Stumbling and Mumbling

Driving without insurance

A loyal S&M reader asks:

Why should driving without insurance be a criminal offence? Surely it's no business of the state to compel us to enrich private companies. And the individual is the best judge of what risks he wishes to take or not. It's not a criminal offence not to buy home contents insurance. What's different about car insurance?

The answer is that if we were free to buy car insurance or not, the people who wouldn't buy it would be those for whom insurance is expensive: young people, bad drivers, or those with a record of accidents or driving offences.
Worse still, these would be the sort of people who are disproportionately unlikely to be unable to compensate other drivers, should they hit them - which is where the parallel with home insurance breaks down. As they are likely to be young, or to have spent their money on an expensive car, they are less likely than the average to have the cash with which to pay compensation. And they are less likely to be able to borrow the money too. People who are reckless drivers are likely to be reckless in other areas of life. Which means  they will disproportionately be bad credit risks, perhaps even bankrupts.
And then there's the moral hazard problem. Emboldened by knowing they will be unable to pay others for their accidents, these people will become even more reckless drivers, and so even more likely to have prangs.
Forcing these people to buy insurance ensures that they pay others for their recklessness, whilst handsome no-claims bonuses and excess payments reduce the moral hazard problem.
Indeed, the problem might be that the penalties for driving without insurance are too small. The sort of people most likely to drive without insurance are precisely the reckless and those with short-term time horizons who are most heedless of criminal penalties. Perhaps we need savage punishments to deter them.
This raises a broader political point. Perhaps a minimal state would lead not to responsible people governing themselves well, but rather to the feckless and irresponsible predating upon others. It's not just welfare claimants who are parasites. Maybe a libertarian world isn't so attractive. after all.

Another Gordon gets it wrong

Everyone’s slagging off Scotchmen called Gordon. So I’ll join in. That Gordon Ramsey talks some rubbish, doesn’t he?:

"Fruit and veg should be seasonal," he said. "Chefs should be fined if they haven't got ingredients in season on their menu.
"I don't want to see asparagus on in the middle of December. I don't want to see strawberries from Kenya in the middle of March. I want to see it home grown."…
"There should be stringent laws, licensing laws, to make sure produce is only used in season and season only," he said.

What this omits is that restaurants are already fined for serving asparagus in December. They are fined by that most intelligent regulator, Mr Market.
If you serve asparagus rather than seasonal vegetables such as swede and parsnips in the winter, you are fined twice over, once by higher costs, and again by lower demand as intelligent diners think: “what sort of addle-brained ponce wants to eat asparagus in winter? I‘ll go somewhere that serves proper food.” Asparagus-in-December restaurants are good candidates to appear in Mr Ramsey’s Kitchen Nightmares series.
He is making a common error here - he’s failing to see that markets can make the law unnecessary, by punishing stupidity.
Where he can perform a public service is not by calling for more laws, but by helping to raise the market-based fines on stupid restaurants, by showing how good seasonal food can be - by shifting the demand curves. And here, he does a damned good job. 

Costing Grangemouth

I fear the media are exaggerating the costs of the strike at the Grangemouth oil refinery. The Times says:

BP has also shut its Forties pipeline system, which is powered by the plant, 25 miles to the west of Edinburgh. As the pipeline carries about 30 per cent of Britain’s daily oil output from more than 70 oilfields in the North Sea, the industrial action could cost Britain up to £50 million per day in lost revenue.

This is surely wrong. If oil is not piped ashore today it's left in the ground, and can be piped ashore in future. Revenue losses occur only if oil prices fall from today's levels. This is of course highly possible, but by no means certain. Indeed, Hotelling's rule tells us that the least worst assumption to make about future oil prices is that they'll rise in line with current interest rates. On this view, the revenue losses - over time - will be nothing. What we lose today we'll get, with interest, in future.
This helps explain why Ineos can afford to take a hard line. If it doesn't refine crude today, it can do so in future at (probably) higher prices and margins. Its losses are not today's production, but rather the maintenance costs incurred by cooling the refinery; cash flow losses - it has less immediate revenue with which to cover its big interest bill; and the risk of falling prices in the future. But these are probably smaller than the headlines about "lost" output.

Gays and house prices

Here's one that'll confuse the Daily Mail - gays are good for house prices.
Shihe Fu estimates that a rise of one percentage point in the proportion of same-sex couples living in an area raises median house prices by 9 per cent even 10 years later, controlling for some obvious other things.
This suggests that gays improve neighbourhoods; they don't just choose to live in nicer places.
This could be because gays higher disposable incomes (they don't have kids) attracts better shops and restaurants. Or it could be that gays' better aesthetic appreciation enables them to spot attractive but under-priced areas, and to care more about urban regeneration.

The cost of beauty

Good-looking women cost you money. You probably know this already, especially if you're Eliot Spitzer. But it's  true in a particular way, as this new paper by Enrichetta Ravina shows:

I study an online lending market in which 7,321 borrowers posted 11,957 loan requests that included verifiable financial information, photos, an offered interest rate, and related context. Borrowers whose appearance is rated above average are 1.41 percentage points more likely to get a loan and, given a loan, pay 81 basis points less than an average-looking borrower with the same credentials.

However, this isn't because good-lookers are better credit risks. Exactly the opposite. Ms Ravina found that they are three times as likely as average lookers to default.
This is evidence that discrimination in favour of the good-looking, which is common in labour markets, might be taste, not statistical discrimination.
Why does this matter? One big reason is this: "Black borrowers pay between 139 and 146 basis points more than otherwise similar white borrowers."

A drag on the economy?

In my previous post, I called George Osborne an obnoxious prat. I was wrong. He's an obnoxious prat who knows nothing about economics. His claim that welfare payments are a " drag on the British economy" might be the precise opposite of the truth. Perhaps what's really expensive isn't the generosity of our welfare system, but its meanness, the fact that it doesn't provide anything like sufficient insurance against unemployment.
To see why, start with the equity premium puzzle, first pointed out (pdf) by Rajnish Mehra and Edward Prescott back in 1985, which says that long-term equity returns are far higher than they should be in theory.
Theory tells us that the average excess return on an asset should be proportional to its covariance with consumption growth*. This is because a major motive for having assets is to see us through rainy days, when our consumption would otherwise fall. An asset that does badly in bad times is especially risky, and so requires high expected returns.
This predicts that the Sharpe ratio on shares should be equal to the product of: the standard deviation of consumption growth, the correlation between consumption and share prices, and a coefficient of risk aversion**.
Now, in the last 40 years, the standard deviation of UK consumption growth has been 0.025 (2.5%), and the correlation between this and annual equity returns has been 0.07. We don't know what the coefficient of risk aversion is, but  10 would be on the high side. Multiplying through gives us 0.018.
But since 1900 the Sharpe ratio for UK shares has been 0.22.
Theory is out by a factor of more than 10. It predicts that equities should out-perform safe assets by around 0.4 percentage points a year. In fact, they've out-performed by 4.4 percentage points.
Why? There are numerous possibilities - of which survivorship bias is one. But the interesting possibility is raised here (pdf) by George Constantinides.
The equity premium is high, he says, partly because individual households' actual consumption is much more  volatile than average households' consumption. Individuals don't think: "my consumption volatility is 0nly 2.5% a year, so I can take on equity risk against that background." Instead, they think: "I could lose my job and so lose  80%  of my income. I don't want even the small chance of losing money on shares if this happens." The upshot is that they stay out of the market. Share prices are therefore low, and expected returns are high.
In other words, the lack of income insurance causes share prices to be low. It is this that is a huge drag upon the economy. If we had better ways of pooling idiosyncratic risk, background risk would be less. People would be more willing to buy shares, and their prices would be higher.
Let's roughly quantify this. The dividend yield on the All-share is now 3.7%. If we assume dividend growth of 5% a year (likely money GDP growth), this implies an expected return of 8.7% a year. This is 4.2 percentage points more than we could get on safe nominal assets. But theory says the premium should be only 0.4 percentage points. We're out by 3.8 percentage points.
If only one quarter of this were due to the inadequacy of income insurance, the dividend yield would be 0.9 percentage points lower. Which would mean that share prices would be £583 billion higher.
In other words, the lack of an adequate welfare system - which of course needn't be run by the state - costs us over half a trillion pounds. This is much more than the cost of paying people to stay on the dole or incapacity benefit, which is small.
So, how might Osborne be right? You could argue that very little (almost none) of the equity premium is due to idiosyncratic consumption risk. Or you could argue that the cost of providing better insurance, by reducing work incentives, would be prohibitive - though Shiller's proposals for insuring  industrial or occupational risks seem to avoid this problem.
I suspect, though, that these are unpromising avenues.   
* John Cochrane's great book, Asset Pricing, explains. Here's the introduction (pdf).
** This pdf by John Cochrane  derives this.

WEHT steam cars?

The news that the steam train is making a comeback raises a question: never mind the steam locomotive, whatever happened to the steam car?
Titter ye not. In the early 1900s, there were more steam cars than petrol ones. And until 1910, the world land speed record was held by a steam car.
So, why did steamers die out in favour of petrol cars? Here's W. Brian Arthur (pdf):

Initially petrol was held to be the less promising option [compared to steam]; it was explosive, noisy, hard to obtain in the right grade, and it required complicated new parts. But in the US a series of trivial circumstances pushed several key developers into petrol just before the turn of the century and by 1920 had acted to push steam out. Whether steam might have been superior given equal development is still in dispute among engineers.

These trivial circumstances include the invention of the electric starter motor - which made petrol engines safer to start - and the fact that it was a petrol car maker who invented the mass production that allowed costs to fall.
The upshot is that today, steam cars are the prerogative of great British eccentrics.
Which raises a lovely question. What if we hadn't had these trivial circumstances? What if the billions of dollars and man-hours spent in developing the petrol engine had instead been spent developing the steam car? What if the price of petrol had reflected its true social cost in the early part of the 20th century, thus giving steam a cost advantage?
Might we now be driving sophisticated steam cars, and not worrying about climate change or "energy security"?
Is this mere whimsy, or were we really close to a better path not taken? And how many other, better, paths did we miss?

Valuing doctors

What's a doctor worth? A lot, says Natasha Kerplunksy:

A dustman is worth £1m for cleaning up the rubbish, as far as I'm concerned, and a doctor is worth £20m for saving someone's life.

Are they really? NICE doesn't seem to think so. Researchers reckon (pdf) that it values a quality-adjusted life-year at a maximum of around £35,000. This is roughly consistent with the rule of thumb (pdf) that the value of a statistical life is 120 times GDP per head - £2.5m.
On this basis a doctor would have to save eight lives  (at birth) a year to be worth £20m a year. More likely, he'd have to add just over 12 QALYs a week to do so.
Seems reasonable? Maybe not:
1. These are net requirements.  In practice, doctors also reduce QALYs through sometimes fatal errors.
2. Successful medical interventions don't so much save lives as merely postpone death, sometimes for only a few painful months. This adds little to QALY.  Much good doctoring, of course, consists in relieving discomfort or uncertainty, not prolonging life.
3. Even if doctors are worth £20m to us, there's no reason we should pay them this. For one thing, some of doctors' remuneration is non-monetary - job satisfaction and the like; you don't often find a doctor with a low sense of self-worth. And for another, doctors' pay depends upon the supply of them, not their "value." The benefit of doctors can take the form of consumer surplus, not necessarily their pay.  It's a howling error to assume that people must be paid what they're worth.

eBay and feedback mechanisms

How do we design optimal feedback mechanisms? This is the question raised by eBay's decision to ban sellers from leaving negative or even neutral feedback about buyers.
Superficially, this seems daft. If all buyers, good payers and bad, are rated equally, useful information is lost - as it is when exams give all students top marks.
So, why's eBay restricting negative ratings? Two reasons:
1. People are gaming the system. A seller who gets a bad rating can retaliate by giving the buyer a bad reputation. Knowing this, buyers don't give sellers bad ratings. That means sellers of tat who are slow to deliver end up with inflated reputations. And this costs subsequent buyers money, because sellers with good reputation can command higher prices. This paper (pdf) by Daniel Houser and John Wooders estimates that a 10% rise in the number of negative or neutral ratings a seller has cuts prices by 0.24%.
If sellers can't retaliate, buyers have more incentive to give bad ratings to bad ones.
2. The information conveyed by buyers ratings doesn't affect prices, according to the Houser and Wooders paper. So grade inflation on the buyers' side doesn't destroy price-relevant data, on average.
So, eBay aren't being completely daft. But could they do better? These two papers suggest yes. A better solution might be to prevent buyer and seller knowing how the other has rated them before making their ratings. This would prevent tit-for-tat negative ratings.

Entrepreneurship & ideology

Tyler Cowen interprets this paper (pdf) as demonstrating that "entrepreneurship is predicted by family characteristics, most of all having other entrepreneurs in the family and coming from a large family."
However, what stands out for me is this:

In the entrepreneur sample 54% of fathers and 27% of mothers were directors or senior managers compared respectively to 18% and 3% for non-entreprenuers. Entrepreneurs come more often from wealthier families than non-entrepreneurs.

In other words, what makes an entrepreneur is access to capital - the sort of access that comes from having a wealthy background. This is consistent with two other papers. David Blanchflower suggests here that lack of access to credit explains  African-Americans low rate of entrepreneurship, whilst he and Andrew Oswald say here (pdf) that: 

The probability of self-employment depends markedly upon whether the individual ever received an inheritance or gift.

Now, why do I stress this whilst Tyler picks out "family characteristics"? The difference between us, I suspect, reflects a widespread difference between supporters and critics of capitalism. Whereas supporters of capitalism look for personality-based explanations of differences in people's behaviour, critics look instead for more impersonal, structural factors - though of course these influence (determine?) personality.   
And funnily enough, we can both easily find what we're looking for.