Saturday 30 June 2012

Things to not criticise economics about

At the Unlearning Economics blog some advice is given on How Not to Criticise Economics. The advice is don't,
Criticising early assumptions

Don’t get me wrong, criticising economist’s perversion of the use of assumptions is fair game. However, critics often go down the path of criticising ’pure rationality’ or ‘perfect information.’ Whilst these are elements of core models (and these models should be attacked because of this, but with the caveat that the core models are the target), they are generally not found in the higher echelons of economics. Many of these assume imperfect information, bounded rationality, and can also incorporate other biases.

Most specifically, idea that economic theory assumes everybody is a selfish, emotionless self-maximiser is common trope, but as Chris Dillow noted in the link above, it’s not entirely true. More importantly, it is also defensible as an assumption – a heuristic by which to approximate behaviour, at least until something better comes along. It is important to distinguish between good and bad assumptions from a scientific standpoint, rather than how absurd they appear to be at first glance.


Many critics of economics, including well-informed ones, make the mistake of arguing that economics always assumes the economy is in equilibrium, tending to equilibrium, oscillating closely around equilibrium, or something along these lines. It is true that many economic models do this; it is also true that economic models start from the assumption that the economy is in equilibrium, and see what happens from there. However, economists generally mean something very different to other scientists when they say equilibrium. From the horse’s mouth:
An equilibrium in an economic model is characterized by two basic conditions which hold in all of the model’s time periods: i) all agents in the model solve the maximization problems implied by their preferences, resource constraints, information sets, etc; and ii) markets for all goods in the model “clear.” An equilibrium is not a snapshot of the model economy at one point in time. Instead, it is the model’s entire time path.
Even on first inspection, this type of equilibrium clearly has problems of its own, but I will save them for another post. The important thing to remember is that this, rather than a stable state, is what economists often mean when they talk about equilibrium.

Economist’s Political Beliefs

Economists are not all free marketeers – in fact, they generally lean to the left. Neoclassical economics, broadly speaking, concludes that we should: regulate oligopolies, monopolies and banking; do more to protect the environment and intervene in the case of other externalities; have some public provision of health, education and welfare; and as that survey shows, economists are generally approving of things such as safety regulations.

As I have said before, I think economic theory as taught lends itself to being used by free marketeers, because of the way the ‘market’ is presented as natural and the government ‘intervenes.’ I also object to the fact that economics applies the same analysis to every market from apples to education to labour. And it is true that the market is presented as generally equilibrating and efficient, except in a few choice cases. However, the impact of these things is not that all economists support ‘right wing’ policy prescriptions, but that neoclassical theory can generally be coopted to provide justification for them.
My only comment would be with the political beliefs comment. There is nothing in neoclassical economics which is "right wing", as it is put. In fact what caused the break between the Austrian school and the neoclassical school was the use by the socialists during the socialist calculation debate of the neoclassical model (standard GE) to argue that market socialism would work. Put simply they replaced the auctioneer with the central planner and showed that everything worked very nicely. Thus the neoclassical model looks very left wing,

Will our anti-economics friends at The Standard take the advice?

Friday 29 June 2012

Maximisation v. morality

At the Stumbling and Mumbling blog Chris Dillow asks,
What is, or should be, the link between morality and narrow economic rationality?
which in turn causes him to ask a second question,
should maximizing behaviour really be tempered by considerations of morality?
His answer begins,
In many cases, the answer is clearly yes, because there is in fact no trade-off between rational maximization and moral conduct.As Deirdre McCloskey has argued, "bourgeois virtues" of prudence and temperance enrich both individuals and societies. Trustworthiness is one way of overcoming the problem of asymmetric information which can cause markets to fail to develop.
But could you ask in this case, Are you in fact being moral or just rational? If being moral is a purposeful act then is acting in this way moral? Morally seems to be externality here.

Dillow continues,
In other cases, though,there is a sharp trade-off between morality and economic maximization.

This is most clear in the euro. The moral belief that reckless debtors and lenders must suffer ther consequences of their imprudence is perhaps the biggest obstacle to a resolution of the debt crisis.

But it's also true in other areas. For example, social solidarity and fellow-feeling can retard growth by encouraging the emergence of "Olson groups" who lobby for special favours.

And one might argue that the trade-off also exists in the cases I started with:

- The same sort of desire to follow rules that would have prevented Barclays from manipulating Libor can also inhibit innovation. One feature of genuine entrepreneurship is the desire to reject established ways of doing things. A society in which people followed unwritten rules would have fewer Libor manipulators - but also fewer good entrepreneurs.

- Greater tax morale would encourage governments to spend more, not necessarily on useful projects.

- A stronger work ethic would make the unemployed even more unhappy.
So what we see here is that having a stronger moral code may make us worse off in economic terms. Thus there is a trade-off between morality and economic well being, something that those who argue for economic agents to act in a moral way should keep in mind.

Steven Horwitz: "Do We Really Need a Central Bank?"

As we have just had a new Governor of the Reserve Bank appointed, perhaps it is timely to ask this question.

Steven Horwitz gave this lecture entitled "Do We Really Need a Central Bank?" at the Future of Freedom Foundation's Economic Liberty Lecture Series at George Mason University on December 2, 2009.

Thursday 28 June 2012

The ‘good-citizen’ economist

As the NZAE meetings are on right now I would hope that one issue being discussed is how can we be, what Donald J. Boudreaux calls, The ‘good-citizen’ economist?

Boudreaux's answer involves attempts to chip away at the Everest-sized mountain of "man-in-the-street" myths that wildly distort the public's understanding of the workings of the economy. Chief among these myths is the notion that the key to economic prosperity lies not in attending chiefly to the long-run interests of consumers but, rather, in attending to the short-run interests of producers – the false notion that the ultimate point of consumption is to stimulate production rather than the understanding that the ultimate justification for production lies only in the consumption it makes possible. This myth is made especially pernicious because it is so politically convenient for office-holders and seekers.

Notice that economists have for a long time have been battling this myth. Adam Smith pointed out more than 240 years ago that "Consumption is the sole end and purpose of all production" and that the measure of a country's true wealth, is the total of its production and commerce. That is, a country's wealth is what the people of that country can consume. The great 19th century French economic pamphleteer Frédéric Bastiat wrote, "Consumption is the end, the final cause, of all economic phenomena, and it is consequently in consumption that their ultimate and definitive justification is to be found."

Here'e hoping that those at the NZAE meeting are "good-citizen economists". I have my doubts about some of them :-(.

Sale of the century ...... not

From Stuff comes the news that
The Government has written down the value of KiwiRail's land and network assets from $13.4 billion to $6.7b and converted $322.5m of debt to equity in a major restructuring of the state-owned rail company.

The change will hit the Budget deficit adding another $1.8b of red ink to the expected operating balance which on Budget day was forecast to be $10.6b deficit for the year to June 30.
Michael Cullen thought the buying back of KiwiRail was the Sale of the Century and I'm thinking it was, for the seller. But Cullen was spending other people's money so he really didn't care what price was paid.

The report continues,
They said the Government was committed to ensuring KiwiRail could fund its business on a commercial basis.
Good luck with that! Just what bits of KiwiRail are commercial viable? It will be intersting to find out.

Another interesting question is, Will KiwiRail become part of the government's (partial or full) privatisation plans? I guess that Labour and the Green have nothing to fear from this since I can't see that anyone would ever want to buy KiwiRail.

Wednesday 27 June 2012

The past and present of the invisible-hand proposition

There is always much discussion of what Adam Smith meant or said about this or that. One of the most discussed ideas is the "invisible hand". (Take a look at Gavin Kennedy's blog for extended discussion.) A new working paper looks at The Past and Present of the Invisible-Hand Proposition: From 'Scottish Political Economy' to Axiomatic General Equilibrium Analysis. It is by Arash Molavi Vasséi. The abstract reads,
The present study raises the following questions: To what extent is axiomatic general equilibrium analysis a rational reconstruction of Scottish Political Economy as defined by the writings of David Hume and Adam Smith? How much is gained and how much lost by the axiomatic transformation of the invisible-hand proposition? What are the implications of negative results like the Sonnenschein-Mantel-Debreu demonstrations for the Scottish point of view? Did it reach deadlock, or is there still hope for the dominant trajectory in the history of economics? In contrast to the rich historical literature on the invisible-hand proposition, the present study does not level any paradigmatic criticism at neo-Walrasian analysis. Rather, by focalizing the most important results against the backdrop of Scottish Political Economy, it provides some flesh to the bones of axiomatic economics and, insofar, may inform theory choice within the neo-Walrasian paradigm. Naturally, the answers to the questions raised are complex and do not fit into an abstract. Instead, the reader is referred to the final section, which lists, interrelates, and discusses the major results of the study.
I'm not sure that Smith would have believed in any invisible-hand proposition so I'm not sure that its even meaningful to ask what is "lost by the axiomatic transformation of the invisible-hand proposition?" In a working paper of my own I write,
For Smith competitive markets were the most prominent mechanism for coordinating and motivating people to maximise the grains that result from increased specialisation and an expanded division of labour. Well functioning market institutions leave individuals free to pursue self-interested behaviour, but guide their choices by the prices they pay and receive. For economists, the 200 years following Smith involved a search for conditions under which the price system would function well, conditions under which it would not descend into chaos.

The formal (neoclassical) model that arose from this search is one which abstracts completely from any form of centralised control in the economy.
But I add the footnote,
For Adam Smith this would be an abstraction too far. Smith knew of the importance of institutions to the proper functioning of the market economy. Mark Blaug points out that “[ . . . ] Smith’s faith in the benefits of ‘the invisible hand’ has absolutely nothing whatever to do with allocative efficiency in circumstances where competition is perfect `a la Walras and Pareto; the effort in modern textbooks to enlist Adam Smith in support of what is now known as the ‘fundamental theorems of welfare economics’ is a historical travesty of major proportions. For one thing, Smith’s conception of competition was, as we have seen, a process conception, not an end-state conception. For another society, a decentralised competitive price system was held to be desirable because of its dynamic effects in widening the scope of the market and extending the advantages of the division of labour - in short, because it was a powerful engine for promoting the accumulation of capital and the growth of income”. (Blaug 1996: 60-1).
Thus the question "[t]o what extent is axiomatic general equilibrium analysis a rational reconstruction of Scottish Political Economy as defined by the writings of David Hume and Adam Smith?" would have the answer, very little.

Tuesday 26 June 2012

Stand your ground laws and homicides

Earlier I posted on a paper that asked Does Strengthening Self-Defense Law Deter Crime or Escalate Violence? Evidence from Castle Doctrine. At the end of that posting I said,
One thing that is interesting is that they don't seem able to deal with the issue as to whether the increase in deaths is due to an "increased use of lethal force in self-defense situations, or the escalation of violence in otherwise non-lethal situations". I take it this to mean that they can't tell whether more attackers are being killed by would-be victims or if the level of violence is being forced up in general. And I would think that for many people that difference is important. In the first case fewer victims are being killed while in the second more victims are dying.
Now a new NBER working paper claims that the increase in killing is unlikely to be driven entirely by the killings of assailants. The paper is Stand Your Ground Laws and Homicides by Chandler B. McClellan and Erdal Tekin. The abstract reads,
Since 2005, eighteen states have passed legislation that has extended the right to self-defense, with no duty to retreat, to places a person has a legal right to be, and several other states are debating to introduce similar legislation. The controversies surrounding these laws have captured the nation's attention recently. Despite significant implications that they may have on public safety, there has been little empirical investigation of the impact of these laws on crime and victimization. In this paper, we examine how Stand Your Ground laws that extend the right to self-defense to areas outside the home affect homicides using monthly data from the U.S. Vital Statistics. We identify the impact of these laws by exploiting the variation in the effective date of these laws across states. Our results indicate that Stand Your Ground laws are associated with a significant increase in the number of homicides among whites, especially white males. According to our estimates, between 4.39 and 7.44 additional white males are killed each month as a result of these laws. We find no evidence to suggest that these laws increase homicides among blacks. Our results are robust to a number of specifications and unlikely to be driven entirely by the killings of assailants. Taken together, our findings raise serious doubts against the argument that Stand Your Ground laws make America safer.
An interesting question is why there in an increase in killings among whites but not blacks.

Shadow economies all around the world

Ceyhun Elgin and Oguz Oztunali are two economists who have been looking at the size of black-market economies around the world. Using a dataset with 7,395 observations for 161 countries from 1950 to 2009, they're looking into how the size of black markets differs in rich and poor countries.

Their estimate of the (mean) size of the shadow economies is 22.67 percent of world GDP.  Elgin and Oztunali  note a downward trend in the size of the black markets around the world.
For almost all country groups (except for the post-Socialist one), we observe a declining trend over time. However, the pace of the reduction seems to lose some momntum in the last decade. Somewhat more interestingly, we observe a spike staring in 2007. Considering the emergence of the global economic crisis, this could give further support for the hypothesis that the size of the shadow economy is countercyclical [ ... ].
Another, not too surprising, result Elgin and Oztunali find is that Latin American and sub-Saharan economies have significantly larger shadow economies than the other groups of countries, while the OECD-EU group has a significantly smaller shadow economy.
In Figure 2, we group countries with respect to GDP per-capita and then report the average GDP-weighted shadow economy size in each group. Here, we divide the countries into five categories – poorest, second, third, fourth and the richest 20%. Not surprisingly, richer countries tend to have a smaller shadow economy; [ ... ]
How much of the Lain American black market is drugs and how much of the sub-Saharan shadow economies is related to political corruption? Related to these questions is the question of whether rich countries have smaller shadow economies or if having a smaller black market results in you being measured as being rich. Does the smaller shadow economy just mean that more economic activity is in the measured sectors of the economy, and thus you are considered as being rich, while the overall size of an economy, black plus white markets, could be similar between rich and poor countries. One wonders what the true size of some Latin American countries GDP would be if both black and white markets were measured correctly and countered.

EconTalk this week

Enrico Moretti of the University of California, Berkeley and the author of the New Geography of Jobs talks to EconTalk host Russ Roberts about the ideas in his book. Moretti traces how the economic success of cities and the workers who live there depends on the education of those workers. Moretti argues that there are spillover effects from educated workers--increased in jobs and wages in the city. He uses changes in the fortunes of Seattle and Albuquerque over the last three decades as an example of how small changes can affect the path of economic development and suggests a strong role for serendipity in determining which cities become hubs for high-tech innovation. The conversation concludes with Moretti making the case for increasing investments in education and research and development.

Monday 25 June 2012

How to lower productivity and employment

From the New York Times
BRUSSELS — For most Europeans, almost nothing is more prized than their four to six weeks of guaranteed annual vacation leave. But it was not clear just how sacrosanct that time off was until Thursday, when Europe’s highest court ruled that workers who happened to get sick on vacation were legally entitled to take another [paid] vacation.
If you want to raise the costs of employing people this looks like a good way of doing it. Such a ruling  doesn't give much of an incentive to an employer to want to employ anyone and if he does employ someone they could be a way from work for even more weeks that he thought. Not having workers actually at work doesn't improve productivity.

The Times article goes on to make the point,
With much of Europe mired in recession, governments struggling to reduce budget deficits and officials trying to combat high unemployment, the ruling is a reminder of just how hard it is to shake up long-established and legally protected labor practices that make it hard to put more people to work and revive sinking economies.

But what about prices?

From the McKinsey Global Institute.
The McKinsey Global Institute (MGI) finds these trends gathering force and spreading to China and other developing economies, as the global labor force approaches 3.5 billion in 2030. Based on current trends in population, education, and labor demand, the report projects that by 2020 the global economy could face the following hurdles:

  • 38 million to 40 million fewer workers with tertiary education (college or postgraduate degrees) than employers will need, or 13 percent of the demand for such workers
  • 45 million too few workers with secondary education in developing economies, or 15 percent of the demand for such workers
  • 90 million to 95 million more low-skill workers (those without college training in advanced economies or without even secondary education in developing economies) than employers will need, or 11 percent oversupply of such workers
But what about prices? Don't prices adjust when there is a shortage or over supply? An econ 101 supply and demand diagram tell us they do. If there really is a shortage of workers with tertiary education will the wages paid to those with such education raise, thereby giving an incentive to gain tertiary qualifications? If there are too many workers with low levels of skills will their wages not drop, thereby giving an incentive to gain additional education?

Talking about changes to markets without taking into account prices does seem a little strange.

Sunday 24 June 2012

Privatising the city

Something to keep Bob Parker awake at night. From the New York Times comes this piece on Sandy Springs, Georgia.
Cities have dabbled for years with privatization, but few have taken the idea as far as Sandy Springs. Since the day it incorporated, Dec. 1, 2005, it has handed off to private enterprise just about every service that can be evaluated through metrics and inked into a contract.

To grasp how unusual this is, consider what Sandy Springs does not have. It does not have a fleet of vehicles for road repair, or a yard where the fleet is parked. It does not have long-term debt. It has no pension obligations. It does not have a city hall, for that matter, if your idea of a city hall is a building owned by the city. Sandy Springs rents.

The town does have a conventional police force and fire department, in part because the insurance premiums for a private company providing those services were deemed prohibitively high. But its 911 dispatch center is operated by a private company, iXP, with headquarters in Cranbury, N.J.
Applying for a business license? Speak to a woman with Severn Trent, a multinational company based in Coventry, England. Want to build a new deck on your house? Chat with an employee of Collaborative Consulting, based in Burlington, Mass. Need a word with people who oversee trash collection? That would be the URS Corporation, based in San Francisco.

Even the city’s court, which is in session on this May afternoon, next to the revenue division, is handled by a private company, the Jacobs Engineering Group of Pasadena, Calif. The company’s staff is in charge of all administrative work, though the judge, Lawrence Young, is essentially a legal temp, paid a flat rate of $100 an hour.
As any contract theorist will tell you one of the big problems with contracting out is a reduction in quality over time. Sandy Springs has come up with a way of dealing with this problem, at least in part:
To dissuade companies from raising prices or reducing the quality of service, the town awarded contracts to a couple of losing bidders for every winner it hired. The contracts do not come with any pay or any work — unless the winning bidder that prevailed fails to deliver. It’s a bit like the Miss America pageant anointing the runner-up as the one who will fulfill the winner’s duties if, for some reason, Miss America cannot.
Does it all work?
It does for Sandy Springs, says the city manager, John F. McDonough, who points not only to the town’s healthy balance sheet but also to high marks from residents on surveys about quality of life and quality of government services.
If only we could see such experimentation and innovation here in Christchurch. This looks at lot better than the some old `lets spend $800 million of other people's money on our pet projects' approach we are seeing.

Saturday 23 June 2012

Spending other people's money: more on stadiums

The Press reports that
A new uncovered, rectangular stadium seating 35,000 contains two of the three elements sought by Canterbury rugby bosses.

That was the sentiment from Canterbury Rugby Football Union (CRFU) chief executive Hamish Riach yesterday after news the annual-plan recommendation to go before Christchurch City councillors next week contained two things he had hoped for in a new stadium.

He said it was disappointing the recommendation was not for a covered stadium.
Hamish Riach may want a covered stadium but is he willing to pay for it? The CRFU seems to be getting excited a covered stadium but appears rather less excited about paying for it. The Union's view would carry more weight if they were saying that they are willing to spend their money rather than other people's money.

Woodward and Bernstein talk about Watergate

From Face the Nation:

A reminder of just how bad politics can be.

Economic experimentation and regulation

Obviously experimentation is important in the economy. Consumers experiment with new goods and services, they do a bit of 'learning by doing' to see if they prefer the new things compared to what they have been buying in the past. Firms experiment on many dimensions, they try out new business models, they introduce new products and services, change their organisational structures etc. This experimentation is a normal part of the 'creative destruction' that we see around us all the time.

Over at the Knowledge Problem blog Lynne Kiesling has been writing on the effects of regulation on economic experimentation.
In all industries and markets, regulatory policy affects the extent to which such economic experimentation can occur. Some regulations restrict the nature of new technologies, products, or services that can be offered to consumers (think, for example, of all of the debate over the past three years about retail financial services and the new CFPB). Some regulations either directly or indirectly affect the scale and scope of the organizational structure that firms can have. Some regulations restrict entry into the provision of specific technologies, products, or services (one example here is occupational licensing, which erects entry barriers). And some regulations do all three of these things, stifling economic experimentation in multiple dimensions.

Traditional electricity regulation restricts product and service characteristics and restricts entry, thereby reinforcing the old vertically-integrated monopoly utility organizational structure (three for three in my above taxonomy). Not surprisingly, then, this is an industry in which exogenous technological change and pervasive economic dynamism in the rest of the economy has been so slow to penetrate, because traditional cost-based regulation of vertically-integrated monopolists presents sizable barriers to economic experimentation. If Rosenberg and Greenstein and Shane and others are correct that the freedom to engage in economic experiments is one of the most significant causal factors in economic growth, the limit on economic experimentation in an industry that is so intimately connected to innovation and well-being and thriving in so many dimensions of our lives is an exceedingly costly limit that electricity regulation imposes on all of us.
The comments on the electricity market are interesting give the debate here over the partial sell-off of SOEs in that industry. Something I have heard nothing about is whether a partial change in ownership for the SOEs will be accompanied by changes to the regulatory environment. If one of the hoped for changes to be bought about by the partial sell-off of shares in the SOEs is greater innovation and experimentation then we have to ask the question, How much of the lack of experimentation and innovation now is due not to ownership but due to regulation? The partial sell-off of shares is unlikely to do much to increase experimentation since 51% of the firms will still be in government hands. May be looking at the regulatory structure the industry works under would do more to invigorate innovation than a partial ownership change.

Interesting blog bits

  1. Anna Jacobson Schwartz (November 11, 1915–June 21, 2012)
  2. Gary Becker on Controls Over consumer Choices
    New York Mayor Michael Bloomberg’s proposal to ban sugary drinks larger than 16 ounces from restaurants, street carts, movie theatres, and stadiums would seem to be a joke for hosts of late night shows were he not completely serious. Although the proposal makes little sense, and could even increase the consumption of these drinks, (see my later discussion), it does raise once again the question of how far governments should go in interfering with consumer choices?
  3. Ed Dolan on Behind the Russian Protests: Rising Economic Expectations and a Business Leader Turned Activist
    Last week saw another mass protest in Moscow, the first since Vladimir Putin has returned to the presidency and undertaken tough new measures to curb the opposition. As seen on Western TV, the demonstrations appear to be dominated by the colorful flags of monarchists, anarchists, communists, and other extremist groups, but those images are misleading.
  4. Steve Sexton on How California’s GMO Labeling Law Could Limit Your Food Choices and Hurt the Poor
    The American Medical Association resolved this week that “there is no scientific justification for special labeling of bioengineered foods.” The association has long-held that nothing about the process of recombinant DNA makes genetically engineered (GE) crop plants inherently more dangerous to the environment or to human health than the traditional crop plants that have been deliberately but slowly bred for human purposes for millennia. It is a view shared by the National Academy of Sciences, the World Health Organization, the Food and Agriculture Organization of the U.N., the European Commission, and countless other national science academies and non-governmental organizations.
  5. Eric Crampton on Tax incidence: alcohol edition
    Pop quiz: if the alcohol excise tax is charged to consumers rather than to producers, are winemakers better off?
  6. Chris Dillow on Tax-dodging: the left's problem
    Lefties love talking about tax dodging, perhaps because it's an easy way of claiming moral superiority. But in fact, it raises an embarrassing question for them, namely: why do legal tax loopholes persist?

Friday 22 June 2012

Economists reach a conclusion on subsidies for stadiums

After the comment on the economics of sports stadiums in my previous posting I was reminded of this survey paper on the topic:
Do Economists Reach a Conclusion on Subsidies for Sports Franchises, Stadiums, and Mega-Events?

by Dennis Coates and Brad R. Humphreys


This paper reviews the empirical literature assessing the effects of subsidies for professional sports franchises and facilities. The evidence reveals a great deal of consistency among economists doing research in this area. That evidence is that sports subsidies cannot be justified on the grounds of local economic development, income growth or job creation, those arguments most frequently used by subsidy advocates. The paper also relates survey evidence showing that economists in general oppose sports subsidies. In addition to reviewing the empirical literature, we describe the economic intuition that probably underlies the strong consensus among economists against sports subsidies. (Emphasis added)
May be I should send a copy of the paper to Mayor Parker.

Anna Schwartz, economist who collaborated with Friedman, dies at 96 (updated)

So reports the New York Times. The Times writes,
Anna J. Schwartz, a research economist who wrote monumental works on American financial history in collaboration with the Nobel laureate Milton Friedman while remaining largely in his shadow, died on Thursday at her home in Manhattan. She was 96.

Her death was confirmed by her daughter Naomi Pasachoff.

Mrs. Schwartz, who earned her Ph.D. in economics at the age of 48 and dispensed policy appraisals well into her 90s, was often called the “high priestess of monetarism,” upholding a school of thought that maintains that the size and turnover of the money supply largely determines the pace of inflation and economic activity.

The Friedman-Schwartz collaboration “A Monetary History of the United States, 1867-1960,” a book of nearly 900 pages published in 1963, is considered a classic. Ben S. Bernanke, the Federal Reserve chairman, called it “the leading and most persuasive explanation of the worst economic disaster in American history.”

The authors concluded that policy failures by the Fed, which largely controls the money supply, were one of the root causes of the Depression.
“Anna did all of the work, and I got most of the recognition,” Mr. Friedman said on one occasion.

After Mr. Friedman’s death in 2006, Mrs. Schwartz “became the standard-bearer” of Friedman monetarism, said Michael D. Bordo, a professor of economics at Rutgers University and for decades a Schwartz collaborator himself.

Though “not a deep theorist,” he said, Mrs. Schwartz was “probably the best woman economist of the 20th century.”

During the financial collapse that began in 2008, she was one of the few surviving economists with a firsthand recollection of the Depression. After praising early moves by Mr. Bernanke, she wrote, at age 93, a bitingly critical Op-Ed article for The New York Times in July 2009 opposing the reappointment of the Fed chairman who had been so influenced by her work.

She contended that Mr. Bernanke had erred in producing “extreme ease” in monetary policy and in failing to warn investors that new financial instruments were difficult to price.

Mrs. Schwartz also held that the government had been a bigger contributor to the crisis than had been widely realized. By her measure, the government had oversold the benefits of homeownership, pushing Fannie Mae and Freddie Mac, the government-backed mortgage finance giants, to lend increasingly to lower-income borrowers and fostering exceptionally low mortgage rates.
10 days ago it was Elinor Ostrom who died, now Anna Schwartz, its a bad run for economics.

Update: James A. Dorn at Cato@Liberty notes Anna Jacobson Schwartz (1915–2012), RIP . San Francisco Chronicle on Anna Schwartz, Economist Milton Friedman's Co-Author, Dies at 96.

Bob's wishlist

We now have Bob Parker's master-plan and wishlist for Christchurch. The graph below is from The Press and gives the big-ticket items on Bob's list.

The Press reports,
Mayor Bob Parker has unveiled his $800 million big-ticket wishlist for the new Christchurch.

He will ask councillors on Monday to sign off on his annual-plan recommendations for the city – the most ambitious of his mayoralty.

The city council's final draft of the 2012-13 annual plan will be considered on Monday, Tuesday and Wednesday next week after a long public submissions and hearings process.

It covers community facilities, infrastructure and support programmes deemed critical to the city's recovery.

Ten big-ticket items have been identified, costing $823m over the next six financial years, with most of the cost budgeted for 2013-14 onwards.

The most expensive item is a $220.7m convention centre, which would rely on a $70m government contribution.

Parker said the council's plan was "utterly unique" and a fair budget for ratepayers.
Bob may think its "fair". But there are a number of items on his wishlist that questions have to be asked about. The most obvious ones are the new AMI stadium and the new convention centre. What is the justification for these items.?As have been noted many times on the various New Zealand economics blogs, stadiums don't pay, so why are we being ask to front-up with $241.4 million for a white-elephant? I'm thinking that the economics of convention centres will be similar to that for sports stadiums so, again, why are we being ask to pay $220.7 million for another white-elephant?

We need to see the reports that justify the spending of the $823.1 million and we need to see it now. A healthy scepticism  seems in order about the benefits that these project will bring to Christchurch.

Thursday 21 June 2012

Government must stop meddling and leave pay decisions to shareholders

So argues Elaine Sternberg at City AM.
Government regulation of corporate governance is not justified by envy or inequality, or by gaps between aggregated remuneration levels and averaged share performance. When unequal payouts reward unequal contributions, they are not an indication of unfairness or market failure. Similarly, reciprocal back-scratching, upward ratcheting of pay, and the capture by executives of remuneration consultancies, are not necessary features of market operations. They can be corrected by free market mechanisms. It is the shareholders’ responsibility to insist that rewards fairly reflect the corporate objective.
Shareholder own the firms, if they are happy with the remuneration of the top management then it is not the job of the government, or anyone else, to interfere with that remuneration. If the shareholders are not happy they can use one of "voice or exit" strategies. That is, they can either change the remuneration or sell their shares.
The High Pay Commission, an inquiry set up to look at executive remuneration, concluded that high pay is corrosive and unfair. But the purpose of corporations is not to promote an egalitarian society. Corporations aren’t creatures of the state, there to serve official social ends. They are the private property of their shareholders, and serve the ends designated by their owners.
This idea that firms "serve the ends designated by their owners" helps explain why there are so many types of firms, each with there own governance structure. We see for-profit firms, not-for-profits, producer cooperatives, consumers cooperatives, worker-owned firms etc and we see each of them because each is best at serving the particular ends designated by their owners. One size does not fit all in firms.
Corporate governance refers to ways of ensuring that corporate actions, agents and assets are directed at the constitutional objectives of the corporation, set by the shareholders. It should be up to the shareholders to determine the rights, responsibilities and remuneration of all their corporate agents, and to specify the kinds of accountability they require. Given the varied history, size, activity, jurisdiction and shareholder composition of corporations, one size will emphatically not fit all.
Keep in mind that regulation by the government is often counterproductive. It is by its very nature inflexible and imposes substantial costs, both in funds and freedoms: even disclosure is not costless. And regulation can make it more difficult or even prevent a firm's owners from governing their firm in their way.
The government needs to reduce obstacles to free markets and genuine owner control. Free markets elicit innovative solutions to problems as they arise, in all their real-life variety; they effectively test those solutions and disseminate best practice. In a genuine market for corporate control, companies would compete for shareholders, and investment managers would compete for funds, partly on the degree and kinds of accountability they offered to owners and investors. The best way to ensure good corporate governance would be to maximise shareholders’ freedom to govern their own corporations in their own ways.
Shareholder power, not government power, is the key issue for good governance.

Quote of the day

G.L.S. Shackle on economics:
Economics is one of the strangest items in mankind's intellectual cupboard. The styles of thought exemplified in its literature range from mathematics of a purity to which observational data are quite alien, through measurement-procedures which are culinary and gastronomic in their fascination, to the treatment of the subject as a branch of philosophy and, finally, to its use as the material of literary art. All these styles are expressions of humanity's untrammelled imagination and creative urge. Each in its own way is a form of art, and in each we may
truly discover beauty. (G.L.S. Shackle, "The Years of High Theory", p. v)

Chart of the day: share of world GDP, 1-2008 AD

The Carpe Diem blog brings us this chart on the share of world GDP for different regions, 1-2008 AD. Click to make larger.

Trade deal may see milk hit the fan

The white stuff may be aboot to hit the fan in Canada, eh. John Ivison writing in the National Post:
Canada has taken an historic leap toward securing its longterm interests in the AsiaPacific region by joining the Trans-Pacific Partnership trade negotiations, according to John Manley, the president of the Canadian Council of Chief Executives. It’s not an opinion that will find favour among many of his former Liberal Party colleagues, who appear more interested in domestic partisan, rather than long-term strategic, advantage.

“Can the Conservative government give Canadians assurances that our supply management system will be preserved under this new agreement? asked Wayne Easter, the party’s trade critic.
For the sake of most Canadians you would hope the answer to that question is no.
Mr. Harper said his government has a strong record of defending Canadian interests at trade talks but it will be interesting to see if his government, in particular Gerry Ritz, the agriculture minister, will be quite so emphatic in their defence of supply management in the days to come. Mr. Ritz has claimed that consumers wouldn’t benefit from an end to the protected system that critics claim raises prices — and could even lead to safety issues from imported milk.
How can consumers not benefit from the end of such a scheme? How can a more competitive market and lower prices be bad for consumers? One wonders what these unspecified "safety issues" would be. Are such comments just an indicator of the power of the farming sector in Canada? At least New Zealand farmers have gotten over this protection at all costs type mentality. This could be something that New Zealand farmers could teach their Canadian counterparts. I very much doubt that anyone in the farming sector here wants to go back to the days of over-regulation and protection.
But Mr. Davies has promised an “intelligent, balanced and well-structured” fresh perspective on trade. He is right to ask for more information on what concessions have been made to get to the table. When it comes to finding out what is happening on any given trade deal, it pays to talk to everyone but the Canadian delegation, who are tighter than two coats of paint when it comes to divulging information.
More information is indeed a good thing, especially given the position the U.S. takes on IP. But the benefits of joining the Trans-Pacific Partnership, of which New Zealand is already a member, are great for Canada and more access to Canadian markets has to be good for New Zealand as well.

Wednesday 20 June 2012

Labour v. National on asset sales

The following is from Kiwiblog:
Based on a release from Tony Ryall, a useful guide as to how National and Labour did asset sales. And recall Phil Goff, Annette King and Trevor Mallard vote for the Labour asset sales.

Labour 1988 – 90National 2012
Announced policy before electionNoYes
Used urgency to pass legislationYesNo
Kept majority in Govt handsNoYes
Sold all or most to foreignersYesNo
Priority for NZ investorsNoYes
10% share capNoYes
Allowed select committee hearingsNoYes
Public floatNoYes

Labour sold a total of 15 assets, so some answers vary by asset sold.
If you look at the "economic" issues in the table; that is, ignore the "political" issues, lines 1,2 and 7, Labour looks better than National on asset sales. Lines 3, 4, 5, 6 and 8 would be indicators of a better sales process than that being put forward by National.

Compare these lines with the argument I have made previously about the downsides to the National proposal.

First, selling only 49% of the shares in the companies is unlikely to make an difference to the way the SOEs are run. In particular the sell off will not make the firms anymore efficient since the government will still be the controlling shareholder.

Second, if the government really does want to maximise the income it gets from the sales selling 49% is not a good idea. 51% is worth a lot more than 49%, that is people will pay a premium for control.

Third, selling to "Mums and Dads" will do nothing for the amount of money raised, since Mums and Dads will need a discount to make them buy shares.

Fourth, selling to "Mums and Dads" will do nothing for the efficiency effect of having private owners, since there will be too many "Mums and Dads" for them to be able to coordinate their effects to effect the firm's behaviour.

Fifth, given that each "Mum or Dad" will own only a very small share of any of the firms, they have little incentive to become informed on the firm's activities since they will only capture a very small amount of any improvement in performance they could bring about. This is another reason why performance is unlikely to change.

Sixth, the discipline of bankruptcy or takeover is not greater since the government is still the controlling shareholder and is unlikely to let either of these options happen.

The Labour method of sale does much to address the issues I raise with regard to the problems with National's scheme.

Hayek Memorial Lecture by Professor Elinor Ostrom

On March 29th 2012, Professor Elinor Ostrom presented the 21st Hayek Memorial Lecture for the Institute of Economic Affairs.

The title of the talk was Market Failure and Government Regulation.

Tuesday 19 June 2012

The european origins of economic development

There is a new NBER Working Paper - No. 18162 - on this topic by William Easterly and Ross Levine. The abstract reads:
A large literature suggests that European settlement outside of Europe shaped institutional, educational, technological, cultural, and economic outcomes. This literature has had a serious gap: no direct measure of colonial European settlement. In this paper, we (1) construct a new database on the European share of the population during the early stages of colonization and (2) examine its impact on the level of economic development today. We find a remarkably strong impact of colonial European settlement on development. According to one illustrative exercise, 47 percent of average global development levels today are attributable to Europeans. One of our most surprising findings is the positive effect of even a small minority European population during the colonial period on per capita income today, contradicting traditional and recent views. There is some evidence for an institutional channel, but our findings are most consistent with human capital playing a central role in the way that colonial European settlement affects development today.
The results of the study are consistent with the view that the proportion of Europeans during the early stages of colonisation exerted an enduring, positive impact on economic development. These findings hold when (1) restricting the sample to non-settler colonies, (2) conditioning on the current proportion of the population of European descent, and (3) using instrumental variables to extract the exogenous component of Euro share.

This would be an interesting idea to explore in more detail with regard to New Zealand, especially in terms of the human capital that European may have bought with them.

Is the term "firm" useful?

That's a big question when you study the theory of the firm. If the term isn't useful you get left with the theory of               . Over the Organizations and Markets blog Peter Klein posts on a talk by Harold Demsetz at ISNIE, in a session honouring Yoram Barzel on his 80th birthday. Klein writes
Demsetz’s remarks made me wonder if we should ban “firm” as well. Demsetz pointed out, quite rightly, that Coase (1937) defines the firm in terms of the employment relation. A one-person operation, in this definition, is not a firm, and vertical integration deals with the question of adding producers of intermediate products to the firm’s employment roll. Demsetz thinks independent contractors are firms, and hence it makes little sense to speak of “firm” and “market” as alternatives, as Coase does. (Oliver Williamson, during an earlier session, noted that Coase expressed more interest in intermediate product markets in his 1988 article than in “The Nature of the Firm.”)

For Knight, Williamson, Hart, and other notables, in contrast, the firm is defined not by the employment relationship, but by the ownership of alienable assets. In this approach, the question is who owns what, not who is employed by whom. (Dan Spulber offers yet another approach, defining the firm as nexus of transactions with objectives different from those of its owners.) Of course, even in the Knightian approach, to get from the one-person firm to the multi-person firm requires some theory about the relative transaction costs of employment versus independent contracting, a theory Nicolai and I try to provide in chapter 8 of our recent book, focusing on the conditions under which the entrepreneur to delegate judgment to subordinates.

So, what is a firm?

I would add that with regard to Coase's use of the employment relationship to define a firm in a 1988 paper Coase writes
"I consider that one of the main weaknesses of my article stems from the use of the employer-employee relationship as the archetype of the firm. It gives an incomplete picture of the nature of the firm. But more important, I believe it misdirects our attention".
Seeing a single person as a firm isn't all that silly. Think of a lawyer in practise by himself, is he not a firm? But what makes him a firm. You may say that even if he is the only lawyer in the firm he may have a receptionist which means there is an employment relationship to define the firm. In terms of alienable assets, a single lawyer with no receptionist will still own some assets, if only a client list, so we have a firm in the property rights sense. Note that for Spulber the lawyer is not a firm sense clearly the business doesn't  have objectives different from those of its owners. The business and the owner are one and the same.

So it is not clear what the answer to Klein's question is. But its one worth thinking about. Also if we do away with the term "firm" what do we replace it with and will there be any less in the way of problems with the new term.

EconTalk this week

Jim Manzi, author of Uncontrolled, talks with EconTalk host Russ Roberts about the reliability of science and the ideas in his book. Manzi argues that unlike science, which can produce useful results using controlled experiments, social science typically involves complex systems where system-wide experiments are rare and statistical tools are limited in their ability to isolate causal relations. Because of the complexity of social environments, even narrow experiments are unlikely to have the wide application that can be found in the laws uncovered by experiments in the physical sciences. Manzi advocates a trial-and-error approach using randomized field trials to verify the usefulness of many policy proposals. And he argues for humility and lowered expectations when it comes to understanding causal effects in social settings related to public policy.

Sunday 17 June 2012

What if we could accurately predict the stock market?

Many of you will have seen the new TV advertisement for the University of Canterbury based around the question "What if ...?"

The "What if" questions include one which asks "What if we could accurately predict the stock market?" The late great Milton Friedman thought of this question more than 60 years before the university. In a letter from Friedman to Don Patinkin, Friedman writes
"Thus in the social sciences the enunciation of a result or law for predicting the stock market perfectly may make that law invalid. For example, if one where to state a technique for predicting the stock market perfectly, you know that if that technique were believed in it would then become wrong."

Letter from Milton Friedman to Don Patinkin, January 18, 1949.
I guess that not too many advertising executives have read Friedman; or Patinkin for that matter.

Trade v. invasion

From the Stuff website comes the observation that
If we were living in earlier times, our country would be a prime target for invasion and takeover.

Our combination of natural wealth and small population would put us square in the sights of a bigger, aggressive nation looking to expand. We would be Gaul to Caesar's Rome, England to Canute's Denmark.

Our luck in settling a fertile country watered by plentiful rain is envied by many.

As the foodbowl of the South Pacific, we are eyed by countries worried about their ability to feed a population growing in numbers and in quality of life. They show no inclination to invade, thank goodness.

The paranoid among us would point to a takeover by stealth through the purchase of farmland but I don't see that.

We are beneficiaries of the generations who fought to ensure a country like ours could thrive unmolested. And, befitting such enlightened times, we share our wealth with those who would formerly have enslaved us. It's called trade.
This notion is a version of the famous quote by  Otto T. Mallery,
If soldiers are not to cross international boundaries, goods must do so. Unless shackles can be dropped from trade, bombs will be dropped from the sky. (Emphasis in the original.)
This highlights yet another advantage of trade; it is cheaper and easier to gain what you want from others by trading with them than by fighting with them.

Is government necessary?

Many people don't like government but think it a "necessary evil". It is argued that government has a "night watchman" function to play in society. In this video Professor Ed Stringham argues that government might not be necessary even for this "night watchman" role. This is a extreme position even for many classical liberals, but its fun to see just how far you can push the no government argument.

Saturday 16 June 2012

Don't worry, be happy

Over at Forbes Art Carden wants us to stop worrying about things. In this article he says we don't have to worry about overpopulation and resource exhaustion.

For the case of resource exhaustion Carden points to the work of Julian Simon on why we shouldn't worry about running out of things. Carden notes,
Simon (and those who have come after him) have been derided for having a blind “faith” in technology, but Simon is more careful than he gets credit for being. If demand for resources rises, prices of resources will rise in the short run. This will give people incentives to search for more of those resources or develop substitutes. We don’t just “get lucky” with technology. Rather, we have the conditions under which people have powerful incentives to solve seemingly intractable problems. When people have those powerful incentives—the incentives provided by private property and free markets—we don’t need to worry about whether we will run out of anything.
So what about overpopulation? Carden continues,
What, then, should be done to restrain population growth? I think the answer is easy even though it offends our biases toward action and our conceit: nothing. Ebenezer Scrooge cruelly and callously dismissed “the surplus population,” but as I argued in 2010, there is no such thing. If anything, we don’t need fewer people. We need more of them. Why is this? Every person brings something unique and precious into the world: a mind. It is this mind that he or she uses to solve problems, to come up with newer and better ways to remove what the economist Ludwig von Mises called “felt uneasiness,” to conceive of and create feats of engineering or artwork that boggle the mind. As a lot of people before me have done, I ask you to consider people who are the kinds of one-in-a-million game-changers who rewrite history. With a billion more people, we would have another thousand such geniuses.

Nonetheless, there are billions of people who still live in dire poverty around the world; indeed, by the one-in-a-million math, for the two-and-a-half billion or so people in the world who live on less than $2 per day, it means that there are about 2500 one-in-a-million geniuses who are denied the opportunity to live to their full potential because of an accident of birth. Why are they poor? It isn’t because there are a lot of them. It’s because, for the most part, they live in countries that lack economic freedom and what Deirdre McCloskey calls Bourgeois Dignity.

The solution to world poverty and resource constraints most certainly isn’t “fewer people.” The solution is to create opportunities for the world’s poor through the institutions and attitudes that are responsible for the explosion of wealth we have seen in the last few centuries in the western world: secure private property rights, free markets, and dignity for entrepreneurs and innovators.
So don't worry, be happy.

Friday 15 June 2012

Women on boards

Recently there has been talk about the role of women in business and the number of them in senior management positions and on company boards. For example, the TVNZ website has reported that
The Chair of New Zealand Global Women, Dame Jenny Shipley, said the NZX needs to follow its Australian counterparts immediately and enforce reporting on how many women sit in boards in New Zealand.

"It is time. We said last year that we would accept nothing less from the NZX than transparent public reporting on diversity. We say today they need to do it now," she said.

In Australia, evidence shows reporting on how many women sit in boards has helped boost the number of women in management and governance roles, according to the group.
Earlier this year a working paper came out on Women on Boards and Firm Performance: What Exactly Constitutes a 'Critical Mass'? Utilising a panel data set of 151 listed German firms for the years 2000-2005, the paper's authors explore the link between gender diversity and firm performance. The interesting result is that the relationship appears to be "U" shaped so that, controlling for reversed causality, they find that gender diversity at first negatively affects firm performance and only after a certain point is it associated with higher firm performance than completely male dominated boards.

The point at which all male boards are out preformed is estimated to be 30% female representation.

Fire and trade

Matt Ridley writes at his blog
There may be an ancient parallel. The very first hunter-gatherers to start trading (about 120,000 years ago, according to the hazy archeological evidence) probably already had an ethos of communal sharing within the tribe-and an ethos of violent predation of other tribes. That's roughly how chimpanzee society works today. Then they gradually discovered a way to share with other tribes that was mutually beneficial: trade.

When the limitations of barter became too obvious-what the other lot has in surplus may not be what you need right now-a common currency was invented. But that only encouraged sharing through trade. Likewise the monetization of the Internet's sharing ethos will only spread it.
Is does rise the question that if you do have an ethos of violent predation against others just what would get you trading with them? How about a good which is very valuable to others, and yourself, but which you can trade without reducing amount you still have. So even if you make a "sale" to one person this doesn't reduce the amount of the good you have left to trade with others. Such a good would be, by definition, a non-rival good. Your consumption of it doesn't lower other people's consumption. If the good is also such that people can be excluded from its use then you have a powerful impetus for trade.

What is the good? Fire (at least before the invention of simple ways to start fires on demand). Trade is hot!

Haim Ofek in his book "Second Nature: Economic Origins of Human Evolution" writes,
The impact of fire on civilization from the hearth to the microwave oven is fairly well recorded. Yet, by comparison, the bearing of fire on human evolution prior to civilization is still poorly understood and far more speculative. Given its antiquity in human use, from 300,000 years according to fairly conservative indications, up to 1.5 million years according to others, it is hard to escape the conclusion that fire had a role to play not only as an agent of civilization but also as an agent of evolution promoting hardwired adaptations - not in the least, incitement to trade.
Ofek also notes that
Thanks to thousands of generations that have experienced the advantages of free trade and occasionally the dire consequences of abandoning it, we are no longer reluctant to cut (bilateral) commercial deals with each other. But early on, the very first converts to the games of trade had to overcome the full brunt of the inhibition - unmuted and undiminished - and without the aid of a (genetically, let alone, culturally) preconceived notion of exchange at their disposal. The only thing that could have possibly spurred exchange between such early traders was a persistent clear-cut opportunity to gain extraordinary large mutual benefit from the activity. In terms of the impetus to trade, the threshold necessary to trigger a transaction between them far exceeded the threshold necessary to trigger a similar transaction between veterans like us. This understanding should, in a way, help us trace exchange closer to its roots simply because it narrows the range of commodities (i.e., objects of exchange) that are reasonable candidates for scrutiny. This is not to say that we can open up a merchandise catalog and point with a great degree of certainty to the specific item that started it all going in the first place. What we can do with some degree of certainty is figure out, however generically, at least the relevant properties of such a commodity - and then rule out the rest.
Those properties are, in Ofek's view, exclusion and non-rivalry. Ofek calls goods with these properties, contrived commodities.
Fire takes the form of a contrived commodity by virtue of two peculiarities closely associated with the distinct characteristics that define such a commodity (exclusion but no rivalry). First, there is the requirement associated with all (nonspontaneous) chemical reactions: activation energy (i.e., a source of ignition). The enormity of this requirement is no longer fully appreciated by modern humans within easy reach of matches. But until a point not so distant in the past it still posed a major challenge to all fire users giving ample opportunity for exclusion. The second peculiarity of fire is its capacity for self-generation. Granted fuel, fire can propagate itself indefinitely, and its human handler can make-fire-with-fire at no extra cost. All the elements of a contrived commodity at the deliberate manipulation of humans were therefore in place not only as a prelude to history, but for several hundred thousand years before. Under the right configuration of conditions, it is not unreasonable to infer that there were many opportunities for the impetus to trade to arise and take effect.
So if Ofek is right, trade really was a burning issue for out ancestors!

Dr Eric Crampton - the economics of organ donation

From RadioNZ
Dr Eric Crampton from the University of Canterbury is an expert on the economics of organ donation, and he talks about improving New Zealand's donation rates which are among the lowest in the Western world.

Demand curves slope downwards ...

even for petrol. From Stuff we learn
Kiwis' quality of life is being hit by the high cost of fuel, a new survey shows.

Financial research and ratings agency Canstar Blue's monthly survey of 2,500 New Zealand consumers revealed nearly 70 per cent are being affected by high fuel prices.

More than half now say they only use their cars for essential trips, and over two-thirds use fuel discount vouchers to save money.
So what can we take form this? The price of petrol goes up and the quantity demanded goes down. This is exactly what we would expect. This is how price conserve resources. A price increases give people an increase to use less, i.e. demand curves slope downward.

The other thing we are told is that people use discount vouchers to save money. Seriously, this is news?!! Must be a very slow news day.

New book from Ariel Rubinstein

Well known game theorist Ariel Rubinstein has a new book out, Economic Fables.
Part memoir, part crash-course in economic theory, this deeply engaging book by one of the world's foremost economists looks at economic ideas through a personal lens. Together with an introduction to some of the central concepts in modern economic thought, Ariel Rubinstein offers some powerful and entertaining reflections on his childhood, family and career. In doing so, he challenges many of the central tenets of game theory, and sheds light on the role economics can play in society at large.
Alvin Roth tells this story of an  with Rubinstein,
I once gave a talk at the Hebrew University that was followed immediately with a talk by Ariel, to the same audience. My talk was called something like "The Economist as Engineer," and focused on the kinds of market design applications of game theory covered in this blog: labor market clearinghouses for doctors and others, school choice mechanisms in various American cities, kidney exchange...

Ariel's talk was called something like "Why game theory isn't useful."

So, I gave my talk, we broke for a fifteen minute coffee break, then we all came back and Ariel stood up and I sat where he had been sitting and everyone else returned to their seats. Naturally the first question he got, just about when he had finished saying the title of his talk, was "how about all that stuff that Al just talked about? Isn't it useful?"

He answered (I paraphrase from memory): "Oh, Al's stuff is useful alright. But it's not game theory."
The book can be read online here.

Interesting blog bits

  1. John Cochrane on Taylor's "First Principles".
    Cochrane reviews John Taylor's new book First Principles: Five Keys to Restoring America's Prosperity.
  2. Winton Bates asks Do libertarians have a problem with empathy and disgust?
    It seems to me that a high value should be placed on liberty because it enables people with different values to live in peace and to pursue their individual objectives in ways that are compatible and even mutually beneficial. This doesn’t make liberty the only ethical value that matters. It does mean, however, that the onus should rest squarely with those who seek to restrict liberty to show that this will result in net benefits in terms of human flourishing.
  3. Not PC on Bring back capital controls? It’s already happening!
    You may have noticed in recent months a growing chorus of economic morons, from Jane Kelsey to Bernard Hickey to NZ Manufacturers and Exporters Association CEO John Walley, calling for the imposition of capital controls—or to put it in real English, for the government to put bans, restrictions and prohibitions on the use, storage and movement of your money and valuables.
  4. Eamonn Butler says Happy birthday, Adam Smith
    It's Adam Smith's birthday. Well, sort of. His birth was registered at the church in Kirkcaldy, Scotland, on 5 June 1723. So he was probably born around 3 June 1723. But in 1872 the calendar changed and a few days were added, so that works out to 14 June, which is the day we celebrate it here at the Adam Smith Institute.
  5. Eric Crampton on Exam security
    Canterbury takes its invigilated exams pretty seriously.
  6. Klaus Desmet, Ejaz Ghani, Stephen D O'Connell and Esteban Rossi-Hansberg on Spatial disparities in India: Have Mumbai and Chennai become too congested?
    Will India’s rapid growth in the services sector lead to overcrowding of its cities? This column compares India’s experience to that of other countries.
  7. Lynne Kiesling on Frontiers in dynamic pricing: spot advertising auctions
    According to this Ars Technica story (and a linked Bloomberg article), Facebook is going to offer a new advertising model to its potential advertisers: a spot auction for real-time ads based on changes in current events or time-sensitive things like sporting event results.

Rising protectionism

In a new article at Simon J Evenett points out that in recent weeks official bodies such as the World Trade Organisation and the European Commission as well as leading private sector associations – the International Chamber of Commerce (ICC) and the so-called B20 group of business leaders – have made strong statements concerning rising protectionism in the run up to the G20 summit in Los Cabos, Mexico. On the basis of most extensive update to the Global Trade Alert (GTA) database, that was conducted in preparation for this, the eleventh GTA report, they were right to do so.

Evenett writes,
There has been a steady stream of protectionist measures introduced since the last G20 summit – at least 110 measures have been implemented, 89 of which were imposed by G20 members. This report demonstrates that the amount of protectionism in 2010 and 2011 was considerably higher than previously thought. An additional 226 protectionist measures were found in those two years, representing a 36% increase on the number of beggar-thy-neighbour policies implemented during 2010 and 2011.

Such protectionism translates into lost commercial opportunities, threatened jobs, and slower economic recovery. In very tangible terms, if the information available now had been known just six months ago – in November 2011 when our last report was published – then the number of times China’s commercial interests have been hurt by foreign protectionism in the three years following the November 2008 summit would have been increased by 105. Over the same time frame the US’ commercial interests were harmed 107 more times than previously thought. The understatement in previous reports of the frequency of harm done to many G20 countries’ commercial interests is of the order of at least 20%. Ultimately, what this means is that the world trading system did not settle down to low levels of protectionism after the spike in beggar-thy-neighbour policies in 2009.

What is more, the evidence presented in this report casts doubts on the strength of international restraints on the resort to protectionism by governments, in particular by G20 governments. There are two pieces of compelling evidence here.
  • First, the share of the worldwide totals of protectionism implemented by the G20 countries has risen year-in and year-out. In 2009 60% of protectionism was implemented by G20 governments – that percentage has risen in the year to date in 2012 to 79%. Findings such as these cast the repeated G20 commitments to eschew protectionism in a particularly bad light. Some observers of the G20 have noted that these commitments have been demoted in the respective summit declarations and the GTA’s evidence reveals just how little priority the G20 countries have actually given to maintaining an open world trading system.
  • Second, while there has been a sustained increase in the use of trade defence measures since the last G20 summit, resort to the traditional forms of protectionism that are relatively-speaking better regulated by the WTO account never exceeded 42% of measures implemented in any recent year. During the crisis era, then, governments have circumvented tougher WTO rules and used beggar-thy-neighbour policies subject to less demanding or no binding multilateral trade rules. Much of that discrimination is pretty non-transparent – that is, it is murky protectionism.
This finding does not imply that the WTO rules are useless, rather so long as they remain incomplete that circumvention is to be expected. If anything, the policy implication is that more far-reaching WTO rules are ultimately needed, even if there is little apparent appetite among governments for expanding the remit of multilateral trade rules at this time. It is probably safer to conclude that the WTO rules have altered the composition rather than the amount of protectionism in recent years.

Since official international initiatives amount to a weak bulwark against protectionism, any restraint is likely to have domestic sources. For sure, it would be desirable for G20 governments to start doing what they said they would do at their first summit in November 2008 – that is, refrain from protectionism – and having failed to do so to date, to unwind the protectionism that has been put in place. Moreover, peer pressure could and should be employed to rein those G20 countries that have engaged in extensive discrimination against trading partners.

Short of a major change of heart, the G20 is unlikely to deliver on these recommendations – and expectations should be moderated accordingly. The emphasis, then, must be on winning the argument for maintaining open borders in each major trading nation. Here business associations, consumer groups, and the media – supported by information provided by international organisations – should be at the fore of making the case against protectionism. The hard work in fighting protectionism is at the national level and not in writing reports for international summits. Information has its role, but it is not enough to limit the damage done to the relatively liberal world trading system created in the post-war era.
So even here in New Zealand we must be alert to any move to introduce more protectionist measures and fight them when they do arise.

When economists agree

Adam Ozimek writing at The Atlantic says,
In reading the sometimes polarized debate in the economics blogosphere, the discipline often appears to suffer from an excess of disagreement and uncertainty. But this is more about the incentives economists face when writing and speaking in the public sphere than the actual state of knowledge in the field. In reality economists agree about a lot of things, and in many cases they do so with a high degree of certainty.
This is true, the "economists always disgree" card is well overplayed. There are issues on which they disagree but there are also a lot of issues on which there is agreement. But it makes better news for the disagreements to be played up. Saying "economists agree on X" isn't much of a headline.

Ozimek continues,
This fact is on display frequently at the IGM Economic Experts Panel from the University of Chicago. This is a panel of 41 of the worlds top economists who are offered statements about economic policy to which they can indicate whether they agree, disagree, or are uncertain. In addition they rate the certainty of their answer on a scale of 1 to 10, which allows the answers to be weighted. Over the past few months there have been several issues where this ideologically diverse group of economists have shown resounding unanimity. Some of these may surprise people, as it's fairly obvious that public opinion would not side with economists with the same amount of unanimity. So here are a few things economists strongly agree on.
A list of the economists on the Expert Panel can be found here.

The issues:
The benefits of free trade and NAFTA far outweigh the costs

None of the economists surveyed disagreed that the gains to freer trade are much larger than any costs. And only two economists even said that the answer is uncertain. In a space for additional comments, MIT's Richard Schmalensee declared "If that's not right, almost all of economics is wrong".

Government policies don't explain high gas prices

Individual's beliefs about the extent to which the U.S. government should be blamed for high gas prices seems to have a strangely strong correlation with whether they like whoever happens to be in charge at the time. Economists on the other hand strongly reject the idea that the government has much affect on these prices. None of the surveyed economists disagreed with the following statement:

"Changes in U.S. gasoline prices over the past 10 years have predominantly been due to market factors rather than U.S. federal economic or energy policies."

The Stimulus and Bailouts Lowered the Unemployment Rate

Economists may differ on whether the American Recovery and Reinvestment Act was worth the cost overall, but they are in solid agreement that as of the end of 2010 it lowered the unemployment rate. Very few disagreed with or were uncertain about this. In contrast, a significant number questioned whether the recovery act was worth the cost. Importantly, in the space for comments, Stanford's Pete Klenow emphasized what Scott Sumner and others would say is the central issue: "how much was it offset by less aggressive (than otherwise) unconventional monetary policy?" But even stimulus skeptics should keep their criticisms in perspective: economists strongly reject the idea that stimulus is to blame for our economic woes.

In addition, economists strongly agree that the bank bailouts also lowered the unemployment rate. Of course as Austen Goolsbee commented: "the fact it was necessary doesn't mean we should be happy about it."

The Gold Standard is a Terrible Idea

This is an issue that has returned to a certain prominence in the last few years. But despite it's popularity among some on the right -- and Ron Paul fans in particular -- economists overwhelmingly agree that the gold standard is a bad idea. In this sample of leading economists, 100% of disagreed with the claim that returning to a gold standard would improve price-stability or employment outcomes. Nobody even answered uncertain, because this question really isn't up for debate anymore.
This result I found a bit surprising, I would have expected a bit more support for the gold standard. This may reflect those on the panel, there is no obvious Austrians on it for example.
Some Other Things Economists Agree On

Rent control is bad, congestion pricing is good, eliminating tax deductions and lowering rates is efficient, and the tax deductibility of healthcare creates consequential distortions.
So it may not make the news but economists really do agree on stuff.

Wednesday 13 June 2012

Rational economics

In a recent article in The Freeman Steven Horwitz writes in a review of Dan Ariely's book Predictably Irrational, that Ariely argues that,
People act “irrationally,” in the sense of not picking the utility-maximizing (that is, money-maximizing) choice, all the time. (Of course this notion of rationality is much more stringent than the Misesian idea of rationality as choosing the appropriate means for a desired end.) But, as his title suggests, the experimental evidence is also clear that these irrationalities are not random, but predictable. Our reasoning processes are subject to a variety of what seem to be built-in biases that lead us to deviate from the rational-actor model. Ariely doesn’t discuss the sources of these biases that much, but other literature on cognition indicates that they may be features of the very structure of our brains that reflect the long evolutionary path that created modern humans.
Lynne Kiesling comments on this by noting,
If you use the “money-maximizing” definition of rationality to evaluate individual choices, many things are going to fail to meet that definition that would still meet the more general conception of rationality as “choosing the appropriate means for a desired end”. Steve attaches that idea to Mises, correctly, but I’d also attach it to Vernon Smith’s ecological rationality (and through him to David Hume and the psychologist Gerd Gigerenzer and his evaluation of “fast and frugal” heuristics), Herb Simon, and Thomas Schelling. Not all desired ends can be captured neatly or observed as being “money-maximizing”, so that narrow definition of rationality is quite restrictive.
and she adds,
Note also the difference in focus between the two concepts. The “money-maximizing” definition of rationality emphasizes outcomes, and outcomes as measured using a particular unit of account. The “choosing the appropriate means for a desired end” definition still poses a desired outcome, but note how the locus of evaluation of the action shifts back from the demonstrated outcome toward the process of choice. It’s a subtle shift; even in the theoretical literature grounded in the “money-maximizing” concept of rationality the point is to evaluate the choices individuals make. But that concept relies more on using the outcome to evaluate the rationality of the choice process ex post, while the “choosing the appropriate means for a desired end” framing of the concept takes a more process-oriented, ex ante evaluation of whether or not the choice process appears to make sense.
Horwitz goes on to say,
What Austrians and their fellow travelers can argue is that it’s not the rationality of market participants that matters, but the institutional context within which they act. In other words, rationality is not a feature of the individual choosers but of the market as a whole. Even if people make “mistakes” by not acting as the strict model would suggest, they will receive feedback from the competitive marketplace that will demonstrate their errors and give them the incentive and knowledge to correct them. Those who can recognize their biases and correct for them will do better than those who can’t, and markets enable us to do that when they are genuinely free and competitive. This is what Nobel laureate Vernon Smith calls “ecological rationality.” Even if individuals are irrational, the system as a whole produces rational outcomes.

The case for markets is not about people making perfectly rational choices. Rather the question is comparative: Under what set of institutions will people learn from and have incentives to correct the mistakes they will inevitably make? The standard is not perfection; it’s learning.
So what's important is not the rationality of what agents do but rather how they learn from mistakes and observed outcomes. The system will result in a rational outcome even if the individuals in it act "irrationally". Note that this places much emphasis on the institutional framework in which decisions take place. Getting the right institutional in place for a given transaction - for example, should it take place in a market or a firm - effects the learning that goes on and the incentives that agents face.

Also this means that agents don't have to be strictly rational in order for us to think that markets are good. If markets help people learn and adjust their behaviour then they are "good".

Does strengthening self-defense law deter crime or escalate violence?

An interesting and important question. It is a question looked at in a new NBER working paper, Does Strengthening Self-Defense Law Deter Crime or Escalate Violence? Evidence from Castle Doctrine by Cheng Cheng and Mark Hoekstra. The abstract reads:
Since Florida adopted the first castle doctrine law in 2005, more than 20 other states have passed similar self-defense laws that justify the use of deadly force in a wider set of circumstances. Elements of these laws include removing the duty to retreat in places outside of one’s home, adding a presumption of reasonable belief of imminent harm necessitating a lethal response, and removing civil liability for those acting under the law. This paper examines whether aiding self-defense in this way deters crime or, alternatively, escalates violence. To do so, we apply a difference-in-differences research design by exploiting the within-state variation in law adoption. We find no evidence of deterrence; burglary, robbery, and aggravated assault are unaffected by the laws. On the other hand, we find that murder and non-negligent manslaughter are increased by 7 to 9 percent. This could represent either increased use of lethal force in self-defense situations, or the escalation of violence in otherwise non-lethal situations. Regardless, the results indicate that a primary consequence of strengthening self-defense law is increased homicide.
One thing that is interesting is that they don't seem able to deal with the issue as to whether the increase in deaths is due to an "increased use of lethal force in self-defense situations, or the escalation of violence in otherwise non-lethal situations". I take it this to mean that they can't tell whether more attackers are being killed by would-be victims or if the level of violence is being forced up in general. And I would think that for many people that difference is important. In the first case fewer victims are being killed while in the second more victims are dying.