Monthly Archives: October 2014

Thoughts on Two-Sided Markets

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Lynne Kiesling writes,

the distribution wires firm can, and should, operate as a platform and think about platform strategies as the utility business model evolves. An electric distribution platform facilitates exchange in two-sided electricity and energy service markets, charging a fee for doing so. In the near term, much of that facilitation takes the form of distribution, of the transportation and delivery. As distributed resources proliferate, the platform firm must rethink how it creates value, and reaps revenues, by facilitating beneficial exchange in two-sided markets.

Until now, I have not thought much about this whole two-sided market concept. I am struggling to see what it buys you. Earlier in her post, she quotes from a Harvard Business Review article.

In the traditional value chain, value moves from left to right: To the left of the company is cost; to the right is revenue. In two-sided networks, cost and revenue are both to the left and the right, because the platform has a distinct group of users on each side. The platform incurs costs in serving both groups and can collect revenue from each, although one side is often subsidized

If I’m understanding this correctly, then a brothel is a traditional value chain, but a singles bar is a platform. In terms of that metaphor, Kiesling is suggesting that electric utilities could change from operating like brothels to operating like singles bars.

Some problems I am having:

1. I am not sure what, if anything, makes brothels the natural business model in one industry and singles bars the natural business model in another.

2. Suppose that a singles bar has to pay women in order to get them to show up. By my reading of the HBR excerpt, then it becomes a traditional value chain. Metaphorically, it becomes a brothel, although I assume that it can avoid legal difficulty as long as the beds are off premises.

3. To me, cable TV looks like a brothel, not a singles bar. And to me, electricity looks like cable TV.

4. Metaphorically speaking, taxi companies and hotels operate brothels. Uber and airbnb operate singles bars. What Uber and airbnb are tapping into is supply-capacity that taxi companies and hotels were not using, either because they didn’t think of it or because it didn’t fit their business model. Is there spare electricity-generating capacity that utilities could be tapping into? If so, do they have the know-how and flexibility to tap into it?

Textbooks, Venture Capital, and Pharmaceuticals

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Timothy Taylor writes,

It is by no means obvious that a lower-cost book (yes, like my own) works less well for students than a higher-cost book from a big publisher. Some would put that point more strongly.

Yes, I know that professors do not care much, if at all, about the prices of the textbooks they select for their students, but that is not the only reason that prices are so high.

Another factor is that the industry is similar to venture capital and pharmaceuticals. The organizations that fund projects in these areas incur heavy expenses on failures. A lot of textbook projects fail. The author may not even finish the book. Or it will flop in the market.

For a VC firm to stay in business when most of the companies that it funds wind up failures, it has to earn spectacular returns on its successes. For a pharmaceutical firm to stay in business when a lot of its research fails to yield a marketable compound, it has to charge a lot for those drugs that do make it. And for textbook publishers to stay in business when many of their projects flop, they have to charge a high price for the books that do sell.

Advances in technology have made it easier to produce a textbook at low cost. However, by the same token, it has probably increased the probability that any given textbook will fail to get a toehold in the market. So the overall economics of the business still requires publishers to absorb a lot of failed-project costs.

What I’m Reading

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The Making of the Modern World: Encounters, by Alan MacFarlane. He has an almost infinite list of books on Amazon, many of them with “Modern World” in the title. This is a Kindle edition, very garbled, but with much interesting material. An attempt to summarize:

1. “Modernity” is different and important. One way to think of it is that in modern societies, there is separation and balance among power, economic activity, religion, and kinship.

2. In pre-modern societies, whether tribal or imperial, these forces are fused, into the tribe or the state, respectively.

3. The 18th century was when thinkers such as Adam Smith began to notice a cultural break with the past. 19th-century legal historian Henry Maine called this the transition from a society of status in which social relationships are determined at birth to a society of contract, in which social relationships are more egalitarian and formal.

4. Maine notwithstanding, modernity reflects a balance of status and contract. We are not so atomistic that we live in a world of arms-length contracts. We belong to various types of associations (MacFarlane notes that many more team sports were invented in England than in other countries) which are bound by more than self-interest, but we do not belong to one single encompassing tribe or theocratic state.

5. The smaller, more fluid units of civil society are key to keeping modern states from reverting to tribalism or all-powerful states. This idea goes back to Tocqueville, of course. Nowadays, I would note that Yuval Levin is one of its leading champions, and he often cites Burke.

6. Modernity is not necessarily robust. Modern societies have managed to make production more rewarding than predation, and consequently they are wealthier and more powerful than pre-modern states. But humans remain attracted by encompassing ideologies, such as Communism or radical Islam. In fact, MacFarlane cites several scholars who wrote over 100 years ago that Islam did not adapt to modernity as did Christianity, and Islam still calls for a pre-modern unity of all spheres.

7. The Industrial Revolution combines modernity with the scientific/technological revolution. Neither alone is sufficient.

I highlighted numerous passages in the book. A few are given below the fold. Continue reading →

My Take on the Piketty Poll

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1. The poll asked whether the post-1970s increase in inequality in the U.S. is due to r>g. No one* agreed with that statement. Piketty does not agree with that statement.

2. What this makes clear is that Piketty is making a claim about the future. That is, in the future, we will have rising inequality because r>g.

3. Supporters of Piketty can say that the poll asked the wrong question, and those of us who jumped on the poll should have known that.

4. Still, in my opinion, the poll serves to highlight that there is no necessary link between (i) rising inequality and (ii) r>g. You can have (i) without (ii), and you can have (ii) without (i). Yes, we already knew that. You can argue that it does not refute Piketty, because he would never come out and insist that (i) entails (ii) or that (ii) entails (i). However, his book is making a rhetorical attempt to link the two propositions (he would hardly have written it otherwise). I think that the poll illustrates that the rhetoric cannot overcome the economics.

*except for Hilary Hoynes

Paul Krugman on the State of Macro

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He writes,

whenever somebody claims to have a deeper understanding of economics (or actually anything) that transcends the insights of simple models, my reaction is that this is self-delusion. Any time you make any kind of causal statement about economics, you are at least implicitly using a model of how the economy works. And when you refuse to be explicit about that model, you almost always end up – whether you know it or not – de facto using models that are much more simplistic than the crossing curves or whatever your intellectual opponents are using.

Pointer from Mark Thoma.

Shorter version: it takes a model to beat a model

I find that persuasive, although I wish we had a less pretentious term than “model,” which makes us sound more scientific than I believe we are. What I would like to do is compare the state of the IS-LM-Phillips Curve model with that of the PSST model. PSST, or patterns of sustainable specialization and trade, says that a sharp rise of unemployment is the result of patterns of trade made unsustainable by changes in technology and/or asset prices, and that only a gradual process of entrepreneurial trial and error can discover new patterns of sustainable specialization and trade. More about this model can be found here (see items 2,3, and 4).

Some comments:

1. I think that both PSST and IS-LM-Phillips are difficult to falsify. In some sense, the macroeconomic data are over-fit, so that the dataset cannot be used to decisively reject one model in favor of another.

2. I would counter one of Krugman’s narrow points, where he says that the liquidity trap explains why the huge reserves in the banking system have not had major effects. If this is true, then why did the Fed need to pay interest on reserves? I assume that the Fed thinks that if they had not paid interest on reserves, then its huge injection of reserves would have caused rapid money growth and high inflation. It would be interesting to poll economists on whether they would agree–my guess is that most would. It seems to me that Krugman would have to say “no” to the poll, but perhaps I am misunderstanding him. I am not sure how I would answer such a poll myself.

3. I do not align myself with those who see the Fed as the prime mover of inflation. My “model” of inflation is a pretty weak one. Basically, I just think that businesses get into habits about how much to raise workers’ wages each year. Maybe those habits are affected by the aggregate unemployment rate, as in the Phillips Curve, but I would caution that we do not have homogeneous “labor.” Some folks can be getting regular raises that are large, while others may fail to get raises at all. Each business looks at its own labor market, not at the economy-wide unemployment rate.

What about the 1970s? I would say that the 1970s were a period of “inflation consciousness.” Everyone became aware of it, and “cost-of-living” raises got built into the system, because so many employers incorporated recent inflation into current wage increases. I am tempted to suggest that the advent of wage-price controls starting in 1971 had the adverse consequence of raising inflation consciousness.

What about hyperinflation? I believe that really, big, long-term inflation is a fiscal phenomenon. That is, the government runs huge deficits, people stop lending to government, and then it meets its deficits with paper claims. We are not at that point in the U.S., but if we ever do reach the point where bond investors lose confidence–watch out.

4. So I have a PSST model for unemployment, and my “weak” model[s] for inflation. I think it is fair to criticize them as “just-so stories.” But I would say the same thing about the sorts of models preferred by Blanchard or Krugman. Just-so stories, dressed up in pretty math.

5. Elsewhere, Krugman writes,

Basically, the new IO [industrial organization, the field of recent Nobel Laureate Jean Tirole] made it OK to tell stories rather than proving theorems, and thereby made it possible to talk about and model issues that had been ruled out by the limits of perfect competition. It was, I can tell you from experience, profoundly liberating.

Jean Tirole on French Government

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In 2007, he wrote,

Every action of the State must be subject to a double independent evaluation. The first should be before the action: Is public intervention necessary? What are the costs and benefits? The second is after. Did it work? Was it cost effective? On this point, it would be necessary to require that the audit recommendations (for example, those of the Audit Court) be either followed according to a strict schedule, or rejected with a convincing justification.

Interesting throughout. Pointer from Mark Thoma.

No Economic Experts Agree with Piketty

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The IGM forum asked its panel of leading economists to agree or disagree with

The most powerful force pushing towards greater wealth inequality in the US since the 1970s is the gap between the after-tax return on capital and the economic growth rate.

Actually, one economist agreed with the statement, newly-added panelist Hilary Hoynes. Let me know if you can find another panelist with a less impressive resume or a narrower body of work.

Six economists, including Raj Chetty, answered “uncertain.” Seven economists strongly disagree. The remaining twenty economists who gave an answer (including Emanuel Saez!) checked “disagree.”

UPDATE: Brad DeLong speculates that Piketty himself would have answered “disagree” to the poll. (Pointer from Mark Thoma). Brad thinks that the IGM forum should have asked a different question, but he does not say what that question should be. Let me suggest this, and I hope this would make Brad happy: Going forward, the most powerful force pushing towards greater wealth inequality in the U.S. will be the gap, etc.

Jean Tirole and Josh Lerner on Open Source

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They wrote,

Open source and academia have many parallels. The most obvious parallel relates to motivation. As in open source, the direct financial returns from writing academic articles are typically nonexistent, but career concerns and the desire for peer recognition provide powerful inducements

They wrote this almost ten years ago. I bring it up because of Tirole’s Nobel Prize, announced yesterday.

Tirole and Lerner noted, with a bit of puzzlement that, compared with open-source software writers, academics were less likely to make their data sources public and more likely to allow their work to be hidden behind publishers’ paywalls. I think that in those ten years there has been a shift, at least in economics, more in the direction of the open-source model.

Casey Mulligan on the ACA and Employment

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Some highlights:

the ACA’s [Obamacare] generous assistance to part-time workers for health insurance premiums and out-of-pocket expenses offsets much of the income they forgo by working fewer hours. The lack of this insurance assistance for full-time workers amounts to a tax on full-time work.

…For 20 percent of the labor force—some 33 million workers—their family’s eligibility for exchange subsidies hinges entirely on their employment status. In any month they work part time or not at all, they can obtain subsidized coverage; in any month they work full time, they do not qualify for these subsidies. Members of this group would, on average, have to work an additional 5.5 hours per week to make up for the subsidies they forgo by working full time.

Because of the penalty on employers who do not offer health insurance, 5 percent of the workforce faces a new implicit income tax. These workers, who are left to obtain coverage from the ACA exchanges, would have to work at least four hours a week for free if they were to compensate their employer for the $2,000-per-employee penalty the ACA imposes.

An additional 21 percent who work for employers not offering coverage will find that their employers are less willing or able to pay their workers because of the ACA’s employer penalty. These workers, on average, would have to work four hours a week for free if they were to compensate their employers for the non-coverage penalty.

See also this NBER paper, although at the moment it is not coming up on the NBER site.

Patent Pools

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Josh Lerner and Jean Tirole (the latter was just awarded a Nobel Prize) write,

Innovations in hardware, software or biotechnology often build on a number of other innovations owned by a diverse set of owners.

Pointer from Joshua Gans. For more on Tirole, see Tyler Cowen and subsequent posts by Alex and Tyler.

Two (or more) firms may hold complementary patents. That is, the value of using firm A’s patented innovation is higher to a licensee who can also use firm B’s patented innovation. Lerner and Tirole ask when a social planner would want these firms to pool their patents, that is to license them together. If you do not care to follow their mathematical analysis, you can skip to the end where they summarize their conclusions.

The situation is a form of the dual-monopoly problem. As I once explained,

suppose that a single company has a monopoly in both peanut butter and jelly. When it sets the price of jelly, it knows that the more jelly it sells the more peanut butter it will sell. Therefore, at the margin, it will tend to want to set a lower price for jelly than if it were just looking at jelly as a stand-alone product.

If you then break up the PB and J monopoly into two separate companies, the incentives of the two separate monopolies will change. The peanut butter company is not going to worry about the fact that higher peanut butter prices will reduce jelly consumption, and the jelly company is not going to worry about the fact that higher jelly prices will reduce peanut butter consumption. The net result of the breakup is that prices to consumers will rise.

This theory goes all the way back to Cournot.

It seems to me that we observe patent pools more often internally than externally. Think of Apple Computer as one gigantic internal patent pool. Or a large pharmaceutical company. It might be easier for one firm to internalize complementary patents than for several firms to get together and pool them.