Wednesday, November 17, 2010

When To Tariff

Subsidizing an industry (ignoring positive externalities) is not good for efficiency. This sort of argument is often cited about trading with China and its alleged undervalued currency. I have some thoughts about fixed exchange rates, but I'll post them another time. Right now, I'm more interested in the talk about if the US should institute retaliatory tariffs against China on the basis of its more direct subsidization (i.e. giving money directly to firms, not keeping the exchange rate down).

The nice thing about retaliatory tariffs, is that if they succeed, China will stop subsidizing industries. This is not good because the US will export more; it's good because it decreases price distortions. Wealth (on a global scale) increases. But such tariffs can back-fire if China doesn't back down. Instead of having one problem, you have two.

Suppose China will remove subsidies at a probability of x. If W is world wealth, S is the effect subsidies have on world wealth, and T is the effect tariffs have on world wealth, the US (assume the US cares about the world's wealth, not just American wealth) should not threaten a tariff if:

W - S > W - (1 - x)(S + T)


S < (1 - x)(S + T)

If that equation looks familiar to you, then bravo to you! It's the Learned Hand Rule. To quote the Wikipedia entry,
an act is in breach of the duty of care if:
B < PL
where B is the cost (burden) of taking precautions, and P is the probability of loss (L). L is the gravity of loss. The product of P x L must be a greater amount than B to create a duty of due care for the defendant.
In other words, you're held liable for something if it was cheaper to remove the possibility of the bad thing from happening than it was to suffer the bad thing, weighted by the probability that the bad thing would happen. For example, it's easy to install a guardrail, likely someone will fall and very harmful if the person falls. So if you don't install a guardrail and someone falls, you're held liable.

My equation runs a similar vein, though you tolerate a subsidy instead of put up a guardrail. If the cost of suffering the subsidy is less than cost of the subsidy and tariff, adjusted for probability, you shouldn't threaten a tariff. Not tolerating the subsidy is negligent as threatening the tariff exposes the world economy to an inefficient level of risk.

Let's rewrite the equation:

S/T < (1-x)/x

If the above inequality holds, then threatening a tariff would be negligent. Let's summarize the right handed side with a graph. If S/T is above the line, you should threaten the tariff; if below, you should not.

Suppose we agree that subsidies and tariffs have an equally negative impact on wealth, or S/T is one. That means if x < 0.5 (Chinese have less than even odds at backing down), don't threaten. If x > 0.5, then you should threaten. Yes, you can get into a lot about reputation building, threatening (and following through) even if x is low in an attempt to increase x. But this post is already quite long and would make this model very complex.

It's politically harder to get rid of subsidies than tariffs, I'd wager, since tariffs are a tax and people love seeing their taxes fall. Therefore, S > T because the long term damage is higher. But it also means x is lower than we thought since it's harder for the government to give up something that is so popular. Assume S is twice as bad as T (S/T = 2) because it is twice as hard as we thought to get rid of (x is 0.5x). Because of the curve of the graph, x would have to be 0.67 (before adjusting for the change due to political viability) before you get the same payoff threatening a tariff as you do letting the subsidy stand. That's higher than the even odds I mentioned earlier.

The point of this post is to get us to think more about retaliatory tariffs as an efficiency goal, not a justice goal. Lots of people point to "leveling the playing field" and "fairness" when they advocate retaliatory tariffs, as if the aim is to punish people for wrong doing. But that's a means to an end, which is to stop subsidies. Recognizing that some subsidies aren't worth the risk of retaliation is the first step to being smarter about trade policy.

Thursday, November 11, 2010

A Theory of Book Survival

Russ Roberts believes the days of the physical book are numbered.
So while there are some advantages to physical books, I’m predicting that the advantages of digital books will crush them. And it won’t take long...There will be one exception. The Jews. We will still publish prayer books and Bibles and Talmuds for use on the Sabbath when the iPad and the Kindle take a rest. But for the most part, I think that’s going to be it.
No doubt investing big in a physical book market is a fool's errand. But I don't think new physical books will become extinct. In fact, I think the disadvantages of such books will be the key to their (muted) survival.

Books as yard signs. Because books have that hefty annoying mass, they can be displayed in a home. I once heard that most people who buy books written by popular public figures don't actually read them, or read very little of them. They mostly have them to display in their bookcases. "Look what team I'm on," they scream. Displaying your copy of a hip new author plays a similar role.

Books as uncomfortable shoes. We wear uncomfortable clothes when we're trying to be serious because genuinely serious people are more willing to tolerate such discomfort. Similarly, "true readers" will read the book in the physical form because it's a pain to do. Only people who want to be part of that "serious readers" club will tolerate a physical book. Oh they'll fool themselves that the minor differences between the physical and the digital matter, e.g. the smell of the book, but it will really be about signalling.

Books as candles. While I think most of the "smell of the book" stuff is nonsense, it's true that people like nostalgia and novelty. Yeah, I think candle light's romantic but I might think that because I grew up with electricity. Old stuff always seems exotic and cool.

GRANTED, there's lots of old media where new stuff doesn't exist. Vinyl records. VHS. Cassette tapes. But such things weren't around very long. They didn't have the opportunity to entrench themselves as a nostalgic enough to warrant making new ones and they make even poorer signalling. But physical books have been around for a while and when you add in print on demand services, I think we'll be seeing new physical books around for a long time.

Bookstores, however, are a different story.

Wednesday, November 10, 2010

Tuition Fee Riots

Protests against rising tuition fees in London turned violent today with massive property damage as angry students swarmed the street. I first heard this story on CNN and saw it again on the BBC. Both networks kept citing that the fees would triple, which is a very dramatic increase. But no one said how exactly how much fees were increase which told me it wasn't as high as your gt reaction might believe.

I found the actual increase (notably via the BBC...apparently it's worth writing in an article but not worth saying in a newscast). For one, they are not increasing the fees per se, but increasing the cap universities can charge. It will grow from $4,830 to $14,500 (3,000 pounds to 9,000 pounds, using current exchange rates). So yes, a $10,000 increase is quite a hunk of money. But the average in state tuition in the US is $10,674. Out-of-state tuition for public universities is much higher. And that was in 2004; average tuition is certainly higher today for the same reason the Brits kicked up fees: governments are strapped for cash.

In other words, tuition rose not because the Tories, et al are picking on students but because students have been underpaying for a long time. That's why even in the wake of the violence, the Tories aren't backing down.

The Significance of Significance

William Easterly admits to being sloppy with his statistical reporting.
Aid policy was based on the premise that aid raises growth, but …{a major} study of this question was saying that this premise was false.
This quote refers to the Rajan-Subramanian paper (later published in a peer-reviewed journal) that was unable to reject the hypothesis of a zero effect of aid on growth. As I never tire of pointing out, we often get our conditional probabilities mixed up. Based on standard statistical methodology, the (1) probability of failing to reject the zero effect hypothesis is high when the effect is indeed zero. Unfortunately, the author of the quote incorrectly thinks this implies the opposite probability is high — (2) the likelihood that the effect is indeed zero when you fail to reject the hypothesis of zero. This likelihood can actually be quite low even if the first probability is high.
This is an important point, but it's not intuitive. Let me take a moment to interpret.

Suppose you and some friends are out partying but your friend Bob didn't show up. Where's Bob? It's late: Bob's probably at home. Bob being at home is your null hypothesis. (When I first learned about null hypothesis, I learned it as the theory that nothing interesting's going on. It's more complex than that but that will suit us for our purposes.)

You decide to call Bob to figure out if he can come party with you. Granted, Bob might be busy playing poker or getting drunk at his favorite bar. But he also might be home and it's a lot easier to get Bob to do something when he isn't doing anything.

If Bob tells you he's at home, you can accept the null hypothesis. Bob is indeed at home. (Technically, you never actually accept the null due to mathematical constraints but ignore that to build the intuition.) If Bob tells you he's in the gutter somewhere, at a strip club, or doing something else "interesting," you reject the null hypothesis. But if Bob doesn't pick up the phone, if it just rings and rings and rings, then you fail to reject the null hypothesis. This is not the same thing as accepting the null. Bob could be asleep in bed OR he could be in jail after having just spray painted a cop's car while wasted on vodka. You just don't know.

That confusion, that not getting an answer is the same thing as getting something boring, is the confusion William Easterly made. The Rajan-Subramanian paper didn't get statistical significance when it came to aid's relation to growth which is the same as the phone not picking up. To quote Easterly once more, "Absence of Evidence does not constitute Evidence for Absence."

The Fake Endorsement

I've always known what a politician said and what they believed were often at odds but this brings it to new heights.
Trying to be even-handed and polite, the [visiting] Brits said something diplomatic about McCain’s campaign, expecting Bush to express some warm words of support for the Republican candidate.

Not a chance. “I probably won’t even vote for the guy,” Bush told the group, according to two people present.“I had to endorse him. But I’d have endorsed Obama if they’d asked me.”

Endorse Obama? Cue dumbfounded look from British officials, followed by some awkward remarks about the Washington weather. Even Gordon Brown’s poker face gave way to a flash of astonishment.
When I first read that, I was utterly confused. "Had to?" You're the President at the end of his final term. You're basically done with politics; you don't need to be re-elected or get any bills passed. But I suppose between the speaking opportunities and book deals, you want to leave on good terms with the party faithful. A good example of how strong of an impact incentives are.

Monday, November 08, 2010

The Most Expensive Liquid You Can Buy

I'm in the market for a new printer. My existing one, a cheap Canon printer I've been using for over five years, is wearing down. It jams and the head occasionally prints a letter out of alignment. Since I'm sending out job applications, a new printer would be a big help.

But printer ink's the most expensive liquid you can buy. Printer manufacturers claim it's the technology which drives up the price. And yes, ink technology has noticeably improved over the past 20 years. A single cartridge for my printer runs $23.49 at Office Max and contains about 12 ml of ink, or $7,409.94 per gallon. I'm not buying the technology story.

I trust the tying pricing model, a form of price discrimination. Manufacturers sell a cheap printer (another reason to discredit the technology story: about half to one-third the price of the printer is eaten up by the ink it comes with) but charge a lot for ink. They are able to charge more for people who like to print and less for people who don't print very much, capturing the gains from those who are willing to pay a lot while still getting profit from those who are willing to pay only a little.

I tell my students to make sure you know the whole price of a good before you buy it and so I called Cartridge World to verify they carried cartridges of a printer I'm looking at, the Epson Stylus NX125 (the web site says it's $50 but I swear when I saw it in the store it was $40). They do not...yet. Cartridge World takes the empty cartridges people bring in (presumably for some store credit or a discount), fills them up, and sells it back. But the NX125's a new model and they don't have any cartridges yet. Moreover, manufacturers know places like Cartridge World exist and reformulate their ink so it only works with that cartridge (the printer head's a patented piece of technology), requiring other guys to figure out the formula so they can produce it for the manufacture's competitors.

It's around this point in our conversation I realized printer pricing is backwards from pricing of virtually all other consumer products: the new stuff isn't more expensive than the old stuff. It's cheaper.

If you buy an old printer, the manufacturer knows they can't get as much money from you since you can reliably buy ink elsewhere. They have competition from a key source of revenue. So they charge more for the printer to (a) capture some of the value when they can and (b) discourage you from buying the old printer in favor of the new one. I doubt new technology's driving up the price of ink but it looks like it's driving down the price of printers. Weird.

Note this also puts manufacturers in a tough place when it comes the planned obsolesce. They want you to buy a new printer but they don't want your printer to fall apart so fast you go to another manufacturer.

If my current printer didn't work, I'd probably buy a "old" printer since I print a lot. But most of my printing are things like rough drafts of papers, things where great printer quality isn't an issue. So I'll probably buy a new printer and live off the ink it comes with, printing only professional documents. The only thing is I'm not sure how annoying it will be to constantly plugging and unplugging printers. But it will make me feel like I'm outsmarting these manufacturers and I do like feeling clever...