Revisiting Predictably Irrational: Beauty and the (Slightly Less Attractive) Beast

Dan Ariely's Predictably Irrational is one of my favorite books that I have ever read. The topic combination of economics and the truth behind human nature was a match made in heaven. Today, I recall one study that Ariely specifically discusses: relativity.

The understanding that humans are bound to act against the rational decision making is tough for many stiff minded scholars to grasp. Sure, we can assume that all competitors will reach economies of scale, allowing the customer the lowest price at all times. In reality, the key for any goods and services does not matter in the grand scale of things, but more so what is going between you and the competitor in the vicinity. This delves into matters of recognizing the differences between Comparative and Absolute advantages.

Ariely's best relativity example in my opinion was the relativity of beauty. The main argument is that if you were to go out with one of your friends (preferably one who looks more or less alike), whoever is naturally more "attractive" will ultimately have an easier time finding a mate. Reasoning? Yes, justification exists.

Say you are set to compare 3 subjects. A and B would be both you and your closely (yet less attractive) looking friend. C, on the other hand, will be a person similar attractiveness to A, yet will look completely different (blonde hair and blue eyes, or vice versa to your own traits). Your admirer will look at all 3 of the potential mates, but find a natural base of relativity when judging A and B. Because there is a benchmark for A to be judged, the ability to recognize attractiveness  is likely to ensue, allowing a higher probable victory over C.

While this will never be a 100% sure thing, I can state that the relativity theory will up the probability higher than a standalone challenge between A and C. For more information, purchase Predictably Irrational and enjoy the rest of the fun, exciting tests that Ariely runs on the guinea pig undergrads of Duke University! 

Note: Ariely advises to never let your less attractive friend know your actions. I advise the same.

Pensions in California Go Wild...

Pensions incentivize people to stay employed with companies for the long haul.  Pensions avoid relocation loss in efficiencies.  But what happens when pensions lead to the destruction of entire cities?

Steven Greenhut writes a piece about the current status of Stockton and its near bankruptcy run due largely to the heavy amounts of money due to government pension plans.  In the article, Greenhut states that there are 94 people who are currently receiving over $100,000 a year in their pension plan in Stockton.  That number is double the amount of a relatively similar sized city in California.  There are also 15,000 total Californians receiving $100,000+ pension plans, which take away a big question mark to where government money could be better off spent.

Now, this is all within Greenhut’s opinion.  It is true that these people who are receiving these luxurious pension plans have worked hard and deserve a solid foundation heading into retirement; however, the problem exists when we see the state of the economy.  It would seem logical that these numbers would be adjusted when times have changed in order to benefit the entire economy.  Instead, California is stuck with a few wealthy government retirees and tons of troubled civilians in the rest of the state.  Balance within the economy is the crux to a successful state, and unfortunately, this isn’t benefiting anyone in the long run.

While it seems largely unfair to strip retired government officials from their golden parachutes (to some degree), our government should be reevaluating the way that pension plans are structured in the future.  If we are giving the same rates that have been offered in the past, we will never be able to dig ourselves out of this crisis in the future.  Yes, creating flexibility in pension plans would be violating the exact reasoning the plans themselves are typically established, but in times of uncertainty, it is difficult not to readjust. 

Take for example quantitative easing.  If we hadn’t been able to print more money to try and stimulate our economy, the United States would have crashed and burned so hard that we would still remain in a recession.  

There is always a need to reevaluate situations and adjust to the surrounding environment.  Sometimes this occurs at huge costs, but as long as the benefits are higher, especially for the long run, we must be willing to sacrifice for the greater good of the country.       

Reference:

1. Greenhut, Steven. “If Stockton is Broke, Then Why Isn’t San Diego?” Bloomberg. http://www.bloomberg.com/news/2012-03-02/if-stockton-is-broke-then-why-isn-t-san-diego-steven-greenhut.html

More on Education, Krugman's Logic

Here is a further pursuit on the effects of policy on the US education system.  Paul Krugman wrote a piece about the current state of our education system, and Krugman specifically targets the right wing for impeding on the growth of youthful minds.  The whole argument surrounds religion, and how colleges in the south have even parted away from certain majors that may contest what the bible has stated.

This question really sparks what I believe is a greater problem beyond the point of hindering human capital in America.  The standards that have been set by each party is something that I have had a problem with. 

Especially in the recent election, the GOP has reached out to focus on social hot button topics that ultimately ruin the opportunity for the fiscal policy to be implemented.  The economy should come first in the government system with the struggles of current times.

Another point to note is the final argument in Krugman’s piece.  If colleges are taking away certain majors in science departments, we are seriously crippling diversity in college education.  As of today, science majors have some of the highest growth potential, with innovation continuously occurring in the fields of science. 

The consequences of fewer schools offering science courses could cause a heavier flow of other majors to become impacted, including business and economics majors (two of the higher impacted majors already). 

My opinion is that it is likely that students going to colleges that aren’t offering these majors are schools with religious backgrounds.  Because of this, students aren’t going to be likely to partake in the same beliefs, hence little effect to the development in major diversification.  Even though it may not be the best for human capital growth in America, everyone should have a choice in what they want to pursue as a career.  In this case, Professor Krugman may be overlooking this matter, and should respect people’s decisions to follow their beliefs in their careers. 

Reference:

1. Krugman, Paul. “Ignorance is Strength”. NY Times. http://www.nytimes.com/2012/03/09/opinion/krugman-ignorance-is-strength.html

The Retail Numbers Should Be Marching

As we see growth in the US job market, we can only hope that we begin to see growth in the retail market as well.  Reuters reports that currently, the United States economy hasn’t quite built up to the proper level of retail sales since the growth of the economy has started to climb back over the past months.  Stella Dawson insists that because retail is responsible for 2/3 of the economic activity in the US, the stability of the economy will eventually rely on consumers continuing to buy products. 

Dawson points out that not only has the job market improved, but more people are starting to buy cars in 2012.  As historical data can explain, people choose to save more during tougher times.  In the past few months, more Americans are feeling confident with the state of the economy.  In the next few months, it would be safe to bet that people are going to continue to trust more in the economy.

The Personal Savings Rate in the United States shows that people are saving less of their money as the US has started to climb out of the Great Recession.  Hopefully this is a sign that the tougher times are behind us.

The growth in the United States economy has come at a time when most of the other major countries are struggling.  China has forecasted slower growth in the GDP.  Europe is still dealing with the constant threat of default by Greece.  But among all of this, the US still has a chance to benefit and bounce back. 

Dawson, Stella. “US Retail Therapy Needed”. Reuters. http://www.reuters.com/article/2012/03/11/us-economy-global-weekahead-idUSBRE82A0BT20120311

“Personal Savings Rate”. FRED. http://research.stlouisfed.org/fred2/series/PSAVERT

Tuition in America

The goal of higher education has a simple goal: educate those who want to learn, and allowing them to further improve their chances at obtaining a high income position.  However, universities have started to feel pressure to be the best university in order to create the best opportunities for their students.  Robert Frank writes about the consequences of this competitiveness, which has ultimately led to universities hiking up the price of tuition. 

The logic behind tuition raises still remains questionable.  Why would it make sense to raise monetary values of a college education and push out potential highly capable students who may not be able to afford the tuition? 

As I argued in a past entry, there is a problem with institutions raising prices to create any form of competitive edge or selectiveness.  Limiting human capital is the worst things a country can have occur.

In this case, the tuition raises are coming due to a perception by large corporations only considering students for employment from a select list of schools.  While this makes sense for convenience, the truth is that historical experience may support choosing candidates from these schools.  But Frank states the need to bump up the competitive level of these schools via tuition is unnecessary.

In my belief, there shouldn’t even be a high effect.  Coming from a school that is likely not in the highest tier of the chosen universities, the development in my human capital has grown similar to the state that I have seen from my former high school peers.  I reiterate that there is a benefit for corporations to target select schools for the convenience factor, but truly the corporations are likely missing out on maximum growth with their candidate selections. 

The situation goes back to the ability to efficiently skill match for positions around the United States.  I believe the first step to improving the matching process is to avoid limiting human capital.  Let’s hope that Frank’s message to the top tier universities stop the rising costs in tuition.

Reference:   

1. Frank, Robert. “The Prestige Chase is Raising College Costs”. NY Times. http://www.nytimes.com/2012/03/11/business/college-costs-are-rising-amid-a-prestige-chase.html?_r=1
2. King, Stephen. “Should We Break Up Our Universities”. CoRE Economics. http://economics.com.au/?p=8388

China Manufacturing Growing... Yet the GDP Slows

After writing quite a bit over the past few weeks about US manufacturing and the current boost of growth, I figured to see how our great rival of the eastern hemisphere was fairing in the same industry.  Bloomberg reported last week that China had received an increase in manufacturing for the third straight month.  This comes at the same exact time as US manufacturing has taken a sharp rise over the same time.

However, there is a problem that seems to be following both China and the US.  Both countries saw a decrease in growth in GDP this past quarter.  This could be a sign that the economy, at least for the US, is not quite at the level we have been expecting since quarter 3's promising numbers.  China is still growing at an 8.9% rate, far above the United States, but economists believe that the market is likely to slow down even further.  Economists predict the first quarter growth rate should be around 8.6% in China.

I predict that China is going to continue to grow throughout 2011, however, at a far slower rate than expected. With the rising wages in China, companies are always looking to find ways to save on wages and move to places with the technology capable of doing business at the lowest cost.  With these wages comes more growth in human capital, which China has needed to transcend past the agricultural and more rural development that harbored much of the GDP in the past.

What should be interesting is seeing  how China reacts to the lowered growth in GDP.  Like the United States, I don't believe that the manufacturing is going to play a huge role in the growth of the Chinese economy.  But they do send some shocks through the markets and offer consumers faith to invest in the market.  I don't believe that China and many of the eastern Asian countries have experienced the intense recession that the rest of the world has dealt with.  This may become a problem, as the closely woven global economy seems to leave no prisoners as nations begin to fall.

References:

1. "China Manufacturing Improves for 3rd Month". Bloomberg News.

MLB’s Playoff Expansion: Economically Good?

Last week, Major League Baseball agreed to add an additional wild card slot to both the American and National League, allowing for a total of 10 teams to compete in the playoffs for the World Series title. (ESPN)

What I was wondering is whether or not this move was a positive note for the league economically or not.  Or to further propose was enough change made to improve the league financially?

In 2010, Reuters reported that the MLB was making a record amount of revenue, surpassing $7 billion.  However, the fact was that attendance at games was down, and television viewship also took a toll.  The only reason revenues were up was the value that advertisement slots had on numerous companies.  Sports sponsorship and advertising is an art form in itself, but I want to focus on the longevity of the main variables in sports business success: attendance and viewship.

When we see decline in both attendance and viewship, this signals huge red flags for the league.  One of the big financial problems that other leagues, especially NASCAR, have had in the past is the lack of interest in the regular season.  NASCAR was forced to adapt a playoff series in order to gain younger viewers and attempt to rejuvenate a dying sport.  For the MLB, many concerns with younger fans are the numerous amounts of regular season games, followed by very few spots in the playoffs.  This turns away many people from the sport, and overall causes a lack of interest in the league. 

The majority of the viewship for the MLB comes during playoff times.  By increasing the number of teams, there is bound to be higher viewership if the right amount of games is adjusted.  I believe that majority of American’s utility curves towards playoff games, regardless of the sports, has a regular production curve, where diminishing returns are eventually reached.  The point where the MLB stands though, in my opinion, is very low on the utility level.  Therefore, I expect to see some growth, but far more potential growth, with the development of just two more teams in the playoffs.

At this point, the costs of including more teams in the playoffs are far below the potential benefits of more playoff teams.  Fans enjoy seeing their team winning.  With the viewship and attendance down in the MLB, it seems only logical to test the waters.  Furthermore, advertisement slots are most sold (and most expensive) during the playoff season.  By having more games, the probability that demand will still exceed the level of supply to keep prices high on advertisement slots.  I am interested to see what the MLB will plan to due in the next five years, as I see so much potential for a sport that has lost the place of America’s sport in the past decade.

References:

1. Klayman, Ben. “Analysis: No Perfect Game but MLB to Post Record Revenue”. Reuters. http://www.reuters.com/article/2010/10/25/us-baseball-economics-idUSTRE69O4GQ20101025 
2. “MLB, Union Agree to Expand Playoffs”. ESPN. http://espn.go.com/mlb/story/_/id/7638357/mlb-expand-playoffs-two-teams-10

More on Income Inequality

Earlier this year, I discussed the origins of the terminology of the “1%” and the “Occupy” movement described by Joseph Stiglitz.  Stiglitz has once again reaffirmed when speaking at Ramapo College, reported by North Jersey, about the income inequality in America.

Stiglitz talks about what makes income inequality such a mess for the United States.  Because of the separation, the amount of economic growth is hindered, and ultimately has led to recessions in American history.

“When we have a lot of inequality, demand goes down. … All this inequality was offset by creating a bubble. The bubble allowed people to consume more. Now we have the inequality but we don't have a bubble, and that means that we will have persistent, weak demand, and therefore unless we create another bubble it's going to be very difficult for us to get back to full employment.” -Economist Joseph Stiglitz

So this leaves us at our current standing.  The market looks to be growing, but as long as we continue to stand at a level of inequality in wealth, how far will we be able to hold growth?

Further points are made by Stiglitz that the problem with income inequality doesn’t revolve simply around the need to literally redistributing money to the poor, but more so the ability to create economic growth in the United States.  This includes building on education, infrastructure, and technology that will ultimately benefit growth in human capital.      

In my behavioral economics course, we have discussed the valuation of risk, and what the overall utility effect will have on society.  When looking at the situation theoretically, we can determine that there are two kinds of people: those who thrive off the benefits of wage gain, and those who further fear the loss of wages.  For each scenario, there are benefits that can be gained by society when determining what people would prefer. 

 Figure A

Figure A shows the benefits that a person who values higher wages gains over the risk of lower wages (a typical 1% mindset).  We can see that the overall benefit, or utility, of receiving an equal pay raise compared to pay reduction.  The raise in wage offers higher utility and outweighs the risk of receiving an equal pay cut.  In this scenario, If we were to assume society taxed the people to average the initial wage, the person with this preference curve would consider themselves worse off.    

 Figure B

On the other hand, figure B shows the other spectrum.  As one can see, the person typified for this curve is more risk adverse, and realizes a larger drop in utility from the initial price, showing the value placed on the initial price.  This preference would benefit from the averaging of the wages of the initial price, as the growth of more wages, as a whole, would not benefit enough to see a large change in preference.

Now how does this relate with Stiglitz’s arguments?  Well, we can likely assume that majority of the people in America take harder hits from wage cuts of the same value of a raise (based off assumptions that the 99% stand for).  With the ability to balance out the income distribution, we can potentially see higher utility for a higher quantity of Americans. 

While this may be a bit of a stretch, trying to connect the problems with income inequality can further benefit the potential that the United States economy can hold.  Perhaps extending the term wages, to amount spend towards human capital per capita, would be more sufficient.  This variable may then hold Stiglitz’s points on redistributing in order to stimulate the economy, and avoid the dreaded bubble that we have fallen victim to in the past.

References:

1. Tangel, Andrew. “Famed Economist: Income Inequality Bad for Economy”. North Jersey. http://www.northjersey.com/news/141149483_Economist_says_wealth_gap_is_bad_for_growth.html

Bond Ratings Continue to Plummet in Greece

Even with the cooling of the flames in the EU and the agreement to establish austerity in Greece, the bond rating indices don’t seem to fully compromise with the plan.  News last Friday reports the drop in the Moody rating, going from “C” to “Ca”.  This comes only a week after S&P dropped Greece’s rating to what they call “selective default”.  Both of these rating companies agree that they believe there will be further problems to pursue Greece, even with approximately 70% of the bonds due to be forgone.  

Through this whole debacle, the question that everyone seems to want to know is when the EU is willing to let go and let Greece default.  As we have discussed in my economic forecasting course, the avoidance of Greece’s default may just be a way to avoid a total collapse of the European and global economy.  By holding off and making sure investors see what is going to happen, there will be more control in the spending within the individual countries surrounding Greece.  

Another article brought to the attention of BBC News is the thought of leaving the EU and being able to control their currency.  The first point that is made is the devaluation of the currency itself.  The biggest problem with Greece has been its inability to control the value of its currency.  When the currency is pinned to the standard in all of the Eurozone, whenever problems occur in the country, the easiest way besides devaluation would involve cutting wages, part of austerity.  Unfortunately, people aren’t too keen on that idea.  At this point in Greece’s economy, there is truly no other choice but cutting wages and government spending.

The article continues to explain the process of creating a new currency.  When announced, there would be a grace period in which the currency would have to be produced and put into the system in an orderly fashion.  The process may end up catastrophic.  I believe by what we have seen already, with riots over austerity, the citizens of Greece won’t be pleased by having new currency that will likely be worth less and less the minute they get their hands on the currency.   However, what other choice will Greece have?  The enormous amount of pressure that has built up over the past few years could very well be nearing an end, and unfortunately, I can’t imagine the situation ending well.

References:

1. Bowlby, Chris. “What if Greece had to Get a New Currency?”. BBC News. http://www.bbc.co.uk/news/business-16981897 
2. “Credit Ratings: How Fitch, Moody’s and S&P Rate Each Country”. The Guardian. http://www.guardian.co.uk/news/datablog/2010/apr/30/credit-ratings-country-fitch-moodys-standard 
3. “Moody’s Warns of Greece Default Despite Debt Deal”. BBC News. http://www.bbc.co.uk/news/business-17238523

The Times Brought Back for Uncle Sam

 The American economy is on the rise, but a question that has loomed is how long can we hold onto this success?  Well, one way we can attempt to find these answers is to look at the damage that has already occurred to our economy (and others).  The Economist reported on data and created the Proust Index, a measurement that factor in real wages and unemployment, financial asset and property prices, and household wealth.  The Proust Index shows how much time has been lost in economic growth, and the results were not good.  America holds the third worst position, facing 10 years of lost time.  In the stock market itself, the S&P 500 hasn’t seen the levels currently since 2008, and the growth on average since the 1990’s is minimal.  The article states that Greek stocks were actually worth more in 1992 than today.  Yikes.

The data provided by the Economist show that the value in people’s houses would be equivalent to those in 2001.  With these numbers, what hope do we have to believe that we are truly climbing out of the Great Recession?

One perk can be seen in the growth rate the stock market has experienced over the past year.  In the past, there have been some devastating hits to American and other stock markets.  The Economist has provided a graph to show the amount of time until recovery for 3 recessions, including our current predicament.     

As one may be able to see, stocks are looking better than previous scenarios; however, this comparison shows that we may not necessarily be out of the woods quite yet.  The market is quite unpredictable, and the trends in the past show that even though there were promising climbs at points in recovery, the effect of the business cycle (or attempts to prevent lowered growth) may push the stock market down into a longer period of recovery.

                                                                                                                                               

I believe that America has a lot of things going for it right now; however, I still find a lack of stability in the long run for our country.  While we may be able to reach the peak from 2007 in the S&P 500, we may find ourselves quickly dip down soon after.  When recessions hit countries, the amount of damage economic growth becomes a number that is nearly impossible to catch up to, and truly paints an image of the economy turning back the clocks to redo the mistakes made along the way.

Reference:

“The Proust Index”. The Economist. http://www.economist.com/node/21548255