Business & Economics: September 2003 Archives

Bill Hobbs points to a sad and sickening tragedy that happened in a Nashville nursing home last night.

Seven elderly people died in a fire at a Nashville nursing home late last night and 20 were critically injured from burns and smoke inhalation. The building had no sprinklers because it's an old building that was built before sprinklers were required by law. Okay. But what I want to know is: Why would a company that operates nursing homes put frail elderly people to live in a building without sprinklers? What were they thinking?

The answer to Bill's question is pretty simple: the owners of the nursing home predicted that they would make more money that way. The company must have thought that the chance of a deadly fire times the cost of such a fire (in damage and lawsuits) would be less than the cost of housing the elderly folks somewhere else or of adding sprinklers.

Of course, there's also the fact that the elderly people and their families should have noticed that there were no sprinklers in the facility. The absence of sprinklers lowered the safety of the facility's residents, and that lowered safety should have been taken into account by the company's potential clients. Maybe they didn't notice, but the opportunity was there, and a lack of sprinklers is easy to see if you're looking for it.

But most people probably wouldn't think to look for such a thing; most people are probably rationally ignorant about such safety concerns. That is, they are ignorant about such details on purpose, because it would be impossible for every person to know every possible safety measure that should be in place at a nursing home. Or in a car, or a plane, or anything. Because of this rational ignorance, people entrust the government with the responsibility of regulating certain aspects of life. The public can then rest assured that not everyone is ignorant, and that in fact there are some people who dedicate their careers to ensuring the safety of old people in hospitals.

It sounds like the building in question did satisfy the existing regulations. Perhaps the tragedy that occurred is an acceptable loss to society, perhaps not. That's what democracy is about. I expect the relevant regulations in Nashville to be strengthened, if this tragedy gets wide coverage.

One of the consequences of capitalism, and freedom in general, is that each individual bears the majority of the responsibility for their own welfare. In a socialist society, no one is responsible for anything -- everything is provided by the state. The system breaks down, though, because when no one is responsible, no one does anything. There's no incentive.

On the other hand, in a free society everyone is responsible for themselves. If you don't have any food, you have to get a job. Sure, someone might be charitable towards you, but there's no legal obligation for anyone else to support you. In a totally free society, anyone could build a home for old people however they wanted, and each potential client would be wholly responsible for verifying the safety of the establishment. Same for restaurants and their food, and for cars, &c. The benefit of such a society would be that you could open any type of business you wanted, and you could pretty much do whatever you wanted to do -- as long as you were willing to face the potential consequences afterwards.

But you might find yourself spending most of your time testing every hamburger you eat for E. coli, since there would be no regulations to protect you. A free society may be able to take corrective action through lawsuits after a problem (such as a fire in an unsafe nursing home), but there would be little it could to to prevent such problems.

It's pretty easy to see that some non-zero level of regulation is beneficial to society. Where is that level? That's where capitalists and socialists disagree. Personally, I'm happy to know that the food I eat has been prepared to some minimum health standard, and that I'm not likely to get sick and die. Sure, most restaurants might cook good food anyway, even without regulations (it's good for repeat business)... but then, one might expect most nursing homes not to burn down, either.

I love Tradesports and the market it represents. Who is more likely to know the odds for any particular event than people who've got money riding on it? They've got a section for betting on politics, and I like tracking the action; when the volume is high enough, I think that these odds give a good representation of reality.

Let's take a look at a few interesting samples. Note that with perfect information, the "Bid" column would add up to 100%, since the contracts for each question are all mutually exclusive. They generally don't, and they usually add up to less than 100%; this reflects that the bettors are conservative with their uncertainty, and are bidding less than they think the contracts are actually worth. (The opposite holds for the "Ask" column.)

[I've never bet on Tradesports, and am not affiliated with them in any way.]

First up, the question on everyone's mind: what's going to happen with the California recall?

For some reason, Bustamante's odds have gone up significantly today -- in anticipation of the debate tonight? Arnold has improved slightly, and the big loser has been the "Recall Fails" contract. High trade volume -- it's not looking good for Davis. Expect some action here after the debate.

Next question: who will be the Democrat nominee for president?

Too bad I didn't get a screenshot of this question last week, because the "Field" contract skyrocketed when Wesley Clark declared his candidacy (and Hillary jumped a bit, too). Both "Field" and Hillary are falling as Clark's shine wears off, but Dean doesn't recover any of the ground he lost when Clark declared. Very high trading volume on all the contracts except McCain.

And finally, will George W. Bush win the 2004 presidential election?

High volume, and no change. In fact, this contract hasn't changed much in value since I've been watching -- it's been around 66% for months. I wonder if this constancy speaks more loudly than his fading poll numbers?

Polls and bets reflect different things, though, and it's important to keep that in mind. A poll shows what percentage of people (for example) want President Bush to win, whereas these contracts show what percentage of people think Bush will win.

As a new home-owner, it's nice to read from Bill Hobbs that the recent surge of house construction hasn't created a "real estate bubble". In the early 1990s, Southern California property value was depressed pretty severely due to an over-supply of new houses being built by developers on speculation. Buyers didn't materialize, and new houses sat vacant for months, pushing down the prices of real estate all across the state. So are all the new homes being built now creating a similar effect? Apparently not.

The most recent Census Bureau numbers show one key measure of new homes available for sale as low as it's been at any time in the last 40 years — a 3½-month supply at the current sales rate.

Homeowners can take some comfort from that. The biggest regional housing busts of the last 25 years — Texas in the 1980s and Southern California and the Northeast in the early 1990s — shared a common characteristic: a huge number of unsold new homes that depressed home values for everyone. As the Texas real estate market was about to tank, for example, the supply of unsold new homes nationally stood at a record high — nearly 12 months' worth.

Before I bought my house in the South Bay (south of LAX airport, in Los Angeles) I considered buying in the Westside, but decided against it partly because of this fear. Real estate values in the Westside had risen about 70% in the 18 months before I was looking to buy, and I thought it would be ridiculous to jump into a market like that. Plus, thousands of new apartments and condos were being built in nearby Playa Del Rey at an old industrial site. I don't expect the Westside to start appreciating significantly soon, especially considering that interest rates are going to rise for a while.

There is also new residential construction planned on the current site of the Los Angeles Air Force Base (near where I live), and I am concerned about the effect those additional units may have on local property value. Hopefully the generalities in this article will apply to this specific circumstance.

College students should borrow as much money as they can get their hands on. It's possible to take out student loans now from Sallie Mae at around 3% interest or less, and you don't need to make any payments until you graduate. I know several beginning freshmen who are wary of going into debt, but there are many compelling reasons to do so.

First, borrowing money at 3% is literally free money. You can drop it in a mutual fund until you graduate, pay the loan back, and keep all the capital gain for yourself. Even if you're afraid the stock market is going to crash again, you could make money on 5 year treasury bills (remember, no payments until graduation, and often no interest).

Second, the time of an average college freshman is worth little more than minimum wage. Some 19-year-olds I know are working two jobs, day and night, for a couple hundred bucks a week, rather than borrowing money and working one job. It hurts their performance at school, and leaves them perpetually tired and busy. If they were to borrow a few thousand dollars a year, the payments they would eventually have to make on the loan would be trivial -- their salary after graduation will be substantially higher than minimum wage.

Both of these factors are caused by the difference between the value of the time of a high school graduate, and the value of the time of a college graduate. To an employer, the time of a college graduate is worth far more than the time of a high school graduate; to the student in question, their time is best spent on their highest priority activity -- school, and then work after graduation. By borrowing money, the student can trade an hour in the future for 2, 3, 4, or more hours in the present.

Such trades could lead to better performance at school, more leisure time, a better social life, and any number of other benefits that may even translate into higher earning potential in the future. What's more, the student could die before graduation, thereby gaining full use of this extra time without paying a penny for it.

Tyler Cowen over at the Volokh Conspiracy gives some reasons why movies don't cost more on a Saturday night. But, in Los Angeles at least, they often do.

There are many theaters in Los Angeles that have variable ticket prices for different movies on different days at different times. Prices for different movies at the same time and day can be different, as can prices for the same movie on different days at different times.

Two examples are The Bridge in Westchester, and the ArcLight in Hollywood. At each there is a large scrolling display screen that gives the current ticket prices for each upcoming movie showing. It can be confusing, and most of the time you don't know how much a movie is going to cost you before you arrive (yeah yeah, unless you do research).

All of these theaters have student tickets, however, that provide quite substantial discounts and address some of the price effects that Tyler mentions. For example, a Friday night movie at The Bridge might be $15 normally, and $8 for students.

This may be old hat, but I had an interesting thought about the interplay between the concentration of wealth and fertility. It's well-known that as people get richer they tend to have fewer children, and to have them later in life. The natural result of this correlation is that over generations, wealthy families will dilute their resources much more slowly than average and poor families.

(Of course, many poor parents leave nothing to any of their children, but ignore the technicalities for the moment. There is probably a threshold level of wealth that must be met for children to receive anything from their parents, and the existence of such a threshold would further heighten the concentration of wealth effect.)

For example, consider two families, A and B, with equal wealth but differing fertility. Family A has 2 children every 33 years, and family B has 3 children every 25 years. After 100 years, the latest generation of family A will have 8 members (2*2*2), and the latest generation of family B will have 81 members (3*3*3*3). The wealth of the progenetors of family A will be far less diluted than the wealth of the progenetors of family B.

After 100 years, the aggregate wealth of family B may be greater than that of family A, simply due to its greater number of productive members. However, assuming that any member of either family is able to generate an equal amount of wealth on their own through working, the difference in wealth between any two individuals will be attributable to what they inherited from their ancestors. The concentration of wealth for family A will certainly be greater, and each individual member of A will be wealthier than each individual member of B.

Additionally, the members of these families will probably not care about their family's aggregate wealth, especially in the case of family B where the 81 great-great-grandchildren are unlikely to even know each other, much less be willing and able to wield their combined wealth toward any profitable end.

Aside from every other social and economic factor that encourages the concentration of capital, it appears that simple arithmetic creates a positively reinforced cycle that leads to the concentration of wealth. Even assuming equal-wealth starting conditions, differences in fertility will lead to differences in wealth, over time.

It looks like the music industry is starting to face reality: the optimal price for its product has fallen. Universal is cutting its wholesale price and pushing retailers to cap prices at $12.98 per CD.

Universal hopes the actual retail price of most of its CD will end up about $10 or less, comparable to the $9.99 retail price (search) that music fans enjoyed in the early 1990s, at the height of a price war between the recording companies. ...

Universal's current wholesale price for a CD album is $12.02, with a manufacturer suggested retail price of $18.98. Under the new pricing structure, the wholesale price would be $9.09.

I wonder if the music stores will go for it? Such a pricing scheme would cut their profit from $6.96 per CD to $0.90 -- if these numbers are correct -- and it's hard to imagine volume increasing by the (at least) 700% required to make up this marginal revenue difference.

The world's largest recording company hopes retailers, who have suffered as industrywide music sales dropped 31 percent the last three years, will follow its lead and pass on the savings to consumers. ...

"Our new pricing model will enable U.S. retailers to offer music at a much more appealing price point in comparison to other entertainment products," said Jim Urie, president of Universal Music & Video Distribution. "We are confident this pricing approach will drive music fans back into retail stores."

Well, I don't know about that, but it's certainly a good start. Simple economics has finally forced the music industry to adapt to the changing market; these drastic price cuts reflect their reluctant understanding that their stranglehold on music production and distribution is weakening.

The recording industry blames its sales slump largely on illegal music swapping over peer-to-peer networks and is expected to take legal action against hundreds of suspected file-swappers this month.

But industry critics say the record companies have, for more than a decade, ignored the effects of soaring CD prices on sales. They also contend the artistic quality of music has deteriorated.

"This is something that the industry has failed to address ... You could make downloading music go away tomorrow and the industry would still face challenges," said Sean Baenen, managing director of Odyssey, a consumer marketing research firm in San Francisco.

"All the data suggests that quality and price are major factors to the equation."

Not only that, but anyone who's been watching the stock market for the last few years should realize that music sales aren't the only thing that's been down 30%. Get a grip folks; even if file sharing has cut into your revenue (which is debatable), it's certainly not the only factor.

On another music-related note, I went to see Eleventeen at the Troubadour last night, and they were predictably awesome. The played a short set, but from what I heard it's because there were label scouts in the audience and the band only wanted to play their best stuff. There were also an extraordinary number of beautiful babies in the crowd -- possibly also due to the label presence. To the girl in the blue t-shirt and red hip-huggers: I love you.

I expect that in the future, most bands will reap most of their revenue from touring and performing live shows, and that they'll end up giving recordings of their music away for free. The social construct of intellectual property is on the decline, and I expect it to largely fade away as technology makes it ever-easier to share bits and bytes of raw, digital data. I'm not saying this is good or bad, but I think it's inevitable. The music industry as we know it may be the first major victim of this societal sea change, but it won't be the last. Movies, even books, will be forced to make more of their money from presentation rather than content -- at least as long as people are required to physically change location to engage in certain experiences.

Essentially, technology enchances competition, and that increased competition will drive profit and prices down, across the board.