Interesting blog bits

1. Bjorn Lomborg suggests A Better Way Than Cap and Trade.
2. Tyler Cowen tells us that Leonid Hurwicz passes away at 90.
3. Michael Giberson blogs on Electricity market pricing and how to think about it.
4. The Economist studies the economics of inflation expectations.
5. Megan McArdle blogs on Gun statistics.
6. Eric Crampton reviews "Predictably Irrational: The hidden forces that shape our decisions" by Dan Ariely.
7. Bryan Caplan asks Aren't Voters Disgusting?

Are the Greens a communicable disease?

From Kiwiblog we learn that

The ultimate nanny state bill is being pushed through Parliament, having survived select committee. And the Greens say:

The Green Party said the bill would mean the health minister could issue regulations to reduce the risk associated with non-communicable disease.

“Given that poor diet is the leading cause of preventable illness and disease, it is vital that we take steps to create an environment which encourages healthy eating in New Zealand.”

The party said it was strange that there were virtually unlimited powers to prevent communicable diseases but little to prevent or respond to non-communicable diseases.

I may be missing something, but what is strange about the fact that governments have powers to deal with the problems caused by communicable diseases but little power to respond to non-communicable diseases. After all the diseases are .... well .... non-communicable.

Aren't the powers the government has there precisely because the diseases are communicable, that is they could have large negative externalities associated with them. What are the negative externalities of non-communicable diseases? You having bubonic plague could affect me in a very direct and obvious way, without me knowing, until it's too late. So I may want the government to be able to take action to prevent you giving me the plague. But you are eating a "poor diet", how does that affect me? What, exactly, is the negative externality here?

1000 years of urban history

One of the biggest questions in economic history is Why did the Industrial Revolution begin in northwestern Europe? Why countries like England and Holland? Looking back to the turning of the first millennium, the chances of Europe becoming the economic power house of the world weren't great. It was a backward part of the world economy with low levels of urbanisation and income. But between 1000 and 1800, Europe surged from a backwater of the world economy to its most dynamic region. The big question is why?

There are many answers, or partial answers, to this question. Some scholars, like Douglas North, stress that socio-political institutions constraining the predatory actions of the state mattered most. But the likes of Avner Greif have challenged this view. Greif maintains that it was contracting institutions that mattered most. These facilitated economic exchange and this is what made the difference. Daron Acemoglu and Simon Johnson make the same distinction between 'vertical' socio-political institutions (property rights) and 'horizontal' economic institutions (contracting institutions). The evidence they present suggests that it is the vertical institutions that matter most for long-term economic growth.

This debate is continued in a recent paper, From Baghdad to London: The Dynamics of Urban Growth in Europe and the Arab World, 800-1800 by Maarten Bosker, Eltjo Buringh and Jan Luiten van Zanden. Bosker, Buringh and van Zanden provide a summary of their argument in a column at VoxEU.org.

The paper looks at the long-term development of the urban systems of Europe and the Arab world between 800 and 1800. Using a dataset of individual cities in Europe, North Africa and the Middle East, Bosker, Buringh and van Zanden are able to assess the importance of various factors that drove urban expansion. They argue that

Consideration of factors such as geography, religion, and institutional provides some answers to the question why, during this millennium, the urban and economic centre of gravity moved from Iraq, or more generally the Arab world, to Europe and the shores of the Atlantic in particular.

More specifically, we are able to provide insights into the relevance of the economic institutions governing exchange on the one hand and socio-political institutions on the other in a way that explains Europe’s rise and eventual overtaking of the Arab world in terms of economic prosperity.

They use the number and size of cities as a measure of economic performance. Their focus is on the existence and development of positive feedbacks between cities. In particular, they consider as to whether or not cities profit from other cities insofar as the presence of many, large, cities in a given city's neighbourhood acted as a spur to growth. An important section of their results concerns the changes that occurred in these neighbourhood effects over time.

Bosker, Buringh and van Zanden write

Our maintained hypothesis here is that a powerful neighbourhood effect signifies that the institutions governing exchange are efficient, so the growth of one city stimulates expansion in others. Our analysis shows some striking results.

From about 800 to 1200, the level of positive spillovers among Muslim cities was high – suggesting that the institutions governing exchange in the Arab world were efficient.

Around 800, the position of Arab cities was quite favourable. The Arab world enjoyed a highly integrated urban system reaching from Cordoba to Baghdad. Transaction costs were low as the region was politically united, shared a common language and a common (Islamic) legal system that included a number of institutions promoting exchange (such as the rule of using written contracts). There was also a highly efficient means of transportation between urban centres in the form of the caravan routes.6

During this same period, the neighbourhood effect did not exist in Europe. Europe did not have an integrated urban system, perhaps due to very high transport and transaction costs following the break-up of the Carolingian Empire around 900. Europe fragmented into a large number of political entities. Merchants spoke many different languages and a variety of legal regimes regulating exchange (Roman law in the south, customary law in the north) were in place.

As this period drew to a close, fundamental changes rocked both Europe and the Arab worlds – but with very different economic effects. Our empirical results for the 1000 to 1500 period show that Europe and the Arab world switched places in terms of their respective neighbourhood-effects.

Changes occurred from 1100 onwards. Europe started to enjoy an efficient urban system with positive feedbacks between cities which was based largely on on sea and river trade. This was in spite of the fact that it remained politically fragmented. By contrast, the neighbourhood effects stated to disappear in the Arab world. Bosker, Buringh and van Zanden note,

There the break up of the Abbasid Caliphate was eventually followed by a new empire, the Ottoman Empire. To some extent, this took over the role of its predecessor – but without restoring the efficient system for economic exchange that was present during the Golden Age of Islam.

An interesting result from the Bosker, Buringh and van Zanden study is the importance of religion to city growth.

Muslim cities interacted strongly positively with other Muslim cities, and Christian cities with Christian cities, but we find hardly any evidence of positive feedbacks between the two sets. This suggests that different institutions regulated exchange in these two worlds, and that exchange over religious borders was handicapped by much higher transaction costs, and oftentimes outright hostility, compared to exchange within each urban system.

The study also reveals insights into the socio-political situation in the two regions from looking at the differences between the two urban systems.

Cities in the Arab world were on average much larger than those in Europe, and the size of the “primate” city – the megapolis such as Baghdad, Damascus, Cairo or Istanbul – was much bigger; a fact that is indicative of a predatory state and low trade openness.7 Europe, on the other hand, developed a very dense urban system, with relatively small principle cities. Big cities in Europe were quite often located near the sea, being able to optimally profit from long-distance trade, whereas the largest cities in the Arab world were almost all inland.

The Arab cities were much more centres of government and military protection or occupation than the European cities. Arab cities provided services such as administration and protection in return for rentals from land, taxes and some non-market transactions. These cities were intimately linked to the state in which they are embedded. Growth in the state acted as a spur to growth in these cities. This was particularly true of the capital city.

European cities, on the other hand, had as their basis the production and exchange of goods and commercial services with the city's hinterland and other cities. The relationships between the city and the state were typically much weaker. This follows from the fact that these cities have their own economic bases. Bosker, Buringh and van Zanden go on to argue that

Between 1000 and 1300 Europe acquired an urban system dominated by typical producer cities, which prospered in spite of Europe’s political fragmentation. In fact, this fragmentation was strongly enhanced by the rise of independent communes – city-states, or cities with a large degree of local authority – which form the core of the political system of Europe’s urban belt stretching from Northern Italy to the Low Countries. Indeed, we still find this pattern in the so-called ‘Hot Banana’ – the industrial agglomeration that stretches from the southern UK to the Netherlands, through Germany and down to northern Italy.

Arab cities at this time were, by contrast, heavily influenced by strong, predatory states that could, and oftentimes did, impose a heavy tax or military burden on the cities in their realms. Under these predatory regimes it was typically only the capital city thrived, with this honour shifting from Baghdad to Damascus, Fez, Cairo and finally to Istanbul.

So why in Bosker, Buringh and van Zanden's view was it possible for Europe to overtake the Arab World in the period between 800 and 1800? Their answer being,

Arab cities were part of the ‘predatory’ structure of the state. When the region was unified under the Abbasids, this worked well and the region experienced its ‘Golden Age of Islam’. Efficient institutions regulated exchange, allowing high levels of commercialisation and urbanisation. When state systems disintegrated, so did the urban system and the underlying commercial networks.

In Europe, after a period of disintegration, a different urban system more or less independent of ‘predatory’ states emerged. These managed to claim their own niche in the political economy of the period and developed increasingly effective ways of organising commercial exchange in spite of the fragmented political system.

It is this development in Europe of an economically well integrated urban system largely independent of large territorial states, spurred on by the effect of the Great Discoveries that can explain to a large extent why London, an economic backwater in 800, was able to overtake Baghdad, the formerly thriving capital of the Abbasid caliphate.

One thing I would like to know is how does China fit into all of this. Does this also explain why the industrial revolution didn't occur in China?

Boettke on economic policy

Peter Boettke over at the Austrian Economists blog makes a couple of interesting points in a recent message. With regard to much of the current economic policy debate Boettke writes

The basic lessons of political economy seem to have been lost in much of the current debate. Government cannot be seen as a corrective, but at best should be viewed as a referee. The incentives politicians face are distorted, and the knowledge they have to work with is constitutionally limited, that efforts to tinker with the economy let alone guide the economy are destined to fall short of the goal and in most cases in fact make matters worse. From Bastiat to Friedman the problem of crowding out of private investment by public investment has been noted as a source of trouble. And perhaps nowhere has the problem been stated so clearly as in Adam Smith when he wrote: "The statesmen, who should attempt to direct private people in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would no-where be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it." (1776, Bk IV, p. 478).

He goes on the point out, correctly, that

Yet in our current political context we are once again looking for government to be an active player in the economy, and for the economists to be saviors with their grand plans. But it was precisely government policies that created the problems we confront today (and got us into the mess in the 1970s, and the mess of the 1930s before that).

Boettke then makes a very relevant point about the fate of the economist giving (good) advice to government.

As F. A. Hayek put it once, the economist is called upon to offer policy advice more often than any other social science, yet suffers the fate that once his advice is given to have it discounted as soon as it is uttered. Obviously Hayek had a certain type of economists in mind when he made that statement because some individual who call themselves "economists" are in fact listened to everyday. What Hayek meant is the economist who understandings incentives, realizes the limitations of knowledge, and focuses his analysis on structures and constraints. It is that economist -- the one worthy of the name -- that places parameters on people's utopias, and in so doing is actually viewed as impolite and impractical in the context of politics. But getting excluded from a conversation that is corrupted by the lust for power is not a sin --- if you speak truth to power and get kicked out you have done your job, if you speak nonsense and you get kicked out, then you have failed to do your job and you have discredited your discipline.

He then gets to the bottom line.

But the bottom line, we will never get out of this current economic downturn until the government gets out of the way and the creative powers of the market society are unleashed to correct the previous malinvestments caused by government distortions, and to adjust to changing circumstances to coordinate the creative innovations of producers with the demands of consumers to live more enjoyable and comfortable lives.

Boettke then draws a comparison between where we are today and where we were in the 1970s, and perhaps in the New Zealand context where we were in the early 80s.

Government policy got us into this mess fueled by bad ideas of social justice and public policy, and the incentives within policy making which bias the policies proposed and adopted in a certain direction, and we have to understand that government policy will not get us out of this mess --- especially if the bad ideas on social justice and public policy persist in our culture. We are in a situation similar to the mid- to late- 1970s again, but this time we don't have a Milton Friedman producing FREE TO CHOOSE, and we don't have a political leader like Reagan who employed Friedman's rhetoric (if not his actually proposed solutions) within the political debate.

In UK you could add leaders like Margaret Thatcher and for New Zealand Roger Douglas et al. Boettke then adds

Pivotal times require pivotal people. Think of the economists in the 1970s that could articulate the case for limited government: Friedman and Hayek lead the list, but also Buchanan and Stigler, Becker and Coase, Alchian and Demsetz, Meltzer and Brunner, etc. Who would be on your list today that has achieved the same scientific status as these men, but also are articulate spokesmen for their position on limited government?

While Boettke is right we need scholars of the standing of these people to argue the case for limited government, more importantly we need everybody to so argue. If we really want change, then it is up to all of us to back that change. We must all be willing to fight for a different policy direction.

But this does raise the question, Who among scholars in the New Zealand is likely to make the case for limited government, especially given that both major, and most minor, political parties are all for ever increasing government interference?

What's wrong with petrol prices?

Justin Wolfers at the Freakonomics blog asks What Exactly Concerns Us About Gas Prices? He notes that many voters seem to believe that petrol price are "high" and that "something oughta be done about it." Wolfers offers the following six possible reasons for people being concerned about petrol prices.

1. Relative prices: Are people frustrated that a gallon of gas now requires more foregone “stuff.” Or alternatively phrased, are they concerned about the low relative price of “stuff”? Stated this way, it sounds a bit odd that we are so upset that the benefit of giving up one more gallon of gas is now a heckuva lot more stuff. (Indeed, environmentalists should be thrilled.)

2. Absolute prices: Are people concerned about the change in the absolute average price level? The consumer price index is currently 216.632; is this too high? If so, what is the right average price level?

3. Real wages: Is the real concern about the average price level relative to (nominal) incomes? That is, if the average price level rises but our money incomes stay the same, we tend to cut back on both gas and “stuff.” If so, I have some good news: money income typically rises roughly in tandem with the average price level, keeping the real wage constant. And if you think the current episode will be an exception to this rule, then are your concerns about the gas market or the labor market — and does this change what “oughta be done”?

4. Inflation: There are also concerns about the rate of change of gas prices (#2 is about the level, not the change) and how this may impact inflation. However while gasoline and oil futures markets suggest that current high prices are here to stay, they aren’t expected to continue rising.

5. Reallocative costs of changes in relative prices: In the long run we will learn that a Pruis does as good a job at getting you to work as a Hummer and at a much lower cost. But in the short run, it will be expensive to shut down Hummer production and expand Prius production.

6. Redistribution due to changes in relative prices: It is unsurprising that the loudest gas-price whining is coming from those in the exurbs whose house prices have fallen due to higher commuting costs. But what is missing here is the urban homeowners who have simply kept quiet about their gains. In many cases one group’s losses are roughly offset by another group’s gains.

Number 1 is just prices doing what they should do, provide information about relative scarcity. This is the effect that gives people the incentive to reduce their consumption of petrol - which is why the environmentalists should be thrilled. As noted, the question with 2 is, What is the right price level? Number 4 is the focus of much discussion by macroeconomists, although its not clear just how concerned about the inflationary effects we should be. In the short-run number 5 is clearly important, but less so over the longer term. Also 5 tends, in many discussions, to be too easily confounded with 3 and 6. In addition, Wolfers notes

... because we rarely see pictures of workers enjoying their compensatory cost-of-living wage rises or investors in urban housing or green companies rejoicing that their investments have paid off, too often we focus only on the losses but miss the gains.

This leaves 3. In fact nominal wages will probably continue to rise in line with the increase in the average price level, that is inflation. The problem is that when each person gets their wage increase, they think that it is a reward for their hard work and ability, rather than just an adjust for the increase in the cost-of-living. Wolfers puts it this way

So each year we think that our employer realizes we are ever more brilliant, even as rising gas prices steal more from our paychecks. But workers should be tipped off that it isn’t just a coincidence that each year these two forces tend to balance out.

All this leads to the question, Are we over-emphasizing the importance of high petrol prices?

Bill Gates's theory of philanthropy

The blog Creative Capitalism: A Conversation contains discussion by leading economists of Bill Gates's theory of philanthropy, what Gates thinks philanthropy can do and what it can't. The participants include Gary Becker, Ed Glaeser, Richard Posner, Bill Easterly and Steven Landsburg.

(HT: Marginal Revolution)

Why post-Christmas sales?

There are many questions asked about Christmas. But for economists, one question to do with Christmas is, Why do we see post-Christmas sales?

There are a number of possible reasons. To get rid of all the unwanted merchandise is one, while to reduce inventories for tax purposes, is another. May be post-Christmas sales are a consequence of store buyers' misjudgements about the market demands for various goods and thus come down to mistakes in ordering.

But if such sales happen year after year after year can it really be chalked up solely to misjudgements and errors. If post-Christmas sales can be chalked up to misjudgments and mistakes, then you have to ask, Why are the store buyers at these stores retained, year after year after year? Shouldn't they be fired and replaced
with buyers whose misjudgements and errors aren't as pervasive and persistent? After all, we are looking at stocking "mistakes" at Christmas that are systematic, that extend to all departments in the stores and result in "excess inventories" that are discounted by 50% or more. Also if stores have "excess inventories" why not sell them off at full price slowly over the next year, and order less next Christmas.

There must be a better explanation. And there is, price discrimination. This amount to saying that retail stores have post-Christmas sales (often deep ones) because the price-insensitivity of their customers takes a plunge between the day before Christmas and the day after. McKenzie (2008: 71) puts it this way,

Before Christmas, many customers need the goods they buy to be able to stand witness to the considerable (often only imagined) joy of their love ones and friends on Christmas morning receiving their gifts. Before Christmas, many customers are working and have high opportunity costs of their time; they also might have low storage costs. They have not yet filled their cabinets and closets with countless gifts, most wanted but some kept only out of respect for the givers. After Christmas, many buyers are often fully stocked with more goods than they need, or want. Many are often on holiday breaks at Christmas time, with low opportunity time costs.

More to the point, before Christmas, buyers' demands are highly inelastic. After Christmas, they are highly elastic because they have time to consider more carefully the prices charged by any number of sellers, and they have to see significant price reductions to stuff their cabinets and closets with more products. [...] firms can maximize profits only by playing to the different elasticities of demand, which means that they should charge relatively higher prices before Christmas in anticipation of charging relatively lower prices afterwards.

Stores order earlier in the year, and they order with both markets in mine. That is, they order with both the pre-Christmas and post-Christmas buyers in mind. What is tell us is that post-Christmas sales are planned for, they are not the result of mistakes. McKenzie again,

The higher before-Christmas prices fit the higher demand and lower price elasticities of demand that stores then face. The after-Christmas prices fit the then lower demand and higher price elasticities of demand. Christmas allows stores to segment their markets with the prices charged before Christmas being higher than it would be if a constant price for both market segments had to be charged. (McKenzie 2008: 72)

McKenzie goes on to note

Of course, the elevated before-Christmas prices, followed by expected after-Christmas sales, can cause many price-sensitive shoppers to postpone as many purchases as they can until after Christmas. But such postponements are not necessarily all bad for stores, since the postponements further segment their markets into price-insensitive and price-sensitive shoppers. Purchase postponements can leave the before-Christmas market dominated by highly price-insensitive customers, giving rise to some additional price increase tailored to the demands of the before-Christmas shoppers. Shoppers who delay their purchases can increase the after-Christmas demands for goods, thus tempering the extent of the after-Christmas price cuts. (McKenzie 2008: 72)

So post-Christmas sales are just a way for retailers to get you to reveal your price sensitivity, and then charge you accordingly.

• McKenzie, Richard B. (2008). Why Popcorn Costs So Much at the Movies: And Other Pricing Puzzles. New York: Copernicus Books.

Drew Carey on trade

In this short video Drew Carey talks about trade and employment and the similarities between effects of trade and technology.

(HT: Arnold Kling)

Interesting blog bits

1. Gray Becker writes on Energy Prices, Offshore Drilling, and an "Excess" Profits Tax.
2. Richard Posner comments on Oil Prices, Offshore and Alaska Drilling, and Excess Profits Taxes.
3. Tim Worstall is Worrying about Oxfam.
4. The mathematician Pietro Poggi-Corradini has a proposal for "redistributing" students' grades.
5. Alex Tabarrok has his China Fact of the Day.
6. The Undercover Economist tells us that Impatient people can’t wait for financial education

No comment please ..... we're the JPE

Stan Liebowitz it has to be said is no stranger to controversy. But he is now involved in a controversy about a comment he sent to the Journal of Political Economy which was rejected by the then editor Steven Levitt. The JPE is one of the very top economics journals.

Last year the JPE published a paper by Felix Oberholzer-Gee and Koleman Strumpf on file sharing. The paper claims to show that file-sharing websites on the internet have not been responsible for the sharp decline in music sales since the turn of the millennium. Liebowitz claims that the research is fundamentally flawed. He submitted a comment to this effect to the JPE. Liebowitz believes that Oberholzer-Gee and Strumpf are guilty not merely of sloppiness, but of academic dishonesty, and is upset that they refuse to share their data. The Liebowitz comment which was rejected by the JPE editor, Levitt. This story has been commented on before at the Newmark's Door blog, see here and here.

But now this story has been picked up by the German newspaper Handelsblatt. The Handelsblatt article deals, in the main, with Levitt’s decision to ask Strumpf to write a reply and then to use the reply as an anonymous referee report in rejecting Liebowitz’s comment. The paper writes

Ignoring Liebowitz was not possible any more, however, after he submitted his counter-study officially as a comment to the JPE in September 2007. Levitt started by asking one of the authors, Koleman Strumpf, for his opinion. Strumpf handed in his reply in November. He defends the study and retaliates by pointing to alleged mistakes in Liebowitz? comment.

In addition, Levitt asked for a report from an impartial referee. The referee recommends publishing the comment in order to "save subsequent researchers from building on a flawed research foundation." While he advises Liebowitz to rephrase his comment such that it would not contain any overt assertions of data manipulation he sides with him on almost all the critical points and comes to a damming conclusion regarding the file-sharing article: "I would suggest that the authors? conclusions are not warranted given the analysis and evidence that they provide."

However, Levitt is not inclined to publish the comment. He anonymizes the reply by Strumpf and uses it as a second referee-report on which he bases his rejection of Liebowitz? comment. "There is no doubt you raise some reasonable points. Nonetheless, I think the negative referee (negative toward the comment, N.H.) is correct in most of what he says", Levitt writes to Liebowitz. The only point he takes up from the impartial referee is the advice to moderate the tone, should Liebowitz wish to submit the comment to some other, lesser journal.

But what may be more troubling in all of this is the unwillingness of Oberholzer-Gee and Strumpf to share their data (and we could also ask why the JPE hasn't insisted on them doing so). The point is that important empirical results in economics have to be, as a matter of course, carefully and fully scrutinized and shown to be replicable. Sharing data so this can be done must become the standard practice, since we can not have any faith in the results of an empirical study where such a practice has not been followed. The newspaper article notes

The impression that procedural standards of economics journals are not particularly strict is widely shared in the profession. Zurich-based economist Ernst Fehr, an associate editor of the top-five journal "Quarterly Journal of Economics" and of "Science" points to a lack of clear rules as to when an editor should recuse himself because of potential prejudice. Science journals also seem to deal more openly with the competition among scientists. "Authors who submit an article to a science journal can say who they do not want to review their article", praises Fehr, a choice which is typically not given to economists.

One internationally renowned economist, who did not want to be named, expresses the complaint more bluntly: "Little scandals and big scandals are commonplace: editors who publish articles in their own journals, referees or editors who decide about articles submitted by their own doctoral students."

This is not a good look, especially for one of the top economics journals.

(HT: Organizations and Markets and Newmark's Door)

Cowen on Bloggingheads.tv

Tyler Cowen is interviewed by Will Wilkinson at Bloggingheads.tv. The conversation covers many different topics, including whether capitalism will triumph, whether you should have more kids, and which country is most likely to be hit by the next nuclear weapon attack.

This week on EconTalk

I have mentioned Richard McKenzie's new book Why Popcorn Costs So Much at the Movies and Other Pricing Puzzles before, well now you can listen to McKenzie talk with EconTalk host Russ Roberts about a wide range of pricing puzzles. They discuss why Southern California experiences frequent water crises, why price falls after Christmas, why popcorn seems so expensive at the movies, and the economics of price discrimination.

Red tape goes wild

Eric Crampton, a man who knows stupid government when he sees it or at least when he reads about it, sent me a link to an article in the Economist on The wood for the trees. The article says

WHAT could be more relaxing than to amble through an ancient wood, pausing to rest beneath a gnarled old tree or even to hug one? Where some see rest and relaxation, though, others see danger and an opportunity for red tape. BSI British Standards, an official setter of benchmarks, is drafting guidelines on safety inspections for trees that cast a very different light on these venerable denizens and the hidden dangers of “branch shedding” (falling branches, to the layman) and even “whole-tree failure” that they pose. It suggests they should all be scrutinised once a year by their owners. Trained inspectors should beat them with mallets and prod them with probes every two years or so and still more expert folk assess the risk they pose to ambling, snoozing or tree-hugging passers-by every five years.

With such a draconian standard proposed, one could be forgiven for thinking that trees pose a grave threat to life and limb, one surely magnified by the fact that these seemingly ferocious specimens cover some 12% of Britain. Yet, according to the best available data, kamikaze trees crush only some six people to death a year (though more die after driving into fallen trees or branches). In contrast, the Royal Society for the Prevention of Accidents reckons that more than 4,000 are killed each year in accidents in their own homes.

A possible explanation for this stupidity comes at the end of the article.

Rick Haythornthwaite, the chairman of the Risk and Regulation Advisory Council, which gives independent guidance to the government, reckons the attempt to over-regulate trees reveals two trends. The first is the tendency for small risks to become magnified in the public mind and provoke disproportionate responses. The second is the growing involvement of special-interest groups in campaigning for tougher regulation. It is surely no coincidence, he points out, that among the most active proponents of the new standard are the tree professionals who stand to gain most from a more burdensome inspection regime.

But what are the incentives here? By raising the cost to tree owners of having trees don't these regulations give very incentive to simply cut down trees to avoid said costs? And then what of the many benefits of trees, not least in ameliorating the great Satan that is climate change. As the article itself notes, such incentives

... would exacerbate an existing trend: some public bodies are already cutting down trees rather than risk getting sued if one causes harm.

Would it not be better to use the resources that would be wasted because of these tree regulations on preventing some of the 4000 deaths that occur in people's own home? Yet again regulators are not thinking things through.

Theory of military dictatorships

That the military intervenes in domestic politics is obvious even from the briefest of overviews of history. In recent times many Latin American and African nations have seen military interventions. Often these would be in the form of military coups and the emergence of military dictatorships.

At VoxEU.org there is new column which offers A theory of military dictatorships, by Daron Acemoglu, Davide Ticchi and Andrea Vindigni. The paper, in the authors' view,

... takes a first step towards a systematic framework for the analysis of the role of the military in domestic politics. Our objective is to ultimately understand what types of nondemocratic regimes can survive with the support of the military, which regimes will generate interventions from the military, and why the military may align itself with some segments of the society against others.The basic framework in which the authors work is simple.

Two groups, the elite rich and the citizens, are in conflict under democratic and nondemocratic regimes. Under democracy, redistributive policies benefit the citizens at the expense of the rich. Under oligarchy the rich keep their wealth but have to create (and pay) a repressive military to maintain them in power. A repressive military is a double-edged sword, however; once created, it has the option of attempting to establish a military dictatorship, seizing power from democratic or oligarchic governments. This is the political moral hazard problem at the core of our framework.

The framework is there to help when thinking about the military's relationship with oligarchies. In particular, the conditions under which the military will act as a perfect agent of the elite in oligarchies. This in turn raises the question of under what conditions the military will turn against the elite and attempt to set up its own dictatorship. The framework also helps when dealing with the issue of the military’s role in transitions to democracy.

The key element concerns the credibility of future pay-offs. Since oligarchies need a repressive military in ways that democracies do not, the oligarch’s commitment to future pay-offs is credible while those of a democratic government may not be. Consequently, our framework suggests that military coups are more likely to take place against democracies than against oligarchies because of the inability of democratic regimes to commit to not reforming the military in the future. Nevertheless, military coups against oligarchies are also possible when the political moral hazard problem is sufficiently severe. The point turns on the assumption that there is a probability that coups against oligarchies will fail.

This perspective also suggests that military coups may be more likely when the external role of the military is more limited. When a strong military is needed for national defense, democratic regimes can also commit to keeping a relatively large military, thus reducing the incentive for military takeover at the early stages of democracy.

This framework also predicts that the historical relations between nondemocratic regimes and the military are important for the consolidation of democracy once this regime emerges. If a powerful military has been created by the elite to prevent democratization, then this military will be present at the early stages of the nascent democracy. However, since democracy does not have as much of a need for coercion as the nondemocratic regime, the military anticipates future reforms by the democratic government to reduce its size and power. This anticipation induces the military to take action against nascent democratic regimes, unless credible commitments for the continued role of the military in politics or other significant concessions can be made.

Interestingly other factors that appear to be important include the extent of income inequality and abundance of natural resources. Conflict between the elite and the citizens is greater when inequality is greater and this encourages oligarchic regimes to maintain power by using stronger militaries. This increases both the risk of military intervention during the oligarchic regime and also once democracy emerges. Large amounts of natural resources makes military interventions more likely since the military can exploit natural resources once it comes to power.

The conclusions offered by Acemoglu, Ticchi and Vindigni are

One of the important implications of this general research program is that, when trying to shape or influence transitions to democracy, it is important that policy makers consider the complexities of the three-way interactions between the elite, the military and citizens. Our theory is a step towards a systematic framework for the analysis of the role of the military in domestic politics and will hopefully spur more theoretical and empirical research to understand the factors that facilitate the emergence and persistence of democratic regimes.

Interesting blog bits

1. Gavin Kennedy asks Is Homo Economicus a Sociopath?
2. Foreign Policy gives Five Reasons to Love $4 Gas.
3. Will Wilkinson asks Is Blog Traffic Inequality Evidence of Unfairness?
4. An interview with Steven Pinker.
5. Ross Kaminsky over at Rossputin.com points out that Free trade is good for us. Don Boudreaux comments that

   Ross -- like many other pro-market friends -- does one thing that I refuse to do: call the anti-market, anti-trade, anti-individual-liberty crowd "liberals." They're not liberals; they're antediluvian reactionaries. I simply cannot bring myself to concede the noble term "liberal" to those people.

6. VoxEU.org has a column which asks Too young to leave the nest? The effects of school starting age.

   Do children do better if they start school later? Contrary to the great concerns of many parents, this column says that the age at which kids start school matters little.

What does campaign finance do?

Or at least this is the question Tyler Cowen asks at Marginal Revolution. And a question that a good number of politicians here need to ask, and answer. Cowen writes

Overall the academics who work on this issue tend to see the practical ramifications of campaign finance restrictions as very often constituting less than meets the eye. It's also well understood that most campaign finance reform benefits incumbents, who already have name recognition.

Here is (pdf) one survey of the literature by Edward Lopez from the Encyclopedia of Public Choice. The pointer to this is from Lopez who asks us to

Consider two ratios.

1. In 2000 the federal government spent about 1.8 trillion (~18% of GDP), and total campaign expenditures on all federal elective offices was about $1.85 billion (about $1b on congressional races, $0.35b on presidential, and $0.5b in soft money). So federal public sector advertising was 1/1000th of federal public spending. Ratio 1 = 0.001.

2. In 2000 the private sector share of GDP was about $7.5 trillion (after federal, state and local spending net of intergovernmental transfers), and total private sector advertising, according to Advertising Age, was $240 billion (Statistical Abstract Table 1251). So private advertising was 3.2% of private spending. Ratio 2 = .032.

By this comparison, private sector advertising is more than thirty times greater than the amount we spend on federal elections trying to make sure we get the right person for the job. Given how much we expect from our federal government, isn't it surprising that campaign spending isn’t twice, or even ten times, more than it is right now?

In Lopez's view the campaign finance system needs more money flowing through it, not less. Tell that to the government.

Lopez also gives a link to this 2005 survey of literature by Thomas Stratmann that appeared in Public Choice.

Schools, Skills, and Synapses

Nobelist James Heckman has a new paper out in the The Institute for the Study of Labor (IZA) discussion paper series, IZA DP No. 3515, on Schools, Skills, and Synapses (pdf). The abstract reads

This paper discusses (a) the role of cognitive and noncognitive ability in shaping adult outcomes, (b) the early emergence of differentials in abilities between children of advantaged families and children of disadvantaged families, (c) the role of families in creating these abilities, (d) adverse trends in American families, and (e) the effectiveness of early interventions in offsetting these trends. Practical issues in the design and implementation of early childhood programs are discussed.

Heckman says

The argument of this paper is summarized by the following 15 points:

1. Many major economic and social problems such as crime, teenage pregnancy, dropping out of high school and adverse health conditions are linked to low levels of skill and ability in society.
2. In analyzing policies that foster skills and abilities, society should recognize the multiplicity of human abilities.
3. Currently, public policy in the U.S. focuses on promoting and measuring cognitive ability through IQ and achievement tests. The accountability standards in the No Child Left Behind Act concentrate attention on achievement test scores and do not evaluate important noncognitive factors that promote success in school and life.
4. Cognitive abilities are important determinants of socioeconomic success.
5. So are socioemotional skills, physical and mental health, perseverance, attention, motivation, and self confidence. They contribute to performance in society at large and even help determine scores on the very tests that are commonly used to measure cognitive achievement.
6. Ability gaps between the advantaged and disadvantaged open up early in the lives of children.
7. Family environments of young children are major predictors of cognitive and socioemotional abilities, as well as a variety of outcomes such as crime and health.
8. Family environments in the U.S. and many other countries around the world have deteriorated over the past 40 years.
9. Experimental evidence on the positive effects of early interventions on children in disadvantaged families is consistent with a large body of non-experimental evidence showing that the absence of supportive family environments harms child outcomes.
10. If society intervenes early enough, it can improve cognitive and socioemotional abilities and the health of disadvantaged children.
11. Early interventions promote schooling, reduce crime, foster workforce productivity and reduce teenage pregnancy.
12. These interventions are estimated to have high benefit-cost ratios and rates of return.
13. As programs are currently configured, interventions early in the life cycle of disadvantaged children have much higher economic returns than later interventions such as reduced pupil-teacher ratios, public job training, convict rehabilitation programs, adult literacy programs, tuition subsidies or expenditure on police.
14. Life cycle skill formation is dynamic in nature. Skill begets skill; motivation begets motivation. Motivation cross-fosters skill and skill cross-fosters motivation. If a child is not motivated to learn and engage early on in life, the more likely it is that when the child becomes an adult, it will fail in social and economic life. The longer society waits to intervene in the life cycle of a disadvantaged child, the more costly it is to remediate disadvantage.
15. A major refocus of policy is required to capitalize on knowledge about the life cycle of skill and health formation and the importance of the early years in creating inequality in America, and in producing skills for the workforce.

Arnold Kling makes a good point

In the conclusion to his paper, Heckman stresses making sure that these early interventions "respect the sanctity of early family life and...cultural diversity." It is not clear that the basis for this concern is practical, or whether it is because Heckman is experiencing queasiness over promoting state intervention into family life. I can appreciate a libertarian concern with having the state take a large role in child-rearing. I am less persuaded if the concern is one of political correctness, where you want the state to intervene but then fret about the self-esteem of the families or groups where the intervention is undertaken.

(HT: Arnold Kling)

Enjoyment and the price of wine

Over at the American Association of Wine Economist's blog, Robin Goldstein and Johan Almenberg discuss their paper Do More Expensive Wines Taste Better? Evidence from a Large Sample of Blind Tastings (joint work with A. Dreber, J. W. Emerson, A. Herschkowitsch, and J. Katz) which is due out in the forthcoming issue of the Journal of Wine Economics. They say

Our main finding is that participants in blind tastings do not appreciate expensive wines more than cheap wines. In our sample of over 6,000 blind tasting observations, compiled by food and wine critic Robin Goldstein and discussed at length in his new book, The Wine Trials (Fearless Critic Media, 2008), we find that the correlation between price and overall rating is in fact small and negative, suggesting that individuals on average enjoy more expensive wines slightly less.

They go on to ask

Why, then, do everyday wine drinkers spend money on expensive wines? The price tag itself may influence how much we appreciate the good. This is in line with a familiar finding in marketing research: increasing the price of a good sometimes increases the demand for the good for psychological reasons alone (see for example Cialdini, 1998), by signaling that the good is covetable. Goldstein explores this effect in The Wine Trials, which examines the methods of modern wine marketing, the undue deference of consumers toward numerical ratings in industry publications such as Wine Spectator, and the inconsistencies between controlled blind-tasting results and those sorts of ratings, which exhibit a strong positive correlation with price.

So cheap may not be nasty. You may just think it is. Given that you have seen the price.

Tyler Cowen on Authors@Google

Here is a video of Tyler Cowen talking in the Authors@Google series. Cowen talks about his book Discover Your Inner Economist: Use Incentives to Fall in Love, Survive Your Next Meeting, and Motivate Your Dentist.

Water privatisation in poor countries

An obvious and sad fact about the world is that hundreds of millions of people in poor countries just don't have access to enough clean water. In many countries women and children will walk miles carrying heavy buckets or balancing them on their heads just to bring water back to the house. Carrying water isn't just a pain, it is also expensive. Carrying can cost between five and twenty times more than piped water. Also the water sources are often dirty and carry disease. Hundreds of thousands of children die each year from diarrhea which many contracted from drinking bad water. The extra expense and disease dangers matter when you are living on a few dollars a day.

A radical approach to dealing with this problem has been suggest by Tyler Cowen. He has a piece at Forbes.com arguing for the privatisation of residential water supply in the Third World. Cowen writes

I'd like to suggest a radical idea. The solution for the poorer parts of the Third World is deregulation of the market for piped water, combined with the enforcement of property rights. Yes, I'm saying that Third World governments should consider letting private companies sell water at any price they want. This includes giving them the right to cut off people who don't--or can't--pay their bills.

And no, I don't mean a water concession with a price regulated by the government, I mean true laissez faire in water supply. No price regulation, no rate of return regulation, no government ownership of assets, no political pressure to keep prices low. Water companies should be allowed to maximize their profits, and because supplying water is nearly always a monopoly, they should be allowed to make monopoly profits. I know the idea sounds crazy--to an economist, water supply is a classic "natural" monopoly--but on closer inspection the other alternatives might be worse.

Later he writes

Deregulation would give water companies a stronger monetary incentive to serve these customers. For starters, an unregulated private monopoly would try to bring as many buyers into the system as possible, so as to make as much money as possible.

Of course deregulated monopolies are bad, mostly because monopolies raise market prices and not everyone can afford the higher rates. But for all the problems deregulation can bring, the status quo seems much worse. And it's worth asking what these higher prices are relative to. Carrying water on your head costs much more--in terms of both money and effort--than piped water. If you're a poor person, wouldn't you rather face a private monopolist, selling you water through pipes, than not have any water company at all? Whether we like it or not, those are the real world alternatives.

But Cowen also realises that some people won't like the idea of complete deregulation.

If complete deregulation is too radical for you, consider the interesting compromise proposed by the economist Jeffrey Sachs, currently heading the Earth Institute at Columbia University. He suggests that the private company be allowed to charge high prices, but only under the condition that it allocates a minimum amount of water for everyone, either for free or at a much lower price. Basic water needs would be met, and the company still might make a profit.

That said, I'm less worried about high prices than Sachs. Let's say the new water prices were so high as to capture all the benefits that buyers would receive from the new supply of water. We can expect much lower rates of diarrhea and other diseases, if only because the water supplier can charge more for cleaner and safer water. The resulting decline in disease means that children will die less frequently and adults will be healthier and more energetic. Those long-term social benefits are of enormous help to poor communities, even if high prices take away many of the initial, upfront benefits of the new water supply. In other words, we should consider radical privatization precisely because water is a public good and because clean water is so important for long-run economic growth.

On the issue of privatisation and disease, history is an interesting guide. Troesken (1999) looks at typhoid rates in US waterworks in the period 1880-1920. He writes

Also, a sample of roughly one-third of all water companies operating in 1899 indicates private companies were no less likely than public companies to have invested in water filters. On the contrary, private companies invested in filters at greater rates than public companies. About 20 percent of all private water companies had installed filters by 1899. Only 6 percent of all public companies had installed filters by 1899. Taken together, these results call into question the arguments of Progressive-Era reformers. Public ownership, it appears, did not lead to larger investments in filtration systems or significant reductions in typhoid rates.

There is also information on a more recent privatisation scheme. Galiani, Gertler and Schargrodsky (2005) looks at the effects of water privatisation on child mortality in Argentina. In the 1990s Argentina embarked on one of the largest privatization campaigns in the world, including the privatization of local water companies covering approximately 30 percent of the country's municipalities. Galiani, Gertler and Schargrodsky hypothesized that increased access to the water and sanitation network, and potential changes in service quality, improved health outcomes of young children. Using a combination of methods, they found that child mortality fell by approximately 8 percent in the areas in which water systems were privatised and that the effect was largest (26 percent) in the poorest areas. Many people fear that private operators would fail to take into account the significant health externalities that are present in this industry and therefore underinvest and supply suboptimal service quality. On the contrary, the evidence in the Galiani, Gertler and Schargrodsky paper suggests that the deterioration in performance of water systems in Argentina under public management was so large that it allowed for a privatisation that generated private profits, improved access, expanded service, and reduced child mortality. While the regulated private sector may not be providing first-best services, it seems to be doing a much better job than the public sector. There is also a public perception that privatisation hurts the poor. This perception is driven by the belief that privatised companies raise prices, enforce service payment, and invest only in lucrative high-income areas. In contrast, they find that the poorest population experienced the largest gains from privatisation in terms of reduction in child mortality. Privatisation appears to have had a progressive effect on reducing health inequality.

Cowen also asks But what of those areas where the poor can pay very little?

Even with deregulation, many companies still won't be interested in serving the poorest elements of their societies because they can't charge poor customers a lot of money. They might not be able to charge enough to cover the costs of billing, much less the cost of laying down the pipes. But the more weight that point carries, the weaker the case for doing nothing and weaker still for regulating water prices. We already know that with artificially low, regulated prices the poor get no water; with a private market they at least have a chance. Governments need to be doing everything possible to encourage piped water supply, and that means allowing high prices.

Cowen end his article by pointing out that the real question is

What do we have to lose? Let's try some water deregulation and hope that at least a few million people can take those buckets off their heads and trade them in for the pleasure of paying a monthly water bill.

• Troesken, Werner. (1999). "Typhoid Rates and the Public Acquisition of Private Waterworks, 1880-1925", Journal of Economic History, 59: 927-48.
• Galiani, Sebastian, Paul Gertler and Ernesto Schargrodsky. (2005). "Water for Life: The Impact of the Privatization of Water Services on Child Mortality", Journal of Political Economy, 113(1): 83-120.

Money can buy happiness

Below is a (US) Nightline segment summarizing research by Justin Wolfers and Betsey Stevensonon on the relationship between income and happiness. Betsey Stevenson is interviewed in the piece.

(HT: Freakonomics)

Tabarrok in China

Alex Tabarrok is in China and has had first hand experience of Chinese pollution. Tabarrok writes

An hour and a half out of central Beijing, traveling through orchards of apples and pears and still the smog blankets the fields obscuring the view. Pollution like this I have never seen.

And yet the intensity of the pollution makes me optimistic. Pollution in China isn't like the demise of the snail darter or some wispy thing that might take a few weeks off your life if you live long enough. Pollution here irritates, it chokes and it kills young and old. Pollution like this people are willing to pay to avoid and as the economy grows the Chinese are willing to pay more and more.

An interesting point about China is had it seems wealthy enough to have a manufacturing sector which can manufacture a lot of pollution but not wealthy enough to feel that its right and worthwhile to sacrifice at least some growth for an improvement in air and water quality. The longer the government waits to begin the cleanup, the larger the problem will be. The question is; would a government in a more democratic state already have been forced to clean up the environment whereas the more totalitarian government of China can't be so forced. Do democratic and totalitarian governments see the trade-off between growth and environment that differently? Are the incentives they faced that different? And do people see the trade-off differently from their government? If they do, and are willing to trade-off a little more growth for a cleaner environment than the government, then they will be better able to enforce those preferences in a democracy than in a totalitarian state.

Interesting blog bits

1. The Adam Smith Institute on Hope for carbon-eating GM trees
2. Zimbabwe inflation now over 1 million percent
3. Will Wilkinson reports on Stranger-Reported Economist Happiness.
4. Bryan Caplan asks Do Grad Students Really Swagger? He thinks not.
5. Jean-Paul Carvalho at Oxonomics comments on Rationality vs Evolution.
6. At The visible hand in economics blog they are asking A technical recession in New Zealand: What’s the big deal?

Quote of the day

This from Peter Klein's posting, Overheard at the Conference, at the Organizations and Markets blog.

A prominent economic theorist, introducing a well-known business professor who has published in several fields: “In addition to his important scholarly contributions, he has also written several articles in management journals.”

You do have to wonder sometimes ...... (updated x3)

Earlier I commented on the fact that the University of Chicago is to set up an institute named after Milton Friedman. Now from this article from the Chicago Tribune we find out that

... some faculty [...] want to put the brakes on a plan to name a new research center after the Nobel Prize-winning economist.

The article notes that

About a half-dozen faculty members aired their concerns Tuesday in a meeting with Zimmer [U. of C. President] and Provost Thomas Rosenbaum, who remain committed to the project.

One faculty member is quoted as saying

"It is a right-wing think tank being put in place," said Bruce Lincoln, a professor of the history of religions and one of the faculty members who met with the administration Tuesday. "The long-term consequences will be very severe. This will be a flagship entity and it will attract a lot of money and a lot of attention, and I think work at the university and the university's reputation will take a serious rightward turn to the detriment of all."

Another member of faculty is quoted as saying

"I don't think any institute of any educational institution should be so strongly aligned behind a single ideological program," said U. of C. music professor and department chair Robert Kendrick.

Other faculty have said

"For many people who travel around the word, the university has had a pretty bad reputation that is tied to the Chicago School and economic principles that Milton Friedman advocated," said Yali Amit, a U. of C. statistics and computer science professor. "We don't think it's a great idea to strengthen this reputation."

The article also notes that

Rosenbaum [U. of C. Provost] said the center will not push any particular point of view.

"We are honoring a great scholar, and that is the intent here," Rosenbaum said. "We are supportive of a wide range of ideas across the spectrum of ideologies, and it's not intended to promote any ideology."

And

Economics professor Lars Peter Hansen, chair of the committee that proposed the institute, said the opponents are confusing Friedman's economic scholarship with his social and political views. He said the center will not have any "particular political slant."

John Cochrane, a business school professor who served on the Friedman Institute committee, also emphasized that the center will be nonpartisan.

But the best response came from Jagdish Bhagwati

Columbia University economics professor Jagdish Bhagwati laughed when he heard about the latest debate at the Hyde Park campus.

"It is nonsensical to object. . . . Chicago should be proud it has someone like Milton on its rolls," he said. "Anybody who can claim that Milton was not one of the major thinkers of his time is crazy."

Well said that man!

Update: Stephen Kirchner of Institutional Economics comments here, and notes

The opposition probably tells us more about the lack of diversity and the ideological biases at the rest of the university than at the new research centre.

Update 2: Michael C. Moynihan comments at Reason magazine.

Update 3: Steven D. Levitt comments here and David Warsh comments here.

Taking risks and safety (updated)

This article, from the Washington Post, by Shankar Vedantam, tells you that you are Taking More Risks Because You Feel Safe. Vedantam writes

Trying to fix problems that affect vast numbers of people has an intuitive appeal that politicians and policymakers find irresistible, but several warehouses of research studies show that intuition is often a poor guide to fixing systemic problems. While it seems like common sense to pump money into an economy that is pulling the bedcovers over its head, the problem with most social interventions is that they target not robots and machines but human beings -- who regularly respond to interventions in contrarian, paradoxical and unpredictable ways.

"How well does government do in helping the market to improve what it does?" asked Clifford Winston, an economist at the Brookings Institution and the author of the 2006 book "Market Failure Versus Government Failure." "The research consistently finds that, in fact, government efforts to correct market failures have little effect, or actually make things worse."

"There is a tendency for people to say, 'If things are safer, then I will take more risk,' " he added. "It does not have to involve government interventions: Drugs are developed to reduce blood pressure, so people say, 'Okay, I can eat more, and it does not matter if I gain weight, because I can take this pill.'"

Previous research has shown that people drive faster in vehicles that feel safer, attempt to bike on more dangerous terrain when they wear helmets and pay less attention to infants being bathed when the children are in seats that are said to reduce the risk of drowning.

Vedantam adds, a little later, that

He [Winston] once studied the effect of installing air bags in cars at a time when automakers were offering customers the option of buying cars with and without the safety devices. Winston found that people who bought cars with air bags tended to be the safest drivers to begin with. And now, lulled into a sense of security, they tended to drive faster, effectively canceling out the safety benefits.

The basic insight here is nothing new. In the 1960s the US government bought in a range of automobile safety legislation. They mandating the use of seat belts, padded dashboards, collapsible steering columns, dual braking systems, and penetration-resistant windshields.

What were the effects of this? First note that the regulations tended to decrease the number of driver deaths by making it easier to survive an accident. But at the same time, the regulations tended to increase the number of driver deaths by encouraging reckless driving behaviour. Which effect is the greater? Do we see an overall increase or decrease in driver deaths? In the middle 1970s, Sam Peltzman of the University of Chicago looked at the evidence. What he found was that the two effects were of approximately equal size and therefore canceled each other out. There were both more accidents and fewer driver deaths per accident, but the total number of driver deaths remained essentially unchanged. But perhaps the must interesting result found in the Peltzman study was the side effect that the regulations appeared to have leading to an increase in the number of pedestrian deaths; those outside the car are affected by the increase in accidents, but are not protected by the in-car safety equipment.

When explaining these results Steven Landsburg asks

If the seat belts were removed from your car, wouldn't you be more cautious in driving? (p.5)

He then notes

Carrying this observation to the extreme, Armen Alchian of the University of California at Los Angeles has suggested a way to bring about a major reduction in the accident rate: Require every car to have a spear mounted on the steering wheel, pointing directly at the driver's heart. Alchian confidently predicts that we would see a lot less tailgating. (p.5)

The fundamental message from all of this is, "people respond to incentives." And politicians and policymakers need to remember this when designing policy.

Update: Not PC is concerned about Unintended consequences.

The rise in American inequality (updated x2)

An article on VoxEU on The rise in American inequality by Ian Dew-Becker and Robert J. Gordon tells us

Within the top 10 percent, SBTC [Skill-Biased Technical Change] has certainly still been an issue, and there is a role of SBTC in contributing to pay premia of entertainment and sports superstars. In a variety of settings, technology has allowed superstars to distribute their talent to a wider variety of consumers. This has driven their incomes up exponentially. Their earnings are an outcome of market forces, and the only policy measure available to achieve greater after-tax equality is an increase in tax rates at the top balanced by a decrease at the bottom.

Greater after-tax equality? Why? What is wrong with the earnings that these people receive? An increase in tax rates at the top balanced by a decrease at the bottom looks like a "solution" without a problem. If the earning outcomes are the result of market forces, there will be good reasons why the market rewards people in this way. Someone must believe these people are worth what they are paid, or they wouldn't get paid it. So what's the problem?

However, for top corporate executives, there is strong evidence that incomes have been driven by non-market forces. This is where policy can have the most positive impact on inequality; increased disclosure and improved corporate governance laws can not only raise firm value but help distribute economic gains more evenly across society.

Insofar as top corporate executive income is driven by non-market forces, such as CEO-Board complicity in pay setting and managerial power being behind some of the gains in CEO pay, isn't the problem one for the owners of the firms concerned, not for the government. There appears to be no government policy issue here. If the owners of firms are happy with what their executive are paid, where's the problem, and insofar as they are unhappy, the solution is in their own hands. No government policy changes seem needed.

Update: Arnold Kling comments on Trends in Relative Earnings.

Update 2: Russ Roberts asks a couple of good questions in this posting, Egalitarian?

Incentives matter: Firefox file

From Yahoo! News we learn that

Five hours after Mozilla officially released Firefox 3.0, researchers found a vulnerability in the new browser.

Tipping Point has verified the bug and reported it to Mozilla, Tipping Point said on Wednesday.

The incentive for fast finding of problems

Tipping Point found out about the vulnerability through its Zero Day Initiative, which lets researchers earn cash by submitting new vulnerabilities to the company. Once Tipping Point validates the issue, it pays the researcher for the information and notifies the relevant software vendor of the technical details.

(HT: Market Power)

Interesting blog bits

1. Dani Rodrik talks about the Stolper-Samuelson for the real world. Note Rodrik's warning:

   This is a long and wonkish entry, aiming at self-comprehension, and the product of one too many long plane ride.

2. The Naked Economist talks about argues that High Fuel Costs Could Spur a New Rationalism.
3. The Economist looks at Education in Sweden and Finland.
4. There is a review of Stephen Marglin's book "The Dismal Science, how thinking like an economist undermines community" by E. Roy Weintraub.
5. Tyler Cowen talks about What you don't know that you don't know. This is a reply to Bryan Caplan.
6. There is an article at VoxEU which argues for The IMF as a reserve manager

   The IMF needs a new job. This column makes the case for the bold proposal that the IMF should manage a significant part of the new surplus countries’ sovereign wealth funds.

7. Professor threatens to sue over student "anti-intellectualism."
8. Lynne Kiesling replies to Bryan Caplan.

Lies, damned lies, and statistics

93.257% of the comments by Matt Burgess are brilliant.

In defence of profiteering

Mark Koyama at Oxonomics points us towards a piece by Tim Harford about the valuable services performed by so-called profiteers. As Koyama puts it

Price gouging communicates valuable information - it signals that there is a real and immediate scarcity.

The effects of "price gouging" is that those whose needs are not immediate do not buy and therefore those who do really need the good, petrol in this case, will be able to get it. A high price sorts people into these two groups. Harford makes the point that

... price-gouging is woefully undersupplied in this market.

Why is this the case? Basically because most retailers are terrified of being accused of profiteering. Well, all power (and profits) to the profiteer I say!

Boudreaux on Obama

Don Boudreaux makes a nice point about the economic reasoning of Barack Obama. Boudreaux writes

According to today's Wall Street Journal, Barack Obama alleges that "Globalization and technology and automation all weaken the position of workers." If this presidential wannabe is correct, then some of the world's most prosperous workers must be the people in that newly discovered tribe in Brazil -- persons with absolutely no contact with the global economy or with modern technology.

Kling on Caplan

Arnold Kling attempts to answer Bryan Caplan's challenge. Kling writes

Let me attempt an answer. I would say that "don't know that you don't know" corresponds to an event for which there is no traded contingent claim. The neoclassical world is one in which there are contingent claims for every meaningful event.

If there is an insurance contract, a security, or a futures market on something, then we know what we don't know. We don't know whether the event will occur, but we know what the market thinks about it.

When there is an event for which there is no traded contingent claim, then we don't know what we don't know. We don't know what we don't know about climate change or a future terrorist attack, and the evidence for that is the lack of any contingent claims market that could be used to draw inferences about climate change.

Pigovian taxes (updated)

In recent years problems such as pollution and global warming have resulted in a renewed interest in issues to do with Pigovian taxes. For example, it is becoming increasingly common to see calls for the addition of Pigovian taxes on the price of petrol. A number of prominent economists, lead informally by N. Gregory Mankiw, from all parts of the political spectrum have made calls for petrol taxes as a potential means of dealing with unpriced externalities. Mankiw has aggregated these concerns in his calls for a "Pigou Club" of economists who identify themselves by their support for a petrol tax.

In a draft paper, Finding the Right Pigou Tax in a World of Imperfect Coasian Bargains (scroll down to find the paper), to be given at the upcoming 2008 International Society for New Institutional Economics (ISNIE) meetings in Toronto, John VC Nye, of George Mason University, calls into question the economic justification for Pigovian taxes. The abstract of his paper reads

This paper calls into question the economic justification for Pigovian taxes and argues that existing empirical work is inadequate to justify the standard policy recommendations. In particular, it calls into question claims that the identification and measurement of a Pigovian externality is a sufficient condition for determining the optimal level of the tax. A claim about the optimal Pigou tax is a joint claim about the size of the externality and about the optimality of observed outcomes, not just the externality. Measuring the size of the observed Pigovian externality – even if done perfectly -- is not a reliable guide to the proper level of the Pigovian tax because in a world of efficient transfers we will still observe some externalities. Hence the debate about externalities should be about whether those compensating factors exist and not about measuring the externality itself. Contrary to received wisdom, we do not have strong evidence that any positive gas tax in the current economy is advisable, let alone information about what its level should be.

Nye goes on to explain

The basic arguments can be outlined as follows:

First, the benchmark Coasian case: In a world of costless bargaining, well-defined property rights, and very low transactions costs, the various parties will negotiate till a jointly maximizing outcome is reached. No taxation is necessary or desirable.

Second, even in a world of positive transactions costs, some Coasian transfers may take place which partly mitigate the harm of the externality. Unless one can fully account for all these transfers – whether conscious or accidental – any estimate of an appropriate Pigovian tax based solely on the size of the Pigovian externality that is measurable will clearly overstate the optimally efficient tax level.

Third, in the presence of regulations (at any level from that of the local community up to the federal government) that have bearing on the supply of the externality causing activity – even if not directly tied to the externality itself – we will need to estimate how different the level of the activity actually is from the hypothetically efficient level. Absent such an estimate, simply knowing the size of the externality itself will give us no clue about the appropriate tax nor its optimal level.

Fourth, even in a strictly Pigovian world in which both the possibility of Coasian bargains and the indirect effects of regulation on the equilibrium supply of the externality-producing good are simply assumed away, the optimal Pigovian taxes are likely to be lower than the standard Pigovian rate if there are other taxes in the economy (Bovenberg and Goulder, 2001). That is, the Pigovian tax rate estimated in a partial equilibrium setting is likely to be supraoptimal in a general equilibrium setting in which a variety of distortionary excises already exist – even if those taxes were not explicitly designed to cope with externalities. Furthermore, taking into account regulations which are substitutes for Pigou taxes – even if indirectly – further moves the optimal tax level away from the standard Pigou solution and makes it likely that applying a straightforward Pigovian tax in addition to existing taxes and regulations is inefficient and even counterproductive.

The single major problem is that the applied Pigou tax literature concentrates on the presumption that TAX = MARGINAL EXTERNALITY or Pigou Externality (PEX). But in actuality what we need to know is the optimal quantity of the good or activity that produces the externality. Absent detailed information about both regulatory distortions and private Coasians transfer, knowing the size of PEX gives us NO clue as to the size of the optimal Pigou tax.

(HT: Division of Labour )

Update: There are interesting comments on the Nye idea in The overestimation of Pigovian taxes posting at The visible hand in economics.

Caplan on radical uncertainty

Bryan Caplan takes the Austrian school to task again. He writes

Austrian economists often attack the mainstream for ignoring something they call "radical uncertainty," "sheer ignorance," or sometimes "Knightian uncertainty." A common Austrian slogan is that "Neoclassical economists study only cases where people know that they don't know; we study cases where people don't know that they don't know."

He then asks that someone from the Austrian school to do at least one of two things

1. Explain his point using standard probability language. What probability does "don't know that you don't know" correspond to? Zero? But if people really assigned p=0 to an event, than the arrival of counter-evidence should make them think that they are delusional, not than a p=0 event has occured.

2. Give a good concrete example.

These seem like good challenges. But what are good replies?

Don Boudreaux on EconTalk

This week on EconTalk, host Russ Roberts talks with his GMU colleague Don Boudreaux. They talk about the recent surge in energy prices and why prices have risen, the implications for America's standard of living and the implications for public policy.

Religion and economic organisation

Explaining economic institutions; firms, guilds, clubs, cooperatives etc, is a core issue for microeconomics. Avner Grief pioneered the use of game theory to study historic economic organisations. His work shows that reputations, repeated relationships, and folk-theoretic interactions fostered the rise of anonymous exchange during the later Middle Ages. But when the mortality rate is high, these mechanisms alone may not be enough to sustain cooperation, and religion can come into play as an additional mechanism which helps shape economic institutions. This is the basic idea behind a new NBER working paper, Religion, Longevity, and Cooperation: The Case of the Craft Guild by Gary Richardson and Michael McBride, NBER Working Paper No. 14004, issued in May 2008.

Richardson and McBride set out to examine the organization of industry in late medieval England. In this era artisanal activity occurred in organizations referred to as craft guilds. Craft guilds were basically groups of self-employed skilled craftsmen with ownership and control over the materials and tools they needed to produce their goods. Guilds were in part small business associations and in part cartels. As Ekelund et al explain

The guild system was an example of government-sponsored cartelization. A local group of producers practicing a particular craft would obtain sanction from municipal authorities to forbid the entry of new competitors into the local market, without first securing, the permission of the guild. These organizations tended to be composed of groups of small independent masters (a sole proprietor) and represented local cartels. They frequently entered into open agreements with one another to fix prices and restrict output, with government approval and support. (p.125)

Ekelund et al also note that

The fact is that the Church did not actively campaign against the system of guild-cartels. (p.125)

These associations of artisans dominated economic activity for centuries.

Explaining the rise, decline and changing nature of guilds has perplexed scholars since at least the time of Adam Smith. Richardson and McBride offer a new theory to explain the nature and development of guilds. Richardson and McBride note that the key to their explanation

... is to understand how guilds convinced members to cooperate, and how exogenous changes in the environment influenced the effectiveness of guilds' enforcement mechanisms. The principal driving forces were the disease environment and religious doctrines.

They continue

Disease influenced craftsmen's ability to cooperate by determining the mortality rate. Folk theorem logic holds that cooperation occurs more readily when individuals care more about the future, which in turn, depends on how long one expects to live. Low mortality rates meant long lives and extensive cooperation. High mortality rates meant short lives and little cooperation. The mortality rate for craftsmen fluctuated dramatically during the Middle Ages, as the introduction of virulent, infectious diseases, such as the Black Death, scourged urban populations.

In such an environment a grave concern would be the afterlife. Religion had an influence on the level of cooperation between craftsmen by emphasising the concept of an afterlife.

The late-medieval Christian church promoted the doctrine of purgatory, which stated that after death, individuals experienced excruciating pain, which purged them of sins in preparation for entrance into Heaven, where one experienced ecstasy. Purgatorial pain could be lessened by the prayers of the living, particularly by pious people who knew one well, such as family, friends, and colleagues. Guilds were organized to provide prayers for the souls of deceased members. Guilds threatened to punish members caught breaking the rules by excluding them from intercessory services. This threat became more salient when belief in the doctrine spread and mortality rates rose, enabling guilds that bundled together religious and occupational activities to sustain occupational cooperation in environments where purely secular associations employing folk-theorem threats could not.

This logic underpins Richardson and McBride's explanation of the development of the guilds in medieval and early modern England. They argue

During the twelfth and thirteenth centuries, when industrial activity initially expanded in towns, urban residents formed organizations focused on secular, economic, and legal concerns. During the fourteenth century, as the doctrine of purgatory spread and the disease environment deteriorated, craftsmen organized increasing numbers of guilds that prayed for the souls of deceased members. Guilds that engaged both in religious and occupational activities proved especially effective at facilitating cooperation. During the sixteenth century, mortality rates fell, religious reformation swept aside the doctrine of purgatory, and new methods of organizing industry evolved.

The analysis of Richardson and McBride links two literatures. One is the literature that employs game theory to study economic institutions and the other the literature that uses club theory to study religions institutions. Richardson and McBride provide one channel by which religion can influence the extent of economic activity. In late medieval England religious belief was one contributing factor in the organisation of industry and the scope and scale of occupational cooperation.

Benjamin Klein's contributions to law and economics

Josh Wright, of the School of Law at George Mason University, has written a piece on the contributions of Benjamin Klein to law and economics. The paper is a chapter for the forthcoming volume "Pioneers of Law and Economics" (Lloyd R. Cohen and Joshua D. Wright eds.). Klein has produced pioneering analysis of the hold-up problem, the theory of the firm, vertical restraints, franchising, and the role of contract terms in facilitating self-enforcement of contractual relationships. Peter Klein has noted

Klein’s 1978 paper with Armen Alchian and Robert Crawford and his 1981 paper with Keith Leffler are of course part of the organizational economics canon. His ongoing debate with Ronald Coase on the GM-Fisher Body case has helped clarify important issues on the role of asset specificity in vertical integration.