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Luke Froeb



Articles by Luke Froeb

How to sequester carbon cheaply: buy a coal mine!

8 days ago

Each ton of burned coal produces 2.5 tons of carbon dioxide. A coal mine sells for about $1/ton of coal reserves.  It costs about $100/ton to take the resulting carbon dioxide out of the air and sequester it.  So, rather than burning coal and paying $100/ton to sequester the resulting CO2, why not buy the coal mine and close it, for only $0.40/ton of CO2.  Am I missing something?HT:  Marginal Revolution

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Will driving data lead to better insurance pricing?

8 days ago

Chapters 19 and 20 talks about the problems of adverse selection and moral hazard caused by asymmetric info.  This makes car insurance difficult to buy because you know whether you drive carefully, but the insurance company does not.  Better information, e.g., by letting your insurance company monitor your driving via your cell phone location, will reduce prices for good drivers and raise them for bad ones.  In lieu of good information about driving, insurance companies use proxies like credit score: those with higher credit scores pay lower car insurance rates.  Now Allstate is leading an industry-wide group who wants track your driving to determine your insurance rates:

With telematics, insurers monitor policyholders’ driving behaviors either through smartphone applications or devices

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Nobel awarded for inferring causality

15 days ago

This year’s Nobel prize in econ goes to three economists who developed methodologies for identifying correlation from causality.  We have blogged extensively about why causality is important to business and how to design experiments or analyses to identify it.  In particular, use the web app to teach regression to understand the two mistakes you can make:  Type I (mistakenly inferring causality) and Type II (mistakenly inferring no causality) errors occur.  Try the learning exercises in this paper: A Simple Way to Teach RegressionVanderbilt Owen Graduate School of Management Research Paper15 Pages Posted: 10 Jan 2020 Last revised: 5 Aug 2021Luke M. FroebVanderbilt University – Owen Graduate School of ManagementDate Written: August 05, 2021AbstractThis paper introduces a simple free web

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What does a bursting bubble look like?

16 days ago

Like China’s property market:

As China enters what many economists say is the final stage of one of the largest real-estate booms in history, it is confronting a staggering bill: More than $5 trillion in debt that developers took on when times were good, according to economists at Nomura Holdings Inc.

That debt is nearly double what it was at the end of 2016 and is more than the entire economic output of Japan, the world’s third-largest economy, last year.

Global markets are braced for a possible wave of defaults, with warning signs flashing over the debt of about two-fifths of development companies that have borrowed from international bond investors.

Chinese leaders are getting serious about addressing the debt, with a series of moves meant to curb excessive borrowing. But doing

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Gender and majors, happiness, single-sex education, and for-profit education

19 days ago

Interview with Claudia Golden:On why men are more likely to major in economics:One of the problems that we have, as a field, is that when students — before they even come into their freshman year, and they’re asked what do they want to major in, women will — if they want to major in the social sciences — will put down psychology, and men will put down economics, so we lose them before they even unpack their suitcases.On happiness:…people recenter their happiness. You can be in a place in which, if you were plunked down there from somewhere else, you’d be miserable, and yet, you’re there, and you recalibrate yourself, just like people recalibrate themselves when they have a bad health event. It takes a while. On single-sex education:…I had girlfriends, but I enjoyed being around the

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Price vs. Value

24 days ago

Good post from Merle Hazard on the difference between Value and Price:Simply put, price is what you pay for an investment, and value is what you get. …Given that "price" and "value" are different, it is possible that the market quotation for an
investment, its price, may be higher or lower than value. …Investors tend strongly to fall into one of two camps. Most primarily see publicly traded stocks,
for example, as something akin to baseball trading cards. They are focused on price, not the
underlying economics. … If you have to sell in a hurry, it is impossible to deny that you are in the hands of others.On the other hand, value believers see stocks as real pieces of real
businesses, with an intrinsic worth independent of what others say. … …the "value" perspective yields the

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Danish Criminals respond to incentives

29 days ago

The Effects of DNA Databases on the Deterrence and Detection of OffendersAnne Sofie Tegner Anker, Jennifer L. Doleac and Rasmus LandersøThis paper studies the effects of adding criminal offenders to a DNA database. Using a large expansion of Denmark’s DNA database, we find that DNA registration reduces recidivism within the following year by up to 42 percent. It also increases the probability that offenders are identified if they recidivate, which we use to estimate the elasticity of crime with respect to the detection probability and find that a 1 percent higher detection probability reduces crime by more than 2 percent. We also find that DNA registration increases the likelihood that offenders find employment, enroll in education, and live in a more stable family environment. Full-Text

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Why is Bezos such an extraordinary manager?

September 25, 2021

Reading Amazon Unbound by Brad Stone, his second bio of Jeff Bezos and Amazon, which picks up where The Everything Store left off.  In the book, Bezos punishes managers for wasting time on small incremental–and successful–projects. It is as if Bezos recognizes the perverse incentives created by ordinary managers, who punish employees for making the more-visible Type I errors (doing something that they shouldn’t), rather than the less-visible Type II errors (failing to do something they should).  Typically this kind of reward asymmetry leads to fewer Type I errors but more Type II ones. But in an innovative environment, Type II errors typically have bigger costs, so it is incumbent on managers to find a way to avoid them.  So Bezos rewards managers who fail spectacularly in pursuit of

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Less of other peoples’ money is funding insurance

September 23, 2021

Health insurance costs about $20,000, 3/4 of which is paid by your employer.  One way to keep costs down is to raise deductibles.  This reduces costs is two ways:By reducing consumption of low value care (moral hazard); and
By giving consumers an incentive to shop for lower price and higher quality care

HT:  MarginalRevolution.com

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Big data and the curse of dimensionality

September 23, 2021

I just finished a fabulous book, Everybody Lies, written by Seth Stephens-Davidowitz.  From the Amazon description of the book:
Everybody Lies offers fascinating, surprising, and sometimes laugh-out-loud insights into everything from economics to ethics to sports to race to sex, gender and more, all drawn from the world of big data. What percentage of white voters didn’t vote for Barack Obama because he’s black? Does where you go to school effect how successful you are in life? Do parents secretly favor boy children over girls? Do violent films affect the crime rate? Can you beat the stock market? How regularly do we lie about our sex lives and who’s more self-conscious about sex, men or women?

I particularly liked the metaphors that Stephens-Davidowitz uses to describe his results.

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Density is green!: California housing supply to increase.

September 22, 2021

Restrictive zoning laws have decreased supply and driven up housing prices in almost every state, especially in California. This has led states to build "affordable housing" to combat the problem that their own restrictive zoning laws created. But now, the California Governor is trying to attack the zoning problem directly.

Newsom previously had shaken up single-family zoning by signing legislation that allowed more homeowners to build in-law units on their properties. SB 9 takes that further, allowing property owners to build up to two duplexes on what was once a single-family lot.
However, the usual suspects [we hypocrites] are opposing density that reduces sprawl, pollution, and traffic:

Slow-growth group Livable California, which has pushed back against SB 9, called it a

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Is it time to adapt by buying land in Alaska?

September 22, 2021

People are concerned about climate change:…a recent 10-country study showing the fears of young people about climate change. Four in 10 are afraid to have children. Almost half said that fears about climate change caused them stress and anxiety in their daily lives.  Its estimated effects will be different for different regions:…the hottest regions in South America, Africa, India and Australia experience welfare losses of 15% and the coldest regions in Alaska, Northern Canada, and Siberia undergo welfare
gains as high as 14%. On average, the world is expected to lose 6% in terms of welfare…The net estimated effect is negative but very uncertain:One recent estimate suggests that climate change is likely to destroy about 10% of global welfare … by the year 2200. To the economist,

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Good metaphor for Equity/Efficiency tradeoff

September 21, 2021

To communicate ideas, we need metaphors.  Greg Mankiw has a good one in this mornings NY Times, Can America Afford to Become a Major Welfare State?Providing a social safety net is like using a leaky bucket to redistribute water among people with different amounts. While bringing water to the thirstiest may be noble, it is also costly as some water is lost in transit.In the real world, this leakage occurs because higher taxes distort incentives and impede economic growth. And those taxes aren’t just the explicit ones that finance benefits such as public education or health care. They also include implicit taxes baked into the benefits themselves. If these benefits decline when your income rises, people are discouraged from working. This implicit tax distorts incentives just as explicit

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The paradox of ESG investing

September 6, 2021

ESG definition:

Environment. What kind of impact does a company have on the environment? Social. How does the company improve its social impact?Governance. How does the company’s board and management drive positive change? John Cochrane has a good post on how it effects change:

The point of ESG investing is to lower the stock price and raise the cost of capital of disfavored industries, and therefore slow down their investment.

If it works, it raises the cost of capital to non-ESG firms, which lowers the Net Present Value (NPV) of their investments (because they have higher discount rates). As a consequence, non-ESG firms get very picky, and invest only in projects with higher rates of return. On the other side of the coin, NPV investing lowers the cost of capital to ESG firms,

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Price discriminating against brides seems profitable

September 4, 2021

The wedding industry is notorious for sticking it to brides.   But whether this is due to price discrimination or higher costs (brides can be demanding) is still a matter of debate.  But here is an example that seems clear:
As I wrote in the column, part of the reason that retailers can get
away with charging higher prices for wedding-related services is that
spouses-to-be probably have stronger preferences for their “special day”
than consumers shopping for other kinds of events do. That means
they’re less price-sensitive. In the case of gowns, for example, brides
probably have much more specific requirements for their own dresses than
for the dresses that their bridesmaids will wear, allowing retailers to
charge different prices for each, regardless of what material or labor

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Jeff Bezos does HR

September 2, 2021

Reading Amazon Unbound by Brad Stone, his second bio of Jeff Bezos and Amazon, which picks up where The Everything Store leaves off.  It is amazing how much Bezos involves himself in the details of running the company.  For the many of problems that Amazon faced–Kindle, Alexa, expansion into India, Mexico, and Brazil, or even HR–Bezos would form a team, give them an insane deadline, and dive into the details himself.  Most significantly, Bezos is not afraid to make mistakes.  He initially tried detailed performance reviews, but then moved to a something simpler, and easier for employees to digest.  Explaining the change to his board of directors, he said "its like telling your wife how great she is, and then adding, `but you are a little overweight.’  She won’t remember anything else."

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Differences-in-DIfferences explained, albeit with a macroeconomics example

August 31, 2021

[embedded content]Another great video from MRU.  Teaches students how to "create" natural experiments using non-experimental data.  To complement this video, try the "Hidden Causality" and "Spurious Correlation" exercises for this free web app described in A Simple Way to Teach Regression.Froeb, Luke M., A Simple Way to Teach Regression (August 05, 2021). Vanderbilt Owen Graduate School of Management Research Paper, Available at SSRN: https://ssrn.com/abstract=3507142 or http://dx.doi.org/10.2139/ssrn.3507142

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Costco’s profit comes mostly from membership fees

August 31, 2021

In 2018, Costco’s profit was equal to its membership fees.  In 2020 membership fees were 87% of profit.  These barely profitable prices (only 30¢ out of every $100 in sales is profit) increase demand for Costco membership.   In other words, people pay to become Costco members because they get very good prices, on average.  HT:  Merle Hazard

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Vaccine inequality

August 30, 2021

From The Economist:

By late August 2021 around 60% of people in higher-income countries had received at least one dose of a vaccine. In poorer countries only 1% had.The extended lockdowns have huge costs: 

The need to extend social-distancing measures, loss of revenue from tourism and business travel, and the likelihood of social unrest in the event of a prolonged struggle against the virus, among other factors, will all weigh on their economic trajectory.

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China gives the poor a bigger slice of the proverbial pie, but if it affects incentives…

August 30, 2021

…it will also make the pie smaller.  The Economist reports on the efforts of the Chinese government to redistribute income from rich to the poor.  Chairman Xi has pronounced, “We must not allow the gap between rich and poor to get wider.” He seems to be channeling Confucious whose writings he frequently quotes, "a wise leader worries not about poverty but about inequality."  If this sounds familiar, it may be because the top 1% in China own 30.6% of household wealth; close to the US figure of 31.4%.

The trick will be to redistribute income without muting the incentives that have made China so successful. [See earlier posts about the incentive aligning effects of private property in China]

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Why would an air traffic controller deliberately put two planes on a collision course?

August 30, 2021

In 1974, it became more difficult for air traffic controllers to qualify for "burn out" disability insurance.  They needed some hard evidence that they were actually burned out.  In response, some deliberately put planes on a collision course to generate "near misses" that would qualify them for disability.  The good news is that they did it in low-traffic periods so that the controller could closely monitor the two flights to make sure that they did not actually collide.  (link to article)

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Should physicians be bill collectors?

August 30, 2021

On the upside, physicians would see the bills as their patients see them, which would remind them of the tradeoffs associated with expensive treatments.One the downside, physicians have to play the dual role of healer and bill collector.FROM JAMA:Through increasing deductibles, coinsurance, and co-payments, the privately insured population in the US is responsible for a larger share of health care out-of-pocket costs. Although many studies have examined the effects on patients, the implications for physicians have received less attention. The increase in cost sharing is forcing many physicians and health systems to take on the role of bill collectors. It is a task for which physician practices are unsuited. The result is a system with substantial administrative burden, frustrated patients

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Trust only 1/3 of the results from Pscyhology, but 2/3 of the results from behavioral economics

August 24, 2021

Dan Ariely (psychologist and behavioral economist) was forced to retract a well-cited paper based on fraudulent data. Ariely, a frequent TED Talk speaker and a Wall Street Journal advice columnist, cited the study in lectures and in his New York Times bestseller The (Honest) Truth About Dishonesty: How We Lie to Everyone — Especially Ourselves. We have blogged about Ariely’s work and want to warn readers that we may have retract the blog posts, pending the outcome of an internal investigation.  Professor Ariely’s problems are part of a larger "replication crisis." It began when the journal Science found that only 1/3 of the psychology experiments underlying the most cited papers in the field of psychology  could be replicated.  A bigger and more recent study finds much the same thing.

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How did our underfunded public pensions do during the pandemic?

August 24, 2021

Previous posts have focused on the underfunding of public pensions caused by unrealistically high discount rates, e.g., 7%.  For these "defined benefits" plans, the states and cities usually do not save enough.For example, if a pension fund needs to pay a teacher $100 in 20 years and uses a 7% discount rate, it must save 100/(1.07)^20=$26.  Then, if it invests $26 and earns a 7% return, the fund will have $100 in 20 years when the employee retires.  However, if it earns only 4.7%, the fund will have only $26*(1.047)^20=$65, a shortfall of 35%.  MarketWatch reports on a Boston College study of the effect of the pandemic on defined benefit pensions:2020 funding of public-pensions to invest sector plans at 74.7%, up from 72.8% last year.The good performance was due to the huge stockmarket

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What my daughter is learning in Rome

August 23, 2021

We have blogged about the labor market problems in Italy before:
This is why Southern Europe is a messLook ahead and reason back:  ItalyIf you can measure absenteeism, you can control it

But I never realized how bad it was until I received this e mail from my daughter who is studying in Rome this summer:
Today, in my global practicum class we had a speaker who owns several McDonald’s
franchises in Rome and he enlightened us on the troubles of being an employer
in Italy First of all, he said, all employees who are hired, are hired for life.
They are allotted 6 weeks of paid vacation per year– even working at Mcdonald’s!!! Each employer must pay a 100 percent tax of what he pays to the employee to the
government. Each employee has a 6 month paid sick leave per year that they can take

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Book Review: Chaos Monkeys:

August 23, 2021

Chaos Monkeys, Obscene Fortune and Random Failure in Silicon Valley is an autobiography of a Physics PhD from Berkeley who:Went to Goldman Sachs to model credit derivatives; Founded a startup to be the Goldman Sachs of online ads:  instead of moving companies to their highest valued uses it moved ads to the best content .  Created FBX (Facebook Ad Exchange) that allows advertisers to bid for targeted users.The NY Times begrudgingly gave it a good review (they were able to look past the self-interested behavior the book celebrates and satirizes) because of its "educational value."  The book teaches readers:1.  To anticipate opportunistic behavior caused by the incentive conflicts between entrepreneurs, angel investors, and venture capitalists.  2. To understand how ad exchanges (i) find

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Price transparency at last!

August 23, 2021

Colleague Larry van Horn’s efforts to require negotiated prices between payers (insurance companies) and healthcare providers (doctors, hosptials) be made public are about to bear fruit.   Larry showed thatEven when insurance covers the cost, there is, on average, a 300 percent price variation within a market for the exact same services.
As a special advisor to President Trump, Larry encouraged the President to force the bargaining pairs to make public their negotiated prices.The first data is now trickling out and the NY Times seems to approve, and gives President Biden credit for not reversing Larry’s efforts:The requirement to publish prices is a rare bipartisan effort: a Trump-era initiative that the Biden administration supports

MEA CULPA:  17 years ago, when I was Chief Economist

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