A smart post from Felix Salmon

Felix Salmon:

My point here is that technology has a tendency to create its own norms. The classic example is the automobile — a technology which kills more than 30,000 Americans every year. From the 1930s through the 1990s, societal norms about who roads belonged to, and what people should do on them, were turned on their head thanks to the new technology. The dangerous new activity allowed by the new technology became the privileged norm, to the point at which just about all other road-based activity — and roads have been around for thousands of years, remember, since long before the automobile — essentially ceased to exist. Eventually, we reached the point at which elected representatives were happy saying that if a bicyclist gets killed by a car, it’s the bicyclist’s fault for being on the road in the first place

.I think that this is a very interesting point at two levels.  One, is that it does point out that society can change around innovation just as much as innovation can change society.  I think that this will be broadly applicable to innovations like driverless cars that are legal nightmares now, but could easy become the standard with enough adoption.  It's never clear when a technology will win this sort of breakthrough success (the innovation grave-yard is full of such examples).  But it does point out that some classes of argument are less likely to succeed.

But the second point is also really salient -- it is often amazing how much we overlook the subsidization of activities are social norms.  We don't see the use of roads for cars and not bicycles as a subsidization of the car.  Heck, I am often annoyed by bicyclists who can't decide what set of rules they are following (when they switch back and forth between being a fellow vehicle and a pedestrian it makes me nervous as I have a life-long goal to never hit a cyclist).  But the roads could just as easily be claimed by walkers, horses, bicycles and so forth in a much easier form of mixed use. 

Rich versus poor

It was interesting to go from reading this piece on the lives of the urban poor to this piece from Felix Salmon.  I had not previously heard the term BANANA (Build Absolutely Nothing Anywhere Near Anything), but it does seem to nicely reflect the sensibilities of the people in question.  But the real issue is why this is a stable state of affairs:

The result is that the normal state of affairs — where powerful individuals get trumped by even more powerful construction-industry inevitabilities — is turned on its head, to the point at which new construction can no longer keep up with the de-densification endemic to gentrification. Bloggers may rail against this state of affairs — both Ryan Avent and Matt Yglesias have written at great length about how important it is to allow new buildings to rise within urban areas — but ultimately the natural conservatism of the rich is winning out, across the nation. If you want to move to a city where density is going up rather than down, you might just have to move to Miami. Or China.
 

 I mean I like the idea of nice places to live and low density can be really pleasant in a lot of ways.  But I think these thigns should be compromises and it is a sad fact of reality that growth and statis are going to be inevitability opposed. 

A break from the Felix-bashing

I realize I've been hard on him lately, but it's worth taking a moment to remember that Felix Salmon is one of the best financial journalists out there, especially on the philanthropy beat:

While the Cooper Union ethos never left the students or the faculty, however, it did seem to desert a significant chunk of the Board of Trustees and the administration. Starting as long ago as the early 1970s, the board started selling off the land bequeathed by Cooper, not to invest the proceeds in higher-yielding assets, but rather just to cover accumulated deficits. Cooper hated debt and deficits, but that hatred was not shared by later administrators, who would allow debts to accumulate — bad enough — until the only solution was to sell off the college’s patrimony, thereby reducing the resources available for future generations of students. If you visit Astor Place today, the intersection once dominated by the handsome Cooper Union building, the main thing you notice are two gleaming new glass-curtain-walled luxury buildings, one residential and one commercial, both constructed on land bought from Cooper Union.

Then, when you turn the corner and look at what hulks across the street from the main Cooper Union building, you can see where a huge amount of the money went: into a gratuitously glamorous and expensive New Academic Building, built at vast expense, with the aid of a $175 million mortgage which Cooper Union has no ability to repay.

I started to quote more, but as startling and depressing as the details are, you really need to read the whole thing to get the full impact. It's an extraordinary story with particular significance to those following the tuition debates. While it would be a mistake to assume Cooper Union is completely representative, it is an enormously instructive example that seems to give us one more reason to question the cost disease theory.

A word of warning, I would not advise reading past the phrase "vision process" on a full stomach.

Free TV blogging -- betting against Felix Salmon

[Update: Andrew Gelman joins the conversation and, as usual, brings with him a fantastic comment section. Felix Salmon sites this Nielsen study to support his case. Rajiv Sethi (who was possibly the first major blogger on this beat) joins in. I'm still the only one talking about terrestrial superstations, but the night's still young so you never know.]

If you've been reading the last few posts, you know that Felix Salmon has weighed in on the free TV debate and that I find myself in the very unusual position of disputing pretty much everything he says (it is far more common for me to be completely in agreement). I'll be addressing the cost of Salmon's policy recommendations (born disproportionately by minorities and the poor) and questioning the economic implications later. Right now I want to focus on some disputed facts and assumptions.

In the post Salmon is dismissive of the claim that there are fifty million over-the-air television viewers:

The 50 million number, by the way, should not be considered particularly reliable: it’s Aereo’s guess as to the number of people who ever watch free-to-air TV, even if they mainly watch cable or satellite. (Maybe they have a hut somewhere with an old rabbit-ear TV in it.)

And he strongly suggests the number is not only smaller but shrinking. By comparison, here's a story from the broadcasting news site TV News Check from June of last year (if anyone has more recent numbers please let me know):

According to new research by GfK Media, the number of Americans now relying solely on over-the-air (OTA) television reception increased to almost 54 million, up from 46 million just a year ago. The recently completed survey also found that the demographics of broadcast-only households skew towards younger adults, minorities and lower-income families.

OTA can be tricky to measure -- unlike cable, there's no way of telling who has an old set of rabbit ears -- but we can look at other indicators and see which set of assumptions they are consistent with. Specifically consider the recent decisions of NBC and Fox to launch dedicated OTA channels this year

Let's assume Salmon's right and put ourselves in the position of a Fox or NBC executive who has to decide whether or not to create a new broadcast network. We can be reasonably confident that the executives have access to reliable data (particularly the Fox executive if the deal with Weigel included a look at some numbers from ThisTV and METV).

You find, given our premise, that the total over-the-air audience is, say, forty million, the technology is obsolete and entire medium will probably be gone in a few years. At this point, it's hard to imagine you'd proceed with an expensive, time-consuming project that is likely to be an embarrassing failure but the situation actually gets worse.

You are looking at launching an advertiser-driven, English-language station but the OTA market is disproportionately poor and immigrant (I get programming in over a half dozen languages); the maxim relevant audience for your station now drops to maybe thirty million and there's more bad news. You're going to have to share that thirty million with a crowded field of competitors. A major market will have dozens of OTA channels including multiple PBS channels, This, ME, Antenna, Bounce, RTV, three ION channels and various independents.

Given Salmon's assumptions about the size and trajectory of this market, there is simply no way NBC or Fox would have gone ahead with these channels. They couldn't possibly recoup their start-up costs before OTA is phased out. Put bluntly, both NBC and Fox are betting against Salmon's position.

Obviously this is not conclusive, but it's a strong piece of evidence and it's consistent with what we've seen elsewhere. It's also consistent with GfK's numbers.

There's more to come on this. There are many aspects to this story and I'll try to get to as many as I can but I've been looking at this for a long time from a lot of different angles and from every angle it looks to me like OTA is a promising technology supporting an innovative and growing industry, serving important economic and social roles.

The technology is doing fine in the marketplace. It's lobbyists who are likely to kill it.

Felix Salmon vs. Chet Kanojia

It's too late for me to think through and research all of the possible issues with these numbers so I'm going to pass these on without further comment for now.

From Salmon's "Aereo and the death of broadcast TV"

Here's the passage Salmon quotes from from Forbes on Kanojia:

“The real question is a consumer question: Can you rightfully disenfranchise 50 million consumers?” he asked. “Is that what the preferred policy is?”

In the event that the networks did go through with it, he speculated that other programmers would be quick to replace them in the role of public broadcasters. “That spectrum is incredibly valuable. Somebody’s going to take advantage of that,” he said.

Here's Salmon's dismissive response:

The 50 million number, by the way, should not be considered particularly reliable: it’s Aereo’s guess as to the number of people who ever watch free-to-air TV, even if they mainly watch cable or satellite. (Maybe they have a hut somewhere with an old rabbit-ear TV in it.)

Here's a comment to Salmon's blog:

“The 50 million number .. is the number of people who ever watch free-to-air TV, even if they mainly watch cable or satellite. ” No! That is the number of people who rely exclusively on over-the-air TV without any cable or satellite. http://www.tvnewscheck.com/article/60230 /us-otaonly-tv-viewing-hits-178-of-hhs Also, far from being on the decline, this is actually one of the fastest growing segments of the market. I think it may have something to do with the digital switch and the accompanying radical improvement in visual quality of OTA TV. Exclusive OTA viewer estimates go from 42M in 2010, to 46M in 2011, to 54M in 2012. The reports of the death of bunny ears have been greatly exaggerated. But yes, it is true that OTA-only viewers rank low on the amount of political clout. They are disproportionally young adults and minorities.

And here's what you get when you follow the link:

According to new research by GfK Media, the number of Americans now relying solely on over-the-air (OTA) television reception increased to almost 54 million, up from 46 million just a year ago. The recently completed survey also found that the demographics of broadcast-only households skew towards younger adults, minorities and lower-income families.

The 2012 Ownership Survey and Trend Report, part of The Home Technology Monitor research series, found that 17.8% of all U.S. households with TVs use over-the-air signals to watch TV programming; this compares with 15.0% of homes reported as broadcast-only last year. Overall, GfK Media estimates that more than 20.7 million households representing 53.8 million consumers receive television exclusively through broadcast signals.

I will be posting some arguments that some of the activity we've seen (see the terrestrial superstations post) support Kanojia over Salmon but those come from a completely different direction. I'll take another look at these numbers in the morning.

Terrestrial Superstations

Normally, I have to work hard to find something to criticize in a Felix Salmon post. With this one, I'm having to work hard to lay the groundwork so I can spell out all of the problems.

When US television went digital, the new platform didn't just allow you to get HD video over a set of rabbit ears, it also allowed TV stations to broadcast multiple subchannels. This has created all sorts of interesting changes in the television landscape (for example, your PBS station is now probably putting out four times the programming). One area of particular relevance to this discussion is the appearance of general interest stations created specifically for the new technology.

The idea of using digital subchannels to launch a TBS style superstation seems to have originated with Weigel Broadcasting, a well-respected regional player noted at the time for being Chicago's last independent television broadcaster. (Both Weigel and Chicago figure prominently in this story.)

Weigel's ThisTV (a partnership with MGM) was up and broadcasting the day American television went digital. Here's what I said about the concept a couple of years ago.

ThisTV has caught on to the fact that the most interesting films are often on the far ends of the spectrum and has responded with a wonderful mixture of art house and grind house. Among the former, you can see films like Persona, the Music Lovers and Paths of Glory. Among the latter you'll find American International quickies and action pictures with titles like Pray for Death. You can even find films that fit into both categories like Corman's Poe films or Milius' Dillinger.

Of course, the other great insight was that movies on the far end of the spectrum tend to be cheaper.

I've written a great deal about Weigel and I have a lot more on the to-do pile. The company is one of my favorite examples of a well-run business but for the purposes of this story, the pertinent factors are: Weigel is an innovative with a good track record; it moves as decisively as any company I've ever seen; it is the most important player in the digital television landscape (as you'll see later).

Skip forward a couple of years and the follow-the-data approach starts to get interesting. The company with the most complete information (Weigel, obviously) announces another, more ambitious superstation called METV, a classic TV channel built around old but prestigious shows like Mary Tyler Moore, Columbo and the Twilight Zone (making very limited use of block programming to allow airing of fifty different programs a week) and promoted a surprising elaborate campaign. In-character station ads featured Betty White as Sue Ann Niven, Ed Asner as Lou Grant, Carl Reiner as Alan Brady and Bob Newhart as Bob Hartley.

The company that arguably had the second best information and experience was Weigel's long-time competitor, the Tribune Company's WGN. Tribune had data from its stations (including KTLA which carried ThisTV in the Los Angeles market), experience with one of the first and most successful cable superstations and finally the inevitable back channel communication you would expect from Chicago's famed television community. It is not a coincidence that Tribune launched its terrestrial superstation, AntennaTV about the same time METV went on the air.

After LA and New York, the two most important television towns are Chicago and Atlanta so it's not surprising that the next terrestrial superstation came from Atlanta. A few months after the launch of AntennaTV, Andrew Young and Martin Luther King III founded BounceTV as an over-the-air alternative to BET.

This is a good place to stop and note something interesting about all of these terrestrial superstations. Neither ThisTV, METV, BounceTV nor AntennaTV have regularly scheduled infomercials. This is a business model built on program driven advertising and we are going on five years of data that seems to say that it works.

2013 continues the trend of more investment on terrestrial television by bigger players. A few months ago NBCUniversal unveiled COZITV. COZI is the only terrestrial superstation with infomercials but, like Bounce, it also has original programming [link added].

And now there's this:

Movies! is an upcoming American digital multicast television network, that will feature an emphasis in its programming on feature films. The network will be a joint venture between Chicago-based Weigel Broadcasting and the Fox Entertainment Group subsidiary of News Corporation, and will be available in the United States through the digital subchannels of broadcast television stations, as well as on select cable systems. Movies! will broadcast 24 hours a day in 480i widescreen standard definition.

I have limited this post to commercial, general interest, English language stations created specifically for digital broadcasting. That's a small sliver of what's available over the air but it does, pretty much conclusively, show that the model is viable and that, unlike so many recent tech and media fads, the more data comes in, the more interested serious players get.

Felix Salmon on personal finance

Felix Salmon has beaten me to the punch here but I do think that this statement needs to be properly understood for what it means:

It surely comforts modern parents who have spent fortunes educating their children to know that these children are spending money on pork belly and not, for instance, cocaine. But what solace can it offer to realize that $300 a week put into an S. & P. 500 Index fund over the past five years would have provided an annual rate of return of 10.34 percent and grown to $100,354 today? Even saving $300 a week at a 6 percent rate of return would have yielded about $91,000, Mark X. Chemtob, a financial adviser at Ameriprise, said, adding that in both cases, the sums would qualify for a down payment on a starter apartment in New York.

So if a person invested for five years, and got a retern of 10.34 percent they would have a lot of money.  So have happened 5 years ago (2007)?  Here is wikipedia:

The Dow Jones Industrial Average, Nasdaq Composite and S&P 500 all experienced declines of greater than 20% from their peaks in late 2007. 

So if you had perfect market timing then you could have invested directly after a crash (as opposed to during it) taking advantage of the recent market crash.  Unless, of course, you were the 23 year old in the article who is likely in school and not making $300/week of investable income. 

The other side of this coin is that it is very hard to be 23 years old, just graduated from school, making real money for the first time in your life and not enjoy some of it.  After all, perpetual deferred gratification is never being able to enjoy the rewards of your career.  Nor is it clear that somebody in their first year out of college should be buying a Manhattan apartment (a highly leveraged investment) until they find out if they are going to be successful in New York. 

Nor can you drop the cost to zero.  I would find it hard to eat in New York city for less then $75/week.  Remember, we are taking a city where space is at a premium and everything bought in the city is expensive (including kitchen facilities).  So eating 21 meals at about $3 apiece is actually pretty tough, even if you have good skills for cooking from scratch.  And, even more interesting, the person in this example is taking on extra work to fund her leisure time (as opposed to, for example, debt). 

So I agree -- a very misleading example. 

Following Mark's link on education

As a follow-up to Mark I wanted to specically call out some of the pieces of Felix Salmon's piece on test scores and education. 

Instead, reformers are rushing to use this data as a quantitative performance-review tool, something which can get you a raise or which can even get you fired. And by so doing, they’re turning it from something potentially extremely useful, into a bone of contention between teachers and managers, and a metric to be gamed and maximized.
 

When all decisions on based on a single score, you incent behavior which maximizes the score and minimize additional focus.  Felix makes an interesting point that if you used this data to provide coaching and feedback then it could actually be really useful.  Teachers would still want students to do well on the test (it is much, much nicer to talk to your principal about how generally well your students are doing than to get coaching on how to try and shore up a weak point). 

I also think that this point was really sharp:

School reformers in general, it seems to me, tend to be obsessed with the idea of Good Teachers and Bad Teachers, as though the quality of the education a kid gets in any given classroom is somehow both predictable and innate to the teacher. And yes, at the extremes, there are a few great inspirational teachers who we all remember decades later, and a few dreadful ones who had no idea what they were talking about and who had no control of their classes. But frankly, you don’t need student surveys to identify those outliers. And the fact is that schools are much more than just the sum of their parts: that’s one of the reasons that reformers love to talk about excellent principals who can turn schools around.

He is very cleverly and accurately pointing out a form of equivocation that is being used here.  There are extreme examples, but they were never the problem in terms of identification.  There are some odd employment rules in some places that made acting on this knowledge awkward, but very few people saw these as being good policy.  The real use of these tests to to try and break apart the middle of the distribution.  But, by definition, the gain in the middle of the distribution is much less than the difference between exceptional and abysmal.  You are not taking Jaime Escalante versus an incompetent as your contrast.  You are taking pretty good versus very good as your contrast, and thus setting things up for a life event to move people back and forth in the distribution.  Your child gets ill, you are more tired and work so you lsoe your job because you slip below the median.  No wonder teachers are suspicious of such metrics. 

Data is good but one of the lessons of the MBA approach to management is that not everything can be broken down into numbers on a spreadsheet to be maximized.  I fear we'll figure that out, sooner or later. 

Felix Salmon is back: California pension edition

Felix has a very nice post on the new retirement program that California is considering.  I think it is a very good idea and the state running it is a major plus.  It's astounding but true that the very best instruments that I can find in the private sector (currently thinking Vanguard here) seem to run neck and neck with large retirement plans in terms of both fees and returns.

I am a little less thrilled by investment guarantees, unless they are really well adjusted for inflation.  But, conditional on that, this would also smooth out returns in a very nice way.  Sure, it has the government investing in the markets.  But the only other alternative is paygo, which has come under a lot of question as to the willingness of taxpayers to honor previous promises.

I agree that this is an exciting development.

Felix Salmon's overview of education

In a long but pithy post, Salmon uses the over-hyped Aspen Festival as a springboard to discuss education reform, starting with this sharply written paragraph:

For me, one of the more interesting tracks of the Aspen Ideas Festival is the series of conversations about education. Aspen is the natural habitat of America’s overconfident plutonomy: the kind of people who are convinced that since they have been successful themselves, they are therefore qualified — more qualified than education professionals, in fact — to diagnose problems and prescribe solutions. The ultimate example of this in recent weeks was the firing of Teresa Sullivan as president of the University of Virginia, by rich trustees who had no substantive beef with her at all. Instead, they just didn’t like her reluctance to sign on to various inchoate strategies, which sound great in a mass-market leadership book but which are unlikely to be particularly helpful in the context of a venerable educational institution.

Dual Class shares and free markets

Andrew Gelman weighs in on dual class shares: 

Now I’m just confused here. Who’s supposed to be “concerned” here? As a New Yorker subscriber, am I supposed to be concerned that dual-class firms underperformed the market? I just don’t get it. Why should I care? If the shares underperform the market, people can buy a piece of Facebook for less. That’s fine too, no?

I think that Andrew would be completely correct in a perfect market (one in which all of Mark Thoma's issues are not present).  If some financial products give a piece of the return while others give ownership plus return then people could choose which ones to purchase. 

However, the modern American economy has fallen in love with the 401(k) as an investment vehicle.  This leads to two problems.  One, investors are generally not free to switch to a different fund because they dislike the investment decisions of the fund that they are in.  Since the individual investor bears all of the losses of bad decisions but the employer has control of the fund (and has an incentive to cut costs) you have a classic principal agent problem.

This problem is made worse by giving a limited group of people control over a group investment.  One can easily imagine the small group making decisions that benefit them at the expense of the majority of shareholders.  Again, not necessarily a problem in an open market.  But with the constraints that individual investors are under this could be problematic as they lack the freedom to enter or exit the market. 

This is why I wax poetic about Social Security (or the Canada Pension Plan): they shift the risk from small investors (who generally can't bear it) to large entities (that can).  I totally get that there are total social resources constraints, but I would rather that they be dealt with openly.  Instead I see the stock market becoming a worse and worse deal just as a large American cohort (the "Baby Boom") is about to retire. 

I am not sure that this is a good thing. 

See also Matt Ygelasis and Felix Salmon.

More on the growth fetish -- Facebook vs. Groupon

There is a worthwhile exchange going on between Felix Salmon and Pascal-Emmanuel Gobry. I've already quoted Salmon, but Gobry makes some good points as well. Still, the part I found the most interesting is the part I think he got wrong.

Breakthrough technology startups are different from other kinds of businesses in that they either create a new market or violently disrupt an existing one. This means that they almost invariably require to spend lots of capital in order to stake out a defensible market position against their numerous competitors. In particular, many technology markets have winner-take-most or winner-take-all dynamics, either because of network effects or economies of scale…

Felix writes that Groupon had a profitable Q1 2010 and “it’s easy to see how it could have grown steadily from that point onward.” Except that given the characteristics of the daily deal business, particularly the need for scale, what would have happened if Groupon had tried to “grow steadily” and profitably, is that the company wouldn’t be around anymore.

It’s LivingSocial that would have raised over a billion dollars and be worth $10 billion today, Groupon would have been sold for scrap like BuyWithMe and plenty of other daily deals also-rans, and Andrew Mason would be back to doing yoga on YouTube. Groupon would be a footnote.

This illustrates (at least for me), a common error among growth fetishists -- overgeneralizing valid arguments for growth-at-all-costs. The first paragraph above is absolutely on target. There are situations where establishing dominance and critical mass as quickly as possible is incredibly valuable. Cases like Facebook. To make a bad pop culture reference, when it comes to mainstream social networking sites, there can be only one. Once Facebook was in place, all that was left was niches.

Put another way, it would cost more to unseat Facebook than it did to build it. Under those circumstances, Zuckerberg's bury-the-problem-in-money approach to running a business made sense (even if it was aesthetically lacking).

The first mover advantages for Groupon are far less obvious. There's no reason why we couldn't have two online gift card businesses. Consumers would get a wider selection and the merchants would almost certainly see lower fees (there's no way Groupon could charge those rates in a competitive market). Nor are the economies of scale that significant, at least not for the part of the business based on arranging deals with local merchants.

A potential competitor would have to spend a lot of money building a mailing list but probably not that much more than Groupon spent on its list. In short, if a potential competitor were to spend as much money as Groupon has, it might just catch up (particularly given the fact that Groupon is not a very well run company).

In terms of lifetime value, I suspect that the money Groupon spent on explosive growth was badly invested. However, in terms of buzz and stock price, it may have been money well spent as far as the backers were concerned.

Venture capital and the growth fetish

Felix Salmon has another smart post on venture capital and the way he feels it distorts American business:

Another way to look at this question is to compare US fight-to-be-number-one capitalism with the kind of capitalism practiced in undeniably successful countries like Germany, Korea, Brazil, and Japan. Those countries don’t have nearly as many world-beating behemoths as the US does, but overall their economies and current accounts are doing very well on a bedrock of medium-sized firms and family-owned corporations.

So in a way, Gobry is making my point for me. The IPO market and the VCs who feed off it are playing a game which might make a small number of people extremely rich, and which will create a very small number of hugely successful world-beating companies. They’re not playing a game which is good for founders; they’re not playing a game which is good for healthy, long-lived companies; and they’re not playing a game which is good for the economy as a whole. That’s kind of the point I’m making in the piece when I say that “Silicon Valley is full of venture capitalists who have become dynastically wealthy off the backs of companies that no longer exist”.

I think this fits nicely with one of our ongoing themes here at OE, the growth fetish:

Think of it this way, if we ignore all those questions about stakeholders and the larger impact of a company, you can boil the value of a business down to a single scalar: just take the profits over the lifetime of a company and apply an appropriate discount function (not trivial but certainly doable). The goal of a company's management is to maximize this number and the goal of the market is to assign a price to the company that accurately reflects that number.

The first part of the hypothesis is that there are different possible growth curves associated with a business and, ignoring the unlikely possibility of a tie, there is a particular curve that optimizes profits for a particular business. In other words, some companies are better off growing rapidly; some are better off with slow or deferred growth; some are better off simply staying at the same level; and some are better off being allowed to slowly contract.

It's not difficult to come up with examples of ill-conceived expansions. Growth almost always entails numerous risks for an established company. Costs increase and generally debt does as well. Scalability is usually a concern. And perhaps most importantly, growth usually entails moving into an area where you probably don't know what the hell you're doing. I recall Peter Lynch (certainly a fan of growth stocks) warning investors to put off buying into chains until the businesses had demonstrated the ability to set up successful operations in other cities.

But the idea of getting in on a fast-growing company is still tremendously attractive, appealing enough to unduly influence people's judgement (and no, I don't see any reason to mangle a sentence just to keep an infinitive in one piece). For reasons that merit a post of their own (GE will be mentioned), that natural bias toward growth companies has metastasised into a pervasive fetish.

This bias does more than inflate the prices of certain stocks; it pressures people running companies to make all sorts of bad decisions from moving into markets where you don't belong (Borders) to pumping up market share with unprofitable customers (Groupon) to overpaying for acquisitions (too many examples to mention).

I didn't consider the role of venture capital at the time. Perhaps I missed the biggest factor.

Model assumptions

Felix Salmon and Matt Yglesias:

The entire debate in congress over taxes is that President Obama wants to restore the top marginal rate to the level that Dimon thinks it already is. Meanwhile, Dimon doesn’t even know what tax rate he pays.

I think that this quote is really, really important. Classical economic models presume that individuals act to maximize their utility. But real people often have limitations, including lack of perfect information about what costs really are. I would be surprised if Mark did not have follow-up thoughts.

But the key point is that if these assumptions about informed persons can't hold for the CEO of JP Morgan Chase (whom you would assume is numerate) then how likely is that these models are going to be good at prediction? After all, we presume Jamie Dimon is maximizing his utility for a 39.6% marginal tax rate; so a change in taxes to what he currently thinks that they already are would alter his incentives how?

Math issues

Felix Salmon's last two posts are brilliant. I strongly recommend reading both of these posts. Seriously!

Heck, I am likely to come back and post on them later today if I have enough time. Paul Krugman and Mark Thoma might be representing the outrage of progressives, but Felix is documenting the damage coldly and dispassionately.

However, this is a statistics blog. So I wanted to visit a comment on one of Felix Salmon's posts:

The top 10% of Americans pays 45% of all taxes, a higher proportion by far than any other country, while the American top 10% earns only 33% of total income.

By comparison, the 10% of the UK earns 32% of total income and pays only 38% of all taxes. And the UK is one of the more progressively taxed countries. The taxes paid by the top 10% of other European countries are on average around 30% of total taxes.

As an epidemiologist (a field that is in love with proportions), I realize how misleading they can be. In the example above, the rich earn roughly the same amount of income. But they pay a higher proportion of taxes. However, is it the proportion of taxes that matters or the absolute tax burden?

Consider a simple example. In two countries there are 10 people. Of these people, nine make 10 units of income per year and one makes 50 unites of income. This is pretty close to the income distribution of the US and UK cited above.

In country A, the nine people pay 2 units of tax per year and the rich person pays 16 units of tax. Total tax revenues are 34 units (or 24% of GDP). The rich definitely pay more as a proportion of taxes but pay 47% of the taxes overall.

In country B, they pay something more like the OECD average (35%). So the nine people pay 3.5 units of tax (31.5) and the rich pay 17.5 units of tax. That is 49 units of tax collected (exactly 35%). The rich pay 36% of the tax burden.

Which country is a low tax country for rich people to live in? One where they pay an effective tax rate of 32% versus 35%? Or one where they pay a higher proportion of total taxes collected?

The trick here is that the US total tax burden is so light that the top 10% can both pay a higher proportion of taxes than in other countries and, at the same time, still pay less absolute tax. That can make proportional analysis potentially misleading.

Words of Wisdom -- Weekend Edition

Felix Salmon is unimpressed with Alan Greenspan and suggests a different perspective:

In fact, the opposite is true — ask anybody who has experienced both wealth and poverty. When you’re wealthy — when you have a nice capital buffer to absorb mistakes — you don’t worry so much about running risks, and you’re significantly happier than when you’re poor and you have to be much more worried about where your money might end up. Insurance improves living standards, it doesn’t detract from them. Let’s have more of it.

Virtuous Circles

The ever interesting Felix Salmon has reasons for optimism about the future of Paywalls. In particular, he notes how the porous paywall of the NYT beats the FT paywall (which is consumer unfriendly and annoying).

But even better is the marketing opportunity that this sort of paywall creates:

Those paying digital subscribers, however, are much more valuable than their subscription streams alone would suggest. They’re hugely loyal, they read loads of stories, they’re well-heeled, and advertisers will pay a premium to reach them. Judging by the second-quarter results, which is admittedly early days, it seems as though total digital ad revenues are going up, not down, as subscriptions get introduced: the holy grail of paywalls.

This is a principle worth keeping in mind -- there are virtuous circles as well as vicious ones. Not only does the NYT get to collect predictable revenue from a steady stream of subscribers (and predictable revenue is worth a lot), it also gets an advertising boost from being able to identify these readers. It's an amazing outcome and I remain delighted that it worked out for them.

Now I wonder if we could try and apply these principles to public health. How can we create incentives where patients identify themselves in ways that save money and are happy to do so? Because when you manage to get these sorts of two for one punches, efficiency is massively improved.

Challenges of causal inference in complex systems

From Felix Salmon:

“Spend less money, create more jobs” is the kind of world one normally finds only in Woody Allen movies, and it’s a profoundly unserious stance for any politician to take. Spending cuts, whether they’re implemented by the public sector or the private sector, are never going to create jobs. And there’s simply no magical ju-jitsu whereby government spending cuts get reversed and amplified, becoming larger private-sector spending increases.

I think that one of the difficulties in macroeconomics is that you have complex systems that are not subject to experimentation. So you are forced to try and use observational studies and analogies with microeconomics to try and determine the causal effects of policies. Even instruments are questionable as they also rely on unverifiable, strong assumptions.

The inability to have a consensus on the counter-factual is pernicious and causes no end of trouble. Consider the tax increases passed at the beginning of the Clinton administration. Are they responsible for the late-1990's boom, unrelated to it, or did they act to slow it down (making the current economy smaller than it could have been)? How would you know this?

Cross country comparisons are possible but you have both confounding factors and effect measure modification. Changing the tax rate in Sweden might have different consequences than in the United States due to both different cultures (confounding) and to differences in current tax rates (effect modification). So, by picking different analogies and different models for the observational data, we can end up with some really strange claims being made about how economies work.

It is not an area with easy solutions. But I think to agree with Felix that the model he is critiquing is making heroic assumptions about the influence of tax levels on economic growth.

More on Groupon

As a follow-up to Mark, the comment thread to this post is worth reading. One clever reader noted, in the S-1 groupon just filed:

Our merchant arrangements are generally structured such that we collect cash up front when our customers purchase Groupons and make payments to our merchants at a subsequent date. In North America, we typically pay our merchants in installments within sixty days after the Groupon is sold. In most of our International markets, merchants are not paid until the customer redeems the Groupon.

Now you match this up with this, admittedly anecdotal example:

A good mate who owns a restaurant and did one of these deals after said it was outright amazing - many people would come in and spend EXACTLY the amount of the coupon. They didn't want to go 50c under and heaven forbid they went 50c over and have to pay more at full price

Even worse, you seem to have to more effects. One is a priming effect. New customers assume your $30 entree is worth $15. That is poison. The second is that merchants have begun to do things like "Groupon lines" (rational from their point of view to focus on the full-paying customers first) that reduce the value of the service.

So the business model involves a slow reimbursement to the merchant (waiting for money is death in a small business where cash flow issues can be fatal), enormous discounts (typically 75% off, with the last 25% coming in slowly), and "bargain hunters" who are unlikely to become regular customers.

As a final point, consider:

Perhaps Groupon management thinks it is creating a sustainable Prisoner’s Dilemma, one that ultimately destroys value for the local merchant ecosystem but benefits Groupon. In other words, Groupon could grow so big that local merchants have to use it, even though it ultimately hurts them. In game theory terms, Groupon creates an equilibrium point at “All Local Merchants Defect,” and then, having forced merchants into this value-destroying equilibrium, takes a cut for having rigged the game. Obviously, Groupon couldn’t share this thinking publicly. They would just continue to use the attract-loyal-new-customers argument even though it no longer makes any sense for a ginormous Groupon.

This may sound cynical. But if this is Groupon’s game plan, it isn’t cynical. It’s naïve. Most local merchants simply don’t have enough value in their collective ecosystem to share anything remotely like this much value with Groupon. This isn’t a stable equilibrium, it’s a suicidal one. The local merchants will have to stop using Groupon en masse not long after they first start experimenting with it.

The only way this works is if process quadruple for restaurants (because everyone uses a groupon). Maybe more than quadruple because you replace cash in hand with a 60 day payment. Why would restaurants not break this equilibrium and offer 60% off if you show up without a groupon? Immediate cash in hand, much higher profits, the customer pays less and they don't have to buy a groupon in advance.

And if you don't get this type of prisoner's dilemma, then it is hard to see where the sustainable value is going to be in this business model when your clients will eventually hate you.

Thought of the day

I was reading this statement (via a link from Felix Salmon):

Emergers also have a better chance of being part of the coveted 1% who control 40% of wealth in America someday.

It got me thinking again about precisely why we have low marginal tax rates on those who make above (for example) 500 thousand per year. Now, by low I mean low in comparison with other rates in the post-WWII era.

There seem to be two explanations: 1) competition for key talent and 2) incentive for performance.

The first seems unlikely. All US executives pay taxes in the same country so it just resets the baseline. Americans seem to be the best compensated class of business executives and stock traders so international competition can only matter so much.

The second is much clearer if we (following Linda McQuaig and Neil Brooks) look at sports stars. Did Babe Ruth or Lou Gehrig under-perform relative to Micheal Jordan due to low compensation? Do we really think that the overall quality of play would decline in some massive sense?

Now we might get fewer people wasting their lives trying to become a sports superstar if they paid more in marginal taxes, but is that really a shame?

Meanwhile, infrastructure, education and the rule of law all make economic activity possible. Is it not possible that these areas are under-invested in and could use some transfer of cash?

I do not know for sure, but it is worth thinking about.