Sunday, 31 May 2009

The economics zeitgeist, 31 May 2009

This is a word cloud from all economics blog postings in the last week. I generate this every Sunday so please subscribe using the links on the right if you'd like to be notified each time it is published.

It has been constructed from a list of economics RSS feeds from the Palgrave Econolog and other sources, and uses Wordle to generate the image, the ROME RSS reader to download the RSS feeds, and Java software from Inon to process the data.

You can also see the Java version in the Wordle gallery.

If anyone would like a copy of the underlying data used to generate these clouds, or if you would like to see a version with consistent colour and typeface to make week-to-week comparison easier, please get in touch.

Wednesday, 27 May 2009

Surprise article on CVM

The psychology and economics of pricing and value allow you to serve your client’s interests and your own by ensuring they perceive the highest possible value in what you offer. Want to have more people upgrade from your £5 to your £9 bottle of wine? Just put a £15 bottle on the same shelf and about half will switch to the £9 option. The best thing about this is that in tests, consumers reported that the same wine actually tasted better when they had spent more money on it.

Behavioural economics research provides a range of around 20 such cognitive biases – ways that people can be guided to perceive more value in the products and services they buy. The big question is how to take advantage of this research to increase sales.

Customer value management

Customer value management (CVM) is the business process of analysing a client, understanding what they value most and designing your offer to match it.

Most professional firms, consultancies and modern service-based businesses base their pricing on an hourly or daily rate, even when they quote a fixed project price. The danger is that the customer and supplier’s interests may not match or that the supplier over-services the client and is not fairly paid for the value they produce. In contrast, structured pricing aligns charges with what customers and clients want most and is a powerful sales technique.

Read more in my full article on behavioural economics and CVM on AccountingWeb: "The psychology of selling". I didn't even know this was going in, but it's getting some attention so please do have a look.

Live blogging The Apprentice series 5: episode 10

Today's economic lessons?
  • Market research and historical data of all kinds are of critical importance in certain sectors which are relatively high-volume and predictable - especially those where there is no arbitrage opportunity and therefore where predictability is a stable equilibrium.
  • A range of different price options is necessary for maximising revenue.
  • Frequent calls to action help combat cognitive inertia, which stops people buying things even when they want them.
  • It's hard to optimise for more than one goal at once: public image, winning the task, surviving the boardroom and winning the whole series are different - and often incompatible - objectives (and now that Newsnight's on, we can see Julie Kirkbride MP selling out her own husband to save her own political skin - Alan Sugar would be proud).

Do join me next week - for five exciting and excruciating interviews with the remaining candidates. In the meantime, please subscribe by filling in your email address at the top right (see what I did there with the call to action?!) and you'll get updates between now and then, and a reminder on Wednesday morning to tune in again.

If you're arriving here for the first time, please read from the bottom of the article upwards - preferably as you're watching the show on BBC iPlayer.

And the nearly-traditional space for readers who haven't yet seen the episode.

10:30 A lovely little preview of Yasmina in next week's episode - the interviewer has a copy of the accounts from her previous business. I can't wait to find out the story behind that.

10:29 You know what's really interesting? They are asking Howard's opinion on the other candidates as if he's a peer of the panel instead of just one of the players.

10:28 Margaret thinks Lorraine should have gone instead of Howard. So does Hasfa, and so does the audience - by a vast majority, which Adrian says is the biggest ever.

10:27 Rufus's tip for final two: Debra and Yasmina.

10:25 Especially with Nick and Margaret. A couple of nice moments in the last few weeks between them.

10:24 So has Debra. Four boardrooms in five losses. She ain't popular.

10:23 James has survived the boardroom four times, it seems. Not a bad record.

10:21 James of course shows up as the comedy character, but maybe there are secret strengths there too. Yasmina versus James in the final?

10:19 Rufus Hound is good at finding the 'wow' factor - and picks Debra as the "wow - why haven't you been buried in a shallow grave" candidate.

10:18 Yasmina seems to be regarded as a slow burner with hidden talents. I am slightly surprised but I wouldn't mind seeing her in the final.

10:16 Lorraine and Kate of course are in focus on the show: Lorraine seems to have survived despite lots of losses, Kate because of lots of wins.

10:15 Relative versus absolute utility, and its influence on choices - Lorraine apparently looked good when Philip was fighting with her, but not so great on her own. No surprise given what we all (I think) think about Philip.

10:12 Howard will get some good offers after this show, I think. He's obviously smart and articulate, and has shown himself to be a cut above his competition.

10:08 The You're Fired panel thinks that Howard understood the business pretty well. Adrian Chiles points out that Howard was not so risk-averse as all that, volunteering to be team leader in the first task.

10:05 Highly unlikely that anyone reading this cares about the football result and hasn't seen it yet. But I'll just say that people in either Spain or England will be happy tonight, and other people in either England or Spain will be depressed. Hope that clears things up.

10:00 And now a quick switch to You're Fired. I might have a little look at the football on the way over...

9:59 A nice preview of next week's interview episode. I do like that one. Fortunately Alan is pointing in several different directions and so I don't get too many clues about who will be sacked.

9:58 Howard thinks maybe he needs to be "a bit more maverick" in future. I suspect he just needed to be a bit more colourful on TV.

9:57 And Howard's fired! For being too ordinary. I think we all wish the other team had lost. But we will get better TV out of James, Debra and Lorraine.

9:56 Alan seems to be at pains in the last few episodes to emphasise what a difficult decision he's making every time he fires someone. I wonder if he is planning his own exit strategy.

9:55 Is Lorraine on her way out? She's getting the longest chat from Alan.

9:54 Howard explains rationally what a strong candidate he is. Lorraine mainly talks about her motivation and desire to get back into the workplace. Kate cleverly reminds Alan of her actual performance in this series. A good tactic I suspect, because resurfacing recent memories is a good way to strengthen someone's impression of you.

9:53 Nick is really putting the knife into Howard. Quite a sinister little comment there! I wonder whether Nick and Margaret have their own careers to take care of...

9:52 Final chance for someone to burn their public image in an attempt to save themselves. But it's probably worth taking the risk - any insults today will be quickly forgotten. Which makes it interesting that Alan also describes Howard as risk-averse.

9:49 A very low-vitriol boardroom. These are quite mature candidates, I think, and have an eye on their reputation after the show. Interesting and subtle comments from Alan, Nick and Margaret on the three of them.

9:47 Kate only sold £277, compared to Debra's over £900. Quite a gap there. But despite Howard and Lorraine's selling over £1000, apparently it's only 5% of the expected revenue for the time slot.

9:45 Howard thinks Lorraine didn't push the dinosaur product hard enough to persuade the rest of the team to take it up, and Alan agrees. Instead of Howard letting her take the heat, he steps in and puts himself back in the spotlight.

9:44 Kate's animal craft kit sold only one. I think Kate has to take responsibility for that. But Howard did pick it.

9:43 Lorraine sets up a nice boardroom moment by claiming that she will only talk about her own performance and "if I bow out today, it will be with a bit of integrity and grace". Clearly that's not going to happen.

9:42 Then again (don't worry, nothing's happening on TV except the winning team is going flying) Kate did choose the top products.

9:41 Alan thinks the high-end products were right but it was sold badly. I guess the problem was: enough rapport and charm (except from Kate!) and not enough focus on proven calls to action: phone number, website and price.

9:40 Shows what I know. Howard loses, because Debra sold as many ponchos as a professional presenter would have done. Well done folks.

9:39 And from Ignite: £1376.73

 Total sales from Empire (Yasmina's team): £1541.88

9:37 A bit like last week's lesson - limited sales resource implies that more expensive items are worthwhile.

9:36 Yasmina is criticised for that risk aversion which Lorraine thought was a problem for Howard.

9:35 Great loyalty from Howard's team - it's such a disciplined and functional team that they almost have to win. But...

9:34 Into the boardroom, and I am very curious to get some insight into this. They have avoided giving us many sales clues, which normally is a sign that the results are completely one-sided. I still think Howard's team has done much better - because of the more diverse price range - but I have been wrong often enough to not put money on this.

9:33 However - possibly good product choices, because the craft product and air guitar are sufficiently specialist products to sell on their own without much help from Kate. And they aren't getting any.

9:32 Kate unfortunately wasn't the right choice to put on screen on her own - but I think the other two will have sold enough to compensate for her.

9:31 Missing the experienced director - they aren't giving out the phone number and website enough. Boosting perceived utility is great, but you also need to bypass key cognitive barriers for people: make sure they know how to get the product and are prompted to do so.

9:30 Lorraine and Howard have a nice rapport and their bizarre metallic leather jacket is reminiscent of the wolf sweater which was the surprise seller of a previous series. I saw one of those on the tube once. Not sure if anyone is buying them ironically though.

9:29 But something has to go badly wrong with Howard and Lorraine's pitch - otherwise it would just be no fun.

9:28 Alan Sugar doesn't like their pricing strategy either. All the products are low priced. I anticipate a shortage of revenue.

9:27 Now Debra tries to sell a head scarf/neck warmer. Unfortunately she is utterly devoid of the charisma you need to be a solo salesperson.

9:26 Sold £400 in the first session - someone thinks that needs to be "fixed".

9:25 Yasmina and James are messing up their pricing. Telling everyone the hair clips cost £9.99 and then correcting their mistake - the correct price is £17.99 - is about the worst anchoring mistake you can make.

9:23 Again we have a bit of subjectivity to mix with the sales figures: Sralan is watching too.

9:22 What's more, I like everyone on Howard's team and only one on Yasmina's. So of course I'll be supporting Howard's lot.

9:20 My first impression is that Yasmina's team has picked cheap products that are fairly suitable for the market (that's my prejudice showing) but Howard's team has a better range of prices, which is a very powerful match with a diversity of consumer utility functions. That looks like a potential win for Howard.

9:19 A bit of Prisoner's Dilemma here. Each subteam has to sell products picked by the other. So do you pick the best product possible? Or one that you think will screw over your teammates?

9:18 Lorraine believes Howard is risk-averse. Interesting theory - risk-aversion might be the right economic approach in this scenario but possibly not as an Apprentice candidate. We're getting more focus on this team which implies they might be planning to lose.

9:17 A toy baby dinosaur whose personality evolves according to how it's treated. Cute but £229?

9:16 £139.99 chip pan - Kate likes. Some dreadful-looking leather jackets for £149.99. Kate doesn't like.

9:15 Product choice. Has anyone thought to ask about the sales figures of the products they're considering? Howard at least figures out that it's something he should be thinking about.

9:14 Kate's presenting on her own - though her practice wasn't much cop - and Howard and Lorraine will be together. Possibly better than trying to put Kate and Lorraine together, because they are about to kill each other even with Howard in the room.

9:13 Of course the target market is also key - Howard might go down better if the audience is bored housewives. Lorraine thinks he's good but Kate doesn't want to hear it.

9:12 Hope we can get some idea of the rules - because whether you put Kate or Lorraine on TV is a very different decision if you have any choice in the matter.

9:10 Subjectivity rules - all the candidates are busy figuring out which products they like instead of which ones have good historic sales figures. Direct marketing is one of the most data-intensive sales channels there is, and you need to privilege every piece of hard information you can get above your own instincts.

9:08 A nice little insight into how the shopping is directed. Clearly a lot of domain knowledge about what people respond to - close eye on the clock, reminders of the item number and which products to push. Do you think the teams will ask for a professional director to hep them?

9:05 OK, no surprises - it's TV shopping. "One of my favourite tasks" says AS.

9:04 A little bit of philosophy from Howard "this could be my last day...but I don't think of it like that" and James "I have to start winning some tasks. Maybe I'm a jinx, maybe I'm bad luck". Or maybe you're just rubbish, James.

9:03 At the start of this series I thought the candidates were all so indistinguishable I'd never remember any of their names. Funny how they're unmistakable now. Though Yasmina and Debra look a bit more alike then they should.

9:00 And we're off! While the BBC repeats the same two-minute intro from every previous episode and shows last week's episode over again, you may as well watch the Cassetteboy video again.

The last of the regular tasks tonight as Yasmina, Debra, Howard, Kate, James and Lorraine get on TV and try to sell stuff.

This should give us some good insights into economics: demand curves, specialisation, market knowledge and search theory may all make an appearance. See you at 9 for a live blog on an increasingly tense series.

In the meantime, watch this hilarious, if slightly puerile video from Cassetteboy.

Tuesday, 26 May 2009

Zeitgeist analysis, 24 May 2009

Bank is jumping back up the rankings in this week's word cloud, up from number 29 to number 15. And financial is up seven places to 11.

Apart from that, no major moves at the top. US moves up from 4 to 3, market is up slightly and government down one (reinforcing last week's move, but still slightly too early for the Randians to declare victory).

But the biggest move of the week is a new entry, representative at number 44. I spent some time trying to figure out why this is - there is not a lot of news about representative agents or bank representatives. But what there is, is a listing of all US Representatives and their fax numbers, in a not-very-Internet-savvy (or economics-savvy) Ron Paul campaign to abolish the Federal Reserve.

UK readers may remember when became popular - about eight years ago. After at least a hundred thousand faxes in three years, they gradually switched to email - and their successor site, (to which one of my companies donates data) has been using email for the last four or five years at least. I do hope that the US catches up; although if it's only Ron Paul who is still using faxes, he is welcome to stay behind a bit longer. In related news, Senate is also a new entry at 264, because of course there are fewer senators on that page than representatives.

Some words dropping down the tables: trade down about 50 to 98, GDP and health both down a few dozen places at around 130, and economics down 74 to 172. Other than that, power and energy are both down but with oil and well up, it doesn't seem to portend much. Unemployment and sales are both down substantially, which could indicate that public spending is starting to save jobs and/or crowd out the private sector, but probably doesn't. Contraction is down 416 places into the 600s, which I take as a positive indicator.

Other new entries are India at 380, rating and prediction around 470 and emerging, pension and party in the 500s. A few other countries also appear afresh: Japan at 633, Hungarian (yes really) at 646, British at 704, Russian at 821, Japanese at 826 and (ahem) Texas at 837. Chinese is down 426 places to 872 and is overtaken by London at 870.

Most of the people and companies of the last few weeks are dropping out of the news: Obama is down 88 to 191, Geithner back in but only at 816, Bernanke gone. GM is down 318 to 777, Chrysler down 379 to 697 and although Bloomberg remains well-placed as always (up 61 at 493) I don't think that really counts as either company or person, even though it's both. And Adrian, which looks like a person, is actually from Adrian College, whence many of the WAIS posts come (WAIS, you might recall, is the grandly titled World Association of International Studies which has an active blog containing its name in the footer of every posting).

Trillion is up a little (87 up at 538), billion down 4 at 37 and million up 3 at 57.

Now what's up this week? Interest (up 67 to 28) as well as real, ratesmarkets, state and debt. Investment is up a hundred places and capital up 40, central up 160 (probably to go with the rise in bank) and inflation up 68. Assets and income both jumping, and Fed up 136 to 139 despite Ron Paul's clearly effective campaign. Must try harder, Ron! Recovery up 73 is a nice sign, and fiscal up 190 probably a neutral one. Monetary and California are both surging up the charts - I guess most economists prefer the former, which would just confirm how out of touch they are with the rest of the world. I attended a seminar today where moving to California was given as the canonical example of a utility-increasing (and evolutionary-fitness-increasing) action that an economic agent could take.

Consumption, trading and reserve are all up substantially, as is the dollar, currency and negative. I'm not sure I can make a story out of those, but online is up, technology is up and Internet is a new entry. There's certainly a theme there for anyone who wants to pick it out.

One final note, just to scare anyone who thinks the crisis is coming to its end. Gold is up 486 places: cash, buying, long-term and stocks all up, but is that enough to combat the apocalysm of the hoarders? Maybe so, but death at 886 is where my eye alights and that seems an apposite place to stop.

Monday, 25 May 2009

The economics zeitgeist, 24 May 2009

This is a word cloud from all economics blog postings in the last week. I generate this every Sunday so please subscribe using the links on the right if you'd like to be notified each time it is published.

It has been constructed from a list of economics RSS feeds from the Palgrave Econolog and other sources, and uses Wordle to generate the image, the ROME RSS reader to download the RSS feeds, and Java software from Inon to process the data.

You can also see the Java version in the Wordle gallery.

If anyone would like a copy of the underlying data used to generate these clouds, or if you would like to see a version with consistent colour and typeface to make week-to-week comparison easier, please get in touch.

Saturday, 23 May 2009

Eeyore vs Pangloss

missmarketcrash has been busy analysing the perception-driven world of economics and the contest between optimists and pessimists - or is it pessimists and optimists?

I am firmly on the optimists' team but I have a feeling she has a sneaking affection for the opposition. The bad boys always get the girls.

Anyway here are some results from my economics zeitgeist data from the last three months - showing that bloggers at least are more positive than negative. And according to miss's search data, much more positive than the general public.

pessimism: 7
optimism: 11

pessimism: 4
optimism: 16

pessimism: 14
optimism: 13

pessimism: 12
optimism: 15

pessimism: 6
optimism: 16

pessimism: 5
optimism: 29

pessimism: 3
optimism: 9

pessimism: 11
optimism: 23

pessimism: 5
optimism: 30

pessimism: 5
optimism: 28

pessimism: 6
optimism: 28

pessimism: 1
optimism: 25

pessimism: 7
optimism: 25

Friday, 22 May 2009

Pigovian taxes and government credibility

Most economists are inclined to agree with Greg Mankiw that a high tax on carbon, reflecting the best estimate of its social cost, is the best way to mitigate the effects of carbon emissions. [Edit: In this posting I consider a carbon tax to be roughly equivalent to cap-and-trade - of course there are differences but my point applies to both mechanisms]

In theory, this should encourage the right mix of reduced growth in consumption, development of energy-efficient technology, and compensation to those affected by climate change. Economic theory says that the market will respond in the most efficient way to a tax which fully reflects the external costs of the activity (known as a Pigovian tax after economist Arthur Cecil Pigou who was an early proponent of the concept).

In particular, it should not be necessary for the government to subsidise research into green technologies - they might pick the wrong ones, and they will probably end up wasting more money than the market would if left to itself. If green technology is a better way to solve the problem than simply cutting our energy usage, the market will say so. If a mix of both is the best solution, people trading in their own interest will find the right balance.

So is it economically illiterate for the Obama administration to be proposing such subsidies? Not necessarily.

There's a specific reason why a carbon tax might not work, and why it might not stimulate the optimal levels of R&D investment that economic theory indicates.

That reason is the inability of governments to credibly bind themselves in the future. Congress might pass a carbon tax in 2011, and then rescind it in 2014 with a tough mid-term election coming up. Or a presidential candidate in 2012 or 2016 might run on an anti-carbon-tax platform. Or the optimal level of the tax might be underestimated and future Congresses may be unwilling to increase it. For example, the Waxman-Markey bill currently passing Congress contains a cap-and-trade provision which is probably not sufficient to achieve what the US needs to do and may not in itself stimulate much investment. (note that something similar happened in Europe in 2007, when carbon prices dropped by over 99% in a couple of years as it became clear that the caps were too high)

Because investment in green technology must by necessity be carried out before it earns a return, such investment relies on the future being predictable. If I could be convinced that a carbon tax would stay in place for the next 30 years, that might be sufficient certainty for me to invest in developing energy-saving technology. But if I can only see it sticking around for the next four or six years, I probably won't invest.

Politically, the price of carbon credits in the near term will almost certainly be lower than optimal: because the expected energy-efficient technologies do not exist yet, and voters will fiercely resist an increase in their current costs which they will see as unjust because they have limited options for offsetting it. A future increase, to be imposed in several years when these technologies have been developed, would be more politically achievable but few investors will commit on the basis of a hypothetical future tax.

In this circumstance, the optimal solution may in fact be to subsidise research. Companies will then have a short-term incentive for research in which they can more readily believe than the 'jam tomorrow' of a carbon tax which has to survive at a high rate until 2030 or beyond.

And indeed this is just what Obama proposed during the election campaign (and in his inauguration speech), and is one of the many provisions in the Waxman-Markey bill. Is it possible that the politicians understand incentives better than the economists?

Because of the subsidies, this green technology may be over-supplied in comparison with the optimal solution. If so, it should be cheaper, and consumers will adopt it even with a slightly lower carbon tax than would otherwise have been required. Thus a lower tax will achieve the same emissions reduction - or, alternatively, a higher cut in emissions will be achievable for a given tax hike (of course other tax rises will eventually be required to pay for the subsidies, and Pigou's theory indicates the total bill will be more expensive than the optimal carbon tax. That's the cost of this approach).

It's important to remember that this solution is still economically less efficient than a permanent Pigovian tax. But short of passing a constitutional amendment, it may be impossible for the US government to credibly bind itself to keep such a tax in place over the long term.

(There are other problems with the idea of a carbon tax - such as the question of coordination among countries. There are also other problems with the Waxman-Markey bill. Both are outside the scope of this article. But some notes on the international coordination question:

The tragedy of the commons is an issue here - a country which reduces its impact on global carbon levels bears all the costs but gains only a small fraction of the benefits. Without international agreement, countries can easily free-ride on others and so everyone has an incentive to keep burning carbon. And there are debates about the level of effort different countries should make.

Even the EU didn't have the power in its own right until 2007 to enforce energy policy among its members - though there was enough cultural similarity and common interest between the countries that they were able to negotiate a solution, the EU Emission Trading Scheme. This is a cap-and-trade scheme rather than a carbon tax, but in this posting I'm treating them as variations of the same idea.

However, countries can and do sometimes impose a carbon tax unilaterally. Those which have committed themselves to a reduction in emissions under the Kyoto agreement can use this as a mechanism to fulfil their promises.

Crucially, the US is not one of those countries. It has no external commitment to reduce carbon - and even if it had, one could doubt whether it could be enforced - and this leads to a critical problem with the Pigovian thesis: the credible binding issue described above.)

Thursday, 21 May 2009

Private productivity and public debt

Robert Peston, famous among his blog commenters as the BBC's banking editor (with a sideline in other businesses) has come up with his most creative definition yet of a "business" - the UK government.

He points out, in a surprisingly sanguine article, that UK government debt has been put on negative watch by Standard and Poor's. As he says, it's not that big a deal - I suppose the surprise is that it didn't happen earlier. As the UK is likely to be one of the world's top ten debtors in the next few years, with about £1 trillion of public debt (still less than Citigroup or RBS, incidentally, and much lower than the Japanese, US or Italian governments), it is only natural that people would keep an eye on the figures.

S&P have said that the downgrade might happen if the next government does not come up with a credible plan to put the debt on a long-term downward trend. Seems fair - and everyone expects the next Chancellor, whoever it might be, to do exactly that.

If, as I expect, the next election results in a hung parliament, there's a strong possibility this could be Vince Cable. Apparently he is the most trusted politician around and he's regarded by the public as a very good economist (though I do think Alistair Darling knows what he's doing, and even George Osborne wouldn't be a disaster). Vince as Chancellor could be the Liberal Democrats' price for a coalition, and would probably give them their best chance of establishing themselves as a serious, credible choice in future elections.

Back to the public debt - one of the key questions for investors in UK debt is not the (tiny) possibility of default, but the likely value of their sterling-denominated assets in terms of other currencies. I don't think S&P's evaluation takes this into account, but today's 3-cent fall in sterling raises an interesting question. The pound has fluctuated by about 40% in dollar terms over the last 18 months - over $2 at its highest point and $1.20 at its lowest. It's slightly below the middle of that range at the moment, and rational expectations theory says that's exactly where investors expect it to stay.

The price of the pound is determined in the short-term by interest rates relative to other countries; in the medium term by expectations of inflation, and in the long-term by the money supply - which in turn is a function of productivity and thus the central bank's reaction to real and nominal growth rates.

Do we think the productivity of the UK economy is likely to keep up with other countries? Against the rest of the world in aggregate, it certainly will not - because productivity in China and India has a lot of catching up to do, driving world productivity growth to perhaps 4%, and the UK has no chance of matching those rates of growth. But in comparison with the other OECD countries? I am more positive about the UK economy than many observers, because I believe financial and business services do actually drive genuine productivity, and the UK is strong on both.

But there are interesting challenges for the UK in day-to-day management, and the skills of its people. The government is well aware of this long-term issue in British industry, and has made various attempts to remedy it through industrial and education policy - with mixed success. I believe that this is the key long-term challenge for all modern economies - but the UK probably has more work to do on it than most. The strength of the British business services sector is a big advantage, but I feel that there is a corresponding weakness of general management skills and human capital in the rest of the economy. The government (and indeed private companies) would do well to try to disseminate some of this expertise more widely through the private sector, and for that matter the public sector.

We can have a useful debate about whether this should be done via an interventionist industrial policy, by laissez-faire, by strengthening education or other means - but it does have to be done. The success of this programme will be the real determinant of how quickly we can pay off our public debt and how much those repayments are worth: the debate about cutting public spending or increasing taxes is, frankly, a sideshow.

Wednesday, 20 May 2009

Live blogging The Apprentice series 5: episode 9

Economics lessons from this week's episode?
  1. Flexibility in pricing creates economic value. If something is worth less to a client than your cost base will bear, they (and you) won't benefit from it unless you can bring down the costs. And if you can also capture some of the higher value to clients who do derive more value, you can reduce overall costs by sharing the fixed costs.
  2. Being competitive on price is important, but not critical - even in a commodity market
  3. Operational problems can usually be solved if you have the right product and price point
  4. If you want a sustainable, predictable business you need to keep the granularity of your sales smaller than your measurement time horizon (or your working capital)

The usual courtesy for later viewers: a blank space.

Stop scrolling now if you haven't seen the show - jump down to the bottom and read upwards.

10:30 Another show over: and just three more until we know this year's apprentice. I would love to see the story of what happened to all the previous years' winners while working for AS.

10:28 Ben gets a unanimous vote of no confidence from the panel and a nearly unanimous one from the audience. Not too surprised.

10:25 Hugh seems to like everyone. Lorraine, James, Ben - he is either a really nice guy or wants to be seen as one.

10:23 And Ben: he could easily have played the game better and pinned the blame on rocking scapehorse Debra. And high-risk strategies aren't always smart on The Apprentice, even if they have a positive expectation value, because you never have time for the long-term averages to work out.

10:21 James: mostly did what he had to do as team leader - quite rational to have had children, it seems, because that got him picked as leader and the leaders have been surprisingly safe in this series. There is something high-risk - but on balance probably smart - about the way he presents himself as a foot-in-mouth moron to the cameras. He's going to be one of the dark stars of the series when he's finally fired. I can't see him winning it - he comes across as a bit too fake (though Hugh Dennis thinks he's a "proper bloke").

10:19 Debra: actually not a bad decision to pick the horse, though it's usually rational to try to negotiate, especially when you don't have an ongoing relationship to maintain. But there is a potential irrationality in excessive attachment to her chosen product - a bit too much anchoring.

10:16 And the losers. Yasmina made two good moves - behaving well and keeping her head down in the boardroom (mostly), and more importantly being in the same (sub)team as team leader James. This gave her the chance to butter him up (and she's quite pretty) and also left lots of uncertainty about the performance of the two candidates who weren't accompanying him.

10:13 Back to the candidates: the winning team. Howard: intelligent and down-to-earth - no real issues. Kate: about the same. Lorraine: claimed to be acting on instinct which sounds irrational, but actually she knew exactly where those "instincts" came from - straightforward arithmetical reasoning.

10:11 Hugh Dennis is quite rational for that matter - points out that at the start of a task, it's worth asking why it has been set. Correctly judging the future and eliminating uncertainty are two of the hallmarks of successfully furthering your rational interests.

10:10 This show is a bit boring, so let's see whose irrationality we can spot. Alan was on form this week. Nick and Margaret are always smart. So how about the rest?

10:09 They pick up on the nice "who's responsible" line from the boardroom. One of the lines of the show. Michael Ball, unexpectedly, has a smart insight on this: "I take full responsibility for completely going along with your idea". Clearly learned from Gordon Brown.

10:08 Hugh Dennis is definitely one of the funniest people to have been on this show.

10:06 Seems that I was wrong about the price comparison - apparently it's standard practice in these exhibitions. I guess I only spend time at trade shows.

10:00 You're Fired now? Join me there.

9:59 And next week is the TV shopping task - always fun.

9:58 Interesting little point - Ben in the taxi insists he is better than James - and "probably" better than Debra too! Odd way to put it...

9:58 Next week then is the last regular episode, followed by the interviews and grand final.

9:57 So we now have four women and two men left. A nicer balance than previous series.

9:56 Debra did save herself in the boardroom - but admittedly while she's really annoying, her performances on the tasks have been OK.

9:56 But he chucks Ben out.

9:55 Alan almost looks upset to be firing someone.

9:55 On performance in the boardroom, I'd get rid of James. On the task, Ben. On the series, Debra.

9:54 James does have a legitimate defence that it was nothing to do with him.

9:53 Clever trick from Alan - getting everyone to claim responsibility for the horse.

9:51 Debra has some passion and can talk about results. James claims unconvincingly to be a leader in his company. Ben has a scholarship to Sandhurst.

9:50 Debra isn't very popular with Alan, Nick or Margaret. But we still have ten minutes until the end of the show.

9:49 Ben is trying to give evidence for how great he is. Worth doing - again bounded rationality means that whatever people remember is more true than what they have forgotten.

9:48 A more in-depth analysis than usual between Nick, Margaret and Alan of the candidates' relative strengths.

9:46 Exhibitions are time-sensitive and you need to offer a deal to get people to buy now. Bounded rationality - people will forget what you had to sell after they leave the room.

9:44 What's more, they didn't negotiate with the vendor to be able to offer a lower price.

9:43 Although she is lining up Debra and Ben as the scapegoats for picking the rocking horse.

9:42 I do like it when Yasmina doesn't talk. Because she is much less likely to be brought into the room if she keeps quiet.

9:41 I do like it when Nick talks. They (or he) makes sure he only says sensible things that show a good understanding of business.

9:39 Quite a lot of time spent on the prize this week - Gerald Scarfe is making cartoons of the winning team. Don't fancy Lorraine's avatar much.

9:38 It has to be James or Ben to go - they have made themselves highly visible. Debra probably into the boardroom with them.

9:37 £722 for Empire: over £1100 for Ignite! The nice team won!

9:36 Alan points out that the high-value rocking horse is a very risky strategy. Of course if they had sold any, he might not have said that.

 Ben is clearly convinced that they have lost the task - he is getting his attack on James in already.

9:34 "A very interesting task" according to Sir Alan. I'm not sure I agree.

9:33 A sudden end to the show - and we're in the boardroom.

9:32 Oddly enough, they are not allowed to vary the price - and so they lose the sale. A perfect example of neoclassical economic theory - price controls reduce economic activity.

9:31 Someone is interested...but for £1500 instead of £1762. We don't know what the margin is.

9:30 Desperation sets in and the rocking horse hasn't been sold yet. High stakes - it will win or lose the task for them.

9:28 Howard and Lorraine are frustrated at not being able to work the pushchair, but they will get the hang of it pretty soon. Easy to get annoyed at the beginning of the day, but human capital develops quickly.

9:26 Pricing question: should the rocking horse come with a price tag? James and Debra realise they should probably take it off so that the child starts to like it before the parent gets scared.

9:24 Lorraine realises her negotiation wasn't so good and they may have paid over the odds for the collapsible pushchair - they can't compete with the cheaper supplier of the same thing. But I am not too worried - there's so much noise and confusion at an exhibition that price comparison is hard.

9:22 7am and they show up at the exhibition centre. I remember doing this - wandering around to look at the competition, comparing our stand to theirs, figuring out what last-minute gimmicks we can think of to grab more customers.

9:19 In a near-comedy moment, Lorraine, Kate and Howard (i.e. the likeable team) nearly talk each other out of a decision they both agree with - not to pick the birthing pool.

9:17 Debra and Ben make a good economic point: the balance between capital and labour (they don't quite put it that way, surprisingly). Labour is scarce and thus expensive - because there is a small team and a limited amount of time to sell - and so the value of capital goes up. This argues for picking a high-value product such as the £2000 rocking horse rather than the £10 headguard, which they'll have to sell two hundred of.

9:15 I'm curious about the best strategy here. Should the teams pick compatible products (for instance two high-end or two cheap things), so that the stand is attractive to a specific audience and they can offer multiple products to the same people? Or should they pick diverse products to cover a broader set of customers? A retail store would want some kind of consistency so that it has a memorable identity. But that might not apply to a stand in an exhibition.

9:13 A birthing pool supplier sold £5,000 of product at last year's Earl's Court show. Yasmina thinks that's a lot, but three days in Earl's Court must cost more than that.

9:11 Nice to see the teams being sold to by other people for once - gives us a little insight into how it's done!

9:09 Feels like there's been several tasks this series where product selection and design have been combined with selling. I guess that does highlight two of the key aspects of business, but it feels like Alan is preparing for a very specific job in his "empire".

9:05 The teams have to choose products to promote at the Baby Show in Earl's Court. Already Ben and James are disagreeing about something irrelevant.

9:00 Welcome to the Apprentice liveblog, particularly to anyone who's come over from the Guardian today. Don't forget to keep Anna's blog open in another window too (as if you wouldn't)!

Time ticks on, and so does Alan Sugar. Two hours to go and eight episodes down, the ninth of twelve Apprentices is on tonight.

Seven people remain: Raef, Lee,, that's not right. Yasmina, Ben, Lorraine, Howard, Kate, James and Debra. So if they're keeping things balanced, it's a woman's turn to be fired tonight.

Tune back in at nine o'clock and find out whether the candidates obey the laws of economics or if they're (predictably) irrational.

In the meantime, I recommend Anna Pickard's liveblog at the Guardian - enjoy the Adam and Joe videos while you wait.

Can corruption be a public good?

I'm reading Dani Rodrik's "One Economics, Many Recipes" which sheds interesting light on the understanding of developing-country growth and its causes.

Chapter one focuses on the idea that there are basic principles behind economic development (indeed, economic activity in general): property rights, sound money, fiscal solvency, and market-oriented incentives. The exact policies which result in these outcomes are not necessarily those from the standard (Washington Consensus) list: privatisation, tariff reduction, etc. Instead, the universal principles need to be achieved with policies that are tailored to the country in question.

There's one point he makes in passing which struck me as fundamental. From p38 (of the 2007 edition):
"...policy changes at the outset have been typically modest...[South Korea's] military government led by Park Chung Hee that took power in 1961 did not have strong views on economic reform, except that it regarded economic development as its key these instances illustrate, an attitudinal change on the part of the top political leadership toward a more market-oriented, private-sector-friendly policy framework often plays as large a role as the scope of policy reform itself. Perhaps the most important example of this can be found in India: such an attitudinal change appears to have had a particularly important effect in the Indian takeoff of the early 1980s, which took place a full decade before the economic liberalization of 1991."

Why would this be? There's an ongoing debate (mostly between economists and sociologists) about how much importance to ascribe the influence of culture in prosperity. Economists traditionally say that choices arise from the incentives that individuals face - for instance if they get to keep and spend the profits of hard work, they're more likely to work hard and invest; while sociologists talk about culture and how that influences the behaviour of a population (for instance would you say that German culture encourages hard work and saving more than, say, Portuguese? Are American people more entrepreneurial than French?)

As with many interdisciplinary debates, this is a false dichotomy - where culture does influence people's behaviour, it probably happens through incentives, which can be social or psychological as well as material. And this is my explanation for the effect that Rodrik describes - specifically the fact that the incentives provided by new policy measures are highly uncertain. Especially if your government has been inconsistent in the past (or previous governments have not managed to stay in power long enough to be consistent), you may not trust the new institutional arrangements to last. And if you think your property rights are only here until the politicians change their mind, you may not act any differently than if you had no property rights at all.

What's more, policy changes are needed as circumstances change, or when the results of experiments have played out. And as I've mentioned before, it's hard to distinguish between a change in policy which is genuinely intended as an improvement, and one which is a disguised way of backing off from a commitment. Thus, if the government is not entirely credible, it may get stuck with suboptimal policies to avoid giving the impression of a lack of will.

In these cases, the attitude of your leaders to business is a key indication that private-sector-friendly policies will continue, regardless of the details of individual policies.

So a visible and credible commitment to the principle of an economy with a strong private sector may act as a signal that policies will be sustained - and may allow a government to optimise its policies over time without investors losing faith.

An important question - not answered in detail in the book - is: how can leaders signal such a commitment?

Sometimes, institutional mechanisms work, and this is the main theme of the rest of Rodrik's text. These are most successful in mature democracies - for instance the constitutional protection of private property in the United States is not seriously doubted by businesspeople there, because they know and trust the structures by which it will be enforced, and there is wide agreement among participants in the political, justice and enforcement communities about how these things work. But in a young or unstable society these tacit agreements may not exist, and institutions can always be overthrown.

A potential solution, then: Corruption, at the highest level possible. Specifically, crony capitalism of the sort that used to be familiar in East Asia.

The way to ensure commitment to business-friendly policies is to give political leaders an incentive to help businesses be successful. An excellent way to do this is to choose leaders who own businesses and make sure they keep hold of them during their term in office. They're likely to create an environment that imposes few barriers to doing business, with a low chance of asset confiscation by government. And, crucially, if they are allowed to align government policy with the interests of their own firm - provided their firm is not fully dominant within the economy - it will be in the interests of the private sector in general. Even if they decide to support their own businesses directly with government resources, at least that is likely to keep demand circulating within the domestic economy.

Growth in almost every country has been driven by private sector development and encouraging it in this way is likely to outweigh the welfare disadvantages - even in the short term - of more unequal wealth distribution and the economic rents extracted by politicians.

Of course there are caveats. One is that this is a completely unsustainable model and cannot be the basis of long-term development. Rodrik draws the distinction between igniting growth and sustaining it, and this feel much more like an ignition tactic than a sustenance strategy. The other is that not all businesses are equal: a corrupt leader may divert resources to his or her own businesses at the expense of others. To discourage this, leaders should be chosen whose businesses are closely embedded in trading networks with others.

Where has this worked? I probably have to be careful in what I say here, so I'll just suggest you look at the recent history of some East Asian economies. Certainly some smaller countries have been able to take advantage of the signalling value of having an industrialist in charge. I wouldn't know whether there is actually corruption in such places, but Belize is probably regarded as more business-friendly due to its government's relationship with Michael Ashcroft ("The billionaire who bought Belize"). And Italy is arguably considered a better place to do business under Berlusconi than under previous governments.

I hasten to note that this conclusion is not drawn from (or even implied by) Dani Rodrik's book. And of course it is a rather tongue-in-cheek idea.

But before dismissing it, let's remember one situation that is comparable: the principal-agency model of investment bank compensation. Under this theory, bankers decide to pay each other an amount of shareholders' money which is well above their marginal productivity (some have even claimed that such bonuses are 'corrupt'). The idea is that this reduces their incentive to take actions that are against the shareholder's interests. Is it really any different in a political system?

Monday, 18 May 2009

Zeitgeist analysis, 17 May 2009

For some reason this week's economics zeitgeist has year and percent as big risers, up to number 3 and 6 respectively. But puttings those aside, the movements at the top of the chart are reasonably tame: US and market are up four and five places, with government down two - market is clearly beating government this week but I don't think laissez-faire can declare victory just yet.

Bank and banks are both down plenty from last week's heights, 26 and 34 places respectively. Oil on the other hand is up 280 places (with energy up 72, climate up 250, emissions up 485 and gas up 377) presumably because of the proposed Waxman-Markey cap-and-trade bill. Oil has been rising consistently over the last three months, incidentally - likely because of expected rises in demand with the end of the recession. The FT's Lex column agrees with me that the fall in oil prices has been more important than fiscal stimulus in triggering recovery in the industrialised countries.

Trade is up 218 places with exports and imports both new entries at 289 and 493 respectively. Growth is up 10, GDP up 182 and output also up 10. Recession down 40, recovery staying exactly where it was at 229.

Bond and bonds both up several hundred places - I am not sure why. There is an extensive discussion of European covered bonds, and some mention of bond yields rising, and a difficult Treasury auction in the US last week (something similar happened in the UK and Germany a few months ago). Also a bit about the Chrysler bondholders, and a little macro analysis from Paul Krugman which talks about the IS-LM model in terms of a three-good micro model in general equilibrium, with the three goods being 'goods in general', money and bonds. Not having looked at this in previous weeks, I'm not sure whether this is an unusual amount of discussion about bonds, but in any case there doesn't seem to be one dominant cause.

Trillion is up 144 places but billion and million both down. Confidence is up 200. Production, services, industry are all up, with goods a high new entry at 325, but manufacturing is down after last week's big increase.

Highest new entries: deficit, exports and German, with Spanish, Spain, UK, Slovakia, EU, eurozone and euro all new as well (but America down over 200).

Company of the week is Chrysler again, up 201 to 318. GM is not far behind, up 325 to 459. No other companies unless you count twitter. Not many people this week either: Obama is the most popular as always, up 9 to 103, but Geithner and Bernanke have dropped out.

Of some note, health has risen 58 places to 110, Medicare is new and Social and Security are both up a lot. Maybe this is where trillion and deficit originate too. Think I'll need to be on the look for quadrillion any time soon?

Sunday, 17 May 2009

The economics zeitgeist, 17 May 2009

This is a word cloud from all economics blog postings in the last week. I generate this every Sunday so please subscribe using the links on the right if you'd like to be notified each time it is published.

It has been constructed from a list of economics RSS feeds from the Palgrave Econolog and other sources, and uses Wordle to generate the image, the ROME RSS reader to download the RSS feeds, and Java software from Inon to process the data.

You can also see the Java version in the Wordle gallery.

If anyone would like a copy of the underlying data used to generate these clouds, or if you would like to see a version with consistent colour and typeface to make week-to-week comparison easier, please get in touch.

Update: Analysis of this week's moves is here.

Friday, 15 May 2009

Ascent and Exchange: reviewing two books

My review of two books - The Ascent of Money and A Splendid Exchange - is up at Culture Wars today - Ascent and Exchange.

Do go and read it on Culture Wars, but I'll post the text here as well after the weekend. A couple of excerpts:

When they set out to write these texts, neither author must have expected to create an especially political book. But for the first time in decades, opinions about the detailed management of the economy are intensely political, and any book, article or quotation on financial matters in the last few years is likely to be re-read in that light.

Bernstein’s other argument is a little more controversial, and therefore more interesting. He portrays nearly every major development in world history as the result of trade, competition over trade profits, or protection against trade. Early chapters cover the expansion of Islam across the Middle East, North Africa and South Asia; the middle of the book explores European exploration and colonisation of key locations in the Pacific and the New World; and the last third explains the rise and fall in turn of Portugal, Spain, the Netherlands, Britain and America as dominant world powers. At times the idea is stretched – was protectionism really a major contribution to the outbreak of World War II? – but in general it is well argued and sheds much light on how the world turned out as it is.

The Ascent of Money on the other hand has no such argument. It is a survey of six different aspects of money, conveniently scaled to fit into six one-hour episodes on Channel Four. The chapters – on the invention of money, bonds, bubbles, risk, property, and ‘Chimerica’ – contain some interesting ideas, and there’s more enquiry into the nature and philosophy of money than Splendid Exchange makes into the ideas behind trade. But the book is still unsatisfying, and it is hard to see any thread consistently running through the chapters.

The best segments of both books are between about 1400 and 1800, where Bernstein tells stories of exploration, misunderstanding and chance, and of the grand contest between the English and Dutch East India Companies (and by proxy, Britain and Holland); and Ferguson shows us that bond and derivatives profiteering and stockmarket bubbles are nothing new. Each book less evocative in the further past, with Ferguson showing some pictures of 3000-year-old money in clay tablet form, and Bernstein providing a thousand years of detail about ports and sultanates in the Middle East which no longer exist and have little relevance to the ongoing argument.

Strangely, the book that’s about the stuff of all our lives – how often do you live a day without money? – feels less relevant and meaningful than the book about something we only come into occasional contact with, international trade. There is a book waiting to be written about how we psychologically interact with money and what it means to us when it’s in our pocket or leaving our wallet. Maybe that will be informed by history too, but The Ascent of Money isn’t it. A Splendid Exchange, on the other hand, makes real and immediate the effects and benefits of the movements of containers that most of us never see and goods whose origin we rarely notice. The arc of the story of the rise of trade over five thousand years is well drawn.

If you only have time to read one...

I'm afraid you'll have to go and read the review to find out which one it should be.

Bonuses again

Robert Peston reveals a report by MPs on bankers' bonuses. Of course they are calling for reform. But what should that reform look like?

Here are a couple of odd things about such bonuses:
  1. Behavioural economic theory indicates that it's not so much the absolute amount of money that acts as the reward, but the relative amount - if I get £5m to your £3m, it's just the same as me getting £500k and you £300k. The 'reward' seems to be the ego boost of being at the top of the tree.
  2. But unfortunately it's also not the amount of money that has led to the risk-taking behaviour. Even if banks had only paid their employees 1/10 of the bonuses, they would still have acted the same way.
So how to change behaviour, if that's what we want to do?

Certainly tying bonuses to long-term results instead of short-term is one option. But for motivational purposes, people should still receive performance bonuses relatively quickly, as this is how their mental association between action and reward is stimulated.

And please don't suggest that bankers do not need or deserve motivation - even if that were so, it's still in a bank's interest to offer it to them. Companies don't pay bonuses out of charity - it's because they believe that, in certain cases, this is the way to incentivise the performance that they want (though sometimes companies are subject to 'capture' by their management and end up paying employees an unwarranted proportion of their shareholders' money).

So perhaps we need to go back to a system with a bit of wisdom and human judgment, where an experienced manager makes decisions on whether the employee's actions have put the bank in a good position for the long term. There's some risk involved here, but probably less than rewarding either based on the immediate profit from a deal or waiting until four years have elapsed before paying anything.

Of course banks would still save a lot of money by cutting those bonuses by 90% and just relying on the motivational effect of positional utility. Maybe an exception to the competition laws would be justified here, to let the banks cooperate to arrange this? Or just an even higher tax rate on bonuses over £1m? After all, we don't necessarily just want the banks to keep the difference - ideally it should either contribute to the public good, or go into reduced fees or higher returns for bank customers.

And these sums would make quite a difference (at least in the investment banking world), - compensation tends to make up well over half of the costs of an investment bank, and a big chunk of that is usually bonuses.

Unfortunately there will still be a loophole: companies and people based offshore, or more specifically tax and regulatory competition between countries. But if governments do want to make an agreement that stops this happening, now is probably their best chance ever.