It’s a good piece of legislation, even if at times some aspects of it may result in greater costs than benefits.

TimesLive has a story about the alleged noncompliance of medical schemes with the CPA.

Some of the issues may have merit, but this struck me as particularly troubling:

According to the act, it is unfair when a consumer is discriminated against on the grounds of age.

Our constitution explicitly allows discrimination on actuarially sound rating factors that have both a statistical and causal link. This is how insurance is South Africa still uses underwriting to select homogenous groups of risks and to limit anti-selection by policyholders. If widespread anti-selection were to occur, then life insurance would not be viable.

Medical Schemes in South Africa have only very limited underwriting options in order to provide as many citizens as possible with fair health coverage. “Late joiners” are charged a premium since they haven’t contributed to the societal risk pool since they were most healthy and therefore haven’t paid “their fair share”. This has to do with a specifically identified risk rather than general discrimination based on age. These restrictions are important to maintain the solvency and viability of medical schemes.

Some schemes prevent women who fall pregnant within nine months of joining the scheme from claiming for the pregnancy even though they pay full premiums

This point is more tricky, but it does again reflect a misunderstanding. “Full premiums” on an actuarial sound basis have probably not been paid, since the fair premium for a member who joins just to get pregnancy benefits and hasn’t contributed at other times would be much higher than the premium that is charged. This one is a little more grey and while I feel the rules are entirely fair, they may not be viewed that way by a particular judge on a particular day.

Some schemes require that members give three months’ notice when terminating their membership, whereas the act deems 20 business days to be reasonable

This might reflect the desire to not have members leave a scheme immediately after having utilized the maximum benefit available to them before joining another scheme. I don’t know how much of this behavior would ever happen, so this might also ultimately be changed.

Many schemes don’t enforce the allowed waiting periods for members joining. If some of these other changes were to be made, I would expect these provisions would be more regularly used. Of course, that is another of the problems cited with medical schemes arising from the CPA.

All in all, we may see some changes, but by and large these comments reflect a lack of appreciation for the actuarial realities of managing a health scheme with community rating.

When I say “doesn’t seem right” I’m referring mostly to the fairness of it, but I’m also wondering how it can possibly be true.

Of course the analysis if by the Authors’ Guild, so they are naturally likely to be biased towards authors. Specifically, I don’t care how many examples they quote – I’d like to see the real data or at least a random sample of data.

They don’t talk about sales volumes, but although higher volumes might still make authors better off than the pure margin analysis shows, I expect it will have an even better impact for the publishers.

The comparison of ebooks against hardcovers is an interesting choice. I would imagine there are far more paperback books sold each year – a more thorough analysis would consider that as well.

I read another recent story about John Locke making a fortune by leveraging the low cost of ebooks and the price elasticity of books. By dropping the price of his books to 99c he is making more money than when he was selling them for ten times that.  I don’t see how that isn’t a boon to authors from ebooks.

Ultimately, it probably isn’t ebooks that are bad for authors as much as it is the pricing model of current ebooks (in this case basically Amazon but also Apple with their iBook Store).

As I said at the start – I don’t know enough about this. If anyone can shed some light, please comment away!

One of the reasons given is:

Satawu previously warned that Aarto will result in job losses, as drivers will lose their licences once the maximum amount of demerit points are exhausted, and have a negative impact on the economy.

This demonstrates two of my favourite principles:

1. Almost everything is partisan. So partisan and self-interested as to make it blind to anything and everything else.
2. Economics is a mystery.

There isn’t a lack of taxi drivers. There isn’t a lack of a deep pool of resources of potential taxi drivers just waiting to take the place of a recently vacated driving job.

What really surprised me though is that the taxi industry seems to think they are subject to the law than the average joe driving on the roads today. Given the overloading, dangerous driving, smooth-tired aqua-planing, randomly stopping, unroadworthy taxis on the road, not much law enforcement seems to be happening as it is.

Unless AARTO means the bribes will have to go up since the consequences of not bribing are now more serious?

The economics of a fund manager depends entirely on growing funds under management so that revenues (based on assets under management) grow to be larger than costs (significantly fixed and at most semi-variable). Details of performance fees and the second order impact of investment performance aside, a successful fund manager must attract positive net client cashflow, and lots of it.

Half the 960 available unit trusts have less than R100m in AUM. Some of these may be rapidly growing new funds, but many have been stagnant with slow growth for several years.

The FSB’s attention presents opportunities for consolidation between funds and should place larger funds in a stronger position competitively. Total Expense Ratios (TER) for these funds with significant scale should already be lower than smaller funds. Maybe it’s time the larger funds made more if their size and cost efficiencies. If they are going to take the heat for being too large to be nimble, they might as well reap the benefits too.

It will be interesting to see what this means for white labelled funds and whether the economics of these convince the regulator that they should survive.

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1 The Competition Commission is necessary

Monopolies serve to increase prices for consumers. In Monopoly, the “rents” charged are instantly higher as soon as a player has a monopoly on property in a certain area.

Worse than the increase in prices and decrease in supply, the additional profit for suppliers is not equal to the cost to consumers from higher prices, resulting in an overall “dead weight loss of monopoly” or an overall cost to society.

To date, the Competition Commission has focussed on cartels and price collusion. We can only hope soon they will consider issues of local loop unbundling to provide real competition to the effective monopoly Telkom has on ADSL lines.

2 The easy availability of credit is a useful and dangerous tool

An important consideration in Monopoly is to prevent competitors from owning property (so that you don’t have to pay rent on as many properties as possible) and definitely don’t get a monopoly (so they can increase rents and improve the properties, increasing rents even further).

A key way of doing this is by buying as many properties as possible, even if you mortgage many of them with a fresh injection of cash from the bank and very reasonable repayment terms. Leverage, or borrowing, can provide cost effective (especially after tax considerations) financing for profitable projects. It can be cheaper to raise than equity and increases returns to shareholders.

Leverage also creates significant risks, both in Monopoly and real life. Overextending can make you more likely to end up bankrupt. Also, by artificially increase the supply of funds for purchasing property while keeping the supply constant, the price of property will increase dramatically with distorting impacts on the allocation of resources within an economy.

3 Trading is good for those who trade

Every time two people (or organisations, or countries) trade, both parties are better off than they were before. (A hint, otherwise they wouldn’t have traded.) The trading parties are each better off, and the non-trading competitors are worse off, because a potential trade is now off the table and they are not in a better position otherwise.

There are some plausible arguments for trade restrictions in very particular circumstances. For example, I think I buy the idea of nurturing infant industries, but only if there is a reasonable chance that the industries won’t only grow as far as pimply, sulky adolescents with no drive or ambition.

Other than that, trade is good as it increases prosperity on average, which is one important way to lift more families incomes above the poverty line.

4 Liquidity risk can be the end of you

While buying as much property as possible and mortgaging some to provide additional funds will generally work in your favour and allow you greater control over the board, it also introduces liquidity risk. If you don’t have the funds to pay rent or taxes or fines when they unexpectedly fall due, you will be forced into a fire-sale of houses and hotels at way below replacement cost. You may need to mortgage even more properties, reducing your income generating ability and possibly sending you into a debt trap where your income isn’t sufficient to meet your expenses.

Always watch your liquidity. It has almost become a truism that more businesses fail because of liquidity than solvency or profitability.

5 The world is full of randomness, but it always helps to calculate the numbers

In Monopoly, the player “roles the dice and moves the mice” so to speak. There is plenty of luck around and skill can seem to disappear in an avalanche of random numbers.

Nassim Taleb (of Fooled By Randomness fame) would suggest that in everyday life we underestimate risk and overestimate skill. I tend to agree with this overall comment. It doesn’t mean that we should try to use our skill as much as possible.

Did you know that certain properties are relatively more valuable than others? The properties just after Jail are more likely to be hit than others, since several cards and one square on the board send the player to jail. Similarly, several chance cards require the player to advance a certain way, making the squares immediately after a chance square less likely to be hit. The cost to benefit of houses on certain squares are better than others, and the best bang for buck is somewhere between 2 and 3 houses per property.

It’s important to be aware that risk and uncertainty exists, but it’s more important to understand risk in a way that allows informed, risk-aware decisions to be made.

Identify, measure, mitigate and monitor risk!

Are all the lessons good?

Slightly tongue in cheek, there are a few other lessons of dubious validity:

1. Stay in jail and make more money
2. You get to keep the money if the bank makes an error in your favour
3. You can take as long as you want to repay your mortgage and only have to pay 10% interest
4. If the bank runs out of money, it can always photocopy some more
5. When the game is over, you can forget about the debt you have and walk away

Regulations and Big Bank Buildings

Why have banks historically had impressive  marble-slathered floors and columns, high ceilings and ornate, heavy front doors? Would you really deposit your salary and savings into an operation run out of a caravan parked on a corner on your way to work?

The fixed, permanent high-investment nature of the impressive buildings is one way that banks can  communicate their seriousness, their high investment requiring a long-term relationship with a large customer base to recoup their upfront costs and their inability to up and off and disappear with all their assets overnight. This communication of financial strength and longevity gives customers the confidence to trust in them and bank with them.

If you’ve thought about this for more than a few seconds, you should be asking an important question. “How do Internet-only banks, with their apparent lack of real, physical assets and high upfront investment in their operations support this argument?”

The answer is that the world has moved on in the last hundred years or so. Banking regulations and rules, smarter prudential supervision, deposit insurance (in some countries) generally provide an additional safety net not present in the past when the huge, expensive bank buildings were constructed. We now have greater trust and confidence (even after the testing and trying of the Global Financial Crisis) that our money is safe with a regulated bank.

In fact, in South Africa, I’m not aware of a retail depositor losing money in a regulated  bank in decades. The financial  crisis in the US, in which many banks failed (41 that I’m aware of) no individual depositors have lost money. Northern Rock in the UK was fully guaranteed by the Bank of England.

We have many reasons to be confident in our banks, and thus the physical demonstration of stability is no longer required.

Would you fly on my airline?

I have a plane. You don’t know when it was last inspected, let alone service, and certainly not by whom. You can’t be sure that the pilots are trained, awake and  sober. We’ll land at airports we chose, but you won’t know whether we considered weather conditions, have working communication with air traffic control or whether we bothered to check that the runway is long enough for our type of aircraft.

Did I mention that our prices are very low?

Somehow I doubt that our low prices are much of an incentive. In fact, I would argue that many passengers would choose to fly on a carrier where the prices reflected sufficient profit and margins for investment in safety and maintenance, for paying trained pilots and not skimping on fuel because cash flow was tight.

Choosing a strong, profitable airline as as proxy for a safe airline

Many would choose airlines with strong balance sheets and long histories of profitable trading. Airlines could differentiate themselves through safety records and the use of highly paid independent safety inspectors and consultants.

Sure, the prices would probably be higher than the are today. This might be a strong recommendation for safety regulations in that they may well increase the number of passenger miles flown since they lower costs subject to a minimum level of safety enforced through the rules.

The safety regulations, imposed by a credible regulator and inspector, give us confidence to fly on airlines irrespective of other indicators as to the safety or otherwise of plans and the training of staff. The regulations fill the requirements of fancy bank buildings and strong financial track records.

Without regulations, we might have a more profitable airline industry, not because of the costs imposed by the regulations themselves but rather because of the removal of pricing power.

The hype and hoopla around this topic is fueled by our feelings as consumers of being charged too much big big monopoly companies. So I should start by saying that I’m not saying that we are paying too much. I’m not saying that because I don’t know enough about the costs of providing cellular services in South Africa. Maybe we are, maybe we’re not. Also, I’m not saying there aren’t monopolistic practices in the market – again I simply don’t know. Given the other stories torn from inside companies by the sharp teeth and salivating jaws of the Competition Commission, it’s understandable that many suspect consumer-unfriendly play by most large South African companies, particularly those in industries with a small number of players.

What I am saying is that most of what you read in the news about interconnect is horribly misguided.

The biggest misconception is that interconnect fees are an expense for cellular providers, and that the removal of this expense would allow them to reduce tariffs to consumers. Well, it is an expense, but it is also a source of revenue. Every time one company pays an interconnect fee, another company is receiving it.

Interconnect does not change the total amount of profit within the cellular industry. It may redistribute it a little, and there may be negative medium term competitive implications arising from interconnect, but lower interconnect won’t automatically increase profits that could allow competitive price lowering for the benefit of consumers.

TechCentral has an interesting article: Bain warns consumers not to expect cellular price cuts.  Of course, it also include some done-to-death flawed statements (whether from Bain or inserted by the zealous staff writer) such as:

Because new players have few customers at first, most calls on their networks will be to networks of other operators. High interconnection fees make it difficult for them to enter the market.

It’s not that this statement is incorrect (it is in fact correct) it’s just that it is horribly misleading because it only presents one side of the story. I’ve reworded it to provide the stunning insight:

Because new players have few customers at first, most calls to their networks will be from networks of other operators. High interconnection fees make it profitable for them to enter the market.

If you are a small cellular operator, most people calling your customers won’t also be your customers. You get to charge them an interconnect fee for most calls. You can model this in a spreadsheet (I’ve done it) and provided two basic assumptions hold, interconnect is irrelevant as a primary force. Fees in and expenses out equate .

1. “Cellphone users must make calls, on average, equally to all other subscribers independent of network.” If Cell C customers are more likely to call Cell C customers rather than a random cellphone user in South Africa, the numbers start to change. Although I don’t have info to back this assumption up, it feels reasonably robust.
2. “Customers on all networks must, on average, make the same number of calls.” This is actually where the problems arise and the true cost of interconnect exists.

Why is assumption #2 a problem? Think about the goal of competition for consumers: “Profit maximising companies see to increase volumes by lowering prices, gaining market share and thus making more profit. Provided Marginal Revenue is above Marginal Cost, companies should cut prices.”

So, what happens with interconnect fees above “true” cost of completing the call? When a company seeks to lower its prices, below that of the competition, its customers will make more calls than average. (This is intuitive and also expected from a downwards sloping demand curve.)

Company A reduces its call rates. Company A’s subscribers will make more calls (incurring interconnect expenses for Company A paying to Companies B, C and D) but customers of Company B (and C and D etc.) won’t be making more calls into Company A. Thus, Company A pays more interconnect and receives no more interconnect. Its costs have just gone up, pushing up Marginal Cost to a point where it doesn’t make sense to lower prices.

Voila – a perfect pricing system to force prices higher and higher. If Company B raises it’s prices, its subscribers will receive more calls than they make, resulting in more interconnect revenue than expenses for Company B. If the interconnect fee is sufficiently above the true cost, the reduction in profit form lower call volumes will be more than offset by the much  higher profit from interconnect fees being greater than interconnect expenses.

So interconnect fees need to come down to true cost plus a fair profit margin. It has little to do with interconnect being an expense factored into retail tariffs, but rather a function of the competitive pricing actions it encourages.

“But they’re profiteering” you cry!  Well, yes, in a word. But if the incredible expense of building stadia in the shape of donuts and white elephants is to be recouped, someone has to make some money out of the whole deal.It’s a pity that locals will be mostly priced out of the festivities, but that could be remedied with an auction of cheaper tickets to SA ID holders, or by providing a modest tax and rebate (for locals) system.

I want foreigners to come here with their fat Euro, Dollar, Pound, Yen and Namibian Dollar (yes them too) wallets to spend on our goods and services, to provide employment and profit for South Africans. I want South Africans to spend this earned money in our economy. I want businesses and entrepreneurs to gear up for higher profits and expand the scale of their businesses, train their staff and invest in technology.

(Of course, I also wish the vuvuzelas we should sell for 500% mark-ups were made in South Africa, but apparently I only get one wish a day.)

I want South Africa to get some sort of benefit out of this whole footie thing.

It’s fair to say the South African taxi industry isn’t besotted with the Bus Rapid Transport (BRT) system. It’s understandable too. No matter what assurances are provided around newly jobless taxi drivers being placed within BRT, the reality is that a more efficient service with larger vehicles will need fewer drivers.

It’s also blindingly obvious that a more efficient, safer and better controlled public transport system is overwhelmingly to the advantage of pretty much every other citizen in our wonderful country.

A small group (often termed a Special Interest Group) lobbies (politically or through protests or violence) for a change (or the maintenance of the status quo) to their advantage at the expense of the wider population. Taxi owners and drivers have their livelihood at stake. Of course they care disproportionately compared to the rest of us!

The Tea Party

The Boston Tea Party is commonly interpreted as an inspirational story of the colonists of the New World growing tired of economic exploitation and the famous “No taxation without representation”.

Of course this is not the true story.

It is true that the British East India Company was THE monopoly of the time and pushed hard for its profits. It’s also true that the British constitution of the day stated that citizens could be taxed only through consent of their representatives in Parliament. There was no directly elected official representing the colonists, so arguments about taxation without representation are probably fair. (As an aside, although there is no specific document called the “constitution” the rules and principles that make up a de facto constitution exist.)

The reality is that tea shipped to the americas, and imported through official channels, was taxed. This tax had been in place for several years and did not change around 1773 when these events took place. It’s also instrumental to note that historians have estimated the amount of team consumed by colonists and the amount taxed during the same period. Only 5% of tea consumed was imported through official channels so the tax  levied was almost irrelevant for colonists.

However, what did change, was that the East India Company (EIC) was allowed to sell tea directly to colonists rather than being forced to use local merchants as intermediaries. The EIC had a large surplus of tea that it needed to sell, and would have provided large quantities of tea at low price to the colonists.

More tea at a low price would have been a good thing for the colonists, given their voracious appetite for the dried leaves. However, the small special interest group of the local merchants who previously made a good profit out of reselling the tea were rather more put out.

It was these merchants who stoked support for the “no taxation without representation” catchy slogan of the day. They stood to lose and focused their energy on fixing the problem. The benefit that hundreds of thousands of colonists and settlers would have experienced through lower prices was somehow  forgotten.

But not forgotten by all. Reports at the time show that there were some who wrote that it seemed a small group would benefit and uncovered rather less honourable motivations. History doesn’t remember them as well.

I owe my understanding of these events to the fantastic book, “A Splendid Exchange – How Trade Shaped The World” by William Bernstein. If you enjoyed this, please buy his book at amazon.com or amazon.co.uk or your regular bookstore.

The Tax and the Tea Party and unbalanced interests

Those with a special, intense, personal or focused interest in legislation or policy will act disproportionately to enact their desired outcome. We need strong leaders to focus on the needs of the entire country to balance the manipulation of special interests and public apathy.