Price Setting with Inelastic Demand: An Ethical Approach

Introduction - Overview of a Global Business

The modern pharmaceutical industry came of age with the growth of chemistry as a science. Though healing compounds can be traced back millennia to various civilizations in Europe, the middle east, the Indus valley and China, there was no formal or systematic approach to developing new healing compounds until the rise of capitalism and the industrial revolution. The industry as we know it rose out of the german dye manufacturing companies in the late nineteenth century. With the development of compounds to treat a variety of symptoms and diseases, along with new imaging technology in the x-ray and the germ theory of disease, the science of pharmacology is a rather new science in the scope of human existence.

Though it is relatively new, it is very large. The World Health Organization explains how large it is on their website: “The global pharmaceuticals market is worth US$300 billion a year, a figure expected to rise to US$400 billion within three years. The 10 largest drugs companies control over one-third of this market, several with sales of more than US$10 billion a year and profit margins of about 30%.”  These large companies are largely American or European, and they sell many of their drugs to americans and europeans and the Japanese. In fact, the same site notes that the companies spend roughly one third of their sales revenue on sales and marketing - more than double the amount they spend on research and development.

This paper will focus on the decisions that just one of these companies has to make. Gilead science is a biotechnology drug firm located in Foster City California. In 2014, the company enjoyed revenue of almost twenty five billion dollars compared to just over eleven billion the previous year.  (financials 10-k).  What drove this increase? It was the release of a new treatment for hepatitis C, called Sovaldi. This drug is a breakthrough in treatment, and it is priced as such. Sovaldi is available as a twelve week treatment that is a daily pill. It is effective in treating 90% of Hepatitis cases. It also costs whoever is paying for the treatment a thousand dollars a pill. That means it cost the payer $84,000 in the United States. That price is the process of a deliberate set of choices in the decision making process.

Problem Statement - What Challenges in Organizational Design Exist in This Business

Though a thousand dollars a pill sounds as if it was an arbitrarily chosen price that is not true. Internally, the company should have to balance a lot of factors with their pricing decision, if they were using a rational model of decision making. A firm will look at the costs and the potential market of the drug to set pricing. In terms of Hepatitis C, the centers for disease control estimate that there are 2.7 million people living with chronic Hepatitis C in the United States. Most are unaware that they have the disease, Many of these people will develop chronic liver disease, and be in need of a new liver at some point down the line, if they can get one (CDC). This means that there is a ready market for a pill that can essentially cure Hepatitis C. With the advent of wiser health coverage under the Affordable Care act, many if not most of the people affected by the disease will have coverage that in theory should be able to pay for it. So in terms of a product, the demand side is solid The other side to look at is the supply side. The government grants patent protection to companies who make new products. This patent is a temporary monopoly on a product, meaning that there is no other company that can legally make and sell the drug. That means the price setting decision in theory is internal. Again, the company should look at the costs here. This is easier said than done, as accountants can look at costs in several different ways and they all can be correct. In one sense of the term, the cost of the drug is just the raw materials cost. How much do the constituent parts of that drug cost, and there is the cost of the drug. The problem with this view is that there may be subsumed costs. The company has to run itself and sell the drugs. This cost Gilead almost three billion dollars last year (10K). The company has to do research on new drugs, the line item for Gilead’s R&D last year was just at three billion (10K). How do you allocate these costs? Are they part of the cost of Sovaldi, or are these the costs of future drugs? A recent study by the Tufts Center for the Study of Drug Development puts the average cost of the development of a new drug that makes it to market at almost 2.6 billion dollars. Gilead is right to recoup these costs, but finding the right cost for the drugs should go through the evidence based decision making process as described in Kinicki and Fugate’s “Organizational Behavior” First, the problem is identified, then internal evidence is gathered, then external evidence is gathered, then the views of the stakeholders, then all the views and data are integrated, and then a decision is made. This model  is will inform the basic outline of the rest of this investigation.

Causes  - A look at Stakeholders

The drug pricing decision does not happen in a vacuum. The medical delivery industry in the United States is enormously complex, with many stakeholders. It is also where a lot of the GDP is funneled to. Of the large economies in the world, the United States spends the most in terms of its economy on health care. The World bank estimates that as a nation over 17% of GDP was from health spending, only bested by tiny Tuvalu (World Bank).  Overall, there are five separate players in the drug pricing scheme that all can be looked at in terms of why the pricing is so high and informs Gilead’s decision on how to price the drug.

The first stakeholder is the Gilead itself. It is the one that sets the prices, and they are the easiest to look at and say they should do things differently. There is the fact though that they did go through the research and development and clinical trials (or bought a company that did), so they should be able to reap the profits from that work. The counter argument is that they have patent protection, and we don’t know what the marginal cost is of one pill. It is most likely less than a thousand dollars.

The second stakeholder  is the government, which plays a couple of roles in the medical infrastructure of the nation. First, it helps keep prices high as a regulator, making the company have to jump through numerous hoops just to gain regulation to sell the drug from the FDA. Then if a secondary use is found for the drug, the company has to go through more trials to prove that the drug that was already proved safe and effective for one treatment is safe and effective for another. These are the so-called “off-label” uses of the drug. There are a couple of notable examples of this. The drug known as Rogaine was first used as a blood pressure medication before it was found to be a hair rejuvenator (Our History). The drug Viagra was first used as a heart medication before it was found to have its more well-known properties (The Little Blue Pill that Could). The government makes the companies show that the new use is safe, and by putting up those walls, it increases the price of bringing a drug to market (Downsides).  Governments at all levels are also one of the biggest buyers of a lot of drugs. Theoretically, they could use that market power to bargain with the drug companies to lower their prices, but unfortunately through custom and statute, they often fail to fully bargain on price where they might be able to in a sad case of regulatory capture. The government also covers a disproportionate number of patients, because many people who suffer from Hepatitis C are poor. Many are also drug users. There is a perception that some victims may have gotten the disease from tattoos or sexual intercorse. This means from a political standpoint, these patients covered by the government are not sympathetic victims. They may somehow be perceived to have deserved their disease. That lowers the government incentive to treat them, especially at such a high rate.

The third stakeholder is are the insured people, particularly the ones who have the disease. Hepatitis C, especially the chronic and acute versions of the disease do not sound like enjoyable things to have.  The current treatments are more long term, and the even then the result of managing the disease for years is liver failure and the need for a new liver. Donor livers can be found, since a live donor can give up part of their liver and there is not 100% reliance on cadaver livers. Even then, the patient will still be at risk for rejection and will have to remain under treatment for the rest of their life. So it makes sense if the patient sees Sovaldi and its success and short time frame of treatment and they decide, “I want that treatment.” and through the structure of the healthcare market, they don’t know anything about how much things cost because there is no transparency in the market about prices. This is the demand side looked at earlier.

The demand would not exist without the mediators between the drug companies and the people with the disease. These are the doctors and hospitals, who prescribe the treatment. It is their job to match the patient with the proper treatment. Is Sovaldi for every patient, or are the maintenance drugs for even chronic Hepatitis a worthwhile treatment if and until it gets worse? This is a decision for a trained medical profession to make and for the medical infrastructure to enact. By connecting patients to Sovaldi, they help mediate between the supply and demand for the drug. If no physicians prescribed the treatment, then there would be no demand, and thus the price would not matter. So that even though it is much more effective than other treatments, the ones that have been out there longer are less expensive so might be more affordable and covered by the insurance companies.

It is these insurance companies are the final stakeholder to look at. These companies do not want to pay that sort of money because Hepatitis C, as seen earlier, is relatively common. If they paid the full list price for even half of the current Hepatitis C victims out there, they would have to pay $126,000,000,000. Which is a lot of zeros. The counter to paying the cost of the treatment now is that as a long term, chronic disease, the cost for treatment over time adds up. Further, many of these patients will eventually face liver failure and the cost of a liver and transplant and after care is over half a million dollars. There are other, more expensive drugs than Sovaldi, but most of the diseases they treat have relatively few victims.  This means that there is less outcry over the price by the insurance companies and the general public. There are fewer economies of scale, so a cancer with a multisyllabic name is anticipated to cost a lot to treat. Someone with a less sympathetic disease that is actually fairly common could be seen as less of a priority, especially if there are management drugs in existence. The bottom line for the insurance companies is the bottom line. They do not want to pay for any treatment that they determine to be in excess. With the price of Sovaldi,  this has already come into play. One example in the Washington Post was a patient whose physician had prescribed the drug on three separate occasions only to be told by the insurance company that they were not sick enough yet to receive the treatment (Who gets what). The patient’s very goal was to get the available treatment and to not get sicker, but the insurance company exists to pay for needed treatment. The only catch is that they get to decide what treatments are needed.

Ethical Considerations - What What possible solutions are available for the organization?

Within the organization, with all the stakeholders just looked at, the question is what price should be priced at. This is a hard decision to make because their product is one that can greatly enhance the quality of life for people who suffer from Hepatitis C. It can also save their life. Thus it is no ordinary product. In fact, it is a special case. In terms of drugs that can cure Hepatitis C, from an economic standpoint,  they are the sole supplier. There are other similar compounds on from other companies, so the time that Gilead is the sole provider will be short. This means that Gilead comes into a special  market with a lot of power. The market is special because there is a set amount of people who want the cure. Most students of economics should be familiar with the crossing supply and demand curves. The supply curve slopes up, where companies will supply more goods when the price rises. This meets the downward sloping demand curve, where as the price rises, some customers will drop out of the market. This is a special market case. Where most demand curves are upward sloping, like water in a desert, cures for fatal diseases have an almost unchanging demand. This means that the demand curve is a nearly vertical line in a situation known as “inelastic” demand. With inelastic demand, the three million people in the United States who want a cure for their Hepatitis C will continue wanting that cure no matter how much Gilead will charge them, and they will pay as much as possible. This gives Gilead a lot of power over those other stakeholders on their pricing, and it becomes an ethical decision that they have to make through the evidence-based decision making model taking into consideration all aspects of the variou stakeholders to make an equitable pricing decision that benefits all parties.

Alternative Evaluation

Gilead can take several different tracks when it looks at its pricing. One look would be to go with the pure logic of the market. This is where the company could set the price at a point to maximize profits at the expense of the stakeholders. Looking at the data, what Sovaldi prevents at the most drastic case is a liver transplant. Seeing that the transplant and the after care cost almost half a million dollars, the company could price Sovaldi at that price and show that not only does the drug save the transplant cost, it also improves the patient’s quality of life and eliminates costly after care and lowers the chance of rejection so even at half a million dollars for a course treatment, Sovaldi is in fact a good deal. Some insurers and the the government might balk at such a pricing level. At a true market price, there would be fewer payers willing to pay even though there would be patients who wanted the treatment. It just shows the disconnect between supply and demand in our medical economy.

On the other end of the spectrum, Gilead could offer up the treatment for cost. Looking at the cost of bringing a new drug to market averaging over two and a half billion dollars seems like a lot of money. But remember that Gilead covered that average cost over four times in 2014. Based on their current pricing, everything above the materials, manufacture, and overhead for each new pill of Sovaldi is pure profit. Gilead could give away the drug as part of a lasting legacy towards the health of the planet, effectively eliminating Hepatitis C as a cause of death of the peoples of the world. There is precedent for such an action. Jonas Salk famously did not take royalties for his polio vaccine, an action that made him a much less rich man than he could have been, but cementing his legacy as a scientist and an ambassador of goodwill (How Much). Estimates for cost of manufacture of a run of Sovaldi run to about $130 (Sovaldi Tax), so the minimum price could be just that much.

The final option lies somewhere in the middle. Companies under capitalism are hard pressed not to be secular saints like Salk, but the realities of the market is that they are not the cold, hard, calculating markets of a simplified version of Econ 101. There are other issues at play and other stakeholders. Looking at the government as regulator, patents protect companies and provide a temporary monopoly so that the company can reap the benefit of its investment. The United States government has proven itself to be strong supporter of these property rights. But other countries may not be so forgiving. If Gilead takes too much license with its property, the government may expropriate it from the company and license or manufacture itself. Gilead also has to participate in the court of public opinion. This drug will soon have competitors, and there is always goodwill to be built or destroyed. Even in America, profit over and above some unspecified level is unseemly. Yes, the citizens can applaud someone for making innovative strides in medical research, but economic rent-taking is too much. The outcry over the pricing of Sovaldi proves that Gilead crossed this line. There is reaction not just from the pundits, but also the potential payees of the treatment. Though it may cost more over time, insurance companies do not want to pay the piper if they feel the benefit is not in balance with the cost.

Recommendation - what are the solutions and state the benefit of this course of action

Gilead did try the middle ground, but they aimed too high. The evidence should be reappraised and what should be examined is greater flexibility by the company. It is in drug pricing the gulf between costs to the company and price to the consumer are sometimes the most evident. Gilead has actually already shown flexibility on their pricing globally. The price for Sovaldi in some developing countries is as low as $900, such as in Egypt and India. Even in some countries that have comparable levels of development to the United States, the drug is sold at a discount to the sticker price. Gilead charges $55,000 in the UK. The difference is that there is less regulatory capture in the UK of policy makers (Unacceptable). These differences and flexibility are good in terms of being able to treat patients with a dreadful disease, but it only serves to highlight what subjectively feels like too high a price the United States. This is where Gilead should refigure all the data that they have received and make a new decision. At this point they could lower the pricing of Sovaldi even to the prices seen in the UK and they would benefit on two fronts. First, they would get credit for cutting their price almost in half - many outlets have rounded up to $100,000 for the treatment costs. Secondly, there would be greater access in terms of patients successfully treated for Hepatitis C.  The patient whose insurance company thrice rejected the treatment might be more open to paying for the treatment for patients who are only a little sick.

References

http://www.forbes.com/sites/theapothecary/2014/06/17/the-sovaldi-tax-gilead-cant-justify-the-price-its-asking-americans-to-pay/

http://www.forbes.com/sites/quora/2012/08/09/how-much-money-did-jonas-salk-potentially-forfeit-by-not-patenting-the-polio-vaccine/

http://www.forbes.com/sites/johnlamattina/2014/08/08/even-at-900-per-cure-sovaldis-cost-could-be-unacceptable-in-india/

http://www.rogaine.com/category/facts/our+history.do

Working Bibliography: “Price Setting with Inelastic Demand: An Ethical Approach”

Kinicki and Fugate Organizational Behavior

World Bank http://data.worldbank.org/indicator/SH.XPD.TOTL.ZS?order=wbapi_data_value_2013+wbapi_data_value+wbapi_data_value-last&sort=desc

http://www.cdc.gov/hepatitis/hcv/cfaq.htm#cFAQ21

file:///home/chronos/u-97582656d28a10e66f11e8d2a8a68a34398f53fd/Downloads/GileadSciences_10K_2014.pdf

http://www.who.int/trade/glossary/story073/en/

High prices for Drugs Criticized at Meetings; Joseph Walker June 1 2015 Wall Street Journal

http://www.wsj.com/articles/high-prices-for-drugs-attacked-at-meeting-1433119411

Drug Shortages Plague U.S. Medical System. Peter Loftus. Wall Street Journal June 1, 2015

http://www.wsj.com/articles/u-s-drug-shortages-frustrate-doctors-patients-1433125793

Speeding up Drug-Approval Process Could Have Downsides. May 29. Wall street Journal.

http://www.wsj.com/articles/speeding-up-drug-approval-process-could-have-downside-

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Appleby, J. (2014, May 2). New hepatitis C Drugs’ Price Prompts an Ethical Debate: Who

Deserves to Get Them? Washington Post. Retrieved from

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ethical-debate-who-deserves-to-get-them/2014/05/01/73582abc-cfac-11e3-937f-

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Pollack, A. (2015, Feb 3). Sales of Sovaldi, New Gilead Hepatitis C Drug, Soar to $10.3 Billion.

The New York Times. Retrieved from http://www.nytimes.com/2015/02/04/business/sales-of-sovaldi-new-gilead-hepatitis-c-

drug-soar-to-10-3-billion.html

Wilson, J. (2013, March 27). Viagra: The Little Blue Pill That Could. CNN. Retrieved from

http://www.cnn.com/2013/03/27/health/viagra-anniversary-timeline/index.html

Kinicki, A., & Fugate, M. (2012). Organizational Behavior: Key Concepts, Skills, and Best

         Practices (5th ed.). New York: McGraw-Hill Irwin

Filling The Gap: 401(k) / 403(b) Architecture to Enhance Savings

Introduction

Early in a career, an employee can often be laissez-faire about the benefits that a company offers. The various add-ons are not really noted. These benefits are wide ranging, ands provide both extra compensation and protection for the employee. The top line number on the salary is easy to focus on, but health insurance, paid leave, long-term and short term disability, and life insurance are all part of a comprehensive benefit plan. These are not entirely benefits for the employee. The employer benefits by having a present and healthy workforce. The various benefits aid in that manner. They also can be used as positives. In their textbook “Human Resources Management,” Robert Mathis and John Jackson point out that these benefits are not just costs, but that they can help keep an organization competitive in recruitment and as a competitive advantage in competition, as employees with better benefits have been found to have higher job satisfaction and thus better outcomes (p. 427). As strong and varied benefit package also help the organization by keeping the best employees around, even if they do not necessarily use them. The authors further note that benefits have the advantage of often being untaxed as income to employees (p. 429). So that the marginal return in terms of utility is enjoyed more on a dollar spent on more salary.  

Problem Statement - What Challenges in Organizational Design Exist in This Business

Politicians from both sides of the aisle have been raising alarm bells about the coming insolvency crisis of the Social Security trust fund for a long time. The last major changes in the program came thirty years ago, and it has been a political football ever since. The Social Security Administration estimates that at current rates, the trust fund will be depleted by 2037. At that point the funds for social security will no longer be paid out of the trust fund, but will come from incoming taxation. The inflows are expected to be lower than the outflows, so this means that payments after that date will be at 76% of the expected amount. Thus the SSA is calling for either slightly lower benefits now or a raise in taxes to plug that shortfall (Future financial status). If this doomsday scenario happens or not, Social Security was not fully formulated to replace all of a household’s income. The exact amount of income social security replaces varies, but for the median family, it is just a little over a half of the last year’s income (income replacement). The good news is that there are costs associated with with work that can be avoided by being retired. A worker has added food and transportation costs. In retirement many people after long careers should have reduced housing costs as well. When all the costs are considered, only eighty percent of the previous income is calculated as necessary for retirement. Eighty percent needed with fifty percent filled by Social Security creates a gap of thirty percent of the former take home pay. The question then becomes how do you fill that gap.

Traditionally, one way to fill that gap has been through private pensions. At their height, thirty-five percent of private sector Americans were working under a defined benefit pension plan. For better or worse, that number has almost halved in the last two decades, where now only eighteen percent of private workers have some defined benefit coverage. Because of traditional working patterns where one spouse worked outside of the home in the workforce, while another stayed home in domestic toil, there are still thirty one percent of households that are covered by pensions (pension coverage). There are still sectors where pensions are still extant, but they face pressures of their own. Currently pensions are found amongst government workers at a much higher rate with seventy-eight percent of government workers covered. This has created  a disconnect between government workers who are funded by the taxpayers. The taxpayers see the government workers enjoying a benefit that the private workers do not get to enjoy, so the easy response is that they government workers should not continue to enjoy those benefits. The reasons that the private sector scaled back on pensions is complicated and has political and social correlates with the decline of unions and the rise of globalization, but the bottom line is that from a business perspective pensions are long term, open-ended liabilities. For a business to be competitive currently, it needs to operate leaner, and that means having long term, open-ended liabilities on the books is not optimal. Though proper benefit design is a competitive advantage in attracting and retaining talented staff, there are other competitive pressures that predominate, and the general trend is to do away with private defined benefit pensions.

With Social Security perhaps dropping what it pays the average retiree along with the diminishing of defined benefit pensions, what has to replace the thirty percent gap between what Social Security replaces and what is needed to live a comfortable life then has to come from the employee's own savings. Thankfully, the federal government has created ways so that employees can save money and be incentivized with tax favors. 401(k)’s and related plans for nonprofits were set up so that savings could be put into various funds and then grow tax free until they were pulled out of the funds for use in retirement. This means that taxes can be deferred, and taxes will be paid at a lower rate as it is assumed that the tax rate when the monies are pulled out will be lower than the rate that exists when the employee is working. There is a secondary benefit in adding money to a 401(k) in that employee contributions lower taxable income, so the employee has lower taxes. There are limits to how much can be contributed. In 2015, the limit is $18,000, which is almost a third of the median household income (Tax Information). 401(k)’s as of right now are the most efficient vehicle for employees to use to save their money to make up that gap. There exist other retirement plans, such as a Roth IRA which uses taxed funds and are allowed to grow untaxed. These are also subject to limits, and are not an option at upper income levels. For the majority of the middle class, the 401(k) is where it is at.

The problem is that not enough people are saving enough money to fill that gap in retirement. If a saver took that $18,000 limit and put that much away every year for a thirty-year career, they would have put away a nominal $540,000, which would appreciate nicely barring some untimely rift in the global economy and markets. If that was just put in a money market fund with no growth, it would allow an income stream of $21,600 a year if withdrawn at the commonly accepted rule of thumb to withdraw only four percent of your savings a year. This is more than the gap, and an employee who saved along these lines would be in line for a comfortable retirement

The problem is that most people are not saving for retirement at anywhere the rate that would allow a comfortable retirement. Younger workers see retirement as far off, and there are always bills that need to be paid first, from student loans to housing costs to bringing children into the world and all of those associated cost. What young are missing out on is the potential for great growth in whatever money is out aside. To retire with half a million dollars which will be needed to make up the gap between what is needed and what Social Security can provide, it is much cheaper in dollars to start early than it is when older. Using the shorthand of the rule of 72, where you divide 72 by the assumed fixed growth to see how fast it will take for the money to double, any saving done by the time a worker hits thirty will double three times before their retirement using the long term trend in the S&P index of 6.5% growth (real returns). The reality is that very few people are making contributions to their retirement plans that will allow them to take advantage of the seeming magic of compounding growth. The reality is much more grim. Social Security will be around in some form, but with the decline of pensions, personal savings is what will support people in their retirement, a period of life that is increasing with every generation with better medical care to enhance longevity. The General Accounting Office (GAO) of the federal government did a recent survey that shows just how unprepared most people are for retirement. The GAO looked specifically at people who are close to retirement and how ready they were for the coming life change. They found that 29 percent of people in the cohort of people from 55 to 65 had exactly no retirement savings. For those that did, the median amount was just $104,000 (Retirement Crisis). As seen earlier, this will not be enough to fill the gap between social security and the amount needed. That is why the GAO also looked at other studies about future retirement insecurity, and determined that somewhere between a third and two thirds of retirees will not have the resources to live a comfortable life (Retirement Crisis). Many people further infer that that they will be able to work past the traditional retirement age to shield themselves from this crisis on a personal level, but these plans are often thwarted because people end up having to drop out of the workforce for a myriad of issues that were not foreseen.

Literature Review

If the problem is that the average person will not have enough resources in retirement, then the answer is that more resources should be allocated to the worker in retirement. There are three possible sources. First is the government, which could allocate more resources to the retired, through raising the taxes for Social Security, or raising the cap on money that is taxable for Social Security purposes, currently at $118,500. With the gridlock in Washington, the SSA will advocate for some of these changes, but their implementation remains an unknown. The second source would be from the employer of the retiree, but as seen earlier, these defined benefit plans are receding from common use, not increasing. So that leaves the retiree as the source of the retiree’s resources that will fill in the gap.

The question is how do you get people to save money when it is clearly in their long term interest, but it is still something that does not happen. Here is where insights from behavioral economics can come into play. The field looks at how people interact economically in real world situations. This approach runs counter to a more traditional view of economics where the economic actor is a self-maximizing, rational character. Behavioral economics asks the question “What if people aren’t rational”. It is still contentious in some circles, but it has had some useful applications at the micro level. Richard Thaler is one of the founders of the field, and in his new book “Misbehaving,” he talks of the application of behavioral economics to making people save money. His view is that signing up is complicated, and most people will not sign up for something that is complicated. Evert friction put in place makes people less likely to do something, even if that thing is in their best interest (Thaler 312). So one of the big insight of behavioral economics is about setting the defaults so that people are forced into the choice that is best for them, this choice architecture has entered the language by the title of one of Thaler’s previously co-written books. It is a nudge. Through nudging, whoever is making the default can make it so that the default is the best option. As Thaler puts it: “Why not make joining the plan the default and tell people that if they do not opt out, they will be enrolled in the plan at some default savings rate and in some default investment product?” (312). The opt out is important because it still allows the employee choice in the matter. If they really do not want to save any money for retirement for whatever reason, they have the choice to do so. There are critics of nudging who say that nudging is paternalism and limits options, but the opt out clause leaves saving up to the individual.

Causes

The lack of savings is just not an issue to look at at the higher levels. Each organization in their human resource departments have to make choices about benefit design that will balance the available resources and what is necessary to attract and retain talent. Making sure that their people do what is best for them is in the long term interest of every organization. My organization is no different. We have health and life insurance and disability and worker’s comp, we have twelve holidays and more vacation and sick days than you can use accumulate. The problem is that as an organization, we are not saving enough. CSS provides services to the developmentally disabled in the western suburbs of Chicago. There are approximately 150 hourly staff who provide front-line services for the individuals we serve. We also have 56 benefits-eligible employees who work in our administrative offices and other full time workers.

There are two proximate causes to our own lack of savings. First of all, we work in the nonprofit sector, which offers fewer extrinsic rewards to employees in the sector, which are balanced in part by the intrinsic reward of doing well in the community. More bluntly, the pay is not what it is in the private sector. Paychecks are stretched The second cause is that we have to opt into the retirement plan, here a 403(b) because of our nonprofit status. The default is structured so that you have to fill in these forms and there are enough people who end up not putting anything aside in spite of the tax-sheltered nature of the plan, and also in spite of the matching, which is half of what the employee puts aside up to four percent. This default means that of the 56 eligible employees who could put their money aside, only 30 do so. Of that thirty, only 12 people save more than what they need to do to get full matching, which is four percent. That means that as a whole, we are not saving enough.

Solutions

A couple of ways exist to improve the amount of money we save as individuals at the agency. First, there could be better outreach and education from the HR and Finance Departments to individual employees about the need for retirement savings and a recommended level of savings. This could work so that every employee would make an educated choice about their savings rate and their plans that they allocate their money too, which is a separate discussion to be had once you just get people putting money back for retirement. A related option would be to seperate the retirement discussion from where it is now. Currently, we now have to make decisions about all the various benefits that we have options for at one meeting in October. It is overwhelming, and when people have too much cognitive load they will reach for the safe and easy choice to make. Isolating the decisions so that they can be focused on would allow the individual decision to be the center of the employee’s attention, and thus would be able to benefit from deep concentrated thought from the employee. From an organizational perspective, however, doing everything all at once is more efficient in that you do not have to pull all the employees away from their productive duties for administrative tasks, no matter how important. The third option would be changing the defaults. If currently only about half of the employees are taking advantage of the retirement plan and two thirds of those people are sticking right at the default, then the defaults are off.

Recommendation - what are the solutions and state the benefit of this course of action

The current structure of the retirement benefit at CSS is that for eligible employees, the company will match fifty percent of your first four percent of savings if you opt-in. These defaults have resulted in under-saving by our employees, and they need to be changed. The easy thing to say is that there should be greater maching, so that it was dollar-for-dollar up the a set amount. Unfortunately, we operate in an industry that generates a lot of its funding from governmental bodies, and governmental bodies are at the point in the political cycle where they are not freeing up extra funds for their partner agencies. There is a marked constraint on the agency’s resources, but still the need exists to incentivize employee savings. The thing to do is change the defaults. First off, change the enrollment from an opt-in to an opt-out structure. That means that the half of the people who are not enrolled would now be part of the plan, barring disenrollment. Secondly, change the matching. It may sound less generous, but matching a smaller percentage of the employee contribution would mean that employees would have to contribute more to themselves in the future to ensure that they received the full match from the organization. A simple proposal would be to match only twenty five percent of the employee contribution up to eight percent of the employee’s salary. That means that in real terms the agency would not have to contribute any more to the employee than they already are, but instead of the sum of savings being six percent of the employees’s salary, it would be ten percent. Set that as the default and then you would help the employees have a more secure. There is also the added benefit that humans love nice round numbers. One final consideration exists in designing this nudge. People do not like seeing their take-home pay decreased, so to make sure the most people take this up as possible, it has to be phased in gradually. The increased withholding should be timed to pay increases, so that the employee will see their take home increase at the same time they are increasing their own contribution. Otherwise, people would see their pay decrease in the here and now, and might take the opt-out option to stiff their future selves.

References

Thaler, R. (2015). Misbehaving. New York, New York: Norton

Mathis, R., & Jackson, J. (2011). Human resource management (13th ed.). Mason, OH: Thomson/South-western.

Social Security Crisis: http://www.ssa.gov/policy/docs/ssb/v70n3/v70n3p111.html

People Have No Savings:

http://www.nbcnews.com/business/personal-finance/retirement-crisis-29-percent-older-americans-have-no-savings-gao-n369241

Fall of Defined Benefit Plans:

http://www.epi.org/blog/private-sector-pension-coverage-decline/

Income Replacement:

http://www.ssa.gov/policy/docs/ssb/v72n3/v72n3p37.html

IRS Tax Information:

http://www.irs.gov/Retirement-Plans

Equity returns:

http://www.pragcap.com/u-s-equities-long-term-real-returns

On my own "Unsolicited solicitation of advice"

Five years ago now, I first reached out to figure how to extend my knowledge formally, to the director of graduate studies at the economic department at the University of Illinois - Chicago.


Unsolicited solicitation of advice:

You do not know me, but I have a question.  I have become more and
more interested in economics in the last few years.  As the
re(de)pression came about, and it looked like there was no fact no
‘end of depression economics’ and instead the field remained at
contention in reference to the large structural aspects, I have become
interested to the point of self educating myself.  I have followed the
contemporary debates in the field and that has sent me back to
theoreticians going back to when it was called ‘political economy’
such as Smith, Marx and Hayek.
I want to go back to school, but I am not sure the track to take.  I
have a degree and some graduate study in English, so I can understand
the rigor of advanced study.  I have an objective side too.  I studied
chemistry before dreaming of being a writer.  I have taught chemistry,
both as a TA in college and at the high school level.  If and when I
enroll in a program, I will have to brush up on my mathematics; I
realize this.  However, the more I think of what I want to do, the
less it has to do with applying my liberal arts degree and the more it
has to do with reeducating myself in an area of study that explores
the inner and outer workings of society (not to be too deterministic
about things).
My question is simple: What path do I take?  Do I go back for a BA?
Should I, or even can I, enroll in an MA program and try to fill in my
knowledge? Alternatively, do I remain an interested layman, on a
program of self-education with my interest remaining hobby-like?

Thank you,

J. Edgar Mihelic





And she was nice --

Hi J. Edgar,

   If you have a strong interest in Economics, I would suggest that you
apply to UIC for admission as a non-degree student. In this capacity,
you'd take selected courses in economics and mathematics.  If you do well
in this coursework, you could then go on from there to a master's in
Economics.

  Should you choose to go this path, we'l be happy to guide you on the
coursework.

   With best wishes,


------------------------------------------------------------------------
Evelyn L. Lehrer




But I'm still sitting here trying to figure it out (and complete an MBA that is more instrumental than theoretical).

The Case of Walmart v.Joseph Casias

Casias is a father of two who from 2004 to 2008 had risen through the ranks of Walmart employees to be honored with the title of “Associate of the Year,” an honor that goes to only half a percent of all employees. Not all is well, as Casias later had a workplace accident. Twisting his knee at work, the Walmart policy was such that a drug test was dictated. Casias was found to have the chemical residue of marijuana in his system. By policy, Casias lost his job. The story does not end there. Casias was also a victim of inoperable brain cancer. The marijuana is his system had been prescribed to him by his oncologist. Walmart stood by its policy and did not accept the medical card issued by the state he was living in as an acceptable excuse (p. 111-2).  The story does not end there, however. Casias was not just a brain cancer victim, he was a continued survivor. According to the ACLU, which is suing Walmart on behalf of Caisis, the pain from the cancer had been debilitating to the point where Casias was on heavy opioids, which both did nothing for his pain and left him nauseous. The marijuana prescription which was legal under state law and given under the direction of his oncologist, was against policy where opioids were not (Casias v. Wal-Mart).

The question then follows about who is correct. Should Walmart disregard its policy and give Casias his job back because he is an exceptional employee and who was following the law of his state? Or should Walmart instead be constant in its policy so that the termination is final - after all, marijuana is illegal under federal law? Or is this not an issue of legality at all, and Casias should not be allowed to work for Walmart because of the danger posed to his fellow workers and customers?

The easiest issue to look at the first instance. In spite of legal restrictions, is Joseph Casias a threat to anyone he works with? He is most likely not. According to his testimony, he never used marijuana on the job or came into work under the influence of the drug (Casias v. Wal-Mart). What happened was that Casias tested positive for metabolites of THC, the active ingredient in marijuana. This is the same as having glucose in your body after you have eaten cake. It is not cake in your system anymore, but just what is hanging around when it is done having that delicious tummy-filling effect. The problem is that even anti-drug scare sites hosted by the government note that these stay in your system for up to weeks after exposure (Marijuana: Facts for Teens).  So if the question is was Casias intoxicated at work, its impossible to answer except through observation. The fact that alcohol can be detected to such mathematically precise numbers gives the public a misconception of how inebriation can be measured. The fact is that two different people can have highly varied levels of impairment at the same blood concentration: it is why field sobriety tests exist. Did Casias appear intoxicated? There is no positive evidence. The sole mark against him was that chemical that showed up in his blood. And there’s no telling when that came into the system.

Having determined that Casias was not a threat to anyone in his direct area, the question becomes about the applicability of the proper federal law and the company’s policies as they pertain to the pertinent laws. Here the evidence is not as clear. On one hand, marijuana is still considered a scedule one narcotic, meaning that is has no medicinal value. The overall trend in the country is towards acceptance, where several states have started allowing medicinal use such as Casias was doing under the direction of his physician. Other states are going so far as to legalize the plant for recreational purposes. The Federal government has had a varied take on this progression. The Obama administration said that it would prioritize such enforcement actions, but the nascent industry still has had the DEA pressure it in various ways. The state of legalization is in flux. The states have led on this issue with Washington falling far behind. At the Federal level they are still under administrators who came of age during the “War on Drugs” era that saw a disproportionate number of minorities be locked away for significant fractions of their lives based on nonviolent drug offenses. If economically it is best to ignore sunk costs, it is almost impossible to do it in a political or policy context. The march of marijuana legalization is such that even recently the federal government had to put out a memo that marijuana is still illegal to use or possess (Memo to Federal Workers). This shows a consciousness of the reality. The social norms are changing, The problem is that there are people who will suffer while the wheels of history make their turn -- people like Joseph Casias.

Casias broke federal law by using and possessing marijuana. That fact is not under debate. This is mitigated by the fact that he was in compliance with the relevant state rules. The autodidactic constitutional scholar can go to the Archives and find the Constitution. In it are enumerated powers saying what a congress can do, and then a bit of the Bill of Rights saying that what the federal government cannot do is given to the states (The Constitution of the United States). This simplistic reading has been debated back and forth for the duration of the republic and complicated.  At issue is a different question, however, than federalism versus states rights. Ultimately, Walmart kept to a policy that is a derivative of the original anti-drug scare mongering, There is a zero tolerance policy for marijuana under their policy. Having a hard policy at a corporate level makes sense because it protects you from the potential of favoritism. What it  also does is erase the subjectivity that would be necessary in a case like this. Casias was demonstrably a quality employee, and as such honored by the company for his service. If he was under care with the narcotic and that would have been fine under policy is unclear. The policy is standard, as has been seen with the federal government’s application of the same policy. The difference is that Walmart is not a governmental body, nor do they exist to enforce the rules of the government. The policy of mandatory drug testing after an accident is one that is created so that they can minimize their own culpability if a worker injures themselves at work. If the worker can be shown to have broken the law, the company will not have to pay for the injury. It is a defensive and reactive stance. Does it make sense as a company under a capitalistic, market system? From Walmart’s perspective, the answer is yes.

But is it right? Ultimately the answer to that circles back to the first part of the discussion. Caisis did not appear to be inebriated and it was only after the fact that it came out that he was a patient under the care of a doctor who had prescribed medical marijuana to treat his cancer. Other drugs would have been acceptable, but Caisis became a test case for states moving into the gray area that the federal government has been uncertain on. This is where a human element would have been crucial. Someone from the public relations department from Walmart had to have seen this and been very frustrated, The polls may have looked slightly different then, but the people who are accepting of marijuana use, especially for medical purposes, are Walmart’s customers. A sizeable majority of Americans are in favor of legalization, according to respected polling outfits like Gallup (Americans Favor Legalizing Marijuana).  Being dogmatic on policies such as those that affected Caisis is alienating to a large number of Americans, and Walmart does not need any more negative marks against it in the public eye. Therefore, Walmart should reinstate Caisis not just since it is utilizing talent in the right way, but their reason for dismissal is fading fast into the past. Even someone with a less sympathetic back-story should be able to use their medicine on their own time as long as they do not create a risk for those around them while they do their work.

References

ACLU. (2015). Casias V. Walmart. The American Civil Liberties Union. Retrieved From  https://www.aclu.org/cases/casias-v-wal-mart

Kinicki, A., & Fugate, M. (2012). Organizational Behavior: Key Concepts, Skills, and Best Practices (5th ed.). New York: McGraw-Hill Irwin

Madison, J. et al. (1787). The Constitution of the United States. The National Archives. Retrieved from http://www.archives.gov/exhibits/charters/constitution_transcript.html

NIH. (2015). Want to Know More?: Some FAQs About Marijuana. National Institute on Drug Abuse. Retrieved from http://www.drugabuse.gov/publications/marijuana-facts-teens/want-to-know-more-some-faqs-about-marijuana

Rein, L. (2015, May 27). Memo to Federal Workers, Using Marijuana Could Cost You Your Job. The Washington Post. Retrieved fromhttp://www.washingtonpost.com/politics/memo-to-federal-workers-using-marijuana-could-cost-you-your-job/2015/05/27/285b084e-04a9-11e5-8bda-c7b4e9a8f7ac_story.html

Swift, A. (2013). For First Time, Americans Favor Legalizing Marijuana. Gallup. Retrieved from http://www.gallup.com/poll/165539/first-time-americans-favor-legalizing-marijuana.aspx

The Market is Efficient Enough: Robert Shiller's "Irrational Exuberance".

I read this not long after I had read Malkiel’s “A Random Walk Down Wall Street”. Both books came out in new editions this year, and both had been on my long list of books to read in the back of my head.

Oddly enough, both books were compelling and believable. The reasons that this is odd is mostly because one would think that they are diametrically opposed. The entire argument of Malkiel is that you can’t beat the markets consistently, so the best bet is to get into index. This is an acceptance of part of the efficient market hypothesis, where there is no free lunch and arbitrage opportunities disappear and are not predictable.

I can be into Shiller too because there is another part of the EMF that says that market prices are the right prices, so the value of the market is the true value of the market. If this is true there should never be any bubbles. You should also never be able to short sell anything unless you had inside information. But alas, the market can stay irrational longer than you can stay liquid. Bubbles do happen, in all markets and everywhere. Shiller got a bit lucky by having the first edition of this book come out at the point where the dot com bubble was right at the top. Those who had gone all in on technology were not as lucky. As Shiller examines. bubbles can and do happen.

So how can I reconcile the fact that the EMF is the tool I rely on for investing even though I have full knowledge that bubbles happen and massive dollar amounts are lost in them? I answer by saying that the markets are rational enough. Bubble happen, but it is hard to know when you’re in them and you can’t time them. The prominent economist who called the housing bubble beforehand are small in number. If they were calling it, they were dismissed as bearish or too heterodox. Too many people had failed to read their Kindleberger. This time wasn’t different and the bubble popped. Harder to know is when it will pop and at what level. That’s where the EMF works. When it pops, you’re going down with it, but so will everyone else. It makes me think of a couple of quotes. First, Keynes: “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally,” and then Citi’s Chuck Prince approps the last bubble: “As long as the music is playing, you've got to get up and dance”. Sure, if you were in the main indices you lost half the value of your investments. Of course if you stayed in them you made them all back. Now imagine if you had put all your money into junior tranches of residential mortgage backed securities -- it seemed like a sure thing, but you would have ended up with nothing. It’s not perfect, but the market is efficient -- enough.