Shirking

When I first heard this "technical term" in my Econ. 110 class, I was skeptical. Is this really worthy of being discussed in an economic class, or does it belong in Business Management 450? But at its root, shirking is based on the idea that everyone is self-interested (the basis of my economic beliefs) and that they will shirk, if given the chance. And the ideas behind correcting and preventing shirking are amusing, so...why not? Let's talk about shirking!

First off, shirking occurs whenever there is a team working together toward some output. Like, say, a group project in school or roadside litter cleanup. Because the output of the entire GROUP is measured, and not the contribution of each individual member, there is an opportunity to slack off and not be detected (or punished).

This is the classic story for why firms are organized hierarchically. You have a group of workers (people who do actual work, say manufacturing cars). Then there are another group of people - a tier above them - who are hired just to watch other people work (these are called managers). They don't do actual work; they just watch people work and yell at shirkers. Then, there is another tier of people above them who are hired to make sure the managers are watching the workers (and not shirking in their watching duties). And so on and so forth until you get to the CEO who doesn't need someone to make sure he doesn't shirk because his bonus schedule is tied directly to his performance, and since he's just the one guy it's easy to measure whether or not he's shirking.

Okay, so that works well for Ford and GM, but what about the lowly college student who's stuck on a group project with 3 other students. The group must prepare some sort of output to give to the teacher to be graded. The teacher gives all the members of the group the same grade. How do you police and enforce effort? Simple - by doing what college students do best: nagging, fighting, coercing eachother through rude emails and simple peer pressure. This is probably the most ineffective (and least interesting) solution to shirking, in my opinion.

A more interesting shirking solution was developed by the LDS church in regards to missionary work (and credit is due to Professor Kearl for first explaining this to me in Econ. 110). Missionaries are 19-21 year old men who are encouraged to go out in the world and do missionary work. There are currently about 52,000 missionaries serving, and they are paired up into 2's and 3's so that at any one time, there could only be a maximum of 26,000 doors being knocked on. There must be a reason for this duplication of effort, right? Yep - shirking. Mission Presidents know that if they sent missionaries out to work alone, they'd all sneak off to the movie theaters. So, they pair up the missionaries and send them out together. Then the MPs tell the missionaries to get to know their companion and be nice to them - LOVE your companion, they say. (But secretly, they don't want you to get to be too good of friends, because then you will conspire together to shirk!) So the Mission President tells you to write him a private letter once a week TATTLING on your companion! And to prevent you from becoming good enough friends with your companion so that you conspire to stop tattling, there is an ingenious system called TRANSFERS wherein they randomly mix up the companionships every 6 weeks so that you don't have time to become good enough friends to agree to shirk together.

Don't get me wrong - shirking is great...if you can get away with it. :)

Rent v. Buy?

The classic question "Rent v. Buy" always seemed so easy to me (ALWAYS buy, because then you're not just throwing your money away - you will OWN the asset at the end of the payments). However, recently I've come to realize that it MIGHT be smarter to rent when prices of the assets are falling (such as houses) or when dealers are dying to lease you a car and make you a better lease price than a sale price.

Turns out, it actually is complicated trying to decide whether to rent or buy something, because you have to predict the future. You have to forecast what you think the salvage price of the asset will be at the end of the term, and compare that to renting v. buying costs.

Closely related to this question is the decision of when to pay off your debt, in what order, and how much of it to pay off. The famous debt snowball worksheet helps you figure out what to do, based on the interest rates you pay.

The last thing I have to say about rent v. buy, is that there is some inherent benefit to owning stuff, instead of renting all the time - something intangible and thus, unquantifiable - but definitely beneficial.

Moral Hazard Problem

This has nothing to do with ethics, but I feel just as strongly about it as I do about right and wrong. The moral hazard problem is the idea that people will change their behavior when the costs and benefits change. For example, the classic example is car insurance. Someone who has full coverage car insurance is likely to drive a bit more recklessly, because if they get into an accident, there is no cost to them (insurance pays!) Sure, your rates may go up, but not as much as the accident cost. Thus, people drive more recklessly when they are insured, because they don't bear the full costs of doing so.
We must let people "suffer the consequences" so that they understand the options and can make the correct choices. The problem with health care in this country could be solved by making people more responsible for their health care choices, not providing FREE health care to everyone. Can you imagine what a wreck it would be if we provided free auto insurance to everyone? There would be wrecks all over the place! Similarly, if we provide free health insurance to everyone, there would be health wrecks all over the place. Got a sniffle? Go to the doctor! It's FREE! Feeling a little down? Go get some pills! They're FREE! Want to eat deep fried Krispy Kreme bacon cheeseburgers everyday until you need triple bypass heart surgery? Go ahead! It's FREE!
When you separate consequences from choices, you aren't helping anybody. Consequences are a part of learning. As one of my favorite quotes goes: "Good judgment comes from experience. And experience comes from bad judgment."

Are People Self-Interested or Altruistic?

Now, don't rush to judgment. Consider the real meaning of those words: "Self-interested" and "Altruistic". "Self-interested" doesn't mean lying, stealing, cheating, or beating people up for lunch money. It simply means that, given the option, you'd choose which one you like most. It is self-interested of you to order your favorite flavor of ice cream at Baskin Robbins. It is self-interested of you to accept a position that pays more than another position. And it is also self interest that motivates a burglar to steal your stuff. Clearly, self-interest is not synonymous with honest. You can be honest and self-interested.

Now consider "altruistic". Altruism means that you want other people to be happy more than you want yourself to be happy. In other words, you'd be "happier" if everyone else was happier. Altruistic people would be more concerned with finding ways to make other people happy, right? So do we observe any altruistic people that are honestly just trying to make other people happy? Every day I see people acting self-interestedly. Just the other day I was shopping at a fabric store, and I saw a woman use a coupon while paying for her purchases! The greed! Oh the insatiable greed of humankind! This woman actually preferred to pay the store LESS money and get the same amount of goods. Did she even stop to CONSIDER how the store FELT about that? I'm sure the store would have preferred that she pay full price for her purchases. And if that woman hadn't been so self-interested as to use a coupon, they would have received more money from her. The woman could have chosen to not use the coupon and just pay full price, and that would have demonstrated much greater altruism. In fact, the ultimate altruistic act would be for the woman to just donate her money without taking anything from the fabric store. (See what I'm getting at here?) People act self-interested all the time, and there's nothing wrong (criminally or morally) with that. So just accept it.

In economics, we assume everyone is self-interested. It's easier that way. It makes our little models and equations work (because I can find the maximum point on a curve quite easily) and it seems to most closely follow actual human behavior. I just wanted to clear that up before we get too involved in discussing the economics of everyday things. Because as I analyze situations, I automatically assume everyone is self-interested...and usually I'm right.

In a fun little mind-bender, consider this: Altruistic people set about doing things to make other people happy, because it makes themSELVES happy also. So, even altruistic people are self-interested! It just happens to be that they make themselves happy by making other people happy...but in the end, they're still doing it because it makes them happy to do so. Sounds like self-interest to me.

There's no such thing as a free lunch

Classic, I know. But still true. And now it's popping even more. Anytime you hear the word "Free", you should laugh. ESPECIALLY when it comes to credit card rewards. You can call it "sky miles", "cash back" or "points", but it all boils down to the same story: The credit card companies want you to think that you're getting something for nothing. They want you to think it's a bribe. "Use our card, and we'll give you free ____[miles, points, cashback]_..." I know all of you are too smart to fall for that. It definitely costs you to use that credit card and rack up those skymiles. And I am certainly not referring to any finance charges you may or may not pay each month. So, don't think that just because you pay off your whole bill each month that you aren't paying for those rewards. You are! They're hidden in a little thing I like to call: the merchant discount.

The merchant discount is the fee a merchant pays to a credit card company for the right to collect payment from you through their credit card system. Each time you swipe your card at Nordstrom's, they have to pay a percentage of your purchase to American Express. Then, American Express turns around and offers you a credit card that comes with "rewards" that are...amazingly!...a percentage of the dollar value you spend. Doesn't this sound like a transfer of wealth? American Express is taking from the rich (Nordstrom's) and giving to the poor (you!) through the system of credit card rewards.

Now here's the kicker...who pays for it? Well, think about it like this: Nordstrom KNOWS that you love to use your credit card, and that you really WANT to use your credit card, but it costs them the merchant discount each time you do. So? They increase the price of the goods. ALL the goods in their store (since American Express has mandated that no one can charge a surcharge for using their credit card). So, a person paying cash pays the same price for a pair of boots as a person using an American Express card. But the American Express cardholder turns around and collects "rewards" based on the amount of their purchase. This could be seen as a discount on the boots. (I.e. They get the boots, but they also get a small benefit from the rewards, so the net price of the boots is lower than someone who paid with cash).

The moral of this story is: As long as credit cards offer rewards, EVERYONE should be using a credit card! Otherwise, the cash payers are paying a higher price than the credit card buyers. So run out and find the card that comes with the best rewards at the lowest annual fee you can find, and once a year you can take a trip with a free airline ticket, or get $200 cash back, or get a gift card to Bed Bath & Beyond, or some other "free" lunch. Use your credit card as long as there are rewards! Because if you pay with cash, all you get is....lunch.

Education as a Way of Signaling

Tis the season for recruiting, interviewing, and hiring around my office. And I am reading the resumes and cover letters of these fresh-faced, over-eager, handshake harder-than-it-needs-to-be, discount power-suit wearing and too-much-gel-in-their-hairdo yuppies who use big words and timelessly lame phrases such as, "I can go anywhere and do anything" or "I know I would be an asset, and not a liability, to your company," I wonder why we are hiring these people who know absolutely NOTHING about what we do here, or the real working world at all.

In general, universities - especially top universities - do not teach job skills. Technical colleges do a much better job at teaching skills. So what exactly makes companies hire from universities where the students know how to derive mathematical proofs and can analyze Shakespeare, when they do not do ANY of those things that you learn in college in the actual workforce? Simple - education is a way of signaling.

Signaling is a specific concept: It is the idea that you are trying to communicate to someone, and make them really believe you're telling the truth. Since we all know that everyone is self-interested, we cannot trust what people say, but what they do. Signaling is whatever method you find to show your commitment to what you're saying.

Think of it in more simple terms: Companies want to hire smart people. They can then teach smart people the job skills they will need to perform the job well. Okay, so how do you find smart people? EVERYONE you interview will proclaim they are smart. Even the highschool dropouts can claim that they dropped out because they were bored with the curriculum because it was too easy. So if you can't trust what candidates SAY, then observe what they DO. Specifically, do they put their money where their mouth is?

Smart people, who realize they are smarter than the average dumbskull, will apply to college and pay lots of money in tuition, in exchange for nothing but a degree. They will - for the most part - not learn technical skills. But at the end of the 4 year program, they can emerge and apply for jobs and say, "Look at me! I really AM smart! I KNEW I was smart, and so I spent all this money and time and went to college because I knew it would pay off for me in the end." And the prospective employer realizes that nobody knows the candidate better than the candidate themselves, and if they were willing to invest in themselves, it must be because they believe they are smart.

The REALLY smart people go on to graduate programs and get fancy "signals" called "MBAs". MBAs do not learn anything in an MBA program. It is purely networking. Some of the top MBA programs do not even issue grades to their students. It is entirely "pass/fail". Which means that it really doesn't matter how well you learned anything, because an MBA is merely a signal.

Now that you know that signals are ways of committing to something, which you cannot back out of and which depends on other people's responses, you will see signaling everywhere. What is an expensive engagement ring, really, but an irreversible signal of a potential husband's intentions? And when companies spend billions on advertising a product that is purchased repeatedly (such as Mr. Clean's Magic Erasers) you'll realize that they must really believe their product will sell well - repeatedly! - or else they wouldn't be able to recoup their investment.

Anyone else out there seen any signaling recently?

The Best Time to Buy

While "timing the market" is highly frowned upon and all financial analysts tell us over and over and over that we can't do it right, and we'll only lose more money by trying to do it, blah blah blah...but I did it! Not in the stock market, (I just invest, diversify, and leave it alone) - but in car shopping.

The automobile industry was really hurting over the summer in the large truck/suv area, because gas prices were so high and everyone freaked out and tried to sell their big suv, and nobody wanted to buy one. Well, I decided that since I knew that oil prices would have to come down eventually, I wanted to buy a truck when the truck prices were low - and then sit around and wait for gas prices to come down...which they did, as they always do. (We have a winner!)

With the economic turndown lately, you may not have too much extra cash to go buying things, - unfortunately, there's the irony. The best time to buy is usually when you don't have the money. But retailers are really hurting right now, so the discounts are deep. Walk through your nearest mall and just notice how many "50% off" signs you see.