Cafe Hayek

Competition is a Discovery Procedure

My friend (and co-blogger at Market Correction) Andy Morriss yesterday sent this excellent letter to the Wall Street Journal:

Sirs,

David Wessel warns that “the business model for big U.S. banks is broken” and that if bankers don’t devise a better model Rep. Barney Frank will (“How to unbreak the banks,” Jan. 10). Mr. Wessel is correct that most banks’ business models are not currently producing profits, but this is not cause for concern for anyone but their shareholders. Markets are a discovery process, with firms and investors learning as they try new ideas and react to changed conditions. What markets need is a stable regulatory environment, in which every dip in the market does not produce a new set of rules.  Unfortunately, there is little evidence that Rep. Frank and his comrades on the House Financial Services Committee understand this, making it virtually certain that they will rush to “solve” the banking crisis with new legislation. The best assistance Rep. Frank could offer would be to commit his committee to resolute inaction for an extended period of time, offering both banks and investors the assurance that the rules of the game would remain unchanged and allowing them to learn from their experience in the market place.

Andrew P. Morriss
H. Ross & Helen Workman Professor of Law and Business
Professor, Institute for Government and Public Affairs
University of Illinois

I here emphasize only that Wessel's suggestion that someone specialized in winning elections to Congress (such as Rep. Frank) could possibly develop a better business model for banks is ridiculous.  It's like supposing that a crocodile, observing some misfortune visited upon an owl, could sensibly develop a better way for birds to behave.

Competition, everywhere

I have believed for a while now that an important reason that suburban public schools outperform urban public schools is that suburban public schools have to keep the parents happier because of the competition from private schools. That is, in a rich suburban neighborhood, you get excellent public school, partly because the parents are rich enough to send their kids to private schools if the public schools perform poorly. In the inner city, the parents are poor and the private school alternative is not much of a threat.

I've never seen any formal evidence on this. One way to test it would be to look at inner cities that have strong private Catholic schools which usually find a way to take kids, poor or not, and see if that improves the quality of the public schools.

Competition is powerful. When you have alternatives, it forces people to treat you better than they otherwise would, as a customer, as a worker, in business, in education, in love and life, generally.

I was thinking about this while listening to this episode of This American Life, an extraordinary podcast that always inspires me to try and make EconTalk better. (If you want to hear why I think TAL is so phenomenal, listen to Act V You can listen to it for free. Download is 95 cents.)

The episode was a retrospective on Harold Washington, the first black mayor of Chicago who was elected shortly after the end of the Richard J. Daley era, the era when the Democratic machine with all its patronage and corruption was in its heyday, or at least one of its heydays.

The show describes how horribly the Daley Machine treated blacks even though blacks voted overwhelmingly for Daley. The show describes all the racist stuff Daley did in the way he allocated contracts, handed out patronage jobs, used federal funds to keep blacks in black neighborhoods and so on. One black alderman recounts feeling like "The Garbage Alderman" because he spent so much time getting the city just to pick up the garbage  in black neighborhoods.

But of course that's the way it was. The blacks had no alternatives. They couldn't vote Republican. So you get the seeming ironic result that one of the most loyal voting blocs received virtually none of the swag from the system. They had no alternatives. Daley didn't have to be nice to them. He knew they'd vote for him anyway, especially in the general election. Just another delightful aspect of democracy's bluntness as a tool for self-expression.

The other tragicomic part of the story is that it appears that Washington, once elected, didn't use the spoils system to disproportionately reward blacks, black neighborhoods, black contractors. Some of his followers, expecting more of a bonanza, saw this as "undemocratic" and the show essentially takes it as a given that the Irish mayor gives the Irish goodies, the Italian mayor gives the Italians goodies, etc. That's America but there's a double standard for blacks. And that Harold Washington conformed to that standard and simply treated blacks equally, which was a huge improvement over Daley.

I don't know if any of that is true, The tragicomic part is implicit and sometimes explicit thinking that municipal government is about the spoils rather than doing something that makes the city run well.

Clemens vindicated

The uproar this morning is that Roger Clemens, someone who everyone agrees is one of the best pitchers of all time, is a cheater, a steroids user going back to 1998. His reputation is ruined, he may not make the Hall of Fame, and according to Thomas Boswell, one of the deans of America's baseball scribes, he's like Pete Rose,  Barry Bonds or maybe even Shoeless Joe Jackson in that his name will never be the same:

Now, Roger Clemens joins Barry Bonds in baseball's version of hell. It's a slow burn that lasts a lifetime, then, after death, lingers as long as the game is played and tongues can wag. In baseball, a man's triumphs and his sins are immortal. The pursuit of one often leads to the other. And those misdeeds are seldom as dark as their endless punishment.

Shoeless Joe Jackson, an illiterate outfielder who hit like a demon in the 1919 World Series, but neglected to blow the whistle on his crooked teammates, died with his good name as black as their Sox. Pete Rose, who bet on his team, but never against it, finally confessed. It could be good for his soul, and buys him dinner at my house any night, but may never get him into Cooperstown. Now, they have company: two giants of our time, just as humbled, though no less tarnished.

Why does no one seem to understand that if many and maybe most of the batters are taking steroids, a pitcher who takes steroids is leveling the playing field, not getting an unfair advantage?

BTW, I'm a Red Sox fan. Clemens left the Red Sox in 1997 saying he wanted to be closer to his family in Texas, then signed with the Toronto Blue Jays, a team not known for its proximity to the Lone Star state. Red Sox fans have always resented his exit, particularly given what followed. He proceeded to have what was arguably his best single season as a pitcher, throwing 264 innings and posting an ERA of 2.05 when the league ERA was 4.53, An astounding steroids-free performance.

Halfway through the 1998 season, when we know that a lot of batters started using steroids, Clemens, according the Mitchell Report released yesterday, started using steroids as well. He pitched extremely well in 1998, but nothing close to his 1997 performance.

Clemens's steroid use in 1998 tarnishes his reputation? How exactly? To suggest that his failure to blow the whistle on teammates or fellow players outside his team is to misunderstand the culture of athletes. And to compare him to Shoeless Joe Jackson for not blowing the whistle is a repugnant comparison. Boswell conveniently fails to mention that Jackson (who I do sympathize with, given his on-field performance in that 1919 World Series) took money under the expectation that he would deliberately play poorly. His failure had nothing to do with whistle-blowing.

Yesterday's report shouldn't tarnish Clemens or his teammate Andy Pettitte, or the other 80 or so names mentioned. The report relied on FOUR sources, a clubhouse guy for the Blue Jays, a clubhouse guy for the Mets, the Balco investigation and various news stories that have found evidence of steroid use. The number of sources wasn't low because they were the main sources. The number was low because virtually no one wanted to talk to Mitchell. The sources he used were already under investigation. That means that we are only seeing the tip of the iceberg.

What we now know is that steroid use was widespread, extremely widespread, in major league baseball beginning in 1998. The effects of steroids and HGH (which was also widely used) on performance are unclear. Yes, great players took steroids to get an edge. But so did mediocre players. It didn't make them great either because everyone was taking them or because the extra impact on performance was small.

When everyone cheats, it's not cheating any more.

You can judge a man morally for having so much competitive fire that he flaunts the rules and endangers his health. I think that's particularly strange when the rules are not enforced as they were not in 1998.

But even so, what yesterday's report makes clear to me is that you can't judge a man's reputation as a baseball player because he used something that so many other people were using in search of an edge. For me, the "scandal" of steroid use is now a smaller story, even though it is all over today's front pages.

Roger, you'll never be as good as Pedro, but you belong in the Hall of Fame. I wish I could vote. And of course, in some sense, I can. I believe that in 20 years, the consensus among fans will be that Roger Clemens was one of the greatest pitchers of all time, without an asterisk. And Barry Bonds and Mark McGwire will join the same true pantheon of greatness even if they never get to Cooperstown.

Storms are more like Super Bowl Sunday and less like Valentine's Day

One more way the world is getting better (the Oregonian reports):

Northwest employees of two big-box chains received e-mail alerting them of a storm barreling toward their stores a full four days before 100-mph winds whacked the Oregon coast and murky floodwaters blocked Interstate 5 last week.

Behind a computer in Bentonville, Ark., Lucas McDonald, meteorologist for Wal-Mart Stores Inc., tracked the weather and notified colleagues that Oregon and Washington stores could lose power and the retailer should consider alternative truck routes.

McDonald's counterpart at Home Depot Inc. -- Jim Schortal, the retailer's director of crisis management -- coordinated more than a dozen recovery workers, from hazardous-material cleanup crews to structural safety assessors, to Portland. From his Atlanta office, he also summoned trucks as far as Nebraska and Texas to hightail it west with extra batteries, flashlights, heaters and generators.

How cool is that? The earlier and more accurate storm forecasting becomes, the lower the cost of carrying more inventory and moving new supplies to the customer. That means prices won't rise as much or at all in response to a catastrophic storm.

Prices for lumber and milk and flashlights and generators often rise after a hurricane because of the sudden and unexpected increase in demand. During "normal" times, stores use inventories to keep the shelves stocked rather than using fluctuating prices as a way of coping with the inevitable variation in demand on any particular day in a particular store. The result is that stores have stuff waiting for us and the prices don't go up and down. Both availability and the price is pretty predictable. The average price is higher than it otherwise would be in a perfectly predictable world. The store bears a cost for carrying inventory. It's worth it, though, to the consumer, who apparently is willing to pay a premium rather than find the store doesn't have the good.

A hurricane that's predicted well in advance is like Super Bowl Sunday. On Super Bowl Sunday, demand for beer and pizza are probably close to their annual peak. But the price of beer or pizza isn't higher on Super Bowl Sunday. That's because Super Bowl Sunday is predictable. Groceries and pizzerias know it's coming and they stock up. And because beer (and pizza dough) can be stored pretty well, the cost of having too much on hand isn't very high relative to the cost of not having enough and sending an unhappy customer to a competitor. This also explains why roses on Valentine's Day are more expensive even though florists get a lot of advance notice that February 14th is coming.

A hurricane that's a surprise (and that just means it's too costly to get the extra inventory there quickly) will lead to shortages or higher prices. An unpredictable storm is like Valentine's Day--prices rise unless anti-gouging laws or social norms keep prices fixed. Then you get empty shelves.

As we get better at predicting storms, their impact on prices becomes more like Super Bowl Sunday and less like Valentine's Day.

(HT to Division of Labor via Spencer at Angry Bear. Note to Spencer--we here at the Cafe have more imagination than you seem to imagine.)

Rating Postal Rates

One of my students at George Mason University recently asked about my thoughts on the U.S. Postal Service's government-granted monopoly on the delivery of first-class mail.  I told him that I see no justification for that monopoly privilege -- that, if I could, I would eliminate it immediately.

"But postal rates aren't outrageous," he challenged (in good and appropriately skeptical spirit, I add).  "Wouldn't a true monopoly charge much higher rates?"

This question recalled to mind the very first letter that I published in the New York Times, back in 1994.  (It is co-authored with my good friend, the University of Georgia's George Selgin.)

It has been suggested that, because the nominal price of first-class postage is about where it was in the late 18th century, Americans who complain about the proposal to increase postal rates are merely whining wimps who are lacking in historical perspective.

However, the real price of transportation (a key input in postal service) has plummeted over the last 200 years. In 1799 it took 53 days for an Army courier to travel from Detroit to Pittsburgh.

Today the same trip can conveniently be made in minutes. Likewise, the productive efficiency of the United States is vastly greater now than it was even a few decades ago.

Given the plunge in transportation costs, joined with other technological improvements and a large increase in the scale of postal activity, the price of postage should have fallen dramatically.

Americans do not oppose postal-rate increases because of their ignorance of history. 

Rather, opposition to these increases grows from the correct perception that a legally protected monopolist such as the United States Postal Service can keep prices higher, and service inferior, to what these would be under competition.

Regardless of how today's postal rates compare with rates in the past, opening the delivery of first-class mail to competition would lower rates still further while improving service.

DONALD J. BOUDREAUX
G. A. SELGIN
Clemson, S.C., March 24, 1994

The writers are, respectively, an associate professor of legal studies at Clemson University and an assistant professor of economics at the University of Georgia, Athens.

Frank Talk on Status

In response to this review by Daniel Gross of Robert Frank's latest book, I sent the following letter to the New York Times Book Review:

Reviewer Daniel Gross should have asked harder questions about Robert Frank's argument that higher taxes on "the rich" will moderate individuals' quest for status ("Thy Neighbor's Stash," August 5). Monetary wealth and the material goodies it buys are hardly the only source of status.  Consider, for example, Prof. Frank's faculty position at Cornell University.  He earned this position in large part through his hard work.  By his own thesis, then, he inadvertently caused other scholars to work unnecessarily hard in their quest to win high status Ivy-League appointments -- a quest that for the vast majority of us futile.

Higher taxes on the rich will do nothing to create more Ivy League faculty positions, more mansions with stunning views of the Pacific ocean, a greater number of the world's most beautiful women or most eligible bachelors, or most of the other things that confer and signal high status for those who possess them. Frankly, it is naive to suppose that muting competition in markets will mute humans' competition for status.

Indeed, given that humans are quite status-conscious, a social system in which we seek status chiefly through earning money provides what is likely the best available outlet for this proclivity -- namely, competition within private-property-based markets.  Not only does it result in new and greater quantities of goods and services for others, but it sure beats the hell out of violence and even politicking as a means of challenging others for status.

My Brand of Economics

How best to protect consumers from unreliable or even unsafe products?  Contrary to the dogma espoused by many people who fancy themselves "progressive," brand names are among consumers' best friends -- as explained in this excellent op-ed, appearing in yesterday's Chicago Tribune, by Edward Snyder, Dean of the University of Chicago Graduate School of Business.

Note that few Chinese producers yet have established brand names in the west.  That's a problem -- but it's a problem best solved, as Snyder argues, by letting the market deal with it.

Here are the final few paragraphs of Snyder's op-ed.

Those who advocate regulation by the West as the solution might be smoking unregulated substances. Aside from the obvious point that we have plenty of inspections and regulations of our own to worry about, the opportunity for Western manufacturers and anti-globalization interests to lobby against particular Chinese imports would be irresistible. They would use the new bureaucracy to reduce the general flow of Chinese goods. That would forward their objectives, but the results would be bad overall policy.

Waiting for the market to fix Chinese product quality -- doing nothing -- sounds like an unattractive solution. But the market is already reacting.

Consumers are thinking twice about buying no-name Chinese products with long lists of ingredients. U.S. distributors are checking their sources. Retailers, especially those who stock a lot of Chinese goods, are becoming a lot more concerned about their reputations. And Chinese firms and their partners are investing in brands.

How does all this happen? Firm by firm, case by case and step by step. You might recall the recent case of the 1.5million Thomas & Friends toy rail cars and accessories with lead paint. Fair or not, Thomas & Friends has lost quite a chunk of its brand-name capital, and its very survival is in question. No doubt Thomas & Friends has some new protocols.

How long will it take for the market to respond? Pretty much the same amount of time it takes other branded toy manufacturers to check and recheck for lead paint on their products.

Here's another Key Fact: Mattel, which produces Barbie dolls and characters from Sesame Street and Nickelodeon, this month stopped about 700,000 toys with lead paint from reaching U.S. consumers and recalled 300,000 additional toys sold through retailers such as Target, Toys "R" Us and Wal-Mart.

So how long will it take for the market to respond? Less time than it would  take for new regulations to take effect.

(HT John DeVries)

Cartoons, Capital, and Competition

Here's my latest column in the Pittsburgh Tribune-Review.  In it, I draw an economic lesson from The New Yorker's weekly cartoon-captioning contest, in which people are invited to submit captions to accompany uncaptioned cartoons.  My vanity compels me to quote at length from the heart of the article.

Think of each uncaptioned cartoon as a capital good. It has the potential to create value (in this case, to make readers laugh). By itself, though, this capital good produces almost no value; without a caption, each cartoon is virtually worthless. The cartoon becomes valuable -- it contributes to human satisfaction -- only when a clever caption is added to it.

Suppose for a moment that The New Yorker allowed only residents of Manhattan to submit captions. No doubt many submitted captions, when added to the cartoons, would produce the intended humorous result. But editors of the magazine could not be certain that the best possible caption was submitted.

What if, for a particular cartoon, someone living in Brooklyn had an even better idea for a caption? By prohibiting non-Manhattanites from contributing their caption ideas to the cartoons, the caption that would have been submitted by the person in Brooklyn -- the caption idea that would have added to the cartoon even more value than is added by the best caption from Manhattan -- never is added. Thus, the cartoon -- this particular capital good -- fails to produce as much value as it would have produced had Brooklynites been among those who were permitted to submit captions.

Sadly, though, no one ever learns this fact. The winning caption submitted from Manhattan might be judged by everyone to be excellent. But because the even better caption from Brooklyn never materializes, no one ever discovers just how funny that cartoon could be.

If the goal is to ensure maximum value of this particular capital good (a weekly uncaptioned cartoon), clearly it is advisable to have larger, rather than smaller, numbers of people able to try their minds at devising clever captions. With everyone in the world free to contribute captions, each cartoon is joined with cleverer and more creative captions than would be the case if only Manhattanites -- or only residents of New York state, or even only Americans -- were allowed to submit captions.

The very same process is true of factories and machines and workers. It might be that the entrepreneur with the best idea for how to use a particular factory and its machines and workers to produce maximum value is an American. But fewer than 5 percent of the world's people live in America. So it is inevitable that the best and most creative ideas for how to use particular assets that are located in America will often be possessed by non-Americans.

Leamer on outsourcing and competition

In the latest EconTalk episode, I talk with Ed Leamer about outsourcing, globalization and a host of related issues. One issue that comes up is the nature of competition when goods are heterogeneous. Ed argues that in such cases, supply and demand is the wrong way to look at such products. There isn't going to be a single price and deviations from "the" price will be tolerated because of the uniqueness of each transaction. We spar over it a bit. Here's my attempt to make the case for markets even when every transaction is unique. Graduate students in economics will want to look at Rosen's work on hedonics.

EDIT: When I said "make the case for markets" above, I meant "make the case for using supply and demand to understand pricing" and to treat such markets as competitive even though each transaction is unique. Leamer implies, if I understood him correctly in the podcast, that heterogeneity and long-term relationships mean that prices aren't determined by competition and supply and demand in such situations.

The Power of Competition

In a number of recent posts, there have been comments questioning whether "the market will solve all problems," or whether competition works as advertised. In my post on the myth of clutch hitting, K. Williams wrote:

All these baseball people, who spend all of their lives presumably thinking about the game and about ways to improve their own performance and the performance of their players and (if they're in management) about what creates real value on the field, and they all have an essentially false view of something as fundamental as clutch hitting.

Why is it, again, that we're supposed to believe that competition ensures that people will make optimal decisions?

A similar complaint has been made about the insights of Billy Beane, the GM of the Oakland A's who discovered that players who walk a lot, all other things held equal, are undervalued in the market for baseball talent. How could this insight go undiscovered for so long? Why do some teams still ignore on-base percentage?

My claim is that baseball, while competitive (in the everyday sense of the word), is not a very good testing ground for the power of competition as economists use the term. It's not a very good measure of how competition works in markets even though there is a "market" for baseball players in the everyday sense of the word.

The biggest problem with generalizing from baseball to the rest of the economy is that if you do a lousy job in baseball, you still make a lot of money. That is hard to do in most markets. In most markets, if you fail to keep up with your competitors, if you use outdated technology, if you fail to please the customer, you don't just make less money than your competitors. You go out of business.

In baseball, you can have an inept owner who hires an inept general manager, who signs inept players (or who doesn't  bother signing ept ones), who fails to spend sufficient money on the fundamental assets necessary to excel, who signs players who do the little things and the big things badly, who neglects the team's farm system. You can perform poorly, year after year and you can not only survive, you can thrive.

Since 1998, the Kansas City Royals have been horrible. They have won more games than they've lost only once in that span. The other years, they've been dreadful. They've lost 100 games or more four times since 1998. Yet according to Forbes, the value of the franchise doubled between 1998 and 2005.

Even though the Royals are terrible, the Yankees can't drop them from their schedule. Despite fielding a mediocre team, when the Yankees or the Red Sox come to town, the Royals draw a nice crowd. Even though the Royals are terrible, the owner keeps the team. Can a different owner buy him out the way he would if another asset weren't used to its full potential? It's possible but it's not easy. There are only 30 baseball teams. If an owner sells he can't just buy another one. So the non-monetary thrills of owning a team can't be easily replaced. As long as an owner gets sufficient non-monetary thrills from being an owner, he will rationally turn down lucrative offers.

The other owners would prefer a more profitable franchise in Kansas City, but not too profitable. They would prefer better attendance when the Royals come to their parks but they are happy that the Royals are not a threat to win the pennant. So there is little incentive for the other owners to force out the owner in Kansas City for performing so badly. The owners almost never force out a mediocre owner who doesn't try very hard. Having a few of those is tolerable.

So while baseball has competition in the sense that teams play each other and keep score and while baseball keeps precise measures of relative performance (called the standings), baseball is not competitive in the traditional economic sense. There is no free entry or exit. Excellence is rewarded (as long as it is relative excellence) but mediocrity is not punished.

In such a world, it is not surprising that the best strategic ideas can take a while to be adopted by baseball teams. It is not surprising that racism can persist for years in the explicit form of a color line and it is not surprising that even after Jackie Robinson, teams can be slow to sign African-Americans.

In the competitive world of sports, you can indulge your preferences for hiring a pleasant fellow as a general manager rather than a smart one. You can indulge your preference for hiring someone with your skin color. And you can indulge your preference for hiring someone who is not much of a risk-taker. In fact, a risk-taker is a bit scary.

After a while, if enough of the other teams start signing African-Americans or using better decision-making heuristics or starting a baseball academy in the Dominican Republic, the costs of your inadequate strategies might get so costly that you join the new ways of doing things.

But I don't think you want to argue that because baseball teams forgo profit by using crummy heuristics for what makes a good player or a good team or a successful strategy, that markets don't work very well.

Contrast the market for baseball players or baseball strategies with the market for restaurants. Consider the following insight from a former student of mine, Steve Daley. Every town in America over a certain size (50,000, maybe) has a Chinese restaurant. There's no Chinese Restaurant Czar to allocate Chinese talent to towns and cities all over America. The profit motive is sufficient. A town with more than 50,000 people but no Chinese restaurant is a forgone profit opportunity. Somehow, word gets around. And a town of 150,000 people with only one Chinese restaurant or attracts others. If a Chinese restaurant is badly run, it usually goes out of business and another one opens that does a better job. And in bigger cities, the standard for what is badly run is more demanding because there are even more competitors both in the Chinese niche but also outside of it, competing with the Chinese restaurants.

Finally, consider my local grocery store in a prosperous Maryland suburb outside of DC. I went in there the other day and the shelves in the soft drink section were half empty. It's not the first time I've noticed this. You're out of root beer I told the cashier. Oh, she replied, we can't do anything about that. They just show up when they show up, she explained. I suggested that she might want to tell the manager to ask them to show up more often. She shrugged.

There's are only two grocery stores in my neighborhood (both owned by Giant) and both are run poorly relative to other grocery stores in my experience. A failure of markets to serve customers? My guess is that it's a lot harder to open a new grocery in my neighborhood compared to other neighborhoods—a combination of various zoning regulations. 

Are Professional Sports Competitive?

Michael Lewis's Moneyball lays tells the story of how the Oakland A's became successful. Part of the answer is that they appreciated the value of an undervalued asset, the ability to get on base via walk.

In this EconTalk podcast, Skip and I talk about whether this story is true and if it is true, how such an insight about the value of walks could lay undiscovered (or at least underutilized) for so long. One interesting part of the conversation is about just how competitive or uncompetitive the baseball industry is. It appears very competitive. Winners and losers are observable. Unsuccessful managers and general managers are fired all the time. Yet I argue that the costs of failure are very small. Mediocre franchises can be highly profitable because of the inherent monopoly power an owner has in the local market. Even worse, it is very hard to buy out a mediocre owner because the replacement must be approved by the other owners whose incentives in this situation are rather mixed.

The next Econtalk will be Monday with Clint Bolick talking about the virtues of judicial activism.

Phelps wins Nobel

Edmund Phelps has won the 2006 Nobel Prize in economics.

Who Can I Blame?

I've been out of town with limited computer access. Many thanks to Don for his active fingers and active mind.  One of my travels took me to Boston and Cambridge. To my disappointment, one of my favorite stores in Cambridge had closed after years of delightful shopping. Gone, I asked an employee of a nearby store? Yes, he said, gone. Who can I blame for this loss? So I composed the following haiku, no doubt influenced by the miasmas of the Boston area:

On Creative Destruction

My favorite store closed
Must be Wal-Mart's fault or due
To global warming

One of the virtues of this construction is its versatility. The first line could be any five syllable complaint: My knee is aching or Red Sox lose again or My basement's leaking or Wish I had more hair.

Can you feel the consolation?

The New Yorker and the Beatles

Each week, the final page of the New Yorker is devoted to that magazine's "Cartoon Caption Contest."  The contest is this: a single-frame cartoon is presented with no caption.  Readers are invited to submit their own captions.

In the next-week's issue, that cartoon appears again, but beneath it are three "finalists" captions -- the captions that the editors choose as being the three best submitted for that cartoon.

Readers are then invited to vote (online, of course) on which of the three captions is the best.  Then, two weeks after the uncaptioned cartoon first appeared in the magazine, it appears for a third time -- this third time featuring the winning caption.

The first thing that struck me about this "caption contest" is the difficulty I have trying to think up clever captions.  With rare exceptions, each new uncaptioned cartoon is one that sparks in me no clever ideas.  I try and try, but almost always come up empty-minded.

So when each cartoon appears for its second time, with the three "finalists" captions printed beneath it, I'm consistently and considerably impressed by how imaginative, witty, and clever people are.

I'm looking now at the March 13th issue of the New Yorker.  This week's uncaptioned cartoon shows a 60-ish couple walking into a  church filled with a well-stocked bar and two unshaven bar bums gazing disinterestedly at this couple's entrance.  The man entering the church has his wife on one arm, a bible in the other, and his mouth is open, saying something.

But what's he saying?  I'll be darned if I can think of a clever caption to put in his mouth.

Now I look just above this cartoon to the one first printed in last-week's issue.  Each of the three "finalists" captions that accompany last-week's cartoon are very, very good -- indeed, one is rip-roaringly funny.

One of these "finalists" captions was submitted by a Mr. Mako from Connecticut; another by a Mr. Cassidy from California; and the third by a Mr. Flores from Florida.

Now suppose the New Yorker starts a policy of not accepting captions submitted by anyone living west of the Mississippi.  What would happen to the quality of the captions?  It would fall.  Mr. Cassidy's caption wouldn't have been considered simply because he lives in Los Angeles.

But even if this week's three best "finalists" captions were all submitted by people living east of the Mississippi, the quality of the captions will inevitably fall over time -- perhaps not next week or even two weeks from now.  It's quite possible that the best captions during the next few weeks all will be submitted by people living east of the Mississippi.

But how will we know?  With Californians, Minnesotans, Texans and other westerners prevented from contributing their creative ideas to the cartoons -- prevented from competing with easterners in the Cartoon Caption Contest -- we can't possibly know that any caption that actually wins the magazine's contest in any week is truly the best that is humanly possible.

And so it is with investors and products.  By preventing certain people from investing in your country because they aren't citizens of your country, or by preventing certain people from selling goods and services in your country because they are produced by people who aren't citizens of your country, you diminish the size of the pool of creative ideas available to help you.

I'm reminded here of one of Paul McCartney's lines in his lyrics for the Beatles' song "We Can Work It Out":

Think of what you're saying.  You can get it wrong and still you think that it's alright.

Think of what I'm saying: creative human insights are the driving force of our prosperity.  By allowing xenophobia and protectionist rent-seekers to restrict the number of people who contribute their ideas to the market process, we inevitably reduce -- and perhaps even reverse -- the rate of economic growth. Our prosperity will be lower and lower than it would otherwise be.

And this lower rate of economic growth and the correspondingly lower standard of living might well never be revealed by the data.

Monopoly

Did a piece for NPR's Morning Edition yesterday on the dangers of learning economics from the game of monopoly.  You can listen to it here.  Here is the text:

When our children got old enough, we'd play Monopoly, a game that was an important part of my childhood.  The vivid orange of Tennessee Avenue.  The royal blues of Boardwalk and Park Place.  The little man with the mustache being hauled off to jail.    And all that pastel colored money.

But if I play Monopoly now, it's only to teach my kids how badly its lessons prepare you for the real world.

In Monopoly, whoever has the most toys wins and winning means taking everything belonging to everyone else.

In Monopoly, landlords are parasites that eventually drive everyone into bankruptcy.  And bankruptcy is like death.  Game over.

Monopoly is the ultimate zero-sum game.  You profit only by taking from others.  The assets of its world are fixed in number.  Yes, you can build houses or hotels, but somehow, the greater the supply of places to live, the HIGHER the price, an absurd contradiction to real-world economic life.

In Monopoly, hotels never get a makeover and railroads, unlike Amtrak, are always profitable. 

In Monopoly, getting rich and succeeding in business only comes from exploiting unlucky suckers who randomly enter your life.  There's no role for hard work or creativity— figuring out what customers might want to buy that isn't being offered by a competitor.  There’s no competition. 

I know.   That’s why it’s called monopoly.  But only Marxists look at the world of capitalism the way the game of Monopoly does—as an unrelentingly gloomy system of exploitation where the rich eventually wear everyone else down.

Ironically, most of the new board games with more realistic economic lessons come, like Karl Marx, from Germany. 

In games like The Settlers of Catan players compete, but they also cooperate and trade in various ways.  One player’s economic success can end up benefitting fellow players.  Yes, there’s a random element to success but life has that too.  And in these new German-style board games as they’re sometimes called, strategy and skill matter more than the roll of the dice.

So leave Monopoly on the shelf and try the Settlers of Catan.  My wife usually wins when we play, but at least my kids learn about the value of trade and cooperation in creating wealth and success.

I have gotten a number of angry emails from people who believe that the real world really is a lot like monopoly.  Many people believe that the world is a zero-sum game and that the wealthy take money from the rest of us.  What is the appeal of this worldview?  Does it provide some form of consolation?  Paul Graham has some interesting thoughts on this issue here.

A hat-tip to Noah Yetter for telling me about the Settlers of Catan.  It really is a great game.

Wal-Mart's Benefits

This new NBER paper, by Jerry Hausman and Ephriam Leibtag, finds that big-box retailers such as Wal-Mart bring enormous benefits to consumers -- and especially to low-income consumers.  Here's the abstract:

Consumers often benefit from increased competition in differentiated product settings. In this paper we consider consumer benefits from increased competition in a differentiated product setting: the spread of non-traditional retail outlets. In this paper we estimate consumer benefits from supercenter entry and expansion into markets for food. We estimate a discrete choice model for household shopping choice of supercenters and traditional outlets for food. We have panel data for households so we can follow their shopping patterns over time and allow for a fixed effect in their shopping behavior. We find the benefits to be substantial, both in terms of food expenditure and in terms of overall consumer expenditure. Low income households benefit the most.

Who'd a'thunk it?

(Hat tip to Karol.)

A Note on Coupons

Here are a few interesting facts about coupons:

Last year, manufacturers placed 342 billion coupons in circulation. Of those, 3.2 billion (roughly one for every hundred printed) were redeemed with a total face value of more than $2.9 billion. That might sound like a lot, but it was actually less than what was redeemed the previous year. In fact, redemptions have been on at least a five-year slide. The reason? There are competing theories, from the rise of discounters such as Wal-Mart to the increasingly hurried lives of shoppers.

I suspect that both hypotheses have merit.  The rise of discounters such as Wal-Mart and Target and the increasingly intense competition among producers of consumer staples make the demands facing each manufacturer and each retailer more elastic.  Being more elastic, there’s less consumer surplus available to be captured as producer surplus by any one seller through price discrimination. Because coupons are likely a method of price discrimination, perhaps the payoff from issuing coupons falls as competition grows more intense.

This trend will be strengthened as people’s time becomes more and more valuable – that is, as the opportunity costs of their time rise. As the value to Ms. Jones of working out of the home rise – or as the value to her of spending quality time with her family rises – she’ll be less inclined to spend time clipping and keeping track of coupons.

Liberty Belle on Advertising

Bravo! to Clara at Liberty Belles for her pre-emptive exposure of what will surely be another instance of Bill Frist's hypocrisy.  (Precis: Senator Frist publicly questions the value of advertising of pharmaceutical products.  Candidate Frist will surely advertise his merits for the presidency of the executive branch of the U.S. government.)

Advertising is one of the most misunderstood (and, hence, easily ridiculed) features of market economies.  My favorite treatments of it are:

Robert B. Ekelund & David Saurman, Advertising and the Market Process (1988)

George Bittlingmayer, "Advertising".

Lee Benham, "The Effect of Advertising on the Price of Eyeglasses," Journal of Law & Economics, Vol. 15, October 1972, pp. 337-352.

Chapter 4 of Israel M. Kirzner, Competition and Entrepreneurship (1973).

The Status of Status

My case for ignoring income inequality brought several thoughtful rebuttals. The best of these focused on human beings’ undeniable desire for status.

The argument goes something like this: even if everyone has greater access to material goods and services, differences in people’s access to these goods and services still matters because each of us cares about his relative standing among others.

Suppose, for example, that in year one my real income is $50,000, same as Jones’s. In America today, this is no princely sum, but it’s more than enough to keep each of us far out of absolute poverty.

Now suppose that at the end of year two my real income has risen to $55,000 but Jones’s has shot up to $60,000. I’m worse off in a very real way – in a way that matters deeply to me. My subjective assessment of my situation at the end of year two might well be that I’m worse off than I was when Jones and I each earned an income of $50,000 (even though this amount is $5,000 less than I earn in year two).

The reason for my distress isn’t envy; it’s my lower status. In year one I was Jones’s equal; in year two, his status is higher than mine. I suffer. Most importantly for me as a male with a healthy sexual appetite, my chances of attracting desirable women to my bed are lower in year two than they were in year one.

What do all the leather-trimmed cars, vaulted foyer ceilings, and iPods matter if I can’t entice beautiful babes to sleep with me? What do I care if I can afford to eat more Chilean sea bass and drink finer wines if I’m looked upon by everyone other than my mother as a nondescript nobody?

Ultimatly, my relative status -- not my absolute level of income -- will determine my access to the acclaim of others and (most importantly) my access to young, attractive women.

I have no doubt that people care deeply about their status relative to others. And I have no doubt that higher relative income is one determinant and signal of higher status.

But why focus so obsessively on monetary income (or wealth) as the determinant of status?

Suppose a policy tool were available that would keep all sports and rock stars from earning incomes above that of the average factory worker. Would implementing this policy keep the social status of Shaquille O’Neal and Paul McCartney equal to that of the average factory worker?

My guess is that Shaq and Sir Paul would continue to enjoy more acclaim and access to beautiful babes – in general, more status – than would any factory worker who earns just as many $$$ as they do.

So, on one hand, if my guess is right, the status-based case for redistributive taxation to equalize incomes is weakened. The status problem isn't necessarily reduced just because post-tax $$$ are more equally distributed across the population.

On the other hand, though, if my guess is right, then one element of the case against redistributive taxation is weakened. To the extent that rewards from productive activity come in the form of higher status, then taking from the likes of Shaq, Paul McCartney, and Brad Pitt some, or even much, of the $$$ they earn in their high-status jobs would do less to dampen their incentives to do these jobs well than if their sole motivation were to consume as many goods and services as possible. (The economic and moral case against redistributive income taxation has other elements that are unaffected by correctness of my guess.)

Most generally, precisely because people do care so very deeply about status, it’s naive to suppose that eliminating income or wealth as a means of establishing or signaling higher status will equalize status. Competition for status will be diverted from income-getting efforts into other efforts.

Would these other non-income-earning efforts to secure high status be as productive to society as are efforts to secure high status by earning high incomes?

Reputation on eBay

My George Mason University colleague Dan Houser just wrote a very nice paper with the University of Arizona’s John Wooders showing that a seller on eBay can expect to fetch higher prices for his offerings the more positive is his reputation, especially as revealed in eBay’s user profiles. (The title of the paper is "Reputation in Auctions: Theory, and Evidence from eBay." I’ll try later today or tomorrow to provide a link to the paper.)

Having digested Dan Klein’s important volume Reputation, this result doesn’t surprise me. But it’s reassuring to see my priors confirmed by another high-quality, careful empirical study.

Giant Steps

The other day I blogged on how the Montgomery County Council voted to make it harder for Wegmans and Wal-Mart to compete with Giant Foods in the Maryland county just outside of Washington, DC.  The Washington Post reports on remarks to stock analysts by executives from Royal Ahold NV, the Dutch conglomerate that merged Giant with Stop & Shop stores:

The merger of Giant Food with its corporate sibling hurt employee morale at the Washington area's largest supermarket chain, the chief executive of the combined operation said Monday.

"We need to win our people back," Marc E. Smith said in a presentation here to stock analysts who cover Royal Ahold NV, the Dutch conglomerate that last year combined its 200-store Giant chain with Stop & Shop, a 348-store operation based in the Boston area.

Further on in the article, we learn of what might be an even bigger problem facing Giant in the DC area:

Discussing the merger, William J. Grize, the head of U.S. retail operations for Ahold, told the analysts the company is "not totally pleased with the results to date," adding, "We will make it better."

During his presentation, Smith said Giant and Stop & Shop must offer more competitive prices and renovate aging stores to compete against an influx of new food retailers in both the Washington and Boston regions.

Giant, in particular, he said, will require a major investment in store renovation and replacement. Smith said the average Giant stores is 8.7 years old, compared with an average age of 6.4 years for Stop & Shop's stores. "The Giant number calls out for a significant amount of investment over the next few years," Smith said.

No hurry on those renovations or bringing down prices, of course.  Without Wegmans or Wal-Mart breathing down their neck, Giant can take its time.

(Hat tip to Daniel Lurker)

Monopoly Power?

The Washington Post reports that nationwide newspaper readership is down:

The key chart is the second one.  Circulation has fallen from almost 80% of the adult population in 1970 to barely over 50% today.

Of course there are many reasons for this decline.  The most obvious one is the rise of alternative sources for news and information—cable television, free suburban papers and more recently the Internet.

But there is perhaps another reason, the complacency of the newspapers and the failure to understand the nature of their competition.  Since 1970, a lot of evening newspapers have folded leaving many cities with only a single newspaper.  I suspect the lone survivor of those newspaper wars saw itself as a monopolist.  After all, there was only one newspaper in town. Yet there was always plenty of competition from other media outlets.  Newspapers that act as if they are the only game in town are unlikely to thrive.

When I saw these data, I was reminded of a recent story in the Washington Post describing an internal meeting that was to focus on the decline in daily circulation at the Post, a 10% decline over the last two years.  But the meeting took an unexpected twist as the opening of the article reports:

Washington Post Executive Editor Leonard Downie Jr. met with hundreds of newsroom staffers yesterday to outline management's latest attempts to combat declining circulation. However, the more intense discussion at the meeting involved diversity at the newspaper, as several minority staff members lamented that a white man recently was chosen over a woman and a black man as the paper's new managing editor.

Further on in the article, we see that the Post does care something about diversity:

    

Downie told staffers that the paper has made strides to increase newsroom diversity in recent years, and said that of the paper's 30 to 40 top editors, "white males are in the minority." But he said the paper needs to hire more minorities and to improve its coverage of the area's increasingly diverse population.

Downie and Bennett will hold a meeting to address diversity issues early next month.

Diversity probably is a good thing, but maybe they ought to hold a meeting on how to improve the paper and sell more copies.  Otherwise, all those minority hires will have to find work elsewhere.

 

 

 

Four Cheers for Choice

My colleague and co-blogger Russ Roberts said much of what I would say about the notion that too much choice can be bad for you. Russ chose his arguments well.

But let me add just a bit more.

It's high time that clever people stop parading possibilities before the general public without first winnowing out the merely possible from those possibilities that are likely enough to matter. Almost anything is possible. In consequence, the proportion of All That’s Possible that is also likely enough to matter in reality is quite small.

Identifying mere possibilities is child’s play, especially for clever folk. It’s also dangerous for society. After all, when the array of identifiable possibilities is increased and displayed to the general public, how does the typical citizen know how to choose which of these possibilities are most likely and hence most relevant for policy-making purposes, and which are mere idle curiosities? Democratic choice made in the teeth of this overwhelmingly large number of choices of theories and policy options is sure to stupefy and mislead ordinary voters.

We have here -- in the argument of Steve Pearlstein that "choice is overrated" -- not only the seeds of a policy that would restrict consumer choice among goods and services, but also the seeds of an argument to restrict freedom of speech, freedom of religion, and freedom of the press.

Evil Choice

Steve Pearlstein in today's Washington Post thinks economists overestimate the power of choice.

Among economists, it is an axiom that choice is good and more choice is better. Giving buyers more choice means more -- and more intense -- competition, which lowers prices, raises quality and fosters innovation. In the end, workers are more productive, consumers are better off and the economy is bigger and more efficient.

It's a lovely theory, and one that is particularly attractive to conservatives, who use it to justify replacing government services -- Medicare, Social Security, public housing, public schools -- with market-based solutions.

Unfortunately, it turns out not to be true. Yes, up to a point, choice does enhance efficiency and consumer welfare. But at some point, there get to be so many options about what to buy or what career to go into or which mutual fund to invest in that many people make worse decisions than they would if they had fewer choices -- or simply put off making a decision at all. Even when people make what seems, objectively, to be the right choice, odds are they will be less happy about it as they second-guess themselves.

Pearlstein then discusses a new book by Barry Schwartz, a Swarthmore psychologist who finds that people are sometimes overwhelmed by a profusion of choices, choose foolishly and so on.

So choice is good, but only up to a point. I wonder where that point is.

Do we have too many newspapers? Too many bloggers? Too many internet sources of news? Too many columnists? Too many at the Washington Post? Too many TV channels? Radio stations? Candidates for President?

If people are overwhelmed by choice, how did Home Depot ever become successful carrying so many items? How does a Wal-Mart superstore manage to compete with 7-11?

Are we all lured and seduced into the virtues of choice by some great marketing scheme? Or is it possible that actually, we really do like choice? (I do, by the way. I even like it in ridiculous areas. I like that my foldable lawn chair can come with or without a drinkholder.)

This theme, that capitalism produces too many choices probably goes back to Marx. It was a common theme among my friends in the early 70's growing up in Lexington, Massachusetts. How many car brands do we really need, they would ask. How many brands of toothpaste? Toilet paper? The Soviet Union had a better system. They didn't waste all those resources with endless, wasteful permutations that were pure marketing slickness producing nothing. Yes, better to drive a Ladha than have to choose among all those brands.

As for those market-based choices that Pearlstein criticizes, if choice in say, education is such a foolish idea, why have so many different public schools, each neighborhood wastefully running its own school. Would it be more efficient to have a single school in each city? Would it be well run or would a little competition like we have now improve the quality? Would even more competition not prove even more beneficial?

And what about the Post Office. Should we ban FedEx and UPS? Isn't one deliverer enough? It sure would make life easier.

And as for private social security—if it's so unhealthy, maybe we should stop allowing people to make all those private choices from that vast array of mutual funds. It's so bewildering. Why not have all savings and investment done by the government. Would that simpler world be a better one?

I like choice. Give me more of it not less. As adults, I suspect most of us feel the same way.

Monopsony Power in Labor Markets?

Arnold Kling, with his usual deep insightfulness, addressed Alan Krueger’s August 19th New York Times column on labor markets. In that column, Krueger mentions Alan Manning’s 2003 book Monopsony in Motion.

Here’s a description of Manning’s book that I found on Amazon.com:

What happens if an employer cuts wages by one cent? Much of labor economics is built on the assumption that all the workers will quit immediately. Here, Alan Manning mounts a systematic challenge to the standard model of perfect competition. Monopsony in Motion stands apart by analyzing labor markets from the real-world perspective that employers have significant market (or monopsony) power over their workers. Arguing that this power derives from frictions in the labor market that make it time-consuming and costly for workers to change jobs, Manning re-examines much of labor economics based on this alternative and equally plausible assumption.

I’ve not read Manning’s book, but judging from Krueger’s comment on it, this description seems to be accurate.

Put aside the straw man of “perfect” labor markets. No serious economist believes that an employer who cuts the wages he pays by one cent will lose all of his employees – immediately or otherwise.

Without doubting that genuine monopsony power is harmful, I dispute the implication that the absence of textbook perfection in labor markets is evidence of such power.

I have some evidence that workers – even (especially?) low-skilled workers – are extraordinarily mobile: the fact that the United States government posts armed guards along its border to keep Mexicans from entering the U.S. to work tells me that workers are willing and able to move great distances, both physically and culturally, to find higher wages and better working conditions.

If humble Mexicans must be threatened with guns and prison to keep them from migrating from poorer jobs in Mexico to better jobs in the U.S., it seems incredible that workers legally within the U.S. are stuck for any length of time in jobs offered by employers with monopsony power.

You've Got Mail

On April 1 of this year, Google announced the beta version of a new email program, Gmail, that would give users 1 GB (1000MB) of storage. In return, users would allow Google to send them various automated ads related to content in the messages received. This created a storm of controversy over alleged privacy issues which ignored or deemed irrelevant that Gmail was a voluntary program. Some viewed Gmail as an April Fools hoax. One gigabyte of storage? At the time, Yahoo was offering 6 MB.

As far as I know, Gmail is still in beta, with access limited to invited guests. In the meanwhile, Yahoo has raised their limit to 100MB. Yahoo also no longer counts spam as part of your storage quota. For 19.99, Yahoo offers 2GB of storage.

I still don't know whether Gmail will really launch or how attractive it will be. But Yahoo must be worried about it. Competition is wonderful.

Competition and Oil

Here is a remarkable video, made in 1956 about the role that oil and competition play in producing prosperity. It's a short animated film funded by the American Petroleum Institute. Check it out. It comes from a remarkable archive of films you can find here. Enjoy. Thanks to Coudal Partners for the pointer.