Business & Economics: July 2006 Archives

The New York Times has an article by Damon Darlin about how foolish consumers subsidize sophisticated consumers. The piece is pretty vague, but the idea behind it is one that I do my best to take advantage of in my business dealings.

The two economics professors — Mr. Laibson at Harvard and Mr. Gabaix at the Massachusetts Institute of Technology and Princeton — have looked at how companies hide fees and costs. They found that sophisticated consumers have somehow learned how to game the system by having enough naïve consumers around to subsidize them.

The smartest strategy, they say, is for the sophisticated consumer to choose the service with the most hidden charges and highest add-on prices, but then avoid paying those added costs. "The sophisticated consumer takes advantage of that," Mr. Gabaix said. "The naïve pay all the fees." ...

For example, you see an offer for a room at Nontransparent Hotel for $75 (which costs the hotel $100 to provide). The guy checking in behind you also rents a room, but will rack up $70 in fees from the minibar, the phone and garage parking (all of which cost the hotel $20 to provide). You, on the other hand, were not tempted by the minibar, used your cellphone for calls and took public transportation to the hotel. The other guy subsidized your room.

Smart consumers now have a strategy. They should go to the company offering the discounted product even if the company has loads of hidden fees. The sophisticated consumer then exploits the company by taking the below-cost product and shunning the fees. "It’s a perpetual battle between the firm that fools consumers into paying fees and the smart consumer who can avoid them," Mr. Laibson said.

Every time I call a creditor -- be it a utility, cellphone provider, credit card company, or whomever -- I always ask them to waive fees, cancel charges, or upgrade my service for free. Most of the time they will. I get new, free, top-of-the-line phones from Cingular all the time, and I get interest rate reductions and fee waivers from my credit card companies several times a year. Ask and thou shalt receive. Plus, I never pay the outrageous prices for food from hotel minibars or movie theaters.

(HT: Sound Mind Investing Blog.)

Pete Du Pont has a great editorial detailed the ways in which tax cuts benefit everyone.

Mr. Bush signed the most recent tax cuts into law in the spring of 2003. In the past 33 months the size of America's entire economy has increased by 20%--or, as National Review Online's Larry Kudlow put it, "In less than three years, the U.S. economic pie has expanded by $2.2 trillion, an output add-on that is roughly the same size as the total Chinese economy."

In the 2 1/4 years before the 2003 tax cuts, economic growth averaged 1.1% annually; in the three years since it has averaged 4% per year, and in the first quarter of this year it was 5.6% on an annualized basis. Inflation-adjusted per capita GDP has grown 7.8% from 2003 through the first quarter of this year.

According to the government's establishment survey, in the 36 months since the tax cuts became law, 5.3 million new jobs have been added to the economy. According to its employment survey, 288,000 jobs were added in May and 387,000 in June. The unemployment rate dropped from 6.1% when the bills were signed to 5.4% at the end of 2004 and 4.6% today, and the rate has gone down for men, women, blacks and Hispanics. Hourly wage rates for workers are up 3.9% in the past year, and they increased at an annualized rate of 4.6% in the second quarter of this year, the highest quarterly rate in nearly 10 years.

Incomes are up too. As Stephen Moore noted in The Wall Street Journal, "the percentage of Americans earning more than $50,000 a year rose from 40.8% to 44.2%" between 2002 and 2004. As for very wealthy families, the portion of total income "captured by the richest 1%, 5% and 10% of Americans is lower today than in the last year of the Clinton administration."

All this has been good news for the government. Federal tax receipts increased by 15%-- $274 billion--last year and 13%-- $206 billion--in the first nine months of this fiscal year, which, as the Journal points out, means the nine-month increases for the past two years represent the highest growth rates in 25 years. Looking ahead to the end of this fiscal year, total inflation-adjusted government receipts will likely be 23% above 2003 when the Bush tax cuts were signed into law.

Reducing the capital gains tax rate from 20% to 15% increased capital gains tax receipts by 79% from 2000 to 2004. Cutting the dividend tax rate by more than half--from 39.6% to 15%--increased dividend tax receipts by 35% from 2002 to 2004. And corporate tax receipts have nearly tripled since 2003, reaching $250 billion for the past nine months, 26% higher than the same period last year.

So why have Democrats promised to "roll back President Bush's tax cuts" (i.e., increase taxes) if they're elected in November? Because the Democratic party can only survive when people are forced to depend on the government; when people can provide for themselves, they don't need leftist "compassion". The Democrats have a vested interest in keeping as many people as poor and as dumb as possible.

The ongoing nationwide power distribution crisis is a perfect illustration of how monopolies can hurt consumers.

LOS ANGELES · Days of tropical heat and humidity have driven demand for electricity to record highs in California and other states. If people can't take the weather anymore, neither could transformers and other equipment, which sputtered and shorted out and left tens of thousands of people without power.

Authorities issued a warning Monday that the high demand could lead to rolling blackouts, a dreaded term in California that brings reminders of widespread blackouts in 2000 and 2001 during an energy supply crisis.

In other parts of the country, thunderstorms have compounded problems, leaving hundreds of thousands of people in the St. Louis area without electricity since Wednesday. Thousands of people in Queens, N.Y., entered the second week without power after equipment failures there at one point left about 100,000 people without electricity.

Unfortunately, because power distribution (and to a lesser extent, power generation) is typically a "natural" monopoly, there isn't much that can be done to improve the situation over the long term -- i.e., this just about is the best we can do.

In economics, a natural monopoly occurs when, due to the economies of scale of a particular industry, the maximum efficiency of production and distribution is realized through a single supplier.

Natural monopolies arise where the largest supplier in an industry, often the first supplier in a market, has an overwhelming cost advantage over other actual or potential competitors. This tends to be the case in industries where capital costs predominate, creating economies of scale which are large in relation to the size of the market, and hence high barriers to entry; examples include water services and electricity. It is very expensive to build transmission networks (water/gas pipelines, electricity and telephone lines), therefore it is unlikely that potential competitor would be willing to make the capital investment needed to even enter the monopolists market.

It may also depend on control of a particular natural resource. Companies that grow to take advantage of economies of scale often run into problems of bureaucracy; these factors interact to produce an "ideal" size for a company, at which the company's average cost of production is minimized. If that ideal size is large enough to supply the whole market, then that market is a natural monopoly.

Some free market-oriented economists argue that natural monopolies exist only in theory, and not in practice, or that they exist only as transient states.

Natural monopolies should generally be closely regulated by the government for the best possible performance, but just imagine how awful every other sector of our economy would be if they were similarly under centralized control! Thankfully, most other industries aren't natural monopolies and thrive under competition, not regulation.

California tried deregulating its electrical distribution and generation in the 1990s, but the plan was really only partial deregulation since it set a ceiling on the price producers could charge customers; as you can imagine, the plan led directly to California's power crisis in 2000 - 2001. I believe that some other states have tried deregulation with more success, but there's going to be a limit on how well competition can work for natural monopoly industries in "small" markets.

Ok, so you're all heard the saga about the house we bought, but didn't, and since all the checks have cleared and we've gotten our money back now, here's the list of people I strongly recommend you don't deal with if you're ever interested in St. Louis real estate.

Dilla Goedert was the "experienced" listing agent for the sellers, and probably the most dishonest. She didn't disclose a lawsuit that directly affects the value of the property, and she pulled the purchase price out of thin air. Before the appraisal came in she repeatedly tried to get us to waive our appraisal contingency, fully aware that the house would appraise for $50,000 below asking. The appraiser was so disturbed by Dilla's behavior that she wrote a letter to Dilla's boss. Dilla also apparently lied to us about having an "all cash" backup offer that prevented her from lowering the price of the house down to the appraisal value; since the house is still on the market and there's an open house tomorrow, I'm assuming the all cash offer never existed. I hope Coldwell Banker Gundaker takes some disciplinary action against her.

Then there's Barbie Porter and her husband Bruce. Bruce owns Quality Renovations (no website), the company that bought the house and renovated it. The renovations acctually looked like they were well-done, despite being a little on the cheap side. Unfortunately for the Porters, they put too much money into 5 Berkshire Dr. and now need to sell it for far more than it will appraise for just to break even. That's a shame, but don't be the one to buy their mistake! The Porters weren't dishonest in my interactions with them, but they hid behind Dilla so there's no real way for me to know.

Jerry Bower has a reasonable explanation for why high gold (and other commodity) prices may not indicate imminent inflation.

Here's a good fundamental question: why gold? The point of a gold standard currency is to keep governments from cheating their citizens. This goes all the way back to Moses: "a just weight and measure thou shalt keep." Paper can be produced in nearly infinite supply, electrons even more so, but gold is scarce. The basic case for gold is that we get better at producing it at about the same pace that we get better at producing everything else. In other words, our gold output usually grows at about the same rate as our everything-else output. There's the rub: usually. However, sometimes gold -- and other commodities -- grow at different rates than the rest of the economy.

From the 16th century to the 18th century, gold came flooding into Europe from North America. Explorers discovered the Western Hemisphere, plundered the Indians' gold supplies, and shipped boatloads of the stuff back to Europe. Because of exploration and (then) modern shipbuilding, the European economy got much more efficient at gold 'production' than at everything else. So, even countries with a gold-based monetary system were hit with many years of inflation. Their money supply grew more quickly than their economies.

I think that we currently face the opposite scenario. We're not much better at getting gold out of the ground than we were last century, but we're much better at getting wealth out of electrons. Our economy can now grow at a faster pace, by far, than the mining industry can. Our economy now grows faster than our gold supply. This means that gold prices, reflecting gold scarcity, will be an imperfect messenger.

Sounds right to my naive intuition. I'd guess that unlike times past, a good proportion of American wealth is stored intangibly, in things like education (degrees, experience, specialized knowledge) and intellectual property. We're producing knowledge-wealth at an exponentially increasing rate, and the production of gold simply isn't keeping up.

So, how can I make money if it appears that many people are expecting inflation to go up, but I don't think it will? Are there any investment instruments I can use to profit from this situation?

(HT: Larry Kudlow.)