Mandating extra employee benefits comes at a cost

May be not immediately but over time they do. Tyler Cowen makes the point in an article at Bloomberg.

Most likely, there is a big difference between short-run and long-run effects. For instance, employers value the workers they have, and are reluctant to fire them when labor costs go up. A lot of “pro-worker” policies thus seem to be a kind of magical free lunch. Over time, however, as a generation of workers turns over and is replaced, mandatory benefits represent a real added cost, evaluated anew, and employers will respond accordingly. They will cut the paid dollar wage, cut other job benefits, require more hard work, automate more, or cut back on plans for growing the business. The downward-sloping demand curve is the best established empirical regularity in all of economics, and in this context that means some laborers -- maybe most laborers -- will pay a price for their new benefits, one way or another.

My 5 open questions in economics

Recently Tyler Cowen asked Adam Ozimek about the five biggest open questions are in the current economic debate.

@ModeledBehavior ...the five biggest open questions for you in current economic debate...

— tylercowen (@tylercowen) August 13, 2016

Ozimek's answer is here.

This got me thinking about what are my 5 biggest questions in current economics. Of course all such answers are idiosyncratic in that we all have our own interests and research areas in economics, but here are my 5 questions, which unsurprisingly have to do with the theory of the firm. Actually 3 of them are old questions.

1) why do firms exist?
2) what determines the boundaries of firms?
3) what determines the internal organisation of firms?

These are, of course, the 3 questions asked by Ronald Coase back in 1937 but I list them here because we still don't have really good answers to them. As Oliver Hart wrote back in 1989,

"An outsider to the field of economics would probably take it for granted that economists have a highly developed theory of the firm. After all, firms are the engines of growth of modern capitalistic economies, and so economists must surely have fairly sophisticated views of how they behave. In fact, little could be further from the truth. Most formal models of the firm are extremely rudimentary, capable only of portraying hypothetical firms that bear little relation to the complex organizations we see in the world. Furthermore, theories that attempt to incorporate real world features of corporations, partnerships and the like often lack precision and rigor, and have therefore failed, by and large, to be accepted by the theoretical mainstream.”

And while progress has been made since 1989 we still don't have a completely satisfactory theory of the firm.

But today we can add at least 2 more question to those above.

4) how and why are firms formed? This is a question about the role of the entrepreneur in the development of the firm and thus offers the opportunity for the theory of the firm to be integrated with the theory of the entrepreneur.
5) what role do firms play in the formation of markets? Market formation is another under appreciated area in economics but having a better understanding of firms will help us better understand the process of market creation.

Oil booms leave the poor in the dark

In a new column at VoxEU.org Brock Smith, Thomas McGregor and Samuel Wills make a simple but important point about poverty. That is, one of the biggest challenges in fighting poverty is to know where it is. What the authors offer in this column is a new way to measure poverty by using satellites to count people who live in darkness at night. This shows that the economic benefits of oil booms don’t trickle down to the very poor.

They argue,

Darkness lets us study whether oil booms reduce poverty and inequality.

Total lights in oil-rich countries tend to increase during oil booms. In the period 2002-2013, when the price of Brent crude rose from $20 to over $110 per barrel, illumination and GDP per capita in oil-rich countries grew by nearly one third relative to countries without oil. On average, countries that make a giant oil discovery with a net present value worth 100% of GDP see total lighting increase by almost one fifth, and GDP by 8% after ten years, compared to countries that don’t make discoveries.

But

These booms do not benefit the rural poor. All the extra light during the 2000s oil price boom came from cities and towns, in which illumination grew by 15% and 38%, respectively. The share of people living in darkness stayed the same. New lights did not turn on, and the poor did not move for better opportunities elsewhere. Giant oil discoveries show the same effect. In these cases lighting in towns and cities grew by 15% and 22% respectively after 10 years, but did not cause any lights to be switched on in rural areas. There is some evidence, though, that oil discoveries prompted around 1% of the rural poor to move to towns.

I do wonder if support for governments in many oil rich countries is concentrated in towns and cities and thus those governments focus the benefits of oil on their supporters in towns and cities.

A letter to incoming students at the University of Chicago

"Once here you will discover that one of the University of Chicago’s defining characteristics is our commitment to freedom of inquiry and expression. … Members of our community are encouraged to speak, write, listen, challenge, and learn, without fear of censorship. Civility and mutual respect are vital to all of us, and freedom of expression does not mean the freedom to harass or threaten others. You will find that we expect members of our community to be engaged in rigorous debate, discussion, and even disagreement. At times this may challenge you and even cause discomfort."

and

"Our commitment to academic freedom means that we do not support so called ‘trigger warnings,’ we do not cancel invited speakers because their topics might prove controversial, and we do not condone the creation of intellectual ‘safe spaces’ where individuals can retreat from ideas and perspectives at odds with their own."

The gains from trade go mainly to ....

the poor. This is the conclusion of a new paper in the Quarterly Journal of Economics (Volume 131 Issue 3 August 2016). The basic reason for this being that the poor tend to concentrate their spending on good and services from the traded sectors of the economy.

The abstract of the paper, Measuring the Unequal Gains from Trade by Pablo D. Fajgelbaum and Amit K. Khandelwal, 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. The approach requires data on aggregate expenditures and parameters estimated from a nonhomothetic gravity equation. We find that trade typically favors the poor, who concentrate spending in more traded sectors.

So another reason for being pro international trade.

Are markets efficient?

In this audio from the Chicago Booth Review Eugene Fama and Richard Thaler discuss this question. A fun and interesting discussion on issues like market efficiency, bubbles and behavioural economics.

Some non-shocking statistics on gender pay from the IFS

At the IEA blog Ryan Bourne writes,

‘On average, women in paid work receive about 18% less per hour than men’. So reads the opening line of an Institute for Fiscal Studies–Joseph Rowntree Foundation press release for a new briefing note today.

Here we go again. It’s a shame that another two high-profile organisations are propagating this. As we argued in last week’s ‘How much do you earn?’ paper, these aggregate statistics are largely meaningless and designed to create a sense of unfairness. Are these workers full time or part time? In the public or private sector? How many years’ experience? The education level of the workers? What type of roles? What is the age profile of the workers? And what about all those compensating differentials which we know are important?

This is not merely theoretical, because using these stats as a catalyst to force pay to be equal for work which the market rates unequally produces damaging distortions in the economy.

But taken with all these caveats, the IFS report helpfully provides us with some facts which are pretty intuitive:
1) The gender wage gap per hour is falling (down from 28 per cent to 18 per cent between 1993 and 2015), which we’d expect given educational and societal trends. Though it must be said, this is not based on the ONS’s preferred definition of the pay gap, or their preferred data source.
2) The wage gap between young men and women, where you’d expect societal and educational trends to bite most, is just 6 per cent (before you even control for any of the points above).
3) The wage gap prior to having children is much lower at 10 per cent than the overall average wage gap, suggesting that having children is a big contributory factor.
4) Indeed, following the arrival of the first child, the wage gap steadily increases, on average, to 33 per cent after 12 years.
5) Why is this? A big clue is that 20 years after the birth of their first child, women have on average been in paid work for four years less than men and have spent nine years less in paid work of more than 20 hours per week.

A lot of research now tell us that points 4 and 5 are some of the most important reasons for the male/female wage gap.

In a paper, "A grand gender convergence: its last chapter" by Claudia Goldin in the American Economic Review (104(4): 1091-1119),  it is argued that reducing the gender gap in pay requires greater temporal flexibility, to help counter points 4 and 5, in the labour market. Being able to work long hours and work particular, antisocial hours is limited by childcare responsibilities. This effects women more than men and thus changes to the structure of labour markets with regard to hours worked and remuneration will advantage women to a greater degree than men.

The abstract of the paper reads,

The converging roles of men and women are among the grandest advances in society and the economy in the last century. These aspects of the grand gender convergence are figurative chapters in a history of gender roles. But what must the "last" chapter contain for there to be equality in the labor market? The answer may come as a surprise. The solution does not (necessarily) have to involve government intervention and it need not make men more responsible in the home (although that wouldn't hurt). But it must involve changes in the labor market, especially how jobs are structured and remunerated to enhance temporal flexibility. The gender gap in pay would be considerably reduced and might vanish altogether if firms did not have an incentive to disproportionately reward individuals who labored long hours and worked particular hours. Such change has taken off in various sectors, such as technology, science, and health, but is less apparent in the corporate, financial, and legal worlds.

But presumably firms reward individuals who labour long hours and work particular hours because it is profit maximising for them to do so and thus this may be a feature of the particular industries in which it occurs. If so this could be a difficult thing to change, it would take either a change in the cost structure of the industry, what would bring about such a change?, or a change on the demand side, that is, customers would have to start demanding a different set of goods or services. Why would they do so?

Errata section added

Sadly the webpage for my favourite theory of the firm book has had to have a section on errata added to it.

Yes I've already come across errors in the book, some due to the publisher but also some, more embarrassingly, due to me! I guess I should have checked things more thoroughly. There are three things you must do when writing a book; proofread, proofread, proofread.

Matt Ridley on the fate of economic libertarianism

Matt Ridley sums up the current state of economic liberalism in just a few words:

It is the same around the world. Economic liberty is out of fashion. There is almost no country trying the sort of free-market reforms – tax cuts, deregulation, privatisation – that so many countries achieved in the 1980s and 1990s. China and Russia, liberalised briefly in the late twentieth century, seem to be heading back to Big Brother. Brazil has seen its market reforms congeal into crony-corporatism. India and Japan are hardly paragons of small-government economic liberalism. Even here in Britain, I doubt Theresa May took Hayek’s “Road to Serfdom” to Switzerland as holiday reading.

Sad but true, just think of the case of New Zealand. The days of Rogernomics are long gone if this current government (or opposition) is anything to go by. I don't see the likes John Key, Gerry Brownlee or Andrew Little sitting up in bed reading The Wealth of Nations or The Constitution of Liberty.

But why is liberalism out of favour?

Unlike welfare-socialism and crony-capitalism, it fails to create vested interests dependent on its subsidies. The whole point of running for president [or Prime Minister] is to be able to hand other people’s money to your favourite causes and generate grateful patronage. Laissez-faire robs you of that treat.

Anything that stops politicians from bribing some of the people with some other people's money will not go down well with either the politicians or those who, gratefully, receive the largess.

It does exist!

A specimen of the once thought only mythical beast has been spotted in the wild, well on my desk anyway,

The only known example of this rare creature outside of captivity in the UK was sighted this afternoon. And unlike the Loch Ness Monster this picture is real!

The Big Mac index 2016

From the Economist magazine comes the 2016 Big Mac Index:

While it is not shown in the graphic above if you look at the more detailed version of the raw index you find that the New Zealand dollar is undervalued by 16.2% when compared to the US dollar but is overvalued by 7.1% when compared to Sterling. Adjust for GDP per person and the New Zealand dollar is undervalued by 1.1% when the base currency is the US dollar compared to being overvalued by 14.1% when the base currency is Sterling.

Boudreaux on robots

At Cafe Hayek Don Boudreaux makes a good point about the effects of robots on employment:

Robots not only do not threaten to increase long-term unemployment, they make our lives easier and more prosperous – and they’ve done so for eons. Witness the wheel, the lever, the bucket, the shovel, the cart, the harness, the plough, the rope, the spear, the knife, the pulley, the pipe, the pump, the oar, the sail, the printing press – and, of course, the steam engine, the locomotive, the bulldozer, the bus, the jet engine, the kitchen blender, the washing machine, the light switch, the flush toilet, the microprocessor. As Deirdre McCloskey writes in her new volume, Bourgeois Equality, “[t]he repeated alarms against robots are silly, since robots are merely mechanical slaves for our benefit.”

I agree with Boudreaux and McCloskey on this. Changes in technology are nothing new and employment has kept on growing. Why should today be any different? New technology changes the types of jobs there are but it doesn't reduce the number of jobs. And it makes us richer. What's not to like?

The greatest book ever written is now out

I've just received an email telling me that the greatest book ever written, aka The Theory of the Firm: An overview of the economic mainstream, has now been published.

So start buying. Its a great book, well worth buying for wives, husbands, girlfriends, boyfriends, mistresses, mothers-in-law, toy-boys, family, friends, pets, total strangers you meet in the street, or any combinations of the above. Its great for Christmas, holiday reading, birthdays, Mother's day, Father's day, any day.

Honestly I don't really care why you buy it, what's important is that you do buy it, preferably multiple copies, often!

Fleckner on Adam Smith on the joint stock company

That Adam Smith was not a huge fan of the joint stock company is well known. But what exactly did he think and why did he think it? And why was he wrong? These questions are considered in a new paper Adam Smith on the Joint Stock Company by Andreas Martin Fleckner.

The abstract reads:

In 1784, Adam Smith released the third and definitive edition of the Wealth of Nations, the most influential work in economics ever written. Of the eighty pages he added, more than thirty deal with “joint stock companies” and other commercial organizations. While these additions caused many observers to praise Smith as the first to coin the governance problems in firms, a closer examination of his remarks reveals that Smith’s theory of the firm, or the lack thereof, is in fact one of his work’s weaker parts. Smith thought history had shown that joint stock companies cannot compete with smaller firms, attributed this fact to certain organizational deficits, and concluded that joint stock companies should be established only under rare circumstances. Yet, in the following decades, exactly the opposite came to pass, with joint stock companies thriving in almost all fields and markets today. What made Smith so pessimistic about the joint stock company? The answer lies, this paper argues, in the sources Smith consulted, the companies he studied, and the general beliefs he held. Why did Smith’s pessimism turn out to be wrong? Smith probably overestimated the joint stock company’s weaknesses and underestimated developments that helped overcome them, such as technological progress, organizational innovations, and regulatory responses.

Fleckner raises a number of interesting questions to do with Smith's analysis of the firm. Let me make a couple of comments.

First Fleckner notes that Smith (and the classical economists who followed him) showed little interest in the firm. It could be argued that there are two reasons for this. Firstly the An Inquiry into the Nature and Causes of the Wealth of Nations was largely a book concerned with macro economics, in particular with growth theory and thus a study of firms as such had little to offer. The historian of economic thought D. P. O'Brien has remarked that

"[c]lassical economics ruled economic thought for about 100 years. It focused on macroeconomic issues and economic growth. Because the growth was taking place in an open economy, with a currency that (except during 1797-1819) was convertible into gold, the classical writers were necessarily concerned with the balance of payments, the money supply, and the price level. Monetary theory occupied a central place, and their achievements in this area were substantial and - with their trade theory - are still with us today".

Secondly large firms were not an empirically important part of the economy in Smith's day. Most production at the time was little more than household based production or small scale production based around a master craftsman and a few apprentices. Often the larger firms that did exist were partnerships rather than joint stock.

This lack of interest in the firm by Smith, and the following classical economists, explains why "Not once does he speak of a “firm,” nor does he develop anything that would resemble a theory of the firm." And when Smith does show interest it is not in terms of the firm in general - the no theory of the firm point - but in particular firms, the regulated and joint stock companies - mainly the East India Company.

Fleckner also notes that Smith placed his discussion of the joint stock company in a section of the Wealth of Nations to do with goods and services provided by the government. Smith put the discussion in the section to do with “Expence of publick Works and publick Institutions”. Smith explains that: "The third ... duty of the sovereign or commonwealth is that of erecting and maintaining those publick institutions and those publick works, which, though they may be in the highest degree advantageous to a great society, are, however, of such a nature, that the profit could never repay the expence to any individual or small number of individuals, and which it, therefore, cannot be expected that any individual or small number of individuals should erect or maintain".

Fleckner explains,

Smith adds two further distinctions before he finally gets to the joint stock company. In a first step, Smith subdivides the public goods into “publick Works and Institutions for facilitating the Commerce of the Society” (pp. 93–150), “Institutions for the Education of Youth” (pp. 150–92), and “Institutions for the Instruction of People of all Ages” (pp. 192–237). In a second step, he breaks the first group into those public works and institutions “necessary for facilitating Commerce in general” (pp. 93–107) and those “necessary for facilitating particular Branches of Commerce” (pp. 107–50). What kind of public works and institutions does Smith have in mind here? For “facilitating Commerce in general,” Smith thinks of the “erection and maintenance of the publick works which facilitate the commerce of any country, such as good roads, bridges, navigable canals, harbours, &c.” (pp. 93–4). This list at the outset of the section is almost complete, supplemented only by a “coinage” (pp. 94–5) and a “post-office” (pp. 95, 99, 243–4).

In the first (1776, vol. II, p. 340) and second (1778, vol. II, p. 342) editions, Smith’s discussion of public works and institutions that facilitate commerce concludes at this point. In the third edition, his older remarks become the first subsection, on the promotion of commerce in general, followed by new thoughts on public works and institutions that facilitate particular branches of commerce.

These new thoughts include thoughts on the joint stock company. This seems a strange place to put such a discussion.

Fleckner goes on to say that,

Unlike the older parts, the new section on particular branches of commerce lacks a concise definition and a list of introductory examples. Smith speaks in a rather bored tone of “particular institutions …, which again require a particular and extraordinary expence” (p. 107). To illustrate, he adds (ibid.): “Some particular branches of commerce, which are carried on with barbarous and uncivilized nations, require extraordinary protection. An ordinary store or counting-house could give little security to the goods of the merchants who trade to the western coast of Africa. To defend them from the barbarous natives, it is necessary that the place where they are deposited, should be, in some measure, fortified.”

If Smith had stopped here, with the insight that overseas trading requires additional protection, and moved on to other branches of commerce, hardly any reader would have criticized him for leaving out important information, given the wide range of topics under consideration. Yet, Smith does not stop here. He gets carried away by his example and, to mimic a British idiom, literally goes round the fortified houses. In the next sentence, he mentions another example of a place where commerce needs special protection: “Indostan” (p. 107). This brings him, for the first time, to the trading companies (p. 107): “[I]t was under pretence of securing their persons and property from violence, that both the English and French East India Companies were allowed to erect the first forts which they possessed in that country.” Now Smith goes into the details of overseas trading and discusses the role of ambassadors, ministers, and consuls (p. 108), along with an outline of commercial organizations engaged in overseas trading (pp. 107–10). He then examines in great depth, without any further sub-division, regulated companies (pp. 110–22) and joint stock companies (pp. 122–50). While Smith’s original context, the promotion of particular branches of commerce, seems to be almost forgotten, the facilities that prompted him to discuss overseas trading are frequently mentioned: “forts” and “garrisons,” also “settlements” and “habitations.” For Smith, the protection of foreign trading posts is apparently the most important cost factor in overseas trading. Ships and cargoes, in contrast, are only rarely brought up, and never as a major item of expenditure. Not even once does Smith refer to the scope, the duration, and the risk of the voyages as factors that caused overseas trading to be more capital-intensive than local exchange.

Fleckner then says,

Returning to the initial question of why Smith added his comments to the chapter on public expenses: Has Smith made a good case for discussing the joint stock company in this context? Is it clear how the joint stock company relates to “publick Works and Institutions for facilitating the Commerce of the Society”? Does it intuitively make sense how Smith incorporates his remarks?

In Fleckner's view the answer to this question is no. But let me make the case that if thought of in modern terms the answer could be yes.

What the government was doing can be seen as a form of contracting out. Today if the government want some good or service provided, eg rubbish collection, instead of providing that good itself the government pays a private firms to do it.

If "extraordinary protection" needs to be provided to traders in "barbarous and uncivilized nations" and the government doesn't want to provide such protection services itself then it could get the private trading firm to do so. And if the government doesn't want to pay for such services directly it could give the firm a monopoly as a way for the firm to recover its costs. So the consumer rather than the government ends up paying. Great for the government even if not so great for the consumer.

Now it seems unlikely that Smith was thinking in this way but it does at least make some sense of the placement of Smith's discussion.

Another point to keep in mind when thinking about Smith's analysis of companies is his criticism of firm's structure, eg are they partnerships, joint stock, regulated companies etc, versus his criticism of monopolies. Smith saw the, obvious, problems with giving a firm a monopoly to trade and saw shortcomings, mainly related to principal-agent issues, with the joint stock companies. But these are separate issues and should be treated as such.

And Smith did see a use for the joint stock company is areas such a banking, insurance, water supply and construction of aqueducts and canals.

Key findings on alcohol consumption and a variety of health outcomes from the nurses’ health study

From the American Journal of Public Health, Volume 106, Issue 9 (September 2016): Key Findings on Alcohol Consumption and a Variety of Health Outcomes From the Nurses’ Health Study by Elizabeth Mostofsky, Kenneth J. Mukamal, Ed L. Giovannucci, Meir J. Stampfer, and Eric B. Rimm.

Conclusions. Regular alcohol intake has both risks and benefits. In analyses using repeated assessments of alcohol over time and deaths from all causes, women with low to moderate intake and regular frequency (>3 days/week) had the lowest risk of mortality compared with abstainers and women who consumed substantially more than 1 drink per day. (Am J Public Health.2016;106:1586–1591. doi:10.2105/ AJPH.2016.303336)

The role of governments in hostile takeovers

Maximilian Rowoldt and Dennis Starke discuss "The role of governments in hostile takeovers – Evidence from regulation, anti-takeover provisions and government interventions" in the latest issue of the International Review of Law and Economics (Volume 47, August 2016, Pages 1–15).

The abstract reads:

This paper addresses the role of governments in hostile takeovers by analysing 263 hostile takeover bids in Europe and North America during 2000–2014. Our results suggest that governments may influence the openness of the domestic hostile takeover market through takeover regulation, potentially implementing protectionism. The corresponding features of the regulatory regime may in turn stimulate the deployment of anti-takeover provisions by entrenched target managers. Rather than increasing takeover premiums, anti-takeover provisions are associated with lower success rates of hostile bids, and may thus harm corporate governance. Governments’ direct intervention in hostile takeovers is more likely in case of a foreign bidder, large transactions, high unemployment and high GDP growth rates, pointing to both protectionist and populist motives. The hostile bid failed in all cases of government intervention identified in our sample. Direct government intervention may thus serve as ultimo ratio in order to block unwanted transactions.

Rowoldt and Starke write

Hostile takeover bids emphasise the conflicting interests of shareholders, managers and governments (Romano, 1988; Shleifer and Vishny, 1997). While targets’ shareholders are interested in maximising their return on investment, targets’ management may seek to entrench themselves and protect their job position by deploying anti-takeover provisions (ATPs). The misalignment of shareholder and management interests is especially pronounced in the case of hostile takeover bids (Armour and Skeel, 2007; DeAngelo and Rice, 1983; Jensen and Meckling, 1976). Against this background, the role of governments is of particular importance as they define the playing field for hostile takeovers through takeover regulation. Furthermore, governments may directly intervene in corporate takeovers. Takeover regulation and direct intervention in hostile takeovers may therefore follow national interests.

One is left wondering exactly what the "national interest" is. Interestingly the French takeover regulations were amended in 2014 in ways that help block unwanted foreign takeover bids. In particular, the French government eliminated mandatory board neutrality and shifted to a system which enables managers to deploy ATPs without shareholder approval.

A neutrality rule provides restrictions on board activity once a bid has been commenced or is imminent. These restrictions prevent a unitary board of directors or a management board from using corporate powers provided to them to frustrate the bid without obtaining shareholder approval for using the powers for such a purpose. The term ‘neutrality’, whilst widely used, is somewhat misleading as the requirement is not that the board remains neutral. In all Member States the board is required to give its views – whether in favour or against – on the hostile bid, and can legitimately search for an alternative and, in their view, more favourable suitor. It is only in relation to the use of board power to defend a bid where such a rule neutralises or disempowers the board in the absence of contemporaneous shareholder approval. (Gerner-Beuerle, Kershaw and Solinas 2011)

Rowoldt and Starke continue

In this paper we examine the role of governments in hostile takeovers and its implications on corporate governance. We focus on hostile takeover bids as they pronounce the conflict of interest between strong corporate governance and protection of the domestic industry. Our analysis involves three steps. First, we focus on the direct effects of takeover regulation. We analyse whether national takeover regulation is a potential protectionist tool for governments. In particular, we test whether the existence of a board neutrality rule (BNR) affects the openness of the domestic hostile takeover market to foreign bidders as measured by the likelihood of cross-border hostile bids and the deployment of ATPs by the target’s management. Second, we turn to the implications of takeover regulation on corporate governance by examining whether ATPs stimulate management entrenchment as measured by the success rate of hostile bids or benefit shareholders by strengthening their bargaining power. We measure bargaining power as the likelihood of bid increases and the final takeover premium. Third, we analyse determinants of direct government intervention in hostile takeovers and its consequences on the bid success.

Our results indicate a lower probability of cross-border hostile bids in case no BNR is considered in takeover regulation of target countries. Takeover regulation may thus limit the openness of the domestic hostile takeover market to foreign bidders. This supports the notion that takeover regulation may serve protectionist motives of governments as indicated by the implementation of the European Takeover Directive 2 (Davies et al., 2010). As board neutrality is only one feature of the legal environment, we additionally use alternative measures of shareholder protection in our analysis and find similar results. Thus, our results may be driven by the general legal environment and not necessarily the BNR alone. However, the recent reform of the French takeover law and the implementation of the European Takeover Directive emphasise the particular importance of board neutrality as a potential protectionist tool (Hopt, 2009). Moreover, not only board neutrality but also the general regulatory environment fall into governmental responsibility and may thus be used by governments to implement protectionism.

With this respect, the regulatory choices made by governments may affect corporate behaviour. In specific, board neutrality determines whether target managers are able to deploy ATPs without shareholder approval. Our results show a negative association between BNR and the application of ATPs by targets’ management, confirming that if takeover regulation grants the option to deploy ATPs to the targets’ management, they are likely to exercise it.

Regarding the role of ATPs in corporate governance, our results indicate that the application of ATPs does neither increase the likelihood of bid increases nor the final takeover premium offered. On the contrary, ATPs seem to decrease the likelihood of a successful completion of a transaction. This finding supports the management entrenchment hypothesis. A regulatory framework that favours ATPs may therefore increase managerial power and in turn decrease the effectiveness of the corporate government system (Humphery-Jenner, 2012; Masulis et al., 2007).

Finally, our results suggest that direct government intervention is more likely in case of a foreign hostile bidder, pointing to protectionist motives for government interventions and supporting prior evidence provided by Dinc and Erel (2013). Additionally, we find positive associations between negative government interventions and transaction size as well as the unemployment rate in the targets’ nation supporting the idea that government intervention follows populist motives in search for votes (Hopt, 2009).

Besides, the hostile takeover bid failed in all of the identified cases of negative government intervention. Due to this missing variation in the bid outcome in case of a negative government intervention in our sample, we are unable to empirically assess the corresponding relationship. However, this observation potentially points to the role of direct interventions for governments as ultimo ratio to block hostile takeovers of domestic companies.

Ref.:

• Gerner-Beuerle, Carsten, David Kershaw and Matteo Solinas (2011). Is the Board Neutrality Rule Trivial? Amnesia About Corporate Law in European Takeover Regulation, LSE Law, Society and Economy Working Papers 3/2011 .

Tolerance in the United States: Does economic freedom transform racial, religious, political and sexual attitudes?

This is the title of a forthcoming article in the  European Journal of Political Economy by Niclas Berggren and Therese Nilsson. The abstract reads:

Tolerance is a distinguishing feature of Western culture. Still, it varies between and within countries, as well as over time, and irrespective of whether one values it for its own sake or for its beneficial consequences, it becomes important to identify its determinants. In this study, we investigate whether the character of economic policy plays a role, by looking at the effect of changes in economic freedom (i.e., lower government expenditures, lower and more general taxes and more modest regulation) on tolerance in one of the most market-oriented countries, the United States. In comparing U.S. states, we find that an increase in the willingness to let atheists, homosexuals and communists speak, keep books in libraries and teach college students is, overall, positively related to preceding increases in economic freedom, more specifically in the form of more general taxes. We suggest, as one explanation, that a discriminatory tax system, which is susceptible to the influence of special interests and which treats people differently, gives rise to feelings of tension and conflict. In contrast, the positive association for tolerance towards racists only applies to speech and books, not to teaching, which may indicate that when it comes to educating the young, (in)tolerant attitudes towards racists are more fixed.

The Olympic Games are a human rights disaster

So writes Ilya Somin at the FEE website. The Olympic Games cause a great amount of harm to many people in the host city, in particular to the poor and politically weak.

Host cities routinely lose enormous amounts of money on the games, and end up with decaying stadiums that have little or no value. Even worse, governments often forcibly displace large numbers of people from their homes and businesses in order to make room for Olympic venues. Over one million people lost their homes for the 2008 Beijing games alone. Brazil has similarly evicted large numbers of people for the currently ongoing Rio Olympics, and even more to build stadiums for the 2014 World Cup. Most of those evicted are the poor and people lacking in political power.

The Olympics have also often become propaganda showcases for authoritarian regimes, as happened with the 2008 Olympics in China, and the 2014 Winter Olympics in Sochi, Russia. In an earlier era, the the same problem arose on an even more egregious scale with the 1936 Olympics in Nazi Berlin, and the 1980 games in the Soviet Union.

But, Somin goes on to argue, none of this has to happen.

We can reform the Olympics to put an end to it. The forcible evictions are perhaps the easiest problem to fix. The International Olympic Committee and the international community more generally should insist that organizers commit to building the necessary venues without forcibly displacing residents. If a city cannot or will not do that, it should not be allowed to host the games. No sports event is worth the forcible displacement of innocent people from their homes.

We can also put an end to the economic harm caused by the Olympics by insisting on private funding, instead of government subsidies. The 1984 Los Angeles Olympics, almost the only modern games to avoid massive losses, did so by relying on almost entirely on private funds. Government subsidies for sports facilities have a strong tendency to cause more economic harm than benefit. Private investors have stronger incentives to use resources efficiently, since their own money is at stake. And if they do err, at least the taxpayers won’t be left holding the bag.

Finally, we can end the use of the games as a propaganda tool for repressive regimes by limiting host rights to liberal democracies. If the IOC again awards the games to authoritarian states, the West should boycott. The mere threat of a large-scale boycott might well disincentivize such regimes from trying to host in the first place, and prevent the IOC from awarding them the games if they do bid.

The problem I see with Somin's reforms is that they would result in the IOC getting a lots less money from the games and that is something they will fight to the bitter end to avoid. Many of the problems we see with organisations like Fifa are present in the IOC and until there is genuine reform of the IOC itself you will not see any changes to the Olympics. Until then money will talk and the poor and powerless will pay the price.

EconPop - the economics of the LEGO moview

Definition of a firm

At the Entrepreneur website Per Bylund, author of The Problem of Production: A new theory of the firm (well worth a read if you are into the theory of the firm), has an article on 4 Reasons You Should Start a Firm Instead of Launching a Startup.

Bylund opens the article by saying

Should your next startup be a firm? In conversational usage, the terms are synonyms, so the question might seem odd.

Economically speaking, a firm is a for-profit entity detached from market solutions of the day. The label implies some sort of innovation is happening behind the business’s doors, whether through novel production techniques, new organizational patterns or previously unseen products. (Emphasis added)

The point about the bit in bold is that I'm not sure its a useful definition of a firm.

Consider, for example, a market where you have for-profit entities and not-for-profit entities competing. In the healthcare market you could have for-profit hospitals going up against not-for-profit hospitals. Both groups could be doing the same thing in the same way using the same types of equipment. They may even share some staff in common. So is saying that one is a firm while one isn't really useful?

Or consider a law "firm" which makes profit out of some clients (and then some!) but works pro bono for others. Is the "firm" a firm for some part of the day and not-a-firm for other parts of the day?

Or what of a software company that sells some software but gives away other software. Is it a firm for part of its product line but not for other parts?

In short, I'm not sure for-profit restriction is a useful one.

More on the economics of the Olympics

This article on the economics of the Olympics is from the Project Syndicate web page and is by Andrew Zimbalist who is Professor of Economics at Smith College and the author of Circus Maximus: The Economic Gamble Behind Hosting the Olympics and the World Cup.

Zimbalist writes,

According to Olympic legend, hosting the Games is an economic boon for the chosen city and country. In reality, the Games are more often a boondoggle, as Rio de Janeiro is finding out.

First, consider how the games are awarded to a host city. The International Olympic Committee (IOC), an unregulated global monopoly, conducts a biannual auction whereby the world’s cities compete against one another to prove their suitability. Business executives – often from the construction industry – who stand to gain from the Games’ preparation usually lead a prospective city’s bidding process. Among other things, cities will offer lavish sporting venues, ostentatious ceremonial spaces, newly built transportation networks, luxurious accommodations for athletes, and media and broadcasting centers.

The outcome of this process is predictable: winning cities usually overbid. The cost of hosting the Summer Olympics these days runs from $15 billion to $20 billion, including venue construction and renovation, operations and security, and additional infrastructure. The total revenue for the host city from its share of international television contracts (roughly 25%, with the other 75% going to the IOC), international and domestic sponsorships, ticket sales, and memorabilia is $3.5-4.5 billion. In other words, costs comfortably exceed revenues by $10 billion or more.

Those vying for their city to host the Games often argue that any short-term deficit will turn into long-term gain, because tourism, foreign investment, and trade will grow, to say nothing of improved national morale. Again, the empirical evidence does not support this extravagant claim.

But what about investments in infrastructure?

One area where some host cities – but not all – can actually realize long-term gains is in infrastructure spending. In Rio’s case, one could argue that the city will benefit from improvements to its international airport and downtown port. But this is not a valid reason to become a host city; it is merely a consolation prize. A billion dollars of productive infrastructure development does little to make up for the other $19 billion spent on the Games, which will not improve the city for most of its residents or regular visitors.

Consider the $2.9 billion subway line (originally budgeted at $1.6 billion) connecting the Games’ beachside event space to Barra da Tijuca, a wealthy suburb ten miles away. This new infrastructure will boost property values in Barra da Tijuca, while doing nothing to improve Rio’s horrendous street traffic. The bulk of Rio’s workers living north and west of downtown will have just as difficult a commute as ever.

Examples like this abound. The city built a new golf course on the protected wetlands of the Marapendi Natural Reserve, which will degrade the ecosystem and consume vast amounts of water – a preciously scarce resource in Rio. It also built bus lanes that run between Olympic venues, which will ease travel for IOC executives but only further congest the city’s now-narrower roadways for everyone else.

What of the human cost of the games?

Along with pointless and disruptive infrastructure, the Rio Games have exacted a human cost. To make room for the 32 sport venues, the athletes’ Olympic Village, the broadcasting and media center, the ceremonial green space, and to beautify the surrounding landscape, the Rio government has evicted more than 77,000 residents from shantytowns or favelas since 2009, the year the city was awarded the Games.

Overall what are the dangers of hosting the games for different cities? If you look at less developed cities they often don't have the necessary infrastructure and thus must spend more to meet the IOC’s transportation, communications, and hospitality requirements. For more developed cities they may already have the infrastructure, but not necessarily the land, and risk disrupting thriving industries to bring the Games to fruition. So what we see are large costs to hosting the games and benefits that, usually, just don't compensate for those costs.

Economic benefits from mega-events like the Olympics are often overstated

This title will not come as a great surprise to many people. But its still worth reminding everyone of it. Especially as we have something as stupid as the Olympics going on right now.

At the American Economic Association website Tim Hyde writes on about a paper in the recent Spring issue (vol. 30, no. 2, 2016) of the Journal of Economic Perspectives which breaks down the costs and benefits of hosting the Olympic Games and explains why some of the perceived economic blessings of the Olympics are mostly wishful thinking.

Hyde opens by saying,

In Going for the Gold: The Economics of the Olympics (PDF), authors Robert Baade and Victor Matheson consult estimates from academic, public, and media sources on the costs and benefits of hosting the Games. As with any mega-event, costs and benefits can be hard to estimate, but the general story is clear: for most modern Olympics, the costs have far outstripped the benefits.

The direct costs of hosting the Games are probably easier to estimate and tabulate. First there is the non-trivial cost of mounting a bid, which can run into the hundreds of millions of dollars for planning, marketing, and architectural renderings. During this stage, candidate cities sign on to build future amenities in an attempt to impress the International Olympic Committee (IOC) and win the Games.

This might mean committing to a signature architectural marvel to host the Opening Ceremonies or a major upgrade to public transit to accommodate the once-in-a-lifetime demand surge that will result. A minimum of 40,000 hotel rooms and additional housing for 15,000 athletes and officials is required for the Summer Olympics, so often the bids must include plans for new hotel capacity and dormitories.

The IOC will tend to favor the city that makes the most lavish offer of gleaming new facilities and infrastructure improvements, so the bidding process can give way to a “winner’s curse” effect. The city that wins tends to be the one that overestimated the value of hosting the Olympics the most, and hence the one that went furthest overboard in their bid.

Once the Olympics have been assigned, the host city must typically spend billions of dollars building transit and airport improvements, reaching the requisite hotel capacity, and constructing specialized athletic facilities like a swimming facility, a velodrome, or a larger stadium that can accommodate an Olympic track. Disentangling these costs from planned infrastructure improvements that would have happened even in the absence of the Olympics can be difficult, but the best estimates put the cost of hosting at between $5 and $15 billion for most recent events.

Hyde continues by looking at the benefits of the games.

The costs are clear, but the benefits of hosting the Olympics can be substantial as well, even if they are usually overstated by overzealous city officials or self-interested boosters. Host cities receive revenue from ticketing and sponsorships, and local organizing committees receive a share of the proceeds from the sale of television broadcast rights. These benefits are easy to quantify, but don’t add up to a significant fraction of the hosting costs in most cases. Vancouver 2010 produced about $1.5 billion in direct revenues and London 2012 about $3.3 billion; in each case, far less than the costs.

The rest of the benefits are more nebulous. Proponents tout supposed benefits ranging from the economic stimulus provided by construction demand, to increased tourism during and after the games thanks to a worldwide advertising campaign, to increased foreign investment and better trade connections, to an improved sports infrastructure for future generations (this last benefit is most easily debunked). The authors argue that most of these benefits tend to be less than hoped, or only appear in specific situations.

Infrastructure improvements can provide a form of fiscal stimulus to a city with a slack labor market, but if the city’s economy is near full employment anyway in the years leading up to the Games, the extra construction jobs are more likely to come at the expense of other sectors.

Tourism, meanwhile, can be crowded out by the hustle and bustle of the Olympics themselves – Beijing and London both saw fewer international visitors during the months they were hosting the Olympics in 2008 and 2012 compared to the same months in previous years, and Utah ski resorts noticed a dip in traffic during the 2001-02 ski season that coincided with the Salt Lake City games.

A few cities have had success generating future tourism business with the Olympics, notably Barcelona in 1992 which used the games to emerge from the shadow of nearby Madrid, another major tourist destination. Likewise, the Utah ski economy saw a boost in the years after 2002. But many other host cities like Calgary (1984) and Lillehammer (1994) have seen limited increases in tourism after their games.

One study did find that countries hosting the Olympics see a 20% increase in export trade in the years after hosting, relative to similarly-situated countries, which might go a long way to justifying the economic expense of hosting the event. But the same study found similar gains for countries where cities unsuccessfully bid for the Olympics. The authors suggest that the very act of bidding for the Olympic Games suggests a government is looking to increase international connections and willing to make infrastructure investments, which can attract foreign interest.

It is also likely that the types of cities that decide to mount bids are on an economic upswing and poised for growth, and actually winning that bid might be more likely to stunt that growth rather than accelerate it

All of this does raise one interesting, and important question: if the balance of evidence is that the economic costs of hosting the Olympics far outpace the benefits, so why do cities bother to bid at all? Hyde writes,

One possibility is civic pride or the desire to affirm a city’s status as a “world city.”

But this does look like very expensive warm fuzzies. Hyde goes on to say,

These benefits are hard to translate into economic terms, but two careful studies used contingent valuation survey methods (similar to the techniques economists use to see how much people value maintaining the rainforests or keeping a species from extinction) to measure this benefit in the runup to the 2012 Olympics in London. They found that people across the United Kingdom collectively valued the opportunity to host the Olympics at about £2 billion, still well short of the cost of hosting.

Hyde concludes by noting,

This problem may end up solving itself if enough cities wise up and stop incorporating such grandiose plans into their bids. After a streak of cost overruns for Olympics during the 1970s, interest in hosting the Olympics waned and Los Angeles was the only bidder for the 1984 Games. The city used its leverage to insist on using existing facilities rather than building new ones and adopted a cost-conscious approach that maximized sponsorship and TV revenues. The result was one of the few profitable games in history – and a model that future host cities might want to emulate.

But perhaps the most interesting observation made by Hide is this one:

Mounting evidence showing that hosting the Games is a costly proposition for host cities seems to have turned voters across the world against the idea. A popular outcry derailed the Boston 2024 bid, and city officials scuttled Hamburg’s 2024 bid after losing a referendum there.

Increasingly, it seems like cities in liberal democracies are not willing to bid for the games: the competition for the 2022 Winter Olympics was reduced to two cities in autocratic regimes after four European cities dropped out. Not coincidentally, the authors note, the two recent Olympics hosted in countries with less accountable governments were major outliers in terms of cost.

Casey Mulligan visits Cuba

Economist Casey B. Mulligan went to Cuba and earlier in the year posted some observations on his trip:

On boats:

Government permission is needed to have a boat. The fishermen’s boats are smaller than a normal rowboat and therefore too small to take far from shore (e.g., to another country). Most seafood has to be imported. This is a clear case where the regime has sacrificed productivity in order to exercise control over its people.

On paper:

In order to make opposition more difficult, paper is scarce throughout the country. This is another clear case where the regime has sacrificed productivity in order to exercise control over its people.

On livestock:

Cows are still government owned. They cannot be killed for beef; all beef is imported. It is also illegal to sell beef in some situations. I believe that Cubans can own chickens and other birds. Urban dwellers may even be encouraged to own chickens. I do not know who owns the horses.

On residences:

Until recently, Cubans could own their home but could only sell a home to the government. In other words, it was more like living as a tenant for zero rent and being paid something for vacating. Now Cubans tell me that they have a right to buy and sell homes (since 2011; even now Cubans cannot own more than two homes), and that Cubans typically live in a home owned by a family member. They do not pay property taxes and often do not have mortgages, but they do pay for metered electricity and gas. For multi-unit buildings, it has never been clear who has the property rights (does the roof of an apartment building belong only to those who live on the top floor?).

The urban residences are densely populated. They were originally constructed in the 1920s or 1950s with tall ceilings and room sizes that would be familiar to Americans. But since the Revolution the rooms and hallways have been subdivided many times, including vertical subdivisions known as barbeques. Not much lighting is used. [...]

The disrepair and proliferation of subdivisions are to be expected when quality housing is prohibited from commanding a price or rent premium in the marketplace and when property rights are lacking, as during the half-century before 2011.

But

There are families who are permitted to rent out space in their homes to tourists. A blue emblem marks such homes. These homes are nicely maintained.

On shopping:

Cuban families receive a ration book that allows them to obtain food (for ten days a month?) at regulated prices in quantities according to the size and composition of their family.

We were told not to take pictures in the food stores. I visited one of them and was encouraged to leave because “it was not for tourists.” I sat outside another as customers came and went.

The stores sell less than two dozen distinct items in large quantities. E.g., large containers of canned mangos, three-liter bottles of soda, three-liter bottles of water, eggs in trays of 30. There was no refrigeration, even though it was hot. There are plenty of flies and stockouts. [...]

Large containers are probably not what people would pay for in a market setting, given that so few of them have cars (although I saw a couple of customers pull up in horse-drawn carts) and the small size of their living places. But packaging, availability, variety, and refrigeration are all good examples of non-price product attributes that can be expected to disappear when prices are regulated (Mulligan and Tsui 2016).

Clothing and electronics are, and market exchange rates, cheaper in the U.S. than in Cuba. Many of these items are obtained when Cuban-American family members visit. I don’t know if or how they were obtained prior to 2009, when the family visits began to be permitted.

On politics:

To be blunt, my overall impression is that Fidel Castro is like an abusive father with several million “children” that he abused. Many of them ran away from home and still hate him many decades later (you can meet them here in America). Others stayed, continue to take the abuse, and focus on a few apparently good things that he does/did. To put it another way, the Cubans still in Cuba obtain a significant amount of some kind of psychic value from Castro and the Revolution that partly offsets the large tax they implicitly pay in terms of foregone freedom material goods and services.

On labour

Cubans own their labor in the sense that they get wages for most of their work.[10] However, their employer is typically the government and those wages are far below their productivity (which is itself low). Government employees were paid about $20 per month in 2014, whereas national income per worker was $839, which suggests that government employees keep about five percent of the value of what they produce.

Relative usefulness of economics

In the abstract to a paper Methodological institutionalism as a transformation of structural econometrics the author, Marcel Boumans, writes,

Economics is an inexact science, incapable of providing a complete set of causal factors to explain any economic phenomenon.

But a basic point is missed here. To be useful economics doesn't have to provide the complete set of causal factors, it just has to provide a greater set than the next best alternative. It may well be that no field of study can provide the complete set of factors. Its a relative standard that matters, not an absolute one, for the usefulness of economics.

Specialization and trade: a re-introduction to economics

Arnold Kling joins Trevor Burrus and Aaron Powell on Free Thoughts to talk about his new book, Specialization and Trade: A Re-introduction to Economics.

What’s the “MIT” approach to economics, and what’s wrong with it? Is economics a hard science? What is an economic model? What are some of the problems with thinking of the world this way?

Arnold Kling claims that the economy isn’t like one big machine with a single purpose that can be fine tuned and regulated by experts. In this week’s episode, he presents an alternate way of thinking about economics, one you won’t find being taught in most college classrooms.

The audio is available here.

Hayek’s modern family: classical liberalism and the evolution of social institutions

Professor Steven Horwitz joins Trevor Burrus and Aaron Powell on Free Thoughts for a discussion on the family and how it has changed over the years. Where does classical liberalism fit into the conception of a family? Horwitz talks about his new book, Hayek’s Modern Family: Classical Liberalism and the Evolution of Social Institutions.

The audio is available here.

Greg Mankiw on Donald Trump

Mankiw isn't exactly one of the Democrat's most favourite economists, but even he isn't a Trump fan. At his blog, Greg Mankiw's Blog, Mankiw writes,

He will not be getting my vote.

I have Republican friends who think that things couldn't be worse than doubling down on Obama policies under Hillary Clinton. And, like them, I am no fan of the left's agenda of large government and high taxes. But they are wrong: Things could be worse. And I fear they would be under Mr. Trump.

Mr. Trump has not laid out a coherent economic worldview, but one recurrent theme is hostility to a free and open system of international trade. From my perspective as an economics policy wonk, that by itself is disqualifying.

We live in a strange world when such a well known Republican supporting economist comes out with such a statement about the Republican presidential candidate.

Bloomington School of Political Economy 2

This is the third installment in which Jayme Lemke talks to Professor Peter Boettke about the Bloomington School of Political Economy.

Bloomington School of Political Economy III: The Continuing Relevance of Institutional Analysis


The first two installments are available here.

Brexit realism: What economists know about costs and voter motives

David Miles (Imperial College Business School) has a new column up at VoxEU.org on Brexit realism: What economists know about costs and voter motives. Miles writes that to some, the Brexit referendum was a failure by economists to persuade UK voters that leaving the EU would entail major economic costs. In his column Miles argues for a more nuanced view by making two points:

• First, it questions whether there really is a consensus about the costs. While all the mainstream estimates were negative, they ranged from rather small to nearly 10% - a range that hardly sounds like a consensus. Moreover, the key mechanism - Brexit's impact on productivity growth - is not something economists really understand.
• Second, a rational voter could accept the cost as a tolerable price for having greater independence from EU decisions. Economics does not tell us that a voter who makes such a choice is ignorant, irrational, or economically illiterate.

And independence from EU decisions does seem to have been a big player in the pro-Brexit vote.

Perhaps the most interesting question Miles asks is, Do we know voters ignore economic estimates? He writes,

But suppose we put to one side the rather wide range of central estimates of the long-run effect of Brexit on GDP, and also ignore the enormous uncertainty about any one such central estimate, and stick to the view that there was a consensus amongst economists about the effects and that this was that Brexit is significantly bad for incomes. What is the evidence that such a consensus (to the extent that it existed) was ignored by those that voted to Leave? I think we should be realistic as economists about how little we really know here.

One point is obvious. A rational voter could accept that there would be an economic cost to leaving the EU but think this is an acceptable price to pay for not having to accept some EU decisions over which the UK has limited say. There clearly are decisions of this sort - from judgements by the European Court of Justice, to rules on financial regulations (e.g. the strange decision to make capital requirements on banks maximum harmonisation, or EU rules on bonuses), to accepting the right of entry of people to whom other EU countries have decided to grant citizenship.

Economics has little to say about whether someone who values avoiding being tied by such decisions, and accepts in return the likelihood of a lower income by a few percentage points, is ignorant, irrational, or economically illiterate. For many years the mantra of many from the European Commission has been the desirability, even the necessity, of "ever closer union". What does economics tell you is the right answer to the question, "How much should I pay to avoid that?"

As it happens, I did not think it worth paying the price to avoid the risk that the fuzzy concept of "an ever closer union" could create damage down the road. I do not, however, believe those who took a different view were ignorant or befuddled. It is not right to think that if only they understood the economics of it they would surely have voted differently.

This point is one that has not been acknowledged by most of the anti-Brexit crowd. From my reading of much of this group's material they do seem to think anyone who was pro-Brexit was an economic fool, and this just doesn't have to be true.

Bloomington School of Political Economy

In this installment, Jayme Lemke is joined by Peter Boettke, University Professor of Economics and Philosophy at George Mason University and Director of the Hayek Program. In this conversation, Boettke and Lemke discuss the foundations and continuing importance of the Bloomington School of institutional analysis and development.

Bloomington School of Political Economy I: The Science & Art of Association


Bloomington School of Political Economy II: Rules in Form versus Rules in Use

High human capital and worker-owned firms

In a recent paper in the Journal of the Knowledge Economy I argued, via a simple model of the firm based on the reference point approach to the firm, that 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.

To illustrate this idea I considered the ownership structure of professional sports teams. 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,  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.

But this argument could be applied to any worker-owned firm in which their is a range of worker ability. My argument would mean that the given a relatively flat compensation structure high ability workers would be more likely to leave a worker-owned firm.

In a new paper in the latest issue of the Economic Journal Gabriel Burdín argues that Equality Under Threat by the Talented: Evidence from Worker-Managed Firms.

The abstract of the paper reads:

Does workplace democracy engender greater pay equality? Are high-ability individuals more likely to quit egalitarian organisational regimes? The article revisits this long-standing issue by analysing the interplay between compensation structure and quit behaviour in the distinct yet underexplored institutional setting of worker-managed firms. The analysis is based on novel administrative data sources, which allow constructing a simple ordinal measure of the workers' ability type. The article's key findings are that worker-managed firms have a more compressed compensation structure than conventional firms, and high-ability members are more likely than other members to exit. (Emphasis added.)

Thus Burdin finds what you would expect, high-ability workers (players) are more likely to exit worker-owned firms (teams) leaving such firms (teams) at a disadvantage compared to employee based firms.