Bad banks and (you guessed it) free TV

I was listening to NPR a few days ago and I heard a financial reporter say that other banks would probably follow BoA's lead and start charging a fee for debit cards because "that's how markets work." That is, in fact, pretty much the exact opposite of how markets are supposed to work.

Even with the new regulation, merchants' fees are still many times what the transactions cost the banks. When markets are doing their job, businesses shouldn't be able to use a competitor's price increase as cover to raise their own. Competition is supposed to prevent this kind of de facto price fixing. In a well-functioning market, BoA's move should provide an ideal opportunity for a smaller bank to come in and grab a bigger slice of what is still a multibillion dollar market.

Of course, we don't have anything like a well-functioning market in banking. The considerable inconvenience of changing banks (particularly in an age of direct deposit) means that price increases and cuts in service will only cause minimal loss in market share. Poor transparency means that even if you get fed up enough to change banks, you probably won't be able to get the information you need to make an informed choice (at least not in a form that even a financial advisor can understand). Finally, and most importantly, the market is dominated by a handful of huge players, implicitly backed by the federal government thanks to their too-big-to-fail status.

Which brings me to my main point, and yes, the connection to free TV. We seem, as a society, to have become indifferent, if not openly hostile, to the idea of competition. I'm not talking about intrusive government anti-trust policies (those we can debate at another time); I'm talking about intrusive government policies that actively discourage competition. Implicitly guaranteeing the biggest banks, mangling patent and copyright laws to favor major established players, and, in the case of over-the-air television, proposing to shut down the only part of the television industry that's diversified and not dominated by large corporations (you could look at this as roughly analogous to proposing that we shut down credit unions).

The go-to guy on this story is, of course, Joe Nocera, but both Salmon and Baseline Scenario are also doing some great work here.

Financial security and the decision to start a family

I mentioned earlier that there was reason to suspect that being financially secure might influence the decision to adopt. This interview with demographer Carl Haub explores the similar relationship between economic downturns and birthrate (via the good people at NPR).

Best economic metric based on a Seinfeld routine

The joke about men keeping underwear until it broke down into individual underwear molecules came to mind while I was listening to an entertaining piece on alternative economic indicators (via the good people at Marketplce). The list included Marine retention and abandoned pets and, of course, this:

Ryssdal: I'm just looking at the list of things we were going to talk about and I see next -- and I hesitate to mention this -- the men's underwear index.

Brancaccio: The theory is during bad times we're less likely to replace our boxers and our briefs. I wouldn't have brought the tone of this conversation down this far if the source had not been so exalted.

Ryssdal: Give it up. Who is it?

Brancaccio: Well, back in the '70s before he was Fed Chairman, Alan Greenspan ran his consulting firm. One way he kept track of the economy was by looking at offbeat economic indicators like the men's underwear indicator -- MUI for those of you in the know. Here's the theory: When you're feeling strapped for cash, your less likely to replace your undergarments even though most people see under see underwear as a necessity not a luxury.

Ryssdal: So one is obliged to ask David, how are sales now?

Brancaccio: Well, we did check. And according to an analyst who tracks these things -- underwear sales for the NPD Group -- sales, currently, are up 5.2 percent.

Testing Theory

Matt Yglesias:

Last week I was outside my office and I saw a $5 bill on the ground. Famously, economists say you never see a $5 bill on the ground because someone would pick it up. But instead of picking it up, I stood around watching to see if anyone else would. A bunch of people walked by not noticing it. Then one guy saw it, saw me, and asked if it was mine. I said no it wasn’t, I was just curious what would happen. He laughed and made a joke about economists. Then a second guy came by, picked it up, and said I’d dropped five dollars. I said no, actually it was there before me. He looked around, noticed a homeless guy across the street, said “I think he needs it more than me,” walked over and gave it to him.

While a single test is not proof of anything (expect the strongest of the possible theories), I have certainly had people tell me that I have dropped money. That seems to go against the assumption that rational people will always act to increase their wealth (after all, they could just pick up the bill).

I think that it is worth keeping in mind that the assumptions of economic models are just that. Models can be useful but are rarely ever completely correct.

And Matt's stuff in the same post on the Night Watchman state is simply not to be missed.

Update on BoA severance

In a recent post, I referenced the decision of Bank of America to give a very large settlement package to two departing executives. Given how tone deaf the settlement seemed, many people assumed that it was part of an employment contract. Mark, my co-blogger, has many times talked about the importance of upholding contracts (see comments on this post).

It turns out that the decision to pay $11 million dollars in severance was voluntary and not required at all by any contract.

Social Justice

Tyler Cowen points out a great interview with the head of a major Slovakian political party on why Slovakia isn't necessarily thrilled about the plans in Europe:

SPIEGEL ONLINE: Nevertheless, banks could run into significant problems should they be forced to write down billions in sovereign bond holdings.

Sulik: So what? They took on too much risk. That one might go broke as a consequence of bad decisions is just part of the market economy. Of course, states have to protect the savings of their populations. But that's much cheaper than bailing banks out. And that, in turn, is much cheaper than bailing entire states out.

SPIEGEL ONLINE: Does one of your reasons for not wanting to help Greece have to do with the fact that Slovakia itself is one of the poorest countries in the EU?

Sulík: A few years back, we survived an economic crisis. With great effort and tough reforms, we put it behind us. Today, Slovakia has the lowest average salaries in the euro zone. How am I supposed to explain to people that they are going to have to pay a higher value-added tax (VAT) so that Greeks can get pensions three times as high as the ones in Slovakia

I think that this is becoming one of the real flashpoints in our economic discourse. I am a huge supporter of pensions. But I can see the potential moral hazard in the Eurozone where making reckless promises can result in being bailed out (and working through your problems can result in being billed for others failure to do so). That sort of "tragedy of the commons" is a much bigger threat to economic stability than I had previously suspected.

We will have some of the same issues between generation here in the United States. There have been proposals to limit Medicare to people who are currently 55 plus. That will mean my generation (which began their careers with a terrible job market) will be playing taxes so that the generation ahead of it (which did comparatively well) can retire at a higher standard of living. These sorts of approaches can be toxic to any social contract.

But I can see Slovakia's position now, even if I am not necessarily in favor of it.

Epidemiology is about communication

This article highlights the critical importance of continuing to try and communicate evidence-based medical information:

Most pancreatic cancers are aggressive and always terminal, but Steve was lucky (if you can call it that) and had a rare form called an islet cell neuroendocrine tumor, which is actually quite treatable with excellent survival rates — if caught soon enough. The median survival is about a decade, but it depends on how soon it’s removed surgically. Steve caught his very early, and should have expected to survive much longer than a decade. Unfortunately Steve relied on a diet instead of early surgery. There is no evidence that diet has any effect on islet cell carcinoma. As he dieted for nine months, the tumor progressed, and took him from the high end to the low end of the survival rate.

Why did he do this? Well, outsiders like us can’t know; but many who avoid medical treatment in favor of unproven alternatives do so because they’ve been given bad information, without the tools or expertise to discriminate good from bad.

Everyone would prefer to avoid surgery -- especially painful, high-risk surgery with an uncertain prognosis. But this seems to be a clear case where better advice could have made a real difference. Unfortunately, the literature is full of spurious findings and it can be hard for even experts to sort these issues out.

The ultimate goal of Epidemiology is to give patients the best (high-quality) evidence available in order to assist them in making optimal decisions. We'll never know if the advice given to Steve Jobs was good or bad, but stories like this highlight how important it is to keep focusing on communication.

Testing teachers

It has been a while since we talked about education reform but Arnold Kling has a great perspective:

Simple formulas can be “gamed.” That is, employees learn to achieve the objectives in the formula while failing to work toward the longer-term goals of the firm. On Wall Street, we have seen how bonus formulas proved dysfunctional. The older partnership form of organization appears to have provided better incentives.

A government-run system of teacher compensation, based on test scores, would in some ways be the worst of all worlds. It would create incentives for teachers to “game” the system. It would give too much weight to a noisy indicator of performance. As a result, it would do little or nothing to improve accountability or to reward better teachers.

This classic insight is shown in this dilbert comic.

Are we sure that test score based measures are the way to go? Most information technology jobs have the same sort of issues, often solved by comparative rankings and broad evaluations. Even worse, a bad metric drives out the good (meaning it could actually be counter-productive).

The whole post is worth reading.

More on Executive Compensation

I do not agree with the amount of vitriol in the linked post, but Joshua Brown has a very strong set of feeling on the decision to pay two low level executives at Bank of America an $11 million dollar severance package:

You pay fired executives more in severance than the average American worker will earn in a lifetime. For most people on the outside looking in, this seems like it's from outer space, another world entirely. These numbers just do not exist to regular human beings, they cannot be fathomed.

He also points out the bad timing:

It's not that this isn't your prerogative as a private company - it is. But seriously, numbers like these at a time when you're instituting added fees on customer accounts just sound farcical, almost like you're making these payments to get a reaction out people.

I have been interested in this dynamic for a while. Mostly because I am beginning to see executive compensation as an intriguing form of market failure. After all, let us consider the example of these two executives. What are they being compensated for?

Do executives at banks really add so much value that $5.5 million dollar severance packages are just a way of saying thank you? Is there really no competitive pressure on salaries? Is the supply of potential bankers really this low? Supply side issues seem to be dubious. Are these skills really so rare (and, if they are, how do banks really select for them because the rest of us want to know).

Or is it due to the risk of taking a corporate job instead of being a school teacher? Well, these two executives are not really taking any real risk. Even if this is the last job either one ever holds. they are already well above the typical lifetime earnings curve based on this severance package alone. Debts required to reach this position (like School debt) are simply dwarfed by the size of the payout.

It is a very interesting problem.

Schlock Mercenary

It is certainly one of the best science fiction themed web comics out there. It is a new addition to the blogroll.

Enjoy!

Free TV blogging -- Why Weigel Broadcasting may be the best business story that no one's covering -- part I

[I should start with the disclaimer that all of the information I have about Weigel comes from two sources: Wikipedia and way too many hours of watching television. It's entirely possible that a competent journalist could discover that the truth here is something entirely different, but if competent journalists were paying attention I wouldn't be writing these posts.]

Though the improvement in picture and sound got most of the attention, another aspect of the transition to terrestrial digital was arguably more important, particularly for broadcasters: under the new technology, each station could broadcast multiple subchannels. The situation was analogous to the TV landscape thirty years earlier when cable and satellite stations were exploding on the scene. It's not surprising that someone would try to create the broadcast equivalent of superstations like TBS. What is surprising is who was able to get a channel up and running before any of the competitors were out of the gate.

The name of the channel was ThisTV. It was produced by a regional broadcasting called Weigel, best known for operating the last independent station in Chicago and being the home of the cult favorite Svengoolie -- last of old time horror hosts. Weigel had a content deal with MGM which was not nearly as impressive as it sounds -- Turner had bought out the classic MGM library years earlier -- but MGM still had a lot of films including the catalog of American International, the studio responsible for virtually every drive in movie you can think of from the late Fifties through the early Seventies.

Access to all those AIP films probably had a lot to do with the unique ThisTV brand. Here's how I summed it up earlier:

Weigel are the people behind ThisTV and the exceptionally good retro station MeTV (more on that later). ThisTV is basically a poor man's TCM. It can't compete with Turner's movie channel in terms of library and budget -- no one can (if my cable company hadn't bumped TCM to a more expensive tier I never would have dropped the service), but it manages to do a lot with limited resources using imagination and personality. As a movie channel, it consistently beats the hell out of AMC.

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.

If I ran a TV station, I would definitely combine Bergman and ninjas. I would not, however, run Mario Bava's feature length pulp magazine cover, Planet of the Vampires from twelve till two. Some of us have to get up in the morning.

This mix was in place from the very beginning. The station officially debuted on November 1, 2008 with Spike Lee's She's Gotta Have It but many stations started carrying it a day earlier to take advantage of a day of cheesy Halloween horror films. It was a formula that made a virtue out of cheapness (rarely seen auteur films and drive-in movies both have the advantage of not costing much) and it produced a format that's been running smoothly with remarkably few adjustments for almost three years.

For a small player to identify a new market, develop a concept, negotiate the necessary deals with a content provider (MGM), line up affiliates, make the countless other arrangements that accompany a major launch and to be up and running with a quality product when the support technology first comes online is an impressive accomplishment. But it gets better.

So far we have a solid business story -- small yet nimble company with some good ideas beats big, well-established competitors into a new market. Not exactly the most original piece of journalism but certainly good enough for the front page of the business section. However the story doesn't stop there. Weigel didn't just beat its big and well-financed competitors; it lapped them. Before the next entrant, Tribune/WGN, was able to get its station, AntennaTV on the air, Weigel managed to launch a second channel, the ambitious classic television station, METV. If this weren't enough, AntennaTV is the only one of the three to look slapped together despite having taken far longer to make it to the air (of course, we have no way of knowing how long it took Tribune to see the opportunity and how long it took them to act on it but either way Weigel looks good by comparison).

To put this in context, at least half of this story takes place after the collapse of '08, a downturn that hit advertiser-based businesses particularly hard. Furthermore, the story occurs in an industry that a large number of lobbyists and at least a few pundits were literally trying to kill. There had even been a New York Times op-ed calling for the government to eliminate over the air television and sell off the spectrum.

One of the great memes of the Great Recession has been that uncertainty paralyzes businesses. Even the possibility of a tax increase or some additional regulation -- both extremely mild by historical standards -- are enough to bring the economy to a standstill, but here's a market filled with unknowns under a credible threat of annihilation and we can still find a company like Weigel moving aggressively to establish dominance of it.

That's the other side of uncertainty. It allows companies to substitute boldness and decisiveness for money and market position and take advantage of opportunities that would otherwise be out of their reach.

[also posted at MippyvilleTV]

CERN disproves global warming!

I exaggerate but not by much. Jon Chait has a wonderful time disembowelling this piece of bottom-scraping from the WSJ.

(The Churchill analogy alone is worth the price of admission)

Equal time for American Public Media

Having singled out NPR, I should mention that APM's Marketplace has been doing some extraordinary work lately. Today they ran the best piece I've come across yet on the business genius of Steve Jobs but the whole episode merits a link.

It feels strange talking about good journalism.

The unhappiest place on earth?

NPR has an excellent report out on J visas:

“You have 300,000 workers come to the US and they’re just lacking in protections,” Costa said. “Workplace protections, wage protections and we’ve see complaints where employers have been threatening people who complain about their work conditions with deportation.”

In fact, it’s even worse than that. In recent years, J1 workers have reported that their stays in the US were characterized by menial jobs, low wages, filthy living conditions, and a lot of economic exploitation.

J1 workers apply for the program and then pay between $3,000 and $6,000 to a sponsoring organization, accredited by the State Department. The sponsor organization places them with American companies. One of the biggest J1 employers is Disneyland.

“They work on rides, quick service food and beverage, housekeeping, parking attendants, merchandising, lifeguards, dispatch, and most importantly showkeepers- those are the janitors,” said Kit Jonson, a law professor at the University of North Dakota.

Jonson’s been researching the J1 labor force and says it’s become a very clever business strategy for American companies. They save on wages, state and federal taxes, healthcare, housing and pension plans.”

“For Disney those figures end up being really stunning,” Jonson said. “Disney’s saving in wages alone upwards of $18.2 million a year in hiring international workers. So international students are simply a lot cheaper than American labor.”

Both Kit Johnson and Daniel Costa say that especially now, when unemployment is so high, these jobs should be filled by local workers. But J1 workers are more attractive because on top of the cost savings, they’re less likely to put up a fuss. If they do, they’re easy to get rid of. Like a group of J1’s from Russia who came to work as lifeguards in Texas, and ended up begging in the streets when they weren’t paid.

Response to Comments

Comments from Trevor:

I agree that the logic of this argument is very strong, and it seems to me that the same argument applies to the morality of punishment.

and the link posted by Stuart Buck seemed to share a common theme. In the link, the authors argue that:

According to data provided by the California Department of Corrections and Rehabilitation, in 1977, parolees who were returned to prison or convicted of new crimes accounted for just 10% of California’s prison population. The percentage topped 20 only once prior to 1980. In 2009, however, the number was an alarming 77%, having held firm between the high 60s and low 80s since 1986.

I think that there is a real point here: vindictiveness is expensive. The previous focus in California prisons on rehabilitation and returning prisoners to society was based around minimizing losses of social capital. This is not to excuse the crimes (as most criminal activity is either selfish, mean or petty), but to point out that a focus on punishment is expensive and not especially good for the prisoners themselves. Clearly something was going right if only 10% of prisoners were coming back into prison. A return rate of 77% might actually indicate that we are simultaneously less safe and making life worse for the imprisoned.

Now, we can always find single examples of people who should never be released. Serial killers with psychiatric issues come immediately to mind. But we should not let the extreme example determine the policy for the median prisoner. Similarly, we have a 100% chance that at least one person on parole will re-offend. That would be true even if the crime rate in the parolees was less than that in the general population.

This is a hard issue. I have strong and irrational feelings of fear about many convicts. But the focus on punishment over rehabilitation may well have been a mistake.

"100,000 Tablets for School Children in New Delhi"

To be perfectly honest, the original post I had planned for this NPR story was rather critical of Apple, but before I could get around to posting it word came of Steve Jobs passing away and it seemed disrespectful. I'm sure we'll return to this subject later. In the mean time, check out this interesting interview from NPR's the World.

100,000 Tablets for School Children in New Delhi

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.

Is smoking really the most important predictor of obesity?

Does this headline really represent the data?:

The No. 1 Reason Americans Are Getting Fatter: We're Not Smoking

The text goes on to discuss the rise of anti-smoking laws and the increase in obesity. Then at the end of the article, they discuss the actual magnitude of the effect:

"Using the traditional Blinder-Oaxaca decomposition technique" -- a social science method often used to study two groups or components with different credentials; a method, essentially, of comparing apples to oranges -- "we find that cigarette smoking has the largest effect: the decline in cigarette smoking explains about two percent of the increase in the weight measures," Baum and Chou, both professors of economics at Middle Tennessee State University and Lehigh University, respectively, explain in the paper's abstract. "The other significant factors explain less."

Two percent? Really? So non-smoking factors explain 98% of the change?

So either the model explains very little of the variation or smoking is a small contributor to the obesity epidemic, regardless of how it ranked on a list of covariates. And this doesn't even consider the possibility of correlation (obesity is rising as smoking falls) of temporal trends instead of causation.

In either case, that is not a useful headline.

Beware of pundits bearing ADA arguments

Reading Paul Krugman (more a cumulative effect than any particular post) has gotten me thinking about how ADA arguments have come to dominate much of the Euro debate. ADA arguments (let me know if you have a better name) follow an Aggregate-Disaggregate-Aggregate pattern. Here's the classic example:

I. Ominous statement about Social Security and Medicare;

II. Frightening statistic about Medicare;

III. Draconian changes for Social Security and Medicare.

The troubling statistic never applied in any way to Social Security. It invariably referred to some aspect of Medicare that was completely different from the first program but those not listening carefully could easily come away with the impression that the statistic applied to both.

Now the most common example is the PIGS Austerity argument which goes like this:

I. Portugal, Ireland, Greece and Spain are in trouble;

II. Greece engaged in profligate spending and ran up a huge deficit;

III. Portugal, Ireland, Greece and Spain need to slash spending immediately.

In a way, Greece makes an even better D in the ADA than Medicare does. Both entitlement programs do, at least, share some common troubles (though not to comparable degrees). With PIGS, two of the countries were actually recognized models of fiscal restraint, displaying the exact opposite of the behavior that got Greece into trouble, but through the magic of ADA, a large portion of the pundit class is now convinced that all four countries partied their way to ruin.

The Growth Fetish cont. -- Netflix and Dylan

Joseph has a great post up that dovetails nicely with my earlier post on attitudes to corporate growth and contraction in which he elaborates on Karl Smith's insightful reaction to a statement by Netflix CEO Reed Hastings. You should definitely read what both Joseph and Smith have to say but it was another aspect of Hastings' quote that caught my eye:

Most companies that are great at something – like AOL dialup or Borders bookstores – do not become great at new things people want (streaming for us) because they are afraid to hurt their initial business. Eventually these companies realize their error of not focusing enough on the new thing, and then the company fights desperately and hopelessly to recover. Companies rarely die from moving too fast, and they frequently die from moving too slowly.

This fable of CEO as Dylan at Newport, boldly walking away from proven success to try something new, is a cherished part of the mythology. It is not, however, true all that often. I can think one example offhand (CBS's rural purge of 1971) and of many counterexamples where a business lost a lot of money trying to do something new to avoid the dreaded contraction. Interestingly, one of these counter-examples is Borders which hastened its demise with an ill-considered attempt to expand into overseas markets.

Principal agents

I suspect that this reaction to a press release by the CEO of Netflix is just a principal agent problem:

In classical economics AOL should have died. Borders should have died.They should have spun every dime out to the shareholders who could have invested in the next big thing themselves.

However, Hastings is specifically saying this is the mark of a bad CEO and everyone nods there heads. He is saying that we should burn shareholder profits in an effort to move away from what made the company great.

Shareholders are diluted across thousands of mutual funds and cannot easily exercise control. Returning money to these people also means no longer being the CEO of Borders or AOL. Management loses access to resources and are looking for jobs with less experience. If there was a cultural sense in which winding down the firm made an executive more employable at a later firm, that would be different.

But, as it is, why would an executive ever decide to walk away from the resources of managing a large company when they could profit from spending down the corporate resources. It is not like they can be held accountable by the shareholders, in any meaningful sense. They merely need to promise that, in their judgement, they can invest the money more effectively than the shareholders and keep going.

Heck, how many people working for a large firm consider themselves as working for a shareholder pool as opposed to working for the CEO? After all, only one of these two groups has any day to day authority in the company and access to complete information.

Leave SpongeBob aloooooooone!

I have to admit a certain bias here. I'm a big fan of Mr. Squarepants. I like the classic Fleischer look with the occasional Wolverton grotesque touches, the witty asides to the more sophisticated viewers, the sensibility that built the climax of the first episode around a Tiny Tim song and the cultural literacy to pick the lovely and wonderfully apt "Livin' in the Sunlight, Lovin' in the Moonlight" for the song in question (and, of course, the fact that in Bikini Bottom you can build a campfire under water).

SpongeBob has been all over the news lately, even making the teaser for at least one local station's 11:00 broadcast. The cause of the furor was a recent study, described here on All Things Considered:

"I would not encourage parents of a 4-year-old boy to have him watch SpongeBob right before he goes in for his kindergarten readiness assessment," Dimitri Christakis told Shots. He's a child development specialist at Seattle Children's Hospital who wrote a commentary on the new study, which was just published in the journal Pediatrics.

But fans of the optimistic denizen of Bikini Bottom can take solace in the fact that the new study comes with a boatload of caveats. Just 20 4-year-olds were tested after watching the popular Nickolodeon show, and they watched it for nine minutes. That's a very small sample size, and it hardly reflects the real TV-watching habits of young children, who commonly watch two to five hours a day of TV.


And the researchers, psychologists Angeline Lillard and Jennifer Peterson of the University of Virginia in Charlottesville, didn't measure if the problems with attention and executive function lasted. But they did compare the SpongeBob watchers to 20 children who watched Caillou, a slower-paced PBS show that features a sweet yet whiny preschooler. Another 20 colored for 9 minutes.

Neither of those groups had problems with the tests, which involved remembering a series of numbers, following rules, and delaying gratification. (That test asks the preschoolers to resist eating a plateful of Goldfish crackers for 5 minutes, which would be hard for many members of the NPR Science Desk.)

But the kids who watched SpongeBob, which changed scenes every 11 seconds, did significantly worse on the tests than either the children who colored, or those who watched educational TV. Caillou changed scenes every 34 seconds.

Other studies have found that children who watch a lot of TV as preschoolers have more problems with attention in the elementary-school years. Christakis, who has conducted several of those studies, says that the findings of the new study are consistent with what he's found. It's not SpongeBob himself who's the culprit, he says, but fast-paced or violent shows. "It's overstimulation that causes the problem," he says. The theory is that overstimulation while a child's brain is developing makes it harder to focus on sustained tasks later on.

This is the classic one-two punch of so much behavorial science: observational studies with data confounded to within an inch of its life* and little n experiments that answer a trivial (and in this case painfully obvious) question that relates only tangentially to the major issues.

This incredibly hyped study basically showed that small children have trouble concentrating immediately after they get wound up. This conclusion is not exactly news worthy. Anyone who has ever dealt with groups of pre-schoolers can tell you that the transition from squealing with laughter to sitting quietly can be difficult and that's really all this study tells us.

There has been a long history of research, going back at least to Seduction of the Innocent, built around puritanical disapproval of children seeking out stimulating entertainment. It is based on a vision of young people as miniature Roderick Ushers with constitutions so delicate that anything but lives of unrelenting blandness would damage them forever.

I don't buy it. Kids are remarkably resilient, often emerging relatively unscarred from some truly tough situations. It's difficult to believe that a few extra camera angles would cause them irreparable damage.

More importantly children have an evolutionary imperative to seek out stimulation. Their appetite for excitement and laughter matches and often exceeds their appetite for food and drink. There's a reason for this. Our creativity, our curiosity and our ability to organize and explore our world through narrative are all connected to that desire for fun.

This is not to say you should give your preschooler the remote any more than you should give a four-year-old free run of the refrigerator. Providing structure and maintaining balance are part of a parent's job, as is reading to your kids and taking them outside to play and any number of other things that everyone knows are important for a growing child. Television should certainly take a backseat to these things. You can even make a good case for eliminating it entirely.

Just make sure it's based on common sense, not questionable research.


*yeah, 'data' is plural -- what are you, the grammar police?

Logic on social security

Somehow, I doubt that this post will be influential:

Oftentimes, however, I see people on your television programs or your televised debates making reference to the idea that “younger workers” should divert some of our payroll tax money into some kind of private retirement accounts. At this point you, the national political reporter, absolutely must ask them how we’re going to pay current benefits of this happens. What privatizers want to say is that current retirees will keep getting benefits and future retirees will be okay despite our lack of benefits because we’ll have private accounts. But current retirees can’t get benefits if my money is in a private account. And my account can’t be funded if I’m paying benefits for current retirees.

The obvious answers are either a) we will stop paying benefits or b) taxes are about to hit a new and large high as we switch from Paygo to pre-funded accounts. If the answer is a), why do we trust these same people not to play games with the individual accounts when they start to become a major liability (i.e. have to be paid out)? I am not against option b) but it seems to be an unusual direction for the United States to go, and an enormous financial sacrifice for a fairly small policy gain.

I also think that the distinction between lending to the government, via a private savings account, and having a future claim on government revenues is a narrower difference than most people think. After all, playing with the tax rates on withdrawals from these accounts has the same effects as a benefit cut in social security (and both are within the easy ability of the government to accomplish).

How do you say Los Angeles

For the curious, Americans often pronounce the names of cities in interesting or unusual ways. It seems there was actually a risk Los Angeles could have ended up pronounced with a hard "g" (like angle instead of angel".

Loss AN-ju-less versus Loss AN-guh-less: did they pick correctly?

What is up with Arkansas?

Looking at the student loan defaults rates by state, one is struck by how much the defaults are concentrated in the South East. Why would this be so?

But nothing is as shocking as how badly the for-profit institutions do. I think some sober looks at these numbers make sense before we conclude that for profit is automatically better, especially given that student debt is large and can no longer be discharged by bankruptcy.

Medical spending as a zero-sum game

Marketplace has a good piece on the debate over hospital construction in Detroit. It raises real questions about creating new jobs by adding what seems to be unneeded capacity to the health care system.

Definitely worth a look.

Professionals and Advancement

A few years ago, a Fortune 500 company I was working with started worrying about retaining their technical people. The wages were competitive and the bonuses were good, but the concern was that statisticians, programmers and other people who were doing analytic work and who weren't interested in management really didn't have a career track. In other words, even with high salaries and incentive pay, it's difficult to hold on to good, highly skilled professions without offering some opportunity of advancement.

With almost all careers, we expect a certain level of ratcheting advancement. We generally assume that if we maintain a certain quality of work, we will see a more-or-less steady increase in either our compensation, our employability or our job security. This advancement can take all sorts of forms from traditional promotions to a salesman's contact list to a writer's readership, but whatever the form, it is exceedingly rare to find jobs where you start each year about where you started the last one and it's next-to-impossible to find one that would be considered a 'profession.'

(Of course, there are many freshwater economists who are deeply uncomfortable with this ratcheting effect, who would argue that an ideal labor market should have no memory, that the services provided by a long time employee should be treated no differently than any other commodity. Long time OE readers will probably know I don't agree with the idea that labor should be treated as just another market, but that's a topic for another time. For now we're talking about the way things are.)

The discussion of teacher compensation and job security has almost entirely ignored the larger question of advancement, looking at the unusual contractual protections afforded the profession but failing take into account the equally unusual limitations. Take a minute and try to think of professions that have the following career constraints:

Few opportunities to move up the org chart. Not only is the structure here relatively flat, but unlike many industries, the move to management is almost a complete break from your previous role. Thus 'rewarding' the best teachers by making them administrators is a questionable strategy. We obviously need exceptional principals but we can't have teacher career track focused on taking the best teachers out of the classroom;

Non scalable work. Even if you accept claims about class size not mattering (and there's a lot to dispute in the reasoning behind those claims), there are still hard limits to the number of fourth graders one person can teach in a year. Compare this to someone like a journalist who can, in a sense, sell the same piece of work a virtually unlimited number of times;

Bounded compensation. Though movement reformers talk a lot about different incentive pay plans, pretty much all of them are metric based and have pre-determined maximums;

Lack of entrepreneurial opportunities. It is true that administrators can go out and start their own charters but teachers can't start their own classes;

Limited chances for promotion through relocation. This does happen but it's discouraged with good reason. The winners tend to be high-income suburban schools. Add to this the logical results of movement reforms that effectively reduce job security for teachers in schools bad neighborhoods and you have a huge incentive to actually widen the achievement gap.

In other words, we have here another case of advocates for business-based solutions who don't understand how businesses actually operate. Not coincidently, this is also an area where conservatives with actual business experience (like Jim Manzi) tend to take more nuanced positions.

Appropriate Scales

Paul Krugman has a clever post about where to start a Y-axis of a graph from. He plots the temperature changes of New York . . . in kelvins. The result is a graph that makes it seem like New York has very small variations across the year.

On the other hand, very small variations can look large if the axes covers only the range of variation. The real piece of information that is missing is what is the size of a meaningful change. Maybe we should have graphs declare this extra piece of information so that this point can be discussed along with the variation shown in the graph, itself,

The Wisdom of Salmon

About ten minutes after putting up the last post, I came across this relevant passage from Felix Salmon:

What’s more, everybody wants to be invested in stocks when the market’s going up — just not when it’s going down. Is it possible to actively manage your 401(k) so that you try to go long stocks when they’re going up and then move to cash or bonds when stocks are falling? Well, you can try. But that’s called timing the market, and it tends to end in tears. You are not a hedge-fund manager, and even they get these things wrong. Don’t think you can time the market, because you can’t. So if you want to be invested in up markets, you have to be invested in down markets, too. And as the chart shows, your retirement account will tend to grow most of the time anyway.

The main reason for this is that we’re not just sitting back and hoping that the stock market will do all the heavy lifting. Every paycheck, we’re putting money into our 401(k) accounts — about 8.7% of what we earn, on average. And so every quarter, we see our balance rise not just because we’re great at investing, but also because we’re manually adding to the pot.

And in fact that second aspect of saving for retirement is significantly more important — and much more under our own control — than the first aspect. When it comes to our 401(k) plans, people tend to focus far too much on the quarter-to-quarter fluctuations in mark-to-market asset value, rather than trying simply to save as much money as they can for when they’re older. My advice is to think of a retirement account like a piggy bank: you put money in there on a regular basis, and eventually it grows to a substantial sum. Once it’s in there, of course, you try to invest in something reasonably sensible — target-date funds are a pretty good idea, so long as their fees are low. But you don’t have much control over the internal returns on your retirement funds; you do have control over how much you save. So concentrate on the latter more than the former.

The Growth Fetish

[This is a big topic so I'm just going to lay out the bare bones for now and flesh things out later, hopefully with a little help.]

It's obvious that our economy is suffering from a lack of growth but for a while now I've come to suspect that in a more limited but still dangerous sense we also overvalue growth and that this bias has distorted the market and sometimes encouraged executives to pursue suboptimal strategies (such as Border's attempt to expand into the British market).

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).

As mentioned before we need to speed up the growth of our economy, but those pro-growth policies have to start with a realistic vision of how business works and a reasonable expectation of what we can expect growth to do (not, for example, to alleviate the need for more saving and a good social safety net). Fantasies of easy and unlimited wealth are part of what got us into this mess. They certainly aren't going to help us get out of it.

Dream a little dream for me

If you have a few minutes, listen to this episode of KCRW's Unfictional (sorry, I can't find a transcript) where neuroscience researcher Moran Cerf publishes a paper on brain machine interfaces in Nature then watches the popular press spin out a string of fantasies about dream recorders and the government monitoring your subconscious.

It's a funny story but it has a serious undercurrent. At the risk of sounding like an alarmist, I'm beginning to think that our discourse, our ability exchange and evaluate important information and use it to collectively make informed decisions is in serious trouble, and I'm not sure how you can run a democracy without that.

The decline in journalistic professionalism is a big part of that problem. There are some excellent journalists out there, but there are also far too many like the ones in this story. They nonchalantly build on each other's fictions. They unquestioningly accept claims from interested parties. They dodge responsibility for uncomfortable facts by hiding behind he said/she said stories.

As I've said before, I honestly believe that given good information, the American public tends to make good decisions but there's a corollary to that claim: given the crap we've been fed recently, it's a wonder we still have a country.

And now for a break from serious discussion

I would like to imagine that this could not happen in a modern roundtable, but it is just too close to reality:

Imagine a host talking to a panel of four pundits about someone about to roll a 6-sided die.

Host: What's your prediction for the big dice roll?

Judy: Well, Jim, I've knocked on thousands of doors in this province, and families everywhere are telling me the same thing. They like the number 1, so I expect it to do really well.

Bill: Remember, the big dice roll is taking place on a Sunday after church, so the smart money is on 3, the trinity. We all remember Easter Sunday 1985 when a three was rolled three consecutive times. History is on the side of 3.

Jim: Look at the data. An even number has come up on 9 of the last 13 rolls. You have to play the hot hand on this one and go for 2, 4, or 6.

Alice: I agree with Jim's data, but all that means is that odd numbers are due. Judy is right that 1 is the trendy pick, but I really like 5 as a dark-horse candidate.

[Off-screen a mathematician is sobbing].

And, I suppose, a casino operator is gloating . . .

401(k) plans

We have talked a bit about how personal finance and saving for retirement is hard. One reason that 401(k) plans have been able to charge high fees (management fees plus fees from the individuals mutual funds) is that they are tax free savings vehicles (and tax free covers a lot of sins). That is now being openly discussed:

The tax break for defined contribution retirement plans will cost the Treasury $212.2 billion between 2010 and 2014, according to the Joint Tax Committee. But the vast amount of that benefit - as much as 80 percent - goes to the top 20 percent of earners, according to estimates from the Tax Policy Center, a nonpartisan, but liberal-leaning, think tank.

For example, a person in the 35 percent tax bracket saves $35 in taxes every time he puts $100 in his 401(k), for a net cost of $65. Someone in the 15 percent bracket pays $85, after tax, for the same $100 contribution. The Pension Rights Center, which has favored traditional defined benefit pensions and other programs aimed at lower-income retirees, advocates rolling back the current $16,500 annual 401(k) tax-deferred contribution limit to the $10,500 level it was at before the Bush tax cuts, its director, Karen Ferguson, has said.

One way to address both the cost and the disparity is to change the deduction into a credit. William Gale, of the Brookings Institution, will present a plan like that to the Senate committee on Thursday. His plan would eliminate the deduction entirely and replace it with a federal match that would be deposited directly into workers retirement accounts. A match of 30 percent would be revenue neutral, he says.

Neither solution is ideal. Lowering the deduction limit makes these plans less able (even in theory) to store enough wealth for retirement. It also makes "catching up" after a period of unemployment or education more difficult.

Matches, on the other hand, are much easier to cut than tax breaks. Dropping the match from 30% to 28% is an easy cut that raises a lot of revenue. It may be harder to penalize post-tax withdrawals, which runs the risk of funds being emptied due to an unexpected job loss.

None of this would really matter if we were confident that social security would be around. It really is the key government anti-poverty program. But ponzi scheme comments are not helping build confidence in the long term health of the program.

Open Call

Consider this an open call for Mark, my co-blogger with a strong interest in education, to give his reactions to this piece on educational reform.