Economics of digital media

From VoxEU.org comes this audio in which Joel Waldfogel of the University of Pennsylvania’s Wharton School talks to Romesh Vaitilingam about the economics of digital media, including: music file sharing (both illegal and legal) and the impact on artists and record labels; the threat that intellectual property piracy poses to the movie business; and the future of books and newspapers in the digital age.

Podcast: an economist gets stoned

From npr's Planet Money comes this podcast of Harvard economist, Jeffrey Miron, talking about what happens when drugs move from the black market to the open market. Do they get 100 times cheaper? Or instead, more expensive? Miron talks about the economics of prohibition, and reveals his drug of choice (which is legal) and one he would like to try (which is not).

The discussion is based on Miron's paper The Effect of Marijuana Decriminalization on the Budgets of Massachusetts Governments, With a Discussion of Decriminalization’s Effect on Marijuana Use An Update of Miron (2002a).

You know the recession is bad when ....

the sex trade is in trouble.This comes from the Toronto Star:

The vices – smoking, drinking, sex – are usually bulletproof during a recession, says economist Perry Sadorsky, who teaches at York University's Schulich School of Business. So if the sex trade is hurting, "we are in the most serious depression since the 1930s. This shows the magnitude of the decline. It is deep and it is problematic."

Sex workers say their incomes began plummeting last fall, with johns pleading poverty and haggling over prices, and prostitutes bidding against each other.

"There are 60 people on the street, but they are all sex workers and there's no money for anybody," says Ray, who, like other prostitutes, did not want his real name used. "This economy is causing a lot of misery."

If prices are dropping is it a decrease in demand or an increase in supply or both?

Sadorsky wonders if the economic crisis is forcing more people into sex work, thereby increasing competition on the street. Toronto police, who use a community complaints system to keep track of prostitution, report no increase in complaints, though they suggest this may mean sex workers are trolling in non-residential areas.

...The recession has seen the street price of oral sex, the most common service, plummet from $60 last fall to $20 today. "Full service" involving intercourse has dropped from $150 to $80.

Econ 101 tells us that a decrease in demand will decrease price and decrease the quantity traded. An increase in supply also decreases price but increases the quantity traded. If both are happening then price will drop but the effect on quantity is indeterminate. The article also says,

Escort workers, both those with agencies and independents, report a 15 per cent decline in clients, says Valerie Scott, executive director of Sex Professionals of Canada, a volunteer group working toward the decriminalization of sex work.

which would suggest that the demand effect is dominating.

(HT: Market Power)

Price gouging in Haiti

You will find many reports in the media suggesting that prices for many useful and necessary goods have jumped considerably since the earthquake in Haiti. I'm sure you will also find many reports saying that these price increases are examples of "price gouging" and that such activity is unethical and thus ought to be condemned, if not prosecuted.

One of the better responses to such reasoning comes from Michael Giberson at Knowledge Problem blog. He writes,

But I find it hard to condemn these actions, which generally appear to be pro-social commercial responses to abnormal social and economic conditions. Higher prices motivate more careful use of existing supplies as well as extraordinary efforts to secure additional supplies. Changing relative prices help guide the efforts of suppliers and merchants to the most vitally needed items. Both the incentive and information aspects of prices are critical to guiding decentralized responses to human needs in this rapidly changing situation.

The New York Times article observes that, “Haiti’s huge informal sector reacted faster to the quake than did established companies and banks. Outdoor markets like La Saline are already filled with goods from the countryside, including salt, cornmeal, fruits like mangoes and used clothing from the United States.” How fast would that informal sector have reacted if the government felt an obligation to enforce some notion of anti-price gouging policy?

Markets work, even in extreme circumstances, if you let them.

Hayekian comments on student papers

Peter Klein at Organizations and Markets says that a grad student inspired these Hayekian Comments on Student Papers,

"The writer clearly suffers from a fatal conceit."

"Reading this proposal helps me understand the knowledge problem."

"Your paper appears to be the result of human action, but not human design"

"The proposed outline reveals how little people really know about what they imagine they can design."

In the comments section two additional comments were suggested,

"Spontaneous order does not apply to writing."

"Time spent on this paper was a malinvestment?"

Anything better?

Schools of thought and influence on policy making

Relying on the interpretations of opinions of people is one way to characterise a school of thought and measure its influence. But John Taylor at Economics One asks if there is a less inherently subjective way to characterise a school of thought or to measure the extent of its influence on policy making. He writes

Are there more objective, perhaps quantitative, ways? Consider, for example, measuring influence by the representation of members of a school in top economic positions in government where there is an opportunity to influence policy. And consider as a measure of an economist’s school, the university where he or she received the PhD. The data in the chart follows this approach. It shows the university PhD percentages of appointees to the President’s Council of Economics Advisers (CEA).

The blue line shows the percentage of presidential appointees to the CEA who have a PhD from Chicago. The red line shows the same for MIT or Harvard (Cambridge), one possible definition of an alternative to the Chicago school. The years from the creation of the CEA in 1946 until 1980 are shown along with each presidential term thereafter. Observe that the peak of the Chicago school influence was in the Reagan administration; it then dropped off markedly. In contrast Cambridge reached a low point of zero appointees to the CEA during the Reagan administration and then rose slightly to 20 percent in Bush 41, to 82 percent in Clinton, and to 100 percent in both Bush 43 and in Obama.

Blaming the financial crisis on the free-market influence of the Chicago school is certainly not consistent with these data. There were no Chicago PhDs on the President’s CEA leading up to or during the financial crisis. In contrast there was a great influx and then dominance of PhDs from Cambridge. And also notice that there were plenty of Chicago PhDs on the CEA at the time of the start of the Great Moderation—20 plus years of excellent economic performance. These data are more consistent with the view that the waning of the free-market Chicago school and the rise of interventionist alternatives was largely responsible for the crisis. But the main point is that there is no evidence here for blaming the influence of Chicago.

Taylor goes on to note,

The data are robust when you look beyond the CEA to other top posts normally held by PhD economists. All assistant secretaries of Treasury for Economic Policy appointed during the Bush 43 and Obama Administrations had PhDs from Harvard. During the same period, all chief economists appointed to the IMF had PhDs from MIT, and, except for Don Kohn, who was promoted from within and Susan Bies who was appointed as a banker, all PhD economists appointed to the Federal Reserve Board were from Cambridge MA.

So do free market supporters really have influence on policy making these days?

Quote of the day

From Don Boudreaux at Cafe Hayek:

I’m at a conference in south Florida with Paul Rubin, a superb scholar of law and economics. Paul just observed that whenever there’s a corporate scandal, it’s typically blamed on an increase in greed, but when there’s a sex scandal, it’s never blamed on an increase in lust.

Words fail me

and now apparently also some school students in the US. Alex Tabarrok at Marginal Revolution points us to this:

The 9,000-student K-8 district this week pulled all copies of Merriam-Webster's Collegiate Dictionary after an Oak Meadows Elementary School parent complained about a child stumbling across definitions for "oral sex."

The decision was made without consultation with the district's school board and has raised concerns among First Amendment experts and some parents.

Other parents and Menifee residents, though, have praised the district's decision, saying a collegiate-level dictionary is inappropriate for younger children.

So now dictionaries are only allowed to have "approved words" in them?

Productivity and wages

In an earlier posting I wrote that Trevor Mallard had been blogging his support for an increase in the minimum wage. Mallard wrote

Business NZ would squeal. But most employers know that lifting wage rates encourages investement in capital equipment and training to make their labour force more productive. It is all part of the movement to a high skill, high wage economy.

I also noted that, yes, there is a relationship between productivity and wages but it runs the opposite way to what Trevor claims. Over time if you make people more productive, wages will increase.

Following up this, the information below comes from a paper by Martin Feldstein (George F. Baker Professor of Economics at Harvard University and President Emeritus of the National Bureau of Economic Research) given to the American Economic Association on January 5, 2008. The paper is entitled "Did Wages Reflect Growth in Productivity?" Feldstein writes,

The level of productivity doubled in the U.S. nonfarm business sector between 1970 and 2006. Wages, or more accurately total compensation per hour, increased at approximately the same annual rate during that period if nominal compensation is adjusted for inflation in the same way as the nominal output measure that is used to calculate productivity.

More specifically, the doubling of productivity represented a 1.9 percent annual rate of increase. Real compensation per hour rose at 1.7 percent per year when nominal compensation is deflated using the same nonfarm business sector output price index.

In the period since 2000, productivity rose much more rapidly (2.9 percent a year) and compensation per hour rose nearly as fast (2.5 percent a year).

and later he says

The relation between wages and productivity is important because it is a key determinant of the standard of living of the employed population as well as of the distribution of income between labor and capital. If wages rise at the same pace as productivity, labor’s share of national income remains essentially unchanged. This paper presents specific evidence that this has happened: the share of national income going to employees is at approximately the same level now as it was in 1970.

So when measured correctly, productivity and wage do roughly move together over time. For the US at least.

Keynes vs. Hayek rap video

This is a a rap video developed by Russ Roberts, of Cafe Hayek and EconTalk fame, and John Papola.

More resources including lyrics and a free download of the song are here.

(HT: Cafe Hayek)

EconTalk this week

Nobel Laureate Michael Spence of Stanford University's Hoover Institution and the Commission on Growth and Development talks with EconTalk host Russ Roberts about the determinants of economic growth. Spence discusses the findings of the Commission's recent report and how it compares to earlier attempts to uncover the sources of growth and the lack of growth such as the Washington Consensus. Spence makes the case for government provision of infrastructure including education and the problems of corruption and governance. The conversation closes with a look at Spence's career and the lessons of that experience.

Just let them in

The following is from a post at Aid Watch by Michael Clemens, a research fellow at the Center for Global Development in Washington, DC, and an affiliated associate professor of public policy at Georgetown University.

The best thing the United States could do for Haitians would be to let them in, either temporarily or permanently. We are now accepting about 21,000 permanent Haitian immigrants per year, and just a few hundred temporary workers per year. If we really wanted to raise Haitians out of destitution, we could absorb many times more than this.

Water economics and management: lessons from Australia’s drought

In thsi audio from VoxEU.org Mike Young, executive director of the Environment Institute at the University of Adelaide, talks to Romesh Vaitilingam about how Australia has responded to the big shock to its water supply – through new regulations, through technological solutions, through public education and through the introduction of market mechanisms. Water and its management is a big issue not only in Australia, New Zealand has issues with this as well and may be can learn something from across the Tasman.

Econ 101 and the minimum wage

In a posting about the minimum wage Eric Crampton, at Offsetting Behaviour, quotes the National Business Review as saying

When the 2025 Taskforce made its controversial list of proposals for increasing New Zealand’s economic performance to catch up to Australia’s, it missed an obvious one.

The only way to really lift New Zealand’s woeful economic performance is to smack every New Zealander over the head with a textbook of “Economics 101”.

This nation-wide lack of financial common sense was reflected in a poll by the NZ Herald that found 61% of respondents want the minimum wage lifted to $15 an hour.

Of course, the Herald didn’t ask the follow-up question- “do you support higher unemployment, particularly among groups vulnerable to labour market changes such as young people and Maori, as well as the possible collapse of many businesses already burdened by ever-increasing government-imposed costs?”

One of those who needs a smack 'over the head with a textbook of “Economics 101” ' is Marty G at The Standard.

In a comments to a posting about the minimum wage at The Standard I made the point that most economists would argue that an increase in the minimum wage would increase unemployment among those at the bottom end of the wage distribution. When asked for empirical evidence to back up my claim I referred to the book, “Minimum Wages” by David Neumark and William L. Wascher, Cambridge: MIT Press, 2008. To counter my claim Marty G wrote

One book by two no name US neoliberal economists, whose 2007 paper says:

“We review the burgeoning literature on the employment effects of minimum wages – in the United States and in other countries – that was spurred by the new minimum wage research beginning in the early 1990s. Our review indicates that there is a wide range of existing estimates and, accordingly, a lack of consensus about the overall effects on low-wage employment of an increase in the minimum wage.”

This quote interested me since it seems to undermine the Economics 101 idea that demand curves slope downwards, so I went looking for the quote. The "two no name US neoliberal economists" are David Neumark - Professor of Economics, University of California, Irvine - and William L. Wascher - Senior Associate Director, Division of Research and Statistics, Federal Reserve Board - and I found the 2007 working paper that Marty G seems to be referring to, see here. The working paper was published in Foundations and Trends in Microeconomics, 2007, Vol. 3, Nos. 1-2, pp. 1-182. The quote that Marty G gives comes from this abstract to this paper.

Now let me quote the sentence that come directly after the quote that Marty G gives,

“However, the oft-stated assertion that recent research fails to support the traditional view that the minimum wage reduces the employment of low-wage workers is clearly incorrect.”

So in other words, the very next sentence after the quote Marty G gives, counters the very point that Marty G seems to have been trying to make by using the quote, and in fact support my claim. Marty G was being selective, shall we say, with the use of his quote.

Neumark and Wascher go on to say,

“A sizable majority of the studies surveyed in this monograph give a relatively consistent (although not always statistically significant) indication of negative employment effects of minimum wages. In addition, among the papers we view as providing the most credible evidence, almost all point to negative employment effects, both for the United States as well as for many other countries. Two other important conclusions emerge from our review. First, we see very few – if any – studies that provide convincing evidence of positive employment effects of minimum wages, especially from those studies that focus on the broader groups (rather than a narrow industry) for which the competitive model predicts disemployment effects. Second, the studies that focus on the least-skilled groups provide relatively overwhelming evidence of stronger disemployment effects for these groups.”

Thus the 2007 paper that Marty G quotes in fact supports my contention that the minimum wage reduces the employment of low-wage workers.

Liberalism v's liberalism

George Will on (American) liberalism:

The essence of contemporary liberalism is the illiberal conviction that Americans, in their comprehensive incompetence, need minute supervision by government, which liberals believe exists to spare citizens the torture of thinking and choosing.

Joseph Schumpeter on (Classical) liberalism:

Still more important, they did so in a spirit of laissez-faire, that is to say, on the theory that the best way to promote economic development and general welfare is to remove fetters from the private-enterprise economy and to leave it alone. This is what will be meant in this book by Economic Liberalism. The reader is requested to keep this definition in mind because the term has acquired a different– in fact almost the opposite– meaning since about 1900 and especially since 1930: as a supreme, if unintended, compliment, the enemies of the system of private enterprise have thought it wise to appropriate its label. (emphasis added) [ Joseph Alois Schumpeter, History of economic analysis, p.372]

(HT: Cafe Hayek)

The World Bank and how many people in the world are in extreme poverty

At the Aid Watch blog Bill Easterly point us to the AEA Presidential Address that Angus Deaton (see right) gave recently at the AEA meetings. Deaton discussed the measurement of world poverty and inequality, with particular attention to the role of PPP (purchasing power parity) price indexes from the International Comparison Project. Global inequality increased with the latest revision of the ICP, and this reduced the global poverty line relative to the US dollar. The recent large increase of nearly half a billion globally poor people came from an inappropriate updating of the global poverty line, not from the ICP revisions. Even so, Deaton explained, PPP comparisons between widely different countries rest on weak theoretical foundations. Deaton argued for a wider use of self-reports from international monitoring surveys, and for a global poverty line that is truly denominated in US dollars.

Easterly tells us that the lecture

will not let you ever trust the World Bank again on how many people in the world are in extreme poverty.

Easterly gives four examples as to why this is so:

1) “India has become poorer because India has become richer!”

The World Bank’s recent 40 percent upward revision of the global poverty number was based on an absurd procedure that led to the paradox in the quote.

To make a long story short, the World Bank decided to boot richer India out of the group of poorest countries used to determine the poverty line, which made the poverty line higher, which made Indian (and global) poverty higher – all because India was richer. This misguided revision of the poverty line, which accounted for virtually all of the upward revision, was not clear to virtually anyone until this new paper by Deaton.

2) Adjusting for purchasing power (how cheap the goods are) across countries is complex and probably impossible.

The details are as incredibly boring as they are hugely consequential.

As only one tiny example, the poverty count is sensitive to a mostly-made-up number that is incomparable across countries: the imputed rent to housing.

Then there is the “index number problem,” which only is of great fascination to 2 people, but unfortunately can change the ratio of US/Tajikstan incomes by a factor of 10. The trouble is that rich people and poor people consume very different things. For example, poor people may consume a lot of something that is cheap in the poor country, which is not consumed much and is expensive in the rich country. Similarly, rich people consume a lot of something else that is cheap in the rich country and expensive in the poor country. If you use rich country prices, you exaggerate poor people’s consumption basket value (they are given a lot of credit for consuming a lot of something very expensive, but it isn’t that expensive in the poor country and if it were, they would consume a lot less of it). Conversely, if you use poor country prices, you exaggerate rich people’s consumption basket value. There are possible intermediate solutions but no complete solutions to this intractable problem.

Deaton muses: “perhaps we are aiming too high when we try to construct a real income scale on which every country in the world can be placed.”

3) Why don’t you just ask people if they think they are poor?

World Gallup Poll does.

In contrast to the World Bank global poverty rate of 25 percent (around which there were those misguided revisions and many other uncertainties on the order of 40 percent of the original estimate):

33 percent worldwide say they don’t have money for food,
38 percent say their living standards are poor, and
39 percent say they are “in difficulty.”

So you are on safe ground saying, “there are lots of people in poverty.” But don’t insult our intelligence with an exact number.

4. Deaton offers consolation: you don’t really need a global poverty number.

In spite of the attention that they receive, global poverty ... measures are arguably of limited interest. Within nations, the procedures for calculating poverty are routinely debated by the public, the press, legislators, academics, and expert committees, and this democratic discussion legitimizes the use of the counts in support of programs of transfers and redistribution. Between nations where there is no supranational authority, poverty counts have no direct redistributive role, and there is little democratic debate by citizens, with discussion largely left to international organizations such as the United Nations and the World Bank, and to non-governmental organizations that focus on international poverty. These organizations regularly use the global counts as arguments for foreign aid and for their own activities, and the data have often been effective in mobilizing giving for poverty alleviation … It is less clear that the counts have any direct relevance for those included in them.

The moral of the story: don’t cite global poverty numbers unless you know they’re trustworthy, and most of the time they aren’t.

The 2010 index of economic freedom

The 2010 Index of Economic Freedom is now available. New Zealand comes in at number 4 with a score of 82.1, up by 0.1 compared to last year. Australia is one place ahead of New Zealand at number 3. New Zealand is also ranked 4th out of 41 countries in the Asia–Pacific region.

The index says

The economy has an impressive record of market reforms and benefits from its openness to global trade and investment. The banking sector is characterized by sound regulations and prudent lending practices, and well-implemented structural reforms have allowed the New Zealand economy to weather the recent global financial and economic crisis relatively unscathed.

The index's top ten countries areInterestingly the US score has fallen by 2.7 and the UK has fallen out of the top ten completely. The UK's score fell by 2.5, leaving it at number 11 in the rankings. Commenting on the fall in the US score Terry Miller at the Wall Street Journal writes,

The U.S. lost ground on many fronts. Scores declined in seven of the 10 categories of economic freedom. Losses were particularly significant in the areas of financial and monetary freedom and property rights. Driving it all were the federal government's interventionist responses to the financial and economic crises of the last two years, which have included politically influenced regulatory changes, protectionist trade restrictions, massive stimulus spending and bailouts of financial and automotive firms deemed "too big to fail." These policies have resulted in job losses, discouraged entrepreneurship, and saddled America with unprecedented government deficits.

The bottom two countries, for which data are available, are, at 178, Zimbabwe with a score of 21.4 which has fallen by 1.3 since last year and at 179, North Korea with a score of 1.0 which has fallen by 1. No real surprises with the bottom two.

Unemployment insurance and moral hazard

Moral hazard is a well known problem in all forms of insurance, unemployment insurance being no exception. The problem being that unemployed workers who are insured may not do enough in the way of searching for a job or may turn down job offers that they do receive. But trying to get a handle on how large this effect is very difficult. This is an area where field experiments can help: randomly assign people to treatment groups where there is an increased level of the monitoring of claimants relative to the control group. Claimants in the treatment group have to make more frequent visits to the employment office and face questioning about their search behaviour. And see what happens.

Such an experiment was carried out in Hungary in 2003. The results are reported in a paper, The e ffect of monitoring unemployment insurance recipients on unemployment duration: evidence from a field experiment by John Micklewright and Gyula Nagyy. The paper reports results which show marked differences between the sexes in the effect of treatment on benefit duration and outflows to employment. Treatment has quite a large effect on women aged 30 and over, especially for those married with a working husband, while they typically find no effect for younger women or for men.

Micklewright and Nagyy note that,

There are (at least) two alternative explanations for the experiment’s results (‘explanations’ in the sense of descriptions of the observed behaviour). First, search effort of men and younger women is already high and the marginal return to additional effort encouraged by the treatment is zero. Men and younger women in the control group make frequent visits to employment offices to access vacancies of their own volition, so their contact with the offices is no lower than for their counterparts in the treatment group. For the older women, treatment does bring more contact in practice with the offices’ vacancies compared to the control group, and there is a positive return to additional search stimulated by treatment in terms of job offers generated.

Second, search effort of men and younger women is not high in the absence of treatment but the treatment does not produce additional search. The questions faced by the treatment group during visits to the employment office are answered with equanimity, with no disutility resulting. Treatment does mean in practice that additional visits are made to the employment offices but these visits do not result in better contact with vacancies. Only the women aged 30+ take advantage of the increased access to information on vacancies through the office visits. And only these women experience disutility from the additional visits and the questioning about job search, which increase the cost of leisure while unemployed, and react to a threat of sanctions if they do not increase their search activity.

Unfortunately Micklewright and Nagyy do not have the detailed information on actual search activity of both the treatment group and the control group that would allow them to judge between the competing explanations.

Investment and regime uncertainty

In an earlier posting on government actions in Venezuela to take over a French-owned retail chain I wrote,

I'm guessing foreign investment isn't at the top of Hugo Chavez's list of must haves for economic development. I'm also guessing that Robert Higg's idea of regime uncertainty isn't something Chavez is too concerned about. One wonders what effect all this will have on private investment, both foreign and local, in Venezuela.

Now this story from Reuters UK tells us

Venezuela's Mariscal Sucre project, which has estimated reserves of 14.7 trillion cubic feet of gas, has failed to attract private interest after the government invited firms to make offers last week.

Offers were to be made on Friday until midnight.

The government this month improved the conditions it was offering companies to help develop the project, but in the end nobody came forward, private sector sources close to the process said on Monday.

Given past actions, such as the nationalisation of the French-owned retail chain and the threatening of international car companies with nationalization, it is hardly surprising that foreign firms don't want to invest in Venezuela. They too, rationally, fear seizure of their assets at some future date. The possibility of hold-up in the future reduces firms willingness to invest today. A point lost, it would appear, on Hugo Chavez.

Maybe there is more to this story than is obvious from the news report, but the argument above seems sufficient to explain the lack of interest in investing in Venezuela.

(HT: Knowledge Problem)

More on the new paternalism

Over at the ThinkMarkets blog Glen Whitman is continuing his series of postings on the "New Paternalism on the Slippery Slopes".

• New Paternalism on the Slippery Slopes, Part 7: The Inevitable Misinterpretation of New Paternalist Arguments
• New Paternalism on the Slippery Slopes, Part 8: Hyperbolic Discounting in Public Policy

Links to the first 6 postings can be found here. This set of posting is based on a new paper "Little Brother Is Watching You: New Paternalism on the Slippery Slopes" by Whitman and Mario Rizzo, published in the Arizona Law Review. You can find the full text here.

The abstract of the full article reads,

The “new paternalism” claims that careful policy interventions can help people make better decisions in terms of their own welfare, with only mild or nonexistent infringement of personal autonomy and choice. This claim to moderation is not sustainable. Applying the insights of the modern literature on slippery slopes to new paternalist policies suggests that such policies are particularly vulnerable to expansion. This is true even if policymakers are fully rational. More importantly, the slippery-slope potential is especially great if policymakers are not fully rational, but instead share the behavioral and cognitive biases attributed to the people their policies are supposed to help. Accepting the new paternalist approach creates a risk of accepting, in the long run, greater restrictions on individual autonomy than have been heretofore acknowledged.

It's the margin that matters

Dave Prychitko writes at the Economic Way of Thinking blog:

About twenty years ago I needed to fax to my publisher a copy of my signed book contract, or something like that. There was not a single fax machine on the SUNY-Oswego campus where I taught. It was 4:50 and the fax needed to be sent before 5:00pm.

I raced to the sole fax service provider in town, a small office supply shop. He charged two bucks. I opened my wallet and discovered that I only had a dollar. (To this day I rarely have more than five bucks in my wallet.) I asked him if he'd please fax it for a buck. He flat out refused my offer. "I have my overhead to consider."

The shopkeeper obviously didn't know he was dealing with an economist. "No, you really don't have overhead to consider. You face the same overhead expense whether or not you fax my paper. It will cost you no more than fifty cents for the phone call. Period. I give you a buck and you can make fifty cents that you can allocate to your overhead or anything else for that matter. If you keep insisting upon two bucks, you receive nothing for your overhead expenses. You lose. You don't make a penny."

He accepted my offer. I don't know if he bought my marginal cost / marginal revenue argument, or if he just wanted me out of his store. In either case, it's the margin that mattered.

Advice, don't confuse fixed and marginal costs.

Eminent domain powers and the size of government

This is not good news. This paper, Do Broader Eminent Domain Powers Increase Government Size? in the Review of Law and Economics, looks at the effects of widening eminent domain powers on the size of state and local governments in the US. It looks in particular at the 2005 U.S. Supreme Court decision Kelo v New London which allows the use of eminent domain to transfer property from one private party to another when it serves a broadly defined public purpose such as economic development. The empirical results show that states which explicitly empower their local governments to use eminent domain for private economic development have larger state and local public sectors than those that do not.

The abstract reads,

The 2005 U.S. Supreme Court decision Kelo v New London allows using eminent domain to transfer property from one private party to another when it serves a broadly defined public purpose such as economic development. This paper examines the effect of this doctrine on the size of state and local governments. In the leviathan model, constitutional constraints are needed to control government expansion. The Kelo decision removes one such constitutional constraint on how state and local governments gain command over privately owned resources. The empirical results show that the breadth of eminent domain power affects the size of the public sector; states that explicitly empower their local governments to use eminent domain for private economic development have larger state and local public sectors than those that do not.

Does voting for an inefficient government make sense?

This question is asked by the Economic Logician, he writes

Given a distribution of skills and interest in public service in the labor force, would it be best if the public-minded workers go into government or to the private sector? Essentially, this is what Esteban Jaimovich and Juan Pablo Rud ask. If the better ones go private, then the unmotivated ones go into government and wreak havoc: they seek rents, hire more public (low-skilled) employees, thus inflating their wages and depressing the returns of the most skilled private workers, which lessens their incentives to do better in terms of entrepreurship. Jaimovich and Rud also claim that this outcome is actually preferred by the (low-skilled) working class, because of the higher wage. They also support the outcomes of their model with observations from the data.

A counter argument as to why inefficient government is good comes from this from an address, Economic Freedom, Human Freedom, Political Freedom, given by Milton Friedman, at the Smith Center for Private Enterprise Studies in 1991.

The United States today is more than 50% socialist in terms of the fraction of our resources that are controlled by the government. Fortunately, socialism is so inefficient that it does not control 50% of our lives. Fortunately, most of that is wasted. People worry about government waste; I don't. I just shudder at what would happen to freedom in this country if the government were efficient in spending our money.

Trade-offs are an inescapable part of the economy.

EconTalk this week

Mike Munger of Duke University talks with EconTalk host Russ Roberts about many things. Listeners sent in questions for Mike and Russ to talk about and they chose ten of the most interesting questions with the idea of talking about each for six minutes. The topics are the scarcity of clean water, asset bubbles, the role of Fannie and Freddie in the financial crisis, can a business pass a tax on to its customers (or maybe even its workers), compassionate food, the study of economics, how to choose a college, the nature of cooperation in a modern economy, the humanity of non-profits, and the American Dream.

London’s first financial markets

In this audio from VoxEU.org Anne Murphy, lecturer in history at the University of Hertfordshire and associate director of the Centre for Financial History at Newnham College, Cambridge, talks to Romesh Vaitilingam about her new book ‘The Origins of English Financial Markets: Investment and Speculation before the South Sea Bubble’.

The minimum wage, again

Trevor Mallard blogs his support for an increase in the minimum wage. He writes

Business NZ would squeal. But most employers know that lifting wage rates encourages investement in capital equipment and training to make their labour force more productive. It is all part of the movement to a high skill, high wage economy.

Yes there is a relationship between productivity and wages but it runs the opposite way to what Trevor claims. Over time if you make people more productive, wages will increase. Even Paul Krugman has noted this fact. He writes,

As it happens, the past 40 years offer considerable evidence on what happens to the wages of a country whose productivity gains on that of higher-wage nations. Four decades ago, productivity in Europe was well below U.S. levels in most industries, and Japan lagged even further; since then, productivity levels in the advanced world have converged, although most measures still suggest that the United States retains some edge. More recently, a group of "newly industrializing economies" in Asia has achieved spectacular productivity increases starting from a very low base. Given these dramatic changes in relative productivity, what has happened to relative wages?

The answer is that wages have risen in each country, more or less in line with productivity. Table 2-3 shows data on long-run increases in productivity and real wages in several representative countries. Bearing in mind that there are some slippages in the data (for example, there are a number of technical problems in the way that both productivity and real wages are calculated), the basic picture is one in which converging productivity has produced a convergence in wages, just as the theoretical analysis would predict.

Notice that we do not have good data on South Korean wages over the full sample. However, the United States government has been collecting hourly compensation (wages plus benefits) data for the industrial sector of several newly industrializing countries since the mid 1970s. According to these data, South Korean compensation rose from only 5 percent of the U.S. level in 1975 to 46 percent in 1996. An index of compensation in several newly industrializing Asian economies rose from 8 percent of the U.S. level in 1975 to 32 percent by 1996. In short, the experience to date is that wages always do move more or less in line with productivity. (Paul Krugman and Maurice Obstfeld, "International Economics: Theory and Policy", Prentice Hall.)

and in a similar vein he says,

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

Raising wages will just cause employers to use less labour, that is, increase unemployment. Demand curves slope downwards even for labour.

One of best discussions of the effects of the minimum wage is the book "Minimum Wages" by David Neumark and William L. Wascher, Cambridge: MIT Press, 2008. In this book Neumark and Wascher offer a comprehensive overview of the evidence on the economic effects of minimum wages. Synthesizing nearly two decades of their own research and reviewing other research that touches on the same questions, Neumark and Wascher discuss the effects of minimum wages on employment and hours, the acquisition of skills, the wage and income distributions, longer-term labour market outcomes, prices, and the aggregate economy.

Based on their reading of the evidence, Neumark and Wascher argue that minimum wages do not achieve the main goals set forth by their supporters. They reduce employment opportunities for less-skilled workers and tend to reduce their earnings; they are not an effective means of reducing poverty; and they appear to have adverse longer-term effects on wages and earnings, in part by reducing the acquisition of human capital. The authors argue that policymakers should instead look for other tools to raise the wages of low-skill workers and to provide poor families with an acceptable standard of living.

In chapter 9 “Summary and Conclusions” they write

“Three conclusions, in particular, stand out. First, as indicated in chapter 3, the literature that has emerged since the early 1990s on the employment effects of minimum wages points quite clearly – despite a few prominent outliers – to a reduction in employment opportunities for the low-skilled and directly affected workers”. (p. 286)

Also from Table 9.1 page 287 when dealing with the effects on employment, under the ‘Summary of evidence’ heading Neumark and Wascher write

“Minimum wages reduce employment of low-skilled workers; adverse effects even more apparent when research focuses on those directly affected by minimum wages.”

At The Standard we are told Kiwis back fairer minimum wage. We are told

An overwhelming 61% of people in a large (2,300 person) survey conducted by the Herald favour immediately lifting the minimum wage $15 an hour from its current $12.50.

On the other hand economist Greg Mankiw has a list of things that economists agree on in chapter 2 of his first year textbook. Number 12 on this list is “A minimum wage increases unemployment among young and unskilled workers” and 79% of economists agree. So this result is widely accepted by economists.

How not to run an economy

The Wall Street Journal reports that Venezuela Nationalizes French Retail Chain,

President Hugo Chavez ordered Sunday the seizure of a French-owned retail chain on accusations that it raised prices after Venezuela devalued the currency by half.

So much for PPP.

The Venezuelan leader said that a new law could be needed to carry out the nationalization. "I'm waiting for the new law to begin the expropriation process," he said. "There's no going back," he added.

and

Separately, Mr. Chavez also ordered the nationalization of a large shopping-mall recently built in a downtown district in Caracas. The stores controlled by Exito and the shopping mall will be used to build up Comerso, a new government-run retail chain which seeks to sell its products at "socialist" prices, according to the president.

During his 11 years in power Mr. Chavez has nationalized large swaths of the Venezuelan economy, including a Spanish-owned bank and an Argentine-controlled steel-mill.

I'm guessing foreign investment isn't at the top of Hugo Chavez's list of must haves for economic development. I'm also guessing that Robert Higg's idea of regime uncertainty isn't something Chavez is too concerned about. One wonders what effect all this will have on private investment, both foreign and local, in Venezuela.

Nazi capitalism: an oxymoron?

In a couple of recent articles in The Freeman, see here and here, Steven Horwitz asks Is the Name “Capitalism” Worth Keeping? Having just read Adam Tooze's book, “The Wages of Destruction: The Making and Breaking of the Nazi Economy” I can see why he may ask such a question.

Tooze refers, in a number of places, to the Nazi economy as a "capitalist economy". For example he writes,

Never before has national production been redistributed on this scale or with such speed by a capitalist state in peacetime.

and

To reiterate, the Third Reich shifted more resources in peacetime into military uses than any other capitalist regime in history.

and

Never before, in peacetime, had a sophisticated capitalist economy been redirected so purposefully.

A question that could be asked is What does Tooze mean by a "capitalist economy"? I would assume that, at least in part, what he means is private ownership of the means of production. This in turn raises the question of What does private ownership mean? Here I follow Grossman and Hart (1986) in defining ownership in terms of control rights. You "own" an asset insofar as you have control rights over that asset. As Grossman and Hart put it

We define a firm to consist of those assets that it owns or over which it has control; we do not distinguish between ownership and control and virtually define ownership as the power to exercise control.

This terminology seems consistent with standard usage. For example Oliver Wendell Homes (1881) writes,

But what are the rights of ownership? They are substantially the same as those incident to possession. Within the limits of policy, the owner is allowed to exercise his natural powers over the subject-matter uninterfered with, and is more or less protected in excluding other people from such interference. The owner is allowed to exclude all, and is accountable to no one but him.

Another characteristic of ownership, I would guess, that Tooze may note is having control over residual income. Note that above ownership has been defined only in terms of control rights, not income rights. As Hart (1997) explains income rights may not be a well defined term,

A problem that one faces when discussing the notion of residual income is that in many contexts it is not well defined. For example, if two parties enter into a profit-sharing agreement, whereby party A receives log(pi+1) and party B receives pi-log(pi+1), where pi is total profit, then who is the residual claimant? The answer is both parties are. Given that profit-sharing contracts are not in principle costly to write if profits are verifiable (and it is unclear how residual income is to be allocated if profits are not verifiable), the conclusion is that residual income may not be a very robust or interesting theoretical concept.

In such a situation is hard to see how ownership can be define in terms of (undefined) income rights. That is not to say there are not good reasons for income and control rights being bundled together, as we normally see, it just means that having control rights over an asset is what makes someone the owner. Firms may, for example, have a profit sharing arrangement with their managers (effectively giving them residual income rights) without the managers being owners in the accepted meaning of the word. However the two sets rights are bundled in many contexts because they are highly complementary. To put it simply, income rights give you the incentive to use an asset efficiency, and control rights give you theability to do so. Thus having residual income rights (alone) in private hands doesn't mean ownership rights are also in private hands. The question of ownership depends on the allocation of control rights.

So did private individuals control rights over "their" assets within the Nazi economy? Tooze makes a number of comments with regard to state involvement in the economy and control over business: to take a few examples,

Now capitalism's deepest crisis left German business powerless to resist a state interventionism that came not from the left but the right

and

The first years of Hitler's regime saw the imposition of a series of controls on German business that were unprecedented in peacetime history.

and

As we have already seen, the New Plan, which effectively regulated the access of each and every German firm to foreign raw materials, created a substantial new bureaucracy, which controlled the vital functions of a large slice of German industry.

and

Managing this burdensome system of controls was the primary function of a new framework of compulsory business organizations imposed by Schacht between the autumn of 1934 and the spring of 1935. In each sector, the existing multiplicity of voluntary associations was fused together into a hierarchy of Reich Groups (for industry, banking, insurance, and so on), Business Groups (Wirtschaftsgruppen, for mining, steel, engineering and so on) and Branch Groups (Fachgruppen, for anthracite as opposed to lignite mining, and so on). Every German firm was required to enrol. Each subdivision in each Business Group was headed by its own Fuehrer. These men were nominated by the existing associations, vetted by the Reich Group and appointed by Schacht. The primary role of the Business Groups was to act as a channel between individual firms and the Reich Ministry of Economic Affairs. Decrees came down from the Ministry via the Business group. Complaints, suggestions and information travelled upwards from the firms, via the Business Groups to Berlin. The organization was tireless in the production of publications, guidelines and recommendations for the best practice. On the basis of emergency decrees first issued during the latter stages of World War I, the Business Groups were also empowered to collect compulsory reports from their members, establishing an unprecedented system of industrial statistics. After 1936 they were authorized to penetrate even further into the internal workings of their members, with the introduction of standardized book-keeping systems.

and

So far-reaching were the regime's interventions in the German economy - starting with exchange controls and ending with the rationing of all key raw materials and the forced conscription of civilian workers in peacetime - that one is tempted to make comparisons with Stalin's Soviet union.

and

[...] though there clearly was a dramatic assertion of state power over business after 1933, naked coercion was applied selectively [...]

What his points to is a high level of state control over business. While control over business was widespread, ownership was not taken over by the state in the manner of the Soviet Union. In Germany ownership remain in the hands of private individuals. While it is true that "formal" ownership remained with private individuals, a question has to be asked as to what happened to "real" ownership. As Aghion and Tirole (1997) point out for the case of organisations, there is a difference between formal authority (the right to decide) and real authority (the effective control over decisions). Formal authority need not confer real authority. A similar situation can occur with ownership when the state regulates business activity. Formal ownership (the right to decide) may not confer real ownership (the effective control over decisions) in so much as many of the control rights normally associated with ownership are not in the hands of the formal owners. Formal owners may be left with only residual income rights and a limited range of control rights. Given the level of regulation of the Nazi economy many of the rights usually thought of as making up (real) ownership had been effectively usurped by the state. 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.

So while formal ownership remained with the private sector, this was little more than just an empty shell since real ownership had been (mis)appropriated by the state.

Also if we think of capitalism as an institutional arrangement involving the use of free markets, a common assumption, then clearly the Nazi economy was not capitalist.

Thus what meaning does the term capitalist retain in this example? If an economy that was so purposefully redirected by the state as the Nazi economy was, is capitalist, then the difference between socialism and capitalism becomes burred, to say the least. This burring of boundaries suggests that there is justification in Horwitz's call for a replacement for the word "capitalism" (and socialism).

Suggestions?

References:

• Aghion, Philippe and Jean Tirole (1997). ‘Formal and real authority in organizations’, “Journal of Political Economy”, 105(1): 1-29.
• Grossman, Sanford J. and Oliver D. Hart (1986). ‘The costs and benefits of ownership: a theory of vertical and lateral integration’, “Journal of Political Economy, 94(4): 691-719.
• Hart, Oliver (1995). “Firms Contracts and Financial Structure”, Oxford: Oxford University Press.
• Holmes, Oliver Wendell (1881). “The Common Law”, Reprint. Boston: Little, Brown, 1946.

Interesting blog bits

Fun for the weekend.

1. Mark Perry points out that Higher Education Is Failing Men, Not Women.
2. Brian Monteith suggest we See beyond glass to get Smith's house in order. It would be a pity, and ironic, if Adam Smith's house could not be used for the sort of discussions he used to hold in it, just because of modern-day bureaucracy.
3. Michael Enriquez notes that Fed Chairman Bernanke Chosen as Time Magazine's Person of the Year. For good or bad Bernanke had a big effect in 2009.
4. John Cassidy interviews John Cochrane. The real Chicago is about thinking hard and arguing with evidence.
5. John Cassidy also interviews Eugene Fama. The man who promulgated the efficient markets hypothesis.
6. Arnold Kling on Market Failure. Kling want to propose a new definition of market failure.
7. Freakonoimcs on When Radio Kills. During the 1994 Rwandan genocide, Radio Télévision Libre des Mille Collines (RTLM) broadcast anti-Tutsi propaganda and called for violence against Tutsis, which many experts believe significantly contributed to the violence.
8. Kristian Niemietz asks Should private schools be nationalised? After all, an invasion of South Korea by North Korea would not spread the South’s prosperity northwards, but the North’s misery southwards.
9. John Yaylor gives us More on "Too Low For Too Long". Much continues to be written about whether interest rates were too low for too long in the period 2003-2005 .
10. Liberty Scott says Pity Haiti and the Vatican's hypocrisy. If ever there was a country that long needed rule of law,a culture of reason and respect for individual liberty and property rights, and the end of kleptocratic violent government, it would be Haiti.

Ronald Coase: "markets, firms and property rights"

This address by, the then 98 year old, Ronald Coase (Clifton R. Musser Professor Emeritus of Economics at the University of Chicago Law School) to the conference "Markets, Firms and Property Rights: A Celebration of the Research of Ronald Coase" was recorded November 23, 2009.

Wealth and earthquakes

Donald J. Boudreaux makes a good point about the recent tragedy in Haiti,

Registering 7.0 on the Richter scale, the Haitian earthquake killed tens of thousands of people. But the quake that hit California’s Bay Area in 1989 was also of magnitude 7.0. It killed only 63 people.

This difference is due chiefly to Americans’ greater wealth. With one of the freest economies in the world, Americans build stronger homes and buildings, and have better health-care and better search and rescue equipment. In contrast, burdened by one of the world’s least-free economies, Haitians cannot afford to build sturdy structures. Nor can they afford the health-care and emergency equipment that we take for granted here in the U.S.

The benefits of economic freedom and the wealth that it helps generate are sometimes not seen until tragedy befalls us.

You may argue that stricter building codes are a major reason why the 1989 Bay Area quake killed far fewer people than did this week’s Haiti quake. But stricter building codes increase the cost of building and if you are poor and cannot afford expensive buildings you build cheap, less safe, ones. So you can have all the building codes you like, but people have to be wealthy enough to be able to afford to obey them, for them to work. Also buildings will get safer, even without building codes, as people get wealthier. The more wealth you have the more you have to protect and thus the more you are willing and able to spend on protecting it.

Mechanism design and terrorism

Fareed Zakaria gives us another reason (if you need one) not to torture people:

As for the calls to treat the would-be bomber as an enemy combatant, torture him and toss him into Guantanamo, God knows he deserves it. But keep in mind that the crucial intelligence we received was from the boy's father. If that father had believed that the United States was a rogue superpower that would torture and abuse his child without any sense of decency, would he have turned him in? To keep this country safe, we need many more fathers, uncles, friends and colleagues to have enough trust in America that they, too, would turn in the terrorist next door.

Incentives matter even in terrorism.

(HT: Jeff Miron)

Evil shortage

Bryan Caplan argues that the Soviet Union fell because of a shortage of evil. In his blog posting Evil Shortage: Why the Evil Empire Fell Caplan writes,

So why did the USSR fall? Because a new generation of half-hearted Communists like Gorbachev were allowed to take the reins - and they just weren't evil enough to retain power. If Stalin had been in Gorby's shoes, he would have reinforced the foundations of totalitarianism by murdering a few million people - beginning with active dissidents and gradually expanding to anyone who'd ever visited the West. And like Kim Jong Il, he would still be in power today. Gorbachev's generation of leaders were far from saints, but as tyrants go, they were wimps.

Of course it could have been that the economy had turned to crap and just couldn't keep on working.

Economics 101 moral hazard

This Center for Freedom and Prosperity Foundation 's Economics 101 video discusses the Moral Hazard, which occurs when bad choices are subsidized. This often happens when government intervention lets people take risks while having little or no skin in the game. Housing policies, for instance, subsidized mortgages, thus enabling irresponsible borrowing and leading to bubbles and bailouts. Politicians may be setting the stage for the next crisis with a too big to fail policy that will subsidize the biggest financial institutions.

Unwinding the monetary and fiscal stimulus

In this audio from VoxEU.org Pablo Guidotti, Director of the School of Government at the Universidad Torcuato Di Tella and former deputy minister of finance in Argentina, talks to Romesh Vaitilingam about the challenges facing monetary and fiscal policy-makers as they plan their exit strategies from the extraordinary measures taken to deal with the global crisis.

Why "Buy American'' is a bad idea but politicians still like it

and, of course, its not just "Buy American" that's a bad idea, all "buy local" campaigns are dumb. This point is made in a new working paper by Mario Larch and Wolfgang Lechthaler called Why Buy American'' is a Bad Idea but Politicians Still Like it, Kiel Institute for the World Economy, Kiel Working Paper No. 1570, November 2009.

Larch and Lechthaler are interested in whether it is a good idea to respond with protectionism in the case of a negative productivity shock. They analyse the dynamics of transitory changes to trade barriers as a short-run response to an economic downturn in a dynamic, general equilibrium new trade theory model with heterogenous firms. They look at a number of different scenarios, where they distinguish whether the trading partner responds to increased trade barriers or not. The main conclusion is that protectionism hurts all countries, including the country imposing the protectionist measures, even if the other countries do not react with protectionism by themselves. Thus they show that the beggar-thy-neighbour policy does not work. A country cannot shield itself from an economic downturn of its trading partners by imposing temporarily higher trade barriers, but rather hurts itself. Thus, the results from their model yields a powerful argument against any kinds of protectionism.

But politicians still seem to like protectionist measures, Why? Is there a way to rationalise the actions of politicians? The answer from Larch and Lechthaler is yes. There are two rationales that help to understand why countries consider protectionism to be a good idea as a response to a recession: Firstly, even though higher trade barriers deter the gains from trade, they mitigate the negative spill-over effects from shocks in other countries. Secondly, firms are hit differently by protectionism. Domestic firms that do not export at all gain in terms of total profits from raising trade barriers, whereas exporting firms loose. Governments may raise trade barriers in order to support local firms, which may be important campaign contributors and voters in the next election. So rent seeking by non-exporters influences politicians.

$123,000,000,000,000 question

Will China's economy be worth $123 trillion by 2040? The Nobel Prize winning economist Robert Fogel says yes. In the journal Foreign Policy he writes,

In 2040, the Chinese economy will reach $123 trillion, or nearly three times the economic output of the entire globe in 2000. China's per capita income will hit $85,000, more than double the forecast for the European Union, and also much higher than that of India and Japan. In other words, the average Chinese megacity dweller will be living twice as well as the average Frenchman when China goes from a poor country in 2000 to a superrich country in 2040. Although it will not have overtaken the United States in per capita wealth, according to my forecasts, China's share of global GDP -- 40 percent -- will dwarf that of the United States (14 percent) and the European Union (5 percent) 30 years from now. This is what economic hegemony will look like.

A big call, but not one I would argue is necessarily wrong. China has been growing fast and will continues to do so. But there are problems ahead: rising income inequality, potential social unrest, territorial disputes, fuel scarcity, water shortages, environmental pollution, and a still-rickety banking system, for example.

For Fogel there are five main reasons for thinking China can overcome these problems and become a world economic superpower.

The first essential factor that is often overlooked: the enormous investment China is making in education. More educated workers are much more productive workers. (As I have reported elsewhere, U.S. data indicate that college-educated workers are three times as productive, and a high school graduate is 1.8 times as productive, as a worker with less than a ninth-grade education.) In China, high school and college enrollments are rising steeply due to significant state investment. In 1998, then-President Jiang Zemin called for a massive increase in enrollment in higher education. At the time, just 3.4 million students were enrolled in China's colleges and universities. The response was swift: Over the next four years, enrollment in higher education increased 165 percent, and the number of Chinese studying abroad rose 152 percent. Between 2000 and 2004, university enrollment continued to rise steeply, by about 50 percent. I forecast that China will be able to increase its high school enrollment rate to the neighborhood of 100 percent and the college rate to about 50 percent over the next generation, which would by itself add more than 6 percentage points to the country's annual economic growth rate. These targets for higher education are not out of reach. It should be remembered that several Western European countries saw college enrollment rates climb from about 25 to 50 percent in just the last two decades of the 20th century. [...]

The second thing many underestimate when making projections for China's economy is the continued role of the rural sector. When we imagine the future, we tend to picture Shanghai high-rises and Guangdong factories, but changes afoot in the Chinese countryside have made it an underappreciated economic engine. In analyzing economic growth, it is useful to divide an economy into three sectors: agriculture, services, and industry. Over the quarter-century between 1978 and 2003, the growth of labor productivity in China has been high in each of these sectors, averaging about 6 percent annually. The level of output per worker has been much higher in industry and services, and those sectors have received the most analysis and attention. (I estimate that China's rapid urbanization, which shifts workers to industry and services, added 3 percentage points to the annual national growth rate.) However, productivity is increasing even for those who remain in rural areas. In 2009, about 55 percent of China's population, or 700 million people, still lived in the countryside. That large rural sector is responsible for about a third of Chinese economic growth today, and it will not disappear in the next 30 years.

Third, though it's a common refrain that Chinese data are flawed or deliberately inflated in key ways, Chinese statisticians may well be underestimating economic progress. This is especially true in the service sector because small firms often don't report their numbers to the government and officials often fail to adequately account for improvements in the quality of output. In the United States as well as China, official estimates of GDP badly underestimate national growth if they do not take into account improvements in services such as education and health care. (Most great advances in these areas aren't fully counted in GDP because the values of these sectors are measured by inputs instead of by output. An hour of a doctor's time is considered no more valuable today than an hour of a doctor's time was before the age of antibiotics and modern surgery.) Other countries have a similar national accounting problem, but the rapid growth of China's service sector makes the underestimation more pronounced.

Fourth, and most surprising to some, the Chinese political system is likely not what you think. Although outside observers often assume that Beijing is always at the helm, most economic reforms, including the most successful ones, have been locally driven and overseen. And though China most certainly is not an open democracy, there's more criticism and debate in upper echelons of policymaking than many realize. Unchecked mandates can of course lead to disaster, but there's a reason Beijing has avoided any repeats of the Great Leap Forward in recent years. [...]

Finally, people don't give enough credit to China's long-repressed consumerist tendencies. In many ways, China is the most capitalist country in the world right now. In the big Chinese cities, living standards and per capita income are at the level of countries the World Bank would deem "high middle income," already higher, for example, than that of the Czech Republic. In those cities there is already a high standard of living, and even alongside the vaunted Chinese propensity for saving, a clear and growing affinity for acquiring clothes, electronics, fast food, automobiles -- all a glimpse into China's future. Indeed, the government has made the judgment that increasing domestic consumption will be critical to China's economy, and a host of domestic policies now aim to increase Chinese consumers' appetite for acquisitions.

Crime and the economy 2

Earlier I noted the article by Heather MacDonald from the Wall Street Journal which raised the question, in terms of the US, If poverty is the root cause of lawlessness, why did crime rates fall when joblessness increased? Fred Hansen at the ASI blog notes a similar trend for the UK. He writes,

If you look at the latest crime statistics you are probably in for a surprise. Recorded crimes fell 5% to 4.7 million in 2009. Here are the latest stats for the UK:

* Violence against the person down 6%
* with injury down 7%
* Domestic burglary up 1%
* Offences against vehicles down 10%
* Theft from the person down 12%
* Criminal damage down 10%
* Robbery down 5%
* Drugs offences up 6%

But unemployment is also up in the UK, so we have the same question for the UK as for the US.

But perhaps we shouldn't be too surprised that the current data show something different from past data. As Papps and Winkelmann, who looked at the relationship between unemployment and crime in New Zealand, put it

The unemployment-crime relationship is an old issue. No consensus has been reached by economists during the last three decades, nor does one seem likely to emerge in the near future. (Papps and Winkelmann p. 68)

Those words were published in 2000 and if we accept 2010 as the near future, the current debate just proves Papps and Winkelmann right.

• Papps, Kerry and Winkelmann, Rainer. 'Unemployment and Crime: New Evidence for an Old Question', New Zealand Economic Papers, June 2000, v. 34, iss. 1, pp. 53-71.

EconTalk this week

Michael Belongia of the University of Mississippi and former economist at the St. Louis Federal Reserve talks with EconTalk host Russ Roberts about the inner workings, politics, and economics of the Federal Reserve. Belongia talks about the role that power and politics play in Federal Reserve decision-making and how various Fed chairs used their power to suppress dissent within the Fed that was critical of Fed policy. He argues that the Fed faces an unresolvable dilemma when asked to achieve the multiple goals of full employment and price stability using only the federal funds rate as a policy lever. The discussion concludes with Belongia's indictment of the monetary data that the Fed produces.

Not all innovation works

However, thanks largely to its absurd specifications, which called for dive bombing capability, the He 177 was a disaster. Its wings were prone to falling off and its peculiar back-to-back engine configuration resulted in frequent self-combustion. (Adam Tooze, “The Wages of Destruction: The Making and Breaking of the Nazi Economy”. p. 448)

The impact of class size on the performance of university students

The effect of increasing class size in tertiary education is not well understood. A new column at VoxEU.org estimates the effects of class size on students’ exam performance by comparing the same student’s performance to her own performance in courses with small and large class sizes. Going from the average class of 56 to a class size of 89 would decrease the mark by 9% of the observed variation in marks within a given student. The effect is almost four times larger for students in the top 10%. This last result is a bit worrying, your best students are effected most. I hate to think what they would make of our lectures with 400 students!

The column, The impact of class size on the performance of university students, is by Oriana Bandiera, Valentino Larcinese, and Imran Rasul. Their approach to identifying class-size effects is to look at the within-student variation in marks across different courses with different class sizes.

To address this policy question, we estimate the impact of class size on the final exam marks of graduate students in a leading UK university between 1999 and 2004 (Bandiera et al. 2010). As we observe the same student being exposed to very different class sizes, we estimate the effects of class size on students’ exam performance by comparing the same student’s performance to her own performance in courses with small and large class sizes. It is important to stress that, on average, most of the variation in marks is due to fixed students’ characteristics and not university inputs. On average the performance of a given students only varies by around 7% of the average mark across her courses. We shed light on how much of this within-student difference is attributable to differing class sizes the student faces.

The effect of class size on students’ performance is – as expected – negative; students do worse in big classes. Namely, a given student receives lower marks in courses with larger classes, everything else equal.

To get a sense of the magnitude of this effect, our estimates imply that a one standard deviation increase in class size from the mean (that is going from the average class of 56 to a class size of 89) would decrease the mark by 9% of the observed variation in marks within a given student. These estimates, however, mask two important forms of heterogeneity: (i) the impact of class size varies across the range of class sizes; (ii) the effect of class size varies across students.

On the first form of heterogeneity, the negative effect of class size on student exam performance is large and negative only in the smallest and the largest classes. There is no class size effect across a wide range of intermediate class sizes. The magnitudes imply that moving the average student from a class of 10 to a class of 25 leads to a drop in exam performance of around 12.5% of within-student standard deviation. Increasing the class size from 25 to 45 determines a further 12.5% drop. In contrast, there is no impact in a wide intermediate range, while moving from 80 to 150 determines a further drop of 25% in the within-student standard deviation. If moved from a very small class (of size 10) to a very large class (of size 150), the average student can be expected to suffer a loss corresponding to about 50% of the overall variation in exam marks the average student experiences across all of her courses.

The second form of heterogeneity concerns students’ ability. Students at the top of the mark distribution are those most affected by class size. The effect is almost four times larger for students in the top 10% of the distribution of exam marks than for students at the bottom 10%, and about 50% larger than the average student. This heterogeneity is most apparent in the largest classes and virtually non-existent for a range of intermediate class sizes. This implies the highest-ability students would benefit the most, in terms of academic achievement, from any reduction in class sizes, when class sizes are initially very large.

What mechanisms are at work here? Bandiera, Larcinese, and Rasul explain,

To shed light on the underlying mechanisms for the class-size effect, our analysis uses information on teachers' assignments to classes and on students' characteristics. We find no evidence that departments purposefully assign faculty of differing quality to different class sizes, and we find no evidence that faculty members alter their behaviour when exposed to different class sizes. It appears that the preparation and delivery of lectures is independent of the number of students taught.

On student characteristics, the class-size effect does not vary with proxies for students' wealth. Hence if larger classes resulted in lower grades because students had more limited access to library books or computer laboratories, the effect should have been smaller for students who can purchase these inputs privately. Moreover, the class-size effect does not vary with student's familiarity with this particular university as an undergraduate or with the UK system generally. This casts doubts on the relevance of mechanisms that work through the information students have, such as their awareness of other local resources (for example other libraries in the area), or their knowledge of the characteristics of faculty, courses, or departments.

Clearly class size matters for student performance and particularly for the most able students. So the question is, How effective is reducing class size as a strategy for improving the performance of students? Bandiera, Larcinese, and Rasul argue that reducing class size is not always an effective strategy and is certainly not effective for all students in the same way.

Reducing the size of very large modules (above 100) could be a cost-effective way to improve students’ performance. For modules in the range 30-100 reducing class size could be a rather ineffective strategy, while for classes below 30 it could be a valid but not necessarily cost-effective strategy. Attention should be devoted to other inputs in such cases, and more refined and cost-effective solutions than pure number counting should be identified. To this end, it is important to have a better understanding of the mechanisms that link class size and performance.

Although student-to-staff ratio is a commonly used indicator of quality both in national and international comparisons, this might be a noisy measure of quality over this intermediate range of class sizes.4 Given the mechanisms our data rule outs, there appear to be at least two ways that larger classes reduce students' performance. First, changes in student behaviour such as their attentiveness or participation. Second, reduced resource availability, such as library books or faculty time during office hours.

As the best students are the most affected, that could imply that large classes induce a reduction in tutoring activity rather than a substantial deterioration in classroom conditions. It is reasonable to expect that the best students are able to compensate classroom deterioration at least as well as other students. However, the best students are also those that benefit the most (in terms of both learning and motivation) from contact with teachers. They, therefore, suffer the most in terms of reduced performance when such contacts or tailored feedback is less frequent.

• Bandiera, O., V. Larcinese and I. Rasul (2010), “Heterogeneous Class Size Effects: New Evidence from a Panel of University Students”, forthcoming, Economic Journal.

Joseph Schumpeter and regime uncertainty

In Capitalism, Socialism, and Democracy, Joseph Schumpeter argued that policy shocks, and policy uncertainty generally, lengthened the Great Depression:

The subnormal recovery to 1935, the subnormal prosperity to 1937 and the slump after that are easily accounted for by the difficulties incident to a new fiscal policy, the new labor legislation and a general change in the attitude of government to private enterprise all of which can, in a sense to be defined later, be distinguished from the working of the productive apparatus as such.

Since misunderstandings at this point would be especially undesirable, I wish to emphasize that the last sentence does not in itself imply either an adverse criticism of the New Deal policies or the proposition — which I do believe to be true but which I do not need right now — that policies of that type are in the long run incompatible with the effective working of the system of private enterprise. All I mean to imply is that so extensive and rapid a change in the social scene naturally affects productive performance for a time, and so much the most ardent New Dealer must and also can admit. I for one do not see how it would otherwise be possible for the fact that this country which had the best chance of recovering quickly was precisely the one to experience the most unsatisfactory recovery. (p. 64-5).

This idea that government policies can effect people's view of the economy and in particular investor's confidence in the longevity of private property rights and thus the return they may get from any investment has come to be known, thanks to Robert Higgs, as regime uncertainty. Higgs's argument being that that FDR’s policies at the time of the Great Depression, prevented a robust recovery of long-term private investment by significantly reducing investors’ confidence in the durability of private property rights. This lack of investment prolonged and deepened the depression in the US.

But there is nothing new under the sun. Schumpeter was ahead of even Higgs.

(HT: Organizations and Markets)

More on get rid of government experts

A previous posting, Get rid of government experts: they do not know what is best for the people, was based on an a article by philosopher James Otteson in Forbes. The Forbes article was in turn based on an academic piece by Otteson which has now appeared in the journal Social Philosophy and Policy. The full details are Adam Smith and the Great Mind Fallacy, James R. Otteson, Social Philosophy and Policy (2010), 27:276-304. The abstract reads,

Adam Smith raised a series of obstacles to effective large-scale social planning. In this paper, I draw these Smithian obstacles together to construct what I call the “Great Mind Fallacy,” or the belief that there exists some person or persons who can overcome the obstacles Smith raises. The putative scope of the Great Mind Fallacy is larger than one might initially suppose, which I demonstrate by reviewing several contemporary thinkers who would seem to commit it. I then address two ways the fallacy might be overcome, finding both wanting. I close the paper by suggesting that Smith's Great Mind Fallacy sheds interesting light on his “impartial spectator” standard of morality, including with respect to the specific issues of property and ownership.

The whole issue is worth reading as it collects together a number of papers from a distinguished group of scholars all addressing the general topic of "ownership and justice."

Thomas Sowell on intellectuals and society

From the Hoover Institution and The National Review Online comes this series of videos in which the great economist Thomas Sowell introduces his new book, Intellectuals and Society. Thomas Sowell is the Rose and Milton Friedman Senior Fellow on Public Policy at the Hoover Institution.

In Chapter 1 of 5 he expounds on what he calls “the fatal misstep of intellectuals.”




Chapter 2 of 5 Thomas Sowell offers examples of why intellectuals are so often wrong about economics.



Chapter 3 of 5 What is the vision to which contemporary intellectuals subscribe? Thomas Sowell responds.



Chapter 4 of 5 Thomas Sowell reasons that intellectuals certainly can renounce war, “and that does not stop your neighbor from building up the biggest army in the world and coming in and killing you.”



Chapter 5 of 5 Thomas Sowell explains how the demand for public intellectuals is largely manufactured by the public intellectuals themselves.