The economics of low-cost carriers

The nation’s low-cost carriers are profitable even as the venerable “legacy” airlines barely tread water. How can they make money while offering fares that are 40 to 70 percent lower? The reasons are many — cost of labor is a big one — but here are 10 major differences between the cheeky upstarts and the big boys.

The list runs as follows:

1. Low cost carriers generally serve cities of 1.3 million or greater.

2. Southwest has 84.6 employees per aircraft, United has 116.

3. JetBlue sells 2 percent of its tickets through travel agents, US Airways sells 61 percent through agents.

4. The low-cost carriers have more point-to-point flights. 40 percent of American passengers have connecting flights, it is only 10 percent for Southwest. Connecting passengers cost more money to serve.

5. Low-cost carriers generally avoid costly foreign flights.

6. A Delta captain earns $215,000 a year, an AirTran captain earns $135,000.

7. The low-cost airlines have cheaper pension plans.

8. Southwest, JetBlue, and AirTran have no downtown ticket offices. US Airways has 13.

9. US Airways pays its telephone reservation agents $21 an hour. JetBlue pays them $8.25 an hour and has them work from home, saving on office costs.

10. JetBlue flies one kind of plane, Delta flies 16 different kinds of aircraft.

Here is the full story. Obviously many of these cost savings can cut into long-run profitability, but that is how the low-cost airlines have penetrated the market.

If air genius Gary Leff offers commentary, I’ll write an addendum.

Addendum: Here’s Gary, he says “It’s the labor costs, stupid”.

Irrational gloom, or Alex cheers me up

Alex remains worried about our future, but let us look more closely at his concerns. His biggest fear is our future demographic structure:

…the Bush policies are not the major problem. The major problem is that we are about to be hit by a tidal wave of old people (contra Tyler demographics are the problem not the solution).

Hey, I hope to be part of that wave, the problem will be if I am not!

Let’s redo Alex’s doctor example. In my version, the doctor suddenly tells Alex that he will live to the ripe old age of two hundred, most of those years in reasonable health. This is reason to celebrate, even though Alex would have to restructure his retirement plans. Something like this, albeit in less extreme form, is going on in America: a large baby boom cohort can be expected to live to older ages. Bravo, I say. Count up those extra years, including the implicit value of leisure, at their full economic value, and our “intergenerational accounts” will look much better. Note also that the elderly have a higher quality of life than ever before, for reasons ranging from cheap eye surgery to bypass operations to new drugs.

Two other issues:

First, contrary to what Alex suggests, “g>r” would solve the problem. Growing debt, which is a transfer, doesn’t change the fact that the intertemporal budget constraint has melted away, provided we can shift real resources into the present (if you’re not an economics nerd, the point would take too long to explain in non-technical language, read the link if you must).

Second, I am not convinced that Alex has put his money where his mouth is. He is conspicuously silent about whether he has gone short in bonds. Plus I bet he would have taken a tenured professorship, bought a house, and bought an internationally diversified portfolio anyway, I certainly did all of these and I am an optimist.

The bottom line? A growing population, combined with a bulge of old people, requires planning wisdom and creates some costly expenditure pressures. But overall longer lives are cause for rejoicing, not our economic doom. Love and time are what we are ultimately seeking to economize, and longer lives contribute toward both ends.

My Haitian fears confirmed

While many in the crowds greeting the rebels appeared joyous, they were also raucous. Early in the afternoon, Mr. Philippe appeared on the balcony of the former headquarters of the Haitian Army, which sits adjacent to the palace and was renovated into a museum in honor of Haiti’s 2004 bicentennial. He flashed victory signs to the crowd.

A moment after he stepped away, a soldier began tossing art from the museum into the street, beginning with a sculpture of a casket with a figurine inside. It shattered as it hit the ground and the crowd roared. More paintings followed, and someone set the pile of art aflame.

Inorel Delbrun, an art collector who had come hoping to catch a glimpse of the rebel leader, was horrified.

“This is Haitian art,” Mr. Delbrun said. “It hurts to see it destroyed. This is our culture.”

Here is the New York Times story, with a few photos. Here is my previous worry.

Now here’s rational gloom.

Rational gloom

Tyler is not as pessimistic as I am (see my earlier posts here and here) regarding our long-term budget problems. Unfortunately, he should be. Consider Tyler’s most gut-level response:

The United States remains a strong and prosperous country. Our infrastructure, national culture of innovation, human capital, and economic dynamism are unparalleled in world history.

Of course. Who would deny this? The problem is that the budget projections of Kotlikoff et al. already take these factors into account. Their projections assume that the economy will continue to grow, they assume that a nuclear weapon will not go off in Washington, they assume that we will not become bogged down at increasing expense in the Middle East for the next 50 years etc.

A doctor tells a man that he has just 6 months to live. The man replies but doctor I’m only 25, I’m in great shape and I’ve never been seriously sick before. Yes, the doctor says that’s why I gave you 6 months.

Tyler’s next comment reveals a misunderstanding. He says, “The Bush fiscal policies, whatever their irresponsibilities, costs, and drawbacks, haven’t changed those core facts.” But the Bush policies are not the major problem. The major problem is that we are about to be hit by a tidal wave of old people (contra Tyler demographics are the problem not the solution). The baby boom generation, born beginning in 1946, will begin to retire in 2008 and as they do so the demands on social security and Medicare are going to explode. By 2030 there will be 18.2 million people in the United States 85 years of age and older! In 2000, the 65 years and older crowd made up 12.4 percent of the population. By 2030 they will be 19.4 percent of the population.

Critically, combine baby boomers with rising life-expectancy and declining fertility and we have that by 2030 there will be only 2 workers per retiree (down from 16.5 workers per retiree in 1950).

Comparing today’s US budget deficit with that of Brazil or any other country misses the point. It’s the present value calculation over the future that is important. Put simply: Kotlikoff is applying Milton Friedman’s permanent income hypothesis to government accounting. (Kotlikoff is to Stone as Friedman is to Keynes).

Tyler’s most technical point, that g may be greater than r, also misses the mark. If g is greater than r then we can continually roll over our debt and eventually grow our way out of it. But this calculation is only relevant for a fixed debt – the problem is that our debt is rising very rapidly. If the debt were to stand still we could pay it but it ain’t standing still.

Tyler challenges me to put my money where my mouth is. In fact, I have. First, I got a job as a tenured professor! Second, I borrowed a lot of money at the lowest interest rate I expect to see in my lifetime and bought housing. The key problem in the future is going to be inflation and rising tax rates so you want to borrow at a fixed rate and put your wealth in hard to tax assets (Tyler, art may be an even better investment! You can always take it with you over the border.) I also own an internationally diversified portfolio (yes, even some in Brazil).

No, I’m not yet stocking up on cans of spam. We could get lucky. Kotlikoff could be wrong. The obvious facts of demography make me think that he is right enough, however, to warrant taking serious actions now rather than later. But like Kotlikoff, I don’t think our political system is ready.

New trends in self-publishing

Why not go with Borders, the people who sell you the books?

“It’s easy to publish your own book!” the “Borders Personal Publishing” leaflets proclaim. Pay $4.99. Take home a kit. Send in your manuscript and $199. A month or so later, presto. Ten paperback copies of your novel, memoir or cookbook arrive.

Fork over $499, and you can get the upscale “Professional Publication” option. Your book gets an International Standard Book Number, publishing’s equivalent of an ID number and is made available on Borders.com, and the Philadelphia store makes space on its shelves for five copies.

Borders is the latest traditional bookseller or publisher to branch into self-publishing using print-on-demand or P.O.D. technology. P.O.D., inheritor of the vanity press and survivor of the dot-com implosion, makes it feasible – technologically and economically – to produce one copy of a book.

Unlike e-books, which also appeared in the late 1990’s, P.O.D. self-publishing has developed into a real business, attracting involvement from the likes of Random House, Barnes & Noble and now Borders.

Forty percent of all self-published books are sold to the authors, and most of the other sixty percent are sold on-line. One company, iUniverse, has 17,000 published titles. 84 have sold more than 500 copies, and a half dozen have made it to Barnes and Noble shelves. But then again, traditional vanity presses charge you at least 8 to 10K to publish a book, with no guarantees.

Here is the full story. As Clay Shirky notes, the world is moving from the paradigm of “first filter, than publish” to “first publish, then filter.”

But does self-publishing have a bright future? Yes and no. Soon self-publishing won’t be worse than going with a mediocre press. The value of the very best certifiers will go up (in the academic market this is Harvard, Princeton, Chicago, and MIT presses, for a start), if only because the proliferation of writing makes their sorting function more important. At the same time the relative value of the middling certifiers will fall. It will become apparent they don’t offer a better product than writers operating on their own. At some point you have to ask whether the press is lending reputation to the author, or vice versa.

By the way, here is one self-published memoir which I love, the author Thelma Klein was the mother of well-known economist Daniel Klein. Yes they still have copies if you want to buy one, and they only cost a few dollars.

Can suicide be rational?

Carolyn G. Heilbrun’s suicide this past October could not have come as a great surprise to her family and friends. After all, the 77-year-old former Columbia University literature professor and mystery author [pen name Amanda Cross] had written for years about her plans to kill herself.

Heilbrun was suffering from none of the conditions commonly associated with suicide when she evidently took an overdose of pills and put a plastic bag over her head. She was neither terminally ill, in severe pain nor, apparently, depressed. Instead, she committed what some have called “rational suicide” — ending one’s life out of a conviction that one has lived long enough, that the likely future holds more pain than joy.

Rational suicide, a coinage dating back nearly a century, has also been called balance-sheet suicide, suggesting that sane individuals can objectively weigh the pros and cons of continued life, and then decide in favor of death.

Read the whole story. (You will note that The Washington Post has new registration procedures, it takes no more than a minute, and we link to them frequently, you are encouraged to register.) Or sometimes you may attempt suicide to get more attention and resources from other people.

I am a skeptic, and unlike many economists I am willing to point The Finger of Irrationality. Consider the following:

Heilbrun’s decision [is] such a disturbing one, says suicide expert John L. McIntosh, chairman of the psychology department at Indiana University South Bend. Even someone making what appears to be a thoroughly rational case for suicide, McIntosh says, can be suffering from depression or cognitive rigidity, an unwillingness to consider other options. Health professionals, he stresses, should be diagnosing and then treating such individuals.

So what happened?

Heilbrun…had been especially open about her plans. In her 1997 book, “The Last Gift of Time,” she described life after age 70 as “dangerous, lest we live past both the right point and our chance to die.”

Two concerns that Heilbrun mentioned were her “inevitable decline” and becoming a burden on others. Her motto, she said, was, “Quit while you’re ahead.” But though she was then 71 years old, Heilbrun chose not to act — not yet. Her sixties, to her surprise, had been a source of astonishing pleasure. She wanted to keep writing, enjoy her family and friends, spend time in a new home and keep certain “promises.”

In the July 2003 issue of the Women’s Review of Books, however, Heilbrun wrote that she feared “living with certainty that there was no further work demanding to be done.” She had consented to life, she stated, “only on the terms of borrowed time.”

On Oct. 9, 2003, Heilbrun was found dead in her New York apartment, having committed suicide. A nearby note read “The journey is over. Love to all.”

My take: I plan on hanging on until the bitter end. Perhaps that is why I cannot so easily imagine a rational suicide, apart from cases of extreme pain and terminal illness.

The baby boomers take over music

For the first time, people in their 40s are buying more albums than teenagers. According to recent figures from the British Phonographic Industry (BPI), the 12-to-19 age group accounted for 16.4% of album sales in 2002, a sharp fall on 2000 (22.1%), while 40- to-49-year-olds went the other way, rising from 16.5% to 19.1%. Buyers in their 50s (14.3%) are not far behind. Soon, half of albums will be bought by people who have passed their 40th birthday.

That’s Britain, of course. Here is the full story. America is not yet at this point, but a mix of demographics and downloading has changed our music market as well. So expect more stars like Norah Jones and more Paul Simon reissues.

And does this line make you feel old?

The term “adult oriented rock”, meaning the Eagles if you were lucky and Boston if you weren’t, was common currency 30 years ago.

In the U.S. last year, the biggest musical earners were The Rolling Stones and the Eagles, largely through touring. Paul McCartney was next in line, I shelled out over $100 to see him lip synch through the high notes of “Maybe I’m Amazed.”

Economic freedom in North America

The Fraser Institute has just put out its Economic Freedom of North America, 2004 report, here is the full and lengthy text, including all the data.

And how do the freedom rankings look? If you look at all sources of government intervention, the winners are:

1. Delaware
2. Colorado
3. Georgia
4. Nevada
5. New Hampshire

Louisiana comes in seventh, Alberta comes in ninth. Here is a short piece on enterprise culture in Alberta, here is a press release on possible declines in economic freedom in Alberta.

The eight biggest losers are all Canadian provinces, with Prince Edward Island as the least free. Here is a bureaucratic report on their current economic situation. Here is a summary of other Canadian results, including a recent upward freedom trend in Canada as a whole.

As for the States, West Virginia comes in last; for the full list go the linked report. If you look only at “sub-national” freedom (state-level regulations but not federal impacts), Colorado moves into first place, most of the other results do not change very much.

Economic freedom and prosperity are strongly correlated (Louisiana is an outlier), although the direction of causality of course can be debated. Here is a link to other Fraser data sources.

Children’s Television that I like too

Cyberchase is a PBS show for kids that teaches math. It’s designed for children 8-12 but my 5 year old loves it. I’m impressed too. My son picked up on the concept of negative numbers from one episode involving an elevator traveling from above ground to below ground. In another episode, the cyber-kids use backwards induction to save the world! The cyber-kids even figure out the value of having a medium of exchange. If you have kids, check it out.

I also recommend, Between the Lions, the hippest kids tv show I have ever seen. One episode featured the music of Charlie Parker, recurring bits are Dr. Ruth playing Dr. Wordheimer (she counsels words on how to blend together), Martha Reader and the Vowelles, Gawain’s Word and more.

Why I am not as pessimistic as Alex

Alex, citing Larry Kotlikoff, despairs for our fiscal future, read his earlier post as well.

I agree with the Krugman-DeLong-A.Sullivan-Tabarrok (if I may call it that) critique of current fiscal policies. But I don’t agree that our government is “bankrupt,” or accept the cited claim by Kotlikoff that “our country is in worse long-term fiscal shape than Brazil.” Neither is close to being true, check out Brazil’s BB bond rating for a start.

What is the real cost of our fiscal irresponsibility? First, we could be using current resources more effectively. But productivity trends have been strongly positive for some time now. So while things could and should be better, current magnitudes are not themselves evidence of disaster.

Second, when the time comes to pay off the debts, we will require some combination of inflation, spending cuts, and tax increases. Since most of the debt is short-term, inflation won’t do it. The real problem has to be taxes. Spending cuts Alex probably favors, at least I get that feeling reading the guy’s blog. The danger is that we will end up with Western European levels of taxation, stifling our entrepreneurial culture.

So the real cost of our current fiscal irresponsibility is the increase in deadweight loss, resulting from the required increase in taxation, as will be needed to pay off all those trillions. The real cost is not equal to the number of trillions that need to be paid back. And most of the associated transfers are within a generation (tax some living people to pay off bondholders, other living people at the time), rather than across the generations. Let’s not confuse the size of the deficit, or the debt, with the size of the intergenerational transfer.

Keep two other things in mind as well. First, there is some chance that the growth rate of the economy will exceed the real rate of interest. In that case we can simply grow out of our debt, which over time will become small relative to the size of the economy. It is irresponsible for a government to take the risk of spending on this basis. Nonetheless it is at least possible that, in technical parlance, “g > r”.

Second, America will likely experience favorable demographics. Here is Nicholas Eberstadt:

…the United States is envisioned to grow from 285 million in 2000 to 358 million in 2025. In absolute terms, this would be by far the greatest increase projected for any industrialized society; in relative terms, this projected 26 percent increment would almost exactly match the proportional growth of the Asia/Eurasia region as a whole. Under these trajectories, the United States would remain the world’s third most populous country in 2025, and by the early 2020s, the U.S. population growth rate – a projected 0.7 percent per year – would in this scenario actually be higher than that of Indonesia, Thailand, or virtually any country in East Asia, China included.

No, that won’t solve the problem but it is a help.

I should note that Alex and I probably do not disagree about the economics of the matter (if we do, you will hear from him soon enough). But I think he is neglecting the importance of the following:

The United States remains a strong and prosperous country. Our infrastructure, national culture of innovation, human capital, and economic dynamism are unparalelled in world history. The Bush fiscal policies, whatever their irresponsibilities, costs, and drawbacks, haven’t changed those core facts.

So I walked down to Alex’s office and issued him the following challenge: if you think I am wrong, sell all your stocks and go short on U.S. Treasury securities (and long on Brazil, if you wish!). With all the money you will make, you can buy out my half of this blog.

A Rose by Any Other Name?

Years ago, the possibility of adopting a 28% “flat” tax on income (generally no deductions allowed) was seen as the solution for fixing the complex tax system. Today, there is outcry over a tax calculation that preserves a preferential 15% tax rate for dividends and capital gains, allows deductions for home interest and charitable contributions, but generally taxes income at 28%. A modified version of the flat tax? No, it’s called the AMT.

That is Kenneth Barkoff’s letter in the March 8 issue of Business Week, Barkoff is a tax specialist.

Some people complaining about the Alternative Minimum Tax may be objecting to its unfairness, as not everyone falls under its rubric. People with high deductions, as might arise from a second home, are the most likely victims. Other objections cite the height of the rate. Yet other critics may not like the process through which the AMT became so binding, namely the so-called Bush tax cuts, which made more people eligible for AMT status.

Gary Becker’s analysis suggests that a flat tax, if it is efficient, also will make government larger in size. Efficient taxation will make it easier to afford large government.

My take: I’ve never understood the conservative/right-wing obsession with flat taxation. I don’t favor arbitrary taxation per se, but we already have something resembling a flat tax right under our noses, and no one is very happy with it.

Haitian update

FoxNews reports that U.S. troops are protecting “key sites” in Port-Au-Prince. Let’s hope that this includes the murals at the Episcopal Church of Haiti, the high point of Haitian artistic achievement, dating from 1950-1951. Please let us be more prepared than we were in Iraq.

View some images, but they don’t come close to seeing the murals in person. Here are some more visuals, combined with a brief essay on Haiti by DeWitt Peters, an early patron saint of Haitian art. Here is the best single view. Note that the murals are currently falling apart from moisture and leakage, they require extensive renovation.

Here is The Lord’s Prayer According to Papa Doc Duvalier, a less notable Haitian achievement. Here is a picture of the voodoo gods, pondering Haiti’s destiny.

Addendum: Here is Daniel Drezner on Haiti and drugs.

Why celebrities are good for your kids

Celebrity worship may play an important part of growing up, suggest the results of a UK study.

Star-struck teens are generally emotionally well-adjusted and popular, with their celebrity interests forming a healthy part of adolescent development and bonding, say psychologists from the Universities of Leicester and Coventry.

However, those with extreme celebrity fascination, are likely to be lonely children without close attachments to friends or family, suggests the new study.

John Maltby and David Giles surveyed 191 English schoolchildren between the ages of 11 and 16. They found that those who avidly followed celebrities’ lives were the most popular.

For about 30 per cent of the children, gossiping about favourite celebrities with their peer group took up much of their social time. These children were found to have a particularly strong and close network of friends and to have created a healthy emotional distance from their parents.

“As children grow up, they start to transfer their attachment from parents to their peers. Celebrities start to take on the hero status role that their parents formerly fulfilled when the children were younger and it seems to be a healthy part of development,” explains Maltby, who led the study.

“The main function of celebrity attachments in adolescence may be as an extended social network – a group of ‘pseudo-friends’ who form the subject of peer gossip and discussion,” he told New Scientist. “The ongoing subject of celebrities’ lives can provide a valuable bonding tool among their friends, while enabling them to be emotionally autonomous from their parents.”

Here is the full story. And don’t forget my book on fame, which views the production of celebrity as one of the most beneficial aspects of modern popular culture. Not only do stars give us focal points for social orientation, but we gain by paying them with fame rather than having to part with more money.

Buy one get one free

Washington Post consumer columnist Margaret Webb Pressler writes:

I also got a huge response about the growing use of buy-one-get-one-free promotions, or BOGOs, as they’re called in the industry….Shoppers don’t understand why retailers offer this kind of promotion when it’s no better for customers and no more profitable for stores than a half-price sale.

On the contrary, BOGOs can be much more profitable for stores than a half-price sale. To see why, assume that you value your first pizza of the night at $15.01 and the second at $5.01 and let’s say it costs the store $2 to make each pizza. If the pizza store has a buy-one-get-one-free offer at $20 then you will buy two pizzas and the store will have profits of $16 ($20-$2-$2). But if the store sells pizzas for half price, $10 each, you will buy just one pizza and the store will have profits of just $8 ($10-$2). The BOGO doubles the store’s profits!

Carefully designed BOGOs increase profits because they let the firm price more flexibly, what economists unfortunately call “price discrimination.” At $20, the BOGO is equivalent to charging $15 for the first pizza and $5 for the second. Notice that these prices are ideal for the firm since they are the maximum the consumer will pay – any more and the consumer won’t buy.

Although BOGOs may make consumers worse off they generally increase total welfare because the price on the last unit sold is pushed closer to marginal cost and because of this output expands. Even if the efficiency gain from price discrimination goes mostly to firms don’t forget that firms are owned by people too!

For more on price discrimination see Hal Varian’s classic, Differential Pricing and Welfare.