Month: August 2004

Congressional Investigation Starting Soon

I await the outrage. The Economist recently noted that…

“According to army figures dug up by the New Yorker, over the past three-and-a-half years military surgeons have performed 556 breast enhancements and 1,592 liposuction procedures on soldiers and their close relatives. Soldiers have to pay only the cost of their breast or, potentially, buttock implants; family members must cover other expenses. Face-lifts and nose jobs are also available.”

My take: The military provides lots of valuable training to soldiers in exchange for which soldiers take a pay cut. It is even possible the practice is efficient. Unlike private employers the military can force those it provides a valuable skill to continue working at a wage below their current market wage. I suspect most doctors enter the military to receive a medical education. If that education is more valuable because they can perform plastic surgery and military doctors’ wages are low enough, the service may be beneficial to tax payers as well as the doctors, and one assumes, the soldiers.

Candidate Public Good

A colleague of mine at CMC is valiantly continuing his crusade against the notion of public goods (A public good is not rival in consumption; my using it does not diminish your use of the good and not excludable). My colleague has two issues. First, he has never come across a good that fits the description well enough to deserve the label and second, almost any discussion of public goods inevitably leads to a discussion of the need for government provision. I find his argument persuasive. It doesn’t take long in government to hear about countless public goods crying out for government provision.

Thus it is with some trepidation that I mention a candidate for the textbook public good. The Global Positioning System, GPS, which provides location information for both military and civilian uses, is currently provided by the US government at no direct cost to users. GPS was constructed to be non-rival and non-excludable. The way the GPS system works is that a series of signals allow a receiver to triangulate the user’s location without the user needing to communicate back to the satellite. The military nature of the system means that users do not actually want to be found; hence GPS is designed for passive use only. It also makes it very difficult to charge end users for using the signals.

The US government has picked up the cost of providing the system and, according to the Economist

“…after spending $20 billion, the Pentagon has built a global system that is a key ingredient of NATO defense. But it is also an essential prop to countless civil applications: for every military user, there are now 100 civilian users. GPS provides not only satellite-navigation systems in cars and boats; it is used by internet service providers, by banks and by surveyors. One day it might be used by air traffic control systems to permit “free flight”, in which pilots of commercial aircraft find their own route and stay clear of other aircraft, without the cumbersome business of radio telephone contact with controllers on the ground.”

So is this a lighthouse or not? The debate is currently more than academic. The Economist details the European Union’s solution to the provision of position navigation and timing services. The EU’s proposed system,

“…will be in part a commercial system. A concessionaire will get the right to operate the system for a fixed period in return for plunking down two-thirds of the deployment costs–around $2.8 billion.”

I look forward to the day when a Principles of Economics textbook uses GPS as an example of public good. Whether Pigou or Coase wins this one I cannot predict.

Google makes money managers work for a living

In the weeks leading up to Google’s IPO, few people had anything good to say about the company or its decision to go public using a modified Dutch auction. (Here’s one notable exception.) But now we’re seeing a welcome backlash to the anti-Google backlash, with a host of articles arguing that, glitches notwithstanding, the IPO worked. (My take is here, but unfortunately you need to subscribe to the Financial Times to read it.)

Most discussions of the IPO have focused, appropriately, on the fact that Google maximized the amount of money it raised by reducing the commissions it paid its investment bankers and by getting itself a fairer price than it would have under the traditional system. (Even though Google’s price did jump 18% on the first day, that was a relatively reasonable discount given all the fear and uncertainty Wall Street had tried to sow about the company and the offering.) As Alex wrote last week, the true test of the success of an IPO is the “cost per dollar of raised funds,” and by that standard Google did well.

But the offering was also a success for another reason, which is that it forced institutional investors to compete, for once, on a level playing field. The problem with the current IPO system isn’t just that companies end up leaving billions of dollars on the table when they go public, but that select mutual-fund and hedge-fund managers (as well as well-connected individuals) are handed what amounts to free money. In a traditional IPO, the investment bank underwriting the offering controls the allocation of shares. In the late 1990s in particular, that allocation process became a way of doling out favors and securing future business. For instance, if you were a mutual-fund manager who funneled a lot of trades through an investment bank — or who agreed to do so — then you were more likely to get a hefty allocation of IPO shares.

This made money managers look a lot smarter than they were — even if you set the bubble aside, there are lots of fund managers whose returns from the late nineties need an asterisk next to them — and it wrecked the price-setting process, since there was no real attempt to let the price reflect the real demand for a stock. It also sabotaged one of the best things about capital markets, which is that in theory they aggregate the opinions of anyone with enough capital and enough risk tolerance to participate, and not just the opinions of those with the right connections. (There should be no velvet ropes in capital markets: if you can pay, you can play.) Google turned all this around: the only way to get shares in the Dutch auction was to do the valuation work and make a reasonable bid. The traditional IPO relies on the power of cronyism. Google’s IPO, flawed as it was, relied on the power of markets. Bad for the Street, good for everyone else.

Randomness in Venezuela

At this point, it seems clear that Venezuelan president Hugo Chavez won a definitive victory in the recall referendum that the country held a week ago Sunday. The opposition, though, continues to insist that there was massive fraud. There doesn’t seem to be any proof of this, but one piece of evidence that Chavez’s opponents seized on almost immediately was the curious fact that at hundreds of polling stations around the country more than one voting machine recorded the exact same number of “yes” votes (“yes” was a vote for Chavez’s removal). For instance, the Wall Street Journal reported that at one polling station in Bolivar, two machines each recorded 153 “yes” votes while recording 215 and 237 “no” votes.

The opposition argued that this was proof that the number of “yes” votes had been “capped,” so that after a certain number of votes had been recorded, every additional “yes” vote was changed to a “no” vote instead. (Venezuela uses computerized touch-screen voting machines.) And at first glance, this might seem suspicious. But at second glance, it seems like a simple product of chance, as the Journal pointed out:

Aviel Rubin, a computer-science professor at Johns Hopkins University, said he calculated odds of roughly one in 17 that two of three computers at a voting table would have identical results. That compares to about one in 15 that so far have shown similar results in Venezuela’s referendum.

In other words, with twelve thousand voting “tables,” many with multiple machines, it was inevitable that some would end up with matching scores. (It’s similar to the fact that if there are 23 people in a room, the chances are 50-50 that two of them have the same birthday.) Not surprisingly, then, when international observers audited a sample of the results, they found that while there were 402 tables with matching anti-Chavez votes, there were 311 tables with matching pro-Chavez votes, too. What seemed to be proof of fraud was most likely just a statistical artifact.

This is a classic example of what Nassim Taleb calls being “fooled by randomness,” in his intriguing book of the same name. We think that randomness means there will be no clusters or sequences of similar behavior, and therefore when we see them we assume they’re evidence of some hidden pattern. (You can see this in the way people interpret everything from clusters of cancer cases to hitting streaks in baseball.) But they’re really just evidence of the numbers working themselves out.


QED: Beauty in Mathematical Proof by Burkard Polster is a short book with some elegant proofs (about 1 per page) from elementary geometry and number theory. Here are two that caught my eye. I know that .999…. =1 but I have always thought of this as something like a convention. Not so. Here is the proof.

Let x=.999…
then 10x=9.999…
now subtract x from both sides and we get
9x=9 or x=1


And here is a just too lovely proof for the sum of the first n natural numbers.


Our crowd gets wiser

This week James Surowiecki will join Marginal Revolution as a guest blogger! James is one of the few journalists who really “gets economics,” which is why he has been called the “best business journalist in America.” He has written for Slate, Wired, has a regular slot at the New Yorker and is the author of the highly acclaimed new book The Wisdom of Crowds. We are looking forward to his insights!

The economics of Mexican kidnapping

The following is based on hearsay from Mexicans:

1. Many people of means in Mexico City buy kidnapping insurance.

2. If you are taken, the kidnappers and the insurance companies have a close working relationship. The kidnappers and the company will speak, and a mutual transfer will be arranged. No one need send a chopped off ear to establish that they have you.

3. Most kidnappers much prefer to kidnap someone with insurance. The transaction runs more smoothly and everyone behaves professionally. (There are, by the way, some “rogue” kidnapppers who behave in nasty ways and spoil the market for everybody.)

4. Didn’t Yoram Barzel and Eugene Fama, among others, teach us that the limits of the firm are arbitrary? If the kidnappers and the companies trade with such low transaction costs, can we not think of the kidnappers as part of the firm, in some sense? Or shall I say that the insurance company is part of the kidnappers?

5. Can we not think of the insurance company as an institution that helps the kidnappers make credible commitments? The company certifies which kidnappers will in fact return a live body in return for the money. The company is a kind of Better Business Bureau for the kidnappers.

6. The victims pay the nominal costs of this service. You might think this a coup for the kidnappers, but of course the long-term incidence of the charge is less clear. In any case, it is more important to have the insurance company pay greater immediate heed to what the potential victims want.

7. The general presence of kidnapping insurance may make the potential victims worse off. True, if you are kidnapped you much prefer to have the insurance. But if no insurance were possible, the costs of kidnapping would be much higher to the kidnappers. Kidnappings would be less frequent, albeit more costly for the victim.

8. The insurance confers positive externalities on those, such as myself, who are obviously uninsured [hey, kidnappers, if it is not obvious, here’s hoping you read MR!]. Presumably I am seen as a tourist, not as a local CEO of a wealthy American multinational. My chance of being kidnapped is much lower, as in relative terms I am a difficult target to extract wealth from. It is much more likely that I am robbed.

Here is an earlier MR post on the economics of kidnapping; it also includes some simple data.

How to spot a liar

By studying large groups of participants, researchers have identified certain general behaviors that liars are more likely to exhibit than are people telling the truth. Fibbers tend to move their arms, hands, and fingers less and blink less than people telling the truth do, and liars’ voices can become more tense or high-pitched. The extra effort needed to remember what they’ve already said and to keep their stories consistent may cause liars to restrain their movements and fill their speech with pauses. People shading the truth tend to make fewer speech errors than truth tellers do, and they rarely backtrack to fill in forgotten or incorrect details. [emphasis added]

“Their stories are too good to be true,” says Bella DePaulo of the University of California, Santa Barbara, who has written several reviews of the field of deception research.

Liars may also feel fear and guilt or delight at fooling people. Such emotions can trigger a change in facial expression so brief that most observers never notice. Paul Ekman, a retired psychologist from the University of California, San Francisco, terms these split-second phenomena “microexpressions.” He says these emotional clues are as important as gestures, voice, and speech patterns in uncovering deceitfulness.

And a (scant) few people can serve as super lie-detectors:

O’Sullivan now says that her further studies of federal agents, forensic psychologists, and other groups of professionals indicate that a very small percentage of people are extremely good at spotting a phony. “We always found one or two people who were very good,” she says.

Here is the full story.

Heidegger on the screen

[The movie] is more than three hours long and explores the theories of a German philosopher while wending its way up a European river.

A challenging package, you might think, even by the relatively adventurous standards of a film festival audience.

Yet this film, called The Ister, has been playing to packed houses everywhere from Rotterdam to Sydney and Melbourne. Few people have seen anything like it before.

Made by a pair of Melburnians armed with little more than a digital camera and a sense of inquiry, The Ister is loosely based on a wartime lecture delivered by ex-Nazi Martin Heidegger on one of Germany’s most celebrated poets, Friedrich Holderlin, whose poem The Ister (an old Roman name for the Danube river) is another source of inspiration for the documentary.

It is a movie made with great care:

Ross [the filmmaker] was concerned that it be intellectually coherent.

“In the back of his mind was, ‘What if Jacques Derrida sees this?”‘ Barison says.

Here is the full story.

Happy Birthday to Marginal Revolution!

We are one year old today! Here is our first post. Since that time we have written 1,685 posts (388 from myself and an incredible 1,208 from Tyler, the remainder from some great guest bloggers) and have had over 870,000 visitors. When imported into Word, MRs first year is 1,842 pages long. Technorati watches 3.5 million blogs and ranks Marginal Revolution at number 463 and rising! Pretty good for a 1 year old. Sorry to crow but heh, I have to be paid somehow.

Facts about the Mexican judiciary

1. In Mexico the federal judiciary employs 29,800 employees; in the much larger and richer United States the same number is 34,000.

2. Mexico employs about 900 federal judges; in the United States it is 1700.

3. The Mexican Supreme Court employs 3400 individuals; in the United States the corresponding number is 430.

4. The Mexican federal judiciary employs more chaffeurs than judges.

I can think of at least two explanations. First, Mexico, which has lower wage rates, chooses a higher labor-to-capital ratio. Second, the Mexican system is full of corrupt perks.

My blog source writes:

En MĂ©xico, el tercer poder es totalmente disfuncional en todos sus niveles y funciones. [In Mexico the third branch of government is totally dysfunctional in all of its levels and functions.]

Number of judges do not the rule of law make.

The data are from La Boveda, an excellent Spanish-language blog, from Mexico, for economics and politics.

The Economics of Declining Architecture, Once Again

Last week I asked why contemporary urban architecture has declined in some regards; trace back the link for the full context. My final suggestion concerns the issue of resale value.

I, like many others, have occasionally been tempted to buy a house that looked interesting. I’ve also been tempted to have huge and beautiful murals painted on the walls of my house. I did neither. Why? I feared for resale value.

The quest for resale value encourages standardized packaging. Just look at the mortgage market or the New York Stock Exchange.

In (many) older settings, people bought homes and buildings and stayed in them for long periods of time. Often they were passed down through the generations. If you do not have to worry about resale, simply buy what you want. But the buyers of modern America often will be moving on to another house within three or maybe five years. They think about selling again at the best price possible, as quickly as possible. So they are led to appeal to mainstream taste.

Andy Warhol understood these dynamics better than many other artists. The most saleable Warhols are those from definite “series.” He did flowers, soup cans, Chairman Mao, and so on. These works are easiest to price, market, and brag about in casual conversation. No doubt Warhol, whether you like him or not, was an innovator. But within his ouevre he sought a fair degree of homogenization.

In the music market, in contrast, few people buy CDs for resale value (those that do will focus on the hits). The scope for heterogeneity and innovation is correspondingly greater.

The economics are of course tricky. A world with easy resale is a world with many buyers, which can encourage innovation. But holding the number of buyers constant, a higher demand for resale may well lower innovation.

Why the growth rate is important

The importance of the growth rate increases, the further into the future we look. If a country grows at two percent, as opposed to growing at one percent, the difference in welfare in a single year is relatively small. But over time the difference becomes very large. For instance, had America grown one percentage point less per year, between 1870 and 1990, the America of 1990 would be no richer than the Mexico of 1990. At a growth rate of five percent per annum, it takes just over eighty years for a country to move from a per capita income of $500 to a per capita income of $25,000, defining both in terms of constant real dollars. At a growth rate of one percent, such an improvement takes 393 years.

That’s me quoting me, from a book I am just starting to write. The tentative title is “The Welfare Economics of Human Tragedy: A New Approach to the Theory of Economic Policy.”

If I had to explain, in one sentence, the reason I am not on the political left, I would cite the enormous long-run benefits of economic growth. Of course it still can be argued that various left-wing policies, properly understood, will contribute to long-term growth. But in my view, if you are not supporting growth-maximizing economic policies, you better had a pretty good reason in your pocket.

From hot water to cold air

My post on hot water (and followup here) is drawing more hot air than I expected. Daniel Davies over at Crooked Timber is often very good so I am frankly surprised that he gets this one very wrong. Davies thinks the argument falters if you assume the landlord has monopoly power.

Even if there is a slight oversupply of rental units for sale, time is almost always on the landlord’s side, because waiting is typically much more inconvenient for the party that has to wait without a house to do wait in [sic]. In general, when tenants and landlords are negotiating over the potential Pareto gain that could be made from renting the house, the landlord ends up capturing most or all of the surplus. The hot water and habitability laws are simply aimed at skewing things a bit in favour of the tenant and putting a floor on how bad a deal the tenant can end up accepting.

Wrong. Assume that a rapacious landlord owns the only apartment in the entire universe and you want it. The landlord is therefore going to extract all of your consumer surplus. Without the hot water the apartment is worth $500 a month to you – so that’s the rent. With the hot water it’s worth $550 – so that’s the rent. There is no skewing in favor of the tenant because the law doesn’t change the landlord’s bargaining power one iota. All it does is raise the landlord’s costs so that he may, in fact, quit the business making you worse off.

Daniel has not absorbed the lesson of my post, the rent will go up. He would have an argument if we added rent controls thereby squeezing the landlord from both ends. [Addendum: Glen Whitman gets the analysis exactly right.]

On a different note, many people have focused undue attention on hot water, something that most of us (in this country) really do want in an apartment. The principles involved, however, don’t change much with the good. If you like, think air conditioning instead. Eric Kilby kindly sends me an editorial from a few years ago in the Philadelphia Inquirer (registration required). Here’s what it says:

The zoning board under Thomas Kelly, president of Sheet Metal Workers Local 19, has required some developers of subsidized housing to install central air conditioning – a pricey, discouraging requirement for what are supposed to be low-cost projects. AC, in case you haven’t guessed, is installed by sheet-metal workers.

Is Globalization Changing How We Eat?

Here is my recent keynote address to the International Association of Culinary Professionals. Since it is a transcribed talk, this is about as chatty as I come. I present a simple approach to thinking about excellent food, based on the ideas of competition, experimentation, and pride.

You will also “hear” me on the decline of diners, my idea of food paradise, and how to find a good dive in rural Louisiana. Here is one excerpt:

If you look at Mexican food in this country, a lot of it, of course, is not eaten by Mexicans at all. It is eaten by Americans. But consider the Mexican food eaten by Mexicans. Well, who are the Mexicans, for the most part, who are currently coming to America? They tend to be fairly young, and they tend to be male. So take a group of young men, say ages eighteen to twenty-five, put them together in large numbers and let them eat. What do you get? Well, some of it is quite excellent, some of it is not so great, but you get something very different than the native cuisine. Let’s say you performed this thought experiment with France. Take a million Frenchmen, male, ages eighteen to twenty five, bring them to the United States, let them loose, have them eat. You are not going to get classic French cuisine.

Can you implore “read the whole thing” when it is your own talk?