The Mark of the Entrepreneur

Which of Schumpeter's five roles of the entrepreneur is/are illustrated here?

I'm Back

And before you say "were you gone?", a combination of a family funeral, a round of the flu, a secondary respiratory infection and end of term for one of my on-line courses have made things a bit busy here.  I'm still recovering but I'm feeling better.  Nevertheless, I thought I would start out slow...

Here are a couple cartoons (HT to Economics and Ethics) to use in your class.  The first is a classic example of how constantly chasing efficiency can create its own trade-offs.


And this link will take to you an illustration from The Washington Post that could prove very useful when explaining the risk/return concept.

I'll try to get back in the swing of things during this week.  

Risk-Pricing, Adverse Selection and Moral Hazard

There's an entertaining article in today's edition of The Wall Street Journal that has all kinds of possibilities for the classroom. The article is about subway riders in Scandinavia who ride for free. Instead of buying tickets, they contribute to a pool that pays their fines if they get caught. They've set up a kind of "insurance" pool.

But if we think about it, we have an excellent example of adverse selection. I suspect the only ones who are paying into the pool are those who have no intention of purchasing a ticket and thus know they run the risk of being caught. Once a person has purchased the "insurance", they will likely be even less inclined to pay a fare.

So what keeps the premium from being the same as the amount of the fine? It's the likelihood or risk of being caught. If chances were 100% that you would be caught and fined, the pool would have charge a premium equal to the fine. This scheme can only work as long as enforcement by the authorities is lax enough to keep the premium less than the fare. Once the risk rises to the point where the premium costs more than the fare, it is cheaper to buy the ticket.

There is much more to this issue, as you'll see when you read the article. I'm sure you will see more possibilities. I did. But I hope you will share your ideas.

Ruthless Capitalism and Alternative "Technology"

Dr. Mark sends this link as something to think about. I think it would make a great discussion starter. What do you think?

Interviews about Black Swans

National Public Radio's Planet Money blog yesterday released a short podcast interview with Nassim Taleb. A couple years ago, Taleb wrote Black Swans. He explained that "Black Swans" are rare, extreme events that can drive the economy. Taleb believes that economic models can provide helpful forecasts much of the time; but that certain events that can't be foreseen or forecast, end up driving and changing markets.

The NPR interview is interesting. I recommend it. But I also recommend the interview Russ Roberts did with Taleb on Econtalk in 2007, in 2009, and earlier this year. They run from just under an hour to more than an hour and a quarter. But they are worthwhile.

Junk Bonds

I ran across this comic...

the day after reading this article in The Wall Street Journal. I like to think there is a connection and a possible lesson. You may disagree. But I welcome your comments.

The Globalization of an American Export

In my opinion, one of the best definitions of globalization is found in the first paragraph of this page of the Globalization 101 web site.

When I was teaching a course on Globalization for the Powell Center for Economic Literacy, I would start off the course with that paragraph. I would ask the students about the various parts of the paragraph and what they thought was meant by each part, or if they could give me an example.

The Wall Street Journal had an excellent example of how globalization drives cultural and economic decision-making recently. The story is about how movies are pitched, written and produced in the U.S. as a result of the global marketplace. The short explanation is that proposals for Hollywood films need to be translatable (and I'm not talking about language) to foreign audiences. To truly understand what I mean, check out the graphics that are part of the article.

And please share your thoughts.

Institutions and Incentives

This article from the summer 2010 issue of City Journal (HT to Cafe Hayek)is a sobering reminder that much of what happens in any economic system can be explained as a logical reaction to incentives. What is particularly arresting is that the incentives were often created by government in an attempt to manage economic growth and decision-making.

If we remember that incentives are the result of institutions, the rules and beliefs that guide our decision-making, it is harder to discount the effect of the institutions that have been put in place over the last quarter to half-century.

That is not to say that the rules were put in place to move the nation toward a financial crisis of the type and at the time of the the one recently incurred. However, one can say that efforts to promote certain activities (whether home-buying or derivative-trading) by distorting or transferring risk, should be seen for what they may result in - the attempted disguising of risk and postponed imposition of market discipline.

I hope you take a few minutes to read the article, think about it and then consider sharing your thoughts.

Lizzie Borden's Axe and Unintended Consequences

Today's issue of The Wall Street Journal has an informative article (free content at this writing) on the front page. The subject is the financial reform bill now before Congress and the impact it could have a group many of us don't consider when thinking about derivatives markets - farmers.
It seems that how Congress chooses to deal with derivatives could impact farmers' ability to hedge risk for their operations. Farmers use a type of derivative known as a future to help them control costs.

The article reminded me of an article I wrote for the economic education newsletter, ON RESERVE, when I was with the Chicago Fed. It was written in the mid-1990s so it is somewhat dated; but it followed on the heels of a derivative-driven problem in Orange County, CA. I began each article with a relevant quote, and part of the quote I used for that issue on derivatives said "Lizzie Borden's axe was never on trial." The point then, like now, is that the tool doesn't cause the problem. The problem arises from how people choose to use the tool.

Regardless of how Congress acts on the issue of derivatives in the financial reform bill, it needs to consider behavior - not the tool. I welcome your thoughts, as always.

Risk and the Limits of Monetary Policy

Two articles in the newspaper caught my attention this morning. And as they are related, they had more significant impact.

The first was from The Washington Post. Ezra Klein discusses some moves the Fed is said to be contemplating as there are signs the recovery may not be as strong as previously thought. The efforts are largely designed to provide banks with an incentive to lend.


This brings me to the second article, which was in The Wall Street Journal. (Subscriber content at this writing, but put “Risk Aversion Keeps Economy in the Slow Lane” in your browser and you may find a free version. This article talks about risk aversion both by borrowers and lenders. For borrowers, the desire to avoid debt when the future appears shaky is understandable. I suspect you tie in Keynes’ “paradox of thrift” when you discuss this. On the lenders side, it may be more complex. Yes, lenders are reluctant to lend, especially to businesses when the outlook is uncertain. But add the pressure being put on lenders by regulators and the government. The lenders are being chastised (in many cases correctly) for taking on excessive risk. This is being translated by many as “lenders shouldn’t take risk.” Unfortunately, credit involves risk.

We can get into the aspects of maturity risk, liquidity risk, and default risk another time. But when lenders are being chastised for lending, and borrowers are being told that things aren’t as rosy as we would have hoped, the appetite for risk is muted. I look forward to your thoughts.

How We Save Money

For those of you teaching personal finance, here is an engaging graphic from VisualEconomics that shows how Americans choose to save money. I think it lends itself, not only to discussions about saving, but about to risk/reward and opportunity cost.

What do you think?

The Question of Research and Risk

Given the last flight of the Space Shuttle is not too far off, the future role of NASA is in question. That eventually leads us to ask "Who should fund research?" "Who should bear the costs of high risk ventures?"

The argument for private funding (corporate, etc.) is that knowledge then is proprietary and can be used for private gain. Losses are part of the risk. The argument for government funding is that knowledge should be available to everyone, and the cost should thus be spread as any gain should be for everyone.

However, this cartoon reminds me that many of the discoveries that are part of the "Age of Discovery" ended up being for the benefit of government (kings, etc.). Anyway, it's something you can use to stir debate.

NFL Draft

For those of you into pro football, tonight may be as much fun as the Super Bowl, but without the expensive commercials. Yes, it's the opening round of this year's NFL draft.

Today's issue of The Wall Street Journal has two engaging articles. This first one is about how the NFL draft drives economists crazy. Talk about a pricing system that really doesn't work... And there's a graphic that lays out an alternative auction system. As the article indicates, it incorporates a little game theory. It's fun.

The second article is actually just a chart with an explanation. It compares salaries of 10 first round picks with the salaries of major corporate executives. I find it interesting that people get upset with the salaries paid to people in corporate America, but don't seem to mind the fact that rookie players, many of whom don't make it past their first year, get paid more.

I think it goes back to what we choose to value. To what extent do salaries reflect what we truly value? I'll leave the question with you.

Risk and Moral Hazard

I recently was teaching about risk, and we discussed moral hazard and adverse selection. That's probably what put the concepts into my mind. Then I was watching the movie Joe vs. the Volcano which starred Tom Hanks and Meg Ryan. It hit me. Here's an example of how "knowing" the future can affect our choices. Specifically, Tom Hanks' character, Joe, is told he has an incurable disease. He is then approached by a multi-millionaire to take on a dangerous mission - one which would end with him throwing himself into a volcano. All his expenses are covered. He immediately begins making decisions and taking risks that he previously wouldn't have taken - moral hazard.

Take a look at it and let me know if you agree.

Fast Food in the Old West: Entrepreneurship and Utility

There is an extremely interesting book review in the most recent Weekend Edition of The Wall Street Journal. The book reviewed is Appetite for America by Stephen Fried, and it describes the life of Fred Harvey. Harvey was a 19th-century entrepreneur who developed and operated the first fast food chain in the United States. By putting his restaurants at railroad depots shortly after the completion of the transcontinental railroad, and then standardizing fare, maintaining quality, and staffing the restaurants with young ladies, he provided utility for travelers and frontier residents alike.

The utility I refer to are the basic types of utility (form, place, time). He was able to provide meals of predictable quality in a convenient place (think about on/off ramps on the interstates of today) and in short order (the train frequently didn't stop for long).

As to entrepreneurship, I'm falling back on Schumpeter's five roles of the entrepreneur:

introduction of a new product,
using new or different inputs to produce a product,
introduction of new technology or process,
opening a new market,
and creating a new economic organization.

I can make a case for at least three of these (the second, fourth and fifth). And after I read the book, I may be able to make a case for more.

I think this book could be useful to both the economics and the American History teacher. I will add it to my carousel at left. And I will try to review it when I read it. But be forewarned - my current 'to be read' pile is fairly tall. I look forward to your comments.

Markets for the Unusual...or Not

Yesterday's issue of The Wall Street Journal had a somewhat amusing story (free content at this writing) about mortgages and "unusual housing." Specifically it talked about how bankers are balking at lending for houses built of unusual materials or using unusual construction methods. Since there is little to compare against to get a measure of value; and since bankers were burned with mortgages at some time in the not too distant past; the result is no mortgage.

One of the ideas that the article triggered in my head was the debate about value - does it arise from supplier's cost or from demander's intended use? Or does it come from an understanding of the market? And how big does the market have to be to provide sufficient information to avoid significant asymmetries?

I look forward to your comments.

A Touch of "Madness"

A "March Madness" tournament view of what caused the financial crisis, courtesy of Allen Sanderson, University of Chicago economist and the American Economic Association. (HT economicprincipals.)

It is great. Please comment.

Economics and Somali Pirates

I think this story from The Financial Post about Somali pirates setting up a "stock exchange" has a lot of possibilities. (HT to Arts & Letters Daily.)

It provides a platform to launch discussions on a variety of concepts. The author examines risk and reward, providing an opportunity to discuss incentives. The story can also be used to discuss markets and other economic organizations (or lack thereof), as well as the rules (institutions) used in the market (from participation to cash to barter). There are even aspects of marginal analysis (cost vs. benefit) that can be brought out with a little discussion of "everyday life" in Somalia. As you're approaching the end of the semester and looking for something to prime their brains for exams, this could be a fun and educational diversion.

I welcome your thoughts and comments.

Subsidized Risk

I ran across this opinion piece in today's issue of The Wall Street Journal.

I think it does a very good job of explaining how institutions introduce moral hazard to the larger system. (And I love the image.) The changes that result from policy are sometimes subtle, but they eventually get to be assumed. And we know how to spell assume.

Maybe I'm Too Suspicious, but...

Recently, a number of stories have broken that remind me of the old saw about history repeating itself. And while I've found versions of the stories in a number of places, I'm going to provide links to the versions in The Wall Street Journal, mainly because it's convenient and I don't have to start my search anew.

The first story that caught my attention was this one, which talks about the federal government providing $35 billion to the states to promote local housing. That was followed quickly by this blog post about rising delinquencies at Fannie and Freddie.

Now add in two pieces from today's edition. The first is a story (subscriber only at this writing - search for "Wall Street Wizardry Reworks Mortgages") about financial institutions repackaging their bad debt (much of it mortgages) into new financial instruments. The goal is to move the debt out by securing better credit ratings on some of it. And finally, there's this opinion piece about the rating agencies getting a pass in recent legislation.

Separately, the stories may not amount to much. Together, I think they raise the potential to rebuild many of the same institutions that got us here. And those institutions provide incentives. The question for our students: “If people respond to incentives, is it possible that these developments are creating similar incentives to those that existed before the crisis?”

But before you ask it, I offer this last opinion piece as a possible follow-up. It provides a look into an era when incentives aligned with ownership and risk on Wall Street. I think it provides an idea for the future.

I look forward to you thoughts.