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    Opposing Austerity

    Apr 12 • Behavioral Economics, Economic History, Environment, Government, Macroeconomic Measurement, Regulation, Thinking Economically, Uncategorized • 685 Views

    Thinking about our fiscal woes, I keep returning to the fallacy of composition.

    Here it is:

    When one farmer harvests a huge crop and sells it, her profits soar. But if every farmer grows more and sells more, then the price drops. Similarly, if one person races out of a theater, she easily exits. When many do, it is tough to get out.

    The point? Sometimes what is good for a single person becomes a problem when everyone does the same thing. Economists call it the fallacy of composition. Harrisburg, Pennsylvania’s fiscal plight reminds me of the fallacy of composition.

    The Harrisburg story begins when they decide to retrofit their trash incinerator with borrowed money. If every garbage truck pays a fee, the incinerator business can be exceedingly profitable. At first though, the mechanics do not work and then the EPA says the facility does not meet federal standards. Each time, the community borrowed and upgraded. The result? The incinerator cost $326 million. A city with 50,000 people owes $326 million. And then the recession hits. The result? A debt crisis.

    With local officials resisting, the governor of Pennsylvania mandates austerity. His representative says sell municipal parking garages, cut fire and police wages and pensions, sell the incinerator. But, the Harrisburg city council, a 4-3 vote, says no.

    Responding to individual incentives, law makers reject the austerity policies that are best for their community. Individual law makers are each doing what is best for them. Anyone who supports tax hikes, wage freezes and pension cuts might not get re-elected. And then ultimately, as with a farmer’s bumper harvest or a fire in a theater, when enough law makers act similarly, everyone suffers. Sounds like the fallacy of composition.

    My Bottom Line? For controlling Medicare and Social Security spending, do we have a fallacy of composition problem?

    This article tells the whole Harrisburg incinerator story while NPR’s Planet Money tells the sad tale of the receiver who was sent to Harrisburg to solve their fiscal problems. As for Greek legislators, as this article tells us, the bribes that flowed to legislators will evaporate if they support austerity.

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    Hedging Health Risks, Hedgehog Style

    Apr 11 • Businesses, Demand, Supply, and Markets, Households • 827 Views

    By Mira Korber, guest blogger.

    Oppressive fluorescent lights, the antiseptic squeak of rubber soles on linoleum, and the omnipresent pulse of machines envelop you at the hospital. You’re anxiously awaiting the results of surgery on your beloved family member.

    Her name is Harriet, she’s a hedgehog, and this actually happened.

    This (just slightly) unusual medical story is the result of pet medical insurance. (NB: The purpose of any health insurance is not to pay for medical procedures, but rather to hedge against risk of medical disaster [see this Econlife post.])

    Without the coverage, would Harriet would have undergone treatment? Maybe, maybe not. 

    Why? The proliferation of pet health insurance demonstrates a changing series of behavioral incentives. Logically, the more coverage you have for your pet, the greater the incentive to supply costly care and medications. Then, will you see an incentive to own more pets because insurance covers advanced treatments? Disregarding the cost of vet school, will more students see a lucrative future in veterinary fields?

    A segment from NPR “This American Life” episode 392  exemplifies how incentives change for pet owners with insurance. Quoting a report from the National Commission on Veterinary Economic Affairs, NPR reports, “‘with pet insurance, clients likely will use your services even more often and opt for more advanced medical procedures.'”…insurance can reduce  ‘price resistance on the part of the client…with cost concerns removed, clients become more engaged and more responsive.'”

    Additionally, these statistics express the nature of a growing pet insurance market (cited from an informative USA Today article):

    • Pet insurance costs from $15-$75/month, and covers 80-90% of claims
    • Dogs are insured 4x more than cats
    • 1% of American pets are insured, compared to Europe’s 20%
    • In 2011, Americans spent $50.8 billion on pets; $14.1 billion was health related expenditure


    The Bottom Line? By providing health insurance to four-legged family members, owners are more willing to leap for the big-ticket bills. By the same token, vets are more likely to prescribe expensive procedures.

    Find some interesting reads and blog source material below:

    Details on Harriet the hedgehog. Information on dogs and the American economy, here.
    VPI Pet insurance. And finally, The cost of advanced procedures, without insurance.

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    Jumping (or Not) and Unemployment

    Apr 10 • Businesses, Demand, Supply, and Markets, Labor • 591 Views

    By Mira Korber, guest blogger.

    Pretend for a moment that you are mounted on a jumping horse approaching an obstacle full speed.  The next thing you know, you go hurtling through the air like some limp animal. What happened? Your ever-so-noble-steed has pulled a “dirty stop” at the last possible moment before takeoff.

    Sounds like what some (non-horse) people are worrying about…regarding American jobs and the unemployment rate. So, what are the odds of an economic “dirty stop?”

    In March, the US added 120,000 jobs, and the unemployment rate fell to 8.2%.  That’s showing “improvement” but hardly represents a panacea for ever-burgeoning recovery woes. Some economists expected 210,000 jobs added to the economy, and the unemployment rate to remain at 8.3% (accounting for people actively looking for work).

    However, as the rate has fallen and a smaller than expected number of jobs have materialized, it seems that fewer people are looking for work. Another issue is that companies, while laying off less, are also hiring less. This accounts for a decrease in unemployment claims. You may expect those claims to demonstrate a healing jobs market, but they more accurately reflect a bottoming out of layoff activity (not necessarily an increase in hiring).

    That’s numbers and analysis  according to an article from ABC News, but here’s a different perspective: things will get better with just a little more time.

    The bottom line? Some say getting thrown from the financial carousel is likely. Others are optimistically waiting for the economic ride to improve. Either way, you’ve got to ride the horse you’re on.

    By the way, see this Econlife post for more information on how employment and GDP are related.

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    Should We Keep the Penny?

    Apr 9 • Economic Debates, Government, Households, Money and Monetary Policy, Uncategorized • 832 Views

    Because cost is up and use is down, the Royal Canadian Mint stopped producing pennies and, during the fall, will stop distributing those that exist.

    Should we also eliminate the penny?

    Pennies are expensive. At 2 1/2 cents a piece, making and distributing them lost the Treasury $60.2 million last year. Proposals, though, for a cheaper coin, have always generated a flap. When, to save money, President Reagan proposed diminishing the copper in a penny in 1981, the uproar included a suit from the Copper and Brass Fabricator’s Council. However, the switch did take place and today’s penny is 97.5% zinc and 2.5% copper.

    Now, we are debating whether to eliminate the penny, create a cheaper one, or do nothing. A penny phase-out has some people worrying that rounding up prices will be inflationary. Others say charities will raise less.  And some just like Abraham Lincoln. You can see that the arguments are not really convincing and yet all Congress has done is ask the Mint if it can make a less expensive small coin. Perhaps, tradition is the real reason that many of us feel penny loyalty.

    My bottom line: Eliminating the penny might not be necessary. Soon it might no longer have the basic characteristics of money:

    1. It is accepted as a medium of exchange. For example, you and I are willing to use the commodity in a supermarket. A peso or a tie is not a medium of exchange in the United States.
    2. It is a unit of value. We all know how much purchasing power a penny represents but not necessarily the yen.
    3. It is a store of value. We all like our money to retain its purchasing power if we do not spend it immediately.

    My sources were this Huffington Post article, this NY Times article, an excellent New Yorker Magazine discussion from David Owen, and this from a Canadian newspaper.

    Just an interesting post script: In 2001, the NYSE did the reverse. Replacing fractions with decimals, the trading price included pennies. For example, instead of 50 1/8, the price of a stock had to be expressed as $50.12 or $50.13.

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    African Developments

    Apr 8 • Behavioral Economics, Developing Economies, Economic Debates, Economic History, Economic Thinkers, International Trade and Finance, Macroeconomic Measurement, Regulation, Uncategorized • 623 Views

    In Malawi, when local newspapers referred to the president as “the big kahuna,” his office threatened a jail sentence if they did not stop. This threat and subsequent events take us straight to Why Nations Fail.

    Malawi is a small sliver shaped African nation.  Landlocked, it is sort of tucked into Mozambique, south of Tanzania and east of Zambia. Until recently, with tobacco and tea its major exports, and foreign aid that included Madonna’s $15 million school building project, economic growth touched 7%.

    Now though, as its economic woes increase, Malawi remains among the poorest nations in the world. The value of their currency, the kwacha, went down when the world price of tobacco dipped and foreign aid declined. The crisis worsened when the UK froze foreign aid after the British ambassador was kicked out for saying the government was becoming increasingly authoritarian. In addition, Madonna scaled down her school building project to a $300,000 donation to a local NGO. And finally, perhaps creating a succession battle, the 78 year old Malawian president had a fatal heart attack last week.

    And that returns us to Why Nations Fail. While there is much more of a Malawian story to be told, even these disparate facts point to basic reasons that certain nations are poor. In Why Nations Fail, economists Daron Acemoglu and James Robinson tell us that economic success does not depend on geography or natural resources, cultural traits or wise economic advice. Instead it is political institutions. “As political institutions influence behavior and incentives in real life, they forge the success or failure of nations.”

    Our bottom line: Whether considering foreign aid or our own economy, we might more consistently assess how political institutions are shaping behavior. Or, as Dr. Acemoglu said in an econtalk podcast, “…prosperity is created by incentives, and incentives are created by institutions.”

    My Sources: These WSJ articles here and here. Why Nations Fail by Daron Acemoglu and James A. Robinson. You might also enjoy this Thomas Friedman, NY Times Op-Ed on the book and also this econtalk podcast.

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