What are the best Christmas gifts?

Here is my post from last year:

Experiences, not possessions. Concerts and travel are remembered for
longer than clothes and jewelry. The result is robust to different ages
and groups, but tends to be strongest for high-income individuals.

See the above link for references and more information.  I was reminded of this post by scrolling through John Palmer’s new economics (and miscellany) blog, The Econoclast.  Here is the web site for John’s group, the Philistine Liberation Organization.  Here is John’s list of economics-related websites.

Mirror, mirror on the wall

The reason Hillary Clinton and others on the left want government provided health care is that they hate the market.  The left isn’t sincerely concerned about people without health insurance they are worried that market forces will solve the problem and take away one of their wedge issues.  The left knows that free market health care is the wellspring of  progress to which we all owe longer and better lives and that is precisely why they want to destroy it.

Who wrote the above?  A loony blogger from the right?  A red-state, meat-eating Republican?  No, it was Paul Krugman.  Ok, he didn’t write that exactly, what he said was:

…very little about the privatizers’ position is honest. They come to bury Social
Security, not to save it. They aren’t sincerely concerned about the possibility
that the system will someday fail; they’re disturbed by the system’s historic
success. For Social Security is a government program that works, a demonstration
that a modest amount of taxing and spending can make people’s lives better and
more secure. And that’s why the right wants to destroy it.

Bile to the left of me, bile to the right.  My stomach churns, but at least this junk makes me look like a centrist.

Cowen and DeLong on what makes for a good Treasury Secretary

Econoblog returns, courtesy of The Wall Street Journal, and again no subscription required.  Brad DeLong and I discuss what makes for a good Treasury Secretary, how John Snow will fare, and our current fiscal position.

What I would like to see (I am not sure whether WSJ is the appropriate forum) is a comparable yet longer dialogue on areas of major political and economic disagreement.  One contributor starts with a post on why he thinks he disagreees with the other, in the most general terms, and the other responds.  To how many or how few dimensions can we reduce extant political disagreements?  When it concerns Brad and me, I will predict that the number is four: assumptions about feasibility/willingness to be utopian, the scope of cosmopolitan obligations across borders (I don’t count Americans for more), how likely is benevolent government (not very), and the choice of social discount rate (I think it should be low, implying growth-maximizing policies at the expense of some social spending).  You might recall this earlier exchange.

Soft landing or economic Armageddon?

Stephen Roach comes around to a more optimistic point of view

The constructive developments should not be minimized.  The recent plunge in oil prices is nothing short of stunning — 13% alone, for WTI quotes in the first three trading days of December.  I have no idea if this move is sustainable, but it has opened up a $7.50 gap from the $50 threshold that I have long felt would pose great risks to the global economy.  Moreover, the dollar’s weakness — despite the angst of the headline writers — fits the rebalancing script to a tee.  While euro and yen cross-rates are raising discomfort levels in Frankfurt and Tokyo, the dollar’s descent still looks like a well-managed soft landing to me.  In real terms, the Federal Reserve’s broad trade-weighted dollar index is down 15% from Febryary 2002 through November 2004 — a pace that equates to a decline of about 5% per year.  That’s a measured and encouraging adjustment path — provided, of course, the burden of currency realignment now spreads from Europe to Asia, including China. 

Furthermore the Chinese economy appears to be slowing in the appropriate, non-implosive fashion.  Roach’s bottom line?    

Even I have to concede that a number of positives have fallen into place recently.  I am on record of assigning a 40% probability to a global recession scenario in 2005…However, given recent favorable shifts in oil, the dollar, and China, I now believe that it is appropriate to reduce this risk to 25%.   

Note, however, that in his view (and mine) the U.S. still remains on a dangerous consumption binge when for demographic reasons more saving would be in order.  In my view the big problem lies in the long run, not the short run.  Now asset markets have a remarkable ability to compress long run problems into the here and now.  But how will this play out?  Most likely U.S. taxes in twenty or thirty years time will be much higher than today. Yes this will depress current asset prices but it should not, on its own, imply a current implosion or crash. Here is my previous post on economic Armageddon.

One more reason why New Zealand is not a growth dynamo

An interview-based correlation of financial satisfaction with overall life satisfaction lists 31 countries.  Tanzania has the highest correlation, by far, coming very close to 0.7 on the bar graph.  In other words, the wealthy Tanzanians report the strongest satisfaction with their lives.  Next is Korea, Bahrain, Jordan, Kenya and Greece, roughly clustered in the 0.4 to 0.5 range.  The U.S. comes in at about 0.4, which is high for the wealthy countries in the sample.

Where is the correlation by far the weakest?  New Zealand does not even make it past a correlation of 0.1. 

I can think of at least three reasons why this correlation might be so low:

1. New Zealanders don’t think you need to be rich to be happy.

2. New Zealanders sense their economy isn’t going anywhere, and so rationalize their forthcoming failure by pretending they will be happy anyway.

3. New Zealanders find it uncouth to admit that money makes you happy.

None of these views bodes well for a country’s commercial dynamism.

Here is my earlier post on why Kiwi growth has been slow. 

See the January 2005 Scientific American, p.90, drawing on the research and E. Diener and M. Diener.

Me-Too Two

Yesterday I introduced the gold-mine model.  Today, I want to look at some solutions but also ask whether the model fits the pharmaceutical market.

Recall, the problem is that I discover a gold-mine, you undermine my profits by digging on nearby land.  Society loses because instead of searching for another gold-mine you spend resources trying to exploit what has already been discovered.  Applied to me-too drugs the idea is that firm A innovates and earns big profits, firms B,C,D try to imitate and grab some of the profits rather than search for innovations of their own. 

In the gold-mine model one solution is to give the miner who first makes the discovery the mining rights on all nearby land.  The miner won’t exploit these rights but will prevent others from wasting resources through undermining.  How does this apply to me-too drugs?  Critics of the pharmaceutical
industry will probably be upset to find that the analogous solution is to grant stronger patent rights.  In particular, the problem with me-too drugs is companies investing resources in R&D that will end up producing a drug with similar effects through somewhat different means.  If patent rights were broader then the costs of undermining would be higher and the me-too problem reduced.

Thus, me-too policy is patent policy and now we begin to see why the problem is complex.  Broader patents, for example, have costs as well as benefits.  Selden’s auto patent, for example, was originally held to be so broad that it almost finished Henry Ford.  (For more examples see my paper Patent Theory versus Patent Law (email me if you can’t get access) or the new book Innovation and Its Discontents.)

Moreover, we have been assuming that the innovating firm strikes gold and then other firms rush onto nearby land.  But that’s not the way most pharmaceutical innovation works.  More often, there is some basic research, often done in a university lab, which suggests a possible drug target or mechanism.  The research is public knowledge so a number of pharmaceutical firms begin the long slog of trying to turn an idea into a drug.  Think of the original research as a prospector shouting "there’s gold in them thar hills," – the firms then rush into the hills to start researching/digging.  One of them may strike gold first but the others are close behind.

The key point is that the R&D used to develop the me-too drugs was not spent to undermine the innovator it was spent in an effort to become the innovator.  Think about it this way.  Ten people are in a race to deliver a letter.  Critics of me-too drugs complain that the runner coming in second is wasting society’s
time.

Now it is possible to have too many firms racing to be the innovator – perhaps we should only have 8 firms in the race not 10.  But critics of me-too drugs don’t argue that there is too much R&D, which at least would be consistent, they argue that there is too little. 

Although it is possible to have too much R&D, I find the argument especially difficult to believe in the pharmaceutical industry.  First, even in the best scenario the returns to the innovating firm are less than the social returns so "too much" R&D may simply make up for this defect.  Second, there are many positive externalities to drug research.  A substantial fraction of the increase in life expectancy over the past thirty years has been due to pharmaceuticals and the value of this reduction in mortality is in the trillions.  Third, research indicates that the R&D efforts of different firms is in fact complementary – when you drain your mine of water my costs of mining fall.   

Tomorrow I will wrap up with some final comments, Why me-too for you may not be me-too for me.

Me-Too Drugs

At Tyler’s prompting I will have several posts this week on me-too drugs.  It’s a difficult area but one that I have been thinking about.  Why are me-too drugs bad, even though competition is ordinarily good?  The reason is that when an industry is characterized by market power and price exceeds marginal cost the private returns to innovation may exceed the social returns.

Here’s a simple model.  I own a profitable gold mine.  You buy some land nearby and begin to dig but instead of finding your own gold you tunnel underneath my land and steal my gold – you undermine my profits.   Now this may be very profitable to you but as far as society is concerned your digging is wasted effort.  You expended resources not to increase production but simply to transfer profit from me to you.  The prospect of stealing my gold attracts too much entry (and the threat of this may in turn cause me to invest less in the first place).

A patent on a blockbuster drug is like a gold mine.  Me-too drugs undermine the profit from the blockbuster.  The R&D that goes into the me-toos is thus a social waste.

The gold-mine problem is the economic case against me-too drugs.

The gold-mine model leads to some surprising insights.  Me-too drugs are bad because resources are used to undermine someone else’s profits.  But a firm won’t undermine it’s own profits.  Thus, a firm’s own "me-too" drugs are not an example of the gold-mine problem.

AstraZeneca introduced Nexium just as their drug Prilosec was going off patent.  Nexium is very similar to Prilosec and for almost all patients it offers few additional benefits – it is widely cited as a me-too drug.  The Nexium problem, however, is quite different from the gold-mine problem.  The Nexium problem is, Why do people buy the expensive brand when the cheap generic would be just as good?  The Nexium problem is that customers think, or act is if they think, that Nexium is not a me-too drug. 

In contrast, in the statin market there is Zocor, Lipitor, Pravachol, Lescol and Crestor.  Even if consumers thought these drugs were me-toos, each of them would still have a market.  Here the problem is, or appears to be, the gold-mine problem.

Solutions to the Nexium problem, such as better informed patients or getting consumers to pay a larger share of their drug purchases, do not necessarily solve the gold-mine problem.    

In a future post, I will look at some solutions to the gold-mine problem.  I will also look more closely at whether the pharmaceutical market fits the assumptions of the model.

Are seasonal business cycles effcient?

A disproportionate percentage of economic activity — both production and consumption — comes in the fourth quarter as Christmas approaches.  Similar trends occur in other economies with major gift-giving holidays.  Yet most economic models imply benefits to smoother production and consumption.  In fact seasonal business cycles look a great deal like regular business cycles.  Major economic variables such as employment, production, and sales move in similar ways across the two kinds of cycles.  Yet we typically disapprove of regular business cycles.  So does it make sense for so much economic activity to be clustered in seasonal fashion?

Here are some con reasons:

1. Congestion: try parking your car at Tysons Corner on a Saturday afternoon in December.

2. Producers must make all-or-nothing bets on new styles, which then either take off or fall flat.  The economy becomes riskier than it need be.

3. The short-run marginal cost curve is (possibly) rising, so it is more costly to produce so much for the final quarter all at once.  Overtime rises as well.

4. Gift-giving may be an inefficient form of signaling with high deadweight losses.

5. The Christmas season encourages undue attention to creating "blockbusters" rather than quality niche goods.  This trend is evident in the book market.

If these hold, on net, we pay an inefficiently large amount of attention to Christmas.  We should tax Santa at the margin.

Here are some pro reasons:

1. Shopping involves fixed costs, so let’s get it all over with at the same time.  The same might be said for tracking consumer demands, or even producing the stuff.

2. New ideas have a better chance of getting a start when we bunch demand in concentrated fashion and increase returns.  Christmas boosts innovation, which is in general undersupplied.

3. Once the season is over, it is over.  We have a simpler mechanism for getting rid of failed products and failed ideas.

4. There is no other way to produce that "Christmas spirit."

I incline toward the "pro" reasons, with emphasis on number two.  Though I do not pretend to have a grip on the empirics of this question.)  But if seasonal cycles are so good, why do I object to regular business cycles?  Can it matter so much that one is anticipated and the other not?  If, statistically, they look so much alike, can it be said that one is based on coordination failure and the other not?

Why do some stores have longer lines than others?

Let’s put aside the simple explanations, such as "Nobody goes there."  Let’s also put aside artificially contrived scarcities, such as for Super Bowl tickets or hot restaurants on Saturday night.  We are left with the following:

1. Some stores put impulse purchases next to where you wait in line.  If the line is too quick you won’t spend any more money.  Borders uses this strategy very effectively, it is harder for Home Depot.

2. The authority of final decision-making is to some extent indivisible, plus managers can only be hired in integer numbers.  Yet some stores require more managerial attention to resolve disputes than others.  I never bicker over price in the supermarket, but ever try to get a late fee waived in a video store?

3. Some stores may use growing and shrinking lines as a substitute for changing prices.  The waiting time in line at my Giant is often longest late at night.  In essence they are charging you a higher price to shop late at night.  The company "wins back" some of this tax by skimping on labor costs.  Perhaps this system of "flex prices" is easier than altering the bar codes or price stickers on an hourly basis.

4. Long lines may serve the cause of price discrimination.  Perhaps the store offers personalized shopper services, free home delivery, or other services at a premium.  These ancillary benefits might be more profitable if shopping takes just a bit of time.  Low-income demanders won’t mind so much, high-income demanders may be pushed to the extra services.

5. Rentals take more time to process than do cash transactions.  Some of the incidence of this burden falls on consumers.  If rentals take twice as long to process, and consumers arrive at random rates, the profit-maximizing solution is not generally to double the number of service clerks.  This would lead to an excess of idle labor during the day.

6. Many consumers are a pain.  But they are less likely to complain or slow down the process when the line behind them is long.  So attempts to shorten the line are to some extent counteracted by the increasingly difficult behavior of your fellow man.  This lowers the store’s return to line-shortening.  The store prefers to capture some of these rents by cutting back on service, rather than allowing their more difficult consumers to push everyone around.

7. Perceptual biases and selection – It feels like you are waiting in line most of the time because you are.  When you are not waiting, the experience ends quite rapidly.

Explanation number two is taken from Caroline Mayer’s "A Perpetual State of Pause," The Washington Post, December 5, not yet on-line.