Digital currecncy bad news for debt-ridden consumers

(A version of this article appeared in the Sunday-Star Times in July 2011.)

The Weekend Herald contained a small news item about the CEO of PayPal Scott Thomson who claimed that wallets will soon be obsolete. Thomson suggested that by 2015 digital currency will be accepted everywhere, at least in the US. Soon you will not have to carry around either cash or cards but be able to make all your payments via your cell phone.

 

Experts believe that PayPal’s CEO is being overly optimist about the timeline. Nevertheless the fact remains that the advent of digital currency is not too far away in the future.

 

What are the implications of digital currency for consumer debt? Not good, I am afraid. Drazen Prelec and Duncan Simester of MIT suggest that digital transactions fundamentally change the way we spend money. When we pay via credit cards we tend to spend a lot more than if we paid with cash.

 

When we pay with cash, there is a sense of loss when we have to hand over the dollar bills to complete the transaction. Credit cards make the transaction abstract and as a result digital transactions do not affect our brain the same way that paying with money does.

 

The part of our brain which deals with feelings of aversion (such as a reaction to a bad smell) is called the insula. Economic decision making experiments using brain imaging suggest that when we pay with our cards, as opposed to cash, there is reduced activity in the insula. This implies that we do not feel as bad about spending money when we use our cards rather than cash. Ergo, we end up spending more.

 

Prelec and Simester organized a sealed bid auction of tickets to a Boston Celtics game. Half the participants in the auction had to pay with cash while the other half could pay with a card. When Prelec and Simester looked at the average bids they found that the average credit card bid was twice as much as the average cash bid.

 

Cell phone transactions will further increase the disconnection between the pleasure of buying and the pain of paying and will almost certainly exacerbate the tendency to spend money. 

 

Think of this as a tussle between the emotional and rational parts of our brain. The emotional part looks at things – shoes, handbags, golf-clubs and silk ties – and wants to buy them. The rational brain thinks about the cost of paying for these and holds us back.

 

Brian Knutson, a neuroscientist at Stanford, along with colleagues carried out an ingenious experiment to understand how people make purchasing decisions. Participants were given an amount of money to start with and then shown various different objects they could choose to buy. If they bought something then the item’s cost was subtracted from their starting balance.

 

While people made these decisions the researchers were studying their brain activity using fMRI scans. They found that when people first encountered the goods for purchase, this activated their nucleus accumbens (NAcc) which is the part of the brain that deals with pleasure and rewards.

 

Then they are told the price of each item. At this point the insula and the prefrontal cortex (PFC) got involved. The insula, as I mentioned, is engaged when we find something distasteful like actually having to fork out money for things we want to buy.  

 

The PFC is the rational part of the brain which is involved in decision making or handling complex cognitive tasks. Faced with the NAcc wanting to buy the pair of shoes badly while the insula objects at the price tag, the PFC tries to figure out if this is actually a good deal or not.

 

By looking at the activity in the different regions the researchers could predict how people would decide. If the activity in the insula was stronger, then people would end up not buying the good. But if on the other hand the NAcc was more active or if the PFC was saying that this was indeed a good deal, then the participant ended up buying the good.

 

So what’s the catch? If you want to get people to buy things then you have to increase the activity in the NAcc. Think about the prominent displays in duty free stores for a minute. These are designed to appeal to your pleasure centre and make it harder to stop yourself from buying something.   

 

But stimulating the NAcc is not enough; you also need to deactivate the insula. One way of doing that is to postpone the act of paying. Credit cards, digital currency or instant financing all contribute towards that end. Signs saying “sale!” or “huge reductions!” achieve similar goals of inhibiting the insula or convincing the PFC that this is indeed a great deal.

 

The end result is the same. We end up buying things we don’t need and often cannot afford, simply because the rational part of the brain loses out to the emotional part.

 

Do you have a problem with debt? Do you find yourself compulsively buying things and later regretting? Then here is my advice: forget the cell phone, hang on to your wallet and if you have to buy something, try and pay with cash.

 

The high price of All Black jerseys

A version of this article appeared in the New Zealand Herald (on-line rather than in print) on August 10, 2011,  during the Rugby World Cup of 2011.


Adidas New Zealand would have us believe that the considerably higher cost of All Black jerseys being sold in New Zealand compared to the cost of those available overseas reflect local market conditions. According to the manager of Adidas New Zealand the price they set in New Zealand is “relative to the local market”.

 

What does this really mean? Can it mean that the higher New Zealand prices are the result of higher costs here, as seems to be the implication in the statement released by Adidas New Zealand? This seems unlikely since in all probability these jerseys are being made in China or another less developed country. From there they are being shipped to all parts of the world.

 

It is possible that transportation costs for getting them to New Zealand might be higher. But it also likely they are being imported in bulk into New Zealand because it is unlikely that the demand for All Black jerseys can be that much higher in countries outside New Zealand. This means that there must be some cost savings from the higher volumes of these jerseys being imported into New Zealand. 

 

But in any case it seems improbable that these cost differences can explain mark-ups of close to 100% with each jersey costing twice as much in New Zealand than in say the US.

 

I think it is a safe bet that Adidas New Zealand is engaging in some good old fashioned price discrimination. This is where sellers charge a much higher price to those buyers who are willing to pay up, mostly because they are less flexible in terms of their purchase decisions.

 

This is why the person sitting in the seat next to yours on the airplane may have paid hundreds of dollars more than you did because he bought his ticket at the last minute while you bought yours two months back.

 

But the more appropriate comparison here might be between hard-cover books and paperbacks. Who shells out the mega-bucks for the hard-cover version of the latest thriller from John Grisham? The dedicated fan who wants to read the book right now rather than wait for it to show up at the local library later or in paperback form even later.

 

So what Adidas New Zealand is implicitly assuming is that once the world cup gets going – and especially if and when New Zealand starts to win (hopefully) – the fans will catch the fever and in the heat of the moment will willingly snap up these jerseys in spite of the much higher prices rather than coolly compare prices and then wait for a week for the jersey to be shipped to them.

 

We all do it. We walk out of a concert by our favourite rock group still on a high and humming the tunes and then promptly snap up the memorabilia – the t-shirts and the dvds – from the store outside the venue, even though we can easily buy these much cheaper from an on-line store, only if we are willing to wait a few days. But we don’t because we want to possess them immediately. And somehow the act of buying these – even at prices we know and recognize to be inflated – becomes part of the same religious experience as attending the concert, it sustains the high; it helps us remember later that we were there, we took part in that momentous occasion.

 

There are, however, two other aspects to the logic of price discrimination. One of these relates to people’s willingness to accept the price. If enough people consider the price to be unfair and refuse the buy the jerseys at these high prices then the logic of price discrimination starts to fall apart.

 

But at the same time successful price discrimination – charging a higher price to the more eager and more committed Kiwi customer while charging less to those living abroad – requires that there is no arbitrage. This means that the strategy of price discrimination can be profitable only as long as people buy from retail outlets in New Zealand. If enough people go on-line and buy there or even worse for Adidas if an enterprising Kiwi goes on-line and buys a lot of these jerseys at half price in US and re-sells them here in New Zealand – say on Trademe - at a small profit which still makes the jerseys cheaper than what Adidas is charging, then Adidas will no longer be able to engage in price discrimination.

 

Reports published in the Herald earlier this week suggest that Adidas has woken up to this threat and is now taking steps to prevent this from happening. For instance an American website selling the merchandise no longer has NZ as a shipping option. It is likely though that resourceful All Black fans may find a way around this.

 

Nevertheless, at this point it is clear that Adidas has seriously underestimated the degree of displeasure both from the fans as well as retail outlets.

 

I expect that sooner rather than later someone at Adidas will figure out that the increased profit margins on these jerseys are not worthwhile after all given the amount of goodwill that Adidas is losing among the fans, retailers and probably, more importantly, among the All Blacks themselves who proudly wear these jerseys and who might have something to say the next time the jersey contract comes up for renewal.

 

One hopes that such good sense prevails soon so that we can move beyond this fracas to enjoying the World Cup festivities.

 

 

The reasons behind the gender pay gap

A slightly modified of this article appeared in the New Zealand Herald on Saturday June 25, 2011.

Women should get paid the same as men for doing the same job. This should not be a matter of debate, particularly in the country that was first in giving women the right to vote way back in 1893.

The existence of a gender wage gap in the work-place is well documented. Women earn less than men in similar jobs even after controlling for other factors such as education and experience. In the United States annual earnings data released by the Census Bureau in September 2010 shows that women working full time make, on average, only 77 cents for every dollar earned by men.

The UK Office of National Statistics reported in April 2010 that hourly wage rates for men working full time was £13.01 while for full time working women the rate was £11.68. This difference amounts to women earning about £10.60 less per 8-hour working day and about £425.60 less per 40 hour work week. Assuming a 48 week year, in 2010 women working full time in the UK earned £20,428 less than men working full time.

What explains this lower earning for women? A number of people put forward arguments similar to those expressed by the Employer and Manufacturers Association chief Alasdair Thomson, albeit with finesse; that women often take time off from work to start a family or take care of children and other arguments along those lines.

The question has been the subject of much research. If we do observe differences in the relative pay of men and women, this can be due to two separate sources; either differences in observable characteristics such as education, hours worked, work experience, and choice of occupation, or due to unobserved factors like discrimination against women in the work place such as lower wage for the same work.

Two leading labour economists from Cornell University Francine Blau and Lawrence Kahn carried out a comprehensive study that takes into account a large number of variables such as education, labor market experience, race, choice of occupation and report that while the gender wage gap does diminish when all these factors are taken into account nevertheless a substantial part of the gender wage gap – about 12% - remains unexplained.


Robert Wood, Mary Corcoran and Paul Courant look at graduates of the University of Michigan Law School. They match the men and women in their sample for many of the possible explanatory factors, such as occupation, age, experience, education, and time in the workforce, time spent in childcare, average hours worked, grades while in college, etc. Even after accounting for all that the authors find that one-quarter to one-third of the gender wage gap remains unexplained.

Recent research throws up another reason why women may earn less than men: women simply do not ask for more. In the 2003 book Women Don’t Ask Linda Babcock and Sara Laschever point out that among MBAs from Carnegie Mellon University starting salaries for men were almost $4000 higher than that for women; to a large extent because while only 7% of the women negotiated their starting salary, 57% of the men did so. While $4000 at the beginning of one’s career may not be a large difference, given that salary increments are typically a percentage of base salary – and other things like bonuses also depend on current salary - a small difference early on translates into large differences later in life.

In research carried out by me and others, we document a similar reluctance on the part of women to compete. Given the essentially competitive nature of the work-place this usually does not bode well for their future success. To a large extent this aversion to competing is a function of women’s socialization and nurture.

In the late 1990s Lilly Ledbetter’s lawsuit against the Goodyear Tire and Rubber Company in the US became an important milestone in the fight for gender pay equity. When she retired after 20 years of service she found that her monthly salary was lower than the salary of the lowest paid male workers. Why didn’t she ask for more? Ledbetter said that this was because she simply had no idea that she was getting paid so much less than the men for doing the same work!

The US Supreme Court decided against Ledbetter by a 5-4 margin arguing that the statute of limitations had passed since she did not file suit within 180 days of the first act of discrimination as was required by law. In January 2009 one of the first bills that President Barack Obama signed into law is the Lilly Ledbetter Fair Pay Act which got rid of this 180 day filing requirement.

Women, here and elsewhere, are not asking for a hand-out. They are asking to be paid the same wage as men for the same work, an idea that is fundamental to democratic ideals of equity and justice. Catherine Delahunty’s bill which proposes to amend the Equal Pay Act by allowing for gender pay comparisons in the work place will help reduce the disparity in pay between men and women. It will prevent others from suffering the same fate as Lilly Ledbetter. It is an important step forward for achieving the goal of gender pay equity.

I wrote this article as a response to comments made by Alasdair Thomson, the Chief Executive of Employers and Manufacturers Association. Related articles on the topic in the New Zealand Herald:

Call for employers' chief to resign after 'insult to women

Alasdair Thompson walks off interview over 'sexist' claims

Murray Deaker's comments

I do not really expect much in the way of scholarship, thoughtfuness or intellectual depth from radio and television commentators in New Zealand. It is a small country and obviously draws from a very shallow talent pool. But is it too much to expect that they will stay away giving vent to their latent racism while on air? In recent years we had Paul Holmes calling the UN Secretary General a "cheeky darky". Then came the asinine jokes from the crude Paul Henry. Now we have Murray Deaker with his euphemism for blacks.

The strange thing is that in each of these cases the employers of these commentators, rather than expressing their dismay and condemning the comments, jumped up to defend these people and suggested that it was not a big deal.

It is a very big deal. Of course, I have no delusions that these people will turn into enlightened souls any time soon. But could we at least expect their employers to set slightly higher standards and ask their commentators to keep a check on the racist remarks during a broadcast? And how about the Broadcasting Standards Authority? Does it have any teeth at all?

We should not make our bill payments records public

(A version of this blog appeared as a perspectives article in the New Zealand Herald on June 1, 2011 under the title "Banks put vulnerable at risk from predatory lending")

We should not make our bill payments records available to lenders. Doing so has the potential of exposing consumers to predatory lending practices which ultimately will not serve our best interests. I will come back to this shortly.

According to the banking industry this is all about being a responsible consumer. The idea is that paying your bills on time will help you get a better credit rating and better access to loans. Those who are struggling with their bills will not be given any more credit to prevent them from piling up debt.

If you buy that argument, then you should also buy the argument that with all those sub-prime loans that the banks handed out, they just made honest mistakes. They did not realize that they were making loans to people who would not be able to repay. If only they had access to the debtors’ bill payments history they never would have advanced those loans!

Suppose for the moment that banks are really concerned with credit-worthiness and want to figure out who would be diligent about repaying the loans and who not.

They have adequate means at their disposal right now. They can ask you whether you have a steady income or not and how much money you make. They can ask you for your payslips and for your bank statements. And you know what - if they really wanted - they can ask you about your payment history as well!

For most of the transactions we engage in such as telephone and utilities payments our past bills and payment records (usually up to a year’s worth) are available on-line. All you have to do is to log in to your account and print them out. Getting an online account is free and so is printing out the past bills. If you want you are at liberty to provide this information to your bank.

There is absolutely no reason why all of us should be subjected to this massive intrusion on our privacy just to help banks figure out who is credit-worthy and who is not.

So what is it about then? This is, I believe, to a large extent about credit card debt.

A lot of our household debt is carried on credit cards. According to the Reserve Bank, at present the total amount of outstanding credit debt in New Zealand is approximately $5.4 billion and the average interest rate on these is 18.8%. Our banks are raking in a little over $1 billion in interest payments on credit card debt.

According to Dan Ariely, a professor at Duke University and author of the book “Predictably Irrational” “the average American family has six credit cards (in 2005 alone, Americans received 6 billion direct-mail solicitations for credit cards). ...the average debt on these cards is US $9,000; and seven in ten households borrow on credit cards to cover such basic living expenses as food, utilities and clothing.”

And when it comes to credit cards, banks are actually looking for people who are having difficulties paying of their bills; people who will run up debts, carry the balance and keep making the exorbitant interest payments.

But how do you find the consumer that will keep on making the interest payments rather than paying off their balance? This is a little trickier. The bank cannot really say to you: so I hope you are not the type that likes to pay off your card balance at the end of every month; because what we are really looking for are people who will only pay the interest.

But if they can look at your bill payments history and see that you have had some trouble in that area, then they know who is a good mark and who is not. Then they know whose mailbox to stuff (or whose phone to call during dinner-time) with the announcement of an exciting new card offer of a low teaser interest of 5.99% for the first 6 months but then going up to 25.99% after that.

With the bill payment history available, finding desirable targets becomes easier. The lender can even tailor his appeal more specifically. Having trouble with the heat bill? What do you know, we have a credit card with a very low introductory rate that will also give you gift vouchers that you can use to pay for your heat!

Providing detailed records will place the more vulnerable consumers at much greater risk of being subjected to predatory lending practices.

Will our banks do this? Banks in other countries have certainly engaged in such practices. But, at the very least, making our records available makes it possible to exploit such information to the detriment of consumer interest. The downside to making such records public should be obvious.
What is the upside?

Why would the banks wish to promote consumer responsibility, when their profits depend crucially on consumers behaving irresponsibly?

Should we pay more to our school teachers?

A version of this blog appeared as a perspectives article in the New Zealand Herald on Tuesday, September 21, 2010.

Should our school teachers be paid more? I think so. Because at current salaries we will have a very hard time attracting high quality individuals to that profession. Only those motivated by a desire to serve society at some level might step forth but possibly not too many of them.

At the University of Auckland, I teach a course called “Understanding the Global Economy” which is designed for students who are studying disciplines other than business and economics. The course usually has upwards of 500 students in the class and attracts students from all over the university. These are the best and brightest students in our community. Every year I ask them what they are planning to do after they graduate. Doctors? A multitude of hands. Engineers? Another array of hands. School teachers? And a strange hush falls over the lecture theatre.

Why? The answer is simple. The salaries are abysmal.

But how can we afford to pay them more, critics ask? The right question to ask, I think, is how can we not? Teaching students at our schools is fundamental to our long-term well-being. This is where our children are spending their formative years and it is imperative that they be taught by people who are enthusiastic, inspiring and visionary. Do we get them currently? I doubt very many.

The answer is easy to understand. Consider two job candidates. I will call them Harry and Sally. Sally is a dynamite young person; full of ideas and getting ready to change the world. Harry is a bit of a plodder with limited ambitions. Sally has decided that after she graduates she will only accept jobs that pay her $50,000 or more while Harry is content with $30,000.

Along comes a multinational company which offers $55,000 and a primary school offering $35,000. Which job do you think Sally will take? Maybe Sally is an altruist and does take the job in the primary school. But then one day Sally will meet Harry, fall in love and start a family. She will realize that if she is to give her children the best opportunities in life then she cannot afford to be a school teacher anymore. Sally will start looking for another job that pays more.

Now think of this from the employer’ perspective. Will paying more attract better qualified applicants? This is not guaranteed but certainly improves the odds. Why? Suppose you are recruiting for the primary school. Harry and Sally both look like impressive young people; clean-cut, well-dressed, well- spoken. But you know that there is one-half chance that one of them is more qualified than the other. What you do not know is whether it is Harry or Sally who is the better candidate.

The problem is that you cannot quite make out from the interview which of the two is more dynamic. What salary do you offer them? If you offer anything less than $50,000 then it is guaranteed that Sally will not accept the job and only Harry will. This in turn implies that offering less than the minimum Sally – the more dynamic candidate – is willing to accept is a certain recipe for ending up with the less qualified candidate. But what if you offered $50,000? Will that guarantee you get Sally. No. But it certainly improves your chances of recruiting Sally. Offering the higher salary radically improves your chances of hiring the better candidate because you will now be attracting a better pool of candidates – Sally and many others like her.

Can we afford to pay our teachers more? I do not know. But what I do know for sure is that if we keep paying these low salaries then our children will not be taught by inspiring and visionary teachers. Are will really willing to take that gamble with our children and the future of our nation?

Is New Zealand a rip-off?

(This blog is co-authored with my colleague Dr Debashis Bandyopadhyay. A version of this blog appeared as a perspectives article in the New Zealand Herald, Page A13, August 11, 2010)

In recent days there has been a lot of discussion about whether New Zealand is a “rip-off” following comments – no doubt well-meaning ones - made by a British columnist, later supported among others by our very own Justin Marshall. However, it is important to understand that there are actually two separate questions implicit in this one simple phrase.

First, is New Zealand a rip-off in the sense that our prices for day-to-day goods are higher than other countries even after you make the necessary corrections for differences in exchange rates? Second, and probably more importantly in the current context, are those prices high because of deliberate over-charging by producers? I would submit that the answer to the first question is most likely yes and the answer to the second is most likely no.

Let us start with the second question first. It is important to remember that the extent to which a producer has power over the price he charges depends on how competitive the market is. A producer can only charge high prices if there are no competitors available to undercut his price and lure customers away from him or if he can somehow or the other collude with his competitors in over-charging his customers. Because if a particular producer is making large profits, then it is most likely that another producer can come into the market, undercut his prices and still make enough profit to make such price cutting worthwhile.

This implies that in markets with vigorous competition and many small firms, it would be difficult to keep over-charging customers because there are enough other producers around who can and will undercut prices if it makes money to do so. And if there are a whole lot of competitors, colluding with all of them is a difficult proposition. This in turn most likely implies that – given the profusion of cafes around the city – we are most likely not paying too much for our daily dose of flat-white and those prices truly reflect the underlying costs with not much of a margin. A similar argument is probably applicable to hotel prices in popular tourist resorts.

How about fine dining? These markets are certainly not competitive and the issues here are somewhat different. Is $28 for an entrée in a restaurant in the Viaduct Harbour too much? There is no clear answer to this question. For those who are going there and enjoying the food along with the ambience and the view of the water, it most likely is not. Someone who is not willing to pay that price is surely not going to eat there. What the restaurant is clearly exploiting is their monopoly power arising out of their prime location. But the point here is that the restaurant is not primarily interested in the price it charges but rather in the profit it makes. It is most likely that the restaurant calculates that they can get away with charging $28 for an entrée and still enough people will line up to make it worth their while. Because if their profits would go up by charging lower prices they would surely do so!

Given that restaurants in the Viaduct Harbour or on top of the Skytower clearly enjoy the advantages of being in a premier location they are charging the prices that maximize their profit and it is difficult to see how one can increase competition in this regard in an attempt to lower those prices. So if the view and the setting are not worth that much to you then you should probably not patronize these establishments. It is also probably worthwhile to remember that these people also pay a premium on the rent for these locations.

Okay, so are there any situations where producers are deliberately over-charging? Yes, it is most likely that we are paying too much for our meat and produce at the local supermarket. It is one thing if we have to pay through the nose for exotic foreign goods that are shipped from a long distance away. But that does not explain why we pay top prices for locally grown meat, fruits and vegetables.

In the absence of hard data, one can make conjectures as to why this might be the case. In Auckland, the supermarkets are owned by one of two companies Woolworths and Foodstuffs. The extreme lack of competition in this market pretty much guarantees that the supermarkets can get away by charging high prices. It is also not unlikely that there is some amount of implicit collusion among these two companies.

However, before we condemn the supermarkets, there is one other issue that needs to be remembered. It is possible that our supermarkets also experience higher costs than would be true of supermarkets in other countries. We all know the price a producer charges is related to the underlying costs. For large supermarkets there are large fixed or set-up costs. It costs money to build and operate one of these stores. This cost is fixed in the sense that if you decide to build a large supermarket then you have to incur some of these costs in terms of building costs, the cost of air-conditioning etc. which is independent of the amount of goods that you sell.

Now the more you sell the less your costs become on average because this large fixed cost gets distributed over a larger volume of goods making each item less expensive to produce and sell on average. But the extent to which these average costs decrease depends on the volume of your sales. Here is the problem. Auckland – and New Zealand - is a very small market. And therefore it is possible that the sales volumes are just not large enough to give the producers adequate cost savings. So which view is correct? Are costs too high? Or are they deliberately over-charging given the lack of competition? Probably a bit of both. This is an open research question.

So, what is the average consumer to do? Well, it depends. How important to you is the convenience of buying everything under the same roof in air-conditioned comfort? How pressed are you for time? If you can spare the time, then drive to the nearest Chinese supermarket or farmers’ market. But this might mean having to make multiple stops for all the things you need during the week.

And how about romantic dinners? Summer is just around the corner. Pack a chilly-bin, grab a beach-mat, get in the car and drive to a scenic spot. We are lucky to live in a country where there are plenty of these in close proximity and they are all free!