Econ 101 and tech commentators, part 1 (Amazon monopoly edition)

As an undergraduate one of my highly science oriented friends explained how frustrated he was with Econ 101 because there were so many places in which calculus so obviously belonged but couldn't be used because the class was not geared towards that kind of audience.  

I feel the same way when John Gruber and Marco Arment (or any of a large number of tech commentators) discuss Amazon and ebook "monopolization."  There are gaping holes in the discussion where Econ 101 belongs but is absent.  

Gruber and Marco take it for granted that Amazon's now defunct $9.99 pricing for almost all (popular) Kindle books, even if Amazon itself paid $12.50 to the publisher for the book, was a "textbook example of predatory pricing," with the ultimate goal, presumably, being Amazon left as the only ebook provider getting to raise prices to monopoly levels.  

Missing is any consideration of what it takes to enforce a monopoly.  Anyone arguing that Amazon is capable of establishing a long standing monopoly by driving out competitors with below cost prices has to explain how Amazon could thwart new entrants after raising prices to monopoly levels.  It's literally impossible to say anything useful without first addressing this issue.  Marco makes some hand-waving references to the need to buy a dedicated device (i.e., the Kindle), but in a world awash in iPads, Nexii 7's, etc, etc, that's not a very compelling argument.

I have no special insight into Jeff Bezos' psyche.  Perhaps he is trying to create a monopoly by driving all competitors out with temporary below cost pricing, although I suspect he's much too smart for that.  Nonetheless, from a public policy perspective, the relevant question isn't what he is trying to do, but what he can do.  Creating a long-term monopoly in ebook sales just isn't in his arsenal.  

FWIW, I've always assumed that Amazon's strategy is some mixture of three things:

1)  Establish ebooks in the consumer mind as a standard mechanism for buying books.  Before the fanfare surrounding the Kindle (and, later, the iPad), ebooks were a decided niche product.  Now they are a consumer standard.  It seems reasonable to believe that it is worth it to Amazon to "pay" readers in the form of subsidized book purchases for a time to help develop that market.  

2)  Establish Amazon as the first place a book reader would think to go to to buy ebooks.  

3)  Illustrate to the book publishers that lower revenue from lower book prices would be more than offset by greatly increased book sales.  For me, anyway, the $9.99 price point was just on the right side of the impulse purchase line to make me buy on a whim.  But I tend to buy a lot of books.  

Personally I think that book publishers are too frightened of innovation and don't want to be shaken from their comfortable "release a cheap, paperback edition after all the highly motivated buyers already shelled out for the hardback" model.  I think Bezos is/was trying to slap them in the face to recognize a new, more profitable, reality…to be sure, one that also includes lower wholesale prices to Amazon, but still involves more income to book publishers through much higher book sales.  (In other words, I think book publishers are mistaken about what is in their own best interests.  No, I don't think government policy should be made on this basis.)  

Of course, those basic facts can be fit into two slightly different stories, each of which attempts to answer the biggest question that must be addressed:  Why would publishers object so strenuously to a reseller selling books for less than the price the resellers have paid for those books?  Normally one would expect the publishers to sit smugly in the corner wondering how they got so lucky.  

 

Story 1)  Publishers currently release hardback editions in advance of paperback editions to gain added revenue from buyers willing to pay extra for the benefit of reading the book now rather than 6 months from now.  This is an important aspect of the book publishing business model that ebooks disrupt.  I imagine publishers are struggling to figure out how to fit ebooks into their decades old hardback-paperback release schedule.  Amazon seems to have one thought about how they should fit in, and that thought seems to come pretty close to destroying the model entirely.  I don't know how the publishers think that ebooks should fit in.  I suspect they still don't know themselves, but I also suspect that they would like to make that choice themselves, rather than cede the choice to Amazon.  

 

Story 2)  The ubiquitous monopsony story.  Amazon becomes by far that largest seller of ebooks, which gives it some degree of monopsony power over the publishers.  One can easily imagine publishers being extremely concerned about this, but is this a bad thing for consumers? 

Amazon's hypothetical monopsony power would exist only because the publishers have some monopoly power themselves.  Amazon can, in this story, be seen as form of a consumer cartel negotiating better prices from publishers, which sounds good for consumers.  

But perhaps not.  Publishers have their monopoly power because of copyrights granted by the government.  By negotiating away some of the monopoly value of the copyright, this "consumer cartel" diminishes the value of the copyright, thus, reducing the production of books.  

 

I doubt that the government has the knowledge necessary to determine which of these most accurately describes reality, nor, in the case of the monopsony story, that it has the ability to determine whether Amazon monopsony power over publishers is good or bad for consumers.  So, I think the government should just leave it alone to play out on it's own.  

 

Outliers

Outliers is a nice collection of marginally related, well written (Malcolm Gladwell, natch), stories that are ostensibly tied together by their ability to disprove the notion of a "self made man".

It's a little difficult to tease out what Gladwell thinks a "self made man" would look like, but we know what he doesn't look like: any existing human being with a family history that influenced his life. You're not a self made man if you were raised in an environment which valued education or entrepreneurship. You're not a self made man if you were a life-long computer nerd in your mid twenties at the dawn of the micro-computer revolution and became successful in that industry. You're not a self made man if you were unfairly shut out of the "best jobs" because of your ethnicity only to end up with a "second tier" job that, because of changes in society, ended up being much more lucrative than ever predicted.

What Gladwell doesn't do it look at the history of similar people with similar backgrounds. Joseph Flom presumably wasn't the only Jewish law student from an immigrant, garment industry family who couldn't get a job at the top law firms. Why was he so successful and not the others? More relevantly, why did some of them become at least reasonably successful, while others gave up (if any did)?  What was it about Bill Gates' nature that drove him to sneak out of the house at 3:00am to code in the University of Washington Academic Computer Center that was not the nature of other nearby children? 

Gladwell's argument is that Flom and Gates wouldn't have been able to do what they did had a fairly specific set of things not happened in their lives, but he doesn't investigate people for whom those or similar sets of things did happen.  In science this is referred to as "survivor bias", and Gladwell is assuredly familiar with it. 

"Self made man" is a trite, wince-inducing phrase that anyone should be embarrassed to apply to himself.  But let's not pretend that all life is random chance.  Or, if you want to make that claim, you have to do a better job than Gladwell does here.

In the end the book works extremely well at illustrating a point that precious few ever doubted: That the exact path of one's life is heavily influenced by family environment and elements of random chance. It that regard it's a kind of "Connections" for the social psychology set. But the stories themselves are best read as enjoyable, unrelated, long form magazine pieces. 

 

Thinking, Fast and Slow

Anyone listening to the intellectually oriented radio and podcast world over the last several years will recognize this theme: recent scientific research has identified types of decisions in which human beings tend to make somewhat counter-intuitive decisions. From memory: 

1) People faced with a promotional display of 24 different varieties of jam will not buy as much jam as people presented with the same promotional display of a mere 6 flavors. 

2) Hotel customers will be more likely to respond to a card noting that 75% percent of other customers choose to save water by not requiring the hotel to wash their towels every night than will respond to a card making the intellectual case against profligate water consumption. 

3) People will choose to save more if their employment contracts default to contributing to a 401k program rather than waiting for the employee to take the positive step of enrolling in the program. 

4) An Israeli day care center’s institution of a sliding “lateness penalty” in an attempt to reduce tardiness among parents picking up their kids backfires as parents interpret the charge as giving them license to be late, when previously they had considered arriving late as an act of rudeness towards the center.

As an Economics grad student in the mid 1980’s I was introduced to Daniel Kahneman through his research that found that even math experts (not to mention everyone else) were very bad at incorporating general information about we know about the world when dealing with specific types of questions. E.g. (and I’m making the details up entirely), when presented with a description of a person that includes the characteristics “bookish” and “likes poetry,” survey respondents will probably be more likely to choose “philosophy professor” over “computer programmer” when asked to speculate about his profession, even though there are many many many more computer programmers in the world than philosophy professors. In fact, there are almost assuredly more bookish computer programmers who like poetry than similar philosophy professors simply because there are so many more computer programmers in general. 
Frequently this research is presented as a frontal assault on the assumption of rationality employed by standard economic analysis, especially of the “Econ 101” variety. And it is, to some extent. But just to some extent. 

Kahneman is disappointingly full of himself when lambasting expected utility theory, a mainstay of economic theory which Kahneman appears to think is entirely overthrown by his research. The work on which he bases this assessment investigates the difficulties humans have dealing with very small probabilities, difficulties which have some unusual effects at the margin (such as most people “irrationally” overweighting a .0001% chance of something happening), and making inconsistent decisions depending on the framing of options (e.g., starting with $300 with the ability to possibly make an additional $200 vs starting with $500 with the ability to possibly avoid the loss of $200). 

This is valuable research, and well worthy of the Nobel Prize bestowed upon him. But how many real world decisions fall into these categories? How does this research weigh on the Econ 101 discussion of, say, the effect of a carbon tax on oil at the wellhead on the price and consumption of gasoline? The effect of the minimum wage on the unemployment rate of unskilled teenage labor? The effect of rent control on the housing market? Not a lot. Some, perhaps. But not a lot. 

Attacking the “rationality assumption” in economics has become something of a shibboleth among the less educated critics of Economics. But, in fact, the sort of super-human feats of hyper-rationality that are mocked by these critics really aren’t necessary for what economists want out of the “rationality assumption.” When you find yourself in a supermarket (never mind how you got there), and you’re hungry, do you usually find yourself walking out with a roll of toilet paper, a bar of soap, and two quarts of oil, or are you more likely to toss a pound of ground beef and some buns in your car for the trip home? For the basic, regular lessons, that’s really all that Economics needs from the rationality assumption.

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The Omnivore's Dilemma

Michael Pollan is an alluring writer.  He's not a scold.  His writing is quiet and humble and lacks the arrogant confidence of most activists pushing his agenda.

The bulk of "The Omnivore's Dllemma" tells the story of three different modern ways of making food:  1) What is referred to as "industrial," and is best thought of as the consistent application of science and efficient specialization to agriculture, 2) what I'll call "Industrial organic," which also strives for efficient specialization while avoiding some chosen aspects of conventional agriculture which are believed to be toxic for the environment, and 3) essentially "nostalgia" farming (my term, not Pollan's), which tries as hard as possible to source inputs directly from the land on the farm, and is basically what most of us think of when we think of a "family farm."

Joel Salatin, a nostalgia farmer (and a libertarian, bless his heart) is the hero of the story, and many inspiring paragraphs are devoted to the sophisticated understanding of a seemingly infinite variety of details associated with making his farm work, from (hyper) local watershed management to optimal chicken coop construction and deployment strategies (it's regularly moved from spot to spot to take advantage of natural fertilizer).  

By comparison, the Iowa corn farmer is presented as needing to know little more than how to drive a combine and plug his iPod into his climate controlled cab, a circumstance occasionally rued by the farmers themselves.  

Of course, by being so specialized, the Iowa corn farmer can manage to grow a lot more corn than could ever be managed by nostalgia farmers, even if he doesn't get to raise his own chickens.  

This points to a bit of a blind spot in the book.  By stressing the impressive range of knowledge Salatin brings to bear on his farm, as compared with the seemingly meager array of skills needed to farm corn in the corn belt, Pollan subtly downplays the vast array of skills brought to bear in the entire "industrial" farming complex.  

As an journalistic exercise, Pollan purchased part of a cow to watch as it worked its way through the industrial system, moving from place to place to better address its needs at various stages of its life-cycle, and occasionally leaving questionable environmental messes along the way (it's telling that the benefits of specialization would make it worthwhile for cattle ranchers to abandon manure, in earlier years valuable as fertilizer, in toxic pools).  It's a decidedly unromantic life for the cow, perhaps, even, one that the government should forcibly modify, but it's also a life that illustrates the value of specialization and gains from trade.  Moving cattle isn't cheap.  Profit seeking businesses aren't going to do it unless there are good reasons.

The book would have been well served if Pollan made an effort to calculate how many Joel Salatins would be needed, at his level of productivity, to feed seven billion people.  I don't know the answer to that question, but I bet it would have tamped down the romance a bit.

Pollan is well known for being perhaps the uber-critic of "Big Corn," having found that essentially everything Americans eat appear to have some corn product in it.  This is supposedly because of the malevolent influence of processed food manufacturers who push for crop subsidies which are heavily weighted to corn production.  His argument is pretty compelling, although I suspect that more of the recent innovation in the use of corn would survive sans corn subsidy than the fashionable anti-corn crusaders would expect or like.  Still, I'd be happy to join forces with them in fashioning a more rational agriculture policy (meaning, something approximating none at all).  The big worry is that the sausage-factory of Congress will keep the corn subsidies and add on new policies pushing broccoli, or snap peas, or beets, or what have you, rather than letting consumers make their own non-nudged choices.  

That would probably be worse than the current system, and one wonders whether Pollan, anyway, is equipped to grapple with these issues.  Consider the following:

"Perhaps it is no accident that sentimental communism founders precisely on the issue of food.  The Soviets sacrificed millions of small farms and farmers to the dream of a collectivized industrial agriculture that never managed to do what a food system has to do:  feed the nation.  By the time of its collapse, more that half of the food consumed in the Soviet Union was being produced by small farmers and home gardeners operating without official sanction, on private plots, tucked away in the overlooked corners and cracks of the crumbling Soviet monolith.  George Naylor, speaking from deep within the American monolith, might be onto something when, during our conversation about industrial agriculture, he likened the rise of alternative food chains in America to '...the last days of Soviet agriculture.  The centralized food system wasn't serving the people's needs, so they went around it.  The rise of farmer's markets and CSAs is sending the same signal today.'  Of course, the problems of our food system are very different--if anything, it produces too much food, not too little, or too much of the wrong food.  But there's no question that it is failing many consumers and producers, which is why they are finding creative ways around it."  

Interesting comparison.  Naylor and, I assume, Pollan, miss the key point in the difference between Soviet and American agriculture:  Soviet private plots were an attack on the system.  They ran completely counter to what socialist collectivism was all about.  In a free market system, like we kinda have in the US, people abandoning Safeway for farmers markets and CSAs when they decide that the latter do a better job than the former is the system.  When someone comes up with a better process, people are allowed to use it, the wails of the spurned incumbents be damned.  

And then there's this piece of bizarre pseudo-science:

"We don't have the scientific tools to measure or even account for these fungi's unusual powers.  (Andrew) Weil speculates that their energies derive from the moon rather than the sun, that mushrooms contain, instead of calories of solar origin, prodigious amounts of lunar energy."
"Who's to say the day won't come when science will be able to measure the fungi's exotic energies, perhaps even calculate our minimum daily requirement of lunar calories?"

Oh Michael!  I thought you were speaking to the reality-based community.  

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The Rule of Law was a pretty hard won principle...

to be abandoned just because you think that electorate will always choose angels (and gods, apparently).

Chris Bertram argues that law enforcement agencies should be allowed to just "zap the bad people" regardless of whether they are actually, y'know, violating the law.  

I guess that even though ex ante watertight rules are impossible, the ex ante ability to predict who, ex post, might interpret your actions as being "at or over the moral and legal boundaries" is possible.  

Bertram assumes quite a bit more knowledge than he should.  He assumes that so-and-so "kn(e)w perfectly well" what these "moral boundaries" were, and that "enforcers" are actually capable of knowing that he so knew.  He assumes that the enforcers know what the "moral boundaries" are.  He assumes that "that the rest of society" (whatever that might mean) agrees with the enforcers.  

It seems to me that the urge to punish such "obvious" moral transgressors is a manifestation of the cognitive bias called the availability heuristic.  Easy to imagine scenarios overly influence one's judgment.  Because it's easy to imagine banking transactions that can be used for gaming regulatory systems, it's natural to assume that that is their primary use, and that distinguishing between such use and ordinary use is straightforward.  When the enforcement boots hit the ground, though, all sort of complications arise.  

Bertram notes that: "Rule-of-law fetishists, Hayekians, and the like tend to think (that this law enforcement discretion) just appalling."  Yep.  

 

Hat tip:  Megan McArdle, on twitter

Coase and Bain

Matt Yglesias writes probably the best one paragraph summary of Coase's Theory of the Firm I've ever read.  

"Why don't free agents just contract with one another for services as a means of economic cooperation? One reason, [Coase] argues convincingly, is that trying to spell out each and every obligation in contractual terms would be both laborious and absurdly inflexible. If you think about the way your workplace actually functions, people have roles and obligations vis-a-vis each other that are considerably richer and more nuanced than what's spelled out in legal documents. These roles evolve over time in various ways, but they also have some stability to them. The point is to create a space of collaborative endeavor that isn't dominated by constant lawyerly bickering."

Matt makes the point that the existence of Coasian implicit agreements between employers and employees that are too subtle and flexible to be specified as a formal contract could make buying out the firm to shirk on those tacit understandings profitable.  This is thought-provoking, but just how likely is that?  Missing in Matt's piece is any discussion of long term viability of firms susceptible to being bought out by someone primarily interested in milking the firm by breaking tacit agreements with employees.  Is it not likely that these firms are being bought out because the existing management structure is not working, rendering the entire organization unsustainable?  In that case all sorts of agreements, including existing Coasian tacit ones, are not viable, and cannot continue unchanged.