Saturday, 18 April 2015

Forget the Minimum Wage, Welcome to the 'Happiness Wage'


Dan Price, who founded Seattle-based credit card
processing startup Gravity at just the age of 19.
Earlier this week, Dan Price, the founder of a credit card processing company called Gravity, saw his salary drop from a million dollars to a figure around $70k- a drop of 93%.
This reduction, strangely, wasn't due to the company suffering or another authority acting upon him- on the contrary, he was the instigator of this unselfish act, part of his company's wage overhaul that has gained much attention in the past few days.

Price's announcement that his new wage would set the minimum wage for all of his 120 employees was not new in its nature- many companies, such as JP Morgan, Chelsea FC and Deloitte have already committed to giving all their employees a 'living wage', one that is above the minimum wage and in line with the ever increasing cost of living.

But minimum wage chosen by Dan Price itself is quite staggering. The new minimum of 70 thousand dollars (£47,000) means that 90 (70%) of Gravity's 120 staff will be receiving a pay rise, a staggering amount that clearly will take a toll on the company's finances.

Of course, this move has been calculated meticulously. If we take the average US wage of $51k to be representative of Gravity staff, Price's $930k wage decrease alone is enough to 49 of his staff to have their pay boosted to $70,000. Of course, that still leaves 41 staff to fund- but Price plans to spend up to 80% of the company's forecasted profits over the next three years to ensure this wage promise is met.

It is likely that Price will be receiving more than just his $70k salary, just as so many of those 'one dollar CEOs' do. Being a co-founder of the company, he's likely to have a sizeable amount of shares in the company.

So, what inspired Price make this bold move? According to The New York Times, inspiration came from multiple sources, most notably Price's own experiences of friends struggling to make ends meet on less than $40k. "It eats me inside," he stated.

With regards to the specific figure of $70k, the idea came from Princeton economists Daniel Kahneman and Angus Deaton, whose studies on potential causal effects of money on happiness concluded that "emotional well-being also rises with log income, but there is no further progress beyond approximately $75,000.". Essentially, they found that money buys happiness- but this causal effect wears away once surpassing $75k. Think of this as not a minimum wage but a kind of 'happiness wage'.

The USA currently is in an appalling state of income inequality across the socio-economic spectrum, with the executives of society clearly detached from the rest. The average American CEO salary of around $11.7m is 331 times that of their average employee- and this gap is something Price himself seeks to address with this minimum wage. "The market rate for me as a CEO compared to a regular person, it's absurd," he said in an NYT interview. "As much as I'm a capitalist, there's nothing in the market that is making me do it."
Mohammad Lone Editor

Tuesday, 14 April 2015

When Incentives Go Wrong: The Cobra Effect



A story goes that during their colonial rule of India, the British rulers were unhappy with the number of venomous Cobra snakes rolling around the streets of the capital Delhi.
They wondered- how could we get rid of these snakes?
They followed a financial route- offering a bounty for every dead cobra presented to the authorities. This seems perfectly rational- under colonial rule the natives were not exactly the most well off or comfortable people, so most would certainly be willing to kill snakes in exchange for payment. And the British were right, for a while- the number of cobras on the streets decreased initially.

But of course, we wouldn't be recalling this story if nothing went awry. After a while the British found that more cobras were on the streets, despite the same number, if not more, of Indians presenting them dead cobras. What was happening?

The answer was simple but ingenious. The natives were offered financial incentive to kill snakes for the British- but they were now not just from the streets of Delhi, but from farms- cobra farms specially created by the locals to provide a supply of cobras that could be killed and then exchanged for money. Of course some of these cobras managed to escape the farms and go onto the streets, explaining the lack of drop in number despite the incentive program.

This is an example of the Cobra Effect (named after this story)- the name given to a situation in which an attempted solution to a problem makes the situation worse rather than better.
Want to see a modern day example of the Cobra Effect? Check out the article on how it affected Mexico City here.
Mohammad Lone Editor

Friday, 3 April 2015

The Great Penny Debate Part II: Why The Penny Needs To Go.


Welcome back. Here in the second instalment of the debate on Pennies, we shall look at a selection of the arguments against the penny and for its abolition.

1) Value for Money
Many pro-pennyists counter-argue the idea that pennies are bad value for money for the government with the claim that, while pennies may well be financially inefficient, this doesn't mean their abolition will improve the financial efficiency of the Mint- in fact it may worsen it. They argue that should the penny be abolished, demand will rise for the next lowest coin- the silver nickel, worth 5 cents, which actually loses more money per coin than the penny. So, the argument goes, more investment will have to go into a bigger loss-making product should the coin be abolished.

With the cost of producing a nickel at 7.7 cents, and that of a penny at 1.26, this is theoretically true. Take the cost of making one dollar with either coin- it would cost (7.7*20) 154 cents to create a dollar with nickels, but just (1.26*100) 126 cents to do so with pennies. A 28 cent difference, quite decent proof that the penny is more cost-effective to produce. But this hits a snag- these figures are correct, but as of 2008. Seven years ago.

Today, the tables have figuratively turned. As of late 2014, a Nickel costs 8.1 cents to produce (a 3.1 cent loss), whereas a penny costs 1.7 cents to produce (a 0.7 cent loss). This may not seem to be a game-changing difference from 2008, but it makes all the difference. Today, making 1 dollars' worth of nickels costs 162 cents. Making the same from pennies costs 170 cents. The prices of the two have crossed, to the point at which nickels are now more cost-effective than pennies- rendering the pennies causing greater financial inefficiency.

2) Productivity
Just as the potential 'rounding tax' could have tiny but compounding impacts upon the spending of consumers, there already exists a tiny but recurrent way in which we lose because of pennies- not in terms of money, but time. Whether it's spending time rummaging in our pockets for a few remaining pennies, or waiting to receive them as change, it wastes time- not in the short term, but the seconds add up and become minutes, minutes, over the course of a year or two, hours. Hours that can be spent being more productive, whether it's a store employee gaining more time to perform other duties or the customer having more time to spend in town and buy other stuff.

It's difficult to imagine seconds making such a difference, but added up in the long term, they can. Economist Robert Whaples quantifies the losses that the penny can cause. Using the average American wage of $17 an hour, he evaluates every two seconds of the average American's work time to be worth a cent, and thereon estimates that time lost due to the complications brought on by pennies can cost around $300m per year to the US Economy.

Whaples proposes that rounded sale prices would help improve productivity of the economy as a whole, not by giving one significant boost but by trimming the excesses, the little seconds of time wasted because of the business of handling pennies.

3) Are they Useful?
Have a look at this menu here. The price of a full dinner with multiple courses, at just 25 cents, is one that you might think is ridiculous, but that was how things were in 1900, the year this American bistro menu comes from.

Go forward to 1931, and food was still ridiculously cheap in comparison to the modern day. A penny could buy you an egg, or a pound of flour.

Today? Well, if you can find anything that I could buy with a penny in any store today I'll give you one (not that you'd probably appreciate it). The fact is that pennies were not always the lowest valued coin- until 1857 you could get a half-cent, and currencies throughout the world have seen smaller denominations than a penny (think, for example, the British shilling). But over time, they have been taken out of circulation, for a number of reasons, but primarily because of inflation. Rising prices nullify the value of all denominations of money- and at one point we must re-evaluate whether any certain coin is necessary. We have very little use for pennies- so why should we carry on keeping them in circulation?

Economist Greg Mankiw summarises it effectively, stating "the purpose of the monetary system is to facilitate exchange... the penny no longer serves that purpose."


RECOMMENDED READS

2014 Biennial Report to the Congress (US Mint) http://www.usmint.gov/about_the_mint/PDFs/2014-rd-biennial-report.pdf

Congress Looking At Steel Pennies And Nickels (2008) http://www.nbcnews.com/id/24491928/ns/business-stocks_and_economy/t/congress-looking-steel-pennies-nickels/#.VR2wlZPF8yA

How Much Does It Cost to Make A Penny? http://blogs.wsj.com/economics/2014/12/15/just-how-much-does-it-cost-to-make-a-penny/

The Penny's End Is Near http://www.consumeraffairs.com/news04/2006/07/penny_sense.html
Mohammad Lone Editor

Thursday, 2 April 2015

The Great Penny Debate Part I: Why Pennies Should Be Kept.


The penny coin. The cent coin. Whatever you call it, we're all undoubtedly acquainted with the coin that holds the lowest value in your currency, whether you're from America or Britain or pretty much anywhere else. Except Canada, and a number of other countries who have decided to abolish the penny from their currency. But why have they done it, and does it mean the penny holds no point in our modern economies?

In this first of a two-parter, we'll look at the reasons why pennies should be kept in our economies.

1) 'Rounding Tax'
Perhaps the most prominent argument of the pro-pennyists, much research suggests that removing the penny from the currency would cause a change in price; naturally, if the penny was to be abolished we would no longer be seeing any '.99' prices. Instead, we would see either '.95' or '.00' prices- and considering that businesses would have to lose .4 on any purchase should they round it down, rounding up would seem an attractive option. This would have rather insignificant effects on the consumer in the short term, but in the long term it has the potential to further weaken those closer to the bottom of the economic ladder.

Data from the Federal Reserve indicates that Americans earning under $10k and also those with less than 12 years of education, use cash for over half of their purchases. This is opposed to credit cards, particularly spending online. Credit card real world spending would also be affected by 'rounding tax', though as no online transactions are made in cash they would be unlikely to be affected. This would put online spenders at a very slight advantage, whereas for the more disadvantaged it could make a huge number of tiny differences to their spending. These may not directly cost them in the short term, but in the long term the cost can aggregate into something considerable.

Canada has implemented a system of 'rounding' that charges credit card users differently from cash users in the real world- for example, something costing $2.98 would be rounded up to $3 for cash users, while the price remains the same for credit card users. This is an example of the potential imbalances that could arise and, in the long term, harm those who use cash.

2) Charity
The 'Common Cents' campaign has seen considerable success,
like many other charities, thanks to the penny.
Abolishing the penny is a move that is likely to work against the interests of charity organisations. Many charities rely significantly on spare change for funding, and though it may seem small, the total power of the penny shouldn't be underestimated: in 2009, the Leukemia and Lymphoma Society of the USA celebrated raising $150 million- entirely in the form of 1.5 billion pennies. The organisation 'Common Cents' organises what it calls 'Penny Harvests', and was able to collect $756k in 2009 exclusively by collecting pennies.

The penny holds a special place in this respect because in a way respect is just what it lacks; it is one of the most common items given to charity, and arguably one of the most beneficial for all parties. No one has bankrupted themselves by giving a penny to charity- yet all the pennies put together have been shown to make rather significant differences. The 'Common Cents' guys call the penny "the philanthropic property of young people"- and it seems they do have a point, so abolishing the penny could indeed harm charitable organisations.

3) Appeal to Tradition
This is not so much a practical argument for keeping the penny, but rather a sentimental one. Many feel an attachment to the penny, for various reasons- whether it is its role in infant numeracy development (who doesn't remember playing with penny coins while learning numbers), its historical/cultural value (Lincoln holds a cherished place on the penny in the USA) or just the traditional side of everyone who dislikes change (or should I say likes change, see what I did there? No? Sorry.).
Even one of the staunchest of critics of the penny, Professor of Economics at Wake Forest University Robert Whaples, admits this, stating "The vast majority want to keep a penny... it's a sentimental attachment."
Mohammad Lone Editor