Friday, April 30, 2010

My Problem with Part of the Proposed Financial Reform

I'm not sure if it's in the current version of the reform bill or not, but one proposal for financial reform was a sort of FDA for financial instruments. It would review new instruments and determine whether they were valuable innovations or excessively complex and unnecessary--possibly even fraudulent--tricks that will lead to further financial disaster. So, for example, if a company offers some fancy new kind of derivative, the review board would have to approve it before issuance.

I have two problems with this (they're closely related to each other, but I think they're different enough to call them separate arguments). The first is well-summarized here with an example:

For example, before 1996, certain initial public offerings of stocks were subject to merit review in certain states, where the state decided if a security is a "bad" investment and thus not appropriate to be offered to its citizens. In fact, this is exactly what happened to Apple Computer when it first went public in 1980. Massachusetts prohibited the offering of Apple shares because they were "too risky," and Apple did not even bother to offer its shares in Illinois due to strict state laws on new issues. What if federal bureaucrats had had the power to impose their judgment on a "risky" financial product (such as an IPO) on a nationwide scale, or every state followed Massachusetts' lead?
That's taken directly from Marginal Revolution, which quoted it from Paul Atkins.  This is a great example of my first problem with this kind of reform: Financial instruments are really just contracts, and every one is new and different. New financial instruments are created all the time, with new and different terms. Every new financial instrument is a new contract. Can a review board really review and approve all of them in anything resembling a timely fashion? The only way I can imagine that they could do so would be to restrict financial instruments to a set of standardized forms. Issuers are allowed to change a few things--the interest rate, the time period, etc.--without needing approval. Changing anything else would require approval.

Yet this would almost certainly leave some value-increasing exchanges foregone. There must be some value in allowing new and different financial instruments that don't follow strict forms; they can't all be schemes and frauds. Arnold Kling would probably argue that we can do without the complexity and do fine with simple forms, but I'm no more comfortable with that than I am with governments deciding if an innovator like Apple should be able to issue stock.

My second problem with this kind of reform has to do with the FDA. Economists (particularly Robert Higgs) have long suspected that the FDA tends to be too reluctant to approve new drugs. The reasons for this are straightforward: The incentive to approve new drugs is low, and the incentive to deny them is high. If a drug is approved, and someone gets sick as a result, the public and Congress are going to blame the FDA. If a drug is approved, and it works wonders without getting anyone sick, then no one is going to sing the praises of the FDA. Furthermore, the people who could have been saved by a drug that is not approved are usually not a vocal interest group (a notable exception being HIV/AIDS victims), and their suffering is not visible to most of the public. As a result, the FDA tends to require drugs be tested for a long time before approval.

I would expect the same problem to occur with financial instruments. The regulatory approval body would have an incentive to reject most instruments, or at least subject them to lengthy reviews that delay their implementation (leaving many potential users of these instruments without them for some time).

To add my usual caveat, I'm not an expert in finance or macro, and my opinion on this subject is not as valuable as the opinion of such an expert would be.

Wednesday, April 28, 2010

Why Do Soccer Players Fake Injuries So Frequently?

I've often seen this question asked, and I don't think it's just an imaginary pattern. Here's my armchair economics-based analysis.

Real injuries in soccer are usually intensely painful, but brief (particularly shin and other lower-leg injuries--even with pads, they can still hurt). An injured player may briefly be in agony, but it ends quickly and the player can get back up.

This means that it can be difficult for a referee to tell a real injury from a fake one. If the referee is fooled, the penalty to the "offending" team is the same whether an injury is real or faked, so it pays to fake injuries. Furthermore, there's no disincentive to fake an injury--the referee is not going to penalize a team for trying to make the other team look guilty. Even if the referee wanted to do so, he'd have to use replays to reliably find the truth, and soccer fans cannot tolerate the delays that would be associated with replays. Maybe they could fine players after a game upon reviewing a recording of the game, but I suspect the fines would have to be really big to change player behavior.

So to sum up: In soccer, faking injuries is pretty much all benefit, no cost. Again, this is merely an armchair just-so story. I'd be interested in hearing other just-so stories, too!

Friday, April 23, 2010

Why Are Some Commercials Insulting to the Advertiser and Its Customers?

For example, there's the GEICO gecko's clueless boss (and his dumb ringtone), or the two idiots that sit in their car at Sonic--two examples of effective commercials. Then there are those annoying Progressive commercials with the completely unfunny woman at the counter; again, they make their customers and employees look dumb, but the effect is annoying. I guess my question is, why are companies so willing to look stupid and insult their customers? I don't mind; in fact, I think self-deprecation is endearing, but it still seems counterintuitive.

ADDENDUM: Upon further reflection, the relationship is more interesting than that. Commercials are more likely to be insulting to employees and customers if they are for companies that have direct interfaces with consumers--restaurants, car insurers, etc. Advertisements that speak in vague, positive generalities about companies come from companies that don't have much direct interaction with the customer (such as commercials from ADM or GE). Again, this seems counterintuitive. Shouldn't companies that are closer to their customers be less willing to depict customers as idiots, and less willing to portray themselves as awkward and stupid? Perhaps companies with a close relationship with consumers have goodwill that allows them to be silly, while companies without such relationships cannot afford to insult anyone.

This is all anecdotal; perhaps I'm just imagining things. 

Peel Back the Layers of the Marketplace Onion and it Still Stinks

I really don't like American Public Media's public radio show Marketplace. It's rife with bad economics. I once heard a show in which a reporter explained that the Federal Reserve has two tools for influencing the economy: interest rates and money supply. That's like saying there are two ways to drive a nail into a board: you can use a hammer, or you can use a stick with a metal head on it.

Last night while driving I heard the host of the show explain that there is a law against futures trading for onions in the U.S. I was excited because I had actually learned something new from this show that so frequently annoys me. I was delighted when the host pointed out that prices in the onion spot market are more volatile than in other agricultural markets. It turns out that both statements are correct, too.

Then, of course, I was let down, as the host said (and I'm paraphrasing) "It just shows that you never know what to expect from a market". This is an indication of incredible ignorance of economics. Increased volatility is exactly what economics predicts should happen if futures markets are eliminated. Why? Because futures markets allow people to bet on future prices. If I look at weather data and conclude that onions are going to be in short supply in three months, I can sell a promise to deliver onions then (at what will be a high price) and buy a promise from someone else to give me onions (at today's low price). The result is an increase in the demand for onions now, and an increase in the supply onions later. What happens to the price? It goes up now, and down in three months. Prices are smoother over time because speculating in futures markets allows planning for the future. It's intertemporal arbitrage. (This does not mean that speculative bubbles cannot occur; it just means that we should generally expect prices to be smoother over time.)

This is not a surprising result. Econ 101 students should understand this intuitively. It's disappointing that the creators of a much-listened-to radio show do not seem to understand this.

Tuesday, April 20, 2010

Economic Freedom and Government Requests for Data

Google has made available the number of requests for information and requests for removal of information that various governments made from July 1, 2009 to December 2009. I was curious what kinds of countries made various kinds of requests, so I plotted their Index of Economic Freedom score against their number of requests.

There are so few observations that's it's hard to say much. I had to throw out most of the removal request data because so many of them were classified as "less than 10" rather than specific number. It looks like there is a weak negative relationship, as one might expect--countries with lower rankings on the index of economic freedom made more requests. I suppose one could consider all sorts of variations on this, such as requests per capita. Maybe an industrious undergraduate could take a look at this. China is missing from this data, which leaves the U.S. with the most requests for data, and Brazil with the most requests for removal. Apparently Brazil's government requests lots of information from Orkut, which is a social networking site. Perhaps it's part of anti-drug investigations or some other criminal investigations. 

Friday, April 16, 2010

What If

I'm not a global warming denier; I accept the consensus view of climatologists that anthropogenic global warming is real. I am even willing to accept that it's worth doing something about.

It is my understanding, however, that the earth has been in a lengthy period of remarkably stable climate for some time, and that sometime "soon" (I'm not sure what that means in climatological terms--it could mean a thousand years from now as far as I know) we're due for some a cooling cycle. I can't find any nice summaries of the science on this, so let's just ignore my ignorance and suppose that we found out that global cooling was about to happen in the near future. Suppose also that this cooling would have serious implications for humans and for species around the world.

What would environmentalists want to do in this case? Would they be in favor of letting the world cool down, possibly leading to human suffering, and the extinction of many species? Would they be in favor of trying to warm the world somehow (not necessarily by increasing CO2 emissions--they might not like ocean acidification or some other side effect)? I don't know what their answer would be. Maybe different environmentalists would answer differently. I think the answer says something important about the opinions of the person answering, though.

I think economists would be in favor of doing whatever cost-benefit analysis supports, even if that means trying to manipulate global temperatures to avoid the costs of accommodating rapid climate change.

Wednesday, April 14, 2010

Art Carden and Others on The Myth of the Rational Voter

There's video up of Mike Munger, Art Carden, Randall Holcombe, Geoff Brennan, and Bryan Caplan discussing The Myth of the Rational Voter at the 2008 Public Choice Society.

Part 1

Part 2

Part 3

Part 4

Part 5

Art Carden makes a lot of points from our forthcoming piece in Economic Affairs, The Truthiness Hurts. You can read a pre-print version of it here. I was disappointed to see that Art didn't mention that my wife came up with the name for "Stick-It-To-the-Man Bias", but then, his time was very limited. In fact, the editor seems to have cut out some of his remarks (which is a shame, as I thought he was more interesting than the other speakers).

Sunday, April 11, 2010

A Research Project for an Industrious Undergrad: Discrimination in the Checkout Line

There's an interesting literature that attempts to measure racial discrimination. For example, I once read a paper that tried to determine whether basketball referees are harsher on players who are not of the same race (as I recall, they were).

Here's something that an industrious undergrad might be able to pull off (although he or she might need a partner). Go to a local supermarket and sit near the checkout lines. Record the gender and race of each employee in the checkout line and each customer that goes through the line (you probably ought to ask a manager for approval first). Also  record the number of people that go through each line in, say, an hour. Repeat this at some other grocery stores.

This data should allow one to determine:

  • Whether customers are more likely to go to an employee of the same race or gender than pure chance would predict.
  • How much customers are willing to pay, in time, to go through a checkout line operated by someone of the same race or gender (assuming a same-race or same-gender preference exists). That is, you can find out how much they are willing to pay to indulge their racism or sexism. 
There may be some confounding factors--self-checkout or express checkout, and the relative attractiveness of the employee, but I think it should be a fairly straightforward project.