Marginal Revolution

Why are commodity prices rising so fast?

Well, today they're not, they seem to be plummeting.  Still they have been rising rapidly for years.  Paul Krugman surveys some views, click through to the Frankel post as well.  Yes I do think high and rising commodity prices have been a bubble -- but not just a bubble -- and no I don't think that low real interest rates are much of a factor.  (Recall Cowen's Third Law: "All propositions about real interest rates are wrong.")

My basic explanation for rising commodity prices is simple.  Most commodities are produced under conditions of short-run rising costs, often quite steeply rising short-run costs.  Furthermore many production processes cannot do without these commodities in the short run.  Coal, copper, and the like are not always easily substitutable for a factory within the medium run.  (Furthermore until you are sure that the price increase is permanent, why re-gear at all?  Why switch from copper plumbing to plastic plumbing, when price of copper might fall again?)

Now China has become wealthy quite fast but the country didn't become wealthy by producing more commodities.  That's Albert Hirschman's "unbalanced growth."  So demand for most commodities has outstripped the supply, production can't make up the difference in the short run, and commodity prices can rise sharply.  Don't forget that logistics and transport are a big part of the production process and so infrastructure often constrains the flow of supply.

In the long run price will adjust (even if you believe we are near "peak oil" this is true for most commodities.)  People will substitute or find new sources of the commodity or find new ways of producing the commodity more efficiently.  Infrastructure improves.  But yes those adjustments can take ten years or more.  And in the meantime we have a commodity price boom and on top of that a bubble to make these items look even more expensive.

One final kicker: lots of commodities are produced by governments and/or their production is heavily controlled by governments, most of all oil.  Then supply adjustments will be especially slow and cumbersome.  Read this article about coal:

...94 percent of India's coal mining is in the hands of government-owned companies. The biggest, Coal India, produces four-fifths of the country's coal. Because the government is worried about social unrest, the prices for coal and electricity are kept low.

See the problem?

The bottom line: The best long-run bet is still that there is nothing special about risk-adjusted rates of return on commodities.  That probably means falling real prices and falling real costs over time.  The Chinese demand aberration is a temporary blip superimposed on very consistent longer-run trends.

Why have burglaries declined?

Eric H. points to the question of why burglaries have declined steadily, when other crime rates have been more volatile.  Here is one bit:

Criminologists have a lot of theories why burglaries are so different..."If you're going to do a burglary, you need to have some buyers," Mathis says. "Everybody has everything now."

Mathis says there's just too much on the street already. Everyone he knows already has a digital camera, iPod knockoffs and pirated DVDs shipped in from China. "And if it's not new, a lot of people don't even want to fool with it," Mathis says. Forget about last year's video games and old laptops, Mathis says. And don't even bring a VCR or boxy TV to the street.

"You can get a TV for nothing almost," he says. "People are giving them away now."

In other words, we have fewer burglaries because of low wages in China.  You'll note that the standard Baumol-Bowen model of the cost-disease predicts an ongoing decline in burglaries.  Goods become cheaper over time, and thus not worth stealing, while services grow more expensive over time.  It is usually harder to steal services so burglary rates should fall.

The article also cites the decline of heavy drug use, better locks and deadbolts, and more widespread use of locks, plus less cash left around the house.  Some experts cite greater neighborhood vigilance.  Note that robberies are not falling in similar fashion, which suggests that criminals prefer to get the victim away from home turf advantage.

Here is further information.  British burglary is falling too.

All you can eat?

Allegedly tipped off by senior officials close to the matter, the Financial Times suggests that Apple is in talks with music labels to follow an approach first pioneered by Nokia and Universal Music Group.

Dubbed Comes With Music, the upcoming service has customers pay more for a cellphone in return for as many a la carte music downloads as the customer likes over the course of a year. In this implementation, customers can either renew a subscription once it expires or else keep the tracks they've downloaded, even if they switch to competing phones or music services.

Here is the article.  One point is that songs will get shorter and their best riffs will be held to higher standards of immediate accessibility.  If the marginal cost of a song is free, people will sample lots more and they will give fewer songs a second listen (higher opportunity cost); of course the opening bits of a song are already free in many cases but this will make sampling even easier.

Second, this will redistribute more of the market surplus away from song providers and toward hardware providers.  Say everyone bought the "all you can eat" version and Apple received zero revenue per song (there are few songs that will swing a decision to subscribe or not).  TAddendumhat helps Apple in its bargains with individual song providers.  If you have a hit song, and Apple controls iTunes, there's an element of bilateral monopoly.  So Apple is better off if it can precommit to not caring whether they have your song or not.  On the music company side, there would be a tendency toward consolidation, and bargaining over catalogs rather than songs, to offset Apple's new bargaining advantage.

What other effects can you think of?

Addendum: Some sources are claiming this is just a rumor.

Liability Law and Firm Size

I would like to tile my front porch steps and have been shopping.  Lowe's and Home Depot have plenty of tile but although they advertise installation they won't install it outdoors.  The salespeople, however, will surreptitiously recommend small family contractors.  Call Jose, they tell me handing me a number.  Why won't the big firms install outdoor tile?

As best as I can figure the answer is liability.  A few slips, falls and an enterprising lawyer or two and Lowe's could be out millions of dollars.  The revenues aren't worth the risk so small firms step into the breach.  The key, of course, is that the small firms won't be sued because they are judgment proof.

Roberta Romano was here yesterday and offered another example.  The big auditing firms won't do SOX audits for small firms because the revenues are low relative to the risks.  The smaller firms must turn to judgment proof auditors of less reliable reputation. 

In one sense, this is a good workaround for a liability system that seeks out deep pockets.  Consumers are better off than they would be if neither Lowe's nor the judgment proof firms offered services and they are also better off than if Lowe's was required to offer services, because the price at which Lowe's would do so voluntarily would be prohibitive (consumers would be forced to buy insurance they didn't want at the price). 

But more deeply the resulting system is inefficient.  Consumers don't get the insurance that the liability law is supposed to provide and they must turn to lower quality, higher cost service providers even when they would prefer larger firms with solid reputations.