Archive for the 'Economics' Category

Going green

April 22nd, 2007

This website is now proudly carbon neutral.

Green Web Hosting! This site hosted by DreamHost.


I have to admit that I’ve got some real concerns about the way the current carbon offset thing is going, especially the recent trend towards carbon neutral everything. It’s starting to appear absolutely everywhere – a friend of mine recently had a carbon neutral wedding, and even got featured in the paper for it.

The market is still pretty new, and there’s a lot of dodgy dealers out there – people selling things that don’t have any interaction with carbon emitting industries. So you have to be fairly careful with what you buy right now.

But, leaving that problem aside, does this work? Let’s look at an extreme case, to help inform us in the analysis (this is inspired by some analysis from Tyler Cowen). So suppose that everyone in a town does this.

Company A provides electricity to the town, charging a price that maximises their profit (they are, after all, a monopoly). The plant was well planned, so sells all 100 units it can produce.

Then, all of a sudden, An Inconvenient Truth starts playing at the local cinema, and a wave of green enthusiasm strikes. Everyone in town then buys carbon credits from Company B. Company B is obtaining these credits from the emissions market (for the sake of argument, let’s say it’s purchasing them from an aluminum producer that’s shutting down).

From the individuals perspective they’re now paying more for every unit of electriciy, as they’ve internalised the carbon production externality. As a result, at the prevailing price they’ll start to consume less electricity. Let’s say they start consuming 80 units. To use slightly more technical economics jargon, their demand curve shifts left.

This isn’t good news for Company A. They’re capital intensive (as all electricity production is), and the sudden excess capacity means that part of their plant is no longer making the return they once expected. Now they could shut down part of the plant, and reduce emissions, but this would result in a substantial loss in the value of their capital. Alternatively, they could lower their price a bit and try to encourage the consumers in town to expand consumption to 100 units again.

Now, the world is certainly better off – the aluminum plant shut down, so emissions are less. But the town is still consuming the same amount of power as before!

But compare this to the world where Company A has to pay for the carbon it emits. Now, the outcome in the short run will be the same, in terms of price and quantity. But because the cost of carbon is internal to the company, they’ll have a much greater incentive to invest in more carbon efficient means of producing electricity. In the world where everyone buys offsets, the incentive to invest in cleaner technology is much less, as there wouldn’t be a direct reduction in cost, just a potential increase in demand.

Overall, I think that the carbon neutral thing is good. As consumers adjust to a price that better reflects the true costs of production, it’ll be easier to introduce changes in policy that better encourage emission reductions. But they aren’t a good way to do this forever, because the direct emitters of carbon need to be facing the price, or the system just isn’t going to induce the kinds of changes in behavior that are needed.

So we certainly shouldn’t mistake it for a solution to the carbon problems the world is facing. So I worry that ‘easy answers’ like carbon neutral websites, weddings or cars will just make people too complacent, and make it that much harder to push for the kinds of more fundamental changes that might prove needed.

(As a footnote, I should point out that I’m not paying a penny to make this site carbon neutral, my ISP has done it as part of my overall hosting without raising my price at all. Pretty close to a free lunch…)

Free Trade?

March 20th, 2007

Dean Baker makes an excellent point about a lot of rhetoric in free trade discussions:

It is positively bizarre how discussions of trade liberalization always ignore the possibility of liberalizing trade in highly paid professional services.

I agree with this strongly – but the problem in this area is so severe that even thinking about free trade is a long way away. We don’t even have free markets in this area. Many professions (doctors and lawyers most famously) have very strict rules that prevent anyone who is not licensed from practicing. Now this probably seems like a very good idea – who would really let an unlicensed doctor treat them?

Well, the answer seems to be lots of people: alternative medicine practitioners (whatever opinion I might have of how well those treatments work) are very popular. But they are hamstrung by the rules on medical practice in many ways. I can make a good argument that these rules help people by saving them from themselves. But that kind of argument always makes the economic rationalist part of me pretty uncomfortable.

But even worse than restricting the right to practice, the licensing in many of these professions is actually in the hands of some professional association, rather than the government. Even if you can get the economic rationalists to agree that licensing might be a good idea, it’d be hard to convince any economist that letting the professional association manage things with only light government oversight is a good idea. As Adam Smith said in 1776:

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.

The professions is an area where a lot of reform is possible. It’s also extremely unlikely to ever happen, for obvious political reasons.

(By the way, I’d just like to endorse Dean Baker’s oft made point about the strange way media groups always call trade agreements ‘free trade agreements’, even if there’s nothing free about them)

Would I have bought Enron?

March 14th, 2007

I just finished reading a couple of books on the share market, in particular about the early 2000s frauds by Worldcom and Enron: A Mathematician Plays the Stock Market and The Smartest Guys in the Room.

The question that struck me while reading the books (particularly the Enron one) was whether or not I would have bought those shares, and got caught up in the same collapse. What was it about the Enron shares that ‘smelled’ before the big collapse became inevitable.

This isn’t really a question about making money in the short run, but rather about whether or not a company’s business is “real”, and there for the long run. In the short run, all kinds of silly things can make money, so long as you sell in time. But in the long run, there has to be a real business behind the company.

Enron, as far as I can tell, was a company where the fundamental ‘real’ business was pretty non-existent, or was losing a lot of money because they weren’t charging enough. A lot of the gains were coming from mark-to-market accounting (taking the entire profits of a 20-year deal as soon as it was signed), or the trading operations (which were good, but a very volatile business). As far as I can tell the actual fraud was a fairly small part of the problem, really only delaying the final end of the company by a few quarters.

Paying attention to the actual cash flow, rather than just the reported profits, would probably have helped spot the problems early (as, indeed, it did for some), but I suspect that this rule would be too strict – you’d tend to eliminate some companies that do have a good business, just not a lot of cash.

I have a few personal rules of thumb for my own (hypothetical, so far) share purchases:

  • Focus on businesses that supply some bit of GDP that is clearly identifiable.

  • Avoid businesses that depend on Government decisions for their profitability: health insurance, airlines, and so on.

  • Make sure that the price to earnings ratio isn’t too wacky (normally a good sign that there’s speculation, or some kind of other problem, going on).

  • Understand the actual business of the company (where does it make its money from), as opposed to what they say the rules are.

By this basis, Enron would have thrown up red flags on at least two, maybe all four, if I’d looked into it enough.

Which I suppose is the real lesson – if you’re going to invest in a company, you should understand it in a lot of detail, because otherwise you’re at a lot of risk.

Virtual Economics

March 12th, 2007

Recently saw this post on Boing Boing about virtual economics. Cory Doctorow’s take on the inflation endemic to these games:

I think that this has profound implications for in-game democracy — democracy requires that you play together for a long time, in order to establish civil society. But inflation is such a fixture in virtual worlds that they are necessarily short-lived — only by beating inflation can games sustain themselves.

Cory is right, I think: dealing with these things is an essential step for the kind of virtual world that Second Life wants to create. I suspect that World of Warcraft (where the main focus) is not really the economic parts of the world) doesn’t need to worry so much.

The simplest economic theory for inflation is the quantity theory of money. In simple terms, we can say that:

M . V = P . Q

where M is the total money supply, and V is the velocity of money (how quickly money changes hands), P is the price level and Q is the number of ‘things’ in the economy. So what causes inflation (that is, changes in P)?

Change in P = Change in M + Change in V – Change in Q

(Strictly that’s in log change terms, but just think of it as percentage changes)

So the simplest version of inflation is that it happens when growth in the money supply outpaces growth in output in the virtual economy.

How do virtual worlds generally try to control things? Well, there are some significant problems to do with growth in the money supply, because there are lots of in-game tasks that create money. In Second Life, for instance, many players get a weekly allowance from the system, all of which is new money. Most of the systems involve ‘sinks’ that remove money from the game, which are adjusted to try and keep the system in balance.

But what would we call this system if it happened in real life? Well, the government of the system is printing money to finance welfare payments. Inflation isn’t really a surprise.

Can we use this real life analogy to inform the system design? How could they get inflation under control?

First, the government could run a balanced budget. The taxation in these systems is pretty implicit, making it explicit would allow a proper government budget to be produced. Then welfare payments could be balanced against income. I suspect that the system most games use is actually pretty close to this, but the democracy element that Cory suggests would really require that this power be taken out of the ‘god’ of the system and placed in the hands of some explicit government within the system.

Secondly, an independent monetary authority or central bank could play a part. Real world countries rely on monetary policy to control inflation, through setting a price on money. It’s not as clear to me that this could work in a virtual setting. In particular, in the absence of a functioning credit market it’s hard to see how the normal monetary transition channels could work.

(Setting up a banking or credit system in a virtual economy wouldn’t be that hard. The tricky part is distinguishing it from a Ponzi scheme).

All of this is just a long way to say that so long as the key government functions, such as welfare, taxation and control of the money supply, are in the hands of the ‘god’ of the system, then democracy in virtual worlds is probably going to have a hard time getting started. What’s needed is a virtual world that hands over more of the control of these types of levers to the players through the form of some kind of government.

So in actual fact, the elements that Cory suggest need to be solved to create a virtual democracy are actually some of the things that might help such a virtual democracy grow.

But until then, Second Life and its friends look to just be a bunch of hype to me.

A few thoughts about 1976

January 3rd, 2007

1976 isn’t just the year of my birth (epoch making an event that may be). It was also the year of a fairly interesting economic policy showdown in Australia. This has been prompted by the release of the 1976 Cabinet Papers as well as some recent commentary by John Stone. This is going to be a fairly long post, so it’ll be continued over the page, to keep the important musings about movies and Lego where they belong.

Read the rest of this entry »

Is Google turning evil?

December 12th, 2006

Search engine turned portal-omnivore Google has a reputation as being an ethical company. The informal corporate motto is “Don’t Be Evil”. But two stories today have made me start to wonder if maybe the ‘magic of the market’ has done its bit, and Google is starting to behave like pretty much any old monopolist.

First, Jeremy Zawodny spots Google stealing some content:

[T]hey decided to basically copy our page and slightly Googlify it. If you look, the design, layout, and most of the text are the same!

And then Tech Crunch reports on Google’s move into radio ads, and the hurt feelings at a competitor:

He [ CEO David Ciccarelli] claims the Google ad product is nearly identical, although he hasn’t seen it yet and has nothing to go on but the CNET quote above. But he also says that for the last couple of months traffic to the site from Mountain View (where Google is headquartered) has gone through the roof, accounting for about 5% of total traffic. He’s suggesting that Google has scoured the site to figure out what to copy in the business model.

Neither of these two stories by themselves is very remarkable. Web designs get copied all the time, and it’s very unlikely this was the deliberate decision of any of the senior executives (like Microsoft’s recent embarrassment is likely just one rogue designer). And it’s a rough business out there, but competition is fair game. Just because you got there first doesn’t mean you own the land (AltaVista, anyone?).

But together these stories give a sleazy feel that goes against the image Google has been trying to paint. It looks like the company is getting a bit too big to control, the feature sprawl is getting a bit too broad to be properly policed, and the quality is suffering as diminishing returns set in on the staff.

So what’s going on here?

Google is a really good search engine, but nothing else it’s done has really impressed me except email. Google ‘gets’ search, and has come up with some good advertising solutions. The other businesses seem to be attempts to create greater traffic to their site, and to create new revenue streams that are increasingly far removed from their core business of web search.

None of the core search engine business really justify the price to earnings ratio the stock price implies at the moment: 53.1, compared to a ‘sane’ figure of around 15-20. That kind of share price suggests that investors are expecting massive growth in future earnings. Given that Google is at maturity in the search engine business (with little market share left to take), that growth can only come adding new businesses to Google. Or, to put it another way, investors are implicitly expecting earnings to quadruple, which even YouTube isn’t going to do on its own.

So this makes Google a shark: it can’t stop swimming, or it’ll die. Every month Google needs to be doing something that expands its business, makes its revenues larger, and makes the investors confident that it’ll keep growing. As soon as they stop swimming, the share price is going to take a sharp, dramatic dive.

But sharks can’t stop to be nice. Google can’t afford to be “not evil” now, if being “not evil” causes it to lose any of these opportunities to expand revenue. The wedge will be thin at first, with these kind of mild, almost unnoticeable offences. But they have to grow over time, the imperative of the stock market (and the insane valuation of Google) demands it.

It’s a bit sad really, and it would’ve been nice if Google hadn’t become the single-stock manifestation of the bad-old-days of the late 1990s tech boom, but it’s pretty inevitable now. We can just hope that a pretty good search engine sticks around once all the dust has settled.