Why Foreign Aid Fails

I think at this stage in history, there’s not really much question that foreign aid has been a colossal failure. Shovelling money and goods from first world taxpayers to third world tyrants has definitively failed to improve the standard of living in third world countries. By some measures, it’s made the problem worse – foreign aid is easy to seize, and selectively distributing it to one’s political allies is a great way to shore up political loyalty for corrupt kleptocrats.

The question is, how surprised should we be that didn’t the experiment work? 

My answer is ‘not very’. And here’s why.

The reality is that the principle of foreign aid has embedded in it an important assumption about development. This assumption is so insidious that I doubt that most of the proponents of aid even realize that it’s the basis on which their whole program is built.

The assumption being made sounds almost comically simple, and it is this: poor countries are poor because they don’t have enough stuff. Hence if we give them the stuff, they’ll stop being poor.

Sounds almost too obvious to state, right?

The ‘stuff’ takes on a variety of different forms – food aid, infrastructure spending, bed nets to combat malaria, vaccines, laptops for children, cash transfers, etc.

And that’s exactly what we’ve provided. So why hasn’t this worked?

Because there’s an alternative possibility. It may be that the lack of stuff is not the problem, but is just the symptom of the problem. The real wealth of society is its ability to produce stuff. Rich countries are defined by their ability to produce all of their own bed nets, etc. And when you take the stuff away from a wealthy country, it gets replenished. Haiti, Biloxi and Fukushima all got destroyed by natural disasters. But local production was vastly different a few years later in each place. I’m sure if you switched the populations (moved the Japanese tsunami survivors to Haiti just after the hurricane, for instance) and repeated the experiment, the outcome would take longer, but the end result would be similar. The Singaporeans took 50 years to turn the whole country from a swamp into a first world nation.

What if the things that produce the wealth can’t be easily shipped in? If it’s institutions, it’s hard to transplant those in without a hefty dose of colonialism (although Paul Romer is giving it a red hot go in Honduras, and more power to him). If it’s culture (such as an allegiance to civil society, instead of a tribalist mindset), that’s much harder to fix. If it’s genetics – yikes. Thankfully, cases like Singapore suggest that you can get a hell of a large change in a short period of time without altering the genetic makeup of your country.

People have talked about all these things plenty of times. But what I think isn’t properly appreciated is that the assumption that “more stuff -> development” was entirely unproven when the aid experiment started.

Take all the rich countries in the world today. How many of them were made rich by being given stuff from other countries? The answer is of course ‘none’. Whatever caused their development, it wasn’t because they got huge transfers from the outside world. Even if you doubt this general principle (and you’d be wrong), you’d have to concede that this is surely true for the industrial revolution in England, since there wasn’t anybody richer to give them a handout.

So we know that being given stuff isn’t a necessary condition for development. And now we know that it’s not sufficient either. In this light, the complete failure of the foreign aid experiment shouldn’t come as a surprise at all. We were trying to make poor countries rich using a method that had not been successfully implemented before in human history. Like most experiments tried without a strong reason to presuppose success, the result was failure. Poor countries, it seems, can’t be made rich in any meaningful way just by giving them more stuff.

One of the current poverty ‘silver bullets’ seems to be microfinance. Like bed nets, I presume that it will have some benefit. Like bed nets, I also presume that it will be entirely insufficient to make meaningful changes to poverty levels. We’ll see if I’m right -  I’d be delighted to be proven wrong, but I’m not holding my breath.

The worst assumptions are the ones you don’t even realize you’re making.

Where does value come from?

Most people have very little idea what makes one business more valuable than another.

This state of affairs tends to persist, because most businesses aren't exactly eager to reveal where their competitive advantages come from either.

My favourite example of this principle is Coca-Cola. In one of the classic bits of corporate mis-direction, Coca-Cola has managed to convince the world that the key to its success is the secret recipe for Coca-Cola, closely guarded by only a few corporate executives. Astonishing numbers of people seem to believe it.

Viewed logically, this is kind of perplexing. Not least, because there's a wikipedia entry for 'Coca-Cola Formula', which lists a number of different purported recipes to try, including one uncovered by Ira Glass on 'This American Life' which claims to be the real deal.

And yet somehow, Coca-Cola doesn't seem to have collapsed since the February 11, 2011 Ira Glass show.

What's truly amazing, though, is that Coca-Cola seems to have managed to convince it's own employees that the value of Coca-Cola is in the recipe. You know this because a number of Coke employees went to Federal prison for trying to sell the Coke secret recipe to Pepsi, back in 2006.

Really?!? In this age of modern chemical analysis? When half the ingredients are listed on the back of the bottle? When the rest could probably be pieced together by a halfway decent organic chemist? That's the thing that's keeping the company afloat?

Of course not. But the myth persists.

The easiest way to see what Coke's real advantage is is to consider the obstacles you'd face if you managed to make a cola that unambiguously tasted better than Coke, to at least 70% of Coke drinkers.

Straight off the bat you've got economies of scale. Coke is enormous and gets enormous discounts. So does Pepsi though, so perhaps we could partner up or at least get financing to grow. But your new drink has to be close to as cheap to produce as Coke in order for you to be competitive.

What else? Well, marketing is the one that probably comes to most people's minds. And truthfully this is a big one. Lots and lots of people around the world know and love Coke. That means that when they go into the supermarket, they already know they'll like it, and so they buy it. Add in fancy marketing terms for affective associations between Coke, good times, and fun parties. Why? Because advertisers have crammed this into their heads over decades.

But perhaps the most neglected is simply logistics. Coke has a crazily effective distribution network. Even if you manage to set up the most-watched viral video that gets everyone fired up about your new cola, you're going to face the problem that it's damn hard for most people to purchase it. Soft drinks tend to be bought with the aim of being consumed then and there. This means that your Amazon strategy of doing internet-only distribution ain't gonna work so flash - people don't plan most of their soft drink purchases weeks in advance. The only way you'll get sales is if you can have your soft drink there at the point that the consumer is thirsty.

And how do you do that? By having your Coke alternative available to buy in every supermarket, every deli, every liquor store, and every hamburger stand. In the whole world. Supplied constantly. So that they never run out.

Think about that. How the hell are you even going to begin doing that?

And that's why you're never going to out-compete Coke.

Setting up an equally good marketing and distribution system isn't impossible, of course. It's just very hard.

It becomes even harder if you're spending all your time trying to work out the magic soft drink formula instead. Coke is happy to let you believe that this is the source of their success, for very good reasons:

In making tactical dispositions,

the highest pitch you can attain is to conceal them;

conceal your dispositions, and you will be safe

from the prying of the subtlest spies,

from the machinations of the wisest brains.

Bathroom Floor Herd Immunity

I was in the gym with SMH and we'd adjourned to the locker rooms to shower.

SMH is American, and a fairly organised kind of fellow. As a result, he had his shower thongs (or flip flops, in the parlance of these lands).

I, on the other hand, manage to be chronically disorganised. It should thus come as no surprise to find out that despite meaning to do so for about 3 years, I still haven't bought a spare pair of thongs and put them in my gym bag.

Now, I lean towards the laissez faire attitude to hygiene. The human immune system is incredibly well suited towards things like touching bathroom door handles and toilet seats without collapsing in a quivering heap of bacterial infection. Most purported hygiene issues (outside a hospital or food handling setting) are largely just a feeling of ickiness masquerading as health concerns.

Boy howdy do Americans go crazy for bathroom hygiene. There is a shocking number of otherwise sensible people who literally will not touch a bathroom door handle, and will grab a paper towel to open the door because they're so paranoid. This even makes its way on to official instructions sometimes, like here. There doesn't seem to be much of a sense of historical perspective - back in the 60s, I'm pretty sure people weren't using paper towels to open doors (not least because paper towel wasn't that common). I'm also pretty sure they weren't dropping dead from bathroom-door-related infections either. Perhaps, just perhaps, all this craze for hand sanitisers and never touching any public surfaces is just modern man turning into a complete weenie.

Nonetheless, showers in gyms do run the risk of getting fungal infections. The floors tend to be always wet and slightly warm, and lots of feet are walking over them. So it probably is prudent to get a pair of thongs.

But despite 3 years of not wearing them and showering at this gym, I'd pretty much been fine.

And I finally figured out why.

Herd Immunity.

When enough people are vaccinated against a disease, it becomes hard for the disease to spread. As a result, people who don't get vaccinated get to free ride off the added group protection from those who do vaccinate.

And something similar happens with bathroom floors. In the US, the vast majority of people wear thongs to public showers. I'm quite sure this is due to the hygiene/gross-out combo, and not out of any sense of public-spiritedness. But the effect is the same - if there are very few people who aren't wearing thongs, there's very few people likely to be spreading around foot infections. And that means that it's actually pretty safe for free-riders like me to go without.

I'm like the Jenny McCarthy of the gym shower world, free to be recklessly stupid and indulgent thanks to everyone else's good decisions, meanwhile imposing a small negative externality on everyone else by my own actions.

It's just like Tom Petty sang:

And I'm Freeee
I'm Freeee Riiiiiddding.

Good times.

A sufficient but not necessary condition for being an economist

You might be almost certainly are an economist if you've ever got irritated at an establishment because their prices were too low.

I remember in Chicago when Mayor Richard M Daley decided to fund the latest of his permanent election bribe fund by privatising the city parking. This of course led to parking immediately becoming about 3 times more expensive.

Most people were pissed off.

But I remember speaking to an economist friend of mine. "How good is this?" I remarked. "I know", he responded, "I can now get a park any time and pay with a credit card!".

This was truly a market that wasn't clearing. Tools kept circling around at peak hour looking for that vacant spot (which didn't exist), all to save a couple of bucks. Sure, you spent 20 minutes and a few dollars in petrol, but the point was you didn't pay for it! Idiots.

Being happy at price increases shows at least two phenotypes of economists.

The first is a recognition of a market that isn't clearing, and the fact that long queues signal a need for price increases (or increased supply). Since the number of parking spots is fixed in the short term, price increases are the answer.

The second phenotype (even more characteristic of economists) is the willingness to place an explicit value on your time. Waiting twenty minutes to save $2 is only a good deal if your implied hourly wage is less than $6. Red hot tip - mine isn't. Hell, minimum wage is more than that in half the country.

With respect to the second phenotype, a lesser appreciation makes you not really mind when prices go up - you accept that there's a tradeoff, but you still liked the cheap version, for all its problems.

A greater appreciation makes you positively glad when prices go up. Getting to buy back 20 minutes of your life for $2 is a bargain, and it's a bargain that you couldn't have before now. Earlier you were paying 25c and 20 minutes. Now you're paying $2. That's a price drop in real terms, my friends.

I remember going to this place that sold really delicious and really cheap ice cream - around a buck fifty. Total bargain, right? Awesome!

Except that every time I went there, there was a half hour wait.

Screw that. I'm not going back there until they raise their damn prices.

Clear that market or don't get my custom, fools!

Markups and Price Discrimination in RAM

Dell computers have some smart cookies working out their pricing policies. They've (correctly) estimated that a very large proportion of their customers will pay a substantial premium in order to not have to open up the inside of their computer. This is because when you open up a computer, it seems to the newbie like the electronic equivalent of doing open heart surgery when you've only seen a youtube clip of the operation. Screw it up, and there goes your two grand computer.

I know this for two reasons:

1. Until a few days ago, I was one of those people, and

2. My computer tech guy pointed me in the direction of aftermarket RAM.

The latter only occurred because I'd bought a computer hoping to cannibalise the RAM from an old machine. As bad luck would have it, the old RAM was the wrong specification.

But look at the markups they charge!

A Dell Precision T3500 Workstation with 2GB of RAM will set you back $779.

When you increase your RAM to 24GB, using 1333MHz, DDR3 SDRAM, ECC (6 DIMMS), it will add another $1580 to the price.

Now let's go to my new favourite site, www.crucial.com. They're RAM finding device lets you locate RAM that will work with your T3500 workstation. How much will 24GB of 1333MHz DDR3 RAM set you back?

As it turns out, about 140 bucks. So Dell is getting a lazy 900% markup on their RAM, and that's assuming they're buying it on crucial.com without any discount for bulk.

That's a hell of a premium you're paying because you're afraid of opening up your computer.

As it turns out, not checking the specification of the RAM I'd need cost me $150 in the short term, but has saved me at least a couple of grand in expected lifetime savings.





Update: So I decided to not wait for the computer guy (who had shown me where the RAM would go when he opened the computer up), and tried to install it myself. No dice - it wouldn't start up. Tried to install the old RAM - still no dice. Started to think I'd bricked the computer. Read the manual, fiddled around with it, eventually realised from the error lights that it wasn't reading that there was any RAM installed. More fiddling revealed that I hadn't pushed the RAM in hard enough, and my reluctance to push too hard meant that it wasn't fully in place. Ironically, I was only willing to push hard once I'd decided that I'd probably ruined the computer, which was in fact what it needed to fix it.

So overall, a bit nerve-wracking, but still not worth paying fourteen hundred bucks to avoid.

French Free-Market Economic Wisdom

No, that is is neither a typo, nor sarcasm.

From the great Frédéric Bastiat:

When James B. gives a hundred pence to a Government officer, for a really useful service, it is exactly the same as when he gives a hundred sous to a shoemaker for a pair of shoes.

But when James B. gives a hundred sous to a Government officer, and receives nothing for them unless it be annoyances, he might as well give them to a thief. It is nonsense to say that the Government officer will spend these hundred sous to the great profit of national labour; the thief would do the same; and so would James B., if he had not been stopped on the road by the extra-legal parasite, nor by the lawful sponger.

Let us accustom ourselves, then, to avoid judging of things by what is seen only, but to judge of them by that which is not seen.

Words to live by.

This is taken  from one of his most famous essays, about the broken windows fallacy - that you cannot spur economic activity by destroying assets and claiming that the increased production to replace them is an economic benefit, because this ignores the cost of the forgone spending on other items.

Everyone knows that, right? Nobody is seriously advocating destroying productive assets to boost the economy?

Ha ha ha! Oh, how little you understand Washington!

Bastiat himself was quite familiar with the difficulties of getting politicians to not justify wasteful spending because of it's stimulating effects:

Dear me! how much trouble there is in proving that two and two make four; and if you succeed in proving it, it is said, "the thing is so plain it is quite tiresome," and they vote as if you had proved nothing at all. 

Bastiat discusses at length the implicit arguments of those who demand government protection for their industry:

Ought not the protectionist to blush at the part he would make society play?

He says to it, "You must give me work, and, more than that, lucrative work. I have foolishly fixed upon a trade by which I lose ten per cent. If you impose a tax of twenty francs upon my countrymen, and give it to me, I shall be a gainer instead of a loser. Now, profit is my right; you owe it me." 

They're still saying exactly that.

Bastiat also makes the oft-neglected point that to oppose the government subisidising an activity is entirely different to the question of whether you desire that activity in general. His essay makes the point that subsidy policies are only ever about transferring wealth, not creating wealth. The policy must live or die on the merits of the thing to be susidised, and not the claim that the employment of the labor itself is productive:

But, by a deduction as false as it is unjust, do you know what economists are accused of? It is, that when we disapprove of Government support, we are supposed to disapprove of the thing itself whose support is discussed; and to be the enemies of every kind of activity, because we desire to see those activities, on the one hand free, and on the other seeking their own reward in themselves. Thus, if we think that the State should not interfere by taxation in religious affairs, we are atheists. If we think the State ought not to interfere by taxation in education, we are hostile to knowledge. If we say that the State ought not by taxation to give a fictitious value to land, or to any particular branch of industry, we are enemies to property and labour. If we think that the State ought not to support artists, we are barbarians who look upon the arts as useless.

The essay is most famous for the broken windows analogy. But in fact the whole essay is brilliant throughout. As they say, read the whole thing.

Frédéric Bastiat, in other words, pioneered the concept of opportunity cost (although he didn't coin that term). This is such a basic tool of economic thinking these days that we tend to forget that it wasn't always there. It came about largely because of Frédéric Bastiat. And it's still one of the most powerful arguments against hare-brained government programs - where did the money to fund this come from, and what else could have been done with that money instead?

Here is the moral: To take by violence is not to produce, but to destroy. Truly, if taking by violence was producing, this country of ours would be a little richer than she is. 

As true now as it was in 1850.

Trenchant advocate of economic liberty and opponent of sloppy thinking, M. Bastiat is richly deserving of the posthumous induction into the Shylock Holmes Order of Guys Who Kick Some Serious Ass.

"Austerity Measures"

So Greece has been rioting again, as the parliament passed a set of "austerity measures" designed to combat their rampant budget deficit.

This headline from The Daily Beast is instructive, and typical of the way it gets written up:

Greece Riots: Have Greeks Had Enough of Austerity?

This is why it has been such a marketing disaster to call these rounds of budget cuts "austerity measures".

Austerity implies that the relevant aspect of these cuts is a kind of severity, a harshness of measures designed to achieve a strong outcome. More tellingly, it implies a choice. Austerity describes an action you take to limit your intake of something to more humble, and less pleasant, levels.

And who wants that?! Nobody. I've had enough of this austerity! Let's go back to the days of plenty.

The message that needs to be gotten into the heads of the marginal Greek voter is the following: riot all you want, but those days ain't coming back. Not if Greece defaults. Not if Greece raises taxes. Not if Greece prints money.

If it were me, I'd call these 'The New Normal Cuts'. That ought to indicate the correct mindset. Get used to it, because this is how it's going to be. I'd also settle for the "There's No More Money, Because It's All Been Spent Cuts". It's been spent, and borrowed, and spent again. And now there's nothing left, and no private investor with two braincells to rub together is going to lend the Greek government money again any time soon.

Because this is the problem - you can default on the debt, but it doesn't make the deficit go away. And once you default, you've got very little chance of being able to finance that deficit with borrowing at any reasonable rate. So sooner or later, the pensions and the government wages will get cut, by hook or by crook. The only other option is printing money to close the budget deficit, which is the triumph of imbeciles who think that money illusion is a fast track to prosperity. Sadly, it doesn't take much experience of hyperinflation to realise that this isn't actually the case. Ask Zimbabwe how it's working out.

These aren't the austerity cuts. These are the reality cuts. Which is why the headline is so inane:

Greece Riots: Have Greeks Had Enough of Reality?

You bet they have. Unfortunately, to paraphrase Tolstoy, you may not be interested in fiscal reality, but fiscal reality is interested in you.

Raise Those Prices, Jean-Pierre - The French Government Demands It

The French are determined to continue their unofficial national motto of 'Le Ass, Le Gas or Le Grass - Nobody Can Provide Stuff For Free'.

Check out this classic decision - Google Maps was fined for providing maps for free to businesses.

In a ruling Tuesday, the Paris court upheld an unfair competition complaint lodged by Bottin Cartographes against Google France and its parent company Google Inc. for providing free web mapping services to some businesses....

The French company provides the same services for a fee and claimed the Google strategy was aimed at undercutting competitors by temporarily swallowing the full cost until it gains control of the market.

Trying to provide maps for free, eh? That'll cost you 500,000 euros!

It's true that Google has begun charging for corporations that make large use of their mapping service.

So what can developers do against this vicious, anti-competitive behaviour?

One option is to switch to free, open-source mapping services. Which some companies have indeed started doing.

Now, you may look at this as evidence that there's plenty of competition for Google's free service.

But that just shows that you don't understand French courts! No, instead it is the open source mapping service being equally, if not more, anti-competitive. Once their open source product has driven out the competition, think how much they'll be able to exploit consumers by jacking up their prices!

This is of course in line with the French government putting mandatory prices on books, both electronic and paper. That'll teach you to try to sell products more cheaply.

Never mind that the benefits of lower prices tend to flow the most to the poor.

The French Government - putting the liberté in liberté économique.

The Value of Society

Take an average day in a first world city.

You go for a walk down to a coffee shop, or to the mall, or wherever your travels take you. In that time, you'll pass by hundreds of people. If you're like me, chances are that the vast majority of them are complete strangers - you don't know them, and you'll never see them again.

Think back to the people you passed today. How many of them can you remember? How many of them did you notice at the time, even fleetingly? Probably very few. Even the ones you interacted with, at the checkout line or in the lift, you probably did so without really thinking much about it.

Now imagine you're out on the savanna, or in some post-apocalyptic wilderness. You come across another person in the distance. What are you going to be thinking?

Probably some combination of: are they friendly? Are they going to try to rob me? Would I be able to defend myself in a fight if they try something? Is this a trap where they have other people ready to jump me?

I'm going to go out on a limb and predict that running into other people that you don't know would probably be pretty damn stressful. It wouldn't be the kind of thing you'd do lightly.

Small early societies got around this through tribalism. You knew the people in your clan, and repeated interactions with them ensured that people treated each other reasonably. But interactions with other tribes were likely to be somewhat fraught, especially tribes you didn't know. Then you were back to the mutual suspicion and fear.

Now think back to modern society. It's remarkable how well norms of behaviour are not only common and widely accepted, but known be everyone to be common and widely accepted. In a modern city, I can interact with literally millions of strangers and have strong expectations about how they're going to behave. The norms of trust and respect have become strong enough that we don't need repeated interactions at the individual level to maintain them. People internalise the trust of strangers, and as long as most people reciprocate, it's a mutually beneficial trend. I can now engage in commerce and trade with millions of people, instead of just the small number in my own village. This allows institutions to develop that rely on crazy levels of trust for strangers, such as valet parking.

In America, you can travel thousands of miles and interact with complete strangers in such an innocuous fashion that most people don't pause to reflect on how remarkable that would seem to somebody born a few thousand years ago.

Mankiw on SOPA

First off, I am working on fixing what I describe as the Steve Jobs problem - that you generally agree with a lot of what someone says (or does), but you're only motivated to write about the small amount you disagree with.

So, with that in mind N. Gregory Mankiw is a cool dude. I first became a fan of his when he was George W. Bush's Chairman of the Council of Economic Advisers. He distinguished himself by sticking to economic theory even when it was politically unpopular, in particular defending outsourcing as likely to be of economic benefit to America. Which it is, for much the same reason that trade is beneficial - if it's cheaper to build a car in Korea, build it in Korea. If it's cheaper to answer a phone call in India, answer it in India. And with the savings we get, export more in the areas that the US does particularly well. I remember cheering for this even before I knew anything else about him.

Also, in recent days he's done a great job of attacking the 'Warren Buffet pays less tax than his secretary' idea, noting (correctly) that he implicitly pays tax through the tax on corporate income. His blog is always a good read for interesting mainstream economic analysis

So I like a lot of what he writes. And he's impeccably polite in dealing with intellectual opponents, which is exceedingly rare.

But I did find myself a little ... underwhelmed... at his discussion last week of repugnant Stop Online Piracy Act, currently (thankfully) off the legislative agenda, at least in the short term. SOPA, and it's house equivalent, PIPA, sought to make content providers more liable for their user-submitted content, and liable to have their entire site (not just the offending material) taken down if copyright holders alleged any violation. It could also compel search engine sites not to include allegedly infringing sites, with the definition of infringing being shockingly vague. In short, these were terrible Bills, designed to try to pad recording company and movie profits, the viability of the internet be damned. If you want a great summary  of the problems of the bill, Sal Khan of the Khan Academy has a very good rundown.

But Mankiw was more ambivalent.

The anti-SOPA crowd argues that this is a matter of basic liberty. But it's not. In a free society, you don't have the freedom to steal your neighbor's property. And that should include intellectual property. Moreover, it is the function of the state to enforce those rights. We don't leave it up to civil litigation to protect property rights (although that is part of the solution). We give the state substantial powers to stop theft. Just as owners of tangible personal property have good cause to call for a police force and a system of criminal courts, owners of intellectual property have good cause to ask the state to stop those who would infringe on their rights.

I find the statements in bold to be particularly sloppy. And to explain why, let's revert to some terms I cribbed from Mankiw's own 'Principles of Macroeconomics', currently sitting on my bookshelf.

Why is it wrong to steal your neighbour's property? Generally speaking it is because most goods are rival. If I take my neighbour's Ferrari, he is deprived of the use of said Ferrari. Taking the good is thus a pure transfer - I take it, and he doesn't get it.

Now that's manifestly not true of nearly everything that SOPA is targeting. If I copy an MP3 or a movie, I make a replica of the original file. I have not deprived the original owner (that is, the person who had the mp3 on his computer) of anything. To a first order of magnitude, welfare has increased. Before, we only had one copy of the mp3 to be listened to, and now we have two.

What has been lost is the potential funds that might have been transferred to the copyright owner. But this is a nebulous concept - suppose I set the price of my CD at $10 million, and 100 people pirate a leaked demo from the studio. Have I been deprived of $1 billion? Of course not. None of these sales would have taken place absent the piracy. In addition, the world has gained utility ex post, because now 100 more people get the enjoyment of listening to the music.

And Mankiw doesn't just obliquely run into this error in logic - he rams into it head on :

If offshore websites find a way to distribute this intellectual property without paying for it, it is as if organized crime were stealing merchandise from a manufacturing firm at the loading dock. It is neither efficient nor equitable.

No! No it isn't! If I take merchandise from a dock, then the merchandise (which is rival) can't be consumed by anyone else. An mp3 can be consumed over and over. Ex-post, nothing is lost.

There is of course one good argument for these kinds of efforts - that without legally enforced grants of monopoly rents to owners, there won't be enough of these goods produced. This is saying that we need these protections ex ante, because otherwise society won't have a movie industry or a music industry. This is similar in logic to why we need patents - their non-rival nature makes them a public good, and the monopoly rents help them be produced more because the market will not provide enough otherwise.

But is that really true? Yes and no. Piracy represents an existential threat to the movie industry, if  it happens often enough. Nobody is going to spend $300-odd million making Avatar if they're not making a return on it. It's unclear that piracy will get that common, since there really is a benefit to seeing a movie on a huge screen versus on your computer. So there is some tradeoff here.

This seems way less persuasive for the music industry though. People have been making music for millennia, and will continue to do so. Even if piracy becomes complete, the industry will (and already is) evolving into being based off ticket sales for live shows, with free online clips being like promos for the show. This worked as a model for minstrel singers for centuries, and would work now.

And the argument that 'you have a moral obligation to not take anyone's intellectual contribution without paying for it' is ridiculous. Suppose I write a catchy pop song. Should Greg Mankiw have to send me a royalty cheque before he is allowed to play a cover version on the guitar in his own home? Should I need to send Black and Scholes a cheque before I can compute the Black Scholes formula? Of course not. So clearly there is a limit to how much this rule applies.

And this is all such a completely obvious argument that I'm really surprised that Mankiw doesn't make it. Instead he resorts to really weak reasons for defending it. Mankiw personally (as he acknowledges) stands to lose a lot from piracy, as he writes a best-selling economics textbook.

Frankly, if I stood to lose as much as he did, I'd be trying to make much better arguments for SOPA-like laws than the ones he is offering up.

Why American Flight Attendants are so Rotten

My guess? Age discrimination laws. Once upon a time, the de facto rule was 'we keep you employed as long as you're young, hot and friendly. When these change, hit the bricks'.

This meant that being a flight attendant was one of those jobs that women (and at the time, it was just women) planned to do for a while then quit, like modeling.

Now, if you start firing people over 40, you get a massive lawsuit under the Age Discrimination in Employment Act of 1967. I would have thought that airlines would have implemented a 'when you're 35 you're out the door' policy, but they haven't. My guess is that unions make the rest of it hard.

But the net result is that flight attendants are less attractive. In addition, it seems that dealing with the flying public tends to grate in you over time. So you end up with a lot of older flight attendants who (in my anecdotal experience) are nasty and grumpy all the time. But since it's hard to write people up for that, it just persists.

The only major exception to this trend seems to be Singapore Airlines. The Singapore government decided that since it is in charge of the airline, messy things like discrimination and labor laws weren't going to stand in the way of providing young, hot, and impeccably trained flight attendants. Until they're 30, then they're never seen again. It's ruthless, but competitive markets that maximise consumer surplus usually are.

Harry Reid - Imbecile

Listen to this choice quote from the Senate Majority Leader:

'Millionaire job creators are like unicorns - they're impossible to find, and don't exist.'

Hand that socialist fool control of the economy!

Okay, okay, surely a quote this stupid has some additional context that somehow makes it coherent, right?

See the whole clip and decide for yourself.

If you (quite sensibly) don't want to spend 3 minutes of your life watching Harry Reid, let me summarise the context, : apparently nearly everyone with over a million dollars 'is lawyer or a hedge fund manager', and we know that there aren't any millionaire job creators, because NPR went around looking to try to interview one and said they couldn't find any. So them someone (at this point in his ramble, it's unclear whether it's still NPR doing the searching) started looking through Facebook (no, really), and found some guy who claimed to be a millionaire who was hiring, and he supported the Reid tax on millionaires.

Yes, that is the larger context in which this is meant to make sense.

Apparently according to this buffoon, individuals and small business owners create jobs, but only when their net worth is less than $1 million.

Because $1m is that lucky number where people just decide to coast, and develop a hatred of hiring anybody. Aggressive hiring expansions only take place by those with less net worth to pay their new employees, don'tcha know? No wait, the boss is paying for hundreds of jobs only out of the massive company earnings instead, even though these earnings somehow aren't translating into him having a net worth above six figures.

Next comes the second great plank in this Jenga Tower of Stupid, the claim that you can only be a job creator if you're a small business owner. Because it's not like a corporation ever hired anybody! Small business may be important, but it employs around half of private employees. Were you hired by Microsoft? Bad luck, because we couldn't get Steve Ballmer on the phone to claim to be a 'millionaire job creator', your job just came out of the ether!

Maybe it's because senior executives in large corporations don't have the hubris to claim that 'I created jobs'. Doesn't mean that they're not contributing. And maybe, just maybe, when your net worth starts to get higher, you're running a sufficiently large and complicated company that you're no longer arrogant enough to claim that every job there is created by you, and you alone.

But what about all those evil lawyers and hedge fund managers? They're not hiring anybody?

Well how do you think corporations fund themselves? The lawyers don't just bathe in a vault of money like Scrooge McDuck. They tend to invest it in ... bonds and stocks! Which are issued by the corporations, and the capital from which is used to expand.

The clip itself was posted by the Democrats, who liked this speech so much that they advertise it.

As Ace of Spades said about this incident:

I am actually moving away from the question of "Can America survive?" to "Should America survive?" 

Indeed.

Update: I also forgot to mention the other distinct possibility for explaining why NPR can't find any millionaire job creators - people who have a million dollars may find it in poor taste to publicly boast about that fact, and the only exceptions are people who are doing so as a way of ostentatiously flouting their socialist bona fides. I can just imagine the phone call now - "Hi, this Jim Jones from NPR, and we were wondering whether you, John Smith, would like to be the public face of 'millionaires who oppose tax hikes'." Yeah, who could possibly refuse that interview?

File this under 'unpersuasive'

To put it mildly.

Robert Frank wrote an op-ed claiming that there was an arms race in thanksgiving store opening hours which, of course, needed regulation. Tyler Cowen wrote about it, and Frank sent Cowen an email with some additional details. Included was the following anecdote about the recent allowing of Sunday trading hours in liquor stores in New York State :

I had a recent conversation about this issue with a friend in Ithaca who owns a wine store. Traditionally, New York State wine merchants were not allowed to do business on Sundays. But last year that restriction was repealed, and I asked my friend how the change had affected him.

His overall sales were about the same, he told me. The change had thus been a clear negative from his perspective, since it meant that he and his wife were no longer able to spend Sundays together with their children. The upside was that customers who lacked the foresight to shop in advance for their Sunday wine needs could now be accommodated. If we’re willing to discount the cost of an inconvenience suffered by those who could easily have avoided it, the costs in this case seem clearly to outweigh the benefits.

You don't say! If you're willing to discount the main cost of a given action, the benefits will frequently outweigh the costs. Feel free to try this with a range of meddling economic proposals:

-If you're willing to discount the millions in unrecoverable funds, the benefits of the government guarantee of Solyndra seem to clearly outweigh the costs.

-If you're willing to discount the cost of reduced competition and higher prices, the benefits of mandatory licensing of interior decorators clearly outweigh the costs.

 etc.

But there's an easier way to tell that this proposal doesn't make sense. What's so special about Sundays? Why not restrict Mondays as well? Or only allow trading one day a week? After all, if we're willing to discount the inconvenience suffered by those who could easily have avoided it, these would clearly make sense too!

Eventually, the Robert Franks of the world would look at this and say, yes, but there's a limit, customers need some convenience.

But this implicitly acknowledges that his argument, as phrased, is a crock. It's not that you can actually 'discount the cost of an inconvenience suffered by those who could easily have avoided it', but instead that Robert Frank thinks that the inconvenience they suffer is less valuable than the benefit to the liquor store owners.

To which I ask, how exactly are you arriving at that conclusion? Because it sounds a lot like you're just pulling that conclusion out of your @**, and you'd have no idea what the actual inconvenience to customers is, nor how many of them there are, nor how to value it.

Personally, I cannot fathom a theory of government that says if I want to open my store at 9am, 4pm or 2am to sell you a computer, a suit, or a bottle of whisky, why it is any business whatsoever of the government's. A government that is willing to intrude in this is willing to intrude in absolutely anything.

High Marginal Value Cleaning

The law of diminishing returns is called a law for a reason. The more of something you do, eventually the payoff decreases. It might increase at first (e.g. if there's network effects or economies of scale), but sooner or later, it turns negative.

But if you're clever, you can use this to your advantage. Take the lazy bachelor's approach to cleaning. Suppose (entirely hypothetically in my case, I assure you), your bathroom is quite dirty. In the case of cleaning, the first efforts at cleaning have huge payoffs. Just wipe the floor with a paper towel and you'll pick up maybe 70% of the filth. And it only takes 5 seconds! This is clearly a huge return on effort. But if you really want to get the floor clean, you'd have to get the mop and bucket, run the water, put in detergent, scrub the floor, and wait for it to dry.

In other words, that last 30% is going to take you 10 minutes, minimum. Honestly, who's got that kind of time?

The answer, of course, is people who are OCD about dirt, clean for a living, or have too much time on their hands.

It will come as no shock to those who know me in real life that I would self-classify as none of those three. Okay, maybe the third one is true (see, for instance, this blog), but I don't have the inclination to spend it cleaning.

If you don't believe me, just ask David Ricardo:

You should listen to your friend David Ricardo, he's a cool dude.

Market-Clearing is Overrated

In Australia, today they voted in the Senate to pass a tax on carbon dioxide.

Now, there are some reasonable argument for having a world-wide price of carbon, assuming countries could somehow be arm-twisted into doing so.

There are bugger-all reasonable arguments for imposing carbon tax when very few other countries are doing so. All that will happen is that carbon-intensive industries will be exported overseas.

But (as Tim Blair notes) to add to the hilarity, the tax comes in at a specific amount - in this case $23 a tonne. The trouble is that the current carbon price in Europe is about half that. You can see the progress for yourselves.

But that's alright, we've got Climate Change Minister (yes, really, Australia actually has one of those) Greg Combet to point out the answer:

But Climate Change Minister Greg Combet is not convinced the difference demands a change in the local price, saying a few months ago the European cost was “there or thereabouts” of $23 a tonne.

“We’ve just got to take a bit of a longer term view of this,” he told ABC Radio

Hmm. Any particular reason you think that the current price is unrepresentative, but the old price is clearly accurate? Any reason at all? I mean, if you're willing to admit that the market is inefficient today, why is 'a few months ago' the gold standard for the halcyon days of price efficiency?

Don't hold your breath waiting for a good answer to that one. But even this is beside the point - efficient or not, the European price of carbon right now is a lot less than it will be in Australia. (Not to mention that the Chinese price is forecast to be $0 for quite some time now, with an R-Squared of about 100% on that regression). As long as there's going to be a price, it ought to be the market price. Unless you think the relevant market is the US and China, in which case we're back to the earlier Shylock regression.

In Australia, the price will be at $23 a tonne, which some days will be less than Europe, and other days will be more.

In other words, the price will definitely not be a market-clearing price. This gives Australian firms a fluctuating competitive position relative to Europe, and a permanent disadvantage relative to just about everywhere else. Heckuva Job, (Bob) Brownie!

One prediction I can make with some confidence - expect the market for Australian-produced Aluminium to start clearing very rapidly at an equilibrium quantity supplied of zero.

Alan Joyce, You Magnificent Bastard!

So over the weekend, Qantas Airlines grounded all of its planes, without any warning. This of course stranded thousands of passengers, and did massive damage to the Qantas brand. The Associated Press has a reasonable summary.*

This story all unfolded very fast, and it wasn't quite clear what the hell was going on. After reading around, here is what I've managed to piece together as the underlying explanation:

Firstly, to make any sense of this, you need to know that a lot of Australia's industrial relations disputes are governed by statute. In other words, there are courts to decide what strike actions are acceptable, and what wage and conditions are reasonable in various contracts. Sounds monstrously stupid? That's because it is! Apparently people need the government to intervene in private disputes, because of ... well, who the hell knows? The point though is that when unions get into a stoush, it will end up being settled by a quasi-court body like 'Fair Work Australia'. That's point #1.

Secondly, the Qantas unions (baggage handlers, pilots etc.) have been engaging in rolling strikes for several months now, causing huge damage to the company. It's workers are already paid pretty damn well - baggage handlers make between $70,000 and $85,000 including penalty rates but not overtime, an amount over 20% above the industry rate. For lifting suitcases. And they were demanding even more money, based on the impeccable logic of 'Hmm, the company seems to be turning a profit - why don't we try to expropriate all of that to ourselves, even though we're not actually adding any more value?'.

Thirdly, Alan Joyce, the CEO of Qantas, decided that if he gave into the union's demands, Qantas was going to go broke. This has actually happened in the last decade, with Ansett Australia, one of the previous major airlines, being liquidated in part to ridiculous union demands making it unprofitable.

So here's where it gets interesting. With the unions engaging in industrial action, Alan Joyce took the radical step of a lockout of union employees, grounding the airline in the process.

Now, on face of it this seems odd. Usually, union lockouts are designed where the company hires a bunch of non-unionised strike-breakers and plans to engage in a long-term plan to replace the union workforce. At a minimum, lockouts are meant to harm the workers by depriving them of wages for an extended period, thereby hoping to make them concede.

But that clearly wasn't the case here. Qantas couldn't possibly replace its workforce in a hurry, and if they didn't get flying again soon, the company would be finished. So what the hell was the point?

The point, which I was slow to realise, is that the lockout was actually designed to force the hand of the government and Fair Work Australia. In other words, Alan Joyce was doubling down by making the union's industrial action implicitly not just a problem for Qantas management, but for the entire travelling public, for Australia's reputation as a safe place to do business, and for the whole Australian tourism industry.

He was wagering, in other words, that the grounding of planes would cause such a holy sh*tstorm that the government and Fair Work Australia would do just about anything to get the planes back in the air. And they did - they declared the lockout over, but much more importantly, they declared that future union strike action was illegal. Bingo - game over unions, victory to Qantas.

In addition, the government was complaining that Joyce didn't give them enough notice. As it turns out, this claim looks to be bogus. But on the other hand, Joyce was also in a game of chicken with the government too. The Labor Party is beholden to the unions. If Joyce had tipped them his plans early, they would likely have taken the opportunity to figure out how to make him into the bad guy and try to get him to back down. When he presented them with the lockout as a fait accompli, there was nothing they could do. He'd already committed to shutting down the airline if needs be, and the only Nash Equilibrium was for the courts and government to back down.

It's far too early to tell what the longer-term damage to the Qantas brand will be from all of this. But screw it, even if this is the end of Qantas, what a way to go out! You can either give in to the unions and slowly die of unprofitability, or you can give them a big middle finger, knowing that either you'll win the dispute, or you'll go out like Francisco D'Anconia.

Alan Joyce, in other words, had both a very clever strategic and political insight, and the huge brass balls to pull it off.

The grounding of Australia's major airline over industrial action is something to regret greatly, not least because of the huge disruption to lots of innocent bystander travellers.

But Alan Joyce deserves serious props in my book for staring down the unions instead of giving them the airline. Very nicely played, Mr Joyce. Very nicely played, indeed.


*(My newspaper of choice, The Australian, has decided to put all their content behind a paywall, also known as the 'I really felt we had too many readers anyway' strategy, so you get the AP instead. This also goes to show that companies are more than capable of destroying their brands without any union interference).

Free Business Plan of the Day

McDonalds is an astonishingly successful franchise. If you need to get a clear example of this in practice, just look at the distribution of customers across restaurants in the average airport.

Every time I go past one, the McDonalds is easily the most packed place there. For some reason, the appeal of cheap and tasty comfort-food hamburgers is especially large for tired travelers whose self-control is depleted. The queues in front of the place are typically at least twice as large as those at the next most crowded place.

Let us make the rather heroic assumption that the profit per customer is similar between McDonalds and other comparable fast food restaurants at the airport. By this measure, being the most packed place is a pretty good proxy for being the most profitable. I can’t back this up with any hard numbers, but I’d be willing to wager a decent amount of money to this effect at 2:1 odds.

But here’s where things start getting weird. My guess is that not only is McDonalds the most profitable store at the airport, but I’d wager that the difference is so big that the second-most profitable restaurant you could open at the airport would be another McDonalds in the same terminal, right next door to the first if needs be. Even though you’ll clearly be competing with (and cannibalizing) the first one.

Now, this obviously doesn’t appear to happen. I’m not sure if the McDonalds franchising arrangement prohibits McDonalds granting another franchise license within a certain distance (it probably does). And I’m not sure the airport would grant another McDonalds tenancy right next door (they may not, based on a nebulous idea of serving different customer needs, although my guess is that they should, if they’re profit-maximising). 

But it’s just possible that nobody has thought of an idea so absurd as opening up a second McDonalds right next door. My guess is that it would make quite a bit of money. If you decide to avail yourself of this awesome free business plan, make sure to let the manager of your store know that you owe a guy called Shylock a free Big Mac Meal. I'll plan to collect when I run into two McDonalds stores at an airport within 15m of each other.

Save Water, Comrade! The Glorious People's Republic of Australia Demands Your Sacrifice!

Politicians are, for the most part, suspicious of decentralised controls of any sort. Instinctively they tend to reach for technocratic solutions to problems, where a bunch of smart people can come up with clever solutions to problems and then boss around the reluctant citizenry, for their own good of course.

One example that always amused me was the absurd way that Australian governments approached questions of water shortages. If you believe what the government tells you, Australia is permanently short of water.

Part of this shortage is due to deliberate government mismanagement of supply. Namely, they refuse to increase it by adding more dams. As Andrew Bolt has pointed out:

No, the real cause of our shortage has been as I’ve warned since 2001 - that Melbourne has added a million more people since we built our last big dam, the Thomson, and never bothered to find more water for the newcomers’ extra showers, toilets, washing and gardens.

So there's a lot of environmental hysteria that effectively makes it impossible to build another dam, the one technocratic solution that might actually solve the problem.

But let's forget about that, and just take the supply as being fixed. People keep using a lot of water, and the dam levels are getting low. How can we solve the problem?

If you're from an Australian state government, the answer is clear - we need a public advertising campaign hassling people to use less water. "Target Every Drop", we'll call it! Are you taking a 10 minute shower? Shame on you! You should feel guilty for enjoying that water for more than 4 minutes at a time! We'll guilt the plebs into better behaviour!

That's Plan A. To the astonishment of absolutely nobody, this plan seems to work as well as the laughable 'Whip Inflation Now' campaign of the seventies (memorably described by Alan Greenspan as 'unbelievably stupid').

Okay, so what's Plan B?

Forced water restrictions! Firstly you can only water two days a week in the early morning or late evening, and we'll encourage your neighbours to dob you in if you exceed this. Failing that, we'll restrict you to only using a hand-held hose! "Deadweight loss", you say? Never heard of it! It'll be good for the proles to get the exercise of walking back and forth. And if that doesn't work, we'll restrict them to using buckets!

I haven't seen the next step of restricting the public to water their gardens only using teaspoons, but surely it can't be far away.

As this happens, millions of dollars in property damage pile up as lawns and gardens turn brown and die. Never mind! We all must sacrifice!

Wait a second - here comes the pesky Australian Bureau of Statistics to point out that in New South Wales, agriculture comprises 46% of water use, while all households combined only account for 12%. Hmmm, so we could eliminate the households altogether and it might not save that much water?

Here's what's staggering about all this: at absolutely no point does it seem to occur to do the one thing that would really stop the problem of excess water use - raise the bloody price of water! They're growing rice in New South Wales, for crying out loud! Do you think this kind of economic activity makes the slightest bit of sense in a semi-arid climate with a market-clearing price for water? Of course not.

If there's one thing markets are really, really good at, it's solving shortages. If you just raise the price, people will save water all by themselves. You won't need to hector them. You won't need to make them waste hours watering their lawns with a thimble. You won't need to spend millions of dollars on advertising campaigns in order to not reduce water consumption.

And even better, they'll reduce consumption without you having to do anything or spend any money. They'll put in more water efficient plants. They'll take shorter showers. They'll replant their rice fields with wheat or something better suited to the climate. And a thousand other things that the bureaucrats never thought of.

And the ones that don't? Well, that's their way of telling you that they value the water at the market-clearing price. They really, truly are getting a lot of utility out of that 10 minute shower.

So here's the bottom line. I refuse to feel the slightest bit guilty about taking long showers as long as the water department are blowing taxpayer dollars on ridiculous ads. If you want people to use less water, raise the damn price.

Mixed Strategies

John Nash would be proud.

Today is clearly a double-dose of Yank Sports + Economics.

In other news, penalties for 'excessive celebration' are seriously pissweak. When even curmudgeons like me who don't care at all about American football think the rule is just needlessly squashing the joy in sports, that's a pretty lame achievement.

Moneyball

Let me start with the punchline:

If you've ever run a regression in your life, you should definitely see the movie Moneyball.

This is a sufficient but not necessary condition for liking it - it's a very good movie anyway. The combination of Michael Lewis for the original book and Aaron Sorkin for part of the script is a pretty damn compelling one.

It's the story of the Oakland Athletics, and how the general manager (Billy Beane, played by Brad Pitt) got a great team on a tiny budget by following the advice of Peter Brand (played by Jonah Hill), who uses a data-driven approach to identify undervalued players and better strategies to winning games.

The whole movie is like catnip for econ nerds. The main guy who shakes things up is this fat, awkward young guy who studied economics at Yale. And even better, the obligatory montage for any movie seeking to convey computer programming (closeups of lots of numbers, statistical looking outputs) featured code running in Stata! I was at this point thinking Ha ha, I run those regressions too! I could be that fat econ nerd. No wait - I am that fat econ nerd!

But the phrase 'catnip' above is deliberately chosen, in the sense that non-statistical people are likely to see it differently. The key dynamic is that Brand/Hill has the underlying regression-based strategy for winning games, and Beane/Pitt is the general manager who sees the promise in the idea, and implements the it against the wishes of the establishment. So which of the two is more crucial to the process? Both are are necessary, but which part you emphasise depends on how you view the world.

Here's how IMDB describes the movie:

The story of Oakland A's general manager Billy Beane's successful attempt to put together a baseball club on a budget by employing computer-generated analysis to draft his players.

In other words, to the non-statistical public, the role of Brand/Hill is limited to 'computer-generated analysis' -  this is a story about the general manager with the vision. The statistical guy is the wonk who runs the numbers in the background. Same as in finance: you need the quants to do the analysis, but you need the visionary portfolio manager to know when to implement it.

The stat nerd views it as follows: 'Screw that! If I could only pick one of them, the data guy knows the strategy to run, and without him the vision guy is toast. Ulysses Grant won the Civil War for the North, not Abraham Lincoln'.

The CEO type rejoins: 'Lots of people have visions for how to run baseball, and a large part of being a general manager is knowing who to listen to. If you can't get yourself into a position of authority to actually make the decisions, your strategy is useless. Lincoln had to go through seven generals before he found Grant.'

(In an ironic twist for the nerds, in real life Paul Podesta was the assistant GM, but he didn't want his name used, in part because he objected to being portrayed as a pure stats nerd. So he became 'Peter Brand'.)

And in fairness to Beane/Pitt's character, he does come to understand and embrace the strategy, and we're also shown that he understands the general problem even before coming across Brand/Hill. Specifically, how can teams with small resources and budgets hope to compete with the far better funded Yankees?

The answer is screamingly obvious to econ types - stop trying to buy the assets that everyone agrees are the best, for which you'll almost certainly overpay, and start buying the most underpriced assets that get you the same output. I've written about this before in the context of stocks:

In the language of the common man, you're better off buying a crappy but underpriced company than a solid but overpriced company.

As it turns out, this is as true in baseball as in any other business.

The tragedy for Oakland, of course, is that any strategy that exploits mispricing will be most effective when few other people are doing it. The best chance for this actually getting them a World Series was the first year it was tried. The more people think the strategy is successful, the more it gets copied, and the less of an advantage it brings you. True to form, the Oakland Athletics have still not won a World Series since the strategy was started..

Update: The one scene that the movie didn't show is the one where the strategy initially isn't working, and Brand/Hill is seen furiously re-checking his analyses late at night and muttering to himself, 'Oh $#**, I really hope I didn't make a coding error or run a badly mis-specified regression.' Because I guarantee you that that happened at some point.