Happy birthday Ronald Coase

Coase was born at 3:25 p.m. on December 29th, 1910 in a house in Willesden, a suburb of London so he now a young and sprightly 101!

Coase received the 1991 Sveriges Riksbank (Bank of Sweden) Prize in Economic Sciences in Memory of Alfred Nobel

“for his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy”

In its press release on Coase’s Nobel award, The Royal Swedish Academy of Sciences makes mention of only two papers: "The Nature of the Firm" and "The Problem of Social Cost". It is largely on these two contributions to the theory of the firm and the theory of externalities that Coase’s rightful claim to be the greatest economist of the 20th century is based.

Incentives matter: marketing file

Thanks to Tim Worstall for this wonderful example of a bad marketing promotion and the rational response to it.

To introduce you to a little bit of English English. To “do a Hoover” is not exactly everyday language, even here, but it will be understood by those discussing retail promotions. It means doing something sufficiently silly that it ends up enraging your customers, costs you a lot of money and in general is entirely counter-productive. You may have started off trying to sell more goods and thus making more profit but that’s not quite the way it turns out.

It comes from what the UK subsidiary of Hoover did back in 1992. In order to sell more of those machines that suck the dirt out of your carpet (a “spangler” we might say) the company decided that anyone who bought more than £100 worth of the company’s goods would be entitled to two free roundtrip air tickets.

Seeing that sales did go up they decided to expand the offer, to two roundtrip tickets to the US. Which is where the roof really started falling in. For instead of simply accelerating future purchases, moving them from the future to today (this was a time of severe recession in the UK so that could have been a decent tactic), or transferring sales from competitors to Hoover, what was actually happening was that people who wanted to visit the US bought a sucking machine.

In fact, the classifieds sections of local papers across the country began to fill up with new, unused but very cheap Hoovers. For what the promoters of the scheme seemed to have missed was that the value of two roundtrip tickets (from memory, at the time, perhaps £300 to £400) was rather larger than the amount they were asking people to spend with the company.

So, rational beings that people are, people were buying the Hoover as a cheap way of getting the tickets. Chaos obviously ensued, it became very difficult to actually cash in on the offer (they had not limited it to the first 1,000, or 10,000) and Hoover was desperately running around trying to book cheap flights from the airlines. Who, of course, knowing that they had them over a barrel, were not playing ball.

In the end this cost the company £50 million (yes, even in our funny money, quite a significant sum) the people responsible were fired and Hoover US sold off the UK company to some Italians. The court cases were still rumbling on years later.

EconTalk this week

Alex Tabarrok of George Mason University talks with EconTalk host Russ Roberts about his new book, Launching the Innovation Renaissance. Tabarrok argues that innovation in the United States is being held back by patent law, the legal system, and immigration policies. He then suggests how these might be improved to create a better climate for innovation that would lead to higher productivity and a higher standard of living.

Productivity does matter

From Mark Perry at the Carpe Diem blog:

According to new data just released by the United Nations, China surpassed the United States in 2010 to become the world's No. 1 manufacturing nation, ending America's dominance as the world's largest manufacturer since the late 1800s (see chart above of the top five manufacturing countries). China's manufacturing output in 2010 of $19.222 trillion and 18.89% share of world manufacturing output of $10,176 trillion,was slightly ahead of America's manufacturing output of $1.855 trillion and 18.24% share of global manufacturing production.

But note:

China's manufacturing workforce is estimated to be around 100 million and could be as high as 120 million, compared to America's manufacturing employment of about 11.5 million. Therefore, China is producing roughly the same manufacturing output as the U.S. but Chinese worker productivity is so low it needs 9-10 workers for every one American factory worker.

So China's workforce is huge and not very productive, but cheap.

Even though China is now the world largest manufacturer, its GDP per capita of only $2,800 (data here from the USDA) is just now reaching a level of output per person that the U.S. achieved back in 1878, 133 years ago.

Put simply having low productivity results in low income per capita. Paul Krugman makes the point when he writes,

Economic history offers no example of a country that experienced long-term productivity growth without a roughly equal rise in real wages. In the 1950s, when European productivity was typically less than half of U.S. productivity, so were European wages; today average compensation measured in dollars is about the same. As Japan climbed the productivity ladder over the past 30 years, its wages also rose, from 10% to 110% of the U.S. level. South Korea's wages have also risen dramatically over time. ("Does Third World growth hurt First World Prosperity?" Harvard Business Review 72 n4, July-August 1994: 113-21.)

Thus in the battle to improve wages and the standard of living, China (and New Zealand) must improve its productivity.

EconTalk this week

Dan Klein of George Mason University talks with EconTalk host Russ Roberts about the ideas in Klein's new book, Knowledge and Coordination. Klein argues that allegory is a powerful way to think about outcomes of emergent order. He goes deeply into the concept of the invisible hand and creates a novel way to evaluate processes that not under any one's control. Klein then suggests novel ways of evaluating economic outcomes outside of the traditional metrics and techniques. Along the way, Klein emphasizes the role of uncertainty and imperfection in the entrepreneurial process.

How big is the North Korean army? Evidence from missing population

In a recent column at VoxEU.org Ho Il Moon notes that little is known about North Korea's economy as official statistics are scant. But North Korea cannot be ignored, especially when it comes to the size of its army. This column suggests that the true number is hidden between the lines of the census. It provides an estimate based on missing population, that is, the difference between the whole population and the number of registered citizens. Moon writes

Since the country established its armed forces in 1963, North Korea has never published any number on military personnel. One estimate from The Military Balance is formally used by the Japanese government. It suggests North Korea's military personnel are around 1,020,000 in the ground forces, 60,000 in the navy, and 11,000 in the air force. However, no clear explanation is provided as to how these figures were obtained.

But North Korea may have accidentally published its number of military personnel. It implemented two population censuses – one in 1993 and one in 2008. As the censuses were supported by the UN Population Fund and South Korea's Foundation for Inter-Korean Cooperation, North Korea was obliged to report the data.

A close examination of the numbers reveals an anomaly. The population overall is greater than the sum of the populations by administrative district. The discrepancy in the 1993 census is of 691,027 persons, while in the 2008 census, it is of 702,373 persons. This means that roughly 700,000 people are not registered in administrative districts.

The reason for this discrepancy lies in North Korea's citizen registration system. According to the Citizen Registration Law, not all citizens are registered. Article 13 stipulates that the citizen ID, ie the citizen registration, is to be returned to the public security office where the citizen resides if she enlists in the Korean People's Army or Korean People's Guard, or a public- or national-security institution, or if her citizenship ceases because of death or mental illness. This implies that the 700,000 discrepancy consists in part of those enlisted in the army.

Looking at the demographic characteristics of these 700,000 persons, it is highly likely that a majority of them are in the Korean People's Army. Figure 1 shows the sex ratio by age taken from the 1993 data by administrative region. At the time of birth, there are slightly more boys than girls (the ratio is around 1.05). Because men have a higher mortality than women the older they get, the ratio declines from around age 30. However, as can be clearly seen in the figure, there is a sharp dent between ages 16 and 26. This coincides exactly with the end of compulsory-education, when some join the armed forces, and is entirely due to a decline in the number of men, which make up the numerator of the ratio. As the majority of the armed forces are young men, it is likely that most of the unregistered 700,000 persons are members of the armed forces.

At best, this number of 700,000 persons forms the upper bound for estimates of the number of North Korean military personnel.

Figure 1. Sex ratio by age (1993 census)

Another big question to do with North Korea is, How many famine victims were there? Moon writes on this question,

Another area in which available data are extremely scant is the number of victims of famine. Numbers circulated indicating that “several million people” had died from starvation. Although there were numerous sources for such claims, the first to provide a statistical underpinning is South Korea's Korean Buddhist Sharing Movement. The latter repeatedly interviewed food refugees in China's border regions and tried to estimate the scale of the famine. These estimates suggest that in the roughly three years from the floods in 1995 until late 1997, about 3.5 million people had died from starvation (KBSM 1998). But these estimates are extrapolations reconstructed from demographic information given by refugees from the region with the highest mortality rate and the most prone to famine. Hence, these numbers are unconvincing.

Taking a very different approach, I estimate the number of famine-related deaths based on ‘excess mortality,’ ie the difference between the mortality rate at normal times and that at the time of the famine. My estimates, which have been published by South Korea’s government, suggest that 336,000 persons died of famine from 1995 to 2000.

So that's, roughly, the population of Christchurch killed in the space of 5 years. And we thought earthquakes were bad.

EconTalk this week

Mike Munger of Duke University talks with EconTalk host Russ Roberts about profit. What is profit's role in allocating resources? How should we feel about the people who earn profits or who take them in ways that may not be earned? How easy is it to discover profitable opportunities? Munger examines these questions through a series of stories, real and fictional, to illuminate the sometimes puzzling nature of profit.

Great new paper

Well actually it's not that great or that new, it's a revision of a previous paper, but it is here.

Simple models of a human-capital based firm: a reference point approach

Some days you just get lucky!!!

And this is one of those days.

Tossing your toys

From Greg Mankiw:

1. John summarizes a recent Hoover conference on restoring robust economic growth.
2. Paul is annoyed at John.
3. John is annoyed at Paul.

On what basis is Krugman getting upset at a summary of papers given at a conference he didn't attend?

Mario Rizzo says It is Hayek versus Keynes

From ThinkMarkets comes this from Mario Rizzo,

And yet the recent obsession Krugman has with Hayek (and lately the obsession DeLong has with Mises) means that some nerve has been touched. Of course, it might simply be that Krugman needs material for his blogs and columns.

However, I think the real issue is this. Hayek’s approach attacks, root-and-branch, the macroeconomic way of thinking. It is not simply a challenge to a particular theory of the determinants of mass unemployment, inflation, business cycles and the like. Hayek is not accepting the rules of the game or the parameters of the sub-discipline of modern macroeconomics. Hayek does not want to argue that the government expenditure multiplier is 0.5 instead of 2.0, for example. He does not want to discuss just how much fiscal stimulus should be undertaken and what form it should assume.

In short, he does not want to focus on aggregate spending and aggregate consequences. Hayek’s approach says: Let us pierce the veil of aggregates and look at the distortive effects on relative prices and relative output produced by boom-time credit expansions. Let us look at the distortive effects that booms leave us as we work our way through a recession. Let us concentrate on sustainable lines of expenditure both during the boom and during the road out from the bust.

Suffice it to say this greatly erodes the intellectual capital of a field of economics – although one not noted for its successes.

There is much that economic aggregates don't tell us.

EconTalk for two weeks

Tyler Cowen of George Mason University talks with EconTalk host Russ Roberts about the European crisis. Cowen argues that Greece is likely to default either in fact or in spirit but that the key question is which nations might follow--whether Italy and Spain can find a road to economic health and honoring past debts. Cowen gives his best guess as to what is likely to happen to the euro and the European Union and the implications for the rest of the world. He explores some less likely scenarios as well. He is pessimistic about Greece and the short-run prospects for preserving the status quo, but he is optimistic in the long-run about the European Union though it may have a different structure down the road.

Simon Johnson of MIT and the author (with James Kwak) of 13 Bankers talks with EconTalk host Russ Roberts about the origins of the financial crisis and how the next one might be prevented. Invoking the work of George Stigler, Johnson argues that the financial sector has captured the regulatory process and the result is that regulation and government intervention have been steered more by the interests of the financial sector than to the benefit of the general public. Johnson argues for capping the size of banks in order to reduce the danger of systemic risk and the too-big-to-fail excuse for bailing out banks. Johnson also discusses the role of the Fed in subsidizing risk-taking and leverage in the financial sector.

Explaining charter school effectiveness

Charter Schools are in the news right now with much uninformed comment is being made by those on all sides of the debate, so here's some actual research on Charter Schools.

In December 2011 edition of The NBER Digest Linda Gorman summaries a recent NBER Working Paper, "Explaining Charter School Effectiveness" by Joshua D. Angrist, Parag A. Pathak, and Christopher R. Walters.

"Over-subscribed urban charter schools that admit students by lottery have produced the largest improvement in student achievement."

Comparisons of those who did and did not win charter school admissions lotteries in Massachusetts suggest that urban charter schools boost student achievement. In Explaining Charter School Effectiveness (NBER Working Paper No. 17332), Joshua Angrist, Parag Pathak, and Christopher Walters find that student demographics are related to the extent of this improvement: urban charter schools are most effective for non-whites and low-baseline achievers. They also find that while over-subscribed urban charter schools that admit students by lottery have produced the largest improvement in student achievement, non-urban charter schools are uniformly ineffective in raising measured achievement.

This research uses data on students who attended any of 32 Massachusetts charter schools at any time between the 2001-2 and 2009-10 school years. The authors match school records with test scores and administrative data, including demographic variables such as race, gender, and poverty status, as well as information on school policies, teaching staff, and hours spent in school. Overall their results show that middle school charter lottery winners outscored lottery losers somewhat in English and more significantly in math. High school lottery winners outscored lottery losers about equally in English and math.

Massachusetts' urban charter school students are drawn from a population in which middle school students generally score below the average on state-wide math and English tests. The authors estimate that one year in an urban lottery charter middle school boosts scores dramatically, by 0.34 standard deviations in math and 0.14 standard deviations in English. In contrast, non-urban charter schools appear to degrade performance. Although, as the authors note, "most non-urban students do reasonably well in any case," the causal effect of a year of non-urban charter attendance is a substantial reduction in achievement in all levels and subjects, on the order of 0.16 standard deviations in middle school with almost a quarter of a standard deviation decline in high school math.

The researchers conclude that the relative effectiveness of urban lottery charter schools can be explained by over-subscribed schools' embrace of the No Excuses approach to education.

The second best

When looking at many of the discussions of claims of some form of market failure and how governments can fix things, I wonder if this is one area where partial equilibrium modelling can leads us astray. While the use of taxes or subsidies may, in theory, correct a failure in a single market the question has to be asked, What effect does this have in general? It is here that the theory of second best can ruin the day of our would be market failure fixes.

It is well known that the attainment of a Paretian optimum requires the simultaneous fulfillment of all the optimum conditions. The general theorem for the second best optimum states that if there is introduced into a general equilibrium system a constraint which prevents the attainment of one of the Paretian conditions, the other Paretian conditions, although still attainable, are, in general, no longer desirable. In other words, given that one of the Paretian optimum conditions cannot be fulfilled, then an optimum situation can be achieved only by departing from all the other Paretian conditions. The optimum situation finally attained may be termed a second best optimum because it is achieved subject to a constraint which, by definition, prevents the attainment of a Paretian optimum.

From this theorem there follows the important negative corollary that there is no a priori way to judge as between various situations in which some of the Paretian optimum conditions are fulfilled while others are not. Specifically, it is not true that a situation in which more, but not all, of the optimum conditions are fulfilled is necessarily, or is even likely to be, superior to a situation in which fewer are fulfilled. It follows, therefore, that in a situation in which there exist many constraints which prevent the fulfillment of the Parteian optimum conditions, the removal of any one constraint may affect welfare or efficiency either by raising it, by lowering it, or by leaving it unchanged. (R. G. Lipsey and Kelvin Lancaster, The General Theory of Second Best, The Review of Economic Studies, Vol. 24, No. 1 (1956 - 1957): 11-2)

So even if the use of a tax or subsidy may appear to have removed some market failure in a single market it may cause more trouble that it is worth in a general equilibrium setting.

Interesting blog bits

Mark Blaug

1. Frederic Sautet on Mark Blaug (1927-2011), fellow traveller of Austrian economics
2. Tyler Cowen on Very sad news, Mark Blaug passes away, 1927-2011
3. Eric Schliesser on Weekly Philo economics: Mark Blaug (1927-2011)
4. Gavin Kennedy on Mark Blaug and the Invisible Hand
5. Eric Crampton on Blaug
6. Steve Kates on Mark Blaug

Andrew Skinner

1. Eric Schliesser on Weekly Philo economics: Mark Blaug (1927-2011) & Andrew Skinner (1935-2011)
2. Gavin Kennedy on Andrew Skinner; doyen among Smithian Scholars, 1935-2011

Blaug on Smith

Given the recent deaths of both Mark Blaug and Andrew Skinner I was reminded of this comment by Blaug on Adam Smith and the "invisible hand",

"[ ... ] Smith's faith in the benefits of 'the invisible hand' has absolutely nothing whatever to do with allocative efficiency in circumstances where competition is perfect a la Walras and Pareto; the effort in modern textbooks to enlist Adam Smith in support of what is now known as the 'fundamental theorems of welfare economics' is a historical travesty of major proportions. For one thing, Smith's conception of competition was, as we have seen, a process conception, not an end-state conception. For another society, a decentralised competitive price system was held to be desirable because of its dynamic effects in widening the scope of the market and extending the advantages of the division of labour - in short, because it was a powerful engine for promoting the accumulation of capital and the growth of income."

Blaug, Mark 1996. Economic Theory in Retrospect. 5th edn. 60-1. Cambridge: Cambridge University Press.

In today's terms, in some ways, I would see Smith as more "Austrian" than "neoclassical".

Andrew Skinner, 1935-2011

Eric Crampton has noted the passing of Mark Blaug. It now turns out that we must also note the passing of another great historian of economics, the Adam Smith scholar, Andrew Skinner. From the Adam Smith’s Lost Legacy blog comes this tribute to Skinner:

Eric Schliesser, a fine scholar who is much appreciated for his knowledge of 18th-century leading figures of the Scottish Enlightenment, has written a tribute to Andrew Skinner, whose death was reported today:

“This has been a terrible week for the history of economics: two of its giants, Andrew Skinner and Mark Blaug, died a few days apart. Skinner was the Daniel Jack Professor of Political Economy from 1985 to 1994 and Adam Smith Professor of Political Economy from 1994 until 2000 at University of Glasgow. Skinner is best known for his superb editing of the 2-volumes of the The Wealth of Nations in The Glasgow Edition of the Works and Correspondence of Adam Smith (1976).

He was also the author of a very fine collection of essays on Adam Smith, A System of Social Science: Papers Relating to Adam Smith. (He also edited several volumes of scholarly papers on Adam Smith.) He should have been better known for his very helpful (1966) edition of Sir James Steuart (1767) An Inquiry into the Principles of Political Economy. (The edition does contain some cuts, so let the buyer be aware.) Steuart was a subtle reader of Hume's political economy, and was deliberately ignored by Adam Smith; it mattered a lot to Skinner to ensure that Steuart was not forgotten.

I did not have much interaction with Skinner. But one is worth recounting. At the start of 2000, I sent him a draft of my main methodological/interpretive chapter on Smith's Wealth of Nations of my dissertation-then-in-progress. (We had never met.) Skinner was a natural choice because he was the leading scholar of the connections between Adam Smith's economics and Smith's Kuhnian theory of science. A few months went by, and just before his official retirement from the university he sent me his (kind) reflections on my chapter. Then I did not realize how rare such generosity is. He concluded his letter with a remark that I quote: "I met [Thomas] Kuhn in 1975 in Princeton when he told me, as I recall, that he was unaware of [Adam Smith's "The History of] ASTRONOMY" - if true, intriguing in that both Kuhn and Smith cite Copernicus' introduction as a classic example of the crisis state?"

Mega-events “crowding out effect”

One reason economist frequently cite when arguing that the economic impact of mega-events like the rugby world cup or the Olympics is lower than advertised is the “crowding out effect.” According to the UK’s Guardian newspaper,

The Really Useful Group, Andrew Lloyd Webber’s production company, is reportedly considering closing West End shows including The Phantom of the Opera and The Wizard of Oz, with tourist bookings predicted to slide in July and August.

The European Tour Operations Association (ETOA) has announced that its members are facing a 95% decrease on London bookings for the period, while the managing director of Encore Tickets, John Wales, said the company was bracing itself for “sales from tourists to be at least 40 per cent down on last year”.

While it will be true that London will have more that its fair share of Olympics tourists next summer, it has to be remembered that London is normally overrun with all sorts of other tourists in the summer including those who go to musicals. Sports fans, rugby or Olympic, don't always add to the tourist base, rather they simply displace other visitors leading to lower than expected increases in net tourism.

The case against a financial transactions tax

There is a new web publication from the IEA on The case against a financial transactions tax by Tim Worstall. The main points made in the article are:

• There is strong economic evidence that the proposed Financial Transactions Tax (FTT) would not increase the amount of tax revenue collected by governments. In fact it would reduce total tax revenue by shrinking the economy.
• Workers and consumers in general - not the banks - would carry the main economic burden of the FTT. Wages would be lower because the tax would increase the cost of capital, thereby reducing growth in productivity.
• Returns on pension funds and other savings would also be lower, in part because the FTT would increase the costs of buying and selling shares as well as reducing their values.
• The FTT would not have prevented the financial crisis, nor would it have avoided current sovereign debt problems. The tax would shrink those parts of the financial markets which did not contribute to the recent crisis but would not make much difference to the factors that caused the crash.
• The FTT would not reduce volatility; it would increase it. Market movements will come in larger steps if speculation is discouraged. It is preferable to have deep and liquid markets so that changes are incremental and smooth.

The Green Party supports such a tax if all countries were to implement one, while the Maori Party and Hone Harawira are also in favour. May be they should read the essay.

EconTalk this week

Gary Taubes, author of Good Calories, Bad Calories, talks to EconTalk host Russ Roberts about what we know about the relationship between diet and disease. Taubes argues that for decades, doctors, the medical establishment, and government agencies encouraged Americans to reduce fat in their diet and increase carbohydrates in order to reduce heart disease. Taubes argues that the evidence for the connection between fat in the diet and heart disease was weak yet the consensus in favor of low-fat diets remained strong. Casual evidence (such as low heart disease rates among populations with little fat in their diet) ignores the possibilities that other factors such as low sugar consumption may explain the relationship. Underlying the conversation is a theme that causation can be difficult to establish in complex systems such as the human body and the economy.