Econ 101: Game Theory and Car Dealers

The Oregonian reports today on the Oregon Automobile Dealers Association request to lawmakers that they prohibit the sale of cars on Sundays. Huh? Why on earth would dealers want lawmakers to limit how they operate? Isn't this the antithesis of allowing free markets to produce efficient outcomes?

Actually, in economics, game theory provides some useful insight into situations in which, when strategic interactions exist, the free market might lead to inefficient outcomes.

Let's try and see how auto dealers might be in just such a situation using the canonical example of the prisoner's dilemma game. Even though the title of the game refers to a particular story told with it, the canonical nature of the game is actually in the payoffs and outcomes. Here goes:

Suppose, for simplicity, that there are only two auto dealers. I shall describe their interaction with a payoff matrix (shown below). The two dealers are Honest Moe's and Crazy Larry's. Their strategies are either to stay closed on Sunday or to be open on Sunday. Honest Moe's payoffs from each of the four possible outcomes is the first number written (let's call it weekly profits) and Crazy Larry's is the second. Thus if both Honest Moe and Crazy Larry close on Sunday they will both get 120 and so on.



So what will happen if they are both left to their own devices? Well if Honest Moe knows Larry will close on Sunday, Moe will stay open because he can get 140 instead of the 120 he would get if he stayed closed. If Moe knows Larry will be open on Sunday, then Moe will open on Sunday because 100 is better than 80. The exactly same calculations apply for Larry. So, no matter what the other does, it is always better for each individual dealer to stay open on Sunday. Thus the outcome of the game is that both will be open Sunday and they both will get 100.

But is this the best outcome for the two dealers? No, they would both be better off if they both stayed closed on Sunday. This would give both of them payoffs of 120. This is the essence of the prisoner's dilemma: individual incentives lead this market into a sub-optimal outcome and thus the efficiency of the free market breaks down.

Just agreeing to stay closed on Sunday won't work, because each has an individual incentive to cheat and open up and get 20 more at 140 than at 120. In other words, the very best individual outcome is the be the only one open on Sunday.  So they need the option of opening up in Sunday removed from their choices and then they can both be made better off.

Whether consumers are better off is another story...

Income Tax and the Current Economic Crisis

A while back I engaged in a whole series of blogs that tried to investigate the question: should Oregon have a sales tax? I learned a lot from that exercise. But due the particular quirks of the current economic crisis it just may be that we are very lucky to have what we have.

I have heard it stated, by no less than Oregon's Chief Economist Tom Potiowsky, that currently Oregon's revenues are in good shape relative to other states thanks to our reliance on income taxes. Contrast this with Washington which relies on sales taxes and is resorting to fairly draconian measures to deal with their budget crisis.

The basic theory is this: right now consumers are retrenching and consumption spending has dropped dramatically, aided in part by falling home values. Unemployment is rising, but not by nearly as much as consumption is falling. So, this time at least, we are fortunate to rely on income taxes and not sales taxes.

Is this theory supported by the facts? Perhaps. The BEAs national figures seems to support it - personal income is stagnating but consumption is plunging.

Of course, new data out today show Oregon's unemployment surging to 7.3% so this trend might not last for long. I don't think state personal income figures are out yet, so we'll have to wait and see.

Of course time can change everything as well, as we recover from this recession it may be that consumption spending picks up faster than incomes. But given the nature of the bubble that burst, it is hard to say. Also, if federal stimulus includes lots of job creation, Oregon might again be well positioned.

Food for thought. Comments?

Oregon Unemployment: 7.3%

From the Bureau of Labor Statistics, Oregon Unemployment Rate:Ouch. This is .6 percentage points higher than the national rate. This represents almost 20,000 newly unemployed in Oregon from September to October.

Note: These numbers are preliminary and are subject to revision.

Wither Saab?

It seems more than likely. GM has not been able to make it viable for the US market. I think the likely scenarios are that some european buyer will take it and will pull out of the US, or that it will just be folded into Opel and assets and the brand will die. Either way, as a Saab owner and enthusiast, I will be sad. What will the professoriate drive?

But the question remains, why on earth continue to focus on Buick and GMC. Buick's audience is dying and serious luxury buyers will look to Cadillac, which GM resuccitated nicely, and GMC is just rebadged Chevy trucks, no? Chevy and Cadillac are the the core of the GM empire (with Opel in Europe), who needs anything else?

Newspapers and Public Goods

On Monday, I received my Oregonian with the notice that, starting with that edition, the Metro section would be cease to exist and would become part of the A section. On Blue Oregon, Paul Gronke see it as a sign that it is time to abandon the paper. This is just another indication of the sad trend of dying dailies. Some see this as the inevitable result of market realities and we should let the market decide how and where people get their news. This is wrong.

Markets only 'decide' efficiently if they are complete and this means, among other things, that all costs and benefits of a product are private. But there are clear public goods aspects to newspapers: they provide oversight of government (the 4th estate); they inform the population which, especially in a democracy, leads to better policy; and they enhance community through their coverage of local events.

So why then don't we offer public funding for such a public good just as we do things like parks and schools? I fear for a state that has virtually no professional reporters covering the government, the community, etc. For such a vital role that we assign newspapers we should be much less indifferent to their decline. And, no, blogs are not a good substitute. Nor are the electronic versions of the papers, because without reporters, the web-sites won't have much news.

It is hard to imagine public subsidies to newspapers given the long tradition of leaving it to private market forces (and vast fortunes were once made in the newspaper business when there were few other ways to advertise widely), but I am beginning to worry that the health of our democracy will suffer if we don't start thinking creatively about how to preserve the papers. Look what cable news has done to public discourse and our democracy...

Perhaps we need an on-line national public newspaper similar to NPR. Partly funded by taxpayers, this would ensure that 'print' journalism would continue and could include, as a big part of its mission statement, local state-by-state coverage. I don't know the answer, but I am worried.

Econ 101: Cost Disease

This provocative picture from the New York Times show just how quickly college costs are outpacing inflation. [Though it is important to note that this is the sticker price, many students get some form of financial aid which reduces their cost considerably]

This type of data is not new and always begs the question, are colleges and universities to blame for not being able to keep costs under control?

Perhaps not. In economics we talk about something called cost disease. Cost disease refers to industries that do not see productivity gains over time similar to other industries. Take a simple example (and the classic example of Baumol who coined the term): A string quartet takes the same amount of time and the same amount of people to perform a piece today as it did 100, 200 or even 300 years ago. Compare that with, say, the amount of time it takes to produce a knit sweater - a fraction of the time on a big mechanical loom than it did 200 years ago. Thus the string quartet has become relatively more expensive over time - in the same amount of time it takes to perform the piece we could now knit 100 sweaters, rather than 1/2 of one we could have knit 200 years ago. So what we would experience over time is the cost of performing by this quartet would vastly outpace inflation. Why? Well, inflation, or the CPI, is a measure of AVERAGE price increases. So industries that have below average productivity gains, like string quartets, will see their prices rice faster than average, or outpace the CPI.

To restate this more generally, over time most industries see productivity gains, some faster than others. How cheap or expensive a product becomes in relative terms is largely a function of this productivity gain. And this works both ways as well. For example, personal computers today are a much smaller purchase as a part of a budget then they were 10 or 20 years ago. If I were to draw a graph like the one above with computing power per dollar versus the CPI, the CPI would be going up but computing per per dollar would be going down sharply.

Universities have economized in many ways (for example the use of computers in registration) but the essential function of teaching and learning is still relatively the same as it was 100 years ago. Sure we have bigger lecture halls aided by microphones and video screens, this helps a little but, but the process of teaching and learning is not conducive to huge productivity gains over time. Since most of a college or university's budget is tied up in professors, there is not a lot of economizing that can be done.

Which is to say that it is natural for university costs to increase faster than the CPI. 30 years ago, an Apple IIE might cost the same as one semester's tuition. Now, you can buy about about 10 desktop computers that are about 100,000 times more powerful than that Apple for the price of one semester's tuition.

The point is that there is nothing necessarily sinister about this increase, and, more importantly, it will NEVER go away. What we must do is accept it, while being ever vigilant to get as much efficiency improvement as possible, and start coming up with better policy solutions for it.

In the end it is all a matter of perspective. For $300 I bought an iPhone that is more stocked with technology than I could have even imagined 20 years ago - that is the payoff to living in the 21st century - I get to pay much less for this stuff. The other side of this coin is that classroom based learning is pretty much the same as always and so I have to pay more for that. The hard part is that what is by far most important in the 21st century is the hard stuff - the education - and not the iPhone.

Credit and the US Auto Industry

We all know how badly managed the US auto industry has been, willfully oblivious to the obvious: that huge demand for big trucks and SUVs were not going to last forever and that fuel efficiency was not the the enemy. If they had spend half the time, energy and money into design, R&D and engineering that they devoted to ensuring protection from Washington they would probably not be in this mess (or at least not nearly as bad off).

We also know that they represent a pretty significant part of the manufacturing base in the US, especially with all of the links to suppliers. This makes a pretty compelling case for the government coming to their aid.

But is their trouble all their own fault? It can be argued that the credit crisis hurts their industry much more than most because of the fact that most auto purchases rely heavily on credit. Since traditional consumer credit sources have dried up (including home equity lines of credit), it is possible for them to argue that they are in a special position as sufferers from the credit crisis that the government allowed to happen.

I don't know how much water this argument holds, but I have been interested that this point is not being made much. One thing is for certain, the US auto market has cratered. Above, from Econbrowser, is a chart of US domestic car sales. Look at how far off are current year sales to previous years. Ouch.

India

I have a particular connection to, and affection for, India, having spent a good deal of time their particularly as a college junior living and studying there. So it was with great horror that I witnessed the terrorist attacks on Bombay and their aftermath. [Yes, I said Bombay, ignoring the Hindu-nationalist inspired name change] I have dined at Leopold's restaurant, I have sat at the India gate gazing at the Taj Hotel, and I have traveled through Victoria Terminus - the train station that was attacked - so this really struck me.

I have to admit, I have never had any faith in the emergency services in India and many times while there have I thought "please don't let anything happen where I would need assistance" because I was quite convinced in the futility of such a need. The police seem hopelessly incompetent and vaguely violent (occasionally resorting to thrashing a beggar with their canes without provocation), the firefighters nonexistent and in general the government seems obsessed with bureaucracy and hierarchy and uninterested in competence. I have stories upon stories of trying to get things accomplished only to be completely stymied by layers upon layers of bureaucratic machinations and endless middlemen.

It came as no surprise to me as a development economist, then, that when there was finally some liberalizing of the commercial bureaucracy the economy skyrocketed. Unfortunately this has not translated yet to other parts of the government. Perhaps this unfortunate event will do the same. India, an ancient civilization steeped in caste and class, is not eager to see this eternal protection of the upper castes place in society disappear - at least not among those upper castes who still control the country. But a new culture of competence must arise. India cannot long sustain its economic progress without addressing its lacuna in governance in other areas. The central government must work to create new mechanisms through which talent and performance is rewarded - regardless of position or caste. I am not optimistic that this will happen quickly though. But I hope it happens quickly enough, because to sustain this society, more economic progress is needed.

I also worry about the success of these terrorist attacks. These will surely test the fragile fabric of what is a magnificent achievement: a diverse, democratic, pluralistic, secular country of over one billion people. It is in all of our interests to assure the success of this grand experiment in democracy. As the new home minister, Palaniappan Chidambaram, said so eloquently to reporters on Monday:

“This is the threat to the very idea of India, the very soul of India, the India that we know, the India that we love — namely a secular, plural, tolerant and open society, I have no doubt in my mind that ultimately the idea of India will triumph.”

I hope and believe it will, but it will take much hard work - and some help.

Bravo!

Good news about Oregon's budgetary priorities in this time of scarce resources. Governor Kulongoski is absolutely right to protect education, something I have blogged about twice in the recent past (here and here) and not just K-12 education - university education and research are critical to success in the 21st century. I would only add that just protecting budgets is not enough, but giving more money for scholarships is a good idea for fiscal stimulus and long term economic growth.

And, by the way, others have jumped on my education bandwagon.

Bravo!

Economist's Notebook: Random Thoughts from Brazil

Some random thoughts I never had a chance or the will to turn in to full posts:

1. GM has a HUGE presence in Brazil, all under the Chevy brand, though almost all the cars they sell are European designed Opels (the German car company which is owned by GM). Unlike most of the crap sold as Chevys here (and mostly fleet sales and to rental car agencies it seems), these cars are relatively stylish and well engineered. One wonders why US auto makers are so content to make great cars for Europe but bound and determined that US consumers won't like them and instead sell their crap to us. GM has awoken to this and has now transformed Saturn into basically Opel USA to widespread acclaim in the auto press. It is time for these companies to consolidate and start leveraging their European designs. But the Latin American presence of Chevy is a very good thing for the future of GM (if there is to be one). Time to jettison all of the other brands in the US and just be Chevy.

2. VW has the biggest presence in Brazil dating back to the days of the Bug and the Combi (which is still made and very common in Brazil - making me wistful for my old bus). Fiat is relatively new, I'm told but now huge as well and the french companies are pretty big. But Japanese and Korean cars are not - they are just now trying to break in. This is curious given the fact that the largest Japanese ethnic community outside of Japan is in Brazil.

3. Brazil is a huge and amazingly diverse country and the three places I have spent time, Salvador, Sao Paulo and Rio are as diverse as California, New York City and Florida (in that order). You just can;t generalize too much about the county from a visit to any one place, and there is still the huge interior agricultural and ranching regions and the Amazon - it is a truly wonderful and wonderfully diverse country.

4. I was told by residents of Rio that though one often takes the admonitions to tourists to be careful in Rio lightly (must be an overabundance of caution one is apt to think), on the contrary, Rio is VERY dangerous and you have to be VERY careful. Hard to imagine living that way and one wonders why it is so hard to fix. A big clue lies in the fact that Brazil is a fairly rich country but one of the most unequal on earth.

5. Sao Paulo has got to be on par with NYC, Paris and London as world class dining spots. Yes, I said London - been there recently?

6. What do you do when land is enormously expensive but labor is relatively cheap? Well in one trendy Sao Paulo neighborhood, a new supermarket decided not to build a parking lot, but offer free delivery to your home.

7. A draft beer is called a "Chopp" and good luck finding anything but pilsners. I did try a Brazilian wine, but Brazil has a long way to go to catch up to the Argentinians and, especially, the Chileans.

Econ 101: External Economies of Scale

Note: I am back in the Oregon after a long trip home from Brazil. Much now to catch up on, but will try and keep the blogging active as much as possible because there is so much to talk about. Please be patient.

The New York Time's website this morning has a lead story with a fascinating headline: "Ford Says It Can Get By if Rivals Survive" Huh? Isn't being having bigger market share the goal of all auto manufacturers? If so, why not hope for your two domestic rivals to go away? Turns out, Ford is worried about something economist's call external economies of scale.

Scale economies are most often talked about as internal to the firm. As firms get bigger they can specialize workers tasks more more (a la Henry Ford) and make them more productive, they can get volume discounts on inputs, they can economize on warehousing and shipping costs, and productivity improving technology has a bigger payoff for bigger firms so they are willing to invest more in developing and utilizing such technologies (welding robots for example), and so on.

But there are also external economies of scale - efficiencies that occur when the entire industry is large. As the auto industry grows, suppliers of parts can also get bigger and exploit their own internal economies. So can the suppliers of raw materials for many of the same reasons listed above. Iron ore miners, steel manufacturers, stamping businesses can all become more efficient with greater scale that a large auto industry and the resulting large demand can provide. Also manufacturers of technologies like welding robots will have an increased incentive to come up with the next iteration of productivity improving technology because the payoff is bigger when there is a larger potential demand. Storage and shipping economies can also depend on the size of the industry.

So it is interesting that Ford believes that these economies will suffer if GM and Chrysler go under given the presence of many other manufacturers in the US (which would surely increase if GM and/or Chrysler went away). Ford also believes that the loss of these economies are more severe than the potential gain arising from market share - probably because the foreign competition is already fierce enough that it doesn't matter if GM and Chrysler are around.

Interesting times...

Happy Thanksgiving

Somehow the holiday goes unnoticed in Brazil...go figure.   So what am I thankful for today?  In the heart of the Sao Paulo business district the is a small but delightful little park, Parque do Trianon (Tenente Siqueira Campos)‎‎, that reminds you that you are not in America or Europe.  A tiny bit of the jungle amongst a cavalcade of cars and people that is a peaceful spot for contemplation and rest.  And so I did.

Two Thanksgiving thoughts from an economist:

One, today is the day for time inconsistent preferences - you eat too much even though you know that later you'll regret it.  And more power too you!

Two, spare a thought though for those across the world with not enough to eat - close to 1 billion by some estimates or almost 1/6th of the world.  And it is not because the world does not have enough food.  I am not saying this to be a downer on this festive day: not eating in America will not fix things precisely because it is not a shortage of food, but largely a shortage of proper institutions, mechanisms and peace to distribute food to those in need.  The solutions are not easy, but we mustn't stop trying.

Happy thanksgiving everyone.  I shall celebrate with a Feijoada.

The Best iPhone App Ever

Google Mobile App.  Go get it.  You can thank me later.  Of course it is quite likely that I am the last to know about this and you all already have it.  Such is my life.

Oregon Home Prices: OFHEO Data

The OFHEO has come out with its latest house price data. Remember that these cover much more of the US than the 20 cities of the Case-Shiller report, but are based home sales only with conventional mortgages. Anyway, we can see the data for Oregon cities, Oregon and the USA.

Here (a bit messy) is the raw data since Q1 of 2004:



Here (even more messy) is the quarter to quarter % change in home values:



Here is the overall depreciation (so positive numbers are bad in the sense that they represent loss of value) since Q1 of 2007 when the market in Oregon really turned:



Overall, it is bad, especially for Bend and Medford which are seeing collapses of California proportions, but overall the state is not doing too badly in relative terms.

Here is a nice picture from their summary report that shows the national picture. Oregon is the 35th best state in terms of home value appreciation (or limited depreciation):

Now That's a Bridge!

You want to spend on infrastructure? How about this for a new interstate bridge in Portland?

Ponte Estaiada Octávio Frias, São Paulo - Brazil

Another Look at the Case-Shiller Numbers

From the Wall Street Journal's Economics Blog:

Is Deferred Maintenance Spending a Good Idea?

Our Governor has proposed to President-Elect Obama that the federal government give us some dough to spend on deferred maintenance at our state universities.  Is this a good idea?

Well, if it means that outside construction contractors that are otherwise out of work would be employed to do a lot of it then it seems like a pretty good idea to me. Especially because right now with labor and machines being idle, we should be able to do the work at a pretty good price. If it is true that there is no advance planning that needs to be done ad that work could start tomorrow, then again, it seems like a god idea.  If it helps with the education of the state's college students, then its even better (it is not clear to me how much, but if science labs and such are a part of this then I can see some benefit). I am happy to volunteer my office to be the starting place.  

However, if the money is just transfered to universities who will use their already employed staff and divert other monies elsewhere, it is probably a bad idea.  Why, because then the multiplier effect of this spending will be severely muted and universities might benefit but not so much the Oregon economy.

Even better, I would like to see a discussion of the entire range of possible projects - university deferred maintenance, roads and bridges, scholarships, etc. -  the positive impacts of the projects themselves and the expected multiplier effect of the spending.  Let's make sure that if we spend money, we do it wisely.

Housing Market and Credit

The feds are still worried about the housing market (see post below for an idea of why).  So now they have another new plan to get credit going again, especially mortgages. Above is a chart of national average mortgages rates for 30 year fixed conventional mortgages.  This is the one credit market that has done fairly well all things considered (after the Fannie and Freddie bailout - oh, and don't blame Fannie and Freddie for the subprime crisis, the evidence clearly shows it was not they that caused the huge sub-prime glut) 6% historically is a great rate.  But clearly the feds think it needs to be even better to finally put a floor under the free-fall of the housing market.  

The bailout was in the beginning of September and you can see how mortgage rates responded sharply.  Then came Lehman Brothers bankruptcy in mid-september and the credit markets went nuts.  Mortgage markets have struggled since, but have mostly been pretty calm in November.  The bigger problem is that banks are unwilling to loan without a lot of collateral and fantastic credit, so the rate is only part of the story.

Anyway, the point of all this is that the plan today is supposed to try and staunch the bleeding in the housing market as exposed by Case-Shiller.  I wonder if it is a coincidence that they announced this today - the day of the C-S report?

Portland Housing Prices: New Case-Shiller Data

Here are the latest Case-Shiller home price data.  Portland is back to values last seen in February 2006, but is much better off than other cities.  All bets are off for the period ahead. In a normal slowdown I would not be worried, but this is not normal and I am very worried about everything.   

So, to give a little moderating perspective, here is the entire Portland Case-Shiller history:



So, what this shows is what we all know about real estate - it is almost always a good long term investment. We have had a bad year, but one year is but a blip in the grand scheme of things. It also suggests that we might be near the bottom based on long-term trends. But who really knows? Remember, however, that the near complete halt in new construction is providing a very strong supply response which helps prices recover. So though poor housing stars is bad news for jobs and growth, it is good news for the housing market (save for the fact that jobs and growth show up on the demand side as well).

Economist's Notebook: Helicopters

From my office at the Fundação Getulio Vargas in São Paulo, I look out on this view. Fortunately, I have a window that opens.  I am on the 13th floor and so I can hear the faint hum of the horrendous traffic below.  It soft and unintrusive.  What is intrusive is the noise of the multitude of helicopters flying all around (there is one on the top of the apartment building in the picture but a bit too small to see perhaps).  As FGV is right in the central business district, just off the Avenida Paulista, we are in seriously rich businessperson land.  And what do the super-rich do when the traffic in a city becomes too much?  Take to the air, of course!  As I flew into the small airport in the city you could see hundreds of helipads on the apartment buildings.  Its all about the marginal cost, marginal benefit calculation.  The marginal cost of helicopter travel is high and always has been, but the marginal benefit (avoiding hours stuck in traffic) is now very high as well.  So, yes, I can confirm that the legend is true - there are lots of helicopters flying around São Paulo.

Ironically, I was told that one of the most uncorrupt agencies here is not the police, who are corrupt but not too bad (unlike the ones in Rio who are pretty badly corrupt), but the traffic bureau who have a type of traffic cop who can issue tickets, etc. They are everywhere, making sure nothing happens to disrupt traffic.  Traffic is such a politically radioactive topic here, no politician can afford to have a corrupt and inefficient traffic bureau.  Again, its all about the incentives.  And they are efficient: an illegally parked car was causing a bit of a jam yesterday and so I saw the traffic bureau swoop in with a flatbed tow truck and remove it in seconds flat (with alarm screaming) they left a big sign on the curb that said "ILLEGALLY PARKED CAR HAS BEEN REMOVED." No ticket, no warning - boom - car gone.  

Note to self: never rent a car in São Paulo.