Category: Market failure

Reverse Voxsplaining: Drugs Vs. Chairs

Slate Star Codex:

Let me ask Vox a question: when was the last time that America’s chair industry hiked the price of chairs 400% and suddenly nobody in the country could afford to sit down? When was the last time that the mug industry decided to charge $300 per cup, and everyone had to drink coffee straight from the pot or face bankruptcy? When was the last time greedy shoe executives forced most Americans to go barefoot? And why do you think that is?

The problem with the pharmaceutical industry isn’t that they’re unregulated just like chairs and mugs. The problem with the pharmaceutical industry is that they’re part of a highly-regulated cronyist system that works completely differently from chairs and mugs.

A succinct description of one example of market failure.

Don’t Buff it up

The Economist notes how Buffett’s investment strategy has changed:

But there is another problem with Mr Buffett: his fondness for oligopolies. After being disappointed by returns from textiles in the 1960s and 1970s, and then by shoe manufacturing and airlines, he concluded his firm should invest in “franchises” that are protected from competition, not in mere “businesses”. In the 1980s and 1990s he bet on dominant global brands such as Gillette and Coca-Cola (as well as Omaha’s biggest furniture store, with two-thirds of the market). Today Berkshire spans micro-monopolies such as a caravan firm and a prison-guard uniform maker, and large businesses with oligopolistic positions such as utilities, railways and consumer goods.

As more money has followed his example, America’s economy has become Buffettised. Among investors there is a powerful orthodoxy that you must own stable, focused businesses with high returns and market shares and low investment needs. Managers have obliged. Of America’s top 900 industries, two-thirds have become more concentrated since the mid-1990s. Last year S&P 500 firms reinvested only 45% of the cashflow they generated. Protecting margins and cutting costs is the priority. Economic growth suffers as a result.

Emphasis.  Not a criticism of Buffet – he’s just seeking the best returns – but a good indication that the market many not be as efficient as many believe.

Calculated misery

The New Yorker:

If fees are great for airlines, what about for us? Does it make any difference if an airline collects its cash in fees as opposed to through ticket sales? The airlines, and some economists, argue that the rise of the fee model is good for travellers. You only pay for what you want, and you can therefore save money if you, for instance, don’t mind sitting in middle seats in the back, waiting in line to board, or bringing your own food. That’s why American Airlines calls its fees program “Your Choice” and suggests that it makes the “travel experience even more convenient, cost-effective, flexible and personalized.”

But the fee model comes with systematic costs that are not immediately obvious. Here’s the thing: in order for fees to work, there needs be something worth paying to avoid. That necessitates, at some level, a strategy that can be described as “calculated misery.” Basic service, without fees, must be sufficiently degraded in order to make people want to pay to escape it. And that’s where the suffering begins.

The necessity of degrading basic service provides a partial explanation for the fact that, in the past decade, the major airlines have done what they can to make flying basic economy, particularly on longer flights, an intolerable experience.

An interesting observation – that when menu pricing is introduced there is collateral pressure to downgrade the “free” services in order to encourage people to trade up.  The author, Tim Wu, coined the phrase net neutrality.  As Quartz notes:

One reason open internet activists and, to some extent, US internet regulators, are uncomfortable with the idea is that they fear that everyone who doesn’t pay will be treated unfairly. As the US Federal Communications Commission put it in a 2011 document (pdf): 

[I]f broadband providers can profitably charge edge providers for prioritized access to end users, they will have an incentive to degrade or decline to increase the quality of the service they provide to non-prioritized traffic. … Even more damaging, broadband providers might withhold or decline to expand capacity in order to ‘‘squeeze’’ non-prioritized traffic, a strategy that would increase the likelihood of network congestion and confront edge providers with a choice between accepting low-quality transmission or paying fees for prioritized access to end users.

What Labour’s Red Princes tell us about Britain

The New Statesman:

Or perhaps it was natural for Straw, Prescott, Dromey and Kinnock to follow in their parents’ footsteps. The authors found that 10 per cent of lawyers in the US have fathers who do the same job, as do 14 per cent of carpenters and doctors (but just 1.5 per cent of economists). Yet, once you account for the relative size of these professions, politics emerges as by far the most dynastic. A GP’s child wanting to become a medic is striving to join a workforce of about 150,000 NHS doctors, while an MP’s son or daughter is hoping to take up one of just 650 seats in the Commons. That 22 have succeeded suggests that having a parent in politics is a big advantage.

So what do the Red Princes have over the rest of us? The Institute for Government estimates that it costs £41,000 over four years to become a parliamentary candidate. This is a lot but nothing compared to the $1.7m that American candidates need to raise for a seat in the House, or roughly $10m for one in the Senate. US candidates need to be good fundraisers; in the UK, it’s more important to ingratiate yourself with the party leadership.

So if you felt like being kind, you could say that Labour’s Red Princes have benefited from “high social capital”, but perhaps you would prefer the term “nepotism”. The children of MPs enter politics with an understanding of the Westminster system, as well as ready-made political connections and influential backers, which all help if you are looking for a parachute into a winnable seat.

In this way, at least, Labour reflects the society it aspires to represent: the UK has the lowest level of social mobility in the developed world. A 2011 survey by the recruitment agency Aldi found that over a third of Britons were not even interviewed for their job, having been recommended by a friend or relative. Politics, because it involves the trading of favours and the formation of alliances, lends itself quite naturally to nepotism – which might be why top-down attempts to tackle the problem have been so embarrassing. Last year, it emerged that the government’s anti-nepotism tsar, the Dragons’ Den entrepreneur James Caan, had given jobs to two of his own children.

Pension returns

Tax Research UK:

The FT ha an excellent article that anyone with an interest in pensions should read this morning. The argument is clear from the title, which is ‘Fees are a scourge on pension funds‘.

The article makes three things clear. The first is that fees in most pension funds are much higher than for direct investing, but the returns aren’t necessarily any better.

The second is that getting data on this issue is nigh on impossible, but a new report is trying to put that right.

The third is that in the UK the average rate of return on pension fund investment between 2000 and 2013 was minus 0.7% (in real terms) despite the fact that these funds in the UK managed more money than UK GDP.

And there are no excuses for this rate of return: by no means all countries delivered such poor returns. Denmark managed 3.8% positive returns over the same period and we live in an era of globalised markets.

As the article mentions, this dismally failing activity receives a subsidy of £50 billion a year from the UK taxpayer and still cannot produce a return.  For everyone, and especially those without a public sector pension, this is a matter of concern.

The Financial Crisis: Why Have No High-Level Executives Been Prosecuted?

New York Review of Books:

The final factor I would mention is both the most subtle and the most systemic of the three, and arguably the most important. It is the shift that has occurred, over the past thirty years or more, from focusing on prosecuting high-level individuals to focusing on prosecuting companies and other institutions. It is true that prosecutors have brought criminal charges against companies for well over a hundred years, but until relatively recently, such prosecutions were the exception, and prosecutions of companies without simultaneous prosecutions of their managerial agents were even rarer.

The reasons were obvious. Companies do not commit crimes; only their agents do. And while a company might get the benefit of some such crimes, prosecuting the company would inevitably punish, directly or indirectly, the many employees and shareholders who were totally innocent. Moreover, under the law of most US jurisdictions, a company cannot be criminally liable unless at least one managerial agent has committed the crime in question; so why not prosecute the agent who actually committed the crime?

In recent decades, however, prosecutors have been increasingly attracted to prosecuting companies, often even without indicting a single person. This shift has often been rationalized as part of an attempt to transform “corporate cultures,” so as to prevent future such crimes; and as a result, government policy has taken the form of “deferred prosecution agreements” or even “nonprosecution agreements,” in which the company, under threat of criminal prosecution, agrees to take various prophylactic measures to prevent future wrongdoing. Such agreements have become, in the words of Lanny Breuer, the former head of the Department of Justice’s Criminal Division, “a mainstay of white-collar criminal law enforcement,” with the department entering into 233 such agreements over the last decade. But in practice, I suggest, this approach has led to some lax and dubious behavior on the part of prosecutors, with deleterious results.

If you are a prosecutor attempting to discover the individuals responsible for an apparent financial fraud, you go about your business in much the same way you go after mobsters or drug kingpins: you start at the bottom and, over many months or years, slowly work your way up. Specifically, you start by “flipping” some lower- or mid-level participant in the fraud who you can show was directly responsible for making one or more false material misrepresentations but who is willing to cooperate, and maybe even “wear a wire”—i.e., secretly record his colleagues—in order to reduce his sentence. With his help, and aided by the substantial prison penalties now available in white-collar cases, you go up the ladder.

But if your priority is prosecuting the company, a different scenario takes place. Early in the investigation, you invite in counsel to the company and explain to him or her why you suspect fraud. He or she responds by assuring you that the company wants to cooperate and do the right thing, and to that end the company has hired a former assistant US attorney, now a partner at a respected law firm, to do an internal investigation. The company’s counsel asks you to defer your investigation until the company’s own internal investigation is completed, on the condition that the company will share its results with you. In order to save time and resources, you agree.

Six months later the company’s counsel returns, with a detailed report showing that mistakes were made but that the company is now intent on correcting them. You and the company then agree that the company will enter into a deferred prosecution agreement that couples some immediate fines with the imposition of expensive but internal prophylactic measures. For all practical purposes the case is now over. You are happy because you believe that you have helped prevent future crimes; the company is happy because it has avoided a devastating indictment; and perhaps the happiest of all are the executives, or former executives, who actually committed the underlying misconduct, for they are left untouched.

I suggest that this is not the best way to proceed. Although it is supposedly justified because it prevents future crimes, I suggest that the future deterrent value of successfully prosecuting individuals far outweighs the prophylactic benefits of imposing internal compliance measures that are often little more than window-dressing. Just going after the company is also both technically and morally suspect. It is technically suspect because, under the law, you should not indict or threaten to indict a company unless you can prove beyond a reasonable doubt that some managerial agent of the company committed the alleged crime; and if you can prove that, why not indict the manager? And from a moral standpoint, punishing a company and its many innocent employees and shareholders for the crimes committed by some unprosecuted individuals seems contrary to elementary notions of moral responsibility.

These criticisms take on special relevance, however, in the instance of investigations growing out of the financial crisis, because, as noted, the Department of Justice’s position, until at least recently, is that going after the suspect institutions poses too great a risk to the nation’s economic recovery. So you don’t go after the companies, at least not criminally, because they are too big to jail; and you don’t go after the individuals, because that would involve the kind of years-long investigations that you no longer have the experience or the resources to pursue.

The whole article – by a United States District Judge – is well worth reading.  Policing companies is fundamental to law and order.  There has to be an effective approach.

Private Island: Why Britain Now Belongs to Someone Else review

The Guardian:

Privatisation, rather than ushering in an era of consumer power and open competition, has led to monopolistic stitch-ups against consumers and allowed fat cats to pay themselves silly money on the basis of “performance indicators” produced for their benefit. “The reality is that the faceless state bureaucrats of the old electricity boards have been replaced by the faceless (and better paid) private bureaucrats of the electricity companies.” The dream of free marketeers was to turn Britain into a nation of small shareholders. Before Mrs Thatcher came to power in 1979, individuals held almost 40% of shares in UK companies. By 1981, it was less than 30% and by the time she died in 2013, it had slumped to under 12%.

As demolition jobs go, this can hardly be bettered. The absence of polemic makes the quietly withering prose all the more powerful. And yet in his understandable desire to provide a single narrative, Meek does not mention those industries whose privatisation could be deemed a success. Do we hark back with pride to the era of nationalised airlines? And what about our phones? There’s surely no nostalgia to be found in the old rickety GPO.

Most people, I would suggest, are agnostic about the means of ownership. What matters is what works. And as the author demonstrates beyond peradventure, many of the privatisations have failed in their core goals of delivering better services. To say so is not ideological; to deny the overwhelming evidence is.

This is why we need a better understand of marketplaces and the Government’s role in framing them.

Private hospitals ‘must provide more safety data’

The BBC:

Private hospitals should release the same levels of data about patient safety incidents as NHS providers, a report says.  The organisation behind the report says it is difficult for the public to judge the safety of private hospitals.

A think tank scrutinising the role of markets and competition in the NHS, the Centre for Health and the Public Interest (CHPI), says figures obtained from the Care Quality Commission (CQC) show just over 800 patients died unexpectedly in private hospitals in England between October 2010 and April 2014 – and there were more than 900 serious injuries.

The report says: “It is not possible to state whether these rates of death and serious injury are significant, as we do not know in which hospitals they occurred, the health status of the patients concerned, nor the types of treatments that were being provided.  “It is also not possible to state whether the rates are unusually high or to be expected.”

Given that the essence of private health care is that it is er market based, it is astonishing that they don’t provide allow customers to make informed choices.


Insurers to provide clearer renewal quotes

The BBC:

When consumers are informed of a new premium, they are not usually reminded what they paid previously.  As a result, some customers may not even be aware that the cost of their insurance policy is going up.  Now the City regulator is drawing up new rules to ensure renewal quotes include previous premiums as well.  That would enable policy-holders to see whether, and by how much, their bill had risen.

Inertia is clearly a very significant obstacle to the working of an effective market.  This should be addressed structurally.