EconTalk this week

Emily Oster of the University of Chicago and author of Expecting Better talks with EconTalk host Russ Roberts about her book on pregnancy and the challenges of decision-making under uncertainty. Oster argues that many of the standard behavioral prescriptions for pregnant women are not supported by the medical literature. The conversation centers around the general issue of interpreting medical evidence in a complex world using pregnancy advice as an application. Alcohol, caffeine, cats, gardening and deli-meats and their effect on pregnant women are some of the examples that come up. The conversation closes with a discussion of Oster's work on hepatitis-B and the male-female birth ratio.

You just have to love the French

From the Economics of information blog comes this wonderful insight to French economic thinking:

According to an article on FT.com today:

France’s parliament has passed a law preventing internet booksellers from offering free delivery to customers, in an attempt to protect the country’s struggling bookshops from the growing dominance of US online retailer Amazon.

Wouldn't you just love to be a consumer in France? Your parliament deliberately sets out to make you worse off. Yes, politicians are your friend ................ not!

Why do politicians think that protecting the inefficient and obsolete is a way to enhance welfare? Isn't the very fact that consumers are buying from stores like Amazon a message to politicians that these consumers want the services that these online store have to offer rather than the services offered by more conventional business? In which case what we seem to be seeing is creative destruction and to try to prevent it will only lower social welfare.

Was tulipmania irrational?

It is often assumed that the tulipmania was the result of financial market irrationality and the mania is often used as an example of said irrationality. These idea were popularised by Charles Mackay, a mid-19th century Scottish writer. Mackay is best known for his book, Extraordinary Popular Delusions and The Madness of Crowds. But was the tulipmania really all about irrational markets. Some economic historians say no and provide alternative explanations for what happened.

Some of these alternatives are discussed in an article at the Economist's blog Free Exchange.

First start with the work of Peter Garber including this 1989 paper in the Journal of Political Economy, "Tulipmania". Garber also has a book, Famous First Bubbles: The Fundamentals of Early Manias. In short Garber argues that the tulipmania was not simply irrational trade in rare bulbs. As the Economist puts it:

Peter Garber blames the general public for the price increases. He reckons that an outbreak of bubonic plague in Amsterdam made people less risk-averse. Dutch city-dwellers knew that each day could be their last—so did not mind indulging in a little speculation. And because gambling was illegal, contracts were unenforceable. If traders misjudged the market, they could just run off without paying.

But on the whole, Mr Garber reckons that investors acted rationally. He suggests that the trend towards extremely high prices, followed by rapid declines, was typical for rare bulbs, due to their growing cycle. And according to Nicolaas Posthumus, a Dutch historian, serious tulip financiers generally did not participate in the speculative markets. Any “mania” was pretty self-contained, and was pushed forward by casual traders, drunk on jenever and moral hazard. Only in the month before the crash does Mr Garber find evidence of speculation from more serious traders.

Then there is E. A. Thompson's 2007 paper in Public Choice which asks "The tulipmania: Fact or artifact?". The Economist continues,

Earl Thompson, formerly of UCLA, takes a different approach. He reckons that the market for tulips was an efficient response to changing financial regulation—in particular, the anticipated government conversion of futures contracts into options contracts. This ruse was dreamt up by government officials, who themselves were keen to make a quick buck from the tulip trade.

In plain English, investors who had bought the right to buy tulips in the future were no longer obliged to buy them. If the market price was not high enough for investors’ liking, they could pay a small fine and cancel the contract. The balance between risk and reward in the tulip market was skewed massively in investors’ favour. The inevitable result was a huge increase in tulip options prices [...]. (The price of options collapsed when the government saw sense and cancelled the contracts.) Spot prices (the price that traders paid for immediate delivery of tulips) and futures prices (the prices that traders would be compelled to pay for future delivery of tulips) were not volatile. And any movement of the spot/futures price was determined by simple supply and demand—the fall-out from the Thirty Years’ War, one of the bloodiest in European history, was one important factor.

Thompson argued that popular interpretations of tulipmania have failed to distinguish between options and futures. Tulipmania was only a contractual artifact. There was no “mania” at all.

Is there a lesson here? Perhaps it is that it is all too easy to say that bubbles are irrational since they seem to represent a deviation of prices from fundamental values. But to understand these "deviations" we need to understand how speculation actually works and there has been little effort put into doing this. The Economist's article closes by saying,

The example of tulipmania shows the importance of doing that—rather than relying on lazy quips about “animal spirits” or irrationality.

A new paper regarding Austrian capital theory

For those with an interest in Austrian capital theory Nicolai Foss points us to a new paper on the formalisation of Eugen von Böhm-Bawer work on Austrian capital theory. The paper is Renaud Fillieule’s “A comprehensive graphical exposition of the macroeconomic theory of Böhm-Bawerk.” Fillieule argues that Böhm’s theory can be seen as a precursor of Solowian growth theory and of macroeconomics in general. The abstract reads:

This paper offers a comprehensive graphical exposition of Böhm-Bawerk’s formalised macroeconomic theory. This graphical model is used here for the first time to study the effects of the changes in the explanatory variables (quantity of capital, number of workers and level of technical knowledge) on the dependent variables (interest rate, wage and period of production). This systematic application of the model shows that some of the conclusions drawn by Böhm-Bawerk are incorrect and need to be amended. A comparison with Solow’s model also shows that Böhm-Bawerk can legitimately be considered as one of the main originators of the standard contemporary approach in macroeconomics of equilibrium and growth.

Friedman on the minimum wage

Via Mark J. Perry comes this classic 1980 Milton Friedman video on the minimum wage. Professor Walter E. Williams makes a guest appearance.

The ex ante and ex post benefits of events

When considering the issue of the benefits of of big events Shamubeel Eaqub writes at the TVHE blog that,

In the lead up to the RWC, we looked at a range of events. International studies of sporting events fall into two categories, those done before the event, and those done after. The studies in the lead up to events on average forecast economic boost of around 1% of GDP. The studies done after the event estimate economic boost of around 0.1% of GDP [...].

Once the initial boosterism fades, large economic benefit estimates are largely disowned and there is a greater focus on intangible benefits such as showcasing the area, long term positive association and somewhat esoteric ‘feel-good’ factor.

There is nothing wrong with events. They are fun. But the fetishist need to justify it on economic grounds is entirely unnecessary. Events provide very small, if any, tangible net economic benefit. There are many other intangible things that can be good, like speeding up the beautification of the city, or finishing off motorways in the lead up to the RWC for example. Its not that they wouldn’t have been done, but events have a habit of getting things done on a deadline.

Eaqub also points us to a working paper by Sam Richardson at Massey which looks at Justification for Government Involvement in the Hosting of Sports Events: Do Projected Impacts Materialise? As to the question in the subtitle, the short answer is no. The abstract of the paper reads,

Major sporting events are said to generate substantial economic impacts to host cities. Estimates of these impacts are typically used as justification for government involvement in the staging of such events. The majority of independent academic research, however, has found that ex-ante projections of economic impacts for host cities from major sporting events rarely materialise. This paper considers the realised economic impacts of fifteen major sporting events hosted in sixteen New Zealand cities between 1997 and 2009. Realised economic impacts are found to be the exception, not the rule.

Given that the economic impacts do not live up to the hype that comes from the ex ante studies I want to ask Why not? What are the people who writes these reports doing? How can they be so wrong so often? There seems to be a systematic basis here. Are these people just producing reports to support a predetermined outcome?

Eaqub also goes down the there are no tangible benefits so lets justify spending taxpayer's money on an event by saying there are lots of intangible benefits. He says, for example, speeding up beautification of the city or finishing off motorways is an intangible benefit. But you have to ask question about the optimal timing of such projects. If a delayed finish to these projects is optimal then you don't want them finished at an earlier date. And if an early finish is optimal then there has to be much cheaper ways of getting these projects finished earlier.

Also if you want to host events on the grounds that some people will get positive utility from the "thrill" of hosting then you have to net out the negative utility that other people suffer from hosting. You must consider both sides of the ledger. It's the net-thrill that matters. And good luck with that.

A more general point, you could justify any amount of spending on anything if you allow the benefits to be some "intangibles". You can always come up with a huge amount of "intangible". Policy based on "intangibles" is policy based on nothing. And what does this say about evidence based policy. What evidence can you have for intangibles?

And what else could be done with any money spent on an event? How many hip operations could be done with that money? How many child cancer patients would receive quicker treatment if that money went to them? How many schools could be kept open with that money? Opportunity costs are real costs.

Quote of the day

Swedish economist Assar Lindbeck on rent control,

'Next to bombing, rent control seems in many cases to be the most efficient technique so far known for destroying cities'. (The Political Economy of the New Left, Harper & Row, New York 1971, p. 39)

Prof. Lawrence White asks Can the monetary system regulate itself?

This is an audio of a talk Professor White gave at CEVRO Institute in Prague earlier this month. White begins at around 6:30 minutes in.

Markets v. capitalism

Writing at the blog of the Adam Smith Institute Tim Worstall says,

Forgive me but this is going to be a bit of a rant on one of my bugbear themes: why is it that the British left simply cannot understand markets? Here we've got Martin Kettle describing one of David Sainsbury's ideas:

As a result, says Sainsbury, in opposition Labour now needs to embrace a new form of political economy – the progressive capitalism of his title – in order to govern better and better understand the future. That means embracing capitalism in two particular ways – the recognition that most assets are privately owned and the understanding that goods and income are best distributed through markets.

Neither of those two things are in fact capitalism. Capitalism does indeed describe a method by which assets (and more particularly, productive ones) are owned but it means that they are owned by the capitalist, not simply privately. The opposite to private ownership is State ownership. It's entirely possible to have privately owned assets but which are not owned by capitalists as the various flavours of mutual ownership show us. John Lewis and Mondragon by the workers in those companies, the Co Op or building societies by the customers for them and so on. Private ownership of assets is not necessarily capitalism.

Tim calls his piece "Why cannot the British left understand markets? I would argue that the problem is more general than title may suggest. Is not just the British and its not just the left that don't understand markets and capitalism. Most people everywhere miss the point Tim is making.

In popular discussion worldwide the distinction between "market economies" and "capitalist economies" is not often drawn. It may not surprise many than the distinction is not made since the association between markets and capitalism is so common place. Ownership rights do tend to be assigned to the providers of capital in western style developed economies such as the U.K, the U.S. and even New Zealand. But, as Henry Hansmann notes,

[...] investor ownership is not a logically necessary concomitant of free markets and free enterprise.

In fact one of the most interesting points about ownership of firms in a market economy is just how varied it is. As Martin Ricketts has written,

The assignment of ownership rights to workers, for example, can be found in some industries - the ply wood industry in the United states is a frequently cited case. More significantly, many professional partnerships in law and accountancy are owned by the people who work in them. In the United Kingdom, worker ownership can be found in retailing. The John Lewis 'partnership' has 37,000 worker partners who elect representatives to a central council which in turn provides 5 members to the Board of Directors. Similarly, consumer ownership has a significant history in retailing. The Rochdale Pioneers in 1844 began a working class movement which was taken up later (in 1864) by the middle classes when the Civil Service Supply Association was formed. The Co-operative Wholesale Society is still in existence with sales in 1997 in excess of £3 billion. Agricultural supply co-operatives for seeds, fertiliser and other farm inputs are important in the United States as are electric utility co-operatives in rural areas.

Mutual ownership, that is the sharing of rights between all participants in a club, is still very common in the area of financial services. The origins of this structure go back far into social and economic history. In life insurance, the Amicable Society (now the Norwich Union) was set up in 1706 as a simple club. Members paid a premium at the beginning of the year and the collected sum was distributed at the end of the year to the dependents of members who had died. By the middle of the 18th century, 'modern' characteristics were appearing such as differing premiums depending upon age and a specified sum assured. The mutual form was crucial however. In spite of advances in actuarial science the calculations were so uncertain that investor ownership would have resulted either in the risk of bankruptcy if premiums were set too low. or enormous profits to investors if premiums were set too high. The 'club' was therefore a fairly 'natural' response to these problems in the 18th century When investor ownership developed in the 19th century, this was always linked to profit sharing with policy holders. The Deed of Settlement of the Prudential in 1853, for example, determined that periodic valuations of new profits would be made and that 80 per cent of these would go to policy holders and 20 per cent to shareholders.

The building society movement represents another classic example of the evolution of mutual governance in the area of financial services. Fire insurance companies also initially adopted a mutual structure of governance - the 'Hand-in-Hand' (1698) providing an early example in London. Stock exchanges, popularly regarded as centres of financial 'capitalism', have historically been organised on principles of mutuality. The London Stock Fxcthange is still owned by its members rather than outside investors as are many other exchanges such as the International Petroleum Exchange (IPE) or the London International Financial Futures and Options Exchange (LIFFE). It may turn out that, under modem conditions, the days of mutual governance for these financial organisations are numbered. But the historical existence and durability of mutual arrangements in a market setting is not in doubt. Other examples taken almost at random include motoring organisations such as the Automobile Association (AA) and Royal Automobile Club (RAC) which have recently 'de-mutualiscd'. as well as the Silverstone Racing Track.

Sometimes the distribution of surpluses is ruled out by an organisation's constitution. Such organisations can thus be said to have no owners. They exist within market settings even if we would not expect them to be very common. Education and health care are areas in which non-profit enterprises compete with profit making organisations. At the so-called 'private' University of Buckingham there are no residual claimants and 'ownership' of the assets is no more clearly defined than in some bureaucracies. The same could be said of many other charitable organisations. Early examples of savings banks in the United Kingdom and in the United States, designed to encourage thrift amongst the relatively poor, were charitable rather than mutual organisations. In the modern world BUPA, which provides care homes, hospitals and occupational health facilities, employs over 30.000 people and retains all surpluses within the organisation.

So in a modern market economy firm ownership may be dominated by investor-ownership but you also have producer-ownership, employee-ownership, customer-ownership, non-profits ans mutuals.

So why so many types of firms. Put simply, one size dos not fit all. First, it is argued that all other things held equal, costs will be minimised for a firm if ownership is assigned to the class of patrons for whom the problems of market contracting--that is, the costs of market imperfections--are most severe. Thus, if the cost of contracting with workers is higher than the cost of contracting with suppliers, customers, etc., in a particular economic sector, then theory would predict that employee ownership would be the dominant form of ownership.

However, the story is further complicated by a second major factor: the cost of governance. The more diverse the interests of a patron group, the higher the costs of politically mediating those differences through the structure of the firm. As a result, the optimal form of ownership in an industry is that which minimises the sum of all of the costs of a firm's transactions. That is, it minimises the sum of (1) the costs of market contracting for those classes of patrons that are not owners and (2) the costs of ownership for the class of patrons who own the firm. In different situations different ownership structures will minimise these costs.

Jobs are a cost

We are often told by politicians and interests groups how many jobs this project or that project will create, as if jobs are somehow a benefit of the project. But are they? At the Forbes website Tim Worstall argues that jobs are not a benefit of a project but a cost. How so? Well,

Start with it from the point of view of the individual: neither I nor you particularly want a job. We most certainly aren’t all that fond of having to do the work that a job entails. We absolutely love being able to consume things, of course. And we all view having an income as most useful in being able to purchase the things we want to consume. But we all also view the job, the work we have to do, as a cost of getting that income so that we can consume stuff. The job is the cost, the consumption the benefit here.

Now look at it from the point of view of whoever is doing the employing of that labour. They certainly look upon a job as being a cost: they’ve got to pay out the wages to get people to do it after all. The benefit is that they get that work done so that they can go sell the goods or services produced. But the job itself, that’s still a cost to them. We even record the wages they pay on the cost ledger side of their accounting books, not on the benefits or income side.

Finally, think of it from the point of view of the whole society. No, don’t start thinking about “full employment” and the like just yet. Think instead about labour as being a scarce resource. Which it is of course: and just as with any scarce resource we want to use it as efficiently as possible. Say, imagine, we have 100 workers and all 100 were working on the farms to produce the food that kept all 100 people alive. Now we bring in new technology to farm with and we only need two people working to feed all. Well, we could say that 98 of the people are losing their jobs and that’s a disaster. But hold on a moment, jobs are a cost. Jobs here are a cost of producing food and we've just saved 98 job’s worth of cost. What this actually does is frees up those 98 people to go and do other things. Like, ooh, build libraries, hospitals, start manufacturing industry, join the military and so on. Roughly speaking this is also what has happened to the North Atlantic economies over the past four hundred years or so. We've moved from having nearly everyone working the land to about 2% of us doing so. And that has freed the labour up to go and build all the other things that we now generally refer to as civilisation.

Now you may well say I enjoy my job, which means, most likely, you enjoy some parts of your job but not others. This just means that the good parts of the job increase the consumption benefits that occur because of the job but the bad bits of the job are still a cost. They are the crap you have to put up with to get the good bits.

One of the great advantages of technological improvements and trade is that they reduce the requirement for labour to produce a given amount of output. Increasing specialisation and the division of labour has the same effect. All these reduce the cost of jobs for a given level of output and thus work to make us wealthier. As Tim Worstall points out as you reduce the number of jobs in one area you release a valuable resource to be utilised in another area of the economy.

EconTalk this week

Tyler Cowen of George Mason University and blogger at Marginal Revolution talks with EconTalk host Russ Roberts about his latest book Average is Over. Cowen takes a provocative look at how the growing power of artificial intelligence embodied in machines and technologies might change labour markets and the standard of living. He tries to predict which people and which skills will be complementary to smart machines and which people and which skills will struggle.

Governments behaving badly

That governments often behave badly is clear, but what would be the worst things a government has done?For the U.S. there is now an answer. The Independent Institute has recently released a new book, The Terrible 10: A Century of Economic Folly by Burton A. Abrams. In the book Abrams looks at a series of disastrous government policies that, he argues, cost trillions of dollars in wasted resources, created mass unemployment, and kept millions in poverty who otherwise could have participated in the nation's growing prosperity. Government decision-makers, regardless of political party, have tended to favour short-run benefits for friends while imposing costs on current and later generations. Interestingly Abrams's ten worst blunders divide equally among Democrats and Republicans. The book also provides key lessons to help us avoid repeating such policy mistakes in the future.

A summary of worst economic blunders of the past century is given by

Prohibition

Ratified in 1919, the 18th Amendment reflected the desire of a minority of Americans to impose their views of morality and the proper lifestyle on the majority. The effort failed miserably. In hindsight, most Americans—and especially those who lived through it—probably view Prohibition as a bizarre, foolish, and even dangerous experiment: a massive, precedent-setting governmental intervention in personal freedom, a waste of our national resources, a loss of an important source of tax revenues, a boon to criminals, a corrupting influence on public officials, and an encouragement to otherwise law-abiding citizens to disregard and disrespect the law. Prohibition produced many more costs than benefits and clearly belongs among the ranks of the worst economic interventions of the last 100 years.

The War on Drugs has had the same sort of unintended and undesirable consequences that Prohibition had, and it has failed for exactly the same reason: government officials cannot stop people from engaging in mutually agreeable exchanges. They may reduce the extent of such exchanges with harsh penalties, but they won’t stop them. Efforts to stop such exchanges will spawn many unintended and undesirable outcomes.

Monetary Policy During the Great Depression

The Federal Reserve Act of 1913 was created to resolve a problem: frequent banking panics, or widespread runs on banks, that plagued the U.S. economy. The Act created a central bank—the Federal Reserve System—which was expected to eliminate them. But the biggest banking panic in U.S. history was in the making, and the Fed did little or nothing to prevent it. What would have been a recession was turned into the Great Depression. The Fed’s failure to act decisively was one of the most costly economic policy errors to have been made in the past 100 years.

The Hawley-Smoot Act

In an unprecedented show of unanimity, over 1,000 economists from the United States signed a letter urging Congress and President Herbert Hoover to reject the Hawley-Smoot Act. Their warning went unheeded. The Act touched off a trade war, intensified the Great Depression, and helped set the stage for World War II. The Act and the story of its passage highlight Congress at its worst in pandering to special interests. More than fifty years after its passage, President Ronald Reagan referred to the Republican sponsored Act as “the most destructive trade bill in history.”

Social Security

The pay-as-you-go government program originally was designed to have a “full reserve,” but members of Congress couldn’t keep their fingers out of the cookie jar. The result is the second largest Ponzi-type scheme sponsored by the U.S. government (Medicare is the biggest). Social Security has contributed to de-capitalizing the economy by substituting government promises of retirement income obtained through taxation in lieu of income that would have been obtained from private-sector savings. The Social Security program is a non-transparent welfare program that redistributes enormous amounts of wealth, often in ways that most Americans would find undesirable.

Tax Follies

The 16th Amendment to the Constitution, passed in 1913, made the income tax a permanent fixture of the U.S. tax system. The first personal income tax was quite simple: three pages of forms and one page of instructions. Income taxes today are excessively complicated, non-transparent, and costly. There are now over 500 separate tax forms and over 7,000 pages of taxpreparation instructions. In 2009, the IRS estimated there were between 900,000 and 1.2 million paid tax-preparers to help hapless taxpayers through the morass of tax rules. Worse yet, the income tax hides over a trillion dollars in hidden subsides that distort economic decision-making and produce economic waste. Reforming our wasteful tax system remains a difficult-toachieve goal as entrenched special interests fight hard to resist change.

Medicare

The pay-as-you-go health insurance program for retirees, unlike Social Security, was not designed to have a full reserve. In fact, Bess and Harry Truman received the first Medicare cards despite never paying any taxes into the program. Today, the program is the single worst Ponzi-type scheme in the government’s arsenal. It is $20 trillion to $30 trillion dollars in the red and is in far worse shape than Social Security. This chapter sheds light on the extent of the transfers and the impending crisis in financing the program.

The Nixon-Burns Political Business Cycle

The Nixon tapes, secret recordings made in the White House, reveal how Richard Nixon pressured Federal Reserve Chairman Arthur Burns to overheat the U.S. economy prior to Nixon’s reelection bid. Acting against his better judgment, Burns caved in to Nixon’s lobbying and set the stage for a decade of inflation that required three recessions to extinguish. The tapes reveal how the Fed’s independence can be compromised for political gain and why the power of the Fed’s printing press must be kept out of the reach of politicians.

Environmental Mismanagement

The failure to take into account pollution costs in the pricing of various goods leads to the production of goods that are worth less than their costs. Economists generally agree that some type of environmental regulation is needed to correct market failures arising from producers and consumers neglecting the costs of pollution. And often they've assumed that once a market failure was identified, the government would take the appropriate corrective actions.

When they’ve investigated regulatory behavior, however, they've discovered that government regulations all too often failed to correct market failures and all too often created market failures of their own. Wasteful environmental regulations are the rule, not the exception. And usually they benefit special-interest groups while harming the society at large. This chapter highlights the problem with two case studies: a proposed “clean coal” power plant for northern Minnesota and the federal ethanol mandate.

Government Failure and the Great Recession

The busting of the real estate bubble beginning in 2006 sent the U.S. economy into a tailspin. This chapter reveals the government’s role in fostering the bubble. The Great Real Estate Bubble was nourished by paternalistic policies, fostered by both Democrats and Republicans, to engineer a better society by greatly expanding home ownership, especially to the young and lower income groups. In contrast to government’s role in Prohibition, government became a “pusher” during the housing bubble. The government’s “policy drugs” hooked millions of lower-income Americans on homeownership, indebtedness they could ill afford, and eventual bankruptcy. The economic damage done to the young and less fortunate added another cruel dimension to the economic catastrophe.

Decades of Deficits

The rapid and unprecedented peacetime run-up in the nation’s public debt, begun at the turn of the 21st century, threatens to sink the U.S. economy. Unlike the situation following World War II, paying down this debt will be much more difficult due to expected increased outlays for entitlements as the baby-boomers begin to retire. At the very least, the burden of the public debt will slow economic growth and raise the normal unemployment rate. This chapter explains why irresponsible deficit spending is one of the terrible ten.

This isn't the first book to look at government policy failures. Across the other side of the Atlantic in 2007 the IEA released a related book on They Meant Well, Government Project Disasters by D. R. Myddelton. This book, more tightly focused than the Abrams's work since Myddelton only considers quasi-commercial projects, also highlights just how wrong government policy ideas can go.

A summary of the book's argument is given by

Government officials and ministers usually mean well when they promote and manage quasi-commercial projects in the public sector, which however often turn out to be financial disasters. Any technological advances come at huge expense.

A recurring rationale for grandiose projects, from the groundnut scheme to the Millennium Dome, has been to boost ‘national prestige’, but this concept has little real value.

The costs of ventures dependent on new, untried technology, such as the R.101 airship or nuclear power, are extremely uncertain, so taxpayers have to underwrite their high risks. Initial financial estimates may often be purposely too low.

Partly due to changes in specifications, many of the projects incurred time and cost overruns of more than 100 per cent. The high speed Channel Tunnel Rail Link is still not ready more than thirteen years after the Tunnel itself opened.

The absence of market pressures in the UK’s civil nuclear power programme meant that nobody knew or cared how much it was costing. The result was total losses far exceeding those of all the other five projects together.

State projects are always liable to short-term political interference, which may increase costs, as for the Millennium Dome, or risks, as for the R.101 airship.

The government’s opaque accounting practices often disguise the true level of state spending on large projects, as with the Channel Tunnel Rail Link.

Governments do not understand markets, and on some projects, such as Concorde, made little effort to research likely customer demand.

In the market system investors bear the costs of ventures that fail, but in the political system taxpayers have to do so. As a result, governments often choose to continue projects such as the groundnut scheme and Concorde, even after it has become clear they are not commercially viable.

None of the six projects was well managed and many of the failures were down to politicians: installing inadequate or over-complex organisations, appointing incompetent managers, or insisting on excessive secrecy.

The six projects examined are:

• The R. 101 Airship (Chapter 2)
• The Tanganyika Groundnut Scheme (Chapter 3)
• Nuclear Power (Chapter 4)
• Concorde (Chapter 5)
• The Channel Tunnel (Chapter 6)
• The Millennium Dome (Chapter 7)

But what of a New Zealand list? Think Big would have to be there. The student loans scheme? Capital controls and import controls? A fixed exchange rate? Monetary policy before the Reserve Bank Act? New Zealand Railways? Air New Zealand? Car-less days! Subsidies to framing. Widespread government regulation of economic activities: bars closing at 6pm, a doctor's prescription needed for margarine, shops not permitted to open on weekends, road transportation of goods, except over short distances, prohibited to protect the railways, use of statutory marketing broads etc.

Is Bill Gates wealthier than 140 nations?

A question that its not even clear makes much sense. Jason Brennan at the Bleeding Heart Libertarians blog argues why it doesn't.

First, it’s a mistake to compare Gates’s total wealth to countries’ GDP. That would be like comparing Gates’s total wealth to Warren Buffet’s income this year. The relevant comparison is Gates’s total wealth to various countries’ total wealth (however you want to measure that).

Second, the pic means Gates compared to nations one-by-one, not as a collective.

Third, when it comes to complaining about wealth inequality, what is this meant to prove? There are questions about whether Gates earned some of his money wrongly, by violating the standards of business ethics. But, for the sake of argument, assume he did not. What then? Does this show that the world is in some way deeply unfair. Maybe.

But there’s another take on it: the fact that one dude has more wealth than many fairly large countries produce in a single year is evidence that these countries have really bad institutions and should change. Seriously, Ecuador, get your shit together.

Did slavery make economic sense?

This is a question asked at the Economist's blog Free Exchange. The profitability, or otherwise, of slavery is one of the most enduring and controversial questions in economic history. At the Free Exchange they write,

Intuitively, a business that uses slaves should be profitable. You pay your workers nothing, and reap the benefits of their labour. And some economic historians try to show just how lucrative it was.

Against this is the obvious principal-agent problem, slaves don't want to work that hard. As Adam Smith put it,

The experience of all ages and nations, I believe, demonstrates that the work done by slaves, though it appears to cost only their maintenance, is in the end the dearest of any. A person who can acquire no property can have no other interest but to eat as much and to labor as little as possible.

The Economist notes,

John Elliott Cairnes [1823 - 1875], an economist, reckoned that slavery stifled economic growth in the South [of the U.S.]. Cairnes argued that reluctant workers depleted soils more quickly. In addition, scientific agriculture was impossible. Reluctant slaves, with little interest in learning, had no interest in using new farming techniques. And this meant that Southern farms lost competitiveness to their Northern counterparts.

The Economist goes on,

Robert Fogel and Stanley Engerman made the most famous contribution to the debate. Their book, Time on the Cross, suggested that slavery in the American South was a lucrative enterprise for plantation owners. The authors reckoned that slaves were treated pretty well. And this meant that they were productive. So for the owners, slavery was:

generally a highly profitable investment which yielded rates of return that compared favourably with the most outstanding investment opportunities in manufacturing

Another study, by Alfred Conrad and John Meyer, calculated the rate of return on investing in slaves. They reckoned that “slave capital” earned at least equal returns to those from other forms of capital investment—such as railroad bonds. The rate of return on slaves could be as high as 13%—compared to a yield of 6-8% on the railroads.

So an organisational framework had to be developed to overcome the principal-agent problems. The plantation was that framework. Within slave plantations, the labour system was organised tor the purpose of maximising worker productivity while minimising disruptions of work operations and loss of property. Two major types of work systems were utilised to achieve this: the task system which was organised around the assignment of slaves by the driver (supervisor) to specific work tasks, usually related to crop production; and the gang system in which work was organised around tasks that required work performed by such groups as ploughmen, hoe-hands, and fence-repairers.

Individual plantation owners may have done well out of slavery but the effect of slavery on the wider economic development of the South is also important. Not only may have Southern farms lost competitiveness to their Northern counterparts but,

Others reckon that slavery made it difficult for the South to establish trading networks. According to Ralph Anderson and Robert Gallman, slavery forced planters to diversify their economic activities. The costs of owning a slave—such as food and shelter—were pretty constant. And so if plantations specialised in a certain crop, they left themselves open to sudden drops in income and consequently big losses. But by pursuing a range of economic activities, they had a steadier revenue flow to match their fixed costs.

Diversification posed problems. Messrs Anderson and Gallman argue that it inhibited trade within the South—and, consequently, the development of towns and villages. Slaveowners found it easier to produce something themselves, rather than buy it. And the South found it difficult to develop a manufacturing industry—instead, it depended on imports from the North. As a result, economic growth was stifled.

Slavery hindered the development of Southern capitalism in other ways. Eugene Genovese, writing in 1961, reckoned that the antebellum South was not profit-seeking. In fact, slavery was not even meant to be profitable. Slaveowners were keener on flaunting their vast plantations and huge reserves of slaves than they were about profits and investment. Rational economic decisions were sacrificed for pomp and circumstance.

The Economist ends by saying,

Of course any account of the economic effect of slavery should note the effect of treating human beings as capital equipment. The direct impact on the utility of the slaves themselves of this condition represented a terrible economic cost. And there was also an opportunity cost to the broader economy, which lost out on the potential human capital and entrepreneurial contributions slaves might have made as free workers. Abolition of involuntary servitude to say nothing of chattel slavery, was clearly a moral imperative. We can also feel pretty safe concluding that, whatever the benefit of the system to slave-owners, its abolition made as much economic sense as anything can.

Blackberry: lessons from the smartphone wars

In this video from the Mises Institute Peter G. Klein discusses the demise of Blackberry and how the market, not regulators, should pick technology winners and losers.

Did U.S. beer mergers cause a price increase?

One of the great unanswered questions in economics is, Do beer mergers cause the price of beer to increase? Well the answer, based on U.S. experience at least, is a definitive yes and no. Orley Ashenfelter, Daniel Hosken and Matthew Weinberg discuss the findings of their research into the Miller and Coors merger in a column at VoxEU.org.

They write,

Football season is here. Bud, Miller, or Coors, the classic American lagers, are the beverage of choice to accompany the big game throughout the US. Despite the recent surge of microbrews and imports, the big three brands still capture more than 60% of the market. With the recent merger of Miller and Coors only two large national brewers remain. No doubt many beer drinkers have wondered whether this merger has raised the price of their brand.

We have recently taken up the task of answering this question. We did this for two related reasons.

• We wanted to measure net price increases to beer drinkers.
• But we also wanted to see if we could sort out (a) the cost savings that might result from beer production being closer to consumers from (b) the monopolistic pressure on prices that mergers encourage.

As it turns out, breweries make a great place to study these two issues because shipping beer to markets far away is costly.

What did we find? Well, it turns out there were both anti-competitive effects of the merger and cost saving effects. What this means in practice is that whether a beer drinker faced a price increase or a price decrease depended on where the drinker lived. On average prices neither increased nor decreased, with increases in some markets being offset by decreases in others.

Mass produced beer all around the world is most of the time crap, and there are a lot of better quality substitutes out there, so I find myself asking Why do we care even if mergers do lead to price increases? After all if increases in price cause people to substitute away from the low quality mass produced beers into higher quality beers, why do we care? This looks like a good thing.

George Smith and David Friedman on defending libertarianism.

From the Bleeding Heart Libertarian blog comes this video of a 1981 debate between George Smith and David Friedman on the role of ethical and economic arguments in defending libertarianism.


In this video from a 1981 Libertarian Party of Texas event, Smith and Friedman have a debate over whether economics or ethics--whether natural rights or rule utilitarianism--forms a better basis for libertarian ideas.

Interesting blog bits

1. Gary Becker on Capitalism’s Return from the Financial Crisis
   

   Karl Marx saw every major depression in the nineteenth century as the final crisis of capitalism, due to its “ internal contradictions”, that would usher in the era of socialism and communism. Alas for Marx, each time he was proved wrong because the end of these depressions was often followed by an even stronger capitalist surge.

2. Richard Posner asks Has Capitalism Revived/Survived?

   The recent (actually current, though diminishing) depression kicked off by the worldwide financial crisis of September 2008 has not created any new communist or socialist countries. What it has done is give rise in almost all countries to a demand for more stringent regulation of banks and other financial institutions, and of some of their financial instruments, and to large public deficits; but neither of these developments is a harbinger of socialism. It’s no longer even clear what “socialism” means, or who has a coherent program of socialist administration of a modern economy.

3. Donal Curtin on How governments rort their own countries' airline passengers
   

   A while ago I had a go at the protectionist stupidity of typical bilateral inter-government airline agreements, as instanced on this occasion by Cathay Pacific having to get the Australian government's permission to increase the number of flights it would like to make between Hong Kong and Australia.
   More recently I've come across some research documenting just how much of a dead hand these agreements tend to be, and how much more airline traffic would be enabled by having more liberal arrangements.

4. William Easterly asks Are the Aid Donors Un-Developing Ethiopia?

   The World Bank, the US Agency for International Development (USAID), and the UK’s Department for International Development (DFID) have consistently failed to act on allegations of human rights abuses in Ethiopia, including ones that are tied to their aid programmes, according to new reports.

5. Peter Klein on NBER Papers of Interest

   Klein points us to 3 new NBER papers on compensation, performance, and productivity.

6. Eric Crampton on Of Free Riders and Forced Riders: America's Cup edition
   

   But there's a necessary complement to free-rider problems. If we do make payment mandatory through taxes, we'll get a forced rider problem: lots of people who get epsilon, zero, or negative utility from the yacht race are forced to pay for it through their taxes.

7. Daron Acemoglu and James Robinson ask Why Hasn’t Botswana Diversified out of Diamonds?

   Yet despite this and the fact that diamonds are running it out, Botswana has struggled to diversify out of diamonds, and it also has very high levels of inequality. There has not been a resource curse in terms of economic growth, but the economy has not diversified out of diamonds and into more modern sectors either.

8. Matt Nolan says That’s it, I’m done: RBNZ takes the path of discretion

   This seems to be saying that simply ensuring the resilience of the financial system is not enough, the central bank should be trying to exert direct, and discretionary, control over what financial markets do and where investment heads. Fine tuning at its finest. It does appear that policymakers here have been strongly influenced by Borio.

9. John Cochrane on McDonalds and the minimum wage

   Recently, on a long car trip returning from a glider contest, I did something unusual among our liberal elite: I actually went to a McDonalds and ate there.

10. Michael W Klein and Jay C. Shambaugh ask Is there a dilemma with the Trilemma

    The ‘financial trilemma’ – that open capital markets and pegged exchange rates mean a loss of monetary autonomy – has recently been challenged. Some argue that even flexible exchange rates cannot assure monetary autonomy without capital controls, while others argue even countries with fixed exchange rates can gain autonomy through temporary capital controls. This column argues that free floating exchange rates do in fact allow autonomy, and partially floating ones allow partial autonomy. For countries with fixed exchange rates, capital controls provide monetary autonomy when they are widely applied and longstanding, but not when they are temporary and narrowly targeted.

Misunderstanding Coase.

At the Forbes website Steve Denning asks Did Ronald Coase Get Economics Wrong? I would say not, but Denning does get Coase wrong.

Denning writes,

Coase’s 1937 essay set out to explain why firms exist. The article asked: given that “production could be carried on without any organization at all”, and given that “the price mechanism should give the most efficient result,” why do firms exist? Coase’s answer was that firms exist because they reduce transaction costs, such as search and information costs, bargaining costs, keeping trade secrets, and policing and enforcement costs.

The expression

production could be carried on without any organization at all

appears at the end of a paragraph in Coase's paper which begins with the sentence,

It is convenient if, in searching for a definition of a firm, we first consider the economic system as it is normally treated by the economist.

And of course the way the economic system was normally treated by the economists at the time was, implicitly but importantly, as a zero transaction cost system. As to the second expression noted by Denning

the price mechanism should give the most efficient result

I can't find it in Coase's paper and so don't know its context and thus what to make of it.

Denning continues,

These arguments were widely accepted by economists in the 20th Century and are still accepted by many today. But let’s face it: at least one of the starting assumptions of Coase’s article was flat out wrong, even in 1937. Although it’s true for simple commodities that “production could be carried on without any organization at all”, it is simply untrue that complex products and services such as airliners, smart phones or multi-disciplinary professional services “could be carried on without any organization at all.”

Here he has lost the plot entirely with regard to Coase's argument. As I noted above the expression “production could be carried on without any organization at all” occurs in a discussion of the standard, zero transaction cost, approach to the study of the economic system. In such a world production can and would be carried out without organisations such as firms since such organisations would have no reason to exist. As I have noted before, Nicolai Foss summaries the situation as,

With perfect and costless contracting, it is hard to see room for anything resembling firms (even one-person firms), since consumers could contract directly with owners of factor services and wouldn’t need the services of the intermediaries known as firms.

The zero transaction cost world is a world of perfect and costless contracting, that is, a world within which complete contracts can be written. This means that firms serve no purpose, markets can do everything.

But it wasn't a starting assumption of Coase's theory. To quote Coase,

The world of zero transaction costs has often been described as a Coaseian world. Nothing could be further from the truth.It is the world of modern economic theory, one which I was hoping to persuade economists to leave.

The starting point of Coase's theory is assumption of positive transaction costs, it is only in such a world that firms make any sense at all for Coase. That was the basic point Coase was trying to make For 80 years he was saying positive transaction costs matter, let us leave the world of zero transaction costs, - blackboard economics, as he called it - behind and study the world as it really is, a world with positive transaction costs.

Denning goes on to say,

Those products and services [complex products and services such as airliners, smart phones or multi-disciplinary professional services] require collaboration for their very existence. The economic reason that such organizations exist is that they provide value to customers that could not be produced without an organization.

Such collaboration could occur across markets if transaction costs are low compared to the costs of carrying out the transaction in a firm. If transactions are high then Coase wold say that a firm would be formed.

Following this Denning notes,

Coase’s theory did help explain the spread of big hierarchical bureaucracies of the 20th Century built on economies of scale. In the 20th Century, firms could generally succeed by pushing products and services at customers with greater efficiency than smaller firm

If economics of scale result in lower costs of management compared to transaction costs then firms would tend to be larger. As Coase said,

Other things being equal, therefore, a firm will tend to be larger :
[...]
(c) the greater the lowering (or the less the rise) in the supply price of factors of production to firms of larger size.

However in a world of low transaction cost there is no reason that things like large fixed costs can not be handled across the market. With complete contracts organising large amounts of capital present no insurmountable problems.

Denning also states,

But even in narrow economic terms, Coase’s theory was just plain wrong.

When properly understood it becomes clear that Coase's theory is fine, its Dennings arguments that are wrong.

The good news from the America's Cup

Paul Lewis writing in the New Zealand Herald points, without intending to I'm sure, to the big positive that comes from Oracle winning the next race. It could save the New Zealand taxpayer millions.

Team chief executive and fundraising power source, Grant Dalton, has already hinted that he will not do another America's Cup challenge if this one fails, though such decisions are always open to review. If he goes, there are doubts that multi-millionaire benefactor Matteo de Nora will continue either.

and

Lose, and Government money becomes harder to prise out of the public coffers. This year's nail-biting Cup match has been tremendous theatre but it will make the private fundraising job that much harder. One America's Cup lost campaign allows hope to burn. Two lost campaigns raises the issues in sponsors' minds of throwing good money after bad.

If the private money goes, the taxpayer money is, hopefully, sure to follow. Lewis also notes that,

Losing after leading 8-1 in the first-to-nine series would be bad enough. But the bigger picture is even worse. Lose, and the syndicate may fall apart.

There may be no syndicate left to waste taxpayer money on.

Sam Richardson comments at the Fair Play and Forward Passes blog,

Think about this from New Zealand's perspective. We've had the theatre, and the drama, and the world's eyes are now firmly fixed on San Francisco as Oracle seeks to finish what would be nothing short of a miracle, being virtually dead and buried a week ago. Think of the advertising this is giving this country - granted, it would be nicer if we were not on the wrong end of the comeback, but it is publicity all the same, and publicity that likely would not have occurred if we had won the Cup earlier in the regatta. Now the US have something to talk about with this regatta - and it is synonymous with New Zealand. So we get this advertising benefit (which is difficult to quantify but is nonetheless part of the package). How much has this cost the taxpayer? The Government committed about NZ$40m to the TNZ challenge - and are now reaping the rewards of that investment.

But you have to ask, What exactly are these "rewards"? Are the world's eyes really fixed on San Francisco? What coverage is the cup getting overseas? Do we really have any idea of what publicity New Zealand is getting, and if it is getting some, is backing Team New Zealand really the cheapest way to get that amount of publicity? Why on just run a (cheaper) standard advertising campaign?

Sam continues,

What happens if we win it? Several things, possibly; one of which is that there are fair questions to be asked as to whether hosting an event such as the America's Cup is the goldmine people say it could be (I blogged about this earlier in the week). We also know that the Government has in the past expressed an interest in throwing more cash at a Cup defence - for what might be considered fairly obvious reasons - and New Zealand taxpayers are not averse to more dollars being committed to a future defence. The question must be asked as to whether the return on the investment in a defence is as great as the return on the investment for a challenge? If there's one thing to be said for a challenge, it is that the Government writes a cheque for a fixed amount - end of story. A defence is more likely to be accompanied by a blank cheque - much like we had for the Rugby World Cup, where the loss was expected right from the start, on top of government spending towards stadiums, infrastructure, security and the like. Right now, we're getting great intangible mileage out of a $40m taxpayer investment - would we get such mileage if we hosted the event? Is that $40m better spent elsewhere? Important questions that need answers.

I agree that a challenge, should one occur, would be cheaper than a defense given that as Sam says a defence would be, most likely, a blank cheque job. But I'm not sure what to make of the idea that

Right now, we're getting great intangible mileage out of a $40m taxpayer investment".

For $40m I think we need more than just some supposed "intangibles". This amount of money should be buying something very tangible. Also, you could justify any amount of spending on anything if you allow the benefits to be some "intangibles" .You can always come up with a huge amount of "intangible". Policy based on "intangibles" is policy based on nothing. And what does this say about evidence based policy. What evidence can you have for intangibles?

And what else could be done with any money spent on a defence/challenge? How many hip operations could be done with that money? How many child cancer patients would receive quicker treatment if that money went to them? How many schools could be kept open with that money? Opportunity costs are real costs.