Half Sigma

Value creation vs. value transference

There are (at least?) two ways that people can earn money:

(1) They can create value.

(2) They can transfer value created by other people to themselves.

Certain economist types, even though they acknowledge the existence of “rent seeking behavior,” seem oblivious to the fact that the majority of economic activity in the United States (if measured by dollars) is about value transference rather than value creation.

The most base type of value transferring activity is theft. For example, you reach into your wallet, and it’s not there. A pickpocket has stolen your wallet, transferring the money that was in there to himself.

The most blatant types of value transference activities are illegal. It’s considered illegal fraud when someone tries to sell you a share of the Brooklyn Bridge. But what about when Juicy Couture sells you a $5 t-shirt for $88? Surely this is an example of value transference, yet it’s perfectly legal, and not really so much different than the Brooklyn Bridge hypothetical.

The more money a person makes, the more likely it is that he’s involved in value transference and not value creation. This is because there is only so much value that a single human being is capable of creating. The salary paid to the best engineers or computer programmers, about $150,000/year, is probably close to the upper limit of how much value a person can create. It’s extremely unlikely that a person making more than $200,000/year is doing it purely through value creation.

You don’t have to be rich to earn your living through value transference. Both the welfare mother and the senior citizen living off of Social Security rely on value transference as their primary source of income. Being rich merely increases the likelihood that you’re a transferee rather than a creator.

Winner-take-all markets are an important mechanism of value transference. Take CEO pay for example. The nature of the system creates the opportunity for the person who is CEO to transfer a lot of value from the shareholders to himself. What would have happen if A, the CEO of Big Corporation who gets paid $10 million per year, died in a car accident? Well, shortly afterwards, someone else, B, would be given A’s CEO job, and B would get a huge increase in his income because of his good luck (which was A’s bad luck). Is B somehow magically able to create more value because he was promoted? No! It should be obvious that B’s ability to create value hasn’t changed, only his circumstances have changed.

Entrepreneurialism is often idolized as the ultimate in value creation, but actually it’s just another example of a winner-take-all market and value transference. If Bill Gates had died in a high school computer accident, would all his billions of dollars of wealth have never been created? This is highly unlikely. Other people would have stepped into his shoes and the same stuff would have been created. (There are many who think that better software would have been created in his absence.)

Our economy is a big pyramid in which the majority of people on the bottom create value (but take home less money than the value they created because some of it is transferred away from them), while the small number of people at the top are very rich because of the value they transferred from the people at the bottom of the pyramid to themselves.

Value transference doesn’t lead to long-term economic growth, but it can create the illusion of short-term economic growth based on the way that the economy is measured. Suppose that B transfers X value from A to himself. Then C transfers X value from B. Then D transfers X value from C. Then finally A transfers X value from D. In reality, there has been no value creation, the value has just moved around in a circle. But economists, who assume that all income is legitimate, will say that there has been 4X of income added to the economy.

Investment banking vs. stucco

On the front page of yesterday's Wall Street Journal, there is an article about how a once successful black entrepreneur saw his stucco business ruined because of competition from Mexican immigrants.

It seems to me more a tale of business strategy and microeconomics than it does about immigration.

Skill-biased technical change

Economist David Card talks about skill-biased technical change (among other things, link courtesy of Marginal Revolution).

The theory some have is that the reason for growing wage inequality is that the market is rewarding those with more skill. David Card says it's more complicated than that, and to that I have to say, "duh! of course it's more complicated than that." This David Card fellow seems brighter than your average economist.

One thing we pointed out, for example, is that women are lower skilled than men, if you take the fact that they have lower wages as evidence of their skill. The SBTC theory says that people with lower skills should have slower wage growth than people with higher skills. But over the 1980s, women did much better than men. It's also the case that over the 1990s, women's relative wages were fairly stable again. So there was a long period of stability of women's relative wages, then a period of convergence of women relative to men that ended in 1991-92, and then stability again. That's an important set of trends that SBTC doesn't address. SBTC might be consistent with it; it might not be, but the theory needs a lot of auxiliary hypotheses to work.

Obviously the change had to do with women choosing to acquire more valuable skills because society encouraged women in this direction during the 1970s and 1980s. However, many women still choose to acquire less valuable skills because they place less value on money. Furthermore, in fields dominated by women, the average salary is depressed because women place less value on earning money thereby depressing the collective bargaining power of all the workers in that field.

Another trend that didn't fit with the SBTC hypothesis concerns the relative wages of people with different bachelor's degrees. There are a couple of different data sets that collect starting salaries for newly minted B.A.s. What these data show is quite remarkable. Everyone knows that the average wage of young college graduates went up over the 1980s. It wasn't the case, however, that the gains were most pronounced in engineering or science. They were actually greater for graduates in the humanities, which doesn't seem consistent with the idea that there is increasing demand for technically proficient, computer-savvy people.

Now there's something I never knew before! Maybe, because of a combination of H1-B visa technical workers and outsourcing of labor to foreign countries, wages for technical workers are being depressed. Humanities graduates are probably working in marketing related functions, and this lends evidence to my long held contention that the United States is moving towards a marketing economy.

This doesn't mean that the average engineering or computer science graduate doesn't still earn more than the average humanities graduate, just that the gap has been declining.

The Upside Down Laffer Curve and the natural price of labor

I previously blogged about how there is a natural price of unskilled labor, which is the amount of money it costs to sustain the laborer and allow him to reproduce and raise children thus maintaining the labor pool. (This is also known as the Iron Law of Wages.)

It therefore follows that when the government gives out benefits to poor people, this means they require less additional money to sustain themselves, so as a result of government benefits wages will decrease.

But I also blogged about the idea of an inheritance dividend in which every adult citizen is given an equal share of government profits such that everyone would be able to sustain themselves without having to work at all. The inheritance dividend would lower that natural price of labor to zero. Does it follow that wages would be reduced to zero? This wouldn’t happen because no one would work for free. Most people assume that the inheritance dividend would raise wages because higher wages would be required to lure people away from enjoying life without work.

I therefore conclude that there is an Upside Down Laffer Curve for labor:

When government benefits increase, wages decline because this lowers the natural price of labor. However, there comes a point where wages reach their minimum level and after that point additional government benefits cause wages to rise because workers don’t see the point of working for such low wages when they’re getting such good benefits.

Examples of benefits on the right side of the Upside Down Laffer Curve are Aid to Families with Dependent Children and Unemployment Insurance. These benefits are so good that people can live off them. If the goal is to encourage people to work and contribute to the economy, than these premium-level benefits provide bad incentives.

On the other hand, benefits to the working poor such as Earned Income Tax Credits and Medicaid are on the left side of the Upside Down Laffer Curve. Government benefits for the working poor are bad policy because they lower the natural price of labor and cause lower wages. The end result is a taxpayer subsidy to employers. This distorts the free market by encouraging an economically inefficient over-reliance on unskilled labor.

The "Iron Law of Wages" and Walmart

DAVID RICARDO AND THE NATURAL PRICE OF LABOR

It seems that I have independently come upon a theory of labor that David Ricardo observed nearly 200 years ago. (See the following article at a Fordham University website: David Ricardo: The Iron Law of Wages, 1817.)

David Ricardo wrote the following about the natural price of labor:

The power of the labourer to support himself, and the family which may be necessary to keep up the number of labourers, does not depend on the quantity of money which he may receive for wages, but on the quantity of food, necessaries, and conveniences become essential to him from habit, which that money will purchase. The natural price of labour, therefore, depends on the price of the food, necessaries, and conveniences required for the support of the labourer and his family. With a rise in the price of food and necessaries, the natural price of labour will rise; with the fall in their price. the natural price of labour will fall.

I'm not sure why it was later named the "Iron Law of Wages." It is probably a double entendre, referring to the fact that it's a hard and fast rule, as well as to the basic point that labor is priced like a commodity, and iron was the most important commodity in the 1800s. In contrast, I compared labor to crude oil which is a commodity that's more important today than iron.

David Ricardo's theory is more subtle than how socialists and communists later came to explain it. It also seems to accurately describe how unskilled labor is priced even today. Can anyone claim that the wages paid by Walmart are anything more than subsistence?

The majority of Americans do earn more than the subsistence wage, and this is because America is a middle class economy in which most workers have some level of skills which differentiate them from unskilled labor. I will leave it to a later blog post to explain the mechanism by which skills translate into higher than subsistence level wages.

WALMART AND THE NATURAL PRICE OF LABOR

Brandon Berg from the blog Catallarchy brought to my attention his recent post on Walmart and the Iron Law of Benefits.

Opponents of Walmart with an intuitive although not complete understanding of the natural price of labor have correctly identified the fact that the government subsidizes Walmart's low wages through Medicaid. Were it not for Medicaid, Walmart and other employers of unskilled labor would need to pay higher wages in order to provide basic subsistence to their employees.

Now Brandon Berg disagrees. He writes, "I don’t see any reason to suppose that cost of living is a factor in determining wages. The price of labor is determined just like any other good." But Brandon, that's exactly the point of the Iron Law of Wages. The price of unskilled labor is determined like the price of commodity goods such as iron or crude oil!

If the government gave a subsidy to farmers because it was felt that they weren't making enough money, this would have the effect of making farming a more profitable enterprise, so more farmers would enter the market and existing famers would increase output, thereby raising the supply and lowering the market price until farmers are once again earning the same low profits they were before the subsidy.

Meanwhile, a restaurant in Manhattan can charge $50 for a meal using ingredients that the farmers sold for one or two dollars. The restaurant has managed to differentiate the produce in a way which makes it many times more valuable than its original state as a fungible commodity. Yet another demonstration of how the U.S. is a marketing economy.

UPDATE

Read my post on the Upside Down Laffer Curve and the natural price of labor.

Why do prostitutes make so much money?

Via Marginal Revolution comes a link to an analysis of prostitution by mathematics author John Allen Paulos. Paulos asks why prostitutes make so much money. He comes up with a ridiculously complicated answer involving the benefits women get from being married versus how engaging in prostitution hurts a woman's chances of finding a husband. His policy recommendation is to reduce prostitution by increasing salaries for both men and women. Huh?

Paulos needs to bring his head of the clouds and apply basic economics to the problem.

The earnings from prostitution is determined by supply and demand, just like everything else. Because demand for prostitution services is high relative to supply, prostitutes make pretty good money.

Why is supply so low? It ought to be pretty easy to think of reasons for why there aren't more prostitutes.

(1) The stigma of the profession--and this is really a big one.

(2) Risk of catching disease.

(3) Risk of violence by customers.

(4) Risk of violence by pimps.

(5) Risk of going to prison. (In the same manner, the risk of going to prison for selling cocaine keeps the price of cocaine much higher than it otherwise would be.)

(6) Prostitutes prefer leisure over money so they service far fewer customers than they might be able to.

(7) Prostitutes might not make as much money as you think because pimps take most of it from them. (Similarly, Steven Levitt, the author of Freakonomics, researched drug dealers and discovered they make approximately minimum wage because their bosses take most of the profits.)

(8) Barriers to entry. I'm not sure what they are exactly, but I'm willing to entertain the notion that there are hidden barriers to entry I don't know about.

Ethical gold?

I've been investing in gold for years, but I've never heard of ethical gold until reading about it in the NY Times. Ethical gold is either recycled or mined "responsibly."

These changes are partly coming about, people in and out of the jewelry industry say, because gold mining's environmental and social impacts have become impossible to ignore, especially in developing countries where political protests, corruption and displacement of indigenous peoples have often accompanied mining.

People who think they are helping the environment by buying ethical gold do not comprehend basic economics. Buying gold from any source increases demand and thus increases the price of gold, and higher gold prices encourage more mining operations.

Furthermore, I dispute the assertion that gold mining hurts developing countries; just the opposite, it pumps money into countries in Africa that have few other exportable products.

Message to liberals: you do not help the planet by wasting money on overpriced luxury items. If people really feel bad about their gold purchases harming the environment, they should fix the problem buy not buying gold. Better yet, they can take the money they saved and donate it to charity.

The winner-takes-all economy

I was going to write my own original piece about the winner-takes-all economy, but first I did a Google serach and came up with a Prospect Magazine article which does an excellent job explaining winner-takes-all markets and why they are more prevalent in the modern society.

The acting market is a great example of a winner-takes-all market:

Take the film industry. At any time there are only a few actors who can command millions of dollars to appear in a new film; only a few who are household names across the western world. The second rank comes far behind them in earning power, and behind them trail the resting members of the profession, scraping by on waitressing and the odd commercial. The range of income is extreme; distribution is an extraordinary pyramid with a tiny tip and a wide bottom.

The phenomenon applies to more ordinary professions as well. The ultra-libertarian Russell Roberts recently blogged about real-estate agents, and he missed the opportunity to point out that real estate sales is a winner-takes-all market. The median real estate agent income is pretty low. According to a NY Times article, "From 2002 to 2004, during one of the hottest real-estate markets in American history, the median income for Realtors actually fell — to $49,300 from $52,200."

The article then explains how real estate sales, like other sales professions, is winner-takes-all:

As in most sales professions, whether the product is diamond rings or crack cocaine, the people at the top of the pyramid make an awful lot more money than those down below. It's just that the base of the real-estate agent pyramid grows significantly during a boom."

Top real estate agents are surely making several hundreds of thousands of dollars per year.

This goes hand in hand with my previous blog post about the marketing economy. Sales is a marketing activity, and the growth of the marketing economy coincides with the growth of the winner-takes-all economy.

Krugman, education, and oligarchy

Here is a free link to the latest Paul Krugman column entitled "Graduates vs. oligarchs."

I think that Paul Krugman's point is that we are being fed a lie about the new economy. We are told that wealth gap between rich and poor is an education gap. And if only everyone went to college, then everyone would be in the top 10% of income and there'd be no more gap.

But Krugman points out that it's only the people at the very top who have had their incomes rise: "income at the 99th percentile rose 87 percent; income at the 99.9th percentile rose 181 percent; and income at the 99.99th percentile rose 497 percent. No, that's not a misprint."

Nearly all the people (except for Bill Gates) in the top 1% have college degrees, so this creates the artificial correlation between having a college degree and having higher income. But the implication is that for regular people with college degrees, their income has actually gone down. Krugman writes, "The 2006 Economic Report of the President tells us that the real earnings of college graduates actually fell more than 5 percent between 2000 and 2004."

This doesn't even account for the student loan factor. If college graduate income is falling while student loan debt rising, college graduates are far worse off than anyone realizes.

Krugman, as usual, doesn't give us an explanation for why these things are occuring. There is just the vague implication that if we only vote Bush out of office everything will get better.

But this is not true. The reason for the growing wealth disparity is because the value of labor relative to the value of capital is decreasing. This is because the pool of labor is increasing, due to high levels of immigration and outsourcing of labor to low wage countries.

Because the Democrats are even more pro-immigration than the Republicans, and the Democrats have little to say about the outsourcing issue, changing the political party in power isn't going to change anything.

Status is a negative-sum game

There is a fixed amount of status in any group, and the total amount is a function of the number of people in the group. One's status only rises at the expense of others. So money spent raising one's status is a classic example of negative sum rent seeking behavior. Society would be collectively better off if less money were spent on status seeking.

Yet Tyler Cowen of the blog Marginal Revolution doesn't quite get it. He creatively argues that status games are positive-sum because "status games encourage people to earn more income."

It sucks to be young

If my previous post about rising interest rates on student loans isn't bad enough, the WSJ also reports that "housing affordability" is at a 14 year low.

Why not at an all time low? Because affordability is affected by interest rates, so the low interest rates today make houses more affordable than they otherwise would be. But if interest rates rise and housing prices don't fall, houses will become even less affordable.

The same article reports that house ownership is at an all time high. Older people without student loan repayments own the homes, while young people with student loans are faced with unaffordable houses, as well as ever rising FICA taxes which represent yet another transfer of money from the young generation to the old generation.

Never in the history of the U.S. has the deck ever been so stacked against the young.

Transit strikes and economic inefficiency

The New York City transit workers are threatening to strike again. It almost happened on Friday morning, but at the last minute they agreed to set a new deadline for Tuesdsay morning.

This demonstrates a significant inefficiency of public transportation. It's no wonder that all modern U.S. cities are car oriented. I'm sure the people who moved away from the New York City to live in places like Phoenix and Denver are glad they can drive to work and not deal with transit strikes.

Christmas and the broken windows fallacy

There is a myth that Christmas benefits the economy.

I don't see how it benefits the economy when I get a gift that I wind up throwing out because it's useless. Which is what typically happens. Even worse, I keep the gift around for a few years, because I feel guilty about throwing it out right away. Thus the gift not only incurs costs on the giver, it incurs costs on me in the form of storage costs.

This is the broken windows fallacy. Mindless activity doesn't, like repairing broken windows, or digging holes and then refilling them, doesn't benefit the economy.

Manhattan apartments and parental support

From an article in today's NY Times about small apartments:

Typical of the young buyers is Laura Cave, 24, who bought a 450-square-foot studio at 20th Street and Seventh Avenue after moving from California to study graduate-level humanities at New York University. As with many younger buyers in the studio market, Ms. Cave's parents financed the purchase, and she pays rent to them. The apartment is in all their names.

This demonstrates a very important source of high prices in Manhattan. Young people usually get money from their parents to pay their rent.

This is contributing to the new social immobility. Young people whose parents are just middle class can't afford to live in Manhattan and are denied the better career and social opportunities because of this, keeping them forever in the class they were born to.

Flickr and economics

No, this is not about how Flickr makes any money (but with all the bandwidth the site uses up, one wonders).

It's about what photos "sell." By "sell," we mean how popular the becomes. The 500 Views 50 favourites group reveals that the most popular photos have unnaturally bright colors. To become the popular guy on Flickr, you need to turn up the saturation in Photoshop.

Some might think this just another indication that the masses have poor tastes.

Are dense cities economically inefficient?

There are a lot of pro-public transportation liberals who think that we would all be better off if we lived in dense urban environments where we could take public transportation and not have to waste resources driving around in our own individual cars.

Does this make sense from an economics viewpoint? Based on how expensive it is to live in New York City, the answer is a big loud NO.

New York City is the most expensive place I've ever lived. Northern Virginia was the second most expensive place I lived. The car oriented Phoenix area was a lot less expensive. It seems that the more densely you pack people together, the more economically inefficient the area becomes. This is the complete opposite of the conventional liberal wisdom.

I have two theories for why densely populated areas are more expensive.

THEORY I

Dense populations create transportational and space inefficiencies.

Public transportation is a lot less efficient than getting into your own personal vehicle. And all vehicles get stuck in big traffic jams. It becomes a lot more expensive to make commercial deliveries, which gets reflected in higher prices for everything.

Space inefficiencies should be obvious. It's easier to work in a roomier environment. When everything is all squeezed together, a lot of labor goes into organizing stuff so it can fit into the limited space. There isn't even any room in New York City to store the garbage.

In New York City, there's
no room for the garbage

THEORY II

Densely populated areas attract liberals, who elect liberal politicians who then pass into law economically inefficient liberal politices. Like rent control, wasteful government spending which necessitates high taxes, and all sorts of burdensome regulations which increase the cost of doing business.

I also think that unions might contribute to the expensiveness of New York City. A lot more labor is unionized here than it was in Phoenix. The more conservative politicians in Arizona did everything possible to discourage unionization.

How fast can Bush spend money?

$200 billion for Katrina, and now NASA unveils its $104 billion program to land men on the moon in 2018, one year shy of the fiftieth anniversy of the 1969 moon landing, which is even more expensive than the $40 billion it cost the first time around.

This demonstrates that just because an activity is technologically possible doesn't mean it's possible to do it cheap. People like to say "if we can put a man on the moon, we can do (fill in the blank)," but in fact learning how to do something affordably is a much more difficult task than merely doing something if there's a near infinite amount of money to spend.

Pharoah built a huge pyramid, but it took another 4,500 years before it was actually economically practical to build tall buildilngs.

Conservation and recycling

My previous post on garbage in the city has drawn a surprisingly large number of comments. So here are more of my thoughts on the issue.

Forced conservation is a dumb idea. As has been pointed out by many commenters, one’s time is also a valuable resource, so forcing people to place their trash in different receptacles wastes a huge amount of society’s scarce resources.

If there were a free market solution, then I’d be in favor of it. If the recyclers were going to pay for the recycled goods, and people wanted to put in the extra effort to make some extra money, then I’d be all in favor. But how one spends one’s own time should be a personal decision, and not one forced upon you by the government. Slavery was outlawed 1865, but liberal do-gooders want to bring it back.

The free market is the best way to allocate the values of various resources. The fact that there is no economic incentive to recycle unless government forces it is ample proof that it doesn’t make sense, and there is a heavy burden of proof upon the pro-recycling people to justify their position.

Now I actually do agree with the theory that we are using up our bounty of resources. It’s a simple mathematical fact. The population of the world keeps increasing but the amount of resources that came with the world are finite. I believe that when people far in the future look back in history, the 20th century will be seen as a golden age of man in which resources were abundant. During the current century we are going to hit the limits of Mother Earth to keep giving us more natural resources.

However, once again, I don’t see how recycling or conservation can really stop the inevitable. Only cutting down on population growth can do that, but the human race seems dead set on having more children. The only thing conservation and recycling might accomplish is to set ahead some date by a few years, such as the date that a certain resource runs out will be extended from 2103 to 2112. But whatever the exact date is, mankind will eventually have to deal with the resource running out so in the end it really makes no difference.

Generation X receives financial support from parents

The title of the article from yesterday’s NY Times, Financially Set, Grandparents Help Keep Families Afloat, Too, on its surface seems to be about grandparents and their grandchildren. But really it’s about a much more interesting topic, parents giving financial support to their adult children.

I have written many posts about how Americans are worse off today than we used to be (in contrast to the don’t worry be happy posts at the ultra-libertarian Café Hayek blog).

The article contains evidence that an important social shift is occurring. For example, an employee at a private school told the reporter that an increasing percentage of tuition checks were written by grandparents, and he estimated that 15% to 20% of kids had grandparents paying the tuition.

The above revelation makes me wonder, what percent of the 85% to 80% of parents who write the checks themselves are receiving significant support from their own parents? Probably quite a large percentage.

How do so many young people afford to live in Manhattan where a studio apartment costs $2,000 per month? Most of my sister’s female friends have their rent paid for by their parents, or perhaps their parents bought a condo and let them live in it. (I think the reason why Manhattan has more female than male residents is because women receive more help of this sort from their parents. This is a topic I hope to write more about in the future.)

This is definitely the dirty secret of generations X and Y. No one comes out and tells you that their parents give them $20,000 per year or more. So the unfortunate with poor parents wonder how all their peers seem to have more money.

Asset inflation certainly has a lot to do with this generational shift. When a young person buys a ridiculously overpriced house from an older seller, it’s a transfer of wealth from the young generation to the old generation.

The government makes this situation worse with Social Security, taking money from the poor young workers and giving it to the rich older retirees.

In general, the ratio of the value of labor compared to the value of capital has been decreasing, which explains why the rich are getting richer and why the older generation is suddenly better off than the younger generation. The young college graduate enters the work force with negative capital because of student loans.

Does competition cause higher prices?

Three days ago, I wrote the following about competition in toothpaste:

If one toothpaste company decided to go with only one type of toothpaste, it would surely suffer a loss of shelf space and a corresponding loss of sales. So every toothpaste company is forced to compete in the marketing game, to the overall detriment of the consumer who is faced with too many choices and higher prices for toothpaste. (Prices are higher because marketing costs are passed on to the consumer.)

It made perfect sense to me when I wrote it, but Robert Bell noticed my post and wrote:

Well, no, competition does not cause higher consumer prices, unless elementary economic principles have completely changed recently.

What I wrote truly is a complete reversal of what everyone thinks they know about economics! But I think we need to examine whether competition is always guaranteed to lower prices.

When people think of competition, they usually think of a market where there are an infinite number of sellers selling fungible goods. In such a market, the price of each good will be equal to its cost of production plus the opportunity costs of the sellers (who could otherwise be making and selling something else).

In our marketing based economy, we usually have oligopolies selling goods which the sellers have tried very hard to present as non-fungible. Depending on the price elasticity of demand for the items in question, firms may find it more beneficial to compete on the non-price components of marketing. These marketing expenses are then passed on to consumers.

To use the toothpaste example, this might mean that it’s easier to sell a $2.50 tube of toothpaste than it is to sell a $1.25 tube of toothpaste. Imagine you were able to manufacture toothpaste and well it at a wholesale price point such that it could sell for $1.25 retail, half the price of other brands. Do you think you would sell any? Would the supermarkets be jumping at the opportunity to sell your budget toothpaste? Most likely not. You would have to spend huge amounts of money on marketing in order to convince consumers to buy it and supermarkets to stock it, and the end result would be that your marketing costs were so high that you now have to sell it for the same price as all the other toothpastes.

(Half price for toothpaste is probably quite doable considering the ingredients in toothpaste are dirt cheap. In fact, one of the major ingredients, “hydrated silica,” is quite literally dirt.)

The negative sum game of too much choice

At Asymmetrical Information, Mindles H. Dreck writes about the problem of too many consumer choices.

Well, he doesn’t see it as a problem, but I say that the story from this NY Times op-ed piece by Stach Schiff, about the consumer so overwhelmed by choices in the toothpaste aisle that he wound up not buying any toothpaste, is yet another example of how marketing is a negative sum game.

If there was only one company selling toothpaste, then it might make sense for that company to sell six different types of toothpaste. But when there are six toothpaste companies, and each has six different types of toothpaste, then the consumer is faced with the unpleasant task of having to pick from 36 possible choices.

If one toothpaste company decided to go with only one type of toothpaste, it would surely suffer a loss of shelf space and a corresponding loss of sales. So every toothpaste company is forced to compete in the marketing game, to the overall detriment of the consumer who is faced with too many choices and higher prices for toothpaste. (Prices are higher because marketing costs are passed on to the consumer.)

The economics of charity

Last week I wrote about the economics of cheating. In some ways, charity is the opposite of cheating. By cheating, one does the wrong thing to gain a benefit. By donating to charity, one suffers a loss in order to do the right thing.

But is giving to charity really the right thing? Ayn Rand didn’t think so. Howard Roark, the protagonist of The Fountainhead, looked down upon charity. Taking this idea to a ridiculous extreme, in the ideal society of Galt’s Gulch in Atlas Shrugged, giving anything away at all was forbidden. (In my opinion, here’s an example of Ayn Rand taking a meritorious idea to a ridiculous extreme. The right to own property is the right to do whatever you want with it, even to give it away to someone.)

Charity seems like illogical behavior. People give but get nothing in return. Of course, people never really do anything without some benefit. People giving to their church probably expect to receive some benefit in the afterlife. In the case of secular charities, the benefit is feeling good, guilt alleviation, or social stigma avoidance. The latter “benefit” occurs when someone calls you on the phone and asks for money. You don’t want to seem like a bad person or a cheapskate in the eyes of the solicitor. Although why anyone could care what a telemarketer thinks about them is beyond me. The social stigma effect is more powerful when the solicitation is in person, especially if you know the solicitor. This is why shaking down office co-workers for charitable donations has proven to be an effective fundraising strategy.

But not all charity is truly devoid of material benefits to the giver. In fact, giving money to charity, if done the right way, can be an effective way to raise one’s status. Those in the fundraising business understand this very well. Charity dinners, for example, allow the dinner attendee to hobnob with the right crowd. The higher the cost per plate, the better the crowd you get to hang with. At a $100 per plate dinner, you may wind up sitting at a table with a school teacher or a chiropractor, but as you move up to $1,000 or even $10,000 per plate dinners, you get to hang out with the elite and raise your status accordingly (and also make some valuable business contacts).

A very large donation allows you to sit on the board of a prestigious cultural or philanthropic institution. And with even more money you can get a building named after you.

We see that effective charitable giving requires one to give in a public matter. Giving in the privacy of one’s home is a complete waste of money. It’s like the proverbial tree falling down in the forest where no one is around to hear it fall. Charity only helps the giver when other people know about it.

This discussion should set to rest the notion that charity is strictly about altruism. Therefore, I don’t see why it should be tax deductible. Why should middle class taxpayers fund the status seeking activities of the rich? This is yet another example of how the system is rigged against the middle class.

Financially responsible children: an oxymoron?

A W$J article begins:

Unfortunately, it's all too easy to raise financially irresponsible children. Many teenagers learn nothing about personal finance in school, and they learn all the wrong lessons from their free-spending friends.

Free-spending friends? What about free-spending parents? With personal indebtedness at an all time high, I don’t understand why we need an article about teaching children to be financially responsible. We need to teach adults to be financially responsible!

Furthermore, because children have a very short-term perspective on life, they are psychologically incapable of making what adults would consider to be responsible financial decisions. If given the choice between a new car or a college education, a lot of young people would unwisely choose the new car.

It seems to me that raising children is a catch-22 when it comes to finances. I’m not convinced that denying your children things that all of their friends have will teach them anything at all about responsibility. Just the opposite, they may very well develop an irresponsible fixation on short term acquisition of material goods, the lack of them causing the desire to be all the greater.

Paul Krugman says we’re running out of bubbles

I’m two days late linking to Paul Krugman’s 5/27/05 NYT column, but it’s one well worth reading. Paul Krugman makes a concise but excellent case for why a collapsing housing bubble will lead to bad economic times ahead. This is a rare case in which Paul Krugman is 99% correct, and he even avoids unnecessary Bush bashing (which he only does when he feels he has something really important to say).

Before I read his column, I was thinking the exact same thing this week, how a huge global recession (maybe even a depression) seems unavoidable. I also believe that the higher housing prices rise before they finally collapse, the worse it will be.

Donald Luskin notes the one weird statement in Krugman’s piece:

the Fed's ability to manage the economy mainly comes from its ability to create booms and busts in the housing market.

I don’t care for Alan Greenspan much either, but implying that the Fed has no power except to create housing booms and busts is certainly a huge overstatement.

The economics of cheating

This essay is inspired by the chapter in Levitt’s book Freakonomics (see my review) in which he writes about cheating. But I think his book was long on stories and short on analysis. So here is some of my analysis.

The obvious reason why people cheat is that they gain some kind of benefit from it.

Hedonic methods, inflation, and college textbooks

The blog Catallarchy has a post about hedonic methods and inflation. And there is a recommended free link to a WSJ article.

The U.S. Bureau of Labor Statistics uses hedonic methods to calculate the Consumer Price Index. In other words, the BLS uses complicated models to compare items being bought today to non-identical items bought in the past. The BLS explains it as follows:

The idea behind hedonic models is that items can be thought of as bundles of item characteristics. Hedonic models estimate values for the individual characteristics of a good or a service. Parameter values from hedonic models can be used by CPI analysts to calculate changes in quality between two items with different characteristics.

How does one compare a college textbook today with a college textbook from twenty years ago when they are different books? The BLS has a paper explaining. The number of pages, the subject, and whether it’s hardcover or softcover turn out to be important units of comparison.

The problem with hedonic methods is that they tend to understate true inflation by overvaluing current items. For example, thanks to new technologies in printing, color printing is a lot less expensive than it used to be. It’s now pretty common for college textbooks to be printed entirely in color. Does this mean that the $50 textbook bought today is really worth $100 because that’s how much a full color book would have cost twenty-five years ago? I say no because the color pages are merely an artifact of how cheap it is include that feature and they do not substantially increase the pedagogical usefulness of the book. (Similarly, I'm not a millionaire because the computer which I'm using to write this blog post has greater computing power than a multi-million dollar computer from the 1960s.)

Thankfully the BLS is ignoring color as a way to compare textbooks. But one factor the BLS does use which I disagree with is whether the book is published by a “major publisher.” According to the BLS paper, being published by a major publisher adds $4.46 to the cost of a book. But does this reflect higher quality? I doubt it. What it most likely reflects is the superior marketing power of the major publisher. This touches a theme I write about a lot in my blog, which is that larger organizations have superior bargaining power and enjoy marketing economies of scale.

Does it benefit the student that the publisher made higher profits on the book because of its superior marketing power? The answer is no. Therefore this factor should have been excluded from the regression analysis. Consolidation in the textbook publishing industry, resulting in a higher percentage of books being published by “major publishers,” will cause an increase in the average price of textbooks. But the BLS will consider these higher prices to be quality improvements and by doing so will understate the true rate of inflation in college textbooks.

Rising immigration, falling salaries

Russell Roberts, author of The Invisible Heart: An Economic Romance, posts some disturbing figures about immigration in his Cafe Hayek blog.

“The proportion of the workforce that is foreign born” remained stable at about 6% between 1960 and 1980, but has since been soaring and was 13.2% in 2000. Pro-immigration people have argued that immigration is nothing new and that the United States has always had immigration. However, Roberts’ statistics show that the percent of immigrant workers more than doubled over a twenty year period.

Roberts also explains that the average immigrant has a lower wage than the average American. The obvious conclusion is that immigrants are lowering salaries in the U.S. for people who were born here because employers can turn to a substitute good, a foreign born employee willing to work for less money.

Do too many people own homes?

There’s some home ownership data posted at EconLog by Bryan Caplan. From 1991 to 2004, home ownership rose from 64% to 69%, a pretty big increase considering that home ownership was “stable” between 1980 and 1991.

There is no doubt that this increased demand for home ownership has contributed to the rising prices.

Does everyone in America really need to live in their own home? Many would be better off living in an apartment. Homes incur significant transactions costs when one moves. Homes also require more time commitment from the owner. In our increasingly mobile society in which white collar employees are putting in more hours not less, one would think that home ownership would be falling, not rising.

Of course people who owned homes during the last few years are a lot better off financially because of it; but that’s a lucky historical anomaly that may end in tears for the last owners to jump on the bandwagon.

Bryan seems to imply that the government shouldn’t be subsidizing home ownership via the tax code. If that’s what he means, then I agree with him.

Trade deficit: good or bad?

David Altig says the trade deficit is bad. “[F]oreigners do not provide us with more goods than we provide to them out of the goodness of their hearts. They do so because they expect to be paid back sometime in the future….”

But libertarian Don Boudreaux says don’t worry be happy. “It’s the free market, stupid.” Well, that’s not exactly what he says, but I think that’s what he means.

I like to think of dollars as a product we produce, much like Saudi Arabia produces oil or South Africa produces gold. When you look at it this way, the trade deficit is a really great deal because it costs us nothing to “manufacture” dollars, but we’re getting a lot of really good stuff in return for them.

Economics of pizza

A post at Marginal Revolution asks about the economics of barbeque. Well, I have no clue about that, but this is a great introduction to the economics of pizza.

The beautiful thing about a slice of pizza (if you are lucky enough to live in the northeast where there’s a pizza by the slice market) is that it’s a wonderful indicator of inflation. Something about pizza wonderfully merges the prices of food, commercial rent, and labor into a wonderful indicator of overall price levels.

Not so the fast food hamburger. Unlike the pizza market, which resembles a true free market with large numbers of small mom and pop suppliers, the hamburger market is dominated by a small number of large chains. Each chain tries to differentiate its hamburger from those of other chains, and prices will vary widely because often the hamburger itself will be a loss leader (with the real money being made on the fries and the soda).

Unlike the slice of pizza, the hamburger is not a fungible good.