Ministry's figures need analysis (updated)

so says Eric Crampton in this morning's Press here in Christchurch. And he is right. The figures in question are the Ministry of Health's estimates on the health costs of smoking - $1.9 billion. Eric writes,

You could be forgiven for thinking that the health system could save $1.9 billion if tobacco had never existed. That's what the Ministry of Health says smoking costs the public health system.

But, you'd be wrong.

Not that the ministry would correct your error. Eric goes on to make the real point about the ministry's numbers,

The ministry's latest estimate of the cost of smoking has nothing to do with the costs that smokers impose on taxpayers or the costs that could be avoided if smoking were to disappear.

Rather, it's a politically convenient number whose promotion has much to do with gaining voter support for anti-tobacco initiatives and nothing to do with real economic costs.

Interestingly the ministry's number

[...] was much higher than the previous estimate of $350 million dollars - a figure produced not by the Big Tobacco lobby but rather by Des O'Dea in a report commissioned by anti-tobacco crusaders Action on Smoking and Health.

So, you may ask, how did the ministry get their figure?

After sorting the population by age, gender, income, ethnicity and smoking status, they then compared the costs of providing health services to smokers as compared to nonsmokers for each group.

The excess costs of the smoking group were tallied up to produce the $1.9b figure.

But there are problems with such an approach. Eric deal with two of the big ones.

It's easiest to think of smoking as bringing forward a whole lot of end-of-life costs.

Smokers die earlier than nonsmokers.

We know that.

And the costs to the health budget of somebody who is dying are rather higher than the costs of somebody who is healthy.

But everybody dies sometime and most of us will incur end-of-life costs that will be paid for by the public health system.

Suppose that a smoker will die at age 65 and a nonsmoker will die at 75. Comparing 65-year-old smokers to 65-year-old nonsmokers and calling the difference the cost of smoking then rather biases upwards the measured costs of smoking.

We ought to be comparing the health costs of a smoker dying at age 65 with the health costs of a nonsmoker dying at age 75.

And, perversely, the deadlier cigarettes are, the greater will be this bias. The younger smokers are when they die of smoking-related illnesses, the greater will be the measured cost difference between smokers and non- smokers because a smaller proportion of comparable nonsmokers would be incurring end-of-life costs.

The figures assume that in the absence of smoking, smokers would never have imposed end-of-life costs on the health system. But for their smoking, all smokers in this scenario would have died of a sudden, and cheap, heart attack and would only have had average health costs up to that point. That's clearly nonsense, but the $1.9b figure only makes sense if it's true.

Further, we might well expect that there are differences between smokers and nonsmokers beyond those accounted for by income, gender, ethnicity and age.

Imagine a 45-year-old white female of average income who happens also to be an active jogger, moderate drinker and health food enthusiast. Is she more or less likely to be a smoker than a 45-year-old white female of average income who happens also to avoid the gym, drink too much and never touch a vegetable?

On average, we'd expect that folks who are more health conscious on other margins are also less likely to smoke.

But the ministry's method, which doesn't correct for those other health-related behaviours, necessarily lumps all of the differences between smokers and non- smokers into the cost of smoking rather than into the cost of having a generally unhealthy lifestyle that includes smoking.

It's only if smokers and nonsmokers are otherwise identical, on average, in their health-related behaviours - after correcting for income, gender and ethnicity - that the ministry's figure holds up. But that's also pretty clearly nonsense.

So the ministry may not be telling us the truth, the whole truth and nothing but the turth. Anyone surprised? As Eric notes we should

[...] be as sceptical of numbers coming from the Ministry of Health as you would be of numbers produced by the tobacco industry. Neither is a disinterested party.

Well said Crampo.

Update: Eric writes more on the matter here.

Second report of the 2025 Taskforce

The NBR reports that

Current government policies show no sign of delivering the growth rates New Zealand needs to close the large income gap with Australia, according to the second report of the 2025 Taskforce.

Like someone needed to be told this? The NBR article continues,

The broad recommendations - in what is a very in depth and detailed document – are:

• Cutting both government spending and tax rates
• Government withdrawal from most commercial activity to allow the private sector to drive value for money and innovation in those areas – including health and education services
• Proper cost-benefit analyses of government infrastructure projects
• More focused research and development in the public and private sector, including better governance of research and development in tertiary institutions and full contestability for government research and development funding
• Better quality regulation - more “fundamental review” of the Resource Management Act, restoration of the youth minimum wage, and a less restrictive hazardous substances and new organisms regime.
• More openness to foreign investment
• Better processes for scrutiny of regulations along the lines of the Regulatory Responsibility Bill.

The NBR reports Don Brash as saying,

"We were criticised last year for saying that smaller government was essential to closing the gap, but we stand by that statement. International evidence provides no reason to believe we can close the gap without significantly reducing the share of government spending in the economy, allowing tax rates to be lowered further. The state should withdraw from commercial activity to allow the private sector wider scope to generate the high levels of growth that are needed"

That isn't saying much, I think most economists would basically agree that the government is involved in areas where it shouldn't be and reducing the government's business footprint and size in general would help simulate growth. The other points noted above also don't look all that radical. But the government will nevertheless ignore the report.

The 2025 Taskforce report is available here.

America’s economic policy mix is a threat to the world

Or so says Philippe Legrain over at VoxEU.org. Legrain argues,

While the debate over global imbalances often focuses on China, this column argues that the biggest threat to the world economy comes from the other side of the seesaw – the US.

He continues,

Yet because it has a current-account surplus, China is widely perceived to be a drag on the global economy. This is misleadingly simplistic.

• Its imports grew by 24% in the 12 months to September, creating jobs and growth elsewhere.
• Its trade surplus is shrinking.
• And, lest critics forget, even Chinese exports have their benefits. Assembled from parts made in other countries, they provide cheap inputs for businesses everywhere. They spur companies outside China to innovate and become more competitive. And they increase consumers’ welfare – why else would people buy them?

Legrain wants the US to look at its own polices before complaining about other countries.

For the most part, the alternative to cheap Chinese imports is not goods “made in the USA” but goods made in other emerging economies. Reshaping the US economy to cater more to the needs of emerging economies would do far more to boost US exports. Above all, trying to force the renminbi up with protectionist threats – as the US Congress demands and many respectable and ostensibly liberal commentators now seem to advocate – is to invite a trade war that would beggar us all.

Instead of threatening others, the US should put its own house in order. The Federal Reserve helped cause the mess we are in and is now sowing the seeds for the next crisis. Having wrecked the US economy by encouraging a huge debt-fuelled bubble to inflate, the Fed now finds itself unable to ensure recovery. Even with near-zero interest rates, indebted consumers don’t want to borrow and fragile banks don’t want to lend. Businesses that could generate growth are either starved of credit or too uncertain about the future to invest. As the Fed pumps out ever more money, banks invest it in higher-yielding Treasuries, pocketing easy profits and paying out ill-deserved bonuses, while much of it leaks out overseas. The net result? Hardly any additional US growth.

Since the monetary transmission mechanism is broken, injecting ever more money into the system does not get the wheels of the economy spinning faster. It floods the engine. A better way to stimulate the US economy would be fiscal measures that promote its restructuring and enhance its productive potential – for instance, investment in its dilapidated infrastructure, cuts in payroll tax and retraining subsidies to get people into work and, in the absence of a carbon tax, measures to promote venture capital in the clean-tech industries of the future.

Current US policy is not just ineffectual, it is also dangerous. Banks that ought to fold are kept on life support. Homeowners who ought to default and move to where the jobs are cling on to their depreciated houses in depressed areas. Bubble-prone investors believe in a Bernanke put. Money gushes out of the US and into emerging economies that don’t need it and can’t cope with it. This is economic vandalism.

The strategic rationale for printing money – sorry, “quantitative easing” – may be to force Beijing’s hand on the renminbi. Yet protected by capital controls, adept at sterilising monetary inflows and loath to give in to US pressure, China is unlikely to move much. Carrots – such as a bigger role at the IMF and the opportunity to convert some of its dollar reserves into special drawing rights (SDRs) – might work better than sticks. The victims are instead the Eurozone, Japan, Australia and other advanced economies whose currencies are soaring, as well as emerging economies such as Brazil and Thailand that cannot do much to stem the tide of US cash.

More from EconStories.tv

Hayek and Keynes Battle at The Economist’s Buttonwood Gathering:

On October 25th, an audience of financial managers and CEOs, politicians, central bankers and Nobel Prize-winning economists at The Economist’s Buttonwood Gathering were treated to an unusual experience: a live rap battle between John Maynard Keynes and F. A. Hayek.

Following a presentation by Nassim Taleb, the lights went down in the auditorium and Fear the Boom and Bust blasted onto the screen. This video picks up at the end of that special presentation, where Keynes and Hayek stepped onto the stage to give a preview of the next EconStories music video.

In the final new video, which will be completed in the months ahead, expect many more lyrics and an all new beat.

Lastly, Russ Roberts and John Papola took the stage with John Micklethwait, editor-in-chief of The Economist for a brief Q&A about the origins of FTBB and the resurgence of Hayek in the global debate over the economy.

Free trade and globalisation: more than "just stuff"

So writes Donald J. Boudreaux in this article Free Trade and Globalization: More than "Just Stuff" . Boudreaux concludes by saying,

The fear that globalization makes the world less interesting culturally is baseless. The effect of free trade is twofold: first, it gives us more prosperity and, second, this prosperity creates diversity and dynamism. Both of these effects are good reasons for opposing the antediluvians who would obstruct international trade.

Something to keep in mind is that when you are wealthy, the wealth due in part to trade and globalisation, you can afford to develop art and culture. But it goes further than this:

Learning and rich culture require wealth—what the above mentioned critics would call "more stuff"—for their growth and sustenance. They also require exposure and openness to different cultures. Such wealth and exposure are promoted by trade, which enables an extensive and productive market-directed division of labor.

The wealth, freedom, and diverse experiences of a commercial culture liberate artists and educators both to be more creative and to cater to the demands of the general population. In a poor society in which only a small elite has wealth and leisure, artists and educators cater only to the elite's desires. Art forms disliked by elites, as well as knowledge not useful to them, do not thrive. But as trade creates greater and more-widespread wealth, the range of tastes and opportunities that are available to support and influence art and education grows. With the elites no longer being the exclusive supporters of art, the artist who previously found no support for his musical compositions or his poetry might now find sufficient support from the middle classes. Likewise for the teacher who, earlier, found no market for his knowledge.

This trade-fueled process results not only in a more literate society, but also in immense cultural enrichment. Culture takes on many more dimensions: not only orchestral music, but also rock'n'roll, rhythm'n'blues, and rap; not only portraiture and landscapes, but also Andy Warhol soup cans and abstract paintings; novels not only by Virginia Wolff, Marcel Proust, and William Faulkner, but also by Nora Roberts, J.K. Rowling, and Clive Cussler. Movies cater to high tastes, dull tastes, and vulgar tastes. Likewise for music, theater, television, dance, photography, and—more recently—websites and blogs.

Yes globalisation helps even blogs. Imagine if you could only read the blogs from any one country or region, how much would we miss out on? Here in New Zealand we would miss Don Boudreaux for a start. So there is more to globalisation than just "stuff".

Institutions and economic performance: what can be explained?

And the answer seems to be, not much. At least this is the outcome of a new working paper by Simon John Commander London Business School; Institute for the Study of Labor (IZA) and Zlatko Nikoloski, University College London. The abstract for their paper, Institutions and Economic Performance: What Can Be Explained?, reads:

Institutions are now widely believed to be important in explaining performance. In this paper, we analyze whether commonly used measures of institutions have any significant, measurable impact on performance, whether of countries or firms. We look at three 'levels' of institutions and associated conjectures. The first concerns whether the political system affects performance. The second concerns whether the business and investment environment affects the performance of countries and the third concerns whether perceived business constraints directly affect the performance of firms. In all instances, we find little evidence of a robust link between widely used measures of institutions and our indicators of performance. We consider why this might be the case and argue that mis-measurement, mis-specification, complexity and non-linearity are all relevant factors.

In the conclusion to the paper Commander and Nikoloski write:

Our paper has taken a close look at this proposition by focusing on three, related questions. The first concerned whether the type of political system, and its associated institutions, tends to affect performance. The simple conjecture, drawn from a significant literature, was that democracy in particular has features that should be encouraging for performance, even if that underlying relationship was not linear. This was addressed using several sets of country level measures of political institutions and through use of leading edge GMM estimation. The second concerned the impact of institutions connected to the investment and business environment on the performance of countries, irrespective of their political configuration. In particular, this part of the analysis focused on a widely cited measure of the business environment that covers 175 countries; the World Bank’s Doing Business. The third question was to ask whether the evidence could robustly support the broad proposition that the performance of firms’ could be materially influenced by the business environment. This required, above all, econometric implementation able to address the pervasive problems of endogeneity and unobserved heterogeneity.

The results reported in the paper are ambiguous, if not hostile, to the default proposition of institutions affecting performance. In the case of political institutions, none of the explanatory variables was significant. For country level analysis we were limited by an absence of an adequate number of observations on time. But the analysis that we were able to implement indicates that no robust conclusions can be drawn. In the case of firm level analysis, using a large two-period dataset on twenty six transition countries – countries whose initial conditions comprised largely similar institutional formats – we were unable to find any strong relationship between revenues and the institutional constraints. Country effects that captured other sources of cross-country heterogeneity were found to matter for performance.

Finally, the paper addressed why these exercises have yielded a relatively meagre harvest, at least when held up against the prevailing orthodoxy. Put simply, it would appear that issues of measurement – including bias arising from subjective evaluation – misspecification, complexity and non-linearity are all relevant.

There is, I would say, a broad consensus that institutions do matter for economic performance, and its hard to see why they wouldn't. May be we just don't have good measures of those parts of the institutional frame work that do matter for performance.

EconTalk this week

John Quiggin of Crooked Timber and the author of Zombie Economics talks with EconTalk host Russ Roberts about ideas in economics that should stay dead and buried. Quiggin argues that many economic theories such as the Great Moderation, the efficient markets hypothesis and others have been discredited by recent events and should be relegated to the graveyard. Roberts challenges some of Quiggin's claims and wonders whether proposed alternatives might do even worse than the policies Quiggin is criticizing. Much of the conversation focuses on the role of government in the financial sector and how that might be improved going forward.

Jeff Miron and John Taylor on the stimulus package in the US

In the current issue of The Harvard Journal of Law & Public Policy an article by Jeffrey Miron makes The Case Against the Fiscal Stimulus. He concludes by saying:

A few weeks after President Obama’s victory in the 2008 election, adviser Rahm Emanuel quipped that “[y]ou never want a serious crisis to go to waste . . . [because it] provides the
opportunity for us to do things that you could not do before.” Emanuel was correct: The situation in which the new Administration found itself constituted an unusual political dynamic that, properly used, would have allowed the Obama Administration both to stimulate the economy and make it more productive over the long haul.

The Administration should have endorsed a stimulus package based on a repeal of the corporate income tax and reductions in employment taxes. This policy would have accomplished its stated goals, and the budgetary implications would have been less negative than those of the package ultimately adopted because this alternative plan would have enhanced rather than detracted from economic efficiency. This approach would also have been difficult for Republicans to oppose.

Yet the Administration did not take this approach, presumably because its true goals were not just economic stimulus. Instead, the Administration wanted to reward its constituencies (unions, environmentalists, public education) and increase the size and scope of government. This tactic is consistent with the Administration’s policies in general. Across the board, it has taken a big government, redistributionist approach, whether regarding housing, unions, health, the auto industry, trade, antitrust,or financial regulation. The Administration’s view appears to be that government is better than individuals at deciding how taxpayers get to spend their money and that government should engineer large transfers from richer to poorer.

Whether the Administration’s stimulus package will be successful is still to be determined. If the extra spending ends up being productive, then the impact of the stimulus might be positive on net. My own prediction, however, is that the programs adopted will generate large distortions and substantial waste, with minor stimulus impact. This is a pity because much better alternatives were available.

In other words politics bets economics every time. Payback to those who supported you in your battle to get power is important if you wish to keep power. Obama has one more election to fight and he needs the support of the unions, the environmentalists and the public education sector to win it, hence he has to give them something to keep them on side. The actual effects on the economy may well be of lesser importance.

Note that over at the Economics One blog, John Taylor gives More Evidence on Why the Stimulus Didn't Work. Taylor and John Cogan have been looking at the impact of the American Recovery and Reinvestment Act of 2009 (ARRA).

It is necessary to know that that

change in GDP =(government purchases multiplier) times (change in government purchases).

Taylor writes,

But few have focused on the second term in the above multiplier formula: the change in government purchases due to ARRA. John Cogan and I have been tracking data on the changes in government purchases since ARRA was passed, using a new data series provided by the Commerce Department. We just finished a working paper reporting the details of our findings, which provide additional evidence that the stimulus has not worked and, just as important, on why it has not worked.

Despite the gigantic $862 billion stimulus package, the change in government purchases due to ARRA has been immaterial to the economic recovery: government purchases increased by only 2 percent of the $862 billion package ($18 billion). Infrastructure was even less at $2.4 billion. There has been almost no change in government purchases for the multiplier to multiply. It’s no wonder people don’t think the stimulus worked. And the size of the multiplier is largely irrelevant!

The dog that didn't bark in the night or the stimulus that didn't stimulate.

Incentives matter: Rolling Stones file

High marginal taxes do matter:

The Stones are famously tax-averse. I broach the subject with Keith [Richards] in Camp X-Ray, as he calls his backstage lair. There is incense in the air and Ronnie Wood drifts in and out--it is, in other words, a perfect venue for such a discussion. "The whole business thing is predicated a lot on the tax laws," says Keith, Marlboro in one hand, vodka and juice in the other. "It's why we rehearse in Canada and not in the U.S. A lot of our astute moves have been basically keeping up with tax laws, where to go, where not to put it. Whether to sit on it or not. We left England because we'd be paying 98 cents on the dollar. We left, and they lost out. No taxes at all. I don't want to screw anybody out of anything, least of all the governments that I work with. We put 30% in holding until we sort it out." No wonder Keith chooses to live not in London, or even New York City, but in Weston, Conn.

More here.

(HT: Greg Mankiw)