Saturday, 27 October 2012

Words without substance

Welly Gnome highlights the Living Standards Framework new from the Treasury. Welly writes,
The framework incorporates the politically correct dialogue necessary for evaluating all potential policy options by the New Zealand Government in 2012.
“Living standards encompass much more than just income or GDP. It also includes a broad range of material and non-material factors which impact on the well-being of both the individual and society (such as trust, education, health and environmental quality).”
But notice that all these "broad range" of things are positively correlated with economic growth. Countries with higher growth and thus higher levels of income have better education, health and environmental quality etc. So growth is still the key factor and concentrating on growth still the right policy.

The words may have changed but the actions will not. These are just words without substance.

Friday, 26 October 2012

More on partial privatisation

From Homepaddock comes this interchange from Parliament's questions and answers time for October-24.
Michael Woodhouse: Why is it important that the share offer programme goes ahead?

Rt Hon JOHN KEY: It is important, firstly, because the Government can use the proceeds of the share offer to invest in new public infrastructure without having to borrow so much to do so. This is exactly the same situation as in 2005 when the previous Government took $600 million from the sale of publicly owned asset Southern Hydro and used it to invest in roads. The share offer also gives New Zealand savers the opportunity to invest either directly or indirectly in big New Zealand companies, and being publicly listed will be good for the companies themselves.

I do believe bringing these companies to the market through the mixed-ownership model is a good, sound economic approach, and actually I think it will deliver a better result for New Zealand without having to borrow more money. . .
I have noted a number of times that I don't agree with the argeement used here by the PM. In the past I have said
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.
If the government is really worried about the proceeds of the sale of share it should take note of points 2 and 3 above. Points 1, 4 5 and 6 are relevant for the effects of the sale on the "companies themselves". And why do we care about giving
"New Zealand savers the opportunity to invest either directly or indirectly in big New Zealand companies".
Where New Zealanders invest is surely up to them and not something the government should be interfering with.

Less government borrowing is good but if the government sold 100% of the SOEs even less borrowing would be needed. And you would get better outcomes for the firms.

Thursday, 25 October 2012

Returning to growth

Increasing economic growth is a big issue in most, if not all, countries around the world right now. For the case of the U.K. recovery from severe recessions was achieved in the 1930s and the 1980s in the presence of fiscal consolidation. In this article at Nicholas Crafts asks if there are any lessons from these experiences for today's situation.

Crafts writes (references deleted)
The policy lessons from these episodes can be summarised as follows.
  • First, although it is not possible to cut nominal interest rates when, as now, they are at the lower bound, it is possible to deliver monetary stimulus by reducing real interest rates if, as in the 1930s, the authorities are willing and able to commit to higher inflation. However, the inflation-targeting regime in place since the 1990s would have to be revised.
  • Second, although there are reasons to think the fiscal multiplier may be relatively large when interest rates are at the lower bound, history says that this claim needs to be treated with caution especially when public debt-to-GDP ratios are large.
  • Third, a key component of a policy to stimulate recovery during an episode of fiscal consolidation is an ability to ‘crowd in’ private sector spending – private housing investment aided recovery in the 1930s and consumer spending did so in the 1980s.
  • Fourth, if politicians wish to devise more interventionist industrial policies then it is essential that they are designed with a view to minimising the adverse impacts on competition.
If radical changes to monetary policy are ruled out and fiscal consolidation continues, the implication is that reforms to supply-side policies have to play a significant part in any attempt to stimulate growth. The ‘good news’ is that there are plenty of evidence-based reforms that can strengthen the UK’s growth performance by improving horizontal industrial policies which have left much to be desired in the last 30 years. These include repairing a serious infrastructure shortfall , institutional reforms to deliver higher quality schooling and improve cognitive skills , reforming taxation to reduce corporate taxes and expand the VAT base , and addressing the massive distortions created by the land-use planning system which undermine the potential productivity gains from successful agglomerations . The ‘bad news’ is that these policy choices are very much exposed to government failure, are subject to implementation lags, and have their effects in the medium- and long-term.

If there is one area that could deliver short-term stimulus and long-term efficiency gains, as in the 1930s, it is surely private house building. The evidence suggests that draconian planning restrictions mean that the stock of houses is three million below and real prices are 35% above the long-run free market equilibrium. The welfare gains from some relaxation of these planning rules are huge and the employment implications of steadily addressing the housing shortfall could be considerable – building 200,000 extra houses per year might employ 800,000. This would require addressing issues of housing finance and incentivising local communities to want development because they can benefit from it and builders to believe that delaying construction would not be profitable. In principle, this could be achieved very quickly but, sadly, it is not politically acceptable so the Chancellor of the Exchequer may find himself in the role of Mr Micawber for a while longer.
The last comment is interesting. Is this a case of a good economic policy not being popular and thus not enacted?

One also wonders what effect "draconian planning restrictions" are having on the stock of houses here in Christchurch, and around the rest of the country.

The economic policy dilemma

Chris Dillow at the Stumbling and Mumbling blog (a blog well worth reading - think "The Standard" but with brains) sums up what he call the The economic policy dilemma with the Venn diagram given below
Chris argues that,
Whatever the cause, the fact is that there is a sharp trade-off between democracy and good economic policy-making.
And I agree.

But I'm willing to bet that while most economists would agree with Chris's diagram they would not agree on what goes into the left hand side of the figure. My view of "policies which are good" is likely to be very different from Chris's view of good policy. But, interestingly, we would both see our favoured policies, whatever they are, as unpopular. Which raises the question if all "good economic policies" are unpopular can we ever get anyone's version of good policy implemented? Does politics gut all economic policy, no matter whether "left" or "right", of all serious content? Are we doomed by the populist nature of politics to get crap economic policy no matter how we define good policy?

Wednesday, 24 October 2012

Cost of the Olympics

The New Zealand Herald tells us that
The British government says the London Olympics cost about $NZ786 million (400 million pounds) less than expected.

The final financial report for the games projects that the cost will be $17.6 billion from an original budget of $18.33 billion.
But Sam Richardson over at Fair Play and Forward Passes notes that
It sure is a significant achievement. Especially when you are aware of this information, taken from Brad Humphrey's piece in on the economic impact of the Olympic Games in the New Palgrave Dictionary of Economics (well worth a read in general if you are at all interested in the economics of mega sporting events):
London expected its 2012 Games to cost under $4 billion, but they are now projected to cost over $19 billion (Carlin, 2007; Simon, 2006; Sports Business Daily, 2008a). As expenses have escalated for London, some of the projects have been scaled back, such as the abandonment of the planned roof over the Olympic Stadium. The stadium was originally projected to cost $406 million and will end up costing over $850 million. Further, its construction will be financed by taxpayers and the government has been unsuccessful in its effort to find a soccer or a rugby team to be the facility’s anchor tenant after the 2012 Games. This will saddle the British taxpayers with the extra burden of millions of dollars annually to keep the facility operating. It is little wonder that the London Olympics Minister Tessa Jowell stated: ‘Had we known what we know now, would we have bid for the Olympics? Almost certainly not’. (Sports Business Daily (2008b), citing a story in Daily Telegraph (2008). The Olympic Village was to be privately financed, but the plan fell through and will instead cost the taxpayers nearly $1 billion. The government hopes that the apartments will be sold after the Games and the financing will be recouped.)
So yet another warning, approach mega sporting events (and the building of stadiums) and the claims made about them from the organisers  with much caution.

What is Hickey's problem? (updated)

Bernard Hickey is getting all upsetting because he thinks companies are not paying enough tax.

Now there is the obvious point that people don't invest in companies to increase the government's income, they invest to increase their own income. Thus as an investor you would want firms to pay as little tax as possible.

But consider some of the arguments Hickey uses to back up this claim of too little tax being paid. Try this one
Starbucks was in the crosshairs in Britain this week after Reuters reported Starbucks had racked up over 3 billion pounds (NZ$5.88 billion) in sales since 1998, but had paid just 8.6 million pounds (NZ$16.8 million) in taxes.
But what has revenue got to do with tax? Tax is paid on profits not revenue, so the size of Starbucks revenues is irrelevant to what taxes they should pay.

Over the last three years its paid no income tax, despite comments from management to shareholders that its British operation was so successful and profitable that it was moving its British CEO to head up the American operation.
Starbuck may pay little in U.K. taxes but if its profits are consolidated in the home office, which I guess is in the U.S., what are their U.S. tax payments? Is Hickey really suggesting that Starbucks be taxed twice?
Starbucks forces its British operation to pay 'intellectual property' fees to its Dutch operation, from where it's unclear where the money goes.
In which case the question would be how much tax did Starbucks pay in Holland.
Starbucks is not alone among many multi-nationals who use perfectly legal but morally questionable tactics to shuffle money through tax havens and structures that have the effect of reducing their overall tax rates. Google, Apple and Facebook are masters at it.
Note the "perfectly legal" bit. You should also ask "morally questionable" to whom? Not to me. As noted above people invest in companies to increase their income and less tax means more income.

Hickey also says
Google, for example, made losses for tax purposes in New Zealand in the last two years, despite advertising industry estimates that it made revenues from New Zealand of over NZ$100 million last year. Last year it paid just NZ$109,000 in tax in New Zealand.
Again we have a meaningless comparison of revenues and taxes. And the revenues figures are just guesses!

Hickey ends by saying,
Perhaps it's time New Zealand consumers and taxpayers started targeting companies such as Google and Facebook that don't pay their fair share of tax globally.
And "fair" means what?

And if Bernard thinks the amount of tax paid by a firm is too low, that is, the dividends paid to investors is too high, he has the option of becoming an investor in a low taxed firm and taking the dividends and writing a cheque to the IRD. This should in a small way redress the balance and make Bernard feel morally superior.

You may well think firms should pay more tax, but if you do you need to use better arguments than Bernard Hickey has put forward to back up that claim.

Update: Mark Hubbard writes on Bernard Hickey’s Latest Outage, Sorry, Outrage

Trotter, Shearer and the labour market

In a recent column in The Press Chris Trotter says that
"Immigrants have become an indispensable component of the New Zealand labour market".
And how! As I type these words I sit in a room with an American, two Englishmen, two Canadians, a Czech and an Indian. What would come of our universities if David Shearer got his way on restrictions on immigrant labour? This is just one example of a labour market in New Zealand for which the last thing we need are restrictions on immigrant labour.

Trotter goes on to say that
"In his speech to the Hornby Working Men's Club on Thursday, Shearer quite rightly stated that: "We need to avoid being locked into a downward spiral where our skilled people go to Australia for better wages, where those people are replaced by migrants who are paid less, which in turn sends more of our skilled workers to Australia."

In that single sentence the Labour leader encapsulated the grim dynamic of New Zealand's labour market. This country's ability to hold on to its skilled workers has been very seriously weakened by the power of what is, in effect, a single Australasian market for skilled labour."
I take from this that our skilled workers are heading to Australia and thus reducing the supply of such workers in New Zealand. This should put upward pressure on wages. But I also take from the Trotter piece that wages are not increasing, which is where Shearer's comments on the increased supply of immigrants comes in. The supply of skilled labour in increasing and thus, roughly, the two effects cancel each other out. Wages stay about the same.

What is the problem with this? If the supply and demand conditions are such that wages do not increase, why should we worry? Does this not mean that our firms are more competitive as their costs of production are not increasing at the rate that they are overseas. Does this not help our exporters, which we keep being told need our help. Does this not help those firms trying to rebuild Christchurch by controlling their costs?

Trotter goes on to write,
Shearer appears to think that limiting the influx of immigrant labour will somehow slow the exodus of skilled New Zealand workers to Australia.
Insofar as low wages are the reason for workers heading to Australia then it would help. If the supply of skilled workers is reduced then the wages paid to these workers will increase. This will close the relative wage gap between New Zealand and Australia. But will increase the cost of production for New Zealand firms making them less competitive in world markets and less able to compete against imports.

Trotter argues later in his article that
At the core of the problems Shearer identifies in his speech is the depressed levels of New Zealand wages and salaries.
But this depressed level of wages and salaries may well be simply a reflection of low productivity. As Paul Krugman has said,
Economic history offers no example of a country that experienced long-term productivity growth without a roughly equal rise in real wages. In the 1950s, when European productivity was typically less than half of U.S. productivity, so were European wages; today average compensation measured in dollars is about the same. As Japan climbed the productivity ladder over the past 30 years, its wages also rose, from 10% to 110% of the U.S. level. South Korea's wages have also risen dramatically over time. ("Does Third World Growth Hurt First World Prosperity?" Harvard Business Review 72 n4, July-August 1994: 113-21.)
So if Trotter and Shearer want to see an increase in incomes, they need policies to increase productivity. It is far from clear how Trotter's ideas of
[ ...] pass[ing] legislation designed to reverse the flow of wealth from wage and salary earners to owners and shareholders. It [a Labour lead government] will not, by substantially lifting the minimum wage, engineer a wholesale winnowing-out of New Zealand's most inefficient businesses. It will not pass legislation restoring universal union membership or the national award system. It will not use the government's ability to set wages and salaries in the public sector to provide both a guide and a goad for private sector employers
will increase New Zealand's productivity.

Tuesday, 23 October 2012

Carrots that look like sticks

A well known result in the contracts literature in that if the output of one or more tasks is more straight forward to measure than the output of other tasks then piece-rate incentive schemes will lead to a distortion of effort toward the more easily monitored outcomes. A new NBER working paper by Omar Al-Ubaydli, Steffen Andersen, Uri Gneezy and John A. List argues that contrary to the above argument the use of piece rates can, when the agent is uncertain about the principal’s monitoring ability, signal to the agent that the principal is efficient at monitoring. Such a signal induces greater effort on all fronts.
Carrots that Look Like Sticks: Toward an Understanding of Multitasking Incentive Schemes
Omar Al-Ubaydli, Steffen Andersen, Uri Gneezy, John A. List

NBER Working Paper No. 18453
Issued in October 2012
NBER Program(s): LS

Constructing compensation schemes for effort in multi-dimensional tasks is complex, particularly when some dimensions are not easily observable. When incentive schemes contractually reward workers for easily observed measures, such as quantity produced, the standard model predicts that unrewarded dimensions, such as quality, will be neglected. Yet, there remains mixed empirical evidence in favor of this standard principal-agent model prediction. This paper reconciles the literature by using both theory and empirical evidence. The theory outlines conditions under which principals can use a piece rate scheme to induce higher quantity and quality levels than analogous fixed wage schemes. Making use of a series of complementary laboratory and field experiments we show that this effect occurs because the agent is uncertain about the principal’s monitoring ability and the principal’s choice of a piece rate signals to the agent that she is efficient at monitoring.

The question of the moment

What if governments can't pay their debts?

For 2012 the Condliffe Memorial Lecture in Economics at Canterbury will be held on Wednesday, 5 December, as part of the University of Canterbury's ongoing "What If?" lecture series. This year, we're pleased to host Professor John Cochrane. Professor Cochrane is AQR Capital Management Distinguished Service Professor of Finance in the Chicago Booth School of Business at the University of Chicago. He blogs at The Grumpy Economicst. Please RSVP via the University's website.

EconTalk this week

Jonathan Rodden, political science professor at Stanford and a senior fellow at the Hoover Institution speaks with EconTalk host Russ Roberts about the geography of voting. The main focus is on the tendency of urban voters around the world to vote for candidates on the left relative to suburban and rural voters. Rodden argues that this pattern is related to the geography of work and housing going back to the industrial revolution. He also discusses the implications of various voting systems such as winner-take-all vs. proportional representation, the electoral college and how political systems and voter preferences can produce unexpected outcomes.

Sunday, 21 October 2012

Do we get the economic policy we deserve?

A number of economic bloggers have in recent times commented on policy ideas coming from various politicians. Matt Nolan on QE, Eric Crampton on exchange rates, Seamus Hogan on local workers and me on the F&P takeover, to name just a few of the very recent ones. The one thing all these posts have in common is pointing out obvious problems with the policy concerned.

If spotting errors in the policies is so simple why then do politicians continue to put such ideas before the public? Doesn't it just make them look bad? It can't be because the politicians do not know the problems with their policy ideas. They all have access to economists who can find the errors just as well as bloggers. So politicians must know their policy suggestions are flawed but the enter them into the political arena anyway. Why?

Assuming that the politicians concerned are not completely stupid, and they are not, then there has to be a good reason for what they are doing. Are they signalling to supporters that they will get a payback when the government changes? So keep supporting us. Are they working on the "any publicity is good publicity" theorem? Are they just floating ideas to gain media attention with no real intention of putting the policies into action if given the chance? Or are the politicians in question trying to gain support from particular groups who they don't think support them now? Have they have calculated that the gain in support from whoever gains from their stated policy will outweigh the loss in support from those who lose from it.

Or is the calculation more Machiavellian  Is it simply that politicians assume most voters don't understand a lot about economics and thus may well think the policies sound good without understanding the true effects that would follow if a given policy was enacted? In short, do politicians think voters are just stupid? If they are right, and we do vote for politicians and their policies, then may be we do get the economic policy we deserve.

Friday, 19 October 2012

Labour's economics really is bad at times (updated)

From Scoop we learn,
Fisher and Paykel appears destined to be sold offshore while the National Government passively waves goodbye, which is a blow to innovation and skilled jobs in this country, says Labour’s Economic Development spokesperson David Cunliffe.

“The threat of an overseas takeover of Fisher and Paykel is now very real and the likelihood of excellent skilled jobs going overseas is worryingly high.

“Fisher and Paykel is a Kiwi innovation icon. It is the sort of company we need more of in New Zealand, not less. But National is just waving it goodbye.

“The implications of its sale to New Zealand are too important leave the takeover approval to officials. Such a major decision must be made by Ministers. That’s Labour’s policy.
Why does changing the ownership of F&P affect the likelihood of the firm changing where it makes its products? If it is profit maximising for a foreign owned F&P to make products overseas  - and thus having "excellent skilled jobs going overseas" - then it must also be profit maximising for a New Zealand owned F&P to make their products overseas. The location of production is independent of the nationality of the owners of the firm. A New Zealand owned F&P can outsource its production if it is in the interests of the firm to do so, in exactly the same way as a foreign owned F&P can do so.

Also you do have to ask why "officials" have a say in the takeover of the firm. Such a decision is best left to those people that have the best information and best incentives to make the decision, that is, the firm's owners.

About the only thing worse that having officials interfering with the takeover decision is having politicians interfering in that decision. A takeover decision should be made on the economic merits of the offer, not on some opportunistic political grounds. Politicians have no knowledge or understanding of the company or the merits of a takeover bid and have quite possibly the worst possible set of incentives for making such a decision. They are the last people who should be involved.

Render therefore unto economics the things which are economic.

Update: Homepaddock notes that Labour wants more power to meddle

Interesting blog bits

  1. John Taylor gives us More on the Unusually Weak Recovery
    The weak recovery continues to be a major topic.
  2. John Taylor on Weak Recovery Denial
    Paul Krugman disagrees with my recent post that the recovery is weak compared to recoveries from past serious U.S. recessions including those associated with financial crises. I’ve been writing about the reasons for weak recovery for two years, but the issue has heated up because of its relevance to the elections this fall.
  3. John Cochrane on Are recoveries always slow after financial crises and why
    Carmen Reinhart and Ken Rogoff have an interesting new Bloomberg column, "Sorry, U.S. recoveries really aren't different." They point to the great Barry Eichengreen and Kevin O'Rourke "Tale of two depressions: what do the new data tell us" columns. (Hat tip, commenter Tim to "slow recoveries after financial crises" who asked what I think. Here's the answer)
  4. Lynne Kiesling on Lifecycle analysis: environmental impact of electric vehicles ambiguous
    A forthcoming article in the Journal of Industrial Ecology reports on a lifecycle analysis comparing electric vehicles with internal combustion vehicles (at the moment the full article is available for our edification!). This thorough analysis looks at the resource use and environmental impact of the production, use, and disposal of the vehicle.
  5. Joshua Gans on Media disruption: it is not journalism, it is advertising
    This morning, I had a “someone is wrong on the Internet” moment. The someone was Clay Christensen, David Skok and James Allworth who wrote a long piece for the Nieman Foundation for Journalism at Harvard entitled “Mastering the art of disruptive innovation in journalism.” The report is about the woes facing the newspaper industry and what they have to do to get back in the game. But the narrative makes the classic mistake of searching for keys under a lamppost because that is where the light is. That is, it fails to start with the causes of disruption and so, I think, makes an error in focussing on second order issues. Put simply, I contend, as I have done many times before, that what was disrupted for the newspapers was not journalism but advertising.
  6. Tom Papworth on Land underlies everything
    The use and ownership of land has been perhaps the most important question facing societies going right back into antiquity. Arguably the biggest story in human history is the settlement of particularly fertile regions by previously nomadic people, and their attempt to protect the land they cultivate from still-itinerant tribes and those who want to settle the same patch. It lies at the heart of many armed conflicts: even today, conflicts such as Dafur are, at heart, battles between the pastoral and agricultural peoples of that region.
  7. Seamus Hogan has More on exchange rates
    Eric posted on Monday about the article in which he was extensively quoted. I am mostly in agreement, with the article and Eric’s quoted comments, but there are a couple of places where I take issue.
  8. Matt Ridley on The benefits of GM crops
    Generally, technologies are judged on their net benefits, not on the claim that they are harmless: The good effects of, say, the automobile and aspirin outweigh their dangers. Today, arguably, adopting certain new technologies is harder not just because of a policy of precaution but because of a bias in much of the media against reporting the benefits.

Thursday, 18 October 2012

Incentives matter: French housing file

Yes even the French respond to incentives.
France's new 75 percent income tax on the rich may not be popular with millionaires. But it's being cheered by another group: Paris real-estate buyers. Real estate agents say that the number of multi-million-dollar real-estate listings in Paris has jumped more than 25 percent over last year -- due in part to the threat of the new income tax [...] [B]rokers say the 75 percent tax on the wealthiest French citizens has contributed to the decision by many of the them to sell their homes in anticipation of a possible move to another country.

Why co-operatives in farming?

A few days ago Ele Ludemann at the Homepaddock blog noted that Co-ops key to feeding world and in a sense she is right. Co-ops are more common in argiculture than any other sector of the economy. The big question is Why?

To see why start from the idea that there are two basic ways to organise production, via contracts or via ownership. So what are the costs of each? First consider the costs of contracting. In farming one reason for the formulation of co-operatives was monopsony power. Farming is a business with many producers of highly homogeneous commodities. It is one of the most competitive of all industries. In contrast, the middlemen-handlers and processors - who purchase farm products are often highly concentrated and hence have the potential for exercising a degree of monopsony power over the farmers they deal with. Such monopsony power can be accentuated by seasonality or perishability of agricultural products. Any individual farmer who simply grows and harvests his crop and then takes it to market risks encountering prospective purchasers who offer only a very low price _ which may in fact be less than the farmer's cost of production - due to the knowledge that the farmer has very little time in which to market his crop and therefore cannot credibly threaten to hold out for long or to engage in an extensive search for other purchasers. A purchaser, in contrast, can often realistically threaten to turn to other farmers to satisfy his needs.

Such a cost of contracting results in farmers having an incentive to form cooperatives through which they can bargain collectively with middlemen, or with which they can displace the middlemen entirely. Such incentives have apparently played an important role in the formation of farm marketing cooperatives. In more recent times the use of forward markets has lessened the need for co-operatives to over come monopsony power. A farmer can sell his crop even before it is grown via the use of forward markets.

Next consider costly information. Asymmetric information about crop attributes and prices has sometimes served as a stimulus to the formation of farmer marketing cooperatives. An example would be grain elevators and warehouses in the late nineteenth century U.S. Proprietary operators, who understood the grading methods employed in the terminal markets better than did local farmers, would assign grain they purchased from a farmer an inappropriately low grade, paying the farmer only the price appropriate for that grade and then reselling it at the price prevailing for the higher grade.

More generally, farm marketing cooperatives economise on a variety of information costs for their farmer-members. If each farmer in a given locality were to decide separately when and at what price to market his crops, there would be substantial duplication of effort in gathering information about market conditions, prospective purchasers, transportation, and other matters. Cooperatives allow farmers to share these costs.

It has also been argued that there are marketing externalities available to co-operatives than are not available to investor-owned intermediaries. If there are barriers to entry into agricultural production, but processing is relatively competitive, then there may be opportunities for promoting a given commodity through advertising that are available to a co-operative but not to an investor-owned intermediary. This may help explain the success of the fruit and vegetable cooperatives. Entry into (and exit from) production for many fruits, and perhaps some vegetables, is relatively inelastic in the short run because the trees take time to mature and represent a substantial crop-specific investment with a long expected life.

Now what of the costs of ownership? The preceding discussion suggests that, while market contracting for agricultural products has some costs that offer an incentive for farmer ownership, those costs are not conspicuously high. The reason for farmer ownership may therefore to be found in the low costs of ownership for farmers.

First up consider the monitoring costs of farmer owners. The farmer-members of agricultural marketing cooperatives are in an unusually good position to exercise effective control over the firm. The result is that agency costs are, from all the evidence available, unusually small in these organisations. Farmers have both the incentive and the opportunity to monitor marketing cooperatives actively and intelligently. The. crops that the cooperatives market represent a major, and often the only, source of income for the farmer. Farmers commonly produce the same crop, and deal with the same cooperative, for many years and sometimes for generations. Farmers of a given crop tend to be geographically concentrated, making participation in governance relatively easy. And where a cooperative covers a large region, it is both possible and a common practice to structure the cooperative in ways that continue to permit active and informed member control. Farmer-members of cooperatives are commonly well informed about the cooperative's affairs and take an active interest in them. Members usually know one or more directors personally. The directors play an important role not only in conveying the members' views to management but also in conveying information from management to the members. Managers pass important or potentially controversial issues to the board for decision. Boards scrutinise managerial performance closely and not uncommonly replace managers who are not performing well. In this and other ways, management in the cooperatives is highly responsive to members' interests.

The cost of collective decision making are also low for co-operatives. A critical advantage for farming cooperatives is the extreme homogeneity of interest among the typical cooperative's members. Most cooperatives handle only a single agricultural commodity which is exceptionally homogeneous. Often the outputs of the various members of the co-operative are fungible. This means that the members of the cooperative all share the relatively simple goal of maximising the value of the commodity involved. Costs of collective decision making, as a consequence, are kept to a minimum.

One possibly high cost for the co-operative is the supply of capital. Mostly the equity capital required by farm cooperatives must generally be raised from the cooperatives' farmer-members. There are obvious costs to having farmers provide such capital. Modern farms, though predominantly family-owned - as was argued in a previous posting - businesses, are relatively capital intensive. Therefore farmers are unlikely to have substantial amounts of liquid capital available to invest elsewhere. In addition, the returns to a farmer from investing in a marketing cooperative are likely to be positively correlated with the returns to his farm. Since farming is a volatile business in itself, this means that a marketing cooperative is a highly risky investment for a farmer.

In conclusion farm based cooperatives thrive even where the potential costs of market contracting appear relatively low, the costs of ownership are even lower. It has been argued that the success of the cooperatives does not seem to depend importantly on their own exploitation of monopoly power or on governmental tax preferences or subsidies. Risk bearing and accumulation of capital have apparently not been important obstacles. Henry Hansmann argues that
[ ... ] where the costs of ownership are low-and, in particular, where the potential producer-owners have highly homogeneous interests-producer cooperatives can succeed even in the absence of serious market imperfections that would make market contracting costly for the producers.
The last question to consider is will the advantages of co-operatives continue and thus will the domination of co-operatives in farming continue? The answer seems to depend on whether or not changes in agriculture mean that the homogeneity of interest of farmers continues. Should the costs of ownership begin to rise investor-owned firms may become more common.

Central banks: reform or abolish?

This is the title of a new working paper by Gerald P. O’Driscoll at the Cato Institute. The abstract reads:
Advocates of central bank reform must examine why central banks emerged and what forces sustain them. They did not arise in an institutional vacuum, and will not be reformed in an institutional vacuum. The historical origins of central banks explain how they came into existence.  The forces sustaining and feeding their growth may differ from those explaining their origin.

Plans to abolish central banks constitute an extreme reform. It is doubtful that such plans can succeed without broader institutional change, occurring either first or simultaneously. That is likely true regardless of the strength of evidence on central bank performance. I examine these issues in what follows.
In his conclusion O'Driscoll argues that we have two intertwined systems, the fiscal and the monetary. They must be reformed together. In part O'Driscoll's conclusion reads,
I have suggested that the rise of the central bank coincides with the rise of nation states, whose spending commitments exceed their capacity to finance those commitments. Historically, wars were the chief source of fiscal embarrassment to monarchs. Early central banks, like the Bank of England, were not conceived as monetary institutions, but banks to the king. Even the Federal Reserve was not conceived as a monetary authority. “The responsibilities originally assigned to the Fed did not need to include, and in fact did not include that of managing the stock of money or the price level” (Selgin et al., 2010: 36). It did not arise for fiscal reasons, but became indispensable to a growing federal government both in wartime and peacetime. Standard economic justifications do not take adequate account of historical reality. Consequently, they are theoretically naïve.

Wars are still expensive, but most governments no longer fight major wars. The United States is a conspicuous exception. The modern welfare state with its vast array of entitlements drives government finances into deficit (Buchanan and Wagner 1977). Currently, the European Union is suffering an acute financial crisis. Its economies grow too slowly to generate the tax revenues to finance the benefits promised the citizens of those countries. The governments borrow chronically to help pay for ordinary, current expenses. Unforeseen events, like recessions, or housing bubbles bursting, throw the governments deeper into deficit. The modern European sovereign finds himself in much the same situation as his 18th century predecessor.

The European Union is an interesting case because its own central bank is limited in its ability to finance government deficits. So the commercial banking system has become a huge holder of sovereign debt. Partly that reflects the favorable treatment given to government securities under the Basel rules (Basel II). Banks do not need to hold reserves against the sovereign debt of OECD members. Since all such debt was preferred by regulators, bankers choose to hold the highest‐yielding and riskiest sovereign debt, e.g., that of Greece instead of  Germany. Governments also pressured their own banks to hold sovereign debt to keep funding costs down. That pressure is being very much felt today. So the EU banking system is in crisis along with their governments.

We Americans should not cultivate schadenfreude at the plight of Europe. The United States is not far behind Europe on its fiscal trajectory to default, or what amounts to the same thing, high inflation. We benefit temporarily because, relatively speaking, U.S. assets offer a safe haven for investors. If that changes, and global capital repositions elsewhere, borrowing costs for everyone, including the federal government, will rise. That by itself could produce a fiscal crisis here. A U.S. fiscal crisis is being postponed but not avoided.

It is institutionally impossible to end central banking in this environment. I certainly do not mean that it should not be discussed. But, as they have always been in the history of central banking, monetary and fiscal institutions are linked. Monetary reform will need to go hand‐in‐hand with fiscal reform.

Capabilities and organisational economics: how do they relate?

This interesting question is asked by Nicolai Foss at the Organizations and Markets blog. His answer is comes via the Strategy and Globalization blog:
A long-standing discussion in management research concerns the relation between capabilities perspectives on the firm and organizational economics, including transaction cost economics and agency theory. In particular, proponents of capabilities ideas have criticized organizational economics for exaggerating the role of opportunism (and similar constructs), neglecting value creation and downplaying dynamics. Conversely, proponents of organizational economics have criticized the lack of a clear unit of analysis, causal mechanisms and micro-foundations in the capabilities approach.

“While these early debates clarified many things,” says SMG Professor Nicolai J Foss, “the field is increasingly moving towards a more conciliatory stance in which the two perspectives are seen as capable of cross-fertilizing each other. This is going further than merely stressing a relation of complementarity in which capabilities ideas lend themselves to the explanation of organizational heterogeneity while organizational economics provides the understanding of the organization of heterogeneous resources and capabilities. The new view is that, notably, organizational economics has the potential of illuminating capability emergence and therefore organizational heterogeneity.”

With Nicholas Argyres (Washington University), Teppo Felin (Brigham Young University), and Todd Zenger (Washington University) Foss is an editor of the September-October issue of the leading management research journal, Organization Science, titled “Organizational Economics and Capabilities: From Opposition and Complementarity to Real Integration” ( This special issue contains a number of articles by leading contributors to the discussion, and mixes theoretical, empirical and modeling approaches, as well as an introduction by the editors that survey the debate and defines a new agenda for research in the field.

“We are pleased that we got so many high-level contributions for this special issue,” says Foss, “and in particular that these contributions truly manage to define a new, creative research frontier where the emphasis is on researching the interplay between theoretical mechanisms identified by the two perspectives.

Wednesday, 17 October 2012

Just what do they teach at Waikato? (updated x3)

This is from The Herald and is written by Ryan Wood who is a history student at the University of Waikato.
This is where the maximum wage comes in. If the top salary is legally fixed at, say, $200,000 a year, these economic miracle-workers running companies will have no choice but to start their own businesses where, as shareholders, they can indulge in the dividends they deserve. The creation of new companies will in turn lead to more jobs, thus negating the need for any "starting-out" wage.

A maximum wage also has a trickle-down effect. The millions of dollars that would have been paid to CEOs could instead be paid as bonuses to workers, or used to lift the average wage of employees at the company. These people could then spend their extra income, further supporting the economy.
This is so wrong for so many reasons. First, what happens to the businesses that these CEOs leave? Assuming these CEOs are better at running those companies than an alternative manager (if they are not why did they get the job in the first place?) then when these guys leave that firm will perform worse than it is now. If they are less efficient what happens to the employment levels at these firms? Second would these people really start up new firms? Why not just go overseas where they can get paid what they are worth? The market for company managers is international. This means that to get the best we have to pay the going international wage. A lower wage just means we would have less able managers running our biggest companies. As an example consider the problems of getting good managers for cooperatives which often have flat pay scales and limits on how large the CEO's pay can be. Ricketts (1999: 20) explains the problem as "[f]urther, to minimise antagonism a rough equality in the division of the residual will be necessary and this may conflict with outside opportunities. Those with high transfer earnings reflecting high productivity elsewhere will desert the co-operative." Jossa (2009: 709-10) explains the basic issue in terms of the management of capitalistic versus co-operative firms: "[g]iven the tendency of cooperatives to distribute their income equitably among all the members, it is difficult to deny that few cooperatives are in a position to pay the high salaries that able managers can expect to earn in capitalistic firms. Whenever a group of people resolve to work as a team-we may add-the member who outperforms the others in initiative and organizational skills will inevitably take the lead. The crux of the matter is that such a person has no incentive to establish a cooperative and share power and earnings with others. He or she will prefer to found a capitalistic firm, where he or she will hold all authority and, if sole owner, appropriate the whole of the surplus [references deleted]. Thirdly, I would assume that Wood assumes there would be more small firms in the economy. What does this mean for economies of scope and scale. Firms are big for a reason, and reducing the size of currently large firms or making them less efficient - see above - doesn't help the economy. Fourth, Wood says that,
The millions of dollars that would have been paid to CEOs could instead be paid as bonuses to workers, or used to lift the average wage of employees at the company.
Except this assumes that the same level of profit will be made after the CEO leaves the company as before, but will it? Not only are profits likely to be lower due to less able mangers running the company but the incentive effects on lower level mangers will also be reduced. Part of the reason lower level mangers work hard is to became the top guy. But if its not worth becoming the top guy given that the benefits of being at the top have been reduced, why work hard? Fifthly, Wood assumes that demand is what matters for the economy. He writes,
These people [workers] could then spend their extra income, further supporting the economy.
Even if workers marginal propensity to consume is higher than that of managers this just means their marginal propensity to save is lower and thus we get less saving in the economy. And aren't we always being told we don't save enough? Six, if big firms become less efficient, what happens to our exports? Many of our biggest firms are exporters and they would become less competitive. Seven, one way to make an manager act more like an owner  is to use some form of performance pay. This aligns the incentives of the manager with those of the owner. Basically you make the manager's pay dependent on the profits of the firm. Have, say, a base wage of $200,000 and then make up the rest of the competitive wage via some type of performance pay which gets around whatever regulation is put in place. This would be much like the manager of the firm being the owner and getting the dividends of the firm. A lower basis wage would mean a higher performance component to the wage. The problem here is that, as has been shown via sometimes bitter experience, performance pay can have unintended consequences and lend to more risk-taking by the managers along with other measures to manipulate the factors that are included in the performance part of his pay package. All this can negatively effect the performance of firms, in extreme cases bankrupting them. Next, Wood argues,
The creation of new companies will in turn lead to more jobs, thus negating the need for any "starting-out" wage.
But the argument for a "starting-out" wage has nothing to do with the number of firms or jobs, its about the productivity of workers. Young workers just starting out in employment are less experienced and skilled and therefore less productive than older workers. The lower wage they get reflects this lower productivity. If you have to pay a low productivity worker the same as a higher productivity worker it is the latter that you will employ.

Update: As far as the exCEOs will become entrepreneurs argument is concerned, it should be noted that they had this option even without the incentive offered by the maximum wage and didn't take it. Given they don't appear to want to be entrepreneurs is the wage limit really likely to be enough to get them to change into entrepreneurs rather than just moving out of New Zealand to continue with their preferred option? An additional point I should have made when discussing the effects on exporters is the effects on those firms which compete with imports. If they become less efficient then we could not only lose jobs among out exporters but also among import substitution firms.

Update 2: Welly Gnome writes on the Dunce of the Week: Ryan Wood and Kiwiblog writes on A maximum wage.

Update 3: On the idea that managers may not become entrepreneur I should have remembered this footnote from a paper of mine on the difference between the skills and personality types of managers and entrepreneurs.
"See, for example, McCelland (1961) and Beugelsdijk and Noorderhaven (2005) for discussions of the link between personality type and employment preferences. Fuchs-Schundeln (2009) looks at the preference for being self-employed and finds that the self-employed report higher job satisfaction than the employed. Hartog, van Praag and van der Sluis (2010) compares the effects of cognitive and non-cognitive abilities on the performance (measured by income) of entrepreneurs and employees. Their results show a markedly different returns for entrepreneurs and employees. Bandiera, Prat, Guiso, and Sadun (2011) show that managers' risk aversion and talent are correlated with the incentives they are offered and, through these, with the characteristics of the firms that hire them. So managers with different characteristics are matched with firms with different characteristics."
In other words its not clear that managers and entrepreneurs would want to be in the role of the other.

Dumb reactions to the Nobel (updated)

Some of the reactions to the recent Nobel Prise win by Alvin E. Roth and Lloyd S. Shapley seem to me to be just dumb. Peter Klein at the Organisations and Markets blog writes,
Market design is basically the study of exchange without prices.
I would think that this is not so much dumb as wrong. One of the examples of market design that Roth himself gives is he auctioning of radio spectrum by many governments and there were prices there, very large prices!

But worse I think is the reaction from some "free market" types. Klein writes,
Enthusiasm among my informal circle of professional friends is muted. One suggests that, rather than take cultural resistance to the price mechanism (e.g., for kidney allocation) as exogenous, scholars should work to overcome this resistance.
David Henderson at the EconLog blog is another example of this basic argument. He writes,
With human organs, we know the answer: it's to allow free markets so that thousands of people can make some extra money, either by contracting to have their organs to removed after their death or by selling a spare organ, such as a kidney or a piece of their liver, when alive. Now that that question is answered, where is my Nobel?
While David is right that the best answer is a market for things like kidneys, the reality is that we don't have and will not have in the near future, a free market in such things. But people are dying right now because of inefficiencies in the current organ (non)market. We need to do the best we can right now given the constraints we face right now. This is what Roth's work on market design does. It improves the efficiency of the current (non)market and saves lives in the process. As Virginia Postrel writes, - and David Henderson quotes in an update to his post -
Yet unlike the economists, wonks and polemicists who rail against the prohibition of organ sales, Roth can claim credit for actually increasing the number of kidney transplants. "Alvin Roth has been a major contributor to the fastest-growing source of transplantable kidneys in America, and probably in the world, through paired donation," says Rees.
In short Alvin Roth has literately saved lives. The free-market argument is letting the perfect get in the way of the good.

Update: Eric Crampton writes on Kidney Counsels of Despair

Tuesday, 16 October 2012

Offshoring and middle-income workers

A point about the wage distribution noted by labour economists has been about a relative decline in wages at the middle of the income distribution relative to wages at the top and bottom, or a 'polarisation' of the labour market. In the 1980s and 1990s the trend was a more straightforward increase in income inequality between high- and low-wage workers, with wages over time increasing more or less monotonically with a worker's position in the income distribution. Yet sometime around the start of the new millennium that pattern shifted, with relative wage gains concentrated at both the top and the bottom of the distribution and relative losses in the middle.

In an article at Lindsay Oldenski offers new evidence on the relationship between this polarisation of the labour markets and offshoring. Oldenski writes about a new working paper (Oldenski 2012),
The results show that when the share of offshoring increases in a given industry, there is a significant increase in the gap between wages earned by workers in the highest-paid occupations relative to workers in the median-wage occupation in that industry. At the same time, the gap narrows between wages earned by the lowest-paid workers and workers in the middle of the distribution.

The relationship between offshoring and polarisation is driven by two important forces. The first, which has been mentioned in earlier work on polarisation, is the relative ease with which different types of occupational tasks can be fragmented across borders. The second, which has been neglected in the labour literature, is comparative advantage.

First, fragmenting the production process in a way that moves certain intermediate inputs or processes to another country is easier for some types of tasks than for others. For example, activities that involve direct interaction with consumers, such as haircuts or food service, are extremely difficult to offshore while those that are not location specific, such as data entry, can be performed anywhere. In addition, firms are more likely to offshore routine tasks and keep non-routine tasks in their headquarters. Routine tasks can easily be broken down into a clear set of steps, which can then be communicated to someone located in another country. Non-routine tasks involve decision making, problem solving, or creativity. These non-routine tasks are both more difficult to communicate to overseas contractors or foreign affiliates and more crucial to a firm's core mission or strategy, and thus they are more likely to be performed in a company's US headquarters rather than offshored.
But, argues Oldenski, if you focus just on the ease with which a given task can be traded you do not get the whole story. She continues,
Many extremely high-skilled tasks, such as engineering and research, are becoming increasingly tradable as well. Yet US workers in professions that require these tasks have seen their wages rise. Interactions between offshorability (or, more accurately, tradeabilty) and comparative advantage can explain both the overall widening of the wage gap in the US, as well as disproportionate gains for workers at the top of the skill distribution and disproportionate relative losses for workers in the middle of the distribution. Non-routine and communication intensive occupations are concentrated at both the top and the bottom of the skill distribution in the US. However, US workers at the top of the distribution also perform the jobs in which the US has comparative advantage. Thus we should expect these high-skilled, high-wage workers to gain the most from the increased tradeability of certain tasks both because the areas they specialise in are activities that are more in demand in the US as trade expands and because they are made more productive by the availability of cheaper complementary low-skilled tasks through offshoring. Middle-skilled workers gain the least, as they are not in occupations for which the US has comparative advantage and are also more likely to perform routine, easily offshorable tasks. Workers at the bottom of the distribution are not in sectors in which the US has comparative advantage, yet many of the tasks they perform are either non-routine manual or location specific and thus less vulnerable to offshoring than middle-skill jobs.
The conclusion Oldenski reaches is,
New evidence shows that there is indeed a link between offshoring and relative declines in the wages of middle-skilled workers. However, it also shows that offshoring has had a positive effect in terms of increasing the demand for workers in the most highly skilled, highly paid jobs. Given the benefits of offshoring, the policy message this election season should not be to try and restrict offshoring, but rather to find ways to match workers to the areas where labour demand is growing. This paper suggests that a focus on training workers to perform more highly skilled, non-routine and communication intensive occupations is one component of that policy.
  • Oldenski, Lindsay. (2012), (Offshoring and the Polarization of the US Labor Market), Working Paper.

2012 Nobel Prize in Economics 2

From the Nobel website,
The Royal Swedish Academy of Sciences has decided to award The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for 2012 to

Alvin E. Roth
Harvard University, Cambridge, MA, USA, and Harvard Business School, Boston, MA, USA


Lloyd S. Shapley
University of California, Los Angeles, CA, USA

"for the theory of stable allocations and the practice of market design".

Stable allocations – from theory to pratice

This year's Prize concerns a central economic problem: how to match different agents as well as possible. For example, students have to be matched with schools, and donors of human organs with patients in need of a transplant. How can such matching be accomplished as efficiently as possible? What methods are beneficial to what groups? The prize rewards two scholars who have answered these questions on a journey from abstract theory on stable allocations to practical design of market institutions.

Lloyd Shapley used so-called cooperative game theory to study and compare different matching methods. A key issue is to ensure that a matching is stable in the sense that two agents cannot be found who would prefer each other over their current counterparts. Shapley and his colleagues derived specific methods – in particular, the so-called Gale-Shapley algorithm – that always ensure a stable matching. These methods also limit agents' motives for manipulating the matching process. Shapley was able to show how the specific design of a method may systematically benefit one or the other side of the market.

Alvin Roth recognized that Shapley's theoretical results could clarify the functioning of important markets in practice. In a series of empirical studies, Roth and his colleagues demonstrated that stability is the key to understanding the success of particular market institutions. Roth was later able to substantiate this conclusion in systematic laboratory experiments. He also helped redesign existing institutions for matching new doctors with hospitals, students with schools, and organ donors with patients. These reforms are all based on the Gale-Shapley algorithm, along with modifications that take into account specific circumstances and ethical restrictions, such as the preclusion of side payments.

Even though these two researchers worked independently of one another, the combination of Shapley's basic theory and Roth's empirical investigations, experiments and practical design has generated a flourishing field of research and improved the performance of many markets. This year's prize is awarded for an outstanding example of economic engineering.
Additional information is available here. Joshua Gans notes A Nobel Prize for Market Design.

In this paper Alvin Roth himself asks: What have we learned from market design? Update to Roth (2008). The abstract reads:
"After a market has been designed, adopted, and implemented, it has a continuing life of its own. For those involved directly in the market, it is useful to continue to monitor it to make sure it is functioning well. For those of us involved in market design, it is also good to check how things are going, as a way to find out if there are unanticipated problems that still need to be addressed. Finally, the design and operation of new marketplaces also raises new theoretical questions, which sometimes lead to progress in economic theory. In this update, I’ll briefly point to developments of each of these kinds, since the publication of Roth (2008), What have we learned from market design?. I’ll discuss theoretical results only informally, to avoid having to introduce the full apparatus of notation and technical assumptions."
The 2008 paper referred to is available from: Roth, Alvin E. "What have we learned from market design?" Hahn Lecture, Economic Journal, 118 (March), 2008, 285-310. Roth also writes about The Art of Designing Markets in the Harvard Business Review. Lynne Kiesling writes on the Roth/Shapley Nobel at the Knowledge Problem blog.

EconTalk this week

Arnold Kling, economist and teacher, talks with EconTalk host Russ Roberts about recent technological innovations in education and Kling's forecast for their impact on learning and how they might affect traditional education. Examples include the recent explosion of online lessons and classes, new teaching styles that exploit those offerings, and the nature of learning in various kinds of classrooms and student-teacher interactions.

2012 Nobel Prize in economics

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2012 was awarded jointly to Alvin E. Roth and Lloyd S. Shapley "for the theory of stable allocations and the practice of market design"
More on this later.

Monday, 15 October 2012

Wren-Lewis on Haldane on economics

As I have noted before Andrew G Haldane has asked the question, What have the economists ever done for us? In this article Haldane makes two claims,
“Two developments – one academic, one policy-related – appear to have been responsible for this surprising memory loss. The first was the emergence of micro-founded dynamic stochastic general equilibrium (DGSE) models in economics. Because these models were built on real-business-cycle foundations, financial factors (asset prices, money and credit) played distinctly second fiddle, if they played a role at all.

“The second was an accompanying neglect for aggregate money and credit conditions in the construction of public policy frameworks. Inflation targeting assumed primacy as a monetary policy framework, with little role for commercial banks' balance sheets as either an end or an intermediate objective. And regulation of financial firms was in many cases taken out of the hands of central banks and delegated to separate supervisory agencies with an institution-specific, non-monetary focus.”
Now at Simon Wren-Lewis takes issue with Haldane's claims:
There is obviously some truth in this, but are these really major factors behind the financial crisis? Imagine looking at the following chart in 2005 or 2006. The increase in leverage that began in 2000 is both dramatic and unprecedented. (Much the same is true for the US.) Was this ignored because central bankers said this variable is not in their DSGE models? In my experience those involved in monetary policy look at a vast amount of information, particularly on the financial side, even though none of it appears in standard DSGE models, and even though their ultimate target might be inflation. For some reason monetary policymakers discounted the risks this explosion in leverage posed, or felt for some reason unable to warn others about it, but I very much doubt these reasons had anything to do with DSGE models.

Figure 1. UK bank leverage

I say this because to place too much weight on the culpability of DSGE models and inflation targeting can lead to overreaction, and may sideline more fundamental issues.[ ... ] Let me take overreaction first. It is one thing to claim, as I have, that the microfoundations approach embodied in DSGE models encouraged macroeconomists to avoid modelling difficult (from that perspective) issues like the role of financial institutions in credit provision. It is quite another to suggest, as some do, that DSGE models are incapable of doing this. This second claim was false before the crisis (e.g. Bernanke, Gertler & Gilchrist, 1999), and has clearly been shown to be false by the post crisis explosion of DSGE work on financial frictions. Forming a rough consensus around a reasonably simple and tractable model of the crisis that can also assess the subsequent policy response will not happen overnight (it never does), and I suspect it will involve tricks which microfoundation purists will complain about, but I’m pretty certain it will happen.

Andy Haldane talks about the need to model the interconnections (networks) of actors and institutions in order to understand how sudden crises can emerge. This must be right, and recent work that begins to do this looks very interesting. However what seems to me critical in avoiding future crises is to understand why leverage increased (and was allowed to increase) in the first place, rather than the specifics of how it unravelled. As I suggested here, we may find more revealing answers by thinking about the political economy of how banks influenced regulations and regulators, rather than by thinking about the dynamics of networks. We should also look at the incentives within banks, and why short term behaviour in the financial sector may be increasing, as Haldane himself has suggested. Investigating networks is clearly interesting, important and should be pursued, but other avenues involving perhaps more conventional economics and political economy may turn out to be at least as informative in understanding how the crisis was allowed to develop.

Sunday, 14 October 2012

Why Paul Krugman is wrong about the recession

Professor Steve Horwitz debunks Paul Krugman's myths about the recession and explains why the Keynesian path to recovery won't help us, and how free market policies will.

Saturday, 13 October 2012

Why Hayek matters

Eamonn Butler talks to the Adam Smith Institute about the relevance of the ideas of Friedrich Hayek to understanding contemporary economic issues. Watch it, if only for the opening line.

Interesting blog bits

  1. John Taylor gives a Simple Proof That Strong Growth Has Typically Followed Financial Crises
    People are looking for answers to why the economy is growing so slowly. Is the answer that economic growth is normally weak following deep recessions and financial crises, as, for example, Kenneth Arrow argued in the presidential election event with me this week at Stanford? Or is poor economic policy the answer, as I argued?
  2. The Pin Factory blog raises The problem of BBC bias
    The Chairman of the BBC Trust, Chris Patten, has launched an enquiry into impartiality in BBC news reporting. It should be noted that the BBC controls 60% of the broadcast news audience in the UK, which makes a mockery over any fears that Sky might pose a threat to competition in the market. The BBC is required by its statutes to adhere to impartiality in its reportage. This position is reinforced by the requirement that all broadcasters in the UK present impartial views on news. Clearly this presents some serious issues for freedom of speech; it allows politicians and bureaucrats to have general oversight over the content of news broadcasts as they are in a position to arbitrate what constitutes impartiality.
  3. Welly Gnome on Lee Hsien Loong in the Herald
    Singapore’s leader Lee Hsien Loong has a great op-ed in the Herald today.He talks about the strong links between New Zealand and Singapore, and the opportunities for New Zealand to use Singapore as a launching pad for doing business in Asia.
  4. Jacob Funk Kirkegaard on Youth unemployment in Europe: More complicated than it looks
    Youth unemployment in the Eurozone looks like a social and economic disaster in the making – 30%, 40%, even 50% of young people sitting on their hands instead of building skills and experience. This column argues the headline numbers are misleading. While youth unemployment is a serious problem, a large share of EZ youth are not in the labour force, so the headline figures overstate the labour-market ‘scar tissue’ that will be left over from the crisis.
  5. Anders Olofsgård on Why political short-sightedness and randomised control trials can be a deadly mix for aid effectiveness
    The recent focus on impact evaluation within development economics has led to increased pressure on aid agencies to provide evidence from randomised controlled trials. This column argues this reinforces a political bias towards immediately verifiable and media-packaged results at the expense of more long-term and complex processes such as institutional development.
  6. Daron Acemoglu and James Robinson on The Sad State of Civil Liberties
    Two excellent articles in the latest issue of The New York Review of Books powerfully underscore the sad state that respect for civil liberties has sunk in the United States in the 11 years since the war on terror was declared (and yes, we know that US record of civil liberties wasn’t always exemplary before then, but still). Perhaps it’s in the nature of declaring war against concepts that takes us down the slippery slope.

Thursday, 11 October 2012

Economists agree, but will the Greens listen?

It is often said that economists never agree. But when it comes to the Green's ideas on quantitative easing we seem to have a case where they do agree. Matt Noan doesn't like the idea here, Eric Crampton doesn't like it here and Bill Kaye-Blake doesn't like it here.

Now David Mayes, Professor of Finance at Auckland University, has been saying why he doesn't like the idea in the New Zealand Herald. Mayes writes,
Printing money is usually a last resort that seriously troubled countries use to stave off collapse, and not some mysterious trick that other nations have conjured up to achieve quick riches. More often than not it is disastrous, which is why it is not permitted under the EU Treaty.

New Zealand has definitely not run out of opportunities to use conventional monetary and fiscal policy if it feels the economy faces a lack of demand. So why move to the unconventional now?

Quantitative easing is used when short-run nominal interest rates have been lowered to zero and it is still necessary to expand the economy. If the central bank then buys longer dated bonds or other financial securities (including commercial paper or mortgages from the private sector), it may continue stimulating the economy.

Evidence from a symposium being published by The Economic Journal suggests that this is achieving a little in the United Kingdom, the United States and the Euro area.

The problem is that it only works well if people fear major inflation and rush out to buy before prices rise. Once growth re-establishes again, the central bank sells all assets and mops up the extra money before inflation gets out of hand. That of course explains why it doesn't really work. If inflation is going to be headed off, then why buy now? Hence the weak effect.

Thus quantitative easing needs to be on a massive scale if it is to work. What central banks worry about now is how to extricate themselves elegantly from massive distortion, when the world economy turns round for the better. It has not been done before, so the chances of it going badly are high. After all, the easy monetary policy after the dotcom boom and the 9/11 disaster have turned out to be a significant cause of the present crisis.
In short, printing money is not a good idea. We don't need to do it and when it has been done it hasn't been very effective. Mayes continues,
Dr Norman's proposed scheme goes further. The Reserve Bank will buy Government earthquake recovery bonds to help pay for the Christchurch rebuild, and buy overseas assets to restore the Earthquake Commission's Natural Disaster Fund. Rather than borrowing government money to do this, it will simply create it. There lies the trick.

Maybe investors won't see through this, there will be little short-run impact and the inflationary pressure can be quietly reduced by restraint in the upturn. However, it could also weaken international confidence in the central bank's independence and New Zealand's commitment to fiscal prudence, hence increasing the price of new and renewing debt. Do we feel lucky?
Do we feel lucky? No would seem the obvious answer. The last thing we need is to have a Reserve Bank that is not independent of the government. Didn't the Muldoon years teach us at least this much?

So economists agree, but will politicians take notice?

Wednesday, 10 October 2012

A new way to understand consumer surplus

At Jeremy Bulow and Paul Klemperer have a new article on A new way to understand consumer surplus, price controls, and rent seeking.

Bulow and Klemperer show that consumer surplus in any market equals the area between the demand curve and the industry marginal-revenue curve. They argue that this observation has interesting implications for understanding rent seeking and price controls. For example, a price control reduces consumer surplus in an otherwise-competitive market with convex demand whenever supply is more elastic than demand.

Consumer surplus as conventionally defined (that is, the sum of consumers’ valuations less the prices they pay) can be computed as the difference between industry demand and industry marginal revenue of the units supplied. In the figure below consumer surplus equals areas I plus II but also equals areas II plus IV.

This is because both areas I plus III and III plus IV give you total revenue. And thus area I equals area IV.

Bulow and Klemperer use this idea in two examples.
Price controls often hurt consumers

Textbook analyses of rationing typically focus on the cost of reduced supply. But the available supply will not necessarily be allocated to those with the highest values, and rent-seeking behaviour, such as queuing, lobbying, and search costs, also dissipates surplus. When do these costs outweigh the benefits of lower prices, so that price controls reduce consumer surplus?

Measuring consumer surplus using marginal revenues provides crisp answers. In Bulow and Klemperer (2012) we show that if output is allocated randomly among those prepared to pay more than the controlled price and supply is more elastic than demand, then a price control in an otherwise competitive market always hurts consumers if the industry marginal-revenue curve is no more than twice as steep as the demand curve. This condition holds if demand is convex, e.g., linear, log-linear, etc.

Even with completely inelastic supply, total consumer surplus falls whenever the marginal-revenue curve is less steep than demand. This condition holds if demand is log convex; constant elasticity is one example.

So, as a group, consumers (as well as producers) would often gain from higher prices that avoid rationing. Rationing typically hurts consumers far more by allocating goods to the wrong people, than by the reduction in supply described in the standard textbook calculations which assume efficient rationing.
Rent seeking

Our approach is particularly powerful for modelling phenomena such as rent seeking.

The reason is that consumers who have to make expenditures on search, queuing, lobbying, or other rent seeking are, in effect, paying different prices for the goods they receive. And measuring consumer surplus as the area between demand and price is hard if every consumer is facing a different (effective) price, and these (effective) prices also depend on the details of the context. But total consumer surplus is still easily measured as the sum of buyers’ values minus their marginal revenues, since buyers’ marginal revenues do not change even when their (effective) prices change.

So, for example, it is easy to show that, for an extremely wide class of models, the previous results about rationing are unaffected by rent-seeking behaviour. Though rent seeking leads to allocation of goods that is more efficient than random, the costs it dissipates mean a price control is guaranteed to hurt consumers under exactly the same conditions that applied with random allocation.

The same methods extend the results to models that include resale, and to partially controlled markets. Our analysis does ignore distributional issues – even when price controls reduce aggregate consumer surplus, they redistribute it among consumers. But in sum, and especially if supply is fairly elastic, it is unlikely we can be confident that consumer surplus is enhanced by any price control.

Similar techniques can also be applied to producer surplus, and rent seeking by producers, for example, the social costs of lobbying for import quotas, etc.

Bulow, Jeremy, and Paul Klemperer (2012), “Regulated Prices, Rent-Seeking, and Consumer Surplus”, Journal of Political Economy 120 (1): 160-86.

Interview with John List

From the Federal Reserve Bank of Richmond comes an interview (pdf) with University of Chicago economist John List.
In the 1950s, Vernon Smith — then teaching at Purdue University and influenced by the work of Edward Chamberlin, one of his instructors at Harvard University — began conducting experiments to see how people responded to various market incentives and structures in a laboratory-type environment. At first, many economists questioned the importance of those experiments’ results. But by the 1970s, others, including Charles Plott of the California Institute of Technology, began using experiments to better understand decision making in various market settings, and in 2002 Smith was awarded the Nobel Prize in economics along with the psychologist Daniel Kahneman of Princeton University.

In the mid-1990s, John List, who believed that experimental work had provided unique insights into human behavior, began conducting experiments of his own, but in the field rather than in the lab. By setting up carefully designed experiments with people performing tasks they are used to doing as part of their daily lives, List has been able to test how people behave in natural settings — and whether that behavior is consistent with economic theory. List’s field experiments, like Smith’s lab experiments, were initially greeted with skepticism by many economists, but that has changed over time. List has published more than 150 articles in refereed academic journals during the last 15 years, many on field experiments and related work.

List began his career at the University of Central Florida, with stops at the University of Arizona and the University of Maryland before arriving at the University of Chicago in 2005. While at Maryland, List served as a senior economist with the President’s Council of Economic Advisers, working largely on environmental and natural resources issues. He is co-editor of the Journal of Economic Perspectives and serves on the editorial boards of several other journals. Aaron Steelman interviewed List at his office in Chicago in May 2012.

Tuesday, 9 October 2012

EconTalk this week

Garett Jones of George Mason University talks with EconTalk host Russ Roberts about the ideas of Irving Fisher on debt and deflation. In a book, Booms and Depressions and in a 1933 Econometrica article, Fisher argued that debt-fueled investment booms lead to liquidation of assets at unexpectedly low prices followed by a contraction in the money supply which leads to deflation and a contraction in the real side of the economy--a recession or a depression. Jones then discusses the relevance of Fisher's theory for the current state of the economy in the aftermath of the financial crisis.

Monday, 8 October 2012

Interesting blog bits

A short one on the reaction to the Green's ideas of QE.
  1. Matt Nolan on No QE “free lunch” for NZ
    As a general rule of thumb, whenever someone offers you something for nothing they aren’t telling you the full story – and that is exactly what we have with the Greens stating the Reserve Bank should start rebuilding Christchurch themselves by printing money.
  2. Eric Crampton on Paying for earthquakes
    Matt Nolan walks us through why quantitative easing to pay for the Christchurch Rebuild isn't particularly good policy. If we need a monetary push, the place to start is interest rates - and then only if RBNZ thinks we're going to be below the 1% lower inflation bound over the medium term. If we need a fiscal push, which is highly debatable, doing it through earthquake spending might not be as helpful as the Greens might like - especially as regulatory bottlenecks and regulatory capacity constraints in Christchurch seem to be holding things up at least as much as money.
  3. Bill Kaye-Blake on Greens solving the wrong problem
    It looks like the Greens are trying to import the US solution to a problem we don’t have.
  4. Not PC on Russel Norman wants to make bankers richer, and wage-earners poorer
    The world is full of monetary cranks. Russel Norman is one of them. If the Reserve Bank were to go out and print $2 billion of new money, as Russel Norman wants them to, are we all better off?
  5. Liberty Scott on Russel Norman says "fuck the poor" with his economic illiteracy
    It's a shame really, you can rely on Russel Norman to engage in reality evasion, but his latest attempt to introduce monetary policy into the Green Party's repertoire is laughable.
  6. Kiwblog on Greens literally believe money does grow on trees
    I thought this madness died with Social Credit, but Greens (and Labour may not be far behind) have said that they want the NZ Reserve Bank to effectively start printing money. They think that NZ printing more money is a good way to increase the relative value of the US dollar. We might as well start burning our savings.
  7. Homepaddock on Green snake oil on sale
    The Green Party has come up with what co-leader Russel Norman calls a suite of measures to address the high value of the kiwi dollar.

Sunday, 7 October 2012

The family owned farm

Over at Homepaddock Ele Ludemann is discussing the ownership of farms and the profitability of farms:
These are usually larger family owned businesses. They have economies of scale that smaller ones lack and don’t have problems of governance and management which often dog corporate farms.

However, while profitability is essential for the long-term health of any business, money isn’t all that matters.

From my observation family owned and run farms are more likely to take a longer term view and seek to balance economic, environmental and social factors in their businesses.
This obviously is an important (and interesting) topic for a farming country like New Zealand. As noted by Ele an odd fact about farming is that family-based firms still dominate the industry. This is unusual given that most other industries are dominated by investor owned firms, so why isn't farming?

The short answer given by Allen and Lueck (1998) and Allen and Lueck (2002) is "nature". They argue that farms operate in unique circumstances defined by nature, in particular seasonality. This is the main feature that distinguishes farm organisation from industrial organisation.

For farmers a season is a distinct period of the year during which a given activity is optimally undertaken. This is key to understanding the why the incentives generated within agriculture favour family farms. The two basic issues are opportunities for hired workers to shirk due to random production shocks from nature and the limits on the gains from specialisation and the timing problems caused by seasonality. The trade-off between effect work incentives and gains from specialisation help determine the costs and benefits of different farm organisational types.

The family farm model provides the best work incentives since the owner is the sole recipient of the benefits, but this model misses some benefits due to specialisation. This follows from the fact that the farmer must engage in numerous different tasks during each stage of production, and in addition, numerous production stages throughout the year.

On the other hand, large factory-style corporate farms gain from a specialised labour force and lower cost of capital, but suffer from bad worker incentives since hired workers, not being one of the owners, have an increased incentive to shirk.

To some degree all firms are governed by the trade-off between gains from specialisation and work incentives. For the case of farming it is the unique, large impact of nature that biases it towards family operations.

An obvious, but key, feature of agriculture is that it involves a living, growing product. In the case of livestock, for example, you have breeding, husbandry, feeding and slaughter. Such a cycle is largely governed by nature. In principle there is no reason that a different farmer could not own each stage. But timing difficulties between stages result in high costs of engaging in market transactions. Such timing issues are particularly severe in farming because the inventories of the intermediate goods cannot be held given the living nature of the product.

There are a number of factors, such as the number of crop cycles, the length of the production stages and the number of tasks within a stage, which also influence wage labour incentives. When cycles are few, stages are short, random shocks are large and the tasks are few, there is little to gain from specialisation and labour is especially costly to monitor. Thus family farms.

If these issues can be overcome, that is, if farmers can mitigate seasonality and random shocks to output, farm organisation starts to look much like that in the rest of the economy. Under such conditions farm organisation will gravitate towards factory process and develop the large-scale corporate forms of other sectors of the economy.

Another issue that family ownership of farms raises for theory of the firm types is, Are farms firms? An answer of Yes may seem obvious, but a little thought could suggest otherwise.

In Spulber (2009) Daniel Spulber defines a firm
"[ ... ] to be a transaction institution whose objectives differ from those of its owners. This separation is the key difference between the firm and direct exchange between consumers". (Spulber 2009: 63).
Note that under this definition organisations such as family owned farms - along with other types of family owned businesses, clubs, basic partnerships, worker cooperatives, non-for-profit organisations and public enterprises - are not firms. The basic reason being that the objectives of these types of organisations cannot be separated from those of their owners.

  • Allen, Douglas W. and Dean Lueck (1998). "The Nature of the Farm", Journal of Law and Economics, 41: 343-86.
  • Allen, Douglas W. and Dean Lueck (2002). The Nature of the Farm: Contracts, Risk, and Organization in Agriculture, Cambridge Mass.: The MIT Press.
  • Spulber, Daniel F. (2009). "The Theory of the Firm: Microeconomics with Endogenous Entrepreneurs, Firms, Markets, and Organizations", Cambridge: Cambridge University Press.