The (non)Standard again

Tane at "The Standard" writes

Once again, the people who we entrust to run our economy have failed us. Perhaps it’s time we considered some alternatives to the current model. Alternatives like industrial democracy that empower workers to make their own decisions and provide some accountability to management.

Actually no one has failed us, things are working the way they should. The point is that the system is a profit and loss system. Both parts of that statement provide incentives. In this case we are seeing the loss part. The loss part, when working correctly, results in businesses being allowed to fail, and thus resources being released from employments where they don't add value and made available for employments where they do.

Note that when resources are used for one purpose the same resources can't be used for another. What is important for welfare is that that resources find their way to the purposes we value most. As Peter T. Leeson has written recently

Enter the profit-and-loss system. Under this system, when producers use resources in ways that are consistent with our wants, they earn profits. When they don't, they earn losses. If losses are severe enough or accumulate over time, the producers who earn them go under.

When ineffective producers fail, resources they have been using to produce things we value less are freed for producing other things which we value more. In fact, who better to sacrifice the resources required to expand production of the goods and services we want than producers of the those things we don't? The whole profit-and-loss system works because successful producers reap rewards when they combine resources effectively and unsuccessful producers incur costs when they don't. It is both the prospect of making profits from making good decisions and of making losses from making bad ones which encourages producers to make choices that provides us with the good and services we want.

Tane continues

Because one thing’s for sure, you’d struggle to do any worse than the clowns who’re currently running the show.

Given this Tane should be happy with the profit and loss system. One thing it does well is remove the "clowns".

A new weapon in the fight against crime?

Thanks to the Adam Smith Institute blog for this picture:



Just what will the RSPCA say? Things could get very messy.

Why the Alliance Party is irrelevant

This Alliance Party media release comes via from Scoop.

The Alliance Party says the Government should take ownership of the Lane Walker Rudkin (LWR) Factory in Christchurch to prevent a disastrous loss of hundreds of jobs.

Despite everything we know about the relative performance of state v's privately owned companies they still want the government to "own the means of production." There is a world for that .... stupid.

The evidence on the effects of privatisation seem relevant here. The following comes from the summary of chapter 4, 'Empirical Evidence on Privatization's Effectiveness in Nontransition Economies', from William L. Megginson's book, The Financial Economics of Privatization, New York: Oxford University Press, 2005,

The 87 studies from nontransition economies discussed in this chapter offer at least limited support for the proposition that privatization is associated with improvements in the operating and financial performance of divested firms. Most of these studies offer strong support for this proposition, and only a handful document outright performance declines after privatization. Almost all studies that examine post-privatization changes in output, efficiency, profitability, capital investment spending, and leverage document significant increases in the first four measures and significant declines in leverage.

Sunita Kikeri and John Nellis write in their article, An Assessment of Privatization, "The World Bank Research Observer", vol. 19, no. 1 (Spring 2004)

This article takes stock of the empirical evidence and shows that in competitive sectors privatization has been a resounding success in improving firm performance. In infrastructure sectors, privatization improves welfare, a broader and crucial objective, when it is accompanied by proper policy and regulatory frameworks.

In other words privatisation improves performance, meaning that privately owned firms out perform state-owned firms.

The Alliance Party media release continues,

Alliance Economic Development Spokesperson Quentin Findlay says it is vital that jobs and incomes are preserved to prevent mass unemployment in New Zealand.

How does taking ownership of one firm prevent mass unemployment? And if you take a look at the unemployment figures we are along way from "mass unemployment".

He says the Government should take control of failing enterprises and investigate options such as public ownership, employee shareholdings and worker ownership.

When we look at the relative performance of different types of ownership what do we find? Mary M. Shirley and Patrick Walsh write in Public versus Private Ownership: The Current State of the Debate, Working Paper, The World Bank,

Our review found greater ambiguity about ownership in theory than in the empirical literature. In the debate over the effects of competition, theory suggests that ownership may matter and if so, that private firms will outperform SOEs. The empirical studies squarely favor private ownership in competitive markets. Theory’s ambiguity about ownership in monopoly markets seems better justified, since the empirical literature is also less conclusive about the effects of ownership in such markets. Theories that assume a welfare maximizing government suggest that SOEs can correct market failures. In contrast, public choice theories are skeptical of the benevolent government model. Corporate governance theories suggest that even well intentioned governments may not be able to assure that SOE managers do their bidding. The empirical literature favors those skeptical of SOEs as a tool to address market failures. In studies of industrialized countries, where we might expect more developed political markets to motivate greater government concern with welfare maximization or better information and incentives to overcome corporate governance problems, private firms still have an advantage. The private advantage is more pronounced in developing countries, where market failures are more likely.

The kinds of problems that mixed forms of ownership can bring can been seen from the New Zealand experience with the SOEs. While many are not in actual mixed ownership, the pressures that such ownership can bring about can, nevertheless, be seen in our recent history with the SOEs.

The SOE Act states that SOEs, basically, have to be run like normal non-government owned firms. In effect this requirement is the same as you could get if private owners have a stake in a firm. The private owners would, we assume, wish to maximise profits, but the government may not. And you see this with SOEs. The government often wishes to intervene in the running of SOEs to get them to carry out non-profit maximising activities, just as it would if it had a partial stake in a mixed ownership firm.

This problem of having SOEs (or mixed ownership firms) trying to serve two masters was noted more than 10 years ago by Spicer, Emanuel and Powell in their book "Transforming Government Enterprises: Managing Radical Organisational Change in Deregulated Environments" (The Centre for Independent Studies, 1996). They warned that there are two pressures on SOE's: the first being towards privatisation since the productivity and efficiency gains achieved by SOE are in danger of being eroded over time. Privatisation is a way of both cementing in the commercial orientation of enterprises and wringing out further gains resulting from the high powered incentive and control mechanisms which can be bought to bear in privately owned and publicly traded companies. The second pressure on SOEs is towards being pulled back into the public sector where social and political objectives can be more readily be meet. Most interventions seem to be more politically motivated.

These pressures would also be there for a mixed ownership firms and help explain why they don't do as well as fully privately owned firms. For example, Aidan Vinning and Anthony Boardman in "Ownership and Performance in Competitive Environments: A Comparison of the Performance of Private, Mixed, and State-Owned Enterprises", Journal of Law and Economics, vol. XXXII (April 1989) conclude

'The results provide evidence that after controlling for a wide variety of factors, large industrial MEs [mixed enterprises] and SOEs perform substantially worse than similar PCs [private corporations].

The basic problem is that partial government ownership politicises the firm.

What of labour-owned firms? The shortcomings of such organisations are all too obvious: lack of access to capital, inadequate risk pooling, investment problems − older workers want a shorter pay-back period than younger workers, are membership rights tradable and if so under what conditions, new members would have to purchase ‘equity’ in the business from retiring ones, borrowing to cover such a purchase could be a problem for younger would-be members etc. One should also note that we don't see many labour-owned firms - outside partnerships and the like - in reality and this should tell us something.

The Alliance Party media release goes on

Mr Findlay says the cause of the LWR factory’s closure was both National and Labour led Governments supporting free trade deals and free market policies.

How often must this point be made? Free trade does very little to the total number of jobs in the economy. What it does is move jobs around, away from areas in which we don't have a comparative advantage into areas where we do. As Paul Krugman, yes that Paul Krugman, has said

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

and as trade economist Douglas Irwin has put it,

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

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

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

But perhaps Laura LaHaye puts it best

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

Alliance Party media release says more,

Mr Findlay says the use of tariffs, a regulated economy and an expansionary monetary policy could have saved this factory and 470 jobs.

So saving 470 jobs prevents "mass unemployment"? But as has been pointed out above tariffs will not save a single job. It will save a particular job, but only at the cost of a job somewhere else in the economy. Net effect zero.

Every economy is regulated. The question is, By what? The government or the market? Market regulation via competition is by far the most effective regulator of firm behaviour. Take as an example government regulation of the economy via antitrust (or competition) policy. 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.

The media release says latter,

The Government has no real strategy to prevent job losses and business failures aside from listening to the failed mantras of so called 'market' and business leaders, he says.

“The fact is that this ‘advice’ has led to domestic factory failures and layoffs. The Clothing industry, in particular has been put to the sword by the free market and in return New Zealand is flooded with clothing made by virtual ‘slave’ labour from overseas.”

What "slave" labour?

But the main group who benefit from these imports are the poor. The very people I assume the Alliance Party wishes to help. The low cost of these imported cloths means that the poor have received an increase in their standard of living. Take the following example to do with Wal-Mart in the US.

Christian Broda writes at VoxEU.org on China and Wal-Mart: Champions of equality. He opens his article by noting that the public debate, especially in the USA, and as can be seen in New Zealand, has taken for granted that inequality has risen as a result of globalisation. And then asks, "But has it really?" He argues that in fact it hasn't.

Broda points out that,

How rich you are depends on two things: how much money you have and how much the goods you buy cost. If your income doubles but the prices of the goods you consume also double, then you are no better off. Unfortunately, the conventional wisdom on US inequality is based on official measures that only look at the first half, the income differential. National statistics ignore the fact that inflation affects people in different income groups unevenly because the rich and poor consume different baskets of goods.

Inflation affects the rich and poor to different degrees, and these inflation differentials change our view of the evolution of inequality in the US. Broda writes

Inflation of the richest 10 percent of American households has been 6 percentage points higher than that of the poorest 10 percent over the period 1994 – 2005. This means that real inequality in America, if you measure it correctly, has been roughly unchanged. And the reason is just as dramatic as the result. Why has inflation for the poor been lower than that for the rich? In large part it is because of China and Wal-Mart!

The important point here is that relative to wealthier families, the poorer families in the USA, and most other countries, spend a larger share of their income on goods whose prices are directly affected by trade – obvious examples being clothing and food. What we see is that the wealthier you are the more you spend on services. Such services are less subject to competition from abroad. From the data we see that since 1994 the price of goods in the US has risen much less than the price of services. Broda writes,

This trend can partly be explained by China. In U.S. stores, prices of consumer goods have fallen the most in sectors where Chinese presence has increased the most. Take canned seafood or cotton shirts, for instance. Exports of China to the rest of the world in these categories have increased dramatically over this decade. Inflation in these sectors has been negative over the last decade, while in other sectors with no Chinese presence inflation has been over 20 percent. Moreover, as China produces goods of relatively low quality, sectors with strong Chinese presence are disproportionately consumed by the poor.

Broda goes on to note that the effects of the expansion of superstores like Wal-Mart has been good for the poor. He explains,

The expansion of superstores – like Wal-Mart and Target – has also played an important role in accounting for the inflation differentials between rich and poor. Superstores sell the same products as traditional shops at much lower prices. Today the poor do roughly twice as much of their buying of non-durable goods in these stores than the rich. So poor consumers have been the biggest beneficiaries of Wal-Mart coming to town.

Broda ends his column by making the important point that,

We need to remind politicians and the public that the gains from trade are broadly shared. Every time the discussion over trade is diverted towards the problems facing specific producers, be they farmers in France or textile workers in the U.S., we miss the central point. Trading allows everyone, and especially the poor, to buy things that they could not otherwise afford. Without better public understanding of these facts, governments will not only keep supporting policies aimed against China and Wal-Mart but may receive the uninformed support of many consumers who are benefitting from trade. (Emphasis added)

The same basic story plays out here in New Zealand. Cheaper imports help the poor.

The Alliance Party media release ends by saying,

"It's about time that the Government started to see economic sense in the face of the global recession and pressed the eject button on the failed policies of extreme capitalism."

Extreme capitalism?! In New Zealand?!

The general point that comes from all of this is that the government picking which firms to protect and which not to protect will result in a miss-allocation of resources which will ultimately decrease the welfare of New Zealanders. The government can not know which areas of the economy will grow in the future and therefore provide employment. A policy of intervention will be counterproductive in the medium to long term. It is unsustainable since it is not consistent with the preferences of consumers-savers-investors. Government bureaucrats carrying out the such a policy, have no way of knowing what the efficient, productive investments are likely to be, they are not entrepreneurs, they are not trying to determine the efficient and sustainable direction of resources. It is the market that can, over time, work this out, via the interactions of countless investors, consumers and producers. The public choice part of me would ask if the bureaucrats would really care what the investments they make are, which firms survive and which don't, as long as short-term employment is increased. And this seems to be the Alliance Party's only concern.

(HT: Brad Taylor)

Incentives matter: Bible file

The principal-agent problem is as old as the Bible. John 10:11-13.

The good shepherd lays down his life for the sheep. The hired hand, who is not the shepherd and does not own the sheep, sees the wolf coming, deserts the sheep, and runs away. So the wolf snatches them and scatters them, because he is a hired hand, and the sheep don’t matter to him.

Alex Tabarrok: How ideas trump economic crises -- a surprising lesson from 1929

Eric Crampton rightly congratulates Denis Dutton because he's scheduled for the 2010 TED conference. Well here is another man Eric will know talking at TED, Alex Tabarrok, co-blogger at Marginal Revolution.

The "dismal science" truly shines in this optimistic talk, as economist Alex Tabarrok argues free trade and globalization are shaping our once-divided world into a community of idea-sharing more healthy, happy and prosperous than anyone's predictions.

In addition here is an interview of Tabarrok by Matthew Trost. They talk about whether limited natural resources are a constraint on growth, the Lebensraum fallacy, The Wire, the tragedy of the commons and other topics. On natural resources and the Third World Tabarrok says

I utterly reject the view that the Third World is doomed to poverty and starvation. Not only is this wrong, I think this attitude verges on the immoral, like thinking that slavery is an unalterable facet of the human condition so why bother doing anything about it? Moreover, thinking of this kind -- I call it the Lebensraum point of view -- leads to war and destruction. The Lebensraum point of view, however, is rejected by evidence from the second half of the twentieth century. Peace and free trade are the routes to wealth -- not a grab for "limited" resources.

Tabarrok is also asked "Once you're in such a tragedy of the commons-type situation, how do you get yourself out?" His answer,

It's not easy. New Zealand has been quite successful at creating property rights in fish. That is, if you're a fisherman, you get an assigned quota: you're only allowed to fish so much. When this is enforced, everybody can be better off. Almost paradoxically, limiting how much each fisherman can catch can means that every fisherman catches more, because they allow the fish stock to grow.

It can be done, but it takes a lot of political will, especially when the problems are global, because then you need agreement of a bunch of different nations, and that's hard to get.

(HT: Marginal Revolution)

This job is ‘getting old’

In this audio from VoxEU.org David Autor of MIT talks to Romesh Vaitilingam about his research on the hollowing out of the occupational distribution in the US and Europe over the past 30 years: high- and low-wage occupations have been expanding rapidly and hiring younger workers, while routine middle-skill occupations have been shrinking and ‘getting old’.

Interesting blog bits

1. Defective Equilibrium reports on a poll on the 'The 10 "Most Important" Philosophers of the Early Modern Period'. Adam Smith comes in 9th with David Hume at 2 and Immanuel Kant at 1.
2. Market Power on The Peltzman Effect and NASCAR. May be these guys need a Tullock Spike.
3. Offsetting Behaviour on Opposition to redistribution: self-interest, or economic thinking? Is it that folks who are more likely to understand economics are also more likely to understand the costs of redistribution in terms of economic growth foregone?
4. Not PC on Bad banks. Looking at the "aggregates" can mean you miss the details-which can be very important.
5. The Inquiring Mind comes across a letter to the editor from someone from a parallel universe. How we can have had no national wealth creation since 1984 but still have a $130 billion in national income I don't know.
6. Tyler Cowen is Against torture prosecution.
7. Brad Taylor on Technology and Freedom. Whether new technologies will enhance freedom or reduce it is one of the big question we will have to face in the future.
8. rauparaha at TVHE suggests Bicycle helmet laws kill.
9. Mario Rizzo on University of Michigan: Teacher Yes, Father No.The University of Michigan has announced that it will become completely smoke-free in 2011. Why? In part because "2. “A healthier, smoke-free physical environment will only enhance the intellectual vigor of our campuses,” said U-M President Mary Sue Coleman.”" Really?
   

EconTalk this week

Ricardo Reis of Columbia University talks with the host of EconTalk Russ Roberts about Keynesian economics in the classroom and in research. Reis argues that Keynesian models are a useful framework for helping undergraduates understand macroeconomic ideas of general equilibrium. More generally, Reis argues, Keynesian ideas remain influential in macroeconomic research, particularly among Neo-Keynesians. Reis discusses the lessons the economics profession and the world have learned from the Great Depression and suggests that those lessons have helped us manage the current crisis. The conversation closes with a discussion of whether economics is a science.

P.J. O’Rourke in New Zealand

Not PC reports that P.J. O’Rourke will in New Zealand, well Auckland anyway, on Thursday, 30th of April to talk at the Center for Independent Studies. Be there if you can.

Markets and asymmetric information

A common reason, we are told, that markets may fail is asymmetric information. This idea goes back, at least, to Akerlof's famous paper on adverse selection and his example of the used car market. However we know that markets can deal with this problem. But a commonly held belief is that for markets to work, formal enforcement of contracts is necessary to prevent failure when information asymmetries exist. If fact, as Trevon D. Logan and Manisha Shah point out,

[...] it is hard to imagine the contracts that would be entered into in a world void of formal enforcement. How could fraud be detected and punished? Would assets be misappropriated? Wouldn’t the unscrupulous actors in the economy drive out the good, leaving us with corruption, uncertain property rights, and low levels of economic progress?

and they add

The standard results in game theory and contract design say yes. Theoretically, formal enforcement per se is not necessary if one uses, for example, long-term relationships. Without such added structures, however, a rational principal would never trust the information received from an agent, as it could likely be cheap talk. Also, the fact that additional structures must be in place suggest that the absence of formal enforcement is less efficient than formal enforcement. Any discussion of the role of institutions, the rule of law, and contract enforcement is predicated on the existence of formal enforcement. In the institutional developments now taking place in Iraq and Afghanistan, the development of formal institutions is a pressing policy concern.

But as Logan and Shah argue in a column, Information and illegal market mechanisms, at VoxEU.org the question of whether formal enforcement is necessary to overcome the problems of asymmetric information is an inherently empirical one. Logan and Shah explain,

If, using the definition of Robert Hall and Charles Jones (1999), “good” social infrastructure is the mechanism that gets the prices right, we would like to see if markets without formal enforcement (which would presumably be riddled with “bad” social institutions such as corruption, rent seeking, and theft) get the prices wrong more often than markets with formal enforcement, which are presumably the “good” social infrastructure. In other words, does the data support the theory?

But there is a problem,

Testing this proposition, however, requires that we have access to the prices in an illegal market, if only to guarantee that the underlying contract is illegal and therefore unenforceable. Illegal markets, by their very nature, tend to stay hidden, so finding one where the information that agents communicate varies only increases the difficulty. To be sure, it is the rare illegal market where prices are widely known and where information on contractual arrangements can be observed by outsiders. In a recent paper (Logan and Shah 2009), we exploit one such market to answer this important question – the online market for male sex work. What we find is fascinating, and at many turns supports the existing theory of the economics of information, but also cautions that formal enforcement may not get the prices right more often than markets without formal enforcement, especially in the digital age.

What about the market for male sex work? Logan and Shah write,

First, male escorts are independent owner-operators who advertise online. The ability of male escorts to price directly without intermediaries and the large number of escorts create a market setting similar to competitive market assumptions where we expect markets to function well. Since this market is an illegal market, however, there is potential for escorts to mislead clients and engage in fraud. In particular, an escort’s ability to post unreliable information should lead to adverse selection in the market. While escort claims are verifiable ex post, there are no formal institutional penalties for ex ante misrepresentation. Indeed, most of the scenarios one could think of (posting deceptive information, obtaining and maintaining a false reputation, etc.) would lead us to predict that information would have little value. We found, however, that the market for male sex work is well regulated, informally, by the principals. Clients police escorts in two ways – through posts to independent client-owned forums and through detailed reviews of escort services on the escort websites, which are linked to the respective escort’s specific advertisement. This well developed system allows clients to review the services of male escorts and alert other clients to deceptive male sex workers. In fact, clients have identified, and made known, their preferred signal of escort quality – face photos in an escort’s advertisement.

So while informal enforcement is ubiquitous, the question has to be asked, Is it enough to get the prices right? Logan and Shah say, yes.

We find that this illegal market values information just as much as legal markets where truth-in-advertising and subsequent contracts are rigorously enforced. Interestingly, the price premium we estimate for the total number of pictures in escort advertisements (about a 1.5% increase in the price for every picture) is quite similar to the premium for pictures estimated by Gregory Lewis (2009) for used automobiles on eBay.com. That information has a value in any market is quite intuitive, but that it has such a large value in an illegal market is unexpected. In particular, we find that the market does not respond to all types of information – the premium to information in this market is driven entirely by face pictures, which command a premium in excess of 3% per face picture.

Logan and Shah conclude,

Our investigation into the market for male sex work provides a case where the richness of the information environment overcomes some of the problems of asymmetric information. The illegality of the market and the near-impossibility of guaranteed truthful disclosure imply that the market should deteriorate into a “lemons” market or one where information has dubious value. Surprisingly, clients informally police the market, punish misrepresentation, and reward credible disclosure. This enables male escorts to credibly signal their quality, and prices in the market respond accordingly. The illegal market mechanism is strikingly similar to it legal counterpart.

So, yet again, we find that markets do work and can find ways of dealing with asymmetric information. This is another example of the failure of market failure.

• Hall, Robert E. and Charles I. Jones. (1999) "Why Do Some Countries Produce So Much More Output per Worker than Others?" Quarterly Journal of Economics 114(1):83-116.
• Lewis, Gregory (2009). “Asymmetric Information, Adverse Selection and Seller Disclosure: The Case of eBay Motors” Working paper, Harvard University.
• Logan, Trevon D. and Manisha Shah (2009). “Face Value: Information and Signaling in an Illegal Market.” NBER Working Paper No. 14841.

Incentives matter: income tax file

From the an article, We’re fleeing high-tax Britain, say City tycoons, from the Times Online.

Two of Britain’s best known entrepreneurs are considering leaving Britain in protest against Alistair Darling’s new 50 per cent tax rate, as leading figures from business and the City warn of a talent exodus.

Hugh Osmond, the pubs-to-insurance entrepreneur, is thinking about a move to Switzerland. Peter Hargreaves, the £10 million-a-year co-founder of Hargreaves Lansdown, the financial adviser, is looking at the Isle of Man or Monaco. More are likely to follow.

Osmond, whose net worth is estimated at £230 million, said: “A lot of people will be off. It’s highly unlikely that I will continue to have the UK as my country of residence. It’s just as easy to work from any close location – Switzerland or wherever.”

Hargreaves, facing an extra £500,000 on his tax bill, warned: “I won’t pay, I’ll leave.”

Robert Pfeiffer, a partner at Compass Advisers, a mergers and acquisitions firm, said that businesses such as his did not need to be based in Britain. “We all love living in London but in the end it becomes an economic decision. The clients don’t care.”

He and his partners were discussing a move to Geneva. “Do we want the hassle of moving? Probably not. But there comes a point economically when it’s hard to justify being here.”

And Philip Lambert, chief executive of Lambert Energy, said his consultancy was “seriously considering” relocating abroad, saying the state had “total hostility or apathy towards entrepreneurs”.

Greg Mankiw asks,

Do economists tend to migrate toward low-tax states? I have not noticed much evidence of it, but perhaps they should.

I'm thinking that few of them make enough money to make it worthwhile. Except, perhaps, those who write bestselling textbooks!

P.J. O'Rourke on Adam Smith

Thanks to Brad Taylor for pointing out to me this audio of an interview with P.J. O'Rourke talking about Adam Smith. This comes from the ABC's (Australian Broadcasting Corporation) "Philosopher's Zone".

Adam Smith is known today as the father of economics, but he was, by profession, a philosopher. His book The Wealth of Nations is an attempt to apply philosophy to the world of money-making and commerce. This week, we dip into his great work with the help of P.J. O'Rourke, the American political commentator, wit and author of a recent study of Smith.

Property rights and economic development

The importance of property rights to economic development is now well acknowledged, but an interesting question is: What is the relationship between the security of property rights and the various channels through which they affect economic activity? In a world where property titles are ill-defined, where legal disputes take decades to settle, where poor farmers or small business owners face eviction threats, it is difficult to imagine how they can take a long-run view – saving, investing, and climbing their way out of poverty. Security of property rights therefore is of utmost importance.

Tim Besley and Maitreesh Ghatak discuss this issue in a column at VoxEU.org. They start by explaining

The term property right refers to an owner's right to use a good or asset for consumption and/or income generation (referred to as "use rights"). It can also include the right to transfer it to another party, in the form of a sale, gift or bequest ("transfer rights"). A property right also typically conveys the right to contract with other parties by renting, pledging, or mortgaging a good or asset, or by allowing other parties to use it, for example, in an employment relationship.

By property rights, economists typically refer to private property rights, a key feature of which is being able legally to exclude others from using a good or asset. This affects resource allocation by shaping the way that individuals choose to carry out productive activities involving the use of the good or asset, undertake investments that maintain or enhance its value, and also, to trade or lease the asset for other uses.

Peruvian economist Hernando de Soto is one economist who has forcefully argued for the importance of property rights to development.

According to him, what the poor lack is easy access to the property mechanisms that could legally fix the economic potential of their assets so that they could be used to produce, secure, or guarantee greater value in the market. Therefore, even when they have some assets, they are "dead" capital.

Besley and Ghatak go on to explain that economists have emphasized four main aspects of how property rights affect economic activity.

• The first is expropriation risk – insecure property rights imply that individuals may fail to realise the fruits of their investment and efforts.
• Second, insecure property rights lead to costs that individuals have to incur to defend their property, which, from the economic point of view, is unproductive.
• The third is failure to facilitate gains from trade – a productive economy requires that assets be used by those who can do so most productively, and improvements in property rights facilitate this. In other words, they enable an asset's mobility as a factor of production (e.g., via a rental market).
• The fourth is the use of property in supporting other transactions. Modern market economies rely on collateral to support a variety of financial market transactions, and improving property rights may increase productivity by enhancing such possibilities.

You can take a bird's eye view of the quality of property rights using cross-country data. To illustrate this point Besley and Ghatak take two measures of property rights regimes using standard sources.

The first is a measure of the security of property rights from the International Country Risk Guide. It is measured on a scale between 0 and 10. A higher score corresponds to better protection of property rights. Figure 1 shows that this score is positively correlated with income per capita. In other words, countries with a higher risk of expropriation have lower levels of income per capita.

Figure 1 comes from Besley and Ghatak

The second measure comes from the World Bank’s Doing Business project. We focus on a measure of the ease with which individuals can register their property, specifically the country's rank on this measure for 172 countries. This is a purely administrative dimension to property rights and follows the logic of the de Soto argument. Figure 2 shows that this too is strongly negatively correlated with income per capita in 2000. Thus, this more administrative dimension of property rights is weaker in low-income countries

Figure 2 comes from Besley and Ghatak. Both Figures 1 and 2 are taken by Besley and Ghatak from Besley and Ghatak 2009.

Taking these two figures together, they illustrate the central proposition that improving property rights is associated with economic development. But what is not clear is which way the causation runs. Is it that economic development induces a switch to improved property rights or is it that property rights facilitating economic development. Besley and Ghatak go on to say,

The economics literature now has a plethora of microeconomic studies that suggest that securing private property affects economic decisions in the way that the theory suggests. For example, improving squatters’ rights in Peru seems to have reduced the need to use guards according to Erica Field (2007). Her work on Peru with Maximo Torrero also suggests that property titles are associated with increase in approval rates on public sector loans by as much as 12% when titles are requested by lenders (Field and Torrero 2006).

In a related study, Sebastian Galiani and Ernesto Schargrodsky (2005) have looked at the collateral effect of property rights reform. They look at a group of squatters who occupied an area of wasteland in the outskirts of Buenos Aires more than 20 years ago from the time of the study. An expropriation law was subsequently passed, ordering the transfer of the land from the original owners to the state in exchange for a monetary compensation, with the purpose of entitling it to the squatters. They find that it improved housing investment, among other things.

While property rights help development, the creation of private property rights cannot be taken for granted. To get effective private property rights a course has to be steered between, on the one hand, anarchy and on the other, predation.

In a state of anarchy, the main problem is dispersed coercive power, as now characterises warlord societies. The obvious answer is to create a monopoly protector as suggested, centuries ago, by Thomas Hobbes. But who is to protect the citizens against Leviathan? This is the problem of predation.

All societies have had to grapple with this dilemma at one point or another in their history and many continue to do so. That the West has managed to, by and large, achieve a workable balance helps explain its economics growth. Just compare property rights and growth in Western Europe, post 1600, with that of Russia over the same period to see the point. Besley and Ghatak note,

There are a number of ways of dealing with these issues, most notably by building political institutions that create effective checks and balances and establish the rule of law in a way that is binding on policy makers. But these require more than the stroke of a pen. A lot rests on the reputation of government that needs to recognise its long-run interest ahead of short-term gains from expropriating property. History is replete with examples where governments have expropriated their citizens. A case in point is modern day Zimbabwe, where Robert Mugabe seized the property of farmers to distribute to his political supporters.

And the effects of the Mugabe approach to property right are all too obvious when you look at what passes for an economy in Zimbabwe. Especially in agricultural sector.

Policymakers who are aware of the problem of predation can seek innovative ways of creating secure property. One possibility is to tolerate some amount of secrecy and anonymity in private economic decisions vis-à-vis the government, which allow individuals to protect themselves against expropriation. Another is to use more decentralised policymaking and competition between governments, what is known as market preserving federalism.

Another problem can be that many governments have simply failed to invest sufficient in the public goods of basic legal institutions and property registration institutions. The main priority is then to spend more in such areas to promote more secure property rights. But there can be problems here too. If the powerful can benefit from insecure property rights, there may be much pressure on the government not to enforce property rights and thus limited political will for property rights reform.

Besley and Ghatak close their column by noting,

In all cases, it is clear that the solutions have to be, to some degree, country-specific. The mantra of property rights reform too easily degenerates into an empty slogan. Also, property rights improvement is not a panacea especially when other aspects of an economy perform badly. But identifying the appropriate institutionalised solution is only a first step. How the political process is able to prevent the potential losers from blocking the reform is likely to be the crucial element.

• Field, Eirca (2007) “Entitled to Work: Urban Property Rights and the Labor Supply in Peru”, Quarterly Journal of Economics, November 2007
• Field, Erica and Maximo Torrero (2006) “Do Property Titles Increase Credit Access Among the Urban Poor? Evidence from a Nationwide Titling Program”, Working Paper, Harvard University, 2006.
• Galiani, Sebastian and Ernesto Schargrodsky (2005) “Property Rights for the Poor: Effects of Land Titling”, Working Paper, University of Washington, St. Louis, 200.
• Ghatak, Maitreesh and Tim Besley (2009) Property Rights and Economic Development, CEPR Discussion Paper 7243.

Seriously bizarre (updated x2)

Even by the non-standards of The Standard this has got to be seriously bizarre,

It seems that Zimbabwe is, after all, a world leader. Mugabe’s government which followed the IMF and World Bank’s neo liberal plan for their economy to the letter, has shown us all how these policies will finish up.

The austerity medicine prescribed for Zimbabwe by the world Bank, Included oppressive and harsh debt repayment, and massive tax cuts for the rich, all funded by the privatisation of virtually every public service and national asset, and by slashing the ’social wage’.

Exactly when did the IMF or the World Bank, or anyone else for that matter, say create an annual inflation rate of 89,700,000,000,000,000,000,000% and in the process totally destroy your currency so that you have to start using the US dollar? Or when did the IMF or the World Bank, or anyone else for that matter, say totally ignore property right and take over farms without compensation and give them to political supporters and in the process totally destroy your agricultural sector and with it most of your economy? As this 2008 report notes

Zimbabwe, once the bread basket of southern Africa, is reeling from its worst economic crisis since independence from Britain in 1980.

The crunch is widely blamed on mismanagement by Robert Mugabe's government, especially the seizure of white-owned farms, which has led to the collapse of the agricultural sector, formerly the mainstay of the economy.

When did the Zimbabwe government privatise anything much? As this 2009 report explains

The commercialisation and privatisation of parastatals started in the early 1990s but since then only a few companies have been privatised.

These included CBZ Bank, Dairibord, the Cotton Company of Zimbabwe, Zimre and Rainbow Tourism Group.

The privatisation of these former parastatals transformed them into very profitable entities that are competing favourably in the market.

Government however still holds 100 percent shareholding in the National Railways of Zimbabwe, Zesa Holdings, Cold Storage Company, Air Zimbabwe and the National Oil Company of Zimbabwe.

Others include the Industrial Development Corporation, TelOne, NetOne, The Zimbabwe Mining Development Corporation, Minerals Marketing Corporation of Zimbabwe and the Zimbabwe National Water Authority.

Efforts to privatise some of these, which continue to be a drain on the fiscus, has not yielded any fruit to date. (Emphasis added.)

And when did the Zimbabwe government do much in the way of debt repayment? In fact Zimbabwe has run up large foreign debts. As this 2009 report notes

The IMF says it was owed $89 million at the end of February 2009. The World Bank says Harare owes it $600 million, and the African Development Bank says it was owed $429 million as of the end of June last year.

Gono said Zimbabwe also owed the Paris Club of sovereign creditors about $1.1 billion.

As economists Peter Draper and Andreas Freytag put it in this article, What future for monetary policy in Zimbabwe?, at VoxEU.org.

Mr Mugabe and his Zanu PF party not only destroyed the economy thereby creating hyperinflation, poverty and starvation– they also eradicated a workable [government] 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.

According to the 2008 "Economic Freedom of the World Report", Zimbabwe was one of only three counties in the world to decreased their score by more than one point: Zimbabwe's dropped by −1.93. In fact Zimbabwe once again has the lowest level of economic freedom among the 141 jurisdictions included in the study.

All of this had nothing to do with the IMF or the World Bank. There are many things you may be able to blame these organizations for, but the situation in Zimbabwe isn't one of them. Zimbabwe's terrible, horrifying, economic and social conditions have but one cause, Robert Mugabe. To claim otherwise is totally bizarre, even for "The Standard".

Update: Liberty Scott comments here and Brad Taylor here.

Update 2: The Inquiring Mind inquires here.

Sunk costs and the Wellington city council

This from Wellington city councillor Andy Foster in an article in the Dominion Post,

One thing the council is clear on is that we don't want Rongotai to develop into another town centre. The Kilbirnie town centre is within walking distance, and the council has invested much public money in facilities such as the regional aquatic centre, community centre, library, and council housing to serve the eastern and southern suburbs

What is the secondhand market for 'regional aquatic centres', 'community centres' and libraries like? Much of these "investments" have a non-recoverable look to them and insofar as they are sunk costs why is the councillor getting worked up about them? Sunk costs are irrelevant to decision making.

Cross-country comparisons of wage rates: the Big Mac index

From VoxEU.org comes this audio of an interview in which Orley Ashenfelter of Princeton University talks to Romesh Vaitilingam about his research comparing wage rates for workers in identical jobs across countries, for which he has collected data from branches of McDonald’s, the fast food restaurant chain, in North and South America, Western and Eastern Europe and the rising economies of Asia.

The cost of cost studies (updated x3)

Over at Offsetting Behaviour Eric has a nice piece, Costs of everything, value of nothing, on a recent BERL study into the costs of alcohol use in New Zealand. The costs, and only the costs, no benefits just the costs, and even then they don't measure the costs correctly.

Read Eric's posting because the basic logic he uses applies not just to this study but to many other of these types of things. You see any number of these types of reports, most of which should be ignored for the reasons Eric points out. Unfortunately at times such wastes of paper become influential in policy circles and bad policy is the result. What would happen if this report was taken seriously? What would happen if large extra taxes were applied to alcohol or if outright bans were imposed? The short answer would be a black market would develop with all its associated costs. The control or even banning of alcohol comes with its own costs and these should not be ignored.

Another example of this type of report would be the O'Dea Report, a similar report on the costs of smoking. Eric criticised that report in the New Zealand Medical Journal. Lots of similarities between this report and that one. When the desired conclusion drives the method, take care in interpreting the results.

Update: rauparaha at TVHE comments here.

Update 2: Eric adds an additional posting on this topic at Offsetting Behaviour. He notes

BERL cites total social costs of $5.3 billion. $3.9 billion of that, 74%, cannot honestly be counted as policy-relevant costs from an economic perspective.

He also adds an Update/correction to his previous post.

I misread the final paragraph of the report. They list excise taxes of $167 million from excessive alcohol use and health costs of $286 million. Note, though, that these are only the proportion of excise taxes paid by individuals defined as consuming "excessively". Actual excise taxes in 2008, by Crown reports, were $573 million. Actual alcohol tax revenue outweighs actual health expenditures on alcohol, but tax revenues from problem drinkers don't cover their health costs. This is always a problem with a linear tax on something that has convex costs. See Felicity Barker's excellent Treasury analysis of 2002 on alcohol taxes.

Update 3: Will de Cleene has a go at BERL bashing.

Arnold Kling and Mark Thoma talk macroeconomics

From Bloggingheads.tv come this video where Arnold Kling and Mark Thoma talk about the current state of macroeconomics.

Tullock can't be all bad (updated)

Further to my recent Interesting blog bits posting where I pointed out that I like Gordon Tullock on the grounds that he once threatened to have Eric Crampton killed. Eric tells the story here and pays homage to Tullock in general along with providing an explanation for the following picture that I linked to.



One point about which I disagree with Eric is on his Pantheon of the Econ-Gods. He, of course, has Tullock sitting at the top with Becker, Friedman, Buchanan, Coase, Alchian, Demsetz, Hayek as the Elder Gods. My ranking would interchange Tullock and Ronald Coase. For me Coase is the greatest econ god. With Tullock as one of the Elder Gods. But I am a theory of the firm man. Coase received the 1991 The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for

"For his discovery and clarification of the significance of transaction costs and property rights for the traditional structure and functioning of the economy."

Coase is most famous for two papers including his 1937 paper "The Nature of the Firm", the paper which started the whole theory of the firm literature.

Update: In the comments section to Eric's posting at Offsetting Behaviour, Brad Taylor makes the valid point that Douglass North should be added as an Elder God.

Interesting blog bits

1. Don Boudreaux on Gordon Tullock. I like Tullock, he once threatened to have Eric killed! And has has a great attitude towards driving.
2. Defective Equilibrium on Coercion. What does it mean to be coerced?
3. Brad Taylor responds to the above post here.
4. Eric Crampton gives a Survey of economists on the financial crisis. To me it doesn't look good.
5. Oxonomics discusses A Return to Industrial Policy in the UK. Again this doesn't look good.
6. Alberto Alesina and Paola Giuliano discuss Preferences for redistribution: The crisis, reduced inequality, and soak-the-rich populism. Will Americans turn into “inequality intolerant” Europeans? Such a radical shift is unlikely, but this column argues that this crisis may be a turning point towards more government intervention and redistribution in the US. More and more Americans believe that hard work is insufficient to climb the income ladder and are expressing anger against “unfairly” accumulated wealth. Politicians should prefer wise policies but may be tempted by populist outbursts. More stuff that doesn't look good.
7. Not PC on Apostrophes to the gallant apostrophe. The apostrophe is an essential part of English grammar but errors in apostrophe usage abound.
8. Freakonomics on Japan's Weird Unemployment Solution. The solution? Get the unemployed out of the country by offering citizenship buyouts. Now that is weird!

Benjamin Friedman interview

From VoxEU.org comes this audio of Benjamin Friedman of Harvard University talking to Romesh Vaitilingam about his book, The Moral Consequences of Economic Growth, which explores how growth boosts such values as opportunity, tolerance, generosity and democracy. They discuss how growth relates to inequality, happiness and the environment – and the potential consequences of a period of economic stagnation.

Bastiat quote or non-quote 2

Following up on my first post and having gotten my hands on a copy of the Alfred E. Eckes's book, "A Search for Solvency: Bretton Woods and the International Monetary System, 1941-1971", I can confirm that the said quote is on page 37. Eckes writes,

Like nineteenth-century liberals, Otto Mallery believed that free trade was the panacea for economic nationalism and great power rivalries. "If soldiers are not to cross international boundaries," he said, "goods must do so."

The reference that Eckes gives to the quote is "Otto T. Mallery, "Economic Union and Enduring Peace," Annals 216 (July 1941): 125-134; quotations on p. 125."

Let me give the full, albeit two sentence, paragraph from "Economic Union and Enduring Peace" which runs over the bottom of page 125 and the top of page 126:

If soldiers are not to cross international boundaries, goods must do so. Unless shackles can be dropped from trade, bombs will be dropped from the sky. (Emphasis in the original.)

The details given at the end of the paper on Mallery are

Otto Tod Mallery, A.B., Philadelphia, was one of the drafters and sponsors of the National Employment Stabilization Act and is a consultant on the National Resources Planning Board which administers this act. He has originated legislation which brought into being new governmental agencies in Philadelphia and Pennsylvania and has held administrative positions in city, state, and Federal Governments. He was chief economist of the United States Department of Commerce. In 1937 he was economic adviser to the United States Government Delegation to the Conference of the International Labor Organization at Geneva, and in 1939 to the United States Employers' Delegation to the Conference of the American States, members of the Inter- national Labor Organization, at Habana. He is president of the Playground and Recreation Association of Philadelphia, and member of the Board of Directors of The American Academy of Political and Social Science. He is part author of "Business Cycles and Unemployment" (1923).

But we are still left with the question of whether or not the Bastiat quote is genuine.

A couple of good moves by the Obama administration

From Greg Mankiw's blog I see that the Obama administration has made a couple of good moves on trade policy recently. Mankiw quotes Phil Levy

For the second time in a week, the Obama administration has discarded a major campaign pledge on international economic policy. In its decision last week not to name China a currency manipulator, and now to forswear renegotiation of NAFTA, the administration avoided two potentially costly mistakes.

Indeed, it has avoided two very costly mistakes. One of the biggest fears about the Obama administration was that, with regard to international economic policy, the President might actually follow through on his campaign rhetoric. That would have been a disaster, and so its good to see he isn't.

Bastiat quote or non-quote

In this posting at the excellent Not PC blog Peter Cresswell uses the quote

"when goods don't cross border, armies will."

and attributes it to Frederic Bastiat. Bastiat is the most commonly given source for the quote. But I have never see an actual reference to where Bastitat said it. Does anyone have such a reference?

I ask because Bastiat isn't the only source I have see given for the quote, or at least one very similar,

'If soldiers are not to cross international borders, goods must do so.'

According Jeffry Frieden, on page 255 of his 2006 book "Global Capitalism", the above quote is due to one Otto Maller and gives, in turn, a reference to page 37 of Alfred E. Eckes's 1975 book, "A Search for Solvency: Bretton Woods and the International Monetary System, 1941-1971". Maller we are told was a supporter of FDR's Secretary of State Cordell Hull. But that's it.

Anyone know anything more?

Motivating politicians

It is often argued that governments which secure property rights, regulate entry less, and curb corruption are those which create the right incentives for economies to prosper. But while the virtues of good government for economic development and growth are widely acknowledged, it is more difficult to learn what determines the quality of government. One view in the literature argues that political institutions that restrict rent-seeking and promote electoral accountability shape the necessary incentives for good policy-making. However, political institutions can only partially explain the variation in the quality of government both across countries and over time. A complementary view is that the quality of policy-making depends on the honesty and competence of the political class. Recent empirical evidence suggests that leaders play an important role in enacting the right policies and affecting economic performance. One only has to think of Lee Kuan Yew in Singapore to get the point.

But if the characteristics of policy-makers matter, then a central question becomes, what attracts high quality politicians into office and what provides them with the incentives to perform according to voters preferences.

In a new NBER working paper Claudio Ferraz and Frederico Finan look at the effects of monetary incentives on the performance of politicians. Their paper is Motivating Politicians: The Impacts of Monetary Incentives on Quality and Performance, NBER Working Paper No. 14906, April 2009.

In this paper, Ferraz and Finan examine whether higher wages attract better quality politicians and improve political performance. They do this by using exogenous variation in the salaries of local legislators across Brazil's municipal governments. The analysis exploits discontinuities in wages across municipalities induced by a constitutional amendment defining caps on the salary of local legislatures according to municipal population.

Their main findings show that higher wages increases political competition and improves the quality of legislators, as measured by education, type of previous profession, and political experience in office. Ferraz and Finan write,

Our findings indicate that increases in the salary of legislators not only attract more individuals to run for political office, but also attracts more educated ones. A one standard deviation increase in wages increases political competition by 0.7 candidates per seat and the share of candidates with a high school degree by 7.4 percent. We also find that higher salaries attract more candidates from white-collar professions (i.e. more businessmen and lawyers compared to farmers and policemen). Moreover, these effects are not limited to the pool of candidates. In municipalities that offer higher salaries, politicians have higher reelection rates, particularly those that are more educated. Thus, legislative bodies that pay higher wages have more educated and experienced legislators.

This is the political version of Henry Ford's $5 a day deal.

In addition to this positive selection, they find that wages also affect politicians’ performance, which is consistent with a behavioral response to a higher value of holding office. Ferraz and Finan explain,

In addition to these effects on political selection, we also find that salaries affect politicians’ performance. Legislators can influence local policy-making by submitting bills (formal requests for project that are then passed into laws) and petitions (requests for targeted public works). We find that higher wages increase both the number of bills submitted by the legislators and those approved. But, our findings show mixed evidence with respect to public goods provision. While higher salaries increase the number of health clinics and schools, and improve school infrastructure, we find no effects on households’ access to water and sanitation.

It should be noted that while these effects on legislative performance are consistent with a political agency model where changes in the value of holding office affect political behaviour, there are problems with being able to separate this agency effect from a positive selection effect. Ferraz and Finan do however provide suggestive evidence that the increase in legislative productivity is not entirely driven by the positive selection of politicians. Their results do, in fact, suggest that legislators do put more effect into policy-making due to an increase in the future value of holding office.

In addition the Ferraz and Finan findings suggest that increases in wages are likely to make incumbent politicians more accountable because it makes the value of holding office in the future higher. Politicians respond by increasing their legislative effort in order to boost their chances of re-election.

So politicians respond to incentives just like everybody else. Who would have guessed?

Views on the scope of government

Also over at TVHE Matt Nolan gives a simple distinction between the broad brush strokes of libertarianism, the underpinning beliefs of economics, and statism as statements for the scope of government.

Libertarian:

• Market prices are a good allocation mechanism - therefore market prices make sense.
• Initial endowment of resources is fair - therefore no need to redistribute initial endowments.

Economist:

• Market prices are a good allocation mechanism - therefore market prices make sense,
• Initial endowment of resources is unfair - need a democratic state to define what is fair and redistribute endowments.

Statism:

• Market prices are a poor allocation mechanism - therefore market prices are not necessarily any good and pragmatic government shifts to prices make sense,
• Initial endowment of resources is unfair - need a democratic state to define what is fair and redistribute endowments.

Now I'm not 100% what either the "initial endowment of resources" is, or what "fair" means. But thinking in terms of an Edgeworth box, if you don't like some given endowment-call it the initial endowment-you can move it to an endowment you do like via lump-sum payments. Basically this is the second welfare theorem. So for economists I don't see why they would much care about the initial endowment. Such an endowment could be either fair or unfair, but changeable without incentive effects. It would be the "final endowment" rather than the initial that they would worry more about. Their main concern would be efficiency.

For libertarians, is it the case they think that any initial endowment is fair, or is it they they think a reallocation of that endowment would create more problems than it solves? Would they not see a forced reallocation as a violation of a person's rights? Which returns us to the first of the two points, that they would see a market reallocation of resources as fair.

Also why should any of the three think that an initial endowment is necessarily unfair? For example, if in the Edgeworth box, the initial endowment is the center point, would any of three call this unfair?

The free home loan scheme

Matt Nolan at TVHE draws our attention to idea that the government could be putting forward an interest-free loans for first-home buyers scheme. As Matt notes

Now, this is essentially a transfer from everyone (taxpayers) to first home buyers and the people they are selling to. In such a situation I have to ask why? It certainly doesn’t seem fair to take money from people and give it to first home buyers and the section of the property market they are involved in [...]

The government says it is to “encourage building” - if this is the case, then why this scheme? Why not a direct subsidy to home builders.

And he is right on both points. It is a transfer from taxpayers to first home buyers and that a direct subsidy would achieve the same end, if this really is an end worth achieving.

But a further problem with the idea is that it is an example of the point made by Mario Rizzo over at the ThinkMarkets blog that I blogged on yesterday. While the government may be able to create employment via such a scheme we have to ask what will the scheme do to resource allocation? Such spending is counterproductive in the medium to long term. The scheme seems unsustainable (once the stimulus stops) since it is not consistent with the preferences of consumers-savers-investors. Will we get a whole pile of resources moving into housing which would be better used in some other area of the economy but which are in housing only because of the government loan scheme. What happens to the housing sector when those resources do get reallocated to other areas of the economy. Is the government just inducing a boom and bust cycle in the housing sector? The government is not acting as a super-entrepreneur who is trying to determine the efficient and sustainable direction of resources, it spends according to economically irrelevant criteria of job creation. This is short-termism at its worst. Doing something, anything, for the sake of being seen to be doing something.

Ideas that may look good at the macro level don't look so good at the micro.

EconTalk this week

EconTalk host Russ Roberts talks with reporter Robert Pollie about the basics of wealth and growth. What happens when the stock market goes down or the price of housing? When wealth goes down, where does the wealth go? How do these changes affect our wealth? What is the relationship between wealth and inflation? Roberts explains the economic fundamentals of these changes. At the end of the conversation, Roberts discusses the implications of the current economic crisis for assessing the state of economics as a discipline.

More on ticket scalping

Over at the Virtual Economics blog it is pointed out that Ricky Gervais became the latest in a seemingly never ending list of performers to rail in fury against ticket scalping, that is, the workings of supply and demand. On his blog Gervais writes

Tickets for my Edinburgh show are changing hands for £200 (almost $300). Please don't buy them. The people selling them are scum. I have tried to stop this happening but I can't. I've tried holding tickets back for sale on the night. I've tried putting gigs on sale at the last minute so people don't have time to put them on eBay, but nothing works. I'm flattered that anyone would want to see me that much but it breaks my heart that people spend their hard-earned money because of someone's greed. On my last tour one theatre manager excitedly told me that he'd just seen someone pay a thousand pounds for two tickets right by the ticket office. I think he thought I'd be pleased. I was horrified. Anyway please get a ticket but don't pay too much. That's all I'm saying.

Seamus McCauley at Virtual Economics responds

And, indeed, nothing will, short of playing more nights so that the supply of performances matches the demand for them at whatever price Ricky imagines fair. Want the after-sale ticket price to fall below £200? Put on more shows. You'll know you're doing enough shows when the price on eBay falls to the face value.

Many performers and promoters complain about the activities of ticket scalpers but as Seamus McCauley correctly notes the performers, if they really care about this, have several potent weapons that would eliminate ticket scalping pretty much immediately. They could increase the number of tickets available. This is possible in two ways. First they could increase the number of shows in a given location so that supply of tickets equals the demand for tickets. Secondly they could perform in a larger stadium, which would have the same effect on the supply of tickets. Or a bit of both. Another weapon performers have available to them is to do the economically obvious when facing an excess demand and increase ticket prices up to the market clearing level. This would reduce the reselling of tickets a prices greater than the face value of the ticket.

Given that is it the pricing policies used by the performers that creates the resale market it seems a bit disingenuous for them to complain about it.

Is all spending created equal?

So asks Mario Rizzo over at the ThinkMarkets blog. The issue here is whether or not government spending is as good as anybody else's when it comes to economic stimulus and fighting unemployment. Brad DeLong seems to think so. Mario Rizzo thinks not. He writes

So when DeLong, among others, says that government spending is as good as private in restoring employment, he is speaking against the whole thrust of the principle of efficient resource allocation. The essence of our recessionary problem is not the fall in aggregate demand and the lack of business confidence that accompanies it. First, it is the misallocation of resources produced by excessive risk-taking and by excessive expansion of interest-sensitive sectors. (These were generated by excessively low interest rates over the past several years.) Second, it is the uncertainty that is natural to the discovery of more appropriate combinations of resources. Third, it is the endogenous uncertainty created by the fits and starts of stimulus, bailout and unclear monetary policies.

When government adds to investment as a result of fiscal stimulus or directed monetary expansion (like buying mortgage-backed securities, student loans, etc) it does not act as a super-entrepreneur who is trying to determine the efficient and sustainable direction of resources, including the allocation of capital goods. It spends according to economically irrelevant criteria of job creation, propping up over-expanded sectors, and preventing politically painful adjustments.

Such spending is counterproductive in the medium to long term. It is also unsustainable (once the stimulus stops) since it is not consistent with the preferences of consumers-savers-investors.

Now I think here is little in the way of doubt that government spending can create jobs, as can monetary policy. Both these policy instruments can affect output and thus the level of employment/unemployment. But the government bureaucrats carrying out the fiscal or monetary policy, have no way of knowing what the efficient, productive investments are likely to be. They are not entrepreneurs. It is the market that can, over time, work this out, via the interactions of millions of investors. The public choice part of me would, therefore, ask if the bureaucrats really care what the investments they make are, as long as employment is increased. This is short-termism at its worst. Doing something, anything, now is better than waiting for the market to work things out, that takes too long. Or so bureaucrats and politicians think.

I would also suggest reading the comments section on the Rizzo posting. De Long replies and Rizzo responds. All good stuff.

Repaying TARP loans

Over at the Becker-Posner Blog Gary Becker writes on the repayment of the TARP bank Loans. He explains

Six months ago essentially all large American banks and many smaller ones received loans from the federal government to help shore up their capital base as they tried to weather the financial storm. Some banks would likely have failed during the severe strains in the capital market last September and October were it not for these loans. This past week, however, the two strongest large banks, Goldman Sachs and JPMorgan Chase, indicated that they wanted to, and were able to, repay their loans. Should they be allowed to do so?

Is this just signaling? Are these banks saying to the market, we are in good financial shape and to prove it we will repay our TARP loans. Becker goes on to say,

It appears that not all banks wanted to take government loans in October, but some large banks were apparently "forced" to as part of the TARP loan program devised by then Secretary of the Treasury Henry Paulson. According to some accounts, the government exercised this pressure in order to avoid disclosing which banks were the weakest and needed these loans to survive.

So the government was trying to cover up which banks were in bad shape. There is an obvious question as to whether this was a good idea. Wouldn't people want to know which banks are in a strong position and which are not? Participants in the financial markets surely need as much information as possible to make wiser decisions. Stopping them getting it seems counterproductive.

But my point is that even if this was the government's plan it seems to be unraveling, some banks appear to be trying to signal that they are strong by offering to repay the TARP loans. This would make sense for good banks, they hope to be able to separate themselves out from the bad banks and thus attract more business.

So should the government let the banks repay the loans? If they do they get a lot of money back-the taxpayers will be happy. But they would also provide a way for banks to show they are strong and thereby show which banks are weak. But this is the very separating equilibrium that the government was trying to avoid. Government plans never seem to workout just the way the government thinks they will.

Competition and managerial slack

Adam Smith, the Scottish philosopher not the New Zealand blogger, once wrote "Monopoly [...] is a great enemy to good management" while Sir John Hicks wrote "The best of all monopoly profits is a quiet life". The idea being that monopoly is the enemy of efficient management, or to put it another way, competition mitigates managerial slack. Managers of firms in competitive industries are under constant pressure to reduce slack and improve efficiency:

Over the long pull, there is one simple criterion for the survival of a business enterprise: Profits must be nonnegative. No matter how strongly managers prefer to pursue other objectives [...] failure to satisfy this criterion means ultimately that a firm will disappear from the economic scene (Scherer, 1980).

The hypothesis that competition mitigates managerial slack is important, should it turnout to be true.

In a new NBER Working Paper, Xavier Giroud and Holger M. Mueller try to test whether or not it is true. Their paper asks "Does Corporate Governance Matter in Competitive Industries?" Giroud and Mueller test the hypothesis that competition mitigates managerial slack by using exogenous variation in corporate governance in the form of what are called business combination (BC) laws. BC laws impose a moratorium on certain transactions, especially mergers and asset sales, between a large shareholder and the firm for a period ranging from three to five years after the large shareholder's stake has passed a prespecified threshold. Importantly such a moratorium hinders corporate raiders from gaining access to the target firm's assets for the purpose of paying down acquisition debt, thus making hostile takeovers more difficult and often impossible. By reducing the threat of a hostile takeover, BC laws thus weaken corporate governance and increase the opportunity for managerial slack. There were 30 such laws passed between 1985 and 1991 on a state-by-state basis in the US.

When summarising the results of their research Giroud and Mueller write

Using the passage of BC laws as a source of identifying variation, we examine if these laws have a different effect on firms in competitive and non-competitive industries. We obtain three main results. First, consistent with the notion that BC laws increase the opportunity for managerial slack, we find that firms’ return on assets (ROA) drops by 0.6 percentage points on average. Given that the average ROA in our sample is about 7.4 percent, this implies a drop in ROA of about 8.1 percent. Second, the drop in ROA is larger for firms in non-competitive industries. While ROA drops by 1.5 percentage points in the highest HHI (Herfindahl-Hirschman index) quintile, it only drops by 0.1 percentage points in the lowest HHI quintile. Third, the effect is close to zero and statistically insignificant for firms in highly competitive industries. Thus, while the opportunity for managerial slack increases equally across all industries, managerial slack appears to increase only in non-competitive industries, but not in highly competitive industries, where competitive pressure enforces discipline on management. It is in this sense that our results suggest that competition mitigates managerial slack.

Giroud and Mueller go on to point out that while their results suggest that competition mitigates managerial agency problems, they do not say which agency problem is being mitigated. Does competition curb managerial empire building? Or does it prevent managers from enjoying a “quiet life” by forcing them to “undertake cognitively difficult activities”? Giroud and Mueller explain

We find no evidence for empire building. Capital expenditures, asset growth, PPE growth, the volume of acquisitions made by a firm, and the likelihood of being an acquirer are all unaffected by the passage of the BC laws. In contrast, we find that input costs, overhead costs, and wages all increase after the laws’ passage, and only so in non-competitive industries. Our results are broadly consistent with a “quiet life” hypothesis, whereby managers insulated from hostile takeovers and competitive pressure seek to avoid cognitively difficult activities, such as haggling with input suppliers, labor unions, and organizational units within the company demanding bigger overhead budgets.

Giroud and Mueller also wonder if the effect shows up in stock prices. To test this they conduct event studies around the dates of the first newspaper reports about the BC laws. Their results show that

Across all industries, we find a significant cumulative abnormal return (CAR) of −0.32%. When we compute CARs separately for low- and high-HHI portfolios, we find that the CAR for the low-HHI portfolio is small and insignificant, while the CAR for the high-HHI portfolio is large (−0.54%) and significant. Similarly, if we compute CARs for low-, medium-, and high-HHI portfolios, we find that the CAR for the low-HHI portfolio is small and insignificant, while the CARs for the medium- and high-HHI portfolios are large (−0.44% and −0.67%) and significant.

So overall Giroud and Mueller find that, consistent with the notion that competition mitigates managerial slack, while firms in non-competitive industries experience a significant drop in operating performance after the laws' passage, firms in competitive industries experience no significant effect. When they examine which agency problem competition mitigates, the evidence is in support of a "quiet-life" hypothesis. Input costs, wages, and overhead costs all increase after the laws' passage, and only so in non-competitive industries. Similarly, when they conduct event studies around the dates of the first newspaper reports about the BC laws, their results find that while firms in non-competitive industries experience a significant stock price decline, firms in competitive industries experience a small and insignificant stock price impact.

Incentives matter: parking ticket file

From Tim Harford's review of "Economic Gangsters: Corruption, Violence, and the Poverty of Nations", by Raymond Fisman and Edward Miguel at reasononline

The United Nations in Manhattan kindly provided guinea pigs for just such an experiment. Diplomatic immunity meant that parking tickets issued to diplomats could not be enforced. The decision to park legally or not, therefore, was a matter of each person’s conscience.

Fisman and Miguel found that countries with endemic corruption at home, as measured by the anti-corruption organization Transparency International, were represented by habitual illegal parkers. Chad and Bangladesh, so often near the top of “perceptions of corruption” rankings, produced more than 2,500 violations between them from 1997 to 2005. Squeaky clean Scandinavians, on the other hand, committed only 12 unpaid parking violations, and most of those involved a single criminal mastermind from Finland. On the face of it, this evidence supports the view that poor countries are corrupt because they’re full of corrupt people.

Yet incentives clearly matter, too. In 2002, after decades of playing cat and mouse with the United Nations, New York City won much greater power to punish deadbeat diplomats. [...] The city began to tow cars and the State Department deducted fines from the relevant foreign aid budgets. Almost overnight, unpaid violations fell dramatically.