Private Cities, Continued

On this post, Patri Friedman commented,

Think about the famous “double size, increase infrastructure cost by only 85%” rule for cities. So roughly every 16x size increase halves cost. You are trying to compete with established, funded incumbents who are easily 256x bigger than you and thus with 1/4 the infrastructure costs. And with high transaction costs for their customers to leave.

I think that the last sentence, concerning transaction costs of leaving, is interesting. I am not sure what the equilibrium would like if you brought those costs to zero.

Suppose that a big challenge with creating a new city is that the value is in the people there. This creates a Catch-22. You cannot convince me to move to a city until I know there are people there with whom I want to interact. And there won’t be people with whom to interact until you convince people to move to the city.

If there were zero transaction costs in changing cities, then you might get me to try a city before I am sure that it has enough interesting people for me. However, if I know that there are zero transaction costs to changing cities, then when I see interesting people in a city I may not be confident that they will stay there. So what do I do in that case?

I think that in that scenario, cities would behave like dating bars. Such bars tend to surge in popularity until they suddenly lose clientele.

The License Barrier

Jared Meyer writes,

Excessive permitting processes are part of professional licensing. They also act as a deterrent to work and were seen as a large problem by small businesses. The utter complexity of many states’ permitting processes makes it difficult for entrepreneurs to focus on getting their ideas off the ground, and for small business owners to devote the necessary time to ensuring their businesses stay alive.

He cites a survey by Thumbtack, a business services firm working with the Kauffman Foundation, which shows that small business owners find licensing and permitting to be a significant barrier to their development.

Pointer from Don Boudreaux.

Good Sentences, Bad Sentences

1. From Edward Conard:

The key to accelerating the recovery is not to generate unsustainable consumption, as Mian and Sufi propose. Rather, we must find sustainable uses for risk-averse savings

Mian and Sufi make a big deal over the fact that consumer spending fell in places where housing prices fell. Conard suggests that this is because consumers in those areas were spending at an unsustainable rate, based on capital gains in housing that disappeared.

2. From Alex Ellefson:

Laplante said he expects all 50 states to require software engineering licenses within the next decade, and possibly much sooner.

Not surprisingly, most software engineers endorse this. [UPDATE: from the article “The licensing effort was supported by nearly two-thirds of software engineers surveyed in a 2008 poll.” Commenters on this blog dispute that most software engineers endorse licensing. They may be correct.] But it is really, really, not a good idea. Bad software may be created by coders. But its cause is bad management. The typical problems are needlessly complex requirements, poor communication in the project team between business and technical people, and inadequate testing.

I would favor licensing for journalists if I thought that it would keep incompetent stories like this one from appearing. But I don’t think that would work at all.

The pointers to both of these are from Tyler Cowen.

Room for a Regulatory Arbitrageur?

Matthew Mitchell and Christopher Koopman write,

Startups in the craft brewing industry face formidable barriers to entry in the form of federal, state, and local regulations. These barriers limit competition and innovation, reducing consumer welfare.

If this is correct, then it should open up opportunities for regulatory arbitrage. An existing craft brewery that has licenses and regulatory know-how could market the products of start-up breweries.

Marc Andreessen on EconTalk

Self-recommending. I was talking last night with Steve Teles about personality and executives. Think in terms of OCEAN. Which personalities are likely to like to take risks? I think of high O (openness) and high E (extraversion) as positive toward risk taking, with high N (neuroticism) and high A (agreeableness) negative toward risk taking. Teles and I agree that the market tends to select for CEO’s men with high O, high E, and low N and somewhat low A, thus creating a bias toward risk-taking among CEOs. I think that Andreessen exemplifies that. He is much more struck by the mistakes venture capitalists make in missing out on the big hits than the mistakes they make in backing losers.

I think that his attitudes toward risk are probably really a good fit for venture capital. I think they are a terrible fit for being a banker backed by deposit insurance. That is why I think that regulators should be concerned about the personalities of bank CEOs. Teles thinks I ought to write up my theories on that. I think I would have to do a lot of empirical research first.

Andreessen says that journalists are nostalgic for an era of oligopoly, and now they face an era of intense competition. I think that is correct. Even if he is correct that the market is big, that does not mean that there are easy profits in it. Think of a sort of California Gold Rush, with enough miners competing to drive profits near zero. You want to figure out how to be Levi’s.

Was Galbraith Right After All?

Ian Hathaway and Robert E. Litan write,

the firm entry rate—or firms less than one year old as a share of all firms—fell by nearly half in the thirty-plus years between 1978 and 2011. The precipitous drop since 2006 is both noteworthy and disturbing. For context, the rate of firm failures held relatively steady—aside from the uptick during the Great Recession. In other words, the level of business deaths kept growing along with the overall level of businesses in the economy, but the level of business births did not—it held relatively steady before dropping significantly in the recent downturn. In fact, business deaths now exceed business births for the first time in the thirty-plus-year history of our data.

…—whatever the reason, older and larger businesses are doing better relative to younger and smaller ones. Firms and individuals appear to be more risk averse too—businesses are hanging on to cash, fewer people are launching firms, and workers are less likely to switch jobs or move.

Some possibilities:

1. Galbraith was right. Large, established firms have the advantage, due to advertising and technocratic management. Consider what Wal-mart has done to the small-town pharmacy or grocer. There is dynamism in the market, but it is not coming from the mom-and-pops.

2. Population aging. Older workers are less mobile, and older consumers are less willing to change.

3. Consider the sectors in the economy that have expanded: health care, where there is consolidation (fewer small practices, lots of mergers); finance, where our system has become much more concentrated; education, where new entry faces regulatory barriers. As the share in the economy of more-dynamic sectors (manufacturing, retail) shrinks, and the share of less-dynamic sectors rises, the average dynamism falls.

4. Perhaps incumbent firms have become better at using regulation to deter entry. I think of automobiles, where I am guessing it takes more lawyers than engineers to bring a new car into the market.

Question in the Comments

On this post.

“Perhaps the [record company] who makes a risky bet on a raw [artist], and who take the time and effort to train her, should be entitled to a small portion of her lifetime earnings as she moves on to more lucrative employment. That would create a powerful incentive for [record companies] to devote real resources to building the skills of their [artists].”

How’d that work out?

1. It worked out better for the record companies when they had a monopoly on the means of distribution. The Internet tends to undermine that monopoly.

2. Regardless of technology, the supply of people who want to be in the entertainment business seems to be highly elastic. And the nature of demand for entertainment (people want to like stuff in part because other people like it) tends to produce winners-take-most outcomes. So a lot of artists will make low incomes, and a few will get lucky.

3. I think that artists cultivate an image of being unusual and self-made. So they will not shout it from the rooftops that their skills reflect real resources invested by major corporations. But my guess is that if the Beatles had been so determined to think of themselves as original that they had never taken any suggestions from their producer, they would have been just been the WannaBeatles.

Tyler Cowen’s Best Business Aphorism

From an interview with Nick Beckstead on the topic of existential risk, meaning fundamental threats to the human race.

In his view, uploads are just an idea that some people came up with, most ideas don’t work, and most institutions are dysfunctional. Those truths seem more important for thinking about the distant future than any complicated arguments for the feasibility and importance of uploads.

Emphasis added to highlight the phrase that grabbed me.

Another aphoristic excerpt from the interview:

People in rural areas care most about things like fights with local villages over watermelon patches. And that’s how we are, but we’re living in a fog about it.

Short-termism

While on a Sunday stroll, I encountered Jerry Muller, author of The Mind and the Market, among other works. He asked me what I thought about “short-termism.” Mostly, I think that it is a difficult concept to pin down.

I guess my working definition would be that short-termism is a bias among executives to forego long-term opportunities in order to achieve short-term profit objectives.

But how would you measure it? What observations would confirm it?

For example, I might argue that, at today’s low long-term interest rates, a nuclear power plant looks like a high net-present-value investment for a utility company. Does their failure to invest in nuclear power plants reflect short-termism? Obviously, it is more complicated than that. There are regulatory barriers, site licensing barriers, and there is economic risk–suppose that ten years from now solar power becomes so inexpensive that the price of electricity no longer provides a decent return on the up-front investment? Not to mention the risk that the plant will have something wrong, or that the nuclear waste will be a problem, or some other risk.

The point is, it is very hard to separate pure time preference from risk when it comes to real-world investments.

Some other thoughts:

1. For the economy as a whole, most pundits think that the big long-term investment opportunities are in energy, computers/communications/robotics, nanotechnology, and biotechnology. My impression is that biotech is perhaps being held back by regulatory issues. But otherwise, I get the sense that investment is pretty active. Google certainly is making some long-term investments.

2. Sometimes, the financial crisis is blamed on short-termism. But there is very little evidence that the banks knew that they were making short-term profits that were going to turn sour in the long term. Instead, it seems that they believed that things were fine, both short term and long term.

3. If you were going to advise a firm to sacrifice some short-term profits in order to undertake long-term investments, which firm would that be? What investment should it make? Can you be confident that it is short-termism rather than concern about risk that is inhibiting the investment?

Brad DeLong’s Hierarchy of Work

He writes,

We (1) move things with large muscles; (2) manipulate things with small muscles; (3) use our hands, mouths, brains, eyes, and ears to make sure that ongoing processes and procedures stay on track; (4) via social reciprocity and negotiation try to keep us all pulling in the same direction; and (5) think up new things for us to do. The coming of the Industrial Revolution –the steam engine to power and the metalworking to build machinery — greatly reduced the need for human muscles and fingers for (1) and (2). But it enormously increased (3), for all those machines needed to be minded and all of that paper needed to be shuffled. Each improvement in machines made each human cybernetic control element more valuable as well.

Think of (1) as working without tools. (2) is working with tools, but without machinery. (3a) is working with machinery in large organizations. (3b) is working in middle management in large organizations. (4) is managing large organizations, but without creativity and innovation (I think of accountants, m. (5) is creativity and innovation.

Brad’s point is that over historical time, you can watch machines move up the food chain. Today, the computer revolution is in the process of taking away jobs at level (3). The question is whether it is possible to find matches at level (4) and level (5) for most workers, or whether they are instead doomed to a lower-level existence.

Along similar lines, see Kevin Maney’s column, which I arrived at via Irving Wladawsky-Berger (who writes that “larger numbers of people will have to invent their own jobs”) by following a pointer from James Pethokoukis.