Physical and virtual aren’t always substitutes

Lynne Kiesling

Whether the topic is retail sales or higher education (or some other application), the role of digital technology raises the question of how, if at all, online activity substitutes for physical, face-to-face activity. That relationship differs case-to-case; you wouldn’t expect the effects of online shopping on bricks-and-mortar shops to have the same patterns as the effects of digital technology on learning. But digital innovation is having effects on the relationships, outcome patterns, and models that we use regularly. I know, earth-shattering insight …

Analyzing the question of substitutability between online and physical is an important application of the economic way of thinking. One reason why digital technology has different effects in different cases is its varying degrees of substitutability for a face-to-face physical experience. Sometimes, actually a lot of the time, online shopping is a close substitute for going to the store, with that substitutability enhanced by online vendor offers of free returns (thank you Zappo’s for being the innovator on that front!). In education, though, the degree of and pattern of substitutability is different, and I would argue substantially lower in most cases than that in online shopping.

The next step in thinking analytically about the effects of digital innovation is complementarity — does the change prompted by the technological change enhance the product offering, the learning experience, etc.? Here’s my simple hypothesis/model: it’s the differing patterns of substitutability and complementarity of digital technology that leads to differing patterns of outcomes and models across industries and across different applications of digital technology.

If I wanted to add another dimension to that model, the next step I’d take is to acknowledge that many of our actions in these different cases take place within networks, and that digital technology can both extend and deepen the networks in which individuals act and make choices. Whether it’s sending a tweet of those cute boots while shopping (either online shopping or in a store) to get your friends’ reactions, or using discussion forums or video chats to enable collaborative learning and problem-solving, no one acts in isolation. In essence, I could analyze the effects on our social networks of digital technology using this same simple substitutability/complementarity model. But is there a deeper factor that can affect the extent of virtual substitutability and complementarity with an individual activity?

Two things I’m currently reading provoke these simple musings. The first is this insightful article from John Hagel and John Seely Brown arguing that virtual interactions have limits, and that stores and conferences won’t go away (I’d add books to that list). Their argument tackles this substitute/complement question head on, and identifies what I think is one of these deeper factors in determining substitutability and complementarity — trust:

Are we just stubborn creatures of habit who are slow to adopt a better solution? Or, is there a fundamental value to the brick-and-mortar, flesh-and-bone world that cannot be replaced?

There is nothing as compelling as direct human interaction. It strengthens trust, creates serendipity, and fosters community in an irreplaceable way. And although technology is progressing, there will always be a premium placed on meeting in person.

Face to face interactions provide us with a much richer context that helps to build deeper trust. There is a richness and depth of information that comes from physical cues, such as the firmness of a handshake or the sweatiness of someone’s palm, that are invaluable. Even subtle details, such as the state of someone’s office or how stressed their administrative assistant looks, provide context and clues that help us decide how to act, and are impossible to convey virtually.

Then there is also an authenticity that comes from the “off-camera moments” that accompany face-to-face interactions. Small talk before meetings start, coffee breaks, and running into people into the halls all provide a litany of unscripted, unorchestrated interactions that make it difficult for people to package themselves. The resulting mutual transparency inspires a confidence and trust that is much more difficult and time-consuming to develop through other means. Trust-based relationships are fundamental to effectively participating in the knowledge flows that accelerate learning and performance improvement, something that is becoming more and more essential in a world of mounting performance pressure.

They also identify the extent to which serendipity can lead to new value creation more in face-to-face interaction than in virtual interaction, and make a pointed observation that even those who start virtual communities around a shared interest usually strive to find ways to meet in person (this is my experience too).

The second thing I’ve been (re)reading is Clay Shirky’s Here Comes Everybody, which we’ve been discussing over the past two weeks in my freshman seminar. Shirky expands on many of the issues of generating trust and serendipity in physical and virtual networks, and how we use digital technology to broaden and deepen our networks and to organize and coordinate our actions without formal, hierarchical organizations. The fundamental economic question of the substitutability and/or complementarity of digital technology with other aims, goals, products, etc. is at the core of Shirky’s argument.

A tip of the hat to Popehat

Lynne Kiesling

I’d like to offer an enthusiastic hat tip to Popehat for writing the blog post that I had worked on all weekend in my head, but couldn’t pull off that incisively. Over the weekend the Volokh Conspiracy’s resident authoritarian and author of TSA policies, Stewart Baker, wrote a bizarre post expressing his bewilderment at widespread opposition to the TSA, particularly among women. Perhaps his attempt at sexualization of the TSA screening experience, and his confession of his performance anxiety and his Michael Chertoff envy, were some ham-handed and clod-footed attempt at humor. If so, they show Baker’s tone deafness while implementing authoritarian policies that erode our civil liberties with little, if any, benefit arising from the security theater he has helped bring into being.

Popehat says with wit and style what ran through my mind while contemplating Baker’s post:

But there are no real women in his analogy; he dismissed them with a hand-wave: “I can’t explain the women who hate TSA with a passion, though I’m not sure how many there are. Anti-TSA sites and comments have a distinct whiff of testosterone.”

That would be a surprise to, say, Amy Alkon, who was threatened with a lawsuit by a TSA agent for having the temerity to complain about having fingers thrust into her during a search. It would be a surprise to women harassed over their breast milk by TSA agents too stupid or careless to know their own policies, or these women forced to remove prosthetic breasts, or this woman forced to expose her gastric tube to gawking polyster-clad subnormals, or this rape survivor cupped and groped and probed by TSA “professionals,” or this woman told to remove her nipple rings, or any of these women. I’m pretty sure they aren’t critics of the TSA because of some sort of surge of testosterone.

And yet I’m being unfair — to the women. Women don’t just criticize the TSA because some of them are getting groped and harassed and abused. Women, as much as men, love liberty. Women, like men, love America. Women love America, and they’re skeptical if the proposition that, if America is in such grave danger that we must surrender rights to save it, we should be surrendering rights to the sort of people who get recruited by ads on pizza boxes. Women — as you’ll know if you’re in a relationship with one — question things. Among the thing they question: why should we trust the TSA’s statement that these measures are effective, or necessary? Why should we accept the logical fallacy that these measures work because there have been no more terrorist attacks on planes? How do we know this isn’t merely more security theater? Why is the TSA steadily increasing its power over more and more avenues of American travel? How can we possibly yield to an agency that openly believes that it is entitled to unquestioning compliance from Americans? How is the canine obedience of government demanded by “national security conservatives” reconcilable with actual conservatism? What kind of Americans would we be if we just said “sure, Department of Homeland Security, whatever you say?”

I have posed those questions here, several times, from several economic and moral perspectives. Of course the wasteful, invasive, ineffectual, violating TSA procedures affect both men and women, but I appreciate Popehat’s giving voice to the unwritten blog post in my head.

I, Pencil: The Movie

Lynne Kiesling

Whether or not you’ve read Leonard Read’s famous essay I, Pencil, I recommend this short video rendition, courtesy of the Competitive Enterprise Institute.

It captures poetically the fascinating, marvelous coordination that we achieve through markets, enabling prosperity and well-being beyond what we would each individually be able to achieve alone. And at there’s a set of additional commentary videos and other resources for your enjoyment, for use in the classroom, and to share with friends.

Disruptive innovation in education

Lynne Kiesling

The disruptive digital innovations that have transformed music, movies, and news are now changing business models in higher education. This month’s Cato Unbound features a set of essays on the possible effects of changes like universities offering MOOCs (massive online open courses) at zero price. In the lead essay, Alex Tabarrok argues that online courses offer the prospect of excellent learning opportunities while overcoming Baumol’s cost disease (i.e., the traditional education model is not particularly prone to productivity enhancements). Alex is walking the talk here, in the form of his Marginal Revolution University initiative with Tyler Cowen.

The three response essays make varying critiques of Alex’s claims for the benefits of online education — Alan Ryan contends that the traditional model’s benefits have been robust to other innovations, so we should be wary of claiming too much for online disruption; Siva Vaidhyanathan thinks Alex engages in hyperbole and doesn’t account for the diversity of classroom experience and its benefits; and Kevin Carey thinks that Alex doesn’t go far enough, and that online education technology may be truly disruptive and transformative.

The one area where I think all of the authors would agree (as do I) is with Kevin Carey’s statement that “… as with so many things, Neal Stephenson got there first” (if you haven’t read Stephenson’s The Diamond Age: Or, A Young Lady’s Illustrated Primer, you should; it’s my favorite book of one of my favorite authors, and he sure did get there first).

This collection of essays is a thoughtful set of analysis of some of the issues in online education. Clay Shirky also analyzed the potential implications of online technology for education recently, and thoughtfully. He analogizes higher education to the music industry in the 1990s, and how in the face of Napster the music industry members did not imagine that digital innovation would ever make the album format obsolete. And yet it did, with a mix of implications, good and bad, that are still playing out — advertising or subscription as a revenue model? Artists selling music, or giving it away and selling concerts and other merchandise to make a living? It’s an analogy worth considering, and it’s going to require faculty, administrators, and students to think more consciously and creatively about the benefits and values in education, the various ways to generate those benefits, and the relationship of cost and benefit in those various methods of generating value.

I don’t have a good answer for this, and I take Yogi Berra’s caution seriously that prediction is hard, especially about the future. Both individually and at the university level I am thinking about these changes and how best to use technology to improve my teaching and the value of what I contribute to the residential higher education model, and lots of other faculty are doing the same. There are ways that online resources are complements for classroom learning, and ways that they are substitutes. When they are substitutes for what we do in the classroom, that should push us to be creative and think differently about how to improve learning, thoughtfulness, habits of mind, and critical thinking in face-to-face learning.

Two new blogs of note

Lynne Kiesling

I hope you are enjoying a fun and relaxing holiday weekend! I’ve been using it, among other things, to catch up on my reading, made more enjoyable by two new additions to the rotation:

askblog: Arnold Kling has started blogging again, this time at his own new site. Given that his tagline is “taking the most charitable view of those who disagree”, I look forward to more of the same insightful and civil discourse that has made Arnold one of the most valuable and appreciated economist voices among public intellectuals.

Political Entrepreneurs: Ed Lopez and Wayne Leighton have a brand-new book out, Madmen, Intellectuals, and Academic Scribblers, and this blog is a companion to that work. From the publisher’s website:

Madmen, Intellectuals, and Academic Scribblers offers up a simple, economic framework for understanding the systematic causes of political change. In order to distill the smorgasbord of scholarship on political evolution, Madmen takes up three fundamental, interrelated questions: Why do democracies generate policies that impose net costs on society? Why do such policies persist over long periods of time, even though they may be widely known to be socially wasteful and even though better alternatives could be implemented? And why do certain wasteful policies eventually get repealed (e.g., airline rate and route regulation), while others endure (e.g., sugar subsidies and tariffs)?

Authors Wayne A. Leighton and Edward J. Lopez examine these questions through familiar policies in contemporary American politics, but also to draw on examples from around the world and throughout history to paint a lively picture and illustrate the pervasiveness of these quandaries.

Both the book and the blog look like a worthwhile read, and have moved to the top of my list.

Which states have price gouging laws?

Michael Giberson

A graphic illustrating states with price gouging laws (blue) and states without them (gold). For a list of the states with citations and related notes, see my earlier “List of States With Anti-Price Gouging Laws.”



So far as I know, the only serious attempt to explain why some states do have price gouging laws and others do not is Cale Wren Davis’s thesis,  “An analysis of the enactment of anti-price gouging laws,” Montana State University, (2008).

Davis makes some progress, but there is still a lot of work to be done on the political economy of price gouging.

Some more worthwhile price gouging links

Lynne Kiesling

I cannot recommend highly enough the EconTalk conversation between Russ Roberts and Mike Munger on price gouging. Some hurricane, some gasoline, some John Locke, some Aquinas, well worth your time. Their discussion of Locke is fascinating. The comments from readers/listeners are also quite good.

On the same topic, Art Carden posts a useful infographic on price gouging. Good conversation starter/discussion focal point for students.

Regulation’s effects on innovation in energy technologies: the experimentation connection

Lynne Kiesling

Remember the first time you bought a mobile phone (which in my case was 1995). You may have been happy with your land line phone, but this new mobile phone thing looks like it would be really handy in an emergency, so you-in-1995 said sure, I’ll get a cell phone, but not really use it that much. Then, the technology improved, and more of your friends and family got phones, so you used it more. Then you saw others with cool flip phones, in colors, and you did some searching to see if other phones had features you might like. Then came text messaging, and you experimented with learning a new shorthand language (or, if you’re like me, you stayed a pedant about spelling even in text messages that you had to tap out on number pad keys). You adopted text messaging, or not. Then came the touch screen, largely via the disruptive iPhone, and the cluster of smartphone innovation was upon us.  Maybe you have a smartphone, maybe you don’t; maybe your smartphone is an iPhone, maybe it isn’t. But since 1995, your choice of communication technology, and the set from which you can choose, has changed dramatically.

This change didn’t happen overnight, and for most people was not a discrete move from old choice to new choice, A to B, without any other choices along the way. Similarly for technological change and the production of goods and services. For both consumers and producers, our choices in markets are the consequence of a process of experimentation, trial and error, and learning. Indeed, whether your perspective on dynamic competition is based on Schumpeter or Hayek or Kirzner (or all of the above), the fundamental essence of competition in market processes is that it’s a process of experimentation, trial and error, and learning, on the part of both producers and consumers. That’s how we get new products and services, that’s how we signal to producers whether their innovations are valuable to us as consumers, that’s how innovation creates economic growth and vibrancy, through the application of our creativity and our taste for creating and experiencing novelty.

This kind of dynamism is common in our world, and is increasingly an aspect of our lives that creates value for us; mobile telephony is the most obvious example, but even in products as mundane as milk, the fundamental aspect of the market process is this experimentation, trial and error, and learning. How else would Organic Valley have started coming out with a line of milk that is entirely from pasture-raised cows? (I am happily consuming this milk; pasture-raised cows make milk with more essential fatty acids and conjugated linoleic acid, very important for health)

But this kind of dynamism, while common, is not pervasive. Institutions matter, and in particular, various forms of government regulation can influence the extent to which such technological dynamism occurs in a market. The example I have in mind as a counterpoint, the example I want to explain and understand, is consumer-facing electricity technologies, like thermostats and home energy management systems. For the past several years there has been considerable innovation in this space, due to the application and extension of digital communication technology innovations. But despite the frequent claims over the past few years that this year will be the year of the consumer energy technology, it keeps not happening.

Tomorrow in New Orleans, at the Southern Economic Association meetings, I’ll be presenting a paper that grapples with this question. My argument is that traditional economic regulation of the electricity industry slows or stifles innovation because regulation undercuts the experimentation, trial and error, and learning of both producers and consumers. As I state in the abstract:

Persistent regulation in potentially competitive markets can undermine consumer benefits when technological change both makes those markets competitive and creates new opportunities for market experimentation. This paper applies the Bell Doctrine precedent of “quarantine the monopoly” to the electricity industry, and extends the Bell Doctrine by analyzing the role of market experimentation in generating the benefits of competition. The general failure to quarantine the monopoly wires segment and its regulated monopolist from the potentially competitive downstream retail market contributes to the slow pace and lackluster performance of retail electricity markets for residential customers. The form of this failure to quarantine the monopoly is the persistence of an incumbent default service contract that was intended to be a transition mechanism to full retail competition, coupled with the regulatory definition of product characteristics and market boundaries that is necessary to define the default product and evaluate the regulated monopolist’s performance in providing it. The consequence of the incumbent’s incomplete exit from the retail market suggests that as regulated monopolists and regulators evaluate customer-facing smart grid investments, regulators and other policymakers should consider the potential anti-competitive effects of the failure to quarantine the monopoly with respect to the default service contract and in-home energy management technology.

In August 2011 I wrote about the Bell Doctrine, Baxter’s precedent from the U.S. v. AT&T divestiture case, and how we have failed to quarantine the monopoly in electricity. This paper is an extension of that argument, and I welcome comments!

If you’ll be at the SEA meetings, I hope to see you there; I am headed to NOLA tonight, and look forward to a fun weekend full of good economic brain candy.

New York state also moves quickly on price gougers

Michael Giberson

The New York Attorney General’s office takes action against 13 gas station owners in the state for price gouging. Like last week’s prompt response by New Jersey, this is unusually quick work for price gouging cases.

A few quotes from the AG’s press release:

NEW YORK – Attorney General Eric T. Schneiderman today announcedthat his office has notified 13 gas station operators of his intent to commence enforcement proceedings against them for violations of the New York State Price Gouging statute. These are the first of what is expected to be a series of actions taken in a wide-ranging investigation launched in the wake of Hurricane Sandy for price gouging after receiving hundreds of complaints from consumers across the state of New York.

“Our office has zero tolerance for price gouging and we are taking action to send a message that ripping off New Yorkers is against the law,” said Attorney General Schneiderman. “Today’s action is the first in a series of steps my office will take as we continue to actively investigate the hundreds of complaints we’ve received from consumers of businesses preying on victims of Hurricane Sandy. We will do everything we can to stop unscrupulous individuals from taking advantage of New Yorkers trying to rebuild their lives.”

Included is some explanation of price gouging law details:

New York’s price gouging law does not specifically define what constitutes an “unconscionably excessive price.” However, the statute provides that a price may be “unconscionably excessive” if: the amount charged represents a gross disparity between the price of the goods or services which were the subject of the transaction and their value measured by the price at which such consumer goods or services were sold or offered for sale by the defendant in the usual course of business immediately prior to the onset of the abnormal disruption of the market.

In other words, a “before-and-after” price analysis can be used as evidence of price gouging. Evidence that a price is unconscionably excessive may also include proof that “the amount charged grossly exceeded the price at which the same or similar goods or services were readily obtainable by other consumers in the trade area.” However, a merchant may counter with evidence that additional costs not within its control were imposed for the goods or services. Notably, the price gouging law does not prohibit any disparity between the price charged before and after there is an abnormal disruption of the market. Rather, the statute prohibits a “gross disparity,” when it is clear that a business is taking unfair advantage of consumers by charging unconscionably excessive prices, and increasing its profits, under severe circumstances that call for shared sacrifices.

Attorney General Schneiderman added, “These thirteen retailers stand out from others in the high prices they have charged and in the size of their price increases.”

Note the phrase “additional costs not within its control.” If a store manager takes actions to increase cost that are within the managers control: paying overtime to an employee, or undertaking extraordinary efforts to stock up on goods that post-emergency consumers might use, it may find that the state does not consider such costs as legitimate grounds for charging higher prices. (Case in point: People v. Chazy Hardware. Expense and risks involved in effort to procure generators after an ice storm not grounds for charging higher price.)

Two gasoline price gouging examples listed in the press release:

Attorney General Schneiderman noted as an example that, in the case of the Mobil station located at 40-40 Crescent Street in Long Island City, the price per gallon was posted at the roadside as $3.89. The line for the station was three city blocks long. When the consumer got to the pump, the price sign noted a cash price of $4.89 for regular gas and a credit card price of $4.99. The consumer paid the $4.99 using his credit card because he was low on cash and needed the gas.

In another example, at the Express mart station located at 1000 Rte 9 in Lindenhurst, a consumer has reported that there were no road signs indicating the gas prices, only a plywood sign next to the road stating they were only accepting cash for gasoline purchases. There was a long line at the gas station. When the consumer pulled up to the pump he was told the gas price was $4.99 a gallon. He paid the $4.99 because he needed the gas.

The 13 gasoline stations are branded: Shell (3), Mobile (4), USA Petroleum (2), Babylon Gas/Express Market, Sonomax, Delta, and Getty. Without looking for any evidence, I’ll hazard the guess that the seven “big name” stations are all franchisees and not vertically integrated companies with refineries and distribution operations and the other six are small local chains or franchisees of regional brands. Compare to the NJ seven listed here.