Public-private partnerships

A recent editorial in the Wall Street Journal discussed Government Motors: GM's new owner (the Obama administration) should stop bullying the company's bondholders. The editorial says,

It is now clear that there is no real difference between the government and the entity that identifies itself as GM. For all intents and purposes, the government, which is set to assume a 50 percent equity stake in the company, is GM, and it has been calling the shots in negotiations with creditors. While the Obama administration has been playing hardball with bondholders, it has been more than happy to play nice with the United Auto Workers. How else to explain why a retiree health-care fund controlled by the UAW is slated to get a 39 percent equity stake in GM for its remaining $10 billion in claims while bondholders are being pressured to take a 10 percent stake for their $27 billion?

So $10 billion buys the union 39% of GM but bondholders get 10% for $27 billion? That has to be one of the stranger pricing schemes I have seen in a long while. The editorial goes on,

It's highly unlikely that the auto industry professionals at GM would have cut such a deal had the government not been standing over them -- or providing the steady stream of taxpayer dollars needed to keep the factory doors open.

That has to be something of an understatement.

The editorial ends by saying,

The administration argues that it could not risk alienating the union for fear of triggering a walkout that could permanently cripple GM. It also posits that it had to agree to protect suppliers and fund warranties in order to preserve jobs and reassure prospective buyers that their cars would be serviced. These are legitimate concerns. But it's too bad that the Obama administration has not thought more deeply about how its bullying of bondholders could convince future investors that the last thing they want to do is put money into any company that the government has -- or could -- become involved in.

And here is the big problem for government ownership, the incentives it provides for investors. Why would anyone put money into an business were there is a chance of being treated the way bondholders of GM have been? Public-private projects are not going to get off the ground if the private investors think they will be treated in his manner. And how will investors react if the government looks like it may intervene in a firm they have money in?

In the New York Times David Brooks summed up the relationship between the public and private sectors in this way,

Recently we were uplifted when the president informed Chrysler’s secured creditors that they had agreed to donate their ownership stake in the company to the United Auto Workers. Just last week, we were enthralled to see a group of auto executives beaming with pride as the president announced that in order to reduce gas consumption, they would henceforth be scaling back on all those car lines that consumers actually want to buy.

These events have heralded a new era of partnership between the White House and private companies, one that calls to mind the wonderful partnership Germany formed with France and the Low Countries at the start of World War II. The press conferences and events marking this new spirit of cooperation have been the emotional highlights of the administration so far.

These events usually begin when the executives gather in the Oval Office, where they experience certain Enhanced Negotiating Techniques. I’m not exactly sure what the president does to inspire the business leaders’ cooperation and sense of public service, though those who remember the disembowelment scene in “Braveheart” will have a general idea

Then the president leads the executives out onto the White House lawn for the announcement ceremony. Often, the president will still be carrying the riding crop and the pliers used in the private negotiation. He moves to the microphone while the executives take their pre-assigned places behind him, the jingle of their leg shackles blending with the dulcet tones of spring. I thought one hospital executive was so moved by the occasion that he had slipped into catatonic shock, except that he was blinking “Save Me! Save Me!” in Morse code to his shareholders.

“We meet at an exciting moment for our country, a time of unprecedented cooperation between government and private industry,” the president intones, lifting his foot from the trachea of an unconscious pharmaceutical executive. “Many of the business leaders behind me have seized an exciting opportunity to join the nonprofit sector without even switching jobs.”

At this, the C.E.O.’s behind him don frozen smiles, exuding the sort of spontaneous enthusiasm often seen at North Korean pep rallies.

All of this should be a warning to any private companies that may be thinking of entering into a public-private "partnership" with the government here in New Zealand. The very thought, Gerry Brownlie, a riding crop and pliers .... arrrrrrrrrrr!

Clive W. J. Granger, 1934-2009

James Hamilton at Econbrowser has a short posting on the late Sir Clive Granger, winner of the Nobel Memorial Prize in Economic Sciences in 2003 for his development of the concept of cointegration.

Clive visited the economics department here at Canterbury 8 times. You could not meet a nicer or more helpful person. He had a great interest in rugby, being a big supporter of the Welsh team, a subject we discussed on a number of occasions, which was useful since I didn't understand a thing about the econometrics that he did!

Clive was Emeritus Professor at he University of California San Diego where he taught for 30 years and the first Canterbury Distinguished Professor.

The picture is of Clive in the department of economics at Canterbury on the day he won the Nobel.

Interesting blog bits

1. Brad Taylor notes that Long Division: The Next Big Threat to Democracy. A video, which features Gordon Tullock, does a pretty good job of explaining the irrationality of voting.
2. James Otteson considers Wise Words: Mill's On Liberty. This year marks the 150th anniversary of John Stuart Mill's powerful essay On Liberty. Some works do not hold up well after so long a duration; this one does.
3. Mario Rizzo asks What Ended The Great Recession? If there is recovery soon, the public will no doubt attribute it to Team Obama. But then when the inflation occurs they may well do the same. It is also likely that such inflation will be accompanied by high unemployment because the recovery will have barely begun. Welcome back to the 1970s.
4. Greg Mankiw on Keeping Things in Perspective.
5. MacDoctor on Never Enough. It is a truism that Health is a giant black hole that swallows government funding and always wants more.
6. Will Wilkinson on Bruce Bartlett on Liberaltarianism. One can believe that the state may legitimately act only to protect liberty. But that does not imply that the state must do anything in its power that might protect or enhance liberty.

Thinking about trade

If only more people would. One person who does think about trade is Don Boudreaux and he sent the following letter to the American Prospect:

You boast that your magazine is "the essential source for progressive ideas." And yet your contributors, including recently Dean Baker in the blog that you host, are forever lamenting the U.S. trade deficit ("China Knows It Will Take a Beating on Its Treasury Investments," May 21). Alas, these laments reveal no progress beyond the poor economic thinking and mercantilist policy proposals of the late middle ages.

For example, in 1381 Richard Leicester, worried about England importing more than it exports (and paying for these extra imports with money), could have been featured in your pages when he wrote that "Wherefore the remedy seems to me to be that each merchant bringing merchandise into England take out of the commodities of the land as much as his merchandise aforesaid shall amount to; and that none carry gold or silver beyond the sea, as it is ordained by statute."

True progress in understanding the nature of trade and the absurdity of fretting about the "balance of trade" - in understanding that wealth is access to goods and services and not gold, silver, or currency per se - did not begin until the late 17th century, especially with Nicholas Barbon. Adam Smith capped this progress when in 1776 he noted that "Nothing, however, can be more absurd than this whole doctrine of the balance of trade."

Why is it that more than 600 years after Richard Leicester little appears to have changed? Basic mercantilist policy proposals seem just as common today as they were in the middle ages. How aften do we hear that we must do something about out current account deficit? How often do we hear that when a country runs a current account deficit it must borrow or run down its foreign assets, or do both, and something must be done because of this? How often do we hear that import restrictions will save jobs? How often do we hear that we must do something about our international competitiveness? And so on ......

Is trade really so difficult to think about and understand?

Tax deductions and tax reform

From VoxEU.org comes this audio of James Poterba of MIT and President of the National Bureau of Economic Research talking to Romesh Vaitilingam about his research on the economic consequences of ‘tax expenditures’ (the US term for tax deductions), and the short- and long-term prospects for tax reform in the United States.

Incentives matter: speeding tickets file

Michael D. Makowsky and Thomas Stratmann have a paper on Political Economy at Any Speed: What Determines Traffic Citations? Their abstract reads

Speeding tickets are determined not only by the speed of the offender, but also by incentives faced by police officers and their vote-maximizing principals. We hypothesize that police officers issue fines more frequently when drivers have a higher opportunity cost of contesting a ticket, and when drivers are not residents of the local municipality. We also predict that local officers are more likely to issue a ticket to out-of-town drivers when fiscal conditions are tight and legal limits prevent increases in property taxes. Using data from traffic stops in Massachusetts, we find support for our hypotheses.

Who would have guessed?

Budget 2009 (updated)

Personally I find budgets boring, so I tend not to follow them. For me budgets have everything to do with politics and nothing to do with economics.

But others do follow them:

• Brad Taylor comments here. His considered reaction: meh.
• Matt Nolan comments here. The one time that we need a shift in government policy - and nothing happens.
• BK Drinkwater comments here. The Government's not gonna be in surplus in the next three, or even five, years; but the drastic cuts and unpleasantness necessary to achieve that will be avoided.
• Homepaddock comments here. The budget is a balanced response to the recession.
• Not PC comments here. Disgraceful.
• Frogblog comments here. Warm healthy homes confirmed.
• Bowalley Road comments here. FEAR. That’s what Bill English’s first Budget is all about.
• The New Zealand Business Roundtable comments here. The government must not repeat the performance of the previous government of talking the talk about lifting New Zealand up the international income rankings and not walking the walk.
• MacDoctor comments here. I would have been considerably nastier than Bill.
• Kiwiblog and The Standard say the things you would expect them to say.

And I'm sure there will be lots more pointless, meaningless bs spouted about the budget over the next few days. Enjoy!

Update: BK Drinkwater has a Budget Roundup.

Quote of the day

At the heart of economics is a scientific mystery: How is it that the pricing system accomplishes the world's work without anyone being in charge? Like language, on one invented it. None of us could have invented it, and its operation depends in no way on anyone's comprehension or understanding of it. Somehow, it is a product of culture; yet in important ways, the pricing system is what makes culture possible. Smash it in the command economy and it rises as a Phoenix with a thousand heads, as the command system becomes shot through with bribery, favors, barter and underground exchange. Indeed, these latter elements may prevent the command system from collapsing. No law and no police force can stop it, for the police may become as large a part of the problem as of the solution. The pricing system--How is order produced from freedom of choice?--is a scientific mystery as deep, fundamental, and inspiring as that of the expanding universe or the forces that bind matter. For to understand it is to understand something about how the human species got from hunting-gathering through the agricultural and industrial revolutions to a state of affluence that allows us to ask questions about the expanding universe, the weak and strong forces that bind particles and the nature of the pricing system, itself.

Vernon L. Smith, "Microeconomic Systems as an Experimental Science," American Economic Review, Dec. 1982

Defintion of economics

Matt Nolan over at TVHE has posted a number of times on the definition of economics, see for example here and here. Well the following is the quote that Tyler Cowen and Alex Tabarrok will use as the epigraph in their new textbook:

Economics is the study of how to get the most out of life

Looks like a good a definition as you are likely to get.

Innovation and employment

Don Boudreaux wonders

As I checked out of my hotel room -- rolling my suitcase behind me -- I wondered how many bellmen jobs were destroyed by the innovation that put wheels on luggage.

Should we ban wheels on luggage to save the jobs of bellmen? This is a small example of the issue of the affects of innovation on employment. Even a small thing like wheels on luggage will have some effect on employment and so in these times of recession, should be ban innovation to protect jobs?

On the other hand we could ask, What are the benefits that accrued to society when a greater number of people can use a service simply because technology lowers the price? And also ask, What other jobs are opened up because of innovation? But these jobs are unseen and the loss of bellmen is seen and thus there are calls to protect these jobs.

Hope for Zimbabwe?

A new report on the state of the economy and society in Zimbabwe along with a program for reform has been released by 9 think-tanks from throughout Africa. The report, The Zimbabwe Papers: A Positive Agenda for Zimbabwean Renewal , is written by members of think-tanks from Zimbabwe, Ghana, Nigeria, Guinea, South Africa, Burkina Faso and Zambia.

The report is clear about what the main driver of Zimbabwe's problems is

The suffering of the Zimbabwean people is not the consequence of historical or external factors. It is entirely due to policies adopted, decisions made, and actions taken by the government of Zimbabwe. Many people have been the victims of violence perpetrated by the government, the institution that was supposed to protect them and provide them with an institutional environment in which they could lead happy and productive lives.

The reports notes that

Zimbabwe's hyperinflation has crippled the country, led to political unrest, a massive "brain drain" to other countries, and produced an 80 percent decline in living standards over the last 10 years.

Is there anywhere else in the world where living standards have drop by so much in such a short time? The report explains that while nearly every country in the world has over the pasted decade experienced at least some economic growth, people in Zimbabwe have seen their per capita incomes decline by more than two-thirds. By the standard of conventional economic indicators Zimbabwe has had the worst economic performance of all countries for which comparable data exists. This drop in income has resulted in tremendous suffering.

For example, since 1998, the average life expectancy for Zimbabweans declined from 55 years to 35 years. More than 80 percent of the adult population is unemployed. Nearly half of all Zimbabweans are at risk of malnutrition and starvation. Compared to sub-Saharan African averages, Zimbabwe's children face higher rates of mortality, suffer more malnourishment, and experience the worst from stunted growth. The children who make it to adulthood are more likely to suffer from disease and face constant threats of politically motivated, State-sponsored violence.

And, to be fair, sub-Saharan African averages are not the highest standards in the world to met.

The report goes on to say,

While many claim that Zimbabwe's faltering economy is the result of sanctions imposed on Zimbabwe by Western governments, there is little evidence for this claim. In fact, the claim is patently false: Zimbabwe's economic decline and corrupt rule preceded sanctions by several years, which suggests that sanctions could not have possibly caused the crisis. Rather than point fingers at the West, we think Zimbabwe's leadership needs to look in the mirror and accept that most of their problems are the result of misguided internal policies. Reversing bad policies and the perverse incentives created by these policies therefore requires looking inward and finding ways to reform the domestic economy.

Clearly much reform is much needed, Zimbabwe needs to rediscover the rule of law, constrain government, and grant their citizens important economic and political rights. The report sets out a blueprint for reform based on the idea,

[...] that for Zimbabwean renewal to occur, reformers must be committed to reduce government intervention, so that individuals have greater economic, personal, and political freedom.

The report goes on to discuss

[...] the key economic reforms needed in monetary policy, fiscal policy, and trade. Zimbabwe's inflation has arguably been the single biggest contributory factor in Zimbabwe's collapse; we argue that Zimbabwe's government needs to cut spending and quit printing money. Zimbabwe's taxes are high and opaque; we recommend a flat tax and argue for reducing the total number of different taxes. Zimbabwe's trade barriers are also high, and customs processes hamper trade flows.

As the country moves towards Free Trade Areas (FTAs), we recommend lowering trade barriers and improving incentives for customs officials.

The important the role that property rights can play in Zimbabwe's recovery are discussed. The report argues for widespread privatisation of de facto rights as a way to empower the poor. It is also argued that lower taxation on mineral rights and the elimination of the Indigenisation and Empowerment Act could encourage greater foreign direct investment in mining. And I'm guessing that there isn't much in the way of foreign direct investment going on right now.

The report also considers water markets and the health care sector. Zimbabwe's water shortages could be eliminated if ownership rights to water were assigned and prices deregulated. Zimbabwe's health care system could be improved by reducing import taxes on pharmaceuticals and cutting regulation. It is also explained how deregulation of labour markets, business, and communications are needed for the recovery of Zimbabwean economy.

Costly labour laws cause unemployment and raise employer costs; we argue that many of the laws are unnecessary and should be eliminated. In terms of regulatory delays and licensing processes, Zimbabwe is one of the worst places to start a business; we recommend a streamlining of business regulations and the establishment of a one-stop business start-up office. Zimbabwe's communications systems are out of date and highly centralized; they should be privatised and foreign entrants should be granted access to Zimbabwe's markets in order to generate efficiency-inducing competition.

The last sections of the report look at political and legal reforms. Obviously the power of the state must be limited by the upholding of the rule of law. Violence must be reduced via more state transparency and by allowing more personal self-protection. Free speech must be guaranteed to all as a powerful check on the excesses of the government.

Its a bold program but then the problems are huge.

The report should be required reading for those at The Standard who believe that Zimbabwe's problems are due to Mugabe’s government following the IMF and World Bank’s neo liberal plan for their economy to the letter!

Boudreaux on tax cuts

From a letter Don Boudreaux sent to the New York Times on the reasons for tax cuts:

By far, the chief economic reason for cutting taxes is to increase the return to productive activity - to increase the return to investment, to risk-taking, to creativity, to work. The economic justification for lower taxes rests squarely on the understanding that cutting marginal tax rates makes profitable many productive efforts, including hiring more workers, that are unprofitable at higher tax rates.

Is this so hard to understand? Will the minister of finance ever understand this? In the upcoming budget Matt Nolan is betting on

Future tax cuts to be postponed into the indefinite future

If Matt is right then may be the minster needs to have a chat with Don Boudreaux.

International competitiveness

From Scoop comes this news release from The New Zealand Council for Infrastructure Development,

The New Zealand Council for Infrastructure Development has welcomed the appointment of the eight member National Infrastructure Advisory Board

“Developing our national infrastructure is key to improving New Zealand’s international competitiveness”, says NZCID Chief Executive, Stephen Selwood.

I have already commented on the usefulness, or otherwise, of the Infrastructure Advisory Board.

My concern here is different, it has to do with this idea that "infrastructure is key to improving New Zealand’s international competitiveness". This statement is meaningless at best, dangerous at worst. Infrastructure isn't key to improving New Zealand’s international competitiveness since countries don't compete. Even Paul Krugman has got this idea, he summed up the problem with such thinking in the title of one of his essays - written when he was still an economist - Competitiveness: A Dangerous Obsession. An obsession Mr Selwood would seems to share.

We don't compete with other countries, this is a false analogy that comes from thinking that countries are like firms, they're not. As Paul Krugman, in a different essay, put it A Country Is Not a Company. The point is that Coke and Pepsi, for example, do compete, one gains at the others expense, but New Zealand and Australia don't, their loss is not our gain. International trade is not a zero-sum game. To see this, note that while Coke may wish to put Pepsi out of business, so that Coke can increase their sales and prices and therefore profits, New Zealand would not gain if we put Australia "out of business".

Why? Well in the Coke/Pepsi case, Coke gain a lot, in terms of sales and profits, from not having Pepsi to complete with and lose little since Pepsi doesn't buy much , if anything, from Coke. Or Coke from Pepsi. This is not true of the New Zealand/Australia example. We may gain some sells if Australia stopped producing, but we would lose much more. Australia is our biggest export market and if they "went out of business", they would stop importing, and that would hurt us a lot. Also they are suppliers of much of our useful imports and that would stop too, which would hurt us even more.

Countries trade, they don't compete.

So if people wish to justify having a National Infrastructure Advisory Board let that justification not be based on a false analogue.

The Commerce Commission on electricity markets: part 2

I posted earlier on The Commerce Commission on electricity markets arguing that I had problems with the use of a perfectly competitive benchmark to arrive at the well publicised "$4.3b ripoff" figure.

Well it now looks like I'm not the only one with problems to do with the use of a competitive benchmark and with the way the results of the study have been interpreted and reported-note the quote from Colin Espiner I included as Update 2 in my previous posting.

There is a critique from Energy Link Ltd. Unfortunately this report is available only as a pdf file. Their report states,

But measuring the degree of “unhealthy” market power solely against the textbook perfectly competitive market is not appropriate given the over-riding need to preserve security of supply and the realities of electricity supply which diverge from the perfect market assumptions. The market‟s problems must be assessed through analysis based on realistic assumptions, and addressed in the context of an imperfect market which can and should be able to function in a way in which the imperfections can be managed, mitigated or otherwise controlled.

Also at interest.co.nz they quote a statement from the Energy Centre in the University of Auckland Economics Department and the Electric Power Optimization Centre in the Department of Engineering Science.

In part the statement reads

However, we disagree with Professor Wolak’s assumptions in calculating market rents in dry years. In his report, Professor Wolak has chosen competitive benchmarks in which either hydro‐electricity dispatches are fixed, or the opportunity cost of water is set equal to the marginal cost of the highest cost thermal generator.

Drawing on an analysis of the California electricity market in the American Economic Review, he claims that these models of hydro‐electricity costs overestimate the true opportunity costs. However, in the New Zealand setting, we believe this is incorrect, because it ignores New Zealand’s likelihood and resulting costs of running out of water. Whereas California always has the option to import electricity from other states, New Zealand faces rolling blackouts and considerable economic losses if hydro lakes run out of storage. In the face of shortages, the (risk‐neutral) opportunity cost of using water today must account for the probability of a blackout in the future and the economic cost of that blackout (often named the Value of Lost Load).

The California paper Wolak cites does not make any estimate of shortage costs, yet these shortage costs are likely to be higher than the marginal cost of thermal generation. As water levels fall, the probability of incurring these costs will rise to a point where the expected opportunity cost of water will exceed the most expensive thermal plant. If this is correct, then the Wolak report overstates the amount of market rents during dry years.

We also take issue with the interpretation of the Wolak report’s estimate of NZ$4.3 billion in market rents. The media has claimed that this represents a transfer of wealth of NZ$4.3 billion from consumers to generators. This is a misinterpretation of the results of the analysis.

Wolak himself, on p173 note 313, cautions that these figures relate only to the wholesale market. Market rents are a measure of the difference between spot prices and generator costs. Most consumers do not pay these spot prices. During dry years, the actual retail price consumers pay is well under the spot price. In theory, the retailer will turn around and pay the generator the spot price, but since they are vertically integrated, this amounts to an internal transfer of funds between different arms of the same company, with zero net effect. Generators will typically have other fixed price contracts in addition to retail load, so in practice they will only receive market rents as actual earnings for some fraction of their generation.

Thus the true transfer of wealth from generators to consumers during periods of high wholesale prices is likely to be much lower than Wolak’s estimate of market rents, even ignoring the way he estimates hydro costs. It may be the case, as Professor Wolak speculates, that high spot prices during dry years will be passed onto consumers in the form of higher retail prices in the future, but this has not been established conclusively by his report.

Likewise caution is warranted when claiming that recent retail price rises (residential as well as commercial/industrial) are attributable to these market rents. As underlying input prices have risen significantly over the last decade (e.g. gas from NZ$ 3.14/GJ in 2000 to NZ$ 6.3/GJ in 2007), even in a perfectly competitive market, wholesale and retail electricity prices would have risen significantly.

Thus I think it is far to be sceptical as to whether or not anyone has been ripped-off and if someone has, the size of that rip-off.

One good thing to say about the Commission's actions is that they are taking no action. Their media release says,

This behaviour does not meet the criteria of ‘taking advantage’ of market power for a proscribed purpose, namely the hindering or deterring of competitors, under section 36 of the Act, and is therefore not a breach.

So they at least seem to have done the right thing, nothing. Albeit for the wrong reasons.

EconTalk this week

Peter Leeson of George Mason University and author of The Invisible Hook talks with EconTalk host Russ Roberts about the economics of 18th century pirates and what we can learn from their behavior. Leeson argues that pirates pioneered a number of important voluntary institutions such as constitutions as a way to increase the profitability of their enterprises. He shows how pirates used democracy and a separation of powers between the captain and the quartermaster to limit the potential for predation or abuse on the part of the captain. He explains the role of the Jolly Roger in limiting damages from conflict with victims. The conversation closes with a discussion of the lessons for modern management.

National Infrastructure Advisory Board

Via Homepaddock I see that the government has announced appointments to the new National Infrastructure Advisory Board. The chair will be Dr Rodd Carr, Canterbury University Vice Chancellor. The other members are Sir Ron Carter, Lindsay Crossen, Dr Arthur Grimes, Dr Terence Heiler, Rob McLeod, John Rae and Alex Sundakov.

My main question is, Why do we need a National Infrastructure Advisory Board? What will this board be doing? Thinking big? Hasn't history taught us anything about what happens when governments decide to "invest" in infrastructure? The "Think Big" projects were a disaster. The last thing we need in more of this type of "investment".

I have argued here that infrastructure is a loose (meaningless?) term covering a collection of very different industries and assets and, importantly, that the government does not have a major role to play in many of them. Normally we think of things like roads, railways, water, sewerage and stormwater systems, gas, telecommunications, ports and airports as infrastructure industries. Notice two things here, each of these industries has different characteristics and most are run as commercial operations in the private sector. That is, the private sector can and does invest in these areas. Thus is it not possible to talk sensibly about any general infrastructure problem in New Zealand. There is very little concern about gas distribution and transmission, for example. The industry is 100 percent commercial and not subject to problematic capacity constraints.

On the other hand, some of the problems that government "investment" can create are discussed in Matt Burgess's guest post as to why National's plan to spend $1.5 billion building fibre to the homes of 75% New Zealanders is not a good idea. I agree with Matt on this issue.

When it comes to investment a important point to note is that under private ownership (in competitive and well-regulated markets) we can be confident that investments in infrastructure industries will be expected to meet their cost of capital since investors will demand normal returns, adjusted for risk. While some investments will not work out, investors will not continue to throw good money after bad. In contrast, with government ownership political imperatives dominate over time and returns on capital and hence economic growth will be sacrificed. Government ownership of rail is expected to result in losses, which will reduce GDP. Distortions will be created with sea, air and land transport. Political imperatives also impede industry rationalisation, as is obvious in the port industry.

So, no matter who is on the board I don't see good things coming from it. Governments have a very bad record at picking winners.

The Commerce Commission on electricity markets (updated x3)

Looking at the media release from the Commerce Commission on its electricity markets investigation, this statement stood out for me,

By comparing the actual wholesale prices with hypothetical competitive benchmark prices, Professor Wolak estimated that the wholesale prices charged over the period 2001 to mid-2007 resulted in an extra $4.3 billion in earnings to all generators over those that they would have earned under competitive conditions. This suggests that wholesale prices were, on average, 18 per cent higher than they would have been if the wholesale market had been more competitive, and the gentailers had not been able to exert market power. Less competition was especially evident in the wholesale market during the dry years of 2001 and 2003, when additional earnings attributable to the exercise of market power are estimated at $1.5 billion in each of those years.

If this means what it says and the benchmark for the investigation was a perfectly competitive market then I'm not sure what the investigation is worth.

The problem is that I'm not sure that a competitive benchmark is the right benchmark. A market like electricity will never be perfectly competitive, the cost structure is such that this will not happen. In particular the size of fixed costs would result in non-perfectly competitive conditions. I would think that having just four firms - Contact, Genesis, Meridian and Mighty River Power - control 85 per cent of total capacity is a result of the cost structure of the industry. So how likely is it that the industry will ever be competitive? Next to zero probability would be my guess. So what the Commerce Commission is doing is comparing reality with the impossible. And funnily enough reality doesn't match up.

As noted above, in the press release we are told,

Professor Wolak estimated that the wholesale prices charged over the period 2001 to mid-2007 resulted in an extra $4.3 billion in earnings to all generators over those that they would have earned under competitive conditions. This suggests that wholesale prices were, on average, 18 per cent higher than they would have been if the wholesale market had been more competitive, and the gentailers had not been able to exert market power.

So there were $4.3 billion in earnings to all generators over those that they would have earned under competitive conditions, but competitive conditions are impossible, so what does this tells us. Reality isn't as good as an impossible to implement theoretical standard? That isn't at all surprising. To say that pole-vaulting records are pretty awful compared to those we could archive in a gravity free world isn't saying much.

Surely a better standard of comparison would have to be ask what alternative feasible, implementable industry structures are there and is the best of these likely to give better results? If so, then compare the New Zealand situation to this real world alternative and then see how large any excess earnings are.

Then at least if our current market structure falls short we have an idea of what changes to make. If we accept the Commerce Commission's results, what are we to do? Their report seems to gives no guidance as to what changes to make as we can never have a perfectly competitive industry.

To be fair to the Commerce Commission I have not read all 6 parts that make up their 500 page report, and they may cover these issues somewhere in the middle of all those pages. But its not clear to me from their public statements that they have.

Update: MacDoctor comments on the CC's report here, Kiwi Polemicist comments here and BK Drinkwater comments here and here.

Update 2: On reading comments by Colin Espiner, via BK Drinkwater, I came across this bit,

The Comcom says that according to the work of eminent scientist Professor Frank Wolak, the amount of overcharging by power companies amounted to around $4.3 billion over the past six years - that's $1000 for every man, woman, and child in the country.

I'd like my $1000 back, please

But that's the problem Colin mate, you can't get it back because it was never there. If the Commerce Commission have done what it looks like they have done, then the $1000 is mythical, it appears only if you compare reality with the impossible. But you are a journalist, so such a comparison probably seems reasonable.

Update 3: goonix writes In defence of the New Zealand wholesale electricity market

Markets work

Greg Mankiw is thinking of buying another car. He writes

[...] I got a copy of the Consumer Reports auto issue (April 2009).

Page 15 was particularly enlightening. There, in their "Automakers report cards," Consumers Union summarized their findings for each of fifteen major car companies.

Dead last was Chrysler. CU recommended zero percent of the Chrysler vehicles they tested. That's right--zero. Second to last was General Motors. CU recommended 17 percent of GM models. By contrast, most other companies had half or more of their models get the thumbs up. Honda was the top ranked brand; CU recommended 95 percent of its models.

Is there a message in this? Following the Consumers Union report why is anyone surprised that Chrysler and GM are going out of business? Bankruptcy for these two tells us that the market is working. These car manufacturers aren't producing product worth buying and the market punishes this with bankruptcy. Now if only the government would stay out of things.

Aid Watch: reader survey (updated)

At his blog Aid Watch Bill Easterly has a very short Reader survey running. He asks

Please tell me which you think is more probable:

(A) a country succeeds at economic development, or
(B) a country succeeds at economic development with a wise and capable leadership.

I went with A on the grounds that in many cases economic development takes place despite rather than because of "wise and capable leadership". Such leadership may be useful but seems to be neither necessary nor sufficient for development.

Anyway, go vote!

Update: Given the bet discussed in the comments section the following comes from Bill Easterly's blog:

On one level, A is the right answer, because B is a subset of A. A contains all successes, both (1) those achieved with wise leadership, and (2) those achieved with any other means. B only contains (1), and so is less likely than A. Well known psychology experiments find the same thing -- that many people have what is called the “conjunction fallacy” (again from my continuing Mlodinow and Kahneman obsession) that would cause them to choose (B). A set of outcomes that fits a plausible story is thought to be larger than one unrestricted by ANY story, even though ANY restriction on the set of possible outcomes always makes that set less likely than an unrestricted set. An explanation usually trumps no explanation, even if it gets the probabilities wrong!

But he then writes

But on another level, the reaction of many readers made me aware of how I had phrased the alternatives too sloppily, which taught me something about how the language we commonly use is often fuzzy on exactly what probabilities we are talking about. I think many of those who voted B were interpreting the question differently: when is development success more likely? With good leadership (B)? Or when the quality of the leadership is unspecified, and so could be either good or bad (A)? Obviously (B). Neither our brain wiring nor our education is good enough to give us linguistic precision about probability and randomness. So my sloppy language created a coalition in favor of (B) between an incorrect answer and a correct answer!

Unintended consequences, again

Another example of the law of unintended consequences comes from the proposed national fuel efficiency standards for cars and trucks and a new tailpipe standard for C02 emissions that President Obama has announced. You could end up with more pollution and increased road deaths.

Robert Grady writes in the Wall Street Journal on Light Cars Are Dangerous Cars And other unintended consequences of strict fuel-economy standards. He says

An economic phenomenon called "price elasticity of demand" is well established when it comes to automobile purchases. In other words, if you raise the price of new cars, people will buy fewer of them or, at a minimum, put off the purchase for a year or so while they drive the old clunker for a few thousand more miles. And fewer new cars means more pollution, which can cause significant health problems. Yet environmentalists and the press have ignored this issue, so as not to inject a note of complexity or doubt into the chorus of glee that greeted the president's attack on greenhouse-gas emissions.

and

The Obama fuel efficiency plan may also contribute to a significant increase in highway deaths as vehicles are required to quickly meet the new CAFE standard and will likely become lighter in weight as a result. According to a study completed in 2001 by the National Research Council (NRC), the last major increase in CAFE standards, mandated by the Energy Policy and Conservation Act of 1975, required about a 50% increase in fuel economy (to 27.5 mpg by model year 1985 from an average of 18 mpg in 1978). The NRC study concluded that the subsequent downsizing and down-weighting of vehicles, "while resulting in significant fuel savings, also resulted in a safety penalty." Specifically, the NRC estimated that in 1993 there were between 1,300 and 2,600 motor vehicle crash deaths that would not have occurred if cars were as heavy as they were in 1976.

The president now proposes a fuel economy increase of similar magnitude in an even quicker time frame -- to 39 mpg by model year 2016 from 27.5 mpg now. Given the time it takes for new technologies to be developed, tested and incorporated into new car models, it is likely that down-weighting of cars will be an important means of meeting the new standard. And one result again could be highway deaths that might otherwise not have occurred.

Good news from IRD

From stuff.co.nz I find out,

Inland Revenue has confirmed it is seeking to cut as many as 250 jobs through voluntary redundancies.

Inland Revenue Commissioner Robert Russell said economic pressures were "real and growing" and the department was having to tighten its belt in the current downturn like many other businesses and organisations.

A few less bureaucrats to put their hands in our pockets. But only a few less, the loss of 250 jobs represents a 4 per cent cut in staff numbers. Which means there are still around 6000 too many people at the IRD.

US v. European unemployment (updated x2)

Bryan Caplan is in a betting mood,

I'm going to offer the following bet to the authors of the CEPR report:

The average European unemployment rate for 2009-2018 (i.e., the next decade) will be at least 1% higher than U.S. unemployment rate. The bet will be resolved when Eurostat releases its final numbers for 2018.

I'm happy to bet each of the three authors $100 at even odds. Will they accept?

P.S. By 1% I of course meant 1 percentage-point.

I'll bet that the reports authors will not take the bet.

But what about New Zealand's unemployment rate? Would anyone take a bet that New Zealand's unemployment rate will be lower than that in the US over the same period. Given our current labour markets I'm not sure I would. How about an iPredict market on this?

Update: As you can see from the comments section Eric Crampton and I now have a $100 bet on this. Come back in 2018 to see who wins!

Update 2: Bryan Caplan writes

The authors of the "U.S. Unemployment Rate Now as High as Europe" report have turned down my bet.

Interesting blog bits

1. Brad Taylor on Parental Sovereignty and the Reason of Rules. When can the state intervene between parent and child?
2. Eric on Gender gaps. Female physicians provide about 14% fewer hours of direct patient care as compared to their male colleagues.
3. Mario Rizzo asks What is the Philosophy of Freedom Called? The philosophy of freedom doesn't have much to do, in an essential way, with conservatism.
4. Greg Mankiw on Women are less happy. By many objective measures the lives of women in the United States have improved over the past 35 years, yet it seems that measures of subjective well-being indicate that women's happiness has declined both absolutely and relative to men.
5. James Stanfield wants to Privatise all business and law schools. For-profit institutions can deliver higher education.
6. Tom M on Conservatives and Individualism

A pig of a problem (updated x2)

Brad Taylor points out that pig farmers are using recent controversy in New Zealand over sow crates to argue for protection against international competition and I agree that these calls have little to do with animal welfare and a lot to do with rising prices.

I have two issues with the argument about banning imports.

First I don't see how this will help the welfare of the pigs at all. All it will do is help the profits of pig framers. Why? The argument seems to be that it is imports of pork that forced local farmers to use sow stalls to remain competitive. That is, the sow stalls are the least cost method of production and thus is used to maximise profits. Why would banning imports change this? If pig framers want to maximise profits after an import ban is imposed, as they seem to want to do now, then they would use the least cost method of production post-ban in exactly the same was as they do pre-ban. That is, they will use sow stalls. As a theory of the firm man I don't like arguments that seem to assume producers will change there objective function in the face of trade restrictions. The banning of imports will have no effect pig welfare.

Secondly would the ban really help the pork industry? The issue here is the elasticity of demand for pork and bacon type products. If this is high then a increased in price resulting from the banning of imports could lead to a large fall in quantity demanded. Is it likely that the elasticity is large? At a guess yes, there are many substitutes for pig meats: fish, chicken, lamb, beef etc. A ban may not help the industry as much as some pig framers seems to think.

A better approach, if farmers really do care about animal welfare, may be product differentiation. Much like free trade coffee, "high pig welfare pork". Farmers would need to set up a credible verification system that consumers can use to identify pork that comes from farms that use framing methods that don't mistreat their pigs. Then, as is the case for fair trade coffee, consumers will self identify as those who are willing to pay more for their pork products based on farming method.

Update: Matt Nolan posts on Cruelty to pigs, willingness to pay, and intrinsic animal rights.

Update 2: Eric Crampton has been thinking about Welfare and animal welfare: NZ pork edition.

Regulation of loan sharks (updated x2)

From the TV3 news website I learn that,

Regulation of loan sharks and the interest rates they charge are the focus of a new member's bill about to be put into Parliament's ballot by Labour MP Charles Chauvel.

The Credit Reforms (Responsible Lending) Bill proposes the Reserve Bank governor would set the maximum interest rate lenders could charge, while lenders would be required to assess the borrower's ability to repay the loan.

The most obvious question is how does the Reserve Bank governor know what the maximum interest rate should be? How could he ever decide what the rate should be given that, I assume, he isn't going to pick the market rate. What makes him better at setting prices than the market?

Also I assume that the Reserve Bank governor will be setting a rate that is less than the market rate, there seems little point in him setting it above, so how will he deal with the excess demand for loans that will arise. What mechanisms will be available for the non-price allocation of loans? And why are these non-price mechanisms more welfare enhancing than the price mechanism? In addition there will be people who want loans but can't get them, so what will they do?

Another question is why are the interest rates on loans so high? The market looks pretty competitive so these rates may well reflect the actual cost of providing loans. For a start what is the default rate on these loans? A high interest rate may just reflect, in part, a high default rate. Also as most loans are for a small amount over a short time period the cost of administrating the loan as a percentage of the value of the loan will be very high. Again the high interest rate may reflect actual costs of production.

The high administration costs of these loans may well explain why other lenders, such as banks, don't offer this service. So without "loan sharks" this service may not be available at all.

Chauvel also wants " lenders would be required to assess the borrower's ability to repay the loan". Don't all lenders do this already? After all it is in their own best interests to do so. They want the loan repaid, so making sure that the person can repay is simply good business sense.

You do at times see the argument that people "have to borrow" to live and thus high interest are are immoral and so a cap is justified. But this seems to be a case where, if this is true, then a cap on interest rates isn't the answer, a better plan would be financial or budget advice or a revamp of the welfare system so peoples income is such that borrowing is not "needed".

All in all I don't seen any economic sense in the proposed bill.

Update: I see I'm behind the times on this one. Kiwblog comments here and Matt Nolan comments here.

Update 2: BK Drinkwater has Questions About The Loan-Shark Bill In The Ballot and has now been Gathering My Thoughts On Loan-Sharkery: Information and Gathering My Thoughts On Loan-Sharkery: Interest Caps and Gathering My Thoughts On Loan-Sharkery: High Interest Rates and Gathering My Thoughts On Loan-Sharkery: Black Markets and Gathering My Thoughts On Loan-Sharkery: Other Ideas.

The invisible hand

From Organizations and Markets,

What one hundred trillion dollars looks like

At least in Zimbabwe



And its not worth the paper its printed on. Its worth more as a collectors item than it can buy.

(HT: The Adam Smith Institute)

Eminent domain

The taking of 239 homes for the proposed new Waterview motorway in Auckland raises, again, the question of the use of eminent domain.

The standard argument for eminent domain is that the government cannot let vital projects be held hostage to private owners who might withhold their property. The idea being that a motorway or airport or some such thing would get built but for the recalcitrant homeowner who refuses to sell their family home, either because they truly attach an enormously high sentimental value to the homestead or because they are strategically holding out for an absurdly high price. Empirically you can't tell the difference. And of course if one person manages to get such a high price, in the future everyone will holdout for a similar price, making public projects near impossible to build.

In his book Skepticism and Freedom: A Modern Case for Classical Liberalism, the above case for eminent domain is made by Richard A. Epstein. An interesting response to this argument is given by Donald J. Boudreaux in his review of the book in Regulation, 27(1), Spring 2004. Boudreaux writes

While it is easy to imagine such problems [such as the recalcitrant homeowner], I doubt that they are significant enough to entrust politicians with the power to take private property, even if politicians follow Epstein’s sound advice on when to pay for whatever properties are taken. America is planted thick with housing developments on large contiguous plots of land. Private developers manage to assemble those tracts without eminent domain. The Walt Disney Company purchased 30,000 contiguous acres of land in central Florida for its amusement park and resort. That is an area twice the size of Manhattan. With skillful contracting maneuvers — for example, buying each plot of land contingent upon the successful purchase of all other plots of land necessary to build the road or airport — a government intent on serving the public should be able to do its job without powers of eminent domain.

So with a bit of foresight and sensible contracting the use of eminent domain is not needed. If only our government had the same skills as private developers.

Insuring without insurance

When crisis strikes, how do you cope when there are no insurance markets for you to insurance against loss in? A new paper by Futoshi Yamauchi, Yisehac Yohannes and Agnes Quisumbing tries to answer the question by looking at disasters in Bangladesh, Ethiopia and Malawi. What they find is that individuals with better nutrition and human capital fare better. This is a form of self-insurance via investment in biological assets rather than financial assets. Having good nutrition and health allows you to make it physically through times of crisis. Education allows for the transfer of wealth through time and this is wealth you cannot lose to a disaster and it is very portable should you have to move.

The paper's abstract reads

This paper examines the impacts of disasters on dynamic human capital production using panel data from Bangladesh, Ethiopia, and Malawi. The empirical results show that the accumulation of biological human capital prior to disasters helps children maintain investments in the post-disaster period. Biological human capital formed in early childhood (long-term nutritional status) plays a role of insurance with resilience to disasters by protecting schooling investment and outcomes, although disasters have negative impacts on investment. In Bangladesh, children with more biological human capital are less affected by the adverse effects of floods, and the rate of investment increases with the initial human capital stock in the post-disaster recovery process. In Ethiopia and Malawi, where droughts are rather frequent, exposure to highly frequent droughts in some cases reduces schooling investment but the negative impacts are larger among children embodying less biological human capital. Asset holdings prior to the disasters, especially the household's stock of intellectual human capital, also helps maintain schooling investments at least to the same degree as the stock of human capital accumulated in children prior to the disasters.

(HT: Economic Logic)

Blundell on Thatcher

From Reason TV. Head of the Institute of Economic Affairs and Reason contributor John Blundell gives a remembrance of Margaret Thatcher's achievements as British prime minister.

EconTalk this week

Michele Boldrin of Washington University in St. Louis talks with EconTalk host Russ Roberts about intellectual property and Boldrin's book, co-written with David Levine, Against Intellectual Property. Boldrin argues that copyright and patent are used by the politically powerful to maintain monopoly profits. He argues that the incentive effects that have been used to justify copyright and patents are exaggerated--few examples from history suggest that the temporary and not-so-temporary monopoly power from copyright and patents were necessary to induce innovation. Boldrin reviews some of that evidence and talks about the nature of competition.

Ferguson on the financial crisis

Niall Ferguson writing in the New York Times has this to say about financial innovation, regulation and deregulation:

Human beings are as good at devising ex post facto explanations for big disasters as they are bad at anticipating those disasters. It is indeed impressive how rapidly the economists who failed to predict this crisis — or predicted the wrong crisis (a dollar crash) — have been able to produce such a satisfying story about its origins. Yes, it was all the fault of deregulation.

There are just three problems with this story. First, deregulation began quite a while ago (the Depository Institutions Deregulation and Monetary Control Act was passed in 1980). If deregulation is to blame for the recession that began in December 2007, presumably it should also get some of the credit for the intervening growth. Second, the much greater financial regulation of the 1970s failed to prevent the United States from suffering not only double-digit inflation in that decade but also a recession (between 1973 and 1975) every bit as severe and protracted as the one we’re in now. Third, the continental Europeans — who supposedly have much better-regulated financial sectors than the United States — have even worse problems in their banking sector than we do. The German government likes to wag its finger disapprovingly at the “Anglo Saxon” financial model, but last year average bank leverage was four times higher in Germany than in the United States. Schadenfreude will be in order when the German banking crisis strikes.

We need to remember that much financial innovation over the past 30 years was economically beneficial, and not just to the fat cats of Wall Street. New vehicles like hedge funds gave investors like pension funds and endowments vastly more to choose from than the time-honored choice among cash, bonds and stocks. Likewise, innovations like securitization lowered borrowing costs for most consumers. And the globalization of finance played a crucial role in raising growth rates in emerging markets, particularly in Asia, propelling hundreds of millions of people out of poverty.

Ferguson ends by noting

The biggest blunder of all had nothing to do with deregulation. For some reason, the Federal Reserve convinced itself that it could focus exclusively on the prices of consumer goods instead of taking asset prices into account when setting monetary policy. In July 2004, the federal funds rate was just 1.25 percent, at a time when urban property prices were rising at an annual rate of 17 percent. Negative real interest rates at this time were arguably the single most important cause of the property bubble.

All of these were sins of commission, not omission, by Washington, and some at least were not unrelated to the very considerable political contributions and lobbying expenditures of the financial sector. Taxpayers, therefore, should beware. It is more than a little convenient for America’s political class to blame deregulation for this financial crisis and the resulting excesses of the free market. Not only does that neatly pass the buck, but it also creates a justification for . . . more regulation. The old Latin question is highly apposite here: Quis custodiet ipsos custodes? — Who regulates the regulators? Until that question is answered, calls for more regulation are symptoms of the very disease they purport to cure.

How not to own a company

I have commented before on the problems that mixed ownership brings to a company. Mixed meaning the firm having both government and private owners. 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. You can't have your cake and eat it. Either the firm (SOE) has to set out to maximise profits or it has to try to carryout some political or social role, what it can't do is both. The two objectives just conflict.

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].

Well now the Americans have gone one better (or worse). The Obama administration’s plan to restructure Chrysler involves the company having three different sets of "owners": Fiat (35 percent), UAW (United Autoworkers) retirees (55 percent), and the U.S and Canadian governments (10 percent collectively). As William F. Shughart writes

Reconciling their separate and divergent objectives may well be impossible. Fiat will want profitability, the union will want to protect pensions and healthcare benefits, and governments will want to protect jobs and pursue who knows what other political ends—tellingly, the administration’s first priority is to preserve UAW jobs.

And how long will it be before the U.S. and Canadian governments differ as to what the firm should be doing?

The upshot of this is, don't bet on seeing a robust, well run and profitable company anytime soon.

Deficient thinking

A nice Don Boudreaux letter sent to the Wall Street Journal on a point that economics professors should know better about:

University of Massachusetts economics professor Ronald Olive asserts that "When a country runs a current account deficit it must incur liabilities, that is, borrow or run down its foreign assets, or do both" (Letters, 15 May).

This assertion is simply untrue. If Mr. Olive spends $500 on a bottle of Chateau Latour and the owner of that French chateau then holds those dollars as cash, or uses them to buy dollar-denominated equities or real estate, America's current-account deficit rises without any corresponding increase in Americans' indebtedness or any reduction in Americans' holdings of foreign assets.

Has to be the headline of the day

Sandy Ikeda titled his blog entry on the Obama Administration’s decision not to auction landing slots at NYC airports, Airports: Coase, but no cigar.

Ikeda writes

A year ago the Bush administration proposed auctioning landing slots at Kennedy, LaGuardia, and Newark airports in the New York region. Yesterday the Obama administration canceled these plans. From the NYT article:

“In proposing to rescind the auctions, the department noted that the rule making was highly controversial and that most of those filing comments opposed the slot auctions,” the Transportation Department said in a statement. “The Department also noted that circumstances have changed since the rules were issued, including changes in the economy.”

Interestingly among those who were opposed to the auction were the airlines themselves. It turns out that the Bush administration argued the slots are the property of the FAA while the airlines claimed the slots belong to them. This looks like just a fight over who gets the rents from the auction rather than a efficiency issue.

Should we put a carbon tax on China?

Paul Krugman wants to say yes:

As the United States and other advanced countries finally move to confront climate change, they will also be morally empowered to confront those nations that refuse to act. Sooner than most people think, countries that refuse to limit their greenhouse gas emissions will face sanctions, probably in the form of taxes on their exports. They will complain bitterly that this is protectionism, but so what? Globalization doesn’t do much good if the globe itself becomes unlivable.

Tyler Cowen says no:

1. The Chinese are often paranoid (arguably for good reason) and we will get further being nice to them than by being confrontational. Krugman himself admits that they don't seem themselves as culpable on this issue. Chinese citizens wanting clean air at home are possibly our biggest ally so let's not alienate them.

2. Last I checked China was funding a big chunk of our government's debt. Confronting them would have to be bundled with a regime of extreme fiscal conservatism and unilateral foreign policy.

3. It can be very hard to identify and isolate the energy inputs into an exported product, especially if the host government is uncooperative and a lot of money is at stake.

4. We cannot credibly penalize the Chinese until we solve our own pollution problem. Even under Obama's proposed policies, in their purer forms, that is at best decades away. In the meantime, what is it that is really being advocated? Non-credible threats?

5. Once the political process gets its hand on such tariffs they will be directed against, say, Chinese cars, including maybe relatively clean ones, rather than the dirtiest Chinese exports.

6. Last I checked there was something called the United Nations and China sat on its Security Council. The UN is the (supposed) forum for handling problems of this nature. Yes, we could construct an alternative "League of Democracies" as John McCain (!) had suggested, in part to deal with global warming and other multilateral problems where the non-democracies won't cooperate. I don't favor this change but if we are going to do it we need to realize how radical a foreign policy step it would be and how Russia would respond as well.

Point 3 raises the issue of on what basis do you tax on? You would want to tax the pollution causing inputs in the production processes but how do you do that? You only have the final product and not details of how it was made. Point 5 does raise the issue of self serving protectionist measures being put to place under the reasoning of doing something about climate change but which will harm world trade and do nothing to help climate change. They may however get politicians a few more votes.

Increasing productivity

Over at the TVHE blog Matt Nolan comes up with a new way of increasing productivity, shooting half the population!

My first question for Matt is, Why only half? If shooting half increases productivity wouldn't shooting three quarters increase it even more? Second, I'm worried about which half he plans on shooting. If he shoots the most productive half his plan may not work. Third, What if productivity is linked to the size of the population. If a bigger population gives us bigger markets and returns to scale, could this not result in more efficient use of resources and thus greater productivity? Fourth, as what is important to living standards is increasing productivity over time, does Matt plan on shooting half the population each year? And if so for how long? Paul Krugman makes an important point when he says,

Economic history offers no example of a country that experienced long-term productivity growth without a roughly equal rise in real wages. In the 1950s, when European productivity was typically less than half of U.S. productivity, so were European wages; today average compensation measured in dollars is about the same. As Japan climbed the productivity ladder over the past 30 years, its wages also rose, from 10% to 110% of the U.S. level. South Korea's wages have also risen dramatically over time. ("Does Third World growth hurt First World Prosperity?" Harvard Business Review 72 n4, July-August 1994: 113-21.)

Last, and most importantly, At what point will Matt have to shoot himself? :-)

My basic point is, of all the things a government could get excited about, increasing productivity is properly one of the least harmful things. More output is what we value and having a government do what it can, which isn't all that much, to help this isn't a bad thing. In the past government have worried about other things and our productivity growth has suffered because of it and with it has gone our standard of living.

Sweatshop debate: tomorrow (updated x2)

Together with Stephen Hickson, Eric Crampton of Offsetting Behaviour fame, will be debating a couple of lecturers from the philosophy department on the merits of sweatshops. Eric is of course defending the argument that sweatshops are far better than the real world relevant alternatives that sweatshop workers face.

If interested and in Christchurch, it's on at 1:00pm in Commerce Room 002, Friday 15 May.

The debate is hosted by EconSoc.

Update: Eric's comments are available here.

Update 2: Brad Taylor on Quote of the Day: Death by Warm Fuzzies Edition.

Interesting blog bits

1. Jerry O’Driscoll on Spending Is The Tax.
2. Brad Taylor on Claudia Williamson on Informal Institutions. Institutions matter but may not be easily transplanted.
3. Not PC on Effects of Auckland uber-city already being felt. Rational expectations?
4. Madsen Pirie on The exodus begins. Yes taxes do have incentive effects.
5. Adrian R. Bell, Chris Brooks and Tony Moore on The credit crunch of 1294: Causes, consequences and the aftermath. It is widely believed that the current credit squeeze, leading to bank failures, is a modern phenomenon arising from the interplay of a historically unique set of circumstances that could not have been foreseen. But a team of academics – a finance professor and two medieval historians – at the University of Reading’s ICMA Centre has documented a medieval credit crunch that bears remarkable parallels with the current crisis.
6. Greg Mankiw on Measuring Jobs Created or Saved. Mankiw asks "Going forward, what macroeconomic data would you have to observe before you concluded that the stimulus bill has been a failure? Or will you conclude, no matter how bad things get, that the economy would have been in even worse shape without the stimulus? And if the latter is the case, aren't these quarterly reports just a bit surreal?"
7. William Easterly on How ethnic profiling explains Dani Rodrik’s fondness for industrial policy . It's all about reversing conditional probabilities.

Lower prices are anti-competitive! (updated x3)

From Mark Perry at the Carpe Diem blog I learned of this piece from the Washington Post

The world's biggest semiconductor maker yesterday was fined a record $1.45 billion by European regulators for allegedly using its dominance to edge out rivals, a decision that has cast a spotlight on similar investigations by U.S. antitrust watchdogs.

After a five-year review of Intel's sales tactics, the European Union's competition commission said the company, with 70% share of the global chip market, gave hidden discounts to computer makers to use its chips and paid the firms not to use those made by competitor Advanced Micro Devices. It also paid a major retailer to stock only computers outfitted with Intel chips, the commission said.

Perry goes on to note

The chart above shows montly "CPI for Personal Computers and Peripheral Equipment" back to January 1998 (BLS data via Economagic here). Adjusting for quality improvements, computer equipment today costs only about 10% of what the same equipment cost in 1998. Consumers have never had it better when it comes to affordable computer equipment, so how can it be claimed that Intel is guilty of anti-competitive behavior that is damaging to consumers?

The true anti-competitive behavior of a coercive monopolist that should most concern government officials is when a producer (or group of producers, i.e. cartel like DeBeers or OPEC) restricts output and raises price. In the case of Intel, just the opposite has been happening: microchip output has been increasing, quality and speed have been improving significantly, and prices have been falling dramatically, and consumers have benefited enormously.

The whole point of market power is to raise prices, and thus profits. But how can Intel be accused of anti-competitive behavior when it was giving "hidden discounts" to computer makers? A real anti-competitive monopolist, with real market power, acting in a truly anti-competitive way, would be in a position to raise prices, not lower them.

So it seems no matter what firms do, raise prices, lower prices, keep them the same, they can run up against the competition police. This is a great example of the point of the story William Landes tells about why Ronald Coase gave up antitrust,

“Ronald [Coase] said he had gotten tired of antitrust because when the prices went up the judges said it was monopoly, when the prices went down they said it was predatory pricing, and when they stayed the same they said it was tacit collusion.”

–William Landes, “The Fire of Truth: A Remembrance of Law and Econ at Chicago”, JLE (1981) p. 193.

The world of anti-trust looks truly bizarre.

Update: Matt Nolan comments on Low prices and anti-competitive action.

Update 2: Richard A. Epstein (James Parker Hall Distinguished Service Professor of Law at the University of Chicago) writes at the IEA blog on Monopolization gone haywire. He says

[...] his academic at least can raise two doubts about the Commission’s attack on rebates.

First, no claim of consumer harm can look just at individual cases. It must look at overall market conditions. Here the Intel rebates lowered prices for the 80 per cent of consumers that used its products. What consumer harm could outweigh those particular gains in either the short or the long run? Without these rebates Intel’s share of the market would fall and that of Advanced Micro Devices (AMD), the complainant in this case, would rise from its 12 per cent share. Suppose AMD’s share doubled, Intel would still serve about 2/3rds of the market. Where is the net harm when more consumers are helped than hurt by the rebate?

Second, AMD, as a nondominant firm, could of course offer rebates (or larger rebates) for its products to increase its market share. Now price competition increases, which is all to the good. The EC’s Kroes has gathered the scalp of yet another large American company by intoning the phrase “abuse of a dominant position”. But in so doing she has converted Article 82 into an anticompetitive provision, just as her critics have long feared.

Update 3: Don Boudreaux notes that Government Is Anti-Trustworthy.

Government failure caused the financial crisis

A very interesting statement was published, 12th May, in the Daily Telegraph (UK), in which fourteen leading economists - authors of the new IEA study, Verdict on the Crash - explain how government failure caused the financial crisis and why politicians’ calls for tighter regulation are misconceived. The statement reads:

The prevailing view amongst the commentariat (reflected in the recent deliberations of the G20) that the financial crash of 2008 was caused by market failure is both wrong and dangerous. Government failure had a leading role in creating the conditions that led to the crash.

● Central banks created a monetary bubble that fed an asset price boom and distorted the pricing of risk.
● US government policy encouraged high-risk lending through support for Fannie Mae and Freddie Mac (which had explicit government targets of providing over 50pc of mortgage finance to poor households) and through the Community Reinvestment Act and related regulations.
● Regulators and central bankers failed to use their considerable powers to stop risks building up in the financial system and an extension of regulation will not make a future crash less likely.
● Much existing banking regulation exacerbated the crisis and reduced the effectiveness of market monitoring of banks. The FSA, in the UK, has failed in its statutory duty to “maintain market confidence”.
● The tax and regulatory systems encourage complex and opaque methods of increasing gearing in the financial system.
● Financial institutions that have made mistakes have lost the majority of their value. On the other hand, regulators are being rewarded for failure by an extension of their size and powers.
● Evidence suggests that serious systemic problems have not arisen amongst unregulated institutions.

As such, no significant changes are needed to the regulatory environment surrounding hedge funds, short-selling, offshore banks, private equity or tax havens.

A revolution in financial regulation is needed. The proposals of the G20 governments and the EU are wholly misconceived. Specific and targeted laws and regulations could restore market discipline.

These should include:

● Making bank depositors prior creditors. This will provide better incentives for prudent behaviour and make a call on deposit insurance funds less likely.
● Provisions to ensure an orderly winding up, recapitalisation or sale of systemic financial institutions in difficulty. Banks must be allowed to fail.
● Enhancing market disclosure by ensuring that banks report relevant information to shareholders.

This should be reinforced with central bank action to ensure that:

● Proper use is made of lender-of-last-resort facilities to deal with illiquid banks.
● The growth of broad money is monitored together with the build-up of wider inflationary risks.

Yours faithfully,

Dr James Alexander, Head of Equity Research, M&G; Prof Michael Beenstock, Professor of Economics, Hebrew University of Jerusalem; Prof Philip Booth, Professor of Insurance and Risk Management, Cass Business School; Dr Eamonn Butler, Director, Adam Smith Institute; Prof Tim Congdon, Founder, Lombard Street Research; Prof Laurence Copeland, Professor of Finance, Cardiff Business School; Prof Kevin Dowd, Professor of Financial Risk Management, Nottingham University Business School; Dr John Greenwood, Chief Economist, Invesco; Dr Samuel Gregg, Research Director, Acton Institute; Prof John Kay, St John’s College, Oxford; Prof David Llewellyn, Professor of Money and Banking, Loughborough University; Prof Alan Morrison, Professor of Finance, University of Oxford; Prof D R Myddelton, Emeritus Professor of Finance and Accounting, Cranfield University; Prof Geoffrey Wood, Professor of Economics, Cass Business School.

The book referred to above is Verdict on the Crash: Causes and Policy Implications, by the authors of the statement above and published by the Institute for Economic Affairs, London. (A pdf version of the book can be downloaded from the IEA site. )

The summary of the book reads:

• To some degree, UK and US monetary policy was to blame for recent problems in financial markets, thus replicating previous boom and bust episodes both in the UK and overseas.
• US government policy, by encouraging banks to lend to people with poor credit records, was a contributory factor in undermining US banks’ balance sheets. This problem was exacerbated both by the presence of the securitisation agencies, Fannie Mae and Freddie Mac, and by dishonest behaviour by some US borrowers.
• International bank capital regulation did not reduce the risk of insolvency. It may have contributed to the crisis, however, by encouraging all banks to have similar risk models, by lulling banks’ counterparties into a false sense of security and by making banks accountable to regulators rather than to market participants.
• Both international and domestic regulation also encouraged banks to make their activities more opaque than would otherwise have been the case, thus contributing to the build-up of risk.
• The management of the crisis by the UK public authorities exacerbated the problems rather than eased them. Both the slow reaction of the Bank of England and the use of market-value accounting rules in inappropriate circumstances made liquidity problems in the wholesale banking market worse.
• Market monitoring of banks was less effective than it should have been. The presence of regulation was probably a contributory factor to this. Banks over-leveraged, however, in ways that, ex post, were clearly inappropriate.
• Short selling by hedge funds played no significant part in the crisis. The use by regulators of credit ratings to set regulatory capital has undermined their integrity. As such, attempts to regulate ratings agencies and hedge funds further are likely to be damaging.
• While regulators might now understand how to prevent the crash of 2008 from happening again, they have demonstrated that they have no special gifts of foresight that justify confidence in the view that regulation would be effective in preventing future problems in financial markets. In general, the public authorities welcomed the innovations in financial markets that many commentators suggest are at the root of the problems we face now.
• Public choice economics suggests that financial market regulation should be based on very clear principles, with regulators being given specific objectives. This involves a complete reversal of recent trends in financial regulation.
• The most important specific objective that should be given to bank regulators is the protection of the payments system. Regulation should also ensure that those who provide capital to a bank should not be sheltered from the risks.
• Specific legal mechanisms should be brought in to achieve these goals. A variety of approaches is possible, and these would not involve detailed regulation of the activities of banks.
• Such an approach to regulation would ensure that the risk of failure fell squarely on a bank’s shareholders and counterparties rather than on taxpayers.

Go forth ... and read.