Firms reorganise to grow

Lorenzo Caliendo, Ferdinando Monte and Esteban Rossi-Hansberg have a new column up at VoxEU.org on the subject Firms reorganise to grow (by hiring workers that know and earn less). The basic idea is that firms that reorganise production to grow account for almost 40% of the value added created in the manufacturing sector. They add layers of management, increase by 7% the average hours worked in the firm, and reduce the average wage at pre-existing layers of managers or workers by 11%.

The Caliendo, Monte and Rossi-Hansberg column presents new stylised facts about the way firms organise production and explains how recent advances in economic theory can help to understand these findings.

In recent research (Caliendo et al. 2012) we identify a number of robust empirical patterns on the organisation of firms as well as the changes in this organisation as firms grow. We find that:

• Firms that expand (or contract) significantly are exactly those involved in a reorganisation process;
• Firms that do not reorganise typically change very little.

One part of the literature on firms thinks of firms as hierarchies of knowledge. This idea of a division of knowledge within a firm was first recognised by Demsetz (1988) and formalised by Becker and Murphy (1992). What these works suggested was simply a new interpretation of the role of the firm. Given that there are limitations to what a worker can know, the competence that a firm has to possess to produce must be divided into manageable portions and allocated between the workers. The actions of the different groups of workers are then coordinated by the firm’s management. Thus workers who produce on the basis of knowledge they themselves do not possess, have their activities directed by someone who does possess (at least more of) the necessary knowledge. This gives a rationale for management. As there are asymmetries in information among workers, management is required to coordinate the activities of the different groups of employees. If the workers knew everything about the production process they could carry out production without coordination. In this way, direction is a substitute for education, that is, a substitute for the transfer of the knowledge itself.

Caliendo, Monte and Rossi-Hansberg make the point that it is useful to interpret the data  if we think of firms as hierarchies of knowledge.

• Production requires labour and knowledge.
• Knowledge is embedded in individuals and is costly to acquire.
• The organisational problem is then the result of the limited time of individuals.

This time constraint implies that it is not optimal to have only very knowledgeable employees, but to have many agents with basic knowledge and fewer experts that focus on exceptions. Subordinates save the time of knowledgeable expert by dealing with the simple problems. This is the essential role of organisations.

• Firms are hierarchical with a large base of workers, who know and are paid less, and with higher layers of management with more knowledgeable employees that earn more.

The next question worth asking is, Are firms different in their organisation? Caliendo, Monte and Rossi-Hansberg present new evidence on this point.

We use administrative data from the French manufacturing sector on the balance sheet of firms and the occupations of their workers from 2002 to 2007. To construct a picture of the organisation of firms our empirical analysis is guided by Caliendo and Rossi-Hansberg (2012). We can distinguish up to three layers of management (supervisors, senior staff and CEOs) above clerks and blue collars whom we refer to as production workers.

Firms do, in fact, differ in their organisation. On average firms have 1.5 layers of management above their production workers, many small firms have only production workers, and about as many large firms have all three of them (the maximum we can observe). Larger firms (i.e. firms that employ more workers and add more value) tend to have more layers of management. This fact makes perfect economic sense. If an artisan wants to produce more, he or she can of course hire other workers that perform exactly his or her tasks, but it is better just to hire apprentices, who know only the most common operations (and are therefore cheaper), and use his or her own time to deal with more infrequent matters. Organisations allow exactly this leveraging of the time of managers through the extensive use of a less able workforce. The data shows that firms are hierarchical, in the sense that higher layers of management tend to have fewer employees and pay them more than lower layers.

Now we get to the point of reorganising a firm. The question is, When do reorganisations occur?

Looking at all the firms with a given organisation type (i.e. with the same number of layers of management), we find that the larger the firm, the higher the likelihood that it will reorganise its production by adding one layer (symmetrically, the smaller firms are more likely to contract their production by dropping one). This fact also makes economic sense. Firms can respond to a given increase in the demand for their product with or without a reorganisation. In the latter case, they just expand their production base, i.e. they hire more workers. By doing so, however, a strain is put on the time of the managers above them, who now would have to deal with more people (and more problems). Hence, firms expanding this way must have more employees at each layer and must pay them more (in order for them to be more knowledgeable and ask less). Hence, the average wages at all layers must rise. Among all the firms with a given organisation, those which grow in this way are the small ones, since they employ fewer employees and so expanding the knowledge of all of them is cheaper. In contrast, if the firm is relatively large, it makes sense to add one layer of managers and reduce the knowledge of everyone below. In this case, firms grow by reorganising.

Another advantage of a more extensive division of labour was noted as far back as Charles Babbage. In his book “On the Economy of Machinery and Manufactures” Babbage observed that the greater the division of labour with workers knowing less about the overall production process reduced the less time required for learning any requisite skills. This results in a lessening of the period during which a new entrant to the workforce would be relatively unproductive and unremunerative. Because less knowledge and training was required to learn to undertake a single operation, as opposed to that required to undertake many different operations, a new employee would more quickly reach a situation where he generates a profit for his employer.

Caliendo, Monte and Rossi-Hansberg now ask, Why is growth through reorganisation different?

The data tells us that when firms reorganise, they have a larger number of employees than they used to in all layers, but the average wage at all pre-existing layers falls. Following the logic above this drop in average wages has a very clear economic rationale. The objective of the reorganisation is exactly to economise on the knowledge of all pre-existing layers. Apprentices are hired exactly because they know less than the master, and can deal with the most frequent and basic issues. So firms that expand by reorganising pay their workers less, because they prefer to employ less knowledgeable workers.

Caliendo, Monte and Rossi-Hansberg conclude that

While, in our data, only about 13% of the firms go through reorganisation episodes in a given year, these episodes account for almost 40% of the value added created in the manufacturing sector. These findings shed light on the process through which firms grow. Most of the existing literature documents a 'firm size – wage premium', whereas average wages are higher for larger firms; we show that this relation is just the result of the composition of many firms that grow little and raise wages, and a few firms that reorganise, grow a lot, pay the new top manager more, but reduce average wages in all pre-existing layers [...] Our analysis also explores the export behaviour of firms. Accessing a foreign market is a particularly important form of expansion for many firms, and we find that the same facts described above are reproduced for the subset of firms that grow and start exporting (or, of course, shrink and stop exporting). In particular, firms who start exporting are more likely to reorganise their activity than firms who keep operating only domestically, and new exporters who reorganise tend to reduce (rather than increase) average wages paid at all pre-existing layers.

The great ideas of the social sciences

At the ThinkMarkets blog Gene Callahan put forward a list of great ideas in social science:

* The state as the individual writ large (Plato)

* Man is a political/social animal (Aristotle)

* The city of God versus the city of man (Augustine)

* What is moral for the individual may not be for the ruler (Machiavelli)

* Invisible hand mechanisms (Hume, Smith, Ferguson)

* Class struggle (Marx, various liberal thinkers)

* The subconscious has a logic of its own (Freud)

* Malthusian population theory

* The labor theory of value (Ricardo, Marx)

* Marginalism (Menger, Jevons, Walras)

* Utilitarianism (Bentham, Mill, Mill)

* Contract theory of the state (Hobbes, Locke, Rousseau)

* Sapir-Worf hypothesis

* Socialist calculation problem (Mises, Hayek)

* The theory of comparative advantage (Mill, Ricardo)

* Game theory (von Neumann, Morgenstern, Schelling)

* Languages come in families (Jones, Young, Bopp)

* Theories of aggregate demand shortfall (Malthus, Sismondi, Keynes)

* History as an independent mode of thought (Dilthey, Croce, Collingwood, Oakeshott)

* Public choice theory (Buchanan, Tullock)

* Rational choice theory (who?)

* Equilibrium theorizing (who?)

I would add:

*Organisational theories explaining why a given organisational form gets used in a given situation (Coase)

Others?

Cutthroat v. cuddly capitalism

Why, ask Daron Acemoglu, James A. Robinson and Thierry Verdier, can't we all be more like Scandinavians? They have a new working paper out on the question Can't We All Be More Like Scandinavians? Asymmetric Growth and Institutions in an Interdependent World.

Acemoglu, Robinson and Verdier argue that many people perceive average welfare to be higher in Scandinavian societies than in the United States due to Scandinavian countries having more limited inequality and more comprehensive social welfare systems. This raises the question of Why doesn't the United States adopt Scandinavian-style institutions? Why isn't the U.S. more like the Scandinavians? More generally, in an interdependent world, would we expect all countries to adopt the same institutions? To provide theoretical answers to this question,  Acemoglu, Robinson and Verdier develop a simple model of economic growth in a world in which all countries benefit and potentially contribute to advances in the world technology frontier. A greater gap of incomes between successful and unsuccessful entrepreneurs (thus greater inequality) increases entrepreneurial effort and hence a country’s contribution to the world technology frontier. Under plausible assumptions, the world equilibrium is asymmetric: some countries will opt for a type of "cutthroat" capitalism that generates greater inequality and more innovation and will become the technology leaders, while others will free-ride on the cutthroat incentives of the leaders and choose a more cuddly form of capitalism. Paradoxically, Acemoglu, Robinson and Verdier are able to show that those with cuddly reward structures, though poorer, may have higher welfare than the cutthroat capitalists; but in the world equilibrium, it is not a best response for the cutthroat capitalists to switch to a more cuddly form of capitalism. They also show that domestic constraints from social democratic parties or unions may be beneficial for a country because they prevent cutthroat capitalism domestically, instead inducing other countries to play this role.

Stadiums and opportunity costs

John Spry, an economist with St. Thomas University in the Twin Cities, has written an opinion piece in the St. Paul Pioneer Press in which he takes issue with proposals to build a new stadium for the St. Paul Saints (an independent league baseball team) and to renovate the Target Center, the arena for the NBA’s Minnesota Timberwolves.

Spry make a number of points against these ideas, but one of the most important is

Finally, politicians erroneously claim that construction spending for these sports facilities will create jobs for Minnesotans. These claims ignore the basic economic concept of opportunity cost. Instead of building duplicative facilities, we could have either more productive public spending, such as improved courts or roads, or reduced taxes on private-sector investments.

Thinking about the opportunity cost of such proposals is important in any situation but it is doubly important for cities like Christchurch were there is so much that needs to be done.

(HT: The Sports Economist)

Interesting blog bits

1. Matt Nolan writes In defence of inflation targeting in NZ

   Why the RBNZ is a scapegoat for the failure of government

2. Steven Horwitz writes Ezra Klein Mistakes the Arsonist for a Firefighter

   In Friday’s Washington Post, Ezra Klein raises a number of criticisms of the gold standard using as his hook the call for a new Gold Commission that appears in a draft of the new Republican Party platform. Putting aside the question of party politics and what a new Commission might do, Klein’s arguments against the gold standard are not as strong as he thinks. I want to respond to three of them here, and in reverse order of importance.

3. John Cochrane on Gordon on Growth

   Bob Gordon is making a big splash with a new paper, Is US Growth Over?

4. Francisco Ceballos, Tatiana Didier and Sergio Schmukler on Different facets of financial globalisation

   A lot has been said about the pros and cons of financial globalisation. But what exactly is ‘financial globalisation’? This column argues that we can’t be clear about the pros and cons of financial globalisation unless we are clear on what it actually is.

5. Chris Dillow writes on Bad Incentives in Politics

   Why do politicians not solve social problems? One reason, of course, is that such problems are intractable. But there's another reason - politicians sometimes lack the incentive to do so because politicians need to keep their enemies alive just as parasites need to keep their hosts alive.

6. Russ Roberts on Competition

   In this conversation with Roger Noll, we talked about how much more purposive and less relaxed sports are for kids these days. There are travel teams. Coaching is much more intense and serious. Training and conditioning is much more intense and serious. All of it starts young. Roger and I chalked this up to the increased amount of money coursing through the sports pipeline. That money makes professional sports more competitive which in turn makes the stakes higher for college sports (which has its own cash pipeline) which in turn make high school and middle school more intense.

7. Donald J. Boudreaux on Inconceivable Complexity

   Nevertheless, too many people, including politicians, continue to believe that because they can observe a handful of bulky facts about the economy, they can thereby know enough to intervene into that economy in ways that will improve its operation. That belief, though, is hubris. It’s very much like believing that you’ll fly if you simply strap on a pair of wings and commence to flapping madly.

What is it about Labour and economics?

Another example of Labour getting basic economics wrong. Thanks to a message at the Homepaddock blog my attention to drawn to this comment on the upcoming partial sale of Mighty River Power:

Labour's state-owned assets spokesman, Clayton Cosgrove, seized on the result as evidence the company was in no fit state for sale.

"Mighty River's profits have almost halved. That will have a real impact on their share price if the Government rushes ahead with the sale. Listing a struggling company in a market like this is economics for dummies."

But the current level of profits of the company doesn't determine what people will pay for (part of) the company. The sale price will be determined by the expected future profits of the firm. Even if this years profits are down, what matters to investors are future profits. If investors think the future is likely to be good they will pay more for the firm no matter what the current level of profits are. Investors are forward looking, not backward looking as is the case with Clayton Cosgrove.

There are, I would argue, good reasons for not liking the partial sell-off of SOEs but Cosgrove's argument isn't among them.

Incentives matter: organ donation file

A new NBER working paper looks at the incentives for organ donation and bone-marrow donations. The paper, Removing Financial Barriers to Organ and Bone Marrow Donation: The Effect of Leave and Tax Legislation in the U.S., is by Nicola Lacetera, Mario Macis and Sarah S. Stith. The abstract reads,

In an attempt to alleviate the shortfall in organs and bone marrow available for transplants, many U.S. states passed legislation providing leave to organ and bone marrow donors and/or tax benefits for live and deceased organ and bone marrow donations and to employers of donors. We exploit cross-state variation in the timing and passage of such legislation to analyze its impact on organ donations by living and deceased persons, on measures of the quality of the organs transplanted, and on the number of bone marrow donations. We find that these provisions did not have a significant impact on the quantity of organs donated. The leave legislation, however, did have a positive impact on bone marrow donations. We also find some evidence of a positive impact on the quality of organ transplants, measured by post-transplant survival rates. Our results suggest that these types of legislation work for moderately invasive procedures such as bone marrow donation, but may be too low for organ donation, which is riskier and more burdensome to the donor.

So getting the incentives right matters for donation rates and what "right" means depends on what is being donated.

One instrument can't achieve two goals

From Don Brash

The Reserve Bank has got only one instrument, and that's monetary policy. You can't deliver two objectives with one instrument, and David Parker at least should have the brains to know that. Apparently not.

In short the RB can't control both inflation and the exchange rate.

The idea that some economic quantities can be classified as targets and others as instruments goes back to the 1950s and is due to the Dutch Nobel Prize winning economist Jan Tinbergen. He argued that targets are those macroeconomic variables the policy maker wishes to influence, whereas instruments are the variables that the policy maker can control directly. The important point that Tinbergen made, but David Parker has missed, is that achieving the desired values of a certain number of targets requires the policy maker to control an equal number of instruments.

Caplan v. Dickens on poverty and welfare (updated)

Bill Dickens and Bryan Caplan argue about poverty and welfare. Just read it all: start here then go here and then go here. The debate is obvious about the U.S. welfare system but but many of the issues carry over to New Zealand.

Update: Bryan responds to Bill's essay at Reply to Bill Dickens on Poverty: Part 1. David Henderson also has some Thoughts on Dickens.

EconTalk this week

Roger Noll of Stanford University talks with EconTalk host Russ Roberts about the economics of sports. Noll discusses the economic effects of stadium subsidies, the labour market for athletes, the business side of univeristy sports, competitive balance in sports leagues, safety in sports, performance-enhancing drugs, and how the role of sports in the lives of children has changed.

The interview begins with a discussion of the financial impact of sports stadiums. Noll makes the point that for a stadium to just break even it has to be used around 250-300 nights a year! This is something to keep in mind when you hear local councils arguing that their city should have a new sports stadium. Ask yourself, Will it be used 300 days a year?

The above comments refer to multiple-use stadiums. As for single use stadiums, rugby/cricket here in New Zealand, baseball/football in the U.S., Noll says,

Baseball and football stadiums, however--there aren't any that have been substantially subsidized where the local community has received anything remotely resembling a reasonable return on investment. They are financial black holes.

Preaching to the unconverted

The good news of the day is that there is now an economics blog on Sciblogs. It's called The Dismal Science and will pull posts from New Zealand economics blogs such as Fair Play and Forward Passes (Sam Richardson), Groping Towards Bethlehem (Bill Kaye-Blake), Offsetting Behaviour (Eric Crampton and Seamus Hogan) and The Visible Hand in Economics (Matt Nolan, James Zucollo and co-bloggers).

Eric Crampton explains there are still a few problems workings of the new blog:

We're still working out some back end issues to let me efficiently curate the different inbound feeds. When everything is working right, I'll see a morning dashboard with a list of new posts up at the source blogs that their authors deemed worthy, then schedule them for appearance at Dismal. I'd also like to be able to pull classic posts from our combined back archives when topics like capital gains taxes or stadiums become timely. Peter Griffin, the Editor at SciBlogs, is seeing what we can do to set up the system's back end.

But the problems will be sorted quickly, so keep an eye on The Dismal Science to add to your daily fix of economics blogging!

Growth and wages

I have made the point in the past that economic growth leads to wage growth. Paul Krugman makes the point when he writes,

Economic history offers no example of a country that experienced long-term productivity growth without a roughly equal rise in real wages. In the 1950s, when European productivity was typically less than half of U.S. productivity, so were European wages; today average compensation measured in dollars is about the same. As Japan climbed the productivity ladder over the past 30 years, its wages also rose, from 10% to 110% of the U.S. level. South Korea's wages have also risen dramatically over time. ("Does Third World growth hurt First World Prosperity?" Harvard Business Review 72 n4, July-August 1994: 113-21.)

Now James Otteson shows that Adam Smith was ahead of us on this issue, as he was on so many things.

It is not the actual greatness of national wealth, but its continual increase, which occasions a rise in the wages of labour. It is not, accordingly, in the richest countries, but in the most thriving, or in those which are growing rich the fastest, that the wages of labour are highest. [...] But though North America is not yet so rich as England, it is much more thriving, and advancing with much greater rapidity to the further acquisition of riches. ("An Inquiry into the Nature and Causes of the Wealth of Nations" I.viii.22-23)

De jure and de facto determinants of power

Is political power the result of the formal rules of the game or the result of more informal social conventions or both? Are the political rights of one group suppressed by legislation or by the use of extralegal forces, violence and intimidation. A new working paper (CEPR Discussion Paper No. 9064) from the Centre for Economic Policy Research looks at this question. The paper, De Jure and de Facto Determinants of Power: Evidence from Mississippi, is by Graziella Bertocchi and Arcangelo Dimico.

The paper evaluates the empirical relevance of de facto vs. de jure determinants of political power in the U.S. South (Mississippi) between the end of the nineteenth and the beginning of the twentieth century. The main message emerging from the paper is that on the one hand, there is clear evidence of an effect of legislation on political outcomes but on the other, the process of black disfranchisement starts well before the introduction of the new constitution and disfranchisement is stronger in counties where a black majority represents a threat to the de facto power of white elites. Moreover, the effect of the black share of voters becomes stronger after 1890, suggesting that the de jure barriers may have served the purpose of institutionalising a de facto condition of disfranchisement.

The abstract reads,

We evaluate the empirical relevance of de facto vs. de jure determinants of political power in the U.S. South between the end of the nineteenth and the beginning of the twentieth century. We apply a variety of estimation techniques to a previously unexploited dataset on voter registration by race covering the counties of Mississippi in 1896, shortly after the introduction of
the 1890 voting restrictions encoded in the state constitution. Our results indicate that de jure voting restrictions reduce black registration but that black disfranchisement starts well before 1890 and is more intense where a black majority represents a threat to the de facto power of white elites. Moreover, the effect of race becomes stronger after 1890 suggesting that the de jure barriers may have served the purpose of institutionalizing a de facto condition of disfranchisement.

Interesting blog bits

1. Carlo Altomonte, Tommaso Aquilante and Gianmarco I.P. Ottaviano on Triggering competitiveness: A 'decalogue' from new firm-level evidence
   

   Competitiveness is one of the most debated issues in policy circles. But, what triggers it? Capitalising on the first existing harmonised cross-country dataset measuring the entire range of international activities of firms in seven European countries, this column identifies the triggers of competitiveness. It argues that policymaking could be improved by firm-level evidence if there were less reluctance to the use of micro-founded indicators to inform policy decisions.

2. Eric Crampton on A symposium, of sorts

   The latest issue of the New Zealand Medical Journal features three papers on alcohol policy, including one from Matt Burgess, Brad Taylor and me, along with a commissioned editorial piece on the set. I have not yet had a chance to read the other two papers in the series but the editor of the journal kindly forwarded along a copy of the editorial piece late Thursday night.
   
   Doug Sellman, lead author on the editorial piece, says about what I expected he would say about our work on alcohol.

3. Alexander de Ville points out that the EU trade plans will increase protectionism and hinder development

   In June, the European Commission drew attention to the increase in protectionist tendencies worldwide. It claimed that over the previous eight months 123 new trade restrictions had been put in place, an acceleration of 25% compared with the previous period studied. However, the Commission’s own proposed trade reforms, published in January, were overlooked. These will push the EU itself towards further protectionism. They will 'hamper the global economy' and ‘hurt developing countries', according to a recent ODI study.

4. Ben Vollaard on How to cut prison numbers

   How to reduce incarceration rates without fuelling a crime boom? This column argues that by being more selective over whom to lock up and for how long, scarce public funds can be put to better use.

5. Art Carden asks Isn't it high time we legalize marijuana?

   On a couple of different occasions, I have used this space to call for an end to the economic, moral, and cultural disaster that is the drug war. American governments at all levels have been fighting the war on drugs for over four decades now, and it’s overwhelmingly clear that it’s time to cut our losses, admit that the whole thing was a mistake, and work toward restoring the lives that have been destroyed by the drug war.

6. Olivier Coibion and Yuriy Gorodnichenko say we should be Paying attention to inattention

   Economics and economists have taken a beating in the last few years. One practice on the receiving end of much criticism has been the use of models that assume rational expectations when individuals are well informed. This column proposes some tests of these assumptions and argues that 'imperfect information' models may succeed where others have failed.

Hype v. reality

As Sam Richardson and Eric Crampton have been interviewed for a Close Up segment, that will air early next week on TV One, on the economics of sports stadiums Sam has written a brief summary of why people should not be taken in by the hype around a stadium build. Sam writes,

Tangible economic impacts from sports facilities often fail to materialise for a variety of reasons. These include:

1. A substantial proportion of the crowds at stadiums are local rather than visitors. Some estimates I've seen in the literature suggest that it ranges from 80 to 95% of attendance being local.

1a. Spending by locals within a city on attending games is usually substituted from elsewhere within the local economy, for example, movie theatres, video rental stores, and other entertainment venues. A game merely redistributes spending rather than generates it.

2. Spending within a city often leaks outside the local area, as not all goods and services purchased by event attendees are produced locally, so a proportion of the spending has to go out of the local economy to pay for imported goods and services.

3. Government spending on stadiums, contrary to popular opinion, is not costless. That is, the funding has opportunity cost that must be considered. Money spent on a stadium could have been spent elsewhere in the local economy, and as such alternative activity is forgone. A benefit is only observed if the stadium activity more than outweighs the lost activity elsewhere.

4. Stadiums are almost always underutilised. Westpac Stadium in Wellington has around 45-50 event days per year. That is around one day per week. Game days are usually a hotbed of activity, but six of the seven days there is nothing going on. Surrounding development feels this too. Are businesses located nearby dependent on stadium activity going to survive with more off days than game days? It is unlikely.

5. Much of the projected activity that a new facility attracts comes from within the city at the expense of other facilities. Things such as conferences, conventions, trade shows, etc would by and large have been hosted elsewhere within the city at another venue. Thus we see another form of substitution in action here, which works towards reducing the overall realised impact of a new facility.

6. A replacement facility can not realistically be expected to do a lot more than a pre existing facility. Research in the US has suggested that there is a short term honeymoon effect of up to ten years where attendances spike due to the novelty of the new facility, but beyond this the experience has been that attendance returns to pre facility levels.

What about the intangible benefits? Surely they matter?

Relevant intangible benefits include consumer surplus that locals enjoy from attending games at the facility as well as the public good aspects. They are recognised as benefits but there are weaknesses in their ability to justify government funding. Firstly, consumer benefits are often captured to a greater or lesser degree by event organizers through ticket pricing structures - season tickets, family/adult/children, concessions, etc. It is in the organizers interest to capture as much of this as possible so as to maximize event profits. Secondly, it isn't just within the stadium that these benefits are appropriated. To watch your team elsewhere, you pay for it via Sky TV subscriptions. To read about your team you pay for it via newspapers, magazines, internet access, etc. A lot of benefits can be captured privately. Thirdly, one can argue that just about any activity or enterprise has some intangible benefits, but this doesn't mean we should subsidise every activity that generates intangibles!

The bottom line is that if tangible benefits don't materialise, the intangible benefits have to be substantial and international evidence suggests that while they aren't insignificant, they are nowhere near the size of subsidies given to build sports facilities and/or attract sports franchises.

People in Christchurch should think about these points very carefully and ask, Can spending $500 million on a new covered stadium really be justified? I can't help thinking the answer is no. I would also like to see the justification that CERA or the City Council or the government have for the idea of a new stadium.

Are bosses worth anything?

Do bosses matter? This is a question that Stephen Marglin famously answered in the negative. He argued that management doesn't affect productivity, just the share of output appropriated by managers. Now a new NBER working paper (No. 18317) looks at the question of  The Value of Bosses. The abstract of the paper, which is by Edward P. Lazear, Kathryn L. Shaw and Christopher T. Stanton, reads:

Do supervisors enhance productivity? Arguably, the most important relationship in the firm is between worker and supervisor. The supervisor may hire, fire, assign work, instruct, motivate and reward workers. Models of incentives and productivity build at least some subset of these functions in explicitly, but because of lack of data, little work exists that demonstrates the importance of bosses and the channels through which their productivity enhancing effects operate. As more data become available, it is possible to examine the effects of people and practices on productivity. Using a company-based data set on the productivity of technology-based services workers, supervisor effects are estimated and found to be large. Three findings stand out. First, the choice of boss matters. There is substantial variation in boss quality as measured by the effect on worker productivity. Replacing a boss who is in the lower 10% of boss quality with one who is in the upper 10% of boss quality increases a team’s total output by about the same amount as would adding one worker to a nine member team. Using a normalization, this implies that the average boss is about 1.75 times as productive as the average worker. Second, boss’s primary activity is teaching skills that persist. Third, efficient assignment allocates the better bosses to the better workers because good bosses increase the productivity of high quality workers by more than that of low quality workers.

So bosses matter and good bosses matter a lot. This may not be so surprising as this previous posting on work by Amanda Goodall that shows that the best research universities are lead by top researchers highlights.

The impact of right to carry laws

Right to carry laws have been discussed here before, see for example here and here. Now we have another  NBER working paper that that looks at right-to-carry (RTC) laws and concludes, we don't know what the effects are.

The paper is The Impact of Right to Carry Laws and the NRC Report: The Latest Lessons for the Empirical Evaluation of Law and Policy by Abhay Aneja, John J. Donohue III and Alexandria Zhang. The abstract reads:

For over a decade, there has been a spirited academic debate over the impact on crime of laws that grant citizens the presumptive right to carry concealed handguns in public - so-called right-to-carry (RTC)laws. In 2005, the National Research Council (NRC) offered a critical evaluation of the "More Guns, Less Crime" hypothesis using county-level crime data for the period 1977-2000. 17 of the 18 NRC panel members essentially concluded that the existing research was inadequate to conclude that RTC laws increased or decreased crime. One member of the panel, though, concluded that the NRC's panel data regressions supported the conclusion that RTC laws decreased murder.

We evaluate the NRC evidence, and improve and expand on the report's county data analysis by analyzing an additional six years of county data as well as state panel data for the period 1977-2006. We also present evidence using both a more plausible version of the Lott and Mustard specification, as well as our own preferred specification (which, unlike the Lott and Mustard model used in the NRC report, does control for rates of incarceration and police). While we have considerable sympathy with the NRC's majority view about the difficulty of drawing conclusions from simple panel data models, we disagree with the NRC report's judgment that cluster adjustments to correct for serial correlation are not needed. Our randomization tests show that without such adjustments the Type 1 error soars to 44 - 75 percent. In addition, the conclusion of the dissenting panel member that RTC laws reduce murder has no statistical support.

Our paper highlights some important questions to consider when using panel data methods to resolve questions of law and policy effectiveness. Although we agree with the NRC's cautious conclusion regarding the effects of RTC laws, we buttress this conclusion by showing how sensitive the estimated impact of RTC laws is to different data periods, the use of state versus county data, particular specifications, and the decision to control for state trends. Overall, the most consistent, albeit not uniform, finding to emerge from both the state and county panel data models conducted over the entire 1977-2006 period with and without state trends and using three different specifications is that aggravated assault rises when RTC laws are adopted. For every other crime category, there is little or no indication of any consistent RTC impact on crime. It will be worth exploring whether other methodological approaches and/or additional years of data will confirm the results of this panel-data analysis.

Now this is weird ....

even for the Greens. From the NZ Herald:

Meanwhile, the Green Parties of New Zealand, Australia and Canada are joining forces to campaign against the Trans-Pacific Partnership.

They issued a joint statement yesterday after Metiria Turei, co-leader of the NZ Greens, held a press conference in Canada with her counterpart from there.

Among the Greens' concerns is the prospect of the heavily protected Canadian dairy industry being de-regulated, removing safeguards which they say aim to preserve farmers' livelihoods.

Yes, but this is the point. Some Canadian farmers can't make a living without regulation and protection, so they should be doing something else. Also the farmer's lifestyle is costing Canadian taxpayer a huge amount. De-regulation would remove much of these costs to the Canadian taxpayer.

Hasn't Metiria noticed that New Zealand de-regulated its farming in the 1980s, and yes some farmers went under, but today farming is better and stronger then it ever was under the old protection and regulation regime.

De-regulation of the Canadian farming sector would in the short run hit some farmers hard but over time it would, like New Zealand did, come out more productive and stronger than it is now. Also the Canadian consumer would be better off as would New Zealand farmers. What is Metiria's problem?

EconTalk this week

Lee Ohanian of UCLA talks with EconTalk host Russ Roberts about the recession, the recovery, and the state of labor market. Ohanian describes the unusual aspects of this recession and recovery in the United States as shown by the labor market and the unusual performance of hours worked, productivity, and wages. He also discusses the behavior of business investment and speculates as to why this recession and the recovery has been so different in the United States. The conversation closes with a discussion of the role of the foreclosure process in encouraging unemployment.

A nice point

At the Homepaddock blog Ele Ludemann makes a nice point about the difference between what people say they want and what they are willing to pay for:

A survey established that New Zealanders support incentives to encourage clean industries and technologies.

The survey, of 2829 New Zealanders aged 18-plus, taken between July 5 and 16, 2012, asked recipients about their attitude toward incentives to encourage technologies such as marine energy and fuel-efficient cars,Carbon News reports.

All received strong support – with home insulation topping the list with nearly 100% backing.

The results showed that:

• 98.8 per cent support further subsidies to insulate un-insulated homes (1.3 per cent oppose).

• 78.4 per cent support incentives to develop biofuel from waste wood (2.8 per cent oppose).

• 74.5 per cent of respondents support reducing the annual registration fee for vehicles with smaller engines (6.7 per cent opposed).

• 72.3 per cent support incentives to develop wave and tidal power (9.1 per cent oppose).

• 64.7 per cent support cash incentives to buy fuel-efficient and lower-emissions cars (8.2 per cent oppose).

• 57.9 per cent support investing in alternative fuel technologies, such as those that capture and store emissions from coal-fired power stations (92 per cent oppose).

• 49.8 per cent support requiring standards on imported vehicles’ fuel efficiency to lift national fleet performance overall (10.7 per cent opposed).

The survey didn’t say if it asked respondents if they would be happy to pay for these incentives, nor if they were already doing what they could to support clean industries and technologies.

The last point above is a good one. The important thing to get people to reveal is what they are actually willing to pay for something. Just saying you favour X isn't the same as paying for X. Most people are more willing to do the former than the latter.

This is one reason why economists aren't too keen on survey data, what you really want is data on what people really do. Putting your money where your mouth is, is very different from just putting words where your mouth is. Or, talk is cheap.

How many of those answering the survey are will to pay more in tax to pay for the subsidies and incentive they say they favour? Are these same people willing to pay more for a used car because of the fuel efficiency requirement they support? And how much more?

More on the Christchurch rugby stadium

As noted in the previous post Sam Richardson has been continuing his thinking on the feasibility of a new covered rugby stadium for Christchurch over at his Fairplay and Forward Passes blog. He writes,

If tangible benefits and costs exist for these projects, then it is worth considering whether intangible benefits (and costs) do too. There is a small but not insignificant area of research that have examined the nature of intangible benefits and quantified them, using techniques such as demand analysis, travel cost methods and contingent valuation (all of which have been borrowed from recreational demand and natural resource economics). What is needed in the stadium context is some measure of net intangible benefits - that is, the 'warm fuzzies' from the stadium itself (which includes the retention of the franchise(s) it plays host to) less 'warm fuzzies' from the next best alternative, say repairing the east side of Christchurch. If the net warm fuzzies are positive, this suggests the project might well have some justification. What is the likelihood of this happening? A $500 million facility would be twice as expensive as the Forsyth Barr Stadium, and they've found the going tough. It would also be the largest amount ever spent on the construction of a sports facility in this country. Is the argument going to be that $500 million is going to pump some badly needed capital into the city and has to translate into some tangible benefits? Or will we see those behind the stadium blame the state of the local economy if the expected benefits don't materialise?

I agree that if we are to include "intangibles" in our calculus then it is the "net intangibles" that should be included. I guess my problem is whether or not we should include such things in the first place. First there is the question as to what gets measured, and how well it's measured, by the types of methods Sam mentions, but I will leave that aside. I want to make two other quick points. One, if we are to include intangibles for deciding on the subsidies for rugby stadiums, why not for all goods? Don't all goods have intangibles attached to them? I'm sure there are many, and large, intangibles that go along with Microsoft Windows so why don't we include these to justify a subsidy to be paid to Microsoft? Second, if there are intangibles with a rugby stadium what can't these benefits be turned into tangibles? For example, if there is a large amount of consumer surplus generated by a rugby stadium why can we turn that surplus into revenue for the stadium via, say, some form of nonlinear pricing? If this is done then the stadium should be able to be justified on a straight forward cost-benefit analysis.

Interesting blog bits

1. Sam Richardson on The departure of a key tenant: Implications for Christchurch's proposed stadium

   Sam continues his thinking on the feasibility of a new covered rugby stadium for Christchurch.

2. Elena Nikolova on What explains political institutions? Evidence from colonial British America

   Why do some states develop as democracies while others remain authoritarian? The question continues to puzzle social scientists. This column presents new data from 13 British American colonies from before the American Revolution. It shows that democratic institutions had a lot to do with the need to attract workers.

3. Yves Zenou and Jackline Wahba asks Do return migrants need their social capital for entrepreneurship?

   Are return migrants more likely to become entrepreneurs than non-migrants? This column, using data from Egypt, argues that although migrants lose their social networks whilst overseas, savings and human capital accumulation acquired abroad overcompensate for this loss. This makes return migrants more likely to start businesses.

4. Bill Kaye-Blake has been having Thoughts on the rate of return on capital

   I've found myself wondering what the average rate of return on capital really is. Some of the numbers that get tossed around are an 8% average stock market return over the long term, a 15% to 20% risky rate of return for capital invested in a business, and an 8% to 10% rate of return for business generally (which is the basis for the country’s discount rate).

5. John Cochrane asks Inevitable slow recoveries?

   The economy is stuck in slow growth, not the fast growth we should see after a steep recession.

6. Eric Crampton on Coercion everywhere: welfare edition

   It's hard to draw the line between coercion and choice. Some people see coercion in normal market transactions between consenting adults where relative wealth differences are large - prostitution markets are often banned as somehow coercive; most countries would ban me from selling you one of my kidneys for fear that the money offered had coerced me. I don't see any of those as being coercive; others do.

Stadiums in the context of natural disasters

Sam Richardson has been writing on the topic of stadiums in the context of natural disasters, in particular with regard to Christchurch, over at the Fair Play and Forward Passes blog. At one point he writes,

At the heart of this dilemma is a point that Matheson and Baade make beautifully, so I'll post it here:

Sports yields hedonic value, in other words, and the quality of life benefit it imparts is a luxury affordable in affluent communities rather than an activity that helps a community achieve affluence. Sport for the most part is properly viewed as a luxury good and not a productive resource.

What this seems to be saying is that if you are rich you can afford lots of warm fuzzies and if you are poor you can't. I would point out that Christchurch is really poor right now. I would also note that most things generate warm fuzzies to some degree, so if we are to count fuzzies for the calculation on whether or not to spend money on sports stadiums we need to count them for all good and services that the council could spend money on.

Sam continues,

Therein lies the crux of the argument, and it is here that we are likely to see the more passionate divergences of opinion. There is no doubting the importance and potential quality of life value of sports in Christchurch. The initial call of whether the investment makes sense is largely dependent on this value, I believe, and how it stacks up to the costs. This is a complex value, as one must also factor in the role of the sports environment including the new temporary stadium, as well as the impact on other facilities in the city and surrounding areas. As I have mentioned in my earlier posts on this issue, complicating matters further is the role of sports in the context of the rebuilding city's priorities. Do Christchurch policymakers see the stadium as a luxury good or a potential productive resource?

As Sam himself points out,

There are sound reasons why a facility in Christchurch is unlikely to generate tangible benefits, [...]

So productive resource doesn't look likely. Thus we are left with, "luxury good". The problem I see here is that even if we accept the idea of including warm fuzzies in our calculations my point above about most goods producing them comes in play. As Eric Crampton has noted

The covered rugby stadium is tipped to cost $506 million

You would have to generate a lot of warm fuzzies to justify spend $500 million and if you are going to spend that amount of money is a rugby stadium the most cost effective generator of warm fuzzies. I mean just how many hip replacement could you do for $500 million or how many cancer treatments could people get for that amount? Won't these thing also generate a lot of warm fuzzies? Improved health would I'm sure increase the quality of life for many people. Or how many warm fuzzies could be generated by spending $500 million on repairing the east-side of Christchurch?

There is also the obvious question of how do you include warm fuzzies in any analysis? It is far from clear how you could measure such things.

John Cochrane interview

An interview with John Cochrane on the Tom Keene show on Bloomberg TV.

Plain packaging

The policy of ‘plain packaging’ for tobacco products is an issue here and many other places around the world. The idea is being discussed in the U.K. right now. The Adam Smith Institute has argued against plain packaging. It has published a report by Chris Snowdon on the subject.

The executive summary of the report reads:

1. The UK government is considering the policy of ‘plain packaging’ for tobacco products. If such a law is passed, all cigarettes, cigars and smokeless tobacco will be sold in generic packs without branding or trademarks. All packs will be the same size and colour (to be decided by the government) and the only permitted images will be large graphic warnings, such as photos of tumours and corpses. Consumers will be able to distinguish between products only by the brand name, which will appear in a small, standardised font.

2. As plain packaging has yet to be tried anywhere in the world, there is no solid evidence of its efficacy or unintended consequences.

3. Focus groups and opinion polls have repeatedly shown that the public does not believe that plain packaging will stop people smoking. Even ardent antismoking campaigners do not make such a claim. Instead, activists assert that nonsmokers take up the habit as a result of seeing “glitzy” tobacco packaging. This claim lacks plausibility and is bereft of empirical evidence.

4. One in nine cigarettes smoked around the world is counterfeit or smuggled.The illicit market lowers prices, fuels underage consumption, deprives the treasury of tax revenue and makes an unhealthy habit still more hazardous. It is hard to think of a policy that could delight counterfeiters more than standardising the design, shape and colour of cigarette packs.

5. The wholesale confiscation of an industry’s brands and trademarks represents an unprecedented assault on commercial expression. It not only tramples on the principles of a free market, but it may also be illegal. Expert opinion, including that of the European Communities Trade Mark Association, the British Brands Group and the International Trademark Association, says that plain packaging is an infringement of intellectual property rights and a violation of international free trade agreements to which the UK is a signatory.

6. Anti-smoking lobbyists claim that plain packaging will not be imposed on other industries in the future, but this is a hollow reassurance in the light of the accelerating war on alcohol, sugar, salt and fat. What happens to tobacco tends to happen to other products sooner or later. Public health organisations around the world have been applying the blueprint of antitobacco regulation to other products for years. Sin taxes and advertising bans are increasingly common for certain types of food and drink, and various campaigners have called for graphic warnings to be placed on bottles of alcohol. It should be no surprise that in Australia, where a plain packaging law was passed in 2011, activists are already demanding that ‘junk food’ be sold in generic packaging. Australian anti-smoking lobbyists, meanwhile, say that the next step after plain packaging is to force the tobacco industry to make cigarettes “foul-tasting”.

7. Plain packaging is not a health policy is any recognisable sense. It neither informs nor educates. On the contrary, it limits information and restricts choice. It will serve only to inconvenience retailers, stigmatise consumers and encourage counterfeiters. Wholesale expropriation of private property to make way for public propaganda represents an unacceptable intrusion into an already over-regulated marketplace which will set a dangerous
precedent for other products.

I'm not sure that counterfeit or smuggled cigarettes is, yet, a big problem in New Zealand , so point 4 may not apply here. The other points, however, would seem to be relevant to out debate.

New Zealand's olympic success

Over at the ever interesting Fairplay and Forward Passes blog Sam Richardson asks, New Zealand's Olympic success - what's in it for us? A good question. At one point Sam writes,

What perked my ears, though, was this comment:

[Canterbury University senior lecturer in Management Ekant] Veer said New Zealand was a sports crazy country and a successful Olympic campaign often had huge impact on the nation’s mood.
"Which, in turn, can lead to increased productivity at work, improved relationships, increased consumer spending and all manner of behaviours that are positive for this nation."

In reply Sam makes the point,

I'm not aware of much in the way of evidence that supports the economic arguments mentioned above (increased productivity at work and increased consumer spending).

My question would be isn't anyone going to ask what the opportunity cost of sport funding is? What would happen if we put the money used for sport into health or education or welfare or ........? With a bit more money going into education maybe Canterbury University won't have had to fire as many members of the management department. Or what if we just gave it back to the taxpayer, wouldn't that do wonders for the taxpayer's mood?

EconTalk this week

Tammy Frisby of Stanford University's Hoover Institution talks with EconTalk host Russ Roberts about the likelihood of U.S. tax reform in the near future. Frisby reviews the changes in tax policy over the last 30 years focusing on the changes of the 1980s, looking at both the economics and politics of past changes. The conversation then turns to the present and the possible changes that might be coming as the Bush tax cuts expire on January 1, 2013.

The wonder that is empirical economics

Being a theoretical type I am am always impressed by the wonder that is empirical economics. Now over at the NYU DRI blog Bill Easterly has come up with another example as to why we should hold empirical economics in such high esteem:

Using data conveniently available from the Peruvian, Ecuadorean, Bolivian, and Chilean Olympic trials, the study compared athletes who just made the Olympic team with those who just fell short. This rigorous regression discontinuity design allowed the study to identify the effect of Olympic participation on Olympic medals.

The study found on average zero effect of Olympic participation on Olympic medals. This study found no evidence that the Olympics produces Olympic medals.

Business cycles explained

In this series of videos from LearnLiberty, Professor Tyler Cowen gives a quick introduction to different views on the business cycles.

EconTalk this week

Josiah Ober of Stanford University talks with EconTalk host Russ Roberts about the economy of ancient Greece, particularly Athens. Ober notes that the standard view of ancient Greece is that it was very poor. Drawing on various kinds of evidence, Ober argues that Greece was actually quite successful, and that the average citizen of ancient Athens lived quite well by ancient standards. He suggests two possible explanations for Greece's economic success--an openness of the political process that reduced transaction costs and encouraged human capital investment or innovation and cross-fertilization across Greek states. The conversation also explores the nature of evidence for understanding antiquity and the prospect for future discoveries pertaining to ancient Greece.

Fixed v.floating exchange rates

There is an on going debate over which of fixed or floating exchanges rate is best. At the Free Banking blog Kurt Schuler writes on Milton Friedman's views on exchange rates. He writes

The key to reconciling Friedman’s apparently contradictory positions is to understand that clean fixed and clean floating exchange rates, though differing in their degree of nominal rigidity, are similar in that both give market forces free rein. Under a clean fixed exchange rate, the nominal exchange rate is fixed and market forces determine the nominal monetary base. Under a clean floating exchange rate, the nominal monetary base is in the short term fixed (or perhaps a better word would be "set") and market forces determine the nominal exchange rate.

The important thing to take from this is that clean forms of both exchange rate systems work. But keep in mind the word clean in that sentence. In the real world nether system is clean so the real question is which system works best when governments intervene?

Schuler goes on the write,

The overall impression Friedman's statements on exchange rates leave is that he considered flexible exchange rates to be the system most desirable and most politically sustainable for large and medium-size economies that were politically independent and able to keep inflation relatively low.

Does New Zealand meet these conditions?

EconTalk .... for four weeks

Nobel Laureate Joseph Stiglitz of Columbia University talks with EconTalk host Russ Roberts about the ideas in his recent book, The Price of Inequality. Stiglitz argues that the American economy is dysfunctional, benefitting only those at the very top while the bulk of the workforce sees little or no gain in their standard of living over recent decades. Stiglitz blames this result on deregulation and the political power of the financial sector and others at the top. He wants an increase in regulation and the role of government in the economy and a more transparent Federal Reserve Bank that he blames for coddling the financial sector. The conversation also includes a discussion of the Keynesian multiplier.

Gary Taubes, author of Why We Get Fat, talks with EconTalk host Russ Roberts about why we get fat and the nature of evidence in a complex system. The current mainstream view is that we get fat because we eat too much and don't exercise enough. Taubes challenges this seemingly uncontroversial argument with a number of empirical observations, arguing instead that excessive carbohydrate consumption causes obesity. In this conversation he explains how your body reacts to carbohydrates and explains why the mainstream argument of "calories in/calories out" is inadequate for explaining obesity. He also discusses the history of the idea of carbohydrates' importance tracing it back to German and Austrian nutritionists whose work was ignored after WWII. Roberts ties the discussion to other emergent, complex phenomena such as the economy. The conversation closes with a discussion of the risks of confirmation bias and cherry-picking data to suit one's pet hypotheses.

David Brady, Professor of Political Science and the Graduate School of Business at Stanford University and a senior fellow at Stanford's Hoover Institution talks with EconTalk host Russ Roberts about the November elections in the United States. Brady argues that while the economy favors the challenger, Mitt Romney, current polling data gives a slight edge to President Obama in both the popular vote and the electoral college. The data all suggest that House will stay Republican and the Senate will either go slightly Republican or be tied. Brady also discusses why this may change over the next few months, the importance of the independent vote, and Romney's strategy in choosing a running mate.

Scott Atlas, Senior Fellow at Stanford University's Hoover Institution and author of In Excellent Health, talks with EconTalk host Russ Roberts about the U.S. health care system. Atlas argues that the U.S. health care system is top-notch relative to other countries and that data that show otherwise rely on including factors unrelated to health care or on spurious definitions. For example, life expectancy in the United States is unexceptional. When you take out suicides and fatal car accidents, factors that Atlas argues are unrelated to the health care system, the United States has the longest life expectancy in the world. A similar change occurs when measuring infant mortality--foreign data do not include as many at-risk births as in the United States and the measure of a birth is not comparable. In a number of other areas including cancer survival rates, access to hip replacement surgery and waiting times to see a physician, Atlas argues that the United States is also at or near the top. The discussion concludes with a discussion of access to health care for the poor and the failure of Medicaid.

This is how to examine students

This is from to the io9 webpage:

University exams are never anyone's idea of a rollicking time, particularly when your professor rambles on besotted for 23 hours, denies you sustenance and bathroom breaks, and covers topics not on the syllabus, such as her wardrobe and outside business interests.

And according to students at Russia's Kazan Federal University, this is exactly what precipitated on June 26, when an oral nuclear physics examination began at 10:00 AM and ended at 9:00 AM the following day. In an interview with the newspaper Moskovsky Komsomolets, one of the pupils noted, "Towards the end, everyone was just sitting there, totally exhausted [...] The lecturer would go into another room, drink, come back and start telling us about her business."

Oral exams are not uncommon in Russia, and even the instructor admitted that this one in particular ran long. But marathon examiner Landysh Zaripova responded to these allegations with a swipe at her fifteen students' academic aptitude. ("Do you think I am an idiot? [...] I was sober. The students just decided to get revenge on me because they couldn't pass the exam.")

Now that's what a real exam is like! And imagine what it would do for coffee sales.

Thanks to EC for the tip.

A bigger slice of a smaller pie

Institutions are a key determinant of economic development and indeed many developing institutions are deeply dysfunctional. A new column a VoxEU.org presents a new model suggesting that those in power may prefer to keep bad institutions despite their anti-development effects since they alllow the elite to grab a bigger slice of a smaller pie.

Bernardo Guimaraes and Kevin D Sheedy look at Power sharing and institutional stability. Clearly if you are creating a smaller pie then your institutions are not right. This in turn raises the question, Why inefficient institutions persist,

Institutions determine the allocation of resources and power among the individuals in the model. However, institutional choices have to survive popular uprisings, coups d'états, and all types of insurrections against them. Hence the elite in power chooses the rules that maximise its members’ payoffs subject to avoiding challenges that would dislodge them from power. For instance, excessively large taxes on some groups would prompt the disaffected groups to fight to take power and change the institutions.

In many cases, rules necessary for economic efficiency require restrictions on the untrammelled exercise of the elite's power. Including the possibility of investment in the model immediately raises this issue: rules against expropriation are needed, because protection of private property is optimal for the elite ex-ante, but not ex-post. There needs to be a means of preventing the elite from using its power to sweep aside existing rules and reshaping institutions to conform to their ex-post interests. The problem is essentially the classic question of ‘who will guard the guardians?’.

The model provides an answer: there must be many guardians if institutions are to be safe. A larger group holding power emerges as a commitment mechanism that allows them to act as a government bound to a set of policies that would otherwise be time inconsistent. This large group in power could perhaps be interpreted as including armed forces, police, parliaments, judges, etc. This resonates with Montesquieu's doctrine of the separation of powers, now accepted and followed in well-functioning systems of government.

How does it work? Once sunk investment costs have been incurred, many groups will want to destroy the current institutions and replace them with new ones. That is the time inconsistency problem: a group taking power would have incentives to expropriate the fruits of investments previously made. But importantly, this group would also have some optimal degree of power sharing in mind. For instance, a large legislative body might be thought of as unnecessary when institutions are rebuilt. Now suppose that the current institutions share power among a wider group. If a coup d’état occurs, some of those in power will lose their privileged status. Anticipating that, they will be willing to ‘fight’ to defend the current institutions.
The key idea is that power has to be shared so that power is less concentrated than it would be if institutions were destroyed and the group that took power were to rebuild institutions from scratch. Interestingly, the mechanism through which this operates is not bringing in new types of individuals who represent or care about other citizens. All members of the elite care only about their own rents under the status quo, and that is what gives them incentives to fight against insurrections from both insiders and outsiders. But alas, that is also what precludes efficient institutions from arising.

Although it is possible to sustain protection against expropriation by sharing power among a sufficiently large group, in equilibrium there is too little power sharing and thus too little commitment to rules such as protection of property rights. The reason is that sharing power requires sharing rents – because were powerful individuals not to receive rents commensurate with their status, they would have incentives to join rebellions against the current institutions, and no incentive to defend them. Hence those in power might want to choose a small pie (inefficient institutions) in order to guarantee their slice will be larger (little power sharing).

In many parts of the world, the threat of conflict has played and continues to play an important role in shaping institutions. Understanding that connection might teach us why some parts of the world are still so underdeveloped, and perhaps help us to devise better ways to address the problem.

Foreigners may just be good for your economy

Just don't tell Winston Peters! A new paper in the Journal of Economics and Management Strategy looks at Firm Productivity and the Foreign-Market Entry Decision. The abstract reads:

We use Japanese firm-level data to examine how a firm’s productivity affects its foreign-market entry strategy. The firm faces a choice between exporting and foreign direct investment (FDI). In the case of FDI, the firm has two options: greenfield investment or acquisition of an existing plant (M&A). If it selects greenfield investment, it has two ownership choices: whole ownership or a joint venture with a local company. Controlling for industry- and country-specific characteristics, we find that the more productive a firm is, the more likely it is to choose FDI rather than exporting and greenfield investment rather than M&A.

If these results hold for firms setting up in New Zealand they look like good news for New Zealand. If we see FDI, and in particular in areas of greenfields investment, in New Zealand then this tips the probability that the investing firm is a high productivity firm. But these are exactly the type of firms we want setting up shop in New Zealand. Given they are high productivity firms they will bring with them the industry best management, manufacturing and organisational practices which can flow onto New Zealand firms. Also given their productivity these firms will provide the most competition for local firms forcing the locals to lift their game and benefiting local consumers.

Of course if we make investment in New Zealand harder for foreign firms then this research suggests we could be loosing the benefits of having the best firms in our markets.

Council asset sales

There is much heat and little light being generated over the funding of the Christchurch City Council's spending plans via increased debt or asset sales. I think part of the problem with the discussion is that there are in fact two issues here and not just one. The first is, for a given spending plan, should more debt be issued or should revenue be increased? And the second is, Should the council sell assets? These two question can being seen as related but they don't have to be. It is possible, for example, that the council could in increase revenue by, say, selling assets to another council. This would raise cash without privatisation. Or it could privatise assets by giving them away which would result in no revenue. Also even if the council had no problems with its budget it still would face the issue of asset sales.

Actually there is a third option, cut spending. No I don't see the council going for that option! But you do have to ask, do we really need a new rugby stadium or a new convention centre, for example.

One of the big issues to do with debt has been the discussion of the difference between the rate of return on the council assets and the cost of debt. But as Eric Crampton has noted its more really possible to compare the two given the way the rate of return on assets is worked out.

“It’s a bit of a shame that so much of the discourse around asset sales has focused on differences between dividend rates and the interest rate on Council borrowing. First, it’s harder to put a fair value on assets held by government because they’re not traded on the open market; the recent rather large reduction in the book value of KiwiRail points to some of these difficulties. Where we are less certain of the asset’s value, we have less confidence around the actual dividend rates. Further, where reported dividend payments include a lot of booked capital gain rather than actual cash payments, it’s not entirely a fair comparison with bond payments. But more fundamentally, ownership of assets comes both with risk and with ongoing maintenance liabilities; gaps between dividends paid by Council enterprises and interest on Council debt is largely explained by that the former is riskier.”

There is little point in keeping the "family silver" as a hedge against bad times if you're not willing to sell it when bad times hit.

As to the should the council privatise question, the answer is, it depends. Privatisation makes sense when the private sector is more efficient than the public sector. Incomplete contracts models show that even when the government sets out to maximise welfare there are still times when it makes sense to privatise (Klaus M. Schmidt (1996) 'The Costs and Benefits of Privatization: An Incomplete Contracts Approach', Journal of Law, Economics, & Organization, Vol. 12, No.1 (April), 1-24 and Klaus M. Schmidt (1996) 'Incomplete contracts and privatization', European Economic Review, vol. 40, 569-579.) . This is because there is a trade-off bwteen allocative efficiency - which the government is good at achieving - and productive efficiency - which the private sector is good at achieving. If the gain in productive efficiency is greater than the loss in allocative efficiency then privatisation makes sense.

As a general guide, Hart, Shleifer and Vishny ("The Proper Scope of Government: Theory and an Application to Prisons", Quarterly Journal of Economics, 112(4): 1127-61, November 1997) argue that the case for government provision of goods or services is generally stronger when non-contractible cost reductions have large deleterious effects on quality, when quality innovations are unimportant and when corruption in government procurement is a severe problem. It has been argued that the case for government production is strong in such services as the conduct of foreign policy, police and armed forces. The case can also be made reasonably persuasively for the case of prisons. The case for private sector provision is stronger when quality reducing cost reduction can be controlled through contract or competition, when quality innovations are important and when patronage and powerful unions are a severe problem inside the government.

The Christchurch City Council ownership of assets is controlled by Christchurch City Holdings Ltd (CCHL) which is the commercial and investment arm of the council. CCHL manages the ratepayers' investment in these seven fully or partly-owned council-controlled trading organisations: Orion New Zealand Ltd – 89.3 per cent shareholding. Christchurch International Airport Ltd – 75 per cent. Lyttelton Port Company Ltd – 78.9 per cent. Christchurch City Networks Ltd (trading as Enable Networks) – 100 per cent. Red Bus Ltd – 100 per cent. City Care Ltd – 100 per cent. Selwyn Plantation Board Ltd – 39.3 per cent.

It's hard to see how any of these assets are in anyway like foreign policy, the police or the armed forces. It is difficult see how non-contractible cost reductions would have negative effects on quality and it seems likely that quality innovations are important in these areas, so (local) government ownership is not justified.

So if the council can not justify keeping assets in terms of it is the most efficient owner of them, then it could use the revenues gained from a sale to offset spending. Or it could buy another asset which it is the most efficient owner of and thus increase returns. But, on the other hand, if the council is the most efficient owner of an asset then selling it just to get money doesn't make sense.

So asset sales or increase debt? If some the assets the council controls are not those it can economical justify owning then increasing revenue by selling them should be on the table. If the council can justify owning these assets then increasing debt should be on the table. I would remind the council however there is option three: cut spending your spending plans.

Job search and employment

In these times of increased unemployment an interesting question is Does job search help with finding a job? And the answer appears to be the obvious, yes. That at least is the finding for a new working paper Job search methods in times of crisis: native and immigrant strategies in Spain by Javier Vázquez-Grenno. The abstract reads:

This paper uses Spanish Labor Force Survey data for the period 2005 to 2010 to examine the use of job search methods and the intensity of the job search strategies of unemployed natives and immigrants. We focus on the determinants of the job search methods and search effort. Additionally, we examine the impact of the methods selected and of the search intensity on the job-finding probabilities of native and immigrant groups in a period that covers the transition from economic growth to crisis. Our findings suggest that, irrespective of the job search methods adopted, the probability of employment is higher among immigrants than it is among natives. However, this gap is closed following the onset of the current crisis in 2008. We find that most job search methods have a positive impact on the probability of finding a job, with the exception of registration at a public employment office. Search effort (measured as the number of methods adopted) seems to matter in finding work. (Emphasis added)

But note the highlighted comment. The one thing that doesn't appear to help getting a job is registration at a public employment office! The government may be here to help, it just doesn't help you get a job.

Knock it down quick!

Eric Crampton writes over at Offsetting Behaviour

The National Business Review reports that the Heritage New Zealand Pouhere Taonga Bill will make it more difficult for owners of pre-1900 buildings to make any kind of alteration. In addition to requiring a building consent and, for buildings listed in district plans, a resource consent, you'll now also need an archaeological permit.

NBR points to the Law Society's submission on the bill. They write:

The practical implications of this definitional change, however, are wide-ranging for New Zealand’s older settlements. In some of these (for example, Nelson and Dunedin) there is still a substantial housing and commercial building stock comprising pre-1900 structures. A literal application of the definition of “archaeological site”, together with its companion definition of “harm”, means that there will be many thousands of private dwellings around New Zealand that will require an archaeological authority to be obtained for the most minor maintenance work, such as the replacement of spouting or the hanging of new wallpaper. It is not clear whether this level of intervention with private ownership rights is intended by the Bill. If that is not intended, then revisiting the definition of “harm” or “archaeological site” is warranted. The Law Society does not believe that this difficulty can be addressed by Heritage New Zealand simply applying the legislation in a pragmatic way, since the failure to obtain an archaeological authority is a criminal offence of strict liability.

Who would want to own a heritage home if they had to seek archaeological approval if they wanted to change the wallpaper? If the value of heritage buildings is bid down because of the regulatory encumbrances, investments in maintenance and strengthening are attenuated too.

What is the rational reaction to this? If you own a pre-1900 building which you think will need work done to it in the future or that you may want to renovate, What do you do? With the costs imposed by a Bill like this why not knock you building down now, while you still can, and put up something new.

So we could see a  large reduction in the number of heritage buildings around in the future. This I'm sure is not the intention of the Bill but it may be its effect.

You can only imagine the effect on heritage buildings here in Christchurch if you face these additional costs for earthquake related repairs.

Assumptions underlying the case for free trade

Don Boudreaux has been writing to the Washington Post about the assumptions underlying the economic case in support of free trade.

In fact, the critical assumptions on which the economic case for free trade rests are highly descriptive of reality: (1) the ultimate justification for economic activity is to improve living standards for consumers; (2) producers facing competition serve consumers better than do monopolists; (3) each party to a voluntary trade is generally made better off by such trades; and – most importantly – (4) the first three assumptions aren’t nullified merely by putting a national political border between consumers and producers.

Other subsidiary assumptions, when they hold, explain particular trade patterns and the size of trade’s benefits. But the proposition that trade between America and, say, India is beneficial for the people of both countries rests on assumptions no more unrealistic, tentative, or fragile than does the proposition that trade between Arizona and Indiana is beneficial for the people of both states.

So if people in the South Island are made better off by trading with people in the North Island (and vice versa) then people in the South Island are made just as well off trading with people in Iceland (and vice versa).

Testimony on fractional-reserve banking

Lawrence H. White, Professor of Economics, George Mason University, testified before the House Subcommittee on Domestic Monetary Policy and Technology, United States House of Representatives. His testimony is a good discussion of fractional-reserve banking.

One of the more interesting sections of the testimony has to do with advantages and disadvantages of fractional reserves.

The advantage to the bank from keeping fractional reserves is clear: it earns interest on the lent-out funds. A few commentators have declared that FRB [fractional-reserve banking] must be a fraud: the gain is all on the bank’s side, and no customer would agree to it if she realized what the bank was up to. But this claim assumes that there are no advantages to the bank’s customers. In fact there are clear advantages to the bank’s customers, at least under competition. To compete for customers, all experience shows, banks offering fractional-reserve accounts charge zero storage fees and even pay interest on deposits, up to point where the interest they pay falls short of the interest they earn only by just enough to cover the bank’s operating costs for safekeeping and payment services. In this way FRB creates a synergy between payments services (checkable deposits, banknotes) and intermediation (pooling savers’ funds for lending to selected borrowers). When the deposited funds that are not needed as reserves can be lent out, depositors enjoy lower (or zero) storage fees and interest on checking deposit balances.

By contrast to money warehousing, the savings of fractional-reserve banking do carry a disadvantage in the form of greater default risk. If the bank’s investments go sour, the depositor may not be repaid in full. The warehouse, by contrast, makes no investments. So the customer choosing between a bank account contract and a warehousing contract needs to consider: is the saving in storage fees and the interest paid on deposits high enough (relative to the increased risk of not being paid promptly)? Historically, in competitive systems where banks were free to diversify and capitalize themselves well, the answer was yes for most people. Thus well informed consumers who want economical payment services typically prefer a fractional-reserve bank to a warehouse. In sound banking systems historically, before deposit insurance, the risk of loss was a small fraction of one percent, while the interest was more than one percent, and the sum of interest and storage fee savings was even higher. Thus FRB can arise and survive without fraud. The economist George Selgin has examined the record of the London goldsmith bankers, and debunked the myth that they pulled a fraudulent switcheroo, promising 100% reserves but holding less, at the beginning of the practice of FRB. Goldsmith bank accounts became enormously popular in the mid-1600s because they offered interest on demand deposits. The offer of interest is a clear signal that the contract is not a warehousing contract.

For payment by account transfer, FRB offers a more economic way of providing payment services. A money warehouse or 100% reserve institution could also offer payments by account transfer, but its services would be significantly more expensive. The other bank payment instrument, redeemable banknotes circulating in round denominations, simply cannot exist without fractional reserves. Banknotes are feasible for a fractional-reserve bank because the bank doesn’t need to assess storage fees to cover its costs. It can let the notes can circulate anonymously and at face value, unencumbered by fees, and cover its costs by interest income. An issuer of circulating 100% reserve notes would need to assess storage fees on someone, but would be unable to assess them on unknown note-holders. There are no known historical examples of circulating 100% reserve notes unemcumbered by storage fees.

Under a gold or silver standard, the introduction and public acceptance of fractionally backed demand deposits and banknotes means that the economy needs less gold or silver in its vaults to supply the quantity of money balances (commonly accepted media of exchange) that the public wants to hold. Thus money is supplied at a lower resource cost, that is, with less labor and capital devoted to mining or importing precious metals and fashioning them into coins or bars. Looking at the change in balance sheets from money warehouses to fractional reserve banks, the economy can now fund productive enterprises where before it only held metal. Gold can be exported, and productive machinery imported. This development in Scotland was praised by Adam Smith as a source of his country’s economic growth. As the economist Ludwig von Mises put it, “Fiduciary media [fractionally backed demand deposits and banknotes] … enrich both the person that issues them and the community that employs them."

Under a fiat money standard, as we have today with the Federal Reserve dollar, things are different. There are no mining or minting costs saved by holding fractional rather than 100% reserves in the form of fiat money. For commercial banks to hold 100% reserves in the form of fiat money issued by the federal government would, however, change drastically the function of the banks. Instead of funding productive enterprises, the banks would instead only fund the federal government. Fewer loanable funds would be available to the private economy, and more to the government. Private investment would be suppressed, and public spending enlarged.

White's conclusion is

The evidence shows that a fractional-reserve banking system is not unstable when the banking system is free of hobbling legal restrictions and free of privileges. The US banking system in the 19th century was weakened by legal restrictions. In response to that weakness, rather than let the banking system become robust by repealing its restrictions, Congress in the 20th century patched over the problem by creating the Federal Reserve system (to act a “lender of last resort”) and federal deposit insurance. As a result, the US banking system in the 21st century is chronically weakened by government privileges (especially taxpayer-backed deposit insurance and taxpayer-backed “too big to fail” bailouts) that generate moral hazard. Banks take advantage of these guarantees by holding asset portfolios too full of default risk and interest-rate risk. They finance their portfolios with excess leverage (too much debt, not enough equity). Rather than trying to come up with another patch, Congress should seek to dismantle the restrictions and the privileges that have left the American people saddled with an unhealthy banking system.

EconTalk this week

Luigi Zingales of the University of Chicago and author of A Capitalism for the People talks with EconTalk host Russ Roberts about the ideas in his book. Zingales argues that the financial sector has used its political power to enhance the size of the sector and the compensations executives receive. This is symptomatic of a larger problem where special interests steer resources and favors based on their political influence. Zingales argues for a capitalism for the people rather than a capitalism for cronies or the politically powerful. The conversation concludes with a plea by Zingales to his fellow economists to speak out against behavior that is legal but immoral--lobbying Congress for special treatment that exploits others to benefit one's own industry, for example.

The reality of the wartime economy

A common story told about the U.S. economy, and many other economies, is that World War II got the U.S. out of the Great Depression and thus a war like effort should act as a model for getting the U.S. out of the Great Recession. Economic historian Robert Higgs is one author who has for many years challenged this view. In a paper published in 1992 Higgs wrote

Relying on standard measures of macroeconomic performance, historians and economists believe that “war prosperity” prevailed in the United States during World War II. This belief is ill-founded, because it does not recognize that the United States had a command economy during the war. From 1942 to 1946 some macroeconomic performance measures are statistically inaccurate; others are conceptually inappropriate. A better grounded interpretation is that during the war the economy was a huge arsenal in which the well-being of consumers deteriorated. After the war genuine prosperity returned for the first time since 1929.

Higgs end his paper by saying

To sum up, World War II got the economy out of the Great Depression, but not in the manner described by the orthodox story. The war itself did not get the economy out of the Depression. The economy produced neither a “carnival of consumption” nor an investment boom, however successfully it overwhelmed the nation’s enemies with bombs, shells, and bullets. But certain events of the war years—the buildup of financial wealth and especially the transformation of expectations—justify an interpretation that views the war as an event that recreated the possibility of genuine economic recovery. As the war ended, real prosperity returned.

Now Steven Horwitz and Michael J. McPhillips join the club of those arguing against such a narrative. They have a paper forthcoming in the "Independent Review" on The Reality of the Wartime Economy: More Historical Evidence on Whether World War Il Ended the Great Depression The abstract reads,

In response to contemporary arguments that the expenditures associated with World War II were a major factor in ending the Great Depression and should therefore be imitated today, we offer historical evidence to suggest that the wartime economy was hardly a model of success in the eyes of most Americans. Expanding on Robert Higgs’ criticisms of the ability of conventional macroeconomic data to tell the real story, we examine newspapers, diaries, and other primary source material to reveal the retrogression in living standards in the US during the war. Our investigation suggests that wartime prosperity is largely a myth and hardly a model for recovery from the Great Recession.

What of New Zealand? Did war expenditure get us out of the depression? It appears not. This piece from Greasley and Oxley (2002) suggests that changes to New Zealand's monetary regime was behind the recovery from the depression here.

New Zealand's recovery from the Great Depression was unusually fast, and was associated with a fundamental shift in monetary regime. The new regime ended the conventional sterling standard, and diminished the influence of the trading banks on monetary conditions in New Zealand. Since the trading banks' operations spanned to Australia, the new monetary regime also decoupled the Dominion's monetary conditions from those across the Tasman. Devaluation and the formation of a reserve bank underpinned the new regime. This article shows that monetary growth in New Zealand was dramatically faster in the 1930s than it would have been had the old regime survived the Great Depression. New Zealand's nominal money stock, measured by M1, fell during the years 1923-9, but almost doubled between 1929 and 1939. The new monetary regime stimulated a recovery from New Zealand's long depression of the 1920s, as well as from the Great Depression. Had the old regime survived, New Zealand's GDP per caput in 1938 would have been around one-third lower.

New Zealand's recovery experience in the 1930s differed sharply from that of other export economies of the periphery, and was based on a new monetary regime that took effect in two stages. In contrast to what happened in Brazil, Mexico, and Australia, devaluation was chosen rather than forced, and eventually associated with a new inflationary regime. Initially, though, devaluation in New Zealand promoted recovery, in 1933, by redistributing income to the hard-pressed farm sector (the 'Copland effect'). Subsequently, during 1934-5, New Zealand's record to some extent mirrors that of the Argentine where the destruction of deflationary sentiments also ameliorated the depression (the 'Mundell effect'). However, New Zealand went much further, by more than doubling money supply between 1932 and 1937, which led to lower real interest rates (the 'Keynes effect').

New Zealand's experience also differed from that of the US, where monetary growth woe initially rapid but was curtailed in 1936 by the Federal Reserve increasing reserve requirements to counter possible inflation. Moreover, the strategy for redistributing income towards farmers in New Zealand did not rest, as it did in the US, on output restrictions, but on monetary manipulation. In concert, the three mutually reinforcing monetary transmission mechanisms, the 'Copland', 'Keynes', and 'Mundell' effects, stimulated powerfully real economic recovery. The growth potential of New Zealand's economy was strong in the 1920s but constrained by a deflationary regime. The Great Depression destroyed the Dominion's old monetary regime, and the new regime promoted a remarkable recovery.

• David Greasley and Les Oxley, "Regime shift and fast recovery on the periphery: New Zealand in the 1930s", Economic History Review, LV, 4 (2002), pp. 697-720.