IPL payments and CEOs

The winners of the IPL will earn $1.5MM. Works out to $75K for each player if there are 20 in the squad.

Sure, $75k is nothing to sneeze at. Unless you’ve been paid $500K to just show up and take part. The incentives aren’t sloped steeply enough. It is creditable that the stars are playing hard despite the relatively small prize.

For the true geeks reading this post…the formula that describes optimal effort in a tournament is (w1 – w2) = g(0)*c’(e). (w1 – w2) represents the increase in wealth due to winning. g(0) is a measure of how much randomness effects winning. c'(e) is a measure of effort. This formula is lifted from a seminal 1981 paper by Sherwin Rosen and Edward Lazear. If you really want to get under the skin of the formula, you can download the paper from jstor for $14.

The intuitive part of the result is that people work harder to win if the rewards of winning are greater. The fascinating part of this result is that the rewards for winning need to be greater in games with more randomness to extract the same effort. If you can win through pure luck, you’re less likely to work hard to win. So the reward needs to be bigger to get the same hard work.

This Sherwin Rosen paper - and the vast body of secondary research that his paper spawned - is often used to understand why CEOs get paid so much. Everybody in an organization works hard to become the CEO because the reward is so big. That hard work is what creates value for the organization, or for society, which is good. The reward goes to one CEO, one individual who basically got lucky, which feels unfair. Horrible dilemma. The only way to square this circle seems to be to design games with less randomness.

Do better driving tests save lives?

Earlier this morning, I was talking a friend through the painful process of getting a UK driving license. My friend is a Chartered Accountant and a banker. He is bringing up a family. He has been driving for about 20 years in India, the USA and various holiday destinations. It's hard to find a lower risk-profile than him. But getting a UK license remains a painful process, low-risk-profile or otherwise.

Part of the pain is, of course, the sheer bureaucracy. But a part of the pain is that there is a real risk of cautious and experienced drivers failing the test. The UK test is a heck of a lot more rigorous than equivalents in either India or, slightly more surprisingly, the USA.

Does the UK get anything valuable out of these rigourous tests (apart from the perverse pleasure oily government employees get from randomly saying no)?

A quick Google search seems to show that the testing works. The per capita death rate through road accidents in the UK is about half US levels. That is massive, a lot more than I was expecting.

An interesting twist in the data is that almost 65% of the difference in death rates seems to be explained the fact that the US has more cars per capita. A first glance the more money -> more cars -> more road deaths pattern seemed natural. But no. One might have expected a society that is more dependent on cars to invest more in road safety. And at some human level, the risk of death per individual just feels like a much more important metric than the risk of death per vehicle.

Another interesting slant in the data is the ratio of injuries to deaths. The UK and the US are around the same level here, suggesting that there are no material differences in the quality of medical care delivered to accident victims. If anything the much-reviled NHS seems to be delivering a slightly better ratio than the USA.

There is a specter haunting Eurpoe

Here is another surprisingly simple reason why property prices in the UK are unreasonably high.

A price fixing building cartel with more than a 100 members. I'm surprised that the cartel manaegd to hold.

There is a specter haunting Europe (2)

Britain is one of the world's more over-priced property markets. Prices can go into free-fall.

So what should be done about that? Cut interest rates to prop up prices? Or use the inevitable carnage as an opportunity to massively expand housing supply...to deliver a step-change improvement in the real lives of real people?

My (contrarian) vote is for the supply side expansion.

The elephant in the very-tiny-room during any conversation about housing in Britain is that the quality of housing really sucks. A country as rich as Britain need not live in homes that are so small that a standard "bedroom" is about the size of an American walk-in closet. Where double bedrooms don't fit double beds. Or where faucets that mix hot and cold water are an exotic luxury.

The simple and obvious solution is to develop large tracts of high quality housing, either on greenfield sites or by bulldozing some of the existing housing stock. But this simply has not happened. Is there a subtle but powerful political pressure from property owners defending high prices?

A counter-argument that is sometimes reflexively trotted out is: Britain is a small island and land is scarce. This is pure hokum. Britain can easily import tomatoes or milk. Britain can't import land. A very similar argument was used in the 80s to justify Japan's over-priced "rabbit hutches" and its heavily subsidized rice farms.

More realistically, a supply side expansion that might happen during this downturn is that sellers might be forced to spend more on the house to sell it at the same price. This will not get picked up as deflation in the published house price indices. But that investment will be a welcome improvement in the real lives in real people.

Science or religious war?

Are neo-classical and behavioural economics truly irreconcilable? Are the foundations of one of our great sciences crumbling before our eyes? Or, is behavioural economics a useful elaboration on the neo-classical tradition, that enriches rather than wrecks the great neo-classical insights?

My chips are on the enriching rather than wrecking side of the argument. Right here, right now, I clearly am in the minority. The sloppy-thinking chat tends to pit one tradition against the other.

Here is Elizabeth Kolbert, writing in the New Yorker.

"Rational calculators are supposed to consider their options, then pick the one that maximizes the benefit to them. Yet actual economic life, as opposed to the theoretical version, is full of miscalculations, from the gallon jar of mayonnaise purchased at spectacular savings to the billions of dollars Americans will spend this year to service their credit-card debt. The real mystery, it could be argued, isn’t why we make so many poor economic choices but why we persist in accepting economic theory."

Notice the condescension. "The real mystery...why we persist in accepting economic theory." She illustrates this self evident truth - that the assumption of rational economic behaviour is so broken that it is pitiful - with a personal anecdote.

Ms Kolbert was buying a book on Amazon for her work when a message popped up on her screen "add $7.00 to your order to qualify for FREE Shipping". She hesitated. Her nine-year-old twins wanted a Tintin book. She clicked it into the shopping cart and checked out, saving The New Yorker $3.99 and spending $12.91 of her own money.

Then comes the sucker-punch. "From the perspective of neoclassical economics, self-punishing decisions (such as this purchase of a Tintin comic) are difficult to explain." Really?

Neo-classical economics is very comfortable thinking about the Tintin comic as a bundle of information (about prices), services (delivery) and physical product (the comic book itself). Remember complements and substitutes from Econ 101? Amazon reduced the price of that bundle by flashing a free shipping advert on Ms Kolbert's screen, which reduced her tacit search costs, and by waiving the delivery charges. This prompted a purchase which otherwise wouldn't have happened. Lower price, more sales. This is the demand curve from Econ 101. There is no more unsurprising result in neo-classical economics.

Notice that the neo-classical theory makes no claims about the mechanism by which people maximize utility. In the neo-classical view people maximize utility the way a dog catches a frisbee. The calculations a dog needs to make to catch a frisbee are way beyond the scope of what a dog, or human, can consciously perform. Yet, dogs and humans successfully catch millions of frisbees every day.

This is where behavioural economics comes in. It sheds more light on the heuristics that people actually use while maximizing utility. This might prompt governments or businesses to use those heuristic mechanisms. For example, tax collections in America increased when taxes were collected at source. Once the money is in my bank account I am much more reluctant to give it to the government. Brilliant behavioural insight. By Milton Friedman, the godfather of neo-classical economics.

None of this challenges the one thought central to all of neo-classical economics: people respond to incentives. The way in which different people respond to different incentives is infinitely varied, which is why economic life is fascinating to observe.

Stealing Music?

Fans and musicians are enjoying each other's presence at the South by South West music festival, unencumbered by record companies. And they are talking about how they can do just fine, forever after, without record companies.

It's good to move beyond the toxic divisions of the digital rights/ copyright wars and start the conversation about how the music industry ought to work.

Record company jobs and copyright laws serve a useful purpose if they bring together artists and fans. Everything else is secondary.

Culling elephants

The South African government has decided to kill several thousand elephants to keep the elephant population within sustainable limits. Are they killing 5000 elephants? The number is not totally clear.

http://www.guardian.co.uk/environment/2008/feb/26/environment

This is heartbreaking, especially for the foster daddy of a four year old elephant called Naserian who lives at the David Sheldrick orphanage in Kenya. But understandable. Especially if more humane alternatives have been seriously attempted. The good news is that elephant and tiger populations do really well when protected, unlike say, cheetah or pandas.

The news so far has shied away from a really interesting economic question: should the South African government sell ivory from this cull?

The money from selling ivory could be used to give elephants better protection. This has traditionally been the South African position. On the other hand, legitimate sales of ivory could "prime the pump" of the ivory trade by bringing craftsmen back to ivory, increasing steady state demand, and make it harder to protect elephants. This has traditionally been the Kenyan position.

I totally see and sympathize with both sides of the argument. Would love to hear about an objective no-spin analysis that sizes up these arguments.

Tear-free shampoo and the frightening guest

Took my daughters swimming on Sunday. Showered many blessings on the wonderful person who invented tear-free shampoo. And reflected that the history of science is obsessed with boring things like penicillin and does not celebrate genuinely great advances like tear-free shampoo.

This blogger is not alone in trying to set right this historic injustice. The late Viktor Schreckengost - whose name means "frightening guest" in German - is the grand-daddy of the sort of scientist who invents tear-free shampoo. Dan Boudreaux of Cafe Hayek thinks Mr Schreckengost has "done more for humanity than any single politicican in the twentieth century". Homage is in order.

http://cafehayek.typepad.com/hayek/2008/01/viktor-schrecke.html

Fixing match fixing

This is absurd. The organizers of the French Open are sueing online betting sites (including Betfair - the site I use) to prevent betting on the French Open.

http://sports.espn.go.com/sports/tennis/news/story?id=3225440

Yes, match-fixing in tennis is a serious problem. Tennis matches are easy to fix. But surely, major branded sites like Betfair and Ladbrokes are part of the solution. These sites are dependent on the trust of millions of small time punters. They have the data needed to spot odd betting patterns and extra-big bets.

This could actually be counter-productive. Betting on sport is great fun. It will always be a part of sport. Driving good, clean, fun betting underground will only bring in sleaze and increase the likelihood of match fixing.

House Prices

Enjoyed Robert Samuelson's take on housing in America.

http://www.realclearpolitics.com/articles/2008/01/can_we_cure_our_house_lust.html

Blood Diamond, Syriana. The Economics

To me (and fellow geeks like me), the economic truth Blood Diamond and Syriana illustrate are as fascinating as the movies themselves.

Resource based economies tend to breed truly horrible social and political systems. Because to get rich and powerful in resource economies, all one needs to do is control the resource in question. The tycoon/ mogul/ sheikh/ oligarch who owns the oil well is the boss. The rest of society is all about getting on the gravy train that this tycoon/ mogul/ sheikh/ oligarch maintains. There is no reason (or room) to create or cooperate.

This is often phrased as "why is Bihar the poorest state in India despite it's wealth of natural resources?" This question is almost precisely invested. The real question is "how to save Bihar from it's wealth of natural resources?".

It's a hard question. One thing we do know is that nationalizing the resources does not work. Just look at Bihar or Putin's Russia for proof.

Cultural learnings of Eng-a-land for make benefit glorious nation of Hindustan

The city magistrates of Nottingham has just banned five notorious, aggressive beggars from begging in the city center, sitting within ten meters of a cash point, or selling the Big Issue without authorization.

In case you're wondering, the UK's per capital GDP at ppp is around $35000.

http://www.thisisnottingham.co.uk/displayNode.jsp?nodeId=133965&command=displayContent&sourceNode=133948&contentPK=18991107&moduleName=InternalSearch&formname=sidebarsearch

Reminds me of a conversation I had with my driver back in Bombay in the late 90s.

My driver then was Anil Thakker, a hard working Gujarati who was carefully saving up money to pay a broker for a job in the Gulf. We were on Marine Drive. A few beggers were hovering around the car. Anil asked me if there were beggers outside India. I told him there were, many. He flatly refused to believe me.

Stealing Music?

My friend Greg Pye is worried that people-like-us who are "stealing" music are not ashamed.

http://gregpye.wordpress.com/2007/10/05/stealing-music/

Shame is a good word for the feelings that should be involved here. I don't think shame is clicking-in right now, because social norms on what constitutes reasonable music-buying behaviour have not yet evolved. The real problem is that there is no sign of a mechanism emerging to define or shape these new norms.

When I was leaving college my entire gang made and swapped swapped copies of each other's favourite audio tapes. I resent (and reject) the insinuation that that was either illegal or immoral. Most reasonable people agree that ordinary listeners like you or me should be people should be able to share our music with our friends and family.

Almost everyone also agrees that people who make music should be able to make a decent living. Nobody is really fussed about whether that decent living is paid for by CD sales, concerts or royalties from on-line radio stations.

The hard part is finding a set of social norms on what constitutes a "reasonable" level of copying. For instance, I think there is something shady about borrowing a DVD from Blockbuster, burning a few dozen copies and selling the copies on eBay. I don't have any qualms about copying a ~80 GB of music from a high-school buddy's hard drive for my own listening pleasure.

Calibrating personal judgments like this socializing them would help all of us evolve to a new set of norms. This is similar in spirit to calibrating performance ratings or credit decisions at a company like Capital One. The courts could have been the credible authority forcing the calibration to happen. They could have forced results of the calibration to be socialized through the media. Instead, by coming down squarely on the side of the fat-cat media bosses, the courts have simply polarized the situation.

It's been a bit of a needless tragedy. The only silver lining is that enough reasonable and powerful people hate the court's one-sided view passionately enough to hope that something will shake loose.

Homo Sapiens evolved to be fair? Part 2

We know that people tend to reject deals which they see as grossly unfair. This is most apparent in the classic economic experiment of the ultimatum game.

In this game, two players are given a pot of money to share. One player is randomly chosen. She can propose any a split for herself and for the other player. The second player can then reject the deal outright, in which case both players get nothing, or can accept the deal, in which case both players get what the first player proposed. Critically, there is no second deal. There is no Shadow of the Future notion of reciprocity of retribution. This game has been played thousands of times, across cultures. The consistent finding is that deals where the second player gets less than 20% of the pot are consistently rejected...although the second player is worse off in rejecting the deal outright.

The common interpretation of this game is that this dents the neo-classical notion of homo economicus. This is just wrong. The Economist article makes this error, quite surprising because the Economist is usually sympathetic to neo-classical notions. Neo-classical utility maximization theory easily accommodates this behaviour. The theory is framed in terms of maximizing utility rather than income for a very good reason. All you need to believe is that utility is a function of relative income as well as absolute income. The second player in the ultimatum game is maximizing utility, not income. He is happier saying no to a deal which feels wrong.

Under this interpretation the great neo-classical results, like Ronald Coase's insight into free agents negotiating their way to a Pareto-optimal outcomes, are totally valid. The ultimatum game does not create a case for governmental/ authoritarian meddling in people lives or in the economy generally.

What the ultimatum game does offer a really useful insight into is not economics, but politics. Why does income distribution so dominate political discourse? Why is unequal income distribution even though of as "unfair"? It seems to be a pattern of thought that is hard-wired into us as a species.

This is not a normative point; more equal outcomes in a society is not better or worse in a moral sense. My own take is that equality is simply irrelevant from a moral or normative viewpoint. This is just a positivist point. Privilege is naturally resented in every social group: cricket team, company or nation state. More so if it is seen as unearned, inaccessible or both. Finding ways to address or harness that resentment in a creative way is a necessary part of any polity. This is a managerial task...not a moral task.

There are some interesting puzzles that this view might help answer.

For instance, why to the janitors employed by Goldman Sachs earn more than the janitors employed by the municipal government? Both sets of janitors are equally skilled and productive. This is a commonly observed phenomenon. Most companies that pay well do so across job families or skill levels. Are companies trying to address that political problem thrown into sharp relief by the ultimatum game? I can just hear the Goldman janitor cribbing to his mates at the pub "I work for Goldman. The guy with a funny nose also works for Goldman. Why does he make 100 times what I make? How is that fair?". The guy with the funny nose might have a Ph.D. or an ivy league degree...but that sense of grievance is going to be out there anyway.

This may be the reason outsourcing often reduces costs even when working within the same labour pool. Changing the badge on the janitor's uniform breaks that limbic sense of connection between the janitor and the Ph.D. guy with the funny nose. Breaking that limbic connection makes the inequality easier to swallow.

A much more speculative and flaky line of argument...but what the hell...I've been drinking some Chardonnay from Burgundy...

This view might also talk to why third world countries find it hard to trade with the first world. As an Indian, I find it weirdly easy to understand the emotional heft of this argument.

India has done spectacularly well since opening up to the world economy in 1991. Yet, despite this success, political commitment to trade or free-market principles is really thin. Why? Because an Indian negotiating with an American is still talking to someone about 25 times richer than him. He is likely to come away from that negotiation feeling screwed, regardless of the objective outcome of the negotiation. I grew up in Indira Gandhi's India when we were trying to promote South-South co-operation. Meaning...we liked dealing with other poor countries more than we liked dealing with rich countries. This is self-destructive. India still badly needs the income that trade brings and the gains from trade are greater between dissimilar countries or agents. But at some visceral level, this all makes sense.

Homo Sapiens evolved to be fair?

Another fraught moral question. Does distribution matter? Is it really OK if the winners win really big if the losers are also a little bit better off.

Both evolotionart biology and behavioural experiments suggest that this does matter. People consistently refuse deals which feels unfair, even if they are obviously better off taking the unfair deal. This is a very well established result in behavioural economics. It's called the ultimatum game.

The surprising new learning is that chimps will accept unfair deals. This notion of fairness seems to be unique to our species. We probably evolved with this sense. It probably plays a key role in our success as a species, in making possible more complex social organization.

http://www.economist.com/science/displaystory.cfm?story_id=9898270

Sick Leave

Very topical post. Wasn't feeling good this morning. Have taken the afternoon off: 4 hours of sick leave.

Brings to mind some interesting stats. At the company I work for, call center staff are sick about 5% of the time. The same metric never crosses 1% among professional staff. I'm pretty sure our call-center staff are as healthy as the professionals, their average age is about 22. So why the gap?

The first effect is measurement. Call center staff are tightly monitored. Lawyers, project managers and financial analysts are not. So lawyers going home at lunch time may not show up in the sick leave stats only because nobody is watching.

Fortunately, some professionals in the IT department log their time very precisely. Sick leave in the IT department breaks the 1% mark, but only just. So there still is a big gap to explain.

The best explanation I've come across for the remaining gap is work piling up. If I'm not at work, nobody else can quickly step in and do my job for me. So my work just piles up. I'll have to work extra hard tomorrow because I'm at home this afternoon. In the call center, I would handle exactly the same number of calls tomorrow, regardless.

I like the Shadow of the Future part of this argument. A lot of good behaviour is created by the Shadow of the Future. Just like a lot of good outcomes are created by the Invisible Hand.

Tax farming?

Paul Krugman thinks the Bush Administration using specialist collections shops to raise tax revenue is a scandal. His key point is that the collections shops charge 20% commissions, while it costs to IRS 3% to collect. Does that actually mean something bad is happening?

http://krugman.blogs.nytimes.com/2007/09/30/tax-farming/

This is a topic I'm close to professionally. Using collections agencies to raise taxes is completely consistent with responsible governance. Comparing this practice to tax-farming is just wrong; mis-leading economic analysis. He is making a mistake that he has probably told thousands of undergraduates to avoid: he is confusing the average with the margin.

A better economic analysis would recognize that:

(i) The most skilled collectors out-perform the average collector by a factor of about 3x. This is not surprising. The most skilled economists, baseball players and computer programmers are more productive than the average by even bigger factors.

(ii) The most skilled collectors tend to migrate to organizations where they get paid more for their skill. This is also not surprising. So, the best collectors tend to move to specialist collections shops. And the IRS is left with a pool of ever-less-skilled collectors.

(iii) Most people don't need collectors to make them pay taxes. The IRS needs collectors to deal with just a small slice of the population.

Given these very believable assumptions, it could be more effective and more efficient to use professional third-party collectors. Collectors on 20% commissions would work only with a thin slice of delinquent tax-payers. And would more than pay for their higher costs by collecting more money then the IRS collectors.

Clearly, it takes management skill to make this skills-matching happen. But if the author really wants to claim that something bad is happening, he needs to show that this perfectly plausible story is not playing out. Until then, comparisons with the Romans or with the ancien regime are just rhetorical smoke and mirrors.

Of course, Krugman could still be right about the scandal.

The populists are winning

Got into a discussion on Greg Mankiw's blog. Mankiw's post was about how even Republicans are turning protectionist.

http://gregmankiw.blogspot.com/2007/10/populists-are-winning.html

Politicians understand that protectionism makes nations poorer. They also understand that lumping blame on foreigners is easy.

The real question that needs answering is: how do politicians make free trade a vote-winning position? Even when times are not all that good.
___________________________

An interesting response to my comment was: "the responsibility for educating the public lies with those companies and those workers who would be harmed by restrictions on trade."
___________________________

It's a good thought, and is a beginning. But it's not going to win the war for the good guys who want all of humanity to live better lives.

The first problem is rhetorical. Corporations claiming the free trade will be no more credible than snake-oil salesmen claiming to cure erectile dysfunction. The fact that, in this case, the corporations are telling the truth will not matter.

The second problem is that most corporations are not for free trade. They like nothing more politicians shielding them from the tough world of real competition. Read Raghuram Rajan's "Saving Capitalism From the Capitalists" for a nice riff on this topic. One of the Bush government's failings is that it does not distinguish capitalism from the capitalists. Sweetheart deals for buddies who own companies is corruption, not capitalism.

The third, and possibly the deepest reason why this does not work is that corporations generally will not have the resources to do this important work. Most companies fail. Or just about survive. And even the few wildly successful ones like Walmart or Microsoft will become vulnerable. Because of capitalism. Talk to people who worked at Microsoft when Netscape had an 80% share of the browser market to know what that felt like. General Motors bosses haven't been shy about lobbying Washington for tariffs or handouts.

When the going gets tough, corporations inevitably look to friends inside the Beltway to help them out. Companies are fair weather friends of capitalism. Can't be trusted.

So who will fight the good fight?

Universities. It is not a coincidence that we are talking on an economist's web site. Ambitious academics looking for political appointments can have surprisingly convenient views. But in general, academic's standards of intellectual honesty are higher than those of businesses.

And politicians. Al Gore has done his share of 360 degree pandering. But he did sell NAFTA with passion and conviction when it mattered. John McCain took on the might of Mississippi catfish farmers to fight for Vietnamese farmers who can supply the same catfish cheaper. Tony Blair (on the left) and Kenneth Clarke (on the right) have sold the case for the Polish plumbers who might breathe some life into Britain's building trades. Vaclav Havel in the old Czechoslovakia and Chandrababu Naidu in Andhra Pradesh, India, have tried to sell a case for trade to their people. Anders Borg, Sweden's 39 year old pony-tailed finance minister is selling his people radical market oriented messages like "make work pay", if welfare is too generous people have less reason to work.

It can be done. The case for trade has to be made in the public sphere. It has to be digested and accepted by the public for trade and its soul-mate, democracy, to co-exist. Unfortunately, this takes more political skill than pandering to xenophobia.

Blogger Econometrics

Greg Mankiw thinks he has had 3,000,000 visitors to his blog.

http://gregmankiw.blogspot.com/2007/10/3000000.html

This was my comment on his blog...with a helpful link to direct some traffic to my blog:

Sitemeter also measures the time each visitor spends on your site. Fifteen of the last twenty visitors had spend zero seconds. And the other five had spent less than a minute.

Sure, this blog is great. And fellow bloggers like me spend a lot of time here. But 3 million visitors is a huge over estimate of your effective reach.

He’s Happier, She’s Less So

Nice article on the NYT on how happy women and men are.

http://www.nytimes.com/2007/09/26/business/26leonhardt.html?ex=1348545600&en=594e67d014f6dc88&ei=5124&partner=permalink&exprod=permalink

Today's women have many more choices than their mothers or grandmothers. This is good.
However, choice in itself does not make people more happy. People with more choices are more responsible for their own destiny. This responsibility can, and does, feel onerous.

"All women in my society are housewives, therefore, I am a housewife" is a very comfortable position. "I am a smart, educated woman who chose to walk away from a lucrative, satisfying career to be a housewife" is a much less comfortable position. It's totally unsurprising that women in this position report being less happy.

What the research misses is that these less happy women are better off than their mothers and grandmothers who never had the option of having a career.

This is a serious argument worth making. Serious and influential people, including Professor Richard Thaler of the University of Chicago, have argued that reducing the choices available to individuals is good because it makes people more happy. This is just wrong-headed. Freedom, liberty, the ability to influence one's destiny...these are greater ends than the sort of experienced happiness that gets reported in surveys.

The happy people living in the Matrix were victimes.