Book club: Capitalism and Freedom

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

Comment on Reserve Bank monetary policy

A friend sent me the following,

Imports good; exports bad (updated)

In a discussion on our trade balance the Visible Hand in Economics takes up the frog blog challenge to talk about imports. I agree with what is said there so won't repeat it. Here I just wish to make the simple point that "imports are good; exports are bad". Not an idea I think frog blog would go for.

Why? Well, notice that Adam Smith pointed out more than 240 years ago that "Consumption is the sole end and purpose of all production" and that the measure of a country's true wealth, is the total of its production and commerce. That is, a country's wealth is what the people of that country can consume. The great 19th century French economic pamphleteer Frédéric Bastiat wrote, "Consumption is the end, the final cause, of all economic phenomena, and it is consequently in consumption that their ultimate and definitive justification is to be found." Note also that exports are things that we produce and send to other (overseas) people. That is, they are goods and services that we produce but do not consume and thus they lower our welfare. Imports on the other hand, are goods and services that other counties produce and send to us to increase our consumption. This means imports increase our welfare. So imports are welfare increasing and exports are welfare decreasing. Therefore "imports are good; exports are bad"

But this does raise the question of why do we bother to export and not just import? The obvious answer is that exports are the way we pay for our imports. If we want people to send their goods and services to us we have to send our goods and services to them in exchange. Adam Smith also noted that in any free exchange, both sides must benefit. The buyer profits, just as the seller does, because the buyer values whatever he gives up less than the goods he obtains. That's why we trade at all.

This simple idea blew a hole through the trade walls that had persisted for centuries. It destroyed the notion that "exports are good; imports are bad" which was the prevailing view of trade before Smith, and seemingly still the view at the frog blog. Before Smith people believed that the measure of a nation's wealth was the gold and silver in its treasury. Imports were bad because this gold and silver must be given up in payment. Exports were good because these precious metals came in. Trade benefited only the seller, not the buyer, and a nation could get richer only if others got poorer.

The flog blog thinks that imports destroy jobs in New Zealand while I assume they think exports create jobs. In fact trade has little effect on the total number of jobs in the economy. What it does is move jobs around, away from areas in which we don't have a comparative advantage into areas where we do. As Paul Krugman, of all people, has said

It should be possible to emphasize to students that the level of employment is a macroeconomic issue, depending in the short run on aggregate demand and depending in the long run on the natural rate of unemployment, with microeconomic policies like tariffs having little net effect. Trade policy should be debated in terms of its impact on efficiency, not in terms of phony numbers about jobs created or lost.

and as trade economist Douglas Irwin has put it

The claim that trade should be limited because imports destroy jobs has been around at least since the sixteenth century. And imports do indeed destroy jobs in certain industries: [...]

But just because imports destroy some jobs does not mean that trade reduces overall employment or harms the economy. [...]

Since trade both creates and destroys jobs, a frequently asked question is whether trade has any effect on overall employment. Unfortunately, attempts to quantify the overall employment effect of trade are I exercises in futility. This is because the impact of trade on the total number of jobs in an economy is best approximated as zero.

But perhaps Laura LaHaye puts it best

Of the false tenants of mercantilism that remain today, the most pernicious is the idea that imports reduce domestic employment. This argument is most often made by American automobile manufacturers in their claim for protection against Japanese imports. But the revenue that the exporter receives must be ultimately spent on American exports, either immediately or subsequently when American investments are liquidated.

Thus if the flog blog is really worried about unemployment, there are much more important issues to deal with than imports.

So imports are not bad for employment and exports are not good for employment.

Update: Not PC suggests we Buy foreign-made.

Interesting blog bits

1. The Visible Hand in Economics on The frogs challenge: Discuss imports.

   No mercantilism is not dead in New Zealand :-(

2. Richard Posner on Compelled Disclosure of Food Characteristics.
3. Gary Becker on Is Government Intervention in the Fast Food Industry Justified?
4. The Economict on one of Hugo Chávez’s lesser-known feats: a tripling of the annual homicide rate.
5. World Bank Report on Public Sector Reforms - What works and Why?
6. From the Economist, a chart of the highest-denomination banknotes since 1900. The 100 billion Zimbabwe dollars ranks #4
   
   
7. The Economic Logician on Zimbabwe: how to beat hyperinflation

Varian on EconTalk

The latest episode of EconTalk is a conversation with Hal Varian, the Chief Economist of Google. Varian talks with Russ Roberts about Google, the role of technology in our everyday lives, the unintended paths of innovation, and the value of economics.

Adam Smith in less than 800 words

Gavin Kennedy at the Adam Smith's Lost Legacy blog points us to this piece in the The China Post in Tapei, Taiwan. The article is Adam Smith: Economics can set you free by Eamonn Butler. Butler is director of the Adam Smith Institute, London. This short piece is about as good as it get in explaining Smith's ideas in so few words.

Adam Smith: Economics can set you free

The pioneer of modern economics and the most influential thinker Scotland ever produced has at last been honored in his homeland with the first public statue of him in the United Kingdom. His message of freedom has worked wherever it has been tried, but it still needs spreading further.

Adam Smith's great and practical 'An Inquiry into the Nature and Causes of the Wealth Of Nations' (1776), is one of the most influential books ever written. It transformed our understanding of economic life from an ancient to a modern form, based on a completely new understanding of how human society works.

His 10-foot classical bronze statue was unveiled on July 4 (he was a friend of American independence) on the historic Royal Mile in Edinburgh by Nobel Prize-winning economist Vernon Smith (no relation).

Before Adam Smith, people assumed that the measure of a nation's wealth was the gold and silver in its treasury. Imports were bad because this gold and silver must be given up in payment. Exports were good because these precious metals came in. Trade benefited only the seller, not the buyer, and a nation could get richer only if others got poorer.

So countries erected vast trade barriers and controls to prevent money going out of the country -- taxing imports, subsidizing exports and protecting domestic producers (as many still do, hampering the World Trade Organization's troubled Doha Round negotiations).

Over 240 years ago Smith showed this was counterproductive.

He started not with theories, but from the fact that in any free exchange, both sides must benefit. The buyer profits, just as the seller does, because the buyer values the cash less than the goods it buys. That's why you buy things.

Since trade benefits both sides, said Smith, it increases our prosperity just as surely as do agriculture or manufacture. It is not gold and silver that measure a country's wealth, but the total of its production and commerce. Today we call that Gross National Product.

This blew a hole through the trade walls that had persisted for centuries. Leading politicians to read the book. They were convinced, cutting back trade restrictions and subsidies. That led to the great 19th-Century era of free trade and rising world prosperity.

Smith told politicians to get out of the way and let people trade freely: Social and economic harmony did not need to be planned from the center. It emerged naturally as human beings struggled to find ways to live and work with each other. Freedom and self-interest did not lead to chaos but -- as if guided by an "invisible hand" -- to order and concord.

All that was needed was an open society and free markets, with rules to maintain that openness and freedom. But those rules, of justice and morality, would be general and impersonal, not for the benefit of minority cliques.

It was not 'The Wealth Of Nations' which first made Smith's reputation, but a book on ethics, 'The Theory Of Moral Sentiments.' That book argues that the source of human morality is our natural sympathy for others (today we might say empathy). By seeing things from other people's point of view, we learn how best to live happily alongside them.

Some wonder how the self-interest that drives Smith's economic system can be reconciled with the sympathy that drives his ethics. But Smith understood that human nature is complex. The baker does not supply us with bread out of benevolence, but nor is it self-interest that prompts someone to dive into a river to save a drowning stranger. Self-interested human beings can -- and do -- live together, peacefully and productively.

So 'The Wealth Of Nations' is no endorsement of dog-eat-dog capitalism, as sometimes caricatured. Self-interest may drive the economy, but freedom is a force for good. Smith believes in free markets because the poor will benefit most from them. Only the rich and powerful benefit from other systems.

Now Smith dominates the main street of the city where he worked and, in 1790, died. Tourists from all over the world pose for pictures and guides use the prominent monument as a natural assembly point. Many wonder who Adam Smith was and why he deserves such prominence.

In an age when governments claim to be able to solve every problem, people will find his message refreshing: When we reject political interventionism and rely on natural liberty, we find ourselves, unintentionally but surely, in a harmonious, peaceful and efficient society.

For a (short) book length, "general reader", discussion of Smith's ideas try Adam Smith - A Primer by Eamonn Butler. For a more academic discussion try these two books by Gavin Kennedy, Adam Smith's Lost Legacy and Adam Smith: A Moral Philosopher and His Political Economy. Assuming you can actually afford them!

P. J. O'Rourke on Adam Smith

In this video P. J. O'Rourke gives a modern-day spin on The Wealth of Nations and Adam Smith's revolutionary theories on liberty: pursuit of self-interest, division of labour, and freedom of trade. Employing Smith’s insights, P. J. tackles such present day topics as outsourcing, blogs, central banks, and lobbyists, to name just a few. As P. J. puts it, he read The Wealth of Nations "so you don't have to".

How can we end poverty?

How can we end poverty? Perhaps the most important question there is. The problem is that there isn't a clear answer to it. Each and every year, billions of dollars of both government and private development aid are spent on food aid, transportation infrastructure, insecticide-treated bed nets, and vaccine development for tropical diseases. An obvious question, not often enough asked, being Is this money well spent?

As Raphael Auer points out there are two general views on this question:

Jeffery Sachs (2005) claims that these measures will help poor nations getting their first step on the "ladder of development" and ignite self-sustaining growth. William Easterly (2006) asserts that already several trillion dollars have been spent on inefficient aid that increased corruption and that, to a large extent, failed to reach those in need.

Auer has a new column at VoxEU.org where he asks How can we end poverty? The determinants of development. Auer opend his column by asking Why do economies prosper? He points out there are two rival theories on this.

What explains the huge international differences in GDP per capita? Surprisingly, the economics profession disagrees on the answer to this fundamental question. At the risk of simplifying a diverse discussion, one can group the existing literature into two rival schools of thought emphasising either:

• geographic endowments, or
• institutions

as the main determinant of economic development.

Auer goes on to explain

The first school of thought argues that the prevalence of disease, climate, the quality of soil, the abundance of natural resources, terrain ruggedness, and other geographic endowments directly impact income. Peasants in tropical areas are likely to be bed-ridden with malaria during harvest and have to spend much of their savings on the treatment of the disease. Agricultural yields are low in arid areas with nutrition-poor soil. While roads and railways have to be built everywhere, the cost of doing so varies greatly with the surrounding terrain. Following this line of reasoning, the "endowments" school of thought argues that most Sub-Saharan countries are among the poorest of the world due to their adverse climate, rugged terrain, and rampant disease.

The second school of thought disagrees, arguing that institutions are the basic force of development. Countries with rampant corruption and high risk of expropriation do not prosper because private effort and investment are not rewarded and, therefore, do not materialise. If checks and balances on politicians are absent, public goods are not provided efficiently or not at all. Where private contracts are not enforceable, valuable business partnerships are not formed in the first place.

While it is true that the two rival groups have been able to provide ample empirical evidence for views, the discussion is still far from being settled. Auer explains that the main issue is that the two literatures often interpret very similar correlations as evidence for very different theories.

For example, malaria has a large effect on income today, but it also had an impact on settler mortality during colonialism. Should we attribute the high correlation between the prevalence of malaria and income to the direct effect of the disease or, rather, is it an artefact of malaria's impact on settler mortality rates and colonial institutions?

Important policy implications hinge on the answer to this question.

• If most of the effect is direct, one should distribute bed nets, mass-produce Artemisia-based medication, and develop new vaccines.
• If, on the contrary, this correlation is a by-product of the institutions brought forward by colonisation, policy should be focused on fixing past mistakes and restoring good governance.

Since the instrumental variables used in the existing institutions literature are either geographic variables themselves or are highly correlated with geography, they cannot distinguish the partial effects of geography and institutions on income. Based on similar considerations, Avinash Dixit (2007) concludes that

"the notion that geographic and historical variables are merely instruments for institutional determinants of economic success is supported more by the intuitive appeal of the stories told than by the statistical significance of the tests performed. The value of rhetoric should not be ignored, but I wish the econometric evidence were more compelling."

Auer goes on to argue that the interaction of history and geography can distinguish between theories of development. He writes

To address this concern, in a recent study (Auer 2008), I show how the effects of institutions and geographic endowments can be distinguished.

The key insight is that one can distinguish between the determinants of development by utilising the fact that geographic endowments had a differential effect on institutional development in former colonies and in the rest of the world. For example, in a former colony, high prevalence of malaria has reduced income because of both the direct effect of the disease on income and the indirect effect of the disease on settler mortality and thus colonisation policies. In contrast, in a country that has never been colonised, only the first of these two effects is present.

While the indirect impact of endowments on colonisation policies and thus institutions is present only in former colonies, the direct impact of endowments on income is present in all countries. Therefore, one can identify the relation between income and institutions by utilising the difference in how endowments have shaped institutional development in former colonies and in the rest of the world.

In contrast to the existing literature, this way of identifying the relation between institutions and income does not restrict the direct effect of endowments on income to be absent, thus allowing me to estimate the partial effects of the two channels.

Put simply the result of Auer's research is, institutions dominate. That is institutions are the main, but not the only, determinant of development. Endowments do have a statistically significant and economically relevant impact on income.

For example, in a typical specification, I find that a one standard-deviation difference in the included measures of geographic endowments is associated with a direct effect on income per capita equivalent to a seven-fold difference in GDP per capita. For a former colony, the same one standard-deviation difference is associated with an effect on colonisation policies, institutional outcomes, and thus income equivalent to an additional 18-fold difference in GDP per capita. Thus, while institutions are substantially more important that endowments, the direct effect of economic endowments can hardly be neglected.3 Together, both channels can explain around 40% of the variation in international income levels.

What then are the implications of these results for what is needed to end poverty? Auer explains

In my view, two conclusions can be drawn.

• First, geographic endowments do matter for prosperity and we do have policy recipes at hand to address the most pressing problems of the world's poorest countries such as high prevalence of disease, lack of access to clean water, and poor agricultural yields.

Therefore, the current development efforts seem to be the only appropriate course of action and can put an end to extreme poverty. However, it is not certain that the current efforts can end poverty.

• Second, we need to be aware of the limits of the current policy recipes and need to focus much more on developing appropriate institutional reforms that can convert development aid into sustained economic growth.

While it is obvious that sick and malnourished peasants cannot easily escape poverty on their own, it is far from certain that a country with healthy and well-nourished inhabitants will automatically grow.

To ignite development, the presence of private incentives to work and invest is as fundamental as is the physical capability to do so.

So one thing we do understand is that aligning social and private incentives is a prerequisite for growth. The important thing we don't fully understand is how this can be achieved.

• Raphael Auer (2008), "The Colonial and Geographic Origins of Comparative Development," Swiss National Bank, Working Paper No. 2008-08.
• Avinash Dixit (2007), "Evaluating Recipes for Development Success," The World Bank Research Observer, 22(2), pp. 131-158.
• William Easterly (2006), The White Man's Burden: Why the West's Efforts to Aid the Rest Have Done So Much Ill and So Little Good. Oxford University Press: New York
• Jeffrey Sachs (2005), The End of Poverty. Economic Possibilities for Our Time. The Penguin Press: New York.

The price of petrol

Is petrol more expensive for consumers today than it was in the 1970s? An interesting question. One way to answer it is to adjust the price of price in 1970s for inflation and compared this adjusted price with the price today. For the US

The average retail price of a gallon of 87-octane gasoline in 1979, in the U.S., was 90 cents. Adjusted for inflation, a gallon of regular gasoline retailed in 1979 at $2.67 reckoned in 2008 dollars -- more than a dollar less than gasoline is retailing for today.

Or so writes Don Boudreaux at the Cafe Hayek blog. Thus petrol prices are higher today.

Or are they?

Boudreaux continues

While the inflation-adjusted dollar price at the pump for gasoline is indeed higher today than it was during the disco decade, consumers' expense of acquiring gasoline is arguably now lower. The 1970s were notorious for long queues at filling stations. These queues meant that consumers back then paid not only with dollars at the pump, but also with hours spent waiting in line (not to mention suffering anxiety over the prospect of being unable to get gasoline at all).

The average price of a gallon of gasoline in 1979 was (in 1979 dollars) 90 cents. So if a worker in 1979, earning that year's average hourly wage of $6.19, spent one hour waiting in line to buy five gallons of gasoline - a standard maximum amount that filling stations would sell to customers during periods of shortage - he would have spent, waiting in queues, $1.24 worth of his time for every gallon he bought. The total cost per gallon to him would have been $2.14 ($0.90 in cash expense plus $1.24 in time expense). $2.14 in 1979 was worth about $6.36 of today's dollars -- a cost per gallon much higher than the roughly $4 that we Americans now pay (without having to queue up for the privilege of filling our tanks).

So taking into account the full cost of petrol, petrol price plus queueing costs, petrol is cheaper today.

Compare this calculation with this one from my blog posting Petrol prices are high? In that posting I looked at a calculation by Mark Perry at the CARPE DIEM blog. Perry looked at the cost of 1,000 gallons of petrol in the US as a percent of US per-capita disposable income, annually back to 1929. He showed

The retail price of gas was only about 20 cents a gallon from 1929 to 1946, but annual per-capita disposable income in the 1930s was only about about $400-500 (about $6,000 in today's dollars), so that a 1,000 gallons of gas cost as much as almost 49% of per-capita disposable income in 1933, and averaged more than 38% from 1929-1939~!

To reach those levels today, gas would have to sell for between $14 and $17 per gallon!

So in the US at least petrol still looks cheap.

Book club: Capitalism and Freedom

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

Interesting audio

From VoxEU.org comes a couple of interesting interviews. First, Alvin Roth of Harvard University talks to Romesh Vaitilingam about his Journal of Economic Perspectives paper on repugnance as a constraint on markets; and his work designing markets for kidney exchange, mechanisms for school choice in New York and Boston, and efficient systems for getting doctors and economists into their first jobs.

Second, Justin Wolfers of the University of Pennsylvania’s Wharton School talks to Romesh Vaitilingam about prediction markets – where they come from; their use in election campaigns and corporate decision-making; how well they perform compared with alternative ways of aggregating information (such as opinion polls or staff meetings); how they can best be designed; and prospects for their application to such areas as geopolitical risks and the spread of disease.

The Big Mac is back

From Economist.com comes the latest Big Mac Index.

THE Big Mac Index is The Economist's light-hearted guide to exchange rates. The index is based on the theory of purchasing-power parity, which says that exchange rates should move to make the price of a basket of goods the same in each country. Our basket contains just one item, a Big Mac hamburger. The exchange rate that leaves a Big Mac costing the same everywhere is our fair-value yardstick. Many of the currencies in the Fed's major-currency index, including the euro, the British pound, Swiss franc and Canadian dollar, are overvalued and trading higher than last year's burger benchmark. Only the Japanese yen could be considered a snip. The dollar still buys a lot of burger in the rest of Asia too. China's currency is among the most undervalued, but a little bit less so than a year ago.

More information is available here, from the Economist website.

The full McCurrency menu is given below. The New Zealand dollar is 4% overvalued according to the Big Mac Index.

Ninjas vs Professors

From PHD Comics

Interesting blog bits

1. Gary Clyde Hufbauer and Matthew Adler on Why large American gains from globalisation are plausible.

   A popular headline figure quantifying the US payoff from globalisation at $1 trillion per year has been criticised by Dani Rodrik and other sceptics. Here is an explanation and defence of the Peterson Institute’s big number.

2. Gary Becker asks Should US Taxes on Gasoline be Higher?
3. Richard Posner asks Should Gasoline Taxes Be Raised or Lowered?
4. The Illogic of Farm Subsidies, and Other Agricultural Truths from Freakonomics
5. Not PC comments on Queenstown fascists bankrupting bar owners
6. The Visible Hand in Economics comments on the July 2008 official cash rate cut: The long and winding road.
7. Greg Mankiw says its Time to pass out the WIN buttons.

Norberg on Klein on economic freedom

Naomi Klein's recent book, The Shock Doctrine, points to the cases in which authoritarian regimes liberalized their economies. Johan Norberg argues that most countries, both authoritarian and non-authoritarian, have liberalized over the last three decades and capitalism is given rise to many of the ends that Klein herself would appreciate.

More on Fannie Mae and Freddie Mac (updated x3)

Gerry O'Driscoll (former vice president and economic adviser at the Federal Reserve Bank of Dallas) warns against bailing out Fannie Mae and Freddie Mac in an article in the New York Post.

Commenting on Treasury Secretary Henry Paulson's bailout plan for the mortgage giants O'Driscoll writes

Absent from Paulson's plan is any protection for taxpayers. They'll fund the downside if losses mount at the two mortgage giants. But if Fannie and Freddie recover, stockholders and management gain. Call it "casino capitalism" - taxpayers bankrolling management high rollers.

The plan doesn't ask stockholders or management to suffer for their financial indiscretions. The players who put their companies in jeopardy get to stay in charge - Paulson says he isn't looking for "scapegoats." Someone should remind him that capitalism without failure is like religion without sin.

O'Driscoll explains there are now three possible outcomes:

* Congress passes the Treasury plan in its current form. That gives us the status quo on steroids - Fannie and Freddie continue to make risky bets and rack up more losses, with the taxpayer guarantee fueling the financial fiasco. This would be the worst outcome, but it's where we're headed.

* We could truly privatize the two companies: Remove the federal guarantee and force them to retrench and reform. Fannie and Freddie would have to raise private capital and downsize their bloated portfolios. They'd become just two ordinary-sized financial firms, whose balance sheets would be measured in billions, not trillions, of dollars. A long shot now, this would be the best outcome.

* Nationalize both companies and end all pretense that they're private. (Fannie was a government agency until 1968; Freddie was only chartered in 1970.) They could return to being federal guarantors and packagers of mortgages, and would hold no sizeable assets themselves. This last approach is called "honest socialism."

I can't help but think that O'Driscoll is right that the second option is the best, but also the least likely. O'Driscoll end his article by noting

The Treasury's provision of the government's full faith and credit guarantee to Fannie and Freddie has stabilized the situation. Rather than rush through a bad reform, Congress should get it right. Trillion-dollar businesses should never again be wards of the taxpayer.

I'm not sure any sized businesses should be wards of the taxpayer. That only lends to trouble, as we are seeing.

(HT: Cafe Hayek)

Update: A short Cato Daily Podcast featuring Gerald P. O'Driscoll Jr talking on "Shrink, Privatize Fannie Mae and Freddie Mac" is available here. A copy of the CNBC item referred to in the podcast is available here.

Update 2: Not PC recommends reading this article from the Wall Street Journal, The Fannie Mae Gang by Paul A. Gigot.

Update 3: Arnold Kling on The McCain-Stiglitz Axis.

Great economic idea from Australia

Buy Nothing Day! That should increase economic growth. Problem is the Greens may just love the idea!

So which agency makes a better ad for Buy Nothing Day?

(HT: Not PC)

Book club: Capitalism and Freedom

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

More on food prices

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

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

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

Tangermann makes the point that

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

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

That evidence?

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

and

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

So where is the problem?

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

and

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

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

But Tangermann goes on to say

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

He continues

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

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

His conclusion is

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

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

Fannie Mae and Freddie Mac: what to do (updated)

For two very different views on what to do see:

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

The comments to these two articles are also worth reading.

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

Should taxpayers bail out the banking system?

He contrasts the

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

Thomas Sowell's view is that

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

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

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

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

Update: More from Tom Sowell

How did the government help create the current financial mess? Let me count the ways.

In addition to federal laws that pressure lenders to lend to people they would not otherwise lend to, and in places where they would otherwise not invest, state and local governments have in various parts of the country so severely restricted building as to lead to skyrocketing housing prices, which in turn have led many people to resort to "creative financing" in order to buy these artificially more expensive homes.

Meanwhile, the Federal Reserve System brought interest rates down to such low levels that "creative financing" with interest-only mortgage loans enabled people to buy houses that they could not otherwise afford.

But there is no free lunch. Interest-only loans do not continue indefinitely. After a few years, such mortgage loans typically require the borrower to begin paying back some of the principal, which means that the monthly mortgage payments will begin to rise.

Since everyone knew that the Federal Reserve System's extremely low interest rates were not going to last forever, much "creative financing" also involved adjustable-rate mortgages, where the interest charged by the lender would rise when interest rates in the economy as a whole rose.

In the housing market, a difference of a couple of percentage points in the interest rate can make a big difference in the monthly mortgage payment. For someone who buys a house costing half a million dollars— which can be a very small house in many parts of coastal California— the difference between paying 4 percent and 6 percent interest would amount to more than $7,000 a year. For people who have had to stretch to the limit to buy a house, an increase of $7,000 a year in their mortgage payments can be enough to push them over the edge financially.

In other words, government laws and policies at federal, state and local levels have had the net effect of putting both borrowers and lenders way out on a limb.

(HT: Carpe Diem)

And this from James Surowiecki at The New Yorker

When do the words “not guaranteed” actually mean “guaranteed”? Whenever the mortgage giants Fannie Mae and Freddie Mac are involved. The two companies have long been required to tell investors that their securities are not guaranteed by the federal government. But in the financial markets everyone has always assumed that this demurral was just window-dressing, and everyone, it turns out, was right. Last week, when fears of a possible collapse of the two companies threatened to spark a major financial crisis, the Treasury Department and the Federal Reserve quickly came up with a rescue package. What had been an implicit guarantee became an explicit one.

And this

It wasn’t until 1968 that Fannie was privatized. (Freddie Mac was created two years later, and was private from the start.) The main reason for the change was surprisingly mundane: accounting. At the time, Lyndon Johnson was concerned about the effect of the Vietnam War on the federal budget. Making Fannie Mae private moved its liabilities off the government’s books, even if, as the recent crisis made clear, the U.S. was still responsible for those debts. It was a bit like what Enron did thirty years later, when it used “special-purpose entities” to move liabilities off its balance sheet.

Followed by

The result of all this was that the companies reaped the rewards of the private sector while enjoying the security of the public sector. Seemingly insulated from all harm, they became reckless. They constructed a giant pyramid of debt on a very small base of capital (eighty-one billion dollars, by the most recent publicly available figures), and by May, 2008, either owned or guaranteed more than five trillion dollars in mortgages. As a result, even though just a small percentage of Fannie’s and Freddie’s mortgages are delinquent, the potential losses are huge.

And thus the reason for the recent actions by the Fed and the Treasury.

(HT: Greg Mankiw)

Central banks, the financial crisis and the threat of inflation

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

EconTalk this week

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

The lemons market (updated)

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

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

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

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

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

The Most Profitable Wine in the World

Michael Veseth at the Wine Economics blog writes

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

He goes on

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

The footnote referred to above is interesting

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

You know you have inflation when .....

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

The article states

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

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

This is because Zimbabwe has an

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

The article also says

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

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

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

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

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

(HT: Carpe Diem)

Book club: Capitalism and Freedom

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

Economic principles

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

(HT: Eric Crampton)

The Water Shortage Myth

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

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

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

Why no Marx?

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

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

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

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

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

Phil Miller at the Market Power blog agrees with Carden,

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

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

Economics of climate change

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

Wal-Mart and small business (updated)

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

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

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

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

Dean and Sobel conclude

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

(HT: Carpe Diem)

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

Interesting blog bits

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

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

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

Globalisation: three waves of change

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



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

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

Globalisation: lessons from the past

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

Milton Friedman and Augusto Pinochet

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

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

There are several problems with this theory:

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

2) This occurred years after the coup.

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

Book club: Capitalism and Freedom

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

Incentives matter: traffic ticket file

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

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

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

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

How Often are Economists Wrong?

At the Scott Adams blog at Dilbert.com we find Adams asking How Often are Economists Wrong?

Adams opens by making the point that while experts may be wrong at times, what matters is weather consulting them produces a better result on average than whatever is the alternative. Economists, like most experts, are likely to be more reliable than the public at large, depending on the sort of question asked. Adams goes on to say

If the question involves predicting the value of the stock market next year, economists aren't any better than a monkey with a dart board. And they know it. But if the question is whether using food crops for ethanol could hurt the economy more than it helps, or whether free trade is a good idea, or whether a gas tax holiday makes sense, you would be wise to listen.

Economists are also historians when it comes to their field. They would know, for example, that government price controls would be a disaster because they have failed in the past. If doing X with the economy caused Y to happen the last three times someone tried it, wouldn't you like to know it? Economists already do.

When you are talking about the global economy, making the right decisions just barely more often than before is a huge deal. So the bar is set low for economists. They only need to be right more often than the public and the politicians. Is that so hard?

No its not. But while economist are more likely to be right on these issues, votes still believe politicians. Why? (Cue Bryan Caplan) Voters have only themselves to blame for bad economic policy and the resulting bad outcomes.

(HT: Eric Crampton)

Quote of the day

From McDonald's Corp. CEO Jim Skinner:

Skinner was asked what responsibility his fast-food company has for combating the national "obesity epidemic." Skinner replied:

"We are not going to solve society's problems. People have to do that on their own ... [I]f you can’t get your kids to eat vegetables, why is it my job?"

Will Wilkinson talks with Bruce Caldwell

At Bloggingheads.tv Will Wilkinson talks with Bruce Caldwell. Caldwell is author of Hayek's Challenge which is account of the development of Hayek’s economic and methodological ideas. They talk about all things Hayekian.

Book club: Capitalism and Freedom

Over at the Free Exchange blog they have just started running their Summer book club on Milton Friedman's Capitalism and Freedom. The first posing is here. Enjoy!

EconTalk this week

This week we have Eric Hanushek of Stanford University's Hoover Institution talking with EconTalk host Russ Roberts about the strange evolution of school finance in the last four decades. In particular, the courts have played an important role in recent years in mandating expenditure increases for public school systems. Hanushek talks about why this has come about and the lack of effect these expenditures have had in affecting student achievement.

The French Revolution: good or bad?

At the Austrian Economists blog Frederic Sautet asks Should We Celebrate the French Revolution? A good question. Sautet writes

Today is Bastille Day (la Fête Nationale, as the French say), the celebration of the beginning of the French revolution in 1789. Most French people and many others outside France, have a good opinion of the revolution and its legacy for the history of the world. It is fascinating that they remain blind to the negative impact it has had on the development of political and economic ideas in the West. The French Revolution spread the wrong ideas about individualism, promoted statism, and perverted the concept of liberty.

Sautet continues

The French revolution was the primary event that gave social reformers and progressives the idea that societies can be designed by the human mind. In contrast, the "true" individualistic tradition discussed in Hayek’s Individualism: True and False is one of "humility toward the processes by which mankind has achieved things which have not been designed or understood by any individuals and are indeed greater than individual minds."

He adds a warning from Hayek

Following the Hayekian view, should we think that all revolutions are bad? Hayek warned us: "While it may not be difficult to destroy the spontaneous formations which are the indispensable bases of a free civilization, it may be beyond our power deliberately to reconstruct such a civilization once these foundations are destroyed."

Sautet ends by saying

Perhaps we should conclude that some revolutions will always be necessary not as tools for social rebuilding, but as remedies against the excesses of the state. In other words, Hayekian revolutions may be desirable, not Jacobin ones. That's how we should commemorate the day the Bastille was destroyed.

This does raise the question, Can we control the state so that "remedies against the excesses of the state" are not needed? Or are we doomed to be forever suffering the excesses of government no matter how are try to constrain it?

Remember the 4th Annual Condliffe Memorial Lecture is tonight

Anyone in Christchurch tonight should attend the 4th Annual Condliffe Memorial Lecture. The lecture will be held at 6:00-7:00pm in the Coppertop, Level 2, of the Commerce Building at the University of Canterbury. A pdf map of the University is here. The Commerce Building is at I4.

The lecture is hosted each year by Department of Economics here at Canterbury in honour of John Bell Condliffe, who became the first Professor of Economics at Canterbury University College in 1921. This year the lecture will be given by

Professor Joel Slemrod

on the topic of

Tax Policy in the Real World

Letters from America

Angus Deaton's thought-provoking Letter from America appears every six months in the Royal Economic Society's Newsletter and has done so for a number of years. What I hadn't realised, until now, is that they are available online.

(HT: The Undercover Economist)

Adam Smith and businessmen

One of the best know quotes from Adam Smith is

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.

(Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations: B.I, Ch.10, Of Wages and Profit in the Different Employments of Labour and Stock in paragraph I.10.82)

Which I had taken to be a comment on business and businessmen in general. But from Gavin Kennedy at the Adam Smith's Lost Legacy blog, I discovered that

This is often presented as Smith's general comment on business. It was, in fact, a reference to the incorporated towns where the members of each ‘trade’ – clockmakers, mechanics, drapers, weavers, butchers, printers, carriage makers, wheel makers, bakers, builders, metalworkers, and such like and so on, held a local monopoly over the sale of their designated products and prevented, legally, anybody not a member from setting up their business. It was major remnant of the old Guilds of the time, and choked competition such that members of different trades agreed not to buy from other sources, such as in nearby towns or imports, and thereby paid higher prices, but kept out competition which was a mutual benefit to all of them - but, alas, not their consumers.

What if the politicians pandered to economists?

N. Gregory Mankiw, professor of economics at Harvard, has an article in the New York Times which asks What if the Candidates Pandered to Economists?. Mankiw asks readers to

Imagine that those running for office tailored their economic positions to attract the experts in the field. What would it take to put the nation’s economists solidly behind a candidate?

Mankiw offers

... an eight-plank platform designed to attract a majority of economists.

Now the piece is written in terms of the upcoming US Presidential race but most of points apply to the upcoming election here in New Zealand as well.

Mankiw's eight points - he explains each in his article

1. SUPPORT FREE TRADE
2. OPPOSE FARM SUBSIDIES
3. LEAVE OIL COMPANIES AND SPECULATORS ALONE
4. TAX THE USE OF ENERGY
5. RAISE THE RETIREMENT AGE
6. INVITE MORE SKILLED IMMIGRANTS
7. LIBERALIZE DRUG POLICY
8. RAISE FUNDS FOR ECONOMIC RESEARCH

Number 8 gets my vote!:-)

Mark J. Perry doesn't agree with 4, 5 and 8, while Tyler Cowen asks "does he mean carbon-based energy?" when thinking about 4 and he says "I don't disagree that there is a consensus on retirement age but it was news to me to read that" and "... personally I would sooner subsidize hard science than economics; I don't think we've earned our keep lately!". Arnold Kling says "Greg Mankiw runs on support for free trade, opposition to farm subsidies, an energy tax, raising the retirement age, and other proposals. I think he is correct that this platform would win a lot of votes with Ph.D economists. It would probably do horribly with the public at large. Cue Bryan Caplan, even though my guess is that he would not be such a fan of the energy tax."

Optimal taxes?

Tim Worstall at the Adam Smith Institute blog says

I've been banging on for some time now about how various people seem to massively misunderstand green taxes. Most especially, the way in which everyone seems to think that the green taxation of petrol should mean higher taxes than we already pay. As I've said repeatedly, if you work through the numbers from the Stern Review ($85 per tonne CO2-e) you end up with the correct emissions taxation of a litre of petrol being 11 p. We already pay north of 50 p a litre. Yes, there are other things that need to be paid out of that: the cost of roads, noise and particularate pollution and so on, but the fuel duty escalator has, since 1993, added 23 p a litre in tax to pay specifically for the costs of those carbon emissions.

Worstall claims that he's been feeling so lonely saying these things ... until now.

Now the Institute for Fiscal Studies has released a press release saying

The UK's green taxes should be reformed to achieve their environmental objectives more effectively, but policymakers should be wary of calls for a big increase in green taxes to finance a significant shift away from the use of other taxes. So argues a study commissioned by the Mirrlees Review of the UK tax system, which is being chaired by Nobel prize-winner Professor Sir James Mirrlees for the Institute for Fiscal Studies.

The release go on to say

The authors note that road fuel duty is much higher in the UK than the environmental cost of vehicle emissions would appear to justify. The overall level may be justified by the much greater costs of congestion, but taxes on fuel are a very blunt instrument for dealing with this problem. This suggests that a national system of road pricing should be introduced as soon as it is administratively and politically feasible, with the revenue raised from it offset by cuts in road fuel duty.

Worstall continues by pointing out

There's a larger point to be made here. Whenever someone comes up with an argument that implies an optimal level of taxation (and this could be for green reasons, for equity, for moral purposes, whatever) it's always worth examining exactly what that optimal level is in relation to the taxes we already pay. For yes, there will of course be an outcry that this optimal level means we should increase taxes: but the truth is that as often as not we're already paying higher than that optimal level. (Emphasis added)

Now there's an interesting idea, we could be paying to much tax.

The Doha Round

From VoxEU.org comes two audio interviews dealing with issues to do with the current round of world trade negotiations, the Doha Round. First there is an interview with L Alan Winters, Professor of Economics at the University of Sussex and who was recently appointed chief economist at the UK’s Department for International Development. He talks to Romesh Vaitilingam about the current round of world trade negotiations – the benefits of reaching an agreement; the dangers of failure; the conflicting aspirations of different interest groups; and the relationship between trade liberalisation and poverty reduction in developing countries.

Next there is an interview with John Whalley, Professor and William G. Davis Chair in International Trade, Department of Economics, University of Western Ontario. Just ahead of the ‘mini-ministerial’ of the World Trade Organisation, which is intended to conclude the Doha Round, Whalley talks to Romesh Vaitilingam about the prospects for reaching an agreement. He notes the potential conflict between the trade liberalisation agenda and the big global issues that have emerged since the Round was launched in 2001, notably national security and climate change.

Faster European growth (updated)

Concerns over problems with productivity growth are common in many parts of the world and New Zealand is no exception. Politicians come up with the same "answers" world wide as well: support for the "knowledge economy" and more R&D. But when you look at the results of such policies they aren't so great. More progress would come if politicians accepted and facilitated the "dark side" of productivity improvement – the exit of high-cost producers and re-deployment of labour.

In a new column at VoxEU.org the economic historian Nicholas Crafts looks at European productivity growth and say if Europe want faster growth then they should learn to love creative destruction. The title of his column makes this point: Want faster European growth? Learn to love creative destruction. New Zealand could do worse than listen to this advice.

Crafts open this piece by noting that Paul Krugman has observed that for GDP growth in advanced economies, 3% per year is about as good as it gets. He then points out that while the United States has achieved this since 1995, the EU15 have fallen well short – averaging only 2.3%. Crafts argues that the real issue for Europe is sluggish labour productivity growth. Over the post-1995 period for Europe it averaged 1.4% per year compared with 2.1% in the United States. So over the last decade Europe has been falling behind rather than catching up with the US. Crafts does note however that there is huge variation around the European average, from Irish labour productivity growing at 3.7% down to Spanish labour productivity growth of 0.2%.

Crafts continues by explaining that

Two further aspects of comparative productivity growth should be flagged:

• Weak European performance compared with United States is characterised by a shortfall in TFP growth rather than in capital deepening.
• As analysis of the EUKLEMS dataset by Bart van Ark and his colleagues has revealed, market services are the key problem area, notably, but not only, in information technology intensive sectors such as distribution (van Ark, O'Mahony, and Timmer 2008).

Again, the variation in the contribution from labour productivity growth in the service sector is considerable, from 1.6% per year in United Kingdom to 0.1% in Italy during 1995 to 2004.

To understand the policy implications of comparative growth outcomes requires an appropriate model. Crafts argues that the most suitable model is the Schumpeterian framework developed by Philippe Aghion and Peter Howitt. The Aghion and Howitt model places innovation and creative destruction at the very heart of the growth process and views these as determined endogenously by incentive structures.

Crafts goes on by pointing out that

A central feature of their model is that as catch-up becomes relatively complete, the institutions and policy settings that are conducive to good performance change –importantly there is a stronger role for competition as a key driver of rapid TFP growth. Thus, barriers to entry and regulations that sustain them become more costly. These arguments are powerfully amplified if, at the same time economies approach the frontier, a new technological epoch that rewards those who can flexibly adjust to the new opportunities arrives.

It is then noted by Crafts that this helps explain a paradox.

Standard American criticisms of European economies stress that there is too much taxation, too much regulation, and too little competition. All these points were at least equally valid from the mid-1970s to the mid-1990s, when Europe continued to grow faster than the US. The point then is not that economic regulation has become more stringent or that competition has weakened in the recent past but rather that existing policies became more damaging as catch-up (mostly) completed and the information and communication technology era arrived.

It is also noticeable that coordinated market economies such as Germany have generally experienced lower productivity growth after 1995 whereas the opposite is the case in liberal market economies such as United Kingdom.

Peter Hall and David Soskice, who introduced this terminology, stress that a key difference between “coordinated market economies” and “liberal market economies” is that the scope for creative destruction is greater in the latter. Whereas the former did well in the catch-up of the Golden Age, their institutions and policies are less well suited to the early 21st century.

What then of the evidence that competition and potential entry promotes productivity growth. On this Crafts says

There is substantial evidence that competition and potential entry promotes productivity growth in today's European economies. The research programme led by Guiseppe Nicoletti and Stefano Scarpetta at OECD has provided an empirical handle on the inverse relationship between competition inhibiting product market regulation and productivity growth that helps to account for differences across the OECD in recent productivity performance (Nicoletti and Scarpetta 2005). The analysis of Rachel Griffith and her colleagues at IFS has demonstrated that the transmission mechanism runs from barriers to entry through high mark-ups to lower investment and research and development (Griffith, Harrison, and Simpson 2006).

Against this background, it is disappointing to note that regulations that inhibit competition and the rapid take-up of new technologies are still prevalent in many European economies. This is particularly true in the retail sector, where the cost in foregone productivity has been considerable. It should be noted that this applies to the United Kingdom, which – despite being classified by the OECD as having the lowest product market regulation in the EU – still has strict planning laws that have blocked the development of out of town supermarkets and have exacted a considerable productivity penalty as Jonathan Haskel has shown (Haskel and Sadun 2007).

But Crafts goes further and argues that it is not just at the national level that deregulation has been too slow. This is also true at the European wide level. He says that there has been only a half-hearted implementation of the Single Market Programme and therefore its impact on productivity has not been as great as it should have been.

The sad tale of the European Services Directive epitomises the problem. The symptom of inadequate competition in European service sectors is the relatively high mark-ups estimated by the OECD.

Crafts concludes by explaining

Politicians find it attractive to wax lyrical in support of the "knowledge economy" and rush to adopt targets for R&D spending and participation in tertiary education. This "happy clappy" approach to addressing Europe's productivity growth shortfall keeps them in the comfort zone. More progress would be made if the dark side of productivity improvement implied by creative destruction – exit of established producers and re-deployment of labour – were accepted and facilitated.

If only ministers could bring themselves to think (better still occasionally to say) "these job losses are good news".

Again there is much here that New Zealand could learn from. How much rubbish have we been told about the wonders that different government policies would do for the development of the "knowledge economy", how often are we told about how important participation in tertiary education is, how often are we told about the importance of R&D, but where are the tangible results of all of this rhetoric?

• Crafts, N. and Toniolo, G. (2008), "European Economic Growth, 1950-2005: an Overview", CEPR Discussion Paper No. 6863.
• Griffith, R., Harrison, R. and Simpson, H. (2006), "Product Market Reforms and Innovation in the EU", Institute for Fiscal Studies Working Paper No. 06/17.
• Haskel, J. and Sadun, R. (2007), "Entry Regulation and Productivity: Evidence from the UK Retail Sector", mimeo, Queen Mary College, London.
• Nicoletti, G. and Scarpetta, S. (2005), "Regulation and Economic Performance: Product Market Reforms and Productivity in the OECD", OECD Economics Department Working Paper No. 460.
• van Ark, B., O'Mahony, M. and Timmer, M. P. (2008), "The Productivity Gap between Europe and the United States: Trends and Causes", Journal of Economic Perspectives, 22.

Update: Tim Worstall says More companies should go bust.