Category Archives: markets

Thoughts on Two-Sided Markets

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Lynne Kiesling writes,

the distribution wires firm can, and should, operate as a platform and think about platform strategies as the utility business model evolves. An electric distribution platform facilitates exchange in two-sided electricity and energy service markets, charging a fee for doing so. In the near term, much of that facilitation takes the form of distribution, of the transportation and delivery. As distributed resources proliferate, the platform firm must rethink how it creates value, and reaps revenues, by facilitating beneficial exchange in two-sided markets.

Until now, I have not thought much about this whole two-sided market concept. I am struggling to see what it buys you. Earlier in her post, she quotes from a Harvard Business Review article.

In the traditional value chain, value moves from left to right: To the left of the company is cost; to the right is revenue. In two-sided networks, cost and revenue are both to the left and the right, because the platform has a distinct group of users on each side. The platform incurs costs in serving both groups and can collect revenue from each, although one side is often subsidized

If I’m understanding this correctly, then a brothel is a traditional value chain, but a singles bar is a platform. In terms of that metaphor, Kiesling is suggesting that electric utilities could change from operating like brothels to operating like singles bars.

Some problems I am having:

1. I am not sure what, if anything, makes brothels the natural business model in one industry and singles bars the natural business model in another.

2. Suppose that a singles bar has to pay women in order to get them to show up. By my reading of the HBR excerpt, then it becomes a traditional value chain. Metaphorically, it becomes a brothel, although I assume that it can avoid legal difficulty as long as the beds are off premises.

3. To me, cable TV looks like a brothel, not a singles bar. And to me, electricity looks like cable TV.

4. Metaphorically speaking, taxi companies and hotels operate brothels. Uber and airbnb operate singles bars. What Uber and airbnb are tapping into is supply-capacity that taxi companies and hotels were not using, either because they didn’t think of it or because it didn’t fit their business model. Is there spare electricity-generating capacity that utilities could be tapping into? If so, do they have the know-how and flexibility to tap into it?

Jean Tirole and Josh Lerner on Open Source

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They wrote,

Open source and academia have many parallels. The most obvious parallel relates to motivation. As in open source, the direct financial returns from writing academic articles are typically nonexistent, but career concerns and the desire for peer recognition provide powerful inducements

They wrote this almost ten years ago. I bring it up because of Tirole’s Nobel Prize, announced yesterday.

Tirole and Lerner noted, with a bit of puzzlement that, compared with open-source software writers, academics were less likely to make their data sources public and more likely to allow their work to be hidden behind publishers’ paywalls. I think that in those ten years there has been a shift, at least in economics, more in the direction of the open-source model.

Patent Pools

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Josh Lerner and Jean Tirole (the latter was just awarded a Nobel Prize) write,

Innovations in hardware, software or biotechnology often build on a number of other innovations owned by a diverse set of owners.

Pointer from Joshua Gans. For more on Tirole, see Tyler Cowen and subsequent posts by Alex and Tyler.

Two (or more) firms may hold complementary patents. That is, the value of using firm A’s patented innovation is higher to a licensee who can also use firm B’s patented innovation. Lerner and Tirole ask when a social planner would want these firms to pool their patents, that is to license them together. If you do not care to follow their mathematical analysis, you can skip to the end where they summarize their conclusions.

The situation is a form of the dual-monopoly problem. As I once explained,

suppose that a single company has a monopoly in both peanut butter and jelly. When it sets the price of jelly, it knows that the more jelly it sells the more peanut butter it will sell. Therefore, at the margin, it will tend to want to set a lower price for jelly than if it were just looking at jelly as a stand-alone product.

If you then break up the PB and J monopoly into two separate companies, the incentives of the two separate monopolies will change. The peanut butter company is not going to worry about the fact that higher peanut butter prices will reduce jelly consumption, and the jelly company is not going to worry about the fact that higher jelly prices will reduce peanut butter consumption. The net result of the breakup is that prices to consumers will rise.

This theory goes all the way back to Cournot.

It seems to me that we observe patent pools more often internally than externally. Think of Apple Computer as one gigantic internal patent pool. Or a large pharmaceutical company. It might be easier for one firm to internalize complementary patents than for several firms to get together and pool them.

The State of the Economy

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1. There have been several posts pointing out that wage growth has been slow, even though the unemployment rate has fallen.

2. There have been several posts, including some of mine, on low long-term interest rates. More recently, the WSJ talked with James Bullard.

Right now, “the markets are making a mistake” and expect the Fed to maintain its ultra-easy policy stance longer than Fed officials themselves currently expect, Mr. Bullard said. When it comes to these expectations, “I would prefer that those be better aligned than they are.”

3. Scott Sumner writes,

The 4-week moving average of layoffs came out today at 287,750. Total civilian employment in September was 146,600,000. The ratio of the two, i.e. the chance of being laid during a given week if you had a job, was below 2 in 1000. That’s only happened once before in all of American history–April 2000.

However,

We are even seeing a lower employment/population ratio in the key 25-54 demographic, compared to seven years ago.

Read his whole post.

On (1), I would note that a few years ago wage growth was violating the Phillips Curve on the high side, and now it is violating the Phillips Curve on the low side. And yet mainstream macroeconomists stick to the Phillips Curve like white on rice. I would emphasize that the very concept of “the” wage rate is a snare and a delusion. Yes, the Bureau of Labor Statistics measures such a thing.

Instead, think of our economy as consisting of multiple labor market segments, not tightly connected to one another. There are many different types of workers and many different types of jobs, and the mix keeps shifting. I would bet that in recent years the official statistics on “the” wage rate have been affected more by mix shifts than by a systematic relationship between “the” wage rate and “the” unemployment rate.

On (2), I view this as evidence for my minority view that the Fed is not a big factor in the bond market. Instead, the Fed is mostly just following the bond markets. When it actually tries to affect the bond market, what you get are “anomalies,” i.e., the failure of the bond market to do as expected by the Fed.

On (3), I think that we are seeing a Charles Murray economy. In Murray’s Belmont, where the affluent, high-skilled workers live, I am hearing stories of young people quitting jobs for better jobs. On the basis of anecdotes, I would say that for young graduates of top-200 colleges, the recession is finally over. The machinery of finding sustainable patterns of specialization and trade is finally cranking again.

In Murray’s Fishtown, on the other hand, the recession is not over. I would suggest that we are seeing the cumulative effects of regulations, taxes, and means-tested benefits that reduce the incentive for firms to hire low-skilled workers as well as the incentive for those workers to take jobs. As Sumner points out, President Obama’s policies have moved in the direction of making these incentives worse.

Economists Heart Uber

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The IGM forum asks its elite economists to react to the assertion that,

Letting car services such as Uber or Lyft compete with taxi firms on equal footing regarding genuine safety and insurance requirements, but without restrictions on prices or routes, raises consumer welfare.

Of those who respond, 2/3 “strongly agree” and the remainder “agree.”

Let me suggest the next poll question: “Letting unlicensed medical providers compete with doctors and other licensed practitioners on equal footing regarding genuine safety requirements, but without restrictions on prices or services, raises consumer welfare.”

Or, more puckishly: “Letting unaccredited professors compete with Ph.D’s on equal footing using tests devised and graded by the same third party, but without restrictions on prices or services, raises consumer welfare.”

I wanted to title this post “economists heart markets,” but I fear that is not always true.

Again, I schedule posts in advance, so others have already mentioned this poll, but more favorably.

Economics Nobel Suggestions

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From Science Watch. Thanks to Greg Mankiw for the pointer. Their ideas:

1. Aghion and Howitt for Schumpeterian growth theory. I appreciated Howitt’s comment on one of my PSST papers, so I would be happy if this came true. I suspect it won’t.

2. Baumol and Kirzner on entrepreneurialism. I have been predicting Baumol for a long time. He has a phenomenon named for him (Baumol’s cost disease), which is a good sign. In the past, I have remarked on Bill James’ distinction between top peak performers (Koufax) vs. consistent high performance (Don Sutton). I have observed that economics Nobels tend to reward peak performances rather than more consistent high performance. Baumol, notwithstanding cost disease, may not have the one big idea. I recently took another look at “contestable markets,” which at the time looked like it could be his big idea, and I can see why it failed to take off. It is hard for me to think of markets in which potential entry is an important factor. Baumol’s later work, on what he called “the free market innovation machine,” seems more on target, but less novel.

As for Kirzner, at the risk of committing Austro-blasphemy, I have to say that I don’t get what makes him such a big deal. His idea of entrepreneurs always struck me as somewhat enervated–the entrepreneur as arbitrageur rather than as a creative force.

3. Mark Granovetter. An interesting suggestion. I hope people are replicating his “weak ties” research and finding that it holds up.

If this were a horserace, I would place my bet on the field, i.e., on someone other than those listed above.

Housing Re-Bubble?

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Nick Timiraos reports,

the [Federal Housing Agency home price] index shows U.S. prices now standing just 6.4% below their previous peak in April 2007.

…The Case-Shiller national index, which is set to report its own measure of July home prices next Tuesday, showed that home prices in June were 9.9% below their 2006 peak.

Some comments:

1. Overall, consumer prices have risen about 15 percent since 2007, so you might say that on an inflation-adjusted basis home prices are more like 20 or 25 percent below their 2007 peak.

2. However, even on an inflation-adjusted basis, house prices are higher than they were in late 2003, by whichi point cries of “bubble” already were being heard.

3. If I were Scott Sumner, perhaps I would say that this suggests that the 2007 prices were not really a bubble. Indeed, the real anomaly was the crash in house prices in 2008-2009, due to tight money. But I am not Scott Sumner.

4. The case that we are in another bubble strikes me as weak. It is certainly is not a sub-prime lending phenomenon. Two phrases that I hear a lot in casual conversation with real estate folks are “all-cash deal” and “foreign buyer.”

5. Even if house prices were to fall sharply again, my guess is that there would be many fewer loan foreclosures. Lenders are taking on much less risk, and instead home buyers are taking on more of it.

6. It seems to me that we are much closer to full recovery in the housing market than we are to full recovery in the labor market. Does that not pose a problem for the theory that the recession was mostly an aggregate-demand phenomenon caused by the loss of housing wealth?

7. Again, today’s economy feels so much like 2003 and 2004. Very low r, seemingly below g. Last decade, Bernanke labeled this a “global savings glut.” This decade, Larry Summers calls it “secular stagnation.”

8. In June of 2004, I wrote Bubble, Bubble, is there Trouble? arguing that low r was the central economic puzzle, and that given low r, housing prices were not out of line. I have been excoriated since then for failing to call the housing bubble. In 2009, that excoriation seemed warranted. Today, it seems like you could change the date to June of 2014 and re-print it.

A Puzzle

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Kevin Williamson writes,

New York City is not only poorer than the New York State average, its median household income is, in absolute dollar terms, lower than that of such dramatically less expensive areas as Austin, Texas, or Cleveland County, Okla., where the typical household income is a few thousand dollars a year more than in New York City but the typical house costs less than a third of what the typical New York City home costs

So why don’t people move from NY to cheaper cities, until something closer to parity is restored in the cost of living? Some possibilities:

1. By some more accurate measure, the cost of living is not so much higher in NY.

2. Living in NY is an expensive taste that occurs among many people, even those of modest means.

3. NY has jobs for lower-income people that are not available in the other cities.

4. NY’s rent controls and other housing regulations have created a lot of inframarginal winners whose housing costs are well below those of the marginal resident. (Think of those who are able to buy their apartments when they turn co-op at ridiculously below-market prices.)

5. Location adjustment is a very slow process. In fifteen years, these differentials will be noticeably smaller.

I do not claim to have the answer.

More on DeLong-term Interest Rates

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Brad DeLong writes,

the most likely–possibility is that the fact that r < g for the government is a byproduct of an extremely large outsized risk premium because of private financial markets’ failure to mobilize the risk-bearing capacity of the public and failure to establish trust and overcome moral hazard in the credit channel. Thus more government debt provides the private sector with something that it is willing to pay through the nose for: a low-risk way to transfer purchasing power into the future.

Pointer from Mark Thoma.

Imagine you had a bank that, whenever it got into trouble through bad investments, could pay off its creditors by taking wealth from people at gunpoint. Such a bank could issue debt with a low risk premium. It is not as clear to me as it is to Brad that the social optimum is for this bank to be very large. Particularly when its “investments” may earn so little in return that at some point even taking wealth at gunpoint may not be enough to enable the bank to meets its obligations.

Gender and Risk-Taking

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Jason Collins favorably reviews The Hour Between Dog and Wolf, a book by John Coates, who says that hormonal responses to success and failure serve to reinforce risk-taking and risk aversion. I note from the book description on Amazon:

Dr. John Coates identified a feedback loop between testosterone and success that dramatically lowers the fear of risk in men, especially younger men—significantly, the fear of risk is not reduced in women.

I count this as additional support for what I have said I would do if I were financial regulatory czar: change the gender of the CEO’s of the largest banks.