One nation, under guard

Lynne Kiesling

This TechDirt article pulls together a lot of the various strands that are worrying about the growth of the U.S. police state — extralegal detention, the militarization of local police at the hands of the DHS, surveillance, increased imprisonment despite an all-time low crime rate, punitive immigration policy, the war on x where x is a member of the set {drugs, terror, …}. The only dots they don’t connect here are the invasive, expensive, ineffective policies and practices of the TSA and the indiscriminate use of drone strikes. But even without connecting those dots in, their assessment is

Bad news about the impending police state here in America: it’s already here. From the indefinite detention (without trial) of terrorism suspects both foreign and American to the escalating militarization of our nation’s police forces, there’s little to indicate that any level of government is willing to “walk back” the overreach of law enforcement, much of which stems from the Patriot Act’s anti-terrorism aims.

The persistence of these policies defies both logic and common sense. For how long are we going to put up with these rights-eviscerating, socially corrosive uses of our tax money? After following the Patriot Act, DHS, TSA, digital surveillance, the NDAA, and so on over the past decade, I fail to see either the moral or economic justification for these policies that fall under the Patriot Act umbrella, particularly since the terrorist threat has ebbed. And what’s more disturbing is that support for such authoritarian policy is high and crosses the tribal Team Red-Team Blue political boundaries.

It’s enough to make a dispassionate economist weep for her country’s lost principles.

Honeywell vs. Nest, continued

Michael Giberson

Slate‘s technology columnist Farhad Manjoo examines Honeywell vs. Nest from a tech consumer’s point of view.

The Honeywell v. Nest lawsuit is being justifiably criticized as another black mark on our broken patent system. If Honeywell invented all these cool features, why didn’t it make something of them? …

Honeywell seems to have patented a bunch of great ideas in order to just sit on them. The sad thing is that if it tried, Honeywell seems capable of building a thermostat that’s every bit as wonderful as the Nest. From my testing, I found that Honeywell really does make great home heating and cooling equipment. If it competed in the marketplace rather than in the courts, I suspect it could really turn up the heat on Nest. (Sorry, couldn’t resist.)

When I compared the Nest and the Prestige, I found that feature for feature, Honeywell’s thermostat is more capable. …

On the other hand, you don’t need a one-page dossier, two installers, and an hour-and-a-half briefing to describe and install the Nest. That’s Honeywell’s greatest problem….

Manjoo concludes Honeywell has the technology, but not the consumer design nor the business model to get consumers clamoring for their product.

But Nest isn’t unstoppable. Honeywell has been in the thermostat business forever, and it’s got a lot of engineering and distribution advantages. It also, clearly, has a lot of innovative ideas. From what I’ve seen of its gear, Honeywell seems quite capable of creating a consumer-friendly version of the Prestige, one that works as easily and stylishly as the Nest. Now that Nest has paved the way, Honeywell would likely earn a lot of press coverage, too.

If I can summarize that last paragraph, he’s suggesting that rather than suing Nest for copying Honeywell technology, Honeywell ought to be copying some of Nest’s consumer-oriented design and marketing attitudes. (Fortunately for Honeywell, you can’t patent attitudes.)

A secret to Chipotle’s good-food-fast innovations

Michael Giberson

At Slate, Matthew Yglesias tells the story of a business that is booming: Chipotle’s Mexican Grill, “a company that shows there’s clearly room for growth and innovation in even the most basic sectors of the economy.”

The chain has been expanding rapidly, Chipotle’s stock has risen 500 percent over 5 years, and yet:

… the food service industry can’t seem to get any respect. Politicians don’t name-drop burrito innovators as examples of the kind of entrepreneurs they want to encourage, and despite food’s ubiquity in our lives, culinary progress is slighted as a source of human progress.

Chipotle’s growth since its 2006 IPO should be seen as a great American success story. There’s nothing new about fast food, of course. But it’s not as if Steve Jobs invented the cellphone.

Yglesias follows with, “In many ways, the Chipotle burrito is very similar to the iPhone.” Maybe that analogy is a little strained, but it doesn’t matter, we get a peak at some of Chipotle’s key innovations. The article usefully reminds us that not all innovations are high tech or high science.

(The article gives a brief shout out to burger chain Five Guys, also a family favorite.)

MORE: Another story of entrepreneurial insight in action: Risk and stealth paid off in Eagle Ford shale.

Dynamic pricing and technology in different markets

Lynne Kiesling

Dynamic pricing has long been a topic of great interest here, in large part because digital technology is increasingly making it feasible to implement dynamic pricing in retail electricity markets in ways that can be acceptable to consumers. But dynamic pricing is fraught with challenges, and not just in retail electricity markets. Dynamic pricing is a form of price discrimination, and as such can improve efficiency; prices also are knowledge surrogates, communicating diffuse private knowledge about the relative scarcity of that good in that place at that time. Dynamic pricing is also most applicable in markets in which demand varies over time, and if you are going to implement dynamic pricing without annoying and aggravating consumers, consumers have to have access to the prices in advance.

These general principles showed up recently in a kerfuffle over dynamic pricing of taxi services by a new firm called Uber:

On New Year’s Eve, Uber, a start-up in the city, adopted a feature it called “surge pricing,” which increases the price of rides as more people request them.

Although New Year’s Eve was very profitable for Uber, customers were not happy. Many felt the pricing was exorbitant and they took to Twitter and the Web to complain. Some people said that at certain times in the evening, rides had spiked to as high as seven times the usual price, and they called it highway robbery. Uber’s goal is to make the experience as simple as possible, so customers are not shown their fare until the end of the ride, when it is automatically charged to their credit card. While the app does not show the total fare in dollars when customers book a ride, Uber did show a “surge pricing” multiple to customers booking rides for New Year’s Eve.

So what’s the underlying economics here? Jodi Beggs comments on the kerfuffle starting from first principles, pointing out that when demand increases, consumers are not likely to be able to get the quantity they want at the price to which they may have gotten habituated as “the price”. She also points out that the dynamic pricing is what keeps shortages from occurring — think about it: would you rather pay 7 times the base fare to have an immediate ride home after your New Year’s Eve party, or would you rather wait in line for the next available car? Either way, you pay; opportunity cost matters. In other words, as my colleague Jeff Ely observes, variable pricing means that prices go up and down, and generally will be higher when more people want the good (due both to higher and more inelastic demand at that time and to higher relative scarcity). Note that these observations also apply to retail electricity pricing — market demand varies over time, and prices can signal relative scarcity, if regulators allow them to.

The relative scarcity is another aspect of the economics here, because in the immediate run the firm can’t go out and scare up more cars and drivers; in other words, supply is not going to increase. Here we see the analogue to other industries that use dynamic pricing, such as airlines and hotels and car rentals — they have a pretty fixed supply, so as demand rises and falls the price to the consumer will rise and fall accordingly, because the supply response at the time is so limited. Over time profit signals will indicate to them whether or not to invest in more cars, planes, hotels, but if you’re trying to get home on that New Year’s Eve that’s not going to kick in that quickly. Thus prices adjust to communicate relative scarcity.

But notice another aspect of the story of Uber’s pricing: although they told the customer what the “surge multiple” was when they called the car, the customer doesn’t know the fare until after the transaction has occurred. Here I concur entirely with the NY Times blog post, Jodi, and Jeff, that not informing customers ex ante about at least an estimate of the fare is a bad way to implement dynamic pricing! Especially for flesh-and-blood humans who are more than calculating machines, and are likely to be royally ticked off when they are charged 7 times base fare for such a short ride. The NY Times blog post quotes Yale economist Dirk Bergemann, saying that consumers prefer price predictability, which is true as a very broad claim … but if I draw an analogy from regulated retail pricing in electricity (and using a rhetorical trope of Jeff’s), consider the equilibrium. If instead they kept their fares constant, it’s entirely possible that the average fare could be higher in the single fare market design than in the dynamic pricing market design. That’s one of the anxious concerns that regulated electricity firms have about dynamic pricing — what if our revenue falls because a large enough share of demand ends up happening in low price periods (i.e., more demand is more elastic)? In any case, not giving customers at least an estimated fare before they commit to the order is bad business, and it should be easy to communicate that estimate, because customers are all using smart phones to order the cars.

I’d like to suggest a couple of alternatives that my colleagues did not. The first alternative is inspired by time-of-use pricing as used in electricity, or by the types of dynamic pricing contracts used in car rentals. If I know well enough in advance that I want a car at 2AM on New Year’s Eve, why not offer me a contract in which I can make a reservation at a firm price, albeit one that is higher than the base price? Then Uber could, say, take reservations for 50% of their fleet, and leave the other 50% open for spot-market transactions. With that model, those customers who are risk averse and want to make sure to have a car at a particular time at a reasonable price will have an option. But if they can’t commit to a time for a pickup, then they suck it up and deal with the spot market.

The second alternative is less relevant to the Uber example, but in lots of markets that could have dynamic pricing, we can use technology to automate our responses to the price. I’ve gone on ad nauseam about the potential for transactive technology in retail electricity markets, and it’s applicable in other markets too — automated reservation bots for making a flight reservation if the price on your preferred itinerary on your dates goes below a trigger price that you set, or a device in your car or an app on your phone that receives the current toll level and tells you whether or not to take the toll road, wait to go home, etc. Transactive technolgies reduce the cognitive barriers associated with price uncertainty, as well as reducing the transaction costs of using dynamic pricing in the first place.

New paper: Knowledge Problem

Lynne Kiesling

I have a new paper that may be of interest to KP readers, since the subject of the paper is the same as the name of this site: Knowledge Problem. I am honored to have been invited to contribute this paper to the forthcoming Oxford Encyclopedia of Austrian Economics (Peter Boettke and Chris Coyne, eds.). Here’s the abstract:

Hayek’s (1945) elaboration of the difficulty of aggregating diffuse private knowledge is the best-known articulation of the knowledge problem, and is an example of the difficulty of coordinating individual plans and choices in the ubiquitous and unavoidable presence of dispersed, private, subjective knowledge; prices communicate some of this private knowledge and thus serve as knowledge surrogates. The knowledge problem has a deep provenance in economics and epistemology. Subsequent scholars have also developed the knowledge problem in various directions, and have applied it to areas such as robust political economy. In fact, the knowledge problem is a deep epistemological challenge, one with which several scholars in the Austrian tradition have grappled. This essay analyzes the development of the knowledge problem in its two main categories: the complexity knowledge problem (coordination in the face of diffuse private knowledge) and the contextual knowledge problem (some knowledge relevant to such coordination does not exist outside of the market context). It also provides an overview of the development of the knowledge problem as a concept that has both complexity and epistemic dimensions, the knowledge problemʼs relation to and differences from modern game theory and mechanism design, and its implications for institutional design and robust political economy.

In this paper I analyze the development of the two categories of the knowledge problem — the complexity knowledge problem and the contextual knowledge problem — and explore both the history of the development of these concepts and their application in robust political economy and new institutional economics. As is the hallmark of a good research project, I think on balance I learned more than I created in the process of writing this paper.

One other thing I made sure to include was a discussion of how the knowledge problem and its development relates to game theory and mechanism design, through the work of Oskar Morgenstern (and then through some of the work of Herb Simon and Vernon Smith, among others).

Tying together economics, institutional design, history of thought, and epistemology, I hope you find this paper informative and useful! I’ll also make sure to update when the full volume is available.

Online privacy is like portfolio diversification

Lynne Kiesling

You know the down-home advice on investing — don’t put all of your eggs in one basket? That advice also holds for maintaining your online privacy in the face of Google’s impending “service integration” to use all of the information you provide in all of their services. This Wired article on how to hide from Google is the best I’ve seen thus far, and the advice is pretty straightforward — don’t put all of your activity in the Google basket. Use different search engines, use different browsers, spread it around.

For example, I’m now using Chrome to manage my Gmail accounts, calendar, and Google+ account. I have signed out of all Google accounts in Firefox and Safari, and I do all of my searching and other activities in one or the other of those browsers, depending on the application.

Sure, I’m giving up the ability to +1 articles, but that’s a small price to pay … and as we learn from portfolio theory, diversification comes at a cost but provides a net benefit.

Art Berman spots distress in the natural gas industry

Michael Giberson

Apparently I’m just a hot-headed, temperamental guy unwilling to sit still and listen to a patient explanation of a contrary point of view. I’ve only read the first paragraph of Art Berman’s new post at the The Oil Drum and already I’m arguing with my computer screen and searching around for data to illustrate my rebuttal.

Here in the first paragraph in question, from a post entitled “After The Gold Rush: A Perspective on Future U.S. Natural Gas Supply and Price”:

On January 23, 2012, Chesapeake Energy announced that it would curtail drilling in shale gas plays in the United States. Subsequently, other operators have followed suit. While the outcome of this announcement is unclear, it is a signal that the industry is in distress. One can argue that this distress stems from a lack of discipline as market price began to decline.

Distressed? Chesapeake Energy is in the oil and gas business. The ratio of oil prices to natural gas prices is at historic highs. Chesapeake announces they are shifting their drilling activities away from natural gas resources and toward oil resources. Since when is responding to incentives a sign of distress?

Jump back six years ago and oil prices (quoted in barrels) were about 6 times the price of natural gas (quoted in million BTU), a ratio that happens to be near the relative energy contents of the two energy resources. Prices of both went up and then down together in 2007 and 2008, oil a little more than gas, but beginning in 2009 oil prices resumed an upward path while gas prices have drifted downward. The current oil-to-gas price ratio is an astounding 40 to 1.

The following EIA chart is from May 2011, but it shows that the oil and gas industry as a whole has been quite reasonably switching from natural gas drilling to oil drilling as the relative price differences began to change. The trends shown have continued over the last several months.

U.S. oil rig count overtakes natural gas rig count (Chart)

U.S. oil rig count overtakes natural gas rig count. Source: EIA (Link to EIA analysis and supporting data.)

If anything, to the extent Chesapeake stayed with natural gas drilling even as the oil-to-gas price ratio was shifting against gas, it signals one of three things: (1) their gas operations were exceptionally profitable, at least relative to their oil opportunities, but now prices have tipped their calculations toward oil, (2) they had contractual obligations that kept them in gas drilling longer than they would have preferred, given the way prices developed, or (3) they irrationally stuck to natural gas drilling well after incentives should have pushed them to oil, but they’ve recently regained their senses. Which of these three options reveal an industry in distress?

The reality is simpler. A few moments searching Google news turns up stories from 2011, 2010, and 2009 in which Chesapeake has said it was shifting from gas to oil drilling. Chesapeake has been slowly shifting from gas to oil drilling over the past few years just like the rest of the industry, perhaps the only change in the most recent announcement is that the company is increasing the pace of its shift.

Okay, later today I’ll have time to read the rest of Berman’s post. Maybe reading the rest of his reasoned analysis will enlighten me, will calm me down a bit.