Book club: Capitalism and Freedom

There are more postings over at the Free Exchange blog in their Summer book club on Milton Friedman's Capitalism and Freedom. Read here, here and here.

More on food prices

When it comes to world food price an often asked question is What has caused the increases in the price of food? Several culprits have been blamed.

1. Newspapers have cited an internal World Bank document as having found that 75% of the price increase was due to biofuels
2. Several governments and commentators see speculation as a major driving force.
3. Widely held view has it that rapidly growing food demand in the emerging economies is pushing up global food prices.

Stefan Tangermann in an article at VoxEU.org asks What's causing global food price inflation? The column aims to ask the question Which contributions have the above, or other factors, made to rising food prices?

Tangermann makes the point that

The OECD has carefully looked at market developments and analysed the implications of biofuel support policies. The analytical framework used is a large-scale partial equilibrium model of agricultural commodity markets in all major countries and at the international level, with detailed representation of the multitude of policy instruments affecting these markets, including those targeting biofuels.

Results were published recently in the OECD-FAO Agricultural Outlook, a paper on the causes and consequences of rising food prices, and a report on the economic assessment of biofuel support policies. The evidence is pretty clear.

That evidence?

Food demand in China, India, and other emerging economies is rising as their incomes grow. However, domestic food production in most of these countries is growing in parallel. China, for example, has been a consistent and growing net exporter of cereals (including rice). The Agricultural Outlook expects China’s net cereals exports to decline only very gradually in the coming decade. For India, the picture is similar, though there was significant variability in its net trade position in the past. In short, growing food demand in the major emerging countries cannot be held responsible for the rise in world market prices for cereals.

and

Yet, there is no hard evidence that “speculation” has added much to the price increase on spot markets. After all, it is only when “speculators” actually buy produce on the spot market that they can drive up the price, and this would have to be reflected in growing stock levels – but stocks appear to have declined throughout the period of rising prices

So where is the problem?

A different type of panic, though, has without doubt contributed to food price inflation – the barriers to exports that some food exporting countries have imposed in order to keep domestic food prices under control.

and

OECD analysis clearly shows that two factors external to agriculture and food have had, and will continue to have in the years to come, a significant impact on the rise of global food prices.

• The rapid increase in crude oil prices and energy prices more generally has significantly raised the costs of producing and shipping agricultural products.
• The weak dollar has contributed to driving up dollar-denominated commodity prices in international trade.

But Tangermann goes on to say

... there is also one policy-made ingredient in the story – the high and growing level of support provided to the production and consumption of biofuels.

He continues

The use of agricultural products, in particular maize, wheat, and vegetable oil, as feedstock for biofuel production has expanded dramatically in recent years. Between 2005 and 2007, i.e. in the period when food prices began to explode, nearly 60% of the growth in global consumption of cereals and vegetable oils was due to biofuels. Global output of cereals and vegetable oil did not decline during that period, but just grew slower than the rapid expansion of use.

In a situation of depleted stocks and very low demand and supply elasticities, this gap between use and output growth has pushed prices up very strongly. As a large part of the use expansion was due to biofuels, there cannot be any doubt that biofuels were a significant element in the rise of food prices. More specifically, in North America and Europe biofuels cannot be produced, and would be very little used, in the absence of government support through subsidies, tax breaks, tariffs, and use mandates. In other words, biofuel support policies have contributed greatly to the rise in global food prices.

His conclusion is

In summary, several factors are behind the recent dramatic increase in food prices. But one of them is clearly a result of deliberate policy decisions, i.e. to support the expansion of biofuels production and use. The OECD’s recent report on the economic assessment of biofuel support policies has clearly shown that their effectiveness is disappointingly low, with public support costing between $960 and $1700 per tonne of greenhouse gas emissions saved. In a situation like that, governments have good reasons to reconsider their biofuel support policies if they want to help to calm food prices down.

Thus we find that there cannot be much in the way of doubt that biofuels are a significant factor in the rise of worldwide food prices. Add to this the fact that other research suggests that biofuel support policies are disappointingly ineffective on environmental grounds, then it should be clear that governments need to reconsider their support for biofuels. But many governments, including New Zealand's, seem to want to push ahead with such policies despite the kind of evidence Tangermann brings to bear on the issue.

Fannie Mae and Freddie Mac: what to do

For two very different views on what to do see:

1. Moral hazard misconception by Ricardo Caballero, and
2. There is never a right time to tackle moral hazard ... by Willem Buiter

The comments to these two articles are also worth reading.

A related article is Financial crisis resolution: It’s all about burden-sharing by Charles Wyplosz. Wyplosz asks

Should taxpayers bail out the banking system?

He contrasts the

... Larry Summers “don’t-scare-off-the-investors” pro-bailout view with the Willem Buiter “they-ran-into-a wall-with-eyes-wide-open” anti-bailout view. He concludes that either way, taxpayers are always the losers. The best policy makers can do is to be merciless with shareholders and gentle with bank customers.

Thomas Sowell's view is that

It was government intervention in the financial markets, which is now supposed to save the situation, that created the problem in the first place.

Laws and regulations pressured lending institutions to lend to people that they were not lending to, given the economic realities. The Community Reinvestment Act forced them to lend in places where they did not want to send their money, and where neither they nor the politicians wanted to walk.

Now that this whole situation has blown up in everybody's face, the government intervention that brought on this disaster in is supposed to save the day.

Politics is largely the process of taking credit and putting the blame on others— regardless of what the facts may be. Politicians get away with this to the extent that we gullibly accept their words and look to them as political messiahs.

Central banks, the financial crisis and the threat of inflation

Another short audio tape from VoxEU.org. Willem Buiter (Professor of European Political Economy at the London School of Economics and formerly a member of the Monetary Policy Committee of the Bank of England and Chief Economist at the European Bank for Reconstruction and Development) talks to Romesh Vaitilingam about the financial crisis, the global cyclical slowdown and the rise of inflation. He discusses central banks’ responses to the credit crunch and calls on them to tighten monetary policy to counter the inflationary threat.

EconTalk this week

Doug Rivers of Stanford University and YouGov.com talks with Russ Roberts, host of EconTalk, about the world of political polling. Rivers explains why publicly provided margins of error overstate the reliability of most polls and why it's getting harder and harder to do telephone polls. Rivers argues that internet panels are able to create a more representative sample. Along the way he discusses automated telephone polls, the Bradley effect, and convention bounce, and the use of exit polls in calling states in Presidential elections.

The lemons market (updated)

The seminal paper on the lemons market was by George Akerlof - The market for "Lemons": quality uncertainty and the market mechanism, Quarterly Journal of Economics 84 (1970), pp. 488–500. This is the paper that won him the Nobel Prize. His result was that asymmetric information between the buyer of a used car and seller of that car can cause failure in the proper functioning of the market because the seller of a used car knows the quality of his car but the buyer is unable to discern good from bad cars. The upshot being that only bad cars get sold, good cars are driven out of the market.

In a recent paper (Lemons hypothesis reconsidered: An empirical analysis) in Economic Letters, Arif Sultan sets out to test this idea. He argues that used cars, if inferior to new cars, would require higher maintenance expenditures. His paper tests the hypothesis that there is no difference in the average maintenance expenditures required for cars acquired used and those acquired new.

The results he gets show that there is no evidence that cars acquired used required more maintenance expenditures than those of a similar age acquired new. The conclusion to the paper reads, in part,

The purpose of this paper was to examine the difference in the quality between cars acquired used and those acquired new. I measured the quality of the car by using maintenance expenditures incurred on a car [... ] I found that cars acquired new required the same maintenance expenditures as those acquired used, all else being equal, implying that cars acquired used are of same quality as cars acquired new of a similar age. If cars acquired used were of lower quality, they would have required more maintenance expenditure.

Update: The Visible Hand in Economics comments on The lemon hypothesis vs evidence and points us to other comments at Division of Labour and Marginal Revolution.

The Most Profitable Wine in the World

Michael Veseth at the Wine Economics blog writes

Profits, of course, are all about the difference between price and cost. So which country gets the highest average price for its wine exports? Most people are surprised to learn that it is New Zealand (see footnote below). New Zealand is unusual among wine producing countries in that its exports are almost entirely premium and super premium wines. The domestic Kiwi market for low cost bulk wines is filled by imports from Australia and Chile, leaving NZ producers free to focus on higher value export markets. This nearly single-minded concentration on upmarket wines results in high average export prices

He goes on

I was not completely surprised, therefore, to read Atkin’s conclusion that the most profitable wine is probably Marlborough Sauvignon Blanc from New Zealand ...

The footnote referred to above is interesting

Here is an interesting fact: Canada actually earns higher per liter revenues from its bottled wine exports than New Zealand, according to my copy of The Global Wine Statistical Compendium, but comparing it to New Zealand is like comparing apples and oranges. Or table wine to ice wine, to be more specific. Canada’s wine exports are tiny compared to New Zealand, but the per-bottle revenues are high because it is mainly expensive ice wine - sweet dessert wines made from grapes left on the vine so that freezing weather can concentrate the juice and flavor.

You know you have inflation when .....

From CNN.com comes the news that Zimbabwe introduces $100 billion banknotes. The article states

Zimbabwe started issuing large bank notes in December, starting with denominations of $250,000.

In January, the government issued bills in denominations of $1 million, $5 million, and $10 million -- and in May, it issued bills from $25 million and $50 million up to $25 billion and $50 billion.

This is because Zimbabwe has an

... official inflation rate now at 2.2 million percent.

The article also says

As high as they are, though, the bills still aren't enough to buy a loaf of bread. They can buy only four oranges.

The new note is equal to just one U.S. dollar.

The article goes on to explain that Gideon Gono, governor of the Reserve Bank of Zimbabwe, has said

"The RBZ has noted with concern the unjustifiable and incessant general increases in prices of goods and services. It is therefore appealing to the business community to follow ethical business practices as well as take an interest in the plight of the general public,"

Why doesn't he "take an interest in the plight of the general public" and stop printing money?! Following "ethical business practices" is not the answer to hyper-inflation, stopping the printing of money is.

(HT: Carpe Diem)

Book club: Capitalism and Freedom

There are more postings over at the Free Exchange blog in their Summer book club on Milton Friedman's Capitalism and Freedom. Read here, here, here and here.

Economic principles

This lecture in lolcatnomics from Periscope Depth lays out some important economic principles in a format you may recognize and understand.

(HT: Eric Crampton)

The Water Shortage Myth

David Zetland has an piece (The Water Shortage Myth) in Forbes about water scarcity and pricing in California. He writes

The real problem is that the price of water in California, as in most of America, has virtually nothing to do with supply and demand. Although water is distributed by public and private monopolies that could easily charge high prices, municipalities and regulators set prices that are as low as possible. Underpriced water sends the wrong signal to the people using it: It tells them not to worry about how much they use.

While the Zetland article is about California, its basic message holds true for all places, including New Zealand. Prices are the signals that people respond to when it comes to the use of resources. Underprice a resource and people will use too much of it. This is as true for water as it is for any other good. A high price tells consumers to use less, the demand curve for water is downward sloping.

Why no Marx?

In an article in the Chronicle of Higher Education, Russell Jacoby asks

How is it that Freud is not taught in psychology departments, Marx is not taught in economics, and Hegel is hardly taught in philosophy? Instead these masters of Western thought are taught in fields far from their own. Nowadays Freud is found in literature departments, Marx in film studies, and Hegel in German. But have they migrated, or have they been expelled? Perhaps the home fields of Freud, Marx, and Hegel have turned arid. Perhaps those disciplines have come to prize a scientistic ethos that drives away unruly thinkers. Or maybe they simply progress by sloughing off the past.

Art Carden from the Division of Labour blog sent this letter to the Chronicle in response to Jacoby's article.

Russel Jacoby raises several interesting and important points about the apparently conspicuous absence of Freud, Hegel, and Marx from their respective disciplines ("Gone, and Being Forgotten," July 25). I cannot speak to the marginalization of Freud in psychology and Hegel in philosophy, but I can speak to why economists no longer read Marx: for the most part, we don't read him because he contributed nothing of lasting value to the discipline. My undergraduate comparative economic systems professor referred to Marxian economics as having been "stillborn." Thomas Sowell correctly points out that "there is no major premise, doctrine, or tool of analysis in economics today that derived from the writings of Karl Marx" and quotes Paul Samuelson's assessment of Marx as "a minor post-Ricardian."

As I prepare to teach a course entitled "Classical and Marxian Political Economy" this Spring--for which I now plan to assign Jacoby's article, I might add--I would be the first to agree that one's education should include a broad historical overview of the ideas in a particular discipline. I further agree that Marx is an important figure in the history of ideas. He plays a minor role in economics, however, because he has been thoroughly refuted.

Phil Miller at the Market Power blog agrees with Carden,

That's an accurate assessment. Economics is a social science that examines rational, self-interested thought (i.e. how beings behave when they compare the costs and benefits of actions). An economics education, especially at the graduate school level, prepares students to perform economic research and consists of the learning of the tools and language of economic analysis. While History of Thought is a useful undergraduate class for the reasons listed by Carden, its usefulness is not so great in learning the techniques of economics modeling.

History of Thought can give perspective on what we do today and how we do it, so I think it is useful to have a knowledge of the history of economics, and I think its interesting in and of itself. As far as Marx being useful to economics I trend to agree with both Carden and Miller, I don't see what he has contributed to the tool kit of the modern economist. Todays economic analysis and research has not grown from a Marxian base and has not developed Marxian themes.

Economics of climate change

At VoxEU.org there are two short audio interviews to do with the economics of climate change. In the first Robert Stavins of Harvard University talks to Romesh Vaitilingam about what should follow the Kyoto Protocol – the potential architectures for a new international agreement on tackling global climate change; lessons from previous international agreements on a range of issues; and the main stumbling blocks to an agreement. In the second William Cline of the Peterson Institute for International Economics talks to Romesh Vaitilingam about climate change – in particular, its impact on developing countries; what economists bring to analysis of carbon mitigation technologies and policies; and the importance of an international agreement on global warming.

Wal-Mart and small business (updated)

Many commentators have argued that mega discount store Wal-Mart is death to small "mom-and-pop" businesses. President Clinton's former secretary of labour, Robert B. Reich, wrote in a 2005 New York Times op-ed that Wal-Mart turns "main streets into ghost towns by sucking business away from small retailers."

An interesting and obvious question is, How true is this? To answer this question consider the graph below

The graph is from an article (Has Wal-Mart Buried Mom and Pop?) by Andrea M. Dean and Russell S. Sobel in the latest issue (Vol. 31, No. 1, Spring 2008) of Regulation. With regard to this graph Dean and Sobel write

Interestingly, the slope of the regression line in Figure 4b is actually positive and significantly different from zero, which suggests that states with more Wal-Mart stores actually have significantly higher levels of five-to-nine-employee establishments.

Dean and Sobel conclude

Our research suggests that the popular belief that Wal-Mart has a significant negative effect on the size of the mom-and-pop business sector of the United States economy is statistically unfounded. After examining a plethora of different measures of small business activity and growth, examining both time series and cross-section data, and employing different geographic levels of data and different econometric techniques, it can be firmly concluded that Wal-Mart has had no significant impact on the overall size and growth of U.S. small business activity.

(HT: Carpe Diem)

Update: The visible hand in economics asks Could Wal-mart help small business?

Interesting blog bits

1. Jonathan Chait in The New Republic on The Shock Doctrine.
2. The Visible Hand in Economics on Why has the price of oil fallen so sharply.
3. Brandon Fuller on Deterring Suicide Bombers.
4. Gary Becker on Cats and Dogs, and "Sensible" Bequests
5. Richard Posner asks Should Dogs Get $8 Billion from the Helmsley Estate?

   There is a supplemental comment by Posner: Trusts for Pets.

6. The Undercover Economist on At last, a sensible way to measure poverty.
7. Ken Rogoff on global inflation
8. Bryan Caplan asks Are Central Banks the Most Efficient State Enterprise?

Globalisation: three waves of change

From the Daily chart section of the Economist comes this chart on the three waves of globalisation.



As historians of globalisation point out, globalisation has been with us for a long time. The Economist writes

Industrialisation and technological changes—such as the invention of the steam ship, which produced cheaper means of migrating and trading between continents—spurred one period of globalisation in the 19th century. In similar fashion new inventions—jet aircraft, the internet—helped to encourage later periods of it. In a new World Trade Report published this week, the WTO compared three broad periods, looking at global growth in GDP, in population and in the trade of goods. Migration rates are shown only for four countries of the “New” world.

Globalisation: lessons from the past

This short audio interview comes from VoxEU.org. In it Alan Taylor of the University of California Davis talks to Romesh Vaitilingam about the first era of globalisation and the policy lessons that researchers in economic history and international economics are drawing for contemporary experiences of financial market integration, trade liberalisation and the growth of international reserves.

Milton Friedman and Augusto Pinochet

Megan McArdle has been blogging on the relationship between Milton Friedman and Augusto Pinochet. She writes

Oh, Lordy, the nuts with a shaky knowledge of history, but the talismanic word "Pinochet" have crawled out of the woodwork to assert that Milton Friedman did, too, cause a dictatorship!

There are several problems with this theory:

1) Milton Friedman spent all of an hour with Augusto Pinochet

2) This occurred years after the coup.

3) The "Chicago Boys" reforms didn't even start until 1975, although I believe they did hand the brick to Pinochet the day after the coup. The Chicago Boys were not behind the coup; rather, they helped Pinochet undo the Allende nationalizations after he had already taken power. Early Pinochet economic reforms were along standard right wing Latin American crony capitalism lines. In fact, many of the reforms that the Chicago Boys put in place, such as opening trade, acted against traditional entrenched business interests.

Book club: Capitalism and Freedom

There are more postings over at the Free Exchange blog in their Summer book club on Milton Friedman's Capitalism and Freedom. Read here, here, here and here.

Incentives matter: traffic ticket file

This example is from the Division of Labour blog. E. Frank Stephenson quotes from a article by John Stossel,

Day after day in Warren, Mich., people wait in a long line to pay traffic fines. Many are there because police say they didn't come to a full stop at a stop sign. Often the policeman saying that is Officer David Kanapsky.

On last week's "20/20," you heard a motorist in court insist that she did come to a complete stop. The judge replied, as judges there often do: "I find Officer Kanapsky's testimony to be credible. He is an unbiased witness."

But the officer is not really unbiased. The more tickets he writes, the more overtime he gets. Last year, Kanapsky spent so much time in court he increased his pay by $21,000.