The Luddites may be right

Yes, robots takeover even more jobs!

The US Navy’s most adorable employees are about to get the heave-ho because robots can do their job for less.

The submariners in question are some of the Navy’s mine-detecting dolphins which will be phased out in the next five years, according to UT Sand Diego.

The dolphins, which are part of a program that started in the 1950′s, have been deployed all over the world because of their uncanny eyesight, acute sonar and ability to easily dive up to 500 feet underwater.

Using these abilities they’ve been assigned to ports in order to spot enemy divers and find mines using their unparalleled sonar which they mark for their handlers who then disarm them.

However, the Navy has now developed an unmanned 12-foot torpedo shaped robot that runs for 24 hours and can spot mines as well as the dolphins.

And unlike dolphins which take seven years to train, the robots can be manufactured quickly.

Will we see dolphins protesting by smashing these robots in an effect to keep their jobs? There could be rioting in the streets ..... errrr ..... water!

(HT: Marginal Revolution)

Sharing the pain of a disaster

Michael Giberson writes over at the Knowledge Problem blog about the effects of allowing prices to adjust when a disaster hits. That is, the effects of "price gouging".

One idea advanced by proponents of anti-price gouging laws is that after disaster strikes people should put aside their usual self-interests, join in with the community, and share in the burden of recovery. What these proponents often miss is that normal market adjustments will support a sharing in the burden of recovery, even among those lacking much in the way of charitable impulses, when prices are relatively free to adjust.

Prices go up in the disaster zone, supplies are diverted from elsewhere, prices go up elsewhere, people elsewhere cut back a little in response to higher prices, and there we have it: sharing the pain. Adam Smith’s “invisible hand” is a helping hand to those in need.

But the actions of the “invisible hand” were constrained by the very visible hand of the state. In both New York and New Jersey state officials were prominently threatening to slap businesses with thousands of dollars in fines if prices went up too much. Prices did go up a bit in the disaster struck area, but not enough to prompt extraordinary efforts from elsewhere. New York saw none of that normal, voluntary response to changing supply and demand conditions elsewhere, and post-disaster sacrifices remained concentrated mostly in the hardest hit areas.

So if you believe in everybody feeling the pain of a disaster let prices adjust otherwise those in the worst affected areas will feel all the pain.

2012 Condliffe Memorial Lecture: tomorrow

2012 Condliffe Memorial Lecture: What if governments can't pay their debts?

Date: Wednesday 5 December 2012
Time: 6:30 p.m. to 8:00 p.m. Location: A1 lecture theatre

John H. Cochrane is the AQR Capital Management Distinguished Service Professor of Finance at the University of Chicago Booth School of Business. His recent finance publications include the book Asset Pricing, and articles on dynamics in stock and bond markets, the volatility of exchange rates, the term structure of interest rates, the returns to venture capital, liquidity premiums in stock prices, the relation between stock prices and business cycles, and option pricing when investors can't perfectly hedge. His monetary economics publications include articles on the relationship between deficits and inflation, the effects of monetary policy, and on the fiscal theory of the price level. He has also written articles on macroeconomics, health insurance, time-series econometrics and other topics. He was a co-author of The Squam Lake Report. He writes occasional op-eds, and blogs as "the Grumpy Economist" at johnhcochrane.blogspot.com

A paper you might want to read

So suggests Lasse Lien at the Organizations and Markets blog. He writes,

Here’s a link to the “online first” version of a new Org. Science paper by Peter and myself. This one has been in the pipeline for some time, and we’ve blogged about the WP version before, but this is the final and substantially upgraded version. Please read it and cite it, or we will be forced to kidnap your cat:

So in the interests of keeping my cat safe here is a link to the paper, "Can the Survivor Principle Survive Diversification?", and the abstract reads,

The survivor principle holds that the competitive process weeds out inefficient firms, so that hypotheses about efficient behavior can be tested by observing what firms actually do. This principle underlies a large body of empirical work in strategy, economics, and management. But do competitive markets really select for efficient behavior? Is the survivor principle reliable? We evaluate the survivor principle in the context of corporate diversification, asking if survivor-based measures of interindustry relatedness are good predictors of firms’ decisions to exit particular lines of business, controlling for other firm and industry characteristics that affect firms’ portfolio choices. We find strong, robust evidence that survivor-based relatedness is an important determinant of exit. This empirical regularity is consistent with an efficiency rationale for firm-level diversification, though we cannot rule out alternative explanations based on firms’ desire for legitimacy by imitation and attempts to temper multimarket competition.

EconTalk this week

Casey Mulligan of the University of Chicago and the author of The Redistribution Recession, talks with EconTalk host Russ Roberts about the ideas in the book. Mulligan argues that increases in the benefits available to unemployed workers explains the depth of the Great Recession that began in 2007 and the slowness of the recovery particularly in the labor market. Mulligan argues that other macroeconomic explanations ignore the microeconomic incentives facing workers and employers.

David Friedman on How to Privatize Everything

David Friedman sat down to talk with Reason TV at Libertopia 2012 in San Diego. Friedman reflected on the impact of his landmark book, "The Machinery of Freedom", discussed the differences between libertarianism and anarcho-capitalism and revealed what his father, economist Milton Friedman, thought of his anarchist leanings.

Firm organisation: what we know and why we should care

An interesting question asked by Laura Alfaro, Paola Conconi, Harald Fadinger, Patrick Legros and Andrew Newman at VoxEU.org. Increasingly, some people are pointing the finger of blame for economic woe at large firms. This column argues that organisation design is often affected by government trade policy. If firm organisation design has implications for consumer welfare (in terms of prices and quality of product), evidence suggests that governments should make sure that in future, trade policy and corporate governance policy are more complementary.

The column starts by looking at how market forces affect organisation design.

First steps toward understanding how market forces affect organisation design have been made by McLaren (2000), Grossman and Helpman (2002), and Legros and Newman (2008). They have investigated the role of market thickness and terms of trade in supplier markets. More recent studies examine how organisational firms behave in competitive markets, how efficient and inefficient ones can coexist in the face of competition, and how they respond to changes in market conditions and policies. In particular, Legros and Newman (2012) develop a tractable model in which firm organisation – specifically, ownership and control à la Hart and Holmström (2010) – depends on product prices, as well as the terms of trade in supplier markets. Integrating an enterprise enhances productivity, but also imposes higher private costs on the managers who determine its ownership structure. Product price enters the tradeoff because it directly affects the organisation’s profit objective, but has a negligible impact on the costs. As the price rises, the tradeoff is resolved in favour of more integration, since the organisational goal becomes relatively more valuable than private goals.

Now note that policies that affect product prices affect firm organisation.

A recent paper by Alfaro et al. (2012) examines the predicted relationship between price levels and vertical integration. The authors exploit both cross-sectional and time-series variation in the degree of trade protection faced by firms2; the authors use WorldBase from Dun and Bradstreet (D&B), which contains data about millions of plants around the world. For each plant, the dataset includes information about its different production activities, as well as its ownership (e.g. its domestic or global parent). This allows constructing firm-level vertical integration indices, measuring the fraction of inputs used in the production of a firm’s final good that can be produced in-house.

Alfaro et al. (2012) find that, the higher the tariff applied by a country on the imports of a given product – and thus the higher domestic prices – the more vertically integrated firms will be that are producing that product in that country. The effect is larger precisely where organisational decisions ought to be more responsive to import tariffs, i.e. for firms that only serve the domestic market and in sectors in which tariffs have a larger impact on domestic prices. These results suggest that policies that affect product prices can have direct effects on firm organisation.

The next issue considered is the effects of falling trade barriers since polices which liberalise product and factor markets trigger price changes that can lead to significant waves of mergers and divestitures within countries.

Conconi, Legros and Newman (2012) adapt Legros and Newman’s framework (2012) to examine the impact of falling trade barriers on organisation. They consider the effects of the successive liberalisation of product and factor markets and obtain two main results. First, consistent with the evidence in Alfaro et al. (2012), even when supplier firms do not relocate across countries (i.e. there is no ‘offshoring’), freeing trade in goods triggers price changes that can lead to significant changes in ownership structures (waves of mergers and divestitures) within countries. Second, following the liberalisation of product markets, the removal of barriers to factor mobility can induce further organisational restructuring, which can lead to increases in goods price (or decreases in their quality). These effects will tend to result from a shift toward outsourcing in the country with the less productive suppliers. (The intuition for this result is integration is more flexible than outsourcing in its ability to distribute surplus between suppliers -- since they do not make decisions, the profit shares they receive have no incentive effects -- and will therefore tend to be adopted when the supplier market strongly favors one side or the other.) This finding is in line with evidence of inefficiencies often attributed to firms switching from integration to non-integration (e.g. the safety problems associated with US-designed toys produced by Chinese contractors and subcontractors or customers’ frustration with the outsourcing of call centres).

One important result from all of this is that since integration favours consumers because it produces more than non-integration, managers without full financial stakes will tend to overvalue their private costs, leading to inefficient outsourcing. In the international context, factor market liberalisation can lead to price increases/quality losses, possibly hurting consumers in all countries. These results suggest the potential for a complementarity between trade policy and corporate governance policy.

• Alfaro, L, P Conconi, H Fadinger, and A F Newman (2012), “Do Prices Determine Firm Boundaries? Evidence from Trade Policy”, CEPR Discussion Paper, 9200.
• Conconi, P, Legros, P, and A F Newman (2012), “Trade Liberalization and Organizational Change”, Journal of International Economics, 86, 197-208.
• Grossman, G M, and E Helpman (2002), “Integration Versus Outsourcing In Industry Equilibrium”, Quarterly Journal of Economics, 117, 85-120.
• Legros, P, and A F Newman (2012), “A Price Theory of Vertical and Lateral Integration”, forthcoming, Quarterly Journal of Economics.
• McLaren, J (2000), “Globalization and Vertical Structure”, American Economic Review, 90, 1239-1254.

Just for fun: the theory of privatisation

Having been working on a survey of the theory of the firm I noted that an often neglected topic in the literature is that of state owned firms and their privatisation. Thus I added a short section on the literature on privatisation.

There is a surprising overlap between the theory of the firm and the theory of privatisation. Hart (2003: C69) makes this clear when he writes,

"Let me begin by discussing the very close parallel between the theory of the firm and the theory of privatisation. In the vertical integration literature one considers two firms, A and B. A might be a car manufacturer and B might supply car-body parts. Suppose that there is some reason for A and B to have a long-term relationship (e.g., A or B must make a relationship-specific investment). Then there are two principal ways in which this relationship can be conducted. A and B can have an arms-length contract, but remain as independent firms; or A and B can merge and carry out the transaction within a single firm. The analogous question in the privatisation literature is the following. Suppose A represents the government and B represents a firm supplying the government or society with some service. B could be an electricity company (supplying consumers) or a prison (incarcerating criminals). Then again, there are two principal ways in which this relationship can be conducted. A and B can have a contract, with B remaining as a private firm, or the government can buy (nationalise) B".

and

"[ ... ] the issues of vertical integration and privatisation have much more in common than not. Both are concerned with whether it is better to regulate a relationship via an arms-length contract or via a transfer of ownership". Hart (2003: C70)

The incomplete contracting framework discussed in the previous subsection gives an approach which can be utilised to study the difference between public and private ownership. In fact incomplete contracts are a necessary condition to explain the differences between the two forms of ownership. In a world of complete or comprehensive contracts there is no difference between private and state owned firms. In both cases the government can write a contract with the firm that will anticipate all future contingencies - it will detail the managers' compensation, the pricing policy of the firm, how changes in technology will the change the firm's products etc - and thus the outcome under both forms of ownership will be the same.

This intuition has been formalised into a series of Neutrality Theorems. These theorems establish the conditions under which private or public ownership of productive assets is irrelevant for the final allocation of resources. Consider first the `fundamental privatisation theorem' due to Sappington and Stiglitz (1987). Assume the government's aim is to simultaneously achieve three objectives: (i) economic efficiency; (ii) equity; (iii) rent extraction. What Sappington and Stiglitz show is that the government can design an auction scheme that will result in these three objectives being achieved and where both public and private production give the same outcome. The government has a `social' valuation of the level of output. This valuation embodies the government's concerns with regard to equity issue such as the consumption levels of the good among different classes of citizens. It is assumed that the costs of production are such that production by a single firm is optimal but there are at least two risk-neutral firms, who have symmetric beliefs about the least-cost production technology, willing to bid to be the supplier. The government auctions off right to the supplier of the good with the understanding that the supplier receives a payment which equals the social evaluation. The most efficient firm will win the contract with the highest bid, which will equal the firm's (expected) profits, and will set the production level most preferred by the government. Rent extraction is achieved since the wining bit equals the firm's profits and economic efficiency is achieved since the most efficient firm is selected as the producer and the firm produces the government's preferred (social welfare maximising) level of output.

A simple example of this mechanism is given by Bos (1991: 20). Let the payment received by the firm equal the government's social valuation which equals the sum of consumer surplus plus revenue. (This is the total area under the demand curve for a given quantity.) This induces a profit maximising firm to maximise the sum of consumer and producer surplus. This implies technological and allocative efficiency. Since the highest offer in the competitive auction is identical to the expected profit of the firm, the expected monopoly profit goes to the government.

Shapiro and Willig (1990) obtain a similar result for a setting in which a public-spirited social planner or framer decides on the nationalisation/privaitisation outcome and sets up the governance structure for the enterprise chosen. The framer's decision is driven by the informational differences between private and public ownership. The important pieces of information are: (i) information about external social benefits generated by the firm; (ii) information concerning the difference between the ``public interest" and the private agenda of the regulator; (iii) information about the firm's profit level (cost and demand information).

First consider the case where the firm is state owned. Here the firm is run by a public official that Shapiro and Willig refer to as a Minister. By virtue of his role in managing the enterprise, the minister receives the private information about the profitability of the enterprise. By virtue of his position in the public sector, the minister also observes information that bears on the external social benefits generated by the enterprise's operations. Given this information the minister makes decision as to the level of investment in the firm and the level of output for firm. The overall social welfare function that the framer seeks to maximise is the sum of external benefits plus enterprise profits where there is a magnification factor added to the profit term which equals the unit cost of raising public funds, including any distortions caused by the taxes required to finance public sector operations. The minister's objective function is that of the framer plus a term related to the private agenda of the minister where there is a weighting parameter attached to private agenda term which measures how easily the minister can extract these benefits. This parameter can be interpreted as being a proxy for how well the political system works. The better the system the greater the limits on what the minister can extract.

If the firm is a private company then it is managed by a professional manager and is overseen by a regulator. The manager observes the profitability of the firm while the regulator learns the nature of the externality variable and the private agenda variable. The regulator designs a regulatory scheme that offers the expectation of a competitive rate of return on the private firm's sunk capital. The firm then maximises profit subject to the regulatory scheme while the regulator has the same objective function as the minister under state ownership. The framer's objective is to maximise the sum of the external benefits plus profits net of the cost of rasing any public funds needed to make the transfers to the private company required under the regulatory scheme.

The important difference between the two ownership forms is who receives the information about cost and demand conditions. The manager is the informed party under private ownership while under public ownership the minister is informed. This means that an informational barrier is created between the firm and the government by privatisation. The advantage of this barrier is that it reduces the discretion the minister has to interfere with the working of the firm. The disadvantage is that it makes it more difficult for the regulator to motivate the firm to purse social welfare objectives.

When considering neutrality results first consider the operation of an enterprise in an environment in which there is no private information whatsoever. Suppose all information about the external benefits of the enterprise and all information about its profitability is contractible. In such circumstances, the regulator could put in place a set of taxes or subsidies, contingent on what will become commonly known realisations of the public costs and benefits of the enterprise's operations. These taxes and subsidies could be designed to induce the owners to operate the enterprise to serve precisely the regulator's objectives in every contingency.

Perhaps it is not surprising that one can obtain a neutrality result in the complete absence of noncontractible private information, for in such a case there is no truly active role for the managers of the enterprise. They need only carry out the detailed instructions left by the minister or the regulator, and the manager cannot claim that there will ever be any new information or extenuating circumstances that can justify departures from that mechanical mandate.

The more interesting neutrality results arise in situations where there is private information. First assume that the private information about the firm's profitability is known only after the investment is made but the private information concerning public impacts and private agenda is known to the regulator when he must commit himself to the regulatory mechanism, before the time of the investment decision. Under these conditions, the regulator can exert sufficient indirect control over the private firm to obtain the same outcome and payoff as under public ownership, so the framer is indifferent between public and private enterprise. The regulator's control is secured by paying the firm according a the schedule which takes into account the sum of external benefits generated plus the private agenda of the regulator plus the smallest possible payment that will induce the firm to invest. With this schedule, the regulator induces the same actions and achieves the same payoffs as does the minister under public enterprise. The mechanism operates by forcing the firm to internalise the objectives of the regulator.

The second distinct case occurs when private information concerning both costs and public impacts is revealed only after the investment commitment must be made. Only the prior probability distributions of the private information of the regulator and the profitability of the firm are known at the time the investment decision must be effected. After the investment has been made, but before the activity level must be chosen, the private information of the regulator will become know to him and the nature of the firm's profitability will be revealed to the manager of the enterprise. Again, the regulator's optimal payment scheme results in the same choices of activity levels and the same expected drain on the treasury that would be the result of public enterprise. The logic behind this result is a straightforward extension of the analysis of the first case. Here the regulator commits himself to the menu of payment schedules, with the understanding that he will choose a particular schedule from this menu after investment is made and his private information is revealed to him, but still before the activity level must be chosen by the firm. The firm is indifferent, ex ante, about which particular schedule will be chosen from the menu by the regulator, because each of them offers the same zero level of expected profits, that is just enough to induce the firm to make the investment. Once the regulator learns his private information, he will be motivated to select the payment schedule corresponding to that information because that schedule is optimal for his objective function. Given this payment schedule, the firm will be motivated to choose the same activity level as in the first case above, and here too that is the optimum from the perspective of either the regulator or the public minister.

In the third case of neutrality the private firm has private information about its costs before the investment decision must be made. It is assumed that there are no costs to raising public funds and thus any transfers from the treasury are not a matter for concern to the framer, the regulator or the public minister. Because the firm knows information about its profitability and the regulator is aware of that fact but does not know this information himself, the regulator, to assure that investment will be made, must commit to a payment schedule or to a menu of schedules that provides non-negative profit for all demand/cost cases. Here, because of the stipulation that public funds can be raised at zero cost, this requirement poses no problem for the regulator: he is perfectly willing to add enough funds to any payment schedule to assure its profitability in the light of his indifference to transfers from the treasury. Consequently, it is optimal for the regulator to offer the firm internalisation schedules, each with different levels of investment funds, such that these funds are sufficiently large to guarantee the firm non-negative profit even if its profitability level is the worst possible. In the end, the regulated firm chooses the same activity levels that the public enterprise would choose, but the drain on the treasury caused by regulation is greater than that caused by public enterprise. Since, in this case, however, that drain is not a matter of concern, the framer would find no difference between the performance of public and private forms of organisation.

The third neutrality result is that of Shleifer and Vishny (1994). Their starting point is the idea that politicians control SOEs in order to achieve political objectives, such as excess employment and/or high wages. In this model the politician derives benefits from this inefficient allocation of resources, as they create political support for him. If the firm is privatised then the politician must bargain with the manger of the firm to get the outcome he wants. Clearly the manager, who aims to maximise profits, and the politician, who wants political support, have conflicting objectives. The firm will not want to expand employment above the profit maximising level as the politician wishes to do. The politician must make a transfer, from the treasury, to the firm to induce the takeing on of the extra workers. This is a problem to the politician since the transfer is costly to him as taxes need to be raised to finance the subsidy.

The Shleifer and Vishny model allows for a complete separation of income rights and control rights. There is no clear-cut dichotomy between state-owned and private firms in the model as it allows for four corparate forms: (i) a SOE, the Treasury has income rights and the politician has control rights; (ii) a regulated firm, the private owners have income rights, but the politician has control rights and can interfere in the operating activity of the firm; (iii) a 'corporatised' firm, when the government has income rights, but the control rights are in the hand of the firm's management; (iv) a purely private firm, when the manager/owner has both income and control rights.

As the model has the two parties bargaining, disagreement points have to be identified. These point are were the politician and the manager control the firm. When the politician controls the firm he has control over the manager and is able to the firm down to zero profits. He can use the firm's cash flow to hire extra labour up to the point where the marginal benefits of the excess employment equals the marginal cost of raising public funds. Under control by the manager, the manager has power over the politician, and the firm produces at the efficient level (with zero excess labour) but does not receive any transfer from the Treasury.

As far as the manager and the politician are concerned, the efficient point is reached when the level of excess employment reaches the point where the marginal political benefits equals the wage, which is the marginal cost of labour. At this point the amount of excess labour employed is lower than that under politician control and the subsidy paid to the firm is higher than under private control.

The neutrality result that Shleifer and Vishny present is basically an application of the Coase Theorem to privatisation. As side payments are allowed - or more correctly in this case, when the manager and politician can freely bribe each other - then the manager and the politician will reach the jointly efficient solution no matter what the initial allocation of income and control rights.

The importance of the above theorems is that they outline the conditions under which ownership of the firm does not matter. Of all the assumptions on which the irrelevance results hinge the most important requirement is that complete contingent long-term contracts can be written and enforced. But writing complete contracts is only possible in a world of zero transaction costs. In a positive transaction costs world only incomplete contracts can be written but contractual incompleteness creates a role for ownership - making decisions under conditions not covered in the contract. It is only within such an environment that we can explain why privatisation matters, that is, why the behaviour of state owned and private companies differ. This reliance on incomplete contracts means that the theory of privatisation can be seen as forming a part of the incomplete contracts framework explained in the subsection directly above.

These results also shows why the previous theoretical privatisation literature was largely unsuccessful. That literature took a `complete' or `comprehensive' contracting perspective, in which any imperfections present in contracts arose solely because of moral hazard or asymmetric information. But as Hart (2003: C70) notes

"[ ... ] if the only imperfections in are those arising from moral hazard or asymmetric information, organisational form - including ownership and firm boundaries - does not matter: an owner has no special power or rights since everything is specified in an initial contract (at least among the things that can ever be specified). In contrast, ownership does matter when contracts are incomplete: the owner of an asset or firm can then make all decisions concerning the asset or firm that are not included in an initial contract (the owner has 'residual control rights').

Applying this insight to the privatisation context yields the conclusion that in a complete contracting world the government does not need to own a firm to control its behaviour: any goals - economic or otherwise - can be achieved via a detailed initial contract. However, if contracts are incomplete, as they are in practice, there is a case for the government to own an electricity company or prison since ownership gives the government special powers in the form of residual control rights".

Thus privatisation matters only in an incomplete contracts world. In such an environment the allocation of residual control rights will differ and so the behaviour of publicly owned firms will differ from that of privately owned firms and thus ownership and therefore privatisation will become meaningful.

Schmidt (1996a) considers a monopolistic firm that producers a public good in a world of incomplete contracts. (Schmidt (1996a) is variant of Schmidt (1996b). 1996b considers the case of privatisation to an employee manager while 1996a applies to the case of privatisation to an owner-manager. While this second case is less realistic it is simpler and does not require the assumption that the manager is an empire builder that is utilised in 1996b.) His model is multiple period with the privatisation decision being made in the initial period. That is, the government must decide whether to sell the SOE to a private owner-manager or keep it in state hands and hire a professional manager to run it. Importantly knowledge concerning the firm's cost is private information known only by the firm's owner. Given this, privatisation amounts to a transfer of private information from the government to the private owner. In the next period the manager selects his effort level and the state of the world is then revealed. The importance of the manager's effort level is that it affects the probability of the state of the world. A high level of effort from the manager results in productive efficiency being enhanced and costs being lowered for any level of output. In the last period, the government selects the transfer scheme and payoffs are revealed.

When the firm is an SOE the government observes the firm's realised cost function and thus can implement the first-best allocation by choosing the ex post efficient level of production. But the manager's wage will be fixed, since contingent contracts can not be written, and thus independent of level of output. Given this the manager has no incentive to exert effort and the government knowing this will therefore offer him only his reservation wage.

On the other hand when the firm is in private hands the government does no know the exact cost structure of the firm. In an effort to get the private owner to produce the efficient level of output the government must provide an incentive via the payment of an informational rent.But if transfer are costly it will be impossible to implement the optimal allocation and therefore the cost to private ownership is an inefficiently low level of production. However given the rent payment provides an incentive to increase effort, productive efficiency is greater.

Schmidt's main conclusion is therefore that when the monopolistic firm produces a good or service which provides a social benefit, there is a trade-off between allocative and productive efficiency that needs to be considered when deciding if a firm is to be privatised. The equilibrium production level is socially suboptimal but the incentive for better management results in cost savings. Considered overall the welfare effect of privatisation should be positive for cases where the social benefits are small, but social welfare will be greater under public ownership for those cases where production exhibits large social benefits.

An important implication of this is that a case can be made for privatisation even when the government is a fully benevolent dictator who wishes to maximise social welfare. Even if all the deficiencies of the political system could be remedied it is still possible for privatisation to be superior to state ownership.

In the Laffont and Tirole (1991) model a firm is assumed to be producing a public good with a technology that requires investment by the firm's manager. In the case of a public firm this investment can be diverted by the government to serve social ends. For example, the return on investment in a network could be reduced by the government if it were to allow ex post access to the general population. Such an action may be socially optimal but would expropriate part of the firm's investment. A rational expectation of such an expropriation would reduce the incentives of a public firm's manager to make the required investment. For a private firm, the manager's incentives to invest are better given that both the firm's owners and the manager are interested in profit maximisation. The cost of private ownership is that the firm must deal with two masters who have conflicting objectives: shareholders wish to maximise profits while the government purses economic efficiency. Both groups have incomplete knowledge about the firm's cost structure and have to offer incentive schemes to induce the manager to act in accordance with their interests. Obviously the game here is a multi-principal game which dilutes the incentives and yields low-powered managerial incentive schemes and low managerial rents. Each principal fails internalise the effects of contracting on the other principal and provides socially too few incentives to the firm's management. The added incentive for the managers of a private firm to invest is countered by the low powered managerial incentive schemes that the private firm's managers face. The net effect of these two insights is ambiguous with regard to the relative cost efficiency of the public and private firms. Laffont and Tirole can not identify conditions under which privatisation is better than state ownership.

In the Shapiro and Willig paper discussed above privatisation is considered in a context where the regulator pursues a different agenda from the framer. Assume that either information about profitability is known before investment is decided upon or that there are costs to rasing public funds. In these cases the neutrality results of Shapiro and Willig don't hold. The equilibrium behaviour of the minister who is in charge of the firm is virtually unconstrained and he will set the activity levels of the firm as to maximise his utility. The regulator of the private firm has a more complex problem to deal with. This involves the designing of regulatory scheme which ensures non-negative profits for the firm. Given this is a case of optimal regulation under asymmetric information we would expect to see the firm enjoying informational rent, which are proportional to the activity chosen. As public funds are costly to raise these transfers are costly to the state.

The trade-off in this model is driven by how easily the public official can interfere with the operations of the firm. If the public official's objectives are the same of the (welfare maximising) framer, i.e. the public official has not private agenda, then public ownership is optimal. In this case private ownership reduces performance since the firm extracts a positive information rent. But when there is a private agenda then a reduction in discretion may increase welfare. Politicians find it easier to distort the operations of a firm in their favour when that firm is an SOE and under the direct control of the minister. The regulated private firms does earn a positive rent but is less subject to the control of the regulator. This means that regulated private firms are likely to out perform SOEs in poorly functioning political systems,which are open to abuse by the minister, and where the private information about the profitability of the firm is less significant. This makes it easier for the regulator to get the firm to maximise social welfare.

In Boycko, Shleifer and Vishny (1996) information problems do not explain the difference between public and private firms. Here it is differences in the costs to a politician of interfering in the activities of the different types of firms that explains the effects of privatisation. The starting point of the paper is the observation that public firms are inefficient because they address objectives of politicians rather than maximise efficiency. One common objective for a politician is employment. Maintaining employment helps the politician maintain his power base. In their model Boycko, Shleifer and Vishny assume a spending politician, who controls a public firm, forces it to spend too much on employment. The politician does not fully internalise the cost of the profits foregone by the Treasury and by the private shareholders that the firm might have.

Boycko, Shleifer and Vishny argue privatisation can be a strategy to reduce this inefficiency in state-owned enterprises. By privatisation they mean the reallocation of control rights over employment from politicians to a firm's managers and the reallocation of income rights to the firm's managers and private owners. The spending politician will still want to maintain employment and can use government subsidies to `buy' excess employment at the private firm. In this model the advantage of privatisation is that it increases the political costs to maintaining excess employment. It is less costly for the politician to spend the profits of the state-owned firm on labour without remitting them to the Treasury than it is to generate new subsidies for a privatised firm. Given that voters will be unaware of the potential profits that a state firm is wasting on hiring excess labour they are less likely to object than they are to the use of taxes, which they know they are paying, to subsidise a private firm not to restructure. This difference between the political costs of foregone profits of state firms and of subsidies to private firms is the channel through which privatisation works in this paper.

Shleifer and Vishny (1994) is a continuation of research stated in Boycko, Shleifer and Vishny (1996). As with the 1996 paper Shleifer and Vishny assume that there is a relationship between politicians and firm mangers that is governed by incomplete contracts and thus ownership becomes critical in determining resource allocation. As noted above the Shleifer and Vishny model is a game between the public, the politicians and the firm managers. The model derives the implications of bargaining between politicians and managers over what the firms will do. A particular focus is on the role of transfers between the private and state sectors including subsidies to firms and bribes to politicians.

To consider the determinants of privatisation and nationalisation Shleifer and Vishny utilise what they term a "decency constraint" which says that the government cannot openly subsidise a profitable firm. To do so would be seen as politicians enriching their friends. The first, obvious, point made is that politicians are always better off when they have control rights. Control brings political benefits, via excess employment, and bribes, to allow a reduction in the excess employment. Both the Treasury and the politicians prefer nationalisation. (Remember that as a SOE the Treasury has income rights and the politician has control rights.) to subsidising a money-losing private firm. Control brings bribes and even without bribes politicians get a higher level of employment and lower subsidies when they have control. The Treasury likes the smaller subsidies that come with nationalisation. When it comes to profitable firms politicians like control or Treasury ownership because these firms have a strong incentive to restructure since the profits go to the private owners and they lose little in terms of subsides due to the decency constraint. To ensure the firms achieve political objectives politicians need control. Given the decency constraint politicians don't want managers who have control rights to also have large income rights since the decency constraint means smaller subsidies are lost if employment is cut and income rights mean the managers gain from restructuring and maximising profits. Politicians who have control prefer higher private and lower Treasury ownership since higher private ownership implies higher bribes. Without bribes the private surplus is extracted via higher levels of employment.

Given that politicians like control, Why would they ever privatise a firm? To explain privatisation the interests of taxpayers must become more prominent. Given this the decision to privatise then becomes the outcome of competition between politicians who benefit from government spending (and bribes) and politicians who benefit from low taxes and support from taxpayers. We would expect privatisation to take place when political benefits of public control are low, and the desire of the Treasury to limit subsidies is high. This is most likely to occur when the political costs of rasining taxes to pay subsides is high and when the political benefits from excess employment are low.

The final paper to be considered is Hart, Shleifer and Vishny (1997). Again in this paper information problems are not the driving force of the analysis of contracting out. The provider of a service, either public or private, can invest his time in improving the quality of the service or reducing the cost of the service. The important assumption is that investments in cost reduction have negative effects on quality. Investments are non-contractible ex ante. For the case where the provider is a government employee he must obtain approval from the government to implement any innovation he has created. Given that the government has residual rights the employee will gain only a fraction of return on his investment. This gives him weak incentives to innovate. If the service provider in an independent contractor, i.e. the service has been contracted out, then he will have stronger incentives to both cut costs and improve quality. This is because he keeps the returns to his investment. The downside to private provision is that the incentives to cut costs are strong and the provider does not fully internalise the negative effects on quality of the reductions in cost. With public provision the incentive for excessive cost cutting are reduced as are the incentive for innovation and quality improvements. Costs are always lower under private ownership but quality may be higher or lower under a private owner. Hart, Shleifer and Vishny argue that the case for public provision is generally stronger when (i) non-contractible cost reductions have large deleterious effects on quality; (ii) quality innovations are unimportant; (iii) corruption in government procurement is a severe problem. On the other hand their argument suggests that the case for privatisation is stronger when (i) quality-reducing cost reductions can be controlled through contract or competition; (ii) quality innovations are important; (iii) patronage and powerful unions are a severe problem inside the government.

• Bos, Dieter (1991). Privatization: A Theoretical Treatment, Oxford: Oxford University Press.
• Boycko, Maxim, Andrei Shleifer and Robert W. Vishny (1996). `A Theory of Privatisation', The Economic Journal, 106 no. 435 March: 309-19.
• Hart, Oliver D. (2003). `Incomplete Contracts and Public Ownership: Remarks, and an Application to Public-Private Partnerships', The Economic Journal, 113 No. 486 Conference Papers March: C69-C76.
• Hart, Oliver D., Andrei Shleifer and Robert W. Vishny (1997). `The Proper Scope of Government: Theory and an Application to Prisons', Quarterly Journal of Economics, 112(4) November: 1127-61.
• Laffont, Jean-Jacques and Jean Tirole (1991). `Privatization and Incentives', Journal of Law, Economics, & Organization, 7 (Special Issue) [Papers from the Conference on the New Science of Organization, January 1991]: 84-105.
• Sappington David E. and Joseph E. Stiglitz (1987).`Privatization, Information and Incentives', Journal of Policy Analysis & Management, 6(4) Summer: 567-85.
• Schmidt, Klaus (1996a). `Incomplete Contracts and Privatization', European Economic Review, 40(3-5): 569-79.
• Schmidt, Klaus (1996b). `The Costs and Benefits of Privatization: An Incomplete Contracts Approach', The Journal of Law, Economics & Organization, 12(1): 1-24.
• Shapiro, Carl and Robert D. Willig (1990). `Economic Rationales for Privatization in Industrial and Developing Countries'. In Ezra N. Suleiman and John Waterbury, (eds.), The Political Economy of Public-Sector Reform and Privatization, Boulder: Westview Press.
• Shleifer, Andrei and Robert W. Vishny (1994). `Politicians and Firms', Quarterly Journal of Economics, 109(4) November: 995-1025.

What if. Tonight

What If alcohol was not as socially costly as everyone says?

Presented by Dr Eric Crampton, Wednesday, 28 November, from 7.30pm to 9.00pm, Lecture theatre A1.

Was The Hobbit worth it?

A question asked at the Homepaddock blog and we are offered this picture claiming it was,

Let us assume the numbers themselves are totally correct (a big assumption). The question we should ask ourselves is, If these are the benefits what are the costs? We need to trade-off benefits against costs to make a judgement about the usefulness of The Hobbit. After all we are often told of the great benefits of many things that governments back, like sports stadiums, and such claims turnout to be false, so why should we think otherwise about a movie?

Thus, what are the costs of the subsidies to the movie? And most importantly what are the opportunity costs of these subsidies. The money that went to the movie could have been used for something else which also would have produced benefits that we could make a graphic of.

So we need a full cost-benefit analysis before we can say the movie was worthwhile.

Adam Darwin

This video is of a talk by Matt Ridley, given at the Adam Smith Institute, entitled Adam Darwin - Spontaneous order in biology and economics..

Global climate talks

Dr. Richard S J Tol, Research Professor, Economic and Social Research Institute; and Professor of the Economics of Climate Change, Vrije Universiteit Amsterdam, writes that the 18th UN Conference on climate change negotiations has just started in Doha and he argues that the probability of success is a mere 2.3%. Recently, over $100 million per year was spent on fruitless negotiations. Tol suggests that having flogged, ever harder for 18 years, the dead horse of legally binding emission targets, the UN should close that chapter and try something new.

Tol writes,

The previous 17 conferences have failed to reduce emissions. There were glimmers of hope in 1997 and 2001 when the Kyoto Protocol was, respectively, initiated and finalised. This international treaty, however, bound Europe and Japan to do nothing much and most other countries to do nothing at all. The US and Canada would have had substantial obligations under the Kyoto Protocol, but the US decided not to ratify the treaty and Canada withdrew after ratification.

Tol then argues that if we assume that the first Conference of the Parties in Berlin in 1995 had a 50-50 chance of succeeding and if we also assume that the successive negotiations were independent tries, we can estimate the probability of success in Doha. The outcome of the series of negotiations follows a binomial distribution. Initialising with a Jeffrey uninformative natural conjugate Beta prior, then there is a 2.3% change of success in Doha, and we are 95% confident that the success probability is smaller than 22%.

Tol also says,

The international climate negotiations are expensive, though. Almost 1,000 delegates attended in 1995 [...]. This rose to almost 11,000 in 2005 and to 24,000 in 2009. The numbers have fallen somewhat since then, with only 16,000 delegates in Durban in 2011. 17,000 delegates are expected in Doha. Almost 7,000 person-working-years have been spent on the conferences alone.

But the UNFCCC organises more than one meeting per year. In 2012, 107 meetings were held, down from 111 meetings in 2011. Meetings were (much) rarer in the earlier years. I reckon that the UNFCCC has organised 682 meetings since 1995. Some of these were small. Negotiation meetings, now held once every quarter, attract thousands of participants. Assuming an average attendance of 200 delegates (one per country) and a duration of one week (including travel), 3,000 person-working-years have been spent at subsidiary meetings. Travel and subsistence for these meetings (say $2,000/person for a subsidiary meeting and $3,000/person for a conference) would amount to over $700 million. If delegates earn $30,000/year on average, the total costs of the UNFCCC meetings alone (ignoring preparation and overhead) would be $1 billion.

[ ... ] Recently, over $100 million per year was spent in fruitless negotiations. This is not a large sum of money, but [the data] suggests that ever more effort has been put into an increasingly obviously hopeless venture. This seems foolhardy.

This does seem a hell of a lot of money to have spent for nothing.

Poor old WalMart

I have come across a survey article on the efforts of WalMart on local economies. The abstract reads:

This article reviews the literature that evaluates WalMart’s impacts on local economies. The authors first describe the methods used to account for potential reverse causality of WalMart’s store location decisions, and then they discuss the literature assessing the company’s effect on three aspects of community life: (a) retail (and nonretail) businesses, across large- and small-sized stores and in different business environments; (b) retail workers, wages, and types of jobs; and (c) producer and consumer welfare through the company’s price-decreasing effect and other potential indirect effects. Last, articles focusing on a broad spectrum of local conditions that could be affected by the company, including poverty rates, social capital, food insecurity, policy effectiveness, and obesity are reviewed. For each dimension, evidence is found of both positive and negative effects, suggesting that we are still far from truly understanding the net effect of WalMart on local economies, let alone the overall consequences in the long run. (Emphasis added)

The bit in bold is what gets me. Are they seriously trying to hold WalMart responsible for poverty rates, social capital (what ever that means), food insecurity, policy effectiveness, and obesity?!!!

Bloody hell, poor old WalMart just can't win, they manage to get blamed for everything!

Interesting blog bits

1. Eric Crampton on Do Costs Matter (Revisited)
   

   Crikey's Bernard Keane has been questioning the taxpayer-subsidised anti-alcohol campaign in Oz. And, usefully, he's drawn a response from Sandra Jones. Let's have a bit of a look.

2. Mattia Nardotto, Tommaso Valletti and Frank Verboven, on Unbundling the incumbent: Evidence from UK broadband
   

   In many countries, incumbent broadband providers are required to let new entrants access their network, what is called ‘local loop unbundling’ (LLU). This column uses data from the UK to ask whether such a policy stimulates broadband penetration. In contrast to what is commonly believed, local loop unbundling doesn’t provide more choice. However, it does raise both the quality of service and the speed of internet connections.

3. Gary Becker on Online Courses and the Future of Higher Education

   What is new about the MOOCs (which stands for “massive open online courses”) is not the use of the Internet to instruct in particular subjects, but that they are free, and they often are sponsored by some of the very best universities, such as MIT, Harvard, and Stanford. Since they cost little if anything to take, it is much easier for the MOOCs to get massive enrollments than the fee-charging courses offered during the earlier boom in online courses. Various recent articles on MOOCs in the New York Times by Tamar Lewin show that the massiveness of the enrollments is somewhat misleading since, as one would expect with free courses, the great majority of those initially enrolled fail to finish. Still, the number of persons who do finish these courses is very large compared even to what are considered very big enrollments in on-site courses.

4. Eric Posner on MOOCs—Implications for Higher Education

   Not that online education is new; there are adult-education online courses such as are sold by The Teaching Company; there are even online college degree programs, offered mainly by for-profit colleges. What is new is the scale and potential of free online education offered by, or in conjunction with, the nation’s leading universities.

5. Greg Mankiw on Slugging It Out, Inside Obama’s Mind

   Throughout Washington, policy makers are debating how to avoid hitting a wall on Jan. 1, when large and abrupt tax increases and spending cuts will take effect automatically unless Congress acts. The debate is perhaps no more fervent than it is inside the head of our newly re-elected president, who must now decide what kind of policy leader he will become, both in this confrontation and throughout his second term.

6. Nicolai Foss asks A Naturalistic Foundation for the Hierarchy?

   In economics, the hierarchical firm arises for reasons related to economizing with transaction costs, managerial attention allocation, information synthesis and what not. Many organizational economists would argue that absent transaction costs, there would be no hierarchies as there would be no firms. But, what if the existence of hierarchy has a partly genetic basis, that is, humans evolved in such a way that they have come to “like” hierarchies (which may therefore exist even if transaction costs were zero)? After all, those small hunting bands roaming the African savannahs 30, 000 years ago likely had leaders, a division of labor and so on, and evolutionary anthropology suggests that our brains evolved to handle the intricacies of handling this division of labor. Thus, we may be “hardwired for hierarchy.”

7. Diego Comin, Mikhail Dmitriev and Esteban Rossi-Hansberg on Heavy technology: The process of technological diffusion over time and space
   

   Geographical distance is a fundamental impediment to virtually all economic transactions. This column, using data on technology adoption in 161 countries over 140 years, argues that it also inhibits the spatial diffusion of technology. Moreover, it shows that technology spreads like an epidemic. As more people adopt a technology, the importance of distance to the technological leader diminishes until it eventually becomes irrelevant.

8. John Cochrane on Taxes and cliffs
   

   The whole tax debate is supremely frustrating to anyone who survived econ 1.

9. Mark Hubbard on The Dairy Cliff in America: An Alice in Wonderland of the Planned.

   A journalist from the land of fiat money and central banking sat down this week and, no doubt with a straight face, wrote the following about the American ‘dairy cliff’:

EconTalk this week

Marcia Angell of Harvard Medical School and the author of The Truth About the Drug Companies talks with EconTalk host Russ Roberts about the impact of pharmaceutical companies on academic research, clinical trials and the political process. Angell argues that the large pharmaceutical companies produce little or no innovation and use their political power to exploit consumers and taxpayers.

Incentives matter: recycling file

The Conversable Economist, Timothy Taylor, writes

If we want people to be serious about recycling, having a policy of 5-10 cents for returning cans and bottles is likely to be a more effective tools than curbside recycling.

Arnold Kling is blogging again

This is news worth knowing. Go here to see Arnold's new blog.

"What if?" lecture (Wednesday 28 November, 7.30 – 9.00pm)

Next week's University of Canterbury "What If?" lecture will be given by Dr Eric Crampton on the topic:

What if alcohol was not as socially costly as everyone says?

In his review of New Zealand's alcohol legislation, Law Commissioner Rt. Hon. Sir Geoffrey Palmer pointed to the large gap between alcohol's social costs, estimated at $5.3 billion, and the excise tax take of $795 million as justifying much tighter controls. But what if the cost figure were wildly wrong? Should we really consider, for example, $700 million of drinkers' own expenditures on alcohol as a social cost? Dr. Crampton will discuss his work comparing social costs, as measured in the public health literature, with more standard economic notions of cost. For economic numbers to meaningfully inform policy, they must be produced using standard economic methods that allow comparison of costs across different policy areas. Dr. Crampton will then discuss the influence of bad statistics around alcohol on the Law Commission's review and on legislation before noting some of the other, less publicized, findings around alcohol and moderate drinking. While the harms from hazardous drinking are very real, exaggerating alcohol's harmful effects while ignoring moderate drinkers' enjoyment makes for poor policy.

Date:            Wednesday 28 November Time:            7.30 – 9.00pm

Innovative govenrment?

When writing, at the Groping towards Bethlehem blog, about how to make government more innovative Bill Kaye-Blake says that private business has a pretty clear goal - make money - and this forces them to be innovative. But he says,

Government, on the other hand, doesn’t necessarily have clear goals. It’s a bit about keeping people happy, keeping things ticking over, improving the living standards of some people while not harming others too much, responding to pressures from all sides. The goals are fuzzy and changing. The bureaucracy compensates by creating clear processes. When things go wrong, bureaucracies often defend their actions by saying, ‘we followed the correct procedures.’

The push for innovation puts government in a new quadrant. Now, bureaucrats are asked to challenge their own processes, to think continuously about how they can do better. The goals are still fuzzy — that’s the nature of governing — but now the process is, too. This quadrant creates a quandary: how are they to know what ‘better’ is?

We may be able to get a handle on how to make government more innovative by asking what could seem an odd question in this context: Which goods or services the government should provide? This question has addressed in a paper by Oliver D. Hart, Andrei Shleifer and Robert W. Vishny, 'The Proper Scope of Government: Theory and an Application to Prisons'. "Quarterly Journal of Economics", 112(4) November 1997: 1127-61.

Why the scope of government question may help us with the innovative question is the answer that HSV come up with when they examined the conditions which determine the relative efficiency of in-house provision versus outside contracting of government services. Their arguments suggest that the case for in-house provision is generally stronger when noncontractible cost reductions have large deleterious effects on quality, when quality innovations are unimportant, and when corruption in government procurement is a severe problem. In contrast, the case for privatisation is stronger when quality reducing cost reductions can be controlled through contract or competition, when quality innovations are important, and when patronage and powerful unions are a severe problem inside the government.

The bits in bold can help us think about the question of how to make government more innovative, let the private sector do it!

The incentives faced by the public sector just aren't those you want if you want innovation. The private sector lives or dies by how well they innovate. How well they improve the goods and services they provide to customers. How well they can reduce costs while improving quality. It is the high-powered incentives of the market, a bottom line that matters, that drives innovation. Governments use softer incentives because they have different aims, they have goals which are "fuzzy and changing", for which lower-powered incentives are appropriate. But this does mean that government, because of its very nature, is unlikely to be hugely innovative.

Does economics need saving from economists?

In a piece in December 2012 issue of The Magazine Coase writes about Saving Economics from the Economists. He opens his article by noting,

Economics as currently presented in textbooks and taught in the classroom does not have much to do with business management, and still less with entrepreneurship.

He continues,

The degree to which economics is isolated from the ordinary business of life is extraordinary and unfortunate.

He goes on to write,

That was not the case in the past. When modern economics was born, Adam Smith envisioned it as a study of the “nature and causes of the wealth of nations.” His seminal work, The Wealth of Nations, was widely read by businessmen, even though Smith disparaged them quite bluntly for their greed, shortsightedness, and other defects. The book also stirred up and guided debates among politicians on trade and other economic policies. The academic community in those days was small, and economists had to appeal to a broad audience. Even at the turn of the 20th century, Alfred Marshall managed to keep economics as “both a study of wealth and a branch of the study of man.” Economics remained relevant to industrialists.

In the 20th century, economics consolidated as a profession; economists could afford to write exclusively for one another. At the same time, the field experienced a paradigm shift, gradually identifying itself as a theoretical approach of economization and giving up the real-world economy as its subject matter. Today, production is marginalized in economics, and the paradigmatic question is a rather static one of resource allocation. The tools used by economists to analyze business firms are too abstract and speculative to offer any guidance to entrepreneurs and managers in their constant struggle to bring novel products to consumers at low cost.

My own experience as someone with an interest in the theory of firm certainly is one where "production is marginalized in economics". In New Zealand the production side of the economy receives much less emphasis than the demand/consumer/government parts of the economy. Coase sees the lack of interaction between the working economy and economics as damaging to both.

Since economics offers little in the way of practical insight, managers and entrepreneurs depend on their own business acumen, personal judgment, and rules of thumb in making decisions. In times of crisis, when business leaders lose their self-confidence, they often look to political power to fill the void. Government is increasingly seen as the ultimate solution to tough economic problems, from innovation to employment.

Economics thus becomes a convenient instrument the state uses to manage the economy, rather than a tool the public turns to for enlightenment about how the economy operates. But because it is no longer firmly grounded in systematic empirical investigation of the working of the economy, it is hardly up to the task. During most of human history, households and tribes largely lived on their own subsistence economy; their connections to one another and the outside world were tenuous and intermittent. This changed completely with the rise of the commercial society. Today, a modern market economy with its ever-finer division of labor depends on a constantly expanding network of trade. It requires an intricate web of social institutions to coordinate the working of markets and firms across various boundaries. At a time when the modern economy is becoming increasingly institutions-intensive, the reduction of economics to price theory is troubling enough. It is suicidal for the field to slide into a hard science of choice, ignoring the influences of society, history, culture, and politics on the working of the economy.

As I have said before,

I see it as a social science with close relationship with moral and political philosophy, political science, psychology etc. But this it seems is a minority view.

and I would argue that to include the "the influences of society, history, culture, and politics on the working of the economy" economics need to expand its interaction with the other social sciences and not just see itself as purely a handmaiden to management and accounting, as others I know seem to think.

Peter Klein argues that the inductive method being utilised by Coase has its limits,

Economics provides general principles, or laws, about human action and interaction, mostly stated as “if-then” propositions. Applying the principles to concrete, historical cases requires Verstehen, and is the task of economic historians (as analysts) and entrepreneurs (as actors), not economic theorists. Deductive theory does not replace judgment. Without deductive theory, however, we’d have no principles to apply, and nothing to contribute to our understanding of the economy except — to quote Coase’s own critique of the Old Institutionalists — “a mass of descriptive material waiting for a theory, or a fire.” To be sure, Coase’s own inductive method has led to several brilliant insights. Coase himself has a knack for intuiting general principles from concrete cases (e.g., theorizing about transaction costs from observing automobile plants, or about property rights from studying the history of spectrum allocation), though not perfectly. But, as I noted before, Coase himself is probably the exception that proves the rule — namely that induction is a mess.

Coase turns 102 in December and yet he can still generate and stimulate debate about big issues in economics.