Cheer up. Capitalism and free trade have made the world better

From the IEA blog comes this piece by Sam Collins,

It is easy to pick up a newspaper, watch television or look on a blog and assume the end is nigh. Between foreign affairs crises, demographic time bombs, debt icebergs and having only hours left to save the NHS (more on that another time…), it would not be unreasonable for us all to assume the world has got a lot worse – that capitalism has failed, inequality has sky-rocketed, and we are living shorter, sadder and more violent lives.

Happily, this is not so. Thanks to capitalism, free trade and globalisation we live in the most prosperous, healthy, safe, equal and free period in human existence. Across the globe, as liberal economic policy and capitalism have left communism and command economies in the dustbin of history, we are seeing remarkable falls in worldwide poverty, hunger, disease, inequality and (despite current humanitarian disasters) deaths from war and natural disaster.

and

Over the past fifty years, and particularly the last thirty as liberal economic reforms have been enacted across the world, the fall in poverty levels has improved the lives of hundreds of millions of people. More than 500 million Chinese have been lifted from poverty since Deng Xiaoping’s enactment of the Four Modernisations starting in 1978 as the economy has surged. Today the GDP of Mozambique is 60 per cent larger than it was in 2008. India, Vietnam, Peru and Rwanda have all experienced the benefits of reforms to their economies, although some still have room for reform and growth.

Despite constant questions about its efficacy, freer trade has seen more consumers around the world afford better food (for example, the level of meat consumption in China has doubled since 1991), as well as items that would have been considered luxuries only decades ago (such as the computing power that sent a man to the moon in the palm of your hand).

In human health we have seen an almost unbelievable improvement over the past fifty years. We have eradicated smallpox, cases of polio have been cut to the low hundreds (down from 350,000 in 1988), the incidence of tuberculosis has been halved (since 1990) and cases of measles have fallen 71 per cent. Infant mortality has fallen dramatically as well. There are more than 7,200 fewer infant deaths every single day compared to 2000. That is a child’s death avoided every 12 minutes.

Reason for pessimism lies not in this incredible improvement in living standards, but in governments around the world retreating from free markets and free trade. In particular, putting up trade barriers will hurt the world’s most vulnerable – protecting comparatively wealthy westerners at the expense of poor farmers from Asia and Africa.

Clearly the world is still far from a perfect place but it is getting better over time. Life is still ‘nasty, brutish and short’ for far too many people but it is such for fewer people than it was 50, 100 or 200 years ago. There is hope even for Africa, see my most recent Interesting blog bits posting for a couple of articles on economic growth there and why there are good reasons for cautious optimism about the continent's economic progress. So as Collins puts it,

[...] in the great march of human civilisation, from slavery to freedom; from castes to social mobility; from dictators and kings to presidents and parliaments, it is sometimes worth stopping and appreciating how far we have come.

John Cochrane talks about life after "Dodd-Frank"

This video is of a talk given given by Professor John H. Cochrane at the Mercatus Center / CATO conference "After Dodd-Frank: The Future of Financial Markets."

How to misunderstand the Coase theorem 4

Continuing with the application of the Coase Theorem to reclining seats in aircraft, Jodi Beggs writes at the Economists do it with Models blog,

Assignment of property rights: To me, it seems pretty clear that the property rights belong to the recliner, for two reasons. First, there is a functional recline button on the chair- when airlines don’t allow you to recline (in front of emergency exit rows, for example), they disable the functionality as opposed to just asking you to not recline. Second, the device used to prevent the seat from reclining is banned, and it’s only a small logical jump from “preventing an activity is banned” to “said activity is allowed.”

My problem here is that just because I have a product that will do X, doesn't mean I have the right to do X. If I buy a gun, which has the ability to shoot people, doesn't mean I have the right to shoot people. As to the second point, the fact that I can't do Y to stop you doing X doesn't mean you have the right to do X. Just because I can't shoot you to stop you peeing on my foot doesn't mean you have the right to pee on my foot.

Beggs goes on to say,

That said, this scenario highlights the fact that it’s not only the assignment of property rights that is important, but also the recognition and respect for said property rights. (When multiple parties believe that they have the property rights, you get coexisting news headlines such as “Don’t Want Me to Recline My Airline Seat? You Can Pay Me” and “Don’t Want Me to Spit on You When You Recline Your Airline Seat? Pay Me.” as opposed to effective bargaining.)

This I think is the real point. If people don't know what the rights are or if different people think the rights have been defined differently, then its as if the rights have not been defined. Without clearly defined, well known  and respected property rights the Coase Theorem doesn't apply.

Of course this just raises the question of why don't airlines delineate rights more clearly?

Interesting blog bits

A bit of interesting weekend reading:

1. Steven G. Medema on Neither Misunderstood Nor Ignored: The Early Reception of Coase's Wider Challenge to the Analysis of Externalities

   The ‘Coase theorem’ has long been the idea most commonly associated with Ronald Coase’s analysis in The Problem of Social Cost. Yet, Coase frequently argued late in his career that he has been misunderstood, and that the central message(s) of the article lay elsewhere. Though virtually all of the discussion in decades following the publication of The Problem of Social Cost focused on Coase’s negotiation result, the fact is that Coase’s message was not, at the start, misunderstood. This paper takes up a number of the treatments of The Problem of Social Cost in the years immediately following its publication to demonstrate that Coase’s emphasis on the reciprocal nature of externalities, the importance of transaction costs, the possibility of merger solutions, the costs associated with state action, and the need for a comparative institutional approach were anything but lost on these early commentators. It was only later that the negotiation result became the major fixation of interpreters of Coase’s work.

2. Timothy Taylor on The Secular Stagnation Controversy

   For economists, the word "secular" isn't about a lack of religious belief. Instead, it's refers to whether a condition is expected to last for a long and indefinite period--and in particular, a period not related to whether the economy is entering or exiting a recession. Thus, the concept of "secular stagnation" is the idea that the U.S. economy is not just suffering through the aftereffects of the Great Recession, but is for some reason entering a longer-term period of stagnant growth.

3. Tim Worstall on Why Uber might be making a mistake in paying by the hour

   There’s a little technical detail about incentives that suggests that Uber might be making a mistake in their policy of paying minicab drivers by the hour. That mistake being not quite getting the difference between the income effect and the substitution effect as it affects pieceworkers (those two effects together being what gives us the Laffer Curve of course).

4. Masayuki Morikawa asks Are large headquarters unproductive?

   Headquarters play important strategic roles in modern companies, but downsizing of headquarters is often advocated as a cost-cutting measure. This column presents evidence from Japanese firm-level data that headquarters size is positively associated with firms’ overall productivity. Moreover, the benefits of ICT are greater for companies with relatively large headquarters. Downsizing headquarters to cut costs may thus be harmful for long-term company performance.

5. Marco Annunziata on African growth looking forward

   Africa has generated a lot of enthusiasm lately. The cynical view of the continent as a hopeless basket case has been replaced by the lofty narrative of Africa Rising. This column argues that Africa’s progress is impressive, and there is more to the story than a commodity boom. But Africa is at a crossroads. The opportunities are huge, but the road ahead is long, and will require persistent and patient effort from policymakers as well as business.

6. Margaret McMillan asks What is driving the ‘African growth miracle’?

   Some argue that growth across Africa is fundamentally a result of rising commodity prices and that if these prices were to collapse, so too would Africa’s growth rates. This column documents substantial shifts in the occupational structure of most African economies between 2000 and 2010 and thus provides a good reason for cautious optimism about the continent’s economic progress.

7. John Cochrane on Lazear on Labor

   Modern labor economists see employment and unemployment as a search and matching process with a lot of churn. The popular impression, echoed in most media discussion, is that there is a fixed number of jobs, and people just wait around for more jobs to be "created." That's what it may feel like to an individual, but that's not how the economy works. Lazear's column puts in one very short space some of the better ways to think about unemployment.

8. Keith Boyfield on Privateers and the sinister threat posed by ‘patent trolls’

   Many in Britain may not be familiar with the term ‘patent privateering’ – but that may all be about to change. British courts are apparently being targeted in a forum-shopping exercise by global monopolists, who are using this technique to reduce competition and innovation in the hi-tech sector.

   Earlier in the week I discussed patent trolls here.
   

How to misunderstand the Coase theorem 3 (updated)

From the comments on one of my previous posts comes this from Economists Do It With Models

Actually, one of the articles on the subject mentioned that the SeatDefender device that was used was not allowed, which would imply that the property rights are at least implicitly assigned to the recliner.

I have not seen that. But if true then the airline just has to make clear what the property right is and let bargaining take place or while the SeatDefender may be illegal it still doesn't necessarily mean that property rights have been defined. Use of the device may just be an attempt at "homesteading" legroom.

Update: Economists Do It With Models has kindly provided the source that mentions the device being banned: http://consumerist.com/2014/08/26/united-flight-diverted-after-passenger-uses-banned-seat-recline-jammer-starts-scuffle/

Also from the Environmental and Urban Economics blog comes an Update:

Yes, I am well aware that the Coase Theorem assumes that property rights are well defined and agreed upon (so some have said that the Coase theorem does not apply here) but what is interesting about this case is that the airline has not established these rules. It is also interesting that transaction costs precluded the ability of others on the plane to offer their seat to the woman who wanted to recline because this simple solution would have resolved this "crisis". Nobody gained by landing the plane in Chicago. People lost time, they had to land and takeoff one more time. The Coase theorem assumes a smooth redistribution of resources but instead resources were destroyed in this multi-player interaction. This should interest economists.

How to misunderstand the Coase theorem 2

Following on from my posting yesterday I see that someone does get the Coase Theorem. Writing at the Wall Street Pit Donald Marron says

Somewhere Ronald Coase is smiling. He identified that answer in 1960 in his famous paper, The Problem of Social Cost.

If the little girl has the property right to recline, then you can pay her not to do so. If you have the property right, you can install a Knee Defender.

Yes, but as I noted yesterday the problem here is that property rights are not defined.

Marron goes on the say,

But who should have the property right? Coase would say it depends–some people don’t like negotiating with other passengers. Given those “transaction costs” the right ought to be given to whichever person is most likely to want it most.

I’d bet on the “reclinee” not the recliner. Which might explain why more airlines now offer the ability to pay extra for more legroom. After all, United would rather you pay them than the little girl.

This answer, extra legroom, may not be about the airline collecting the payment which would otherwise go to the recliner since a seat with more legroom is not the same thing as a seat with less legroom. The amount of the externality is not reduce by having more legroom, the recliner may still recline just as much, its just that the reclinee is no longer affected by the reclining. So seats with more or less legroom are two different goods and thus the airline may simply be selling different types of goods to different types of customers.

The Economics of World War I. 3

Another in the series of posts from The Economics of World War I project at VoxEU.org

Walking wounded: The British economy in the aftermath of World War I
Nicholas Crafts 27 August 2014
It is well-known that World War I was expensive for Britain. The indirect economic costs were also huge. This column argues that the adverse implications of the Great War for post-war unemployment and trade – together with the legacy of a greatly increased national debt – significantly reduced the level of real GDP throughout the 1920s. A ballpark calculation suggests the loss of GDP during this period roughly doubled the total costs of the war to Britain.

How to misunderstand the Coase theorem

This comes from Matthew E. Kahn's Environmental and Urban Economics blog:

My fellow University of Chicago economists, stop reading Krugman's latest and explain this puzzle to me. A United Flight to Denver was diverted to Chicago because of a fight between two 48 year olds over whether the person sitting in front in Economy Plus has the right to recline her chair. For details read this.

As we get ready to start the new academic year, here is an excellent example of the Coase Theorem not working! Who has property rights on an airplane when the person in front of you wants to recline while you care about your knees? Why was this United flight diverted to Chicago? Wasn't that a destruction of resources for everyone involved? My fellow Becker students, what is the answer? You have 10 minutes to answer this 6 point question. The Coase Theorem predicts that the recliner should have paid the person behind her? True, false, uncertain. Explain.

Kahn states "here is an excellent example of the Coase Theorem not working" and then asks "Who has property rights on an airplane when the person in front of you wants to recline while you care about your knees?" And he does not seem to notice the importance of the second point to his first point.

The Coase Theorem assumes that property rights are well defined, it doesn't matter who has those rights, but someone must have them allocated to them. The problem with the seat example, as the second point makes clear, it that property rights are not well defined and thus the theorem does not apply here. Not, at least, until the airline clearly defines seating rights.

Even sweatshop jobs can be good for you,

especially if you are female.

A new NBER working paper looks at Manufacturing Growth and the Lives of Bangladeshi Women. The paper is by Rachel Heath and A. Mushfiq Mobarak.

Heath and Mobarak note that there is very little rigorous analysis of the welfare effects of access to factory jobs - "sweatshop jobs" - for women, and the "evidence" that there is is dominated by anecdotes from anti-sweatshop activists about the negative effects of hazardous working conditions. The evidence gap is especially pertinent for policymaking in Bangladesh, where well-publicized garment factory collapses and fires and their attendant death tolls recently captured the world’s attention. In response to the disasters individual large buyers, in addition to the U.S. government, have made moves to restrict or boycott garment exports from Bangladesh but such export restrictions and boycotts come with the potential to hurt the very workers that they are designed to protect.

The manufacturing industry in Bangladesh currently employs almost 4 million workers and it was the first industry to provide employment opportunities to women on a large-scale in a country where women traditionally have not worked outside the home. In doing so to it has raised the opportunity cost of being married and having children. These sweatshop jobs require a basic level of literacy and numeracy skills and the arrival of garment factories therefore has potentially affected enrollment, employment, marriage and childbearing decisions for Bangladeshi women.

Heath and Mobarak's

[...] results suggest that the rise of the garment industry can help explain the declining fertility, increasing age at marriage, and rapid increase in girls' educational attainment during this period, both in absolute terms and relative to boys [...]. Approximately 80 percent of garment factory workers in Bangladesh are female [...] and extrapolation from our data and national surveys suggest that around fifteen percent of women nationwide between the ages of 16 and 30 work in the garment industry. The education results are particularly policy- relevant, as Bangladesh has surpassed the third Millennium Development Goal of gender equity in enrollments, a goal with which many other countries in Western Asia and sub-Saharan Africa continue to struggle. Our research design permits a study of investments in girls relative to boys, which is of considerable policy [...] and also academic interest, given the comparative advantage girls possess in skilled tasks [...]. Our results provide one hitherto unexplored explanation for the accelerated gender equity in education in Bangladesh, thus generating important policy implications for other developing countries interested in emulating Bangladesh's success.

There are, in theory, a number of different ways that access to factory jobs can alter women’s school, work, marriage and childbearing decisions.

As documented for maquiladora jobs in Mexico, older children may be induced to drop out of school to access the factory jobs [...]. Conversely, younger children (who are still too young for the factory jobs and do not face the temptation to drop out and begin earning immediately) may respond by investing in education if the availability of relatively well-paid manufacturing jobs increase the returns to education. Educational attainment might also increase through a wealth effect, if parents can now better afford to send their children to school. Both the increased enrollment channel and the direct factory employment effects would result in girls delaying marriage and childbirth.

Heath and Mobarak

[...] document that the hazard of marriage and childbirth at early ages (12-18) drops sharply for girls when they gained exposure to the ready- made garment sector. This is important because other research has documented large negative welfare implications of early marriage and early childbirth [...].

Next Heath and Mobark examine the ways by which these delays in marriage and childbirth occur.

Did girls increase their educational attainment in order to obtain well-paying garment jobs which require numeracy and literacy, which then led to a postponement of marriage due to greater educational attainment? We assess the effect of cumulative years of exposure to garment factory jobs on the total years of educational attainment (for those with completed schooling histories), adding an additional comparison to the girls’ male siblings, given that garment production is has been a much larger innovation in the labor market for girls than for boys [...]. We find that girls gain an extra 1.5 years of education relative to their brothers in the median garment-proximate village. This represents a 50% increase in girls’ educational attainment over control villages that do not have a garment factory nearby. We observe the increase in female education (relative to their male siblings) even in families where the mother or older sister never worked in a factory, which suggests that increased demand for skills in factories that offer job opportunities for women is a likely channel through which the enrollment gains are realized, in addition to any family wealth effect or changes in intra-household time allocation from other household members working in garment factories.

We next use retrospective data on the entire history of annual school enrollment decisions for each girl to test whether the effects of the garment industry on schooling are strongest for younger girls. We find that young girls (aged 5-9) are more likely to stay enrolled in school hen factories open close to their village compared to girls in comparison villages in the same sub-district that are not located within commuting distance of factories, relative to earlier years (before the factory opens), and relative to male siblings of the same age.

While there is a positive effect on education for young girls, what about those a bit older?

Our data also indicate that the delays in marriage and childbirth we estimate likely also stem from girls in garments-proximate villages choosing to work in factories when they are about 17-23 years old, instead of getting married (or staying in school). Factory job access has a small negative effect on school enrollment of 17-18 year olds (unlike the positive effect for younger girls). More importantly, girls who are exposed to factory jobs when they are between 10 and 23 years old (which is the critical age group at risk for early marriage in Bangladesh) are 17 percentage points more likely to have done wage work outside the home, and this is a 79% increase over the control group.

In summary,

[...] access to factory jobs significantly lowers the risk of early marriage and childbirth for girls in Bangladesh, and this is due to both the girls postponing marriage to work in factories, and the girls staying in school at earlier ages. We benchmark the magnitude of the effects of the garment industry against the effects of a large-scale (US$15 million per year) conditional cash transfer for schooling intervention run by the Bangladesh government with multilateral donor support. The program has paid for 2 million girls to remain in school, conditional on remaining unmarried. The dramatic improvement in girls' outcomes in Bangladesh in the past 30 years has 5 frequently but casually been attributed to the FSP, but our estimates suggest that the rapid expansion of the garment sector has been a much more important reason for the decreases in earlier marriages and fertility and the closing of the gender enrollment gap in Bangladesh.

While sweatshop jobs are not great jobs, by our standards, they do come with positives for those people in poor countries who can get them. The anti-sweatshop groups should keep this in mind when attacking such forms of employment. Sweatshops are the first step down the road out of poverty.

Video of Alvin Roth talking on "Repugnant markets and prohibited transactions"

This is a 30 minute video of Alvin Roth's recent lecture at Lindau, on Repugnant Markets and Forbidden Transactions.

The effects of patent trolls

There is a new organisational form, called the non-practicing entity (NPE), in the world of intellectual property. NPEs have recently emerged as a major driver of IP litigation. The idea is that NPEs amass patents not for the sake of producing any actual product, but rather they aim to prosecute infringements of their patent portfolios. (rent-seeking?) The rise of NPEs has sparked a debate regarding their value and their impact on innovation. Proponents argue that imperfections in the legal system implicitly reward large, well-funded organisations, enabling them to infringe at will on small innovators’ IP and that NPEs are there to protect small innovators from such abuse. Opponents cast NPEs as organisations that simply raise the costs of innovation by exploiting the fact that an imperfect legal system will rule in their favour sufficiently often—even if no infringement has actually occurred—that the credible threat of the legal process can yield rents from producing, innovative firms.

So what are the effects of these "patent trolls"? A new NBER working paper, Patent Trolls: Evidence from Targeted Firms by Lauren Cohen, Umit Gurun and Scott Duke Kominers, tries to find out. Cohen, Gurun and Kominers add to the debate on NPEs by providing the first large-sample evidence on precisely which corporations NPEs target in litigation, when NPE litigation occurs, and the impact of NPE litigation on the targeted firms’ innovative activity.

Cohen, Gurun and Kominers argue that there are two reasons that patent trolls can prevent welfare-increasing innovation from being brought to market.

1. innovators with profitably commercialisable inventions but with a high enough probability of being sued to be deterred from production
2. innovators that decide not to commercialise because the ex ante expected profitability of becoming a patent troll is higher than that of commercialisation

In their empirical work Cohen, Gurun and Kominers

[...] link patent-level data on NPEs and their activities to data on all publicly traded firms. Using this linked data, we show that NPEs behave opportunistically; that is, typically acting as patent trolls. Specifically: NPEs target firms that are flush with cash (controlling for all other characteristics) and firms that have had recent, positive cash shocks.

Indeed, a one standard-deviation increase in cash level increases the probability of being sued by an NPE by 11% (t = 6.84). Given that the mean probability is 2%, this is more than a fivefold increase.

In fact, NPEs even target conglomerate firms that earn all of their cash from segments having nothing to do with the allegedly infringing patents. For example, an NPE is likely sue a firm regarding a technology patent even if the firm is earning all its revenue from a lumber division entirely unrelated to the allegedly infringing technology patent—even if the division holding that patent is unprofitable. Indeed, we find that profitability in unrelated businesses is almost as predictive of NPE infringement lawsuits as is profitability in the segment related to the allegedly infringing patent.

Consistent with our model, we also find that NPEs target firms against which they have a higher ex ante likelihood of winning. We demonstrate this fact using multiple measures of ex ante likelihood of lawsuit success. First, we show that NPEs are significantly more likely to target firms that are busy dealing with a number of other litigation events unrelated to intellectual property. Being tied up with outside litigation roughly doubles the probability (t = 2.87) of being sued by an NPE. Moreover, we show that, controlling for all other characteristics, firms with larger legal teams have a significantly lower probability of being targeted by NPEs, consistent with large legal teams serving as a deterrent.

Of course, the true prediction of our model is on the ex ante expected profitability of NPE litigation. To capture this, we interact our measures of expected cash payouts with our measures of expected lawsuit success. We find that, as the model predicts, NPEs systematically target those firms for which the ex ante expected profitability of litigation is large. In particular, the payout probability interaction terms are significant and economically large. Our finding suggests that nearly all the firms targeted by NPEs have large pools of cash for potential payouts and are ex ante more likely to pay off in some form (either an out-of-court settlement or an in-court loss). To further explore this connection, we construct a measure of the ex ante expected outcome if a targeted firm were to go to court. This measure relies on the assumption that defendants often make predictions about the likely outcome based on observations of other firms in the same industry and location. We find that the interaction term of this expected outcome and expected payout is again large and significant, providing further evidence that NPEs choose targets based on expected profitability: suits with high probability of payoff against firms with deep pockets.

Non-practicing entities don’t have a monopoly on IP litigation. Practicing entities (PEs), such as IBM and Intel, also sue each other for patent infringement. If our results are simply picking up general characteristics of IP litigation, then we might expect to see PEs behaving in much the same way as NPEs. In order to compare PE and NPE behavior, we hand-collected the universe of patent infringement cases brought by PEs against other PEs in the same period (2001–2011). However, we find the opposite. If anything, PEs are slightly less likely to sue firms with high cash balances and less likely to sue firms with many ongoing cases. All of the other determinants of NPE targeting have (statistically and economically) no impact on PE litigation behavior. This comparison suggests that our results on NPE litigation behavior are not just reflections of general characteristics of IP litigation. Rather, our findings are consistent with agent-specific motivations for NPEs in targeting firms flush with cash just when favorable legal outcomes are more likely.

Lastly, we examine the real impacts of NPEs’ litigation activity. Comparing firms that are sued by NPEs and go to court (and in this way controlling for selection of firms targeted by NPEs), we find that firms that lose in court have significantly lower post-litigation patenting activity and fewer citations to their marginal post-litigation patents, relative to firms whose cases are dismissed. Furthermore, after losing to NPEs, firms significantly reduce R&D spending—both projects inside the firm and acquiring innovative R&D projects outside the firm. Our evidence suggests that it really is the NPE litigation event that causes this decrease in innovation. Prior to litigation, firms that subsequently lose to NPEs are identical to those that subsequently have suits dismissed. They have the same R&D, patenting, and patent quality. Moreover, patents of firms developed pre-litigation continue to accrue citations at exactly the same rate after litigation, whether or not the suit was dismissed. This is in stark contrast to the divergent amount of citations of firms’ post-litigation patents.

In short, NPEs behave as patent trolls.

But what is the point?

From the TVNZ website we learn that

The New Zealand dollar dropped sharply in mid morning trade today, shedding half a US cent in about five minutes and prompting speculation of Reserve Bank intervention.

The kiwi fell, from 9:15am when it was trading at 83.96 US cents, to 83.40 US cents at 9:21am. The local currency subsequently touched a six-month low of 83.36 US cents and was recently trading at 83.44 cents.

Let us assume that it is intervention by the RB that caused this, What is the point? As soon as the intervention stops the dollar will go back to where it began, assuming other factors haven't changed. And if other factors have changed to bring the dollar down, there seems no point to any intervention. To keep the dollar "low" the RB would have to keep on intervening and it can't do that, so what does the RB get for its effort?

The TVNZ article goes on to say,

New Zealand's Reserve Bank has previously said the local currency is too high and raised the possibility it could intervene in the market by selling kiwi in an attempt to push it down.

Which brings us back to the old question of what does "high" or "low" even mean? After all the exchange rate is just the price of foreign exchange and like all freely determined prices, they are what they are. "High" or "low" has little meaning.

EconTalk this week

Daphne Koller of Coursera talks with EconTalk host Russ Roberts about online educational website Coursera and the future of education both online and via bricks-and-mortar. Koller, co-founder of Coursera with Andrew Ng, explains how Coursera partners with universities, how they try to create community and interaction, and the likely impact of widespread digital education on universities and those who want to learn. The conversation includes a discussion of why Koller left a chaired position in computer science at Stanford University to run a for-profit start-up in a crowded field.

A direct link to the audio is available here.

Competition and productivity

An obvious and important question in industrial economics is does competition raise productivity and if so, through what mechanism? In a 2010 working paper, Does Competition Raise Productivity Through Improving Management Quality?, John Van Reenen sets out to answer that question. He writes,

I discuss recent empirical evidence from both large-scale databases and specific industries which suggests that tougher competition does indeed raise productivity and one of the main mechanisms is through improving management practices. To establish this, I report on new research seeking to quantify management. I relate this to theoretical perspectives on the economics of competition and management, arguing that management should be seen at least in part as a transferable technology. A range of recent econometric studies suggest that (i) competition increases management quality and (ii) improved management quality boosts productivity.

Thus Van Reenen's argument is that competition does indeed increase productivity and a major mechanism for this is via improved management practices. He says that management is a transferable technology and that competition fosters the adoption of better management practices through both selecting out the badly managed firms (reallocation) and giving incumbent firms stronger incentives to improve their management practices. He argues that this perspective is supported by a range of new evidence both from new ways of measuring management and from more robust forms of identifying the causal impact of competition changes on productivity outcomes.

This has important implications for a small trading country like New Zealand. Given our small internal market how do we increase competition? One way is to open our markets to foreign trade and investors. Yes, allow foreigners to trade here and to buy assets here. Yes I know, certain political parties will not be too pleased with this idea.

Allowing foreign companies to trade here increases competition in our market in general and thus forces improvement in terms of management on local firms. But as my previous posting on the example of France showed foreign ownership can also improve a firm's productivity. Foreign investors are more likely to takeover firms that are currently under-performing and thus are open to productivity improvements. Such investors are more likely to buy firms that aren't working, right now, as well as they have in the past. The targets of foreign buyouts normally had experienced substantial productivity decline in the years prior to the foreign takeover. The foreign buyers then use their expertise, including improved management practices, to correct things and thus increase productivity. Of course this performance improvement puts additional pressure on other firms to up their game as well.

Thus foreign trade and ownership can both improve productivity by increasing competition in the local market and thus putting pressure on local firms to improve the quality of their management.

You know your economy is in trouble when .........

In City A.M. Guy Bentley writes

The President of Venezuela, Nicolas Maduro, has announced plans for a major mandatory fingerprinting system to combat the increasingly dire food shortages and rampant smuggling afflicting the Latin American state.

He said the fingerprinting system would be similar to the one the country uses for voting and was intended to stop Venezuelans buying too much of a single item. Venezuelan authorities report up to 40 per cent of the goods the country subsidises for its domestic market are smuggled to Colombia and sold at higher prices.

and

The opposition argued mandatory fingerprinting is yet another demonstration of the government's "failed socialist policies", which has seen essential goods driven from shop shelves, oil production plummet and growth slow to a snail's pace.

Venezuela has been running short of basic goods like toilet paper, soap and cooking oil for over a year. Strict currency controls and a shortage of US dollars have hammered consumers' ability to get imported goods.

Furthermore, price controls have crippled the ability of producers to make profits and correctly identify market signals.

and

Earlier this month, in a desperate move to combat a wave of smuggling, the government deployed 17,000 troops on the Colombian border and began closing crossings at night.

I can't help but think that any system that requires 17,000 troops to stop smuggling of staple food items and fingerprinting of shoppers to stop them buying "too much" is a system that clearly is not working. Instead of such measures, which won't work anyway, President Maduro should remove subsidies, price controls and currency controls and reintroduce markets so that the price mechanism can work to give producers the right incentives to produce and consumers the right information to make decisions about what to buy. Only then will shortages be removed and smuggling stopped.

Do economists play well with others?

The unlikely sounding answer to this question is yes. This answer comes from a paper in a recent issue of The American Economist (Vol. 59, No. 1 (Spring 2014)) on "Do Economists Play Well with Others? Experimental Evidence on the Relationship Between Economics Education and Pro Social Behavior" by Bryan C. McCannon. The abstract reads:

Does an economics education affect an individual's behavior? It is unclear whether differences in behavior are due to the education or whether those who choose to study economics are different. This issue is addressed using experimental evidence from the Trust Game where trusting and reciprocating behaviors can be measured. First, it is shown that economics students provide greater trusting investments and reciprocate more. Accounting for the selection effect, these effects are explained by those who choose to study economics and not directly from the education being provided. Thus, economists play well with others and these social preferences are not taught in the classroom.

The upshot of the experimental research discussed in the paper is that as the number of economics courses taken increases, more trusting investment and more reciprocation occurs. Thus, students of economics create more wealth and engage in more "pro-social" behaviour. Using the surveys as an instrument to disentangle the selection effects and learning effects, the results indicate that this outcome is due to the selection effect rather than learning. The estimated impact of an additional economics course taken reduces and becomes statistically indistinguishable from zero. Thus, those who choose to study economics are, indeed, different from other students and the classrooms do not have a substantial, independent impact on behaviour. Thus, the answer posed in the title, do economists play well with others, can emphatically be answered, yes.

That is, economists are just nice!

But you all already knew that ...... didn't you.

Interesting blog bits

1. Carlos Vargas-Silva asks Are Migrants Good for the Economy?

   Two studies about the impact of migration on the UK economy have been published which – if media reports are to believed – appear to contradict one another. A closer reading of these reports, however, shows that in fact they come to very similar economic conclusions.

2. Chris Dillow on Optimum Deaths

   What is the optimum number of migrant deaths? The answer is not zero.

3. Tim Worstall points out What glories this capitalist free market thing hath wrought

   There’s nothing worse than being exploited by some running lackey pig dog of a capitalist, as Deirdre McCloskey reminds us.

4. Joel Waldfogel on Piracy Undermining Content Creation: Loch Ness Monster or Black Swan?

   Theory and common sense dictate that piracy should threaten new product creation. If it costs money to bring new works to market, then a reduction in revenue – all else constant – should render some projects uneconomic. So compelling is this theory that the content industries share it with lawmakers at every opportunity. Robert Solow once quipped, “You see the computer age everywhere but in the productivity statistics.” So it has been with piracy and content creation: one can see a negative impact of piracy everywhere except in the evidence about content creation. Maybe until now.

5. Ed Dolan on Universal Basic Income and Work Incentives: What Can Economic Theory Tell Us?

   Everywhere you look, it seems, people are talking about a Universal Basic Income (UBI)—a monthly cash benefit paid to every citizen that would replace the existing means-tested welfare system.

6. Tim Harford on Monopoly is a bureaucrat’s friend but a democrat’s foe

   “It takes a heap of Harberger triangles to fill an Okun gap,” wrote James Tobin in 1977, four years before winning the Nobel Prize in economics. He meant that the big issue in economics was not battling against monopolists but preventing recessions and promoting recovery.

7. Andrea Prat asks How can we measure media power?

   The potential for political influence is what most people think of when they talk about the power of the media. A new media power index, proposed in this column, aggregates power across all platforms and focuses not on markets but on voters. It measures not actual media influence but rather its potential. Using the index, the author finds that the four most powerful media companies in the US are television-based and the absolute value of the index is high. This indicates that most American voters receive their news from a small number of news sources, which creates the potential for large political influence.

8. Gabriel M. Ahlfeldt, Stephen Redding, Daniel M. Sturm and Nikolaus Wolf on The economics of density: Evidence from the Berlin Wall

   Economic activity is highly unevenly distributed across space. Understanding what drives the agglomeration and dispersion is important for many economic and policy questions. This column describes a theoretical model of internal city structure incorporating agglomeration and dispersion and heterogeneity in local fundamentals. The authors use the division and reunification of Berlin as a natural experiment. Their findings show that both heterogeneity in locational fundamentals and agglomeration forces are important in shaping a city’s internal structure.

9. Tim Worstall on Companies are the cells of the economy

   It’s often pointed out that companies are little sections of a command economy and thus, some leap to say, obviously it’s possible to have a command economy because we actually do.

EconTalk this week

Terry Anderson, Distinguished Fellow at the Property and Environment Research Center (PERC) and Senior Fellow at the Hoover Institution, talks to EconTalk host Russ Roberts about free-market environmentalism, the dynamics of the Yellowstone ecosystem, and how property rights can protect natural resources.

A direct link to the audio is available here.

Should change the way we teach economics?

This is a question that Professor, and Nobel Prize winner, Alvin Roth was asked by a reporter from Brazil. The questions and Roth's answers follow:

1) Should the content of economics degrees change? Why? Why not?

I guess you mean should we change what we teach young economists, and of course the only answer is “of course!” What we teach young physicists and biologists and doctors and civil engineers changes as we learn more about those things, and economics is no different.

2) Has the criticism of economics been exaggerated after the 2008 crisis? To what extent is the current debate on content useful?

I think the 2008 crisis has been useful for pointing out that economics is, in many of its parts, still a very young science. For an analogy, think of medicine, which is the part of biology that we most often look to for advice, and is also a young science in many of its parts. Each year we worry that there might be an influenza epidemic due to whatever new strain of flu is observed in Asia that year, and each year vaccines are prepared, in an attempt to avert a disaster like the influenza pandemic of 1918. So far we've been lucky, but it’s not because we have a deep understanding of what could cause another epidemic or how to prevent it. But if another epidemic occurs, we’ll need to rely more on doctors and medicine, not less. So, while we need to understand epidemics better, that’s not a deep criticism of medicine, just an acknowledgement of some of its current limitations. Similarly for economic crises, and economics.

3) What changes should be made?

One of the things we’re devoting more attention to at Stanford is the kind of economic engineering called market design, which pays attention to the detailed rules by which particular marketplaces operate, and to experimental economics, which gives us a tool to better understand how people behave in economic environments.

4) Has economics teaching become too wedded to scientific pretension? Was excessive faith invested in abstract mathematical models?

Abstract mathematical models are very useful, in combination with other kinds of investigation. A lot of my work is devoted to market design, and my colleagues and I build a lot of marketplaces that have some of their ancestry in abstract mathematical models (including some of those explored by the famous Brazilian economist Marilda Sotomayor, in whose honor there is a conference next week). Mathematical models are becoming increasingly important as we start to explore really big data sets, since not only do you need mathematical tools to test hypotheses on data, you need models to even suggest what hypotheses you should be testing. Theory and observation work best in combination…

On this last point one of the top economic theorists in the area of the theory of the firm and contract theory, Oliver Hart, has noted (and this would be my answer to Matt Nolan's recent Discussion Tuesday question),

Although theory may not be as prominent as it once was, it remains essential for understanding the (increasingly) complex world we live in. One cannot analyze the bewildering amount of data now available without the organizing framework that theory provides. I would also suggest that one cannot understand the extraordinary events that we have recently witnessed, such as the financial crisis, or make sensible policy recommendations in response to these events, without the organizing framework of theory.

So for those who seem to think data can do everything, and we should therefore stop teaching theory, I don't think so. Empirical work is only as good as the theory underlying it. So, no, running a million regressions and picking the one that confirms your prejudices isn't how you do good economics.

Coase's view of the firm

An obituary of Ronald Coase appeared in the first issue of the new journal he helped set up, Man and the Economy. The piece is by Ning Wang, Coase's co-author of his last book "How China Became Capitalist". At one point Wang discusses Coase's 1937 paper "The Nature of the Firm". He notes that Coase asked a very simple question, if everything in a market economy is coordinated by the price mechanism, as claimed in standard economics textbooks, "Why does a firm emerge at all in a specialized exchange economy?" The answer we now know as transaction costs.

The answer was not that the firm performed some magic that the market could not. Rather, Coase found that using the market itself was not free. The costs of using the pricing mechanism, which have become known as transaction costs, give rise to the firm.

and

For his [Coase's] purpose, the discovery of transaction costs in the working of the market economy was sufficient as a novel explanation of the firm. For Coase, transaction costs were more an empirical finding than an analytical invention. Their nature and magnitude could only be unveiled through a cumulative interplay of empirical investigations and theoretical refinement. Attempts to elaborate the concept on purely analytical ground, without systematic empirical studies, would not bring much clarity.

A question that Coase's answer gave rise to is, what is the relationship between the market and the firm?

Coase’s explanation of the firm has led many to view the firm and the market as substitutes. Observing the ubiquity of firms in a market economy, Coase inferred that there must exist a cost of using the pricing mechanism. Otherwise, coordination among specialized agents could all be done through the market. From a static point of view, the firm and market present two competing mechanisms to organize business transactions, a choice later often referred to as "to make" versus "to buy" in the literature. In the real dynamic world, the firm and the market are the two main types of business organizations that make up the economy. They complement each other as well as substitute each other.

Seeing markets and firms as substitutes often results in economists seeing the creation of firms as an answer to market failure. But, I have often wondered, why is it we see market failure as giving rise to rises rather than "firm failure" giving rise to markets?

The rise of the firm in a market economy does not imply "market failure" or the triumph of "selective intervention" on the part of the firm. Selective intervention would require the firm (or its manager) to know ex ante its advantages relative to the market and to act accordingly. This information requirement is far too demanding to be met in reality even if the firm has the correct incentives to collect and act on the relevant information. Coase urged us to come to terms with the fact that no economic institution is perfect.

The impossibility of firms having the needed information for selective intervention has a Hayekian feel to it. Perhaps not too surprising given that Hayek as at the LSE during Coase's time there.

Also in the same issue of Man and the Economy is a two part interview between Wang and Coase. Part 1 having taken place on December 28 and 29, 2010 and Part 2 on May 4 and 5, 2013. Part 2 of the interview contains the following exchange:

Wang: Microeconomics is about demand and supply. Compared with classical economics, marginal analysis clearly offers a deeper understanding of consumer choice. But I don’t think it is equally powerful in explicating production, the supply side of the economy.

Coase: To understand production, we have to go back to Adam Smith’s division of labor. It serves well as a starting point, even though the modern economy today has become far more complicated.

Wang: This must be Smith’s most undeserving failure. Modern economics is built on Smith’s framework of the “invisible hand”. But it leaves no room for the division of labor.

Coase: Modern economics shows little interest in production. I am not sure production function tells us anything about production in the economy.

Wang: Adam Smith used the pin factory as an example to develop his analysis of the division of labor. Today, to investigate the division of labor, we can no longer afford to confine our focus to a single firm. Instead, we have to study the organizational structure of production.

Coase: That’s right. The firm remains the cell of the economy, but the intricate relations and constant interactions among the cells determine economic dynamism.

Coase and Wang (2011) also emphasises the importance of the division of labour,

Price theory is primarily concerned with resource allocation, with little to say about production and innovation. The study of the industrial structure of production offers a research program to bring the division of labor back to the center of economics, with direct implications for the study of innovation and entrepreneurship.

Interesting that even as late as 2013 Coase thought that standard economics still took little interest in the production side of the economy. Per Bylund made the same point a couple of years earlier,

[t]he theory of the firm has been a neglected area of study in mainstream economics. Despite Ronald Coase bringing the issue up for discussion in 1937, it was not on the research agenda until the 1970s. Even now, as both Coase and Oliver Williamson, the founder of and prominent scholar in the transaction cost-focusing analysis of firm organization, have received the Nobel Prize in economics, the area remains in the periphery of economic analysis (Bylund 2011: 189).

But the more interesting point is the emphasis Coase puts on the division of labour as the starting point of an analysis of production. The division of labour is often thought to be something Coase assumed to be of little importance to the theory of the firm. Clearly not.

Refs.:

• Bylund, Per (2011). `Division of Labor and the Firm: An Austrian Attempt at Explaining the Firm in the Market', Quarterly Journal of Austrian Economics, 14(2): 188-215.
• Coase, Ronald H. and Wang, Ning (2011) 'The Industrial Structure of Production: A Research Agenda for Innovation in an Entrepreneurial Economy', Entrepreneurship Research Journal, 1(2): Article 1.

Two interesting looking recent working papers

First a paper on Thomas Piketty's recent book:

The Rise and Fall of General Laws of Capitalism
Daron Acemogluy James A. Robinsonz

Abstract
Thomas Piketty's recent book, Capital in the Twenty First Century, follows in the tradition of the great classical economists, Malthus, Ricardo and Marx, in formulating "general laws" to diagnose and predict the dynamics of inequality. We argue that all of these general laws are unhelpful as a guide to understand the past or predict the future, because they ignore the central role of political and economic institutions in shaping the evolution of technology and the distribution of resources in a society. Using the economic and political histories of South Africa and Sweden, we illustrate not only that the focus on the share of top incomes gives a misleading characterization of the key determinants of societal inequality, but also that inequality dynamics are closely linked to institutional factors and their endogenous evolution, much more than the forces emphasized in Piketty's book, such as the gap between the interest rate and the growth rate.

and then one on free banking and economic growth in Quebec:

Free Banking and Economic Growth in Lower Canada, 1817–1851
Mathieu Bedard and Vincent Geloso

Abstract
Generally, the historical literature presents the period from 1817 to 1851 in Lower Canada (modern day Quebec) as one of negative economic growth. This period also coincides with the rise of free banking in the colony. In this paper we propose to study the effects of free banking on economic growth using theoretical and empirical validations to study the issue of whether or not economic growth was negative. First of all, using monetary identities, we propose that given the increase in the stock of money and the reduction in the general price level, there must have been a positive rate of economic growth during the period. We also provide complementary evidence drawn from wages that living standards were increasing. It was hence impossible for growth to have been negative. Secondly, we propose that the rise of privately issued paper money under free banking in the colony had the effect of mitigating the problem of the abundance of poor quality coins in circulation which resulted from legal tender legislation. It also had the effect of facilitating credit networks and exchange. We link this conclusion to the emergence of free banking which must have been an important contributing factor. Although we cannot perfectly quantity the effect of free banking on economic growth in Lower Canada, we can be certain that its effect on growth was clearly positive.

Books on the firm

When thinking about the history of the theory of the firm, as we all do early on a Sunday morning, I've been thinking about which books are really important to the subject and thus are actually worth reading. Many of the major contributions to the theory of the firm have come in the form of journal articles. Economists are not big on writing books.

But what books are worth reading to get an understanding of the contemporary (post-1970) mainstream theory of the firm? Well here's my list.

Two books which contain the classics on which most of the contemporary theories are based are:

1. Knight, Frank H. (1921). Risk, Uncertainty and Profit, Boston: Houghton Mifflin Company. This is a book that is getting an increasing amount of attention. Albeit very late in the piece
2. Oliver E. Williamson and Sidney G. Winter (eds.) (1993). The Nature of the Firm: Origins, Evolution, and Development, New York, Oxford: Oxford University Press. This includes a reprint of Coase's 1937 classic "The Nature of the Firm". It also includes reprints of Coase's three essays on the Origin, Meaning and Influence of his 1937 paper as well as his Noble Lecture: "The Institutional Structure of Production".

When it comes to the important books that the classics gave rise to, there are a few. An obvious place to start is with three books by Oliver Williamson. These develop the transaction cost approach to the firm:

1. Williamson, Oliver E. (1975). Markets and Hierarchies: Analysis and Antitrust Implications, New York: The Free Press.
2. Williamson, Oliver E. (1985). The Economic Institutions of Capitalism, New York: The Free Press.
3. Williamson, Oliver E. (1996). The Mechanisms of Governance, Oxford: Oxford University Press.

To cover the property rights approach to the firm there is:

1. Hart, Oliver D. (1995). Firms, Contracts, and Financial Structure, Oxford: Oxford University Press.

As to the reasons for, and the shortcomings of, different forms of ownership of firms see Henry Hansmann's book:

1. Hansmann, Henry (1996). The Ownership of Enterprise, Cambridge, Mass.: Harvard University Press.

A number of interesting essays appear in this book by Harold Demsetz:

1. Demsetz, Harold (1995). The Economics of the Business Firm: Seven Critical Commentaries, Cambridge: Cambridge University Press.

Two recent books that may have influence in the future due to their integration of the theory of the entrepreneur with the theory of the firm are:

1. Spulber, Daniel F. (2009). The Theory of the Firm: Microeconomics with Endogenous Entrepreneurs, Firms, Markets, and Organizations, Cambridge: Cambridge University Press.
2. Foss, Nicolai J. and Peter G. Klein (2012). Organizing Entrepreneurial Judgment: A New Approach to the Firm, Cambridge: Cambridge University Press.

I'm sure there are a few others I have missed.

Payday lending

Payday lending is controversial all around the world including New Zealand. But the quality of debate on the issue often isn't that high. At the Bleeding Heart Libertarians blog philosopher Matt Zwolinski improves things by noting 5 Points about the Morality of Payday Lending:

Here are five of the most important points I’ve found to bear in mind when thinking about the morality of payday loans.

1. If payday lending is so profitable, why isn’t everybody doing it? This is a good question to ask yourself anytime you hear a story about some company earning unusually high profits off the back of a vulnerable population. If investors could earn a 200% rate of return by investing in new payday lending operations, why are smart investors wasting their time and money with anything else? Perhaps there’s something more to the picture that we’re not seeing?
2. Payday lending is not that profitable. Well, we don’t have to guess. People have studied this. And according to one study, the average profit earned by payday lenders was just 7.63%. By way of comparison, the same study reports that the average Starbucks franchise earns about 9% profit. So, if that 400% APR isn’t translating into sky-high profits for payday lenders, where exactly is it going?
3. Payday loans are short term loans. An Uber ride from downtown San Diego to La Jolla costs about $25. I think that’s a pretty reasonable price. But suppose I told you that the rate Uber charges to drive you 12.5 miles in San Diego would translate into a $6,000 trip from San Diego to Boston! Outrageous! Exploitative! Except, nobody uses Uber that way. And almost nobody uses payday lenders to take out loans that are appropriately characterized by an annual percentage rate. Payday loans are short term loans. They’re like an Uber ride to your local pub. Thinking about their fees in the same terms you’d use to think about the 30 year mortgage on your home gives us a very misleading picture of how much revenue payday lenders are bringing in.
4. Being a payday lender is expensive. So payday lenders aren’t earning as much as we think. But they’re also spending a lot more than we think. Payday lenders, unlike banks, keep long hours. That costs money. They also have a relatively high store density. That costs money, too. Finally, think about this. Payday lenders are lending to people who have a hard time getting credit elsewhere. Why do they have a hard time getting credit elsewhere? Because they have very bad credit. What does that mean for payday lenders? It means that sizeable portion of the loans they extend are going to default. And that costs money.
5. Bans on “usury” only make things worse. So, at the end of the day, payday lenders charge a high rate to their customers because that’s what it takes to cover their costs. That means if we try to artificially lower their rates by legal bans on “usury,” we’re going to make it impossible for them to cover their costs. And when businesses can’t cover their costs, they shut down. Question: who does that help? The who were forced by poverty and desperate circumstances to utilize the services of payday lenders are still poor, and still desperate. All you’ve done is taken away from them the least bad option they had. It’s a good thing to be concerned with the plight of the poor. It’s a good thing to want to do something to help. But it’s important to make sure that the thing you’re doing actually helps, rather than hurts.

Are foreign takeovers getting domestic cherries or lemons?

The concerns of economic nationalists - read NZ First, the Conservatives, Labour etc in the case of New Zealand - about foreign takeovers of assets, including land, are rooted in the idea that foreign enterprises extract the most valuable assets from top performing domestic firms. This argument puts to one-side for now the ever present xenophobia which underlies much of the anti-foreign investment rhetoric in New Zealand. Practical concerns about economic efficiency of cross-border mergers and acquisitions markets hinge on whether takeovers transfer underperforming domestic economic resources toward more productive uses at foreign enterprises. How then to reconcile these concerns when forming policies about cross-border activity? Well in a new column at VoxEU.org Farid Toubal , Bruce Blonigen, Lionel Fontagné and Nicholas Sly argue it’s all in the timing.

One of the big questions about foreign investment is are the foreign firms picking cherries or choosing lemons?

For many years the evidence about targets of foreign acquisitions has been mixed. Some theories and data suggest that ‘lemons’ – domestic firms with relatively weak performance – are the most likely targets of foreign acquisition. Yet more recent empirical studies have pointed to ‘cherries’ as the most likely targets for takeover by foreign firms. The disagreement about which type of domestic firms – cherries or lemons – are pursued by foreign enterprises made it difficult to answer policy makers’ question about which of their assets, economic networks, and production possibilities were suddenly in the hands of foreign ownership.

The doubt over which types of firms were being acquired also raises concerns about the efficiency of international merger and acquisition (M&A) markets. Ideally, market transactions should transfer resources toward their most efficient use. The same holds for M&A markets, which should transfer the assets of lesser performing firms to enterprises that can make better use of them. If domestic firms are high performing cherries, it is not evident that a transfer of ownership of their resources to a foreign enterprise is optimal; being a cherry implies that a domestic firm is already using its resources effectively. Poor performing lemons might seem to fit the bill. Yet the question remains open as to why a foreign enterprise would choose to enter a market using resources that even a domestic firm – which had more familiarity with resident consumers, regulations, and distribution networks – could not use profitably.

Blonigen, Fontagne, Sly, and Toubal argue its all in the timing.

In Blonigen, Fontagne, Sly, and Toubal (2014), we show that the conundrum over whether domestic cherries or lemons are targets of acquisition can be resolved by considering not only the types of assets that foreign acquirers seek, but also the timing of takeovers. Indeed, foreign firms seek domestic targets that are historically high performing. In fact, when we look at foreign acquisitions that occur in the French manufacturing sector over the last decade, we find that even the least productive domestic target outperforms the typical firm in its sector in the years prior to acquisition. See Figure 1 below, which takes advantage of detailed administrative data from France to illustrate systematic changes in firm characteristics as they transition from domestic to multinational status. We plot total factor productivity (TFP) for all manufacturing firms that are acquired by foreign owners between 1999 and 2006 relative to sector and year averages, from three years prior to the acquisition to four years after the firm is acquired. The middle line shows the relative detrended TFP for the average French firm acquired by a foreign owner, whereas the lines above and below show the relative detrended TFP for the 95th and 5th percentiles, respectively. In the years prior to acquisition, domestic targets of foreign acquisition do appear to be ‘cherries.’ They have all a TFP that is above industry-year average.

Figure 1.

Yet despite the high performance of target firms observed several years prior to acquisition, Figure 1 shows that, prior to acquisition, targets realize significant productivity losses relative to other firms in their sector. The losses in productivity are so severe that by the time they are acquired, targets of foreign acquisition no longer appear to be cherries; on average they are indistinguishable from the typical firm from their sector. Put differently, in the years leading up to acquisition domestic targets are underperforming relative other firms in their industry. In these years, targets do look like ‘lemons.’

Rather than targets of foreign acquisition being characterized purely as top performers or underperformers in the market place, foreign enterprises seek out domestic firms that were previously the stars of their industries but then suffered a recent series of negative shocks. Hence, the targets of foreign takeovers are ‘Cherries for Sale.’

This timing of cross-border acquisition activity is quite intuitive. Foreign enterprises seek out targets that have the best and most valuable assets. And not surprisingly, it is the most productive target firms that had the largest incentives to invest in developing such assets. However, foreign enterprises can only offer viable takeover bids once the domestic firm has suffered a turn in fate, and is underutilizing it valuable assets. In this case it is better for the domestic firm to sell its assets to a foreign acquirer that can make better use of them.

So what is the upshot of all of this?

This timing of takeover activity implies that policy makers should have fewer concerns about relinquishing national ownership of its domestic enterprises, as the ‘Cherries for Sale’ are no longer the best and most valuable economic agents within their economic sectors. The observed timing of takeover activity also suggests the efficiency of cross-border M&A markets. Cross-border acquisitions appear to transfer productive assets, technologies, and distribution networks toward enterprises that can make better use of these valuable resources.

So foreign ownership may be good for you after all. The assets being bought by the foreign companies are those not preforming well under their current owners and the foreign owners can make better use of those assets. This is a gain for the local economy.

Ref.:

• Blonigen, B A, L Fontagne, N Sly, and F Toubal, “Cherries for Sale: The Incidence and Timing of Cross-Border M&A”, Journal of International Economics, 2014, forthcoming.

Is the division of labour a form of enslavement?

Or so asks Timothy Taylor at the Conversable Economist blog. Taylor writes,

The idea that an economy functions through a division of labor, in which we each focus and specialize in certain tasks and then participate in a market to obtain the goods and services we want to consume, is fundamental to economic analysis. Indeed, the very first chapter of Adam Smith's 1776 classic The Wealth of Nations is titled "Of the Division of Labor," and offers the famous example of how dividing up the tasks involved in making a pin is what makes a pin factory so much more productive than an individual who is making pins.

While Smith opens "An Inquiry into the Nature and Causes of The Wealth of Nations" with a discussion of the division of labour at the microeconomic (pin factory) level he quickly moves the analysis to the market level. When discussing Smith’s approach to the division of labour McNulty (1984: 237-8) comments,

“[h]aving conceptualized division of labor in terms of the organization of work within the enterprise, however, Smith subsequently failed to develop or even to pursue systematically that line of analysis. His ideas on the division of labor could, for example, have led him toward an analysis of task assignment, management, or organization. Such an intra-firm approach would have foreshadowed the much later−indeed, quite recent−efforts in this direction by Herbert Simon, Oliver Williamson, Harvey Leibenstein, and others, a body of work which Leibenstein calls “micromicroeconomics”. [ ...] But, instead, Smith quickly turned his attention away from the internal organization of the enterprise, and outward toward the market and the realm of exchange, perhaps because he found therein both the source of division of labor, in the “propensity in human nature ...to truck, barter and exchange” and its effective limits”.

Taylor then moves on to point out that Karl Marx saw a downside to the division of labour.

But what if the division of labor, with its emphasis on focusing on a particular narrow job, runs fundamentally counter to something in the human spirit? Karl Marx raised this possibility in The German Ideology (1846 Section 1, "Idealism and Materialism," subsection on "Private Property and Communism"). Marx wrote:

“Further, the division of labor implies the contradiction between the interest of the separate individual or the individual family and the communal interest of all individuals who have intercourse with one another. … The division of labor offers us the first example of how, as long as man remains in natural society, that is, as long as a cleavage exists between the particular and the common interest, as long, therefore, as activity is not voluntarily, but naturally, divided, man's own deed becomes an alien power opposed to him, which enslaves him instead of being controlled by him. For as soon as the distribution of labor comes into being, each man has a particular, exclusive sphere of activity, which is forced upon him and from which he cannot escape. He is a hunter, a fisherman, a shepherd, or a critical critic, and must remain so if he does not want to lose his means of livelihood; while in communist society, where nobody has one exclusive sphere of activity but each can become accomplished in any branch he wishes, society regulates the general production and thus makes it possible for me to do one thing today and another tomorrow, to hunt in the morning, fish in the afternoon, rear cattle in the evening, criticism after dinner, just as I have a mind, without ever becoming hunter fisherman, shepherd or critic. This fixation of social activity, this consolidation of what we ourselves produce into an objective power above us, growing out of our control, thwarting our expectations, bringing to naught our calculations, is one of the chief factors in historical development up till now.

But Marx was not alone in seeing a bad side to the division of labour. Smith himself wrote,

In the progress of the division of labour, the employment of the far greater part of those who live by labour, that is, of the great body of the people, comes to be confined to a few very simple operations, frequently to one or two. But the understandings of the greater part of men are necessarily formed by their ordinary employments. The man whose whole life is spent in performing a few simple operations, of which the effects are perhaps always the same, or very nearly the same, has no occasion to exert his understanding or to exercise his invention in finding out expedients for removing difficulties which never occur. He naturally loses, therefore, the habit of such exertion, and generally becomes as stupid and ignorant as it is possible for a human creature to become. The torpor of his mind renders him not only incapable of relishing or bearing a part in any rational conversation, but of conceiving any generous, noble, or tender sentiment, and consequently of forming any just judgment concerning many even of the ordinary duties of private life. Of the great and extensive interests of his country he is altogether incapable of judging, and unless very particular pains have been taken to render him otherwise, he is equally incapable of defending his country in war. The uniformity of his stationary life naturally corrupts the courage of his mind, and makes him regard with abhorrence the irregular, uncertain, and adventurous life of a soldier. It corrupts even the activity of his body, and renders him incapable of exerting his strength with vigour and perseverance in any other employment than that to which he has been bred. His dexterity at his own particular trade seems, in this manner, to be acquired at the expence of his intellectual, social, and martial virtues. But in every improved and civilized society this is the state into which the labouring poor, that is, the great body of the people, must necessarily fall, unless government takes some pains to prevent it.

So, like all of economics we see here that there is a trade-off involved with the division of labour. In this case it is between the effects of the division of labour on the worker who can become trapped in the grip of the mind numbing tedium of specialisation versus the real income increasing effects of the division of labour.

And even if we accept that the division of labour can create problems, a world without it - ie a world with total self-sufficiency - would create its own set of problems, which I would argue would be worse. So being a "slave" to specialisation is better than being a "slave" to self-sufficiency.

Ref.:

• McNulty, Paul J. (1984). ‘On the Nature and Theory of Economic Organization: the Role of the Firm Reconsidered’, History of Political Economy, 16(2) Summer: 233-53.

Interesting blog bits

1. Timothy Taylor on Characteristics of U.S. Minimum Wage Workers
   

   Set aside for a few heartbeats the vexed question of just how a minimum wage would affect employment, and focus on a more basic set of facts: What are some characteristics of U.S. workers who receive the minimum wage? The statistics here are from a short March 2014 report from the U.S. Bureau of Labor Statistics, "Characteristics of Minimum Wage Workers, 2013." Of course, the facts about who is receiving the minimum wage also reveal who will be most directly affected by any changes.

2. Chris Dillow on Economists and the Public
   

   In a comment here, I propose the creation of a new job, or jobs - professors for the public understanding of economics, analogous to the professorships at Bristol and Oxford which do the same for science.

3. Ben Jones asks Should Philosophers Avoid Politics?
   

   In a recent blog post and article, Bas van der Vossen makes a straightforward argument for why political philosophers should stay out of politics: (1) professionals have a prima facie moral duty to make a reasonable effort to avoid activities that predictably make them worse at their tasks (the principle of “responsible professionalism” or RP), (2) the task of political philosophers is to seek the truth about politics, (3) engaging in politics predictably makes us worse at seeking the truth about politics, and (4) therefore political philosophers have a prima facie moral duty to avoid engaging in politics.

4. Kristian Niemietz argues that Brick shortages come and go. Planning restrictions are the real obstacle to house building
   

   An unexpected increase in construction (from an extremely low base) has left building materials, especially bricks, in short supply, leading to a sudden surge in prices. Anti-development activists are having a field day, because this turn of events has provided them with a convenient excuse to explain away the negative effects of their obstructionism. A shortage of bricks, not Nimbyism, is causing the housing crisis, or so we are told.

5. Peter Klein on Making Money from Behavioral Social Science?
   

   Longtime readers of this blog expect skepticism about behavioral social science. One of my issues is the assumed, but unexplored, assumption that private actors and market institutions cannot deal with behavioral anomalies, and therefore government intervention is necessary to make people act “rationally.”

6. Tim Worstall argues The NY Times Is Wrong; There Is No Case For High-Speed Rail
   

   I always find it slightly odd that left liberals are so in love with a 19th century technology such as the railroads. They’re most certainly not in favour of 19th century science nor moral attitudes so what is it about rail that so excites them? But other than that mystification they’ve missed a very important point. There simply is no case for high-speed rail in the US.

7. Kaoru Hosono and Daisuke Miyakawa on Natural disasters, firm activity, and damage to banks

   Natural disasters affect firm activities both directly and indirectly. One prominent indirect effect is on firms’ transaction partners, in particular – their banks. This column shows how damage to banks affects firm activities, such as capital investment and exports, using as a natural experiment Japan’s 1995 Kobe earthquake. Bank damage has a significant and negative impact on both firm investment and on exports but this effect does not last very long.

8. Joseph E. Aldy and Seamus J. Smyth on Heterogeneity in the value of life

   Increasing longevity yields large economic benefits. However, public policies do not take into account the heterogeneity in these benefits across the population. This column presents simulated experimental findings about the heterogeneity in the value of statistical life. There is heterogeneity over the life-cycle, as well as prominent ‘black-white’ and ‘female-male’ gaps in the value of life, driven by differences in the labour income across these groups. The findings suggest that one-size-fits-all policies would not correctly reflect the individual willingness to pay to reduce mortality risk.

EconTalk this week

Barry Weingast, professor of political science at Stanford University and senior fellow at Stanford's Hoover Institution, talks with EconTalk host Russ Roberts about the nature of law. Weingast takes issue with some of the standard views of law, and proposes a better way to understand law. The two discuss the fundamental principles of law, how it can emerge in a decentralized way to resolve disputes over property and other commercial and social interactions. Examples include Iceland, Ancient Greece, and California during the gold rush. Also considered are how laws coordinate expectations and the way that social pressure can be used to enforce law in a decentralized fashion.

A direct link to the audio is available here.

The damage done by subsidies

From the Economist magazine comes this piece on China'a subsidies to ship building. In 2006 China enacted a “Long and Medium-Term Plan” [read subsidies to shipyards] to enlarge its shipping industry by 2015.

Yet economists’ views on subsidies have hardened over time. China’s policy provides subsidies both for the construction of ships themselves and for the building or expansion of shipyards. These interferences can distort trade, resulting in inefficient production. In deciding whether a subsidy flouts trade rules the World Trade Organisation (WTO) uses a “price gap” approach. The idea is simple: if a country is producing and selling something at a big discount to what others are charging, there is probably something fishy going on.

Price gaps provide a quick warning system, but are a poor way to judge the full extent of subsidies, according to a 2013 book by Usha and George Haley, of West Virginia University and the University of New Haven. It is a static approach, ignoring how demand for each shipyard’s differentiated products varies over time. It also fails to account for variations in efficiency. Whereas Chinese workers may be relatively cheap, large South Korean or Japanese shipyards exploit economies of scale that smaller Chinese yards cannot. The balance of all these factors, in addition to subsidies, should influence a shipyard’s costs and prices.

Recognising this, a 2014 working paper by Myrto Kalouptsidi of Princeton University provides a new way to spot subsidies and measure their impact. Using detailed quarterly data on factors like a shipyard’s age, size, capacity and staffing levels Ms Kalouptsidi estimates cost functions—the relationship between a yard’s output and its cost of production—for 192 yards across China, Japan, South Korea and Europe. By analysing data between 2001 and 2012, she can isolate the impact of China’s 2006 policy.

The results are striking. A simple price-gap approach shows that Chinese ships cost 7.3% less than rivals’. Controlling for quality differences—Chinese ships are seen as lower quality and so should be around 3.5% cheaper, even in the absence of subsidies—gives a 4% gap, hardly justification for WTO rage. But Ms Kalouptsidi’s estimates show this is just part of the story. Government help artificially lowered Chinese firms’ costs by between 15-20%. The aid will have included explicit subsidies and hidden benefits, such as tolerating losses at state-owned yards. China’s market share jumped as the policy was introduced.

As in [Adam] Smith’s day, this has shifted resources. By comparing the costs and productivity of the shipyards in her sample, Ms Kalouptsidi forecasts how the market might have developed in the absence of China’s subsidies. Her analysis points to a big resource reallocation: absent the meddling, Japan’s market share would have been around 30 percentage points higher. Since many South Korean or Japanese yards are more efficient than China’s, it means that the true cost of ship production may well have risen. Bloated by subsidy, China’s yards have turned out a surfeit of vessels, often poorly matched to customers’ demands.

The important point here is that many of the distortions introduced by government meddling are hard to find but dangerous and expensive nonetheless.

Guns, suicide, crime

It would seem obvious that if you have fewer guns in people's hands you would get fewer suicides and less crime. But is life that simple? After reading a couple of article by Mark Gius, Professor of Economics at Quinnipiac University, Hamden, Connecticut, USA, I'm beginning to think not. In a recent article in "Significance: statistics making sense", a magazine from The Royal Statistical Society, Gius writes, with regard to gun-related murder rates in the US,

In one of the more recent studies [Gius (2014)], I attempted to determine if assault weapons bans and concealed carry laws had any effects on gun-related murder rates. I decided to focus on these two types of laws because they have changed the most over the past thirty years. I used data for the period 1980–2009, which is one of the longest time periods examined in any research on assault weapons bans or CCW laws. Using the gun-related murder rate as the dependent variable was important because most other studies looked at violent crime rates or homicide rates. Violent crime rate data is not disaggregated into gun-related and non-gun-related violent crime, and homicides include justifiable killings and state-sanctioned killings; hence, an analysis using these types of crime rates may result in spurious conclusions. After analysing the data, I found that states that had more restrictive CCW laws had higher murder rates than states with more permissive CCW laws and that assault weapons bans had no significant effects on murder rates at the state level.

The lack of an affect on the part of state level assault weapons bans was not unexpected: as mentioned previously, very few murders are committed using assault weapons. The higher murder rates during the federal assault weapons ban probably reflected the inadequacy of the federal law and the overall higher crimes rates of that period due to the crack epidemic of the late 1980s and early 1990s.

The concealed carry results, however, were somewhat unexpected. States with more restrictive CCW laws had gun-related murder rates that were 10% higher (p < 0.01). At first sight this would seem to support the deterrent effect hypothesis of many gun rights proponents. There may, of course, be other explanations for these results. Laws may be ineffective due to loopholes and exemptions. The most violent states may also have the toughest gun control measures. Nonetheless, the results of my study do suggest that the potential deterrent effect of concealed weapons should not be ignored.

In another paper, Gius (2011), Gius has also looked at the relationship between gun ownership and suicides. Using recent data on suicide rates, gun control measures, and gun ownership rates, Gius's study suggests that states that require handgun permits have lower gun-related suicide rates, and states that have higher gun ownership rates have higher gun-related suicide rates. Which is what you may expect. Regarding non-gun suicides, results suggest that stricter gun control laws may result in higher non-firearm suicides, and higher rates of gun ownership result in lower non-gun suicide rates. These results suggest that stricter gun control laws may actually induce potential suicide victims to alter the method by which they commit suicide. That is, there is substitution effect. Hence, the overall effects of firearm availability on suicides may be muted due to the fact that while reduced firearm availability reduces firearm suicides, it also increases non-firearm suicides.

Ref.:

• Gius, M. (2014) "An examination of the effects of concealed weapons laws and assault weapons bans on state-level murder rates". Applied Economics Letters, 21(4), 265–267.
• Gius, M. (2011) "The Effects of Gun Ownership Rates and Gun Control Laws on Suicide Rates". New York Economic Review, vol. 42, Fall