The paradox of schools choice revisited

Diminishing returns is a feature of many things in life. School quality is one example. It is already widely acknowledged that a significant part of learning takes place outside the classroom through parental and peer engagement, and other off-classroom sources. This also means that incremental school quality beyond a certain level is unlikely to have any effect. 

This point about the importance of school quality is brought out in a new paper that uses data from parental preferences, peer quality, and causal effects on outcomes for applicants to New York City's centralised high school assignment mechanism,

School choice may lead to improvements in school productivity if parents’ choices reward effective schools and punish ineffective ones. This mechanism requires parents to choose schools based on causal effectiveness rather than peer characteristics... We use applicants’ rank-ordered choice lists to measure preferences and to construct selection-corrected estimates of treatment effects on test scores, high school graduation, college attendance, and college quality. Parents prefer schools that enroll high-achieving peers, and these schools generate larger improvements in short- and long-run student outcomes. Preferences are unrelated to school effectiveness and academic match quality after controlling for peer quality... 

Moreover, no subgroup of parents systematically responds to causal school effectiveness. We also find no relationship between preferences for schools and estimated match quality. This indicates that choice does not lead students to sort into schools on the basis of comparative advantage in academic achievement. This pattern of findings has important implications for the expected effects of school choice programs. Our results on match quality suggest choice is unlikely to increase allocative efficiency. Our findings regarding peer quality and average treatment effects suggest choice may create incentives for increased screening rather than academic effectiveness. If parents respond to peer quality but not causal effects, a school’s easiest path to boosting its popularity is to improve the ability of its student population. Since peer quality is a fixed resource, this creates the potential for socially costly zero-sum competition as schools invest in mechanisms to attract the best students. MacLeod and Urquiola argues that restricting a school’s ability to select pupils may promote efficiency when student choices are based on school reputation.

The results of the new study and its concerns about zero-sum competition among school managements is confirmed by anecdotal and other qualitative accounts of how the best schools in India compete to attract the best students. This, in turn, allows them to command a disproportionate fee premium. The quality divide gets exacerbated in the process, leaving the best performing children in a few schools and the rest to struggle in the large majority. 

I have blogged earlier, using the logic of Schelling's chessboard experiment, to argue that school choice is likely to lead to 'emergent outcomes' that may be far less benign than expected. This is a wonderful game illustrating the point. See more on school choice here. 

Weekend reading links

1. Larry Summers resurrected Alvin Hansen's argument on secular stagnation to explain the low productivity growth in the US. The likes of Robert Gordon, Nicholas Bloom and Tyler Cowen have point to a plateauing of transformative innovations, increased cost of new inventions, and low hanging fruits having been plucked.

Now comes Valerie Ramey with the argument that this may be technological lull,

The slow recovery of the economy from the Great Recession and the lingering low real interest rates have led to fears of “secular stagnation” and calls for government aggregate demand stimulus to lift the growth rate of the economy. I present evidence that the current state of the U.S. economy does not satisfy the conditions for secular stagnation, as originally defined by Alvin Hansen (1939). Instead, the U.S. is experiencing a period of low productivity growth. I suggest that long intervals of sluggish productivity growth may be natural in an economy whose growth is driven by technological revolutions that are large, infrequent, and randomly-timed. If this is the case, then the best description of the recent experience of the U.S. economy is a technological lull. In this situation, traditional government aggregate demand stimulus policies are not the appropriate response. Instead policies that can increase the rate of innovation and its diffusion may be more appropriate.

2. From an excellent essay by Derek Thompson peering into the post-Covid future. Sample this about restaurant industry,

Americans before the crisis spent more money dining out than in grocery stores—something that had never happened before 2015. But COVID-19 could bring this golden age to an abrupt close. OpenTable reservations have collapsed all the way to zero. Restaurant spending has fallen by about 60 percent across the country, with the sharpest declines in fine-dining, lunch, and late-night food. The situation is especially bad for independent restaurants.

Social distancing requirements, likely for the foreseeable future, will worsen the problem for mom-and-pop eateries and coffee shops. This is a fascinating prospect,

Like Prohibition did 100 years ago, a delivery-first restaurant business could change the American palate. Pizza and Chinese food are well positioned for the transition, since they already account for 70 percent of the U.S. delivery market, according to a report by the investment firm Cowen and Company. But not every entrée is made to be left in a car for 30 minutes. Grilled salmon and medium-rare steak don’t benefit from a microwave zap. Neither do Michelin-star entrées... It would be glib to suggest that most restaurants can survive by simply pivoting to delivery. Indeed, many won’t—and not just because some consumers might be afraid of lukewarm trout. The bigger problem is that the most popular delivery items (appetizers and entrées) tend to be the least profitable, while delivery consumers rarely order the higher-margin items, like dessert and booze, that actually pay the rent... Summarizing these dizzying changes to the food industry, Parsa said: “Food that travels is the future.” 

And this about the retail industry,

We are entering a new evolutionary stage of retail, in which big companies will get bigger, many mom-and-pop dreams will burst, chains will proliferate and flatten the idiosyncrasies of many neighborhoods, more economic activity will flow into e-commerce, and restaurants will undergo a transformation unlike anything the industry has experienced since Prohibition... the pandemic is accelerating the retail reckoning. Over the past 50 years, the number of American malls grew almost twice as fast as the U.S. population, to the point that in 2015, the U.S. had 10 times more shopping space per capita than Germany. Such abundance makes no sense in the age of Amazon. Overleveraged, overbuilt, and oversprawled, American retailers had a long way to fall as the country moved toward online shopping. In 2017, and again in 2019, physical-store closures reached an all-time high, led by the decay of suburban totems like Sports Authority and Payless. The year 2020 may bring the death of the department store, marking the end of that 200-year-old retail innovation after decades of decline. Macy’s has furloughed more than 100,000 workers. Neiman Marcus has filed for Chapter 11. More legacy department stores and apparel retailers will almost certainly follow them to bankruptcy court or the corporate graveyard. As these anchor stores shutter, hundreds of malls that were already wobbling in 2019 will be knocked out in 2020.

And this about home delivery,

In the past month, online shopping has gone from a regular habit for a minority of consumers to a crucial part of America’s recreational infrastructure. One-third of Americans bought groceries online in the past month, and tens of millions of them did it for the first time. Walmart deliveries have skyrocketed, and Amazon now delays deliveries of nonessential items to deal with unprecedented demand. Online shopping’s share of total retail sales has been increasing approximately one percentage point per year, but a recent UBS analysis predicted that COVID-19 will immediately increase that share from 15 percent to 25 percent—a decade of change concentrated in several months.

3. On the rise and rise of Vietnam, courtesy businesses exiting China,

The country had a 28% share of mattress imports in the recent numbers compiled by Raymond James, up substantially from earlier levels. Man Wah, a large Chinese upholstery producer, said it had built a 2.5 million square feet factory in Vietnam in just nine months and is rapidly shifting production to reflect the changing trade situation. From zero, it now ships 1,100 containers a month from Vietnam, a rate it expects to increase to 2,000 a month by the end of the year and eventually to 4,000 per month as it builds out production.

But furniture isn’t the only industry were Vietnam is gaining market share. Sourcing Journal, an online industry newsletter, reports that footwear imports from Vietnam are up 11.3% year-to-date and the country’s share of the American market is now just over 26 percent. That still trails China’s nearly 50% share but marks a significant shift in a product classification that once was overwhelmingly dominated by China.

4. Very good article in the Economist on private entrepreneurship in China. This goes to the underlying philosophy,

The People’s Republic recognised its first private business in 1980, when a 19-year-old street hawker named Zhang Huamei registered her stall selling buttons and toys in the port city of Wenzhou. Since then the party has developed its own form of “economic gardening”—the notion, popularised in America in the 1980s, that grassroots entrepreneurs drive growth. It told business folk what not to do—certain industries, such as tobacco, were out of bounds—but otherwise let them grow unimpeded. As Jonathan Woetzel of McKinsey, a consultancy, puts it, China’s garden has had more in common with the deliberate wilderness of an English one than with manicured French lawns. This approach has let entrepreneurship put down deep roots in China over the past 40 years. By 2017 budding business owners were registering close to 6m firms a year—or more than 15,000 a day—nearly three times the figure in 2010. Private firms contribute three-fifths of gdp and four-fifths of urban employment. Private wealth funds 70% of investment.

Success begets success, and this matters,

... a belief that anyone can make it big. Chen Long, provost of the Hupan School of Entrepreneurship in Hangzhou, a startup-rich city in Zhejiang province, puts his compatriots’ entrepreneurial vim down to “countless examples of success”, which give “a sense that you can change your own fate”. In Fujian, a hive of business activity in pre-Mao days, people asked about the secret of business success recite a folk song: “Three parts of your life the heavens determine, the other seven you can if you’re hard-working.” Tales like that of Jack Ma, who twice failed to get into university and started Alibaba, an e-commerce titan, in a cramped Hangzhou apartment, enrapture millions. Biographies of rock star founders like him or his namesake Pony Ma of Tencent, an online games-to-payments giant, fly off the shelves. Their pronouncements become aphorisms.

5. Another good article, a review of a new book by Geoffrey Cain on Samsung, the company whose success upends the conventional wisdom on many standard toolkits of management. Sample these,

Long before Kim Jong Un, North Korea’s dictator, disappeared from view in April, Samsung’s chairman, Lee Kun-hee, vanished into hospital. The 78-year-old has not been heard from since 2014. No one outside the family knows how ill he is. His only son and heir-apparent, Lee Jae-yong, aged 50, faces a retrial on charges of influence-peddling, for which he spent almost a year behind bars in 2017-18... The chaebol’s corporate culture is no less eyebrow-raising. Mr Cain describes a leadership style at Samsung Electronics that is military-like, macho and intolerant of mistakes... Mr Cain recounts numerous expletive-filled tirades by the firm’s top brass. And yet Samsung Electronics continues to be South Korea’s most prestigious employer and a magnet for bright graduates...

Samsung makes diversification seem like a virtue, not a distraction. When sales of phones and other gadgets suffer, as they did in the first quarter owing to the covid-19 crisis, the memory-chip business provides ballast; it got a boost from lockdown-related use of cloud-based servers, Samsung said on April 29th. Ten years after the Lees decided to further diversify the conglomerate by 2020, the pandemic has helped turn Samsung Biologics, a manufacturer of vaccines and other pharmaceuticals, into South Korea’s third-most-valuable company.

And the Group may be in for further turmoil with its Chairman now facing the possibility of returning to jail for an extended period.

6. Graphic which captures the financial strength and external vulnerability of 66 emerging economies.

Bangladesh's financial strength is very impressive.

7. Fascinating account of profiteering in times of Covid 19 by manufacturers in medical equipment,

A small number of Chinese factories are certified by the Food and Drug Administration to make N95 masks, and “those are the diamonds right now,” said Lily Liu, a Chinese hospital executive turned Silicon Valley entrepreneur who now helps run Operation Masks. “What’s happening at those factories is France shows up in the morning, and then they get Germany at breakfast, and then Italy after lunch, and then the U.S. in the afternoon,” she said. “In between they get distributors showing up at their doorstep with stacks of cash.” That demand has fueled the spike in prices. While some factory owners are probably making handsome margins, much of the price increase is likely spread across the supply chain, from the firms that ship and inspect the masks to those that make the masks’ fabric and the machines that assemble them.

This is a fascinating account of enterprising hoarders profiteering from the pandemic outbreak in the US and how Amazon's marketplace has been the outlet for cashing out.

8. Encouraging that Indian manufacturers have stepped up to provide most of the medical equipment procurement during the Covid 19.

9. Very good summary of options to support MSMEs in Indian Express,

While each case is unique, all are united over the basics they want the government to ensure: cheaper bank loans to help them tide over the working capital problem, permission for longer daily working hours in major business districts during initial weeks, and easing of supply-chain constraints to ensure availability of inputs and outflow of finished goods and services... since cash flow is the biggest issue, the government could consider providing some sort of refund or money transfer linked to payment history of income tax or GST by the company... the government can consider splitting the package in different ways: interest waiver on working capital loans at least for a quarter, moratorium on repayment for three quarters, some tax relief such as a cut in GST rate to 5 per cent, safety net to workers such as part-payment of wages, PF contributions for micro and mini enterprises, and easing labour laws allowing them to let staff work overtime.

And this very informative article on why MSMEs are very important. In the absence of further support, the already high non-performing assets of banks with MSMEs are expected to rise even further.  

10. Rahul Jacob worries about Covid 19 ushering in a return to the license raj in the form of capricious and impractical directives on the nature of local restrictions on economic activities. This is a headline symptom,

According to PRS Legislative Research, a think-tank, the central government has issued almost 600 notifications and state governments a further 3500.

This is sobering,

Exporters are especially vulnerable as this depressing saga of threats to businesses and misconstrued messaging within the government apparatus plays out. Many exporters were already weakened by the complications of the goods and services tax regime. Now, with China, Vietnam and Bangladesh running factories at close to normal levels, the risk of losing business permanently looms large. Oblivious to this challenge, the Modi government has instead been arguing that the covid-19 crisis will allow India to position itself as a manufacturing alternative to China. Tiruppur-based Elangovan has heard such predictions before. For the past couple of decades, companies in the West have been looking to diversify their outsourcing requirements and pursuing a China+1 strategy. “India has never been a candidate; the ecosystem is not there. We cannot replace China for 50 years to come," he told a roundtable organized by Apparel Resources, an online trade publication. Impressed by how well the finance ministry in Dhaka works with garment manufacturers and exporters in Bangladesh, Elangovan had a more realistic goal for India: “Let’s compete with Bangladesh."

11. Michael Kremer et al argues for advance market commitment (AMC) for Covid 19 vaccine,

Today, the U.S. government could go big and create a Covid-19 vaccine A.M.C., guaranteeing to spend about $70 billion on new vaccines — enough to make direct investments to support capacity installation or to repurpose capacity and to pay, say, $100 per person for the first 300 million people vaccinated... An advance market commitment for Covid-19 should combine “push” and “pull” incentives. The “pull” incentive is the commitment to buy 300 million courses of vaccine at a per-person price of $100, for vaccines produced within a specified time frame. If multiple vaccines are developed, the A.M.C. fund will have authority to choose products to purchase based on efficacy, the availability of sufficient vaccine for timely vaccination or suitability for different population groups. So firms compete to serve the first 300 million people with the most attractive vaccines, and the “pull” component provides strong incentives for both speed and quality.

The “push” incentive guarantees firms partial reimbursement for production capacity built or repurposed at risk and partial reimbursement as they achieve milestones. The partial reimbursement ensures that manufacturers have “skin in the game,” while inducing them to build large-scale capacity before approval is certain.

An AMC assumes the lack of incentive to pursue a particular goal with vigour and speed. I struggle to understand how either should be missing now among the leading global pharmaceutical companies. Isn't the possibility of windfall gains for the first mover, despite the risk of losing out to competition, adequate enough incentive? In fact, isn't this exactly the opportunity that pharma companies are primed to pursue?

12. The IMF's latest Fiscal Monitor has a good graphic of the Covid 19 economic response by G-20 economies.

Clearly the developed countries have been able to turn fully open the fiscal spigots, whereas the developing countries have had to do with modest stimuluses. India comes second last in the size of its stimulus, despite the toughest lockdown.

13. Fascinating insight that highlights why quick resolution of stressed companies is important,

Consider what happened to now-famous House of Debt firms, the 17 large companies (excluding Essar Steel and the Adani group) that Credit Suisse long ago identified as stressed. In March 2010, their market value was Rs 3.1 lakh crore. A decade later, their value had fallen to just Rs 0.8 lakh crore, a loss of Rs 2.3 lakh crore or nearly 75 per cent. Accounting for inflation over this period, the real value of that loss is even greater.

Zombie companies kept alive on ventilators merely get worse and adds to the pile of accumulated debt.

14. Finally, the Reliance deleveraging continues at a rapid clip. The company has committed to pare down its $21.4 bn debt to zero by 2021. First it was Facebook investing $5.7 bn for a 9.9% stake in Jio Platforms Ltd at a valuation of $65.95 bn (Rs 4.62 trillion pre-money). Then came PE firm Silverlake Partners taking a 1.15% stake at an enterprise value of Rs 5.15 trillion. Now comes a 2.32% stake sale to another PE firm Vista Equity Partners at enterprise value of Rs 5.16 trillion. The total amount raised in the three deals concluded in three weeks comes to $8 bn.

All this is on top of a rights issue worth Rs 53, 125 Cr and a $15 bn stake sale in RIL to Aramco which is currently on hold.

The challenge with APMC reforms

Niranjan Rajadhyaksha writes about the challenges associated with the development of an integrated agriculture market for India. He talks about the new legislation's market consolidation and electronic trading platform as providing the thickness and congestion mitigation that the previous fragmented and physical Agriculture Producer's Market Committees did not provide.

But this assumes that market fragmentation was the major contributor to thickness and physical markets were coming in the way of congestion management. But what if there are factors that go beyond them in either case.

Thickening the markets require not only bringing together enough buyers and sellers, but also making them transact. The latter requires addressing the information asymmetry problems that hinder transactions. In case of agriculture, primarily such problems involve information about the quality of produce in distant markets. A trader in the neighbouring state should be assured about the quality of tomato or paddy being offered by the farmer so as to be confident about making the payment and transacting. This is where product standards assumes significance. Unfortunately, India is some distance away from getting there. In its absence some other more invasive standards validating mechanism or incentive compatible payment system assume significance. The market design has to be constructed keeping this in mind.

Then there are also entry barriers for both buyers and sellers that come in the way of thickening. In the prevailing environment, commission agents influence entry and access of both farmers and traders. They are the primary creditors to both. In the absence of measures that initiate the process of breaking this monopoly, market participation will remain very thin. 

It is here that some prudent compromise may be necessary. Given the near impossibility of wishing away these commissioning agents, they need to be strategically co-opted into any proposed process reform. Their role could vary based on context, from becoming formal moneylenders to product validation intermediaries or the provider of any other service along the agricultural value chain. 

Undoubtedly, the reforms initiated will set the ball rolling in thickening and decongesting the markets. But, by itself, it will be a very long haul. The expected progress will be largely dependent on the leadership within Agriculture departments in States and their commitment to embrace such opportunistic tactics.

The market incentive problem with smart meters

There is a fundamental incentive mis-alignment problem with any smart meter installation program. In order to realize their full benefits, smart meters need to be able to service both consumers and the utility through the price and consumption signals respectively. The utility should be able to effectively allocate supply and consumer be able to optimize usage.

However, while the former is easily achieved by mere installation of smart meters, the later requires going beyond. In fact, from the consumer's side, the inevitable last mile gap emerges. Though, they have access to consumption and price signals, they neither have the infrastructure to make it cognitively salient nor act on them.

Consumers can respond to the price signal and manage consumption only if they have the systems to track their consumption. They should have access to devices with real-time displays of not only total consumption (and pricing), but also those of their appliances. Further, they should have systems that enable them to automatically respond to higher consumption or prices by disconnecting part of their load.

Therefore, the smart meter becomes meaningful for the consumer only if the displays, network software, and internal wiring are made available. But the meter manufacturer does not supply these devices nor do the utilities have any direct interest in providing them. And, in view of the expenditures involved, the consumers will rarely install on their own.

In fact, smart meters without its accompaniments leaves the consumer as the loser. The meter manufacturer sells his product and the utility improves its grid-management efficiency. The consumer is left with higher bills!

In the absence of effective policies to address this market failure, we can be sure that the initial rounds of smart meter installation programs will not yield the desired results. While helping utilities with supply allocation, it will do little towards demand management. In the absence of consumer support, given the expenditures involved (front-loaded costs and back-ended systemic benefits), smart grid projects will come up against the usual opposition to any new intervention.

What are the possible solutions? Just as energy efficiency ratings have now become commonplace with electrical appliances, it is imperative that newer generations of equipments come with real-time power consumption displays. Smart meters could be bundled with consumption and pricing display LEDs. Over time, the home electricity wiring should be configured and attached to the smart meter with default provisions that trips-off one or more phases when either the consumption or the price breaches a pre-defined threshold.

Observations from liquor license auctions

The Andhra Pradesh state government raised a massive Rs 6904 Cr in the recently conducted auctions for two-year liquor retail sales licenses for 6596 retail outlets across the state from a record 48600 bids. This is in comparison to the Rs 3200 Cr received for the 2008-10 auctions from 20000 bids.

This means that, coupled with the excise and sales tax receipts on the liquor sold, which is estimated to be double the auction amount, the excise department is expected to be the highest revenue earner for the state government topping the traditional commercial taxes department. These auctions have highlighted several interesting examples of economic incentives at work.

1. Under the existing state government policies, the number of retail licenses have remained frozen at 6596 for almost a decade now. The geographical distribution of these licenses are such that while the towns and cities can have more than one shop, based on the population and some other parameters, only one license is issued in each mandal (the small administrative unit in the rural areas with a population of about 40000 to 1 lakh, of which there are nearly 1100 in the state).

The single license holder in each mandal assumes all the characteristics of a classic monopoly. This automatically contributes towards increasing the premiums on bagging license rights, especially for rural areas. This is borne out by the fact that the rural areas witnessed the most intense competition, evidenced both in the numbers of bidders and the amounts bid. In fact, the higest bid of Rs 5.21 Cr came for a shop in Nadikudi village of Dachepalli mandal in Guntur district and several other bids for mandals were higher than Rs 3 Cr.

In these areas, given their monopoly character, these outlets become the single point dispensing counter for the numerous illegal outlets that invariably dot the rural landscape. Further, given the intimate relationship between crime, liquor, and political power, a successful bid confers on the license holder a powerful source of patronage.

2. Apart from licenses for retail sales outlets, the excise department also issues license for serving liquor - bars in urban areas and permit rooms in rural areas. These license fees are fixed by the government and its revenues are a small percentage of the collections from retail shop auctions. In the rural areas, the successful bidders for retail sales are provided the choice to bid for one permit room (attached to the license holding retail outlet) on payment of some small additional amount. In other words, while there are multiple (though restricted) serving centers in each urban area, there is only one legally permissible serving center in each mandal.

The aforementioned architecture makes retail liquor sales business very constricted, especially at its downstream end. While the outflows (from the retail outlets) are massive and growing, the consumption end is serviced by a limited number of bars and permit rooms. In the absence of adequate numbers of institutionalized formal centers for serving the massive quantities of liquor flowing in, informal centers inevitably spring up. This restriction opens up another parallel market - in illegal "serving rooms" (attached to both licensed retail outlets and the numerous illegal ones). It is an open secret that most, if not all, the retail outlets and their numerous illegal off-springs function as sales-cum-serving centers.

3. In many respects, liquor retail licenses and bar/permit room licenses are complementary goods. Every few retail outlets have to be serviced by some legal serving rooms. A market design where there are downstream restrictions on the numbers of bar/permit room licenses (even as consumption is increasing) is only bound to increase the premium on upstream retail sales licenses.

In other words, the retail license bidders have internalized the (the one legal permit room and illegal serving rooms) benefits that accrues from their ownership of a retail license, and have priced that into their bids.

4. Though the permit room licenses are obtained relatively cheap at the margins (for a few lakhs of rupees in comparison to the crores paid for shop license), it is commonly found that less than half the license holders prefer to take them. Since all of them invariably end up serving liquor in their outlets, those without permit room licenses presumably do so because the cost of evading detection of their illegal activity is less than the price of the permit room license. In other words, especially given the fact that the permit room license itself is relatively cheap, the enforcement officials of the Prohibition and Excise Department are selling themselves too cheap!

5. Interestingly, another contributory factor to the over-sized bids may have been the economic recession which has had the effect of depressing the real-estate market and leaving builders and developers in the search for alternative remunerative investment opportunities. Further, the very large parallel economy resulting from the aforementioned monopoly characteristics offers them an added attraction of acting as an outlet to funnel the massive amounts of black money that had been sloshing around the real estate sector.

Bundling Vs à la carte marketing of services

James Surowiecki has an interesting article that analyzes cable television companies marketing strategy of bundling a group of channels into a package instead of promoting individual channel based offerings.

Consumer advocates point to the rising prices of these packages and oppose this pricing strategy. They claim that offering consumers the option to buy channels individually, or a system of the so-called "à la carte" programming, will be more beneficial and cost-effective for consumers.

It is undeniable that bundling with a flat-price has a cross-subsidy dimension that enables some of the less popular channels to survive at the expense of the popular ones. However, as Surowiecki illustrates, bundling is a fundamental characteristic of many markets - magazines, newspapers, television channels, gym memberships, Disneyworld passes, holiday packages, and so on. The pricing strategy in the market for journals and their individual articles (the individual articles get sold for a substantial premium than when purchased as part of the journal) is another example of consumers being better off with a flat-price bundle than selective purchases.

He also points to the "option value" of cable packages - "you may never watch those sixty other channels, but the fact that you could if you wanted to is worth something"; and the popular perception that bundles are bargains - "getting a bunch of things for one price feels like a deal, even when it’s not". Bundling also eliminates transactions costs and uncertainty for everyone - consumers, cable companies and television channels.

In many respects, cable television and other similar markets closely resemble insurance markets. Experience from across the world shows that financing health care by purchasing individual services has been found to be so expensive as to make them unaffordable to the vast majority of patients. In contrast health insurance keeps administration and other transaction costs, and thereby premiums, at a minimum by offering a basic minimum coverage for diseases and aggregating the widest possible risk pool of customers. The insurance package would contain coverage for health conditions, irrespective of whether the customer would need it or not, to be availed of if and when the need arises.

Interestingly, the success of cable television and journals with bundled product offerings could provide lessons to those who feel that the cost-effective approach to health care is by purchasing individual components as the need arises. In other words, universal health insurance sceptics could take a leaf out of cable television businesses while opponents of bundling could learn from the successes of universal health insurance in many countries!

In the same theme, Uwe Reinhardt has a fascinating analogy between the piece rate model of remunerating doctors and service providers followed in the US health insurance market, and Universities with piece-rate compensation based pedagogic profit centers, each with its own fee schedules and ownership patterns. This would mean professors renting office space from the university; charging students course-wise, even lecture-wise, for thesis advice, and for evaluating their tests; students paying for laboratory and library use, even book-wise fee for borrowing from library; hourly rate for computer use and so on.

Toxic asset auction design

One of the biggest challenges that Central Bankers and policy makers faced in their efforts to administer the TARP and similar toxic asset purchase schemes during the sub-prime mortgage crisis was the problem of valuing these assets and desinging an efficient price discovery mechanism. Now, Oxford Professor Paul Klemeper (of the European telecom spectrum auction fame) has proposed a new auction design, called "product-mix auction" (more details in pdf here), that can be used for toxic asset purchases and central bank liquidity auctions in a credit crunch.

Simultaneous multiple-round auctions are infeasible in financial market auctions because of the transaction costs and incentive distortions they are likely to impose. He therefore proposes a "simple-to-use, sealed-bid, auction that allows bidders to bid on multiple differentiated assets simultaneously, bid-takers to choose supply functions across assets", and one that makes it harder for bidders to collude or exercise market power in any unfair manner. He desribes his auction design thus,

"Each bidder can make one or more bids, and each bid contains a set of mutually exclusive offers. Each offer specifies a price (or, in the Bank of England’s auction, an interest rate) for a quantity of a specific "variety". The auctioneer looks at all the bids and then selects a price for each "variety". From each set of offers in each bid, the auctioneer accepts the one that gives the bidder the greatest surplus evaluated at the selected prices or no offer if all the offers would give the bidder negative surplus. All accepted offers for a variety pay the same (uniform) price for that variety.

The idea is that the menu of mutually exclusive bids allows each bidder to approximate a demand function, so bidders can, in effect, decide how much of each variety to buy after seeing the prices chosen. Meanwhile the auctioneer can look at demand before choosing the prices. (Allowing the auctioneer to choose the prices ex post creates no problem here because it allocates to each bidder precisely what that bidder would have chosen given those prices in the environments for which the auction is proposed.) Importantly, offers for each variety provide a competitive discipline on the offers for the other varieties, because they are all being auctioned simultaneously."

To clarify, "each bidder can make any number of bids and each bid specifies a single quantity and an offer of a per-unit price for each variety. The offers in each bid are mutually exclusive. The auctioneer looks at all the bids and chooses a minimum "cut-off" price for each variety, consistent with both market demand and its own supply curve. The auctioneer accepts all offers that exceed the minimum price for the corresponding variety, except that it accepts at most one offer from each bid. If all the price-offers in any bid exceed the minimum price for the corresponding variety, the auctioneer accepts the offer that maximizes the bidder’s surplus, as measured by the offer’s distance above the minimum price. All accepted offers pay the minimum price for the corresponding variety – that is, there is 'uniform pricing' for each variety."