Archive for the ‘Economics’ Category
Back in 1999, a start-up company called Napster introduced the world to an unprecedented method of instantly delivering music to consumers via the internet. The peer-to-peer (“P2P”) delivery mechanism Napster innovated inspired a “new attitude” in consumers, who began demanding the availability of more options from the legacy record companies. Instead of adapting this path-breaking new technology to its own model, however, the record industry’s response was simply to start filing lawsuits against Napster and its progeny in order to muscle them out of the picture. Yet, once they succeeded, the industry never made any earnest attempts of their own to deliver what consumers wanted and had already realized was possible.
A decade after the record industry’s reactionary and ill-fated response to P2P, traditional book publishers are now faced with a technological revolution in its own industry in the form of digital books, or “ebooks,” delivered instantly and inexpensively to ereaders. Although it is still early, it appears the publishers have repeated both of the record industry’s two major tactical failures. First, the publishers, like the record industry before them, failed to initiate the revolution on their own. Instead, the path-breaking innovation came from a challenger when online bookseller Amazon developed the first widely used ereader, the Kindle, along with its ebook delivery service through its online bookstore. Second, the publishers, again imitating the record industry, appear to be doing all they can to resist rather than embrace the new digital model.
If the first failure can be forgiven, the latter is more difficult to account for. When P2P came on the scene, the record industry regarded it as more of a nemesis than an opportunity. “The truth is the music industry has no interest in providing its music digitally . . . . the music industry wants to destroy Napster . . . not work with them.” The principal threat Napster posed to the music industry was not the fact that it competed for its customers, but rather that it challenged the industry’s entrenched business model. While the industry succeeded in leasing a few more years on its model through court victories, it nonetheless failed to transition—even though, ironically, the Napster court relied on the industry’s expert’s testimony to conclude that the “‘record company plaintiffs have already expended considerable funds and efforts to commence Internet sales and licensing for digital downloads,’” and thus Napster was precluded from entering this market.
In fact, record companies benefit from the inefficiencies implicit in legacy delivery mechanisms. The large record companies own the infrastructure for the manufacture, packaging, delivery and marketing of physical media, the costs of which are passed along to the consumer at a premium. New technologies that purport to eliminate several of these points of process, thus lowering the cost to the consumer, inherently deprive the record company of potential profit.
Of course, the industry’s foot-dragging eventually backfired. Perhaps most importantly, it cost them the opportunity to develop and define the way electronic music delivery would work. Instead, computer companies like Apple and its iTunes service, and Microsoft and its Zune service, have rushed to fill the void. These challengers now have a substantial say in how digital music will be packaged and delivered—decisions over which the incumbent record companies might have enjoyed greater hegemony had they responded differently to the digital revolution.
For the incumbent record companies, a key problem with the iTunes model of digital distribution is that it allows consumers to purchase individual songs. As a result, artists, even those getting heavy airtime, are having trouble selling out venues. As a further result, there is a shrinking number of “popular” artists, traditionally understood. The record industry is suffering not just because it failed to transition to digital, but because it failed to account for the other systemic impacts this transition would cause. Total music sales today, including digital, continue to decline from an all-time high in the late ‘90s. This perhaps explains why the average age of today’s touring musician is 46, and climbing.
Judging from the recent criticism of several authors and commentators, book publishers have a similar motive to squelch or slow the advance of ebooks in order to retain their hegemony in the paper model. Novelists Barry Eisler and Joe Konrath, each boasting respectable numbers in both paper and digital sales, discuss how publishers systematically hobble their digital sales for the purpose of preserving paper sales. One way publishers do this is to insist on an unsustainable 75%/25% publishing split in favor of the publisher on ebook sales. After deducting Amazon’s 30% take and agents’ 15%, authors are left with 17.5%—a curiously small fraction of the sale considering it came with virtually none of the costs typically associated with paper sales. Similarly, publishers typically price ebooks well above the $.99 to $4.99 price points where maximum revenues are achieved, and hold back digital releases until the paper release is ready. All of these practices are designed, Eisler and Konrath suspect, to retard the growth of digital and thus protect the publishers’ paper sales.
As Eisler explains, “it’s extremely hard for an industry to start cannibalizing current profits for future gains. So the music companies, for example, failed to create an online digital store, instead fighting digital with lawsuits, until Apple—a computer company!—became the world’s biggest music retailer.” Invoking Upton Sinclair, Konrath summarizes: “It is difficult to get a man to understand something, when his salary depends upon his not understanding it.”
Despite the best efforts of the entrenched legacy interests, however, artists continue to find ways to employ the new technology to reach growing numbers of consumers. The Ninth Circuit Court of Appeals observed that the alt-rock band Wilco, after being dropped from recording giant Warner/Reprise as having “no commercial potential,” purchased their unreleased album from Warner and proceeded to release it on the internet. Despite the media giant’s bleak predictions, the album was a hit, and Wilco’s record was subsequently picked up by an independent label and released on the traditional market.
On the book publishing front, more and more authors are finding the self-publication alternative not only viable, but superior. Eisler shocked industry insiders and commentators when he recently turned down a $500,000 deal with St. Martin’s Press in favor of going it alone. Eisler breaks down the numbers supporting his decision:
But to understand what the number really represents, you have to break it down. Start by taking out your agent’s commission: your $500,000 is now $425,000. Then divide that $425,000 over the anticipated life of the contract, which is three years (execution, first hardback publication, second hardback publication, second paperback publication). That’s about $142,000 a year. This is a more realistic way of looking at that $500,000.
But there’s more. Some people have mistakenly argued that, for my move to make financial sense, I’ll have to earn $142,000 a year for three years. But this is one time when you don’t want to be comparing apples to apples. Because the question isn’t whether I can make $425,000 in three years in self-publishing; the question is what happens regardless of when I hit that number. What happens whenever I hit that point is that I’ll have “beaten” the contract, and then I’ll go on beating it for the rest of my life. If I don’t earn out the legacy contract, the only money I’ll ever see from it is $142,000 per year for three years. Even if I do earn out, I’ll only see 14.9% of each digital sale thereafter. But once I beat the contract in digital, even if it takes longer than three years, I go on earning 70% of each digital sale forever thereafter. And, as my friend Joe Konrath likes to point out, forever is a long time.
. . . . So if I’m right about all this, and I’m pretty sure I am, I should be able to beat the contract about halfway through the fourth year. And again, all of that ignores the continued growth of digital, the way low-priced digital books reinforce sales of other such books, etc.
This model not only works for established authors like Eisler, but for many unknowns writing novels and short stories in their spare time. Among those is the no-longer-unknown Amanda Hocking, whose 9 self-published books, targeted at the young adult audience in the vein of the Twilight series, have generated more than 100,000 digital sales each month. Perhaps trying out a new strategy following its inability to pen a deal with Eisler, St. Martin’s Press recently struck a four-book deal with Hocking. St. Martin’s declined to disclose the deal points, though Hocking reportedly will receive a seven figure advance.
Nonetheless, Eisler and Konrath maintain that, by and large, it simply “isn’t a good idea for most authors to sign a legacy deal anymore.” Other authors are also convinced that “by 2012 everything we have thought about traditional publishing will be history.”
Eisler is probably correct that industries cannot be expected to “cannibalize” present profits for future ones, and thus, path-breaking innovations like P2P and digital books can only come from challengers to industry incumbents. These innovations represent more than a mere modification to the business model or an addition to an existing menu of consumer options: Digital delivery of music and books have changed, and continue to change, the very nature of the content being produced, having removed many of the economic barriers to entry, and many of the “quality control” functions served by legacy content providers. In the examples of the record and book publishing industries, that is, the value added by technology is the tail wagging the dog.
 Napster, 114 F. Supp. 2d. at 910. As another Ninth Circuit court acknowledged, the peer-to-peer technology that Napster popularized “significantly reduc[es] the distribution costs of public domain and permissively shared art and speech, as well as reducing the centralized control of that distribution.” MGM Studios, Inc. v. Grokster Ltd., 380 F.3d 1154, 1164 (2004).
 Music’s Brighter Future, The Economist, Oct. 28, 2004, available at
http://www.economist.com/displaystory.cfm?story_id=3329169 (“Historically, the majors have controlled physical distribution of CDs.”).
 Jason Calcanis, LETTERS: Free Napster (or why Judge Patel has started the revolution, not ended it), indieWIRE: Biz, available at http://www.indiewire.com/biz/biz_000801_napster.html.
 For example, the court decision in the MGM Studios, Inc. v. Grokster, Ltd. lawsuit scared off LimeWire, other another peer-to-peer music delivery service:
Fearing lawsuits similar to MGM v. Grokster, Mark Gorton, the chief executive officer of the firm that produces LimeWire, has said that he plans to stop distributing his file sharing program. He explained this by saying
“Some people are saying that as long as I don’t actively induce infringement, I’m O.K. I don’t think it will work out that way…[the Court] has handed a tool to judges that they can declare inducement whenever they want to.”
See Wikipedia, MGM Studios, Inc. v. Grokster, Ltd.,, available at http://en.wikipedia.org/wiki/MGM_Studios,_Inc._v._Grokster,_Ltd.
 A&M Records v. Napster, 239 F.3d 1004, 1017 (9th Cir. 2001); A&M Records v. Napster, 114 F. Supp. 2d 896, 908 (N.D. Cal. 2000) (“The record company plaintiffs have invested substantial time, effort, and funds in actual or planned entry into the digital downloading market.”).
 See Music’s Brighter Future, The Economist, Oct. 28, 2004, available at
http://www.economist.com/displaystory.cfm?story_id=3329169 (“Historically, the majors have controlled physical distribution of CDs.”). It is also suggested that other strangle-holds on the marketplace (such as bribing radio stations) that contribute to the majors’ domination will collapse on the Internet. Id.
 Jay Yarow, Business Insider (Feb. 16, 2011), at http://www.businessinsider.com/chart-of-the-day-music-industry-sales-2011-2.
 Paul Resnikoff, Digital Music News (Nov. 29, 2010), at http://www.digitalmusicnews.com/stories/112910averageage.
 Barry Eisler, Ebooks and Self-Publishing: A Conversation Between Authors Barry Eisler and Joe Konrath (Mar. 19, 2011), at http://barryeisler.blogspot.com/2011/03/ebooks-and-self-publishing-conversation.html.
 MGM Studios v. Grokster, 380 F.3d 1154, 1161 (9th Cir. 2004).
 Wilco’s case study indicates the flaw in Napster’s reasoning: major record labels are not interested in markets that may be attainable through the internet, when they are operating quite comfortably under their own model. Wilco illustrated that, while the internet may not guarantee as much profit as traditional content delivery, it may be an effective alternative for challengers.
 Jason Pinter, Why I’m Self-Publishing (Mar. 24, 2011), at http://www.thedailybeast.com/blogs-and-stories/2011-03-24/barry-eisler-explains-self-publishing-decision.
 Eli James, The Very Rich Indie Writer (Feb. 27, 2011), at http://www.novelr.com/2011/02/27/rich-indie-writer.
 Tara Bannow, Huffington Post, Amanda Hocking Signs Four-Book Deal with St. Martin’s Press (Mar. 24, 2011), at http://www.huffingtonpost.com/2011/03/24/amanda-hocking_n_840169.html.
 Terrill Lee Lankford, Maybe the Mayans Were Right…But They Were Talking About the Publishing Industry (Feb. 4, 2011), at http://quixoticprod.blogspot.com/2011/02/maybe-mayans-were-rightbut-they-were.html.
For a depressing read, check out Greg Mankiw’s 2026 State of the Union speech. And if you think we can shore up all our overspending-undertaxing problems by turning Sauron’s gaze on the billionaires at the tippy top of the income scale, consider that even if we hogtied and took every last penny from each of the 500 or so billionaires and almost-billionaires in the U.S., it would cover little more than a third of a single year’s spending.
I find this argument offensive:
Politicians don’t understand that the voters don’t care about the deficit because the voters themselves don’t understand that they don’t care about the deficit. . . .
But they don’t. Public understanding of fiscal policy is hazy, inaccurate, and dominated by fallacious analogies between a national government and a household. What’s more, voters believe that deficits are primarily driven by wasteful government spending. So when a recession strikes the deficit spikes, and people complain. The smart thing for a politician to do under the circumstances is ignore the voters, do what you can to fix the economy, and recognize that in the end the economy drives public opinion.
Is there any wonder why voters don’t understand macroeconomic policy? Left-leaning macroeconomists have, for the better part of century, sought to render this topic inscrutable and beyond the American public’s understanding. They have done this precisely for the purpose of de-politicizing some of the most important political questions, making politicians unaccountable for running up massive deficits, and generating greater need for ever greater taxes. And all this has resulted in a massive shift of political power to Congress. (According to Wikipedia, “[e]very US state other than Vermont has some form of balanced budget amendment; thus, this macroeconomic mojo is less effective at the state level.)
This is a phenomenon I noted in my review of Bruce Bartlett’s The New American Economy: The Failure of Reaganomics and a New Way Forward. Bartlett notes that Keynes had enormous confidence in his ability to manipulate public opinion, and that this was a driving motivation of his work. As a result, Keynes was not concerned with consistency in his approach to economics: if the approach he advocated to meet one political challenge was inapposite to another, he showed little reluctance in making the necessary adjustments without regard to consistency among the approaches. As Bartlett puts it:
Through the years, many economists have puzzled over the contradictions in Keynes’s work. But there is one thing that ties it all together: his intense desire to influence public policy. As Keynes biographer Robert Skidelsky put it, “He invented theory to justify what he wanted to do.” If one goes through the 30 volumes of his collected works, the vast bulk of the material is not technical economics, but articles for newspapers and popular magazines, as well as memoranda and policy papers for government officials. “He was an opportunist who reacted to events immediately and directly, and his reaction was to produce an answer, to write a memorandum, and to publish at once, economist Elizabeth Johnson explains.
Bartlett goes on:
It is clear that Keynes would often put forward proposals because he thought they would be helpful at a particular moment in time, knowing full well that it would be highly undesirable for them to be maintained for the long term. . . .
Thus, for Yglesias to suggest that voters “are not that savvy about New Keynesian macroeconomic models” strikes me as disingenuous: The Keynesian model was never meant for consumption by voters. It was meant to confuse and disorient them so political leaders could govern without having to make their macroeconomic policies economically defensible.
In my previous post, I argued that it was indefensible to suggest, as the left recently has, that Republicans’ attempts to reform public employee unions is purely politically motivated. Specifically, I argued that to make this claim, the left ignores a vast record replete with documented abuses caused by public sector unions. The left’s argument, then, lacks merit: There must be an account made of these abuses before the left can plausibly suggest there could be no other reason for the right’s effort to reform public sector unions.
One of the criticisms of public sector unions is that they have resulted in compensation levels in excess of the private sector. The left objects that this criticism fails to account for disparate education levels in the public and private sectors. While this is essentially a question to be settled by an economic analysis—which I do not purport to provide here—a little digging indicates that many factors and much subjectivity and speculation goes into answering this question one way or another. Thus, the left’s focus on education levels is not a silver bullet that can fully explain or justify public employee compensation levels.
Yet, this is just what is happening in the debate in Wisconsin. With respect to Wisconsin compensation levels, Menzie Chinn provides this graph in support of the conclusion that the public sector provides less compensation than the private sector. The blue bars indicate private sector compensation; the red public sector compensation:
First, remember that what taxpayers are concerned about is that public employees are receiving more and better compensation for similar work, and that this disparity is the result of public sector unions. Neither Chinn’s post nor Jeffrey Keefe’s study on which it’s based attempt to correlate work and compensation. Similarly, they fail to discuss the effect public sector unions have had in moving up the level of compensation. Thus, taxpayers still have no way of knowing whether government workers are paid fairly with respect to the quality or quantity of work they do, or what role public unions play.
Chinn’s graph also indicates a potentially shocking data point with respect to professional degrees. However, such employees are unlikely to be unionized; the Keefe study does not indicate one way or another. Moreover, according to Table 1 in the study, 29% of public employees have post-graduate degrees, whereas only 7% of private employees do. This raises the obvious question of whether such highly skilled employees are necessary. Also, the fact that workers with advanced degrees—who thus could earn significantly more in the private sector—would still opt for public employment strongly suggests that the work, hours, prestige, lifestyle, benefits, and other factors offered by government work make it worth their while. It should also not be overlooked that educated workers have implicitly greater bargaining power, given their unique skillsets, and thus traditionally have not needed the bargaining influence of unions. Thus, the emphasis on the education factor with respect to post-graduate education seems to be potentially misleading.
As to the education’s role in public employment more generally, several other relevant factors and questions go unaccounted for and unanswered in Chinn’s graph and Keefe’s white paper, including:
- The true value of the workers’ product. Chinn and Keefe appear to treat education as the determinative factor of an employee’s value.
- Whether additional education is necessary. Indeed, the paper focuses solely on education level, and provides no information about what jobs the individuals at those various education levels typically have.
- Serious discrepancies in the values concerning compensation. According to numbers provided by the Wisconsin Department of Public Instruction, the average public school teacher receives compensation just under $75,000 per year. Administrative compensation is more than $107,000. This lines up better with reports of public sector union abuse across the nation (Joe Klein at Time recalls that school janitors in New York 30 years ago were paid $60,000 a year, and still negotiated their way out of mopping the cafeteria floor more than once a week). Keefe does not indicate where he derived the values used in his study.
- Job security. The public sector layoff and discharge rate is only about one-third of the private-sector rate.
- The prestige factor. Lawyers in particular actively seek out law jobs in government, as they provide a unique experience and excellent mobility into academia, the private sector, or other government work. Not to mention more humane hours.
- Work hours and lifestyle. Cato reports that private-sector employees nationally worked an average of 2,050 hours in 2008, 12 percent more than the 1,825 hours worked by the average public-sector employee. (While in law school and looking for jobs, I very seriously considered working for the county, which offers fixed hours and Fridays off twice a month.)
- The fact that many teachers work just 9-10 months out of the year.
- The rising number of public employees.
- Low turn over. California’s exceptionally generous prison guards union boasts an annual turnover rate of just 3.6%, while other states’ turnover rates among correctional officers hover around 20%.
- The attractiveness and value of defined benefit rather than defined contribution pensions.
Also, here in California, the California Department of Corrections and Rehabilitation (CDCR) boasts it has made public employment in the corrections system “the greatest entry level job in California,” and that "[a]long with the great salary, our peace officers earn a retirement package you just can’t find in private industry."
Chinn’s graph also seems drastically out of step with national averages. Daniel DiSalvo explains:
Generally speaking, the public sector pays more than the private sector for jobs at the low end of the labor market, while the private sector pays more for jobs at the high end. For janitors and secretaries, for instance, the public sector offers an appreciably better deal than the private economy: According to the Bureau of Labor Statistics, the average annual salary for the roughly 330,000 office clerks who work in government was almost $27,000 in 2005, while the 2.7 million in the private sector received an average pay of just under $23,000. Nationwide, among the 108,000 janitors who work in government, the average salary was $23,700; the average salary of the 2 million janitors working in the private sector, meanwhile, was $19,800.
For workers with advanced degrees, however, the public-sector pay scale is likely to be slightly below the private-sector benchmark. Private-sector economists, for instance, earn an average of $99,000 a year, compared to the $69,000 earned by their government colleagues. And accountants in the corporate world earn average annual salaries of $52,000, compared to $48,000 for their public-sector counterparts.
See also this chart from the U.S. Bureau of Labor Statistics’ December 8, 2010 News Release:
Or this chart from the USA Today last August.
In sum, the education level of public employees is indeed a relevant factor in determining the appropriate level of compensation. Criticisms of public sector unions should take this into account before claiming that public employees are overcompensated. But in like measure, defenders of the public sector unions should not presume that citing to higher average levels of education is a silver bullet in explaining the average levels of public sector compensation. In this way, Chinn’s graph is confusing at best and misleading at worst. Many other factors are critically relevant in determining the proper measure of compensation. Instead of making blanket claims that all public sector employees are under- or over-compensated, we should resolve to do the hard work of making case-by-case analyses.
[Update: Ezra Klein asks the same question today, and gets the wrong answer.]
Apparently, I gave up on the music biz—and sold out to become a lawyer—just in time.
However, I don’t think Yglesias is right when he says this:
This is one reason why I would discourage bands from trying to underprice tickets at their own shows as a reward to fans. Since digital copies of recordings are non-rival and basically free to make, any non-zero sale price entails some deadweight loss. And since concert tickets are necessarily scarce, any sub-market price entails some deadweight loss. The optimal strategy for a popular band that wants to do something nice is market pricing for concert tickets, plus free recordings. Or even better, you could release your records into the public domain.
Part of the problem with the iTunes model of digital distribution is it allows consumers to purchase only the songs they heard on the radio or over the store audio system at Target. As a result, artists, even the ones getting heavy airtime, are having trouble selling out venues. Maybe Yglesias is right in a very narrow sense when he revers to “popular bands”—it’s just that there is a shrinking number of popular bands anymore. The average age of a touring musician is currently 46, and getting older. With this in mind, look at the where the graph above tops out, and it’s not hard to understand that album sales and ticket sales are closely linked.
It’s been a while since I split rent in college and the few years thereafter, but it seemed to be the assumption that everyone would pay the same. If someone got a bigger room, then we would try to find other accommodations to make up the difference, like giving the other guy the garage. I suppose that fits in either the “pick rooms then adjust” and/or “just pick rooms and split it” categories.
One of the ways we tried to keep rent evenly split in college was to agree to switch rooms between semesters. This worked out well once when I shared a two bedroom with two other guys: one would get the small bedroom to himself while the others shared the master, and we rotated each quarter (UCI uses the quarter system). But when we tried with a fourth guy in another two bedroom, I got to share the master bedroom with the fourth guy while the two other two got the tiny second bedroom. This seemed like a good deal for me. But then my wildcard roommate unilaterally, and over the objections of everyone else, brought his behemoth waterbed that took up half the room. It wouldn’t have even fit in the small bedroom—and the other guys were charitable enough not to insist we try. We might have insisted he pay more at that point, but he had already blown through his cash from working over the summer and was eating our left over Del Taco hot sauce packets. Not really an option. College.