Measuring economic welfare (updated)

John Taylor at the Economics One blog draws our attention to a new measure of economic welfare. The measure combines consumption, leisure, mortality, and even inequality. Interestingly, if not surprisingly, the new measure is positively correlated with GDP per capita. But as Taylor points out there are differences.

For example, income per capita in France is only 70 percent of that in the United States, while the new welfare measure for France is 97 percent of that in the United States. The difference is mainly due to more leisure and less income inequality in France.

One point that I'm sure that many people will not like is

[t]he gains and losses of utility from different levels of income inequality are based on the Rawls abstract concept of the veil of ignorance in which each person enters a lottery each year determining what country he or she will live in--one with less or more income inequality.

This idea has been criticized by a number of welfare economists.

The last point Taylor makes may be the most important,

Chad and Pete have a whole section on “caveats” in their interesting paper.

but you can bet they will be ignored.

Update: Tim Worstall comments here.

EconTalk this week

Arnold Kling of EconLog and author of Unchecked and Unbalanced, talks with EconTalk host Russ Roberts about the book and the relationship between knowledge and power. In a modern economy, specialization has increased and knowledge is increasingly dispersed. But political power has become more concentrated and fails to exploit the potential for decentralization. Kling discusses these trends and the potential for decentralization of power under different policies.

Poverty kills

In more ways than one. Frederic Sautet writes over at the Coordination Problem blog:

Clearly the impact of earthquakes is mostly an economic issue. What happened in Kobe many years ago or in Christchurch last weekend doesn’t compare with what happened in Haiti. And the difference is economics. NZ has a building code and by and large buildings are built according to the code in place—it is enforced. But it is not the building code that ultimately saved people's lives; it is capitalism. Indeed, compare this to Haiti. Haiti probably had a poorly enforced building code. But it is not because building inspectors in Haiti are corrupt that buildings are poorly built. Rather it is because of the lack of surplus in the economy. It is the surplus created in a free economy that enables people to dedicate more resources to earthquake protection thereby making code enforcement easy. As long as Haitians will be poor, building codes will not be enforced because people have more urgent things to do with the small amount of resources they have.

The sad truth us that no-one died in Christchurch partly because of luck and partly because New Zealand is a relatively rich country and thus can afford buildings that, mostly, withstand the effects of an earthquake. On the other hand countries like Haiti are poor and the buildings there reflect this and people die because of it.

Butler and utility, again

In reading Eamonn Bulter’s book Austrian Economics: A Primer I came across another comment on utility:

Utility is not quality of objects that we can stacked up and compared like piles of bricks – as mainstream economics textbooks often suggest. (Butler 2010: 29).

I would ask, Who suggests this and how often do they do so? A utility function is just a convenient representation of an underlying preference relation. As that preference relation is subjective I don’t see how anyone would claim that utility can be stacked up and compared. As I noted before utility is ordinal, not cardinal, so stacking it and comparing it doesn’t make much sense.

Butler goes on to say,

This is why textbook indifference curves are also misleading. They purport to show the amount of one good that people would willingly sacrifice to get another. (Butler 2010: 29).

The slope of the indifference curves tells us that how much a person is willing to give up to get another very small unit of the other good.

A little farther down the page Butler adds,

To see how people really do decide, take the example of a farming family with five sacks of gain – one to feed themselves, one to feed their animals, one to plant for crops, one to sell for essentials they need, and one they use to feed their pet parrots. Unfortunately they have to give up one stack of grain to pay an old debt. Do they cut back their uses of grain by one fifth, as mathematics would suggest? No, they eat, feed, plant and sell as much as before, but let the parrots starve, because that is the most marginal use to them. (Butler 2010: 29)

What would the RSPCA say?! But does the ‘mathematics’ really say that “they cut back their uses of grain by one fifth”? Butler does not show this. What the ‘maths’ says that they are willing to sacrifice an amount of one good (a parrot) to gain another good (less debt). Where is the problem here? The maths seems to be saying the right thing.

Butler’s representation of “mainstream economics” looks at bit straw-manish. The mainstream are more sophisticated he is willing to admit.

A point I have never understood

Previously I made mention of Eamonn Butler’s new book Austrian Economics: A Primer. At one point Butler raises an issue I have seen raised before in some Austrian writings. He says,

Though utility is as inherently personal as joy or shame, their [mainstream economists] textbooks suggests that ‘units of utility’ can be measured and added. (Butler 2010: 98).

As utility is only assumed to be ordinal, and not cardinal, I have never understood this criticism. The only thing that matters with utility functions is that if A is preferred to B then a utility function will append a higher number to A than B. That is, if u is a utility function representing the above preference relation then u(A)=10 and u(B)=9 will do. But a utility function v where v(A)=1 and v(B)=0.1 will also do the job. Now if we assume u and v are the utility functions for two different people, the sum of u+v makes no sense at all. Thus I don’t get the point Butler is trying to make.

University closed

Thanks to the earthquake the university is closed until 6am on Monday, 13th September. All staff (and students) are asked to stay at home, unless specifically invited to come to campus by a member of the Senior Management Team. So everyone has to try and work from home for the next 10 days. Oh joy.

In the email they sent out they said:

If you wish to access your email using remote access: https://exchange.canterbury.ac.nz/

Why tell anyone how to access their email given that they're already reading their email?

David Friedman on macroeconomics

Friedman writes at his blog Ideas

Macro is not my field. One of the reasons it is not my field is that, so far as I can tell, it lacks a theoretical structure as solid or as well supported as price theory—popularly but misleadingly called "Micro." One result is that a course on the subject is a tour of either a cemetery or a construction site.

I wonder what his father would have said about such a view?

Macro is just witchcraft if you ask me. :-)

A reason to move to the U.K.

According to the Daily Express

BRITAIN was condemned as a sex-obsessed “hedonistic wasteland” yesterday by an influential figure in the Roman Catholic church.

The U.K. has something going for it after all.

Now I have seen everything

This is from the comments section of No Minister:

Adolf Fiinkensein said...

Eric Crampton, instead of smart arse sarcasm, what about some factual response? Do I take it you would rather we did not have the guarantee scheme or are you just another useless academic socialist troll?

I am willing to bet a lot of money Eric has never been called a socialist troll before! Now all we need is for Peter Cresswell to be called a raving Marxist and the world will have officially gone mad!!

The Austrian School and fractional reserve banking

The following comes from an interesting new book Austrian Economics: A Primer by Eamonn Butler, Adam Smith Research Trust, 2010. Butler writes

Many Austrians would also like to take action on bank lending. At present, banks are required to keep only a small fraction (say, 10%) of their depositors' money in their vaults to provide for customers' requests for repayment. The rest they can lend. If they lend to other banks, those banks in turn can lend 90% of that amount to others. So if banks get in more deposits, or ease their lending terms, it is possible for this extra money to be magnified many times through the banking system. Thus a modest increase in the supply of a government's fiat currency, for example, can have a much larger impact on the real economy, making its malign effects that much larger too.

Some Austrians would scap the fractional reserve banking system entirely, and force banks to keep on hand 100% of the cash their customers deposit. They argue that this would neutralize the potential dangers of the money multiplier, and would end bank runs, because depositors would know that all their money was held safely. In practical terms, though, it is doubtful that many customers would be willing to pay banks to look after their money, rather than getting interest on their deposits as they do at present.

Again, competition might provide a solution. Lawrence White has wrrtten much on the history and practicality of free banking. Banks, he argues, performed much better when they were not as closely regulated by governments as they are today, and were not subject to fixed reserve requirements set down by the authorities. They would keep on hand as much cash and other liquid reserves as they thought necessary to keep paying their depositors' daily withdrawals. And they would (quite literally) make money by printing more banknotes than they had money in their vaults to back them all. As long as people thought a bank's financial management was sound, they would accept its notes at face value. But if people began to get worried about the security of a bank, they would grow more cautious - perhaps accepting its notes at a discount rather than full value, to reflect the risk of the bank suffering a run and being unable to pay its depositors and note holders. However, the fact that a bank's notes were trading at a discount would send it a strong signal that it needed to strengthen its financial position and so avoid these dangers, and this was enough to keep the banks sound.

In the nineteenth century, the Suffolk Bank, in Boston, acted as a clearing house that would exchange the notes of other banks that customers might find it hard to get to, applying discounts where it was concerned about their soundness. There is no need for central banks in such a system because there is no state issued national currency. For the system to work, however, there can be no government bailouts of failing banks: that would simply encourage banks to take bigger and bigger risks, knowing that taxpayers would bail them out. It is precisely the fact that worried customers would pull out all their money that would make free banks keep their business and their currency sound enough to retain customers' trust - which is perhaps more than one can say of the government-regulated commercial banks and government run central banks of today. (Butler 2010: 78-9).

So there is nothing to stop Austrian economists from believing in both free banking and fractional reserve banking. Fractional reserve banking is seen by some as the worst of all possible world, but this need not be the case. If the system is allowed to function without interference there is no reason it can not work.

Perhaps given the current situation this bit of the above comment should be emphasised:

For the system to work, however, there can be no government bailouts of failing banks: that would simply encourage banks to take bigger and bigger risks, knowing that taxpayers would bail them out.

This seems like a general rule for banking to me. Governments shouldn't have deposit insurance in place at all. As Not PC notes such schemes have a number of bad effects.

Sweatshops are good?

In a recent posting over at the Aid Watch blog Benjamin Powell writes,

Sweatshop jobs are often far better than the vast majority of jobs in the countries where they are located. David Skarbek and I researched sweatshops that were documented in U.S. news sources (or see here for my shorter, more general defense of sweatshops). We found that sweatshop worker earnings equaled or exceeded the average national income in 9 out of 11 countries we studied. Working in a sweatshop paid more than double the national average in four of the countries.

Sweatshops can also play a crucial role in economic development. Sweatshops bring investment, better technology, and the opportunity for workers to build skills. It was not long ago that sweatshops existed in many now-wealthy Asian countries.

So sweatshops may be bad, but they are better than the alternative.

A libertarian conundrum?

This question is asked by James Otteson:

Adam Smith argued that showing "too little spirit" can sometimes be a vice, because sometimes a situation can call for rising to confront a challenge--even when the challenge confronted is merely a verbal one. I think this suggests that there is such a thing as a "justified punch in the nose." If I'm right, it might present a limited counter-example to the first principle of libertarianism, which is an injunction against initiating violence.

For more see here. So is there such a thing as a justified punch in the nose?

How to read an academic article

Peter Klein over at the Organization and Markets blog gives advice on:

How to Read an Academic Article

1. Caveat: no single style works for everyone!
2. Klein’s basic steps for skimming, scanning, processing…
   
   1. Read the abstract (if provided)
   2. Read the introduction.
   3. Read the conclusion.
   4. Skim the middle, looking at section titles, tables, figures, etc.—try to get a feel for the style and flow of the article.
      
      1. Is it methodological, conceptual, theoretical (verbal or mathematical), empirical, or something else?
      2. Is it primarily a survey, a novel theoretical contribution, an empirical application of an existing theory or technique, a critique, or something else?
   5. Go back and read the whole thing quickly, skipping equations, most figures and tables.
   6. Go back and read the whole thing carefully, focusing on the sections or areas that seem most important.
   
   
3. Once you’ve grasped the basic argument the author is trying to make, critique it!
   
   1. Ask if the argument makes sense. Is it internally consistent? Well supported by argument or evidence? (This skill takes some experience to develop!)
   2. Compare the article to others you’ve read on the same or a closely related subject. (If this is the first paper you’ve read in a particular subject area, find some more and skim them. Introductions and conclusions are key.) Compare and contrast. Are the arguments consistent, contradictory, orthogonal?
   3. Use Google Scholar, the Social Sciences Citation Index, publisher web pages, and other resources to find articles that cite the article you’re reading. See what they say about it. See if it’s mentioned on blogs, groups, etc.
   4. Check out a reference work, e.g. a survey article from the Journal of Economic Literature, a Handbook or Encyclopedia article, or a similar source, to see how this article fits in the broader context of its subject area.

The law of unintended consequences: lighting example

From The Economist comes this piece of news:

SOLID-STATE lighting, the latest idea to brighten up the world while saving the planet, promises illumination for a fraction of the energy used by incandescent or fluorescent bulbs. A win all round, then: lower electricity bills and [...] less climate-changing carbon dioxide belching from power stations.

Well, no. Not if history is any guide. Solid-state lamps, which use souped-up versions of the light-emitting diodes that shine from the faces of digital clocks and flash irritatingly on the front panels of audio and video equipment, will indeed make lighting better. But precedent suggests that this will serve merely to increase the demand for light. The consequence may not be just more light for the same amount of energy, but an actual increase in energy consumption.

South Canterbury Finance and all that jazz (updated)

There have been a number of good blog postings on the South Canterbury Finance saga so let me just make a couple of brief comments on what I agree with or disagree with from these postings.

Matt Nolan over at TVHE makes a number of good points including

1. The government had to pay the money when the receivers came in – they had no real choice, after all SCF was guaranteed by government.
2. However, it does show you the type of cost that can be associated with such a scheme – and raises the question of whether putting finance companies in the scheme was a good idea

What I would take from these two points is that we should not have had the deposit guarantee scheme in the first place, so I agree with Matt when he says

Surely this tells us that it is at least near the time to get rid of this deposit guarantee scheme – and why not do it retroactively so they all don’t “fail” just before the scheme runs out. Investors that get burned because they saw a high return and decided to face a high risks should have to deal with the consequences of it.

No Right Turn is also right to highlight the moral hazard issues in all of this. Where I disagree with him is here,

Banks have customers, who are innocent victims in any collapse. Finance companies, OTOH, have investors, people who are effectively gambling.

I see no real difference between "customers" and "investors". Consumers are a type of investor and thus should take all the same precautions as regular investors and face the outcomes in the same way as regular investors..

Eric Crampton writes

AntiDismal called the other day for ending deposit insurance. I'd be reluctant to pull deposit insurance for the banks until after the current financial mess is over with. And even then, I'd worry that the government now has zero credibility in the face of potential bank default and so may be stuck with deposit insurance for the longer term - at least in that case, they collect premiums on the insurance.

I am, obviously, less reluctant to pull deposit insurance since this would at least help send the message that the government is serious about letting the banks deal with any default themselves and this should reduce the chance of such a default. Unfortunately I think Eric is correct when he says,

If things stay as they are, the message to Kiwi investors is pretty clear. Forget all that "diversify your portfolio" nonsense. Put everything into a government-guaranteed roulette wheel. Heads you get high interest payments; tails the government covers you.

So lets change things!

David Farrar is right when he says,

Which is well intentioned. But he lent too much bad money, and in the end he has left the taxpayer with the bill. That is not generosity. Allan Hubbard is not the victim here – the taxpayer is.

We lose again. :-(

Update: Mongrel Dog comments here.

EconTalk this week

Daniel Pink, author of Drive, talks with EconTalk host Russ Roberts about drive, motivation, compensation, and incentives. Pink discusses the implications of using monetary rewards as compensation in business and in education. Much of the conversation focuses on the research underlying the book, Drive, research from behavioral psychology that challenges traditional claims by economists on the power of monetary and other types of incentive. The last part of the conversation turns toward education and the role of incentives in motivating or demotivating students.

Africans do not want or need Britain’s development aid

The letter below was published in the Telegraph (U.K.) on 22 Aug 2010 under the subtitle noted above.

SIR – The parlous state of the public finances in Britain provides the perfect opportunity for British taxpayers to end their half-century-long experiment with “development aid”, which has, since its inception, stunted growth and subsidised bad governance in Africa.

As Africans, we urge the generous-spirited British to reconsider an aid programme they can ill afford, and which we do not want or need. A real offer from the British people to help our development would consist of the abolition of the Common Agricultural Policy, which keeps African agricultural exports out of the European marketplace.

It is that egregious policy, combined with the weight of regulations, bad laws and stifling bureaucracy, subsidised by five decades of development aid, which prevents Africans from lifting themselves out of poverty.

Andrew Mitchell, the Secretary of State for International Development, speaks about a “moral imperative” to combat poverty around the world. We could not agree more. The British have a unique opportunity to cut the deficit and help Africa: please, ask your new government to stop your aid.

Andrew Mwenda
Editor, Independent newspaper, Uganda
Franklin Cudjoe
Executive Director, IMANI Center for Policy and Education, Ghana
Kofi Bentil
Lecturer, University of Ghana and Ashesi University, Ghana
Thompson Ayodele
Executive Director, Initiative for Public Policy Analysis, Nigeria
Temba Nolutshungu
Director, Free Market Foundation, South Africa
Leon Louw
Law Review Project, South Africa

The interesting thing is that the abolition of the Common Agricultural Policy would not just help Africa it would also help the U.K. by lowering consumer prices and saving the taxpayers a fortune.

(HT: Aid Watch)

The joy of being a zealot

From the Herald we learn:

Supermarkets are drug "pushers" who are selling high quantities of discounted wine and should be viewed the same as dealers dishing out Ecstasy pills or morphine.

It may seem extreme but it's a view that Professor Doug Sellman, director of the National Addiction Centre and spokesman for the Alcohol Action Group, is taking quite seriously.

Professor Sellman believes the Government should remove alcohol from supermarket shelves and limit the amount of advertising operators are allowed for liquor, among many changes he hopes might alter people's attitudes to drinking.

The alcohol Taliban are at it again. The good professor should realise that the majority of people don't need their attitudes to drinking changed, but may be he does.

Actually Sellman may be on to something here. There may be something to be said for supermarkets selling drugs in the same way they do alcohol. Legalisation of the sale of drugs would be a big step forward.

Hans-Hermann Hoppe interview

Hoppe is interviewed by Emrah Akkurt, Turkey-Association for Liberal Thinking. To be published in a forthcoming special issue of the economic journal Piyasa on socialism.

A couple of interesting answers given by Hoppe.

Akkurt: In its modern version, Austrian economics, with its emphasis on property rights, entrepreneurship and freedom have natural allies among different schools of economics. For example, the property rights approach of Alchian and Coase come mostly to similar policy positions with Austrians. Do you think, Mises’s writings were somehow influential on the emphasis on property rights and market based approach besides Austrians. Was there a visible link between Mises and some of these people?

Hoppe: I am not aware of any intellectual link between Mises and the modern Chicago law and economics school, in particular Coase, and in his footsteps, Richard Posner. On the other hand, Hayek was one of Coase’s professors at the London School of Economics.

In any case: I believe the similarity between the Austrian and the Chicago view of law and economics to be merely superficial. In reality, both intellectual traditions are fundamentally opposed to each other. It is a common but serious error to think of the Chicago school as a defender of property rights. In fact, Coase and his followers are the most dangerous enemies of property rights. I know, this may sound unbelievable to some people. Thus let me explain, using one of Coase’s examples from his famous article on “Social Cost.”

A railroad runs beside a farm. The engine emits sparks, damaging the farmer’s crop. What is to be done? From the Austrian (and the classic as well as the commonsensical) viewpoint, what needs to be answered is who established property first, the farmer or the railroad? If the farmer was there first, he could force the railroad to stop emitting sparks or demand compensation. On the other hand, if the railroad was there first, then it may continue emitting sparks and the farmer would have to pay the railroad to be spark-free.

Coase’s and Posner’s answer is entirely different. According to them, it is a mistake to think of the farmer and the railroad as either ‘right’ or ‘wrong’ (liable), as ‘aggressor’ or ‘victim.’ Let me quote Coase from the very beginning of his famous article. There he says “the question is commonly thought of as one in which A inflicts harm on B and what has to be decided is, How should we restrain A? But this is wrong. We are dealing with a problem of a reciprocal nature. To avoid the harm to B would be to inflict harm on A. The real question that has to be decided is, Should A be allowed to harm B or should B be allowed to harm A? The problem is to avoid the more serious harm.” Or put differently, the problem is to maximize the value of production or ‘wealth.’ According to Posner, whatever increases social wealth is just and whatever doesn’t is unjust. The task of the law-courts, then, is to assign property rights (and liability) to contesting parties in such a way that ‘wealth’ is maximized.

Applied to our case this means: if the cost of preventing sparks is less than the crop loss, then the court should side with the farmer and hold the railroad liable. Otherwise, if the cost of preventing sparks is higher than the loss in crops, then the court should side with the railroad and hold the farmer liable. But more importantly, this means also that property rights (and liability) are no longer something stable, constant and fixed but instead become ‘variables.’ Courts assign property rights depending on market data. And if these data change, courts may re-assign such rights. That is, different circumstances may lead to a re-distribution of property titles. No one can ever be sure of his property. Legal uncertainty is made permanent.

This seems neither just nor economical. In particular, this ‘variable’ way of assigning property rights will certainly not lead to long-run wealth maximization.

and

Akkurt: What are your views on the public choice school. If I am not wrong you criticize James Buchanan for defending the state. Would you briefly describe your view on this issue. Why is there a tension between your thinking and public choice?

Hoppe: The Public Choice school—most notably Buchanan and Tullock—is typically credited for the insight that people within government are just as much self-interested as people outside of government, i.e., in private business. People do not change their nature and become less self-interested upon becoming a government official.

Now this is of course a fundamentally correct insight. But this insight is not new. You can find it all over in the literature. Certainly ‘realist’ political sociologists such as Gaetano Mosca and Robert Michels knew this much, and ‘Austrians’ knew it too, of course.

What is new about the Buchanan-Tullock school is its theory of the State and political (as contrasted to economic) action. However, this innovation is patently false.

Buchanan and Tullock think the State is essentially a voluntary institution, on a par with private business firms. They claim that ‘the market and the State are both devices through which cooperation is organized and made possible.’ (Calculus of Consent, p. 19) And since the State is like a firm, Buchanan then concludes in his Limits of Liberty, whatever happens in politics, every status quo, ‘must be evaluated as if it were legitimate contractually.’

Now, I regard all of this as dangerous nonsense. Until Buchanan & Tullock, there existed almost universal agreement, regardless of whether one was a State-apologist or an anarchist critic of the State, as to the nature of the State, i.e., what a State actually was. States were recognized as categorically different forms of organization than firms: unlike firms, every State fundamentally rested on coercion. Buchanan’s claim to the contrary would have been regarded as a childish intellectual error.

The great Austrian economist Joseph Schumpeter (himself a member of the Lausanne rather than the Vienna or Austrian School) once remarked on views such as Buchanan’s: a “theory which construes taxes on the analogy of club dues or the purchase of the service of, say, a doctor only proves how far removed this part of the social sciences is from scientific habits of minds.” I wholeheartedly agree with this verdict.

Is South Canterbury Finance really is too big to fail?

This is a no brainer: No! When discussing this issue Bernard Hickey writes:

Receivership would trigger a payout to investors under the government guarantee of around NZ$1.7 billion. Some believe that shock to the government's finances would be enough to trigger a review of New Zealand's sovereign credit rating downgrade by Standard and Poor's and/or Moody's.

The message here is that we should not have had the government guarantee in the first place. So let South Canterbury Finance go under and get rid of the government guarantee scheme so that this problem doesn't arise in the future.