Wednesday, 29 May 2013

Incentives matter: physician motivation file

Using Performance Incentives to Improve Medical Care Productivity and Health Outcomes

Paul Gertler, Christel Vermeersch

NBER Working Paper No. 19046
Issued in May 2013
NBER Program(s): CH DEV HC HE LS
We nested a large-scale field experiment into the national rollout of the introduction of performance pay for medical care providers in Rwanda to study the effect of incentives for health care providers. In order to identify the effect of incentives separately from higher compensation, we held constant compensation across treatment and comparison groups – a portion of the treatment group’s compensation was based on performance whereas the compensation of the comparison group was fixed. The incentives led to a 20% increase in productivity, and significant improvements in child health. We also find evidence of a strong complementarity between performance incentives and baseline provider skill.

Interesting blog bits

Some good mid-week reads:
  1. Diego Comin, Martí Mestieri on Technology and income dynamics: 1800-2000
    Cross-country inequality is persistent. This column draws on economic history to explain the mechanisms by which dramatic cross-country differences in income emerge. We can reduce inequality through policies that facilitate the penetration of new technologies in poor and middle-income countries. Such policies can go a long way towards reducing existing cross-country income disparities.
  2. Carmen M. Reinhart and Kenneth S. Rogoff write a Dear Paul letter.
    Reinhart and Rogoff fire back at Paul Krugman.
  3. Daron Acemoglu and James Robinson on The Economic Nature of the Resource Curse: Mechanisms
    We saw in our last post that cross-national evidence suggests countries with poor institutions, such as lack of checks and balances or high levels of corruption, experience economic contractions when they discover natural resources? The question is why.
  4. Jeremy Greenwood, Philipp Kircher, Cezar Santos and Michèle Tertilt on An equilibrium model of the African HIV/AIDS epidemic
    How can we accurately model the African HIV/AIDS epidemic? This column presents new research that uses computational general equilibrium models to map the spread of HIV/AIDS. Emphasising the importance of understanding behavioural adjustments and equilibrium effects, this new way of modelling the epidemic may well prove a useful tool for further research.
  5. Ben Southwood asks Does speculation really harm the world's poor?
    Development activist Deborah Doane said yesterday on comment is free that Goldman Sachs should admit it drives food prices up through speculation. She excoriates the finance giant for what she sees as its role in 44m across the world being in food poverty, suggesting its charitable efforts amount to little given its speculative activities.
  6. Eli Berman, Joe Felter, Jacob N. Shapiro and Erin Troland on Effective aid in conflict zones
    Can foreign aid help countries emerge from civil war? This paper presents new research that suggests that injecting lots of money into conflict zones may in fact encourage corruption and violence. The aid community should focus on what it can do well: working closely with communities to target small-scale, modest improvements that can be implemented in conflict zones. If accompanied by a gradual improvement in the quality of governance, current aid recipients can aspire to a long-run improvement in both security and prosperity.
  7. Danielken Molina and Marc Muendler on Preparing to export
    Exporting is essential for economic development. But can firms move from local sales to export sales? How do firms prepare for exporting? This column presents new research showing that worker mobility is an important mechanism by which exporter knowledge spreads through the economy.
  8. Gary Becker asks China’s Tilt Toward the Private Sector?
    In a speech this month to Communist party officials (reported in yesterday’s New York Times), Li Keqiang, the recently chosen Prime Minister of China, called for greater reliance on the private sector and reduced dependence on governmental regulations and oversight of the economy. In a remarkable admission he said “The market is the creator of social wealth and the wellspring of self-sustaining economic development.” Several troubling developments in the Chinese economy led to Li’s speech.
  9. Richard Posner on The Chinese Economy
    I don’t know what the future holds, but it wouldn’t surprise me if the Chinese rate of economic growth plummeted. There are many negatives in China’s economic picture. The obvious one is the state-owned enterprises, which account for about half of total Chinese output. They are inefficient and corrupt, but also deeply entrenched, with numerous links to the communist officialdom that runs the country.

Tuesday, 28 May 2013

How not to run a business: examples of poor SOE performance

In a previous posting I noted that
By the late 1970s-early 1980s the sceptical minority was becoming larger, the mood was turning against government ownership [of firms] among both politicians and economists.
One of the motivating forces for politicians and economists rethinking their position on state-owned enterprises was a history of under performance by these firms worldwide. Some of the more extreme cases of poor SOE performance that have been publicised include:

McDonald (1991) outlines the case of the Hindustan Fertiliser Corporation in Haldia, West Bengal, India. By 1991 the firm had been operating for twelve years and employed twelve hundred workers. Yet up to that time the enterprise had not produced a single kilogram of fertiliser for sale!

The Economist (Economist 1994) details similar experiences in Italy: "[o]ne example was a rolling mill at Bagnoli near Naples built by Italy's state-owned steel company ILVA. Designed to create jobs in a depressed area where the Christian Democrats were strong, the plant, which took nearly a decade to complete, was never used. In Sardinia, another area of high unemployment, politicians made ENI, a state chemicals and energy conglomerate, refit a coal mine, only to leave the miners idle but on the payroll".

In France, the near-bankruptcy of then state-owned bank Credit Lyonnais is another example. In 1997 the French finance minister Dominique Strauss-Kahn admitted that the bank had probably lost around Ffr100 billion (around US$17 billion). The bank had to be bailed out three times in the 1990s. The total cost to the French taxpayer of the whole debacle has been estimated at between US$20 and US$30 billion. See the Economist (1997) for more on the affair.

With regard to the experience of the steel industry in the United Kingdom, Aylen (1988: 2) writes that in "1980/1 the [British Steel] Corporation made a total loss of pounds 1 billion on a turnover of just under pounds 3 billion, earning a place for a while in the Guinness Book of Records. [ ... ] By 1980 British Steel was fundamentally uncompetitive, with cost per tonne almost a third above those of West German producers, and by rights should not have survived". About coal, Vickers and Yarrow (1988: 331) could write, "[i]n recent years, mostly as a consequence of the combination of overinvestment in new capacity and the relatively slow rate of closure of inefficient collieries, the NCB [National Coal Board]'s continued viability has depended upon large injections of Government finance. In 1983-1984, for example, operating losses were covered by subsidies, known as deficit grants, amounting to pounds 875 million.". During a House of Commons debate on nationalisation, denationalisation and renationalisation in 1991 the then Financial Secretary to the Treasury, Francis Maude, said of the British experience with nationalised industries: "I do not wish to dwell on the record of nationalised industries in Britain. It is a sad and depressing saga in our nation's life. We all remember the British Steel Corporation, with its losses of £1 million every day of the year. We all remember British Telecom being in the Guinness Book of Records for the largest loss ever. We all remember the sloppy standards, the waiting lists for telephones, the ever-rising prices, the dingy tale of failure, the contempt for the customer, the craven management and the political interference". (Maude 1991).

The World Bank (World Bank 1995: 33-35) notes that in "Turkey, Turkiye Taskorumu Kurmu, a state-owned coal mining company, lost the equivalent of about $6.4 billion between 1986 and 1990. Losses in 1992 worked out to about $12,000 per worker, six times the average national income. Yet health and safety condition in the mine were so poor that a miners' life expectancy was forty-six years, eleven years below the national average. [ ... ] In the Philippines, the performance of the National Power Corporation steadily deteriorated from 1985 until the early 1990s. In 1990 the capital region alone lost an estimated $2.4 billion in economic output due to power outages. By 1992-93, electricity was shut off about seven hours a day in many parts of the country. In Bangladesh, in 1992 the state sugar milling monopoly had twice as many office workers as it needed, or about 8,000 extra employees. [ ... ] Meanwhile, sugar cost twice as much on the open market in Bangladesh as it did internationally. In Tanzania, the state-owned Morogoro shoe factory, built in the 1970s with a World Bank loan, never manufactured more than about 4 percent of its supposed annual capacity".

Kikeri, Nellis and Shirley (1992: 2) state that "[o]f particular concern to governments is the burden that loss-making SOEs place on hard-pressed public budgets. SOE losses as a percentage of gross domestic product (GDP) reached 9 percent in Argentina and Poland in 1989; through the 1980s about half of Tanzania's 350 SOEs persistently ran losses that has to be covered from public funds; in Ghana from 1985 to 1989 the annual outflow from government to fourteen core SOEs averaged 2 percent of GDP; and in China about 30 percent of SOEs were loss-making in 1991. The losses have important consequences: Mexico's minister of finance has noted that a fraction of the $10 billion in losses incurred by the state-owned steel complex would have been enough to bring potable water, sewerage, hospitals, and educational facilities to an entire region of the country (Aspe 1991)".

Monday, 27 May 2013

EconTalk this week

Jim Manzi, founder and chair of Applied Predictive Technologies, senior fellow at the Manhattan Institute, and author of Uncontrolled, talks with EconTalk host Russ Roberts about the Oregon Medicaid study and the challenges of interpreting experimental results. Manzi notes a number of interesting aspects of the study results that have generally been unnoticed--the relatively high proportion of people in the Oregon study who turned down the chance to receive Medicaid benefits, and the increase (though insignificant) in smoking by those who received Medicaid benefits under the experiment. Along the way, Manzi discusses general issues of statistical significance, and how we might learn more about the effects of Medicaid in the future.

Sunday, 26 May 2013

Just for fun: nationalisation/privatisation pre-1990

In an earlier posting I discussed the theory of privatisation. This theory has largely developed since around 1990. But what was the thinking before then? What was the logic behind the nationalisations of the early and mid 20 century? What was the thinking on privatisation before 1990?

Privatisation as an important economic and political issue is a relatively recent phenomenon. Even the word is of recent origin, dating back to only around 1959. (The second edition of the Oxford English Dictionary gives an etymology of the word dating back to 1959.) Before the Thatcher government came to power in the United Kingdom in 1979 and started implementing the first, widely known, privatisation programme during the 1980s, very few people anywhere around the world had heard of privatisation or knew what it meant. While there were attempts at reform involving denationalisation before the mid-to-late 1970s, such sales were sporadic and limited, and there were no systematic, on going, asset sales programmes until 1974 when the first wave of genuine privatisation started in Chile, a few years before the United Kingdom's privatisation programme got underway.

A number of commentators have argued that the early privatisation programmes weren't so much the result of the deliberate implementation of a preplanned strategy founded on a well developed theoretical base, but rather were ad hoc policies developed in practice, evolving over time, with the theory catching up later. This argument is commonly made with respect to the Thatcher governments privatisation programme in the United Kingdom. Bortolotti and Siniscalco (2004: 5) state that, ``[c]uriously, the United Kingdom embarked on the first large-scale privatization programme in the late 1970s largely on faith, as the main privatization theories were not yet developed". Pirie (1988: 9-10) notes, ``[i]t is highly significant that the election manifesto which the Conservatives put forward under Mrs Thatcher in 1979 referred to the sale of only the shipbuilding and aerospace industries and the National Freight Corporation. The fact that dozens of pieces of privatization have been successfully implemented indicates that the British government developed the techniques in practice. Privatization in Britain was not the end-result of an ideological victory in the world of ideas; it was something which was so successful in practice that the government did more of it." Arguing in a similar vein Veljanovski (1989: vii) writes, ``[t]he remarkable thing about the whole [privatisation] process is that it was unpredictable, and it followed no coherent over-arching strategy. Privatisation evolved, each sale was self-contained and each pattern of disposing of assets, from the legal requirements to the terms of sale, was ad hoc." In a review of the Thatcher government's economic policies Samuel Brittan (Brittan 1989: 6) goes so far as to argue that privatisation became an important policy plank for the Conservative government simply because it was easier to carry out than other policies: ``[ ... ] privatization was hardly mentioned in the 1979 Conservative manifesto, except for shipbuilding, aerospace and National Freight. But it became a major thread when it was found easier to carry out than many other Conservative aspirations."

In addition, Kay and Thompson (1986) lay the charge that privatisation in the United Kingdom lacked any clear rationale. They summed up their view in the title of their paper ``Privatisation: A Policy in Search of a Rationale". They argue that ``[ ... ] the reality behind the apparent multiplicity of objectives [of privatisation in the United Kingdom] is not that the policy has a rather sophisticated rationale, but rather that it is lacking any clear analysis of purpose or effects; and hence any objective which seems achievable is seized as justification." (Kay and Thompson 1986: 19). (It should be noted that the view that privatisation was not part of the Thatcher governments original objectives but was more a piece of political opportunism has been challenged by former British Chancellor of Exchequer Nigel Lawson. Lawson (1993: 199) has written, ``[t]he limited and low-key reference to denationalization in the 1979 manifesto has led many commentators [ ... ] to suppose that privatization was not part of our original programme and emerged as an unexpected development into which we stumbled by happy accident. They could not be more mistaken. The exiguous references in the 1979 Conservative manifesto reflected partly the fact that little detailed work had been done on the subject in Opposition; partly that the enthusiasts for privatization were Keith Joseph, Geoffrey Howe, John Nott, David Howell and me, rather than Margaret [Thatcher] herself; and, perhaps chiefly Margaret's understandable fear of not frightening the floating voter. But privatization was a central plank of our policy right from the start.")

Following the increased importance of privatisation in practice came a, belated, increase in interest from economists. By the early 1980s the role of the state in the economy were being increasingly questioned and it was at this time that the first formal theoretical and empirical investigations of privatisation began to appear. There were, of course, discussions of the proper role of the state before this time with consideration of the economic consequences of privatisation going back at least as far as Adam Smith. On the sale of crown lands Smith (1776: Book V Chapter II Part II p.824) famously wrote:
``[i]n every great monarchy of Europe the sale of the crown lands would produce a very large sum of money, which, if applied to the payment of the public debts, would deliver from mortgage a much greater revenue than any which those lands have ever afforded to the crown. [ ... ] The crown might immediately enjoy the revenue which this great price would redeem from mortgage. In the course of a few years it would probably enjoy another revenue. When the crown lands had become private property, they would, in the course of a few years, become well improved and well cultivated. The increase of their produce would increase the population of the country by augmenting the revenue and consumption of the people. But the revenue which the crown derives from the duties of customs and excise would necessarily increase with the revenue and consumption of the people".

In the period between the end of World War 2 and the 1980s there was some, if not vigorous, debate as to the correct economic role of government, including state ownership of firms, but there was little or no formal modelling of either privatisation or nationalisation despite the prevalence of state ownership at this time. As late as 1989 George Yarrow (Yarrow 1989: 52) could write:
``[u]nfortunately, at the theoretical level, economic analysis has not accorded a high priority to the question of the likely effects of ownership on industrial performance. Despite a number of distinguished contributions from property rights theorists, the literature is much less well developed than in other areas of the subject. Thus, as an examination of economics textbooks will show, it is hard to find convincing positive theories of public enterprise behaviour. This may be because of factors such as the complexities arising from international differences in the frameworks of accountability and control for state industries but, whatever the cause, the point is simply that, on this issue, the cupboard is remarkably bare".
During this period many governments and economists favoured, for various reasons, at least some degree of state ownership of firms. (It is interesting to note that Shleifer (1998: 135n1 and 138) argues that economists pre war and pre depression were more skeptical about state ownership; Alfred Marshall is one example:``[t]he same may be said of the undertakings of Governments imperial and local: they also may have a great future before them, but up to the present time the tax-payer who undertakes the ultimate risks has not generally succeeded in exercising an efficient control over the businesses, and in securing officers who will do their work with as much energy and enterprise as is shown in private establishments". (Marshall 1920b: 253-4). ``Starting from the fact that the growth of the national dividend depends on the continued progress of invention and the accumulation of expensive appliances for production; we are bound to reflect that up to the present time nearly all of the innumerable inventions that have given us our command over nature have been made by independent workers; and that the contribution from Government officials all the world over have been relatively small". (Marshall 1920b: 593). ``A Government could print a good edition of Shakespear's works, but it could not get them written. When municipalities boast of their electric lighting and power, they remind me of the man who boasted of ``the genius of my Hamlet" when he has but printed a new edition of it. The carcase of municipal electric works belongs to the officials; the genius belongs to free enterprise". (Marshall 1907: 22). Carlson (1994: 83) portrays Eli Heckscher's view of state ownership, in 1918, as ``Heckscher also considered the time ripe for new reflections on state enterprises. If his reasoning prior to the war had laid stress on proposals for improvements to enable state enterprises to live up to the more stringent requirements now being imposed on them, he was now (SvT 1918, p. 520) clear ``that it is a contraction and not an expansion of state business activity, even such as existed before the war, that we need." The criterion which Heckscher (1918a, pp. 6-7, 21-23) propounded for the choice between state and private enterprise was now: who will best serve the interests of the consumer? And the answer (just as with Cassel) was that private firms in a competitive environment always have a sword of Damocles hanging over them which keeps efficiency alive and weeds out incompetent companies by natural selection - ``survival of the fittest". In the case of publicly-owned corporations, however, ``their survival or death really has no connection at all with their capacity for managing their affairs" but is decided on ``political grounds or [by] prejudices concerning the expediency or otherwise of state production". Because state-owned corporations do not live under the sword, what they supply is not automatically adapted to market demand, and they are not compelled to develop new techniques and products. ``For state monopolies the watchword, more or less inevitably, is the well-known phrase ``Quieta non movere - don't ruffle the prevailing calm." And on the occasions when they do experiment, it is often popular fancies and not the prospect of profit that are the guiding star".) Megginson and Netter (2001: 323) note that:
``[t]he Depression, World War II, and the final breakup of colonial empires pushed government into a more active role, including ownership of production and provision of all types of goods and services, in much of the world. In Western Europe, governments debated how deeply involved the national government should be in regulating the national economy and which industrial sectors should be reserved exclusively for state ownership. Until Margaret Thatcher's conservative government came to power in Great Britain 1979, the answer to this debate in the United Kingdom and elsewhere was that the government should at least own the telecommunications and postal services, electric and gas utilities, and most forms of non-road transportation (especially airlines and railroads). Many politicians also believed the state should control certain ``strategic" manufacturing industries, such as steel and defense production".

Scitovsky (1952: 374) argues that concerns over the power of private monopolies explains the creation of state-owned monopolies in telephone, telegraph and public utilities in most European countries during this period. But monopoly was not the only reason for public ownership. As Vickers and Yarrow (1988: 125) point out, when dealing with the case of the U.K., there were a number of other motivations for state control:
``British Petroleum (BP), in which a controlling interest was acquired by the Government before the First World War with the object of securing fuel oil products for the Navy; the British Sugar Corporation, created by the Government in 1936 to promote domestic production of beet sugar for reasons of national security; Cable and Wireless, acquired in two stages (1938 and 1946) with a view to extending state ownership in telecommunications activities; Short Brothers and Harland (aircraft and aircraft components), acquired during the Second World War because the company was not being operated efficiently and the Government was not prepared to see it collapse; Rolls-Royce and British Leyland (now the Rover Group), both taken into public ownership in the 1970s to mitigate the consequences of impending bankruptcy".

As far as the U.K. nationalisations of the 1940s are concerned Jewkes (1948: 145) is sceptical of there being any economic basis for them, ``[b]ut the experience of the British Labour Government in the first years of office suggests that, in fact, no objective economic principles were being applied in choosing industries for nationalisation". Millward (1997: 215), on the other hand, put forward the hypothesis that these nationalisations can be explained by
  • The infrastructure industries of electricity, gas, water, transport, and communications display the classic problems of natural monopoly and externalities on a substantial scale and this explains why in many western countries, and in Britain specifically form the middle of the nineteenth century, they were subject to increasing government control.
  • The failure of arm's length regulation of the infrastructure industries in the interwar period explains why in the 1940s public control took the form of public ownership and why this has support over a wide political spectrum.
  • Manufacturing, commerce, and agriculture did not have problems of natural monopoly and externalities on anything like the same scale and were left largely in private hands.
  • The fundamental class division between wage earners and owners of capital to be found in the neo-marxist characterisations of capitalist society played a limited role in the 1940s drive to public ownership and had a clear manifestation only in that large industry whose working conditions and economic fortunes in the nineteenth and twentieth centuries appeared to suffer most from the cold winds of market forces - the coal industry.
  • The election of a Labour government in 1945, and its commitment to economic planning together with the specific historical context of reconstruction following the Second World War go along way to explaining the particular institutional arrangements which emerged in the public sector, specifically the nationwide dimension of public ownership, the legal form of the public corporation, the means of achieving coordination within the fuel and transport sectors, and the nationalization of the Bank of England.
Writing in 1953 Jewkes notes that, ``[i]t is only recently that the claim has been made that nationalization is a more efficient way of organizing an industry than is possible whilst it remains in private hands". (Jewkes 1953: 616). (Jewkes adds that ``[t]he claim that nationalization represents a more efficient manner of running industry and of translating decisions regarding prices and investment into actions can best be examined in terms of the fundamental changes introduced in any industry subjected to nationalization. They are:
1. The nationalized industry is a larger operating unit than those it replaced. From this arises the claim for the economies of scale.
2. The nationalized industry is monopolistic. Out of this arises the claim that it can adopt more complete integration and coordination of related functions.
3. The nationalized industry is not operated for private profit. From this it is asserted that price and investment policy can be made more rational and that the collaboration between different classes of workers in the industry can be made more willing, smoother and, thereby, fruitful". (Jewkes 1953: 617).)

Carlson (1994: 77) makes the case for defence policy as the motivation behind the first (partial) nationalisation of an incorporated company in Sweden:
``[t]he state's first major involvement in the incorporated company form was initiated in 1907, under Lindman's Conservative government, when the state become half-owner of the mining company LKAB. This action of the Conservatives was dictated largely by considerations of defence policy".

In the U.S. context, Troesken and Geddes (2003) argue that for the case of the municipal acquisition of waterworks in the period 1897$-$1915 the data supports the explanation that municipalities were unable to credibly precommit to not expropriating value from the private water companies once investments were made, resulting in a rational reduction in investment in water provision by private companies. This rational underinvestment was then used by local governments as an pretext for municipalising the private water companies. Similar results were found for the municipalising of gas companies in the U.S. Troesken (1997) argues that the data are consistent with commitment and small market theories of public ownership. The commitment hypothesis, again, refers to the inability of municipalities to be able to credibly precommit to not expropriating value from the private companies once investments were made, while the small market hypothesis argues that in small towns inadequate consumer demand prevents suppliers from exploiting scale economies and from recouping their large capital investments.

Towards the more radical end of the spectrum of views of economists, Joseph A. Schumpeter (Schumpeter 1950: 228-31) argued that, in England at least, an extensive programme of nationalisation could accomplish a big step forward towards socialism. His list of industries ready for nationalisation included the Bank of England; insurance; inland transport, in particular railroads and trucking; mining, in particular coal mining; the production, transmission and distribution of electricity; iron and steel and the building and building material industries (It's interesting to note that much of what Schumpeter recommended came to pass within a short period after the publication of the first edition of his book. The first edition appeared in 1942 and the Bank of England was nationalised in 1946, road and rail transport in 1948, the coal industry in 1947, electricity in 1948 and the iron and steel industry in 1951 (and again in 1967).) He added to this list a number of other industries - the armaments or key industries, movies, shipbuilding, trade in foodstuffs - that could also, for `special, mostly non-economic reasons', be nationalised. In addition he noted that `as an economist' he had no objection to make to land nationalisation.

Shleifer (1998: 133) sums up the prevailing thinking among the majority of more mainstream economists as ``[ ... ] economists were quick to favor government ownership of firms as soon as any market inequities or imperfections, such as monopoly power or externalities, were even suspected". On the basis of fears about monopoly power Sir W. Arthur Lewis (Lewis 1949: 101) argued for the nationalisation of land, mineral deposits, the generation of electricity, telephone service, insurance and the motor car industry. Similar concerns led James Meade (Meade 1948: 68) to suggest that the iron and steel and chemical industries, to take just two examples, should not `long escape socialization'. On the other side of the English Channel Maurice Allais (Allais 1947: 66) went as far as to recommend the trial nationalisation of a small number of the most important firms in each industry to make possible the comparison of public and private ownership. But Allais was not alone in making this suggestion, back on the English side of the channel, Arthur Lewis (Lewis 1949: 102) argued in a similar vein:
``[t]here is a case for having some private firms in industries mainly nationalised, to act as a check on the efficiency of the public firms, and to provide an outlet for ideas which the public firms might suppress (this is particularly important in a country dependent on foreign trade). And equally there is a good case for public firms in many industries that are largely in private hands, to serve similarly as a yardstick and as an opportunity for experiments".

There was, however, also a minority view which was sceptical about state ownership. Jewkes (1965: 13-14) agues that state owned industries could not help but be politicised:
``[t]hus it is claimed that a government may take responsibility for some new public service but take the whole operation `out of politics' and thereby escape any increase in its own administrative burdens. [ ... ] Experience in the past twenty years suggests that that view is naive. Nationalization has not taken industries out of the political area. It has pushed them more firmly into it".

By the late 1970s-early 1980s the sceptical minority was becoming larger, the mood was turning against government ownership among both politicians and economists. ``In the eighties the opinions of many public economists began intensively to deviate from the Musgravian view which has long been prevalent. The allocation of resources became the field of central interest. [ ... ] Theories of public enterprises similarly began to concentrate on the question of how a regulating government could give the best incentives for efficient production in the firm. Internal subsidization was increasingly considered undesirable, as was any form of pricing with redistributive features. Furthermore, stabilization by public enterprises fell into disapproval. [ ... ] This view on allocation, distribution, and stabilization dismissed many of those arguments in favor of public enterprises [ ... ] in particular the desirability of distributional and stabilization politics of public firms". (Bos 1994: 21).

One factor driving the changes in economists' point of view as the slow accumulation of empirical evidence that was beginning to suggest that private firms were, by and large, more efficient than public firms. The theoretical question this raised was, Why?

During the first ten years, 1980-1990, efforts to explain the empirical results consisted of either informal, somewhat ad-hoc, models of the advantages of bringing market pressure and institutions to bear on state-owned firms, or formal models which, in the main, utilised a principal-agent framework to analyse the differences between public and private firms. The major problem with these formal frameworks is that they assume that contracts are complete/comprehensive and so cannot credibly address the issue of ownership and thus cannot satisfactorily explain why privatisation/nationalisation should make any difference to the operations of a firm.

It turns out that incomplete contracts are in fact a necessary condition to explain the differences between the two forms of ownership. In a world of complete or comprehensive contracts there is no difference between private and state owned firms. In both cases the government can write a contract with the firm that will anticipate all future contingencies - it will detail the managers' compensation, the pricing policy of the firm, how changes in technology will the change the firm's products etc - and thus the outcome under both forms of ownership will be the same.

It is at this point that my previous post takes over. That post discussed the post 1990 literature.

Denmark’s fat tax fiasco

The Institute for Economic Affairs in London has released a new report by Christopher Snowdon on The Proof of the Pudding: Denmark’s fat tax fiasco. A summary of the findings of the study are:
  • Denmark’s tax on saturated fat was hailed as a world-leading public health policy when it was introduced in October 2011, but it was abandoned fifteen months later when the unintended consequences became clear. This paper examines how a policy went from having almost unanimous parliamentary support to becoming ‘an unbearable burden’ on the Danish people.
  • The economic effects of the fat tax were almost invariably negative. It was blamed for helping inflation rise to 4.7 per cent in a year in which real wages fell by 0.8 per cent. Many Danes switched to cheaper brands or went over the border to Sweden and Germany to do their shopping. At least ten per cent of fat tax revenues were swallowed up in administrative costs and it was estimated to have cost 1,300 Danish jobs.
  • The fat tax had a very limited impact on the consumption of ‘unhealthy’ foods. One survey found that only seven per cent of the population reduced the amount of butter, cream and cheese they bought and another survey found that 80 per cent of Danes did not change their shopping habits at all.
  • The fat tax was always controversial and it became increasingly unpopular as time went on. Objections came not just from business owners, but also from trade unions, politicians, journalists and the general public. It was widely criticised across the political spectrum for making the poor poorer. By October 2012, 70 per cent of Danes considered the tax to be ‘bad’ or ‘very bad’ and newspapers routinely described it as ‘infamous’, ‘maligned’ and ‘hated’. Mette Gjerskov, the minister for food, agriculture and fisheries, admitted in late 2012: ‘The fat tax is one of the most criticised policies we have had in a long time.’
  • Denmark’s fat tax remains the leading example of an ambitious anti-obesity policy being tested in the real world. The results failed to match the predictions of the health lobby’s computer models and the failed experiment has since been largely swept under the carpet in public health circles. Ultimately, Danish politicians weighed the negligible health benefits against the demonstrable social and economic costs and swiftly abandoned it. Few mourn its passing.
  • The economic and political failure of the fat tax provides important lessons for policy-makers who are considering ‘health-related’ taxes on fat, sugar, ‘junk food’ and fizzy drinks in the UK and elsewhere. As other studies have concluded, the effect of such policies on calorie consumption and obesity is likely to be minimal. These taxes are highly regressive, economically inefficient and widely unpopular. Although they remain popular with many health campaigners, this may be because, as one Danish journalist noted, ‘doctors don’t need to get re-elected.’
Taxing a product to reduce its consumption sounds all well and good, after all demand curves slope downwards, but the reduction in quantity demanded will be small when demand for the product is inelastic. And the results noted in the third point above suggest that for the Danish at least, unhealthy foods are inelastically demanded. Other methods should be tried if reducing consumption of these foods really is worthwhile.

In short, yet another failed piece of social engineering. Not that this failure will have any effect on the demands of public health campaigners. As Snowdon notes,
Despite the unambiguous results of this natural experiment, public health campaigners in the UK continue to lobby for similar policies. Just four days after the Danes announced the abolition of the fat tax, the National Heart Forum called on the government to introduce a tax on foods that are high in salt, sugar and fat. Two months later, a coalition of 61 organisations demanded a 20p per litre tax on sugar-sweetened beverages (or - as they call them - ‘mini-health timebombs’). Most recently, the Academy of Medical Royal Colleges called for a 20 per cent tax on the same soft drinks. The Academy sheepishly mentioned that Denmark had experimented with ‘a slightly broader plan’, but did not acknowledge that the experiment had ended, let alone explain why.
If one really believes in 'evidence-based policy' should not this evidence be taken into account. Should we not be concerned with what actually happens when policies are tested in the real world? Should evidence of job losses and the cost of living increases not be of concern in policy development? But will health campaigners in New Zealand respond any differently from those in the U.K. when they just ignored the Danish results?

Friday, 24 May 2013

Interesting blog bits

  1. Victor Duggan, Sjamsu Rahardja and Gonzalo Varela on Service-sector reforms enhance manufacturing productivity: Evidence from Indonesia
    The ‘manufacturing matters’ movement has gained prominence on the policy agenda even as the nature of manufacturing continues to morph. This column discusses new research showing that opening service sectors to competition and foreign direct investment can be a powerful conduit for productivity gains in manufacturing. The gains depend on both the types of reforms and the specific services sectors in which these are implemented.
  2. Daron Acemoglu and James Robinson on The Economic Nature of the Resource Curse: Evidence
    Is it true more generally that natural resource wealth, or perhaps more specifically oil wealth, has a negative effect on economic growth? If it does, via what mechanisms?
  3. Jon Danielsson on Iceland’s post-Crisis economy: A myth or a miracle?
    Icelandic voters recently ejected its post-Crisis government – a government that successfully avoided economic collapse when the odds were stacked against it. The new government comprises the same parties that were originally responsible for the Crisis. What’s going on? This column argues that this switch is, in fact, logical given the outgoing government’s mishandling of the economy and their deference towards foreign creditors.
  4. Richard Posner on Security Surveillance Cameras
    Many businesses (notably banks) and even homes have surveillance cameras nowadays. Usually they are pointed at the interior of the building though sometimes also or instead at the entrance to or the grounds of the building. These uses of surveillance cameeras are uncontroversial. But there is controversy over surveillance cameras that are owned by or form part of a network of surveillance cameras that is accessible to government, especially when, as is increasingly common, the surveillance cameras are technologically sophisticated and can for example enlarge the photographed images, take pictures at night, enable face recognition by matching facial features of a person photographed by the camera with a database of facial features, and even follow a vehicle or pedestrian as it or he goes out of the range of one camera and into the range of another.
  5. Gary Becker on The Internet, Surveillance Cameras, and Misuse of Big Data
    Surveillance cameras, tax reporting, Internet-based data, emails, mobile phone records and their cameras are some of the more salient modern ways that provide information on individuals and organizations. Few object when banks and other organizations use surveillance cameras on their premises to deter theft and robbery. There is much greater concern when Internet companies like Google and Facebook use their vast stores of data to learn about the interests and other personal information, of the millions of individuals who use their services. Probably, however, the most serious threat is the misuse of “big data” by governments, including democratic governments.
  6. Kristian Niemietz on Poor people in rich countries – a new approach to measurement and policy
    Relative poverty measures are deeply flawed, but that does make absolute measures any better. Poverty is not absolute. Perceptions of what is a ‘necessity’ and what is merely a convenience change over time. Our great-grandparents would not have considered a washing machine, a central heating or an indoor bathroom to be necessities. To us, they are necessities, and this is simply because we live in societies where virtually every household has these items.
  7. Chris Dillow On Terrorist Probabilities
    Why aren't the Scots doing more to combat their culture of violence? Why aren't its community leaders doing more to rein in their violent minority? Don't we need tougher laws to protect us from the threat posed by men of Scottish appearance? You might think I've lost my mind. From a statistical point of view, though, I haven't.

Thursday, 23 May 2013

Why is there no Milton Friedman today?

Why Is There No Milton Friedman Today?

A symposium co-sponsored by the Mercatus Center at George Mason University

Imagine that someone with all the endowments of a Milton Friedman were born in the 1960s or 1970s. Is it conceivable that such a person would develop into a ‘Milton Friedman’ like we know the actual Friedman to have been, including his academic eminence and his eloquent and influential advocacy of classical liberalism? Here leading economists address the question: Why is there no Milton Friedman today?

  • John Blundell
  • David Colander
  • Tyler Cowen
  • Richard Epstein
  • James K. Galbraith
  • J. Daniel Hammond
  • David R. Henderson
  • Daniel Houser
  • Steven Medema
  • Sam Peltzman
  • Richard Posner
  • Robert Solow
Well worth a read.

Wednesday, 22 May 2013

How to increase prices and profits in the U.K. retail energy market

This piece from the Adam Smith Institute website should act as a warning to countries wanting to reregulate their energy markets. Stephen Littlechild, Professor emeritus at the University of Birmingham, fellow of Judge Business School at the University of Cambridge and a top regulator from 1983 to 1998, explains how politicians and regulators have, by misunderstanding how markets work, regulated to boost energy firms' profits at the expense of higher bills for consumers. Markets may not be perfect but it helps to understand how they work before setting out to "fix" them.
Britain’s competitive retail energy market was the first in the world, and for many years the most competitive. It had the most active suppliers, and the most active customer switching. This competition and choice brought better offers for customers. It may not seem like it because of recent energy price increases. But these reflect increases in fuel costs like gas, higher costs of renewable energy and other obligations on suppliers, not a lack of retail competition.

In fact, retail competition was sometimes too fierce, witness the problem with doorstep mis-selling. But Ofgem took action to fix that problem.

Retail profits in the domestic sector used to be minimal; Ofgem calculated that many were negative. New entrants came into the market, but until recently most found it tough to survive.

Retail competition has been enhanced by a dozen switching sites. Each seeks the best way to attract users, to offer the simplest calculations, to include the most relevant information and the clearest comparisons, to facilitate subsequent switching. No other country can boast as lively, innovative and effective market for information and assistance to energy customers as Britain.
What you may ask is wrong here? Energy prices were increasing and someone had to be blamed. Ofgem (Office of Gas and Electricity Markets) the U.K. regulator for energy markets, was unable to find evidence of market failure and thus it concluded that the problem was customer failure. Customer failure being a nice way of saying "consumers are stupid"!. Customers were paying high prices because they were unable or unwilling to understand suppliers’ offers and thus the market had to be simplified.
An increasingly crackpot series of proposals and directives has emerged from Ofgem, Government and now Which? magazine for dumbing down the retail market. All are well-intentioned, none shows any understanding of competitive markets, none will increase customer engagement, and all will make customers worse off.
First came ideas from Ofgem,
It noticed that suppliers based in one area were offering lower prices to customers in their competitors’ areas. In 2009 it decided that requiring suppliers to charge the same price to all customers would bring the benefits of the lower prices to all customers - Right? Wrong. Suppliers predictably found it more profitable to raise their low prices to new customers than to lower their prices to existing customers.

Customers suffered because the low-price offers were withdrawn. They also began to lose interest in switching supplier: the switching rate has since fallen by nearly a half. But suppliers did not lose out from this reduction in competition. Quite the opposite: Ofgem’s calculations show their retail profit margins increasing to an all-time high: from minus £10 per dual fuel customer in May 2009 to about £50 from 2010 to 2012 to £100 now.

In 2011 Ofgem proposed that all suppliers should offer the same monthly standing charge – which Ofgem itself would specify. It overlooked – or didn’t care – that this prohibited tariffs with no standing charge, which are popular with pensioners. And that Ofgem would now be jointly responsible for setting energy prices. Ofgem withdrew its proposal.

Meanwhile, suppliers found other ways to compete – for example by offering lower prices online. Customers benefited – until Ofgem decided that this made the market too complicated. In October 2012 Ofgem proposed that suppliers would be allowed only four tariffs per fuel. This of course is tough on customers with minority tastes, like green tariffs, or even tariffs with no standing charge. And innovation will cease if a supplier can only innovate by withdrawing an existing tariff that supplies about a quarter of its customers. But now it’s simplicity that counts, not the availability of products that customers want.

There are other petty restrictions. Discounts must be the same each year, expressed in pounds not percentages. If this restriction had been in place, it would have banned the best offer in the market earlier this year. And in future it may not be viable for suppliers to offer discounts that don’t use percentages to tailor the discount to the size of bill. But the availability of good offers is no longer a relevant consideration.
Then ideas from the government,
At the same time, another bright idea popped up at Prime Minister’s Question Time. Just in time for the County Council Elections. The campaign leaflet says “Conservatives in Government have forced energy companies to put customers on the lowest tariff”. Leave aside that this is not yet enacted, and still just an idea that Ofgem might reluctantly trial. Leave aside too why Conservatives in Government and not Ofgem are now regulating energy companies. Let us just ask: what does it mean and is it a good idea?

If it means that energy suppliers will be forced to put their own customers on to the lowest tariff offered by their rivals, is there the remotest chance of this working? Suppose it means that energy suppliers will be forced to put customers on the lowest tariff they themselves offer. But if a supplier offers a discount on its standard tariff coupled with an exit charge of £50, do we really want to force that supplier to put all its customers on a tariff that locks them in? And if a supplier wanted to offer a discount for new customers, but was forced to put all its existing customers on the same discounted tariff, isn’t it obvious that it would be more profitable not to offer the discount in the first place? Once again, the proposal will drive out the best offers.
And finally ideas from Which? magazine.
It says that Ofgem’s proposals for simplifying the market don’t go far enough. The government should require single unit prices for each energy tariff, like petrol prices on a garage forecourt. Simplicity is flavour of the month, and petrol is a competitive market, so what’s wrong with this? Lots.

First, Which? seems to be asking for a single uniform price across the whole of the country. But distribution network charges vary considerably across the country. To impose a uniform retail price or network charge would require massive geographic cross-subsidisation between network operators and between customers that would be neither workable nor obviously equitable.

Second, forcing all tariffs to have a zero standing charge would mean that suppliers would not be allowed to offer a lower unit price to larger customers that are more economic to serve, and suppliers would no longer be interested in attracting smaller customers. The likely impact on different kinds of customers has not been considered.

Third, limiting the variety of energy products so that customers are faced with only one price per supplier would enable and encourage suppliers to coordinate prices. If one supplier breaks ranks then other suppliers will either follow or that supplier will fall back into line. Customers will find that suppliers offer similar prices almost all the time. Where then is the incentive to engage in the market?
Littlechild's conclusion,
All these schemes assume that regulators and governments know more about customers than those who make a living by discovering and providing what customers want. These schemes won’t really simplify the market and they won't persuade customers to engage more. But they will restrict competition, and customers will be worse off because the best offers will disappear. Suppliers will find it costly to comply with the proposed 126 pages of new regulatory red-tape, but the costs will be passed through to customers and the suppliers will grumble all the way to the bank.

Monday, 20 May 2013

EconTalk this week

Richard Epstein of New York University and Stanford University's Hoover Institution talks with EconTalk host Russ Roberts about the U.S. Constitution. Topics covered in this wide-ranging conversation include how the interpretation of the Constitution has changed over time, the relationship between state and federal power, judicial activism, the increasing importance of administrative agencies' regulatory power, and political influences on the Supreme Court.

Sunday, 19 May 2013

Interesting blog bits

  1. Sam Richardson asks Events capital = big returns, right?
    The New Zealand Herald today is reporting that Auckland is a more successful city than Sydney at attracting and hosting major events. Auckland Mayor Len Brown says: "Major sporting events are big business and bring substantial economic benefits to the host region, so there is fierce competition globally to secure events." There certainly is fierce competition all right - but not a whole lot in the way of compelling evidence that the economic impacts of events are as substantive as commonly thought.
  2. Matt Zwolinski asks Should You Buy a T-Shirt Made in Bangladesh?
    Recent events in Bangladesh have brought moral questions surrounding sweatshops into the spotlight again. And many consumers are wondering whether they might be doing something wrong by purchasing goods that are made in Bangladeshi textile firms.
  3. Mario Rizzo on Bangladeshi Garment Workers and the Perversion of Ethics
    This is another instance of the simplistic pseudo-morality of those who can only see what is right in front of them at the present moment. This attitude is closer to a sympathetic reflex than a reasoned moral judgment.
  4. George Hall and Thomas J. Sargent on Fiscal prioritisation: Lessons from three wars
    Can we learn from previous instances of fiscal prioritisation? This column surveys the US Treasury’s response to three wars – the Revolutionary War, The War of 1812 and the Civil War. Contemporary advocates of engaging in fiscal discrimination might ponder the actions of previous US Presidents Madison and Grant, who honoured all existing federal obligations despite challenging fiscal conditions.
  5. Chris Dillow on Adam Smith on Immigration
    UKIP claims that its tax policies are derived from Adam Smith. But what would the great man make of its anti-immigration policies? I suspect the answer is: not much.
  6. Klaus Desmet and Stephen L. Parente on Unleashing growth: The decline of innovation-blocking institutions
    Innovation is the beating heart of modern growth. This column argues that innovation-blocking institutions weaken when markets expand and competition intensifies. The rise and decline of medieval Italian crafts guilds offer valuable insights into this process. Policies that promote greater market integration and stronger competition are key steps in lowering the barriers to innovation.
  7. John Taylor on Why Title II of Dodd-Frank Has Not Reduced the Likelihood of Bailouts
    Today the House Financial Services Subcommittee on Oversight and Investigations held a hearing on whether the Orderly Liquidation Authority (OLA) in Title II of the Dodd Frank Act has reduced the likelihood of bailouts of large financial firms. I was one of the witnesses. Here is a summary of my 5 minute opening statement.
  8. William Kerr on Cuddly or not, the design of worker insurance is critically important
    Do economies’ social policies affect their innovative outcomes? This column uses the case of venture capital investors to argue that it may. Countries that protect workers rather than jobs – and thus avoid employment-protection laws – developed stronger venture-capital markets over 1999-2008, especially in highly volatile sectors like computers or energy.
  9. Gary Becker on The Rise in College Tuition and Student Loans
    Many commentators have criticized these large tuition increases. Colleges and universities are said to be too greedy and are charging what the traffic will bear, or colleges are claimed to conspire together to increase tuition. Although colleges do conspire on some financial issues, such as agreeing through the NCAA to prevent payments to college athletes, conspiracy is not likely to be important in determining tuition since over 4000 colleges and universities compete fiercely for students, faculty, and funding.
  10. Richard Posner on College Costs and Quality
    I graduated from Yale College in 1959. Tuition, room, and board at Yale in the late 1950s was $2000 a year; this year it is $60,000. Adjusted for inflation, this is a more than threefold increase. Average salary for a full professor at Yale went from $13,000 in 1959 to $186,000 this year (excluding medical school faculty), which after correction for inflation, an almost twofold increase. The rates of increase in these two variables varies from college to college, but I believe it is generally true that college costs have risen significantly faster than faculty costs. One thing that has depressed the increase in faculty costs is the increasing use of graduate students and other part-time faculty in lieu of tenure-track faculty. In addition, the administrative staffs of colleges have grown rapidly, in part because of increased legal regulation of education. Also, colleges have increased the quality of student housing and provided other amenities for students, in an effort to compete more effectively for rich kids. In addition, greatly reduced state subsidies for state colleges, in the wake of the economic depression that began in 2008, have forced state colleges to increase tuition.

Tuesday, 14 May 2013

EconTalk this week

Austin Frakt of Boston University and blogger at The Incidental Economist talks with EconTalk host Russ Roberts about Medicaid and the recent results released from the Oregon Medicaid study, a randomized experiment that looked at individuals with and without access to Medicaid. Recent released results from that study found no significant impact of Medicaid access on basic health measures such as blood pressure and cholesterol levels, but did find reduced financial stress and better mental health. Frakt gives his interpretation of those results and the implications for the Affordable Care Act. The conversation closes with a discussion of the reliability of empirical work in general and how it might or might not affect our positions on social and economic policy.

Monday, 13 May 2013

Will "big data" be big?

What effect will the increasing use of very large data sets have on economics? Liran Einav and Jonathan D. Levin look a the effects of "big data" on economic analysis in a new NBER working paper The Data Revolution and Economic Analysis.

There is little doubt that "big data" will change the landscape of economic policy and economic research. Something worth noting however is that big data will not be a substitute for common sense, economic theory, or the need for careful research designs. This may come as a shock to many economics students who these days are taught that all economics amounts to is pushing the "regress" button and picking whatever results confirm your prejudices. Data is a complement to real economics. In the case of "big data" how exactly remains to be seen. Einav and Levin look at the opportunities, as well as challenges, that come with the ongoing data revolution.

The abstract reads
Many believe that "big data" will transform business, government and other aspects of the economy. In this article we discuss how new data may impact economic policy and economic research. Large-scale administrative datasets and proprietary private sector data can greatly improve the way we measure, track and describe economic activity. They also can enable novel research designs that allow researchers to trace the consequences of different events or policies. We outline some of the challenges in accessing and making use of these data. We also consider whether the big data predictive modeling tools that have emerged in statistics and computer science may prove useful in economics.

Sunday, 12 May 2013

Interesting blog bits

  1. Yasuyuki Todo on Estimating the effect of the TPP on Japan’s growth
    Japan looks set to participate in the Trans-Pacific Partnership (TPP) negotiations. Reflecting the current debate in Japan, this column assesses what effect the Partnership will have on Japan’s growth. Evidence suggests that the economic effects may be far bigger than the current consensus suggests.
  2. Richard Wellings makes The case for raising speed limits
    If major roads were privately owned and freed of government regulation, the setting of speed limits would be a commercial decision. Entrepreneurs would seek to attract customers to their routes in order to maximise toll revenues, and one way of doing so would be to offer fast journey times by allowing high speeds.
  3. Jeffrey Chwieroth and Andrew Walteron on Banking crises and political survival over the long run – why Great Expectations matter
    The economic consequences of financial crises have been systematically explored. Their political consequences haven’t. This column argues that without paying attention to politics, crises will remain poorly understood. After all, politics shapes policy choices, market sentiment and, ultimately, economic outcomes. Evidence from the effects of banking crises over the past century show that crises have a dramatic impact on the survival prospects of governments.
  4. Steve Davies argues Free banking was robust and effective
    In an earlier blog post, Philip Booth discussed the likely scenarios for Scottish monetary policy in the event of Scottish independence and the difficulties, both political and economic, associated with these. What can be very useful is to add historical perspective and to see how things worked out in the past, given that Scotland has an interesting monetary and banking history which is very different from that of England.
  5. Bas van Der Vossen on Libertarian Human Rights?
    When you read about the philosophy of human rights it’s hard to not to notice the nearly complete absence of libertarian input. This post is a call for a libertarian take on human rights.
  6. Balázs Égert on France’s weak economic performance: Sick of taxation?
    France has recorded one of the lowest real per capita income growth levels in the OECD over the last 20 years or so. One of the many structural weaknesses causing this weak performance is the French tax system. This column argues that complexity, instability and non-neutrality coupled with very high effective tax rates in many areas of the French tax system put a heavy burden on the economy.
  7. Tatiana Didier and Sergio Schmukler on Finance and growth in China and India: Have firms benefited from the capital-market expansion?
    The growth of China and India’s financial sectors is hard to ignore. This column presents a new dataset on domestic and international capital raising activity and performance of the publicly listed firms in China and India. The data suggest that expanding capital markets might tend to directly benefit the largest firms – those able to reach some minimum threshold size for issuance. More widespread direct and indirect effects are more difficult to elucidate.
  8. Gary Becker on Alternatives to the War on Drugs
    The 40 year-old American “war on drugs” has been a colossal failure. No progress in dealing with drugs can be expected until that basic truth is recognized. Every conceivable approach has been tried to help the war succeed, such as long prison terms for persons convicted of selling or using drugs, trying to prevent drugs from entering the US from Mexico and other countries, and confiscating huge quantities of drugs (remember The French Connection?). At some point all wars that fail are terminated, and alternative approaches explored. The two main alternatives to the war on drugs are decriminalization and legalization of drugs. Decriminalizing drugs means that using drugs would no longer be a criminal activity, while trafficking in drugs would remain a crime. Legalization of drugs means that trafficking in drugs as well as using drugs would not be a crime.
  9. Richard Posner asks is there a Breakthough in the War on Drugs?
    The publication of a White House “National Drug Control Strategy” is an annual event, which wordily (the 2013 version is 95 pages long) heralds nonexistent progress and makes false promises of more to come. The General Accountability Office has evaluated the 2013 version and found it wanting, noting the government’s lack of progress toward achieviing the goals of diminished drug use stated in the 2010 version.

Thursday, 9 May 2013

Did FDR end or extend the depression?

Thanks to NotPC I came across this video in which Lee Ohanian, Professor of Economics at UCLA, challenges this conventional wisdom that President Franklin Roosevelt's "New Deal," rescued America from the Great Depression of the 1930's.

The knowledge problem

One thing anti-market types don't seem to get is the importance of being able to coordinate diffuse private knowledge. Markets are surprisingly good at this, governments are not. This is part of what is known as the "Knowledge Problem". The knowledge problem in fact has has two main components:
  • Complexity knowledge problem: The difficulty of coordinating individual plans and choices in the ubiquitous and unavoidable presence of dispersed, private, subjective knowledge
  • Contextual knowledge problem: The epistemic fact that some knowledge relevant to such coordination does not exist outside of the market context; such knowledge is either created in the process of market interaction, tacit knowledge that is not consciously known, or inarticulate knowledge that is difficult to express or aggregate.
Lynne Kiesling of Northwestern University and the Knowledge Problem blog has a recent article surveying the literature on the Knowledge Problem. The abstract reads,
Hayek's (1945) elaboration of the difficulty of aggregating diffuse private knowledge is the best-known articulation of the knowledge problem, and is an example of the difficulty of coordinating individual plans and choices in the ubiquitous and unavoidable presence of dispersed, private, subjective knowledge; prices communicate some of this private knowledge and thus serve as knowledge surrogates. The knowledge problem has a deep provenance in economics and epistemology. Subsequent scholars have also developed the knowledge problem in various directions, and have applied it to areas such as robust political economy. In fact, the knowledge problem is a deep epistemological challenge, one with which several scholars in the Austrian tradition have grappled. This essay analyzes the development of the knowledge problem in its two main categories: the complexity knowledge problem (coordination in the face of diffuse private knowledge) and the contextual knowledge problem (some knowledge relevant to such coordination does not exist outside of the market context). It also provides an overview of the development of the knowledge problem as a concept that has both complexity and epistemic dimensions, the knowledge problemʼs relation to and differences from modern game theory and mechanism design, and its implications for institutional design and robust political economy.

A debate about the patent system

A debate about patent law between the Honorable Judge Richard Posner (7th Circuit) and Professor Richard Epstein (the Hoover Institution & New York University School of Law).

Christchurch stadium, again

The issue of a new sports stadium for Christchurch in in the news again with a couple of recent articles on Stuff ("Stadium concept 'would be money maker'" and "New stadium plan 'smart, bold'"). Fortunately there are those at Massey who are on the ball when it comes to stadiums. Massey economist Sam Richardson writes at his blog Fair Play and Forward Passes:
A stadium will only ever be used sparingly. That is reality. Westpac Stadium is used for between 40-50 event days per year - and it has been making operating surpluses since it has been opened. Westpac Stadium was also built with a mere 1/3 of its funding from local and regional government. It is not clear yet where exactly the funding for Christchurch's stadium plans is coming from, but it is fair to say that it will be largely funded by taxpayers - locally, regionally and nationally to some degree. As such, if my taxpayers money is going into funding a stadium, I would like to see some evidence that this amenity is going to be at least self-sustaining, and should not be detrimental to the local area. The idea that office buildings will make the stadium profitable is missing the point. If the office blocks are the profit-making parts of the venture, why not just build the office blocks? If they must be built as part of a stadium plan, we have to acknowledge that the rents earned by stadium offices will simply be transferred from other office spaces elsewhere within the city. It may well be the case that office space is at a premium in Christchurch, in which case the stadium offices may be beneficial to the city of Christchurch in that clients who were previously unable to obtain office space may now be able to do so. If, however, the offices are simply populated by clients who relocated from the suburbs, then this isn't making money (nor necessarily welfare enhancing either) at all - it is merely redistributing the rents on office space from the suburbs back into the CBD.

It is exactly the same argument as the claim that stadiums generate conference revenues too - which is only beneficial if the conferences wouldn't have been held in the city in the first place without the stadium conference spaces.*

Sure, the office rents may make the bottom line of the stadium better (if indeed things pan out as projected). But from a wider (city or regional) perspective, is it really regenerating or simply redistributing? That's the question that ratepayers need to be asking of their policymakers.
One further question I would ask is about the opportunity cost of any taxpayer money used for the stadium. There are many other (better?) things to use money on in Christchurch right now. Sam's response to that question is,
Is a stadium an essential or luxury for Christchurch? I know they have the 'temporary' stadium, but surely there are more compelling alternative uses of scarce government funds at this time. Decisionmakers should at least be open about the fact that it is highly unlikely to be a money maker for the city. If you build it for public good purposes, show us the value of the public goods it will generate.
I have to agree with Sam about seeing evidence about the value of any public goods a stadium will provide. Off the top of my head I can't think of any. So those backing the stadium need to front-up with details as to what the real reasons for the stadium are.

Hogan on cricket

Ignore Jeremy at the beginning, Hogan comes in at about the 3:50 mark.
• What if economics could help cricket teams win matches? And what if teams employed economists alongside their sports psychologists, conditioning coaches and physiotherapists?

• Why is it that New Zealand traditionally punches above its weight in the One Day International (ODI) format of the game?

• Why has the batting powerplay had so little effect on team ODI scores on average?

• And how is economics remotely related to cricket anyway?

Sports teams are increasingly using detailed statistical analysis to help give them an advantage over their opposition. In contrast, the economics of sport mostly focuses on sport as a business rather than on-field strategy. During this session, I am going to discuss how ODI cricket is a natural subject for the application of economics reasoning and how this reasoning can be a useful tool both for helping teams think about strategy and for informing spectators about the state of a game as it's played out.

Tuesday, 7 May 2013

EconTalk this week

William Bernstein talks with EconTalk host Russ Roberts about his latest book, Masters of the Word. Bernstein traces the history of language, writing, and communication and its impact on freedom. The discussion begins with the evolution of language and the written word and continues up through radio and the internet. A particular focus of the conversation is how tyrants use information technology to oppress their people but at the same time, technology can be used to liberate people from oppression.

Sunday, 5 May 2013

Schmidt & Cohen, from Google, talk about their visit to North Korea

Google Chairman Eric Schmidt and Jared Cohen, director of Google Ideas, talk with WSJ's John Bussey about what they hoped to accomplish from a visit to North Korea, and their observations about the country's technological potential and its likelihood of embracing the Internet.

Friedman on Walras

From Milton Friedman, "Leon Walras and His Economic System", American Economic Review, December 1955.
I am tempted, in concluding this rather discursive commentary, to paraphrase Mill's comment that "A person is not likely to be a good economist who is nothing else." A person is not likely to be a good economist who does not have a firm command of Walrasian economics; equally, he is not likely to be a good economist if he knows nothing else.
Seems a reasonable point.

Thursday, 2 May 2013

State-owned enterprises in the global economy

Some state-owned enterprises have become global players and the subject of much policymaking concern. There is a widespread perception that they may be acting differently when competing with private firms in the global market place. A new column at, "State-owned enterprises in the global economy: Reason for concern?" introduces a new database on state-owned firms that shows that more than one in ten of the world’s largest firms are state-owned.

The article, by Max Büge, Matias Egeland, Przemyslaw Kowalski and Monika Sztajerowska, argues,
The rise of state capitalism – the spread of a new sort of business in the emerging world will cause increasing problems” argued a January 2012 special issue of The Economist. State-owned enterprises have always been an important element of most economies, including the most advanced ones. However, the state sector has traditionally been characterised by orientation towards domestic markets and often lagging business performance. Today, some contemporary state-owned enterprises are among the largest and fastest expanding multinational companies. They increasingly compete with private firms for resources, ideas and consumers in both domestic and international markets.

This new trend has attracted the attention of the media which reports regularly on large cross-border deals sealed by state-owned firms. It has also been noticed by policymakers and business, many of whom are calling for a 'levelling of the playing field' in international trade and investment. The discussions of new state-owned enterprises disciplines in the ongoing Trans-Pacific Partnership negotiations and the implementation of stricter national investment screening mechanisms for state-owned enterprises in some countries are testimony to this.
The article goes on to ask, Why do these international SOESs matter and what policy tools are available to deal with any problems they may cause? There does seem to be one obvious way of dealing with such SOEs, have the home countries of the SOEs privatise them. The article continues,
The significant extent of state ownership among the world’s top companies raises a question about its impact on the global competition. The triple role of the government as a regulator, regulation enforcer and owner of assets opens a possibility of favourable treatment granted to state-owned enterprises in some cases. These advantages can take the form of, for instance, direct subsidies, concessionary financing, state-backed guarantees, preferential regulatory treatment, exemptions from antitrust enforcement or bankruptcy rules. They may well be justified in a domestic context, for example, to correct market failures, provide public goods, and foster economic development. But if their effects extend beyond borders, they may undermine the benefits from international trade and investment, which are predicated on the basis of non-discrimination and respect for market principles. Two recent OECD workshops on the issue (one in 2012 and in 2013) gathered numerous representatives of global firms and governments revealed this is indeed a serious concern.

Given these potential anti-competitive effects of state ownership on the global market, what tools are available to address them? We look at those in detail in our paper, surveying existing regulatory frameworks at the national, bilateral or multilateral level, and consider their relative strengths and weaknesses. For example:
  • National antitrust law can in principle be used to deal with the abuse of dominant position by state-owned enterprises, including in the international context, or to prevent anticompetitive effects associated with merger and acquisition activities of state-owned enterprises.
However, traditional antitrust standards apply to profit maximising firms and are not aimed at preventing subsidies and artificially low prices –except where these are manifestly motivated by predatory strategies [...].
  • Competitive neutrality arrangements introduced by some OECD jurisdictions aim to mitigate or eliminate competitive advantages of state-owned enterprises, including with respect to taxation, financing costs and regulation [...].
Some of these frameworks refer specifically to state-owned businesses (e.g. in Australia) while others are ownership-neutral. In the EU, for example, the state interactions with private and state-owned firms alike are governed by a set of special rules in the areas of antitrust, state aid and transparency.
  • WTO rules are generally ownership-neutral (except for the notable exceptions in the Accession Protocols of China and Russia).
The disciplines that they impose on government regulations and actions do not distinguish between situations where the provider of the goods or services covered by the regulation or action is a public or a private entity. They can nevertheless discipline some government policies and actions involving state-owned enterprises, for example, when they receive trade-distorting state subsidies. Violation of national treatment or most-favoured nation principles, granting of subsidies or other forms of influencing trade by state-owned enterprises themselves can also be covered by WTO disciplines if these enterprises can be proven to be “vested with or performing a governmental function”. Yet, some of the definitional ambiguities have rendered application of these disciplines uncertain and some provisions allow countries to exempt state-owned enterprises’ actions from certain WTO disciplines (e.g. in the GATS).
  • Many existing preferential trade agreements and bilateral investment treaties include specific provisions on state-owned enterprises, attempting to fill gaps in existing multilateral provisions;
Some explicitly specify that their provisions apply similarly to state-owned enterprises, clarify some of the definitional lacunae in the WTO context, or include additional state-owned-specific disciplines. As mentioned at the outset, state-owned enterprises provisions are currently being discussed in the ongoing Trans-Pacific Partnership negotiations.

Some of these regulatory frameworks have been used to contest actions or advantages of state-owned enterprises [...]  and in some of these cases the relevant ruling bodies have found that governments have indeed pursued state-owned enterprises strategies inconsistent with these frameworks. Yet, in some cases these challenges were found to be without merit.
The article's conclusion,
Our understanding of the recent emergence of international trade and investment by state-owned enterprises, and thus policy responses, are still in the early stages of development. International trade and investment by state-owned enterprises could well continue to increase as countries with significant state-owned enterprise sectors grow and become more internationalised, or because of advantages state-owned enterprises may enjoy – even though nascent privatisation programmes in some countries pull in the opposite direction. A better understanding of the implications of state-owned enterprises’ trade and investment for the functioning of international markets is needed to help governments formulate informed and balanced policy responses.
The first best answer would seem to be to encourage these "nascent privatisation programmes". Regulation in the overseas countries is second best, at best.

Economic stupidity? Yes ..... by the Greens

From TV3 we learn,
The Green Party is criticising the latest sale of land to foreign investors, calling it "economic stupidity".

Yesterday the Overseas Investment Office approved the sale of more than 14,000 hectares of prime forestry land, previously owned by the New Zealand Superannuation Fund, to a company owned by the Chinese government.

The blocks of land are located in Kaipara, Coromandel, Waikato, Rotorua, Gisborne and Wairarapa.

Speaking on Firstline this morning, Green MP Steffan Browning said the sale would send profits offshore, and make it harder for Kiwis to own New Zealand land.

"Every time we sell off some land to foreign interests, we are stopping New Zealanders being able to do that purchase," says Mr Browning.

"It automatically cranks the price up that New Zealanders would have to pay, and for New Zealanders to be able to stay on the land whether they be foresters or farmers."
As to the money goes overseas bit I have said this before but let me say it again: Let us assume for a moment that evil foreigners make a NZ$1 profit which, in an effort to piss-off Steffan Browning, they wish to take it back to, say, China. How do they do it? Clearly a New Zealand dollar isn't worth anything in China so the Chinese holder of NZ currency will have to sell their NZ$1 to buy Yuan. But why would anyone want to buy said NZ$1? The only use for a NZ$s is to buy something made in NZ. Thus the buyer of the NZ$s must want it to buy a NZ export of some kind. What is Steffan Browning's problem with this? The NZ$1 doesn't go overseas in any meaningful way, it gets spent on New Zealand produced goods and services no matter who gets the profits from the ownership of local firms. If a New Zealander gets the profits they spend them on New Zealand made goods and services, if a foreigners gets the profits they sell the NZ$s to someone who wants to buy New Zealand made goods and services.

Also to the bit about "it automatically cranks the price up that New Zealanders would have to pay", that is exactly the point, the New Zealand Superannuation Fund sold the land to the Chinese company because they got a better price. If we had stopped foreigners from being able to buy land the New Zealand Superannuation Fund would have gotten a lower price. How does that help the fund and the New Zealanders who rely on it for an income in old age?

You have to ask, Why do people sell assets to the highest bidder? One reason is that it allocates those assets to whoever thinks they can utilise them most productivity. You pay a higher price for an asset than another bidder because you think you can use that asset in a way which in more productive than the other bidder. Your knowledge and skills are such that you can produce more at a given cost or produce a given amount of output at a lower cost. Methods of production and asset utilisation that are highly productive are what makes a country "rich" and thus exactly what New Zealand needs. So let us sell land to those most likely to use it most productively, no matter where they come from.

I do have to ask, Just who are the Green's economic advisors and why do they think that xenophobic scaremongering is a reasonable basis for making good economic policy?

Just for fun: theory of the firm 13

As has been noted previously the theory of the firm is not well developed within Austrian economics. But his does not mean there have been no attempts at formulating an Austrian approach to the firm. One such attempt is that of Nicolai Foss and Peter Klein in their book Organizing Entrepreneurial Judgment: A New Approach to the Firm.

The classic questions in the theory of the firm are, Why do firms exist, what determines a firm's boundaries and how are firms organised internally? To see Foss and Klein's answers lets begin with the one-person firm. For Foss and Klein the explanation for such a firm lies in the fact that markets for judgement are incomplete. A combination of two factors result in an entrepreneur having to form a one-person firm. To begin, entrepreneurs may know their ideas are "good risks" but my not be able to communicate this to the capital markets. A similar problem arises in a more standard model in Rabin (1993). Rabin works within an adverse selection framework and shows that the adverse selection problems can be such that, in some cases, an informed party has to take over the firm to show that their information is indeed useful. For Rabin an informed party has information about how to make a firm more productive but can't reveal the information to the owners of a current firm. If the information is revealed the current firm can produce using it without any payment to the informed party. If the information is not revealed why should the firm believe the information is in fact useful? Within the Rabin framework it is suggested that firms are more likely to trade through markets when informed parties are also superior providers of productive services that are related to their information. But if, on the other hand, information is a firm’s only competitive advantage, it is likely to obtain control over assets, possibly by buying firms that currently own those assets or setting up his own firm. Second, Foss and Klein argue that entrepreneurship represents judgement under "genuine" uncertainty and such judgement can not be assessed in terms of its marginal product and thus it can not be be paid a wage. This idea is more innovative since standard models of the firm work, at best, within environments of risk, rather than uncertainty. In short, there is no market for the judgement and therefore exercising judgement requires the person with judgement to control the firm. Foss, Klein and Linder (2013: 25-6) explain an implication of this incompleteness of the judgement market,
Exercising judgment implies [...] asset ownership, for judgmental decision-making is ultimately decision-making about the employment of resources, that is: to arrange or organize the capital goods the entrepreneur owns (or has influence over). Obtaining ownership rights over tangible and intangible assets also strengthens the bargaining position. Ownership rights—as stressed in organizational economics—allow parties to “fill in the blanks” of a contract, including the right to exclude others from accessing or using an asset [...]. It thus also ensures that the entrepreneur can appropriate rents from his/her entrepreneurial idea.
Similarly the standard property rights approach to the firm sees asset ownership at the centre of the explanation of the firm. Both the Rabin(1993) adverse selection model type model and the related moral hazard model of Brynjolfsson (1994) utilise the property rights framework and both result in the informed party (the entrepreneur) owning the firm (controlling the physical assets of the firm) so they can appropriate rents.

But what of the multi-person firm? As many attributes of capital only become apparent via using those assets, experimentation in an effort to discover the best uses for the particular assets the firm owns is needed.
Given the interdependence that typically exists in a multi-state value chain and involving different inputs, the best time and place to use a particular asset depend on the specification of the uses of all other assets that are needed in value delivery [...] Thus, entrepreneurs need a contractual set up that allows them to experiment at low cost. (Foss, Klein and Linder 2013: 26).
Such experimentation can lead to hold-up problems if a market contract is used to coordinate collaborators. The basic argument Foss and Klein (2012) make is that foregoing the market as a means of coordination in favour of a firm lowers the costs of experimentation. Under market contracting collaborators have the power to veto changes in the experimental set-up which allows them to extract extra quasi-rents from other collaborators in return for their agreement to make the changes to the set-up. Within a firm, a hierarchical relationship, the entrepreneur can redefine and reallocate decision rights among the collaborators, who are now employees, and can sanction those who do not utilise their decision rights efficiently. The use of a firm therefore allows the entrepreneur to experiment without enduring the costs, bargaining and drafting costs, of constant contract renegotiation. For Foss and Klein (2012) this provides the basic rationale for the multi-person firm.

When considering the boundaries of the firm, Foss and Klien (2013) argue that Austrian ideas developed in the socialist calculation debate suggest that when organizations are large enough to conduct activities that are exclusively internal – so that no reference to the outside market is available – they will face a calculation problem. That is the firm's size is limited by the fact that the more a firm does internally the fewer genuine market prices in has as a basis for rational rational judgements about the scarcity of the resources and whether an entrepreneurial profit exists.

With regard to the internal organisation of firms Foss and Klein (2012) note a problem arises in that the entrepreneur will typically lacking information or knowledge to make optimal decisions. One way to deal with this dispersed knowledge is for the entrepreneur delegate decision rights to managers who have better information. This delegation allows the firm is able to exploit the locally held knowledge without having to codify it for internal communication or motivating managers to explicitly share their knowledge. There is however a trade-off with such delegation.
Unlike independent players in markets, managers within firms never possess ultimate decision rights and thus there are incentive limits to the extent to which market principles can be applied within firms [...] This gives rise to problems of motivation, i.e. moral hazard – to use the organizational economics terminology. Managers and employees may use the delegated decision-rights in both productive, that is, functional or value-enhancing from the owners’ perspective, and destructive (i.e. dysfunctional or value-diminishing) ways [...]. They may pursue new profitable business opportunities or engage in developing new forms of exploiting (quasi)-rents from the firm by creating new forms of hold-ups etc (ibid.). Yet, delegation may also imply risks of duplication of effort due to a lack of coordination of activities. The benefits of delegation in terms of better utilizing dispersed knowledge thus need to be balanced against the costs of delegation due to problems of interest alignment (what organizational economics would call “agency costs”) and coordination [...]  (Foss, Klein and Linder 2013: 29-30)..
This means entrepreneurs need to exercise judgement about other people's judgement in insofar as they must evaluate employees according to their ability to use delegated decision rights properly.

One point that Austrians share with their mainstream counterparts has been the reluctance until recently to open the "black box" of the firm. The judgement-based approach suggest that the Austrians have much to offer now that the box is has been opened.

  • Foss, Nicolai J., and Peter G. Klein (2012). Organizing Entrepreneurial Judgment: A New Approach to the Firm. Cambridge: Cambridge University Press.
  • Foss, Nicolai J., Peter G. Klein and Stefan Linder 2013. 'Organizations and Markets', SMG Working Paper No. 8/2013 April, Department of Strategic Management and Globalization, Copenhagen Business School.