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Midgrade Gasoline: Worst Deal on the NJ Turnpike February 24, 2017

Posted by federalist in Energy, Government Regulation, Markets, Transportation.
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The New Jersey Turnpike is an interesting study in government price regulation. In order to avoid price gouging by the gas vendors at Turnpike rest stops, the NJTA requires prices to be set competitively with regional gas retailers.

Furthermore, the NJTA contract allows only one price change per week. A familiar consequence of this has been that during spikes in gas prices people flood the Turnpike to fill up at the old prices during the few days before the Turnpike vendors are allowed to raise their prices to the market level.

Another strange pricing quirk has persisted for years: Sunoco, which has the contract for most of the rest stops, offers four grades of gasoline. A recent offering was:

  • 93 octane: $2.83 (“Ultra”)

  • 91 octane: $2.81 (“Premium”)

  • 89 octane: $2.70 (“Plus”)

  • 87 octane: $2.37 (“Regular”)

The weird thing is that 91 octane is always priced 2 cents per gallon lower than 93 octane. It turns out that this 93-91 price spread is specified in the NJTA contract, because most competitors used in the survey to set prices only sell three grades of gas.

This makes 91 octane the worst deal on the NJ Turnpike. Why? Gasoline octane is a linear function of blending. I.e., you can get a tank of 91 octane gas by mixing two parts 93 octane with one part 87 octane. (In fact, most gas stations only store two grades, and the pumps blend them to produce the mid grades.) At these prices, one could buy a tank of 91 octane by blending 93 and 87 at a cost of just $2.68/gallon – that’s lower even than the listed price for 89 octane!

I suspect Sunoco is exploiting this in two ways. First, NJ still does not allow customers to pump their own fuel. So blending a tank requires explaining the process to the attendant, who rarely seems that attentive. Second is the fact that Sunoco labels the overpriced 91 octane blend as “Premium.” The manuals and stickers in cars designed for high-octane gas typically specify “premium” fuel. Depending on the season and location the highest grade available might be 91, 92, or 93 octane, so drivers are likewise accustomed to asking for “premium.” On the Turnpike, “premium” gets you a tank of 91 octane. You have to explicitly request “Ultra” or “93” to get the highest grade.

Government Competition Update May 18, 2014

Posted by federalist in Government, Government Regulation, Markets.
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What remains of state sovereignty in this country is both entertaining and heartening.

Of course state competition for business has a long history. Before government became a distinguishing factor businesses would often establish themselves based on access to needed natural resources, labor, and markets. Gradually each state’s tax and regulatory burden became a significant part of that equation. Now the political environment itself is becoming an explicit factor.

For example, the last round of gun control hysteria had quite disparate results. States that enacted draconian new gun laws have found themselves losing firearm businesses to more friendly states.

More recently the CEO of a California company complained publicly that its government is becoming reminiscent of the communist Vietnam he fled 35 years ago. Texas is one of the states that has been reaching out to companies with this compelling invitation from its governor:

Texas’ low taxes, predictable regulations, fair courts and world-class workforce make our state the ideal place for any business looking to relocate or expand….

Government Shakedowns May 4, 2014

Posted by federalist in Government Regulation, Markets.
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He knows that it’s cheaper to settle than it is to fight this investigation.

Most government shakedowns don’t get coverage like this in the Wall Street Journal. But then, as the FERC lawyers paraphrased above noted, most people realize it’s cheaper and easier to just settle.

In its legitimate role the government enforces clear laws and applies well-defined penalties to lawbreakers. In practice the government has promulgated so many laws that they are uncountable. Executive agencies ostensibly ordained to enforce these laws then compound them with rules and regulations so extensive and opaque that even expert enforcers often cannot say with certainty what is or is not permitted.

I have previously noted that the greatest peril of this situation is selective enforcement. I have since observed a more nefarious phenomenon: the government shakedown.

What motivates regulators in a system in which one can argue that virtually anyone is doing something wrong? Criminal convictions for clear violations of the law are great, certainly. But evidently when it’s too hard to find or convict criminals the next best thing for a regulator is a settlement. And, like all gangsters, the government goes after people with money.

I’ve seen this from traffic courts to tax assessors to market regulators: Pick an amount that is low enough that the target will decide it’s cheaper to settle than to fight. When you run out of criminals start with the wealthy, or just pull people over at random. Threaten them with laws and rules that may not even exist. Find the highest number they’ll pay to avoid further hassle, and if they turn out to be fighters just close the case and move on to the next target. There are no penalties for government enforcement agents who engage in such harassment. On the contrary, it seems, they are rewarded for “settlements” even if no wrongdoing was admitted or even committed. And since shakedowns are easier than full-scale prosecutions that could be lost under the judicial scrutiny of the courts and juries it often appears that enforcers would rather accumulate these token settlements than pursue the hard criminals they were created to take down.

We need more public scrutiny of the everyday government shakedown. And we need more people like the Gates brothers to stand up and say, “Even though it’s cheaper for me to pay you to leave me alone, I’m going to fight you because what you are doing is wrong.”

Is Silicon Valley Ironic? March 23, 2014

Posted by federalist in Human Markets, Markets, Open Questions.
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I’ve had a number of friends over the years go to Silicon Valley (SV) to pursue opportunities in technology and finance. SV has a unique entrepreneurial culture, and I have seen second-hand how, once you’re plugged in, you have first call on talent, funding, and ideas.

I find this ironic because so much of the output of SV has been products and services that eliminate physical location as a barrier to production and collaboration. Yet there’s still no substitute for being there in person: absent a physical presence you’re an outsider. Unless you can show up in person you’re mostly excluded from the discussions, ventures, and partnerships that form in face-to-face meetings.

Is this an expression of a human social instinct that technology won’t be able supplant? Or is it just an expression of the path of least resistance: I.e., since so much of the money and talent is willing to make the physical move there it’s just not worth the trouble, however small, to engage someone remotely?

Why don’t I just move out there? Yes, the cost of living is exorbitant. But if you’re any good you’ll make enough money to compensate. Besides, as one outdoorsy friend said referring to the perfect year-round climate: that’s the price for living in heaven.

But there’s a second irony: the government. My understanding is that the dominant ideology of the SV tech/finance world is libertarian, yet they elect to live under the most heavy-handed state government in America. All evidence I’ve seen suggests this is in spite of, not because of, that government: just look at the number of entrepreneurs and companies that setup operations outside of the state at every opportunity. Yet the core of this capitalist engine still operates from within a political regime that seems to despise wealth and free markets.

Yes, I could leave all my CA-illegal guns in a free state. But I chafe at the idea of “voting with my feet” for such a bad government. Granted, California is still something of a constitutional democracy, so because in principle you have a marginal influence on its government joining its public body isn’t quite like handing your life and property to a totalitarian state.

Yes, there’s some level of compensation that would make it worth my while to move to an expensive and politically oppressive place like that. Evidently my price is higher than most.

Re: Desert Tech Pakistan Contract — me too! January 8, 2014

Posted by federalist in Markets, RKBA.
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Desert Tech (formerly Desert Tactical Arms), a small Utah gun manufacturer, grabbed national headlines when it announced it wouldn’t pursue a $15MM RFP for small arms for Pakistan. Never mind that Desert Tech can barely meet domestic demand for their guns: they boasted that not pursuing the contract had nothing to do with their probability of winning or fulfilling it, and everything to do with their ethical concerns about their pricey bolt-action rifles somehow falling into the hands of enemies of American.

Which is funny, because I recently faced a very similar dilemma: The Pakistani government is looking for elite American technology strategists to enhance their infrastructure. Naturally I would make any short list for those roles, but given the turmoil in the region I have decided that regardless of the personal cost I will forgo any such opportunities for fear that they might lead to situations that could compromise my stalwart American values. Like Desert Tech, I know it’s not always easy or profitable to stand by one’s principles. And I just want to make sure everyone knows that.

Also, due to its latest human rights abuses I had no choice but to publicly inform the Russian Olympic Committee that I will not license my image for any of their public-relations efforts. (The U.S. government hasn’t put my striking good looks on their export control list, but you know it’s only a matter of time.)

Hopefully my manifest willingness to put my patriotism and principles before profit won’t deter anyone else from approaching me with enormous consulting, contracting, or modelling offers.

The Beauty of Bounties November 8, 2013

Posted by federalist in Markets, Uncategorized.
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Bounties for solving big or hard problems are not new. But they should be more common.

I was impressed to discover a data company (SNL) that issues cash rewards to anyone who finds errors in their data. Based on my experience not many data vendors could afford to do that! So it serves the dual purposes of advertising their quality and ensuring it. (And yes it’s real: I recently collected on a handful of errors uncovered during some tedious work.)

Many major information technology vendors have publicized substantial “bug bounty” programs for researchers who reveal serious security flaws in a gracious manner. (I.e., instead of exploiting their discoveries to attack, blackmail, or humiliate the companies, as is a sometimes attractive alternative.)

Another interesting “error bounty” is Donald Knuth’s, begun in 1968 for errors in his publications. I assume he began the program because he realized he had authored the most important reference texts in Computer Science, and he wanted them to stand worthy of the role. Obviously the scientific community agrees, since the bounty check is minimal and rarely even cashed: Evidence of earning it is far more prestigious.

Pseudoephedrine Update August 30, 2013

Posted by federalist in Healthcare, Markets.
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My wife takes pseudoephedrine continuously to control chronic allergies. When the Combat Methamphetamine Epidemic Act took effect in 2006 I noticed an across-the-board price increase in the generic formulations: 20-count packs of 12-hour pseudoephedrine went up about 50%. Perhaps this was justified because pharmacies were suddenly liable for extra training, control, and logging of sales of any medication containing pseudoephedrine.

The law made it a big pain to keep a supply of the medicine: Individuals are prohibited from buying more than 3.6gr/day. And strangely, the largest and most economical size packaged by pharmacies was kept at just 2.4gr. (The daily limits do not apply if you go through the trouble of getting a prescription for the drug.)

Costco has finally come to the rescue: They now sell 3.6gr of 12-hour Sudafed for $10, which takes advantage of the full daily limit and is the same price as 2.4gr of the generic 12-hour I’ve found at any other pharmacy.

Victims of the Meth Epidemic need not worry: For whatever it’s worth it’s still a misdemeanor to buy more than 9gr in a 30-day period.

Efficient Market Hypothesis Disproved! February 15, 2013

Posted by federalist in Markets.
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Efficient markets are often explained with a joke about an economist walking by a $100 bill. His companion exclaims, “Look, there’s a $100 bill on the sidewalk!” Without stopping the economist responds, “That’s impossible; if it were really there somebody would have already picked it up.”

Found $100 BillSo here’s a picture of a $100 bill my wife found folded on the sidewalk outside a parking garage. She picked it up and looked around to find its owner. Seeing nobody, she concluded it must be fake. But she brought it home thinking I would enjoy figuring out what’s wrong with it.

Well, it passes every unclassified test for authenticity. Perhaps God knew that I needed a reminder of how inefficient the real world can be.

Holiday Tipping Etiquette December 14, 2012

Posted by federalist in Markets, Uncategorized.
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This has become the time of year when all sorts of service employees become very interested in you knowing their names and addresses (often post office boxes!). Notes and envelopes appear from garbagemen, mailmen, paperboys — people you may never see. And it’s no subtle mystery why: They want holiday tips.

In many cases this has become a soft extortion racket: Pay up and you’ll get your paper on your doorstep. Come up short and look forward to picking through bushes for your paper.

Too cynical? Maybe some of these servicemen assume that of course you’re thinking of them during the holidays, and they just want to save you the trouble of waiting outside early in the morning to hand them a bonus check and wish them a Happy New Year.

But isn’t this a recent phenomenon? I don’t remember getting these sorts of holiday notices ten or twenty years ago. I do remember when I ran a paper route as a boy being surprised at the extra cash appearing in my collection envelopes during December.

I guess it was inevitable that spontaneous generosity would evolve into a custom and finally an entitlement. I have been surprised in recent years to read etiquette experts enumerating all sorts of people you should tip — as if money trees sprout in December and every gainfully employed person deserves a windfall.

There may still be some who feel moved by the holiday spirit to share their good fortune with others, but it should be neither expected nor solicited. We are plagued by an entitlement culture, and to cure that I like a suggestion Alex Tabarrok made several years ago: If you would like to express some seasonal generosity remit your tip anonymously. That will foil those who are using the holidays as an excuse for extortion, since they won’t know for sure who “paid up” and who didn’t.

Meanwhile, we need to re-normalize expectations. Here’s my tip: If you have a job now be grateful if you get to keep it in the New Year.

The Truth About Food and Drug Expiration Dates July 25, 2012

Posted by federalist in Government Regulation, Healthcare, Markets.
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The FDA colludes with food and drug manufacturers to maintain a twisted myth about food and drug longevity. For example, here’s an FDA “Consumer Update” in which a pharmacist emphatically warns people not to use drugs after their expiration dates.

But how are expiration dates set, and what happens when drugs “expire”? A great article by Laurie Cohen in the 2000-03-29 WSJ investigated these questions. Key discoveries:

  1. Manufacturers can set expirations as short as they want.  It appears that they mostly choose dates to optimize the turnover of inventory.  I.e., they don’t want their products sitting in stores or medicine cabinets for 10 years, even if they’re good for that long.  They’d rather stamp a date a year or two out, forcing retailers and encouraging consumers to buy “fresh” replacements.
  2. Pharmacies typically mark dispensed drugs with a 1-year date of expiration, without regard to the expiration date of their supply.
  3. Military tests have determined that most drugs are safe and potent for years after their marked expiration dates.
  4. Storage conditions have a dramatic effect on food and drug longevity.  In general, the lower the exposure to heat, moisture, oxygen, and light, the longer they last.
  5. Most drugs begin to “decay” from the moment they are manufactured.  The risk of consuming old drugs is not that they will be dangerous, but rather that they will be less effective than fresh drugs.  E.g., an old 100mg pill might be only as therapeutic as 90mg of  a new pill.

For a lot of drugs “reduced potency” is not a reason to discard them.  Perhaps the most outrageous piece of this conspiracy:

[P]oor countries — under urging from the World Health Organization — often reject drug-company donations of much-needed medicines if they are within a year of their expiration dates.

Precious Metals September 30, 2011

Posted by federalist in Markets.
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What is the lingering obsession with gold? I was amused by an ad campaign launched this month by Palladium Alliance International: “I’m so over heavy metal” points out that palladium is intrinsically more desirable for white metal jewelry than silver, platinum, or alloyed gold.

Whether you’re buying metal for investment or for jewelry the relative merits of palladium are compelling:

  • Unlike gold, palladium has significant industrial uses (similar to platinum) that provide price support near its current trading levels.
  • Palladium is as rare as gold and platinum, but currently sells at less than half the price.
  • Palladium is stronger than silver and gold.
  • Palladium is light — half as dense as gold and platinum, almost as light as silver.
  • Palladium doesn’t tarnish like silver.

Score: Bubbles & manias – 1; Efficient Markets – 0.

Charter Cities — Better Than the Free State Project February 3, 2011

Posted by federalist in Federalism, Government, Markets.

The United States of America was supposed to be a federation of independent states. If the Federal government hadn’t so overstepped its constitutional bounds we would presently have a great experiment in which fifty States were free to test different polities, and some measure of competition between them would over time lead to and preserve good government. Sadly, owing to Federal overreach the States have been left with less power and freedom to shape their polities, so the Great Experiment has become a Modest Experiment: States still compete for citizens and businesses through tax and regulatory policies1. But no matter where you go you’re subject to the same Federal government that controls nearly 20% of GDP and whose regulatory power dwarfs that left to the States.

The Free State Project was an effort begun a decade ago to focus the political power of a large number of libertarians on a single State (ultimately choosing New Hampshire) where they would, as citizens, work to incrementally free the State from unconstitutional Federal rule.

Recently, “Tenthers” (so named for the Tenth Amendment) have been working more broadly to restore State rights under the Constitution.

But to me nothing beats the idea of a “Charter City” as promoted by Paul Romer: This would be a territory cut free from its donor government, governed only by its own charter. The Charter City would have its authority guaranteed by a strong and stable third party — Hong Kong under British administration was an example of this. Like free trade zones and for-profit states a charter city in a relatively unfree or poorly governed region of the world would expect to attract extraordinary investment, leading to exceptional growth and prosperity, which would hopefully be contagious to its neighbors.

1 The Mercatus Center has an excellent analysis of the current differences between states in its 2009 publication Freedom in the 50 States.

Farm Subsidies Plumb New Depths May 21, 2010

Posted by federalist in Diplomacy, Economic Policy, Government Spending, Markets, Special Interests, Uncategorized.
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Commodity farmers are a tenacious special interest, and the federal government seems to have no shame in pandering to them.

The Obama administration would rather subsidize foreign farmers than reduce domestic subsidies that violate our trade agreements:

Rather than reduce the U.S. subsidies to American cotton farmers that are the cause of the trade fight, the Administration is proposing that U.S. taxpayers also compensate Brazilian cotton farmers for the harm done by the U.S. subsidies. Thus the absurd U.S. cotton program would dip into the Commodity Credit Corporation to pay what is a bribe to Brazil so it won’t retaliate.

Capitalism in Higher Education April 11, 2010

Posted by federalist in Education, Markets.
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Our most prestigious colleges and universities are … simply corporations operated to exploit their pricing power for the financial benefit of their senior faculty and staff, and to build monuments to their alumni.

That’s Andrew Manshel in his explanatory essay, “Why Top Colleges Squeeze You Dry,” following a theme I first covered two years ago in my post on “Runaway Higher Education.” He provides an extraordinarily revealing explanation of how this market works based on his two years as CFO at Barnard College:

[A]t the beginning of my tenure as an elite school’s chief financial officer, I was surprised to learn from my colleagues that tuition and fees were not set by analyzing budget projections. Instead they were set by looking at a chart of the prior year’s tuition charges at comparable schools and then trying to predict their increases for the next year. The goal was to maintain the college’s position in the pecking order of total charges. I learned that the most prestigious and desirable institutions have a good deal of information about the shape of the demand curve for the families seeking to obtain elite higher education for their offspring. These schools have the capacity to estimate with some precision how many applicants will go elsewhere for each additional dollar they charge in tuition and fees. Each sets its tuition so as to produce a targeted “yield”—the percentage of accepted students who actually enroll there. If in any year we over- or under-estimated the price changes made by the other schools, and we had moved up or down in rank, we corrected the following year by raising or lowering tuition by more or less to compensate. We essentially followed the price leadership of the wealthiest, most prestigious institutions.

The results of this market pricing power are straightforward. First, and most significantly—given that 60% to 75% of college costs go to salary and benefits—is handsome compensation for senior faculty and administrators.

QOTD: Root Causes of Education and Healthcare Inequality February 5, 2010

Posted by federalist in Education, Government, Healthcare, Markets.
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From Will Wilkinson’s paper last year on Income Inequality:

If we are worried about inequalities in education and health care, as we should be, we might stop to consider that these are precisely the areas we have chosen to shield most jealously from entrepreneurship and market

Emperor Has No Clothes: Oenophilist Edition November 15, 2009

Posted by federalist in Markets, Open Questions.
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Leonard Mlodinow summarizes extensive research calling into question the abilities and value of wine critics. It turns out that wine critics and purveyors have been attributing far too much detail and precision to their reviews.

I confess that I am no wine connoisseur, but even a nephalist can be amused by the prices, prose, and rituals that surround the marketing and consumption of wine. In addition to nuanced appellations that detail which grape varieties were juiced as well as when, where, and how they were fermented, each particular wine gets adorned with pretentious and colorful descriptions of its distinctive traits. Today critics also rank wines on a 21-point scale (80-100) intended to establish their relative value.

Not surprisingly, most of this is absurd. Critics disagree so widely on the same wines that the outcomes of wine competitions cannot be distinguished from simply awarding medals at random. In fact, even the same critic tasting the same wine at the same sitting cannot reliably reproduce his own ratings. This industry has simply strayed far beyond the precision and detail inherent in either wine itself, or in the human ability to evaluate it.

Perhaps now we can retreat to a more realistically coarse system of description and quality that is both reproducible and standardized. A reproducible rating system would be one that is sufficiently coarse that (A) the same critic should never diverge from an earlier rating of the same product and (B) all critics should be within one point of the average rating. Obviously a 21-point system for wine will never be reproducible, so how about 4 levels — call them bad, not-bad, delicious, and sublime? A standardized system of description would dispense with nuanced and subjective prose and hew instead to positive — perhaps even measurable — qualities. Sweetness, acidity, and viscosity seem like obvious dimensions for any beverage. The universe of permissible flavors should be substantially narrowed. After all, we’re talking about fermented grape juice. Is there a meaningful and consistent distinction between “leather” and “tobacco?” Do we gain by dissecting the general flavors of “berries” or “flowers” into the subtleties of “black-currant” and “lavender?” Mlodinow notes that “even flavor-trained professionals cannot reliably identify more than three or four components in a mixture, although wine critics regularly report tasting six or more.”

I wonder why wine in particular has developed such a peculiar and unjustifiable culture of devotion. In other times and places wine has been a commodity more like, for example, grape juice: Juice may be bad, good, or delicious. It can come from this grape variety or that. But one glass of good red concord grape juice is treated pretty much the same as any other. Likewise, tea, coffee, and chocolate have in times past enjoyed ritual and nuance to rival that of wine today, but now they are now mostly treated like commodities. Why?

Intrinsic Inefficiencies in Executive Pay October 25, 2009

Posted by federalist in Human Markets, Markets, Unions.
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Can every CEO be above average?  Obviously not, but when a shareholder’s board is responsible for hiring and compensating an employee there is a structural defect, perhaps best summarized by Jonathan Macey:

No self-respecting board of directors is willing to admit that their company’s CEO is below average. So anytime the new disclosures indicate that an executive’s pay is below average in any way, a pay increase is ordered.

The board is responsible for representing shareholders’ interests.  They would be abdicating their duties if they retained a substandard executive, so unless they’re either resigning their seat or firing a CEO they practically have no choice but to assert that he is above average, and to pay him accordingly.  This leads to an “arms race” of sorts with respect to executive compensation, and the race can become completely detached from efficient labor markets.

If labor markets were efficient then executive pay would be set based on the supply of competent executive candidates and the demand for their labor.  Demand would be limited by the marginal value that a “good” versus “not-as-good” executive could create in a business.

However, the dynamics of a representative board can overwhelm this microeconomic model.  As Rick Bookstaber suggested in a recent post: the board may not be able to quantify or predict the marginal value of an executive.  But that’s their job, so whether they have actually quantified the value of an executive — whether it is even theoretically possible — they behave (perhaps subconsciously) as if they are doing their job, which means they have retained exceptional executive talent.  And the only way to confirm that — to themselves, to the executive, and to their shareholders — is to give their executives above-average compensation!  So every board has to look at what every other board has chosen to pay comparable executives, and then they have to raise it.  The only escape valve for this cycle is for compensations to get so clearly out of line with fundamental supply and demand of executive labor that a majority of shareholders not only see the disconnect but also become sufficiently energized to shake up the board.  And as we know the threshold for large-scale shareholder activism is a high one indeed!

Note that this dynamic is not unique to executives or public companies.  Governmental boards — e.g., school boards — often fall into the same compensation arms races with neighboring districts.  Unions also exploit the arms race dynamic to inflate their wages by negotiating contracts, not on the basis of supply and demand for their labor, but on the basis of keeping up with some reference group (ideally one also engaged in the same arms race).

QOTD: Business vs. Big Business September 4, 2009

Posted by federalist in Markets.
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James Taranto clarifies a distinction that often trips up detractors of free-market proponents, who claim that being pro-capitalism is the same as being a shill for corporations:

A useful distinction can be drawn here between business (commercial activity) and big business (large corporations or industries acting collectively to seek economic advantages from the political system). Those of us who adhere to free-market principles are pro-business, in that we think commerce is a good thing, but owe no allegiance to corporations or industries as such.

Dye-Free, Perfume-Free July 26, 2009

Posted by federalist in Markets, Open Questions.

I was surprised to learn from a discussion with a P&G product manager that dye- and fragrance-free consumer products are only a 5% market niche! This is baffling to me, and not just because I find most artificial fragrances irritating: It’s not like we’re living in primitive conditions where lack of hygiene and sanitation permeate our surroundings with the stench of unwashed animals, waste, and decay.

I suppose nosegays and perfume might still be in order for excursions to the zoo, circus, or municipal waste processing facilities. But why would normal humans in a well regulated household in a civilized community want to immerse themselves in the cacophony of artificial scents from their laundry detergent, fabric softener, dish soap, surface cleaners, bath soap, shampoo, antiperspirant, lotion, etc? And maybe then further compound that with “air fresheners” and colognes?!

As I wondered before: Shouldn’t I be able to buy dye- and perfume-free products at a discount, since they require fewer ingredients and development? Apparently not, and because consumer product companies consider “dye- and fragrance-free” to be a niche market they typically don’t consider removing those ancillary additives until a product line is well established!

Standardization Enhances Market Efficiency July 5, 2009

Posted by federalist in Finance, Government Regulation, Markets.
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Standardization is a public good.  So do we need government to promote it?

Standardization of products and specifications is invaluable to market efficiency.  For example, a standard “letter”-sized sheet of paper will fit in a standard envelope, or binder.  It is sold in “reams” of 500, making it easy to compare prices.  It can be used in almost any printer or scanner.  Imagine if each paper company manufactured proprietary paper dimensions to increase the likelihood that only their file cabinets and folders could keep their products organized?

Mechanical fasteners tend to be standardized.  Only a handful of screwdrivers are sufficient to adjust almost any screw.  What if you had to go to the manufacturer to buy a special set of tools for every individual product you wanted to repair?

Common languages, formats, and specifications are the backbone of the information markets, just as standardized shipping containers, roads, and vehicles are the backbone of our physical markets.

Unfortunately there are incentives for producers to secure rents by avoiding standards.  Inkjet printer manufacturers have proliferated proprietary ink cartridges in order to inhibit competition for replacements.  Most beverages are sold in standardized containers, but odd-sized bottles are an occasional ploy to make a product literally stand out from its competitors that can be tucked away in standard shelves.

Whenever the market wouldn’t overly penalize it, a manufacturer would prefer to create a specialized component that only it can economically manufacture instead of a standardized component that performs the same function but that is broadly and competitively produced.  I.e., unjustified specialization is an attempt to extract monopolistic rents from the market by avoiding competition.  However, unlike true monopoly, specialization is always suboptimal because it also avoids the economies of scale (in both production and use) that result from standardization.

What market forces resist specialization?  Only the ability of consumers to detect and properly incorporate the cost of specialization into their behavior.  But in the real world there is information and behavioral inertia that will always prevent markets from reaching optimal levels of standardization.  No consumer is equipped to analyze a product for specialized components, and determine where specialization was justified, or what the added cost of specialization will be over the life of the product.

What market forces promote standardization?  There is an upfront cost to be born in defining standards, and no individual consumer or producer has an incentive to make that investment.  Standardization is something of a public good.  Therefore, do we need the coercive hand of government to promote standardization to ensure the good functioning of markets?  I have wondered before whether we can rely on the gentle hand of non-governmental organizations to nudge markets to more optimal behavior.