Why capitalism is better than socialism

In this short (8 mins) video from ReasonTV philosopher Jason Brennan discusses his book "Why Not Capitalism?".

"We're not the Borg from Star Trek. We want to engage in private projects we do by ourselves and not with others," says Jason Brennan, an associate professor of philosophy at Georgetown University.

Brennan's new book, Why Not Capitalism?, casts a critical eye on a notion with wide appeal among academics, politicians, and the general public: That even though history has shown that socialism is unworkable in practice, it's still the best way to run society in theory.

Brennan says that such thinking neglects the fact that even in utopia people will have significantly different visions of a life well lived. "You want a system under which you can realize all these different conceptions of the good life and the good community," he argues. Even in a world free of petty rivalries, tribalism, and human failings, capitalism would still be superior because it uniquely affords citizens the rights and freedoms necessary to customize their lives and pursue their own, personally meaningful projects.

Tyler Cowen on inequality and what really ails America

Eduardo Porter writes-up an email interview he had with economics professor Tyler Cowen on the subject of inequality.

A few interesting questions:

Q: Inequality is running amok. The richest one percent of Americans pull more than a fifth of the nation’s income. The top 10 percent take half, more than during the Roaring Twenties. President Obama seems to believe this is “the defining issue of our time.” Is it?

A: “Income inequality” consists of at least three separate issues: 1) the top one percent is earning more; 2) the relative return to education is rising; and 3) economic growth is slow, and thus many lower- and middle-income groups are not seeing their incomes rise very much over time. The third of these is arguably the defining issue of our time. Grouping these issues all together under the broad heading of “income inequality” I view as a big intellectual mistake.

Q: So should we worry at all about the chasm opening up between the income of the rich and the rest?

A: I worry about stagnation in the middle and towards the bottom, not the income gap per se. A lot of the income growth at the top has come from globalization; for instance, Apple now sells a lot of iPhones to China. That’s not something we should be worried about. Rather, we should celebrate it.

Q: So, your conclusion is we should obsess less about rising inequality in America.

A: We should focus policy on increasing the quality and affordability of housing, health care and education, and on raising the rate of technological advancement. If we did that, we wouldn't have to worry about this red herring of “inequality” writ large any more.

By the way, the biggest inequalities are those across borders. So if we are talking policy, how about a more liberal immigration policy for the United States? That should be the No. 1 priority for anyone concerned about income inequality.

"Neo-liberals" and "progressives": never the twain shall meet?

I was asked to give evidence on behalf of the Fabian Society to the Beveridge Committee on Broadcasting, and although I refused on the grounds that I was not a Socialist (this was countered by saying that there was not a specifically Socialist point of view on broadcasting), I did in fact prepare the first memorandum considered by the Fabian Society Committee on broadcasting and which was the basis from which their discussions proceeded.

Ronald Coase 1961
There is an interesting new working paper out on Ronald Coase and the Fabian Society: Competitive discussion in liberal ideology by David M. Levy and Sandra J. Peart. Levy and Peart open the paper by saying:

Ronald Coase wrote the 1949 memo that guided the discussion of the Fabian Research Group on broadcasting. In the evidence presented to the Beveridge Committee on broadcasting, the Fabians endorsed his recommendations by and large. These two facts have previously escaped notice and, as a result, our understanding of post-war economic thought has been misinformed. The stereotype of post-war economic thought divides the profession into two groups, “neo-liberals” and “progressives”. In this stereotyping “neo-liberals” are said to advance a policy agenda in which markets, rather than governments, provide services; “Progressives”, by contrast, are said to favor a greater role for governments in the provision of services. In this admittedly broad characterization, there is little room for “neo-liberals” to collaborate with “progressives”.

Coase is said to typify the “neo-liberal”, while the Fabians do the same for “progressives.” As such, we would expect that they would have nothing in common in the dimension of policy recommendations. The evidence presented below, however, demonstrates that Coase and the Fabians proposed a third alternative, one that avoided the government-market dichotomy that has been so important in stereotyping post-war thought. Instead of proposing a market or a government solution, Coase and the Fabians recommended that broadcasting in Britain be fragmented to break up the BBC monopoly whose origins Coase had so carefully studied (Coase 1950). When the Beveridge Committee recommended a continuation of the monopoly, Coase was, not surprisingly, distressed. Moreover, he was not pleased with the minority report that recommended commercializing television because Coase thought that policy would be outside the British consensus.

Coase’s willingness to allow public consensus to trump the theoretical rationale for market provision of broadcasting suggests a deep problem with the stereotype of post-war market liberalism. In both the memo for the Fabian Society and his book, Coase used a recently coined word—totalitarian—to describe the theoretical rationale for a broadcasting monopoly presented by the spokesperson of the BBC, Lord Reith. By the word “totalitarian” Coase meant something more general than the policies advocated by Hitler, Mussolini, or somewhat nearer at hand, Mosley, but rather the view that state policy can ignore the legitimate wishes of the citizens of the state. The idea that there are “democratic goals” that can be separated from “democratic means”—a view that Lord Reith articulated frequently as we document in note 8—is the heart of the danger which Coase always and everywhere opposed.

Interesting stuff. The idea that a socialist group like the Fabians were willing to go along with Coase on breaking up the BBC monopoly is not something we would expect to see given the standard division of post-war thought into two, non-intersecting, groups of socialists and (classical) liberals. Coase's opposition to totalitarian thought is somewhat less surprising.

Levy and Peart continue,

The first two paragraphs of the Coase memo reproduced in the documents section below (p. 20) speak to the heart of the issue. What is needed, Coase urged, is sufficient public information to allow an informed discussion to take place. In Coase’s view public discussion had been stymied. Perhaps for strategic reasons, those in authority have not revealed the requisite information about possible alternative arrangements. The issue Coase stresses is not the efficient satisfaction of wants by market processes but public knowledge with which people can work out what institutions seem best to them. In his 1950 British Broadcasting, Coase closes the chapter “Public Discussion of the Monopoly” with the consequences of systematic suppression of information:

Though the programme policy of the Corporation gave the lower social classes what they ought to have, it gave the educated classes what they wanted; or, at any rate, more of what they wanted than they thought they would obtain with what was believed to be the only alternative—commercial broadcasting (1950, p. 177)

The paternalism of the BBC is obvious in that the "lower social classes" got what the BBC considered they should have, rather than what they actually wanted and the "educated classes" got an amount of what they wanted decided by the BBC.

The first two paragraphs of Coase's memo referred to above read:

Memorandum by Mr. R. H. Coase

1. The task of the Beveridge Committee

What is wanted is an entirely new approach to the problems of broadcasting policy in Great Britain. The present attitude is one of uncritical acceptance of the existing organisation. This can largely be attributed to the way in which previous Committees worked. The Crawford Committee, which led to the establishment of the BBC, made (so far as I have been able to discover) no detailed examination of alternative schemes. And we know from Lord Elton that the Ullswater Committee (of which he was a member) came to their conclusions without questioning the basic assumptions on which the case for the existing organisation (and in particular the monopoly) rested.

The present Committee should take a different view of its responsibilities. Alternative arrangements should be examined. And most (if not all) of the evidence presented to the Committee should be published. The lack of information on what is possible has greatly handicapped public discussion. Publication of the evidence would permit an independent assessment of the conclusions reached by the Committee and would assist in the development of an informed public opinion on broadcasting policy.

Here we can see the typical Coaseian call for comparative institutional analysis. And a call to make sure that people have the information to basis such analysis on. We should always think about the role that alternative institutions play in ameliorating or exacerbating conflicts in a world of positive transaction costs - including broadcasting.

EconTalk this week

Sam Altman, president of startup accelerating firm Y Combinator, talks to EconTalk host Russ Roberts about Y Combinator's innovative strategy for discovering, funding, and coaching groundbreaking startups, what the company looks for in a potential startup, and Silicon Valley's attitude toward entrenched firms. The two also discuss Altman's thoughts on sectors of the economy that are ripe for innovation and how new firms are revolutionizing operations in these industries.

A direct link to the audio is available here.

Trade and the poor

A interesting new NBER working paper on Measuring the Unequal Gains from Trade by Pablo D. Fajgelbaum and Amit K. Khandelwal. The abstract reads:

Individuals that consume different baskets of goods are differentially affected by relative price changes caused by international trade. We develop a methodology to measure the unequal gains from trade across consumers within countries that is applicable across countries and time. The approach uses data on aggregate expenditures across goods with different income elasticities and parameters estimated from a non-homothetic gravity equation. We find considerable variation in the pro-poor bias of trade depending on the income elasticity of each country's exports and imports. Non-homotheticities across sectors imply that trade typically favors the poor, who concentrate spending in more traded sectors. (Emphasis added.)

So trade helps the poor given the fact that the poor concentrate their spending in the traded sectors of the economy. Fajgelbaum and Khandelwal writes,

We also find important effects from sectoral heterogeneity. As in the single-sector setting, the pro-poor bias increases with a country’s income elasticity of exports. But, in contrast with the single-sector estimation, the multi-sector model implies a strong pro-poor bias of trade in every country. On average over the countries in our sample, the real income loss from closing off trade are 57 percent for the 10th percentile of the income distribution and 25 percent for the 90th percentile.5 This bias in the gains from trade toward poor consumers hinges on the fact that these consumers spend relatively more on sectors that are more traded, while high-income individuals consume relatively more services, which are the least traded sector. Additionally, low-income consumers happen to concentrate spending on sectors with a lower elasticity of substitution across source countries. As a result, the multi-sector setting implies larger expenditures in more tradeable sectors and a lower rate of substitution between imports and domestic goods for poor consumers; these two features lead to larger gains from trade for the poor than the rich.

Deirdre McCloskey on the great enrichment

From the IEA comes this short video of Professor Deirdre McCloskey. Deirdre McCloskey, Author of The Bourgeois Era series, speaks to ieaTV about inequality, the amazing growth in the wealth of the working class over the past three hundred years and how wealth and commerce has been viewed over the centuries.

Deirdre is the Distinguished Professor in English, Economics, History and Communication at the University of Illinois. As a self-described "postmodern free-market quantitative Episcopalian feminist Aristotelian", she has worked on numerous areas of economic history, including British economic 'failures' during the 19th Century. She has written fourteen books and edited another seven.

Interesting blog bits

1. Andrew Cohen on Libertarianism and Parental Licensing
   

   Back in December of 2011, I posted “Licensing Parents,” defending a view Hugh LaFollette had introduced into philosophical literature in 1980: that the state should license parents (LaFollette further defended this stance in 2010; see Note 1). LaFollette is not a libertarian and as I indicated then, I disagree with him about a lot–including the need to license medical doctors and lawyers. I nonetheless think he is right that we ought to license parents. In this post, I explain why libertarians—or at least minarchist BH-libertarians—ought to endorse parental licensing.

2. Bryan Caplan on The Economist on Overparenting
   

   Though I'm no fan of The Economist's editorials, their science coverage remains outstanding. Check out their latest piece on overparenting.

3. Ryan Bourne on ‘Does good broadcasting require compulsion?’ The question the BBC won’t address
   

   I got to thinking about how helpful this interview style would be when I read the BBC’s own Director of Policy James Heath’s response to my response to his original blog post on why the licence fee is the right method of funding for the BBC. Rather than focusing on the arguments that I had made as to why a licence fee – a compulsory charge applied to everyone who wants to watch any live television – was indefensible and unnecessary, Heath instead used his article to outline why the BBC itself was of value to us.

4. Thorsten Beck, Hans Degryse, Ralph De Haas and Neeltje van Horen on When arm’s length is too far

   The small and medium-size enterprises (SMEs) were among the most severely affected in the Global Crisis. This column discusses new evidence on how different lending techniques affect lending in bad and good times. Data from 21 countries in central and eastern Europe show that ‘relationship lending’ alleviates credit constraints during a cyclical downturn but not during a boom period. The positive impact of relationship lending in an economic downturn is strongest for smaller and more opaque firms and in regions where the downturn is more severe.

5. Linda Goldberg, Signe Krogstrup, John Lipsky and Hélène Rey ask Why is financial stability essential for key currencies in the international monetary system?

   The dollar’s dominant role in international trade and finance has proved remarkably resilient. This column argues that financial stability – and the policy and institutional frameworks that underpin it – are important new determinants of currencies’ international roles. While old drivers still matter, progress achieved on financial-stability reforms in major currency areas will greatly influence the future roles of their currencies.

6. David Saha on The Transatlantic Trade and Investment Partnership: Review of the debate on economic blogs

   An early draft of the Transatlantic Trade and Investment Partnership (TTIP) sparked an intensive public debate over possible advantages and disadvantages. This column reviews some arguments in favour of the Partnership and against it. While there is some debate over how large the economic benefit could be in the face of already relatively low trade barriers, critics claim that the deal will lower standards of consumer protection, provision of public services, and environmental protection in the EU.

7. Tim Woratall on Don't Believe What You Read; Google Doesn't Avoid Tax

   It’s the results reporting season over in my native UK again and once again, as regular as the seasons themselves roll around, we’ve spluttering pieces in the press about how Google avoids all of this tax that it should justly and righteously pay. Which means it must be the time of year for me to point out that Google doesn’t in fact avoid paying UK corporation tax, whatever you might be being told in the newspapers.

8. John Cochrane on Lucas and Sargent Revisited

   The economics blogosphere has a big discussion going on over Bob Lucas and Tom Sargent's classic "After Keynesian Macroeconomics."

FEE video: John Blundell - Lessons from Margaret Thatcher

John Blundell speaks about his experience with Margaret Thatcher at "An Evening at FEE" on May 21st, 2011.

Complexity and the art of public policy

Complexity science is changing the way we think about social systems and social theory. Unfortunately, economists’ policy models have not kept up and are stuck in either a market fundamentalist or government control narrative. In this audio from VoxEU.org Roland Kupers argues for a new, more flexible policy narrative, which envisions society as a complex evolving system that is uncontrollable but can be influenced.

A direct link to the audio is available here.

Employee satisfaction, labour market flexibility, and stock returns around the world

In a new NBER working paper Alex Edmans, Lucius Li, and Chendi Zhang study the relationship between employee satisfaction and abnormal stock returns around the world, using lists of the “Best Companies to Work For” in 14 countries. They show that employee satisfaction is associated with positive abnormal returns in countries with high labour market flexibility, such as the U.S. and U.K., but not in countries with low labour market flexibility, such as Germany. I wonder New Zealand would come in this ranking.

These results are consistent with high employee satisfaction being a valuable tool for recruitment, retention, and motivation in flexible labour markets, where firms face fewer constraints on hiring and firing. In contrast, in regulated labour markets, legislation already provides minimum standards for worker welfare and so additional expenditure may exhibit diminishing returns. The results have implications for the differential profitability of socially responsible investing (“SRI”) strategies around the world. In particular, they emphasise the importance of taking institutional features into account when forming such strategies.

The conclusions of the paper:

This paper studies how the relationship between employee satisfaction and stock returns depends critically on the level of a country’s labor market flexibility. The alphas documented by Edmans (2011, 2012) for the U.S. are not anomalous in a global context, in terms of economic significance, and do extend to several other countries. However, they do not automatically generalize to every country – being listed as a Best Company to Work For is associated with superior returns only in countries with high labor market flexibility. These results are consistent with the idea that the recruitment, retention, and motivational benefits of employee satisfaction are most valuable in countries in which firms face fewer constraints on hiring and firing. These benefits are lower in countries with inflexible labor markets, leading to a downward shift in the marginal benefit of expenditure on employee welfare. Moreover, in such countries, regulations already provide a floor for worker welfare, leading to a movement down the marginal benefit curve. Both forces reduce the marginal benefit of investing in worker satisfaction, and thus being listed as a Best Company may reflect an agency problem.

The results emphasize the importance of the institutional context for both managers and investors. Edmans (2011, 2012) uses long-run stock returns as the dependent variable to mitigate concerns about reverse causality from firm performance to employee satisfaction – any publicly- available performance measure should be incorporated into the stock price at the start of the return compounding window. However, these papers do not make strong claims about causality, as it may be that a third, unobservable variable (e.g. management quality) drives both employee satisfaction and stock returns. Even if their results are interpreted as causal, it is not the case that managers can hope to increase stock returns by investing in employee satisfaction, as a positive link only exists in countries with high labor market flexibility. Turning to investors, a strategy of investing in firms with high employee satisfaction will only generate superior returns in countries with high labor market flexibility. Given that the vast majority of empirical asset pricing studies that uncover alpha are based on U.S. data, the results emphasize caution in applying these strategies overseas. This caution is especially warranted for strategies that are likely to be dependent on the institutional or cultural environment, such as socially responsible investing strategies. Just as the value of employee satisfaction depends on the flexibility of labor markets and existing regulations on worker welfare, the value of other SRI screens such as gender diversity, animal rights, environmental protection, and operating in an ethical industry also likely depend on the context.

The role of labour market flexibility for the results of the paper is interesting. New Zealand is not in their data set and I wonder how flexible our labour markets would look internationally.

Urbanisation makes the world more unequal

A recent article, by Kristian Behrens and Frédéric Robert-Nicoud, at VoxEU.org deals with the above issue and argues that large cities are more unequal than the nations that host them. The article contends that this is because large cities disproportionately reward talented superstars and disproportionately 'fail' the least talented. Cities should thus be the primary focus of policies to reduce inequality and its adverse consequences for society. Now the obvious question is Why should there be policies to reduce inequality? Are the authors attacking inequality when their real concern is with poverty?

The basic argument of the article is,

Large cities are more unequal than the nations that host them. For example, income inequality in the New York Metro Area (MSA) is considerably higher than the US average and similar to that of Rwanda or Costa Rica. Large cities are also more unequal than smaller towns. Figure 1 plots the relationship between population size and the Gini index of income inequality for a 2007 cross-section of US MSAs (solid line). The relationship is clearly positive. This holds true even when considering that large cities host more educated people on average (dashed line); income inequality cannot be entirely explained by higher educational attainment in large cities.

How can we then explain the size-inequality nexus? Researchers have proposed two main explanations so far, both of which have to do with city composition.

First, large cities may differ systematically in their industrial structure and the functions they perform. Large cities host, for example, more business services and the higher-order functions of finance and R&D, whereas small and medium-sized cities host larger shares of lower-order services and manufacturing. Consequently, larger cities are more skilled. However, industry composition explains only about one fifth of the observed skill variation across cities (Hendricks 2011). Furthermore, that variation cannot fully account for observed income inequality.

Second, large cities attract a disproportionate fraction of households at the bottom and at the top of the income distribution [ ... ]. Central cities of US MSAs attract, for example, poor households because they offer better access to public transportation [ ... ]. Large cities also attract rich households because they reward their skills more highly than smaller cities – a ‘superstar effect’ in ‘superstar cities’ [ ... ].

This is the second potential source to the positive relationship in Figure 1: returns to skill are increasing in city size [ ... ].

The argument for the second issue is that while larger cities increase the income of everyone, the top 5% benefit substantially more than the bottom quintile. The article continues,

In a recent study we propose a simple theory to explain why this happens [ ... ]. In our theory, large cities are places that disproportionately reward the most talented people (the ‘superstars’) and that disproportionately fail the least talented (‘selection’). In a nutshell, larger cities provide incentives for the most able to self-select into activities that offer high payoffs to the successful. However, the risk of failure associated with those activities also increases because workers in larger cities compete against more numerous and better rivals.

Disproportionate rewards for the most skilled – and failure for the less skilled – then drives income inequality. Both channels are stronger in larger cities, thus establishing the positive link between city size and inequality, even when abstracting from differences in industry composition and educational attainment.

The theory also predicts that increasing globalisation among global cities will translate into larger urban income inequality. Just as large cities provide large local markets to reward skills, larger global markets serve the same function. One novel aspect of our analysis is to emphasise the existence of both a direct effect of increasing globalisation on inequality (the ‘superstar effect’) and an indirect effect that goes through increasing urbanisation and the growth of cities. Cities are more ‘valuable places’ in a globalised world, which may serve to explain increasing urbanisation. The latter is positively linked to inequality, an aspect that has not been much analysed until now.

But perhaps the most interesting bit of the article are the caveats they put at the end.

We conclude with two words of caution. First, nominal income inequality (which is measured) is not equivalent to real income inequality (which is not directly measurable). Insofar as large cities offer a wider range of cheaper goods and services than small cities do, and if this pattern is especially pronounced for the least well off, then actual real urban inequality may be less severe than nominal inequality [ ... ]. Actually, Harvard economist Edward Glaeser claims that the large poverty rates of central cities are a testimony of their success, not their failure: they attract poor households by catering better to their needs [ ... ].

Second, fighting (urban) inequality does not require aggressive local redistributive policies, for such policies attract the poor and repulse the rich, leading to the bankruptcy of local governments, such as the fiscal crisis that hit New York City in the 1970s.

If inequality really is the issue then you may ask, Inequality of what? Is nominal/real income inequality what we should be worried about or is consumption inequality the real issue?

Theoretical v. applied economics

"Then, as now, applied economists, “realitics”, as Sir John Clapham called them, and theoretical economists (‘analytics’) were often a race apart who neither properly understood nor appreciated each other’s roles and approaches. Then, as now, views differed on whether or not theory had to be directly applicable in explanations of ‘real world’ observations and much misunderstanding occurred because the separation between logically coherent ‘high theory’ in its own domain and, a separate issue, its direct applicability, was not made by protagonists in an argument. Or, if it were, one side would be concerned with the former, the other with the latter, without either making this understanding explicit."
(Stephanie Blankenburg and Geoffrey Harcourt (2007), ‘The Debates on the Representative Firm and Increasing Returns: Then and Now’ In Philip Arestis, Michelle Baddelely and John S. L. McCombie (eds), Economic Growth, New Directions in Theory and Policy, Cheltenham, UK and Northampton, MA: Edward Elgar Publishing, pp. 44–64.)

Housing affordability

Paul Cheshire - Professor Emeritus of Economic Geography at LSE, and twice visitor to the econ department at Canterbury - asks, What lies behind Britain’s crisis of housing affordability? His answer is that it is nothing to do with foreign speculators but decades of planning policies that constrain the supply of houses and land and turn them into something like gold or artworks. He also exposes myths about the social and environmental benefits of ‘greenbelts’.

Cheshire writes,

When things go wrong, it is always handy to blame foreigners and currently even the liberal press are blaming them for our crisis of housing affordability. The problem is not 50 luxury houses empty on London’s Bishops Avenue (as The Guardian reported in January) or foreign speculators buying luxury flats to keep empty in London. It is that we have not been building enough houses for more than 30 years – and those we have been building have too often been in the wrong place or of the wrong type to meet demand.

and

This is what explains the crisis of housing affordability: we have a longstanding and endemic crisis of housing supply – and it is caused primarily by policies that intentionally constrain the supply of housing land. It is not surprising to find that house prices increased by a factor of 3.36 from the start of 1998 to late 2013 in Britain as a whole and by a factor of 4.24 over the same period in London.

and he adds,

What also happens – and this is central to our ‘blame the foreigners and speculators’ scapegoating – is that houses are converted from places in which to live into the most important financial asset people have; and the little land you can build them on becomes not just an input into house construction but a financial asset in its own right.

In other words, what policy is doing is turning houses and housing land into something like gold or artworks – into an asset for which there is an underlying consumption demand but which is in more or less fixed supply. So the price increasingly reflects its expected value relative to other investment assets. In the world as it has been since the financial crash of 2007/08, with interest rates at historic lows and great uncertainty in global markets, artworks and British houses have been transformed into very attractive investment assets.

and

The more tightly we control the supply of land and houses, the more housing and housing land become like investment assets. In turn, the stronger the incentives for their owners to treat them as an option to hold in the expectation of future price rises.

So to blame speculators for housing shortages and rising prices is simply incorrect. It is our post-war public policy that has converted a good that is in principle in quite elastic supply into a scarce and appreciating asset.

And what of greenbelts?

Supporters of urban containment policies argue that Britain is a small island and we are in danger of ‘concreting it over’. But this is a myth: greenbelts in fact cover one and a half times as much land as all our towns and cities put together.

And

So the second myth about greenbelts is that they are ‘green’ or environmentally valuable. They are not because intensive farmland is not. Moreover, there is little or no public access to greenbelt land except where there are viable rights of way. Greenbelts are a handsome subsidy to ‘horseyculture’ and golf. Since our planning system prevents housing competing, land for golf courses stays very cheap. More of Surrey is now under golf courses – about 2.65% – than has houses on it.

The final myth about greenbelts is that they provide a social or amenity benefit. The reality is that a child in Haringey gets no welfare from the fact that five miles away in Barnet, there are 2,380 hectares of greenbelt land; or in Havering another 6,010 hectares.

What SERC research has shown is that the only value of greenbelts is for those who own houses within them. What greenbelts really seem to be is a very British form of discriminatory zoning, keeping the urban unwashed out of the Home Counties – and of course helping to turn houses into investment assets instead of places to live.

Solutions?

So the solution to our crisis of housing affordability is not to blame speculators or foreign buyers but to sort ourselves out. We need to allow more land to be released for development while protecting our environmentally and amenity-rich areas more rigorously than we do at present.

Building on greenbelt land would only have to be very modest to provide more than enough land for housing for generations to come: there is enough greenbelt land just within the confines of Greater London – 32,500 hectares – to build 1.6 million houses at average densities. Building there would also reduce pressure to build on playing fields and amenity-rich brownfield sites such as the Hoo Peninsula and improve the quality of housing.

Basic message: release more land for building houses. Now I wonder if any other country could learn from this idea.

Hmmmmmmmm

Investor-owned firms as cooperatives

Having written a couple of posts recently on cooperatives, see here and here, I thought to compare cooperatives with investor-owned firms, the main form of firm in the economy. While investor-owned firms dominate the economy what is not often realised is that they can be seen as a form of producer cooperative. This argument is due to Henry Hansmann, "Ownership of the Firm", Journal of Law, Economics, & Organization, Vol. 4, No. 2. (Autumn, 1988), pp. 267-304.

Hansmann begins by noting that

In the discussion that follows it will be helpful to have a term to comprise all persons who transact with a firm, either as purchasers of the firm's products or as suppliers to the firm of some factor of production, including capital. Such persons—whether they are individuals or other firms—will be referred to here collectively as the firm's "patrons."

Most firms are owned by persons who are also patrons. This is conspicuously true of producer and consumer cooperatives.

He then notes that this is also true of the standard business firm, which is owned by persons who lend capital to the firm. In fact, Hansmann argues, the standard investor-owned firm is in a sense nothing more than a special type of producer cooperative—a lenders' cooperative, or capital cooperative.

To show this Hansmann starts by looking at the structure of a typical producer cooperative.

A representative example is a dairy farmers' cheese cooperative, in which a cheese factory is owned by the farmers who provide the raw milk for the cheese. The firm pays the members a predetermined price for their milk on the occasion of each sale. (In keeping with conventional usage, the term "member" will be used here to refer to the patron-owners of cooperatives.) This price is usually set low enough so that the cooperative is almost certain to make a profit from its operations. Then, at the end of the year, profits that have been earned from the manufacture and sale of the cheese are distributed pro rata among the members according to the amount of milk they have sold to the cooperative during the year. Voting rights are held only by those who sell milk to the firm, either on the basis of one-member-one-vote or with votes apportioned according to the volume of milk each member sells to the firm. Some or all of the members may have capital invested in the firm. In principle, however, this is unnecessary: the firm could borrow all of the capital it needs. In any case, even where members invest in the firm, those investments typically take the form of preferred stock that carries no voting rights and is limited to a stated maximum rate of dividends. Upon liquidation of the firm, the net asset value—which may derive from retained earnings or from increases in the value of rights held by the firm—is divided pro rata among the members, usually according to some measure of the relative value of their cumulative patronage.

In short, ownership rights are held exclusively by virtue of the fact, and to the extent, that one sells milk to the firm. On the other hand, not all farmers who sell milk to the firm need be owners; the firm may purchase some portion of its milk from nonmembers, who are simply paid a fixed price and do not participate in net earnings or control. (Consumer cooperatives are set up similarly, with net earnings and votes apportioned according to the amounts that a member purchases from the firm.)

Now what of the standard business firm?

A business corporation is also organized in this fashion, except that it is owned not by persons who supply the firm with some commodity, such as milk, but rather by some or all of the persons who lend capital to the firm. To see the analogy clearly, it helps to characterize the transactions in a business corporation in somewhat stylized terms: The members each lend the firm a given sum. For this they are paid a fixed interest rate, set low enough so that the firm has a reasonable likelihood of running at a profit. Then at regular intervals, or upon liquidation, the firm's net earnings (after all contractual expenses, including wages and the cost of materials as well as the fixed interest rate on the capital borrowed from the members, have been paid) are distributed pro rata among the lender-members according to the amount they have lent. The firm may also have lenders who are not members. These lenders, commonly banks or bondholders, simply receive a fixed market interest rate and have no share in profits or participation in control.

As it is, in a business corporation the interest rate that is paid to lender- members (that is, shareholders) is generally set at zero for the sake of convenience. Moreover, the loans from members are not arranged annually or for other fixed periods, but rather are perpetual; the principal can generally be withdrawn only upon dissolution of the firm. In the typical cooperative, by contrast, members generally remain free to vary their volume of transactions with the firm over time, and even to terminate their patronage altogether. This distinction is not, however, fundamental. Investor-owned firms can be, and sometimes are, structured so that the amount of capital invested by each member can be redeemed at specified intervals or even (as in a simple partnership) at will. Conversely, cooperatives can be, and often are, structured so that members have a long-term commitment to remain patrons. Electricity generation and transmission cooperatives, for example, commonly insist that their members (which are local electricity distribution cooperatives) enter into requirements contracts that run for thirty-five years.

Indeed, we can view business corporation statutes as simply specialized versions of the more general cooperative corporation statutes. In principle, there is no need to have separate business corporation statutes at all; business corporations could just as well be organized under a well-drafted general cooperative corporation statute. Presumably we have separate statutes for business corporations simply because it is convenient to have a form that is specialized for the most common form of cooperative—the lenders' cooperative—and to signal more clearly to interested parties just what type of cooperative they are dealing with. (All quotes, Hansmann 1988: 270-2. Footnotes deleted.)

So the standard business firm can be seen as a form of cooperative, a capital cooperative. Not that it is often thought of in this way.

Do large modern retailers pay premium wages?

An important question given the grow we have seen in larger retailers in New Zealand and around the world. The question is studied in this new NBER working paper Do Large Modern Retailers Pay Premium Wages? by Brianna Cardiff-Hicks, Francine Lafontaine, Kathryn Shaw. The abstract reads,

With malls, franchise strips and big-box retailers increasingly dotting the landscape, there is concern that middle-class jobs in manufacturing in the U.S. are being replaced by minimum wage jobs in retail. Retail jobs have spread, while manufacturing jobs have shrunk in number. In this paper, we characterize the wages that have accompanied the growth in retail. We show that wage rates in the retail sector rise markedly with firm size and with establishment size. These increases are halved when we control for worker fixed effects, suggesting that there is sorting of better workers into larger firms. Also, higher ability workers get promoted to the position of manager, which is associated with higher pay. We conclude that the growth in modern retail, characterized by larger chains of larger establishments with more levels of hierarchy, is raising wage rates relative to traditional mom-and-pop retail stores.

So the short answer seems to be yes, at least for the U.S., but to me the interesting thing is the sorting effect with better working employed at the bigger retailers. Is this a version of the Henry Ford $5 a day idea?

Henry Ford’s friend and general manager, James Couzens, came up with the innovative idea of paying the workers enough to keep them from leaving. $5 a day, said Couzens. Henry, himself a multimillionaire, countered that $3 a day was more than enough, then a few days later he grudgingly agreed to $4 before eventually caving in to Couzen’s insistence. Finally, in January 1914, Ford doubled the wages of his workers to an unheard-of $5 a day. Ford was swamped with job applications and absenteeism dropped from 10% to 0.5%.

Worker (and other) cooperatives

As I have posted before on when worker cooperative may be a viable governance structure, and when they won't be, I thought I would take a look at just how large a force they are in the economy. Data is a bit hard to get but I did come across this from the US Federation of Worker Cooperatives

Though we lack comprehensive data on the nature and scope of worker cooperatives in the U.S., researchers and practitioners conservatively estimate that there are over 350 democratic workplaces in the United States, employing over 5,000 people and generating over $500 million in annual revenues.

Given the size of the US economy, 5000 people is not many.

However if you look at all cooperatives things look a bit different. The International Co-operative Alliance states that there are

30,000 co-operatives [which] provide more than 2 million jobs

Of course cooperatives being big employers is nothing new for New Zealand given the size of Fonterra (17,300 employees as at 2012). But to put this into perspective Wal-Mart alone employs around 2.2 million people world-wide.

EconTalk this week

Chris Blattman of Columbia University talks to EconTalk host Russ Roberts about a radical approach to fighting poverty in desperately poor countries: giving cash to aid recipients and allowing them to spend it as they please. Blattman shares his research and cautious optimism about giving cash and discusses how infusions of cash affect growth, educational outcomes, and political behavior (including violence). The conversation concludes with a discussion of the limits of aid and the some of the moral issues facing aid activists and researchers.

A direct link to the audio is available here.

Why not worker control?

This question is asked by everyones third favourite Marxist Chris Dillow at his Stumbling and Mumbling blog. Chris writes,

"Workplace autonomy plays an important causal role in determining well-being" conclude Alex Coad and Martin Binder in a new paper. This is consistent with research by Alois Stutzer which shows that procedural utility matters; people care not just about outcomes but about having in having control, which is why the self-employed tend to be happier than employees.

This implies that a government that is concerned to increase happiness - as David Cameron claims to be - should have as one of its aims a rise in worker control of the workplace.

The first question you may ask is, If workers control is so great why does it need government help? If it really can out perform other governance structures it should be able to dominate these other structures without any government help. In fact doing so would prove that it is a better form of governance. A second question to ask is Why, if worker cooperative are so great, are there so many conversions to investor ownership?

But let me give an answer to Chris based on my paper Simple Models of a Human-Capital-Based Firm: a Reference Point Approach which is forthcoming in the Journal of the Knowledge Economy. The abstract of the paper reads,

One important feature of the knowledge economy is the increased importance placed on human capital, especially when dealing with the firm. We apply the reference point approach to contracts to the modelling of a human-capital-based firm. First, a model of firm scope is offered which argues that the organisation of a human-capital-based firm depends on the “types” of human capital involved. Having a firm based on a homogeneous group of human capital leads to a different organisational form than that of a firm which involves a heterogeneous group of human capital. Second, a simple model of a human-capital-based firm is discussed. Three organisational forms are considered: an investor-owned firm, a labour-owned firm and a market transaction involving the use of an independent contractor. Results are given that show when each of these forms is optimal. The effects of a firm’s size and scope on organisation are considered as is the question of why are there conversions from worker to investor ownership.

My basic argument is that worker control can work when the labour force is homogeneous but is less likely to work when the labour force is more heterogeneous. Let me illustrate the idea with an example from the conclusion of the paper. One place you may expect to see labour ownership is in situations where the skills of the work force is the major, if not the only, source of value added. An example of this is pirates. I write,

The labour-owned firm is more likely to be formed when the human capital is relatively homogeneous in its characteristics and faces a common set of incentives. The pirate example at the beginning of the paper is an (unusual) example of this

In the introduction to the paper I say,

To illustrate how having a firm based on knowledge workers—human capital—rather than physical capital can change the structure of the firm, consider the example of pirates (a human-capital-based firm) versus privateers (a more physical-capital-based firm).

Lesson (2009) argued that given the economic environment and incentives faced by pirates a “worker cooperative” type organisational form was found to be viable for “pirate firms” (ships), but as he also notes one size does not fit all and thus worker-owned firms are unlikely to be an exploitable organisational form for all firms, in all situations. Leeson’s point about different economic contexts resulting in different organisational forms for firms can be illustrated by comparing the organisational form of the privateers with that of pirates and considering the role that non-human capital (or the lack of it) plays in determining that form.

An important difference between privateers and pirates is that although they both practised maritime plunder, privateers were state-sanctioned. That is governments would commission privateers to attack and seize enemy nations’ merchant shipping during times of war.The most obvious piece of non-human(physical in this case)capital for both pirates and privateers was their ship. The role of investors in providing this capital was important to the organisational form that the pirates and privateers developed. Pirates had no investors; they simply stole the capital they needed. Privateers, on the other hand, as legal enterprises could not just go out and steal the capital they required; they needed external financiers to supply their capital requirements. This difference in capital supply resulted in very different organisational forms, the privateers having a more autocratic management system than pirates. Pirate crews were equal contributors and part owners of the firm they worked for. Having no need for investors, pirates did not need to develop mechanisms to protect the interests of the firm’s financiers as the privateers needed to do. This meant that incentive problems could be dealt with by developing a worker-owned firm with the crew (usually) sharing equally in “profit” and electing their leaders and having power dispersed among multiple members of the crew such as the captain and the quartermaster. In contrast, the privateer had investors and a management system designed to protect their investments. The investors appointed privateer captains and developed an organisational scheme that in some important respects mirrored the managerial organisation of (also investor backed) merchant ships.

Chris's point seems to be that we would be happier and more productive if we were pirates.

Well may be not I argue. In the conclusion I go on to say,

Another (more usual) example of a human-capital based “firm”, but one where labour-owned firms are seldom, if ever, found, is that of the professional sports team. The models developed above can explain this. Here we have a situation where human capital,talent at playing a particular sport, is the basis for the “firm” but ownership by the human capital, the players, is extremely rare since a worker-owned team would be at a disadvantage relative to a player-as-employee-based team.

Heterogeneity in playing talent—playing talent being the human capital here—and thus in earning potential is a disincentive to the formation of a worker cooperative, an organisation which normally involves (rough) equality in payment, 25 since those players with the greatest earning potential, the largest outside options, will transfer away from the cooperative to maximise their income stream. Thus,a worker-owned team would have few, if any, star players, a handicap in the winner-takes-all world of professional sports.

Another issue for a cooperative sports team is that while the star players may leave the team too soon, the “average players” may stay too long. The average players will have smaller outside options and thus less incentive to leave but as they are also owners of the team it would be more difficult to get rid of those who are not performing. It would be easier for an employee-based team to remove under performing players as they are not owners of the firm.

Also, to the degree that exit barriers are entry barriers, a worker-owned organisation is at a disadvantage. Such an organisation could hinder rapid transfers between clubs. Problems with transfers could arise, for example, if the conditions under which a player can exit the team have to be negotiated with the remaining player-owners at the time of exit. Or the remaining owners may be unable or unwilling to buy out the exiting player—under a “right of first refusal” or “right of first offer” scheme—or any of them could veto an incoming replacement player-owner. Also, there is the question of the value of a player’s interest in the team as well as the question of the time period over which an agreed upon value would be paid. These costs make exit more difficult than it would be under an employment contract and thus tend to lock-in the player-owner to the team. Such lock-in is a disincentive to forming, or joining, a labour-owned firm, especially for the best players. Many of these problems can, to a degree, be contracted around but this imposes additional negotiation costs at the time of entry into the team, which again is a disincentive to forming a worker-owned team. Utilising a worker-owned organisation would result in additional haggling costs, either ex ante or ex post, relative to a player-as-employee team.

Put simply, an employee can leave an organisation more quickly and easily than an owner and in the case of professional sports, transfers between teams, or at least a credible threat to transfer, are particularly valuable to the best players. Therefore, a player-owned team would be at a competitive disadvantage compared to teams comprised of employee players.

In the model in the section “a simple model of a human-capital based firm”, an independent contractor contract implies giving control over production decisions (choice of the widget in the model) to the consultant which in the sports team example would mean giving control to the players. This would create at least some of the same problems as player ownership. If the consultant’s (player’s) contract restricted the amount of control that players have, then it’s not clear what the effective difference between the independent contractor contract and an employee contract would be.

An alternative interpretation of the results in the paper is to say that they show that organisational form depends, in part, on the relative mix of the inputs used in production. For a largely human-capital-based firm, some form of labour-ownership may be feasible while for a firm with a greater (relative) use of non-human capital, a capital owned organisation is more likely. If you increase the relative importance of the non-human capital compared to the human capital, i.e. increase the amount of non-human capital the knowledge worker needs to be productive, you increase the ability of the non-human capital owner to "shade" and thus his ability to impose welfare losses. What we see is that when the firm is homogeneous in its inputs, in the sense that they consist largely of the efforts of the knowledge worker some form of worker-owned organisation is feasible. But as the relative importance of the non-human capital increases the firms begins to look more “traditional” in its input mix and thus begins to look more traditional in its organisational form in that a capital-owned firm becomes increasingly likely. If you are a computer scientist using a PC to design small business accounting software, then your firm being a partnership is feasible whereas if you are writing software for a super-computer you are more likely to be an employee of whoever owns/rents the computer.

So the argument which is based around the "reference point" approach to the theory of the firm suggests that when a firm's human capital is homogeneous, and thus there is little reason for "shading", worker ownership may work but when the human capital becomes heterogeneous or non-human capital starts to play a big role in the production of the firm, investor ownership becomes more likely.

I would suggest that the general thrust of my argument is similar to that of Henry Hansmann's discussion of worker cooperatives and why we see so few of them. Hansmann, for example writes,

[t]he most striking evidence of the high costs of collective decision making [for employee-owned firms] is the scarcity of employee-owned firms in which there are substantial differences among employees who participate in ownership. Most typically, employee-owned firms all do extremely similar work and are of essentially equivalent status within the firm. Rarely do they have substantially different types or levels of skills, and rarely is there much hierarchical authority among them.

and

[t]he preceding evidence implies that employee ownership works best where the employee-owners are so homogeneous that any decision made by the firm will affect them roughly equally, or where, though the employees differ in ways that cause the burdens and benefits of some decisions to be shared unequally, there is an objective and widely accepted basis for making those decisions. That is, employee ownership is most viable where either no important conflicts of interest exist among the employee-owners, or some simple and uncontroversial means is available to resolve the conflicts that are present

Arnold Kling on macroeconomics

From Kling's blog askblog,

I remain concerned that macroeconomists have very elastic theories and empirical methods that can be used to confirm almost any story.

Interpreting the "representative firm"

Marshall's notion of the representative firm is an idea I have never really understood. But, to be fair to me, I'm not sure anyone else understands it either. Take, for example, Michel Quere (Quere 2006) who has written

The representative firm is a key analyical device in Marshall's Principles of economics.

and compare this with Lionel Robbins's view that the representative firms was,

Conceived as an afterthought ... it lurks in the obscurer corners of Book V [of Marshall's Principles] like some pale visitant from the world of the unborn waiting in vain for the comforts of complete tangibility.

Its difficult to see how the notion can be both a key device and a pale visitant from the world of the unborn.

In fact it was Robbins along with Piero Sraffa who are largely to blame, or who deserve most of the credit, for the controversy that lead to the replacement of the representative firm with Pigou's equilibrium firm.

One of the problems with the representative firms is that it has at  least two interpretations. Quere writes,

On the one hand, long-run equilibrium and free competition have been mainly associated with static equilibrium and perfect competition. In line with this interpretation, Sraffa [...] demonstrated the inconsistency of the representative firm as an equilibrium firm, due to the role played by internal and external economics. However, as became clear afterwards, the originator of the representative firm as an equilibrium firm was Pigou [...] and not Marshall [...]. To put it more precisely, increasing returns (resulting in economics of production on a large scale) are incompatible with the requirements for the supply curve. Their effects are either too wide or too restricted. For example, internal economics can be seen as excessive because they rapidly become incompatible with competitive conditions. On the other hand, external economies are inconsistent with the conditions of the particular equilibrium of one commodity. In order to be compatible with the laws of returns, the representative firm requires a very particular context, namely one in which external economics are 'those economics which are external from the point of view of the individual firm, but internal as regards he industry in its aggregate' [...]. But that context is likely to be rather useless as 'it is just in the middle that nothing, or almost nothing, is to be found'[...]. Therefore, the likelihood of supply curves showing decreasing costs can only be very low. Moreover, Robbins [...] complemented Sraffa's attack by showing that the concept of a representative firm was inappropriate to a proper distribution theory, and very misleading. Thus, when Keynes arranged for the 1930 symposium, this interpretation of the theory of the representative firm was brought to an end, despite Robertson [...] - and, to a lesser extent. Shove's [...] attempt at a defence. In the end the symposium fully legitimated the importance of a framework of monopolistic competition.

So by around 1930 Marshall's representative firm was no longer represented in economic theory.

But in the 1950s there was a renewal of interest in the idea. But with this new interest came a new interpretation of the notion. Here the representative firm is seen as a device to blend theory and facts in a proper fashion. Quere again,

First, the representative firm is a central device for bridging the contents of Book IV and Book V of the Principles. It also has a pivotal role in reconciling static equilibrium and evolution [...]. Second, thanks to the representative firm, an industry supply price can be downward-sloping but compatible with equilibrium, as the supply curve is not expressing the marginal costs of production for various firms in the industry, but 'the prices at which particular quantities demanded will be supplied in equilibrium' [...]. In other words, 'marginal' cost in Marshall's wording is something to be applied to aggregate values; that is, to the shape of the supply curve for the whole industry. It is a means of expressing the fact that cost lies on the marginal short-period cost curve but is conditional to any movement along the long period unit cost curve. As pointed out by Frisch [...], Marshall focused his attention much more on the nature of marginal production than on that of marginal cost. Therefore, a marginal cost curve for the individual firm is not meaningful. With the representative firm theory, Marshall was providing the best approximation he could find to solve the difficulty of making long run evolution compatible with equilibrium analysis.

Third, beyond the issue of costs, the representative firm theory also expresses the need to deal with the structure of industries. This is where I think Marshall's economics is still very relevant. With respect to this, it is especially essential to highlight two central issues: one is the heterogeneity in the organization of industries, the other is the importance of market imperfections with regard to the dynamics of industries.

The representative firm theory legitimates the importance of the concept of industry, which can he defined as a set of producers, a group of various firms significantly affected by any decision of one of them [...]. Wolfe insists on the usefulness of that Marshallian definition, which frames 'a theory [of the structure of industries] much more complete than any competitor' [...]. Moreover, the representative firm theory is a means of reflecting about the variety of firms' behaviour and performance (weak, average, strong) within an industry. Due to internal economics, firms in the same industry do not command the same technological and organizational resources. The representative firm theory is therefore an attempt to take into better account not only the structural variety among producers hut also their various reactions to changes and shocks in their environment. Both differ substantially from industry to industry: the representative firm theory is a means of expressing how industrial contexts are differently organized, sensitive, and reactive to shocks. By doing so. Marshall provides the best possible way of applying his constructive work philosophy lo the problem of the organizational diversity of industries.

The second issue is the importance to be given to 'market imperfections', to use the modern phrase. Free competition requires that internal economics do not lead to a permanent monopoly. This is only possible because of the twofold importance of innovation and market imperfections. Innovation brings about the weakening of temporary monopolies, but this point is not really considered in Marshall's analysis, which is mainly concerned with 'limited dynamic change' [...]. But a free competitive context also requires the existence of market imperfections; that is, of all kinds of frictions in the working of markets. Without the latter, an individual firm experiencing increasing returns would come to monopolize the whole market and increasing returns would then be incompatible with competitive equilibrium. Connections between producers (taking care of a whole 'supply chain oligopoly') are very influential in determining the price that will prevail at equilibrium. Now, if market imperfections are essential for understanding Marshall's dynamics, their critical importance cannot be really acknowledged within the frame of the Principles, at least with regard to the representative firm theory. Finally, despite the richness of the latter, one has to remember the prominence of Marshall's machinations at Cambridge to establish economics as a profession, and the role played by the Principles in establishing marginalism as the dominant paradigm.

While there was this renewal of interest in the representative firm it largely came to nothing. The mainstream theory of the firm remained the equilibrium firm up until the 1970s (and in textbooks even to today) when the Coaseian approach to the firm began to be developed by people like Oliver Williamson.

So what is the representative firm? Damned if I know. But even if I did I'm not sure it would matter for understanding the modern theory of the firm.

Ref.:

• Quere, Michel (2006). 'The representative firm'. In Tiziano Raffaelli, Giacomo Becattini and Marco Dardi (eds.), The Elgar Companion to Alfred Marshall (pp. 412-7), Cheltenham, U.K.: Edward Elgar.

Do patents stifle cumulative innovation?

This important question is ask by Joshua Gans at the Digitopoly blog. The question is whatever other benefits and faults there might be with the patent system, a fault that really matters for the operation of the system and for growth prospects is how patents might stifle cumulative or follow-on innovation. Gans writes,

The standard, informal theory of harm here is that follow-on innovators, feeling that they can’t easily deal with the patent holder on the pioneer innovation, decide that the risks are too high to invest and so opt not to do so. To be sure, this ‘hold-up’ concern is not good for anyone, including possibly the patent rights holder who loses the opportunity to earn licensing fees from applications of their knowledge. Suffice it to say, this has been a big feature of the movement against the current strength and, indeed, existence of the patent system.

Now I'm not sure this really is a hold-up problem in the Goldberg sense, it looks more like a barrier (or a delay) to entry problem. Either way if innovation is affected then the cost could be high. A problem, however, with dealing with this issue was that the evidence on the impact of patents on cumulative innovation was weak. Gans continues,

At the NBER Summer Institute a new paper by Bhaven Sampat and Heidi Williams [...] actually found a way to examine the impact of patents on follow-on innovations themselves. Their setting was to look at precisely the area of the Myriad case. They utilised the human genome and the fact that genes that were sequenced could be patented. What’s great about this setting is that the gene itself has a unique identifier that the researchers can use to identify whether it is subject to a patent claim (and indeed a patent application that may be accepted or rejected by the USPTO) and then also identify whether that gene was the subject of publications and clinical trials. This is as good as it gets for the measurement of innovation.

But how do you find a way of comparing what happens if there is a patent on a gene sequence versus if there is no patent? After all, there may be no patent because no one things that gene is important which may also be the reason why there is no follow-on research. That means you have to find some relatively independent reason why a patent may exist or not. Sampat and Williams exploit imperfections at the USPTO that can be themselves identified to obtain that reason.

They use several methods that all give the same answer but let me explain the best one. Patents are examined by examiners that are essentially randomly assigned.

Examiners are also identified and thus it is possible to look at their history and work out if they are tough or lenient. Gans again,

The researchers worked out that this characterisation was unrelated to other things and so could use it to identify patents that might have otherwise been accepted but were given to a tough examiner and the reverse. That is not perfect but is a fairly convincing way to measure and incorporate randomness to assess causality.

Prior to this paper, had you asked the 200 economists in the room at the NBER what they thought the outcome would have been, it is fair to say, all of them (including myself) would have predicted that patents would have a negative impact of at least 10 percent. This probably included the authors. As it turned out, the paper showed that those magnitudes in reduction could be rejected statistically. But more to the point, the paper presents pretty convincing evidence that you cannot reject zero as the likely prediction. That is, the effect patents on follow-on research appears to be non-existent.

So the impact of patents on cumulative innovation may be zero. But is this surprising? If the patent holder and the follow-on innovators both gain from allowing innovation, a Coaseian bargain should be able to be agreed to which allows innovation and makes both parties better off.

Brazil and tourism during the 2014 World Cup

Victor Matheson at the Sports Economist blog writes,

According to a statement by Aloisio Mercadante, Brazilian president Dilma Rousseff’s chief of staff, “We lost the trophy, but Brazil won the World Cup. He said that according to figures released this week by Brazil’s federal government, the World Cup was a triumph for the country’s transportation and tourism industries.

As reported by CNN, “according to government figures, 1 million foreign tourists visited Brazil during the month-long event, far exceeding its pre-Cup projection of 600,000 visitors coming to the country from abroad. About 3 million Brazilians traveled around the country during the event, just short of the expected 3.1 million.”

The devil here is in the details and whether when we get to see the details the numbers quoted hold up. One would be surprised if they did since as Matheson goes on to say,

If this is true, this would be unprecedented increase in tourism due to a mega-event. Brazil only welcomed 342,000 foreign visitors in total in June of 2012, so an increase up to 1,000,000 would be huge if the data holds up. By comparison, South Africa experienced about a 200,000 increase in international visitors during the 2010 World Cup, Germany experienced an increase of 700,000 overnight stays in 2006, and no effects on tourism could be identified for France in 2008. For the Summer Olympics in Beijing and London, overall travel to Beijing and the UK actually fell during the month of the games compared to the previous year.

Matheson also notes that while Brazilian government has been quick to announce their news, they have been much less forthcoming with the actual source data. I wonder why. Matheson then points out that the annual tourism data for Brazil is only available in a form that allows decent comparisons to past periods up to 2012 and so far the World Cup data is only available in limited press releases. Time will tell if the government's enthusiasm will last. But I'm not betting on it.

Forum on McCloskey

The Liberty Fund via its Online Library of Liberty site hosts a "Liberty Matters" forum which currently consists of a discussion of Deirdre McCloskey's two recent books Bourgeois Virtues (2006) and Bourgeois Dignity (2010). There is a Lead Essay by Don Boudreaux, "Deirdre McCloskey and Economists’ Ideas about Ideas", and comments by Joel Mokyr and John Nye, and replies to her critics by McCloskey.

The key issue is to try to explain why “the Great Enrichment” of the past 150 years occurred in northern and western Europe rather than elsewhere, and why sometime in the middle of the 18th century. Other theories have attributed it to the presence of natural resources, the existence of private property and the rule of law, and the right legal and political institutions. McCloskey’s thesis is that a fundamental change in ideas took place which raised the “dignity” of economic activity in the eyes of people to the point where they felt no inhibition in pursuing these activities which improved the situation of both themselves and the customers who bought their products and services.

The conversation following on from the lead article and comments is available here. All interesting stuff, well worth the time to read.

Audio of a discussion about the economic necessity of sweatshops

Dr. Ben Powell, author of Out of Poverty: Sweatshops in the Global Economy, appeared on BBC World Service as part of a debate on the economic necessity of sweatshops in developing countries.

You can listen to an audio of the full debate here.

Interesting blog bits

1. Konstantins Benkovskis and Julia Woerz, on Lower import prices = 100% welfare gains? Not necessarily: don′t forget the impact of consumer taste and product quality

   Import price statistics may not be a reliable indicator of welfare gains. They must adequately reflect the fact that consumers value variety, and that consumer tastes and product quality change over time. This column evaluates existing findings, and introduces new results for the four largest EU economies – including evidence of higher consumer welfare gains than suggested by official import prices for the period from 1995 to 2012.

2. Susan Ariel Aaronson on Why the US and EU are failing to set information free

   The internet promotes educational, technological, and scientific progress, but governments sometimes choose to control the flow of information for national security reasons, or to protect privacy or intellectual property. This column highlights the use of trade rules to regulate the flow of information, and describes how the EU, the US, and their negotiating partners have been unable to find common ground on these issues. Trade agreements have yet to set information free, and may in fact be making it less free.

3. Nico Voigtländer and Mara Squicciarini on Knowledge elites, enlightenment, and industrialisation

   Although studies of contemporary economies find robust associations between human capital and growth, past research has found no link between worker skills and the onset of industrialisation. This column resolves the puzzle by focusing on the upper tail of the skill distribution, which is strongly associated with industrial development in 18th-century France.

4. Don Boudreaux on Cool!

   2014 is the centenary of an unusually large number of regrettable events. But some good things also happened that year – for example, 1914 saw the first installation in a private residence of air-conditioning.

5. Art Carden on Should Your City Run More Buses or Build Light Rail? Cato's O'Toole Says More Buses

   If your city doesn’t have a light rail system, someone in town probably wants to build one. If your city already has a light rail system, someone in town probably wants to expand it. According to a June 3 Policy Analysis by the Cato Institute’s Randal O’Toole, this would be an expensive mistake.

6. Peter Boettke on The Good, the Bad, and the Ugly ... of crony capitalism?!

   Paul Rubin is an economic thinker I respect tremendously, but I am not sure I agree with him here. I do agree with live in the 2nd best (at best) world and thus it is a mistake to use 1st best theoretical ideas to guide practical affairs of public policy. I prefer instead to think of institutional robustness, rather than ideal welfare economics.

7. John Taylor on New Legislation Requires Fed to Adopt Policy Rule

   A lot of research and experience shows that more predictable rules-based monetary policy leads to better economic performance—both in terms of price stability and steadier-stronger employment and output growth. But in practice there have been big swings in Fed policy between rules and discretion, with damaging results as in the 1970s and the past decade of a financial crisis, great recession and slow recovery. This experience—especially the swing from rules to discretion in the past decade—demonstrates the need for legislation requiring the Fed to adopt rules for setting its policy instruments.

8. Bryan Caplan on Ownership for Cartoonishly Nice People

   The noble and prolific Jason Brennan has just released Why Not Capitalism?, a short book replying to Gerald Cohen's Why Not Socialism? Outstanding work, as usual. For me, the highlight is Brennan's explanation for why even cartoonishly nice people would want to own private property. It's easy to see why cartoonishly nice people - classic Disney characters like Mickey and Minnie Mouse - would want other people to own private property. But why would the nicest people imaginable want to claim ownership on their own behalf?

9. Art Carden on Intolerant Socialism

   As Jason Brennan writes, capitalism is preferable to socialism because voluntary socialist experiments like utopian communes and socialist camping trips are possible in a world with private ownership of the means of production. Capitalism tolerates socialism. Socialism does not tolerate capitalism.

Why not capitalism? (updated)

In this 2014 video from Bloggingheads.tv Will Wilkinson and Jason Brennan discuss Brennan's new book "Why Not Capitalism?"

Most economists believe capitalism is a compromise with selfish human nature. As Adam Smith put it, "It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest." Capitalism works better than socialism, according to this thinking, only because we are not kind and generous enough to make socialism work. If we were saints, we would be socialists.

In Why Not Capitalism?, Jason Brennan attacks this widely held belief, arguing that capitalism would remain the best system even if we were morally perfect. Even in an ideal world, private property and free markets would be the best way to promote mutual cooperation, social justice, harmony, and prosperity. Socialists seek to capture the moral high ground by showing that ideal socialism is morally superior to realistic capitalism. But, Brennan responds, ideal capitalism is superior to ideal socialism, and so capitalism beats socialism at every level.

Clearly, engagingly, and at times provocatively written, Why Not Capitalism? will cause readers of all political persuasions to re-evaluate where they stand vis-à-vis economic priorities and systems—as they exist now and as they might be improved in the future.

A link to the Bloggingheads.tv clip is available here.

Update: Brennan gives a brief summary of his book's thesis here.

When should we vote?

Given we have an election coming up we have to ask, When, if at all, should we vote? In this 2008 video from Bloggingheads.tv Will Wilkinson and Jason Brennan discuss Brennan's paper "Polluting the Polls: When Citizens Should Not Vote" which appeared in the Australasian Journal of Philosophy, 87(4): 535-49, 2009.

Just because one has the right to vote does not mean just any vote is right. Citizens should not vote badly. This duty to avoid voting badly is grounded in a general duty not to engage in collectively harmful activities when the personal cost of restraint is low. Good governance is a public good. Bad governance is a public bad. We should not be contributing to public bads when the benefit to ourselves is low. Many democratic theorists agree that we shouldn’t vote badly, but that’s because they think we should vote well. This demands too much of citizens.

A link to the Bloggingheads.tv clip is available here.

EconTalk this week

D.G. Myers, literary critic and cancer patient, talks with EconTalk host Russ Roberts about the lessons he has learned from receiving a cancer diagnosis six years ago. Myers emphasizes the importance of dealing with cancer honestly and using it as a way to focus attention on what matters in life. The conversation illuminates the essence of opportunity cost and the importance of allocating our time, perhaps our scarcest resource, wisely. The last part of the conversation discusses a number of literary issues including the role of English literature and creative writing in American universities.

A direct link is available here.

Sourcing foreign inputs to improve firm performance

A new article at VoxEU.org by Maria Bas and Vanessa Strauss-Kahn opens by asking

Should trade policy fight or promote imports of intermediate inputs?

The answer is, of course, neither, the decision about what inputs a firm should use and where they should get them from is up to the firm, not policy makers.

That said, it is certainly true the effect of foreign intermediate goods on firm productivity and export behaviour is not without economic and (unfortunately) political interest. Bas and Strauss-Kahn write,

There are several mechanisms through which foreign inputs could affect firm competitiveness and export performance.

• The first mechanism is the complementarity channel. By accessing new varieties of intermediate goods, firms expand the set of inputs used in production and reach a better complementarity between them. These complementary gains result from imperfect substitution across intermediate inputs and lead to increased firm efficiency. This allows more firms to access export markets and/or to export more varieties.
• The second channel is related to an input cost effect. Importing cheaper intermediate inputs increases firms’ competitiveness, boosts expected export revenues, and allows more firms to enter the export markets.
• A third mechanism is foreign technology transfer. International trade promotes economic growth through the diffusion of modern technologies embodied in imported intermediate inputs. Technology transfer is also related to quality transfer – imports of high-quality intermediate inputs lead to exports of high-quality goods. Firms may access new export markets with better quality/technology products, or export more varieties to existing markets.

Imports of intermediate inputs thus allow firms to access a bigger range of inputs, including more sophisticated or lower-cost ones, resulting in higher firm productivity and export scope (i.e. the number of varieties exported).

Bas and Strauss-Kahn then turn to look at evidence from French firms.

In recent work (Bas and Strauss-Kahn 2014), we present evidence from French firms involved in international trade, and reveal that these mechanisms are important drivers of firms’ export patterns. French firms importing more varieties of intermediate inputs over the 1995–2005 period (the average firm adds four varieties of imported inputs) have increased their productivity gains by 2.5%. By enhancing productivity, importing more input varieties also raises firms’ export scope – firms are more likely to bear the fixed costs of exporting, and to survive in competitive export markets.

Direct channels are also at play – controlling for productivity gains, a 10% increase in the number of imported input varieties results in a 10.5% expansion of firm export scope. The average firm, by importing four additional varieties of inputs, increases its exports by 2.7 varieties.

The input cost effect and the foreign technology/quality transfer channel are distinguished by looking at the country of origin of imported inputs. The rationale behind this strategy lies in the principle that developed countries produce goods with high technology/quality content, whereas developing countries provide low-price inputs. In the case of French exporting firms, foreign inputs from the most advanced economies have the strongest effect on firm productivity. Concerning export scope, both imported inputs from developed and developing countries help raise the number of exported varieties.

Overall, French firms benefit from importing intermediate goods, as it fosters both their productivity and exports. These results shed some new light on the debate on the benefits and costs of trade integration. The positive role of imported inputs in the economy should be acknowledged and accounted for.

So the importing of intermediate inputs helps both productivity and exporting.

Refs.:

• Bas, M and V Strauss-Kahn (2014), “Does importing more inputs raise exports? Firm-level evidence from France”, Review of World Economics, 150(2): 241–475.

Paul Zak on Trust, morality — and oxytocin?

From TED talks comes this video (recorded at TED Global, July 2011, in Edinburg, Scotland. Duration: 16:35) which asks the question, What drives our desire to behave morally? Neuroeconomist Paul Zak shows why he believes oxytocin (he calls it "the moral molecule") is responsible for trust, empathy and other feelings that help build a stable society.

What’s behind the human instinct to trust and to put each other’s well-being first? When you think about how much of the world works on a handshake or on holding a door open for somebody, why people cooperate is a huge question. Paul Zak researches oxytocin, a neuropeptide that affects our everyday social interactions and our ability to behave altruistically and cooperatively, applying his findings to the way we make decisions. A pioneer in a new field of study called neuroeconomics, Zak has demonstrated that oxytocin is responsible for a variety of virtuous behaviors in humans such as empathy, generosity and trust. Amazingly, he has also discovered that social networking triggers the same release of oxytocin in the brain -- meaning that e-connections are interpreted by the brain like in-person connections.

A professor at Claremont Graduate University in Southern California, Zak believes most humans are biologically wired to cooperate, but that business and economics ignore the biological foundations of human reciprocity, risking loss: when oxytocin levels are high in subjects, people’s generosity to strangers increases up to 80 percent; and countries with higher levels of trust – lower crime, better education – fare better economically.

He says: "Civilization is dependent on oxytocin. You can't live around people you don't know intimately unless you have something that says: Him I can trust, and this one I can't trust."

Shackle on economics

From the forward to the paperback edition of "The Years of High Theory: Invention and Tradition in Economic Thought 1926-1939".

Economics is one of the strangest items in mankind's intellectual cupboard. The styles of thought exemplified in its literature range from mathematics of a purity to which observational data are quite alien, through measurement-procedures which are culinary and gastronomic in their fascination, to the treatment of the subject as a branch of philosophy and, finally, to its use as the material of literary art. All these styles are expressions of humanity's untrammelled imagination and creative urge. Each in its own way is a form of art, and in each we may truly discover beauty.

I'm sure only an economist could write such a thing!

Was the Fed a good idea?

This is the question considered in a series of papers in the latest issue (Volume 34, Number 2 Spring/Summer 2014) of the Cato Journal.

Passed on December 23, 1913, the Federal Reserve Act was designed to provide an elastic currency that would respond to the needs of trade. Today, the Federal Reserve System is much different than it was a century ago. How well has the Fed performed? Was the Fed a good idea? Can we do better?

The Editor's Note introduces the various papers:

The Federal Reserve Act was passed on December 23, 1913. It was designed to provide an elastic currency that would respond to the needs of trade. There was nothing in the Act about price stability, interest rates, or full employment. The expectation was that the United States would continue to define the dollar in terms of gold, and that the operation of the international gold standard would ensure long-run price stability.

It was widely accepted that “the highest moral, intellectual, and material development of nations is promoted by the use of money unchanging in its value,” as declared by the U.S. Monetary Commission of 1876. The classical gold standard ended with the First World War, and, in August 1971, the dollar became a pure fiat money when President Richard Nixon closed the gold window.

Today the Federal Reserve System is much different than a century ago. How well has the Fed performed? Was the Fed a good idea? Can we do better? To address those and related questions, the Cato Institute brought together some of the most respected monetary scholars and policymakers at its 31st Annual Monetary Conference in Washington, D.C., on November 14, 2013. The papers from that conference are featured in this volume.

In the lead article, Charles I. Plosser argues for a rules-based monetary policy and a “limited central bank” devoted to the primary task of safeguarding the dollar’s long-run purchasing power. Jerry L. Jordan considers the lessons learned from a century of U.S. central banking, while George A. Selgin provides a detailed account of how the Fed has twisted its true record. Athanasios Orphanides, like Plosser, makes a strong case for a “price stability mandate.”

Lawrence H. White examines the Fed’s “troubling suppression of competition from alternative monies” using the examples of the liberty dollar and e-gold. Legal restrictions are also noted by Richard H. Timberlake in his article on “clearing house currency.” Scott B. Sumner advocates rules rather than discretion in the con duct of monetary policy. His preferred rule is to target nominal GDP rather than inflation or the price level.

Since the Panic of 2007, the Fed’s balance sheet and power have expanded dramatically. The Fed’s ultra-low interest rates and quantitative easing have distorted capital markets, increased risk taking, politicized credit allocation, monetized government debt, and allowed the government to expand its size and scope. Moreover, the Fed’s regulatory powers have increased uncertainty and dampened the disciplinary forces of private free markets.

Rep. Jeb Hensarling, the chairman of the House Financial Services Committee, pledges to conduct hearings to hold the Fed account able and help improve its performance. John A. Allison draws on his experience as chairman and CEO of BB&T Corporation to discuss the unintended adverse consequences of top-down financial regulation as opposed to the spontaneous positive results of market-based discipline, given the appropriate institutional framework making individuals responsible for their actions. Kevin Dowd and Martin Hutchinson look at the institutions that helped mitigate moral hazard and harmonize financial markets in the pre-Fed era and compare them to changes in the financial architecture since the creation of the Fed. Their main conclusion is that competitive markets bound by laws of contract and an overarching rule of law that protects private property rights provide incentives to manage risk and avoid the problem of “too big to fail”—a central bank and hordes of government regulators do not.

Rep. Kevin P. Brady, chairman of the Joint Economic Committee, makes the case for a bipartisan Centennial Monetary Commission to examine the Fed’s history and consider alternatives to pure discretionary government fiat money. He takes seriously the constitutional mandate for Congress to ensure stable-valued money. Gerald P. O’Driscoll Jr. considers the prospects for fundamental monetary reform and the strategies to promote such reform. R. David Ranson argues that the Fed’s over reliance on conventional statistics to guide its policy and its politicization have led to failed policies. In particular, by distorting interest rates and trying to “stimulate” the economy, the Fed has actually slowed recovery. Ultimately, real reform of the monetary and financial system requires that voters understand the limits of central banking and the benefits of limited government and free markets.

In the final article, Lewis E. Lehrman, a member of the President Ronald Reagan’s Gold Commission in 1981, makes a compelling case for returning to a classical gold standard, not only to protect the purchasing power of the dollar but to prevent the federal government from using the printing press to pay its bills.

Articles

A Limited Central Bank 

By Charles I. Plosser
 

A Century of Central Banking: What Have We Learned? 

By Jerry L. Jordan 
 

Operation Twist-the-Truth: How the Federal Reserve Misrepresents Its History and Performance 

By George Selgin
 

The Need for a Price Stability Mandate 

By Athanasios Orphanides
 

The Troubling Suppression of Competition from Alternative Monies: The Cases of the Liberty Dollar and E-Gold

By Lawrence H. White 
 

Clearing House Currency

By Richard H. Timberlake Jr. 
 

Nominal GDP Targeting: A Simple Rule to Improve Fed Performance 

By Scott Sumner
 

Fed versus Market Regulation 

By Rep. Jeb Hensarling
 

Market Discipline Beats Regulatory Discipline 

By John A. Allison
 

How Should Financial Markets Be Regulated?

By Kevin Dowd and Martin Hutchinson
 

The Case for a Centennial Monetary Commission 

By Rep. Kevin Brady
 

Prospects for Fundamental Monetary Reform 

By Gerald P. O'Driscoll Jr.
 

Why the Fed's Monetary Policy Has Been a Failure 

By R. David Ranson
 

The Federal Reserve and the Dollar 

By Lewis E. Lehrman