Good questions

Speedmaster, at the Pretense of Knowledge, asks a couple of good questions:

1. If companies/corporations can simply get rich by being greedy, “gouging”, and otherwise scr*wing customers. Why does any company/corporation ever go out of business?

2. If minimum-wage laws are necessary to prevent employers from paying less than that, why does anyone ever earn more than the legislated minimum-wage?

Markets in Everything: Souls

In this post, the Freakonomics blogger Stephen Dubner posts an offer from Caleb B. who is looking to buy souls for $10 to $50.

Here’s his offer:

…what is it about the idea of a soul that even people who confess to not have one are hesitant to sell it? I have been trying, for the better part of ten years, to buy a soul. I’ve offered a dollar amount, between $10 and $50, for someone to sign a sheet of paper that says that I own their soul. Despite multiple debates with confessed atheists, no one has signed the contract. I have been able to buy several people’s Sense of Humor and one guy’s Dignity, but no souls. Additionally, will any Freakonomics reader take me up on this? I’m willing to spend $50 on souls.

One fellow, Jared, says he’ll take the offer:

Caleb B., I will absolutely sell you my soul. To be fair, this won’t preclude me from selling it again to other suckers who (a) believe in souls and (b) believe they can be readily transferred on purchase. To be clear I’m offering because I don’t believe (a).

Or does he?

In my opinion, Jared’s conditions make this a non-sell since he’s reserving the right to sell his soul again to someone else.  In other words, he’s trying to take Caleb’s money.

With these conditions, it would be easy for Jared to get his soul back if he ever decided he’d like to.  He’d just need to find a willing person to sell it to…again… and then buy it back from them.

I love Caleb’s approach.  It taps into what economist, Paul Samuelson, called revealed preferences or, as non-economists say, putting your money where your mouth is.

That is, we say we will behave one way and then we behave differently when we face the actual consequences.

The Post Office beats Paperboys (and girls)

As a former paperboy, I was a little disheartened to receive my community newspaper  in my mailbox instead of on my driveway.  I noticed that my name and address was printed on it.

I opened the paper and saw the announcement that it was changing to mail delivery.  I found a couple paragraphs in the announcement interesting.

First, I was surprised by this paragraph:

We’ve been proud to have served as the “first jobs” for hundreds of outstanding independent contractor youth carriers, providing the opportunity for young people to learn responsibility and get real-world customer service, sales and entrepreneurship experience.

I was surprised because newspapers are normally vocal supporters of minimum wage and child labor laws.  I suppose its only okay when they employ children and pay less than minimum wage.  After all, they know they are well-meaning, but they can’t be sure about other employers.

I was also surprised that the paper recognized the opportunity of a “first job”.  This is something editorial boards fail to consider when supporting minimum wage and child labor laws.

Here’s the second paragraph I found interesting:

Kids’ lives (and their parents’ lives) are busier now than ever before.  With the increasing number of school and after-school functions, sports, church, club and family activities, it has become increasingly difficult to recruit and retain a full complement of reliable, dedicated youth carriers…

There’s a couple points to consider here.

One, maybe the gig simply just doesn’t pay enough.  I gave up my paper route quickly.  It was an early lesson in opportunity cost.  I could make as much mowing four lawns what it took in a month of throwing papers.

Two, with all the activities in our kids lives, when do they learn how to be productive in working world, live within a budget and support themselves?  Some of them seem to be learning this way too late.

With one-size-fits all education, it costs only time and opportunity costs (which are hard for children to assess sometimes) to participate in an abundance of activities.

I recall reading several months ago about one school district that had gone to a fee-based approach with extracurricular activities and kids were having to make tough choices.  Instead of running cross country and track, some could only afford to pick one because each cost the student or their parents about $1,000.  The nice thing here is that perhaps being more selective on school activities free up their time to be productive and get a job.

“What do we need jobs for?”

A commenter on the blog Carpe Diem linked me to this excellent Wizard of Id parody:

As Homer Simpson says, “Doh!”

Perhaps one reason we have over 9% unemployment is because the opportunity cost of not working is lower than it use to be.

“I can turn this $100 bill into 100 pennies!”*

In their book From Poverty to Prosperity, Arnold Kling and Nick Schulz examine a few natural experiments of side-by-side countries with varying economic “software” or economic systems.

I think this nicely sums the results of these experiments (p. 135):

Another dramatic example of the effect of bugs in the software layer [their term for economic systems and institutions] is the difference between Communist and non-Communist countries.  In the aftermath of World War II, some countries, notably Germany and Korea, became divided along ideological lines.  North Korea and East Germany were Communist.  South Korea and West Germany were capitalist.

The results of this “natural experiment” were striking.  By 1997, North Korea’s GDP per capita was $700, while South Korea’s was $13,590, or nearly 20 times as high.

They then quote the work of Jaap Sleifer which showed that East Germany’s per capita income was 103% of West Germany’s before World War II and shrunk to 31% by 1991.

That should be sobering to anyone who holds romantic notions for a centralized economy.  The opportunity cost in living standards is enormous.

They go on:

Another telling phenomena is the immigration of workers from Latin America to the United States.  Crossing the border appears to make the productivity of a low-skilled worker ten to twenty times higher, based on the wage differential for low-skilled workers in Mexico or Central America and the United States.

These natural experiments are good to keep in mind as some folks encourage centralization of large swaths of our economy.  Years down the road it will be difficult to know how much improvement we traded away, but the outcomes of these natural experiments should give you an idea.

If you have a tough time imagining these differences in living standards in terms of numbers, then imagine it in terms of time periods.  A low-skilled worker crossing the border from Mexico to the U.S. is similar to someone from around 1900 to 1930 America being transported to around the year 2000.

If you still have a tough time imagining this, watch Back to Future III, where Marty McFly journeys back to 1880s Hill Valley.  While eating dinner with his great-great grandad, he’s shocked when he discovers that the meat he’s eating contains buckshot from the fresh kill and his water looked fresh from a mud puddle.  I liked this scene because it’s little improvements like that that we never think about and we take for granted.

*The title of the post is a quote from the television series Arrested Development.  Gob impressed the Board of Directors with this magic trick.  His brother, Michael, pointed out that the Board didn’t realize that Gob’s magic just cost them $99.  Similarly, folks who hold grand visions of centralized planning never seem to realize how much those truly cost when implemented.

Let your customers do the experimenting

I saw a piece on CNBC the other day about the new Coca-Cola Freestyle soda fountain.  It uses a touch screen and inkjet printer cartridge technology to bring a soda fountain that delivers 106 soda flavor choices to a restaurant near you.

I know this sounds extremely spoiled, but each time I go to a place with a soda fountain with only 10 or 12 choices, I find myself wishing there were more because none of the available choices are that appealing.  (I also wish it dispensed beer).

The Freestyle communicates it’s daily “pour” statistics to Coca-Cola HQ so they can track which flavors are selling.

Offering 106 flavors in the space of a typical soda fountain is an awesome value proposition (though I am disappointed that I don’t see a cranberry flavor on the offerings – man I’m hard to please).  The Coke spokesman said that in many locations they find that each flavor is poured at least once each day, so I’m not the only one pining for more choices at the standard fountainhead.  Offering an order of magnitude more choices is good as evidenced by this usage stat.

This also enables Coke to let the customers experiment with and test market flavors.  Coke can’t stock 106 flavors in the supermarket.  There’s not enough space.  But, they can track results from the Freestyle to see if there are any hot selling or hot trending flavors that might outsell some of the flavors they do stock.   And they can do this geographically.

Nice job Coke.

“Giving back”

Syracuse University's Carnegie Library. Taken ...

Carnegie Library at Syracuse University

This post from Don Boudreaux and this opinion piece from Daniel Henninger at the Wall Street Journal are about  “giving back” to the community.

Boudreaux takes exception to the use of the phrase after receiving a promo piece from Ritz-Carlton touting their “giving back” to the community activities.

Please, though, unless your profits are the product of dishonest deals or theft, please drop the rhetoric of “giving back.”  This sort of talk implies that you possess something that isn’t rightfully yours.

Henninger defends against the idea that the government must act as the intermediary of “giving back” by pointing out that voluntary philanthropy seems to be working well:

Since the Pilgrims, no nation has seen more wealth flow back from those who earned it into the welfare of the nation they inhabit.

Andrew Carnegie alone built more than 1,600 libraries in the U.S. Today, according to Internal Revenue Service data, there are some 110,000 grant-making private foundations in the U.S. Beyond the foundations bearing the names of famously undertaxed plutocrats such as Warren Buffet and Bill Gates there are another hundred thousand or so, often run by modestly wealthy families whose foundations support a vast array of needs—scholarships, schools, hospitals, cultural institutions and even causes across the political spectrum, no doubt including windmills.

Great points.  But I think there’s a more important point that we overlook when thinking about “giving back”.

Before business owners donate a dime to charity they have already “given back” a great deal just by the mere existence of their business.

First, they’ve given back in the form of the value they create for customers who voluntarily pay for the business’s product or service.  It’s this value that differentiates us from our cave dwelling ancestors, gives us the standard of living we enjoy, enables government to exist and generates the wealth that can be donated to charity.  And that is not well understood by most people.

Many people seem to view businesses as criminal-like organizations designed to exploit customers, even though most of these same people take delight and comfort in many of the products these enterprises make available to them.  This has to be some sort of paradox or dissonance.

Second, businesses have “given back” in the form of the gainful employment they’ve provided to the employees of the business.

Because of the value of the products and services and the jobs it provides, I contend that owning and operating a successful business often does more good for the community than a charity and is the source of what allows us to donate to charity.

Even wealthy folks don’t seem to grasp this.  Once they earn their wealth, they often create charitable foundations to “give back”.  I don’t begrudge them of their right to do this.  But, I wonder if they consider whether that’s the best use of their wealth.

Henninger cites Andrew Carnegie for building 1,600 libraries.  I love libraries and I think they add tremendous value to a community.

But, we ignore opportunity cost and we don’t ask what would we have if Carnegie didn’t build a library for us?  Would we have nothing?  I don’t think so.

Donations were not used to open thousands of Blockbuster video stores across the nation, which is essentially a for-fee library.  Donations were not needed for Netflix and RedBox to find better ways to lend videos.

We might have something very different without Carnegie’s libraries, but I believe we would have something.  Without Carnegie, libraries might look more like Blockbuster than the august buildings we have now (see picture).  But, is that really so bad? Do we like libraries because of their grand buildings or because they give us access to a wide range of books, periodicals and reference materials?  My local library is not in an extravagant building and that doesn’t stop me from using it.

Rather than over build beautiful free libraries, perhaps Carnegie could have paid for the less fortunate to use Blockbuster-like fee libraries that may have emerged.  He could have invested in for-fee libraries and built an organization that could be sustained by its users rather than third party funding sources.

Which brings us back to opportunity cost.  Was there a more effective way for Carnegie to use his money?

I would argue yes.  We’ll never know how much better off and how many more jobs we would have now had Carnegie decided to invest and grow more businesses instead of building libraries that might have been built anyway.

The same goes for many of the other wealthy who are “giving back”.  They may find creative and effective ways of donating that will produce great value.  But, all I ask is that they consider that, for some, the best thing they may be able to do is to reinvest and teach others how to carry on their efforts.

Gas prices

A common quandary that perplexes many folks is fluctuating gas prices.  Whenever gas prices increase quickly, I typically hear something like the following:

  1. The cost of the current stock of gas in the underground tank at the gas station was bought at a lower price.
  2. Rising gas prices do not change what the gas station paid for that current stock.
  3. The gas station could keep the lower pump price and still have cleared a nice profit on that stock of gas.
  4. Why do they raise the price?  It must be greed.

I have something for folks who have not got past this quandary to think about.

Let’s say you bought a rookie baseball card for pennies.  Years later, that rookie develops into a future hall-of-fame player and is loved by a large fan base.

Ten years from when you bought that rookie card, you discover you have it and look up the market value and find that it is now worth $50.

You tell a friend that you have the card.  He wants it.  What do you consider to be a fair price?

You tell your friend the price is $50 since that’s the market value.  He might argue that it only cost you a few cents and even with inflation, the cost of the card to you in today’s dollars is $1.   He might offer to pay you a storage fee of $0.10 per year, which brings the total offer price to $2. Does he have a fair argument?  Are you motivated by greed for not agreeing to sell it for $2 and wanting $50 instead?

While you are negotiating a price with your friend, the player tragically dies in a car accident and you find out the next day that demand for his memorabilia has increased substantially.  You see his rookie card is now selling for $400 on eBay.

Remember, you only paid a few cents for the card and you have not agreed to a final price yet.  Do you accept your friend’s offer of $2?  Do you stick with your original asking price of $50?  Do you raise the price to $400?

If you choose the second or third option, you are behaving identically to the gas station owner and you are not being motivated by greed, but rather by your opportunity cost.

By selling the card to your friend for $2 you would give up the opportunity to sell it for $400 and you are giving your friend that opportunity. You recognize that what you paid has little bearing on the situation.  You also recognize that you would be giving your friend $398.

Now, let’s revisit the gas station.   The gas station owner fills his underground tank for $10,000 and sets a price that will earn him $11,000 once all that gas is sold – a tidy $1,000 profit.

A fire takes out a major refinery and the price of gas on the commodity market jumps.  The gas that cost the the owner $10,000 last night is now going for $15,000 on the commodity market.

Let’s say there’s a local law that requires the gas station owner to not change his price until he sells out of this batch.  He can sell the gas to his customers and make $11,000 or he can call his supplier and have them come pump the gas out of his tank and sell it back to them for $15,000.  Which would you do?

Trump ignores the opportunity costs of his foreign trade policy

In today’s column, Thomas Sowell proposes that one reason Trump is leading the Republican polls is his:

…ability and the willingness to articulate his positions clearly, forcefully and in plain English. Too many Republicans talk like the actor of whom a critic once said, “he played the king like he was afraid that someone else was going to play the ace.”

Sowell has a good point, but I think there are other characteristics that make Trump appealing to folks.

One, he isn’t a politician, yet.  Two, he is market tested.  His TV show attracts viewers. Three, he is a successful businessman, which appeals to folks who want jobs.

But, folks need to get over their crush on Trump.  His foreign trade policies stink and his views on government are no better than any other politician.

First, foreign policy.  With his protectionist approach, he wants to restrain imports to create jobs.

He doesn’t understand that is like me deciding not to buy food from grocery stores (imports to my home) so I can create the job of growing my own food.  While it’s true that restraining grocery imports to my home will create work for me, most people will deduce that I am not better off with my protectionist policy.

Instead of working an hour each day to buy those grocery imports (and an overabundance of calories), I will now need to work 10 to 12 hours plus weekends to produce just enough calories to sustain myself.

Which means I also need to give up whatever it was I was doing before to earn the wealth I used to buy the imports.  What I gave up to produce my own food is my opportunity cost.  It’s a steep cost that nearly everyone would advise me not to incur, wouldn’t you agree?

Yet it’s that very same opportunity cost that Trump, and all the folks who like what he says, ignores.  While he points out the work that is created, he misses the opportunity cost of creating that work by restraining imports.

My example is not much different when you expand it from the boundaries of my property to the boundaries of our country.

The big difference is that whomever is made busy with protectionist policies are easy to find and make great emotional anecdotes in Trump’s stump speeches, while the enormous opportunity costs (like going from one hour a day to earn an abundance of calories to 10-12 hours + weekends to produce a sustenance level of calories) are spread across millions and cannot easily be imagined or pointed out in a stump speech.

The other problem I have with Trump is that, like most politicians, he seems weak on the Constitution and the role of government.   I think he suffers from the same affliction as Obama.  He believes the President’s role is to run the country rather than defend liberty.  Unfortunately, many of the voters in the country have that affliction as well and vote accordingly.

Steven Levitt on health care

On the April 13, 2011 Freakonomics podcast, Steven Levitt describes the two problems he doesn’t believe were addressed with health care reform.

The following is my dictation of Levitt’s comments, which start about 10 minutes into the podcast:

There were two things you needed to do to health care reform to materially improve the situation.

The first was to break the link between the provision of health care and employment.  That is just an archaic element of our health care system that really makes no sense, and yet because of tax subsidies, it’s the way that most get their health care.   There’s no good economic justification for it.  If anything, I think this health care reform bill strengthened that link.

Why doesn’t it make sense to have health care tied to employment?  I think that you actually want to turn the question around.  Why in the world would you want it tied to employment?  I think there’s no good reason.  For one thing, many people don’t work.

It leads to job lock, where it’s difficult to change jobs, and it leads to circumstances where we have to have these overlapping systems, which are inefficient.

He then asks a question I often ask:

Why is your auto insurance not tied to your employer?

Reason number two:

An even bigger problem with health care today, which was not addressed at all in the reform bill, is that people aren’t paying for the services that they’re getting.

It’s virtually the only part of the economy where I can go out and get any service I want — cancer treatment, open heart surgery — whatever it is and I pay $3 for it even if it costs $50 thousand or $100 thousand.

Then Levitt goes on to explain that health care is just like any other good in the economy and because

…we aren’t charging people for it what it costs to produce, people are inefficiently consuming it, they’re making the wrong choices and you can tolerate that if it were a small part of the economy, but since it’s 15% to 17% of economy we have to treat it like its any other good.

Now people hate to talk about this trade-off between health and life and money, but the fact is that if not today, then sometime in the not too distant future, we’re going to have to make trade-offs, such as my grandmother is in a vegetative state being kept alive by machines pumping her heart, and instead of the state paying for that, they’re going to say, look, you’re going to pay for some of this.  You can either take the $150,000 and we’ll keep your grandmother alive or you can put your kids through college, your choice.

And people are going to have to start making those tough choices.  It won’t be pretty.  It won’t be fun or happy.  Economics is the study of scarcity and in a world where health care becomes more and more costly, the scarcity is going to be more and more binding and we’re going to have to make those tough choices that are imbued with this moral element, but nevertheless it’s an economic choice when you get down to it.

I agree with Levitt.  I believe these two things will do more to improve the status of our health care and the world’s health care than anything else.

But, as I typed the last two paragraphs it occurred to me that perhaps those tough choices are what people hope to escape.  In a freer health care market, we fear for that moment when we have to make such an economic choice, knowing we have to live with it and others may question our motives.  Maybe its easier on our conscience to have someone else make that choice for us.  Or we’d rather make the choice without money being a factor.

However, something I think many of us overlook is that innovation and competition in a freer health care market could drive costs down and improve effectiveness to the point that money is about as much of a factor as it is in deciding whether to eat at Chili’s or Applebee’s (it’s not).  Innovation and competition have worked wonders for other goods and services.

The other part of the podcast on college education was worth it too.