Category: Economics

The question is why anyone might think Cuba is doing OK, relative to northern Mexico.  Megan McArdle offers (more than) two points:

3) Deep poverty is much more picturesque than moderate poverty. Poor
countries have their old colonial buildings still standing, because no
one had the money (or the reason) to tear them down and put up
something bigger. The countryside is dotted with adorable houses made
out of natural materials and natives wearing colorful traditional garb.
Animals graze in verdant fields, besides teams of sowers and reapers.
Middle income countries are smoggy, and almost everything looks like a
cheaper, shabbier version of what you get in the US. Scenic landscapes
are despoiled by cinderblock buildings with hideous tin roofs, or
trailers; cities are choked with boxy modern buildings that look
something like our housing projects. The genteel decay that looks
gothic and intriguing on an old Victorian mansion just looks seedy when
it’s eating away at badly poured concrete. Affluent Americans
underestimate the utility value of things like having personal space,
or an automobile.

4) Cuba was relatively wealthy in 1959; it therefore has more
of the markers, like old majestic buildings, that we associate with
wealth.

I found the most evident signs of Cuban poverty to be the unceasing supply of articulate and sometimes weakly sobbing mendicants, none of whom sounded like con men, all of whom needed money to buy food and clothes for their families.  The most shocking part is what small sums of money they would ask for or be made happy by.  Or the numerous women — and I mean ordinary women in the streets — who would offer their bodies to a stranger (handsome though I am) for a mere pittance.  Yes in Cuba there is good access to doctors but anesthesia is in short supply and the health care system stopped improving long ago.

If you want to understand northern Mexico, get out of the Tijuana tourist strip and visit Hermosillo.  Count the number of new housing developments, and then count how many of them are inhabited by fairly dark-skinned, previously dirt poor, Mexican mestizos.  Put that number over the number of buildings in Havana that do not have serious maintenance problems and see if you can divide by zero.

It’s quite possible that a lower middle class Mexican eats better food than you do, but there is no chance of that for anyone in Cuba except the top elite.  Powdered milk is a luxury there. 

I’ve long thought that Prague looks much richer than it is, and that the ugly northern Virginia or Houston looks poorer than it is.  Where else looks deceivingly rich or poor?

This is Fred Krupp president of the Environmental Defense Fund interviewed in Wired who after noting the success of markets in acid rain avoidance says this about approaches to carbon avoidance and global warming:

…I know that capitalism works, that American entrepreneurialism works,
and we can damn well expect that private capital – not government money
– will actually solve this problem.

Oakland’s recent gun buyback was especially ridiculous.  The police offered up to $250 for a gun "no questions asked, no ID required."  The first people in line?  Two gun dealers from Reno with 60 cheap handguns.  Fortunately the buyback did manage to get some guns off the street, too bad they were turned in by a bunch of senior citizens from an assisted living facility.   Whew, the streets are safe at last.

Even putting aside the obvious nonsense, gun buybacks simply don’t work.  In technical terms the supply of guns to Oakland is perfectly elastic so buybacks won’t reduce the number of guns in Oakland.  Here is an analogy from my op-ed in the Oakland Tribune.

Imagine that instead of guns, the Oakland police decided, for
whatever strange reason, to buy back sneakers. The idea of a gun
buyback is to reduce the supply of guns in Oakland. Do you think that a
sneaker buyback program would reduce the number of people wearing
sneakers in Oakland? Of course not.

All that would happen is that people would reach into the
back of their closet and sell the police a bunch of old, tired, stinky
sneakers.

Gun buybacks won’t reduce the number of guns in Oakland. In fact, buybacks may increase the number of guns in Oakland.

Imagine that gun dealers offered a guarantee with every gun:
Whenever this gun gets old and wears down, the dealer will buy back the
gun for $250.

The dealer’s guarantee makes guns more valuable, so people will buy more guns.

But the story is exactly the same when it’s the police offering
the guarantee. If buyers know that they can sell their old guns in a
buyback, they are more likely to buy new guns. Thus the more common
that gun buybacks become, the more likely they are to misfire….

The guns bought in this buyback are destined to be melted down to create a monument.  It’s a shame that this monument will be the only lasting effect of the buyback.

I saw you had a post up about some work I did with Bob Gordon, and I
found your comments very interesting.  I have a couple questions that I
hope might help clarify your thoughts on the subject.

First, you
seem to argue that we would expect a CEO to be paid her marginal
product.  As you point out, there is ample evidence that a CEO adds far
more to the value of a company than she is generally paid.  I’m
curious, though, what you mean when you say we would expect the CEO to be paid her marginal
product.  Models in this literature often assume that
each firm must hire one CEO.  The concept of a marginal product breaks
down at this point.  The firm can’t hire a second CEO.  There is no
marginal value.  It’s possible that we can look at marginal products in
terms of the skill a CEO brings to the firm, but in that case, we would
be mixing up marginal and average products if we were to simply look at
the total contribution a CEO makes to firm output.

I think you’re correct to point out the institutional factors
holding down CEO pay pre-1970.  That said though, why didn’t we see CEO
pay rising much faster than market cap during the 80’s in order for it
to catch up to where it should be?  There is a period where the
pay-market cap elasticity may have been higher than 1, but it’s only for a few
years in the 90’s.  Looking at the full 1976-2005 sample, the
relationship is nearly unitary (.935, according to Frydman and Saks).  So I guess I’m surprised there is no
catch up in pay.

I think you’re right to be skeptical of the Bebchuk-Grinstein
results.  To me, the most interesting result
from Gabaix and Landier, no matter what one thinks about their model as a
whole, is that the cross-section and time series may show very
different patterns.
So one wouldn’t necessarily expect the cross-sectional results from Bebchuk and Grinstein to predict the time-series.

One
of my biggest concerns with Gabaix and Landier’s model is that it does
not display decreasing returns to scale.  An analogous
example is Berk and Green’s model of mutual funds.  They assume that if
a manager all of a sudden
sees the size of his fund double, he will see lower average returns.  I
think this is reasonable.  When there are not diminishing returns, it
is difficult to make models function.  Gabaix and Landier are forced to
do it by assuming firms never merge.  That concerns me in this
setting.  Dixit-Stiglitz competition is often a reasonable
assumption because the models using it do not actually care about firm
size
or mergers.  In the case of CEO pay, however, firm size is clearly
critical.

The question about the marginal product of a CEO is a tricky one.  I can imagine the following definitions which either express marginal product or some modified version thereof:

1. How much better the highly-paid guy is than a less-well-paid substitute would be.

2. How much better the highly-paid guy is than the next best person (in stochastic terms, that is) the firm would get for that same sum.

3. How much a bit of extra pay causes the CEO to improve effort and thus performance.

4. The complex econometric definition offered by Jensen and Murphy, read pp.33-38 here.

5. Some number between the CEO’s value of leisure and how well the firm would do with no CEO at all.

None of these quite make sense in pure theory, and it is even harder to say which is the most important variable for practice.

There is now some data for the price discrimination hypothesis:

Looking at detailed revenue data for a chain of movie theaters in Spain,
Wesley Hartmann … and Ricard Gil … compared concession purchases in weeks
with low and high movie attendance.

The fact that concession sales were proportionately higher during
low-attendance periods suggested the presence of "die-hard" moviegoers willing
to see any kind of film, good or bad–and willing to purchase high-priced
popcorn to boot. "The logic is that if they’re willing to pay, say, $10 for a
bad movie, they would be willing to pay even more for a good movie," said
Hartmann. "This is underscored by the fact that they do pay more, even for a
bad movie, as is seen in their concession buying. So for the times they’re in
the theater seeing good or popular movies, they’re actually getting more
quality than they would have needed to show up. That means that, essentially,
you could have charged them a higher price for the ticket."

Should theaters flirt with raising their ticket prices then? No, says
Hartmann. The die-hard group does not represent the average movie viewer. While
the film-o-philes might be willing to pay, say, $15 for a movie ticket, a
theater that tried such a pricing tactic would soon find itself closing its
doors.

"The fact that the people who show up only for good or popular movies
consume a lot less popcorn means that the total they pay is substantially less
than that of people who will come to see anything. If you want to bring more
consumers into the market, you need to keep ticket prices lower to attract
them." Theaters wisely make up the margin, he says, by transferring it to the
person willing to buy the $5 popcorn bucket.

Here is more.  The data are the data, but this doesn’t strike me as a very general explanation.  Specifically it requires that the high-value movie demanders are also the high-value popcorn demanders.  If anything I would expect the casual movie fans to be the ones who want to buy the concessions; the seasoned moviegoer will have some other, better plan worked out in advance.  For other explanations for high popcorn prices, you might look at the research on "shrouding," or consider that ticket revenue is shared with the studio but concession revenue usually is not.

Stephen Jen says yes, here is one media story on his new paper:

With many of its members having already repaid their
debts, the IMF’s annual income from interest repayments has slumped to
new lows recently, forcing it to make major cutbacks. New managing
director Dominique Strauss-Kahn has announced a 15pc cut in staff
levels and an overhaul of its non-core activities.

Mr Jen said such drastic cutbacks were unwise, since the IMF’s role as a monitor of the world economy could be compromised.

"Retrenching
now is tantamount to downsizing a fire department when there is a low
incidence of fire," he said, adding that the Fund should sell some of
its gold to reinvest in instruments with a reliable income. The Fund
owns 103.4m ounces of gold, worth around $92bn (£47bn) at current
prices – up from just $23bn five years ago. But while the cache of
metal has appreciated in value, it does not bring in a regular flow of
cash.

"The IMF has a great deal of scope to enhance its investment returns without exposing itself to undue market risk," said Mr Jen.

The
result could be the creation of a supra-national fund worth as much as
$100bn. Mr Jen predicted that it could be worth $130bn in 10 years’
time. This would be of a size similar to Russia and Singapore’s funds.

Here is a previous post on the IMF’s funding problems.  Here is a previous post on whether we should abolish the IMF.  Jen’s idea may not appeal to many people; the question is whether you can come up with something better.

This afternoon, let’s just do "Control-C" from Craig Newmark:

David Leonhardt reports a clear winner:

I received dozens of diverse responses, but there was still a
runaway winner. The small group of economists who work at the Jameel
Poverty Action Lab at M.I.T., led by Esther Duflo and Abhijit Banerjee, were mentioned far more often than anyone else.

Ms.
Duflo, Mr. Banerjee and their colleagues have a simple, if radical,
goal. They want to overhaul development aid so that more of it is spent
on programs that actually make a difference. And they are trying to do
so in a way that skirts the long-running ideological debate between aid
groups and their critics.

Repeal the [should have read: "Institute an"] antitrust exemption for the airlines and approval all of their mergers, no matter what.

Higher P, lower Q.  And maybe some groups outside the traditional green coalition would support such a change.

By no means a full solution, but maybe better than doing nothing.

The evidence is here.

Kevin Grier at Kids Prefer Cheese continues our book forum on the Logic of Life with a discussion of The World is Spiky.

Here is my summary of Tim’s argument. Cities are expensive, and that
expense is above and beyond paying the necessary rents to gain access
to their unique amenities. Cities are marked by knowledge spillovers, a
positive externality (don’t get mad Bryan)
where human capital grows faster when one is around more humans. And
the internet, rather than reducing the positive effects of cities on
productivity, actually enhances them. Thus, rather than subsidizing
rural areas, perhaps we should consider subsidizing cities.

Luckily
for Tim and his prospective book sales, he tells this story in a much
more entertaining way than I just did. But I still have some questions,
suggestions, and quibbles.

The claim is made that salary
differences don’t match up with cost of living differences and the
reason for this is knowledge spillovers, but it is not spelled out
exactly how that would work. An alternative seems to me that zoning
restrictions create these big rents and pre-existing property owners
are sucking a lot of the consumer surplus out of people with high
valuations on cool experiences…..

Tim discusses
“failing cities” and describes (correctly I think) why people still
live there, but gives no explanation for why they failed if indeed
cities produce these positive externalities. There is no discussion of
some of the very biggest cities in the world; Mexico City, Lagos,
Jakarta. It would be nice to know where the argument works, where it
doesn’t and how to know which is which…

More here.