Jean Tirole, the newest addition to Nobel Laureates in Economics.

                                         Comments due by Nov. 1, 2014

“It’s complicated.” No, that’s not Jean Tirole’s relationship status. Rather,
it’s the conclusion of his research program into how best to regulate market
competition. It earned him this year’s Nobel in economics.
Mr. Tirole is a French economic theorist whose work is central to the
work of the Federal Trade Commission and similar regulators around the
world who have been given the task of ensuring that commerce is not overly
distorted by the exercise of market power. The issues are complex and
subtle, as competition policy affects not only the prices that are set, but also
the incentives to produce more, to invest (or overinvest) and to merge.

The online chatter among my economist friends today has been entirely
enthusiastic about Mr. Tirole’s prize. The consensus is that he represents
the very best of economics. He tackles big problems, he develops new tools
when they’re needed, and his research is always grounded in the real world.
While Mr. Tirole’s work is abstract, in the sense that it involves
mathematical modeling of the likely responses of firms, suppliers,
customers and regulators to one another, it is also very much grounded in a
subtle understanding of the specific markets he has studied. Mr. Tirole’s
scholarship is not about extolling the elegant simplicity of an all-knowing,
omnipotent invisible hand that always finds the best possible outcome.
Rather, his research explores the messier reality in which markets are
populated by monopolists seeking to exploit their market power,
entrepreneurs trying to fool regulators, and regulators whose choices are
constrained by imperfect information, political constraints and their own
human foibles.

This is a research program that has both won enormous acclaim within
the academy — Mr. Tirole has long been a favorite among academic
economists to one day win the Nobel — and has had a profound impact on
public policy. As Joshua Gans, a University of Toronto economist, wrote this
morning, Mr. Tirole’s “work on regulation has influenced virtually all price
and nonprice regulation of firms with market power for two decades.”
While the previous generation of economists had been engaged in the
search for very simple rules that could apply to the regulation of all markets,
Mr. Tirole has shown that the right rule for protecting the public interest
depends critically on the details of a market.

For instance, when regulators link the prices that firms are allowed to
charge to their costs, it may be harmful because it limits their incentive to
find innovative ways to cut costs. But there may be an offsetting benefit if it
blunts the incentives for those firms to cut costs by reducing quality. This
offsetting quality effect is an important consideration when customers can’t
judge quality for themselves, but should be ignored when customers can
figure out the quality of a good before buying it.

In another example, regulators had historically not been overly worried
about monopolists embedded in a production chain. Their view was that
competition among such monopolists’ suppliers or customers would prevent
them from further exploiting their monopoly power in the next link of the
production chain. But in some cases, a monopolist may actually disrupt
competition at the next stage. For instance, the inventor of a cost-saving
innovation might garner a bigger profit by selling the new idea to just one
firm rather than 10. Effectively, that single customer is buying the right to
monopolize the next stage of the market, and so is willing to pay more than
10 times the competitive price for the innovation. Of course, it’s willing to
do this only if it can be guaranteed that it will be the only buyer given access
to that innovation.

To take another case, an earlier rule of thumb had suggested that
regulators should always be suspicious of firms that set their price below
their marginal cost, because they’re probably just trying to drive
competitors out of the market. But many newspapers are given away for
free, and none of them seem like future media monopolists. Rather, the
newspapers are given away in an effort to increase circulation, which in turn
increases advertising revenue.

The new economy has also provided fertile territory for Mr. Tirole. The
development of new platforms, such as video game platforms like the Xbox
or Sony PlayStation, provide a layer of complexity not present in most
markets, because gamers need games, and game developers need gamers.
Similar issues arise whenever the behavior of buyers depends on that of
sellers, and vice versa, such as in the markets for credit cards, social media
and search engines.

Given his interests in understanding linkages within and between
markets, it’s little surprise that Mr. Tirole has turned his attention to
understanding the appropriate regulatory response to the
interconnectedness of the financial system.

The conclusions of Mr. Tirole’s style of analysis defy easy political
characterization. In some cases they may call for a more vigorous regulatory
response from government policy makers than is currently the norm, while
in others, they call for greater restraint. In each case, the recommended
policy depends on the details of the particular market, and in particular on
what information is available; what contracts can be written; and how
competitors, suppliers and customers are likely to respond.

In turn, this shows just how much Mr. Tirole’s work is a sophisticated
mash-up of the three recent Nobel-winning themes that have revolutionized
microeconomic theory. His research extends and applies the tools of game
theory, which is used to analyze strategic interactions between firms and
their competitors, suppliers, customers and regulators. It takes seriously the
problem of imperfect information, analyzing how these interactions are
shaped by what each of these players knows about the others. And he has
been a pioneer within contract theory, assessing the consequences of the
difficulty of writing contracts that fully specify the consequences of
commercial transactions. This prize represents a vote of confidence in the
direction of modern microeconomic theory.

While we economists applaud Mr. Tirole for having pushed back the
frontiers of knowledge, all of us should also be grateful that we live
somewhat better lives in part because of his role in creating policies that
better direct market forces toward serving the public good. And that’s not so
complicated a desire.

(Justin Wolfers is a senior fellow at the Peterson Institute for Internat)

Minimum Wage

    Comments due by Oct. 25, 2014

President Obama is pushing hard for an increase in the federal minimum wage to $10.10, from $7.25. State and local governments have jumped on the bandwagon. Massachusetts has passed a minimum of $11, the highest state minimum in the country, and Seattle's City Council has voted to raise the wage floor to $15 an hour over seven years; San Francisco is considering a hike to $15 too. The president and others argue that a higher minimum wage is needed to help poor and low-income families, who have suffered from stagnating wages and rising income inequality. But a higher minimum wage would do little for such families.

One might think that low-wage workers and low-income families are the same. But data from the U.S. Census Bureau show that there is only a weak relationship between being a low-wage worker and being poor, for three reasons.A higher minimum wage raises wages of low-wage workers, and even though most evidence points to job losses from higher minimum wages, the evidence doesn't point to widespread employment declines. Thus, consistent with a recent Congressional Budget Office report, many more low-wage workers will get a raise than will lose their jobs. But that argument is about low-wage workers, not low-income families. Minimum wages are ineffective at helping poor families because such a small share of the benefits flow to them.

First, many low-wage workers are in higher-income families—workers who are not the primary breadwinners and often contribute a small share of their family's income. Second, some workers in poor families earn higher wages but don't work enough hours. And third, about half of poor families have no workers, in which case a higher minimum wage does no good. This is simple descriptive evidence and is not disputed by economists.

A historical perspective is instructive. Assembling Census Bureau data over nearly seven decades, Richard Burkhauser and Joseph Sabia have shown that in 1939, just after the federal minimum wage was established, 85% of low-wage workers (those earning less than one-half the private-sector wage) were in poor families. Such a high percentage implies that, in that year, the new minimum wage targeted poor families well. However, as the public safety net expanded, family structure changed and more people in families began working, this percentage fell sharply over time—to around 17% by the early 2000s.

In contrast, as of the early 2000s 34% of low-wage workers were in families that were far from poor, with incomes more than three times the poverty line. In other words, for every poor minimum-wage worker who might directly benefit from the minimum wage, two workers in families with incomes more than three times the poverty line would benefit.

It is hard to design government programs that narrowly target those we are trying to help, so evidence that some of the benefits accrue to those who aren't targeted should not be used as a blanket condemnation. But the extent to which this happens with the minimum wage is staggering.

The effectiveness of minimum-wage targeting may have improved in the past decade because of declines in wages for lower-skill adults, and a lower employment rate among teenagers. But the improvement is only slight. Using data from the Current Population Survey for recent years, my graduate student Sam Lundstrom has calculated that if we were to raise the minimum wage to $10.10 nationally, 18% of the benefits of the higher wages (holding employment fixed) would go to poor families. Twenty-nine percent would go to families with incomes three times the poverty level or higher.

What about minimum wages as high as $15 an hour? A higher minimum obviously affects more workers. But because workers at higher wages are even less likely to be in poor families, the targeting only worsens with a higher minimum wage. For example, applying the same calculation as above for a $15 per hour minimum, the share of benefits going to poor families would decline to 12%, and the share to families more than three times the poverty line would increase to 36%. And this does not account for the sizable employment losses that would likely result from such a large minimum-wage increase.

A higher minimum wage can still reduce poverty if the wage gains for workers in poor families outweigh the job losses caused by the increase. Researchers have studied this question, using data from the Census Bureau's Current Population Survey to compare changes in poverty in states that raised their minimum wage vs. states that didn't. Like the longer-running debate on the employment effects of minimum wages, there are some divergent results. However, most studies—this time in contrast to the conclusions that CBO reaches—fail to find any solid evidence that higher minimum wages reduce poverty.

This evidence suggests we should consider alternative policies. The Earned Income Tax Credit directly targets low-income families, rather than low-wage workers. And my research with William Wascher, using Census Bureau data, shows that a higher EITC boosts incomes of poor families, and even—by encouraging work—leads to more low-income families earning their way out of poverty. The EITC could be made more generous, particularly for childless adults who currently get little from it.

Because the EITC operates through the tax code, it also has the virtue, in this era of rising inequality, of being financed disproportionately by those with the highest incomes. Raising the minimum wage is ineffective on that score because it is paid by those who hire low-wage labor. Some employers of low-wage labor may be rich, but many are not.

The desire to help poor and low-income families is understandable. But increasing the minimum wage is a misguided way to do it.

Mr. Neumark is an economics professor and director of the Center for Economics and Public Policy at the University of California, Irvine.

Uber Pricing

                     Comments due by Oct. 18, 2014

NEW competitors always ruffle a few feathers. The unique thing about Uber, a new taxi-market player, is that it seems to have annoyed some of its customers as much as the incumbent cabbies it threatens. The problem is its “surge pricing”, which can make the cost of Uber rides jump to many times the normal fare at weekends and on holidays. Gouging customers like this, critics reckon, will eventually make them flee, denting Uber’s business. Microeconomics suggests that although Uber’s model does have a flaw, its dynamic pricing should be welcomed.

Taxi markets have long needed a shake-up. In theory, entry should be easy—all that is needed is a car and a driving licence—with new drivers keeping cab fares close to costs. Yet in many cities, cabs are far from that competitive ideal. Decades of regulation conspire to keep entrants out. In New York a pair of taxi medallions sold at a 2013 auction for $2.5m; many other cities have similar schemes. In London “the knowledge”, a test of familiarity with the city’s streets which GPS has made redundant but drivers still have to pass, can take four years to complete. Taxi markets often end up suspiciously clubby, with cabs in short supply and fat profits for the vehicle owners. Antitrust concerns have been raised in Australia, Ireland and Bulgaria among others.

Uber aims to change all this. Launched in San Francisco in 2010 it lets passengers hail drivers from their smartphones—a move requiring even less effort than extending your arm. Some vehicles are not so much taxis as private cars that Uber has vetted. The convenience of hailing a cab from the comfort of a sofa or bar stool has given the service a loyal fan-base, but it comes at a cost. Most of Uber’s prices are slightly cheaper than a street-hailed cab. But when demand spikes, the surge prices kick in: rates during the busiest times, such as New Year’s Eve, can be seven times normal levels, and minimum fares of up to $175 apply.

Critics of Uber’s pricing are treading a well-worn path: setting tailored prices for the same good—price discrimination—often causes howls from consumer groups. It seems unfair when the charges for drugs vary across countries, the price of train tickets varies with the buyer’s age, or, as in Uber’s case, the price varies depending on the time that the journey is booked.

But price discrimination is not necessarily a bad thing, as a 2006 paper by Mark Armstrong of Oxford University explained. A firm offering a single price to all customers faces a trade-off: lowering prices raises sales but means offering a cut to customers prepared to pay more. Maximising profits can often mean lowering supply: goods are not provided to cheapskate shoppers so that more can be made from high-rollers. Customers who value the good at more than it costs to produce might miss out in a one-price-fits-all system—as many punters who have tried to find a regular cab on New Year’s Eve will know.

Uber’s price surge aims to solve this. Like many technology companies Uber is a middleman. It links independent cab drivers with customers wanting a ride in the same way that Google links searchers and advertisers or eBay links sellers and bidders. The business model only works when successful matches are made. Because price spikes raise the pay Uber’s drivers receive (they get 80% of any fare, if they drive their own car) more cars are tempted onto the roads at times of high demand. Prices are high at 2am at the weekend not just because punters are willing to pay more, but also because drivers don’t want to work then.

This strategy is common for firms that operate platforms or “two-sided” markets which link buyers and sellers, according to a 2006 paper by Jean-Charles Rochet and Jean Tirole of Toulouse University. Firms often tilt the market to give one side a particularly sweet deal: nightclubs let women in free to justify charging men a hefty fee, telephone directories are given away to create a readership which advertisers pay to access. The theory predicts each side’s deal depends on two things: price sensitivity and how well-stocked each side of the market is. Uber’s price surge fits perfectly: Friday-night revellers are hit by a double whammy since they are willing to pay up precisely when the pool of cabs is low.

The real pricing problem

There is some evidence Uber’s surge pricing is improving taxi markets. The firm says drivers are sensitive to price, so that the temptation to earn more is getting more Uber drivers onto the roads at antisocial hours. In San Francisco the number of private cars for hire has shot up, Uber says. This suggests surge pricing has encouraged the number of taxis to vary with demand, with the market getting bigger during peak hours.

However, the inflexibility of Uber’s matchmaking fee, a fixed 20% of the fare, means that it may fail to optimise the matching of demand and supply. In quiet times, when fares are low, it may work well. Suppose it links lots of potential passengers willing to pay $20 for a journey with drivers happy to travel for $15. A 20% ($4) fee leaves both sides content. But now imagine a Friday night, with punters willing to pay $100 for a ride, and drivers happy to take $90: there should be scope for a deal, but Uber’s $20 fee means such journeys won’t happen.

Despite the revenues a matchmaking fee generates, it may not be Uber’s best strategy. A fixed membership charge is often firms’ best option in two-sided markets. By charging drivers a flat monthly fee Uber would generate revenue without creating a price wedge that gets in the way of matches. Since stumping up cash might put infrequent divers off, they could be offered a cheaper category of membership. Uber should keep its surge pricing in place. But to make the market as big as possible, and really revolutionise taxi travel, it might need to retune its fees. 

The Rise of the Robots

                                                    (C0mments due by Oct.11, 2014)
For decades, people have been predicting how the rise of advanced computing and robotic technologies will affect our lives. On one side, there are warnings that robots will displace humans in the economy, destroying livelihoods, especially for low-skill workers. Others look forward to the vast economic opportunities that robots will present, claiming, for example, that they will improve productivity or take on undesirable jobs. The venture capitalist Peter Thiel, who recently joined the debate, falls into the latter camp, asserting that robots will save us from a future of high prices and low wages.

Figuring out which side is right requires, first and foremost, an understanding of the six ways that humans have historically created value: through our legs, our fingers, our mouths, our brains, our smiles, and our minds. Our legs and other large muscles move things to where we need them to be, so our fingers can rearrange them into useful patterns. Our brains regulate routine activities, keeping the leg- and finger-work on track. Our mouths – indeed, our words, whether spoken or written – enable us to inform and entertain one another. Our smiles help us to connect with others, ensuring that we pull roughly in the same direction. Finally, our minds – our curiosity and creativity – identify and resolve important and interesting challenges.

Thiel, for his part, refutes the argument – often made by robot doomsayers – that the impact of artificial intelligence and advanced robotics on the labor force will mirror globalization’s impact on advanced-country workers. Globalization hurt lower-skill workers in places like the United States, as it enabled people from faraway countries to compete for the leg-and-finger positions in the global division of labor. Given that these new competitors demanded lower wages, they were the obvious choice for many companies.

According to Thiel, the key difference between this phenomenon and the rise of robots lies in consumption. Developing-country workers took advantage of the bargaining power that globalization afforded them to gain resources for their own consumption. Computers and robots, by contrast, do not consume anything except electricity, even as they complete leg, finger, and even brain activities faster and more efficiently than humans would.

Here, Thiel offers an example from his experience as CEO of PayPal. Instead of having humans scrutinize every item in every batch of 1,000,000 transactions for indications of fraud, PayPal’s computers can approve the obviously legitimate transactions, and pass on the 1,000 or so that could be fraudulent for thoughtful consideration by a human. One worker and a computer system can thus do what PayPal would have had to hire 1,000 workers to do a generation ago. Given that the computer system does not need things like food, that thousand-fold increase in productivity will redound entirely to the benefit of the middle class.

Put another way, globalization lowered the wages of low-skill advanced-country workers because others would perform their jobs more cheaply, and then consume the value that they had created. Computers mean that higher-skill workers – and the lower-skill workers who remain to oversee the large robotic factories and warehouses – can spend their time on more valuable activities, assisted by computers that demand little.

Thiel’s argument may be correct. But it is far from airtight.

In fact, Thiel seems to be running into the old diamonds-and-water paradox – water is essential, but costs nothing, whereas diamonds are virtually useless, but extremely expensive – albeit in a sophisticated and subtle way. The paradox exists because, in a market economy, the value of water is set not by the total usefulness of water (infinite) or by the average usefulness of water (very large), but by the marginal value of the last drop of water consumed (very low).

Similarly, the wages and salaries of low- and high-skill workers in the robot-computer economy of the future will not be determined by the (very high) productivity of the one lower-skill worker ensuring that all of the robots are in their places or the one high-skill worker reprogramming the software. Instead, compensation will reflect what workers outside the highly productive computer-robot economy are creating and earning.

The newly industrialized city of Manchester, which horrified Friedrich Engels when he worked there in the 1840s, had the highest level of labor productivity the world had ever seen. But the factory workers’ wages were set not by their extraordinary productivity, but by what they would earn if they returned to the potato fields of pre-famine Ireland.

So the question is not whether robots and computers will make human labor in the goods, high-tech services, and information-producing sectors infinitely more productive. They will. What really matters is whether the jobs outside of the robot-computer economy – jobs involving people’s mouths, smiles, and minds – remain valuable and in high demand.

From 1850 to 1970 or so, rapid technological progress first triggered wage increases in line with productivity gains. Then came the protracted process of income-distribution equalization, as machines, installed to substitute for human legs, and fingers created more jobs in machine-minding, which used human brains and mouths, than it destroyed in sectors requiring routine muscle power or dexterity work. And rising real incomes increased leisure time, thereby boosting demand for smiles and the products of minds.

Will the same occur when machines take over routine brainwork? Maybe. But it is far from being a safe bet on which to rest an entire argument, as Thiel has.

Bradford De Long)