$9.99 v's $10.00

A standard argument in economics is that retailers set their prices just under whole numbers, say $9.99, to force their employees to open the till for change, reducing the chances of them pocketing the bill or because they think, mistakenly, that consumers will somehow read more into the one cent price reduction than a one cent price reduction, all because the first number changed. Economists assume that consumers aren't actually fooled into buying a lot more at $6.00 than at $5.99, because honestly, who's that stupid?

May be the French. According to this this story from the BBC

... according to a French study the phenomenon still swings a considerable number of shoppers. Researchers found that lowering the price of a pizza from 8.00 euros to 7.99 euros boosted sales by 15%.

The BBC report says that Robert Schindler, professor of marketing at Rutgers Business School in the US, argues 0.99 idea was introduced for sale items, to emphasise the discount.

"I studied adverts in the New York Times from 1850 - where there were no 99 endings - to the 1870s and 1880s where they started to appear. Although department stores were doing it - which would fit with the cash register hypothesis - they were advertising discounts. But for the regular price they would use a round number," he says.

He thinks the retail practice developed from there, to communicate discount or the impression that things are on sale - even when they are not.

Wolf on the corporation

Martin Wolf has a strange piece on Profit-maximization as the sole goal of a corporation over at Creative Capitalism. He writes

What is the goal of the limited liability, joint-stock company, the core institution of the contemporary capitalist economy? What implications does the answer have for such a company's freedom to be “creative” in the way Bill Gates uses the term? The classic answer to the first of these questions, repeated often in these discussions, is that its aim is to maximise profits. This statement is not false. But it is vastly too limited. Here are ten points relevant to this theme.

I will make some brief comments on some of his 10 points.

His first point is that the role of a company is to provide goods and services and its goal is profit-maximisation. Wolf writes

The goal of profit-maximization drives the firm to fulfill its role.

No, its the other way round. The role of the firm is to maximise profits and the way it does this is by providing people with goods and services they want. So the goal of providing goods and services drives the firm to fulfil its role, profit-maximisation. Profit-maximisation makes possible consumption maximisation and as Adam Smith pointed out more than 240 years ago that "Consumption is the sole end and purpose of all production".

Wolf's third point is

... a company is viewed in the Anglo-American world as a bundle of contracts.

No. Ever since Grossman and Hart (1986) the economist's view of a company is as a collection of assets under common ownership. That is

... a 'firm' is defined as a collection of assets over which certain agents have property rights. (Moore 1992)

In his fifth point Wolf claims

... shareholders are not genuine owners.

Again following Grossman and Hart, the owners of a firm are those who have residual control rights over the non-human assets of the firm. Such a view seems in line with the legal approach. As Oliver Wendell Holmes Jr. put it,

But what are the rights of ownership? They are substantially the same as those incident to possession. Within the limits prescribed by policy, the owner is allowed to exercise his natural powers over the subject-matter uninterfered with, and is more or less protected in excluding other people from such interference. The owner is allowed to exclude all, and is accountable to no one. (The Common Law, p193, (1963 edn.))

Shareholders would have ultimately the residual controls of the firm. Normally, for good efficiency reasons, shareholders also have the residual income rights over the firm. But if income and control right are separate, then the "owner" of the firm is whoever has the control rights. Wolf goes on to write that those people with the biggest investment in the firm and thus those with the greatest exposure to firm-specific risks are not shareholders, but core workers. And one would say such "core workers" (however one defines that term) are paid, at least in part, directly to carry such "risk."

Wolf goes on to say

Sixth, if companies can be freely bought and sold, relational contracts, which depend on continuing interaction among specific people inside the business, are hardly worth the paper they are (not) written on.

But why? If relational contacts are truly important to the working of the firm, why would a profit maximising owner not want to honour such contacts? Not to do so would seem to endanger the aim of profit maximisation.

In point 8 Wolf claims

The failure of Japanese capitalism to achieve the highest level of productivity and sustained dynamism may have far more to with repression of domestic competition in many markets for goods and, above all, services, rather than with the absence of an active market for corporate control.

But are these things related? Is the lack of an active competition for corporate control just an example of a more general lack of competition in many markets.

Wolf's point 9 is that

Because these companies cannot be forced to maximize shareholder value, they can indeed undertake a range of costly “charitable” activities, provided they do not threaten the company’s ability to survive.

In other words, Wolf want the management of the company to be able to steal the profits of shareholders and use them for whatever “charitable” activities they just happen to want to support, for whatever reasons. If Mr Wolf was to invest in a company I was manager of I would use his money to support the New Zealand Society for the Making Fun of Pommy Journalists, a well known and respected “charitable” activity in these parts. But I'm sure Mr Wolf wouldn't mind. But I do have to ask, Would it not be better for the firm to maximise the income of its shareholders and then let them decide which “charitable” activities to support? What makes a firm's managers so much better at deciding which “charitable” activities to support than the shareholders of the firm?

Wolf ends his article by pointing out

... the more “Anglo-American” capitalism becomes and so the more shareholder driven, [...] the less concerned with wider social results it is likely to be.

And I say that is just as it should be. A firms job is not to be "concerned with wider social results". If Mr Wolf wishes to do social work, which seems likely given that he has given up any pretence of doing economics, let him do it with his money and not by stealing the money of others.

Let me end by making the point that one of the strengths of Anglo-American capitalism is the many forms of governance that it has developed to deal with different situations. We have profit maximising firms, not for profit firms, producer cooperative, consumer cooperatives, worker-owned firms and so on. These firms have developed organically and have evolved through time in response to the changing economic and social environment. Such governance structures may be better suited to dealing the issues Wolf seems to want to address.

• Grossman, S. and 0 . Hart, 1986, The costs and benefits of ownership: A theory of vertical and lateral integration, Journal of Political Economy 94, 691-719.
• Moore, John, 1992, The firm as a collection of assets, European Economic Review 36 493-507.

Robert Pindyck interview

A Q&A with MIT Professor of Economics and Finance Robert Pindyck on the US presidential candidates energy policies.

Sahlin on the Milton Friedman Institute

The setting up of the Milton Friedman Institute at the University of Chicago is opposed by Marshall Sahlins.

Brad DeLong gives his view of Sahlin here. A short quote

Sahlins's claims that it was "the market-industrial system [which] institutes scarcity"... seemed to indicate a total, willful, and culpable ignorance of practically all of the non-market settled agricultural societies of the past ten thousand years.

There is more on this issue from DeLong here.

If money doesn’t make us happy, why do we act as if it does?

In a recent paper in the Journal of Economic Psychology, Aaron Ahuvia asks If money doesn’t make us happy, why do we act as if it does? The abstract reads

Research on income and subjective well-being shows that among the non-poor, increased income has little or no lasting impact on happiness. Yet the desire for more income remains a powerful motive among many people at all income levels. Is this simply because many people are misinformed and believe that higher incomes will make them happier, or are they motivated by something other than the pursuit of happiness? This paper argues for the latter. The paper begins by exploring this question, reviewing the literature on income and subjective well-being, and discussing of the role of utility in decision making. This paper then argues that three main factors lead us to value increased income even if it does not make us happier. First, happiness is just one value among many, and not the only conscious goal people set for themselves. Second, even when people are striving to maximize happiness, our tendency to overweight short-term payoffs leads us to overvalue the short-term rewards that income provides. Finally, I argue that our values-based decision making competes with other motivational systems and evolutionary drives. Three evolutionary desires are discussed: (1) to store resources, (2) to be sexually attractive, and (3) to manage our social relationships and our personal identity within those relationships. While all three motivations play a role in our desire for increased income, this paper argues that it is the third – the use of money and consumption as a social tool – that has the most important overall influence on our desire for increased income past the point where it ceases to increase personal happiness.

But other researchers say that money can buy happiness. Here is a short video on from the US Nightline programme summarizing research by Justin Wolfers and Betsey Stevensonon on the relationship between income and happiness. Betsey Stevenson is interviewed in the piece.

Here is a discussion by Justin Wolfers of research into the question, Are Rich People Happier than Poor People? And the short answer appear to be, yes. Wolfers discusses work that is Delving Into Subjective Well-Being as well.

Book club: Capitalism and Freedom

The last posting is available over at the Free Exchange blog in their Summer book club on Milton Friedman's Capitalism and Freedom. Read here.

The reason for the petrol price reductions

Why have petrol prices dropped? The L.A. Times has the answer. This article in the Times reports on a group claiming that the recent reduction in gas prices was caused by ... prayer.

“If the whole country keeps on praying, we can bring down prices even more — to even less than $2,” says Rocky Twyman, founder of Pray at the Pump.

The Times says

About four months ago, frustrated by the apparently immutable laws of supply and demand, Rocky Twyman turned to a higher authority in his quest for cheaper gasoline.

The recent dip in prices, he says, is proof of divine intervention.

"Prayer is the answer to every problem in life," said Twyman, founder of the Pray at the Pump movement, whose members huddle around gas pumps and ask the Almighty to lower gasoline prices.

Incentives matter: education file

This from the Chronicle of Higher Education

Several British universities apparently are offering cash incentives to students to induce them to enroll in unpopular degree programs, according to an investigation by London’s Sunday Times in which undercover reporters posed as students seeking spots.

A female reporter was offered £1,000, or $2,000, to enroll in Leicester University’s undergraduate physics program and was told “that she was a strong candidate for the money partly because women were ‘underrepresented’ on the course,” the Times reported. [...]

All but a handful of undergraduate courses of study cost the government-set maximum annual tuition of approximately $6,000, but the newspaper noted that the “booming market in cash awards to fill some courses” represents an effort by institutions, “reluctant to appear cheap,” to effectively offer discounted rates while officially charging the national norm.

EconTalk this week

John Taylor of Stanford University talks about the Taylor Rule, his description of what the Fed ought to do and what it sometimes actually does, to keep inflation in check and the economy on a steady path. He argues that when the Fed has deviated from the Rule in recent years, the economy has performed poorly. Taylor also assesses the chances for a monetary or financial disaster and the Fed's recent expanded role in intervening in financial markets.

Incentives matter: performance pay file

Over the last two decades or so there has been a surge in the popularity of performance pay for those in executive and managerial positions within a firm. From CEOs down to middle and lower management incentive packages are now common place. One question about this approach is How does managerial performance pay affects firms' productivity and the performance of individual workers in lower tiers of the firms' hierarchy? A recent paper has tried to answer this question.

O. Bandiera, I Barankay, and I Rasul (2007) "Incentives for Managers and Inequality Among Workers: Evidence from a Firm Level Experiment", Quarterly Journal of Economics 122: 729-74, engineered an exogenous change in managerial incentives by augmenting managers' fixed wages with a performance bonus based on the average productivity of workers that they managed. One important point about this exercise was that lower-tier workers in the firm were rewarded according to the same compensation scheme throughout, so an effect were coming from the changes to the managers' pay scheme.

Bandiera, Barankay and Rasul write

In our context, as in most firms, managers can affect average workers productivity through two channels—(i) they can take actions that affect the productivity of existing workers, and (ii) they can affect the identity of the workers selected into employment. A simple theoretical framework indicates that when workers are of heterogeneous ability and managers' and workers' efforts are complements the introduction of managerial performance pay makes managers target their effort towards the most able workers. We label this a "targeting effect" of managerial incentives. In addition, the introduction of managerial performance pay makes managers select the most able workers into employment. We label this a "selection effect" of managerial incentives.

Both these targeting and selection effects will influence the mean and the dispersion of workers' productivity. Mean productivity unambiguously rises given that managers have the incentive to target the most able workers and fire the least useful. As far as dispersion is concerned Bandiera, Barankay and Rasul note that

The effect on the dispersion, however, is ambiguous. On the one hand, targeting the most able workers exacerbates the natural differences in ability and leads to an increase in dispersion. On the other hand, if only more able and, hence, more similar workers are selected into employment in the first place, the dispersion of productivity may fall, depending on the underlying distribution of ability across workers.

Bandiera, Barankay and Rasul go on to note

Our research design combined with data from personnel records on the daily productivity of individual workers allows us to provide evidence on how the provision of incentives to managers affects manager's behavior and therefore filters through to the performance of individual workers at lower tiers of the firm hierarchy. We identify the effect of managerial performance pay on average worker productivity, on the dispersion of workers' productivity, and use individual productivity data to separate the targeting and selection effects.

The design of the experiment was as follows.

We divided the peak picking season into two periods of two months each. In the first period the COO [chief operating officer] and managers were paid a fixed wage. In the second period, we added a daily performance bonus to the same level of fixed wages. The performance bonus is an increasing function of the average productivity of workers in the field on that day, conditional on average productivity being above an exogenously set threshold.

The all important results were

First, the introduction of managerial performance pay increases both the average productivity and the dispersion of productivity among lower-tier workers. The average productivity increases by 21 percent, and the coefficient of variation increases by 38 percent.

Second, the increase in the mean and dispersion of productivity is due to both targeting and selection effects. The analysis of individual productivity data reveals that the most able workers experience a significant increase in productivity while the productivity of other workers is not affected or even decreases. This suggests that the targeting effect is at play—after the introduction of performance pay, managers target their effort towards more able workers.

The individual data also provides evidence of a selection effect. More able workers, namely those who had the highest productivity when managers were paid fixed wages, are more likely to be selected into the workforce when managers are paid performance bonuses. Least able workers are employed less often, and workers at the bottom of the productivity distribution are fixed.

Third, the selection and targeting effect reinforce each other, as workers who experience the highest increase in productivity are also more likely to be selected into employment. The introduction of managerial performance pay thus exacerbates earnings inequality due to underlying differences in ability both because the most able workers experience a larger increase in productivity and because they are selected into employment more often.

Finally, we evaluate the relative importance of the targeting and selection effects through a series of thought experiments. We find that at least half of the 21 percent increase in average productivity is driven by the selection of more productive workers. In contrast, we find that the change in dispersion is nearly entirely due to managers targeting the most able workers after the introduction of performance pay. Namely, the dispersion of productivity would have increased by almost the same amount had the selection of workers remained unchanged. The reason is that the distribution of ability across workers is such that even when the least able workers are fired, the marginal worker selected to pick is still of relatively low ability. Hence, there remains considerable heterogeneity in productivity among selected workers.

So the introduction of an incentive scheme for managers effect not only the performance of the managers but also the performance and make-up of the workforce.

There is one obvious problem, and strength, of this approach. The study uses very detailed data and hence can produce detailed results. This clearly is a strength of the paper. But this data only comes from one firm, and a somewhat special situation, in particular the employment situation is rather special in that the pool of managers and workers available for employment is fixed and observable. Thus precision comes at the cost of generality.

Econ academics blogs

Christian Zimmerman of the Economics Department at the University of Connecticut has set up a blog aggregator focused on academic economics research, Econ Academics Blog. As Zimmerman points out, there are lots of economics blogs, but only a few that deal primarily with academic economics (theories, research papers, debates).

Book club: Capitalism and Freedom

There are more postings over at the Free Exchange blog in their Summer book club on Milton Friedman's Capitalism and Freedom. Read here and here.

Krugman on globalisation

In a recent New York Times piece Paul Krugman makes an interesting point about the fate of globalisation,

Some analysts tell us not to worry: global economic integration itself protects us against war, they argue, because successful trading economies won’t risk their prosperity by engaging in military adventurism. But this, too, raises unpleasant historical memories.

Shortly before World War I another British author, Norman Angell, published a famous book titled “The Great Illusion,” in which he argued that war had become obsolete, that in the modern industrial era even military victors lose far more than they gain. He was right — but wars kept happening anyway.

So are the foundations of the second global economy any more solid than those of the first? In some ways, yes. For example, war among the nations of Western Europe really does seem inconceivable now, not so much because of economic ties as because of shared democratic values.

Much of the world, however, including nations that play a key role in the global economy, doesn’t share those values. Most of us have proceeded on the belief that, at least as far as economics goes, this doesn’t matter — that we can count on world trade continuing to flow freely simply because it’s so profitable. But that’s not a safe assumption. [...]

But the belief that economic rationality always prevents war is an equally great illusion. And today’s high degree of global economic interdependence, which can be sustained only if all major governments act sensibly, is more fragile than we imagine.

My fear would be that Krugman is right. In particular the necessity for all governments to act sensibly is not an idea that history gives us much reason to believe in.

Johan Norberg on the unseen benefits of globalization.

In this audio tape from the Cato Institute, Johan Norberg talks about the unseen benefits of globalization. Norberg explains why open markets are beneficial to all of us.

Poverty and economy in Mugabe's Zimbabwe

This short audio from the Cato Institute discuss "Poverty and Economy in Mugabe's Zimbabwe". This Cato Daily Podcast features Rejoice Ngwenya, a Zimbabwean writer and head of the Zimbabwean Coalition for Market & Liberal Solutions.

A lesson for StatsNZ?

This comes from a paper "Skill Measurement in Official Statistics: Recent Developments in the UK and the rest of Europe" by Peter Elias and Abigail McKnight, Oxford Economic Papers 3 (2001), 508–540.

An amusing and extreme example derives from the 1981 Census of Population carried out in the Channel Island of Jersey. One census question consisted simply of the word ‘Occupation’, with an empty box alongside for the written response. Many older residents wrote in ‘1939–1945’.

ExxonMobil's tax bill and costs

An interesting piece from ABC News.

ExxonMobil CEO and chairman Rex Tillerson defended his company's staggering $11.7 billion in profits for the second quarter, saying that the company's earnings reflected the magnitude of its business operation.

"I saw someone characterize our profits the other day in terms of $1,400 in profit per second. Well, they also need to understand we paid $4,000 a second in taxes, and we spent $15,000 a second in cost," Tillerson told ABC News' Charles Gibson. "We spend $1 billion a day just running our business. So this is a business where large numbers are just characteristic of it."

Interesting blog bits

1. Gavin Kennedy on Once More on Murray Rothbard and his Lack of Knowledge About Adam Smith.
2. Richard Posner on The Economics of Gay Marriage.
3. Gary Becker asks Should Gay Marriages be Allowed?
4. Economic Logician asks Should Economists be certified?
5. The Visible Hand in Economics give their First impression of National energy strategy
6. Edwin M. Truman on Sovereign wealth funds: Debunking four popular myths.
7. Carol Propper asks Can performance targets produce better healthcare outcomes?

Human capital and the firm

When reading on the reasons behind the famous takeover of Fisher Body by General Motors I came across an issue I hadn't thought of before with regard to why vertical integration takes place. The claim is human asset specificity was important reason for the General Motors takeover. For example Freeland (2000) writes

Despite the importance of physical asset specificity in the Fisher case, issues of human asset specificity and knowledge acquisition played a much greater role in integration than has heretofore been recognized. General Motors's initial investment in Fisher occurred because the automaker wanted more than a source for car bodies-it wanted to capture the knowledge and human assets of the Fisher brothers while limiting competitors' access to that knowledge. The fact that GM management placed a higher priority on retaining the Fishers than on acquiring the physical assets of Fisher played a central role both in shaping the initial contract between the companies and in determining the subsequent course of events that eventually led GM to purchase Fisher. The Fisher case thus suggests that knowledge acquisition may play a crucial role in shaping the boundaries of the firm, an area in which additional research is needed.

Now my problems with this are two fold. 1) I don't see why an employment contract is any better at controlling human capital than a general contract between firms. Why can't whatever is written into one of these contracts be written into the other? And thus we should get the same outcome in each case. 2) If you really do want the human capital of certain people, why not just employ those people directly. Its not clear why you need to takeover a whole firm just to get the human capital of some of its employees.

Or am I missing something?

• Freeland, Robert F. (2000). Creating Holdup through Vertical Integration: Fisher Body Revisited, Journal of Law and Economics, XLIII(1) April 2000.

Must the Government Combat Americans’ Addiction to Foreign Bananas?

At The Independent Institute website Robert Higgs asks Must the Government Combat Americans’ Addiction to Foreign Bananas? Higgs points out that

Americans, we are told again and again, are “addicted to foreign oil” and “in love with the automobile.”

He then suggests that

Suppose a serious policy of “energy independence” were actually implemented, rather than being merely spewed out along with the rest of the political hot air. Would we be better off? Absolutely not. We would be vastly poorer because we would have to sacrifice a great deal more of the non-oil products we now produce and consume in order to acquire the petroleum products we demanded.

Higgs continues by arguing

If we were talking about bananas, everybody would see immediately the foolishness of seeking “banana independence.” Nobody would fall for half-baked arguments about our addiction to foreign bananas or our love affair with banana bread. It’s obviously uneconomic to grow millions of bananas in this country; it could be done, but doing it would entail much greater costs than buying them from producers in places better suited to their production (that is, places where they can be produced at lower opportunity cost).

The argument with regard to oil, or anything else, is identical and it is identical for any country, not just the US.

Financial and environmental costs of ethanol

The following short video is from Reason.tv. It examines the financial and environmental costs of ethanol.

Ethanol advocates claim that the biofuel is a cheap, renewable energy source that reduces pollution and our dependence on foreign oil. It sounds too good to be true—and it is.

Ethanol, especially the corn-based variety, is bad for taxpayers, bad for consumers, bad for the environment, and horrible for the world's poor. In fact, even environmentalists are critical of ethanol subsidies these days. The ethanol craze has distorted markets and increased the price of food worldwide. The only people who still support ethanol subsidies are the ethanol producers—and politicians from both sides of the aisle. Together, they make sure the subsidies keep coming.

A concise but accurate summary of the situation.

Book club: Capitalism and Freedom

There are more postings over at the Free Exchange blog in their Summer book club on Milton Friedman's Capitalism and Freedom. Read here and here.

What to do with forensic science?

There is an interesting piece by Radley Balko, a senior editor for Reason magazine, and Roger Koppl, Professor of Economics and Finance in Fairleigh Dickinson University's Silberman College of Business, over at Slate in which the authors suggest the need for reforms to the way forensic science is carried out. The conclusion reads:

The continuing stories of forensics error and wrongful convictions are troubling but not all that surprising. Our criminal justice system is centuries old. It just hasn't adapted well to the dramatic advances in science and technology over the past 30 years. But as forensic evidence becomes more and more important in securing convictions, the need for monitoring and oversight grows exponentially. Every other scientific field properly requires peer review, statistical analysis, and redundancy to ensure quality and accuracy. It's past time we applied the same quality-control measures to criminal forensics, particularly given the fundamental nature of what's at stake.

Crazy ideas: social credit file

Of the ideas that economists have to deal with every so often, one of the stranger ones is that of Social Credit monetary theory. Here in New Zealand Social Credit was once a third party with a reasonable following by voters. Even today it is still alive as part of the Democrats. Back in 1955 it was such a force that an economist at the University of Canterbury Alan Danks (later Professor and Sir) wrote a short pamphlet explaining what was wrong with the Social Credit approach to economics. The pamphlet is What Everyone Should Know about Social Credit by A.J. Danks, Christchurch: The Caxton Press, 1955. We have scanned it to a pdf file which is available here for those interested.

Oil and the dollar

James Hamilton at Econbrower talks about oil and the dollar. Hamilton opens his piece by saying

Although movements in the value of the dollar are one factor contributing to recent changes in the dollar price of oil, I do not believe they are the most important factor. Here I review some of the evidence that persuades me of this.

He concludes by noting

The exchange rate is unquestionably one variable that influences the dollar price of oil. In recent data, as much as 20% of oil price movements could be attributed to changes in the exchange rate, or at least to news developments that matter for both exchange rates and oil prices. But that also means that 80% of what we see happening to the price of oil is completely uncorrelated with whatever might be influencing the exchange rate.

If you are interested in such things the bit between the beginning and the end is worth a read.

EconTalk this week

Bruce Bueno de Mesquita of Stanford University's Hoover Institution and New York University talks to Russ Roberts on EconTalk this week about threats to U.S. security, particularly Iran.

Bueno de Mesquita argues that Iran is of little danger to the United States and that Ahmadinejad is an unimportant player in Iran's political system, more of a stalking horse for provocative ideas rather than a wielder of power. Bueno de Mesquita then looks at what Iran has to gain and to lose by appearing to build a nuclear weapons program and actually using a nuclear weapon. He then goes on to examine the nature of other threats to the United States. The closing topic of the conversation is the peculiar incentives facing U.S. Presidents as their terms expire.

A note on rising food prices

Back on the 5th of July I commented on a Secret report: biofuel caused food crisis. Aditya Chakrabortty, economics leader writer for the Guardian, wrote an article based on a then unavailable World Bank report unofficially obtained by the Guardian. The document, dated April 8 2008, the Guardian used is A Note on Rising Food Prices (pdf) prepared by Donald Mitchell - Lead Economist, Development Prospects Group (DECPG), World Bank, Washington. The Summary of the document reads

The World Bank's index of food prices increased 140 percent from January 2002 to February 2008. This increase was caused by a confluence of factors but the most important was the large increase in biofuels production in the U.S. and EU. Without the increase in biofuels, global wheat and maize stocks would not have declined appreciably and price increases due to other factors would have been moderate. The export bans and speculative activity would not have occurred because they were responses to rising prices. Higher energy and fertilizer prices would have still increased crop production costs by about 15 percent in the U.S. and lesser amounts in other countries with less intensive production practices. The back-to-back droughts in Australia would not have had a large impact because they only reduced global grain exports by 4 percent and other exporters would normally have been able to offset this loss. The decline of the dollar has contributed about 20 percentage points to the rise in food prices. Thus, the combination of higher energy prices and related increases in fertilizer prices, and dollar weakness caused food prices to rise by about 35 percent from January 2002 until February 2008 and the remaining three-quarters of the 140 percent actual increase was due to biofuels and the related consequences of low grain stocks, large land use shifts, speculative activity, and export bans. The growth in global grain consumption (excluding biofuels) was 1.7 percent from 2000 to 2007 while yields grew 1.3 percent and area grew by 0.4 percent.

So the World Bank's index of food prices increased 140 percent from January 2002 to February 2008 and of that increase 75% is down to biofuels.

The World Bank has now released, 1 July 2008, an official version of the Mitchell paper, A Note on Rising Food Prices. The abstract of this version reads,

The rapid rise in food prices has been a burden on the poor in developing countries, who spend roughly half of their household incomes on food. This paper examines the factors behind the rapid increase in internationally traded food prices since 2002 and estimates the contribution of various factors such as the increased production of biofuels from food grains and oilseeds, the weak dollar, and the increase in food production costs due to higher energy prices. It concludes that the most important factor was the large increase in biofuels production in the U.S. and the EU. Without these increases, global wheat and maize stocks would not have declined appreciably, oilseed prices would not have tripled, and price increases due to other factors, such as droughts, would have been more moderate. Recent export bans and speculative activities would probably not have occurred because they were largely responses to rising prices. While it is difficult to compare the results of this study with those of other studies due to differences in methodologies, time periods and prices considered, many other studies have also recognized biofuels production as a major driver of food prices. The contribution of biofuels to the rise in food prices raises an important policy issue, since much of the increase was due to EU and U.S. government policies that provided incentives to biofuels production, and biofuels policies which subsidize production need to be reconsidered in light of their impact on food prices.

The report notes

The IMF’s index of internationally traded food commodities prices increased 130 percent from January 2002 to June 2008 and 56 percent from January 2007 to June 2008

In the Summary and Conclusions section Mitchell writes

Thus, the combination of higher energy prices and related increases in fertilizer prices and transport costs, and dollar weakness caused food prices to rise by about 35-40 percentage points from January 2002 until June 2008. These factors explain 25-30 percent of the total price increase, and most of the remaining 70-75 percent increase in food commodities prices was due to biofuels and the related consequences of low grain stocks, large land use shifts, speculative activity and export bans.

Interesting blog bits

1. Gavin Kennedy points out that there is No Contradictions Between Moral Sentiments and Wealth Of Nations.
2. Gary Becker asks Is America in Decline?
3. Richard Posner comments on Is America in Decline?
4. Tyler Cowen on Regulation and Distrust

   Brought to you by Aghion, Algan, Cahuc and Shleifer, this is one of the best papers so far this year.

5. Roger Kerr on Why a Tax-Free Zone is a Bad Idea (pdf)
6. Antoine Berthou and Lionel Fontagné on The microeconomic impacts of the euro

Financial Olympics

This short piece, Prime Numbers: Rings of Gold by Brad R. Humphreys, professor of economics at the University of Alberta, from Foreign Policy, looks at some of the financial aspects of the Olympic Games. Among the highlights ...

• the IOC took in over $4.2 billion in the Salt Lake/Athens cycle, mostly from broadcast rights and sponsorship, and keeps an increasing share of the revenues;
• you really have to pay to play the Olympic hosting game: unsuccessful bids to host the games typically cost from $22 million to almost $50 million;
• the cost over-runs in host countries are huge; and
• although it didn't make it into the article, the IOC is a bloated bureaucracy with no oversight. As recently as 1964, the IOC employed 5 full time staff; in 2000 there were 113.

You have to hand it to them, the IOC are running a world class rent extraction scheme.

(HT: The Sports Economist)

Dale Jorgenson interview

In this short audio from VoxEU.org, Dale Jorgenson, the Samuel W. Morris University Professor at Harvard University, talks to Romesh Vaitilingam about his projections for the growth of the US economy over the next 10 to 25 years, focusing particularly on the impact of information technology and labour supply.

MBAs as economic indicator

The graph below comes from the Daily chart section of the Economist magazine and shows that a slowing world economy is good for business schools. And, as the Economist points out, if attempts to gain admittance to MBA courses are a useful indicator of economic activity then the global economy is in for a rough future too. Applications next year are expected to climb even higher. So the more MBAs, the worse the global economy.

Clunker of an idea

Alan Blinder, professor of economics at Princeton University, recently proposed a new government program which he called “Cash for Clunkers” in an article in The New York Times. Steven D. Levitt explains the program as

... the government would buy back old cars at above market prices and scrap them. According to Blinder, this would accomplish a policy trifecta: 1) help the environment by getting the most polluting cars off the road; 2) stimulate the economy by getting money in the hands of people who will spend it and increase the demand for new cars; and 3) reduce income inequality by funneling the money to the poor.

Over at the Freakonomics blog Levitt says he is sceptical of this proposal for a number of reasons. A possible positive for the "cash for clunkers" program is that as long as they are being driven, old cars pollute and so getting them off the road could reduce pollution. But

... my guess is that unless the price the government pays for the clunkers is very high, the majority of vehicles that are turned in will not have been driven much, if at all. Indeed, I suspect one of the most visible responses to this program will be a new market for mechanics fixing up cars that don’t run at all just enough so that they can be driven to the government’s lot to collect the cash.

and

The biggest problem with this policy, however, is the way it distorts long run incentives. Let’s say the rules of the program say that a car must be at least fifteen years old to qualify for a big government subsidy to scrap it. This gives powerful incentives to people with twelve-year-old cars they were planning on scrapping to keep driving them for three more years to collect the government bounty. Instead of reducing the number of clunkers on the road, this program could actually lead to an increase!

It also seems to me that any effect on the demand for new cars would be extremely limited. People who drive clunkers are generally not in the market for new cars. Presumably their replacement car will be a used car. The increased demand for used cars will lead to higher prices for used cars, which will push some buyers towards a new car, but the likely impact on new cars would be small.

and

Finally, it is not even clear that this program would have such beneficial redistribution effects either. In the short run, it would represent a windfall profit to those who own clunkers. In the long run, however, there is a market for used cars. In response to the program, the price of nine-year-old cars would have to rise enough to offset the increased value associated with a near-clunker someday becoming a clunker that can be sold to the government. The benefits of the program will actually be spread widely over all car owners, not narrowly focused on the poor.

For Levitt the program highlights some general concerns that arise with government programs.

The first is that policies which might be a good idea if implemented as one time, short term programs, can be much less attractive if made permanent because of the way they distort incentives.

And as Milton Friedman once noted, "Nothing is more permanent than a temporary government programme".

The second thing this program highlights is that it is extremely difficult to deal with negative externalities (in this case pollution) by subsidizing them (as this program does). If folks are doing things that we want less of, it makes a lot more sense to punish them for those behaviors (through extra taxes for instance) than to reward them.

The current account deficit

At Infometrics Matthew Nolan has a piece on the current account deficit or the capital account surplus, depending on how you want to think about it.

A current account deficit is one of these issues non-economists get worked up about but economists, by and large, don't. Why? As Matt points out

It appears that the recent increase in our current account deficit is the result of both rising consumption and rising investment.

So what is wrong with more consumption or investment?

On the investment side, the idea of borrowing now to fund capital expenditure is a fairly mundane concept. The benefit of an investment project will materialise over time, while a disproportionate portion of the cost is incurred straight away. As long as the benefit of the investment exceeds the cost over the investments lifetime, and the risks are known, then there is no reason to be concerned about this form of borrowing.

What about the consumption side? Matt writes

On the consumption side, a nation may spend more than it earns because it either anticipates that it will grow in the future or it may substantially favour spending now ahead of spending in the future. As the goal of policy should be to maximise society’s lifetime happiness, if individuals want to consume more now (to the detriment of future consumption opportunities) they should be allowed to.

For a household, this type of borrowing is equivalent to “smoothing” the amount you consume over time. When you are young, you expect your lifetime earnings to increase in the future – as a result it is in your interest to borrow now. As a nation, we expect our lifetime earnings to increase in the future – and as a result, if we are offered credit at attractive rates we will be willing to borrow now.

Thus should we worry about the current account deficit,

The current account deficit is merely the result of the borrowing, consumption, and investment decisions of every household and firm in the economy. As long as these households and firms are fully informed of the risk and return associated with their borrowing decisions, is there really any reason to fear the spectre of a current account deficit?

The short answer to his question is, no.

Economics does not lie

In this recent article in the City Journal Guy Sorman tells us Economics Does Not Lie. Sorman writes

If economics is finally a science, what, exactly, does it teach? With the help of Columbia University economist Pierre-André Chiappori, I have synthesized its findings into ten propositions. Almost all top economists—those who are recognized as such by their peers and who publish in the leading scientific journals—would endorse them (the exceptions are those like Joseph Stiglitz and Jeffrey Sachs, whose public pronouncements are more political than scientific). The more the public understands and embraces these propositions, the more prosperous the world will become.

The list is

1. The market economy is the most efficient of all economic systems.
2. Free trade helps economic development.
3. Good institutions help development.
4. The best measure of a good economy is its growth.
5. Creative destruction is the engine of economic growth.
6. Monetary stability, too, is necessary for growth; inflation is always harmful.
7. Unemployment among unskilled workers is largely determined by how much labor costs.
8. While the welfare state is necessary in some form, it isn’t always effective.
9. The creation of complex financial markets has brought about economic progress.
10. Competition is usually desirable.

The Sorman article discusses each of these in more detail. While you can always pick holes in any list such as this, this one isn't bad.

When looking to the future, Sorman writes

In the future, the threat to the beneficent influence of economic science will come less from tired socialist revolutionary rhetoric than from new dangers, such as terrorism and epidemics. Terrorism is, in part, a consequence of globalization: young, uprooted people unable to adapt to a dynamic, capitalist world invent new global ideologies and seek to put them into practice with global weapons. Globalization can also accelerate the proliferation of deadly illnesses. The AIDS epidemic was the first global attack by a mutant virus; SARS, avian flu, or some unknown illness could follow, surging from uncontrolled Chinese, Indian, or African backwaters and following the massive migrations of a global economy. Terror and epidemics could both unleash political upheavals that would undermine the market order itself.

Then there’s the fear of ecological disturbances, which could result in incoherent policies that wouldn’t necessarily diminish risks to the environment but might prevent development and thus harm the interests of the poorest peoples. One example: prohibiting genetically modified organisms—which, evidence suggests, pose no threat whatsoever to the environment—will hurt the productivity of farming at a time when global demand for food will grow.

Sorman see another danger in the very nature of economic systems: the cyclical nature of growth. While he thinks that recessions on the scale of the Great Depression are less likely to happen today because the political mistakes that aggravated it, such as protectionism and the drying-up of credit, aren't as likely to be repeated in the future, he does see smaller crises as being inevitable. Such problems are bound up with innovation and the forces by which the new drives out the old in periods of creative destruction. Similarly he argues that free trade will mean that some people will lose their jobs, that foreign competition will wipe out entire companies or even entire industries. Sorman points out that

We all know it because, as Friedman argued, layoffs and closings get disproportionate media coverage. Meanwhile, nobody talks about the ongoing reduction in prices for consumers and investors, scattered among a huge number of beneficiaries. That helps explain why politicians are prone to deride free trade and voters are too often ready to agree.

Sorman goes on to say

To help the losers in the free market, government shouldn’t back away from either free trade or creative destruction and start subsidizing doomed and obsolete activities, a protectionist course that guarantees only economic decline. Instead, it should help the losers change jobs more easily by improving educational opportunities and by facilitating new investment, which creates more employment. An essential task of democratic governments and opinion makers when confronting economic cycles and political pressure is to secure and protect the system that has served humanity so well, and not to change it for the worse on the pretext of its imperfection.

Sorman closes this piece by noting that one of the hardest ideas to translate into language that public opinion will accept is the fact that even the best of all possible economic systems is still imperfect. Markets are one of the many human institutions that are the result of human action, but not of human design. But they are based on people and without perfect people you are unlikely to get perfect markets. But for all these imperfections, we have yet to find a better economic system.

Modern business cycle theory (updated)

The Kids Prefer Cheese blog has a short posting on The evolution of modern business cycle theory. If you are into macro it may be interesting. They argue that modern business cycle theory is built around two ideas.

First was the audacious idea that the observed business cycle was not a problem but actually Pareto optimal in the sense that the economy was fully competitive, there were no externalities, and all agents were operating on their supply curves at all points in the cycle. This was the original real business cycle (RBC) theory of Prescott that the cycle was just the result of optimal responses to real shocks.

Second was the insight that the macroeconomics of imperfect competition was fundamentally different than that of perfect competition. Specifically, if firms face a downward sloping demand curve, then deviations from their optimal price are not infinitely costly and perhaps small nominal barriers to changing prices (menu costs) could deter rational profit maximizing firms from always immediately adjusting their price in response to a nominal disturbance. This was the original new Keynesian economics (NKE) of Mankiw and Blanchard & Kiyatoki.

It is also argued that the downside of the early RBC and NKE models was that they just didn't work. These two initially competing strains of business cycle research have gradually merged over time. More recently things have gotten better for a number of reasons.

First is the work estimating the models rather than calibrating them, often using Bayesian computational methods, and testing the models in a more rigorous way. Second is the new attention being paid to regime switches in monetary policy. Third is work that allows for real state dependent pricing in the model. Fourth are new theoretical ideas being applied, like the paper I referenced yesterday that explores the public good aspect of a firm's price change.

Update: The visible hand in economics asks What is modern business cycle theory.

Airline ticket prices

One of the big economic question of the age is

Why do most airlines charge substantially more for a one-way ticket than a round-trip ticket on the same route?

At the Austrian Economists blog three possible answers have been put forward:

1. It's price discrimination - one-way fliers might need specific times and flights in a way that makes their demand more inelastic.
2. Some people might pay a premium for a one-way ticket in order to leave their return open-ended.
3. It's a matter of not wanting an empty seat coming back the other way given the low probability of a "double coincidence of one-way tickets."

None of which seem totally convincing.

Boudreaux on the Cato Daily Podcast

Donald J. Boudreaux talks about the "Big Visions for Energy and the Fatal Conceit" in this Cato Daily Podcast.

The NZ petrol market

This report from Newstalk ZB tells us that the NZ petrol market "fundamentally competitive". The news report says

An independent review of petrol pricing has found the New Zealand market is fundamentally competitive.

It says price fluctuations have been driven by increases in taxes and the price of crude oil, while retail prices are not as fast to rise and as slow to fall as consumers have feared. It says the New Zealand market is more transparent than the Australian market, because buy-sell contracts are not used and New Zealand does not have the same price cycles.

The report also says

UBS senior economist Robin Clement says the New Zealand dollar cost of crude oil is roughly where it was at the start of June. He says the price was just below $2.00 so there is scope for another cut. Mr Clement says the effects of declines in the global oil price seem to flowing through to New Zealand quite quickly.

This does raise a couple of issue with me. First, what are we to make of the kinds of comments at the consumer.org.nz website:

Oil companies led by BP - New Zealand's largest - have given motorists a hard time since the New Year. They've raised prices at the pump as soon as crude oil prices rise and then failed to pass on savings from falling prices and the high New Zealand exchange rate.

Does Consumer NZ really know so little about the NZ petrol market? Or do they know something the "independent review" doesn't? What is the basis for their comments?

And, second, if these finding are correct what does it say about the nature of the New Zealand petrol market? Given the research I commented on earlier which suggests there is an asymmetry in price adjustments, for the US at least, Why don't we see such an asymmetry here? This research argues that their is a consumer search asymmetry. When retail petrol prices are rising, consumers search harder for the best price; when prices are falling, consumers ease up on search. This “reference price” consumer search model assumes consumers’ expectations of prices are based on prices observed during previous purchases. The model predicts that consumers search less when prices are falling. This reduced search results in higher profit margins and a slower price response to cost changes than when margins are low and prices are increasing. Do New Zealand consumers just search more than those in the US?

Below is a graph from the MED website which shows the make up of the retail price of regular unleaded petrol. The graph breaks the retail price down into taxes and levies, importer cost, and importer margin.

The importer cost is based on the Singapore benchmark petrol price plus an estimated quality premium and an assessment of the importation costs of freight, insurance, losses, and wharfage. The importer margin is calculated by the Ministry as the retail price less taxes and levies, and less the importer cost. That is, it is the margin available to the importer to cover domestic transportation, distribution and retailing costs, as well as wholesalers' and retailers' marketing margins. The importer margin is lagged by one week, i.e. it is assumed that retail prices this week are based on the importer costs of last week.

Book club: Capitalism and Freedom

There are more postings over at the Free Exchange blog in their Summer book club on Milton Friedman's Capitalism and Freedom. Read here, here and here.

State workers overpaid (updated)

This is what we are told by this NZPA article at stuff.co.nz. The article reports on research by Dr John Gibson, Professor of Economics in the Management School at Waikato University.

The research was published in the New Zealand Journal of Employment Relations and used the New Zealand component of the International Social Survey Programme Work Orientations Survey. It compared like-with-like work.

The article quotes Gibson as saying

"The average pay differential between the public and private sector was between 17 percent and 21 percent,"

The article also notes that

The study was based on 2005 data, so given the faster rate of public sector pay rises recently, the premium was likely to be even higher now.

The stuff report goes on to say

"In addition, public sector workers appear to benefit much more from a `warm glow' belief that in their job they can help others and that their job is useful to society.

"In competitive labour markets people would be willing to work for less to feel so good about themselves and their jobs.

"So the fact that public sector workers actually get paid 20 percent more is evidence of how out of line wage setting has been in the public sector."

It is also noted by Gibson that given that the study was able to compare like jobs with like jobs, it suggests that the higher pay levels for the public sector had little to do with needing to pay more to attract more skilled workers. In addition Gibson could find no justification for the pay premium in the public sector in terms of job conditions.

So we are left to wonder, Why are government salaries so high? I'm sure its got little to do with productivity. This article from Infometrics argues

Public sector wages have also been boosted by the promotion of collective bargaining via the Employment Relations Act 2000. A key justification for the promotion of collective bargaining is a perspective that there is an “inherent inequality of power in employment relationships”.

There is no provision within the Act for addressing circumstances where the inherent inequality favours employees. Yet public sector employment relations are such a case. To begin with, governments’ statutory powers to raise taxes mean that they do not face the same type of immediate financial pressures that inhibit wage rises in most private firms. In addition, it is difficult for citizens, the ultimate employers of public sector workers, to ensure that they are well represented in the wage negotiation process.

The article goes on to make the point

There are natural conflicts of interest between each of these parties and their ultimate employers, the citizens. Using public sector wages to illustrate: high wages improve the wellbeing of employees at the expense of taxpayers, yet the threat of unemployment to public sector workers from excessive wage demands and industrial action are negligible compared with the private sector. In addition, the political fall-out of industrial actions are potentially more serious to politicians than the cost of higher wages, which can be spread thinly across all taxpayers.

Infometrics also adds,

Promoting collective bargaining in the public sector seems a recipe for excessive public sector wage growth. Although a key purpose of government activities is to redistribute incomes from the wealthy to the less fortunate, it is not obvious that public servants, teachers, and medical practitioners are the “unfortunates” most of us have in mind.

Updated: NotPC comments on The "warming glow" of bureaucracy and adds links to more discussion of the issue while Kiwiblog notes 20% higher pay in the public sector.

How an economist thinks

Alex Tabarrok at Marginal Revolution on How an Economist Thinks. He writes

Over the weekend a crew came round my neighborhood offering to paint house numbers on the curb. Large bold curb numbers, they pointed out, make it easier for emergency service workers to find houses in the dark. Good argument. The price was good too. Then I noticed my neighbors were having their numbers painted. So of course, I declined.

Make trade not war?

In this short audio from VoxEU.org, Philippe Martin talks to Romesh Vaitilingam about his research with Thierry Mayer and Mathias Thoenig on the ambiguous relationship between globalisation and war – both civil war and war between states. They find that trade deters severe civil conflicts but fosters less severe ones. And trade created by regional trade agreements is pacifying in terms of wars between states, but greater overall openness has the opposite effect.

Now not to deal with inflation

This report, by Angus Shaw of the Associated Press, from the SFGate tells us that

Zimbabwe announced Wednesday that it is knocking 10 zeros off its hyper-inflated currency - a move that turns 10 billion dollars into one.

The report goes on to say

President Robert Mugabe threatened a state of emergency if businesses profiteer from the country's economic crisis, a move that could give him even more sweeping powers to punish opponents in the event that political power-sharing talks fail.

"Entrepreneurs across the board, don't drive us further," Mugabe warned in a nationally televised address after the currency announcement. "If you drive us even more, we will impose emergency measures. ... They can be tough rules."

The report also notes why the zero have been dropped.

Gono, the central bank governor, acted because the high rate of inflation is hampering the country's computer systems. Computers, electronic calculators and automated teller machines at Zimbabwe's banks cannot handle basic transactions in billions and trillions of dollars.

Inflation, the highest in the world, is officially running at 2.2 million percent in Zimbabwe, but independent economists say it is closer to 12.5 million percent.

Will this reduce inflation? No, as it does not deal with the real cause of the problem, but only a symptom. As the report says

Economist John Robertson said the new bills will soon be worthless, because the inflation rate continues to skyrocket. What costs $1 at the beginning of the month can cost $20 by month's end, he said.

"This is attending only to the symptoms of the problem. The real problem is the scarcity of everything driving up the prices. ... The government has not only caused the scarcities but damaged our ability to fix the problem."

At the root, he said, is the damage to the farming sector, along with government raids on the state pension fund and foreign currency bank accounts of businesses.

This report from the Washington Post tells us

Zimbabwe's money shortages, inflation and chronic shortages of food, gasoline, medicine and most basic goods have brought many businesses in Harare to a standstill. Smaller shops and at least four main restaurants have shut down.

State media reported Saturday that nightclubs were canceling music shows because audiences dried up after a 2,000 percent increase in prices for beer and soft drinks in the past week. Several bars and clubs were openly accepting U.S. dollars, even though that is against the law

No one should be surprised that this is happening. With the Zimbabwe dollar worthless, it is sensible for people to move to another median of exchange. The new notes will do nothing to change this. It is impossible to believe that people will assume that the government will stop printing money money just because it issues new notes and coins.

The law of unintended consequences: again

At the Spectator's CoffeeHouse blog, Fraser Nelson looks at Taxing alcopops: the Australian experience.

Australia made the decision to raise the tax on alcopops. As to the consequences of this decision Nelson writes

Jacking up pre-mixed drink prices by 70% cut their consumption by 30%, but pushed bottled spirit sales up by 46% as kids mixed their own. And - surprise, surprise - the people pour far more generous measures than they were getting with the Bacardi Breezers. Result: a sharp 10% hike in the amount of alcohol consumed in Australia, the precise opposite of what was planned.

Nelson also points out

But there is some consolation for its government. The extra boozing means some A$600,000 a month extra in duties.

Working conditions in the foreign operations of multinational enterprises

One of the many thing some people dislike about multinational enterprises are their foreign labour practices. But what is the evidence on this issue? In a column at VoxEU.org, Alexander Hijzen (Employment Analysis and Policy Division of the OECD) presents new evidence on how foreign takeovers affect workers’ wages and non-wage working conditions. The basic result is that foreign investment is worth encouraging.

Hijzen's column is Working conditions in the foreign operations of multinational enterprises. The column is based on OECD (2008).

Hijzen points out that

... OECD (2008a) adopts a “local standard” to evaluate the social impact of FDI in the host country. This involves comparing the wages and working conditions of employees in the foreign affiliates of MNEs and their supplier firms to the wages and working conditions that they would have received had they not been employed by a foreign firm or one of its suppliers. The difference may be interpreted as the contribution of MNEs to improving wages and working conditions in the host country as employment conditions in comparable domestic firms provide a plausible approximation (“counterfactual”) of the conditions that would have been offered to individuals had they not been able to work for MNEs (directly or indirectly).

An often asked question to do with MNES is, Do foreign multinationals pay higher wages than domestic firms? Hijzen writes

Simple comparisons suggest they do. Moreover, wage differences between MNEs and local firms tend to be larger in developing countries, presumably reflecting the larger productivity advantage MNEs over local firms in those countries. Simple comparisons between MNEs and local firms, however, overstate the contribution of FDI to improving pay, because FDI is typically concentrated in the most advanced sectors and largest firms in the host economy, which would pay above-average wages even if they were locally owned. Even after correcting for this bias, it is still the case that MNEs offer better pay than domestic firms, particularly in developing countries where their productivity advantage is greatest.

Hijzen looks at evidence on the effects of foreign takeovers on average wages within firms for two emerging economies (Brazil and Indonesia) and three OECD countries (Germany, Portugal and the United Kingdom). He explains

It shows that foreign takeovers raise average wages in the short-term, particularly in emerging economies. Wages rose between 10% and 20% following foreign takeovers in Brazil and Indonesia, and between 0% and 10% in the three OECD countries. While these figures show the effect on average wages, they do not tell how the change is distributed across workers within firms and, particularly, whether the increase in average wages reflects wage gains for incumbent workers or instead changes in the skill composition of the workforce. To the extent that foreign takeovers lead to skill upgrading, the evidence overestimates the positive effects of takeovers on individual wages.

Hejzen than looks at the effects of foreign ownership on individual workers.

Foreign takeovers of domestic firms have a small positive effect on the wages of existing workers in Brazil, Germany and Portugal in the short-term, ranging from 1% to 4% and no effect in the United Kingdom. While the short-term impact of takeovers on incumbent workers is modest, the role of foreign ownership is more substantial for new hires. This is indicated by the relatively large wage gains of workers who move from domestic to foreign firms. They range from 6% in the United Kingdom to 8% in Germany, 14% in Portugal and 21% in Brazil. The differential effect of foreign ownership on incumbent workers and new hires may reflect more competitive conditions in the market for new hires that allow new employees to more widely share the productivity advantages of MNEs. In the longer term, however, one would expect the positive effects to spread across the entire workforce, as large pay disparities between new and old workers within firms are unlikely to be sustainable.

Whether multinational enterprises also promote improvements in other aspects of workers’ employment conditions, such as training, working hours and job stability, is a more complex question, and the existing evidence is scarce. Studies that have looked into this issue suggest that MNEs have a low propensity to export non-wage working conditions abroad. New analysis by the OECD suggests that, in contrast to wages, non‑wage working conditions do not necessarily improve following a foreign takeover. Even when they do, it is not clear whether these effects derive from a centralised policy to maintain high labour standards or merely reflect the optimal responses by MNEs to local conditions.

In addition to having direct effects on workers, FDI may also have indirect effects on workers’ employment conditions in domestic firms when there are knowledge spillovers associated with FDI. The effect on workers in domestic firms, however, is considerably weaker than the direct effect on employees of foreign affiliates of MNEs. While it is true that FDI typically has a strong effect on average wages in local firms, this largely reflects the competition between foreign and domestic firms for local workers. Positive productivity-driven wage spillovers do not necessarily arise. They are likely to be more important when there are strong links between local firms and foreign MNEs, such as through the participation of local firms in the supply chain or through worker mobility.

In summary Hijzen says

The potential of multinational enterprises to contribute to economic development in host countries provides a case for encouraging inward foreign direct investment. For a start, removing specific regulatory obstacles to inward FDI could be important. Under certain circumstances, it may also be appropriate to provide specific incentives to potential foreign investors. Such targeted policies should not, however, become a substitute for policies aimed at improving the business environment more generally. By contrast, lowering core labour standards in an effort to provide a more competitive environment for potential investors is likely to be counter-productive. It does not appear to be effective in attracting FDI and is likely to discourage investment from responsible MNEs, anxious to ensure that minimum labour standards are respected throughout their operations.

• OECD (2008), “Do Multinationals Promote Better Pay and Working Conditions?”, OECD Employment Outlook, Paris.

EconTalk this week

Robert Barro of Harvard University and Stanford University's Hoover Institution talks about disasters--significant national and international catastrophes such as the Great Depression, war, and the flu epidemic in the early part of the 20th century. What do we know about these disasters? What is the likelihood of a catastrophic financial crisis in the United States? How serious is the current economic situation in the United States? The conversation also includes discussions of economic stimulus, tax policy, and the recent worldwide rise in commodity prices.

Aleksandr Solzhenitsyn dies at 89

For something a little different on Solzhenitsyn, here is a piece on the economics of Solzhenitsyn (pdf) by Cecil Bohanon.

(HT: Marginal Revolution)

Book club: Capitalism and Freedom

There are more postings over at the Free Exchange blog in their Summer book club on Milton Friedman's Capitalism and Freedom. Read here and here.

Shooting Ourselves in the Food

Ernesto Zedillo (Director, Yale Center for the Study of Globalization, and former president of Mexico) says we are Shooting Ourselves in the Food. Zedillo opens his Forbes.com piece by noting

Rising food prices are eroding the real income of people all over the world, undoing some of the last decade's progress in combating poverty.

Zedillo then makes the point

Protectionists haven't missed the opportunity to blame free markets for the crisis. The absurd goal of "food sovereignty" has made a comeback in a number of countries both poor and rich and is being used as an argument to resist and cancel the liberalization of agricultural markets. This position--most clearly exemplified by France--is ironic because agricultural protectionism, not freer markets, is what has aggravated the problem.

Zedillo goes on to say what nearly all economists have been saying, that the problem is not with markets but with government policy. He writes

Increasing demand for grains in emerging countries such as China and India and two successive years of severe drought in Australia, an important contributor to world supply, could never in and of themselves have caused the huge price hikes we're experiencing.

and he adds

Consequently, one must look at other factors to understand the spike in food prices: high energy costs, increased fertilizer prices and the weakening of the U.S. dollar. But to get the complete picture, one cannot ignore the severe protectionist distortions, both new and old, that have crippled the much needed supply response in world food markets.

By reducing the incentive for domestic farmers to increase production, controls over grain exports in some developing countries have worsened shortages instead of alleviating them, thus contributing to higher world prices. This has been the case, for example, with the recent restrictions in rice exports by China, India and Vietnam and wheat exports by Argentina and Kazakhstan.

Zedillo then joins the chorus of those making the point that the most damaging distortions in agricultural markets originate with polices in the rich countries.

There's little doubt that the present spiral in grain prices is closely linked to U.S. and EU policies enacted to boost production of biofuels. The American and European governments subsidize the production of biofuels, limit their import and mandate their use. The exact extent to which these policies have impacted food prices is still a matter of contention, but not even the most enthusiastic proponents of ethanol can deny that by inducing a greater allocation of agricultural resources toward biofuel production, the amount of grain available for food has been reduced. According to the World Bank, while global production of corn increased by 51 million tons from 2004 to 2007, biofuel use of corn in the U.S. alone increased by 50 million tons, thus leaving no margin to satisfy the increase of 33 million tons in global consumption for other uses during the same period. This explains why some respectable experts, such as the former chief economist for the U.S. Department of Agriculture and a top World Bank agricultural economist, have imputed a large proportion of the rise in food prices to the growing use of food crops for fuel.

Again we see biofuels as the major villan in the food price story. So why do so many governments, including New Zealand's, want to go down the biofuels route?

Politicians understanding of economics

What is it about economics that politicians just don't get? This is a letter from Donald J. Boudreaux to the Aurora (Illinois) Beacon.

Barack Obama proposes to deal with rising gasoline prices by giving a $1,000 "emergency rebate" to consumers - a rebate to be paid for by taxing the so-called "windfall profits" of oil producers ("Obama pitches $1,000 energy rebate checks," August 2).

In other words, a critical part of Sen. Obama's strategy for reigning in high gasoline prices is to subsidize gasoline consumption and more heavily tax its production. This plan - which increases the demand for gasoline and reduces its supply - makes as much sense as trying to put out a fire by dowsing it with jet fuel.

E. Frank Stephenson at the Division of Labour blog writes

Earlier this year, much was rightfully made of McCain's call for a gas tax moratorium and how no economists thought it was a sound idea. For example, here's Mankiw: "I don't know any prominent economist who favors this McCain-Clinton proposal."

What I'm wondering now is if there are any prominent economists who support Obama's tax/rebate scheme? Any takers? Anyone?

I'm sure there will be no takers but this does raise the question as to why did Obama put this idea forward in the first place? I'm sure he's too smart to believe its a good idea and even if he did he has advisers who would tell him its a stupid idea, so why say it? The reason must be political, that is, he thinks its a vote winner. Or in other words he thinks voters are really stupid.

So either Obama doesn't understand the economics of what he said or he does, but doesn't care as long as he thinks it will win him votes. Neither of which look like good options.

Interesting blog bits

1. Dwight R. Lee on Economic Protectionism.
2. Laura LaHaye on Mercantilism.
3. Jagdish Bhagwati on Protectionism.
4. Alan S. Blinder on Free Trade.
5. Douglas A. Irwin on GATT Turns 60
6. Jagdish Bhagwati on Globalization (Word doc.)
7. Douglas A. Irwin on why 'Outsourcing' is Good for America.
   

Quote of the day

Like Dracula, protectionism never really dies, and we who support free trade must always keep our intellectual wooden stakes sharp and ready.

Bob McTeer
President and Chief Executive Officer
Federal Reserve Bank of Dallas

Glaeser interview

Edward Glaeser, an economics professor at Harvard University, talks with Bloomberg's Tom Keene about the impact of oil prices on urban economies, the outlook for the U.S. housing market, and the relationship between urban diversity and economic growth.

Asymmetric price adjustment and petrol prices

Petrol prices are in the news more often than not these days. One particular point that has been made is that when retail petrol prices are going up, they tend to go up quickly, but when the same prices are heading down, they tend to go down slowly. This asymmetry leads some critics to berate oil companies for not passing along the savings when crude oil or wholesale petrol prices fall. For example the consumer.org.nz website writes

Oil companies led by BP - New Zealand's largest - have given motorists a hard time since the New Year. They've raised prices at the pump as soon as crude oil prices rise and then failed to pass on savings from falling prices and the high New Zealand exchange rate.

This is just? May be not. It turns out that the pricing phenomena may be more appropriately pinned on petrol consumers. When retail petrol prices are rising, consumers search harder for the best price; when prices are falling, consumers ease up on search.

Matthew Lewis of the Ohio State University has a paper on the Asymmetric Price Adjustment and Consumer Search: An Examination of the Retail Gasoline Market (pdf). The abstract reads

It has been documented that retail gasoline prices respond more quickly to increases in wholesale price than to decreases. However, there is very little theoretical or empirical evidence identifying the market characteristics responsible for this behavior. This paper presents a new theoretical model of asymmetric adjustment that empirically matches observed retail gasoline price behavior better than previously suggested explanations. I develop a “reference price” consumer search model that assumes consumers’ expectations of prices are based on prices observed during previous purchases. The model predicts that consumers search less when prices are falling. This reduced search results in higher profit margins and a slower price response to cost changes than when margins are low and prices are increasing. Following the predictions of the theory, I use a panel of gas station prices to estimate the response pattern of prices to a change in costs. Unlike previous empirical studies I focus on how profit margins (in addition to the direction of the cost change) affect the speed of price response. Estimates are consistent with the predictions of the reference price search model, and appear to contradict previously suggested explanations of asymmetric adjustment.

The outcome is that if consumers are diligent about seeking out the lowest available price, maybe retail petrol prices will drop more more quickly when wholesale prices fall.

Are economists taken seriously?

In many areas of government, economists are called on to size up the issues involved in almost every policy. But should they be taken seriously? In this short audio from the BBC Today programme, Tim Harford, author of The Undercover Economist, and Phil Collins, of the London School of Economics, discuss how much influence economists should have.

More Tui ads

A couple more unofficial Tui ads.

This one to go up at No 1 The Terrace



This one to go up at the Backbenchers on 1 October 2008

John Cochrane on the Milton Friedman protest letter

On the 6th of June a group of University of Chicago faculty wrote a petition to the University's President, Robert Zimmer, and Provost, Thomas Rosenbaum, opposing the foundation of a Milton Friedman Institute to support economic research. John Cochrane, Myron S. Scholes Professor of Finance, has responded with some Comments on the Milton Friedman Institute Protest.

Both barrels, point blank range. Brad DeLong says "As far as polemic goes, I don't think I will ever see a better one".

(HT: Marginal Revolution)

How inflation robs Zimbabwe

This short audio from the Cato Institute discuss "How Inflation Robs Zimbabwe". This Cato Daily Podcast features Rejoice Ngwenya, a Zimbabwean writer and head of the Zimbabwean Coalition for Market & Liberal Solutions.

A related audio and video is "Escaping Poverty in Sub-Saharan Africa". This features Rejoice Ngwenya and Marian Tupy of the Cato Institute.

The southern African countries of Botswana and Zimbabwe are neighbors. Botswana is peaceful, stable, and increasingly prosperous. Zimbabwe, in contrast, is beset by political and economic crises. Their diverging fortunes are partly explained by their government’s attitudes to economic freedom: Botswana is one of Africa’s economically freest states, and Zimbabwe is among Africa’s least free countries. Rejoice Ngwenya and Cato’s Africa analyst Marian Tupy to discuss Zimbabwe’s meltdown, Botswana’s ascent, and lessons for the rest of Africa.