Friday 6 December 2013

EconTalk this week

Lant Pritchett of Harvard University and author of The Rebirth of Education talks with EconTalk host Russ Roberts about the ideas in the book. Pritchett argues that increases in years of schooling for students in poor countries do not translate into gains in education, learning, or achievement. This tragic situation is due to corruption and poor incentives in the top-down educational systems around the world. School reforms that imitate successful systems fail to take into account the organic nature of successful school systems that cause various external attributes to be effective. The conversation concludes with a discussion of school systems in rich countries and possible lessons for reform that might apply there.

Collaboration, stars, and the changing organisation of science

The NBER has released a new working paper on Collaboration, Stars, and the Changing Organization of Science: Evidence from Evolutionary Biology by Ajay Agrawal, John McHale and Alexander Oettl.

The abstract reads:
We report a puzzling pair of facts concerning the organization of science. The concentration of research output is declining at the department level but increasing at the individual level. For example, in evolutionary biology, over the period 1980 to 2000, the fraction of citation-weighted publications produced by the top 20% of departments falls from approximately 75% to 60% but over the same period rises for the top 20% of individual scientists from 70% to 80%. We speculate that this may be due to changing patterns of collaboration, perhaps caused by the rising burden of knowledge and the falling cost of communication, both of which increase the returns to collaboration. Indeed, we report evidence that the propensity to collaborate is rising over time. Furthermore, the nature of collaboration is also changing. For example, the geographic distance as well as the difference in institution rank between collaborators is increasing over time. Moreover, the relative size of the pool of potential distant collaborators for star versus non-star scientists is rising over time. We develop a simple model based on star advantage in terms of the opportunities for collaboration that provides a unified explanation for these facts. Finally, considering the effect of individual location decisions of stars on the overall distribution of human capital, we speculate on the efficiency of the emerging distribution of scientific activity, given the localized externalities generated by stars on the one hand and the increasing returns to distant collaboration on the other.
Now this makes sense. As we become more specialised, as the division of labour becomes greater, we each know more about less and thus collaboration offers increasing returns. Also if we think of the falling cost of communication as falling transaction costs then greater inter-departmental collaboration makes sense. This is because there is an asymmetry in the way that falling communication costs affects intra-departmental and inter-departmental transaction costs. Things like the internet, skype and email will not affect intra-departmental transaction costs much, if at all, but they will lower the transaction costs of inter-departmental collaboration. And thus we should expect to see greater use of the relatively cheaper option. Also one could see the increasing difference in institutional rank as being, in part, due to the now lower costs for up-and-comers, who may be starting their careers at lower ranked institutions,  to collaborate with "stars".

Henry Simons and laissez faire

For those not up on these things Henry C. Simons was an economist at the University of Chicago - he started teaching in the department of economics and later become the first professor of economics in the law school - and author of a pamphlet, A Positive Program for Laissez Faire: Some Proposals for a Liberal Economic Policy. This work was discussed by Ronald Coase when he gave the 1992 Henry C. Simons Memorial Lecture at the University of Chicago Law School.

Coase notes that the pamphlet was more an essay in political philosophy than economics and
[...] when it did touch on economics, or at any rate on those parts of economics in which I was interested, his views were such as to provoke serious reservations. He thought that the regulation of railroads and public utilities generally had been a dismal failure. And what was his solution for this problem? He argued that "the state should face the necessity of actually taking over, owning, and managing directly, both the railroads and the utilities, and all other industries in which it is impossible to maintain effectively competitive conditions." Carrying out Simons's proposals would have involved the nationalization of a large part of American industry, perhaps the greater part. It is a strange route to laissez-faire and brings to mind the proposals of Oskar Lange and Abba Lerner for market socialism.
Strange indeed. But what of industries other than railways and utilities?
For other industries, those not candidates for nationalization, Simons said that "there still remains a real alternative to socialization, namely, the establishment and preservation of competition as the regulative agency." But how was this to be accomplished? He thought that the antitrust laws should be used to bring about a drastic restructuring of American industry. "The Federal Trade Commission must become perhaps the most powerful of our governmental agencies." I can give the flavor of Simons's approach by describing some of his proposals regarding the corporation:
There must be an outright dismantling of our gigantic corporations. . . . Few of our gigantic corporations can be defended on the ground that their present size is necessary to reasonably full exploitation of production economies: their existence is to be explained in terms of opportunities for promoter profits, personal ambitions of industrial and financial "Napoleons", and advantages of monopoly power. We should look forward to a situation in which the size of ownership units in every industry is limited to the minimum size of operating plant requisite to efficient, but highly specialized production—and even more narrowly limited, if ever necessary to the maintenance of freedom of enterprise.
What Simons had in mind is made clearer in a footnote: "It will be necessary to revise notions commonly accepted (especially by courts) as to the maximum size of firm compatible with effective competition. The general rule and ultimate objective should be that of fixing in each industry a maximum size of firm such that the results of perfect competition would be approximated even if all firms attained the maximum size. One may suggest, tentatively, that in major industries no ownership unit should produce or control more than 5 percent of the total output."
It is interesting to see that the attempt to limit the size of firms in this way is driven by desire to apply the idea of  "perfect competition" to the real world. Competition is seen in terms of an 'end state' rather than a process, as it is for the Austrian school, and so to achieve a 'competitive' outcome the real world must be forced to meet the requirements of that end state. This without considering what the actual results of such an policy would be.

If this was his approach to the structure of industries, what were his views on other areas of industrial economics such as advertising,
"It is a commonplace that our vaunted efficiency in production is dissipated extravagantly in the wastes of merchandising. ... If present tendencies continue, we may soon reach a situation where most of our resources are utilized in persuading people to buy one thing rather than another, and only a minor fraction actually employed in creating things to be bought."
Coase continues by noting,
In making such statements and generally in dealing with industrial organization, Simons provides no empirical backing for his contentions, makes no serious investigation of what the effects of his proposals would be on the efficiency with which the economic system would operate, nor does he consider whether the Federal Trade Commission would be likely to do what he wanted or whether, even if it wanted to do so, it would be possible for it to acquire the information necessary to implement his proposals.
If this is a positive program for laissez faire, I hate to think what a negative one would be like!

I guess economics thinking at the University of Chicago has changed over the years. Coase notes,
Simons's approach is the very antithesis of that which was to become dominant as a result of the emergence of that new subject, law and economics. Stigler's description of Simons is eminently just: Simons was a Utopian.
While Simons's arguments may be rejected by economists today its interesting to ask how many Utopians there are outside of economics still.

Ref.: The quotes from Coase come from:
  • Coase, R.H. (1993). 'Law and Economics at Chicago', Journal of Law and Economics, 36(1, Part 2) April: 239-54.

Managerial control versus performance pay

One of the most obvious problems in any employment relationship is moral hazard. What the boss wants workers to do and what the workers actually do can be two very different things. Two of the most common methods firms utilise to try to deal with this problem are the use of performance pay and managerial control. In the empirical literature the performance pay aspect of this solution has received much greater attention than has the managerial control aspect.

In a recent NBER working paper Kirabo Jackson and Henry Schneider examine how an experiment in managerial control affected revenue at an auto repair firm. When the firm provided detailed checklists to mechanics, and managers monitored their use, revenue was 20 percent higher under the experiment. They compare this effect to that of quasi-experimental increases in mechanic commission rates. The managerial-control effect is equivalent to that of a 10 percent commission increase.

These results suggest that managerial control can be a viable alternative to performance pay for the mitigation of the effects of moral hazard. Furthermore, the managerial-control treatment was larger for mechanics that had higher commission rates, suggesting that in this context managerial control and performance pay are complements. The results also support the theoretical prediction that the optimal incentive contract depends on the level and quality of monitoring.

When they investigated the forces underlying the results, Jackson and Schneider find that the mechanics under the managerial-control treatment increase revenue through doing more repairs on each car and working more hours each week. In contrast, mechanics that received commission increases, increased revenue by substituting away from low-revenue repairs toward high-revenue repairs and getting customers to consent to higher price repairs, with no increase in time on the job or number of repairs conducted. Because this shifting toward more expensive repairs may reflect mechanics exploiting their informational advantage over customers, the result underscore the possibility that pay-for-performance may encourage undesirable worker actions.

Also the behaviour of the mechanics is adversely affected because as they only receive a fraction of the firm's revenue, the additional compensation for mechanics for conducting a more thorough inspection of a car is insufficient to offset the associated effort and time costs. Jackson and Schneider's calculations based on their results indicate that a modest transfer of the profits due to checklist use from firm to mechanic could compensate mechanics for their additional costs and achieve a sizable Pareto improvement.

The Jackson and Schneider study shows that increased managerial control can reduce moral hazard, something that has not often been tested empirically. Evidence is also provided that shows that increased managerial control can generate complementarities with performance pay, most likely in settings with multiple complementary tasks. Given the widespread emphasis on performance pay as an incentivising tool, their results suggest that managerial control may be an additional important tool for designing compensation schemes.