I Do Not Understand

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.

Paragraphs to Ponder

Two pointers from Reihan Salam.

Michael Schrage wrote,

America doesn’t have a jobless recovery; it has a hireless recovery. Don’t confuse them. After all, you first have to get hired to have a job. Organizations may be desperate to grow, but they overwhelmingly lack the desire to hire. Fewer people are working longer, harder and (presumably) smarter hours. So many firms have proven so productive even after several rounds of layoffs, that serious economists wonder if, in fact, large slices of the workforce actually offer ZMP — Zero Marginal Productivity — to their enterprise. In other words, the Great Recession reveals many employees not just to be worth less but economically worthless. Ouch.

For most organizations, people are a means and medium to an end. They’re not hiring employees, they’re hiring value creation.

One point I am starting to harp on is that many workers are not concurrently productive. That is, the work they do helps the firm be more productive in the future. That means that when firms think about hiring they have a lot of discretion (we can meet the demand for widgets today without adding new people) and they face a lot of uncertainty (will these social media marketers really deliver us new customers?).

Schrage again:

What’s structurally changed is not the job but why people get hired. In other words, is hiring someone really essential to getting the job done? Just as important, as we look at employment costs, risks and uncertainties over the next five years, is hiring someone the most cost-effective way to get the job done?

David Levinson wrote,

[in the year 2030] Firms also are not interested in paying for training, so most people now go through a 10-year unpaid internship while simultaneously attending school online and engaging other pursuits on a more or less random schedule.

Puzzling Through Brad DeLong

He writes,

if we combine the costs of idle workers and capital during the downturn and the harm done to the US economy’s future growth path, the losses reach 3.5-10 years of total output.

That is a higher share of America’s productive capabilities than the Great Depression subtracted

Pointer from Reihan Salam.

Brad goes on to say that conventional macroeconomists know how to fix this, but the evil, heartless plutocrats will not let conventional macroeconomic policy be followed.

I am really struggling to follow his reasoning. I may be wrong, but I think this is how he arrives at the insinuation that what is taking place now is worse than the Great Depression.

1. If you graph U.S. output, the Great Depression shows up as a deviation from trend, but you get back to trend. From a a long-term perspective, there is an adverse shift in the timing of output, but not much in terms of permanently foregone output.

2. Assume that in the future, the U.S. is not going to get back to trend. When you cumulate this shortfall relative to trend, it will be really huge.

If I have this right, then my comments would be:

a) it is the assumption of no return to trend that drives the calculation of such a large loss. The cumulative loss would diminish considerably under an assumption that we do return to trend.

b) if we are not going to return to trend, then it seems to me that Brad has to explain why this does not constitute a supply shock. The conventional macroeconomic theory says that permanent phenomena are supply shocks, not demand shocks. I realize that Larry Summers has floated the idea of “secular stagnation” on the demand side, but if this has already become a generally accepted thesis then I missed the memo.

c) Brad’s political economy appears to assume that rich people knew that we were suffering from secular stagnation five years before Larry did.

One of the points that I emphasize in my book (which is almost finished, by the way), is that the last few years we have seen a lot of on-the-spot macroeconomic theorizing that differs considerably from what was taught prior to the crisis. That’s fine. We need it. If you feel like stoning to death DSGE models and their kin, I’m happy to join in. But by the same token, I believe that new, outside-the-box thinking has to be marketed as tentative and speculative, not as scientific truth that only the evil or ignorant would deny.

Why Public Choice Matters

Reihan Salam writes,

And so Gyourko calls for replacing the FHA with a subsidized savings program aimed at helping low-income borrowers accumulate a 10 percent down payment, a policy he describes as preferable for a number of reasons…

2. Focusing on borrowers helps ensure that benefits will flow to the intended beneficiaries rather than realtors and homebuilders.

From a public choice perspective, the realtors and the homebuilders are the intended beneficiaries. People with modest incomes are what Thomas Sowell calls the mascots for the policy. The housing lobby isn’t going to come out and say that they engaged in rent-seeking. They tell you that if you abolish FHA, you will be depriving people of the American Dream™.

Private Securitization and the Housing Bubble

Adam J. Levitin and Susan M. Wachter write,

We argue that the bubble was, in fact, primarily a supply-side phenomenon, meaning that it was caused by excessive supply of housing finance. The supply glut was not due to monetary policy or government housing finance. The supply glut was not due to monetary policy or government affordable-housing policy, although the former did play a role in the development of the bubble. Instead, the supply glut was the result of a fundamental shift in the structure of the mortgage-finance market from regulated to unregulated securitization.

Pointer from Reihan Salam.

The implication is that if government regulates securitization, things will be fine. Some problems I have with this analysis:

1. They do not examine how the market for “unregulated” securitization was in fact bolstered by capital market regulations. Take away the regulatory advantage for AAA-rated and AA-rated securities, and I do not think that the securitization market is able to take off. Remember that capital requirements for banks were so perverse that holding a tranche in a pool backed by sub-prime mortgages required more less capital than originating and holding a low-risk mortgage.

2. The “regulated” sector, namely Freddie and Fannie, lowered its standards at exactly the wrong time, in 2005 through 2007. Several private players, including AIG, either exited the market or tightened standards before the bubble burst.

3. The problem with private securities is not that they lack standardization. It is that the whole securitization model is flawed. It introduces more costs than benefits into the mortgage finance system. That fact has been obscured by all of the support that government has given to securitization, including the “too big to fail” status of Freddie and Fannie and the perverse capital requirements noted in (1) above.

Two Recommendations From Reihan Salam

I. On higher education, he recommends a proposal for a $10,000 degree, written by Anya Kamenetz. She concludes,

Making college affordable—without loans—by stripping it of its perks, refocusing the mission on education, using new technology in a blended learning model, and cutting administrative costs could be one of the most important economic boons for the middle class and the poor. Graduating students with massive debt—and even worse, failing to graduate students who acquire massive debt—is the worst way to start young people toward meaningful and productive lives. Change is hard, but colleges need to do so to fulfill their mission of preparing subsequent generations to succeed.

If you’re so smart, why aren’t you an entrepreneur? That is, what is stopping someone from starting a college like this and making a killing? Some possibilities:

1. The credentials cartel is too strong. You cannot get accreditation unless you waste a lot of money on admin, old-fashioned teaching methods, and non-educational resources.

2. The consumers are too stupid. Students will not to go low-cost, efficient schools. They would rather run up big debts an high-cost, inefficient schools.

3. Entrepreneurs are stupid. Only policy wonks can come with ideas like this.

I have to say that I really get annoyed when policy wonks write as if the answer is (3). The whole Obamacare thingy fits in that category. If health insurance exchanges are the answer to affordable health insurance, what was stopping entrepreneurs from creating them? (And if your answer is “moral hazard,” your assignment is to read David Hogberg’s essay, which describes the logic of paying the fine until you get sick under Obamacare) What is it that is stopping insurance companies from compensating doctors on the basis of outcomes rather than procedures, if that is so great?

II. On poverty programs for an Average is Over world, he recommends an article by Oren Cass, who writes,

Rather than have numerous federal agencies each administer numerous programs, the federal government would ideally have a single agency apply a formula, establish the year’s lump-sum payment for each state, and transfer the funds. Call it the Flex Fund. States happy with the existing funding allocations and program structures could continue to apply the funding as they do today. But states with better ideas—even radically different ones—would be free to pursue them.


An adjustment in benefit types offers the best opportunity to incentivize work without slashing benefits or increasing spending. Two families—one whose head of household works, one whose head of household does not—may both need $3,000 worth of nutritional support. But if the non-working household receives the $3,000 in food stamps while the working household receives it as cash via a wage subsidy, the latter might feel substantially better off. While the Affordable Care Act draws an arbitrary line, providing Medicaid to those below 138 percent of the poverty line and a subsidy for private insurance to those above 138 percent of the poverty line, the benefit could instead be provided as Medicaid for those who do not work and, for those who do work, as additional cash provided via wage subsidy.

Changing some income-support programs to wage subsidies sounds like a good idea to me. The Flex Fund I’mm no so sure about. Many wonks have thought in terms of replacing food stamps, Medicaid, and the rest with a simple cash assistance program. Cass is suggesting replacing all the Federal programs with a state program. Will the states make fewer mistakes with the money than individual poor people? My guess is “no.” Also, if the money comes from the Federal government, how strong is the incentive for states to use it well? If a state puts together an inefficient transfer system, funded by the Feds, how much will voters care?

The Neocon Servile Mind

David Brooks writes,

The conservatism that [Irving] Kristol was referring to is neoconservatism. Neocons came in for a lot of criticism during the Iraq war, but neoconservatism was primarily a domestic policy movement. Conservatism was at its peak when the neocons were dominant and nearly every problem with the Republican Party today could be cured by a neocon revival.

Kristol and others argued that the G.O.P. floundered because it never accepted the welfare state. “The idea of a welfare state is in itself perfectly consistent with conservative political philosophy,” he argued. In a capitalist society, people need government aid. “They need such assistance; they demand it; they will get it. The only interesting political question is: How will they get it.”

I am reading The Servile Mind, by Kenneth Minogue, which takes the opposite point of view. Minogue argues that the welfare state substitutes political agency for moral agency. As citizens, we lose our moral compass and instead pick up a political one.

I find the book rather heavy going, but I probably will review it somewhere down the road. If you are looking for someone who concedes nothing to the oppressor-oppressed axis and instead views it as undermining Western values completely, then Minogue is your champion.

Back to the squishier conservatives, Reihan Salam lauds Brooks and Irving Kristol.

the right response to programs that really do undermine self-reliance and individual liberty may well be to eliminate or consolidate or devolve them. But it is important to acknowledge that not all programs undermine self-reliance and individual liberty, e.g., wage subsidies are designed to entice low-wage workers into the labor market, a crucial first step if these workers are eventually to climb the economic ladder to self-sufficiency. Wage subsidies are a paradigmatic example of a conservative welfare state initiative, and when well-designed they can do a great deal to strengthen the social foundation of a free enterprise economy by making it more inclusive.

Read the whole thing.

Matthew Yglesias vs. Murray Edelman

Yglesias writes,

Nationalized, very partisan politics in which elected officials are looking over their shoulders at a blend of ideologically motivated grass-roots and ideologically motivated mega-donors and falling in line…the real story of politics today—more sorting, less deal-making.

Read the whole thing. The best paragraph is the one that begins “It’s not dead…”

Pointer from Reihan Salam.

The late Murray Edelman, as rendered to me by the late Merle Kling, would describe politics in terms of insiders and outsiders. The “ideologically motivated grass-roots” are outsiders. The lobbyists are insiders. In Edelman’s major work, The Symbolic Uses of Politics, the insiders manipulate the outsiders by engaging in battles that are symbolic, and ultimately phony. Behind that smokescreen, they capture the goodies.

The dichotomy I have in mind is not between centrist deal-making and partisan extremism. The dichotomy is between insiders engaging in successful rent-seeking and outsiders falling for the political theatrics. I wonder if Yglesias would care to comment on the latter dichotomy, and in particular whether he can cite examples that suggest that the insiders are losing their mojo.

Reform Conservatism

Ross Douthat defines it.

The core economic challenge facing the American experiment is not income inequality per se, but rather stratification and stagnation — weak mobility from the bottom of the income ladder and wage stagnation for the middle class. These challenges are bound up in a growing social crisis — a retreat from marriage, a weakening of religious and communal ties, a decline in workforce participation — that cannot be solved in Washington D.C. But economic and social policy can make a difference nonetheless, making family life more affordable, upward mobility more likely, and employment easier to find.

Let’s evaluate this along the three-axes model. Even though Douthat shows concern for low-skilled workers, he views the problem in terms of the civilization-barbarism axis rather than the oppressor-oppressed axis. On the freedom-coercion axis, although Douthat throws libertarians a bone by saying that the problems cannot be solved in Washington, he thinks that Washington “can make a difference nonetheless.”

Pointer from Reihan Salam. Indeed, the paragraph above sounds like a reprise of Douthat and Salam’s Grand New Party. Not that there is anything wrong with that.

Read the entire post. If we think in terms of the current institutional structure, I would be willing to sign on to Douthat’s agenda. (One difference is that I would be more favorably disposed to easing up on immigration for low-skilled workers. I think it is at least as likely that low-skilled immigrants are complements for low-skilled domestic workers as it is that they are substitutes. And in general I do not think that protectionist measures can do much for low-skilled workers: protect them from labor at home and they still can face competition from labor abroad, from capital, and from consumer substitution away from artificially high-cost goods and services.)

However, I think that for libertarians, attempting policy reforms within the current institutional structure is an exercise that uses up a lot of energy without moving the ball very far, if at all. I think that any significant motion in a libertarian direction will have to come from an evolution toward competitive government. We need to restructure government services so that there is less centralization, less bundling, and less protection from private competition.

Of course, that is nothing but a reprise of the widely-unread Unchecked and Unbalanced.

The Null Hypothesis in Health Insurance

is that, in the United States, better health insurance produces no difference in health outcomes. Recently, for example, Katharine Baicker, et al, found

This randomized, controlled study [in Oregon] showed that Medicaid coverage generated no significant improvements in measured physical health outcomes in the first 2 years, but it did increase use of health care services, raise rates of diabetes detection and management, lower rates of depression, and reduce financial strain.

Pointer from, well, everyone. All I can say is that this is really separating what David Brooks calls the “detached” from the “engaged.” The latter are making an all-out effort at what I call trying to close minds on your own side.

Somewhat detached commentary includes

Tyler Cowen, Ray Fisman, and Reihan Salam.

Robin Hanson has an even stronger version of the null hypothesis. His version says that differences in health care spending produce no difference in health care outcomes. He and I disagree about how to characterize this result. Let me try to explain how we differ. Let us stipulate that:

1. Some medical procedures improve health, but not in a way that shows up in statistics. For example, if you get your broken arm fixed, you are much better off than not getting it fixed, but this will probably not show up in measured statistics of health outcomes, including longevity.

2. Some medical procedures are a waste (futile care, unwanted care, treatments of non-existent ailments, treatments that do not work, and so on).

3. Some medical procedures have an adverse effect on health.

4. Some medical procedures improve health outcomes, but only with a low probability (e.g., precautionary screening).

5. Some medical procedures definitely improve health outcomes in a measurable way.

Note also, that most studies of medical spending are not controlled experiments. In observational studies, including cross-country comparisons, the results tend to be dominated by a 6th factor, namely that health outcomes are determined much more by individual genes and behavior than by medical intervention.

Robin and I agree that (5) is true. The question becomes, how does (5) wash out in the statistics on differences in spending? His view is that there has to be enough (3) to offset the (5). My view is that it is mostly that (1), (2), and (4) serve to dilute (5). If I am correct, then researchers should find some quantitative differences in health outcomes, but these differences will not be statistically significant. Out of (bad) habit, they will report this as “no difference in outcomes.” This makes it sound as if they have proven the null hypothesis, when they have merely failed to reject it.

Of course, in a large study (as this was), there may not be much difference between failing to reject the null and proving it. The confidence interval around zero could be small (if someone has access to the paper, you can let me know).