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December 23, 2007

Economist's View - 4 new articles

Be Evil?

I don't think Aaaron Edlin is a big fan of the market power exploiting profit maximizers at Microsoft:

System That Stole Christmas, by Aaron Edlin, Project Syndicate: Before asking for a new Windows PC this holiday season, remember the old adage: ''Be careful about what you wish for."

In the best of all worlds, we would all benefit from the so-called ''network effects'' that result from most people using the same software: everyone could easily communicate with each other and teach each other how to use the software efficiently. Unfortunately, since Microsoft uses network effects to maximize its profits rather than to benefit users, the world it delivers is far from the best.

Consider Vista, yet another "great" new operating system that Microsoft rolled out this year, together with Office 2007. The first person at my company to use Vista was our Executive Vice-President. He was furious. Vista and Office 2007 came with his new Dell computer by default. Dell didn't ask: "Would you prefer the old versions of the operating system and MS Office that you know how to use?" So our VP got a shiny new computer that he didn't know how to use: functions were rearranged, and keyboard shortcuts were different.

Think of the productivity cost of millions like him having to adjust to a new system. Moreover, his coworkers couldn't read the Microsoft Word files that he sent them in the new ".docx" format. They wrote back and asked him to resend files in the older ".doc" format ― which might not have worked if he had inadvertently used some new-fangled formatting feature.

To be sure, Microsoft does provide a patch that allows old versions of Office to read the new ".docx" format. But Microsoft doesn't publicize it ― or warn you if your Office 2007 file is about to become incompatible with older versions.

While Microsoft could have kept the traditional ".doc" as its default format for MS Word, this would not have served its purpose: eventually, after enough of the world pays for Office 2007, holdouts will be dragged along, kicking and screaming. Then, in four or five years, Microsoft will begin our agony all over again. ...

Whenever Microsoft rolls out a new operating system, the question is not whether you should switch, but when. Adding new features can speed the transition, but what is necessary is only that the new system be incompatible with existing systems in certain respects, and that a sufficient number of people expect that it will become the new standard.

Of course, creating new software is costly. So why should Microsoft bother?

The Nobel laureate Ronald Coase answered that question long ago. According to "the Coase Conjecture," a monopolist selling a durable good must sell it at marginal cost. For Microsoft, the problem is that the marginal cost of software is zero. As a result, Microsoft cannot extract anything close to its full monopoly rents unless it sells upgrades. ...

So, by creating incompatibilities, some subtle and some obvious, that make its old software obsolete, Microsoft can sell its operating systems at high profit margins without fear that people will wait until the price drops. The price will never drop, because Microsoft will just roll out a new system, again at high profit margins.

Microsoft has been in antitrust trouble for 15 years, and ... it will probably be in trouble again. When that happens, I hope the antitrust authorities will consider a remedy that Ian Ayres, Hal Varian, and I devised.

Suppose Microsoft had to license its old software freely whenever it brings out a new version. This would give the company an incentive to ensure that new versions are compatible with and significantly better than old versions ― otherwise the new versions wouldn't sell, or at least not easily. If Microsoft's new software had to compete successfully at least against its old software, we would know the world was improving.

In the meantime, I recommend installing the Microsoft patch to your old computer and just suffering the devil you know.

"Life after Peak Oil"

According to Gregory Clark, running out of fossil fuel may not reduce living standards by as much as you might think:

Life after peak oil, by Gregory Clark, Sacramento Bee: Oil prices have receded from their recent flirtation with $100 a barrel, but ... increased demand, high prices and the prospect of an eventual peak in oil production has caught Americans paralyzed between ... the fear that rampant consumption of oil and coal is irreversibly warming the Earth and the dread that without cheap oil our affluent lifestyles will evaporate. ...

Study of the long economic history of the world suggests two things, however. Cheap fossil fuels actually explain little of how we got rich since the Industrial Revolution. And after an initial period of painful adaptation, we can live happily, opulently and indeed more healthily, in a world of permanent $100-a-barrel oil or even $500-a-barrel oil. ...

Many people think mistakenly that modern prosperity was founded on this fossil energy revolution, and that when the oil and coal is gone, it is back to the Stone Age. If we had no fossil energy, then we would be forced to rely on an essentially unlimited amount of solar power, available at five times current energy costs. With energy five times as expensive ... we would take a substantial hit to incomes. Our living standard would decline by about 11 percent. But we would still be fantastically rich compared to the pre-industrial world. ... Our income would still be above the current living standards in Canada, Sweden or England. Oh, the suffering humanity! At current rates of economic growth we would gain back the income losses from having to convert to solar power in less than six years. ...

The ability to sustain such high energy prices at little economic cost depends on the assumption that we can cut back from using the equivalent of six gallons of gas per person per day to 1.5 gallons. Is that really possible? The answer is that we know already it is.

The economy would withstand enormous increases in energy costs with modest damage because energy is even now so extravagantly cheap that most of it is squandered in uses of little value. Recently, I drove my 13-year-old son 230 miles round-trip ... to play a 70-minute soccer game. Had every gallon of gas cost [considerably more], I am sure his team could have found opposition closer to home.

The median-sized U.S. home is now nearly 2,400 square feet, for an average family size of 2.6 people... Much of that heated, air-conditioned and lighted square footage rarely gets used. Cities ... that were developed in the world of cheap gas have sprawled across the landscape so that the only way to get to work or to shops is by car...

Some countries in Europe, such as Denmark, which have by public policy made energy much more expensive, already use only the equivalent of about three gallons of gas per person. I have been to Copenhagen, and believe me the Danes are not suffering a lot from those the daily three gallons of gas they gave up.

But can we get down to 1.5 gallons without huge pain? We can see even now communities where for reasons of land scarcity people have been forced to adopt a lifestyle that uses much less energy – places like Manhattan, London or Singapore. ... Housing space per person is much smaller, people walk or take public transit to work and to shop, and energy usage is correspondingly much lower, despite the inhabitants being very rich.

So the future after peak oil will involve living in such dense urban settings where destinations are walkable or bikeable, just as in pre-industrial cities (the city of London in 1801 had 100,000 inhabitants in one square mile). Homes will be much smaller... Nights will be darker. We will not have retail outlets lit up like the glare of the midday sun in Death Valley.

Such a lifestyle is not only possible it will be much healthier. We are not biologically adapted to the suburban lifestyle... – lots of cheap calories delivered right to your seat in the SUV that shuttles you from your sofa at home, to your chair at work, to the gym where you try and work on your weight problem. ...

So life after peak oil should hold no terror for us – unless, of course, you have invested in a lot of suburban real estate.

The New Gilded Age

An article in The Economist raises familiar objections to evidence of rising inequality and claims that people such as Krugman have been misled on the issue. Krugman, in response, explains the "four dodges" present in the article and I added a couple of points in rebuttal as well:

The new (improved) Gilded Age, The Economist: ...Paul Krugman ... has recently argued that contemporary America's widening income gap is ushering in a new age of invidious inequalities. But a peek at the numbers behind the numbers suggests that Mr. Krugman has been misled: far from a new Gilded Age, America is experiencing a period of unprecedented material equality.

This is not to deny that income inequality is rising... But measures of income inequality are misleading because an individual's income is, at best, a rough proxy for his or her real economic wellbeing. ... Consumption surveys, which track what people actually spend, sketch a more lifelike portrait of the material quality of life. According to one 2006 study, by Dirk Krueger ... and Fabrizio Perri ..., consumption inequality has barely budged for several decades, despite a sharp upswing in income inequality.

But consumption numbers, too, conceal as much as they illuminate. They can record only that we have spent, but not the value—the pleasure or health—gained in the spending. A stable trend in nominal consumption inequality can mask a narrowing of real or "utility-adjusted" consumption inequality. Indeed, according to happiness researchers, inequality in self-reported "life satisfaction" has been shrinking in wealthy market democracies ... suggesting that the quality of lives across the income scale are becoming more similar, not less.

You can see this levelling at work in markets for transport and appliances. You no longer need be a Vanderbilt to own a refrigerator or a car. Refrigerators are now all but universal in America, even though refrigerator inequality continues to grow. The Sub-Zero PRO 48, which the manufacturer calls "a monument to food preservation", costs about $11,000, compared with a paltry $350 for the IKEA Energisk B18 W. The lived difference, however, is rather smaller than that between having fresh meat and milk and having none. Similarly, more than 70% of Americans under the official poverty line own at least one car. And the distance between driving a used Hyundai Elantra and a new Jaguar XJ is well nigh undetectable compared with the difference between motoring and hiking through the muck. ...

This compression is not a thing of the past. ... Wal-Mart's move into the grocery business has lowered food prices. ... As a rule, when the prices of food, clothing and basic modern conveniences drop relative to the price of luxury goods, real consumption inequality drops. But the point is not that in America the relatively poor suffer no painful indignities, which would be absurd. It is that, over time, the everyday experience of consumption among the less fortunate has become in many ways more similar to that of their wealthier compatriots. A widescreen plasma television is lovely, but you do not need one to laugh at "Shrek". ... New technologies and knock-off fashions now spread down the price scale too fast to distinguish the rich from the aspiring for long.

This increasing equality in real consumption mirrors a dramatic narrowing of other inequalities between rich and poor, such as the inequalities in height, life expectancy and leisure. ...

Some worrying inequalities, such as the access to a good education, may indeed be widening, arresting economic mobility for the least fortunate and exacerbating income-inequality trends. Yet even if you care about those aspects of income inequality, the idea can send misleading signals about the underlying trends in real consumption and the real quality of life. Contrary to Mr Krugman's implications, today's Gilded Age income gaps do not imply Gilded Age lifestyle gaps...

Here is Paul Krugman's response:

Inequality denial, by Paul Krugman: Well, there they go again. The Economist has a piece asserting, as a critique of Conscience of a Liberal, that rising income inequality hasn't translated into a big rise in social inequality. It's actually an argument I take on explicitly in Chapter 12 . But The Economist nonetheless rounds up the usual suspects.

Inequality denial generally involves four dodges — all four of which are present in this article.

First is a narrow technical issue — the misuse of the Consumer Expenditure Survey, which is used to claim that there hasn't been much rise in spending inequality. First of all, that's not true even if you believe the survey; plus, there's good reason to believe that the Survey has been systematically underreporting the growth in higher-income-group consumption. See CBPP on all this.

Second is the use of very long-run comparisons — what I think of as the "but even Louis the XIV didn't have electricity!" defense. Yes, over the centuries economic progress has reduced some gross disparities — modern Americans are relatively unlikely to simply starve to death (though it can happen), so in that sense the gap between rich and poor has narrowed. But the question isn't whether society is, in some sense, more equal than it was in 1900. It's whether it is radically more unequal than it was in 1970. And of course it is.

Third is the downplaying of poverty. Seventy percent of the poor have cars! They must be doing fine! Except that they often can't afford medical care, sometimes can't afford enough food, and usually can't find a way to get their children a decent education.

Finally, there's the failure to appreciate just how rich today's rich are. They're not people who drive cars just like the rest of us, only fancier. In his book Richistan, Robert Frank (the other one) of the Wall Street Journal's Wealth Report — yes, the Wall Street Journal — reports what he found when he began looking at how the rich live:

They had built a self-contained world unto themselves, complete with their own health-care system (concierge doctors), travel network (Net Jets, destination clubs), separate economy….The rich weren't just getting richer; they were becoming financial foreigners, creating their own country within a country, their own society within a society, and their own economy within an economy.

That quote is in my book, which as I said specifically takes on the whole issue of inequality denial. But maybe The Economist didn't get that far in its reading.

Since consumption inequality is at the heart of the argument The Economist is making, let me add this:

Poor by what standard?, FedGazette, Minneapolis Fed ...Some economists prefer to look at consumption because it is less volatile than income... People smooth their consumption based on long-term income expectations. ...

[But] this is not to say that consumption wins the best-measuring-stick debate hands down, even among advocates. Sullivan, for example, acknowledged "some important practical concerns with switching to consumption," including the fact that consumption surveys are much smaller in scale than income surveys, making it difficult to analyze local patterns because of sampling problems.

The consumption model has other blind spots. For example, it can only measure total costs; it has no ability to distinguish the quality of purchases or the utility of different types of purchases to a household. For example, a 2005 working paper by Thomas Deleire ... and Helen Levy ... found that higher expenditures among single-mother households during the 1990s "can be explained by a shift from food at home to food away from home." While that is positive in some senses—less work cooking at home and more food "leisure"—an alternative explanation is that more meals were eaten outside the home out of necessity and at higher cost to the household budget, as more single mothers worked, either voluntarily or because of changes to the welfare system in the 1990s. Better off? Hard to say for sure.

Sullivan and others also point out that income poverty has simple longevity on its side. "I think it is well understood that there are flaws in the official measure of poverty," Sullivan said. "(But) we have been using the current measure for about 40 years, so we have a nice time series that is generally understood." ...

Not even researchers within the same organization agree on the best way to measure poverty. Gregory Acs is a senior research associate at the Urban Institute. Along with his counterpart Nichols, he has considerable experience with both poverty trends and the definition-measurement issue.

Acs and Austin tend to disagree over the utility of consumption-based poverty measures. According to Acs, "Ultimately, consumption is a better measure of well-being than income, but I think it is harder to measure, and income is not a bad proxy for consumption." But Nichols responded, "I disagree that consumption is a better measure of well-being," in part because researchers don't know how much consumption is financed by unsustainable borrowing. He added that consumption measures "have just as many problems as income-based measures." ... Said Acs, "I think Austin and I agree that there are pros and cons to all the poverty approaches," both income and consumption.

The other key part of the argument from The Economist is about changes in happiness, or "self-reported 'life satisfaction'". But these measures are also suspect:

Relative Comparisons and Economics: Empirical Evidence, by Mary Daly and Daniel Wilson, Economic Letter, FRBSF: ...Despite promising results, serious concerns have arisen about the quality of data on self-reported happiness. These concerns involve language ambiguities (respondents may not all agree on the exact meaning of terms like "happiness" and "life satisfaction"), scale comparability (one person's "very satisfied" may be higher, lower, or equal to another person's "satisfied"), ambiguity regarding the time period over which respondents base their answers, and respondent candidness.

Concerns about data reliability and interpretation have left many economists and others unconvinced of the robustness of the findings coming out of the research using experimental and subjective survey information. Much of this skepticism, among economists at least, likely is a product of the grounding of traditional economics in the revealed preference principle, which states that the best way to study and understand what determines utility is to infer people's preferences from observations of their behavior rather than from questions to them about their likes and dislikes (direct measurement).

The points about consumption inequality and happiness made by The Economist are not new, these objections to the income inequality results are well-known to those working in the area, yet the belief that inequality has been rising in recent decades persists. Krugman is not the one who has been misled.

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