EconTalk this week

Emily Oster of the University of Chicago and author of Expecting Better talks with EconTalk host Russ Roberts about her book on pregnancy and the challenges of decision-making under uncertainty. Oster argues that many of the standard behavioral prescriptions for pregnant women are not supported by the medical literature. The conversation centers around the general issue of interpreting medical evidence in a complex world using pregnancy advice as an application. Alcohol, caffeine, cats, gardening and deli-meats and their effect on pregnant women are some of the examples that come up. The conversation closes with a discussion of Oster's work on hepatitis-B and the male-female birth ratio.

You just have to love the French

From the Economics of information blog comes this wonderful insight to French economic thinking:

According to an article on FT.com today:

France’s parliament has passed a law preventing internet booksellers from offering free delivery to customers, in an attempt to protect the country’s struggling bookshops from the growing dominance of US online retailer Amazon.

Wouldn't you just love to be a consumer in France? Your parliament deliberately sets out to make you worse off. Yes, politicians are your friend ................ not!

Why do politicians think that protecting the inefficient and obsolete is a way to enhance welfare? Isn't the very fact that consumers are buying from stores like Amazon a message to politicians that these consumers want the services that these online store have to offer rather than the services offered by more conventional business? In which case what we seem to be seeing is creative destruction and to try to prevent it will only lower social welfare.

Was tulipmania irrational?

It is often assumed that the tulipmania was the result of financial market irrationality and the mania is often used as an example of said irrationality. These idea were popularised by Charles Mackay, a mid-19th century Scottish writer. Mackay is best known for his book, Extraordinary Popular Delusions and The Madness of Crowds. But was the tulipmania really all about irrational markets. Some economic historians say no and provide alternative explanations for what happened.

Some of these alternatives are discussed in an article at the Economist's blog Free Exchange.

First start with the work of Peter Garber including this 1989 paper in the Journal of Political Economy, "Tulipmania". Garber also has a book, Famous First Bubbles: The Fundamentals of Early Manias. In short Garber argues that the tulipmania was not simply irrational trade in rare bulbs. As the Economist puts it:

Peter Garber blames the general public for the price increases. He reckons that an outbreak of bubonic plague in Amsterdam made people less risk-averse. Dutch city-dwellers knew that each day could be their last—so did not mind indulging in a little speculation. And because gambling was illegal, contracts were unenforceable. If traders misjudged the market, they could just run off without paying.

But on the whole, Mr Garber reckons that investors acted rationally. He suggests that the trend towards extremely high prices, followed by rapid declines, was typical for rare bulbs, due to their growing cycle. And according to Nicolaas Posthumus, a Dutch historian, serious tulip financiers generally did not participate in the speculative markets. Any “mania” was pretty self-contained, and was pushed forward by casual traders, drunk on jenever and moral hazard. Only in the month before the crash does Mr Garber find evidence of speculation from more serious traders.

Then there is E. A. Thompson's 2007 paper in Public Choice which asks "The tulipmania: Fact or artifact?". The Economist continues,

Earl Thompson, formerly of UCLA, takes a different approach. He reckons that the market for tulips was an efficient response to changing financial regulation—in particular, the anticipated government conversion of futures contracts into options contracts. This ruse was dreamt up by government officials, who themselves were keen to make a quick buck from the tulip trade.

In plain English, investors who had bought the right to buy tulips in the future were no longer obliged to buy them. If the market price was not high enough for investors’ liking, they could pay a small fine and cancel the contract. The balance between risk and reward in the tulip market was skewed massively in investors’ favour. The inevitable result was a huge increase in tulip options prices [...]. (The price of options collapsed when the government saw sense and cancelled the contracts.) Spot prices (the price that traders paid for immediate delivery of tulips) and futures prices (the prices that traders would be compelled to pay for future delivery of tulips) were not volatile. And any movement of the spot/futures price was determined by simple supply and demand—the fall-out from the Thirty Years’ War, one of the bloodiest in European history, was one important factor.

Thompson argued that popular interpretations of tulipmania have failed to distinguish between options and futures. Tulipmania was only a contractual artifact. There was no “mania” at all.

Is there a lesson here? Perhaps it is that it is all too easy to say that bubbles are irrational since they seem to represent a deviation of prices from fundamental values. But to understand these "deviations" we need to understand how speculation actually works and there has been little effort put into doing this. The Economist's article closes by saying,

The example of tulipmania shows the importance of doing that—rather than relying on lazy quips about “animal spirits” or irrationality.

A new paper regarding Austrian capital theory

For those with an interest in Austrian capital theory Nicolai Foss points us to a new paper on the formalisation of Eugen von Böhm-Bawer work on Austrian capital theory. The paper is Renaud Fillieule’s “A comprehensive graphical exposition of the macroeconomic theory of Böhm-Bawerk.” Fillieule argues that Böhm’s theory can be seen as a precursor of Solowian growth theory and of macroeconomics in general. The abstract reads:

This paper offers a comprehensive graphical exposition of Böhm-Bawerk’s formalised macroeconomic theory. This graphical model is used here for the first time to study the effects of the changes in the explanatory variables (quantity of capital, number of workers and level of technical knowledge) on the dependent variables (interest rate, wage and period of production). This systematic application of the model shows that some of the conclusions drawn by Böhm-Bawerk are incorrect and need to be amended. A comparison with Solow’s model also shows that Böhm-Bawerk can legitimately be considered as one of the main originators of the standard contemporary approach in macroeconomics of equilibrium and growth.

Friedman on the minimum wage

Via Mark J. Perry comes this classic 1980 Milton Friedman video on the minimum wage. Professor Walter E. Williams makes a guest appearance.

The ex ante and ex post benefits of events

When considering the issue of the benefits of of big events Shamubeel Eaqub writes at the TVHE blog that,

In the lead up to the RWC, we looked at a range of events. International studies of sporting events fall into two categories, those done before the event, and those done after. The studies in the lead up to events on average forecast economic boost of around 1% of GDP. The studies done after the event estimate economic boost of around 0.1% of GDP [...].

Once the initial boosterism fades, large economic benefit estimates are largely disowned and there is a greater focus on intangible benefits such as showcasing the area, long term positive association and somewhat esoteric ‘feel-good’ factor.

There is nothing wrong with events. They are fun. But the fetishist need to justify it on economic grounds is entirely unnecessary. Events provide very small, if any, tangible net economic benefit. There are many other intangible things that can be good, like speeding up the beautification of the city, or finishing off motorways in the lead up to the RWC for example. Its not that they wouldn’t have been done, but events have a habit of getting things done on a deadline.

Eaqub also points us to a working paper by Sam Richardson at Massey which looks at Justification for Government Involvement in the Hosting of Sports Events: Do Projected Impacts Materialise? As to the question in the subtitle, the short answer is no. The abstract of the paper reads,

Major sporting events are said to generate substantial economic impacts to host cities. Estimates of these impacts are typically used as justification for government involvement in the staging of such events. The majority of independent academic research, however, has found that ex-ante projections of economic impacts for host cities from major sporting events rarely materialise. This paper considers the realised economic impacts of fifteen major sporting events hosted in sixteen New Zealand cities between 1997 and 2009. Realised economic impacts are found to be the exception, not the rule.

Given that the economic impacts do not live up to the hype that comes from the ex ante studies I want to ask Why not? What are the people who writes these reports doing? How can they be so wrong so often? There seems to be a systematic basis here. Are these people just producing reports to support a predetermined outcome?

Eaqub also goes down the there are no tangible benefits so lets justify spending taxpayer's money on an event by saying there are lots of intangible benefits. He says, for example, speeding up beautification of the city or finishing off motorways is an intangible benefit. But you have to ask question about the optimal timing of such projects. If a delayed finish to these projects is optimal then you don't want them finished at an earlier date. And if an early finish is optimal then there has to be much cheaper ways of getting these projects finished earlier.

Also if you want to host events on the grounds that some people will get positive utility from the "thrill" of hosting then you have to net out the negative utility that other people suffer from hosting. You must consider both sides of the ledger. It's the net-thrill that matters. And good luck with that.

A more general point, you could justify any amount of spending on anything if you allow the benefits to be some "intangibles". You can always come up with a huge amount of "intangible". Policy based on "intangibles" is policy based on nothing. And what does this say about evidence based policy. What evidence can you have for intangibles?

And what else could be done with any money spent on an event? How many hip operations could be done with that money? How many child cancer patients would receive quicker treatment if that money went to them? How many schools could be kept open with that money? Opportunity costs are real costs.

Quote of the day

Swedish economist Assar Lindbeck on rent control,

'Next to bombing, rent control seems in many cases to be the most efficient technique so far known for destroying cities'. (The Political Economy of the New Left, Harper & Row, New York 1971, p. 39)

Prof. Lawrence White asks Can the monetary system regulate itself?

This is an audio of a talk Professor White gave at CEVRO Institute in Prague earlier this month. White begins at around 6:30 minutes in.

Markets v. capitalism

Writing at the blog of the Adam Smith Institute Tim Worstall says,

Forgive me but this is going to be a bit of a rant on one of my bugbear themes: why is it that the British left simply cannot understand markets? Here we've got Martin Kettle describing one of David Sainsbury's ideas:

As a result, says Sainsbury, in opposition Labour now needs to embrace a new form of political economy – the progressive capitalism of his title – in order to govern better and better understand the future. That means embracing capitalism in two particular ways – the recognition that most assets are privately owned and the understanding that goods and income are best distributed through markets.

Neither of those two things are in fact capitalism. Capitalism does indeed describe a method by which assets (and more particularly, productive ones) are owned but it means that they are owned by the capitalist, not simply privately. The opposite to private ownership is State ownership. It's entirely possible to have privately owned assets but which are not owned by capitalists as the various flavours of mutual ownership show us. John Lewis and Mondragon by the workers in those companies, the Co Op or building societies by the customers for them and so on. Private ownership of assets is not necessarily capitalism.

Tim calls his piece "Why cannot the British left understand markets? I would argue that the problem is more general than title may suggest. Is not just the British and its not just the left that don't understand markets and capitalism. Most people everywhere miss the point Tim is making.

In popular discussion worldwide the distinction between "market economies" and "capitalist economies" is not often drawn. It may not surprise many than the distinction is not made since the association between markets and capitalism is so common place. Ownership rights do tend to be assigned to the providers of capital in western style developed economies such as the U.K, the U.S. and even New Zealand. But, as Henry Hansmann notes,

[...] investor ownership is not a logically necessary concomitant of free markets and free enterprise.

In fact one of the most interesting points about ownership of firms in a market economy is just how varied it is. As Martin Ricketts has written,

The assignment of ownership rights to workers, for example, can be found in some industries - the ply wood industry in the United states is a frequently cited case. More significantly, many professional partnerships in law and accountancy are owned by the people who work in them. In the United Kingdom, worker ownership can be found in retailing. The John Lewis 'partnership' has 37,000 worker partners who elect representatives to a central council which in turn provides 5 members to the Board of Directors. Similarly, consumer ownership has a significant history in retailing. The Rochdale Pioneers in 1844 began a working class movement which was taken up later (in 1864) by the middle classes when the Civil Service Supply Association was formed. The Co-operative Wholesale Society is still in existence with sales in 1997 in excess of £3 billion. Agricultural supply co-operatives for seeds, fertiliser and other farm inputs are important in the United States as are electric utility co-operatives in rural areas.

Mutual ownership, that is the sharing of rights between all participants in a club, is still very common in the area of financial services. The origins of this structure go back far into social and economic history. In life insurance, the Amicable Society (now the Norwich Union) was set up in 1706 as a simple club. Members paid a premium at the beginning of the year and the collected sum was distributed at the end of the year to the dependents of members who had died. By the middle of the 18th century, 'modern' characteristics were appearing such as differing premiums depending upon age and a specified sum assured. The mutual form was crucial however. In spite of advances in actuarial science the calculations were so uncertain that investor ownership would have resulted either in the risk of bankruptcy if premiums were set too low. or enormous profits to investors if premiums were set too high. The 'club' was therefore a fairly 'natural' response to these problems in the 18th century When investor ownership developed in the 19th century, this was always linked to profit sharing with policy holders. The Deed of Settlement of the Prudential in 1853, for example, determined that periodic valuations of new profits would be made and that 80 per cent of these would go to policy holders and 20 per cent to shareholders.

The building society movement represents another classic example of the evolution of mutual governance in the area of financial services. Fire insurance companies also initially adopted a mutual structure of governance - the 'Hand-in-Hand' (1698) providing an early example in London. Stock exchanges, popularly regarded as centres of financial 'capitalism', have historically been organised on principles of mutuality. The London Stock Fxcthange is still owned by its members rather than outside investors as are many other exchanges such as the International Petroleum Exchange (IPE) or the London International Financial Futures and Options Exchange (LIFFE). It may turn out that, under modem conditions, the days of mutual governance for these financial organisations are numbered. But the historical existence and durability of mutual arrangements in a market setting is not in doubt. Other examples taken almost at random include motoring organisations such as the Automobile Association (AA) and Royal Automobile Club (RAC) which have recently 'de-mutualiscd'. as well as the Silverstone Racing Track.

Sometimes the distribution of surpluses is ruled out by an organisation's constitution. Such organisations can thus be said to have no owners. They exist within market settings even if we would not expect them to be very common. Education and health care are areas in which non-profit enterprises compete with profit making organisations. At the so-called 'private' University of Buckingham there are no residual claimants and 'ownership' of the assets is no more clearly defined than in some bureaucracies. The same could be said of many other charitable organisations. Early examples of savings banks in the United Kingdom and in the United States, designed to encourage thrift amongst the relatively poor, were charitable rather than mutual organisations. In the modern world BUPA, which provides care homes, hospitals and occupational health facilities, employs over 30.000 people and retains all surpluses within the organisation.

So in a modern market economy firm ownership may be dominated by investor-ownership but you also have producer-ownership, employee-ownership, customer-ownership, non-profits ans mutuals.

So why so many types of firms. Put simply, one size dos not fit all. First, it is argued that all other things held equal, costs will be minimised for a firm if ownership is assigned to the class of patrons for whom the problems of market contracting--that is, the costs of market imperfections--are most severe. Thus, if the cost of contracting with workers is higher than the cost of contracting with suppliers, customers, etc., in a particular economic sector, then theory would predict that employee ownership would be the dominant form of ownership.

However, the story is further complicated by a second major factor: the cost of governance. The more diverse the interests of a patron group, the higher the costs of politically mediating those differences through the structure of the firm. As a result, the optimal form of ownership in an industry is that which minimises the sum of all of the costs of a firm's transactions. That is, it minimises the sum of (1) the costs of market contracting for those classes of patrons that are not owners and (2) the costs of ownership for the class of patrons who own the firm. In different situations different ownership structures will minimise these costs.

Jobs are a cost

We are often told by politicians and interests groups how many jobs this project or that project will create, as if jobs are somehow a benefit of the project. But are they? At the Forbes website Tim Worstall argues that jobs are not a benefit of a project but a cost. How so? Well,

Start with it from the point of view of the individual: neither I nor you particularly want a job. We most certainly aren’t all that fond of having to do the work that a job entails. We absolutely love being able to consume things, of course. And we all view having an income as most useful in being able to purchase the things we want to consume. But we all also view the job, the work we have to do, as a cost of getting that income so that we can consume stuff. The job is the cost, the consumption the benefit here.

Now look at it from the point of view of whoever is doing the employing of that labour. They certainly look upon a job as being a cost: they’ve got to pay out the wages to get people to do it after all. The benefit is that they get that work done so that they can go sell the goods or services produced. But the job itself, that’s still a cost to them. We even record the wages they pay on the cost ledger side of their accounting books, not on the benefits or income side.

Finally, think of it from the point of view of the whole society. No, don’t start thinking about “full employment” and the like just yet. Think instead about labour as being a scarce resource. Which it is of course: and just as with any scarce resource we want to use it as efficiently as possible. Say, imagine, we have 100 workers and all 100 were working on the farms to produce the food that kept all 100 people alive. Now we bring in new technology to farm with and we only need two people working to feed all. Well, we could say that 98 of the people are losing their jobs and that’s a disaster. But hold on a moment, jobs are a cost. Jobs here are a cost of producing food and we've just saved 98 job’s worth of cost. What this actually does is frees up those 98 people to go and do other things. Like, ooh, build libraries, hospitals, start manufacturing industry, join the military and so on. Roughly speaking this is also what has happened to the North Atlantic economies over the past four hundred years or so. We've moved from having nearly everyone working the land to about 2% of us doing so. And that has freed the labour up to go and build all the other things that we now generally refer to as civilisation.

Now you may well say I enjoy my job, which means, most likely, you enjoy some parts of your job but not others. This just means that the good parts of the job increase the consumption benefits that occur because of the job but the bad bits of the job are still a cost. They are the crap you have to put up with to get the good bits.

One of the great advantages of technological improvements and trade is that they reduce the requirement for labour to produce a given amount of output. Increasing specialisation and the division of labour has the same effect. All these reduce the cost of jobs for a given level of output and thus work to make us wealthier. As Tim Worstall points out as you reduce the number of jobs in one area you release a valuable resource to be utilised in another area of the economy.

EconTalk this week

Tyler Cowen of George Mason University and blogger at Marginal Revolution talks with EconTalk host Russ Roberts about his latest book Average is Over. Cowen takes a provocative look at how the growing power of artificial intelligence embodied in machines and technologies might change labour markets and the standard of living. He tries to predict which people and which skills will be complementary to smart machines and which people and which skills will struggle.