Confusion on ownership

Recently over at the Stumbling and Mumbling blog Chris Dillow discussed the problems involving the ownership of the Liverpool football club, which does look somewhat strange. But he seems to be confused over what ownership is all about. He writes,

The Hicks-Gillett saga shows that, despite the impression given by Jimmy Tarbuck and Stan Boardman, great comedy can come out of Merseyside. It also throws into question the standard view about the ownership of assets generally (I’d call it the neoliberal view if I were a pretentious git.)

How I have to say I have never come across a "neoliberal" view of ownership so I'm not too sure what exactly Dillow is on about. Does he mean a transaction cost view, property rights view, reference point view or ....? But I go on hoping I can make sense of his argument.

Dillow continues,

This says that it is efficient for the ownership of an asset to go to the highest bidder. This is because the very act of bidding most for an asset suggests that a man knows best how to maximize its value. A free market in assets, then, ensures that assets go to those best able to manage them.

Hicks and Gillett’s mismanagement of Liverpool, however, shows that this story isn’t right all the time; highest bidders - as they were once - can make a horrible mess.

Yes, they can make a horrible mess but the point of a free market in ownership is that if they do then they will lose control of the firm, or football club, which is what has happened. Giving ownership to the highest bidder doesn't guarantee that the best use of the asset will occur but it does increase the probability of it. No method of ownership determination can guarantee optimal asset use.

Dillow than asks:

Which raises the question: what is wrong with this standard story?

and say four things are:

Over-confidence. It’s well-known that bidders can overpay for assets - the winner‘s curse is a cliche. This is especially likely when those bidders are entrepreneurs who have been successful in other businesses. Such men are selected twice over for their overconfidence. Once, because the very act of becoming an entrepreneur in the first place betokens an overconfidence. And twice, because previous success further raises that confidence and breeds the belief that the ability to own baseball clubs or mobile phone shops gives one the ability to own a football club.

Ownership, then, doesn’t flow to the most competent potential owner, but to the most deluded.

See my point above. If they are "deluded" this will soon be found out and given a free market in ownership, the ownership of the asset will change. Which is what you would want.

Ownership does not confer genuine power. In the case of football clubs, real power - the ability to extract cash - lies with players, not owners; Alan Sugar called this the prune juice effect. Similarly, in banks shareholders lacked power to control excessive risk-taking.

That ownership and "power" may not be the same is well known, see for example, Jean Tirole and Philippe Aghion, "Formal and Real Authority in Organizations", Journal of Political Economy, vol. 105, n. 1, February 1997, p. 1-29. Why Dillow thinks "the ability to extract cash" is ownership or power I can't see. "The ability to extract cash" will have more to do with markets conditions than ownership. If you are a monopoly, for example, then you have more "ability to extract cash" than a competitive firm, but this has nothing to do with ownership. Ownership is about control rights (and maybe income rights) independent of "the ability to extract cash". If you went from being a monopoly to being a competitive firm "the ability to extract cash" would change but does this mean that ownership or power has changed? I can't see how.

As to the "banks shareholders lacked power to control excessive risk-taking" point, ownership isn't about being able to control the actions of the management and workers perfectly. Its about being able to do so better than an alternative set of owners. This doesn't mean that the owners have perfect control of the firm, they don't, no set of owners would have; it means they have better control than the alternative owners.

The collective action problem. The people with the best knowledge or incentive to manage an asset might be a dispersed group; fans in the case of football clubs or employees in the case of other companies. Organizing such a group, however, can be prohibitively tricky.

This is true, but if those with the "best knowledge or incentive to manage an asset" are a "dispersed group" then you have to ask if they really are those who should be the owners. Hansmann makes the point that homogeneity of interest is important for the group that are the owners of a firm. Would the fans really have such a homogeneity of interest? They may not care too much about profits - the normal thing that investors have in common- they are fans after all, but they may care about other things, who's the manager, who are the players, which players should play, who the sponsors of the team should be etc, and assuming they all can't agree, this results in heterogeneity of interests, which is bad for ownership.

Capital constraints. The standard view assumes that the people best able to maximize an asset’s value will be able to raise the cash to buy it. But this needn’t be true. Even the wealthy Red Knights were unable to put together a bid for their club, so it was always going to be impossible for Liverpool fans to do so, with one job between them. And of course, the point here extends way beyond football clubs.

Why is it impossible for Liverpool fans to bid for the club? Why can't they just sell shares in the club and raise money the same way any investor-owned firm does? If there are enough fans, and I'm guessing there are, then why can't they use the standard methods of raising funds from small investors that all share-holder owned firms do?

Part of Dillow's conclusion is that:

These four difficulties undermine the standard argument for a free market in ownership [...]

I would say not. In fact what the whole Liverpool things shows is that free markets in ownership work. If you are the owner of an asset and use it badly someone else will be able to take ownership away from you and this is what we have seen. Ownership is determined by profit and loss, if you make a (big enough) loss you will lose ownership. This is how you give the best incentives to owners and how you move assets into the hands of those who really do value them most and who will use them most efficiently. The system can take time and isn't always perfect in the way it works, but we have yet to come up with a better method.

What is the optimal number of courts

A paper by Stefan Voigt looks at this question.The abstract of his paper, On the Optimal Number of Courts, reads:

This is the first paper to investigate whether the number of high courts in a country has systematic effects both on the quality of its legal system and on its level of economic development more generally. It is theorized that due to the division of labor and a higher degree of specialization, high courts might be advantageous in terms of court productivity. Yet, they might also be disadvantageous in terms of a less coherent legal system. It is empirically tested whether the positive or the negative effects prevail. Results show that a larger number of high courts never has any positive effect; indeed, with regard to some dependent variables, a greater number of high courts is correlated with worse outcomes.

Voigt opens the paper by explaining that,

The various effects of different legal origins have been the subject of intense debate in the field of economics for about a decade. The number of courts or, more precisely, the number of complete court hierarchies (sequence of courts, stages of appeal, “vollständige Instanzenzüge” in German) is one difference often attributed to different legal origins. For example, in their book, The Civil Law Tradition, Merryman and Pérez-Perdomo (2007), have a chapter entitled “The Division of Jurisdiction” in which they explain that the typical common law system has a unified court system that might be represented by a pyramid, whereas matters would be quite different in the civil law world (ibid., 86): “There it is usual to find two or more separate court hierarchies, each with its own jurisdiction, its own hierarchy of tribunals, its own judiciary, and its own procedure, all existing within the same nation.”

The basic question Voigt is interested in is : What is the optimal number of court hierarchies? Issues that can be thought about include: Does the number have consequences for the (perceived) quality of the judicial system and its effectiveness? What are the implications for broader issues, such as the protection of political rights and civil liberties? Voigt goes on the say,

This paper tests whether the division of judicial decision-making has systematic (economic) consequences. In economic terminology, choosing the optimal number of courts can be thought of as the result of a tradeoff. On the one hand, a higher number of specialized courts allows judges to become experts in specific legal areas, thus allowing them to arrive at decisions faster (i.e., be more productive) and to produce better decisions. This is conjectured to reduce court delay and reduce the number of decisions that are appealed; in short, a higher number of courts is correlated with a higher quality of the judicial system.

Yet, the division of courts into many different legal areas could also have disadvantages. Judges at “single issue” courts could be somewhat removed from the more general developments in judicial decision-making. In the long term, this could lead not only to inconsistencies in judicial decision-making across various legal areas, but also to “narrow” decision-making in which specialized judges keep only “their” legal area in mind, neglecting the effects of their decisions on the more general legal development and also, and of particular interest here, on economic development.

His conclusions:

The results show that a high number of court hierarchies never has any positive effect on total factor productivity, civil liberties, or confidence in the legal system. Indeed, some results point in the opposite direction: both the number of court hierarchies and the number of specialized courts explicitly mentioned in the constitution are negatively correlated with political rights as well as with civil liberties. Among particular court hierarchies, high administrative courts are at least marginally detrimental to both total factor productivity and confidence in the legal system. Among the specialized courts mentioned in the constitution, religious, labor, impeachment, and military courts have negative effects on some of the dependent variables tested here.

Anyone thinking about making changes to their court system would be advised to consider such results.

Clio and the economist

There is a new paper out in the Journal of Economic Surveys on Clio and the Economist: Making Historians Count. The abstract of the paper by David Greasley and Les Oxley reads:

Cliometrics reconnected economic history an economics in the 1960s. The deeper foundations of cliometrics research lie in the longer standing traditions of quantitative history and the contemporaneous growth of the social sciences and computing. Early cliometrics research
reinterpreted economic history through the lens of neo-classical economics. Over the past half century cliometrics has matured and now utilizes a broad array of theoretical perspectives and statistical methods to help understand the past. The papers introduced here illustrate the achievements of several key areas of cliometrics research and show how new theoretical perspectives, innovative data construction and sophisticated econometric methods are the hallmarks of the discipline.

In the paper Greasley and Oxley write

The heat of the early debates, the label of the new economic history, and the controversies surrounding counterfactuals and applying neo-classical economics to re-evaluate long-standing historical questions sometimes disguises the wider foundations of cliometrics. In that wider setting several intellectual traditions shaped the emergence and the subsequent evolution of
cliometrics. The ones that now stand out include:

1. Quantitative history and most especially the construction of historical series of prices, wages and incomes, which have long traditions dating back to at least the 19th century.
2. Quantitative social science of the 1950s and 1960s which placed emphasis on empirical research, and the use of censusand mass survey data. Sociologists for example, pioneered the use of sampling and significance testing to handle large volumes of social data, see Hudson (2000). The manipulation of large data sets was facilitated by concomitant developments in computing.
3. Econometric testing, including of macroeconomic business cycles models which developed strongly in the 1930s; seeMorgan (1990). Tinbergen’s (1939) Statistical Testing of Business Cycles published in 1939 drew on classical statistical methods but also set out the best practices for applied econometrics which eventually became embedded in cliometrics.
4. Cliometrics has been an evolving discipline, with its shifts in direction and emphasis in part reflecting newdevelopments in economic theory. Most importantly the return of growth theory to centre stage in mainstream economics and the development of endogenous growth models in the 1990s enabled cliometricians to reduce their relianceof neo-classical models and measures of residual productivity, see Greasley and Oxley (1997).
5. The evolution of cliometrics has also been strongly influenced by new developments in econometrics methods, most especially in the analysis of non-stationary time series following the work of Engle and Granger (1987).

Is it just me or does that list make it look like microeconomics doesn't exist, or at least plays
little or no part in historical economics? The paper has little to say about the actually interesting bits of
historical economics, that is the microeconomics bits.

I'm thinking of work such as that by several authors which looks at the characteristics that determine contract choice using data on historical agricultural contracts. Ackerberg and Botticini (2002), for example, looks at agricultural contracts between landlords and tenants in early Renaissance Tuscany. Their abstract reads

Empirical work on contracts typically regresses contract choice on observed principal and agent characteristics. If (i) some of these characteristics are unobserved or partially observed and (ii) there are incentives whereby particular types of agents end up contracting with particular types of principals, estimated coefficients on the observed characteristics may be misleading. We address this endogenous matching problem using a data set on agricultural contracts between landlords and tenants in early Renaissance Tuscany. Controlling for endogenous matching has an impact on parameters of interest, and tenants’ risk aversion appears to have influenced contract choice.

Oriana Bandiera provides another example with her paper on "On the Structure of Tenancy Contracts: Theory and Evidence from 19th Century Rural Sicily". This looks at the empirical determinants of contract length utilising data on tenancy agreements signed between 1870 and 1880 in the district of Siracusa, Italy. The abstract reads,

This paper analyses the empirical determinants of contract length, a key and yet neglected dimension of contractual structure. I use data on tenancy agreements signed between 1870 and 1880 in the district of Siracusa, Italy to estimate the choice over length and compensation schemes jointly.

The findings indicate that the choice of contract length is driven by the need to provide incentives for non-observable investment, taking into account transaction costs and imperfections in the credit markets that make incentive provision costly. The results also illustrate that since both length and the compensation scheme are used to provide incentives within the same contract, joint analysis is important for a correct interpretation of the evidence.

An example other work not covered in the survey would be Jeremiah Dittmar's paper, “Information Technology and Economic Change: The Impact of the Printing Press”. The abstract reads:

The movable type printing press was the great innovation in early modern information technology, but economists have found no evidence of its impact in measures of aggregate productivity or income per person. This paper examines the technology from a new perspective by exploiting city-level data on the establishment of printing presses in 15th century Europe. I find that between 1500 and 1600, cities where printing presses were established in the late 1400s grew at least 60 percent faster than similar cities which were not early adopters. I show that cities that adopted printing in the late 1400s had no prior growth advantage and that the association between adoption and subsequent growth was not due to printers anticipating city growth or choosing auspicious locations. These findings imply that the diff usion of printing accounted for between 20 and 80 percent of city growth 1500-1600. They are supported by historical evidence and instrumental variable regressions that exploit distance from Mainz, Germany — the birth place of printing — as an instrument for early adoption. The printing press reduced the costs of transmitting information between cities, but fostered new face-to-face interactions and localized spillovers. Print media notably fostered the development of skills, knowledge, and innovations valuable in commerce.

Here we see the use of data disaggregated to the level of cities, rather than the more usual national income type data, to look at the effects of changes in technology on growth and finding interesting results that the macro data miss.

There is also work such as that by John McDonald and G. D. Snooks on the "Domesday Economy: A New Approach to Anglo-Norman History". McDonald and Snooks apply modern theoretical and statistical methods to the data of the Domesday Book (1086) to analyse the system of manorial production and the nature of the national tax system known as danegeld in eleventh-century England. Domesday Book includes detailed information on land ‘ownership’, income, resources, and fiscal responsibility for almost every manor in 1086 and, in some cases, in 1066. The data allows the authors to estimate production functions for the manors in the Anglo-Norman economy.

All of this suggests to me that there are interesting and important things that micro theory and data can tell us about the past that are missed by the concentration on macro theory and data. We await a good survey.

EconTalk this week

Matt Ridley, author of The Rational Optimist, talks with EconTalk host Russ Roberts about why he is optimistic about the future and how trade and specialization explain the evolution of human development over the millennia. Ridley argues that life is getting better for most of the people on earth and that the underlying cause is trade and specialization. He discusses the differences between Smith's and Ricardo's insights into trade and growth and why despite what seems to be strong evidence, people are frequently pessimistic about the future. Ridley also addresses environmental issues.

Why do economists disagree?

The New York Times asks this question.

Let’s leave aside the merits of these arguments and ask a question so basic it will sound naïve: Why do economists argue at all? Given that Fed members and economists are looking at the same data, and given the reams of evidence accumulated over decades — not to mention a few centuries of great minds, great theories and thick books that preceded this crisis — why isn’t a right answer self-evident?

George Bernard Shaw once said, “If all economists were laid end to end they would not reach a conclusion.” How come? What prevents economics from yielding answers the way that physics, chemistry and biology do?

and

To explain the case for humility in economics, Mr. [Robert] Solow said, look no further than the stimulus bill: “It has run its course over the past year and a half, but it is not an isolated event. One thousand other things were happening that had an effect on employment and real G.D.P.,” a measure of a nation’s total output adjusted for changes in prices. “You want to trace the effect of one of a very large number of significant causal effects, and that’s a very hard thing to do.”

That the world doesn’t offer up clean economic experiments is a common refrain in the discipline, said Gary Becker, a Nobelist at the University of Chicago. There have been endless studies on every tax change in the modern history of the republic, Mr. Becker said, from Kennedy to George W. Bush, and arguments about the wisdom and aftereffects of each. It’s not just that there is so little clear signal amid so much noise. It’s that many economists have a unique idea of what signal to listen to and what priority it deserves.

In other words, the world is really, really complicated. And it is complicated because of people,

But economics will forever have to contend with the biggest X factor of all: people. As Mr. Solow notes, you feed people poison, and they die. But feed them a subsidy and there is no telling what will happen. Some will use it wisely, others perversely and some a mix of both.

But you shouldn't over play the disagreement card. There are many things on which economists do agree.

This is not to suggest that economics is a total free-for-all, lacking a broad consensus on any subject. Polls of economists have found near unanimity on topics like tariffs and import quotas (bad), centralized economies (very bad) and flexible, floating exchange rates (very good).

I would suggest however that agreement is more likely on the microeconomic side than on the macroeconomic of the discipline.

The market for marijuana in California

We have another example of a transaction which takes a small step away from repugnant to not: Schwarzenegger approves bill downgrading marijuana possession of ounce or less to an infraction.

"Gov. Arnold Schwarzenegger, who opposes legalization of marijuana for recreational use, has approved legislation downgrading possession of an ounce or less from a misdemeanor to an infraction.

"Supporters say the change will keep marijuana-related cases from becoming court-clogging jury trials, even though the penalty will remain a fine of up to $100, with no jail time. Violations will not go on a person's record as a crime.

"I am signing this measure because possession of less than an ounce of marijuana is an infraction in everything but name," Schwarzenegger wrote in a message released after he signed the bill. "In this time of drastic budget cuts, prosecutors, defense attorneys, law enforcement and the courts cannot afford to expend limited resources prosecuting a crime that carries the same punishment as a traffic ticket."

That is the good new but the bad news is that marijuana cultivation is still illegal in California e.g: Mendocino officials pursue third day of marijuana eradications.

"Mendocino County Sheriff's officials, assisted by state and federal agencies, made several more arrests in the third day of eradicating illegal marijuana grows and sales in Round Valley on Thursday.

On Tuesday 17 people were arrested, and another 20 were arrested on Wednesday, officials reported."

Hasn't law enforcement got better things to do with their time?

(HT: Market Design)

Gender and human capital

It is common today for people to note that females are more numerous than males in most levels of education, and that they perform better in school. The obvious question this raises is Why? One possible answer is that there are simply biological differences between men and women that make men better at tasks that require force, while women are better at task for which reasoning is paramount. Over at the Economic Logic blog the Economic Logician comments on this idea:

Mark Pitt, Mark Rosenzweig and Nazmul Hassan build a model of investment in human capital that differentiates genders. Better nutrition improves strength and education improves skills. Individuals make these choices, as well as in which activities to work. Using panel data from rural Bangladesh, they find that model is a reasonable description of reality. That is particularly interesting, because rural Bangladesh does not strike me as an economy where brain would dominate brawn. Also of interest is that improvements in health do not increase education for men, it may even reduce it, while women education clearly benefits from them. Thus policies that focus on health improvements are likely to improve women's schooling more than men's, lead to more occupational differentiation across genders, and a larger gender wag gap.

An interesting result, should this turnout to be true, is that as the so-called "knowledge economy" expands more intelligence/education will be asked for from employees, replacing the need for force, and thus women will find more opportunities and better pay. This will result in a gender pay gap.

Decriminalizing cannabis: the impact on crime Imran Rasul

There is a new audio from VoxEU.org in which Imran Rasul of University College London talks to Romesh Vaitilingam about his research with Jerome Adda and Brendon McConnell on the effects of a localized policing experiment that decriminalized cannabis possession in the London borough of Lambeth between 2001 and 2002.

Unemployment issues

At Marginal Revolution Alex Tabarrok raises a couple of interesting points about search-matching models of unemployment.

The first puzzle about unemployment when thought about from within the search-matching framework is that unemployment rates are highest among the least skilled and most homogeneous skills, i.e. among those worker/jobs with the easiest matches. It's hard to believe that it takes a year to match a construction worker to a job.

Closely related is the issue of how much uncertainty is holding back employment. The case for uncertainty is that hiring a worker is like exercising an option--once you hire, there are sunk costs of hiring (and potentially firing) that go beyond the wage such as administrative and training costs.

Note that you may not need a lot of uncertainty (i.e. you may not need regime uncertainty) to reduce hiring because you don't have to explain why firms aren't hiring only why they aren't hiring this day. Even if we assume, for example, that hiring would be profitable, all else equal, it doesn't take much uncertainty to make it worthwhile to delay hiring a little bit, to wait and see. It's precisely when sales are low and unemployment is high that firms don't mind waiting because uncertainty may resolve in due course and the workers aren't going away.

Ok, that's the positive case for uncertainty but the second puzzle is that uncertainty should matter most when hiring and firing costs are high and once again these costs are lowest for those workers with the greatest unemployment rates. It's one thing not to hire when you can't fire but when firing is easy what's the risk? Moreover, unemployment has increased more in the United States than in Europe even though hiring and firing costs are higher in Europe.

So we certainly learn things from the search-matching framework but it also appears that they don't tell us everything about unemployment. It still seems that things like aggregate demand shocks, sticky wages and prices are important for unemployment. Or in other words, the real world is complicated.

If real wars were like trade wars ....

At Cafe Hayek Don Boudreaux discusses what would happen if real wars were fought in the same manner as trade wars are fought. He gives a transcript of the communiqués between the leaders of two warring nations:

Leader of Absurditoptia (A): I say, leader of Stupidia – we demand that you stop occupying that contested strip of land. If you refuse, we’ll have no choice but to shoot our own citizens.

Leader of Stupidia (S): You don’t scare us! That land is ours. And if you do kill some of your own people, make no mistake that we will immediately – and just as cruelly – commence to killing our own people. Courage is our national motto!

(A): Ha! You’re bluffing. But I’m not. I’ve just courageously ordered my troops to mow down in cold blood ten percent of my fellow countrymen. Take that!

(S): How dare you attack you like that! You leave us no choice but to attack us. I am ordering the Stupidian army to slaughter 15 percent of innocent Stupidians here in Stupidia. How do you like them apples?!

(A): You are cruel and inhuman to damage us by killing your people. I hereby instruct all of my fellow Absurditopians to commit suicide! Only then will you nasty Stupidians get your proper comeuppance and we Absurditopians the justice that we are due!

(S): You can’t beat us, you Absurditopian you! Listen up. I’m ordering all of my fellow citizens – Stupidians all! – to commit suicide. We’ll see who emerges victorious!
....

Then a long, long silence.

Well said that man! The British economist Joan Robinson famously put the idea as, "if your trading partner has rocks in his harbour, that is no reason to throw rocks into your own".

Big Mac Index 2010

More Burgernomics from The Economist. From the Economist website in article dated July 22nd 2010. The Economist's Big Mac index, shows that currencies continue to be undervalued in the developing world but overvalued in Europe.

The Economist writes that,

The index is a lighthearted attempt to gauge how far currencies are from their fair value. It is based on the theory of purchasing-power parity (PPP), which argues that in the long run exchange rates should move to equalise the price of an identical basket of goods between two countries. Our basket consists of a single item, a Big Mac hamburger, produced in nearly 120 countries. The fair-value benchmark is the exchange rate that leaves burgers costing the same in America as elsewhere.

The New Zealand dollar is undervalued by 4% according to this measure.

Macroeconomics after the crisis

Ricardo J. Caballero has a new NBER working paper out entitled Macroeconomics after the Crisis: Time to Deal with the Pretense-of-Knowledge Syndrome. The abstract reads:

In this paper I argue that the current core of macroeconomics—by which I mainly mean the so-called dynamic stochastic general equilibrium approach—has become so mesmerized with its own internal logic that it has begun to confuse the precision it has achieved about its own world with the precision that it has about the real one. This is dangerous for both methodological and policy reasons. On the methodology front, macroeconomic research has been in “fine-tuning” mode within the local-maximum of the dynamic stochastic general equilibrium world, when we should be in “broad-exploration” mode. We are too far from absolute truth to be so specialized and to make the kind of confident quantitative claims that often emerge from the core. On the policy front, this confused precision creates the illusion that a minor adjustment in the standard policy framework will prevent future crises, and by doing so it leaves us overly exposed to the new and unexpected.

Caballero opens the paper by saying,

The recent financial crisis has damaged the reputation of macroeconomics, largely for its inability to predict the impending financial and economic crisis. To be honest, this inability to predict does not concern me much. It is almost tautological that severe crises are essentially unpredictable, for otherwise they would not cause such a high degree of distress. Of course, it is well-known that certain elements can increase the fragility of a financial system, such as high levels of leverage or mismatches between short-term liabilities and long-term assets, and that these issues may justify policy intervention. But knowing these mechanisms is quite different from arguing that a severe crisis can be predicted. Modern Cassandras will always claim to have seen the crisis coming. What they will not say is how many times they saw things coming that never materialized, or how the specific mechanisms behind the crisis are different from those on which their predictions were based. In my view, the conviction that one can foretell a severe crisis in advance is mostly a manifestation of pareidolia—the psychological phenomenon that makes people see faces and animals in clouds and the like.

There is a nice point here, severe crises are essentially unpredictable, for otherwise they would not cause a high degree of distress, that is, they wouldn't be severe. If we could predict severe crises we could take actions to mitigate the effects of the crisis thereby rendering it less severe. Policymakers should keep this in mind. There is only limited scope for policy that can in advance eliminate the risk or costs of a financial crisis.

Only the French

From the New York Times we find out

"It was Cédric Villani, a 37-year-old professor at Lyon who won the 2010 Fields Medal, who gave the most spirited reply to France’s critics. Calling himself “a pure product of the French system,” Mr. Villani, a Normalien who has often taught in the United States, said that while American academic salaries were higher “and it’s easier to make big projects,” France also has particular strengths: “Our tradition, our quality of life, our social cohesion. My big problem in Princeton was finding a place to buy a decent cheese.”

To hell with the eduction, worry about the cheese!

(HT: Market Design)

Do economic freedom and entrepreneurship impact total factor productivity?

An interesting question, with an on the face of it strange answer, asked by Christian Bjørnskov and Nicolai J. Foss in a new working paper Do Economic Freedom and Entrepreneurship Impact Total Factor Productivity? The abstract reads:

The economics of growth has shown that countries not only grow by deploying higher levels of inputs to production, but also by better allocating whatever resources are at their disposal and by introducing productivity-enhancing innovations. We proffer arguments as to why and how entrepreneurship as well institutions of liberty (i.e., economic freedom, including the rule of law, easy regulations, low taxes and limited government interference in the economy) positively impact total factor productivity (TFP): These institutions allow entrepreneurial experimentation with the combination of factors to take place at low transaction costs. We test these ideas on a unique panel data set derived from Compendia, World Bank data and the Fraser Institute’s economic freedom data. We find that while entrepreneurship positively impacts TFP, the marginal contribution of entrepreneurship to TFP is strongest in economies with substantial government activity.

The strange bit is that they find that increasing the active involvement of the government in the economy as well as the tax burden actually increases the impact of entrepreneurship on TFP. Their explanation of this somewhat surprising, to say the least, finding is that a reduced supply of entrepreneurship increases the marginal productivity of entrepreneurship; thus, the best ideas do survive even in the relatively hostile welfare state environment. So entrepreneurs succeed despite the government rather than because of it.

(HT: Markets and Organization)

Who should pay for university?

This is the question asked by Tim Worstall. His answer?

The major beneficiaries of a degree are the people who hold that degree in the higher lifetime earnings they gain from having that degree. So it should be they that pay the costs of gaining that degree.

There’s no real way to have private funding of the loans though: yer average 18 year old isn’t the greatest credit risk for £50k now, are they? So government provision of the loans seems fine.

The greater societal benefit of having lots of graduates: I’m entirely unconvinced about that. Yes, I’d say there is a public good to having a largely numerate and literate society, thus meaning tax subsidy to that part of the education system that provides that (and if only we did have a part of the education system that does provide that) but having 40, 50% of the age cohort with degrees?

Given that the vast majority of them go on into careers which were not traditionally thought of as requiring a degree I don’t really see it I’m afraid.

In fact, I rather hope that the unwrapping of the current subsidy, the making plain what are the true costs, will mean fewer taking a degree in the first place.

But the basic concept being proposed seems just fine to me. Here’s what a degree costs, we’ll help finance it but you’ll have to pay for it: just fine by me.

And it seems pretty fine to me as well. As Tim notes getting a loan against human capital isn't easy as you cannot really sell the asset if things go pear-shaped. Thus government involvement in making loans may be a good idea. But they should be serious loans, that is, they should have the market rate of interest charged on them. Otherwise you are just subsiding a few years of beer consumption for many students. (Yes I know interest free loans are a great idea of you want the student vote. But getting a few votes isn't really a great basis for public policy. No matter what politicians tell you!) This would hopefully have the effect of making students actually think about whether or not going to university is a worthwhile idea, rather than it being just the default option.

2010 Nobel Prize in economics 2

Over at Marginal Revolution Tyler Cowen has written profiles on each of this year’s winners: Diamond, Mortenson, and Pissarides. Alex Tabarrok sums things up by saying,

The 2010 Nobel Prize awarded to Peter A. Diamond, Dale T. Mortensen, Christopher A. Pissarides can be thought of as a prize for unemployment theory.

A key breakthrough was to realize that the problem was not how to explain unemployment per se but rather how to explain hiring, firing, quits, vacancies and job search and to think of unemployment as the result of all of this underlying microeconomic behavior. Notice that the underlying behavior involves not just workers looking for jobs but also employers looking for workers so explaining unemployment would require a theory of job search, worker search and matching and each aspect of the theory would have to be consistent with every other aspect; i.e. how much workers search depends on how much employers are searching (e.g. advertising) and vice-versa and also on the quality of matching and all of these considerations need to be addressed together. It was Mortensen and Pissarides in particular, building on work by Diamond, who built just such a consistent model.

A very surprising empirical fact helped to motivate this perspective: even in a recession millions of jobs are being created every month. The figures we usually hear about the number of jobs created is the net figure but in the United States in August, for example, there were 4.1 million hires (and 4.2 million separations). Thus, as noted above, understanding unemployment requires understanding these much larger flows of job creation and destruction.

The Press Release from The Royal Swedish Academy of Sciences reads,

Markets with search costs

Why are so many people unemployed at the same time that there are a large number of job openings? How can economic policy affect unemployment? This year's Laureates have developed a theory which can be used to answer these questions. This theory is also applicable to markets other than the labor market.

On many markets, buyers and sellers do not always make contact with one another immediately. This concerns, for example, employers who are looking for employees and workers who are trying to find jobs. Since the search process requires time and resources, it creates frictions in the market. On such search markets, the demands of some buyers will not be met, while some sellers cannot sell as much as they would wish. Simultaneously, there are both job vacancies and unemployment on the labor market.

This year's three Laureates have formulated a theoretical framework for search markets. Peter Diamond has analyzed the foundations of search markets. Dale Mortensen and Christopher Pissarides have expanded the theory and have applied it to the labor market. The Laureates' models help us understand the ways in which unemployment, job vacancies, and wages are affected by regulation and economic policy. This may refer to benefit levels in unemployment insurance or rules in regard to hiring and firing. One conclusion is that more generous unemployment benefits give rise to higher unemployment and longer search times.

Search theory has been applied to many other areas in addition to the labor market. This includes, in particular, the housing market. The number of homes for sale varies over time, as does the time it takes for a house to find a buyer and the parties to agree on the price. Search theory has also been used to study questions related to monetary theory, public economics, financial economics, regional economics, and family economics.

Additional information is available here and here.

EconTalk this week

Douglas Irwin of Dartmouth College talks with EconTalk host Russ Roberts about the role the gold standard played in the Great Depression. Irwin argues that France systematically accumulated large amounts of gold in the late 1920s and 1930s, imposing massive deflation on the rest of the world. Drawing on a recent paper of his, Irwin argues that France's role in worldwide deflation was greater than that of the United States and played a significant role in the economic contraction that followed.

I discussed Irwin's work of the role of France and the gold standard during the great depression here.

Is foreign ownership of land so bad?

Stephen Hickson asked this question in yesterdays Press here in Christchurch. Steve teaches in the Department of Economics and the MBA programme at the University of Canterbury. The short answer is, of course, no but Steve explains it better:

Many New Zealanders also object to the inevitable consequence of foreign ownership of any New Zealand asset or business which is "profits going overseas". In August of this year, Winston Peters declared that he would ban the foreign ownership of rest homes. No doubt Mr Peters would strike a sympathetic chord with many when he says that in foreign ownership he sees "foreign owners getting rich at the expense of the elderly".

Hmmmm, Winston is against it, can't help thinking that means it has to do good!!! But Steve continues by asking an obvious, but not often asked question: Why do we have foreign investment in New Zealand?

New Zealand is a great place to do business and there are lots of good opportunities to grow businesses and create jobs. To grow requires funds and so businesses either borrow money or issue shares in order to finance that growth. This requires someone who is a saver to lend the money or buy the shares.

However, the pool of savings in New Zealand is too small to fund this expansion and so we use the savings of people overseas who are willing to invest in a great place with great prospects.

Naturally, those overseas who lend us money or buy shares in our businesses need to be paid interest or dividends - hence profits going overseas.

Take rest homes as an example and suppose we do not allow foreigners to own New Zealand rest homes. If we want the same number of rest homes to be built then we will have to build them with New Zealand savings.

To do this might mean building less of something else, perhaps schools, shops, roads or wind farms. Or maybe we could increase our own savings to pay for those rest homes.

To increase our savings is very simple - as a nation we just need to consume less. Of course the reality is never as simple as all that.

Are we prepared to reduce expenditure on health and education in order to save more? Remember the Government is a consumer and a saver as well. Are we prepared to reduce our standard of living in some other way? New Zealanders don't appear to be very willing to do so.

Alternatively we could just build fewer rest homes. That will reduce choice for New Zealanders looking to use rest homes and most likely push up the price of going into a rest home.

Now if these outcomes are not too appealing then we have no choice but to dip into the savings of the rest of the world. What then are the impacts that follow from restricting foreign ownership?

The most obvious impact of restricting foreign ownership in New Zealand is that we restrict the opportunities for business growth and job creation.

While some profits head overseas as a result of foreign investment, much does not and of course the wages, businesses and land stay right here.

Foreign owners, just like any business owner, want to see their investments perform as well as possible so they are also likely to reinvest and create even more value for New Zealand.

When we restrict foreign investment some New Zealand worker now finds it just that little bit harder to find a job than they otherwise would have.

There are other impacts,

New Zealand is a small trading nation in a much bigger world.

That bigger world has a lot to offer us and every time we restrict foreign ownership we also reduce our access to the best knowhow that the world has to offer.

For every foreign buyer looking to buy there is a New Zealander looking to sell. By restricting or preventing foreign ownership we are preventing a fellow New Zealander from selling what they themselves own for the best that they can get.

New Zealand is a nation that values freedom and choice.

One of the cornerstones of our society is that we are all free to buy, sell and own land and businesses.

When we impose restrictions on some people in society we tread dangerously on that freedom.

When it comes to private businesses, assets and land it is odd to think that "we" own them. On the day before a New Zealand farm is sold to a foreign owner, I didn't own it and I had no right to say how that farm should be used.

The day after it is sold I still don't own it and I still don't have any rights to say how it is used.

The new foreign owner is also subject to the laws of the land just as much as the previous owner. If a piece of land is important for, say, access to a river or beach then that should be written explicitly into the title of the land.

So if you don't want foreign ownership then the choice is, keep consumption constant and and have less investment, or increase investment and reduce consumption. If neither appeals then welcome foreign ownership.

Roger Kerr has also written on the topic of foreign ownership in New Zealand. In an article in the Otago Daily Times on the 8th October 2010 he said,

Start with some basic economic perspectives.

First, New Zealand has a freely floating currency. A foreigner wanting to acquire a New Zealand asset has to buy New Zealand dollars. The New Zealand dollar seller will be paid in foreign currency, which will logically be used to acquire some other overseas asset (maybe a farm). The country’s net asset position is unchanged.

Second, for a given balance of payments position, more restrictive rules on purchases by foreigners of some class of asset (say land) will automatically mean greater foreign ownership of some other assets (eg businesses). Are there sound grounds for biasing overseas investment in this way?

and added

The spokesman also said that “once land is gone it’s gone.” This is also incorrect. Some years ago a New Zealand company owned Land’s End and John O’Groats in the United Kingdom: iconic sites par excellence. Then it sold them to an English buyer.

Likewise Carter Holt Harvey, with forest land interests, was majority owned by US company International Paper. Then Graeme Hart bought it back (and has purchased land in many other countries).

You can’t physically take land away, nor can you force any owner to sell to foreigners.

There is also the question of if we stop foreigners owning property here should we also not stop New Zealanders owning property overseas?

Another aspect of globalisation is New Zealand investment in agriculture abroad. Fonterra and individual dairy farmers are investing in farms in China, India, Brazil and other countries. New Zealand Farming Systems owned farms in Uruguay (now being onsold to Singaporean interests).

Should other countries ban such New Zealand investment?

Do we really wan t to stop Fonterra and other firms from investing overseas?

Roger Kerr ends this article with a similar point to Stephen Hickson:

Nevertheless, New Zealand governments are entirely at liberty to impose tighter restrictions for non-economic reasons. If they do, however, the community should understand that they come at an economic cost.

or as Hickson put it:

The amount and type of foreign ownership that New Zealand allows is a political choice that we make as a society via the ballot box but there are consequences to the decisions that we make.

If we are to restrict or, in some cases, ban foreign ownership then we should be fully informed and understand the consequences. We might not find some of those consequences appealing.

There is no such thing as a free lunch. Restrictions on foreign ownership come at a cost.

2010 Nobel Prize in economics

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2010

has gone to

Peter A. Diamond
Massachusetts Institute of Technology, Cambridge, MA, USA,

Dale T. Mortensen
Northwestern University, Evanston, IL, USA

and

Christopher A. Pissarides
London School of Economics and Political Science, UK

"for their analysis of markets with search frictions".

More on this later.

Useless information for today

From the Nobel website:

On all "Swedish" Nobel medals the name of the Laureate is engraved fully visible on a plate on the reverse, whereas the name of the Peace Laureate as well as that of the Winner for the Economics Prize is engraved on the edge of the medal, which is less obvious. For the 1975 Economics Prize winners, the Russian Leonid Kantorovich and the American Tjalling Koopmans, this created problems. Their medals were mixed up in Stockholm, and after the Nobel Week the Prize Winners went back to their respective countries with the wrong medals. As this happened during the Cold War, it took four years of diplomatic efforts to have the medals exchanged to their rightful owners.

Only four years, relations must have been improving!!

High tech labour markets

One of the problem with developing a theory of the firm for firms based on human capital is that human capital can not be owned by the firm. Employees can always walkout the door in a way that non-human capital can not. This means that human capital firms can be very unstable with workers leaving anytime they want. Hart (1995: 56-7) goes so far as to argue that, at least some, nonhuman assets are essential to a theory of the firm. To see why this may be so consider a situation where 'firm' 1 acquires 'firm' 2, which consists entirely of human-capital. The question Hart raises is, What is to stop firm 2's workers from quitting? Without any physical assets - e.g. buildings - firms 2's workers would not even have to relocate themselves physically. If these workers were linked by telephones or computers, which they themselves own, they could simply announce one day that they had decided to become a new firm. For the acquisition of firm 2 by firm 1 to make economic sense there has to be a source of value in firm 2 over and above the human-capital of the workers. It makes little sense to buy a 'firm' if that 'firm' can just get up and walk away. Hart argues there must be some 'glue' (non-human assets) holding firm 2's workers in place.

So if firms can not own their human capital how do they overcome such a problem. What is the gue? It looks like companies in Silicon Valley tied to deal with the issue by agreeing not to hire people of each others companies.

Six leading technology companies, including Apple, Google and Intel, reached an antitrust settlement on Friday with the Justice Department that promises to increase the competition for sought-after technology workers. The government had conducted a yearlong investigation into agreements among companies not to poach employees from each other.

The investigation focused on five agreements by the companies not to make cold calls to employees that each company had placed on a do-not-call list. Each of the pacts, according to the Justice Department filing, involved a pair of companies: Apple and Google, Apple and Adobe, Apple and Pixar, Google and Intel, and Google and Intuit.

Anti-competitive or just an rational response to not being able to own some of your most valuable assets?

• Hart, Oliver D. (1995). Firms, Contracts, and Financial Structure, Oxford: Oxford University Press.

Recession and recovery in the euro area

From VoxEU.org come this audio interview:

CEPR’s Euro Area Business Cycle Dating Committee has announced that the recession that began in the first quarter of 2008 came to an end in the second quarter of 2009. Harald Uhlig of the University of Chicago, who chairs the committee, talks to Romesh Vaitilingam about how this recession compares with previous recessions and with the US recession, and about the components of GDP that are driving recovery.

Maurice Allais

From Alex Tabarrok at Marginal Revolution comes the news that Maurice Allais has died.

French physicist and economic Nobel Laureate Maurice Allais has died at age 99. Allais is best known among American economists for the Allais paradox but Allais was a polymath with contributions (and JSTOR here) in a huge number of areas many of which were often overlooked because his work was not translated into english (an unfortunate fact which is still true today).

To be honest I thought he had died years ago. Tabarrok continues with something I didn't know,

One thing that few people know about Allais was that he was a big proponent of the gold standard and Austrian business cycle theory, even citing Mises and Rothbard in some of his work. See in particular his paper in English, The Credit Mechanism and its Implications (1987) in Feiwel (ed), Arrow and the Foundations of the Theory of Economic Policy.

Interesting idea

Firm as a Nexus of Markets is a new paper by Ivan Jankovic. The abstract reads:

The Austrian School's conventional theory of the firm is based on an attempt to synthesize Coase's concept of the firm as a centrally planned hierarchy with the Austrian theory of entrepreneurship and monetary calculation. This paper is a critique of that program as well as an attempt to outline the alternative theory of the firm, one based on the synthesis of the contractual agency theory of the firm (Alchian-Demsetz, Jensen-Meckling) with the same Austrian arguments about entrepreneurship and calculation. The firm in this paper is defined as a nexus of various markets for goods as well as for labor and managerial services rather than as a hierarchy or “organization.” Both the neoclassical and Austrian critiques of the latter concept are utilized to prove that a clear distinction between the market and the firm cannot be established. That distinction is based on the misunderstanding of the firm's dynamics as exclusively tied to the managing/transaction costs ratio as well as on the mischaracterization of inter-firm relations as commanding ones (Demsetz-Alchian, Jensen, Meckling, Fama, Cheung). On the other hand, the central planning view of the firm is equally at odds with the key Mises's argument that rational economic planning is impossible in the absence of market prices (Mises, 1990). If this is so, the firm, as understood in a Coasian paradigm, would not have any reason to exist, or any reason to contribute positively to economic efficiency, because it would simply represent a centrally planned “island of incalculability” in a wider market setting (Rothbard, 2004). Since the firm is a nexus of various markets, its operation is contrary to the Coaseian assumptions led by the price signals. Only insofar as the internal firm's operation is driven by the price signals can the firm be efficient.

The idea that there is no distinction between the market and the firm has been tried before and has not been widely accepted. For me the Rothbard argument would hold but only when when the firm came to dominate the market since this would mean doing away with input prices which would make economic calculation impossible. This puts an upper limit on the size of the firm rather than saying hierarchical organisation can not exist.

Markets fail, so we need more markets

Bernard Hickey, one of New Zealand's business journalists, has been putting about some rather odd ideas that only prove he doesn't seem to understand economics. Matt Nolan and Eric Crampton have covered his nuttiness so I won't say anything more about that. What I think interesting is a point Eric made when he said,

The case for markets never lay in their perfection but rather in the relative imperfection of alternatives. I'm teaching intermediate micro this semester. We go through the welfare theorems, and they're beautiful. We know that they don't apply generally. However, it's really hard to improve on the imperfection of markets. Both markets and policies are imperfect instruments. Markets fail relative to blackboards, but regulatory solutions often fail relative to the real world market alternative.

This is a basic point that many people miss. A version of this idea I like is by Oliver Willaimson,

Students of the NIE eschew hypothetical ideals-which work off of omniscience, benevolence, zero transaction costs, full credibility, and the like-and deal instead with feasible organizational alternatives, all of which are flawed. Coase (1964) and Demsetz (1969) were among the first to take exception with the asymmetric standards that were once used in the "market failure" literature-according to which markets are beset with failures whereas "omniscient, omnipotent, benevolent" governments (Avinash Dixit 1996, p. 8) would reliably administer efficacious remedies. As we all should have recognized (but needed to be told), all feasible forms of organization-government included-are flawed.

What I have referred to as the remediableness criterion is intended to rectify this asymmetric state of affairs. This criterion holds that an extant mode of organization for which no superior feasible alternative can be described and implemented with expected net gains is presumed to be efficient.

To be sure, public policy analysis becomes more complicated when analysts can no longer condemn extant modes because they deviate from a hypothetical ideal, full stop. The remediableness criterion presses the public policy analyst to display a superior feasible alternative. If, moreover, a proposed feasible alternative cannot be costlessly implemented, then the costs of implementation are appropriately included in the net benefit calculus-which has major ramifications for the path dependency literature. Finally, grounds for rebutting the efficiency presumption need to be addressed-which brings in politics (Williamson 1996, 1999). Absent rebuttal, the remediableness criterion stands as a reminder of the obvious: it is impossible to do better than one's best. (Williamson 2000: 601-2)

Government can not do what Hickey seems to want to believe they can do, they are flawed and usually when compared to markets they are more flawed. Thus if Hickey want to show that the use of markets is wrong he has to show that there is a superior feasible alternative can be described and implemented by the government with expected net gains. That isn't easy to do.

So the argument, as Eric notes, for markets isn't that they are perfect, rather its that they are less imperfect than the alternative.

• Williamson, Oliver E. "The New Institutional Economics: Taking Stock, Looking", Journal of Economic Literature, Vol. 38, No. 3 (Sep., 2000), pp. 595-613.

Incentives matter: fire fighting file 2

Previous I posted on one way to deal with the free rider problem associated with firefighting. Now Scott Masten over at the Organizations and Markets blog has extended the discussion. He writes,

My guess is that the reason governments rather than private companies generally provide fire services has a lot to do with the difficulty of pricing fire services. (The Tennessee case involved a quasi-market transaction in that residents outside of South Fulton paid the city of South Fulton for fire protection.) It is certainly conceivable that private fire companies could offer homeowners and businesses a choice between (i) prepaid fire service for an annual fee and (ii) on-demand fire service. But how would you determine the price of the latter? I’m pretty sure you wouldn’t want to negotiate the price while your house is burning down. (Talk about temporal specificity!) And you wouldn’t want to negotiate the price after the fact either: Gee, guys, thanks for saving my house; can I buy you all a beer?

Another problem with on-demand fire services is would the courts enforce any agreement made while the house is burning down? So the obvious alternative is to set the price for on-demand fire protection ex ante.

But this poses problems, too. Either you need a price list (kitchen fire, $X; smoldering electrical fire, $Y; whole-house conflagration, single family ranch-style house, $ZZZZ; and so on) or you set a single price reflecting the cost of the average fire. But even then, you have questions like, what if the fire department were slow to arrive, or sent the wrong equipment or inadequate personnel, or whatever? Even if the department did everything it should, the house might burn down anyway (maybe because, like the first little pig, I’d built my house of straw). You can imagine the law suits over whether or not a homeowner should have to pay the on-demand fire suppression fee if the fire department’s efforts were unsuccessful. Government-supplied fire protection avoids all of these pricing issues. Sure, government supply has its own inefficiencies, but everything’s comparative, and the problems of pricing fire services seem pretty severe to me.

So public provision could be the least bad of two imperfect alternatives.

Econ Nobel at iPredict 2

Richard Thaler now leads with a 31% chance of winning, Robert Schiller in on 30%, Martin Weitzman is on 24% and Oliver Hart has a 20% chance of winning.

Does Robert Barro really have only a 1% chance of winning? There could be some money to be made there.

Eric Crampton has the economics department picks for the prize here. Not that I would trust any of them!

Canada’s budget triumph

David Henderson has a new paper out on the federal deficit in Canada:

A federal government runs a large deficit. Deficits are so large that the ratio of federal debt to Gross Domestic Product (GDP) approaches 70 percent. A constituency of voters have gotten used to large federal spending programs. Does that sound like the United States? Well, yes. But it also describes Canada in 1993. Yet, just 16 years later, Canada’s federal debt had fallen from 67 percent to only 29 percent of GDP. Moreover, in every year between 1997 and 2008, Canada’s federal government had a budget surplus. In one fiscal year, 2000–2001, its surplus was a whopping 1.8 percent of GDP. If the U.S. government had such a surplus today, that would amount to a cool $263 billion rather than the current deficit of more than $1.5 trillion.

So Canada seems to be doing something right. We should ask what they are doing to see if we can do it to.

The main policy actions that the Canadian government took to shrink its budget deficit and turn deficits into surpluses were cuts in government spending. Moreover, the Canadian government didn’t just cut the growth rate of spending, a favorite trick of U.S. politicians who want to claim the mantle of fiscal conservatism. It also cut absolute spending on many programs in dollar terms. And because the inflation rate in Canada, though low, was greater than zero over the whole time period, these cuts in dollar terms were even larger in inflation-adjusted dollars.

Henderson argues that there are two morals from the story:

First, the Canadian experience shows us that a large budget deficit can be turned into a budget surplus with ten years of fiscal discipline, mainly with spending cuts. [...] We do not have to accept the idea that we have only two grim choices: living with huge budget deficits and a federal debt that both increase as a percent of GDP, or accepting our current spending but reducing the budget deficit with major tax increases.

The second moral of the story is that the Canadian experience does not support the Keynesian view that policymakers should not cut government spending during an economic slowdown. The Canadian experience, just like the U.S. experience during the 1920–21 recession and in the first two years following World War II, shows that cutting government spending even during low-growth years can be good for long-term economic results.

Properly not a view many politicians will think agreeable.

Information technology and economic change: the impact of the printing press

In this audio from VoxEU.org it is noted that the movable type printing press was the great innovation in early modern information technology, but until now, little evidence has been found of an impact on growth. Jeremiah Dittmar of American University in Washington, DC, talks to Romesh Vaitilingam about his research, which seems to resolve this precursor of the Solow paradox.

Dittmar's research is “Information Technology and Economic Change: The Impact of the Printing Press”. The abstract reads:

The movable type printing press was the great innovation in early modern information technology, but economists have found no evidence of its impact in measures of aggregate productivity or income per person. This paper examines the technology from a new perspective by exploiting city-level data on the establishment of printing presses in 15th century Europe. I find that between 1500 and 1600, cities where printing presses were established in the late 1400s grew at least 60 percent faster than similar cities which were not early adopters. I show that cities that adopted printing in the late 1400s had no prior growth advantage and that the association between adoption and subsequent growth was not due to printers anticipating city growth or choosing auspicious locations. These findings imply that the diff usion of printing accounted for between 20 and 80 percent of city growth 1500-1600. They are supported by historical evidence and instrumental variable regressions that exploit distance from Mainz, Germany — the birth place of printing — as an instrument for early adoption. The printing press reduced the costs of transmitting information between cities, but fostered new face-to-face interactions and localized spillovers. Print media notably fostered the development of skills, knowledge, and innovations valuable in commerce.

Econ Nobel at iPredict

iPredict is running contracts on who will win this year's Nobel Prize in Economics. As I write Oliver Hart heads the field with a 25% chance, Robert Schiller, Richard Thaler, Martin Weitzman come next, all with an 18% chance of winning.

Also listed are William Nordhaus, Jean Tirole, Angus Deaton, Ricahrd Posner, Gene Grossman, Ernst Fehr, Gordon Tullock, Avinash Dixit, Sam Peltzman, Eugen Fama and Robert Barro.

The Economic Sciences prize is due to be announced on Monday 11 October, 11:00 a.m. GMT, at the earliest.

So put your money where your mouth is!

The ownership of the firm under a property rights approach

This is the title of an interesting looking new working paper by Leshui He. The abstract reads,

The boundaries of the firm and the ownership of the firm have been two of the main themes of the economics of organization over the past several decades. In this paper, I develop a general multi-party framework that integrates the ownership of the firm into the property-rights approach to the firm. I consider the ownership of the firm as the ownership of the rights to terminate cooperation with any party while maintaining a contractual or employment relation with all the other related parties of the firm. The model in this paper allows for the separation of the ownership of the firm from the ownership of the alienable assets that partly constitute it. Such a general multi-party setup may provide new tools for the study of the problem of the firm's boundaries as well as inspiration for further applications of the theory of property rights.

The referral to property rights here means the Grossman-Hart-Moore approach.

Incentives matter: fire fighting file

This news report shows one of way getting people's incentive to pay and avoid free riding right:

OBION COUNTY, Tenn. - Imagine your home catches fire but the local fire department won't respond, then watches it burn. That's exactly what happened to a local family tonight.

A local neighborhood is furious after firefighters watched as an Obion County, Tennessee, home burned to the ground.

The homeowner, Gene Cranick, said he offered to pay whatever it would take for firefighters to put out the flames, but was told it was too late. They wouldn't do anything to stop his house from burning.

Each year, Obion County residents must pay $75 if they want fire protection from the city of South Fulton. But the Cranicks did not pay

Basically the county let a guy's house burn down to give everyone else the right incentives to pay the $75.00 fire protection fee. You would assume that the home owner would have willingly paid more than $75 to have his house saved, but the county understood that if they accepted his late payment, it would have caused other residents not to pay their annual fire protection fee. That is one way to deal with free riding!

(HT: Division of Labour)

EconTalk this week

The (in)famous Bryan Caplan of George Mason University and EconLog blogger talks with EconTalk host Russ Roberts about immigration. Caplan takes on the common arguments against open borders and argues that they are either exaggerated or can be overcome while still allowing more immigration than is currently allowed in the United States.

Whither the EMH?

The following comes from the BNZ Annual Lecture given by Professor Glenn Boyle, Department of Economics and Finance, University of Canterbury, under the title "Whither Economics?", delivered in Christchurch on 1 July 2010. EMH means "efficient market hypothesis".

But what specifically are the failings of the EMH that lead to such damning criticism?

Four appear to be central:

• Financial economists didn’t predict the crisis, thereby ‘proving’ that markets can’t be efficient in the way that economists believe.
• The collapse occurred too quickly for markets to be efficient.
• There was an obvious asset price bubble, which is incompatible with an efficient market.
• Belief in the EMH by traders and regulators created a false sense of security thatallowed the crisis to occur.

Those who argue that a failure to predict the crisis disproves the EMH are simply confused, since a central insight of the EMH is that such events should be unpredictable. In a market where prices already reflect all existing information, only new information can change prices. But new information, by definition, is unpredictable, both in content and in timing. Ergo, price changes must also occur unpredictably – implying that no investor can consistently earn above-average returns, net of the costs of acquiring information. If financial economists as a group had announced in December 2007 that financial markets would collapse in nine months time, and that they had sold all their securities and taken on as many short positions as possible, and then the collapse had occurred just as predicted in September 2008, that would have constituted strong evidence against the EMH. But what actually happened was entirely consistent with the EMH.

Similarly, prices should respond quickly in a market that processes information efficiently – when a fire breaks out in the theatre, it’s perfectly rational for everybody to head for the exits at once. A slow and gradual downturn – which is what the critics seem to think should happen in an efficient market – would in fact have been a strong indicator of market inefficiency.

The EMH does not imply that security prices are always ‘right’ in some fundamental sense, only that it’s impossible to tell whether prices are right or wrong. If all available information is incorporated in prices, there cannot be any information left to determine whether prices are ‘right’ or ‘wrong’. Any new information could confirm that prices are ‘right’ or indicate that they are ‘wrong’, but because this information is unpredictable it’s impossible to tell which is the case ex ante. Consequently, the formation of so-called asset price ‘bubbles’ is inconsistent with the EMH only to the extent that these are identifiable at the time they occur. While there were a number of commentators who regularly ‘cried wolf’ over many years prior to the 2008 crisis, few, if any, seem to have withdrawn from securities markets altogether – which, as Ray Ball points out, is the only reliable test of predictability. As Robert Lucas (Economist, 8 August 2009) notes, a central lesson of the crisis is the futility of attempting to find central bankers and regulators who can identify bubbles – since such people are unlikely to exist in the first place, and would be unaffordable if they did.

The most serious charge against the EMH is that it helped cause the crisis. Did financial market traders load up on risk and debt in the belief that an efficient market would give them early warning if they went too far? Did regulators sit on their hands secure in the knowledge that they could rely on an efficient market to do their job for them?

The answer to both questions is surely ‘no’ – if anything, the behaviour of both traders and regulators exhibited a lack of belief in the EMH. Traders have never subscribed to the EMH – after all, their principal raison d’etre is to out-perform the market. And in the years leading up to the 2008 crisis, some loaded up on risk and leverage in a selfdefeating attempt to attain this objective. Nor did regulators behave as if they had even the remotest belief in the EMH. If they had, they would have looked very closely at the suspiciously good performance of Freddie Mac and Fannie Mae and at the leverage of Lehman and Bear Sterns. They would certainly have been crawling all over Bernie Madoff. But instead they behaved as though they believed consistently high, above market returns were nothing at all to be sceptical about.

So the critics have got it the wrong way round. To the extent that there was indeed a link between the emergence of the crisis and belief in the EMH, the problem was too little belief, not too much. If traders had believed more in the EMH, they would have given up trying to beat the market and reduced their risk. If regulators had believed more in the EMH, they would have spotted, and taken action against, the high-risk and fraudulent strategies staring them in the face.

A nice brief readable summary of the issues to do with the EMH and the recent financial crisis.

The overriding lesson to take from this may well be,

Ultimately, economists must take a large share of the blame for the demise of sensible commentary on economics. Too many seem all too happy to offer up regular forecasts of financial market variables such as exchange rates and short-term interest rates, despite a huge research literature indicating that changes in such variables are not predictable. Such economists need to learn some humility. Too many others seem all too happy to advocate significant government intervention in financial markets on the slightest pretence, despite a huge research literature indicating that such action inevitably has unintended consequences. Such economists need to learn some economics.

Canada and fractional reserve banking

Steve Horwitz over at the Coordination Problem blog wants to say something nice aboot Canada (no, I can't see the point either).

If you ventured over to the Land of the Tinfoil Hat also known as my Daily Bell interview, you'll have seen many folks there (and elsewhere in the wacky world of libertarianism) arguing that fractional reserve banking is reponsible for everything from bad breath to why the Detroit Lions suck. Okay, those were exaggerations, but they do think, for example, it was responsible for the pre-Fed panics among other things.

The problem with that argument (aside from the fact that it was existing government interventions that caused those panics) is that it ignores the Great White North. During the same period of the late 19th and early 20th century, Canada had no central bank and fractional reserve banking, yet it had none of the panics the US suffered and it got through the 20s and 30s with no bank failures, compared to the 9000 or so that failed in the US.

If fractional reserve banking is the problem, how does one explain the success of the Canadian system? I have asked the question over in the Land of the Tin Foil Hat and will be curious to see what they have to say. Or if I can understand it. Til then.... take off, eh.

Fractional reserve banking working? Oh dear, what would Murray Rothbard say?!

Regulating knowledge monopolies: the case of the IPCC

This paper, Regulating Knowledge Monopolies: The Case of the IPCC by Richard S.J. Tol, calls for regulation of the IPCC. The abstract reads,

The Intergovernmental Panel on Climate Change has a monopoly on the provision of climate policy advice at the international level and a strong market position in national policy advice. This may have been the intention of the founders of the IPCC. I argue that the IPCC has a natural monopoly, as a new entrant would have to invest time and effort over a longer period to perhaps match the reputation, trust, goodwill, and network of the IPCC. The IPCC is a not-for-profit organization, and it is run by nominal volunteers; it therefore cannot engage in the price-gouging that is typical of monopolies. However, the IPCC has certainly taken up tasks outside its mandate; the IPCC has been accused of haughtiness; innovation is slow; quality may have declined; and the IPCC may have used its power to hinder competitors. There are all things that monopolies tend to do, against the public interest. The IPCC would perform better if it were regulated by an independent body which audits the IPCC procedures and assesses its performance; if outside organizations would be allowed to bid for the production of reports and the provision of services under the IPCC brand; and if policy makers would encourage potential competitors to the IPCC.

Competition is the answer to monopoly. I'm not sure that the IPCC is a natural monpoly, its power comes from the fact that the World Meteorological Organization and the UN Environment Programme back it. Its power is therefore basically the product of "government" actions. The IPCC is the sole advisor to the international negotiations on climate policy under the UN Framework Convention on Climate Change. Remove such backing and the IPCC would have to stand on its own merits - such as they are.

Tol's call for increased competition is a positive move. But he could go further and call for an end to the IPCC itself and then let other bodies, national and international, provide what ever advise they wish. Why should a free market not work in the intellectual sector in the same way its works in other sectors of the economy?

Interesting paper: Inside Organizations

An interesting new paper from Robert Gibbons: Inside Organizations: Pricing, Politics, and Path Dependence. Annual Review of Economics, Vol. 2: 337-365, September 2010. The standard theory of the firm asks questions, mainly, about the boundaries of the firm. Less interest has been shown in the internal organisation of firms. This is beginning to change, as this survey from Gibbons shows. The abstract reads:

When economists have considered organizations, much attention has focused on the boundary of the firm, rather than its internal structures and processes. In contrast, this review sketches three approaches to the economic theory of internal organization—one substantially developed, another rapidly emerging, and a third on the horizon. The first approach (pricing) applies Pigou's prescription: If markets get prices wrong, then the economist's job is to fix the prices. The second approach (politics) considers environments where important actions inside organizations simply cannot be priced, so power and control become central. Finally, the third approach (path dependence) complements the first two by shifting attention from the between variance to the within. That is, rather than asking how organizations confronting different circumstances should choose different structures and processes, the focus here is on how path dependence can cause persistent performance differences among seemingly similar enterprises.

Gibbons explains,

The first approach (pricing) may feel familiar to economists because it can be seen as applying Pigou's (1932) prescription: If markets get the prices wrong, then the economist's job is to fix the prices. The resulting models ask not only what prices should be attached to various actions inside organizations, but also what direct and indirect methods are available to set these prices. Because of its focus on pricing, this approach naturally addresses incentive contracts. Because it also considers indirect methods for setting prices, however, this approach also addresses many structures and processes within and between organizations, including job design, transfer pricing, and outsourcing.

The second approach (politics) considers environments where important actions inside organizations simply cannot be priced, directly or indirectly. As a result, power and control become central, as in models of battles for control, lobbying those in control, and so on. More generally, this approach views the organization as a decision process, so issues of gathering and communicating information naturally arise, in addition to issues of control and decision making. The politics approach has received less attention from economists than has the pricing approach, but it has grown rapidly over the past decade, and it has interesting connections to earlier work outside economics.

Finally, the third approach (path dependence) is not an alternative to either of the first two, but rather a complement to both. This approach shifts attention from the between variance to the within. That is, rather than ask how organizations confronting different circumstances should choose different structures and processes, the focus here is on how path dependence can cause seemingly similar organizations to perform at persistently different levels. One important source of path dependence connects to an important issue in both the pricing and politics approaches: relational contracts (i.e., agreements so rooted in the particulars of the parties' circumstances that they cannot be written down and hence must be self-enforced rather than adjudicated by outsiders such as courts). Whereas both the pricing and politics approaches include work emphasizing the importance of relational contracts in steady-state outcomes, the path-dependence approach enriches the others by focusing on how the dynamics of building and changing relational contracts can affect which steady-state outcomes are reached.

An interesting and important expansion of the standard approach to the theory of the firm into organisational economics, where the internal structure of firms, as well as their boundaries, are looked at.

Speed cameras: only for the money

From the Express.co.uk website we learn:

THE first town to switch off its speed cameras is celebrating the decision after accident rates and fines plummeted.

There have been no deaths on Swindon’s roads since the fixed cameras were turned off in August last year.

In the past 12 months, the town has had just two serious accidents and 14 slight accidents.

This is compared to one death, five serious and 15 minor crashes the year before. The council raked in £80,000 less than the previous year, issuing 1,341 fewer speeding tickets.

So speed cameras don't improve road safety but do bring in money. Well this explains why councils love them so much.

It could all be just part of normal statistical variation, of course, but still an interesting result which would be good to see tested in other areas.

If a new economy, what about a new economics?

Random thought for the day. We are often told that we live in a "new economy", that changes in computing and information technology, financial innovation, more globalised trade etc have changed in economy and society in which we live. If this is true then why have we not seen a similar change in economic thinking? Or do we not need a new economics for the new economy?

One idea that has found favour with who argue for the new economy comes from the world of old economics. Back in 1937 Ronald Coase argue that firms exist because for some transaction it is more effective to carry out those transactions within firms than it is via markets. That is, in some circumstances firms minimise transaction costs.

For some new economy advocates this is a compelling idea. One consequence of the information revolution is surely that it is now cheaper to communicate. This should affect firms and their boundaries since it will lower transaction costs and thus make market transaction more likely. More market transaction mean fewer within firm transactions and thus firms should downsize and rely on outsourcing to a greater degree.

However, if it is cheaper to communicate via the market is it not also true that it would be cheaper to communicate within the firm as well? In fact anything that reduces internal communication costs will lead to an increase in the size of firms.

Thus firm size could go either way. The nature of the reduction in transaction costs is all important. There are three groupings of transaction costs: information and search costs, haggling and decision costs, and policing and enforcing costs. Hal Varian has considered each of these groups:

The Internet certainly reduces search and information costs, but, as we have seen, this cuts both ways. Bargaining and decisions still require a team of managers and lawyers sitting around a table. What makes contracts easier is codification and standardization, trends that are important, but are not greatly affected by the Internet, at least so far.

Policing and enforcing costs are the most relevant category. The reason the assembly-line worker doesn't negotiate with the person next to him is that it's too easy for him to say, ''Give me a good deal or I'll stop the line.'' Putting all the assembly-line workers under command-and-control reduces this sort of opportunistic behavior, at least as long as it can be easily observed.

Two important addition factors need to be considered. One is the more general application of opportunistic behaviour. People can act opportunistically in many settings and ways. The incentive for such behaviour hasn’t been much affected, at least not yet, by the Internet and computers. The second factor is the increased importance of human capital to the production process. What we see is that human capital is now a bigger part of the value added of firms. This gives people more power within the firm and it has been argued that firms boundaries are changing because of this. Many firms are now developing structures that are looking more like partnerships than the more traditional command-and-control organisations.

But none of this however requires a new economics. In fact, as noted above, it is all based on old economics. No only in terms of years, but also in terms of method. Coase set out to apply the marginal analysis of Marshall to his theory of the firm. So the new economy seems to work just fine within an old economics framework.

The Latest from the "Standup Economist"

(HT: Greg Mankiw)

Collusion between administrators and students unions?

This press report tells us,

Lincoln University says student associations are vital to campus life and it is condemning an ACT bill to make their membership voluntary.

and

Lincoln University and its student association issued a joint statement today, condemning the bill.

You do have to ask why this collusion between the university administrators and the students union? It can't be for the good of the students, if the uni administrators cared about that they would just let the students vote on what they really wanted and go along with the students wishes. No it's more likely that administrators find it easier to ignore what students really want while maintaining the fiction that students have been consulted on issues, when all they have really done is talk to the student president.

As Sir John Hicks put it, the best form of monopoly is a quit life, and student unions give uni administrators that.

Arnold Kling on eduaction

Over at the EconLog blog Anrnold Kling writes,

In my final comments, I took aim at the university administrators. I said that "Education is no longer a public good." I said that education is dominated by special interests, such as teachers' unions. I did not add "and rent-seeking university administrators." Before you give me kudos for courtesy and discretion, you should know that I think what actually happened is that I was working on my next train of thought and dropped the thread. I then did a 30-second rant about credentials cartels, during which I suggested that some of the college wage premium was due to artificial requirements to enter various professions. I said that government should remove the subsidies, regulations, and accreditation barriers that stifle competition in health care and education.

Only wish I had been there to hear that. One could indeed argue that universities no longer seem to exist to teach and so research, the primary function for them these days is protecting the rents of administrators, to hell with the academic and students. The idea of that the "government should remove the subsidies, regulations, and accreditation barriers that stifle competition" will not go down well with the aforementioned administrators. Actually if Kling thinks there is a lack of competition among universities in the US he should take a look at New Zealand!

Also you do see barriers to entry in many academic based areas and it would be interesting to know just how much of the "wage premium" in these areas has to do with these barriers. An increase in demand for training in such jobs may not explain the increase in wages as many people claim.

George Stigler on what makes a teacher

The following quotation is from George Stigler's collection of essays on academia and society, "The Intellectual and the Marketplace".

The good teacher is a mysterious person, and yet we must know his character before we can prescribe his training. In my view, the good teacher is not distinguished by the breadth of his knowledge, by the lucidity of his exposition, or by the immediate reactions of his students. His fundamental task is not to dispense information, for in this role he is incomparably inferior to the written word. His task is to fan the spark of genuine intellectual curiosity and to instill the conscience of a scholar--to communicate the enormous adventure and the knightly conduct in the quest for knowledge

[...]

To this end, the fundamental requirements of the good teacher are competence (How can the incompetent be other than slovenly?) and intellectual vitality (How can the sedentary excite us to bold adventure?).

These traits may be acquired by wide reading and deep reflection, without engaging in research and becoming a specialist. But it is an improbable event. It is improbable psychologically: it asks a man to have the energy to read widely and the intellectual power to think freshly, and yet to do no research. He is to acquire knowledge and construct ideas--and keep them a secret. It is improbable scientifically: it asks a man to be competent in his understanding of work that he has had no part in constructing. At lease in economics, this is almost impossible. There is no book that states the consensus of the profession on the ideas that are changing--and these are naturally the most interesting ideas. Only the man who has tried to improve the ideas will know their strengths and weaknesses. Scholarship is not a spectator sport.

In other words, research and teaching are linked. One wonders what powers that be in our universities would make of this.

(HT: Division of Labour)