Thursday, April 30, 2009

Starbucks Overdose

If you have ever been to the loop area of Chicago you have probably noticed that there are a fair number of Starbucks locations. OK, that was a slight understatement. I can’t think of a single location in the Loop that is not within sighting distance of a Starbucks. Given the scarcity of retail space in Downtown Chicago, having three or four Starbucks locations on a single block hardly seems like an optimal allocation.
I am struggling to see the economic logic of extreme chain concentration. Surely the marginal revenue of an independent establishment would be greater than that of the 50th Starbucks within a relatively small area.
Since every location within the Loop is within two blocks of a Starbucks, I can’t imagine that a new location would attract many new customers. However, if one of the Starbucks were converted to an independent shop it would likely attract a large share of customers who preferred not going to Starbucks. Thus you would think that an independent shop would be willing to pay more to lease a location than Starbucks.
I can think of two possible explanations:
1. The major chains that dominate the area are engaged in an implicit price fixing. Basically, Starbucks and the other chains (I am looking at you Dunkin and Caribou) fear that any independent shops would significantly diminish there business. Thus when they open a new location they are really acting to freeze out any independent competitors.
2. Even though the expected return on investment is higher for an independent coffee shop the high price of commercial real estate may scare off many entrepreneurs. For a company like Starbucks committing to an expensive lease is not a great risk, but a local entrepreneur may be unwilling to take the same risk, preferring to locate to a cheaper neighborhood.

I don’t think that these two explanations tell the whole story, so I would be very curious to hear what other people think.

Inequality at Birth

Emmanuel Saez’s work on income inequality has been getting a lot of attention recently, for good reason. He has shown the extent to which inequality has grown rapidly in recent years. The benefit of economic growth this decade has gone almost exclusively to the extremely rich. The top 1% of the population now earn 25% of all income.
Yet I fear that this work may underestimate the true nature of inequality in our society. One of the flaw of much of the work on income and wealth distribution is that it fails to account for age. For example, my income is currently below the median household income; yet as a 23 year old with no dependents I am financially better off than the average American. The way that income and wealth distribution vary throughout the lifecycle of an age cohort is an important area where further research is needed.
In a perfect world everyone would start at the same place, as time passed differences would emerge due to talent, hard work and other elements of the meritocracy. Of course, that is not the world that we live in. Children born in wealthier families start life with a huge head start.
Marion Nestle recently noted that half of the infants in America received food aid last year. It is no secret that fertility rates in America are negatively correlated with income and education. Given the stark level of inequality present in America today, it stands to reason that inequality is even greater among newborns and young children than among the population at large.
This reality could have severe consequences for the future of the American economy and society. Numerous studies have shown how growing up in poverty can adversely affect a persons prospects for life. Is the future generation of Americans going to disproportionately suffer these consequences. Will the relative scarcity of Children from affluent backgrounds give those fortunate few an even larger advantage than the well off currently enjoy. Or will new opportunities open up to the children of the poor.
More research needs to be done to uncover the rates of inequality among households with young children, and to see how this rate has changed over time. A cohort based approach to income and inequality studies would provide a better understanding of how our society and economy is likely to evolve.
While more research is needed, I think it is clear that a significant commitment needs to be made to ensure that our future generation does not disproportionately grow up in poverty.

The bloated private sector vs. the starved public sector

For the past 3 decades faith in the free market powers of the private sector have led to a massive misallocation of resources away from public sector investment. A careful reading of price signals reveal a severe under investment in public goods relative to private sector goods. I would further argue that the unstable bubbly nature of financial markets is the result of excessive capital being allocated to the narrow range of goods and services in which the market works well.
The following contrasting sets of investments opportunities demonstrate how the private sector has become bloated while the public sector has been starved of necessary resources.

Public Education vs. Information Technology

The development and rapid proliferation technologies such as the internet, cell phones and other communication tools has brought undeniable benefits. But is the market calling for more resources to be dedicated to these industries. Not really. Over the past couple of decades, the price of computing power and communication technologies has been in nearly continuous free fall. New innovations quickly become commodities while many of the best and most popular innovations from Youtube to Facebook have failed to find a revenue stream.
If some of the investment in IT has been misplaced, what would be a better use of the bright mathematically inclined minds. Over the long run, human capital is the limiting factor in innovation and growth. The wage differential between educated and uneducated workers is a clear price signal indicating demand for education. Yet we have ignored this rapidly rising price signal by failing to provide adequate support to schools at all levels. The rapidly rising tuitions at public universities is another indicator of declining public support for education at precisely the time when this sort of investment is most needed.

Public Health vs. Processed food

Public health spending is one of the ultimate public goods as it benefits the society as a whole. There is no doubt that American’s spend a lot on healthcare, more per capita than any other country. Yet our health outcomes are hardly impressive. Investing a little more in creating an environment that promotes health could save far more in future healthcare and lost productivity due to preventable disease. From teaching basic nutrition principles to providing safe places for people to be physically active to preventing outbreaks of food borne illnesses our public health efforts have been pathetic due to a lack of commitment.
While, we have barely attempted to create a healthy environment, the food industry has had no trouble bringing new food like substances to market. Given this failure it is not surprising that today’s young people may be the first generation in American history that fails to outlive their parents.

Urban Infrastructure vs. Suburban housing

The housing collapse of the last couple of years makes the misallocation of resources in the housing sector abundantly clear. Yet the market has been sending out the same signals for years. Developers always justified suburban car based residential development as providing what the market. Yet a simple look at price data tells a different story. Real estate prices in walkable urban areas have consistently been far higher than in suburban car oriented areas. In the current crises real estate markets in places like Manhattan, DC and San Francisco have held up far better than the rest of the country.
Yet it would be impossible for private developers to recreate high quality urban environments. These places require significant investment in transit, law enforcement, parks and other amenities that require government support. Without public investment private developers could only create a limited range of housing options. Hence the appreciation of urban real estate prices relative to suburban areas.

The market is incapable of providing the full range of investments needed to maintain a healthy growing society. If we come out of the current economic crises with a more balanced distribution between public and private investment we will be in a better position to maintain long term growth.

Sunday, April 12, 2009

What is saving?

I have been thinking a lot about the meaning of saving money. Which brings me to what I call the fundamental question of finance: How does forgoing consumption today translate to increased consumption in the future?

In thinking about this question I have identified six distinct answers to this question:

The dog: Place a bowl of food in front of a hungry dog and it will devour it without hesitation, lick the bowl clean and then look around for more. The dog's world represents the very simplest economic system. What you have now is what you consume now. If there is plenty today the dog will eat itself sick. If there is no food tomorrow he will go hungry.

The squirrel: Before the first human walked the earth, animals such as squirrels discovered the first financial innovation. Just as the squirrel gathers nuts to get through the long winter, there are some goods that we can simply store and use in their current form. This is the simple and most obvious answer to the question listed above. For many people this is as far as they get when thinking about savings. However, money is not a can of beans. Simply storing money today does not automatically translate to purchasing power in the future.

The farmer: Around 10000 years ago humans discovered that seeds left in the ground would grow into new plants. Thus the birth of agriculture also represented the first investments. By not consuming some grain today, early farmers could ensure a reliable supply in the future. Many natural and living things allow this sort of simple investment. We now know that by not clear cutting a forest or fishing a species to extinction we can ensure an adequate supply for the future.

The builder: Some projects take a lot of time and effort before they yield any value. 10 people might have to work for half a year to build a house. Bigger projects like highways and dams can occupy hundreds or thousands of people for years. Of course all of those people need food, shelter and all the other necessities of life. Which brings us to the fourth answer to our big question. When I consume less then I produce, my surplus can sustain those who are working on larger projects. In exchange, I expect to receive some of the benefit of the completed project.

The parent: Over the course of ones life ones needs and abilities change. A new born infant is completely helpless to meet its basic needs. By providing for young children during their peak production years, the parent can count on their children to sustain them as they age. This familial relationship has been a cornerstone of nearly every society in human history. In modern societies this function is often aggregated, in that governments invests in education for children and pensions and medical care for the elderly. The logic is basically the same, individuals in their prime working years consume less then they produce, while the surplus goes to supporting children and the elderly.

The creator: The greatest achievements often require years of effort with only a small possibility of creating anything of value. Great works of literature, billion dollar corporations and medical breakthroughs all follow this pattern. An individual researcher may toil for 20 years with no tangible results before a discovery that creates millions of dollars of value. The artists, entrepreneurs, scientists and writers depend on the savings of the general population to support them in their efforts.

The financial sector is responsible for taking the excess production of today and using it to meet the needs of the future. Some goods can be stored for the future, but the vast majority of the production is services or perishable goods that cannot be stored. Forsaking consumption today does not guarantee that there will be plenty tomorrow.

Wednesday, April 1, 2009

3 Technologies that don't impress me much

I am something of a technophobe. When some new technology is hyped as the latest greatest thing, nine times out of ten I am unimpressed.

1. Cell Phone Features: I want to be able to do three things with my phone; talk, text and store numbers. Beyond that I value battery life over every other damn thing that can be put on my phone. I don't need to check email, take photos, look up restaurant reviews or play scrabble 24 hours a day. The best phone I have ever had was the first one I got for free with service in high school .

2. Kindle: I like reading books. Removed from electronic connections it allows the reader to spend hours immersed in the authors world experiencing the content as the author envisioned it. When reading from electronic content people want to customize the view, follow links, look up unfamiliar concepts etc. I just feel no desire to fold books into the broader spectrum of electronic media.

3. Twitter: Seriously, I don't get it. Has anything so useless ever been so hyped. Have any of the throngs of reporters breathlessly declaring twitter the second coming of language ever actually read a twitter. We all have a stream of random thoughts running through our heads, but until now no one expected everyone they have ever met to care.