Which discount rate?

This week we introduced the concept of discounting in MBA 505.  We approached it strictly from a private sector perspective -- how do households and organizations compare a dollar today with one in the future.  Of course the same concept gets used in public policy analysis.  For instance an investment in workplace redesign to promote safety costs dollars up front but yields long-term benefits, so a discount rate is needed to valuate the future payoff. 

The choice of the proper discount rate can raise some complex issues, as illustrated in a current NYT blog post on climate change.  In 2010 economists, lawyers and scientists from a dozen federal agencies determined that it would be wise to use a consistent discount rate across the board.  After careful analysis and discussion, they settled on 3 percent.  At this rate a ton of carbon imposes a cost of $21 on society (pollution, global warming, etc.). 

This finding has been challenged by a study that argued the real cost was much higher -- $55 to $266.  Why were these numbers so much higher?  Simple answer, the authors used much lower discount rates between 1 and 2 percent. 

The issue boils down to how much value to be place on the welfare of people who have not even been born yet.  On the one hand, we would expect them to be much better off than we are and quite capable of paying for some carbon abatement on their own.  On the other, there is uncertainty about how severe the consequences of global warning might be (which might dictate larger investments in abatement now to prevent Manhattan from turning into another Venice) as well as the ethical issue of taking responsibility for the type of planet we leave to future generations. 

Ultimately politicians and voters will determine whether increased investments in carbon abatement are worthwhile.  Until the economy recovers, I would bet that more people would be using a 3 percent rate than a 1 percent rate. 

On Government Motors

I am not following all of this 47 percent dependency society stuff.  I bet most voters did not know that each and everyone of us is a shareholder -- in General Motors!  The US government owns 26.5% of the one-time automotive titan.  Even though Chevy Volts are not exactly flying out the door, both the GM top brass and the feds are starting to look forward to the day when the government cashes in its stake.

But when is this deal going to go down?   WSJ reports that the government is in no hurry because if it sold its GM stock now it would end up losing $15 billion.  GM stock would have to go up to $53 for the government to break even; right now the stock is trading at $25.  

So what do we have to show for our $15 billion "investment" in GM?  GM currently employs 202,000 worldwide and about 68,500 in the US.  Of course, GM is part of a global supply chain, so there are parts and materials providers and auto dealers who also depend on their continued existence.  Let's propose that the bailout saved 200,000 US jobs (this is probably much too big a number; someone -- Toyota, Volkswagen, Honda? -- would have purchased GM's assets in bankrupcy and redeployed them).  Then it ended up costing US taxpayers $75k per GM job saved.  Each person can judge on his or her own the wisdom of that investment. 

Full-time MBA applications down

WSJ reports that applications to full-time, two-year MBA programs fell by 22% worldwide last year.  In the US, 62% of schools reported declines; we had a slight increase in full-time applications here at NC State. 

Some perspective is in order.  Schools had record high enrollments in 2009-2011 in the aftermath of the market crash and the Great Recession.  People who might have otherwise waited until now to start their MBA decided to start earlier because of the difficult labor market. 

Applications grew worldwide for part-time, online and executive MBA programs.  There also was growing demand for one year masters degrees in specialized business topics, degrees largely targeted toward those who have just completed their undergraduate degrees. 

Employer bias against the long-term unemployed?

Learned today about an NBER study done by three economists (one at Chicago Booth) on how employers react to job applications from the unemployed.  The researchers sent out identical resumes to employers with online postings in 100 cities that varied only on one critical dimension: number of months since the applicant's last job, which randomly varied between 1 and 36.  The key result: the odds of getting a callback dropped with the amount of time unemployed.  Persons reporting 8 months of joblessness had a 45% lower probability of getting a call than those reporting 1 month.  After 8 months, additional time unemployed had no effect on the odds of getting a call. 

The study took a more careful look at how local labor market conditions influenced the results.  They found that the relationship between months unemployed and callback odds was strongest in cities with tight labor markets (relatively more vacancies and low unemployment).  In cities with few vacancies and high unemployment, there was no strong relationship between months unemployed and callback odds.

These results indicate that employers use time out of work as a signal of productivity and motivation.  In tight labor markets, employers seem to think something must be wrong with the applicant if they have been out of work 6 months or more; in contrast, time unemployed does not seem to be an issue in areas where there are very few jobs.  The lesson: holding out for better job offers can be a self-defeating strategy. 

Welcome to QE3

Yesterday the Fed announced it would buy $40b of mortgage-backed securities each month and committed to keep interest rates low through mid-2015.  The idea is to reduce the supply of these securities and thereby push investment funds into other outlets such as the stock market, real estate, and corporate bonds.  The hope is that long-term interest rates will fall, the private sector will have more liquidity, the stock market will rise and good times will be here again. 

Will it work?  WSJ reports that economists are split: of 51 surveyed, 28 said that more quantitative easing will not help and 17 said that it would.  Not exactly a ringing endorsement, and not surprising either because (1) banks continue to hold unprecedented levels of excess reserves and (2) interest rates are already at historic lows.  People may want to make big-ticket purchases or re-finance their houses, but with a large share of consumers still carrying high debt burdens, their key issue will be qualifying for any loan, regardless of interest rates. 

Economics of the new iPhone

Today Apple announced the new iPhone 5.  The key features appear to be (1) the phone is thinner and lighter, (2) the display has a much higher resolution, (3) faster performance, (4) a smaller connector and (5) enhanced camera performance, including a tool for shooting panoramic photos.  All of this for $199! 

Sales are expected to be strong, so strong that GDP could get a significant boost in the 4th quarter.  WSJ reports that an economist at J.P. Morgan Chase estimates the phone will add 0.25 to 0.5 percent to economic growth.  That's 8 million phones times $400 value added ($600 price minus $200 imported components). 

Wireless carriers sell the phones at $200 but lock in customers with two year contracts that more than make up the $400 discount.  They have reacted, WSJ reports, by adding upgrade fees and more expensive data plans. 

I am still using a three-year-old iPhone 3, so I think I will be ready for an upgrade.  Will have to think awhile about the best carrier and data plan. 

Food truck rodeos

My wife and I went with another couple to our first food truck rodeo in Durham yesterday.  Turns out it was the biggest rodeo yet in the RTP area, with 44 trucks offering goodies ranging from American Meltdown's grilled cheese goodies to Valentino's meatballs.  We had Only Burgers (veggie for Linda) and Hawaiian ices; the burgers were superb, the ices not so much (where are you when we need you Matsumoto?).  Paid a visit to Fullsteam Brewery afterwards to enjoy their dog-friendly (even indoors!) atmosphere.

Food trucks are changing the business model for food away from home.  Owners benefit from much lower capital costs up front and the ability to move the restaurant to where the demand is.  Each truck specializes in a single food item or cuisine, simplifying preparation and building a reputation with customers.  Lower overhead results in lower prices.  Customers gain in a rodeo setting by being able to enjoy a variety of foods (our friends had Korean barbeque and a raw kale burrito).

Only two downsides that I could see from a customer standpoint.  First, the lines at many of the vendors were quite long; we were originally hoping to do a variety of small plates but two lines were enough for one afternoon.  Second, for those who want to create their own wine-food pairings -- too bad, the rodeo took place in Durham Central Park where adult beverages are not allowed.  Next time we will bring a tarp or beach towel as well. 

Summers on shrinking government

The appropriate size of government will be a central issue in this year's election.  Harvard economist and former Treasury secretary Larry Summers wrote in a WP op-ed this week that a number of "uncontrollable" factors will lead to an even bigger government in future years.  There is no denying two of the arguments he makes: (1) we face a triple whammy from rising health costs per person, more elderly people, and higher longevity and (2) at some point interest rates are going to return to normal levels which will increase the cost of debt service.  Less convincing is his claim that the cost of government services will continue to rise relative to the price of goods produced in the private sector.  Careful process analysis of government activities and adoption of private sector benefits packages could turn this trend around. 

Currently the federal government is spending 25% of GDP.  Mitt Romney pledges to cut this to 20% (close to the average over the last 30 years) whereas his opponent has yet to pick a numerical target.  Summers thinks the "uncontrollables" will get federal spending up to 31% of GDP. 

WP columnist Robert Samuelson faults Summers for being silent concerning what should be done in the future:

What should the nation do? Summers punts. Here’s his column’s last sentence: “How government can best prepare for the pressures that loom, and how greater revenue can be mobilized without damaging the economy, are the great economic questions for the next generation.”

Wrong. They are questions for this generation. They loom now; the longer we ignore them — as we have for decades — the harder the choices.

Apple takes on TV

Over the summer I read Walter Isaacson's bio of Steve Jobs.  Toward the end, Jobs claims that he finally figured out how Apple can be successful in the television market: "I've finally cracked it."  But of course he does not reveal the strategy to Isaacson.

One of the more interesting anecdotes from Jobs' biography shows his thought process concerning the mobile phone -- a piece of equipment he derided with a four-letter fecal expletive.  You could easily say the same thing about the customer interface with television.  Also with the growth of cloud computing, we should be able to watch anything at anytime we want. Try doing that now with the typical cable box!

Last week, there were multiple press reports (here is one from WSJ) hinting that Apple aims to shake up the TV industry the same way it shook up computing, music players, music distribution, mobile phones and tablets.  Apple is reportedly in discussions with both cable companies and entertainment producers.  This case study of market entry will no doubt be a fascinating one.  

Building better bosses

Three years ago Google started taking an analytical approach to human resource issues, including the age-old question of why do some bosses perform better than others.  After grinding gigs of data, Google found that there were eight key factors that determined which bosses were most effective.  Of those eight, the least important was technical expertise.

Most important? According to NYT, "even-keeled bosses who made time for one-on-one meetings, who helped people puzzle through problems by asking questions, not dictating answers, and who took an interest in employees’ lives and careers."

Three economists at the Stanford Business School have done a field study of boss effectiveness in a large services company.  Their key findings are

1. Bosses are important and vary in productivity. Replacing a boss who is in the lower 10% of boss quality with one who is in the upper 10% of boss quality increases a team’s total output by about the same amount as would adding one worker to a nine member team.
2. Bosses primarily teach; motivating workers is less important.
3. The worst bosses are unlikely to be retained. Over a given 1 year period, bosses in the lowest 10% of the quality distribution are 64% more likely to leave the firm than other bosses.
4. The difference between the effect of good and bad bosses on high quality workers is greater than that on lower quality workers, which suggests that good bosses should be allocated to the higher quality workers. Comparative advantage is key. Allocating bosses appropriately can raise firm productivity.

The bottom line on boss management seems to be shape up or ship out. 

Source: Kathryn Shaw's address to Society of Labor Economists.  

Things economists agree on

NPR's Planet Money reports a six-step economic plan that virtually all professional economists would support, regardless of their political stripes:  (Link courtesy of Greg Mankiw's blog.)

• Eliminate the home mortgage interest tax deduction
• Eliminate the corporate tax deduction for employee health insurance
• Eliminate the corporate income tax
• Eliminate all income and payroll taxes
• Tax carbon emissions
• Legalize marijuana

Of course most, if not all, of these ideas are politically toxic.  MBA 505 students this fall will learn why these changes would help the economy and why they face an uphill climb politically. 

Zakaria busted for plagiarism

This is orientation week for many MBA programs, including NC State.  Each year we spend time on the touchy subject of plagiarism.  Ironically, today's news cycle provides a great example from media pundit Fareed Zakaria.  Here is Zakaria in Time magazine (link courtesy of the Atlantic Wire; Time has removed the article):

Adam Winkler, a professor of constitutional law at UCLA, documents the actual history in Gunfight: The Battle over the Right to Bear Arms in America. Guns were regulated in the U.S. from the earliest years of the Republic. Laws that banned the carrying of concealed weapons were passed in Kentucky and Louisiana in 1813. Other states soon followed: Indiana in 1820, Tennessee and Virginia in 1838, Alabama in 1839 and Ohio in 1859. Similar laws were passed in Texas, Florida and Oklahoma. As the governor of Texas (Texas!) explained in 1893, the "mission of the concealed deadly weapon is murder. To check it is the duty of every self-respecting, law-abiding man."

Compare to Jill Lepore in the New Yorker in April:

As Adam Winkler, a constitutional-law scholar at U.C.L.A., demonstrates in a remarkably nuanced new book, “Gunfight: The Battle Over the Right to Bear Arms in America,” firearms have been regulated in the United States from the start. Laws banning the carrying of concealed weapons were passed in Kentucky and Louisiana in 1813, and other states soon followed: Indiana (1820), Tennessee and Virginia (1838), Alabama (1839), and Ohio (1859). Similar laws were passed in Texas, Florida, and Oklahoma. As the governor of Texas explained in 1893, the “mission of the concealed deadly weapon is murder. To check it is the duty of every self-respecting, law-abiding man.

This is a highly egregious case; not an exact quote, but clearly the same ideas expressed in almost the same words.  Zakaria, to his credit, has accepted full responsibility.  He has been suspended by CNN and Time. 

How big is the multiplier?

Cal-San Diego economist and blogger James Hamilton summarizes the research of his colleague Valerie Ramey on how much government spending affects GDP.  The results, based on almost 75 years of data, show that a one percent increase in government spending per capita results in a 0.7 percent decrease in private spending per capita.  So GDP goes up, but not by nearly as much as simple textbook models imply; the multiplier (ratio of change in GDP to change in government spending) appears to be much less than one.  This certainly would explain why the economy failed to respond to the stimulus packages of Bush 43 and Obama.

Generational politics

Great WP op-ed today by Robert Samuelson on an issue that is receiving zero attention in this year's election: the future of the next generation.  Samuelson notes the combination of the Great Recession, aging and rising health care costs puts young people today in a real squeeze.  They are at risk, he argues, of having a lower standard of living than their parents. 

Simple arithmetic dictates that at least one of the following will happen: retirement ages for Social Security and Medicare will be raised, taxes will be increased or government services will deteriorate.  But no one is campaigning on this platform, are they?  Samuelson's closing quote is priceless: "There are real conflicts between the young and old; so far, the young are losing."

Down on Chick-fil-A

Chick-fil-A CEO Dan Cathy recently shared his personal views on gay marriage with a reporter.  The news media have had a field day, reporting both protests and shows of support.  Georgia Tech b-school dean Steve Salbu has a great NYT op-ed that strikes what I believe is the proper perspective.  Salbu, who happens to be gay, was disheartened by Cathy's remarks but was also disappointed with lefty pols who threatened to chase Chick-fil-A out of their towns:

True individual freedom includes allowing consenting adults to marry the partners they choose, regardless of gender. To those for whom same-sex marriage is personally objectionable, their free choice is simple: Don’t enter into one. But don’t impede the freedom of others to do so. As long as Chick-fil-A operates within the boundaries of the law, municipalities and institutions should leave the decision about whether to eat at Chick-fil-A to individual consumers.

Salbu also delivers a business lesson: Cathy should expect his business from gays to fall off a bit.  Is it any wonder CEOs tend to stay silent on social and political issues?

How will new healthcare law affect employment?

Now that the Supreme Court has upheld the key provisions of the Affordable Care Act (AAC), employers are taking a more careful look at the details, according to today's WSJ.  Here are some examples of the decisions employers are facing:

• A Quiznos franchisee in Virginia Beach has two locations with 36 employees.  At 50 employees he must provide health insurance or pay a fine.  He once was hoping to triple the size of his operation, but now is not so sure.  It will no doubt depend on how the final regulations define the size of an enterprise, whether by location or by ownership.  
• A Dunkin' Donuts franchise with 10 locations in New Hampshire provides health insurance but his policies do not provide enough coverage to meet AAC standards.  His choice: pay higher premiums or dump the coverage and pay the fine.  
• AAC kicks in for employees working 30 or more hours.  Watch out for a surge in the number of employees capped at 29 hours. 

This is all basic microeconomics: when the price of something rises, people seek substitutes.   

MBAs in retail

Bloomberg BusinessWeek is running an online story about opportunities for MBAs in retail.  The article says that Nike, Target and the Gap have become sought-after employers for a rising share of MBAs.  Retail was shaken a decade ago by the growth of e-commerce; it is being shaken again by the emergence of big data.  An MBA with a strong mix of creative and analytical skills will be in a position to contribute. 

The luxury sector continues to be especially strong globally.  NC State launches its new masters program in Global Luxury Management this fall.  The Poole College of Management is partnering with the College of Textiles and SKEMA Business School in France to offer this one year program where students study in Raleigh in the fall and in France in the spring. 

Is deposit insurance the real problem in banking?

Former Citibank CEO Sandy Weill garnered headlines last week when he said that the megabanks (one of which he created) should be busted up into smaller units.  Two WSJ columnists (Zweig and Jenkins) point out that size may not be the real problem -- instead, they argue, we need to take a closer look at deposit insurance. 

Currently the FDIC insures deposits up to $250,000.  Zweig quotes Rutgers economist Eugene White, who thinks the insurance could be cut back to a limit of $100,000.  This would protect the deposits of middle class investors, while forcing those with larger balances to pay more attention to the security of their deposits.  Bankers -- of all shapes and sizes -- would be less willing to take risks if they knew they could not count on the FDIC to bail them out with their depositors. 

Of course it would be hard, without full disclosure of compensation formulas and balance sheets, to know how risky a bank might be.  But maybe such info should be disclosed?

Sensible analysis of the gold standard

We continue to have a small but vocal minority (I'm talking to you James Grant and Ron Paul) that blames virtually all of our macroeconomic problems on our departure from the gold standard in 1971.  Chicago Booth finance professor John Cochrane has a great WSJ op-ed this weekend that does a great job explaining why the traditional gold standard would fail miserably in today's world: the price of gold fluctuates much more than the CPI, it would do nothing to stop the Fed from buying and selling securities and would readily be abused by governments facing piles of debt.  Best line: "This isn't theory.  It's history."

Cochrane argues that the idea behind the gold standard has one virtue: it commits the government to exchange each unit of currency for something real.  He argues this could be done more easily by having the government commit to buy and sell CPI-indexed bonds at fixed prices.  The key words in this idea are "at fixed prices;" it does not take much cynicism to imagine a debtor government welching on its side of the deal.  

Bernanke's midyear report

Fed chair Ben Bernanke gave his midyear report on the state of the economy to Congress yesterday, and the news is not encouraging: "The U.S. economy has continued to recover, but economic activity appears to have decelerated somewhat during the first half of this year."  Investment by businesses in plant, equipment and inventories is especially worrisome, Bernanke said.

Some lawmakers encouraged Bernanke to do more to stimulate the recovery.  However, his means to do so appear extremely limited.  The Fed's main tools are lowering interest rates and buying bonds to create more liquidity.  Yet banks have mountains of excess reserves and have decided it is better to keep them at the Fed to earn 0.25% than to loan them out.