Yes, but why?

An interesting observation from Tyler Cowen over at Marginal Revolution:

Nearly a quarter of South Korean men over 75 are still in the labor force, as are 14 percent of Japanese men. In the United States, a 10th of such men are working or seeking work, compared with half of 1 percent in France.

Put another way, a Korean man over 75 is more likely to be working than a Frenchman in his early 60s.

Is this good or bad? And what does government social benefit systems have to do with it? More discussion here.

Does size matter?

An age old question.

And one that keeps coming up in policy circles when talking about job creation. And when are policymakers not talking about job creation?

There is a view, often strongly argued, that small and new firms create a disproportionate share of new jobs. Which means that governments should be helping new firms if they want new jobs. But is it right? John Haltiwanger, Ron Jarmin, and Javier Miranda take a look at the US data and find that it is age, not size, that matters. (That will come as a relief to many I'm sure!)

There’s been a long, sometimes heated, debate on the role of firm size in employment growth. Despite skepticism in the academic community, the notion that growth is negatively related to firm size remains appealing to policymakers and small business advocates. The widespread and repeated claim from this community is that most new jobs are created by small businesses. Using data from the Census Bureau Business Dynamics Statistics and Longitudinal Business Database, we explore the many issues regarding the role of firm size and growth that have been at the core of this ongoing debate (such as the role of regression to the mean). We find that the relationship between firm size and employment growth is sensitive to these issues. However, our main finding is that once we control for firm age there is no systematic relationship between firm size and growth. Our findings highlight the important role of business startups and young businesses in U.S. job creation. Business startups contribute substantially to both gross and net job creation. In addition, we find an “up or out” dynamic of young firms. These findings imply that it is critical to control for and understand the role of firm age in explaining U.S. job creation.

Studying the biases of bureaucrats

Matt Ridley seems to think this is a good idea. In a piece in the Wall Street Journal Ridley argues that behavioural economics needs to be applied to bureaucrats as well as markets.

But while there is a lot of interest in the psychology and neuroscience of markets, there is much less in the psychology and neuroscience of government. Slavisa Tasic, of the University of Kiev, wrote a paper recently for the Istituto Bruno Leoni in Italy about this omission. He argues that market participants are not the only ones who make mistakes, yet he notes drily that "in the mainstream economic literature there is a near complete absence of concern that regulatory design might suffer from lack of competence." Public servants are human, too.

Human may be going a bit far!!!!

The paper by Tasic identifies five mistakes that government regulators often make:

1. action bias,
2. motivated reasoning,
3. the focusing illusion,
4. the affect heuristic and 
5. illusions of competence.

Ridley notes,

In the last case, psychologists have shown that we systematically overestimate how much we understand about the causes and mechanisms of things we half understand. The Swedish health economist Hans Rosling once gave students a list of five pairs of countries and asked which nation in each pair had the higher infant-mortality rate. The students got 1.8 right out of 5. Mr. Rosling noted that if he gave the test to chimpanzees they would get 2.5 right. So his students' problem was not ignorance, but that they knew with confidence things that were false.

The issue of action bias is better known in England as the "dangerous dogs act," after a previous government, confronted with a couple of cases in which dogs injured or killed people, felt the need to bring in a major piece of clumsy and bureaucratic legislation that worked poorly. Undoubtedly the rash of legislation following the current financial crisis will include some equivalents of dangerous dogs acts. It takes unusual courage for a regulator to stand up and say "something must not be done," lest "something" makes the problem worse.

Motivated reasoning means that we tend to believe what it is convenient for us to believe. If you run an organization called, say, the Asteroid Retargeting Group for Humanity (ARGH) and you are worried about potential cuts to your budget, we should not be surprised to find you overreacting to every space rock that passes by. Regulators rarely argue for deregulation.

The focusing illusion partly stems from the fact that people tend to see the benefits of a policy but not the hidden costs. As French theorist Frédéric Bastiat argued, it's a fallacy to think that breaking a window creates work, because while the glazier's gain of work is visible, the tailor's loss of work caused by the window-owner's loss of money—and consequent decision to delay purchase of a coat—is not. Recent history is full of government interventions with this characteristic.

"Affect heuristic'" is a fancy name for a pretty obvious concept, namely that we discount the drawbacks of things we are emotionally in favor of. For example, the Deepwater Horizon oil spill certainly killed about 1,300 birds, maybe a few more. Wind turbines in America kill between 75,000 and 275,000 birds every year, generally of rarer species, such as eagles. Yet wind companies receive neither the enforcement, nor the opprobrium, that oil companies do.

Regulation and government economic interventions looks a lot less good when you look at it the way Ridley does. Of course this may be why governments don't do this. Good policy should always keep in mind that regulators might not be as competent as they think they are.

Hickson on RNZ

Previously I noted that Stephen Hickson has written a good piece in the Christchurch Press on foreign ownership. Thanks to Offsetting Behaviour we lean that Stephen Hickson has now appeared on Radio New Zealand's "The Panel". The segment starts at 3:30; Stephen Hickson comes in around the 7:30 mark.

Well said Steve!

Using online experiments in business

Economist Susan Athey talks to NPR:

Did you know that every time you do a search on Google or Bing, you are improving the quality of the search engine? The more people click on a search advertisement from a clothing company or on a link on an online news story, the more prominently it is displayed for the next consumer. And the firms constantly experiment to get things right. They watch what consumers do and adapt their products in response to the results of their experiments.

But designing the right experiment is difficult. To see just one example, consider spam. An e-mail provider wants to eliminate spam from your inbox. It is nuisance for all of us. That company might test out a new way to filter spam. The filter may do a great job in short-term experiments, where the spammers don't have a chance to respond. But once the new filter is introduced in practice, spammers may find a way around the filter. So, that means that some legitimate e-mail is filtered out and the end result may be that you haven't solved the spam problem at all. You could very well end up worse than where you started, even though the experimental numbers looked great.

So, if you want to figure out whether a new product will work out the way you hope, you need to be able to anticipate how people will react to your innovation. That is, you don't just have to be a good statistician. It's not just about the numbers that come out of simple experiments; it is about predicting how people will react to the changes you make. You need to understand behavior and how to build models that reflect the choices we all make.

Unfortunately, our universities and business schools haven't figured out how to train students to do this kind of modeling and prediction. That is, we aren't preparing students to manage the new data-driven businesses. And let's face it: This is where our economy is headed, as consumers are spending more and more of their time online. Creating new jobs in this economy is a must, but making sure that the workforce is ready for the jobs where our growth is happening is more important. The good news is that the young people who do develop the talent and skills to capitalize on this opportunity will be in high demand, which puts them in a great position in today's tough economy.

Survivor bias

Lasse Lien at Organizations and Markets gives a nice example of Survivor Bias: WW2 ed.

One fascinating anecdote is how these pioneers used data on damage from German air defense fire. The RAF collected large amounts of data on exactly where returning aircraft had received damage. The intuitive recommendation would be to reinforce the aircrafts were the data indicated they took the most damage. However, realizing that they only had data from surviving aircraft, the OR-group under leadership of Patrick Blackett recommended that they reinforce the aircraft in the sections where no damage was recorded in the data.

Nice. What you would really like to know is what damage did the planes that didn't return suffer.

Incentives matter: insurance file

"There was another man who took out insurance with 28 or 38 companies," said Murray Armstrong, an insurance official for Liberty National. "He was a farmer and ordinarily drove around the farm in his stick shift pickup. This day - the day of the accident - he drove his wife's automatic transmission car and he lost his left foot. If he'd been driving his pickup, he'd have had to use that foot for the clutch. He also had a tourniquet in his pocket. We asked why he had it and he said, 'Snakes. In case of snake bite.' He'd taken out so much insurance he was paying premiums that cost more than his income. He wasn't poor, either. Middle class. He collected more than $1-million from all the companies. It was hard to make a jury believe a man would shoot off his foot."

The full article is available here.

(HT: Marginal Revolution)

Why don't the players own football clubs?

The question of why the players in professional sports don't own the teams they play for is one I have been thinking about recently. On the surface it would like they should. After all the human capital of the players - talent at playing a particular sport - is the only real asset that teams have and we normally see worker ownership in human capital based firms. Think of partnerships in the case of lawyers, accountants, GPs etc. So why not football players?

My argument would be that heterogeneity among playing talent is at least part of the answer. Differing talents leads to differing earning potential which results in a disincentive to form a cooperative structure since those players with the greatest earning potential will wish to be able to transfer between teams easily to maximise competition for their services. Martin Ricketts explains the problem as

Further, to minimise antagonism a rough equality in the division of the residual will be necessary and this may conflict with outside opportunities. Those with high transfer earnings reflecting high productivity elsewhere will desert the co-operative. It is for these reasons that control of the firm by its labour force is usually found in circumstances which permit a high degree of common interest.

A cooperative form of organisation would hinder rapid transfers between clubs. Issues that could slow transfers could arise if, for example, the terms of the exit have to be negotiated with the remaining player/owners of the cooperative team. The remaining player/owners could, as an example, be unable or unwilling to buy out the exiting player or any of them could veto an incoming replacement player/owner. Transfers would be easier if the player was just an employee of the team rather than an employee/owner.

In addition there are principal-agent problems such as those which could arise between the manager or coach of the team and the player/owners in their roles as players and as owners. Who is the principal and who is the agent?

I don't know of any player owned teams - if anyone does have an example please give it in the comments - and heterogeneity of human capital is part of the reason why.

New videos featuring Lawrence H. White talking about the work of F A Hayek

EconStories.tv has three new videos available in which Lawrence H. White talks about the work of F A Hayek.

Part one, Fear the Boom, focuses on the unsustainability of a boom driven by artificially low interest rates and credit expansion by the central bank (the Fed) beyond the supply of genuine savings.



In part two, The Bust, Lawrence White offers his view on a Hayekian response to the bust phase of the Boom and Bust cycle and responds to the charge that F. A. Hayek was a “liquidationist.”



In part three, The Cluster of Errors, White addresses the expectations and the cluster of entrepreneurial errors that reveal themselves during a bust.



Lawrence H. White is a professor of economics at George Mason University.

EconTalk this week

Thomas Hazlett of George Mason University talks with EconTalk host Russ Roberts about the growing rivalry between Apple and Google. It is commonly argued that Apple with its closed platform and tight control from the top via Steve Jobs is making the same mistake it made in its earlier competition with Microsoft. Google on the other hand is lauded for its open platform and leveraging of a large number of suppliers for its Android phone, for example. Hazlett, drawing on his recent article in the Financial Times, argues that these arguments fail to recognize the different competitive advantages of Apple and Google and the implications of those advantages for the companies' respective strategies. The conversation concludes with a discussion of the move to application-based web browsing such as Facebook, Twitter, and the implications for Google.

The Smoot-Hawley Act and trade retaliation

As noted in the previous posting the Smoot-Hawley Act in the US invited trade retaliation from the US's trading partners. Jim Powell has been discussing these retaliations in the Washington Times. He writes,

On June 17, 1930, Hoover signed what became known as the Smoot-Hawley Act. It was named after Utah Sen. Reed Smoot and Oregon Rep. Willis C. Hawley, both Republicans. The law raised import duties an average of 59 percent on more than 25,000 agricultural commodities and manufactured goods. Smoot-Hawley was a factor in the subsequent plunge of the stock market and the doubling of unemployment within a year. More than 60 countries retaliated with restrictions against whichever products would inflict the worst losses on Americans.

Smoot-Hawley outraged people, starting with our neighbors. "The tariff on halibut was doubled, thus offending the eastern provinces of Canada," explained Joseph M. Jones Jr., in his classic study "Tariff Retaliation." "The tariff duties on potatoes, on milk, cream, buttermilk, skimmed milk and butter were all radically increased, thus antagonizing the populations of Quebec and Ontario; the prairie and western provinces were provoked by increased duties on cattle, fresh meats, wheat and other grains; British Columbia and Alberta were infuriated by increases in the duties on apples, logs and lumber." Canadians slapped steep tariffs on U.S. agricultural implements, electrical apparatus, household equipment, cast-iron pipe, vegetables, gasoline, shoes, paper, fertilizers and jewelry - perhaps a billion dollars' worth of business down the tubes.

In Great Britain, long the greatest champion for free trade and prosperity, Smoot-Hawley helped provoke a protectionist reaction that led to the Import Duties Act (1932), the country's first general tariff law in more than a century. Part II of the Import Duties Act provided 100 percent tariffs on goods from countries such as the United States that penalized British goods.

Because Smoot-Hawley included cork, which accounted for more than half of Spain's exports to the United States, Spain increased tariffs on American cars by 150 percent, enough to shut American cars out of the Spanish market.

Smoot-Hawley hit Italy's principal exports to the United States, including raw cotton, wheat, copper and leather, and Italy retaliated by more than doubling its tariffs on American cars. Sales of American cars in Italy subsequently dropped 90 percent. Italy also increased tariffs on American radios more than 500 percent.

France responded to Smoot-Hawley with import quotas that, together with its tariffs, business taxes and other obstacles, shut American goods out of the French market.

Smoot-Hawley affected just about every Swiss export to the United States, watches in particular. A tenth of the Swiss population was involved in the watch business, and 95 percent of Swiss watches were exported. There was popular support for a Swiss boycott aimed at all American goods.

But did any of this actually help the farmers that the act was supposed to help? Powell continues,

American farmers, who had lobbied hard for Smoot-Hawley, were among the biggest losers from all this. They saw their exports plunge from $1.8 billion in 1929 before Smoot Hawley to $590 million just four years later.

As Don Boudreaux put it "That worked well."

Trade retaliatory is no "yolk"

Donald J. Boudreaux has been writing, as only he can, to the Washington Times:

Jim Powell offers a long list of some of the many trade-destroying retaliatory tariffs that foreign governments imposed on their citizens in response to Uncle Sam’s 1930 Smoot-Hawley tariff (“The tempting path of protectionism,” Oct. 24). I offer here yet another candidate for that list: Canada’s tariff on American eggs.

Harvard government professor Jeffry Frieden explains that “Smoot-Hawley raised the tariff on egg imports into the U.S. from eight cents to ten cents per dozen. This higher tariff caused egg imports from Canada to fall by 40 percent. In response, Canadian authorities increased the tariff on U.S. eggs exported to Canada; this tariff went from three cents per dozen to ten cents per dozen. The result was that American egg exports to Canada fell by 98 percent – from 11 million annually just before Smoot-Hawley to a mere 200,000.”

That worked well.

So if the straight economic arguments against protectionism aren't convincing enough when you add in the political economy arguments, like retaliation, it is difficult to see why people still support protectionism. Does anyone really think the Smoot-Hawley tariff helped US egg producers?

Tariff s costs jobs

Some people even in the US seem to understand this point:

"Think about the IPod, for instance. It is designed in America and its 451 parts are made in dozens of different countries. But just because it is finally assembled in China, it officially counts as a Chinese import and therefore a contributor to America’s trade deficit — never mind that the Chinese add only $4 to the IPod’s $150 final value. Imposing duties on IPods to slash the deficit, then, won’t just cost Chinese jobs in Beijing assembly plants, but American jobs in Cupertino (Apple’s headquarters) computer labs."

And hurts the worst-off of people,

But if raising the barricades against Chinese products will hurt highly-paid techies in America, it will hurt working class folks even more.

Consider the research by University of Chicago economist Christian Broda. Contrary to conventional wisdom, he found that inequality in this country has gone down – not up — thanks to trade with China. Between 1994 and 2005, he found, any rise in income inequality was offset by a decline in prices of goods consumed by poorer households. Indeed, inflation for the richest 10% of U.S. households, which tend to spend more on services, was 6% higher than the poorest 10%, who spend more of their income on household goods supplied by China. “In sectors where there is no Chinese presence,” Broda has pointed out, “inflation has been more than 20%.” In short, China has likely done more to help America’s poor than the stimulus, TARP or any other program invented by Uncle Sam.

That is Shikha Dalmia in Forbes.

But what is the opportunity cost?

The New Zealand Herald tells us that:

New Zealand's largest education union says te reo Maori should be compulsory in all schools to ensure it's kept alive.

But if it is to be compulsory what is to be dropped to make way for it? Should students not be taught maths, English, history or .....? There is no such thing as a free compulsory subject.

Minimum wages and youth unemployment

An interesting post over at Economic Logic blog on the effects of minimum wages on youth unemployment. The Economic Logician writes,

Aspen Gorry uses a suddenly popular labor search model that differentiates between those seeking a first job (the young) and those that have experience (the old). Varying the level of the minimum wages from American to French levels, he finds that about 50% of the gap between youth unemployment rates can be explained. What this is implies is that the minimum wage prevents some of the young workers to find their first job. And this lack of experience implies that they enjoy only later the job stability of an incumbent. Thus the impact of the minimum wage adds up quickly for the aggregate unemployment rate.

The abstract of the Gorry paper reads:

Significant employment differences between the US and Europe are concentrated among young workers. This paper constructs a labor search model that accounts for age patterns of employment. Work experience reduces the probability that workers lose their jobs. By introducing minimum wages, the model explains empirical findings on the effects of minimum wage laws. In addition, the model shows that minimum wages can account for about half of the differences in youth employment between Europe and the United States.

The model suggests that the introduction of minimum wages means that the representative inexperienced workers, the young, have a more difficult time finding their first job and are less likely to become experienced. Such negative effects decline with age as workers become experienced and the minimum wage no longer binds. So the minimum wage effects of job prospects of the young inexperienced worker.

Copyright and endogenous market structure

There is a new working paper out on Copyright & endogenous market structure: A glimpse from the journal-publishing market. It is by Giovanni B. Ramello. The abstract reads,

This article explores the journal publishing industry in order to shed light on the overall economic consequences of copyright in markets. Since the rationale for copyright is among others to promise some market power to the holder of the successful copyrighted item, it also provides incentives to preserve and extend market power. A regular trait of copyright industries is high concentration and the creation of large catalogues of copyrights in the hands of incumbents. This outcome can be observed as the aggregation of rights and is one of the pivotal strategies for obtaining or extending market power, consistently with findings in other cases. Journal publishing is no different in this respect from other copyright industries, and in the last decade has experienced a similar trajectory, leading to a highly concentrated industry in which a handful of large firms increasingly control a substantial part of the market. It also provides a clear example of the effect of copyright dynamics on market structure, suggesting that a different attitude should be taken in lawmaking and law enforcement.

So one unintended consequence of copyright, for academic publishing at least, is simply that given some market power, via copyright, the "monopolist" will seek to expand this power by making acquisitions and thereby obtain even more dominance in the market. Many would argue that this has happened in economics. As the Economic Logician says,

The obvious example is Elsevier, which has reached now a market share that should trigger anti-trust investigations along with profit margin in the order of 30%. The situation is quite bad in Economics, as scholarly societies have done little to prevent Elsevier taking hold of the major field journals, thereby making it essential to any tenure file. And given this, research libraries have no choice but subscribe to those journals, falling in the trap of the monopolist.

The economics of talent

Tim Worstall tells us what What Rooney tells us about football. He writes,

It’s a simple effect of the structure of the business. When you’ve a business which depends upon human talent, slight gradations in said talent, then all the money in the business will end up in the hands of said talent. This is as true of banking as it is football, movies or, dare I say it, the writing of books.

Those who have that extra 10%, 1% even, will see their prices bid up as the moneymen compete with each other to employ that extra 10%, 1% of talent.

It’s analagous as to why the workers’ wages in general rise over time. As productivity rises then the capitalists are competing among themselves for the ability to employ that now newly more valuable labour. Thus wages in general get bid up.

Interestingly this may also help explain why the players don't own the football clubs. To take advantage of the money on offer the players have to be able to move from club to club and player ownership of clubs would make this more difficult.

Deferred fees for universities

This is an idea put forward by Neil Shephard, Professor of Economics, University of Oxford in response to the call for evidence “Proposals for a new higher education system” by the Browne Review on “Higher Education Funding and Student Finance” in the UK.

The main points of Shephard's system are:

1. Make student financial support available to cover all tuition and a modest cost of living.
2. Allow graduates to repay according to earnings with protection for poorer graduates.
3. Call HEFCE teaching grants “scholarships” and make students aware of their value.
4. Cap the level of funded fees plus HEFCE grant at the current level.
5. Allow universities to charge deferred fees.

a. When they are paid the money goes to the student’s university not to the state. These fees have no fiscal implications.
b. Bring some of the cash flow from deferred fees forward by working with a bank.

6. In the long-run move to making the cost of living support simpler by

a. Providing more realistic cost of living support for all students.
b. Removing means-tested university bursaries for cost of living expenses.
c. Removing means-tested grants to students provided by the state.

Shephard goes on to say,

Whenever I refer to “financial support” I will mean the following. Students can opt to take out a
financial support package to fully or partially fund their fees and/or cost of modest living. Whatever the size of the financial support package, students will be offered payment terms as graduates which are 9% of earnings above £15k until they have paid back the full amount (net present value) of support. The parts of support package which are not repaid due to low earnings are forgiven after 25 years. The interest rate should be the state’s cost of borrowing (currently 2.2% real). The system is run through the Student Loan Company (SLC).

The Economic Logician comments,

I think this is a very good programme. It essentially boils down to students borrowing against future income, and seeing how the return to education is vastly superior to the financial cost, they should want to take this opportunity as long as there is a market. Universities are the ones providing this market and they are incentivized to provide a good educational product.

One of the major problems for students with financing higher education is the inability to borrow against future income given the investment being made is in human capital which can not be used as collateral for a loan in the way physical capital can be. Shephard's idea does deal with this issue. The system also does have a real rate of interest (2.2%) applied to it. This at least should make students think about the worth of taking out financial support.

Confusion on ownership

Recently over at the Stumbling and Mumbling blog Chris Dillow discussed the problems involving the ownership of the Liverpool football club, which does look somewhat strange. But he seems to be confused over what ownership is all about. He writes,

The Hicks-Gillett saga shows that, despite the impression given by Jimmy Tarbuck and Stan Boardman, great comedy can come out of Merseyside. It also throws into question the standard view about the ownership of assets generally (I’d call it the neoliberal view if I were a pretentious git.)

How I have to say I have never come across a "neoliberal" view of ownership so I'm not too sure what exactly Dillow is on about. Does he mean a transaction cost view, property rights view, reference point view or ....? But I go on hoping I can make sense of his argument.

Dillow continues,

This says that it is efficient for the ownership of an asset to go to the highest bidder. This is because the very act of bidding most for an asset suggests that a man knows best how to maximize its value. A free market in assets, then, ensures that assets go to those best able to manage them.

Hicks and Gillett’s mismanagement of Liverpool, however, shows that this story isn’t right all the time; highest bidders - as they were once - can make a horrible mess.

Yes, they can make a horrible mess but the point of a free market in ownership is that if they do then they will lose control of the firm, or football club, which is what has happened. Giving ownership to the highest bidder doesn't guarantee that the best use of the asset will occur but it does increase the probability of it. No method of ownership determination can guarantee optimal asset use.

Dillow than asks:

Which raises the question: what is wrong with this standard story?

and say four things are:

Over-confidence. It’s well-known that bidders can overpay for assets - the winner‘s curse is a cliche. This is especially likely when those bidders are entrepreneurs who have been successful in other businesses. Such men are selected twice over for their overconfidence. Once, because the very act of becoming an entrepreneur in the first place betokens an overconfidence. And twice, because previous success further raises that confidence and breeds the belief that the ability to own baseball clubs or mobile phone shops gives one the ability to own a football club.

Ownership, then, doesn’t flow to the most competent potential owner, but to the most deluded.

See my point above. If they are "deluded" this will soon be found out and given a free market in ownership, the ownership of the asset will change. Which is what you would want.

Ownership does not confer genuine power. In the case of football clubs, real power - the ability to extract cash - lies with players, not owners; Alan Sugar called this the prune juice effect. Similarly, in banks shareholders lacked power to control excessive risk-taking.

That ownership and "power" may not be the same is well known, see for example, Jean Tirole and Philippe Aghion, "Formal and Real Authority in Organizations", Journal of Political Economy, vol. 105, n. 1, February 1997, p. 1-29. Why Dillow thinks "the ability to extract cash" is ownership or power I can't see. "The ability to extract cash" will have more to do with markets conditions than ownership. If you are a monopoly, for example, then you have more "ability to extract cash" than a competitive firm, but this has nothing to do with ownership. Ownership is about control rights (and maybe income rights) independent of "the ability to extract cash". If you went from being a monopoly to being a competitive firm "the ability to extract cash" would change but does this mean that ownership or power has changed? I can't see how.

As to the "banks shareholders lacked power to control excessive risk-taking" point, ownership isn't about being able to control the actions of the management and workers perfectly. Its about being able to do so better than an alternative set of owners. This doesn't mean that the owners have perfect control of the firm, they don't, no set of owners would have; it means they have better control than the alternative owners.

The collective action problem. The people with the best knowledge or incentive to manage an asset might be a dispersed group; fans in the case of football clubs or employees in the case of other companies. Organizing such a group, however, can be prohibitively tricky.

This is true, but if those with the "best knowledge or incentive to manage an asset" are a "dispersed group" then you have to ask if they really are those who should be the owners. Hansmann makes the point that homogeneity of interest is important for the group that are the owners of a firm. Would the fans really have such a homogeneity of interest? They may not care too much about profits - the normal thing that investors have in common- they are fans after all, but they may care about other things, who's the manager, who are the players, which players should play, who the sponsors of the team should be etc, and assuming they all can't agree, this results in heterogeneity of interests, which is bad for ownership.

Capital constraints. The standard view assumes that the people best able to maximize an asset’s value will be able to raise the cash to buy it. But this needn’t be true. Even the wealthy Red Knights were unable to put together a bid for their club, so it was always going to be impossible for Liverpool fans to do so, with one job between them. And of course, the point here extends way beyond football clubs.

Why is it impossible for Liverpool fans to bid for the club? Why can't they just sell shares in the club and raise money the same way any investor-owned firm does? If there are enough fans, and I'm guessing there are, then why can't they use the standard methods of raising funds from small investors that all share-holder owned firms do?

Part of Dillow's conclusion is that:

These four difficulties undermine the standard argument for a free market in ownership [...]

I would say not. In fact what the whole Liverpool things shows is that free markets in ownership work. If you are the owner of an asset and use it badly someone else will be able to take ownership away from you and this is what we have seen. Ownership is determined by profit and loss, if you make a (big enough) loss you will lose ownership. This is how you give the best incentives to owners and how you move assets into the hands of those who really do value them most and who will use them most efficiently. The system can take time and isn't always perfect in the way it works, but we have yet to come up with a better method.

What is the optimal number of courts

A paper by Stefan Voigt looks at this question.The abstract of his paper, On the Optimal Number of Courts, reads:

This is the first paper to investigate whether the number of high courts in a country has systematic effects both on the quality of its legal system and on its level of economic development more generally. It is theorized that due to the division of labor and a higher degree of specialization, high courts might be advantageous in terms of court productivity. Yet, they might also be disadvantageous in terms of a less coherent legal system. It is empirically tested whether the positive or the negative effects prevail. Results show that a larger number of high courts never has any positive effect; indeed, with regard to some dependent variables, a greater number of high courts is correlated with worse outcomes.

Voigt opens the paper by explaining that,

The various effects of different legal origins have been the subject of intense debate in the field of economics for about a decade. The number of courts or, more precisely, the number of complete court hierarchies (sequence of courts, stages of appeal, “vollständige Instanzenzüge” in German) is one difference often attributed to different legal origins. For example, in their book, The Civil Law Tradition, Merryman and Pérez-Perdomo (2007), have a chapter entitled “The Division of Jurisdiction” in which they explain that the typical common law system has a unified court system that might be represented by a pyramid, whereas matters would be quite different in the civil law world (ibid., 86): “There it is usual to find two or more separate court hierarchies, each with its own jurisdiction, its own hierarchy of tribunals, its own judiciary, and its own procedure, all existing within the same nation.”

The basic question Voigt is interested in is : What is the optimal number of court hierarchies? Issues that can be thought about include: Does the number have consequences for the (perceived) quality of the judicial system and its effectiveness? What are the implications for broader issues, such as the protection of political rights and civil liberties? Voigt goes on the say,

This paper tests whether the division of judicial decision-making has systematic (economic) consequences. In economic terminology, choosing the optimal number of courts can be thought of as the result of a tradeoff. On the one hand, a higher number of specialized courts allows judges to become experts in specific legal areas, thus allowing them to arrive at decisions faster (i.e., be more productive) and to produce better decisions. This is conjectured to reduce court delay and reduce the number of decisions that are appealed; in short, a higher number of courts is correlated with a higher quality of the judicial system.

Yet, the division of courts into many different legal areas could also have disadvantages. Judges at “single issue” courts could be somewhat removed from the more general developments in judicial decision-making. In the long term, this could lead not only to inconsistencies in judicial decision-making across various legal areas, but also to “narrow” decision-making in which specialized judges keep only “their” legal area in mind, neglecting the effects of their decisions on the more general legal development and also, and of particular interest here, on economic development.

His conclusions:

The results show that a high number of court hierarchies never has any positive effect on total factor productivity, civil liberties, or confidence in the legal system. Indeed, some results point in the opposite direction: both the number of court hierarchies and the number of specialized courts explicitly mentioned in the constitution are negatively correlated with political rights as well as with civil liberties. Among particular court hierarchies, high administrative courts are at least marginally detrimental to both total factor productivity and confidence in the legal system. Among the specialized courts mentioned in the constitution, religious, labor, impeachment, and military courts have negative effects on some of the dependent variables tested here.

Anyone thinking about making changes to their court system would be advised to consider such results.

Clio and the economist

There is a new paper out in the Journal of Economic Surveys on Clio and the Economist: Making Historians Count. The abstract of the paper by David Greasley and Les Oxley reads:

Cliometrics reconnected economic history an economics in the 1960s. The deeper foundations of cliometrics research lie in the longer standing traditions of quantitative history and the contemporaneous growth of the social sciences and computing. Early cliometrics research
reinterpreted economic history through the lens of neo-classical economics. Over the past half century cliometrics has matured and now utilizes a broad array of theoretical perspectives and statistical methods to help understand the past. The papers introduced here illustrate the achievements of several key areas of cliometrics research and show how new theoretical perspectives, innovative data construction and sophisticated econometric methods are the hallmarks of the discipline.

In the paper Greasley and Oxley write

The heat of the early debates, the label of the new economic history, and the controversies surrounding counterfactuals and applying neo-classical economics to re-evaluate long-standing historical questions sometimes disguises the wider foundations of cliometrics. In that wider setting several intellectual traditions shaped the emergence and the subsequent evolution of
cliometrics. The ones that now stand out include:

1. Quantitative history and most especially the construction of historical series of prices, wages and incomes, which have long traditions dating back to at least the 19th century.
2. Quantitative social science of the 1950s and 1960s which placed emphasis on empirical research, and the use of censusand mass survey data. Sociologists for example, pioneered the use of sampling and significance testing to handle large volumes of social data, see Hudson (2000). The manipulation of large data sets was facilitated by concomitant developments in computing.
3. Econometric testing, including of macroeconomic business cycles models which developed strongly in the 1930s; seeMorgan (1990). Tinbergen’s (1939) Statistical Testing of Business Cycles published in 1939 drew on classical statistical methods but also set out the best practices for applied econometrics which eventually became embedded in cliometrics.
4. Cliometrics has been an evolving discipline, with its shifts in direction and emphasis in part reflecting newdevelopments in economic theory. Most importantly the return of growth theory to centre stage in mainstream economics and the development of endogenous growth models in the 1990s enabled cliometricians to reduce their relianceof neo-classical models and measures of residual productivity, see Greasley and Oxley (1997).
5. The evolution of cliometrics has also been strongly influenced by new developments in econometrics methods, most especially in the analysis of non-stationary time series following the work of Engle and Granger (1987).

Is it just me or does that list make it look like microeconomics doesn't exist, or at least plays
little or no part in historical economics? The paper has little to say about the actually interesting bits of
historical economics, that is the microeconomics bits.

I'm thinking of work such as that by several authors which looks at the characteristics that determine contract choice using data on historical agricultural contracts. Ackerberg and Botticini (2002), for example, looks at agricultural contracts between landlords and tenants in early Renaissance Tuscany. Their abstract reads

Empirical work on contracts typically regresses contract choice on observed principal and agent characteristics. If (i) some of these characteristics are unobserved or partially observed and (ii) there are incentives whereby particular types of agents end up contracting with particular types of principals, estimated coefficients on the observed characteristics may be misleading. We address this endogenous matching problem using a data set on agricultural contracts between landlords and tenants in early Renaissance Tuscany. Controlling for endogenous matching has an impact on parameters of interest, and tenants’ risk aversion appears to have influenced contract choice.

Oriana Bandiera provides another example with her paper on "On the Structure of Tenancy Contracts: Theory and Evidence from 19th Century Rural Sicily". This looks at the empirical determinants of contract length utilising data on tenancy agreements signed between 1870 and 1880 in the district of Siracusa, Italy. The abstract reads,

This paper analyses the empirical determinants of contract length, a key and yet neglected dimension of contractual structure. I use data on tenancy agreements signed between 1870 and 1880 in the district of Siracusa, Italy to estimate the choice over length and compensation schemes jointly.

The findings indicate that the choice of contract length is driven by the need to provide incentives for non-observable investment, taking into account transaction costs and imperfections in the credit markets that make incentive provision costly. The results also illustrate that since both length and the compensation scheme are used to provide incentives within the same contract, joint analysis is important for a correct interpretation of the evidence.

An example other work not covered in the survey would be Jeremiah Dittmar's paper, “Information Technology and Economic Change: The Impact of the Printing Press”. The abstract reads:

The movable type printing press was the great innovation in early modern information technology, but economists have found no evidence of its impact in measures of aggregate productivity or income per person. This paper examines the technology from a new perspective by exploiting city-level data on the establishment of printing presses in 15th century Europe. I find that between 1500 and 1600, cities where printing presses were established in the late 1400s grew at least 60 percent faster than similar cities which were not early adopters. I show that cities that adopted printing in the late 1400s had no prior growth advantage and that the association between adoption and subsequent growth was not due to printers anticipating city growth or choosing auspicious locations. These findings imply that the diff usion of printing accounted for between 20 and 80 percent of city growth 1500-1600. They are supported by historical evidence and instrumental variable regressions that exploit distance from Mainz, Germany — the birth place of printing — as an instrument for early adoption. The printing press reduced the costs of transmitting information between cities, but fostered new face-to-face interactions and localized spillovers. Print media notably fostered the development of skills, knowledge, and innovations valuable in commerce.

Here we see the use of data disaggregated to the level of cities, rather than the more usual national income type data, to look at the effects of changes in technology on growth and finding interesting results that the macro data miss.

There is also work such as that by John McDonald and G. D. Snooks on the "Domesday Economy: A New Approach to Anglo-Norman History". McDonald and Snooks apply modern theoretical and statistical methods to the data of the Domesday Book (1086) to analyse the system of manorial production and the nature of the national tax system known as danegeld in eleventh-century England. Domesday Book includes detailed information on land ‘ownership’, income, resources, and fiscal responsibility for almost every manor in 1086 and, in some cases, in 1066. The data allows the authors to estimate production functions for the manors in the Anglo-Norman economy.

All of this suggests to me that there are interesting and important things that micro theory and data can tell us about the past that are missed by the concentration on macro theory and data. We await a good survey.

EconTalk this week

Matt Ridley, author of The Rational Optimist, talks with EconTalk host Russ Roberts about why he is optimistic about the future and how trade and specialization explain the evolution of human development over the millennia. Ridley argues that life is getting better for most of the people on earth and that the underlying cause is trade and specialization. He discusses the differences between Smith's and Ricardo's insights into trade and growth and why despite what seems to be strong evidence, people are frequently pessimistic about the future. Ridley also addresses environmental issues.

Why do economists disagree?

The New York Times asks this question.

Let’s leave aside the merits of these arguments and ask a question so basic it will sound naïve: Why do economists argue at all? Given that Fed members and economists are looking at the same data, and given the reams of evidence accumulated over decades — not to mention a few centuries of great minds, great theories and thick books that preceded this crisis — why isn’t a right answer self-evident?

George Bernard Shaw once said, “If all economists were laid end to end they would not reach a conclusion.” How come? What prevents economics from yielding answers the way that physics, chemistry and biology do?

and

To explain the case for humility in economics, Mr. [Robert] Solow said, look no further than the stimulus bill: “It has run its course over the past year and a half, but it is not an isolated event. One thousand other things were happening that had an effect on employment and real G.D.P.,” a measure of a nation’s total output adjusted for changes in prices. “You want to trace the effect of one of a very large number of significant causal effects, and that’s a very hard thing to do.”

That the world doesn’t offer up clean economic experiments is a common refrain in the discipline, said Gary Becker, a Nobelist at the University of Chicago. There have been endless studies on every tax change in the modern history of the republic, Mr. Becker said, from Kennedy to George W. Bush, and arguments about the wisdom and aftereffects of each. It’s not just that there is so little clear signal amid so much noise. It’s that many economists have a unique idea of what signal to listen to and what priority it deserves.

In other words, the world is really, really complicated. And it is complicated because of people,

But economics will forever have to contend with the biggest X factor of all: people. As Mr. Solow notes, you feed people poison, and they die. But feed them a subsidy and there is no telling what will happen. Some will use it wisely, others perversely and some a mix of both.

But you shouldn't over play the disagreement card. There are many things on which economists do agree.

This is not to suggest that economics is a total free-for-all, lacking a broad consensus on any subject. Polls of economists have found near unanimity on topics like tariffs and import quotas (bad), centralized economies (very bad) and flexible, floating exchange rates (very good).

I would suggest however that agreement is more likely on the microeconomic side than on the macroeconomic of the discipline.

The market for marijuana in California

We have another example of a transaction which takes a small step away from repugnant to not: Schwarzenegger approves bill downgrading marijuana possession of ounce or less to an infraction.

"Gov. Arnold Schwarzenegger, who opposes legalization of marijuana for recreational use, has approved legislation downgrading possession of an ounce or less from a misdemeanor to an infraction.

"Supporters say the change will keep marijuana-related cases from becoming court-clogging jury trials, even though the penalty will remain a fine of up to $100, with no jail time. Violations will not go on a person's record as a crime.

"I am signing this measure because possession of less than an ounce of marijuana is an infraction in everything but name," Schwarzenegger wrote in a message released after he signed the bill. "In this time of drastic budget cuts, prosecutors, defense attorneys, law enforcement and the courts cannot afford to expend limited resources prosecuting a crime that carries the same punishment as a traffic ticket."

That is the good new but the bad news is that marijuana cultivation is still illegal in California e.g: Mendocino officials pursue third day of marijuana eradications.

"Mendocino County Sheriff's officials, assisted by state and federal agencies, made several more arrests in the third day of eradicating illegal marijuana grows and sales in Round Valley on Thursday.

On Tuesday 17 people were arrested, and another 20 were arrested on Wednesday, officials reported."

Hasn't law enforcement got better things to do with their time?

(HT: Market Design)

Gender and human capital

It is common today for people to note that females are more numerous than males in most levels of education, and that they perform better in school. The obvious question this raises is Why? One possible answer is that there are simply biological differences between men and women that make men better at tasks that require force, while women are better at task for which reasoning is paramount. Over at the Economic Logic blog the Economic Logician comments on this idea:

Mark Pitt, Mark Rosenzweig and Nazmul Hassan build a model of investment in human capital that differentiates genders. Better nutrition improves strength and education improves skills. Individuals make these choices, as well as in which activities to work. Using panel data from rural Bangladesh, they find that model is a reasonable description of reality. That is particularly interesting, because rural Bangladesh does not strike me as an economy where brain would dominate brawn. Also of interest is that improvements in health do not increase education for men, it may even reduce it, while women education clearly benefits from them. Thus policies that focus on health improvements are likely to improve women's schooling more than men's, lead to more occupational differentiation across genders, and a larger gender wag gap.

An interesting result, should this turnout to be true, is that as the so-called "knowledge economy" expands more intelligence/education will be asked for from employees, replacing the need for force, and thus women will find more opportunities and better pay. This will result in a gender pay gap.

Decriminalizing cannabis: the impact on crime Imran Rasul

There is a new audio from VoxEU.org in which Imran Rasul of University College London talks to Romesh Vaitilingam about his research with Jerome Adda and Brendon McConnell on the effects of a localized policing experiment that decriminalized cannabis possession in the London borough of Lambeth between 2001 and 2002.

Unemployment issues

At Marginal Revolution Alex Tabarrok raises a couple of interesting points about search-matching models of unemployment.

The first puzzle about unemployment when thought about from within the search-matching framework is that unemployment rates are highest among the least skilled and most homogeneous skills, i.e. among those worker/jobs with the easiest matches. It's hard to believe that it takes a year to match a construction worker to a job.

Closely related is the issue of how much uncertainty is holding back employment. The case for uncertainty is that hiring a worker is like exercising an option--once you hire, there are sunk costs of hiring (and potentially firing) that go beyond the wage such as administrative and training costs.

Note that you may not need a lot of uncertainty (i.e. you may not need regime uncertainty) to reduce hiring because you don't have to explain why firms aren't hiring only why they aren't hiring this day. Even if we assume, for example, that hiring would be profitable, all else equal, it doesn't take much uncertainty to make it worthwhile to delay hiring a little bit, to wait and see. It's precisely when sales are low and unemployment is high that firms don't mind waiting because uncertainty may resolve in due course and the workers aren't going away.

Ok, that's the positive case for uncertainty but the second puzzle is that uncertainty should matter most when hiring and firing costs are high and once again these costs are lowest for those workers with the greatest unemployment rates. It's one thing not to hire when you can't fire but when firing is easy what's the risk? Moreover, unemployment has increased more in the United States than in Europe even though hiring and firing costs are higher in Europe.

So we certainly learn things from the search-matching framework but it also appears that they don't tell us everything about unemployment. It still seems that things like aggregate demand shocks, sticky wages and prices are important for unemployment. Or in other words, the real world is complicated.

If real wars were like trade wars ....

At Cafe Hayek Don Boudreaux discusses what would happen if real wars were fought in the same manner as trade wars are fought. He gives a transcript of the communiqués between the leaders of two warring nations:

Leader of Absurditoptia (A): I say, leader of Stupidia – we demand that you stop occupying that contested strip of land. If you refuse, we’ll have no choice but to shoot our own citizens.

Leader of Stupidia (S): You don’t scare us! That land is ours. And if you do kill some of your own people, make no mistake that we will immediately – and just as cruelly – commence to killing our own people. Courage is our national motto!

(A): Ha! You’re bluffing. But I’m not. I’ve just courageously ordered my troops to mow down in cold blood ten percent of my fellow countrymen. Take that!

(S): How dare you attack you like that! You leave us no choice but to attack us. I am ordering the Stupidian army to slaughter 15 percent of innocent Stupidians here in Stupidia. How do you like them apples?!

(A): You are cruel and inhuman to damage us by killing your people. I hereby instruct all of my fellow Absurditopians to commit suicide! Only then will you nasty Stupidians get your proper comeuppance and we Absurditopians the justice that we are due!

(S): You can’t beat us, you Absurditopian you! Listen up. I’m ordering all of my fellow citizens – Stupidians all! – to commit suicide. We’ll see who emerges victorious!
....

Then a long, long silence.

Well said that man! The British economist Joan Robinson famously put the idea as, "if your trading partner has rocks in his harbour, that is no reason to throw rocks into your own".

Big Mac Index 2010

More Burgernomics from The Economist. From the Economist website in article dated July 22nd 2010. The Economist's Big Mac index, shows that currencies continue to be undervalued in the developing world but overvalued in Europe.

The Economist writes that,

The index is a lighthearted attempt to gauge how far currencies are from their fair value. It is based on the theory of purchasing-power parity (PPP), which argues that in the long run exchange rates should move to equalise the price of an identical basket of goods between two countries. Our basket consists of a single item, a Big Mac hamburger, produced in nearly 120 countries. The fair-value benchmark is the exchange rate that leaves burgers costing the same in America as elsewhere.

The New Zealand dollar is undervalued by 4% according to this measure.

Macroeconomics after the crisis

Ricardo J. Caballero has a new NBER working paper out entitled Macroeconomics after the Crisis: Time to Deal with the Pretense-of-Knowledge Syndrome. The abstract reads:

In this paper I argue that the current core of macroeconomics—by which I mainly mean the so-called dynamic stochastic general equilibrium approach—has become so mesmerized with its own internal logic that it has begun to confuse the precision it has achieved about its own world with the precision that it has about the real one. This is dangerous for both methodological and policy reasons. On the methodology front, macroeconomic research has been in “fine-tuning” mode within the local-maximum of the dynamic stochastic general equilibrium world, when we should be in “broad-exploration” mode. We are too far from absolute truth to be so specialized and to make the kind of confident quantitative claims that often emerge from the core. On the policy front, this confused precision creates the illusion that a minor adjustment in the standard policy framework will prevent future crises, and by doing so it leaves us overly exposed to the new and unexpected.

Caballero opens the paper by saying,

The recent financial crisis has damaged the reputation of macroeconomics, largely for its inability to predict the impending financial and economic crisis. To be honest, this inability to predict does not concern me much. It is almost tautological that severe crises are essentially unpredictable, for otherwise they would not cause such a high degree of distress. Of course, it is well-known that certain elements can increase the fragility of a financial system, such as high levels of leverage or mismatches between short-term liabilities and long-term assets, and that these issues may justify policy intervention. But knowing these mechanisms is quite different from arguing that a severe crisis can be predicted. Modern Cassandras will always claim to have seen the crisis coming. What they will not say is how many times they saw things coming that never materialized, or how the specific mechanisms behind the crisis are different from those on which their predictions were based. In my view, the conviction that one can foretell a severe crisis in advance is mostly a manifestation of pareidolia—the psychological phenomenon that makes people see faces and animals in clouds and the like.

There is a nice point here, severe crises are essentially unpredictable, for otherwise they would not cause a high degree of distress, that is, they wouldn't be severe. If we could predict severe crises we could take actions to mitigate the effects of the crisis thereby rendering it less severe. Policymakers should keep this in mind. There is only limited scope for policy that can in advance eliminate the risk or costs of a financial crisis.

Only the French

From the New York Times we find out

"It was Cédric Villani, a 37-year-old professor at Lyon who won the 2010 Fields Medal, who gave the most spirited reply to France’s critics. Calling himself “a pure product of the French system,” Mr. Villani, a Normalien who has often taught in the United States, said that while American academic salaries were higher “and it’s easier to make big projects,” France also has particular strengths: “Our tradition, our quality of life, our social cohesion. My big problem in Princeton was finding a place to buy a decent cheese.”

To hell with the eduction, worry about the cheese!

(HT: Market Design)

Do economic freedom and entrepreneurship impact total factor productivity?

An interesting question, with an on the face of it strange answer, asked by Christian Bjørnskov and Nicolai J. Foss in a new working paper Do Economic Freedom and Entrepreneurship Impact Total Factor Productivity? The abstract reads:

The economics of growth has shown that countries not only grow by deploying higher levels of inputs to production, but also by better allocating whatever resources are at their disposal and by introducing productivity-enhancing innovations. We proffer arguments as to why and how entrepreneurship as well institutions of liberty (i.e., economic freedom, including the rule of law, easy regulations, low taxes and limited government interference in the economy) positively impact total factor productivity (TFP): These institutions allow entrepreneurial experimentation with the combination of factors to take place at low transaction costs. We test these ideas on a unique panel data set derived from Compendia, World Bank data and the Fraser Institute’s economic freedom data. We find that while entrepreneurship positively impacts TFP, the marginal contribution of entrepreneurship to TFP is strongest in economies with substantial government activity.

The strange bit is that they find that increasing the active involvement of the government in the economy as well as the tax burden actually increases the impact of entrepreneurship on TFP. Their explanation of this somewhat surprising, to say the least, finding is that a reduced supply of entrepreneurship increases the marginal productivity of entrepreneurship; thus, the best ideas do survive even in the relatively hostile welfare state environment. So entrepreneurs succeed despite the government rather than because of it.

(HT: Markets and Organization)

Who should pay for university?

This is the question asked by Tim Worstall. His answer?

The major beneficiaries of a degree are the people who hold that degree in the higher lifetime earnings they gain from having that degree. So it should be they that pay the costs of gaining that degree.

There’s no real way to have private funding of the loans though: yer average 18 year old isn’t the greatest credit risk for £50k now, are they? So government provision of the loans seems fine.

The greater societal benefit of having lots of graduates: I’m entirely unconvinced about that. Yes, I’d say there is a public good to having a largely numerate and literate society, thus meaning tax subsidy to that part of the education system that provides that (and if only we did have a part of the education system that does provide that) but having 40, 50% of the age cohort with degrees?

Given that the vast majority of them go on into careers which were not traditionally thought of as requiring a degree I don’t really see it I’m afraid.

In fact, I rather hope that the unwrapping of the current subsidy, the making plain what are the true costs, will mean fewer taking a degree in the first place.

But the basic concept being proposed seems just fine to me. Here’s what a degree costs, we’ll help finance it but you’ll have to pay for it: just fine by me.

And it seems pretty fine to me as well. As Tim notes getting a loan against human capital isn't easy as you cannot really sell the asset if things go pear-shaped. Thus government involvement in making loans may be a good idea. But they should be serious loans, that is, they should have the market rate of interest charged on them. Otherwise you are just subsiding a few years of beer consumption for many students. (Yes I know interest free loans are a great idea of you want the student vote. But getting a few votes isn't really a great basis for public policy. No matter what politicians tell you!) This would hopefully have the effect of making students actually think about whether or not going to university is a worthwhile idea, rather than it being just the default option.

2010 Nobel Prize in economics 2

Over at Marginal Revolution Tyler Cowen has written profiles on each of this year’s winners: Diamond, Mortenson, and Pissarides. Alex Tabarrok sums things up by saying,

The 2010 Nobel Prize awarded to Peter A. Diamond, Dale T. Mortensen, Christopher A. Pissarides can be thought of as a prize for unemployment theory.

A key breakthrough was to realize that the problem was not how to explain unemployment per se but rather how to explain hiring, firing, quits, vacancies and job search and to think of unemployment as the result of all of this underlying microeconomic behavior. Notice that the underlying behavior involves not just workers looking for jobs but also employers looking for workers so explaining unemployment would require a theory of job search, worker search and matching and each aspect of the theory would have to be consistent with every other aspect; i.e. how much workers search depends on how much employers are searching (e.g. advertising) and vice-versa and also on the quality of matching and all of these considerations need to be addressed together. It was Mortensen and Pissarides in particular, building on work by Diamond, who built just such a consistent model.

A very surprising empirical fact helped to motivate this perspective: even in a recession millions of jobs are being created every month. The figures we usually hear about the number of jobs created is the net figure but in the United States in August, for example, there were 4.1 million hires (and 4.2 million separations). Thus, as noted above, understanding unemployment requires understanding these much larger flows of job creation and destruction.

The Press Release from The Royal Swedish Academy of Sciences reads,

Markets with search costs

Why are so many people unemployed at the same time that there are a large number of job openings? How can economic policy affect unemployment? This year's Laureates have developed a theory which can be used to answer these questions. This theory is also applicable to markets other than the labor market.

On many markets, buyers and sellers do not always make contact with one another immediately. This concerns, for example, employers who are looking for employees and workers who are trying to find jobs. Since the search process requires time and resources, it creates frictions in the market. On such search markets, the demands of some buyers will not be met, while some sellers cannot sell as much as they would wish. Simultaneously, there are both job vacancies and unemployment on the labor market.

This year's three Laureates have formulated a theoretical framework for search markets. Peter Diamond has analyzed the foundations of search markets. Dale Mortensen and Christopher Pissarides have expanded the theory and have applied it to the labor market. The Laureates' models help us understand the ways in which unemployment, job vacancies, and wages are affected by regulation and economic policy. This may refer to benefit levels in unemployment insurance or rules in regard to hiring and firing. One conclusion is that more generous unemployment benefits give rise to higher unemployment and longer search times.

Search theory has been applied to many other areas in addition to the labor market. This includes, in particular, the housing market. The number of homes for sale varies over time, as does the time it takes for a house to find a buyer and the parties to agree on the price. Search theory has also been used to study questions related to monetary theory, public economics, financial economics, regional economics, and family economics.

Additional information is available here and here.

EconTalk this week

Douglas Irwin of Dartmouth College talks with EconTalk host Russ Roberts about the role the gold standard played in the Great Depression. Irwin argues that France systematically accumulated large amounts of gold in the late 1920s and 1930s, imposing massive deflation on the rest of the world. Drawing on a recent paper of his, Irwin argues that France's role in worldwide deflation was greater than that of the United States and played a significant role in the economic contraction that followed.

I discussed Irwin's work of the role of France and the gold standard during the great depression here.

Is foreign ownership of land so bad?

Stephen Hickson asked this question in yesterdays Press here in Christchurch. Steve teaches in the Department of Economics and the MBA programme at the University of Canterbury. The short answer is, of course, no but Steve explains it better:

Many New Zealanders also object to the inevitable consequence of foreign ownership of any New Zealand asset or business which is "profits going overseas". In August of this year, Winston Peters declared that he would ban the foreign ownership of rest homes. No doubt Mr Peters would strike a sympathetic chord with many when he says that in foreign ownership he sees "foreign owners getting rich at the expense of the elderly".

Hmmmm, Winston is against it, can't help thinking that means it has to do good!!! But Steve continues by asking an obvious, but not often asked question: Why do we have foreign investment in New Zealand?

New Zealand is a great place to do business and there are lots of good opportunities to grow businesses and create jobs. To grow requires funds and so businesses either borrow money or issue shares in order to finance that growth. This requires someone who is a saver to lend the money or buy the shares.

However, the pool of savings in New Zealand is too small to fund this expansion and so we use the savings of people overseas who are willing to invest in a great place with great prospects.

Naturally, those overseas who lend us money or buy shares in our businesses need to be paid interest or dividends - hence profits going overseas.

Take rest homes as an example and suppose we do not allow foreigners to own New Zealand rest homes. If we want the same number of rest homes to be built then we will have to build them with New Zealand savings.

To do this might mean building less of something else, perhaps schools, shops, roads or wind farms. Or maybe we could increase our own savings to pay for those rest homes.

To increase our savings is very simple - as a nation we just need to consume less. Of course the reality is never as simple as all that.

Are we prepared to reduce expenditure on health and education in order to save more? Remember the Government is a consumer and a saver as well. Are we prepared to reduce our standard of living in some other way? New Zealanders don't appear to be very willing to do so.

Alternatively we could just build fewer rest homes. That will reduce choice for New Zealanders looking to use rest homes and most likely push up the price of going into a rest home.

Now if these outcomes are not too appealing then we have no choice but to dip into the savings of the rest of the world. What then are the impacts that follow from restricting foreign ownership?

The most obvious impact of restricting foreign ownership in New Zealand is that we restrict the opportunities for business growth and job creation.

While some profits head overseas as a result of foreign investment, much does not and of course the wages, businesses and land stay right here.

Foreign owners, just like any business owner, want to see their investments perform as well as possible so they are also likely to reinvest and create even more value for New Zealand.

When we restrict foreign investment some New Zealand worker now finds it just that little bit harder to find a job than they otherwise would have.

There are other impacts,

New Zealand is a small trading nation in a much bigger world.

That bigger world has a lot to offer us and every time we restrict foreign ownership we also reduce our access to the best knowhow that the world has to offer.

For every foreign buyer looking to buy there is a New Zealander looking to sell. By restricting or preventing foreign ownership we are preventing a fellow New Zealander from selling what they themselves own for the best that they can get.

New Zealand is a nation that values freedom and choice.

One of the cornerstones of our society is that we are all free to buy, sell and own land and businesses.

When we impose restrictions on some people in society we tread dangerously on that freedom.

When it comes to private businesses, assets and land it is odd to think that "we" own them. On the day before a New Zealand farm is sold to a foreign owner, I didn't own it and I had no right to say how that farm should be used.

The day after it is sold I still don't own it and I still don't have any rights to say how it is used.

The new foreign owner is also subject to the laws of the land just as much as the previous owner. If a piece of land is important for, say, access to a river or beach then that should be written explicitly into the title of the land.

So if you don't want foreign ownership then the choice is, keep consumption constant and and have less investment, or increase investment and reduce consumption. If neither appeals then welcome foreign ownership.

Roger Kerr has also written on the topic of foreign ownership in New Zealand. In an article in the Otago Daily Times on the 8th October 2010 he said,

Start with some basic economic perspectives.

First, New Zealand has a freely floating currency. A foreigner wanting to acquire a New Zealand asset has to buy New Zealand dollars. The New Zealand dollar seller will be paid in foreign currency, which will logically be used to acquire some other overseas asset (maybe a farm). The country’s net asset position is unchanged.

Second, for a given balance of payments position, more restrictive rules on purchases by foreigners of some class of asset (say land) will automatically mean greater foreign ownership of some other assets (eg businesses). Are there sound grounds for biasing overseas investment in this way?

and added

The spokesman also said that “once land is gone it’s gone.” This is also incorrect. Some years ago a New Zealand company owned Land’s End and John O’Groats in the United Kingdom: iconic sites par excellence. Then it sold them to an English buyer.

Likewise Carter Holt Harvey, with forest land interests, was majority owned by US company International Paper. Then Graeme Hart bought it back (and has purchased land in many other countries).

You can’t physically take land away, nor can you force any owner to sell to foreigners.

There is also the question of if we stop foreigners owning property here should we also not stop New Zealanders owning property overseas?

Another aspect of globalisation is New Zealand investment in agriculture abroad. Fonterra and individual dairy farmers are investing in farms in China, India, Brazil and other countries. New Zealand Farming Systems owned farms in Uruguay (now being onsold to Singaporean interests).

Should other countries ban such New Zealand investment?

Do we really wan t to stop Fonterra and other firms from investing overseas?

Roger Kerr ends this article with a similar point to Stephen Hickson:

Nevertheless, New Zealand governments are entirely at liberty to impose tighter restrictions for non-economic reasons. If they do, however, the community should understand that they come at an economic cost.

or as Hickson put it:

The amount and type of foreign ownership that New Zealand allows is a political choice that we make as a society via the ballot box but there are consequences to the decisions that we make.

If we are to restrict or, in some cases, ban foreign ownership then we should be fully informed and understand the consequences. We might not find some of those consequences appealing.

There is no such thing as a free lunch. Restrictions on foreign ownership come at a cost.

2010 Nobel Prize in economics

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2010

has gone to

Peter A. Diamond
Massachusetts Institute of Technology, Cambridge, MA, USA,

Dale T. Mortensen
Northwestern University, Evanston, IL, USA

and

Christopher A. Pissarides
London School of Economics and Political Science, UK

"for their analysis of markets with search frictions".

More on this later.

Useless information for today

From the Nobel website:

On all "Swedish" Nobel medals the name of the Laureate is engraved fully visible on a plate on the reverse, whereas the name of the Peace Laureate as well as that of the Winner for the Economics Prize is engraved on the edge of the medal, which is less obvious. For the 1975 Economics Prize winners, the Russian Leonid Kantorovich and the American Tjalling Koopmans, this created problems. Their medals were mixed up in Stockholm, and after the Nobel Week the Prize Winners went back to their respective countries with the wrong medals. As this happened during the Cold War, it took four years of diplomatic efforts to have the medals exchanged to their rightful owners.

Only four years, relations must have been improving!!

High tech labour markets

One of the problem with developing a theory of the firm for firms based on human capital is that human capital can not be owned by the firm. Employees can always walkout the door in a way that non-human capital can not. This means that human capital firms can be very unstable with workers leaving anytime they want. Hart (1995: 56-7) goes so far as to argue that, at least some, nonhuman assets are essential to a theory of the firm. To see why this may be so consider a situation where 'firm' 1 acquires 'firm' 2, which consists entirely of human-capital. The question Hart raises is, What is to stop firm 2's workers from quitting? Without any physical assets - e.g. buildings - firms 2's workers would not even have to relocate themselves physically. If these workers were linked by telephones or computers, which they themselves own, they could simply announce one day that they had decided to become a new firm. For the acquisition of firm 2 by firm 1 to make economic sense there has to be a source of value in firm 2 over and above the human-capital of the workers. It makes little sense to buy a 'firm' if that 'firm' can just get up and walk away. Hart argues there must be some 'glue' (non-human assets) holding firm 2's workers in place.

So if firms can not own their human capital how do they overcome such a problem. What is the gue? It looks like companies in Silicon Valley tied to deal with the issue by agreeing not to hire people of each others companies.

Six leading technology companies, including Apple, Google and Intel, reached an antitrust settlement on Friday with the Justice Department that promises to increase the competition for sought-after technology workers. The government had conducted a yearlong investigation into agreements among companies not to poach employees from each other.

The investigation focused on five agreements by the companies not to make cold calls to employees that each company had placed on a do-not-call list. Each of the pacts, according to the Justice Department filing, involved a pair of companies: Apple and Google, Apple and Adobe, Apple and Pixar, Google and Intel, and Google and Intuit.

Anti-competitive or just an rational response to not being able to own some of your most valuable assets?

• Hart, Oliver D. (1995). Firms, Contracts, and Financial Structure, Oxford: Oxford University Press.

Recession and recovery in the euro area

From VoxEU.org come this audio interview:

CEPR’s Euro Area Business Cycle Dating Committee has announced that the recession that began in the first quarter of 2008 came to an end in the second quarter of 2009. Harald Uhlig of the University of Chicago, who chairs the committee, talks to Romesh Vaitilingam about how this recession compares with previous recessions and with the US recession, and about the components of GDP that are driving recovery.

Maurice Allais

From Alex Tabarrok at Marginal Revolution comes the news that Maurice Allais has died.

French physicist and economic Nobel Laureate Maurice Allais has died at age 99. Allais is best known among American economists for the Allais paradox but Allais was a polymath with contributions (and JSTOR here) in a huge number of areas many of which were often overlooked because his work was not translated into english (an unfortunate fact which is still true today).

To be honest I thought he had died years ago. Tabarrok continues with something I didn't know,

One thing that few people know about Allais was that he was a big proponent of the gold standard and Austrian business cycle theory, even citing Mises and Rothbard in some of his work. See in particular his paper in English, The Credit Mechanism and its Implications (1987) in Feiwel (ed), Arrow and the Foundations of the Theory of Economic Policy.

Interesting idea

Firm as a Nexus of Markets is a new paper by Ivan Jankovic. The abstract reads:

The Austrian School's conventional theory of the firm is based on an attempt to synthesize Coase's concept of the firm as a centrally planned hierarchy with the Austrian theory of entrepreneurship and monetary calculation. This paper is a critique of that program as well as an attempt to outline the alternative theory of the firm, one based on the synthesis of the contractual agency theory of the firm (Alchian-Demsetz, Jensen-Meckling) with the same Austrian arguments about entrepreneurship and calculation. The firm in this paper is defined as a nexus of various markets for goods as well as for labor and managerial services rather than as a hierarchy or “organization.” Both the neoclassical and Austrian critiques of the latter concept are utilized to prove that a clear distinction between the market and the firm cannot be established. That distinction is based on the misunderstanding of the firm's dynamics as exclusively tied to the managing/transaction costs ratio as well as on the mischaracterization of inter-firm relations as commanding ones (Demsetz-Alchian, Jensen, Meckling, Fama, Cheung). On the other hand, the central planning view of the firm is equally at odds with the key Mises's argument that rational economic planning is impossible in the absence of market prices (Mises, 1990). If this is so, the firm, as understood in a Coasian paradigm, would not have any reason to exist, or any reason to contribute positively to economic efficiency, because it would simply represent a centrally planned “island of incalculability” in a wider market setting (Rothbard, 2004). Since the firm is a nexus of various markets, its operation is contrary to the Coaseian assumptions led by the price signals. Only insofar as the internal firm's operation is driven by the price signals can the firm be efficient.

The idea that there is no distinction between the market and the firm has been tried before and has not been widely accepted. For me the Rothbard argument would hold but only when when the firm came to dominate the market since this would mean doing away with input prices which would make economic calculation impossible. This puts an upper limit on the size of the firm rather than saying hierarchical organisation can not exist.

Markets fail, so we need more markets

Bernard Hickey, one of New Zealand's business journalists, has been putting about some rather odd ideas that only prove he doesn't seem to understand economics. Matt Nolan and Eric Crampton have covered his nuttiness so I won't say anything more about that. What I think interesting is a point Eric made when he said,

The case for markets never lay in their perfection but rather in the relative imperfection of alternatives. I'm teaching intermediate micro this semester. We go through the welfare theorems, and they're beautiful. We know that they don't apply generally. However, it's really hard to improve on the imperfection of markets. Both markets and policies are imperfect instruments. Markets fail relative to blackboards, but regulatory solutions often fail relative to the real world market alternative.

This is a basic point that many people miss. A version of this idea I like is by Oliver Willaimson,

Students of the NIE eschew hypothetical ideals-which work off of omniscience, benevolence, zero transaction costs, full credibility, and the like-and deal instead with feasible organizational alternatives, all of which are flawed. Coase (1964) and Demsetz (1969) were among the first to take exception with the asymmetric standards that were once used in the "market failure" literature-according to which markets are beset with failures whereas "omniscient, omnipotent, benevolent" governments (Avinash Dixit 1996, p. 8) would reliably administer efficacious remedies. As we all should have recognized (but needed to be told), all feasible forms of organization-government included-are flawed.

What I have referred to as the remediableness criterion is intended to rectify this asymmetric state of affairs. This criterion holds that an extant mode of organization for which no superior feasible alternative can be described and implemented with expected net gains is presumed to be efficient.

To be sure, public policy analysis becomes more complicated when analysts can no longer condemn extant modes because they deviate from a hypothetical ideal, full stop. The remediableness criterion presses the public policy analyst to display a superior feasible alternative. If, moreover, a proposed feasible alternative cannot be costlessly implemented, then the costs of implementation are appropriately included in the net benefit calculus-which has major ramifications for the path dependency literature. Finally, grounds for rebutting the efficiency presumption need to be addressed-which brings in politics (Williamson 1996, 1999). Absent rebuttal, the remediableness criterion stands as a reminder of the obvious: it is impossible to do better than one's best. (Williamson 2000: 601-2)

Government can not do what Hickey seems to want to believe they can do, they are flawed and usually when compared to markets they are more flawed. Thus if Hickey want to show that the use of markets is wrong he has to show that there is a superior feasible alternative can be described and implemented by the government with expected net gains. That isn't easy to do.

So the argument, as Eric notes, for markets isn't that they are perfect, rather its that they are less imperfect than the alternative.

• Williamson, Oliver E. "The New Institutional Economics: Taking Stock, Looking", Journal of Economic Literature, Vol. 38, No. 3 (Sep., 2000), pp. 595-613.