Naked Economics by Wheelan, Charles (best books to read .TXT) 📗

government regulators can only protect me from the most egregious kinds of fraud. They do not protect me from shoddy business practices, many of which are perfectly legal. Businesses routinely advertise their longevity. That sign outside the butcher proclaiming “Since 1927” is a politic way of saying, “We wouldn’t still be here if we ripped off our customers.”

Brands do the same thing. Like reputations, they are built over time. Indeed, sometimes the brand becomes more valuable than the product itself. In 1997, Sara Lee, a company that sells everything from underwear to breakfast sausages, declared that it would begin selling off its manufacturing facilities. No more turkey farms or textile mills. Instead, the company would focus on attaching its prestigious brand names—Champion, Hanes, Coach, Jimmy Dean—to products manufactured by outside firms. One business magazine noted, “Sara Lee believes that its soul is in its brands, and that the best use of its energies is to breathe commercial life into the inert matter supplied by others.”5 The irony is lovely: Sara Lee’s strategy for growth and profits is to produce nothing.

Branding can be a very profitable strategy. In competitive markets, prices are driven relentlessly toward the cost of production. If it costs 10 cents to make a can of soda and I sell it for $1, someone is going to come along and sell it for 50 cents. Soon enough, someone else will be peddling it for a quarter, then 15 cents. Eventually, some ruthlessly efficient corporation will be peddling soda for 11 cents a can. From the consumer’s standpoint, this is the beauty of capitalism. From the producer’s standpoint, it is “commodity hell.” Consider the sorry lot of the American farmer. A soybean is a soybean; as a result, an Iowa farmer cannot charge even one penny above the market price for his crop. Once transportation costs are taken into account, every soybean in the world sells for the same price, which, in most years, is not a whole lot more than it cost to produce.

How does a firm save its profits from the death spiral of competition? By convincing the world (rightfully or not) that its mixture of corn syrup and water is different from everyone else’s mixture of corn syrup and water. Coca-Cola is not soda; it’s Coke. Producers of branded goods create a monopoly for themselves—and price their products accordingly—by persuading consumers that their products are like no other. Nike clothes are not pieces of fabric sewn together by workers in Vietnam; they are Tiger Woods’s clothes. Even farmers have taken this message to heart. At the supermarket, one finds (and pays a premium for) Sunkist oranges, Angus beef, Tyson chickens.

Sometimes we gather information by paying outsiders to certify quality. Roger Ebert’s job is to see lots of bad movies so that I don’t have to. When he sees the occasional gem, he gives it a “thumbs up.” In the meantime, I am spared from seeing the likes of Tomcats, a film that Mr. Ebert awarded zero stars. I pay for this information in the form of my subscription to the Chicago Sun-Times (or by looking at ads that the Sun-Times is paid to display on its free website). Consumer Reports provides the same kind of information on consumer goods; Underwriters Laboratories certifies the safety of electrical appliances; Morningstar evaluates the performance of mutual funds. And then there is Oprah’s book club, which has the capacity to send obscure books rocketing up the best-seller lists.

Meanwhile, firms will do whatever they can to “signal” their own quality to the market. This was the insight of 2001 Nobel laureate Michael Spence, an economist at Stanford University. Suppose that you are choosing an investment adviser after a good stroke of fortune in the Powerball lottery. The first firm you visit has striking wood paneling, a marble lobby, original Impressionist paintings, and executives wearing handmade Italian suits. Do you think: (1) My fees will pay for all this very nice stuff—what a ripoff!; or (2) wow, this firm must be extremely successful and I hope they will take me on as a client. Most people would choose 2. (If you’re not convinced, think about it the other way: How would you feel if your investment adviser worked in a dank office with twenty-year-old government-surplus WANG word processors?)

The trappings of success—the paneling, the marble, the art collection—have no inherent relation to the professional conduct of the firm. Rather, we interpret them as “signals” that reassure us that the firm is top-notch. They are to markets what a peacock’s bright feathers are to a prospective mate: a good sign in a world of imperfect information.

What signals success when you walk into an office in parts of Asia? Ridiculously cold temperatures. The blast of frigid air tells you immediately that this firm can afford lots of air-conditioning. Even when the temperature is more than ninety degrees outside, office temperatures are sometimes so cold that some workers use space heaters. The Wall Street Journal reports, “Frosty air conditioning is a way for businesses and building owners to show that they’re ahead of the curve on comfort. In ostentatious Asian cities, bosses like to send out the message: We are so luxurious, we’re arctic.”6

Here is a related question that economists like to ponder: Harvard graduates do very well in life, but is that because they learned things at Harvard that made them successful, or is it because Harvard finds and admits talented students who would have done extraordinarily well in life anyway? In other words, does Harvard add great value to its students, or does it simply provide an elaborate “signaling” mechanism that allows bright students to advertise their talents to the world by being admitted to Harvard? Alan Krueger, a Princeton economist, and Stacy Dale, an economist at the Mellon Foundation, have done an interesting study to get at this question.7 They note that graduates of highly selective colleges earn higher salaries later in life than graduates of less selective colleges. For example, the average