Economics and charity

Jane Galt has an excellent post today about charity and the government. I worked for an anti-hunger non-profit in DC (Share Our Strength) and one of the things they were great at was encouraging people to give their time, not just their money, one of the things Jane discusses in her post.

Onto the economics. Questions of "should charity be provided by the government or individuals" aside, you can ask whether charitable contributions should be tax deductible. Classical economics would be pretty comfortable with that because of the externalities in charity -- for not only does your charitable contribution do you good (because it makes you feel better), it presumably also helps the person receiving the contribution. But since you don't really feel the "happiness" experienced by the recipient, you end up not giving enough. A tax deduction lowers the price of charitable giving and thus increases its quantity, getting us closer to the appropriate amount. (The trade off is higher marginal taxes which slow economic growth and reduce wealth overall).

Not feeling the "happiness" experienced by the charity's recipients also makes us end up giving to sub-optimal causes, and so reduces the quality of charitable giving. Since we don't know how effective a non-profit is at using the money, we may not support the most productive ones, and we may also give to things we feel are important to us, but may not be that valuable to the poor recipient.

Chicago's Judge Posner argues that nonprofits' operating constraints (which, among other things, cap salaries and expenses as a proportion of revenue) are designed to tackle some of the quality problems. By limiting the organization's ability to make profits and limiting salaries, it will be forced to maximize output, which is the least worst we can hope for since it's much easier to track how much "good" a charity is doing than how "good" that "good" is. And if you go to your average non-profit, you'd see lots of stats measuring outputs, but very little measuring "outcomes".

This focus on output over outcome creates its own wacky pathologies that are really really hard to fix (I've worked in this field, take my word for it). Giving allocation control to those who use the services, by giving poor people cash, may improve their wellbeing, but it reduces their incentive to work, and society is uncomfortable with that type of unrestricted redistribution (except where taxes are involved). Anyway, go read Jane's post, where she discusses exactly these issues at greater length.

Coase and Lighthouses

I read a series of lectures Coase wrote in the 50s and was struck by how lucid and insightful his thinking was. I've been reading D-Squared Digest (Daniel Davies) for a few months and while some of it is quite fun, it's not Coase (no offense intended). Imagine my surprise when I see " Score: Daniel Davies, 393; Ronald Coase, 0" on J Brad DeLong's site.

It turns out to center on an argument between Coase and Samuelson on lighthouses. Samuelson posited that lighthouses are a "public good" in that, since it is very hard to charge for the services lighthouses render, there will be no lighthouses unless the government steps in and provides them. Coase looked at the history books and found that there were lighthouses before the government stepped in to provide them (1836), and they were paid by charging ships when they came into port (so much so for "public goods" then). D-Squared Digest then looks at the history books more closely, and notes that Henry III created a a Royal Patent dated 1261, where some private individuals can collect "light duties" from shipping to pay for the upkeep of a light house. He goes on to argue that this sort of "mandatory duty" does not jibe well with the free-market / free-participant negotiations Coase implied sorted out the lighthouse problem long before the government got involved. OK.

D-Squared Digest generally paints a false caricature of Chicago style economics, and this most recent post is no different. While Daniel claims a "mandatory duty" does not seem like a typical free-market, to me it sounds like backward integration by consumers to set up a two-part tariff regime to provide a necessary service where a more classical free market is not possible.

Here's what I mean. When you have a good with a marginal cost of zero (like light from a lighthouse, or an mp3) you face the problem of covering your upfront, fixed costs (like building a lighthouse, or recording a song for the first time). This is a very tricky area, and no solution works very well, but one common system is the "two part tariff" where a consumer pays some upfront cost to "enter" the market, and then pays the marginal cost after that. The upfront "entrance fee" covers fixed costs, while the marginal price after that covers marginal costs. In the lighthouse example, ships had to pay an upfront fee (in the form of a port tax) to sail around, where they consumed light from lighthouses for their marginal cost (zero).

To me this seems to fit perfectly well within the neo-classical economics systems. Chicago school economics is not against government regulation per se, it just feels that governments should support markets and let individuals sort it out from there, and that governments should not engage in social engineering. In the lighthouse example, private parties (the sailors) needed a two-part tariff system to create a market for a good they needed but would not otherwise be provided (lighthouses). They contracted with other private parties (ports) to arrange this, and the government supplied the legal infrastructure needed to support that market (making paying the tax mandatory).

Samuelson's public good argument had the entire population paying taxes to support lighthouses only used by sailors (which seems strange) and after 1836, the government itself started to operate lighthouses (which seems even stranger since private individuals were already doing that just fine). And perhaps most bizarrely, Daniel notes "...there are numerous accounts of "rent-seeking" behavior in lighthouses, whereby lighthouse entrepreneurs with good political connections sought to build unnecessary lighthouses in anticipation of the stream of light duties they would be allowed to extract" as if this refutes the neo-classical interpretation of what would happen in the market and seems to deny that exactly the same sort of rent-seeking would go on if the government ran lighthouses itself. Note how, in the US, states lobby for all kinds of unnecessary pork-barrel public works projects that seek only to transfer wealth from other states to their own.

I'll will also note that in 1995 in Britain, there were 56 automated lighthouses, 11 staffed lighthouses, 10 automated lightvessels, 2 automated lightfloats, 2 large automatic navigation buoys (lanbys), 414 buoys (of which 94 were unlit), 26 beacons, 62 radar or radio beacons, and 11 Decca Navigator stations. All in an age where a GPS system costs about $100. I'm not saying there would be more or less of these things if the government was not in the business of lighthouse provision and therefore had a bureaucracy invested in lighthouses, I'm just sayin'.

Merry Christmas!

Merry Christmas and Happy Holidays to all winterspeak readers!

Will Microsoft buy Macromedia?

When I worked at Creative Good, Flash (and by extension, Macromedia) had a terrible name. Flash animations were only seen on websites, and they inevitably made those websites more irritating and difficult to use. Sean Martin (of IBM) pointed out to me a few months ago that Flash is actually a serious attempt to offer easy and rapid application development that extends across the client and server for novice "script" coders. I've written on this site many times about how easy to use Microsoft's old VB IDEs were, and how (with .NET) they've now isolated a lot of that community. Integrating Flash within Microsoft's product suite would be a way to offer web services to novice "script" coders.

Why the US runs a surplus even when it's in deficit

The newspapers are full of people warning that the US government, which used to run a surplus, is now plunging into deficit and that will lead the country to ruin. This is wrong.

Over time, the tax receipts a government takes in has to equal its expenditure out plus all outstanding debt.

Tax in over time = Expenditure over time + Outstanding debt

But government accounting includes interest payments on outstanding debt as an expenditure, when it isn't. That means that all the interest on debt that the US government pays (which is quite a lot) should not be counted as an expenditure in real economic terms, even though it is in accounting terms. Once you add back interest payments, taxes in once again become larger than expenditures out, and the government in back in surplus.

Those of you who are still awake are angry because this seems to make no sense -- how can making interest payments not count as an expense? Think about it this way: if you loaned me $100 at 10% interest rate for 2 years, I'd pay you $10 in year 1, $10 in year 2, and your $100 in principal back in year 2 also. If you loaned me $100 at 10% interest rate for 10 years, then I'd pay you $10 every year for 10 years, and include a $100 payment in year 10 on top of everything. All else equal, if you were willing to loan me $100 at 10% for two years and ten years, then why not loan it to me for 1,000,000 years? I'd pay you $10 every year, and in year 1,000,000 I'd pay the $100 back. But $100 1,000,000 years from now is worth about 0, so why don't I never pay the principal back and just pay you $10/year.

The point is that making interest payments on debt is the same as paying down the debt. So long as your ability to make interest payments is never called into question, then you don't actually need to reduce the debt to 0, you can just carry it infinitely. In fact, there is no different between carrying the debt and paying interest on it infinitely, and not having the debt at all. The opportunity cost of not having the debt precisely equals the interest you're not paying on it.

True deficit spending is when expenditures out (excluding interest payments on debt) > taxes in, which increases outstanding debt. The US has gone through periods like this, but it was in surplus for quite some time before the surplus "officially" began and is in surplus still, even though in accounting terms it is now running a deficit.

What is cost?

It's useful to contrast this nostalgic piece on rural America with this article concerning water rights in California. Essentially, the subsidized farmers in the Imperial Valley pay $15.50 per acre-foot for water, while nearby San Diego pays $258 an acre-foot. So, what is the real cost of water to Imperial Valley farmers?

"Cost" is not about money, it's about what you have to give up to get something else, and money is merely a medium of exchange. One way to think about rich people is that "they have a lot of money", and another way to think about it is "everything, to them, is cheap" because they don't have to give up much to get stuff. This means the "subsidized" Imperial Valley farmers actually pay $258 per acre-foot for their water because this is the amount of money they have to give up by not selling their water to San Diego for that price. That's a healthy chunk of change, and I don't think most Imperial Valley farmers value water that much.

Which brings us back to the nostalgia piece. If the value of something you own goes up, then so does the cost of you using that thing (because you bear the opportunity cost of not selling it to someone else). And if you don't use that resource in the most productive way, then you bear the costs of that inefficiency too. That's not to say the cost may not be worth it, but let's be honest about the cost being there. The only folks who can make a cost/benefit trade-off are those who enjoy all the benefits and bear all the costs. Nostalgics, like tourists, do not fit in this category and so are unreliable guides to "what is best"--their sense of "what makes me feel most good" is too short and narrow to make a useful proxy.

But that's not to say that nostalgia isn't a powerful force, nor does it mean there is not real disruption when reality changes prices and makes something that used to be cheap (rural American land) very expensive. Personally, I would prefer to see disenfranchised groups be paid off because it seems more humane than charging them $258 per acre-foot for "free" water. But there seems to be something deep about human psychology that makes economics (which is really pretty simple) often so counter-intuitive and emotionally distasteful. (link via Arnold Kling)

Oracle, Sun, IBM, and Eclipse

Eclipse is IBM's open source IDE for Java. There are very clear and obvious reasons while it's called "Eclipse", so it's funny to see Sun using Oracle to try and reign it in.

Lessig & Epstein

This FT piece has Lessig & Epstein commenting on the whether or not open access provisions should apply to broadban providers. My sympathies are broadly with Epstein. Essentially, as I've documented many times before on this site, broadband internet access makes you choose between two of the following three: a) competition at the service level, b) competition at the infrastructure level, or c) investment in new infrastructure.

The Telecom Act of '96 required incumbent telco's to offer entrants access to their equipment (unbundled network elements, UNE) at marginal cost, which reduced investment in new infrastructure and forced telcos to offer special online services (which Lessig derides in his piece as being dangerous and discriminatory). If new legislation forced common carrier provisions on broadband service providers AND kept the UNE requirement, then incumbents would stop upgrading their facilities because they would have no incentive to do so.

Lessig, like many others, fears that incumbents will censor parts of the internet and charge high prices, but as Epstein argues, they have no incentive to do so as restricting access will merely reduce the value of the service to customer and so reduce their profits. As things stand now, the legislation is a subsidy to entrant telco providers (who do not invest in plant) and content industries. If people have examples of swathes of the Internet broadband providers are cutting of for profiteering reasons, I'd like to hear about them.

Step 3:

This is so nice. I just licensed winterspeak under the Creative Commons Attribution-NonCommercial-ShareAlike License 1.0. If you think that's a mouthful, read the text here.

Why is this important? After all, I was perfectly willing to spend my time writing all this stuff for free long before Lessig & Co. came up with this Creative Commons license, and it's the oodles of free online content that gives paid content providers the willies. What's important is that my site is machine readable, meaning it can be read by news aggregators like the excellent Net NewsWire Lite AND the Creative Commons license is also machine readable, meaning it too can be read by news aggregators. This means that any content that gets locked up by it's owner will be excluded from distribution (which is kind of the point) while open content will go forth and multiply (and conquer).

Update to "CD Price fixing"

Larry Staton writes in pointing out that the CD price fixing case I wrote about recently was settled -- there was no judgement. He is correct. I meant to say that I do not think the RIAA harmed the public through retail price maintenance since this practice can be efficient.

File trading's effect on price and quantity

A while ago I wrote how file trading effects the music industry will depend on what it does to the demand curve. Prices and quantities could go up or down. This lengthy paper (.pdf) looks at things in more details and concludes (tentatively) that file trading will reduce CD consumption by 20%-30% per capital (3.5 CDs/person/year). He also notes that quantity is falling while price is staying constant. This other post catalogs how investment in new music is falling (and erroneously says that is why sales fell--the opposite is almost certainly true) and that prices are rising slightly. So, coming back to the original post, the data suggests that file trading 1) makes the demand curve slightly more inelastic because more elastic customers are switching to mp3s and 2) record companies are responding by investing less in new bands. [Links via susupply and The Register.]

I, Cringely, has a fairly inane piece that begins well (make money off concerts) but then goes off the deep-end, suggesting record labels become VCs ("after all, they're both hit driven businesses"). Venture capitalists don't put money in risky ventures for fun, they do it because they can get profits out of it. File trading shifts profits to consumers, reducing a financier's incentive to back musicians. It may or may not reduce musicians' incentives to play, given that the chances of making any money in that business are about zero anyway.

CD Price fixing

A while ago, the RIAA was sued for conspiring with retailers to keep the prices of CDs high. The suit centered around "minimum advertised prices" where the distributors (RIAA) would pay for retailers' advertising in local media, provided the retailers did not advertise CD's at a sale price below a minimum established by the distributor. This has been settled in favor of consumers.

Long time readers of this site will know how I feel about the content cartel, but in this case I do not feel the judgement was correct (I've taken the opposite position here and here but I think I was wrong before). Collusion amongst horizontal market participants (i.e. they are all in the same industry and do the same thing) is pretty straightforward -- coordinating action lets you restrict quantity, raise price, and earn monopoly rent. But it's tempting to cheat, and since you cannot contract to enforce the cartel, your best bet is to get Congress to pass legislation that does, usually through some "just and reasonable" non-discrimination clause. (Telecom and media regulation is rife with this sort of thing.)

Collusion amongst vertical market participants (i.e. one is a wholesaler who sells to the other, who is a retailer) is a different matter altogether. Since the wholesaler can perfectly control the wholesale price, why bother the retailer with some minimum price requirement (as the RIAA did under their "minimum advertised price" regime)? After all, if I want you to sell CDs for at least $15, why don't I simply charge you $15 for them?

The answer is that wholesalers think they would be best served if the retailers invested in selling the product also. In the CD example, this could include things like 1) stocking a wide selection of music (not just the hits), 2) keeping a clean store, 3) hiring knowledgeable salespeople, 4) investing in listening booths etc. By setting a minimum retail price above the wholesale price, the RIAA has restricted record stores' ability to compete by discounting, meaning they have to compete on service instead. And being good, greedy capitalists, they've figured out that they can sell more stuff through better service than through lower price (this is not always true -- sometimes low price is the way to go). This type of thing also happens in the electronics business, where high-end audio is offered under a minimum retail price so customers can't go to one store, learn all about the system, and then buy it from a discounter.

Hollywood vs the Future

This article (rather foolishly) declares the content wars drawing to a close because a technology company called SmartRight has agreed to provide technology that provides total end-to-end encryption for copyright technology, regional encoding, digital watermarks, and every other content control gizmo Hollywood could want. The key to all of this is whether people can put up open content if they want, and if they can (which I believe surely will happen) then every constraint Hollywood puts on its stuff is just one more reason to avoid it. And that's just fine by me.

I'm organizing a panel at the U Chicago GSB technology conference on DRM, and I want panelists to explore how DRM media will compete and cooperate with open media.

Being set straight

My old college buddy (and crack programmer) SS comments on my IBM, Microsoft, and Rational musings:

I think your last blog entry misses on a technical point- "But why does Microsoft, which already makes such great dev tools, want to buy Rational?". Their dev tools have little overlap besides source control.

The Visual Studio environment, for VB, C++, and now C#, is basically the best integrated development environment (IDE) out there. Rational has a number of products, but no IDE. Rational's major product is ClearCase, basically a source control tool, and is the premier tool on the market. MSFT's primary source control tool, SourceSafe, sucks ass. I think they bought some other company that does source control a few years ago but I know nothing about that product. Besides that, Rational makes profiling, analysis, and UML design tools that MSFT does not have, to my knowledge. So I see a potential Rational acquisition by MSFT as fairly complementary in terms of technology, price considerations aside.

So now I know better from the technical side, but I'm still flummoxed on the business side. Given that IBM already has a bid in, Microsoft will have to pay a very steep price premium to buy Rational. Their software, while complementary, seems to be the type of thing that Microsoft should be able to do quite well, so I still don't understand why MSFT thinks it's worthwhile to shell out all that dough.

And while I'm being set straight, Joel Spolsky (always worth reading) says it's vacuous to over generalize and say things like MSFT is bad at operating systems. My point was that I think Microsoft's applications are so good I wish they would ship them on cheaper OSes (Linux) so more people would buy them instead of shelling out for the overpriced bloatware most enterprise software vendors are choosing to ship. While Apple folks (and I am one of them) like to criticize Microsoft for making hard-to-use software, I encourage them to use Lotus Notes before moaning about Outlook. I think Microsoft's OS obsession is now keeping them from delivering the best apps they can deliver, and we're all poorer for that.

IBM, Microsoft, and Rational

This report on Microsoft attempting to buy out Rational (which IBM announced it was going to buy a few days ago) is really weird.

"I just don't believe the medium-term competitive risk to Microsoft would justify some sort of huge premium here" if Microsoft were to attempt a competing bid, Sanford C. Bernstein analyst Charles Di Bona told Reuters.

I knew folks at Sanford C, and it's a level headed, smart shop, so Di Bona is probably on the money.

Some background; Microsoft makes great developer tools, and IBM makes lousy developer tools. VB is as easy to use because Microsoft worked really really hard to making it easy to use (note to Apple loyalists -- don't moan about MSFT usability until you've tried some pre-MSFT usability). IBM is a typical techno-snob and believes that if someone can't develop (or install) a platform, they're probably too dumb to have that platform in the first place. When I was at IBM over the summer, my very smart fellow interns all moaned and whined about how hard the IBM kit was to install. IBM's response? "Why are you moaning if it takes you five hours to install? It used to take five days!" *Sigh* MSFT stuff installs in five minutes.

The good news is that IBM is very serious about the software space and realizes it needs developers and good developer tools. That's why it bought Rational. IBM only has four software "brands"--Tivoli, Lotus, WebSphere, and DB2--Rational was slated to be the fifth and this is a very big deal for the company.

But why does Microsoft, which already makes such great dev tools, want to buy Rational? The only reason I can think of is to keep it out of IBM's grubby paws. This, to be blunt, is nutso. The Web standards war between .NET and J2EE is very real and very central to the competition between MSFT and IBM, but thinking you can buy your away out of it reveals an organization with lots of cash and little business sense. Office and Windows makes about 120% of Microsoft's profits, every other division loses money, and they don't seem to care. Even if XBox is viable some day, Microsoft will have spent so much money on it that the investment will have negative economic profit overall. The amount of short term advantage Microsoft may get by keeping Rational out of IBM's hands is not worth the price it has to pay for it. It seems as if Microsoft is using its monopoly money to maintain its monopoly, an example of wasteful rent seeking and a complete waste of time from a shareholder or business perspective. It also suggests that Microsoft has no ideas for how to actually grow its business.

MSFT apps on Linux

The Meta Group speculates that Microsoft will ship apps on GNU/Linux (server side) within two years. I've been arguing that Microsoft's applications are much better than their operating systems, and the only thing keeping them from being a force in the enterprise market is their insistence on tying applications to .NET server instead of on Linux. I also predict that MSFT will relinquish their OS addition when Apple starts licensing OS X to third party OEMs.

Spitzer v U Chicago

I suppose it's kind of a backhanded complement that Eliot Spitzer blames U Chicago for high priced drugs, corporate scandals, and dishonest banks.

Paul O'Neill is out

So O'Neill's been booted from the government. Good riddance -- from what I saw of him at U Chicago, he understood nothing about economics or the economy. But I have no confidence that his replacement will be any good, or have any influence.

Krugman on Krack

I was chatting with some U Chicago law school professors last year when it dawned on me that they really didn't understand economics very well. I checked with the Ec. Faculty across the Midway at the U Chicago Econ dept, and it turned out I was right. I get the same feeling when I read Krugman's NYTimes columns these days. His Slate pieces were very good, and his old (MIT) website was filled with thoughtful notes jam-packed with Economic goodness.

No more. View today's screed against broadband access in general, and FCC chair Michael Powell in particular. Krugman hails the Telecom Act of 96 as a wonderful piece of legislation thwarted by incumbents to block entrant competition. While I am under no illusions about the greed of the incumbent telco industry, I am also under no illusion about the greed of entrant telco companies. Under TA96, entrants gained access to incumbent's pipes at marginal cost, which understandably halted all (incumbent) investment in new equipment, keeping costs higher and contributing (in part) to the current telco meltdown. Of course, nothing stopped entrants for investing in their own new, equipment, but somehow these paragons of virtue declined. I've covered this story here and here.

Krugman then claims that telco providers will both 1) jack up broadband prices to maximize profits AND 2) restrict access to large sections of the Internet. These two things are inherently contradictory as cutting of large sections of the Internet will lower the value of access, and so reduce telco profits. But Krugman believes that these guys are some opaque combination of evil and stupid which limits their greed, harming both their profits and the public good at the same time. I, on the other hand, beleive they are merely average in their intelligence, but limitless in the greed, so consumers are quite safe in their hands.

He finished with the old trope of "media consolidation is dangerous", which I agree with from the standpoint of the content industry, but not as a consumer. I've dealt with that here. I should add that the only arena I think media consolidation might be dangerous is the political one where a locale may only be exposed to partisan news from one side (politicians agree with me here). But given other popular concerns (no one votes, people only read stuff that they agree with, no one cares about political debate) I think even the most hysterical of alarmists would agree that the damage is likely to be limited in scope.

My Krugman related point is that there are good economic arguments about why these laymen concerns really have no basis. There might be important stuff that the economics misses, but on a profit maximizing basis none of the concerns listed in the article is likely to happen. As an economist, Krugman should either make or poke holes in the economic argument, not rehash what non-economists have already asserted about the issue.

More economic wrongness

Jane Galt quotes Musil, incorrectly asserting how IP in the public domain too can get "overgrazed". Answer -- someone can use it in a way that gives it negative connotations and so reduces its value. Urgh. Musil gives the example of a Cole Porter song that was parodied in the toilet cleaner add, and cites the harm done to the Cole Porter estate as a result. The argument is really tortured, because the song actually was under copyright and the Cole Porter estate (productive artists all) did not charge the toilet cleaner company enough to make up for subsequent loss of sales.

This to me seems like mismanagement by owners, not any kind of "overgrazing". (Note: The whole "overgrazing" idea comes from a story called "The Tragedy of the Commons". The economic lesson behind this has been so mangled by so many people that I refuse to ever refer to it again. Just be warned, if someone refers to something as being a "Tragedy of the Commons", 90% chance it's not.)

While you can build economic models where other people's preference builds into your own (Becker, again) saying this will neccessarily happen with public domain IP is dead wrong, because a bad externality is just as likely as a good externality, if not less so. One can certainly think of more examples of public domain material becoming more valuable because of subsequent innovation on top of it (every fairy tale any one of us can think of) than less so, and public domain goods stay available more thanks to distributed filesharing.

Usability matters

Businessweek has an article on how software usability leads to profits. If usability is starting to matter, it means 1) markets are getting more competitive and/or 2) products are moving towards newer, less tech savvy customer segments. Microsoft (before VB.NET) always understood how important it was to make their stuff easy for their customers (3rd party developers) to use.

CD prices and piracy

Fellow Chicago GSB grad Jane Galt has a piece arguing that piracy will increase CD prices because, if people are getting unauthorized copies for free, labels will have to charge a higher average price to make up their upfront fixed costs. I don't think this is quite right.

Firstly, labels only need worry about making up their upfront fixed costs before deciding to launch a new CD. Once a CD is out, all that upfront stuff is sunk and shouldn't factor into pricing decisions. And since labels have a great amount of discretion over what those upfront fixed costs are (ie how much to spend on promotion, packaging etc.) they can simply change what kind of CD they support and how they market it (lowering upfront investment) instead of raising price.

So how do we know whether they will lower upfront investment or raise price? The answer has to do with the elasticity of demand for CDs. Elasticity is one of those jargon terms that represents such a useful concept, you wish everyone knew about it. It simply means "how will people respond to a change in price?" If demand is inelastic, people won't change how much they buy if the price changes. If demand is elastic, people will buy lots more if the price falls, and lots less if the price rises.

We know labels have the power to set prices (unlike onion farmers) because CDs are priced considerably above marginal cost. How much above marginal costs depends on the elasticity of demand -- if demand is very elastic, then the price will be lower, if demand is very inelastic, that means price will be higher. Think about it this way, if someone's going to buy something no matter what, why not jack the price up on them? So a record label's price response to unauthorized copying depends on whether mp3s increase or decrease the elasticity of demand for CDs.

This is actually a tricky question. You could say that mp3s make demand more elastic, because now a CD needs to be really good otherwise I'll just substitute an mp3 for a CD (we might see this happen with albums that feature a single good song). This means labels should lower price. Or you could say mp3s make demand less elastic, because the only people left buying CDs will be those who *really* *really* value buying CDs and by definition, they respond less to changes in price. Examples of these folk could be older jazz and classical buyers, who don't like computers. In this case, labels should raise price. Or you could say that everyone substitutes equally from CDs to mp3s, meaning the elasticity is the same. In this case, price stays the same but labels will sell less, and make less money overall. Or you could argue that since mp3s promote CD purchases, file trading increases CD sales, meaning price stays the same but labels sell more, and make more money overall.

So which is it? (Or more realistically, which of the four possibilities is happening more?) According to the RIAA, between 2000 and 2001, quantities shipped dropped 10% and expenditure dropped 4% (meaning prices rose around 7%). This suggests that demand is becoming less elastic (price rises, quantity falls) but I haven't controlled the data for larger macroeconomic factors--so this isn't a firm conclusion.

iDrive a failure (and other pervasive thoughts)

I've been thinking a lot about pervasive computing recently, and it struck me that as computers appear in more and more everyday devices, they are entering market segments that have avoided computers to date, implying that these folks 1) don't think computers are all that useful and 2) have greater trouble learning how to use them. This means that pervasive technology is trying to get adopted by customers who have the lowest willingness to pay (because they see the smallest benefit) and highest cost (because training cost is part of the price too) of any technology buyer to date. Tough market to crack -- good customer experience will be key in driving adoption.

The Times has an article on how BMW's vaunted iDrive system is an utter failure -- it turns out that cramming 700 functions into a single joystick did not make anything easier to use. What a shock. But I'm sure the usability consultants on the project, Design Continuum will do better next time (watch out for the Flash animation on the way in). *Sigh*

And to bring the comments back to consumer segmentation, here's a Wired article musing about why Mac users are so fanatical. It talks about brands, cults, quality etc. etc., but I'd simply observe that everyone who doesn't care much switched to Windows, leaving just the most inelastic part of the demand curve behind.

Nice article from Cringely

Cringley documents how P2P filetrading will effect some media more than others. He thinks text will be the most effected, then music, and that movies will not change much. I agree -- consumers have already backward integrated into most text-based content--the web and my inbox are much more interesting to me than the largest library or book store. Mashups are the area of music where consumers have backward integrated into production (through becoming DJs), and it's hard to see what content owners can do about that. There isn't a good analog for film.

Phone+Camera

Generally, I'm skeptical about "converged" devices, but I think the mobile phone + camera combo is great. Not because I think such a gizmo would replace my Canon digital elph, but because sharing inanities with your friends is the killer telecommunications app. I'm looking forward to when Sprint offers cheap, integrated phone/cameras so I can replace my semi-functional Sanyo phone.

Happy Thanksgiving to US readers!

Wrapping up exec compensation

Many people have written in about executive compensation, insisting that CEOs are paid way too much and that CEO pay should be even more closely tied to performance. I point out that since CEOs (like almost all of us) are risk averse, tying their pay more closely to performance will result in even higher pay on average since they will have to be compensated for the extra risk.

For example, I would take a $100,000/year job over a job which would pay me $200,000 or $0 with equal probability. Force people to take on even more risk, they're going to hold out for a higher salary. So you can hold out for lower pay, or better incentives, but not both. As a shareholder, I vote for better incentives.

More on intergenerational transfer of wealth

I asked U Chicago labor economist Robert Topel about the recent (upward) revision to intergenerational transfer of wealth. He said that when Becker first thought about the problem he calculated it to be around 20%, which is actually surprisingly small. He argued that productivity clearly has inherited components to it, whether it be nature (intelligence genes) or nurture (family values include healthy work habits), and so you would expect earning potential to be as inheritable as other inheritable traits. The revised figure is closer to this. Moreover, you would expect this to be stable across income brackets and time because heritable traits are, well, heritable.

He also pointed out that intergenerational transfer of wealth does not answer the question people think it does, namely, "how mobile is the society?" The true test of that is how quickly does individual wealth react to some external shock. For example, does a prodigy with an IQ of 120 (I know, I know, IQ is a terrible measure of productivity, work with me here) born to very poor parents end up very poor? Or does a particularly dumb, lazy, obdurate, and feckless scion of the rich end up equally rich? I don't know the answer to that, but my anecdotal experience says "no." The US may be a lot of things, but it's certainly not a class based society.

I guess my point is that an immobile, class based society of privilege and an efficient, meritocratic society (where heritable traits influence productivity) can look exactly the same from an intergenerational transfer of wealth perspective.

Customer experience and DRM

I'm organizing the DRM panel at U Chicago GSB's upcoming High Tech Confernece. I inviited Don Norman to come and speak about user experience and DRM, but he declined saying he didn't know much about the subject. A pity. As Arnold Kling points out, Convenience is King, and customer pain adds to price as much as dollars and cents. One of the reasons that Napster never made unknown, garage bands famous was because there was no difference in price between a popular song and an obscure song, so the popular song always wins. I think that Arnold is right though, and there is so much legal involvement in these services that they cannot possibly serve actual customers.

Palladium, for all it's evils, promises to improve the experience of using DRM content. Since using non-DRM content on Microsoft systems is currently so horrible, I'm skeptical about how good a "good" DRM experience can me.

Microsoft's great innovation

Turns out that Microsoft is bundling a new application into Office called OneNote. It's integrated software designed for taking notes. Funny -- I call this a text editor, and have been using it as such for years. Sadly, this is also a great innovation for Microsoft.

Breakfast with Epstein

I (and a bunch of other folks) had breakfast with famed U Chicago Law prof. Richard Epstein today, discussing corporate governance. Epstein was dismissive of the new corporate governance laws coming out of Congress, predicting that they will merely raise the cost of doing business, make it harder to build boards, and reduce the likelihood that a private company will choose to go public (and, by extension, that private companies will be funded at all). He argues that these laws increase the risk of being on a board (since investigating potential trouble carries legal liability) and the required commensurate compensation will have to come out of shareholders pockets. Shareholders paying for better corporate governance sounds OK by me, but given the immense responsibility of independent directors, I'm skeptical of how independent they can remain. Moreover, Epstein discussed how board members are chosen for prestige, not competence, which will exacerbate the problems caused by these new requirements.

I'm not sure what the best way to tackle corporate governance problems are. Epstein left it at "enforce existing laws better".

More exec compensation

MH wrote in pointing out that simply subtracting CEO compensation ($6B) from market cap ($9.1T) is wrong -- one is a single year expense and the other is the cumulation of all future performance. Arnold Kling corrected my calculation by treating the $6B expense as a perpetuity, multiplying it by 25x (or 20x at a 5% discount rate) giving you a grand total of...$150B. More to be sure, but just 1.6% of total market cap.

Executive compensation

Although it has nothing to do with technology, I thought I'd post some numbers on executive compensation -- a hot topic these days. Executive compensation has risen between 1950 and now (although it was comparably high in the 30s when Ford was running Ford). According to Forbes, average CEO pay was $4M in 1996 and $7.5M in 2002 (it was 11% higher in 2001).

But to put this in perspective, total CEO pay in 1991 was $6B out of an organizational market capitalization of $9.1 trillian. That means that if all the CEOs decided to work for free forever, it would add just 0.006, or 60 points, to the Dow. To put it another way, if they were to work for free and all the money went to employees, the average employee salary would go up $54.

So, to say high executive pay is robbing shareholders or employees is wrong -- the transfer effects here are trivial.

Instead, let's look at how CEO pay effects their incentives. CEO's raise a classic agency problem, because a CEOs job is to manage the firm for the benefit of shareholders, not to indulge in ivory backscratchers. The thinking is that tying CEO compensation to firm performance reduces this agency problem and gets him to act in the shareholders' best interest. Moreover, since CEOs are risk averse and shareholderes are risk neutral, compensating them in options (which reward risk) aligns incentives even better. Most CEO compensation in the US (and to a lesser extent in the UK) comes from performance pay, of which options are a common component.

The best options isolate company performance from broader market performance. After all, why pay a guy if he does a lousy job but the market as a whole goes up, and why penalize him if he does everything right but the market tanks? If you look at how much CEO wealth depends on company performance vs. market performance, it turns out that things work out roughly correctly -- CEO wealth is more closely tied to how his firm does. But, compensation is more closely tied to broad measures of market performance (like the that S&P 500) than narrow measures (such as close competitors) -- which is the opposite to a good compensation scheme.

So, if you want to complain about CEO pay, it is not right to argue that shareholders or employees are getting a bad deal -- the effect on them is trivial. It is correct to complain that pliant boards don't index options to close competitors (which reveals a whole new agency problem between boards and shareholders). And it is right to say that stronger incentives also call for greater monitoring, as CEOs with lots of options have more reason to cook the books.

Pentium v. P4

A PC with a new 3 Ghz Pentium III is faster at video editing (and probably lots of other things) than a Mac with a 1.25 Ghz P4. While this may matter for all the video editors who live between QuickTime Pro and a clustered Lintel blade farm, most home consumers stopped caring how fast their computers were about 2 Ghz ago. This is because most important applications are now being written to the Internet Operating system, not Win32 API, nor MacOSX API, or anything else. And with Internet Operating system applications, what matters is not local processing ability, but bandwidth.

Becker and social capital

MR writes in pointing to this article in the New York Times (reg. required) arguing that parental success is (much) more important to a child's success than previously thought. Combine this with the Krugman's recent "the rich are too rich" op-ed, and it seems that the fabled "American dream"is a hoax.

In particular, MR writes

What I don't understand is why their is no mention of social privilege as a major factor (see excerpt below). In my experience, children of the rich have much greater access to capital as well as a greater chance to interact with influential business people because of their "connections," ie. because their family is part of the social elite.

Children of poor people trying to get a bank loan are like "nobodys" trying to get into a fashionable Hollywood party.

While children of the privileged have many advantages over children of the poor, access to capital is not one of them. If anything, capital markets are *much* more democratic now than they ever have been in the past. Innovations like junk bonds, angel investing, warrants, and venture capital means that money cares less about privilege than it ever did. In home ownership, a more prosaic form of capital, low interest loans and zero-downpayment mortgages mean that more low income individuals have access to home ownership than ever before.

If you look at return to capital over the past 30 years, it's stayed pretty constant at around 8%. This is what one expects of capital markets are competitive -- investors seeking higher returns drive down the value of high-return investments. The returns to human capital however have skyrocketed, particularly to education, which is also reasonable as productivity improvements made by investment in capital ends up going to labor through higher wages (returns to capital are constant).

But the article argues that education only explains 60% of the data. This means they've done a regression, and the coefficient infront of the "education" variable was 60%. This type of analysis is pretty inaccurate, so I'd be wary of trusting it. I don't know why intergenerational correlation in income seems so high, but it's not because only the rich have access to capital. Capital has, without a doubt, become more democratic than it ever was before.

Siebel v the world

I spoke with a couple of Siebel guys the other days about who their big competitor was. They are mostly worried about ERP vendors bundling CRM into their product, so see SAP, Oracle, and PeopleSoft as their big competitors. I argued it was Microsoft, since they will make easy applications that will be first class citizens on .NET and squeeze Siebel out, starting at the midmarket and moving upwards. While Siebel felt that .NET would become the enterprise standard, they did not think Microsoft was a threat because it only went after little businesses.

Outlook is used by everyone from individuals at home to people in big companies, even though it does just a fraction of what Lotus Notes does. Even people who value the extra stuff Notes can do are not willing to pay much for it, because they take Outlook as their reference product. Even if Siebel only targets big companies, there will be potential buyers on the margin who will compare Siebel's expensive application to Microsoft's cheap application and feel that, even if Siebel does more, is it really worth that extra price? A low end competitor reduces the high end incumbent's ability to price, even if the high end product is better.

Microsoft enters Enterprise IM

The Register has a piece on Microsoft entering the enterprise IM space next year. Oddly enough, the article mentions AOL and Yahoo! as potential competitors but does not note that Lotus is currently the dominant vendor in the market with SameTime. That says something about Lotus's visibility these days. I used the system when I was there and (to my surprise) really liked it. It turns out that the killer feature is "presence", the warm fuzzy feeling you get when the little green dot lets you know your friend is online. Who knew?

Chimera rocks

I've been using Opera 5 in Classic on my iBook because no OS X.x browser came close to its speed and responsiveness. But, being a classic app, it used to get bogged down under after a few days of use. Chimera 0.6 is fantastic though, it even renders blogger pro correctly. Nice.

Movielink is finally up

So the Hollywood consortium has finally put up an online movie site. It's terms: $2.99 - $4.99 for 24 hours worth of unlimited access within a 30 day period. That seems comparable to renting, but it does not include hassle costs -- the 17 minute estimated download time is way too optimistic. And I have no idea what the viewing experience is like. I don't like watching movies off my computer and I don't think that's going to change. I expect the quality to be poor.

Movielink is engaged in a law suit for collusion against independent VoD services. There is no economic benefit to the studios owning content and pipes, but it makes it easier for them to keep an eye on each other's pricing schemes. I don't know...I think VoD was solved by TiVo and Netflix.

Hollings out

After the midterm elections, Hollywood Handpuppet Fritz Hollings (Dem South Carolina) is out of the Senate Commerce Committee. Den Beste thinks this will make the world safe for PCs again, at least for two years. I hope he's right.

Murphy on Microsoft

Chicago economist Kevin Murphy commented briefly on CKK Microsoft ruling this morning. His take was that the Microsoft case was a hard one to decide, and remedies in particular were very difficult to work out to maximize social good. He also mentioned how the politicization of the Attorney General's office, how it's transformed into a "learn to be Governer" role, means that Attorney Generals are more interested in staying in the limelight that enforcing laws and defending the public interest, and this became an issue in DOJ v MSFT.

People who applaud the nine dissenting States who are considering appealing the CKK decision should bear in mind why they are doing it. Certainly, their alternative settlement proposal was ludicrously not in the public interest. This isn't to say that I think the current settlement is any good--I think it's terrible--but I don't view the politicization of the Attorney General's office as a good thing either.

"Blackpeopleloveus.com" update

A reader sent in an link unravelling the mystery humour site a friend pointed me to earlier.

Archipelago

I just deleted a number of trial posts to this weblog I made using Archipelago a client-side weblog editor. Right now, the only thing I use Internet Explorer for is writing to winterspeak.com, and I would like to no longer need to do that.

What was interesting was how my initial stupification with Archipelago matched by initial experience with Radio. Getting everything set up was confusing, and I had no idea what any of the menu commands did. I don't mean to pick on either program's authors-- creating good software is hard, especially in a new design area where there aren't many norms.

Both Archipelago and Radio cross the divide between client and server. This is similar to the Lotus software I worked with at IBM over the summer. Simple menu commands like "save" and "new" are confusing in this new context. Is "save"ing something on my desktop the same as "post"ing something on Blogger? Or is the same as "publish"ing something on Blogger? Or is it the same as "save"ing something in Word, with a seperate "publish" coming later to get it all on the site. And given the agony of synchronization (a daily struggle at Lotus) how can you seperate/integrate data between client/server so the user doesn't go home and freak out because all his email has vanished (easy to do on IMAP if you haven't set things up correctly).

People moan about web interfaces all the time, but web apps are often *much* easier to use than their desktop counterparts. It's easy to forget how bad things were before, just as it's easy to forget how good Microsoft software is compared to what it has replaced (check out SmartSuite if you don't beleive me).

I haven't thought this through, but here are my rough and ready rules-of-thumb for these client/server type apps:
1) What people want is essentially the web functionality, but with the fast client-side responsiveness and free of the necessity of having to be online.
2) This does not mean you need to look like a webpage. Focus on the *simple* functionality of the webpage and deliver that in the best way possible.
3) Don't worry about seamless synchronization. If snychronization makes the easy, core stuff harder, drop it.
4) Focus on delivering the web functionality, but faster and easier.

The poster children I see for this is 1) POP email, 2) Watson, and 3) Napster.

With POP email you write your message, connect, and send the message. There is no complication with editting your email once it's sent. Your email lives on your client or on the server -- getting some setting wrong does not mean everything vanishes the minute you disconnect from the Internet. Now I know all the drawbacks of POP, but it delivers a simple experience when bridging the gap between client and server.

Watson simply brings key web application functionality (eBay, Amazon) to a desktop app. Yes, you need to be online to use it, but that's OK. It takes a website and makes it simpler.

Napster did the networked drive this really well. Pick a folder on your hard disk and call it the network drive. Drag something to that, and it's shared. Delete it, and it's gone. If you copy it to another local drive, it's now in two places. If the two go out of synch, they go out of synch. This model of network drives (with lots of gunk) is essentially what Ray Ozzie is trying to do with Groove now that he's done with he synch-happy Lotus Notes. Other network sharing systems require you to go to some website and upload stuff. This is like forcing the user to *save things twice*. Predictably, the user refuses to do this, keeps stuff up to date on his local drive, and then emails it to everyone once it's "kind of" done. The whole notion of "place" does not work because networked places are harder to get to than local places if you need to access a remote server through a web interface.

My ideal desktop weblog editor would be like POP email. I compose the post offline, see how it looks "online" offline, edit, and then post whenever I connect. If I want to edit it, I fire up I.E. and do that through the Blogger UI.

Random stuff

I've been having some frustrating economics-related discussions with some of my friends, both from U Chicago and from before. I take this frustration on my part as a bad sign, it means that my own thinking isn't clear enough to explain things in sufficiently simple language. Gary Becker puts it well -- economics is both really easy and really hard at the same time. When things get cheaper, people buy more, and when they get more expensive, people buy less sums up about 50% of it. I stumbled upon this great Becker interview again and thought I would link to it.

On an unrelated note, an old school chum has these comments on this site. Read his comments first (funny).

Robert Rubins speaks at Chicago GSB

Recently, Treasury Secretary Paul O'Neil came to speak at U Chicago. He was a nice enough fellow, but kinda dumb. He began by talking for 40 minutes on improving safety at Alcoa, for reasons which remain opaque to me. This being Chicago, the Q&A session focused on securities regulation and tax policy. About 10 minutes into it, Paul encouraged us to ask questions about his trip to Africa with Bono. We laughed, and then refocused on Glass-Steagal.

Yesterday, Robert Rubin, Treasury Secretary under Clinton, came to speak at the school. The contrasts between these two men were staggering. Rubin is a very very smart and thoughtful man. O'Neil just seemed way out of his league. The 30 minute Q&A afterwards spanned everything from expansionary fiscal and monetary policy, moral hazard in emerging market financing, total factor productivity growth and economic expansion, and market consequences of Reg-FD. Rubin handled them all intelligently without breaking a sweat. Unfortunately, he is no longer in charge. I am afraid.

Microsoft trial

As expected, the government caved into Microsoft in its anti-trust settlement and the company got off scott free. The loopholes around "business models" and DRM APIs mean Microsoft does not have to disclose anything to anyone -- just like now. Read about it on /..

FCC and open spectrum

I like Michael Powell. I liked the sort-of-libertarian-with-a-sense-of-humor portrait of him in a recent New Yorker article (thanks for the link, DF). I like the way he kinda grins and does nothing, infuriating crusty incumbents and opportunist entrants alike. It seems he gave quite a remarkable speech on reworking radio spectrum pointing out (quite correctly) that current spectrum usage is grossly inefficient.

While I'm no fan of unregulated spectrum, there might be more 802.11x like bands we can free up, and current spectrum owners should certainly be encourages to sell of what they're not using efficiently now. Will we see perpetual leases, with no use restriction, and a free spectrum aftermarket? Sadly, I doubt it, but I think more radio bandwidth is going to become available under Powell.

Is technology maturing?

HP is on the record stating that the technology industry is maturing. While this may provide cover as Carly reduces the once great innovator into a Microsoft VAR, in these recessionary days it's worth pondering if the tech sector has any growth left. And what does "maturing" mean anyway?

Historically, demand for computing cycles has proven incredibly elastic. The cost of computing has gone down dozens of orders of magnitude from the 60s, but total real expenditure on computing has continued to rise. Note that this is quite remarkable -- if the price of gasoline went down we wouldn't drive around more because gas was cheaper, we'd take our savings from gas and spend them on other things. So I guess one good measure of maturity is "have we entered the inelastic part of the demand curve"? In other words, have we run out of new uses to put ever cheaper computing to or are we going to take our savings from falling computer prices and use them to buy other stuff?

A good way to think about this is to ask "is technology becoming more durable?" It may be strange to think of something both as immaterial and as hard wearing as "software" as a "durable" good, but we do decide whether the latest version of Windows or whatever is worth buying, and if the program just isn't improving much any more it makes sense to postpone the purchase.

Economists model durable goods as "stock and flow", and while I don't want to get into the maths I will say that "stock" is the amount of that good out there (installed base) and "flow" is the amount of new goods needed each year to cover growth and "depreciation" in the stock.

Growth is, well, new demand from increasing populations or whatever, but "depreciation" is what you need to make to replace all that existing stock that gets worn out. This include both physical wear and tear, and "Pt - Pt-1", which is how much the value of last year's product (Pt-1) has fallen compared to this year's (Pt). Another way of interpreting "Pt - Pt-1" is "how much better is this year's product compared to last year's?" If there has been alot of improvement, Pt - Pt-1 will be big -- compare the price of a new computer to a five year old machine on eBay.

If good depreciate very rapidly, like strawberries, they're non-durable. If goods depreciate less rapidly, they're more durable. If computers are no longer improving at the rate they were, Pt - Pt-1 is becoming smaller and computers are becoming more durable. This means the industry is maturing.

J Bradford Delong (U Berkeley) actually has some data on this stuff. It turns out that real investment in computers is at an all time high -- 21 time as much as in 1989. But nominal investment in computers is only 2 times what it was in 1989. So our total expenditure on computing continues to rise even as the price continues to fall. It looks like we are still in the elastic part of the demand curve and technology is not yet maturing.

I don't have information on particular sectors within "technology", but you might be able to mine eBay to see if the difference between a 2001 and 2002 computer is smaller or between a 2000 and 2001 computer. Remember: as Pt - Pt-1 become smaller, the good becomes more durable and the industry "matures".

(Here's a quick application: Before the return of Jobs, Macs held their price pretty well, meaning that they had "matured" and weren't getting any better (Pt - Pt-1 was small). People claimed this meant Macs were better value, but all it really meant was that they were stagnant, so it's unsurprising that people chose not to buy them. Once Apple began to improve its products again, the value of old Macs began to plummet. PCs, on the other hand, seem to be becoming more durable as people are opting not to buy the fastest and most expensive Intel chip any more and are buying cheaper systems, spending their savings elsewhere).

Krugman v Kling on income

Arnold Kling has an excellent commentary on Krugman's recent NYTimes piece complaining about increasing income inequality in the US.

I remember, back in the day, when Krugman's MIT site and Phillip Greenspun's homepage were high points of the Internet. Sadly, Krugman has degenerated into a complete hack, and his NYTimes article doesn't even read as if it was written by an economist. (Topel, labor economist at U Chicago, felt pretty much the same way).

Topel also pointed out that the very tip of the income distribution is made up of atheletes/entertainers and CEOs (top .0001%), and technological change and stock ownership explains why their incomes rose so dramatically, and that these aren't bad things. He also points out that the rich have become richer, and the poor poorer, but the two are not linked and that economics has nothing to say about this being societally harmful.

Microsoft v. Linux

A friend of mine was interviewed by some Microsoft strategy folk a few days ago, and they were grilling him on Linux. The Microsoft employee felt that since MSFT has more man hours to throw at the operating system, it will always be better than Linux.

This is nuts. The interviewer was an ex-consultant, so he probably knows little about software development and has never read Brook's excellent "Myth of the Man Month"--in short, man hours don't scale linearly. Secondly, even if Windows OS is better, Linux reduces Microsoft's ability to price it high, and if users cannot absorb Windows improvements fast enough, they'll switch anyway even if Microsoft's product is better AND improving more quickly. Finally, the interviewer made some bizarre comment about Linux being a niche operating system (servers, embedded, etc.) Linux is just a (commodity) instantiation of a client/server OS, applications themselves are being written to the Internet operating system. In that context, Windows is a niche operating system just as much as anything else.

Good words for the boom

Michael Lewis has a really nice article defending the Internet boom from the villification it's going through now. And I feel disdain towards the smug bankers/consultants/MBA students who sneer at Internet companies now when they themselves were 1) selling services to the companies before while 2) hating themselves for not joining in the boom themselves. Lewis points out that democratic capital is good, and there was lots of that in the 90s and technological innovation is good for the economy, even though producers (and their shareholders) tend not to capture much of the benefits for themselves.

Happy Halloween

Kat and I went as Magritte's ""Son of Adam" to the annual Belgian Student's Halloween party at U Chicago. A good time, as always, and playing to the home crowd netted us second place in the costume competition.

UK Indie labels compete

I guess recording labels in the UK are not bound by the CARP flat rates, so the Indie labels there are competing on price for web radio distribution in the US. If CARP rates had simply been fixed as a ceiling, maybe Indie labels in the US would be doing the same thing.

Moore's law and accounting

I think David Reed went to Harvard Business School, so perhaps he can be forgiven for not understanding accounting. In this article he claims that since telco equipment follows Moore's law and becomes obsolete quickly, depreciating it (in accounting terms) is wrong and leads to under investment.

First of all, accounting measures of depreciation don't drive business decisions (actually, accounting measures of anything don't drive business decisions much). I will talk more about the economics of durable goods in a future column, but essentially the way it works is that if a good depreciates rapidly (ie. the price for a one year old version of the good on eBay is *much* lower than the price of a new one) you better anticipate earning lots of money from owning that good to justify going out and buying it now.

In telco, the Telecom Act of 96 means entrants can freeride on capital investments made by incumbents, which has lead to neither making capital investments. Unfortunately for Reed, this will be fixed by giving back local monopolies to incumbent phone carriers, not a change in accounting rules. And I don't see him arguing for that.

Microsoft has stopped making it easy

My friend in Europe followed up on yesterday's letter, talking about how VB.NET shares none of the features that made VB so popular (easy, quick, gets the job done) and how Microsoft may be making an error in abandoning this segment. Sean Martin (IBM, Advanced Tech Group) also wonders what's going to enter that low end niche.

Yes, the transition to .NET may be traumatic for many VB shops. This is one of the issues we've been discussing here.

If non-OO to OO is a bigger transition than non-microsoft to microsoft, then going from VB to Java is not necessarilly harder than going from VB to VB.NET or to C#. This is the idea at least. However, it may be that familiar Microsoft tools and brand names will significantly sugarcoat the the transition, even if the fundamental change is real and substantial.

To be honest, it seems like an error for microsoft to push everyone into .NET in a way that seems simply to abandon all this territory in the low-end niche. As I said, I don't know what the concentration curves look like, but I've heard the same stat as everyone else that there are more VB developers in the world than anything else. Presumably that's not because V & B are magic letters. What I'm saying is, maybe VB developers are the most common type of developer for the same reason bad novelists are the most common kind of novelist -- that is, because it's easier that way.

If Msoft imagines they can bully the world into using technologies which are harder, and more expensive in terms of talent and training, in order to produce exactly the same lightweight standalone enterprise apps, then they must be making a mistake. If they imagine that because of web services, internet, basic shifts in technology, etc., there is no longer going to be a place for very low-end development, that's probably also wrong. Cheap-and-easy-development is surely as important a feature as robustness, security, etc., to many organizations.

I feel pretty sure about this. I've observed the growing shock on the part of the CEO as he slowly realizes that careful OO development is simply slower than VB, which *already* felt slow to him because he doesn't know enough about development. If Microsoft is planning to force a wholesale upgrade of their low-end developers then they're throwing away one of their comparative advantages, which is their dev tools. (The dev tools are a kind of a bridge between their strength in apps and their weakness in the enterprise apps the tools create.) And anyway, this upgrade might be simply impossible.

Microsoft makes it easy

A friend of mine working in Europe wrote in describing his experiences with IT out there. He points out what many tech-heads, through arrogance, ignorance, or whatever, refuse to get: it's important to make things really really easy. I saw this often at IBM. Although they now pay lip service to making better developer tools, their IDEs are still not as good as Microsoft's and Lotus Notes makes it pretty plain how well they understand Human-Computer Interaction. Maybe J2EE will create better IDEs, Microsoft will certainly continue to improve their's.

I am advising the CEO of a small software company, which is now basically a VB shop (20-30 people), on the transition to J2EE, to .NET, or maybe a little of each. They've decided they want to do some kind of shift to java, and now I'm setting up trainings on technology, best practices, etc..

Here is what I notice:

People know much less out here on the margins. It would shock you. This goes for management as well as techies. Mgmt knows less about proprietary vs. open, microsoft vs. non-microsoft. Techs know less about development methodologies, basic engineering, alternative technologies. At first I was astonished, but now I see that their clients are on the same knowledge level so deals still happen.

But overall this plays to Microsoft's advantage.

Management likes MSoft partly because it projects respectability and talks like a business. The Neal Stephenson 'command line' article that originally talks about M's OS addiction being like Apple's hardware addiction, also talks about M's bourgeois appeal. That observation seems pretty believable from where I stand. But -- ignorance is a fickle patron. Their clients may not know exactly what java is but they think it's trendy so they want to buy some of it and ask for it specifically. Also, they don't like paying licenses and maybe they feel angry at Msft because they're frustrated with computers (like everyone else who uses them).

This may be the smaller factor. Microsoft's advantage with unsophisticated tech may be bigger.

Out here, tech likes microsoft because it's easy. Microsoft has great IDE's and VB development is quick and easy. You're right Msoft makes great apps. That carries over into their development tools, and the integration between their DB's, IDE's, etc., so that you can whip together a lot of stuff on Msoft tech very quickly. This gives them an advantage in small intranet and enterprise apps, even if their servers are dodgy or expensive.

Also, when you add it all up, I'm not convinced it's an open-shut case if microsoft costs you more than, say, linux and java.

In javaworld you don't need to pass microfost licensing costs along to your customers. BUT, maybe development takes longer and costs more per hour, because the tech is harder, and because the tools and overall development environment is not as well integrated. I've also followed close discussions of this on places like www.theserverside.com, and it's not a no-brainer.

(Personally I'd recommend developing in a well-integrated environment like Websphere + WSAD, then deploying ontro free platforms like Tomcat/Apache. Sort of a half-half solution.)

Lots of these hacky VB apps stumble and certainly don't scale, but most software fails so it's hard to pin it on the fact that it's sloppy rushed VB work.

I don't know what the distribution curve of global IT sophistication looks like. But I wouldn't be surprised if the least sophisticated make up most of the people, and my context which was at first very surprising to me is in fact close to the norm.

Perhaps the transition to .NET may disrupt some of this, since it's fully OO and hard and slow like java, at least relative to vb6. Too soon to tell. I suspect Msoft excellent IDE's and platform integration will still make it easier to develop for.

Crazy rumour

Word on the street is that Microsoft is going to buy (a stake) in Siebel. Why? 1) Microsoft has no channel to sell into enterprise, and Siebel is quite good at that and 2) Microsoft needs an application that will drag .NET into enterprise, and Siebel's CRM apps will do that. Look for what billg announces at the upcoming Siebel conference (Oct 20-23).

Windows isn't good at operating systems

Paul Wolpe wrote in disagreeing with my assertion that Microsoft makes poor operating systems. He argues that NT is actually quite good, and given time, it will be even better. I spoke with Sean Martin at IBM about this (Sean is one of the advanced engineers there and a really smart guy) and he had good things to say about the way Microsoft pumps out code. Given how hard code production is, and how bad most companies are at it, I concur--Microsoft software is actually quite good compared to most other commercial software.

So why they insist on lumbering it with their bad OSes I don't know.

Microsoft is bad at operating systems the same way Apple is bad at hardware. (Note that I write this on my 800 Mhz iBook which I deeply, deeply love. But I would love it more if it had a fast x86 processor.) Just as Apple hindered its wonderful operating system in the 1980s by clinging to proprietary hardware, Microsoft is hindering its wonderful applications now by clinging to proprietary operating systems.

Having an inhouse team of developers, no matter how talented, is just not the best model for producing and maintaining a kernal. Wolpe mentions GNU/Linux in his post, but then dismisses it. Balmer doesn't, he's on the record as saying Open Source software is the #1 threat to Microsoft. And he's right, in terms of performance, scalability, robustness, and cost GNU/Linux beats the pants of anything produced in Redmond.

So why doesn't Microsoft exit the OS business (the way Apple has and simply ship their quite good enterprise applications on Lintel blades? It's because they're addicted to the operating system business, and that will prove their downfall.

Microsoft on GNU/Linux

Microsoft is quite good at applications, but quite bad at operating systems. It wasn't until working at IBM this summer that I appreciated how easy to use, simple, and user friendly Microsoft software was (shocking, but true). Microsoft's biggest obstacle to penetrating enterprise computing is their insistance on running SQL Server, BizTalk, MSFT CRM etc. on the lousy .NET Server instead of Lintel. I asked a VP of .NET if this would ever change, and once he had finished laughing he told me "no."

But the failed Passport identity system seems to be crossing over to Unix, which is pretty wacky. They really must beleive it has no chance.

Don't knock selling bananas

A few weeks ago, the Register ran an article complaining that the capital markets destroy research because they won't fund True Engineering. MJ wrote in asking what I thought of this.

From my time hanging out around tech companies, I've noticed that engineers beleive salvation lies in the Right Technology and have little patience for whatever those MBA marketing guys waste their time doing. I would argue that history demonstrates how having the Right Technology rarely determines who wins, but distribution (what marketers call "channel") does.

No piece of engineering is an island--it sits in a "solutions stack", all of which must be in place, to deliver something useful that a customer is willing to pay for. Engineers might recognize a hardware, OS, application stack, but from a customer perspective it actually extends all the way up through education, training, service, technical support, etc. Now, this stack can be provided by one company or many. Apple integrates alot of it, while the PC market has Microsoft monopolizing the OS layer (and Office software) while having competitive markets for hardware, education, training, service, technical support etc. The guys who own the scarce parts of the solution stack get all the profit in the industry.

By the way, did I mention that distribution was part of the solution stack too?

My point is that financial markets only care about money, not technology or distribution, but don't knock how important the distribution part is to making money. This single minded focus on lucre is a good thing because it means they're quite happy funding anything consumers will buy (like Napster of TiVo) without getting bogged down in nostaligia. It so turns out that technology and its distribution channel need to coordinate quite strongly (ie. distribution and technology are often co-specialized assets). IBM research has invented lots of neat stuff over the years, but its distribution was often optimized for other things so they were never able to capitalize on their inventions. Xerox invented the future of computing at PARC, but again had no co-specialized distribution assets that could take it to market.

So don't underestimate distribution. Commercializing technology is hard. Really really hard. Hard hard hard. It often makes sense to build a whole new company, essentially one big specialized distribution asset, to get that technology to market. Which brings us back to the capital markets. While people accuse Wall Street of being short sighted it really isn't (although it gets over-emotional--just look at how far it was looking into the future when valuing Internet stocks!) The market is very hard nosed and will evaluate R&D spending by 1) will it come up with anything useful and 2) when it does come up with anything useful, will the company make money off of it? Sadly the answer to 1) is: probably not (Microsoft) and to 2) is: almost certainly no (Xerox, IBM, Apple, IBM, Motorola, IBM).

But do not lose heart. The above just means that public financial markets are not a good source of financing for speculative technology investment, although they support developmental applied research (Intel) handsomely. But this is the way it should be -- you really don't want lots of start-ups working on crazy ideas to try and IPO so they could test them out (and despite what anyone thinks, speculative technology does not suddenly become free if it is inside a big company). Fortunately, there are lots of financing sources standing by to develop speculative technology, including government grants, VCs, Private Equity, Angel Investors, etc. If financial markets seem to favor distribution these days it's only because distribution makes more money. If HP wants to withdraw from systems research and focus on becoming a Microsoft VAR that's fine with me -- their R&D didn't bring great products to market.

What's really killing the technology sector right now isn't lack of financing (remember, VC firms are struggling to make good investments and are having to give money back because they can't find opportunities) it's lack of demand. Consumers are not that excited about PDA/Phones, PVR/DVDs, or digital media/PC combos (not that *some* consumers aren't excited, but it's not an Internet-esque stampede). Business are not excited about CRM, ERP, EAI, or ERM, and are struggling to make their numbers at a time when the bottom line really matters to shareholders. There is lots of patient capital out there funding new technology, but right now, dissatisfied, burnt out customers aren't buying.

Kill the CD

Since CDs are easy to rip, the music industry wants to shift to a crippled media format that will forbid that. Unless the CD (and MP3, and PC) are banned, these formats will fail.

RIAA vs the Turing Machine

Ed Felton writes how the US Government thinks "the general purpose computers is a threat, not only to copyright but to our entire future." Now, while the PC is often too complicated to use, and some users may benefit from a simpler, restricted machine, the desktop Turing Machine is still critical to innovation. But last year when I mentioned this to Randall Picker (U Chicago Law prof and smart guy) he struggled to see why.

Given the market success of most information applicances, the general purpose computer is not going anywhere unless outlawed by the Government. Microsoft, with Palladium, is already locking up the Windows PC, but there are many other platforms more focused on empowering end users.

Lessig's afterthoughts on Eldred v. Ashcroft

It is very worth reading Lessig's notes after arguing Eldred v. Ashcroft.

Hobbyists and copyright

There's a nice op-ed in the NYTimes, answering Valenti's argument for extending copyright "Who is going to digitize these public domain movies?" Answer: Us.

Laboratory economics experiments

I wanted to update my last post on the 2002 Nobel Prize for Economics. A Slate article on it pointed to an experiment where people seemed willing to force others to give money to another party, and pay for the priveledge, even if they would not give money to others directly.

The article mocked this result as being weird, but I think it illuminates how limited people's understanding of the consequences of their actions are. For example, people often support rules and regulations that take money from one group (i.e. car makers) and give it to another (i.e. steel manufacturers) even though it costs them money (through higher car prices, which in turn reduce the amount of money available for *all* *other* *workers*). This type of wealth destruction is known as dead weight loss, which is pretty obscure outside academic circles. 50 years ago, one economist got so angry at this widespread ignorance that he wrote an entire book talking about nothing else. "Economics in one easy lesson" by Henry Hazlitt is a fun read, which I recommend to all.

Certainly around taxes and regulation, people do seem very willing to make laws which impoverish themselves and confiscate wealth from one party to give to another. I think that people do not realize that government spending comes from taxes, or how law can act as a tax and take money from one group to enrich another, and how this harms society as a whole.

Nobel prize for Economics, 2002

When I wrote about last year's Nobel prize for economics I ended up getting a cease and desist letter from MIT Press and had to take it down. *Sigh* For those who remember, last year's prize went to information asymmetry, which showed how people would not trade if they could not be convinced that they weren't being cheated. A nice and interesting wrinkle on Chicago School micro.

This year's prize goes to Behavioral Economics. There are two schools of "behavioral economics", one which focuses on empirical research and the other which takes the classical micro model into new areas.

First, some context. The standard microeconomic approach looks at how a rational individual, who tries as best as he can to look into the future, goes about maximizing his "utility." While it's easy to make jokes about how unrational people are in real life, this approach is unparalleled in its power and generality, and by that I mean it explains a great deal of many different sorts of behavior. Quantum Mechanics aside, I struggle to come up with any other theoretical model that has had quite the material success of the microeconomic rational utility maximizer. This school of economics was invented at Chicago in the 50s.

One school of "behavioral economics" takes the standard micoeconomic rational actor and extends the utility function to include all kinds of goods that go beyond wealth. For example, racial prejudice can be thought of as a consumption good where an individual exchanges money for prejudice (by not hiring black labor even though it's cheaper and better). This school of behavioral economics was also invented at Chicago by Gary Becker (who won a Nobel Price in 1992), who has done amazing work in this area with Kevin Murphy. Through this, they've come up with powerful and insightful models of personal taste, addiction, the family, crime, etc.

The other school of "behavioral economics" does away with the rational actor and instead presents real people with real choices in a lab and sees what they do. One of the leaders in this field, Richard Thaler, is also at Chicago (along with Barberis) and focuses on "unrationality" in the financial markets. It is for this school that Kahneman and Smith won their prize this year. (Note: Kahneman was the thesis advisor of a good friend of mine at Chicago).

Of course it's hard to argue that people are perfectly rational, but you can make the utility function in the the standard microeconomic model pretty broad, including alturism, (unstable) preferences, and lots of other things and come up with good, robust predictions about the world. Whenever you deviate from this sort of thing you end up with someone losing all their money unless they become "rational" again, so the model is pretty self correcting. I don't think the experimental behavioral economics gained much traction until it found irrationalities in the stock market (which, when publicized, were arbitraged away and no longer exist).

The main criticism of the experimental school of BE is that, well, people perform strangely in labs. When Thaler points to some small, market irregularity and calls it the tip of the iceberg, Gene Fama (Chicago, invented modern Finance) says "No, that's the whole iceberg!"

So I'm pretty torn about this year's prize. I guess I'm skeptical of how useful lab experiments are in generating useful data, but people are wacky and market anomalies remain (for example, there is too much volatility in the stock market, and there are financial booms and busts). Useful stuff may come out of experimental BE in the future, but I'm still trying to wrap my head around the standard microeconomic model.

Ick

This converged MSFT device is just the sort of nonsense I feel will fail in the marketplace. At least Microsoft dropped some of the Digital Restriction Management flaws.

Eldred v. Ashcroft, Day 1

I found some good notes on the first day of Eldred v. Ashcroft, but I have no idea how to interpret any of it. Ultimately, the length of copyright is something that needs to be set by society via Congress, not through the courts. As O'Conner pointed out, bad policy is not unconstitutional. But retroactive extension absolutely *is* unconsitutional as it clearly does nothing to "promote arts and science" and so should be beyond Congress' power to mandate. I was glad to see Breyer get sensibly "economic" on this.

Goodeasy for Windows

Someone's trying to put together a Goodeasy for Windows. Nice! (Via Mark)

CARP modified

Since I've written about CARP before it seems appropriate that I comment on it now. (CARP, incidently, is the royalty system set by the US Copyright Office that sets a fixed rate for web radio.) It seems there's been a small carve out for small webcasters that sets rate according to complicated accounting defitions of costs and percentages etc. (details here). These ammendments may help some small webcasters, but they don't do much to inject competition into the online distribution of streaming music, because the (lower) rates are still fixed, and not ceilings. Sadly, I heard neither the RIAA nor webcasters argue for a rate structure that just set the ceiling, and let content owners compete for distribution.

Spectrum is scarce

USS Clueless wrote up a good article talking about how CDMA cellular technology squeezes more data into less radio spectrum through "spectrum sharing". Spectrum sharing (forcing processors to clean up noisy signals) is one of the key technologies open spectrum advocates invoke when arguing that all spectrum should be unregulated. I've long been skeptical of these assertions, so I asked Steve Den Beste if spectrum sharing technology can, indeed, make spectrum non scarce. He answered:

No.

Spectrum usage is subject to Shannon's work. Spectrum is a finite resource and if too many people try to use the same spectrum then no one gets anything out of it.

Technology can't fix this. It's inevitable because of the laws of physics.

Shannon's work is in part based on the Second law of Thermodynamics.

To do: bone up on Shannon.

DVDs

There's a nice article on how DVDs are not only outselling VHS tapes, but they're grossing more than movies. This is changing the how movies are made -- stuff is now being filmed for the express purpose of it ending up on the DVD.

The economics of all of this are pretty neat. Tapes cost about $25 to make, degrade with use, and cannot store much. DVDs cost about $1 to make, don't degrade, and can store lots. Given that demand for movies seems to be pretty elastic, lowering their cost greatly increases the amount people consume. This, combined with the fact that DVDs don't degrade, means that not only is consumption higher, but it also shifts from renting to owning. The article ends by suggesting DVD prices may fall to $10 a pop, making them impulse buys. The most efficient distribution network for video may end up being supermarket checkout lines.

Regulating fair use

I think Lessig, at some recent conference, pointed out that most things people did with content was unregulated--that is neither protected under fair use or controlled by copyright. Such uses include lending a book to a friend, listening to a CD multiple times, or watching a DVD at a friends house. The RIAA and MPAA's fight against unauthorized copying often involves regulating previously unregulated activities--and assigning new rights to copyright owners. Now, economics does not care who owns something, just that people are free to trade stuff, so giving content owners perfect control is economically efficient, but makes consumers unhappy by raising prices on them. Assigning ownership to new (previously unregulated goods) is best done through a political process, which is essentially what the Boucher bill is about.