Insurance Markets

Frances Woolley has a few worries about ending supply management in Canada. She's right that it's worth worrying about whether and how we'd compensate those losing their quotas. The rest seems to put a bit too much weight on dairy lobby scaremongering.

But one bit in the comments section seems worth further expansion. "Greg" there wondered why dairy farmers aren't insured against the potential loss of quota rents:

Canada's dairy farmers are in business. They ought to be holding insurance against the loss of their quotas, the same as with other capital. If they aren't, well, they made that decision.

Frances replied saying that such insurance markets are impossible:

Insurance works through risk pooling, i.e. car insurance works because not everybody has car accidents at the same time. The elimination of milk quotas is a correlated risk - i.e. if one farmer loses their milk quotas, everyone will lose milk quotas. It's not possible to buy private insurance against highly correlated risks (which is why, for example, house insurance doesn't cover acts of war, crop insurance doesn't exist without government subsidies, etc).

Let's twist things around. Imagine that ICE Futures Canada defined and started trading a very particular set of futures contracts. The contract would read something like the following:

This contract pays $1000 if, at Dec 31 2013, the average auction price for dairy quota in the previous six months across all provinces was under $5000 or if supply management ceased to exist.

There are a few proposals floating around to get rid of supply management. CD Howe's was to expand the supply of quota over time to erode it; others say do away with it and compensate the losers; others say do away with it without compensation. You'd need to be a careful to define what "supply management" means for purposes of the contract. But the low quota price option is to guard against "erode the rents" plans.

It's pretty easy to imagine people being willing to trade this contract. Suppose that the true value of the contract were $100: a 10% chance that Canada gets rid of supply management by the end of next year. Dairy farmers have a whole lot of wealth tied up in their quota. They should be willing to pay more than the fair-odds price for the contracts. Other dispersed risk-neutral people should be happy to sell at a premium above the fair odds price. Or, you could do it through option contracts.

So long as farmers are willing to pay a premium to lay off risk affecting a good chunk of their asset base, and so long as there are other folks willing to sell them bits of that kind of insurance, this works. No one guy would want to take on all that risk because then he has even more at stake than the dairy farmers. But it wouldn't be a bad small bit of a portfolio for somebody whose other positions don't go south in case of the abandoning of supply management. Or, you could imagine some large corporates who'd do well if Canada got into the Pacific trade deal being willing to short those contracts - if Canada gets rid of supply management and into the TPP, the corporates do better through trade but lose on the contracts; if Canada doesn't, they win on the contracts and lose on trade.

And, if there are enough of the risk-neutral investors, we could start getting some market-based assessments of the probability of doing away with supply management.

I don't know the regulatory framework within which ICE operates. But a few contracts on policy like this could be awfully helpful.

Banning hate

You can't ban hate. You can put in laws banning discriminatory treatment in employment or consumer markets, but if the differences in treatment arose from real differences in costs rather than hatred, you're probably doing more harm than good.

Today's edition? Here:

"Fat hatred" should be banned like racism or sexism, says a pro-fat scholar who argues that obesity isn't a health problem.

Massey University lecturer Cat Pause says "the war against fat" and "fat phobia" were much more damaging than carrying a few extra kilos or, in her case, a lot.

"Obesity is not a big health problem. If you really look at the science, that is what comes through."

...In New Zealand – the world's third-fattest nation – more than a quarter of the population are classed as obese.

But Dr Pause, who has a PhD in human development, says it is "fattism" that should be feared, not expanding waistlines.

She called on New Zealand to be the first country to outlaw discrimination against fat people, which has been described as the "last socially acceptable form of prejudice".

Fat people were having to live in a culture that openly hated them, she said.

I agree with Cat that policy moves trying to bash fat people really aren't warranted.

But suppose that she's wrong and most other folks are right about the actual health or other costs of obesity. What happens if we mandate that health insurers ignore weight if weight actually does predict health problems? We effectively socialise the private costs of being obese. What happens if we mandate that employers provide reasonable accommodation for the obese? Employers start avoiding hiring them in the first place for fear of having to make unreasonable accommodations. If we ban airlines from requiring larger passengers to purchase extra seats to prevent overflow into the neighbour's seat, we again socialise the costs of obesity, either by making every other passenger pay extra for the obese person's extra free or subsidized seat, or by giving random draw unlucky lotto tickets to other economy-class passengers.

Further, if markets are competitive, any firm that unreasonably penalizes the obese will be out-competed by one that doesn't. Discrimination ought only persist if it either reflects something real, or something that other customers value - which is also real, though subjective. You can imagine a nightclub that only lets in thin people being successful in the market. But discrimination against the obese in this situation would be little different than discrimination against the ugly, or bars banning economists' entry because we're argumentative. You could maybe make the case that banning nightclubs from having exclusive entry policies can shift social norms such that, in a few decades' time, the ban would no longer be needed. But it would be a pretty speculative proposition; there seem to be reasonably fixed beauty preferences that correlate with a mix of genetic fitness (symmetry) and fertility (waist-hip ratio). And preferences against having economists around ought to be understandable to anybody who reads this blog.

The more that is done to ban markets from responding to any real costs of obesity, the more justified are policies that try to tax the correlates of obesity like excess sugar consumption. It's more efficient to let markets sort out costs associated with the output than to have governments tax the inputs where people have very heterogeneous production functions, where the costs of obesity are heterogeneous across activities, and where insurers very likely have a better handle on whether any individual case warrants higher premiums.

War of ages

So it's all about the intergenerational conflict and how the old are sucking the life out of the young, and how the young might cut the oldies off. Nolan makes some threats. Bill shows that the oldies will never have the numbers to outvote the young folks so they'd better behave themselves. Nick Gillespie figures the same thing's set to happen in the States.

But there's a problem. Young people generally support giving money to old people. Or at least every bit of US evidence I'd previously seen suggested that young people would rather have the state take care of their aging parents and inlaws. support transfers to the elderly.

What does the New Zealand data say? This is just a 5 minute cross-tab. But the 2008 New Zealand Election Survey has an age variable, and it has a question: "Should the government be responsible for the old?".

If you run a straight correlation between the age variable, zage, and the "should the government support old people" variable (zgovold), where higher numbers mean "shouldn't", I get a -0.0462. So older people are slightly less likely to support giving lots of money to old people.

Let's break things up. Split the age cohort variable into the under 40s, the 40-64 year olds, and the 65+ folks. Not correcting for anything else. What do I get?

47% of the young think the government "Definitely should" be responsible for the old.
52% of the middle aged also say "Definitely should". Their parents are in that cohort, if alive.
49% of the oldies say "Definitely should".

What happens when we just move down to "Should" instead of "Definitely should"?

46% of the young, 43% of the middle aged, and 48% of the old say the government "Should" be responsible for the old.

If we add up the "Should" and "Definitely should", we get just about everybody regardless of age wanting the state to take care of old people.

If we add up the "Shouldn't" and "Definitely shouldn't"? 5% of the young, 4% of the middle aged, and 3% of the old fall into that category.

Among the cohort of respondents aged 18-39, 37 of 712 people giving a response said either "Shouldn't" or "Definitely shouldn't".

If there's some incipient revolution against the elderly, I'm not seeing it in the data. But maybe things have changed since 2008.

Every young person who's below the median income will prefer that the state pay for their parents by taking money away from richer people. And a lot of folks would prefer that the government pays for a nursing home (or give the money that can be used to rent a small flat, or help support a reverse mortgage) than that they wind up hosting their parents or inlaws in their own home.

Things will get worse as the effects of the massive burden of transfers to the elderly becomes more apparent. And there's a fantastic case for raising the retirement age. But intergenerational warfare is far from the radar.

Adoption incentives

Bethman and Kvasnicka put the adoption decision into a standard rational choice framework and, unsurprisingly, find that those with higher opportunity costs of time and altruism are more likely to adopt rather than have their own children. They argue this helps explain celebrity decisions to adopt rather than to have their own children.

Unfortunately, they leave as something "for further research" the potential use of surrogates.

I'm not going to do any modelling here, but I really would have expected that celebrities would disproportionately use surrogates. Surrogates aren't cheap; celebrities have lots of money. Surrogates might make unobservable decisions about nutrition, substance consumption, or activities that underweight the fetus's interests; a celebrity can afford to have the surrogate live in their house for the period from IVF through to birth. And, while celebrities might have greater incentive to demonstrate altruism than do us normal folks, they're also more narcissistic - which should push towards stronger preference for their own genes.

I really don't follow celebrity gossip. Maybe there's lots of celebrity use of surrogacy options that I've just not caught. But the only case that comes to mind is Patri Friedman, if he counts as a celebrity. On celebrity adoption, it's so common that Sarah Silverman was able to lampoon it in her TED talk.

The only answer that makes sense to me is that surrogacy (alas!) remains subject to disapprobation while adoption draws kudos. And, Bethman and Kvasnicka hint at that answer:

For a celebrity, the adoption of a child generates headlines and adds to popularity, which benefits the career and ultimately income.

A celebrity expecting "rent-a-womb shocker!" headlines in response to a rational decision to avoid personally incurring the physical costs of pregnancy might well be tempted to choose adoption over surrogacy.

HT: @CJFDillow

Anti-tobacco virus

SciBlogs (US) reports that gene therapy for tobacco addiction may be around the corner. Code a virus to produce an antibody that neutralizes nicotine, inject, and there's no longer any buzz from smoking. Apparently the tests in mice have worked.

A couple of thoughts:

• An injectable treatment available as a choice for smokers who wish to quit has to be good.
• The availability of such a choice also makes more desirable a strategy of "I'll smoke 'till I'm 25, enjoy being cooler than other people, and then take the treatment before I do any long-term damage." Just as barriers to exit are barriers to entry, things that facilitate exit also facilitate entry in a rational addiction model. This doesn't bother me, but it might bother others. 
• It's hard to imagine the vaccine being made mandatory. But what happens when some fanatic decides to build it into something that can be spread by sneezing? Lower vaccine distribution costs than injection. But egads.

Shame elasticity of demand

Here's a fun one. New Zealand supermarkets have started putting in self-checkouts. Turns out customers buying embarrassing or personal products are more likely to choose those checkouts than ones staffed by clerks.

Pak 'n Save Moorhouse Ave was the first supermarket in New Zealand to have them installed, in 2006.

Foodstuffs chief executive Steve Anderson said 20 to 30 per cent of transactions were now through self-checkouts. However, they accounted for a far lower proportion of customer spending.

Customer research showed people who used the self-checkouts tended to buy fewer items and were often mothers with children, the technology-minded or introverted.

"Embarrassing products", such as personal or indulgent items, were more commonly bought at the self-checkout.

Anderson said there had been some savings for the business, but "nothing major". It had not saved on employee numbers. "The idea was more about customer choice and convenience," he said. "You still need staff there." [emphasis added]

So here's a potential IV study for somebody. If people are more likely to buy condoms when these kinds of self-checkouts are introduced, and there's no correlation between self-checkout installation and underlying sexual behaviour trends, you could use the availability of self-checkouts as an instrument for condom use. Ta dah!

It would likely be a weak instrument, alas; the correlation isn't likely to be that high.

About that Canadian study...

Last week, anti-alcohol advocacy group Alcohol Action NZ put out a press release where the University of Otago's Jennie Connor was quoted:

"A recent Canadian study has shown that a 10% increase in the minimum price of alcohol reduces its consumption by 16% relative to other drinks".

I got in touch with one of the authors of what has to be the study to which she's referring.

Chris Auld reported that the -1.6 price elasticity figure indeed only refers to a measure of own-price elasticity. Except it isn't quite own-price elasticity. Because the estimation technique doesn't correct for substitution effects, it combines the own-price elasticity with cross-price elasticity from other products. Quoting from Chris, with his permission:

Suppose we have two types, 1 and 2. Demand for type 1 is x_1( m_1, m_2 ), presumably decreasing in own min price m_1 and increasing in the min price, m_2, of the other type. The panel models recover d(x1 - x2)/d(m_1), so they are not estimates of own-demand slopes. For example, we might estimate -1.6 if the own-elasticity is -0.9 and the cross-elasticity is +0.7. Since we are not controlling for the cross-price, nothing can be said from these models about the effect of increasing both minimum prices---it could be that total consumption is almost invariant to min prices, but we could still generate big estimates from these models if various types of alcohol are strong substitutes. Test statistics against the null that the total effect is zero are still valid, but it's easy to misinterpret what the estimates mean

Chris also confirms that the -0.34 estimate is the one that best reflects the expected effects of an across-the-board price increase like minimum pricing, but notes that the standard kinds of time series problems makes that estimate rather less robust than he'd like.

I think it's [the estimate] probably too high, although it may be in the ballpark - a variety of evidence does suggest that min price changes are quite effective in targetting heavy drinkers.

Wagneaar found -0.28 among heavy drinkers, so I'm less worried about potential lack of robustness around Chris's estimate; if every estimate of this sort has similar robustness issues, then we might worry about systematic overestimation of demand elasticity with publication bias.

Heavy drinkers who consume cheap alcohol will be targeted with minimum prices, but so too will moderate poor drinkers who choose cheap alcohol.

Chris says he's doing some theory work showing that:

the central planner would always like to impose minimum pricing but reduce conventional taxes when confronted by consumers who are heterogeneous in an underlying demand parameter and when externalities are nonlinear in consumption---because there is an externality on the quantity but quality choice, the planner would like people to drink less alcohol, but drink higher quality alcohol.

I agree with Chris on this one - I'd posted a pretty similar point last week. The New Zealand Drug Foundation should perhaps pay attention to this one: having a minimum price should be coupled with excise reductions, not increases; NZDF has been pushing for both a minimum price and an increase in excise. If the ex ante excise were seriously below the optimum, then I'd expect a model like the one Chris is likely working up to say instead that minimum pricing lets us increase excise less than we otherwise would. But aggregate excise here isn't far out from actual external harms from alcohol. And I still worry about effects on moderate drinkers of lower income. The policy seems likely to be severely regressive.

Jennie Connor really should retract her press release or issue a correction. It leads people to believe that a minimum price will have far more effect on harmful drinkers' consumption than can be supported by the evidence. Otherwise, how much weight should anybody place on any "fact" claimed by Jennie Connor in her press releases?

In other scorekeeping, Ross Bell is right and John Key is wrong: a minimum price will increase the average quality of drink consumed, not reduce it. Here's Key:

"Instead of buying a $10 bottle of wine that might go to $15, they'll buy a $5 bottle of wine that'll cost $10. Their outlay is the same, the quality of what they're buying is worse," John Key said.

Competition among retailers, distributors, and producers ensures that drinkers get at least the minimum price's worth of value for the drink they're consuming except where there are other restrictions in the system that allows agents to accumulate rents.


But in that same article, Bell underestimates the number of standard drinks in a bottle of wine; this has the effect of reducing the perceived effect of a minimum price. Bell writes:

If the Government were to set the minimum price for alcohol at $1.50 - a reasonable and workable price - it would mean a seven-standard-drink bottle of wine could not be sold for less than $10.50.

Most bottles of wine are closer to 8 standard drinks than to 7. I had a quick flip through our wine rack. A Pegasus Bay riesling came in at 6.6 standard drinks. Nothing else in the rack rounded to 7 - everything else rounded to 8, except a few Aussie reds that rounded to 9. 8 standard drinks at a $1.50 minimum price is $12, not $10.50. And, though I'm a moderate high-income drinker, I do often buy bottles of wine in the $10-$12 range. The Montana Classics range on special for $9 is typically great value; I never feel bad about using third of a bottle in cooking at the price, and a glass while cooking is generally decent too.

Bell cites a Scottish government study suggesting that moderate drinkers won't reduce their consumption by much in absolute terms while heavy drinkers will have massive reductions in absolute consumption. If that one's based on Sheffield, and if Sheffield there is assuming constant elasticity across moderate and heavy drinkers, I wouldn't put much weight on it. Sometimes Sheffield estimates differential elasticities, sometimes they just assume constant elasticities. I'm not sure what they're doing in this particular one. And I also worry too about differential patterns in how people reduce their consumption. The Australian study I'd cited last week showed that most of the action in price increases is in reducing the number of days of light drinking rather than reducing the amount of heavy drinking, though there are other studies suggesting reasonable price elasticity of binge drinking. 

Finally, Bell cites BERL's (adjusted) figure on alcohol-related harm: $4.4 billion. That's disappointing. Ross, please remember that that study is just terrible. Again,

• They count the VSL from lives lost while simultaneously counting the total value of forgone production from premature mortality. The Ministry of Transport, who puts out the VSL measure, never does this when they tabulate the social costs of car crashes. They count the value of lives lost in accidents, the cost of injuries, and the value of production forgone due to injuries, but they don't count forgone production from those who die. The measure of the value of a statistical life is inclusive of the measure of forgone production. BERL says that VSL costs are $1.52 billion and that labour costs, mostly from deaths, is $1.48 billion. 


• Where their model study, Collins and Lapsley, counted both the health benefits and the health costs of drinking and took a net measure of costs to the health care system, BERL took a one-line assumption that harmful drinking can never have any health benefits as justifying a move zeroing out any of the aetiological fractions where alcohol reduced costs. This was absurd and points strongly to that they just wanted to give the Ministry of Health the very very large number that the Ministry of Health wanted. Even drinking that is on net harmful can have a mix of underlying positives and negatives. 


• They everywhere conflate private and social costs. Ross, you probably want to include all the costs that drinkers impose on themselves. And that's fair enough where you accurately characterise those total costs as mostly consisting of costs drinkers impose on themselves. But neither of the points above have anything to do with that. It's just poor method designed to inflate reported costs. And repeating the "costs New Zealand" line without the qualification makes people think that you're referring to a cost to the taxpayer through the health system rather than a cost drinkers impose on themselves - it's misleading; I hope not purposefully so.

Peter Dunne seems pretty sensible on this one, even if I do curse his name each and every time I want to get cold medicine that works.

"To say that we'll have a minimum price of $12 for a bottle of wine because people who can't afford to pay $12 shouldn't pay a lesser price, but Chardonnay socialists who can pay $25, $30 for a bottle of wine will still be able to get their wine. I think that's a really elitist and ridiculous argument."

The policy would reduce some harmful consumption, but it would also reduce some reasonable consumption from lower income drinkers - and from a few higher income cheapskates like me. We either need more serious work showing that the harms prevented outweighs the harm imposed by the policy, or at least coupling the policy with transfers to those negatively affected.