Naked Economics (17 page)

Compare that to the billboard advertising Chuck’s Big Burger. Chuck’s may offer one of the best burgers west of the Mississippi. Or it might be a likely spot for the nation’s next large
E. coli
out-break. How would you know? If you lived in Omaha, then you might be familiar with Chuck’s reputation. But you don’t; you are driving through Nebraska at nine o’clock at night. (What time does Chuck’s close, anyway?) If you are like millions of other people, even those who find fast food relatively unappealing, you will seek out the golden arches because you know what lies beneath them. McDonald’s sells hamburgers, fries, and, most important, predictability.

This idea underlies the concept of “branding,” whereby companies spend enormous sums of money to build an identity for their products. Branding solves a problem for consumers: How do you select products whose quality or safety you can determine only after you use them (and sometimes not even then)? Hamburgers are just one example. The same rule applies in everything from vacations to fashion. Will you have fun on your cruise? Yes, because it is Royal Caribbean—or Celebrity or Viking or Cunard. I have a poor sense of fashion, so I am reassured that when I buy a Tommy Hilfiger shirt I will look reasonably presentable when I leave the house. Michelin tire advertisements feature babies playing inside of Michelin tires with the tag line “Because so much is riding on your tires.” The implicit message is clear enough. Meanwhile, Firestone has most likely destroyed much of the value of its brand as the result of the link between faulty tires and deadly rollovers in Ford Explorers.

Branding has come under assault as a tool by which avaricious multinational corporations persuade us to pay extortionate premiums for goods that we don’t need. Economics tells a different story: Branding helps to provide an element of trust that is necessary for a complex economy to function. Modern business requires that we conduct major transactions with people whom we’ve never met before. I regularly mail off checks to Fidelity even though I do not know a single person at the company. Harried 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.”
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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.”
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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.
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They note that graduates of highly selective colleges earn higher salaries later in life than graduates of less selective colleges. For example, the average student who entered Yale, Swarthmore, or the University of Pennsylvania in 1976 earned $92,000 in 1995; the average student who entered a moderately selective college, such as Penn State, Denison, or Tulane, earned $22,000 less. That is not a particularly surprising finding, nor does it get at the question of whether the students at schools like Yale and Princeton would earn more than their peers at less competitive schools even if they played beer pong and watched television for four years.

So Mr. Krueger and Ms. Dale took their analysis one step further. They examined the outcomes of students who were admitted to both a highly selective school and a moderately selective school. Some of those students headed to places like the Ivy League; others chose their less selective option. Mr. Krueger and Ms. Dale’s chief finding is best summarized by the title of the paper: “Children Smart Enough to Get into Elite Schools May Not Need to Bother.” The average earnings of students admitted to both a highly selective school and a moderately selective school were roughly the same regardless of which type of college they attended. (The one exception was students from lower-income families for whom attending a more selective school increased earnings significantly.) Overall, the quality of student appears to matter more later in life than the quality of the university he or she attended.

Is it irrational to spend $150,000 or more to attend an Ivy League university? Not necessarily. At a minimum, a Princeton or Yale diploma is the résumé equivalent of Roger Ebert’s “thumbs up.” It pronounces you highly qualified so that others in life—employers, spouses, in-laws—will have fewer doubts. And there is always the possibility that you may learn something while huddling for four years with the world’s great minds. Still, Mr. Krueger offers this advice to students applying to college: “Don’t believe that the only school worth attending is one that would not admit you…. Recognize that your own motivation, ambition and talents will determine your success more than the college name on your diploma.”

The notion that bright, motivated individuals (with similarly motivated parents) will do well, however or wherever they are schooled, is often lost on America’s school reformers. In Illinois, each fall is greeted with the release of the state’s school report cards. Every school in the state is evaluated based on how well its students have performed on a battery of standardized exams. The media quickly seize on these school report cards to identify the state’s “best” schools, most of which are usually in affluent suburbs. But does this process really tell us anything about which schools are the most effective? Not necessarily. “In many suburban communities, students would do well on standardized tests even if they went to school and sat in a closet every day for four years,” says University of Rochester economist Eric Hanushek, an expert on the somewhat tenuous relationship between school inputs and student outcomes. There is a fundamental piece of missing information: How much value is really being added at these “high-performing schools”? Do they have exceptional teachers and administrators, or are they repositories for privileged students who would do well on standardized tests regardless of where they went to school? It’s the Harvard question all over again.

This chapter started with a serious social issue, and so it will end. Racial profiling is an information problem. There are two simple questions at the heart of the issue. First, does race or ethnicity—alone or in conjunction with some other circumstance—convey meaningful information related to potential criminal activity? If so, what do we do about it? The answer to the first question gets most of the attention. After the attacks of September 11, one could certainly make the case that thirty-five-year-old Arab men posed a greater risk to the country than sixty-five-year-old Polish women. Police officers have long argued that race can be a tip-off; well-dressed white kids in poor black neighborhoods are often looking to buy drugs. Criminal organizations have racial or ethnic affiliations. At the same time President Clinton was declaring racial profiling “morally indefensible,” the website of his drug czar, Barry McCaffrey, was doing just that. In Denver, the site noted, the heroin dealers are predominantly Mexican nationals. In Trenton, crack dealers are predominantly African-American males and the powdered cocaine dealers are predominantly Latino.
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Indeed, we all profile in our own way. We are taught from a young age that one should never judge a book by its cover.
But we must; it is often all we get to see.
Imagine you are walking in a parking garage at night when you hear footsteps behind you. Ideally, you would ask this person for a résumé you and he would sit down for coffee and discuss his goals, his job, his family, his political philosophy, and, most important, the reason he is walking behind you in a dark parking garage. You would do a criminal background check. Then, with all this information in hand, you would decide whether or not to hit the panic button on your key ring. The reality, of course, is different. You get one quick glance over your shoulder. What information matters? Sex? Race? Age? Briefcase? Clothing?

I’ll never forget my own experience as a victim of racial profiling. I boarded a westbound bus from downtown Chicago just as it started to get dark. Chicago is a very segregated city; most of the neighborhoods west of downtown are predominantly African-American. I was wearing a suit, and after a few blocks I was the only white guy on the bus. Around that time, an older black woman asked kindly, “Oh, are the Bulls playing tonight?” The Chicago Bulls play at the Chicago Stadium, which is also directly west of the city center. This woman had inferred, innocently enough, that the only reason a white guy in a suit would be on this bus around 7:00 p.m. would be to go to a Bulls game. Obviously it was unfair and potentially hurtful for her to draw any conclusion about my destination based only on my skin color and style of dress. The really weird thing is that I was on my way to the Bulls game.