EconTalk this week

Pete Boettke of George Mason University talks with EconTalk host Russ Roberts about the life, work, and legacy of Ludwig von Mises. Boettke outlines Mises's most important contributions to economics--business cycle theory, the socialism/calculation debate, and the application of economics to a wide range of behavior beyond the financial. Boettke discusses how Mises fits into the Austrian tradition and how he influenced scholars who came after him. The conversation closes with a discussion of Mises's most important works and suggests which books and articles are most accessible to a beginner who wants to explore Mises's ideas.

Happy birthday Ronald Coase

Coase was born at 3:25 p.m. on December 29th, 1910, which means he turns 100 today!

He has a new book, coauthored with Ning Wang an Assistant Professor at the School of Politics and Global Studies Arizona State University, coming out from Palgrave Macmillan and the Institute of Economic Affairs on How China Became Capitalist early next year.

Trade and farming

Which came first? In his book "The Rational Optimist: How Prosperity Evolves" Matt Ridley writes,

"One of the intriguing things about the first farming settlement is that they also seem to be trading towns. [ ... ] it is a reasonable guess that one of the pressures to invent agriculture was to feed and profit from wealthy traders - to generate surplus that could be exchanged for obsidian, shells or other more perishable goods. Trade come first." (Ridley 2010: 127).

The basic point here is that there is a conflict between the fact that we specialise in production but diversify in consumption. We produce, or help to produce, a very limited number of things but we consume a great many things. This conflict is reconciled by redistribution, i.e. via exchange/trade. Thus the first farmers who produced a limited number of goods, eg wheat or meat, but wished to consume more that just what they produced needed to be able to trade to expand their consumption set. Hence the necessity of trade for farming to survive.

EconTalk this week

Joe Nocera, New York Times columnist and co-author with Bethany McLean of All the Devils Are Here, talks with EconTalk host Russ Roberts about the origins of the financial crisis. Drawing on his book, Nocera identifies many people he considers devils for contributing to the crisis and a few angels who tried but failed to stop it. The discussion covers the history and development of securitization and the peculiar incentives created by securitization and the relative lack of regulation of the securitization process. The conversation also includes a discussion of whether past bailouts contributed to the crisis.

Boring headline of the day

Do We Need Google To Measure Inflation? Yes economists are coming up with new ways to measure changes in the CPI.


Zzzzzzzzzzzzzzzzzzzzzzzz .........................

EconTalk this week

Wafaya Abdallah of Oasis Hair Salon in Rockville, Maryland talks with EconTalk host Russ Roberts about the challenges and rewards of running a small business. Abdallah discusses her career path from would-be lawyer to owning her own salon with many employees and a management style that is different from the traditional one in her business. She discusses the economics of hair-cutting, how she motivates her employees to be part of the team, the openness of the salon's financial situation, the educational training she offers, and the ways she works with employees to motivate and inspire. You'll also learn how much her scissors cost.

Coase's big idea

The 2009 Nobel Prize in Economics co-winner Oliver Williamson has this to say about Ronald Coase

Ronald Coase is a seminal thinker and has a timeless message. On my reading, the essence of Coase is this: 1) push the logic of zero transaction costs to the limit; 2) study the world of positive transaction costs; 3) because hypothetical forms of economic organization are operationally irrelevant, and because all feasible forms of organization are flawed, assess alternative feasible forms of organization in a comparative institutional way; 4) because the action resides in the details, study the microanalytics of contract, contracting, and organization. That is a subtle and powerful combination of ideas and turns out to be difficult to implement. Although much of it goes against the main tradition, it has nevertheless made progressive headway in relation to, and parts have been incorporated within, orthodoxy.

For me the central message of Coase resides in the second of Williamson's points: study the world of positive transaction costs. It is only when we consider positive transaction costs that we can make sense of economic organisations. The firm is a product of having to deal with positive transaction costs. In a zero transaction cost world there would be no firms. As Foss, Lando and Thomsen (2000: 632) summarise it:

"The pure analysis of the market institution leaves almost no room for the firm (Debreu 1959). Under the assumption of a perfect set of contingent markets, as well as certain other restrictive assumptions, the model describes how markets may produce efficient outcomes. The question how organizations should be structured does not arise, because market-contracting perfectly solves all incentive and coordination issues. By assumption, firm behaviour (profit maximization) is invariant to institutional form (e.g. ownership structure). The whole economy can operate efficiently as one great system of markets, in which autonomous agents enter into very elaborate contracts with each other. However, by treating the firm itself as a black box, where internal structure, contracts, etc. disappear from the picture, there are many other issues that the theory cannot address. For example, the theory does not tell us why firms exist".

Coase changed the very way we see economic organisations. The theory of the firm for Ronald Coase, Oliver Williamson or Oliver Hart is a very different thing from that of Arthur Pigou, Lionel Robbins, Jacob Viner, Joan Robinson or Edward Chamberlin. The questions asked of the theory have changed from being about how the firm acts in the market, how it prices its outputs or how it combines its inputs, to questions about the firm's existence, boundaries and internal organisation. That is, there has been a movement away from the theory of the firm being seen as developing a component of price theory, namely issues to do with firm behaviour, to the theory being concerned with the firm as a subject in its own right.

This change in questions is Coase's great contribution to the theory of the firm. He changed the path analysis of the firm went down. Coase's 1937 paper "The Nature of the Firm" was, as Hal Varian puts it, a "Big Idea". In Coase's work we see most of the main issues of the modern theory of the firm being raised together for the first time. He sets out to "discover why a firm emerges at all in a specialized exchange" - a question about the existence of the firm; he also sets out to "study the forces which determine the size of the firm" - an issue to do with the boundaries of the firm; and he inquires into the reasons for "diminishing returns to management" - issues to do with the internal organisation of the firm. It was the efforts to answer these questions that initiated the charge from seeing the theory of the firm as just part of price theory to seeing it as an important topic in its own right. Coase also provides one of the main building block for answers to these issues, the "costs of using the price mechanism" or transaction costs.

The importance of Coase (1937) stems from the fact that it was the major catalyst, albeit with a long delay, for the modern theory of the firm and the theory of economic organisations more generally. Coase notes "[t]he article was not an instant success." (Coase 1988: 23). In fact it took nearly 40 years for it to become an overnight success.

Coase, who turns 100 on the 29th of December, has a new book coming out from Palgrave Macmillan and the Institute of Economic Affairs, How China Became Capitalist, early next year. It’s coauthored with Ning Wang, an assistant professor at Arizona State. Not bad for an old guy!

EconTalk for many weeks

Don Boudreaux of George Mason University talks with EconTalk host Russ Roberts about Chinese exchange rate policy and the claim that China keeps the value of its currency artificially low in order to boost exports to the United States and reduce U.S. exports. Boudreaux argues that regardless of whether China is manipulating its currency, inexpensive Chinese imports are generally good for the United States. He also points out that manufacturing output in the United States has been thriving despite claims that the United States is being "hollowed out." The conversation also includes a discussion of whether Chinese holdings of U.S. Treasuries threaten the United States.

Robert Frank of Cornell University talks with EconTalk host Russ Roberts about inequality. Is there a role for public policy in mitigating income inequality? Is such intervention justified or effective? The conversation delves into both the philosophical and empirical evidence behind differing answers to these questions. Ultimately, Frank argues for a steeply rising tax rate on consumption that would reduce disparities in consumption. This is a lively back-and-forth about a very timely topic.

Nicholas Phillipson, author of Adam Smith: An Enlightened Life, talks to EconTalk host Russ Roberts about the life of Adam Smith. Drawing on his recent biography of Smith, Phillipson discusses his intellectual roots, his intellectual journey, and what we know of his influences and achievements. Phillipson argues that Smith was shy, ambitious and very well-liked. He highlights the influence of Francis Hutcheson and David Hume on Smith's thinking. Phillipson gives his take on how the ideas of The Theory of Moral Sentiments mesh with The Wealth of Nations and argues that the Theory of Moral Sentiments was a response to Mandeville and Rousseau.

Kevin Kelly, author of What Technology Wants, talks with EconTalk host Russ Roberts about technology and the ideas in the book. Kelly argues that technology is best understood as an emergent system subject to the natural forces underpinning all emergent systems. He argues that any technology creates benefits and costs but that the benefits typically outweigh the costs (perhaps by a small amount) leading to human progress. This is a wide-ranging conversation that includes discussion of the Unabomber, the Amish, the survival of human knowledge, and the seeming inevitability of the advancement of knowledge. The conversation closes with a discussion of the potential for technology to make an enormous leap in self-organization.

George Selgin, of the University of Georgia, talks with EconTalk host Russ Roberts about whether the creation of the Federal Reserve in 1913 has been a boon or a bust for the U.S. economy. Drawing on a recent paper with William Lastrapes and Lawrence White recently released by the Cato Institute, "Has the Fed Been a Failure?" Selgin argues that the Fed has done poorly at two missions often deemed to justify a Central Bank: lender of last resort and smoother of the business cycle. Selgin makes the case that avoiding bank runs and bank panics does not require a central bank and that contrary to received wisdom, it is hard to argue that the Fed has smoothed the business cycle. Additional topics discussed include whether the Fed has the information to do its jobs well, the role of the Fed in moral hazard, and the potential for the gold standard to outperform the Fed.

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)

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.