Global Economics and Management

A Greek Referendum

Uh-oh. And what if the Greeks vote against the European rescue package? Fasten your seatbelts.

Weekend Readings

1). An example of a countercyclical industry: used cars for people with bad credit.

2). Luigi Zingales on the decline of the meritocratic ideal.

3). Declining incomes for college graduates. But non college educated workers saw their incomes decline even more, so the returns to college education are still high. Relatedly, David Brooks discusses the college wage premium.

A Panel Discussion on the Budget Deficit at MIT

If you are interested in current debates on the budget deficit, you should invest the 90 minutes required to watch the panel discussion that took place recently at MIT. The panel features some of the foremost experts on fiscal policy in the United States. (Hat tip: Greg Mankiw's blog)

Debit Card Fees

A few weeks ago we discussed in class Bank of America's plan to charge fees for debit card use. The discussion revolved around the issue of elasticity. We know that if an entire industry charges such fees, the elasticity faced by each individual firm will be lower than if a firm acts alone to impose the fees. Now it appears that B of A's first move is not followed with great enthusiasm by the rest of the industry. This could of course undermine the profitability of B of A's decision. We speculated in class that perhaps B of A was counting on the forces of implicit collusion - that the fact that a big bank started to charge the fees would encourage other big banks, as well as smaller ones, to follow suit. That would have reduced the elasticity faced by each. Instead, few seem to be jumping on the bandwagon.

The article mentions that Wells Fargo is experimenting with debit card fees in five select states. This is an attempt by Wells Fargo to discover the elasticity of their customers to these fees. A proper calculation of this elasticity, however, must take into account the response of competitors. If competitors match the price increase, the elasticity will be lower - in the limit if all firms match the new fee policy, the elasticity facing each firm will simply be the market elasticity of the demand for banking services. So experimenting in some regions is not enough to elicit the correct elasticity, as B of A is no doubt painfully discovering right now.

Update: B of A seems to be wavering, and more on the interesting first mover's curse.

Update 2: Wells Fago drops the idea.

Probabilistic Puzzler Time

Guest Blogging: Robert Michlovich

Your classmate Rob Michlovich sends me two interesting articles about the US economy. They make for a great guest blog post. I post links to the articles along with Rob's thoughts in italics, and mine in normal font.

RM: In my spare time outside of studying for Tuesday’s midterm, I came across a couple of articles that I wanted to share with you and maybe the GEM blog if they’re worthy.  The first touches on the repatriation of American manufacturing jobs and the second is a follow-up to our discussion about Operation Twist.

1) World Power Swings Back to America – UK Daily Telegraph – 10/24

RM: This article describes the future economic contribution of the US in the 21^st century post ‘global recession’. It references a BCG study to show how recent technological advances (long run supply) and a weaker US dollar will lead American productivity higher which will then bring traditional manufacturing jobs back to the US. This is relevant to us in two ways. The first surrounds the unprecedented August Fed move to keep current short-term borrowing rates at or close to zero for the next two years. Dovish Fed policy and a cheap US dollar erodes China’s wage advantage and will repatriate manufacturing jobs back to the states. The second point was concerning fertility rates in the US versus other developed economic powers. The traditional pyramid-shaped demographic trend in the US will face its toughest challenge as baby boomers grow older. If the US can manage to keep its fertility rate above 2.0, our country will be able to continue to finance its own GDP growth much like during the 20th Century. How the US keeps its fertility rate above 2.0 is a function of public policy however it’s evident from my perspective that some element of immigration will be necessary.

RW: The article does an excellent job of describing the slow and painful rebalancing of the US economy in the wake of the 2008 financial crisis. This economy was underproducing and overconsuming - hence the giant trade deficit (we had to import the difference between consumotion and production). The lack of savings meant capital had to be imported - chiefly from China, Japan and Europe. Inevitably, that had to lead to a devaluation of the USD and a reorientation of households toward savings (deleveraging) and away from consumption. This has been painful and will continue to be painful, but needed to happen. A positive side-benefit is the return of some manufacturing activity that had previously left the United States.

2) Could ‘Twist’ Really Be Working?  WSJ – 10/21

RM: This article, albeit through a cynic’s eyes, describes how the stock market has historically reacted positively to the Fed’s quantitative easing (QE) program. It notes the mechanics of QE1 and QE2 and how investors are incentivized to sell their high-priced government holdings and buy riskier assets like corporate/high yield paper or equities. Operation Twist, sometimes referred to as the primer for QE3, is still in its early stages but the results in the stock market have led some to believe that the program has been a success. Since the beginning of October, stocks are up 5.8% and the yield on the 30yr has climbed 28 bps (a welcome relief for my former colleagues on the fixed income desk looking for opportunities to invest). Now, if only we could manage the volatility of the stock market…

RW: Low interest Fed policy is good for the stock market for two reasons: it causes investors to shift from bonds to stocks on the margin, causing the demand for stocks to shift out; and it signals that the Fed is pursuing an expansionary monetary policy, which if successful would lead to greater aggregate demand, greater growth and greater value creation, all of which are good for stocks. Like the Morgan Stanley Managing Director quoted at the end, I am not sure that Operation Twist had much to do per se with the recent performance of the stock market, but there is little doubt that the successive policies of quantitative easing, in the years since 2008, have played an important role in the recovery of both the stock market and the economy. Finally I don't believe policy can or should manage the volatility of the stock market, at least not directly. Such volatility is a symptom of economic uncertainty and risks to the global economy (particularly those coming from Europe), and it is on this uncertainty and on these risks that policymakers should focus. 

Paul Krugman at His Best

Here. 

An alternative to monetary easing by the ECB for the Eurozone as a whole, I might add, would include asking some of the peripheral countries to get out of the Euro. That would be messy, but better than the prolonged period of deflation that Krugman rightly predicts for these countries.

For most of these countries, joining the Euro was a very bad idea indeed. That much is now obvious.

The Process of Deleveraging

Here is an excellent WSJ article on the process of deleveraging by US households, started in the aftermath of the 2008 financial crisis. The graphs and illustrations are startling, particularly when you notice 1) the extent to which household debt and government debt move in opposite directions 2) how unprecedented the deleveraging appears to be relative to other postwar recessions.

Household deleveraging has some short run costs but it is an excellent sign for the long run growth trajectory of the US economy - as long as the government joins on the bandwagon of deleveraging also. The return of thrift was recently celebrated in an excellent David Brooks column in the New York Times, which I also recommend.

Guest Blogging: Billy Wang

You classmate Billy Wang sends be a series of interesting articles related to topics recently discussed in class. In what follows I post the articles, along with Billy's comments (in italics) and mine:

1) Online Banking Keeps Customers on Hook for Fees. 

BW: I think this article ties in nicely with our classroom discussion as these banks feel that customers are more inelastic than before by them using online banking. The white paper referenced in the article states customers will churn less if they have an online banking relationship with a bank. I don't think we covered how online banking affects all of this in class, but it certainly makes sense. There's a high switching cost to the consumer in the form of the hassle of retying all your payment accounts, and in turn that makes the bank less elastic to price changes. I think you were ahead of the curve by banking with a credit union (which the article states as one of the solutions to the problem). 

RW: Agreed. This is all about switching costs, which rise if you benefit from unique services that a bank offers, and if there are costs to using competing services elsewhere. For instance, if you pay your bills through your bank's electronic bill payer, it is a pain to have to reenter all the payees' information into another bank's system, making you less likely to leave the incumbent bank. We will go through the economics of switching costs in greater detail in class in a couple of weeks.

2) Airlines Battle Back to Profits, a Fee and a Fare at a Time.

BW: This article is about how major airlines are finally becoming profitable. It's one of the few instances where bankers may have added value through M&A for the buying company. The strategy employed by the airlines is to shorten the supply while hoping consumer demand is somewhat inelastic, which in the short term it seems to be working. Also, I liked it when the airlines started to charge baggage fees for domestic flights, since I never check bags and this is a way for me to stop subsidizing those who do. But that only works if my ticket price is cheaper, which it isn't. So they effectively raised it's price to the average consumer. I think Apple employed similar strategies. When they were raising music price from 99 cents to $1.29 for the most popular songs, they did it in conjunction with a promotion to buy a $30 iTunes gift card for $20. Music price increased by 30%, cost of buying credits decreased by 30%. And soon that promotion went away and we are now used to buying music at $1.29 and not think much of it.

RW: Agreed. Aggressive cost cutting was a big component of the Airlines' strategy, largely by reacting to the new conditions brought about by the depressed economy by cutting flights and routes. I rarely fly in a plane with empty seats anymore, and this used to happen all the time before the crisis. Right also about iTunes. Apple must have learnt a lesson from the initial pricing of the iPhone - a debacle we discussed in class in the past. Reducing the price of the iPhone too aggressively after capturing the surplus from the early adopters had led to an outcry. Company's have to be cognizant that people can react with moral outrage to managerial decisions that seem to make perfect sense from an exonomic perspective. In this case, habituating customers to higher prices was of the essence. Fee practices that are common to the entire industry (or most of it) rather than undertaken by a single firm is also helpful, as the airline's experience with baggage fees illustrate, because it is easier to convince customers that this is the "new normal" and not a single company trying to fleece customers (it's also helpful that it lowers the elasticity of demand for all!).

3) In a Battle of the e-Readers, Booksellers Spurn Superheroes.

BW: This article relates to the fight for content on the Kindle Fire. It seems Amazon is pulling its weight with the content providers to give them exclusive access to content. I don't like the move, seems awfully anti-competitive. Good for B&N to take drastic measures and send the signal to other content providers. I think this would be a great example for when we start to talk about game theory (I've taken Ben Polak's game theory course for free via iTunesU, really good stuff).

RW: The fascinating strategic angle here is that by removing themselves as distributors of comic books, Barnes and Noble and other booksellers turn Amazon into the sole (or major) distributor of said comic books. Thus, they put the sellers of these comic books at the mercy of Amazon, who becomes a monopsonist (sole buyer). The intended reaction is to discourage future content providers to sign exclusive digital distribution rights, as that puts them in a situation of total dependence to a single distributor (here Amazon). I'm guessing the folks at DC Comics must regret their Amazon deal, and if they don't already, a time will come when they might. When time comes to reprice the deal, publishers might see their share of the take fall dramatically. It will be a nice case to follow.

An Expert View of the Euro Crisis

Willem Buiter, Chief Economist at Citigroup, opines on the Euro crisis at a committee hearing of the UK Parliament. Highly recommended for those who can spare an hour or so to develop some real expertise on the crisis: