonuses tied to eliminating pending examinations on a daily basis. In "Deadlines Versus Continuous Incentives: Evidence from the Patent Office," Frakes and Wasserman examine how patent examiners responded to the new incentives to "clear the inbox." Instead of completing of assignments just before deadlines, there was  a near complete smoothing of task completion ...

leading to large reductions in average examination pendency while resulting in no corresponding reductions in the accuracy of examinations.

This is analogous to "Budget Games: Paying People to Lie" in chapter 22 in which workers have incentives to just meet budget goals. The solution, as the US PTO experience demonstrates, is to find ways to make incentives more linear and less lumpy.

Should we tax the rich more than we already do?

WSJ says "no" for two reasons: 

First, our income taxes are already the most progressive in the OECD, and by increasing the income tax rate, we also increase the incentive to avoid paying it, so it would not raise tax revenue by very much.  

America’s top tax rates often exceed international norms. Our top income-tax bracket of 43.7%—including typical state taxes—exceeds that of the standard OECD nation (40.4%). Our top capital-gains tax rate is 10 points above the OECD average, and our corporate tax rate exceeds not only the OECD mean but that of every Scandinavian nation. America’s effective corporate tax rate is also above average, as are its estate and inheritance taxes.

Second, as we know from Chapter 2, taxes destroy wealth by discouraging wealth-creating transactions, so if we tax income, we get less of it.  This also reduces the amount of money that an income tax would raise. 

 So, what should we do? 

 First, get our spending in line with our income. In the graph below, we see that are spending 8% more than we are making.

Failing that, we can raise more money with a low rate, broad-based consumption tax, like a VAT.  

Politically, we could probably "sell" a consumption tax if we also promised to reduce income tax. But this would be opposed by the left because consumption taxes are not as progressive as income taxes.  Likewise, those on the right would be skeptical because consumption taxes are so good at raising money that they have been used by EU countries to expand the scope of government.  As the late PJ O'Rourke wrote, "Giving money and power to government is like giving whiskey and car keys to teenage boys."  

Apartments vs. Single Family

Housing is good for illustrating the market forces of chapter 8 because everyone has housing and, due to construction lags and the durability of housing (30 years), market adjusts slowly to equilibrium.

In the graph above from Calculated Risk, we see single family housing starts increasing (RED), but apartments (BLUE) decreasing.  The market is adjusting to the high prices for single family by building new supply; and to the expected low future prices for apartments due to the big supply of apartments under construction due to come to market this year and next by reducing new supply.

SINGLE FAMILY HOMES (RED LINE): "...The weakness in 2022 and early 2023 was in single family starts. However, single family starts have now picked up, helped by limited existing home inventory."

APARTMENTS (BLUE LINE): "...we should see ongoing weakness in [apts] based on less household formation, falling asking rents, rising vacancies, and tighter lending. ... A near record number of multi-family housing units are currently under construction due to construction delays. This suggests a large number of multi-family housing units will be delivered in 2024."

Are Things Really that Bad?

Binsbergen, Bryzgalova, Mukhopadhyay, and Sharma develop an index of economic sentiment for the US (and individual states) from accumulated news reports. They use a historical collection of 170 years of digitized newspapers, which includes the text of 200 million newspaper pages from 13,000 local newspapers, collecting instances of a bunch of keywords like "profitable", "success", "opportunity" versus "failure", "insolvent", or "unsuccessful". It turns out it predicts economic activity quite well.

 

 

 

 

 

 

However, the authors also note that sentiment trends downward significantly over the past four, and especially two, decades. My colleagues doubted me when I had claimed that the news presented an increasingly bleak picture. It is nice to know I am not crazy. I suspect this reporting of poor sentiment influences public perceptions.Most laymen I come across think that each decade has a worse economy.

This despite all of the evidence to the contrary. Almost all trends in well-being over this period are positive. This period saw increases in income, innovation, leisure time, life expectancy, food choices, a cleaner environment, literacy, entertainment, tourism - you name it. Moreover, there is every reason to believe these trends will continue. I am confident that my grandchildren's lives will be amazing compared to mine. But that is because my profession puts more stock in the data than the news reports. I hope my grandchildren will do the same.

A Victory Parade is in Order!

Sixty years ago, LBJ declared "War on Poverty." The results are in and poverty in the US has mostly been vanquished. New research in the prestigious Journal of Political Economy points out that the official poverty rate is hugely biased upward. The authors compare this to a measures of the "Absolute Full-Income Poverty" level that includes various cash transfer programs, adjusts for inflation, and adjusts for changes in consumption bundles. All tolled, the poverty rate fell from 19.5% in 1963 to 1.6% in 2019. Yippee!

 

Alas, we may not want to celebrate quite yet. First, those in that bottom 1.6% are truly destitute. I cannot imagine the difficulties these people face.

Second, since inflation adjusted GDP per capita tripled of this period, the rest of us have become quite a bit more wealthy.

 

 

 

 

 

 

 

 

 

The burden to the rest of us of subsidizing the poor does not bite as much. Perhaps public policy should be directed at the lowest X% of the population rather just those below $X per year. We can quibble of the appropriate Xs.

Airbnb Constrains Hotel Market Power

Schaefer and Tran have a new paper that estimates price competition between Airbnb offerings and hotels in Paris, France in 2017 using granular data on tens of thousands of rooms. They find that, while these offerings are differentiated, the do put downward pressure on each others' pricing power. 

Using the estimated models, we assess how Airbnb affects hotel profits and consumer welfare and how much Airbnb hosts value the platform. Our simulations imply that Airbnb increases average consumer surplus and decreases hotel profits substantially. 

Specifically, consumer surplus from Airbnb in Paris increases by 32 euro per night per room for a total of 4.3 million euro (about 0.3% of all hotel revenue). Moreover, about a quarter of this is due to lower hotel prices.

Digital platforms have obliterated some traditional marketing channels, e.g., video rental and music stores, but usually some of the traditional channels survive albeit in diminished form, e.g., book stores and taxis. It appears that even if short term rentals do not replace hotels, they still provide some discipline to the market.

Potential Workers Use ESG as an Employer Screen

A new multiple author study looks at how workers sort into, or out of "good" firms, that is, firms with environmental, social, and governance (ESG) practices. From their abstract:

We conduct a field experiment in partnership with the largest job plat-form in Brazil to study how environmental, social, and governance (ESG) practices of firms affect talent allocation. We find both an average job-seeker’s preference for ESG and a large degree of heterogeneity across socioeconomic groups, with the strongest preference displayed by highly educated, white, and politically liberal individuals. We combine our experimental estimates with administrative matched employer-employee microdata and estimate an equilibrium model of the labor market. Counterfactual analyses suggest ESG practices increase total economic output and worker welfare, while increasing the wage gap between skilled and unskilled workers.

Limiting your investment portfolio to only ESG projects should lower returns. However, this could easily be overcome if better workers have a preference for ESG employers.