Starbucks vs. the little guy

Is the corporate coffee behemoth really unstoppable? Well actually it is. How? Plain and simple competition.

Starbucks has recently announced that it will close 600 of its around 12,000 American stores in the coming year. But as Starbucks contracts, many independent coffee shops are growing, beating the coffee giant in an upscale market it helped to create.

As anti-corporate crusaders are now discovering, instead of advocating for legal prohibitions on chain stores or attempting to zone the offending businesses off of Main Street USA, mom-and-pop shops can successfully combat the coffee behemoth by using old-fashioned market competition.

This video from Reason.tv explains.

Camerer talks about neuroeconomics

In this VoxEU.org interview Colin Camerer of Caltech talks to Romesh Vaitilingam about his research programme on ‘neuroeconomics’ – the creation and use of data on brain processes to suggest new underpinnings for economic theories, which explain how much people save, why there are strikes, why the stock market fluctuates, the nature of consumer confidence and its effect on the economy, and so on.

NZIER Economics Award 2008 (updated)

The NZIER Economics Award for 2008 has gone to Professor John Gibson of the Waikato Management School at the University of Waikato. He graduated with a degree in agricultural science in 1987 and a master's in 1990 from Lincoln University before completing a PhD in economics at the Food Research Institute of Stanford University in 1998.

Gibson is no stranger to controversy. In a recent study he found pay rates for positions in public sector were between 17% and 21% higher than comparable positions in the private sector. He has argued that KiwiSaver will greatly enhance inequality among the elderly. Gibson explains that NZ Super evens out the disparities in income among the elderly to a marked extent, while KiwiSaver magnifies disparities in and of the workplace, male versus female, Maori versus non Maori, and working versus non working. On the differences in wealth and income between Maori and non Maori in New Zealand Gibson has argued that 60-65% of this was due to the younger average age of Maori.

In his acceptance speech Gibson points out that invoking controversy in nothing new for him, it started back in student days. The story also tell us something about the relationship between economists and the bureaucracy.

Looking back, I also had the good fortune to work for the Agriculture Department in Papua New Guinea in the time between my Masters and PhD. Not only did I meet my wife there, I also managed to raise the ire of the Secretary of Agriculture, who was a former politician who ultimately became the PNG ambassador to the UN.

He took issue with research I had done showing that it was far better for Papua New Guinea to trade for rice using tree crops than to try to produce rice in some self-sufficiency effort. After cancelling my contract he went to the unusual lengths of taking out a full page advertisement in the national newspaper to say that all advice that I had given was a load of rubbish.

On the academic front Gibson says that he has been lucky for a seachange in the attitude that economists, and especially the gatekeepers of the profession – journal editors – have to research relying on primary survey data. He says

It is no longer unusual to find articles in good international journals that rely on author collected data. Currently there is a much more equitable treatment for the two inputs into the production of good empirical economic science – method and data – than has historically been the case and my work has benefitted substantially from that change. This is a change that can also benefit institutions like the NZIER that have a long history of data collection.

Much the same could be said of papers based on experimental data.

On the policy front Gibson goes on to say that in his view economists in New Zealand's universities do not enter into public debate as much as they could or should.

It is my impression that as a society we are not getting full value from our university-based economists, in helping to inform public debate on topical matters.

And I would have to agree. His reasons for this are, firstly

The first reason is that many of my colleagues may not know where to turn to, to engage with policy, because they are fairly new to New Zealand. In part due to university’s responses to the Performance Based Research Fund there has been a very substantial turnover of academic personnel.

Second

... some academics might claim that working with policy agencies and research and consultancy companies might result in work that is unlikely to publish is good international journals.

Gibson argues against this. I'm not so sure. There are a few areas in which New Zealand may be interesting to overseas journal editors but there are many areas in which no one cares what happens here. And New Zealand is not as interesting to those overseas today as it was back in the reform period of the 1980s.

Thirdly Gibson writes

There is a final reason why I think that we are not getting full value from our university-based economists. It concerns the way in which tertiary sector independence has greatly eroded under the Tertiary Education Commission. The universities are now essentially centrally planned by the TEC, based on charters, investment plans and so on.

It is puzzling that central planning – which manifestly failed to deliver even basic foods and consumer goods to millions of households in China, Russia, Vietnam and elsewhere, should be expected to efficiently allocate resources for the much more complicated teaching and research services delivered by universities.

This dead hand of the TEC bureaucracy may also mean that universities are not at an ideal arms’ length distance from the government of the day. My own view is that the natural position of academics is to be agin the government, regardless of who that government is. That is part of the contribution that universities can make to a free and open society.

Gibson notes, currently in my view, that

... since the current funding mechanisms are so opaque, with much relying on the discretion of the TEC, one would never know if there was some penalty imposed for universities being overly critical.

All those in universities should feel free to hold whatever views they please without fear of penalty if the government of the day doesn't happen to like those views.

Update: A copy of the full speech can now be downloaded from the NZIER website here.

Markets do good

Even Jeffrey D. Sachs has come to realise that markets do good. In a column, The Digital War on Poverty, at Project Syndicate he writes,

The digital divide is beginning to close. The flow of digital information – through mobile phones, text messaging, and the Internet – is now reaching the world’s masses, even in the poorest countries, bringing with it a revolution in economics, politics, and society.

Extreme poverty is almost synonymous with extreme isolation, especially rural isolation. But mobile phones and wireless Internet end isolation, and will therefore prove to be the most transformative technology of economic development of our time.

The digital divide is ending not through a burst of civic responsibility, but mainly through market forces. Mobile phone technology is so powerful, and costs so little per unit of data transmission, that it has proved possible to sell mobile phone access to the poor. There are now more than 3.3 billion subscribers in the world, roughly one for every two people on the planet. (Emphasis added.)

Whatever next? Joe Stiglitz taking up Austrian economics?!

(HT: Greg Mankiw)

Boudreaux on government

Don Boudreaux sums up, as only he can, the nature of democratic government and the dilemma it represents for sound economic policy. This from Peter Boettke at the Austrian Economists blog. Boettke reproduces a letter by Boudreaux to the editor of Newsweek in responce to a column by Robert Samuelson:

Robert Samuelson is correct: regardless of which party wins the White House or Congress, Uncle Sam is unlikely to get his fiscal affairs in order ("The Rise of Fantasy Politics," September 1).

In principle, government's core responsibility is to prevent Jones from benefiting by his imposing costs on Smith without Smith's consent. In practice, government acts as Jones's agent in securing benefits for Jones by imposing costs on Smith.

Government's modus operandi today is to bestow goodies on politically powerful interest groups, and to pay for these goodies by taxing politically unpopular groups (e.g., oil companies) and politically impotent groups (most notably, future taxpayers). The bottom line is that, through government, Jones imposes costs on Smith without Smith's consent.

Kling on education

Arnold Kling writes at EconLog on Public Goods, Externalities, and Education. He says

For education, the positive externality is the benefits that accrue to me from your education. I think that those benefits tend to be pretty small. You get a higher income, and most of those benefits flow to you. I get some of the benefits, because you are more likely to pay taxes and less likely to require government transfers, so that my tax obligations can be correspondingly reduced.

You also get the consumption benefits of your education. I personally don't benefit from your experiments with drugs, sex, rock'n'roll. Nor do I particularly care that you take a class in art appreciation or get tickets to your school's basketball games.

Finally, you are supposed to be a better citizen because of education, and I should be happy about that. But if what you learn is that profits are evil, man-made global warming is beyond doubt, and it is wrong to question that gender differences are socially constructed, then from my perspective your education is not making you a better citizen.

If the higher income that you get from education is due to its signaling effects, then that is a classic negative externality. The investment in the signal is wasteful, and your investment forces others to make a wasteful investment.

On the whole, the case for taxing education rather than subsidizing it is really quite plausible. It is counter-intuitive, perhaps, but the case for free trade is also counter-intuitive to most people.

Kling has a point. It is not clear that all externalities from education are positive, and even if there are positive externalities its not obvious that there are not also negative ones as well. So its not clear what the net externality effect is. Thus it is not clear that a subsidy, rather than a tax, on education is is the best policy response to deal with education's externalities.

As to his "tax obligations" argument, it looks like a pecuniary externality. I pay an extra dollar in taxes and so Arnold pays a dollar less, things cancel out. It looks like the effect here is via the budget constraint rather than the utility function, so why do we care?

Key rules peters out: may be

At Kiwiblog David Farrar writes:

Up and down the country National Party members are celebrating as John Key has effectively ruled out Winston Peters as a Minister in a National led Government unless he can provide a credible explanation to the letter from Owen Glenn, which of course is impossible.

I see a time inconsistency problem here. Key can say what he likes now but if after the election Peters is the difference between National being able to form a government and not being able to do so then Peters will be in the cabinet. Key can not credibly commit to never giving Peters a place in cabinet, and you can bet Peters knows it.

What is an MBA worth?

So asks the Economic Logician in his posting What is an MBA worth?

He discusses the results of a paper, The Economic Returns To An MBA by Peter Arcidiacono, Jane Cooley and Andrew Hussey who tackle this question using data from the GMAT, the standard test used to select MBA candidates. What is important about this data set is that it contains students that did not pursue the MBA, as well as what potential students were earning at the time they were taking the test and after studies.

The Logician writes

So what is an MBA worth? A raw regression with few controls gives a return of 9.4% for men and 10.4% for women. Add controls for ability, returns drop to 6.3% and 6.7%. Or use fixed effects, and returns are only 4.8% and 3.8%. These numbers are truly not impressive given cost and supposed prestige of those programs. Which begs the question: are all MBA programs equally valuable?

For a school ranked outside the top 25, a full-time or part-time MBA program is essentially useless, in particular after controlling for ability.

Given that all New Zealand MBA program are outside the 25, by a long way, you do have to ask What is the worth of a New Zealand MBA?

But you have have to keep in mind that the results are based on US data and that the average returns may be greater in New Zealand than in the US. But it does make you think. Are our MBA programs worth the time and effort and cost they involve?

Interesting blog bits

1. The Visible Hand in Economics on Happiness, policies, and economics
2. Philippe Gugler on Chinese companies worldwide

   Chinese enterprises are making high profile forays into foreign markets. While these firms’ motivations are explained by traditional theories of multinational enterprises, this column identifies notable characteristics of many Chinese companies that make them distinct. China’s cultural context, market structures, and resources may necessitate changing our thinking about multinational enterprises’ strategies and motives.

3. Richard Posner asks Why Is Hollywood Dominated by Liberals?
4. Gary Becker on Hollywood and Liberals.
5. Bryan Caplan has Questions for Civil Libertarian Economists.
6. James J. Heckman on The growing polarisation of American society and its implications for productivity

   America has a growing skills problem. This column emphasises the importance of early environments in determining skills. It suggests that to promote skills, public policy should refocus attention to the early years of childhood and away from its current emphasis on the later years.

7. Tyler Cowen on the Ways that sheep can die.

Entrepreneurship, growth and public policy

In this audio from VoxEU, David Audretsch of the Max Planck Institute of Economics and Indiana University talks to Romesh Vaitilingam about his research programme on entrepreneurship – the key institutional drivers and constraints; the impact of globalisation and new technology; the links to growth and competitiveness; and the public policy issues.

The 2008 election issues

In a speech to the Probus Club on 22 August Michael Bassett gave his views on The 2008 Election Issues. Bassett writes

If we define the things that governments need to do to increase economic growth, in my view many of this election’s key issues come into sharper focus.

These things are, in Bassett's view:

1. First and foremost, governments must always maintain a steady, predictable investment climate with policies that are clear and defensible.
2. Restraining inflation must be very high in any government’s ambitions.
3. There are some areas of expenditure that are more useful than others. A study conducted by Macquarie Research Economics recently told us that for every 1% increase in the money spent on infrastructure a country can expect to lift GDP growth by 0.5%.
4. Setting a taxation regime that encourages effort is another must.
5. Closely allied to taxation is the need to control the numbers on the state’s payroll.
6. Maintaining employment laws that are fair to both employer and employee is another must. Governments should do nothing to discourage an employer taking on people at the margins.
7. Any government should always be cautious about special favours to any sector. If a government feels obliged to assist a particular group then there ought always to be a compelling reason.

My only real problem with his list is 3. It has a "Think Big" feel to it. Funds borrowed for infrastructure have an opportunity cost and its not clear how governments can workout which infrastructure projects are worth there costs and which are not. "Think Big" does not give us much reason to believe that they can. When carrying out 3. I would hope that they take note of 7.

Economics 'dying out' in UK schools

This from a news report from the BBC.The BBC says

Only three economics teachers were trained on teacher training courses in the whole of England last year, shows a study of students entering teaching.

The report's author, Professor Alan Smithers, warns that economics risks "dying out" as a school subject.

One reason for the lack of economics teacher trainees could just be the better outside options for economics graduates.

The report goes on to say

The figures for economics A-level students have been in a prolonged downturn - down by more than a quarter between 1996 and 2006 to about 17,000 - with the subject overtaken by a range of other subjects that have become much more popular.

The BBC goes on to add

Professor Smithers says it remains uncertain why so few students are entering teacher training for economics - or why the subject is in decline in schools.

Among the suggestions, he offers, are that economics is a difficult subject, requiring a strong grasp of mathematics, which limits the numbers of those able to enter the subject.

and

There might also be a shift away from the demanding academic discipline of economics towards more general business qualifications.

So business studies is easy and economics hard, and thus student move into the easy subjects.

I don't know what the situation is in New Zealand but to be honest having no economics at school may not be that bad. University courses in econ don't assume any background in the subject so doing subjects like English, maths, stats and history at school could provide a better background than doing economics itself.

(HT: The Undercover Economist)

Cool essay

Russ Roberts tells us he has been trying to get Hayek's insights, particularly in "The Use of Knowledge in Society," his 1945 American Economic Review paper across to students. He asks how do you bring these insights into the classroom? How do you get students to understand what Hayek meant when he wrote about price adjustment:

Of course, these adjustments are probably never "perfect" in the sense in which the economist conceives of them in his equilibrium analysis. But I fear that our theoretical habits of approaching the problem with the assumption of more or less perfect knowledge on the part of almost everyone has made us somewhat blind to the true function of the price mechanism and led us to apply rather misleading standards in judging its efficiency. The marvel is that in a case like that of a scarcity of one raw material, without an order being issued, without more than perhaps a handful of people knowing the cause, tens of thousands of people whose identity could not be ascertained by months of investigation, are made to use the material or its products more sparingly; i.e., they move in the right direction. This is enough of a marvel even if, in a constantly changing world, not all will hit it off so perfectly that their profit rates will always be maintained at the same constant or "normal" level.

I have deliberately used the word "marvel" to shock the reader out of the complacency with which we often take the working of this mechanism for granted. I am convinced that if it were the result of deliberate human design, and if the people guided by the price changes understood that their decisions have significance far beyond their immediate aim, this mechanism would have been acclaimed as one of the greatest triumphs of the human mind. Its misfortune is the double one that it is not the product of human design and that the people guided by it usually do not know why they are made to do what they do.

Robert's answer is this essay, "How Markets Use Knowledge" (pdf). The essay tries to integrate supply and demand and Hayek's description of the price system as a "marvel". Ironically, it treats the price system as "perfect" but with luck Roberts has been able to capture in a traditional supply and demand framework, some of what Hayek was getting at.

Read and enjoy.

EconTalk this week

Russ Roberts, host of EconTalk and author of the economics novel, The Price of Everything, talks with guest host Arnold Kling about the ideas in The Price of Everything: price gouging, the role of prices in the aftermath of natural disaster, spontaneous order, and the hidden harmony of the economic cosmos. Along the way, Roberts talks about novels vs. textbooks and other traditional treatments of economic reasoning.

Want world peace? Support free trade

Just today I came across this 2006 piece by Donald J. Boudreaux from The Christian Science Monitor entitled Want world peace? Support free trade.

Boudreaux writes

During the past 30 years, Solomon Polachek, an economist at the State University of New York at Binghamton, has researched the relationship between trade and peace. In his most recent paper on the topic, he and co-author Carlos Seiglie of Rutgers University review the massive amount of research on trade, war, and peace.

They find that "the overwhelming evidence indicates that trade reduces conflict." Likewise for foreign investment. The greater the amounts that foreigners invest in the United States, or the more that Americans invest abroad, the lower is the likelihood of war between America and those countries with which it has investment relationships.

Professors Polachek and Seiglie conclude that, "The policy implication of our finding is that further international cooperation in reducing barriers to both trade and capital flows can promote a more peaceful world."

He goes on to add

Columbia University political scientist Erik Gartzke reaches a similar but more general conclusion: Peace is fostered by economic freedom. Economic freedom certainly includes, but is broader than, the freedom of ordinary people to trade internationally. It includes also low and transparent rates of taxation, the easy ability of entrepreneurs to start new businesses, the lightness of regulations on labor, product, and credit markets, ready access to sound money, and other factors that encourage the allocation of resources by markets rather than by government officials.

Professor Gartzke ranks countries on an economic-freedom index from 1 to 10, with 1 being very unfree and 10 being very free. He then examines military conflicts from 1816 through 2000. His findings are powerful: Countries that rank lowest on an economic-freedom index - with scores of 2 or less - are 14 times more likely to be involved in military conflicts than are countries whose people enjoy significant economic freedom (that is, countries with scores of 8 or higher).

Also important, the findings of Polachek and Gartzke improve our understanding of the long-recognized reluctance of democratic nations to wage war against one another. These scholars argue that the so-called democratic peace is really the capitalist peace.

Democratic institutions are heavily concentrated in countries that also have strong protections for private property rights, openness to foreign commerce, and other features broadly consistent with capitalism. That's why the observation that any two democracies are quite unlikely to go to war against each other might reflect the consequences of capitalism more than democracy.

And that's just what the data show. Polachek and Seiglie find that openness to trade is much more effective at encouraging peace than is democracy per se. Similarly, Gartzke discovered that, "When measures of both economic freedom and democracy are included in a statistical study, economic freedom is about 50 times more effective than democracy in diminishing violent conflict."

Such results do make sense. By supporting polices that promote prosperity, economic freedom gives people (voters) a large stake in maintaining peace. This prosperity is threatened during wartime. War by its very nature gives governments increased control over the resources of the economy and imposes extra burdens in the form of higher government spending and thus higher taxes followed by higher inflation, and other disruptions caused by the increase government control of the economy, all of which hamper the working of the basic commercial relationships that underlie prosperity. Boudreaux ends by making the point that

When commerce reaches across political borders, the peace-promoting effects of economic freedom intensify. Why? It's bad for the bottom line to shoot your customers or your suppliers, so the more you trade with foreigners the less likely you are to seek, or even to tolerate, harm to these foreigners.

So lets see all the peace activists get out there and start supporting free trade!

What Good are Economists?

Scott Adams asks What Good are Economists? His answer:

If a weather expert tells you what the weather will be on a specific day next year, you can safely ignore him. If he tells you a hurricane is heading your way, it's a good idea to get out of the way, even if the storm ends up turning. That's playing the odds.

Likewise, if an economist tries to tell you where the stock market will be in a year, you can safely ignore that. But if he tells you a gas tax holiday is an unambiguously bad idea, that's worth listening to, especially if economists on both sides of the aisle agree.

If you think it is okay to ignore economists because they are so often wrong, you're looking at the wrong questions. Economists are generally wrong with complicated models but right about concepts. For example, they know that additional domestic drilling won't make much of a dent in the energy problem. And they know that free trade is generally good for all economies. (You can argue with my examples, but the point is that some things are generally known by economists while not being understood by the general public.)

By analogy, a mechanic knows that changing your oil is good for your engine, but he can't tell you what problems you will have with your car next year. You shouldn't ignore the mechanic's advice on changing oil just because he doesn't know when your battery will die, or because he didn't personally perform any scientific studies on oil changes.

Doctors are often wrong, but you are still better off going to the doctor than diagnosing problems yourself. And when you get the opinions of several doctors, your odds improve, even if those several doctors aren't a scientific sample. The important thing is that following a doctor's advice, or the consensus of several doctors, increases your odds compared to the alternative. And the more doctors the better.

On the more doctors is better line of reasoning, Adams, as noted previously, has surveyed over 500 economists to get their policy views.

(HT: Eric Crampton)

No, markets are not perfect ......

they are just better than the alternative. This is my very short summary of an article at townhall.com in which David Strom asks Is the Free Market Perfect?

Strom writes

The superiority of free markets to government regulation is not based upon a magical ability of businesses or even markets to operate flawlessly or at optimal efficiency at all times. Businesses often make huge mistakes, and we have known for centuries that markets are constantly fluctuating, even wildly. Recently the tech bubble and now the housing bubble show that even entire segments of the market get so out of whack that we all wind up suffering painful corrections.

Markets, though, correct. Because they are ultimately tied to basic forces such as supply and demand, customer desires, and of course competition, they are anchored to real forces within the economy as a whole. No matter how out of whack they get, the long-term trend is always going to be in the right direction. More economic growth, satisfying customer demands, better quality at lower prices, and increased productivity and efficiency.

[...]

Markets work well—not perfectly, but well—because they are not engineered from the top-down. They are chaotic. They encourage experimentation. They allow mistakes. In markets, even the mighty can fall.

It could also be added that when markets are "out of whack", government action is often the cause. Minimum wage laws lead to youth unemployment, subsidies result in wine lakes and butter mountains, ethanol mandates and subsidies have distorted markets and increased the price of food worldwide and so on.

(HT: Carpe Diem)

A nudge towards libertarian paternalism?

Nudges are for markets not nations. Or so says Tim Harford in a column at FT.com. Harford writes

Libertarian paternalism is the brainchild of Profs Thaler and Sunstein, but nudging is not. Nudging is good architecture, good design or good marketing and most nudges have been invented by private sector companies. Prof Thaler’s best policy idea – a pension plan called Save More Tomorrow – was tried by a manufacturing company rather than a government.

Effective nudges are so common in the private sector that politicians should be asking themselves why. What is it about competitive markets that produces such clever wheezes?

The answer has been obvious for a long time: the market is a machine for producing good ideas, promoting experimentation and scything down concepts that fail, all the while giving the customer the power to choose.

The answer does not appear to have been obvious to most politicians, in the UK or New Zealand, who seem to want to control and direct markets rather than let them experiment and evolve, by rewarding good ideas and punishing bad ones. Harford goes on to say

With the right reforms, public services can show some of the same qualities of permitting experimentation, rewarding success and not propping up failure. Humble civil servants – or, better, the staff of schools and hospitals – are in a position to discover the best public-sector nudges, and with the right incentives they will.

But what evidence is there that they will be given the right incentives?

(HT: Marginal Revolution)

Trade deficits don't matter

This short audio from the Cato Institute discusses why Trade Deficits Don't Matter. This Cato Daily Podcast features Daniel T. Griswold who is Director of the Center for Trade Policy Studies at the Cato Institute.

Divided We Stand, United We Fall

Having just had the chance to listen to Gregory Clark give a seminar on Survival of the Richest: Malthus, Darwin and Modern Economic Growth (pdf) this paper, Divided We Stand, United We Fall: The Hume-North-Jones Mechanism for the Rise of Europe, by Cem Karayalcin looked interesting.

One of the biggest challenges for economic history is to explain the "great divergence" between Europe and the rest of the world. This occurred relatively recently. The question is What enabled Europe, with all its laggards, to dominate the previously successful Eastern economies? Why did Asia, and in particular China and India, suddenly stagnate and why did Europe start growing, leading eventually to the Industrial Revolution, before any other region of the world. As noted at the Economic Logic blog

Some of the standard answers have been that this is due to 1) cultural aspects, but within the time line we are talking about here, this is endogenous; 2) chance events (steam engine, proximity of coal), but European countries away from such events also grew faster than Asian ones; 3) resource grab from America, but would Asia really have benefited from such manna?

The Karayalcin article emphasises one important mechanism (among many others in operation) which highlights the contrast between the European states system and Eastern empires. Political competition for a mobile tax base in a states system forces rulers to provide relatively more secure property rights. This mechanism is one which leads rulers to expropriate less and to provide relatively more public services to their footloose subjects.

Rulers who do not face such competition would be more likely to choose higher expropriation rates relative to what they provide in return. The Song Chinese and the Ottoman and Mughal Indian states in their consolidation periods did in fact face such competition and chose to expropriate less from their subjects, leading to their "golden periods." However, their consolidation into unified, stable empires radically diminished the potential mobility of their subjects and removed a structural barrier to high levels of expropriation. The resulting fall in rates of capital accumulation and growth led these empires into a long period of decline.

Europe was fortunate in that it avoided unification and consolidation into a single empire. The states system that emerged there led to political competition among its rulers to keep and expand a tax base composed of subjects that could, in the long run, move from one state to another in search of lower rates of expropriation and higher levels of "public services." The economic and political privileges won by the footloose subjects translated into higher rates of capital accumulation and economic growth that propelled the rise of Europe.

But this does still leave the question, Within Europe, why did the Industrial Revolution occur in the England first and not elsewhere? Did England offer lower rates of expropriation and a higher level of "public services" for tax paid? Why? If capital accumulation is important, did England have more capital? And if so why? Were wages higher in England than elsewhere in Europe, thereby making capital relatively cheap and therefore giving an incentive to invest in labour saving physical capital. But this in turns raises the question of Why were wages so high?

There are two parts to the Karayalcin paper. In the first a simple theoretical model is put forward which demonstrates the points Karayalcin wants to make. In the second section he uses history to justify the assumptions which underlie his results. Evidence is provided on things like mobility within Europe since medieval times and the lack of mobility in the Asian empires, and the differences in taxation burdens.

(HT: Economic Logic)

The Adams survey of economists

Scott Adams of Dilbert fame has been very smart and funded a survey of professional economists to see which candidate for President of the United States has the most support from economic experts. Adams writes on his blog.

Voters say the economy is the most important issue to them. Foreign affairs will keep dropping down the list of importance now that the current administration supports a timetable for withdrawal from Iraq. So how does a voter decide which candidate would be best for the economy?

Yesterday Reuters/Zogby announced a poll that showed, among other things, which candidate the voters think would manage the economy better. This is like asking people who have hemorrhoids the best way to treat a brain tumor. Shouldn't we be asking brain surgeons?

Forgive me for not caring what your grandma thinks of NAFTA. I want to know which economic policies seem best according to the majority of economists. I got tired of waiting for someone else to give me some useful information and decided to go get it myself. Democracy without useful information is random. This isn't a good time in history to be making random decisions.

Bryan Caplan notes at EconLog

If you know anything about the econ profession, it's clear that Obama will crush McCain. After all, the typical economist is a moderate Democrat; he just happens to be a moderate Democrat who thinks that downsizing has important long-run economic benefits.

The real contribution of an Adams-like survey is the information it provides about economists' specific policy views. NAFTA, for example, enjoys economists' bipartisan support. If the public merely deferred to policies enjoying such support, we'd live in a very different and vastly better world.

It will be interesting to see how this survey of economists turns out.

Interesting blog bits

1. Economic growth may just make the whole society happier.
2. Tyler Cowen on Reexamining the benefits of free trade.

   If there is any piece that can get Dani Rodrik blogging again, this is it.

3. Gary Becker on the Determinants of the Olympic Success of Different Countries.
4. Richard Posner on Financing the Olympic Games.
5. Oxonomics asks What causes inflation?
6. Rebecca Hellerstein and Cédric Tille look at Financial factors and the current account: Is volatility a concern?

   Financial globalisation has made current account balances more sensitive to volatile variables like asset prices and interest rates. This column says that greater current account volatility may be good news if it comes in the form of countercyclical risk sharing.

7. Greg Mankiw has More on Obamanomics.
8. Charles W. Calomiris on the The subprime turmoil: What’s old, what’s new, and what’s next

   The subprime crisis is the joint product of perverse incentives and historical flukes. This column explains why market actors made unrealistic assumptions about mortgage-backed securities and how various regulatory policies exacerbated the problem. The crisis will necessitate changes in monetary policy, regulation, and the structure of financial intermediation.

Best sentence of the day (updated)

From Justin Wolfers at Freakonomics

Feel free to insert joke here about two-handed economists; although recognize that even an octopus couldn’t summarize the consensus within, say, sociology.

Update: The Visible Hand in Economics discusses the Wolfers piece at Is economics not transparent enough?

From the only the Dutch file .....

This from Tyler Cowen at Marginal Revolution

In the Dutch parliament there was commotion today because it happens to be the case that parents can apply for some EXTRA day-care allowances (state subsidized) when they want to go on holiday WITHOUT their children. As a matter of fact: the tax department explicitly draws their attention to this fact.

$9.99 v's $10.00

A standard argument in economics is that retailers set their prices just under whole numbers, say $9.99, to force their employees to open the till for change, reducing the chances of them pocketing the bill or because they think, mistakenly, that consumers will somehow read more into the one cent price reduction than a one cent price reduction, all because the first number changed. Economists assume that consumers aren't actually fooled into buying a lot more at $6.00 than at $5.99, because honestly, who's that stupid?

May be the French. According to this this story from the BBC

... according to a French study the phenomenon still swings a considerable number of shoppers. Researchers found that lowering the price of a pizza from 8.00 euros to 7.99 euros boosted sales by 15%.

The BBC report says that Robert Schindler, professor of marketing at Rutgers Business School in the US, argues 0.99 idea was introduced for sale items, to emphasise the discount.

"I studied adverts in the New York Times from 1850 - where there were no 99 endings - to the 1870s and 1880s where they started to appear. Although department stores were doing it - which would fit with the cash register hypothesis - they were advertising discounts. But for the regular price they would use a round number," he says.

He thinks the retail practice developed from there, to communicate discount or the impression that things are on sale - even when they are not.

Wolf on the corporation

Martin Wolf has a strange piece on Profit-maximization as the sole goal of a corporation over at Creative Capitalism. He writes

What is the goal of the limited liability, joint-stock company, the core institution of the contemporary capitalist economy? What implications does the answer have for such a company's freedom to be “creative” in the way Bill Gates uses the term? The classic answer to the first of these questions, repeated often in these discussions, is that its aim is to maximise profits. This statement is not false. But it is vastly too limited. Here are ten points relevant to this theme.

I will make some brief comments on some of his 10 points.

His first point is that the role of a company is to provide goods and services and its goal is profit-maximisation. Wolf writes

The goal of profit-maximization drives the firm to fulfill its role.

No, its the other way round. The role of the firm is to maximise profits and the way it does this is by providing people with goods and services they want. So the goal of providing goods and services drives the firm to fulfil its role, profit-maximisation. Profit-maximisation makes possible consumption maximisation and as Adam Smith pointed out more than 240 years ago that "Consumption is the sole end and purpose of all production".

Wolf's third point is

... a company is viewed in the Anglo-American world as a bundle of contracts.

No. Ever since Grossman and Hart (1986) the economist's view of a company is as a collection of assets under common ownership. That is

... a 'firm' is defined as a collection of assets over which certain agents have property rights. (Moore 1992)

In his fifth point Wolf claims

... shareholders are not genuine owners.

Again following Grossman and Hart, the owners of a firm are those who have residual control rights over the non-human assets of the firm. Such a view seems in line with the legal approach. As Oliver Wendell Holmes Jr. put it,

But what are the rights of ownership? They are substantially the same as those incident to possession. Within the limits prescribed by policy, the owner is allowed to exercise his natural powers over the subject-matter uninterfered with, and is more or less protected in excluding other people from such interference. The owner is allowed to exclude all, and is accountable to no one. (The Common Law, p193, (1963 edn.))

Shareholders would have ultimately the residual controls of the firm. Normally, for good efficiency reasons, shareholders also have the residual income rights over the firm. But if income and control right are separate, then the "owner" of the firm is whoever has the control rights. Wolf goes on to write that those people with the biggest investment in the firm and thus those with the greatest exposure to firm-specific risks are not shareholders, but core workers. And one would say such "core workers" (however one defines that term) are paid, at least in part, directly to carry such "risk."

Wolf goes on to say

Sixth, if companies can be freely bought and sold, relational contracts, which depend on continuing interaction among specific people inside the business, are hardly worth the paper they are (not) written on.

But why? If relational contacts are truly important to the working of the firm, why would a profit maximising owner not want to honour such contacts? Not to do so would seem to endanger the aim of profit maximisation.

In point 8 Wolf claims

The failure of Japanese capitalism to achieve the highest level of productivity and sustained dynamism may have far more to with repression of domestic competition in many markets for goods and, above all, services, rather than with the absence of an active market for corporate control.

But are these things related? Is the lack of an active competition for corporate control just an example of a more general lack of competition in many markets.

Wolf's point 9 is that

Because these companies cannot be forced to maximize shareholder value, they can indeed undertake a range of costly “charitable” activities, provided they do not threaten the company’s ability to survive.

In other words, Wolf want the management of the company to be able to steal the profits of shareholders and use them for whatever “charitable” activities they just happen to want to support, for whatever reasons. If Mr Wolf was to invest in a company I was manager of I would use his money to support the New Zealand Society for the Making Fun of Pommy Journalists, a well known and respected “charitable” activity in these parts. But I'm sure Mr Wolf wouldn't mind. But I do have to ask, Would it not be better for the firm to maximise the income of its shareholders and then let them decide which “charitable” activities to support? What makes a firm's managers so much better at deciding which “charitable” activities to support than the shareholders of the firm?

Wolf ends his article by pointing out

... the more “Anglo-American” capitalism becomes and so the more shareholder driven, [...] the less concerned with wider social results it is likely to be.

And I say that is just as it should be. A firms job is not to be "concerned with wider social results". If Mr Wolf wishes to do social work, which seems likely given that he has given up any pretence of doing economics, let him do it with his money and not by stealing the money of others.

Let me end by making the point that one of the strengths of Anglo-American capitalism is the many forms of governance that it has developed to deal with different situations. We have profit maximising firms, not for profit firms, producer cooperative, consumer cooperatives, worker-owned firms and so on. These firms have developed organically and have evolved through time in response to the changing economic and social environment. Such governance structures may be better suited to dealing the issues Wolf seems to want to address.

• Grossman, S. and 0 . Hart, 1986, The costs and benefits of ownership: A theory of vertical and lateral integration, Journal of Political Economy 94, 691-719.
• Moore, John, 1992, The firm as a collection of assets, European Economic Review 36 493-507.

Robert Pindyck interview

A Q&A with MIT Professor of Economics and Finance Robert Pindyck on the US presidential candidates energy policies.

Sahlin on the Milton Friedman Institute

The setting up of the Milton Friedman Institute at the University of Chicago is opposed by Marshall Sahlins.

Brad DeLong gives his view of Sahlin here. A short quote

Sahlins's claims that it was "the market-industrial system [which] institutes scarcity"... seemed to indicate a total, willful, and culpable ignorance of practically all of the non-market settled agricultural societies of the past ten thousand years.

There is more on this issue from DeLong here.

If money doesn’t make us happy, why do we act as if it does?

In a recent paper in the Journal of Economic Psychology, Aaron Ahuvia asks If money doesn’t make us happy, why do we act as if it does? The abstract reads

Research on income and subjective well-being shows that among the non-poor, increased income has little or no lasting impact on happiness. Yet the desire for more income remains a powerful motive among many people at all income levels. Is this simply because many people are misinformed and believe that higher incomes will make them happier, or are they motivated by something other than the pursuit of happiness? This paper argues for the latter. The paper begins by exploring this question, reviewing the literature on income and subjective well-being, and discussing of the role of utility in decision making. This paper then argues that three main factors lead us to value increased income even if it does not make us happier. First, happiness is just one value among many, and not the only conscious goal people set for themselves. Second, even when people are striving to maximize happiness, our tendency to overweight short-term payoffs leads us to overvalue the short-term rewards that income provides. Finally, I argue that our values-based decision making competes with other motivational systems and evolutionary drives. Three evolutionary desires are discussed: (1) to store resources, (2) to be sexually attractive, and (3) to manage our social relationships and our personal identity within those relationships. While all three motivations play a role in our desire for increased income, this paper argues that it is the third – the use of money and consumption as a social tool – that has the most important overall influence on our desire for increased income past the point where it ceases to increase personal happiness.

But other researchers say that money can buy happiness. Here is a short video on from the US Nightline programme summarizing research by Justin Wolfers and Betsey Stevensonon on the relationship between income and happiness. Betsey Stevenson is interviewed in the piece.

Here is a discussion by Justin Wolfers of research into the question, Are Rich People Happier than Poor People? And the short answer appear to be, yes. Wolfers discusses work that is Delving Into Subjective Well-Being as well.

Book club: Capitalism and Freedom

The last posting is available over at the Free Exchange blog in their Summer book club on Milton Friedman's Capitalism and Freedom. Read here.

The reason for the petrol price reductions

Why have petrol prices dropped? The L.A. Times has the answer. This article in the Times reports on a group claiming that the recent reduction in gas prices was caused by ... prayer.

“If the whole country keeps on praying, we can bring down prices even more — to even less than $2,” says Rocky Twyman, founder of Pray at the Pump.

The Times says

About four months ago, frustrated by the apparently immutable laws of supply and demand, Rocky Twyman turned to a higher authority in his quest for cheaper gasoline.

The recent dip in prices, he says, is proof of divine intervention.

"Prayer is the answer to every problem in life," said Twyman, founder of the Pray at the Pump movement, whose members huddle around gas pumps and ask the Almighty to lower gasoline prices.

Incentives matter: education file

This from the Chronicle of Higher Education

Several British universities apparently are offering cash incentives to students to induce them to enroll in unpopular degree programs, according to an investigation by London’s Sunday Times in which undercover reporters posed as students seeking spots.

A female reporter was offered £1,000, or $2,000, to enroll in Leicester University’s undergraduate physics program and was told “that she was a strong candidate for the money partly because women were ‘underrepresented’ on the course,” the Times reported. [...]

All but a handful of undergraduate courses of study cost the government-set maximum annual tuition of approximately $6,000, but the newspaper noted that the “booming market in cash awards to fill some courses” represents an effort by institutions, “reluctant to appear cheap,” to effectively offer discounted rates while officially charging the national norm.

EconTalk this week

John Taylor of Stanford University talks about the Taylor Rule, his description of what the Fed ought to do and what it sometimes actually does, to keep inflation in check and the economy on a steady path. He argues that when the Fed has deviated from the Rule in recent years, the economy has performed poorly. Taylor also assesses the chances for a monetary or financial disaster and the Fed's recent expanded role in intervening in financial markets.

Incentives matter: performance pay file

Over the last two decades or so there has been a surge in the popularity of performance pay for those in executive and managerial positions within a firm. From CEOs down to middle and lower management incentive packages are now common place. One question about this approach is How does managerial performance pay affects firms' productivity and the performance of individual workers in lower tiers of the firms' hierarchy? A recent paper has tried to answer this question.

O. Bandiera, I Barankay, and I Rasul (2007) "Incentives for Managers and Inequality Among Workers: Evidence from a Firm Level Experiment", Quarterly Journal of Economics 122: 729-74, engineered an exogenous change in managerial incentives by augmenting managers' fixed wages with a performance bonus based on the average productivity of workers that they managed. One important point about this exercise was that lower-tier workers in the firm were rewarded according to the same compensation scheme throughout, so an effect were coming from the changes to the managers' pay scheme.

Bandiera, Barankay and Rasul write

In our context, as in most firms, managers can affect average workers productivity through two channels—(i) they can take actions that affect the productivity of existing workers, and (ii) they can affect the identity of the workers selected into employment. A simple theoretical framework indicates that when workers are of heterogeneous ability and managers' and workers' efforts are complements the introduction of managerial performance pay makes managers target their effort towards the most able workers. We label this a "targeting effect" of managerial incentives. In addition, the introduction of managerial performance pay makes managers select the most able workers into employment. We label this a "selection effect" of managerial incentives.

Both these targeting and selection effects will influence the mean and the dispersion of workers' productivity. Mean productivity unambiguously rises given that managers have the incentive to target the most able workers and fire the least useful. As far as dispersion is concerned Bandiera, Barankay and Rasul note that

The effect on the dispersion, however, is ambiguous. On the one hand, targeting the most able workers exacerbates the natural differences in ability and leads to an increase in dispersion. On the other hand, if only more able and, hence, more similar workers are selected into employment in the first place, the dispersion of productivity may fall, depending on the underlying distribution of ability across workers.

Bandiera, Barankay and Rasul go on to note

Our research design combined with data from personnel records on the daily productivity of individual workers allows us to provide evidence on how the provision of incentives to managers affects manager's behavior and therefore filters through to the performance of individual workers at lower tiers of the firm hierarchy. We identify the effect of managerial performance pay on average worker productivity, on the dispersion of workers' productivity, and use individual productivity data to separate the targeting and selection effects.

The design of the experiment was as follows.

We divided the peak picking season into two periods of two months each. In the first period the COO [chief operating officer] and managers were paid a fixed wage. In the second period, we added a daily performance bonus to the same level of fixed wages. The performance bonus is an increasing function of the average productivity of workers in the field on that day, conditional on average productivity being above an exogenously set threshold.

The all important results were

First, the introduction of managerial performance pay increases both the average productivity and the dispersion of productivity among lower-tier workers. The average productivity increases by 21 percent, and the coefficient of variation increases by 38 percent.

Second, the increase in the mean and dispersion of productivity is due to both targeting and selection effects. The analysis of individual productivity data reveals that the most able workers experience a significant increase in productivity while the productivity of other workers is not affected or even decreases. This suggests that the targeting effect is at play—after the introduction of performance pay, managers target their effort towards more able workers.

The individual data also provides evidence of a selection effect. More able workers, namely those who had the highest productivity when managers were paid fixed wages, are more likely to be selected into the workforce when managers are paid performance bonuses. Least able workers are employed less often, and workers at the bottom of the productivity distribution are fixed.

Third, the selection and targeting effect reinforce each other, as workers who experience the highest increase in productivity are also more likely to be selected into employment. The introduction of managerial performance pay thus exacerbates earnings inequality due to underlying differences in ability both because the most able workers experience a larger increase in productivity and because they are selected into employment more often.

Finally, we evaluate the relative importance of the targeting and selection effects through a series of thought experiments. We find that at least half of the 21 percent increase in average productivity is driven by the selection of more productive workers. In contrast, we find that the change in dispersion is nearly entirely due to managers targeting the most able workers after the introduction of performance pay. Namely, the dispersion of productivity would have increased by almost the same amount had the selection of workers remained unchanged. The reason is that the distribution of ability across workers is such that even when the least able workers are fired, the marginal worker selected to pick is still of relatively low ability. Hence, there remains considerable heterogeneity in productivity among selected workers.

So the introduction of an incentive scheme for managers effect not only the performance of the managers but also the performance and make-up of the workforce.

There is one obvious problem, and strength, of this approach. The study uses very detailed data and hence can produce detailed results. This clearly is a strength of the paper. But this data only comes from one firm, and a somewhat special situation, in particular the employment situation is rather special in that the pool of managers and workers available for employment is fixed and observable. Thus precision comes at the cost of generality.

Econ academics blogs

Christian Zimmerman of the Economics Department at the University of Connecticut has set up a blog aggregator focused on academic economics research, Econ Academics Blog. As Zimmerman points out, there are lots of economics blogs, but only a few that deal primarily with academic economics (theories, research papers, debates).

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 and here.

Krugman on globalisation

In a recent New York Times piece Paul Krugman makes an interesting point about the fate of globalisation,

Some analysts tell us not to worry: global economic integration itself protects us against war, they argue, because successful trading economies won’t risk their prosperity by engaging in military adventurism. But this, too, raises unpleasant historical memories.

Shortly before World War I another British author, Norman Angell, published a famous book titled “The Great Illusion,” in which he argued that war had become obsolete, that in the modern industrial era even military victors lose far more than they gain. He was right — but wars kept happening anyway.

So are the foundations of the second global economy any more solid than those of the first? In some ways, yes. For example, war among the nations of Western Europe really does seem inconceivable now, not so much because of economic ties as because of shared democratic values.

Much of the world, however, including nations that play a key role in the global economy, doesn’t share those values. Most of us have proceeded on the belief that, at least as far as economics goes, this doesn’t matter — that we can count on world trade continuing to flow freely simply because it’s so profitable. But that’s not a safe assumption. [...]

But the belief that economic rationality always prevents war is an equally great illusion. And today’s high degree of global economic interdependence, which can be sustained only if all major governments act sensibly, is more fragile than we imagine.

My fear would be that Krugman is right. In particular the necessity for all governments to act sensibly is not an idea that history gives us much reason to believe in.

Johan Norberg on the unseen benefits of globalization.

In this audio tape from the Cato Institute, Johan Norberg talks about the unseen benefits of globalization. Norberg explains why open markets are beneficial to all of us.

Poverty and economy in Mugabe's Zimbabwe

This short audio from the Cato Institute discuss "Poverty and Economy in Mugabe's Zimbabwe". This Cato Daily Podcast features Rejoice Ngwenya, a Zimbabwean writer and head of the Zimbabwean Coalition for Market & Liberal Solutions.

A lesson for StatsNZ?

This comes from a paper "Skill Measurement in Official Statistics: Recent Developments in the UK and the rest of Europe" by Peter Elias and Abigail McKnight, Oxford Economic Papers 3 (2001), 508–540.

An amusing and extreme example derives from the 1981 Census of Population carried out in the Channel Island of Jersey. One census question consisted simply of the word ‘Occupation’, with an empty box alongside for the written response. Many older residents wrote in ‘1939–1945’.

ExxonMobil's tax bill and costs

An interesting piece from ABC News.

ExxonMobil CEO and chairman Rex Tillerson defended his company's staggering $11.7 billion in profits for the second quarter, saying that the company's earnings reflected the magnitude of its business operation.

"I saw someone characterize our profits the other day in terms of $1,400 in profit per second. Well, they also need to understand we paid $4,000 a second in taxes, and we spent $15,000 a second in cost," Tillerson told ABC News' Charles Gibson. "We spend $1 billion a day just running our business. So this is a business where large numbers are just characteristic of it."

Interesting blog bits

1. Gavin Kennedy on Once More on Murray Rothbard and his Lack of Knowledge About Adam Smith.
2. Richard Posner on The Economics of Gay Marriage.
3. Gary Becker asks Should Gay Marriages be Allowed?
4. Economic Logician asks Should Economists be certified?
5. The Visible Hand in Economics give their First impression of National energy strategy
6. Edwin M. Truman on Sovereign wealth funds: Debunking four popular myths.
7. Carol Propper asks Can performance targets produce better healthcare outcomes?

Human capital and the firm

When reading on the reasons behind the famous takeover of Fisher Body by General Motors I came across an issue I hadn't thought of before with regard to why vertical integration takes place. The claim is human asset specificity was important reason for the General Motors takeover. For example Freeland (2000) writes

Despite the importance of physical asset specificity in the Fisher case, issues of human asset specificity and knowledge acquisition played a much greater role in integration than has heretofore been recognized. General Motors's initial investment in Fisher occurred because the automaker wanted more than a source for car bodies-it wanted to capture the knowledge and human assets of the Fisher brothers while limiting competitors' access to that knowledge. The fact that GM management placed a higher priority on retaining the Fishers than on acquiring the physical assets of Fisher played a central role both in shaping the initial contract between the companies and in determining the subsequent course of events that eventually led GM to purchase Fisher. The Fisher case thus suggests that knowledge acquisition may play a crucial role in shaping the boundaries of the firm, an area in which additional research is needed.

Now my problems with this are two fold. 1) I don't see why an employment contract is any better at controlling human capital than a general contract between firms. Why can't whatever is written into one of these contracts be written into the other? And thus we should get the same outcome in each case. 2) If you really do want the human capital of certain people, why not just employ those people directly. Its not clear why you need to takeover a whole firm just to get the human capital of some of its employees.

Or am I missing something?

• Freeland, Robert F. (2000). Creating Holdup through Vertical Integration: Fisher Body Revisited, Journal of Law and Economics, XLIII(1) April 2000.

Must the Government Combat Americans’ Addiction to Foreign Bananas?

At The Independent Institute website Robert Higgs asks Must the Government Combat Americans’ Addiction to Foreign Bananas? Higgs points out that

Americans, we are told again and again, are “addicted to foreign oil” and “in love with the automobile.”

He then suggests that

Suppose a serious policy of “energy independence” were actually implemented, rather than being merely spewed out along with the rest of the political hot air. Would we be better off? Absolutely not. We would be vastly poorer because we would have to sacrifice a great deal more of the non-oil products we now produce and consume in order to acquire the petroleum products we demanded.

Higgs continues by arguing

If we were talking about bananas, everybody would see immediately the foolishness of seeking “banana independence.” Nobody would fall for half-baked arguments about our addiction to foreign bananas or our love affair with banana bread. It’s obviously uneconomic to grow millions of bananas in this country; it could be done, but doing it would entail much greater costs than buying them from producers in places better suited to their production (that is, places where they can be produced at lower opportunity cost).

The argument with regard to oil, or anything else, is identical and it is identical for any country, not just the US.

Financial and environmental costs of ethanol

The following short video is from Reason.tv. It examines the financial and environmental costs of ethanol.

Ethanol advocates claim that the biofuel is a cheap, renewable energy source that reduces pollution and our dependence on foreign oil. It sounds too good to be true—and it is.

Ethanol, especially the corn-based variety, is bad for taxpayers, bad for consumers, bad for the environment, and horrible for the world's poor. In fact, even environmentalists are critical of ethanol subsidies these days. The ethanol craze has distorted markets and increased the price of food worldwide. The only people who still support ethanol subsidies are the ethanol producers—and politicians from both sides of the aisle. Together, they make sure the subsidies keep coming.

A concise but accurate summary of the situation.

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 and here.

What to do with forensic science?

There is an interesting piece by Radley Balko, a senior editor for Reason magazine, and Roger Koppl, Professor of Economics and Finance in Fairleigh Dickinson University's Silberman College of Business, over at Slate in which the authors suggest the need for reforms to the way forensic science is carried out. The conclusion reads:

The continuing stories of forensics error and wrongful convictions are troubling but not all that surprising. Our criminal justice system is centuries old. It just hasn't adapted well to the dramatic advances in science and technology over the past 30 years. But as forensic evidence becomes more and more important in securing convictions, the need for monitoring and oversight grows exponentially. Every other scientific field properly requires peer review, statistical analysis, and redundancy to ensure quality and accuracy. It's past time we applied the same quality-control measures to criminal forensics, particularly given the fundamental nature of what's at stake.

Crazy ideas: social credit file

Of the ideas that economists have to deal with every so often, one of the stranger ones is that of Social Credit monetary theory. Here in New Zealand Social Credit was once a third party with a reasonable following by voters. Even today it is still alive as part of the Democrats. Back in 1955 it was such a force that an economist at the University of Canterbury Alan Danks (later Professor and Sir) wrote a short pamphlet explaining what was wrong with the Social Credit approach to economics. The pamphlet is What Everyone Should Know about Social Credit by A.J. Danks, Christchurch: The Caxton Press, 1955. We have scanned it to a pdf file which is available here for those interested.

Oil and the dollar

James Hamilton at Econbrower talks about oil and the dollar. Hamilton opens his piece by saying

Although movements in the value of the dollar are one factor contributing to recent changes in the dollar price of oil, I do not believe they are the most important factor. Here I review some of the evidence that persuades me of this.

He concludes by noting

The exchange rate is unquestionably one variable that influences the dollar price of oil. In recent data, as much as 20% of oil price movements could be attributed to changes in the exchange rate, or at least to news developments that matter for both exchange rates and oil prices. But that also means that 80% of what we see happening to the price of oil is completely uncorrelated with whatever might be influencing the exchange rate.

If you are interested in such things the bit between the beginning and the end is worth a read.

EconTalk this week

Bruce Bueno de Mesquita of Stanford University's Hoover Institution and New York University talks to Russ Roberts on EconTalk this week about threats to U.S. security, particularly Iran.

Bueno de Mesquita argues that Iran is of little danger to the United States and that Ahmadinejad is an unimportant player in Iran's political system, more of a stalking horse for provocative ideas rather than a wielder of power. Bueno de Mesquita then looks at what Iran has to gain and to lose by appearing to build a nuclear weapons program and actually using a nuclear weapon. He then goes on to examine the nature of other threats to the United States. The closing topic of the conversation is the peculiar incentives facing U.S. Presidents as their terms expire.

A note on rising food prices

Back on the 5th of July I commented on a Secret report: biofuel caused food crisis. Aditya Chakrabortty, economics leader writer for the Guardian, wrote an article based on a then unavailable World Bank report unofficially obtained by the Guardian. The document, dated April 8 2008, the Guardian used is A Note on Rising Food Prices (pdf) prepared by Donald Mitchell - Lead Economist, Development Prospects Group (DECPG), World Bank, Washington. The Summary of the document reads

The World Bank's index of food prices increased 140 percent from January 2002 to February 2008. This increase was caused by a confluence of factors but the most important was the large increase in biofuels production in the U.S. and EU. Without the increase in biofuels, global wheat and maize stocks would not have declined appreciably and price increases due to other factors would have been moderate. The export bans and speculative activity would not have occurred because they were responses to rising prices. Higher energy and fertilizer prices would have still increased crop production costs by about 15 percent in the U.S. and lesser amounts in other countries with less intensive production practices. The back-to-back droughts in Australia would not have had a large impact because they only reduced global grain exports by 4 percent and other exporters would normally have been able to offset this loss. The decline of the dollar has contributed about 20 percentage points to the rise in food prices. Thus, the combination of higher energy prices and related increases in fertilizer prices, and dollar weakness caused food prices to rise by about 35 percent from January 2002 until February 2008 and the remaining three-quarters of the 140 percent actual increase was due to biofuels and the related consequences of low grain stocks, large land use shifts, speculative activity, and export bans. The growth in global grain consumption (excluding biofuels) was 1.7 percent from 2000 to 2007 while yields grew 1.3 percent and area grew by 0.4 percent.

So the World Bank's index of food prices increased 140 percent from January 2002 to February 2008 and of that increase 75% is down to biofuels.

The World Bank has now released, 1 July 2008, an official version of the Mitchell paper, A Note on Rising Food Prices. The abstract of this version reads,

The rapid rise in food prices has been a burden on the poor in developing countries, who spend roughly half of their household incomes on food. This paper examines the factors behind the rapid increase in internationally traded food prices since 2002 and estimates the contribution of various factors such as the increased production of biofuels from food grains and oilseeds, the weak dollar, and the increase in food production costs due to higher energy prices. It concludes that the most important factor was the large increase in biofuels production in the U.S. and the EU. Without these increases, global wheat and maize stocks would not have declined appreciably, oilseed prices would not have tripled, and price increases due to other factors, such as droughts, would have been more moderate. Recent export bans and speculative activities would probably not have occurred because they were largely responses to rising prices. While it is difficult to compare the results of this study with those of other studies due to differences in methodologies, time periods and prices considered, many other studies have also recognized biofuels production as a major driver of food prices. The contribution of biofuels to the rise in food prices raises an important policy issue, since much of the increase was due to EU and U.S. government policies that provided incentives to biofuels production, and biofuels policies which subsidize production need to be reconsidered in light of their impact on food prices.

The report notes

The IMF’s index of internationally traded food commodities prices increased 130 percent from January 2002 to June 2008 and 56 percent from January 2007 to June 2008

In the Summary and Conclusions section Mitchell writes

Thus, the combination of higher energy prices and related increases in fertilizer prices and transport costs, and dollar weakness caused food prices to rise by about 35-40 percentage points from January 2002 until June 2008. These factors explain 25-30 percent of the total price increase, and most of the remaining 70-75 percent increase in food commodities prices was due to biofuels and the related consequences of low grain stocks, large land use shifts, speculative activity and export bans.

Interesting blog bits

1. Gavin Kennedy points out that there is No Contradictions Between Moral Sentiments and Wealth Of Nations.
2. Gary Becker asks Is America in Decline?
3. Richard Posner comments on Is America in Decline?
4. Tyler Cowen on Regulation and Distrust

   Brought to you by Aghion, Algan, Cahuc and Shleifer, this is one of the best papers so far this year.

5. Roger Kerr on Why a Tax-Free Zone is a Bad Idea (pdf)
6. Antoine Berthou and Lionel Fontagné on The microeconomic impacts of the euro

Financial Olympics

This short piece, Prime Numbers: Rings of Gold by Brad R. Humphreys, professor of economics at the University of Alberta, from Foreign Policy, looks at some of the financial aspects of the Olympic Games. Among the highlights ...

• the IOC took in over $4.2 billion in the Salt Lake/Athens cycle, mostly from broadcast rights and sponsorship, and keeps an increasing share of the revenues;
• you really have to pay to play the Olympic hosting game: unsuccessful bids to host the games typically cost from $22 million to almost $50 million;
• the cost over-runs in host countries are huge; and
• although it didn't make it into the article, the IOC is a bloated bureaucracy with no oversight. As recently as 1964, the IOC employed 5 full time staff; in 2000 there were 113.

You have to hand it to them, the IOC are running a world class rent extraction scheme.

(HT: The Sports Economist)

Dale Jorgenson interview

In this short audio from VoxEU.org, Dale Jorgenson, the Samuel W. Morris University Professor at Harvard University, talks to Romesh Vaitilingam about his projections for the growth of the US economy over the next 10 to 25 years, focusing particularly on the impact of information technology and labour supply.

MBAs as economic indicator

The graph below comes from the Daily chart section of the Economist magazine and shows that a slowing world economy is good for business schools. And, as the Economist points out, if attempts to gain admittance to MBA courses are a useful indicator of economic activity then the global economy is in for a rough future too. Applications next year are expected to climb even higher. So the more MBAs, the worse the global economy.

Clunker of an idea

Alan Blinder, professor of economics at Princeton University, recently proposed a new government program which he called “Cash for Clunkers” in an article in The New York Times. Steven D. Levitt explains the program as

... the government would buy back old cars at above market prices and scrap them. According to Blinder, this would accomplish a policy trifecta: 1) help the environment by getting the most polluting cars off the road; 2) stimulate the economy by getting money in the hands of people who will spend it and increase the demand for new cars; and 3) reduce income inequality by funneling the money to the poor.

Over at the Freakonomics blog Levitt says he is sceptical of this proposal for a number of reasons. A possible positive for the "cash for clunkers" program is that as long as they are being driven, old cars pollute and so getting them off the road could reduce pollution. But

... my guess is that unless the price the government pays for the clunkers is very high, the majority of vehicles that are turned in will not have been driven much, if at all. Indeed, I suspect one of the most visible responses to this program will be a new market for mechanics fixing up cars that don’t run at all just enough so that they can be driven to the government’s lot to collect the cash.

and

The biggest problem with this policy, however, is the way it distorts long run incentives. Let’s say the rules of the program say that a car must be at least fifteen years old to qualify for a big government subsidy to scrap it. This gives powerful incentives to people with twelve-year-old cars they were planning on scrapping to keep driving them for three more years to collect the government bounty. Instead of reducing the number of clunkers on the road, this program could actually lead to an increase!

It also seems to me that any effect on the demand for new cars would be extremely limited. People who drive clunkers are generally not in the market for new cars. Presumably their replacement car will be a used car. The increased demand for used cars will lead to higher prices for used cars, which will push some buyers towards a new car, but the likely impact on new cars would be small.

and

Finally, it is not even clear that this program would have such beneficial redistribution effects either. In the short run, it would represent a windfall profit to those who own clunkers. In the long run, however, there is a market for used cars. In response to the program, the price of nine-year-old cars would have to rise enough to offset the increased value associated with a near-clunker someday becoming a clunker that can be sold to the government. The benefits of the program will actually be spread widely over all car owners, not narrowly focused on the poor.

For Levitt the program highlights some general concerns that arise with government programs.

The first is that policies which might be a good idea if implemented as one time, short term programs, can be much less attractive if made permanent because of the way they distort incentives.

And as Milton Friedman once noted, "Nothing is more permanent than a temporary government programme".

The second thing this program highlights is that it is extremely difficult to deal with negative externalities (in this case pollution) by subsidizing them (as this program does). If folks are doing things that we want less of, it makes a lot more sense to punish them for those behaviors (through extra taxes for instance) than to reward them.

The current account deficit

At Infometrics Matthew Nolan has a piece on the current account deficit or the capital account surplus, depending on how you want to think about it.

A current account deficit is one of these issues non-economists get worked up about but economists, by and large, don't. Why? As Matt points out

It appears that the recent increase in our current account deficit is the result of both rising consumption and rising investment.

So what is wrong with more consumption or investment?

On the investment side, the idea of borrowing now to fund capital expenditure is a fairly mundane concept. The benefit of an investment project will materialise over time, while a disproportionate portion of the cost is incurred straight away. As long as the benefit of the investment exceeds the cost over the investments lifetime, and the risks are known, then there is no reason to be concerned about this form of borrowing.

What about the consumption side? Matt writes

On the consumption side, a nation may spend more than it earns because it either anticipates that it will grow in the future or it may substantially favour spending now ahead of spending in the future. As the goal of policy should be to maximise society’s lifetime happiness, if individuals want to consume more now (to the detriment of future consumption opportunities) they should be allowed to.

For a household, this type of borrowing is equivalent to “smoothing” the amount you consume over time. When you are young, you expect your lifetime earnings to increase in the future – as a result it is in your interest to borrow now. As a nation, we expect our lifetime earnings to increase in the future – and as a result, if we are offered credit at attractive rates we will be willing to borrow now.

Thus should we worry about the current account deficit,

The current account deficit is merely the result of the borrowing, consumption, and investment decisions of every household and firm in the economy. As long as these households and firms are fully informed of the risk and return associated with their borrowing decisions, is there really any reason to fear the spectre of a current account deficit?

The short answer to his question is, no.

Economics does not lie

In this recent article in the City Journal Guy Sorman tells us Economics Does Not Lie. Sorman writes

If economics is finally a science, what, exactly, does it teach? With the help of Columbia University economist Pierre-André Chiappori, I have synthesized its findings into ten propositions. Almost all top economists—those who are recognized as such by their peers and who publish in the leading scientific journals—would endorse them (the exceptions are those like Joseph Stiglitz and Jeffrey Sachs, whose public pronouncements are more political than scientific). The more the public understands and embraces these propositions, the more prosperous the world will become.

The list is

1. The market economy is the most efficient of all economic systems.
2. Free trade helps economic development.
3. Good institutions help development.
4. The best measure of a good economy is its growth.
5. Creative destruction is the engine of economic growth.
6. Monetary stability, too, is necessary for growth; inflation is always harmful.
7. Unemployment among unskilled workers is largely determined by how much labor costs.
8. While the welfare state is necessary in some form, it isn’t always effective.
9. The creation of complex financial markets has brought about economic progress.
10. Competition is usually desirable.

The Sorman article discusses each of these in more detail. While you can always pick holes in any list such as this, this one isn't bad.

When looking to the future, Sorman writes

In the future, the threat to the beneficent influence of economic science will come less from tired socialist revolutionary rhetoric than from new dangers, such as terrorism and epidemics. Terrorism is, in part, a consequence of globalization: young, uprooted people unable to adapt to a dynamic, capitalist world invent new global ideologies and seek to put them into practice with global weapons. Globalization can also accelerate the proliferation of deadly illnesses. The AIDS epidemic was the first global attack by a mutant virus; SARS, avian flu, or some unknown illness could follow, surging from uncontrolled Chinese, Indian, or African backwaters and following the massive migrations of a global economy. Terror and epidemics could both unleash political upheavals that would undermine the market order itself.

Then there’s the fear of ecological disturbances, which could result in incoherent policies that wouldn’t necessarily diminish risks to the environment but might prevent development and thus harm the interests of the poorest peoples. One example: prohibiting genetically modified organisms—which, evidence suggests, pose no threat whatsoever to the environment—will hurt the productivity of farming at a time when global demand for food will grow.

Sorman see another danger in the very nature of economic systems: the cyclical nature of growth. While he thinks that recessions on the scale of the Great Depression are less likely to happen today because the political mistakes that aggravated it, such as protectionism and the drying-up of credit, aren't as likely to be repeated in the future, he does see smaller crises as being inevitable. Such problems are bound up with innovation and the forces by which the new drives out the old in periods of creative destruction. Similarly he argues that free trade will mean that some people will lose their jobs, that foreign competition will wipe out entire companies or even entire industries. Sorman points out that

We all know it because, as Friedman argued, layoffs and closings get disproportionate media coverage. Meanwhile, nobody talks about the ongoing reduction in prices for consumers and investors, scattered among a huge number of beneficiaries. That helps explain why politicians are prone to deride free trade and voters are too often ready to agree.

Sorman goes on to say

To help the losers in the free market, government shouldn’t back away from either free trade or creative destruction and start subsidizing doomed and obsolete activities, a protectionist course that guarantees only economic decline. Instead, it should help the losers change jobs more easily by improving educational opportunities and by facilitating new investment, which creates more employment. An essential task of democratic governments and opinion makers when confronting economic cycles and political pressure is to secure and protect the system that has served humanity so well, and not to change it for the worse on the pretext of its imperfection.

Sorman closes this piece by noting that one of the hardest ideas to translate into language that public opinion will accept is the fact that even the best of all possible economic systems is still imperfect. Markets are one of the many human institutions that are the result of human action, but not of human design. But they are based on people and without perfect people you are unlikely to get perfect markets. But for all these imperfections, we have yet to find a better economic system.