When will manipulation of public prediction markets begin to work?

Michael Giberson

At Constructive Economics, Abe Othman discusses a purported manipulation attempt in Intrade’s Health Care Reform bill market.  The nut of the story is that early on March 17th a trader apparently poured a bit of money into the market, briefly driving the price from around 60 down to 35.  After a few hours the price bounced back into the 60s; if it was manipulation, it failed.  But Othman speculates about a future in which manipulation would work.

Because the Intrade price can be interpreted as an estimate of the likelihood that the bill will pass, a sharp fall in the price could indicate new information reaching the market suggesting the bill will fail.  In the manipulation story presented by Othman, a new perception the bill is failing could be used to pressure the weakest members of the coalition supporting the bill to drop out (Maybe the argument goes, “Why go down with a sinking ship, when you and your constituents never wanted the ship in the first place?”).  As support actually falls, the likelihood the bill passes drops with it.  The manipulated price becomes, with a little lobbying, a correct prediction.

While Othman recognizes that the purported manipulation failed this time, he wonders whether prediction market prices will become sufficiently trusted that such a manipulation will work.  In fact, he predicts, “It’s only a matter of time, a couple years I would guess, before the kind of manipulation I’ve described actually works.

I disagree.

While it is true that a trader can often move the Intrade price relatively cheaply, because the markets often are thin, it is well known that a trader can move the Intrade price.  No half-way sophisticated interpreter of Intrade price data would take a sudden sharp move based on a few trades as proof of changing fundamentals, at most it might inspire the viewer to scan for new news.  It was only a few hours after the March 17 episode before bloggers were calling “manipulation!”  Are observers going to become less willing to call “manipulation!” in a couple of years? No.

While it is true that a trader can often move the Intrade price relatively cheaply, because the markets often are thin, holding the market to the manipulated target price can get expensive.  A manipulator can’t buy the price signal, he just rents it for a while.  And the rental rate will tend to rise over time because the mis-pricing will attract informed traders to trade against the manipulator.

Maybe this gets interesting.  So long as the markets are thinly traded then the market signal can be rented cheaply, but observers treat the signal as cheap talk.  What if talk is not cheap?  Can a deep pockets manipulator actually buy the market price?  That is to say, can the manipulator rent the signal long enough to overcome the “cheap talk” dismissal and change the likelihood of the outcome? I’d say this would work only in a world in which enough market observers  trust the market price summary more than all of the other information available about the subject of the prediction market, but this is unlikely to be the world we live in.

I predict: this kind of manipulation will not happen within the next several years.

Government, slavery, Jim Crow, The New York Times

Michael Giberson

The New York Times ran an editorial on the election of Rand Paul called the “Limits of Libertarianism.”  I haven’t been paying much attention to Paul’s campaign or related politics, so don’t comment on Paul’s views or the Times response to them.  But I have to draw attention to for the purpose of publicly ridiculing one of the Times final sentences, which contrasts government power against a peculiar view of free markets:

It was only government power that ended slavery and abolished Jim Crow, neither of which would have been eliminated by a purely free market.

Should we give government power credit for ending slavery in the 1860s when government power had been supporting slavery for more than a century before?  How long would slavery have persisted in the United States had the government not used its power to endorse and protect it?  And what is this queer notion of a “purely free market” in which some people can legally assault other people, deprive them of their liberty, and sell them into slavery?  I had imagined that such slavery could not exist in a purely free market.

Should we give government power credit for ending Jim Crow, when Jim Crow attitudes were turned by state and local governments into laws that used government power to force segregation?  How long did it take the Times‘ lauded (federal) government power to overcome the use of (state and local) government power imposing segregation requirements?  In what vision of a “purely free market” can the government tell a business that it must segregate its customers by race?

Idiocy.

Cogeneration vs. monopoly electric utility service, circa 1909

Michael Giberson

The Isolated Plant magazine published “A letter from a New York Correspondent,” in their August 1909 edition:

Mr. Editor:

From the viewpoint of one of the “common people,” the recent issues of your magazine have been striking fire with every telling blow…  The following incident is mentioned as a bit of local history.

Two downtown office buildings adjoining each other on the same side of the street, and carrying the same class of tenants, were not operating under sufficiently even costs.  One of them had its own electric power plant and the other used Edison service.  The man who operated his own plant even had a little power to spare and closed a two years’ contract with the other agent to supply the latter’s building with light at a rate considerably lower than the street service.  A contractor installed a 3 inch loricated conduit carrying three double braid conductors between the generator switchboard through the foundation wall to one side of a three-pole double-throw service switch previously installed.

This switch had been used to supply Edison break down service when the building operated its own plant.  The wiring was installed in full accord with the National Code as adopted by the N. Y. Board of Fire Underwriters, and a certificate of approval was received from the city department.  The contractor received a “violation,” however, from the Fire Underwriters, and any attempt to secure a committed statement from the latter board as to the code rule violated was futile.  This was evidently somewhat peculiar, the contractor had performed his work according to the rules of the board as publicly printed and circulated, yet a certificate of approval was withheld, and he could not receive his payment for the work.  The inspector was called on, he was non-committal … the Chief Inspector was non-commital … [The] Superintendent … quite abrubtly stated that his board would not approve the running of an electric power service through a party line; this ruling being the result of an agreement between his board and the N. Y. Edison Co.

Neither contractor nor agents could understand how any such mutual agreement could affect the fire risk….

The N. Y. Edison Co. also got busy after the contractor and threatened to send him to jail for “interfering with their meters,” which of course was not the case and the contractor was not molested; threat was also made to discontinue the [Edison Co.] service to the elevators, but it also passed over.

Both buildings secured independent insurance, the contractor got his money, and each agent fulfilled their two years’ agreement.

C. J. H.

At a time when cogeneration, smart grids, and decentralized energy resources are creating challenges around the fringe of standard regulated retail power service, it is interesting to see how the battled played out a century ago, when state regulation of monopoly regulated utilities was new and competition between central station power and the isolated plant was ongoing.

The Isolated Plant magazine has been digitized by Google Books.  See also the related post of a week ago, “The central station and the isolated plant.”

Orlando wants to discourage high gas prices near the airport

Michael Giberson

News headlines say, “Orlando wants to prevent gas price gouging,” though the practice Orlando politicians want to stop isn’t price gouging, per se. Rather, the target of the proposal is gasoline retailers near Orlando International Airport who charge substantially higher gasoline prices than neighboring stations. The proposal would require gasoline stations near the airport to post prices in a standardized manner.

Normally, competition between gasoline retailers keeps prices from getting too far apart in a region because at least some customers engage in comparison shopping.  Not all customers will comparison shop, and not even all price-aware customers will switch brands or delay refueling for a few pennies a gallon, so retail gasoline markets usually sport a range of prices.

But most of the time the difference between high and low is on the order of 15 or 20 cents a gallon.  A station near the Orlando airport has had gasolines prices that almost doubled the prices of other gasoline retailers in Orlando (for example, as noted here before, prices at $4.99 a gallon with competitors asking $2.59 to $2.75 a gallon).

It is an interesting little business niche.  Likely most of the sales go to tourists returning a rental car to the airport before hopping a flight home.  Likely the tourists are in a rush, they want to refuel near the airport to avoid paying a refueling charge, and they don’t have a good idea on where to buy cheap fuel around the airport. The price isn’t posted on a roadside sign, but the tourist likely assumes, based on general market experience, that the price isn’t too far out of line with neighboring stations.  Many start pumping the gas without checking the price on the pump – a few gag at the price but pump anyway – and a very few get back into the car and go in search of cheaper fuel.

The principled libertarian in me objects to imposing the price posting requirement as an infringement on the station owners’ freedom to operate his business the way he sees fit.  The consequentialist in me, though, finds it hard to oppose the proposal.  It seems a relatively targeted proposal to help consumers avoid paying the high prices that otherwise flourish in this little niche.

Maybe I should worry not so much about this narrowly targeted proposal itself, this minimalist nudge, but rather I should worry about a government that wants to expand its authority over voluntary deals between retailer and consumer.  Is this the sort of nudge that eventually shoves society onto a slipperly slope down the road to serfdom?

The principled libertarian in me objects, but the overwhelming majority of the voices in my head say the benefits of this proposal will exceed the costs: targeted in scope and aimed at helping the consumer make an informed choice. Why not?

Oil spills, movie stars, robot unicorns and regulation

Michael Giberson

Even before the current oil spill into the Gulf of Mexico it was well understood that drilling offshore sometimes results in spills.  The current oil spill in the news has brought the idea of spills to the attention of many, many more people, people who don’t usually think too much about these things.  But it isn’t obvious to me that the spill should cause us to revise our estimates of the likelihood of spills, or otherwise alter any of the factors that go into well reasoned policy analysis.  And if all of the inputs going into a well-reasoned policy analysis stay the same, then the policy recommendation should stay the same too.

If you now favor changes in regulations to reduce the likelihood of future oil spills, you should identify the new policy-relevant information upon which you base your call for changes.  Or, in other words, you should specify what was wrong with your understanding of offshore oil development as of about two months ago, and then explain how correcting that mistake leads you to favor more restrictive regulations.

It is possible, too, that correcting mistakes in your earlier thinking could lead you to favor less-restrictive regulations.  After all, there is no reason to believe that all errors in earlier thinking were biased in the same direction.  For example, learning about advances in movie-star funded clean-up technologies might lead you to reduce your estimate of the expected costs of spills.

By the way, with Canadian tar sands soon to become the largest single source for U.S. oil imports, any advocates of regulatory changes that diminish oil production from offshore U.S. sources on environmental grounds should  include in their analysis the environmental effects of marginal increases in tar sands output and other oil sources.  (Or did your policy analysis assume that diminished offshore production would be compensated for by people driving less and riding sustainably-fueled robot unicorns more?)

SEE ALSO: Robin Hanson on regulation ratchets for related.

Texas wind power: It isn’t about the RPS

Michael Giberson

Texas did it again, it achieved it’s target for new renewable power generation capacity years ahead of schedule. And so, of course, as it becomes increasingly obvious that the Texas Renewable Portfolio Standard (RPS) is essentially irrelevant to growth in wind power, the Texas RPS is increasingly held up as a success and model for other states and the federal government.

From Brighterenergy.org:

The State of Texas exceeded its 2025 renewable energy target 15 years early last year.

The Electric Reliability Council of Texas (ERCOT) said on Friday that there was a record increase in voluntary participation in the state’s renewable energy certificate program in 2009.

Nearly 15 million renewable energy credits [RECs] were retired last year, with just 6.79 million needed by retail electricity providers to satisfy the state’s renewable portfolio standard for the year.

A further 8.14 million RECs were voluntarily retired, surpassing 2008’s record of 6.77 million.

The figures came as ERCOT submitted its annual report on the scheme to the Texas Public Utility Commission.

With more than 10,000 megawatts of renewable energy capacity on the Texas grid – mostly wind power – the state has reached its 2025 target 15 years early, and has doubled the target set for 2015.

The original mandate for 2009 was just 2,000MW, which was achieved three years early.

“Successful”

ERCOT interim CEO Trip Doggett said: “The Texas program was the first of its kind in the nation when it began in 2001, and it is now recognized as one of the most effective and successful in the nation.

“It’s also one of the biggest influences on the rapid growth of wind energy in Texas,” added Mr Doggett.

Other than the popular but faulty post hoc ergo propter hoc logic, what is the evidence?

Sort of like the 45 mph minimum speed limits on some Texas highways, the constraints are so far from binding that it is hard to see how they are relevant.

I think a better explanation of the growth of wind power in Texas (and about 95% of the Texas REC-qualifying renewable power capacity is wind power) is the combination of federal Production Tax Credit subsidies + reasonably good quality wind resources near transmission lines.  The CREZ transmission expansion plan is likely the next most important factor.  REC monies along with other state and local tax exemptions are far smaller considerations, perhaps tipping the balance in favor of development for a few projects.

What is my evidence? Oh, actually, what I have is more of an inference and interpretation drawn from a number of mostly anecdotal sources.  Nothing really reliable to show.  But given the lobbying for a national RPS, it makes a difference whether or not the Texas law is the model it is held out to be.

I’m sure someone has put together the story somewhere.  Anyone know of anything?

Per capita energy consumption has declined in the United States

Michael Giberson

At the Freakonomics blog, James McWilliams offers a review of sorts of Robert Bryce’s new book Power Hungry: The Myths of “Green” Energy and the Real Fuels of the Future.  McWilliams reports that the book is “a sustained attack on our irrational infatuation with wind and solar power.” Part of Bryce’s “sustained attack” is a chapter on Denmark and wind energy, and McWilliams’s piece mostly directs itself to explaining and commenting on the Denmark chapter.

Unfortunately, McWilliams’s review only convinces me I shouldn’t rely on his opinions on energy topics.

I end up not believing the review mostly because the explanations of Denmark’s situation feel incomplete and a bit ad hoc.  But rather than ask you to trust my feelings, let’s look at a point McWilliams made where fact checking is easy. Here is McWilliams:

It should be noted, in all fairness to Denmark, that its citizens have done something the U.S. seems unwilling to do: they’ve kept energy demand flat. Today, Denmark uses the same amount of per capita energy as it did in 1981. Remarkable.

Do you interpret these two sentences as McWilliams claiming that Danish consumers have kept per capita energy use level since 1981 and U.S. consumers have increased per capita energy use?

A few moments on the internet turns up data from the U.S. Energy Information Administration on per capita energy use: per capita energy use was 332 million BTU in the United States in 1981, 327 million BTU in 2008, and 310 million BTU in 2009.  These numbers are from the 2008 Annual Energy Review and the 2010 Annual Energy Outlook.  A EIA spreadsheet from the 2006 International Energy Annual [XLS] has data on many countries, including the U.S. and Denmark, over the period 1980-2006. In general both countries have seen ups and downs in per capita energy use from 1980 to 2006, with the ups tending to reflect periods of low energy prices or stronger economic growth and the downs tending to reflect periods of higher energy prices or weaker energy growth. Unremarkable.

Since I can’t rely on McWilliams’s review, I don’t know yet whether I’m interested or not in Bryce’s book.  However, Bryce’s “Five myths about green energy,” an op-ed appearing in the Washington Post just before the his book was published, seems similarly incomplete and ad hoc in its analysis. (How critical for energy policy analysis is a calculation of watts of energy output per square meter of land devoted to energy production? It strikes me as reaching for a techno-scientific sounding statistic to dress up the author’s dismissal of wind power which is itself based on other grounds.) But op-eds are brief and by nature driven to anecdote rather than careful explication of data; maybe the book has more substance.

(A tip of the hat with link to John Whitehead at Environmental Economics for drawing my attention to the McWilliams review at Freakonomics.)

Electricity generation, New Source Review, and waste

Lynne Kiesling

On Friday at Environmental Economics, Tim Haab wrote about the implications of New Source Review for innovation in a regulated industry, and how to represent it in the standard Pigouvian model (do go read the whole post, it’s very useful). The basic question is this: does the stifling of innovation that results from New Source Review regulations change the fundamental analysis of the question of pollution?

I have some quibbles with how Tim frames the “externality” question — in particular, I prefer the “markets don’t fail, they fail to exist” formulation of the fact that some uncompensated cost is present, rather than “market failure” — but his post makes a really important point with respect to New Source Review and the Pigouvian model:

The technological improvements resulting from removal of New Source Review may shift the private supply curve to the right, and may reduce the emissions per unit of output, but that doesn’t solve the fundamental externality problem.   So even though the technological improvements may reduce per unit emissions, emissions may actually increase from the decreased costs of producing electricity (decrease per unit emissions, but increased units). Regardless, with or without the NSR regulation, there will still be emissions and those emissions will remain unpriced (inefficiently) by the market. ‘

While I agree that existing regulations may have reduced the incentive for innovation, their existence doesn’t change the fundamental market failure–emissions are not rationed through prices.  For a market to work efficiently, ALL costs and benefits of production and consumption must be internalized.  In such cases, emissions will be efficiently rationed.

I take issue with a couple of these points. First, if the Pigouvian model is the correct way to model the pollution question, it is incorrect that “ALL costs and benefits of production and consumption must be internalized”. For an illustration of why this claim is not correct, ask yourself this question: how much do you pay your neighbors for the lovely flowers they plant in their front gardens, and if you did pay them, would that induce them to plant more flowers? Of course you don’t pay your neighbors for the external benefit you derive from their lovely gardens, and I think it’s a safe generalization that your neighbor-gardeners have more intense preferences over their gardening decisions than you do over their decisions. What does that imply? It implies that even if you did pay them as compensation to internalize your benefit, if your marginal benefit is small relative to theirs, your payment is unlikely to change their decision at the margin of how much gardening to do. In other words, the only uncompensated costs and benefits that are important for achieving the optimal level of abatement (of a cost) or increase (of a benefit) are the costs and benefits that are Pareto relevant, that would at the margin change the behavior of the relevant party.

This must be a pet issue for me because I’ve written about it before, with respect to inefficient energy efficiency consumer subsidies, with respect to externality accounting, and with respect to the fact that Alex Tabarrok got a flu shot because he wanted to get kissed.

As a coda: I do not think that the Pigouvian model is the correct model, because it ignores the reciprocal nature of costs; in other words, it ignores the fact that the pollution problem is a problem of conflicting uses of a scarce common-pool resources, and the people with those different uses are imposing costs on each other. The polluter is not the only one creating a cost.

Second, I think Tim’s right about his interpretation of NSR and the Pigouvian model, but I also think that the Pigou model of a per-unit tax on output from a polluting firm is not the best model to use to see the effects of NSR, unless the policy you are analyzing is a per-unit output tax. I think a fuller answer to his astute student also includes the following:

If the policy is an emissions tax (e.g., a per-ton tax on sulfur dioxide or greenhouse gases), then NSR regulation artificially keeps abatement costs higher than they would be in the presence of the technological innovation. Thus at the margin, the NSR regulation does affect the firm’s choice, and the amount of abatement/emissions, because if the tax rate is higher than the abatement cost, then the firm will choose to abate. Thus NSR means that less abatement takes place under an emissions tax, by keeping abatement costs higher.

If the policy is a tradeable permit system, then NSR regulation artificially keeps abatement costs higher than they would be in the presence of the technological innovation. A firm’s abatement costs determine its demand for permits in the permit market. Thus at the margin, the NSR regulation increases the firm’s willingness to pay for permits, and leads to higher costs of achieving the abatement/emissions target.

“The central station and the isolated plant”

Michael Giberson

H. S. Knowlton said, “In the establishment of many kinds of modern business the question of cheap power is one of fundamental importance, and in not a few cases the industrial manager finds it a most difficult problem to decide between installing an isolated plant and contracting for central station service.” That’s from Knowlton, “The central station and the isolated plant,” Cassier’s Magazine, 32 (August 1907).  Here are a couple of quotes I liked:

To the modern central station man it seems preposterous that scores of small installations, often poorly operated, with wretched load factors, inferior supervision and an oft-times reckless disregard of fixed charges, should be tolerated by keen business men.  Duplication of generating capacity seems to him an idle waste of capital.  But the incubus of distribution cost sets the limit to the minimum profitable power rate, and far too often there is a lack of exact information as to the cost of distribution to particular customers.  The problem of ascertaining it is one of the utmost difficulty, as far as making its influence felt on specific rates is concerned, but it is one of the most fascinating questions in the field of modern electrical engineering.

I’d say that possibilities for distributed energy resources linked with smart grid capabilities makes this question once again “one of the most fascinating questions in the field of modern electrical engineering,” at least within the sub-field of power systems engineering.  Here’s another quote:

No one dreams of the extinction of the central station; it stands upon the solid foundations of maximum potential generating economy and minimum inconvenience to the customer, and even in the face of complex distribution charges and rate making processes which a none too friendly public finds difficult to understand, there will always be a large clientele for the commercial company to supply.

As history has it, the superior economics of the central station approach helped it dominate the electric power industry.  But superior economics in general doesn’t mean superior in every specific case, and changing technologies and energy prices means that all large power consumers should ask themselves the “make or buy” question from time to time, or as Knowlton puts it: central station or isolated plant?

NOTES: The Knowlton article was found via a footnote in John Neufeld, “Price discrimination and the adoption of the electricity demand charge,” Journal of Economic History, Vol. 47, No. 3 (Sep., 1987).  Cassier’s Magazine volumes are available online via Google Books (link to the Knowlton article in volume 32).

Interested readers might also check out The Isolated Plant magazine, first published in December 1908.  The lead article in volume 1, issue 1: “The central station vs. the isolated plant: their respective fields,” by Percival Robert Moses.  (Moses begins, “Has the isolated plant any logical right to exist at present, and if so, is it’s right only a passing one of a few years duration?”)

The smart grid and the advance of civilization

Michael Giberson

Scientific American has an article on the start-up pains associated with smart grid development:

Only one thing is worse than the lights not coming on when the switch is flicked—and that’s the lights going out right afterward. The fact that the problem is most often a burned-out lightbulb is testimony to the reliability of what’s sometimes called the world’s largest machine—the U.S. transmission and distribution grid for electricity.

This made me laugh:

“If Alexander Graham Bell returned to Earth today, the progress in telecommunications over the last 125 years would be mystifying,” said Robert Catell, chairman of the New York State Smart Grid Consortium, at a smart grid event in New York City at New York University (NYU) in February. “If Thomas Edison came back today, not only would he recognize our electricity system, he could probably fix it” when problems arise.

Probably not true. After all, most of the grid is based on alternating current (AC) technology, but Edison was a proponent of and best understood direct current (DC).  Now if Catell would have said Nicolai Tesla, that would have been both funny and true.

The article mentions many trials and early advanced metering programs, emphasizing the costs and uncertain benefits.  Catell is quoted again, saying, “An educated and informed consumer is the best weapon in the war against energy demand, and the smart grid is the best way to educate the consumer.” Some of the examples in the article have benefits coming from having consumers act in response to information provided (via the meter, email and even an in-home orb that glows different colors depending on the price of power).

But engaged, immediate consumer response to changing prices is likely only to play a small part within the bigger energy picture.  People (who are not energy policy geeks or early adopters) have too many other things to do.  As Alfred Whitehead said of civilization generally, consumer engagement in the electric power industry will advance “by extending the number of important operations which we can perform without thinking about them.”