Brian Edwards and economics

Not two things that go together well. I'm guessing Brain doesn't know much about economics given this,

I’m against selling our state assets. I’m impressed by Labour’s argument that you can only sell an asset once, and that, as soon as you’ve sold it, you’ve lost the revenue stream forever. Forever is probably the key word. You have to calculate the dividend loss for an indefinite period that ends – never.

There are a number of things you could say about this but let me cover a few. 1) you don't lose a revenue stream forever since the firm is unlikely to be around forever. 2) even if it was around forever the present value of an income stream along way in the future is to a close approximation zero. Thus Brian will be adding up a lot of nothing. 3) assuming a competitive method of sale the price received by the government for a asset will equal the present value of the (finite) revenue stream. 3) you don't lose all the stream anyway since tax is paid on the profits made by the new owners of the asset. 4) we gain by making more efficient use of resources given that on average over time private firms out perform public ones. 5) a competitive sale process it will capture some of these likely efficiency gains.

Let me return to a question I have asked before: Why do we care about the price? Let there be a debate about privatisation but let it be a debate about efficiency not price.

Government and business: a bad idea

From the New York Times:

WASHINGTON — Halfway between Los Angeles and San Francisco, on a former cattle ranch and gypsum mine, NRG Energy is building an engineering marvel: a compound of nearly a million solar panels that will produce enough electricity to power about 100,000 homes.

The project is also a marvel in another, less obvious way: Taxpayers and ratepayers are providing subsidies worth almost as much as the entire $1.6 billion cost of the project. Similar subsidy packages have been given to 15 other solar- and wind-power electric plants since 2009.

The government support — which includes loan guarantees, cash grants and contracts that require electric customers to pay higher rates — largely eliminated the risk to the private investors and almost guaranteed them large profits for years to come. The beneficiaries include financial firms like Goldman Sachs and Morgan Stanley, conglomerates like General Electric, utilities like Exelon and NRG — even Google.

and

“It is like building a hotel, where you know in advance you are going to have 100 percent room occupancy for 25 years,” said Kevin Smith, chief executive of SolarReserve. His Nevada solar project has secured a 25-year power-purchase agreement with the state’s largest utility and a $737 million Energy Department loan guarantee and is on track to receive a $200 million Treasury grant.

And yes, there is no doubt that the deals are lucrative for the companies involved.

G.E., for example, lobbied Congress in 2009 to help expand the subsidy programs, and it now profits from every aspect of the boom in renewable-power plant construction.

It is also an investor in one solar and one wind project that have secured about $2 billion in federal loan guarantees and expects to collect nearly $1 billion in Treasury grants. The company has also won hundreds of millions of dollars in contracts to sell its turbines to wind plants built with public subsidies.

Mr. Katell said G.E. and other companies were simply “playing ball” under the rules set by Congress and the Obama administration to promote the industry. “It is good for the country, and good for our company,” he said.

And I have no doubt that that last statement is 50% right. It is good for his company. But as for the country keep in mind,

A great deal of attention has been focused on Solyndra, a start-up that received $528 million in federal loans to develop cutting-edge solar technology before it went bankrupt

Iceland and the IMF: why the capital controls are entirely wrong

The IMF has emerged from the global crisis bigger and more powerful. But this column from VoxEU.org argues that the capital controls it required Iceland to adopt in 2008 are not of the soft and cuddly modern type that slow hot money flows. Instead they are akin to the draconian controls common in the 1950s. They violate the civil rights of Icelanders and significantly hamper economic growth.

Iceland was faced with a serious problem of hot money overhang following its crisis in 2008 and it was feared that speculators would head for the exits, causing an uncontrolled collapse in the exchange rate. In our view, this fear was unfounded. Any speculator exiting under those circumstances would have faced significant losses compared with the option of waiting for economic stabilisation and the consequent currency appreciation. After all, the currency approximately reached its long-term equilibrium rate immediately after the collapse.

Thus, in our view, the imposition of capital controls was both unnecessary and unjustified. Without them, the exchange rate might have temporarily fallen even further in a worst case scenario, in which case a surgical intervention in the form of a temporary tax on short capital outflows would have been a sufficient policy response.

Instead, the IMF forced the Icelandic government to impose draconian capital controls of a type last seen in developed economies in the 1950s, causing significant short-term and long-term economic damage. The capital controls were initially touted as a temporary measure, but now three years after the event it looks like they are there to stay, and as the domestic economy adapts to their presence, they will be increasingly costly to abolish. After all, the last time Iceland imposed capital controls in the 1930s, they lasted until 1993.

The capital controls have resulted in an intrusive licensing regime, with government permission required for foreign travel and those emigrating prevented from taking their assets with them. Both are direct violations of the civil rights of Icelandic citizens and Iceland’s international commitments as a democratic European country.

Our hope is that other countries facing a similar situation will have the good fortune of receiving better advice from the IMF.

The IMF got it wrong. Who would have guessed?

Not-for-profits have owners

One of the most common features associated with not-for-profit firms is that they don't have owners. Or do they? In a 2001 article Jennifer Kuan writes,

So, for example. when a nonprofit hospital is sold to a for-profit firm, proceeds from the sale go into a public trust. In fact, Hansmann (1996) goes so far as to state that nonprofits do not have owners.

Hansmann's claim always seemed odd to me since if we follow Grossman-Hart-Moore and see ownership in terms of control rights rather than income rights then clearly someone has the control rights over the nonprofit, for if they did not how could they sell it?

Kuan paper, "The Phantom Profits of the Opera: Nonprofit Ownership in the Arts as a Make‐Buy Decision", backs up my intuition in that she models the nonprofit firm and shows that they do indeed have owners.

Her model looks at a performing arts firm which has two consumers, a high-type consumer and a low-type consumer. These two consumers comprise the market for an indivisible good and each would like to consume exactly one unit of the good. In the classical performing arts industry we know that both types of consumers want to consume the good, tickets are indivisible, and consumers are unlikely to consume the same concert more than once. Next Kuan introduces a profit-maximizing entrepreneur. The entrepreneur is assumed to be able to produce the good profitably, so that a good can be produced at a cost that is lower than a consumer's willingness to pay for that good. Not the high-type has a higher willingness to pay than the low-type. Kuan shows that nonprofits can arise even when a good can be marketed profitably.

In her model Kuan assumes that has a make-or-buy decision. That is, he an either buy the good from the entrepreneur or make the good himself. Making will amount to a nonprofit firm.

It is obvious that the high-type consumer would choose to make the good himself, rather than buy it from an entrepreneur, because the consumer surplus is highest in the make case. Notice that when the consumer chooses to make, he achieves first best and the quality level and total surplus are higher than in either the pooling or separating case.

So the high-type makes the good, but why is this a nonprofit firm?

Now the high-type can charge the low-type an amount, say t, to consume the good. Le t be the ticket price. The high-type also pays t so revenues for the firm are 2t. Let c(x) be the costs of producing the good by the high-type. If c(x)>2t then a "donation" (of c(x)-2t) from the high-type will be needed to keep the firm afloat. The high-type is willing to pay this since he is consuming a good worth this maximum willingness to pay to him which is greater and he only paid c(x)-t and he is getting a surplus greater than that he would have gotten by buying the good from the entrepreneur.

So even though the firm generates a surplus, that surplus is consumed and unobservable. Meanwhile, the firm itself appears lo be always just "breaking even" or on the brink of disaster, and why these firms seem to be dependent on charity.

So the high-type produces the good himself, making him the owner of the nonprofit firm.

Note also that as modelled by Kuan, nonprofits are economically efficient. And just as nonprolits have owners. they also have well-defined  utility maximizing objectives rather than some exotic, unpredictable optimization. Having a framework which identifies a well-behaved objective function for nonprofits enables economists to better deal with issues like the behaviour of nonprofits relative to for-profits, and to understand why nonprofits pursue profit-motivated activities.

Richard Epstein, George Soros and Bruce Caldwell discuss Hayek's Constitution of Liberty

An interesting set of presentations on Hayek's "Constitution of Liberty" by Richard Epstein, George Soros and Bruce Caldwell at a seminar at the Cato Institute. I think Richard Epstein's discussion is the best of them. The discussion that takes place after the formal presentations is also worth watching.

Interesting blog bits

1. Francisco de Castro, Javier J. Pérez and Marta Rodríguez on Fiscal data revisions in Europe and the credibility of fiscal policies

   The recent huge revisions witnessed in Greek data have raised concerns also about the credibility of the EU’s fiscal data reporting system. This column argues that initially published fiscal-deficit figures tend to be to revised towards an increased deficit at subsequent publication dates, and that the proximity of elections and the business cycle explain data revisions. It says that the EU should strengthen the role of Eurostat, the EU’s statistical agency, in auditing individual countries’ fiscal accounts and encourage EU countries to adopt more stringent fiscal rules.

2. Dani Rodrik argues Manufacturing is special

   Poor countries have access to world markets and rich countries’ technologies. In principle, they should catch up. Yet the record belies this expectation. But this column argues labour productivity in manufacturing displays a clear tendency towards convergence, unconditional on the countries’ institutions or policies. The policies that matter for growth are thus those that bear on the reallocation of labour from nonconvergence to convergence activities.

3. George Selgin on Paper bugs, or, Stupid Arguments Against Gold

   Some arguments against a gold stanard are just stupid.

4. Stephen Franks on “Can we just vote now to end this embarassment”

   Elections are full of crap.

5. Tim Harford argues Capitalism can’t just be about money.
6. Jesús Fernández-Villaverde and Juan F Rubio-Ramirez on Supply-side policies and the zero lower bound

   With nominal interest rates in many western countries at or approaching the zero lower bound, economists are calling for more quantitative easing or greater fiscal expansions to generate inflation, reduce real interest rates, and rejuvenate the economy. But what if these policies fail? Or are no longer possible? This column outlines a third way: supply-side policies.

7. Richard Posner on How the United States Is Like, and Unlike, Greece

   The economic situations of the United States and Greece are more alike than one might think. In both countries, the government is insolvent, in the sense that its taxing power, constrained by politics, is insufficient to finance the government’s liabilities, which include not only bonds but also entitlements (such as social security and medicare) and essential public services (such as defense)

8. Winton Bates asks Do commercial interests have excessive influence on people in modern societies?

   Jeffrey Sachs makes it difficult for any libertarians who happen to look at his book, ‘The Price of Civilization’, to consider seriously his claim that powerful corporate interests have excessive influence in America. He claims that libertarians ‘hold that the only ethical value that matters is liberty, meaning the right of each individual to be left alone by others and by the government’.

9. Alex Tarrant on Labour's attacked on StatsNZ.

   I have to agree with Tarrant's article, it does make Labour look desperate. An attack on the political neutrality of StatsNZ 8 days after their media release itsn't a good look.

10. Bill Kaye-Blake on the "economic stories" the political parties are telling

    National
    Labour
    Minor parties
    and then from Narratives to policies

Green growth? evidence from energy taxes in Europe

Seán Lyons and Richard S J Tol discuss green growth in a new column at VoxEU.org. A quick summary:

Politicians around the world like to argue that ‘green growth’ will create jobs and stimulate innovation. This column examines the impact of energy taxes on business, with a dataset of 11 million European firms between 1996 and 2007. The results are mixed – it seems that dirty, smoke-filled growth may well be better for the firm’s workers and their customers.

Lyons and Tol discuss the impact of energy taxes on corporate behaviour.

We test four hypotheses:

• Do energy taxes create employment?
• Do energy taxes stimulate innovation?
• Do energy taxes increase profits?
• Do energy taxes raise investment?

What is the impact of energy taxes on employment by sector?

There are substantial sectoral differences. Most effects are statistically significant. Some sectors show a positive effect; notably wearing apparel, textiles, and primary-resource sectors. Labour, typically less skilled in these sectors, may be used as a substitute for energy. Air transport shows a strongly negative association, which may be spurious – the sample period coincides with the rise of the discount airlines. Other sectors exhibit weaker negative effects, notably machinery and construction. For these sectors, higher energy costs imply an overall contraction. For employment, the average effect is negative and significant. Overall, increased energy taxes reduce employment.

What is the impact on TFP growth rate by sector?

Sectoral variation is large. Primary resources, manufacturing, power generation, pulp and paper and the media sector all show a positive effect. Most of these sectors are energy-intensive. This suggests that higher energy costs forced these firms to innovate. However, energy taxes reduce input price variability and raise barriers to market entry; both could increase TFP as measured here. TFP in chemicals, textiles, wearing apparel, leather and quarrying shows a negative association with energy taxes. These sectors are in decline in Europe, and higher energy taxes seem to spur this trend. The average effect of a tax change on TFP growth is positive. Overall, higher energy taxes accelerate TFP growth in Europe.

What is the impact on the return on capital employed by sector?

This is positive in most cases, particularly for tobacco and air transport. Air transport is exempt from energy taxes. Higher energy taxes, however, imply a lower demand for energy and hence a lower price of kerosene. Higher energy taxes also reduce the price of air travel relative to road and rail. However, the effect may be partly spurious because of the restructuring of the airline industry. Water transport, wood products, quarrying, and refining have significant negative coefficients. Faced with higher energy costs, firms in these sectors take a hit on the bottom line. However, other firms see positive effects as they are able to pass on the higher costs to their customers and take advantage of improved productivity. The average effect is positive. Overall, higher energy taxes increase profitability in Europe.

What is the impact on corporate investment?

The tobacco sector again stands out, but this sector was in decline too for reasons other than energy taxes. It may be that energy taxes were raised faster in countries that reduced smoking most substantially. Textiles and plastics show a negative impact – these sectors substitute energy and capital for labour. In contrast, metal mining, gas extraction, basic metals, refining, and water transport have large positive coefficients. High energy taxes spur investment, we presume in primarily in energy-saving equipment. The average effect is positive. Overall, higher energy taxes spur investment in Europe.

The Lyons and Tol conclusion?

In sum, the following results emerge.

• First, results vary dramatically between sectors, both in size and in sign.
• Second, energy taxes reduce employment.
• Third, TFP accelerates with higher energy taxes.
• Fourth, energy taxes increase the returns to capital.
• Fifth, energy taxes increase investment.

Overall, these results provide only mixed support for the political ‘green growth’ agenda. Energy taxes appear to favour capital over labour. Innovation accelerates, but it may not be the type of innovation that spurs economic growth.

Horizontal integration and competition policy

Today I came across an interesting comment on integration and antitrust policy by Joseph J. Spengler

RECENT decisions suggest that the United States Supreme Court is beginning to look upon integration as illegal per se, under the antitrust laws. It may be presumed, in so far as this inference is valid, that the Court believes that integration necessarily reduces competition "unreasonably." No sharp distinction is made by the Court between vertical and horizontal integration. (Joseph J. Spengler, "Vertical Integration and Antitrust Policy", Journal of Political Economy, Vol. 58, No. 4 (Aug., 1950), pp. 347-352.)

This was written in 1950 and things have changed since, at least with respect to vertical integration,

Because there are often efficiencies to vertical integration, the Antitrust Division typically requires a showing of market power before it considers whether a vertical arrangement poses serious competitive concerns.

At least part of the reason for the change in view is due to the work of Oliver Williamson,

Williamson was skeptical of the conventional wisdom of the time [1960s], which presumed that the purpose and effect of many vertical practices was the enhancement of market power and the erection of entry barriers. Contrary to this view, which was widely adopted by antitrust lawyers and courts in the 1960s, Williamson could see rationales for various vertical practices that were based instead on economic efficiency.

The view of horizontal integration has changed less, but the work of Hart and Holmstrom may be a step in the direction of greater change even here. In their model, two firms are in a lateral relationship and yet they can show that there are conditions under which integration is optimal. So they can show that even horizontal integration can be efficiency enhancing.

This result follows on from a similar conclusion found by Williamson, arrived at via a different framework of analysis, who argued that there is a trade-off between reduced market competition and increased efficiencies due to a horizontal merger. Hart and Holmstrom gives us another reason to consider the efficiency side of the argument.

Greece – where next?

Down the gurgler, would seem the obvious response.

But for another view checkout this audio from VoxEU.org in which Dimitri Vayanos of the London School of Economics talks to Viv Davies about Greece and the eurozone crisis, and argues that leaving the euro would be a disaster for both Greece and Europe. They discuss the bailout package, the appointment of Lucas Papademos as Prime Minister and the benefits of a coalition government of technocrats. Vayanos maintains that the emphasis for Greece should be on deeper institutional and structural reforms.

And why do we care about the price?

At the TVHE blog recently there has been activity base around the question of asset sales, see for example here and here and the comment sections of these posts. The big issue seems to be the price that we get for the sale of any state assets.

But why, I ask, do we care about the price? The logic behind the sate of state assets is about efficiency not the price. As Anbarci and Karaaslan point out in their paper "An Efficient Privatization Mechanism":

In this paper, we consider the privatization of State-Owned Enterprises (SOEs) that are legal monopolies but not natural monopolies; their markets can be opened to competition once privatization takes place and other competitors can emerge and compete successfully against them in a few years. But until that happens, these privatized SOEs can have a significant level of market power. The currently used “Revenue Maximization (RM)” privatization scheme maximizes the government revenue from privatization but does not provide sufficient incentives for the privatized SOE eiher to charge a price lower than the monopoly price or to improve production efficiency until competition arises. We propose a new scheme to privatize such SOEs. We term this new scheme the “Welfare Maximization (WM)” scheme. The WM scheme practically yields no revenue to the government from the privatization of any such SOE; however, it induces the privatized SOE to charge a competitive price in the absence of any regulation. It also turns out that the WM scheme provides greater incentives for post-privatization process invention (i.e., for post-privatization cost reduction) than RM scheme. (emphasis added)

This is a very specific situation but it helps make the point that just worrying about the price received for an asset is not a good idea. In the above example welfare is maximised (and isn't welfare what we should be concerned with?) while revenue is basically zero.

The point I wish to argue here is that there is problem with thinking about privatisation in terms of the money raised. The reasons for privatisation can hold even if you get nothing from the privatisation programme. Talking about maximising the return from privatisation misses the whole point of privatisation which is to improve the efficient and productivity of the economy. If we just worry about how much we will get for the sale of assets then we should sell all of the state assets with the firms being monopolists. But that's unlikely to do much for efficiency and welfare.

The point to note is that the advantage of privatisation is that it will depoliticise the firm. The aim is to have the greatest possible "distance" between the government and the firm. Government interference in the running of a firm is impossible to eliminate completely but a good privatisation plan will result in a situation where any government interference is as obvious and politically costly as possible.

For successful privatisation it is more important to get the regulatory environment right so that competition can breakout in the industry than it is to maximise the price for which the asset is sold. Basically I'm arguing we should have lexicographic preferences, with price low on the list. Worrying about whether or not the ‘family silver’ was sold too cheaply misses the point, the price received can only be see as too high or low relative to the market structure the firm finds itself it. Just arguing that a higher price could be obtained with a different market structure is only useful if the new market structure improves welfare.

So let there be a debate about privatisation in terms of efficiency not price.

Why do firms get merged or acquired?

This question is asked at the Economic Logic blog. There are a number of possible reasons, one of which could be to get the firm's workforce.

Paige Ouimet and Rebecca Zarutskie show that mergers and acquisitions can also be the result of a drive to get access to the other firm's pool of workers. This is particularly true when the labor market is tight and the workers carry high human capital.

I can't help but think there has to be more to it than just a workforce. After all if you just want the workers why not employ them directly? Why buy a whole lot of non-human capital if you don't have to?

The likely answer seems to me to be that you do want the non-human capital. The likely reason you want the human capital is that it highly complimentary to the non-human capital. And buying the firm gets you both.

Complicating GST

Homepaddock points out that

Labour leader Phil Goff reckons removing GST is simple.

He says it will be taken off a lettuce, it will also be taken off a salad at the supermarket and the mayonnaise that is packed with it but it won’t be taken off either if they’re in a hamburger.

One of the things the overseas advisers told the government at the time when GST was introduced was to keep it simple. One important way of doing this was to (basically) put it on everything, at a constant rate. Any change to such a policy is just asking for trouble. Once different rates are charged sellers have an incentive to get their goods and services into the lowest GST grouping and trying to workout who is cheating the system increases compliance costs hugely.

Simple is best.

Investment banking

Professor Charles A.E. Goodhart has an column at VoxEU.org in which he discusses Investment banking. Goodhart argues that the protestors who occupy Wall Street and financial centres around the world and claim that investment banks are “socially useless” are wrong. His column argues that investment banking is critical to any effective economy and the idea that policymakers can safeguard retail banking alone is not only tragically mistaken but also horribly dangerous.

Markets get made by participants taking positions. No one objects to agents taking positions if they bear the loss themselves. Problems arise when there are major externalities to society from such losses. It is the thesis of this note that the role of investment banks is so central to the efficient operation of our complex financial system that losses to such banks have major social externalities. The idea that, once you have carved out the ‘socially valuable’ parts of retail banking, ie the payments system and retail lending and deposit-taking, you can liquidate the rest without massive adverse effects is not only tragically mistaken but also horribly dangerous.

Goodhart is right that investment banking is critical to the economy but I can't help thinking that the best policy would be that governments don't "safeguard" any form of banking.

What is the value of the financial sector?

At VoxEU.org Wouter den Haan of the London School of Economics talks to Viv Davies about his lead commentary in the current Vox Debate on the value of the financial sector. He argues that standard measures of the sector's economic contribution overestimate its true value to a modern economy. They also discuss the views of other notable economists, as well as how regulation could curb excesses in the sector and prevent socially negative spillovers.

EconTalk this week

Steven Kaplan of the University of Chicago talks with EconTalk host Russ Roberts about the richest Americans and income inequality. Drawing on work with Joshua Rauh, Kaplan talks about the composition of the richest 1% and 1/10 of 1%--what proportions come from the financial sector, CEOs from non-financial corporations, athletes, lawyers and so on. Then he discusses how the incomes of these different groups have changed over time. Kaplan argues that these groups have increased their incomes by similar proportions, suggesting that a failure of corporate governance is not the explanation of rising CEO pay. The discussion closes with a discussion of the financial crisis and the compensation in the financial sector.

Quote of the day

“The state has no business getting involved in a matter between two individuals,”

And before you get too excited, the quote is by Cuba's president Raúl Castro and he is explaining why Cuba will now allow people to sell their own cars. Last month the government published rules allowing Cubans to buy and sell used vehicles freely for the first time in half a century. I hope buyers have read their Akerlof.

However while buying and selling used cars is now ok, those allowed to buy new cars is limited to people who earn some foreign currency, including doctors, artists, musicians, members of airline flight crews and the handful of Cubans who work at the American naval base at Guantánamo Bay.

Student protest at Harvard

Students have walked out of Gregory Mankiw's first year economics lectures at Harvard to protest about what the event organizers call a class that promotes a “strongly conservative neoliberal ideology.” Now I can't help but think that "conservative neoliberal" is an oxymoron. Consider that F A Hayek, one of the leading neoliberal economists of his day, wrote an essay on "Why I'm Not a Conservative" and Milton Friedman also called this ideas liberal, not conservative (see the introduction to "Capitalism and Freedom").

Anyway here is Greg Mankiw being interviewed on NPR about the protest.



When I did first year political science we were lectured by an out and out Marxist, should I have walked out in protest because of the "Marxist ideology" being promoted in the class?

I didn't because the classes really were fun.

Critiques of economics

In the comments section of a recent post at TVHE blog the question of Keen's critique of economics given in "Debunking Economics" is raised. Responses to Keen's argument have been made in a number of different places. As to local blogs, in the past, Matt Nolan has commended here and here and I have posted here, here and here. Canadian economist Chris Auld has a more detailed discussion in Auld, M.C., 2002. Debunking Debunking Economics. Working Paper, University of Calgary. Available at http://jerry.ss.ucalgary.ca/debunk.pdf.

An executive summary of a standard reply to Keen's arguments about models of firm behaviour would be that given by Schiffman (2004: 1909-1)

According to Auld, Keen is mistaken concerning the distinction between perfect competition and monopoly (or lack thereof—topic 3), and his perception that mainstream modeling ignores dynamics (topic 6). These errors, in Auld’s estimation, are caused by "either a lack of familiarity with the literature, conceptual errors, or both". As Auld shows, perfect competition can be rigorously derived as the limit of a model of imperfect competition (as the number of firms becomes large). Assume that each firm takes competitors’ outputs as given, but recognizes that it has some degree of market power (its own output influences the market price). The ratio of output under this form of imperfect competition to output under perfect competition is n/(n+1) (where n is the number of firms). When standard theory assumes that firms take prices as given, it is making an innocuous assumption; for example, an imperfectly competitive industry with 100 firms will produce slightly over 99% of the perfectly competitive output.

Another possible approach to rigorously deriving perfect competition is to assume there exists a continuum of firms. In such a situation , it is literally true that any firm can change its output without changing price, even when the market demand is smooth and downward-sloping. Aumann, R. (1964) ("Markets with a continuum of traders," Econornetrica 32:39-50) is a standard reference.

Overall Schiffman notes,

To summarize, Keen is correct that many issues that should be taught to students are not being taught. There is need for a book that introduces students to controversies in theory and methodology, on a level that is accessible to advanced undergraduates. Debunking Economics is, however, too biased to fulfill this need. If one wishes to advocate a reform of economics (and Keen may very well be correct that it is a necessity), one must provide a more nuanced, more accurate, and more up to date picture of its current state.

What to do about Italy?

Right now the Italian economy is doing worse than the Italian rugby team. And that’s not a good thing. As there is an over-400 basis point spread between Italian bonds and German bunds, a 1,900 billion euro public debt, a public debt to GDP ratio of 120% and zero growth prospects for 2012, Italy could be the next Greece.

So, what should the government do now, in the context of the current crisis?

At the IEA blog Dr Alberto Mingardi, the Director General of Istituto Bruno Leoni (www.brunoleoni.it),  outlines some policy options the Italian government could take.

The quickest answer lies in one word: privatisation. The Italian state owns assets worth €1,800bn. Not all of them can be privatised quickly. Nonetheless, Istituto Bruno Leoni, among others, has estimated that the Treasury still holds €100bn in listed or private companies that could be released to the market.

This includes shares in the energy giants ENIand ENEL, 100% of the post and railways monopolies (Poste Italiane and Ferrovie dell Stato), a fully state-owned insurer against accidents at work (INAIL), an insurance company that guarantees to domestic entrepreneurs against political and commercial risks linked with the export of goods and services (SACE) and many others.

On the top of that, the Italian national and local governments own €400bn in real estate. The Berlusconi government is planning to sell some - for a value of €5bn euros a year for three years, which means €15bn all together, i.e. less than 5% of those assets and less than 1% of the total public debt.

It is amazing that, for purely ideological reasons, the Italian government is not undertaking privatisations that would both contribute to the objective of reducing public debt and release still monopolised business sectors to entrepreneurial creativity.

It has often been lamented that Italy's problem is one of credibility. This is true. Italyis not a country without strengths: impressive private savings and strong entrepreneurs are the two most relevant ones. Still, incentives matter. In a world where capital is far more mobile than in the past, Italy's intricate and unpredictable regulations, plus its heavy taxation, make it an unlikely candidate for more investment.

Italians have long waited for a simplification of their legal codes and deep tax cuts. Yet the ingrained resistance of interest groups to a strong restructuring of public finances and, thus, of the scope of government, has made such policies impossible.

Mr Berlusconi and the Italian government should now be what they have never been: bold. This is the right moment to start long awaited liberalisation, aiming at boosting growth. But since the effects of liberalisation take time to materialise, the markets must be reassured of the Italian government's seriousness in getting public debt under control. Privatisation is the right instrument to achieve this.

The problem with academic journals

Noam Nisan at the Algorithmic Game-Theory/Economics blog writes that

Journals are simply not fulfilling their main three functions: dissemination, verification, and allocation of attention.

1. Dissemination: While originally the main point of a print journal was so that Prof. A. can see the results of Prof. B. relatively quickly, it is clear that, in the age of the Internet, journals only slow dissemination compared to, say, putting stuff on the arXiv.
2. Verification: Despite pretenses, refereeing is not really trust-worthy. Results of some importance become believed not when refereed but rather only after the community has studied them for a while.
3. Allocation of attention: an important goal of leading journals is to filter the “important” papers out of all the submitted ones, so that readers need not read everything but rather only the important stuff. I am afraid that today so much is published so that most of what one reads in most journals should have been filtered out. Partially this is a problem of the publish-or-perish culture and partially due to the coarseness of the refereeing model as a filtering tool.

All three of these main goals can be improved upon considerably using the right tools (that need to be figured out) on the Internet. At the same time that the journal system has lost its usefulness, it has created a lot of harmful side effects: the writing of countless worthless papers, lack of recognition for surveys, books, or other non-”paper” contributions, blind and silly use of metrics like impact factors for hiring, grants and promotion which lead to wasteful optimization of these rather than of real research. All these harmful side-effects could be tolerated had the system served its main purpose — but now we are just paying the price but not getting the goods.

I think there are a number of problems with academic journals but the negative externalities that Nisan points out in his last paragraph are not, I would argue, the fault of the journals. Problems with lack of recognition for some types of work or the use of silly metrics for hiring etc are caused by the incentives put in place by administrators for things like promotion, getting grants etc. Here is New Zealand efforts like the PBRF drive the types of side-effects Nisan notes rather than the journals. A lot of useless publishing, for example, takes place just to keep your PBRF ranking up. A lot of lower ranking journal have been created so that people have places to publish the aforementioned useless articles.

On a related matter, the question of the excessive journal pricing by commercial publishers, see Ted Bergstrom's homepage.

Interesting blog bits

1. Kyle Almond asks Just how big is 7 billion?
2. Ed Dolan asks Can Spaceship Earth Carry Seven Billion Passengers, and More to Come?
3. Mario Rizzo notes there are Seven Billion People and Counting
4. Tim Harford on Malthus’s ghost and baby number 7bn
5. Matt Ridley writes on Coping with only six billion

Economics at a young age

From the food blog at NPR.com

But not all candy is created equal, as all children will tell you. And increasingly American kids are getting an early lesson in economics — and business — by finding ways to trade their Halloween candy with friends and siblings.

I decided to peek in on a candy trading party in one of the top 10 Trick-or-Treat scenes in the country — Washington, D.C. I spent the evening with 25 kids, most about 11 years old, who aggressively traded candy after working the streets of the Chevy Chase neighborhood Monday night.

Within seconds of returning home, the first group at the trading party spilled their pillow cases onto the floor and started making piles.

"I've got Whoppers and Nerds. Who wants 'em?" Sierra Lewter, 11, shouted across the room once the floor opened.

Sierra quickly became the queen of Reese's by jumping into the market early. While most kids were still organizing their piles by brand, she was already making moves and trading her way to a hefty collection of Reese's Pieces and Peanut Butter Cups.

Lauryn Donahue displayed a solid grasp of the concept of excess supply. She was working hard to move the less-desirable candy given out at her house earlier that night.

[...]

The decibel level in the candy-trading room rivaled that of Wall Street. The trading peaked about 20 minutes in as cross-room deals had Milk Duds flying overhead while a Jolly Rancher came the other way. Whoppers went for Smarties. Kit Kats went for a Twix. Charleston Chews, the pennies of the lot, didn't seem to move at all.

[...]

As the trading died down, the candy consumption began. Everyone seemed satisfied with the deals they had made.

The first fundamental theorem of welfare economics in action.

Goff on markets

Eric Crampton has been marking Phil Goff on his understanding of how markets work. Eric writes,

Now, here's Phil Goff in last night's Leaders' Debate.

At times you have to intervene. The market is a good system. But there's a thing called market failure. And when you've got 10,000 people chasing sections all at the same time, that's not the normal functioning of the market. And if there isn't the supply to meet that, then your property prices are going to be inflated.

Sorry, Phil, that gets you a C- at best. Yes, if there's a shock to demand for standing houses and supply is relatively inelastic, property prices go up.

I have to say a C- seems a bit too generous for me. Yes prices will rise given that  the relative demand for housing has risen, but to say this is a market failure really is bollocks. The rise in prices shows that markets are working exactly how we would expect them to work. To miss this really does show that Goff doesn't understand a really basic point about how markets work, they allocate scare resources via the price mechanism. They bring about equilibrium by cutting off demand and giving incentives to increase supply.

The real problem here isn't the rise in prices, its the lack of response on the supply side of the market which largely due to restrictions on supply due to local government regulation. So the problem is is government failure rather than market failure.

A slow-growth America can't lead the world

This somewhat obvious point is made by John Taylor in the Wall Street Journal. Taylor argues that after World War II, the U.S. promoted international economic growth through reliance on the market and the incentives it provides. Times have changed. Taylor writes,

At the most recent meeting a year ago in Seoul, the G-20 rejected the president's [Obama] pleas for a deficit-increasing Keynesian stimulus and instead urged credible budget-deficit reduction and a return to sound fiscal policy. And on that trip he had to defend the activist monetary policy of the Federal Reserve against widespread criticism that its easy money was damaging to emerging-market countries, causing volatile capital flows and inflationary pressures.

With a weak recovery—retarded by new health-care legislation and financial regulations, an exploding debt, and threats of higher taxes—the U.S. is in no position to lead as it has in the past.

By contrast, in the years after World War II, the U.S. led the world in promoting economic growth through reliance on the market and the incentives it provides, the rule of law, limited government, and more predictable fiscal and monetary policy. It created a rules-based, open trading system by helping to found the General Agreement on Tariffs and Trade, which slashed tariffs multilaterally. The miraculous postwar European and Japanese recoveries came from greater adherence to these principles of economic freedom and direct support from the U.S.

After getting off track with interventionist policies in the 1970s, the U.S. put its economic house in order in the 1980s, adopting pro-growth policies and creating a long boom that lasted through the 1990s. Again its economic ideas were contagious, not just in Britain under Margaret Thatcher but in the developing world. Seeing the advantages of American-style economic liberty over state intervention and control, Deng Xiaoping expanded his initial and tentative market-based reforms in China and created an economic renaissance. The U.S. helped the countries in Central and Eastern Europe implement market-based reforms, and it encouraged other countries and the international financial institutions to do the same in Africa and Latin America.

As the U.S. has moved away from the principles of economic freedom—instead promoting short-term fiscal and monetary interventionism with more federal government regulations—its leadership has declined. Some, even in the U.S., may cheer the decline, but it is not good for the world or for the U.S.

It could rightly be argued that American economic policy post WW2 was not perfect given its over use of regulation and high marginal tax rates, but comparatively speaking the American model was better than that being used in large areas of the world which were not free either economically or politically. Just compare it with post WW2 Britain with its even greater controls over the economy. John Jewkes summed up the situation in the title of this book "The new ordeal by planning: the experience of the Forties and the Sixties". And it was often better than much of the policy we see today.

Taylor is right when he says,

If [...] the U.S. starts to return to the principles of economic freedom—the best route to improving its own economy—then perhaps it will be able to reassert its economic leadership, benefit the world economy, and in turn create an even more prosperous American economy in a grand virtuous circle.

A musical review of differentiation

I guess you have to be weird to be a mathematician.

(HT: Division of Labour)

Should we believe the German labour-market miracle?

Jobs and the lack of them are top of the agenda for policymakers and increasingly groups of protestors gathered in the financial districts of New York, London, Wellington, Christchurch and elsewhere. Unemployment in many of these countries is in danger of reaching 10%. In Germany, however, unemployment is below 7%. Some hail it as a miracle. This column, from VoxEU.org, finds a scientific – and far less inspiring – explanation.

In recent research (Burda and Hunt 2011), we show that one unnoticed explanation can explain a significant component of the reputed economic miracle. In the export-driven expansion of 2005–07, firms hired significantly less than that expected, given the extent warranted by GDP and wages. As evidenced by data on firm expectations and articles in the business press, firms had unusually low confidence the boom would last. We show that the missing employment increase in the 2005–07 boom was equivalent to 40% of the missing employment decline in 2008–09, and that more than half of the missing employment increase was attributable to firms’ pessimistic expectations. Firms hesitated to hire in the boom, as they feared it would not last, and when eventually the recession they feared arrived, they had less need to fire than in previous recessions.

So if you don't hire people, you don't have to fire them.

EconTalk this week

Ryan Avent of the Economist and author of The Gated City talks with EconTalk host Russ Roberts about The Gated City and how cities have restricted access to land and housing. Avent argues that restricted access has raised housing prices artificially on both the east and west coast of the United States, reducing urban populations and restricting access to labor markets. He argues that this in turn has artificially depressed growth in the United States by keeping workers from their most productive opportunities. The conversation closes with a discussion of possible policy changes that might make cities more accessible to development and growth.

Mechanism experiments and policy evaluations

'Evidence-based policy’ is one of the big things in policy circles these days. One important issue for the research community to think about is ways of increasing the efficiency of the policy-research. One starting point is to revisit the assumption that is prevalent throughout the policy-research industrial complex that the best way to use randomised experiments to inform policy is to test actual policies.

Consider the following example, taken from Improving government efficiency through mechanism experiments by Jens Ludwig and Sendhil Mullainathan at VoxEU.org:

Suppose that the US Department of Justice is interested in learning more about whether to devote scarce resources to supporting ‘broken windows’ policing, which is based on the notion that signs of minor disorder signal to potential offenders that no one cares about crime in the local area, thereby reducing the deterrent threat from punishment and increasing the chances that more serious crimes are committed. Most researchers would argue that the best approach is to carry out a policy evaluation of broken windows policing. Recruit a representative sample of cities, and randomly select some neighbourhoods but not others (or perhaps some cities but not others) to receive broken windows policing. Then compare subsequent crime rates in treatment versus control areas. This policy evaluation would be informative but not cheap. The unit of random assignment in this case is the neighbourhood or city – the level at which the policing intervention of direct interest operates. The number of neighbourhoods or cities that would need to be ‘treated’ to have adequate statistical power is large, and the cost per treated area is high.

Now consider an alternative experiment. Imagine buying a number of cheap used automobiles. Break the windows of half the cars, and then randomly select a set of urban neighbourhoods in which to park cars with different levels of physical damage. Measure what happens to more serious crimes across different neighbourhoods. While less ethically objectionable variants of such an experiment are possible (such as randomising areas to have signs of disorder cleaned up, rather than introduced), our example is basically the research design used in a social psychology experiment in the 1960s that led to broken windows theory and then widespread adoption in New York City in the 1990s. This ‘mechanism experiment’ doesn’t test the policy of direct interest to the Department of Justice, but rather tests the causal mechanism that underlies the broken windows policy.

How can mechanism experiments help economise on research funding? The broken windows theory rests on a simple logic model in which the key policy lever, P (broken windows policing), influences the outcome of primary policy interest, Y (serious criminal offences), through the mediator (M) of local disorder, or PàMàY. Suppose that DoJ thinks it already knows something about policing – specifically, suppose that DoJ thinks it already understands the relationship between broken windows policing and signs of disorder (PàM). Police professionals might need to have learned that relationship to guide all sorts of policing decisions, because citizens dislike disorder for its own sake regardless of whether it accelerates more serious crimes. In that case the new information that DoJ gets from carrying out a policy evaluation of actual broken windows policing is just about the MàY link, but that information is mixed together with the noise about the specific PàM link that would arise in any given experiment. On the other hand the mechanism experiment maximises the research funding available to identify the part of the causal chain (MàY) that policymakers do not already understand. Put differently, mechanism experiments can economise on research funding by taking better advantage of what policymakers think they already know.

This broken windows example is not an isolated case. Depending on what policymakers think they understand, in other applications mechanism experiments might increase the efficiency of research spending by, for example, enabling researchers to randomise at relatively less aggregated (lower-level) units of observation.

So rather than having to test the actual policy directly you may be able to, at lower cost, test the causal mechanism that underlies the policy.

Ludwig and Mullainathan go on to say,

We are not claiming that mechanism experiments are ‘better’ than policy evaluations. In situations where, for example, the list of candidate mechanisms through which some policy might affect outcomes is long and these mechanisms might interact, the only useful way to get policy-relevant information might be to carry out a policy evaluation. Probably more common is the situation in which mechanism experiments and policy evaluations are complements, in which encouraging evidence from a mechanism experiment might need to be followed up by a policy evaluation in order to, for example, reduce the risk of unintended consequences. But at the very least carrying out a series of mechanism experiments first can help improve decisions about when it makes sense to invest research funding in a full-blown policy evaluation.

A country is not a company, and shouldn't be run like one

Over at the, normally reliable, TVHE blog rauparaha writes,

Phil Goff:

[There is] no businessperson in New Zealand that would say when you are in difficulty the best thing you could do is sell off your best-performing assets.

At least both major parties now agree that that the election is all about finding a new CE to run NZ Inc. What a shame we’re not inviting applications from people with proven, international experience.

And I have to say no! The last thing any genral election should be about is "finding a new CE to run NZ Inc". As Paul Krugman (yes even he is right about some things!) said A Country Is Not a Company. To see why consider, for example, the basic point that companies compete with each other but New Zealand doesn't compete with other countries. Thinking that countries compete is a just one false analogy that comes from thinking that countries are like companies when they're not. The point is that Coke and Pepsi, for example, do compete, one gains at the others expense, but New Zealand and Australia, for example, don't, their loss is not our gain. International trade is not a zero-sum game. To see this, note that while Coke may wish to put Pepsi out of business, so that Coke can increase their sales and prices and therefore profits, New Zealand would not gain if we put Australia "out of business".

Why? Well in the Coke/Pepsi case, Coke gain a lot, in terms of sales and profits, from not having Pepsi to compete with and lose little since Pepsi doesn't buy much, if anything, from Coke. Or Coke from Pepsi. This is not true of the New Zealand/Australia example. We may gain some sells if Australia stopped producing, but we would lose much more. Australia is our biggest export market and if they "went out of business", they would stop importing, and that would hurt us a lot. Also they are suppliers of much of our useful imports and that would stop too, which would hurt us even more.

Countries trade, they don't compete. And thus we don't need to find "a new CE to run NZ Inc" because NZ Inc doesn't exist.

Roger Kerr 1945 - 2011 (updated)

The news of Roger Kerr's death came as a shock to me despite the fact that we were all primed to expect it. I can't describe Roger as a close personal friend, but I did meet him on a number of occasions. When in Christchurch he would to come to the economics department or at least meet with members of the department whenever he could. He also gave talks to economics classes discussing issues to do with economic policy when asked. The times I did meet Roger I'm sure I gained a lot more from the encounter than he did!

Roger's influence went beyond New Zealand, Tyler Cowen writes at Marginal Revolution:

Roger had a huge influence on my life. I spent a good deal of time working for him and with him at the New Zealand Business Roundtable in Wellington and he was always up for a discussion and an argument. He seemed to have boundless energy, and he played a key role in making New Zealand a sounder and better country. A lot of my interest in economic policy comes from my time spent with Roger, most of all my interest in the institutional design of central banks but not just. Roger expected you to be ready to discuss anything, at the drop of a hat, and I consider my time with Roger a major influence on my blogging. He exposed me to the New Zealand classical liberal tradition and from that I saw a lot of deficiencies (and some strengths) of the North American traditions. Roger will be missed but we all know that his influence extended far.

And across disciplines, law professor Richard Esptein gives the following appreciation of Roger at the New Zealand Business Roundtable website:

Earlier this morning I received a simple email from Catherine Isaac that “Roger passed away peacefully at home last night surrounded by his family.” That brief email came as no surprise, because her previous communications had indicated that all treatment options had been exhausted. But for me that short message marks the sad end of an era in my personal life.

Roger was one of a kind. I first met him in 1990, when he prevailed on me to come to New Zealand to speak, among other things, against the new pay equity legislation that had just become law into New Zealand. Roger was never a man for half measures so that he managed to line up about eight or ten other speaking engagements during that short stay. It was the first of four such nonstop visits to New Zealand, each of which Roger orchestrated with his customary enthusiasm and efficiency. After each of the trips, he would prepare a transcript of my remarks, be sure that they were edited, and then passed them back to me for elaboration and expansion, after which they were published by the New Zealand Business Roundtable, which he had led since 1986.

Working that closely with Roger over so many years, and in so many different settings, gave a bird’s eye view of the man. Often a close working knowledge of another human being leads to a certain cynicism well captured by the somewhat faded aphorism that no man is a hero unto this valet.

That was not the case with Roger. The more you knew him, the more you came to respect and love him as a person. He had a combination of attributes that are hard to match. On those trips to New Zealand, I was always joined by my wife Eileen, and sometimes by my children as well. We not only worked together, but we vacationed together for extended periods of time. We also managed to get together in other locations, including for the last time at the Mont Pelerin meeting in Stockholm, in August 2009.

Being with Roger was a revelation. All too often it is said of people who are in favor of markets, they only do so because it gives an outlet for their own greed and other base emotions. Nothing could be further from the truth with Roger. The most extraordinary feature about him was the exemplary way in which he consciously chose to lead his life.

For Roger, the freedom under law to act in your own self-interest was an invitation to make sure that you led your life in accordance with the highest principles of right conduct. Roger never used to speak about profit and personal gain. And he never spoke much about how it was that he should lead his own life. He always sensed that self-praise was a way to diminish your own character, so he relied on quiet deeds to communicate the values that he held most dear.

First on that list was his incredible sense of duty toward others with whom he worked. Doing business with Roger was always a pleasure, because you knew down to the marrow of your bones that Roger’s word was indeed his bond. What he said he did, and if that did not satisfy his personal sense of duty, why he would do something else in addition. For Roger the correct ecological balance was to do all that he could to help others, and to be self-reliant in all that he did, so as never to tax the good will resources of others. One might say that throughout his life he enjoyed a favorable balance of trade with the rest of the world. He received much from those with whom he gave, but he always gave back more in return.

Second on that list was Roger’s utter incorruptibility on all matters of first principle. Early in life, and surely in his days at Treasury under Sir Roger Douglas, Roger internalized the importance of open markets and free trade. Watching New Zealand nearly implode under its grotesque policies made a lasting impression on Roger. Taxes and subsidies for competitive advantage fell into the class of original sins. He could never lift a finger to support such ignoble causes, even for his friends.

As head of the New Zealand Business Roundtable, Roger lived his principles on an everyday basis. He labored successfully through his 25 year tenure of office, to make sure that this organization would not seek to find short-term advantages for its members at the expense of the public at large. For Roger, these were matters of high principle, not issues of short-term expediency. To be with him in conversation was to know of the strength of his convictions and of the quiet eloquence and determination with which he defended them.

Third on the list was Roger’s piercing intellect. Dwight Eisenhower once described an intellectual as someone who used more words to say less than he knew. That was never the case with Roger. Over the years, I have had the privilege to read the many addresses and short articles that Roger wrote on a variety in economic and social issues, large and small. In each of these gems, Roger was the master of a clear and orderly exposition of any topic. He possessed the power to persuade without any of the pretense and self-importance of lesser.

During his life, Roger suffered many short term reversals, for his positions were not always popular in intellectual and political circles. But his persistence and clarity have paid enormous dividends to New Zealand. His ceaseless efforts to pass the Employee Contracts Act of 1990 accomplished far more for the health and well-being of New Zealand labor markets than his detractors could acknowledge. The success was so great that even the passage of the misguided Employment Relations Act of 2000 could not undo most of the gains from market liberalisation that the earlier statute had achieved.

Today New Zealand ranks near the top on most indices of economic freedom. Much of the credit for that improvement goes to Roger, whose dedication and wisdom has made the world a much richer place. We shall all miss him greatly, for the grandness of his character, for the strength of his moral fiber, for his clarity of his thought, and for the warmth of his friendship.

Update: Not PC reminds us of this video of the interview Roger Kerr did with Lindsay Perigo earlier in the year.

O’Driscoll on UCLA, Chicago and Vienna

At the ThinkMarkets blog Jerry O’Driscoll writes about the relationship between Austrian economics Chicago and UCLA.

It was obvious to me that Mises had influenced Alchian. Also Hayek, as is made clear in a video of Alchian interviewing Hayek.

Hayek’s classic essays on prices and information were on various reading lists at UCLA. Fisher was used as a text in Hirshleifer’s capital theory class. For purposes of learning capital theory, Fisher was as Austrian as Bohm-Bawerk (and much more accessible). Both Hayek and Mises thought Fisher had improved on BB.

It was by taking Leijonhufvud’s macro course that I became acquainted with Prices and Production. I wrote a term paper on it for that class, which eventually became my dissertation (Economics as a Coordination Problem).

When Harold Demsetz arrived, the influence of Mises on his theory of property rights was evident. We read a lot of Ronald Coase, and his relationship with Hayek at London is well documented by James Buchanan in Cost and Choice.

The relationship between Vienna and Chicago proper is more complex, mainly because Chicago is complex. There was an Old Chicago School of Frank Knight, Henry Simons, Lloyd Mints, Paul Douglas, et al. Some have viewed it as leftwing. It was “Keynesian” on fiscal policy before Keynes. Simons was frequently criticized by classical liberals, yet Hayek defended him vigorously. Simons proposal for 100% reserve banking was adopted as first best by Milton Friedman and second best (to free banking) by Hayek (who thought both systems would be an improvement, but not politically possible).

The new Chicago School, heavily influenced by Friedman and Stigler, struck out on its own. Its relationship with the old school blurred as time passed. On micro topics like competition, there was heavy overlap with modern Austrians. Demsetz and Kirzner made common cause on competition. Hayek was never fond of monetarism, however.

The modern Chicago School of rational expectations and real business cycles is a topic unto itself. But, yes, there is still a connection as John Cochrane and others understand.

Kevin Murphy talks NBA lockout negotiations

Rugby is not the only sport in the news right now. In the US the NBA lockout is big news. Here is an interview with University of Chicago professor of economics Kevin Murphy about the lockout. Here's an interesting point about the relationship between salaries and the number of wins in a season.

NBA.com: One effect of equalizing payrolls is you incentivize good players to go where the money is available. But another might be paying good money to players who might not deserve it, just because more franchises have to spend on … somebody.
KM: That’s a problem. The other thing is, there is some relationship between pay and success but it’s not nearly as strong as people think it is. Even if you were to completely equalize pay across teams, there still would be an enormous variation in strength of teams. In a statistical sense, the level of payroll of a team explains somewhere like 5 percent to 10 percent in the variation in outcomes.
NBA.com: That’s all?
KM: That’s it. I did a little experiment. All you have to do is take the overall distribution of win-loss percentages. Let them tell you what they think the relationship between salaries and wins is. They tell you ‘This much spending is worth this many wins.’ So then you take everybody’s salary down to the mean or up to the mean. Then if you tell me you get an extra win for every $3 million you spend, I’m going to give everyone I’m moving up an extra win for each $3 million. Everybody I move down, I’m going to give one fewer win for each $3 million.
NBA.com: And?
KM: The relationship between salaries and the number of wins in a season is positive, but it’s pretty weak. It certainly is not going to have a dramatic change in the distribution of outcomes. It might change who the winners are and who the losers are, but you’re still going to have some teams that are much better than others. Because some people spend their money much more wisely than others do.

Epstein on the good side of inequality

Law professor Richard Epstein explaining why inequality is a spur for innovation in our economy.

Watch Does U.S. Economic Inequality Have a Good Side? on PBS. See more from PBS NewsHour.

Only economists can save the planet

Economist Ed Dolan has reviewed Gernot Wagner’s book But Will the Planet Notice? Given that Martin Weitzman is coming in a couple of weeks to give the 7th Annual Condliffe Memorial Lecture I thought this piece in the review interesting:

He [Wagner] is especially devastating in his critique of the Endangered Species Act. The ESA is perhaps the least economically inspired piece of environmental legislation on the books, allowing for no tradeoffs or optimization at all. Under the act, everything is all or nothing. If the barred owl is not on the endangered list, it fends for itself until it qualifies. If the spotted owl is on the list, there is, literally, no limit to how much is too much to spend on protecting it. Ten million dollars to save a single bird? Sure, it’s been done. Never mind that the largest expenditures often go to species that are beyond saving while other conservation needs, like habitat protection to keep other species off the list in the first place, are underfunded.

What would be better than dumb regulations? Smart regulations, of course. Wagner likes an idea advanced by his one-time Harvard professor Martin Weitzman: Use DNA testing to measure the genetic distance between species. Adjust the amount of money and effort spent of protecting the spotted owl depending on its genetic distance from its cousin the barred owl. Pursuant to the goal of maximizing genetic diversity, genetic outliers would become the top priority. Measure, maximize, optimize. That’s the economic way of thinking at work.

Weitzman’s work appears elsewhere in the book, as well. Wagner spends a whole chapter elaborating the reasons for thinking climate change is the planet’s number one threat. At first that might seem like overkill, since, for the most part, he seems to address the book to readers who already share his concern for the future of the planet. But it turns out he has more to say than simply to reiterate the findings of the Intergovernmental Panel on Climate Change. Following Weitzman, he explains why conventional climate change research, which focuses on mean values and normal distributions, misses the point.

The risk of climate catastrophe, he argues, is not like the risk that your house will burn down, a case where normal distributions work just fine. Instead, it is more like the kind of systemic financial risk that shook the world after the collapse of Lehman Brothers. Why so? Financial and climate risks both have fat-tailed distributions. That makes it worth taking serious precautions against “black swan” events that are very far from the mean—events that, although not especially likely, would result in huge losses if they did occur.

The consensus among mainstream climate scientists is a mean expected warming of 2 to 4 degrees Celsius by the end of the century. Adapting to such an increase would be costly and disruptive, but it would not mean the end of life as we know it. Instead of the mean, Weitzman and Wagner (who have worked together on the issue) argue that we should be focusing on the 5 percent probability that warming will end up way out in one of those fat tails, say, 12 degrees or more. That would put half the world’s population in areas so hot that a few hours out in the sun would be fatal—even for a person soaking wet, with light clothing and a strong breeze.

The Weitzman-Wagner approach puts the precautionary principle on steroids. With no change in the mean expected rate of warming, fat tails triple the amount we should be willing to invest in climate change now. To put it in dollars, if were willing to tax carbon at $20 per ton based on conventional analysis, then we should be willing to tax it at $60 or more based on fat tail math.

So don't miss the Condliffe Lecture!

Are police services too important to be left to governmental provision?

Economist Edward Stringham discusses the economics and historical record on private provision of police services.

Challenges facing the international economy

In this audio from VoxEU.org Professor Anne Krueger of Johns Hopkins University talks to Romesh Vaitilingam about the issues around globalisation and the crisis covered in her forthcoming book, ‘Struggling with Success: Challenges facing the International Economy’. She discusses the eurozone crisis, US debt issues, the threat of rising protectionism and the role of the multilateral institutions.

New Zealand's future hosting of the Rugby World Cup

At Fair Play and Forward Passes Sam Richardson writes,

So, should we host the tournament again? We need to be objective when it comes to a future tournament, and consider the implications of hosting. Given that much of the infrastructure is in place, I'm sure we'd like to think that in maybe 16 or 20 years time it could well be New Zealand's time again. My concern is that the price tag attached to the tournament may well have escalated well beyond our means by that stage. We have shown how a country can embrace the event. It would be nice to think that the IRB might embrace some form of revenue/profit sharing to see the place many consider the spiritual home of rugby host the tournament again. This, of course, remains to be seen.

Cost is the problem, just as it was the problem for this world cup. In 20 years the infrastructure we have now will most likely need to be upgraded or replaced. This will be expensive. And if the benefits of this world cup don't cover the costs why would we think that the increased costs of a future world cup will be covered? I can't see an economic rationale for a future world cup, warm fuzzies are all well and good, but they come at a very high cost. The IRB would have to come up with a good deal to make another tournament worth New Zealand's while.

The stupidity that is the EU's Common Agricultural Policy

Thanks to Homepaddock for this bit of information.

Milk production in Austria, Cyprus, Denmark, Germany, Italy, Luxembourg and the Netherlands has been higher than expected.

That ought to be cause for celebration in a world we keep being told is short on food and where developing countries are hungry for protein.

But no, they will be fined a total of €221m because they exceeded their annual quota.

What makes it even sillier is that 14 countries produced less than their quota and total EU production was 6% lower than quota.

Policing a cartel is never easy! The good news that Homepaddock notes is that,

The quota system is to be phased out as part of reforms to the Common Agricultural Policy which aim to end government protection for the dairy industry.

If there is any part of the EU economic system that needs reform - that is, to be done away with - it is the CAP. The EU could do worse that to learn from New Zealand, there is life after subsidies and protection.

7th Annual Condliffe Memorial Lecture

‘Why is the economics of climate change so difficult and controversial?  The lecture will be delivered by Martin Weitzman, Professor in Economics at Harvard University.

Date: Thursday 17th November 4.30pm – 5.30pm. Refreshments to follow

Venue: Law 108, Ground floor, Law Building, University of Canterbury

RSVP: by 10th November to karen.ashby@canterbury.ac.nz

Abstract: In this lecture Professor Weitzman will focus on the special features of the economics of climate change that make this area so very difficult to analyse by conventional economic tools. He will discuss such topics as deep structural uncertainty, whose preferences are included, the possibility of catastrophic outcomes, discounting the distant future, and international public goods. Professor Weitzman will speculate on how the dilemmas of climate change might play themselves out.

Biography: Martin L. Weitzman is Professor of Economics at Harvard University. Previously he was on the faculties of MIT and Yale. He has been elected as a fellow of the Econometric Society and the American Academy of Arts and Sciences. He has published widely in many leading economic journals and written two books. Weitzman's interests in economics are broad and he has served as consultant for several well-known organisations. His current research is focused on environmental economics, including climate change, the economics of catastrophes, cost-benefit analysis, long-run discounting, green accounting, and comparison of alternative instruments for controlling pollution.

Be there!!!

Economic impact of the rugby world cup

I have commented on work by Sam Richardson on the economic impact of the rugby world cup before: here, here and here. Richardson is now blogging at Fair Play and Forward Passes and is writing more on benefits of the world cup. Back in September Richardson noted,

And while we are on the economic impact figure, there is a wealth of research that has shown that large sporting events rarely generate anywhere near the economic impact that is promised. Even if the economic impact of $411m actually materialises (I'd say it is unlikely, but let's say it did), it would add no more than 0.2% to the nation's Gross Domestic Project. That is not a misprint. It is a very, very small impact. Surprising, really, that it gets the coverage it has received thus far.

and more recently he writes on the spending that has taken place during the RWC,

Paymark, who cover about 75% of all credit card transactions in the country, have found that spending on cards during the tournament "was up by $195 million." I don't know precisely what this phrase means, but I assume it means that spending is up by $195m on last year's figures for the same period. Of course, the first Christchurch earthquakes was during this period last year, so spending was particularly depressed at that time. It stands to reason that domestic spending was likely to rebound at some stage - perhaps the tournament and the performances of the All Blacks were a catalyst?

Of that $195m, the amount spent by tourists was $70m up on the same period last year. What, only $70m? Yes, $70m is 10% of $700m. or $700m with the decimal point moved one place to the left. Obviously it is early days, and this is by no means a complete measure of spending, but it is pretty clear that the impact of spending by overseas visitors would appear to be quite a bit less than initially projected. Of course, projected economic impacts were gross, not net, which are the figures of particular interest.

Richardson is not the only economist who has doubts about the economic impact of the RWC. Shamubeel Eaqub, principal economist at the New Zealand Institute of Economic Research, also isn't too excited about its economic impact,

A leading economist has labelled the Rugby World Cup's effect on economic growth a "red herring", dismissing expectations that there will be a widespread boost as "hopium".

And while tourists will increase spending, business was being displaced from the main centres, and he argues that New Zealanders were spending less overall

The effect would be "minuscule", he said . "From a GDP point of view it should be marginally positive, but we're talking 0.1 per cent – margin-of-error stuff."

Is "Too Big To Fail" too big to end?

The short answer seems to be yes, for Korea at least.

Can a government credibly promise not to bailout firms whose failure would have major negative systemic consequences? Our analysis of Korea's 1997-99 crisis, suggests an answer: No. Despite a general "no bailout" policy during the crisis, the largest Korean corporate groups (chaebol) - facing severe financial and governance problems - could still borrow heavily from households through issuing bonds at prices implying very low expected default risk. The evidence suggests "too big to fail" beliefs were not eliminated by government promises, presumably because investors believed that this policy was not time consistent. Subsequent government handling of potential and actual defaults by Daewoo and Hyundai confirmed the market view that creditors would be protected.

This is from a new NBER working paper, Ending "Too Big To Fail": Government Promises vs. Investor Perceptions by Todd A. Gormley, Simon Johnson and Changyong Rhee.

But is anyone really surprised that people don't believe what politicians tell them? A no bailout policy is not credible given the way governments have acted in the past. To make such a policy work governments really do have to let big firms fail.

EconTalk this week

Valerie Ramey of the University of California, San Diego talks with EconTalk host Russ Roberts about the effect of government spending on output and employment. Ramey's own work exploits the exogenous nature of wartime spending. She finds a multiplier between .8 and 1.2. (A multiplier of 1 means that GDP goes up by the amount of spending--there is neither stimulus nor crowding out.) She also discusses a survey looking at a wide range of estimates by others and finds that the estimates range from .5 to 2.0. Along the way, she discusses the effects of taxes as well. The conversation concludes with a discussion of the imprecision of multiplier estimates and the contributions of recent Nobel Laureates Thomas Sargent and Christopher Sims.

Bonus points and incentives in rugby

Liam Lenten at the Sports Economist blog writes on Bonus Points and Incentives in Rugby. He says,

The 2011 Rugby World Cup has climaxed with hosts New Zealand being crowned champions for the second time last night (joining Australia and South Africa, while England has won it once). They did so by defeating France 8-7 in a tense affair in the Final at Auckland’s Eden Park, in front of (a capacity) 60,000 supporters – certainly not the easy way as most expected, but having endured 24 years of angst since their last title in 1987, all Kiwis will still take it nonetheless.

Oh yes! We will take it!

Lenten continues,

A co-author of mine, Niven Winchester (these days at MIT), is a native New Zealander who will no doubt be ecstatic after having been at the game in person. He is primarily a Trade Economist, but also has a penchant for modeling predictions and ranking systems in sport. His 2008 paper in JQAS (abstract here) concludes that the current bonus points system is sub-optimal at his defined objective of revealing the best quality teams over the duration of the season. Instead, he favors altering the narrow-loss bonus threshold from seven to five match points, and changing the try bonus to either a minimum of eight tries, or alternatively, for scoring at least three more tries than the opponent does.

Not sure about the 8 try idea, how many teams score 8 tries?, but the 3 more tries notion could strength the incentives for try scoring. An interesting question is how such incentives affect the attacking-defending attitude of teams? Big defence seems to win the big games, so do we need more incentives for attacking play?

Hayek on "The Road to Serfdom"

Steven Horwitz at the Coordination Problem blog has written on Hayek's interpretation of  "The Road to Serfdom". He writes,

Hayek wrote in 1973 (p. 58, my emphasis):

What I meant to argue in The Road to Serfdom was certainly not that whenever we depart, however slightly, from what I regard as the principles of a free society, we shall ineluctably be driven to go the whole way to a totalitarian system. It was rather what in more homely language is expressed when we say: "If you do not mend your principles you will go to the devil." That this has often been misunderstood to describe a necessary process over which we have no power once we have embarked on it, is merely an indication of how little the importance of principles for the determination of policy is understood, and particularly how completely overlooked is the fundamental fact that by our political actions we unintentionally produce the acceptance of principles which will make further action necessary.

It would seem to me that this is a clear statement that the "inevitability hypothesis" reading of RTS is a bunch of nonsense.

The Hayek quote is from Law, Legislation, and Liberty.

Economics gets misunderstood by journalists ... and everybody else

At the Stumbling and Mumbling blog Chris Dillow writes on why economics is misunderstood by journalists. He says, with regard to a radio interview involving economist Patrick Minford,

That interview with Minford highlights three (of many?) reasons for this:
1. Time pressure. Interviewees typically have only a few seconds to state their position. But it takes longer to explain statistical results. The typical item on More or Less, a programme that does explain statistics, lasts longer (I suspect) than interviews or news items in lesser programmes.
2. The adversarial mode encourages binary yes/no thinking. Minford’s views are juxtaposed against those of John Gieve. This encourages the impression that either one or the other is right, or that economists don‘t really know what they‘re talking about. But I suspect if Gieve and Minford were to talk away from the mic, they would exchange empirical evidence about the scale of the competing costs.
3. Incentives. Even in a radio studio, no-one has an incentive to proportion their beliefs to the evidence; it makes for bad (that is, dull but truthful) radio. And this is - of course - still more true in politics; those campaigning for, say, easier planning laws have incentives to overstate their case.
In these ways, even apparently “neutral” media serve a pernicious function. They perpetuate bad thinking and (what might or might not be the same thing) a misunderstanding of economics.

Another reason, which I would argue is relevant for New Zealand at least, is that journalists simply don't understand economics well enough themselves to be able to explain it to the general public. Journalists spread misunderstandings simply because they don't realise they are misunderstandings.

Business and the Literati

At National Affairs Algis Valiunas has a piece on Business and the Literati.

The business of America may be business, but the business of American literature in the past century has been largely to insist that the nation is, in pursuing business, wasting itself on unworthy objects. In the eyes of most novelists and playwrights who deal with the subject, business is not an honorable vocation, but rather an obsessive scramble for lucre and status. Tycoons are plunderers. Salesmen are poor slobs truckling to their bosses, though most of them aspire to be cormorants and highwaymen, too. The mass desire to strike it rich has launched a forced march to nowhere. In short, American literature hates American business for what it has done to the souls of the rich, the poor, and the middling alike.

Right-thinking people now take it for granted that, in criticizing business, American literature has saved (or at least elevated) the nation's soul. But after a century of slander, that assumption needs revisiting.

But the big question is, How is it our culture came to hold the image of the businessman that it now does? Valiunas gives his answer.