I’ve had to lash myself to the mast to avoid linking to every post Megan McArdle has written on the financial crisis, but this time I can’t help myself. Read this excellent post if you, like me, are made queasy by the prevailing ‘greedy bankers’ narrative but have been struggling to explain why.
Posts Tagged ‘economics
Not many sensible people waste energy worrying about the possibility of theocratic takeover in a major western democracy. We have a general optimism in the rationality and intellectual honesty of the people around us and at least some confidence in that of our political representatives. Keep this in mind as you read these three quotes on the subject of the financial crisis.
I am told ‘We don’t know who is responsible.’ Oh yeah? Well let me tell you that when things were going well, we knew who got bonuses. What a strange system…a crazy system which has been our system for years.
(“I don’t understand this science business, and I don’t understand what it’s done for me, but those scientists have been getting rich off it for years, and I can understand that.”)
The idea of the absolute power of the markets that should not be constrained by any rule, by any political intervention, was a mad idea. The idea that markets are always right was a mad idea.
(Straw man; US Financial regulation.)
You guys here in Australia haven’t been hit so hard. It’s because you have more regulation.
- American immigrant I overheard in Sydney
(“The lightening hit my place, but not yours. It must be because you have that lock on your front door. I hear those increase your security. You obviously knew what was coming.” See this excellent post from Megan McArdle.)
I’m not concerned that theocracy is imminent, but we’re not as safe from our own idiocy as we think.
Ronald Coase is easily my favorite economist, and one of my favorite thinkers in general. Among his many insights was the idea of “transaction costs”, or the cost of an economic transaction which may or may not be higher than the benefit accrued from that transaction.
Coase’s classic example was the firm. Under standard models of perfect competition, he pointed out, firms have no reason to exist. If the free market is always on average more efficient than centralised, command-and-control allocation of tasks and the means of production, it should be cheaper for an employer to contract out for a service rather than hire and organise a group of people to do it. Yet it is clear that a world where every internal task of a firm, from ordering to the mail room to payroll management, had to be accomplished by a tangle of individual contracts would rapidly grind to a halt.
The key, said Coase, are the transaction costs: the cost of organising each individual transaction with a private contractor is greater than the cost of hiring somebody to do it for you, even if hiring may result in a slightly less efficient worker. Coase also pointed out that there is a maximum limit where the decreased efficiency cost begins to exceed the transaction cost, which is why firms still outsource a lot of their activities. It is not efficient, for example, for a private school to run the graphite mine to make its pencils.
In this week’s episode of the EconTalk podcast, internet and organisational guru Clay Shirky describes how the internet is lowering Coasean transaction costs for many exchanges, to the point where ‘products’ that were previously impossible due to the cost of organisation can emerge. The value of this podcast is more in the lucid examples than in the insights, which are not entirely original. I particularly enjoyed Shirky’s description of the process by which Flickr co-ordinates individual activities to produce collections of photography which would have been prohibitively expensive in the pre-internet era. His analysis of Wikipedia also goes deeper than the usual vague references to ‘crowd-sourcing’, and he cleverly uses the unexpected success of voluntary, collaborative activities such as many open source software projects to point out the importance of new behavioural economics insights. Unfortunately, the podcast ends with a strange and poorly explained hope that creative commons-like vehicles can be used to better organise collective action in the real world. Isn’t that where the high transaction costs we are trying to escape were to begin with?
12
Aug
08
Show Me More Ads!
The only thing better than a free lunch, IMHO, is a free book. In the last six months I’ve made my way through dozens of great ebooks and audiobooks that I got for free, completely legally, because their authors chose to release them under Creative Commons licences. Cory Doctorow claims that he releases his books for free because it drives up sales of his print editions, and I have no doubt that, for him, this is true. As attractive as this sounds, it is not a long term strategy. Releasing high-quality works under CC drives up print sales because it is still a rare enough event that potential readers who would otherwise not have heard of the work become aware of it. Doctorow acknowledges this when he paraphrases Tim O’Reilly: the problem artists face is not piracy, but obscurity. If all artists were to release their media under CC, overall they would get poorer: their works will still be just as obscure, and those handful who are interested in it can just take it for free.
I’m addicted to the Economist’s audiobook edition. At first I tried to obtain it legitimately, but soon discovered that the legit route was an incredibly painful one. Their distributor’s website refused to accept my registration for days, crashed constantly, and generally spread misery. After a few weeks of this, I gave up and started getting the download from bittorrent, painlessly, freely, and illegally. This is file-sharing, and it’s not going away. As long as media can be digitised, they will be shared. Why waste money and effort on something that can be obtained freely and easily?
So giving media away for free won’t work, and people are not going to stop pirating and sharing the non-free stuff. A world in which the only cultural products around are labours of love, or government backed, or donation-supported, would be a world in which the pool of cultural products would be tepid and a good lot smaller. None of the commonly predicted equilibria – musicians living off live concert profits, authors living off donations and hard copy sales – are remotely plausible except for the top percentile of cultural products. Markets are supposed to find the equilibrium that nobody could ever have guessed, but this isn’t a typical public goods problem: how does a market function when there are no realistically enforceable property rights?
Rather than backing bold and implausible schemes, I think the better part of wisdom is to sit back and see what happens, while supporting the partial solution that has worked for many a non-excludable good in the past: advertising. Please, keep writing your books and audiobooks, and please keep releasing them under CC. But make sure you’re still making money for yourselves. I’d rather hear or read a few ads then have you shut down production entirely. And Economist, I have no idea if your audiobook is breaking even in the face of file-sharing. It’s in my best interest for you to remember though: nobody is ever going to stop pirating your audiobook. However, the world would be a worse place if you stopped producing it.
23
Mar
08
Just a little poke…
Towards the end of a fascinating talk by MIT’s Drew Endy a member of the audience made a sweeping statement about the economics of vaccine research. The gist of the comment – with which Endy casually agreed – was that there was no incentive for Big Pharma to put R&D money into a highly effective influenza vaccine which would erode its own market when they can continue to make semi-effective vaccines for whatever serotypes happen to pop up each year, guaranteeing an annual return.
I’ve heard many variations on this argument before, and am still gobsmacked that anyone finds it even remotely plausible. Why is the vaccine industry always the target of this sloppy reasoning? Do the same people believe that, if unregulated, surgeons would only perform only partial tumor removals so as not to erode the cancer treatment market? Ethical issues aside, no surgeon in their right mind would pass over the incredible profit opportunity to offer cures when their competitors are offering only treatments.
In fact, the existence of partial vaccines such as influenza increases the profit potential of a full vaccine. Think of the institutional pressures that would be put on, say, a vaccine that acts as a complete prophylaxis against cancer. There is nothing like it on the market; outside the suicidal and extremely old, there are few people for whom it would not be a hugely valuable and non-substitutable good. Biomedical products take years and billions of dollars in capital to develop, however, and even with tremendous demand and economies of scale there would be a sizable group of people who could not afford it. Populist governments being as unpredictable as they are, this is a very risky investment for any Big Pharma: will they face broken patents, price controls, boycotts, or more?
Counterintuitively, producing a vaccine for a more mature market would provide a much safer return on investment. Few people would be outraged if only the elite can afford the immune-for-life influenza shot, as long as the elderly and sick can at least get their yearly boosters.
