Monthly Archives: February 2014

I Do Not Understand

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Joshua Gans attempts to explain WhatsApp, the small text messaging service that was acquired by Facebook for a combination of cash and stock reported as $19 billion. He writes,

WhatsApp experimented with various paid models from a paid up to a paid subscription to its now, try before you buy, option. Basically, after a year you pay $1 per year. It is dead simple and quite lovely. There are no gimmicks there either. You have to initialise the paid version. It doesn’t just kick in. There is something so refreshing in a service that just gets people to pay for it if it is worth something to them rather than exploit some failing in their rationality.

Among the things I do not understand.

1. I agree that the business model is refreshing. But I think that in this case it is also self-extinguishing. The service has value to people who are otherwise charged for sending text messages. As more people adopt the service, cell phone companies will obtain less revenue from charging for text messages. The end game is for them to obtain revenue in other ways and drop the charges for text messages (a lot of us in the U.S. already have plans with unlimited text messaging). At that point, the rationale for paying even $1 a year to WhatsApp will have evaporated.

2. I do not understand why, in a bidding war between Google and Facebook, if Google bids $10 billion, Facebook has to pay $19 billion. I would think that the minimum raise in this game would be a little smaller.

3. Reihan Salam reproduces some analysis by Tariq Krim that indicates that WhatsApp has a faster-growing user base than Twitter, which is valued by the market at $20 billion. (a) I think I understand what makes Twitter’s market advantage seem defensible, but I do not understand what is defensible about WhatsApp’s user base. (b) As an investor, I would not go anywhere near Twitter at its current valuation.

4. Reihan points to Ben Thompson, who writes breathlessly,

Still, it’s only recently that the killer app for this era, when the nodes of communication are smartphones, has become apparent, and it is messaging. While the home telephone enabled real-time communication, and the web passive communication, messaging enables constant communication. Conversations are never ending, and friends come and go at a pace dictated not by physicality, but rather by attention. And, given that we are all humans and crave human interaction and affection, we are more than happy to give massive amounts of attention to messaging, to those who matter most to us, and who are always there in our pockets and purses.

I do not understand why Thompson is so confident of this. I teach in a high school, so I think I have a bit of sense of what teenagers are up to these days. They are the natural market for this stuff, and a few students are really into messaging. There also are a few of them who are really into games. A few of them are really into music. And a lot of them are perfectly content to leave their phones in their pockets for the whole day.

Late in 1999, I started my first blog, which I called The Internet Bubble Monitor, to make fun of the stock valuations of that era. I shut it down about six months later, because there was nothing to make fun of any more. I think I might have to start it up again.

The Phelps Contention

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A few nights ago, a number of us met over dinner to discuss Edmund Phelps’ book, Mass Flourishing. He contends that starting around 1970s, America’s commitment to modern values started to recede, and we began reverting to traditionalism. That in turn leads to reduced innovation and slower economic growth.

The reaction to this hypothesis from several Baby Boomers and younger discussants ranged from skeptical to apoplectic. Not modern? Us? Civil Rights! Women’s Equality! Four-letter Words! Gay Marriage! Smart phones!

Against those, here are some counterpoints, some of which Phelps has noted:

–decline in the propensity of young adults to move far from their parents (or even out of the house!)

–increase in NIMBYism (often masquerading as environmental concern), blocking development, for example, of airports.

–lower rate of new business formation

–stifling safety regulations (in nuclear power and in drug development)

–resistance to innovation in food production (GMOs)

–demonization of the 1 percent

–hostility to energy production and consumption

What Phelps means by modern values are individualism, self-reliance, and striving for individual excellence. By his standards, he would argue that those values are on the decline. This is a topic that is a bit squishy for economists to try to grasp, but I am not certain that Phelps is wrong.

By the way, I reviewed Phelps’ book here. He says that, contrary to my review, he is an anti-Schumpeterian. I am not sure what he means by that. In any case, he believes that innovation consists much more of small, everyday innovation than it does of dramatic examples such as the internal combustion engine. I tend to agree, and that is one reason that I have been unwilling to side with stagnationists who complain that we have not seen anything Really Big in the most recent two decades.

Trifurcation?

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Richard Reeves writes,

say, the top decile, or 10%, of the income distribution.

This stratum is not only prospering economically. For the people on this top rung, education levels are high and rising. Families are planned, marriages strong, neighborhoods safe and rich in social capital, networks plentiful, BMIs low and savings rates high.

Below these are what Reeves calls “the squeezed middle” and then the “entrenched poor. Reeves later writes,

Data recently unveiled by my colleague Gary Burtless, showing income growth since 1979 across the distribution, shows that in terms of after-tax income, those at the top have done really well since 1979; that’s perhaps not a surprise. What might be more instructive is the relative performance of the lowest quintile and the middle – ie. a 49% rise compared to a 36% rise. Income growth has clearly been weakest in the middle of the distribution.

Pointer from James Pethokoukis.

Government and Failure

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Megan McArdle writes,

the way that people and groups respond when they’re told that their plan is not working out as intended. Basically, there are three responses you can have:

  • My plan was defective: I should change something.
  • The world is defective: The plan is great, but we clearly need to do even more of this.
  • The information is wrong, and my plan is actually working very well.

The first answer is rarely the one that people go to.

Pointer from Tyler Cowen.

This can be as true of people in business as it is of people in government. But in business, you face what Eamonn Butler calls in The Best Book on the Market the World of Truth. If you do not fix what is broken, you lose money and go out of business. In government, you just keep telling people that Obamacare won’t cost jobs.

Follow-up Questions

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On this post. I will summarize the questions as (1) don’t marginal costs really fall when a sector goes through a structural shift, which should lead to a drop in prices? and (2) why don’t investment booms cause dislocation?

1. In microeconomics, I tell my high school students that price discrimination explains everything. Almost every real-world business case finds firms facing very low marginal costs but needing to recover fixed costs. So you see many efforts to segment the market and charge a higher price to the customer with less elastic demand. For your question, the relevant point is that firms always face very low marginal costs–in either booms or recessions. They choose their price structure so as to maximize revenue. A recession does not fundamentally alter their pricing problem.

As a side note, you give several examples of industries that you argue have mostly production workers. I am not convinced. Take health care, for example. If a hospital or a medical practice experiences a 15 percent decline in demand, which workers become expendable? You still need all the administrative staff–accounting folks, the insurance-billing folks, the IT folks. You can lay off some of the folks who touch patients, but that is not an overwhelming proportion of the health care work force.

2. In the Schumpeterian story of PSST, an investment boom is what you observe when the new opportunity arrives but the legacy industry does not recognize it. So Borders keeps investing in stores while Amazon undertakes expansion. This is unsustainable, since the market is not big enough for both of them. When Borders closes, investment declines. The causal factor is technological change. In the short run, investment and employment rise, because the legacy industry is in denial. When they get the memo, investment and employment fall. It seems to me that the pattern in the legacy industry is for firms to hang on as long as possible, and then crash. You might think that they would decay gradually, but that does not seem to be the pattern.

Clay Shirky on Technology Projects

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Among many possible excerpts, let me pick

On a major new tech project, you can’t really understand the challenges involved until you start trying to build it. Rigid adherence to detailed advance planning amounts to a commitment by everyone involved not to learn anything useful or surprising while doing the actual work. Worse, the illusion that an advance plan can proceed according to schedule can make it harder to catch and fixed errors as early as possible, so as to limit the damage they cause. The need to prevent errors from compounding before they are fixed puts a premium on breaking a project down into small, testable chunks, with progress and plans continuously reviewed and updated. Such a working method, often described as “agile development,” is now standard in large swaths of the commercial tech industry.

The whole essay is here.

Another excerpt:

NASA didn’t figure out how to put a man on the moon in one long, early burst of brilliant planning; it did so by working in discrete, testable steps. Many of those steps were partial or total failures, which informed later work. In digital technology, such an incremental, experimental approach is called “test-driven development.” It has become standard practice in the field, but it was not used for HealthCare.gov. Tests on that site were late and desultory, and even when they revealed problems, little was changed.

Shirky’s essay is ok as far as it goes, but I think that what needs to be emphasized is that the Obama Administration was launching a business. Call it a health insurance brokerage business if you like. It is just as important to take “an incremental, experimental approach” in launching a business as it is in creating a web site. Also, when a business gets launched in the market, its failure causes little notice. For every spectacular success, there are dozens of just so-so businesses and hundreds of total failures. When the government uses its monopoly power to launch a business that everyone is “mandated” to use, this precludes the learning that takes place in markets.

The failure of Obamacare is larger than the failure of the web site. Treating it as a technical failure allows progressives to avoid facing that fact.

The Internet of Things

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Is it the Next Big Thing, or just a buzzword? Michael Mandel is one booster. Neil Gershenfeld and JP Vasseur are also optimistic. They write,

Countless futuristic “smart houses” have yet to generate much interest in living in them. But the Internet of Things succeeds to the extent that it is invisible. A refrigerator could communicate with a grocery store to reorder food, with a bathroom scale to monitor a diet, with a power utility to lower electricity consumption during peak demand, and with its manufacturer when maintenance is needed. Switches and lights in a house could adapt to how spaces are used and to the time of day. Thermostats with access to calendars, beds, and cars could plan heating and cooling based on the location of the house’s occupants. Utilities today provide power and plumbing; these new services would provide safety, comfort, and convenience.

These don’t sound like big deals to me. I could be wrong. I can imagine that if cities had a lot more sensors and id chips embedded along streets then self-driving cars might sooner become inexpensive and reliable. That would be a big deal.I can imagine that having software-defined radios in all sorts of places you could replace telecoms (some techies have been talking up that idea for 15 years or more). That would be a big deal.

James Pethokoukis talks with Erik Brynjolfsson and Andrew McAfee. Brynjolfsson says,

what matters is the value that we’re creating, not whether a particular metric moves – especially a metric like GDP, which often literally goes in the opposite direction of welfare. When things become free, that can often lead to a decrease in measured GDP, even though it leads to a big increase in welfare. Wikipedia is a perfect example of that. Or take the fact that most people now have, you know, a device that gives them turn-by-turn driving directions. It’s pretty much free with most smart phones. But a few years ago, people were paying hundreds of dollars for a GPS machine. So I think we have to be careful about overreliance on a metric that was never understood to be or shouldn’t be understood to be a welfare metric.

Their ideas for a big deal strike me as more ambitious. Brynjolffson says,

IBM’s Watson is not just a Jeopardy champion. It’s now going to med school. IBM has announced that they’re putting Watson technology up in the cloud; serve that down through the smart phones that are going to be available, as Erik says, to billions of people, honestly billions of people around the world within just a few more years. And you have the world’s best diagnostician available to the majority of the world’s human population. Again, if that’s not an impressive change for our societies, our lives, and our economies, then I’m out – I’m out of answers.

Podcast with Calomiris and Haber

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Russ Roberts did the interview live.

I was in the audience, and I stammered out this question”

I’m trying to figure sort of what makes Canada’s banks stable, and the thing that comes to mind is charter value, that the–you only have 5 of them, and they are profitable, and so they don’t want to lose their charter, and so maybe that stabilizes things. First, I wonder if you agree with that. And secondly, if you do, what are the forces that keep that from happening in the United States? I think you mentioned the populist sentiment–people don’t want banks to be profitable. The government wanted to use banks for redistribution purposes. Should we be trying to head toward a system where banks have valuable charters and if so, how could we head that way?

I did not think that they answered the question well. When I was at Freddie Mac, the CEO, Leland Brendsel, was very clear on the fact that the company had a valuable charter that it needed to protect, and this included not taking excessive risk. That changed after I left. In part, it was a new CEO. In part, it was a political environment in which Congress was even more convinced than the private sector that there was no such thing as a loan application that you should turn down.

A lot of the banking deregulation in the 1980s and 1990s was designed to make banking more competitive. The quasi-monopoly power of “unit banks,” which Calomiris and Haber have such contempt for, was ended. But the result was to weaken the value of bank charters, which may have induced banks to take more risk. Gary Gorton made this point a few years ago.

In any event, if I had it to do over again, the question I would ask is, “What explains Switzerland?” Because a lot of their thesis is that banks emerge in order to feed government demand for borrowing to fight wars. Switzerland famously has a significant banking sector, but I don’t see it as having arisen to help finance Swiss imperialism.

FYI

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James Lindgren reports,

in 2012 a majority of Democrats (51.6%) cannot correctly answer both that the earth revolves around the Sun and that this takes a year. Republicans fare a bit better, with only 38.9% failing to get both correct.

I file this under “libertarian thought,” because to me it speaks to the issue of how romantic one should be about democratic voting.