Private v. public ownership (updated)

Bernard Hickey, who wishes to lecture all of us on things economic, writes:

I wonder too, why can't Treasury and the government appoint boards that apply the same rigour as NZX listed companies? Other non-listed entities can do it.

If I interpret this question correctly (and, of course, I may not) then it seems odd that New Zealand's great economic guru has to ask it. The reasons for different outcomes, no matter who is on the board, under public and private ownership have been well known for the last 20 years. Since the early 1990s there has been a well known literature which explains the difference between private and public firms utilising an incomplete contracts framework. Within a complete contracts model - eg a principal-agent type model - the performance of private and public firm will be the same. This is because complete or comprehensive contracts cover all relevant state of the world and ownership is irrelevant in such a situation.

In an world of incomplete contract not all sates of the world are covered and this gives us a role for ownership - the owner is whoever gets to determine what happens in the situations not covered by the contract. Hart, Shleifer and Vishny ("The Proper Scope of Government: Theory and an Application to Prisons", Quarterly Journal of Economics, 112(4): 1127-61, November 1997) argue that the case for government provision of goods or services is generally stronger when non-contractible cost reductions have large deleterious effects on quality, when quality innovations are unimportant and when corruption in government procurement is a severe problem. It has been argued that the case for government production is strong in such services as the conduct of foreign policy, police and armed forces. The case can also be made reasonably persuasively for the case of prisons. The case for private sector provision is stronger when quality reducing cost reduction can be controlled through contract or competition, when quality innovations are important and when patronage and powerful unions are a severe problem inside the government.

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

The Hart, Shleifer and Vishny argument applies to contracting out as well as outright privatisation. A question that arises therefore is, Why would private ownership ever be more efficient than public? As to why private provision is superior, there are two results that need to be explained. Oliver Williamson's idea of selective intervention and the 'Fundamental Theorem of Privatization' by Sappington and Stiglitz. (Sappington, David E. M. and Stiglitz, Joseph E. (1987). 'Privatization, Information and Incentives'. Journal of Policy Analysis and Management, 6(4): 567-82.) These tell us that there should be no differences in efficiency between a privatised and a nationalised firm. Thus any explanation of the relative efficiency between the two must explain why these ideas cannot be applied.

The first notion, of selective intervention, argues that the government can reach the same level of productive efficiency as the private sector by mimicking the private owner. Is this what Hickey is getting at with this question? If the government organises the firm in exactly the same way as a private owner would, if it gives the same incentive schemes to managers and workers, and if it deviates from such a policy only if there is the possibility of doing something strictly better than a private owner, then a nationalised firm should produce at least as efficiently as a privatised one. Think about what the SOE model was all about.

The second idea is concerned with allocative efficiency and says that a public firm will choose a socially more efficient production level because the government cases about social welfare and internalizes externalities, whereas a private owners just maximizes private profits. However, this argument implicitly assumes that the government cannot regulate the firm. Sappington and Stiglitz suggest a privatisation and regulation procedure that perfectly overcomes the problem of different objective functions. The government could auction a contract that entitles the private owner to receive a payment for the firm's output that exactly equals its social valuation. Thus, the owner fully internalizes social welfare and chooses a socially efficient production level. Furthermore, if the bidding process is competitive, the government will extract all the rents form the contract through the auction ex ante even if it doesn't know the cost function of the firm.

At this point the argument tells us that efficiency should be the same for both private and state firms. Why then does the empirical evidence tell us otherwise? Well, both arguments are based on the implicit assumption that it is possible to write a comprehensive contract for the entire horizon of the firm - otherwise the involved commitment problems could not be overcome. To illustrate this point, consider again the auction suggested by Sappington and Stiglitz. For such an auction to work, the government must be able to commit at the stage of privatisation to actually pay the social valuation of output to the private owner in the (possibly distant) future. That is, it must be possible to specify unambiguously in a contract the social benefit of production for all possible state of world such that this agreement can be enforced by the courts. Otherwise, the private owner will rationally expect that once she has made a relationship specific investment the government will exploit the fact that investment costs are sunk and will expropriate her quasi-rents; therefore she will not invest efficiently. However, if comprehensive contracts are feasible, it is not surprising that there is no difference in efficiency, since it is well known that any organizational mode can be copied by any other organizational mode through a comprehensive contract. Therefore, if there is any difference, it must be due to the fact that only incomplete contracts are feasible at the stage of privatisation.

A simple example is the paper by Klaus Schmidt, "The Costs and Benefits of Privatization: An Incomplete Contracts Approach". (The Journal of Law, Economics & Organization, 12(1): 1-24, 1996.) The intuition is roughly as follows: Suppose the manager of the firm has to make a private investment in cost reduction before production takes place. For example, he may have to expend effort to restructure the firm and to organize production more efficiently. Assume also that the manager derives some private benefit from a higher production level, either because he is an "empire builder" or because he is afraid of the firm being liquidated, in which case he loses his job and his reputation may be damaged. To improve the manager's incentives, the government may want to commit ex ante to a subsidy scheme that punishes the manager if costs are high by cutting back production or even closing down the firm. However, under nationalization this commitment is not credible. If the government could observe the cost function - and it can in this case -, it would always choose a production level that is ex post efficient, thus forgiving high costs and paying more subsidies than announced ex ante. Anticipating this, the manager has little incentive to save costs because he faces a "soft budget constraint". Under privatization, however, the government is not informed about the costs of the firm whereas the private owner is. It is shown that the optimal subsidy scheme under incomplete information distorts production below the socially efficient level if costs are high. Furthermore, there is a positive probability that the firm will be liquidated, even though this is inefficient ex post. Thus, under privatization allocative efficiency is clearly lower than under nationalization. The more surprising result is that productive efficiency may be enhanced. The manager faces a harder budget constraint because he rationally foresees that subsidies will be cut back if costs turn out to be high. Thus he has a stronger incentive to invest in cost reduction to avoid the low production level or possible liquidation. To summarize, there is a trade-off between a less efficient production level (lower allocative efficiency) and better incentives for the manager to save costs (higher productive efficiency).

This article makes a very strong assumption about the role of government. The government is modelled as a benevolent, fully rational, and unitary decision maker. There are no conflicts of interest between politicians, ministries, and regulatory agencies; no rent-seeking lobbyists trying to get subsidies; and no self-interested politicians struggling for power, bribes or a larger share of the electoral vote. This assumption is clearly unrealistic. therefore the main result of the paper should be seen as an existence theorem: It shows that privatization can be can be strictly superior to nationalization even in the best of all words for government. Thus, even if it were possible to fix all the deficiencies of the political system a case for privatisation could still be made

I'm not sure if this answers Hickey's question but it does give us insights as to why the performance of public and private firms differ, which I assume is what he is worried about.

Update: Roger Kerr discusses problems with the discussion of privatisation by journalists here and here.

The low standard of debate

The standard of debate on the topic of asset sale isn't great but this extract from a letter to the Editor of the DomPost (thanks to The Inquiring Mind for this quote) really shows just how bad the debate can get:

‘Obviously the Government is planning to sell the majority of the shares overseas to either the Americans or the Chinese.

If power companies go to the Americans, how long will it be before some smart boy in Wall Street does an Enron and figures that more money can be made by not making electricity?

If the companies go to the Chinese, how long will it be before elements of the Red Army are sent to New Zealand in order to protect their asset? How long before coal or oil, destined to power a thermal station here is diverted to China?’

The economic understanding of the general public isn't great at times but this type of xenophobic misinformation and outright rubbish is just too bizarre for words.

Roger Douglas gets the point

Previously I wrote about the aims of privatisation programs and said:

Another issue which is getting much press is how much would the government get for the shares it would sell and what will it do with the money. A problem here is that talking about maximising the return from privatisation misses the whole point of privatisation which is to improve the efficient and productivity of the economy. If we just worry about how much we will get for the sale of assets then we should sell all of the state assets with the firms being monopolists. But that's unlikely to do much for welfare.

Now I see from this article from the New Zealand Herald that Roger Douglas at least has also come to this conclusion:

"Privatisation is not really about how much money you get for the asset, that's important, but the more important issues are to get the regulatory environment right so that competition can take place in the industry.

"What you measure your success by is the productivity that flows following the corporatisation / privatisation process."

Well said that man!

Partial privatisation

There has been a lot of rubbish written recently about the idea of the partial privatisation of some state assets. There has also been some good stuff written. On the good side Roger Kerr has pointed out some of the problems with the idea, as have I previously. Now Eric Crampton makes good sense over at Offsetting Behaviour. Eric writes,

On the one side, besides the usual knee-jerk opposition to any kind of privatization and fearmongering about that foreigners might buy shares, there's the claim that we lose money by selling an asset that currently pays the government a dividend higher than the government's net borrowing costs. So if some SOE pays a 7% dividend to the government and the government's cost of borrowing is 5%, they reckon it makes more sense to keep the asset and to borrow money to cover shortfalls.

Forget SOEs for the moment. If any firm is providing a rate of return that seems to consistently be beating the market, we'd expect the stock price to rise until the rate of return falls into line with market norms, right? And if that doesn't happen, it's probably because there's something a bit nasty hiding in the risk profile. Now think about the SOEs. If they're earning a high return, it's either because their valuation is out of whack or because there's some risk. In the former case, the government can do well through an IPO - they'll get more for it than they thought it was worth. If instead it's just that the assets are risky, looking at the gap between funding costs and rate of return misses something a bit important.

Now, a reasonable counterargument is that the stock market rate of return is higher than the government's borrowing costs in general, so the asset price won't be bid up sufficiently to make the difference. But note two big problems. Sovereign debt from reasonable countries is safer than most stock market investments: the market index has to pay investors for the additional risk they take on. So selling a very safe asset (a bond) at a low interest rate while buying a riskier one (keeping an SOE) isn't a "Hey! Free Money!" deal. If it were, we'd also have proven that the government should borrow heavily on the international markets and buy up shares on the NZX. Most of us don't think that would work. So why do we think there's anything particularly special about the government's current set of asset holdings? If the argument for keeping Solid Energy in government hands is that the government's rate of return on coal investments is higher than its borrowing charges, then the government should also buy up any other firm providing a high enough expected return.

Another issue which is getting much press is how much would the government get for the shares it would sell and what will it do with the money. A problem here is that talking about maximising the return from privatisation misses the whole point of privatisation which is to improve the efficient and productivity of the economy. If we just worry about how much we will get for the sale of assets then we should sell all of the state assets with the firms being monopolists. But that's unlikely to do much for welfare.

With partial private ownership of an SOE you run into the "a man can not serve two masters" problem. The aims of the private owners and the government are unlikely to be the same. Private investors will want to maximise profits while the government may well have political objectives it wants met. A firm can not do both and if it were to try it would just fail to achieve either.

Incentives matter: bonuses versus fines file

Research by Daniele Nosenzo, Theo Offerman, Martin Sefton and Ailko van der Veen looks at the question, Why pay mangers a bonus for doing well rather than fine them if they do badly? The research suggests that fines are better incentives than bonuses.

The paper is Inducing Good Behavior: Bonuses versus Fines in Inspection Games. The abstract reads:

We examine the effectiveness of bonuses and fines in an ‘inspection game’ where an employer can learn the effort of a worker through costly inspection. Standard game theoretic analysis predicts that fines discourage shirking, whereas bonuses encourage shirking. In contrast, ownpayoff effects suggest that both fines and bonuses discourage shirking. In an experiment we find that fines are more effective than bonuses in reducing shirking. However, we do not find that bonuses encourage shirking. Behavioral theories based on Impulse Balance Equilibrium or Quantal Response Equilibrium provide a good account of deviations from Nash equilibrium predictions.

Rational smoking

For non-economists the idea of rational addition seems weird but there is data that supports the theory. From the Economic Logic blog comes this discussion of the effects of smoking bans on smokers: it makes some of them worse off.

Timothy Hinks and Andreas Katsaros provide some evidence that could further validate the rational addiction theory by looking at public smoking bans in England, Wales and Northern Ireland. Using the British Household Panel Survey, which includes questions about happiness and smoking, they find that those who reduced their smoking show no change in happiness compared to those who did not change their smoking. But once public smoking bans were imposed, those who reduce smoking, in particular heavy smokers, exhibit decreases in happiness. In other words, they were forced to reduce smoking by being chased away from public places, and feel worse for it. That is consistent with the rational addiction theory in that imposing an unanticipated constraint makes people worse off.

A message from your friendly tax department

(HT: Turbulence Ahead.)

I am confused, again (updated)

According to this news report:

A new study by Canterbury University's GeoHealth Laboratory showed fast-food outlets were 5 1/2 times more likely to be clustered around schools than other areas and three times more likely to be in poorer areas than rich.

and

Day studied the clustering of fast-food and convenience stores around schools in Christchurch, North Shore, Waitakere, Lower Hutt and Wellington.

So do fast-food outlets cluster around schools or do schools cluster around fast-food outlets or is some other factor causing the clustering? An example of the last point would be that both schools and fast-food outlets occur in areas of high population density. And how did the researchers check for causation?

And as for the fact that fast-food outlets more likely to be in poorer areas than rich, could this be because their food is cheaper? 5-star restaurants in poor areas may be nice but it seems unlikely that there would be enough demand to keep them going.

And if there is a "childhood-obesity epidemic sweeping the Western world" (proof?) whose job is it to bring up the kids with sensible eating habits? The fast-food manger or the parents? The problem here may not be the distribution of fast-food outlets but rather the parents teaching of their kids.

Update: Kiwiblog comments here, Eternal Lacking here. This comments makes the point that may be rents are lower in poor areas which may attract fast food type business.

Why China missed the industrial revolution?

It should be obvious that China has been one of the world's most dynamic economies in recent decades, but why did it need to play catchup with the west. How did China fall so far behind Europe in the first place? This column at VoxEU.org argues that the industrial revolution occurred in Europe rather than China because European entrepreneurs were eager to adopt machines to cut down on high labour costs. China didn’t “miss” the industrial revolution – it didn’t need it.

Jan Luiten van Zanden writes on "Before the Great Divergence: The modernity of China at the onset of the industrial revolution". He argues

The industrial revolution was a process of mechanisation in which expensive labour was substituted for by machines driven by coal – as Bob Allen (2009) has demonstrated. Chinese factor costs were not at all conducive to such a change.

Whereas entrepreneurs in Europe were very eager to develop new technologies that increased labour productivity via the capital-labour ratio, Chinese businesses barely had any incentive to do so. That the industrial revolution emerged in England was therefore not accidental or the result of luck, but the long-run effect of its fundamentally different factor prices, reflecting its different economic and institutional trajectory.

Can't help but think that the likes of Joel Mokyr may say there is more to it than this.

• Allen, Robert C (2009), The British Industrial Revolution in Global Perspective, Cambridge University Press.

Capitalism v. communism: the Korean peninsula example (updated)

The cool picture below comes from a posting by Laura Freschi at the Aid Watch blog. The idea is that the amount of light that can be seen from outer space acts as an interesting proxy for GDP growth. See the NBER working paper, Measuring Economic Growth from Outer Space by J. Vernon Henderson, Adam Storeygard and David N. Weil for details.

The picture shows the Korean peninsula in 1992 and 2008. It highlights the very dramatic contrast in long term growth, as measured by light, between North and South Korea, and gives a picture of how quickly South Korea has developed over the last two decades and the south's growth relative to the north.

Update: Tim Worstall got here first, he thinks Economists Are Beginning to See the Light.

Krugman v's Krugman

Paul Krugman recently wrote in the New York Times that,

It’s true that we’d have more jobs if we exported more and imported less.

But is this the same Paul Krugman who wrote,

It should be possible to emphasize [...] that the level of employment is a macroeconomic issue, depending in the short run on aggregate demand and depending in the long run on the natural rate of unemployment, with microeconomic policies like tariffs having little net effect. Trade policy should be debated in terms of its impact on efficiency, not in terms of phony numbers about jobs created or lost.

The trade economist Douglas Irwin has this to say on the matter of trade and jobs,

The claim that trade should be limited because imports destroy jobs has been around at least since the sixteenth century. And imports do indeed destroy jobs in certain industries: [...]

But just because imports destroy some jobs does not mean that trade reduces overall employment or harms the economy. [...]

Since trade both creates and destroys jobs, a frequently asked question is whether trade has any effect on overall employment. Unfortunately, attempts to quantify the overall employment effect of trade are I exercises in futility. This is because the impact of trade on the total number of jobs in an economy is best approximated as zero.

So who's right? The first Krugman seems to want to say that the number of jobs does depend on international trade while the second Krugman (and Doug Irwin) seems to want to say that the number of jobs doesn't depend on trade. They can't both be right. So is it Krugman or Krugman who's right? Does Krugman know?

I'm confused

According to the University of Otago,

Scientists at the University of Otago have found that regular consumption of school milk significantly reduced the risk of bowel cancer in adulthood. (emphasis added)

So if you drink milk at home it has no effect?

Incentives matter: rational crime file

Mark Perry at Carpe Diem writes,

Paul Kedrosky reported yesterday that copper thefts are rising again, due to the all-time record high prices in recent months.

Copper prices were US$1.40 per pound at the end of 2008 and are now approaching US$4.50 per pound. Perry continues,

According to a Google News search, there have been 545 news stories in just the last week containing the phrase "copper theft," and that compares to 665 stories during the entire year of 2009 when copper prices were between $1.50-$3.00 per pound, and 1,750 stories last year as prices rose above $4 per pound by the end of the year.

So even criminals respond to incentives.

Thoughts on the firm

Eric Crampton points me to this piece by Kevin Dick at the Emergent Fool blog on Thoughts on the Theory of the Firm. On a quick read of the posting I noted a couple of things. First,

Thus the standard approach to explaining firms starts with the Transaction Cost theory (typically attributed to Coase). Whenever the cost of a market-based mechanism is higher than a firm-based mechanism, a firm will end up coordinating production. Of course, to anyone who has ever started a new firm or worked any length of time at a large one, this explanation is not terribly satisfying. How do you know the relative costs in the first place and then explain the apparently wasted resources at large companies?

Yes the transaction cost approach is due to Coase, Coase (1937): The Nature of the Firm, to be exact. How do you know the relative costs? The same way you know any costs, you look and see what others are doing and what there costs are and make a judgement as to what you think the relative costs are. This one of the important activities that an entrepreneur undertakes. Second once you have made your decision you put it to the test by actually producing and the market will tell you, via profits or losses, whether your judgement was right. As to the resources wasted in companies, the waste may be more apparent than real but the really important question is one about relative waste. Companies may waste resources but to survive they just have to waste less than the alternative. That is, they just have to be more efficient than either another firm or a market transaction.

The other point I found strange was this:

Typically, economic theory defines a firm in terms of its production function.

Well no.

Ever since the aforementioned Coase (1937) paper the whole point of the theory of the firm is that a firm isn't just a production function. To see a firm as a production function is to suffer from what Oliver Williamson calls "technological determinism", that is, technology is assumed to be uniquely determinative of economic organization. As Williamson (1993: 4) has noted the boundaries of the firm is an issue of

[ . . . ] make-or-buy. What is it that determines which transactions are executed how? That posed a deep puzzle for which the firm-as-production function approach had little to contribute.

As Oliver Hart points out

[t]o put it in stark terms . . . neoclassical theory [production function theory] is consistent with there being one huge firm in the world, with every existing firm . . . being a division of this firm. It is also consistent with every plant and division of an existing firm becoming a separate and independent firm. (Hart 1995: 17).

Thus the production function tells us little about the boundaries of a firm and so the modern theory of the firm sees the firm as more than just a production function.

EconTalk this week

Steve Fazzari of Washington University in St. Louis talks with EconTalk host Russ Roberts about the economics of Keynesian stimulus. They discuss the stimulus package passed in February 2009 and whether it improved the economy and created jobs. How should claims about its impact be evaluated? What can we know as economists about causal relationships in a complex world? The conversation includes a discussion of the underlying logic of Keynesian stimulus and the effect of the financial crisis on economic research and teaching.

Phillipson on Adam Smith

In this Cato Institute book forum Nicholas Phillipson, Honorary Research Fellow in History, University of Edinburgh, talks about his book Adam Smith: An Enlightened Life. Comment are made by James R. Otteson, Professor of Philosophy and Economics, Yeshiva University, Charles G. Koch Senior Fellow, The Fund for American Studies. The discussion is moderated by John Samples, Director, Center for Representative Government, Cato Institute.

Greg Mankiw's reflections on graduate education

At his blog Mankiw offers his comments on the paper “Completion Rates and Time-to-Degree in Economics PhD Programs” by Wendy A Stock, John J. Siegfried, and T. Aldrich Finegan.

Mankiw writes

This paper is a contribution to an important line of work. As economists, we often remind policymakers that their decisions should be based on objective, empirical research rather than uninformed supposition. Yet when we are the decision makers, as we are when we run our own educational programs, we often have little data-driven analysis on which to base on our judgments. This kind of research should, over time, lead to a better educational system.

I would like to take note of two facts highlighted in this study and to tentatively discuss what they might mean. The first fact is that it is taking longer for students to earn their PhDs in economics. The second fact is that a sizeable percentage of students who start PhD programs do not finish.

It is tempting to interpret these facts as a sign of educational failure. After all, students enter these graduate programs to earn a PhD. If the successful ones are taking longer to finish, and many others are not getting their degrees at all, then it might seem that we are doing something wrong.

But it is far from obvious that these facts are symptoms of a problem. Perhaps longer times to completion and some amount of dropping out are optimal.

Consider time to completion. There is no doubt that economics is still a young science and there is much we do not know. But there is also no doubt that research is continually adding to our stock of knowledge. Perhaps students are taking longer to earn PhDs because there is more for them to learn. It may well be optimal to spend six rather than five years in graduate school before our profession releases students into the world with our highest level of certification.

Another relevant fact is that most students, when they get their first academic jobs, end up at colleges and universities with lower ranked departments than where they earned their PhDs. Why hurry the process of moving to a less vibrant intellectual environment? It may well be better for the professional development of the candidate to spend an extra year or so in graduate school.

Consider now the fact that many students drop out of graduate school without a PhD in hand. While many of these students are disappointed by this outcome, it is likely that in many cases their choice to drop out is optimal. They entered graduate school without fully knowing what it was like and whether it was a good match for them. After a couple of years, they decided it wasn’t. In light of the inherent uncertainty when choosing a path in life, a bit of experimentation is desirable.

My own life is a case in point. When I left college, I was unsure what career path I wanted to take. I therefore enrolled in two graduate programs—the PhD program in economics at MIT and the law program at Harvard Law School—thinking I might finish both. In the end, however, I dropped out of law school after three semesters. Looking back, the decisions to enter and drop out of law school were the right choices. I started because I thought a legal career might be best path for me, and I stopped when I learned it wasn’t.

The question we face as designers of educational programs is how to structure them in light of the longer times that PhDs take and the fact that some students who start these programs may rationally choose not to complete them. The answer may be to divide current PhD programs into two chunks. The first chunk would be a two-year master’s degree focused on taking advanced courses. The second chunk—appropriate for only a subset of master’s students—would be a research degree culminating in the PhD.

Many programs in effect already do that. But the master’s degree is too often viewed as a consolation prize for a PhD dropout. Perhaps we should instead encourage people to view the master’s degree in economics as a fully respectable terminal degree. Moreover, having finished a master’s degree, PhD candidates would be treated as professionals—more like the most junior faculty and less like the most senior students.

Many students leave college wanting to learn a bit more economics. But a PhD may be more than they want or need for their careers. An expansion of master’s programs in U.S. economics departments may offer many students the stepping stone they need.

The fact that it is taking longer for students to earn their PhDs in economics and that a sizeable percentage of students who start PhD programs do not finish are interesting results and I wonder how New Zealand compares to the US in this regard. One explanation for both results would be that the student entering economics PhD program just aren't as good as those students entering other programs, but this should be easy to check.

I do like Mankiw's idea that

The answer may be to divide current PhD programs into two chunks. The first chunk would be a two-year master’s degree focused on taking advanced courses. The second chunk—appropriate for only a subset of master’s students—would be a research degree culminating in the PhD.

The research "chunk" is not needed for many jobs that economists do, so why make students do it? A, say, Master of Economics degree which covers the two years of graduate papers would be attractive and useful for many students who want to work as economists but do not want to be researchers themselves. I'm sure there is market niche here.

Somethings never change

In this book “Adam Smith” (well worth a read) Gavin Kennedy writes

His [Smith's] criticism highlights his common theme about the eighteenth-century Europe: special-interested groups sought political and legal powers to enhance their interests at the expense of the public. Self-interest is not always benign.

I had two thoughts on reading this. First, how does the 18th century Europe differ from any other time or place? Public choice theory, I would think, tells that using political power to enhance ones own interests is the story of all centuries and all places. It would as true today (and tomorrow) as it was in Adam Smith’s time. Second, self-interest is benign, as I’m sure Smith would tell us, in the right institutional framework. In particular competition is the enemy of market power and having government limited to a few key roles so that it cannot provide protection for those who wish to prevent the forces of competition and economic change from undermining their position of privilege is also necessary.

Otteson on Adam Smith

In this brief (around ten minutes) podcast, from the Cato Institute, noted Adam Smith scholar James R.Otteson talks about on Adam Smith as a moral philosopher.

Worth a listen.

I'm all for the division of labour but ......

This is from Physical Review Letters 105, 252303 (2010).

Title: Observation of a Centrality-Dependent Dijet Asymmetry in Lead-Lead Collisions at √sNN=2.76  TeV with the ATLAS Detector at the LHC

Abstract: By using the ATLAS detector, observations have been made of a centrality-dependent dijet asymmetry in the collisions of lead ions at the Large Hadron Collider. In a sample of lead-lead events with a per-nucleon center of mass energy of 2.76 TeV, selected with a minimum bias trigger, jets are reconstructed in fine-grained, longitudinally segmented electromagnetic and hadronic calorimeters. The transverse energies of dijets in opposite hemispheres are observed to become systematically more unbalanced with increasing event centrality leading to a large number of events which contain highly asymmetric dijets. This is the first observation of an enhancement of events with such large dijet asymmetries, not observed in proton-proton collisions, which may point to an interpretation in terms of strong jet energy loss in a hot, dense medium.

Authors: Aad G, Abbott B, Abdallah J, Abdelalim AA, Abdesselam A, Abdinov O, Abi B, Abolins M, Abramowicz H, Abreu H, Acerbi E, Acharya BS, Ackers M, Adams DL, Addy TN, Adelman J, Aderholz M, Adomeit S, Adragna P, Adye T, Aefsky S, Aguilar-Saavedra JA, Aharrouche M, Ahlen SP, Ahles F, Ahmad A, Ahsan M, Aielli G, Akdogan T, Akesson TP, Akimoto G, Akimov AV, Alam MS, Alam MA, Albrand S, Aleksa M, Aleksandrov IN, Aleppo M, Alessandria F, Alexa C, Alexander G, Alexandre G, Alexopoulos T, Alhroob M, Aliev M, Alimonti G, Alison J, Aliyev M, Allport PP, Allwood-Spiers SE, Almond J, Aloisio A, Alon R, Alonso A, Alonso J, Alviggi MG, Amako K, Amaral P, Amelung C, Ammosov VV, Amorim A, Amorós G, Amram N, Anastopoulos C, Andeen T, Anders CF, Anderson KJ, Andreazza A, Andrei V, Andrieux ML, Anduaga XS, Angerami A, Anghinolfi F, Anjos N, Annovi A, Antonaki A, Antonelli M, Antonelli S, Antos J, Anulli F, Aoun S, Aperio Bella L, Apolle R, Arabidze G, Aracena I, Arai Y, Arce AT, Archambault JP, Arfaoui S, Arguin JF, Arik E, Arik M, Armbruster AJ, Arms KE, Armstrong SR, Arnaez O, Arnault C, Artamonov A, Artoni G, Arutinov D, Asai S, Silva J, Asfandiyarov R, Ask S, Asman B, Asquith L, Assamagan K, Astbury A, Astvatsatourov A, Atoian G, Aubert B, Auerbach B, Auge E, Augsten K, Aurousseau M, Austin N, Avramidou R, Axen D, Ay C, Azuelos G, Azuma Y, Baak MA, Baccaglioni G, Bacci C, Bach AM, Bachacou H, Bachas K, Bachy G, Backes M, Badescu E, Bagnaia P, Bahinipati S, Bai Y, Bailey DC, Bain T, Baines JT, Baker OK, Baker S, Baltasar Dos Santos Pedrosa F, Banas E, Banerjee P, Banerjee S, Banfi D, Bangert A, Bansal V, Bansil HS, Barak L, Baranov SP, Barashkou A, Barbaro Galtieri A, Barber T, Barberio EL, Barberis D, Barbero M, Bardin DY, Barillari T, Barisonzi M, Barklow T, Barlow N, Barnett BM, Barnett RM, Baroncelli A, Barr AJ, Barreiro F, Barreiro Guimarães da Costa J, Barrillon P, Bartoldus R, Barton AE, Bartsch D, Bates RL, Batkova L, Batley JR, Battaglia A, Battistin M, Battistoni 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(HT: Marginal Revolution)

Partial privatisation

Over at his blog Roger Kerr discuses privatisation and partial privatisation in particular. He notes a point made by Phil Barry

... partial privatisation has significant disadvantages compared with full privatisation. Ownership of partially privatised companies is often widely held (outside the government’s stake) and control is not readily contestable; private investors have limited incentive to monitor the company, relying instead on the ‘deep pockets’ of the government to bail out the company if it gets into difficulty; and the company remains open to political interference. Further, governments, as owners, may be unable to agree for long as to why they own the company, thus making it difficult for the company to develop and implement a strategic direction.

The empirical evidence supports the view that partial privatisation is not a desirable long-run state. Most studies indicate that there is no lasting difference between the performance of fully state-owned and partially state-owned enterprises: that is, that full private control is necessary to achieve sustained performance gains.

The kinds of problems that mixed ownership can bring can been seen from the New Zealand experience with the SOEs. While many are not in actual mixed ownership, the pressures that such ownership can bring about can, nevertheless, be seen in our recent history with the SOEs.

The SOE Act states that SOEs, basically, have to be run like normal non-government owned firms. In effect this requirement is the same as you could get if private owners have a stake in a firm. The private owners would, we assume, wish to maximise profits, but the government may not. And you see this with SOEs. The government often wishes to intervene in the running of SOEs to get them to carry out not profit maximising activities, just as it would if it had a partial stake in a mixed ownership firm. This problem of having SOEs (or mixed ownership firms) trying to serve two masters was noted more than 10 years ago by Spicer, Emanuel and Powell in their book "Transforming Government Enterprises: Managing Radical Organisational Change in Deregulated Environments" (The Centre for Independent Studies, 1996). They warned that there are two pressures on SOE's: the first being towards privatisation since the productivity and efficiency gains achieved by SOE are in danger of being eroded over time. Privatisation is a way of both cementing in the commercial orientation of enterprises and wringing out further gains resulting from the high powered incentive and control mechanisms which can be bought to bear in privately owned and publicly traded companies. The second pressure on SOEs is towards being pulled back into the public sector where social and political objectives can be more readily be meet. What we saw under the Clark government was the second of these pressures being very strong. But not for socially useful reasons. Most interventions seem to be more politically motivated.

These pressures would also be there for a mixed ownership firms and help explain why they don't do as well as fully privately owned firms. For example, Aidan Vinning and Anthony Boardman in "Ownership and Performance in Competitive Environments: A Comparison of the Performance of Private, Mixed, and State-Owned Enterprises", Journal of Law and Economics vol. XXXII (April 1989) conclude 'The results provide evidence that after controlling for a wide variety of factors, large industrial MEs [mixed enterprises] and SOEs perform substantially worse than similar PCs [private corporations].' The basic problem is that partial government ownership politicises the firm. We just have to hope we don't see a move in this direction in New Zealand. Full privatisation is the better option.

Why you shouldn't talk to people in the pub

or the staff club. Today I got an email from a guy in the Psychology Department saying that I had talked to him about something in the staff club last month. He assures me that what I said seemed quite plausible at the time - to be honest this may have a lot to do with the amount we had had to drink - and did I want to work on it. And of course I do .... if only I could remember what I had been going on about!

There is a lesson here: either take carefully notes of everything you say at the pub or just don't talk to anyone!

The upside to all this is that I now have to meet the guy again at the staff club to workout what we said the last time we were there. I can see this research taking a very long time .... but being a lot of fun!

EconTalk this week

Don Boudreaux of George Mason University talks with EconTalk host Russ Roberts on some of the common misunderstandings people have about prices, money, inflation and deflation. They discuss what is harmful about inflation and deflation, the importance of expectations and the implications for interest rates and financial institutions.

Here is part of the transcript of the beginning of the interview. It makes some simple but important points about prices changes, inflation and deflation.

Intro. [Recording date: January 10, 2011.] Inflation and deflation. Let's talk about inflation, what is usually meant and what we mean as economists. You asked the right question to begin. The definitions of inflation and deflation have changed over time, and in ways that are significant. The original meaning of inflation was an increase iin the money supply. There are still a few people today who hold out for that definition. I'm much more of a spontaneous order guy when it comes to language--words mean what people take them to mean. In fact, inflation today means, to the average person here, even the typical well-informed professional economist who uses it, not an increase in the money supply, but a sustained increase in the general price level--a sustained increase in average prices. But it's important to remember what inflation originally meant, because there's a connection of course between changes in the money supply and changes in the price level. Similarly with deflation. Deflation originally meant a decrease in the supply of circulating medium, and now it means a general decrease in the price level. Let's start with one of the common confusions. Much of the confusion about these two topics of inflation and deflation--really one topic, the average level of prices and their movements--one of the sources of confusion is how the media writes about it. Want to talk about two issues. One is they'll often talk about inflation in one price or deflation in one price. Generally, economists are very careful to distinguish between inflation--which is the average level of prices going up--as opposed to one particular price going up. That's one important confusion; think comes from misuse of the word "inflation" in the media. The other, which is related, is the media often reports, and the government sometimes collects--or always collects, I don't know--the core level of inflation, where they'll exclude certain goods. I think the core level is the level of inflation not including energy prices and food, say. Yeah, I've never understood that. It's a meaningless concept. And yet, it's commonly used. Why is it a meaningless concept? First, let's talk about the first issue--the difference between changes in the average level of prices, general level of prices, and changes in individual prices. It is important to distinguish between changes in individual prices--changes in one price relative to the price of something else--and changes in the price level. The concept to keep our eye on is--we have to ask why does the price change? Inflation becomes salient, becomes a meaningful and interesting concept to study when we recognize that prices are changing not because of any changes in real resource constraints, real consumer demands in the economy, real shifts in consumers' preferences for savings as opposed to consumption--but changes simply caused by exogenous increases in the supply of money. That is inflation. You are correct--a lot of the time people use the term "inflation" quite mistakenly to talk about individual price increases: "The price of gasoline is inflating." Or: "There's been a lot of inflation in the energy sector this year." That's quite confusing and nonsensical talk. If what is meant by "There's been a lot of inflation in the energy sector this year" simply means that the price of energy has risen relative to other goods, all that means is that the supply of energy resources has fallen and/or the demand for those resources to increase, which of course causes their relative price to increase--and their relative price should increase to reflect those underlying real changes in the economy. There's nothing about changes in the money supply that we would expect to show up exclusively in the energy sector, or any other individual sector for that matter. Similarly, the idea that they could somehow on their own ripple through the economy and cause inflation in the absence of a monetary change is unlikely and not really economics, the way you and I were taught it. Underlying what we are going to talk about today is the Milton Friedman sentence that "Inflation is everywhere and always a monetary phenomenon." It used to be people had many theories as to why the average level of prices would increase or decrease. It may be one of the few if not the only area of economics where decisive empirical evidence established a theory that virtually all economists--mainstream and out-of-the-mainstream--accept. In the 1960s there was an idea of wage-push or cost-push, even into the 1970s--this idea that unions could push up the price of labor and since labor is in every commodity. What the monetarists responded was--well, some prices will go up more than others because of their labor component, but sectors that are not unionized would then have decreases in prices in the absence of a monetary change. Just to take another example from the news, I think you often hear people say: What's all this talk of inflation? TVs are getting cheaper! TVs and other electronic goods--there's so much technological improvement in the production of those goods that their relative price has fallen dramatically. Had there not been inflation, it would have fallen even more. The nominal price would have fallen even more. If the average price level had been unchanging--if there had been no inflation over the last 25 years--then the goods that had the most technological increases would have even bigger nominal--meaning the dollar amount that we actually see that is not corrected for any kind of inflation, the actual number written on the price tag in America, say--would be even lower. But if there's inflation--if the money supply had increased enough over the last 25 years--you could have TVs and other goods getting more expensive in nominal terms--that is, the price written--but relative to other things getting dramatically cheaper, which they have, because of the technological changes. That concept is very tricky. Hard for people not used to thinking that way to see it. The real changes you are talking about get tangled up with these overall changes in prices as a whole because of changes in the money supply.

Bureaucracy to drive Adam Smith mad

Bill Jamieson writes in The Scotsman of 16 January on the plight of Panmure House:

LIKE so many dreams that turn to nightmares, it seemed a good idea at the time. Three years ago this spring, the Edinburgh Business School offshoot of Heriot-Watt University appeared to have pulled off a coup.

It won a bid to buy the house, just off Edinburgh's Royal Mile, where Adam Smith spent his last years. Panmure House in the Canongate, close by the churchyard where the philosopher is buried, had fallen on bad times. Edinburgh City Council was glad to be shot of it – and the contingent costs of saving it from its dilapidated state.

Panmure House and its heritage is one of Scotland's treasures, and its neglect a national scandal. This was not just a home to one of Scotland's greatest thinkers and philosophers. It was the epicentre of the Scottish Enlightenment. Smith's dinner guests at Panmure House on Sunday evenings included Adam Ferguson, widely regarded as a pioneer of sociology; William Robertson, Principal of Edinburgh University and Moderator of the Church of Scotland; Joseph Black, a chemist who discovered Latent Heat; Edmund Burke, philosopher and politician; John Hume, playwright and brother of Smith's famous friend, the moral philosopher and historian, David; John Adams, architect and designer of splendid Georgian buildings in Edinburgh, and John Playfair, Professor of Mathematics at Edinburgh.

Here was an opportunity for an ambitious restoration befitting the greatest contributor to the Scottish Enlightenment, one that would bring the building back to life as a research and meeting centre.

Heriot-Watt, which paid £800,000, quickly saw that here was a building that could be used, not just displayed, that would be a centre for debate and discussion, not just a storage archive. And that absolutely suited the council's stipulation that the building be used for educational purposes.

The intervention was widely hailed in Scotland. And news travelled fast round the academic world. The American Economics Association expressed keen interest. Before long, Heriot-Watt had attracted offers of help towards refurbishment totalling a potential £3 million. Here at last, not only would the author of The Wealth of Nations be properly honoured, but the university would also have a research centre and seminar facility in the heart of the capital that would attract visitors from across the world.

Today, almost three years later, not a brick has been laid or even a path cleared. Panmure House remains padlocked and abandoned. The best-laid plans have come to nothing. And Heriot-Watt is now staring into a financial black hole. Panmure House is on the brink of turning into a doomed and disastrously expensive foray into heritage bureaucracy. The fate of the project – delayed by obstacles, clashes and delays – now hangs precariously on the outcome of a public inquiry on 3 March.

How has it come to this? It is an irony that Adam Smith himself would have appreciated, that a gesture to rescue and revive a building abandoned and forgotten for years has suddenly attracted health and safety, heritage and aesthetic interventions bringing delay and despair. Heriot-Watt, says Sir Alan Peacock, economics guru and co-author with Gavin Kennedy, Emeritus Professor at the Edinburgh Business School of a paper on the cultural importance of Panmure House, "has been put through all the hoops".

Barely had the university begun considering outline plans for refurbishment and renewal than building inspectors insisted on appropriate facilities for disabled access. Heriot-Watt's architects EK:JN duly obliged. By March 2009 they presented plans for a new octagonal stair tower and a turret, offering disabled access, modelled on Ford House in Midlothian.

Enter Historic Scotland. It made a site visit and immediately wrote to the city council expressing "strong concerns" over the plans. EK:JN then submitted further proposals in July of that year for the extension of the building. This featured a glass atrium extension to enable it to be used as a meeting place with lecture facilities, in compliance with the council's stipulation. This, as Keith Lumsden, director of the Edinburgh Business School at Heriot-Watt explained, fulfilled both functional requirements and opening up the original stonework to view.

Historic Scotland again objected. Steven Robb, senior inspector of historic buildings, wrote that the atrium and stair would affect the character and special interest of the building "to an unacceptable degree". The plan, he said, would alter the entrance elevation, adding that an external stair was not essential to its reuse. These concerns were repeated in a further letter by Historic Scotland to the council in August of that year. But these objections, Lumsden argued, would make it impossible to develop the house as a seminar centre and meeting place with all the facilities that would be required.

Six months later, in March 2010, Heriot-Watt's plans were formally considered by the city council. Its planning department had recommended refusal. But the planning committee overturned this after a site visit, voting decisively 11 to one in favour.

Barely had the applicants time to celebrate this progress than on 13 August Scottish ministers called in the proposals for examination. Heriot-Watt, sensing that this would prove not the beginning of the end but the end of the beginning, demanded a public inquiry. It believes it has a cast-iron case and a compelling proposal that would bring the crumbling Panmure House back to life, providing an academic magnet at the heart of the city.

What lies at the heart of Historic Scotland's objections? Is it being over fussy, or are there valid concerns? Panmure House was built between 1691 and 1693 by Lt Col George Murray, who sold it in 1696 to James Maule, 4th Earl of Panmure. It passed to the Earl of Dalhousie, a relation. Adam Smith rented the building from 1778 until his death in 1790. It was a two-storey building with basement and attic. A rental agreement of 1753 describes it as having a large dining room and drawing room (ground floor), three good bedchambers with closets and conveniences on the same floor and a basement kitchen below.

As a building it has since been through the wars and there is little now that has survived the time of Smith's occupancy. In the 1840s the northern wing was removed. When the area became industrialised, the grounds were occupied by the Panmure Iron Foundry. By the 1950s the building, according to a Historic Scotland summary, "was ruinous, vandalised and only stone stubs of the internal stair remained." In the mid 1950s the architect John Wilson Paterson converted it for use as a home for delinquent boys, the floors at ground and first floor having already disappeared.

In 1970 the building was Category A listed.

Historic Scotland's concerns are not without merit. This is a rare example of a 17th-century town house within the historic Old Town. The original stone structure presents a sturdy frame. But virtually everything that was within at the time of Smith's occupancy has long gone. It was abandoned, then made over in the 1950s, then abandoned again. What's left is less artefact than association. The case for preservation cannot rest on architectural merit: the building has been internally gutted. So how much of this objection is on heritage grounds – and how much on aesthetics?

The surrounding built environment is very mixed and cannot be said to hold to a particular style or vernacular. The building is shielded from the Canongate by a circa-1930 tenement block providing undistinguished, if not grim, "infill" development. There are also some tenements by Sir Basil Spence, an acquired enthusiasm for many. As Panmure House is not visible from the Canongate, its appearance does not bear on the thrilling Hanseatic style of the Royal Mile as one looks up towards St Giles. As for looking down to Holyrood, there is of course the Scottish Parliament: a building that will forever struggle to avoid that most searing thunderball of condemnation in the entire Edinburgh lexicon of put-down: "inappropriate".

There is the gem of a charming little garden nearby in Dunbar Close, laid out in the formal 17th-century style by Seamus Filor in 1976, but barely known or visited. A refurbished Panmure House would bring fresh interest.

Historic Scotland does have an important role to ensure that as much as possible of the original building is preserved. But specifying what should constitute "re-use" is surely not in its bailiwick. And the dismissal of the disabled-access turret smacks of subjective judgement.

The key point here surely is that this is a historic building transferred on the understanding that it would be used for educational purposes. It has to cater for events and meetings and not just be an archival museum. Heriot-Watt paid £800,000 in good faith and has mustered funds to meet that obligation. What it has submitted is no golden arches McDonald's restaurant or a sprawling and distraught Catalan indulgence, but a refurbishment and extension that serves functionality while opening up the building to wonder and inspection. It has stepped up to provide an immense enrichment to the legacy of Adam Smith where a neglected structure now stands. And it would be an inspiring addition to the city's cultural meeting points that would draw international attention. But the fate of the entire project now dangles at the end of a planning inquiry. The Wealth of Nations offers no guidance on the conduct and function of such inquiries. But I suspect the author would have looked on this three-year episode at the heart of Scotland's capital city – and wept.

If the bureaucracy in Scotland is anything to go by it seems the Scottish Enlightenment is well and truly over! :-(

(HT: Gavin Kennedy)