Interesting blog bits - Coase update 2

The list of obituaries of and tributes to Ronald Coase has now reached more than 60 links including some dealing with the story that Coase was forced out of the University of Virginia in 1964.

Audio of Peter Klein on "The Theory of the Firm"

This audio is of a lecture presented by Professor Peter G. Klein at the Ludwig von Mises Institute's 2003 Mises University conference on the topic of The Theory of the Firm.

Economists versus the cup

As Team New Zealand moves ever closer to winning the America's Cup we are beginning to hear the mindless, uninformed, self serving bs about the wonders having the cup in Auckland will do for the economy. Over a half a billion dollars in financial gain to the country, we are told. Oh what joy! Or is it?

A couple of reporters at the stuff.co.nz website asked a few economists what they thought of all this talk.

Don't believe it, says Shane Vuletich of Covic, specialist in economic evaluation of tourism and major events, who warns numbers already being used are far too large.

"Politicians are usually pleased when a big number comes along and when an independent company says that, they are not in a position to doubt it," he says.

Last year's Volvo Ocean Race was wildly over-sold.

People were counting the dollars spent by everybody who went through the Viaduct village despite the fact that 98 per cent of them would have been there any way.

"You have got to demonstrate that the money is caused by the event, that it would not be present without the event. Measurement is really critical."

Some sectors of a community want to use the big numbers just so they get the event, but ratepayers and taxpayers have to pay for it.

Vuletich says the spectator visitor benefits of the America's Cup will be "reasonably modest". The bigger return will come off teams coming to compete.

"I would say take a deep breath. Don't get caught up in the old numbers, which are a gross overstatement, and let's take a fresh look and build a business case accordingly."

He says money payback would be well down on his list of cup benefits anyway. Feel-good matters more.

It could turnout to be bloody expensive "feel-good", however. The stuff article continues,

Institute of Economic Research economist Shamubeel Eaqub says the economic benefits of a cup regatta in 2017 would be based on "over-hyped studies that are proven to be absolute b........ after the fact."

Post-event evaluations often show a loss in gross domestic product from large sports events.

"There are risks money will be lost, not gained," Eaqub says.

"There are legacy benefits, of course but for Auckland it just brings forward infrastructure projects that were going to happen anyway."

and Sam Richardson, of Fair Play and Forward Passes fame, is reported as saying,

[ ... ] the San Francisco regatta under- delivered in terms of both tourist numbers and spending.

"These figures come from consultant reports that commonly overestimate the positive aspects, like visitor numbers, understate or omit the event's associated costs and as such produce numbers that are optimistic at best."

In summary, don't believe the numbers that you are sure to hear being trotted out about the economic benefits that will flow from having the cup in Auckland and especially keep in mind that there is no economic justification for government, local or central, money being put into a defence of the cup.

EconTalk this week

David Laidler of the University of Western Ontario talks about money and monetary policy with EconTalk host Russ Roberts. Laidler sketches the monetarist approach to the Great Depression and the Great Recession. He defends the Federal Reserve's performance in the recent crisis against the critics. He argues that the Fed's monetary policies have not been unconventional nor impotent as some critics have suggested. The conversation closes with a discussion of the state of macroeconomics and monetary economics.

I wish I had said this

This is Chris Dillow at the Stumbling and Mumbling blog,

To whom should economists offer advice? Traditionally, the answer has been: politicians.But I'm not sure this should be so.

This isn't just because economists can't foresee the future and so a lot of advice on monetary and fiscal policy is pointless.It's because policy is shaped not by what is the right thing to do, but by what politicians can sell to inattentive and sub-rational voters. Whatever else informs immigration policy, for example, it is not economic research.

Of course, economists do sometimes influence policy for the better - auction theory being a good example - but this happens only when economic ideas don't rub too harshly against prejudice and vested interest. Otherwise giving policy advice is, to paraphrase Robert Heinlein, like teaching a pig to sing: it wastes your time and it annoys the pig.

Well said that man. I feel the problem is that politicians care about .... well .... politics, not economics. In some cases politicians don't seem to understand the economic effects of their politics but in other cases I think they do understand but just don't care. They put forward ideas that they can, as Chris puts it, "sell to inattentive and sub-rational voters." That is they want votes and don't much care how they get them.

This does raise the normative issue of whether economists should advise politicians at all. For a start any advice offered will most likely have little effect and when economists have an effect it is not via advice given on a particular topic at a particular time but via a longer term effect via changing the general changing the intellectual climate. Hayek's advice to Antony Fisher, founder of the IEA, still seems relevant. Fisher went to see Hayek who was then at the LSE,

“My central question was what, if anything, could he advise me to do to help get discussion and policy on the right lines… Hayek first warned me against wasting time-as I was then tempted-by taking up a political career. He explained his view that the decisive influence in the battle of ideas and policy was wielded by intellectuals whom he characterised as the secondhand dealers in ideas’. It was the dominant intellectuals from the Fabians onwards who had tilted the political debate in favour of growing government intervention with all that followed. If I shared the view that better ideas were not getting a fair hearing, his counsel was that I should join with others in forming a scholarly research organisation to supply intellectuals in universities, schools, journalism and broadcasting with authoritative studies of the economic theory of markets and its application to practical affairs.”

Thus in an effort to change the intellectual climate economists may well want to give up talking to politicians and start talking to everybody else.

A strange argument for a "living wage"

In an good piece on the "living wage" at the Offsetting Behaviour blog Eric Crampton writes

Collins nicely does cite the literature on that living wage mandates are very poorly targeted and that we could do rather better by increasing targeted benefits. Then he cites U Vic's Morris Altman:

Morris Altman, a renowned Canadian economist who moved to Wellington's Victoria University in 2009, argues that a living wage is "a moral imperative situated in the natural rights of individuals".

His research suggests that a wage rise can actually pay for itself by raising productivity through motivating workers to work harder and stay in their jobs, and by inducing employers to introduce new technology and train workers to work smarter.

But that is only true, he warns, if wages are raised at a rate that productivity can keep up with. "So one has to be ultra-careful about by how much one increases. If it's a radical increase, that might be too much to deal with in the short-term," he says. "You might need a bit of an adjustment period to get productivity up."

This argument by Altman seems odd. If profit maximising firms believe they can increase productivity, and thus revenues, by increasing wages and the revenue increase in greater than the increases in wages (i.e the wage rise "pays for itself"), then why haven't firms done it already? If the wage increase does "pay for itself" then firms must be able to increase wages to such a degree that the cost increase is just less than the revenue increase caused by the productivity increase. And with revenues going up more than costs, profits must increase. Thus a mandated living wage is unnecessary since firms will increases wages anyway in an effort to increase profits.

As to the point made in the third paragraph of the Altman argument, if firms are profit maximising then there can be no margin left to increase wages. In an effort to maximise profits firms will attempt to set the increase in wages equal to the value of the increase in productivity and thus any further wage increase must, by definition, be greater than any productivity increase obtained. This results in a situation where any wage increase from this point will not be able to generate a productivity increase large enough to pay for it.

So I don't see that the Altman argument for a living wage is valid.

Is deregulating firm entry good for the workers? And if so, which workers?

While it is generally agreed that deregulating firm entry is good for firms there is another question of, Is it good for their workers? A VoxEU.org column presents new research on the deregulation of firm entry and how it affects different types of workers. Using a natural experiment from Portugal, the evidence suggests that deregulating firm entry appears to boost competition and employment (and possibly aggregate income) but its gains seem largely to be reaped by better-off, better-educated workers.

The column, by Ana P Fernandes, Priscila Ferreira and L Alan Winters, looks at a natural experiment in Portugal.

Prior to 2005, starting a business in Portugal took 11 procedures, 20 forms and 78 days, and cost around 13.5 % of GDP per capita. In May 2005, however, a new government introduced the ‘On the Spot Firm’ (‘Empresa na Hora’) programme by which entrepreneurs could register a company at a one-stop shop within an hour, receiving the company identification card, the corporate taxpayer number and the social-security number in the same day and at a cost of 3% of GDP per capita. Even better, the programme was largely unanticipated and was rolled out across districts more or less randomly over a four year period, making it a good quasi-natural experiment for research [ ... ] and extensive data are available on firms and their workers before and during the roll out.

The questions in the study have to do with the effects of the 'On the Spot Firm' programme on competition and wages.

We focus on private firms in the manufacturing and services sectors covering over the period 2002-09, which gives us a sample of 431,000 firms and 3.9 million workers. Having established that the skill premium (the difference between skilled and unskilled wages) appears to be greater where competition is greater, we look directly at the effects of the ‘On the Spot Firm’ programme. Working with the 308 municipalities in Portugal, we treat each as joining the programme from the year in which it gets its first ‘one-stop shop’ for conducting registrations. We find that the ‘On the Spot Firm’ programme significantly increased the number of firm registrations even after allowing for differences between municipalities, sectors and years. [ ... ]

We then consider how the wages of workers with different skill levels are affected by this entry, making use of the different timing of the introduction of ‘one-stop shops’ across municipalities to identify the effect. That is, we ask whether the returns to skill or to education vary between included and excluded municipalities and over the periods before and after the deregulation reform was introduced. Our rich data allow us to identify the characteristics of the worker and the firm employing her, the industry and the municipality and so we are able to allow for most of the other factors that may affect wages. This increases our confidence that the programme effects we identify are genuine.

Our regression results [ ... ] show the effects of inclusion in the ‘On the Spot Firm’ programme on workers with different levels of education.

The conclusions?

The results are highly significant statistically, strongly consistent and rather striking:

• Wages in general appear to be 1% lower in municipalities with an ‘On the Spot Firm’ one-stop shop.

This might be because the increased entry of marginal firms increases competition for the outputs that less-educated workers can provide (since we do not have data on firms with no employees – i.e. with only owners – we will miss any returns that such owners receive).

• On top of this negative effect, secondary educated workers receive slightly over 1% extra, restoring them to parity between included and excluded districts.
• Upper-secondary and Higher-educated workers receive stronger stimuli – over 2% and nearly 5% respectively.

The results for skill levels – as defined by workers’ occupations – are similar to those for education, except that low and medium skilled workers appear to gain little (and possibly to lose) while the premium to more skilled occupations is about 3% higher in ‘On the Spot Firm’ municipalities.

Recalling all the effects we have allowed for in making these comparisons, the 3% and 5% premium for skills and higher education are economically important.

• Deregulating firm entry appears to boost competition and employment (and possibly aggregate income, although this has not been investigated) but its gains seem largely to be reaped by the better-off.

This may be quite acceptable to policymakers – and after all it increases the incentives for people to obtain education, which presumably helps Portugal’s competitiveness relative to other countries. However, in these days of sensitivity to inequality, it is not something which governments should be ignorant of.

What we see here is a common pattern these days in the distribution of the gains from economic change. That is, there are better returns to the better educated. These results show an education premium, which should provide an incentive for people to obtain higher levels of skills and education.

Epstein on Coase

In this audio from the Hover Institution Richard Epstein talks about the legacy of his friend and colleague Ronald Coase.

Interesting blog bits - Coase update

The list of obituaries of and tributes to Ronald Coase has now reached 50 links. And there are a number of other links that I haven't bothered to include since they didn't seem to add much. I hate to think just what the actual number of comments about Coase's passing is.

The minimum wage and employment dynamics

In the U.S. the recent proposal by President Obama to raise the federal minimum wage has brought the minimum wage debate back to life. Not that it really left the limelight in the U.S., or anywhere else around the world. A new column at VoxEU.org presents new research suggesting minimum-wage policies may not cause an immediate shock to employment, as is often feared, but do cause a reduction in the rate of net job growth. The long-run prospects for individuals are damaged, as they are delayed the opportunity to develop skills and work experience – that crucial first rung on the career ladder. Thus who suffer most from the effects of the minimum wage are those who can afford to suffer least.

Most papers in the long literature on the minimum wage have focused on the number of people employed but there are several reasons, grounded both in theory and data, to expect the effects to be reflected in the rate of net job growth. The transition from one employment level to the next may be slow due to adjustment costs or even an aversion to firing existing employees, so it is more likely that minimum wage increases result in a change in the rate at which employment grows.

This phenomenon becomes more clear when one considers the composition of the minimum-wage work force. Using the Current Population Survey’s Merged Outgoing Rotation Groups from 1979 to 2011, we found that, although only about 3.3% of all employees are paid the minimum wage, nearly 12% of those who enter the workforce are paid that amount. Indeed, nearly a third of minimum-wage workers are recent workforce entrants. Minimum-wage workers are also likely to transition to higher pay quickly: of those who remain employed after one year, about 60% are paid in excess of the minimum wage the following year. As such, it seems likely that any effects of the minimum wage are more likely to be reflected among new workers and in new job openings than on the existing stock of employment.

So dynamics of the labour market are important for the effects of changes to the minimum wage. Despite this importance little of the previous literature has focused on dynamics. In their VoxEU.org column Jonathan Meer and Jeremy West set out to correct this lack of interest.

In Meer and West's view this lack of focus on dynamics is particularly worrisome because, unlike many of the other policies that economists study, the minimum wage is characterised by frequent, relatively small increases.

This means that slow adjustments in response to these increases are difficult to detect. Moreover, in Meer and West (2013), we use a simulation to show that a common practice in regression analysis in this literature – including state-specific time trends – leads to incorrect estimation of the effect of the minimum wage on the level of employment when the true effect is on the rate of employment growth. Essentially, the deck is often stacked against finding any effect.

The data for our study are drawn from the Business Dynamics Statistics, which covers the population of non-agricultural private employer businesses between 1977 and 2011. The underlying data are sourced from mandatory employer tax filings and aggregated by state in each year. The Business Dynamics Statistics includes not only the number of jobs in each state for every year, but the number of jobs created by expanding establishments and the number of jobs destroyed by contracting establishments. These numbers are used to calculate the rate of net job growth.

We combine the Business Dynamics Statistics with data on state minimum wages and other state attributes, like the state economic environment, to estimate how the minimum wage affects the rate of net job growth. We also account for annual shocks to the outcome variables occurring at the regional level, to account for any conditions that lead a state to see both a change in the minimum wage and job growth. This would be a concern if, for instance, a state legislature responded to lower job growth with a minimum-wage increase. We also conduct a number of robustness checks to ensure that our results are not driven by spurious correlation. For instance, we show that future increases in the minimum wage do not predict current job growth outcomes. If they did, we would be concerned that other factors are driving the correlation.

What of the results of the Meer and West study.

[Their] findings are unequivocal: higher minimum wages lead to lower rates of job growth. Indeed, a ten percent increase in the minimum wage causes roughly half a percentage point reduction in the rate of job growth, a very large effect. The effect of this hypothetical increase is not permanent, though, since it is eroded by inflation and increases in the state’s comparison group. Our calculations show that this ten percent increase in a state’s real minimum wage, relative to its regional neighbours, causes a 1.2% reduction in total employment relative to what it would have been. We further find that this appears to be driven primarily by reductions in job creation by expanding establishments, not by increases in job destruction by contracting establishments. Essentially, then, the intuition is that employers respond to the minimum wage by growing more slowly.

Judging whether the effect we find is large or small is not necessarily simple. Some might point to a 1.2% reduction in the level of employment after five years and argue that is relatively small – it represents about 23,000 fewer jobs for the average state – and that those who earn the minimum wage and remain in the labour force would earn more. But that argument seems coldly indifferent to those who remain outside of the labour market, unable to take advantage of the relatively rapid transitions out of minimum-wage jobs. At a broader level, it is important to note that, in contrast to much of the previous literature and the dismissiveness of some advocates, we document that the minimum wage does, in fact, affect employment.

The conclusion of the column is that the type of effect we should see, and the type found in their study, is a reduction of job creation, not a loss of existing jobs. Minimum-wage policies may not cause an immediate loss in the number of jobs, but rather a reduction in the rate of net job growth. This effect is all the more insidious for being difficult to detect. Employment growth is slowed, but more importantly, the long-run prospects for individuals are damaged, as they are delayed in the opportunity to develop skills and work experience – to grasp that crucial first rung on the career ladder.

Reference:

• Meer, J and West, J (2013), “Effects of the minimum wage on employment dynamics”, Working Paper.

EconTalk this week

Nassim Taleb of NYU-Poly talks with EconTalk host Russ Roberts about his recent paper (with Constantine Sandis) on the morality and effectiveness of "skin in the game." When decision makers have skin in the game--when they share in the costs and benefits of their decisions that might affect others--they are more likely to make prudent decisions than in cases where decision-makers can impose costs on others. Taleb sees skin in the game as not just a useful policy concept but a moral imperative. The conversation closes with some observations on the power of expected value for evaluating predictions along with Taleb's thoughts on economists who rarely have skin in the game when they make forecasts or take policy positions.

Is technological progress history?

When it comes to technological progress and thus economic growth some of the most important questions being asked include, Has technological progress slowed down? Have we really picked all the low-hanging fruit?

A new column by Joel Mokyr at VoxEU.org argues that technological progress is in fact not a thing of the past. Far from it. There are myriad reasons why the future should bring more technological progress than ever before – perhaps the most important being that technological innovation itself creates questions and problems that need to be fixed through further technological progress. If we rethink how innovation happens, we have every reason to suspect that we ain’t seen nothing yet. Not an answer the likes of Robert J. Gordon will take too well.

Technological progress has been the driver of economic growth for the last two centuries. Some authors, such as Robert Gordon and Tyler Cowen, however, are being to suggest that product and process innovation are running out of steam.

• Robert J Gordon and Tyler Cowen, inter alia, have expressed the view that technological progress is slowing down.
• Jan Vijg has suggested that the industrialised West of the 21st century will resemble the declining Empires of late Rome and Qing China .

Their basic point is that technological dynamism is fizzling out. The low-hanging fruits that have improved our lives so much in the 20th century have all been picked. We should be ready for a more stagnant world in which living standards rise little if at all. Joel Mokyr is having none of this. For him "we ain’t seen nothin’ yet, the best is still to come".

My argument concerns both the supply and the demand sides of innovation. Starting with supply, what is it that accounts for sustained technological progress? The relation between scientific progress and technology is a complex two-way street. For example, 19th-century energy-physics learned more from the steam engine than the other way around.

The historical record makes clear that science depends on technology in that it depends on the instruments and tools that are needed for science to advance. New instruments opened new horizons in what Derek Price called "artificial revelation”, observations through instruments that allow us to see things that would otherwise be invisible.

Examples:

• The Scientific Revolution of the 17th century depended critically on the development of the telescope, the microscope, the barometer, the vacuum pump, and similar contraptions.
• The achromatic-lens microscope developed by Joseph J Lister (father of the famous surgeon) in the 1820s paved the way for the germ theory, the greatest breakthrough in medicine before 1900.

The same was true in physics, for instance:

• The equipment designed by Heinrich Hertz allowed him to detect electromagnetic radiation in the 1880s and Robert Millikan’s ingenious oil-drop apparatus allowed him to measure the electric charge of an electron (1911).

In the twentieth century, the impact of instruments on progress is even more apparent. For example:

• X-ray crystallography, developed in 1912, was crucial forty years later in the discovery of the structure of DNA.

If tools and instruments are a key to further scientific progress, it is hard not to be impressed by the possibilities of the 21st century:

• DNA sequencing machines and cell analysis through flow cytometry (to mention but two) have revolutionised molecular microbiology.
• High-powered computers are helping research in every domain conceivable, from content analysis in novels to the (very hard) problems of turbulence.
• Astronomy, nanochemistry, and genetic engineering are all areas in which progress has been mind-boggling in the past few decades thanks to better tools.

To be sure, there is no automatic mechanism that turns better science into improved technology. But there is one reason to believe that in the near future it will do so better and more efficiently than ever before. The reason is access.

Inventors, engineers, applied chemists, and physicians all need access to best-practice science to answer an infinite list of questions about what can and cannot be done. Search engines were invented in the 18th century through encyclopaedias and compendia that arranged all available knowledge in alphabetical order, making it easy to find. Textbooks had indexes that did the same. Libraries developed cataloguing systems and other techniques that made scientific information findable.

But these search systems have their limitations. One might have feared that the explosion of scientific knowledge in the 20th century could outrun our ability to find what we are looking for. Yet the reverse has happened. The development of searchable databanks of massive sizes has even outrun our ability to generate scientific knowledge. Copying, storing, transmitting, and searching vast amounts of information today is fast, easy, and practically free. We no longer deal with megabytes or gigabytes. Instead terms like petabytes (a million gigabytes) and zettabytes (a million petabytes) are being bandied about. Scientists can now find the tiniest needles in data haystacks as large as Montana in a fraction of a second.
And if science sometimes still proceeds by ‘trying every bottle on the shelf’ – as in some areas it still does – it can search with blinding speed over many more bottles, perhaps even peta-bottles.

This brings us to the Cowen question, Have all the low-hanging fruits been picked?

One answer is that the analogy is flawed. Science builds taller and taller ladders, so we can reach the upper branches, and then the branches above them.

• A less obvious answer is that technological progress is fundamentally a dis-equilibrating process.

Whenever a technological solution is found for some human need, it creates a new problem. As Edward Tenner put it, technology ‘bites back’. The new technique then needs a further ‘technological fix’, but that one in turn creates another problem, and so on. The notion that invention definitely ‘solves’ a human need, allowing us to move to pick the next piece of fruit on the tree is simply misleading.

• Each solution perturbs some other component in the system and sows the seed of more needs; the ‘demand’ for new technology is thus self-sustaining.

The most obvious example for such a dynamic is in our never-ending struggles with insects and harmful bacteria. In those wars, evolutionary mechanisms decree that after most battles we win, the enemy regroups by becoming resistant to whatever poison we throw at them. Drug-resistant bacteria are increasingly common and require novel approaches to new antibiotics. The search for novel antibiotics will resume with tools that Chain and Florey would never have dreamed of – but even such new antibiotics will eventually lead to adaptation.

In agriculture, the advance in fertiliser use has helped avert the Malthusian disasters that various doom-and-gloom authors predicted. But the vast increase in nitrate use following Fritz Haber’s epochal invention of the nitrogen-fixing process before World War I has now led to serious environmental problems in aquifer pollution and algae blooms. Again, technology will provide us with a fix, possibly through genetic engineering in which more plants can fix their own nitrates rather than needing fertiliser or bacteria that convert nitrates into nitrogen at more efficient rates.

Another example is energy: For better or for worse, modern technology has relied heavily on fossil fuels: first coal, then oil, and now increasingly on natural gas. The bite-back here has been planetary in scope: climate change is no longer a prospect, it is a reality. Can new technology stop it? There is no doubt that it can, even if nobody can predict right now what shape that will take, and if collective action difficulties will actually make it realistic.

Yes, but what about the workers?!

The big question here is, If technology replaces workers, what will the role of people become? Many commentators have written about having an idle and vapid humanity in a robotised economy. This is a concern for many. There will be disruption and pain, as there always is with progress, but the new technology will also create new demand for workers, to perform tasks that a new technology creates. It is most plausible that in our future new technology will create new occupations we cannot imagine, let alone envisage, as it has in the past.

Furthermore, the task that 20th-century technology seems to have carried out the easiest is to create activities that fill the ever-growing leisure time that early retirement and shorter work-weeks have created. Technological creativity has responded to the growth of free time: a bewildering choice of programmes on TV, the rise of mass tourism, access at will to virtually every film made and opera written, and a vast pet industry are just some examples. The cockfights and eye-gouging contests with which working classes in the past entertained themselves have been replaced by a gigantic high-tech spectator-sports industrial complex, both local and global.

Mokyr closes with a comment on Keynes and his view of the Economic Possibilities for our Grandchildren

In his brief Economic Possibilities for our Grandchildren (1931) Keynes foresaw much of the future impact of technology. His insights may surprise those who regard him as the prophet of unemployment: “all this [technological change] means in the long run [is] that mankind is solving its economic problem” (italics in original). Contemplating a world in which work itself would become redundant thanks to science and capital (Keynes did not envisage robots, but they would have strengthened his case), he felt that this age of leisure and abundance was frightening people because “we have been trained too long to strive and not to enjoy”.

Mises, Coase and central planning

One way to think of firms is that they are small centrally planned "economies". But if they are, Why do they work? After all Mises started the socialist calculation debate by arguing that central planning can't work and yet firms do work, and in some cases for very long periods of time. Perhaps the oldest still existing (multinational) firm is the Roman Catholic Church. Ekelund and Tollison  argue that ``[t]he longest-running institution in Western culture and arguably one that has had an enormous influence on Western civilization has been the Roman Catholic Church". Ekelund et al note that ``[t]he formal character of the Catholic Church, the single institution that come to embody Christianity in its official capacity, emerged as a result of the Edict of Milan in A.D. 313". In an endnote they explain that the edict meant that ``[ ... ] the Church became the recognized legal holder of property". Micklethwait and Wooldridge write ``[t]he oldest existing private-sector company in Europe is probably Stora Enso of Sweden, whose direct ancestor, a copper mine, began trading in 1288 and was issued with a royal charter in 1347". In Japan Kongo Gumi was founded by a Korean in Osaka in 578 and is a builder of Buddhist temples, Shinto shrines and castles—and now also offices, apartment buildings and private houses. It looks like it succumbed to excess debt and an unfavourable business climate in 2006. Not a bad run however.

So what is the relationship between Mises and Coase? A reading of Murray N. Rothbard's essay "Ludwig von Mises and Economic Calculation Under Socialism" suggests an answer. In this article Rothbard explains that Mises's argument about the impossibility of socialism can be applied to the problem of the size of firms. Rothbard argues that

There is one vital but neglected area where the Mises analysis of economic calculation needs to be expanded. For in a profound sense, the theory is not about socialism at all! Instead, it applies to any situation where one group has acquired control of the means of production over a large area - or, in a strict sense, throughout the world. On this particular aspect of socialism, it doesn't matter whether this unitary control has come about through the coercive expropriation brought about by socialism or by voluntary processes on the free market.

In other words it can apply to a firm.

Rothbard continues

[ ... ] Mises analysis also supplies us the answer to the age-old criticism leveled at the unhampered, unregulated free-market economy: what if all firms banded together into one big firm that would exercise a monopoly over the economy equivalent to socialism? The answer would be that such a firm could not calculate because of the absence of a market, and therefore that it would suffer grave losses and dislocations. Hence, while a Socialist Planning Board need not worry about losses that would be made up by the taxpayer, One Big Firm would soon find itself suffering severe losses and would therefore disintegrate under this pressure. We might extend this analysis even further. For it seems to follow that, as we approach One Big Firm on the market, as mergers begin to eliminate capital goods markets in industry after industry, these calculation problems will begin to appear, albeit not as catastrophically as under full monopoly. In the same way the Soviet Union suffers calculation problems, albeit not so severe as would be the case were the entire world to be absorbed into the Soviet Union with the disappearance of the world market. If, then, calculation problems begin to arise as markets disappear, this places a free-market limit, not simply on One Big Firm, but even on partial monopolies that eradicate markets. Hence, the free market contains within itself a built-in mechanism limiting the relative size of firms in order to preserve markets throughout the economy.

Rothbard then notes that this argument is related to Coase's argument about the size of firms.

This point also serves to extend the notable analysis of Professor Coase on the market determinants of the size of the firm, or of the relative extent of corporate planning within the firm as against the use of exchange and the price mechanism. Coase pointed out that there are diminishing benefits and increasing costs to each of these two alternatives, resulting, as he put it, in ah " 'optimum' amount of planning" in the free market system. Our thesis adds that the costs of internal corporate planning become prohibitive as soon as markets for capital goods begin to disappear, so that the free market optimum will always stop well short not only of One Big Firm throughout the world market but also of any disappearance of specific markets and hence of economic calculation in that product or resource. Coase stated that the important difference between planning under socialism and within business firms on the free market is that the former "is imposed on industry while firms arise voluntarily because they represent a more efficient method of organizing production." if our view is correct, then, this optimal free-market degree of planning also contains within itself a built-in safeguard against eliminating markets, which are so vital to economic calculation

While Rothbard makes a telling point about the limits of monopoly in free markets, the issue of the size of the firm that Coase was interested in, I would argue, was what determined the size of the firm well before the firm gets to the point where it takes over entire input markets.

Mises's argument (and Rothbard's) utilises the idea that under socialism, by definition, there are no markets for the factors of production and thus no prices and therefore economic calculation is not possible. But here we have a difference between Mises and Coase: Coase assumes there are markets for all factors of production, thus economic calculation is possible for firms. Such calculation may be costly, as there are transactions costs, but under socialism there are no markets and thus calculation isn't just difficult it is impossible. Thus in the Coaseian view of the firm we have "central planning" with markets, rather than the central planning without markets inherent in socialism.

What causes firms to stop expanding before they get to the Rothbard's point? For Coase there are costs to using the market - transaction costs as we now call them - and there are costs to using the firm. The size of the firm is determined when these two cost are equal. But this is probably the weakness part of Coase's argument since he does really make clearly exactly what the costs of management and transaction costs are. Oliver Williamson has argued that the reason for the limited use of Coases's ideas for nearly 40 years was the fact that transaction costs had not be made "operational". As to management costs we are told in a general way about decreasing returns to management and the "individualistic spirit of the smaller entrepreneurs [who] prefer to remain independent". These reasons haven't fully satisfied economists. As Oliver Hart has mentioned,

Coase’s questions about why firms and markets co-exist are brilliant, but his answers are less satisfactory.

Making transaction costs and management costs clearer and operational has driven much of the research on the theory of the firm since the 1970s. Two examples of this being the development of the transaction costs approach to the firm and the property rights approach.

Thus size does matter, at least when it comes to the possibility of planning. Planning works at the small scale but but fails at the large.

A bizarre piece on Coase

The Guardian in the UK has an absolutely bizarre article on Coase written by a David Walker - no relation I'm very pleased to say or if he is I'm disowning my family! The article is Ronald Coase has died, but his individualist dogma is everywhere: You can't divorce the ideas of the Chicago school economist from his followers today, intent on destroying the protective state.

The piece opens with,

He believed in privatising lighthouses, opposed regulating taxis, thought pollution was a price worth paying for profit, wanted to abolish the BBC and didn't think private companies could ever be monopolistic – you might not call him extreme but the label ideological would surely be applicable.

For a start what exactly would be wrong with privatising lighthouses and doing away with the BBC? What Coase set out to show in his paper on lighthouses was that lighthouses, an often used example of something that has to be provided by the government, were in fact provided by private enterprise in the early years of the British lighthouse system. So privatisation is perfectly possible. As to firms never being monopolistic I don't that Coase ever said this. Murray Rothbard did argue this by applying Mises's argument that about why socialism can't work for a country to the firm. If a firm gets very large it starts to take over its input markets and thus loses prices from those markets and therefore economic calculation is not longer possible. But I don't know what Coase thought about this.

Walker continues,

If, over a long career, that person had won renown as an economist but never once addressed income and wealth inequality or, in markets, the everyday imbalance of bargaining power between employers and employees, you might either think his fame overblown, or the way his reputation was inflated somewhat suspect.

Coase did not say much about income and wealth inequality, but many economists have won renown while not saying much about income and wealth inequality. So what? Its bit like saying X won renown as a physicist but said nothing about elementary particle physics. Well if he wasn't an elementary particle physicist this is not surprising. All this says is that there are gains of specialisation and the division of labour. We don't have a comparative advantage in everything. So we don't work on everything.

Walker goes on,

Coase, they say, was influential. But like cites like. He won a Nobel prize but by what transparent standard is a committee of the Swedish academy the sole arbiter of intellectual merit, or itself unswayed by beliefs and world views? In economics the line between scholarship and ideology is not just fine, but carefully screened from prying eyes.

But by what standard is a committee of the Royal Swedish Academy of Sciences. we could ask, the arbiter of intellectual merit in physics and chemistry, the other wards they decide. Someone has to decide who gets any award, for the economics, physics and chemistry Nobels it just happens to be the the Royal Swedish Academy of Sciences. Again, so what. You could ask this question no matter who gave the award. As to ideology, what are we to make of the awards to people like Gunnar Myrdal, Amartya Sen, Daniel Kahneman, Paul Krugman or Arthur Lewis, for example.

Later Walker writes,

Coase was praised for writing about the real world, for example his assertion that firms grow in relation to the cost of doing business. It's a theory, and attracted attention because so little economics is about real existing companies and the highly imperfect markets in which they operate. But Coase was careful never to frame his theory to make it empirically testable.

Both the transactions cost and property rights theories, which follow from Coase's work, have been empirically tested often. Oliver Williamson has noted at different times over the years,

The transaction cost approach to the study of integration yields numerous refutable implications many of which are unique to this approach. The cumulative evidence, which includes mundane, forward, lateral, and backward integration, is broadly corroborative.

and

To be sure, transaction cost economics, like everything else, will benefit from more and better empirical work. I have no hesitation, however, in declaring that transaction cost economics is an empirical success story.

and

TCE is an empirical success story ... research has been broadly corroborative of the predictions of transaction cost economics

In their 2007 look at "Vertical Integration and Firm Boundaries: The Evidence" Francine Lafontaine and Margaret Slade note that

Since Ronald H. Coase’s (1937) seminal paper, a rich set of theories has been developed that deal with firm boundaries in vertical or input–output structures. In the last twenty-five years, empirical evidence that can shed light on those theories also has been accumulating.

Its hard to see empirical work accumulating for 25 years if the theories are not empirically testable.

After this Walker comments,

Coase belonged to the Chicago school. Like his pal Milton Friedman, government was anathema. Without regulation, and particularly without the welfare state, markets would resolve themselves in benign benefit – all you need are saintly courts and judges where the rampant individualism prevalent everywhere else is miraculously absent.

Was Coase part of the Chicago School? In many ways yes but in others no. Coase, for example,  rejected Friedmanite positivism, as David Henderson has written,

A gentle man, Coase is also quite willing to take on some of the giants of economics when he disagrees with them. In one essay, "How Should Economists Choose?," Coase criticizes a famous 1953 article on methodology by Milton Friedman. Friedman had argued that the correctness of one's assumptions is unimportant and that all that matters for an economic theory is that it be capable of accurate predictions. Coase responds with a devastating counterexample.

"We could have predicted," writes Coase, "over the last few years what the American government's policies on oil and natural gas would be if we had assumed that the aim of the American government was to increase the power and income of the OPEC countries and to reduce the standard of living in the United States. But I am sure that we would prefer a theory that explains why the American government, which presumably did not want to bring about these results, was led to adopt policies which harmed American interests. Testable predictions are not all that matters. And realism in our assumptions is needed if our theories are ever to help us understand why the system works the way it does. Realism in assumptions forces us to analyze the world that exists, not some imaginary world that does not."

Was government really an anathema to Coase (or Friedman for that matter)? Coase showed that in a world of zero transaction costs government actions - normally the imposition of taxes - were not needed to correct for negative externalities. But he goes on to say,

Of course, it does not imply, when transaction costs are positive, that government actions (such as government operation, regulation or taxation, including subsidies)  could not produce a better result than relying on negotiations between individuals in the market. Whether this would be so could be discovered not by studying imaginary governments but what real governments actually do. My conclusion: Let us study the world of positive transaction costs.

In a world of positive transactions costs what policy should be carried out can only be determined by working out empirical case studies. Does this sound like a man for whom government is an anathema or a man who just wants to study the world, including markets and governments, as they really are.

The truth about Coase, work and his legacy is much more subtle than David Walker seems able to comprehend.

Does offshoring hurt domestic innovation activities?

Concerns about the effects of offshoring around the world, including Europe, focus mainly on the loss of factory jobs, but some also worry that innovation will also be affected in a bad way. A new column at VoxEU.org shows that offshoring firms employ more people in R&D and design, introduce more frequently new products, and invest more frequently in advanced process technologies compared to non-offshoring firms. Concerns that offshoring may hurt innovation because of the lost links between production and product development are not supported by the evidence.

The article, by Bernhard Dachs, Bernd Ebersberger, Steffen Kinkeland and Oliver Som, opens by saying,

Offshoring of production activities has been a topic of economic policy debates for at least the last decade. A central issue in these debates are the economic effects of offshoring on firms in the home country. Most contributions investigated the effects of offshoring on output, employment or skills [...] and find a complementary relationship between foreign and domestic economic activity, at least in the long run.

The effects of offshoring on innovation and technology investment came into focus only recently. Conventional economic wisdom suggests that offshoring changes the internal division of labour between various parts of the firm and strengthens capital-, technology-, and skills-intensive types of economic activity in the home country, including headquarter services such as innovation and research and development. Studies on the changing skills composition of offshoring firms [...] provide empirical support for this assumption.

This view has been challenged by various authors who point to possible negative effects of offshoring on national innovation capabilities. Gary P Pisano and Willy C Shih (2012), for example, state that “mass migration [of manufacturing] has seriously eroded the domestic capabilities needed to turn inventions into high-quality, cost-competitive products”. Pisano and Shith argue that close linkages between production product development are main source for product innovation. This idea goes back to the notion of the ‘factory as a laboratory’ [...] and to interactive models of the innovation process [...], and has also been brought forward recently [...] for Finland. Offshoring cuts these ties.

The big question asked in the article is "Are offshoring firms more innovative"? Dachs, Ebersberger, Kinkeland and Som answer by noting,

We first test for effects of offshoring on innovation input.

• Results suggest that offshoring firms employ a significantly higher share of employees in research and development and design.

Research and development and design personnel accounts for 13.7% of total employment in offshoring firms, compared to 11.9% in non-offshoring firms.

This result supports the view that offshoring firms specialise on skill-intensive, non-routine tasks and rejects fears of a lower innovation performance due to offshoring.

• Offshoring firms are also more likely to introduce new products to the market, including market novelties.

58.7% of the firms which have offshored production between 1999 and 2006 have introduced products new to the market between 2007 and mid-2009. The corresponding share for non-offshoring firms is 51.7%. The difference is significant at 10% error level. Internationalisation via offshoring may increase sales expectations of firms, which in turn spur product development. However, offshoring firms do not yield larger benefits from product innovation than non-offshoring firms. Sales from new products as a share of total turnover reveal no significant difference. This may rather reflect the uncertainties of the innovation process than to adverse effects from offshoring.

To study process innovation, we construct an involvement index that resembles the index used in Bozeman and Gaughan (2007, 2011). This procedure weights up (relatively) rare utilisation of technologies, and weights down (relatively) common ones. We calculate an overall involvement index, and sub-indices for production technologies, value chain integration technologies, and product development technologies.

Results reveal a positive effect of offshoring on process innovation [...]. Offshoring firms invest significantly more frequent in production technologies and in technologies that facilitate the management and integration of global value chains. These technologies are a means to facilitate the integration of production processes between suppliers and clients across firm boundaries and therefore promote the trade in tasks. Investment in technologies for product development show no significant difference.

This result clearly contradicts the assumption that offshoring is associated with a loss of domestic production activity. However, it supports the international economics literature which predicts that offshoring firms in the home country will focus on skill-intensive and capital-intensive activities. An explanation is that offshoring firms concentrate on the most advanced, most productive equipment – which can compete with low wages at locations abroad – in the home country to avoid involuntary knowledge spillovers to foreign competitors and increase flexibility.

and

Overall, we see no negative effect of production offshoring on innovation and technological capabilities of firms in the home country. Most indicators reveal that offshoring is associated with a higher innovation performance at the firm level. We explain this result by the changing specialisation patterns of offshoring firms towards research and development, design and innovation in their home country. Moreover, innovation activities in the home countries may also benefit from additional demand generated abroad. Fears that offshoring hurts innovation because it cuts links between production and product development are not supported by our results. An important limitation of the results, however, is the fact that we cannot observe firms that offshored all their production activities.

What then are implications for future research and policy?

Our findings provide fresh evidence on the relationship between offshoring and innovation, a field where empirical results were scarce so far. They support a view on internationalisation of firms that regards offshoring as a strategy of international expansion, and not a passive reaction of firms to a loss of their competitiveness.

With respect to policy, the analysis does not confirm fears of a weakening of national competitiveness due to offshoring:

• Activities that add to the technological capabilities of firms and their ability to create competitive advantage – such as research and development, design or process innovation – are positively associated with a firm’s decision to offshore production activities.
• Concerns that offshoring may hurt innovation because of lost links between production and product development are not supported by the evidence.

On contrary, offshoring firms have higher propensity to invest in advanced production technologies in the home country than the control group of non-offshoring firms.

Our findings also point to complementarities between domestic education and innovation policies and internationalisation:

• Domestic firms are likely to specialise in knowledge-intensive activities when they internationalise their production activities.
• Policy can help to take full advantage of the benefits from internationalisation by promoting education and qualifying personnel early enough, particularly in countries or regions where talent is short.

So offshoring is good for innovation, something worth keeping in mind when you see people complaining about the offshoring activities of firms.

Refs.:

• Bozeman, B, and M Gaughan (2007), "Impacts of grants and contracts on academic researchers’ interactions with industry", Research Policy, 36(5), 694-707.
• Bozeman, B, and M Gaughan (2011), "How do men and women differ in research collabourations? An analysis of the collabourative motives and strategies of academic researchers", Research Policy 40(10), 1393-1402.
• Pisano, G, and W C Shih (2012), "Does America Really Need Manufacturing?", Harvard Business Review, 90(3), 94-102.

If you have a couple of dollars to spare

From the Adam Smith's Lost Legacy blog comes news about the price paid for a first edition of Adam Smith's second book, "An Inquiry into the Nature and Causes of the Wealth of Nation" at a recent auction in Edinburgh:

A rare first edition of Adam Smith’s Wealth Of Nations was bought at auction in Edinburgh by an undisclosed telephone bidder for £46,000 winning bid price, plus the separate sales commission, altogether coming to £55,000.

£46,000 is around NZ$92,000 and £55,000 is roughly NZ$109,000. So if you have a couple of dollars to spare may be you could put in a bit next time a copy comes up for auction.

Competitiveness, the Venezuelan way

Much has been made recently of the fact that New Zealand is now more "competitive" than Australia. For example, The New Zealand Institute has said,

For the first time in the history of the WEF’s competitiveness index, New Zealand is ranked higher than Australia. For the first time, Australia is no longer a top 20 economy globally. Out of 144 countries surveyed, New Zealand now ranks 18th (up from 23rd last year). Australia, on the other hand, dropped one rank from 20th to 21st place. Ouch.

If this is happening near the top of the rankings, what's happening at the other end of the scale. What can we learn from looking at the worst ranked counties?

If you look at the bottom end of the rankings you get an indication of the economic legacy of Hugo Chavez in Venezuela. Peter Spence writes in City A.M. that

The latest World Economic Forum global competitiveness report, released today, is even more striking. Out of 148 countries, here's how Venezuela's institutions fare:

148th for property rights
148th for the diversion of public funds due to corruption
148th for judicial independence
148th for the efficiency of the legal framework in settling disputes
148th for the burden of government regulation
148th for the wastefulness of government spending
148th for favoritism in decisions of government officials
148th for the efficiency of the legal framework in challenging regulations
148th for the reliability of police services
147th for the transparency of governmeny policymaking (Haiti is considered marginally worse, with 2.6/7, versus Venezuela's 2.7)

and

Venezuela slipped from the world's 51st most competitive country in 1999, to the 54th in 2000 and 66th in 2001. It now ranks as the 134th most competitive of 148 states.

Now the country is worst in the world for nine out of 21 categories, and in many it's still pretty close to the bottom, close to nations like Lebanon, Chad, Yemen and Haiti.

A county's basic institutions are one factor that matter for its economic well being. If your institution don't function properly, that is if you don't protect property rights, have an honest public sector, an independent judiciary, sensible business regulation etc, then no matter how much oil revenue you have, eventually your economy, and thus people's welfare, will suffer.

Interesting blog bits (updated lots of times)

A few of the many obituaries of and tributes to Ronald Coase:

1. David Henderson
2. Richard Epstein
3. Richard Epstein
4. Peter Boettke
5. Peter Klein
6. Donald J. Boudreaux
7. David Gordon
8. Robert Higgs
9. Daniel Kuehn
10. Vuk Vukovic
11. Kevin Bryan. A version is also available at VoxEU.org.
12. Victor W. Hwang
13. Joshua Gans
14. Edward Lopez
15. Sarah Galer and Jeremy Manier
16. Caleb Garling and Benny Evangelista
17. Brendan Greeley
18. Todd Zywicki
19. Jonathan Turley
20. Matthew Yglesias
21. Stephanie Flanders
22. John Kay
23. Diane Coyle
24. Nick Gillespie
25. Dylan Matthews
26. Mark Littlewood
27. Timothy B. Lee
28. Rupert Darwall
29. Marc Sidwell
30. Cass R. Sunstein
31. John Naughton
32. Edward Lotterman
33. Phil Rosenthal
34. John Cassidy
35. Richard A. Epstein Epstein is a reply to Cassidy
36. Phil Miller
37. David P Goldman
38. Martin Hutchinson
39. Larry Downes
40. Walter Olson
41. Severin Borenstein
42. Casey B. Mulligan
43. Kenny Tan
44. Ray Perryman
45. Prashanth Perumal
46. Robert Stavins
47. Mike Rappaport
48. J. Gordon Hylton
49. Steven Medema
50. Steven Medema
51. Kevin Rafferty
52. Andrew Sheng and Xiao Geng
53. Walter Block
54. Donald J. Boudreaux
55. Jonathan Z. Zhou
56. Paul Greenberg
57. Anna Demchenko
58. Matt Nolan
59. Peter Cresswell
60. Oliver Hartwich
61. The New York Times
62. The Washington Post
63. The Ronald Coase Institute
64. The Wall Street Journal
65. The New Zealand Herald
66. The Economist
67. The Economist
68. The Sydney Morning Herald
69. University of London
70. Links to do with Coase being forced out of the University of Virginia
1. Hawes Spence
2. Nick Gillespie
3. David Friedman
4. George Leef

Capitalism, government, and the good society

From EconTalk comes this video of an Liberty Fund and Butler University sponsored symposium:

Capitalism, Government, and the Good Society

The evening began with solo presentations by the three participants--Michael Munger of Duke University, Robert Skidelsky of the University of Warwick, and Richard Epstein of New York University. (Travel complications forced the fourth invited participant, James Galbraith of the University of Texas, to cancel.) Each speaker gave his own interpretation of the appropriate role for government in the economy and in our lives. This was followed by a lively conversation on the topic moderated by Russ Roberts of Stanford University, host of the weekly podcast, EconTalk.

Williamson plus Grossman-Hart-Moore gives?

In a comment on the death of Ronald Coase at the Cheap Talk blog it is asked,

But what are these pesky transactions costs that determine the boundary of the firm?

The answer given is that

There we have no consensus. One leading theory invokes costs of haggling ex post if two firms are not integrated (Wiliamson got the Nobel Prize for this theory). The other says there are no costs of haggling ex post and bargaining in efficient but there is a hold up problem in bargaining as surplus is split. Knowing this firms underinvest ex ante. The allocation of property rights affects the ex post division of surplus and hence this leads to a theory of optimal property rights (this theory has been developed by Oliver Hart with his co-authors Sandy Grossman and John Moore (GHM)).

Is the obvious third possibility not missing? A combination of Williamson and Grossman-Hart-Moore or the reference point approach due to Hart and Moore. As I have argued in Walker (2013: 690-1),

The reference point approach can be seen as a movement away from the ex ante GHM approach and back towards transaction cost thinking in so much as contracting is not perfectly contractible ex post. This fact, as Hart (2008, p. 294) points out ‘[...] is a significant departure from the standard contracting literature. The literature usually assumes that trade is perfectly enforceable ex post (for example by a court of law). Here we are assuming that only perfunctory performance can be enforced: consummate performance is always discretionary’, and thus inefficiencies can arise ex post. The development of a tractable model of contracts and organisational form that exhibits ex post inefficiency is one of motivations for advancing the reference point approach in the first place. (Hart and Moore, 2008, p. 4). Hart’s interpretation of the reference point theory is ‘[i]n a sense, this work can be viewed as a “merger” of the transaction cost and property rights literatures’. (Hart, 2011b, p. 106).

While it is true that there may be no overall consensus on which transaction costs matter for the boundaries of the firm, it is also true that the transaction costs and property rights approaches are not as diametrically opposed as the second quote above would suggest since a midway between them can also be found. Oliver Williamson has argued in the past that the ideas in Coase's paper "The Nature of the Firm" had for many years been under-used because the idea of transaction costs had not been "operationalised". What the above would suggest is that transaction costs have yet to be fully incorporated into a general theory but progress has been, and is still being, made.

Refs:

• Hart, Oliver D. (2008). Economica Coase Lecture: reference points and the theory of the firm. Economica 75(299) August : 404–411.
• Hart, Oliver D. (2011b) Thinking about the firm: a review of Daniel Spulbers the theory of the firm. Journal of Economic Literature 49(1) March: 101–113.
• Hart, Oliver D. and Moore, John (2008). Contracts as reference points. Quarterly Journal of Economics 123(1) February: 1–48.
• Walker, Paul (2013). The 'Reference Point' Approach to the Theory of the Firm: An Introduction. Journal of Economic Surveys, 27(4) September: 670-95.