The end of macro?

Over at the EconLog blog Arnold Kling writes,

I was born at the wrong time. I attended graduate school near the peak of ultramasculine economics (my term). The math was almost too much for me (in fact, five years later it would have been too much for me). I have always doubted the value of the theorem-proving approach to economics. I note that these days many people are sharing my doubts about the mathematical macro that emerged during what Paul Krugman calls the "Dark Age." However, unlike Krugman, I do not think that we can simply go back to old Keynesianism. I think that there were many problems with Keynesianism circa 1970 that were not solved by coming up with mathematical solutions for the Lucas critique. The Leamer "con" of econometrics problem and the "unit root" problem are what caused me to "lose my religion" regarding macroeconometric models.

Here's a thought. May be the problem is not with the maths or stats of macro but with the actual idea of macro itself. May be aggregate economics just doesn't work, we lose too much valuable information in the process. May be the costs of aggregation are just too high, we need to look at the micro level for solutions to so-called macro problems. For example unlike the macro-level data, micro-level data provides little evidence in support of Solow's productivity paradox to do with the effects of computers in the economy. While the macro level data can tell us that something has changed, as it did mid-90s in the U.S., it can not tell us what changed and why. The productivity data is the aggregated result of changes at the micro level, in this case at the level of the firm. Such changes require a microeconomic explanation. Would it not be better if we were to go back to thinking about issues like unemployment and monetary theory as microeconomic issues. We could see unemployment as a problem to do with labour markets and interest rates as relative prices, monetary policy as having to do with the supply and demand of money etc. Do away with teaching students AD/AS analysis from day one and just teach them about markets and consumers and producers instead.

Jeff Miron on healthcare reform

Relative prices v. inflation

At Offsetting Behaviour Eric Crampton writes,

RBNZ rightly looks through the one-off hike in price levels that came with the GST increase. That's not inflation. But that level shift working its way into wage settlements would be.

From the latest survey of employers:

* Roughly a third say that the GST increase has been or is expected to be a factor in future wage negotiations (see Table 68)
* A majority of large (50+ employee) firms say wages and salaries either take account of past inflation outcomes, take account of expected future inflation, or are contractually linked to inflation (Table 67). Note that headline inflation numbers will include the GST hike.

I don't get it. Why would the RBNZ worry about a change in wages. Such a change is a change in a relative price, not a change in the price level. Or does the RBNZ believe in cost-push inflation. Oh dear!

EconTalk this week (updated)

Dani Rodrik of Harvard University talks with EconTalk host Russ Roberts about trade, the labor market, and trade policy. Drawing on a recent paper with Margaret McMillan on trade and productivity, Rodrik argues that countries have very differing abilities to respond to increases in productivity that allow production to expand using fewer workers in a particular sector. When workers are displaced by productivity increases, what is their next best alternative? Rodrik discusses how this varies across countries and policies that might improve matters. He argues that poor countries should subsidize new products as a way of overcoming uncertainty and externalities from new ventures.

Update: See also Rodrik and externalities.

The bailouts of General Motors and Chrysler

Bad, very bad, for both the economy and the rule of law. Todd Zywicki, who is in the George Mason University School of Law, writes on The Auto Bailout and the Rule of Law in National Affairs.

The bailouts of General Motors and Chrysler have been held up by President Obama and his supporters as a great success story — proof that, by working together, government and business can save jobs and strengthen the economy. But this popular narrative is dangerously misleading. Far from a success story, the events surrounding the bailouts offer a cautionary tale of executive overreach. And their example clarifies the Obama administration's broader approach to economic policy — an approach that is both harmful to economic growth and dangerous to the rule of law.

and

Of course, this "success narrative" is based on a particular reading of the events surrounding the bailout. According to that reading, the nature of the '08 financial crisis — as well as the economic importance of the auto industry — meant that the government simply could not let GM and Chrysler go under. But at least the unprecedented cooperation between the government and the automakers was undertaken in a deliberate, careful way — using the government's special authority to contend with the economic crisis in order to guide the companies through an orderly re-organization (rather than the dreaded chaotic collapse). As a result, the companies were saved, and now they have a chance to thrive again.

Unfortunately, every part of this reading of events is wrong.

Zywicki contiues

Every piece of the "success story" of the auto bailout would thus seem to be in error. The bailout was not absolutely necessary and was pursued by means of dubious legality; the bankruptcies were highly irregular and inefficient; and the companies that have emerged from bankruptcy are far from lean and fit. They are certainly in no position to repay taxpayers for the generous loans they were given.

But as bad as the facts of the story are, the implications are much worse. Through their actions, both the Bush and Obama administrations have set dangerous precedents — and made it much more difficult to reverse the trends of executive overreach and excessive government entanglement with private business.

As a matter of policy, the Bush interventions early in the process were more ad hoc affairs, motivated largely by panic in the midst of the economic crisis. This was particularly true of Treasury Secretary Henry Paulson, whose performance in the final months of the Bush administration was disgraceful. But it is hard to avoid the conclusion that, at its core, the Bush approach was also influenced by the imperious view of executive power that had developed in the course of the war on terror and had been supported by some conservative thinkers for much of Bush's presidency. The notion that the president simply must do whatever he judges necessary in an emergency — regardless of whether he has the formal legal authority to do it — is among Bush's foremost legacies. The concluding months of his presidency should offer a cautionary tale to conservatives inclined to adopt that view of executive power.

The Obama administration's role in this story, however, is far more troubling. One cannot explain away Obama's overreach as a panicked response to an emergency; rather, his actions toward GM and Chrysler were part of a considered, coherent approach to the relationship between government and private industry. And this approach — defined by broad government power unchecked by legal constraints and possessing sweeping authority to pick winners and losers — has guided the administration's policies well beyond the auto bailout. The aim of this approach is to rejuvenate the New Deal vision of the regulatory state, in which regulators are seen as disinterested experts with the factual knowledge, practical wisdom, and unwavering integrity to manage the economy. They alone are presumed to be capable of steering the nation toward prosperity.

It was this approach that clearly animated, for instance, the financial-reform legislation enacted by President Obama and the Democratic Congress last year. Just as the government was seen as having the wisdom to micromanage the restructuring of Chrysler and General Motors, so the new financial-reform law creates a vast web of regulatory bodies and presumes that they will have the know-how to successfully reshape America's entire financial system. The same basic pattern can be seen in several of the Obama administration's other legislative achievements — from the massive 2009 stimulus package to the health-care reform bill to a host of environmental regulatory initiatives.

Taken together, these laws have dramatically worsened the entanglement of government and the private sector, and have thereby led to an increase in lobbying activity by special interests seeking government favors or protection. The financial-reform law, for instance, is littered with special-interest provisions intended to entice major corporations into supporting the administration's new approach to economic policy. Auto-finance lenders are inexplicably exempted from the jurisdiction of one of the law's new creations, the Consumer Financial Protection Bureau, thereby sparing them (and the influential auto dealers they work with) from the regulatory costs and hassles caused by the CFPB. The nation's biggest banks, too, ultimately came to support the creation of the CFPB, as they recognized that its heavy regulatory burdens would be borne much more easily by large institutions — which can more readily afford to hire lobbyists and lawyers to help navigate the law's complexities — than by their smaller competitors.

Other examples abound; among them, the most outrageous is probably the sweeping health-care law enacted last year. The legislation had the support of America's major health insurers — likely because the law made them the first suppliers in American history to see the federal government mandate the purchase of their product by every single citizen. The opposition of pharmaceutical manufacturers, too, was significantly dampened; presumably this had something to do with the administration's promises of increased market demand for their products. Even the American Medical Association — which should have been representing the interests of doctors, who will face enormous difficulties under the law — rolled over, partly to obtain a repeal of rules that had limited certain Medicare reimbursements. Again and again, large corporate actors and other organizations have been willing to sell some freedom of action in return for a competitive advantage provided by the government.

Zywicki ends by noting,

The Obama administration's economic policy, therefore, returns us to the thinking of the 1950s and '60s — to an economy in which big business, big labor, and big government are tied together in a relationship of mutual succor and support.

The auto bailouts exemplify this new reality. Sold as a means of revitalizing the economy, they are in fact a means of transforming the relationship between the state and the market in a way that empowers large players at the cost of economic growth. The overall effect of such state capitalism is a kind of controlled stasis, in which the preservation of old jobs takes priority over the creation of new ones. Managed decline, rather than dynamic growth, is the defining feature of the Obama economy.

There are good reasons why you want a separation of Church business and State. Business backed by the power of the state may be good for business, but its hard to believe it will be good for growth, entrepreneurship or the consumer. This is something worth keeping in mind given the way the current New Zealand government seems to want to intervene in business.

Can money really buy happiness?

A big question asked by Allen Sanderson in the Chicago Life magazine. The basic message in his argument is  in the last paragraph:

In the end, GDP and average income may still be the best measures of well-being, in part because they correlate so strongly with other quality-of-life variables such as access to basic necessities, better health, and education. And despite their flaws, they are a pretty good ‘North Star’ to follow. Of course, some people watch Dr. Phil, try to keep up with the Kardashians, are avid fantasy sports league participants, or send 100 text messages a day, exhibiting that even in the midst of plenty you can still have no life.

GDP is not a measure of welfare, it was not designed to be one. But is does have a positive correlation with things that we think do improve welfare, so as a first cut, real GDP per capita is not a bad place to look to get a handle on welfare of a country.

A donor kidney market: pro/con

Los Angeles Times debates the issue of whether there should be a market for kidneys for transplants.

For:

People who need kidneys are dying unnecessarily, and an organ market would save lives.

Dr. Benjamin Hippen is a transplant nephrologist at the Carolinas Medical Center in Charlotte, N.C.

The most compelling reason for setting up a market for organs is that there really isn't any other plausible solution to the growing disparity between the demand for and supply of organs. Even if we were to maximize organ procurement from deceased donors, we still couldn't meet the demand.

As that demand grows, it's not just potential kidney recipients who get desperate — it's also potential donors, who often have a close-up view of what their loved ones are going through. We then see people with health problems, like high blood pressure or obesity, say that they're willing to take on a certain amount of risk so that their loved one can live a better life.

A regulated market would be, in some sense, safer — the pressure would be taken off folks who want to be donors but perhaps shouldn't be for medical reasons. Transplant professionals could then select the healthiest donors, who are at the lowest risk for long-term complications. With a regulated market, we could say to high risk-donor candidates, "No, you shouldn't be a donor, and your loved one isn't going to suffer as a consequence of that decision."

There's also a significant difference between what it costs to maintain a transplant versus what it costs to maintain someone on dialysis. In 2007, $28 billion was spent nationally on people on dialysis; about $2.2 billion was allocated to kidney transplantation. So transplants are vastly more cost-effective, and in general they confer a longer survival benefit. Also, a larger proportion of people are able to go back to work compared with people on dialysis.

The unregulated, underground black market in organs in developing countries has been catastrophic for both donors and recipients. But the reason that someone who is desperately poor may be able to sell their kidney on the black market is that people in countries of comparative wealth have failed to solve their own supply problem. That is a policy failure. If the demand for organs could be met through legal, ethical strategies, some of the driving forces that support black markets would disappear.

If, indeed, the current system isn't meeting demand, then there's a sense in which it's unethical not to establish regulated incentives for living donors or to think more carefully about not doing so. The cost is being paid by the people who are dying on the waiting list, getting sicker on dialysis or selling their kidneys under terrible circumstances.

Against:

An organ market would exploit the world's poor and set the precedent for medical transplant tourism that puts everyone at risk.

Dr. Francis Delmonico is the director of renal transplantation at Massachusetts General Hospital and a professor of surgery at Harvard Medical School. He is also the medical director of the New England Organ Bank in Newton, Mass.

Despite the good intentions of those who would suggest that an organ market could be regulated, it's impossible to do so. A market for organ sales enables brokers and extra payments, and in a global society, the market could not be restricted to the United States.

Right now, our country sets the tone on this issue. Once we say it's OK to have a market here, it condones markets everywhere else in the world, and with medical tourism being what it is, those in search of kidneys will go to the place where it's the cheapest price — Americans won't be limited to undergoing transplants locally.

From there, transplant tourism in global markets brings unanticipated consequences. It increases the risk for diseases like hepatitis, tuberculosis or malignancy, and it also opens the door to a variety of unethical practices involving the donor and their medical care.

The central problem of organ sales is that it's a victimization and exploitation of poor people, notwithstanding good intention. The source of these organs is always the lowest socioeconomic class of a particular country — we know that has been the case in the Philippines, in Pakistan, in Egypt and in Iran. And the payment isn't that substantial of an amount, so rather than making them better off or helping them, the money is quickly used, and the donor is left with one less kidney. It's a reality that there's no escaping.

It's true that there has been a plateau of living donors in this country, and something has to be done. For that reason, I do believe in eliminating disincentives for donors. The living donor who doesn't have health insurance should have it — and even life insurance — provided for them, as it pertains to the donation event.

A market is kidneys is just one example of what economists refer to as "repugnant markets".

Interesting blog bits

1. On the AMI bail out:
• Matt Nolan here and here
• Eric Crampton here
• Not PC here
2. Paolo Manasse on The trouble with the European Stability Mechanism
   

   The meeting of the European Council on 24-25 March focused on shoring up the battered Eurozone infrastructure through the European Stability Mechanism. This column argues that the mechanism is seriously flawed. It says it is unlikely to withstand the shock of a severe financial crisis and may even spread the damage to high-debt countries, while leaving the Eurozone in the grip of paralysing vetoes.

3. Tim Worstall on why Fatties and smokers save the NHS money.

   We're told, endlessly, that smoking must be even more highly taxed because smokers cost the NHS oodles of money. Further, that salt, fats, junk food, should all be taxed because fatties cost the NHS lots of money.
   
   This is nonsense, nonsense on stilts.

4. Chidem Kurdas on the Japan Nuclear Crisis vs. the Titanic

   The Fukushima Daiichi nuclear threat and the sinking of the Titanic are both disasters caused by acts of nature – earthquake and tsunami in one case, an iceberg in the other – interacting with technology. Yet they have radically different implications. The Japanese incident has made nuclear power less acceptable, whereas the sinking of a ship, no matter how immense the casualties and spectacular the failure, did not stop shipping.

5. Bryan Caplan on 40 Things I Learned in My First 40 Years.

   Caplan has decided to write a list of important lessons he has learned during his first four decades.

6. Arnold Kling on If Economists Designed Health Policy.

   They would come up with something like this.

7. Ed Dolan asks Is Financial Reform Working or Will It Make Things Worse?

   The 2008 financial crash gave rise to a world-wide call for a review of regulations. In the United States, the EU, and international forums like the Basel Committee on Bank Supervision, the conclusion was reached that regulators had allowed banks and other financial institutions to take risks well in excess of those justified by the public interest. Legislatures were brought into the act where needed to change the regulatory framework. Everyone vowed to fix things.

8. Gavin Kennedy on A Tale of Two Prophets

Global prospects for growth

In this audio from VoxEU.org, Michael Spence of Stanford University talks to Viv Davies about growth prospects in the U.S. and developing countries. He describes the current divergence between growth and employment in the U.S. economy. They also discuss global imbalances, fiscal coordination in Europe, the global investment rate and the threat of rising oil prices to global growth.

In this an IMF video interview Spence talks about New Ideas for a New World.

Austrian thoughts on competition policy

This is from a blog posting by Philip Booth, from the IEA blog, on competition policy. I am increasingly of the view that competition policy is next to useless or outright dangerous. Booth offers an Austrian view of competition policy in which the market is seen as a dynamic process of entry and exit with entrepreneurs discovering new information, new products and new forms of production in ways that actually increase people's welfare. That is, a view that realises that markets really can be good for us. For Austrian's the major issue is whether or not a legal framework allows for the process of competition which sees both entry into the market of new firms and exit from it of failed firms. Standard competition policy looks at the market in too static a manner.

Booth says it better,

Traditional ways of looking at competition policy are problematic in general, but especially in innovative industries. The focus is on the structure of the market as if it is a static entity. There has been more progress in recent years by competition authorities to try to understand the application of different concepts of market definition. But, nevertheless, we have had enquiries into supermarkets and banks in the last decade where the authorities have tried (in the case of the banks) to calculate their super-normal profits using the capital asset price model and (in the case of the supermarkets) taken market definitions to a ludicrous degree of granularity. From this sort of flawed analysis they have then developed policy.

As noted, the Austrian view is to see the market as a dynamic process of entry and exit with the big question being whether the legal framework utilised for competition policy allows for the process of competition, something neoclassical models are not good at doing. Booth continues.

Competition authorities with their neo-classical models have sometimes adapted to this way of thinking in a limited way. They have sometimes replaced models of market structure with models of contestability and looked at barriers to entry.

Booth argues that this approach while an improvement doesn't go far enough.

But this does not take the Austrian perspective far enough. As Vince Cable suggested in some disparaging remarks he made about business, it could almost be said that the purpose of businesses is to create monopolies. What Vince Cable did not say, though, is that, except when governments create monopolies, those private monopolies come under continual attack from potential entrants. Competition comes both from actual entry and the threat of entry. The structure of the market at a particular point in time does not necessarily indicate the degree of competition.

Booth then asks What can Austrian economics tell us about competition policy? His answer:

As ever, the main function of the economist, as Hayek put it, is to help us understand how little we know. One of the chapter headings of Law, Legislation and Liberty read: ‘If the factual requirements of “perfect” competition are absent, it is not possible to make firms act “as if” it existed’. In other words, if we do not have perfect competition there are unexploited opportunities for welfare enhancement that entrepreneurs still have to discover. If they have not been discovered we do not know what they are and therefore we do not know how to correct for the market failure.

This is clearly a problem for the authorities. But, there is another problem. The potential for monopoly profits must be a spur to innovation, research and development. If this were not the case, then why do we grant patents? If we restrict the monopoly profits that arise before a monopoly is contested or before innovation makes the monopoly irrelevant then we will reduce invention and innovation. We can never, know, of course, by how much invention and innovation will be reduced because it is impossible to know what might have been invented in different circumstances. We only know what has been invented: not what has not been invented. I wonder, therefore, if we should have a less restrictive patent regime – especially given the legal uncertainty that most patent regimes lead to – and a less restrictive competition policy regime. To some extent, both are cancelling each other out whilst creating greater legal uncertainty. But, the main point is that competition policymakers are working in the context of two huge unknowns and they are, as Hayek put it, pretending that they know more than they do.

The competition policy authorities might respond by arguing that they need to use some models and that the static models of market structure help them muddle through in this difficult area. The alternative point of view was put by Kirzner who said: 'Now the mere failure of a theoretical picture to replicate with precision all features of the reality it seeks to explain, is not necessarily fatal for the usefulness of that theoretical picture. But mainstream theory filters out of the picture those aspects of reality which are at the core of an adequate explanation for market phenomena.'

Cutting the budget ......

or not.

John Taylor explains the budget debate going on in the U.S. right now:

perhaps the biggest difference is that the House Budget brings outlays as a share of GDP back close to 2007 levels as a share of GDP, thereby removing the large spending increase of the years 2008-2009-2010, while the Administration budget effectively locks in that increase.

Arnold Kling notes:

Somehow, we could ratchet up spending by hundreds of billions at the drop of a hat. Reducing spending by less than $100 billion becomes Armageddon.

So what goes up may not come down. Physics does not apply to politics!

The problems of getting involved in public debate

From Greg Mankiw's blog:

Mankiw Says Higher Taxes Won’t Increase Revenue

The brief article alleges to summarize what I said in an interview. My first reaction was, I didn't say that. My second reaction was, did I misspeak? Fortunately, the audio of the interview is right there. So I listened to myself (always a painful experience), and I think I said what I really believe--that tax hikes do not generate as much revenue as you might think. The Bloomberg headline is an unfortunate misrepresentation.

This kind of thing doesn't improve the incentives for getting involved in public policy.

EconTalk this week

Gavin Andresen, Principal of the BitCoin Virtual Currency Project, talks with EconTalk host Russ Roberts about BitCoin, an innovative attempt to create a decentralized electronic currency. Andresen explains the origins of BitCoin, how new currency gets created, how you can acquire BitCoins and the prospects for BitCoin's future. Can it compete with government-sanctioned money? How can users trust it? What threatens BitCoin and how might it thrive?

A profile of Al Roth

The Boston Globe has a piece on Alvin Roth one of the leading market design economists,

Academically speaking, Roth is a pioneer of so-called market design: finding situations where a market is failing — often, a place that most people wouldn’t even recognize as a market — and making it work better. Roth has influenced a cadre of young, energetic market designers, many of whom have taken up prominent positions at top universities. Inspired by Roth’s work, these rising economists are also setting their sights on real-world problems. Some are looking at dating websites; others are interested in how universities could do better at scheduling their students’ classes. Like Roth, all of them envision a world in which economists, as unlikely as it may seem, are recognized as society’s mechanics.

Sitting in his office last week, Roth talked about how it was time for economics, as a field, to turn a corner — how merely describing markets as they naturally occur was no longer enough. Instead, he said, economists have to make themselves useful by fixing broken systems in which people aren’t getting what they want.

[...]

Roth had noticed instability in the National Resident Matching Program, and soon started seeing it all over the place. In 2003, he helped redesign the process by which kids were assigned to schools in New York, making it more likely that kids were sent where their parents wanted them to go. A few years later, he repeated the trick in Boston, and around the same time, he helped establish the New England Program for Kidney Exchange. He has also helped redesign the job markets for gastroenterologists and economists.

It’s not always easy, bringing economics into the real world like that. Bureaucracy gets in the way a lot, and so do political pressures. But as Roth has learned over the past decade and a half, sometimes the biggest hurdle is that the people he and his fellow economists are trying to help are not totally eager to be helped. People tend to be a little territorial about their problems, Roth said, and they don’t always understand why someone who works at a business school is sticking his nose in. At his first meeting with officials from the Boston public school system, Roth recalls, an administrator asked whether he and his fellow academics knew what they were dealing with.

“We’ve given our spiel, and in the question and answer session, one of the guys says, ‘Professor, you know, the school system is...complicated,’ ” Roth recalled. “His point was there are lots of details in a school system — that it’s not some abstract thing.”

That kind of skepticism is just par for the course, Roth said: People have pretty fixed ideas about what economists do, and some of those ideas don’t really apply to him and his fellow market designers.

Roth’s most recent project is helping to set up a nationwide kidney exchange, which would make it possible to find even more matches than the existing regional networks can find on their own. Running this national network has been a bureaucratic nightmare, and since it opened for business last fall, only two transplants have actually been carried out under its auspices. The problem is that depending on blood type, it can be hard or easy to find someone a compatible kidney. And when a hospital has an easy-to-match patient, its administrators are more likely to withhold that information from the other hospitals in the network because they’d rather do the transplant themselves, and get the business.

But this practice hurts the system, and ultimately cuts down on the number of transplants that get done. The way to fix it, Roth argues, is to assure hospital administrators that they will be given credit down the line for every transplant they give up as a result of sharing information. “Many of them will not understand right away, and we’ll have to say it louder,” he said.

Michael Giberson at the Knowledge Problem blog makes a point worth remembering with regard to market design,

Some market-oriented people will react negatively to the idea of “economists … as society’s mechanics,” but the negative reaction is based on a misunderstanding. Roth is no central planner. The point is to rework organizations so that participants in those organizations can more effectively achieve their goals.

Investment and unempliyment: why not fight about it, some more

Paul Krugman has responded (on 31 March) to a reply (of March 31) by John Taylor to two of Krugman's critiques (afternoon and evening of March 30) of Taylor's January 14 post on the negative correlation between unemployment and investment. Taylor has now replied to Krugman's 31 March response here.

Interesting blog bits

1. Ed Dolan on Why we are losing the war on drugs

   No one who has ever taken Econ 101, or read the works of Friedrich Hayek, should be the least bit surprised. The drug cartels are strong because the US strategy in the drug wars makes them strong. Here's why.

2. Roger Kerr on The Truth about Privatisation: Blog # 7

   You often hear the suggestion that if state-owned enterprises (SOEs) are sold, the government should limit shareholding to ‘Kiwi mums and dads’. In short, not a good move.

3. Tim Worstall on Why we need more markets and less government

   William Baumol, that’s why.

4. Thorvaldur Gylfason on Oil-spill economics: How Ghana can succeed

   And its not what you think. Ghana is about to become a major oil producer. The country’s newfound oil is expected to bring in many billions of dollars, changing the face of its economy. Ghana is the first African country where a major oil discovery is greeted by a well-functioning, albeit young, democracy. This column outlines how it can avoid the resource curse and take full advantage of this historic opportunity.

5. Bjorn Lomborg points out that 'Earth Hour' won't change the world

   There is a certain irony in renting brightly lit advertising space to exhort us to save electricity for one hour — but this is apparently lost on the organizers.

6. Mark Perry at Carpe Diem brings to our attention these clips of Milton Friedman.

   See here, here, and here.

7. PJ Byrne on To have or to be? A reflection on the anti-cuts march

   Byrne reflects on the recent anti-cuts march in London and the rhetoric used by Labour leader Ed Miliband. The movement's materialism and disregard for ideas, says Byrne, will be its undoing.

8. Henry Overman asks, How did London get away with it?

   When the global crisis hit, many predicted that London would suffer more than other parts of the UK, given the city’s reliance on the financial services industry. This column explores how the UK capital’s economy suffered far less than the rest of the country.

9. John Taylor on A Good Exit Strategy Proposed by Philadelphia Fed President Plosser

   Charles Plosser, President of the Philadelphia Fed, proposed an exit strategy for the Fed. It’s the first explicit exit strategy to be put forth by a member of the FOMC, so it deserves careful consideration and discussion.

Investment and unempliyment: why not fight about it

John Taylor argues that the most effective way to reduce unemployment is to raise investment as a share of GDP. His blog post is Higher Investment Best Way to Reduce Unemployment, Recent Experience Shows. He argues for a negative relationship between unemployment and investment. But Paul Krugman isn't having a bar of this. See here and here. What is the role of housing in all of this? Taylor responds in Investment and Unemployment: A Reply. Justin Wolfers thinks this looks like fun and comments here and here. Taylor responds here.

What started all of this is this graph showing a negative relationship between unemploment and investment.

The question is which way does causation run? From investment to unemployment or the other way round? Or is the relationship due to some other third factor?

What’s new in the second edition of The Undercover Economist?

Yes there is a second edition of The Undercover Economist by Tim Harford due out in the U.K. in Apirl. What's new? From Tim Harford's webpage:

I have tried to preserve as much as possible of the original book rather than surrendering to hindsight bias, but I have tried to update as many of the statistics and examples as possible as seamlessly as I can. (Occasionally I have used footnotes to highlight changes between the first edition and the second – especially if the changes have either proved me right, or made me look silly.)

A more substantial change has been to replace chapter six – which was originally about the dot-com bubble – with a new chapter about the banking crisis that began in 2007. The dot-com bubble, alas, now seems fairly benign in comparison with the banking crisis, and it felt impossible to publish a second edition without trying to make sense of it all.

The politics of milk

The stuff.co.nz has an article on the Commerce Commissions decision to investigate milk prices which makes more sense than most of the media output on this topic, and the headline days it all: Election blamed for milk price investigation,

Election year jitters in the Beehive are thought to be behind the sudden decision of competition watchdog the Commerce Commission to investigate retail milk prices, less than a week after telling a Parliamentary select committee it would not do so.

While the commission in a statement late yesterday said Commerce Minister Simon Power had not asked it to initiate a dairy price control inquiry, the turnaround is likely to be politically charged, Wellington and dairy industry sources suggest.

and

The [commerce] commission in its statement yesterday said "a number of parties" had laid specific complaints about the retail price of milk and called for an inquiry. But when pressed on this, a spokeswoman could only say that "a number" of informal approaches had been made to the commission by people unhappy about the price of milk since January. The commission did not discuss specific complaints, she said.

and

An observer close to the situation was sceptical.

"This is about rising milk prices in election year. It takes it off the radar screen for a few months - takes it off the front page. You know how long it takes the Commerce Commission to do anything."

The real downside to all of this is that it makes the Commerce Commission look politicised and that is a very bad look for an "independent" body like the commission.

Economics The Onion way

Its April 1st, so I guess we shouldn't be surprised to learn that the Continued Existence Of Edible Arrangements Disproves Central Tenets Of Capitalism:

Upending more than two centuries of free-market theory, leading economists across the globe announced Thursday that the fundamental principles of capitalism had been "irrefutably disproved" by the continued existence of the designer fruit-basket company Edible Arrangements.

"In theory, the market should have done away with Edible Arrangements long ago," said American Economic Association president Orley Ashenfelter, who added that one of the crucial assumptions of capitalism is the idea that businesses producing undesired goods or services will fail. "That's how it's supposed to work. Yet somehow, despite offering no product of any worth whatsoever, this company not only makes payroll every week, but also generates strong profits."

"It's mind-boggling," Ashenfelter continued. "I honestly have never even heard the name Edible Arrangements mentioned in conversation before. Seriously, has anyone?"

[...]

"To understand this enigma, we must discard the naïve notion that free-market prices reflect what consumers are willing to pay," Nobel laureate Joseph Stiglitz said. "Otherwise, how else are we to rationalize the phenomenon of a human being willingly spending 84 bucks on 18 green apple wedges and a Mylar balloon?"

[...]

Clearly the invisible hand has led us astray when it allows for the continued existence of a store that manufactures 'Sympathy Blossoms' of chocolate-dipped orange slices for funerals and wakes," said N. Gregory Mankiw, a former economic adviser to George W. Bush. "And when people are buying 3,000 'Orange You Gonna Feel Better Soon?' bouquets a day, the idea of consumers as 'rational actors' goes out the window pretty fast."

The standard of NZ's economic journalists

The point that Matt Nolan and myself have noted about the claim that raising your price can be anti-competitive raises another question with me: Why have none of our "economic journalists" asked about the validity of this claim?

I mean it does on the face of it seem a very strange claim. The normal anti-competitive pricing activities would be things like predatory pricing or the closely related limit pricing, but both of these involving lowering your price in such a way as to either force competitors out of the market or prevent them from entering. But raising your price is the opposite of this, it would seem to involve giving an incentive for firms to enter the market or if already in the market expand supply, thereby increasing competitive pressures. So have none of the economic journalists out there asked themselves, Can raising your price really be anti-competitive? Have any journalists thought of going to the Commerce Commission and asking them to explain the logic behind this claim?

This is one for the X-files (updated)

There have been some seriously weird things said about the price of milk recently but this comment in an article from stuff.co.nz has to be the strangest yet:

Dairy market heavyweight Fonterra is artificially inflating the price of milk in New Zealand in a deliberate campaign to lessen competition, says an official complaint to the Commerce Commission.

Now I can not for the life of me see how inflating the price of milk can lesson competition. That is just weird. Predatory pricing or limit pricing are anti-competitive but involve lowering the price of a good to force out or keep out competitors. Raising the price of milk would increase the number of competitors; its competition increasing, if its anything.

The stuff article goes on to say:

The allegation, formally laid with the competition watchdog late last week, is understood to have triggered the commission's announcement it is starting an investigation to determine whether a price control inquiry into retail milk is needed.

The Commerce Commission is taking this idea seriously?! I really would like them to explain how increasing your price is anti-competitive.

The thing to keep in mind is that the price of milk in New Zealand will be the world price. For a good like milk the market is the world market and the price is set by supply and demand conditions in the world market. So the correct question to ask is, Are we paying the world price? If so, then there is no problem.

If the article had been published April 1st it would have made a lot more sense.

Update: Matt Nolan at TVHE seems as confused as I am.

Declaration of independence

Allen R. Sanderson, who teaches economics at the University of Chicago, has had enough. For too long, he says, the U.S. has been far too dependent on the rest of the world for imports of vital commodities. And he has a plan:

My fellow Americans,

For too long, the United States of America has been at the mercy of foreign interests — and nations in faraway lands that are often at odds with our core values — when it comes to the production of perhaps the vital resource that drives our economy. We remain far too dependent on this imported commodity that could, in the time of emergency or international political crisis, be denied to us and thus cripple our productivity and reduce us to quivering masses of migraines in a matter of hours. The time for change is now.

And the commodity?

I speak, of course, of our complete dependence on coffee that we are importing mainly from Brazil and Colombia. It's time to wean ourselves from this harmful addiction. My "Coffee Independence" proposal is the key first step.

And as president of the U.S. he would implement his plan to deal with this crisis:

Thus my administration will propose that we begin immediately to invest in this city [Detroit] and state [Michigan] and turn them into the coffee capital of North America. It will create jobs, jobs, jobs; stimulate economic development; and put Michigan back on the map. After all, it was a beer that made Milwaukee famous, and cows that turned Wisconsin into America's Dairyland. Why not think of Michigan when you think of mocha?

Going without our morning venti half-caf latte and afternoon frappuccino grande will take some time to get used to, of course. As will building the hothouse infrastructure, turning seedlings into hearty trees; and fully implementing our "Cash for Coffee" stimulus program. And until those beans can be picked by American workers who are paid a living wage, have great health care benefits, 40l(k)s and union representation, this will call for shared sacrifice.

To complement this initiative, I will also propose to Congress that we invest in Florida orange juice production, Nicorette gum and California wines, all 100 percent American products. (And we can thus reduce Brazil to a nation known only for its Carnival, bikini waxes and getting suckered into hosting the 2016 Olympic Games.)

Once fully implemented, we will then turn our full attention to growing cocoa in New Hampshire, a state that figures prominently in the 2012 primaries, instead of importing our secondary caffeine and fat additions — chocolate — from the Ivory Coast and Ghana. After that we will move on the idiom — "For all the tea in China" — and have farmers in another early primary state, Iowa, convert some of their corn (aka ethanol) acreage to tea, thus stopping the flow of American dollars to China and India.

And then for the final phase, I am fully prepared to give new meaning to the term "Banana Republic."

American needs this man!

Car insurance and the arbitrary quality of egalitarian justice

Mark Pennington writes on a recent judgement from the European Court of Justice. Pennington says,

Classical liberals claim that theories of justice must be judged by their practical capacity to facilitate positive sum games in society and to eliminate scope for the exercise of inconsistent and arbitrary political power. Unfortunately, as one of the recent rulings by the European Court of Justice reveals few people in today’s legal and political elites are willing to conceive justice in this regard. Three weeks ago the European Court ruled that it was inadmissible for car insurance providers to take into account sex-specific differences for risk assessment and actuarial purposes on the grounds that this breached the fundamental ‘right to equal treatment’ for men and women. As a consequence, European women will no longer be able to benefit from cheaper driving insurance resulting from their lesser likelihood of involvement in automobile accidents than men of equivalent age and experience. It is difficult to see how this decision is compatible with a positive sum view of society. Men will not be made any better off by the decision as their insurance premiums will at best remain unchanged and women will be made worse off as their previously cheaper premiums will now be equalised upwards in line with those of men.

The European Court could have made a better decision had they bothered to read a paper by an old (yes, I really did mean to emphasis the "old" in this sentence) teacher of mine, Alan Woodfield. Back in 2000 Alan published a paper in New Zealand Economic Papers on "Preventing Insurance Markets from Separating into Gender-Dominated Price-Coverage Combinations". (New Zealand Economic Papers, 34(2),  2000, 243-268). The abstract reads:

This article first examines the extant literature on regulatory attempts to prohibit gender-based risk categorization in insurance markets as adopted in a number of countries and proposed in New Zealand's Human Rights Bill 1992 (but not subsequently enacted). The literature suggests that regulators' aspirations and expected outcomes may not materialize. Stronger regulations that effectively impose unisex pricing requirements at either the level of the individual firm or the market level, and which attempt to prevent markets separating into price-coverage combinations dominated by one or other gender, are then evaluated. While these raise the likelihood that targeted gender groups or the majority of their members are made better off via access to pooling contracts, the desired results are still not guaranteed. A variety of outcomes are possible, including pooling contracts that make no insured person better off and separating contracts that make targeted groups better off. Outcomes are sensitive to various parameters and also to the concepts of equilibrium deemed appropriate to the problem.

In conclusion Alan writes,

This article has examined the nature of contracts and welfare implications of interventions in competitive insurance markets which attempt to compensate for gender-based differences in risk. Although these interventions fail to enhance efficiency, they might be expected to raise the welfare levels of those agents allegedly suffering discrimination in insurance markets. For the case where females, for example, are uniformly riskier than males, it is shown that females may not necessarily be better off as a result of regulation, although they will be so in a number of situations, whereas males are always worse off. Where females are riskier on average, but some females are low-risk types and some males are high-risk types, it is shown that if the information required to assign individuals to the correct risk class is prohibitively costly for insurers to obtain, then while high-risk females are typically better off as a result of regulation, they need not be so, and can even be worse off, compounding the inefficiencies associated with adverse selection. The welfare effects for low-risk females are extremely variable, and are critically dependent on the specific form of the regulation, the underlying parameters of the problem, and the choice among alternative myopic (Nash) and non-myopic (Riley, Wilson, Spence-Miyazaki) concepts of equilibrium. Further, equilibrium will not always be characterized by pooling rather than separating contracts even when unisex insurance prices prevail everywhere, and where pooling contracts do prevail, regulators cannot be assured that all members of a disadvantaged gender group will be made better off by regulation.

I'm guessing that the European Court of Justice did not think the issue through. The set of possible outcomes is more complex that the court seems to think. And the outcome they did pick looks like one of the worst.

Balanced budget law

At the Adam Smith Institute blog James Paton is discussing a balanced budget law. He writes,

In 2009, the German constitution was amended to stop the federal and state governments from running budget deficits. The plan in Germany has been set over an eleven-year period. From 2016, governments won’t be able to run a deficit of more than 0.35% of GDP and from 2020 a deficit won’t be allowed to run at all. In America, 49 states have some form of a balanced budget provision (the exception is Vermont). In Oregon, the law forbids a state surplus of more than 2% of GDP. If there is one, anything above this threshold is refunded to taxpayers. The Federal government does not have a cap on its spending at all, but there have been various balanced budget proposed. This has been brought to Congress within the 1991-1992, 2001-2002 and 2005-2006 sessions. These have failed due to the difficulty to pass amendments, which needs a two-thirds majority in both houses in Congress and three-quarters of states ratifying it.

I'm guessing Ganesh Nana would not be too keen on the idea but I think many other economists would give the idea support. The size of budget deficits being run in many countries is of concern to economists. Recently in the U.S., for example, 10 former chairs of the President's Council of Economic Advisers wrote,

There are many issues on which we don’t agree. Yet we find ourselves in remarkable unanimity about the long-run federal budget deficit: It is a severe threat that calls for serious and prompt attention.

Given such concerns that the idea of a balanced budget law being discussed is understandable and not without merit.

The economics of natural disaster

From the Economist magazine,

Now, I believe the [broken window] fallacy is indeed a fallacy, and I find the idea that Japan might somehow gain from this bout of terrifying havoc and mass death both ridiculous and disgustingly Panglossian. But, really, this isn't about us, and I've grown weary of playing a part in the rote broken-windows Punch and Judy show. Much more pertinent and interesting is the fascinating, lively, empirically-informed academic literature on the economic effects of disasters, which I was reading up on last night. Alas, the New York Times' Binyamin Appelbaum beat me to the punch, providing a short overview of some recent research that finds that disasters have no long-term affect on GDP. This excellent 2008 Boston Globe article by Drake Bennett offers a more comprehensive summary.

So an earthquake in either Japan or Christchurch will do nothing to improve economic performance in either place.

Communication skills and economics

Peter Boettke writes at Coordination problem that

Dan [Stastny] concludes this wonderful book [The Economics of Economics] by informing his readers that for economics to be respected and to have its teachings heeded, "it may not only needs its Samuelsons, Friedmans or Hayeks, but also its Cobdens, Brights, and Bastiats. When economists figure this out, there will be a better chance that they may at last become as important as garbagemen, at least in the eyes of those who consider handling of ideas as momentous as handling of garbage."

While Stastny is right about the importance of communicating economic ideas to the general public, I'm not sure that its the job of economists, as such, to do it. Specialisation and the division of labour suggests to me that there are advantages to people doing whatever is their comparative advantage. In general it seems to me that there gains to be exploited when economists write for their peers, while economic journalists write for the general public. Would we really have gained anything if Ronald Coase had spent his time explaining his "The Nature of the Firm" paper to the general public rather than writing "The Problem of Social Cost" or Henry Hazlitt had written journal articles on mechanism design rather than "Economics in One Lesson"? We have to ask, What is the opportunity cost of having economists try to communicate directly with all of their "scientific peers, students, policy makers, and the general public", as Boettke suggests. Trying to create people with a comparative advantage in all four areas defies the economic logic behind specialisation. You can't have a comparative advantage in everything.

EconTalk this week

Vincent Reinhart of the American Enterprise Institute talks with EconTalk host Russ Roberts about the government interventions and non-interventions into financial markets in 2008. Conventional wisdom holds that the failure to intervene in the collapse of Lehman Brothers precipitated the crisis. Reinhart argues that the key event occurred months earlier when the government engineered a shotgun marriage of Bear Stearns to JP Morgan Chase by guaranteeing billion of Bear's assets and sending a signal to creditors that risky lending might come without a cost. Reinhart argues that there is a wider menu of choices available to policy makers than simply rescue or no rescue, and that it is important to take action before the crisis comes to a head.

For a summary of Reinhart's view of the financial crisis see A Year of Living Dangerously: The Management of the Financial Crisis in 2008, Journal of Economic Perspectives, volume 25, number 1, winter 2011, pages 71–90:

A more appropriate narrative of the financial crisis that exploded in September 2008 would begin with how the Corps of Financial Engineers—comprising chiefly the Secretary of the Treasury, the Chairman of the Federal Reserve, and the President of the Federal Reserve Bank of New York—inserted the government into the resolution of the investment bank Bear Stearns in March 2008. The financial authorities interpreted the death throes of the mid-sized investment bank as a problem of systemic importance and, with an ill-considered and unprecedented decision, intervened in a way that protected the uninsured creditors of Bear Stearns and raised the expectations of future bailouts. When the same Corps of Financial Engineers then failed to intervene in September 2008, Lehman Brothers entered bankruptcy. The resulting market seizure was in large part a counter-reaction based on the prior official decision just six months earlier to protect Bear Stearns.

Many observers, including the Secretary of the Treasury at that time Hank Paulson (2010) and Federal Reserve Chairman Ben Bernanke (2010), have looked back at the decision to let Lehman slip into bankruptcy on September 14, 2008, with regret and bemoaned the lack of tools available to them at the time to prevent the outcome. I will argue that Lehman’s failure had widespread consequences because of the false hopes engendered by Fed support to Bear Stearns. Instead of asking “Why not save Lehman?” a more useful and consequential question is “Why save Bear Stearns?”

Incentives matter: immunisation file

From the NBR:

The Ministry of Health should look into paying parents to encourage them to vaccinate their children, a report into New Zealand's lagging immunisation rates says.

and

The report ruled out making immunisation compulsory but directed the Ministry of Health to consider immunisation incentive payments to parents, or linking existing parental benefits to immunisation.

The current incentive scheme offers payments to primary health organisations for reaching certain immunisation targets but no direct payments to parents.

In Australia, parents on any income are eligible for two payments of $A122.75 ($NZ166.91) if they ensure their children have met immunisation schedule requirements by certain ages.

It would be interesting to see just what effect payment would have. Are monetary payments the best form of incentive in situations like this? What exactly stops parent from having their kids immunised? The incentives of the parent and the kids would seem to be aligned well enough to get the parents to have the kids immunised just for the kids sake.

Lanny Friedlander has died

The founder of Reason magazine Lanny Friedlander has passed away. Nick Gillespie at reason reflects: Lanny Friedlander, Founder of Reason Magazine, RIP.

Here is the bit I found weird:

Lanny's death naturally puts us at Reason in a reflective mood. The strangest part of it is that, though we're all his heirs and beneficiaries, nobody currently working at the magazine ever met him. It's been that way for a long time. As Virginia Postrel, editor in chief of Reason from 1989 until 2000, told me via email, not only had she never met him, but during her time at the mag, folks didn't even know what had happened to him.

Technology use and employment protection

A question that is often asked with regard to productivity across countries is Why is the U.S. more productive than the E.U.? Studies have suggested that much of the difference can be explained by the wider use of information and communication technologies in the U.S. But this just raises the obvious question Why does the U.S. use these technologies more? A new column at VoxEU.org provides new evidence suggesting the answer may lie in differences in employment protection legislation.

The column, Employment protection and technology choice by Eric Bartelsman Joris de Wind and Pieter Gautier notes that until the mid-1990s, E.U. productivity had been converging towards U.S. productivity. But since then, U.S. productivity growth has accelerated and the U.S.-E.U. gap has widened. Robert Gordon is one economist who has noted this fact:

[...] since 1995 Europe has experienced a productivity growth slowdown while the United States has experienced a marked acceleration. As a result, just in the past eight years, Europe has already lost about one-fifth of its previous 1950-95 gain in output per hour relative to the United States. Starting from 71 percent of the U. S. level of productivity in 1870, Europe fell back to 44 percent in 1950, caught up to 94 percent in 1995, and has now fallen back to 85 percent. (Gordon 2007: 176).

One factor that has been put forward to explain this productivity difference is the production and use of information and communication technologies (ICT). Such activity is much lower in the E.U. than in the U.S.

Bartelsman, de Wind and Gautier continue,

Why has the adoption of the new ICT been much slower in the EU? Recent research in Brynjolfsson et al. (2008) and our latest paper (Bartelsman et al. 2010) provides evidence that the adoption of these new technologies is associated with an increase in the variance of firm productivity. For example, implementation of advanced business software like SAP and Oracle requires a new organisational structure and the outcome is inherently uncertain. The variance of firm productivity is therefore relatively large in sectors that intensively use ICT.

For a given firm, adopting a technology with risky outcomes is attractive because the benefits can be scaled up if the outcome is good, while firms can fire workers or exit if things go poorly. Essentially, the ability to close a production unit is a real option that bounds the downward risk.

But what is the role of labour market policy? Bartelsman, de Wind and Gautier explain that one major policy difference between Europe and the U.S. is that employment protection legislation is much stricter in Europe. They

[...] show that the employment share of risky (ICT-intensive) sectors is indeed smaller in the EU than in the US, and that, within Europe, high-protection countries have relatively smaller ICT-intensive sectors than low-protection countries. We then find that countries with strict legislation are relatively less productive.

Bartelsman, de Wind and Gautier go on to say,

In order to explore the mechanism and to establish how much of the US-EU productivity divergence can be explained by stricter employment legislation, we develop a two-sector matching model with endogenous technology choice, i.e. firms can choose between a safe sector with stable productivity and a risky sector with productivity subject to sizable shocks. In the absence of employment protection legislation, the risky sector is relatively attractive because firms have the option to fire workers which bounds the downward risk. Introducing legislation makes it less attractive to use risky technologies, so this establishes the negative relationship between employment protection and the size of the risky sector. Legislation also results in more labour hoarding, i.e. the productivity threshold below which a worker is fired is lower if legislation is stricter. Further, the size of the effect increases as the variance of the shocks in the risky sector increases. This explains why productivity growth is lower in high-protection countries in particular when new technologies with a high variance in profitability become available.

So no matter what your views of the origins of employment protection legislation, the research findings Bartelsman, de Wind and Gautier put forward clearly show that the economic costs of employment protection increase with change, over time, in the type of technological opportunities available, but the benefits are unaffected.

If these research results are right then I can't help but think that they have serious implication for New Zealand, and if we really want to have a "knowledge economy", and catchup with Australia, then we should not ignore such findings.

• Bartelsman, Eric J, Pieter A Gautier, and Joris de Wind (2010), “Employment Protection, Technology Choice, and Worker Allocation”, CEPR Discussion Paper 7806.
• Brynjolfsson, E, A McAfee, M Sorell, and F Zhu (2008), “Scale without mass: business process replication and industry dynamics”, Harvard Business School Working Paper, 07–016.
• Gordon, R. J. (2007). ‘Why was Europe Left at the Station When America’s Productivity Locomotive Departed?’ In Mary Gregory, Wiemer Salverda, and Ronald Schettkat (eds.), Services and Employment: Explaining the U.S.-European Gap, Princeton: Princeton University Press.

Unsustainable budget threatens nation .....

or so say 10 ex-chairs of the President's Council of Economic Advisers. In an open letter Martin N. Baily, Martin S. Feldstein, R. Glenn Hubbard, Edward P. Lazear, N. Gregory Mankiw, Christina D. Romer, Harvey S. Rosen, Charles L. Schultze, Laura D. Tyson and Murray L. Weidenbaum argue for prompt action on the long-run federal budget deficit.

There are many issues on which we don’t agree. Yet we find ourselves in remarkable unanimity about the long-run federal budget deficit: It is a severe threat that calls for serious and prompt attention.

While the actual deficit is likely to shrink over the next few years as the economy continues to recover, the aging of the baby-boom generation and rapidly rising health care costs are likely to create a large and growing gap between spending and revenues. These deficits will take a toll on private investment and economic growth. At some point, bond markets are likely to turn on the United States — leading to a crisis that could dwarf 2008.

Of the 10, 4 served under Democratic and 6 under Republican presidents: one worked under Carter, two worked under Reagan, two worked under Clinton, four worked under Bush, and one worked under Obama.

Arnold Kling noted,

Of course, it was another former Clinton economic adviser, Alan Blinder, who once wrote that when economists are most in agreement they are least likely to be listened to.

As is normal, politics will I'm sure win out over economics, even in a situation as serious as this.

Why so few female economics bloggers?

An issue raised by male blogger Matthew Kahn,

REPEC provides an objective measure of who is "Royalty" in the economics profession. The current list of the top 5% is here. I am ranked #681 out of 27,365 economists so that's not bad (and my 3 books aren't counted here). But, here is the interesting part. There are 39 women who rank in the top 1000 and 0 of them blog. Contrast that with the men. Consider the top 100 men. In this elite subset; at least 8 of them blog. Consider the men ranked between 101 and 200. At least, six of them blog. So, this isn't very scientific but we see a 7% participation rate for excellent male economists and a 0% participation rate for excellent women. This differential looks statistically significant to me.

The answer could be very simple. Its possible that female economists simply have a higher opportunity cost of time and the returns to blogging are low.

Interesting blog bits

1. Scott Masten gives us An Early Example of a Hold-up. . .

   . . . in which two Irishman sweep fifteen or thirty Italians into an open ditch.

2. John Taylor on Blogging Blocked in Beijing

   Talyor could not blog while in China.

3. John Taylor on Why the Stimulus Failed to Boost Infrastructure in the US: A Comparison With China

   Stimulus in the U.S. and China. The same?

4. Gary Becker on The Economic Implications of the Japanese Earthquake Disaster and its Aftermath

   Japan has certainly been unfortunate during the past couple of decades. It has had almost twenty years of confidence-destroying slow economic growth, a series of humiliating confrontations with a rising and more aggressive China, and finally the biggest earthquake ever recorded in Japan. And this earthquake not only directly caused great damage, but it also set off a tsunami with huge destructive power. As if this were not enough, the combined earthquake-tsunami badly damaged two nuclear energy plants located on the fault lines and by the sea, damage that led to the release of as yet undetermined amounts of radiation. Still, I do not expect this disaster, despite its severity, to have major effects on the Japanese economy, but it will have a big impact on the nuclear power industry, and may help different countries better prepare for very rare but destructive natural events.

5. Lucian Cernat and Marlene Rosemarie Madsen write about "Murky protectionism" and behind-the-border barriers: How big an issue? The €100 billion question
   

   Compared to recent headline-grabbing events, dealing with “behind-the-border barriers” and keeping protectionist tendencies at bay might seem to be small potatoes. This column argues that the “murky protectionism” that affects €100 billion of trade will have profound implications for Europe and the rest of the world, and as such is worthy of attention.

6. Ann Harrison, Leslie Martin and Shanthi Nataraj on Learning vs stealing: How important are market-share reallocations to India's productivity growth?

   It is broadly agreed that trade liberalisation can increase productivity. The question is how. Earlier literature emphasises the role of firms “learning” to be more productive, whereas recent studies suggest that more productive firms are “stealing” market share from less productive ones, thus raising overall productivity. Presenting evidence from India’s trade liberalisation since 1991, this column finds evidence for both but argues that learning outweighs stealing.

7. Don Boudreaux writes Another Open Letter to Sen. Sherrod Brown

   The economist versus the politician on trade. A debate that never happened: "John Stossel and his team at Fox Business tried to get Sen. Brown to publicly debate trade with me. Brown refused, alleging that I'm an unworthy opponent."

8. Gavin Kennedy answers Interesting Question on the Authenticity of Smith's Lectures on Jurisprudence

   Did Adam Smith really deliver his Lectures on Jurisprudence?

9. Lynne Kiesling on The ATT/T-Mobile merger and spectrum policy

   The benefits of the cost savings from the merger may well exceed the reduction in consumer surplus from any price increase arising from going from 4 national competitors to 3.

Why firms can not be owned

Or at least why Gregory K. Dow argues that they can not be owned. In Dow (2003: 107) he writes,

[...] no one can not own a firm because a firm is a set of human agents.

This seems a bit odd. It’s based on an incorrect definition of a firm. First, obviously the idea of the legal ownership of a firm is well established in most countries. Second, as people own firms and they can not own other people then firms must be something other than a group of human agents. This explains why theories, such as the property rights approach to the firm, define ownership in terms of control rights over non-human assets.

PS: If you have an interest in labour managed firms, Dow's book is a must read.

• Dow, Gregory K. (2003). Governing the Firm: Workers' Control in Theory and Practice, Cambridge: Cambridge University Press.

Parallels between theories of the firm and of privatisation

In the Hart (2003) paper referred to in a previous post the parallels between theories of the firm and of privatisation are discussed in the opening section. The parallels are indeed great. Hart writes,

In spite of these differences, the issues of vertical integration and privatisation have much more in common than not. Both are concerned with whether it is better to regulate a relationship via an arms-length contract or via a transfer of ownership. Given this, one might have expected the literatures to have developed along similar lines. However, this is not so. Whereas much of the recent literature on the theory of the firm takes an 'incomplete' contracting perspective, in which
inefficiencies arise because it is hard to foresee and contract about the uncertain future, much of the privatisation literature has taken a ‘complete’ contracting perspective, in which imperfections arise solely because of moral hazard or asymmetric information.

My own view is that this is unfortunate. One of the insights of the recent literature on the firm is that, if the only imperfections are those arising from moral hazard or asymmetric information, organisational form – including ownership and firm boundaries – does not matter: an owner has no special power or rights since everything is specified in an initial contract (at least among the things that can ever be specified). In contrast, ownership does matter when contracts are incomplete: the owner of an asset or firm can then make all decisions concerning the asset or firm that are not included in an initial contract (the owner has ‘residual control rights’).

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

Hart is right in what he says about the importance of the incomplete contracts approach to both the theory of the firm and the theory of privatisation. What I find odd about the quote above is the comment,

Whereas much of the recent literature on the theory of the firm takes an 'incomplete' contracting perspective, in which inefficiencies arise because it is hard to foresee and contract about the uncertain future, much of the privatisation literature has taken a ‘complete’ contracting perspective, in which imperfections arise solely because of moral hazard or asymmetric information. (emphasis added)

While it is true that during the 1980s the theory of privatiastion was based around asymmetric information models, which really couldn’t explain the difference between state and private ownership endogenously, since around 1990 this shortcoming has been noted and countered via the application of incomplete contract theories.

The need for incomplete contracting models was highlighted by a number of ownership irrelevance results that apply to complete contracting models. These ownership irrelevance results can be illustrated by considering Sappington and Stiglitz's `Fundamental Theorem of Privatization' (Sappington and Stiglitz 1987) and Williamson's idea of selective intervention (Williamson 1986: Chapter 6). Traditionally the theoretical case for public ownership has rested on considerations of allocative efficiency - that is, the properties of resource allocation in the economy taken as a whole - while the case for private ownership has rested on the incentives and constraints that the market provides to ensure efficiency within the firms - that is, productive efficiency. The Sappington and Stiglitz, and Williamson results show that in a complete or comprehensive contracts world, allocative and productive efficiency will be the same under both public and private ownership. Hence it is not clear what advantages privatisation (or nationalisation) could bring under this framework.

The notion of selective intervention argues that the government can reach the same level of productive efficiency as the private sector by mimicking the actions of a private firm. If the government organises the firm in exactly the same way as a private owner would, if it uses the same incentive schemes for managers and workers, and if it deviates from such a policy only if there is the possibility of doing something strictly better than a private firm, then a nationalised firm should produce at least as efficiently as a privatised one.

Sappington and Stiglitz assume that the government's objective in choosing between public or private production is threefold:

• economic efficiency: the government wishes that whoever has the comparative advantage in production undertakes it;
• equity: the government has certain distributional objectives;
• rent extraction: the government wishes to extract as much of the producers rent as possible.

The 'Fundamental Theorem of Privatization' provides conditions under which all of these objectives can be attained perfectly via an auction whereby the potential producers bid to become the single supplier. It is assumed that the good is produced under conditions of increasing returns to scale so industry costs are minimised with a single producer of the good. The fundamental theorem requires at least two risk-neutral bidders who have symmetric beliefs about the least-cost method of production. Actual costs of production are only learned by the producer just before production takes place. The government has a valuation, v, of the level of output, Q, of the good. This valuation is given by v=V(Q). These conditions are refereed to as the 'ideal setting'.

Sappington and Stiglitz show that a simple auction will ensure that all the government's objectives can be reached perfectly. The government auctions off the right to be the good's sole producer and receive a (total) revenue of P(Q) for producing output level Q. The government sets P(.) equal to its own valuation of the level of output produced, i.e. P(Q)=V(Q). In other words, the production decision is delegated entirely to the producer and the producer is paid an amount exactly equal to the value to the government of the level of output produced.

This means that once actual production costs are revealed a profit maximising firm will face the problem Max V(Q)-C(Q), where C(Q) is the cost function. The result of implementing this scheme is that the firm submitting the highest bid (and thus becoming the producer) will subsequently select the level of production most desired by the government (the welfare maximising output), conditional on the realisation of actual production costs.

If we interpret the government's valuation of output, V(Q), as being gross consumer surplus and assume that production costs have been revealed, then the firm's problem, Max V(Q)-C(Q), is to maximise the sum of producer and consumer surplus which implies productive and allocative efficiency.

With risk neutral firms initially sharing symmetric beliefs about the costs of production, the auction will result in the government capturing all the, ex ante, producer rents. Thus the government can ensure its ideal outcome via delegation of production even without any knowledge of the costs of production.

The argument made above was that Williamson's notion of selective intervention shows that state owned enterprises will be as productively efficient as private firms, in addition to their assumed allocative efficiency, and that the Sappington and Stiglitz theorem shows us that private firms can also be both allocatively and productively efficient. In other words, we have argued that the nature of ownership is irrelevant to the performance of a firm. Other neutrality results are to be found in Shapiro and Willig (1990), and in the context of full corruption, i.e. where unrestricted bribes between the manager of the firm and the politicians are allowed, Shleifer and Vishny (1994) show neither privatisation nor corporatisation matter for the final allocation of resources.

The shortcoming of both arguments is that they are based on the implicit assumption that it is possible to write a complete or a comprehensive contract for the entire life of the firm. To illustrate this point, look again at the Sappington and Stiglitz auction scheme and consider the commitment problems involved. For such an auction to work, the government must, at the time of privatisation, be able to commit itself - and all future governments - to actually paying the social valuation of output, V(Q), to the private owner at all times in the (possibly distant) future. That is, it must be possible to unambiguously specify, in a contract, the government's valuation of production for all possible states of world such that this agreement can be enforced by the courts. Otherwise the private owner will rationally expect that once any necessary relationship specific investments have been made, the government will exploit the fact that such investments are sunk costs and will expropriate the owner's quasi-rents and therefore a private owner will not invest efficiently. This will result in the government's most preferred outcome not being achieved. Selective intervention also fails unless contracts can cover all states of the world. As Williamson comments, ``[t]he impossibility of selective intervention arises in conjunction with efforts to replicate incentives found to be effective in one contractual/ownership mode upon transferring transactions to another. Such problems would not arise but for contractual incompleteness [ ... ]." (Williamson 1996: 178). As with the Sappington and Stiglitz auction there are commitment problems with selective intervention. Here the government must be able to commit itself - and all future governments - to intervene only when its economically advantageous, e.g. to deal with externalities. In particular it must be able to commit not to intervene for political reasons, such as requiring productively inefficient overmanning to reduce unemployment in the run up to an election. Such commitment is credible only if it can be made part of an enforceable contract, which is only possible in a complete or comprehensive contracting environment.

The great advantage of a complete/comprehensive contracts environment is that it allows for the complete depoliticisation of firms. With a contract covering all possible circumstances, political opportunism can be eliminated since there are no contingencies in which politicians are are able to exercise any control rights and thus commitments to non-interference are credible and soft budget constraints can be avoided. Thus in a world where contracts which cover all possible states of the world cannot be written, i.e. if only incomplete contracts are possible, the Williamson and Sappington and Stiglitz results will not hold and allocative and productive efficiency may differ depending on ownership. Within such an incomplete contracts framework firms can be politicised since the politicians, as owners, have residual control rights. A theory of privatisation (or nationalisation) is only possible within such a framework, a necessary condition for a such a theory is having a firm's performance depend on the firm's ownership, and incomplete contracts allow this to happen.

The point here is that all this was known by around 1990 and by the mid-1990s incomplete contract models were turning up in the literature - see, for example, Schmidt, K. (1996a) and Schmidt (1996b), with working paper versions even earlier. Given this it does seem at bit add to be saying in 2003 that "much of the privatisation literature has taken a 'complete' contracting perspective". Incomplete contracting models of privatisation has been available for around 10 years prior to Hart's article.

• Sappington, David E. M. and Stiglitz, Joseph E. (1987). 'Privatization, Information and Incentives'. Journal of Policy Analysis and Management, 6(4): 567-82.
• Schmidt, Klaus (1996a). 'Incomplete Contracts and Privatization'. European Economic Review, 40(3-5): 569-79.
• Schmidt, Klaus (1996b). 'The Costs and Benefits of Privatization: An Incomplete Contracts Approach'. The Journal of Law, Economics & Organization, 12(1): 1-24.
• Shapiro, Carl and Willig, Robert D. (1990). `Economic Rationales for the Scope of Privatization'. In Ezra Suleiman and John Waterbury (eds.), The Political Economy of Public Sector Reform and Privatization, Boulder: Westview Press, 55-87.
• Shleifer, Andrei and Vishny, Robert W. (1994). 'Politicians and Firms'. Quarterly Journal of Economics, 109(4) November: 995-1025.
• Williamson, Oliver (1996). The Mechanisms of Governance, New York: Oxford University Press.

Incentives matter: soccer player file

Laurent Belsie writes in the April 2011 NBER Digest on a new NBER working paper, Taxes and the International Migration of Superstars by Henrik Kleven, Camille Landais, and Emmanuel Saez.

A new NBER study of 14 European nations finds that football players tend to locate in countries that have comparatively low income tax rates. This response to tax rates is especially pronounced for the most able and well-paid athletes, and is actually negative for the least able and lowest paid among the professionals. Often, national tax breaks designed to lure top-notch foreign players displace the domestic players in a league.

In Taxation and International Migration of Superstars: Evidence from the European Football Market (NBER Working Paper No. 16545), authors Henrik Kleven, Camille Landais, and Emmanuel Saez construct two models of the labor market for football players in order to determine the top tax rates that nations can levy without driving them out of the country. On the whole, they find that all 14 European nations have rates below these maximizing-revenue tax rates. But the competition for top foreign talent is fierce. And four nations (the United Kingdom, Germany, Greece, and Switzerland) charge foreign players a higher tax rate than the revenue-maximizing rate generated by the model.

By studying football players, the authors hope to begin to address the broader question of how tax rates affect taxpayer behavior. "[F]ootball players are likely to be a particularly mobile segment of the labor market, and our study therefore provides an upper bound on the migration response for the labor market as a whole," the authors conclude. "Obtaining an upper bound is important to gauge the potential importance of this policy question."

In December 1995, the European Court of Justice handed down the so-called "Bosman ruling," which liberalized the market for European football players. Specifically, it eliminated rules that effectively limited the number of foreign players on any one team and practices that discouraged players from moving to another European team once their contract was up. The authors find that the share of foreign players went up dramatically after the Bosman ruling, and the share of domestic players went down in the top leagues of the 14 European nations they examine. Furthermore, in studying teams' performances from 1980 through 2009, they find that low-tax nations had better teams after Bosman. "This suggests that low-tax countries experienced an improvement of club performances by being better able to attract good foreign players and keep good domestic players at home," they write.

Their study also looks at the impact of tax reforms in specific countries. For example, in 2004 Spain introduced the so-called "Beckham Law" (named after British superstar David Beckham, who was one of the first footballers to take advantage of it). It allowed nonresidents to be taxed at a flat rate of 24 percent instead of the progressive rate for residents, whose top marginal rate by 2008 stood at 43 percent. After the law, Spain saw its share of foreign players increase while nearby Italy, which had a similar top league, saw its share of foreign talent shrink. Similarly, Denmark (in 1992) and Belgium (2002) introduced reforms that gave tax breaks to foreign players. Like Spain, their leagues experienced an increase in foreign players. In Greece, after the removal of a tax cap that effectively raised taxes on high earners starting in 1993, Greek players in their prime tended to migrate abroad more often than Greek players in their prime before the change - as well as those Greek players who reached their prime after the tax cap was reinstated (thus lowering taxes). "These observations provide ... compelling evidence of a tax-induced migration response," the authors write.

Yes, taxes really do act as an incentive. In this case, an incentive to migrate.