Tag Archives: economics

More efficient use of rooms and equipment during the shutdown

Instead of the labs, gyms and other rooms standing empty during the shutdown, the same isolation of people could be achieved by allocating each building or other resource to one person. Equipment from gyms or labs could be lent out for the duration of the shutdown, of course keeping a database of who borrowed what and making the borrower liable for its safe return. If only one person uses each object or building the whole time, then there is no cross-contamination or infection-spreading.

Excess demand could be rationed by lottery. Only the winner of the lottery for a resource would be allowed to use the resource, with large penalties for sharing. This would improve efficiency slightly, because one person instead of zero would be using each resource.

If the heat, water and electricity were turned off during the shutdown, then it might be more efficient to let the buildings stand empty, instead of having the utilities on and one person in each building or room. However, the lights in MIT buildings are still on at night, just like before the shutdown (and it seemed wasteful back then already).

Prefereeing increases the inequality of research output

Why do top researchers in economics publish almost exclusively in the top 5 journals? Random idea generation and mistakes in the course of its implementation should imply significant variance of the quality of finished research projects even for the best scientists. So top people should have more of all quality levels of papers.

Nepotism is not necessary to explain why those at top universities find it easier to publish in top journals. Researchers at the best departments have frequent access to editors and referees of top journals (their colleagues), so can select ideas that the editors and referees like and further tailor the project to the tastes of these gatekeepers during writing. Researchers without such access to editors and referees choose their projects “blindly” and develop the ideas in directions that only match gatekeeper tastes by chance. This results in much “wasted work” if the goal is to publish well (which may or may not be correlated with the social welfare from the research).

In addition to selecting and tailoring projects, those with access can also better select journals, because they know the preferences of the editorial board. So for any given project, networking with the gatekeepers allows choosing a journal where editors are likely to like this project. This reduces the number of rejections before eventual acceptance, allowing accumulating publications quicker and saving the labour of some rounds of revision of the paper (at journals that reject after a revise-and-resubmit for example).

A similar rich-get-richer positive feedback operates in business, especially for firms that sell to other firms (B2B). Top businesspeople get access to decisionmakers at other organisations, so can learn what the market desires, thus can select and tailor products to the wants of potential customers. Better selection and targeting avoids wasting product development costs. The products may or may not increase social welfare.

Information about other business leaders’ preferences also helps target the marketing of any given product to those predisposed to like the product. Thus successful businesspeople (who have access to influential decisionmakers) have a more popular selection of products with lower development and marketing costs.

On the seller side, firms would not want their competitors to know what the buyers desire, but the buyer side has a clear incentive to inform all sellers, not just those with access. Empirically, few buyers publish on their websites any information about their desired products. One reason may be that info is costly to provide, e.g. requests for product characteristics reveal business secrets about the buyer. However, disclosure costs would also prevent revealing info via networking. Another reason buyers do not to publicly announce their desired products may be that the buyers are also sellers of other products, so trade information for information with their suppliers who are also their customers. The industry or economy as a whole would benefit from more information-sharing (saving the cost of unwanted products), so some trading friction must prevent this mutually beneficial exchange.

One friction is an agency conflict between managers and shareholders. If managers are evaluated based on relative performance, then the managers of some firms may collude to only share useful information with each other, not with those outside their circle. The firms managed by the circle would benefit from wider sharing of their product needs, because outside companies would enter the competition to supply them, reducing their costs. However, those outside firms would get extra profit, making their managers look good, thus lowering the relative standing of the managers in the circle.

Avoiding the Bulow and Rogoff 1988 result on the impossibility of borrowing

Bulow and Rogoff 1988 NBER working paper 2623 proves that countries cannot borrow, due to their inability to credibly commit to repay, if after default they can still buy insurance. The punishment of defaulting on debt is being excluded from future borrowing. This punishment is not severe enough to motivate a country to repay, by the following argument. A country has two reasons to borrow: it is less patient than the lenders (values current consumption or investment opportunities relatively more) and it is risk-averse (either because the utility of consumption is concave, or because good investment opportunities appear randomly). Debt can be used to smooth consumption or take advantage of temporary opportunities for high-return investment: borrow when consumption would otherwise be low, pay back when relatively wealthy.

After the impatient country has run up its debt to the maximum level the creditors are willing to tolerate, the impatience motive to borrow disappears, because the lenders do not allow more consumption to be transferred from the future to the present. Only the insurance motive to borrow remains. The punishment for default is the inability to insure via debt, because in a low-consumption or valuable-investment state of affairs, no more can be borrowed. Bulow and Rogoff assume that the country can still save or buy insurance by paying in advance, so “one-sided” risk-sharing (pay back when relatively wealthy, or when investment opportunities are unavailable) is possible. This seemingly one-sided risk-sharing becomes standard two-sided risk-sharing upon default, because the country can essentially “borrow” from itself the amount that it would have spent repaying debt. This amount can be used to consume or invest in the state of the world where these activities are attractive, or to buy insurance if consumption and investment are currently unattractive. Thus full risk-sharing is achieved.

More generally, if the country can avoid the punishment that creditors impose upon default (evade trade sanctions by smuggling, use alternate lenders if current creditors exclude it), then the country has no incentive to repay, in which case lenders have no incentive to lend.

The creditors know that once the country has run up debt to the maximum level they allow, it will default. Thus rational lenders set the maximum debt to zero. In other words, borrowing is impossible.

A way around the no-borrowing theorem of Bulow and Rogoff is to change one or more assumptions. In an infinite horizon game, Hellwig and Lorenzoni allow the country to run a Ponzi scheme on the creditors, thus effectively “borrow from time period infinity”, which permits a positive level of debt. Sometimes even an infinite level of debt.

Another assumption that could realistically be removed is that the country can buy insurance after defaulting. Restricting insurance need not be due to an explicit legal ban. The insurers are paid in advance, thus do not exclude the country out of fear of default. Instead, the country’s debt contract could allow creditors to seize the country’s financial assets abroad, specifically in creditor countries, and these assets could be defined to include insurance premiums already paid, or the payments from insurers to the country. The creditors have no effective recourse against the sovereign debtor, but they may be able to enforce claims against insurance firms outside the defaulting country.

Seizing premiums to or payments from insurers would result in negative profits to insurers or restrict the defaulter to one-sided risk-sharing, without the abovementioned possibility of making it two-sided. Seizing premiums makes insurers unwilling to insure, and seizing payments from insurers removes the country’s incentive to purchase insurance. Either way, the country’s benefit from risk-sharing after default is eliminated. This punishment would motivate loan repayment, in turn motivating lending.

Volunteer parking wardens may benefit the environment

Reducing the utility from car use and ownership motivates substitution towards other forms of transportation, which benefits both the environment and public health. One way to cut the convenience of driving is enforcing parking regulations, because drivers have to park further from their destination when the option of illegal parking becomes less attractive. Parking at a greater distance also makes people walk more – a minor health benefit.

Enforcing speed limits and other traffic rules that slow cars down increases the time cost of driving. This may reduce wear and tear on vehicles and roads, which benefits the environment.

An implication of is that people who want to reduce global warming or improve public health should become volunteer parking wardens and traffic police by reporting parking violations, speeding and dangerous driving (preferably with photo or video evidence from phones or dashboard cameras).

A possible countervailing effect of the enforcement of parking rules occurs if the illegally parked cars obstruct the movement of other cars enough to motivate some people to switch away from driving. Then stopping the parking violations may open the road up enough to encourage more use of cars, with an overall negative environmental and health effect. Similarly, if reckless drivers make the roads unsafe enough to reduce others’ car use, then making traffic civil again may attract risk-averse people back to driving. However, in most developed countries, illegal parking and the ignoring of rules of the road is not severe enough to deter driving significantly, so better enforcement is likely to reduce car use.

Slowing traffic down may increase congestion and emissions per kilometre travelled if there is little substitution away from driving. Again, in developed countries public transit and cycling are usually feasible options. Of course, some people always find excuses not to use these, and in remote rural areas public transit may indeed be economically unreasonable and distances may really be too great for bikes. Electric bikes are then an option. These increase the range of travel with less pollution and congestion than cars.

Equilibrium response to reduced material use for plastic bags

Probably to save material on the manufacture of the free plastic shopping bags in the US, these bags are small and thin compared to the ones in Estonia (which used to be free, but are now priced at significantly above production cost due to EU regulations on disposable plastic products). The equilibrium response of cashiers and customers to thin flimsy bags is to double-bag groceries, a practice unheard of in Estonia. After all, if one bag is sturdy enough, almost nobody will use two inside each other. I have successfully carried 10 kg in an Estonian plastic bag.

The equilibrium response to small bags is to distribute the groceries among many bags, especially the heavy or bulky items, for example to put each milk canister or large salad sack into a separate bag. Both double-bagging and the one-item-per-bag distribution lead to more bags being used in response to manufacturing each bag out of less material. It is an empirical question whether thinner, smaller bags result in less or more plastic waste overall. To incentivise reducing the one-time use of plastic bags and to encourage reuse, customers should have to pay for these, like in the EU.

One form of plastic bag reuse is as garbage bags (although it is only a one-time reuse, it is better than nothing). However, the flimsy free bags in the US come in bulk packs with the bottoms of the bags stuck together, so separating one from the stack often results in holes in its bottom an inch wide or more. The holes discourage many forms of reuse, including as trash bags, because small items (dust, crumbs, scraps) fall out. Partly the holes are due to the flimsiness of the material, partly to the way the bags are glued together to make a bulk pack.

Delivered food and restaurants are unhealthy due to moral hazard

Consumers observe the taste and cost of food directly, but checking the ingredients for healthiness takes extra effort and time. Rational inattention then implies that eaters are unlikely to verify the health claims. Thus food suppliers are subject to moral hazard: consumers buy based on the healthiness they expect, not the actual ingredients the seller chooses, so the seller has an incentive to improve taste, reduce the production cost and cut price even when this makes the food less healthy.

The standard solutions to moral hazard from economic theory are verification, repeated interaction and vertical integration (selling the firm). In the context of food, safety standards and truth-in-advertising laws restrict the substances manufacturers may add and claims they can make. Regulators verify claims made and punish for illegal additives or false advertising. Also, if a food supplier is found to use unhealthy ingredients (or amounts of sugar, salt and fat), then some consumers may switch to alternate providers, which is a repeated game punishment for the original seller.

The weakness of both verification and repeated interaction is imperfect monitoring: small increases in unhealthy substances are difficult to detect, because tests are noisy and food composition varies naturally. The variation sometimes makes the amount of an ingredient exceed the healthy limit, so honest suppliers would also be punished with positive probability. Incentives are created by the difference in payoffs, so reducing the payoff of the honest decreases their motive to stay honest. The imperfect monitoring allows unscrupulous sellers to outcompete the providers of healthy food on taste and price, for example by using various tricks to circumvent the legal requirements on labelling (https://sanderheinsalu.com/ajaveeb/?p=728).

The remaining solution to the moral hazard problem is vertical integration of the buyer and the supplier, i.e. home cooking. Of course, the ingredients bought to be cooked at home are subject to similar moral hazard – unhealthy substances can be added at any stage of the production process. The risk could in principle be even larger than for processed foods and restaurant meals, but in practice, it seems that simple and unprocessed ingredients are more difficult to manipulate than prepared meals, which are a mixture of many components. Adding sugar, salt, fat or monosodium glutamate to flour, rice or dry beans without mentioning it on the nutrition label is easier to detect than the same (amounts of) additives in shrimp fried rice, bread or a burrito. Raw meats and fish do have extra salt and food colouring added, but usually less than for ready-to-eat meals.

Relative prices are another reason why there may be less manipulation of ingredients than processed foods. There is a per-unit cost of adding unhealthy substances, as well as a fixed cost due to the risk of lawsuits and fines, especially if the additives are not declared on the label. Unprocessed ingredients are less differentiated, so the price competition is more intense. The increase in the price that customers are willing to pay if an ingredient tastes better than the competitors’ may be small if price is the main dimension of competition. The slightly higher price may not justify the per-unit cost of the additives. In contrast, for processed foods the margin may respond greatly to taste, motivating manipulation of the ingredients.

The taste of the final dish is likely to respond less to manipulating one ingredient than to altering the composition of the entire food, both because the ingredient may be only a small part of the final dish and because the taste of a dish is largely determined by the seasoning and the cooking method. In this case, additives to ingredients do not improve taste that much, reducing the profitability of manipulating these.

Intense price competition motivates cost-cutting, including by substituting cheaper ingredients or using additives (e.g. preservatives) that reduce the manufacturing cost. However, if the additives cost more than they save on production cost (such as preservatives for dry goods that already keep indefinitely), then they are unprofitable to include.

Demand for cooking ingredients may also respond less to price and taste than for restaurant meals or delivered food (raw ingredients may even be an inferior good, but eating out is more like a luxury good). In this case, there is a range of fixed costs of unhealthy substances for which adding these to ingredients is unprofitable, but to processed foods profitable.

Pill testing, placebos and illegal market efficiency

Testing illegal drugs for the active ingredient differs from testing for poisonous adulterants. Both tests have opposite effects on drug use before and after buying. After the pill has been purchased, testing reduces use, because sometimes the drug fails the test, whether correctly or not, and is discarded. Before purchase, the option to test for and avoid adulterated or inactive drugs reduces the buyer’s risk, thus increases use.

In the longer term, testing benefits the dealers of purer, more predictable and less toxic drugs, putting some suppliers of fakes out of business. Pill predictability reduces overdoses – a health effect similar to lower toxicity. If old drugs can be tested, but new ones not, then buyers experiment less and the incentive to invent new narcotics decreases.

The avoidance of poisonous adulterants is good for public health, but purer pills not necessarily so. Inactive drugs undermine consumer confidence in the illegal market, reducing use, prices and casual purchases. Trust then requires a long-running relationship with the seller, which has multiple benefits. It motivates dealers to care about the health of their loyal customers, simplifies policing and gives researchers and social workers better long-term access to the at-risk population.

One claimed benefit of party drugs is that they reduce anxiety, increase the user’s confidence and social interaction, thus improving mental health. Evidence from psychiatric medicines suggests that many such benefits are due to the placebo effect. Users are quite inaccurate in estimating the purity of ingested drugs, and factors like price and place of purchase strongly influence their perception of purity. The price per pure gram is negatively related to purity in some markets, further supporting the placebo interpretation. If inactive pills boost confidence similarly to illegal drugs, then there is a clear case for flooding the market with harmless placebos. The availability of pill tests for the active ingredient reduces this opportunity to make the illegal market inefficient. Tests for toxic adulterants, however, actually favour harmless placebos.

Easier combining of entertainment and work may explain increased income inequality

Many low-skill jobs (guard, driver, janitor, manual labourer) permit on-the-job consumption of forms of entertainment (listening to music or news, phoning friends) that became much cheaper and more available with the introduction of new electronic devices (first small radios, then TVs, then cellphones, smartphones). Such entertainment does not reduce productivity at the abovementioned jobs much, which is why it is allowed. On the other hand, many high-skill jobs (planning, communicating, performing surgery) are difficult to combine with any entertainment, because the distraction would decrease productivity significantly. The utility of low-skill work thus increased relatively more than that of skilled jobs when electronics spread and cheapened. The higher utility made low-skill jobs relatively more attractive, so the supply of labour at these increased relatively more. This supply rise reduced the pay relative to high-skill jobs, which increased income inequality. Another way to describe this mechanism is that as the disutility of low-skill jobs fell, so did the real wage required to compensate people for this disutility.

An empirically testable implication of this theory is that jobs of any skill level that do not allow on-the-job entertainment should have seen salaries increase more than comparable jobs which can be combined with listening to music or with personal phone calls. For example, a janitor cleaning an empty building can make personal calls, but a cleaner of a mall (or other public venue) during business hours may be more restricted. Both can listen to music on their headphones, so the salaries should not have diverged when small cassette players went mainstream, but should have diverged when cellphones with headsets became cheap. Similarly, a trucker or nightwatchman has more entertainment options than a taxi driver or mall security guard, because the latter do not want to annoy customers with personal calls or loud music. A call centre operator is more restricted from audiovisual entertainment than a receptionist.

According to the above theory, the introduction of radios and cellphones should have increased the wage inequality between areas with good and bad reception, for example between remote rural and urban regions, or between underground and aboveground mining. On the other hand, the introduction of recorded music should not have increased these inequalities as much, because the availability of records is more similar across regions than radio or phone coverage.

Would a protest influence you?

Help, a politician I don’t like is in power! I should do something about it. But what? I know! I will join a protest – this is something. Now I can feel good about myself for having done something. And post on social media how I opposed evil so effectively. I am a socially conscious, altrustic person.

On a more serious note, one way to evaluate whether a given protest could change the situation is to put yourself in the position of the target audience. If your favourite politician was in power, would this protest change your support for said politician? If you were the politician in power, would you change your policy when many opponents use this protest against it?

Even if the answer is no, a protest may still have some effect, because it may change the preferences of the swing voters. The „no” may come from deeply ideological people, whereas more open-minded folks may conform to the herd. If they see many people opposed to something, they may start to oppose it too.

On the other hand, a protest may have the opposite effect to the one intended. It may harden ideological positions and increase polarisation. If the majority is weakly in favour of a policy, then protests against it may strengthen the support of the majority for it, leading to greater turnout and more yes-votes.

From an economic viewpoint, marching on the street with signs, chanting slogans or commenting on social media has no direct impact on politicians or most voters. The exception is those who are stuck in a traffic jam when a protest closes a street. Rational agents should not pay attention to protests which do not affect them (such activism is „cheap talk” in economic jargon, or at best „money burning”).

Real people may be swayed by the opinion of a large crowd. However, a form of protest that has an objective impact on people’s lives is likely to influence people more, because it affects them via both the opinion of the crowd and the direct impact. Both the belief shift and the hardening of the opposition are probably greater.

There are many illegal means of directly affecting the population, but also some legal forms of protest with objective impact. Economic protest is boycotting certain countries, firms or goods, refusing to work for the regime, and moving elsewhere („voting with one’s feet”), and is usually legal. The objective impact is that if enough intelligent and hardworking people shift their spending and taxpaying elsewhere, then the regime will be in fiscal trouble. If this does not change the policy of the leadership, then at least the lack of money will make the program harder to carry out.

There is a larger personal cost for economic protest than for cheap talk. One has to give up certain goods, or pay more, or experience the hassle of moving residence. This is why most people who threaten to boycott a firm or leave a country do not end up doing so. The threats are just another form of cheap talk, which can be posted on social media to impress other cheap talkers.

On backpackers and low-spending tourists

Countries encourage tourism to make money. The same goes for local governments, tourism industry associations and tour firms. Some places provide options for low-spending tourists like backpackers, despite not making much money from them. These options may be cheap campsites, backpacker hostels, allowing hitchhiking and work-travel visas. At first sight, any positive revenue from poorer tourists would justify welcoming them. This simple revenue calculation, however, neglects the substitution effect and dynamic demand.

Substitution means that if cheaper travel options are available, then some tourists who would have spent more in the absence of these options now spend less. For example, a person who would stay in a hotel if there was no other accommodation, stays in a backpacker hostel instead. On the other hand, if all options are expensive, then the poorest tourists do not come at all. There is a tradeoff between the number of tourists and the average tourist’s spending. If introducing cheaper options leads to many tourists switching to these, but does not attract many additional low-spending people, then creating these cheaper options reduces total profit.

Dynamic demand means that a person who has toured a particular location once changes his or her likelihood of going there in the future. For example, having seen a tourist site, a person does not visit it again. Or someone going on vacation and liking the location starts going there year after year. If a region encourages young, low-income people to visit as backpackers, then it may increase or decrease future visits by these people when they are older and wealthier. In particular, if people do not tour the same location again (and spend more when older), then encouraging them to visit when young reduces the total profit from them over their lifetime.

The fact that some regions welcome backpackers has several possible explanations. There may not be much substitution, or a visit may increase future visits. The tourism industry may not have thought this through and may be reducing their own profit inadvertently. Or the government may have other objectives than taxes from the tourism industry. For example, allowing people from other countries to visit cheaply may make these people friendly to the host country, which may yield some nonmonetary benefit in international relations.