Does fractional reserve banking endanger the economy? A debate

On April 16, 2018, two free market economists debated a topic that has long divided libertarians. Fractional reserve banking refers to banks' standard practice of keeping only a portion of their depositors' money on hand and loaning out the rest.

In The Mystery of Banking (1983), the anarcho-capitalist economist Murray Rothbard called fractional reserve banking "a shell game, a Ponzi scheme, a fraud in which fake warehouse receipts are issued and circulate as equivalent to the cash supposedly represented by the receipts." Other libertarian economists, such as Larry White and Steve Horwitz, have argued that the practice is perfectly defensible.

At The Soho Forum, a debate series in New York City that is sponsored by the Reason Foundation, Robert Murphy debated George Selgin over the following resolution: "Fractional Reserve banking poses a threat to the stability of market economies."

Murphy, a research assistant professor with the Free Market Institute at Texas Tech University, argued for the affirmative. He has a Ph.D. in economics from NYU has addiliations with the Institute for Energy Research, the Mises Institute, the Fraser Institute, and the Independent Institute. He has authored hundreds of articles and several books explaining economics to the layperson, including Choice: Cooperation, Enterprise, and Human Action.

Selgin, who opposed the resolution, is a senior fellow and director of the Center for Monetary and Financial Alternatives at the Cato Institute and professor emeritus of economics at the University of Georgia. His research covers a broad range of topics within the field of monetary economics, including monetary history, macroeconomic theory, and the history of monetary thought. He is the author of The Theory of Free Banking, Bank Deregulation and Monetary Order, Less Than Zero: The Case for a Falling Price Level in a Growing Economy, and most recently Good Money: Birmingham Button Makers, the Royal Mint, and the Beginnings of Modern Coinage.

The Soho Forum runs Oxford-style debates, in which the audience votes on the resolution at the beginning and end of the event. The side that gains more ground is victorious. ​In this case, Selgin won by convincing 14 percent of the audience to switch over to his side.

Lightships and public goods

From the Economics Detective comes this interview with Vincent Geloso in which he discusses his work with Rosolino Candela on lightships and their importance in economics.

The abstract of their paper reads:

What role does government play in the provision of public goods? Economists have used the lighthouse as an empirical example to illustrate the extent to which the private provision of public goods is possible. This inquiry, however, has neglected the private provision of lightships. We investigate the private operation of the world’s first modern lightship, established in 1731 on the banks of the Thames estuary going in and out of London. First, we show that the Nore lightship was able to operate profitably and without government enforcement in the collection of payment for lighting services. Second, we show how private efforts to build lightships were crowded out by Trinity House, the public authority responsible for the maintaining and establishing lighthouses in England and Wales. By including lightships into the broader lighthouse market, we argue that the provision of lighting services exemplifies not a market failure, but a government failure.

Economists who changed the world

In this audio from the BBC History Extra magazine Linda Yueh discusses her new book, The Great Economists, which explores the work and legacy of some of history’s greatest economic thinkers, and reveals some of the lessons they might offer for us today


An interesting podcast, even if I'm not sure I would entirely agree with some of Yueh's discussion and interpretation of the writers she considers. On the other hand Tyler Cowen is quoted as saying, about the book, "The best place to start to learn about the very greatest economists of all time".

On C-span Chris Coyne discusses police militarisation and state surveillance

Chris Coyne discussed his book, Tyranny Comes Home: The Domestic Fate of U.S. Militarism on C-span.

Thomas Sowell and Samuel Bowles on Marx

From Thomas Sowell's book "On Classical Economics":

Not everybody judges Marx quite so harshly. In a recent article on "Marx and modern microeconomics", at VoxEU.org, Samuel Bowles argues that Marx has, in fact, contributed something significate to modern microeconomics,

Few economists doubt that Marx flunked economics, a judgement mostly based on his labour theory of value. But this column argues that Marx’s representation of the power relationship between capital and labour in the firm is an essential insight for understanding and improving modern capitalism. Indeed, this insight is incorporated into standard principal–agent models of labour and credit markets.

If the rejection of Marx is primarily about the labour theory of value then would we not also have to flunk Adam Smith? We don't so there must be more than this going on.

Bowles goes on to say,

But Marx chose to study a more challenging question: how could the domination of labour by capital take place in a private, perfectly competitive, economy governed by a liberal state? His answer was based on what seems a strikingly modern principal–agent representation of the employer–employee relationship, arising from a conflict of interest over the amount of labour effort performed that could be resolved in an enforceable contract.

In a sense, Bowles is wrong about the perfectly competitive model. Since this model is one of zero transaction costs there are no firms and the production environment is one without principal-agent problems. Firms and principal-agent issues only arise in a world of positive transaction costs.

Bowles continues by saying,

The final step in Marx’s explanation of domination in a liberal capitalist economy was the process of accumulation and technical change that supports a permanent “reserve army" (ibid) of the unemployed, and which provides the basis of the employer’s labour discipline strategy. The private ownership of the means of production conveys the right to exclude others from use of the firm’s assets, and therefore the owners of firms have a powerful threat to induce workers to supply the effort that could not be secured by contract: work hard, or join the "reserve army".

and

Marx did not explain why the labour contract was incomplete. He assumed this was an uncontroversial empirical observation and used it as the starting point for his economic theory.

Further on Bowles writes,

Just as Mendel underpinned Darwin, a more complete understanding of the incomplete labour contract developed in the twentieth century, but did not overturn Marx’s conclusions. Like Marx, Ronald Coase (1937) stressed the central role of authority in the firm’s contractual relations:

“[N]ote the character of the contract into which a factor enters that is employed within a firm ...[T]he factor ... for certain remuneration agrees to obey the directions of the entrepreneur.”

Indeed, Coase defined the firm by its political structure:

“If a workman moves from department Y to department X, he does not go because of a change in prices but because he is ordered to do so ... the distinguishing mark of the firm is the suppression of the price mechanism.” (ibid)

Herbert Simon provided the first Coasean model of the firm (Simon 1951). He represented the employment contract as an exchange in which the employees transfer control rights over their work tasks to the employer, in return for a wage. Simon stressed the advantage to the employer of this arrangement, because there was unavoidable uncertainty about the tasks that would be required over the course of the contract. Therefore there was a high cost of agreeing to a complete contractual specification of the activities to be performed. Simon did not know that he was modelling exactly the incomplete contract for labour that was the fulcrum of Marx’s economic theory.

Coase or Simon did not directly explain why control rights confer power. As an empirical matter, the firm appears to be a political institution in the sense that some members of the firm routinely give commands with the expectation that they will be obeyed, while others are constrained to follow these commands. If we say that the manager has the right to decide what the worker will do, this means only that the manager has the legitimate authority, not the power to secure compliance. Given that, in a liberal society, the manager is restricted in the kinds of punishment that can be inflicted, and given that the employee is free to leave, it is a puzzle that orders are typically obeyed.

Noticing this, Armen Alchian and Harold Demsetz challenged the Coasean idea that the firm is a mini “command economy”, suggesting that the employment contract is no different in this respect from other contracts:

“The firm ... has no power of fiat, no authority, no disciplinary action any different in the slightest degree from ordinary market contracting between any two people ... Wherein then is the relationship between a grocer and his employee different from that between a grocer and his customer?” (Alchian and Demsetz 1972)

Oliver Hart (1989) responded:

'[T]he reason that an employee is likely to be more responsive to what his employer wants than a grocer is that the employer ... can deprive the employee of the assets he works with and hire another employee to work with these assets, while the customer can only deprive the grocer of his customer and as long as the customer is small, it is presumably not very difficult for the grocer to find another customer."

In a footnote in his book "Firms, Contracts, and Financial Structure" Oliver Hart does note that,

Given its concern with power, the approach proposed in this book has something in common with Marxian theories of the capitalist-worker relationship [...]

But what is not clear is that the development of the incomplete contracts approach to the theory of the firm by Grossman-Hart-Moore owes anything directly to the Marxian theories. The connection between them seems to have been noted after the fact rather than being a driving force.

When discussing the why in the property rights theory firms rather than workers own the nonhuman assets used in production Bengt Holmstrom argues that one reason is that by putting the nonhumans assets under the control of the firm, those running the firm have the maximum power to decide how the firm is organised and run. He notes that Marx would have agreed with this, but Holmstrom disagrees with Marx about the purpose of the firm's concentration of power.

This brings me back to Sowell's point that a contribution depends not just on what is offered but also on what is accepted, and I'm not convinced that Marx's ideas were accepted in the sense that they actually drove the development of the property rights approach to the firm.

So I'm thinking that Sowell, rather than Bowles, is right in his assessment of Marx.

Abby Hall on the boomerang effect and the militarisation of the US domestic police force

From the Economic Rockstar comes this interview with Abby Hall on the militarisation of the US domestic police force.

Abby Hall is an Assistant Professor in Economics at the University of Tampa in Tampa, Florida and a Research Fellow with the Independent Institute.

She earned her PhD in Economics from George Mason University in Fairfax, Virginia in 2015.

Her broader research interests include Austrian Economics, Political Economy and Public Choice, and Peace Economics, and Institutions and Economic Development.

Her work includes topics surrounding the U.S. military and national defense, including, domestic police militarization, arm sales, weapons as foreign aid, the cost of military mobilization, and the political economy of military technology.

She is currently researching how foreign intervention adversely impacts domestic political, social, and other institutions.

You can find Abby’s research, writings and other information on her website at www.abigailrhall.com.

Are there limits to free speech?

In this audio from the IEA Kate Andrews and Steve Davies discuss the limits to free speech.

Are there limits to free speech - and if so, where should they be set?

In this week’s podcast, Dr Steve Davies, Head of Education at the IEA and News Editor Kate Andrews examine this question.

They take a look at free speech on social media, and at universities, where issues like ‘safe spaces’ and ‘no platforming’ are increasingly controversial.

Yet, the situation is rather more complex than it might seem.

Though, Steve argues, speech should be as free as possible - private institutions and private individuals also have a right to determine what speech they permit on their own property. And public funding of institutions can also complicate matters.

Dave Rubin interviews Thomas Sowell

Dr. Thomas Sowell (Economist and Author) joins Dave to discuss his new book “Discrimination & Disparities.” They dive into Dr. Sowell’s Marxist past, free speech on college campuses, the role of government, minimum wage laws, his experience as a black conservative, debunking systemic racism, and more.

CEOs and the family firm

Do family CEOs work harder? The answer seems to be no.

A new paper out in The Review of Financial Studies (31(5) 2018: 1605–53) looks at:

Managing the Family Firm: Evidence from CEOs at Work
Oriana Bandiera, Renata Lemos, Andrea Prat and Raffaella Sadun

We build a comparable and bottom-up measure of CEO labor supply for 1,114 CEOs and investigate whether family and professional CEOs differ along this dimension. Family CEOs work 9% fewer hours relative to professional CEOs. CEO hours worked are positively correlated with firm performance and account for 18% of the performance gap between family and professional CEOs. We study the sources of the differences in labor supply across family and professional CEOs by exploiting firm and industry heterogeneity and variation in meteorological and sports events. Evidence suggests that family CEOs value or can pursue leisure activities more so than professional CEOs

Makes sense to me. One reason for founding and running a family firm would be the flexibility it gives to pursue things other than work. Even if this comes at a financial cost.

The determinants of productivity

From VoxEU.org comes this short video in which Professor John Van Reenen discusses the impact of management on productivity.

Competition can foster productivity by eliminating unproductive firms out of the market. John Van Reenen discusses the impact of management quality on productivity - and how this is influenced by market forces. This video was published by the CORE Project.

How much should we care about inequality?

In this podcast from the IEA, Dr Steve Davies, Head of Education at the IEA, and News Editor Kate Andrews examine this question.

How much should we worry about inequality?

With ongoing Corbyn-mania in UK politics, and the popularity of books like Thomas Piketty’s Capital in The 21st Century, it seems like we’ve never cared more about promoting equality of outcome. But is our concern justified? Is economic disparity a characteristic of modernity - or a persistent feature of human civilization?

As Steve explains, inequality - and public concern about it - has been a feature of societies around the world, for centuries.

They also challenge the commonly held view that inequality has been rising in recent years - and examine whether people care more about some kinds of inequity than others.

Monopsony models and the minimum wage

In an interesting and provocative article at Bloomberg Noah Smith discusses recent empirical research that suggests that higher minimum wages do not have negative effects on employment. Smith argues that this work discredits the standard competitive model of labour markets He favours a model of monopsonistic markets where employers have market power. Smith writes,

Together with the evidence on minimum wage, this new evidence suggests that the competitive supply-and-demand model of labor markets is fundamentally broken. If employers have the power to set wages, then not just minimum wage, but other labor market policies -- for example, union-friendly laws -- can be expected to help workers a lot more than popular introductory economics textbooks now predict.

Textbook writers and instructors should respond by changing the baseline model of labor markets that gets taught in class. Students ought to start with a model of market power, in which a few companies set wages below levels found in a competitive market unless prevented from doing so. That model is about as easy to work with as the traditional supply-and-demand setup, but matches the data much better.

Perhaps not too surprisingly not all economists agree with him.

At the EconLog blog, Scott Sumner says he is not convinced by Smith's arguments. Sumner writes,

1. The replication crisis in the sciences, and the social sciences.

2. Conservative studies seem able to explain the very low levels of hours worked in Europe much better than progressive studies. And the studies that Smith cites are progressive studies. That doesn't mean progressives are wrong, but until progressives are able to explain Europe's labor market, I'll continue to have trouble taking them seriously.

3. Most importantly, Smith overlooks the fact that empirical research is just as unfriendly to the monopsony model of labor markets as it is to the competitive model of labor markets. AFAIK, almost all the empirical studies of the minimum wage suggest that higher minimum wages do not come out of profits, but rather are passed on in terms of higher prices. That result is 100% consistent with the competitive model of labor markets, and inconsistent with the monopsony model (which suggests that if employment doesn't fall then product prices do not rise.)

Thus empirical studies show that when a minimum wage increase forces grocery stores to pay higher wages, they pass on the increased costs in the form of higher prices.

Now I suppose that progressives could argue that demand curves don't slope downwards, and that the higher prices will not reduce sales. In that case, a higher minimum wage need not reduce employment. But as soon as you abandon downward sloping demand curves, you are faced with other dilemmas. For instance, why should progressives oppose "regressive" consumption taxes? After all, if demand curves don't slope downwards, then higher prices would not reduce consumption. And since living standards depend on consumption, regressive taxes would not reduce the living standards of the poor.

Of course we know that demand curves do slope downwards, and we know that regressive taxes tend to adversely impact the poor. What we need to figure out is whether higher minimum wages raise prices and reduce sales. So far, the empirical evidence suggests that they do.

To summarize, the empirical evidence on the effect on minimum wages on employment is mixed. The empirical evidence on the effect of minimum wages on prices is pretty clear---it raises prices. That means that, on balance, the empirical evidence is more supportive of the competitive labor market model than the monopsony model.

This doesn't mean that firms have no monopsony power---they almost certainly have some. The question is how much, and whether the short and long run labor demand elasticities differ.

At the Cafe Hayek blog, Don Boudreaux says,

First, as Jim Buchanan, Donald Dewey, and other economists have pointed out, as long as demand curves for outputs are downward sloping, monopsony power is only a necessary and not a sufficient condition for minimum wages not to reduce the employment prospects of low-skilled workers. For minimum wages not to reduce these workers’ employment prospects, employers with monopsony power must also have monopoly power (and not just the sort of such ‘power’ as is identified in models of monopolistic competition). That is, these employers must have the ability to keep the prices of the outputs they sell above average total costs. If they do not have this ability, then there are no excess profits, or rents, out of which the higher labor costs can be paid.

Second, empirical studies typically fail to examine all the many ways that employers and employees can adjust to minimum wages. The list of such possible adjustments other than reduced hours of employment includes reductions in formal fringe benefits (such as paid leave), reductions in informal fringe benefits (such as workplace safety higher than what is minimally required by legislation), and changes in the nature of the jobs such that workers are worked harder in order to produce more output per hour. To the extent that adjustments such as these occur, minimum-wage-induced reductions in employment will be fewer or lower, but the standard textbook model really still holds.

Third, because in the U.S. the national minimum wage has been in place now for 80 years and is at no risk of being repealed, employers have long ago adjusted their business plans – their capital-labor ratios – to the existence of minimum wages. And employers expect occasional minimum wage increases. Therefore, even the finest and most carefully controlled empirical study of a minimum-wage hike today will not detect the employment-reducing effects of the long-standing expectation of minimum-wage hikes. Because employers have already adjusted to the reality of minimum wages – and to the reality of minimum wages being increased from time to time – any study that correctly finds little or no negative employment effect from this or that minimum-wage hike today nevertheless misses the negative employment effects of minimum wages overall.

Fourth, about monopsony power: it’s more difficult to detect than, ironically, standard textbook models suggest. Suppose that Acme, Inc., competes for workers by offering unusually attractive fringe benefits and work conditions. And suppose that Acme, Inc., has a differential advantage over other employers at supplying to its workers such non-wage amenities, or that for Acme, Inc., the marginal cost of attracting X number of workers by supplying non-wage amenities is lower than is its cost of attracting X number of workers by increasing the wages it pays. Under such conditions, Acme, Inc., gains the power to lower its workers wages by some amount without losing all, or perhaps even any, of its workers.

An empirical study of this firm would conclude that Acme, Inc., has monopsony power. But this conclusion would be incorrect, for the ‘power’ that Acme, Inc., is detected to have over its workers is ‘power’ that Acme, Inc., purchased from its workers – workers who voluntarily agreed to Acme’s employment terms.

Put differently, if (as is not unreasonable for many employers) Acme, Inc., values a steady workforce, it can purchase – with non-wage amenities – from its workers the ability to cut their wages without their quitting. The textbook-bound economist, seeing only the reduced wages and no mass exodus of workers from Acme, leaps confidently to the conclusion that Acme has monopsony power. Yet clearly, in this example, that conclusion would be mistaken.

On Twitter, David Neumark, an economist who has spent many years studying minimum wages, wrote,

Strong mischaracterization of the evidence on the #minimumwage https://t.co/Xd5JUXp0ks

— David Neumark (@NeumarkDN) April 5, 2018

Thus, while Smith's position is certainly interesting, and could apply in some particular labour markets, I think he needs to do more to convince many of his fellow economists that the markets with monopsony power should be the standard model for labour markets.

The 10-Year baby window that is the key to the women’s pay gap

An interesting new twist on the effects of children on the pay gap between men and women. It has long been argued that having kids is one reason for the gap in pay between men and women but now a new study suggests that women who have their first child before 25 or after 35 eventually close the salary divide with their husbands. It's the years in between that are most problematic.

Claire Cain Miller discusses the new research at the Upshot blog at the New York Times. Millar writes,

Today, married couples in the United States are likely to have similar educational and career backgrounds. So while the typical husband still earns more than his wife, spouses have increasingly similar incomes. But that changes once their first child arrives.

Immediately after the first birth, the pay gap between spouses doubles, according to a recent study — entirely driven by a drop in the mother’s pay. Men’s wages keep rising. The same pattern shows up in a variety of research.

The new twist in the research is to point out that,

When women have their first child between age 25 and 35, their pay never recovers, relative to that of their husbands. Yet women who have their first baby either before 25 or after 35 — before their careers get started or once they’re established — eventually close the pay gap with their husbands.

Why?

One explanation is that the modern economy requires time in the office and long, rigid hours across a variety of jobs — yet pay gaps are smallest when workers have some control over when and where work gets done. In high-earning jobs, hours have grown longer and people are expected to be available almost around the clock. In low-earning jobs, hours have become much less predictable, so it can be hard for working parents to arrange child care.

The issue, in general, comes down to time. Children require a lot of it, especially in the years before they start school, and mothers spend disproportionately more time than fathers on child care and related responsibilities. This seems to be particularly problematic for women building their careers, when they might have to work hardest and prove themselves most, and less so for women who have already established some seniority or who have not yet started careers.

So it may not just be having kids that matters for the pay gap, but when you have them matters as well.

Early gender gaps among university graduates

In a recent article at VoxEU.org Marco Francesconi and Matthias Parey write on Early gender gaps among university graduates. A summary of their column reads

Women earning substantially less than men in all advanced economies, despite the considerable progress women have made in labour markets worldwide. This column explores the recent experience of university graduates in Germany soon after their graduation. Men and women enter college in roughly equal numbers, but more women complete their degrees. Women enter university with slightly better high school grades but leave with slightly lower marks. Immediately after university completion, male and female full-timers work very similar number of hours, but men earn more across the pay distribution. The single most important proximate factor that explains the gap is field of study at university (Emphasis added).

Francesconi and Parey go on to say,

Several channels may be at work behind our results. One could be related to human capital considerations. The importance of field of study indicates the relevance of pre-market choices. These also interact with subsequent market decisions (such as occupational choice) at the very beginning of professional careers (e.g. Liu 2016). In turn, such choices could be partly driven by gender differences in preferences (e.g. risk aversion and time discounting), self-confidence, competitiveness, earnings expectations, and valuation of non-wage benefits (e.g. Buser et al. 2014, Mas and Pallais 2017, Reuben et al. 2017). Another possible channel is related to statistical discrimination against women, based on employers’ difficulty in distinguishing more from less career-oriented women (e.g. Gayle and Golan 2012, Reuben et al. 2014). These mechanisms deserve more attention in future research.

Collecting data: Domesday Book edition

When commenting on the data collection methods used to compile the Domesday Book in 1086 McDonald (1998: 1) writes,

As with many modern surveys, the data were compiled from answers to questionnaires; but, unlike most contemporary censuses, answers were not given in confidence but were scrutinised publicly in local courts. In many ways the checks on the accuracy of the data were more stringent than those for currently complied official data.

Maybe the old technology is still the best technology. StatsNZ could learn a thing or two from the William the Conqueror and the Normans.

Ref.:

• McDonald, John (1998). Production Efficiency in Domesday England, 1086, London: Routledge.

Noah Smith on immigration economics

From David Beckworth’s podcast series, Macro Musings comes this audio of an interview with Noah Smith on Immigration Economics.

Noah Smith is a Bloomberg View columnist and formerly a professor of finance at Stony Brook University. Today, he joins the show to talk about his journey into the economics blogosphere and some of his recent work on immigration into the United States. . David and Noah discuss some of the false narratives surrounding immigration as well as the impact of immigration on native workers’ wages, labor markets, and the broader economy.

Trade and minimum wages in general equilibrium

An new NBER working paper on the effects of minimum wages on trade.

Trade and Minimum Wages in General Equilibrium: Theory and Evidence
Xue Bai, Arpita Chatterjee, Kala Krishna, Hong Ma
NBER Working Paper No. 24456

Do minimum wages affect economic outcomes beyond low-skill employment? This paper develops a new model with heterogeneous firms under perfect competition in a Heckscher-Ohlin setting to show that a binding minimum wage raises product prices, encourages substitution away from labor, and creates unemployment. It reduces output and exports of the labor intensive good, despite higher prices and, less obviously, selection in the labor (capital) intensive sector becomes stricter (weaker). Exploiting rich regional variation in minimum wages across Chinese prefectures and using Chinese Customs data matched with firm level production data, we find robust evidence in support of causal effects of minimum wage consistent with our theoretical predictions.