Kiesling and the Transitional Gains Trap

At Knowledge Problem, Lynne K. asks a question that's been burning a hole in my head for a couple of weeks now: should regulated utilities be allowed to participate in the household PV market? In particular, I'm wrestling with a Lucas Critique response to this:

I want to step back and ask why the regulated distribution utility should be involved in the residential solar market at all. The growth of producers in the residential solar market (Sungevity, SunEdison, Solar City, etc.) suggests that this is a competitive or potentially competitive market.

Professor K lists 4 vital premises of the regulated model here. At its heart, electricity delivers comforts to hearth and home. With the technology available at the time of mass electrification, the best way to do that was to have regional plants, distribution grids, and household meters. The grid got lumped in with the generation as the "supply side" rather than as what it really is: a middleman, a mancgere if you will. As technology has been changing, the regulated model is growing less salient.

But that doesn't by itself imply that the legacy companies (NOVEC in my neck of the woods) should be barred from participating. They tend to have not only good physical capital, but they're large employers of linesmen and electricians. If you want to contact someone with the specific knowledge in space and time about the grid, you can't do any better than calling your local utility. This competence, as well as the relatively low cost of physical capital, is extremely valuable to the end customer.

Then again, regulated utilities also have a comparative advantage in currying, securing, and protecting political favor. The Lucas Critique bit that has me buffaloed is this: does the present discounted value of all the marginal technical expertise and physical capital possessed by utilities outweigh the marginal risk of giving the keys to the solar clubhouse to guys who've proved (Enron) more than capable of navigating the halls of the several state legislatures already?

In trade economics, there's something called the "infant industry" argument. The gist of the claim is this: new firms are at a natural disadvantage when competing with incumbents, since they go bankrupt faster in a price war. Or perhaps they need some time to establish trade relationships to get over an initial start-up hump. These might be reasonable claims, but as we're seeing right now this very moment, the big barriers to entry for, say Uber, airbnb, and Lyft have nothing to do with technological hurdles and everything to do with regulatory and legislative opposition. But here's the pickle (I hope you like pickles): the grid complicates the story. Legacy taxi companies don't also conduct road maintenance and new construction. Regulated utilities do string new cable and tend to substation maintenance. Because of their political influence, my idea of separating generation and distribution into distinct entities is very probably not much more than a silly pipe dream.

The division of labor is limited by the extent of the market. Home PV generation expands the notion of what counts as the "market" for electricity distribution. If splitting distribution and generation is politically unrealistic, then at least keeping the regulated utilities focused on their core competencies seems reasonable. Were it not for the great threat of the utilities petitioning government officials for special treatment in home generation, I'd happily welcome more competition. My prior belief however is that the existing utilities would act more like local taxi cartels and would think nothing of using their already considerable political clout to elbow rivals straight out of the market. This does not seem to be in the best interests of the end customer.

Lynne asked:

The regulated distribution utility’s main objective is, and should be, reliable delivery of energy. The existing regulatory structure gives regulated utilities incentives to increase their asset base to increase their rate base, and thus when a new environmental policy objective joins the exiting ones, if regulated utilities can acquire new solar assets to meet that objective, then they have an incentive to do so. Cost recovery and a guaranteed rate of return is a powerful motivator. But why should they even be a participant in that market, given the demonstrable degree of competition that already exists?

I'd also ask: why should they even be a participant in that market, given their proven advantage at shutting down the competition that already exists?

Mine's more of a public choice question, so perhaps it'll be of less interest to the folks who actually get to make these sorts of decisions. As for the typical constituent, to the extent that they even care about these issues, it'll probably end up being framed as an issue of trust. I can easily imagine appeals to brand loyalty and trust showing up in the rhetoric. "The alternatives to having clean, reliable energy delivery are too awful to bear, so why not stick with the name you trust?" Electricity is not euvoluntary.

Don't Fear the Reaper Bot

Via VG247, a Bulgarian entrepreneur nets himself over $100,000 in 2013 by auction house arbitrage.

ATSRTWT

Condensed version: he gets the script for a bot from a friend. He modifies that script to scour the in-game real-money auction house. The bot buys undervalued items, then re-sells them at higher prices. He pockets the difference.

Contrast Turner:

I say that I am useful to the king, and to ealdormen, and to the rich, and to all people. I ascend my ship with my merchandise, and sail over the sea-like places, and sell my things, and buy dear things which are not produced in this land, and I bring them to you here with great danger over the sea; and sometimes I suffer shipwreck, with the loss of all my things, scarcely escaping myself.

What things do you bring to us?

Skins, silks, costly gems, and gold; various garments, pigment, wine, oil, ivory, and orichalcus, copper, and tin, silver, glass, and suchlike.

Will you sell your things here as you brought them here?

I will not, because what would my labour benefit me? I will sell them dearer here than I bought them there, that I may get some profit, to feed me, my wife, and children.

"Cherokee Brook" makes no improvements to the in-game items he resells. He doesn't even take them across the wide, winedark sea. He buys low and sells high. He exploits sellers' naivete about the "correct" price.

Both of the exchanges his bots make, the buying and the selling, are consistent with the welfare theorems of economics; each party is better off for having made the trade. But C.B. has access to better information, so does this edge mean that the exchange can no longer be counted as euvoluntary?

Note that his bots' prescience didn't extend to other types of bots. Gold farming scripts caused great inflation, meaning that he was stuck trying to sell goods for which there were no buyers.

Interesting that. It's almost a metaphor for something.

Please refrain from the "too bot to fail" jokes, people.

Mitigating Middleman Moral Mileage

Buy cheap, sell dear. This is the middleman's maxim. She improves not her wares, merely transmitting them as near as possible in their original state from the hands of a willing seller to a willing buyer. WoN, IV.2.30:

The act of navigation is not favourable to foreign commerce, or to the growth of that opulence which can arise from it. The interest of a nation in its commercial relations to foreign nations is, like that of a merchant with regard to the different people with whom he deals, to buy as cheap and to sell as dear as possible. But it will be most likely to buy cheap, when by the most perfect freedom of trade it encourages all nations to bring to it the goods which it has occasion to purchase; and, for the same reason, it will be most likely to sell dear, when its markets are thus filled with the greatest number of buyers.

The consequentialist defense of the mancgere is clear: without someone to navigate the water and roadways of the world, it'd be pretty dang tough to get peppercorns in Continental Europe or Toyotas in Kenya.

Please review Mungo's latest piece here and ask yourself if adding moral distance to an exchange is an underappreciated benefit provided by double arms' reach exchange.

To wit, if the actress in question were to provide the same commodity directly to her professors, a barter exchange where a market exchange were available, the issue would cease being a moral curiosity and immediately become grounds for, inter alia, a few hearty rounds of termination of employment.

NB that adding moral distance makes no value distinction. Sometimes it's wise and useful to close buyers and sellers, particularly if doing so can help make Pareto improvements. But don't be too hasty to abandon the virtue of temperance: sometimes moral distance is a feature, not a bug.

EE Goes to the Movies Ep. 1: Empire of the Sun

One of the legendary classic papers in economics is R.A. Radford's 1945 Economica piece "The Economic Organisation of a P.O.W. Camp" available here. As an object lesson in the value generated simply by trading an initial endowment, this piece is at once brilliant in its simplicity and delightful in its replicability. Some of the more engaging Principles of Economics professors out there should cop to a simple little classroom experiment where you randomly distribute randomly selected tchotchkes (double the randomness, double the fun!) to a classroom full of students. Have them subjectively rate their endowment on a scale of 1-10, tally the scores, then give them 15 minutes to trade (there are little flourishes you can do to this depending on what you want to emphasize) and repeat the assessment phase. In almost every attempt, the post-trading pseudo-GCP (gross classroom product) will be higher after the trading session.

Now, I don't know how many econ courses Spielberg slogged through at California State, but it seems at least a little bit unlikely that he's sat down with Radford for a cozy evening of comparative economic history.

Then again, the paper was based on what Raford himself actually witnessed in a prisoner camp, and spontaneous market formation is hardly rare. Be it marbles, Pogs, Pokemon, Barbie accessories, CIA terrorist playing cards, or thermal exhaust schematics for the Death Star, people require little prompting to begin trading when it's to their advantage.

Regrettably, I can't find a quickly available clip, but this tendency was nicely presented in Spielberg's 1987 film Empire of the Sun. A young Batman, before he even donned a Gatsby (yes, that's the proper term for a Newsboy Cap) and began prancing around the Disney lot singing about the exploitation of child labor, found himself a young ward in the custody of Japanese jailers in wartime China. While there, he busied himself as a gofer for the camp's mancgere, shuttling a little of this, a little of that, buying cheap and selling dear.

Here's the question (and I again apologize for not having a clip to share): do you get the sense from watching the film that the business of POW camp trader is euvoluntary? It's not that easy a question, is it? In an absolute sense, everyone in the camp (perhaps even the guards) has a lousy BATNA, but since the prisoners all more or less share the same grim fate, there's not a lot of disparity there. That is, until the gains from trade start to accrue to the entrepreneur.

Even if everyone is better off in the camp as a result of a functioning market, is it still okay to begrudge the modest wealth accumulated by the shopkeep? What's your opinion? How does Spielberg want you to think about it? Does the silver screen depiction mirror commonplace moral intuitions? Does it attempt to insert its own interpretations into the minds of the audience? How successful do you think it is?

Under what conditions do POW camp black markets stop providing net benefit and begin being truly predatory?

AirBnB: Cost and Choice.

AirBnB is an online service that matches travelers with property owners. The two can then negotiate for a night's stay. Yesterday, I scanned past a comment somewhere that warned of thinking that this idea is all that much of a boon. After all, the opportunity cost of peer-to-peer hosting is that established hotels lose out on business. The comment surprised me, coming as it did from an economist I respect quite a bit.

Consider the purpose of production in very broad terms. The means of production exist to serve the ends of human wants. Here, we've got a matching problem. Under the technology of its time, hotels were a way to match the itinerant with a soft pillow, a roof, and a mass-produced flea market painting. Before that, medieval codes of hospitality had to suffice. Before that, you slept in your caravan or more likely never traveled at all. And it's BATNA all the way back. I've slept under the stars before, and you probably have too. So one way of looking at it is that AirBnB is just another technology that fulfills human wants. And it's not like access to the impersonal market is barred, so folks are unlikely to find systematic exploitation in the business model.

It seems then that most of what the AirBnB service does is permit transfers from firms to property owners. It injects substitutes into the market, making overnight stay services more competitive, more elastic, and therefore closer to marginal cost. Hello people, that's economic efficiency. AirBnB is a high-volume, low-overhead mancgere.

From there, it's a matter of comparison. Compare the reliability of reputational capital between private homeowners and hotels. Compare arguments about economies of scale when it comes to housekeeping and laundry services, or about the lumpiness of opportunity cost. It's easy enough for modeling purposes to assume that people value their time equal to their wage rate, but that's just an assumption. There's no a priori reason to confidently assert there's a linear relationship there, at least much beyond the bounds of a normal workday.

The residual euvoluntarity is a curious question. City elites seem to be comfortable protecting the rents of hoteliers (no surprise there, PAA), and you might see how this service could grate against conventional capacities of trade and ownership and trip over the regret condition. Despite this, I have a hunch that the democratizing of overnight stays is a power-to-the-people sort of thing and I expect that if not this particular service necessarily, then some clone of it will end up the new normal with a bit of spit and polish.

Bet on it.

High Frequency Corn Trading

High Frequency Trading (HFT). It sounds like one of the knobs on an old cabinet-style cathode ray tube television set. It isn't. It's computer-assisted finance that yields a whole bunch of tiny returns. Instead of periodically dropping a brick into your account, it sifts dust in.

Is it euvoluntary to trade for fractions of a penny on contracts that last fractions of a second?

Let's pause for a moment to remind ourselves of the function of the finance. In a fundamental sense, finance is about information. It's a way of pooling and relaying enormous amounts of distilled market signals in the form of prices, of balancing beliefs about future states of the world and permitting folks to share what they know and what they expect. When I list an IPO, investors tell me quite bluntly whether or not they think my venture is worth a tinker's damn. When I write a pork belly future contract, I lock in the sale price and let some Chicago hot-shot bear the risk that my little piggies get swine flu before the end of the season.

When I leverage the hell out of a margin call on a Russian bond spread, it's because I have fancy models that tell me there's arbitrage in them thar hills.

Yikes!

Okay, so finance is obviously not euvoluntary when it introduces systematic risk that snares taxpayers in its briars, but that strikes me as an error to be laid at the feet excessive latitude in constitutional interpretation. I don't know about you guys, but I've gone over the articles and despite my best efforts cannot endeavor to lay one bent knuckle on that passage which authorizes Congress the bailout authority it has so graciously endowed itself.

Recall also one of the chief pillars of economics: nothing is free. The opportunity cost of a CBOE trader is whatever else she might have done with her life, and considering that traders tend to be smart, driven folks, that cost could be high indeed. I imagine there's some costs of capital in there too for buildings and computers and all that, so let's say that's consistent with most other industries and that it's about 1/3 of total income. Good traders earn hefty returns to their efforts, and HFT is part of this environment. Still, this doesn't tell us whether or not there's any residual value captured on the other side of the exchange. When I buy a taco from the truck, I'm better off to the tune of [my subjective value of the taco]-[whatever else I could have spent the cash equivalent on] and Carlos is better off by [the goods he can buy with the money I hand over]-[the time, effort, and materials it took to make and sell me the taco]. BATNA disparity is at least partly driven by the comparison between these two differences. If Carlos is struggling to make ends meet and I'm a high-falutin' aristocrat, the pedestrian morality cuts against me. Contrarily, if we're back in the desert, Carlos is the one with the advantage.

The point of HFT is that neither one of us captures that much excess value per trade. My taco is microscopic and I pay Carlos fractions of a cent. Enough of these trades, and I've got a thermos of taco slurry and Carlos has a pile of zinc shavings. I fear this analogy has fallen apart.

The thing I'm asking is whether or not HFT is marginally welfare-enhancing. The opportunity cost of HFT is the old-style buy-and-hold trading and maybe some brainpower bent to writing algorithms. On this margin, is the change euvoluntary? If not, which condition is violated? If it's nothing at all, then why do I hear my favorite bellwether groaning (Planet Money) from time to time? Is there something else troubling about HFT that doesn't clearly rest on pedestrian morality? Please feel free to sound off in the comments.

12 Parsecs

Smuggling is my favorite crime (to study, not to commit). Smugglers risk imprisonment (or worse) to connect buyers and sellers. In the face of state intervention, they boldly mancgere it up, moving goods and services from lower-value use to higher-value use. Two and a half cheers for the smuggling profession (I reserve the half-cheer for those who traffic in stolen goods or other cargo they have no justifiable claim over). How then ought I feel about those officials who aid and abet the noblest of the criminal class?

Tales from the Mancgere

Claims of skullduggery leveled at market makers come quick to the lips of the pedestrian economist. Such claims are usually grossly mistaken, but every now and again evidence seems to suggest that the secondary market as she is arranged, works poorly.

Here is a story about Christos Kamenides, a Greek professor (un)fed up with non-euvoluntary markups by gadabout wholesalers that he just up and sidestepped the production chain. Tired of excessive markups at the grocer's, he arranged a direct-to-the-consumer market between Greek farmers and shoppers. Farmers, for their part, get paid fairly and immediately--rather than waiting as long as a full calendar year for payments that for all they know might not ever arrive at all (it's fine for foreigners to mull about the ramifications of possible Greek default from our cozy offices, but a much different story for folks who have to live with the Sword of Papademos hanging o'er their head).

Without knowing more about the intricacies of the Greek agriculture market, I can only share my suspicion that the Southern European penchant for interventionism has managed to leak into the production, transportation and sale of food. If a wholesaler can leave farmers in arrears for over a year, that seems to be a rather dreadful failure of either the business model, the regulatory environment or the futures market. I won't bore you with a rehash of criticisms of the locavore movement here, but I will mention that this effort to bypass the middleman does not fall afoul of many of the fallacies of mood affiliation that plague most declarations of local farmer solidarity. Here we have a failed market and a low-cost alternative that (for the moment, anyway) effectively skirts a dysfunctional distribution system. It is a nice little flowering of euvoluntary exchange in a swamp of debt crisis* and central planner meddling.

Simply beautiful.

*(Author's note: it's not my first choice to refer to the problems in Greece as a "debt crisis", as by my reckoning they have a "government problem", but young lass, alas and alack, I lack the clout to rebrand the bee date, let alone the debate)