Compensating differentials outlawed in Birmingham

 From MarginalRevolution:

In 2010 an employment tribunal ruled that Birmingham City Council had discriminated against thousands (6,000) of female workers — cooks, cleaners, care assistants, caretakers — who were denied bonuses paid to the mostly male binmen, gardeners, and gravediggers (400). Why were the binmen given bonuses? Well, refuse collection is filthy, heavy, outdoor work and not many people want to be gravediggers.

Birmingham went bankrupt when they had to pay the bonuses to the 6,000 women and they went bankrupt.  Then they eliminated the bonuses paid to the men, who then went on strike.  Then:

The council hired an outside contractor to take over its rubbish collection and it now pays roughly triple its pre-strike outsourcing bill..

A Pac-Man Defense Against Predatory Pricing?

After the story of how Southwest Airlines broke an attempt at predatory pricing with booze, I learned of the Dow vs. Die Deutsche Bromkonvention episode. See here for an interesting narrative of events. To summarize, at the turn of the twentieth century, the German chemical industry was dominant and the various producers there had a comfortable cartel selling bromine at 49 cents a pound. Herbert Dow had developed a way to produce bromine and sold it in the US for 36 cents. The Germans might have been OK if he stayed in the US, but the cartel swung into action when he began exporting in 1904. 

It poured bromine into America at 15 cents a pound, well below its fixed price of 49 cents, and also below Dow’s 36 cent price.  

Dow simply pulled out of the US market and sold abroad. Moreover, he had his agents secretly buy up hundreds of thousands of pounds at that 15 cents, repackage it, and resell it in Europe at 27 cents. Instead of being driven out of business, he profited from the cartel's actions! At first the Germans were confused by the insatiable demand in the US and the lost orders from Europe. Was one of their cartel members offering secret discounts? Accusations were made. Even after they discovered Dow's ploy, they were not sure how to respond. In the end, the bromine monopoly was broken.

Perhaps Dow got lucky, but perhaps predatory pricing may not be so easy.

The Cost of Going to Space

Terzi & Nicoli have a fascinating new paper analyzing over 4,400 orbital launches since 1960 to estimate "Wright's Law." This law states that a new technology's unit costs fall in proportion to cumulative experience. Essentially, it is an expression of learning-by-doing. They show:

... that the average cost of sending a kilogram to orbit has dropped from 87,023 USD in 1960 to 3,868 USD in 2025. Using a Wright's Law framework, we estimate that for each doubling of cumulative payload to orbit, the average cost of sending a kilogram to orbit decreases by 21.2% ...

This is faster than many past technologies e.g., 19th century Steam engines and recent solar photovoltaics. There is a positive feedback loop because, as launch costs fall, more stuff is launched. Their forecast is that it will cost reach $300/kg by 2040. For reference, sending a kg from LA to London by overnight express costs $5-$50/kg depending on package size. I get giddy trying to imagine all the potential new opportunities.

Incentive Misalignment in Communism: the case of Vietnam

Rainer Zitelmann writes in How Capitalism Beat Communism in Vietnam in Reason Magazine,

The state collectives did not reward members for the amount of rice they produced, but instead counted how many days they had worked. If you worked 30 days, you got 30 points, which gave you the right to a defined share of the harvest. If you worked 20 days, you got 20 points and correspondingly less.

Days worked is cheap to verify, hard to dispute, immune to weather. But it was not what the country needed, which was rice. Output was the right target, but no individual's contribution was measurable, so the Collectives graded attendance instead.

Farmers responded rationally — they showed up. Real effort migrated to private plots where they could keep what they made. While cooperatives absorbed 40 percent of state agricultural funding, over 60 percent of cooperative members' income came from the 5 percent of land left in private hands. In 1980 the country grew 14 million tons of rice against the 16 million it needed.

Private Property (under the Doi Moi reforms) fixed the problem: households leased land and kept what they produced. Vietnam is now among the world's largest rice exporters.

BOTTOM LINE: People will optimize whatever you count; and Private property aligns incentives and makes the proverbial pie bigger.  

Using Demand Signals to Re-Price

A CNBC story indicates that Starbucks repeatedly raised menu prices over the past several years. Initially, this strategy worked well. Higher prices more than offset modest declines in customer traffic, increasing average revenue per transaction. More recently, however, the company's quarterly earnings have shown declining customer visits, and new CEO Brian Niccol has shifted the company's emphasis away from broad price increases and toward improving service, simplifying the menu, and restoring the in-store experience, i.e. product differentiation. While many factors undoubtedly contributed to Starbucks' slowdown, the company's strategic pivot suggests that management believes customers have become increasingly willing to substitute away from Starbucks when prices rise. The available evidence is consistent with demand becoming more price elastic than it was only a few years ago.

Demand elasticity is not a fixed characteristic of a product or brand. Firms may consider premium brands' demand characteristics as permanent, but elasticity depends on the availability of substitutes and customers' willingness to switch. As time passes after a price increase, more consumers become aware that the price has changed, become more willing to experiment with competing brands, and discover acceptable alternatives. With better informed customers, future price increases can trigger much larger reductions in sales than before. The Starbucks experience is less a story about charging "too much" for coffee than about how repeated price increases may inadvertently encourage customers to search for substitutes, making demand progressively more elastic. Every price increase is also an experiment that provides information for future pricing decisions.

Specrtum Auctions Address Economies of Scope

The Federal Communications Commission (FCC) auction can demonstrate economies of scope. The FCC periodically auctions off additional spectrum licenses for advanced services. It recently raised $3.5 billion from recent AWS-3 (Advanced Wireless Services) auctions and expects to raise $30-$6 billion from upcoming Upper C-Band auctions. In telecom, these frequencies are not independent assets; their value is multiplicative. This additional spectrum will allow for greater capacity to handle the exponentially growing demand for wireless data transmission.

Spectrum auctions are usually run as Simultaneous Multiple-Round Auctions (SMRAs). US coverage is divided into many distinct geographic areas that are auctioned simultaneously across many rounds. An aggregation problem arises when a bidder risks winning fragmented licenses that are less valuable without their complementary counterparts. Since transmission has origin and a destination, it is more valuable to win a license in, say, Chicago if the operator can also secure one for Dallas. SMRAs allow bidders to cobble together desired regional capacity by aggregating multiple licenses.

The cell towers, base stations, and cables that link them are huge fixed costs. The ability to defray these costs over more volume reduces average costs. Economies of scale in these fixed costs generate economies of scope across these fixed costs in different regions.

Curating Complements: Apple & USB-C

One of the strongest arguments for industry standards is that they increase competition. A common charging connector means consumers can choose from hundreds of competing cable manufacturers instead of being locked into a single supplier. The resulting competition lowers prices and increases consumer welfare. When the EU required Apple to transition from its proprietary Lightning connector to USB-C in 2023, it illustrated that this logic, while generally sound, is incomplete. The WSJ reports that one independent repair specialist saw Apple iPhone failures associated with poorly designed or non-compliant USB-C cables and chargers. While these failures appear to be relatively uncommon, they highlight an economic tradeoff that is easy to overlook: greater competition among complementors can also increase quality variation. Under the Lightning ecosystem, Apple exercised tight control over accessory manufacturers through its Made for iPhone (MFi) certification program. Consumers paid more for certified cables, but they also purchased into a curated ecosystem with stronger quality assurance. By requiring Apple to adopt the industry-standard USB-C connector, regulators and policymakers may have increased competition, but they may also have exposed consumers to a much broader range of accessory quality.

Firms sometimes vertically integrate to solve coordination and quality-control problems, and not to exploit market power. Apple had strong incentives to ensure that its phones, chargers, cables, and software functioned reliably as an integrated system because failures reflected directly on the Apple brand, regardless of who manufactured the accessory. A proprietary standard gave Apple greater ability to police quality and exclude unreliable suppliers. This is likely the case for many of the Apple iPhone’s complements. An open standard like USB-C creates incentives for lower prices, interoperability, and reduced electronic waste. It also may have shifted more responsibility to consumers, who must distinguish between high-quality and low-quality accessories in a crowded marketplace. In this case, it is unclear if the pre-purchase consumer search costs and post-purchase repair costs were comparable to the competitive benefits from allowing open entry. But the episode demonstrates that a tradeoff could exist.

Can you Go to Jail if your AI Engages in Collusion?

The stereotype of price fixing is fat, cigar-chomping executives meeting secretly in smoke-filled rooms to agree to raise prices. But the Justice Department's recent consent decree with RealPage anticipates that AI collusion may look different. RealPage sold revenue-management software that used confidential pricing information from competing landlords to recommend rents. Although the software generated the recommendations, the DOJ alleged that the system facilitated unlawful coordination among competitors. I had my doubts. Nevertheless, the settlement requires RealPage to stop using certain competitively sensitive data and to change features of its pricing software.

AI can still recommend prices. Firms have used sophisticated pricing software for decades. A broader implication is that firms cannot avoid antitrust liability by outsourcing pricing decisions to an algorithm. If competing firms provide confidential information to a common AI system that helps coordinate pricing decisions, regulators may view the arrangement much like traditional collusion.

This distinction will become increasingly important as companies deploy AI agents to make autonomous business decisions. An AI pricing system that independently analyzes a firm's own costs, demand, and inventory is generally very different from one that relies on competitors' confidential information or otherwise facilitates coordination among rivals. The RealPage consent decree is consistent with antitrust law focusing on economic outcomes rather than how those outcomes were produced.

Use It or Lose It: The Perverse Incentives Draining the American West

If you wanted to design a property rights regime that guaranteed the waste of a scarce resource, you could hardly do better than Western water law's doctrine of prior appropriation. It requires rights holders to put water to "beneficial use" or—after five consecutive years of non-use—forfeit the right. [1] The result is a textbook perverse incentive: a farmer who irrigates more efficiently risks losing the conserved portion of her right, so the private return to conservation is negative even when the social return is big.

Oregon tried to eliminate the perverse incentive with its 1987 Instream Water Right Act that made instream flow a beneficial use. [2] On the Deschutes, conservancies now lease and buy water for the river. [3], but legalizing the trade didn't create a liquid market. Rights are mostly held by irrigation districts rather than individual farmers, so every deal needs board approval, and transaction costs run high: quantifying how much water actually reaches crops through leaky, century-old canals is expensive, and farmers still fear that proving they can conserve invites a future challenge to their right.

In the Colorado River, states face the same problem. If an Upper Basin state conserves, the saved water flows downstream to be consumed by someone else which creates the risk of becoming the baseline for future cuts. [4] Instead, the feds pay farmers billions to fallow fields—a costly government subsidy trying to address the perverse consequences of another government policy. [5]

BOTTOM LINE: any rule tying an asset's ownership to its continuous consumption—budget lines that vanish if unspent, headcount that shrinks if unfilled—will be consumed regardless of value. 

NOTES

[1] Schwabe, Williamson & Wyatt, "Oregon Water Law Questions and Answers" — beneficial use requirement and five-year forfeiture rule. https://www.schwabe.com/publication/oregon-water-law-questions-and-answers/

[2] Oregon Legislature, "Background Brief on Water Rights" — the 1987 legislation adding instream water rights as a beneficial use. https://www.oregonlegislature.gov/lpro/Publications/2004HM_Water_Rights.pdf

[3] University of Oregon School of Law, "Evaluating Instream Flow Programs" — Oregon's 1,100+ instream leases and transfers, including the Deschutes River Conservancy's role. https://law.uoregon.edu/sites/default/files/ai61_ch._22_with_legend1.pdf

[4] High Country News, "Why Colorado River negotiations are so difficult" — prior appropriation dynamics and the interstate stalemate. https://www.hcn.org/articles/why-colorado-river-negotiations-are-so-difficult/

[5] Congressional Research Service, "Management of the Colorado River" (R45546) — federally compensated conservation, including 2.3 million acre-feet paid for with congressionally approved drought funds. https://www.congress.gov/crs-product/R45546

HT:  Claude Fable

Extracting Information from Supply Disruptions

On Sept. 16, 2025, a fire at Novelis's aluminum rolling mill in Oswego, New York disrupted roughly 40 percent of the automotive aluminum sheet used in North America. The importance of this supply disruption can be determined using standard stock market event study analyses. Ford was one of the firms most exposed to the disruption because it relied heavily on automotive aluminum sheet. As analysts began estimating the impact on vehicle production and profitability, Ford's stock price fell sharply. Similarly, investors also penalized Hindalco, Novelis's parent company. The interesting question is what happened to competitors. If one supplier exits temporarily, shouldn't rivals benefit?

Firm	Relationship to Event	Approximate Stock Market Reaction
Ford	Customer of automotive aluminum sheet	-7% abnormal return
Hindalco (owner of Novelis)	Directly affected supplier	-6% abnormal return
Kaiser Aluminum	Potential substitute supplier	+3% to +5% short-term gain
Constellium	Potential substitute supplier	Little measurable effect

Investors appeared to believe that Ford would suffer large costs from the disruption, but they did not assign equally large gains to Novelis's competitors. While aluminum itself is a commodity, automotive aluminum sheet is not. Suppliers must invest in specialized equipment, satisfy demanding quality standards, and undergo lengthy qualification processes with automakers. Even if competitors wanted to absorb Novelis's lost volume, they may not have had sufficient spare capacity or approved production lines to do so quickly. Ford's stock market loss was several times larger than analysts' estimates of immediate production costs because investors recognized that replacing a critical supplier is expensive and time-consuming. There are no doubt benefits to Ford and Novelis from contract exclusivity. This episode highlights the costs.

Rethinking Strategy at Cracker Barrel

Julie Felss Masino was recruited to become the new CEO of Cracker Barrel in 2023 to reinvigorate the brand. Should strategy focus on growing demand by increasing attractiveness to new customers or should it focus on keeping existing customers comfortable? As the WSJ reports, it opted for the former:

The goal was to modernize its stores, menu and design to help bring new customers to the vintage chain. The company had seen some promising results from food updates and marketing tie-ins when, as part of a fall marketing campaign in 2025, it unveiled a new, simplified logo.

And then Cracker Barrel became an unexpected flashpoint in the culture wars. The new logo was described as "going woke" and the changes alienated many of its more traditional patrons. Visits plummeted and the company lost $100 million in market capitalization in a week.

Well that didn't work. To her credit, Masino quickly reversed course.

She cut ties with the marketing firm behind the chain’s rebranding campaign and revamped the company’s leadership structure, bringing back a former vice president for menu strategy and elevating a veteran field operator to oversee store operations. 

They doubled-down on the traditional experience. Even the old logo has returned. The pivot seems to be working. Customers are beginning to return and the share price is rebounding, though not to the $60-$70 range prior to these events.

A strategic decision is a sunk cost. Abandon it when new information indicates a mistake.

Hidden Cost of Environmental Protection

 REASON:

Greenpeace and its activists allies have blocked for more than two decades the adoption of Golden Rice, which is genetically enhanced to produce the vitamin A precursor beta-carotene. The result, according to new calculations by DC Abundance founder and research director at the Golden Gate Institute for AI Abi Olvera, is that "delay has killed about 106,000 children and left another 210,000 to 425,000 blind."

What Set-Asides Cost: A Lesson from Timber Auctions.

California's Public Utilities Commission is pressuring utilities to steer about 1.5% of procurement toward state-certified "LGBT-owned" firms.  Setting aside the certification debate, what will this cost the state? 

In every auction, the winner has to outbid the second-best bidder, so the second-best bidder sets the price. Weaken the field and you weaken that price-setter. But which way the price moves depends on whether the government is buying or selling.

When the government buys, it runs a procurement auction: bidders compete to sell to the government, and the lowest-cost bidder wins, while second-lowest-cost bidder sets the price. Restrict who can bid and the price the government pays goes up.

When the government sells, bidders compete to buy, and the highest-value bidder wins, while the second-highest-value bidder sets the price. Restrict who can bid and the price the government receives goes down.

A set-aside moves price through two separate channels, and they push the same direction. 

• First, it shrinks the number of bidders, so the second-lowest cost is higher (or the second-highest value is lower). 
• Second, the set-aside bidders themselves may be higher-cost or lower-value than the bidders they replace. 

Both channels move price against the government.  An article by a pair of middling economists shows by how much.  Prices in Forest Service small-business set-aside auctions—where only small businesses may bid—run about 15% lower than in open auctions. 

The lesson applies to California. Fewer, weaker bidders mean a worse deal for the government. 

AI and the Shrinking Firm

The way that Artificial intelligence (AI) is changing worker productivity may also be changing the optimal scale of the firm itself. According to a recent Axios report, AI-powered tools are enabling entrepreneurs to launch and operate businesses with little or no staff. Tasks that once required specialists in coding, graphic design, marketing, customer support, and bookkeeping can increasingly be performed by a single entrepreneur assisted by AI. The result is a growing number of "one-person firms" capable of generating revenue levels that previously required a small team. This contrasts with the trend since the industrial revolution in which ever more mechanization generated ever greater economies of scale and ever larger enterprises.

Some aspects of AI fit nicely into theories of the firm.

•          Transactions costs can be reduced by engaging with AI rather than an employee.
• AIs eliminate employee principal/agent issues.
• However, a more personalized AI may represent a relationship-specific sunk cost that can lead to holdup.

Has the risk premium for owning stocks disappeared?

Axios reported that the equity risk premium (ERP) — the extra return investors expect for holding risky stocks instead of safe Treasuries — has shrunk to almost nothing. A safe 10-year Treasury bond pays about 4.5%. Stocks, measured against the companies' current earnings, return only about 3.7%. So right now the safe bond actually pays more than risky stocks, even though stocks have historically paid 3–5% extra. It looks as if you'd be taking on the risk without the usual reward.

HOWEVER: That 3.7% is based on what companies earn today. Stock prices are high because investors expect much bigger earnings in the future, driven by AI. If those bigger earnings actually arrive, then the price you pay today is reasonable, and stocks aren't really overpriced after all.

BOTTOM LINE: The risk premium you calculate depends on which earnings you use — today's or the future's. The historical rule assumes today's earnings are a good guide to the future. If AI changes how much companies earn, that assumption breaks, and the real risk premium is unknowable until we see whether the growth shows up.

Did incapacitation, deterrence, or rehabilitation reduce crime in Baltimore?

The Free Press:

Bates, ``a new tough-on-crime prosecutor, ... replaced a scandal-plagued `progressive.'” '' 

Incapacitation (selection): sometimes referred to as ``specific deterrence.''

Bates said that his office has identified about about 6,000 frequent, violent offenders and put between 3,000 and 3,500 of them in prison. The cooperation of federal law enforcement has helped take a number of these offenders off the streets.

Deterrence (incentives):

...more willingness to process felons in possession of a gun, and a more credible threat of punishment.

Rehabilitation:

“If you’re seeing your friends all going to prison, you’re going to go: ‘What? I don’t want to go to prison,’ ” Bates said. “Now all of a sudden, that job or that program someone’s offered you before that you didn’t want to talk about—now it looks pretty appealing.”

Wheelchair Fraud

WSJ: They Get Wheeled on Flights and Miraculously Walk Off. Praise ‘Jetway Jesus.’ 

One viral account had 30 travelers needing wheelchairs to board a Southwest flight — and all but two walking off on their own at arrival.  Another traveler, Carlos Gomez, described a flight delayed by 25 wheelchair passengers and said he sees more "wheelchair fraud" every trip. A flight attendant reportedly told him many able-bodied passengers request wheelchairs for "the VIP experience" — skipping lines, first crack at overhead bins — and that the "healing begins" once they learn they'd have to wait for assistance to get off.

More Test-Taking Accommodations in Wealthy Areas

WSJ: 

The share of SAT takers getting extra time has increased from 2% to 6.7% in the last decade; on the ACT, it rose from 4.1% to 7%. Qualifying students typically receive 50% more time — and on longer accommodations, up to double the standard limit. The surge is concentrated in wealthy areas, where federal data show that students at affluent schools receive accommodations at more than twice the rate of those at high-poverty schools. 

Why? The payoff is huge (a few points can swing an admission), colleges aren't told who got extra time, and the qualifying bar is easy to clear — a diagnosis you can pay a neuropsychologist thousands to obtain. Same incentive for everyone; different ability to act on it.

(Lack of) Economies of Scale in Home Building

Brian Potter at Construction Physics takes a deep dive into economies of scale in construction. There are enough homes being built to observe economies of scale ... if they existed. But even manufactured homes don't seem to exhibit economies of scale. He marshals a lot of evidence to document where costs are incurred and how these compare to other industries. The lack of scale economies imply that the industry is rather unconcentrated. There are thousands of home builders with the five largest nationally having less than 25% of the market.

He concludes by trying to answer why there appears to be almost no economies of scale. One answer seems to be that that materials and labor home building costs represent 97% of costs with equipment costs being only 3%. Auto manufacturing, in contrast, is extremely capital intensive and hence firms are large. Home construction Fixed Costs (FC) are just not big enough for declining Average Fixed Costs (AFC) with scale to be too important. In contrast, high rise construction might require high cost excavators, cranes, pavers, pile drivers, etc. driving up the equipment cost share. Consequently, the five largest contractors for these projects have closer to 45% market share. The cost structure determines the market structure.

Hat tip: Marginal Revolution 

Is Business More Charitable than Charity?

“If I do my job right, the value to society and civilization from my for-profit companies will be much, much larger than the good that I do with my charitable giving.” - Jeff Bezos

A new opinion piece in the WSJ by Marian L. Tupy tries to calculate the value of the time saved by Amazon customers. I may quibble with some of his assumptions, but his point is that the cumulative value of the amount of time saved by Amazon customers likely exceeds the size of Bezos's fortune. This is on top of savings from lower prices and better product matching from a greater selection. Nordhaus famously estimated that entrepreneurs appropriate only 2.2% of the value of technological advances. Or Bezos likely got just a sliver of the pie that was created. Nordhaus's estimate could be off by a factor of forty and value appropriation by entrepreneurs would still be less than 100%. The amount of consumer surplus enjoyed typically rises when profit is earned. No one needs to get poorer just because someone else got richer.

I am reminded by a video clip of John Stossel interviewing Ted Turner from 1998 (I am that old). Ted Turner made his fortune creating a media conglomerate but had recently announced he would be giving away $1 billion in charity. Stossel's video makes the point that Turner could "do more good" by investing the $1 billion than giving it away. Charity divides the pie, investment grows the pie.

Selling Mattresses on Memorial Day

A nagging thought kept creeping into my more somber thoughts this Memorial Day. Why did retailers turn a day of remembrance into an opportunity to sell large consumer goods?

Wikipedia provide a nice history of the holiday but a short piece by McNutt & Partners explains some retailing aspects. For generations after the Civil War, it was called "Decoration Day" during which acknowledgement for the sacrifices of the dead were paired with commemorations meant to instill pride for country. It was renamed "Memorial Day" after WWII but a more significant change occurred in 1971 when it was moved from May 30 to create a three-day weekend. This made possible quick vacations and more time to consider large irregular purchases. 

In economic terms, it concentrated demand for mattresses, and similar big-ticket items, into a single weekend (and then two weeks around the date). This is efficient if there are economies of scale so that retail costs fall with sales volume. This may also permit some price discrimination as those who are more demand elastic seek out these deals and schmucks like me pay higher prices the rest of the year.