And which is why I scheduled this for 7.30 am, rather than the usual 10 am slot.
I discovered this channel via (who else) Krish Ashok
Month: February 2021
Cesar Hidalgo’s Viral Thread
You might first want to learn about who Cesar Hidalgo is…
… and then go through this thread.
Update: I scheduled this post a couple of days ago, but then came across this excellent Twitter thread by Rathin Roy, which is also worth reading:
Three Excellent Games to Play (Econ related)
We’re running a small workshop on experimental and behavioral economics at the Gokhale Institute, and we had great fun playing these games yesterday.
- Bad News: a game that teaches you how (worryingly) easy it is to get addicted to generating, sharing and amplifying bad news. Yes, I know this isn’t news, exactly – but playing this game allows us to actively participate in the process. And like I said, what is worrying is the ease, and the addiction. Give it a shot, doesn’t take more than 10 minutes.
- Go Viral!: In similar vein, but more topical.
Both of these I found out about via Behavioral Scientist.
And the excellent, excellent, kiviq.us. I’ll be using this again and again in the years to come – a very simple, very hands-on way to help students understand double oral auctions.
Have fun – and please reach out if you need help running any of these games. I’d love to help out, if I can in any way.
Airbnb and the Asymmetry of Information
Devon Zuegel (@devonzuegel on Twitter, and definitely worth following) was less than happy with Airbnb recently:
And so of course I thought about Akerlof (1970)
This paper relates quality and uncertainty. The existence of goods of many grades poses interesting and important problems for
Akerlof, G. (1970). The Market for “Lemons”: Quality Uncertainty and the Market Mechanism. The Quarterly Journal of Economics, 84(3), 488-500
the theory of markets.
It’s a paper that every undergraduate student ought to read. Not just economics undergraduate student, mind you, but every undergraduate student. Because it helps you get an understanding of many modern businesses today.
But first, a relatively simple explanation of the core idea of the paper:
Suppose buyers cannot distinguish between a high-quality car (a “peach”) and a “lemon”. Then they are only willing to pay a fixed price for a car that averages the value of a “peach” and “lemon” together (pavg). But sellers know whether they hold a peach or a lemon. Given the fixed price at which buyers will buy, sellers will sell only when they hold “lemons” (since plemon < pavg) and they will leave the market when they hold “peaches” (since ppeach > pavg). Eventually, as enough sellers of “peaches” leave the market, the average willingness-to-pay of buyers will decrease (since the average quality of cars on the market decreased), leading to even more sellers of high-quality cars to leave the market through a positive feedback loop.
https://en.wikipedia.org/wiki/The_Market_for_Lemons#
Thus the uninformed buyer’s price creates an adverse selection problem that drives the high-quality cars from the market. Adverse selection is a market mechanism that can lead to a market collapse.
Akerlof’s paper shows how prices can determine the quality of goods traded on the market. Low prices drive away sellers of high-quality goods, leaving only lemons behind. In 2001, Akerlof, along with Michael Spence, and Joseph Stiglitz, jointly received the Nobel Memorial Prize in Economic Sciences, for their research on issues related to asymmetric information.
Now, one way to understand the value of many businesses today is to realize that they’re solving asymmetry of information problems. Or at least, that’s how I think of it when I end up looking up the rating for a restaurant on Zomato in a unfamiliar part of town. I don’t know enough about this part of town, and I certainly don’t know this restaurant. Should I walk in for a meal or not?
I could always check if the people already inside are smiling or not, of course, but let’s face it, most of us will simply Zomato our way through this problem. Zomato is reducing the asymmetry of information problem. Successfully or not is a matter of opinion and perhaps controversy. But my argument here is that this is a potentially useful way of thinking about the problem: how to decide where to eat?
How to decide whom to recruit? Linkedin.
How to decide whom to trust? Look ’em up on Facebook, or Twitter, or Instagram, or wherever it is that people look up people these days.
How to decide which product to buy on Amazon? Check out the user ratings. In fact, sort by average user ratings! Yes, Amazon does provide this option.
How to decide which book to read? Goodreads.
How to… you get the drift, right. Part of the reason these firms are so highly valued by the public is because they solve the asymmetry of information problem.
And so does Airbnb. Or does it?
And that brings us back to Devon Zuegel’s tweet.
Every review left on Airbnb informs potential users about the quality of a stay at a particular host’s place. The more information they are able to glean from reviews left by previous users, the more they are likely to definitively transact…or not. That is, potential users will either stay at a particular place, or will definitely not.
Since Airbnb gets a cut from each transaction, but not from each no-stay, they have an incentive to put up only positive reviews. And that is the problem that we have to think about when we read Devon Zuegel’s tweets. Is Airbnb incentivized to leave only positive reviews up? Short answer: yes. Therefore, will they leave only positive reviews up? I’d say it’s a question of horizons, but it is also a question of the calculus.
Airbnb will not last for very long if they pull down every single negative review, because that will destroy trust.
But:
- every now and then…
- particularly for really highly rated hosts…
- especially during a pandemic…
- will the odd negative review…
- have a higher chance of being pulled down?
Nothing in life is ever black and white, and the truth lies somewhere in the middle. So no, Airbnb will not pull down every single negative review, but we also shouldn’t assume that it will leave every single negative review up.
More information in the hands of the consumer is a wonderful thing, and it does reduce the asymmetry of information. But who is providing the information to the consumers, and what are their incentives? What if the providers of the good/service are the ones that are making information available to the eventual consumers? Will that need to be regulated, and if so, how?
Zomato, LinkedIn, Uber, Airbnb – it’s a great time to be alive, because these firms, and many others like them, have provided for many services that would simply have not been possible otherwise. They have successfully reduced the asymmetry of information problem. But it’s not the end of the asymmetry of information problem, not just yet.
If anything, it just got more interesting.
On X-Inefficiency
Yesterday, I wrote this in my summary of Bloom and co-authors’ paper on productivity in India:
Economists tend to not buy into this because they assume that profit maximization implies cost minimization
https://econforeverybody.com/2021/02/23/notes-from-does-management-matter-evidence-from-india-by-bloom-et-al/
So in other words, if firms are not minimizing costs by adopting good management practices, it is because “wages are so low that repairing defects is cheap. Hence, their management practices are not bad, but the optimal response to low wages.”
… which brought to mind of the topic of X-inefficiency, for the second time this year. The first was when Tyler Cowen wrote about it in January. Here’s Wikipedia:
X-inefficiency is the divergence of a firm’s observed behavior in practice, influenced by a lack of competitive pressure, from efficient behavior assumed or implied by economic theory. The concept of X-inefficiency was introduced by Harvey Leibenstein
https://en.wikipedia.org/wiki/X-inefficiency
X-inefficiency, in essence, is the idea that the economic theory idea about efficient firms in efficient markets is perhaps a little overblown. Here’s a quote from the paper itself:
The simple fact is that neither individuals nor firms work as hard, nor do they search for information as effectively, as they could. The importance of motivation and its association with degree of effort and search arises because the relation between inputs and outputs is not a determinate one. There are four reasons why given inputs cannot be transformed into predetermined outputs: (a) contracts for labor are incomplete, (b) not all factors of production are marketed, (c) the production function is not completely specified or known, and (d) interdependence and uncertainty lead competing firms to cooperate tacitly with each other in some respects, and to imitate each other with respect to technique, to some degree.
Leibenstein, Harvey. “Allocative Efficiency vs. ‘X-Efficiency.’” The American Economic Review, vol. 56, no. 3, 1966, pp. 392–415. JSTOR, http://www.jstor.org/stable/1823775
By the way, the entire paper is worth reading, because it contains multiple delightful nuggets. The Hawthorne effect, which I mentioned in yesterday’s blogpost makes an appearance, and it also helps one understand why microeconomic textbooks are a very poor way to learn about the real world. Consider this delightful quote, for example:
One idea that emerges from this study is that firms and economies do not operate on an outer-bound production possibility surface consistent with their resources. Rather they actually work on a production surface that is well within that outer bound.
Leibenstein, Harvey. “Allocative Efficiency vs. ‘X-Efficiency.’” The American Economic Review, vol. 56, no. 3, 1966, pp. 392–415. JSTOR, http://www.jstor.org/stable/1823775
OK, so people and firms are both not as efficient as econ textbooks make them out to be. This is not, to put it politely, headline material in the non-econ world. What might be potential solutions?
In situations where competitive pressure is light, many people will trade the disutility of greater effort, of search, and the control of other peoples’ activities for the utility of feeling less pressure and of better interpersonal relations. But in situations where competitive pressures are high, and hence the costs of such trades are also high, they will exchange less of the disutility
ibid
of effort for the utility of freedom from pressure, etc
In English, this means the following:
- Government offices are unlikely to be as productive as private sector offices
- Surround yourself with folks who are go-getter types
- And this is my take: figure out for yourself a good boss/manager/mentor who will push you, but in a non-zero sum way
This last part is all but impossible, but oh-so-important.
In any case: x-inefficiencies. An underrated topic from micro!
Notes from Does Management Matter? Evidence from India, by Bloom et al
- Yesterday, I had linked to a paper by Bloom et al, and said that it would be a good place to start reading about productivity, particularly from an Indian point of view. Here are my notes from the paper:
- As per Hsieh and Klenow the ratio of TFP in Indian and Chinese firms is 5(!) between the 90th and the 10th percentile
- The quality of management, and therefore management practices, is one explanatory factor
- Economists tend to not buy into this because they assume that profit maximization implies cost minimization
- So in other words, if firms are not minimizing costs by adopting good management practices, it is because “wages are so low that repairing defects is cheap. Hence, their management practices are not bad, but the optimal response to low wages.”
- In this paper, large multiplant textile firms were split into treatment and control groups. The treatment groups were given management consulting from a top consulting group, the control groups weren’t.
- The result: “We estimate that within the first year productivity increased by 17%; based on these changes we impute that annual profitability increased by over $300,000. These better-managed firms also appeared to grow faster, with suggestive evidence that better management allowed them to delegate more and open more production plants in the three years following the start of the experiment. These firms also spread these management improvements from their treatment plants to other plants they owned, providing revealed preference evidence on their beneficial impact.”
- So why wasn’t this being done already?
- No need, because benchmarking was with local competition, who weren’t doing it anyway
- Simple lack of awareness
- A naïve belief that nothing would change by adopting these practices
- But even within local competition, why did firms not exit?
- Competitive pressures were heavily restricted
- High import tariffs
- No entry of firms by lack of external finance
- Number of male family members
- Lack of trust of professional managers (family owned businesses)
- Competitive pressures were heavily restricted
- TFP in India is about 40% that of the USA, as per Caselli 2011
- “Indian firms tend not to collect and analyze data systematically in their factories, they tend not to set and monitor clear targets for performance, and they do not explicitly link pay or promotion with performance. The scores for Brazil and China in the third panel, with an average of 2.67, are similar, suggesting that the management of Indian firms is broadly representative of large firms in emerging economies.”
- The interventions comprised of improvements in:
- Factory operations
- Quality control
- Inventory
- Human Resource Management
- Sales and order management
- This was done by implementing the following steps:
- A diagnostic phase
- An implementation phase (this was for only the treatment group, obviously)
- A measurement phase
- The authors carefully consider whether the Hawthorne effect was at play, and reject the possibility.
- ” In every firm in our sample, before the treatment, only members of the owning family had positions with any real decision-making power over finance, purchasing, operations, or employment. Non-family members were given only lower-level managerial positions with authority only over basic day-to-day activities. The principal reason seems to be that family members did not trust non-family members. For example, they were concerned if they let their plant managers procure yarn they may do so at inflated rates from friends and receive kickbacks.”
- “A key reason for this inability to decentralize appears to be the weak rule of law in India. Even if directors found managers stealing, their ability to successfully prosecute them and recover the assets is likely minimal because of the inefficiency of Indian courts”
- “Hence, the equilibrium appears to be that with Indian wage rates being extremely low, firms can survive with poor management practices. Because spans of control are constrained, productive firms are limited from expanding, so reallocation does not drive out badly run firms. Because entry is limited, new firms do not enter rapidly. The situation approximates a Melitz (2003)–style model with firms experiencing high decreasing returns to scale due to Lucas (1978) span of control constraints, high entry costs, and low initial productivity draws (because good management practices are not widespread).”
- There are three reasons for inefficiency:
- motivation problem
- inspiration problem
- perception problem
- I need to read Lucas (1978) and Melitz (2003) next!
Summers and Krugman in Conversation
Some goof-up seems to have happened, this was supposed to go out on Sunday, the 21st of Feb. Still, FWIW, here you go.
And that means you’ll be getting two posts today, not just the one. Sorry about that 🙂
On Productivity
I really liked Patrick OShaugnessy’s reply to a question that Kunal Shah asked on Twitter recently:
It’s not just mediocre team members at a start-up, of course, it’s everywhere. As Gulzar Natarajan pointed out in a blogpost a while ago, it is also a problem with bureaucrats in government:
Are meetings organised most effectively – in terms of their periodicity, whether clear and brief agendas are communicated in advance, what gets discussed, and how the minutes are recorded? How are the meeting outcomes followed-up? How are failures to comply addressed?
http://gulzar05.blogspot.com/2021/01/management-productivity-improvements.html
The answer, by the way, is usually no, except for what gets discussed and are the minutes recorded. That part is done scrupulously, but the rest of it, not at all. Meetings are not periodic, clear and brief agendas are not sent beforehand, and worst of all, meeting outcomes are not followed up, and there is no clear understanding of what happens if failure to comply is observed.
In fact, I’d add one point to Gulzar Natarajan’s list, the meetings never end with a clear plan of action, who is responsible, and when and how a follow-up is to happen.
Here’s a point that people often miss out on they call a meeting: meetings are expensive. A meeting that lasts for an hour and involves ten people has cost the organization ten hours of work. The meeting had better have been worth the work that could have been done otherwise.*
In fact, the entire blogpost ought to be read by everybody involved in any kind of administrative set-up. Often, people in an organization have no clue about what the organizational objective is, whether work-allocation is effective or not (both in terms of the quantum of work that a person does, but also whether this person is truly equipped to do the work allocated to them), and how monitoring is done.
Human resource management is, quite simply, an alien concept.
The last paragraph from his post is worth pondering over:
While waiting for such a leader is not an institutional solution, it’s a pointer to prioritising the adoption of basic management practices. This is about the adoption of very simple and basic work, people, and situations management techniques, and not the sort of stuff one learns from management schools. Unfortunately, it’s not an area that receives any attention in conventional academic research and management consulting.
http://gulzar05.blogspot.com/2021/01/management-productivity-improvements.html
And if any student reading this is wondering where to get started in this regard, here’s a good place.
* Narrator: It never is
Bonne Maman Jam, The Holocaust and Twitter
Twitter chose to show me this tweet the other day:
Read the whole thread, it warms the cockles of your heart.
And then I saw on of the replies:
And deeper down the rabbit hole, this:
And then because I had an impossibly long list of things to do, I stopped. But if anybody who is reading this is wondering how to spend a lazy Saturday morning… well, I wouldn’t mind being updated!
Oh and by the way, we get Bonne Maman preserves in India. I’ve had them for years, and they’re very, very good.
A very short, but also a very painful post
Seth Godin wrote a post that was painful to read for me, and if you’ve been reading my posts recently you’ll know why. The title of the post was “What does it mean to do well in school?“:
Is it the same as “doing well on some tests”?
https://seths.blog/2021/02/what-does-it-mean-to-do-well-in-school/
Because that’s what we report–that perhaps 240 times in a college career, you sat down for a test and did well on it.
That’s hardly the same as doing well in school.
Where do we look up insight on your resilience, enthusiasm, cooperation, curiosity, collaboration, honesty, generosity and leadership?
Because it seems like that’s far more important than whether or not you remembered something long enough to repeat it back on a test.
Yes, so much yes. But of course, those of us involved in running academia excel at designing tests. The other things, not so much.
And then, to add injury to insult (not a typo), this Twitter thread:
Education as we know it is changing in front of our eyes, and for the better, but it is happening in spite of colleges, not because of them.
And nobody seems to care.