Allison's ode to the second moment


Welcome to the thirty-ninth issue of Allison’s Ode to the Second Moment, a newsletter about the risks involved in, well, let’s just say a wide variety of jobs.

Does technology make markets more efficient?

I think we underappreciate how much commerce changed in the past 20 years. Classical economics assumes transparent pricing and buyers and sellers who can easily find each other. But for most of human history, neither of these things were always true. I’d guess that caused all sorts of market distortions, though it is hard to know what the costs (or benefits) were until the market changed.

Scott Cunningham, Chris Groskopf, and I looked at what happens to a market where prices suddenly become transparent and the goods easy to find. Instead of looking at Amazon, we looked at the market for sex workers. Traditionally sex work, like most illegal jobs, operated in the shadows, prices were opaque, and buyers and sellers had a hard time finding each other. Matching required middlemen (pimps or agencies) who took a large share of earnings and were often controlling and violent.

But in the past 20 years, sex work underwent a radical transformation. The world’s oldest profession was the first to embrace technology and go online. Sex workers advertise on various websites and other websites publish detailed reviews on the transactions. We took review data, scrapped from the Internet. We had 1.1 million (!) observations on different sex work transactions going back to 1999. Our data included price, services, and customer satisfaction (and many other things not appropriate for a family-friendly newsletter). This may be the most complete data set I’ve ever worked with.

We noticed sex workers’ median wages increased, while wages in other industries barely budged. One of the best things about the data is each observation came with the sex worker’s contact details. I spoke to some of the providers about how they set their prices. They described how they used the websites to see what other providers charge and then set their prices accordingly. You might think that their research would bring prices down because customers can shop around and sex workers are worried about exceeding the market rate, but the opposite happened. We suspect technology induced more women to enter the industry because they didn’t have to deal with pimps or Madames. These sex workers had a higher reservation wage, which increased the median.

The market is also fairly efficient. There is a positive correlation between price and customer satisfaction. Well, up to a point. Few customers rated their experience more than an 8 out of 10, no matter what they paid. It seems there is very little difference between a $400 and $600 per hour service.

There is also evidence that adult sex workers, who voluntarily enter the industry, are safer because they can screen out violent lunatics or police. But this all comes with a horrible dark side. The rise of Internet sex work also gave cover to human trafficking, including many minors.

There is no good transition here

Donald Trump revealed his choice for Fed chairperson…Jay Powell. Janet Yellen is doing a great job, but Trump wanted to shake things up with someone who has similar judgement and isn't her. It’s the first time in almost 40 years the Fed chair is not an economist.

I am an economist, so I think people like me should be in power. Post-Bretton Woods markets became more volatile and our understanding of monetary policy advanced. It seemed we needed a chairperson with technical training and a deep knowledge of the literature and history of monetary policy. An intellectual has the foundation to make the hard, sometimes unpopular, decisions. Monetary policy is about balancing the short and long term, not just juicing the economy to keep the stock market rising today, though most media coverage suggests otherwise.

On the other hand, now the job includes more regulatory functions, so perhaps it requires someone with more market experience. I often worry about the future of Fed independence, and maybe we need a political operator to fight for it.

It’s an extraordinary job that wields tremendous power. The last two academics were notable for encouraging dissent and balancing different views. I am a bigger fan of that approach than the Greenspan model. His cult-of-personality kind of Fed is a high-risk strategy because it comes down to one person’s fallible judgement. You don’t need to be an academic to give fair weight to different intellectual arguments and have the confidence to make the right choices, but the training certainly helps.

The cost of freedom

In 2015, the UK tried a big experiment. Before then, the British people had to annuitize most of their pension accounts and take regular payouts from their defined benefit (DB) plans. The change in 2015 lets pensioners take huge lump sums from their DB plans. It feels like a windfall. A steel worker told the FT, after turning his gold-plated DB plan into a six-figure lump sum:

The money is life-changing for me,” says the 55-year-old former steelworker who has traded in his gold-plated final salary pension for a six-figure cash lump sum. “I will never have to work again. I didn’t feel like I had won the lottery, but it is not far off.

Rising asset values have made these pots even bigger and all looks good for pension freedoms—until it doesn’t. Pensioners now have to manage large sums of money and make the money last, and these are not easy financial problems. Markets are up now, but people won’t be so confident they made the right decision when markets fall.

Guaranteed income for life has value and pensioners who took lump sums gave it up. Why would they do such a thing? The DB plans face incentives to encourage lump sums because doing so lessens their risk. One estimate says 55% of pensioners decided to take lump sums after being advised by someone hired by their employer.

Many pensioners are turning to financial advisors who face mixed incentives. There are reports of advisors scaring pensioners by exaggerating the risk of pension bankruptcies. To make matter worse, they may not be investing the lump sums well. An inquiry by the FCA found only 35% of the investment products recommended to individuals taking lump sums were considered suitable.

The changes in 2015 included that workers with DC plans didn’t have to annuitize anymore either. They also have to manage a large pot of wealth in retirement instead of turning it over to insurance companies.

Just two years later, with low interest rates and a booming stock market, pension freedoms seem like a great idea. No one is complaining yet. But good policy provides stability in good times and bad. I fear this won’t end well.

Speaking of, the US military is about to implement their pension reforms. Now retired service members (many retire in their early 40s!) can take lump sums too.

Kids these days

Taking a lump sum may not be a smart risk. But risk taking is critical for success on the battlefield. The military takes risk seriously; I’ve seen the models. But even the best risk models can’t replace good judgement in the heat of battle. This is why training and temperament are so critical. Its seems, though, that the cadets at West Point these days are risk averse. It is not clear what that will mean for future warfare or….politics. Maybe they’ll change as they get older. Most people become more risk averse as they age. Maybe the opposite will be true for soldiers.

Speaking of maturity, there is evidence Millennials and Gen Z are more patient. Based on almost 60 years of giving kids the marshmallow test to measure delay of gratification, kids are getting increasingly patient and able to value rewards in the future. Maybe they’ll be better savers.

In other news

I hope you survived the time change. If you live in Massachusetts or Maine, it may be your last.

Until next time, Pension Geeks!