Month: June 2009

Politicized Lending

The central bank is increasingly having to make politically sensitive choices. For example, it is weighing whether loans to people who buy speedboats and snowmobiles are as worthy of help as those to people who buy cars. And it is being besieged by arguments from R.V. manufacturers and strip-mall developers that they play a crucial role in the economy and also deserve help.

Many of the decisions could have political repercussions. On Feb. 9, President Obama traveled to Elkhart, Ind., a Republican stronghold that Democrats hope to convert to their column. Elkhart is also home to much of the R.V. industry, which has been battered by the recession.

The President gave a speech to the R.V. industry in February. What do you think happened in March?  Read the whole thing if you have any doubts.

Everyone says they want the Fed out of the lending business but power corrupts.  I worry about the long-term impact of politicized lending much more than about inflation.

The Systemic Risk Council

I received this in an email today:

best approach to preventing future financial crises is through the
creation of a Systemic Risk Council —composed of at least the Fed,
Treasury, FDIC and SEC, according to William Isaac, former chairman of the Federal Deposit Insurance Corporation, and now chairman of Global Financial Services for consulting firm LECG.

To be sure, systemic risk is an important topic for regulators.  But the idea of a "systemic risk council" is much better than the idea of a Systemic Risk Council, all caps.  The more formal the institution, the greater its power to spook markets and become a source of systemic risk itself.  Let's say that an SRC were summoned into being and one day the Council warned that systemic risk was unacceptably high.  Economic activity would plummet and freeze up immediately and furthermore a liability issue could arise for any manager who did not shut down lots of plans.  The practical reality is that the Council would have to be very, very cautious in its statements and actions.  It's a bit like how the security alert these days is always on "Orange."  High enough to indicate some kind of warning and to protect the regulators from a charge of complacency, but not so high as to terrify everyone or indeed inform anyone.

I've heard some people argue that once the Council sees that systemic risk is too high, it will proceed silently and secretly, in Ninja-like fashion (my words, not theirs), to stamp it out by alerting other regulators about the problem.  I'm not convinced.

I am not arguing that we should simply stay put when it comes to financial regulation.  It would be good to limit forum-shopping, for instance, and also abolish the Office of Thrift Supervision and transfer its powers to the FDIC.  They are the group that dropped the ball on AIG, if you recall. 

The broader point is this.  Better regulation comes through many years of experience and gradual process improvements, built upon some reasonable methods for imposing regulatory accountability.  That's how the FDIC got to be good at much of what it does.  Better regulation does not come from sitting down, waving a wand, and hoping that a new name or box will address the problem you are concerned about.  Keep that in mind next time you hear that "now is the unique moment," etc.

The economics of ticket scalping

This is quite a good piece, here is one excerpt:

For the scalpers' business to work, they will often need to limit the
supply of tickets–and tear up the extras instead of selling them at
face value. Or in other cases, they create a perceived shortage of
tickets by dribbling them out slowly at auctions with fans not knowing
whether tickets are really available. The result of this is unhappy
fans and empty seats. This has some potentially bad long-term
consequences. On Broadway, to take one example, theater owners are
eager to create buzz around a show by keeping seats filled. If the
venue is going to be half-empty, they'll even "paper the house" by
having anyone connected to the production distribute free tickets.
Short-run gains for scalpers create long-run problems for theater
owners and performers.

This is different from the usual explanation that lower prices create desirable clientele effects.  The piece also offers a good discussion of Eric Crampton and Trent Raznor as well.  Hat tip goes to Felix Salmon.

Vertical integration, luxury handbag crocodile version

What would Oliver Williamson say?:

The economy may be hurting world wide, but those that love Hermes
are still buying. In fact, Hermes has resorted to breeding its own
crocodiles on farms in Australia to meet the demand for its exotic
bags. It is reported that Hermes makes around 3,000 crocodile bags
every year and demand continues to grow while the crocodiles are not
readily available to fill orders. It can take three to four crocodiles
to make one Hermes bag, so the move to use their own farms makes sense.

The pointer is from Bamber.

The FDA regulation of tobacco

Here is an NYT summary of what it means:

…the law would give the F.D.A. power to set standards that could reduce nicotine content and regulate chemicals in cigarette smoke. The law also bans most tobacco flavorings, which are considered a lure to first-time smokers.

For purposes of argument, let's say you buy into paternalism and the government's ability to do a good job with it (no need to reargue those points in the comments, they are only simplifying assumptions for the purpose of focusing on another question). 

My question is: why impose quality restrictions when higher taxes would appear to be more efficient in limiting consumption and raising revenue at the same time?  Revenue is especially scarce right now and making cigarettes less appealing lowers the revenue that can be raised by taxing them.

Can you derive the conditions under which such a quality restriction might be efficient nonetheless?  I see a few cases:

1. More government revenue is a bad thing. 

2. You have a funny model where a quantity restriction serves as a non-convex "notch" incentive and has a more powerful disincentive effect, yet with lower deadweight loss, than the smoother incentive embedded in the higher tax-enhanced price.  (Heterogeneous consumer groups can contribute toward such a result but these are exactly the kind of theory papers which many people hate.)

3. The black market is a big problem.  Quality regulations mean that good black market cigarettes must be made with illegal inputs and thus those inputs can be detected at the factory source and also remain detectable throughout the life of the cigarettes.

What else am I missing?  Overall, given the initial premises, I still suspect that higher taxes are a better policy than quality restrictions.

Russ Roberts has a question

It's about the influence of empirical economics:

I'd like one example, please. One example, from either micro or macro
where people had to give up their prior beliefs about how the world
works because of some regression analysis, ideally usually instrumental
variables as that is the technique most used to clarify causation.

I will cite a few possible examples, although I won't stick with instrumental variables:

1. The interest-elasticity of investment is lower than people once thought.

2. We have a decent sense of the J Curve and why a devaluation or depreciation doesn't improve the trade balance for some while.

3. Dynamic revenue scoring tells us over what time horizon a tax cut is partially (or fully) self-financing.

4. Most resale price maintenance is not for goods and services involving significant ancillary services.

5. More policing can significantly lower the crime rate (that one does use instrumental variables).

6. The term structure of interest rates is whacky.

I see other examples but in general I agree with Russ's point that empirical work fails to settle a great number of important disputes, most disputes in fact.  Many of the examples I would cite turn out to involve an elasticity being lower than we had thought.  And many more involve macroeconomics (rather than micro) than you might expect.

What examples can you think of?

The Economics of the HDMI Cable Ripoff

I just bought a blu-ray player.  (Actually my 10 and 7-year old bought it as a birthday gift for my wife; alas, neither they nor she were fooled for long, but I digress.)  To get the best performance you need an HDMI cable which must be purchased separately (itself a bit of a mystery since almost every blu-ray is going to be attached to a digital tv).  The price difference among brands of HDMI cable are bizarrely large – you can easily spend as much on Monster cable, the brand leader, as on the player itself yet at the same time you can buy decent HDMI cable for virtually nothing at Amazon.  The experts are clear that expensive HDMI cable is a ripoff

There are two puzzles.  First, we have a clear case of consumers wasting a reasonable amount of their own money in an area that involves neither politics nor medical care, the irrationalities of which my colleagues have devoted considerable effort to explaining.  I will have to go for the P.T. Barnum theory on this one.

The second puzzle is, Why don't any stores stock cheap HDMI cable?  I knew cables were a ripoff yet I could not find reasonably priced cables at Best Buy, Radio Shack, Target or even Wal-Mart.  Ordinarily, we would expect competition to push prices down but in this case it seem as if the mere existence of Monster is anchoring high prices everywhere but online.

My best guess is that this is an unusually strong version of the hidden fee model of Laibson and Gabaix.  In that model, firms overprice one aspect of service–such as a hotel charging exorbitant rates for telephone service–as an idiot tax.  Crucially, the idiot tax is matched by an IQ-subsidy; the price of the hotel room is lower than it would be without the idiot tax–so the idiots don't know to shop elsewhere and the high-IQ types are, in fact, drawn to stores with an idiot tax.  Thus, buy your blu-ray player at places such as Best Buy which sell a lot of expensive cable as well as massively overpriced extended warranties.

Regulatory reform

We won't see so much of it for financial services.  I know, I know, a crisis is a terrible thing to waste, etc., but here are a few simple points:

1. Getting current regulators to do a better job may be a better goal.

2. The consolidation behind the Department of Homeland Security has not been a smashing success.  It's too easy for regulators to focus on formal goals of consolidation at the expense of substantive goals of mission.  And the prevention of forum-shopping can be achieved without formal consolidation.

3. The major overseer probably would have to be the Federal Reserve and that would mean the long-run chances for restoring an independent central bank would be slim.  The Fed as super-regulator would be more accountable to Congress than is desirable.

4. Many of the real regulatory problems are due to the preferences of Congressional committees and it is high time we admitted this.  How about reforming them?

Today's regulatory structure is not what anyone would design from scratch.  Still, I haven't seen strong arguments for a major reshuffling of the boxes.  Most of the arguments assume that the box reshuffling is somehow associated with a major strengthening of political will and thus must be a good idea.  I haven't seen a good analysis which holds the amount of political will constant and shows that a box reshuffling will bring major benefits.  In my view box reshuffling may signal political will but it will not itself cause more political will, so we should be holding the political will variable constant when doing our normative analysis.

If there are two ideas I would like to see take root in regulatory reform for financial services, it is the following:

a. Do not trust the states with anything really important.

b. Do not trust international agreements with anything really important.

Apportioning Blame for the Deficit

David Leonhardt's column breaking down the "causes" of the budget deficit has been widely reported and the bottom line repeated many times

President Obama’s agenda, ambitious as it may be, is responsible for only a sliver of the deficits, despite what many of his Republican critics are saying.

I have two problems with the analysis.  First, the NYTimes' excellent graphics department this time goes overboard with a big and difficult to read chart.  Matt Yglesias does much better summarizing the point with that old standby, the pie chart:
Second, although not "wrong" the Leonhardt's analysis doesn't reveal the arbitrariness of this way of apportioning deficit blame.  

The reason why the hundreds of billions of dollars of spending in Obama's agenda is said to be responsible for only a "sliver" of the deficit is that the agenda also includes taxes, thus the net effect is low.

Now Obama deserves kudos for a more honest budget process.  Indeed, if the only choices are the tax and spend party and the no-tax and spend party then I prefer the former for both economic and political reasons.  Thus as political accounting Leonhardt's conclusion is reasonable.

I suspect, however, that many people will not see that the economic accounting is arbitrary and potentially misleading.  To see why, imagine that President Bush increased taxes in the last days of his administration and Obama increased spending in the first days of his administration.  We would then be in exactly the same economic position as we are now but everyone would be writing about how "Obama's ambitious agenda is responsible for a large portion of the deficit."  In other words, if it were not for Obama's spending, the deficit would be hundreds of billions of dollars lower. 

Washington is all about political accounting but we should not be misled into thinking that because Obama's agenda accounts for only a "sliver" of the deficit that this makes it a modest or cheap agenda.  The agenda is big and expensive and every dollar of spending is a dollar that adds to the deficit.  

You don’t (want to) know yourself

Why can't we use a video of ourselves to improve the accuracy of our
self-perception? One answer could lie in cognitive dissonance – the
need for us to hold consistent beliefs about ourselves. People may well
be extremely reluctant to revise their self-perceptions, even in the
face of powerful objective evidence. A detail in the final experiment
supports this idea. Participants seemed able to use the videos to
inform their ratings of their "state" anxiety (their anxiety "in the
moment") even while leaving their scores for their "trait" anxiety

Here is more.  Is it an accident that so many people do not enjoy watching videos of themselves, while at the same time believing they are quite splendid?

What does the public plan equilibrium look like?, part III

I'm still thinking about this topic and I will refer you to a response by Frank Pasquale.  He knows a lot about the topic but I'm still not sure how to translate his points into econspeak. 

Here is another way of looking at my original question: some of the key (possible) problems in private insurance markets are adverse selection and lack of transparency in prices and terms of service.  Previously I asked whether the public plan does compete with the private plans for the same pools of customers.  Today I am asking whether greater competition necessarily improves these outcomes.  (It's trickiest when it comes to transparency; you might think that a more transparent plan will outcompete a less transparent plan, but the whole point of the lesser transparency is to make the plan look more attractive than it really is.  A truly transparent plan could look not so attractive at all.  The model here has many relevant iterations, with unclear results.  You get the best results when the presence of a transparent plan educates consumers about the nature of the market more generally, rather than just educating consumers about the nature of the transparent plan.  But that is hard to do)

As Pasquale points out, a lot of state insurance markets are currently not so competitive.  As it stands today, do the more competitive markets offer superior performance?  I genuinely do not know but I would like to see the evidence on this question.