Deflation: why the worry?

Over at the interest.co.nz Neville Bennett has been talking about deflation. He writes

Deflation is a general decline in prices, usually following a collapse of aggregate demand. There is a severe drop in spending: producers have to cut prices to find buyers. This has the effect of causing recession, high unemployment and widening financial stress.

This is one form of deflation, the bad form-1930s type deflation. But its not the only form. There is a good form of deflation, something that should be kept in mind when people start talking about it. The good kind of deflation is the result of increases in productivity. Research and development means new technology, efficiency gains, cost-cutting, price-cutting and, yes, deflation. Productivity gains mean that businesses could afford to sell their products for less since it is costing less to make them.

“Bad” deflation happens when demand shrinks; “good” deflation happens when supply expands. The price level goes down in both cases but there is only one we should be worried about. George Selgin writes,

The difference between the two sorts of deflation couldn’t be more basic. Most people grasp it without a hitch. Unfortunately, economists seem to be the exception, perhaps because of their obsession with the Great Depression and zeal to avoid repeating it. Nor has their understanding been aided by the fact that none of them has ever actually witnessed the good sort of deflation.

Yet good deflation isn’t just hypothetical. For much of the 19th century, when the gold standard prevented central banks from printing money willy-nilly, prices fell more often than they rose, and people considered that tendency to be perfectly natural. After all, technology was improving, so goods cost less to produce. Why shouldn’t prices reflect that reality? From 1873-96, for instance, prices in most gold-standard countries fell at an average rate of about 2 percent a year, while real output grew at correspondingly healthy rates of between 2 and 3 percent, thanks largely to productivity gains. That isn’t to say that there weren’t occasional crises—there were, and some involved a dose of bad deflation, driven by temporary lulls in lending and spending. But the general trend of spending was up, while the downward trend of prices remained within the bounds of underlying productivity gains and was for that reason perfectly benign: businesses could afford to sell their products for less as long as it was costing less to make them.

There are a couple of things about "bad deflation" I've never really got. One is, Why are people so worried about the possibility of even small amounts of bad deflation? There seems to be an asymmetry between the way people react to the possibility of inflation and bad deflation. Small amounts of bad deflation has people running around shouting that the sky is falling and the world is about to end, eg Neville Bennett, but if you tell people that we are going to suffer small amounts of inflation no one seems to worry. Why? Why aren't the effects of inflation and bad deflation considered to be symmetric? Also why do people worry about deflation when the one thing that any government can do is cure deflation. What government can't expand the money supply? The usual problem we have is that governments are all too keen to do so, eg Zimbabwe. Bennett writes with regard to comments made by Ben Bernanke

[...] the U.S. government has a technology, called a printing press … that allows it to produce as many US dollars as it wishes at essentially no cost. By increasing the number of US dollars in circulation ... the government can also reduce the value of a dollar in terms of goods and a service, which is equivalent to raising the prices in dollars of those goods and services … under a paper-money system, a determined government can always generate higher spending and inflation.

So I am left to wonder why the panic over even small amounts of bad deflation?

A comment on Hitsville

Today I came across a blog called Hitsville which has a posting on it called An economist on scalping, which I read. The posting opens by saying

A British economist, Eric Crampton, discusses scalping here. When he talks about “market clearing” he means “everything selling for the top price people will pay for it,” and in his world that’s how things not only should work, but do, which is why scalping takes place and “clears” the tickets appropriately.

Now there is the obvious error that Eric is Canadian, well no one is perfect, and living and working in New Zealand. But there are other errors in the paragraph as well. Market clearing does mean "everything selling for the top price people will pay for it", it means what it says, the market clears, ie supply equals demand at the going price. Note that the marginal buyer will pay what he thinks the good is worth but the intramarginal buyers will pay less than what they think the good is worth. That is, these buyers will not pay "the top price people will pay for it", they will pay less than that. The top price they are willing to pay is the height of the demand curve and as demand curves slope downwards the market price will be less than the height of the demand curve for all but the last buyer.

Note the claim at Hitsville would be true if the scalpers were able to use first degree price discrimination, that is, charge each person their maximum willingness to pay-the height of the demand curve for each person. But we don't see this in practice.

Now having read the posting, I posted a comment pointing out that the economics in the article were wrong. I said what I have just said above. I have just gone back to the site to find the comment has been deleted. I guess bothering to correct errors is not a big hit at Hitsville!

An economic map of Europe

Looks about right.



(HT: The Adam Smith Institute)

Blog rankings

The latest Tumeke! blog rankings have been good to the economics blogs: all two of them! The Visible Hand in Economics is up 3 to 19th - well done guys - and Anti-Dismal is up 6 to 24th. The third economics blog Offsetting Behaviour is not listed as yet. We will have to wait until next month to see its ranking.

Douglass North on "The Natural State"

An outline of the framework North is discussing in the video can be found in North's 2006 NBER Working Paper No. 12795, written with John Joseph Wallis and Barry R. Weingast, A Conceptual Framework for Interpreting Recorded Human History. The abstract reads,

Neither economics nor political science can explain the process of modern social development. The fact that developed societies always have developed economies and developed polities suggests that the connection between economics and politics must be a fundamental part of the development process. This paper develops an integrated theory of economics and politics. We show how, beginning 10,000 years ago, limited access social orders developed that were able to control violence, provide order, and allow greater production through specialization and exchange. Limited access orders provide order by using the political system to limit economic entry to create rents, and then using the rents to stabilize the political system and limit violence. We call this type of political economy arrangement a natural state. It appears to be the natural way that human societies are organized, even in most of the contemporary world. In contrast, a handful of developed societies have developed open access social orders. In these societies, open access and entry into economic and political organizations sustains economic and political competition. Social order is sustained by competition rather than rent-creation. The key to understanding modern social development is understanding the transition from limited to open access social orders, which only a handful of countries have managed since WWII.

(HT: Brad Taylor)

Quote of the day

Justice Hugo L. Black once told me that he thought all government departments and agencies should be abolished every five or ten years. Black was a senator from Alabama for ten years and a Supreme Court justice for thirty-four, and he knew just about everything there was to know about how government works. His startling idea—and I think he was serious—was his way of dealing with the encrustations of bureaucracy. Anthony Lewis.

Incentives matter: drugs file

SIR – As a veteran of the war on drugs, with some 1,000 arrests under my belt, I have witnessed the utter futility of prohibition. There is no historic evidence that prohibition reduces drug use. Just about anyone who is going to do drugs uses them, regardless of their legal status. In fact, it is the notion of a “forbidden fruit” and prohibition-created profits that entice both young users and dealers. Youths report in federal surveys that it is easier for them to buy illegal drugs than beer or cigarettes.

Polls show that very few Americans would try heroin or cocaine if it were legalised tomorrow. There is no dam of potential drug users being held back by prohibition. Ending it would remove the violence in the same way that repealing the prohibition on alcohol did. This would be a pure win-win situation for everyone but drug dealers and terrorists.

Jack Cole
Director
Law Enforcement Against Prohibition
Medford, Massachusetts

Letters to the Editor, The Economist in response to an article on how to deal with the drugs.

(HT: The Inquiring Mind)

What is "economics" in the most general sense

This is the very good question Matt Nolan asks over at TVHE. Matt gives the definition of economics as

The study of how humans/societies allocate scarce resources.

But I'm not sure what they really means, it raises more questions than it answers. Such a definition gives no real insight into what economists study and what they do. But to be fair no short definition can convey the scope and flavour of the whole subject as it has it has evolved.

The most famous definition was given by Lionel C. Robbins

Economics is the science which studies human behaviour as a relationship between scarce means which have alternative uses.

The great Cambridge economist Alfred Marshall said that

... Economics is a study of mankind in the ordinary business of life; ...

while Ronald Coase said

My view of economics is that it is the study of the economic system, that it studies how people earn their incomes and how they spend them, and that it studies the institutions of the economic system, that is to say, banks, markets, and firms, all influenced ... by the legal system.

Ludwig von Mises said

It is true that economics is a theoretical science and as such abstains from any judgment of value. It is not its task to tell people what ends they should aim at. It is a science of the means to be applied for the attainment of ends chosen, not, to be sure, a science of the choosing of ends. Ultimate decisions, the valuations and the choosing of ends, are beyond the scope of any science. Science never tells a man how he should act; it merely shows how a man must act if he wants to attain definite ends.

and

Economics is, of course, not a branch of history or of any other historical science. It is the theory of all human action, the general science of the immutable categories of action and of their operation under all thinkable special conditions under which man acts.

But for me I think Steven E. Landsburg was heading in the direction when he wrote

Most of economics can be summarized in four words: People respond to incentives. The rest is commentary.

However, perhaps Jacob Viner got it most right when he said

Economics is what economists do.

Good money drives out bad

This report from the BBC says

Prices in Zimbabwe have begun to fall after years of galloping inflation, according to figures from the state Central Statistical Office (CSO).

Prices of goods bought in US dollars, Zimbabwe's new official currency, fell by up to 3% in January and February.

They were the first official figures since the country's recent adoption of the US dollar.

and

The US dollar was adopted by Zimbabwe's government following the inauguration of the unity government between the MDC and President Mugabe's Zanu-PF.

and adds

The Zimbabwean dollar has disappeared from the streets since it was dumped as official currency.

The move to the US dollar is to be welcomed as it will help with the fight against the hyperinflation which Zimbabwe has suffered from in recent years. Hopefully it also signals that more rational economic policies, in general, will be followed in Zimbabwe from now on. Dollarisation was one of the options that Steve Hanke put forward when writing about How to kill Zimbabwe’s hyperinflation.

Peter Draper and Andreas Freytag point out that dollarisation is not without its dangers, however

The currency board or “dollarisation” option is closely associated with US scholar Steve Hanke (2008). In Zimbabwe’s case, he refers approvingly to the currency board Southern Rhodesia operated in the 1940s. However, the preconditions were very dissimilar to Zimbabwe today. Regardless of Rhodesian governments’ other failings, their administrative capacity, and therefore the credibility of any new institutions, was far more developed, whilst trade and capital markets were far less integrated than today. Mr Mugabe and his Zanu PF party not only destroyed the economy thereby creating hyperinflation, poverty and starvation– they also eradicated a workable administration. The latest manifestation is the cholera crisis, now reportedly affecting 80,000 people and spreading rapidly into neighbouring countries. Critically, all kinds of economic institutions necessary for a country to develop are now lacking.

This seems a fair point, its hard to believe that there is much in the way of workable government (or private) institutions left in Zimbabwe. So it will be interesting to see how things progress. Hopefully the new government can rebuild the needed institutions. At least now there is reason for a small amount of hope for Zimbabwe.

Interesting blog bits

1. Eric Crampton on Ignorance in the 2008 NZ Election.
2. Not PC on Clever and creative billboard advertising.
3. Jon Danielsson says Not so fast! There’s no reason to regulate everything.

   Many are calling for significant new financial regulations. This column says that if the “regulate everything that moves” crowd has its way, we will repeat past mistakes and impose significant costs on the economy, to little or no benefit. The next crisis is years away – we have time to do bank regulation right.

4. goonix on France’s novel approach to the wage bargain: ‘boss-napping’.
5. George Selgin on Federal Reserve should resist tinkering
6. A review of Paul Collier´s new book War, Guns and Votes.

Monetary policy: the demand for money

Click on cartoon to enlarge.

(HT: Greg Mankiw)

Incentives matter: Geithner toxic asset plan file

The Streetwise Professor looks at the incentives in the Geithner Toxic Asset plan.

But it is well known that insolvent banks, or banks teetering on the brink of insolvency, face extremely perverse incentives. Shareholder and manager maximization for such institutions is often at odds with efficiency, and wealth maximization. This is true because managers and shareholders of troubled financial institutions have incentives to take unwarranted risks and invest in projects that dissipate wealth. That is, zombie banks (or more accurately, their owners and managers) are living, breathing moral hazard problems. Maximization for them means minimization for us.

Options in the hands of people facing perverse incentives are usually very, very bad things. Sort of like matches, gasoline, and tinder in the hands of pyromaniacs in a lumberyard.

In the present instance, giving potentially insolvent or near insolvent banks options can be expected to exacerbate, rather than mitigate, the current financial crisis, and the ultimate cost to us as taxpayers and economic agents could be huge–and, in my view, is likely to be so.

Selgin on "Good Money"

The 2009 F. A. Hayek Memorial Lecture, presented by George A. Selgin. Recorded at the annual Austrian Scholars Conference, Ludwig von Mises Institute, 14 March 2009. Includes an Introduction by Joseph T. Salerno. Here Selgin gives an entertaining account of private token coinage during the Industrial Revolution in England and Wales, the topic of his recent book Good Money.

(HT: Division of Labour)

Where there's dirt there's dollars

There really are markets in everything. This example comes from the Homepaddock blog:

The Auld Sod Export Company sells Irish dirt to ex-pats and their descendents so they can have a little piece of Ireland wherever they are in the world.

Uses for the dirt are many and varied:

Official Irish dirt products serve a wide array of purposes. Everything from growing your own shamrocks, to wedding gifts, to paying respect at a loved one’s funeral. Irish Dirt aims to bring a piece of the old country straight to you, directly from the Emerald Isle.

Like all good entrepreneurs the company likes to add value so once you’ve got the real Irish dirt, the they’ll sell you shamrock seeds to plant in it.

The International Herald Tribune reports:

An 87-year-old lawyer in Manhattan originally from Galway recently bought $100,000 worth of the dirt to fill in his yet-undug American grave. A native of County Cork spent $148,000 on seven tons to spread under the house he was having built. “He said he wanted a house built on Irish soil so he can feel like he is home in old Ireland when he walked around his house in Massachusetts,” Burke said. Neither man wanted his name mentioned for fear of seeming eccentric or foolish.

Since Auld Sod’s Web site, officialirishdirt.com, went online in November, Burke said, he has shipped roughly $2 million worth to the United States, where about 40 million people claim Irish ancestry and Enterprise Ireland estimates annual sales of Irish gifts at more than $200 million.

Foreign labour in New Zealand

Recently there has been some, but as TVHE point out surprisingly little, discussion of moves to place restrictions on the use of foreign labour in New Zealand now that we are in a recession. The guys at TVHE have written on this, see here, here, here, here, here and here. Not PC has commented here along with Eric Crampton who comments here, Nigel Kearney who comments here and Brad Taylor who writes here. Bill Bennett discusses here. Casey Mulligan in the US comments here.

From an economics point of view this issues seems to me to be a no brainer. You pick the best person for the job, the most productive, and where they come from is irrelevant. Why people wish to decrease the productivity of New Zealand firms-which amounts to decreasing New Zealand's wealth-by forcing firms owners to use less productive inputs I can't workout. But there seems to be bipartisan support for placing restrictions on foreign workers coming into New Zealand. Apart from the odious xenophobia that seems to lie behind these moves such restrictions don't make economic sense. What they amount to is a "Buy New Zealand" campaign for labour. "Buy New Zealand" campaigns are a waste of time for good and services so why people think they are a good idea for labour is somewhat baffling. I guess both main parties feel there are votes in xenophobia but that really isn't a good look.

The glue of firms

This morning the HoD sent me a link to an interesting new paper to do with the theory of the firm. I have started reading it this afternoon and there is one point about which I'm not sure I agree with the author. The paper is "From fictions and aggregates to real entities in the theory of the firm" by David Gindis, Journal of Institutional Economics, 5(1) 2009: 25–46.

On page 30 Gindis writes

What, then, is the link between the owner (e.g., employer) and the other agents necessary for production (e.g., employees)? The existence of such a link is important for a theory of the firm, and Hart (1995: 57) rightly stresses that ‘without something to hold the firm together, the firm is just a phantom’. Hart(1995: 57–59) says:

A firm’s nonhuman assets . . . simply represent the glue that keeps the firm together . . . If such assets do not exist, then it is not clear what keeps the firm together . . . One would expect firms without at least some significant nonhuman assets to be flimsy and unstable entities, constantly subject to the possibility of break-up or dissolution.

Clearly, Hart provides a wrong answer to a good question. Hart makes a logical mistake by stating that a collection holds itself together. Far from being the sort of thing that could bind anything together, a collection is itself in need of being bound together if it is to form a whole. Without some sort of ‘glue’, a collection is no different from a heap of sand easily blown away on a windy day. Arguably, Hart also makes a theoretical mistake by excluding human assets or people from his definition of the firm. Given that property rights hold nonhuman assets together, the glue question makes sense only if it is about what holds human beings together.

To me Gindis misses the point Hart is trying to make here. My take on what Hart is saying is that while property rights hold the nonhuman assets in place, it is the nonhuman assets that keep the human assets in place. That is, the employees stay at the firm because the firm has control-property rights-over the nonhuman assets. These nonhuman assets make the employees more productive and thus the workers wish to remain with the firm to remain productive.

I shall have to ponder longer.

Another reason to like trade

Many studies emphasise the importance of export growth in economic development, but there is an unanswered question: does exporting increase economic growth or does growth increase exports? A question which a recent natural experiment – demand shocks experienced by Chinese exporters due to the Asian financial crisis – may help answer. It short the evidence suggests that exporting improves firm performance.

While a number of studies have documented a positive relationship between trade and growth performance, there is still debate over whether exporting causes economic growth, or whether the causation runs the other way, that is, economic growth causes increased exporting.

There is an analogous question at the level of individual firms – does exporting cause a firm to become more productive and improve its sales and profit growth? Unfortunately this is a difficult question to answer by simply observing the correlation between exports and firm performance. This is because exporting may be the consequence of high firm productivity but it could also be the cause of it.

Dean Yang has an article at VoxEU.org which looks at this issue, he asks Does exporting improve firm performance? Yang writes

It is easy to imagine ways in which export status could be correlated with firm characteristics that directly influence firm productivity growth. For example, dynamic firm managers may be more aggressive in entering export markets and also be more adept learners or more aggressive in making productivity-enhancing investments. The fundamental problem is that non-exporters are different from exporters in a variety of unobservable ways. To establish the causal impact of exporting on firms, one might imagine running a randomised experiment assessing the impact of exporting on firms by randomly assigning shocks to export demand across firms.

In recent research, Park, Yang, Shi, and Jiang forthcoming, a natural experiment – Chinese exporting during the Asian financial crisis – is exploited since in key respects it approximates the randomised experiment suggested above. Yank explains

In June 1997, the devaluation of the Thai baht led to speculative attacks on many other currencies worldwide. While the Chinese yuan remained pegged to the US dollar, many important destinations for Chinese exports experienced currency depreciations due to the crisis (both nominal and real). For instance, between 1995 and 1998, the Japanese, Thai, and Korean currencies depreciated in real terms against the US dollar by 31%, 32%, and 43%, respectively. At the other extreme, the British pound and the US dollar experienced real appreciations against the yuan, by 14% and 7%. Because the exchange rate changes varied so widely, two observationally equivalent firms faced very different export demand shocks if one happened to export its goods to Korea and the other exported to the UK.

Their study uses longitudinal data in 1995, 1998, and 2000 collected by China's National Statistical Bureau on firms with some amount of foreign investment. Park, Yang, Shi, and Jiang construct an exchange rate shock measure specific to each firm in their data set. This measure is the average exchange rate change of a firm’s export partners weighted by the firm's export destinations in 1995, that is, prior to the Asian financial crisis. They look at changes in exports driven by these exchange rate shocks. Yang continues,

Using this approach, we ask whether and how instrumented changes in exports affect measures of firm performance. We find that increases in exports are associated with improvements in total factor productivity, as well as improvements in other measures of firm performance such as total sales and return on assets. Our estimates indicate that a 10% increase in exports causes productivity improvements of 11% to 13%, nearly one-eighth of the mean productivity improvement from 1995 to 2000 in our sample.

Additional results provide suggestive evidence that the association between increases in exports and productivity improvements reflects “learning by exporting,” for example via inflows of advanced technology or production techniques from overseas export customers. We find that changes in exports are more positively associated with productivity improvements in firms exporting to destinations with higher per capita GDP, which presumably have more advanced technologies.

So what Park, Yang, Shi and Jiang find is that exporting improves firm performance. So we have yet another reason to like trade.

• Park, Albert, Dean Yang, Xinzheng Shi, and Yuan Jiang (forthcoming), "Exporting and Firm Performance: Chinese Exporters and the Asian Financial Crisis," Review of Economics and Statistics.

Condliffe Memorial Lecture - 18 March 2009

Last week I noted that the Condliffe Memorial Lecture 2009 would be given by Profosser Hal R. Varian on the topic of Evolutionary Business - The Effect of Computer-Mediated Transactions. Below is a video of the lecture.

EconTalk this week

Nassim Taleb talks about the financial crisis, how we misunderstand rare events, the fragility of the banking system, the moral hazard of government bailouts, the unprecedented nature of really, really bad events, the contribution of human psychology to misinterpreting probability and the dangers of hubris. The conversation closes with a discussion of religion and probability.

Government appointments to boards

Over at Kiwiblog, David Farrar is getting upset about Phil Goff getting upset about the current government not renewing the terms of several Labour appointed member of boards of state controlled companies. Now David has a point about the hypocrisy that Goff is displaying here, but the problem seems to me to be that governments make these appointments in the first place.

Here's a simple answer to the problem of government appointments to state boards: privatise the companies. That way there will be no appointments for governments to make and the whole problem will go away.

Becker interview

Mary Anastasia O'Grady has a piece in the Wall Street Journal based on an interview she did with Nobel Prize winning economist Gray Becker.

Early in the article O'Grady writes

What Mr. Becker has seen over a career spanning more than five decades is that free markets are good for human progress. And at a time when increasing government intervention in the economy is all the rage, he insists that economic liberals must not withdraw from the debate simply because their cause, for now, appears quixotic.

and a little later

Today as Washington appears unstoppable in its quest for more power and lovers of liberty are accused of tilting at windmills, he says it is no time to concede.

When it comes to the current economic crisis O'Grady writes

Mr. Becker sees the finger prints of big government all over today's economic woes. When I ask him about the sources of the mania in housing prices, the first culprit he names is the Fed. Low interest rates, he says, were "partly, maybe mainly, due to the Fed's policy of keeping [its] interest rates very low during 2002-2004." A second reason rates were low was the "high savings rates primarily from Asia and also from the rest of the world."

and

On top of that, Mr. Becker says, there were government policies aimed at "extending the scope of homeownership in the United States to low-credit, low-income families." This was done through "the Community Reinvestment Act in the '70s and then Fannie Mae and Freddie Mac later on" and it put many unqualified borrowers into the mix.

The third effect, Mr. Becker says, was the "bubble mentality." By this "I mean that much of the additional lending and borrowing was based on expectations that prices would continue to rise at rates we now recognize, and should have recognized then, were unsustainable."

On the stimulus package O'Grady writes

Mr. Becker is underwhelmed by the stimulus package: "Much of it doesn't have any short-term stimulus. If you raise research and development, I don't see how it's going to short-run stimulate the economy. You don't have excess unemployed labor in the scientific community, in the research community, or in the wind power creation community, or in the health sector. So I don't see that this will stimulate the economy, but it will raise the debt and lead to inefficient spending and a lot of problems."

There is also the more fundamental question of whether one dollar of government spending can produce one and a half dollars of economic output, as the administration claims. Mr. Becker is more than skeptical. "Keynesianism was out of fashion for so long that we stopped investigating variables the Keynesians would look at such as the multiplier, and there is almost no evidence on what the multiplier would be." He thinks that the paper by Christina Romer, chairman of the Council of Economic Advisors, "saying that the multiplier is about one and a half [is] based on very weak, even nonexistent evidence." His guess? "I think it is a lot less than one. It gets higher in recessions and depressions so it's above zero now but significantly below one. I don't have a number, I haven't estimated it, but I think it would be well below one, let me put it that way."

The whole article is worth reading since, basically, Gray Becker rocks!

How economics can get you a date

This video is of Tim Harford talking about The Logic of Life: How economics can get you a date. Harford, author of "The Logic of Life" and "The Undercover Economist", explains the economics of speed-dating, and asks, "are the romantics right about love, or are the economists right?"

Videos on the financial crisis

Below is a video, the quality of which is unfortunately not too good, of Kevin Dowd giving a talk on the financial crisis. The talk was delivered as the Chris Tame Memorial Lecture for the UK's Libertarian Alliance. The introduction of the speaker, which can be skipped, lasts until 7:05. The entire video including Q&A lasts 1:16:37

Below is an short interview, from Reason.tv, with John B. Taylor, professor of economics at Stanford University in which Taylor challenges the conventional wisdom that it was an excess of deregulation that precipitated our current financial crisis. In fact, he says, the exact opposite is true.

Quote of the day

Over at his blog philosopher James Otteson provides a interesting quote from Hernando de Soto's book, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else. de Soto writes

I am not a die-hard capitalist. I do not view capitalism as a cred. Much more important to me are freedom, compassion for the poor, respect for the social contract, and equal opportunity. But for the moment, to achieve those goals, capitalism is the only game in town. It is the only system we know that provides us with the tools required to create massive surplus value. (p. 228).

In other words, capitalism gets the job done, other systems don't.

'The Standard' at it again

The economics at The Standard isn't getting any better. In a recent posting by 'Guest post' it is written,

Neoclassical economics (the mainstream of economics these days) would say there’s got to be some gain in net utility, because it presupposes that people are utility maximising. If they’re spending money as tourists that must create more utility for them than if they had stayed at home and spent the money there. It also presupposes, however, that people have perfect information and are perfectly rational, in which case advertising campaigns wouldn’t affect their decisions anyway.

Now there are a number things wrong with this paragraph. First it can be argue that "neoclassical economics" isn't the mainstream of economics today, and hasn't been for a while now. See David Colander's 1999 presidential address to the History of Economics Society on the subject of "The Death of NeoClassical Economics" to get the point. Colander writes

The term, neoClassical economics, was born in 1900; in this paper I am proposing economist-assisted terminasia; by the powers vested in me as president of the History of Economics Society, I hereby declare the term, neoClassical economics, dead.

What I ask is "net utility", utility net of what?

By and large economists do assume people maximise utility, but you don't have to, there are other models of individual activity out there. One example being the Nobel Prize winner Herbert Simon's idea of "satisficing", but as Oliver Williamson has put it

[...] a cumulative research tradition within economics did not develop. It is now generally agreed that the satisficing approach has not been broadly applicable.

Also it does not have to assumed that people maximise utility in a world of certainty. Choice under uncertainty is a standard part of economics today. There is the extension of utility maximisation to expected utility maximisation as a way of dealing with risk. But there are also a number non-expected utility models of choice under uncertainty as well.

Perfect information does not have to assumed, and in much of economics today it is not. Asymmetric information is taught from first year on. No student can study economics today without learning, at the very least, the basic ideas of adverse selection and moral hazard. These ideas won Akerlof, Spence and Stiglitz the Nobel Prize in 2001, so its got to be mainstream. Not to mention the even older literature on information and knowledge by people like Hayek.

It is not always assumed that people are perfectly rational. Herbert Simon's idea of bounded rationality is commonplace in economics today. Oliver Williamson makes the point that one of the behavioural assumptions of transaction cost economics, for example, is bounded rationality.

Last, I'm not sure what is meant by "in which case advertising campaigns wouldn’t affect their decisions anyway." Insofar as advertising gives useful information, then this information could form part of the information that consumers use to make their decisions. Or is it meant that people will already know the information that the advertisement gives and so will have already factored this information into their decision making. But if this is the case, then the advertiser will be able to work this out, and will have not need to advertise in the first place.

To end I should point out that most of the issues discussed above, and a number of other recent development-eg game theory, behavioural economics-move economics beyond the realm of neo-classical economics and so in this sense neo-classical economics isn't the economics of today and thus Colander is right, neo-classical economics is dead. So we end where we began.

Interesting blog bits

1. Gavin Kennedy on Adam Smith and Greed.
2. Peter Boettke on You really should watch these --- The Logic of Life on You Tube.
3. Brad Taylor on Fiscal externalities and meddlesome preferences.
4. Not PC on In praise of the eloquent insult.
5. Gary Becker and Kevin Murphy on Do not let the ‘cure’ destroy capitalism.
6. Mark Skousen asks Has Keynes trumped Adam Smith?
7. Liberty Scott on State gangsterism.

Micro v. macro 2

Earlier I commented upon the distinction between macroeconomics and microeconomics made by Don Boudreaux. That posting attracted a very interesting comment by Richard Ebeling which I think is worth offering to a wider audience so I am reproducing it here:

It is unfortunate that the term "macroeconomics" came to be identified with changes in economy-wide and measurable magnitudes: total output, total employment, the general price or wage level.

Because the distinction that Don's comment highlights is more reasonable. All social and economic phenomena arise out of the actions of individuals, since they are the ultimate and elementary "components" of social processes.

The starting point of social and economic analysis, therefore, logically begins with understanding the individual and the "logic of choice and action" that guide his conduct. Thus, "Crusoe" economics is not the "unrealistic" or "irrelevant" exploration that some have claimed over the last two hundred years.

But, now, having grasped the logic and implications of the individual's choices and actions under conditions of various scarcities, constraints and trade-offs, the next step is to analysis the results and outcomes when more than one individual exists, and they interact.

Thus, the arrival of "Friday" introduces a totally new dimension to the study.

It is perhaps of note that when Carl Menger, one of the "fathers" of marginalist analysis aa well as of the Austrian School, moved his investigation to this next level, he spoke of the interactions between the "economies" of men.

That is, each individual is an "economy," i.e., a chooser of ends, an applier and allocator of means, a coordinator of his individual plans to assure an "equilibrium" among his actions and activities according to his overall personal "central plan."

What happens when these individual economies and "central plans" meet in an emergent social arena that arises when individuals "discover" each others presence, and then communicate, interact, associate and possibly trade?

It is not surprising, given this way of approaching the origin and emergence of a "social arena," that Menger also gave special attention to the resulting "spontaneous order" and the many institutions that are the "unintended" outcomes from these interactions -- language, customs, traditions, law, property rights, market rules of association, contract, etc.

This, then, is the "macroeconomic" arena: the origin, development, and evolution of the "social order" in which individual planners and their plans interact, but where there is no overarching plan above the individual plans.

The "macroeconomic" "research program" then becomes an investigation of what arises from all this, and how? Certainly, this is how Menger saw the nature and purpose of social and interpersonal economic theory.

In such a perspective, the "microeconomic" focus is on the individual's plans and their "equilibrium" and equilibrating sequence as the individual is confronted with various types of "change."

The "macroeconomic" focus is on any emerging "coordination" among these individual plans, and what forms that coordination takes on: types of markets, institutions and their associative rules and procedures, etc.

And, of course, if such macro-coordination can be demonstrated, what may bring about "discoordination" and what follows from this, including the processes by which individuals attempt to respond and reestablish interpersonal coordination, including the actions and sequence of events that this recoordinating attempt may take on.

In this approach there is a clear meaning to the idea of "micro-foundations" to macro-phenomena. And the macro phenomena is traceable to micro actions and responses.

Thanks to Richard for the comment.

Commerce Commission: good or bad?

There has been some discussion lately of changes at the Commerce Commission. Everyone seems to think that such a body is needed and that it should be a powerful player in its role as competition regulator. I ask why? May be the commission does more harm than good. Would it be better to do away with it?

The idea behind competition law in New Zealand is, according to the Act, “to promote competition in markets for the long-term benefit of consumers”. This is to say, it is believed, by the Act's supporters, that markets left to themselves, without any oversight from regulators, without any regulation of prices, quantities, or structure, would be harmful to consumers. Such a view rests on the notion that there is a large danger of monopoly power being used to harm consumers and, therefore, competition is a state of affairs which must be regulated and managed by the authorities because undesirable situations of monopoly can emerge all the time.

Frederic Sautet, ex-economist at NZ Treasury and the Commerce Commission, makes the point that this thinking is wrong headed:

At the end of the day, the problem assumed by competition law is only exacerbated by regulation, while economics shows that the entrepreneurial process solves it. So while there may be situations where competition law may seem warranted, in fact there is no crime at the crime scene. While competition law aims to protect consumers, the danger is that it may affect the self-correcting properties of the market system — an outcome worse than the disease it tries to cure.

Much of the problem is due to the fact that competition law was established on an misunderstanding of the nature of competition. The law in New Zealand aims to achieve "workable competition" but the practice of competition law relies on the view of competition as a static (equilibrium) state of affairs - derived from the idea of perfect competition. However, actual competition is a rivalrous entrepreneurial process by which the knowledge enabling a better coordination of individual plans is discovered over time. Again, as Frederic Sautet points it

[...] it must be understood that the competitive process takes place within a set of institutions that guarantee the functioning of entrepreneurial discovery and the exploitation of business opportunities over time. These institutions and regulation must guarantee entry into any market to anyone desiring to compete.

Sautet goes on to make the important point that

Under the disguise of consumer protection, competition law has in fact protected some producers from the greater efficiency of their potential competitors. Indeed, competition can be difficult for some incumbents who run the risk of being outcompeted. However, this process is necessary if the ultimate goal is to let consumers (indirectly) dictate the allocation of resources according to their preferences. The danger with competition law is that it interferes with the entrepreneurial process — a cure worse than the disease.

Thus the danger of the Commerce Commission is that it may so damage or restrict the true competitive process that it harms the very people it set out to help, consumers, but helps the people it wished to control, producers. The law of unintended consequences strikes again.

As far as empirical evidence goes it tends to suggest that competition policy does not improve consumer welfare by much. Robert W. Crandall and Clifford Winston look at the effects of antitrust enforcement in the US and ask Does Antitrust Policy Improve Consumer Welfare? And the short answer is, not much. Crandall and Winston write,

In this paper, we argue that the current empirical record of antitrust enforcement is weak.

and add

We then synthesize the available research regarding the economic effects of three major areas of antitrust policy and enforcement: changing the structure or behavior of monopolies; prosecuting firms that engage in anticompetitive practices, namely, price fixing and other forms of collusion; and reviewing proposed mergers. We find little empirical evidence that past interventions have provided much direct benefit to consumers or significantly deterred anticompetitive behavior.

Overall I'm not sure that we really do want a strong interventionist Commerce Commission.

References: The Sautet paper, which is well worth reading, is "The Shaky Foundations of Competition Law", New Zealand Law Journal, pp. 186-190, June 2007.

The Robert W. Crandall and Clifford Winston paper is "Does Antitrust Policy Improve Consumer Welfare? Assessing the Evidence", Journal of Economic Perspectives, 17(4) Fall 2003.

Public goods for frogs

In a strange posting at the Frogblog on wages in universities, Metiria Turei shows the problems that can occur by not doing economics at university. Metiria writes

Meanwhile the government is looking to further reduce its contribution to what is undoubtably a public good, as well as private benefit. (Emphasis added)

Unfortunately education isn't a public good. For the record, a public good is a good which is non-rival and non-excludable. Put simply this means that the consumption of the good by one individual does not reduce the amount of the good available for consumption by others and no one can be effectively excluded from using the good. Clearly this definition fails for education, as it is easy to exclude people from receiving it, for example.

I wonder if merit good is meant rather than public good?

Even bailouts have opportunity costs

Richard Florida puts it this way:

The bailouts and stimulus, while they may help at the margins, also pose an enormous opportunity costs. One the one hand, they impede necessary and long-deferred economic adjustments. The auto and auto-related industries suffer from massive over-capacity and must shrink. The housing bubble not only helped spur the financial crisis, it also produced an enormous mis-allocation of resources. Housing prices must come a lot further down before we can reset the economy - and consumer demand - for a new round of growth. The financial and banking sector grew massively bloated - in terms of employment, share of GDP and wages, as the detailed research of NYU’s Thomas Phillipon has shown - and likewise have to come back to earth.

On the other hand, there is the classic question: What better and more effective things might have been done with these trillions? That’s for historians to ponder and decide. But the combination of the massively misallocated resources produced by the bubble (plus the costs of military adventures) combined with humongous bailout spending puts the US behind the economic eight-ball in a way it has not been in more than the century. Having hold on the reserve currency helps, but it cannot absolve all these compounded sins. Sooner or later the money will run out; bills will come due.

That creates a wide open structural opportunity to accelerate what Fareed Zakaria has dubbed the “rise of the rest” to accelerate. Crises are periods where the relative position of nations and regions can and do change dramatically. (Do I think the US will lose its hegemonic position: Of course not. My hunch is that the US is in the same position structurally as England at the onset of the Long Depression of 1873. It was not until the next major crisis - the Great Depression of 1929 and the onset of WWII that it lost its position [to] the United States. So worst case: The US has one more long-cycle at the top of the heap). But, just think of all the ways the trillions of bailout money could be used to build the economy of the future. And while you’re doing that imagine that some other places … that have been patiently building and conserving their resources may start to figure out how to do just that.

I can only agree with Florida on the point about the bailouts and stimulus impeding necessary and long-deferred economic adjustments. As I have written before industries like the auto and auto-related industries need to adjust and handouts from the government counter the natural markets forces which would bring this about. This is a point to keep in mind if sometime in the future the New Zealand government goes down the big handouts to big business path.

(HT: Will Wilkinson)

Jay Leno and scalping

Yesterday I read Eric's posting at Offsetting Behaviour on Economics of Scalping: Trent Reznor edition and today I read this from a posting at Greg Mankiw's blog:

As I understand it, here are the facts:

1. Comedian Jay Leno takes his show to Michigan to help "not just the autoworkers -- anybody out of work in Detroit."

2. He gives away tickets for free.

3. Someone tries to sell his ticket on eBay.

4. Mr Leno objects.

So Mr Leno doesn't like scalping either. But why? What does he lose, after all he had already given the tickets away so its not like he is losing an money on forgone ticket sales.

Mankiw writes

So I wonder: If a person down on his luck prefers the cash to the opportunity to watch Leno live, why would Leno object? Is it altruism that is really motivating Leno here? Is he really sure that the unemployed person in Detroit would be better off with an evening of laughs than $800 in his pocket? Or does Leno want to play to a live audience of unemployed workers so he will seem altruistic to his television audience?

The great thing about markets is that they improve the allocation of resources. Both the buyer and the seller engage in the transaction voluntarily, so it must be that both are better off: otherwise they would not trade. So why does Leno object? Does he not like the efficient allocation of resources?

Micro v. macro

Don Boudreaux over at Cafe Hayek blogs on the distinction between "microeconomics" and "macroeconomics." The distinction he makes he says is due to the Swedish economist Erik Lindahl, who spells it out in his book Studies in the Theory of Money and Capital. Boudreaux writes

The distinction, as I understand it, is this:

Microeconomics focuses on the actions of individuals; it examines how individuals respond to incentives, as well as studies the various incentives that individuals in different circumstances confront. Gary Becker is a living example of a premier microeconomist.

Macroeconomics involves tracing out the unintended consequences of various actions and sets of individual actions. It studies the logic of the spontaneous, unintended order (or disorder, as the case may be) that emerges when each of many individuals respond to the incentives identified and classified by microeconomics. On this definition, Hayek is certainly one of history's greatest macroeconomists.

So a typical microeconomic insight, for example, is the recognition that a price cap on gasoline reduces suppliers' incentives to supply and increases the quantities buyers' seek to purchase. A (confessedly simple) macroeconomic insight is the recognition that an unintended consequence of the price cap will be queues at gasoline stations and black-market dealings in gasoline.

A more elaborate macroeconomic insight is Carl Menger's explanation of how money was not the creation of a conscious mind but, instead, evolved into use.

Boudreaux goes on to add

Both "micro" and "macro" are important -- and understanding people accurately at the "micro" level is useful for doing good work at the "macro" level.

I agree with this last statement. I would also agree that micro is about what incentives people face and how individuals respond to these incentives. As Steven E. Landsburg has famous put it,

Most of economics can be summarized in four words: People respond to incentives. The rest is commentary.

I'm guessing that it is the view of macroeconomics that will be the controversial part of the above quote. But I think I agree with that as well. Any other views?

Offsetting behaviour

Over at Offsetting Behaviour Eric comes up with a nice example of, well .... offsetting behaviour.

Give people antilock brakes, airbags and other safety devices, and they “consume” the safety improvements by driving more aggressively. This phenomenon is called the Peltzman Effect, after economist Sam Peltzman, who first wrote about it in 1976. The decades-long effort to make highways straighter, wider and better-marked, with more guardrails and rumble strips, has eliminated one class of dangers only to foster another: the complacent driver with a cellphone in one hand and a cup of coffee in the other, steering the vehicle with a knee while occasionally glancing at what’s ahead.

Meanwhile, modifying roads and intersections so drivers are less comfortable—by making driving, in some ways, more dangerous—forces people to slow down and pay attention, producing a change in behavior that, paradoxically, results in more safety. This is also true for pedestrians, who Vanderbilt says are more cautious away from crosswalks than within them because they don’t know if cars will actually stop.

Eric's solution does seem a bit pointed.

Why do taxpayers own TVNZ? They don't.

Over at Homepaddock the question is asked, Why do taxpayers own two television stations? My response would be they don't.

Homepaddock goes on to say

I can’t remember the last time I watched TV2 but unless it has changed there is nothing on it to justify public ownership.

TV1 has a few programmes which might not appear on privately owned stations, but like Agenda, for instance, they mostly screen at times few people find convenient to watch them.

There may be a case for public service television but TVNZ doesn’t provide much evidence for it.

The problems Homepaddock has with "public ownership" of the television stations may well come down to the point that the "public" don't own them, the politicians do, and so they respond to the wishes of the politicians not the public. There is no accountability to the taxpayer, which I'm guessing is basically Homepaddock's point.

The question is, Why is there no accountability to the public? The short answer is because the public don't own the assets in the first place.

The important point here is that without control you don’t have ownership. 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.))

Clearly the “public” does not have the rights Holmes refers to. The government has these rights. Following Grossman and Hart ("The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration", 'Journal of Political Economy', 94:691-719) economists tend to define the owner of an asset as the one who has residual rights of control over the asset; that is whoever can determine what is done with the asset, how it is used, by whom it is used, when they can use it etc; the public can do none of these thing with a public asset. Hence the public doesn’t have ownership.

The public have no ownership and thus there is no accountability to them.

Reminder

Condliffe Memorial Lecture 2009

Profosser Hal R. Varian

Evolutionary Business - The Effect of Computer-Mediated Transactions

Date: Tonight
Time: 5:30 p.m. to 6:30 p.m.
Location: Central Lecture Block, C3 - University of Canterbury, Christchurch.

Jane Kelsey makes no sense

Yes I know what you are thinking, so what's new? Kelsey never makes sense. But in this article from the New Zealand Herald Kelsey is attacking free trade agreements. Now there are some reasons for concerns about FTAs. Jagdish Bhagwati's outlines these in his book Termites in the Trading System: How Preferential Agreements Undermine Free Trade. I have discussed Bhagwati's ideas here. These are not the arguments Kelsey is making.

Kelsey tells us

The careful stage management of announcements on free trade agreements is not new. But the US decision should encourage us to look beyond the simplistic assumptions that the more free trade agreements we sign, the better off we will be, based mainly on some fanciful modelling of the gains to agricultural exporters.

We in New Zealand stand to learn a lot from the debate that is unfolding in the US under the new administration

Let us assume that the FTAs we sign are sensible - if they are not, Why do we sign them? - then the more we sign, the better off we are. Free trade does makes us better off. This is the basic point Kelsey doesn't accept.

Free trade doesn't make us better off because of "some fanciful modelling of the gains to agricultural exporters". The gains to our agricultural exporters are not fanciful, they are very real. But the important point about free trade is that it increases our national income, on average people are better off. "On average" because there will be those who lose from greater trade, but those people lose less than the those who gain, gain. And thus the gainers could compensate the losers and still be better off.

The gains from additional trade don't come just via gains in agricultural exports, as welcome as these are, they come from an increase in our exports in general and, just as importantly, an expansion in our imports. Extra imports means we can get a wider range of cheaper, better goods to consume. This increases the welfare of consumers and lowers the input costs of producers. An important point in times like these. Also we will change the composition of what we produce. We will move towards those things we have a comparative advantage in and away from those we don't.

But Kelsey is right about one thing: "We in New Zealand stand to learn a lot from the debate that is unfolding in the US". We do have much to learn this debate.

Economist Edward L. Glaeser writes in the Boston Globe on the situation the US in this article, Building walls with US trading partners. He says

FREE TRADE is a child of economic confidence; protectionism is pessimism's progeny. In today's fearful economic climate, policy-makers have again cried "buy American," and embraced interventions that support domestic producers at the expense of our trading partners. Protectionism is bad economics and worse foreign policy, for many of our trading partners have only a tenuous link to peaceful democracy. To avoid the terrible path of the 1930s that led to prolonged depression and global conflict, the United States must maintain its commitment to globalization.

Let us learn this lesson, let us not cry "Buy New Zealand", let us realise that protectionism is bad economics and let us ignore Jane Kelsey.

An additional point we can learn from the US is the effect that vote buying can have on trade outcomes. There are votes in protectionism. Those who are protected will support you, because they know you have helped them. Those who lose from your actions don't know, for sure, that they are losing because of your actions, and thus may not oppose you. It looks like a good deal for politicians, and good deals for politicians should worry the rest of us.

Let us keep in mind the point that Greg Mankiw makes: when asked their view on the proposition

Tariffs and import quotas usually reduce general economic welfare.

93% of economists agree.

(HT: The Inquiring Mind.)

EconTalk this week

Dan Klein, of George Mason University, talks with Russ Roberts, the host of EconTalk, about truth in economics, bias, and groupthink in academic life. Along the way they discuss the Food and Drug Administration (and the drug approval process), the culture of academic life and the roles of empirical evidence and prediction markets in adjudicating academic disagreement. The conversation closes with a discussion of Econ Journal Watch--the watchdog journal Klein founded and edits--and an invitation to listeners to join a discussion of The Theory of Moral Sentiments by Adam Smith.

What Keynes really meant

Russ Robert over at Cafe Hayek inquires into What Keynes really meant. He writes

What did Keynes really mean? It's hard to say. His masterwork is a bit opaque and has been interpreted by many generations of acolytes.

In the current environment, we are told that consumers aren't spending so aggregate demand has fallen. (This is typically discussed as if the reason for this drop is irrelevant). Therefore government must step in as the spender of last resort. This was the defense of the so-called stimulus package of $787 billion. Those who defended it did not defend it on the merits of what was in it, but rather simply on its magnitude. And many of those defenders (including Paul Krugman and Robert Reich) said it was not big enough.

Their basic argument is Keynesian in nature—that aggregate demand, C+I+G, must be boosted up to its former level and that this can be achieved through an increase in G. And according to the Administration (and the study it produced written by Jared Bernstein and Christina Romer), every dollar of government spending would produce 1.57 (or was it 1.54?) dollars of income.

The presumption is that it does not matter what G is spent on. The most important thing is to get spending into people's hands so that they will in turn spend it and the multiplier will kick in.

The presumption is that the multiplier is a constant. It does not matter how G is financed. It does not matter what G is spent on. It does not matter why C is down. G just needs to go up. This is silly pseudo-science.

The presumption is that if G goes up, C will stay unchanged. This ignores any possibility that people will be aware that their taxes are going to go up very dramatically in the future and they will do nothing in response.

The presumption is that the borrowing or printing of money to finance the increase in G will have no effect on aggregate demand.

The presumption is that the people who get the money from the government will spend it rather than save it.

These last points are empirical questions. Actual estimates of the multiplier are all over the map. We don't have a lot of evidence on either side that is reliable. Anecdotal evidence is generally restricted to World War II on the encouraging side and Japan's recent experience on the discouraging side.

I have argued that economists generally came down on one side or the other of the stimulus package based not on their economic understanding but on their political and philosophical biases. I still believe that. I think we're in macroeconomically uncharted territory.

Roberts is right in that The General Theory is "a bit opaque and has been interpreted by many generations of acolytes". No one seems to know what Keynes really meant. The point about people expecting future tax increases in worth noting. Insofar as the world is, at least partially Ricardian, an increase in G will not have the full effects proponents of stimulus think it will. Roberts also point us to this this debate between Brad DeLong and Michele Boldrin.

Boldrin's argues that simply increasing G is not sufficient to induce recovery.

Tyler Cowen and Robin Hanson at Bloggingheads

Tyler Cowen and Robin Hanson argue about "Agreeing to Disagree" at Bloggingheads.tv. Note the discussion at 12:10 into the discussion on "Are economists evil?"

Public finance: theory, evidence and policy

From VoxEU.org comes this interview with Raj Chetty. Chetty talks to Romesh Vaitilingam about the optimal design of tax policies and social welfare programmes like unemployment insurance. They discuss his work on US public finance as well as new research on how to improve tax compliance in developing countries.

Vertical integration in China

In economics vertical integration is normally thought about in terms of providing incentives, protecting relationship-specific investments, dealing with hold-up problems or reducing transaction costs etc. But a new NBER working paper has another story. Joseph Fan, Jun Huang, Randall Morck, and Bernard Yeung have a paper on Vertical Integration, Institutional Determinants and Impact: Evidence from China. They show that vertical integration in highly interventionist environments, like those in China, may be aimed not at the issues noted above, but at rent-seeking and the pursuit of other forms of political privilege. Their abstract reads:

Where legal systems and market forces enforce contracts inadequately, vertical integration can circumvent these transaction difficulties. But, such environments often also feature highly interventionist government, and even corruption. Vertical integration might then enhance returns to political rent-seeking aimed at securing and extending market power. Thus, where political rent seeking is minimal, vertical integration should add to firm value and economy performance; but where political rent seeking is substantial, firm value might rise as economy performance decays. China offers a suitable background for empirical examination of these issues because her legal and market institutions are generally weak, but nonetheless exhibit substantial province-level variation. Vertical integration is more common where legal institutions are weaker and where regional governments are of lower quality or more interventionist. In such provinces, firms led by insiders with political connections are more likely to be vertically integrated. Vertical integration is negatively associated with firm value if the top corporate insider is politically connected, but weakly positively associated with public share valuations if the politically connected firm is independently audited. Finally, provinces whose vertical integrated firms tend to have politically unconnected CEOs exhibit elevated per capita GDP growth, while provinces whose vertically integrated firms tend to have political insiders as CEOs exhibit depressed per capita GDP growth.

This result suggests another reason why highly interventionist governments can lead to economically inefficient outcomes. Firms grow for rent-seeking rather than efficiency reasons. This is one of a small number of papers that deals with the issue of how firms organise to take advantage of political processes and institutions. Public choice meets theory of the firm.

Hal Varian on how the Web challenges managers

This video from The McKinsey Quarterly is of Hal Varian, Google's chief economist, talking about on how technology empowers innovation. Click on the picture to start video. There is also a transcript of his comments below the picture.

A lesson on poverty measurement

Kristian Niemietz at the IEA Blog writes about the situation in the UK

Looking at the evolution of conventional relative poverty (using a threshold of 60% of contemporary median household income), there is a clear pattern: the poverty rate was stable for decades at around 14%, until, from 1983 on, it suddenly recorded a gigantic leap. In 1990, it reached a record of 24%, not falling by much since then. The conclusion usually drawn is that the market-oriented policies pursued in the 1980s may have improved economic performance, but this was achieved at the expense of the poor.

It must be kept in mind, though, that poverty analyses are extremely sensitive to the poverty measure employed. The Institute for Fiscal Studies has experimented with some alternative measures. They have set a poverty line at 60% of the median household income of the year 1996/97, and applied it from 1961 to 2006, adjusted to each year’s price level. From this, a totally different picture is obtained.

According to the fixed-threshold measure, more than half of the population lived in poverty in the early 1960s. The rate fell rapidly over that decade, while in the 1970s it showed marked volatility. Most strikingly, the explosion of poverty of the 1980s that the conventional figure shows is not mirrored. Poverty now falls from 1982 to 1988, and then stagnates for a while to fall again after 1995.

The reason for the divergence seems to be that the absolute measure has a strong negative correlation with economic growth but the relative one does not. One would hope that poverty is negatively correlated with economic growth, if not, why have growth?

On the dismal science

From the Market Power blog

Interesting blog bits

1. Not PC on “Ignoring the Austrians Got Us in This Mess"
2. TVHE on Crampton, Walker on policy. (Looks like economists are agreeing again)
3. TVHE also on The failure of contemporary macroeconomic theory?
4. Market Power points out that Hugo Chavez Going After Hoarders.
5. Richard M. Ebeling on Human Action at Sixty.
6. Greg Mankiw on No Free Lunch: A Corollary.
7. Carpe Diem on the World's 50 Safest Banks.

Well said that man ...

Brad Taylor points out the obvious oxymoron

And yes, an MP for the supposedly classical liberal ACT party did say “we’ve got too hung up on people’s rights”.

and adds the sad truth

ACT is quickly becoming nothing more than another conservative party.

A good night out

Condliffe Memorial Lecture 2009

Profosser Hal R. Varian

Evolutionary Business - The Effect of Computer-Mediated Transactions

Date: Wednesday 18 March
Time: 5:30 p.m. to 6:30 p.m.
Location: Central Lecture Block, C3 - University of Canterbury, Christchurch.

From clay tokens in 3000 BC, to cash registers in the 1800's and to today’s Internet, transformative technologies have enabled companies to optimize business processes. But the Internet does more than just provide an online storefront for selling. Computer technology is revolutionising processes across the board from product development to logistics. Professor Varian will explain how computer-mediated transactions continue to transform business practices.

Professor Varian joined Google in 2002 in a consultancy role and has been involved in many aspects of the company since that time, including auction design, econometric analysis, finance, corporate strategy and public policy. Professor Varian holds academic appointments at the University of California, Berkeley, in three departments: business, economics, and information management. He received his SB degree from MIT in 1969, and his MA in mathematics and PhD in economics from UC Berkeley in 1973. He has also taught at MIT, Stanford, Oxford, Michigan and a number of other universities. Professor Varian is a fellow of the Guggenheim Foundation, the Econometric Society, and the American Academy of Arts and Sciences and has published numerous papers in economic theory, industrial organisation, financial economics, econometrics and information economics. He is the author of two major economics textbooks which have been translated into 22 languages and is the co-author of a bestselling book on business strategy, "Information Rules: A Strategic Guide to the Network Economy" and from 2000-2007 wrote a monthly column for the New York Times.

Unemployment and the minimum wage (updated x2)

The economic analysis at The Standard is not improving. This from Tane in a recent posting there

And there’s no evidence that such a moderate phase-in of a higher minimum wage would lead to higher unemployment. After all, under the last Labour government the minimum wage increased by 70% over nine years, yet unemploment actually halved in that time.

and this

[The graph below is something I whipped up a while ago plotting the real minimum wage against unemployment. You'll see there's no real correlation between the two, despite what your orthodox neoliberals might tell you.]

This has got to be the strangest graph I have seen for a long time. It is totally pointless. No economist, anywhere, would argue that the kinds of increases in the minimum wage we see in most first world countries will have any noticeable effect on the overall unemployment rate, of course it won't. This is simply because most wage earners earn more than the minimum wage and so the minimum wage is irrelevant to their employment. Those who are affected are those at or around the minimum wage level. But these are a small percentage of total employment. For example, if you are being employed at $10 an hour and the minimum wage doubled from $1 to $2, so what? Its not going to effect you.

What economists will tell you is that increases in the minimum wage will effect those at the bottom of the end of the wage distribution. In my toy example above the people who will be effected are those in and around the $1-$2 range. Unemployment in this range could increase but as those in this range are a small percentage of total employment, any increase in unemployment in this range will have little effect on the overall unemployment rate. The effects of minimum wage laws are counter-productive for the very people they aim to help - such as young people, women, ethnic groups, and the disabled. Those with, at least currently, low productivity who are at the bottom end of the wage scale. This is where Tane should look for the effects of a minimum wage increase.

So Tane's graph doesn't tell us much of anything, other than that Tane doesn't know much economics. The title of Tane's posting is "Strawman" and I'm afraid his graph is very much a strawman.

For a summary of the work on the effects of the minimum wage see the recent book Minimum Wages by David Neumark and William L. Wascher, The MIT Press, 2008.

Update: In the comments to this posting Matt Nolan reminds me of the case (a perfect monosponistic labour market) where, at least in theory, an increase in the minimum wage can increase in employment, see here for more. I seem to remember this model being used to explain the Card and Krueger results of some years back.

Update 2: I should have added that on the Mankiw list of things economists agree on, number 12 is

A minimum wage increases unemployment among young and unskilled workers.

and 79% of economists agree.

Capitalism beyond the crisis

In the New York Review of Books Amartya Sen has an essay on Capitalism Beyond the Crisis. Sen opens his essay by saying

The question that arises most forcefully now concerns the nature of capitalism and whether it needs to be changed. Some defenders of unfettered capitalism who resist change are convinced that capitalism is being blamed too much for short-term economic problems—problems they variously attribute to bad governance (for example by the Bush administration) and the bad behavior of some individuals (or what John McCain described during the presidential campaign as "the greed of Wall Street"). Others do, however, see truly serious defects in the existing economic arrangements and want to reform them, looking for an alternative approach that is increasingly being called "new capitalism."

and ends it by saying

The present economic crises do not, I would argue, call for a "new capitalism," but they do demand a new understanding of older ideas, such as those of Smith and, nearer our time, of Pigou, many of which have been sadly neglected. What is also needed is a clearheaded perception of how different institutions actually work, and of how a variety of organizations—from the market to the institutions of the state—can go beyond short-term solutions and contribute to producing a more decent economic world.

With much of interest in between.

Over a his blog, Aid Watch, William Easterly disagrees with Sen. Easterly blogs on Amartya Sen on Moralism, Maoism, and Capitalism. Easterly writes

He [Sen] points out that even Mr. Free Market Invisible Hand, Adam Smith, was aware that you need more than self-interest to make capitalism work. You also need moral values like trust, honesty, and prudence (none of which has been too obvious in the financial sector lately), so business people can do transactions without cheating each other. His story is that free market proponents forgot all that in the run-up to the current crisis. If this is true, free market proponents are amazingly lazy, not bothering to read the zillion articles by economists on precisely these values in the last 15 years. The interesting question is where do these values come from? As this recent research shows, they COULD still arise even in a world of pure self-interest, since self-interested individuals could rationally find ways to bind themselves to norms of good behavior so that they can do repeated transactions with each other (probably helped along by pre-existing norms based on culture or human evolution -- see previous post on values). A norm of trust can sustain a free market driven by the profit motive (usually supplemented by formal institutions). And why do the values sometimes break down? Unfortunately, a norm of distrust is also another possible equilibrium, in which you expect everyone else to be untrustworthy and so you are untrustworthy too. A bunch of cheaters could catch everyone by surprise, destroy trust, and we jump to the bad equilibrium. I don’t know if this has anything to do with the current crisis, but I suspect this type of analysis, as practiced by tons of recent research on values and norms, is more useful than moral sermonizing to those (probably nonexistent) economists who didn’t know you need trust as well as the profit motive.

Properity rights matter

Here's an interesting interview with Karol Boudreaux on TVO's The Agenda with Steve Paikin. Boudreaux talks about community-based natural resource management.

(HT: Division of Labour)

We are all Keynesians now?

Over at the Economist they are having a debate on the motion: This house believes that we are all Keynesians now.

Defending the proposition is Professor Brad DeLong. He says

I regret that I cannot deliver on my promise: to make the case that "We are all Keynesians now." I cannot because it is not true: we are not all Keynesians now.

But adds later

So now, I cannot say we are all Keynesians now. The most I can say is that we should all be Keynesians now—and we should be.

Read more here.

Against the proposition is Professor Luigi Zingales. He says

What does "being Keynesian" mean? Simply believing in the role of demand-side factors in the determination of aggregate output is an insufficient characterisation.

And adds later

Keynesianism has conquered the hearts and minds of politicians and ordinary people alike because it provides a theoretical justification for irresponsible behaviour. Medical science has established that one or two glasses of wine per day are good for your long-term health, but no doctor would recommend a recovering alcoholic to follow this prescription. Unfortunately, Keynesian economists do exactly this. They tell politicians, who are addicted to spending our money, that government expenditures are good. And they tell consumers, who are affected by severe spending problems, that consuming is good, while saving is bad. In medicine, such behaviour would get you expelled from the medical profession; in economics, it gives you a job in Washington.

Read more here.

Over at the excellent Organizations and Markets blog Peter Klein writes, with regard to the second Zingales paragraph quoted above

Three comments: First, the “hangover” metaphor, while not exactly accurate, is an effective way to communicate the basics of the Mises-Hayek malinvestment theory of the business cycle. Use it! Second, Zingales’s description applies equally well to the 1930s and 1940s, when the Keynesian consensus emerged. It’s important to remember that massive deficit spending to “cure” the Depression began with Hoover and Roosevelt in the early 1930s, long before the General Theory appeared. Keynes’s book did not propose a new direction for economic policy; it provided an allegedly scientific rationale for policies already in place, policies government officials were eager to defend and protect. (The use of expansionary fiscal and monetary policy to increase output had long been derided by serious economists as nonsense, as the domain of “monetary cranks” and other snake-oil salesmen).

Third, the Keynesian delusion afflicts not only policymakers, but professional economists as well. I’ve long suspected that the appeal of Keynes to people like Krugman and DeLong is ultimately based on aesthetic, not scientific, grounds. Deep in their hearts, they just don’t like private property, markets, and individual choice. They don’t think ordinary people are capable of making wise decisions and think they, the elites, should be in charge. They resent the fact that most people don’t want their lives controlled by liberal intellectuals. Technical arguments about the effectiveness of monetary and fiscal policy, the relationship between aggregate demand and output, the experience of the 1930s, and the like are really beside the point. For Keynesian economists, the belief that markets are naturally unstable in the absence of government planning is a matter of faith.

Check the debate out, looks like it could be fun. You can also add in your own comments and vote on the proposition. So far 61% are against.