Interview of Ronald Coase and Ning Wang

Nick Schulz interviews Ronald Coase and Ning Wang about issues to so with their new book, "How China Became Capitalist."

The last question is interesting:

NS: You are critical of much modern economics, saying it has been transformed “from a moral science of man creating wealth to a cold logic of choice and resource allocation.” How did this happen? Where did economics go wrong?

RC & NW: Adam Smith, the founding father of modern economics, took economics as a study of “the nature and causes of the wealth of nations.” As late as 1920, Alfred Marshall in the eighth edition of Principles of Economics kept economics as “both a study of wealth and a branch of the study of man.” Barely a dozen years later, Lionel Robbins in his Essay on the Nature and Significance of Economic Science (1932) reoriented economics as “the science which studies human behavior as a relationship between ends and scarce means which have alternative uses.” Unfortunately, the viewpoint of Robbins has won the day.

The fundamental shift from Smith and Marshall to Robbins is to rid economics of its substance — the working of the social institutions that bind together the economic system. Afterward, economics has turned into a discipline without a subject matter, advocating itself as a study of human choices. This shift has been assisted by what Hayek (1952) criticized as the growing trend of scientism in the study of society, which took mathematical formalism as the only secure route to truth in the pursuit of knowledge. As economists become more and more interested in formalism and related technical sophistication, it becomes secondary whether the substantive questions that they choose to perfect their methods or to illustrate their theoretical models bear any resemblance to the real world economy. By and large, most of our colleagues are not bothered by the fact that what they profess is mainly “blackboard economics.”

We are now working with the University of Chicago Press to launch a new journal, Man and the Economy. We chose our title carefully to signal the mission of the new journal, which is to restore economics to a study of man as he is and of the economy as it actually exists. We hope this new journal will provide a platform to encourage scholars all over the world to study how the economy works in their countries. We believe this is the only way to make progress in economics.

We are very much aware that many of our colleagues whose work we admire do not share our criticism of modern economics. But our goal is not to replace one view of economics that we don’t like with another one of our choice, but to bring diversity and competition to the marketplace for economics ideas, which we hope most, if not all, economists will endorse.

Coase has always been somewhat out of step with the rest of the profession when it comes to his view of what is economics is and how it should be done.

John Cochrane interview

A short interview with Bloomberg TV's Betty Liu on the fiscal cliff. Remember Cochrane is to give the he 2012 Condliffe Memorial Lecture in Economics at Canterbury on Wednesday, 5 December, 6:30pm.

Consumer prices and advertising

There is a question in economic theory about the effects of advertising on the prices that consumers pay. Does advertising increase or decrease consumer prices? This debate, which goes back at least to Marshall (1919), is the subject of a new column at VoxEU.org.

The debate is between two effects of advertising. Some have argued that advertising increases the amount of competition in a market, and thereby reduces prices, by providing information to consumers, such as information on prices or the existence of products. But it has also been argued that advertising changes the preferences of consumers thereby shifting demand curves outwards, increasing the monopoly power of brands or decreasing elasticities of substitution. All such effects should lead to an increase in market prices. These different effects of advertising have been called, respectively, the ‘informative’ and ‘persuasive’ effect of advertising.

At VoxEU.org Ferdinand Rauch looks at Advertising and consumer prices. He writes,

In a recent study (Rauch 2011), I use a policy change in Austria to identify this price reaction for all industries. Austria is the only country in the OECD that charges a tax on advertising, which directly affects the cost of advertising. Before 2000, when a nationwide harmonisation introduced a 5% tax rate, each region had a different rate. Thus in 2000 the advertising tax, and therefore the cost of advertising, increased in parts of the country while simultaneously decreasing in other parts [...].

and continues,

I interpret this change of policy as a natural experiment, and collect data on prices of regional products to investigate its effects. I first show that the taxation of advertising is indeed a powerful instrument to restrict advertising expenditures of firms. I also show that advertising increased consumer prices in some industries such as alcohol, tobacco and transportation, in which the persuasive effect dominates. But it also decreased consumer prices in other industries such as food. I use data from existing marketing studies which make it possible to relate different responses of market prices to characteristics of advertisements in industries. I can indeed show that those industries which exhibit the informative price include more information in their advertisements, consistent with the interpretation of informational and persuasive forces of advertising.

The aggregate effect is informative, which means that, on average, advertising decreases consumer prices. This suggests that the Austrian advertising tax increases consumer prices and probably affects welfare adversely. I estimate that if the current 5% tax on advertising in Austria were abolished, consumer prices would decrease by about 0.25 percentage points on average.

So on average advertising seems to be more informative than persuasive. This does raise the question that if advertising is informative, why do it? If it increases competition and lower prices its seems, from the producer's point of view, a bad thing to do. Is it a prisoner's dilemma? If I advertise and my competition doesn't I do well and my competitors suffer but if my competitors advertise and I don't, I suffer and my competitors do well. But if one of us advertises and the other doesn't it is still better for both of us than having both of us not advertising. In such a world we both advertise and make both of us worse off.

References:

• Rauch, Ferdinand, ‘Advertising Expenditure and Consumer Prices’, CEP Discussion Paper 1073, 2011.
• Marshall, Alfred, Industry and Trade, Macmillan Publishing, 1919.

Control rights and super rugby

Sam Richardson over at the Fair Play and Forward Passes blog has commented on what looks to me to be a hospital pass on the "ownership" of the Super Rugby franchises here in New Zealand.

Sam writes,

Yesterday it was announced that there were two successful applicants for licences to operate the Hurricanes and Crusaders Super franchises next season. The Hurricanes franchise is to be run by a consortium including the Wellington Rugby Union, former Hurricanes directors and Welnix, the owners of the A-League franchise the Wellington Phoenix. The Crusaders deal is a little less clear, but is understood to involve a major figure from the West Coast mining industry.

and he continues,

Firstly, there is no question that the NZRU is a clear winner in this process. They get (desperately needed) injections of private funds into the Super franchises which are expensive to run, and have been a drain on the union's coffers. To understand just how they win, though, it is useful to know what the licence for operating a team entails. Also from the NZH article above:

The NZRU will retain full ownership of the franchises, the contracting process and coaching appointments.
Investors will get to select, market and manage their team as well as lobby for players outside New Zealand if that works in tandem with the sport's governing body.

[...] The NZRU therefore has the power to allocate [and pay] the players to each franchise. Investors can do what they like once they get their player list, but a large portion of ownership responsibility is in fact taken away from them. It is a very different ownership structure from, say, US-based, Australian or European sports leagues. At least in the A-League, the Wellington Phoenix can employ whoever they want and sign any player they want. The NZRU retain control of which players can play in Super Rugby, what teams they play for and who coaches them. It is a very favourable set-up to the governing body, no question. It is understandable if the NZRU wishes to avoid any club/country conflict that affects many of our Pacific Island neighbours with overseas-based players contractually bound to overseas clubs that often conflict with commitments to the national team. Crisis averted. The other thing that the licencee model does for the NZRU is to wash their hands of the micro-level management that is often difficult when trying to run the game from a central level. The day-to-day running of a franchise is best done on the ground, and the rationale is that private investors will do the job of running the franchise more efficiently than the NZRU or a provincial-based board could. After all, there might even be some money in it for licencees if they do a good enough job!

Think next of the licencees - show me the money? Where is it coming from? And where are the wider incentives to invest in the franchises? As mentioned above, licencees will select, market and manage their team. That is, they'll do the best that they can with who they are given by the NZRU (who pay the players, after all). They are in the best position to eliminate inefficiencies in the day-to-day running of the franchise - they'll have a clear incentive to run a pretty tight ship.

First Sam is right when he says that the NZRU looks like the winner here. Many of the important control rights are formally in the hands of the rugby union, in particular the control over players. But the first things that comes to mind is the difference between formal authority (the right to decide) and real authority (the effective control over decisions) within organizations. While the rugby union may have formal control of many areas the question is who has real control? Over time its is not hard to imagine real control moving towards the licencees.  Given the amount of time and effort and money the licencees will have to put it, the licencees have a big incentive to make sure they get what they want.

As far as players are concerned this set up doesn't look stable. What happens when the licencees want a given player which the rugby union says they can't have? Given that if the licencees run their franchise well they may be willing and able to pay large amounts for the best players. Clearly this is in the interests of both the franchise and the player but may be not in the interest of the union. Conflict seem certain. The same could also be said of coaches. It seems naive to think that the licencees are just going to sit back and take whatever the rugby union hands out to them, no matter what it is. As Sam notes this is a very different ownership structure from, say, US-based, Australian or European sports leagues. And those leagues are structured in the way they are for good reasons.

The basic problem with the model the rugby union has gone for is that there are just too many different groups with control rights - formal or real. One of the basic outcomes of the literature on the ownership of firms is that ownership is normally in the hand of a homogeneous group. As Henry Hansmann has written,

With larger numbers of owners, however, homogeneity of stakes is the overwhelming rule. Ownership is virtually always confined to a single class of patrons -- such as investors of capital, employees, suppliers of other inputs, or customers. Within the class of patrons who serve as owners, moreover, ownership interests are, or are structured to be, highly homogeneous.

The model being applied by the rugby union just has too many different groups with different agendas involved in the franchises. They are just asking for trouble.

Who is exploiting who?

Are we all Marxists now? At least as far as the theory of the firm is concerned. In a Journal of Finance paper back in 2000 Luigi Zingales wrote,

[...] there is a clear Marxian flavor in the role played by ownership in Grossman and Hart (1986) and Hart and Moore (1990). The residual rights of control allow the owner to extract the surplus out of the worker. The key workers, thus, should control the assets they work for to prevent this “exploitation.” Unlike in Marx, however, this reallocation of ownership is not motivated by distributional concerns but by efficiency concerns. If workers expect to be exploited, they will not make valuable investments. Although I am not aware of any corporate governance paper arguing along these lines, I think this would be a reasonable literal interpretation of the property rights view of the firm.

Actually this point has been made before. In a footnote on page 5 of his 1995 book "Firms Contracts and Financial Structure" Oliver Hart wrote,

[g]iven its concern with power, the approach proposed in this book has something in common with Marxian theories of the capitalist-worker relationship, in particular, with the idea that an employer has power over a worker because the employer owns physical capital the worker uses )and therefore can appropriate the worker's surplus); see e.g. Marx (1867: ch 7). The connection between the two approaches has not so far been developed in the literature, however.

Zingales goes on to say,

[i]nterestingly, this is not the way this view has been used. Quite to the contrary, it has been reinterpreted to support the shareholders’ value maximization paradigm. The best example is Shleifer and Vishny’s (1997) corporate governance survey. They recognize that contracts are incomplete and that the allocation of the residual rights of control shapes the ex post distribution of surplus. But they argue that insiders have a better bargaining position as a result of their ability to quit. Outside financiers — they conclude — should be protected against expropriation through the residual right of control.

So, just who is exploiting who?

Walter Williams on the morality of free markets

(HT: Cafe Hayek)

Thinking at the margin .... or not

One of the most basis rules of economics is to think at the margin. For example, to maximise profits firms set marginal revenue equal to marginal cost. But do consumers think at the margin in the way economists do?

A new NBER working paper looks at this question. Koichiro Ito asks "Do Consumers Respond to Marginal or Average Price? Evidence from Nonlinear Electricity Pricing".

The abstract reads,

Nonlinear pricing and taxation complicate economic decisions by creating multiple marginal prices for the same good. This paper provides a framework to uncover consumers' perceived price of nonlinear price schedules. I exploit price variation at spatial discontinuities in electricity service areas, where households in the same city experience substantially different nonlinear pricing. Using household-level panel data from administrative records, I find strong evidence that consumers respond to average price rather than marginal or expected marginal price. This sub-optimizing behavior makes nonlinear pricing unsuccessful in achieving its policy goal ofenergy conservation and critically changes the welfare implications of nonlinear pricing.

So consumer's thinking is suboptimal insofar as they think on average not at the margin.

Interestingly as far as the theory of the firm is concerned there has been debate about whether firms price on the basis of average or marginal costs since at least the late 1930s. The most famous of these debates were the “full cost controversy” and the related “marginalist controversy”. The full cost controversy was started by the publication in 1939 of a paper by R. L. Hall and C. J. Hitch which looked at pricing policies of firms. On the basis of questionnaire data Hall and Hitch argued that firms set prices in a “full-cost” way by estimating an average-cost amount at a reference level of output and adding to it a fixed percentage. Full-cost pricing came to be seen as a challenge to the usual marginalist (neoclassical) profit-maximising view of the firm. Long-run profit maximisation would only be achieved if the mark-up bore the correct relationship to the firm’s perceived elasticities of demand. In 1946 labour economist R. A. Lester which argued that the theoretical predicts regarding the relationship between wages and employment could not be found in the data. Lester argued that “[ ...] his empirical research raised “grave doubts as to the validity of conventional marginal theory and the assumptions on which it rests” in the following ways: (1) market demand was more important in determining a firm’s volume of employment than wage rates; (2) the firm’s cost structure was not that suggested by “conventional marginalism” and its capital-labor ratio was not tied to its wage rate structure; and (3) “the practical problems involved in applying marginal analysis to the multi-process operations of a modern plant seem insuperable, and business executives rightly consider marginalism impractical as an operating principle in such manufacturing establishments”. Lester’s conclusion was that businessman did not adjust their employment levels in relationship to changes in wages and productivity in a manner consistent with the marginal theory.

So the debate comes back in a different form.

Hanke and Krus on hyperinflation

Steve H. Hanke and Nicholas Krus have a new Cato working paper out on World Hyperinflations. The paper supplies, for the first time, a table - see below - that contains all 56 episodes of hyperinflation, including several which had previously gone unreported. In a footnote (footnote 3, page 3) Hanke and Krus note that the number of hyperinflation could be 57:

If we were to include our estimate for the 2009-11 case of hyperinflation in North Korea, the total number of hyperinflation episodes would increase to 57. However, as explained in the notes to the table, the available North Korean data did not meet our minimum quality standards. Accordingly, we omitted this episode from the table.

The definition of hyperinflation used is that of Cagan (1956): a price-level increase of at least 50% per month. The table utilises clean and consistent inflation metrics, indicates the start and end dates of each episode, identifies the month of peak hyperinflation, and signifies the currency that was in circulation, as well as the method used to calculate inflation rates.

The highest inflation rate is Hungary in July 1946 with an inflation rate equivalent to a daily rate of 207%!

I have omitted the footnotes referred to in the table.

The medieval church and property

An interesting passage from Diana Wood's book "Medieval Economic Thought":

Some thinkers, like John of Paris, ascribed dominion of church property to the pope, and secular property to the lay ruler. A more extreme version of the idea awarded ownership of all property, both ecclesiastical and lay, to the Church. Giles of Rome declared:

there may be no lordship with justice over temporal things or lay persons or anything else which is not under the Church and through the Church: for example, this man or that cannot with justice posses a farm or a vineyard or anything else which he has unless he hold sit under the Church and through the Church.

If property is theft, then this is theft on a grand scale!

Also Europe should be grateful that such an idea never got implemented since it would have suffered the same fate as the socialist countries of the 20th century and for much the same reason: von Mises's critique of socialism would apply here. If all property were owned by the Church, rather than the state, there could be no markets in the factors of production and thus no prices for the factors of production and thus no rational economic calculation would have been possible.

EconTalk for 3 weeks

Steve Hanke of Johns Hopkins and the Cato Institute talks with EconTalk host Russ Roberts about hyperinflation and the U.S. fiscal situation. Hanke argues that despite the seemingly aggressive policies of the Federal Reserve over the last four years, there is currently little or no risk of serious inflation in the United States. His argument is that broad measures of the money supply lag well below their trend level. While high-powered reserves have indeed expanded dramatically, they have not increased sufficiently to offset reductions in bank money, in part because of requirements imposed by Basel III. So, the overall money supply, broadly defined, has fallen. Hanke does argue that the current fiscal path of the United States poses a serious threat to economic stability. The conversation closes with a discussion of hyperinflation in Iran--its causes and what might eventually happen as a result.

Joshua Rauh, Professor of Finance at Stanford University's Graduate School of Business and a senior fellow at Stanford University's Hoover Institution, talks with EconTalk host Russ Roberts about the unfunded liabilities from state employee pensions. The publicly stated shortfall in revenue relative to promised pensions is about $1 trillion. Rauh estimates the number to be over $4 trillion. Rauh explains why that number is more realistic, how the problem grew in recent years, and how the fiscal situation might be fixed moving forward. He also discusses some of the political and legal choices that we are likely to face going forward as states face strained budgets from promises made in the past to retired workers.

Mike Munger of Duke University talks with EconTalk host Russ Roberts about the gas shortage following Hurricane Sandy and John Locke's view of the just price. Drawing on a short, obscure essay of Locke's titled "Venditio," Munger explores Locke's views on markets, prices, and morality.

Words without substance

Welly Gnome highlights the Living Standards Framework new from the Treasury. Welly writes,

The framework incorporates the politically correct dialogue necessary for evaluating all potential policy options by the New Zealand Government in 2012.

“Living standards encompass much more than just income or GDP. It also includes a broad range of material and non-material factors which impact on the well-being of both the individual and society (such as trust, education, health and environmental quality).”

But notice that all these "broad range" of things are positively correlated with economic growth. Countries with higher growth and thus higher levels of income have better education, health and environmental quality etc. So growth is still the key factor and concentrating on growth still the right policy.

The words may have changed but the actions will not. These are just words without substance.

More on partial privatisation

From Homepaddock comes this interchange from Parliament's questions and answers time for October-24.

Michael Woodhouse: Why is it important that the share offer programme goes ahead?

Rt Hon JOHN KEY: It is important, firstly, because the Government can use the proceeds of the share offer to invest in new public infrastructure without having to borrow so much to do so. This is exactly the same situation as in 2005 when the previous Government took $600 million from the sale of publicly owned asset Southern Hydro and used it to invest in roads. The share offer also gives New Zealand savers the opportunity to invest either directly or indirectly in big New Zealand companies, and being publicly listed will be good for the companies themselves.

I do believe bringing these companies to the market through the mixed-ownership model is a good, sound economic approach, and actually I think it will deliver a better result for New Zealand without having to borrow more money. . .

I have noted a number of times that I don't agree with the argeement used here by the PM. In the past I have said

First, selling only 49% of the shares in the companies is unlikely to make an difference to the way the SOEs are run. In particular the sell off will not make the firms anymore efficient since the government will still be the controlling shareholder.

Second, if the government really does want to maximise the income it gets from the sales selling 49% is not a good idea. 51% is worth a lot more than 49%, that is people will pay a premium for control.

Third, selling to "Mums and Dads" will do nothing for the amount of money raised, since Mums and Dads will need a discount to make them buy shares.

Fourth, selling to "Mums and Dads" will do nothing for the efficiency effect of having private owners, since there will be too many "Mums and Dads" for them to be able to coordinate their effects to effect the firm's behaviour.

Fifth, given that each "Mum or Dad" will own only a very small share of any of the firms, they have little incentive to become informed on the firm's activities since they will only capture a very small amount of any improvement in performance they could bring about. This is another reason why performance is unlikely to change.

Sixth, the discipline of bankruptcy or takeover is not greater since the government is still the controlling shareholder and is unlikely to let either of these options happen.

If the government is really worried about the proceeds of the sale of share it should take note of points 2 and 3 above. Points 1, 4 5 and 6 are relevant for the effects of the sale on the "companies themselves". And why do we care about giving

"New Zealand savers the opportunity to invest either directly or indirectly in big New Zealand companies".

Where New Zealanders invest is surely up to them and not something the government should be interfering with.

Less government borrowing is good but if the government sold 100% of the SOEs even less borrowing would be needed. And you would get better outcomes for the firms.

Returning to growth

Increasing economic growth is a big issue in most, if not all, countries around the world right now. For the case of the U.K. recovery from severe recessions was achieved in the 1930s and the 1980s in the presence of fiscal consolidation. In this article at VoxEU.org Nicholas Crafts asks if there are any lessons from these experiences for today's situation.

Crafts writes (references deleted)

The policy lessons from these episodes can be summarised as follows.

• First, although it is not possible to cut nominal interest rates when, as now, they are at the lower bound, it is possible to deliver monetary stimulus by reducing real interest rates if, as in the 1930s, the authorities are willing and able to commit to higher inflation. However, the inflation-targeting regime in place since the 1990s would have to be revised.
• Second, although there are reasons to think the fiscal multiplier may be relatively large when interest rates are at the lower bound, history says that this claim needs to be treated with caution especially when public debt-to-GDP ratios are large.
• Third, a key component of a policy to stimulate recovery during an episode of fiscal consolidation is an ability to ‘crowd in’ private sector spending – private housing investment aided recovery in the 1930s and consumer spending did so in the 1980s.
• Fourth, if politicians wish to devise more interventionist industrial policies then it is essential that they are designed with a view to minimising the adverse impacts on competition.

If radical changes to monetary policy are ruled out and fiscal consolidation continues, the implication is that reforms to supply-side policies have to play a significant part in any attempt to stimulate growth. The ‘good news’ is that there are plenty of evidence-based reforms that can strengthen the UK’s growth performance by improving horizontal industrial policies which have left much to be desired in the last 30 years. These include repairing a serious infrastructure shortfall , institutional reforms to deliver higher quality schooling and improve cognitive skills , reforming taxation to reduce corporate taxes and expand the VAT base , and addressing the massive distortions created by the land-use planning system which undermine the potential productivity gains from successful agglomerations . The ‘bad news’ is that these policy choices are very much exposed to government failure, are subject to implementation lags, and have their effects in the medium- and long-term.

If there is one area that could deliver short-term stimulus and long-term efficiency gains, as in the 1930s, it is surely private house building. The evidence suggests that draconian planning restrictions mean that the stock of houses is three million below and real prices are 35% above the long-run free market equilibrium. The welfare gains from some relaxation of these planning rules are huge and the employment implications of steadily addressing the housing shortfall could be considerable – building 200,000 extra houses per year might employ 800,000. This would require addressing issues of housing finance and incentivising local communities to want development because they can benefit from it and builders to believe that delaying construction would not be profitable. In principle, this could be achieved very quickly but, sadly, it is not politically acceptable so the Chancellor of the Exchequer may find himself in the role of Mr Micawber for a while longer.

The last comment is interesting. Is this a case of a good economic policy not being popular and thus not enacted?

One also wonders what effect "draconian planning restrictions" are having on the stock of houses here in Christchurch, and around the rest of the country.

The economic policy dilemma

Chris Dillow at the Stumbling and Mumbling blog (a blog well worth reading - think "The Standard" but with brains) sums up what he call the The economic policy dilemma with the Venn diagram given below

Chris argues that,

Whatever the cause, the fact is that there is a sharp trade-off between democracy and good economic policy-making.

And I agree.

But I'm willing to bet that while most economists would agree with Chris's diagram they would not agree on what goes into the left hand side of the figure. My view of "policies which are good" is likely to be very different from Chris's view of good policy. But, interestingly, we would both see our favoured policies, whatever they are, as unpopular. Which raises the question if all "good economic policies" are unpopular can we ever get anyone's version of good policy implemented? Does politics gut all economic policy, no matter whether "left" or "right", of all serious content? Are we doomed by the populist nature of politics to get crap economic policy no matter how we define good policy?

Cost of the Olympics

The New Zealand Herald tells us that

The British government says the London Olympics cost about $NZ786 million (400 million pounds) less than expected.

The final financial report for the games projects that the cost will be $17.6 billion from an original budget of $18.33 billion.

But Sam Richardson over at Fair Play and Forward Passes notes that

It sure is a significant achievement. Especially when you are aware of this information, taken from Brad Humphrey's piece in on the economic impact of the Olympic Games in the New Palgrave Dictionary of Economics (well worth a read in general if you are at all interested in the economics of mega sporting events):

London expected its 2012 Games to cost under $4 billion, but they are now projected to cost over $19 billion (Carlin, 2007; Simon, 2006; Sports Business Daily, 2008a). As expenses have escalated for London, some of the projects have been scaled back, such as the abandonment of the planned roof over the Olympic Stadium. The stadium was originally projected to cost $406 million and will end up costing over $850 million. Further, its construction will be financed by taxpayers and the government has been unsuccessful in its effort to find a soccer or a rugby team to be the facility’s anchor tenant after the 2012 Games. This will saddle the British taxpayers with the extra burden of millions of dollars annually to keep the facility operating. It is little wonder that the London Olympics Minister Tessa Jowell stated: ‘Had we known what we know now, would we have bid for the Olympics? Almost certainly not’. (Sports Business Daily (2008b), citing a story in Daily Telegraph (2008). The Olympic Village was to be privately financed, but the plan fell through and will instead cost the taxpayers nearly $1 billion. The government hopes that the apartments will be sold after the Games and the financing will be recouped.)

So yet another warning, approach mega sporting events (and the building of stadiums) and the claims made about them from the organisers  with much caution.

What is Hickey's problem? (updated)

Bernard Hickey is getting all upsetting because he thinks companies are not paying enough tax.

Now there is the obvious point that people don't invest in companies to increase the government's income, they invest to increase their own income. Thus as an investor you would want firms to pay as little tax as possible.

But consider some of the arguments Hickey uses to back up this claim of too little tax being paid. Try this one

Starbucks was in the crosshairs in Britain this week after Reuters reported Starbucks had racked up over 3 billion pounds (NZ$5.88 billion) in sales since 1998, but had paid just 8.6 million pounds (NZ$16.8 million) in taxes.

But what has revenue got to do with tax? Tax is paid on profits not revenue, so the size of Starbucks revenues is irrelevant to what taxes they should pay.

Also,

Over the last three years its paid no income tax, despite comments from management to shareholders that its British operation was so successful and profitable that it was moving its British CEO to head up the American operation.

Starbuck may pay little in U.K. taxes but if its profits are consolidated in the home office, which I guess is in the U.S., what are their U.S. tax payments? Is Hickey really suggesting that Starbucks be taxed twice?

Starbucks forces its British operation to pay 'intellectual property' fees to its Dutch operation, from where it's unclear where the money goes.

In which case the question would be how much tax did Starbucks pay in Holland.

Starbucks is not alone among many multi-nationals who use perfectly legal but morally questionable tactics to shuffle money through tax havens and structures that have the effect of reducing their overall tax rates. Google, Apple and Facebook are masters at it.

Note the "perfectly legal" bit. You should also ask "morally questionable" to whom? Not to me. As noted above people invest in companies to increase their income and less tax means more income.

Hickey also says

Google, for example, made losses for tax purposes in New Zealand in the last two years, despite advertising industry estimates that it made revenues from New Zealand of over NZ$100 million last year. Last year it paid just NZ$109,000 in tax in New Zealand.

Again we have a meaningless comparison of revenues and taxes. And the revenues figures are just guesses!

Hickey ends by saying,

Perhaps it's time New Zealand consumers and taxpayers started targeting companies such as Google and Facebook that don't pay their fair share of tax globally.

And "fair" means what?

And if Bernard thinks the amount of tax paid by a firm is too low, that is, the dividends paid to investors is too high, he has the option of becoming an investor in a low taxed firm and taking the dividends and writing a cheque to the IRD. This should in a small way redress the balance and make Bernard feel morally superior.

You may well think firms should pay more tax, but if you do you need to use better arguments than Bernard Hickey has put forward to back up that claim.

Update: Mark Hubbard writes on Bernard Hickey’s Latest Outage, Sorry, Outrage

Trotter, Shearer and the labour market

In a recent column in The Press Chris Trotter says that

"Immigrants have become an indispensable component of the New Zealand labour market".

And how! As I type these words I sit in a room with an American, two Englishmen, two Canadians, a Czech and an Indian. What would come of our universities if David Shearer got his way on restrictions on immigrant labour? This is just one example of a labour market in New Zealand for which the last thing we need are restrictions on immigrant labour.

Trotter goes on to say that

"In his speech to the Hornby Working Men's Club on Thursday, Shearer quite rightly stated that: "We need to avoid being locked into a downward spiral where our skilled people go to Australia for better wages, where those people are replaced by migrants who are paid less, which in turn sends more of our skilled workers to Australia."

In that single sentence the Labour leader encapsulated the grim dynamic of New Zealand's labour market. This country's ability to hold on to its skilled workers has been very seriously weakened by the power of what is, in effect, a single Australasian market for skilled labour."

I take from this that our skilled workers are heading to Australia and thus reducing the supply of such workers in New Zealand. This should put upward pressure on wages. But I also take from the Trotter piece that wages are not increasing, which is where Shearer's comments on the increased supply of immigrants comes in. The supply of skilled labour in increasing and thus, roughly, the two effects cancel each other out. Wages stay about the same.

What is the problem with this? If the supply and demand conditions are such that wages do not increase, why should we worry? Does this not mean that our firms are more competitive as their costs of production are not increasing at the rate that they are overseas. Does this not help our exporters, which we keep being told need our help. Does this not help those firms trying to rebuild Christchurch by controlling their costs?

Trotter goes on to write,

Shearer appears to think that limiting the influx of immigrant labour will somehow slow the exodus of skilled New Zealand workers to Australia.

Insofar as low wages are the reason for workers heading to Australia then it would help. If the supply of skilled workers is reduced then the wages paid to these workers will increase. This will close the relative wage gap between New Zealand and Australia. But will increase the cost of production for New Zealand firms making them less competitive in world markets and less able to compete against imports.

Trotter argues later in his article that

At the core of the problems Shearer identifies in his speech is the depressed levels of New Zealand wages and salaries.

But this depressed level of wages and salaries may well be simply a reflection of low productivity. As Paul Krugman has said,

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.)

So if Trotter and Shearer want to see an increase in incomes, they need policies to increase productivity. It is far from clear how Trotter's ideas of

[ ...] pass[ing] legislation designed to reverse the flow of wealth from wage and salary earners to owners and shareholders. It [a Labour lead government] will not, by substantially lifting the minimum wage, engineer a wholesale winnowing-out of New Zealand's most inefficient businesses. It will not pass legislation restoring universal union membership or the national award system. It will not use the government's ability to set wages and salaries in the public sector to provide both a guide and a goad for private sector employers

will increase New Zealand's productivity.

Carrots that look like sticks

A well known result in the contracts literature in that if the output of one or more tasks is more straight forward to measure than the output of other tasks then piece-rate incentive schemes will lead to a distortion of effort toward the more easily monitored outcomes. A new NBER working paper by Omar Al-Ubaydli, Steffen Andersen, Uri Gneezy and John A. List argues that contrary to the above argument the use of piece rates can, when the agent is uncertain about the principal’s monitoring ability, signal to the agent that the principal is efficient at monitoring. Such a signal induces greater effort on all fronts.

Carrots that Look Like Sticks: Toward an Understanding of Multitasking Incentive Schemes
Omar Al-Ubaydli, Steffen Andersen, Uri Gneezy, John A. List

NBER Working Paper No. 18453
Issued in October 2012
NBER Program(s): LS

Constructing compensation schemes for effort in multi-dimensional tasks is complex, particularly when some dimensions are not easily observable. When incentive schemes contractually reward workers for easily observed measures, such as quantity produced, the standard model predicts that unrewarded dimensions, such as quality, will be neglected. Yet, there remains mixed empirical evidence in favor of this standard principal-agent model prediction. This paper reconciles the literature by using both theory and empirical evidence. The theory outlines conditions under which principals can use a piece rate scheme to induce higher quantity and quality levels than analogous fixed wage schemes. Making use of a series of complementary laboratory and field experiments we show that this effect occurs because the agent is uncertain about the principal’s monitoring ability and the principal’s choice of a piece rate signals to the agent that she is efficient at monitoring.

The question of the moment

What if governments can't pay their debts?

For 2012 the Condliffe Memorial Lecture in Economics at Canterbury will be held on Wednesday, 5 December, as part of the University of Canterbury's ongoing "What If?" lecture series. This year, we're pleased to host Professor John Cochrane. Professor Cochrane is AQR Capital Management Distinguished Service Professor of Finance in the Chicago Booth School of Business at the University of Chicago. He blogs at The Grumpy Economicst. Please RSVP via the University's website.

EconTalk this week

Jonathan Rodden, political science professor at Stanford and a senior fellow at the Hoover Institution speaks with EconTalk host Russ Roberts about the geography of voting. The main focus is on the tendency of urban voters around the world to vote for candidates on the left relative to suburban and rural voters. Rodden argues that this pattern is related to the geography of work and housing going back to the industrial revolution. He also discusses the implications of various voting systems such as winner-take-all vs. proportional representation, the electoral college and how political systems and voter preferences can produce unexpected outcomes.