Understanding Apple's platform strategy: A little theory can help

Today is the first day of the Worldwide Developer’s Conference (WWDC), Apple’s annual effort to both inform and excite its ecosystem of third-party providers. As with any conference, it’s also a chance to get together with friends, old and new, particularly at parties thrown by companies that want to improve their visibility to the developer attendees.

I remember in 1988 going to my first WWDC in San Jose: our company was so poor that the two cofounders (Neil and I) had to split a single pass to be able to have any presence at all. My last WWDC was in 2003, as my company neared its end, and I went to meet with a former employee who was in town for the conference. The conference is capped at 5,000 developers, but rather than use price to discourage demand (as do most media companies), since 2014 Apple has used a lottery system to allocate seats to registered developers.

Since the early years of the Jobs II era (1997-2011), WWDC has been used to make important product and technology announcements for the broader public. As such, it also gives the business press to take another junket to San Francisco and write their annual (or quarterly) pontifications on the state of Apple, its products, market position, competitive advantage, business model, stock price or anything else.

One article caught my attention on Twitter this morning:

Apple's True Strengths Don't Lie in Innovation
By Christopher Mims
Wall Street Journal, 13 June 2016, p. B.1.
…Apple's normally festive Worldwide Developers Conference begins Monday under something of a pall. The company's first quarterly sales decline in 13 years has many people asking whether it will grow again. They also want to know how Apple, with its healthy supply of cash, could make that happen.

The conventional answer is "create a totally new product line," or its cousin, "unveil something no one has done before." That is, Apple should try to out-innovate its competitors.

That is a terrible idea. It runs counter to Apple's strengths, as well as its growth trajectory.

Here is why: Apple's core strengths are the scale of its ecosystem -- the company says it has more than one billion active devices world-wide -- and the spending power of their owners.

As someone who’s studied the theory of standards wars for two decades — and Apple’s practice of standards wars for three decades, and wrote the most-cited paper on Apple’s iPhone strategy — this seemed somewhere between foolish and idiotic.

But if you dig a little deeper, what the columnist (who seems prone to exaggerating for effect) really is doing is playing a semantic game. The language of "innovation is bad, no innovation is good” would be more accurately summarized as “risky radical innovation is bad, continuous incremental innovation is good.”

The author states

Apple is expert at offering a more polished, more accessible version of products and services that rivals have offered for years. And yet, it reaps over 90% of the smartphone industry's profit, and in 2015 its App Store delivered 75% more revenue to developers than Alphabet Inc.'s Google Play store.

If you look up “innovation” in the Oxford English Dictionary, the very first definition is:

1a. The action of innovating; the introduction of novelties; the alteration of what is established by the introduction of new elements or forms.

In other words, by offering a superior (and unique) version of a now standard product category, Apple is following the dictionary definition of “the introduction of new elements of forms.”

Meanwhile, any MBA who’s had a decent competitive strategy class can tell you that if you have a better product — and consistently superior profits — then you have successfully created some form of sustained competitive advantage that has survived efforts by your rivals to compete away that advantage and those superior margins.

Perhaps this confusion is because the author has an undergraduate neuroscience major but no business degree.

But once we get away from the terminology problems, I did find one paragraph that seemed both factual and prescient:

In any case, I think it will be many years before mobile is toppled as the dominant platform. The PC ruled for nearly 30 years, and we are less than a decade into the age of the iPhone.

I don’t agree with the conclusion that Apple (or Google or Facebook) shouldn’t pursue related diversification. However, I do agree that it must feed and harvest its mobile “cash cow” (as BCG defined it 45 years ago) while continuing to search for new growth opportunities.

As an Apple shareholder, I’m disappointed at the loss in price and market cap over the past year as it lost its growth multiple. But I still think there’s enough of the company’s DNA (even after the loss of its visionary founder) to propel it to new growth as it finds a way to meet needs unmet by its many competitors and imitators.

Economies of scale and specialization in giving thanks

Today is the day that Americans give thanks for (as President Lincoln first proclaimed in 1863) “the blessings of fruitful fields and healthful skies.” Over the next 150 years, 28 successive presidents issued their own proclamations marking this most American of holidays.

When we lived in Silicon Valley, five years ago we hosted a Swedish researcher and his wife visiting Stnaford through the beneficence of a Scancor post-doctoral fellowship. As a homework assignment, I assigned him to “Consumption rituals of Thanksgiving Day,” an exemplar of interpretivist consumer behavior research that I was assigned to read in my PhD marketing seminar. (One of the four students from my cohort became a scholar in this tradition, writing “Religiosity in the abandoned Apple Newton brand community” that earned more cites more quickly than the earlier paper.)

Today we are hosting the extended family’s Thanksgiving feast, with our household of four being joined by 23 others, representing a total of 11 households. Five of those households are singletons (and thus some don't cook) so we have seven households bringing side dishes, desert and other items.

I jokingly said in an email this morning that we’d crowdsourced Thanksgiving dinner. Upon further reflection, that’s not strictly true because we’re not leveraging the “wisdom” of crowds. Instead, it seems more of an example of economies of scale and specialization.

Yes, it’s more work for my better half to cook 30 lbs of turkey than 15, or to make 123 rolls instead of 30. However — from watching my mom make the whole scratch dinner for years — it is far less work if you don’t have to make the mashed potatoes, salad,and (especially) pie the same day you’re making turkey.

So here with our family pot-luck we’ve re-derived the basic principles of barter and trade that were developed by human society thousands of years ago. We will give thanks for the economic and material comforts that such exchange has made possible for us, both in our own family, and in our community, nation and the global economy as a whole.

Favorite quote of the month

Oct. 11 will bring news of the latest winner of the Sveriges Riksbank Prize, endowed by the Bank of Sweden but branded as the “Nobel” prize in Economics Sciences.

As with previous years, there is betting on who will be this year’s winner. To me there is no obvious front-runner as there was last year with Oliver Williamson and his long-overdue prize.

Harvard Economist Greg Mankiw notes two places to find your pool of candidates: a list of top-cited academics (in all the Nobel fields) from Thomson-Reuters, and the REPEC ranking of most cited economists.

However, my favorite quote on the topic (and in fact on any topic this month) comes from Mizzou economist Peter Klein:

It is said that when the Nobel Prize in economics was first established, prizes were given for using economics to teach people things they didn’t already know, e.g., that economic growth might increase inequality, that depressions are caused by central banks, that macroeconomic stabilization policy doesn’t work, etc. Now, prizes are given to economists who teach other economists things that regular people already know — politicians are self-interested, you shouldn’t put all your eggs in one basket, institutions matter, different people know different things, etc.

Ouch. How do you top that for cutting to the heart of the matter?

Beggar thy neighbor day

Except for those who have been living under a rock, almost any American knows that today is the Census enumeration day, as provided by Article I of the Constitution. At $14 billion, it will be the most expensive Census in history, more than double that of the 2000 census. Of that, $340 million is being spent on advertising and other promotional efforts, including a $2.5 million Super Bowl ad.

As a social scientist, I certainly sympathize with the desire to make the Census as accurate as possible. (Lacking a $14 billion research budget, we academics normally accept a certain amount of imprecision as unavoidable.) And, given that Democrats are in control of two branches of government — and the assumption that uncounted residents are disproportionately in Democrat-leaning districts — it was inevitable that Obama would do everything it could to count every last person.

However, the advertising message has emphasized a “beggar thy neighbor” approach: that people should respond in their narrow parochial interests to win a zero-sum allocation of Federal tax dollars. After dissecting the quirky ad scripts, Advertising Age went straight to the hart of the problem.

There's one issue with the campaign that confounds us, too -- maybe not so glaring, but ultimately more serious. Namely: the premise. In more than 100 pieces of communication in 28 languages, the campaign tells people to fill out the census form because it could mean increased funding for their communities. "We can't move forward till you mail it back."

Oh, really? That proposition is a half truth. The federal-budget allocation is a zero sum game. Yes, the census largely determines who gets more money. It equally determines who gets less money. To present it as unlocking better roads and smaller classrooms for all is just dishonest. Even state lotteries are more candid. What they say is, "You've gotta play to win."

Nothing in the Census contributes to economic growth — or even the availability of funds to disperse to the local governments. It’s just about saying “I want mine, and the government should give it to me” — a perfect metaphor for efforts to increase Nanny State dependency.

Economists, Competition and Regulation

The role of economics in antitrust regulation — and the political shifts in regulation under the new administration — was the topic of a great panel early Friday morning at Santa Clara University. It was hosted at the school’s High Tech Law Institute, which is wonderful (and woefully under-appreciated) in running a series of technology seminars for free. (The only other comparable venue is the SVPVS, but those sessions are often too technical for a business audience.)

The formal title was “Antitrust Policy a Year into the Obama Administration: What have we Learned? What's Next?” The main attraction was Carl Shapiro, one of five assistant deputy AGs (and chief economist) of the Antitrust Division of the Department of Justice. Shapiro — the Berkeley economist who co-authored the most famous text on standards competition — has been at DOJ for 12 months, in exactly the same job he held previously in 1995-1996 during the Clinton Administration.

The two other major speakers were (ironically) on the opposite side of the major technology antitrust case of the 1990s, US v. Microsoft. Stanford prof Tim Bresnahan (who held the same job from 1999-2000), while Greg Sivinski is a senior antitrust attroney for Microsoft. (A Santa Clara law school prof made some insightful and succinct insights into standards and antitrust, while a private attorney went on a rant about losing court efforts to destroy Rambus’ patent until the moderator finally shut him down.)

Bresnahan and Shapiro note that there are about 60 antitrust economists in both the DOJ and the Federal Trade Commission. They work alongside the many more lawyers in these divisions: as he joked, when something comes into the division, a spreadsheet goes to the economists and the memoranda goes to the lawyers. Most of the hours are put reviewing large mergers ($63+ million in sales) under the provisions of Hart-Scott Rodino.

Dating to the 1890 Sherman Antitrust Act, the whole idea of competition policy is for the law to prevent anti-competitive behavior. While the lawyers worry about evidence, law and precedent, the economists are necessary to predict whether some future action (such as a merger) will have an anti-competitive effect.

Both Bresnahan and Shapiro note that identifying anti-competitive actions is relatively straightforward for horizontal mergers between discrete 19th century-style industries (such as aluminum cans). It is much more difficult in high tech, Silicon Valley-type industries, where there is a wide range of substitutes, complements, and buyer/seller relationships.

As Bresnahan said, “In high tech industries, it’s quite difficult to figure out what the scope of competition is.” When considering whether a combination is anti-competitive, he said the core question is “if they raise price, reduce quality or innovate more slowly — would there be third firms not involved in the merger who could take that business right over.”

What was most striking about the session was the unanimous agreement that for most antitrust cases, the difference between US administrations — notably Clinton, Bush and Obama — are miniscule compared to the differences between the US and Europe. Shapiro notes that in the name of transparency (and efficiency‚ the ATD is working to update (codify) its written merger guidelines — capturing the policies used across these three administrations.

For example, Bresnahan citied a visit to early Bush-era DOJ lawyer, who complained that firms expected a dramatic switch in policy in the Bush administration. Later on, when an audience member complained about Bush settling US v. Microsoft, Bresnahan quipped: “The Gore administration would have settled it too.”

The one place where elections matter is Section 2 enforcement under the Sherman Act — anti-competitive actions not involving a merger: single-firm anti-competitive behavior. These are much more discretionary, under the control of political appointees.

On the other hand, differences between the US and EU are sizable. Some of it is about priorities and values — e.g. the 1930s era German antitrust law that favors small mom & pop shops.

However, the speakers concluded that the most significant differences are in process. US antitrust regulators are more cautious, because they know they have to convince a third party (a federal judge) that their case meets the written legal requirements. At the European Commission, the DG Competition does not face those constraints, but instead serves as judge, jury and executioner — or, as the Economist termed it last month, is an “Unchained watchdog.”

All the speakers agreed that the problem of multiple jurisdictions is only getting worse. A decade ago, it was only the US and EC, but now many other medium-sized countries think they’re entitled to assert extra-terrirorial jurisdiction over mergers and other actions by US firms. (Witness the various countries piling on to tax Intel.)

I must admit, I’ve been much more impressed with the ideas (if not the practice) of antitrust under Democrats than Republicans over the past 17 years — in no small part due to their use of some of the smartest antitrust economists around to lead their efforts. Shapiro’s boss, Assistant AG Christine Varney, is out giving speeches evangelize American ideas of process transparency, evidence-based enforcement and international cooperation in competition policy. This to me seems like a very good thing.

Illustration by David Simonds, from February 18, 2010 issue of Economist.

Paul Samuelson, 1915-2009

From the front page of Monday’s New York Times:

Paul A. Samuelson, the first American Nobel laureate in economics and the foremost academic economist of the 20th century, died Sunday at his home in Belmont, Mass. He was 94.

His death was announced by the Massachusetts Institute of Technology, which Mr. Samuelson helped build into one of the world’s great centers of graduate education in economics.

In receiving the Nobel Prize in 1970, Mr. Samuelson was credited with transforming his discipline from one that ruminates about economic issues to one that solves problems, answering questions about cause and effect with mathematical rigor and clarity.

Samuelson was a key JFK economic advisor and won a National Medal of Science from Bill Clinton. He built a braintrust of (mostly) Keynsian economists at MIT, including seven other winners of the Sveriges Riksbank Prize in Economic Sciences. Samuelson won only the second “Nobel” prize in economics, starting a domination of the field by Americans (and more specifically Cambridge, Mass. professors).

I knew he had the best-selling economics textbook, but the NYT said it was the best-selling textbook of any kind for almost 30 years. In the late 1990s, it was selling 50,000 copies a year — clearly one of the most lucrative textbook franchises of all time.

The NYT portrays him as the anti-Friedmanite, but one who apparently recognized some of the limits of his Keynseian worldview:

The experience of nations in the second half of the century, he said, had diminished his optimism about the ability of government to perform miracles.

If government gets too big, and too great a portion of the nation’s income passes through it, he said, government becomes inefficient and unresponsive to the human needs “we do-gooders extol,” and thus risks infringing on freedoms.

One thing I found extremely encouraging from the NYT account is that he kept egos in check at MIT, leading by example with his personal humility. Based on my experience of the last 15 years, humility is in scarce supply among academics — particularly successful ones.

Nobel experiment

Economists and author Steven Landsburg notes the economic ignorance displayed by a well-known NYT columnist:

It’s always impressive to see one person excel in two widely disparate activities: a first-rate mathematician who’s also a world class mountaineer, or a titan of industry who conducts symphony orchestras on the side. But sometimes I think Paul Krugman is out to top them all, by excelling in two activities that are not just disparate but diametrically opposed: economics (for which he was awarded a well-deserved Nobel Prize) and obliviousness to the lessons of economics (for which he’s been awarded a column at the New York Times).

It’s a dazzling performance. Time after time, Krugman leaves me wide-eyed with wonder at how much economics he has to forget to write those columns. But today’s, on why America should consider European-style employment protection, is his masterpiece.
…
[E]xactly which brilliant European policies does Krugman believe the U.S. should now consider with favor? Among others, labor rules that discourage firing and incentives for “short-time work schemes”, where everybody puts in fewer hours. You’ve got to admire the effort it took to get from Nobel-quality economic analysis to the sort of stuff that economics professors around the world work so hard to drill out of their less talented freshmen.

If you want to increase employment by making each worker less productive, there are lots of ways to do it besides short-time work schemes. Instead of making them work half-days, we could require all manufacturing workers to work with one hand tied behind their backs. Or we could really handicap them by filling their brains with nonsense. Krugman to the rescue!

The latest in outsourced economic criticism, as a cost saving measure in these difficult financial times.

This year's Nobel prize

An unusual duo are this year’s winners of the “Nobel” prize in economics (from the Bank of Sweden).

Oliver Williamson has been “future Nobel Prize-winner” since I entered grad school in 1994, for his work on transaction cost economics, i.e. the choice of markets or administrative hierarchies to solve problems. EconLog summarizes his most famous idea while both the Hayek and Mises blogs claim him as a disciple of the Austrian school. (That’s certainly more feasible than the same claim about last year’s winner.)

The less expected choice was Elinor Ostrom, a political scientist who uses economic rationality to examine questions of public choice. I know her from her book (and papers) on the tragedy of the commons. When considering open source and other examples of social production, Ostrom (and subsequent authors) give ideas on how to mitigate (or reduce) free-rider effects that would otherwise cause these communities to collapse.

Libertarian blogger Virginia Postrel notes an important common thread between the two. Along with prior winners Ronald Coase and Douglass North, both are key contributors to the New Institutional Economics. I agree with Postrel that a major implication of NIE is that free market economies are governed in part by non-governmental economic institutions, and that getting such institutions right are crucial to economic growth.

So in a year when conventional wisdom is rejecting free markets — and the power of economics as an explanatory social science — this year’s economics selections (at least) validate key pillars of the field as have been recognized for decades.

Economic ignorance is an expensive thing

It appears that economic ignorance will cost the American people hundreds of billions if not trillions of dollars. The NY Post explains:

In the depths of the financial crisis last year, people like Morgan Stanley's John Mack, BlackRock's Larry Fink, Greg Fleming (then of Merrill Lynch), JP Morgan's Jamie Dimon and Goldman Sachs' Lloyd Blankfein were telling everyone that candidate Barack Obama was a "moderate," and moderation was what this country needed.

What a difference a year makes. They won't admit it in public -- but in private conversations, the top guys on Wall Street are feeling burned.
…
I'm told that Treasury Secretary Tim Geithner and chief economic adviser Lawrence Summers have both complained to senior Wall Street execs that they have almost no say in major policy decisions. Obama economic counselor Paul Volcker, the former Fed chairman, is barely consulted at all on just about anything -- not even issues involving the banking system, of which he is among the world's leading authorities.

At most, the economic people and their staffs get asked to do cost analyses of Obama's initiatives for the White House political people -- who then ignore their advice.
…
As one CEO of a major financial firm told me: "The economic guys say that when they explain the costs of programs, the policy guys simply thank them for their time and then ignore what they say."

In other words, the economic people feel that they have almost no say in this administration's policy decisions.

Columnist Charles Gasparino contrasts this to the relatively economically savvy Clinton administration.

After the Berlin Wall fell, and Clinton defeated once of the most experienced foreign policy presidents ever, the political establishment suddenly took economics seriously. If the Federal government didn’t have to fight the Russkis or Nazis or otherwise keep Americans safe, then what remained was to assure the economic well-being of its citizens. In the pantheon of American politics, instead of the “guns and butter” campaign issues, only butter mattered.

Bill Clinton ran on the (internal) slogan “It’s the economy, stupid” and latter bragged about achieving historic levels of economic growth. He had smart liberal economists working for him, he appointed one of his highest profile supporters as Commerce secretary, he staked his political capital on key trade policies and (as Gasparino argues) listened to the advice that he got. Except for taxes, Clinton was a moderate on economic policy (although perhaps after 1994 he didn’t have a lot of choice).

As a consequence, political science and international relations schools started paying more attention to economics, trade, economic development. Even if the faculty didn’t catch the trend, the students certainly did, and economics or business minors became common among poli sci or IR majors.

Now Gaparino implies that a bunch of economically illiterate lawyers are in charge of economic policy. Are they too old to have learned about economics as students in the 1990s? Or does law school emphasize controlling society through legislation and the courts — rather than the traditional role of government in a market economy as defining the rules of the economic game.

Whatever the reason, let’s hope that the lawyers and political scientists in future generations actually paid attention during economics class and will realize the futility of fighting the invisible hand.

Guess what: monopolists gouge customers!

USA Today wrote Friday about how travelers are mad at airport shops that gouge customers. I was reading this in the dead tree paper on the flight home Friday; this would be ironic except that USA Today oversamples travel-related news for its readership, which is mainly travelers.

A few sample paragraphs:

[Frequent flyer Sammy] Tawil's irritation is shared by many travelers, who see themselves as captive to whatever prices retailers charge at a time they're spending more hours in airports and despite efforts by many facilities to prevent gouging.
…
Once you go through security," [Larry O’Neill] says, "you're at their mercy. It's like, 'We can charge anything we want. It's either you eat here or not eat at all.' "

Frequently purchased items at post-security shops in particular, such as bottled water, food and breath mints, are noticeably more expensive than in street stores, travelers say.

Wow! So once you’re inside security, you have less choice, less competition and pay higher prices! Dog bites man!

It turns out, there is one thing they can do to increase competition and cut prices:

Some airports are taking other steps to hold down prices, such as taking retailing out of the hands of a single, or "master," concessionaire and leasing to individual store owners.

"There's no competition" when retail stores are concentrated in the hands of a master concessionaire, says Mark Knight, president of BAA USA, an airport retail developer. "And what you get is higher prices."

At least 12 airports, including Boston, have eliminated the master concessionaire recently, Knight says, and the result not only is lower prices but greater overall sales.

Even with such competition and (claimed) efforts by airports to keep terminal prices closers to street prices, there still is an airport premium. An official airport industry spokesman claims that prices are higher because operating costs are higher. Airport backers claims that the average in-airport location generates 3x as much revenue per square foot — a somewhat misleading figure since may airport shops are much smaller than their external counterparts.

One thing only hinted at in the article: the role of airport owners in raising costs. USA Today quotes one concessionaire paying 2-4% more (as a royalty on net revenues). DFW airport reports the margin as 5% more than outside; Denver charges luxury retailers 10-14% of sales. Meanwhile, a NYC real estate blog estimates LAX rent as $238/square foot.

There is no alternate supplier and no competition for retail space inside the security gates (except in those rare metropolitan regions with two airports owned by two operators). Thus, there’s more than a little hypocrisy by airport owners (i.e. governments) who say “don’t gouge your customers” and “pay us as much as possible.”

As the “street price” movement has concluded, at some point price increases reduce total revenues. However, while both owner and concessionaire have different profit maximizing, and thus their interests are usually not perfectly aligned.

Why not break all the windows?

Part of an ongoing cost reduction via outsourced economic criticism, tied to today’s scheduled Senate vote on $2b more in “cash for clunkers” funding.

Richard Rahn of Cato extends the broken window fallacy of cash for clunkers to justify a broader range of state intervention

If Congress suddenly required every car and truck in America (all 250 million of them) to be immediately destroyed and replaced with new cars and trucks that got better gas mileage, would the country be worse off or better off? Those members of Congress who voted for the "cash for clunkers" program would probably say "better off," even though a perfectly good auto and truck stock would be destroyed.

The congressional clunker caucus would say millions of workers would be employed to replace all of the existing cars and trucks. Yes, that would be true, but everyone else would be poorer. Those who had to buy a new car would have less money to spend on everything else, which would mean fewer jobs in the rest of the economy -- more autoworkers but fewer farmers, teachers and medical researchers -- not a good trade-off.
…
Members of Congress would then say that we are saving gasoline by having a more efficient auto fleet -- which ignores the fact that building a new car takes far more resources, including petroleum, than could possibly be saved by the gain of additional miles per gallon.

Of course, the up front cost vs. lifetime fuel savings is why I’m driving my 2000 pickup for another 5+ years, and why my next econobox is more likely to be a Honda Fit (MSRP $15k, 35 mpg hwy) than a Toyota Prius (MSRP $22k, 45 mpg hwy). In a free-market economy, price signals tell us how to most efficiently allocate resources.

Rahn continues

Congressional "logic" could also be applied to housing.

Why not knock down all houses built in America before 2000 and replace them with new and more energy-efficient houses? Wait -- we already evidenced the results of that experiment -- it happened in New Orleans. Rather than the government directly knocking down the houses, Hurricane Katrina did it for us. Are the people of New Orleans better off or worse off because of Katrina? Are all of the American taxpayers who footed much of the rebuilding cost -- hundreds of billions of dollars -- better off or worse off because of Katrina?

He goes on from there to criticize other spending programs (without ever mentioning Frédéric Bastiat and his 1850 essay).

Finally, even if all this spending is a good idea, how is the government going to pay for it all? The numbers just don’t work:

The Congressional Budget Office projects a total additional deficit of approximately $4.9 trillion dollars during President Obama's first term (2009-2012). …

It is also not mathematically possible to take care of all the new spending by increasing taxes on the top 5 percent of taxpayers (those making $160,000 or more annually) who already pay 61 percent of the federal tax (or $676 billion per year). Most of these people are now paying close to the revenue maximizing rate, which means that any increase in their tax rate is unlikely over the long run to bring in much more tax revenue.

Quite simply, upper-income people have options. History shows that when tax rates are raised, many will choose to work less (leisure is nontaxable), retire earlier than they had planned and save and invest less in taxable, productive activities. Those making more than $160,000 per year would need to have their taxes roughly tripled to take care of just this year's deficit. (One merely has to look at the tax evasion practiced by the chairman of the congressional tax writing committee, the secretary of the Treasury and the former majority leader, et al. at today's tax rates to know that they and their colleagues, as well as most everyone else, will find either legal or illegal ways to avoid paying the tax.)

And thus the administration will inevitably have to raise middle class taxes. Unless of course it wants to inflate its way out of paying debts.

Money for nothing

Cash for Clunkers is out of money, and some politicians say the answer is to spend more.

I think the Mises Economics Blog has it exactly right:

let's just pause and reflect on these people who were surprised. Here is the amazing turn of events:

1. The government starts handing out free money.
2. People start grabbing it as fast as they can.
3. The bureaucrats quickly realize that they are hitting the program's budget in mere days (of the program being finalized) and suspend the program.

What is the reaction to this perfectly foreseeable sequence of events? "...dealers were amazed...", "the explosively popular... program."
…
How do you get an economic recovery going? Start raining free money down on everyone's heads. I grew up thinking that the people from the Middle Ages were idiots... They believed the earth was flat! Turns out they didn't actually. But Rep. Miller (and how many Americans?) really does believe this nonsense. I have found the Dark Ages and it is us.

Economic ignorance is expensive and we’re paying the price.

High margins, high entry barriers

Microsoft reported earnings on Thursday. Its gross margin was 80.3% (i.e. the cost of goods sold was 19.7%), down from 81.9% a year earlier. (Actual revenues were down 17.3%). Revenue from desktop OS licenses were down 29%, due both to cheaper netbooks and deferral of purchases awaiting Windows 7.

On the same day, the Federal government revealed the margins of one Levy Izhak Rosenbaum as it unsealed a sweeping indictment (and conducted arrests) of more than 40 corrupt New Jersey politicians and other community members. Mr. Rosenbaum is accused of buying kidneys for $10,000 and selling them for $160,000. His cost of sales were not revealed, but that implies a gross margin of 93.7%.

High margins are usually an indication of high barriers to entry or imitation: in this case, the government forbids a market in kidneys so there is a black market with high risk and high margins. Writing in the Atlantic two weeks ago, columnist Virginia Postrel notes that — absent markets or any other incentives, there is a huge imbalance of supply and demand for kidney donations. Or, as Harvard economist Greg Makiw summarizes the article:

What market has 80,000 potential consumers each demanding one unit, 300,000,000 potential producers each capable of supplying one unit, and a shortage nonetheless?

There’s no question that stimulating and allocating a supply of kidneys could be done more effectively. Today 11 patients die every day waiting for the donor kidney that never arrives, and all of the 80,000 are undergoing some form of dialysis that many patients view as only slightly better than death.

Postrel talks about donor chains as one short-term solution within the limits of the current rules that forbid kidney sales. In the meantime, she has done her part to solve the problem by donating one of her own kidneys to someone who otherwise had little hope for a donation.

Reasonable vs. unreasonable intellectual opponents

I’ve previously written about Paul Krugman, the political pundit and NYT columnist who shares the same name (and AFAIK body) with an MIT-trained economist who won the “Nobel” prize in economics. Somewhere in the 1990s there was a “body snatchers” type moment and the old (Prize-worthy) Paul got replaced with the new one. Generally fans of the old one don’t have much respect for the new one.

Unfortunately for new Paul, like an incautious politician or Supreme Court nominee (i.e. David Souter), the views of the old Paul are preserved for posterity. As Bryan Caplan of EconLog writes:

The Krugman we've got is sold on the House health bill. But the Krugman we had, the thoughtful economist who wrote The Accidental Theorist, would have responded differently. Krugman Past, unlike Krugman Present, would have pointed out that when the unemployment rate is 9.7%, it's a bad idea to legislate an 8% payroll increase on businesses that fail to offer health insurance. Employers are reluctant to hire workers at today's wages; how are they going to feel once the marginal worker gets 8% pricier?

Serious economists do have differences of opinion, such as about value judgements over equal outcomes vs. equal opportunity. However, they tend to agree (as do physicists or chemists or materials scientists) about the basic precepts of their discipline, things the like increasing the price of something (in this case labor) will reduce the demand.

I’ve experienced this first-hand in my own life as a pro-entrepreneurship, anti-collectivist social scientist studying open source (actually “free, libre and open source software” or F/LOSS) where a majority of the researchers are promoting the cause. It is possible to have different values but agree on the facts.

This week I traded e-mails with a PhD student in the F/LOSS (as opposed to OSS) camp who nonetheless believes that F/LOSS software is usually imitative and (coming late) rarely better than proprietary software: it doesn’t matter to him, because unlike the proprietary software it is “free” (as in speech). Similarly, I have agreed with many activists (and even OSS execs) about certain companies whose open source strategy isn’t really open (in a governance sense) but merely a marketing gimmick akin to demoware or teaseware.

Usually with the reasonable people we can agree everything has its place: proprietary companies and open source companies (or communities) should produce their respective technologies and leave it up to adopters to decide what’s best for their needs. Certainly, if a farmer’s co-op or a rich socialist or a university wants to make something and give it away, then it’s up to the firm selling something for big bucks to show theirs is worth a premium — just as Apple has to show that an iPod or a MacBook is worth a premium over their commodity rivals. And if you can’t beat them, then you pull a Microsoft and give away something (e.g. a mini-Office suite) to compete with your free alternative while selling something for those who want more. (We call that freemium).

Such a pluralism of ideas works much better in free markets (where the markets decide) than government policy, where we have to pick one answer a priori. As in the Caplan example of healthcare, we know that taxing businesses to pay for healthcare will increase business costs and taxing affluent people will reduce investment capital and the incentives to work. What’s in dispute (as with any prediction) are how big these side-effects are, whether they are worth the cost, and whether there’s a more efficient way to achieve a similar outcome.

Alas, in economics (unlike experimental nuclear physics or recombinant DNA) there are enough confounds that the experts will argue over the data for decades, as (some) argue about the impact of minimum wage increases upon unemployment. Unfortunately, national policy choices are hard to reverse, even if they do prove to be flawed (Google “social security Ponzi scheme”).

Everyone needs to learn accountability

“Moderate” NYT columnist David Brooks apparently wrote a column last week criticizing capitalism. Since I put little store in what Brooks (or any other NYT op-ed columnist) says, I hadn’t noticed.

However, in responding to the Brooks column, economist, Hoover Fellow and EconLog blogger David Henderson shared his own personal story about his first job at age 16. He quickly learned that a job was not a right, but a privilege, and if he didn’t perform he wouldn’t have a job. I guess because he assumes his audience is economically literate, Henderson doesn’t circle back to make the larger point.

Central planning has been shown to be an abject failure — no one person is so smart or knowledgeable (even with computers) to be able to make all the right decisions for everyone, whether in a city, a state, a country or an economy. The only alternative is decentralized authority and initiative, with the proper incentives and feedback mechanisms. (Cure cancer=make piles of money; cheat customers=go to jail.)

The one thing that’s often missing (as elsewhere in society) is accountability. Young David H. learned accountability from his restaurant supervisor, but not all workers do. The entire system fails if good workers (CEOs, middle managers or grunts) are not rewarded or bad workers are not punished, whether due to laziness, indifference, or a desire to be surrounded by sycophants.

What applies to individuals also applies to companies. If you make something good, people buy it; if it’s drek, they won’t. The worst thing that happened to the American auto companies is that people continued to buy their (mostly) lousy cars during the 1980s and 1990s out of loyalty or due to superior distribution, postponing and magnifying the inevitable day of reckoning. (The companies also cleverly created new product categories like minivans and SUVs which gave them temporary monopolies until the Japanese learned to make them better.)

When I study the best tech startups, they succeed as ruthless meritocracies fighting for survival, where good ideas and people win out. As they get older, they get more comfortable, more political, more bureaucratic. Eventually, they become indistinguishable from an American car or steel company — that is to say, like RCA, Zenith or (soon) Motorola, once-great electronics companies that drifted into irrelevance and oblivion.

Some of it is the loss of the founder and his (or her) ruthless vision and demand for accountability, such as HP after Dave Packard retired. Apple was this way between the Jobs I and Jobs II eras, and could easily revert when Jobs leaves for good. Google and Qualcomm are heading in this direction, and Intel (despite its paranoia) seems to have lost the battle.

Oddly, the verdict seems still out on Microsoft. The past two decades were more about pugnaciousness — fighting all comers — and milking monopoly rents rather than driving innovation. But a few recent signs (such as Windows 7) suggests that the company is coming back. Perhaps it realizes that it won’t be able print money forever, and (like the post-Gerstner IBM) will have to learn to succeed in the marketplace by providing things that people actually want.

In February, Microsoft CEO Steve Ballmer observed that each generation has to re-learn the need for prudence in saving and spending. Blogger Mike Shedlock applied this to the dissipation of entrepreneurial family fortunes across three generations — until the 3rd (or 4th) generation had to learn how to make a living the way their (great-)grandparents did, by earning it.

DTV is coming: this time we mean it!

On the 2nd day of this year, I wrote:

One prediction I will stand by: digital TV is coming, and analog TV will be gone by mid-February.

As it turns out, I was wrong because I underestimated the spinelessness of our political “leaders.” In January, Congress made a big show of postponing the DTV transition by 4 months so the poor and oppressed masses would not be deprived of their over the air TV.

Well, guess what? Next Friday is the last day for NTSC broadcasts anywhere, and some people aren’t ready. As a car-carrying ally of the scaremongers, the NYT tried Saturday to sound the alarm:

Millions of households will lose television reception next week when about 1,000 broadcasters around the nation shut off their analog signals and complete their conversion to digital programming, federal officials say.
…
The government has spent more than $2 billion to ease the transition to digital television, and in the last few months has cut in half the number of households that are unprepared for the final conversion on June 12. But the latest survey by the Nielsen Company indicates that as of the end of May, more than 10 percent of the 114 million households that have television sets are either completely or partly unprepared.

Michael J. Copps, the acting head of the Federal Communications Commission, said that the people most likely to lose reception are society’s most vulnerable — lower-income families, the elderly, the handicapped and homes where little or no English is spoken. The transition will also hit inner-city and rural areas hardest, he said.

Horsepucky. It turns out there is really no story here:

More than three million homes that do not subscribe to cable or satellite services are totally unprepared for the transition and will lose their reception, according to Nielsen. Another nine million homes that subscribe to cable or satellite services but that have spare television sets — typically in bedrooms and kitchens — that are not connected to any service are also expected to lose reception. The conversion does not affect cable or satellite distribution.

So some people have old TVs that aren’t worth upgrading and they won’t be using them come Saturday morning. (I have two). So what? A converter box cost $40 and a new TV (better than the 15 year old junker) costs $150 from Costco, Wal-Mart or Amazon. And most people (particularly the less technically savvy) are better off getting a new TV rather than try to figure out how to get mediocre results with a complex converter box setup. (If Congress were serious about conversion, they would have means-tested the coupons and used the savings to allow the disadvantaged folks to use their coupon towards a new TV.)

The real number — the one used to justify the delay and extra spending and press releases and squatting on other people’s (expensive) spectrum — is 2.6%. That’s a tiny number. Economists figure 5% unemployment is as close as the economy can get to zero unemployment, and the fraction of people temporarily without TV is half that.

The FCC knows better. Every few years it splits area codes, and people ignore the split until the recording comes up “this number is no longer in service.” Then they go find the new area code.

The idea that the number could be pushed closed to 0% is a typical delusion of statists who believe in the (illusory) magic of a centrally planned economy. It’s not possible to plan this number down to zero. A transition involving 114 million households has to be done by decentralized actors working in their own self-interest, not in response to some centralized mandate. And some of these people aren’t going to deal with it until they have no choice. It is (or at least was) a free country.

So despite the delay, some homes will have dark screens Saturday — because there were always going to be some homes with dark screens. These same people will solve the problem within a few weeks of when they are forced to, just as they would have solved them if the transition occurred 4 months ago. So by the time NFL and the fall network shows start, this transitory inconvenience will just be a bad memory.

Arithmetically challenged reporters

When I was a newspaper reporter, I remember that we looked down our noses at TV reporters — they were airheads, bimbos, pretty boys (such as the one portrayed by William Hurt in Broadcast News). The reputation of radio reporters was that they worked harder for less money, but were not quite as pretty.

When driving to work this morning, the CBS (radio) news at 10am EDT was reporting the grim economic news from the latest quarter. Here’s what the NYTimes.com article said:

The last six months were brutal. Output fell at a 6.1 percent annual rate in the January-through-March quarter after falling at a rate of 6.3 percent in last year’s fourth quarter, according to the Commerce Department. If that pace were to continue, nearly $1 trillion would be wiped out this year from the nation’s economic output of $14.2 trillion last year.

In concluding her summary, the CBS radio reporter said:

It's unusual to have two quarters of such weak economic growth.

My jaw dropped: when it comes to the economy, growth is always up, and down means “contraction.” When I got to the office, I went to the NYT website, which got it right in the breaking headline on its home page:

U.S. Economy in 2nd Straight Quarter of Steep Decline

Here in California, learning about negative numbers is a requirement for every 4th grader in the state. So do we have someone who failed 4th grade math who’s now a national news reporter?

This week our local newspaper (the Merc) and the TV stations have been leading with the news about the swine flu. One person has died in the US so far due to swine flu, which is 20% as many as those who died in the Monterey County bus rollover Tuesday.

Of course, this is not the first time that the media and the public have gotten an exaggerated sense of risks due to poor math. Here is what ABC newsman John Stossel (my favorite TV reporter) wrote two years ago:

Worry About the Right Things
By John Stossel, April 4, 2007

For the past two weeks I've written about how the media -- part of the Fear Industrial Complex -- profit by scaring us to death about things that rarely happen, like terrorism, child abductions, and shark attacks.

We do it because we get caught up in the excitement of the story. And for ratings.

Worse, because many reporters are statistically illiterate, personal-injury lawyers get us to hype risks that barely threaten people… Sometimes they even con us into scaring you about risks that don't exist at all …

Newsrooms are full of English majors who acknowledge that they are not good at math, but still rush to make confident pronouncements about a global-warming "crisis" and the coming of bird flu.

Bird flu was called the No. 1 threat to the world. But bird flu has killed no one in America, while regular flu -- the boring kind -- kills tens of thousands. New York City internist Marc Siegel says that after the media hype, his patients didn't want to hear that.

"I say, 'You need a flu shot.' You know the regular flu is killing 36,000 per year. They say, 'Don't talk to me about regular flu. What about bird flu?'"
…

Economic mis-incentives

Arthur Laffer was the 1970s economist who (gasp!) argued that increasing taxes caused people to reduce their taxable income. His views are out of favor in todays neo-Keynesian, proto-Socialist national policy debate, but that has nothing to do with the accuracy of his observations.

This morning he rails at his favorite recent target, the estate tax. (“Death tax” to its opponents.) — specifically the president’s plan to continue taxing estates above $3.5 million at 45%.

I don’t have the time (or preparation) to discuss the merits of his arguments; I have been more of a fan of raising the exemption than zeroing out the top rate but haven’t researched the issue personally.

However, I found compelling his thoughts on the incentive effects of such policies:

Today in America you can take your after-tax income and go to Las Vegas and carouse, gamble, drink and smoke, and as far as our government is concerned that's just fine. But if you take that same after-tax income and leave it to your children and grandchildren, the government will tax that after-tax income one additional time at rates up to 55%. I especially like an oft-quoted line from Joseph Stiglitz and David L. Bevan, who wrote in the Greek Economic Review, "Of course, prohibitively high inheritance tax rates generate no revenue; they simply force the individual to consume his income during his lifetime." …

If you're rich enough, however, you can hire professionals who can, for a price, show you how to avoid estate taxes. … And all the costs associated with these tax shelters and tax avoidance schemes are pure wastes for the country as a whole and exist solely to circumvent the estate tax. The estate tax in and of itself causes people to waste resources.

Again, a number of studies suggest that the costs of sheltering estates from the tax man actually are about as high as the total tax revenues collected from the estate tax. And these estimates don't even take into account lost output, employment and production resulting from perverse incentives. This makes the estate tax one of the least efficient taxes. …

It is important to realize that less than half of the estates that must go through the burden of complying with the paperwork and reporting requirements of the tax actually pay even a nickel of the tax.

Flat taxes on income, sales or value added are the most regressive taxes we have, but they have a relatively low administrative burden and (generally) an even lower impact on inefficient tax-avoidance.

Money spent on accountants — like money paid to contingency fee lawyers — is a net drain on the productive output of society. If we had an economically literate ruling caste and voter population (not in my lifetime), our political “leaders” would be worrying about efficiency and economic growth rather than using class warfare to assure re-election.

Truth to a declining power

Economist Václav Klaus, the Czech president who has a habit of speaking truth to power, rained on the global warming parade at last week’s WSJ-sponsored WSJ’s Eco:nomics conference.

In a familiar pose, Klaus was the only dissenter from the environmental orthodox among politicians and PC business leaders — at least as reported in Monday’s special Eco;nomics supplement in the dead tree Journal.

But his most prescient remarks in an interview with Robert Thomson of the WSJ were on the decline of economic freedom in the US:

Thomas: Mr. President, obviously during the dark days of communism, America was a beacon for you and many other people in Central and Eastern Europe. What are your impressions of contemporary America?

Klaus: Sitting here in this room in the last two hours and the coming from, first Europe, and, second, from a former communist country where I spent most of my life, I almost don't believe my eyes to see how much you believe in government and how much you don't believe in the market.

This is for me a shocking experience. And I have to say that very loudly. As a professor of economics, I have my theoretical arguments about the impossibility of running the economy from above.

As a person who spent almost 50 years of his life in a communist country, I know how crazy it is to introduce schemes like the cap and trade and similar ideas, how devastating and damaging for the economy all those ideas really are. So I'm rather frustrated. It seems to me that to fight for freedom, free markets, is still the task of today, even if we hoped almost 20 years ago in the moment of the fall of communism that it was over.

This is the same in Europe these days. There is one EU summit after another one weekend after another, there is a summit trying to find solutions. But I don't think that this solution will come from the government.

Some 170 years ago, we needed de Tocqueville to explain to us what we could not see about our own society. Now we need those who were enslaved by statism — and freed by American courage during the Cold War — to see how the American experiment will turn out unless someone stands up for economic freedom.

Economists vs. consultants

In response to a discussion this morning of consultants and their use of 2x2 taxonomies, I offer this memorable quote this morning from Themis Pantos, a trained economist who is one of our senior finance faculty:

Life is not a 2x2. Life is a sequential game.