The Halo Effect

I was reading the New Zealand Commerce Commission’s public release on the potential Warehouse merger with one of the two massive supermarket chains. On page 15, paragraph 81 of this document, Ian Morrice of the Warehouse mentions ‘the halo effect’. He states that this is a term that the Warehouse invented to describe what happens when a firm introduces a new product, with the aim of increasing consumer throughput, which will lead to an increase in demand for the original set of goods sold.

This concept makes sense as there is a transaction cost of going somewhere to buy something. So once you introduce groceries into a Warehouse store, people can now get groceries and general merchandise in the same place, lowering the transaction cost of buying a bundle of both types of goods. This allows the Warehouse to increase the price of general merchandise goods, and to increase the quantity of merchandise goods they sell.

Now I thought that the halo effect was a pretty cool term, so I decided to look it up on wikipedia. Much to my surprise the term existed well before the Warehouse used it. Not only did it exist, but it meant something a little different. In industrial organisation terms the halo effect is what happens to the consumers’ perception of a firm’s set of products when a new product is introduced. For example, Sony makes electronic stuff, like DVD players, that I think are pretty high quality. Now say that they make a battery that really sucks. If I use this battery and don’t like it, then I may also downgrade my perception of the quality of other Sony products. Implicitly, people use brands to proxy the value of a product. If a firm makes a shoddy product, consumers will use this as information about the quality of other products under the brand.

These two definitions are both important, but I think it is important to distinguish between them:

  1. Goods as complements: By putting more products under one roof, a firm can reduce the consumers’ transaction costs, allowing the firm to increase sales and prices for the initial set of goods.
  2. Goods as signal of brand quality: The quality and desirability of a new good sold by a firm can change consumer perceptions (and ex-ante expected values) about other products sold by the firm.

Now if you ever hear the term being used, you should ask the person to define exactly what they mean.

Emission trading: Fairness and efficiency

An article by Adolf Stroombergen (from Infometrics) discusses how NZ is going to meet its obligations under the Kyoto protocol.  First Adolf discusses the merits of a Pigovian tax as a way to cover our obligations.  One line I particularly enjoyed was:

“However, even if a tax has no effect on emissions, it is still fairer to put the cost of emissions on those who cause them than to put the cost on taxpayers generally.”

So damn true!  Having established what the government should do, he then goes on to discuss what they actually will do, an emissions trading system.  While a emissions trading system could, in theory, be as efficient as a tax, governments around the world have taken the strange measure of given out emissions permits for free, instead of auctioning them and using the money gained to pay off the Kyoto obligation.  The reason given for this in the article is that it is fair to compensate industries where investment has occurred only on the basis that producing carbon was free.

However, I think I see it a little differently.  If an established firm can only stay in business when carbon emissions are free, then they are socially inefficient.  So the only way the firm can stay in business is if it makes society bear some of the cost of their production decision.  That seems unfair to me.  As a result, I think that emissions permits should be auctioned by the government in almost all cases.  The only time I see scope for them to be given away for free is when we have an infant-industry, one which would be able to pay for the full cost of their production activity in the medium term.

The week in numbers

  1. QVNZ three monthly house price growth continued to accelerate, reaching 12.7%pa in July
  2. Retail sales growth was up 7.2%pa in the June quarter, and 4.8%pa in the June month.
  3. The exchange rate is crazy, falling to $0.67US at one point, currently around $0.69.

Robust house price growth and reasonable sales growth are not the sort of news that usually leads to a plunge in the exchange rate. However, with credit tight people are pulling out of NZ to try and get hold of some liquidity.

Product diversity and development

Tim Harford’s latest Undercover Economist column covers some interesting research on industrial development. The paper examines the type of products that countries produce, and the way that a country’s ‘manufacturing portfolio’ changes over time. The key finding is that countries tend to develop by producing similar products to those that they already produce.

This makes intuitive sense: if a country already has infrastructure suited to the manufacture of a particular product then it will be less costly to develop similar products than to develop radically different ones. The problem arises when a poor country with limited production diversity approaches the limits of its current manufacturing processes. It is very difficult and costly to make the transition to producing a new, unrelated product type. The paper’s data confirms that this rarely happens. Notably, the authors find that:

Rich countries have larger, more diversified economies, and so produce lots of products […]. East Asian economies look very different, with a big cluster around textiles and another around electronics manufacturing […]. African countries tend to produce a few products with no great similarity to any others.

If poor countries are to make the step to producing new products then some intervention in the development process may be required. This points to a role for some government industrial policy at a national level, or structural intervention at an international level. It could mean a new justification for infant industry protection in developing countries. It also, perhaps, points to a different way of making effective use of the limited aid money available to organisations such as the IMF and World Bank.

Marital Economics

The Economist Blog pointed out the following blog article. In this article Michael Munger points out how a marriage is like a firm, in the way that it internalizes all the transaction costs associated with purchasing ‘relationship’ goods (this is an application of the Coase theory of the firm). Although the Economist Blog agrees with this underlying way of looking at a relationship the two authors disagree on whether a two person relationship is optimal.

The Economist does have a point in that, a relationship with three or four people could hypothetically work, hell they do occur in real life. The way to analyse whether it would work is to look at the margin. Ultimately, the relationship should be willing to accept one more person if the marginal benefit of getting them in-house is greater than the marginal cost. In most monogamous relationships, the benefits of having another partner (Partnership, sex, love) are less than the costs associated with that partner (Putting up with another person all day, cost for deviating from social norms, costs of co-ordination 😉 ), as a result it is often optimal to stay in a two-person relationship.

Ultimately the optimal size of the firm/marriage depends on the preferences of the individuals involved, and the market of available suitors. Isn’t it beautiful to hear economists talk about love 😉 .

Let the healthcare debate continue…

There are plenty of worthwhile discussions amongst economists and policy-makers about the best way to fund health care. A debate that goes on largely outside the policy-makers’ domain, however, is whether increased health care spending actually improves health care at all. There is a sizable body of research which suggests that increased health care spending doesn’t improve outcomes one iota! If this is true then it makes the whole health care funding debate largely irrelevant.

The real problem with these rather counter-intuitive results is endogeneity bias: often large spending in a particular geographical area indicates that people with serious health problems live in the region. If this is the case then the cross-sectional sample is not randomly selected and the results will be biased. Thankfully, some brainy econometricians came up with a way to instrument for the endogeneity problem and they find that health care spending IS positively correlated with health care outcomes. So now we can all get back to arguing over our entrenched, ideological positions on health funding again. Phew!