Matt Nolan

The vegetarian cross-subsidy

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On the Freakonomics blog there is a discussion of why a delicious vegetarian option at a restaurant was cheaper than the meat options:

Was it because his revenue from it was only €63 compared to €91 for a five-course regular menu (which had one meat and one fish course)?  Maybe. But I don’t believe the vegetarian menu used less labor, nor was there a €28 difference in materials cost. My guess is that he prices at mark-up over materials cost, thus making the veggie menu a relatively good deal for the customer—and a relatively bad deal for him. Another possibility is that he thinks vegetarians have lower incomes and higher demand elasticities, and he believes he is rationally price discriminating.

All fair explanations.  However, I’m not convinced by them, as this is an expensive restaurant where the relevant sample of vegetarians will be wealthy.  Furthermore, given they can’t “substitute” to another meal this surely indicates they should be charged more!

I have a simple explanation – cross-subsidisation.

When there is a large upper-middle class group going out to eat there are generally lots of meat eaters, and very few vegetarians.  However, the existence of us pesky vegetarians means that the group has to go to a restaurant that serves vegetarian food.

If we then assume that vegetarians have better knowledge about where the vegetarian food is – they will essentially be the ones deciding which restaurant to go to!  As a result, restaurants will cut the price of vegetarian meals and increase the price of meat ones in order to get the groups to come – and then extract rents.  Huzzah.

For me, this suggests that table bills with vegetarians should be split evenly – if you can get past the issue of over ordering 😉

Matt Nolan

A society of Entrepreneurs?

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Is that the future of the labour market, a myriad of “self-employed” entrepreneurs offering services in order to gain income – income that creates a claim on resources that are largely created by capital/machines.

This is what the “three laws of future employment” at new geography suggests to me. (ht Marginal Revolution) .

The laws are:

  1. Law #1: People will get jobs doing things that computers can’t do.
  2. Law #2: A global market place will result in lower pay and fewer opportunities for many careers. (But also in cheaper and better products and a higher standard of living for American consumers.)
  3. Law #3: Professional people will more likely be freelancers and less likely to have a steady job.

Where does this come from?  Say that a lot of the fundamental things we consume, both in terms of manufacturing and primary goods, can be mechanized extremely cheaply – with virtually no labour input.  In that case, investment in the machines and their maintenance is extremely valuable – and owners will as a result be willing to pay a significant sum (in terms of resources) to those who in turn look after the machines.

If only a very small number of people are required to look after and build the machines, then the rest of society has to move into roles where they do one of two things:

  1. Serve a secondary market of people without access to capital – say making food for their own small group of people, or making clothing.
  2. Offer a service to the owners of capital and the group of people who are looking after it.

In that case, there is likely to be a very very large service sector with a small base of labour manufacturing and primary production that is very productive/capital intensive.

Now why would we expect entrepreneurs, why wouldn’t we see massive scale in the service industry like we have in the other sectors?  Well, generally, services don’t fit the “scale” model – economies of scale do not exist in service industries, and as given the value of heterogeniety in the service industry the flexibility of small firms/entrepreneurs would be vital.  Lets not forget the internet either, which has reduced the cost of entry into service industries and increased competition.

In a situation where capital is very heavily concentrated (both in terms of physical and human capital – given that a small number of people in the service industry will also have significant talent and be able to extract far more rent than others), I see a role for significant redistribution and a minimum income in this type of environment.  As the constraint of scarcity is loosened, the idea of having a government to help ensure a minimum standard of living really becomes more important.  The question is, how far along that road are we now?

Matt Nolan

Why fear labour market globalisation?

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While reading Rates Blog today I came across the following statement:

7. Training your replacements – The next wave of globalisation is going to hit service sectors in developed economies that have previously been immune to outsourcing to the likes of China or India.

First the manufacturing sectors in America, New Zealand and Australia (Toyota laid off 350 workers there yesterday) were gutted. Now the services sectors face being cleaned out.

The first batttleground we are seeing across the Tasman is in financial services. The media there is up in arms about layoffs in banking as some of the big banks outsource IT services and accounting to India.

This could come here too. It has already happened in chunks of Telecommunications (tried ringing Telecom’s Philippino O18 staff lately?) and will eventually spread to the likes of IT, banking, medical services, media, insurance and legal services. The growth of the Internet is accelerating this shift.

My response?   So, in the same way that they’ve lowered the cost of manufactured goods, subsidised them, and done all the work making them – they are now threatening to do the same with the service sector.  So they are offering to do all the work for us?  Sweet deal!

There are two things to keep in mind with all this:

  1. There may a concern that if they make everything we will make nothing!!!  But this is a false dichotomy – in truth, if they can do these things at a truly lower cost, and decide to do it in an environment of free trade they have a comparative advantage and so prices will adjust to ensure that both they and us (with whatever we have a comparative advantage in) are better off.  Now, if they are intervening to do this through subsidies it does not mean we are worse off – as their choice to subsidise is implicitly a transfer to consumers (us).  The people who truly pay are the tax payers in these other countries.
  2. It is possible that, as globalisation in labour markets gets underway, we experience stagnant or even lower wages in the Western world.  However, this is because people who are currently STARVING are now getting the opportunity to pull out of abject poverty and consumer some resources.  Globalisation of labour markets will reduce global income inequality, improve the lifestyles of the worlds most poor, and increase the size of the “economic pie” – this is a great thing.  As a result of this we may see a hollowing out of the middle class in developed countries in the near term – so what.  We could make the argument that the middle class that was artificially holding up their claim on resources by restricting the ability of the very poor to get themselves out of poverty – when we frame it that way does your opinion about what is “morally right” change 😉 [Good post on this sort of issue on Money Illusion]

While reading Rates Blog today I came across the following statement:

7. Training your replacements – The next wave of globalisation is going to hit service sectors in developed economies that have previously been immune to outsourcing to the likes of China or India.

First the manufacturing sectors in America, New Zealand and Australia (Toyota laid off 350 workers there yesterday) were gutted. Now the services sectors face being cleaned out.

The first batttleground we are seeing across the Tasman is in financial services. The media there is up in arms about layoffs in banking as some of the big banks outsource IT services and accounting to India.

This could come here too. It has already happened in chunks of Telecommunications (tried ringing Telecom’s Philippino O18 staff lately?) and will eventually spread to the likes of IT, banking, medical services, media, insurance and legal services. The growth of the Internet is accelerating this shift.

My response?   So, in the same way that they’ve lowered the cost of manufactured goods using outsourced companies including Mexico manufacturing, subsidized them, and done all the work making them – they are now threatening to do the same with the service sector.  So they are offering to do all the work for us?  Sweet deal!

There are two things to keep in mind with all this:

  1. There may a concern that if they make everything we will make nothing!!!  But this is a false dichotomy – in truth, if they can do these things at a truly lower cost, and decide to do it in an environment of free trade they have a comparative advantage and so prices will adjust to ensure that both they and us (with whatever we have a comparative advantage in) are better off.  Now, if they are intervening to do this through subsidies it does not mean we are worse off – as their choice to subsidise is implicitly a transfer to consumers (us).  The people who truly pay are the tax payers in these other countries.
  2. It is possible that, as globalisation in labour markets gets underway, we experience stagnant or even lower wages in the Western world.  However, this is because people who are currently STARVING are now getting the opportunity to pull out of abject poverty and consumer some resources.  Globalisation of labour markets will reduce global income inequality, improve the lifestyles of the worlds most poor, and increase the size of the “economic pie” – this is a great thing.  As a result of this we may see a hollowing out of the middle class in developed countries in the near term – so what.  We could make the argument that the middle class that was artificially holding up their claim on resources by restricting the ability of the very poor to get themselves out of poverty – when we frame it that way does your opinion about what is “morally right” change 😉 [Good post on this sort of issue on Money Illusion]
Matt Nolan

Crisis over before Christmas?

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With bond yields collapsing in Europe the implied “bank run” on the periphery appears to be over.  This is due to the ECB backstopping European banks for the next three years – in some sense they have taken on the lender of last resort role, just in a confusing, seemingly temporary, and poorly communicated way. Note:  Whether this is really “happening” is still an open question – we won’t have confirmation of this, or its impact on CDS’s, until tomorrow at the earliest.

This in no way means that the fundamental issues in Europe are over – in fact, it makes focus on the structural problems in Europe an essential part of what people should now be doing.

However, if the bank run really is over, and credit markets really are unfreezing (something we will know in the next couple of days), it is a positive for the short-term for a little country like NZ.  But lets not forget a few things:

  1. Japan, and now Europe, have shown us the vulnerability of public and private finances to changes in demographic structure – we ignore these issues at our peril, and with plenty of warning.
  2. Europe still has massive structural issues.  These still need to be solved, or we will merely have another crisis down the line.
  3. If Europe isn’t going to sort itself out, hopefully the rest of the world will see the risk and reduce their implied exposure to Europe.
Matt Nolan

Conditional policy

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Today’s Fed statement about monetary policy followed the same pattern that we have seen from other central banks, such as the RBA and RBNZ.

Essentially, fundamental conditions remain a bit weak, and so there is a reason to keep policy stimulatory – however, this view is strongly conditional on the ECB/Europe not being bat sh*t crazy.

Should the ECB/Europe be bat sh*t crazy, these central banks will be ready to support their respective domestic economies.

It makes sense – you can’t have an organisation  being BSC as a central forecast.  However, the risk has to be taken into account – which is why so many other organisations are releasing “downside scenarios” alongside their primary forecasts (the RBNZ and Treasury have both done this in NZ).

Again, I stick to the following line.  The current banking crisis needs to be sorted by the ECB – fiscal authorities need more discipline, and that is a structural issue, but that isn’t the marginal factor pushing things into trouble now.

The ECB is doing things – but they need to communicate them better.  Improve that communication and markets can have more faith in the policies the ECB is already frikken implementing, increasing their effectiveness.  By communicating so poorly they are taking on all the costs of their policies, and not receiving a large portion of the benefit.  It is on the verge of nonsensical …

Matt Nolan

Papers to read

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Via Marginal Revolution

On a banking glut.  On excessive financing.  Both arguing against the “excessive savings” view of the crisis – which is currently my prior.

Will be reading these (rereading in the case of the second one) in order to avoid listening to more crap about the NZ election … seriously, I didn’t realise how much politicians lie during an election till I became an economist, and I’m still uncomfortable with it.

FYI:  I agree with the description of macroprudential policy, but I remain nervous about the “time series” policies – which are really just non-interest rate cyclical tools.  We need a significant burden of proof before these instruments can be used – although I suspect at present monetary authorities are aware of this.