Tuesday 31 January 2017

How old is behavioural economics?

I came across an interesting paper the other day that suggests behavioural economics is older than most people think. The paper "The Relations of Recent Psychological Developments to Economic Theory" by Z. Clark Dickinson in The Quarterly Journal of Economics, Vol. 33, No. 3: 377-421 dates from May 1919!

The summary of the paper reads,
The purely objective factors in economics, 377. - Psychological principles necessarily used in addition, 381. Social assumptions, 385. - Psychical factors are human motives, 387; their analysis needed for most social problems, 389. - Adequacy of psychology assumed in economic theory in dispute, 390. - Analysis of arguments pro and con, 392. - Hedonistic foundation, 394. - Costless production, 401. - Industrial peace, 404. - Sums of utility, 406. - Social demand, 407. - Institutional economics, 409. - Most accurate psychology needed, of producers' motives, 415; of consumers' demands, 419.
Dickinson concludes,
And so our tentative conclusion is that an accurate knowledge of the psychology involved in economic behavior is needed in economic theory, not so much for static as for dynamic purposes. It is needed for static theory if we want to be assured that our static theory is as complete and fundamental an explanation as the existing state of knowledge permits. But it is vital for dynamic theory, which looks beyond the existing conditions of wants, social structures and industrial devices, and prophesies what would be the result of various supposed innovations, if they were made. In this same fashion we have long predicted the probable results of hypothetical taxes and tariffs on production, distribution, etc. If we can set up hypotheses as to ways of changing consumers' demands, or producers' springs to action, which psychological science shows to be plausible, and trace their effect on economic life, we shall be adding to the purely scientific theorems which the legislator or reformer may find helpful. And aside from the possible applications to pure economic theory, such knowledge of motives is bound to be useful in the practice of social art.
So suggesting the use of psychological ideas in economics is older than I guess most economists would think.

Wednesday 25 January 2017

The populist parallels of Sanders and Trump

From the Cato Institute comes this Cato Daily Podcast in which Caleb O. Brown talks to John Samples about the parallels between Sanders and Trump.
President Donald Trump and Senator Bernie Sanders have some strong parallels in their populism.

32% off the greatest book ever written

Right now the Book Depository has 32% off The Theory of the Firm: An overview of the economic mainstream with their price being NZ$159. Actually given the publisher price is 95.00 pounds that isn't a bad price.

Those of you with a Kindle, Amazon has it at US$49.68.

Tuesday 24 January 2017

Protection and job losses

At the Cafe Hayek blog Don Boudreaux makes the point that protection does not stop job losses.
You are correct that under a regime of free trade some people, through no fault of their own, lose jobs. You are also correct that such experiences are unpleasant. But protectionism does not stop job losses from occurring. Even if Uncle Sam were to completely shut the American economy off from global markets, job losses would still occur. American consumers would still change their spending patterns such that goods and services that were in high demand yesterday would be in lower demand today. Entrepreneurs would still experiment with new products and with new, labor-saving methods of production and distribution. Economic churn would still happen, complete with its unavoidable job losses.

The difference would be that, being denied access to the creative insights and productive efforts of 95 percent of the world’s population as well as to the bulk of the world’s resources, we’d all be much poorer.
What changes in trade policy do is change who has jobs, not the total number of jobs. Change trade policy and you just move jobs around the economy without having much effect on the total number of those jobs. 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.
But the other point made by Boudreaux is also important, protection makes us poorer. The more we protect, the more we have to do things we are (relatively) bad at doing and the less time we spend on doing things we are good at doing. In the process we make ourselves worse off. It is better for us to concentrate on what we are good at producing and trading that for the things we are bad at producing with people who are good at producing it. As Krugman notes efficiency is what matter and by doing things we are bad at we become less efficient, not more.

Sunday 22 January 2017

Interesting graph on the relationship between US growth and the trade balance.

This graph is from the Econofact website:

You have to be very careful about causation. Does a trade deficient affect growth or does growth affect the trade balance or do third factors affect both?
It is true that when a country's Gross Domestic Product (GDP) is calculated, a trade deficit counts as a negative. But this is a matter of accounting.
By definition, GDP measures the value of the goods and services produced within a country's borders. To tally GDP we take the sum of what households consume, investment by firms and government spending and account for trade by adding what is produced in the nation but consumed abroad (exports) and deducting the value of imports. The (faulty) idea of a “trade deficit drag” comes from this accounting identity – if the difference between exports and imports is large, then a larger number is subtracted from what households, firms and the government consume and the resulting GDP number must be smaller as well.
But this does not mean that a trade deficit causes GDP to be smaller.
The flaw in this logic is that both the trade deficit and GDP are outcomes of other, underlying factors. For this reason, there is no simple, straightforward link between the size of the trade deficit and the level of overall economic activity as measured by GDP. Consider a case where the United States has a spurt of growth due to, say, an increase in infrastructure spending. This spending will raise incomes and, therefore, consumption – including consumption of imported goods. This would be a situation where faster growth is associated with an increase in the trade deficit. Alternatively, the trade deficit could very well decline when there is a recession that reduces consumption of all goods, including imports.

Wednesday 18 January 2017

Patents, prizes and innovation

The use of patents versus prizes to stimulate innovation is a long debated subject. Jean Tirole has written,
"Consider the patent system. It has long been recognized that patents are an inefficient method for providing incentives for innovation since they confer monopoly power on their holders. Information being a public good, it would be ex post socially optimal to award a prize to the innovator and to disseminate the innovation at a low fee. Yet the patent system has proved to be an unexpectedly robust institution. That no one has come up with a superior alternative is presumably due to the fact that, first, it is difficult to describe in advance the parameters that determine the social value of an innovation and therefore the prize to be paid to the inventor, and, second, that we do not trust a system in which a judge or arbitrator would determine ex post the social value of the innovation (perhaps because we are worried that the judge might be incompetent or would have low incentives to become informed, or else would collude with the inventor to overstate the value of the innovation or with the government to understate it). A patent system has the definite advantage of not relying on such ex ante or ex post descriptions (although the definition of the breadth of a patent does) " Jean Tirole, "Incomplete Contracts: Where Do We Stand?" Econometrica, Vol. 67, No. 4 (Jul., 1999), pp. 741-781.
Another round in the debate is about to open with a new NBER working paper on the topic of Prestige and Profit: The Royal Society of Arts and Incentives for Innovation, 1750-1850.
"Debates have long centered around the relative merits of prizes and other incentives for technological innovation. Some economists have cited the experience of the prestigious Royal Society of Arts (RSA), which offered honorary and cash awards, as proof of the efficacy of innovation prizes. The Society initially was averse to patents and prohibited the award of prizes for patented inventions. This study examines data on several thousand of these inducement prizes, matched with patent records and biographical information about the applicants. The empirical analysis shows that inventors of items that were valuable in the marketplace typically chose to obtain patents and to bypass the prize system. Owing to such adverse selection, prizes were negatively related to subsequent areas of important technological discovery. The RSA ultimately became disillusioned with the prize system, which they recognized had done little to promote technological progress and industrialization. The Society acknowledged that its efforts had been “futile” because of its hostility to patents, and switched from offering inducement prizes towards lobbying for reforms to strengthen the patent system. The findings suggest some skepticism is warranted about claims regarding the role that elites and nonmarket-oriented institutions played in generating technological innovation and long-term economic development".
So maybe prizes did not stimulate innovation and possibly patents were more effective. But I'm sure this will not be the last thing we hear on this topic.

The Marshalls (Alfred and Mary) on farming

In the past I have discussed the theory of the farm explaining why farming is one of the few areas left in the economy still dominated by family businesses. The standard argument as to why this is so is given by Allen and Lueck (1998, 2002).

The is key to understanding why so is that 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 abstract from Allen and Lueck reads:
Using a model based on a trade-off between moral hazard incentives and gains from specialization, this paper explains why farming has generally not converted from small, family-based firms into large, factory-style corporate firms. Nature is both seasonal and random, and the interplay of these qualities generates moral hazard, limits the gains from specialization, and causes timing problems between stages of production. By identifying conditions in which these forces vary, we derive test able predictions about the choice of organization and the extent of farm integration. To test these predictions we study the historical development of several agricultural industries and analyze data from a sample of over 1,000 farms in British Columbia and Louisiana. In general, seasonality and randomness so limit the benefits of specialization that family farms are optimal, but when farmers are successful in mitigating the effects of seasonality and random shocks to output, farm organizations gravitate toward factory processes and corporate ownership.
Allen and Luecks's paper is relatively recent, 1998, so this all looks modern using new ideas to so with contracting to explain family farms. But is it so? A week or so ago I was reading Alfred and Mary Marshall's “The Economics of Industry” published 1879 when I came across the following on pages 57-58:
§ 11. The largest industry is that of agriculture; but there is scarcely any other industry which is able to make so little use of the advantages of division of labour and of production on a large scale. For agricultural labourers cannot be grouped together in large masses ; they must be scattered over the country. And each season of the year has its special work: a man cannot spend his life in reaping. So that the work of agriculture cannot be broken up into a vast number of parts each of which is performed by a band of labourers who devote their lives to acquiring a special skill in this class of work.

Agriculture, however, seems to be following in the steps of manufacture. Field steam-engines are becoming common, and new machines to be worked by them or by horse power are appearing in rapid succession. The fields demand every day a smaller number of dull labourers and a greater number of intelligent mechanics.

This change is exercising an important influence in the competition between small and large farms. The small farmer cannot always afford to have a field steam-engine; he cannot afford to have a great number of machines for occasional use. Thus every year puts him at a greater disadvantage relatively to the large farmer. This disadvantage is diminished but not removed by the rapid growth of a subsidiary industry, which undertakes steam ploughing threshing, &c. for farmers, The growth of this industry is the most important step towards obtaining the advantages of division of labour that has ever been made by agriculture.

In comparison with a small farmer a large farmer gains something in economy of buildings, and in economy of materials. He is able to have a better rotation of crops; he can send a great many labourers into a field in which there is anything to be done quickly. He can, as a rule, borrow capital from the banks more easily than a small farmer can. Lastly, the large farmer is likely to have more knowledge and greater skill and enterprise than the small farmer, He probably received· a better education at starting; and he can afford to leave to subordinates much work that the small farmer does himself, so that he has more time and opportunity for increasing his knowledge, And as farms change hands from time to time, the ablest farmers are likely to find their way to the largest farms. Thus the economy of skill is carried further under a system of large, than under one of small, farms. On the other hand the large farmer loses in the matter of superintendence. The small farmer works hard himself: he watches for every trifling gain and every small saving: and those who work under him have little opportunity of being idle or dishonest.
Its often said that in the late 1800s-early 1900s the answer to any student's question about economics was "It's all in Marshall". Well it appears it is!

  • Allen, Douglas W. and Dean Lueck (1998). "The Nature of the Farm", Journal of Law and Economics, 41: 343-86.
  • Allen, Douglas W. and Dean Lueck (2002). The Nature of the Farm: Contracts, Risk, and Organization in Agriculture, Cambridge Mass.: The MIT Press.

Wednesday 11 January 2017

Trump and trade: threatening Toyota via twitter

More on the wacky world that is Donald Trump and trade. From the Cato Institute comes this Cato Daily Podcast in which Caleb O. Brown talks to Simon Lester about Trump threatening companies.
Can the specter of a President-elect threatening companies with punitive taxes really make the U.S. a better place to invest?

Now this is just wacky

In the UK the Labour Party Leader Jeremy Corbyn has suggested setting a maximum earning limit or, effectively, a marginal tax rate of 100%. Here is a two minute video in which Institute of Economic Affairs Director General Mark Littlewood explains why such a 'maximum wage policy' is economically and socially a terrible idea - and why such a policy would even stand to hurt Corbyn's own agenda.

The most obvious point is that high income earners, who are very mobile, just get up and leave the UK or cut back on the work they do. Littlewood makes this point with the example of footballers in the UK. This would reduce the amount of tax that the government gets from high income earners, not increase it. You must also wonder what effect it would have in the long-run on innovation and growth.

Tuesday 10 January 2017

Trump and trade: the protectionist triumvirate

From the Cato Institute comes this Cato Daily Podcast in which Caleb O. Brown talks to Daniel J. Ikenson and Daniel J. Mitchell about Trump and trade:
With Wilbur Ross at Commerce, Peter Navarro at the new National Trade Council, and Robert Lighthizer as U.S. Trade Representative, Donald Trump has assembled a team aimed at protecting U.S. industry from competition.

Monday 9 January 2017

Let the data speak?

From twitter comes these tweets from Modeled Behavior (Adam Ozimek) @ModeledBehavior
and my response
The Coase quote comes from the third G. Warren Nutter Lecture -- "How Should Economists Choose?" -- which Coase delivered at the American Enterprise Institute for Public Policy Research, Washing­ton, D.C., on November 18, 1981.

But its not the full quote,
I remarked earlier on the tendency of economists to get the result their theory tells them to expect. In a talk I gave at the University of Virginia in the early 1960s, at which Warren Nutter was, I think, present, I said that if you torture the data enough, nature will always confess, a saying which, in a somewhat altered form, has taken its place in the statistical literature. Kuhn puts the point more elegantly and makes the process sound more like a seduction: "nature undoubtedly responds to the theoretical predispositions with which she is approached by the measuring scientist."
A little before this quote Coase had said,
Other studies take the form of a test of the theory espoused by the author: there is a model, then regressions, followed by conclusions. In almost all cases it will be found that the statistical results confirm the theory. Sometimes it does happen that some of the expected relationships are not statistically significant, but they will usually be found to be in the right direction. And when results are obtained that do not square with the theory, which occasionally happens, these results are not usually treated as invalidating the theory but are left as something calling for further study. I would not claim that such studies have never led the investigators to modify their theories, but such cases appear to be rather uncommon. Some articles, of course, involve the testing of alternative theories, and this means that some theories are bound to come out worse. But I doubt whether such studies have often led to a change in the views of the authors. My impression is that these quantitative studies are almost invariably guided by a theory and that they may most aptly be described as explorations with the aid of a theory. In almost all cases, the theory exists before the statistical investigation is made and is not derived from the investigation.
Coase goes on to say,
Quantitative studies, or qualitative studies for that matter, may give someone who believes in a theory a better idea of what that theory implies. But such studies, normally quantitative in the natural sciences and increasingly so in economics, also play, as Kuhn indicates, another and very important role. The choice economists face is a choice between competing theories. These studies, both quantitative and qualitative, perform a function similar to that of advertising and other promotional activities in the normal products market. They do not aim simply at enlarging the understanding of those who believe in the theory but also at attracting those who do not believe in it and at preventing the defection of existing believers. These studies demonstrate the power of the theory, and the definiteness of quantitative studies enables them to make their point in a particularly persuasive form. What we are dealing with is a competitive process in which purveyors of the various theories attempt to sell their wares.
Coase then quotes Dan Patinkin:
What generates in me a great deal of skepticism about the state of our discipline is the high positive correlation be­tween the policy views of a researcher (or, what is worse, of his thesis director) and his empirical findings. I will begin to believe in economics as a science when out of Yale there comes an empirical Ph.D. thesis demonstrating the suprem­acy of monetary policy in some historical period and out of Chicago, one demonstrating the supremacy of fiscal policy.
I have always thought there is too much truth in Patinkin's remark.

Coase comments,
Assuming that Patinkin is right and that the empirical findings of economists at Yale and Chi­cago are not the same, this undoubtedly reflects a difference in their view about how the economic system operates, a difference, that is, in the theories espoused at the two universities.
So empirical results are made to fit the theory?

But there are motives for selecting one theory rather than anotherthat are more worrying, and I think it was this concern that lay behind Patinkin's somewhat facetious remark. In public discussion, in the press, and in politics, theories and findings are adopted not to facilitate the search for truth but because they lead to certain policy conclusions. Theories and findings become weapons in a propaganda battle.

To give some perspective on Coase's whole argument, it should be noted that the point of Coase's lecture was to argue against the position Milton Friedman took in his essay "The Methodology of Positive Economics".
Many economists, perhaps most, think of economics as the science of human choice, and it seems only proper that we should examine how economists themselves choose the theories they espouse. The best-known treatment of this question is that of Milton Friedman, who, in the "Methodology of Positive Economics," his most popular paper, in itself a somewhat suspicious circumstance, tells us "how to decide whether a suggested hypothesis or theory should be tentatively accepted as part of " the positive science of economics. As you all know, the answer he gives is that the worth of a theory "is to be judged by the precision, scope, and conformity with experience of the predictions it yields .... The ultimate goal of a positive science is the development of a 'theory' or 'hypothesis' that yields valid and meaningful ... predictions about phenomena not yet observed.

I should say at once that I do not consider Milton Friedman's answer satisfactory.

[ ... ]

The view that the worth of a theory is to be judged solely by the extent and accuracy of its predictions seems to me wrong. Of course, any theory has implications: it tells us that if something happens, something else will follow, and it is true that most of us would not value the theory if we did not think these implications corresponded to happenings in the real economic system. But a theory is not like an airline or bus timetable. We are not interested simply in the accuracy of its predictions. A theory also serves as a base for thinking. It helps us to understand what is going on by enabling us to organize our thoughts. Faced with a choice between a theory which predicts well but gives us little insight into how the system works and one which gives us this insight but predicts badly, I would choose the latter, and I am inclined to think that most economists would do the same. No doubt it would be their belief that ultimately this theory would enable us to make predictions about what would happen in the real world; but since these predictions would emerge at a later date (and probably would also be about different things), to assert that the choice between theories depends on their predictive powers becomes completely ambiguous.

Thursday 5 January 2017

Managing political risk

At the, oddly named, Pro-Market blog Roy Shapira posts about a recent working paper that suggests that firms react to political risk, both passively by cutting investment and employment, and actively by ramping up lobbying efforts.

Shapira writes,
In a recent working paper titled Aggregate and Idiosyncratic Political Risk: Measurement and Effects, Chicago Booth professor Tarek Hassan and co-authors Stephan Hollander, Laurence van Lent, and Ahmed Tahoun employ an innovative methodology to try to narrow the gap in our ability to measure political risks and how firms react to them. Their findings suggest that firms do indeed react to political risk, both passively by cutting investment and employment, and actively by ramping up lobbying efforts. (Emphasis added)
But isn't this exactly what we would expect? Isn't this the outcome that regime uncertainty would tell us we should expect? The whole point of regime uncertainty is that if investors can not be sure as to how future government actions will effect their property rights and their returns to investment they will be hesitant to make long-term commitments. In other words firms cut back on investment and employment. Decisions about such variables are highly sensitive to risk in various forms, including uncertainty over future tax and regulatory policy. One obvious way to deal with such uncertainty is to lobby the government. If you have input into the policy making process you can gain knowledge of any future polices, thereby reducing uncertainty, and also try to influence the policy agenda in ways that are beneficial to your particular industry.

Interview with Jon Elster

An interesting, if too short, interview with Jon Elster (2016 Johan Skytte Prize Winner).

Interview with Jon Elster (2016 Johan Skytte Prize Winner) from The Johan Skytte Prize on Vimeo.

Monday 2 January 2017

Liquor control and homicide

Howard Bodenhorn, of Clemson University, has a new NBER working paper out on Blind Tigers and Red-Tape Cocktails: Liquor Control and Homicide in Late-Nineteenth-Century South Carolina, NBER Working Paper No. 22980, issued in December 2016..

The abstract reads,
In 1893 South Carolina prohibited the private manufacture, transportation, and sale of alcohol and established a state monopoly in wholesale and retail alcohol distribution. The combination of a market decline in the availability of alcohol, reduced variety, and monopoly pricing at state-operated outlets encouraged black markets in alcohol. Because black market participants tend to resort to extra-legal mechanisms for dispute resolution, including violence, one result of South Carolina’s alcohol restriction was an increase in homicide. A continuous-treatment difference-in-difference approach reveals that homicide rates increased by about 30 to 60 percent in counties that more vigorously enforced the law.
Now while the conclusions of the paper are interesting in and of themselves I can't help but think that such results should give supporters of the current "War on Drugs" pause for thought. I mean what are the chances that the war on drugs has helped enforce a black market for drugs involving a recourse to violence to settle disputes and thus an increase in homicides? This is in addition to the violence inherent in the actions of authorities fighting the war on drugs.

The legacy of Frank Ramsey

A short video from the Royal Economic Society about the legacy of the mathematician Frank Ramsey. A man few have heard of but who has had a huge influence on economics.
Frank Ramsey was an economist who died in 1930 aged just 26. But his remarkable research lives on - in the 125th anniversary edition of The Economic Journal he has not one but two articles. Orazio Attanasio discusses the ongoing influence of his work.

Sunday 1 January 2017

Trump's 100-Day Plan

Donald Trump has a 100 day plan (pdf) which includes "Seven actions to protect American workers" (see below).

With regard to this plan The University of Chicago Booth School of Business Economic Experts Panel was asked the question,
Question A: If all of the “Seven actions to protect American workers” in President-elect Trump’s 100-day plan (see link) are enacted, it will more likely than not improve the economic prospects of middle-class Americans over the next decade.
The responses to the question were,

In addition the panel were asked,
Question B: If all of the “Seven actions to protect American workers” in President-elect Trump’s 100-day plan are enacted, it will more likely than not improve the economic prospects of low-skilled Americans over the next decade.
The responses to this question were,

So in answer to the first question zero percent of respondents "Strongly Agree" or "Agree" while in answer to the second question zero percent "Strongly Agree" and two percent "Agree".

Not exactly overwhelming support for the President-elect's plan. For the sake of middle-class and low-skilled Americans you have to hope the economists are wrong. It just doesn't look that likely to me. I don't see how anything good can come of the First, Second and Third of Trumps actions. As many people have already pointed out trade is good for American, restricting it will only hurt the very people Trump claims he wants to help. As action Four, what exactly is a foreign trading abuse? In the eye of the beholder? As to the Firth, Sixth and Seventh actions I suspect that the devil is in the detail.  The outcome will depend on exactly what policies he puts in place to achieve the end.