Why you don’t have to worry about the trade deficit

From the Marketplace website comes this audio in which Doug Irwin, Jeff Frankel and Margaret McMillan explain why you don't have worry about the trade deficit.

Just before the holidays, President-elect Donald Trump announced he would create something called the National Trade Council to promote U.S. manufacturing. Trump named Peter Navarro, an ardent China critic, to lead the office. Trump and Navarro also share another passion: an aversion to trade deficits. A trade deficit means that the U.S. imports more goods and services than it exports. We've run one every year since 1974. To most economists, that's not a big concern.

Nobel Prize-winning thoughts on incentives and the importance of contracts

On NPR's Morning Edition Steve Inskeep talked to Bengt Holmstrom of MIT, who was one of the winners of the 2016 Nobel Prize in economics.

Perhaps a fitting piece of research to end the year on

A new NBER working paper on Depression for Economists by Jonathan de Quidt and Johannes Haushofer, NBER Working Paper No. 22973, issued in December 2016.

No its not about depressed economists, although recent events are enough to make any economist - especially trade economists - depressed, but rather the economic causes and effects of depression.

Major depressive disorder (MDD) is one of the most prevalent mental illnesses worldwide. Existing evidence suggests that it has both economic causes and consequences, such as unemployment. However, depression has not received significant attention in the economics literature. In this paper, we present a simple model which predicts the core symptoms of depression from economic primitives, i.e. beliefs. Specifically, we show that when exogenous shocks cause an agent to have pessimistic beliefs about the returns to her effort, this agent will exhibit depressive symptoms such undereating or overeating, insomnia or hypersomnia, and a decrease in labor supply. When these effects are strong enough, they can generate a poverty trap. We present descriptive evidence that illustrates the predicted relationships.

But I can't help but think this is, to a degree at least, reinventing the wheel. I'll bet that psychologists have been looking at such things for years.

Why are there still so many jobs?

Here's a paradox you don't hear much about: despite a century of creating machines to do our work for us, the proportion of adults in the US with a job has consistently gone up for the past 125 years. Why hasn't human labor become redundant and our skills obsolete? In this talk about the future of work, economist David Autor addresses the question of why there are still so many jobs and comes up with a surprising, hopeful answer.

Thomas Sowell: so long, and thanks for all the fish

At age 86, Tom Sowell has decided he has better things to do with his time than write magazine columns and so he has retired as a regular columnist. His final column is here. Sowell writes,

Even the best things come to an end. After enjoying a quarter of a century of writing this column for Creators Syndicate, I have decided to stop. Age 86 is well past the usual retirement age, so the question is not why I am quitting, but why I kept at it so long.

It was very fulfilling to be able to share my thoughts on the events unfolding around us, and to receive feedback from readers across the country — even if it was impossible to answer them all.

Being old-fashioned, I liked to know what the facts were before writing. That required not only a lot of research, it also required keeping up with what was being said in the media.

During a stay in Yosemite National Park last May, taking photos with a couple of my buddies, there were four consecutive days without seeing a newspaper or a television news program — and it felt wonderful. With the political news being so awful this year, it felt especially wonderful.

Sowell notes the advances that have been made in terms of material welfare during his lifetime,

In material things, there has been almost unbelievable progress. Most Americans did not have refrigerators back in 1930, when I was born. Television was little more than an experiment, and such things as air-conditioning or air travel were only for the very rich.

My own family did not have electricity or hot running water, in my early childhood, which was not unusual for blacks in the South in those days.

It is hard to convey to today's generation the fear that the paralyzing disease of polio inspired, until vaccines put an abrupt end to its long reign of terror in the 1950s.

Most people living in officially defined poverty in the 21st century have things like cable television, microwave ovens and air-conditioning. Most Americans did not have such things, as late as the 1980s. People whom the intelligentsia continue to call the "have-nots" today have things that the "haves" did not have, just a generation ago.

The effects of economic growth can be dramatic and welcome, and those who are anti-growth, for whatever reason, should keep this in mind.

Realignment: The future of British politics

May be not just UK politics but New Zealand politics, at least to some degree, as well. The idea that in the future politics will not be divided by 'left vs right', but rather by 'nationalism vs liberalism' is one worth considering.

In this audio excerpt from a lunchtime lecture, Dr Steve Davies - Head of Education at the Institute of Economic Affairs - outlines his predictions for the realignment of the UK political parties over the next decade.

The lecture, which took place on September 27th 2016, foreshadowed the Conservative Prime Minister's party conference speech, which showed signs of Steve's prediction that the future of politics will not be divided by 'left vs right', but rather by 'nationalism vs liberalism'.

The fall and fall of Soviet agriculture or why small is sometimes beautiful

In chapter 4 of his recent book “Was Communism Doomed?: Human Nature, Psychology and the Communist Economy" psychologist Simon Kemp outlines the mostly sorry tale of Soviet agriculture. He sums the Soviet experience up by saying,

Overall, Soviet agriculture was not a great success story.

The question raised by this is, Why?

Kemp gives his answer is chapter 8 of his book on “Psychological Ownership”. Kemp notes that agriculture does not require a large organisation. Kemp writes,

Economies of scale are not always important in agriculture. When Stalin initiated the brutal collectivisation of Soviet agriculture, he appears to have done so with the genuine belief that in the long run the larger units would prove more productive. As we have seen, this increase in productivity did not happen [see chapter 4 of Kemp's book]. In part, this is because agriculture does not always benefit from concentrated large-scale production.

Owner-operator (family) farms are still in most countries, including New Zealand, the standard organisation for agricultural production. Why this is so is a question relevant for why collective farms failed. After all collective farms were designed more along large scale industry lines than small scale family lines.

The short economic answer to this question is, I would argue, given by Allen and Lueck (1998). They argue that farms operate in unique circumstances defined by nature, in particular seasonality. This is the main feature that distinguishes farm organisation from industrial organisation. For farmers a season is a distinct period of the year during which a given activity is optimally undertaken.

This is key to understanding the why the incentives generated within agriculture favour family farms. The two basic issues are opportunities for hired workers to shirk due to random production shocks from nature and the limits on the gains from specialisation and the timing problems caused by seasonality. The trade-off between effect work incentives and gains from specialisation help determine the costs and benefits of different farm organisational types.

The family farm model provides the best work incentives since the owner is the sole recipient of the benefits, but this model misses some benefits due to specialisation. This follows from the fact that the farmer must engage in numerous different tasks during each stage of production, and in addition, numerous production stages throughout the year.

On the other hand, large factory-style corporate farms gain from a specialised labour force and lower cost of capital, but suffer from bad worker incentives since hired workers, not being one of the owners, have an increased incentive to shirk.

To some degree all firms are governed by the trade-off between gains from specialisation and work incentives. For the case of farming it is the unique, large impact of nature that biases it towards family operations.

An obvious, but key, feature of agriculture is that it involves a living, growing product. In the case of livestock, for example, you have breeding, husbandry, feeding and slaughter. Such a cycle is largely governed by nature. In principle there is no reason that a different farmer could not own each stage. But timing difficulties between stages result in high costs of engaging in market transactions. Such timing issues are particularly severe in farming because the inventories of the intermediate goods cannot be held given the living nature of the product.

There are a number of factors, such as the number of crop cycles, the length of the production stages and the number of tasks within a stage, which also influence wage labour incentives. When cycles are few, stages are short, random shocks are large and the tasks are few, there is little to gain from specialisation and labour is especially costly to monitor. Thus family farms.

If these issues can be overcome, that is, if farmers can mitigate seasonality and random shocks to output, farm organisation starts to look much like that in the rest of the economy. Under such conditions farm organisation will gravitate towards factory process and develop the large-scale corporate forms of other sectors of the economy. So larger more industrial looking farms may work.

But right now, small it seems really is beautiful.

Ref.:

• Allen, Douglas W. and Dean Lueck (1998). "The Nature of the Farm", Journal of Law and Economics, 41: 343-86.

The enviromental costs of Christmas trees: real vs. artificial

I'm guessing this is the big question in environmental economics. Timothy Taylor takes a look at the issue at his Conversable Economist blog. He writes,

One artificial tree used for one year has greater environmental impact than one natural tree. However, an artificial tree can also be re-used over a number of years. Thus, there is some crossover point, if the artificial tree is used for long enough, that its environmental effect is less than an annual series of trees. For example, the ellipsos study finds that an artificial tree would need to be used for 20 years before its greenhouse gas effects would be less than those of an annual series of natural trees. The PE Americas study offers a wide range of scenarios, and summarizes, but here is the situation "for the base case when individual car transport distance for tree purchase is 2.5 miles each way. Because the natural tree provides an environmental benefit in terms of Global Warming Potential when landfilled, and Eutrophication Potential when composted or incinerated, there is no number of years one can keep an artificial tree in order to match the natural tree impacts in these cases. ... For all other scenarios, the artificial tree has less impact provided it is kept and reused for a minimum between 2 and 9 years, depending upon the environmental indicator chosen."

But a full analysis of the issue needs to look at effects across all the full life-cycle of the tree, whether natural or artificial. And things get complicated right about here.

Under what conditions is the tree manufactured or cultivated, with what use of energy, fertilizer, and logging methods? By what combination of transportation mechanisms is the finished tree moved to the home? A substantial share of artificial trees are manufactured in China and then shipped to North America. What are the different issues in use of the tree, including use of water and emissions of fumes? What is the end-of-life for the tree? For example, the carbon in a natural tree will be stored for some decades if the tree goes into a landfill, but not if if is composted or incinerated.

In short, its difficult being green!

Trump’s trade adviser is a terrible filmmaker

Or so says Scott Meslow at the Politico Magazine. Yes Trump's head of the new White House National Trade Council Peter Navarro has made a film, called "Death by China" (what else?).

No I didn't know either.

The film is apparently based on Navarro's book also with the title "Death by China: Confronting the Dragon - A Global Call to Action".

Perhaps the takeaway from Meslow's review comes early in the article,

As a film critic, I found it an appalling cinematic experience. But it’s a brutally effective, if unsubtle, 79 minutes of propaganda -- which might explain why Trump liked it so much.

Meslow continues,

Within its first five minutes, Death By China lays out the stakes: 57,000 American factories closed, 25 million Americans can’t find "a decent job," and the United States owes $3 trillion to China. The roots of our alleged economic woes, Navarro argues, can be traced back to 2001, when the United States enthusiastically endorsed Beijing’s entry into the World Trade Organization.

Now I have no idea whether this is good film making or not but it sounds like crap economics. As any number of economists have pointed out American's economic woes are not due to trade they have more to do with things like changes in technology.

This bit is interesting,

Navarro attempts to prove this point with an array of cherry-picked talking heads, a series of unenlightening man-on-the-street interviews, and — most strikingly — some computer-animated sequences designed to dramatize Navarro’s argument. In one, a knife bearing the label "Made in China" is plunged into the center of the United States, covering the lower half of the country in a sea of blood. In another, missiles of "currency manipulation" and "illegal export subsidies" are fired from cannons and dropped from planes, leaving American cities in rubble. Navarro structures his film around China’s "Weapons of Job Destruction." Everything is cast in the violent, overheated rhetoric of a war with China — a war Navarro argues we’re losing.

These are all standard tactics in the agitprop documentary playbook: Present one side of a political argument with a dizzying array of semi-credentialed talking heads, leaving dissenting voices on the floor of the editing bay. When your logic is lacking, appeal to emotion instead, depicting derelict factories or unhappy-looking American workers. And, because audiences have been conditioned to expect political documentaries to entertain as well as inform, leaven all the messaging with simplistic cartoons, jaunty music and the occasional joke.

A little later Meslow writes,

Navarro himself appears only briefly, laying out what he views as a practical guide for what the average American can do to combat this threat. "Every time a consumer walks into a Walmart, the first thing they have to do is be aware enough to look for the label. Then, when they pick up that good and it says, 'Made in China,' I want them to think, 'Hmm. It might either break down, or it could kill me, number one. This thing, if I buy it, might cost me, or someone in my family or my friends, their job. Lastly, 'Hey — if I buy this, that money is gonna go over to help finance what is essentially one of the most rapid military build-ups of a totalitarian regime since… when? The '30s. I mean, make no mistake about that."

Again crap economics. So you have been warned. There is more in Meslow's review which you can read for yourself, if you really want to.

Latest Blogwatch column

My Blogwatch column from the latest issue (Issue 57, Decmeber 2016) of the NZAE magazine Asymmetric Information.

A question to end the year with.

A question I have absolutely no idea of the answer to. This comes from Greg Mankiw's blog.

A professor emails me:

My students have the pleasure to use your economics textbook. I have one question: where the symbol "Y" for GDP comes from? All the others, we could detect, such as NX , NCO, etc. My students are curious, and I could not give them a good answer.

My unsatisfying response:

To be honest, I don't know. It is an old convention to use Y to denote real GDP, and I am just following that. But I don't know where or why the convention began.

So anyone who knows the answer let the rest of us in on the secret.

Is the concept of inequality the best way of thinking about our economic problems?

This question is asked by Tyler Cowen in a chapter in a new book The US Labor Market: Questions and Challenges for Public Policy, edited by Michael Strain, which is freely available online from the American Enterprise Institute. The issues raised in the book are relevant to more countries than just the US.

Cowen opens by making an interesting comparison,

I find it useful to compare the productivity slowdown and the increase in income inequality. It seems the productivity slowdown has been of much greater consequence for human welfare, including for lower-income groups. For instance, if American productivity growth had not slowed after 1973, today the median household would earn $30,000 more each year. Alternatively, if income inequality had not accelerated after 1973, today the median household would earn an extra $9,000 more. That is less than one-third of the loss from the productivity slowdown.

One question I would ask is why income inequality and not consumption inequality? Consumption seems more relevant to people's well being.

Cowen goes on to say,

I wish to suggest a simple hypothesis: income inequality (or for that matter wealth inequality) is not the real problem. Rather, the problem is that many Americans are not seeing their lives improve as much as we would like. This is a problem whether or not the top 1 percent is seeing big gains. The problem has to do with the low level of earnings or health or well-being or opportunity for some individuals, not the disparity per se. That is a simple point, but it is difficult to communicate in today’s discourse on these issues, and it turns out to have significant concrete implications for how we should seek remedies.

Later Cowen notes,

Practically speaking, that conceptual mistake misdirects the focus to making people or their outcomes more alike, rather than elevating opportunity for those at the bottom and also in the middle. In fact, opening up enterprise and opportunity for large numbers of people often increases measured income inequality, even when it makes life better for most people, including those at the bottom. Let’s say for instance that global markets were opened up to additional trade, or occupational licensure were relaxed and new commercial opportunities were created. Some people could use these new opportunities to earn much more than others, perhaps millions or even billions more. Probably most people would be better off, but since measured inequality might well rise, analysts who focus on inequality are likely to overlook or undervalue these potential remedies. Keep in mind that the larger a market economy, the larger a country, and the higher the level of aggregate wealth, the higher the level of inequality is likely to be for purely natural reasons; if everything and everyone is clustered at or near zero, inequality just can’t get very high.

Relevant to my question about consumption inequality Cowen points out that,

If we look at the inequality of consumption, rather than income, and count government benefits as a relevant part of income, it turns out actual inequality is considerably lower than many popular or even academic discussions might indicate.

If global inequality is part of the inequality we are worried about, then we should worry less.

Another striking and under-discussed feature of the inequality debates is that global income inequality has been going down for over 20 years. The very poorest people in the world are now much wealthier than before, and significant portions of China, India, Africa, and other developing parts of the world now belong to a growing global middle class. Several billion people have been lifted out of extreme poverty into better circumstances, and over time we can expect the emerging economies to grow at faster rates than the wealthy ones, which will limit inequality all the more. At the same time, scourges such as malaria, polio, and other diseases have for the most part lost ground, most of all in poorer countries. The last 20 to 30 years are probably the most egalitarian time, in terms of income, the world has ever seen. So to the extent income equality is important, we should be celebrating like never before. More specifically, every discussion of income inequality, if it is to be accurate and scientific, should open by framing its worries in the context of a time that has made unparalleled strides toward limiting income inequality overall. Of course for political reasons that is not a popular presentation, but it is an accurate one.

Cowen then looks at key drivers of the increase in inequality. He shows that it makes sense to disaggregate "the inequality problem," as a lot of it isn’t a problem at all, or again it is a problem of some kind other than an inequality problem.

Take as an example one issue you see much discussed which is skills-biased technical change. And there could be a problem here. It is bad that some individuals do not work well with information technology, which is becoming so much more important to most people's work, and this does harm their wages and future opportunities. But the problem part of that equation is not an inequality problem; it is an education problem and a retraining problem. Cowen also discusses issues to do with global markets and rent-seeking.

Cowen sums up this section by saying,

In sum, America [and likely New Zealand] has serious problems of inadequate education, lack of retraining, and some quite bad policies in particular areas. In most cases that disaggregation is a better way of understanding what is going on rather than emphasizing inequality at the macro-economic level. The gap between rich and poor is neither the major driver of the actual problems nor the most important symptom of the most significant problems. Lack of opportunity in absolute terms is the main symptomatic problem.

In the last section of his chapter Cowen looks at the question, How Should Policy Respond? He briefly discusses five areas, Health Care, Occupational Licensing, Education Cheaper Rent and Lower Home Prices, Discontinue or Ameliorate the War on Drugs and End Crony Capitalism.

With regard to house prices and rents, an issue New Zealanders can relate to, Cowen writes,

These days it is harder for Americans to migrate successfully to some of the most economically dynamic American cities, in large part because of high rents and restrictive building codes, stemming from the NIMBY mentality. For a low-skilled worker, the higher wages in New York or San Francisco do not always make up for the much higher rental costs. In the 1950s, a typical apartment in New York City rented for about $60 a month, or adjusting for inflation about $530 a month; today that is closer to the cost of a parking space in Manhattan. If it were cheaper to move into major American cities, more Americans would have an easier path toward a higher salary and a brighter future. Economists Chang-Tai Hsieh and Enrico Moretti have argued that the American economy could become much richer if more workers could move from the low-productivity cities to the high-productivity cities; that would increase income mobility, too. Hsieh and Moretti estimate that lower rents, through building deregulation, could increase American GDP by almost 10 percent. A lot of those gains would go to Americans who cannot currently afford to move to San Francisco and other high-productivity cities.

The size of the effect on GDP of having people move from low-productivity areas to high-productivity areas did come as a surprise to me.

Cowen ends by saying that the United States has some very real and obvious problems, many of which impact the low- and middle-income earners of America in particular, but the concept of inequality is not the best conceptual starting point for finding or evaluating potential solutions.

There are many other interesting points made in Cowen's chapter and it is well worth the read, no matter what your current view of inequality.

The book containing Cowen's chapter also has many other useful chapters on a variety of issues to do with labour markets. Anyone interested in such markets should give it a read.

Should we ban loss leaders?

Loss leaders are one of those retail marketing tricks that are often complained about, for many different reasons. For example, back in 2009 the NBR ran a story Lack of loss-leader sales good news for brand conscious wine industry. In 2011 the Otago Daily Times ran a story claiming,

Supermarkets were also driving binge-drinking by using alcohol as a "loss leader", sold below cost to attract shoppers.

Others see loss leaders as anti-competitive or predatory.

Big chains have the power to buy in bulk, reducing the individual price of products. They use tactics like ‘loss-leaders’ – purposely selling a product below cost to entice customers into their store to buy even more with their ‘savings’. The smaller retailers must match their prices, for fear of losing customers, which reduces their margins. When their rents rise markedly, they are increasingly being forced to move or close.

But are loss leaders really so bad? Are they are anti-competitive or predatory?

A forthcoming paper in the American Economic Review - Unplanned Purchases and Retail Competition by Justin P. Johnson - suggests that loss leaders are non-predatory and possibly even pro-competitive.

Abstract

I propose a framework in which asymmetric multi-product retailers compete for one-stop shoppers who have biased beliefs about their future purchase probabilities (and so make unplanned purchases). One firm carries a full portfolio of products while the other carries an incomplete but endogenous one. Using this framework, I examine the phenomenon of loss leading, the optimal product portfolio of the smaller firm, and the effects of banning loss leading. Among other results, I show that there is a non-predatory (and possibly pro-competitive) justification for the observation that such larger firms may charge below cost on the core product lines of their smaller rivals.

So, sorry, but banning loss leaders may not be such a great idea.

Institute of Economic Affairs: 2016 - a year in review podcast

IEA staff join IEA News Editor Kate Andrews (chair) to discuss all of the surprises and upsets in 2016, what these revelations will mean for the new year.

First, we hear from IEA Director General Mark Littlewood and Digital Officer Madeline Grant join in to discuss the unforeseen triumph of the campaign to leave the European Union.

After that we hear from Communications Director Stephanie Lis and Head of Lifestyle Economics Christopher Snowdon on the aftermath of the Brexit vote, particularly concerning the new government that has risen up because of it.

And finally, Mark will be back to chat with Kate about how America ‘made politics interesting again.’

Also hear from Mark, Maddie, Stephanie and Christopher about their favorite moments, statistics, and 'Person of the Year' in 2016, as well as their best prediction for 2017.

Interesting blog bits

1. The IEA blog covers a new IEA publication on Balancing the economy: The hand of government or the invisible hand?
   

   Despite its considerable strengths, the UK economy is seen as having a number of problems, in particular productivity which lags behind some competitors, low levels of investment and persistent regional disparities. Following the referendum decision to leave the EU, there is wide interest in developing a new industrial strategy. The UK government's proposals are unlikely to help the situation.

2. Jenesa Jeram suggests This Christmas, reject sugar taxes and embrace the joy of food

   We don't need a sugar tax to protect us from Christmas excesses.

3. Andrew Bernard, J. Bradford Jensen, Stephen Redding, Peter Schott on Global firms: Insights for trade and trade policy
   

   Events of the last year have raised questions about the future growth of international trade. This column examines the role played by ‘global firms’ that both import and export, and are likely to be part of multinationals, in the international economy. In a world of interdependent firm decisions, small reductions in tariffs or trade costs can have magnified effects on trade flows, as they induce firms to serve more markets with more products at greater volumes, and also to source greater volumes of intermediate inputs from more countries. At the same time, policies to restrict imports can end up hurting producers for whom both importing and exporting are a central pillar of their overall business strategy.

4. Scott Sumner asks Did monetary offset cause the Great Recession?

   In the past, it has been argued by Summer that tight money caused the Great Recession. But what caused the tight money?

5. Ed Dolan asks What Is the Nairu and Why Does it Matter?

   What happens in terms of US monetary policy will depend, in large part, on what may be the wonkiest number in all of economics—the Nairu. Nairu stands for Non-Accelerating Inflation Rate of Unemployment—such a mouthful that no one ever says it out loud. The basic idea behind the Nairu is simple. It is widely accepted that as the economy moves through the business cycle from recession to expansion to boom, shortages develop in labor and product markets that put upward pressure on prices and wages. The Nairu is supposed to capture the sweet spot—the lowest level to which the unemployment rate can safely fall before inflation starts to accelerate.

6. Scott Burns on Cashing Out of Poverty

   Financial innovations like mobile money have gained fame for transforming commerce in the developing world. But they’re also helping the poor escape poverty.

7. Timothy Taylor offers An Appetizer Buffet of Economic Research Highlights

   The sort of readers who find Taylor's blog interesting might also want to check out the "Research Highlights" blog being run by Tim Hyde for the American Economic Association. Once or twice each week, the blog features a paper chosen from this set of seven journals and offers up a short, readable, nontechnical overview. Here are some examples from the last few weeks.

Import duties

The University of Chicago Booth School of Business Economic Experts Panel was asked the question,

Adding new or higher import duties on products such as air conditioners, cars, and cookies — to encourage producers to make them in the US — would be a good idea.

In response 93% of them "Disagreed" or "Strongly Disagreed". There were three "Did Not Answer" so of those who did answer 100% went with either "Disagreed" or "Strongly Disagreed".

In the comments on their vote Oliver Hart noted,

Duties lead to dead-weight losses and also retaliation.There can be losers from free trade but there are better ways to compensate them.

while Austan Goolsbee just said,

stupid

I guess none of these guys will be getting jobs in Trump's White House National Trade Council.

Fiat money vs. the gold standard

Scott Sumner and Larry White take on monetary policy in this Econ Duel.

Throughout the 19th century and up until the Great Depression, the gold standard was used in the United States. It was largely abandoned in the 20th century.

But what is the gold standard? It’s a system for defining the value of a currency in terms of gold. In other words, you could exchange your $20 paper bill for actual gold at one point in history.

Under a fiat money system, such as the one we have in the U.S. today, that $20 paper bill is inconvertible. You can’t exchange it for a backing store of value because there isn’t one.

In this Econ Duel, economists Scott Sumner and Larry White, who both focus on monetary theory and policy, debate the positives and drawbacks to the gold standard vs. fiat money, and the role of central banks.

On the side of the gold standard, White argues that, when properly implemented without a central bank intervening, it provides a more predictable price level and lower average inflation.

Sumner, taking up the banner for fiat money, argues that the gold standard is simply a rule that worked well in the 19th century and that a good fiat money system is, for this day and age, a better alternative.

What is holding firms back in developing countries?

Chris Woodruff, IGC research programme director, explains why improving management practices is critical for the development of the private sector in developing countries.

Why is rent do damn high?

Many of the arguments here apply to New Zealand.

You’ve no doubt heard it before: the rent is too damn high!

In major cities across the United States, rent prices have been skyrocketing for some time. As a percentage of median income, rent is much higher for those that choose city life over suburbia.

But why are rental prices in these cities so expensive, and what can we do about it?

It’s a classic case of supply and demand: lots of people want to move to big cities because of the opportunities they afford. Naturally, they demand housing. But the supply is often short due to many factors, from geography to regulations. What does economics tell us happens when there’s a lot of demand, but not so much supply? Prices rise. As a consequence, many people are priced out of pursuing the lucrative opportunities available in major cities.

Coastal cities, like San Francisco and New York, have obvious geographical restrictions on building “out.” One way to deal with this problem is to build upwards with more skyscraper housing. This often isn’t feasible due to regulations on building heights, density, parking requirements, etc. But these regulations could be lessened or removed, allowing big cities to become denser and lowering rent prices. Lifelong city-dweller Matt Yglesias discusses this approach in this Duel.

On the other side, Tyler Cowen, who has always lived in the suburbs, argues that allowing cities to become denser may only provide a short-term solution. As more people move in, the cities become more productive with higher incomes for their inhabitants. And the rents rise again.

What to say to those who lose their jobs because of imports

Here at the Cafe Hayek blog Don Boudreaux takes up one of the most difficult issues to do with advocating free trade, what does an advocate of free trade say to to those who lose jobs to imports?

Nothing that you say to someone who loses his or her job to changing market conditions is likely to satisfy that person. The personal almost always trumps the abstract. The seen hides the unseen. The proximate overwhelms the distant. The present is real while the future is still to be created. This reality, however, does not diminish the importance of defending free trade honestly, unconditionally, and without apology.

Such a defense begins with the insistence that jobs are not lost to imports or to foreigners; instead jobs are lost to fellow citizens – in two ways. First, it is the spending decisions of fellow citizens that determine when particular jobs are created and when they are destroyed. Second, the job lost by Smith is replaced with a new (and likely very different) job filled, if not by Smith, then by Smith’s fellow citizen Jones. So when someone complains about losing his or her job “to imports,” it is right to note that protecting that job necessarily requires that fellow citizens’ freedoms be curtailed and fellow citizens’ economic well-being be reduced. Protection necessarily shrinks the spending power of countless fellow citizens. Protectionism also destroys the actual jobs of many other fellow citizens (for example, jobs in domestic machine-tool factories that disappear because steel tariffs take a bite out of domestic machine-tool production) and destroys the job prospects of still other fellow citizens (for example, retail-store-management jobs that never materialize because tariffs on consumer goods reduce consumers’ demand for such goods).

Again, no such arguments will satisfy someone who believes that his job disappeared because of international trade. But that person’s refusal to accept that these arguments are part of a sound case for free trade does not, as emotionally understandable as this refusal is, render these arguments invalid. If we mute or trim our defense of free trade out of understandable sympathy with the unemployed worker who we see, we are complicit in supporting a system – protectionism – that not only destroys the jobs of workers who we don’t see (but who are, and whose sufferings are, every bit as real as the worker who we do see), but also will deny to our children and grandchildren a future that is as prosperous and as peaceful as possible.

It is necessary to keep in mind when defending free trade that it will destroy some jobs (a fact that is often clearly seen), and this has very real negative effects on people, but it is also necessary to realise that it will also create jobs (a fact that is often unseen) which has very real positive effects on other people. As Paul Krugman has written,

It should be possible to emphasize [...] that the level of employment is a macroeconomic issue, depending in the short run on aggregate demand and depending in the long run on the natural rate of unemployment, with microeconomic policies like tariffs having little net effect. Trade policy should be debated in terms of its impact on efficiency, not in terms of phony numbers about jobs created or lost.

The trade economist Douglas Irwin has this to say on the matter of trade and jobs,

The claim that trade should be limited because imports destroy jobs has been around at least since the sixteenth century. And imports do indeed destroy jobs in certain industries: [...]

But just because imports destroy some jobs does not mean that trade reduces overall employment or harms the economy. [...]

So in terms of jobs the free trade/protection debate is about which jobs there are in an economy rather than the total number of jobs. Changes in trade policy moves jobs a round the economy, free trade moves jobs away from sectors of the economy that produce things we are (relatively) bad at doing towards things we are (relatively) good at doing. Each of free trade and protection will be good for some people and bad for others. Perhaps the real question is, how do we best help those who in the short-run are harmed by changes in trade policy?

Bad politics drives out good economics

The idea that politicians will deliberately implement economic policies they know to be bad just to help them politically is highlighted here in a paper about Richard Nixon's wage and price controls.

The Political Economy of Wage and Price Controls: Evidence from the Nixon Tapes by Burton A. Abrams and James Butkiewicz

Abstract

On August 15, 1971, Richard Nixon imposed the first and only peacetime wage and price controls in U.S. history. The Nixon tapes, personal tape recordings made during the presidency of Richard Nixon, are now available to the public and provide a unique body of evidence to investigate the motivations for Nixon’s macroeconomic policies. We have uncovered and report in this paper evidence that Nixon manipulated both monetary and fiscal policies to create a political business cycle that helped secure his reelection victory in 1972. Nixon was very knowledgeable about economic matters and understood the risks to the economy of his macroeconomic policy actions and the imposition of wage and price controls, but chose to tradeoff longer-term economic costs to the economy for his own short-term political gain.

Interestingly the following comes from an 2000 interview with Milton Friedman:

INTERVIEWER: There is a photograph of you and George Shultz with Nixon in the Oval Office. What did you say to him on that occasion? What did you tell him?

MILTON FRIEDMAN: Well, I don't know what occasion that particular one was, but the one that's relevant to your question is the last time I saw Nixon in the Oval Office with George Shultz. What we usually discussed when Nixon wanted to talk was the state of the economy: what monetary policy was doing.

Nixon was a very, very smart person. In fact, he had one of the highest IQs of any public official I've met. The problem with Nixon was not intelligence and not prejudices. The problem with him was that he was willing to sacrifice principles too easily for political advantage. But at any rate, as I was getting up to leave, President Nixon said to me, "Don't blame George for this silly business of wage and price controls," meaning George Shultz. And I believe I said to him, I think I said to him, "Oh, no, Mr. President. I don't blame George; I blame you! " (laughs) And that, I think, was the last thing I said to him. Now, the interesting point of that story is that the Nixon tapes are now available, and I have been trying to get that part of the Nixon tapes, but I haven't been able to get them yet. I want to make sure I didn't make this up.

Legalising all drugs: an interview with Dr. Jeffrey Miron

Steve Patterson interviews Harvard economist Jeffery Miron about legalising drugs and social safety nets.

World trade and world wars

Trade is a mechanism that helps countries exchange goods, raise welfare, and escape poverty. Open markets allow countries to grow their economies through trade. In this video, Faizel Ismail of the University of Cape Town discusses how African countries can work together to build a regional integration project that, in addition to being more balanced and equitable, results in their ability to compete more effectively in the world economy.

A few interesting economics books of 2016

2016 was a good year for books in economics. Here are a few that I thought interesting.

To start with a New Zealand connection we have A Few Hares to Chase: The Life and Times of Bill Phillips by Alan Bollard. Phillips was a New Zealander most famous for the "Phillips Curve" which shows an inverse relationship between the level of unemployment and the rate of inflation..

Phillips experienced the rigours of the Great Depression on construction sites, and while still a young man he roamed the outback of Australia working in gold mines and sometimes crocodile hunting. In 1937 he set off to discover militarising Japan, a guerrilla war in Manchuria, Stalin's Soviet Union, and the tensions in Europe. On the outbreak of war, he joined the RAF and was sent to Singapore where he rearmed planes but was eventually incarcerated in a POW camp by the Japanese. In camp he learned languages, invented gadgets for the troops and built a clandestine radio. After the war, he scraped through a sociology degree at the LSE, before convincing a faculty to let him build a hydraulic model of the economy. This beautiful complex machine was a great success and put Bill Phillips on the track of serious economics. In the next few decades he developed new ideas for stabilising economies, was one of the first to use electronic computers, developed the Phillips Curve, showed ways to help an economy to grow, and developed new techniques to model economies.

Another book with a New Zealand connection is Was Communism Doomed?: Human Nature, Psychology and the Communist Economy by Simon Kemp, who is Professor of Psychology at the University of Canterbury.

Simon looks at whether the ideology of communism was doomed to failure due to psychological rather than structural flaws. Does communism fail because there is not enough individual incentive and does it discourage psychological ownership? If so, does it produce learned helplessness and therefore empower evil? Such questions are considered both with respect to how communism actually functioned and how it could have functioned using examples from Eastern Europe and the USSR itself. It reviews both the ideology of communism and its history, as well as the basic but difficult question of how one might decide whether an economic system can be defined as successful or not.

Two of the very best book of this year are to do with economic history. A Culture of Growth: The Origins of the Modern Economy by Joel Mokyr and Bourgeois Equality: How Ideas, Not Capital or Institutions, Enriched the World by Deirdre N. McCloskey are about how the rich got rich.

During the late eighteenth century, innovations in Europe triggered the Industrial Revolution and the sustained economic progress that spread across the globe. The big mystery with the industrial revolution is why it took place at all. Why did this revolution begin in the West and not elsewhere, and why did it continue making the rich countries rich in the process? Joel Mokyr argues that a culture of growth specific to early modern Europe and the European Enlightenment laid the foundations for the scientific advances and pioneering inventions that would instigate explosive technological and economic development. Mokyr argues that culture--the beliefs, values, and preferences in society that are capable of changing behavior--was a deciding factor in societal transformations. He looks at the period 1500-1700 to show that a politically fragmented Europe fostered a competitive "market for ideas" and a willingness to investigate the secrets of nature. At the same time, a transnational community of brilliant thinkers known as the "Republic of Letters" freely circulated and distributed ideas and writings. This political fragmentation and the supportive intellectual environment explain how the Industrial Revolution happened in Europe but not China, despite similar levels of technology and intellectual activity. In Europe, heterodox and creative thinkers could find sanctuary in other countries and spread their thinking across borders. In contrast, China's version of the Enlightenment remained controlled by the ruling elite.

Deirdre McCloskey points out that most humans today are better off than their forebears. In this book, the concluding volume of her trilogy celebrating the oft-derided virtues of the bourgeoisie, McCloskey argues that the poorest of humanity will soon be joining the comparative riches of Japan and Sweden and Botswana. Why? Not because of the accumulated capital but rather because of ideas. “Our riches,” she argues, “were made not by piling brick on brick, bank balance on bank balance, but by piling idea on idea.” Capital was necessary, but so was the presence of oxygen. It was ideas, not matter, that drove “trade-tested betterment.” Nor were institutions the drivers. McCloskey builds a powerful case for the initiating role of ideas—ideas for electric motors and free elections, of course, but more deeply the bizarre and liberal ideas of equal liberty and dignity for ordinary folk. Liberalism arose from theological and political revolutions in northwest Europe, yielding a unique respect for betterment and its practitioners, and upending ancient hierarchies. Commoners were encouraged to have a go, and the bourgeoisie took up the Bourgeois Deal, and we were all enriched.

A somewhat depressing and critical voice which argues that the level of economic growth that we have become to depend on will come to an end is raised in The Rise and Fall of American Growth: The U.S. Standard of Living since the Civil War by Robert J. Gordon

Economic growth is often seen as the norm for countries like the United States. Innovations such as electric lighting, indoor plumbing, motor vehicles, air travel, and television transformed households and workplaces. But has that era of unprecedented growth come to an end? The Rise and Fall of American Growth challenges the view that economic growth will continue unabated, and demonstrates that the life-altering scale of innovations between 1870 and 1970 cannot be repeated. Gordon contends that the nation's productivity growth will be further held back by the headwinds of rising inequality, stagnating education, an ageing population, and the rising debt of college students and the federal government, and that we must find new solutions.

Looking not at history but at current economies Per L. Bylund writes on The Seen, the Unseen, and the Unrealized: How Regulations Affect Our Everyday Lives.

This book illuminates the effects of regulations on people’s everyday lives. It traces the effects of regulations on an economy by working through the ripple effects of changes. Regulations, which are restrictions placed on the working of the economy, have consequences, both intended and unintended, direct and indirect. While the direct effects are well understood, the indirect effects are often overlooked because they don’t fit with the common understanding of the economy. More to the point, this book emphasises the real effects of regulation and market change on individual actors, thereby stressing how the economy works to provide an individual with the options that exist in choice situations. The book drafts a new definition of prosperity and well-being which focuses on the individual’s access to valuable alternatives. From this point of view, the real implications of regulation are traced step by step, following the logic of exchange and the effects on individual actors rather than the economy as a whole.

One of the more controversial books of the year is Illiberal Reformers: Race, Eugenics, and American Economics in the Progressive Era by Thomas C. Leonard

In Illiberal Reformers, Leonard reexamines the economic progressives whose ideas and reform agenda underwrote the Progressive Era dismantling of laissez-faire and the creation of the regulatory welfare state, which, they believed, would humanise and rationalise industrial capitalism. But not for all. Academic social scientists such as Richard T. Ely, John R. Commons, and Edward A. Ross, together with their reform allies in social work, charity, journalism, and law, played a pivotal role in establishing minimum-wage and maximum-hours laws, workmen's compensation, antitrust regulation, and other hallmarks of the regulatory welfare state. But even as they offered uplift to some, economic progressives advocated exclusion for others, and did both in the name of progress. Leonard meticulously reconstructs the influence of Darwinism, racial science, and eugenics on scholars and activists of the late nineteenth and early twentieth centuries, revealing a reform community deeply ambivalent about America's poor. Illiberal Reformers shows that the intellectual champions of the regulatory welfare state proposed using it not to help those they portrayed as hereditary inferiors but to exclude them. Leonard discusses his book with Russ Roberts at EconTalk here and with Glenn Loury on the Glenn Show at Bloggingheads.tv here.

For me one of the most interesting books of the year is Adaptation, Specialization, and the Theory of the Firm: Foundations of the Resource-Based View by Birger Wernerfelt.

The book sets out to provide a foundation for a new theory of the firm, drawing on Birger Wernerfelt's work on economic theory and the resource-based view of the firm. It addresses a vigorous and long-standing academic debate over what exactly a 'firm' is, both in the field of management and economics. Wernerfelt revisits his classic articles, including an extensively revised 'A Resource-Based View of the Firm' (1984), which have been updated and synthesised to provide precise and accessible concepts and predictions along with a discussion of two his more recent papers 'On the Nature and Scope of the Firm' (1997) and 'The Comparative Advantages of Firms, Markets, and Contracts' (2015). These papers form the foundations of the 'Adaptation Cost' approach to the theory of the firm.

I shall end with what I, obviously, think of as the greatest book of 2016, The Theory of the Firm: An overview of the economic mainstream by Paul Walker

Firms are a ubiquitous feature of the economic landscape, with much of the activity undertaken within an economy taking place within their boundaries. Given the size of the contribution made by firms to economic activity, employment and growth, having a theoretical understanding of the nature and structure of firms is crucial for understanding how an economy functions.The Theory of the Firm firstly offers a brief overview of the past of the theory of the firm/production. Next, the ‘present’ of the theory of the firm is discussed in three sections. The first section considers the post-1970 theory of the firm literature per se, while the second section scrutinises the relationship between the three most prominent of the modern sets of theories: the reference point, property rights and transaction cost approaches. The third section looks at the theory of privatisation. This volume offers an intuitive introduction to the theories of the firm as well as simple formal models of the most important contributions to the literature. It also outlines the historical evolution of the traditional and modern theories of the firm.

Staying safe this Christmas

Thanks to Ele Ludemann at the Homepaddock blog for advice on staying safe this Christmas:

Please be advised that all employees planning to dash through the snow in a one-horse open sleigh, going over the fields and laughing all the way are required to undergo a Risk Assessment addressing the safety of open sleighs.

This assessment must also consider whether it is appropriate to use only one horse for such a venture, particularly where there are multiple passengers. Please note that permission must also be obtained in writing from landowners before their fields may be entered.

To avoid offending those not participating in celebrations, we request that laughter is moderate only and not loud enough to be considered a noise nuisance.

Benches, stools and orthopaedic chairs are now available for collection by any shepherds planning or required to watch their flocks at night.

While provision has also been made for remote monitoring of flocks by CCTV cameras from a centrally heated shepherd observation hut, all facility users are reminded that an emergency response plan must be submitted to account for known risks to the flocks.

The angel of the Lord is additionally reminded that prior to shining his/her glory all around s/he must confirm that all shepherds are wearing appropriate Personal Protective Equipment to account for the harmful effects of UVA, UVB and the overwhelming effects of Glory.

Following last year’s well publicised case, everyone is advised that human rights legislation prohibits any comment with regard to the redness of any part of Mr. R. Reindeer.

Further to this, exclusion of Mr. R Reindeer from reindeer games will be considered discriminatory and disciplinary action will be taken against those found guilty of this offence.

While it is acknowledged that gift-bearing is commonly practised in various parts of the world, everyone is reminded that the bearing of gifts is subject to Hospitality Guidelines and all gifts must be registered.

This applies regardless of the individual, even royal personages.

It is particularly noted that direct gifts of currency or gold are specifically precluded under provisions of the Foreign Corrupt Practices Act. Further, caution is advised regarding other common gifts, such as aromatic resins that may initiate allergic reactions.

Finally, in the recent case of the infant found tucked up in a manger without any crib for a bed, Social Services have been advised and will be arriving shortly.

Compliance of these guidelines is advised in order for you to fully participate with the appropriate save level of festive spirit.

thxs
Risk Management Team

Is psychology education or indoctrination?

A new paper in Current Psychology asks this question, and the answer isn't completely reassuring. It appears that many first year psychology textbooks pass on falsities, half-truths and urban legends.

Education or Indoctrination? The Accuracy of Introductory Psychology Textbooks in Covering Controversial Topics and Urban Legends About Psychology by Christopher J. Ferguson, Jeffrey M. Brown and Amanda V. Torres

Abstract

The introductory psychology class represents the first opportunity for the field to present new students with a comprehensive overview of psychological research. Writing introductory psychology textbooks is challenging given that authors need to cover many areas they themselves may not be intimately familiar with. This challenge is compounded by problems within the scholarly community in which controversial topics may be communicated in ideological terms within scholarly discourse. Psychological science has historically seen concerns raised about the mismatch between claims and data made about certain fields of knowledge, apprehensions that continue in the present “replication crisis.” The concern is that, although acting in good faith, introductory psychology textbook authors may unwittingly communicate information to readers that is factually untrue. Twenty-four leading introductory psychology textbooks were surveyed for their coverage of a number of controversial topics (e.g., media violence, narcissism epidemic, multiple intelligences) and scientific urban legends (e.g., Kitty Genovese, Mozart Effect) for their factual accuracy. Results indicated numerous errors of factual reporting across textbooks, particularly related to failing to inform students of the controversial nature of some research fields and repeating some scientific urban legends as if true. Recommendations are made for improving the accuracy of introductory textbooks.

Interesting blog bits

1. Matt Ridley asks Why is the left reviving apartheid?
   

   Identity politics is taking us backwards to division and prejudice.

2. Tom G. Palmer on A New, Old Challenge: Global Anti-Libertarianism

   A spectre is haunting the world: the spectre of radical anti-libertarian movements, each grappling with the others like scorpions in a bottle and all competing to see which can dismantle the institutions of liberty the fastest. Some are ensconced in the universities and other elite centers, and some draw their strength from populist anger. The leftist and the rightist versions of the common anti-libertarian cause are, moreover, interconnected, with each fueling the other. All explicitly reject individual liberty, the rule of law, limited government, and freedom of exchange, and they promote instead radical, albeit aggressively opposed, forms of identity politics and authoritarianism. They are dangerous and should not be underestimated.

3. Russ Roberts on The Human Side of Trade

   Free trade is on the run. The president-elect of the United States calls the free market the “dumb market.” He wants to renegotiate past trade deals. The death spiral of manufacturing jobs makes people wonder if trade with China was really such a good idea. Some economists claim to have found evidence that increased trade with China causes an increase in suicide. It is tempting to argue then, that free trade, while good for the economy, is not so good for human beings.

4. Timothy Taylor on the Economics of Gentrification

   "Gentrification" arises when a neighborhood in a city that has in the past offered relatively low-cost housing to relatively low-income people experiences the entry of a wave of higher-income buyers. The new entrants often buy the older housing stock and rebuild or refurbish it, pushing up housing prices in the rest of the neighborhood. On one side, this process offers lower-income people who own their homes a chance for a financial windfall, and can also offer benefits to the neighborhood like improved local job opportunities, shopping options, and public safety. On the other side, gentrification also disrupts existing neighborhoods and can displace low-income residents, some of whom may have been living in the neighborhood for a long time.

5. Michael Reddell on Brexit, Trump and all that

   Last week, The Treasury hosted a guest lecture featuring two visiting academics under the heading Brexit, Trump & Economics: Where did we go wrong. When the invitation went out, I was rather puzzled by the title? Who was this “we” that apparently “got things wrong”?

6. Tyler Cowen on Prizes are flourishing.

   Stumped for solutions to hundreds of industrial and technical problems, businesses and governments alike are turning the search for innovative ideas into prize-worthy puzzles that capitalize on the ingenuity of the crowd.

Big corporations are powerful and long lasting?

From Mark Perry at his Carpe Diem blog

What do the companies in these three groups have in common?

Group A: American Motors, Brown Shoe, Studebaker, Collins Radio, Detroit Steel, Zenith Electronics and National Sugar Refining.

Group B: Boeing, Campbell Soup, Deere, General Motors, IBM, Kellogg, Procter and Gamble and Whirlpool.

Group C: Facebook, eBay, Home Depot, Microsoft, Google, Netflix, Office Depot and Target.

And the answer is:

All of the companies in Group A were in the Fortune 500 in 1955, but not in 2016.

All of the companies in Group B were in the Fortune 500 in both 1955 and 2016.

All of the companies in Group C were in the Fortune 500 in 2015, but not 1956.

It turns out that nearly 9 of every 10 Fortune 500 companies in 1955 are gone, merged, or contracted. Only 12% (and fewer than 1 in 8) of the Fortune 500 companies in 1955 were still on the list 61 years later in 2016, and more than 88% of the companies from 1955 have either gone bankrupt, merged with (or were acquired by) another firm, or they still exist but have fallen from the top Fortune 500 companies.

But we so often told about all powerful big corporations are, how the control markets and can force consumer to buy whatever products they sell. John Kenneth Galbraith is perhaps the most (in)famous economist who argued along these lines. He argued that in the industrial sectors of the economy, which are composed of the largest corporations - think Fortune 500 companies, the principal function of market relations is, not to constrain the power of the corporate behemoths, but to serve as an instrument for the implementation of their power. Moreover, the power of these corporations extends into commercial culture and politics, allowing them to exercise considerable influence upon popular social attitudes and value judgements. That this power is exercised in the shortsighted interest of expanding commodity production and the status of the few - the 1% - is, in Galbraith's view, both inconsistent with democracy and a barrier to achieving the quality of life that the "new industrial state" with its affluence could provide to the many. Galbraith argued that we find ourselves living in a structured state controlled by these large and all powerful corporations. Control over demand and consumers is exercised via the use of advertising which creates a never ending consumer "need" for products, where no such "need" had existed before. In addition, as Princeton University Press said in its advertising for a new edition of Galbraith's "The New Industrial State",

The goal of these companies is not the betterment of society, but immortality through an uninterrupted stream of earnings.

If all this is true why is it that so few have survived from 1955 to 2016?

Another hypothesis is that there’s been a lot of market disruption, churning, and Schumpeterian creative destruction over the last six decades. This suggests that no matter what some economists, and competition policy authorities, may want you to think, corporations are not all powerful and consumers are not just feeble minded puppets having their strings pulled by evil corporate executives. Yes, market competition and consumer sovereignty could actually be a thing.

Joseph Henrich on the difference between economics and psychology

Tyler Cowen interviews anthropologist Joseph Henrich. At one point they talk about the difference between economics and psychology:

COWEN: You’re an anthropologist. You’ve spent a lot of time with economists — coauthored, worked with Paul Romer, Colin Camerer, others. As an anthropologist, what do you find strange about the tribe known as econ? [laughs]

HENRICH: I had a real opportunity. I was very fortunate in my career to be a professor of psychology and a professor of economics at the same time but to be neither in some deep sense. I would get to go back and forth from seminars in economics and psychology.

In economics, there’s this really competitive culture. The way I like to describe it: If you’re giving a seminar in economics, the crowd — everybody’s trying to show who’s the smartest guy in the room. Just on your first slide, someone will raise their hand. (I’m like, I haven’t said anything yet!) Then they’ll try to ask the killer question which undercuts your whole talk so that they can get you right at the beginning.

[laughter]

HENRICH: Whereas psychologists, they’ll sit quietly. They watch your talk. You go through your whole PowerPoint. You probably touched a lot of different research projects.

Then there’ll be question time; at first no hands will go up. Then someone will be like, “I got a question.” Then they say, “I just have one small question. I mean, it was a great talk and this is just a very minor thing.”

Then it could be a killer question at that point when they’ve done the preface. It’s a very strong cultural difference between the econ tribe and the psychology tribe.

I’ve always wanted to write an ethnography: My Life among Two Strange Tribes: The Psychologists and the Economists.

Contracts are important and old ..... really old

From the Presentation Speech by Professor Per Strömberg, Member of the Royal Swedish Academy of Sciences, Chairman of the Nobel Committee for the Prize in Economic Sciences in Memory of Alfred Nobel, 10 december 2016.

At the edge of the Mediterranean − outside today's Izmir, Turkey − the Greek city of Teos was located in ancient times. During recent excavations of that city, archaeologists discovered a 1.5 meter high white marble stele, with a fifty line long chiselled inscription. The stele turned out to be a 2,200 year old lease agreement for a property including buildings, farmland and associated slaves.

A wealthy man in Teos had donated the property to a nearby gymnasium, but the students - who were busy with their studies and sports - leased it out to the highest bidder. One clause in the detailed agreement gave the owners the right to inspect yearly whether the tenant was keeping the buildings in good repair and taking good care of the farmland. More than half of the lines of the inscription listed the extra fees and penalties that could be charged to the tenant in case of a breach of contract. The agreement also gave the owners the right to hold religious ceremonies on the property three days per year; this not only provided the students with spiritual sustenance, but also made their rental income tax-free.

Nobel Prize lectures in economic sciences for 2016

From Nobelprize.org:

Oliver Hart: Incomplete Contracts and Control

Oliver Hart delivered his Prize Lecture on 8 December 2016 at the Aula Magna, Stockholm University.


Bengt Holmström: Pay for Performance and Beyond

Bengt Holmström delivered his Prize Lecture on 8 December 2016 at the Aula Magna, Stockholm University.

Oliver Hart on the good and bad in economics

From Hart's speech at the Nobel Banquet, 10 December 2016

After 47 years working in the area, I have learned that economics is both more and less powerful than people think. It is more powerful because it provides an indispensable set of tools for understanding human behavior. Whether we are talking about an individual's decision about how much education to get, a firm's decision about how much to invest, or a society's decision about how best to tackle global warming, economics can provide an invaluable perspective. In the context of the current prize my co-laureate and I have shown that economics can throw light on whether teachers should be rewarded according to their students' test scores; or whether prisons should be run by private companies or by the government.

This is the good news about economics. It can help us to understand many things. The bad news is that it is not the whole story. For understanding many questions other things matter too: psychology, history, sociology, politics. This is the sense in which economics is less powerful than people think. It provides only part of the answer.

And I would add that it is only part of the answer but it is the part that seems to be ignored in those very cases where it is most powerful and useful.

Oliver Hart interview

Guy Rolnik interviews this year's Nobel Prize in Economics co-winner Professor Oliver Hart about incomplete contracts and the theory of the firm.

Half an hour well spent.

1776 was more about representation than taxation

A question not often asked about the American Revolution, Did Monarchists resisting an incipient democracy movement in Britain prevent a compromise that could have placated the American colonists?

Jen Deaderick writes in the December 2016 NBER Digest:

"No taxation without representation" — the rallying cry of the American Revolution — gives the impression that taxation was the principal irritant between Britain and its American colonies. But, in fact, taxes in the colonies were much lower than taxes in Britain. The central grievance of the colonists was their lack of a voice in the government that ruled them.

The political underpinnings of the American Revolution have been discussed and debated for more than two hundred years, and there are multiple explanations of the causes and multiple analyses of the revolutionary dynamic. One question about the revolution that has remained difficult to answer is why, if a little representation in Parliament could have prevented a war for independence, did King George III not grant it?

This question is the motivation for Sebastian Galiani and Gustavo Torrens' study Why Not Taxation and Representation? A Note on the American Revolution (NBER Working Paper No. 22724). They note, in drawing attention to the role of representation as a spark for revolution, that the average British citizen who resided in Britain paid 26 shillings per year in taxes, compared with only one shilling per year in New England, even though the living standard of the colonists was arguably higher than that of the British.

Most accounts of the events that led to the American Revolution depict a conflict between the colonies and a unified British government. In fact, the researchers argue, the reality was more subtle. They draw on a variety of historical accounts to describe the tension between two rival British interest groups, the landed gentry and the democratically inclined opposition, and to explain the failure to reach a compromise that would have granted representation to the colonies. In particular, they focus on how extending representation would have affected the relative influence of these two groups.

The researchers consider events a century before the American Revolution to have set the stage for the domestic tensions in Britain at the time of the colonial protests. In 1649, during the English Civil War, a rebellion of Parliamentarians overthrew — and beheaded — King Charles I. Oliver Cromwell, who ruled for most of the subsequent decade, supported expanding representation in government beyond landowners, and his government was sympathetic to grievances like those raised by the American colonies many decades later. Following Cromwell's death in 1658, however, Royalists returned to power and sought to restore the historical ruling class.

When the colonies asked for representation in the middle of the 18th century, the monarchy was still recovering from its dethroning, and the landed gentry, now returned to primary power, still felt vulnerable. The researchers point out that the Royalists were contending with factions that sought to bring democracy to Britain. While these opposition groups did not hold significant power, if representatives from the American colonies were invited to join Parliament, they likely would have sympathized with the opposition and expanded their influence. The researchers see this tension as critical to understanding why Britain was so reluctant to enfranchise the colonists.

There were proposals to settle the colonial crisis peacefully, most notably by Thomas Pownall and Adam Smith. Smith, for example, proposed "a system in which the political representation of Great Britain and America would be proportional to the contribution that each polity was making to the public treasury of the empire." Such proposals were rejected by the ruling coalition in Britain. "The landed gentry, who controlled the incumbent government, feared that making concessions to the American colonies would intensify the pressure for democratic reforms, thus jeopardizing their economic and political position," the researchers find.

Ultimately, the opposition of the landed gentry to the demands for representation by the American colonies pushed the colonies to rebellion and independence, but helped to delay the development of the incipient democratic movement in Britain.

Is Trump's deal with Carrier a form of crony capitalism? (updated)

Short answer, yes.

Tyler Cowen, professor of economics at George Mason University, gives a longer and more sophisticated answer in an interview on npr. Cowen comes in about the 4 minute mark.



Update: John Cochrane gives this Carrier Commentary.

Glenn Loury talks to Thomas Leonard

On the Glenn Show at Bloggingheads.tv Glenn Loury (Brown University) interviews Thomas Leonard (Princeton University) about Leonard's recent book Illiberal Reformers: Race, Eugenics, and American Economics in the Progressive Era.

The division of labour and the firm: Robinson (1931)

This material relates to Robinson (1931).

One of the earliest attempts to relate the division of labour to the size of firms was Robinson (1931). In The Structure of Competitive Industry Robinson offered an analysis of the factors that determined the optimum size for a firm. For Robinson the interaction of five factors determined the size of the firm: technique, management, finance, marketing and risk of fluctuations. These various theoretical optima have then to be reconciled in the size or constitution of a real firm after allowing for difficulties and anomalies of growth. The division of labour has a role to play with regard to technique and management. Because of this we will concentrate on these two factors here.

For Robinson the optimum firm is that firm which in existing conditions of technique and organising ability produces at the minimum of long-run average costs. Under the conditions of perfect competition we would expect to see the optimum firm emerge but under conditions of imperfect competition, Robinson notes, it may not materialise. Consider, for example, the case of monopolistic competition in which a firm will be in equilibrium at less than the minimum of average cost.

The first application of the division of labour to the size of the firm that Robinson considers is the relationship between the division of labour and the optimum technical unit. Robinson follows Adam Smith in seeing three different reasons for the division of labour giving rise to more efficient production. First is the increase in dexterity of workmen; secondly, the saving of time which is commonly lost in passing from one type of work to another; and thirdly, the invention of a great number of machines which facilitate and abridge labour, and thus enable one person to do the work of many.

With regard to the issue of dexterity, Robinson notes Smith's observation that a person who works at a given task for some time is likely to develop a skill or knack for doing that task. In addition the division of labour can allow those people with a natural skill for carrying out a given task to specialise in that task.

Adam Smith (and Robinson) also saw an advantage in the division of labour in that specialisation at a task saved the time that would otherwise be spent on passing from one task to another. Time could be saved because workers do not have to move between machines or processes. Also time would be lost if machines had to be reset to perform a different function. The division of labour saves time by concentrating both workers and machine upon a given function, and a larger factory enjoys an advantage over a smaller one in so far as it makes this concentration possible.

The third economy Smith saw is due to the development of specialised equipment to carry out the tasks that the manufacture of an item is divided into. Separation of a process into its constituent parts makes development of machines to carry out those parts easier.

It is important to keep in mind when considering the size of a firm that the principle of the division of labour requires a firm of sufficient size to obtain the maximum profitable division of labour. This size will differ across industries depending on the nature of the production process for that industry and how detailed a division of labour can be implemented for that particular process. Larger firms will, often, have the capacity to implement a greater division of labour than a smaller firm, giving the larger firm an advantage in terms of efficiency.

The next issue discussed by Robinson is what he calls `the integration of process'. Robinson explains that often a large firm has fewer rather than more processes of manufacture. They can utilise a large machine which has been designed to takeover what would otherwise be a series of manual, or at least less completely mechanical, operations. A complicated machine can perform two or three or more consecutive processes and it can thereby eliminate the labour and time which would be required to up the work on each of the successive earlier machines. Only large firms can keep such a machine running at its full capacity and this fact gives the large firm an advantage over the smaller, and less mechanised, firm. But this difficulty can be overcome by the small firm as long as the size of the market for the process is large enough. If a given process requires a scale of production too great for a smaller firm the small firm can outsource the process to specialist firm. But such outsourcing if only possible if the extent of the market for a particular process is large enough to allow the division of labour to develop to the point where a specialist firm is viable. Robinson refers to this outsoucing as 'vertical disintegration'.

The second of the areas for which Robinson sees the division of labour having a role to play is with regard to management. A manager in a small firm will have multiple tasks to preform, some of which he will be good at, others that he will not be so good at. In a larger firm a division of labour can develop which allows managers to specialise on those function for which they are best suited. The larger firm gains in two ways from its division of managerial labour: 1) special abilities to be used to their fullest extent. Talents are not wasted by having managers carry out functions which could be better assigned to another manager with a particular ability at that function. 2) a manger who specialises in a given task will increase their knowledge of that task.

A potential downside of the managerial division of labour is the problem of coordination. As the division of labour becomes greater the problems associated with the coordination of the different parts of the production process also increases. As new tasks are created by dividing up the production process, new administrative functions are also created to coordinate the ever more disjoint production process. The advantage that a larger firm has over the smaller depends, in a large part, on how well it solves this coordination problem.

An additional theoretical problem with Robinson's discussion follows from the implicate assumption in the competitive model that complete contracts can be written. In such a world it is not clear why a firm is needed to carry out production at all. As Coase (1937) first highlighted in a world of complete contracts any organisation form can mimic any other meaning that production could be carried out via the market just as efficiently as within a firm.

Refs.:

• Coase, R. H. (1937). `The Nature of the Firm', Economica, New Series 4 No. 16 November: 386-405.
• Robinson, E A G. (1931). The Structure of Competitive Industry, Cambridge: Cambridge University Press.