The fascist economy

At the Fraser Institute economics professor Steven Horwitz has a brief essay on Fascism. On the topic of the economics of fascism Horwitz writes,

What emerged as the fascist economic system then was a combination of the socialist rejection of capitalism and the nationalist rejection of internationalist socialism. It’s not coincidental that “Nazi” was short for National Socialist German Workers Party. The very name suggests that the fascists started from a socialist premise (including the emphasis on being a “workers” party), but added the “nationalist” (and specifically “German”) twist.

Rather than have full-blown socialism as we saw in the early years of the Soviet Union, the fascists generally preferred hybrid forms that often maintained the appearance of elements of capitalism but with a much larger role for the state in allocating resources. A look at the Nazi Party platform of 1920 shows the very strong influence of socialism in the economic planks, including objections to the earning of interest, the desire to nationalize industries, the confiscation of profits, and land reform. Not all of these were put into place when Hitler gained power, but the Nazis’ antipathy toward capitalism is quite clear, even as they often co-opted big business into their power structure in during their reign. The trappings of private ownership were often preserved, but the Nazis used the power of the state to try to ensure that private ownership was used as a means toward the national ends that they defined.

The Italian model was similar in its broad outlines, though different in its execution. The Italians were more clear than the Germans about the way in which market competition was destructive of national goals. They didn’t see Russian socialism as a solution for the reasons noted above. Instead, they argued for industry-level partnerships among labor, capital, and the political class. The idea was that by working collectively, these cartel-like organizations could resolve questions of what to produce, what price to charge, what wage to pay, and the like all without the need for cut-throat competition among firms or workers, or the use of strike threats between workers and capitalists. By putting national interests first, these collectives could plan out production industry by industry and ensure a cooperative peace among Italians. So, once again, the system kept some of the trappings of capitalism, such as nominally private ownership, but set them in a system where collective planning of a limited, and nationalistic, sort was the overarching structure.

Both of these systems are probably most accurately called “corporatism.” In such a system, we get these sorts of private-public collaborations in which private ownership is combined with state control and privileges for labor, and where all are expected to serve some larger national goal. It looks like private ownership, which is often the source of the claim that fascism is a form of capitalism, but the degree of distrust of the unplanned order of free markets and the de facto power that falls into the hands of the state to set goals both point to it as being more accurately a form of socialism or planning.

Avraham Barkai writes in his book "Nazi Economics: Ideology, Theory, and Policy", Oxford: Berg Publishers Ltd., 1990.

In an off-the-record talk with a newspaper editor in 1931, Hitler defined the basic principle of his economic project: "What matters is to emphasize the fundamental idea in my party's economic program clearly-the idea of authority. I want the authority; I want everyone to keep the property he has acquired for himself according to the principle: benefit to the community precedes benefit to the individual ["Gemeinnutz geht vor Eigennutz"]. But the state should retain supervision and each property owner should consider himself appointed by the state. It is his duty not to use his property against the interests of others among his people. This is the crucial matter. The Third Reich will always retain its right to control the owners of property." Here we have all the basic assumptions that later determined the Nazis' economic plans and their actual policy: virulent antiliberalism, subjection of the economy to the primacy of political and social goals as defined by the national leadership, and state control over all economic activities. [p.26-7]

So you could do anything you liked with your own property, just as along as it was exactly what the state wanted you to do with it.

Macroeconomists do it with models

John Taylor has an interesting post - Measuring the Impact of the Stimulus Package with Economic Models - at his Economics One blog on the problems of evaluating the effects of the stimulus package of 2009 in the US. Taylor writes,

It's been nearly a year since the stimulus package of 2009 was passed. Unfortunately most attempts to answer the question “What was the size of the impact?” are still based on economic models in which the answer is built-in, and was built-in well before the stimulus. Frequently the same economic models that said, a year ago, the impact would be large are now trotted out to show that the impact is large. In other words these assessments are not based on the actual experience with the stimulus. I think this has confused public discourse.

In other words, should we be surprised that we see the rabbit come out of the hat given we saw it carefully put it there in the first place? Taylor continues,

An example is a November 21 news story in the New York Times with the headline “New Consensus Sees Stimulus Package as a Worthy Step.” Authors Jackie Calmes and Michael Cooper write that “the accumulation of hard data and real-life experience has allowed more dispassionate analysts to reach a consensus that the stimulus package, messy as it is, is working. The legislation, a variety of economists say, is helping an economy in free fall a year ago to grow again and shed fewer jobs than it otherwise would.”

As evidence the article includes three graphs, which are reproduced on the left of the chart below. Each of the three graphs on the left corresponds to a Keynesian model maintined by the group shown above the graph. All three graphs show that without the stimulus the recovery would be considerably weaker. The difference between the black line and the gray line is their estimated impact of the stimulus. But this difference was built-in to these models before the stimulus saw the light of day. So there are no new hard data or real life experiences here.

Taylor then makes the point that if the rabbit isn't put in the hat, it doesn't come out.

In fact, a number of other economic models predicted that the stimulus would not be very effective, and, using the same approach, those models now say that it is not very effective. To illustrate this I have added two other graphs on the right-hand side of the chart which did not appear in the New York Times article. The first one is based an a popular and well-regarded new Keynesian model estimated by Frank Smets, Director of Research at the European Central Bank, and his colleague Raf Wouters. Focus again on the difference between the black and the gray lines, which is what is predicted by that model, as shown in research by John Cogan, Volker Wieland, Tobias Cwik, and me. Note that the impact is very small. The second additional graph on the right is based on the research of Professor Robert Barro of Harvard University. As he explained last January, “when I attempted to estimate directly the multiplier associated with peacetime government purchases, I got a number insignificantly different from zero.” So according to that research, the difference between the black and the gray line should be about zero, which is what that graph shows. So there is no consensus.

There seems to be at least two basic messages that follow from this: one, when using models to evaluate policy outcomes it is important to go beyond the use of just a few select models, and check to see if the outcome is robust across a number of different models. Second, it is now time to start looking at the direct impacts of the stimulus by looking at the hard data.

Christians and capitalism

From the Cato Institute comes this video of a book forum on Money, Greed, and God: Why Capitalism Is the Solution and Not the Problem by Jay Richards. The forum features the author, Jay Richards, with comments by Doug Bandow, Senior Fellow, Cato Institute, and author, Beyond Good Intentions: A Biblical View of Politics. Moderated by Daniel Griswold, Director of the Center for Trade Policy Studies, Cato Institute, and author, Mad about Trade: Why Main Street America Should Embrace Globalization.

Defenders of the free market must often contend with accusations from Christians that capitalism is immoral despite its track record of delivering the goods. Jay Richards says there's no contradiction between Christianity and capitalism. He argues that markets, though imperfect, are a natural outgrowth of God's creation and an important tool for helping the poor and disadvantaged.

Markets fail. That's why we need markets

Or so says Arnold Kling and Nick Schulz in the Christian Science Monitor:

This view can be summarized as “Markets fail. That’s why we need markets.”

This seemingly paradoxical view is based on several overlapping strands of research in economics as it pertains to development, history, technology, business expansion, and new-firm formation. According to this view, entrepreneurs at work in the economy – in finance, high tech, manufacturing, services, and beyond – are constantly experimenting, creating new business models, techniques, and technologies that upend the established order of things.

Some new technologies and innovations are genuine improvements and are long-lasting welfare enhancers. But others are the basketball equivalent of pump fakes – they look like the real deal and prompt market actors to leap hastily into action, only to realize later that their bets were wrong.

Given this dynamic, markets are unpredictable, prone to booms and busts, characterized by bouts of exuberance that are rational or irrational only in hindsight.

But markets are also the only reliable mechanism for sorting out this messy process quickly. In spite of the booms and busts, markets drive genuine long-run innovation and wealth creation.

When governments attempt to impose order on this chaotic and inherently risky process, they immediately run up against two serious dangers.

The first is that they strangle new innovations before they can emerge. Thus proposals for a Consumer Financial Protection Agency, a systemic risk regulator, a public health insurance plan, a green jobs policy, or any attempt at top-down planning may do more harm than good.

The second danger has to do with the nature of political economy. Politics creates its own kind of innovators who can be as destabilizing to markets as market actors themselves – but in far more pernicious ways.

Economists call these political entrepreneurs “rent-seekers.” Rent-seekers gain wealth, not by creating it, but by channeling it through political favors. Examples include government-sponsored monopolies, “targeted” tax breaks for special industries, and legislative loopholes inserted by lobbyists.

The boom in housing and mortgage securities that ended so badly was fueled by government policies that were encouraged by rent-seekers in the real estate, home building, and mortgage finance industries.

Rent-seekers aren’t partisan. They used President Bush’s push for an ownership society to promote sketchy mortgage products. Before that, they used President Clinton’s push for a fairer economy to compel banks to make loans to poorer neighborhoods. In both cases, rent-seekers turned political slogans into profit, but at a steep cost to society when the boom ended.

The response to the current economic crisis has perpetuated and even intensified this process, as hundreds of billions of dollars of taxpayer funds have been used to prop up the very firms that took such reckless risks. The bigger the bad bet, the bigger the bailout.

This gets to the key difference between markets and governments. When innovation-driven excesses and imbalances are recognized in the marketplace, the system can correct itself quickly. This is less the case when government policy failure occurs.

Because political failure is less publicly tolerable than market failure, the temptation becomes for policymakers to avoid acknowledging their role in creating or perpetuating problems. Or they double down on bad bets. So rather than recognize the government’s central role in the housing boom and bust and quickly changing its ways, we see the federal policy apparatus continuing to throw good money after bad in the mortgage market and on Wall Street.

Markets fail; but they learn from their failures. That’s why we need markets. Government can promise to guarantee our prosperity; but only markets can really deliver.

Is an undervalued currency the key to economic growth?

The short answer seems to be no. A recent paper by Michael Woodford argues that the evidence in favour of an positive link between an undervalued currency and economic growth is less persuasive than some authors, Dani Rodrik being one, suggest. This is for two reasons. First, some papers exaggerate the strength and robustness of the association between the real exchange rate and growth in the cross-country evidence. And second, even granting the existence of such a correlation, a causal effect of real exchange rates on growth is hardly the only possible interpretation.

The abstract of the Woodford paper reads,

Dani Rodrik (2008) offers a provocative argument for policies that seek to maintain an "undervalued" exchange rate in order to promote economic growth. The key to his argument is the empirical evidence that he presents, indicating correlation of his measure of undervaluation with economic growth in cross-country panel regressions. Rodrik does not really discuss the measures that should be undertaken to maintain an undervalued exchange rate, and whether it is likely that a country that pursues undervaluation as a growth strategy should be able to maintain persistent undervaluation. For example, he remarks (as justification for interest in the question of a causal effect of undervaluation on growth) that "one of the key findings of the open-economy macro literature is that nominal exchange rates and real exchange rates move quite closely together." But while this is true, and while it is widely interpreted as indicating that monetary policy can affect real exchange rates (since it can obviously move nominal rates), it hardly follows that monetary policy alone can maintain a weak real exchange rate for long enough to serve as part of a long-run growth strategy. Indeed, conventional theoretical models with short-run price stickiness, that are perfectly consistent with the observed short-run effects of monetary policy on real exchange rates, imply that monetary policy should not have long-run effects on real exchange rates. Rodrik also cites evidence showing that sterilized interventions in the foreign-exchange market can affect real exchange rates. But economic theory suggests that interventions not associated with any change in current or subsequent monetary policy should have even more transitory effects. And the experiences of countries that have sought to use devaluation to boost economic growth have often found that the real exchange rate effect of a nominal devaluation is not long-lasting. Nonetheless, the point of the paper is to provide evidence that undervaluation favors growth, on the assumption that policies to maintain undervaluation are avail- able, and it is that central contention that I shall examine here. I find the evidence less persuasive than the paper suggests, for two reasons. First, I believe that the paper exaggerates the strength and robustness of the association between the real exchange rate and growth in the cross-country evidence. And second, even granting the existence of such a correlation, a causal effect of real exchange rates on growth is hardly the only possible interpretation.

The wages of sin ...

are high.

A new paper by Lena Edlund, Joseph Engelberg and Christopher A. Parsons, The Wages of Sin, looks at the high-end prostitution market, the so called escort market.

A standard argument for the high wages of prostitutes is that they compensate for risk and things like foregone marriage opportunities due to the stigma of prostitution. This new paper looks at the prostitution market where there is a lower risk, the high-end escort service industry. These workers do not work on the street and thus have a better control on who they do business with. Also, they are less visible, which should help a little with stigma issues.

It may be expected that the price paid for an escort would decrease with age. But it appears to do so very little. In fact, wages have a hump-shaped pattern, with a peak at the age bracket where the probability of marriage is the highest in the general population. This suggests that foregone marriage opportunities are important. Furthermore, Edlund, Engelberg and Parsons find that those escorts whose activity has no impact on the marriage market, those who, for example, do not offer sex or are transsexual, do not have such a hump. Finally, in places where most of the business is with travellers, the premium is lower.

The abstract reads,

Edlund and Korn [2002] (EK) proposed that prostitutes are well paid and that the wage premium reflects foregone marriage market opportunities. However, studies of street prostitution in the U.S. have revealed only modest wages and considerable risks of disease and violence, casting doubt on EK’s premise of an unexplained wage premium. In this paper, we present evidence from high-end prostitution, the so called escort market, a market that is, if not entirely safe, notably safer than street prostitution. Analyzing wage information on more than 40,000 escorts in the U.S. and Canada collected from a web site, we find strong support for EK. First, escorts in the sample earn high wages, on average $280/hour. Second, while looks decline monotonically with age, wages follow a hump-shaped pattern, with a peak in the 26-30 age bracket, which coincides with the most intensive marriage ages for women in the U.S. Third, the age-wage profile is significantly flatter, and prices are lower (5%), despite slightly better escort characteristics, in cities that rank high in terms of conferences, suggesting that servicing men in transit is associated with less stigma. Fourth, this hump in the age-wage profile is absent among escorts for whom the marriage market penalty is lower or absent: escorts who do not provide sex and transsexuals.

Happy birthday, Ronald

Happy Birthday to Ronald Coase who turned 99 years young today. He was born at 3:25 p.m. on December 29th, 1910.

Coase received the Nobel Prize in 1991 “for his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy.”

EconTalk this week

Clifford Winston of the Brookings Institution talks about the ideas in his book, Market Failure vs. Government Failure, with EconTalk host Russ Roberts. Winston summarizes a large literature on antitrust, safety regulation and environmental regulation. He finds that government regulation often fails to meet its objectives. While markets are imperfect, so is government. Winston argues that idealized theories of government intervention based on textbook theories of market failure are not the way regulation turns out in practice. He argues that special interest politics explains much of the disappointing outcomes of government regulation.

Attack of the utility monsters

The Cato Daily Podcast for the December 22, 2009 was "Attack of the Utility Monsters" featuring Jason Kuznicki.

The paper being discussed in the podcast is Attack of the Utility Monsters: The New Threats to Free Speech.

Freedom of expression is looking less and less like a settled issue. Challenges to it have lately arisen from the right, from the left, from Muslim perspectives, and even in the name of protecting children online. These challenges seem to share an underlying concern, namely that we must balance free expression against the psychic hurt that some expressions will provoke. Often these critiques are couched in language that draws or appears to draw, on the law and economics movement. Yet the cost-benefit analyses advanced to support restrictions on expression are incomplete, subjective, and self-contradictory.

Several examples help to illustrate this point, including flag-desecration laws, hate-speech laws in the United Kingdom and Canada, U.S. college and university speech codes, the Cairo Declaration on Human Rights in Islam, and the Megan Meier Cyberbullying Prevention Act, currently before the House Judiciary Subcommittee on Crime, Terrorism, and Homeland Security. Although seemingly unrelated, these measures rely on a common assumption, namely that governments should provide emotional well-being to their citizens, even at the expense of free expression. This assumption discounts the emotional well-being of other citizens, neglects countervailing social considerations, and hands arbitrary power to governments.

The result is not more happiness, but a race to the bottom, in which aggrieved groups compete endlessly with one another for a slice of government power. Philosopher Robert Nozick once observed that utilitarianism is hard-pressed to banish what he termed utility monsters—that is, individuals who take inordinate satisfaction from acts that displease others. Arguing about who hurt whose feelings worse, and about who needs more soothing than whom, seems designed to discover—or create—utility monsters. We must not allow this to happen.

Instead, liberal governments have traditionally relied on a particular bargain, in which freedom of expression is maintained for all, and in which emotional satisfaction is a private pursuit, not a public guarantee. This bargain can extend equally to all people, and it forms the basis for an enduring and diverse society, one in which differences may be aired without fear of reprisal. Although world cultures increasingly mix with one another, and although our powers of expression are greater than ever before, these are not sound reasons to abandon the liberal bargain. Restrictions on free expression do not make societies happier or more tolerant, but instead make them more fractious and censorious.

The relationship between capitalism and freedom

The Washington Post reports,

SEOUL -- North Korean leader Kim Jong Il moved early this month to wipe out much of the wealth earned in the past decade in his country's private markets. As part of a surprise currency revaluation, the government sharply restricted the amount of old bills that could be traded for new and made it illegal for citizens to have more than $40 worth of local currency.

It was an unexplained decision -- the kind of command that for more than six decades has been obeyed without question in North Korea. But this time, in a highly unusual challenge to Kim's near-absolute authority, the markets and the people who depend on them pushed back.

Grass-roots anger and a reported riot in an eastern coastal city pressured the government to amend its confiscatory policy. Exchange limits have been eased, allowing individuals to possess more cash.

The currency episode reveals new constraints on Kim's power and may signal a fundamental change in the operation of what is often called the world's most repressive state. The change is driven by private markets that now feed and employ half the country's 23.5 million people, and appear to have grown too big and too important to be crushed, even by a leader who loathes them.

While these events in no way guarantee that North Korea will soon become a freer place, they do suggest that economic freedoms can help constrain even the most oppressive of governments.

The Post continues,

Still, analysts say there has also been evidence of unexpected shifts in the limits of Kim's authority.

"The private markets have created a new power elite," said Koh Yu-whan, a professor of North Korean studies at Dongguk University in Seoul. "They pay bribes to bureaucrats in Kim's government, and they are a threat that is not going away."

Is this a case where corruption can be efficient? Being able to bribe the bureaucrats may not only undermine the power of the state, it may also lead to a more efficient outcome than if the bureaucrats where incorruptible.

Message on Offsetting Behaviour (updated x2)

If anyone is looking for Offsetting Behaviour, it is currently down due to GoogleFail: they think it's a spam blog. But it will be back soon.

Update: Eric comments

Correction: will be back when and if a human at google checks my blog and confirms that it isn't spam.

I had a page rank of 6 before take down for chrissakes. The whole University has only a PR of 7. How the hell does a spam blog get a PR of 6?

If you want to know what has been going on at Offsetting Behaviour here is the Google Cache as at 27 Dec 2009 06:21:26 GMT.

Update 2: Offsetting Behaviour is now back.

Economics as science

From Bloggingheads.TV comes this video of the Alex Rosenberg and David Levine discussing the topic of Economics as Science.

Five questions for a Keynesian

At at PBS's Nightly Business Report, Steven Horwitz has Five Questions for a Keynesian. Should you, over the Christmas period, be involved in a conversation at some social event with a Keynesian type, Horwitz suggests these five questions to get the argument really going:

1. Why did Keynes think savings was bad if when people save through financial intermediaries they give control over resources to the banking system, which in turn will lend that out to firms to create capital and new jobs?

2. How does government spending create jobs and wealth if the resources that government spends must ultimately come from the private sector, through taxes or reduced borrowing due to government borrowing more (or inflation), and the private sector would have spent it either on consumption directly or on investment through savings anyway?

3. If one of the problems of the housing boom is that we put too many resources into housing and finance, how will a Keynesian government spending package know where that spending should have gone instead?

4. Keynes frequently wrote about the importance of the uncertainty of the future and the way that made things difficult for private investors and for the connection between savings and investment. Why doesn't that same uncertainty prevent governments from knowing exactly how much and where they should be spending in a recession, especially because markets have prices and profits as signals to help entrepreneurs navigate that uncertainty while government bureaucrats do not have similar signals?

5. Given the enormous role that government interventions played in causing the current recession, from the expansionary policies of the Fed to GSEs like Fannie and Freddie, to misguided regulations in housing and banking, why should anyone believe that the same government actors will know how to solve it?

Feel free to report here any and all answers you receive to these questions.

The usefulness of the "Buy Kiwi Campaign" 2

Earlier I posted on The usefulness of the "Buy Kiwi Campaign", arguing that the campaign was useless. Now over at Offsetting Behaviour Eric Crampton take me, and NotPC, to task for this view. Eric argues that while it may have had no economic impact, the campaign was not in fact useless. He writes,

The biggest problem with MMP is the costly bargains main parties have to make with support partners. The more efficient that main parties are at creating symbols to placate support parties that have zero real world effect, the better. Yes, they can cost a bit of money in the budget; NotPC says the Buy NZ campaign cost somewhere around $10 million. But that's insanely cheap compared to other anti-trade policies. I cannot imagine a better piece of policy that buys off the Greens and the nationalists while having trivial deadweight costs. Yeah, so every tax dollar has a deadweight cost somewhere around thirty cents. So the policy cost $13 million all up, pure loss. But compared to hiking tariffs or abandoning the free trade deal with China? Priceless.

I guess part of the disagreement is due to me looking at the campaign from a economic point of view, rather a political point of view. Also Eric's argument only works if the alternative buy-off of the Greens was more expensive than the "buy New Zealand campaign", and we don't know what the alternative was. If we are to assume that the campaign buy-off was the cheapest option, then we live in the (2nd) best of all possible worlds. But it seems unlikely to me that, given we are talking politics, we would be in the best of all possible worlds. Just because it is doesn't mean it's best, or even 2nd best. Political markets are not as efficient as economics markets. Politicians are spending other people's money and as Milton Friedman put it "very few people spend other people's money as carefully as they spend their own." I think Eric is, implicitly, assuming we got the best deal possible, something which for me at least seems a little too Panglossian.

Smoot-Hawley tariffs and the Great Depression

A view common among economists is that the Smoot-Hawley tariffs of the 1930s in the US were a poor policy choice, but they were not a main reason for the severity of the Great Depression. With regard to the latter point in the previous sentence, Scott Sumner at the TheMoneyIllusion blog writes,

In the period around March and April 193o, there were a few “green shoots” in the economy. The stock market recovered a significant chunk of the huge losses in 1929. (I recall the Dow fell well below 200 during the famous crash, and got back up over 260 in April. The 1929 peak had been 381.) Then in May and June everything seemed to fall apart, and stocks crashed again. So what happened in May and June?

The headline news stories during those months were the progress of Smoot-Hawley through Congress. Each time it cleared a major legislative hurdle, the Dow fell sharply. This pattern was obvious to those following the markets, and was frequently commented upon. After it cleared Congress it went to Hoover. The President received a petition from over 1000 economists pleading with him to veto the bill. (A veto would not have been overridden.) Over the weekend Hoover decided to sign the bill, and on Monday the Dow suffered its biggest single day drop of the entire year.

Sumner argues that the Smoot-Hawley reduced investment not only in the US but all over the world and interest rates fell, the opportunity cost of holding gold fell, and the demand for gold rose. This caused deflation, which made the Depression even worse.

Implications of the crisis for introductory economics

This comes from Economics One the blog run by Stanford's John Taylor. It rises a number of interesting issues about the teaching of first year economics, in particular after the recent financial crisis.

So how should introductory economics teaching change as a result of the financial crisis? Talyor writes,

Clearly we need to include more on financial markets, but based on my experience teaching in the two-term introductory course at Stanford, I think the single most important change would be to stop splitting microeconomics and macroeconomics into two separate terms. The split has been common in economics teaching since the first edition of Paul Samuelson’s textbook, which put macro first. Many courses now have micro in the first term and then macro in the second.

But regardless of the order now used, I think a reform that integrates micro and macro throughout is worth considering. There were arguments for doing this before the crisis, including the fact that in research and graduate teaching the tools of micro have now been integrated into macro.

The financial crisis clinches the case for full integration in my view. The crisis is the biggest economic event in decades and it can only be understood with a mix of micro and macro. To understand the crisis one must know about supply and demand for housing (micro), interest rates that may have been too low for too long (macro), moral hazard (micro), a stimulus package (macro) aimed at such things as health care (micro), a new type of monetary policy (macro) that focuses on specific sectors (micro), debates about the size of the multiplier (macro), excessive risk taking (micro), a great recession (macro), and so on. It you look at the 22 items that the Financial Crisis Inquiry Commission has been charged by the Congress to examine, you’ll see that it is a mix of micro and macro. Defining the first term as micro and the second term as macro, or visa versa, is no longer the best way to allocate topics.

Austrian economics: recent work

Mario J. Rizzo has a new article, Austrian economics: recent work, available on The New Palgrave Dictionary of Economics, Online Edition, 2009. The abstract reads,

This article reviews research in Austrian economics over the last 25 years, relating it to (but not discussing in detail) earlier classic work in the Austrian tradition. Core issues are business cycle theory, entrepreneurship, market processes and economic institutions, the communication of knowledge in markets, spontaneous order, and issues related to law and economics.

The Introduction continues,

In the past 25 years, a large amount of new research in Austrian economics has developed and expanded the basic themes that are central to its unique identity (O'Driscoll and Rizzo, 1996). These highly interrelated themes are (1) the subjective, yet socially embedded, quality of human decision making; (2) the individual's perception of the passage of time (‘real time’); (3) the radical uncertainty of expectations; (4) the decentralization of explicit and tacit knowledge in society; (5) the dynamic market processes generated by individual action, especially entrepreneurship; (6) the function of the price system in transmitting knowledge; (7) the supplementary role of cultural norms and other cultural products (‘institutions’) in conveying knowledge; and (8) the spontaneous – that is, not centrally directed – evolution of social institutions. The specific ways in which these themes have recently manifested themselves is the subject of this article.

If you can't access the final version, there is an almost-final version available here.

The usefulness of the "Buy Kiwi Campaign"

The Importers Institute comments on the usefulness of the "Buy Kiwi Campaign":

The Greens and the last Labour government decided to fund a "Buy Kiwi Campaign". They spent $10.2 million from our taxes, most of it ($8.4m) with an advertising agency.

The Ministry of Economic Development has now commissioned a review from consultants MartinJenkins and Associates. The report is available from the Ministry's website: http://tinyurl.com/ydnorqw.

The report concluded "there was no convincing evidence of overall impact on consumer spending", "there was a lack of conventional policy analysis" and "there was no assessment of the likely impact or of the costs and benefits". In other words, Green and Labour politicians spent our money like confetti, spraying it against the Wellington wind - and achieved nothing of any use.

We could have told them all of that before they spent a single cent of our money. The only beneficiaries were some residents of Grey Lynn, who lined their pockets with the advertising extravaganza.

The uselessness of the campaign was very predictable. As Chris Worthington wrote back in 2007,

If you haven’t seen the new poster for the “Buy New Zealand made” campaign, it features an attractively attired woman, asking the question, “Does my economy look good in this?” The implication, of course, is that we should think carefully about the damage wrought when we purchase foreign-made goods.

As an economist, I am loath to criticise a campaign that features pretty models urging us to think more about the economy. But, to my great dismay, there simply isn’t any intellectual merit to the campaign’s message. Buy all the foreign products you want – it won’t hurt the domestic economy in the slightest.

Worthington continues,

If we think harder about the trade process, it becomes clear that there is an error in the intuition that when foreign goods are purchased, spending power (and thus jobs) vanish from the domestic economy.

The mistake begins with the terminology. We don’t “buy” imports, we swap for them. In order to purchase that Chinese-made dress, our poster-girl first needs to find someone willing to take her New Zealand dollars in exchange for Chinese currency. But New Zealand dollars serve only one purpose – you can buy New Zealand produced goods or services (exports), or you can lend them to New Zealanders who will in turn buy New Zealand produced goods or services.

So the money does not disappear – we can only buy imports if there is someone willing to accept our exports in return, either now or in the future (if the money is used for lending). And, indeed, imports and exports tend to closely balance over the long-run. Over the last 20 years New Zealand has had an average trade surplus of 0.9% of GDP.

So buy foreign, it makes not difference to the New Zealand economy.

The why of Boxing Day sales

For those of you who have been taking advantage of the Boxing Day Sales here is a question, Why do we see post-Christmas sales? Why are the sales right after Christmas and why do they happen every year?

There are a number of possible reasons. To get rid of all the unwanted merchandise is one, while to reduce inventories for tax purposes, is another. May be post-Christmas sales are a consequence of store buyers' misjudgements about the market demands for various goods and thus come down to mistakes in ordering.

But if such sales happen year after year after year can it really be chalked up solely to misjudgements and errors. If post-Christmas sales can be chalked up to misjudgments and mistakes, then you have to ask, Why are the store buyers at these stores retained, year after year after year? Shouldn't they be fired and replaced with buyers whose misjudgements and errors aren't as pervasive and persistent? After all, we are looking at stocking "mistakes" at Christmas that are systematic, that extend to all departments in the stores and result in "excess inventories" that are discounted by 50% or more. Also if stores have "excess inventories" why not sell them off at full price slowly over the next year, and order less next Christmas.

There must be a better explanation. And there is, price discrimination. This amount to saying that retail stores have post-Christmas sales (often deep ones) because the price-insensitivity of their customers takes a plunge between the day before Christmas and the day after. McKenzie (2008: 71) puts it this way,

Before Christmas, many customers need the goods they buy to be able to stand witness to the considerable (often only imagined) joy of their love ones and friends on Christmas morning receiving their gifts. Before Christmas, many customers are working and have high opportunity costs of their time; they also might have low storage costs. They have not yet filled their cabinets and closets with countless gifts, most wanted but some kept only out of respect for the givers. After Christmas, many buyers are often fully stocked with more goods than they need, or want. Many are often on holiday breaks at Christmas time, with low opportunity time costs.

More to the point, before Christmas, buyers' demands are highly inelastic. After Christmas, they are highly elastic because they have time to consider more carefully the prices charged by any number of sellers, and they have to see significant price reductions to stuff their cabinets and closets with more products. [...] firms can maximize profits only by playing to the different elasticities of demand, which means that they should charge relatively higher prices before Christmas in anticipation of charging relatively lower prices afterwards.

Stores order earlier in the year, and they order with both markets in mine. That is, they order with both the pre-Christmas and post-Christmas buyers in mind. What is tell us is that post-Christmas sales are planned for, they are not the result of mistakes. McKenzie again,

The higher before-Christmas prices fit the higher demand and lower price elasticities of demand that stores then face. The after-Christmas prices fit the then lower demand and higher price elasticities of demand. Christmas allows stores to segment their markets with the prices charged before Christmas being higher than it would be if a constant price for both market segments had to be charged. (McKenzie 2008: 72)

McKenzie goes on to note

Of course, the elevated before-Christmas prices, followed by expected after-Christmas sales, can cause many price-sensitive shoppers to postpone as many purchases as they can until after Christmas. But such postponements are not necessarily all bad for stores, since the postponements further segment their markets into price-insensitive and price-sensitive shoppers. Purchase postponements can leave the before-Christmas market dominated by highly price-insensitive customers, giving rise to some additional price increase tailored to the demands of the before-Christmas shoppers. Shoppers who delay their purchases can increase the after-Christmas demands for goods, thus tempering the extent of the after-Christmas price cuts. (McKenzie 2008: 72)

So post-Christmas sales are just a way for retailers to get you to reveal your price sensitivity, and then charge you accordingly.

• McKenzie, Richard B. (2008). Why Popcorn Costs So Much at the Movies: And Other Pricing Puzzles. New York: Copernicus Books.

Incentives matter: motor industry file

From a story in the Wall Street Journal,

Venezuelan President Hugo Chávez, beset by a recession that is hurting his popularity, has turned his sights on international car companies, threatening them with nationalization and pledging to ramp up government intervention in their local businesses.

The populist leader has threatened to expropriate Toyota Motor Corp.'s local assembly plant if the Japanese car maker doesn't produce more vehicles designed for rural areas and transfer new technologies and manufacturing methods to its local unit. He said other car companies were also guilty of not transferring enough technology, mentioning Fiat SpA of Italy, which controls Chrysler Group LLC, and General Motors Co.

What incentives does this give the car companies? Anyone what to take a bet on what will happen to rural Venezuelans’ access to automobiles and other automotive products? Anyone what to take a bet on what will happen to private foreign investment in Venezuela?

(HT: Cafe Hayek)

Peter Singer and William Easterly on Bloggingheads.tv

Bloggingheads.TV has put up a 45 minute video discussion between Peter Singer and William Easterly where Peter and William discuss imposing tough love on the global poverty charities who take your Christmas gifts and donations. The message that does come through loud and clear from both Singer and Easterly is; give, and, equally important, make sure your gifts reach the poor. Sounds so simple, and yet you have to work hard at the details to get it right.

Scroogenomics: why you shouldn’t buy presents for Christmas

In this audio from VoxEU.org, Joel Waldfogel of the University of Pennsylvania’s Wharton School talks to Romesh Vaitilingam about his new book, Scroogenomics. They discuss his measurements of the deadweight loss of Christmas gift giving over time and across countries, the motivations that people have for giving, and his ideas for encouraging charitable giving at the holidays.

Trade and the trade-income link

The effects of distance on trade and of trade on income have been a puzzle for economists for centuries. A new column, at VoxEU.org, by James Feyrer entitled The 1967-75 Suez Canal closure: Lessons for trade and the trade-income link, presents new evidence on this issue from an usual natural experiment – the 1967-1975 closure of the Suez Canal.

Feyrer's results suggest that a 10% decrease in ocean distance results in a 5% increase in trade. Also, he estimates that every dollar of increased trade raises income by about 25 cents. These income increases occur relatively quickly, reaching a new level four to five years after the shock.

Moreover this particular example has the nice property that the closure of the canal caused movements in trade that are unconnected to income for most countries and thus the causality clearly runs from trade to income and not the other way around. Increases in trade volumes appear to lead to higher income.

The full paper is Feyrer, James (2009), “Distance, Trade, and Income – The 1967 to 1975 Closing of the Suez Canal as a Natural Experiment,” NBER Working Papers 15557.

Karl du Fresne on the "new wowsers"

I have covered the economic aspects of the current outbreak of Wellington wowerism on this blog a number of times before, see BERL for some examples. Now Karl du Fresne writes on One in the eye for the New Wowsers. He says

The New Wowsers have their tails up at the moment because they sense that the public, caught up in a moral panic over binge drinking and alcohol-related crime, will be receptive to a puritanical backlash against liquor consumption.

They are skilled in the selective use of statistics which paint a picture of a country gripped by alcohol addiction. One of their favourite claims is that 700,000 New Zealanders are “heavy drinkers”, based on World Health Organisation criteria.

Selective use of statistics and economics, just look at the BERL report. du Fresne continues,

But they ignore inconvenient statistics that show we are drinking slightly less alcohol per head than we did 30 years ago, and that New Zealand is ranked only 28th out of 190 countries (many of which ban alcohol altogether) for per capita alcohol consumption – well behind Germany, Britain, France, Switzerland and Denmark.

Even using the New Wowsers’ own criteria, the percentage of “potentially hazardous” drinkers has remained stable since 1996, despite the recent teenage binge drinking phenomenon.

The New Wowsers don’t want to acknowledge that alcohol abuse is confined to a relatively small – if highly visible – minority, and that most New Zealanders are moderate and responsible drinkers. And they can’t see, or don’t want to see, that our social drinking habits are vastly more civilised than they were before the liberal reforms of the 1980s and 90s.

Deficits are bad, but the real problem is spending

Huge deficits and skyrocketing debt levels are creating considerable worry. This Center for Freedom and Prosperity Foundation video explains that that government borrowing is excessive - and will get worse in coming decades. But this video explains that deficits and debt are merely the symptoms, and a rising burden of government spending is the real problem.

Incentives matter: education file (updated)

The Press is reporting that

Students' poor grades will hit university bank balances under sweeping Government changes

Tertiary Education Minister Anne Tolley yesterday released the Tertiary Education Strategy 2010-2015.

Tertiary institution funding will be linked to performance, the strategy says.

Initially, this will focus on student results.

Easy answer to getting lots of money, give everybody an A+! Grade inflation on speed.

Update: Eric Crampton notes that the only answer to the grade inflation he can think of is moving back to the old system of purely external assessment, with all papers being (set and) graded offshore. Imagine the cost! But even this may not be perfect, if we get to pick the external examiners then we will pick a few mates who will give the grades we want. Eric also points out that,

The Press article notes that while funding will initially be linked to student results, it'll eventually move to being linked to graduates' eventual jobs. I wonder how they'll track that. We don't even know where most of our undergrads wind up. What do they do with the large chunk of students who head overseas for their OE after finishing University?

This could all prove interesting. If it's the simple "first grades, then whether employed (or salary on employment)", the equilibrium is grade inflation plus refusing admission to anyone with a poor statistical chance of achieving decent employment outcomes.

Current account surplus 'first in 20 years'

This from the NZ Herald

New Zealand recorded a seasonally adjusted current account surplus of $340 million in the September quarter - the first such surplus since late 1988.

Interesting.

The article continues

The recession has caused people to tighten their belts and spend less - which means importers spent less overseas on bringing goods into the country.

Publishing the data today, Statistics New Zealand (SNZ) said the change from a deficit to a surplus was mostly due to a narrowing of the investment income deficit. This indicates a drop in profits by companies who have a presence in New Zealand but are owned overseas.

and then the Hearld gets it wrong,

The actual balance of payments was a better than expected deficit of $1.4 billion in the September quarter, compared to the median forecast of economists in a Reuters poll for a deficit of $2.6b.

As the BoP is zero, by definition, I'm not sure what this means and I'm not sure where the $1.4 figure comes from. StatsNZ says that the (unadjusted) current account deficit was $5.7 billion. The NBR reports,

The other factors are on the investment income part of the account.

The largest factor – and it is a huge one – is the tax disputes overseas-owned banks are having with Inland Revenue. Four of those banks have lost cases with the taxman (though they are appealing). In the interim, they brought $1.366 billion to account during the quarter to cover those tax transactions.

May be the $1.4 Herald figure refers to this $1.366 tax figure. Don't know. FinData says

Today Statistics New Zealand (SNZ) revealed a surplus of $340 million in the September quarter compared to a $1.4b deficit in the same quarter last year, beating economists' forecasts.

So may be the $1.4 figure is last year's (seasonally adjusted) deficit. But I think the September 2008 figure was -3,996 million, so I'm not sure where the FinData figure comes from either.

The Herald goes on,

The current account, also known as the balance of payments, measures all of New Zealand's transactions with the outside world.

Err no. The BoP is made up of the current account plus the capital account plus the financial account and the total of these three accounts sums to zero.

The media release from StatsNZ says

New Zealand's current account deficit was $5.7 billion (3.1 percent of GDP) for the year ended September 2009 and the smallest as a percentage of GDP since March 2002, Statistics New Zealand said today. The deficit has fallen from 8.4 percent a year ago, when the current account deficit was $15.4 billion.

Contributing to the smaller deficit in the latest year was the first quarterly seasonally adjusted current account surplus since the December 1988 quarter. The September 2009 quarter surplus was $340 million, compared with a deficit of $4.0 billion for the September 2008 quarter, driven by falls in the investment income deficit and imports of goods. A surplus in the current account means that New Zealand's earnings abroad are greater than its expenditures.

Economic journalism in this country isn't getting better.

Creative destruction

At Aid Watch Bill Easterly writes

The Wall Street Journal featured this awesome chart yesterday. Only 8 of top global 25 companies in 1999 are still in top 25 in 2009, and some of them have shed a lot of market cap.

One reaction is that free markets are very scary if you were an employee or shareholder of one of the 1999 companies that crashed. OK this kind of destruction scares ALL of us.

Another reaction is that creative destruction is one of the triumphs of the market. The consumer is king: in 2009, the consumer wants iPhones in their Xmas stocking and not whatever Worldcom had been pretending to be producing. The radical uncertainty of how to please consumers is an argument FOR free markets

Where does all that tuition go?

The following comes from an AEI report "Where Does All That Tuition Go?" by Mark Schneider.

We know that the costs of attending postsecondary institutions are increasing at a rate higher than inflation. And there is evidence that institutions are using a disproportionate share of these revenues for institutional and administrative costs rather than for instructional ones. This (mis)allocation is taking place in an environment in which the federal and state governments continue to pump large amounts of money into higher education without asking institutions to meet performance standards.

The above is based on US data, but I would be very surprised if there was not a similar trend in New Zealand. There appears to be an totally elastic supply of unnecessary administrators around the traps.

(HT: Carpe Diem)

"Too big to fail"

Oliver Hart and Luigi Zingales write in How the Tricks That Crashed Wall Street Can Save the World

What really caused the 2008 meltdown -- and is certain to create and burst bubbles in the future -- are the financial industry's distorted incentives. For the past three decades, the most fail-safe way to make money on Wall Street has been to take on risk, borrow, and bet; the crisis did not change that. Either you are lucky and you make a bundle, or you are unlucky and you walk away. In other situations, creditors dampen this opportunistic behavior by imposing covenants and monitoring borrowers. But why bother if the government will bail out ruined gamblers? Then, loans are valuable for borrowers and lenders alike, albeit disastrous from the taxpayer's point of view.

The problem of moral hazard resulting from "too big to fail".

Hart and Zingales continue

The implicit policy of bailing out large financial institutions -- those behemoths widely thought of as "too big to fail" -- will become explicit if the administration's regulatory reforms are approved. They do not stop the encouragement of bald risk-taking by removing the guarantee that the government will never let big, systemically important banks crater.

That is, the US government's plan to reform its financial sector does not address the fundamental cause of the crisis, nor will they help the world avoid more financial disasters down the road. The problem of moral hazard resulting from the government's regulatory framework is a ticking time bomb.

A Beginner’s Guide to Liberty

A Beginner’s Guide to Liberty is the new book from the Adam Smith Institute. The guide consists of the following ten chapters, all of which are jargon-free and written in clear, simple language:

* The importance of liberty by JC Lester
* How markets work by Eamonn Butler
* Free Trade by Daniel Griswold
* Taxation and government spending by Daniel J. Mitchell
* Property rights by Karol Boudreaux
* Why government fails by Peter J. Boettke & Douglas B. Rogers
* Sex, drugs and liberty by John Meadowcroft
* Welfare without the state by Kristian Niemietz
* Banking, inflation and recessions by Anthony J. Evans
* The role of government by Stephen Davies

The book can be downloaded as a pdf file or purchased from the Institute. Well worth a read.

EconTalk this week

James Hamilton of the University of California, San Diego, and blogger at EconBrowser talks with EconTalk host Russ Roberts about the rising levels of the national debt and the growing Federal budget deficit. What is the possibility of an actual default, or an implicit default where the government prints money to meet its obligations and causes inflation? What might signal an impending default? And what is the long-range forecast for the U.S. government's obligations? Later in the conversation, the subject turns to oil prices, an area of Hamilton's research. Hamilton explores the causes of the increasing price of oil over the last decade and the implications for the economy.

Interesting blog bits

1. Don Boudreaux notes that the F.T.C. Sues Intel. Yes the US government has done something dumb. Just who is surprised?
2. Steven Horwitz on The False Dichotomy of Rothbardian Anarchism and Hayekian Classical Liberalism.
3. David Warsh on Paul Samuelson’s Legacy. I have to say Samuelson wasn't my favourite economist. But many others think better of him.
4. Eric Crampton notes that their is a Year end clearance sale: event derivatives at iPredict.
5. Peter Klein ponders the Ironies of Avatar.
6. Not PC asks Is Christmas too commercial? And answers hell, no!
7. Matt Nolan on Monetary policy discussion in the US. Sounds like the argument here.
8. Carmine Guerriero on Agreeing on what really matters: The slow evolution of legal institutions toward efficiency. Do different types of legal system have a lasting effect on the economy? The emerging consensus would argue “yes”. This column suggests that types of legal system can change depending on the culture and political institutions of the country. Determining the effect on the economy is not straightforward.

Zimbabwe switches into official monthly deflation

This piece of news comes from the Mail & Guardian Online.

Zimbabwe, for years plagued by hyper-inflation, has switched narrowly into an absolute price fall on a monthly basis, official data showed on Friday, following adoption of foreign currencies.

The central statistics office said that prices in November were 0,1% lower than in October when monthly prices had shown a rise of 0,8%.

The total disinflationary change from October to November is therefore 0,9 percentage points.

The adoption of foreign currencies is behind the fall,

Since January, inflation has slowed rapidly after the country shelved use of the local currency and adopted various currencies such as the dollar, South African rand, British pound and Botswana pula.

So if you can stop governments printing money you can stop inflation.

Economists putting their money where their mouth is

David Henderson from EconLog and Bob Murphy have agreed to the following bet,

At any point between now and January 2013, if there is a year/year increase in seasonally adjusted CPI that is at least 10%, then I pay Bob at that time $500.

If we get to January 2013, and there has not been any 12-month stretch in which the above happened, then Bob pays me $500 at that time.

It will be interesting to see who pay who, but I think I would rather be David than Bob in the bet.

Exorcising the asset sale bogy

At Infometrics John Carran argues for Exorcising the asset sale bogy. Carran writes,

The New Zealand Government has a considerable amount of capital tied up in commercial assets on its balance sheet – around $15bn as at 30 June 2009. Examples of State Owned Enterprises include New Zealand Post, TVNZ, KiwiRail, and the government-owned electricity generators. Consider what could be achieved for taxpayers if a proportion of that capital was freed for use elsewhere. For instance, it could be invested in much needed infrastructure such as roads, or it could be invested in schools, hospitals, and other public amenities. Alternatively, the Government could reduce the burgeoning public debt burden. This would improve New Zealand’s overall debt position, helping to improve our sovereign credit rating and lowering the cost of financing for all New Zealand businesses.

and

There is a wealth of evidence to suggest that on average privately owned businesses are run more efficiently, innovate more, and provide better customer services than government owned businesses. The nub of the reason for this is because private owners are acutely responsible for the financial performance of their companies. Sustained bad performance will result in a private company going out of business. Government owners of commercial businesses on the other hand don’t have their own “skin in the game” as they say. In many cases the true objectives of government commercial entities are unclear or conflicting (profitability versus social objectives versus “strategic” objectives) making accountability for results difficult to determine. Poor performance can be supported by taxpayers indefinitely to their ultimate detriment.

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

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

The studies examined here are far less unanimous regarding the impact of privatization on employment levels in privatized firms. All governments fear that privatization will cause former SOEs to shed workers, and the key question in virtually every case is whether the divested firm's sales will increase enough after privatization to offset the dramatically higher levels of per-worker productivity. Three studies document significant increases in employment [Galal, Jones, Tandon, and Vogelsang (1992); Megginson, Nash, and van Randenborgh (1994); and Boubakri and Cosset (1998)], but most of the remaining studies document significant-sometimes massive- employment declines. These conflicting results could be due to differences in methodology, sample size and make-up, or omitted factors.

However, it is more likely that the studies reflect real differences in post-privatization employment changes between countries and between industries. In other words, there is no "standard" outcome regarding employment changes.

Perhaps the safest conclusion we can assert is that privatization does not automatically mean employment reductions in divested firms, though this will likely occur unless sales can increase fast enough after divestiture to offset very large productivity gains. Since the empirical studies discussed in this chapter generally document performance improvements after privatization, a natural follow-up question is to ask why performance improves. For utilities, the need to introduce competition and an effective regulatory regime emerges as key, but there is no "silver bullet" answer for what makes privatization successful for firms in competitive industries. As we will discuss in the next chapter, a key determinant of performance improvement in transition economies is bringing in new managers after privatization. No study explicitly documents systematic evidence of this occurring in nontransition economies, but Wolfram (1998) and Cragg and Dyck (1999a,b) show that the compensation and pay-performance sensitivity of managers of privatized U.K. firms increases significantly after divestment. Studies that explicitly address the sources of post-privatization performance improvement using data from multiple nontransition economies tend to find stronger efficiency gains for firms in developing countries, in regulated industries, in firms that restructure operations after privatization, and in countries providing greater amounts of shareholder protection.

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

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

Mary M. Shirley and Patrick Walsh write in Public versus Private Ownership: The Current State of the Debate, Working Paper, The World Bank,

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

As to the New Zealand experience let me deal with one obvious recent example: Kiwirail.

In the July 2009 issue of Competition and Regulation Times put out by the New Zealand Institute for the Study of Competition and Regulation (ISCR) the question is asked, Kiwirail: strategic asset or strategic blunder? The article summaries an ISCR research paper "The history and future of rail in New Zealand" by Dave Heatley.

My view has, for awhile, been nearer the blunder end of the scale than the asset end. The Times article and the research paper argue along similar lines. Heatley opens his Times article by noting that back in 1999 one of the first projects undertaken by the ISCR was a study of the long-term economic performance of New Zealand railways.

Public rail ownership was characterised by declining performance, beginning in the 1920s and culminating in a very poor prognosis in the 1990s. There were signs that since 1993, privatisation had led to improved productivity and profitability; however, the business was still far from achieving financial sustainability. The ISCR report predicted that private-sector ownership would result in better incentives for productivity-enhancing decision making, but in the long run it was unlikely that in its current form the business would be able to generate returns sufficient to cover the costs of the very large sums of capital employed. Given these facts, a rational private owner would likely rationalise services and reduce the scale of the network to the point where it constituted a sustainable long-run business. Revenues freed up from repeated cycles of historic government-funded capital injections and operating subsidies could then be applied to more productive uses, to the wider benefit of the New Zealand economy.

Given that rail is again in the hands of the government it is timely to re-examine the assumption that government ownership will result in superior long-term outcomes for the long suffering taxpayer owners. Heatley writes,

The 2009 analysis reveals little evidence to suggest that overall the economic outlook for rail has improved since 1999. Despite gains in operational productivity, rail's share of the land freight task has declined over the period examined. Profitability has remained poor, suggesting an ongoing lack of competitiveness vis-a-vis other freight modes.

and continues

Rail networks offer benefits from economies of density (increasing use of existing tracks), but not necessarily from economies of size (increasing size of the network).' In a rail network with uneven patterns of use, such as New Zealand's, the economics of density means that the closure of lightly used lines will, in general, improve the overall economic performance of the network.

Importantly Heatley notes that

It proved difficult for private owners to rationalise the size of the network efficiently, due to poorly aligned incentives and political intervention in operational decisions such as exiting from the provision of certain long-distance passenger services.

The retention of land ownership by the Crown at the time of privatisation muted private incentives to rationalise the network as the private operator was unable to access the potential land-sale benefits from closing unprofitable lines. Private-sector owners have been incentivised to persevere with a strategy (originating under public ownership) of retaining otherwise uneconomic lines for their current income-generating potential, but refraining from investing in replacement infrastructure such as sleepers, tracks and bridges.

A return to integrated land, infrastructure and operational ownership resolves the incentive misalignment, enabling its new owners to rationalise network infrastructure efficiently. Yet perversely, extensive recapitalisation has followed re-nationalisation. The government has invested $2.9 billion in rail since 2002, and has committed a further $0.9 billion through to 2013. It is unlikely that the government will earn a reasonable financial return on this investment, as the strong incentives of private owners for ongoing productivity improvements will likely be muted under government ownership, and the scope for political intervention in strategic and operational activities has increased.

The consequences of political intervention are evidenced in the targets set for a modal shift from road to rail freight in the New Zealand Transport Strategy. Any increases in rail freight's share must ultimately come from substitution at the margins away from competing transport modes. Extensive competition from both road and sea freight restrains the ability of rail to set prices. Rail exhibits few apparent cost advantages, even with subsidies from the written-off opportunity cost of capital. So modal shift can only be driven by increasing the level of subsidies in order to lower prices artificially and therefore induce movement of marginal freight away from more efficient road and sea freight. Such shifts will be to the detriment of the overall economic performance of the transport sector and the wider New Zealand economy.

There is little evidence that the real costs of the current government ownership and investment strategy have been adequately assessed in terms of foregone benefits in other taxpayer-funded areas, such as health and education.

After this, an obvious question to ask is, Is there light at the end of the tunnel? Heatley comments,

The 2009 analysis confirms that the issues identified in 1999 still remain, and are unlikely to be addressed by recent changes in governance, ownership and policy direction. Yet rail still remains a viable transport medium for those segments to which it is intrinsically well-suited - long-haul carriage of heavy, bulky freight (coal, logs, manufactured goods, etc.) and high volume urban commuter services. The challenge for rail's new owners is to find a viable subset of the current rail network. Given current and projected freight and passenger types and volumes, it appears a viable subset exists at around 1500-2000 kilometres in length - less than half the present size. Line closures and land sales could fund upgrading of the core network to 21st-century standards.

So, rail makes sense for a small portion of the current network. However I can't see the changes in government policy and public perceptions need for rationalisation of the network coming to pass any time soon. So the taxpayer gets stuck with yet another white elephant

As to a general argument on the value of privatisation we can ask when is government control and production preferable? As a general guide, 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. 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.

Its not clear that the government's interventions have been in areas where the Hart, Shleifer and Vishny arguments would suggest the government should be involved. Banking, for example, is not a area where cost reduction come at the expense of quality, where innovation is unimportant or where there are any problem with government procurement. So why have the government owning a bank? Also government involvement in Air New Zealand is hard to justify on these grounds. As noted above, the case for private sector provision is stronger when quality reducing cost reduction can be controlled through competition, and the airline industry is very competitive, when quality innovations are important, and we want a high quality and innovative airline industry, and when patronage and powerful unions are a severe problem inside the government, which are things we wish to avoid with an airline. Here private provision makes sense.

So I would say that Carran is right when he says,

Sale of public commercial assets needn’t be seen as a bogy. In reality it would result in no great changes in the distribution of power and wealth in New Zealand and confer long-lasting benefits to taxpayers and consumers. Sounds like a free lunch. And it is if sales are an open process and markets are properly regulated. Sales of public commercial assets will help us wring extra performance out of our economy without the economic upheaval that some fear.

Quote of the day

... textbook orthodoxy [the neoclassical model] provides the theory of the firm mainly for economists who are not much interested in the theory of the firm per se. (Winter 1993: 186)

Winter, Sidney G. (1993). `On Coase, Competence, and the Corporation'. In Oliver E. Williamson and Sidney G. Winter (eds.), The Nature of the Firm: Origins, Evolution, and Development, New York, Oxford: Oxford University Press.

Media coverage of economic issues in New Zealand

In a recent article, Media's dimissal of task force premature, in the Otago Daily Times on the 18 December 2009 (or here or here), Roger Kerr makes a couple of important points when he says,

Public understanding about what constitutes good economic policy will ultimately dictate the economic performance of New Zealand.

and when he writes,

The mainstream media have a key role in shaping public understanding (although the blogosphere is becoming increasingly important).

In passing, with regard to the New Zealand economics orientated blogsphere, let me recommend, Offsetting Behaviour, TVHE, Progressive Turmoil, Defective Equilibrium, Not PC, Brad Taylor's Blog and BK Drinkwater. Not that I always agree with them, but at least there is a reasonable, rational, informed standard of debate, something missing in much of the traditional media.

Kerr is right when he says that the media has an important role to play in shaping public understanding of economic policy. The problem is that the aforesaid media understand little about economics and thus are of limited use in informing public debate. Kerr asks, with regard to the 2025 report,

How well did journalists communicate the 2025 Taskforce report to the public?

and answers not too well. Some of the examples of mainstream reporting he gives are,

Some seemed not to have read it at all, or at least taken it in. For example, Martin van Beynen of the Christchurch Press simply asserted that Australia was rich because of minerals, even though the Taskforce devoted 10 paragraphs to debunking this myth.

and

Others dismissed the 2025 goal as just an ACT idea.

But before the 2008 election prime minister John Key had this to say: "I came into politics because I believed New Zealand was underperforming economically as a country. I don't think it's good enough that so many New Zealanders feel forced to leave our country each year to seek higher wages in Australia ... You have my personal commitment that if I am elected prime minister in eight days' time I will work tirelessly over the next three years to deliver the stronger economic future our country deserves."

and

Brian Fallow of the Herald saw the Taskforce as "rooted in 1980s thinking" - Helen Clark's so-called "failed policies of the past", even though she didn't fundamentally change any of them.

Consider also the recent coverage by the traditional media of the BERL report on alcohol or the coverage of the Regulatory Responsibility Taskforce report. In both cases, what coverage there was didn't rise to any great heights.

Kerr then gets to the heart of the problem,

Most journalists don't have strong economic expertise, but they can consult those who do. If, for example, they had spoken to recipients of the NZIER awards for public policy, they would have found that the vast majority approved the Taskforce's report.

If they had bothered to ask most economists I'm sure they would have found support of much of the Taskforces's recommendations.

Kerr concludes from his discussion that

[i]t is easy to get depressed about economic journalism in New Zealand, particularly in contrast to high quality and less sycophantic writing in Australia.

And not just Australia. When you look at economic journalism in most parts of the world you see a much higher standard than in New Zealand. Where are New Zealand's Sir Samuel Brittan, Martin Wolf, Tim Harford, George Will or David Warsh? And who could possibly qualify as New Zealand's Frederic Bastiat or Henry Hazlitt? Do any of the journalists in New Zealand who write on economic issues have an economics background? Also a common feature of overseas newspapers is regular opinion pieces from leading economists. The likes of Paul Krugman, Tyler Cowen, Russ Roberts, Don Boudreaux, Edward Glaeser, Thomas Sowell, John Taylor and Greg Mankiw are just some of the (semi)regular contributors to the traditional media overseas. Too little of this is seen here. Brian Easton writes in The Listener, Roger Kerr writes regular pieces for a number of papers, Eric Crampton and Stephen Hickson do the odd article for The Press, but I don't know of much beyond this.

But I would argue the main problem with the traditional media's coverage of economic issues is the point Kerr makes about the lack of journalists with any genuine economic expertise, knowledge or understanding. Serious debate is unlikely given that those helping to frame the debate don't understand the issues. If we are to fix this problem then it must come to pass that those training journalists actively seek out trainees with a serious economics background and the media companies pay them enough to make economic journalism a worthwhile career.

There is, I guess, at least one counterargument to my position, namely, that the media simply panders to its audience and thus the lack of good economics coverage reflects the fact that people are not interested in economic policy debate, no matter how important it may be. Depressing, but there may be something to it.

The legacy of economist John Maynard Keynes

From the PBS NewsHour comes these videos of Lord Robert Skidelsky and Professor Russ Roberts discussing The Legacy of Economist John Maynard Keynes:

The Essential Keynes


Keynes in Historical Context



Keynes and the Roots of Today's Financial Crisis



Keynes and the Cure for Today's Crisis



Keynes on Morality and Inequality

The gnomes of Canterbury

Eric Crampton, at Offsetting Behaviour, posts on the history of the term "The Gnomes of Canterbury ". Eric writes,

I checked around a bit this morning for where the term "The Gnomes of Canterbury" originated. Best I can reckon, it's this Bruce Jesson article from Auckland Metro, August 1986.

and

He [Jesson] then lists the formidable opponents of the "Treasury View", primarily centered at Victoria University but also at Massey and Auckland. Treasury supporters, on the other hand, are found at one place above all:

Support for the Treasury approach is concentrated at Canterbury where Professor Richard Manning, Labour Party adviser and Reserve Bank appointee, is the intellectual authority. Many Treasury officials are Canterbury graduates, which means that government policies are dominated by the thinking of a particular university department.

The article is consequently titled "The Gnomes of Canterbury".

Yes there were many Canterbury grads up in Wellington at the time. Canterbury was probably the econ department with the strongest support for the 1980s reforms. Many of the then staff were free market supporters, something rather odd for economics departments in New Zealand at the time.

Manning taught most of the third year microeconomics course when I did it. This was his last year at Canterbury before departing for the US. Sadly Manning died not long after he went to the States. It was the loss of one of New Zealand's best economists.

Essay competition

Given the recent release of the 2025 Taskforce report, this essay competition seems very topical:

The Charles G. Koch Charitable Foundation, in cooperation with the Association of Private Enterprise Education, announces the:

2010 POLICY COMMUNICATORS CONTEST

How do public policies influence measures of economic performance?

The 2010 Policy Communicators Contest invites college professors and graduate students from all disciplines to submit essays on the relationship between public policy and economic growth. It is of particular interest to compare and contrast individual countries, states, regions or major metro areas—why some are succeeding and others are failing. Diverse public policies have resulted in an equally diverse set of outcomes affecting economic performance. Therefore, it is of great importance to discern what lessons can be drawn from specific experiences. Winning entries will analyze the economic effect of specific public policies, incorporating new and existing research into a compelling narrative for a general audience.

First Prize: $15,000
Second Prize: $7,500
Third Prize: $4,000

Audience
The Policy Communicators Contest intends to reward skilled communication of sound academic research to non-academic audiences. The persuasive effect should be founded upon the support of academic research. Winners will be selected based on how effectively they deploy their academic expertise in presenting our best scholarly understanding in a package that anyone can easily grasp.

Further details are available here.

May be Don Brash should enter.