Postal Service Allocations II

Recently we wrote that the arguments put forth by The Donald and others that the US Postal Service (USPS) was giving Amazon a subsidy were unconvincing because fixed cost allocations are arbitrary.

Sidebar One: We use first person plural, Sidebars and don’t cite ourselves.  We don’t have that many posts that you can’t look and check.  That is how we roll.  End Sidebar One.

We have changed our mind and concluded that The Donald and others are not just unconvincing but they are wrong.  In looking at the evidence we see that the USPS has excess capacity because there is less first class mail.  The USPS has capacity and Amazon has packages.  The USPS is using Amazon to support first class mail rather than the other way around.  We should salute a not-for-profit organization for making such astute business decisions.

Sidebar Two: An interesting question is what is the extent of the USPS’s fixed costs.  Do they, or realistically, to what extent should labor costs be included.  There is a nice research opportunity there.  End Sidebar Two.

There are reasons to be upset with the USPS.  The Amazon deal is not one of them.


Postal Service Allocations

Allocating fixed costs is a really, really tricky thing.  Arthur Thomas first identified the problem of arbitrary allocations back in the seventies.  To our knowledge his conclusion that the allocation of fixed costs must be arbitrary has not been gainsaid in forty plus years.  The allocation problem leads to lots of controversies about prices in areas with high fixed costs like drugs and airlines.

The latest example of the allocation problem is Amazon and the US Postal Service.  Josh Sandbulte, writing in the WSJ says:

In my neighborhood, I frequently walk past “shop local” signs in the windows of struggling stores. Yet I don’t feel guilty ordering most of my family’s household goods on Amazon. In a world of fair competition, there will be winners and losers.

But when a mail truck pulls up filled to the top with Amazon boxes for my neighbors and me, I do feel some guilt. Like many close observers of the shipping business, I know a secret about the federal government’s relationship with Amazon: The U.S. Postal Service delivers the company’s boxes well below its own costs. Like an accelerant added to a fire, this subsidy is speeding up the collapse of traditional retailers in the U.S. and providing an unfair advantage for Amazon.

Later he partially admits to the allocation problem:

But with a networked business using shared buildings and employees, calculating cost can be devilishly subjective. When our postal worker delivers 10 letters and one box to our home, how should we allocate the cost of her time, her truck, and the sorting network and systems that support her? What if the letter-to-box ratio changes?  [Emphasis added]

Now if Josh changed the bold selection to is arbitrary we would have nothing to talk about.  But he didn’t so Josh appeals to authority:

In 2007 the Postal Service and its regulator determined that, at a minimum, 5.5% of the agency’s fixed costs must be allocated to packages and similar products. A decade later, around 25% of its revenue comes from packages, but their share of fixed costs has not kept pace.

So Josh seems to think that fixed costs should be allocated based on revenue.  It is one of many arbitrary choices.  Then he cites Citigroup (the link connects to the company rather the report) as concluding it should be $1.46 more for each package.  Since Josh didn’t connect to the report we can’t say anything other than there are lots of ways to allocate fixed costs and Arthur would say it is impossible to prove any of them right.  We side with Arthur rather than Josh on this one.


New York Tuition

This is going to take several posts.  Governor Cuomo announced (h/t Instapundit):

New York will be the only state in the country to cover four-year public college tuition for residents after the program was included in the budget package approved Sunday night.

The state’s Excelsior Scholarship program will be rolled out in tiers over the next three years, starting with full coverage of four-year college tuition this fall for students whose families make less than $100,000.

The income cap will increase to $110,000 in 2018 and $125,000 in 2019.

It will cover 80 percent of NY residents.  We are trying to find out more information as the details always matter.  For now let’s consider demand and pricing.

Yes, demand curves slope downward to the right so at a price of zero demand will be higher than it currently is.  The current price is $6,470 so this will have a big impact on demand and the NY budget.  If all of the out-of-state and international enrollment is undergraduate then NY undergraduate headcount enrollment is about 360,000.  Taking 80% and making a big adjustment for part-timers, let’s say there are 200,000 undergraduate full-time students in the system. This would cost 50,000 * $6,470 in the first year or $323 million.  That would explain the entire 6.3 percent increase and then some.  Of course, people don’t complete in four years so our estimate might be high but it seems reasonable to us.

So there will be much greater demand for SUNY from NY residents.  That means more rejections by admissions.  High demand schools will be able to raise admission standards.  Those schools will be happy but the rejected folks will not.  There will also be the within school demand to consider.  Will these financially motivated folks be interested in financially rewarding majors?  That seems likely.  That means that places like the business schools are likely to see increasing demand.  Unless they get resources they will find ways to turn away students.  We know at least one business school that uses a sliding admission standard to admit the number of students they want as juniors.

Pricing is another way that business schools and other in demand programs use to control demand and provide resources because most in demand programs are high cost.  They are, in part, high cost because the faculty are in demand and, consequently, high priced.  Business schools have surcharges to pay the cost of the programs and discourage less motivated students.  We wonder how the NY scholarships will deal with such surcharges.  It is like insurance.  If the students don’t pay they they won’t care.  If the state pays then there will be a great incentive for programs to add surcharges.

In short, making college free is going to put incredible stress on the SUNY System.  There will be more rejections in admissions.  There will be stress on programs to get resources or control numbers.  Given that the state budget increase seems insufficient to pay for the “scholarships,” it is going to be a hard year at SUNY schools.  We are glad we are retired.  We can tell recruiters for any SUNY program in advance that we are not interested at any price.

Henke’s Idea

Steve Hanke at Cato has a good idea:

To stop Venezuela’s death spiral, it must dump the bolivar and adopt the greenback. This is called “dollarization.” It is a proven elixir. I know because I operated as a State Counselor in Montenegrowhen it dumped the worthless Yugoslav dinar in 1999 and replaced it with the Deutsche mark. I also watched the successful dollarization of Ecuador in 2001, when I was operating as an adviser to the Minister of Economy and Finance.

It is a good idea but monetary policy is not the only lever available and inflation is not the only problem in Venezuela.  Dropping Chavismo,

Sidebar: WordPress really wants to convert Chavismo into Charisma.  We hope that it stays as we wrote it.  End Sidebar.

Venezuelan socialism, would be a great idea.  The advantage of Hanke’s idea is that it is easy to implement but a real blow to the current Yankee hating administration in Venezuela.  Renouncing Chavismo would be more important but way more difficult.  The current state of affairs may lead to both.

Duh … But

Michael Tanner has one of those articles on prescription pricing that makes you think, “Duh, that is too obvious for you to write” but then you realize “But if it is that obvious how come it doesn’t happen?”  Michael’s sensible recommendations are they we reform the FDA’s drug review policies:

And finally, we can inject more consumer choice into the health-care system by expanding health savings accounts and transitioning Medicare to a system of premium support. Nothing more effectively disciplines a market and forces down prices than engaged consumers spending their own money.

We should also recognize the pricing problem built into the economics of drug production.  Generally, drugs have enormous fixed costs that are paid upfront but the variable or additional cost of producing the drug is modest.  As long as one market (usually the USA) pays the full cost then everyone is better off if the maker sells the drug above variable cost in markets that can be separated from the main market.  Thus, other countries can get the drugs for less than the USA.  The market USA benefits because it becomes more likely that drugs are developed and prices would be even higher if there were no outside sales.  It would be nice if consumers in other countries were paying full price but at best that will happen sometimes.

Remembering Venezuela

The NYT reports:

To add insult to injury, the Venezuelan government has been forced to turn to its nemesis, the United States, for help.

Just to remember, Venezuela has the largest oil reserves in the world.  Despite this, it is buying oil from the United States!  It is hard to say if this is good news.  The citizens are suffering terribly but this disaster might lead to regime change.  Speaking of regime changes that we’d like to see:

But those profits have evaporated with mismanagement and the drop in global oil prices over the past two years. Now, even Venezuela’s subsidized oil shipments to its vital ally Cuba are slowly being phased out, oil executives with operations in Venezuela contend, forcing Havana to look to Russia for cheap oil.

The citizens of Cuba and Venezuela have had to undergo the awful application of socialism.  Perhaps the failure in one country will lead to changes in both.  We can hope.  It seems unlikely that Putin and Russia have oil to sell cheaply so Cuba will have even more problems.  We wish we could see the current President (mi amigo) or the next President helping the citizens of these two countries but the current President is out of the question and the two candidates for the next seem highly unlikely to have the leadership necessary.

Strange Lede

The Hill reports:

In a blow to the healthcare law, Aetna — one of the largest health insurers in the country — announced Monday that it will significantly scale back its presence on the ObamaCare marketplaces next year. [emphasis added]

The lede has it exactly wrong.  Aetna is reeling from trying to comply.   The healthcare law, which one is that now, is forcing higher prices and lower profits.  A bit later on:

The mix of ObamaCare enrollees has been smaller and sicker than expected. Some experts say that insurers also set their premiums too low. Premiums are expected to rise more sharply in 2017, which could help insurers address some of the losses.

That is a neat trick.  But Aetna’s decision is not the blow to the healthcare disaster named after our current president.  It is a disaster because it was set up poorly causing decisions by the policy sellers, policy buyers, and regulators to cause this mess.  Aetna did not do it to Obamacare.  Obamacare did it to Aetna and the rest of the country.