Monthly Archives: January 2017

A Good Start on Mortgage Finance

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According to this story,

The Department of Housing and Urban Development said Friday that the reduction to the annual mortgage insurance premiums borrowers pay when taking out government-backed home loans has been “suspended indefinitely.”

…Borrowers with larger home loans would have seen an even bigger drop in their premium rate.

The premium cut was an abominable last-minute policy of the outgoing Administration. Fortunately, the Trump Administration canceled it before it could take effect. [Update: Today’s WaPo editorial agrees with me.]

The worst aspect of the policy would have been the special rate cut for large mortgages. Offering particularly cheap loans for large amounts is nothing but a gift to young professionals pushing their way into cities where housing supply is fixed.

If you want to make housing more affordable in San Francisco or Brooklyn, you have to address supply. Subsidizing demand without increasing supply simply serves to drive up prices and squeeze out the lower middle class.

Sports and Media

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Ben Thompson writes,

The truth, though, is that in the long run ESPN remains the most stable part of the cable bundle: it is the only TV “job” that, thanks to its investment in long-term rights deals, is not going anywhere. Indeed, what may ultimately happen is not that ESPN leaves the bundle to go over-the-top, but that a cable subscription becomes a de facto sports subscription, with ESPN at the center garnering massive carriage fees from a significantly reduced cable base. And, frankly, that may not be too bad of an outcome.

Pointer from Tyler Cowen.

Read the whole post, which post surveys the media landscape. I used to pontificate on the topic, but now I am old and out of touch. The best way to forecast the media business is to observe young people. Years ago, I saw data that showed that young people were subscribing to newspapers at much lower rates than their parents had at similar ages. It was not hard for me to extrapolate from that.

I am surprised by Thompson’s optimistic outlook for sports. I think that pro sports on TV historically worked as a sort of focal point or lowest common denominator in households where the TV is always on in the background. People want something else to do while they’re chatting, so they turn on the game.

Nowadays, the TV is not the universal background noise. People have phones to keep them occupied. If you are going to watch sports, you have to be committed to it, and my sense is that young people are not as committed to sports as they used to be. Gambling on games, including fantasy sports, generates some commitment, but that is more of a niche than the sort of mass market that sports used to represent.

In recent years, when I have gone to baseball games, young people have been discussing homework, taking selfies, and watching the Jumbotron. I wonder if the passion for sports is something that is gradually fading away with the younger generation.

If ESPN is the future of TV, then TV may not have much of a future at all.

Questioning Medical Research

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Thomas P. Stossel writes,

The reward systems in universities, such as promotion and tenure, accrue from publication of findings that other researchers consider impressive. Academic culture renders influential peer recognition the dominant measure of success. The fact that the peer reviewers of papers submitted for publication are imbedded in the academic culture (as are many of those who review research grant applications) has assured the ascendancy of reductionism. It also ensures that the measure of value of a researcher’s work is not medical innovation, but publication in prestigious journals that, in turn, serve as the currency for obtaining research grant funding.

The essay has a rather innocous-sound title, “Removing Barriers to Medical Innovation.” In fact, it is a highly contrarian take on medical research.

What we are usually told is that the important research is done at universities using government funds, and the drug companies then appropriate this research for private profit. Those same drug companies waste more money on advertising than they spend on research. Stossel argues that the opposite is the case, and that the huge waste is in government-funded research. His description of the sociology of academic medical research sounds plausible, and some of it applies to academic economics as well.

Economics and Medicine

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Concerning fields comparable to economics, a commenter wrote,

How about an analogy to medicine? We didn’t design the human body. It is a painfully complex system that emerged from evolution and some human intervention (cultural preferences for mates, for example). But we know how to fix it when it breaks under a large variety of circumstances and are getting better at it every day.

I think this is one of the more interesting analogies. I think it is helpful in understanding the preference for economists with “answers.” People would rather see a Shaman who promises to cure them than consult someone who admits that they have no cure.

Until around the late 19th century, a doctor was probably more likely to make you worse than make you better. Even now, we have Hansonian medicine, so progress in some areas has been somewhat offset by flawed thinking in others.

In economics, we face the additional challenge that the economy evolves not (typo corrected) at the speed of cultural evolution, which is faster than biological evolution. Thus, our theories have to hit targets that are moving much faster.

I think of economics as being about where medicine was around, say, 1900. But the pace of progress in economics is slower.

Price Discrimination in Service Industries

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A commenter asks,

“The real world in which most businesses live is one with high fixed costs and low marginal costs.”

Is not two-thirds of the US economy services? I do not see services having the above characteristics, so are you really characterizing all sectors?

I see services as having those characteristics. The biggest service industry is health care. Why do hospitals charge $15 for a carton of orange juice? Because their prices have nothing to do with variable cost. They are trying to cover fixed cost. Doctors’ offices have the same issue.

Another major service industry is education. Why do colleges have such high list prices, and then offer discounts to those prices? Again, they are trying to cover fixed cost.

Yet another service industry is entertainment. The costs of creating a movie or covering a football game are fixed costs. The marginal cost of reaching an additional person in the audience is close to zero.

When UPS delivers a package, the marginal cost is nearly zero. They are allocating fixed cost.

If your business is financial services, the marginal cost of an additional customer is close to zero.

I have to think hard to come up with a service industry that has low fixed costs relative to marginal costs. Maybe day care, or home health care. Or haircuts.

The Deplorables Heuristic

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Chris Dillow writes,
I was being tribal: I didn’t want to be part of a tribe that had a disproportionate number of people I despised. I was using a form of the social proof rule of thumb. I was allowing the numbers of others making their choices to guide mine. The fact that decent people tended to favour remain (with of course counter-examples on both sides) strengthened [m]y support for the cause.

Pointer from Mark Thoma.

The heuristic that Dillow followed was this: he saw many Brexit supporters as racists, therefore he would not support Brexit.

On Facebook, one of my friends posted that although she wanted to attend the anti-Trump march, she was troubled by some of the positions espoused by leaders of the march. So, although I assume that she broadly sympathizes with the marchers, she was having doubts because of this particular heuristic.

For any cause, there are some supporters who are deplorable. I am sure that Chris Dillow could find some prominent Remainers for whom he has animosity, although they are not as numerable as those on the Leaver side.

I think that a heuristic that says “Do not associate with a political cause if you find a fair number of its supporters deplorable” would leave you unwilling to support any political cause.

And that might not be a bad thing.

Jay Winik on the President’s Erratic Style

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He writes,

Often he acted not by following any grand design but by sheer instinct, hastily improvising. . .He deliberately fostered disarray among his own people. . .Disorder, delays, and muddle were frequently the watchwords; problems were met principally by improvisation, not long-term strategy.

He is referring, of course to FDR. FDR was also a wealthy man who was highly regarded by non-affluent voters. He used new media effectively (radio was new at the time). And some of his political opponents really, really hated him.

The book is 1944.

Robert Skidelsky on Economic Methods

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A month ago, he wrote,

If you believe that economies are like machines, you are likely to view economic problems as essentially mathematical problems. The efficient state of the economy, general equilibrium, is a solution to a system of simultaneous equations. Deviations from equilibrium are “frictions,” mere “bumps in the road”; barring them, outcomes are pre-determined and optimal. Unfortunately, the frictions that disrupt the machine’s smooth operation are human beings. One can understand why economists trained in this way were seduced by financial models that implied that banks had virtually eliminated risk.

Good economists have always understood that this method has severe limitations. They use their discipline as a kind of mental hygiene to protect against the grossest errors in thinking. John Maynard Keynes warned his students against trying to “precise everything away.” There is no formal model in his great book The General Theory of Employment, Interest, and Money. He chose to leave the mathematical formalization to others, because he wanted his readers (fellow economists, not the general public) to catch the “intuition” of what he was saying.

Those paragraphs would have fit into Specialization and Trade, particularly the first sentence of the first paragraph.

My view of Keynes’ “intuition” is that it is very appealing but ultimately misleading. I am thinking in particular of the “spending causes jobs” and “jobs cause spending” intuition that is what passes for Keynesian economics in the press. In real economics, you cannot just posit quantity-quantity interactions without any prices involved.

By the way, Skidelsky’s three-volume biography of Keynes (not the abridged version) really is the best thing you can read on “what Keynes really meant.” He really gets at Keynes’ views on the psychology of saving (or hoarding) and investing. I do not think that “animal spirits” means what Akerlof, Shiller, and nearly everyone else thinks it means– bouts of optimism or pessimism. I think it probably is closer to the drive for reproduction, or for immortality. Mr. Trump built his towers to try to give his name a lasting presence, not because he had a burst of optimism about real estate investment.

Price Discrimination Explains Everything

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Two years ago, the Executive Office of the President wrote,

Ultimately, whether differential pricing helps or harms the average consumer depends on how and where it is used. In a competitive market with transparent pricing, the benefits are likely to outweigh the costs. For example, while there is lots of differential pricing in airline ticket sales, the Internet has made it relatively easy for many travelers to compare prices and itineraries across airlines and to select the best deal for any given trip. Some studies even suggest that differential pricing can intensify competition relative to uniform pricing, by allowing high-margin sellers to compete more aggressively for price-sensitive customers who might otherwise buy from a lower-priced rival.

differential pricing seems most likely to be harmful when implemented through complex or opaque pricing schemes designed to screen out unsophisticated buyers. For example, companies may obfuscate by bundling a low product price with costly warranties or shipping fees, using “bait and switch” techniques to attract unwary customers with low advertised prices and then upselling them on different merchandise, or burying important details in the small print of complex contracts.

Pointer from Timothy Taylor.

The report’s reference to “a competitive market with transparent pricing” is disingenuous. There is little scope for price discrimination in a truly competitive market. If there are only one or two airlines flying a particular route, you can price discriminate. Not so if there were a hundred.

So get the highly competitive model out of your mind. The real world in which most businesses live is one with high fixed costs and low marginal costs. Then marginal-cost pricing is too low, while average-cost pricing is too high.

A numerical example will help. Suppose that the fixed cost is $1 million and each unit costs you $1 at the margin to produce. Think of selling a hundred thousand units, which means a total cost of $1.1 million, or an average cost of $11. If you price at marginal cost, of only $1, you fail to recover fixed cost, and you go out of business. If you price at average cost, $11, you drive away a lot of customers who are willing to pay more than your marginal cost of $1 but less than a price of $11.

If you can price discriminate, then you might charge $2 to the price-sensitive customers and $20 to the price-insensitive customers. That way, both sets of customers contribute to covering your fixed costs.

Taking Macroeconomics Backward Through Regression

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Olivier Blanchard recently wrote that there ought to be two classes of macroeconomic models.

Theory models, aimed at clarifying theoretical issues within a general equilibrium setting. Models in this class should build on a core analytical frame and have a tight theoretical structure. They should be used to think, for example, about the effects of higher required capital ratios for banks, or the effects of public debt management, or the effects of particular forms of unconventional monetary policy. The core frame should be one that is widely accepted as a starting point and that can accommodate additional distortions. In short, it should facilitate the debate among macro theorists.

Policy models, aimed at analyzing actual macroeconomic policy issues. Models in this class should fit the main characteristics of the data, including dynamics, and allow for policy analysis and counterfactuals. They should be used to think, for example, about the quantitative effects of a slowdown in China on the United States, or the effects of a US fiscal expansion on emerging markets.

In response, Simon Wren-Lewis rejoiced,

Ever since I started blogging I have written posts … to try and convince fellow macroeconomists that Structural Econometric Models (SEMs), with their ad hoc blend of theory and data fitting, were not some old fashioned dinosaur, but a perfectly viable way to do macroeconomics and macroeconomic policy.

Pointers from Mark Thoma.

For why Blanchard and Wren-Lewis are wrong, see my essay Macroeconometrics: the Science of Hubris. If the profession follows their advice, macroeconomics will be regressing in every sense of the word.