Freakonomics – Laid-Back Labor – New York Times

If you’ve spent much time on this blog, you know that I’m a fan of the boys at Freakonomics, the book that so aptly applies economic theory to the seemingly benign happenings of everyday life. In the article above the Freakonomists examine the difference between labor and leisure. I thought this article did a good job of introducing some of the basic concepts behind how economists think about the world.

As this year’s AP students begin to delve into the world of economics, one of the early topics they study will be the concept of humans as rational beings engaged in the constant pursuit of utility (the economist’s word for happiness). According to our text, “Economics assumes that human behavior reflects ‘rational self-interest.’ Individuals look for and pursue opportunities to increase their utility.”

If, as economists say, the purpose of life it the pursuit of utility, then presumably work is only a tedious but necessary means to an end, which we assume to be leisure. So why, as pointed out in the article above, do so many people willingly choose to spend so much time and money doing things like cooking, knitting, gardening, working in the yard, and other tasks that appear to be work, when they could easily pay others to do these menial chores for them, thus giving them more time for leisure? As the authors say, “Isn’t it puzzling that so many middle-aged Americans are spending so much of their time and money performing menial labors when they don’t have to?”

Where exists the line between work and leisure? This seems like an apt question to explore from an economic perspective. Here’s the author’s view:

“Economists have been trying for decades to measure how much leisure time people have and how they spend it, but there has been precious little consensus. This is in part because it’s hard to say what constitutes leisure and in part because measurements of leisure over the years have not been very consistent.

Economists typically separate our daily activities into three categories: market work (which produces income), home production (unpaid chores) and pure leisure. How, then, are we to categorize knitting, gardening and cooking? While preparing meals at home can certainly be much cheaper than dining out and therefore viewed as home production, what about the ‘cooking for fun’ factor?”

Why a professional (let’s say a lawyer) who spends 50 hours a week in his office, earning somewhere in the range of $100 an hour for his labor, would choose to spend two hours mowing his lawn on a Saturday, rather than hiring the neighbor boy to do it for him, truly poses an economic paradox.

Let’s see why: If this man’s labor is worth $100 and hour, then we can calculate the opportunity cost of mowing his own lawn as $200 plus the value to this man of the leisure he could have enjoyed by not mowing his lawn. The man probably could have hired the neighbor boy to mow his lawn for $20, which would have then freed him up to pursue his own leisure activities (reading, working out, watching a movie, etc.) during those two hours, and compared to the $200 value of his own labor the $20 seems like a bargain. So is a lawyer who mows his own lawn acting irrationally?

It would seem the line separating leisure from work has blurred in modern times. A hundred years ago an activity such as sewing or caring for a lawn would certainly have been viewed as work, but today the behavior of millions of Americans would indicate otherwise. As a science rooted in the belief that humans are rational pursuers of their own happiness and leisure, the paradox of the lawn mowing lawyer poses several interesting questions for students of economics.

Discussion Questions:

According to chapter one of our text (McConnell and Brue’s Economics, 17th Edition), “Purposeful (rational) behavior does not assume that people and institutions are immune from faulty logic and therefore are perfect decision makers. They sometimes make mistakes.”

1. Is the lawyer who mows his own lawn defying a fundamental rule of economics, that people act rationally? Is he making a mistake by not hiring the neighbor boy to do it for him?
2. What is meant by opportunity cost? Give an example of a decision you have made recently that involved an opportunity cost.
3. How is the lawyer’s decision whether or not to mow his lawn rooted in marginal analysis? Describe a choice you’ve made recently that involved marginal analysis.

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The $165 M in AIG bonuses that we have heard so much about this past week should have, in my opinion, been paid and then defended by Congress and the President!

As a former CFO, I can say with certainty that I have never paid an employee a bonus for poor performance. To underscore this point, I am 100% against any publicly-traded company ever making any bonus payment to an employee for poor performance regardless of the circumstances. The recently paid AIG bonuses are not an exception to my strong conviction. The true facts surrounding the $165 M in AIG bonus payments have not been made clear to the American public. Moreover, our cowardly American leadership (President, Treasury Secretary, Congress, AIG CEO) refuse to do what is right and defend the bonuses because, in my opinion, of their fear of public opinion.

The $165M in recently paid AIG bonuses, funded with a portion of approximately $170B in taxpayer “bailout” funding, are not PERFORMANCE bonuses being paid to the same AIG executives that got us into this financial mess in the first place. That is what most of America mistakenly believes. In fact, the senior executives, including the CEO, whose decisions caused the company’s collapse, are long gone. Moreover, the top 7 officials currently at AIG have agreed to forego all bonuses. The recent bonus payment outrage also excludes the next 43 highest ranking AIG leaders whose bonus payments are appropriately being linked to restructuring the company and paying back the taxpayers the $170B that has been already sent to bail them out.

So what exactly are these bonus payments for that all of America has gone mad over? The $165 Million in recent bonuses paid to AIG employees were RETENTION or STAY bonuses and not performance bonuses. AIG employees assigned to unravel the mess were offered retention bonuses to stay and work out the problems of AIG’s Financial Products division which has already been announced to be shut down. These retention bonuses were paid to incent remaining and new workers to stay until the billions of dollars of derivatives, still at risk, were unwound. Using basic common sense, which is why retention bonuses have been paid for decades, no reasonable, talented worker would agree to work in a discontinued division receiving hate mail and death threats without receiving a retention bonus. A retention bonus helps keeps top employees working on problems of a division being shut down rather than them resigning and moving on to another company.

As Congress tries to recover these just recently paid bonuses, either through the AIG employees paying them back or having them be taxed close to 100%, the tax payer is already losing as these employees working out the problems that they did not create are already starting to resign. Yes, America and the taxpayer will not save $165 M but rather lose far more than we save as those working the issues are resigning.

So, why didn’t the new AIG CEO, Edward Liddy, defend the $165 M in retention bonuses in front of Congress this past week and explain to Congress that these were not performance bonuses paid to the people that got us into this mess? Why didn’t Tim Gheitner, U.S. Treasury Secretary, defend his decision to allow the retention bonus payments as outlined in the recently passed stimulus bill? Why didn’t Ben Bernanke, Chairman of the FED, defend the retention bonuses that were know by him since last summer? And of course, where was our Harvard-schooled president when we needed his articulation skills the most as he could have clearly explained and defended these payments so we would not have to rehire new employees for all of the AIG employees who are now turning in their resignations for having to repay their contractual retention bonuses?

In summary, our U.S. government has increased the exposure to the American taxpayers by not supporting the AIG retention bonuses being paid to the workers that did not create the problem and who are assigned to fix up the mess. This is cowardly leadership, in my opinion. It is an easy path to for our leaders to keep the AIG bonus discussion at a very surface level and say “bonuses shouldn’t be paid to business leaders that fail”. Well, of course, everyone agrees with that! But that is not what is being paid at AIG.

Some Britons Too Unruly for Resorts in Europe – NYTimes.com

According to the article above, Great Britain exports more trouble to the rest of Europe than any other nation.

A recent report published by the British Foreign Office, “British Behavior Abroad,” noted that in a 12-month period in 2006 and 2007, 602 Britons were hospitalized and 28 raped in Greece, and that 1,591 died in Spain and 2,032 were arrested there.The report did not distinguish between medical cases and arrests associated with drunkenness and those that had nothing to do with it. But it did say that “many arrests are due to behavior caused by excessive drinking.”

The unruly behavior of Britons does not always end when the vacation is over, either:

Earlier this summer, flying home to Manchester from the Greek island of Kos, a pair of drunken women yelling “I need some fresh air” attacked the flight attendants with a vodka bottle and tried to wrestle the airplane’s emergency door open at 30,000 feet. The plane diverted hastily to Frankfurt, and the women were arrested.

How is this story related to economics, you may be wondering? Well, it’s really about a market failure. The over-consumption of alcohol by British tourists is creating spillover costs for the societies (and police forces) of the nations in which the tourists get themselves into trouble.

As governments often do when market failures exists, some British consulates have begun taking action to reduce the negative externatlities associated with their nationals’ drunkenness.

Worried about the increase in crimes and accidents afflicting drunken tourists, the British consulate in Athens has begun several campaigns, using posters, beach balls and coasters with snappy slogans, to encourage young visitors to drink responsibly.

“When things do go wrong, they go wrong in quite a big way,” said Alison Beckett, the director of consular services. “What we’re trying to do here is reduce some of these avoidable accidents where they have so much to drink that they fall off balconies and are either killed or need huge operations.”

Because British tourists only consider their own enjoyment (benefits) while on vacation, they consume alcohol at a level that fails to take into account the social costs of their behavior. In economic terms, the marginal private benefit of alcohol consumption exceeds the marginal social benefit, representing an overallocation of resources towards alcohol in tourist towns. Government action by British consulates is aimed at reducing demand (marginal private benefit) among tourists, shifting the MPB curve back towards the MSB curve, in the hope  that alcohol consumption will decline to the socially optimal level, where marginal social benefit equals marginal social cost.

There seems to be a fine line between too much drinking and not enough in the tourist spots of Europe. As far as the impact that British drunkenness has on business, some in the tourist trade believe the very prospect of wild parties and cheap booze is what keep the local economies afloat. Crack down too much on the wild Britons, and business could collapse as customers attracted to the anarchy stop arriving.

Discussion questions:

1. Is overconsumption of alcohol a market failure? If so, what type could it be classified as?
2. If the tourist nations were serious about cracking down on drunk tourists, what economic actions could they take in the resort communities where most of the trouble occurs?
3. How are proprietors of bars and clubs in resort communities benefiting at the expense taxpayers from other parts of the tourist nations? Does the private cost of running a bar in a place like Malia, Greece reflect the social cost? Explain.

As Clinton Seeks Gas Tax Break for Summer, Obama Says No – New York Times

Times are tough for American consumers. Rising food and fuel prices have increased the proportion of household incomes that must be allocated towards these two necessities, both for which demand is highly inelastic, meaning that as their prices rise, the quantity demanded by consumers remains relatively high.

In response to the pinching of Americans’ pocketbooks, two presidential candidates are advocating action at the federal level.

Senator Hillary Rodham Clinton lined up with Senator John McCain, the presumptive Republican nominee for president, in endorsing a plan to suspend the federal excise tax on gasoline, 18.4 cents a gallon, for the summer travel season.

Sounds like a good idea, right? If Americans are finding it burdensome to pay more at the pump, and the government can do something to relieve that burden, why shouldn’t they do it?

Let’s do a little calculation here: At 18.4 cents per gallon, how much per fill-up will Americans save?

I drive a ‘94 Toyota pick-up, has a 15 gallon tank and gets notoriously poor mileage. I’ll save $2.76 per tank of gas I buy. I usually fill up my truck about once a week during the summer, meaning I’ll save that much each week. McCain wants to suspend the gas tax from Memorial Day until Labor Day, or for a total of about 12 weeks. If Clinton and McCain get their way, I could very well save as much as $33.12 this year! ASTOUNDING!! What a deal for Americans!

Clearly, repealing the gas tax will have only a minor impact on disposable incomes in America. Obama seems to understand this better than the other candidates:

Senator Barack Obama, Mrs. Clinton’s Democratic rival, spoke out firmly against the proposal, saying it would save consumers little and do nothing to curtail oil consumption and imports…

Mr. Obama derided the McCain-Clinton idea of a federal tax holiday as a “short-term, quick-fix” proposal that would do more harm than good, and said the money, which is earmarked for the federal highway trust fund, is badly needed to maintain the nation’s roads and bridges.

The decision to suspend or not suspend federal gas taxes is essentially a cost-benefit decision. The benefit? Well, apparently around $30 per driver, or about half a tank of gas, compliments of the US government. The cost? Read on…

The highway trust fund that the gas tax finances provides money to states and local governments to pay for road and bridge construction, repair and maintenance. Mr. McCain and Mrs. Clinton propose to suspend the tax from Memorial Day to Labor Day, the peak driving season, which would lower tax receipts by roughly $9 billion and potentially cost 300,000 highway construction jobs, according to state highway officials.

There you have it; $9 billion dollars and hundreds of thousands of jobs that won’t be created in order to put half a tank of gas in each American’s car, which if you think about it, will only lead to Americans driving more this summer. Repealing the gas tax may actually induce Americans who weren’t planning road trips to go ahead and take one, increasing the overall demand for gas and driving the price up to the level it would have been with the tax.

And what about the much needed government revenue the tax creates? Hillary has another plan for recouping that loss:

Mrs. Clinton would replace that money with the new tax on oil company profits, an idea that has been kicking around Congress for several years but has not been enacted into law. Mr. McCain would divert tax revenue from other sources to make the highway trust fund whole.

Clearly, Mrs. Clinton needs a refresher course in basic microeconomics. If she had paid attention in AP Economics (did she even take AP Econ?), Clinton would know that a tax on producers of a highly inelastic good such as oil can be passed almost entirely onto the consumers. In this case, the oil companies, when faced with additional federal taxes on profits, will respond by restricting output, which reduces overall supply in oil market, raising the price of the main input for gasoline. Higher input costs for gasoline refineries will reduce overall supply of gasoline, increasing the price paid by consumers at the pump, negating any price-reduction induced by the suspension of the gas tax.

Ultimately, all taxes are borne by the consumers of an inelastic product: gasoline in this case. Whether the tax is levied on drivers directly, or the oil companies “upstream” in the production process, the outcome is the same: supply is restricted and price is higher.

The suspension of a gas tax that only costs Americans $30 over 3 months appears to impose a much greater cost to society than benefit. At least Obama seems to understand the basic economic reasoning behind this fact.

Obama on State Gas Tax Suspension

Shanghai American School Habitat for Humanity – Lucena City, Philippines. October 2007

This afternoon my wife and I returned to Shanghai after an amazing week in the Philippinese where we led 16 students on a Habitat for Humanity house building project on the island of Luzon (see map here). While this experience is still fresh in my mind, I wanted to share a few comments about how my thinking about Habitat for Humanity evolved over the last eight days.

A week ago right now, the 18 of us from SAS were bouncing scarily southward along Luzon’s main north-south highway, which is only a highway in the western sense for about 30 km outside of Manila, beyond which it turns to a two-lane, pot-holed, multi-use thoroughfare shared by buses, three-wheeled motorcycle taxis, lorries, a handful of personal automobiles and thousands of jeepneys. Three hours of nerve and bone rattling travel brought us to our lovely guest house near the southern Luzon city of Lucena, where we would spend five days building a house in a community on the outskirts of the city. Continue Reading »

From the Undercover Economist:

FT.com / Weekend columnists / Tim Harford – Dear Economist

Is there a relationship between a student’s decision of whether to have sex and his/her performance in school? Tim Harford finds there just might be.

There is little doubt that virgins achieve better grades. Yet is this because sex kills brain cells, or because kids who are already bored at school look harder for ways to amuse themselves?

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