Market Efficiency

For a long time now I have been hearing about how markets set salaries based on the productivity and value of an employee. The ideal was that increases in executive pay were a function of the greater influence a top executive could have in the information age. It was a nice story. Unfortunately, it also seems to be untrue:

Companies have long hid the way they set executive pay, but in late 2006, the Securities and Exchange Commission began compelling companies to disclose the specifics of how they use peer groups to determine executive pay.

Since then, researchers have found that about 90 percent of major U.S. companies expressly set their executive pay targets at or above the median of their peer group. This creates just the kinds of circumstances that drive pay upward.

Moreover, the jump in pay because of peer benchmarking is significant. A chief executive’s pay is more influenced by what his or her “peers” earn than by the company’s recent performance for shareholders, according to two independent research efforts based on the new disclosures. One was by Michael Faulkender at the University of Maryland and Jun Yang of Indiana University, and another was led by John Bizjak at Texas Christian University.

As Kevin Drum observes:

Adjusted for inflation, cash compensation for line workers has actually decreased over the past few decades, and even when you include healthcare compensation it's grown only about 30% or so. In contrast, executive compensation over the same period has more than quadrupled.

This is clearly a result of market failure. It also suggests that the reasons for increases in executive compensation are entirely due to poorly designed compensation system and not because of market forces. Examples like this one are worth keeping in mind when considering whether a market-based outcome is really utility maximizing or not.

Effect Sizes

I think that this is very insightful:

They mistake small truths for large ones, and use the small truth to obfuscate the big one. So, the truth - that a few of the unemployed don’t want to work - is exaggerated and used to hide the bigger truth, that the vast majority of unemployment has other causes.

Mark and I have often discussed how effect size can be easily overlooked in modern debates. In epidemiology, for example, it can be the case that a drug has a serious side effect that is so rare that it basically cannot change the risk-benefit calculus. So, for example, statins can cause rhabdomyolysis (as an adverse drug side effect) despite have massive benefits on all-cause mortality (in secondary prevention of cardiovascular disease). But the rare side effect is often newsworthy and may discourage patients from seeking a beneficial therapy. Fortunately, we have randomized trials to sort out what the net impact of the benefits and risks of the drugs is like across a whole population.

I think lacking these experiments makes it easy to get focused on the details in macroeconomics. Policies that may increase utility across the whole population (e.g. immigration) may have costs to individual workers. Failing to properly specify the relative effect size of different interventions may lead to a focus on "second or third order effects". Or, even worse, to misjudging the net impact of a policy.

I think that might well be correct in the example above, as well. It is certain that there are people who would hire more if the minimum wage was to drop. But it is unclear that adjusting the minimum wage would have a major impact on the >9% unemployment rate we have in the United States. We may have to look elsewhere for solutions.

Now, implementing this advice is rough. Which is why I am pleased we have experiments over here in epidemiology.

The danger of deserve

Karl Smith:

On Facebook I think Robin framed the question as “how weak do temptations have to be before they make people less deserving of charity”

My clear answer would be that there is no level so low. Human suffering is bad. Reductions in human suffering are good.

Why humans are suffering is of concern to us in knowing when our interventions might be productive but it doesn’t affect whether they are warranted.

This is, in my view, precisely correct. The decision to impose a moral worthiness component to helping others is the source of a great deal of misery. For example, the moral implications of being HIV+ (in the early years of the epidemic) clearly reduced overall public health (due to stigma preventing patients from seeking care).

That isn't to say that some approaches that feel good may be counterproductive. If we are going to be good utilitarians then we really need to consider the global consequences of an action. Making one person better off at the cost of making many others miserable is typically a bad trade-off.

But, insofar as we can make lives better, does it ever make sense to ask if people deserve to have better lives?

Why I keep going on about rabbit ears

I'm starting a string of posts on this so I thought I'd take a few moments and explain why I think over-the-air TV is worth discussing.

1. I genuinely like the product

I get my television through an antenna on the top of my set and I can't think of a purchase I've been happier with. The picture is DVD quality and I get over a hundred channels, some of them very good, all for free.

2. It provides an excellent service for people who could use something nice

It has always sucked to be poor but in recent years we seemed determined to make it suck worse. Over the air digital television bucks that trend. Anyone with an old TV, a second hand converter box and a set of dollar store rabbit ears can have a source of entertainment, news and education (I get ten PBS channels). That may not seem like much to you but to a lot of people in this country, it can be a major improvement in quality of life.

3. There are other people trying to take that service away

Some would like to sell off the part of the spectrum used for television. Economist Richard Thaler even wrote a New York Times op-ed on the subject, explaining how the sale could solve virtually all of society's ill. Think I'm exaggerating?

Here's a list of national domestic priorities, in no particular order: Stimulate the economy, improve health care, offer fast Internet connections to all of our schools, foster development of advanced technology. Oh, and let’s not forget, we’d better do something about the budget deficit.

Now, suppose that there were a way to deal effectively with all of those things at once, without hurting anyone... I know that this sounds like the second coming of voodoo economics, but bear with me. This proposal involves no magical thinking, just good common sense: By simply reallocating the way we use the radio spectrum now devoted to over-the-air television broadcasting, we can create a bonanza for the government, stimulate the economy and advance all of the other goals listed above. Really.

(I'm tempted to go off on multiple tangents here about how these sales of public land of have a way of going badly for the government and the tax payer, or how the VHF part of the spectrum isn't actually that useful for mobile applications, or how oblivious men like Thaler are to what life is like in the bottom decile, but Rajiv Sethi has already written the definitive rebuttal so I'll just leave it with a link and a recommendation to follow it.)

At the risk of sounding paranoid, I very much doubt that this idea simply popped into Thaler's head. We live in an age subsidized discourse. Whenever you read a news story or opinion piece that seems to come from a lobbyist's desk, you can generally assume that it originally did. I'm not saying that Thaler was paid to hold these opinions -- I'm sure he wasn't -- but I'll bet good money that the experts he relied on were, either directly on indirectly.

There is a huge imbalance of money in this conflict. A number of big and deep-pocketed corporations are gunning for OTA broadcasters. Some would like to carve up the spectrum. Other would just like to get rid of the competition.

4. Competition is good

And over-the-air television plays a vital role in maintaining competition in the world of live TV. If access is limited to cable/phone lines and satellite, the business will always be dominated by a handful of very big and powerful companies and since these companies fall in the middle of the supply chain, we have to worry about both monopolistic and monopsonistic effects.

The industry currently runs on the up-sell model: get people in the door with a twenty or thirty dollar a month plan (sometimes helped along with some opaque pricing), then make the package crappy enough to get people to move up to a more expensive tier. OTA television presents a potentially deadly threat to that model because, in most markets, OTA is actually better than cable's basic package. It has more channels, better content and less compression (this may be less applicable to satellite). Cable has been able to ignore this threat up until now because most consumers are unaware of what they can get for free, but if word gets out cable companies will have to start giving customers considerably more value for their money.

5. There's a story here

And it has been woefully under-reported. New technology. New markets. Small but smart players like Weigel Broadcasting coming up with innovative business models and easily lapping major media companies. For me that's way more interesting than reading about Facebook throwing money at some business problem.

(also posted at MippyvilleTV)

You should read this

Science is about discarding models, not making them

Performance based teaching

Via Megan McArdle, comes this gem:

It would be naïve to assume that the persons subjected to variable pay-for-performance would accept the respective criteria in a passive way and fulfil their work accordingly. Rather, they spend much energy and time trying to manipulate these criteria in their favour. This is facilitated by the fact that employees often know the specific features of their work better than their superiors. The wage explosions observable in many sectors of the economy can at least partly be attributed to such manipulations, eg when managers are able to contract easily achievable performance goals.

Arnold Kling goes on to link this with education reform:

When a remote authority sets incentives, people respond by manipulating the system. This fact is poorly understood by education reformers who are fond of pay-for-performance and national standards, by health care reformers who are fond of paying for quality, and by financial regulators. In fact, the quoted paragraph provides an excellent description of the financial regulatory process under risk-based capital. The banks spent much energy and time trying to manipulate the risk-based capital regulations in their favor. They got what they wanted, in terms of risky portfolios backed by little capital.

The Hayekian story here is that effective compensation practices require local knowledge and tacit knowledge. In a large company, you give a middle manager a fair amount of discretion in compensating his or her staff. If instead you try to implement an automated bonus system, you will get gamed.

I think that this hits at the heart of the concerns Mark has been expressing for a while. Test-based systems that are implemented at a very high level encourage all sorts of behavior, and it is quite possible that manipulating the system will be easier than actually improving performance. Even worse, bad performers (gaming the system) have an advantage over good performers as they can get top scores for less total effort.

Bed performance drives out good performance and things get worse. I think Megan is very right to be skeptical about how easy it is to reform systems once they adopt this management style as the new backbone of the labor force are the people who thrive in gaming the system and they will resist change back to older approaches.

I wish we'd look more at the history of countries like Russia for how difficult it is to make top-down reform and economic control work at the national level.

Micheal Lewis on California Government

Interesting view:

In 2010, for instance, the state spent $6 billion on fewer than 30,000 guards and other prison-system employees. A prison guard who started his career at the age of 45 could retire after five years with a pension that very nearly equaled his former salary. The head parole psychiatrist for the California prison system was the state’s highest-paid public employee; in 2010 he’d made $838,706. The same fiscal year that the state spent $6 billion on prisons, it had invested just $4.7 billion in its higher education—that is, 33 campuses with 670,000 students. Over the past 30 years the state’s share of the budget for the University of California has fallen from 30 percent to 11 percent, and it is about to fall a lot more. In 1980 a Cal student paid $776 a year in tuition; in 2011 he pays $13,218.

I wonder how many times we need to see these statistics before we wonder if the education for prisons trade-off was really all that effective. Why do people in California have such an obsession with spending on corrections? Is the link to public safety with increased correctional spending really this strong?

In other news, how long until the University of California is not a state school anymore? With support dropping like that, one wonders . . .

What you'd be watching now if you had rabbit ears

I'm working on some longer posts on over the air television, particularly on the innovative people at Weigel broadcasting, so I thought I'd mention that tonight THISTV is running a double shot of Altman including his rarely seen debut.

Why are you still paying to watch TV?

I wish I had time to join this debate

But work's hectic, I just got over some dental work and this blog is already my personal hydra (every time I get one post up, two more appear in the queue). So I'll just briefly mention that Andrew Gelman has good post followed by an even better discussion on economists up at his site. Definitely worth a look.

Tag-teaming Felix Salmon

Felix Salmon recently (and much to his credit) announced a smack-down on himself:

Christopher Mims makes a really good point:

It makes no sense that writers like Felix Salmon, who is generally excellent on just about everything, describe Netfilx, even pre-split Netflix, as an inexpensive alternative to cable. It’s not. It’s only inexpensive if you take fast broadband at home for granted — you know, like every tech pundit and journalist on the planet.

To be fair, it’s a mistake all of those pundits makes regularly — the conflation of their own situation with that of the wider public. But only one in three Americans pays for broadband, which means that something like two-thirds of the population has access to it. That’s not bad (it’s not great either – it puts us something like 27th in world broadband penetration) and it leaves out precisely the people who are being left behind by both our economy and the digital divide.

I moved to the US before the rollout of the cable modem, and for me it was a game-changer: within a few months of its arrival, sometime in the late 90s, I switched from cable-and-no-broadband to broadband-and-no-cable. I was one of the earliest cord-cutters, long before YouTube or Netflix or any real video content on the web which I had any desire to watch. I didn’t want to watch TV on my computer: I just preferred content online to the content on the TV.

Now, over a decade later, it’s possible to look at the population more broadly, and see how their preferences have revealed themselves. And Mims is right: if you have a cable line coming into your home, you’re much more likely to have cable-and-no-broadband than you are to have broadband-and-no-cable. Cord-cutting was a privileged, yuppie behavior when I did it in the 90s, and it remains a privileged yuppie behavior today.* Sure, I like having an extra $100 in my wallet every month due to the fact that I don’t have cable. But I could easily afford it if I wanted it — the fact is that I stopped watching cable long before I cut that cord.

For the time being, the price of broadband — largely set by cable companies — is being set high enough that cable-but-no-broadband subscribers are not switching to broadband-but-no-cable. In order to cut the cord, it seems, you need broadband first: you need cable and broadband, and then you need to come to the decision that you can do without the cable bit.

So, yes, let’s slow down on visions of free or cheap online services supplanting cable for America’s poor. Because Mims is right: broadband is not free. And the cost of Netflix is therefore comparable to the cost of cable — with no live-TV services at all, and in general a much narrower selection of things to watch. At some point, I’m convinced that IP-based video will indeed replace cable. But in order for it to do so, the cost of broadband is going to have to come down. And that doesn’t look as though it’s going to happen any time soon.

This is good as far as it goes but it needs to go much further. There is a significant option for live TV that Salmon omits entirely. It's cheaper than Netflix and it offers better programming than basic cable, both in terms of signal quality and in the number and content of channels.

In Salmon's defense, almost everyone has missed the story of over the air digital TV. The coverage has been sparse and often factually challenged. The New York Times mistaken reported that you needed a special antenna (signal amplification is nice but a set of dollar store rabbit ears will still do the job). It also managed to under report the number of channels available in at least one major market by a factor of more than three.

Sadder still, the little coverage we've seen has pretty much completely skipped over the most interesting parts of the story including:

Pavlovian consumption -- why does anyone continue to purchase bottom tier cable when the free option is better by almost any measure?;

Selling off the commons -- there's a push lead by business interests and conservative economists to remove the free TV option entirely. Rajiv Sethi wrote the definitive post on this over a year ago;

Television in the immigrant community -- Over-the-air broadcasting has a disproportionately large immigrant audience;

New markets and models -- A number of major players (NBC, Tribune, etc.) have come up with innovative programming for the new technology;

Smart, innovative upstarts -- The new technology has also opened up opportunities for small players like Weigel Broadcasting which has been recreating the Turner model for OTA while adding some impressive enhancements. I'll have more to say on this later, but for now I'll leave it at this: if I get cable tomorrow, I will still keep the rabbit ears hooked up because of Weigel.

Journalistic biases -- As Mims points out, the people covering these stories tend to conflate their situation (usually upper-middle class) with that of everyone else. They also tend, all too often, to go where they're told to and cover stories fed to them. An orphan medium primarily serving immigrants and the poor will have a hard time getting on most journalists' radar.

We treat economists as authorities on genetics and epidemiology but we aren't that interested in what they have to say about economics

From Media Matters:

Of the 1,258 guest appearances during segments that discussed the issue in the month leading up to the debt deal, only 52 -- or 4.1 percent -- were made by economists.

View a larger chart here.

The definition of "economist" used in this study is broad -- it includes any guest with an advanced degree in economics or who has served as an economics professor at the college or university level. It also includes guests who have worked as government economists (such as Ben Stein, who formerly "worked as an economist at The Department of Commerce").

When you have to count Ben Stein to get to 4.1%, you know there's a problem

When Greece is an appropriate example

I'd mentioned the problems with using Greece as the prime (and sometimes sole) example in the austerity debate. Now, via Krugman, Kash Mansori brings the point home with a great table that shows how heterogeneous the PIGS were in terms of profligacy and how homogeneous they were in other ways.

If the crisis is due primarily to local causes, then we would expect the best predictor of crisis to be government deficits and debt. On the other hand, if the systemic causes view is correct, then a better predictor of the crisis would be large current account deficits, which necessarily happen when there's a capital flow bonanza.

The following table shows both fiscal (i.e. national government) budget balances and current account balances during the period after the adoption of the euro and before the worldwide financial crisis and recession struck in 2008. All figures are from the OECD and expressed as a % of GDP.


The factor that crisis countries have in common is that, without exception, they ran the largest current account deficits in the EZ during the period 2000-2007. The relationship between budget deficits and crisis is much weaker; some of the crisis countries had significant average surpluses during the years leading up to the crisis, while some of the EZ countries with large fiscal deficits did not experience crisis. This is one piece of evidence that a surge in capital flows, not budget deficits, may have been what laid the groundwork for the crisis.

Joey Skaggs and Rick Perry

I remember an interview with the great prankster Joey Skaggs. Skaggs had a long history of getting major news outlets to report his over-the-top hoaxes as actual news, often scamming the same outlet multiple times. When asked how he managed to avoid running into the same reporters he explained that he would often see people who had covered previous hoaxes but they always had the same reaction: they would pause for a moment trying to place where they had seen him before then would shake it off and go on with the report. I don't have access to the interview, but if memory serves, Skaggs explained that they wanted to believe in the story and that was enough to make them put aside the first-hand experience that told them not to believe it.

I was thinking about Skaggs as I followed the press' eagerness to anoint Perry the GOP candidate for 2012. The press always gets worked up about these late entrants to weak fields. Pundits focus on strengths, downplay weaknesses and fill in the numerous blanks with the most positive possible outcomes. (You can also see this happening with Chris Christie). But I can't think of a case where a Republican entrant has actually jumped into the race (effectively) after the Ames Straw Poll and actually gotten the nomination.

I may be forgetting about an obvious example and even if I'm not it's possible that Perry will get the nomination and even the presidency, but given the recent turn in sentiment both with pundits and at least one (possibly unrepresentative) sample of GOP voters, it's clear that Perry was to a degree a Rorschach candidate.

Why did did so many reporters not anticipate the rough patch that new candidates always face when those initial unknowns are filled in? Why do journalists continue to consistently overrate the chances of entrants who jump in at the last minute? The same reason that the CNN crew didn't recognize Skaggs when he claimed to have written a program that would decide if O.J. Simpson was guilty, because they wanted to believe a good story.

Marginal utility

Frances Woolley asks a question:

In othe words, the reason we care about inequality is that it reduces the happiness achievable from a given amount of income. How much depends upon the happiness/income relationship. Does the marginal utility of income fall rapidly? Or is the happiness from the 100,000th dollar almost as great as the happiness from the 100th?

I think that this question has an obvious answer. Anybody who has lived in poverty can immediately answer that just a few dollars for food can make a huge difference. But how many wealthy executives would feel happy all day over a $3 bonus?

Of course this curve is non-linear. The arguments for inequality that are interesting seem to involve: 1) Whether a class of wealthy investors can stimulate the economy through free market investment and 2) Whether differences in economic outcomes is needed to incentive unpleasant but necessary labor. Now, the later is unlikely to explain Bill Gates or Warren Buffet (are their jobs really so vile?). SO the former really has to do a lot of heavy lifting . . . and is likely overstated.

But an assumption that income effects are perfectly linear seems so contrary to experience that I presume that this post is to stimulate thinking!

California Falling

In interesting news today, California is now at the very bottom of the top ten states for wealth. The continued prosperity of the East Coast is beginning to look a lot like a strong argument for density. Density has historically been a critical way of bringing ideas together. For a while it looked like California was an attempt to show how prosperity could work with lower density population patterns.

We'll see if this is a trend or an isolated blip, but it doesn't bode well for the West Coast pattern of settlement.