The broken window fallacy, again

In an earlier post I took Craig Glen Eden to task for falling for the Broken Window Fallacy. You may argue that I was a bit unfair since a non-economist could be forgiven for not realising the error. But not so for an economist. But Donald J. Boudreaux has had to point out the error to another economist!

Here is a letter he sent to the Boston Globe:

Adam Smith argued that the wealth of nations is enhanced by labor specialization, capital investment, and peaceful trade. Economist Mark Skidmore argues that wealth is enhanced by destroying things: "When something is destroyed you don't necessarily rebuild the same thing that you had. You might use updated technology, you might do things more efficiently. It bumps you up" ("How disasters help," July 6).

I offer to test Prof. Skidmore's thesis by wrecking his car and burning down his house. If he's correct, he'll surely want to reward me with a handsome payment.

Can I suggest that Boudreaux send Skidmore a copy of Hazlitt's "Economics in One Lesson".

Posner interview

This from the Duke Law Journal, Volume 58 April 2009 Number 7, an interview with Richard Posner (pdf)

Judge Richard A. Posner of the Seventh Circuit Court of Appeals is one of the most prominent members of the federal judiciary and one of its most prolific writers. He is a leading law and economics scholar with his book "Economic Analysis of Law" having gone through at least 7 editions.

Tyler Cowen interview

Over at Reason.tv Reason magazine Editor in Chief Matt Welch interviews Tyler Cowen.

The Law Commssion get it wrong (updated x3)

As Eric Crampton points out over at Offsetting Behaviour the Wellington Wowsers Law Commission have released their report on the review of alcohol taxation and regulation and make much of the BERL report. As Eric also notes they get "independent" analysis on the report from Brian Easton. A bit like getting "independent" analysis of abortion from the Pope.

The Law Commission say this about the Burgess and Crampton reply to BERL:

The BERL report has been strongly criticised by two economists (Eric Crampton and Matt Burgess) on the grounds that BERL failed to include any of the economic benefits associated with alcohol consumption and also inflated the costs in a number of ways, including counting as a cost the money spent on alcohol that is consumed in such a way that it leads to alcohol-related harm.25 They concluded that the external costs of alcohol roughly match the amount currently collected by the alcohol excises. (Emphasis added.)

The bit in bold is just plain wrong since BERL did incorporate benefits and the way they did it is important for their result. Matt and Eric criticised BERL not for leaving out the benefits, but for including them wrongly! As Eric has written:

They say that we misinterpret their brief and consequently fault them for things that were never within their remit: specifically, that they do not include the benefits of alcohol.

It is certainly true that benefits were not within the RFP. We noted as much throughout our report, and in our executive summary. However, counting benefits as being precisely equal to zero is what allows BERL to count private costs as social costs. As BERL correctly notes at page 173 of their report: (Emphasis added.)

When measuring the social cost of harmful AOD use, known private costs should generally be excluded…because private costs are offset by private benefits, so there is no net social cost

They there cite Collins and Lapsley, their primary source, as warning against the counting of private costs. They then go on:

In the case of harmful drug use, however, individual decisions are not necessarily made on a rational basis, that is, a decision where the consumer equates their costs and benefits. We argue that the consequences of irrational consumption decisions lead to private costs that are borne by the rest of society, and hence should be included as social costs… We assume that it is irrational to drink alcohol to a harmful level and that harmful alcohol use has zero private benefit.

Without that assumption, BERL could not count private costs as socially relevant. Their entire method hinges critically on that they have decided to assume zero gross benefits to drinkers of their drinking. So while benefits were outside of the RFP, they have taken a very strong position on the absence of benefits: a position without support in the economic literature. It consequently is fair game to critique BERL for counting the benefits as being equal to zero. And we do not understand how BERL can say with a straight face "we cannot accept criticism for not covering issues that were outside the project's brief" when their entire method is built on their having brought it into the project's brief.

If benefits are outside the remit, the proper approach is to consider only external costs. At minimum, BERL should have apportioned its cost tally between private and external costs. Instead, they termed all costs as social costs.

Update: BK Drinkwater on Hurly-BERLy Postscript: Law Commission Releases Issues Paper

Update 2: Not PC in not pleased by Unbridled wowserism

Update 3: Matt Nolan points out, correctly, that Private costs are not policy relevant

War, disease, and urban death may be good for you .....

Further to my Harry Lime quote of yesterday. War, disease, and urban death may be good for you, or at least your economy. In modern economic thinking, peace and prosperity go hand in hand. However, there are good reasons why in pre-modern societies, the opposite relationship held true – war, disease, and urban death spelled high incomes. This idea is explained in a new column at VoxEU.org which attempts to argue why Europe’s rise to riches in the early modern period owed much to exceptionally bellicose international politics, urban overcrowding, and frequent epidemics. Peace gives you cuckoo clocks, war, disease and death gives you Michelangelo, Leonardo da Vinci and the Renaissance.

Nico Voigtländer and Hans-Joachim Voth write about a Cruel windfall: How wars, plagues, and urban disease propelled Europe’s rise to riches. Voigtländer and Voth explain

In a pre-modern economy, incomes typically stagnate in the long run. Malthusian regimes are characterised by strongly declining marginal returns to labour. One-off improvements in technology can temporarily raise output per head. The additional income is spent on more (surviving) children, and population grows. As a result, output per head declines, and eventually labour productivity returns to its previous level. That is why, in HG Wells' phrase, earlier generations "spent the great gifts of science as rapidly as it got them in a mere insensate multiplication of the common life" (Wells, 1905).

The question therefore is How could an economy ever escape from this trap? Clearly some economies have and Europe where the first to do so. Why?

Long before growth accelerated for good in most countries, a first divergence occurred. European incomes by 1700 exceeded those in the rest of the world by a large margin. We explain the emergence of this income gap by a number of uniquely European features – an unusually high frequency of war, particularly unhealthy cities, and numerous deadly disease outbreaks.

First there is a puzzle: The first divergence in worldwide incomes. Incomes in European countries by 1700 were markedly higher than they had been in 1500.

According to the figures compiled by Angus Maddison (2001), all European countries including Mediterranean ones saw income growth of 35% to 180%. Within Europe, the northwest did markedly better than the rest. English and Dutch real wages surged during the early modern period.

Such a performance was exceptional. Places like India and China could not keep pace. The divergence in living standards was large.

In a Malthusian world, a divergence in living standards should be puzzling. Income gains from one-off inventions should have been temporary. Even ongoing productivity gains cannot account for the “first divergence” – TFP growth probably did not exceed 0.2%, and cannot explain the marked rise in output per capita.

Voigtländer and Voth's answer to the divergence puzzle: Rising death rates and lower fertility. In a Malthusian world, incomes can increase if birth rates fall or death rates increase. Voigtländer and Voth explain,

We argue that there were three factors – which we call the “Three Horsemen of Riches” – that shifted Europe’s death schedule outwards: wars, epidemics, and urban disease. Wars were unusually frequent. Epidemics were common, with devastating consequences. Finally, cities were particularly unhealthy, with death rates there exceeding birth rates by a large margin – without in-migration, European cities before 1850 would have disappeared.

The percentage of the European population affected by wars (defined as those living in areas where wars were fought) rose from a little over 10% around 1500 to 60% by the late seventeenth century. Some estimates suggest that, on average, there was a war being fought somewhere in nine out of every ten years in Europe in the early modern period.

Political fragmentation combined with religious strife after 1500 to form a potent mix that produced almost constant military conflict. While the fighting itself only killed few people, armies marching across Europe spread diseases. It has been estimated that a single army of 6,000 men, dispatched from La Rochelle to fight in the Mantuan war, killed up to a million people by spreading the plague.

European cities were not healthy places and where in fact much unhealthier than their Far Eastern counterparts. They probably had death rates that exceeded rural ones by 50%. In China, the rates were broadly the same in urban and rural areas. The reason has to do with differences in diets, urban densities, and sanitation, or lack there of.

Epidemics were also frequent. The plague did not disappear from Europe after 1348. Indeed, plague outbreaks continued until the 1720s, peaking at over 700 per decade in the early 17th century. In addition to wars, epidemics were spread by trade. The last outbreak of the plague in Western Europe occurred in Marseille in 1720; a merchant vessel from the Levant spread the disease, causing 100,000 men and women to perish. Since Europe has much greater variety in terms of geography and climate than China, disease pools remained largely separate. When they became increasingly connected as a result of more trade and wars, mortality spiked.

Voigtländer and Voth continue

In combination, the “Three Horsemen” – war, urbanisation, and trade-driven disease – probably raised death rates by one percentage point by 1700. Once death rates were higher, incomes could remain at an elevated level even in a Malthusian world. The crucial question then becomes why Europe developed such a particular set of factors driving up mortality.

We argue that the Great Plague of 1348-50 was the key. Between one third and one half of Europeans died. With land-labour ratios now higher, per capita output and wages surged. Since population losses were massive, they could not be compensated quickly. For a few generations, the old continent experienced a “golden age of labour”. British real wages only recovered their 1450s peak in the age of Queen Victoria.

Temporarily higher wages changed the nature of demand. Despite having more children, people had more income than necessary for mere subsistence – population losses were too large to be absorbed entirely by the demographic response. Some of the surplus income was spent on manufactured goods. These goods were mainly produced in cities. Thus, urban centres grew in size. Higher incomes also generated more trade. Finally, the increasing number and wealth of cities expanded the size of the monetised sector of the economy. The wealth of cities could be taxed or seized by rulers. Resources available for fighting wars increased – war was effectively a superior good for early modern princes. Therefore, as per capita incomes increased, death rates rose in parallel. This generates a potential for multiple equilibria. Figure 4 illustrates the mechanism. The death rate increases over some part of the income range, which maps into urbanisation rates. Starting at E0, a sufficiently large shock will move the economy to point EH, where population is again stable.

In the discussion paper, we calibrate our model. The effect of higher mortality on living standards is large. We find that we can account for more than half of Europe’s precocious rise in per capita incomes until 1700.

The conclusion of all of this?

To raise incomes in a Malthusian setting, death rates have to rise or fertility rates have to decline. We argue that a number of uniquely European characteristics – the fragmented nature of politics, unhealthy cities, and a geographically heterogeneous terrain – interacted with the shock of the 1348 plague to create exceptionally high mortality rates. These underpinned a high level of per capita income, but the riches were bought at a high cost in terms of human lives.

At the same time, there are good reasons to think that it is not entirely accidental that the countries (and regions) that were ahead in per capita income terms in 1700 were also the first to industrialise. How the world could escape the Malthusian trap at all has become a matter of intense interest to economists in recent years. In a related paper, we calibrate a simple growth model to show why high per capita income at an early stage may have been key for Europe’s rise after 1800.

Quote of the day

From Harry Lime, played by Orson Welles in the 1948 classic "The Third Man",

"In Italy, for thirty years under the Borgias, they had warfare, terror, murder, bloodshed, but they produced Michelangelo, Leonardo da Vinci and the Renaissance. In Switzerland, they had brotherly love; they had 500 years of democracy and peace – and what did that produce? The cuckoo clock."

Economic history in one paragraph.

NZ econ blogs (updated)

Matt Nolan, who clearly doesn't have a life!!!, ( from TVHE ) tells us that New Zealand has a population of 4.3m and 12 economics blogs so that is approximately one blog per 358,333 307,143 people.

The 12 are:

• Aaron Schiff.
• Anti-Dismal.
• Brad Taylor.
• BK Drinkwater.
• Dismal Soyanz.
• Defective Equilibrium.
• Graduate Rhapsody.
• Not PC.
• Offseting behaviour.
• Progressive Turmoil.
• Rates Blog.
• The Visible Hand.

Note that Matt says

[...] all the blogs I have linked to have a lot of economics opinions in them, even if this isn’t their primary description. To me this makes them worthy of being called an economics blog.

If anyone has been missed, put the blog in the comments.

Update: Matt has updated the list, its now up to 14, so we have one blog per 307,143 people. The two additions being:

• Kiwitrader.
• Valuecruncher.

The next big thing in anti-trust?

First there was IBM, then came Microsoft and now the next big thing in anti-trust looks like .... Google! Fred Vogelstein over at Wired Magazine asks Why Is Obama's Top Antitrust Cop Gunning for Google? Vogelstein writes,

"I think you are going to see a repeat of Microsoft."

Christine Varney's blunt assessment sent a buzz through the audience at the National Press Club in Washington, DC. Varney, a partner at Hogan & Hartson and one of the country's foremost experts in online law, was speaking at the ninth annual conference of the American Antitrust Institute, a gathering of top monopoly attorneys and economists. Most of the day was filled with dry presentations like "Verticality Regains Relevance" and "The Future of Private Enforcement." But Varney, tall and professorial, did not hide her message behind legalese or euphemism. The technology industry, she said, was coming under the sway of a dominant behemoth, one that had the potential to stifle innovation and squash its competitors. The last time the government saw a threat like this—Microsoft in the 1990s—it launched an aggressive antitrust case. But by the time of this conference, mid-June 2008, a new offender had emerged. "For me, Microsoft is so last century," Varney said. "They are not the problem. I think we are going to continually see a problem, potentially, with Google."

and continues,

But it is safe to assume that plenty of Googlers were jumping and screaming six months later when President Obama appointed Varney head of the Justice Department's antitrust division, making her the government's most powerful antimonopoly prosecutor. On May 11, during her first public speech on the job, Varney made it clear that her stance had not changed much since her presentation at the conference: She planned to take a forceful approach to applying the nation's antitrust laws. "In the past, the antitrust division was a leader in its enforcement efforts in technology industries, and I believe we will take this mantle again," she said. She did not mention Google by name, but there was little doubt to whom she was referring.

Given the payoff that the public got from the IBM and Microsoft cases, basically zero, I can see the US taxpayer paying for yet another very long, very expensive legal battle with zero returns to their (forced) investment.

An obvious problem for antitrust in high tech industries is that the environment changes so rapidly. Some firm who looks strong and invincible today won't necessarily be strong tomorrow. The market changes so quickly that antitrust enforcers just can't keep up. Also there is pretty of competition out there. If you become dissatisfied with Google, it's very easy to move to a competitor and there are plenty of rivals are ready to snap up Google's user base at the first sign of any weakness.

It again looks like being successful is the real crime.

An unambiguously good bill?

BK Drinkwater posts on An Unambiguously Good Bill He writes

Maryan Street's Customs and Excise (Prohibition of Imports Made by Slave Labour) Bill is not only wonderfully short and a shining example of truth in advertising, it is, as Idiot/Savant notes, a moral necessity

But is it such an unambiguously good bill? There is no doubt that slavery is to be condemned. But will this bill help in the fight against slavery, as I assume it is designed to do.

The fear I have is that the devil is in the detail, or at least in the interpretation and enforcement of the detail. With a broad definition given to "slavery" such a bill may end up as little more than protectionism by stealth. For example, will the bill outlaw the importation of product from countries which pay "slave wages"?

Clause 5 inserts a definition of "slave labour" into the principal Act. The definition mirrors the definition in international law as laid out in the 1926 Slavery Convention and the Rome Statute of the International Criminal Court. Clause 5 reads:

Section 2(1) of the principal Act is amended by inserting the following definition in its appropriate alphabetical order: “slave labour means labour by persons over whom any or all of the powers attaching to the right of ownership are exercised.”

Economists think of ownership in terms of residual rights of control. Following Grossman and Hart ("The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration", 'Journal of Political Economy', 94:691-719) economists tend to define the owner of an asset - normally non-human - as the one who has residual rights of control over the asset; that is whoever can determine what is done with the asset, how it is used, by whom it is used, when they can use it etc. But in a world of incomplete contracts, in particular incomplete employment contracts, the employer has, at least, partial residual control rights over an employee. No employment contract can detail all tasks to be carried out at all times in all circumstances and thus the employer has residual rights to determine these things in the uncontracted for situations. That is she has residual control rights, and thus can exercise, at least, some of the powers attaching to the right of ownership. Is this slavery?

As noted above, What of countries where wags are low compared to New Zealand? Are these "slave wages"? However determined. Does the payment of such low wages imply that the powers attaching to the right of ownership are being exercised?

Clause 6 of the bill states:

Schedule 1 of principal Act amended
Schedule 1 of the principal Act is amended to add the following:
"Goods manufactured or produced wholly or in part by slave labour."

How is this in practice to be determined? And by whom? Given the multi-country production methods in use by many firms today, how are we to know of the labour practices of all those who have a hand in a goods production? With a broad interpretation given to "slavery", the enforcement of the bill could end up as little more than protectionism.

The idea behind the bill is a good one, but the results of the practice of enforcement could be anything but.

Interesting blog bits

1. Al Roth on Corruption and kidneys in New Jersey and Brooklyn. Why not just have a legal market?
2. Seamus Hogan on Electricity Report: Who Paid the $4.3b? It would be useful to correct a misunderstanding in the way that the study has been reported in the press.
3. rauparaha asks Can free markets punish racists? Short anwser to rauparaha, yes, the more competitive the industry, the less discrimination.
4. Greg Mankiw asks Should we envy European healthcare? And then points out that Gary Becker argues no.
5. Oxonomics on The Political Economy of the Ninja. The idea is to explain the rise of the centralized Tokogawa state in early modern Japan. The ninja were local resistence fighters who were eventually crushed by the great unifiers Oda Nobunaga and Toyotomi Hideyoshi in the late sixteenth century.
6. Tim Worstall on How governments run things. Yes, the wise and omniscient beings face incentives, just like everyone else, and as everyone likes something for nothing they've set up a bookies so that it must (note, MUST) pay out more than it gets in plus the costs of doing so.

EconTalk this week

Peter Blair Henry of Stanford University talks with EconTalk host Russ Roberts about economic development. Henry compares and contrasts the policy and growth experience of Barbados and Jamaica. Both became independent of England in the 1960s, so both inherited similar institutions. But each pursued different policies with very different results. Henry discusses the implications of this near-natural experiment for growth generally and the importance of macroeconomic policy for achieving prosperity. The conversation closes with a discussion of Henry's research on stock market reactions as a measure of policy's effectiveness.

Deadweight losses 3 (updatred)

Over at The Standard Steve Keen responses to Matt Nolan's comment. In part Keen writes,

My critique of neoclassical pricing theory has been published in Physica A, long after that exchange with Auld. The maths passed the scrutiny of physicists, who leave economists in the dust when it comes to mathematical reasoning.

An appeal to authority argument. Most people will know what to do with this. But I'm not sure its even true given the number of economists who have graduate and PhD training in mathematics. Keen goes on,

Furthermore, though the Cournot-Nash is mathematically correct, the Nash equilibrium is meta-unstable: independent competitive behaviour will lead instrumental profit maximisers to diverge from it without collusion. The only way to maintain the equilibrium is to presume competitive firms have “perfect knowledge” of each other’s strategies, which makes a nonsense of the concept of competition to agree with.

Now I'm not sure what Keen means by "meta-unstable" but note that by definition a Cournot-Nash equilibrium is where the best response functions of the firms intersect, and thus no one has any incentive to change their behaviour given their (correct) beliefs about the other players behaviour. The collusive equilibrium, on the other hand, is off the best response functions of all players and thus all players have an incentive to change their behaviour.

As to the information requirement, players need to be able to form (correct in equilibrium) beliefs about the other players possible actions, that is, they know the other players best response functions. They do not need or have perfect knowledge about the actual strategy being played by the other players. Martin Osborne explains the belief formation:

On what basis can such a belief be formed? The assumption underlying the analysis in this chapter and the next two chapters is that each player's belief is derived from her past experience playing the game, and that this experience is sufficiently extensive that she knows how her opponents will behave. No one tells her the actions her opponents will choose, but her previous involvement in the game leads her to be sure of these actions.

(More details are provide in a later section of his book on the question of how a player's experience can lead them to the correct beliefs about the other players' actions.)

Note however that the information requirements are really no stronger than those needed for the perfect competition model or the monopoly model.

Keen continues in response to part of Matt Nolan's comment on my posting,

For those on this blog, what Matt wrote was:

“MR-MC = (n-1)/n * (P – MC)”

As perfect competition assumes “many firms” (read infinite) n-1 converges to n, implying that P=MR.”

This is the formula for an individual firm, not the economy as a whole. The convergence Matt notes applies because the firm output “q” in the MR formula for the single firm (MR(q)=P+q*dP/dQ) must go to zero if the number of firms in an industry goes to infinity.

But we are looking for the equilibrium output for a single firms thus q makes sense. The condition MR=MC is for a single firm, and industry output will be n times the individual firm output given that each firm is the same under perfect competition. Under a Cournot oligopoly the total equilibrium out will be Q^N= n/(n+1)(a-c/b). This goes to the competitive equilibrium as n gets large and if n=1 it equals the monopoly output. Inverse demand is P=a-bQ. If we think of the residual demand curve that a given firm faces after all other firms have produced their output, and let the firm act as a monopolist within this residual market, as in the Cournot model, the quantity they produce will decrease as more firms enter the market as the residual market will get smaller. But the firm will still be setting MR=MC no matter how small the residual market is and MR will not be zero. All seems to be working as it should.

Keen also says,

Perfect competition is and always has been a crock that has stopped economists from actually confronting the real world. Though I despair of ever getting neoclassical economists to realise this, I hope that non-believers can appreciate this and start to ignore the irrelevant theories of neoclassical economists.

Another possible approach to rigorously deriving perfect competition is to assume there exists a continuum of firms. In such a situation , it is literally true that any firm can change its output without changing price, even when the market demand is smooth and downward-sloping. Aumann, R. (1964) ("Markets with a continuum of traders," Econornetrica 32:39-50) is a standard reference.

Update: Matt Nolan discusses The basic frame of a firm: Cournot.

Was Britain ever a free trader?

John V.C. Nye has a new working paper, “Political Economy of Anglo-French Trade, 1689-1899: Agricultural Trade Policies, Alcohol Taxes, and War” which has been published by the American Association of Wine Economists, as AAWE Working Papers, no 38 Economics. The abstract reads:

Britain – contrary to received wisdom – was not a free trader for most of the 1800s and, despite repeal of the Corn Laws, continued to have higher tariffs than the French until the last quarter of the century.

War with Louis XIV from 1689 led to the end of all trade between Britain and France for a quarter of a century. The creation of powerful protected interests both at home and abroad (notably in the form of British merchants, and investors in Portuguese wine) led to the imposition of prohibitively high tariffs on French imports -- notably on wine and spirits -- when trade with France resumed in 1714. Protection of domestic interests from import competition allowed the state to raise domestic excises which provided increased government revenues despite almost no increases in the taxes on land and income in Britain. The state ensured compliance not simply through the threat of lower tariffs on foreign substitutes but also through the encouragement of a trend towards monopoly production in brewing and restricted retail sales of beer (which began around 1700 and continued throughout the eighteenth century).

This history is analyzed in terms of its effects on British fiscal and commercial policy from the early 1700s to the end of the nineteenth century. The result is a fuller, albeit revisionist account of the rise of the modern state that calls into question a variety of theses in economics and political science that draw on the naive view of a liberal Britain unilaterally moving to free trade in the nineteenth century. (JEL Classification: F13, H20, N40, N43, N53, O13, Q17 )

So the answer to my question appears to be no.

But not so fast, Douglas A. Irwin counters with this response to Nye’s paper: “Free Trade and Protection in Nineteenth-century Britain and France revisited: a comment on Nye”. Irwin writes

In a recent article in this JOURNAL John V. Nye disputed the "conventional wisdom" that Britain was a paragon of free trade and France a practitioner of protection in the nineteenth century.' Nye's case is based primarily on figures for tariff revenue as a percentage of the value of imports, calculated using various weights. These figures, as Nye interprets them, "suggest that France's trade regime was more liberal than that of Great Britain throughout most of the nineteenth century . . . British average tariff levels did not compare favorably with those of France till the 1880s and were not substantially lower for much of the time."

In this comment I argue that the rate of tariff revenue is an inadequate and potentially misleading indicator of whether a country's commercial policy tends toward free trade or protection. In examining the structure of Britain's tariff in the second half of the nineteenth century, when those problems were particularly acute, I found that the tariff was carefully constructed to avoid protecting domestic producers. A cursory examination of French policy, by contrast, indicates that domestic producers were protected by substantial tariff barriers.

Irwin concludes his paper by saying,

But enormous differences in commercial policy are consistent with comparable average rates of tariff revenue. To assess whether a country's commercial policy tends toward free trade or protection also requires examining the principles underlying the tariff treatment of various goods. The French tariff was broadly based and designed to protect domestic producers by keeping out foreign goods. The British tariff was an extension of the domestic excise system, levied only on a select number of commodities to raise fiscal revenue without discriminating against foreign goods in favor of domestic goods. Equating British and French commercial policies in the second half of the nineteenth century because their tariffs raised similar rates of revenue misses the essential distinction between free trade and protectionism: whether or not domestic producers are sheltered from foreign competition. By this standard, France flunks and Britain passes the free-trade test.

So now the answer to my question appears to be yes.

Feel free to be confused. I am. :-)

(HT: Adam Smith's Lost Legacy, here and here.)

Happy birthday Alfred

I missed it, but on July 26th the great English economist Alfred Marshall would have turned 167.

(HT: Cafe Hayek)

Deadweight losses 2

In a comment to my previous posting, Deadweight losses, Steve claims that Bastard's arguments are correct. Matt Nolan at TVHE replies to Steve and makes all the points I would have made. Thanks Matt.

Let me give you the executive summary of what I was going to say about Steve's more general arguments; actually the summary is due to Schiffman (2004: 1909-1)

According to Auld, Keen is mistaken concerning the distinction between perfect competition and monopoly (or lack thereof—topic 3), and his perception that mainstream modeling ignores dynamics (topic 6). These errors, in Auld’s estimation, are caused by "either a lack of familiarity with the literature, conceptual errors, or both". As Auld shows, perfect competition can be rigorously derived as the limit of a model of imperfect competition (as the number of firms becomes large). Assume that each firm takes competitors’ outputs as given, but recognizes that it has some degree of market power (its own output influences the market price). The ratio of output under this form of imperfect competition to output under perfect competition is n/(n+1) (where n is the number of firms). When standard theory assumes that firms take prices as given, it is making an innocuous assumption; for example, an imperfectly competitive industry with 100 firms will produce slightly over 99% of the perfectly competitive output.

The reference to Auld is Auld, M.C., 2002. Debunking Debunking Economics. Working Paper, University of Calgary. Available at http://jerry.ss.ucalgary.ca/debunk.pdf.

There is something fishy here

Al Roth at the Market Design blog asks Is fish-tossing repugnant?

Fishmongers in Seattle throw dead fish around the market, and it has apparently become not just a way of handling fish for sale, but a form of entertainment.

"Jeremy Ridgway, one of the managers at the market, said that he has done fish shows for the ministry of manpower in Singapore, for schoolchildren in Oklahoma and at countless other venues."

One of those other venues was a meeting in Seattle of the American Veterinary Medical Association, which decided to go ahead with "a plan to host a team-building program offered by the famous fish-throwers of Seattle's Pike Place Fish Market."

The organization People for the Ethical Treatment of Animals (PETA) finds this repugnant, and thinks such events should not be conducted.

What exactly is PETA's problem here? Roth has many great examples of repugnant markets, but I can't see this as one of them. But you can judge for yourself: Seattle's Pike Place fishmongers under fire .

The organization of firms across countries

Peter Klein from Organizations and Markets points us to a interesting NBER working paper on The organization of firms across countries by Nicholas Bloom, Raffaella Sadun and John Van Reenen. The abstract reads,

We argue that social capital as proxied by regional trust and the Rule of Law can improve aggregate productivity through facilitating greater firm decentralization. We collect original data on the decentralization of investment, hiring, production and sales decisions from Corporate Head Quarters to local plant managers in almost 4,000 firms in the US, Europe and Asia. We find Anglo-Saxon and Northern European firms are much more decentralized than those from Southern Europe and Asia. Trust and the Rule of Law appear to facilitate delegation by improving co-operation, even when we examine "bilateral trust" between the country of origin and location for affiliates of multinational firms. We show that areas with higher trust and stronger rule of law specialize in industries that rely on decentralization and allow more efficient firms to grow in scale. Furthermore, even for firms of a given size and industry, trust and rule of law are associated with more decentralization which fosters higher returns from information technology (we find IT is complementary with decentralization). Finally, we find that non-hierarchical religions and product market competition are also associated with more decentralization. Together these cultural, legal and economic factors account for four fifths of the cross-country variation in the decentralization of power within firms.

Interesting that the paper shows that countries with higher trust and stronger rule of law specialise in industries that rely on decentralisation and allow more efficient firms to grow in scale. Given that tacit and local knowledge can be important players in efficient decision making, it makes sense that decentralisation would improve the decisions made since it allows better utilisation of such knowledge. What Hayek argued was true for the economy as a whole also looks like its true at the level of the firm.

Deadweight losses (updated)

You do get some odd economic arguments from non-economist at times. The following comes from comments by Draco T Bastard on the posting Back to the future: electricity privatisation at The Standard:

The supposed dead weight loss that monopolies bring are actually brought about by people trying to maximize profit. This has been proved (google Steve Keen, economist). As the government doesn’t need to make a profit that dead weight loss doesn’t exist.

This is wrong for a number of reasons.

The reason for a deadweight loss is that output is below the perfectly competitive level of output, call it q(c). I am assuming that no one wants to produce at a level greater than q(c) to avoid outright losses. I will also assume here that the price is read off the demand curve so that all output is sold. The reason for output being below q(c) doesn’t matter. Whether the firm is maximizing profits or not there will still be a deadweight loss if output is below q(c). For example, assume that q(c) is 10 and the monopoly level of output, q(m), is 5. Then any level of output between 5 and 10 will not maximise profits for the monopolist but will result in a deadweight loss. So not maximising profits does not mean no deadweight loss. What results in no deadweight loss is producing the perfectly competitive level of output.

Note also that both monopolists and competitive firms maximise profits. But only one results in a deadweight loss. So having firms maximise profits doesn't mean there will be a deadweight loss.

Even state owned firms need to make (non-negative) profits, in that their revenues have to at least as large as their costs of production to avoid any subsidies, and their implied taxes.

Bastard goes on,

Monopolies are actually more efficient than competition due to several factors: Economies of scale and having only to deal with itself and the customer (rather than several independent competitors and the customer) being the most notable.

Now here I'm guessing (the "Economies of scale" bit) that Bastard is assuming a natural monopoly and thus you get the standard result that a single firm is the most efficient form of production. Note that the whole discussing is about electricity and I'm not sure that electricity production is a natural monopoly and thus the natural monopoly arguments don't apply. Natural oligopoly may be.

Update: Bastard goes on to say,

And my description of dead weight loss is spot on – it is profit.

No I'm not making this up!

Interesting blog bits

1. Economic Logic on A large US current account deficit is normal. Enrique G. Mendoza, Vincenzo Quadrini and José-Víctor Ríos-Rull argue that this is completely normal and a consequence of globalization and the fact that the US has much better developed financial markets.
2. Alex Tabarrok on Raising Rival's Costs. Tabarrok explains the economic logic behind the support of some businessmen for a rise in the minimum wage. These employers will benefit from an increase in the minimum wage because it will raise the costs of their rivals.
3. Brad Taylor on Roger Douglas Supports Competitive Government. Roger Douglas as anarchist.
4. Mark Perry on Venezuela to Import Coffee For 1st Time Ever!! Venezuela, a traditional coffee exporter that boasts one of the best cups of java in South America, may have to import coffee for the first time ever this year or face shortages. Producers say rising costs and prices fixed by the government have caused production to fall and illegal exports to rise. The government says poor climate and speculation by growers and roasters is to blame.
5. Not PC on Sexual Consent in the new world. Just watch the video.
6. Eric Crampton on And a victory for the little guy against the union.

Herald on the appointment of Brash

Thanks to the Inquiring Mind I was pointed towards this editorial from the Herald on the appointment of the Brash taskforce. There are a number of odd things in this editorial.

The taskforce is welcome. For more than 20 years, Australia has placed a strong emphasis on productivity. It was recognised in the compulsory superannuation arrangements and in the Australian Productivity Commission.

This was formed as an "independent research and advisory body on a range of economic, social and environmental issues affecting the welfare of Australians". It has been highly successful and enjoys cross-party support.

Exactly, how is this success being measured? What makes the Australian Productivity Commission such a success? How does the editorial writer know it has been successful? Has he actually checked up on this? What evidence do they have that this is true? Could it not be possible that Australia's productivity growth would have been even higher without the commission?

The size of its job is indicated by the fact that, while productivity in New Zealand and Australia was on a par 40 years ago, Australia's is now about a third higher, as are incomes there.

Let us take this as true, the question that should be asked is: What evidence this there that this divergence in productivity has anything to do with the Australian Productivity Commission? If it doesn't, Why does New Zealand need the Brash Taskforce?

In New Zealand's case, these are all the more important because productivity is not helped by a small population and remoteness from large markets.

What do either of these have to do with productivity? Why can't a country with a small population be just as productive as a large one. Is India really all that much more productive than, say, Singapore? How does distance from markets affect productivity?

Australia's Productivity Commission has ventured far and wide in seeking to provide the best canvas for prosperity. One of its recent inquiries found book prices were far too high because foreign versions of any book published in Australia cannot be sold there.

Two things seems odd here. Australians needed the Productivity Commission to tell them that foreign versions of any book published in Australia cannot be sold there? Does it matter? Haven't Australian heard of Amazon.com? Secondly, and more importantly, what precisely has the price of books published in Australia actually got to do with productivity in Australia?

Dumb electricity regulators (updated)

This from the New York Times,

PARIS — A decision by France’s energy regulator that seems to defy both logic and Europe’s green consciousness has set off a political storm here.

At the center is a tiny company that seeks to save consumers money.

Two weeks ago, the French Energy Regulatory Commission, the C.R.E., decided that Voltalis, a company that installs electricity management devices in homes and businesses and then manages their use, would have to, in effect, pay power producers for the power that it saves.

Remember, government is your friend.

Later the article reports,

Challenges, a French business magazine, suggested that the country’s electricity producers, including Électricité de France, which is 85 percent owned by the government, wielded too much influence over regulators.

Remember state ownership of electricity producers is a good thing.

(HT: Market Design)

Update: Thinking about this some more, I wonder if car manufacturers who produce fuel efficient cars should have to pay oil companies for the fuel they save drivers?

A reply to Hogan and Crampton (updated)

In response to my previous posting, Should Meridian be privatised?, Seamus Hogan said

But what do Hart, Schleifer and Vishny say about industries where political pressure is more likely to lead to stupid regulation if profits are privately earned?

and Eric Crampton said

Seamus is right that the IO argument misses the point he was making; you're right that there are political pressures on SOEs as well. I'd expect Seamus to reply, though, that we've observed little expropriation of Meridian's profits through regulatory activity under the current system: the devil we know isn't that bad and we don't know what insanity voters would demand under a private system if a private power company were profiteering.

I worry that the argument could be used to justify any inefficient status quo if the "stupid voter" threat is big enough.

I'm not going to argue that they are wrong, in fact I will argue that they are right, but too right for their own good. In a sense their argument is too good. By picking just the right manner of "voter stupidity" they can get any result they want. They can explain everything, and thus nothing. They have in effect 'done a BERL'. By assuming the right amount of irrationality, of voters not drinkers, they manage to assume their result.

To be fully convincing their theory needs to endogenously determine the form of voter stupidity. Why is it that voters care about the profits of private power companies but not public companies? Why it is that voters care about the profits of private power companies and not private corner dairies? Or private supermarkets? Or private petrol companies? Hogan and Crampton appear to be assuming just the right manner of stupidity amount voters without showing why they are "stupid" in this particular way.

The issue of why voters would care more amount "private profits" than "public profits" seems important given that the government can directly affect the operations of an SOE. Not only can it regulate, it also have the power of ownership, which I would argue means that voters have more reason to apply pressure to the government under state ownership since that pressure has more chance of effecting the outcome.

Crampton is right to

[...] worry that the argument could be used to justify any inefficient status quo if the "stupid voter" threat is big enough

because his own argument, with just the right amount of voter stupidity, seems to lead to state ownership of everything. Crampton the Marxist!!!

As to the problem of,

a private power company [...] profiteering

First, What is profiteering? And second, Why not take an approach similar to that used in Germany where consumer cooperatives have vertical integrated backwards to control distribution and production? It's not clear why such a cooperative would have a incentive for "profiteering". Are consumers likely to rip themselves off? You end up with depoliticisation of the industry and less concern over profits.

Updated: Eric Crampton ponders Voter preferences and electricity generation.

BERL on Crampton-Burgess on BERL

Over at The Visible Hand in Economics, the invisible (or at least unknown) Hand writes on From the Hand: BERL on Crampton-Burgess on BERL. The basic point of the post:

I mean, for gods sake, if the two sides involved spent more time clarifying the differences in their value judgments and less time scoring points in the media (or delivering “smack downs” as Dr Crampton eloquently describes it), then we might have a clearer idea of what the policy relevant issues are.

But I would point out that BERL has stated that their report is not a policy relevant report! After all it is a cost report, not a benefit-cost report, which would be required for policy work. Which leaves us, again, with the question, What is the purpose of the report? Clarifying this issue would be a start in understand the policy issues.

Should Meridian be privatised?

This question is asked by Seamus Hogan over at Offsetting Behaviour. Seamus writes,

This story in yesterday’s Press suggested that the SOE, Meridian Energy, is being restructured in preparation for being privatised after the next election, although this has been denied by John Key.

He goes on,

The reaction of the regular “public finance” economist in me to the suggestion that an electricity company will be privatised is to cheer loudly: the government has no business owning shares in companies providing private goods while at the same time maintaining a large portfolio of debt. The “public choice” economist in me, however, hopes that Meridian and the other two SOE electricity generators (Mighty River Power and Genesis) will remain government owned.

The theory of the firm economist in me says yes to privatisation.

Hart, Shleifer and Vishny ("The Proper Scope of Government: Theory and an Application to Prisons", Quarterly Journal of Economics, 112(4): 1127-61, November 1997) argue that the case for government provision of goods or services is generally stronger when non-contractible cost reductions have large deleterious effects on quality, when quality innovations are unimportant and when corruption in government procurement is a severe problem. It has been argued that the case for government production is strong in such services as the conduct of foreign policy, police and armed forces. The case can also be made reasonably persuasively for the case of prisons. Electricity doesn't look much like these services to me.

The case for private sector provision is stronger when quality reducing cost reduction can be controlled through contract or competition, when quality innovations are important and when patronage and powerful unions are a severe problem inside the government.

On these grounds I can not see why the government needs to be involved in the production of electricity. The incentives look better under private ownership. Electricity production is not a area where cost reductions come at the expense of quality - its difficult to see what low quality electricity would be; where innovation is unimportant - we always want better, more efficient, environmentally friendly ways of producing power; or where there are any problem with government procurement - its not clear that we need government procurement in this case. So why have the government owning Meridian, Mighty River Power or Genesis? It is hard to see competition lessening under private ownership, having the government owning three of the big players in the industry doesn't look like a highly competitive market place. Also privatisation maximises the "distance" between the government and the industry. This makes political interference more obvious and thus more politically costly than under state ownership.

For electricity production, private provision makes sense to me.

Broken window fallacy

Every so often I'm surprise by people's understanding of economics. In this case, not in a good way. The following comes from a comment by Craig Glen Eden left on the posting Same old failed ideas at The Standard:

What a load of crap Paul. Heres one example when the actions of Government/Governments can increase Long Term economic growth its called war.

This is just so wrong on so many dimensions. It is, of course, just a version of the Broken Window Fallacy. If it was true, we could increase economic growth by destroying all our capital, all of the time! After all, that's what war does, it destroys capital, both human and physical, on a very large scale.

People who argue like Craig would say that at the end of World War Two Germany and Japan had an advantage over the USA because their old plant had been destroyed by the Allies and they could replace them with the most modern plant and equipment available. This, it would be argued, meant that Germany and Japan could produce more efficiently and at lower cost than the Americans who still had to produce with their older and half-obsolete factories. But if this really was an advantage then the Americans could have easily offset it by destroying their own plant and equipment. In fact all countries could scrap all their old equipment every year and replace it with the latest plant and equipment.

The truth is of course that there is an optimal rate of replacement, a best time for replacement, of plant and equipment. It is an advantage to have your plant destroyed only if the time had arrived when, through deterioration and obsolescence, your equipment has acquired a zero or negative value just as the plant is destroyed by an act of war. So it is never an advantage to have one's plant and equipment destroyed unless the said plant have already become valueless due to normal business activity.

Post World War Two there was rapid economic growth in Europe and Japan, at least as measured by standard economic methods, but much of this growth was needed just to replace what had been destroyed by the war. By having to build new homes and factories people in Europe and Japan had less resources leftover to create anything else. When business was increased in one direction, it was correspondingly reduced in another.

If only more people would read Henry Hazlitt.

The Great Recession of 2008-9

In this video Prof. Steve Horwitz puts the current recession into historical perspective and explores the different approaches to recovery. Taped at Evenings at Foundation for Economic Education on July 18, 2009 in Irvington, NY.

The video "The Great Recession of 2008-9: Capitalism Hasn't Failed, Government Has (Yet Again)" is available here.

What went wrong with economics

Recently The Economist had an article on What went wrong with economics. The story points out that the view of economics for many of the general public has changed. The reputation of economics has been batted by recent events.

In the wake of the biggest economic calamity in 80 years that reputation has taken a beating. In the public mind an arrogant profession has been humbled. Though economists are still at the centre of the policy debate—think of Ben Bernanke or Larry Summers in America or Mervyn King in Britain—their pronouncements are viewed with more scepticism than before. The profession itself is suffering from guilt and rancour. In a recent lecture, Paul Krugman, winner of the Nobel prize in economics in 2008, argued that much of the past 30 years of macroeconomics was “spectacularly useless at best, and positively harmful at worst.” Barry Eichengreen, a prominent American economic historian, says the crisis has “cast into doubt much of what we thought we knew about economics.”

But I think the most important point the Economist makes is,

In its crudest form—the idea that economics as a whole is discredited—the current backlash has gone far too far. If ignorance allowed investors and politicians to exaggerate the virtues of economics, it now blinds them to its benefits. Economics is less a slavish creed than a prism through which to understand the world. It is a broad canon, stretching from theories to explain how prices are determined to how economies grow. Much of that body of knowledge has no link to the financial crisis and remains as useful as ever.

And if economics as a broad discipline deserves a robust defence, so does the free-market paradigm. Too many people, especially in Europe, equate mistakes made by economists with a failure of economic liberalism. Their logic seems to be that if economists got things wrong, then politicians will do better. That is a false—and dangerous—conclusion.

The current crisis points to problems in macroeconomics and financial economics and these areas are now, rightly, being severely re-examined. Which is all to the good. There are new questions about the relative usefulness of monetary and fiscal policy. And about how the financial sector affects the real sectors of the economy. Also financial economists are starting to study the way that incentives can skew market efficiency.

But let us not throw the baby out with the bathwater. As noted in the quote from the Economist above,

Much of that body of knowledge has no link to the financial crisis and remains as useful as ever.

Steven E. Landsburg famously summed up economics as,

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

This is just as true now as it was before the crisis. People still respond to incentives, just as they did before the crisis and thus economics still has valuable insights to give.

(HT: Peter M Salmon)

Independent central banks or no central banks?

In the US a number of economists have signed a petition urging Congress and the executive branch “to reaffirm their support for and defend the independence of the Federal Reserve System as a foundation of U.S. economic stability.” In support of this defense of the Fed against those now challenging the secrecy of its undertakings and, in some cases, its very existence, these economists offer three arguments:

1. central bank independence has been shown to be essential for controlling inflation.
2. lender of last resort decisions should not be politicize. (Why, I ask, is there a lender of last resort at all?)
3. The democratic legitimacy of the Federal Reserve System is well established by its legal mandate and by the existing appointments process. Frequent communication with the public and testimony before Congress ensure Fed accountability.

Robert Higgs at The Beacon looks at these three arguments. He writes,

First, “central bank independence has been shown to be essential for controlling inflation.” A little difficulty for this claim, however, resides in the undeniable fact that for more than a century before the Fed’s establishment, the purchasing power of the dollar fluctuated around an approximately horizontal trend line—that is, despite inflations and deflations usually associated with the wartime issuance of fiat money and the postwar return to specie-backed currency, the dollar more or less retained its exchange value against goods and services over the long run, whereas since the Fed’s establishment the dollar has lost more than 95 percent of its purchasing power. If this post-1913 experience is what these economists consider “controlling inflation,” I would not want to see what happens to a currency’s purchasing power when inflation is not controlled! It seems that the petitioning economists have placed the performance bar absurdly low in their judgment of the Fed’s containment of inflation. Evidently, barring a Weimar-Germany-style hyperinflation, they suppose that everything is hunky-dory on the monetary front.

Second, say our esteemed economists, “lender of last resort decisions should not be politicized.” This statement only goes to prove that, as everybody knew already, economists make terrible comedians: the statement is obviously a joke, but it’s just not funny. “Not be politicized,” they say? What is one to call the Fed’s decisions during the past year to dole out trillions in loans, credit lines, guarantees, asset exchanges, and so forth to the big boys on Wall Street? Are we supposed to believe that all those big investment banks that were permitted to transform themselves instantaneously into depository institutions, thereby gaining access to various forms of Treasury and Fed support, were selected and accommodated on purely disinterested grounds? Or may we be permitted to imagine that institutions such as Goldman Sachs and Morgan Stanley just might—might, I said—enjoy a tad more political coziness with the government in general and the Fed in particular than, say, you and I and another three hundred million Americans do?

Finally, the leading economists declare: “The democratic legitimacy of the Federal Reserve System is well established by its legal mandate and by the existing appointments process. Frequent communication with the public and testimony before Congress ensure Fed accountability.” But legitimacy, it would seem, properly lies in the eyes of the legitimizer, not in the tables, charts, and econometric exercises of top-tier academic economists. The Fed’s appointment process, as I see it, suggests more the co-conspiratorial character of the ruling elites than anything we might grace with the adjective “democratic.” And if frequent congressional testimony by Fed officials, notorious for its mumbo-jumbo lack of clarity and definiteness, suffices to “ensure Fed accountability,” then we are left to wonder what led Senator Byron Dorgan to complain on the floor of the Senate on February 3: “We’ve seen money go out the back door of this government unlike any time in the history of our country. Nobody knows what went out of the Federal Reserve Board, to whom and for what purpose. . . . When? Why?” Indeed, the lack of Fed transparency and accountability has been so outrageous during the past year that it has prompted nearly three hundred members of the House of Representatives to support Congressman Ron Paul’s bill to audit the Fed.

But perhaps the takeaway message from the Higgs piece is this bit,

Everybody now understands that economic central planning is doomed to fail; the problems of cost calculation and producer incentives intrinsic to such planning are common fodder even for economists in upscale institutions. Yet, somehow, these same economists seem incapable of understanding that the Fed, which is a central planning body working at the very heart of the economy—its monetary order—cannot produce money and set interest rates better than free-market institutions can do so. It is high time that they extended their education to understand that central planning does not work—indeed, cannot work—any better in the monetary order than it works in the economy as a whole.

Is it time for a call for free banking? The recent actions by central banks and their implication in causing the current crisis, including New Zealand's, make me think that the issue should, at least, be raised and seriously discussed.

EconTalk this week

John Taylor of Stanford University talks with EconTalk host Russ Roberts about the fundamental causes of the financial crisis of 2008. Taylor argues that the housing bubble of the early 2000s was caused by excessively loose monetary policy, in particular, a sustained period of excessively low interest rates pursued by the Federal Reserve. Other topics covered include rules vs. discretion in monetary policy and the risks of inflation in the coming months. The conversation concludes with a discussion of the impact of the current crisis on future monetary policy and the field of macroeconomics.

A productivity commission: Why? (updated x2)

Over at Kiwiblog David Farrar writes

I think a productivity is one of the most important things we can do, for increasing long-term growth. The Australian equivalent is one of the reasons they have done better economically

Really? Can David give one example of things the Australian productivity commission has done and show the growth that resulted from its actions? This question is asked because it is not clear that governments can do all that much to increase long-term growth. In this paper John Landon-Lane (a Canterbury grad, of course) and Peter Robertson ask "Can government policies increase national long-run growth rates?" and their answer isn't encouraging. Their abstract reads,

We obtain time series estimates of the long run growth rates of 17 OECD countries, and test the hypothesis that these are the same across countries. We find that we cannot reject this hypothesis for the first and last three decades of the 20th century. We conclude that: (i) there are few, if any, feasible policies available that have a significant effect on long run growth rates, and; (ii) any policies that can raise national growth rates must be international in scope. The results therefore have bleak implications for the ability of countries to affect their long run growth rates. (Emphasis added).

The paper concludes,

The results therefore have stark implications for the ability of most countries to determine their own long run growth rates. The many policy packages used across these countries, including differences in tax, research, education and investment, did not have significant long run effects on relative growth rates. We conclude therefore that long run growth rates are determined by international factors, and are insensitive to national policies, especially for small countries. This implies severe restrictions of the ability of most governments to increase national long run growth rates.

At the Stumbling and Mumbling blog Chris Dillow writes,

To get an idea of what they mean, here are some annualized real GDP growth rates for some significant countries between 1980 and 2007. I present the figures in ranges, such that we can be 95% confident that true growth is within this range. I do this because, even over a period as long as 27 years, it’s possible for two countries with identical true growth to differ if one has good luck and the other bad.

France: 1.7-2.5%.
Italy: 1.3-2.2%
Spain: 2.4-3.6%
Sweden 1.6-3.0%
UK: 2.0-3.2%
US 2.4-3.7%

These ranges suggest we can be pretty confident that Italy has done worse than the US or UK. But we cannot be at all confident that the US has out-performed Sweden, or vice versa. The opposing poles of mixed capitalism - social democratic Sweden and freer market US - are consistent with similar, maybe indistinguishable, growth rates.

Big differences in institutions and policies, then, seem to generate similar growth rates. Which suggests that - at least within the wide parameters set by actually-existing mixed capitalisms - policies (or at least those that have been tried) might not make much difference to trend growth.

So I have to ask, Where is the evidence that a productivity commission will do anything to our long-term growth rate? What I fear we will get is just a another group of bureaucrats wasting taxpayers money for no good purpose. Perhaps, therefore, we shouldn’t look to national governments to promote long-run growth.

Update: The Inquiring Mind says Productivity Commission – No, Growth – YES

What can a Productivity Commission do that companies, industry associations and other lobby groups cannot?

Is it not the responsibility of Company Boards to set direction such that their organizations are efficient, effective and thus productive?

What is it about NZ Business that continually makes it look to government or quasi-government bodies for direction and /or instruction?

Update 2: Matt Nolan asks When did NZ’s right become communist?

Long-term growth is based on technology, resource allocation, and to some degree the structure of institutions in the economy. I severely doubt that the government can turn around and improve any of these things to the degree required to “catch Australia”. Hell, Australia is closer to its markets, has a larger set of currently important natural resources, and gets “economies of scale” due to its higher population. No government policies can magically fill this gap.

The failure of macroeconomics (updated)

Mario Rizzo at the ThinkMarkets blog posts on The Failure of Macroeconomics. Rizzo wrotes

The current issue of The Economist has a very interesting article on the turmoil among macroeconomists (“The Other-Wordly Philosophers”). Essentially, the article argues that although the dominant macro model, dynamic stochastic general equilibrium theory [DSGE], appears to be in a state of near-total breakdown, there is no agreement among economists as to what should replace it.

The Economist writes

“Would economists be better off starting from somewhere else? Some think so. They draw inspiration from neglected prophets, like Minsky, who recognised that the “real” economy was inseparable from the financial. Such prophets were neglected not for what they said, but for the way they said it. Today’s economists tend to be open-minded about content, but doctrinaire about form. They are more wedded to their techniques than to their theories. They will believe something when they can model it.”

To be fair, if you can't model, in some way, the phenomenon you are considering how do you know you understand it? Models are used because we can't handle the "real world" as it is, we have to bleak it down into pieces so we can deal with it. The question for macro is then, Are they using the right model for understanding the current crisis?

Rizzo asks

[...] what is the root of the difficulty in which macroeconomics finds itself?

His answer,

I think it is the inability to reconcile a reasonable treatment of radical uncertainty with the strictures of out-of-control formalism. We have come a long way from Alfred Marshall’s idea that one does the mathematics and then burns it. In a 1906 letter to A.L. Bowley (of the Edgeworth-Bowley box fame) Marshall says:

“But I know I had a growing feeling in the later years of my work at the subject that a good mathematical theorem dealing with economic hypotheses was very unlikely to be good economics: and I went more and more on the rules – (1) Use mathematics as a shorthand language, rather than an engine of inquiry. (2) Keep to them till you have done. (3) Translate into English. (4) Then illustrate by examples that are important in real life. (5) Burn the mathematics. (6) If you can’t succeed in (4), burn (3). This last I did often.”

Clearly, the adherents of DSGE did not follow points (4) through (6).

But modeling radical uncertainty is a difficult as it is not clear that it can be done within the strictures of any formalism. Risk is the best we have managed to model thus far. If Rizzo has a way to do this, it would indeed be a serious step forward.

Josh Hendrickson at The Everyday Economist ask "Has Macroeconomics Failed?" He writes

Mario Rizzo provides this pithy summary of the story:

…the article argues that although the dominant macro model, dynamic stochastic general equilibrium theory [DSGE], appears to be in a state of near-total breakdown.

I think that this is a bit of wishful thinking from the folks at the Economist, Mario Rizzo, and those referenced and quoted in the article. The fact of the matter is that the DSGE model is NOT “in a state of near-total breakdown” and nor should it be. Rather the criticism (hatred?) of DSGE models fails to understand both the purpose and the scope of these models.

Since the start of the financial crisis, macroeconomics has undergone a great deal of criticism. This criticism has largely been directed at (1) the inability of macroeconomists to forecast such a severe downturn, (2) the lack of a consensus regarding fiscal policy, and (3) DSGE models. I have already written in great detail about (2) and I think that the evidence and the theory is much more clear-cut than the debate would have you believe. I think that many of the differences of opinion had more to do with ideology than economics.

The rest of the Hendrickson posting deals with items (1) and (3). He argues that the as far as forecasting goes the fundamental point is that there were prominent researchers out in front of the current crisis, but they were largely ignored until the downturn. As to point 3, Hendrickson argues that much of the criticism aimed at DSGE models seems to result from a failure to understand the use of the DSGE model.

Given the current crisis, debates like this about macro will only intensify and who knows where they will end. But we have to hope that it will result in a better macro. God knows we need one.

Update: Matt Nolan on Quote 22: Stumbling and Mumbling on Macroeconomics.

Interesting blog bits

1. Size Matters. Or so says Ele Ludemann at the Homepaddock blog.
2. Brad Taylor on Space Steading. The Space Frontier Foundation looks like an interesting organization. Their central goal is the colonising of space.
3. Will Wilkinson on Fed Independence: Too Important to Verify. The Fed can be independent and unaccountable and undemocratic, or it can be subject to the political whims of elected officials; neither is a very attractive prospect.
4. David Henderson Audit the Fed, or End It? Some people want the Federal Reserve Bank be audited. Is this a good idea? There's one obvious plus and there are two less-obvious minuses.
5. Tim Worstall on Measuring inequality. It's very definitely true that income inequality has risen in recent decades: but much much harder to insist that consumption inequality has done.
6. Greg Mankiw has some Questions for the President.

Colman comments go international

I posted earlier on the comments by National Business Review publisher Barry Colman about the "huge band of amateur, untrained, unqualified bloggers who have swarmed over the internet pouring out columns of unsubstantiated “facts” and hysterical opinion."

Now Colman's comment have been picked up upon internationally. Economist Peter Klein has blogged on the topic at the The Beacon, the blog of the Independent Institute.

In the comments section to the Klein post Mary Theroux makes the interesting observation that

Yes, the blogosphere has some junk, but our one local daily paper has virtually nothing but junk science in it, and I certainly wouldn’t trust any economic analysis it offered: Give me a free and open marketplace of information anytime!

And this is the point. There is junk in the blogosphere no doubt, but there is also junk in the standard print media, but what keeps the junk in check is competition in the market for information. The more competition, the more likely it is that junk will be spotted and driven out. And the blogosphere provides competition. So we should welcome it, no matter what effects it may have on the more traditional news outlets.

Incentives matter: Goldman Sachs file (updated)

Peter Klein over that the Organizations and Markets blog writes on the $3.4 billion second-quarter earnings of Goldman Sachs and explains that they shouldn't surprise anyone. But I'm sure they have. Klein writes

The business of political capitalism, that is. Like Enron, Goldman operates primarily in the nebulous world of public-private interaction. It is the US’s most politically powerful financial firm, skilled at navigating the byzantine regulations governing the virtually nationalized US financial sector. Goldman’s eye-popping $3.4 billion second-quarter earnings shouldn’t surprise anyone; as Craig Pirrong notes, these earnings reflect good old-fashioned moral hazard, with Goldman exploiting its too-big-to-fail status by taking on huge amounts of risk.

Craig Pirrong at the Streetwise Professor blog explains,

Goldman knows it is too big to fail. How does it know this? Well, the government bailed out AIG not so much for AIG’s sake, but for the sake of big AIG counterparties–most notably Goldman. Moreover, given the conventional wisdom that the government’s primary error in the financial crisis was its failure to bail out Lehman–a piker compared to Goldman–it doesn’t take a rocket scientist to figure out that it won’t repeat that mistake in the future, and let Goldman go down. So Goldman knows it can get bigger, and take more risk. It is the classic heads Goldman wins, tails the sucker taxpayer eats the loss gambit. If nobody steps in to rein in the firm, it will continue to add risk, thereby enhancing the value of the Treasury put hiding in the equity entry on its balance sheet.

Somebody should be stepping in–but nobody is. Why not? Partly, no doubt, it is Goldman’s political heft. It is likely too that important policy makers don’t want to crack down on a major source of risk capital to the markets in the fear that this would impede a recovery. Even though in reality, that risk capital is your money and mine, with the exception that we have no chance of capturing the upside, and are left with a good chunk of the downside. This is a piece with the hair-of-the-dog strategy being pursued by Treasury and the Fed.

The moral hazard problem here should be obvious to anyone. Goldman Sachs takes huge risks, which if they come off makes them huge profits. If they don't come off them they know they are Too-Big-To-Fail, so the taxpayer gets to pick up the bill. A win-win for Goldman Sach, if not the taxpayer. But this should point out the reason why we want to keep politics and business apart.

Update: In the comments section Peter Salmon points us to this Goldman Sachs Internal Memo.

More from the NBR on the infamous BERL report (Updated)

The National Business Review has a story, by Mitchell Hall, in its print edition (can't find it online) on the battle between Matt Burgess and Eric Crampton (amateur, untrained, unqualified blogger?) and BERL on the social costs of alcohol. A nice point that the article makes is a list of yet to be justified assumptions that BERL makes to get to their headline figure. Hall writes,

"Rather than continue to assume without any justification every major component of their headline figures, as BerI appears content to do, we would have expected these economic consultants to mount a defence in economics," the pair [Burgess and Crampton] challenged.

They argued that Berl hadstill not justified, or been able to cite formal theory or evidence in support of some aspects of the report, and contended that these assumptions produced over 90% of Berl's headline costs. Those assumptions were:

• all harmful drinkers are irrational;
• all irrational drinkers receive zero gross economic benefit from all drinking, both above and below the threshold for harmful drinking (therefore all private costs are social costs);
• an epidemiological threshold determines the cutoff point for alI economic benefits;
• in the counterfactual, all harmful drinkers are perfect complements for capital and are irreplaceable;
• other than differences in age and gender, prisoners have the same characteristics as an average member of the population;
• other than differences in age and gender, heavy drinkers would have the same characteristics as an average member of the population but for their drinking;
• using average population values and ignoring most cohort characteristics of heavy drinkers and prisoners; and
• up to 50% of social costs of harmful drinking are potentially avoidable.

It would be good to see BERL address these issues directly. There is more to the differences between BERL and Burgess and Crampton than just different "world views".

Update: I'm behind the play, Eric Crampton blogs on the NBR article here.

Government motors

Reason’s Ron Bailey writes

Back in April, even as the federal government was bailing out General Motors and Chrysler to the tune of tens of billions of dollars, Obama flatly stated, "I don't want to run auto companies...." In June, the president reiterated his stance when he declared, "What I have no interest in doing is running GM...."

And now this from the Washington Post:

Now that the Obama administration has spent billions of dollars on the bailouts of General Motors and Chrysler, Congress is considering making its first major management decision at the automakers.

Under legislation that has rapidly gained support, GM and Chrysler would have to reinstate more than 2,000 dealerships that the companies had slated for closure.

and

Since federal money has been used to sustain the automakers, they [the dealerships] say Congress has an obligation to intervene.

And you can bet this won’t be the last time you see Congress intervening in GM's management decisions.

Amateur, untrained, unqualified: bloggers or the NBR? We report, you decide. (updated x8)

Eric Crampton blogs on a pitch for subscriptions that he received from the National Business Review. This is the bit I loved: the NBR writes,

Worse still the model has spawned a huge band of amateur, untrained, unqualified bloggers who have swarmed over the internet pouring out columns of unsubstantiated “facts” and hysterical opinion.

I don't know about other areas, but when it comes to economics I know I trust a number of bloggers a lot more than I trust the NBR. There are a number of bloggers out there who are much more professional, better trained and more qualified to comment on economics than anyone at the NBR. If you don't believe me take a look at some of the econ blogs on my sidebar.

Does the NBR really think its better at dealing with development economics than Bill Easterly, or better at dealing with Austrian economists than Peter Boettke or Steve Horwitz, or better at commenting on almost any economic issue than Gary Becker or Richard Posner, or more knowledgeable about Adam Smith than Gavin Kennedy, or know more about organizational economics and the economics of institutions than Nicolai J. Foss and Peter G. Klein? Then there is David Friedman or Russ Roberts and Don Boudreaux or Tim Harford or Greg Mankiw or Arnold Kling and Bryan Caplan or Alex Tabarrok and Tyler Cowen, or Al Roth. If only the NBR had such people with their level of professionalism, training and qualifications.

If the NBR wants to be taken seriously it could do well to pull its head in. As it turns out, like Eric, I'm a fan of the NBR, but they have lost the plot on this one.

Update: Whaleoil reckons that Barry Colman does his nut.

Update 2: Cactus Kate notes that Colman Blasts Farrar.

Update 3: Lew at Kiwipolitico writes on Duelling imperatives.

Update 4: Kiwiblog enters the battle that is Barry vs the bloggers!

Update 5: Not everybody hates bloggers. Eric Crampton blogs on an article from the Wall Street Journal which discusses the rise of economics blogs.

Traffic to the top sites, such as Marginal Revolution, Freakonomics and the blogs from academics such as Paul Krugman, Greg Mankiw and Brad DeLong, surged anywhere from 80% to 250% from July to September 2008 as the financial crisis intensified, according to Compete.com, a Web site that measures Internet traffic. The most popular blogs can attract as many as 50,000 to 100,000 page views a day.

Here in New Zealand

The latest New Zealand top-20 blogs list includes three economics blogs: The Visible Hand at #18, your humble narrator [Offsetting Behaviour] at #19, and Peter Cresswell's Objectivist blog, NotPC, which sits at #3 and should also be counted as an economics blog. US readers: you got that right. A stridently Objectivist blog is the #3 ranked NZ blog. I don't think that Bernard Hickey's blog gets counted for some reason, but it's surely up there as well, and probably higher than either TVHE or me. Paul Walker's AntiDismal comes in at #25.

Update 6: Lance Wiggs asks, The NBR is in trouble – what should they do? and Julie Starr comments ‘Hi, you’re hysterical and biased, please subscribe to the NBR’.

Update 7: Peter Salmon has some thoughts on the Media:but not as it was.

Update 8: Bernard Hickey on How to profitably publish financial news online for free.