Josh Zumbrun on the challenges and angst facing the economics profession

From David Beckworth’s podcast series, Macro Musings comes this audio of an interview with Josh Zumbrun on the challenges and angst facing the economics profession.

Josh Zumbrun is a national economics correspondent for the Wall Street Journal. David and Josh discuss what seems to be the diminished status of economists in a populist era and what role economists will play in the Trump Administration. Josh also shares his thoughts on life as an economics journalist in the digital age.

82 copies sold

Today I received a note from my publisher telling me that the greatest book ever written has sold a total of 82 copies! Ok a few fewer than you might expect from a new Harry Potter book, but a (small) step towards being a millionaire.

Thanks to the 82 of you out there.

As for the rest of you ...... shame!

Unpacked: President Trump’s border wall

This video comes from the Brookings Institution:

Vanda Felbab-Brown, senior fellow at the Brookings Institution, unpacks the security, economic and environmental impacts of President Trump’s proposed border wall. Felbab-Brown explains that the wall may accomplish very little and instead jeopardize Mexico-U.S. relations in addition to escalating issues with the existing fence, wildlife and the flow of drugs.

20% off

The publisher, Routledge, of my book "The Theory of the Firm: An Overview of the Economic Mainstream" is offering 20 percent off right now.

That means its just 76 pounds, so be in quickly!!

Those of you with a Kindle can get the Kindle edition for US$50.81 (no idea how they came up with that price!) from Amazon.

Mental experiment on the effects of minimum wages

This thought experiment is from Don Boudreaux at Cafe Hayek.

Imagine that you’re given the option of buying ten-dollar bills for $5 a piece. How many will you buy? The answer is obvious: as many as the sellers of these discount-priced ten-dollar bills will sell to you. Of course, in reality $10 bills are never available for sale at $5 a piece. Or are they?! In a very real way, reality does indeed sometimes offer such deals. If a worker that can produce $10 per hour worth of output is currently paid by his or her employer only $5 per hour, a competing employer can profit by hiring, at some wage higher than $5 per hour, that worker away from his or her current employer. Indeed, employers will compete for this worker until this worker’s hourly wage is bid up to $10. (If you doubt this outcome, the burden is on you to explain why this worker’s wage will stop rising at some amount less than $10 per hour. It’s a surprisingly difficult burden to meet.)

Now imagine that you’re offered the prospect of buying five-dollar bills for $10 a piece. How many $5 bills will you buy? The answer again is obvious: none. Even if you’re a billionaire, you have no incentive to spend $10 to buy a $5 bill. The fact that you can “afford” to do so is irrelevant. If someone is asked to predict how many $5 bills, say, billionaire Nick Hanauer will buy if each of these bills is priced at $10, that someone would surely say “none.” And that someone would surely be correct.

The minimum wage is economically identical to a scenario in which government prohibits the sale of Federal Reserve notes at any price below $10 each. No bill worth less than $10 would be purchased. No one will knowingly buy something worth only $5 for a price higher than $5.

The above example involving Federal Reserve notes is easy to grasp. Yet change the item for sale from “five-dollar bill” to “low-skilled worker who can produce on average no more than $5 worth of output per hour,” and many people – including even some economists – somehow mysteriously find reason to believe that people will pay for $5 bills some price greater than $5.

The drive to mandate paid family leave

From the Cato Institute comes this Cato Daily Podcast in which Vanessa Brown Calder talks to Caleb O. Brown about the effects of mandate paid family leave.

What can federally mandated unpaid family leave tell us about the likely impacts of a proposed mandate for paid family leave?

Relative prices and inflation (updated)

A recent discussion on twitter went as follows:

The basic point is that relative prices changes and inflation are not the same thing despite the fact that the way we calculate inflation makes them look as though they are.

To quote the Federal Reserve Bank Of Cleveland

Relative Price Changes Are Not Inflation

Relative-price changes, like inflation, can cause price pressure in an economy. We experience them every day much like we experience inflation, and they cause changes in standard price indexes. But there the similarity ends. Relative-price changes are not a monetary phenomenon. They arise in market economies as individual prices adjust to the ebb and flow of the supply and demand for various goods. Relative-price movements convey important information about the scarcity of particular goods and services. A rising relative price indicates that demand is outstripping supply (or that supply is falling behind demand), while a falling relative price denotes just the opposite. A rising relative price induces consumers to conserve on the good in question and to look for substitutes. A rising relative price also, by increasing profit opportunities, entices producers to bring more of the good in question to market.

In this way, relative-price changes—no matter how uncomfortable they are for consumers or producers—transmit vital information necessary for the efficient allocation of resources throughout any market economy. Inflation, by contrast, contributes no information useful to our consumption, production, or labor choices. If anything, inflation can temporarily distort vital relative-price signals, leading people to make unsound economic choices. It can even cause people to shift their time and resources away from activities that foster production and long-term economic growth to activities intended to protect their wealth rather than expand it.

Recently, the relative prices of petroleum, agricultural goods, and some other commodities have risen sharply. One factor responsible for much of these increases is the world’s unprecedented economic performance in recent years. Between 2004 and 2007, world output expanded an average of 4.8 percent each year, according to IMF data. While emerging markets, notably China and India, appear to have led the way, nearly every nation on earth shared in the expansion. This growth and development, which itself stems from an increasing willingness of countries to embrace globally integrated markets, has placed greater demand on world resources, leading to sharp increases in the relative prices of commodities. Foods imported into the United States, for example, have increased 4 percent on average each year since 2002 relative to other goods, while the relative prices of imported industrial commodities have increased 17 percent over the same period. Meanwhile, the relative price of petroleum increased 28 percent each year on average—and because petroleum is required to produce food and industrial commodities, its hike fed into their prices as well.

What we need to keep in mind is the difference between what may be called "true or pure inflation" and "relative price changes". One thing that seems odd about much discussion of inflation is the failure to make this distinction.

As noted by the Cleveland Fed changes in relative prices are important because it is relative prices that direct resource allocation. These are the price signals that are important for the smooth functioning of the economy, they provide the incentives for people to change their behaviour. As Cowen and Crampton (2002: 5) put it [t]he Canadian plumber's knowledge of substitutes for copper piping influences the French electrician's choice of home wiring through its effect on the market price of copper. "Pure inflation", on the other hand, is signal jamming noise which can result in the misallocation of resources. One of the major problems with inflation is the fact that people can't tell the difference between changes in relative prices and pure inflation. This is, in part, because the standard measures of inflation, eg changes in the CPI, contain both components: relative price changes and "pure inflation". Sorting these two factors out however is far from easy.

But what exactly is meant when we talk about "true or pure inflation"? Imagine an economy in which every price exogenously doubled. What used to cost $1 now costs $2, those who were paid $10 per hour now are paid $20, and what was worth $100 now is worth $200 and so on. Note that there has been no relative prices changes here. Thus, because people care about trade-offs when making choices, no one will behave any differently in the new "high price" world than they did previously. We would say, there is no "money illusion" in that changes in the unit of account don’t change anything real at all. (In microeconomic theory you learn this when you are told that demand functions are homogeneous of degree zero in prices and income.) Such an equiproportional price level increase, in the example just given the price level has doubled, is what can be called pure inflation.

In a paper - Relative Goods' Prices and Pure Inflation by Ricardo Reis and Mark Watson, CEPR 6593, December 2007 - it is pointed out that central to the story told above is a measure of inflation which is defined by two properties:

1. all prices increase in exactly the same proportion, and
2. the change is unrelated to any relative-price movements.

Reis and Watson argue that the extent to which (2) holds is an inflation measure's "purity." A measure of inflation is purer the more it has been stripped from relative-price changes and so it is closer to the thought experiment carried out above. How then to purify a measure of inflation?

Reis and Watson note that,

[i]n our own work, we noticed that factor analysis also gave a natural way to purify the measure of inflation. Factor analysis produces a set of components (or factors) that explain why prices move together. One of these factors is the equiproportional change in prices that Bryan and Cecchetti emphasised. But the other factors are just as interesting. These factors are measures of relative-price changes due to some common source (say productivity, fiscal, or monetary shocks), and it turns out that a few of these alone account for a great deal of the variability of price changes. Therefore, we can use them to statistically purify our measure of inflation from these main sources of relative price movements.

Using US data Reis and Watson found that

... most of the movements in conventional measures of inflation like the Consumer Price Index (CPI), its core version, or the GDP deflator are due to relative-price changes. Only around 15-20% of the movements in these measures of inflation correspond to pure inflation.

Given that they had measures of relative price changes and pure inflation Reis and Watson could look for evidence of money illusion in their data. They found that once they controlled for relative price changes, the correlation between (pure) inflation and real activity is essentially zero. So,

... when we see that high inflation typically comes with low unemployment or high output, this is indeed driven by the change in relative prices hidden within the inflation measure. When there is pure inflation, that is when all prices increase in the same proportion independently from any relative price changes, nothing happens to quantities.

Update: In a related blog post Michael Reddell at the Croaking Cassandra blog asks What to make of the CPI?

Ricardo and comparative advantage (updated)

David Ricardo is probably most famous because of his introduction of the idea of comparative advantage into economics. Today comparative advantage is the standard reason given as to why countries gain from trade. And as noted in this twit by the great trade economist Doug Irwin, Ricardo's book "Principles of Political Economy" is 200 years old.

But is Ricardo the author of the famous pages in his "Principles of Political Economy"? Some have argued that James Mill is the true author.

In a footnote on page 132 of the fifth edition of his "Economic Theory in Retrospect" Mark Blaug writes

Ironically enough, it is now been shown that the famous pages on comparative advantage in the chapter on foreign trade were almost certainly written by James Mill. Moreover, Ricardo's own conception of foreign trade never effectively went beyond the idea of absolute advantage; in short, he does not deserve the credit he has been given for the theory of comparative advantage.

The basis for Blaug's claim is the paper, by William O. Thweatt, "James Mill and the Early Development of Comparative Advantage", History of Political Economy 8 (Summer 1976) 207-34.

A quick look at Douglas Irwin's book "Against the Trade: An Intellectual History of Free Trade" gives rise to another footnote, from page 91, which reads,

Thweatt's case is plausible because Mill worked closely with Ricardo on the Principles and commented extensively on drafts. Inconclusive evidence against his interpretation comes in a letter from Mill to Ricardo in which he states: "... that it may be good for a country to import commodities from a country where the production of those same commodities cost more, than it would cost at home: that a change in manufacturing sill in one country, produces a new distribution of the precious metals, are new propositions of the highest importance, and which you fully prove." See David Ricardo (1952, 7: 99). Further, in his article on colonies Mill also credits Ricardo with the theory.

It has also argued that Mill explained the idea of comparative advantage better in his "Elements of Political Economy", published after Ricardo's "Principles".

But whoever wrote about comparative advantage Ricardo's book is worth celebrating. So joint Irwin and many other economists in raising a glass of wine, from a country of your choice, to David Ricardo!

Updated: In the comments section to this posting Jorge Morales Meoqui writes,

The authorship debate about comparative advantage has mostly revolved about the relative merits of Ricardo's statement in the Principles and Robert Torrens’ statement in Essay on the External Corn Trade (1815). James Mill never claimed merit for it, and in the letter to his friend Ricardo he indicated unequivocally who should be credited for the insight.

For more on Morales Meoqui's work on the comparative advantage debate see here.

When usury laws are counterproductive

Is it a good idea have a ceiling on the interest rate, be that zero or some positive rate.

We study the effects of interest rate ceilings on the market for automobile loans. We find that loan contracting and the organization of the loan market adjust to facilitate loans to risky borrowers. When usury restrictions bind, automobile dealers finance a greater share of their customers’ purchases, which allows them to price credit risk through the mark-up on the product sale rather than the loan interest rate. Despite having little effect on who receives credit, usury limits therefore have a substantial effect on who provides credit and on the terms of credit granted. Usury limits may harm defaulting borrowers, who face greater liabilities in default than they would if loan contracts were unconstrained.

This is the abstract of a new working paper, Loan Contracting in the Presence of Usury Limits: Evidence from Automobile Lending (Consumer Financial Protection Bureau Office of Research Working Paper No. 2017-02) by Brian Melzer and Aaron Schroeder.

Melzer and Schroeder explain,

Usury restrictions are often motivated by the argument that lenders, if unchecked, will exercise market power and raise interest rates on risky borrowers beyond the level required to compensate for credit losses, origination costs, and required capital returns. Supporters of usury limits thus argue that lenders will respond to interest rate caps by extending credit at lower prices. Opponents counter that price ceilings will cause credit rationing, which reduces access to credit and harms precisely the risky borrowers that supporters of usury limits intend to help. We propose and investigate an alternative view that applies to the large market for certain subprime automobile loans: vehicle sellers can creatively contract around binding usury limits by financing their customers’ purchases and pricing default risk through the mark-up on the vehicle sale rather than through the interest rate.

The strategy of automobile dealers is simple. Vehicle loans are structured as installment contracts that require constant monthly payments for a fixed maturity (typically 3-6 years) and allow the lender to repossess the vehicle if the borrower defaults. Holding fixed the collateral, loan maturity, and principal amount, a lender is typically constrained to adjust the price of credit by changing the interest rate specified in the contract. For a lender that also serves as the vehicle seller, however, there is an additional degree of freedom—marking up the sales price of the vehicle. When the usury limit binds, the integrated dealer-lender can subsidize a negative net present value loan with a higher-margin sale. Within the loan contract, this change amounts to increasing the stated loan amount (along with the sales price) rather than the interest rate, thereby achieving the desired monthly loan payment while still complying with usury law. To give an example, a $9,000 loan at 30% interest has the same required monthly payment as a $10,650 loan at 20% interest over a four-year, fully amortizing term.

While dealers’ contracting flexibility allows them to approximate an unconstrained loan, it does not completely eliminate the friction introduced by the usury limit. First, the constrained and unconstrained contracts are not identical. When a dealer raises the stated loan amount instead of the interest rate, the borrower’s loan balance starts higher and remains higher until the end of the contract. Borrowers who prepay or default thus owe more to the lender when they terminate the contract. Second, risky borrowers may pay higher prices for credit, as their purchases depend upon financing from automobile sellers rather than a broader, and potentially more competitive, universe of third-party lenders. In an equilibrium with usury limits and dealer financing, therefore, few borrowers are completely excluded from the market, but dealers provide captive financing for a larger share of purchases and borrowers that receive dealer financing face different loan terms—lower interest rates, larger loan-to-value ratios, and possibly higher loan payments—than they would in the absence of usury limits (pp. 2-3).

The problem with "ban the box"

Often even well intentioned policies can have harmful unintended consequences. One such example is the "Ban the box" policies that are becoming more widely implemented in the US. Ban the box is a policy that prohibits employers from asking about criminal records. In the short video below, Amanda Agan (Assistant Professor of Economics at Rutgers University) discusses whether these policies affect racial disparities in the chance of getting a job interview.

Julian Simon's "Almost Practical Solution to Airline Overbooking"

The problem of airline overbooking has made headline over the last week. An obvious question this gives rise to is, how do we deal with the problem?

Timothy Taylor at the Conversable Economist blog gives us this explanation of economist Julian Simon's method for dealing with the problem of overbooking. Simon wrote a short note, "An Almost Practical Solution to Airline Overbooking" (pdf), in the May 1968 issue of the Journal of Transport Economics and Policy.

Here's how Simon described the idea in 1968:

Perhaps the reader has suffered a fit of impotent rage at being told that he could not board an aeroplane for which he held a valid ticket. The explanation is clear, and no angry letter to the president of the airline will rectify the mistake, for mistake it was not. The airline gambles on a certain number of cancellations, and therefore sometimes sells more tickets than there are seats. Naturally there are sometimes more seat claimants than seats.

The solution is simple. All that need happen when there is overbooking is that an airline agent distributes among the ticket-holders an envelope and a bid form, instructing each person to write down the lowest sum of money he is willing to accept in return for waiting for the next flight. The lowest bidder is paid in cash and given a ticket for the next flight. All other passengers board the plane and complete the flight to their destination.

All parties benefit, and no party loses. All passengers either complete their flight or are recompensed by a sum which they value more than the immediate completion of the flight. And the airlines could also gain, because they would be able to overbook to a higher degree than at present, and hence fly their planes closer to seat capacity. ...

But of course this scheme will not be taken up by the airlines. Why? Their first response will probably be "The administrative difficulties would be too great". The reader may judge this for himself. Next they will suggest that the scheme will not increase net revenue. But the a priori arguments to the contrary make the scheme worth a trial, and the trial would cost practically nothing and would require no commitment.

What are the real reasons why this scheme will not be adopted? Probably that "It just isn't done", because such an auction does not seem decorous; it smacks of the pushcart rather than the one price store; it is "embarrassing" and "crass", i.e., frankly commercial, like "being in trade" in Victorian England.

It does seem better than beating people up and dragging them off planes.

When business loves regulation

From NPR's Plant Money comes this audio on

A few years ago, Jestina Clayton started a hair braiding business in her home in Centerville, Utah. The business let her stay home with her kids, and in good months, she made enough to pay for groceries. She even put an ad on a local website. Then one day she got an email from a stranger who had seen the ad.

"It is illegal in the state of Utah to do any form of extensions without a valid cosmetology license," the email read. "Please delete your ad, or you will be reported."

To get a license, Jestina would have to spend more than a year in cosmetology school. Tuition would cost $16,000 dollars or more.

On today's show: Why it was illegal to braid hair without a license in Utah. And why hundreds of licensing rules in states all around the country are a disaster for the U.S. economy.

The good news in this story comes in the update at the end.

Yes, a lot of economists do agree on somethings,

and one of those things is the benefits that immigrants to a country bring. The following is the text of An Open Letter from 1,470 Economists on Immigration (pdf).

Dear Mr. President, Majority Leader McConnell, Minority Leader Schumer, Speaker Ryan, and Minority Leader Pelosi:

The undersigned economists represent a broad swath of political and economic views. Among us are Republicans and Democrats alike. Some of us favor free markets while others have championed for a larger role for government in the economy. But on some issues there is near universal agreement. One such issue concerns the broad economic benefit that immigrants to this country bring.

As Congress and the Administration prepare to revisit our immigration laws, we write to express our broad consensus that immigration is one of America’s significant competitive advantages in the global economy. With the proper and necessary safeguards in place, immigration represents an opportunity rather than a threat to our economy and to American workers. We view the benefits of immigration as myriad:

• Immigration brings entrepreneurs who start new businesses that hire American workers.
• Immigration brings young workers who help offset the large-scale retirement of baby boomers.
• Immigration brings diverse skill sets that keep our workforce flexible, help companies grow, and increase the productivity of American workers.
• Immigrants are far more likely to work in innovative, job-creating fields such as science,
• technology, engineering, and math that create life-improving products and drive economic growth.

Immigration undoubtedly has economic costs as well, particularly for Americans in certain industries and Americans with lower levels of educational attainment. But the benefits that immigration brings to society far outweigh their costs, and smart immigration policy could better maximize the benefits of immigration while reducing the costs. We urge Congress to modernize our immigration system in a way that maximizes the opportunity immigration can bring, and reaffirms continuing the rich history of welcoming immigrants to the United States.

Sincerely,

SBW v's BNZ

Sonny Bill Williams has made the news over the last week for this objection to the BNZ logo on his Blue's jersey. My first reaction to hearing his news was, will he return that part of his salary that the BNZ pays? If the BNZ are the modern day version of the baby-eating Bishop of Bath and Wells then along with covering up the BNZ logo should SBW not, for the sake of consistency, also return whatever part of his salary the bank provides? Where does Williams think the money for his salary comes from if not the sponsors? Money made by charging interest.

At the Stuff website Tony Smith writes,

The practising Muslim issued a statement on Wednesday, saying his objection was "central to my religious beliefs". "As I learn more, and develop a deeper understanding of my faith I am no longer comfortable doing things I used to do. So while a logo on a jersey might seem like a small thing to some people, it is important to me that I do the right thing with regards to my faith and hope that people respect that."

But is this central to his religion? Yesterday I was reading, for other reasons to do with the Islamic approach to the corporation, Timur Kuran's (Professor of Economics and Political Science, and Gorter Family Professor in Islamic Studies at Duke University) book "The Long Divergence: How Islamic Law Held Back the Middle East" when I came across this comment,

In its strict interpretation, classical Islamic law requires every loan, regardless of size or purpose, to be free of interest. The principal justification is that the ban appears in the Quran. What the Quran explicitly prohibits is riba, an ancient Arabian practice whereby the debt of a borrower doubled if he failed to make restitution on time. Riba commonly resulted in confiscation of the borrower's assets, even in his enslavement. In banning the practice, Islam effectively prohibited immiserization and enslavement for debt (Kuran 2011; 144-5).

Sounds all fairly sensible. But then Kuran writes,

It is not self-evident that a ban on riba requires a general and timeless prohibition of interest (Kuran 2011; 145).

Thus how did we get the ban?

A little later Kuran sends a couple of pages (pp. 147-150) explaining how in practice people evaded the interest ban. Clearly interest free loans would diminish lenders incentive to lend. Thus borrowers often compensated their creditors through payments that amounted to interest, if not actually being interest. Kuran goes on to say,

All such firms of casuistry received religious stamps of approval, although the legality of any given form could very across Islam's schools of law (Kuran 2011: 150).

If Kuran is right and interest in general is not prohibited and the prohibition is honoured in the breach then how did Islamic law get from this to the position SBW is taking?

Also one has to ask if we accept SBW's objection to the BNZ logo where does this end? In his Stuff article Smith wants the All Blacks to lodge an objection to the sponsorship by AIG. And this raises the important point, if we accept SBW's objection, what objections to sponsors can be rejected?

If a player has strong environment beliefs can they object to a sponsor on that firm's environmental record? Does the firm pollute waterways? What if a player is a "social justice warrior" can they lodge an objection on the grounds of the social effects of a given firm's actions, say their use of "sweatshops" in other countries? What if someone is an economic nationalist, can they object to a sponsor on the grounds that that firm closed a New Zealand plant and "moved those jobs overseas"? Which objections are acceptable and which are not? And how is the difference to be determined?

Accepting any "conscientious objection" to a sponsor could be seen as opening a real can of worms for future sponsorship deals. If sponsors think they may not get the exposure they thought they would get do they cutback on the amount of money they offer or even pullout of sponsorship deals altogether. Either way this can't be good for professional sport.

Ref.:

• Kuran, Timur (2011). The Long Divergence: How Islamic Law Held Back the Middle East, Oxford: Oxford University Press.

Why do financial institutions exist?

Financial institutions have made the news over the last few day, albeit for very strange reasons. But why, you could ask, do such institutions exist in the first place?

Professor Philip Booth argues the answer is very simple, they reduce transaction costs.

Financial institutions exist to reduce transactions costs. Without them, somebody saving money for a rainy day or for their pension would have to seek out and assess the creditworthiness of a vast number of individuals or companies before lending them money. And, without securities markets and banks providing on-demand deposits, the cost of individuals realising their investments at convenient times would be huge.

That firms exist since they reduce transactions costs is the point made by Ronald Coase way back in 1937. According to Coase we carry out a transaction within a firm when doing so costs less than carrying out that transaction across the market.

Of course this is dependent on technology. As technology changes so does the relative advantage of markets compared to firms. This is just as true in finance as anywhere else. For example:

Peer-to-peer lending radically simplifies the “middle-man” in credit transactions; and other innovations are on their way in finance. In China, 2,000 platforms intermediate £100bn of peer-to-peer lending.

Such changes in technology does mean that it is quite possible that banks will go the way of the dodo. The market may become cheaper than the firm. But it doesn't mean that charging interest will go the same way.

Rise the price, don't beat people up

From Stuff: Man dragged off overbooked United flight by police as fellow passengers look on in horror

Passenger Audra D. Bridges posted the video on Facebook. Her husband, Tyler Bridges, said United offered US$400 (NZ$574) and then US$800 vouchers and a hotel stay for volunteers to give up their seats. When no one volunteered, a United manager came on the plane and announced that passengers would be chosen at random.

I can't help but think the airline has missed the obvious here. The price offered was too low. If you want people to get off the flight then keep raising the price till its worth while for people to get off. Don't beat them up and drag them off the flight. There will be a price at which people will get off.

People will value a seat on a given flight in the same way they value any other good or service, what the airline has to do is workout what that value is. The easiest way is to keep raising the compensation offered until someone takes the offer. That way the passenger is happy, they voluntarily took the offer, and the airline is happy, the required number of people have left the flight. The price mechanism works better than violence. This removes the need to beat passengers up.

Could this get expensive for the airline, yes. But you want it to be expensive. If airlines are to be given the incentive not to remove people from flights then you want removal to be expensive, that way the airline will think twice before getting themselves into a position where they have to do it.

Ninja Economics twittered the new United Airlines setting plan.

Tyler Cowen on complacency, immobility, and stagnation

From David Beckworth’s podcast series, Macro Musings comes this audio of an interview with Tyler Cowen on complacency, immobility, and stagnation.

Tyler Cowen is a professor of economics at George Mason University as well as the general director of the Mercatus Center at George Mason University. He joins the show to discuss his new book, *The Complacent Class: The Self-Defeating Quest for the American Dream.* Tyler argues that restlessness and willingness to take risks have been key traits throughout American history. However, in the last few decades, American society has become more risk-averse. While we may have become more comfortable with less risk-taking, this complacency has led to less innovation and dynamism in the economy. Such stasis is causing economic stagnation and other woes throughout the United States.

Austan Goolsbee on concentration in America

From the Pro-Market blog comes this short interview with Austan D. Goolsbee (Robert P. Gwinn Professor of Economics and the University of Chicago Booth School of Business) on the question of concentration in American industry.

Q: The discourse on concentration, market power, and bigness in many U.S. industries has increased dramatically in the last year. Do you believe that we have enough empirical evidence to show that concentration is on the rise and having adverse effects on the economy?

Definitely not. The only representative evidence we have comes from the Economic Census data every five years and is released with a lag. Everything else comes from court cases or non-representative samples and is filled with ambiguity and myth.

Q: In your opinion, what are the main reasons for the rise in concentration?

Wow. Very hard to say so far. Actually, there’s an important task to be done to convincingly even document that is an actual fact.

Q: Which industries should we be concerned with when we look at questions of concentration?

We care about market power, not concentration. Industries where market power can harm consumers the most are the ones we should care the most about. If it slows the rate of innovation, those are probably the worst ones.

Q: Has consolidation in the financial industry played a role in concentration or antitrust issues in the U.S.?

As a factual matter, yes, it has played a role.

Q: The five largest internet and tech companies—Apple, Google, Amazon, Facebook, and Microsoft—have outstanding market share in their markets. Are current antitrust policies and theories able to deal with the potential problems that arise from the dominant positions of these companies and the vast data they collect on users?

There are lots of particulars to the industries of those five different cases.

Q: Is there a connection between the growing inequality in the U.S. and concentration, dominant firms, and winner-take-all markets?

Probably. But we don’t really know more than correlations at this point.

Q: President Trump has signaled before and after the election that he may block mergers and go after certain dominant companies. What kind of antitrust policies should we expect from him? Pro-business, pro-competition, or political antitrust?

I don’t expect antitrust enforcement from his administration, basically, at all. I guess in your schema that would be a combination of pro-business and political.

N. Gregory Mankiw: America's economy and the case for free markets

From Conversations with Bill Kristol comes this interview with N. Gregory Mankiw. Mankiw is the Robert M. Beren Professor of Economics at Harvard University. The discussion is about the state of the American economy and why we need free markets.

Sam Peltzman on concentration in America

From the Pro-Market blog comes this short interview with Professor Sam Peltzman (Ralph and Dorothy Keller Distinguished Service Professor Emeritus of Economics at the University of Chicago Booth School of Business) on the question of concentration in American industry.

Q1: The discourse on concentration, market power, and bigness in many U.S. industries has increased dramatically in the last year. Do you believe that we have enough empirical evidence to show that concentration is on the rise and having adverse effects on the economy?

There are two questions here. We have enough evidence that concentration has increased in recent years. The best data are for manufacturing. I’ve documented the trends in that sector in a 2014 article in the Journal of Law and Economics. Briefly, concentration began rising in this sector in the late 1980s and continued doing so for the next 20-25 years. This process may still be going on. While the data for other sectors is not so good, it is likely that concentration in sectors such as retailing and services has also increased over roughly the same period.

We do not have enough evidence that this process is having adverse effects on the economy. There are some retrospective merger studies that tilt in that direction. But they are focused on a few industries. And there are many ways beyond mergers that concentration increases. There is simply no broad base of evidence that the rise in concentration has had adverse—or beneficial— effects on the economy.

Q2: In your opinion, what are the main reasons for the rise in concentration?

Again, we don’t really know. The timing of the upward trend (beginning in the 1980s) makes it tempting to implicate the relaxed antitrust policy toward mergers, which was formalized in the 1982 merger guidelines. Perhaps there is something to such a connection. But the trend is pervasive and not driven exclusively by mergers.

This raises the possibility that larger scale has just become a more efficient way of doing business. That possibility may, in turn, be related to evidence that the economy has become less dynamic, in the sense that job turnover has been historically higher for small firms than for large, so the reduced turnover seems to signify less innovation and risk taking by small firms. That can be both a symptom and a cause of growing concentration.

Q3: Which industries should we be concerned with when we look at questions of concentration?

The traditional answer, embedded in the merger guidelines, is “be concerned if concentration increases in an already concentrated industry.” The evidentiary basis for this is thin. A much older literature struggled vainly for years to find a broad pattern whereby adverse effects of concentration could be localized to highly concentrated industries. I am unaware that the state of knowledge on where we should be concerned—or indeed if we should be concerned—has improved much. Basically, antitrust policy relies more heavily on beliefs rather than a strong consensus about facts.

Q4: Has consolidation in the financial industry played a role in concentration or antitrust issues in the U.S.?

I don’t know, but my guess would be ‘no.’ The question suggests that perhaps smaller firms have had increased difficulty in raising capital. That remains to be demonstrated. There is, to be sure, a regulatory issue in that Dodd-Frank rules make it harder to grant ‘character’ (unsecured) loans and to avoid writing them down when they stop performing. This can’t help someone with little more than a good idea and a willing banker.

Q5: The five largest internet and tech companies—Apple, Google, Amazon, Facebook, and Microsoft—have outstanding market share in their markets. Are current antitrust policies and theories able to deal with the potential problems that arise from the dominant positions of these companies and the vast data they collect on users?

See my answer to question 3 above. It is hubris to believe that economists and antitrust officials can predict the future, which is what you need to do in this sector. Who remembers that free web browsers were once thought to be a dangerous threat to competition?

Q6: Is there a connection between the growing inequality in the U.S. and concentration, dominant firms, and winner-take-all markets?

The timing suggests so, but there are a lot of unconnected dots in this question. We do know that wage inequality across firms has increased. Larger firms have always paid more. That premium has increased. That may be symptomatic of the ‘larger firms are more productive’ view raised above in question 2.

Q7: President Trump has signaled before and after the election that he may block mergers and go after certain dominant companies. What kind of antitrust policies should we expect from him? Pro-business, pro-competition, or political antitrust?

See question 5 above. I prefer humility to hubris.

Employment effects of Chinese imports in the US

In 2013, Autor, Dorn, and Hanson published a paper in the American Economic Review showing that rising import competition from China has been an important contributor to the recent decline in the employment rate of working age population in the United States.

Exploiting variation in exposure to Chinese import across local labor markets (commuting zones) over 1990-2007, they find that Chinese import exposure caused a large reduction in manufacturing employment: a $1,000 per worker increase in import exposure over a decade reduces manufacturing employment per working-age population by 0.6 percentage points (their Table 3, column 6), explaining about 44 percent of the actual decline in manufacturing employment from 1990 through 2007. Furthermore, the negative employment shock by Chinese imports goes beyond manufacturing and exists for nonmanufacturing workers. To be more specific, import exposure to Chinese imports caused a substantial employment decline in both manufacturing and nonmanufacturing sectors for workers without college education; while for workers with college education, import exposure caused substantial job loss in manufacturing sectors but a statistically insignificant increase in employment in nonmanufacturing sectors (their Table 5, Panel B) (Feenstra, Ma and Xu 2017: 2).

Robert Feenstra, Hong Ma and Yuan Xu have written a comment, "The China Syndrome: Local Labor Market Effects of Import Competition in the United States: Comment" (pdf), on that paper. In their comment Feenstra, Ma and Xu report results that cut the total employment effect in half, and in some groups the employment effect becomes insignificant, by controlling for the US housing boom .

The comment's abstract reads,

We re-examine the findings by Autor, Dorn, and Hanson (ADH, American Economic Review 2013, 103(6)) on the impact of Chinese import penetration on U.S. local employment by taking into account the concurrent housing boom. The responses of total employment, unemployment, or not-in-the-labor force to import exposure fall by about one-half when controlling for changes in housing prices, and become statistically insignificant in a number of cases. Results across sectors are more subtle. Noncollege workers in the manufacturing sector continue to experience a reduction in employment after correcting for the ‘masking’ effect of the housing boom, but that reduction does not occur in the nonmanufacturing sector. For college workers, their employment in the nonmanufacturing sector even rises due to the China shock, which fully offsets their reduced employment in manufacturing during 2000-2007. Our results imply that the net reduction in total US employment due to Chinese import exposure was about 0.8 million workers, or less than one-half of that implied by the estimates in ADH (2013).

Lack of knowledge or foresight can matter

Policy makers often don't know all the consequences of a policy they enact or don't think through all the implications of a policy change. And sometimes this really matters.

Megan McArdle at BloombergView discusses an example:

What happens when you suddenly offer parents generous family leave benefits, paid at the expense of the government? You can probably think of dozens of outcomes. But here’s one you might not have been expecting: people die.

That’s the finding of Benjamin Friedrich and Martin Hackmann, in a new working paper at the National Bureau of Economic Research. The culprit? Nurses, who skew female, provide a lot of vital health care, and made heavy use of Denmark’s new paid family leave benefit when it passed in 1994. Since the supply of nurses was limited, and their skills could not easily be replaced, hospital readmissions went up, and more troublingly, mortality spiked among elderly patients in nursing homes.

Advocates of paid parental leave are no doubt bristling at the implication that their favorite benefit might kill people. But that’s not quite the right implication to take away from this paper. What it really highlights is how difficult it is to know how a given policy will turn out. Had officials understood that in advance, they might have taken steps to mitigate the effects -- such as training extra nurses beforehand. The problem, in other words, wasn’t necessarily family leave policy, but the limited visibility policymakers have into the outcomes of their plans.

To see why, consider what the paper actually found. When parental leave came along, it reduced the supply of nurses. But that impact wasn’t felt evenly. In hospitals, where doctors make more of the medical decisions, it seems to have been costly to patient health. But in nursing homes, where nursing staff have more power over daily operations, it seems to have made a much bigger difference. Meanwhile, nursing assistants seem to have been little impacted by the change in leave policy; while they were also likely to make generous use of the leave, health-care facilities seem to have had little difficulty replacing them.

McArdle continues,

So too with something like parental leave. It isn’t enough to know how many workers you might have who might take advantage of the policy. You also need to know how vital their work is to the enterprise, and how readily the enterprise could adapt to their absence. What regulatory or structural barriers might exist to prevent you from rapidly training extra workers?

It may not be possible to know this in advance. Nursing administrators may find it easy to deal with temporary shortages by enticing retired nurses to temporarily return to the profession, or getting their existing staff to work overtime. It is only in the face of a sustained, large and widespread supply shock that those traditional resources will prove completely inadequate.

Moreover, even if we knew what the impact was likely to be, we probably don’t have exact estimates of the practical effects of suddenly slashing the supply of licensed professionals, like teachers and nurses, who will be hard to replace. I mean, we can probably hazard a guess that fewer teachers and nurses means sicker patients and kids who can’t read as well. But how big will the change actually be?

Thinking through the likely effects of a policy is important. Details matter. A given policy change can have very different consequences for different sectors of the economy. Just coming up with an idea that sounds nice or is politically convenient isn't enough. The law of unintended consequences will always get you if you don't think things through. And sometimes even if you do.

Thus when policy makers suffer from a lack of knowledge and/or a lack of incentives to investigate the effects of a policy change things can go very wrong. When uncertainty is high making evaluation of policy changes against pre-specified criteria for success required after a given time offers the opportunity to modify or rescind policies that are found not to be working.

Are male-dominated tenure committees holding women back in academia?

No.

At the AEA website Tim Hyde discusses a paper in the American Economic Review (2017, 107(4): 1207–1238) which asks the question "Does the Gender Composition of Scientific Committees Matter?" The paper is by Manuel Bagues, Mauro Sylos-Labini, and Natalia Zinovyeva.

In many countries there are concerns that male-dominated tenure committees that are convened to decide whether young professors should be promoted up the ranks are holding female academics back. These committees are composed of full professors in the top roles and tend to be mostly or exclusively male. Does this put young female professors at a competitive disadvantage at a make-or-break moment in their careers?

Hyde writes,

Bagues and Zinovyeva were curious how these policies [gender quotas for hiring/tenure committees] – which had clear costs for senior female researchers – would actually affect hiring and tenure decisions. Along with coauthor Mauro Sylos Labini, they analyzed tenure committee data from Spain and Italy to see what happened when more women participated.

Committee selection is basically random, as professors who volunteer to participate are drawn from all over the country. Some committees just happened to have more women, while many others had zero or just one (at least before Spain introduced quotas in 2007). This creates a natural experiment for the researchers: they can compare the records of committees that were male-dominated with ones that were more balanced.

After analyzing approximately 100,000 hiring decisions across the two countries, the researchers found essentially no strong statistical evidence that having more women on committees improved the prospects of female applicants.

There also didn’t seem to be much change in the quality of candidates who were approved for promotion. Candidates approved by diverse committees had roughly the same previous and subsequent research output as those approved by male-dominated ones.

In the Italian evaluations, where the researchers could see how individual committee members voted, they did find an interesting pattern: including more women in a committee had a noticeable effect on the voting patterns of male evaluators, who became slightly but measurably more negative toward female candidates.

That could happen for a number of reasons, such as the licensing effect. “When there are some women sitting on the committee, men might feel more license [to judge female candidates harshly] because there is a female evaluator that will ‘defend’ the female candidates,” said Bagues.

According to Zinovyeva, the appearance of female decision makers in an arena that was once almost exclusively male might also lead to subconscious or overt resentment. “Traditionally in certain fields there were men sitting on these committees,” she said. “Once women join the committees, there can be a backlash.”

Probably the most important result of the paper is what they didn’t find: any significant improvement in female applicants’ odds of advancement (Emphasis added).

So evaluation is probably not the biggest problem for women’s advancement in academia and gender quotas may just amount to a tax on top female academics’ time, in terms of having less time to do research, without actually having the intended effect.

A point worth making about the Coase theorem

Economist George Stigler dubbed Coase’s insight the “Coase theorem.” Unfortunately, because Coase called attention to what would happen in a world of zero transaction costs, many have interpreted him to mean that ours was a world of zero transaction costs. In Coase’s words, “Nothing could be further from the truth.”  Instead, he highlighted transaction costs because he believed that in many cases they were significant and he thought it important to understand why.

This is from an interesting new book "Applied Mainline Economics: Bridging the Gap between Theory and Public Policy" by Matthew D. Mitchell and Peter J. Boettke.

It is amazing to me just how many people still don't get this point. Many still think Coase's thinking was about a zero transaction cost world when in fact his whole approach to economics was driven by wanting to understand the implications of positive transactions costs. Firms exist because of positive transaction costs (Coase 1932) and the law matters (the allocation of property rights matters) when there are positive transaction costs (Coase 1960).

Part of this confusion is, I think, due to Stigler's statement of the "Coase Theorem" in terms of a zero transaction cost world:

The Coase Theorem thus asserts that under perfect competition private and social costs will be equal (Stigler 1966: 113).

Perfect competition requires zero transaction costs. This seems to have lead many people to believe Coase thought the real world was a zero transaction cost world. Not so.

Refs.:

• Coase, Ronald Harry (1937). ‘The Nature of the Firm’, Economica, n.s. 4(16) November:386–405.
• Coase, Ronald Harry (1960). ‘The Problem of Social Cost’, Journal of Law and Economics, 3 October: 1–44.
• Stigler, George (1966). The Theory of Price 3rd ed., New York: The Macmillan Company.

Imperfect electricity markets versus imperfect regulation

In reality neither markets or regulation work perfectly. So the question in practice is, which of imperfect markets or imperfect regulation works better. This issue is looked at in the April 2017 issue (pdf) of the NBER Digest.

In short

Market mechanisms led to increased coordination across utilities and less output from high-cost generators, substantially reducing the cost of producing electricity.

Linda Gorman writes in the Digest about research from Steve Cicala discussed in his NBER working paper "Imperfect Markets versus Imperfect Regulation in U.S. Electricity Generation".

Gorman writes,

In the last two decades, more than half of the wholesale electricity transmission systems in the United States have adopted some form of market mechanism to determine which power plants would operate. Based on an examination of hourly supply and demand patterns on the U.S. electrical grid, Steve Cicala estimates that these new markets reduced aggregate electricity generation costs by $3 billion a year. His results are reported in Imperfect Markets versus Imperfect Regulation in U.S. Electricity Generation (NBER Working Paper No. 23053).

Electricity production must be exactly synchronized with demand, which has large daily, weekly, and seasonal swings. The integrity of the U.S. electrical grid is maintained by roughly 100 "balancing authorities," which determine when power plants start up and shut down to match these fluctuations. Historically, these decisions were made by engineers within the vertically integrated utilities that owned the power plants, transmission system, and distribution networks that serve customers. This regulatory structure resulted in a grid built for reliability, rather than substantial interregional transmission of electricity. Over 90 percent of power was generated in the local power control area where it was consumed.

With changes in federal regulations (and encouragement from the Federal Energy Regulatory Commission), balancing authorities began to turn their responsibilities over to independent system operators, who use day-ahead and real-time auctions to balance supply and demand, often across multiple power control areas that were previously operating autonomously. Between 1996 and 2012, 60 former power control areas adopted such "market dispatch" overnight by either joining an existing market, or participating in the creation of a new one. Roughly two-thirds of electricity production in the United States is now determined by the outcomes of these markets.

Using data on fuel costs, capacities, heat efficiency, and the operations of nearly all generating units in the U.S., Cicala constructs power supply curves ranking production units from lowest to highest cost for each of the 98 areas at an hourly resolution from 1999 to 2012. He then estimates the excess costs that occur when higher cost plants are used to produce power even though lower cost plants are available. In some cases, using high cost plants is appropriate when lower cost generators are unavailable as a result of normal grid operations such as maintenance, refueling, start-up costs, and transmission congestion. Withholding lower-cost units from auction is also how firms exert market power. He also measures changes in trade across power control areas, and the associated gains from offsetting higher-cost generation.

He uses the staggered roll-out of markets to estimate the impact these new mechanisms have on production costs by comparing changes in operations following market adoption to those of areas that have not undergone any changes. Because fuel price changes unrelated to market transitions impact the measurement of cost savings, he uses machine learning algorithms to predict the system operator's complex rules for dispatching generators in the absence of markets, and compares observed and predicted behavior across groups. He finds that markets encouraged both increased trade across areas, and reduced usage of higher cost units. The 20 percent improvement in each of these metrics reduced production costs by about $3 billion per year.

Migrants and the making of America

A new NBER working paper entitled Migrants and the Making of America: The Short- and Long-Run Effects of Immigration during the Age of Mass Migration, by Sandra Sequeira, Nathan Nunn, Nancy Qian, looks at the effects of historical migrant on economic prosperity today.

And the effects are good.

The paper's abstract reads:

We study the effects of European immigration to the United States during the Age of Mass Migration (1850-1920) on economic prosperity today. We exploit variation in the extent of immigration across counties arising from the interaction of fluctuations in aggregate immigrant flows and the gradual expansion of the railway network across the United States. We find that locations with more historical immigration today have higher incomes, less poverty, less unemployment, higher rates of urbanization, and greater educational attainment. The long-run effects appear to arise from the persistence of sizeable short-run benefits, including greater industrialization, increased agricultural productivity, and more innovation (Emphasis added).

Incentives matter: shipping file

Research summary: We explore captain-ownership and vessel performance in eighteenth-century transatlantic shipping. Although contingent compensation often aligned incentives between captains and shipowners, one difficult-to-contract hazard was threat of capture during wartime. We exploit variation across time and routes to study the relationship between capture threat and captain-ownership. Vessels were more likely to have captain-owners when undertaking wartime voyages on routes susceptible to privateers. Captain-owned vessels were less readily captured than those with nonowner captains, but more likely to forgo voyage profits to preserve the vessel's safety. These results are consistent with multitask agency, where residual claims to asset value rather than control rights influence captain behavior. This article is among the first to empirically isolate mechanisms distinguishing among major strands of organizational economics regarding asset ownership and performance.

This is the abstract of a new paper in the Strategic Management Journal (Volume 38, Issue 4 April 2017 Pages 854–875) entitled Asset ownership and incentives in early shareholder capitalism: Liverpool shipping in the eighteenth century. The paper is by Brian S. Silverman and Paul Ingram.

The interesting points made by the paper include the obvious, incentives matter, captain-owned ships were less likely to be captured by privateers. The results also suggest that the incentives provided by income rights are weaker than those provided by asset ownership. Of course the protection of assets, the ship, made just be a way of protecting future profits at the expense of current profits.

The economic consequences of labour market regulations

A recent working paper from the Penn Institute for Economic Research reviews the empirical evidence on the effects of a minimum wage on employment. And yes, they are still negative.

The paper is "The Economic Consequences of Labor Market Regulations"  (pdf) by Jesus Fernandez-Villaverde. The abstract reads,

What do we know about the economic consequences of labor market regulations? Few economic policy questions are as contentious as labor market regulations. The effects of minimum wages, collective bargaining provisions, and hiring/firing restrictions generate heated debates in the U.S. and other advanced economies. And yet, establishing empirical lessons about the consequences of these regulations is surprisingly difficult. In this paper, I explain some of the reasons why this is the case, and I critically review the recent findings regarding the effects of minimum wages on employment. Contrary to often asserted statements, the preponderance of the evidence still points toward a negative impact of permanently high minimum wages (Emphasis added).

The traditional view among economists of the effect of minimum wages is simple: if the minimum wage is set above the equilibrium wage you get unemployment. This core understanding of how the labour market functions has been attacked, most famously, by the publication of Card and Krueger (1994) and, three years later, by a companion book, Myth and Measurement (Card and Krueger, 1997). Card and Kruger looked a the case of an increase in the minimum wage that took place in New Jersey but not in the neighbouring state of Pennsylvania. On April 1, 1992, New Jersey increased the minimum hourly wage from $4.25 to $5.05. Pennsylvania, in contrast, kept the minimum wage at $4.25.

To most economists’ surprise, Card and Krueger documented a relative increase in employment in New Jersey of 2.75 full-time equivalent (FTE) employees per restaurant. In fact, there was even an absolute increase in employment in New Jersey and a drop in Pennsylvania (Card and Krueger, 1997, Table 2.2, p. 34). While, employment at the restaurants Card and Krueger surveyed in New Jersey went from 20.44 FTE employees per restaurant to 21.03, in Pennsylvania, it fell from 23.33 to 21.17

But as Fernandez-Villaverde notes the result has not aged well.

Card and Krueger’s results were sensational because they challenged a centuries-old understanding in economics. Also, their findings rationalized a policy intervention that has had strong political backing for almost as long. But sensational results invite close examination, and Card and Krueger’s findings have not held up to that torrent.

Refs.:

• Card, D., and A. B. Krueger (1994): “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania,” American Economic Review, 84(4), 772–93.
• Card, D., and A. B. Krueger (1997): Myth and Measurement. Princeton University Press.

The value of empirical economics

An important debate currently taking place is about, What is the value of empirical economics? Russ Roberts says not too much while Adam Ozimek says a lot. John Cochrane comments here while Don Boudreaux comments here.

All worth a read.

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

you are involved in "bread wars"! Kenneth Rapoza writes at the Forbes website,

Venezuela police arrested four bakers cited for making "illegal brownies and other pastries" on Friday. President Nicolas Maduro is threatening to take over bakeries in Caracas as part of a new "bread war", Reuters reported today. Maduro has sent in food inspectors and actual armed soldiers into more than 700 bakeries to enforce a rule that 90% of wheat must be destined to making bread and not pastries. Bienvenidos a la Unión Soviética!

When the government starts cracking down on bakeries, claiming they are consuming too much wheat, you just know the economy is in bad, bad shape. Having the government, rather than the market, determine how much wheat is used for making what is a sure sign the economy is on a downwards trajectory. There is just no way the government has the knowledge of time and place needed to be able to micromanage in this way.