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.

Olympics don't pay

The fact that large sporting event don't pay has been mentioned on this blog, and other blogs, many times. Now British economist John Kay has joined those of us who have doubts about the economics of large sporting events with this piece on the costs of the 2012 London Olympics.

Kay writes that the principal relevant facts are these:

The first detailed specification of what was needed for London to host the games was drawn up in 2002 by Arup. The report by the engineering and planning consultancy put the cost at £1.8bn, much of it to be privately financed. An extended assessment was then commissioned by the Department of Culture, Media and Sport from PwC. The financial consultancy’s 2003 report estimated the total cost at £3.1bn, requiring a public subsidy of £1.3bn. The balance would be recovered from the private sector and from asset sales after the games. According to PwC’s risk assessment, the probability that the taxpayer would need to provide as much as £2bn was less than 5 per cent.

and

The budget had by 2007 increased to about £6.5bn. At Treasury insistence, a contingency allowance, mostly unspecific, of £2.8bn – more than the total original projected cost – was added. The costs of land acquisition and of the Olympic Village were mostly excluded in the belief that they would be recovered from property sales after the event.

But what, you may ask, of the claims that the games “within budget”?

The basis of the claim that the games came in “within budget” seems to be that a small part – currently £300m-£400m – of that £2.8bn contingency remains unspent. That was achieved, however, by excluding a number of additional unbudgeted expenditures from the calculation, as the National Audit Office has highlighted. There is likely to be little, if any, net recovery of the further costs of land and housing, which were due to be recouped from property sales.

The costs were grossly and persistently underestimated, and the financial contributions anticipated from private sources overestimated by very large amounts. Every year, to the present day, the expected cost rose and the likely revenues diminished. The cost of the games to public funds has proved to be about 10 times the original estimate.

Kay continues,

There is a halo effect; the sporting success of the Olympics fosters the mistaken belief that they were an economic success. Papers recently produced by government on the “economic benefits” must be an embarrassment to the many good people of the Government Economic Service, conflating incommensurable monetary amounts and confusing costs with benefits. At the same time, a curious puritanism requires politicians to pretend activities intended to make us feel good about ourselves are justified by their contribution to “the economy”. The Olympiad was a good party, which cost the British population about £200 per head.

Kay then makes the important point that false accounts of the past prevent us learning lessons for the future, of which, he argues, there are many.

The Olympics remind us that enthusiasts typically understate costs and overstate benefits. Consultants win work by pleasing clients, and they rarely please clients by pouring cold water on their pet schemes. We should waste no more public money on risk simulations such as those in the PwC report; the outcome in this case was one of these supposedly statistically impossible events that seem nevertheless to occur on a daily basis. Establishing an allowance for “optimism bias” is realistic, but offers little incentive to make careful projections in the first place. Money put in a budget for general contingencies is not money you are likely to see again.

Just when will governments, and taxpayers, learn that big sporting events, be it the Olympics or the rugby world cup or the America's cup, don't make economic sense. And thus taxpayer money spent on them is taxpayer money wasted.

An interview with Jeremy Adelman on Albert Hirschman

In this audio from VoxEU.org Jeremy Adelman of Princeton University talks to Romesh Vaitilingam about his biography of the economist and social scientist Albert Hirschman. They discuss Hirschman’s ideas about economic development, ‘optimal’ crises and what is perhaps his most famous book among economists, "Exit, Voice and Loyalty". Adelman also speculates on what the citation would have said had Hirschman won the Nobel Prize – and explains why we should read Hirschman now.

Use of the metaphor of the "invisible hand" 2

In the comments to the post Use of the metaphor of the "invisible hand" Owen refers us to the blog - Adam's Lost Legacy - of Scottish economist and Adam Smith scholar Gavin Kennedy. For anyone with an interest in Smith, and who hasn't?, Gavin's blog is a must read.

Gavin's view on the interpretation of the "invisible hand" is a little different from the one I was arguing. Now I see that Gavin has picked up on my comments and has commented on them at his blog.

Gavin explains his view in the following way:

I agree with Paul broadly on his critique of the popular modern economist’s idea of the “invisible hand”. I regard Paul’s treatment as a step or two forward in this debate, and praise him for taking it. In his subsequent comment to “Owen”, Paul kindly refers “Owen” to citations of my published assessments on the IH metaphor from 2008-2011.

However, Paul makes a suggestion also made by my scholarly friend, Craig Smith, several times, including in his excellent book, Smith, C. 2006. “Adam Smith’s Political Philosophy: the invisible-hand and Spontaneous Order”, Oxford, Routledge. Craig is the Reviews Editor of the “Adam Smith Review” (International Adam Smith Society), and a co-editor (with Chris Berry and Maria Paganelli “Handbook on Adam Smith”, 2013, Oxford University Press. Neither Paul nor Craig fully agree with my interpretation of the significance to Adam Smith of his use of the “IH” metaphor, though they both are disturbed with modern interpretations of it to an extent.

Nevertheless, they present an alternative view to mine (argued on Lost Legacy since 2005). In their presentations they agree in effect: “The invisible hand idea … is a very convenient shorthand for Smith’s idea that human actions have unintended consequences; and that provided a few fundamental rules such as the principles of justice are followed, the self-serving actions of individuals can unintentionally produce a well-functioning and beneficial overall social order” (Paul) and: “generally the idea of social evolution through unintended consequences, which represents Smith’s chief legacy to the modern world” (Craig).

I am pleased to see that Paul and Craig both are further away from the post-Samuelson (1948) invention that conflates Smith’s use of self-interest as “selfishness” that “miraculousy” has the effect of creating a “public” benefit.

I can agree with Paul and Craig in so far as they reject the invention, which is a step forward. However, I do not think that they have shown that Smith used the IH metaphor “as Smith’s friend Adam Ferguson observed, the results of human action, not the product of human design”. The phrase was indeed used by Adam Ferguson, and in Smith’s case it is true that Smith also referred to ‘unintended consequences” in the (long) IH paragraph, but Smith's statement says: [The merchant who invests domestically] “generally, indeed, neither intends to promote the publick interest, nor knows how much he is promoting it. By preferring the support of domestick to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. (WN IV.2.9: 456).

To argue from the above that the IH metaphor is about “unintended consequences I suggest misreads the sense of Smith’s paragraph. Smith Lectured on Rhetoric in Edinburgh and 1748 (privately sponsored public lectures) and at Glasgow University from 1751 to 1763 as a member of the Glasgow faculty and the Professor of Moral Philosophy). He was also fluent in Latin and Oxford English grammar. He was therefore most unlikely to make grammatical errors. He taught about the grammar of metaphors as figures of speech, for which we have student notes: Smith. [1762-3] 1983. “Lectures on Rhetoric and Belles Lettres”, Lectures 6, 7, 8 and 9. Oxford University Press.

Smith refers to the “objects” of metaphors, which in this case refers to the specified objects in each of the two cases in which he used the IH metaphor to “describe in a more striking and interesting manner” its “object”.

In the two (only) cases he mentioned, first in Moral Sentiments (the actions of the “proud and unfeeling Landlord” feeding his serfs, labourers, servants, and overseers, which was an absolute necessity – no food meant no labour!). It was that necessity that led the landlord to feed those employed on his estate – described by Smith that he was “led by an invisible hand”. In the second case, mentioned in Wealth Of Nations, the merchant who felt too insecure to send his capital abroad, hence he invested in “domestic revenue and employment”. It was the “merchant’s insecurity that led him to invest locally – described by Smith of him being “led by an invisible hand”.

In short, the IH metaphor refers to the motives of the landlord and merchant that LED them to act as they did. It was NOT the IH that separately intentionally led either of them to create the “unintentional consequences of their actions. The IH describes their actions. That is why the consequences of their actions were “unintentional”!

To argue otherwise makes no-sense of Smith’s use of the grammar of metaphors (still exactly the same as defined in today’s Oxford English Dictionary, 1983, as Smith described it in 1762-62).

Moreover, Paul and Craig imply a theological interpretation of his use of the IH metaphor – what, whomsoever, or whatever, leads an “IH” to cause the “unintentional outcomes”? (see Kennedy, “Adam Smith on Religion”, Handbook on Adam Smith, Oxford UP 2013, or shorter, earlier version, Kennedy, 2011. “The Hidden Adam Smith in his Alleged Theology” Journal of the History of Economics, no 3, 2011).

An action has motives which actions may have consequences, but unintended consequences do not have intentional motivated causes!

Perhaps the point I'm trying to get at is better said by James Otteson. When discussing Smith's essay on "Consideration Concerning the First Formation of Languages, and the Different Genius of Original and Compounded Languages" Otteson writes,

The reader, furthermore, would be correct to detect in this essay the early hints of an argument that Smith will later develop into perhaps his most powerful, what we will call the Invisible Hand Argument: individuals, when seeking to satisfy their own localized desires will tend to behave in ways that will also benefit other - even others they do not know and about whom they therefore have no particular concern, and without their intending to do so.

This Invisible Hand Argument would, I feel, be seen in Smith's work even if the actual references to the "invisible hand" were removed.

When Otteson goes on to talk about "What Smith Got Right" the first thing he mentions is Smith's model of spontaneous order. Otteson argues this is made up of several elements, one of which is "general welfare and the "invisible hand"". Otteson says,

Smith was under no illusion that people in their normal daily activities actually care about the general welfare. Luckily, however, people do not have to. The nature of the unintended system of order suggests that they will tend to conduce to the benefits of everyone concerned regardless - at least in the long run.

So I would argue that the "invisible hand" in a board sense, permeates Smith's works.

What's okay to buy and sell?

Aaron Ross Powell and Trevor Burrus talk with James Stacey Taylor, an Associate Professor of philosophy at the College of New Jersey and the author of Stakes and Kidneys: Why markets in human body parts are morally imperative and the forthcoming book Toxic Trade? An Unapologetic Defense of Universal Commodification, about what society thinks is okay to buy and sell. Buying and selling some things--like books, cars, or house--strike us as fine. But even the thought of trading money for things like love, babies, votes or organs makes many people uncomfortable or even angry.



If the above doesn't work try this link.

Allen's "The Institutional Revolution"

Volume 26, Issue 4 - December 2013 - of The Review of Austrian Economics continues a series of papers reviewing Doug Allen's recent book The Institutional Revolution: Measurement and the Economic Emergence of the Modern World, ... and what a set of reviewers: Deirdre N. McCloskey, Joel Mokyr and Richard N. Langlois, with a reply by Doug Allen.

A neo-institutionalism of measurement, without measurement: A comment on Douglas Allen’s The Institutional Revolution
Deirdre N. McCloskey Pages 363-373

In his elegant book Douglas Allen claims that an improvement in the measurement of Nature made for lower transaction costs and the Industrial Revolution. His argument is a typical example of neo-institutionalism in the style of Douglass North (1990) and North et al. (2009). A fall in a wedge of inefficiency is supposed to provide Good Incentives, and the modern world. But the elimination of wedges lead merely to Harberger Triangles of improved efficiency—not to the factor of 100 in properly measured real income per head, which is the Great Enrichment 1800 to the present to be explained. Allen does yeoman work in explaining some of the peculiarities of British public administration, such as the reliance on aristocratic honor and on the prize system in naval warfare. But he attributes to public administration an implausible effect on private incomes. The merging of power and plenty is mistaken. Further, the alleged increase in a modern ability to measure marginal products is implausible. Large modern enterprises face greater, not smaller, problems of assessing the contribution of individuals. Allen’s book on measurement does not measure, and the probable order of magnitude of the items he focuses on is too small to explain any but the details of administration.

The Institutional Revelation: A comment on Douglas W. Allen’s The Institutional Revolution
Joel Mokyr, José-Antonio Espín-Sánchez Pages 375-381

Institutions are a central topic in economic history. Allen’s work differs in that he is interested in institutions per se, not as a means to economic performance and prosperity. The purpose of this book is to explain the institutions of the premodern world and to show why they changed. His argument is that in a Principal-Agent situation, before the Industrial Revolution, it was harder for the Principal to attribute whether the failure of the project was due to acts of nature or some acts of the agent, hence the “strange” institutions. In a modern world, with a much improved monitoring technology, we can use more “efficient” institutions, hence the Institutional Revolution. Although innovative and interesting, the author over-stresses his argument. Much more than monitoring in a principal-agent relationship is needed to explain the Industrial Revolution and the changes in institutions associated with it.

The Institutional Revolution: A review essay
Richard N. Langlois Pages 383-395

This review essay discusses and appraises Douglas Allen’s The Institutional Revolution (2011) as a way of reflecting on the uses of the New Institutional Economics (NIE) in economic history. It praises and defends Allen’s method of asking “what economic problem were these institutions solving?” But it insists that such comparative-institutional analysis be imbedded within a deeper account of institutional change, one driven principally by changes – often endogenous changes – in the extent of the market and in relative scarcities. The essay supports its argument with a variety of examples of the NIE applied to economic history.

In defence of the institutional revolution
Douglas W. Allen Pages 397-412

I defend my thesis laid out in The Institutional Revolution against the comments made by McCloskey, Espin and Mokyr, and Langlois, who all believe that the weight of the great institutional transition is too great for my theory of measurement, and who all quibble with some aspects of my historical analysis. I argue that some of the comments fail to fully appreciate the Coasean approach, and that most of the historical comments miss the mark. I begin with a short discussion of Coase, and then turn to each author in turn.

Is this really a good deal?

Not for the Scottish taxpayer. From the TVNZ website,

Infratil, the Wellington-based infrastructure investor, has sold its unprofitable Glasgow Prestwick Airport to the Scottish government for 1 British pound.

The transaction was completed over the weekend and will see the airport transferred to TS Prestwick Holdco, an entity wholly-owned by the Scottish Ministers, for a cash consideration of 1 pound.

The purchase price reflected the need for more investment, and the Scottish government is seeking a commercial partner to operate the airport on its behalf, it said in a statement yesterday.

"This acquisition secures continuity of service and we will now begin work with our local partners on developing our vision for the business so we can maximise its contribution to the local, regional and national economy," Deputy First Minister Nicola Sturgeon said.

I can't but help thinking that there is a message in the fact that someone will sell you an airport for one pound. If we think of the sale price of an asset as the present value of the future income stream for the asset then selling the asset for such a price should be a warning to the Scottish taxpayer. It is very unlikely that the taxpayer will ever see a reasonable return on their (forced) investment.

This looks like a bad deal for three related reasons: 1) Prestwick loses money, 2) it is not obvious what the new owners can do that Infratil didn't do to make it pay and 3) it is far from clear that politicians can run the airport better than a private operator. The very fact that a private buyer could not be found is a worrying signal as to the future prospects for the airport.

Libertarians and the poor

Philosopher Matt Zwolinski (Zwolinski is Associate Professor of Philosophy at the University of San Diego, and co-director of USD’s Institute for Law and Philosophy) discusses with Aaron Ross Powell and Trevor Burrus how libertarianism can help the least well-off.

Multitasking can be a problem

One thing theory tells us about multitasking is that you can get into trouble if some of the things you want people to do are easier to measure than other things. What you would expect is that the people will put more effort into the well measured things than the less well measured things. For example, teaching is harder to measure well than research so you would expect to see more effort placed on research than teaching in academia. And, by and large, you do.

But according to a new NBER working paper it's not just academics who respond to such incentives.

Testing the Theory of Multitasking: Evidence from a Natural Field Experiment in Chinese Factories
Fuhai Hong, Tanjim Hossain, John A. List, Migiwa Tanaka
NBER Working Paper No. 19660
Issued in November 2013

A well-recognized problem in the multitasking literature is that workers might substantially reduce their effort on tasks that produce unobservable outputs as they seek the salient rewards to observable outputs. Since the theory related to multitasking is decades ahead of the empirical evidence, the economic costs of standard incentive schemes under multitasking contexts remain largely unknown. This study provides empirical insights quantifying such effects using a field experiment in Chinese factories. Using more than 2200 data points across 126 workers, we find sharp evidence that workers do trade off the incented output (quantity) at the expense of the non-incented one (quality) as a result of a piece rate bonus scheme. Consistent with our theoretical model, treatment effects are much stronger for workers whose base salary structure is a flat wage compared to those under a piece rate base salary. While the incentives result in a large increase in quantity and a sharp decrease in quality for workers under a flat base salary, they result only in a small increase in quantity without affecting quality for workers under a piece rate base salary.

Excess demand?

From TVNZ,

Monty Python's reunion show sold out in just 43.5 seconds today.

EconTalk this week

Joel Mokyr of Northwestern University talks with EconTalk host Russ Roberts about the future of the American economy. Mokyr rejects the claims that the we are entering an area of stagnation or permanently lower economic growth. He argues that measured growth understates the impact on human welfare. Many of the most important discoveries are new products that are often poorly measured and not reflected in measures such as gross domestic product or income. The conversation closes with a discussion of the downsides of technology and why Mokyr remains optimistic about the future.

Use of the metaphor of the "invisible hand"

In the comments section to the previous post on the Foundations of a free society Owen writes,

Shame he mis-quotes Smith. AS never mentioned an invisible hand in reference to markets, in fact he only mentioned it once in Wealth of Nations. Also, AS notion of self-interest was appealing to others self-interest to gain what you wanted, ie mutual trade, nothing selfish about it. I'm not aware of any evidence that markets automatically lead to good outcomes for society, I do think they are the best allocative mechanism though (in most cases).

Butler is not quoting Smith and I'm sure that he is aware of the use Smith made of the term "invisible hand". To quote Butler,, at some length,

Adam Smith is famous for his ‘invisible hand’ idea. Most people take this to mean that our self-interested actions somehow produce an overall social benefit. Our hard bargaining, for
example, creates a market system that allocates resources with great efficiency.

In fact, apart from a mention of the ‘invisible hand of Jupiter’ in The History of Astronomy, Smith uses the phrase just twice in his entire output and not really in the commonly presumed sense. The rich make work for the poor.

In The Theory of Moral Sentiments, Smith suggests that the hand of ‘Providence’ equalises economic rewards. The rich can eat no more than the poor. Their only use for most of the food produced by their land is to exchange it with others – those who supply the luxuries, the ‘baubles and trinkets’, that the rich demand. Thinking only of themselves, the rich provide employment to thousands:

The rich only select from the heap what is most precious and agreeable. They consume little more than the poor, and in spite of their natural selfishness and rapacity, though they mean only their own conveniency, though the sole end which they propose from the labours of all the thousands whom they employ, be the gratification of their own vain and insatiable desires, they divide with the poor the produce of all their improvements. They are led by an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among all its inhabitants, and thus without intending it, without knowing it, advance the interest of the society, and afford means to the multiplication of the species.

The only mention of the invisible hand in The Wealth of Nations is in a passage about official monopolies that promote domestic industries over foreign trade. Smith notes that this induces people to commit more capital to home industries, and then slides into the point:

As every individual ... endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it.
By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.

These two passages suggest to critics that Adam Smith’s real ‘invisible hand’ concept is far removed from the popular notion of it. In one, the happy outcome of self-interest is attributed to ‘Providence’. In the other, it is a side comment in a discussion about the export trade.

In fact, the critics read too narrowly. The invisible hand idea, as commonly understood, pervades Smith’s work, and would do so even if these two specific references had never existed. For the phrase is a very convenient shorthand for Smith’s idea that human actions have unintended consequences; and that provided a few fundamental rules such as the principles of justice are followed, the self-serving actions of individuals can unintentionally produce a well-functioning and beneficial overall social order.

Or as Craig Smith has point it,

It is the idea of the invisible hand, or more generally the idea of social evolution through unintended consequences, which represents Smith’s chief legacy to the modern world. The recognition that many of the most important human achievements are, as Smith’s friend Adam Ferguson observed, the results of human action, not the product of human design, is a profound lesson to us all. It is this observation which leads Smith to his deep scepticism towards ‘men of system’ who would organise humanity to achieve noble ends.

As to whether markets automatically lead to good outcomes for society, Butler is not claiming that they do and Smith never claimed that they do. What I think most economists would say is that markets lead to good outcomes for society more often than any alternative method of resource allocation. A system of rules are required to achieve this end - such as competition and a system of justice - but as long as these are in place then markets are a better bet to achieve good outcomes than "men of system".

I don't follow this argument

This article in the Guardian states,

Joffe [Michael Joffe, professor of economics at Imperial College, London] said university economics department were continuing to teach concepts that had been disproved. In one example he said the idea that companies suffer "dis-economies of scale" when they increase production beyond certain capacity was true in only a small number of firms.

The U-shaped curve shows that unit costs are high when production begins and become cheaper as economies of scale allow a company to spread costs over more units. Units become more expensive to produce after a factory reaches capacity.

Joffe said: "We ought to stop teaching the U shape as the typical relationship between costs and scale, for the simple reason that it is false."

What does this imply? Is Joffe really saying that he thinks all firms are natural monopolies? I think that is what Joffe's comment leads to. If firm's average cost curves are not U-shaped then I assume they are downward sloping over the relevant range and this implies that firms are natural monopolies. Now this may be true for some firms but I can't  see it as true in general. Is your local dairy really a natural monopoly?

Foundations of a free society

An interesting new book by Eamonn Butler published by the IEA in London. Butler makes the point that a free society is not a random collection of selfish individuals. It is something complex and organic, and based on deep values – not values that challenge other moral systems but values that make cooperation and social harmony possible. As Butler wrote in a previous book on Adam Smith,

He [Smith] realised that social harmony would emerge naturally as human beings struggled to find ways to live and work with each other. Freedom and self-interest need not lead to chaos, but – as if guided by an ‘invisible hand’ – would produce order and concord. They would also bring about the most efficient possible use of resources. As free people struck bargains with others – solely in order to better their own condition – the nation’s land, capital, skills, knowledge, time, enterprise and inventiveness would be drawn automatically and inevitably to the ends and purposes that people valued most highly. Thus the maintenance of a prospering social order did not require the continued supervision of kings and ministers. It would grow organically as a product of human nature. To grow best and to work most efficiently, however, it required an open, competitive marketplace, with free exchange and without coercion. It needed rules to maintain this openness, just as a fire-basket is needed to contain a fire. But those rules, the rules of justice and morality, are general and impersonal, quite unlike the specific and personal interventions of the mercantilist authorities.

And this is still a rather good summary of the basic argument in favour of a free society today. Butler argues that the essential foundations of a free society are freedom, property, trade, justice, toleration, moral rules, incentives, rights, and limited government. He also notes that none of us really lives in a free society, its a case of being more or less free and that we must be vigilant so we doesn't end up ambling down the Road to Serfdom.

A brief summary of the book is:

• Freedom creates prosperity. It unleashes human talent, invention and innovation, creating wealth where none existed before. Societies that have embraced freedom have made themselves rich. Those that have not have remained poor.
• People in a free society do not become rich by exploiting others, as the elites of less-free countries do. They cannot become rich by making others poorer. They become rich only by providing others with what they want and making other people’s lives better.
• The chief beneficiaries of the economic dynamism of free societies are the poor. Free societies are economically more equal than non-free societies. The poor in the most-free societies enjoy luxuries that were undreamed of just a few years ago, luxuries available only to the ruling elites of non-free countries.
• International trade gives entrepreneurs new market opportunities and has helped lift more than a billion people out of abject poverty in the last twenty years. Freedom is truly one of the most benign and productive forces in human history.
• Attempts by governments to equalise wealth or income are counter-productive. They destroy the incentives for hard work and enterprise and discourage people from building up the capital that boosts the productivity of the whole society.
• A free society is a spontaneous society. It builds up from the actions of individuals, following the rules that promote peaceful cooperation. It is not imposed from above by political authorities.
• Government has a very limited role in a free society. It exists to prevent harm being done to its citizens by maintaining and enforcing justice. It does not try to impose material equality and it does not prohibit activities just because some people consider them disagreeable or offensive. Leaders cannot plunder citizens for their own benefit, grant favours to their friends, or use their power against their enemies.
• The government of a free society is constrained by the rule of law. Its laws apply to everyone equally. There must be due process of law in all cases, with fair trials and no lengthy detention without trial. People accused of offences must be treated as innocent until proved guilty, and individuals must not be harassed by being prosecuted several times for the same offence.
• Tolerating other people’s ideas and lifestyles benefits society. Truth is not always obvious; it emerges in the battle of ideas. We cannot trust censors to suppress only wrong ideas. They may mistakenly suppress ideas and ways of acting that would greatly benefit society in the future.
• Communications technology is making it more difficult for authoritarian governments to hide their actions from the rest of the world. As a result, more and more countries are opening up to trade and tourism, and new ideas are spreading. More people see the benefits of economic and social freedom, and are demanding them.

Venezuelan inflation

Not a good look. Steve H. Hanke, Professor of Applied Economics and Co-Director of the Institute for Applied Economics, Global Health, and the Study of Business Enterprise at The Johns Hopkins University, has been writing on inflation in Venezuela over at the Cato Institute. Hanke writes,

Just how big of a problem is inflation in Venezuela? The implied annual inflation rate in Venezuela is actually now in the triple digits, coming in at a whopping 283%, as shown in the chart below.

What’s more, the implied monthly inflation rate has now ramped up to 36%, as shown in the chart below. That’s dangerously close to the hyperinflation threshold of 50% per month. This is due to an accelerating depreciation of the bolivar, reflecting Venezuelan’s deteriorating economic outlook.

For the record, official government data put Venezuela’s inflation rate at a mere 50%.

So how soon will it be before Venezuela becomes the new Zimbabwe?

EconTalk this week

Angus Deaton of Princeton University and author of the Great Escape talks with EconTalk host Russ Roberts about the book--the vast improvements in health and standard of living in recent times. Deaton surveys the improvements in life expectancy and income both in the developed and undeveloped world. Inequality of both health and wealth are discussed as well. The conversation closes with a discussion of foreign aid and what rich nations can do for the poor.

Just for fun: Marx on the firm

That Marx didn't much like markets is obvious enough, but what of firms? On the positive side Marx preferred the deliberate order of the firm to the anarchy of the market. After all he wanted to run the entire economy like a firm. This view that the firm can be seen as an organisational alternative to the market anticipated Coase in this regard. But on the other hand he saw the firm as the key locus where labour exploitation ad alienation was perpetrated and he has "issues" with the detailed division of labour that capitalism introduced. His model of communism, to be realised after single-firm socialism, was meant to overcome the depressing human condition existing in the capitalist firm.

Besides being a political proposal, single-firm socialism was, according to Marx, a historical necessity imposed by the development of productive forces. The firm’s greater efficiency (relatively to markets) had already been evinced by the growth in firms’ size during capitalism, and productive forces exerted strong pressure for their further growth. By eliminating private property, socialism did nothing other than complete an inevitable process of concentration, whose onset was 'scientifically guaranteed' by historical materialism (Pagano 2012: 42).

For Marx single-firm socialism’ would supersede the dualism of capitalism, under which firms and markets coexisted, and enable the greater development of the productive forces. The limitations of the market sprang from what Marx saw as its nature as a decentralised coordination mechanism dealing with the, often inconsistent, decisions made by buyers and sellers. This negative view of the market lead Marx to argue for the extension of firm-type organisation to society as a whole.

The extension of the planned organization of production of the capitalist factory would complete a process already ongoing in the historical dynamics of capitalism whereby productive forces tended constantly to increase the size of firms. Socialism was the final outcome of this tendency of the productive forces to shift production relations within the firm. The scientific certainty of the advent of socialism was, for Marx, inherent in the tendency of the productive forces to influence production relations. The extension of the authoritarian world of the capitalist firm to the whole of society was necessary to reap the benefits of a planned coordination made more and more necessary by the increasing interdependence among the production sectors (Pagano 2012: 43).

Even if firms are better than markets, firms are not all good. For Marx capitalism produced a very detailed and hierarchical division of labour. This was one of his major criticisms of capitalism. The capitalist-owned firm is a structure that involved a massive deskilling of workers and made labour alienated and painfully homogeneous. But, in the short term at least, socialism could do little about this:

[ ... ] in the early stage of socialism, planning could be made on an objective basis because, according to Marx, capitalism had eliminated the possibility of subjective preferences among repetitive and simple tasks. These conditions suggested, for the first phase of a socialist society, a form of authoritarian planning based on the theory of labour value that ignored the subjective preferences for different kinds of work (Pagano 2012: 43).

Over the longer term, of course, all this would change and

[ ... ] work would entirely match the preferences and development of individuals [ ... ] (Pagano 2012: 43).

Such an idea was constantly present in Marx’s critique of capitalism but its implications were postponed to a distant future.

Interestingly Marx, unlike Coase, saw costs in using the market but assumed that the firm could be used at basically zero cost.

In some respects, Marx made a mistake mirroring orthodox economics when he assumed that, while the costs of market coordination were very high, the costs of firm-type coordination were negligible, with the consequence that all the economic transactions could be coordinated at zero costs by centralized planning (Pagano 2012: 44).

The standard neoclassical model assumes that transactions costs are zero and thus there is no need for firms while Marx assumed that management coasts are zero and thus there is no need for markets. Coase's argument is that both firms and markets come with costs and it is the comparison of these costs that determined the boundaries of the firm.

Ref.:

• Pagano. Ugo (2012). `Marx'. In Michael Dietrich and Jackie Krafft (eds.) Handbook on the Economics and Theory of the Firm (pp. 42-8), Cheltenham: Edward Elgar.

EconTalk this week

Edmund Phelps of Columbia University, Nobel Laureate in economics, and author of Mass Flourishing talks with EconTalk host Russ Roberts about the ideas in the book. Phelps argues that human flourishing requires challenges, struggles, and success and goes beyond material prosperity. He argues that in recent decades, policy has discouraged innovation and mass flourishing resulting in a slow-down in growth rates. Phelps emphasizes the non-material benefits of economic growth and the importance of small innovations over big inventions as key to that growth.

EconTalk for 4 weeks

Cliff Winston of the Brookings Institution talks with EconTalk host Russ Roberts about his recent article in the Journal of Economic Literature on the U.S. transportation system. Winston argues that the while the United States has a very good transportation system overall, it is extremely expensive and poorly organized. What is needed, Winston argues, is not more money, but to spend the money already allocated more wisely. He discusses the evolution of the U.S. transportation system, government's role in transportation, dramatic innovations that might transform aviation and driving, and the potential for privatizing airports and roads.

Guillermo Calvo of Columbia University and the National Bureau of Economic Research talks with EconTalk host Russ Roberts about the nature of macroeconomic crises and what we have learned or should have learned in the aftermath of the most recent one. Based loosely on his recent paper, "Puzzling Over the Anatomy of Crises," Calvo discusses a wide array of issues related to macroeconomics and the role of financial instability in economy-wide crises. Topics include the role of money, the problem of short-term lending in the financial sector, the black-box approach of modern macroeconomic theory and the forgotten economists we might want to reconsider.

Don Boudreaux of George Mason University and Cafe Hayek talks with EconTalk host Russ Roberts about the intellectual legacy of Ronald Coase. The conversation centers on Coase's four most important academic articles. Most of the discussion is on two of those articles, "The Nature of the Firm," which continues to influence how economists think of firms and transaction costs, and "The Problem of Social Cost," Coase's pathbreaking work on externalities.

John Ralston Saul, author and head of PEN International, speaks with EconTalk host Russ Roberts about his book, Voltaire's Bastards, and the role of reason in the modern world. Saul argues that the illegitimate offspring of the champions of reason have led to serious problems in the modern world. Reason, while powerful and useful, says Saul, should not be put on a pedestal above other values including morality and common-sense. Saul argues that the worship of reason has corrupted public policy and education while empowering technocrats and the elites in dangerous and unhealthy ways.

The law of unintended consequences - child labour

The NBER has released a new working paper on the Perverse Consequences of Well Intentioned Regulation: Evidence from India's Child Labor Ban by Prashant Bharadwaj, Leah K. Lakdawala and Nicholas Li. The abstract reads,

While bans against child labor are a common policy tool, there is very little empirical evidence validating their effectiveness. In this paper, we examine the consequences of India’s landmark legislation against child labor, the Child Labor (Prohibition and Regulation) Act of 1986. Using data from employment surveys conducted before and after the ban, and using age restrictions that determined who the ban applied to, we show that child wages decrease and child labor increases after the ban. These results are consistent with a theoretical model building on the seminal work of Basu and Van (1998) and Basu (2005), where families use child labor to reach subsistence constraints and where child wages decrease in response to bans, leading poor families to utilize more child labor. The increase in child labor comes at the expense of reduced school enrollment. We also examine the effects of the ban at the household level. Using linked consumption and expenditure data, we find that along various margins of household expenditure, consumption, calorie intake and asset holdings, households are worse off after the ban.

No matter how well intended regulations may be you have to ask what do they actually achieve? Often the outcomes are very different from those intended.

What is the case for paid maternity leave?

Not much of one it would appear.

There is a new NBER working paper out which asks, What Is the Case for Paid Maternity Leave? The paper is by Gordon B. Dahl, Katrine V. Løken, Magne Mogstad, and Kari Vea Salvanes and its abstract reads,

Paid maternity leave has gained greater salience in the past few decades as mothers have increasingly entered the workforce. Indeed, the median number of weeks of paid leave to mothers among OECD countries was 14 in 1980, but had risen to 42 by 2011. We assess the case for paid maternity leave, focusing on parents' responses to a series of policy reforms in Norway which expanded paid leave from 18 to 35 weeks (without changing the length of job protection). Our first empirical result is that none of the reforms seem to crowd out unpaid leave. Each reform increases the amount of time spent at home versus work by roughly the increased number of weeks allowed. Since income replacement was 100% for most women, the reforms caused an increase in mother's time spent at home after birth, without a reduction in family income. Our second set of empirical results reveals the expansions had little effect on a wide variety of outcomes, including children's school outcomes, parental earnings and participation in the labor market in the short or long run, completed fertility, marriage or divorce. Not only is there no evidence that each expansion in isolation had economically significant effects, but this null result holds even if we cumulate our estimates across all expansions from 18 to 35 weeks. Our third finding is that paid maternity leave is regressive in the sense that eligible mothers have higher family incomes compared to ineligible mothers or childless individuals. Within the group of eligibles, the program also pays higher amounts to mothers in wealthier families. Since there was no crowd out of unpaid leave, the extra leave benefits amounted to a pure leisure transfer, primarily to middle and upper income families. Finally, we investigate the financial costs of the extensions in paid maternity leave. We find these reforms had little impact on parents' future tax payments and benefit receipt. As a result, the large increases in public spending on maternity leave imply a considerable increase in taxes, at a cost to economic efficiency. Taken together, our findings suggest the generous extensions to paid leave were costly, had no measurable effect on outcomes and regressive redistribution properties. In a time of harsh budget realities, our findings have important implications for countries that are considering future expansions or contractions in the duration of paid leave. (Emphasis added.)

But will supporters of greater maternity leave take any notice of such research, no matter how harsh the budget realities.

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.

Governments behaving badly

That governments often behave badly is clear, but what would be the worst things a government has done?For the U.S. there is now an answer. The Independent Institute has recently released a new book, The Terrible 10: A Century of Economic Folly by Burton A. Abrams. In the book Abrams looks at a series of disastrous government policies that, he argues, cost trillions of dollars in wasted resources, created mass unemployment, and kept millions in poverty who otherwise could have participated in the nation's growing prosperity. Government decision-makers, regardless of political party, have tended to favour short-run benefits for friends while imposing costs on current and later generations. Interestingly Abrams's ten worst blunders divide equally among Democrats and Republicans. The book also provides key lessons to help us avoid repeating such policy mistakes in the future.

A summary of worst economic blunders of the past century is given by

Prohibition

Ratified in 1919, the 18th Amendment reflected the desire of a minority of Americans to impose their views of morality and the proper lifestyle on the majority. The effort failed miserably. In hindsight, most Americans—and especially those who lived through it—probably view Prohibition as a bizarre, foolish, and even dangerous experiment: a massive, precedent-setting governmental intervention in personal freedom, a waste of our national resources, a loss of an important source of tax revenues, a boon to criminals, a corrupting influence on public officials, and an encouragement to otherwise law-abiding citizens to disregard and disrespect the law. Prohibition produced many more costs than benefits and clearly belongs among the ranks of the worst economic interventions of the last 100 years.

The War on Drugs has had the same sort of unintended and undesirable consequences that Prohibition had, and it has failed for exactly the same reason: government officials cannot stop people from engaging in mutually agreeable exchanges. They may reduce the extent of such exchanges with harsh penalties, but they won’t stop them. Efforts to stop such exchanges will spawn many unintended and undesirable outcomes.

Monetary Policy During the Great Depression

The Federal Reserve Act of 1913 was created to resolve a problem: frequent banking panics, or widespread runs on banks, that plagued the U.S. economy. The Act created a central bank—the Federal Reserve System—which was expected to eliminate them. But the biggest banking panic in U.S. history was in the making, and the Fed did little or nothing to prevent it. What would have been a recession was turned into the Great Depression. The Fed’s failure to act decisively was one of the most costly economic policy errors to have been made in the past 100 years.

The Hawley-Smoot Act

In an unprecedented show of unanimity, over 1,000 economists from the United States signed a letter urging Congress and President Herbert Hoover to reject the Hawley-Smoot Act. Their warning went unheeded. The Act touched off a trade war, intensified the Great Depression, and helped set the stage for World War II. The Act and the story of its passage highlight Congress at its worst in pandering to special interests. More than fifty years after its passage, President Ronald Reagan referred to the Republican sponsored Act as “the most destructive trade bill in history.”

Social Security

The pay-as-you-go government program originally was designed to have a “full reserve,” but members of Congress couldn’t keep their fingers out of the cookie jar. The result is the second largest Ponzi-type scheme sponsored by the U.S. government (Medicare is the biggest). Social Security has contributed to de-capitalizing the economy by substituting government promises of retirement income obtained through taxation in lieu of income that would have been obtained from private-sector savings. The Social Security program is a non-transparent welfare program that redistributes enormous amounts of wealth, often in ways that most Americans would find undesirable.

Tax Follies

The 16th Amendment to the Constitution, passed in 1913, made the income tax a permanent fixture of the U.S. tax system. The first personal income tax was quite simple: three pages of forms and one page of instructions. Income taxes today are excessively complicated, non-transparent, and costly. There are now over 500 separate tax forms and over 7,000 pages of taxpreparation instructions. In 2009, the IRS estimated there were between 900,000 and 1.2 million paid tax-preparers to help hapless taxpayers through the morass of tax rules. Worse yet, the income tax hides over a trillion dollars in hidden subsides that distort economic decision-making and produce economic waste. Reforming our wasteful tax system remains a difficult-toachieve goal as entrenched special interests fight hard to resist change.

Medicare

The pay-as-you-go health insurance program for retirees, unlike Social Security, was not designed to have a full reserve. In fact, Bess and Harry Truman received the first Medicare cards despite never paying any taxes into the program. Today, the program is the single worst Ponzi-type scheme in the government’s arsenal. It is $20 trillion to $30 trillion dollars in the red and is in far worse shape than Social Security. This chapter sheds light on the extent of the transfers and the impending crisis in financing the program.

The Nixon-Burns Political Business Cycle

The Nixon tapes, secret recordings made in the White House, reveal how Richard Nixon pressured Federal Reserve Chairman Arthur Burns to overheat the U.S. economy prior to Nixon’s reelection bid. Acting against his better judgment, Burns caved in to Nixon’s lobbying and set the stage for a decade of inflation that required three recessions to extinguish. The tapes reveal how the Fed’s independence can be compromised for political gain and why the power of the Fed’s printing press must be kept out of the reach of politicians.

Environmental Mismanagement

The failure to take into account pollution costs in the pricing of various goods leads to the production of goods that are worth less than their costs. Economists generally agree that some type of environmental regulation is needed to correct market failures arising from producers and consumers neglecting the costs of pollution. And often they've assumed that once a market failure was identified, the government would take the appropriate corrective actions.

When they’ve investigated regulatory behavior, however, they've discovered that government regulations all too often failed to correct market failures and all too often created market failures of their own. Wasteful environmental regulations are the rule, not the exception. And usually they benefit special-interest groups while harming the society at large. This chapter highlights the problem with two case studies: a proposed “clean coal” power plant for northern Minnesota and the federal ethanol mandate.

Government Failure and the Great Recession

The busting of the real estate bubble beginning in 2006 sent the U.S. economy into a tailspin. This chapter reveals the government’s role in fostering the bubble. The Great Real Estate Bubble was nourished by paternalistic policies, fostered by both Democrats and Republicans, to engineer a better society by greatly expanding home ownership, especially to the young and lower income groups. In contrast to government’s role in Prohibition, government became a “pusher” during the housing bubble. The government’s “policy drugs” hooked millions of lower-income Americans on homeownership, indebtedness they could ill afford, and eventual bankruptcy. The economic damage done to the young and less fortunate added another cruel dimension to the economic catastrophe.

Decades of Deficits

The rapid and unprecedented peacetime run-up in the nation’s public debt, begun at the turn of the 21st century, threatens to sink the U.S. economy. Unlike the situation following World War II, paying down this debt will be much more difficult due to expected increased outlays for entitlements as the baby-boomers begin to retire. At the very least, the burden of the public debt will slow economic growth and raise the normal unemployment rate. This chapter explains why irresponsible deficit spending is one of the terrible ten.

This isn't the first book to look at government policy failures. Across the other side of the Atlantic in 2007 the IEA released a related book on They Meant Well, Government Project Disasters by D. R. Myddelton. This book, more tightly focused than the Abrams's work since Myddelton only considers quasi-commercial projects, also highlights just how wrong government policy ideas can go.

A summary of the book's argument is given by

Government officials and ministers usually mean well when they promote and manage quasi-commercial projects in the public sector, which however often turn out to be financial disasters. Any technological advances come at huge expense.

A recurring rationale for grandiose projects, from the groundnut scheme to the Millennium Dome, has been to boost ‘national prestige’, but this concept has little real value.

The costs of ventures dependent on new, untried technology, such as the R.101 airship or nuclear power, are extremely uncertain, so taxpayers have to underwrite their high risks. Initial financial estimates may often be purposely too low.

Partly due to changes in specifications, many of the projects incurred time and cost overruns of more than 100 per cent. The high speed Channel Tunnel Rail Link is still not ready more than thirteen years after the Tunnel itself opened.

The absence of market pressures in the UK’s civil nuclear power programme meant that nobody knew or cared how much it was costing. The result was total losses far exceeding those of all the other five projects together.

State projects are always liable to short-term political interference, which may increase costs, as for the Millennium Dome, or risks, as for the R.101 airship.

The government’s opaque accounting practices often disguise the true level of state spending on large projects, as with the Channel Tunnel Rail Link.

Governments do not understand markets, and on some projects, such as Concorde, made little effort to research likely customer demand.

In the market system investors bear the costs of ventures that fail, but in the political system taxpayers have to do so. As a result, governments often choose to continue projects such as the groundnut scheme and Concorde, even after it has become clear they are not commercially viable.

None of the six projects was well managed and many of the failures were down to politicians: installing inadequate or over-complex organisations, appointing incompetent managers, or insisting on excessive secrecy.

The six projects examined are:

• The R. 101 Airship (Chapter 2)
• The Tanganyika Groundnut Scheme (Chapter 3)
• Nuclear Power (Chapter 4)
• Concorde (Chapter 5)
• The Channel Tunnel (Chapter 6)
• The Millennium Dome (Chapter 7)

But what of a New Zealand list? Think Big would have to be there. The student loans scheme? Capital controls and import controls? A fixed exchange rate? Monetary policy before the Reserve Bank Act? New Zealand Railways? Air New Zealand? Car-less days! Subsidies to framing. Widespread government regulation of economic activities: bars closing at 6pm, a doctor's prescription needed for margarine, shops not permitted to open on weekends, road transportation of goods, except over short distances, prohibited to protect the railways, use of statutory marketing broads etc.