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Updates from Chicago Booth

Four ways to ensure innovation continues after the crisis
Tools for innovating better and faster, even after the recovery
By Lindsey Lyman – The COVID-19 crisis has prompted inspiring acts of innovation. Companies, governments, entrepreneurs, and citizens have proved how capable humans are of innovating during times of crisis. Responding to the acute public-health pandemic has forced rapid changes in health-care-delivery models. The social-distancing mandates have prompted complete workforces to adopt a virtual work model as well as K–12 school districts and university systems nationwide to figure out how to educate students through distance learning. The slowdown of commerce has pushed small-business owners to transform their business models overnight in an attempt to stay afloat amid economic collapse.

Necessity forces companies to innovate. However, waiting for a crisis is not a sustainable innovation strategy, and certainly no one wants a crisis for the sake of innovation. The COVID-19 pandemic provides a natural experiment that allows us to examine conditions that have prompted innovation and to observe and learn how organizations have responded. The circumstances are dire and the effectiveness of many of these innovations remains unknown. Despite this, it is worth observing what is happening and learning from it. Companies should take note of these lessons and apply them to remain innovative, whether in the midst of a crisis or in a position of strength.

Extreme examples of innovation have surfaced from the COVID-19 crisis. In one well-documented example, Wuhan’s Huoshenshan Hospital, a specialty field hospital, was built in just over a week to treat the outbreak. Although this is a great testament to human ability, it does not provide a blueprint for sustainable innovation. The financial burden and other costs—among them, structural and safety concerns and suspect labor practices—do not justify building a hospital at this speed under normal circumstances.

However, other tools used to fight the COVID-19 outbreak can and should become a replicable part of corporate innovation practices. Here are four of them. more>

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Don’t fall for the false trade-offs of COVID-19 policy
By Neale Mahoney – The American economy—like those of many countries—is reeling. As COVID-19 forces businesses to shut their doors and consumers to retreat within their homes, the stock market has plummeted and unemployment-insurance claims have skyrocketed. Many people are predicting that we will soon experience a severe recession, in the United States and around the world.

So it may come as no surprise that in this gloomy environment, there are growing concerns that the economic costs of mitigating the spread of COVID-19—through social distancing and/or isolation, the approaches favored by many health experts—are worse than the health costs we would incur by relaxing such measures. As US president Donald Trump put it on Twitter, “We cannot let the cure be worse than the problem itself.”

Trade-offs are central to economics. Many of our canonical models are designed to illustrate them, and economists are quick to point out trade-offs, or “unintended consequences,” when they are ignored by policy makers.

Because of these trade-offs, reasonable people with a shared goal can disagree, simply because they have differing views of, for instance, the elasticity of labor supply (how workers respond to changes in after-tax wages), the degree of moral hazard (how people respond to the out-of-pocket price of health care), and so on.

However, when it comes to COVID-19, the conventional economic trade-offs are greatly overstated. Indeed, I’m worried that the language of trade-offs is being co-opted to push for shareholder bailouts and corporate cronyism. Some of the “trade-offs” being weighed in discussions of policy are not trade-offs at all. We economists should get ahead of this and call it what it is: nonsense. more>

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Let your customers tell you when to pivot
Small-business owners can get guidance by surveying their own customers
By Pradeep K. Chintagunta – William Wrigley Jr. spent many of his childhood years selling his father’s Wrigley’s Scouring Soap on the streets of Philadelphia. So when he set out for Chicago in the 1890s, Wrigley did what he knew and brought the soap trade with him.

Had Wrigley stuck to his original plan, it’s unlikely his name would stand today as one of the most iconic in Chicago business history. Instead, he took some calculated risks and pivoted his business twice.

Wrigley had been tossing in packages of baking powder as an incentive for purchasing his soap. When the baking powder proved more popular with customers than his soap, he made it his main product. Soon he realized that his new bonus product, chewing gum, was an even bigger draw, and he changed his focus again. The rest is history.

Despite evidence that pivots can improve productivity and competitiveness, businesses aren’t always eager to make changes. It’s difficult to consider experimenting with a business model that has worked in the past, and many small-business entrepreneurs may not feel as though they have the time and resources to do so. more>

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The populism puzzle
What caused the uprising that has transformed global politics?
By Hal Weitzman – When UK voters elected a Conservative government in December 2019, they effectively re-endorsed their view, expressed in a referendum three years prior, that Britain should leave the European Union. The news was celebrated by, among others, US president Donald Trump, who drew a parallel with his own attempt to be reelected in 2020 by tweeting, in a paraphrase of comments by Fox News host Steve Hilton, “Here in America it will be the same victory as BREXIT, but even more so.”

The 2016 Brexit referendum, and its transatlantic counterpart—Donald Trump’s victory in that year’s US presidential race—surprised opinion pollsters, and prompted many observers to question conventional political thinking. This more-recent UK election, and a US presidential campaign that has so far been dominated by candidates on the edges of the political spectrum, demonstrates that political populism is a still-potent force. Two of the world’s most stable and well-established democracies appear to have embraced populism and shunned globalization, which has led to much soul-searching about the future of liberal democracy.

The results have also challenged economic thinking, and Chicago Booth’s Lubos Pastor and Pietro Veronesi have been among the researchers studying the implications. “As economists, we have been taught to think that globalization is good, because people get to specialize, and you have free trade, and that’s a way of making somebody better off without making anybody worse off,” says Pastor. “Yet here—with the Trump and Brexit votes—you saw half the population rebelling. You saw the median voter turning against globalization.”

The real puzzle is this: Why did the United States and the United Kingdom turn to populism at a time of economic growth? more>

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Many retailers are making a basic mispricing mistake
By Robin I. Mordfin – Retailers have long set prices ending in 99 cents, knowing that buyers view $4.99, for example, as significantly less expensive than $5. But many companies underestimate consumers’ left-digit bias and should be using these prices more than they do now, according to research by Chicago Booth’s Avner Strulov-Shlain.

Strulov-Shlain analyzed price data from 1,710 popular products in 248 stores of a single US retailer, as well as data on 12 products carried by more than 60 chains and in 11,000 of their stores. He finds that one-quarter to one-third of all prices ended in 99 cents.

But companies tend to miscalculate how customers react to a one-cent price change, Strulov-Shlain asserts. Buyers treat a price increase from $4.99 to $5 as if it were a 15–25 cent increase, while companies behave as if customers respond as though it were a 1.5–3 cent increase.

To learn how much companies should charge, Strulov-Shlain built a model that combines previously established left-digit bias models with a profit-maximizing formula that takes left-digit bias into account. Using the model and retailers’ pricing data, he estimates what price sensitivity and left-digit bias the companies had in mind when setting prices. Many items would have been better priced with a 99-cent ending, because demand dropped when the dollar digit changed, he finds. That was also the case at higher costs, where selling more units for the lower 99-cent price was more profitable than selling fewer units at a higher price. more>

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A plain way to cut smoking rates
By Meredith Lidard Kleeman – Tobacco has been a known carcinogen for more than 50 years, yet cigarettes continue to attract new smokers to the harmful, addictive habit every day. Research suggests that marketing, including package labels and brand logos, plays an important role in encouraging young people to take up smoking and legitimizing the habit for many smokers who are trying to quit—and that policy makers may have a way to change that.

In recent years, some 120 countries have added mandatory pictorial health warnings to packaging, and a handful have passed plain-packaging laws. These efforts to discourage new smokers and reduce tobacco-related disease and deaths appear to be working. Australia, the first country to implement a plain-packaging mandate, in 2012, saw monthly cigarette sales decline after the mandate was introduced, according to research from Chicago Booth’s Pradeep K. Chintagunta, Deakin University’s André Bonfrer, University of New South Wales’s John Roberts, and University of South Australia’s David Corkindale.

The researchers analyzed sales data from before and after Australia implemented the plain-packaging mandate and compared these with data from New Zealand, where the mandate hadn’t yet been imposed (but was in 2018)

Across the world, tobacco products are subject to strict marketing and advertising regulations, but tobacco marketers still control packaging design in most respects. Australia’s plain-packaging mandate presented the researchers with an opportunity to study the role this packaging plays in influencing product sales. more>

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When rich folks move downtown, inequality gets worse
By Victor Couture, Cecile Gaubert, Jessie Handbury, and Erik Hurst – As the rich in the United States get richer, they have been moving from the suburbs to downtown, boosting the demand for luxury amenities. While this process of gentrification has long been decried for pushing out poor people, it also measurably worsens income inequality, according to University of California at Berkeley’s Victor Couture and Cecile Gaubert, University of Pennsylvania’s Jessie Handbury, and Chicago Booth’s Erik Hurst.

The researchers analyzed US Census data from 1970, 1990, and 2000, along with the Census Bureau’s American Community Survey from 2012 through 2016. They find not only that the income gap between the wealthiest 10 percent and the poorest 10 percent widened by 19 points over 1990–2014, but also that gentrification contributed another 1.7 points to that gap.

This additional welfare calculation addresses the economic fallout for poorer residents, who had to pay more for downtown housing as the influx of wealthy residents drove up prices at restaurants and bars, along with the cost of entertainment and personal services. “Poorer residents, who are mostly renters,” the researchers write, “have a choice between paying higher rents for a bundle of amenities that they do not value as much and moving out of downtown.” more>

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The questions that will shape the future of capitalism
Advocates of free markets must engage in the public debate about them
By John Paul Rollert – What is the promise of capitalism?

That may seem like a strange question, and when I ask it of my MBAs, I suspect they regard it as an exercise in the pedagogical pastime Guess What Teacher Is Thinking. Still I ask it, for I hope it prompts my students to think about the kinds of problems capitalism is equipped to solve as well as those that are beyond its compass.

This is hardly a matter of idle speculation, especially for those who have good reason to believe that they will someday enjoy a disproportionate amount of the system’s spoils. Those fortunate individuals sometimes need to be reminded that free markets, however mighty, will not mend their marriage, relieve their cold, or stop their brother-in-law from bragging about his golf game. Indeed, there are plenty of things capitalism can’t do, and reflecting on them is a good way of distinguishing what it can do—and what it should.

Naturally, what capitalism can and should do are not one and the same. The first is a technical matter best left to economists; the second is more of an ideological affair, the province of moral and political philosophy. The distinction is an important one, but it tends to fade whenever one believes that free markets will solve most any problem: moral, social, and political as well as economic. If capitalism can do anything, so the thinking goes, then it should do everything.

Now, with the kind of intellectual prodding the question above intends, almost no one honestly believes that capitalism can, or should, do everything. Yet up until recently, it passed for conventional wisdom, in the United States and throughout most of the developed world, that capitalism could do most things, that the obvious solution to nearly any pressing problem of social organization was freer trade, fewer regulations, and far less government intervention. more>

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How multinational companies help spread recessions
By Bob Simison – The Great Recession a decade ago was one example of how economic cycles across the world can move in parallel, a phenomenon that economists don’t fully understand. It could be that a common event, such as a surge in oil prices, affects many economies at the same time—or perhaps linkages between countries transmit economic shocks from one country to the world economy.

One such linkage is multinational corporations,  according to Marcus Biermann, a postdoctoral scholar at the Catholic University of Louvain, and Chicago Booth’s Kilian Huber, who explore the role of multinationals in spreading the global recession by analyzing the ripple effects of one German bank’s struggles during the 2008–09 financial crisis.

Commerzbank was Germany’s second-biggest commercial lender behind Deutsche Bank. Losses on trading and investments abroad hammered the bank, especially after Lehman Brothers collapsed in September 2008. Commerzbank’s capital fell by 68 percent between December 2007 and December 2009, which forced the bank to reduce its aggregate lending stock by 17 percent. Biermann and Huber find that this pullback in credit available to German parent companies affected subsidiaries in other countries, thus helping to transmit the economic contraction. more>

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Why central banks need to change their message
The US and European central banks thought they could manage their economies by bringing their secretive plans for interest-rate regulation into the light. But they didn’t account for an unreceptive public.
By Dee Gill – A lot of people don’t have a clue what central banks do, much less how the institutions’ ever-changing interest-rate targets ought to affect their household financial decisions. Recent studies, including several by Chicago Booth researchers, find Americans and Europeans oblivious to or indifferent to the targets’ implications.

This is a serious problem for policy makers. For a decade, monetary policy in many developed economies has relied heavily on forward guidance, a policy of broadcasting interest-rate targets that works only if the public knows and cares what its central bankers say.

“The effects of monetary policy on the economy today depend importantly not only on current policy actions, but also on the public’s expectation of how policy will evolve,” said Ben Bernanke, then chairman of the US Federal Reserve, in a speech to the National Economists Club in 2013. At critical times since 2008, forward guidance has been the Fed’s and the European Central Bank’s go-to tool for revitalizing their ailing economies and holding off widespread depression.

Forward guidance usually involves central banks announcing their plans for interest rates, which traditionally were guarded as state secrets. The openness is intended to spur investors, businesses, and households to make spending and savings decisions that will bolster the economy; typically, to spend more money during economic slowdowns and to save more when the economy is expanding.

Chicago Booth’s Michael Weber and his research colleagues, in several studies, tested the basic assumption that households will respond to forward guidance, and find it flawed. Most people, the researchers conclude, generally do not make spending and savings choices on the basis of inflation expectations. In personal financial decisions—for example, to pay or borrow money for a boat, refrigerator, or renovations, or to sock away funds for rainy days—words from central bankers hardly register. more>

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