Category Archives: Economics

Obama and farm subsidies

Economics, Politics

From Greg Mankiw:

Like President-elect Obama (but unlike candidate Obama), I am all for getting rid of farm subsidies. But why would you want to use taxpayer funds to encourage large, efficient, profitable farms to break up into smaller, less efficient, less profitable farms? Isn’t that precisely what you do if you maintain subsidies only for small farmers?

I’ve thought about this, too. A lot. The answer is pure politics wrapped in an age-old economic battle: equity vs efficiency. Doing what’s efficient vs doing what’s “fair”. (Fairness being a subjectively ambiguous term.)

I’m all for getting rid of farm subsidies to everyone and letting the market sort out who wins and who loses. This places smaller farmers a distinct disadvantage because an industry like wheat farming is the almost-perfect definition of perfect competition. Neither side has market power. The only way for a farmer to increase their income is by producing more wheat. As the big guys are bigger, they have economies of scale, especially in terms of capital investment on their side. In a price-taking market, this advantage is the only business advantage possible.

Subsidizing the little guys makes them more competitive with the big guys, but this is a distortion of market efficiency. Sometimes this makes sense, but not in the case of farming in the US: we produce more food than we could ever consumer, so why are we subsidizing anyone? (Food shortages are not a production problem, they are political and logistics problems.) Subsidizing smaller producers can be done to encourage competition, but we’re already in a perfectly competitive market, so distorting the market in some way is entirely counterproductive.

Alas it is politically unacceptable to make a move that favors the big guy over the little guy. Even though doing so would ultimately better for society. Let us not fall victim to the broken window fallacy that we’re keeping smaller farmers in jobs by subsidizing them. We could just as easily be spending that money more efficiently by putting other people to work in areas that actually make sense: infrastructure repair and long-term capital investments in green energy technology, for example. We need these two things more than we need greater quantities of domestic farm products.

Economics, perceived value, and the framing problem

Economics, ,

At least once a day at the pharmacy, there is a complaint about the price of a medication. Sometimes these complaints are reasonable, most of the time they’re not. The reason these complaints are flawed is because people have a problem with perspective. Today’s particular complaint stemmed from the fact that this individual didn’t want to have to pay the full $7 copayment for one capsule. (She had previously been getting 4 capsules for $7 with a higher dosage.)

I realize that copayments cut both ways. You pay one copayment based on days’ supply, not on number of tabs or capsules, so in her case, it can seem like you’re getting screwed. Where before something was dosed weekly, and afterwards is dosed monthly, it’s frustrating. After all, how expensive could it be to make one capsule? How much should one capsule cost? Certainly less than $7.

Or so you would think.

But if you work the problem the other way, you ask a different question and probably end up at a different conclusion.

Is avoiding vitamin deficiency worth $7 a month to you?

Most rational human beings would answer this questions in the affirmative. But it’s a problem that does not lend itself to rational consideration in the form that the average consumer experiences it. “My price is the same, but I’m getting less!”

It’s a framing problem. To frame the question in economic terms:

Do you receive $____ utility from this good or service?

I’ve applied this thinking to some things that have been rubbing me the wrong way for a little while.

Movies

Going to movies is another easy activity to think about in this way. Personally, my old way of thinking about movie attendance was “I want to see this movie right away, so I will go to the movies to see it.”

Not necessarily a bad way of doing things, but probably not the best way to approach something that adds up quickly if you go often, as I cyclically do. So I’ve begun approaching the problem differently: price, enjoyment (utility), and irritation (disutility).

Am I getting $8.50-10.50 in enjoyment from my 2 hours+ sitting in a padded chair?

Utility:

  • Large screen, great picture
  • High-quality, surround sound
  • Movie previews
  • Seeing the movie now, without having to wait for DVD/Blu-ray

Disutility:

  • Feeling like I’m getting screwed to see a moving picture on a white screen at $9.50
  • Pre-pre-movie commercials (Didn’t I pay for the movie once already?)
  • Previews for horror movies
  • Commercials with higher production values once the movie “begins” (More commercials? I thought I paid to see this film…)
  • Young people making noise and playing on cell phones if it’s early in the evening; even more disutility if its a Pixar or Dreamworks movie before 8pm

Does the total utility I receive outweigh the disutility I experience at a $9.50 price point?

Framing the question in this way has helped me discover that no, I do not. Not at $9.50. Not at any price greater than ~$6. You, of course, may come up with a different figure. (My utility:disutility ratio changes if it’s opening night for a highly-anticipated movie where fans feed off each others’ energy, or if the movie is a date. Et cetera.) I don’t think that this figure will change as my income increases, either. I think it would if the things that annoy me about movie-going were minimized in a meaningful way.

Fortunately for me, there is a theater that does some price discrimination every Tuesday: $4.75 movies all day, regardless of time or rating. So I’ve begun going to the movies almost exclusively on Tuesdays. I feel like I am getting a good value at this price.

Note to theater operator: you can capture more consumer surplus if you make the experience of going to the theater more worthwhile. I know many other savvy consumers who feel the same way. Mark Cuban understand this.

—

By re-framing common consumer questions in this way, you can more adequately come up with a subjectively appropriate value for any consumer decision you make. Speaking for myself, it has caused me to re-evaluate several activities that I used to readily partake in: drinking, going on vacations, visiting people, spending time watching television, etc.

  • Is it worth 23 cents a day to avoid vitamin deficiency?
  • Are the memories you will make visiting family or going on vacation someplace new or doing something different worth the $_____ that it will cost?
  • Is it worth $10 to see an average movie in an average movie theater?
  • Etc.

This isn’t just a way to eliminate things from your life; it’s also a good way to think about things that you should do more of. In my particular case, I’ve discovered that I should probably read more; watch less television; and go on vacation more often. I also drink less in most situations, but drink more in some others.

Part 4: How it will shake out and conclusion

Economics, Science & Technology, , ,

This is part one of a four part series:

  1. Part 1: The Little Things
  2. Part 2: Wind and waste heat
  3. Part 3: Petroleum, plastic, and data centers
  4. Part 4: How it will shake out and conclusion

PDF of the whole thing (2,158 words).

There are other ideas floating around, that might be of interest to private individuals, too. Wind turbines floating on neodymium magnets resulting in ultra-low coefficients of friction that generate electricity spring to mind. Even the smallest gust of wind could offset electricity costs for your home. Applied on a larger scale, these turbines could be installed next to stretches of highway where the wind created by vehicles speeding by generates power for the grid. The ideas get progressively more sci-fi and less based in reality, but all have research and/or working prototypes to support them.

Ultimately, I expect a handful of green power generation strategies to become prominent, based largely on a region’s geographical needs. A landlocked country has little use for generators that harness tidal forces, and a country without large amounts of sunlight will have little use for a solar grid and might be better off with a network of small, personal, near-frictionless turbines to produce a great deal of power. This will have the secondary effect of changing power companies’ dynamics. Private individuals and businesses may end up selling a significant fraction of the electricity that they generate back to the power company, as already happens on a tiny scale.

Rather than being a sunk, overhead cost, electricity could provide a smaller, secondary source of income in some cases. This is good for the overall health and robustness of the power grid itself. Rather than a centralized source vulnerable to operator error, equipment failure, or even an unlikely terrorist attack providing us with all of our power, a grid of consumers becomes a grid of hybrid supplier-producers. This has an effect on the dynamic of the producer-consumer relationship, too. The consumer has more power because they’re doing more than just consuming. They become more of a partner in the relationship.

So while no single master stroke of technology is going to save the world from global climate change, or rescue our economy from its dependence on foreign oil, there are a number of initiatives that, in aggregate, are having a real, profound effect on our economy. That effect will only become more pronounced as time goes on, and these technologies that are mostly in the lab make their way slowly into the real world. It’s important to note that while being green is trendy and gets a lot of press and has considerable mindshare, particularly among the youth, it’s not this trendiness or mindshare that’s going to create lasting change. It has certainly sparked social change, which is good, but as always, it is the bottom line that will be the driver for bigger and better things. It will be economic forces that determine whether we continue our destructive tendencies or move towards a more renewable future. My money is on green, because that’s the direction the invisible hand is pushing us in. Green is, quite simply, how we do more with less, and create new markets while we make our way in that direction.

Part 3: Petroleum, plastic and data centers

Economics, Science & Technology, , ,

This is part one of a four part series:

  1. Part 1: The Little Things
  2. Part 2: Wind and waste heat
  3. Part 3: Petroleum, plastic, and data centers
  4. Part 4: How it will shake out and conclusion

PDF of the whole thing (2,158 words).

Plastic, another petroleum product, is a problem in the making as well both in terms of making more and recycling what we’ve already used. Recently, a 16 year old Canadian high school student conducted a series of experiments designed to isolate organisms that might degrade plastic bags. After collecting soil samples at a local landfill, he spent 3 months culturing them solely on a diet of polyethylene film strips. He narrowed it down to four types of bacteria, and grew each on agar plates, and discovered a new species of bacteria that eats plastic bags more ravenously than Pseudomonas, the only known plastic eater to that point. Burd found that only 0.01% of the microbes’ body mass was released as carbon dioxide, allaying fears that his technique, if implemented on a wide scale could increase the amount of greenhouse gases released during recycling. It’s estimated that these plastic bags will take between 50 and 1,000 years to break down on their own in a landfill. And microbes have been shown to do the opposite as well: taking toxic styrene and turning it into a biodegradable plastic called PHA. Both processes have economic implications, and each seems to be another tiny nail in Malthus’ coffin.

There are other initiatives being worked on, primarily in academia, that will have huge implications for our business and environmental future. Generators that sit in the ocean or river and harness the power of tidal forces. There are some problems associated with this method of electrical production, such as how to store this energy meaningfully, but these problems have analogs with other types of green energy production, like wind power. With enough interest, investment, and work, they’ll be solved.

Other ideas surrounding the harnessing of the oceans include thermal energy converters. It’s thought that the amount of solar energy captured by the ocean is equivalent to 250 billion barrels of oil per day. That means that each day, the world’s oceans capture the energy equivalent of 33 years worth of the US’s total oil consumption. Obviously capturing the entirety of that energy is impossible and undesirable, but any company that comes up with a way of efficiently harnessing just a tiny fraction of it stands to make billions. Quite likely they will find themselves in an oligopolistic or even monopolistic position, too, as the barriers to entry will be huge, and the absolutely large minimum efficient scale of production will prevent new firms from entering.

“Green” thinking is also driving microscale R&D. Electronics companies are looking at solid state storage as a means of cutting down on power consumption in the datacenter. As more and more of our computing and storage moves to the “cloud”, more datacenters are required. Datacenters are expensive to cool, and it’s quite difficult to achieve an inexpensive, efficient, useful power density as well. That means that a large scale reduction in the amount of electricity consumed by individual server components will mean that useful power densities can be lower, or more servers can be crammed into a smaller space.

The largest consumers of electricity in the server are the pieces that move, specifically the hard drive. This movement has the secondary effect of creating waste heat which must be compensated for with adequate cooling lest the entire datacenter overheat. So even a small decrease in power consumption in that one tiny segment of that one specialized market will have domino effect across many secondary industries. It’s similar in scale to the standby power dilemma mentioned above. And when you see companies like Microsoft, Amazon, and Google moving close to hydroelectric dams to build their datacenters, or moving to Siberia to save on cooling costs, you know these concerns aren’t pie in the sky. There are real economic forces at work that are more powerful than the constraining forces associated with having to build fiber infrastructure out to these remote areas.

Part 2: Wind and waste heat

Economics, Science & Technology, , ,

This is part two of a four part series:

  1. Part 1: The Little Things
  2. Part 2: Wind and waste heat
  3. Part 3: Petroleum, plastic, and data centers
  4. Part 4: How it will shake out and conclusion

PDF of the whole thing (2,158 words).

Being green makes good business sense, much of the time. While you obviously wouldn’t want a hospital run directly on solar power, it does make sense to build solar arrays in the right places, and wind farms in perpetually windy areas, and then hook these up to the existing power grid. In that context, running the hospital on solar power doesn’t seem like such a bad idea anymore. In medicine, we manage chronic pain by coupling a long-acting opioid with a short-acting, rapid-onset opioid. The long-acting agent is used to control baseline pain, and you never use short-acting opioids to manage baseline pain because of the greater duel risks of overdose and dependence. These agents are used to breakthrough needs only. In power generation, the metaphor is analogous: renewable resources provide your baseline power, and your coal- and oil-based electricity kicks in only when necessary. Thankfully, exothermic reactions lend themselves to relatively rapid cycling and are therefore suited to “as-needed” use.

Texas billionaire oilman T. Boone Pickens is seeing why it’s valuable to invest in renewable sources of energy. Not only is it good for national security, but it makes good business sense to invest in renewables. With any non-infinite resource, the market is subject to the forces of supply and demand. When supply drops, the price goes up. If demand increases because India and China need their share of the world’s petroleum supplies, prices for the US consumer go up, as well as the ancillary costs associated with anything that needs to be transported. As the amount of available petroleum decreases — as it’s steadily and inevitably doing — these forces increasingly affect the way you operate your business. For a company like National Grid, eliminating the twin problems of scarcity and competitive bidding are good for the bottom line.

Civil and structural engineers and architects are hopping on the green bandwagon as well. The first of them jumped on because it was hip and different, and enabled them to leverage a different kind of brand image to achieve financial success. Lately, though, buildings that are built to be more energy efficient make economic sense. In Sweden, Jernhusen AB is harnessing the body heat of thousands of commuters that pass through Stockholm’s main railway station. The firm believes that the system being designed can provide about 15% of the energy needed to heat the 13-story building being built next to Central Station. This system isn’t even particularly radical. It’s going to cost about $47,000, and will only require a few pumps and some pipes, since the ventilation system is already in place. I think it’s a safe bet that a 15% annual energy savings for a 13-story building will more than cover even the short-term costs associated with it, particularly in a city only ~1,000 miles from the Arctic Circle like Stockholm.

Since every mechanical system wastes energy in the form of heat, recycling waste heat is also becoming more popular. Estimates of the amount of energy lost in the form of heat — expressed in terms of electricity — from smokestacks in the US alone is at 50,000 megawatts, more than half of what this country generates from its aging nuclear fleet. Initiatives to turn this waste heat directly into electricity are already underway, and can be built on small scales that make it worthwhile for these industrial companies to invest in.

Part 1: The Little Things

Economics, Science & Technology,

This is part one of a four part series:

  1. Part 1: The Little Things
  2. Part 2: Wind and waste heat
  3. Part 3: Petroleum, plastic, and data centers
  4. Part 4: How it will shake out and conclusion

PDF of the whole thing (2,158 words).

Being “green” is a badge worn with honor by companies and individuals alike. Just like consuming organic foods, it’s as much a yuppie status symbol as it is a lifestyle choice. At least it used to be. Venture capitalists are on the lookout for interesting green companies these days because there’s lots of money to be made by reducing energy consumption, cutting back greenhouse gas emissions, and generally doing more with less. From a very high, forward-thinking level, it seems bizarre that we haven’t been doing this right along: if economics is the study of human behavior in a world where there are limited resources but infinite demand, it makes sense that we would want to do more with less.

If it requires 50% less electricity to run an efficient datacenter, and 50% less gasoline to get from point A to point B, then that means we can house twice as many servers and end up with the same electric bill, and travel twice as far without burning any more gasoline. So every halving of the resources required to do something results in a net doubling of whatever you can do with that resource, all things being equal.

This model is easily applied to things like fuel efficiency and other commodity consumables, where small increases in efficiency result in immediate, apparent cost savings to an otherwise ignorant consumer. However there are other, less intuitive places to look where small savings aggregated across millions of people results in real macroeconomic benefit.

For example, there is a push right now to get rid of or improve “standby” modes for most electronic devices. This is what is widely considered the “off” position for most things, but in reality is actually the low-power mode wherein a device is not performing its primary function. The clock on the VCR and the microwave. The “breathing” the LED in your Macintosh computer does while it’s asleep. Your laser printer while it’s on standby waiting for a print job. Same for your fax machine.

A single device can suck up as much as 30W of electricity every 24 hours. Multiplied across all of the consumer electronics in your home, multiplied by the number of households in the United States, and you quickly realize that this is a boatload of wasted electricity. In fact, in the lifetime of a single electronic device, this savings is estimated to be $10. This is one of the reasons that President GW Bush directed the entire federal government to buy low-standby-power devices back in July of 2001 (PDF). Uncle Sam buys a lot of electronics. That means tens and possibly hundreds of millions of taxpayer dollars saved by one superficially insignificant initiative.

An economic case for being “green”

Economics, Science & Technology, , ,

If I were a venture capitalist today, I wouldn’t be looking at Internet startups. While the Internet is a sexy market and commands a lot of mindshare, I don’t think that it’s the future. We’re coming to the end of the Information Age. No, the problems uncovered by the Information Age aren’t solved. Search isn’t solved. Scientific computing as a whole is still quite nascent.

But we are gradually working our way out of this Age and into the next: the Renewables Age. Just like we’re still using what was developed during the Industrial Revolution, so too will we continue to use and develop the goods and services developed during this Information Age. So while computing and information management isn’t going anywhere, it will be superseded by bigger economic concerns. Namely, renewable energy.

I firmly believe that a few well-placed, relatively modest investments today can very probably yield absurd returns on investment sometime down the road. It would, however, be a very long-run type of play, and many VCs aren’t prepared to make an investment that won’t pay off within ten years.

With that in mind, I wrote the following as part of a larger essay for an economic history class about a week ago. What is interesting is that when I started the paper, I had no idea where I would end up. Like most Americans, I hadn’t thought about the “greening” of the economy at all. I didn’t have a conclusion in mind when I began. The final result was this, and I think I make a pretty good case for renewables and investment therein. At the very least, I have convinced myself, and I don’t really know how you can argue against it unless you’re talking timespans of less than ten years.

I’ve broken it up into a couple of shorter pieces because it’s simply too long to post as-is. No one would read it. Because it’s unedited, the beginning of each piece might feel a little jarring beginning on day 2.

  1. Part 1: The Little Things
  2. Part 2: Wind and waste heat
  3. Part 3: Petroleum, plastic, and data centers
  4. Part 4: How it will shake out and conclusion

PDF of the whole thing (2,158 words).

Let me know what you think…

A history of debt in America

Culture, Economics,

While going through my RSS reader this morning, I came across one of JD’s daily links posts, and one of them was to A History of Debt in America. It’s quite a long article, but well worth reading. Unfortunately for people like me, reading large quantities of text on a screen gets to be painful after a few minutes.

I whipped up a quick PDF of all of the pages, and Tom, the author of the article, has graciously allowed me to post it here.

It’s 21 pages long, and will take you a little while to read it, but it’s worth the time.

PDF link.

If you enjoyed this, you may enjoy my post on how paying off debt is like folding laundry — a behavioral, as opposed to mathematical approach to paying off debt.

Hillary’s superficial plan to “fix” gas prices

Economics, Politics, , , , , ,

It seems that Hillary Clinton wants to tax big oil, but only on their record profits. She would do this to make up the revenue lost while putting the federal gas tax on hold for a while. While I’m sure this is more of a ploy to pander to voters due to her faltering campaign, the whole thing is incredibly superficial for a couple of reasons.

The first is that taxing big oil is only going to shift the cost to consumers. While you might see a temporary drop in prices at the pump, businesses typically shift such burdens on to the consumers. Doing this only makes sense for their bottom line. Beyond this, it will cause an increase in demand, causing prices to rise naturally. But then, Hillary apparently doesn’t care what economists think.

Secondly, there’s the temporary nature of the repeal. Reinstating the tax after it’s been rolled back for a while will be unpopular on an epic scale, but I suppose Hillary is mostly going for a short-term boost to get her through to the November elections. Naturally, I’ve heard nothing about rolling back the tax on big oil’s profits once the federal gas tax would go back into effect. That means that the consumer is going to be doubly hurt in the end anyway.

This leaves big oil’s profits right where they’re at now. Taxing big oil’s profits isn’t the answer — and neither is breaking up the oil monopolies. (Though the latter might not be a bad first step.)

The real problem is that demand has exceeded supply. This is a result of the American way of life. We depend on oil for literally everything: we are a spread out nation of roads where a child’s first thought of freedom = getting their drivers’ license, and whose development has, for generations, been driven by cheap oil. Every aspect of our lives is controlled by the road: everything from our food to our consumer goods arrives via truck. Auto companies have been complicit as well, and in some cases actively undermined attempts to create efficient mass transit systems that were a direct threat to their business model.

This isn’t a problem that can be fixed overnight, nor is it a problem that will be cheap or easy to fix. Comparisons to European nations and Japan with their comprehensive mass transit systems are inherently flawed because of the US’s relatively low population density and sheer size of our country. While effective, efficient mass transit is certainly the answer in urban and larger suburban areas, those systems do not scale well in more rural areas.

In that respect, we will always be a nation of cars — or other personal transport devices[1]. The mantra that we need freedom from foreign oil is trite, and it misses part of the point: we need freedom from petroleum in general, inasmuch as that is economically and techonologically possible. We will always be somewhat dependent on combustible fuels so long as the internal combustion engine is our primary mode of getting from Point A to Point B. (And really, aside from bicycles and our feet, there’s nothing out there that’s as efficient from top to bottom as a modern internal combustion engine.)

So in that respect, even if Hillary’s plan had a prayer of a chance of long-term success, and if she had any ability to get it passed — which she doesn’t because it’s an idea for this summer, not after January — it would be like prescribing a pain med instead of removing the thorn from one’s foot.

The proposal is just astonishingly dumb on every conceivable level.

I do have some related thoughts about the next ten years…

1) We’ll see a small resurgence of the railroad industry. Rail travel is more efficient than air travel, and solves some of the mass transport problems presented by our spread-out nation. This will resemble the current hub-and-spoke airline system in the short term. Business travelers won’t mind taking the train as much due to the ubiquity of wireless internet access and the fact that you can use cellphones while on a train. Trains don’t have to be slow, either. So while you won’t be taking the train from NYC to LA for a one-day affair, you might well take it from Boston to Washington DC for the same.

2) More effective car-pooling systems. Thanks to the Internet, it’s easier to more effectively carpool with folks headed in your direction. This could be supplemented by mass transit systems — buses in the beginning, and trains later on — where people gather at smaller, de-centralized staging areas for a trip into the city. Many suburban areas already have these systems, but there are many, many larger cities that don’t.

3) More and better research into biofuels as a replacement for traditional petroleum. This goes beyond corn-based ethanol which was a failure of epic proportions, as it resulted in increased food prices and is energy-intensive to produce. The graphic below (click for larger) demonstrates some of the more promising alternatives, particularly algae and switch grass.

biofuels comparison chart
(Preserved against link-rot from this article.)

I think America is getting to the point where they’re ready to think about letting go of their precious four-wheeled transportation. Drive by a used car dealership, and you’re likely to see quite a few gas guzzlers sitting on the lot. This alone is anecdotal evidence that the PED of gasoline isn’t zero. A more formal study finds that when the price of fuel goes up and stays up by 10%, the process of adjustment is dynamic and far reaching:

  • The volume of traffic will go down by roundly 1% within about a year, building up to a reduction of about 3% in the longer run (about five years or so).
  • The volume of fuel consumed will go down by about 2.5% within a year, building up to a reduction of over 6% in the longer run.

The reason why fuel consumed goes down by more than the volume of traffic, is probably because price increases trigger more efficient use of fuel (by a combination of technical improvements to vehicles, more fuel conserving driving styles, and driving in easier traffic conditions). So further consequences of the same price increase are:

  • Efficiency of use of fuel goes up by about 1.5% within a year, and around 4% in the longer run.
  • The total number of vehicles owned goes down by less than 1% in the short run, and 2.5% in the longer run.

Prices have certainly gone up by more than 10% in the last 12 months, and the snowballing effect of this phenomenon is that many people of my generation have gotten rid of their cars where and whenever possible, and instead opt for healthier, less expensive modes of transportation: walking or biking. When they need to travel a longer distance, they rent a Zipcar.

I certainly would if it were realistic.

[1] I could see motorbikes becoming more popular, as they are in the UK, as gasoline prices continue to rise. For Americans who have not been to the UK, it is not uncommon to see motorcycles and scooters out and about, even in the rain.