01 October 2014

One man could save La France, but is he up to it?

Alexia T writes:*

Whilst the French economy has not down-spiraled like that of Italy, Portugal, Spain, or Greece did a couple of years ago, many fear that if another European economy is to wash down the drain, it will be that of France.

The French economy has for a long time been considered as one of the leading economies in Europe. France is amongst the leading industrial economies in railway, automotive, and aerospace sectors, as well as in pharmaceuticals, telecoms, defense, and luxury goods. Nevertheless, in recent decades, the development of state aid in certain economic sectors, and the cost of infrastructure programs and social services, has led to a huge increase in the French state’s budget. And even though the extent of the French state’s involvement in the economy has proven to be one of its greatest strengths, it has also been one of its main weaknesses.

To finance most of its programs, the French government, like most governments, has resorted to increase taxation, however, most of that has fallen on businesses: French businesses currently have one of the world’s highest level of payroll tax ranging from 43% to 60%. Excessive corporate taxes are damaging the French industry, especially as it discourages corporations – French or foreign – to invest in France, and it is seen as one of the main causes for France’s widespread unemployment.

To a large extent, due to traditional (and ironic) public opposition to reforms over the past three decades, the misfortune of the French economy can be traced to the inability of its political leaders, on both right and left, to push through the necessary actions in troubled times.

Unemployed in millions (left axis) and in percent (right axis)
Since President Francois Hollande came into power in 2012, unemployment rates are at its highest ever since the late 1990’s, at a staggering 10.2%. Two years into his presidency, all that voters who had hoped for big changes can observe is the worsening of unemployment (see figure), a rise in taxes, and a gradual decline in living standards. Hollande promised to stimulate growth of the economy and reduce unemployment, however next to none of this has been materialized due to the inflexibility of rules and policies in place.

Reasons for the high unemployment rate differ, but one of the most important reasons is prohibitively high labor costs. France's high minimum wage makes it expensive and thus difficult for companies to recruit entry-level staff. Then there are very high social charges (payroll taxes) and strict labor laws that make it difficult to let go of people -- and therefore difficult to hire – even during economic upswings. With these laws, many enterprises have either moved to countries with lower production costs, become smaller in size, replaced human labor by technology, or simply had to pass on growth opportunities. With the higher cost, margin of profit goes down, decreasing their ability to be innovative and to develop. France needs at least 1% economic growth to create jobs, and 1.5% to stabilise unemployment, but since the economy’s growth will not surpass the 1% this year, a reduction in unemployment is practically impossible.

To lower unemployment, and secure a future for the coming generations, the French economy needs to grow. It needs to start favouring entrepreneurs, the creation of new industries, and make more jobs available for newcomers. The old formula of targeted state aid won’t work this time, mainly because there is no financial backing, so instead it needs to change its laws and policies, and it needs to become more modernised. Hollande should focus on reviving the French economy, and to succeed he needs to do what no other French president has mastered – to confront the multitude of interest groups that, through strikes and protests, have a tradition to stop any and all reforms.

Bottom Line: If you're going to make an omelet, then you have to break some eggs.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.

30 September 2014

Free riding on Ebola drugs?

Jente A writes:*

The WHO has declared that, of the almost 6,000 reported Ebola cases, death rates have exceeded 2,800. Predictions range between 20,000 and hundreds of thousands more deaths before the outbreak is under control. However, the free market has until now failed to provide an effective and largely available drug to fight Ebola.

The challenge that we are facing is to get these drugs developed and produced, and then to get them available on a large scale for patients in West Africa. In order to achieve this, pharmaceutical companies will probably need to invest more that $2 billion in research and development. The market on which these drugs would be sold, however, does not give a prospect of covering these costs and making profits. Ebola drugs will be sold for a relatively short period (during the epidemic) as compared to markets for other diseases, and West Africa is seen as a ‘poor market’. The price for which companies would have to sell the drug to make profit would be so high that most Ebola patients cannot afford to buy the drug.

This 'poor market' is the problem that we need to reconsider. Assuming that those who enjoy the benefits of the drug should also pay for it, which is ideally the case in a market economy, the core question that needs to be addressed is: who actually benefits from an Ebola drug?

Evaluating the benefit of Ebola drugs on a larger scale, it is not just the patient that gets cured from the disease who benefits. Ebola drugs will increase the general level of public health of the people of West Africa, and these people are the same people that provide the labour which companies make use of. The mining industry, for example, has a large interest in healthy employees and thus in the production and availability of Ebola drugs. However, as of now they are not considered part of the market for Ebola drugs. Multinationals working in West Africa will benefit from the production of the drug, but do not pay for the costs: they could ‘free-ride’ on the benefits of the drug if it would be available on the market.

So what would happen if companies would get involved in the Ebola market? Such an idea is not new, but has successfully been applied in South Africa in the 1980s. The South African Chamber of Mines funded a large-scale campaign to curtail the spread of HIV. This campaign proved to be very effective and benefited both the people and the mining companies that wanted healthy workers. Consider the possibility of applying this idea to the market for Ebola drugs: if multinational companies would become part of the market and invest in the provision of these drugs for their employees, there would be more buyers able to pay the market price established on the free market. Pharmaceutical companies could then increase their sales on the market and it becomes profitable for them to start developing and producing the drug.

This is, of course, easier said than done. Companies will need to be convinced that their investment in the drug will eventually benefit them (which might just be a matter of time since share prices of heavily exposed companies have already started to plunge). The costs of investing in Ebola drugs are considerably lower than the potential costs that these companies are facing due to a damaged economy. The damage to the global economy of the SARS outbreak in 2003, with ‘only’ 800 deaths, was approximately $50 billion. Consider the damage that we are facing if the death rates indeed reach hundreds of thousands.

Bottom Line: The challenge that we are facing in the fight against Ebola is to get all those with interest in an Ebola drug involved in the market. This not only includes the patients, but possibly the whole global economy, starting with those companies working with the people of West Africa.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.

Free apples!

Rosanne S. writes:*

It was a pleasant surprise for those doing their groceries at a Jumbo supermarket two weeks ago: Jumbo offered every customer an Elstar apple – for free! The supermarket launched its newest stunt in order to show that not only they, but also the Dutch consumer itself could support Dutch farmers, who are having a hard time keeping their heads above the water due to the Russian boycott. I wondered how that free Elstar apple would taste.

Dutch farmers are facing serious problems indeed. The EU decided to take economic sanctions against Russia this summer to punish it for its involvement in the Ukrainian conflict. Yet, Russia decided to retaliate by boycotting many European products, including Dutch products such as apples, pears, bell peppers and dairy products (cheese, of course). As CBS statistics show, the Netherlands will lose exports worth over 500 million euro’s, leading to a total loss of 300 million in earnings for the Dutch economy. Consequently, this puts 5,000 jobs at risk.

Jumbo’s generous free-apples stunt to stimulate the Dutch economy seems to convey the message that the Dutch can support their own economy and make up for the lacking Russian demand if they simply eat more Elstar apples (not just the free ones), onions, bell peppers and cheese (preferably bought at the Jumbo, of course). Or can they? As Anna Vossers writes in NRCQ (Dutch), that would oblige us to completely adapt our food menu to Dutch farmers’ products and eat about 3 kilos of cheese a day, preferably with pears.

Besides this being a practically impossible menu, there is another problem to this. The prices of Dutch fruit and vegetable products will not decrease in Dutch supermarkets, as they have contracts with Dutch suppliers in which purchasing prices have been fixed on the long run. If we decide to increase our demands drastically, this will create a Valhalla for other European producers who also face the boycott, but who can sell at much lower prices. It is unlikely that we would still buy the much more expensive Dutch Elstar instead of the cheaper German, French, Italian or Polish equivalent. In other words, the menu of cheese and pears and increased Dutch demand would not be a success.

Once we turn back to the local Jumbo store and see their profits rise, we should realize that Jumbo’s free apples are most juicy for Jumbo itself, but not for us, nor for Dutch farmers. Its strategy is a cunning one, as the supermarket benefits from its new image as a generous supermarket supporting the Dutch economy and its farmers.

Thus, the support-Dutch-farmers-by-eating-a-free-Elstar-apple should taste more sour once we realize that the free apple is a delusion. Of course, a consumer appreciates free food, but contrary to what Jumbo implied, there is little we can do in order to support our Dutch farmers, let alone to save our economy.

Bottom Line: Dutch farmers must not expect the Dutch take over the lacking demand of the Russians, whilst the Dutch citizens must realize that they themselves face economic downturn and job risks. In this case, the only one truly enjoying the tastiness of the Elstar, is Jumbo itself.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.

29 September 2014

Monday funnies

Business, or politics?

Speed blogging

  1. This Brazilian artist is raising awareness of urban water pollution

  2. "Invest" in preventing climate change because it makes good business sense

  3. Tomorrow! There's a webinar on water and sanitation in Africa's media at 12:00 GMT. More info here.

  4. Pre-1990 projections of global water demand overshot reality, while post-190 projections undershot the mark [pdf]. Maybe it's better to focus on local supply and demand? Speaking of scary projections, world population "should" hit 11 billion by 2100.

  5. No, water utilities do not need subsidies to "find" cheaper ways of providing water. Subsidies steer innovations in the "planned" -- rather than the efficient -- direction

  6. Property rights: The northern Aral Sea is recovering because Kazakstan has build a dam to protect "its share." Uzbekistan continues to sacrifice the rest of the Aral for its criminal cotton program (farmers are forced to sell to the government, which keeps revenue for cronies)

Uber going under?

Raven H. writes:*

Uber is often viewed as a cheap platform for ridesharing. Uber started as a response to increasingly high taxi prices. The taxi market had little to no entry. To be a legal taxi driver you have to have a license, also called a ‘taxi medallion’. In 2013, a pair of medallions was auctioned for $2.5 million. Not everyone can afford this, which makes entry barrier for the market really high. It is Uber’s goal to assist individuals who aren’t able to afford this. Drivers only need a driver’s license, an Uber-approved car, which implies it has to tick certain boxes (e.g. right age, size, brand, insurance etc.) and via an app they are linked to thousands of customers. Which makes Uber the middleman that connects demand and supply.

Without Uber there was relative inelasticity, which means that taxi drivers can increase the price without losing many customers, because people do not have many other options (monopoly). These things are the reason that taxi drivers can increase their rates greatly. They do this in order to maximize their profits. Consumers are therefore disadvantaged by the monopoly.

Uber is currently breaking the taxi monopoly. They do this by seducing customers with their low fare rates. However, during times that the demand is high Uber increases fares. They do this to attract more drivers (supply) and so they reach equilibrium. This is because drivers react to higher prices, as they will have a bigger incentive to work. As a consequence, more people can get a cab, albeit for a higher price. Nevertheless, Uber is still a cheaper option in comparison to a regular taxi because the profit margin for the driver is lower and taxi drivers keep the prices up so they can have more profit. This is also why some taxi drivers make a detour, which is not transparent.

Last week, the conservative taxi world fought back. They brought out their own app, and chanted that Uber was unfair competition and an illegal, unsafe practice. In Germany and France, Uber is already prohibited. It is illegal because anyone who’s over 21 and has driver’s license can be a taxi driver. This is, according to judges in France and Germany, unsafe. Nevertheless, Uber is still active in over 40 countries and is still expanding. Their low prices still attract many consumers.

Bottom Line: Uber has reached its peak and cab drivers are fighting back. Although prohibited in Germany and France, Uber is still effective and used because of the low prices and transparency of prices causes consumers to choose Uber over conventional taxis.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.

Crispy thoughts, salty concerns

Carolina M. writes:*

Some days ago, I entered a fast food “restaurant” with a friend; we were both on a very tight budget that day and while time was not precisely our main concern, we were definitely quite hungry. “Let’s go to ‘X’!” my friend said, “it’s super cheap and really close by!”, “Yeah that’s true, - I replied - it’s literally a couple of steps away but is it really that cheap? Aren’t the deals around 6-7 euros?” “No, you can get a 2-3 euro deal which includes a burger, fries and something to drink”. Well isn’t that impressive? A relatively filling lunch (since I’d personally go for a bit more food) for what one usually pays just to get coffee or a muffin, or both if you’re lucky enough. In any case, it sounds like a pretty good deal, but is it really? What’s wrong with falling for a super salty, crispy, fast food meal if it makes you happy and saves you time and money?

From an economics perspective, fast food can solve a couple of problems. On the one hand, a student budget tends to be quite constrained and 2-3 euros for a meal is certainly hard to beat, at least when it comes to eating out. On the other hand, time saving can be a key incentive: can we really wait 20 minutes at a restaurant everyday to get a delicious meal taking into consideration all the time needed for attending class, studying and of course socializing? During week days it’s probably better to save that time do the best next alternative, such as studying for that test or doing the readings for that class, and save the nicer, more expensive and time consuming meal for the weekend. Now, when it comes to taste and the amount of satisfaction fast food brings us, this can clearly be debated but all in all we can probably agree that buying fast food is very good as a short-term fulfilling transaction.

However, the problem is that there are many downsides to this kind of food and these become harder to ignore as one becomes more socially conscious and environmentally aware of the impact this industry has on our health, the environment and society as a whole. Obesity, high cholesterol, malnutrition are undeniably related to fast food but so is the ever increasing environmental problem – fast food companies are one of the main drivers of mass production of potatoes and livestock farming which bring consequences such as overgrazing, extra methane production, air and soil pollution as well as animal cruelty. In addition to this, workers in the fast food industry receive really low wages, which brings other socio-economic problems with it as well.

So, on the one hand we have a good short term fulfilling deal, which saves money and time and brings satisfaction to many consumers while, on the other hand, we have many negative spillovers from its consumption, which are both social and environmental. Are these powerful enough to make us stop consuming anything related to this industry? It certainly has changed the perceptions and habits of many but probably not enough since fast food restaurants still seem to overpopulate our planet. Could there be an intermediate solution, where healthy fast food chains arise? Or is that a contradiction in itself? I'm not sure if we're going to make any progress there.

Bottom Line: I propose we make our visit to fast food “restaurants” the exception to the rule, the seldom guilty pleasure, and focus our attention on finding easy healthy options that can adapt to our lifestyle.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.

27 September 2014

Flashback: 22-28 Sep 2013

A year later and still worth reading...

26 September 2014

Friday party!

Young and old swap clothes :)

Why our insecurity costs us money

Judith B writes:*

Classic microeconomic theory teaches us that prices are determined in markets (which, at their best, are assumed to be perfectly competitive). Thus, what I pay for my pair of jeans depends, on the one hand, on how much it costs to produce it and, on the other hand, on how much I am willing to pay for it. The producer should just make enough money to cover expenses and I should just pay as much as the value, which this pair of jeans adds to my clothing ensemble.

In the real world entrepreneurs have found an astute way to sell you pretty much the same exact jeans but make you willing to pay more for it: branding. Nowadays, if you’re buying a pair of jeans is not just the jeans you’re getting – you’re buying a feeling, a feeling of adventure, a bit of sex appeal and maybe some independence too. If you buy a car, it is not just a vehicle that transports you comfortably and safely from A to B. It’s a way of life, of roaring freedom and power. In terms of what they do, the jeans are still the same jeans and the car is still the same car. Yet, we are willing to pay significantly more because we think that we will be happier, socially more attractive and maybe even more successful, if what we buy has just that little brand tag on it.

I’m intentionally careful in not calling the “added value” an illusion. It’s not. Feelings are not illusions, they are real and they are important to people, otherwise they would not be willing to pay for them. Brands have become recognized social symbols, which have a value beyond their physical characteristics. They are used as information shortcuts, whether to identify high quality products or identify social group affiliation. At a time when other recognizable signs of social standing are vanishing, brands help us structure how we view the society.

What worries me is that branding often preys on the most basic human condition of insecurity. Yes, we all want to be accepted and loved and belong to the group and deep down we worry all the time whether we are “good enough” to be part of the group. We are striving for a status, physical attractiveness, career success and all those other values that we are told we need to achieve in order to be accepted by others. Companies tell us that we can actually buy our way in, that we can be better if we just buy their products. And that I think is an illusion. The new jeans might make us feel better for a couple of weeks, and even get us some compliments. Yet, we ultimately stay the same insecure person, even if we buy a hundred brand jeans.

Bottom Line: Whatever advertisement might tell us, we cannot buy a better self. Learning self-acceptance and improving our self-perception requires serious mental work. However, in the end investing in ourselves is probably cheaper than compensating for our insecurity by buying another pair of Levi’s jeans.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.

What to do with underwater leftovers of war?

Rob H writes:*

In the past weeks I have been involved in an NGO called the International Dialogue on Underwater Munitions (IDUM). IDUM is an NGO in The Hague to work on furthering the development of an international strategy on the issue of underwater munitions dump sites.

Throughout and after world war I and II large amounts of munitions were dumped in seas both territorial and extraterritorial waters (here's a video). Ranging from conventional munitions, such as bombs, bullets and mines, to chemical and nuclear waste and weapons. These dump sites are ticking time bombs, as they can literally blow up in someone's face when discovered and because they slowly leak toxic materials into the environment. Studies have yet to confirm the full extent of the problem but on specific sites such as in the Northern European seas there is evidence of toxic materials leaking into the marine ecosystems.

Operations are being undertaken to clean up these side effects of war but far too little is being done. Firstly, because finding and clearing the dump sites is a difficult and costly task. But the foremost reason is that the dumping of these munitions and the sites themselves are a politically sensitive topic which states don't want to bring back to the surface.

So who's to pay? Cleaning up this mess is estimated to cost billions of dollars. The direct victims are mostly fisheries that see fish stocks depleting and people being harmed by munitions while the responsibility lays with the states. Moreover the dumping itself was done by secretive military agencies so there are no clear records. So should states be responsible for their previous governments' war leftovers? Or should we assume that those responsible were not well informed on the potential danger of such dumping?

A good example for this problem are landmines. The demining and related programs depend on private and public voluntary donations but have a strong base of multilateral agencies and NGO's. This has been much more successful because of international recognition of the problem and the commitment of states mobilizing clearing efforts.

To reduce the number of underwater munitions there has to be international commitment and recognition of the problem. Firstly an internationally binding treaty has to be signed specifically condemning underwater munitions. This will open the way for more funding and technical development to clean our seas of underwater munitions.

Bottom Line: When the world faces a problem collectively and responsible parties don't clean up their mess there is need for open international commitment to kick start investment in solutions.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.

25 September 2014

The founder of the EU's agricultural policy renounces it

Sicco Mansholt was a key player in Dutch and EU (EEC at the time) agricultural policy. I visited an exhibit on his career a few weeks ago that described how his initial enthusiasm for industrial agriculture and free trade turned to horror as overproduction wasted money and resources and damaged the environment.

In his original (1950) proposal for the EU's Common Agricultural Policy, note that he wanted to regulate (guarantee) prices to overcome farmers' resistance to free trade within the EU.

Years later, he came to regret that "temporary" price subsidies had become permanent and that taxes had never materialized to offset subsidies. He also regretted the resulting overproduction -- leading to "butter mountains," distorted markets and environmental degradation. The 1972 report, Limits to Growth, had a profound impact on him, and he drafted a new memo on sustainability that focused on growing food (incl. "unprofitable" crops that served different needs), replacing consumption of goods with human services, reducing capital churn, and tackling pollution. (Note his caveat "supposing stable world population," which was 3.85 billion in 1972.):

These goals make sense from a sustainability prospective, but there has been no "progress" on population, consumption or capital. Food production has risen, but only to feed people (hunger is still a problem) and non-food crops have increase agriculture's footprint. Some progress has been made on local pollution, but global pollution (carbon, much of which is linked to people, industrial ag, and consumption) has turned into a much bigger threat.

Mansholt died in 1995, still upset about the EU's unsustainable policies. The EU, ironically, calls him the "founder of green Europe" at the same time as it has censored his critique of EU policies.

Bottom Line: Subsidies encourage overproduction and overconsumption, and they have a way of persisting far beyond any initial justification (cf. ethanol, renewables, freeways, ag irrigation, etc.). Mansholt had the opportunity to see his plans abused for private profits but the opportunity (and honesty) to denounce them. It would have been better to allow markets evolve at their own pace.

Technology steals your job!

Mathijs writes:*

I am a techno optimist! For me the technological revolution is begun, it is unstoppable, and it will bring us to an utopian kind of society soon! Although before we can enjoy the utopian life we have to deal with some problems. In this blog post I will address one of these problems, that, because I’m a humble student, I will NOT solve! This problem is with the increasing influence of technology on the labor market. Simply stated: the machines are taking the jobs of low skilled laborers, and we choose to make them the victims of this.

Andrew MCAfee has an interesting TED talk in which he discusses the influence of technology on the labor market. He is able to show that we are making more money with less people, and relates this to technological progress. Of course, this increase in labor productivity is good thing. Laborers working with technology can make more, when laborers make more, society becomes richer. The problems with it, is that other figures show that we don’t need those laborers anymore! And the projection is that we need laborers less and less. Their jobs are being replaced by machines, and there are no other jobs to replace them.

This will go as followed: A factory owner is confronted with a machine that can do the job of one of her employee cheaper than her employee. The factory owner, that rightfully seeks to maximize her profit, has two options. Which are the following: replace this employee by a machine, or ask her employee to work for less money. In the Netherlands where the majority of employees with these jobs have a minimum wage, the factory owner has only one option: fire the employee. When this scenario is repeated again and again, low skilled laborers will get less and less money, or lose their jobs again and again. They are victims of the development.

The last thing I like to emphasis is the urgency of the problem. Information technology progresses with an exponential rate, jobs will therefore be replaced faster and faster. Today already, in cities all over the world, autonomous Google cars are driving. Predictions are that in 2020 the first autonomous cars will enter the commercial market. How long will it take to replace truck drivers and taxi drivers!? How many jobs in this one example will be taken by machines, and never be replaced!? My message is therefore simple. It is time to think about solutions for the people that can’t compete with new technologies, and that are victims of this beautiful development.

Bottom Line: Jobs are taken by new technology and not replaced. This happens more and more and faster and faster. It is time to have better solutions for the people that lose their jobs than unemployment offers today.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.

Information aggregation: the key to rational decisions

Joes N. writes:*

Although I personally believe that given enough time, education and information, people can make rational decisions, and often will do so, I ultimately think rationality is an assumption that is made too easily and too often in economics. Bounded rationality seems to be a safer bet in many scenarios, as supported for instance by Kahneman in Thinking, Fast & Slow, who argues the brain works with two functions, one being intuitive, the other rational. I think looking at the crisis simulations of historical events organized by students at LUC the Hague through the lens of bounded rationality might actually provide some useful insights. Although these simulations only provide some anecdotal evidence, they might offer insight into the importance of institutions which aggregate information in case of political, but also of economic crises.

Last weekend some of my fellow students and I organized a crisis simulation of the Vietnam War. It included several committees, such as the Senate, the National Security Council, the North Vietnamese Politburo and the Government of (South) Vietnam. I think we were highly successful in 'throwing' sufficient amounts of information at people to make them stop being rational actors, and lapsing into their 'system one' decision-making modus. Rather than taking their time to look at the rules of procedure we provided them, and basing their actions on these rules of procedures, they used their intuition. It could be argued that a rational actor would first take the time to find more information, or should even be assumed to be in possession of all necessary information. However, in a situation in which time is a scarce resource and rational actors do not have all information, they simply have to start following their biases, something also argued by Herbert Simon, in "Models of Bounded Rationality: Empirically Grounded Economic Reason."

This also appeared from the reactions of the participants, for instance, a fellow student of mine noted that he was completely stressed out, leading him to say: “Wow, this was so intense. I never thought it would get this intense.” This does not sound like a cold rational actor, it sounds like someone who was very near to collapsing in despair because of an overload of information. While not presenting any conclusive evidence, this simulation does confirm Simon's theory that if we feed an individual sufficient amounts of information at the same time, he will follow his biases and intuition. Rational decision making takes time, and time was a scarce resource during the simulation.

For me it showed the importance of, firstly, reflection on the intuitive choices I make and, secondly, well-ordered decision-making structures, in which decision makers receive as much relevant information as possible from a pre-structured system set up to provide information (which is the official task of the US National Security Council, one of the Councils we simulated). Whereas in a market with repetitive transactions, people can probably act rationally and base their assumption on previously done statistical research and experiences (for instance Mikhail Myagkov and Charles R. Plott argued in 1997), in less often occurring events, like economic crises, we might expect people to behave according to their intuition, as Kahneman argues and was confirmed by our simulation. Governments and large companies thus need a 'crisis' team which can be assembled in case of an economic crisis, which can aggregate information (which due to the crisis can no longer be taken from the markets or other usual sources), in order to ensure that decision makers have the information necessary to overcome their biases and make an assessment of reality as possible.

Bottom Line: Human beings are inherently flawed, so we need institutions which prevent and mitigate the negative consequences of our biases and flawed intuition as much as possible.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.

24 September 2014

From Amazon to Zola

Iris G. writes:*

In the past week, Amazon, the online warehouse, was in the Dutch news since it might finally come to the Netherlands. For the past years, persistent rumours of this possibility have sparked debates about what this would mean for Dutch retail stores, particularly those specializing in books or home office supplies. There are concerns that the introduction of Amazon in the Netherlands could not only form some serious competition to its Dutch equivalents, but might also lead to the downfall of many small, local businesses since they would not be able to compete with Amazon's low prices. On top of that, the Amazon working environment is questionable at the very least, according to many articles and stories describing the experiences of employees, which certainly does not win the company any sympathy votes. The question is whether Amazon, with all its pros and cons, would truly pose that much of a threat to small, local or specialised businesses.

"Au Bon Marché": the inspiration for Zola's novel
This discussion is, of course, nothing new. In fact, it is already over a century old. A great early example is given by Émile Zola, the famous French writer, in his book 'The Ladies' Paradise' ('Au Bonheur des Dames') which was originally published in 1883.** The book describes the rise of a large department store, revolutionary at the time, in which all kinds of goods are sold: fabric and clothing, but also accessories and furniture. The customers are seduced by the great wealth of choice, the discount-deals, the convenience of having everything under the same roof and the option of home-delivery. At the same time, the employees have to work long hours under harsh conditions, and there is an outrage amongst the local retailers, who see their sales dwindling and fear for their business since competing with the mighty warehouse is almost impossible. Sounds familiar?

Even though the story is fictional, it was modelled after existing organisations and captures the concerns of that time. As it turns out, those concerns are still very relevant. However, it is obvious that the rise of large organisations did not lead to the absolute end of the individual, small-scale retailers, who still exist in the Netherlands (and elsewhere) after decades of competition with large companies. They may not dominate the Dutch streets like they did in the time of Zola's writing, but that is only to be expected since the population of the Netherlands tripled since that time and demand has grown with it.

It is true that large Dutch online retailers and Amazon look-a-likes (such as bol.com, or wehkamp.nl) would have to step up their game in order to survive, but competition in itself is not a bad thing. Amazon is the revolutionary department store of our time, and while there are unpleasant sides to the company, as mentioned above, it has been a game changer to the market of online retail to which aspiring competitors will have no choice but to adapt. The beautiful, fun, quirky and original stores, on the other hand, will persist exactly because they differentiate themselves from this market and do not aim to reach the largest audience possible.

Bottom Line: By catering to a specialised customer base, providing personalised service, or simply offering an unique experience, small retailers have withstood large, cheap and profit-maximizing organisations for over a century. They will survive Amazon, too.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.

** Zola's book is an easy read and a timeless classic -- and available on Amazon.

Market Failure and the Ebola Virus Epidemic

Margot M writes:*

According to a recent update from the World Health Organization (WHO) the Ebola Virus outbreak, believed to have originated in Guinea in December of last year, has infected more than 5,800 people and claimed 2,793 lives so far. With a death rate of 70%, WHO researchers issued a dire new forecast this week, one that anticipates 20,000 deaths by November (10,000 in Liberia alone). The urgency of the issue has been clear for months now, but it has only recently begun to pick up traction and illicit international response in which aid commitments have been stepped up. Why has it taken this long? How is there still no effective and widely accessible vaccine for Ebola? Well, it probably has something to do with market failure.

Image from The Economist
Prof. Adrian Hill, an Oxford professor leading research into a candidate vaccine for Ebola attributes three main reasons to why big pharmaceutical companies like GlaxoSmithKline, Novartis or Pfizer have been reluctant to produce an effective vaccine as of yet: firstly, because of the nature of the outbreak; secondly the estimated number of people to become affected was thought until recently to be quite small; and finally, that the affected people are in some of the poorest countries essentially unable to afford a new vaccine. For an “orphan disease” affecting the impoverished in poor countries, “there is no market”.

Despite a widespread tone of moral indignation towards “Big Pharma” companies, which have essentially monopolized the commercial vaccine supply, the fact remains that there is a lack of profitability from a big market and thus a lack of incentive to produce for those who need it most. This clearly constitutes a market failure whereby the market underprovides a good, which has the potential for vast public benefits. The economic incentives (profits) for the production of these vaccines fall short of public health needs. Yet, if there were to be intervention in the market, which would encourage producers to supply closer to the socially optimal level, demand would be met and the epidemic could be contained. The figure below illustrates the forecast of three different scenarios as predicted by a research team at Columbia University further elucidating the urgency of the matter even in a best-case scenario:

The private benefit of getting the vaccine would be less than the marginal social or public benefit and thus carries with it positive spillover, which goes beyond the obvious health benefits. Said public benefit would not only consist of the lives saved throughout the region by the containment of the virus, but also the prevention of complete economic downturn and further hardship. Strict trade and travel restrictions have already dampened West African economies, but if Ebola is not controlled soon, the World Bank estimates that the long-term effects will be crippling. At its current rate, the virus would cause Liberia’s economy to contract by 4.9% and reduce economic growth in Sierra Leone from 11% to approximately 2%.

It is disillusioning to see that the moral imperative to help those suffering is far weaker than that of the profit incentive. It has been almost 40 years since Ebola was discovered in 1976, yet there is still no cure, despite its medical feasibility. The alignment of incentives is crucial in order to correct for the shortage of a widely accessible and effective drug in the market.

Bottom Line: The Ebola virus has spun out of control and now, the necessity of multi-lateral action is more pressing than ever.

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Student posts are back!

We'll have guest posts from my microeconomics students over the next few weeks. They get an "A" for posting. The learning comes from the give and take of civilized discussion, so please help with comments on unclear analysis, other perspectives, data sources, etc.