Where will it all end?

The Wall St. Journal reports that states are locked into competition that resembles a prisoners' dilemma.

For months, states have been leapfrogging each other to move up their primary votes, seeking a bigger voice in the selection and more revenue from big-spending campaigns. But the race has caused confusion among candidates, who must make advertising and travel decisions, and irked some party officials, who want to bring order to the process of picking their nominees.

The traditional early voting states of Iowa and New Hampshire are in danger of losing their pole position,

Yesterday, state Democratic powerhouse Debbie Dingell, wife of Michigan Rep. John Dingell, linked the candidates' withdrawal from the Michigan primary to national-party efforts to allow Iowa to retain its historical influence at the expense of larger states. "This election is not about president of Iowa, it is about president of these United States," she said.

PREDICTION: this year, most primaries move to January and February; in 2012, they learn how to get out of the prisoners' dilemma by taking turns.

The Circle of Economic Life

Let's say you work really hard to build a line of business into a really successful enterprise. Your customers are satisfied, sales are growing strongly, and profits are nice and fat. What's bound to happen next? The forces of competition will rear their ugly head. Fat profits in a business are like blood in the water to a shiver of sharks (impress your friends with that one: a "shiver" of sharks).

We see this sad tale unfolding once again; this time in the cable business channel market as reported in this story from Business Week. CNBC has built a dominant position, recording an operating margin of 57% and total operating profits of over $300 million according to the article. Who's the shark being drawn by these juicy margins? News Corp. plans to launch the Fox Business Network in the next few weeks.

It's the circle of economic life - I wonder if we could make a movie like the Lion King featuring the death of old companies followed by the rise of new titans (do you think Elton John would write us a theme song?).

Credit cards, bankruptcy, and agency costs

In the past quarter century, unsecured credit card debt has replaced other kinds of (secured) consumer debt, including retail store credit, personal finance companies, friends and family, and pawnbrokers. The graph above shows an increase in "revolving" consumer debt service (as a percentage of income); and a corresponding decline in "non-revolving" debt service.

Over this time period, the bankruptcy rate has quintupled. Colleague Todd Zywicki (visiting Vanderbilt this semester) intreprets the correlation:

...[credit cards] have increased the incentive for indebted consumers to elect bankruptcy as a response to their financial difficulties, thereby increasing the propensity to file bankruptcy.

In October, 2005, bankruptcy reform made it more difficult for borrowers to walk away from credit card debt if they had the ability to repay. Predictably, the number of bankruptcies fell from 2 million in 2005 to 600,000 in 2006.

Under Zywicki's hypothesis, bankruptcy reform lowered the cost of providing credit to consumers by allowing lenders to better penalize moral hazard (actions that increase the likelihood of default) and better guard against adverse selection (lending to borrowers who intend to default).

Note the parallel of bankruptcy reform to the use of credit history to price car insurance. A better predictor of car insurance allows insurance companies to reduce moral hazard by penalizing bad driving and to reduce adverse selection by raising prices to bad drivers.

Maybe College Doesn't Pay

Interesting story from the Seattle Times that expresses some skepticism over whether getting a college education is really such a clear-cut good investment. It cites some work by economist Laurence Kotlikoff at Boston University. The basic argument is that a lot of the statistics supporting the value of education fail to take into account a number of factors that reduce its benefit like higher tax rates, lower Social Security benefits, and potentially lower Medicare benefits. These are all relevant “costs” that vary with the decision to attend college, so they should be taken into account.

As someone who has (over?) invested in education, I’m not sure I’m convinced. But, I see value in questioning “truths” many simply seem to take at face value.

The next big idea: human computing

Saw a fascinating lecture on "Human Computation" by a Carnegie Mellon professor who holds several patents on games like Peekaboom, Phetch, and the ESP Game. The idea is to harness free computing cycles from otherwise idle human minds to accomplish tasks, like image classification, that computers cannot do.

Is everything for sale?

In previous posts we have talked about the "cost" of marriage, what a man and a woman give up to be in one. And now we have this conversation on Craig's List between a woman and a potential mate.

Okay, I'm tired of beating around the bush. I'm a beautiful (spectacularly beautiful) 25 year old girl. I'm articulate and classy. I'm not from New York. I'm looking to get married to a guy who makes at least half a million a year. I know how that sounds, but keep in mind that a million a year is middle class in New York City, so I don't think I'm overreaching at all.

Are there any guys who make 500K or more on this board? Any wives? Could you send me some tips? I dated a business man who makes average around 200 - 250. But that's where I seem to hit a roadblock. 250,000 won't get me to central park west.

My colleagues in the divinity school would criticize what they call the "commodification of relationship," but when you try to sell yourself, it seems only fair that you get treated like a potential investment.

...what you suggest is a simple trade: you bring your looks to the party and I bring my money. Fine, simple. But here's the rub, your looks will fade and my money will likely continue into perpetuity...in fact, it is very likely that my income increases but it is an absolute certainty that you won't be getting any more beautiful! ...

So in Wall Street terms, we would call you a trading position, not a buy and hold...hence the rub...marriage. It doesn't make good business sense to "buy you" (which is what you're asking) so I'd rather lease. In case you think I'm being cruel, I would say the following. If my money were to go away, so would you, so when your beauty fades I need an out. It's as simple as that. So a deal that makes sense is dating, not marriage.

I wonder if the woman would profit from reading our earlier post on strategy from Whole Foods' CEO, John Mackay:

...we have not achieved our tremendous increase in shareholder value by making shareholder value the primary purpose of our business. ... In the customer-centered business, customer happiness is an end in itself, and will be pursued with greater interest, passion, and empathy than the profit-centered business is capable of.

The man also is wary of adverse selection the problem caused when, in this case, the seller has more information the buyer.

...I wonder why a girl as "articulate, classy and spectacularly beautiful" as you has been unable to find your sugar daddy. I find it hard to believe that if you are as gorgeous as you say you are that the $500K hasn't found you...

"It's Up to You" Pricing

Rock group Radiohead is now offering a digital download of its new CD, "In Rainbows," available for ordering only on its website.

What's the price? It's up to you to decide - consumers can pay whatever they want.

I must have missed the lecture that covered this pricing strategy in school.

Will a 2008 Democratic victory result in a boom, then a bust?

In yesterday's post, we documented the effects of EPA's diesel emissions regulation: before they took effect, truckers accelerated demand to purchase trucks with the older, cheaper engines. This made 2006 a boom year--followed by bust--for the industry.

Now it looks likely that we will have a Democratic President in 2008. In the graph below, a contract that pays $1 if a Democrat is elected President is trading at $0.61 at intrade.com. This would imply a 61% probability of a Democratic President.


Can we use the same analysis to predict that a Democratic presidential victory would cause businesses and consumers to accelerate demand in anticipation of more regulation, higher taxes, and restrictions on international trade? Followed by a bust?

I have heard some macroeconomists suggest that the 1982 recession, and the subsequent expansion, were caused by anticipation of the Reagan tax cuts. Congress cut the marginal tax rates, the amount you pay on the last dollar you earn, 25% across all income brackets.

Truckers are stockpiling dirty diesel engines

In 2007, new EPA regulations that mandate cleaner diesel engines took effect. The new engines reduce particle emissions by up to 98% over the previous generation and cut Nitrogen-oxide emissions in half.

But they increase the cost of trucks by $12,000, or about 10%. In addition, truckers (consumers of the new engines) expect higher maintenance costs and worse fuel mileage.

Predictably, the new regulations caused a big increase in demand for 2006 engines and trucks,

Truckers seeking to beat the price increases made 2006 a record year for truck makers. More than 373,000 big-rig trucks were built in North America, says Ken Vieth of A.C.T. Research, which follows truck sales trends. The tally easily topped the previous record of 330,000 trucks in 1999.

But next year, Vieth predicts "a production drought," with sales falling by more than 40% to 220,000 as trucking firms hold off buying to see how the new clean-diesel trucks perform. ...

The cost to truckers goes beyond new big-rig purchases, according to Moskowitz. The new fuel costs 5 cents to 10 cents more per gallon to refine and may produce lower fuel mileage. The new engines weigh more, further cutting mileage. "Over the long run, their increased costs will be passed on to the shippers and ultimately, the consumers," Moskowitz says.

Both the 2006 boom, and the 2007 bust were predictable with simple supply-demand analysis, especially since a similar regulatory change occurred in 2002.

For policy makers, this points out yet another disadvantage of a command-and-control approach to clean air. Mandates from Washington have to be phased in, and this gives consumers an incentive to stockpile old, cheap, but dirty engines so they can use them in the future. Instead of telling producers what to produce, or consumers what to consume (by picking technologies, like ethanol, to subsidize), tax what you don't want (pollution) and let the market decide how best to reduce it.

Bottom line: How many economists does it take to screw in a light bulb? None--the market will do it.

Would you pay $200 to prevent shingles?

Most of economics tends to assume that people are rational decision makers who try to maximize their utility. In general, this seems to me to be a pretty reasonable assumption; however, it's sometimes difficult to predict what gives people utility.

I was reminded of this when I saw a story about a new vaccine for shingles, a particularly painful outbreak of rash or blisters that is caused by the same virus that causes chickenpox. Given the incredible discomfort caused by this disease, you would think that consumers would be willing to pay a fairly sizeable amount to avoid it. Well, not in all cases. According to the article, here's the view of one consumer who already suffered through one "quite nasty" case and doesn't want to pay $200 for a vaccine to prevent another case:

"I can afford to do it, but I got my back up and I'm not going to," said Davidson, who regards her refusal as something of a moral issue. "More people should take a stand; $200 is a horrendous amount of money. The drug companies are rolling in money and should help pay instead of running full-page ads," she said, citing prominent advertisements for the vaccine taken out by manufacturer Merck earlier this year.

I hope Ms. Davidson derives sufficent utility from her moral stand of sticking it to the drug companies to compensate her for the pain of another instance of shingles.