"When goods don't cross borders, armies will."

Over at the EconLog blog David Henderson is discussing the above quote normally attributed to Frederic Bastiat. But as Henderson points out there is little evidence that Bastiat actually said it. I posted on this topic back in 2009, see here and here.

The closest thing to the above quote I was able to find back in 2009 was one that says,

If soldiers are not to cross international borders, goods must do so.

According Jeffry Frieden, on page 255 of his 2006 book "Global Capitalism", the above quote is due to one Otto Maller and he gives a reference to page 37 of Alfred E. Eckes's 1975 book, "A Search for Solvency: Bretton Woods and the International Monetary System, 1941-1971". Maller, we are told, was a supporter of FDR's Secretary of State Cordell Hull.

It looks like the name Maller is a bit wrong as it should be Mallery. If you can find a copy of the Alfred E. Eckes's book you will indeed find the above quote is on page 37. Eckes writes,

Like nineteenth-century liberals, Otto Mallery believed that free trade was the panacea for economic nationalism and great power rivalries. "If soldiers are not to cross international boundaries," he said, "goods must do so."

The reference that Eckes gives to for the Mallery quote is "Otto T. Mallery, "Economic Union and Enduring Peace," Annals 216 (July 1941): 125-134; quotations on p. 125."

Let me give the full, albeit only two sentence, paragraph from "Economic Union and Enduring Peace" which runs over the bottom of page 125 and the top of page 126:

If soldiers are not to cross international boundaries, goods must do so. Unless shackles can be dropped from trade, bombs will be dropped from the sky. (Emphasis in the original.)

The details given at the end of the paper on Mallery are

Otto Tod Mallery, A.B., Philadelphia, was one of the drafters and sponsors of the National Employment Stabilization Act and is a consultant on the National Resources Planning Board which administers this act. He has originated legislation which brought into being new governmental agencies in Philadelphia and Pennsylvania and has held administrative positions in city, state, and Federal Governments. He was chief economist of the United States Department of Commerce. In 1937 he was economic adviser to the United States Government Delegation to the Conference of the International Labor Organization at Geneva, and in 1939 to the United States Employers' Delegation to the Conference of the American States, members of the Inter- national Labor Organization, at Habana. He is president of the Playground and Recreation Association of Philadelphia, and member of the Board of Directors of The American Academy of Political and Social Science. He is part author of "Business Cycles and Unemployment" (1923).

All of which means we are still left with the question of whether or not the Bastiat quote is genuine. But it seems unlikely.

Robert Pindyck on climate models

Robert Pindyck has a recent NBER working paper that looks at one of the critical tools used in climate policy:
Climate Change Policy: What Do the Models Tell Us?
Robert S. Pindyck
NBER Working Paper No. 19244, July 2013 The abstract answers the question in the paper's title:

Very little. A plethora of integrated assessment models (IAMs) have been constructed and used to estimate the social cost of carbon (SCC) and evaluate alternative abatement policies. These models have crucial flaws that make them close to useless as tools for policy analysis: certain inputs (e.g. the discount rate) are arbitrary, but have huge effects on the SCC estimates the models produce; the models’ descriptions of the impact of climate change are completely ad hoc, with no theoretical or empirical foundation; and the models can tell us nothing about the most important driver of the SCC, the possibility of a catastrophic climate outcome. IAM-based analyses of climate policy create a perception of knowledge and precision, but that perception is illusory and misleading.

Freedom in ideas matters

In their recent book, "How China Became Capitalist," Ronald Coase and Ning Wang argue that the market in ideas matters for the future well-being of China. Coase and Wang deplore China's lack of a free market for ideas and the damage that this has wrought on universities and on the Chinese economy's capacity to innovate.

But just how bad are the controls on academics in China's universities? A part answer to this question may be reflected in this recent posting on Greg Mankiw's blog:

A professor in China brings this story to my attention:

A renowned professor has confirmed online rumours that his peers will decide whether he will be expelled from China's most eminent university after he made a series of remarks in favour of free speech and constitutional governance.

Economics professor Xia Yeliang of Peking University was told by his department that his fate would be decided by a faculty vote, he told the South China Morning Post on Monday.

"They told me it's because of all the things I have said and written," Xia said. "They have threatened me before, but this is the first time they will vote on my expulsion."

My correspondent says that the vote will likely take place in September. He also reports that this is not an isolated incidence. He writes, "Though you may not be aware, there is a quiet crack down currently under way in China with other professors being removed for similar offenses....I can tell you from my personal experience here, most Chinese faculty at PKU and other elite Chinese institutions having been educated at top schools in the US are appalled but are quite fearful to speak out."

There are some very obvious issues here about the role of academics in Chinese society - "critic and conscience of society" in New Zealand terms - and for the freedom of speech but if Coase and Ning are right then the effects of such repression could go further than just the social and political spheres, it could negatively effect the future growth of the Chinese economy. Growth that in recent times has resulted in millions of people being raised out of poverty. Anything which retards the enormous potential for future growth that the Chinese economy has must be of concern to anyone who is worried about the well-being of the many millions of people who are still poor in China today.

Why is it that the expression "third way" always worries me? 3

Let me make a few quick comments in reply to Jason Krupp. First let me apologise for any misrepresentation I may have made, this was unintended.

My point about the meaning of ownership is that even taking into account "democracy and the nature of general elections versus specific referenda" taxpayers do not have the rights defining ownership. The residual controls rights for SOEs are not in the hands of taxpayers, these rights are held by the government or its bureaucracy. I fail to see how your dinner companion can in anyway think they are an owner of any SOE in that they do not have residual control rights over any SOE. Or at least this would be my reply to them.

My point about the government being the single shareholder isn't that having a single shareholder is bad, its about the government being a majority shareholder. I would argue that there is likely to be little difference in the operations of an SOE as long as the government is the majority shareholder. Thus an SOE under 100% government ownership will look much like an SOE with 51% government ownership. Hence my comment on the García and Ansón paper.

Using a panel data analysis of Spanish privatised firms, we study how different factors influence the operating performance of divested companies. The results show that it is not privatisation per se but other factors that matter. After controlling for possible sample selection bias related to government timing of divestments, we find that  the greater the relinquishment of State control and the smaller the percentage of ownership held by managers and/or employees,  the better the firms’ post-privatisation performance. Moreover, privatisations that are accompanied by liberalisation programmes and occur during buoyant economic cycles turn out to be more successful. (Emphasis added).

As to having millions of people acting in the role of shareholder this may or may not be a good thing. It is not clear that we need to "foster a savings culture in New Zealand", there is no saving problem here - see, for example, Le, Scobie and Gibson (2009) and Le, Gibson and Stillman (2012) for more on this.

Even if we want, and don't have currently, a "thriving equity market" its not clear that this should be an aim of a privatisation program. The aim should be efficiency and productivity. Roger Douglas made this point in an article from the New Zealand Herald.

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

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

The New Zealand sharemarket may not be thriving, but is it the government's job to fix this, any more than it is the government's job to fix or support any other sector of the economy? I can't help thinking it is not the job of any government to bolster the sharemarket, that is the job of the those who run the sharemarket.

Refs:

• Le, Trinh, Grant Scobie and John Gibson (2009). Are Kiwis saving enough for retirement? Evidence from SOFIE, New Zealand Economic Papers 43(1): 3-19.
• Le, Trinh, John Gibson and Steven Stillman (2012). Wealth and saving in New Zealand: evidence from the longitudinal survey of family, income and employment, New Zealand Economic Papers 46(2): 93-118.

Why is it that the expression "third way" always worries me? 2

The following comes from the comments section to my previous posting Why is it that the expression "third way" always worries me? and is from Jason Krupp author of the New Zealand Institute piece I was commenting on. Let me thank Jason for taking the time to write this comment.

Dear Anti-Dismal:

I enjoyed the article, and you raise many valid points, though some of the positions you attribute to me are a little off.

Firstly, it's the critics of the mixed ownership who've claimed New Zealanders already own the state owned assets. In fact I remember a particular dinner conversation in which one guest said of the partial float “why should I pay for what’s already mine?”.

As for the complicated morass of property rights, democracy and the nature of general elections versus specific referenda, well, I’m sure you’ll agree that it’s too broad to tackle in the 500 words I had to work with.

Also, in a piece of this nature you have to take a few short cuts, such implying Government ownership when referring to a single shareholder. Should I have spelled it out?
Perhaps, but I’m giving the reader the deductive benefit of the doubt – one I’m confident they’ve made.

This need for short cut extends to the share ownership issue you’ve taken umbrage with. Of course we won't have 4.4m shareholders for long as some will sell and some will hold because there is a free market to sell them - something that wasn't available in the Soviet example you used.

But those who sell can use those funds for other things – investing in a business, paying down debt, splashing out at the shops – which have upside benefits for the economy and the government’s coffers.

And adding millions of people to the shareholder roll is a good on many levels. It’s a fantastic way of building up knowledge in the equity market, which we need if we are going to foster a savings culture in New Zealand.

I’m sure you’d also agree that a thriving equity market (which we don’t have at the moment, but it’s getting better) is essential if we’re going to lower the cost of capital for New Zealand businesses, which is notably higher than across the Tasman.

Lastly, “selling 100 per cent of the SOEs by any means would mean that this is at best a one-off trick” is exactly the point, albeit a Hayekian one. If, as a politician, you know you can’t sell the family silverware to get you out of debt, you’re likely to think a bit more carefully about what you’re getting into debt for (actually that might be a little naive).

In conclusion, you’re right, the third way is not that clear at all, but equally neither are the benefits/costs of other options.

Jason Krupp
The New Zealand Initiative

Abusing science in the cause of paternalism

The Institute of Economic Affairs in London has released a new policy paper on Quack Policy – Abusing Science in the Cause of Paternalism by Jamie Whyte.

A quick summary of the paper's findings is given by:

• Politicians and lobbyists who promote new regulations and taxes typically claim to have science on their side. Scientific evidence shows that the actions they wish to discourage are harmful and that government intervention would reduce this harm. Yet much ‘evidence-based policy’ is grounded on poor scientific reasoning and even worse economics.
• Recent examples from the U.K. of flawed evidence-based policy include the proposal to introduce a minimum alcohol price, the ban on smoking in enclosed public spaces, measures to reduce greenhouse gas emissions and attempts to increase gross national happiness.
• A frequent error is to ignore the costs resulting from the policy. For example, minimum alcohol price plans do
not consider the welfare losses associated with reduced consumption among recreational drinkers. The benefits of alcohol consumption, and hence the cost of reducing it, are simply ignored in the analysis.
• Evidence-based policy typically also fails to account for substitution effects, such as the way a minimum alcohol price would encourage consumers to purchase drinks in the shadow economy or adopt intoxicating alternatives to alcohol.
• The external costs of harmful activities are central to the arguments for state intervention but often cannot be calculated with any certainty. To estimate the external cost
of carbon emissions, for example, we would need to know
the subjective preferences of people around the world, and somehow weigh them against each other. We would also need to make assumptions about the preferences of people living many decades in the future.
• The predictions of theories that have not been tested, and are not entailed by well-known facts, do not warrant high levels of certainty. Those who insist on this are not ‘anti-science’, as they are often claimed to be. On the contrary, it is those who are willing to be convinced in the absence of predictive success who display an unscientific cast of mind.
• High levels of scientific doubt are often concealed as a result of ‘noble-cause corruption’. Scientists may exaggerate levels of confidence in their findings if it promotes actions they happen to support. This problem is particularly acute in fields that have long been policy battlegrounds, such as climate, health and education. Many scientists entered such fields because they were already committed to a particular policy agenda.
• Scientists are also interested parties. They stand to gain from policy taking one direction rather than another and will be tempted to support the personally profitable policy direction. Public policy can create demand for their skills and hence drive up the rewards accruing to them. Scientists are natural supporters of policies that draw on their expertise and thus inclined to overstate the credibility and importance of their ideas.
• Expert practitioners in one field may be quite ignorant of other fields, knowing little about either their theory or methods. ‘Expertise slippage’ is the tendency to defer to experts on matters which fall outside their area of expertise. Climate scientists, for example, are experts on hardly any of the issues that determine which climate polices are best. They have no special knowledge of how businesses will respond to taxes or the relative welfare costs of reduced growth.
• Paternalist policies promoted by experts and politicians show contempt for the actual preferences of the general public. People are forced to live according to values that they reject. For example, supporters of ‘happiness policy’ believe the state should coerce people to act against their preferences in ways that policymakers think will increase their wellbeing.

At the heart of argument is an idea central to economics but not to the thinking of many policy makers: trade-offs. Take, as an example, the case of alcohol pricing. It could be true that raising the price of alcohol will reduce the number of alcohol-related injuries, in much the same way that lowering the speed limit will reduce the number of traffic accidents. From this narrow perspective, demands for a minimum price of $0.50, say, for a unit of alcohol and a 20 mph limit on urban roads can be viewed as "evidence-based", both could show a reduction in harms. Which would be a good thing. But, enjoying a drink and getting from A to B in good time are also good things. If the aim of the policy is to have fewer alcohol based injuries then we can have them but it will come at the cost of millions of dollars in higher drink prices and might mean more moonshine and drug use; that is people will substitute cheaper black market alcohol or drugs for more expensive legal alcohol. In the same way we can have fewer traffic accidents but it comes at the cost of driving at a crawl and being less efficient.

In any policy making both costs and benefits have to be taken into account, that is we have to consider both the winners and the losers from a change in policy. Any policy analysis which considers only the bad is not worth the paper it is written on. In Whyte's view the failure to acknowledge trade-offs and competing preferences is endemic in much of the so-called evidence-based policy. By looking at only the "bad side" of a situation you run the very real risk of causing more harm than good. Why not, for example, have a $500 minimum price of alcohol or a 5 mph speed limit. I'm sure that the evidence would show that both policies would reduce harm and thus would pass as "evidence-based policy". But it comes at the cost of denying people the pleases of drinking and the benefits of driving. Would it be a trade-off worth making?

EconTalk this week

Eric Hanushek of Stanford University's Hoover Institution talks with EconTalk host Russ Roberts about his new book, Endangering Prosperity (co-authored with Paul Peterson and Ludger Woessmann). Hanushek argues that America's educational system is mediocre relative to other school systems around the world and that the failure of the U.S. system to do a better job has a significant negative impact on the American standard of living. Hanushek points to improving teacher quality as one way to improve education.

Why is it that the expression "third way" always worries me?

 In the latest issue of "Insights" from the New Zealand Institute Jason Krupp argues for A third way on asset sales.

Krupp argues that

The anti-privatisation camp, rightly or wrongly, have taken glee in pointing out that the Government is selling off assets that generate higher dividend returns than the equivalent interest rate on our public debt.

If true, then it just tells us that the method of sale is wrong, the government is not capturing the full amount of money it could if it used a different method of sale. Answer, change the method of sale.

Also Krupp says,

Critics have also noted retail investors will be paying for these assets twice, since they’re technically owned by all New Zealanders anyway. Plus, those who don’t participate are having part of their national wealth snatched away from them.

This is just plain wrong, New Zealanders do not own the SOEs. Oliver Wendell Holmes Jr. asks the question: What are the rights of ownership? His answer,

They are substantially the same as those incident to possession. Within the limits prescribed by policy, the owner is allowed to exercise his natural powers over the subject-matter uninterfered with, and is more or less protected in excluding other people from such interference. The owner is allowed to exclude all, and is accountable to no one. (The Common Law, p193, (1963 edn.))

Clearly the "public" does not have the rights Holmes refers to, he government (or its bureaucracy) has them. Following Grossman and Hart ("The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration", Journal of Political Economy, 94: 691-719) economist's tend to define the owner of an asset as the one who has residual rights of control over the asset; that is whoever can determine what is done with the asset, how it is used, by whom it is used, when they can use it etc - note that ownership is not defined in terms of income rights. Under "public" ownership it isn't the "public" who has the control rights, its the government. The "public" can not determine what use is made of a "public" asset, rather its use is determined by the politicians and managers in command of it.

Madsen Pirie at the Adam Smith Institute blog puts it this way

The state sector may have the name of the public filled in on the dotted line, but the public do not own it in any meaningful sense of the word. All of the attributes of ownership, such as control, the right to determine what use is made of it and under what conditions, is determined by the bureaucracy in command of it.

and

Because the public has no choice over whether to pay for state services, or to choose what quality of service is appropriate for them, they have no power over them. In their absence it is the managers and workforce who increasingly direct the services to meet their needs and convenience instead of those of the public.

Krupp continues,

Indeed, it could be argued that the efficiency drag of a single shareholder [the government] can already be seen, with Contact Energy and TrustPower (two private companies with diverse shareholder bases) offering the highest returns on equity in the sector. Returns from the state-owned firms lag behind these two companies by a noticeable margin, even though they’ve been operating as private entities for over a decade.

The issues here isn't so much that there is a single shareholder, its that the shareholder is the government. A firm with a single private shareholder would act differently from the SOEs. This is one reason for not liking partial privatisation, the government keeps control with its 51%.

If you look at the economics literature you will find that fully private companies outperform mixed ownership firms. Some insight on this is offered by a recent paper in the Scottish Journal of Political Economy (Volume 59, Issue 1, pages 1–27, February 2012). The paper "What Drives the Operating Performance of Privatised Firms?" by Laura Cabeza García and Silvia Gómez Ansón argues that the greater the amount of privatisation the better the performance of the firm. Not an entirely surprising result as the full force of market discipline can only be applied if the firm is fully in private hands but it is something for the government to keep in mind. It would suggest that any performance improvements due to the government's partial privatisation plans will be modest. The abstract reads,

Using a panel data analysis of Spanish privatised firms, we study how different factors influence the operating performance of divested companies. The results show that it is not privatisation per se but other factors that matter. After controlling for possible sample selection bias related to government timing of divestments, we find that the greater the relinquishment of State control and the smaller the percentage of ownership held by managers and/or employees, the better the firms’ post-privatisation performance. Moreover, privatisations that are accompanied by liberalisation programmes and occur during buoyant economic cycles turn out to be more successful. (Emphasis added)

When you look at the performance of mixed ownership firms they don't do as well as fully privately owned firms. For example, Aidan Vinning and Anthony Boardman in "Ownership and Performance in Competitive Environments: A Comparison of the Performance of Private, Mixed, and State-Owned Enterprises", Journal of Law and Economics vol. XXXII (April 1989) conclude

'The results provide evidence that after controlling for a wide variety of factors, large industrial MEs [mixed enterprises] and SOEs perform substantially worse than similar PCs [private corporations].'

So fully private firms out-perform mixed ownership firms.

Krupp then asks,

So, given these compromises, has the hybrid privatisation been worth it?

In my view there are at least 6 reasons for thinking hybrid privatisation will not be worth it:

• First, selling only 49% of the shares in the companies is unlikely to make a huge difference to the way the SOEs are run. In particular the sell off will not make the firms any more efficient since the government will still be the controlling shareholder.
• Second, if the government really does want to maximise the income it gets from the sales selling 49% is not a good idea. 51% is worth a lot more than 49%, that is people will pay a premium for control.
• Third, selling to "Mums and Dads" will do nothing for the amount of money raised, since Mums and Dads will need a discount to make them buy shares.
• Fourth, selling to "Mums and Dads" will do nothing for the efficiency effect of having private owners, since there will be too many "Mums and Dads" for them to be able to coordinate their effects to effect the firm's behaviour.
• Fifth, given that each "Mum or Dad" will own only a very small share of any of the firms, they have little incentive to become informed on the firm's activities since they will only capture a very small amount of any improvement in performance they could bring about. This is another reason why performance is unlikely to change.
• Sixth, the discipline of bankruptcy or takeover is not greater since the government is still the controlling shareholder and is unlikely to let either of these options happen.

Krupp ends by saying,

Frankly, it’s too early to tell, but it’s interesting to consider that there could have been a third option: just giving the shares away (as pointed out by Professor Sinclair Davidson of the Royal Melbourne Institute of Technology).

While the government would give up a dividend stream, that’s traded off against the $10 billion it would inject into the economy at a local level.

It also scratches two other important itches; it instantly creates 4.4 million equity investors, and removes the political temptation to win votes by blow-out spending, knowing you can sell off parts of the balance sheet when the debts come due.

It should be noted that giving shares away has been used before, especially in the old Soviet Union, but its not clear that its outcomes where that successful. You also have to ask, Why do we want "4.4 million equity investors"? What we want is an ownership structure that results in the most efficient use of our resources, How can we know that having "4.4 million equity investors" is that structure? I'm guessing that most people would not want their shares and thus would simply sell them which results in fewer than "4.4 million equity investors", which seems to defeat Krupp's aim of creating these investors in the first place. All it would do is change who gets the rewards from selling the shares. This may, or may not, be a good thing.

As to the aim of removing the "political temptation to win votes by blow-out spending", selling 100% of the SOEs by any means would mean that this is at best a one-off trick.

All in all its not clear that the third way is the right way.

Not thinking like an economist is dangerous

James Zuccollo at the TVHE blog points us to this piece from the Daily Mail in the U.K.

A council is considering urging taxi firms to provide cheaper cab fares for women who wear revealing clothes.

Brentwood Borough Council is considering the bizarre move in a bid to stop women wearing short skirts or low-cut tops becoming a target for sex attackers.

The council is considering discounted taxi prices so that 'provocatively dressed' women can be driven back home and have less of a problem getting a ride.

This is a good example where not thinking like an economist gives rise to the opposite outcome from that intended. The intention seems to be to get more "provocatively dressed women" (whatever that means) home safely in taxis but the effect of this lower fare may well be the opposite. If "provocatively dressed women" were to be charged a lower fare that would mean they are less profitable to carry than a non-provocatively dressed woman or a man. This would mean that taxi drivers would be less likely to drive "provocatively dressed women" home than other women or men thereby reducing the number of such women taken home safely. Also there is the issue of the effect of the lower fare on the number of "provocatively dressed women" out and about.

In short, such a policy would not work.

EconTalk this week

Jagdish Bhagwati of Columbia University talks with EconTalk host Russ Roberts about the economy of India based on his book with Arvind Panagariya, Why Growth Matters. Bhagwati argues that the economic reforms of 1991 ushered in a new era of growth for India that has reduced poverty and improved the overall standard of living in India. While supportive of social spending on the poor, Bhagwati argues that growth should precede higher levels of spending, providing the tax revenue for expanded spending.

One up for a carbon tax

A new NBER working paper looks at Carbon Taxes vs. Cap and Trade: A Critical Review. The paper by Lawrence H. Goulder and Andrew Schein sees advantages in a carbon tax when compared to a cap-and-trade.

The abstract reads:

We examine the relative attractions of a carbon tax, a “pure” cap-and-trade system, and a “hybrid” option (a cap-and-trade system with a price ceiling and/or price floor). We show that the various options are equivalent along more dimensions than often are recognized. In addition, we bring out important dimensions along which the approaches have very different impacts. Several of these dimensions have received little attention in prior literature.

A key finding is that exogenous emissions pricing (whether through a carbon tax or through the hybrid option) has a number of attractions over pure cap and trade. Beyond helping prevent price volatility and reducing expected policy errors in the face of uncertainties, exogenous pricing helps avoid problematic interactions with other climate policies and helps avoid large wealth transfers to oil exporting countries.

EconTalk this week

Barry Weingast, the Ward C. Krebs Family Professor of Political Science at Stanford University and a Senior Fellow at Stanford's Hoover Institution talks with EconTalk host Russ Roberts about the role of violence and the threat of violence in maintaining destructive economic policies that reduce growth and development. Weingast argues that the threat of violence encourages leaders to create monopolies and other unproductive policies to pay off special interests that would otherwise threaten a coup or revolution. Weingast shows there is a surprising amount of violent regime change in modern times and discusses how this discourages growth-enhancing economic policies. The conversation closes with an analysis of similar ideas in Book III of Adam Smith's Wealth of Nations.

Raghuram Rajan on public economic debate

But, for economists who actively engage the public, it is hard to influence hearts and minds by qualifying one’s analysis and hedging one’s prescriptions. Better to assert one’s knowledge unequivocally, especially if past academic honors certify one’s claims of expertise. This is not an entirely bad approach if it results in sharper public debate.

The dark side of such certitude, however, is the way it influences how these economists engage contrary opinions. How do you convince your passionate followers if other, equally credentialed, economists take the opposite view? All too often, the path to easy influence is to impugn the other side’s motives and methods, rather than recognizing and challenging an opposing argument’s points. Instead of fostering public dialogue and educating the public, the public is often left in the dark. And it discourages younger, less credentialed economists from entering the public discourse.

More can be found here.

Raghuram Rajan is a Professor of Finance at the University of Chicago Booth School of Business and the next Governor of the Reserve Bank of India. New Zealand can only dream of having such people running their central bank.

Keynes on "The Road to Serfdom"

It is well known that John Maynard Keynes said of Hayek's "The Road to Serfdom":

In my opinion it is a grand book [...] Morally and philosophically I find myself in agreement with virtually the whole of it: and not only in agreement with it, but in deeply moved agreement.

What was not known, to me at least, is what Keynes said later in the letter from which the above quote comes. At the end of his letter to Hayek, Keynes wrote,

I come finally to what is really my only serious criticism of the book. You admit here and there that it is a question of knowing where to draw the line. You agree that the line has to be drawn somewhere [between free-enterprise and planning], and that the logical extreme is not possible. But you give us no guidance whatever as to where to draw it. In a sense this is shirking the practical issue. It is true that you and I would probably draw it in different places. I should guess that according to my ideas you greatly underestimate the practicability of the middle course. But as soon as you admit that the extreme is not possible, and that a line has to be drawn, you are, on your own argument, done for since you are trying to persuade us that as soon as one moves an inch in the planned direction you are necessarily launched on the slippery path which will lead you in due course over the precipice.

I should therefore conclude your theme rather differently. I should say that what we want is not no planning, or even less planning, indeed 1 should say that we almost certainly want more. But the planning should take place in a community in which as many people as possible, both leaders and followers, wholly share your moral position. Moderate planning will be safe if those carrying it out are rightly orientated in their own minds and hearts to the moral issue. This is in fact already true of some of them. But the curse is that there is also an important section who could almost be said to want planning not in order to enjoy its fruits but because morally they hold ideas exactly the opposite of yours, and wish to serve not God but the devil. [...] What we need is the restoration of right moral thinking - a return to proper moral values in our social philosophy. If only you could turn your crusade in that direction you would not feel quite so much like Don Quixote.

It seems Keynes believed in philosopher-kings, disinterested, public-spirited people working wholly for the public good. I wish him luck with that. But his point about the "slippery path" is one often made with regard to Hayek's argument.

The Tiwai industrial bailout (updated)

Over at the TVHE blog Matt Nolan writes on what he calls The Tiwai industrial subsidy. He points us to two articles from Infometrics that are relevant to the topic:  Tiwai and electricity and on the Southland workforce and a managed exit. These are well worth reading.

I would like to make an additional point about the opportunity cost of the bailout. Let us assume, for no good reason, that the bailout actually works and 800 jobs are "saved". Does this mean that the government has spent your money wisely? May be not, the government could have used the $30m in some other way and these alternative uses could have generated more than 800 jobs. The bailout will stop or at least delay what is most likely a necessary reallocation of resources within the New Zealand economy. Aluminium smelting is an industry that New Zealand doesn't now, if it ever did, have a comparative advantage in. Reallocating resources and people from the smelter closure will in the short term be painful but beneficial over the longer term. This is why Matt's point about the government helping the plant wind-down in an orderly fashion has merit. Thus to show that this particular bailout is a good use of taxpayer's money the government not only has to show that it will work but it also has to show that the bailout is the best use of taxpayer money. What's the bet it can't do either?!

I do, also, find myself wondering - and not in a good way - about the relationship between this deal and the forthcoming partial sale of Meridian.

Update: Seamus Hogan comments here on the politics of all of this.

The why (or why not) of vertical integration

At the Latent Paradigm blog Seth Goldin asks Why would a firm choose vertical integration? Part of Goldin's answer reads,

Why would a profit-maximizing firm choose vertical integration? Recall from Coase that firms exist to minimize transaction costs. If transaction costs between lessors and lessees are high enough, vertical integration is attractive. According to the widely cited 1978 paper by Benjamin Klein, Robert G. Crawford, and Armen A. Alchian, we might see vertical integration from a specific kind of transaction cost: post-contractual opportunistic behavior. A production technology with high fixed costs that cannot be recovered by being scrapped into alternative uses will tend to be vertically integrated into the rest of the product’s production process. What are some implications of this? The paper explains:

• Fisher Body once supplied specialized metal dies that would stamp entire automobile bodies for General Motors. Fisher repeatedly tried to extract monopoly rents from GM, but eventually, in 1926, the companies merged.
• Oil refineries are usually vertically integrated with oil pipelines, but not with oil tankers. An independent oil refinery would be hostage to a monopsonistic pipeline lessor, but an oil tanker has a potential appropriable rent near zero, because an oil tanker could easily be repurposed for shipping other goods.
• Owners of highly perishable crops are quite vulnerable to collective demands by their laborers. Slavery was a form of vertical integration, but now, absent slavery, long-term labor contracts with unions consist of rigid wages with layoff provisions so that employers can’t opportunistically claim false reductions in demand.
• Franchise relationships mimic vertical integration because, although a franchisee is technically an independent firm, the franchisee is essentially renting a brand, and is subject to certain controls by the franchisor.
• Specific capital investments that have high fixed costs and can’t be easily repurposed could be subject to opportunistic behavior by workers, so the owners of firms tend to own specialized capital investments. Owners of firms use detailed employment contracts to prevent the appropriation of specialized capital by their employees. Such detailed employment contracts mimic the function of vertical integration.

The interesting point about the Klein, Crawford and Alchain argument is that Coase rejects it! As Klein himself  summarised the situation,

I have always considered my work with Armen Alchian and Robert Crawford (1978) on vertical integration to represent an extension of Coase's classic article on "The Nature of the Firm." By focusing on the "hold-up" potential that is created when firm-specific investments are made by transactors, or what we called the appropriation of quasi-rents, I believed we had elucidated one aspect of the Coasian concept of transaction costs associated with market exchange. We hypothesized that an increase in firm-specific investments, by increasing the market transaction costs associated with a hold-up, increased the likelihood of vertical integration. This relationship between firm-specific investments, market transaction costs, and vertical integration was illustrated by examining the contractual difficulties that existed when General Motors purchased automobile bodies from Fisher Body and the corresponding benefits that were created when the parties vertically integrated.

It is clear from Coase's lectures that he considers our analysis not to represent an extension of his earlier work, but rather to be an alternative, incorrect explanation for vertical integration (1988: lecture 3). Coase recognizes that an increase in the quasi-rents yielded by firm-specific investments creates a hold-up potential. However, he argues that there is no reason to believe that this situation is more likely to lead to vertical integration than to a long-term contract. Although long-term contracts are imperfect, opportunistic behavior is usually effectively handled in the marketplace, according to Coase, by a firm's need to take account of the effect of its actions on future business. Coase claims that before writing his classic paper he explicitly considered opportunistic behavior as a motive for vertical integration, in particular as it applied to the General Motors-Fisher Body case, and explicitly rejected it.

The Klein, Crawford and Alchain paper has also lend to the soap opera that is the literature on the General Motors-Fisher Body integration. Some people claim hold-up drove the GM takeover of Fisher Body, some say there was no hold-up at all while others say there was hold-up by the Fisher brothers, but only after the takeover by GM and yet others blame the lawyers!

Read Baird (2003), Casadesus-Masanell and Spulber (2000), Coase (2000), Coase (2006), Freeland (2000), Goldberg (2008), Klein (1988), Klein (1996), Klein (2000), Klein (2007), Klein (2008) and Klein, Crawford and Alchian (1978) ... and then decide.

In short vertical integration is complicated. Modern organisational economics offers diverse theories of the boundaries of firms (i.e. theories of vertical integration). Such theories are based around various frictions or transaction costs; Knightian uncertainty, imperfect foresight or bounded rationality, small-numbers bargaining, haggling costs, private information, cost of processing information, costs of inspecting quality or imperfect legal enforcement. Given such costs internalising activities within a firm may be more efficient than relying on market transactions.

(HT: Knowledge Problem.)

Refs.:

• Baird, Douglas G. (2003). ‘In Coase’s Footsteps’, John M. Olin Law & Economics Working Paper No. 175 (2d series), The Law School The University Of Chicago, January.
• Casadesus-Masanell, Ramon and Daniel F. Spulber (2000). ‘The Fable of Fisher Body’, Journal of Law and Economics, 43(1) April: 67-104.
• Coase, Ronald Harry (2000). ‘The Acquisition of Fisher Body by General Motors’, Journal of Law and Economics, 43(1) April: 15-31.
• Coase, Ronald Harry (2006). ‘The Conduct of Economics: The Example of Fisher Body and General Motors’, Journal of Economics & Management Strategy, 15(2) Summer: 255-278.
• Freeland, Robert F. (2000). ‘Creating Holdup Through Vertical Integration: Fisher Body Revisited’, Journal of Law and Economics, 43(1) April: 33-66.
• Goldberg, Victor P. (2008). ‘Lawyers asleep at the wheel? The GM-Fisher Body contract’, Industrial and Corporate Change, 17(5): 1071-84.
• Klein, Benjamin (1988). ‘Vertical Integration as Organizational Ownership: The Fisher Body-General Motors Relationship Revisited’, Journal of Law, Economics, and Organization, 4(1) Spring: 199-213.
• Klein, Benjamin (1996). ‘Why Hold-Ups Occur: The Self-Enforcing Range of Contractual Relationships’, Economic Inquiry, XXXIV, July: 444-63.
• Klein, Benjamin (2000). ‘Fisher-General Motors and the Nature of the Firm’, Journal of Law and Economics, 43(1) April: 105-41.
• Klein, Benjamin (2007). ‘The Economic Lessons of Fisher Body-General Motors’, International Journal of the Economics of Business, 14(1) February: 1-36.
• Klein, Benjamin (2008). ‘The enforceability of the GM-Fisher Body contract: comment on Goldberg’, Industrial and Corporate Change, 17(5): 1085-96.
• Klein, Benjamin, Robert G. Crawford and Armen A. Alchian (1978). ‘Vertical Integration, Appropriable Rents, and the Competitive Contracting Process’, Journal of Law and Economics, 21(2) October: 297-326.

EconTalk this week

Robert Pindyck of MIT talks with EconTalk host Russ Roberts about the challenges of global warming for policy makers. Pindyck argues that while there is little doubt about the existence of human-caused global warming via carbon emissions, there is a great deal of doubt about the size of the effects on temperature and the size of the economic impact of warmer climate. This leads to a dilemma for policy-makers over how to proceed. Pindyck suggests that a tax or some form of carbon emission reduction is a good idea as a precautionary measure, despite the uncertainty.

And Econ 101 dies (updated)

The Stuff website is reporting that Labour's housing spokesperson Phil Twyford said,

"It is based on the notion that increasing supply of houses at any price will somehow bring down prices. This is trickle-down economics at its most dubious."

WTF?!

Yes Phil increasing supply does lower price. Assuming that demand is not totally elastic, just draw a supply and demand diagram and move the supply curve out to the right, price goes down. Its Econ 101 stuff.

And these people want us to vote for them!!

Update: Matt Nolan at TVHE got to this one first. Sorry, what? he rightly asks.