Funmurphys: the Blog

Cost To School Doesn't Equal Value To Society

I could ramble on at great length and venom on this subject, but as time is short I'll let Captain Capitalism handle Why Social Sciences are Pushed More Than the Hard Sciences in College:

The school I was at needed equipment and gear to teach the kids. This would have required a new building and new equipment. However, somebody got the ingenious idea that they would rent some nearby cheap office space and require the students to get "general ed requirements." Then in shifts the kids would come in and take their general education requirements while the other students used whatever lab equipment they needed. They more or less doubled enrollment without having to spend twice on the gear.

We go on to find out why there are so (too) many lawyers and why certain fields like, oh, feminist studies, to use the actual example from the post, have become so popular with universities and why there are too few scientists and engineers graduating from same. Although I will say, in agreement with Michelle Obama here, K-12 education in America has some significant problems, and lack of rigor in those years is a huge reason there are way too few American born scientists and engineers.

The Rest Of The Circuit City Story

So I'm enjoying reading The 101 Dumbest Moments in Business, 2007 (via Joe Sherlock) And then I come across the answer to an earlier post about Circuit City's novel approach to cost cutting -- firing the highest paid, i.e. the best, salespeople:

Since I'm not one of the people being fired, I can be detached and think that this will provide a nice economics case study in cost cutting. Arguably (i.e. I'm leaving wiggle room for later) it will be used as a case study in business school - but I will leave it up to an excercise for the reader to decide if it will be held up as an effective, an ineffective, or a disastrous way to cut costs.

And now, the rest of the story:

In a cost-cutting move, Circuit City lays off all sales associates paid 51 cents or more per hour above an "established pay range" - essentially firing 3,400 of its top performers in one fell swoop. Over the next eight months Circuit City's share price drops by almost 70%.

I think, unsurprisingly, disastrous is the final answer. I guess companies will go back to laying off the bottom performers instead of the top.

Weather Economics.

I'm kind of shocked about a newspaper story I'm NOT seeing, namely the story that says that the recent slowdown is do the the harsh winter we've been having. They used to run stories about how warm weather increased spending:

The warmest January in more than 100 years lured consumers out to the shopping malls to spend money at the fastest clip in six months, giving a strong boost to the economy as the new year began.

So, does the weather play a role? My wife last night was lamenting that she hadn't been able to do any real shopping in a long while because of the lousy winter weather. Yes, an anecdote, but a perusal of back issues says the weather spending connection was once taken seriously by the media. I don't recall one story yet this winter making that claim.

Could it be that the media is trying to (1) tarnish Bush and (2) affect the outcome of the election?

Another interesting part of the 2 year old story:

However, a third report showed construction spending managed only a 0.2 percent increase in January, the weakest gain in seven months and far below the 1 percent analysts had expected.

A big reason for the slowdown was a tiny 0.1 percent increase in private home building, the poorest monthly performance since an actual decline of 0.4 percent last June.

It was a further indication that residential construction, which has enjoyed five boom years, is beginning to slow.

Sales of both new and existing homes fell in January despite the warm weather. Economists predict continued increases in mortgage rates will slow housing further in coming months.

What's this, a slowdown in the housing market 2 years ago? I thought the current slowdown was just that - current and because of the current sub-prime "debacle". Sometimes it really pays to go back and read old news because the news itself has so little correct historical context to it and too much current narrative.

Clinton: "Prius Owners Won't Get Mortgage Deduction"

I know I'm just a country bumpkin from Missouri, but when a politician says this:

"In addition, Hillary will end the tax incentives to companies that ship jobs overseas, and invest those resources in creating good, high-paying jobs here in the U.S."

I can't help but think

"In addition, Hillary will end the mortgage income tax deduction to individuals who buy Priuses, because they are shipping those good, high-paying jobs overseas. Instead, they should buy cars manufactured right here in the U.S."

Of course, you'll never hear a politician actually say that, although for the life of me I can't see the difference between a company buying products from overseas and an individual buying products from overseas. Companies are just aggregators of all the people necessary to make a product for the purchasers of the product. Economically or morally, it makes no difference if the purchaser or the company aggregates from foreigners - the foreigners are employed just the same (not that there's anything wrong with that). In fact, from this nativist point of view, isn't better to buy from a company that outsources than from a foreign company because the outsourcer preserves more American jobs?

The Empire Strikes Back ...

And so it begins:

French Strike Tonight to Protest Sarkozy Plan

I think it's a remake of the classic: Margaret Thatcher and the Unions.

Does representative government work? Yes, so I'm saying Sarkozy will win this one.

Assolutamente! And I Don't Even Drink Coffee

Someday, I'll finish the tale of the Murphy Family's European adventure and include pictures of Venice, my favorite of all cities. Until then, you'll have to make due with this story:

Immediately upon arriving in Venice, Italy, a friend asked a hotel concierge where he and his wife could go to enjoy the city's best. Without hesitation, they were directed to the Cafe Florian in St. Mark's Square. The two of them were soon at the cafe in the crisp morning air, sipping cups of steaming coffee, fully immersed in the sights and sounds of the most remarkable of Old World cities. More than an hour later, our friend received the bill and discovered the experience had cost more than $15 a cup. Was the coffee worth it, we asked? "Assolutamente!" he replied.

Venice is that good. Heck, I'd take up drinking coffee just for that experience.

The post I took it from is also quite good, and explores the difference between cost and price and why music, even in the digital age, won't be free. The value (and thus the price a consumer is willing to pay) of an experience to a consumer is not the sum of the costs that go into that experience.

And who says posts about economics have to be dismal and boring?

Cereberus Now Has Three Heads

I suppose I'm a bit of an oddity - an ardent free trader who only buys American nameplate cars (kind of the exact opposite of all those "progressives" who decry American companies sending jobs oversees but who will only drive a foreign nameplate car). I'm not a car guy, but I have paid some attention to Chrysler if only because of friends who work there. While Ford and GM continue their slumber, Chrylser has been shocking - first being bought by Daimler, then being sold to Cerebus, then hiring Robert Nardelli of all people, and now hiring Toyota's top American (in both senseis of the word). Now that Oldsmobile has gone the way of all flesh, I can say without risk of legal intanglements that this isn't your father's Chrysler. I suppose it just shows you that it's the company closest to going the way of Oldsmobile that makes the biggest transformations.

Now Cereberus has Lasorda, Nardelli, and Press to run their car company - three heads are better than 1!

How Real Estate Commissions Work

We sold our house. I gathered a number of stories along the way, some good and some bad. I also learned a few things about how real estate commissions work. This information was surprisingly hard to obtain, but very important and valuable. So I'm sharing it with you for free, all part of the life services we offer here at funmurphys.com.

First, some definitions: The seller owns the house and wants to sell it. The buyer is thinking of buying a house. The seller and buyer may be working through real estate agents who represent them, the seller's agent and the buyer's agent. The seller's agent is also called the listing agent. Licensed real estate agents are often known as Realtors (TM).

Here's the executive summary: The home seller pays a percentage commission to the selling (listing) agent, which the agent splits in half with her office. If there is a buyer's agent, that agent also receives a percentage commission, deducted from the selling agent's commission. The buying agent also splits the commission in half with his office. A lot of implications flow from this seemingly simple arrangement. Take a deep breath . . .

You can simply sell or buy a house on your own, but it's a Big Scary Process involving a lot of legal paperwork and financial transactions. So most home sellers sign a listing contract with a seller's agent and let them deal with all that. The seller and agent agree on a commission based on the price of the house; the "classic" real estate commission is 6% of the sales price, but that percentage is neither the typical commission nor the average commission (more on that later). The seller's agent receives her commission at closing, when the house is finally sold. If the house does not sell during the term of the listing contract, the agent gets nothing. Of course she'll try to avoid that scenario.

Let's use a house base price of $400,000, which should be fairly typical for people reading this column. A 6% commission of $400k is $24,000. The seller's agent usually splits the commission 50-50% with his real estate office. In this case the agent would receive $12k at closing, and the agent's office would receive $12k.

The 6% real estate commission is not sacrosanct! Many real estate agents want to list and sell your house, so the seller can negotiate that commission. You can ask if a potential agent will accept a 5% commission, or even a 4% commission; and if they want your business, they may take it. Or try some fractional percentage. They might take you up on the offer, depending on a lot of factors like their workload, the house's likely price, how quickly your house is likely to sell, and so on. "Everything is negotiable." Sellers who calculate the commission amount before signing the listing contract often realize that $24k is a big chunk of change to be sending out the door, and start to wonder if there is some way they can reduce that amount? How about a 5% commission instead, or $20k?

At this point we have enough information to bust one myth right away. Here is the myth: Real estate agents will seek the highest sales price for your house because it means a bigger commission for them. Like most myths, there is a grain of truth in this statement. Anybody with a calculator (and most people without one) can see that a higher sales price yields a higher commission.

But "everything is negotiable," especially the price of the home itself. The seller may occasionally get a buyer who will pay the listing price right away, but more often the buyer offers less than the asking price. How much less? A buyer might offer $380k, the seller might counter to $390k, and the two parties will eventually agree on $387k. The monetary increments in house negotiation are on the order of $10k. Amounts of $10k will make or break the deal.

$10k is a lot of money to the buyer and the seller - you can take your family on a Hawaiian vacation for that! It's worth haggling over. Are you working on margin? - you've probably got a mortgage to pay off, or another house to buy. But what is that $10k to the real estate agent? She and her office stand to collect $24k if the sale closes successfully. The difference in commission over a $10k difference is only $600. Does she want to risk the entire $24k over a measly six hundred bucks? No way! She wants the deal to go through. Her motivation structure is set up to reward deals completed, not to squeeze the most commission out of each deal and risk losing the sale entirely. Yes, it would be nice to earn a higher commission, and the seller will probably give her glowing referrals if she gets a good price. But the motivation structure of the traditional real estate commission is set up primarily to reward sales completed. Price increments in the amount of $10k are of secondary importance to the agent.

Now let's suppose the seller has negotiated a 5% commission with the listing agent, and the house is on the market. A buyer comes along in the company of a real estate agent, which is the usual scenario. The buyer likes the house right away and offers the full $400k. How does the buyer's agent get paid?

The buying and selling agents do NOT split the real estate commission 50-50! Surprise! The commission for the buyer's agent is fixed, and this percentage is sacrosanct for the local area! In my region of Colorado the buyer's commission is 2.8%, fixed not by law but by rigid local custom and practice. Real estate companies that subscribe to the Multiple Listing Service (MLS) agree to honor the buyer's commission. If you look at the bottom of an MLS listing you may see something like "BA 2.80". This means Buyer Agency 2.80%, which is what the seller has agreed to pay a real estate agent working for the buyer.

Everybody wants to attract a buyer, and one way to do this is to attract the buyer's agent. The 2.8% buyer's agent commission is sacred because nobody wants their 2.5% commission sneered at, and passed over, by those buying agents out there trolling for properties. So everybody marches in step with the standard buyer's agent commission, and dares not go below that amount. The professionals know these rules and are very reluctant to break them. And a standard buyer's commission helps to keep the agent neutral with regard to multiple houses. (In some places there has even emerged a practice of offering agent incentives - a larger commission for the buyer's agent - as a way of attracting buying agents. This practice is pretty much a bribe and ought to be illegal, but isn't. Yet.)

Back to the example. The total 5% commission paid by the seller on $400k is $20k. The buying agent gets 2.8%, or $11,200. The selling agent gets what's left over: 2.2%, or $8,800. Notice that the buying agent gets more than the selling agent. $2,400 more. Are you comfortable with that?

You might be more comfortable to learn that buying agents do most of the property tours and walk-throughs. 9 out of 10 showings on our house were conducted by buyer's agents, not by the listing agent or by me. The listing agent puts on open houses, posts advertising, and talks up the property, but most of the showings are done by another agent (working with the buyer). Feel better? Maybe, but it still seems weird to me that the commission is not split 50-50. That's Weirdness #1.

Since the buyer's commission is fixed at 2.8%, you can see that the listing agent gets really squeezed by lower commissions. A 4% total commission only leaves the selling agent with 1.2%, and anything below 3% will lose them money.

The standard listing contract states that the real estate commission is paid by the seller. In our earlier example, the buying agent received $11,200 of that commission. Colorado has a required notice to clarify the relationships, saying that the buying agent is working in the buyer's interests, and the selling agent is working in the seller's interests. Nice to know. So our poor seller is paying the buyer's agent $11,200 to negotiate intentionally, deliberately, and professionally against him! That is Weirdness #2. The seller pays the buyer's agent to work against him and against his best interests. I am not making this up.

A listing contract is a pretty thorough document, specifying conditions and terms and payment. The relationship of a home-buyer with a buyer's agent is less well-defined. Suppose you have looked over a bunch of houses over the past year, got serious about a few of them, and have finally settled on one house to buy. Who is your buyer's agent, and who gets the buying agent's commission?

Real estate agents are professionals, and they want to avoid problems with each other and with their clients. To this end, they have adopted certain practices to ensure fairness and avoid client-stealing. The accepted practice is this: The licensed agent who first showed you the property receives the real estate commission. "Showing the property" means accompanying you in person on a physical tour of the home and grounds. The official buyer's agent is the one who first set foot on the property with you.

Quiz

This practice has some implications that might not be obvious to the casual "Looky Louie" browsing through the neighborhood. Take this test:

You and your spouse are thinking that you might move someday, and you come upon a neighborhood that looks nice. Sure enough, you see a house for sale that's attractive from the outside. You pick up a flyer from the sign on the lawn, and call the listing agent to arrange a showing.

A couple days later you tour the house with the listing agent. But the bedrooms are not laid out the way you want, or the back yard is too small, or something else is not right. It's a nice house, but it won't do for you. You thank the agent politely for her time. As you are leaving, she says, "Before I left the office I gathered a few listings of similar homes in the neighborhood. Would you have time to go look at those?" How do you respond?

Possible Responses:
A. "Sure, we have another hour to spare. Let's go look at them."
B. "Not on your life! What are you trying to do, trick me?!! Get away!"
C. "Not today, but if you give me your business card I might call you later."
D. Without a word, you snatch the listings from her hand, jump in your car, and speed off! As you make your get-away you copy down the addresses and then shred the listings!
E. "No, thank you."

The answer here is that you can do anything you want, but the agent's innocuous offer has some big implications that most people don't realize. Consider Response A: If the agent (whom you just met) accompanies you physically to the 2-3 other houses this afternoon, she will have locked up your buying relationship with that house. That's the commonly accepted practice among real estate agents, remember? In other words, if you later decide to buy one of those 2-3 houses, you'll have to buy it through her. Did you realize that?

When you called to make the original appointment, the agency may have asked you, "Are you working with a real estate agent?" You truthfully answered "No," because you were just looking around at that point. You expected to deal with the listing agent on the original house, but she doesn't represent the 2-3 other properties. At least, she didn't until this afternoon. But now she represents you if you want to buy one of those other houses. That's Weirdness #3.

Response B is not good; it's rarely productive to be rude to someone for no good reason. But at least it demonstrates that you know what's at stake here. (To be fair, she's probably not trying to "trick you", she's merely offering professional assistance. Then again, her name is printed at the bottom of each listing, leading you to believe that she is the listing agent for those properties, too.)

Response D is a dramatic flourish for the Walter Mitty in all of us, and it would be nice to have those other listings. But the agent has performed a small service for you in running a property search - it would be more ethical to log onto realtor.com or coloproperty.com or zillow.com and find those listings yourself.

Response A is okay if you really want to use that agent to buy those properties. But bear in mind that buying a house can be stressful, and you have at least a month of high-intensity business relationship ahead of you before closing. Weren't you going to interview a few real estate agents before choosing one to work with? Now you're stuck with one you didn't even select.

Response E is kind of abrupt. But it's clear.

Response C is my choice, unless I really take a dislike to the agent. We might decide to work with her after talking it over, and she's already shown some initiative. Why not take her business card without promising anything?

Who Pays?

Who really pays the real estate commission? The seller does, right? It says so right there in black and white on the listing contract! The buyer gets all these real estate services for free, right?

Not so fast! Remember that the seller sets the asking price for the house, knowing that they will have to pay a 5% commission out of that sales price. The seller will only sell if they get a certain minimal amount in return. So it's natural for the seller to raise their asking price by 5%. Now it's the buyer who pays the commission, because they have to pay a higher sales price. Remember that the buyer is the one who will supply all the money to complete this transaction. The buyer has to finance the full amount of the sales price, which includes the real estate commission.

In summary: It's not clear who really pays the real estate commission. But no matter how you figure it, real estate commissions have the effect of sending 5% of the property's value off into the real estate industry every time a house is sold.

Most home-buyers go around with a buyer's agent because they think that they are getting something for free. But it's not free! The buyer is paying for that service whether they realize it or not.

Yes, I know that a buyer's agent will negotiate for you, will protect your interests, and so on. They can make sure that a few hundred dollars of plumbing repairs are completed before closing. But most buyer's agents I worked with urged me to raise the offers I was making! "You're going to insult the seller with a lowball offer." Most seller's agents urged me to lower my asking price. It felt like they were working for the other party, not for me. Remember that real estate agents are motivated to close the deal.

Real estate agents are professionals who provide a service. If the value of that service to you is worth $10,000, then go ahead and hire them. But make sure you know what you're getting, and what the real costs and implications are. If you are searching for properties on your own, calling listing agents to arrange showings, checking out comparable sales on zillow.com, and you know the local neighborhood; do you really need to pay an agent $10,000 to tag along behind you and fill out some spaces on a standard sales contract?

The Unattached Buyer

Weirdness #4 comes when you consider an unattached buyer. Let's call him George. George has read the first part of this article, has done some research, has bought and sold houses before, and has decided to buy a house on his own this time. He'd like to save some money somehow. George has successfully fended off the overtures of agents at open houses, has never gone on additional showings offered by listing agents, and certainly has never signed an exclusive right-to-buy contract.

George finds a $400k home that he likes, and he thinks the asking price is reasonable. Knowing that the seller will not have to pay the 2.8% buyer's commission, he considers offering 2.8% under the asking price. But George is a good guy, and he realizes that the selling agent will have to do more work because he's not familiar with mortgages and inspections and title companies and the like. It's just easier to work with another licensed agent. So George offers 2% less than the asking price, figuring that this offer will save everybody money and compensate the agent fairly.

And he's right! Unfortunately, the seller has signed a listing contract with her agent, without first reading the contract carefully and considering what happens to an unattached buyer. The usual listing contract specifies that if a buyer has no agent, the selling agent will work as a "transaction broker" instead. The transaction broker works for neither party, but guides the transaction to completion. That's great. But the transaction broker still receives the full 5% commission, according to the standard listing contract!

George submits an offer for $392k, and is puzzled when the seller doesn't consider this to be a full-price offer. The problem is that the listing agent has already claimed the 2.8% buyer's commission by the terms of the listing contract. The seller did not notice this provision, and there is no automatic discount for unattached buyers. There should be.

It's not clear how George can get the discount that he rightfully earned by doing all the legwork himself. This is Weirdness #4. The selling agent knows perfectly well what's going on, but might not explain it to the seller. The seller might simply accept the offer as is. But if not, George and the seller have to hope that the listing agent will agree to reduce her commission in order to make the sale. Will she do that? Will she kick up a fuss even though she comes out better off than if George had an agent? Who knows?

The seller could have insisted on a 2% discount for unattached buyers, and written that into the listing contract up front (and specified a 3% commission to the transaction broker). The listing agent will probably say that "most agents wouldn't do this" and agree to it anyway. Real estate agents know that most buyers come with an agent. But the seller wants to sell her house, and one way to do that is to offer discounts to whomever she can.

Recommendations:

The buyer and the seller should each pay for their own services rendered to them. This practice of the seller paying the buyer's agent is just nuts.

If you are a home buyer, and you want to work with a real estate agent in the classical manner, go ahead. A professional can save you a lot of hassle. But don't get attached to an agent without realizing what is happening, and what the implications are when you set foot on a new property.

An unattached buyer has about a 2% negotiating advantage, but it's not clear how to use that edge. Be creative and negotiate. Consider signing up with one of the buyer services that refund most of the buyer's commission to the buyer.

If you are a seller, consider listing your house with one of the discount brokerages. They charge a monthly fee of about $100 for the MLS listing, and a flat fee on the order of $1,000 to handle closing. Don't worry about showing the house yourself - the few times that you personally walk someone through will be enjoyable!

Consider hiring a real estate agent on a flat fee basis. They really do know a lot! $1,000 is a reasonable fee to walk you through the process once the sales price is agreed upon, especially if there are problems. The title company is supposed to manage the transaction itself, but an agent can work out disagreements over the inspection and other matters.

If you are a seller, get one of your friends who has an eye for interior design and decorating (you know who they are). Ask them to walk through your house and let you know how to spruce it up (or clean it out) for sale. Serve them dinner afterwards.

Buy a five-gallon bucket of white semi-gloss interior paint. Start repainting the rooms that are not white. Do not stop painting until the bucket is empty.

Good luck!

Circuit City Cost Cutting

I have never been a big fan of Circuit City and we usually go to Best Buy in the Murphy Family. I did buy a camcorder there a few years ago for which the salesperson knocked 200 dollars off the price just so I'd buy the 200 dollar extended warrenty. I later decided I was $200 down on the deal and haven't been back. So I don't see the latest news as out of character: Circuit City to Fire 3,400, Rehire Cheaper Workers .

``Firing 3,400 of arguably the most successful sales people in the company could prove terrible for morale,'' Colin McGranahan, an analyst with Sanford Bernstein & Co., wrote in a note today. ``The question remains as to whether Circuit City can rebuild in time for the all-important holiday season.''

I'm thinking that firing 3,400 of arguably the most successful sales people could prove terrible for more than just morale, I'm thinking perhaps, just perhaps, it could prove terrible for sales as well. Although if the salesman who moved money from the store's pocket to his own is one of the highly compensated ones, maybe not.

Since I'm not one of the people being fired, I can be detached and think that this will provide a nice economics case study in cost cutting. Arguably (i.e. I'm leaving wiggle room for later) it will be used as a case study in business school - but I will leave it up to an excercise for the reader to decide if it will be held up as an effective, an ineffective, or a disasterous way to cut costs.

585 Billion Dollars

Yikes! Does our state and federal governments spend 585 Billion dollars a year on means tested anti-poverty programs?

Moby seems to think that's how much we spent on Iraq up until 2006.

Robert Waste thinks thats how much we spend on our permanent urban crises of high levels of poverty, hunger, homelessness, crime, and low levels of funding for mass transit, infrastructure needs, and education.

Or is that how much money social security taxes will bring in in 2014 in 1997 dollars (doesn't that accounting just make your head swim).

How about the total value of service exports world-wide in 1981 (I assume in 1981 dollars).

Or even the total value of Chinese exports in 2004.

OK, this was sparked by a Bizzy Blog post that used the 585 billion dollar number while noting that it was unconfirmed to determine:

If there are 40 million people living in poverty in the US (that would be 13.3% of the population, slightly higher than the current official rate), that would mean we are spending $14,625 on EVERY man, woman, and child living in poverty. A married family of four in poverty could live very nicely on over $58,500 tax-free dollars a year, as could a single parent with two kids on almost $44,000; but of course, the money and the value of the services isn’t getting to them.

Well, I didn't a little searching (as you can hopefully tell) and back in 2001 Mr. Rector of the Heritage Foundation testified before congress that offical figures showed that in 2000 the feds and the states spent 438 billion dollars in welfare and projected the sum to rise to 626 billion dollars -- or you can check out the Heritage Report. I couldn't confirm the 585 figure for 2006, but it sure looks to be in the ballpark.

If we aren't talking about dollars, LG Electronics made a net profit o 585 billion KRW in 2004

A Little Management Wisdom

I'm always on the lookout for catchy titles, so of course Crappy People Vs. Crappy Systems caught my eye.

This tendency to look for individual goats – and heroes – isn’t just a problem that permeates the world of sports. It is reflected in many misguided ideologies and management practices, which focus excessive energy on hiring stars and weeding-out mediocre and poor performers, and insufficient energy on building a great system that enables most competent people to succeed.

While I don't disagree (I'm one with the idea that systems matter), there are some people who are, well, crappy workers and simply aren't going to work in any system that works for most other people. And no, I'm not going to name names, but we've all worked with people who in fact lower total production because they get little or nothing done themselves and cause their co-workers to spend time and effort to fix the crappy workers mistakes.

But I think Mr. Sutton is entirely correct that systems have much more impact on workers than workers on systems, so companies are better off perfecting the system than trying to find the perfect worker. I'm reminded how Enron was big on finding stars and we all know how that turned out.

On The Other Hand, A Sock

This could be an interesting article, if it were written in english, and not academicese:

There is growing evidence that consumers are influenced by Internet-based opinion forums before making a variety of purchase decisions. Firms whose products are being discussed in such forums are therefore tempted to manipulate consumer perceptions by posting costly anonymous messages that praise their products. This paper offers a theoretical analysis of the impact of such behavior on firm profits and consumer surplus. There are three main results. First, if every firm's manipulation strategy is a monotonically increasing (decreasing) function of that firm's true quality, strategic manipulation of online forums increases (decreases) the information value of a forum to consumers. This result implies the existence of settings where online forum manipulation benefits consumers. Second, equilibria where strategies are monotonically increasing (decreasing) functions of a firm's true quality exist in settings where the firm's net payoff function, inclusive of the cost of manipulation, is supermodular (submodular) in the firm's quality and manipulation action. Third, in a broad class of settings, if the precision of honest consumer opinions that firms manipulate is sufficiently high, firms of all types, as well as society, would be strictly better off if manipulation of online forums was not possible. Nonetheless, firms are locked into a "rat race" and forced to spend resources on such profit-reducing activities; if they don't, consumer perceptions will be biased against them. The social cost of online manipulation can be reduced by developing "filtering" technologies that make it costlier for firms to manipulate. Interestingly, as the amount of user-contributed online content increases, it is firms, and not consumers, that have most to gain from the development of such technologies.

Did you catch that? Yea, me neither. Other than that part about companies using sock puppets to better their reputations. I just have to ask the Dr. Phil question of other people who have used sock puppets -- how's that working out for you? I wonder if the model took into consideration the effect on consumer opinion when the sock is publicly removed from the company's hand.

I also catch more than a wiff of the two handed economist here - on the one hand, company sock puppets could decrease the information value of a forum to consumers, and the other hand, they could benefit consumers. OK Einstein, just what are the "settings" that benefit consumers.

I think companies would be better off the old fashioned way, that is, (1) focus on doing a good job over the entire lifecycle of their product/service, and (2) use clearly identified spokespeople in forums who are (a) honest and (b) engaging. Sock puppets are for losers.

A Little Economic Reading

I just finished reading The Elusive Quest For Growth and The Undercover Economist and I have to give a two thumbs up recommendation for both.

The Elusive Quest For Growth chronicles the attempts over the years to get poor countries to grow economically. It makes for depressing reading, but at leasts confirms my opinion that bad government is the number one problem for developing countries. Sadly, knowing that doesn't make the problem easier, because how do you change the incentives that make everyone's best interest to steal now to incentives that make everyone's best interest to, well, obey property laws or put another way, to take money now versus to provide something in return for money later?

The Undercover Economist is an excellent primer in economic thinking and covers a lot of ground. Mr Harford provides clear explanations by first starting with familiar situations and then scaling them up to more general or important ones. My only sour note was in the brief discussion of used cars - the way I see dealers getting around the assymetric information problem is through warantees - by standing behind every car they sell -- and not on spending money on buildings to indicate they will be around later (at least in the US).

If I had books like this to read back in my econ 101 days instead of dry academic textbooks, maybe it wouldn't have taken so long for me to discover the joys of economics.

What Is A Fair Price?

I know a lot of us view the gyrations of the price of a gallon of gas with a mixture of suspicion and alarm -- and yes, a feeling of unfairness. Researchers from the University of South Carolina examined the perception of fairness and dynamic pricing and came to an unstartling understanding:

Consumers have higher fairness perceptions and satisfaction regardless of the price level when they play a role in the price setting process rather than when prices are set by the retailer," the researchers explain. Additionally, "consumers view price changes within very short time periods as more unfair than changes over a more extended time period."

Additionally, people find it unfair to pay a different price than others (I'm thinking airlines here). But do these factors really determine a "fair" price, or just the perception of one? Clearly, these are factors you can look at when you don't have visibility into the real factors that go into price, i.e. supply and demand.

Lost In Translation

Here's my problem, when I hear the phrase "common good" I think "tragedy of the commons".

Perhaps my problem is that I've found I like economics outside the academic setting, where I found it boring and repulsive.

Dobson, Seipp, and HPV Vaccination

Cathy Seipp is a smart person, so why does she her analysis of the response to an HPV vaccine stumble so badly?

First off, she claims that certain religious fanatics are attacking the new vaccine for HPV:

One of the first things I had my 17-year-old daughter do when she began college this fall was make an appointment to get the new anti-HPV (for “Human Papillomavirus”) vaccine at the university’s student health center. HPV is the sexually transmitted virus that can cause cervical cancer, and the new vaccine (which in my view should only be celebrated, as should all medical progress) has been attacked by religious fanatics almost as soon as it was introduced. ‘Why, this will only encourage young girls to have sex!’ Or so that kind of thinking goes — if you can even call it “thinking.”

OK, what is Focus on the Family's position? Oddly enough, they have a .pdf position statement on their web site:

Recognizing the worldwide detriment to individuals and families resulting from HPV, Focus on the Family supports and encourages the development of safe, effective and ethical vaccines against HPV, as well as other viruses. The use of these vaccines may prevent many cases of cervical cancer, thus saving the lives of millions of women across the globe. Therefore, Focus on the Family supports widespread (universal) availability of HPV vaccines but opposes mandatory HPV vaccinations for entry to public school. The decision of whether to vaccinate a minor against this or other sexually transmitted infections should remain with the child’s parent or guardian. As in all areas of sexual health and education, Focus on the Family upholds parents’ right to be the primary decision maker and educator for their children. The use of these vaccines should involve informed consent for parents as well as education for both parents and youth regarding the potential benefits and risks of the vaccine. In making this decision, parents should consider the following:
• No vaccine is 100% effective against disease;
• There are more than one hundred sub-types of HPV and the current vaccines being tested are effective against, at most, four of these;
• The sub-types of the virus that these vaccines protect against are the cause of most but not all cases of cervical cancer;
• The possibility of HPV infection resulting from sexual assault, including date rape;
• The possibility that young persons may marry someone previously exposed to and still carrying the virus;
• The HPV vaccines do not protect against other STIs or prevent pregnancy;
• The HPV vaccines do not, in any circumstance, negate or substitute the best health message of sexual abstinence until marriage and sexual faithfulness after marriage.

Hmm, how about Family Research Council:

The Family Research Council welcomes the news that vaccines are in development for preventing infection with certain strains of the human papillomavirus (HPV). We also welcome the reports, like those we've heard this morning, of promising clinical trials for such a vaccine. Forms of primary prevention and medical advances in this area hold potential for helping to protect the health of millions of Americans and helping to preserve the lives of thousands of American women who currently die of cervical cancer each year as a result of HPV infection. Media reports suggesting that the Family Research Council opposes all development or distribution of such vaccines are false.

...

We will also continue to take an interest in the activities of the pharmaceutical companies, the federal and state governments, and of the medical community, as vaccines for HPV are approved, recommendations for their use are developed, and their use is implemented. In particular, we encourage follow-up studies to determine whether use of the vaccine has any impact on sexual behavior and its correlates, such as rates of other sexually transmitted diseases or rates of pregnancy.

We are particularly concerned with insuring that medically accurate information regarding the benefits and limitations of an HPV vaccine is distributed to public health officials, physicians, patients, and the parents of minor patients. It is especially important for those parties to understand that such a vaccine:

* will not prevent transmission of HIV or other sexually transmitted diseases, of which there are many;

* will not prevent infection with other strains of HPV, of which there are also many;

* will not prevent infection with all of the strains of HPV that cause cervical cancer;

* and lastly, will not eliminate the need for regular screening.

We recognize that the most current immunological studies suggest that these vaccines would be most effective in pre-adolescents. Our primary concern is with the message that would be delivered to nine- to twelve-year-olds with the administration of the vaccines. Care must be taken not to communicate that such an intervention makes all sex "safe." We strongly encourage the health care community to clearly communicate the medically accurate fact that only abstaining from sexual contact with infected individuals can fully protect someone from the wide range of sexually transmitted diseases.

However, we also recognize that HPV infection can result from sexual abuse or assault, and that a person may marry someone still carrying the virus. These provide strong reasons why even someone practicing abstinence and fidelity may benefit from HPV vaccines.

Because parents have an inherent right to be the primary educator and decision maker regarding their children's health, we would oppose any measures to legally require vaccination or to coerce parents into authorizing it. Because the cancer-causing strains of HPV are not transmitted through casual contact, there is no justification for any vaccination mandate as a condition of public school attendance. However, we do support the widespread distribution and use of vaccines against HPV.

Vaccination at the beginning of adolescence may provide a unique opportunity for both health care providers and parents to discuss with young people the full range of issues related to sexual health. We would encourage this committee to recommend that policy-making bodies, such as the American Academy of Pediatrics, should develop and formalize clinical counseling interventions directed toward sexual risk elimination strategies for pre-adolescents. Such strategies could be incorporated into anticipatory guidance protocols. Such a strategy would also mirror the risk elimination messages presented to adolescents regarding tobacco, alcohol, and drug usage, and youth violence prevention. This risk elimination message is the best form of primary prevention youth can receive.

Both health care providers and parents should reinforce the fact that limiting sexual activity to the context of one faithful and monogamous long-term relationship is the single most effective method of preventing all sexually transmitted diseases, unplanned pregnancies, and the whole range of negative psychological and social consequences that can result from sexual activity outside marriage.

OK, how about Jerry Falwell? Silent on the issue.

National Abstinence Clearinghouse? OK, I admit I'm not a member and don't want to join so I can't actually see what's in their resource library, but here are some titles:

07.05.2006 More on HPV and Condoms…
06.29.2006 HPV Vaccine: How Much Will it Cost?
06.21.2006 HPV Vaccine: Progress, But the Battle’s Not Over Against HPV
05.24.2006 HPV Vaccine Clears FDA Hurdle
04.26.2006 Data from Eight Collected Studies Shows Enormous Risk of Cervical Cancer from HPV
04.07.2006 New Way to Encourage Someone to Test for STD
04.05.2006 Teens and STDs: A New Message for a Healthy Millennium

Call me crazy, but it strikes me that they are in line with Focus on the Family, not opposed, and I'm assuming their position is best summed up by "HPV Vaccine: Progress, But the Battle’s Not Over Against HPV".

Now perhaps these organizations have all moderated their opposition after the FDA approved it and I'm (admittedly) late to the party. But that isn't what is claimed. Now to be sure there may be some people out there actually flat out opposed to the HPV vaccine who are Christians, but I'm sure not seeing some movement by any influential organization.

But it doesn't end there. Ms. Seipp continues:

This naturally brought out all the true believers in hordes -- many of whom insisted that my comparison of vaccines that prevent disease to locked doors that prevent burglars is wrong, wrong, wrong. I don't see why. Some of these people insist the analogy is flawed because airbags and seatbelts encourage people to drive more recklessly, not less.

But while it's true there are some studies that indicate improved safety features in cars do make some people feel inoculated against road hazards and so more likely to speed, what about people like me? I never speed and haven't had a traffic ticket in 26 years -- pretty much what you'd expect from a typical Volvo-driving fuddy-duddy...whose seatbelts always fastened, and whose car has airbags.

It's true my analogy about burglars and disease may be imperfect, but it's nevertheless essentially true. One person, for instance, said I should have used the example of theft insurance instead of locked doors. But I don't see why. Vaccinating against disease and locking your doors against burglars both recognize that we live in a world where bad things can happen even if we don't deserve them. Recognizing that fact no more encourages promiscuity than locked doors encourages burglary; both are simply precautions.

Now let's take up the question of whether or not reducing the risk associated with a behavior increases the incidence of said behavior. That is the what is claimed again by Ms. Seipp as the religious fanatic's objection to this vaccine.

So her analogy is that since locking your doors at night doesn't encourage burglars, making sex less risky won't encourage sex. There are two problems that make her analogy a non-sequitor. The original is about how your ability to lower the risk of your behavior to yourself encourages you to do more of that behavior. The analogy is about how your ability to (1) increase the risk of (2) someone else's behavior doesn't encourage them. Gee, when you get to stand the other person's points on their heads, you can easily refute them.

Now a reader tries to rescue her "One person, for instance, said I should have used the example of theft insurance instead of locked doors. But I don't see why." Here's why: the analogy becomes just because you have theft insurance [lower the risk] you don't stop locking your doors at night [risky behavior]. The reason you should use it is that it actually conforms to the logic of the objection. I have to admit I don't have data, but I'd say there are more people who would take less precautions with their property knowing they would be paid for a loss than there are who would take more.

But I don' have to think too hard about this, because we already have data about this very effect, and Ms. Seipp cites it - anti-lock brakes and airbags have made people feel safer, so we have engaged in riskier driving behavior to the point we are no safer, and even less safe than before. So we have valid evidence that low and behold, if you lower the risk of a certain behavior, people will do more of it.

And how does Ms. Seipp respond to actual real hard data? Anecdote. Hey I own a safe car and I don't engage in risky behavior. OK, what does that have to do with the measurement of real behavior by real people? Yep, none.

As far as Ms. Seipp's analogy, how about we ask the question, if burglars were given a "get out of jail free" card that really worked, even if only once, would they commit more or less burglary? I don't have to think too hard about that one.

But one has to ask, so what? As far as I can tell, what Focus on the Family and Family Research Council are warning against is a false sense of security - that is they don't want the message to be that because of this vaccine, sex has been rendered safe and complication free. Kind of like, just because you lock the front door everynight, don't think you can't be burglarized.

A better response would be that given all of the factors that go into becoming sexually active, the risk of HPV is pretty far down the list and is just not very significant, and that the risk that young girls would misjudge and take this vaccine as a license for risk free sex could be overcome through the proper education -- which sound a lot like the positions take by those religious fanatics at FOTF and FRC.

So what did I learn from reading Ms. Seipp in this case? Nothing about so called religious fanatics. But I did learn that even smart, reliable people goof: they don't accurately represent other people's positions, they don't reason well, they dismiss data if it disagrees with their opinion, and in general can just go off half-cocked. And yes, I'm sure if you were a glutton for punishment and went through my archives you could find similar problems from time to time.

Immigration Ecomonics

I expect you've heard this big picture thermodynamics question before: You have a thermally isolated room with a refrigerator. You plug the refrigerator into a working outlet and open its door. Does the room get colder, warmer, or stay the same? The answer is that the room gets warmer because the total energy in the room is increasing due to the electricity flow via the plug. If you look at the big picture, it's really a very easy problem.

So we come to the point of this post, the effect of large scale immigration on workers. The relevant law here is that of supply and demand, and if you increase the supply of workers, the price at which they are employed will inevitably fall relative to the price without an increase. Now it may well happen that if the increase in demand is greater than the increase in supply the actual price increases, just less than it would have if there had been no increase in the supply. So if you get a lot of immigrants who are increasing the supply of labor, then that will inevitably lower the price everybody is getting paid in that labor pool relative to what they would get without a change in labor supply. I'm not saying this is a good or bad thing, I'm just saying what happens.

What sparked this particular post is a John Tierney column which would appear to be behind the Times Select Wall since the St. Louis Post Dispatch ran a column the NYTs published May 30th today. I'm a fan of Mr. Tierney, but I think he stumbles a bit in this article as he's pretty breezy with one consequence to large scale immigration (legal or not). And yes Virginia, there isn't just one consequence.

First off, neither Mr. Tierney or I compete in the same labor pool with the overwhelming majority of immigrants, so we are able to offer a bit more detachment than those who do. I admits its easy to blase, even upbeat about trends that you don't think affect you.

Secondly, Mr. Tierney makes the common mistake of confusing an anecdote with data. He offers the nice tale of a native American women (not to be confused with Native American) who loses her nail salon to the more numerous, lower cost salons run by Vietnamese immigrants. But she lands on her feet by going freelance and working for the wealthy of LA who are willing to pay to have someone who can carry on an intellegent conversation while doing their nails at home. So, despite the fact that a particular person was able to land on her feet, did the average wage in the nail salon business go up or down? Mr. Tierney doesn't comment on this directly, but I think we are safe to infer from the rest of the story it went down. And I'll point something out that Mr. Tierney doesn't -- the (better) job that his nail salon owner found existed before she found it; that is there were plenty of wealthy people who were willing to pay extra for in home nail care before the Vietnamese took over the salon business, its just that the salon owner was comfortable in her job and was not looking to make a change. But what about the wages of such freelance workers - have they gone up or down with the influx of American workers into that niche, displaced by the Vietnamese into the salon business? Again, Mr. Tierney is silent on this subject, but uses the anecdote to claim out that everything will be just fine for all the displaced workers because everything worked out for the particular lady he featured. What would the story have been like had this particular worker moved into the at home/freelance nail business several years ago? Would it have been quite to happy and upbeat? Or would she have been complained of declining wages due to the increased competition with her fellow natives who were moving into the business?

Well, I have no doubt that some workers will move to better jobs because they will actively seek jobs where they weren't looking in the past. But I also have no doubt that some workers will not move to better jobs, and there will be downward pressure on the wages of those workers who remain in their jobs.

And whether you considered this a positive or negative affect might depend if you were a worker in the field, or if you were a consumer of this product or service who was seeing a decline in its price.

And this raises an even bigger point for me -- I think we are better off as a nation looking at the issue, exploring the costs and benefits, weighing the options, and then devising the laws and regulations through the political process with representative government, than we are with our current system of immigration policy by default, with inflows determined by the immigrants themselves, because they aren't looking at the big picture, nor would I expect them to. They are looking at what it means to them.

One of the problems with illegal immigration is that not only the immigration, but so much of the life of such an immigrant takes place off the books. And as Hernado De Soto observes, this life in legal limbo is what makes so many countries poor, and will certainly hurt our own nation. So for me, whatever else the outcome of immigration reform, I just want to see the illegal, off the books part brought back into the law, back onto the books.

A great American Stephen Decatur once said "Our country! In her intercourse with foreign nations may she always be in the right; but our country right or wrong.” I'm going to say: "Our representative goverment! May the outcome of our representative government always be in the right; but the process of representative government right or wrong."

Reality Catches Up

The easiest promise to make is the one you don't think you'll have to keep. A few years back the government issued accounting rules that made corporations put future retiree healthcare costs on their books. It wasn't pretty. Now governments will have to do the same, and it won't be any prettier. And of course the cry will go up to nationalize healthcare, which won't lower the cost, but shift it to the federales, who are already looking at (I sure hope it's a misprint) 33.4 trillion dollar unfunded liability for Medicare. I guess the state and locals will figure that any increase from their liability won't be noticed in that eye popping figure.

Via Winterspeak at Asymetrical Information.

The Tragedy of Declining Births

The Tragedy of the Commons is the classic illustration of why private property works and communal property doesn't.

I see the tragedy repeating itself in most government run old age support/pension systems in the developed world. In the original example, it was grazing land that was held in common. In the developed world, it is children who are held in common, or more accuately, their productivity. Not that long ago, children were not only cheap to raise, but a source of labor in their youth and support in a parent's old age. Children were a modest investment with a large payout. That's one reason families were larger - large families made economic sense. That is no longer the case - as children cost on the order of $250,000 and provide very little labor and support directly back to their parents. Large families no longer make economic sense; in fact children no longer make economic sense at all anymore for most parents in the developed world.

Where does the money come from for the government to support retired/old people? Taxpayers. And who are these taxpayers? The children and the grandchildren of the retired/old people. But the support a government pensioner receives is not related to how many children that person raised.

Let's dispose of one objection right away - that government saves the contributions of individuals, invests it wisely, and then returns the principle and interest after retirement. Social Security, and other defined benefit plans that do not include some form of individual accounts, are all pay as you go systems - today's retirees are paid by today's workers. Our own government has skimmed money off the top by setting the tax rate higher than it needs to be, setting up a "trust fund" which it immediately takes all the money out of the trust fund and spends but leaves an IOU behind. The amazing thing is how this bit of theft manages to fool so many people (maybe not so amazing when you consider how many people still fall for the Nigerian money transfer fraud) in this country.

So the tragedy is that we have developed a system that removes the clear link (OK, the system doesn't just hide the link, it tries to substitute a fraud in its place) between where a government payment comes from and where it goes. Parents might be too proud or too caring to take money from their own children, but are perfectly fine with taking the money from everybodies children. So each recipient expects a comfortable retirement but has no incentive to provide for it; in fact, the recipient pays a penalty through the high cost of raising a child to provide for it. Is it any wonder than that societies that set up such government funded retirement schemes face collapsing birthrates and unsustainable finances?

Gas Prices

We Americans seem to think that it's our right to always have cheap and plentiful gas. You may have noticed, the price is going up. And as always, we don't ask ourselves why, we look for scapegoats and quick fixes. So Econobrowser has a partial answer to why and thus who's to blame. And in this mornings newspaper, there was an excellent letter to the editor about this very subject that gives a pretty good overview:

I began my week by filling my tank with $2.77-per-gallon gas. The radio was tuned to a station that was commenting on the price of gas and quoting prominent Democratic senators who blame President George W. Bush and Republicans for the lack of a national energy policy. I thought perhaps they are right; maybe we don't have a cogent energy policy.

When I read the Post-Dispatch, I saw a picture of a crowd of Woodstock-wannabes celebrating Earth Day. It occurred to me that we do have an energy policy -- a policy influenced by the likes of the "dancers" in the picture.

Since the first Earth Day, with the help of the media, politically driven educational unions, unelected judges and self-serving elected officials, a de facto energy policy has evolved. That policy forbids drilling for oil and natural gas in places where huge amounts are known to exist, erects countless legal barriers to the building of new gasoline refineries and safe, pollution-free nuclear power plants and limits the use of coal, our most abundant resource, for the generation of electricity.

Before complaining about the high price of gasoline, natural gas and electricity, remember how our energy policy was established and by whom.

Tom Mueller | St. Charles

I think together they tell us why - we've decided there are other things about energy more important than it's price. Gas was getting cheaper, so why not worry more about things other than the price. And guess what, we've raised the price by acting on those values. Now that isn't the complete story, because its the increase in world wide demand coupled with the relative decrease in supply that drives the price up.

Would we be happier if the asian economies weren't booming but the price of gas were cheaper?

Freakonomics: My Take

I read Freakonomics last week. My brother Sean has already provide a great synopsis, so I'm going to content myself with impressions. I found the book a quick and sometimes enjoyable read, but less so as the book went on. Very interesting info on the bagel man, cheating teachers, and real estate agents, but down hill aftwards. Not what I expected from a brilliant eoncomist writting a best seller -- and the cheating teachers section has nothing to do with economics.

I remember when I was in my one and only Economics class (yes, I loved the subject that much) the textbook, probably Economics by Samuelson, or possibly the professor went on about how economics was the study of scarcity. At the time I thought this a logical error, as economics is the study of the production, distribution, and consumption of wealth. Relative scarcity is an important component of wealth, but it isn't the actual subject matter. I bring this up because there seems to be a trend with economists who confuse techniques used in economics with economics itself. The use of regression analysis (or any statistical analysis for that matter) isn't performing an economics analysis, it's the use of a mathmatical tool widely used by many disciplines, including science and engineering. And while human behavior is an integral part of economics since we're the ones doing the producing, distributing, and consuming, economics isn't just about human behavior nor is all of human behavior of interest to economists. Once again the examination of incentives in areas outside traditional economics isn't economic analysis, it's human behavior analysis. So while I thoroughly agree with the importance of incentives to understanding human behavior, I suppose only in academic circles is the application of common sense thought to be revolutionary. (Yes, I know

The book is made up of chapters that don't have anything to do with each other than Dr. Levitt finds the subjects interesting. Of itself this isn't a problem for me, but there are times when the chapters are contradictory. For instance, Dr. Levitt claims in one chapter that abortion lowered the crime rate, and we can tell this because maternal characteristics such as education, age at birth, and marriage status -- none of which are genetically determined -- has a significant effect on whether their children become criminals. And let me be clear - as confirmation of his thesis on crime and abortion, he says that parents who have children they don't want understandably do a worse job at parenting than those that do so it's reasonable that such children are more likely to commit crime. In the next chapter on how much influence parents have on their children, the conclusion is that it's pretty much genetic. Parents matter because of their genetic contribution, not their parenting contribution. He arrives at this conclusion by looking at educational achievement. So if smart parents have smart kids, can we then generalize that parenting doesn't have much effect on their children? In one chapter parenting does, and in the other parenting doesn't.

And there are a couple of big threads left dangling that I would think somebody like Dr. Levitt would just love to pull. One is if the crime rate has returned to the rate of the first part of the century because of abortion, what else has changed that is keeping it there despite abortion's lowering affect? The other is if parenting (as opposed to the genetics of parents) has no effect on children, is crime genetic?

1 Billion Sold

While reading this article about Apple hitting the 1 billion song download mark, yes, I said billion, I noticed the claim that essentially Apple breaks even on the downloads but makes money on the iPods. What this means is that it will be hard to dethrone Apple in the music business. And I assume that this is why a lot of the other entrants are chosing a model of charging a flat fee to provide access to everything - that way they can set the monthy fee high enough to actually make a profit of the downloads without requiring people to buy their hardware. But that also means that it will be hard for other companies to make money following the Apple model without their own proprietary hardware to listen to the songs -- which will tend to limit the companies that can compete that way, and by that I mean good hardware for the player and a good store experience in iTunes.

(full disclosure, I own Apple Stock and I download songs from iTunes).

I'd Be Willing To Pay Real Money

Are some companies famous for their cost cutting reaching the point of doing more harm than good? Megan McCardle has sworn off Dell because of their low cost support. I was in the Wal-Mart in Kirkwood the other day, and even though the store is newer than the one near me in Town & Country (where I haven't had a bad experience other than their refusal via red tape to honor tax exempt status for the Boy Scouts), it is poorly lit and dirty, the staff is surly and unhelpful. My wife observed we always have a bad experience there - this time it was the clerk in the Photo department who told my wife she had no idea where the film drop off was and then ignored her.

Don't get me wrong, cheap is good, but there comes a point in cutting costs where service and quality suffer far more than the price comes down. And it may be that at certain companies, the drive to cut cost above all else may have become counter productive.

Frames Matter

Yeah, I know I've been on an economic kick lately, but it's either that or intestinal bacteria. OK, now that we've cleared that up, on with the numbers and cents.

There has been the usual wailing and gnashing of teeth over the record Current Account Deficit (otherwise known as the trade deficit). First I'm going to point you to another fine piece by David Nicklaus:

Fortunately, there is another way of viewing the trade deficit. Instead of being a sign of weakness in our goods- and services-producing industries, it's a sign of strength in our capital markets.

By definition, the current account deficit must be matched by a capital account surplus, which means foreigners invest more here than we invest abroad. If foreign investors simply view the U.S. as a great opportunity, their enthusiasm may be driving the trade equation.

Bill Poole, president of the St. Louis Federal Reserve Bank, explored this line of thinking Wednesday in a speech at Lindenwood University.

"It may be that the trade deficit is driven by ... investors seeking the best combination of risk and return in the international capital market," he said. "The mechanism creating this outcome is that capital inflows keep the dollar stronger than it otherwise would be, tending to boost imports and suppress exports."

That does make the trade deficit sound less scary. But, the alarmists would argue, the U.S. is in a vulnerable position. Foreigners can simply pull their money out, cause the dollar to plummet and throw us into recession.

Poole thinks that is highly unlikely. "For the United States, unlike almost every other country in the world, a hard-landing process is inherently self-limiting," he said.

That's because our external debts are denominated in dollars. A decline in the dollar's value has no effect on our debts - we still owe the same amount in dollars as we did before - and it makes our overseas assets, denominated in foreign currencies, more valuable.

"To the extent that the foreign exchange value of the dollar declines, the effect on the values of U.S. and foreign asset holdings works not as an accelerator of crisis, but as part of a self-correcting mechanism," Poole said. "The composition of the U.S. international investment account, therefore, contributes to stability rather than to instability."

His view is that the trade deficit will be reduced in a "slow and orderly" way and that the adjustment "may not begin for quite some time."

The real question is if that's the better way to look at the issue ("I'm not overweight, I'm undertall") but since I've been hearing just how bad the trade gap is for a very long time now, and it doesn't seem to have a noticable effect, I'm going to go with looking it as a sign of capital market strength. I recall reading something similar in regards to when Britannia ruled the world -- at least in the economic sense -- and how having the world currency provided certain capital benefits, but I'm too lazy to go track it down.

In addition to the main thrust of the article, a couple of things caught my attention. First, is the use of absolute dollar numbers when comparing ecomonic events that occur at different times. This can be misleading. The best way to compare such figures is to use non-dimensionalized figures, in other words divide dollars by dollars, which removes the effects of inflation and gives a real apples to apples comparison. So in this case, you should divide the gap by either the size of all trade, or by GNP, just as you would divide the budget deficit by either the total budget or the GNP to give meaningful figures. Whenever somebody just gives you absolute numbers and then makes a comparison, even if only implied (e.g. worst deficit ever), take it with a grain of salt.

Secondly, buried in the piece was this interesting fact: Even with record trade deficits, the economy has grown at a rate of 3 percent or better for 10 straight quarters, the longest such streak in more than two decades. What's this, the "Bush" economy beats the "Clinton" economy. Gee, that's not something you hear from the press, mired in a loss of advertising revenues that has gone from glitch to downturn to slump to permanent loss.

TANSTAAFL

A Quote of the Day over at Listless Lawyer reminded me of something (There's more inspiration over at Listless than I have time) the other day:

There is no more dangerous illusion than the belief that one can get something for nothing.

– Bernard Baruch, Baruch: My Own Story.

A decade or so ago I was refinancing Murphy Manor. I was working through a mortgage broker, and just before closing they gave me their itemized closing costs. Since it was a lot different than the sample closing costs they had provided back when I started with them, I looked over the figures carefully enough to spot a mistake. That led to a fine tooth comb and a phone call where I went over every line - both what it was for and why it cost what it did. One of the lines had some boilerplate description and the lady provided me with some boilerplate explanation that was mighty similar to one she had given me for a previous item. I explained that I would like to know exactly what I was getting for my money on this line, and why I should pay twice for what sounded like the same thing. After a couple of other unsuccessful attempts to explain it, she talked to her supervisor and came up with a much better explanation, although still obscure. When I said "It's your fee", she agreed but was apologetic and seemed to expect me to object. I told her I'd much rather they were upfront about their fee rather than trying to hide it since they had to be making money out of the deal somewhere and I'd just as soon know how much than worry about how bad they were screwing me. It's not like they were working for free.

Oil Economics 101

Since Jane Galt is tackling abortion at the moment, I'm going to seize the opportunity to talk about the Senate hearings on oil prices. I suppose the whole thing is one of those moments that Yakov Smirnoff loves -- only in America are private companies called in to explain why in a capitalist system they are making the huge, windfall profit of a whopping 10 percent. The really sad thing is that I, with but one college economics course under my belt understand economics more than our august Senators do (at least some of them, anyway). Or perhaps its that they understand politics far better than economics.

It continues to astound me how people confuse cost and price. The price is what the buyer pays, and cost is the aggregate of the sellers expenses for a given transaction. Profit (or loss) is the difference between the two. The real beauty is that there are least two ways to figure cost -- average or marginal -- but only one way on price. And you can play all kinds of un games by picking and choosing which basis to determine cost.

Now the funny thing is, back when I learned my economics (1983) -- and from a marxist, no less -- they taught that price is set by the intersection of supply and demand curves, as illustrated here. Cost enters in through the back door, as it is part of the supply curve. So let's review - if demand goes up (shifts to the right), the price will go up, but then so does the quantity sold. And if supply goes down (shifts to the left), price goes up, but the quantity sold goes down. Wow, cutting edge economics, only formulated this way for 115 years.

Now pay close attention here, the price changes as rapidly as the change in supply and/or demand, even nearly instantaneously. There's no wait to change for a given product, made at a particular price point, to eventually make it's way all the way through the distribution system to the final consumer. So if for instance a hurricane roars through the Gulf of Mexico overnight and decreases the supply of oil overnight, why the price changes overnight too! Wow, no government price board meets to make it happen, the market simply reacts to the new information. Maybe more countries should use that market thingy.

Permit me a small digression [OK, I've come back from the bottom of the paragraph and it turns out that this is really a great big digression, but its a good one, so stay with it] here, because I know a little something about control theory (OK, a lot more than I know about economics). And if you're into controls, lag is your enemy. You hate lag. Lag screws up your system. Lag can make your system go unstable, lag is something you would like to eliminate completely if you could. Except, then setting up real world control systems would be too easy, and you wouldn't get paid the big bucks to do it, so OK, you love lag, because lag makes your genius necessary. But say I'm a user of a controlled system, then lags my enemy. For all the reasons I cited above, only now I'd just as soon have geniuses working other problems so I don't even have that incentive. The market is simply a control system for economic activity. One big reason it's better than any other method so far devised, is that it is less laggy than the other systems (such as government control). What is one of the things businesses hope for when they flatten their management structure or better integrate different parts of the enterprise? They are trying to reduce lag inside their own control system - vertically and horizontally. So the ability to make rapid price adjustments isn't a bug, it's a feature, and a very important one at that. It means economies can turn on a dime, and not keep overproducing unwanted products and services and fail to produce wanted products and services. One of the reasons improved information technology has helped the ecomony is that it has wrung lag out all over the system. OK, enough about lag, but once you understand control theory, you'll laugh when Princeton economics professors write columns for newspapers saying the worry that increased informational speed and flow could destabilize an economy, and you'll laugh because they got it exactly wrong, and you don't even have a big pointy head.

Another great thing about the market is that in a transparent, open economy we're all colluding together to get what we want, when we want it, where we want it. We all contribute to setting the price and the quantity of each and every good and service out there. We even stimulate the formulation of brand new goods and services. Wow. The amazing thing about price is not only is it feedback from the customer to the producer, it's feedfoward from the producer to the customer.

OK, back to the oil companies. So what do higher prices and higher profits tell us, hopefully including the oil companies. To the oil companies, it says produce more oill!!! That's what it says. And while it's telling the companies that, its actually giving them the money to do it with. Wow. You get told what to do and you get the resources to do it with. But wait, there's more. Because to us consumers, it's saying cut back on oil consumption!!! because there is a greater reward for it than there was before the price went up. Or we could wait for Congress to pass a sense of the Congress resolution that the oil companies should produce more and consumers consume less, and then pass some legislation to give companies incentives to produce and consumers not to consume, and by the time that all happens, we'll be in the middle of an oil glut. See why lag is bad?

So why is it so hard, absent hurricanes and other natural disasters, to figure out the gyrations of gas prices. Because from where you sit, you can't see the supply and demand. You're driving down the road thinking everybody I know is driving just as much, so why does the price go up and down all the time? Energy markets are global, so the whole world is setting the price. So changes in global supply and demand drive the price at your corner gas station. I suppose that's one opposition to globalization - since we can't see the inputs (supply and demand), we distrust the output (price).

Health Savings Accounts bring Market Forces to Health Care

as Kevin wrote almost a year ago:

But healthcare is something too important to be left to the market you say. Or healthcare doesn't work like other goods because you have to have it inorder to live you say. Doesn't food meet those same requirements? Yet we allocate food in this country via the free market, and the crisis du jour is obesity. If we stopped allocating healthcare in this country via the current odd employer standing in for government system, and instead allocated healthcare via a free market, the crisis du jour would be longevity.

Michael Barone now observes that HSA accounts are bring market forces to health care:

How many times have you heard that health care costs are rising at record rates? Well, they aren't any more.
[...]
Something is going on out there. Politicians and political commentators always assume that government must do something new and different if health care costs are to be held down to bearable increases. But the evidence is that health care costs are being held down, by the workings of the marketplace, partly in response to health care legislation passed in the last four years.
[...]
The other interesting development is the emergence of health insurance policies that encourage healthy behavior. Health care experts note that the increasing incidence of diabetes and other obesity-related diseases threatens to hugely increase health care costs in future years.
[...]
The overriding assumption in much commentary on health care finance is that individuals and companies are helpless automata waiting for government action before anything can be done anything about health care costs. But recent developments suggest that, in fact, employers and employees are active players, and that provisions of recent legislation that were not much noticed by the commentariat have enabled them to take action that reduces costs and provides increased benefits and incentives for healthier behavior.

We have problems, yes, but we are not helpless.

I don't know that we are at risk for a longevity crisis yet, but it's a welcome developement that market incentives are finding their way into the health care equation.

Freakonomics

I just finished reading Freakonomics by Steven D. Levitt & Stephen J. Dubner, it's a scale-up of some articles in the New York Times Magazine (available from Freakonomics.com):

• The Economist of Odd Questions: Inside the Astonishingly Curious Mind of Steven D. Levitt,
  by Stephen J. Dubner
  New York Times Magazine, Aug. 3, 2003
• What the Bagel Man Saw: An Accidental Glimpse at Human Nature,
  by Stephen J. Dubner and Steven D. Levitt
  New York Times Magazine, June 6, 2004

The key insights behind the book:

• Understandig incentives is the key to understanding the root cause of complex systems of behavior ("modern life").
  They assume that men are rational actors in their economic activity (not necessarily moral actors, as they may cheat, collude, or mislead, but rational).
• The conventional wisdom is often wrong.
  As my Uncle John used to say "It's generally accepted, so generally accepted it may not be true at all!"
• Dramatic effects can have distant and subtle causes.
  This does not mean that the authors subscribe to the "Butterfly Effect" (meteorologist Edward Lorenz speculation that "flap of a butterfly’s wings in Brazil might set off a tornado in Texas"). They believe that clear cause and effect relationships hold.
• Experts use their information advantage to serve their own ends.
• Knowing what to measure and how to measure it provides simple explanations for complicated situations.

It's a very readable book, but in the immortal words of Mies van der Rohe, "less is more" (or was it actually Robert Browning) and 99.44% of the content in the book can be found in the two articles. I would recommend several others if you are interested in the intersection of economics, systems analysis, and everyday life:

• Hidden Order: The Economics of Everyday Life by David Friedman
• Moneyball by Michael Lewis
• Choice and Consequence by Thomas Schelling
• Micro Motives and Macro Behavior by Thomas Schelling
• Do Lunch or Be Lunch: The Power of Predictability in Creating Your Future by Howard Stevenson
• Bionomics by Michael Rothschild

These books offer insights and ways of looking at the world that can help orient your questions and thinking. The Freakonomics book is interesting, but doesn't really communicate a fundamental perspective or problem solving paradigm(s).

Great Minds and All

From the Great Minds think alike department:

"If you ask most people about the cost of medical care, they may tell you how much they have to pay per visit to their doctor's office or the monthly bill for their prescription drugs. But these are not the costs of medical care. These are the prices paid. The difference between prices and costs is not just a fine distinction made by economists. Prices are what pay for costs -- and if they do not pay enough to cover the costs, then centuries of history in countries around the world show that the supply is going to decline in quantity or quality, or both."

"I've noticed that a lot of Democrats and some Republicans have difficulty with the difference between price and cost. Cost is what it takes to make or provide something. Price is what you are charged for the thing or service. Politicians are constantly telling me how they are going to lower the cost of something -- typically healthcare, ocasionally housing -- when all they are going to do is lower the obvious price and do nothing for cost. Are they going to do anything about the government regulation and oversight that adds to the cost? Heck no. They're going to have a single pay system dictate price. It's enough to make you vote Libertarian."

I'd like to claim "advantage blogosphere" but I can't since Thomas Sowell has been pointing this difference out for a long time and he's the guy who first clued me into the difference.

The problem with healthcare is that we've got a half-baked system that is socialism on the cheap, substituting employers for the government where possible. This leads to a lot of well meaning people to advocate full socialism for medicine - the single payer system. They are convinced that in this case, full socialism will work. The problem is, full socialism never works, and shouldn't be tolerated for something as important as healthcare. The real answer is to end the partial half-baked socialism by getting employers out of the picture and get a market (yes, a well regulated one) in healthcare going.

Dismal Science, Dismal Post?

Just because some long dead English guy named Economics the Dismal Science doesn't mean this post has to be dismal. Perhaps it isn't economics itself that is dismal, but the reporting of it which I find to be uniformly dismal. I'm 41 years old, which doesn't mean I'm any smarter than the young whippersnappers who write most of the blogs out there, but it does mean that I have heard economics reporting over several business cycles over the years, and the script never varies. Right now we are in the "jobless recovery" scene. The media notes at the beginning of every recovery that this, unlike all the other recoveries, is a jobless one. They seem to forget that every other one at this stage was being reported as jobless. And of course that means that manufacturing jobs are disappearing, having been exported overseas, with dire consequences - as in these jobs have been lost "forever". They're never coming back. Japan, the Asian Tigers, and now third world countries are going to put us out of work, and all that will be left is burger flipping. Maybe this time it will be true. But I'll tell you this - only a few short years ago the job market was so tight that you couldn't get decent service in a McDonalds (don't even mention Hardees - they always have lousy service).

While in the past, the stock market has been a leading indicator and employment has been a lagging indicator doesn't mean anything; nope, this time, it'll be different!

The culprit is productivity. We don't want any more of that! You see, productivity growth means that we need fewer workers to produce the same amount of goods. So while I suppose I should be happy that we had enough farm productivity growth over the last several hundred years that I'm not stuck slopping the pigs and tilling the soil in order to survive, along with 99 percent of my fellow humanity, but work in a nice airconditioned office ruining my eyes with a computer terminal, if we get any more, we won't have jobs for everybody.

Or we could look at it that with greater productivity we have more goods, more leisure time, and earlier retirements for the same number of people. I'm sure that just because that's what it's always meant in the past won't mean that it will continue in the future - past performance is no indicator of future performance, you know.

Canadian Healthcare

The Canadian Medical Association is happy that the Canadian Healthcare system is fair when it takes far too long to provide treatment. By that they mean that rich people wait just as long as poor people for their "elective" surgeries. The lead investigator said, "In a system of mixed private and public, and people buy their way to the front of the line, equity isn't an issue. That's not what the goal of the system is. But so long as there is this effective monopoly, we have to be sure that we're being fair to everybody and not discriminating on the basis of social position. And we're happy in this instance we've shown that." Well, fine and dandy. But the report didn't address the difference in wait times for wealthy Canadians who came to the United States to have their elective surgeries done -- thus buying their way to the front of a different line. It only took them seven years to complete the study -- which is considered speedy for Canadian medicine.