Mar

31

Boredom Alert

by Joshua Gans | Filed Under Academia | Comments Off

Boing boing reports on a device that will tell a person if they are boring.

The “emotional social intelligence prosthetic device” is a camera that clips on eyeglasses and feeds images to a small computer that uses image recognition software to characterize emotions. If the listener doesn’t seem to be engaged, the device vibrates to alert the wearer.

I suspect I might have been shaken to death by marginal revenue this week. This surely is in the category “you don’t want to find out this way.”

Mar

31

So now we are the evil foreigners?

by Joshua Gans | Filed Under Economics | 3 Comments

Daniel Gross in Slate raises alarmist bells at the thought that non-US firms were buying up government toll roads. One such firm is Australia’s Macquarie Bank. After the ridiculousness of the Dubai ports non-issue (with real effects), this is similarly silly. After all, US governments are putting these up for sale and non-US firms are bidding more than US ones to take the assets. And the problem with this is … um, that they aren’t American companies?

Gross worries that revenues that could have ended up staying in the US will be going outside in the future. Of course, don’t forget that similarly capital that could have ended up staying outside the US will be coming to it. Moreover, it is not like this was forced on anyone. Gross makes it sound like a foreign conquest, seizing future road revenues and leaving US citizens with a worthless pile of cash!

And why didn’t American companies win these bids? Gross has a ‘theory’:

Why aren’t American companies buying the roads and making the profits that are going to Cintra and Macquairie? Oddly, it may be because the toll roads are good investments—but not great ones. The long-term economics of these sweetheart deals don’t appeal enough to today’s quick-buck American investors. Big private-equity firms are sitting on piles of cash, and money is cheap. And yet they’re not bidding seriously on these lease deals. Ironically, the very factors that make the United States an appealing market for foreign investors—its size and stability, the security afforded by the rule of law—make it comparatively unappealing for some local investors. Macquairie and Cintra might be perfectly happy with 12 percent internal rates of return. But many big U.S. investors are seeking returns at twice that rate, which they believe can be found more easily in riskier markets like India and China.

Yes, you read right: they aren’t good enough investments for US firms? Well, if they aren’t good enough investment for US firms, how can they be good enough investments for US taxpayers? How could it be that the losses to the US are so great? These horrifically inconsistent arguments have no place in Slate.

 

Mar

30

Pharmaceutical prices and innovation

by Joshua Gans | Filed Under Economics, Innovation | 2 Comments

In new research, Alan Garber, Chad Jones and Paul Romer show how the system of co-payments for health insurance may encourage socially desirable use of pharmaceutical drugs. Drugs that are under patent are priced in a monopolistic way. This usually means that their use will be much lower than would be socially desirable: put simply, there may be consumers out there who are willing to pay for drugs more than the marginal cost of producing them but monopoly pricing is rationing them out of the system.

Garber, Jones and Romer point out that when patients are covered by health insurance, they do not pay the full price for drugs. They share the cost with their insurers through a co-payment. This means that a consumer is more likely to purchase a drug than if they had to bear the full price. This over-purchase tendency will counteract the under-purchase tendency that is coming from monopoly pricing of drugs. The end result could be socially optimal drug consumption.

In Australia, the government enacts this system but in a way that makes it more likely that the social optimum can be reached. Drugs that are covered by Australia’s Pharmaceutical Benefits Scheme (a scheme that has been operating since the 1950s) are sold to patients at a price equivalent to marginal cost (taking into account the costs of manufacturing and distributing the drugs). Thus, Australian consumers face (near) socially optimal incentives to use medicines.

The difference between the government scheme and private co-payments is critical. Under the US system, the pharmaceutical company is still able to set their own price and with the co-payment demand is even greater than they would have under monopoly. The end result is much higher profits from drugs. Indeed, as Garber et.al. show this can mean that drug companies have socially excessive incentives to innovate. They recommend capping drug prices to improve the situation.

In Australia, that already happens. Moreover, the cap is set with reference to the profits of pharmaceutical companies who can always opt out of the system if they want. As such, they will always receive at least their monopoly profits. In this way, innovation incentives are not diminished by the Australian scheme and, moreover, do not generate excessive incentives either.

Mar

30

Noise pollution in the air

by Joshua Gans | Filed Under Economics, Technology | 1 Comment

In today’s Financial Times, Jagdish Bhagwati (Columbia University) advocates dealing with the threat of mobile phones on flights. He likens the harm — to one’s mental state at least — as equivalent to smoking (remember that). Bhagwati argues that planes should have special booths that callers would go to to prevent noise pollution.

Interestingly, in many long haul flights phone calls have been an open for a long-time. They just cost a fortune and people don’t use them. It seems to me also that what is a problem for non-callers is a problem for callers; it is hard to hear on flights. Mobiles used for non-voice communication would alleviate all of this and that seems like something worth encouraging.

In any event, if mobiles were available on flights what might one do. It is fun to speculate on this. For instance, consider the following. Provide each passenger with a certain right to make calls — say for no more than 15 minutes. To make a call, they give their coupon to a flight attendant and then go for it. This will limit the total amount of noise pollution.

Then you can make those coupons tradeable. If you want to make more calls you are allowed to purchase coupons from your row — up to two seats either side. Then if your neighbour doesn’t mind the noise you will be able to find a price to trade. If they do, then your right is gone and that is that. This might generate a little more efficiency than Bhagwati’s proposal. Of course, it could also make the plane into a trading pit.

Actually, we could also allow passengers to pre-purchase a coupon up to a certain amount. Then if you want to limit noise in your row, don’t purchase one. But if you want to see if you can make a little dough, do so.

Mar

30

Is public transport doomed?

by Joshua Gans | Filed Under Transportation | 2 Comments

In today’s Age, Alan Moran takes issue with my idea that we should price roads and use credits to fund public transport. He writes:

In his article (Business, 7/3), Joshua Gans suggested an approach involving road pricing and making public transport free, for which he accepts an estimate of costs at $340 million a year.

He believes these two policies could considerably relieve congestion. It might well make sense to charge more accurately for the costs of the road space used at the time of that use. This is notwithstanding that people already pay twice as much in fuel and registration taxes as governments spend on roads.

Basically, he doesn’t see a need to favour public transport as many (including myself) have been suggesting. It is hard to say. It is theoretically possible that the car is actually optimal. Equally, it is theoretically possible that we should ban cars altogether. The truth is in the middle but something worth searching for.

Personally I think hybrid systems of the sort we saw in Minority Report are likely to be the best. But now that is just fiction …

Mar

29

Seriously, why don’t books have ads?

by Joshua Gans | Filed Under Advertising | 6 Comments

Over the weekend, I asked the question “Why don’t books have ads?” It certainly provoked a reaction and the leaped blogged into Andrew Norton (on Catallaxy) with more comments to boot!

One reaction which was not surprising was, because it would be terrible. However, that isn’t answer at all, that is a statement about what the world might be. My question is more targetted. If publishers (and authors) can profit from books in ads, why don’t they have them? It is all about the money.

Here were would be explanations and my response:

  • Readers would not buy books: just as some people don’t watch TV because of ads, of course some people would not buy books. But how many? Could it really be that most of the population is happy to see ads everywhere but a good book they will not read if they see a single ad? Add to that the cheaper price of books and this one doesn’t stack up.
  • Authors would not write books: of course, some authors may want to distance themselves from grubby commercial stuff. Of course, I don’t know any author who refuses to let their publisher promote their books! Again, this can’t apply to all authors. Indeed, if ads were to make my textbooks cheaper, then I am all for it. Not to say that I would want to see a cigarette ad but an ad from a consulting firm as to how good an employer they are, sure.
  • Readers would not look at ads: in many respects, it is always surprising to me how much people look at ads in newspapers, tv, radio etc. It is not at all clear that books are anything special. Indeed, a book with a single ad in it will have that noticed. Even where there were instances of ads in books, such as for other books by the same author or publisher, they are noticed.
  • Books have small print runs: then the ad rates will be low. Ads are paid for by eyeballs. Low eyeballs means low ad revenue but it doesn’t mean no ad revenue.
  • Some books have (had) ads; travel guides, help books and self-promotion: these are interesting but are still small enough that my question’s premise is still justified. Nonetheless, it is interesting to think about why self-promotion ads happily appear in books. By the way, they are not in the Harry Potter series but I suspect that is author intervention. But they are in lots of other children’s books. Perhaps my question could be rephrased: why don’t books sell ads?
  • Advertisers demand glossy colour ads that it would be too costly for books to provide: this doesn’t seem at all plausible a reason. First, there are many books that are colour and glossy (my Principles of Economics book for one). Second, a page of colour printing in a book will cost the same as a page in a magazine. The issue is that in one case the publisher gets the revenue to cover it and in another it does not. Third, not all ads are colour glossy. Google is the biggest ad seller in the world and they are as plain as plain can be.
  • Ads are time sensitive, books are not: Let’s compare this with magazines. First, I am not sure ads are all necessarily that time sensitive. All the marketers tell me is that to get brand names that are lasting is key. How could it be that a corporate image is fleeting? Remember ads are not simply to inform about current promotions but to build recognition, value of association, etc. All this might make them very suitable for books. Second, not all books are so long lived. Textbooks go out of date. Bestsellers have their limited life. And books can be reprinted to update the ads. Compare this to the magazines still sitting in waiting rooms over the world. (Also, as we move to e-books, then ads can potentially update over time but I admit that that is the future — more on this below).
  • Advertisers would not buy ads because they cannot control their impact: this suggested that there was something intrinsically uncertain about the nature of book readers that isn’t shared by other media. Now it may be that because of the lack of ads in books they do not have the more sophisticated ratings data of TV, radio and newspapers but how hard would it be to build that up? Even if a book turned out to be selling to a surprise demographic, the ads could be changed in reprints.

In summary, many of these answers are explanations as to why all (or most) books do not have ads but not explanations as to why (virtually) none have them. As an economist, I like thinking at the margin. That is a powerful tool as it usually leads to a conclusion that we are not at corners. When something doesn’t occur, there would be a glaringly obvious explanation. Here, I have yet to find it.

Put simply, the current state of affairs does not seem robust. One publisher of one book somewhere should be able to find a price at which they can sell one page of that book to one potential advertiser out there. That we don’t even see that is the real puzzle, let alone a more ubiquitous state of affairs.

That said, I think change is coming. E-books will get around even the most salient explanations posted by blog commentators. Advertisers will be able to embed hyperlinks in the margins of e-books. They can be updated and moreover the advertisers could pay for ads viewed so there would be no issue of monitoring.

Hang on a second. Someone has already thought of this. Click here and scroll to the bottom of the page for the future.

Mar

28

Government must put right health insurance pains

by Joshua Gans | Filed Under Economics, Regulation | Comments Off

It took a little while but my earlier post on health insurance premiums (from 25th February) was published in The Age today. I argue that current regulations of health insurance premiums are, to say the least, poor and highlight the problems with our current health insurance system.

Mar

26

Bent bananas

by Joshua Gans | Filed Under Economics, Parenting | 1 Comment

With the banana crop in Australia devastated, one would have thought that, while banana prices might rise somewhat, they would be available over the next year. Not so! There is a ban on imports of bananas, so they won’t be available for nine months. And why would the ban continue? Apparently, the risk of exotic pests.

The government’s reaction is that we can do without. Now, isn’t that interesting? Parents would know that we can constantly fed a line of the importance of bananas for childhood health and nutrition. They are ‘near critical brain food.’ The line is fed by Banana Growing Associations as well as governments around the country.

So what is it? Do we need to buy a banana a day for our children or not? If not, then I guess Federal Agriculture Minister, Peter McGauran, is right when he says that: “People will have to understand that their unsatisfied yearnings for bananas are infinitesimal …” But, if so, then a responsible government surely has to find a way to overcome the supply problem. Perhaps we need to stockpile dried fruit in the future.

This time I don’t think you can bend (!) the truth and have it both ways.

Mar

26

Where is the Power?

by Joshua Gans | Filed Under Economics, Technology | 2 Comments

The Economist this weeks reports on Gillette’s five bladed razor and demonstates that if you graph number of blades against time you get a hyperbolic curve. This is a steeper version of the Power Curve (famously applied to microchips).

The D-Generation famously speculated about a 16 bladed razor many years ago. From the Chaser:

The first blade distracts the hair, while the second and third blades sneak up behind it, cutting off any escape routes. The fourth and fifth blades attempt to coax the hair from its hiding place using modern modern counselling techniques while the sixth blade, posing as a passing motorist, acts as a decoy, allowing the seventh and eighth blades to swoop down and quickly overpower the hair. The ninth blade, disguised as a postman, administers a small dose of chloroform, allowing blades 10 through 13 to remove the hair and escort it away for further questioning. The 14th blade informs the hair of its rights. The 15th blade handles the paperwork and the 16th blade, well, it’s just along for the ride.

It was quite a sight to see if I recall.

If the hyperbolic path holds, we will see it, in actuality, around 2012. If course, what might actually occur is more like the S-curve where the blade-rate falls off at some ‘natural’ limit. The problem, as you can see, is no one can predict that limit.

Mar

25

Weighty pricing decisions

by Joshua Gans | Filed Under Economics | Comments Off

Thanks to Marginal Revolution, here is a report on a German hotel weighing guests and charging them by the pound. OK, but are they weighed coming in or coming out. If the latter, won’t that reduce incentives to hit the mini-bar?

Mar

25

Why don’t books have ads?

by Joshua Gans | Filed Under Advertising, Economics | 10 Comments

This is the start of stream that I think will take a little while to resolve. Recently, I have been researching on the role of advertising in selling information content (most notably, television). While preparing a presentation on this I wanted to summarise options with a traditional 2×2 diagram (the staple of MBA courses).

Here are the dimensions: (pay or not) for content versus (ads or not). And some examples:

  • Free/Ads: broadcast television/radio
  • Free/No ads: public broadcast television/radio
  • Pay/Ads: pay TV, newspapers
  • Pay/No ads: DVDs (some), books

It is the last one that got to me: books. Why don’t we see ads in books?

The reason I was interested in this is because it seemed to me that if you were selling information and there were advertisers willing to pay to be part of it, then you would be better off by selling some advertising space, reducing books prices and selling more books. [Stay tuned for a formal, technical proof] But, of course, we never see advertising in books.

So why not?

  • Too costly to print: doesn’t seem plausible as magazines find that OK and they have colour glossy ads
  • Readers won’t look at ad: but if The New Yorker or The Economist can have ads, why not some trashy or popular novel? Why not a textbook?
  • Authors won’t wear it: well, maybe JK Rawlings, but Dan Brown or Michael Crichton or some unknown.
  • Publishers don’t want it: if there is profit in it, why would this be the case.
  • Libraries won’t wear it: OK, then provide a special version for libraries without ads. Often they are charged more anyway.

As you can see, it is a real puzzle as to why there are no ads in books. Actually, some books have ads for other books but why not Coke?

Actually, it gets worse. Think about a textbook such as mine. If you put ads in a textbook, the good news for publishers is that they last beyond the one reader even as textbooks are sold and resold on second hand markets. In contrast to the purchase price, this is a stream of revenue that is robust to resale.

I can’t provide you answer here but apparently a few have asked the same question before. Jason Kottke had a “horrible thought” in 2003: what if books had ads? An interesting debate ensued but no one really provided an answer as to why publishers/authors do not find it profitable even if the world might be a worse place as a result.

One thing that was pointed out was the product placement had occured in books (as they do in movies). Here is an example. Of course, that is somewhat more costly than ads and easier to see why it is not more common.

There were also some examples that publishers may have tried this before. Here is an example from 1971. These historical bits are worthy of more investigation than I have had time to do yet.

But more recently, in February, 2006, Harper Collins allowed one book to be provided free on the author’s website while also selling it the traditional way. The publisher and author agreed to share the ad revenue generated by the site traffic. The book is Go It Alone by Bruce Judson. You can read it here. It is basically a self-help book for would be entrepreneurs.

Apparently, Russian and Urkranian authors got in on the act earlier.

Anyway, I’d appreciate any comments you might have on this issue.

Mar

24

Global IP has the IP

by Joshua Gans | Filed Under IP, Strategy | Comments Off

IP telephony has arrived although it is hardly ubiquitous. Skype has the most hype but as most people know, Yahoo’s messenger was not far behind. This week Yahoo announced a service that would allow you to call ordinary phones (just like Skype) at the same rate as Skype (2 cents per minute). Google, Microsoft and AOL are all to follow. This all suggests that this will be a highly competitive business and none of these firms will end up making any real money from it.

However, a footnote to the Yahoo! announcement was that it had selected Global IP Sound to imrpove its sound quality. Who are these people? Well, they also supply the same technology to Skype, AOL, Nortel among others. Maybe there is a winner here after all.

Looking at GIPS’s stock price, and the news barely rated. So there is probably more here than meets the eye. Nonetheless, Global IP Sound is something to watch for.

Mar

24

PlayStation 3 to ship region free!

by Joshua Gans | Filed Under Economics, Technology | Comments Off

From Engadget comes news that the PlayStation 3 will ship region free. This is a very significant move as Sony has long been resisting such moves. It signals the game and DVD region coding may finally be coming to an end.

The interesting question is: why now? Region coding allows Sony to price discriminate. Of course, there are currently work arounds. For games, in Australia, it is legal to modify consoles to play games from any region. A few weeks back, a committee of the House of Representatives endorsed those opportunities even if they pose piracy risks (see my earlier post on this). Thus, Sony’s move would shut this down along with piracy risks associated with current practices.

But the other side of the coin is that, when it comes down to it, the price differentials that Sony might want are not that much different from the shipping and transaction costs associated with international purchases of games. Thus, Sony can utilise price discrimination to some degree anyway. This move will constrain them but perhaps they were already constrained.

Anyhow, the news today aside, it will be interesting to see how this all really pans out once PlayStation 3 is launched.

Mar

23

Storming the iTunes Music Store

by Joshua Gans | Filed Under Competition Policy, IP, Strategy, Technology | Comments Off

France has passed a law that requires suppliers of content (most notably Apple’s iTunes Music Store) to provide information that is essential for ‘interoperability.’ Currently, purchases from Apple will only play on iPods, PCs and, of course, Macs, but not on other MP3 players and systems. The intent of the law is to require Apple to provide a means of making their downloads playable on alternative systems.

I have noted before that, in an ideal world, this might not be a bad thing for Apple. It will only encourage more sales from its store and may not make such a difference for iPod sales (after all, most music on iPods does not come from Apple, it is from peoples’ own music collections).

Of course, the world is not ideal. It seems reasonable to suppose that Apple’s agreement with music publishers is contingent upon downloads being in their DRM format. Moreover, it is also likely that Apple would be contractually prevented from providing ‘work arounds’ as the French law would require. So what will happen?

There are several possibilities:

1. Apple exits France.

Notice that this won’t happen immediately. Someone has to make a claim against Apple. They have to then demonstrate the ‘interoperability’ is possible but it is unclear whether this can be modified for piracy concerns.

Moreover, even if that is done, Apple could argue that its downloads are already interoperable. Why? You can burn a CD from iTunes in the original CD format. Then you can load it back to the computer in MP3 format; something playable on most systems.

2. Apple partially exits France

Apple could modify its iTunes Music Store in France to supply content that does not require DRM (e.g., podcasts and independent music publishing). This would leave it with a presence as well as sending on on-going message that French customers are being disadvantaged by the French government.

This is not usually Apple’s style but then again, they did launch the Australian iTunes Store without Sony initially. Australians knew where the blame lay there.

3. Apple finds a way to provide interoperability.

If it is potentially in Apple’s interest to open up the system, it could provide interoperability. Imagine what would happen if it found a way to do this that was proprietary. Then its music store would have a considerable advantage over others and it would retain its dominance there. Thus, there are big incentives to innovate on that dimensions.

So, in summary, given this, the immediate exit notion seems very unlikely to me. It also seems that this will not have long-lasting effects on innovation. It just sends a signal to the music industry: worry about DRM but also worry about providing competition. We want to find out if we can have our brioche and eat it too.

Mar

23

Patent trolls (continued)

by Joshua Gans | Filed Under IP | Comments Off

It took a little while but others are getting in on the patent troll discussion. A few weeks back, in the light of the Blackberry/NTP settlement, I speculated whether patent trolls were receiving a bad rap. The argument likened them to middlemen who saved legitimate innovators time in securing intellectual property rights.

Now the New York Times and Wall Street Journal have gotten in on the act. The WSJ points to the general flaws in the patent system including the process of patent examination. Specifically, it points out that, in many respects, most universities are like patent trolls — securing patents but not commercialising innovations. Indeed, in that respect, Universities are exactly like trolls in that they have fortunately gone and secured IP protection. In the past, their innovations might not have even been brought to that stage. And without that commercialisers would have no chance in securing IP before launching products (as the ideas would already have been deemed to have been invented).

Mar

21

Of Cylons and Television

by Joshua Gans | Filed Under Strategy, Television | Comments Off

I just came across a 2005 article by Mark Pesce on “How Battlestar Galactica Killed Broadcast TV.” He speculates that downloaded television can embed advertisements in a more efficient way than broadcast television. A very interesting read.

All the more so for it is asserted that Australians are the most prolific downloaders of television in the world. That this is so is not that surprising; they have to endure the longest gaps between broadcast elsewhere and broadcast in Australia. In some cases, the lag is so long that the DVD is already released well before a show is broadcast (e.g., The West Wing and, dare I say it, Battlestar Galactica).

Pesce’s second article on “The New Laws of Television” is also good.

Mar

20

Back inside the box: A significant anniversary

by Joshua Gans | Filed Under Economics, Technology | 1 Comment

Next month is the 50th anniversary of a truely significant economic event. On the 26th April, 1956, a converted tanker was loaded with 58 modified, 35 foot truck containers and sailed from Newark (NJ) to Houston (TX). It was significant for two reasons. First, the containers had been filled and sealed inland, loaded on trucks and loaded onto the deck of the ship without being refilled. Second, the whole process involved a single contract.

Thus began the containerisation revolution. Malcolm McLean who bet his trucking fortune on this founded Sealand; the major cargo shipping company of the next 50 years.

I became interested in the container as an innovation about 15 years ago when sitting in class taught by Nathan Rosenberg (on the history of innovation). He commented on the widespread impact of containerisation but the fact that the innovation was simple; “just a box.” I was sceptical that simplicity could lead to such revolution and set out to investigate.

The results of my investigation were published in 1995 in Prometheus. Here is a link to the paper. And the answer: well it wasn’t so simple. There was alot to do to make containerisation profitable. Ships had to be redesigned (the first was introduced in Australia in 1964). Contracts had to be re-written. Ports need overhauling. Unions needed busting. Logistics and reinforced steel had to be invented. And finally, a tipping point had to be reached. So it wasn’t “just a box” at all.

When I wrote my paper, not much had been written about the container. It took me a little time to attribute the whole innovation to Malcolm McLean. Next month a new history by Marc Levinson, The Box: How the Shipping Container Made the World Smaller and the World Economy Bigger, will be published by Princeton University Press. I can’t wait.

Mar

18

Under the cover

by Joshua Gans | Filed Under Academia, Other | Comments Off

Having a hard time fending off people in the train when you are reading Core Economics for Managers? You know, all those people who want to know where you purchased it. Try this courtesy of Freakonomics.

My favourite is: “How to murder your Professor and get away with it”

Mar

18

Busy tooth fairies

by Joshua Gans | Filed Under Parenting | 3 Comments

In the last couple of days, I have spent considerable energy thinking about the tooth fairy. It is our own fault really. On Thursday, our daughter lost her sixth tooth. On Friday morning, she woke up to tell us that the tooth fairy hadn’t come. And then trouble ensued.

My initial reaction to this sad news was to go up and check her ‘tooth box’ carrying money in my hand in a vain attempt to suggest that she had just missed it being bleary eyed in the morning. This plan was aborted when I opened the box to find, well, a tooth. Obviously, to take the tooth now would be a tad too obvious.

On to plan B; imaginative lying. We settled on, “obviously, lots of children must have lost teeth on Thursday and the tooth fairy is just one fairy and can do so much. She will be here tonight.” Our daughter bought that and, indeed, when discussing the incident with a friend, it turned out the same thing had happened to him once. (We must remember to thank the parents!)

A colleague of mine recounted to me his ‘imaginative lie’ when faced with a similar dilemma. He said to his daughter (and I am not making this up), “Oh, I came into your room last night and saw a bright thing buzzing around that looked like a firefly and so I swatted it.” It wasn’t clear that that was to death or just away but his daughter was suitably (and understandably) horrified.

In that light, our lie is much more tame. However, that didn’t stop another parent being horrified with me as I recounted the day’s incident: “how could you just lie to your children?” Ahem, it is the ‘tooth fairy’ we are talking about here! I think I have a pretty much free license on that one.

To continue the story, we almost forgot again on Friday night, but got this just in time. We have so many more teeth to come amongst our three children, this is bound to be an on-going issue.

This led me to think about the whole tooth fairy thing. From an efficiency standpoint, it would be much better if a child could present a tooth to us and receive cash on the spot. No running around at midnight searching for coins. It also saves on other inefficiencies. This time around our daughter ended up with New Zealand currency (I had just returned from there and it was lying about). If she asks about it I’ll embellish our original lie. “The Australia tooth fairy has been busy, as you know, and so probably asked the New Zealand one to come in and help out.” As you can see, globalisation works out for the general good again.

How did we end up in our current situation? According to Wikipedia, the tooth fairy has origins in the United States around 1900. But it really appears to have taken off in Western cultures post-WWII. Suggestions allude to the value of myth and how children like story telling as a rationale for the tooth fairy. But that doesn’t ring true.

When it comes down to it my daughter knows exactly where the money is coming from but is quite happy to ‘play the tooth fairy game’ if only for the benefit of her younger siblings. So there is no sense of wonderment there. Just the usual raw economic calculus.

My hypothesis is that the ‘tooth fairy deal’ persists because it is an excellent incentive device. When a child has a loose tooth, there is a possibility that it may not come up necessitating more drastic action. This might be a parental intervention (you know, the string and the door trick) or worse, an expensive trip to the dentist. What can stop this is if the child endures a little bit of pain and wiggles the loose tooth. To provide an incentive for this action, we offer some money for the tooth. Saving a $50 dentist bill for a dollar or two a pop seems like a good deal.

Indeed, we know of a child who was two days from going to the dentist who was offered (and it is not quite clear how this fits in with the tooth fairy lie) $20 if they could pop the tooth that day. Surprise, surprise that is just what happens. I pity those parents, however, on what will happen with the next tooth. The child will anticipate the dentist deal and wait until the last minute. Much better to hold the strict tooth fairy line.

This all leads me to think more about other economic issues associated with tooth fairies. What drives the price of a tooth? Does it drift with the rate of inflation or the cost of dentists? What about the mechanism for the exchange (tooth under pillow versus tooth in cup of water versus, our solution, tooth in special box)? All interesting questions that I’ll need to return to at some point.

Mar

17

Incentives to bus

by Joshua Gans | Filed Under Economics, Transportation | Comments Off

Here is an interesting report in Slate about Chilean incentives for bus drivers. As usual, there are costs and benefits to incentivising anyone.

Mar

17

Age: Fee change gets too much credit

by Joshua Gans | Filed Under Regulation | Comments Off

The Age today published an opinion piece I wrote on credit cards. You saw it first here earlier in the week.

Mar

15

Apportioning credit on card reforms

by Joshua Gans | Filed Under Regulation | 3 Comments

An article in The Age today reports on a Conference on Payment Systems held at Melbourne Business School, yesterday. Here is a link to the conference site. From the article, one would get the impression that the Reserve Bank was under fire over those reforms with hard hitting criticism coming from all quarters.

I was there and spoke at the conference and that wasn’t my impression at all. In 2003, Australia enacted a set of reforms to the credit card system that from a regulatory standpoint, were dramatic. Prohibitions on surcharges for credit card transactions were removed, access to card schemes opened up and, most critically, the interchange fee — the fee that banks pay each other to settle card transactions — was cut by one half. The last change was significant. Not only was this industry now subject to price regulation but a sharp change in a key price. Now central banks enact sharp changes all of the time in interest rates but for regulatory price setting (e.g., by the ACCC) this kind of thing is unheard of.

The article gives the impression that the predicted massive disruption to industry actually ensued. But that is hardly the case. Dramatic reform has appeared to add up to dramatic non-reaction. Without going into too much detail but according to the Reserve Bank’s own figures, credit card usage (by value or number) has continued to grow at historic rates, credit card debt has grown along with it and the share of credit card use to EFTPOS use has remained roughly constant. Take a look at this graph:

This last point is significant as The Age article suggested that in fact EFTPOS was rising at the expense of credit cards. But this has only occurred in the last quarter; 3 years after the reforms. For all we know it is just a statistical blip.

The most that might be said for dramatic change is that it is still to come. Professor Jean-Charles Rochet (speaking at the conference and one of the most influential academics in this area) raised this possibility; especially considering the long-run effects on investment. What the reforms have potentially done is shifted profits from card issuers (who deal with cardholders) to card acquirers (who deal with merchants). In this case, issuers will have a reduced incentive to invest in the system while acquirers will have a greater incentive. Rochet’s point is that we don’t know if this is a good thing or not and so should have been more cautious about regulatory intervention.

In my opinion, there is less to be concerned about in the long-run than industry participants are making out. Specifically, the interchange fee is but one means that banks might use to share costs of mutually beneficial investments. They need not use this at all and simply agree to alternative funding arrangements. Moreover, these would not be built into the cost of each transaction and would be instead based on forecast profits and the like; just as normal businesses do everyday. That should not deter investment that would assist the credit card system.

It seems to me that the main risk comes from taking the regulatory interventions here too seriously. There are some many other alternatives that this one price just doesn’t really matter. What matters is regulatory uncertainty. Everytime that price is changed, there are consequences and costs on market participants. So uncertainty about whether it is going to change or not will have a ‘chilling’ effect on activity and arriving at mutually beneficial arrangements. Some of this uncertainty comes from continuing RBA reviews. Other uncertainty comes from legal action lauched in relation to those reviews. It would be better if regulators and participants could regulate the interchange fee and just move on.

Indeed, for 20 years, the banks themselves practiced this. At the beginning of the establishment of the BankCard system, the banks set the interchange fee at a nice round number. They then didn’t do anything more until the RBA and ACCC started sniffing around. The very rigidity tells me that the fee is not important as an instrument for changing circumstances; large scale change occurred anyway over this period. What we want to do is return to rigidity.

Mar

14

Opening up iTunes

by Joshua Gans | Filed Under Competition Policy, Technology | 5 Comments

France are considering opening up iTunes to other devices. At present iTunes downloads are in Apple’s proprietary format. Originally this was important in securing appropriate digital rights management to effectively establish the legal downloads market. Nowadays that isn’t an issue as other formats provide the same thing.

The problem is that iPods only play Apple’s format or the open mp3 standard. They do not play standards that are supported, for instance, by Microsoft. Other players do this but cannot play using Apple’s standard.

The French law will make it legal to utilise software to convert songs from one format to another. This would allow users to purchase songs from iTunes and play them on devices other than iPods or with programs other than iTunes. Thus, the link between Apple’s dominant share of music purchases and players would be broken.

There are suggestions that Apple will shut down its iTunes store in France in response to this. It may have to if its agreements with copyright holders cannot be amended. But if it had a choice would this really harm Apple. After all, it would make the iTunes music store more attractive and there are plenty of substitutes for its iPod anyway.

Of course, the alternative to the French approach would be for Apple to open up iPod to alternative formats. This would allow consumers to purchase music from alternative sites. This would also likely make it easier for competition to trancend national boundaries — something it isn’t doing today (see this article for a discussion). From where I sit, that is where the big gains to competition lie.

Mar

14

Google Mars

by Joshua Gans | Filed Under Technology | Comments Off

How long before we can locate the nearest Starbucks? (Google Mars)

Mar

14

Deal or no deal

by Joshua Gans | Filed Under Game Theory | 1 Comment

You just knew ‘Deal or No Deal’ was amenable for the study of rational economic decision-making. Here is a write-up and links to some new studies of the game show.

Here is a link to an on-line version of the game. Of course, it isn’t really what happens as it seems to me there is a strategic player playing the role of the ‘bank.’ Their payoff function will take into account the observed risk profile of the contestant as well as maximising the watchability of the show. It would be interesting to think of what strategies that ‘bank’ might employ.

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