Cheap Talk

An article in the WSJ describes an escalating conflict between American Airlines and intermediaries selling tickets to consumers:

In a retaliatory move against American Airlines, Sabre Holdings Corp., a middleman for many carriers’ seats, said it is raising the fees it charges American to distribute its fare information and sell its seats through thousands of travel agents….The jab follows efforts by American, the third-largest U.S. airline by traffic, to sell more of its tickets directly to consumers, a strategy designed to cut costs and give the airline more opportunities to court customers.

Getting rid of middlemen can increase surplus and efficiency.  Getting rid of realtors or car salesmen eliminates the surplus they capture and hence increases the surplus left for buyer and sellers for houses and increases trade.   This is the famous “double marginalization” problem as both the realtor/carsalesman and the seller charge a margin and eliminating the middleman eliminates one margin and one negative externality and increases trade.  And who cries for the middleman if he loses out?

But the airline story has a different dimension: Expedia, Orbitz etc. allow easy comparison shopping.  With consumers comparing prices, in a fragmented airline market, one firm or the other will undercut its competitors to make sales. This kind of thing will ensure prices are close to costs.  But now, consumers will have to go to the AA website to see the prices and will find it harder to comparison shop. With positive search costs, prices can rise.  The Diamond paradox is an extreme example of this.  So, I guess I agree with Expedia:

Expedia lashed out at American last weekend for trying to replace the distribution model with the direct-connect network that American has developed in recent years to hook up directly with travel agencies. It called American’s push “anti-consumer” and “anti-choice,” arguing costs would jump for travel agents and there would be less pricing transparency for consumers.

If this is right, consumers will lose in the war between Expedia and AA if other airlines follow suit and ditch the intermediaries.

1. …5 radios, a bathtub, and a grand piano.  (with an improvisation due to a dispute with labor unions.)
2. Women laughing, alone, with salad.
3. Douchebags love Grey Goose.
4. Josh Groban sings Kanye West’s tweets.
5. The evolution of Barbie.

Ohio counties solicited bids for road salt from Cargill and Morton Salt.  The two companies divided up the counties and hiked up prices:

James Canepa, a deputy inspector general for the state Department of Transportation, said the pricing practice ”crystallized” in 2008 when Morton and Cargill were the only suppliers that presented bids for salt in Ohio’s 88 counties.

In no instance did the companies present bids against each other, Canepa said. At the same time, prices spiked, shortages were reported and salt companies enjoyed record profits, he said.

”Not once in 88 counties did they bid head-to-head,” Canepa said. ”And the counties that they bid were the same ones that they won previously. Those are their incumbencies. Those are their, quote, customers. So, 2008 really crystallized the carve-up of counties.”

But no explicit communication took place and a Cargill spokesman:

pointed to a statement in the first page of the report that says ”we failed to find evidence that the two companies communicated on salt bids.”

”We never did or would talk to competitors about bids,” he said.

(Hat tip Matt)

Jeff and thousands of others head to Denver for the job market meetings.  Our flyouts in MEDS begin next week.  I am going to dinner with our first candidate on Sunday night.  I already know him and he already has an offer from UofC.  He can relax, enjoy giving his paper and meeting everyone on all his flyouts.  He hopefully can also enjoy dinner on Sunday without any feeling of nervousness.  Those not in this lucky position will be more worried about their visits.  My brain addled by 10 hours of teaching so far this week, I will focus on the most trivial aspect of the visit – the job market dinner.  I discussed this in a previous post from the perspective of faculty so let me switch focus and put myself in the shoes of the candidate.

Most obviously, people will still be checking you out as a future colleague at dinner.  Will you be fun to hang out with?  Are you a potential co-author etc etc…?  So, unfortunately, you’ll still be “performing.”

Less crucially, there are the wine and dessert questions.  Should you have a glass or wine and should you order dessert?  Are you exposing yourself as an alcoholic by having a drink?  Are you exposing yourself as an out-of-control sugar-holic by having dessert?  Let me put your mind to rest on these two questions.

Some if not all the people going to dinner with you will also want to have a glass of wine.  This is especially true of macroeconomists who will want to have many, many drinks and then go to a bar after dinner.  So, by all means say you would like a drink if you want one and say no if you do not.  Others will drink anyway even if you refuse so just report your true preferences.

The dessert question is a bit more subtle.  If you do not order dessert, neither will anyone else.  Perhaps you are really tired and want to go to your hotel and go to sleep.  They will want to be polite and not delay you.  (The macro-economists will drop you off and go to the bar without you.)  But, some of the people at dinner will want to have dessert.  The senior faculty do not get out to good restaurants too much anymore and are focused on childcare most evenings. Of course they want dessert!  So here, you must misrepresent your true preferences – order dessert and let everyone else go crazy and order the crème brûlée and the chocolate cake.  They will thank you for it and think of you kindly when they vote on offers.  If you are not hungry, order a sorbet.  If you can’t eat it, let it melt and pour it surreptitiously into the flower arrangement in the middle of the dining table – there will be such an arrangement at the fine dining destination they will take you to.

Index funds track indices such as the S&P 500 and match the market not try to beat the market.  They are cheap to manage – I guess all you need is a computer program and you don’t need to pay expensive managers.  An individual investor who does not have inside information will lose relative to the market and an index fund provides the best way to guarantee at market returns.

So, people buying index funds should have that kind of philosophy.  This philosophy also means that you cannot beat the market on day-to-day or hourly transactions – any news you are responding to will also be incorporated in the index fund value and all you will do is incur the transaction cost of buying or selling.  So, people who buy index funds should buy and hold.  Unless they have a self-control problem.   Then, they will respond to price movements despite knowing they cannot make money on average.

Investors who face self-control problems face more difficulties if they buy an index fund in the form of an ETF and not a regular mutual fund.  The former are continuously traded and the latter only allow you to buy and sell at the end of the business day.  Hence, the latter allow you to commit not to indulge your self-control problem.

First, ETFs are cheaper than the corresponding mutual fund so the first puzzle is why mutual funds are not driven out my ETFs.  This is one answer: there is demand for mutual funds from people with self-control problems and in fact they are willing to pay to commit.  There is a value to commitment.

Second, investors who think they cannot beat the market but believe they have self-control should buy ETFs.  If their belief in their self-control is naïve, they will trade anyway and get worse returns than investors who bought mutual funds.  Via the NYT:

“An analysis of the numbers by Kevin P. Laughlin of the Bogle Financial Markets Research Center, found that in the five years through October, what investors earned from their holdings in E.T.F.’s trailed the returns of the funds themselves by 3 percentage points, annualized. By comparison, the earnings of investors in traditional mutual funds lagged their funds’ returns by 1.1 percentage points. These lags happened because investors were buying and selling at the wrong times.”

There is a value to commitment but there is also a value to self-knowledge: recognizing your self-control helps you to know that you should commit and if you commit, you will lose less money.

1. Never+gonna+give+you+up -> Google Books ngram search.
2. Manipulating the NYTimes most-emailed list.
3. Ron Jeremy’s Rum.
4. Asparagus pee:  there’s a gene for that.

This year, Germany finally paid off its old bonds for World War 1 reparations, as Margaret MacMillan has noted in the New York Times.  MacMillan asserts that “John Maynard Keynes, a member of the British delegation in Paris, rightly argued that the Allies should have forgotten about reparations altogether.” Actually, the truth is more complicated.  A fuller understanding of Keynes’s role in the 1919 Paris peace conference after World War 1 may also offer a useful perspective on his contributions to economics.

Keynes became the most famous economist of his time, not for his 1936 General Theory, but for his Economic Consequences of the Peace (1920) and A Revision of the Treaty (1922). These were brilliant polemics against the 1919 peace conference, exposing the folly of imposing on Germany a reparation debt  worth more than 3 times its prewar annual GDP, which was to be repaid over a period of decades.

Germans saw the reparations as unjust extortion, and efforts to accommodate the Allies’ demands undermined the government’s legitimacy, leading to the rise of Nazism and the coming of a second world war. Keynes seemed to foresee the whole disaster. In his 1922 book, he posed the crucial question: “Who believes that the Allies will, over a period of one or two generations, exert adequate force over the German government to extract continuing fruits on a vast scale from forced labor?”

But what Keynes actually recommended in 1922 was that Germany should be asked to pay in reparations about 3% of its prewar GDP annually for 30 years. The 1929 Young Plan offered Germany similar terms and withdrew Allied occupation forces from the German Rhineland, but the Nazis’ rise to national power began after that.

In his 1938 memoirs, Lloyd George tells us that, during World War 1, Germany also had plans to seize valuable assets and property if they won WW1, “but they had not hit on the idea of levying a tribute for 30 to 40 years on the profits and earnings of the Allied peoples.  Mr. Keynes is the sole patentee and promoter of that method of extraction.”

How did Keynes get it so wrong on reparations? In 1871, after the Franco-Prussian War, Germany demanded payments from France, on a less vast scale (only a fraction of France’s annual GDP), while occupying northern France. To hasten the withdrawal of German troops, France made the payments well ahead of the required 3-year schedule, mainly by selling bonds to its own citizens. But the large capital inflow destabilized Germany’s financial system, which then led to a recession in Germany. Before 1914, some argued that such adverse consequences of indemnity payments for a victor’s economy would eliminate incentives for war and assure world peace. In response to such naive arguments, Keynes suggested in 1916 that postwar reparation payments could be extended over decades to avoid macroeconomic shock from large short-term capital flows and imports from Germany.

Nobody had ever tried to extract payments over decades from a defeated nation without occupying it, but that is what the Allies attempted after World War 1, following Keynes’s suggestion. Keynes argued about the payments’ size but not their duration.

Today economists regularly analyze the limits on a sovereign nation’s incentive to pay external debts. In our modern analytical framework, we can argue that the scenario of long-term reparation payments was not a sequential equilibrium. But such analysis uses game-theoretic models that were unknown to Keynes. As a brilliant observer, he certainly recognized the political problems of motivating long-term reparation payments over 30 years or more, but these incentive problems did not fit into the analytical framework that guided him in formulating his policy recommendations. So while condemning the Allies’ demands for Germany to make long-term reparation payments of over 7% of its GDP, Keynes considered long-term payments of 3% of GDP to be economically feasible for Germany, regardless of how politically poisonous such payments might be for its government. Considerations of macroeconomic stability could crowd out strategic incentive analysis for Keynes, given the limits of economic analysis in his time.

Reviewing this history today, we should be impressed both by Keynes’s skill as a critical observer of great policy decisions but also by the severe limits of Keynes’s analytical framework for suggesting better policies. Advances in economic theory have greatly expanded the scope of economic analysis since Keynes’s day and have given us a better framework for policy analysis than what Keynes ever had.

Gävle Sweden is the hometown of my teacher and longtime co-author Tomas Sjöström.  The second most famous Swede after Tomas, Elin Nordegren, ex-wife of Tiger Woods, spends time in Gävle because her mother lives there.

At Xmas, Gävle is famous for another reason: it sturdy citizens build a huge goat and it appears to have become a tradition to burn it down, steal it or otherwise damage it.  A brief recent  history:

2001 Goat set on fire on 23 December by Lawrence Jones, a 51-year-old visitor from Cleveland, Ohio, who spent 18 days in jail and was subsequently convicted and ordered to pay 100,000 Swedish kronor in damages.
2002 The goat received only minor damage.
2003 Burnt down on 12 December.
2004 Burnt on December 21.
2005 Burnt by unknown vandals reportedly dressed as Santa and a gingerbread man by shooting a flaming arrow at the goat at 21:00 on 3 December.
2008 The goat finally succumbed to the flames ignited by an unknown assailant.
2009 An unsuccessful attempt was made to throw the goat into the river the weekend of December 11. On the night of December 23 before 04:00 the goat was set on fire and was burned to the frame, even though it had a thick layer of snow on its back.The goat had two online webcams which were put out of service by a DoS attack, instigated by computer hackers just before the attack.

One hour or so before midnight in Sweden, the goat still appears to be standing according to this webcam.