Money and government

It is worth remembering that capitalism requires some form of currency:

Trade is important because, without it, it would be pretty difficult for some of us to survive only consuming what we produce well, especially those of us who haven’t figured out how to eat economics lessons yet. Technically, however, trade only gets us part of the way to what we would consider capitalism, since direct trade (i.e. barter) still requires a double coincidence of wants. 

 The problem with money is that it needs to be guarenteed or to have value independent of social contracts.  The second is the whole idea behind a gold standard.  But even with small and valuable items, it is hard to imagine the vast levels of wealth we see in the modern world existing if you had to store tonnes of gold in vaults.  It would be too simple to be robbed and options for recourse would be quite limited. 

So even the very well off require government to function in order to live in a modern society.  It think that we should remember this when we wonder whether or not we benefit from the existence of governing bodies. 

Reality vs. the Facebook valuation -- part 46

As mentioned before, in order to justify the numbers being discussed in the upcoming IPO, Facebook will not only have to add to its huge base of users; it will also have to bring in considerably more revenue per user. For this to happen, Facebook will have to keep advertisers convinced that the data and targeting algorithms are worth the expense.

Stories like this don't help (from NPR):

CHACE: Welcome to the warehouse district of Little Ferry, New Jersey. Right above the loading dock, I found Alex Melen. He runs Melen LLC. It's an internet marketing company. And he provides Facebook likes to people and companies for about $75 per 1,000 likes.
HENN: Liking something on Facebook means you're a fan. It lets a company talk to you. So clicking that little blue thumbs up actually has value. This company supplies likes for cash. It sells them. So I go in and I say, I want 200 likes. How much?
CHACE: Right. And when you go in, it's exactly what you'd expect. About 10 guys, computers, beer cans, Red Bull, iced coffees. The oldest one there is Melen. He's 28.

...

MELEN: And once we find a supplier that says OK, I have the--2,000 likes or 5,000 likes or whatever the client ordered, we just place the order with that network, and then they fulfill it.CHACE: So who is it that's actually clicking the like button for cash?
PREPIS: Danny Longshanks, Camel Love, Vida, Elvis Adon, Bruce Buffalo...
CHACE: Well, it's people from all over the world who are found on work-from-home sites.
PREPIS: And if they get paid 10 cents per like, then they like it. You know, even 500, the over month total. You're making $50 a month that probably took them, in total, maybe 20 minutes to do.
HENN: Or these Likers might not be people at all. Ben Zhao is a computer science professor at UC, Santa Barbara. He says there are much cheaper ways to get a supply of likes - social bots. These are fake people controlled by a computer. Or you can buy compromised accounts.
BEN ZHAO: Right now on the black market, you can actually buy and sell bundles of Facebook account credentials, tens of dollars or hundreds of dollars for hundreds of thousands of Facebook accounts.

I wonder if someone's researching this

The dual currency story reminded of a research question I thought might be potentially interesting (assuming it's not an old, mined out topic). Way outside my field but it might be worth passing along.

Some friends of mine are serious shellac collectors, the kind of people who spend hundreds of dollars for a hundred year old record. It's a big, well established market with the occasional natural experiment that ought to stand up to some analysis, but what caught my eye was the fact that though mainly cash-based, there's a significant barter aspect. what's more, the cash barter mix has been in place for a long time and seems relatively stable.

Seems like there ought to be some fun questions you could ask about a market like that. 

Dual currencies

NPR's the World has an interesting story on the Roman Empire's practice of letting conquered nations use both their own and the official Roman currency. It's a cool piece of history and it suggests some intriguing questions (particularly during the decline and fall of the Euro).

"Implicit Association Tests"

I hadn't heard of this technique before but this interview got my attention. Here's the Wiki version:

A typical IAT procedure involves a series of seven tasks.^[6] In the first task, an individual is asked to categorize stimuli into two categories. For example, a person might be presented with a computer screen on which the word "Black" appears in the top left-hand corner and the word "White" appears in the top right-hand corner. In the middle of the screen a word, such as a first name, that is typically associated with either the categories of "Black" or "White." For each word that appears in the middle of the screen, the person is asked to sort the word into the appropriate category by pressing the appropriate left-hand or right-hand key. On the second task, the person would complete a similar sorting procedure with an attribute of some kind. For example, the word "Pleasant" might now appear in the top left-hand corner of the screen and the word "Unpleasant" in the top right-hand corner. In the middle of the screen would appear a word that is either pleasant or unpleasant. Once again, the person would be asked to sort each word as being either pleasant or unpleasant by pressing the appropriate key. On the third task, individuals are asked to complete a combined task that includes both the categories and attributes from the first two tasks. In this example, the words "Black/Pleasant" might appear in the top left-hand corner while the words "White/Unpleasant" would appear in the top right-hand corner. Individuals would then see a series of stimuli in the center of the screen consisting of either a name or word. They would be asked to press the left-hand key if the name or word belongs to the "Black/Pleasant" category or the right-hand key if it belongs to the "White/Unpleasant" category. The fourth task is a repeat of the third task but with more repetitions of the names, words, or images.
The fifth task is a repeat of the first task with the exception that the position of the two target words would be reversed. For example, "Black" would now appear in the top right-hand corner of the screen and "White" in the top left-hand corner. The sixth task would be a repeat of the third, except that the objects and subjects of study would be in opposite pairings from previous trials. In this case, "Black/Unpleasant" would now appear in the top right-hand corner and "White/Pleasant" would now appear in the top left-hand corner. The seventh task is a repeat of the sixth task but with more repetitions of the names, words, or images. If the categories under study (e.g. Black or White) are differently associated with the presented attributes (e.g. Pleasant/Unpleasant), you would expect that the pairing that a participant associates with or believes would be considerably easier for the participant.^[1] In this example a participant may perform better when White and Pleasant are paired together than when Black and Pleasant are paired.

 I don't have an opinion on this research, but I can think of all sorts of interesting applications for something like this both in the social sciences and in business if the technique performs as advertised.

Has anyone out there played around with this?

Ddulite Alert I (II to follow shortly)

NPR's Steve Henn  has an excellent story here about Facebook and Yahoo. Lots of good points but a couple struck me as particularly relevant to the ongoing ddulite thread.

Today, Facebook CEO Mark Zuckerberg turns 28 and gets the ultimate birthday gift: His popular social networking site is expected to go public later this week. The IPO could be valued at nearly $100 billion. Meanwhile, Yahoo, another company that also once had a bright future, continues to undergo upheaval as it struggles to define its mission.

Facebook is expected to start selling stock to the public and begin trading on the Nasdaq Stock Market on Friday. One of the things that are remarkable is how quickly Facebook became so valuable. Can a company started less than a decade ago in a college dorm really be worth that much?

To put this in perspective, when Facebook goes public it will probably be valued at more than Boeing and Ford combined. But Facebook's profits are relatively minuscule.

So to justify its sky-high stock price, Facebook will need to grow like a weed for the next few years. The amount of money it brings in will have to double and then double again for this deal to make sense for long-term investors.

Right now, more than 80 percent of the money Facebook makes comes from advertising. So that piece of its business needs to expand really quickly. But Facebook doesn't want to clutter up its site with too many ads and annoy its users.

Late last week Facebook gave us one hint about where it might be headed. The company has huge amounts of data about each of its users. It knows your likes, your friends — and where you went to school. Right now it uses those data to sell ads aimed at you, but those ads only appear on its own website.

Friday Facebook tweaked its privacy policy, allowing it to use that information to place ads aimed at its users anywhere on the Web.

...

So Facebook has to walk this line, while at the same time adding members, selling ads and figuring out how to collect even more information about us.

If Facebook doesn't figure all of this out, it will be very bad news for investors.

Investors who buy Facebook this week and plan to own this stock for the long haul are betting on a kind of crazy, almost unprecedented growth. Because without that, Facebook begins to look a lot like another Silicon Valley company — Yahoo.

Right now, Yahoo and Facebook sell just about the same number of ads. They both have audience measure in the hundreds of millions. But Yahoo stock is worth one-fifth of Facebook's projected value.

...

So this week as Facebook goes public, it's worth remembering that Yahoo was once valued by Wall Street at more than $100 billion too.

First a fairly technical point about marketing. Let's say you're on Facebook and you're in the market for a car and, as luck would have, I own an area dealership that sells the make of car you prefer. Though it doesn't entirely replace the need for untargeted marketing for things like brand building, being able to get my ad to you is quite valuable, but that value drops quite a bit if I find out that some other local dealership hit you with a similar ad when you went to another site. The value probably doesn't drop by half (you're still a good prospect even if I have some competition), but the expected return on the ad has dropped.

Assuming rational players and reasonable efficiency, doubling the number of ads per user should increase Facebook's revenue, but by a factor of less than two.

This brings us to some more basic points. Facebook is a well established company with respectable revenue and a huge user base. If you were worried about Facebook going under, these would be wonderful attributes. If you're worried about Facebook not justifying its stock price, these are causes for concern.

In order for it to be a good deal, Facebook has to grow at a fantastic rate over the next few years. Unfortunately there is a limited pool of potential users and each of those users has a finite amount of disposable income. Of course, those are both very big numbers, but not so big that Facebook wouldn't have to command a significant share of both. That's not impossible but as a general rule, the closer those upper bounds get, the more difficult growth becomes.

And that's assuming almost complete market dominance. Facebook does have substantial first mover advantages but we're talking about a volatile segment of the economy that could be turned on its head by a major technological innovation. There's also the possibility of some other deep pocketed companies making a play for FB's marketshare (already happening with Google), or of small niche competitors getting a foothold or even a major open source alternative. Then, there are the potential regulatory issues Henn mentioned in one of the sections I didn't quote.

None of these things threaten the existence of Facebook but any one or two of them could prevent the company from justifying its price.

The comparison to Yahoo is especially interesting.Yahoo has recently become a bit of a whipping boy for the financial press, despite the fact that it's a company with some pretty good fundamentals (hundreds of millions of visitors and billions in revenue according to Wikipedia), more threatened by management hysteria than by any flaw in its business plan.

There are differences between the two companies and good reasons to value Facebook higher than Yahoo, but to get the gap we see here you have to start considering bad reasons as well, and ddulite investors are high on that list. At the height of the tech bubble a dozen years ago, Yahoo had the aura of being the next big thing in technology and its stock broke $118. Now the aura's faded, it's trading for more than a hundred dollars less and it can't get any respect.

Today that aura surrounds Facebook and people are once again failing to price in potential problems and limitations. Perhaps things will work out better this time (but I don't think that's how the smart money will bet).

A good point on J.P. Morgan

(If you're still getting caught up on the JP Morgan story, you should probably go by Marketplace and check out Heidi Moore's explanation of the fiasco.)

I don't have a direct source for this other than that I heard it on either Marketplace or All Things Considered, but a financial reporter made an observation I've been waiting to hear put concisely since this story broke.

The reporter explained that the group that had the huge recent loss had been given a dual mandate: hedge against losses and make lots of money. The reporter then wondered if assigning those two mandates to the same team was a good idea.

I wonder if this is an example of something I've seen before or at least if something I've seen before might have contributed to it. One of the recurring themes in these bad-finance stories is the arrogant dismissal of seemingly obvious points, things like "it's hard for a hedge to provide protection against big, risky bets going bad when it's also a big, risky bet." Part of this arrogance may come from people's mistaken belief in their own sophistication.

There's a common fallacy often encountered by people who build models and handle data. It's the belief that complication implies sophistication. The truth is largely the opposite: complication amplifies naivety. When people use complicated, impressive-sounding systems they tend to be less concerned with common sense questions like, "is my sample representative?" or "Are the relationships we're assuming stable? Are they likely to break down under extreme conditions?"

In the period leading up to the crash, we heard a great deal about how sophisticated Wall street and the financial sector had become, particularly with respect to risk. I wonder if we, in fact, saw just the opposite. Did the rise of the quants and the reliance on elaborate models simply enable naivety and wishful thinking?

I'm not claiming that this was the (or even a) primary cause of the crisis. I would put before it, in no particular order, greed, misaligned incentives, deregulation, the growth fetish and possibly a few other candidates. Still, I think it's fair to say that things were made worse by the belief that having complicated formulas to deal with risk somehow meant you were safe from it.

Update -- I took advantage of the ten minute blogging rule (you have ten minutes after posting to change things) and added the third paragraph.

For the weekend -- five words with something in common

Project
Record
Produce
Conduct
Progress

UPDATE: I noticed no one had a guess yet so I'll put some clues in the comment section.

"Ar go"

Unlike NPR's Planet Money, which started out with one of the best debuts in in recent journalism then faded rapidly, American Public Media's Marketplace has managed to maintain its exceptional quality for better than two decades.

Here are a couple of examples from today's show (I'll blog about them later if I get a chance):

A beautifully done story on a program to help teen mothers in Cincinnati (*and the source of the title of this post). **

And a good account of the pros and the cons of the coupon business.

This show is definitely worth setting aside a half hour of you afternoon.


** While listening to Rayana and Liyah's story, keep this in mind:

Hart and Risley also found that, in the first four years after birth, the average child from a professional family receives 560,000 more instances of encouraging feedback than discouraging feedback; a  working- class child receives merely 100,000 more encouragements than discouragements; a welfare child receives 125,000 more discouragementsthan encouragements.

A response to a response -- honest libertarians

Following up on Joseph's follow up to this post, there's an important distinction I'd like to make with regard to this argument from the Cato Institute (as reported to Business Week):.

Some believe the Census Bureau does too much already. “They waste a share of their budget on studies that no one actually uses,” says Chris Edwards, an economist with the Cato Institute, who cites periodic surveys on such items as the total hog count in the U.S. to prove his point. “A lot of that could be done by the private sector.”

As I pointed out before, Edwards is basically saying (in reverse order) that:

1. the private sector could perform major functions of the Census (which is demonstrably wrong since, as I pointed out before, the private sector has tried to do this repeatedly without ever coming close to matching the quality of government data) ;

2. no one uses reliable data about American agriculture (which is too laughable to waste any time addressing).

What's interesting and depressing here is not just the bad arguments that Edwards made but the valid ones that he didn't (or at least that he didn't make forcefully enough to be quoted). To understand these other arguments, it's useful to think of a simple value function for evaluating government projects

V = Returns - Traditional Costs - Libertarian Costs

Traditional costs are what you normally think of for a project, direct expense, opportunity costs, negative impact on other economic activities. Libertarian costs are the losses of liberty that go with any action where the majority forces the rest of society to take collective action.

Most of us don't give a lot of thought to LC but it's not zero and libertarians are performing a valuable service when they bring it up. In this case Edwards could have made the following valid arguments:

We're financing the census by taxing people who in some cases object to it.

The census is an invasion of privacy by the government.

A relatively small group gets a disproportionate share of the benefits.

I don't happen to agree with those arguments but they are valid and it's worth noting that Edwards chose to use invalid ones instead. We've seen this sort of thing before -- libertarian groups like Cato pushing flawed reasoning rather than make the honest but difficult-to-argue libertarian case. It's a practice that undermines their credibility.

Or it would if anyone cared about credibility anymore.

A quick response to Mark

I am travelling again with limited email access but I wanted to comment on this point by Mark:

Proprietary data that could be used without the privacy restrictions the government imposes would be worth an incredible amount of money. Despite all that trying, though, no private data source comes close. I realize that the Cato Institute might not like to hear this, but this is one of those cases where the private sector tried to do something the government does and couldn't do it as well.

I am increasingly annoyed at either pro-government extremists (Marxists) and anti-government extremists (Randians).  It is quite clear to me that, as a society, neither approach will work and that a pure version of either vision is difficult to find (we can argue about edge cases like "failed states" but I am not sure that really addresses the major point).

Now it will always be the case that some groups in society will do better with more or less government.  For example, the extremely wealthy are not impressed by the benefits of social security given how unlikely they ar to need this money.  On the other hand, infrastructure developers are probably not delighted by all of the ways that we put in veto points for development projects to weaken the power of government.

But it would be very helpful for the debate if we just admitted that some tasks were better done by some approaches?  Governments have a very hard time with the art of shopkeeping and keeping prices in line without free market price discovery.  Private individuals will have a tough time fielding a modern army.

Why not try to limit the argument to the middle where there is a lot of room to disagree?

Half the ranting I'd do if I were feeling better

Menzie Chinn points out a great Business Week article on the nickel-and-diming of the Census Bureau. It's an incredibly short-sighted place to save what is basically a rounding error.

In 2003 the bureau requested more funding to survey financial, real estate, and other companies on a quarterly basis, rather than wait to take their pulse with its Economic Census, which gathers data on business every five years. Census data are funneled to the Bureau of Economic Analysis, which shares its conclusions with the president’s Council of Economic Advisers, the Federal Reserve Board, and Congress. Every year, Census asked for the extra funds; every year, Congress denied them the money, leaving the Census Bureau largely blind to the health of a sector that made up more than half the total economy.

Finally, in early 2009, after the real estate-fueled financial crisis, Congress gave Census what it had been asking for—an extra $8.1 million. In the view of many, it was too late. “That’s a grand example of how nickel-and-diming statistics agencies can screw up the economy,” says Andrew Reamer, a research professor at the George Washington University Institute of Public Policy and a member of the BEA’s advisory committee. “The government saved $8 million, but how many trillions were lost as a result of not being able to see the crisis coming?”

That extra data, says Reamer, would’ve revealed just how quickly certain parts of the economy were slowing down. For example, in April 2008 the BEA, with no quarterly data to work with, estimated that finance and insurance sector activity fell 0.3 percent in 2007. In July 2011, the BEA recrunched those numbers using quarterly data and showed declines of 2.2 percent, 5.3 percent, and 9.9 percent for those sectors in the last three quarters of 2007.

Most U.S. economic data come from three federal agencies: the Census Bureau, the BEA, and the Bureau of Labor Statistics. They have a combined budget of $1.6 billion, less than 0.05 percent of President Barack Obama’s $3.7 trillion proposed budget. These agencies have always had to fight for more funding. Now they may have to fight just to keep their budgets intact. As part of $19 billion in nondefense discretionary cuts in Paul Ryan’s (R-Wis.) budget—recently passed by the House of Representatives—the agencies are likely to get less funding.

The Senate is unlikely to embrace the Ryan budget in its entirety. Yet specific proposals show what the House has in mind. The House Committee on Appropriations recently proposed cutting the Census budget to $878 million, $10 million below its current budget and $91 million less than the bureau’s request for the next fiscal year. Included in the committee number is a $20 million cut in funding for this year’s Economic Census, considered the foundation of U.S. economic statistics.

 Of course, the census is also an invaluable source of data for businesses, which explains this

One of the most vocal critics of the proposed cuts is the U.S. Chamber of Commerce, a deficit hawk. “The chamber is in favor of getting the deficit under control, but you’re not going to get there by gutting the statistics agencies,” says the chamber’s chief economist, Martin Regalia, who last July signed a letter in favor of fully funding the BEA. “The total amount of money saved is relatively small compared to the massive loss of information it would lead to. It’s like trying to balance your checkbook by buying cheaper checks.”

 I'm tempted to go on a rant here about the importance and economic value of research and data collection, but it's late, I'm fighting a cold and pretty much anyone who reads a blog called Observational Epidemiology is already in the pro-research camp. I do, however, want to say something about this part of the article.

Some believe the Census Bureau does too much already. “They waste a share of their budget on studies that no one actually uses,” says Chris Edwards, an economist with the Cato Institute, who cites periodic surveys on such items as the total hog count in the U.S. to prove his point. “A lot of that could be done by the private sector.”

Edwards packs a lot of wrong in here. Working backwards, the private sector has been spending a tremendous amount of money and effort gathering data similar to that gathered by the census. Proprietary data that could be used without the privacy restrictions the government imposes would be worth an incredible amount of money. Despite all that trying, though, no private data source comes close. I realize that the Cato Institute might not like to hear this, but this is one of those cases where the private sector tried to do something the government does and couldn't do it as well.

Then there's the stunning cluelessness of Edwards' example. Can he actually believe that no one uses data on pork production, one of America's largest agricultural industries (with stocks of 62 million, making us the world's second largest producer) and a major source of protein around the world. Or perhaps he's just so cynical that he assumes the journalists covering the story will be too ignorant of agriculture to spot the absurdity.

Either way, it's a disappointing performance from a spokesman for what is (or, at least, used to be) one of the country's most respected think tanks.

"How venture capital is broken"

Felix Salmon has a long but very pithy post on a new report from the Kauffman Foundation on the state of venture capital. It's a fascinating story with some significant connections to two long-standing areas of concern here at OE (ddulites and growth fetishists). You should definitely take a look.

The whole thing is quotable, but I'll limit myself to what Salmon identifies as the most astonishing part.

What you’re looking at here is the self-reported returns from all 100 of the Kauffman foundation’s funds, plotted on a time zero axis. In theory, if you believe the VC industry’s hype, the returns should look a bit like the green line: negative in early years, as you make investments which won’t pay off for a long time, and then positive by year 10.
In reality, reported returns peak very early on, in month 16 — which just happens to coincide with the point at which the GPs tend to start going out on sales calls, trying to raise their next fund. (The blue line shows total fund returns, while the red line shows returns net of fees — the money which actually goes to LPs.) Of course, at month 16, none of the returns are realized: they’re driven instead by increases in portfolio-company valuations, and those valuations are set by the GPs themselves.
If GPs were incentivized mainly by their 20% performance fee, then you’d expect something like the green line, or at the very least you’d expect the performance to rise over time, as the fund’s illiquidity premium manifested itself. If GPs were incentivized mainly by their 2% management fee, however, then you’d expect something much more like the real-world red and blue lines, where performance figures are used more to raise new funds than to make money.

Amazing.  

This is the second Justin Fox post I've looked at in the past few days

and the second I've felt the need to pass on. There may be a pattern forming (via Krugman).

Don't Like the Message? Maybe It's the Messenger

Back on the subject of agricultural research

I'll be coming back to this.

From the Financial Times

[Cary] Fowler reminds me that losing varieties of crops means losing genes that may one day come into their own. He recounts the story of Jack Harlan, who in 1948 was collecting plants in Turkey. Harlan came across a wheat variety that looked scarcely worth picking up. "It was the most miserable-looking wheat. It had a poor yield, it was susceptible to lots of diseases, it fell over with rot... before it could be harvested." Some years later, wheat in the north-west of the US was attacked by stripe rust, and researchers scoured seed collections to find a way to help. The "miserable-looking" wheat turned out to be resistant. New varieties were bred to incorporate this quality. Fowler estimates that feeble-seeming wheat has been worth more than $100m a year to the US agrarian economy.