Monday, 30 November 2009

2025 Taskforce (updated)

The 2025 Taskforce headed by Don Brash has made 35 recommendations to help close the income gap between New Zealand and Australia. The full report, "Answering the $64,000 Question: Closing the Income Gap with Australia by 2025: First Report and Recommendations", is available here.

The slides from the media briefing, by Don Brash, held for the release of the First Report and Recommendations are available here. What is interesting from this briefing is what the Taskforce is NOT recommending:
We heard proposals but do not recommend:
• Increased government funding for R&D
• Picking winning sectors, industries or firms
• Compulsory private saving
• New or enhanced government financial institutions
• Changing the exchange rate regime
• Typically these address symptoms – our focus is on getting the overall economic environment right
So what isn't recommended looks right. What is recommended?

Government spending
1. Government operating spending (as measured by core Crown operating expenses) as a share of GDP should be reduced by 2012/13 to 29 percent, the same share as in 2004 and 2005.
2. Beyond 2012/13, government spending as a share of GDP should be reduced materially further. To achieve this, the level of core Crown operating expenses per person should be capped in real terms.
3. The Public Finance Act should be amended to require the Minister of Finance to specify publicly a medium-term target for core Crown operating expenses, either in real per capita terms or as a share of GDP. In each Fiscal Strategy Report, the Minister of Finance should be required to report publicly on steps being taken to ensure that that goal is met.
4. The Government should undertake an in-depth examination of the scope for further institutional changes to strengthen long-term spending discipline. Examples of such institutions could include a Taxpayer Bill of Rights and/or an independent Fiscal Advisory Council.
5. Expert taskforces should be established to scrutinise each major area of government spending, with a view to proposing more effective models for delivering those services that the public sector will continue to fund.
6. Processes for evaluating government spending should be materially strengthened, including greater use of rigorous and transparent cost-benefit analysis for both new spending proposals and periodic reviews of the value that is being obtained from existing spending programmes. Enhancing the quality and rigour of such analysis should be a key priority for the Treasury.
7. Ambitious welfare reform measures should be undertaken as a matter of priority to reduce the very large number of people of working age currently receiving welfare benefits.
8. Early steps should be taken to lower the actual and prospective costs (as a share of GDP) of New Zealand Superannuation. The eligibility age should be increased progressively, with increases linked to ongoing improvements in life expectancy, and for some years payments should be indexed to the CPI rather than to after-tax wages.
9. Remaining KiwiSaver subsidies should be abolished.
10. Health:
a. A funder-provider model should be reintroduced in the hospital sector, allowing much greater private sector involvement in the provision of taxpayer-funded services.
b. Universal (unrelated to income or health status) subsidies for doctors’ visits should be abolished.
c. Subsidies for prescription pharmaceuticals should be substantially reduced, with those in generally good health and not on low incomes paying the full price up to a cap.
11. Education:
a. The substantial increases in subsidies since 2005 for early childhood education and day-care should be reversed.
b. A funder-provider model should be adopted for the school sector, allowing new providers to enter, with all-up per student funding equivalent to that for existing state schools.
c. In the meantime, governance and accountability structures in the school sector need to be reformed to provide better incentives for stronger performance and greater accountability for teachers, principals and schools.
d. Government-imposed fee caps on university fees should be abolished.
e. Market-based interest rates should be reintroduced for student loans.
f. Governance of the public tertiary sector should be reformed, including exploring the rationalisation of the non-university sector and the establishment of universities as independent foundations.
g. A full review should be undertaken to identify, and recommend reform of, those areas in which various government education agencies (Tertiary Education Commission, Education Review Office, Ministry of Education) have become overly prescriptive, and to explore other, less intrusive, monitoring and accountability options to achieve policy ends that pass a cost-benefit test.
12. Average tax rates should be substantially reduced, as ambitious expenditure restraint permits. Cutting core Crown expenses to 29 percent of GDP would, for example, allow the maximum personal tax rate, and the company and trust tax rates, all to be reduced to 20 percent.
13. Serious reforms should be undertaken to reduce the high effective marginal tax rates facing many middle income taxpayers with dependent children as a result of the abatement provisions of the Working for Families tax credit scheme.
14. Reductions in average tax rates should be achieved by reducing income taxes, and doing so having regard both to the importance of administrative simplicity and minimisation of tax avoidance on the one hand, and to the evidence that taxes on capital income can be particularly detrimental to economic performance on the other.
Government assets
15. All businesses owned by central government which are operating in markets where competition is actual or feasible should be sold.
16. Local governments should be strongly encouraged to sell their trading enterprises.
17. To strengthen governance while businesses remain in public ownership, an independent Crown Commercial Appointments Commission should be established, to be responsible for making recommendations to Ministers for Board positions on all Crown commercial enterprises and for vetting and publishing suitability assessments of all appointees to such boards.
18. The New Zealand Superannuation Fund should be wound up and its assets used to reduce gross government debt.
19. Congestion charging should be introduced in central Auckland and in any other cities where a cost-benefit analysis supports doing so. Full road-user charging, differentiated by place and time of road use, should be introduced as it becomes economically efficient to do so.
20. Rigorous and transparent cost-benefit analyses should restored to the prime place in guiding decisions on all public capital spending, including infrastructure spending. All such cost-benefit analyses for projects involving the outlay of more than $50 million should be formally reviewed by Treasury.
21. Mining:
a. A governance framework should be put in place to facilitate the best economic use of those mineral resources in which the Crown has a direct ownership interest (under both land and sea).
b. Mining developments on or under sensitive Crown land should generally be permitted provided that they pass a full cost-benefit analysis.
c. Development of mineral resources should be undertaken by private operators, with the Crown securing its financial interest through appropriate royalty-type arrangements.
22. A Regulatory Responsibility Bill should be enacted, based on the draft proposed in the recent report of the Regulatory Responsibility Taskforce.
23. Property rights should be added to the list of rights specified in the Bill of Rights Act.
24. Substantially improving the quality of regulatory impact analysis being undertaken before legislation is introduced and/or government regulatory powers are extended should be treated as a matter of high priority by Ministers and central government agencies. Such analysis should be an integral part of all policy development and review processes, to ensure that the full costs and benefits, to all sectors, are appropriately and rigorously factored into government decision-making.
25. An independent Productivity Commission should be established as a centre of microeconomic and regulatory analytical expertise. The Commission should be authorised (and resourced) to undertake reviews of matters referred to it by Ministers, and of issues it identifies as requiring further in-depth analysis and research.
26. A high quality independent taskforce should be constituted as a matter of urgency to review resource management law from first principles, including identifying the policy goals that should be served by such legislation and assessing the best ways of achieving those goals.
27. When determining the zoning of land for residential purposes, local authorities should be required by statute to take explicit account of any differences between the price of residential-zoned undeveloped land and the price of other undeveloped land in similar areas. These differences should be reported on by local authorities each year, with a strong presumption that scarcity of zoned land, as reflected primarily in price differences, should prompt action to increase the supply of residential land.
28. A system of tradable water rights should be established urgently.
29. Labour market:
a. Labour law should be amended to strengthen the freedom of negotiation between workers and their employers, including, for example, streamlining provisions governing dismissal of workers, and putting less emphasis on procedural matters.
b. Statutory provisions allowing enforceable mutually-agreed probationary periods for new employees should be extended, from the current maximum of 90 days for those working for small firms to a maximum of 12 months for employees of firms of any size.
c. For employees earning in excess of $100,000 per annum, employment relations should be governed by the standard provisions of contract law rather than by the Employment Relations Act.
d. The youth minimum wage should be reinstated as a matter of urgency, and minimum wage rates should be reduced to the same ratio to average wages that prevailed in 1999.
30. Immediate notice should be given that from 1 January 2011 all remaining tariffs will be removed.
31. Foreign investment restrictions should be further reviewed, starting with a strong predisposition that a much more liberal regime should be introduced.
32. Emissions trading legislation and any future emissions reduction targets the Government adopts should be independently monitored and periodically reviewed. Such reviews should focus on monitoring the economic impact of any carbon abatement goals, and the impact of chosen abatement regimes (here and abroad) on prospects for achieving the 2025 goal.
33. A review of the Commerce Act should be undertaken, with a focus on restoring the primacy of economic efficiency considerations and long-term consumer interests in the design and conduct of competition policy.
34. The Government should strongly encourage the transformation of Fonterra into a conventional company structure with fully-traded outside capital, using any appropriate instruments at its disposal.
35. Zespri’s monopoly on the export of kiwifruit to markets outside Australia should be removed.

Nothing particularly new or radical in any of this. There are a number of good ideas in contained within the recommendations. Things like a flatter tax system and restraints on government spending. The water rights trading scheme is an ideas whose time has come. More privatisation is an idea whose time has come again. Welfare, education and labour market reform is clearly needed, etc. But the devil is in the detail, so how successful any actual reform would be would depends on the details of that reform. Not that the government will have the balls to take action on any reform.

A quick overview of things that seem a bit odd to me. I don't get 34. The institutional form of Fonterra is up to the owners of the company, it has nothing to do with the government. If the owners are happy with the current co-operative structure then the government has no role is trying to change it. As to 33, may be doing away with the Commerce Act altogether should be considered. In regard to 26, doing away with the Resource Management Act should be looked at. As for 25, I'm not sure what benefits a Productivity Commission would actually bring.

Update: Homepaddock comments here, Kiwiblog here, here, Not PC here, Kiwiblog again here, MacDoctor here, Karl du Fresne here.

Demand curves really do slope downwards

From the Yahoo!Xtra website comes this bit of "news"
Charging shoppers for plastic bags has generated over $145,000 for local charities and seen a dramatic drop in their use, The Warehouse says.
Warehouse chief executive Ian Morrice said the scheme had already been successful, with plastic bag use dropping 84 percent over July-September.
Yes, the fact that demand curves slope downwards is actually news! If you put the (relative) price of something up, people use less of it. Who would have guessed?

I guess its been a slow news day.

RR Bill: a short summary of recommendations

The Regulatory Responsibility Taskforce was set up so that it could assess the Regulatory Responsibility Bill (RR Bill) - which was reviewed by Parliament's Commerce Committee in 2007 and 2008 - to consider what amendments to the RR Bill and supporting arrangements might be useful, and, in addition, to produce a recommended draft Bill. The full report is available here.

In its report the Taskforce has recommended a substantially modified version of the Option 3 Bill, together with a range of associated measures and practices. The Taskforce's version of the Bill would:
  1. state, in substantially modified terms, the principles of responsible regulation to be advanced by the Bill, which are designed to accord with and reflect broadly accepted principles of good legislation, incompatibility with which is justified only to the extent that it is reasonable and can be demonstrably justified in a free and democratic society;
  2. require those proposing and creating legislation to certify whether the legislation is compatible with those principles, and whether any incompatibility is justified;
  3. provide for a new role for the Courts to make declarations of incompatibility (DoI) with the specified principles of the Bill, but otherwise explicitly exclude any power to make injunctive or compensatory orders on the basis of the Bill’s specified principles;
  4. require the Courts to interpret legislation consistently with the Bill’s specified principles if possible; and
  5. require every public entity to use its best endeavours to regularly review all legislation that it administers for compatibility with the principles, and provide for the Minister with responsibility for the Bill to issue guidelines to public entities on criteria to be used and the steps to be taken in ensuring legislation is regularly reviewed.
The report summaries Option 3, referred to above, as
Option 3, which had only minor modifications from the initial Bill introduced in 2006, would legislate for specified principles of responsible regulatory management, and, in particular, require statements of responsible regulatory management for each proposal for a new Act or regulation, signed off by the relevant Minister, chief executive and control agency (Ministry of Economic Development for regulatory matters, Ministry of Justice – or Solicitor-General – for legal matters).

The Taskforce recommends a substantially modified version of the Option 3 Bill, together with a range of associated measures and practices. The Taskforce considered and substantially modified the principles of responsible regulation contained in the Option 3 Bill. The modified Bill continues to require those proposing and creating legislation to certify that the legislation is compatible with those principles, but supplements that procedure with a new power for Courts to declare legislation incompatible with one or more of those principles. This follows United Kingdom precedent,3 and is intended to have a major impact on legislative behaviour both before and subsequent to any Court decisions.
Note that the Taskforce's recommended Regulatory Responsibility Bill is reproduced in full as Part 3 of their report. and a commentary on the specific provisions of the RR Bill is included as Part 4 of the report.

The principles referred to in the preceding discussion, as recommended by the Taskforce, fall within six broad categories:
(a) Rule of law – legislation should be clear and accessible, not adversely affect rights, or impose obligations retrospectively, treat people equally before the law, and resolve issues of legal right and liability by application of law, rather than the exercise of administrative discretion;

(b) Liberties – legislation should not diminish a person’s liberty, personal security, freedom of choice or action, or rights to own, use or dispose of property, except as necessary to provide for any such liberty, freedom or right of another person;

(c) Taking of property – legislation should not take or impair, or authorise the taking or impairment of, property, without the consent of the owner, unless it is necessary in the public interest and full compensation is provided to the owner, such compensation to be provided, to the extent practicable, by or on behalf of the persons who obtain the benefit of the taking or impairment;

(d) Taxes and charges – legislation should not impose, or authorise the imposition of, taxes, except by or under an Act, nor should it impose or authorise charges that exceed the reasonable cost of providing the goods or services, or the benefit that payers are likely to obtain;

(e) Role of Courts – legislation should preserve the Courts’ role of authoritatively determining the meaning of legislation, and where legislation authorises a public entity to make decisions that may adversely affect any person or property, it should state appropriate criteria for making those decisions, and provide a right of appeal on the merits against those decisions to a Court or other independent body;

(f) Good law making – legislation should not be made unless those likely to be affected by the legislation have been consulted and there has been a careful evaluation of the need for legislation to address the issue concerned. Furthermore the benefits of any legislation should outweigh its costs, and any legislation should be the most effective, efficient and proportionate response to the issue available.
The question is, How would such a Bill alter the incentives faced by those proposing and creating legislation and what unintended consequences could this have?

Friday, 27 November 2009

The Regulatory Responsibility Act

Just last month the report of the Regulatory Responsibility Taskforce was released. Not that many people seem to have noticed. The taskforce was headed by former secretary of the Treasury Graham Scott and included Paul Baines, Hon David Caygill, Richard Clarke QC, Jack Hodder SC, Dr Don Turkington and Dr Bryce Wilkinson. The full report is available here.

One person who did notice is Roger Kerr, who had a piece on the report and the Regulatory Responsibility Act in the The Independent on the 26th of November 2009. He argues that,
The Taskforce report is an outstanding piece of legal and economic analysis. It should give the government comfort that the bill it proposes respects constitutional principles and the sovereignty of parliament. The bill would present no barriers to the adoption of sound regulations but should help to screen out bad ones.
And New Zealand has, unfortunately, much in the way of bad regulation.

Kerr goes on to explain that,
[t]he structure of the bill has three main elements.

First, it elaborates principles for responsible regulation, drawing on the RIS requirements and the LAC Guidelines, that are to apply to new legislation and, over time, to all legislation. These cover such things as the rule of law, personal liberties, taking of property, taxes and charges, and processes for good law-making.

Second, it requires those proposing new legislation (such as ministers and chief executives) to certify that the legislation is compatible with those principles and, if not, the reasons for the incompatibility.

Third, it grants courts the power to declare legislation to be incompatible with those principles.
Note that the,
[c]ourts are given no other powers: they would not be able to stop the passage of legislation by injunctions and would have no new ability to award compensation for regulatory takings. A declaration would only carry moral authority.
One wonders what would happen if a government did go against such a court declaration. Is moral authority enough?

Kerr makes the point that,
[t]here may be opposition to a ‘regulatory constitution’ by politicians who do not wish to tie their hands but rather be free to regulate for the benefit of some interest group rather than in the public interest.
But this seems to be the main reason for having such a bill, trying to stop politicians from regulating for the benefit of some interest group or another ... and themselves.

Kerr also makes another interesting point,
So far there has been minimal media coverage of a proposal that stands to rank with the earlier ‘economic constitutions’ and attract international interest.
Why? Is the media just not interested or do they just not realise the importance of such a bill? Given the woeful standard of economic reporting in this country, it may well be that journalists are just unable to understand the importance of the bill.

Kerr adds
It deserves wider public exposure and debate.
And so it does. So give it more!

The new paternalism

There is an interesting series of postings on the "New Paternalism on the Slippery Slopes" by Glen Whitman at the ThinkMarkets blog.This set of posting is based on a new paper "Little Brother Is Watching You: New Paternalism on the Slippery Slopes" by Whitman and Mario Rizzo, published in the Arizona Law Review. You can find the full text here.

The abstract of the full article reads,
The “new paternalism” claims that careful policy interventions can help people make better decisions in terms of their own welfare, with only mild or nonexistent infringement of personal autonomy and choice. This claim to moderation is not sustainable. Applying the insights of the modern literature on slippery slopes to new paternalist policies suggests that such policies are particularly vulnerable to expansion. This is true even if policymakers are fully rational. More importantly, the slippery-slope potential is especially great if policymakers are not fully rational, but instead share the behavioral and cognitive biases attributed to the people their policies are supposed to help. Accepting the new paternalist approach creates a risk of accepting, in the long run, greater restrictions on individual autonomy than have been heretofore acknowledged.

I will be a binge drinker after a bottle of this stuff .....

Brad Taylor tells us about a new 32% alcohol beer from the Scottish brewing company BrewDog. Brad writes,
BrewDog, the Scottish brewing company behind the 18.2% ABV Tokyo* and the low alcohol Nanny State have revealed their newest brew: Tactical Nuclear Penguin, weighing in at a mighty 32% alcohol!
Managing director James Watt said a limited supply of Tactical Nuclear Penguin would be sold for £30 each.

He said: “This beer is about pushing the boundaries, it is about taking innovation in beer to a whole new level.”

Mr Watt added that a beer such as Tactical Nuclear Penguin should be drunk in “spirit sized measures”.

A warning on the label states: “This is an extremely strong beer; it should be enjoyed in small servings and with an air of aristocratic nonchalance. In exactly the same manner that you would enjoy a fine whisky, a Frank Zappa album or a visit from a friendly yet anxious ghost.”
Now that's a beer!

Should we buy a few bottles for Geoff Palmer?

Thursday, 26 November 2009

Introduction to Hayek’s thought

Don Boudreaux points us to this excellent introduction to F. A. Hayek’s thought. Hayek’s 1973 Wincott Lecture, "Economic Freedom and Representative Government", is now available on-line via the Institute for Economic Affairs in London. See here for the pdf.

The waterbed effect

A question worth asking with regard to the mobile phone market in New Zealand is, Will the recent recommendation to regulate New Zealand mobile termination rates reduce the costs of mobile calling, as many supporters of regulation claim? European evidence suggests that some customers might actually face significant increases in call prices. This point is made by Bronwyn Howell in an article, "Waves in the Waterbed", in the November 2009, Issue 30, of the Competition and Regulation Times from the New Zealand Institute for the Study of Competition and Regulation (ISCR).

The waterbed effect is a feature of what economists refer to as two-sided markets. These types of markets - which include telecommunications platforms, electronic marketplaces, credit cards, newspapers, and clubs - generate the highest value of welfare to society when prices charged to the parties on each 'side' of the trading platform differ from the marginal-cost standard that's used for welfare-maximisation in one-sided markets. Oddly, welfare is maximised when consumers on one 'side' of the platform (the 'money side') are charged a price which is above the costs their usage imposes, whilst consumers on the other (the 'subsidy side') are charged less than the costs their use incurs.

Howell gives the following example to illustrate this point:
[...] newspapers charge high prices to advertisers and subsidise the price of the paper to readers. Circulation increases, which means greater value is offered to advertisers (more readers to view the advertisements). So advertisers can be charged even more – and prices to readers become even lower. Ultimately, newspapers can even be provided free to the reader. Forcing newspapers to charge advertisers only the actual costs incurred to print the copy would inevitably force up the price of newspapers to readers, reduce the number of papers sold, and impose a net loss to society.
Applying this idea to the mobile phone market Howell writes,
[...] mobile telephony network operators often charge prices below cost for calls made between subscribers on their own network (on-net customers), who are the consumers on the platform’s ‘subsidy side’. More on-net customers means the high fixed costs of network construction and operation can be spread over a larger customer volume, reducing prices further and inducing even more customers to join. Welfare increases as more connections are sold and more calls are made – more than than would occur at cost-based call pricing. Shortfalls in calling revenues are recovered by charging a price above cost for services provided to customers who call across networks (cross-net customers) and who are the consumers on the platform’s ‘money side’. Examples of such pricing include calls from other networks terminating on the network in question (mobile termination fees for cross-net calls) or charges enabling other operators to use network resources (mobile roaming).

If the market for mobile calling was ‘one-sided’, then forcing the termination price down would be likely to result in a reduction in retail charges. But the greater the extent to which cross-net calling subsidises on-net calling, the greater the likelihood that reducing termination charges will result in increased charges for on-net calls, with a net loss in welfare to those customers whose calling patterns have evolved to take advantage of the on-net discounts.
Howell goes on to explain that evidence from the European Union - see C. Genakos & T. Valletti (2009) - suggests that in practice, the waterbed effect is alive and well in mobile markets. She writes,
Figure 1 shows the average price paid relative to the world average, both before (periods T-6 to T-1) and after (T+1 to T+6) regulated reduction of mobile termination charges in twenty EU countries. In all cases, regulation was introduced because it was perceived that the unregulated rates were ‘too high’. The actual prices paid by consumers in the studied countries before regulation were lower than the rest of the world. When mobile termination rates were regulated downward, the prices paid actually increased relative to other countries. This is likely to be because of the reduction or elimination of on-net discounts by operators reacting to reduced income from cross-net calling.
The point to take from this is that regulation may have unintended consequences in that for some customers prices could rise, not fall, as planned:
[...] because of the waterbed effect, regulated reduction of mobile termination rates will not automatically be positive for all consumers. Cross-net calling charges may fall; but if the bulk of calls made are discounted on-net calls, then the average prices paid for calls may actually rise – even as network operator profits reduce.
  • C. Genakos & T. Valletti (2009) Testing the ‘waterbed effect’ in mobile telephony (

Wednesday, 25 November 2009

Government outsourcing: the private sector can be good for you

At Emmanuelle Auriol and Pierre M.Picard have a new column, Government outsourcing: Public contracting with private monopoly. They open the column by saying,
Many countries, including Australia, New Zealand, the UK and the US, have chosen to outsource the investment and operation of non-competitive public services, such as water and waste management, public transports, mail services, information and communication technology services, and road infrastructures (Grout 2009). Outsourcing decisions imply the transfer of ownership and control of the facilities or services from public authorities to a private firm. However, economists do not usually recommend such transfers of natural monopolies. Outsourcing is no solution for the lack of competition that prevails in those sectors.
This last point does, therefore, raise the question, Why do governments make such contracts in non-competitive markets?
In the latest issue of the Economic Journal, we present a theoretical study on the costs and benefits of outsourcing in non-competitive contexts (Auriol and Picard 2009). Outsourcing contracts involve the transfer of control and cash-flow rights over a public service or infrastructure to a private firm in exchange for some investment. What distinguishes outsourcing from pure privatisation is that the government contracts with the private firm. We show that government outsourcing to the private sector is most desirable in advanced economies when it is used to deliver high-technology products or to cover low-profitability parts of public services. In very poor countries, outsourcing is beneficial when it leads to the creation of an infrastructure or service that would not otherwise exist.
So both developed and underdeveloped countries can benefit from government outsourcing. This result is based on an analysis which has at its base the government budget constraint captured by the shadow costs of public funds.
The shadow cost of public funds measures the social cost of the government's economic intervention; any transfer of public money to a firm implies either a decrease in the production of public goods, such as schooling and health care, or an increase in distortionary taxation. Shadow costs of public funds also reflect the macroeconomic constraints that are imposed on national governments' debts levels by supranational institutions (e.g. by the Maastricht treaty on EU member states, by the IMF on some developing countries) and the microeconomic constraints of government agencies that are unable to commit to long-term investment expenditures in their annual or pluri-annual budgets. In developing countries, low income levels and difficulties in implementing effective taxation programs are strong constraints on the government's budget, which leads to high shadow costs of public funds. Because our analysis focuses on the micro-economic outsourcing decision of a particular project, we take the shadow cost of public funds as given.
The Auriol and Picard study compares two regimes, a regulation regime and an outsourcing regimes.
In the regulation regime, a utilitarian government decides to set up a regulated firm run by a public manager. The government controls the investment and production decisions of the regulated firm and is therefore accountable for its profits and losses. Such a combination of control rights and accountability duties is typical of public ownership. The government designs incentive contracts to entice the firm’s manager, who has private information about the firm’s cost, to set the efficient level of production at some informational cost.
In the outsourcing regime, a private investor is invited to serve the market, possibly in exchange for a franchise fee. The private investor gains control and cash-flow rights on the outsourced activity. She controls the investment and production decisions and therefore is fully accountable for her profits and losses. As it is, the private firm is allowed to set the laissez-faire monopoly prices. Yet, because laissez faire is not necessarily optimal, the government can improve welfare by offering ex post contracts to the private firm; that is, once investment costs have been sunk and uncertainties have been solved. Ex post contracts are used by governments to entice the private firm to reduce its prices and increase sales. They are designed to fight the deadweight loss generated by monopoly pricing. However, to accept such ex post contracts, the private investor must at least obtain her laissez-faire profit, which raises her participation constraint to the scheme. The right panel of Figure 1 illustrates this point; the private firm’s profit under outsourcing (in blue) is everywhere larger than the private monopoly profit (in green).

What Auriol and Picard are able to show is that the optimal outsourcing contracts are more selective than the contracts under public management. By this they mean that low-cost private firms are offered ex post contracts that lead them to produce the regulated outcome, whereas high-cost private firms are not.
As a result the level of production under outsourcing is the maximum of the level of production under laissez-faire and regulation. The left panel of Figure 1 illustrates this point by showing the output levels under regulation (in red), laissez-faire (in green) and outsourcing (in blue).

This result is intuitive. At the contracting stage, the public manager of the regulated firm knows the cost parameter, whereas the government does not. She takes advantage of this information to obtain rents. To prevent managers of low-cost firms from inflating their cost reports, the government must reduce the output levels it asks to high-cost firms. Incentive issues can be so harsh that the output levels of high-cost firms become smaller than the output levels that they would achieve under laissez-faire. The left panel of Figure 1 illustrates this point by showing the firm with cost parameter β0 such that output is the same under regulation and laissez-faire. There is no point to offer an ex post contract to a private firm with this cost because its output level equals the government’s preferred output level. Ex post contracting and laissez-faire would yield the same consumer and producer surpluses. Consider next a firm with a cost larger than β0. If the government proposes an ex post contract to this firm, it is unable to get a surplus larger than under laissez-faire because incentive compatibility obliges it to distort its output downwards. Moreover, any transfer to this firm also increases the rents of all firms with lower costs. Because the government is harmed by both effects, it offers no ex post contract to firms with such large costs. The government thus has no obligation to subsidise the high-cost firms under outsourcing, and expected transfers to private firms are lower. In the right panel of Figure 1, the private firm’s profit under outsourcing (in blue) is smaller than the public manager’s rent under regulation (in red) for most cost parameters.

Outsourcing hence generates a positive fiscal effect because the government is able to terminate subsidies to those money-losing projects and possibly to collect a franchise fee from the private investor. Outsourcing also generates an economic surplus effect, as production can be higher under outsourcing than under a publicly managed firm, as illustrated by the left panel in Figure 1.

Comparing aggregate welfare in regulation and outsourcing scenarios, we show that the set of economic parameters supporting the outsourcing decision is far from negligible. Moreover, we find that outsourcing is more desirable for activities with stronger technological uncertainty or lower profitability and for governments with tougher financial constraints. This provides a useful grid for policy analysis of outsourcing decisions and public-private partnerships in practice.
Auriol and Picard use the pharmaceutical industry as an example of a high-technology industry that takes large investment risks and that receives, consistent with the optimal outsourcing scheme, ex post contractual arrangements from governments according to their effectiveness. These private pharmaceutical firms are able to choose their investments in R&D and the prices for their patented drugs. But their most effective drugs are subsidised by governments’ health insurance programs. Under such subsidies, consumption is higher than under laissez-faire, where no reimbursement is made.

Auriol and Picard also give examples of outsourcing in low-profit sectors.
Postal services are outsourced to grocery stores and to gas stations in rural areas of France, Sweden, and New Zealand. Our results suggest that such outsourcing policies are welfare-improving; the consumers get a service at extended business hours, the shop owners get additional revenue, and taxpayers shoulder lower subsidies. Similarly public transport is outsourced to local taxi companies in rural France, Switzerland, and Canada. The European Commission has subsidy programs that promote and finance such “taxibus” services. Taxi companies or drivers invest in their fleets and are free to operate their business. They nevertheless get subsidies to provide a public service that allow them to make higher profits than under laissez-faire. In low-density areas, this additional revenue is crucial for their economic survival. More importantly, this solution offers a better quality of service to the users at a lower public cost
Finally they discuss very poor countries. In such places
[...] outsourcing takes the extreme form of laissez-faire and is optimal for low-profitability segments. Sub-Saharan African water, electricity and transport services to the middle class and the poor are often offered by private enterprises without any subsidy. Because those countries have very tough budget constraints, even with the monopoly distortion, it is better than not to have a service at all.
  • Auriol, Emmanuelle and Pierre M. Picard (2009), “Government Outsourcing: Public Contracting with Private Monopoly”, Economic Journal, 119(540), 1464-1493.
  • Grout, Paul (2009), “Private delivery of public services,” Vox Talks,, 19 June.

Tuesday, 24 November 2009

I am a binge drinker

At Offsetting Behaviour Eric Crampton reports
According to Barry Jackson (Radio NZ interview), if you've consumed 5 standard drinks in one day anytime in the last month (4 for women), you're a light binge drinker. If you've done it once in the last two weeks, you're a moderate binge drinker.

The pint of Emerson's JP I had the other night was 3.3 standard drinks. Combine that with a pint of anything else, and you've just had a binge drinking session.
Well Eric isn't the only "light binge drinker". Last weekend I went down to Timaru to see a friend and on Friday night enjoyed a bottle of the 2006 vintage Ata Rangi Pinot Noir. Now, from memory a bottle of wine is well over 5 standard drinks, nearer 7-8. This means that my very enjoyable evening was a binge drinking session! Not that I had noticed.

If drinking a bottle of wine is binge drinking, then given the amount of wine dunk in this country, New Zealand really must have a huge binge drinking problem! Either that or Jackson needs to revisit his definition of "binge drinking".

Eric goes on to say,
He [Jackson] lauds the American system where drunk in public is a criminal offense and where having an alcohol conviction can mean you're forbidden from practicing in any of some 40 different professions requiring registration.
Again if drinking a bottle of wine can get you banded from practising in any of 40 different professions, one wonders how many people there would be left in our professions.

Eric also goes on to
[...] wonder how long 'till he starts pushing for legislation against "drunk at home" as well...
Indeed. The wowsers really are coming out of the woodwork.

EconTalk this week

Carmen Reinhart of the University of Maryland talks with EconTalk host Russ Roberts about the ideas in her book This Time is Different: Eight Centuries of Financial Folly (co-authored with Kenneth Rogoff). They discuss the role of capital inflows in financial crises, the challenges of learning the right lessons, and what is generally true about financial crises over time and place. Reinhart applies these observations to the current crisis, discusses the possibility of the U.S. defaulting on its sovereign debt, and discusses the possibility of financial reforms that might make a difference.

Fiscal policy research

New research on fiscal policy by Alberto Alesina and Silvia Ardagna looks at Large changes in fiscal policy: taxes versus spending. The abstract tells us,
We examine the evidence on episodes of large stances in fiscal policy, both in cases of fiscal stimuli and in that of fiscal adjustments in OECD countries from 1970 to 2007. Fiscal stimuli based upon tax cuts are more likely to increase growth than those based upon spending increases. As for fiscal adjustments those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases. In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions. We confirm these results with simple regression analysis. (Emphasis added.)
Tax cuts have something going for them after all.

Monday, 23 November 2009

Religious identity and economic behaviour

A new study on Religious Identity and Economic Behavior by Daniel J. Benjamin, James J. Choi and Geoffrey Fisher finds that Protestants were more likely than Jews or Catholics to contribute money to a public pool. The Protestants also worked hardest for wages in a labour market game.

The paper's abstract reads,
We identify the marginal effect of religious identity on economic choices by measuring how laboratory subjects’ choices change when their religious identity is made salient to them. We find that Protestantism increases contributions to public goods, and there is suggestive evidence that it increases reciprocity in a labor market gift-exchange game. Catholicism decreases contributions to public goods, increases reciprocity, and decreases risk aversion. Judaism increases reciprocity. We find no evidence of religious identity effects on discount rates or generosity in a dictator game
God knows what it all really means.

How much greenhouse gas emission abatement is enough?

In a column at Richard S.J. Tol, Research Professor at the Economic and Social Research Institute (Dublin) and the Professor of the Economics of Climate Change at the Vrije Universiteit Amsterdam, asks How much greenhouse gas emission abatement is enough?
Climate change will have widespread negative effects of uncertain magnitude. But this column argues that climate change is not humanity’s biggest challenge and needs to be solved without impeding economic development. It calls for a measured policy of greenhouse gas emission reduction.
While calling for a measured policy of greenhouse gas emission reductions Tol also says that there is reason to believe that European climate policy is overly ambitious while climate policy outside Europe is surely not ambitious enough.

Adam Smith said it

Here is an not often seen quote from Adam Smith that I'm not really sure what to make of,
"A half-starved Highland woman frequently bears more than twenty children, while a pampered fine lady is often incapable of bearing any, and is generally exhausted by two or three. Barrenness, so frequent among women of fashion, is very rare among those of inferior station. Luxury in the fair sex, while it enflames perhaps the passion for enjoyment, seems always to weaken, and frequently to destroy altogether, the powers of generation." --Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (1776)
(HT: James R. Otteson)

Excellent letter to the editor

Eric Crampton has sent an excellent letter to the editor of the The Press in response to their weekend editorial on alcohol related harms. Eric writes
Your editorial of 21 November quoted alcohol-related harm as costing New Zealand some $5 billion per year. As Matt Burgess and I rather painstakingly showed in June of this year, BERL's tabulation of $4.8 billion hinged critically on several assumptions that fall somewhat outside the normal bounds of economic analysis. Most importantly, the figure tallies all costs that drinkers impose on themselves while assuming those drinkers receive zero gross benefit from their consumption. When we applied more standard economic method, we found that the net external cost of harmful alcohol use -- the costs drinkers impose upon others -- roughly matches the total alcohol excise tax take. The $5 billion figure is not a sound measure of any reasonable notion of social cost. Australia's figure, produced using similar method, is equally unsound. I urge you to use more caution in the use of such statistics. After all, shonky-figure-related harm costs the country more than $5 fiffillion per month.

Thursday, 19 November 2009

Supply and demand or what?

This report from Reuters is of comments about oil prices made by energy consultant Daniel Yergin recently in Singapore:
"Oil prices today do not reflect the world's supply and demand fundamentals. Instead, prices are reflective of the weak dollar and expectations of a strong economic recovery," Yergin told reporters on the sidelines of a conference.
This seems odd to me. Isn't it true that all that is being said here is that expectations matter? It isn't supply and demand that's important, rather its expectations about supply and demand that matters. But don't the ideas of supply and demand today embed expectations about the future, so what Yergin is saying is that it isn't supply and demand that matter, its ... well ... supply and demand that matters.

Interesting blog bits

  1. Carpe Diem on More Selective Concern on Sex Imbalances.
  2. David Friedman on The Ambiguity of "Utility". Do economists and the philosophers think of utility in the same way?
  3. Bryan Caplan on The Effect of Children on Happiness: The Latest from the Research Frontier.
  4. Arnold Kling on The Economics of Electric Cars.
  5. Eric Crampton on Returns to Office. In the UK research finds that serving in office almost doubled the wealth of Conservative MPs, but had no discernible financial benefits for Labour MPs.
  6. Al Roth on Louis Menand on the market for PhDs in English. "What the surveys suggest is that if doctoral education in English were a cartoon character, then about 30 years ago, it zoomed straight off a cliff, went into a terrifying fall, grabbed a branch on the way down, and has been clinging to that branch ever since. Things went south very quickly, not gradually, and then they stabilized. Statistically, the state of the discipline has been fairly steady for about 25 years, and the result of this is a kind of normalization of what in any other context would seem to be a plainly inefficient and intolerable process. The profession has just gotten used to a serious imbalance between supply and demand." "
  7. Peter Klein on Keynesian Anti-Economics

Chris Berry on Adam Smith

Chris Berry, Professor of Political Theory at University of Glasgow is a leading expert on the life and work of one of the University of Glasgow's most famous academics, Adam Smith.

In this 10 minute talk, Professor Berry describes the making of the man, the global significance of his writing and explains why Smith's work still resonates with us today.


Adam Smith was born in Kirkcaldy in 1723. He entered Glasgow University at the early - but for the time not unusual - age of fourteen.

He studied logic, metaphysics, maths and later Newtonian physics and moral philosophy under some of the leading scholars of the day. In 1740 Smith was awarded a Snell Scholarship (which is still in existence today) to study at Balliol College, Oxford. Smith preferred Glasgow, however, because Oxford’s curriculum was antiquated and he thought the teachers were lazy since, in contrast to Glasgow, their salary did not depend on the number of students taught.

After a period of freelance lecturing, Smith returned to Glasgow University, first as Professor of Logic in 1751 and then a year later as Professor of Moral Philosophy, a post he held until he left academia in 1764.

The mid-eighteenth century saw a period of intense intellectual activity, known as the Scottish Enlightenment. Universities were key players in this outburst of enquiry, with Glasgow a major force. Smith himself is of course the figure of overwhelming historical significance. But he was not alone. Smith’s fellow professoriate included pioneering chemists William Cullen and Joseph Black, as well as engineer and inventor James Watt who also worked at the University). Another historically important figure is a pupil of Smith’s, John Millar. Who became Professor of Jurisprudence and the author of a key work in what we would call historical sociology.

The seeds of Smith's two great books were sown in his professorial years. The Theory of Moral Sentiments appeared in 1759 and drew on his lectures. It went through six editions in his lifetime. Smith’s intellectual range as a lecturer was extensive. Beyond courses in philosophy and jurisprudence he also discussed history, literature and language. He maintained his interest in science and wrote an essay on the history of astronomy. This is notable not only for the breadth of Smith’s knowledge but also as an attempt to link the development of different astronomical accounts to a basic human propensity to seek order.

Although his second great book the Wealth of Nations was published in 1776 we know that he had already considered many of its leading themes at Glasgow as he lectured on as he put it: 'those arts which contribute to subsistence, and to the accumulation of property, in producing correspondent movements or alterations in law and government'. In 1787 Smith was elected Rector of the University and in a letter of thanks remarked that he remembered is professorial days as 'by far the most useful and therefore as by far the happiest and most honourable period of my life'.

If Smith of popular repute is the ‘father of capitalism’, the advocate of ‘market forces’, the enemy of government regulation and believer in something called the ‘invisible hand’ to produce optimum economic outcomes then he would be a disappointed parent. All his work is deeply steeped in moral philosophy. Indeed the simple fact that the final edition of the Moral Sentiments containing extensive revisions appeared in 1790, the year of his death, tells us is that Smith’s commitment to the moral point of view endured alongside and beyond the publication of the Wealth of Nations.

The Moral Sentiments is a leading example of a particular approach to moral philosophy – one that regards it not as sets of rationally or Divine ordained prescriptions but as the interaction of human feelings, emotions or sentiments in the real settings of human life. In many ways it is a book of social and moral psychology. What we can call economic behaviour is necessarily situated in a moral context. But more than that the key theme of the book is an opposition to the view that all morality or virtue is reducible to self-interest. Indeed his opening sentence declares that everyday human experience proves that false, he writes: "How selfish soever a man may be supposed, there are evidently some principles in his nature which interest him in the fortune of others, and render their happiness necessary to him, though he derive nothing from it except the pleasure of seeing it".

Our morality is founded on certain truths about human nature. Everyone is capable of sympathy, or fellow-feeling, and that ability enables us to imagine what we would feel if we were in the situation of another and, once we have made that imaginative move, we can then judge whether those feelings are appropriate. We have to learn about ‘situations’ but Smith believes that happens because humans are social creatures.

Smith illustrates the natural fact of human sociality by likening society to a mirror. It is this responsiveness to others - pleasure in their approval, pain in their disapproval - that Smith used to explain why the rich parade their wealth while the poor hide their poverty. The rich value their possessions more for the esteem they bring than any use they get from them and it is this disposition to "go along with the passions of the rich and powerful" that establishes the foundation for distinctions of status. And it is this desire for esteem that explains the incentive, we all possess, to better our condition. This is one of the links between the Moral Sentiments and the Wealth of Nations. In many ways the moral interactions Smith describes in Moral Sentiments bear on the practices that characterise his contemporary commercial society. The very complexity of that society meant that the bulk of inter-personal dealings were with strangers.

A ‘society of strangers’ is a commercial society which Smith identifies in the Wealth of Nations as one where 'everyman is a merchant'. A commercial society's coherence - its social bonds - do not depend on love and affection. You can coexist socially with those to whom you are emotionally indifferent. As Smith famously said:

“it is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves not to their humanity but to their self-love and never talk to them of our own necessities but of their advantages. Nobody but a beggar chuses to depend chiefly upon the benevolence of his fellow-citizens”

Nothing in this means that Smith is denying the virtuousness of benevolence. When Smith came to write the Wealth of Nations he made it clear that the ‘wealth’ lay in the well-being of the people. This covered not only their material prosperity but also their moral welfare. Accordingly he thought to be in poverty is to be in a miserable condition and commerce is to be praised for improving human life.

The great achievement of the Wealth of Nations was to discern the principles of order in the seeming chaos of commercial or market behaviour – it wasn’t random, it could be reduced to some simple principles. It was for this reason that Smith was described as the Newton of political economy. It is no idle fact that the full title is Inquiry into Nature and Causes of the Wealth of Nations.

He identifies basic principles such as the human propensity to ‘truck, barter and exchange’ that he argues underlies the division of labour but says that this depends on a market and that requires some institutional structures like those that uphold justice such as government and how that in turn mutually relies on principles of public finance.

All of this is placed by Smith into a historical narrative. In his Glasgow lectures he had outlined an account of four stages of social organisation focused around the characteristic form of economic endeavour – hunter-gatherer, herder, farmer, commerce - and in the Wealth of Nations he gives a set-piece account of the transition from the farming to commerce. This process of social change was not brought about by deliberate human policy. This fact reveals for Smith a general truth about social life, namely, that it is pervaded by unintended consequences. This supports the widely-held view of Smith as an opponent of attempts to direct ‘the market’ but, in fact, what he really opposes is the attempt to direct individual’s activities, their ‘natural liberty’ to pursue their own ends in their own way. This is itself a ‘moral’ position and Smith never abandons that perspective.

In the opening chapters of the Wealth of Nations, he celebrates the productiveness of the division of labour with the example of pin-makers but later notes that those whose lives were spent performing a "few simple operations" were rendered "stupid and ignorant" and were incapable of "forming any just judgment concerning many even of the ordinary duties of private life". The 'morality' into which these individuals are socialised is defective; the 'mirror' in which they see themselves reflects back to them to their "mutilated" condition. This is the probable course of events, says Smith, unless "the public" takes remedial steps by instituting a subsidised system of elementary schooling. This example clearly illustrates how Smith's social and moral theories cannot be fully understood in isolation and must be seen as a whole.

Adam Smith’s legacy has had global impact and it is fitting that the work of a world-historical figure was forged in this world-class University.

Wednesday, 18 November 2009

The effect of immigration on productivity

A new NBER Working Paper, No. 15507, by Giovanni Peri looks at The Effect of Immigration on Productivity: Evidence from US States. The abstract reads,
Using the large variation in the inflow of immigrants across US states we analyze the impact of immigration on state employment, average hours worked, physical capital accumulation and, most importantly, total factor productivity and its skill bias. We use the location of a state relative to the Mexican border and to the main ports of entry, as well as the existence of communities of immigrants before 1960, as instruments. We find no evidence that immigrants crowded-out employment and hours worked by natives. At the same time we find robust evidence that they increased total factor productivity, on the one hand, while they decreased capital intensity and the skill-bias of production technologies, on the other. These results are robust to controlling for several other determinants of productivity that may vary with geography such as R&D spending, computer adoption, international competition in the form of exports and sector composition. Our results suggest that immigrants promoted efficient task specialization, thus increasing TFP and, at the same time, promoted the adoption of unskilled-biased technology as the theory of directed technologial change would predict. Combining these effects, an increase in employment in a US state of 1% due to immigrants produced an increase in income per worker of 0.5% in that state.
The results look good for the effects of immigration on local economies. Something New Zealand should keep in mind.

Time for U.S. to declare bankruptcy?

Scott Beaulier and Peter L. Boettke ask this question in this piece in the East Valley Tribune. Drawing on the discussion of the public debt by a guy called Adam Smith, Beaulier and Boettke write,
Rather than erode debt obligations through inflation, the debt could be repudiated through bankruptcy proceedings. Like individual bankruptcy cases, the United States government would admit that it is unable to pay off existing debts. The repudiation would force future politicians to credibly commit to sounder economic policies and, perhaps, would help to avoid future cycles of deficits, debt, and debasement.

Of course, our call for debt repudiation is not a new one. Like many good ideas in economics, Adam Smith was there long before us. “When it becomes necessary for a state to declare itself bankrupt ... a fair, open, and avowed bankruptcy ... is both least dishonourable to the debtor, and least hurtful to the creditor,” he argued. In other words, when the financial storm arrives — and it will — the juggling tricks must stop.
I like this idea!

EconTalk this week

Richard Posner, federal judge and prolific author, discusses the financial crisis with EconTalk host Russ Roberts. Posner (despite the title of his recent book on the crisis, A Failure of Capitalism) places most of the blame for the crisis on the Federal Reserve, inattentive regulators and the subsidization of risk. He also criticizes economists for complacency in the face of impending disaster. A recent convert of sorts to Keynesianism, Posner confesses some disillusion with the implementation of the stimulus plan and the expanding role of the Federal government.

Monday, 16 November 2009

Nonsense upon stilts

At Offsetting Behaviour Eric Crampton posts an article he wrote for NORML on the New Zealand Drug Harm Index. See here. Eric opens by saying,
If the New Zealand Drug Harm Index is nonsense, then Detective Senior Sergeant Scott McGill’s claim that recent police action against marijuana prevented $379 million in social harm is nonsense upon stilts. Social cost measures provided in reports like the “New Zealand Drug Harm Index” and “Costs of Harmful Alcohol and Other Drug Use” are very good at providing very big numbers related to harms but are not terribly useful for public policy purposes. We’ll here contrast the method used in these kinds of reports with proper economic analysis.
There is a real issue here, in that some of the economics underlying these types of "social harm" indexes is just plan bad. When discussing the infamous BERL report on the cost of alcohol Eric writes,
In sum, social cost measures like those derived in BERL’s report of the costs of harmful alcohol use differ substantially from economic notions of social costs and consequently are of very limited policy relevance.
Eric then goes on to discuss the Drug Harms Index. He points out that there are common features between the alcohol cost report and the drug harm report. He concludes that
In sum, the Drug Harms Index mixes together costs of drug use with costs of prohibition and costs borne by drug users with costs imposed by drug users on others so opaquely that it is difficult to say to what possible policy use their numbers can be put. This is truly disappointing; a proper measure that provided the different categories of harms could be very useful in helping to decide which drugs would best quickly be legalized and which might be of lower priority. If it were the case that the vast majority of the costs of marijuana use were really costs associated with prohibition and if external costs were relatively low, a very good case could be made for legalization combined with an excise tax to defray those external costs. If it were the case that methamphetamine were associated with very high relative costs, with most of those costs being due to drug use rather than to prohibition, and with a greater proportion of those costs falling on external parties, that would provide a reason to legalize marijuana while keeping P prohibited. But we simply cannot say anything useful from the numbers as presented.
It seems that the main use of the report is in agitprop: providing big scary numbers with a sciency feel that can help to justify ongoing prohibitionist policies. After all, if the costs of drugs are over a billion dollars, we’d be crazy to even consider legalization, wouldn’t we? Well, maybe not if those costs accrue more to prohibition than to drug use. Unfortunately, from the report as it stands, we just cannot tell.
Bad economics can be used to justify almost anything, which is why reports such as those on the social costs of alcohol and the New Zealand Drug Harm Index need to be examined very carefully. People should not take them at face value. Read all of Eric's piece and you will come away with a healthy scepticism towards such measures.

Avoiding a new inflationary cycle

In this audio from, Domingo Cavallo, former minister of economy and minister of foreign affairs in Argentina, talks to Romesh Vaitilingam about the dangers of a future resurgence in world inflation, as economies that have adopted very expansionary monetary and fiscal policies in response to the crisis are tempted to ‘inflate away the debt’.

Was the Iraq war worth it?

This question is asked by Jeffrey Miron at the Libertarianism, from A to Z blog. His conclusion:
My forecast for Iraq's future: renewed violence between Sunni and Shiite as the U.S. funding that has temporarily bought peace dwindles. And any pretense of democracy will vanish. In the end we will have replaced one authoritarian state with another, at enormous cost.
Ending up were you began, at a huge cost, doesn't look like good economics.

Self-interest is not selfishness

This point is made over at the Adam Smith's Lost Legacy blog by Gavin Kennedy with regard to the writings of Adam Smith.
‘Self-interest’ and ‘self-love’ in 18th-century discourse did not mean selfishness and were clearly distinguished.

Bernard Mandeville (1724) celebrated selfishness as a virtue (as did Ayn Rand in the 20th century). Smith regarded Mandeville’s teachings as “licentious” (Moral Sentiments, 1759: TMS VII.ii.4: 306-14)).
But the point is more general. When economists say we are self-interested they do not necessarily mean that we are selfish, as many non-economists seems to think. Selfishness may be sufficient for self-interest, but it is not necessary.

Friday, 13 November 2009

Paul Milgrom on market design

This video is of Paul Milgrom's 2009 Nemmer's Prize Lecture on "The Promise and Problems of Market Design".

The abstract of Milgrom's talk is:
"Market design has become an exciting area of economics research, with many of its findings useful for setting detailed rules in real markets. For matching markets, most proposed designs aim to be "straightforward" - making it a dominant strategy for participants to report information truthfully. But some recent matching and auction designs sacrifice incentive-compatibility conditions to give priority to various other desiderata. This lecture reviews the goals of market design and the unavoidable trade-offs that are sometimes required, and explores how economists should seek to resolve these trade-offs. "

Paul Milgrom Nemmers Prize Lecture from Steve Goldband on Vimeo.

Thursday, 12 November 2009

Incentives matter: football helmet file

This comes from a story in the Wall Street Journal about head injuries in football in the US. Are helmets part of the answer to head injuries or part of the cause? The incentives on how you play the game change depending on whether or not you are wearing a helmet.

The authors of the article write,
"Some people have advocated for years to take the helmet off, take the face mask off. That'll change the game dramatically," says Fred Mueller, a University of North Carolina professor who studies head injuries. "Maybe that's better than brain damage."
But while these helmets reduced the chances of death on the field, they also created a sense of invulnerability that encouraged players to collide more forcefully and more often.
What nobody knew at the time is that these small collisions may be just as damaging. The growing body of research on former football players suggests that brain damage isn't necessarily the result of any one trauma, but the accumulation of thousands of seemingly innocuous blows to the head.

The problem is that there's nothing any helmet could do to stop the brain from taking lots of small hits. To become certified for sale, a football helmet has to earn a "severity index" score of 1200, according to testing done by the National Operating Committee on Standards for Athletic Equipment, or Nocsae. Dr. Robert Cantu, a Nocsae board member and chief of neurosurgery at Emerson Hospital in Concord, Mass., says that to prevent concussions, helmets would have to have a severity index of 300—about four times better than the standard. "The only way to make that happen, Dr. Cantu says, "is to make the helmet much bigger and the padding much bigger."

The problem with that approach, he says—other than making players look like Marvin the Martian—is that heavier helmets would be more likely to cause neck injuries.
The article also makes an interesting comparison,
One of the strongest arguments for banning helmets comes from the Australian Football League. While it's a similarly rough game, the AFL never added any of the body armor Americans wear. When comparing AFL research studies and official NFL injury reports, AFL players appear to get hurt more often on the whole with things like shoulder injuries and tweaked knees. But when it comes to head injuries, the helmeted NFL players are about 25% more likely to sustain one.

Andrew McIntosh, a researcher at Australia's University of New South Wales who analyzed videotape, says there may be a greater prevalence of head injuries in the American game because the players hit each other with forces up to 100% greater. "If they didn't have helmets on, they wouldn't do that," he says. "They know they'd injure themselves."
This is just the latest example of what economists call the Peltzman Effect. That is, the tendency of people to react to a safety regulation by increasing other risky behaviour, offsetting some or all of the benefit of the regulation.

Wednesday, 11 November 2009

The effect of maternal fasting during pregnancy

This audio comes from In it Douglas Almond of Columbia University talks to Romesh Vaitilingam about his research with Bhashkar Mazumder on women who are pregnant during the Islamic holy month of Ramadan and the impact of fasting on their children – in terms of birth weight and the likelihood of being a boy or girl, as well as later life health outcomes.

Interesting blog bits

  1. Brad Taylor on Corporatism in Everything or: How to Have Government Work for You without Resorting to Bribery
  2. BK Drinkwater is Paging Brad Taylor
  3. BK is also talking about The Corporatism Files: Diaries
  4. Eric Crampton on Heresthetics
  5. Peter Klein get us some Coasean Humor
  6. Céline Carrère and Jaime de Melo ask Has distance died? The distance puzzle is the surprising finding that the volume of trade has become increasingly sensitive to distance. This column shows that low-income countries, which increasingly trade with geographically closer partners, drive the finding. This regionalisation of trade for low-income countries may reflect progress – or problems.

Tuesday, 10 November 2009

Arnold Kling on economic development

In this Cato Daily Podcast Arnold Kling talks about what drives economic development.
Innovation and entrepreneurship are amazingly good things ... and predatory government and corruption are amazingly bad things.

More unemployment, less crime

This from Tyler Cowen at Marginal Revolution,
With a lot more unemployed people, a lot more people are staying home, and they see more in their neighborhood," said Sgt. Thomas Lasater, who supervises the burglary unit of the police department in St. Louis County, Mo., where authorities recorded a whopping 35 percent drop in burglaries during the first six months of 2009.
An upside to unemployment. Cowen also notes another possible factor helping reduce burglaries,
The falling price of raw materials -- which had been producing copper and other thefts -- may be another reason for the change in trend.

EconTalk this week

Scott Sumner of Bentley University and the blog The Money Illusion talks with host Russ Roberts about monetary policy and the state of the economy. Sumner argues that tight money in late 2008 precipitated the recession. He argues that the standard measures of monetary policy--growth in reserves or the Federal Funds rate--are misleading. Sumner suggests focusing instead on nominal GDP. He argues that the failure of the Fed to counter the drop in nominal GDP in late 2008 intensified the recession and points to the growth in unemployment. Along the way he discusses the Taylor Rule and other monetary prescriptions.

Monday, 9 November 2009

Offshoring and local employment

How do firms who offshore change their local workforce? According to this article at offshoring is one of the reasons that firms, in Germany at least, employ more highly educated workers at home. In the article Sascha O. Becker, Karolina Ekholm and Marc Muendler say
This column, using evidence from German multinationals, shows a positive correlation between offshoring and the firm’s proportion of highly educated workers. Offshoring firms have relatively more domestic jobs involving non-routine and interactive tasks. But offshoring is far from the only explanation for the shift towards more educated employees carrying out more advanced tasks.
The articles authors argue there are two important lessons from their work,
  • First, at the level of the individual firm, offshoring seems to be associated with a shift towards more educated workers. We also report a positive correlation between the increase in offshoring and the proportion of highly educated workers in the firm. Both these results suggest that offshoring is associated with an increased relative demand for more educated workers, as traditional theories would predict.
  • Second, our results support the view that the degree to which jobs involve non-routine and interactive tasks is relevant for their propensity to be offshored.

Famine and a free press

In a comment to the posting Famine and trade, John Small notes the argument by Amartya Sen that no substantial famine has ever occurred in a country with a relatively free press,
I have discussed elsewhere the remarkable fact that, in the terrible history of famines in the world, no substantial famine has ever occurred in any independent and democratic country with a relatively free press. We cannot find exceptions to this rule, no matter where we look: the recent famines of Ethiopia, Somalia, or other dictatorial regimes; famines in the Soviet Union in the 1930s; China's 1958-61 famine with the failure of the Great Leap Forward; or earlier still, the famines in Ireland or India under alien rule. China, although it was in many ways doing much better economically than India, still managed (unlike India) to have a famine, indeed the largest recorded famine in world history: Nearly 30 million people died in the famine of 1958-61, while faulty governmental policies remained uncorrected for three full years. The policies went uncriticized because there were no opposition parties in parliament, no free press, and no multiparty elections. Indeed, it is precisely this lack of challenge that allowed the deeply defective policies to continue even though they were killing millions each year. The same can be said about the world's two contemporary famines, occurring right now in North Korea and Sudan. (Amartya Sen, "Democracy as a Universal Value", Journal of Democracy 10.3 (1999) 3-17)
But I won't mind betting that there is a positive correlation between countries who allow relatively free trade and countries who have a relatively free press. Economic and political freedoms go together. Milton Friedman, for example, argued in "Capitalism and Freedom" that economic freedom is not only desirable in itself but is also a necessary condition for political freedom.

Friday, 6 November 2009

Famine and trade

Famine is an all too common fact of life in many parts of the world. But why do these areas suffer from such food shortages? Climate change? Lack of aid to the effected regions? In an article in the Wall Street Journal Julian Morris argues that we should blame famine on neither of these two reasons. He explains that we should blame famine on trade restrictions, not on climate change or a lack of Western aid. Morris writes,
Although thousands of individuals like Ms. Weldu have been saved by Western charity and taxes, millions more have suffered and died needlessly from famine in East Africa in the past quarter century. But their suffering was not caused by a lack of aid. Nor was it caused primarily by climate change (Western-induced or otherwise). Rather, it was and is the result of policies in the affected countries that inhibit freedom and incentives to trade, own land, and invest in diverse, prosperity-enhancing economic activities.
and continues,
Since the 1920s, global deaths from drought-related famines have fallen by 99.9%. The reason? Continued specialization and trade, which has skyrocketed the amount of food produced per capita, and has enabled people in drought-prone regions to diversify and become less vulnerable.

In places where trade is restricted, people are forced to remain subsistence farmers. So, when drought occurs, the majority suffer and many die.

Children and happiness

Children and happiness, a posting for Eric. One common result from empirical studies on the happiness of people is that the number of children has a negative impact on happiness indicators. The more kids, the lower the happiness of people. This rises an obvious question: Why would people have children? Bad luck? Social pressures? Stupidity? An less obvious answer to this question is that the empirics underlying the result are flawed.

Over at the Economic Logic blog it is noted that
Leonardo Becchetti, Elena Giachin Ricca and Alessandra Pelloni find that the typical way the empirical studies are conducted is flawed. Among the controls, there is usually income. But this make it difficult to disentangle the monetary for the non-monetary impact of children. Using equivalised household income (income adjusted for the number of people in the household) allows to focus only on the impact on happiness, and children now have a positive impact. Decomposing their sample (the German Socio-Economic Panel), they find that opportunity costs do matter. Theory is saved.
So two kids is better than just one.

Government failure versus market failure

John B. Taylor looks at Government Failure versus Market Failure at his blog Economics One. He writes,
Cliff Winston of the Brookings Institution carefully reviews three decades of empirical research on a wide range of microeconomic policy studies in his important book Government Failure versus Market Failure. He comes to the same basic conclusion; as he puts it "thirty years of empirical evidence... suggests that the welfare cost of government failure may be considerably greater than that of market failure."
Taylor makes the point that government failure should be at the top of the list of what went wrong in the recent financial crisis,
My Forbes magazine column this week reviews the latest empirical evidence on why government actions and interventions--government failure rather than market failure--should be at the top of the list of what went wrong in the recent financial crisis. Some continue to be surprised by my finding. While I focus on macroeconomic policy, mainly monetary policy and fiscal policy, my finding that government failure rather than market failure rises to the top of the list is not at all unsual in the broader context of empirical policy evaluation research.
This last sentence is supported by the Winston book.

Thursday, 5 November 2009

John Stuart Mill, "On Liberty"

Mill makes a basic point which the government should consider much more deeply and often:
The object of this Essay is to assert one very simple principle, as entitled to govern absolutely the dealings of society with the individual in the way of compulsion and control, whether the means used be physical force in the form of legal penalties, or the moral coercion of public opinion. That principle is, that the sole end for which mankind are warranted, individually or collectively in interfering with the liberty of action of any of their number, is self-protection. That the only purpose for which power can be rightfully exercised over any member of a civilized community, against his will, is to prevent harm to others. His own good, either physical or moral, is not a sufficient warrant. He cannot rightfully be compelled to do or forbear because it will be better for him to do so, because it will make him happier, because, in the opinions of others, to do so would be wise, or even right. These are good reasons for remonstrating with him, or reasoning with him, or persuading him, or entreating him, but not for compelling him, or visiting him with any evil, in case he do otherwise. To justify that, the conduct from which it is desired to deter him must be calculated to produce evil to some one else. The only part of the conduct of any one, for which he is amenable to society, is that which concerns others. In the part which merely concerns himself, his independence is, of right, absolute. Over himself, over his own body and mind, the individual is sovereign.

Why Armen Alchian should win the Nobel Prize

A posting for Brad Taylor. Fred S. McChesney makes the case as to why Armen Alchian should win the Nobel Prize in economics in this article: Armen Alchian: An Economist-Lion in Winter.

The virtues of limiting executive pay

Yes there are virtues to limiting executive pay. Bruce Yandle makes the case in his article, Regulating Executive Pay Can Reduce Systemic Risk: If they are the right executives,
Yes, it is high time that pay and investment guidelines be mandated for all top level executives who may in the normal course their daily work push the entire economy too close to or even over the edge of systemic risk falls. If nothing else, this Great Recession has taught us that top executives can practically capsize the economy.

But the chief concern is not with presidents and vice presidents of too-big-to-fail banks and other bailed-out enterprises. As large as they are, they are small potatoes relative to the big generators of systemic risk. The critical concern is with top government executives who can create national and international panic, lay the groundwork for international inflation or deflation, and just by voting and writing regulations can change the risk profile of entire industries.
In other words limiting the effects and the creation of regime uncertainty can only help the economy.

More on George Soros's "Institute for New Economic Thinking"

Donald J. Boudreaux sent the following letter to the Financial Times,
Sir, You report (October 27) that George Soros is committing $50m to start a new think-tank whose purpose will be to displace what he considers (as you summarise it) “the unwavering belief in unchecked free markets, which remains pervasive in universities”. Or, to quote Mr Soros directly: “The ideologists in the free markets are still in command and I think they’ll be very difficult to remove because they have tenure.”

Mr Soros should check his facts before wasting his money. As my colleague Bryan Caplan writes in The Myth of the Rational Voter (2007), surveys show that, while economists are to the right of their university colleagues in other disciplines, “compared to the general public, the typical economist is left of centre”.
In other words Soros is trying to fix a problem that doesn't exist. Or may be he just want economists to be even more left-wing.