Are foreign takeovers getting domestic cherries or lemons?

The concerns of economic nationalists - read NZ First, the Conservatives, Labour etc in the case of New Zealand - about foreign takeovers of assets, including land, are rooted in the idea that foreign enterprises extract the most valuable assets from top performing domestic firms. This argument puts to one-side for now the ever present xenophobia which underlies much of the anti-foreign investment rhetoric in New Zealand. Practical concerns about economic efficiency of cross-border mergers and acquisitions markets hinge on whether takeovers transfer underperforming domestic economic resources toward more productive uses at foreign enterprises. How then to reconcile these concerns when forming policies about cross-border activity? Well in a new column at VoxEU.org Farid Toubal , Bruce Blonigen, Lionel Fontagné and Nicholas Sly argue it’s all in the timing.

One of the big questions about foreign investment is are the foreign firms picking cherries or choosing lemons?

For many years the evidence about targets of foreign acquisitions has been mixed. Some theories and data suggest that ‘lemons’ – domestic firms with relatively weak performance – are the most likely targets of foreign acquisition. Yet more recent empirical studies have pointed to ‘cherries’ as the most likely targets for takeover by foreign firms. The disagreement about which type of domestic firms – cherries or lemons – are pursued by foreign enterprises made it difficult to answer policy makers’ question about which of their assets, economic networks, and production possibilities were suddenly in the hands of foreign ownership.

The doubt over which types of firms were being acquired also raises concerns about the efficiency of international merger and acquisition (M&A) markets. Ideally, market transactions should transfer resources toward their most efficient use. The same holds for M&A markets, which should transfer the assets of lesser performing firms to enterprises that can make better use of them. If domestic firms are high performing cherries, it is not evident that a transfer of ownership of their resources to a foreign enterprise is optimal; being a cherry implies that a domestic firm is already using its resources effectively. Poor performing lemons might seem to fit the bill. Yet the question remains open as to why a foreign enterprise would choose to enter a market using resources that even a domestic firm – which had more familiarity with resident consumers, regulations, and distribution networks – could not use profitably.

Blonigen, Fontagne, Sly, and Toubal argue its all in the timing.

In Blonigen, Fontagne, Sly, and Toubal (2014), we show that the conundrum over whether domestic cherries or lemons are targets of acquisition can be resolved by considering not only the types of assets that foreign acquirers seek, but also the timing of takeovers. Indeed, foreign firms seek domestic targets that are historically high performing. In fact, when we look at foreign acquisitions that occur in the French manufacturing sector over the last decade, we find that even the least productive domestic target outperforms the typical firm in its sector in the years prior to acquisition. See Figure 1 below, which takes advantage of detailed administrative data from France to illustrate systematic changes in firm characteristics as they transition from domestic to multinational status. We plot total factor productivity (TFP) for all manufacturing firms that are acquired by foreign owners between 1999 and 2006 relative to sector and year averages, from three years prior to the acquisition to four years after the firm is acquired. The middle line shows the relative detrended TFP for the average French firm acquired by a foreign owner, whereas the lines above and below show the relative detrended TFP for the 95th and 5th percentiles, respectively. In the years prior to acquisition, domestic targets of foreign acquisition do appear to be ‘cherries.’ They have all a TFP that is above industry-year average.

Figure 1.

Yet despite the high performance of target firms observed several years prior to acquisition, Figure 1 shows that, prior to acquisition, targets realize significant productivity losses relative to other firms in their sector. The losses in productivity are so severe that by the time they are acquired, targets of foreign acquisition no longer appear to be cherries; on average they are indistinguishable from the typical firm from their sector. Put differently, in the years leading up to acquisition domestic targets are underperforming relative other firms in their industry. In these years, targets do look like ‘lemons.’

Rather than targets of foreign acquisition being characterized purely as top performers or underperformers in the market place, foreign enterprises seek out domestic firms that were previously the stars of their industries but then suffered a recent series of negative shocks. Hence, the targets of foreign takeovers are ‘Cherries for Sale.’

This timing of cross-border acquisition activity is quite intuitive. Foreign enterprises seek out targets that have the best and most valuable assets. And not surprisingly, it is the most productive target firms that had the largest incentives to invest in developing such assets. However, foreign enterprises can only offer viable takeover bids once the domestic firm has suffered a turn in fate, and is underutilizing it valuable assets. In this case it is better for the domestic firm to sell its assets to a foreign acquirer that can make better use of them.

So what is the upshot of all of this?

This timing of takeover activity implies that policy makers should have fewer concerns about relinquishing national ownership of its domestic enterprises, as the ‘Cherries for Sale’ are no longer the best and most valuable economic agents within their economic sectors. The observed timing of takeover activity also suggests the efficiency of cross-border M&A markets. Cross-border acquisitions appear to transfer productive assets, technologies, and distribution networks toward enterprises that can make better use of these valuable resources.

So foreign ownership may be good for you after all. The assets being bought by the foreign companies are those not preforming well under their current owners and the foreign owners can make better use of those assets. This is a gain for the local economy.

Ref.:

• Blonigen, B A, L Fontagne, N Sly, and F Toubal, “Cherries for Sale: The Incidence and Timing of Cross-Border M&A”, Journal of International Economics, 2014, forthcoming.

Is the division of labour a form of enslavement?

Or so asks Timothy Taylor at the Conversable Economist blog. Taylor writes,

The idea that an economy functions through a division of labor, in which we each focus and specialize in certain tasks and then participate in a market to obtain the goods and services we want to consume, is fundamental to economic analysis. Indeed, the very first chapter of Adam Smith's 1776 classic The Wealth of Nations is titled "Of the Division of Labor," and offers the famous example of how dividing up the tasks involved in making a pin is what makes a pin factory so much more productive than an individual who is making pins.

While Smith opens "An Inquiry into the Nature and Causes of The Wealth of Nations" with a discussion of the division of labour at the microeconomic (pin factory) level he quickly moves the analysis to the market level. When discussing Smith’s approach to the division of labour McNulty (1984: 237-8) comments,

“[h]aving conceptualized division of labor in terms of the organization of work within the enterprise, however, Smith subsequently failed to develop or even to pursue systematically that line of analysis. His ideas on the division of labor could, for example, have led him toward an analysis of task assignment, management, or organization. Such an intra-firm approach would have foreshadowed the much later−indeed, quite recent−efforts in this direction by Herbert Simon, Oliver Williamson, Harvey Leibenstein, and others, a body of work which Leibenstein calls “micromicroeconomics”. [ ...] But, instead, Smith quickly turned his attention away from the internal organization of the enterprise, and outward toward the market and the realm of exchange, perhaps because he found therein both the source of division of labor, in the “propensity in human nature ...to truck, barter and exchange” and its effective limits”.

Taylor then moves on to point out that Karl Marx saw a downside to the division of labour.

But what if the division of labor, with its emphasis on focusing on a particular narrow job, runs fundamentally counter to something in the human spirit? Karl Marx raised this possibility in The German Ideology (1846 Section 1, "Idealism and Materialism," subsection on "Private Property and Communism"). Marx wrote:

“Further, the division of labor implies the contradiction between the interest of the separate individual or the individual family and the communal interest of all individuals who have intercourse with one another. … The division of labor offers us the first example of how, as long as man remains in natural society, that is, as long as a cleavage exists between the particular and the common interest, as long, therefore, as activity is not voluntarily, but naturally, divided, man's own deed becomes an alien power opposed to him, which enslaves him instead of being controlled by him. For as soon as the distribution of labor comes into being, each man has a particular, exclusive sphere of activity, which is forced upon him and from which he cannot escape. He is a hunter, a fisherman, a shepherd, or a critical critic, and must remain so if he does not want to lose his means of livelihood; while in communist society, where nobody has one exclusive sphere of activity but each can become accomplished in any branch he wishes, society regulates the general production and thus makes it possible for me to do one thing today and another tomorrow, to hunt in the morning, fish in the afternoon, rear cattle in the evening, criticism after dinner, just as I have a mind, without ever becoming hunter fisherman, shepherd or critic. This fixation of social activity, this consolidation of what we ourselves produce into an objective power above us, growing out of our control, thwarting our expectations, bringing to naught our calculations, is one of the chief factors in historical development up till now.

But Marx was not alone in seeing a bad side to the division of labour. Smith himself wrote,

In the progress of the division of labour, the employment of the far greater part of those who live by labour, that is, of the great body of the people, comes to be confined to a few very simple operations, frequently to one or two. But the understandings of the greater part of men are necessarily formed by their ordinary employments. The man whose whole life is spent in performing a few simple operations, of which the effects are perhaps always the same, or very nearly the same, has no occasion to exert his understanding or to exercise his invention in finding out expedients for removing difficulties which never occur. He naturally loses, therefore, the habit of such exertion, and generally becomes as stupid and ignorant as it is possible for a human creature to become. The torpor of his mind renders him not only incapable of relishing or bearing a part in any rational conversation, but of conceiving any generous, noble, or tender sentiment, and consequently of forming any just judgment concerning many even of the ordinary duties of private life. Of the great and extensive interests of his country he is altogether incapable of judging, and unless very particular pains have been taken to render him otherwise, he is equally incapable of defending his country in war. The uniformity of his stationary life naturally corrupts the courage of his mind, and makes him regard with abhorrence the irregular, uncertain, and adventurous life of a soldier. It corrupts even the activity of his body, and renders him incapable of exerting his strength with vigour and perseverance in any other employment than that to which he has been bred. His dexterity at his own particular trade seems, in this manner, to be acquired at the expence of his intellectual, social, and martial virtues. But in every improved and civilized society this is the state into which the labouring poor, that is, the great body of the people, must necessarily fall, unless government takes some pains to prevent it.

So, like all of economics we see here that there is a trade-off involved with the division of labour. In this case it is between the effects of the division of labour on the worker who can become trapped in the grip of the mind numbing tedium of specialisation versus the real income increasing effects of the division of labour.

And even if we accept that the division of labour can create problems, a world without it - ie a world with total self-sufficiency - would create its own set of problems, which I would argue would be worse. So being a "slave" to specialisation is better than being a "slave" to self-sufficiency.

Ref.:

• McNulty, Paul J. (1984). ‘On the Nature and Theory of Economic Organization: the Role of the Firm Reconsidered’, History of Political Economy, 16(2) Summer: 233-53.

Interesting blog bits

1. Timothy Taylor on Characteristics of U.S. Minimum Wage Workers
   

   Set aside for a few heartbeats the vexed question of just how a minimum wage would affect employment, and focus on a more basic set of facts: What are some characteristics of U.S. workers who receive the minimum wage? The statistics here are from a short March 2014 report from the U.S. Bureau of Labor Statistics, "Characteristics of Minimum Wage Workers, 2013." Of course, the facts about who is receiving the minimum wage also reveal who will be most directly affected by any changes.

2. Chris Dillow on Economists and the Public
   

   In a comment here, I propose the creation of a new job, or jobs - professors for the public understanding of economics, analogous to the professorships at Bristol and Oxford which do the same for science.

3. Ben Jones asks Should Philosophers Avoid Politics?
   

   In a recent blog post and article, Bas van der Vossen makes a straightforward argument for why political philosophers should stay out of politics: (1) professionals have a prima facie moral duty to make a reasonable effort to avoid activities that predictably make them worse at their tasks (the principle of “responsible professionalism” or RP), (2) the task of political philosophers is to seek the truth about politics, (3) engaging in politics predictably makes us worse at seeking the truth about politics, and (4) therefore political philosophers have a prima facie moral duty to avoid engaging in politics.

4. Kristian Niemietz argues that Brick shortages come and go. Planning restrictions are the real obstacle to house building
   

   An unexpected increase in construction (from an extremely low base) has left building materials, especially bricks, in short supply, leading to a sudden surge in prices. Anti-development activists are having a field day, because this turn of events has provided them with a convenient excuse to explain away the negative effects of their obstructionism. A shortage of bricks, not Nimbyism, is causing the housing crisis, or so we are told.

5. Peter Klein on Making Money from Behavioral Social Science?
   

   Longtime readers of this blog expect skepticism about behavioral social science. One of my issues is the assumed, but unexplored, assumption that private actors and market institutions cannot deal with behavioral anomalies, and therefore government intervention is necessary to make people act “rationally.”

6. Tim Worstall argues The NY Times Is Wrong; There Is No Case For High-Speed Rail
   

   I always find it slightly odd that left liberals are so in love with a 19th century technology such as the railroads. They’re most certainly not in favour of 19th century science nor moral attitudes so what is it about rail that so excites them? But other than that mystification they’ve missed a very important point. There simply is no case for high-speed rail in the US.

7. Kaoru Hosono and Daisuke Miyakawa on Natural disasters, firm activity, and damage to banks

   Natural disasters affect firm activities both directly and indirectly. One prominent indirect effect is on firms’ transaction partners, in particular – their banks. This column shows how damage to banks affects firm activities, such as capital investment and exports, using as a natural experiment Japan’s 1995 Kobe earthquake. Bank damage has a significant and negative impact on both firm investment and on exports but this effect does not last very long.

8. Joseph E. Aldy and Seamus J. Smyth on Heterogeneity in the value of life

   Increasing longevity yields large economic benefits. However, public policies do not take into account the heterogeneity in these benefits across the population. This column presents simulated experimental findings about the heterogeneity in the value of statistical life. There is heterogeneity over the life-cycle, as well as prominent ‘black-white’ and ‘female-male’ gaps in the value of life, driven by differences in the labour income across these groups. The findings suggest that one-size-fits-all policies would not correctly reflect the individual willingness to pay to reduce mortality risk.

EconTalk this week

Barry Weingast, professor of political science at Stanford University and senior fellow at Stanford's Hoover Institution, talks with EconTalk host Russ Roberts about the nature of law. Weingast takes issue with some of the standard views of law, and proposes a better way to understand law. The two discuss the fundamental principles of law, how it can emerge in a decentralized way to resolve disputes over property and other commercial and social interactions. Examples include Iceland, Ancient Greece, and California during the gold rush. Also considered are how laws coordinate expectations and the way that social pressure can be used to enforce law in a decentralized fashion.

A direct link to the audio is available here.

The damage done by subsidies

From the Economist magazine comes this piece on China'a subsidies to ship building. In 2006 China enacted a “Long and Medium-Term Plan” [read subsidies to shipyards] to enlarge its shipping industry by 2015.

Yet economists’ views on subsidies have hardened over time. China’s policy provides subsidies both for the construction of ships themselves and for the building or expansion of shipyards. These interferences can distort trade, resulting in inefficient production. In deciding whether a subsidy flouts trade rules the World Trade Organisation (WTO) uses a “price gap” approach. The idea is simple: if a country is producing and selling something at a big discount to what others are charging, there is probably something fishy going on.

Price gaps provide a quick warning system, but are a poor way to judge the full extent of subsidies, according to a 2013 book by Usha and George Haley, of West Virginia University and the University of New Haven. It is a static approach, ignoring how demand for each shipyard’s differentiated products varies over time. It also fails to account for variations in efficiency. Whereas Chinese workers may be relatively cheap, large South Korean or Japanese shipyards exploit economies of scale that smaller Chinese yards cannot. The balance of all these factors, in addition to subsidies, should influence a shipyard’s costs and prices.

Recognising this, a 2014 working paper by Myrto Kalouptsidi of Princeton University provides a new way to spot subsidies and measure their impact. Using detailed quarterly data on factors like a shipyard’s age, size, capacity and staffing levels Ms Kalouptsidi estimates cost functions—the relationship between a yard’s output and its cost of production—for 192 yards across China, Japan, South Korea and Europe. By analysing data between 2001 and 2012, she can isolate the impact of China’s 2006 policy.

The results are striking. A simple price-gap approach shows that Chinese ships cost 7.3% less than rivals’. Controlling for quality differences—Chinese ships are seen as lower quality and so should be around 3.5% cheaper, even in the absence of subsidies—gives a 4% gap, hardly justification for WTO rage. But Ms Kalouptsidi’s estimates show this is just part of the story. Government help artificially lowered Chinese firms’ costs by between 15-20%. The aid will have included explicit subsidies and hidden benefits, such as tolerating losses at state-owned yards. China’s market share jumped as the policy was introduced.

As in [Adam] Smith’s day, this has shifted resources. By comparing the costs and productivity of the shipyards in her sample, Ms Kalouptsidi forecasts how the market might have developed in the absence of China’s subsidies. Her analysis points to a big resource reallocation: absent the meddling, Japan’s market share would have been around 30 percentage points higher. Since many South Korean or Japanese yards are more efficient than China’s, it means that the true cost of ship production may well have risen. Bloated by subsidy, China’s yards have turned out a surfeit of vessels, often poorly matched to customers’ demands.

The important point here is that many of the distortions introduced by government meddling are hard to find but dangerous and expensive nonetheless.

Guns, suicide, crime

It would seem obvious that if you have fewer guns in people's hands you would get fewer suicides and less crime. But is life that simple? After reading a couple of article by Mark Gius, Professor of Economics at Quinnipiac University, Hamden, Connecticut, USA, I'm beginning to think not. In a recent article in "Significance: statistics making sense", a magazine from The Royal Statistical Society, Gius writes, with regard to gun-related murder rates in the US,

In one of the more recent studies [Gius (2014)], I attempted to determine if assault weapons bans and concealed carry laws had any effects on gun-related murder rates. I decided to focus on these two types of laws because they have changed the most over the past thirty years. I used data for the period 1980–2009, which is one of the longest time periods examined in any research on assault weapons bans or CCW laws. Using the gun-related murder rate as the dependent variable was important because most other studies looked at violent crime rates or homicide rates. Violent crime rate data is not disaggregated into gun-related and non-gun-related violent crime, and homicides include justifiable killings and state-sanctioned killings; hence, an analysis using these types of crime rates may result in spurious conclusions. After analysing the data, I found that states that had more restrictive CCW laws had higher murder rates than states with more permissive CCW laws and that assault weapons bans had no significant effects on murder rates at the state level.

The lack of an affect on the part of state level assault weapons bans was not unexpected: as mentioned previously, very few murders are committed using assault weapons. The higher murder rates during the federal assault weapons ban probably reflected the inadequacy of the federal law and the overall higher crimes rates of that period due to the crack epidemic of the late 1980s and early 1990s.

The concealed carry results, however, were somewhat unexpected. States with more restrictive CCW laws had gun-related murder rates that were 10% higher (p < 0.01). At first sight this would seem to support the deterrent effect hypothesis of many gun rights proponents. There may, of course, be other explanations for these results. Laws may be ineffective due to loopholes and exemptions. The most violent states may also have the toughest gun control measures. Nonetheless, the results of my study do suggest that the potential deterrent effect of concealed weapons should not be ignored.

In another paper, Gius (2011), Gius has also looked at the relationship between gun ownership and suicides. Using recent data on suicide rates, gun control measures, and gun ownership rates, Gius's study suggests that states that require handgun permits have lower gun-related suicide rates, and states that have higher gun ownership rates have higher gun-related suicide rates. Which is what you may expect. Regarding non-gun suicides, results suggest that stricter gun control laws may result in higher non-firearm suicides, and higher rates of gun ownership result in lower non-gun suicide rates. These results suggest that stricter gun control laws may actually induce potential suicide victims to alter the method by which they commit suicide. That is, there is substitution effect. Hence, the overall effects of firearm availability on suicides may be muted due to the fact that while reduced firearm availability reduces firearm suicides, it also increases non-firearm suicides.

Ref.:

• Gius, M. (2014) "An examination of the effects of concealed weapons laws and assault weapons bans on state-level murder rates". Applied Economics Letters, 21(4), 265–267.
• Gius, M. (2011) "The Effects of Gun Ownership Rates and Gun Control Laws on Suicide Rates". New York Economic Review, vol. 42, Fall

Does immigration hurt natives? (updated)

Immigration continues to be a hotly debated topic in many countries, including New Zealand. A number of New Zealand politicians express somewhat negative, shall we say, views on the matter, in much the same way as they do on foreign investment in this country. These politicians play on fears that immigration takes jobs away from natives and imposes significant costs on taxpayers. Such ideas continue to shape electoral campaigns and policy discourses in many countries.

Economists have not been able to steer this debate much. Economic models emphasising the benefits of immigration for natives have typically neglected unemployment and redistribution – precisely the things voters are most concerned about. What happens if we introduce issues such as these into economic models of immigration? A new column at VoxEU.org by Michele Battisti, Gabriel Felbermayr, Giovanni Peri and Panu Poutvaara considers How immigration benefits natives despite labour market imperfections and income redistribution. Just from the title you can guess that Winston Peters wouldn't be bring this piece up during the election campaign.

Battisti, Felbermayr, Peri and Poutvaara write,

In our recent working paper (Battisti et al. 2014), we have introduced wage bargaining, search frictions, and a redistributive welfare state into a framework that still includes skill complementarities between immigrants and natives in production. Hence the traditional, and important, channel of gains for natives (skill complementarity) is introduced in a much more realistic world of frictions and redistribution that can make immigrants costly for natives. We have then calibrated the model to match the average statistics that we observe for 20 OECD countries. We have also simulated two ‘counter-factual’ scenarios:

(i) How does native workers’ welfare compare between the status quo and a situation with no immigrants (closed borders), and
(ii) What has been the effect on native welfare of immigration during the last 10 years?

They then go on to discuss "The relative labour-market performance of immigrants".

Looking at the wages of natives and immigrants of similar skills across the 20 countries considered, some interesting regularities emerge. First, immigrants are usually paid less than natives with similar educational attainments. Second, unemployment rates are usually higher among immigrants.

Table 1. Migrants versus natives: Cross-country heterogeneity within the OECD

Rows 3 and 4 of Table 1 show that, within education groups, immigrants receive lower wages than natives, and the gap is particularly important in the low-skilled segment. Moreover, as shown on rows 5 and 6, high- and low-skilled immigrants alike are also more likely to be unemployed. These differences – even allowing for reasonable differences in productivity – suggest that:

(i) Migrants have worse outside options than natives, and so obtain lower wages through bargaining, and
(ii) They are more likely to be hit by job destruction shocks, and so are more often unemployed.

The next issue Battisti, Felbermayr, Peri and Poutvaara turn to is "How immigration can spur job creation".

The introduction of job creation by firms – an important feature of our framework – generates two important effects of immigration. In particular, if firms cannot discriminate between natives and immigrants in the search process, but can pay immigrants lower wages (as is the case in the data), then the presence of immigrants drives up the average return from job creation. This encourages firms to create more jobs, some of which will be filled by natives. However, if matches with immigrants are more likely to break (as implied by their larger unemployment rate), the expected return to job creation is lower and firms will create fewer jobs. Which channel dominates depends on the relative strength of each mechanism. This can be simulated by our model once we have carefully calibrated its parameters on the data.

Figure 1. Native welfare changes in two migration scenarios, %

We calibrate our model to match the empirical moments for the 20 OECD countries shown in Table 1. Besides the relative labour market performance of immigrants, we also match facts on public spending, letting the government finance public goods and unemployment benefits by proportional taxation. We also match GDP per capita and average job durations for both educational groups.

Figure 1 presents results from two main scenarios. In the first, we calculate the difference in welfare (which can be also thought of as the difference in real post-tax income) between the status quo observed in 2011 and a hypothetical situation with no immigrants (closed borders). We find that the native welfare gains from immigration are positive in 19 out of 20 countries. In all countries but Switzerland (where the effect is essentially zero) natives have, on average, gained from immigration, and sometimes the gain is rather large (up to 2% of after-tax income). In the second scenario, we compute the difference in welfare of natives between the status quo in 2011 and a hypothetical situation in which the immigrant share had been kept at the level of 2000. We find a positive gain from this recent immigration in 16 countries.

In 14 out of 20 cases, the existing stock of immigrants makes both skill-groups of natives (college and non-college educated) better off. In the canonical model without labour market imperfections, these Pareto gains would be impossible. Moreover, even incumbent immigrants are found to be better off with immigration. Again, in the canonical framework this is extremely unlikely, as new immigrants are more closely substitutable with incumbent immigrants than with natives. The reason for these somewhat surprising results is the job-creation effect described above. Namely, immigration can grease the wheels of the labour market by affecting job creation incentives.

So what, you may ask "What explains the cross-country heterogeneity in benefits?"

The comparative statics from our analysis reveal that the following country characteristics increase the native immigration gains from a one-percentage-point increase in the immigrant labour force share:

(i) Higher native–immigrant wage gaps, regardless of the skill group;
(ii) A lower native–immigrant unemployment gap for the low-skilled;
(iii) More generous unemployment insurance;
(iv) A higher share of tertiary-educated workers amongst immigrants;
(v) Lower government expenditures.

The intuition is as follows. Lower bargaining power for immigrants implies that they have lower wages, and this encourages firms to create more jobs. Also, lower job-destruction rates for immigrants make hiring an immigrant more valuable for firms and encourage firms to create more jobs. A more generous unemployment insurance system makes immigration more beneficial for natives because higher unemployment benefits reduce job creation, and immigration helps to alleviate this distortion. In other words, the greasing-the-wheels effect and its lowering of the unemployment rate are particularly valuable when distortions are large. A higher share of tertiary-educated immigrants and lower government expenditures increase the benefits because they lower the extent of redistribution from natives to migrants.

So what conclusions can we draw from this?

Our analysis shows that immigration into imperfectly competitive labour markets need not be worsening labour market outcomes for natives. Instead, it can improve the job creation incentives of firms. Thus, measures that aim at eliminating the immigrant–native wage gap may hurt natives. This positive effect is threatened if immigrants are too often unemployed or if too many of them are unskilled. Policies reducing the rate of job loss for immigrants would therefore help natives. Finally, in contrast to widespread belief, immigrants do not seem to hurt low-skilled natives, even in the more realistic framework developed here. This is because immigration is often balanced between more and less educated, because its job-creation effect can help, and because redistribution towards immigrants is not as large as often suggested in the debate.

So, in short, immigration can be good for you. It also suggests that some kinds of inequality (the immigrant–native wage gap in this case) can have positive effects and, perhaps most importantly, immigrants do not seem to hurt low-skilled natives. Just don't tell Winston.

Ref.:

• Battisti, M, G Felbermayr, G Peri, and P Poutvaara (2014), “Immigration, Search, and Redistribution: A Quantitative Assessment of Native Welfare”, NBER Working Paper 20131.

Update: At the Economics New Zealand blog Donal Curtin notes that a recent survey of UK economists concluded "there is overwhelming support for the view that migration will increase the average income of current UK inhabitants". So immigration is good for you.

The size and effects of some forms of protectionism

From the Economist magazine:

India is hardly the only protectionist when it comes to agriculture. Rich countries are the worst culprits. Japan’s tariffs—778% on rice and 328% on sugar—aim to block trade completely, insulating its small and inefficient producers from competition. The European Union’s common agricultural policy soaks up 40% of its budget. But Mr Modi has run away from reform. India’s food subsidies are massive, costing around 1% of GDP. They lead to huge stockpiles of unwanted, rotting produce, and fan pervasive corruption.

But not only are food subsidies and protection costly, they are not the best way to help the poor.

Giving poor families cash or food stamps would be better at helping the neediest while minimising waste—as Brazil, for example, has demonstrated.

But what are the chances of reform if their are political benefits to the current system? Are agricultural intersts too powerful in many countries?

How many miles can you drive on one hour's wages?

The graph below comes from Ed Dolan's blog, Ed Dolan's Econ Blog.

And a few details on the calculations,

I was able to put together 50 years of pretty consistent data for the key variables, with only a little stitching together to make the starting points and end points fit. The series I used were:

• Nominal wage in dollars per hour for production and nonsupervisory workers.
• Average fuel economy of cars on the road, old and new, based on a series from the Department of Transportation for 1980 to 2012 and estimates from various sources to fill in the earlier years.
• Average gasoline prices from the Bureau of Labor Statistics and Department of Energy.

For years before 1964, data are harder to come by. Instead of trying to put together a complete series, I decided to go with spot estimates for three iconic cars of yore: A 1919 Model T (About 17 MPG), a 1935 Ford V-8 (about 15 MPG), and a larger 1950 Ford V-8, about 14 MPG.

To calculate the miles that you could drive per hour worked (MPHW), just divide your wage by the price you pay for gasoline and multiply by your car’s fuel efficiency in miles per gallon.

Decorporatisation

or the knowledge economy, as some people may call it. At the Stumbling and Mumbling blog Chris Dillow invents a new world, decorporatisation. Chris writes,

In the day job, I've coined a newish word - decorporatization.

My chart shows what I mean. It shows that in recent years we haven't seen just a squeeze on wages, but also a squeeze on profits; the share of these in GDP has fallen recently. One reason for this is that the incomes of the self-employed - measured by the ONS as other incomes - have increased. This hasn't happened because the self-employed are raking it in, but because there are so many more of them.

This is what I mean by decorporatization; we're seeing a shift from corporate sector activity to the self-employed.

Some of this might be due to firms employing freelancers and one-man subcontractors rather than staff - perhaps because transactions costs have fallen. However, whilst this might have have increased profits for particular firms, it hasn't increased them in aggregate.

And this is possible. Likely I would say. But I would put forward another factor, the thing that New Zealand governments used to get very excited about, the knowledge economy. Remember the "knowledge wave" the last Labour government promised us but never seemed to deliver on.

At least insofar as the knowledge economy means an increase in the importance of human capital compared to nonhuman capital in determining the organisational form that businesses will take, it could help explain what Chris is seeing in the data. Rajan and Zingales (2003: 90) argue that

[h]uman capital is replacing inanimate assets as the most important source of corporate capabilities and value. In both their organizational structure and their promotion and compensation policies, large firms are becoming more like professional partnerships.

It is also likely that this change has increased the number of sole-proprietorship and small partnerships being formed.

The important point here is that if your firm is based, in the main, around human capital then it is much earlier and cheaper to set-up a firm than it is to set-up a nonhuman capital based firm. There is no need to find and negotiate with and keep happy external financiers who supply the funding required to purchase large amount of nonhuman capital. With a human capital based firm the human capital is much more likely to be able to provide any nonhuman capital required without the need of external funding. For example if you are a computer scientist using a PC to design small business accounting software, then your firm being a sole-proprietorship or a small partnership is feasible whereas if you are writing software for a super-computer you are more likely to be an employee of whoever owns/rents the computer. That is, in the first case human capital is the major input to the production process of the firm while in the second nonhuman capital plays a much greater role and this leads to different organisational forms.

So what Chris is noting is an affect of a change in the importance of human capital to the production process, at least in some areas of the economy. More small firms are being set-up because it is cheaper to do so. Large amounts of expensive nonhuman capital are not necessary.

The basic income and the welfare state

Cato Unbound is hosting a month-long debate on “The Basic Income and the Welfare State.” The lead essay, “The Pragmatic Libertarian Case for a Basic Income Guaranteei” by Matt Zwolinski, is up now. In it, Zwolinski argues that libertarians should regard a BIG as significantly better, on libertarian grounds, than the current welfare state. It is cheaper, less paternalistic, and less prone to rent seeking. And while it might not measure up to strict standards of libertarian purity, it has a much better chance of actually being adopted in a world where 99% of people reject that purist vision.

Responses from Mike Huemer, Jim Manzi, and Robert Frank will go up over the next week.

A related audio: Libertarians for a Guaranteed Minimum Income? featuring Matt Zwolinski. This is the Cato Daily Podcast for December 5, 2013.

EconTalk this week

Reid Hoffman, co-founder of professional networking site LinkedIn, and Ben Casnocha, former Chief-of-Staff of LinkedIn, talk to EconTalk host Russ Roberts about LinkedIn and their book The Alliance. Hoffman and Casnocha discuss the founding and vision of LinkedIn along with their ideas in The Alliance on how to improve employee/employer relations when turnover is high and loyalty on each side is low.

A direct link to the talk is available here

The Economics of World War I. 2

I have written before about The Economics of World War I project at VoxEU.org. There is now an additional article in the series:

International Organisation and World War I
Patricia Clavin, 3 August 2014
Today’s international institutions have roots in the tenuous interwar peace. This column details the importance of Austria as a prototype for international aid and development. In the case of Austria, the interwar powers realized the inefficacy of a punitive peace, and instituted a system by which private credit markets would assist development in a mutually beneficial relationship. The Austrian ‘success story’ is key to understanding today’s international relations.

Xenophobia is not a good basis for economic policy (updated)

Isaac Davison writes in the New Zealand Herald:

Economic Development Minister Steven Joyce has accused Labour of "xenophobia" in their opposition of the potential sale of Lochinver Station to the Chinese company that bought the Crafar Farms.

Mr Joyce and Grant Robertson, economic development spokesman for Labour, appeared on TV3's The Nation this morning and discussed the sale.

Mr Robertson said under Labour the sale would not go ahead.

"Our criteria would definitely mean that a sale like this would be highly unlikely."

Mr Joyce said the opposition were "electioneering" in relation to the issue.

"When did [Labour] go out and oppose the purchase of James Cameron's land?"

"A little xenophobia from the Labour Party to start the day," he said.

Let me make a couple of points here. For efficiency reasons we want resources to be in the hands of those who value them most highly and the way to do that is sell them to the highest bidder. We want land (and other resources) to be used in the most efficient manner and the country of origin of the buyer is irrelevant to this. A thought experiment: ask yourself, Why are auctions used for so many goods? Its a way of finding out who values the good most highly. Whoever bids the most gets the goods. This is how we maximise the probability of getting an efficient allocation of resources. Secondly would a Labour government compensate the seller of the land for their policy? Under the Labour policy the seller would be forced to sell their land at a lower price than they would otherwise get (or not sell at all) and would a Labour government make up the difference between the actual sale price and the highest possible price? And if not, Why should the seller receive a lower return than they otherwise would?. And if this is a good policy for land why not implement it for other goods as well? What makes this idea land specific?

While I'm thinking about this let me add that the "logic" of our xenophobic friends must be symmetric. That is, if it is bad for foreigners to invest in New Zealand it must be equally bad for foreign counties to have New Zealanders investing in them. So why are New Zealand First, the Conservatives and Labour not announcing their intention to introduce legislation preventing New Zealanders from investing overseas?

Update: There are comments on this issue at Kiwiblog and Homepaddock and by Tim Worstall.

Presidents and the U.S. economy

There is a new NBER working paper out on Presidents and the U.S. Economy: An Econometric Exploration by Alan S. Blinder and Mark W. Watson. The abstract reds:

The U.S. economy has grown faster—and scored higher on many other macroeconomic metrics—when the President of the United States is a Democrat rather than a Republican. For many measures, including real GDP growth (on which we concentrate), the performance gap is both large and statistically significant, despite the fact that postwar history includes only 16 complete presidential terms. This paper asks why. The answer is not found in technical time series matters (such as differential trends or mean reversion), nor in systematically more expansionary monetary or fiscal policy under Democrats. Rather, it appears that the Democratic edge stems mainly from more benign oil shocks, superior TFP performance, a more favorable international environment, and perhaps more optimistic consumer expectations about the near-term future. Many other potential explanations are examined but fail to explain the partisan growth gap.

So Democrats got lucky.

Incentives matter: drug mules file

This is the abstract of a new paper The market for mules: Risk and compensation of cross-border drug couriers by David Bjerk and Caleb Mason in the International Review of Law and Economics, Volume 39, August 2014, Pages 58–72.

This paper uses a unique dataset to examine the economics of cross-border drug smuggling. Our results reveal that loads are generally quite large (median 30 kg), but with substantial variance within and across drug types. Males and females, as well as U.S. citizens and non-U.S. citizens are all well represented among mules. We also find that mule compensation is substantial (median $1313), and varies with load characteristics. Specifically, for mules caught with cocaine and meth, pay appears to be strongly correlated to expected sentence if caught, while pay appears to be primarily correlated with load size for marijuana mules, who generally smuggle much larger loads than those smuggling cocaine and meth. We argue that our results suggest that this underground labor market generally acts like a competitive labor market, where a risk-sensitive, reasonably well-informed, and relatively elastic labor force is compensated for higher risk tasks.

Why capitalism is better than socialism

In this short (8 mins) video from ReasonTV philosopher Jason Brennan discusses his book "Why Not Capitalism?".

"We're not the Borg from Star Trek. We want to engage in private projects we do by ourselves and not with others," says Jason Brennan, an associate professor of philosophy at Georgetown University.

Brennan's new book, Why Not Capitalism?, casts a critical eye on a notion with wide appeal among academics, politicians, and the general public: That even though history has shown that socialism is unworkable in practice, it's still the best way to run society in theory.

Brennan says that such thinking neglects the fact that even in utopia people will have significantly different visions of a life well lived. "You want a system under which you can realize all these different conceptions of the good life and the good community," he argues. Even in a world free of petty rivalries, tribalism, and human failings, capitalism would still be superior because it uniquely affords citizens the rights and freedoms necessary to customize their lives and pursue their own, personally meaningful projects.

Tyler Cowen on inequality and what really ails America

Eduardo Porter writes-up an email interview he had with economics professor Tyler Cowen on the subject of inequality.

A few interesting questions:

Q: Inequality is running amok. The richest one percent of Americans pull more than a fifth of the nation’s income. The top 10 percent take half, more than during the Roaring Twenties. President Obama seems to believe this is “the defining issue of our time.” Is it?

A: “Income inequality” consists of at least three separate issues: 1) the top one percent is earning more; 2) the relative return to education is rising; and 3) economic growth is slow, and thus many lower- and middle-income groups are not seeing their incomes rise very much over time. The third of these is arguably the defining issue of our time. Grouping these issues all together under the broad heading of “income inequality” I view as a big intellectual mistake.

Q: So should we worry at all about the chasm opening up between the income of the rich and the rest?

A: I worry about stagnation in the middle and towards the bottom, not the income gap per se. A lot of the income growth at the top has come from globalization; for instance, Apple now sells a lot of iPhones to China. That’s not something we should be worried about. Rather, we should celebrate it.

Q: So, your conclusion is we should obsess less about rising inequality in America.

A: We should focus policy on increasing the quality and affordability of housing, health care and education, and on raising the rate of technological advancement. If we did that, we wouldn't have to worry about this red herring of “inequality” writ large any more.

By the way, the biggest inequalities are those across borders. So if we are talking policy, how about a more liberal immigration policy for the United States? That should be the No. 1 priority for anyone concerned about income inequality.

"Neo-liberals" and "progressives": never the twain shall meet?

I was asked to give evidence on behalf of the Fabian Society to the Beveridge Committee on Broadcasting, and although I refused on the grounds that I was not a Socialist (this was countered by saying that there was not a specifically Socialist point of view on broadcasting), I did in fact prepare the first memorandum considered by the Fabian Society Committee on broadcasting and which was the basis from which their discussions proceeded.

Ronald Coase 1961
There is an interesting new working paper out on Ronald Coase and the Fabian Society: Competitive discussion in liberal ideology by David M. Levy and Sandra J. Peart. Levy and Peart open the paper by saying:

Ronald Coase wrote the 1949 memo that guided the discussion of the Fabian Research Group on broadcasting. In the evidence presented to the Beveridge Committee on broadcasting, the Fabians endorsed his recommendations by and large. These two facts have previously escaped notice and, as a result, our understanding of post-war economic thought has been misinformed. The stereotype of post-war economic thought divides the profession into two groups, “neo-liberals” and “progressives”. In this stereotyping “neo-liberals” are said to advance a policy agenda in which markets, rather than governments, provide services; “Progressives”, by contrast, are said to favor a greater role for governments in the provision of services. In this admittedly broad characterization, there is little room for “neo-liberals” to collaborate with “progressives”.

Coase is said to typify the “neo-liberal”, while the Fabians do the same for “progressives.” As such, we would expect that they would have nothing in common in the dimension of policy recommendations. The evidence presented below, however, demonstrates that Coase and the Fabians proposed a third alternative, one that avoided the government-market dichotomy that has been so important in stereotyping post-war thought. Instead of proposing a market or a government solution, Coase and the Fabians recommended that broadcasting in Britain be fragmented to break up the BBC monopoly whose origins Coase had so carefully studied (Coase 1950). When the Beveridge Committee recommended a continuation of the monopoly, Coase was, not surprisingly, distressed. Moreover, he was not pleased with the minority report that recommended commercializing television because Coase thought that policy would be outside the British consensus.

Coase’s willingness to allow public consensus to trump the theoretical rationale for market provision of broadcasting suggests a deep problem with the stereotype of post-war market liberalism. In both the memo for the Fabian Society and his book, Coase used a recently coined word—totalitarian—to describe the theoretical rationale for a broadcasting monopoly presented by the spokesperson of the BBC, Lord Reith. By the word “totalitarian” Coase meant something more general than the policies advocated by Hitler, Mussolini, or somewhat nearer at hand, Mosley, but rather the view that state policy can ignore the legitimate wishes of the citizens of the state. The idea that there are “democratic goals” that can be separated from “democratic means”—a view that Lord Reith articulated frequently as we document in note 8—is the heart of the danger which Coase always and everywhere opposed.

Interesting stuff. The idea that a socialist group like the Fabians were willing to go along with Coase on breaking up the BBC monopoly is not something we would expect to see given the standard division of post-war thought into two, non-intersecting, groups of socialists and (classical) liberals. Coase's opposition to totalitarian thought is somewhat less surprising.

Levy and Peart continue,

The first two paragraphs of the Coase memo reproduced in the documents section below (p. 20) speak to the heart of the issue. What is needed, Coase urged, is sufficient public information to allow an informed discussion to take place. In Coase’s view public discussion had been stymied. Perhaps for strategic reasons, those in authority have not revealed the requisite information about possible alternative arrangements. The issue Coase stresses is not the efficient satisfaction of wants by market processes but public knowledge with which people can work out what institutions seem best to them. In his 1950 British Broadcasting, Coase closes the chapter “Public Discussion of the Monopoly” with the consequences of systematic suppression of information:

Though the programme policy of the Corporation gave the lower social classes what they ought to have, it gave the educated classes what they wanted; or, at any rate, more of what they wanted than they thought they would obtain with what was believed to be the only alternative—commercial broadcasting (1950, p. 177)

The paternalism of the BBC is obvious in that the "lower social classes" got what the BBC considered they should have, rather than what they actually wanted and the "educated classes" got an amount of what they wanted decided by the BBC.

The first two paragraphs of Coase's memo referred to above read:

Memorandum by Mr. R. H. Coase

1. The task of the Beveridge Committee

What is wanted is an entirely new approach to the problems of broadcasting policy in Great Britain. The present attitude is one of uncritical acceptance of the existing organisation. This can largely be attributed to the way in which previous Committees worked. The Crawford Committee, which led to the establishment of the BBC, made (so far as I have been able to discover) no detailed examination of alternative schemes. And we know from Lord Elton that the Ullswater Committee (of which he was a member) came to their conclusions without questioning the basic assumptions on which the case for the existing organisation (and in particular the monopoly) rested.

The present Committee should take a different view of its responsibilities. Alternative arrangements should be examined. And most (if not all) of the evidence presented to the Committee should be published. The lack of information on what is possible has greatly handicapped public discussion. Publication of the evidence would permit an independent assessment of the conclusions reached by the Committee and would assist in the development of an informed public opinion on broadcasting policy.

Here we can see the typical Coaseian call for comparative institutional analysis. And a call to make sure that people have the information to basis such analysis on. We should always think about the role that alternative institutions play in ameliorating or exacerbating conflicts in a world of positive transaction costs - including broadcasting.

EconTalk this week

Sam Altman, president of startup accelerating firm Y Combinator, talks to EconTalk host Russ Roberts about Y Combinator's innovative strategy for discovering, funding, and coaching groundbreaking startups, what the company looks for in a potential startup, and Silicon Valley's attitude toward entrenched firms. The two also discuss Altman's thoughts on sectors of the economy that are ripe for innovation and how new firms are revolutionizing operations in these industries.

A direct link to the audio is available here.

Trade and the poor

A interesting new NBER working paper on Measuring the Unequal Gains from Trade by Pablo D. Fajgelbaum and Amit K. Khandelwal. The abstract reads:

Individuals that consume different baskets of goods are differentially affected by relative price changes caused by international trade. We develop a methodology to measure the unequal gains from trade across consumers within countries that is applicable across countries and time. The approach uses data on aggregate expenditures across goods with different income elasticities and parameters estimated from a non-homothetic gravity equation. We find considerable variation in the pro-poor bias of trade depending on the income elasticity of each country's exports and imports. Non-homotheticities across sectors imply that trade typically favors the poor, who concentrate spending in more traded sectors. (Emphasis added.)

So trade helps the poor given the fact that the poor concentrate their spending in the traded sectors of the economy. Fajgelbaum and Khandelwal writes,

We also find important effects from sectoral heterogeneity. As in the single-sector setting, the pro-poor bias increases with a country’s income elasticity of exports. But, in contrast with the single-sector estimation, the multi-sector model implies a strong pro-poor bias of trade in every country. On average over the countries in our sample, the real income loss from closing off trade are 57 percent for the 10th percentile of the income distribution and 25 percent for the 90th percentile.5 This bias in the gains from trade toward poor consumers hinges on the fact that these consumers spend relatively more on sectors that are more traded, while high-income individuals consume relatively more services, which are the least traded sector. Additionally, low-income consumers happen to concentrate spending on sectors with a lower elasticity of substitution across source countries. As a result, the multi-sector setting implies larger expenditures in more tradeable sectors and a lower rate of substitution between imports and domestic goods for poor consumers; these two features lead to larger gains from trade for the poor than the rich.

Deirdre McCloskey on the great enrichment

From the IEA comes this short video of Professor Deirdre McCloskey. Deirdre McCloskey, Author of The Bourgeois Era series, speaks to ieaTV about inequality, the amazing growth in the wealth of the working class over the past three hundred years and how wealth and commerce has been viewed over the centuries.

Deirdre is the Distinguished Professor in English, Economics, History and Communication at the University of Illinois. As a self-described "postmodern free-market quantitative Episcopalian feminist Aristotelian", she has worked on numerous areas of economic history, including British economic 'failures' during the 19th Century. She has written fourteen books and edited another seven.

Interesting blog bits

1. Andrew Cohen on Libertarianism and Parental Licensing
   

   Back in December of 2011, I posted “Licensing Parents,” defending a view Hugh LaFollette had introduced into philosophical literature in 1980: that the state should license parents (LaFollette further defended this stance in 2010; see Note 1). LaFollette is not a libertarian and as I indicated then, I disagree with him about a lot–including the need to license medical doctors and lawyers. I nonetheless think he is right that we ought to license parents. In this post, I explain why libertarians—or at least minarchist BH-libertarians—ought to endorse parental licensing.

2. Bryan Caplan on The Economist on Overparenting
   

   Though I'm no fan of The Economist's editorials, their science coverage remains outstanding. Check out their latest piece on overparenting.

3. Ryan Bourne on ‘Does good broadcasting require compulsion?’ The question the BBC won’t address
   

   I got to thinking about how helpful this interview style would be when I read the BBC’s own Director of Policy James Heath’s response to my response to his original blog post on why the licence fee is the right method of funding for the BBC. Rather than focusing on the arguments that I had made as to why a licence fee – a compulsory charge applied to everyone who wants to watch any live television – was indefensible and unnecessary, Heath instead used his article to outline why the BBC itself was of value to us.

4. Thorsten Beck, Hans Degryse, Ralph De Haas and Neeltje van Horen on When arm’s length is too far

   The small and medium-size enterprises (SMEs) were among the most severely affected in the Global Crisis. This column discusses new evidence on how different lending techniques affect lending in bad and good times. Data from 21 countries in central and eastern Europe show that ‘relationship lending’ alleviates credit constraints during a cyclical downturn but not during a boom period. The positive impact of relationship lending in an economic downturn is strongest for smaller and more opaque firms and in regions where the downturn is more severe.

5. Linda Goldberg, Signe Krogstrup, John Lipsky and Hélène Rey ask Why is financial stability essential for key currencies in the international monetary system?

   The dollar’s dominant role in international trade and finance has proved remarkably resilient. This column argues that financial stability – and the policy and institutional frameworks that underpin it – are important new determinants of currencies’ international roles. While old drivers still matter, progress achieved on financial-stability reforms in major currency areas will greatly influence the future roles of their currencies.

6. David Saha on The Transatlantic Trade and Investment Partnership: Review of the debate on economic blogs

   An early draft of the Transatlantic Trade and Investment Partnership (TTIP) sparked an intensive public debate over possible advantages and disadvantages. This column reviews some arguments in favour of the Partnership and against it. While there is some debate over how large the economic benefit could be in the face of already relatively low trade barriers, critics claim that the deal will lower standards of consumer protection, provision of public services, and environmental protection in the EU.

7. Tim Woratall on Don't Believe What You Read; Google Doesn't Avoid Tax

   It’s the results reporting season over in my native UK again and once again, as regular as the seasons themselves roll around, we’ve spluttering pieces in the press about how Google avoids all of this tax that it should justly and righteously pay. Which means it must be the time of year for me to point out that Google doesn’t in fact avoid paying UK corporation tax, whatever you might be being told in the newspapers.

8. John Cochrane on Lucas and Sargent Revisited

   The economics blogosphere has a big discussion going on over Bob Lucas and Tom Sargent's classic "After Keynesian Macroeconomics."

FEE video: John Blundell - Lessons from Margaret Thatcher

John Blundell speaks about his experience with Margaret Thatcher at "An Evening at FEE" on May 21st, 2011.

Complexity and the art of public policy

Complexity science is changing the way we think about social systems and social theory. Unfortunately, economists’ policy models have not kept up and are stuck in either a market fundamentalist or government control narrative. In this audio from VoxEU.org Roland Kupers argues for a new, more flexible policy narrative, which envisions society as a complex evolving system that is uncontrollable but can be influenced.

A direct link to the audio is available here.

Employee satisfaction, labour market flexibility, and stock returns around the world

In a new NBER working paper Alex Edmans, Lucius Li, and Chendi Zhang study the relationship between employee satisfaction and abnormal stock returns around the world, using lists of the “Best Companies to Work For” in 14 countries. They show that employee satisfaction is associated with positive abnormal returns in countries with high labour market flexibility, such as the U.S. and U.K., but not in countries with low labour market flexibility, such as Germany. I wonder New Zealand would come in this ranking.

These results are consistent with high employee satisfaction being a valuable tool for recruitment, retention, and motivation in flexible labour markets, where firms face fewer constraints on hiring and firing. In contrast, in regulated labour markets, legislation already provides minimum standards for worker welfare and so additional expenditure may exhibit diminishing returns. The results have implications for the differential profitability of socially responsible investing (“SRI”) strategies around the world. In particular, they emphasise the importance of taking institutional features into account when forming such strategies.

The conclusions of the paper:

This paper studies how the relationship between employee satisfaction and stock returns depends critically on the level of a country’s labor market flexibility. The alphas documented by Edmans (2011, 2012) for the U.S. are not anomalous in a global context, in terms of economic significance, and do extend to several other countries. However, they do not automatically generalize to every country – being listed as a Best Company to Work For is associated with superior returns only in countries with high labor market flexibility. These results are consistent with the idea that the recruitment, retention, and motivational benefits of employee satisfaction are most valuable in countries in which firms face fewer constraints on hiring and firing. These benefits are lower in countries with inflexible labor markets, leading to a downward shift in the marginal benefit of expenditure on employee welfare. Moreover, in such countries, regulations already provide a floor for worker welfare, leading to a movement down the marginal benefit curve. Both forces reduce the marginal benefit of investing in worker satisfaction, and thus being listed as a Best Company may reflect an agency problem.

The results emphasize the importance of the institutional context for both managers and investors. Edmans (2011, 2012) uses long-run stock returns as the dependent variable to mitigate concerns about reverse causality from firm performance to employee satisfaction – any publicly- available performance measure should be incorporated into the stock price at the start of the return compounding window. However, these papers do not make strong claims about causality, as it may be that a third, unobservable variable (e.g. management quality) drives both employee satisfaction and stock returns. Even if their results are interpreted as causal, it is not the case that managers can hope to increase stock returns by investing in employee satisfaction, as a positive link only exists in countries with high labor market flexibility. Turning to investors, a strategy of investing in firms with high employee satisfaction will only generate superior returns in countries with high labor market flexibility. Given that the vast majority of empirical asset pricing studies that uncover alpha are based on U.S. data, the results emphasize caution in applying these strategies overseas. This caution is especially warranted for strategies that are likely to be dependent on the institutional or cultural environment, such as socially responsible investing strategies. Just as the value of employee satisfaction depends on the flexibility of labor markets and existing regulations on worker welfare, the value of other SRI screens such as gender diversity, animal rights, environmental protection, and operating in an ethical industry also likely depend on the context.

The role of labour market flexibility for the results of the paper is interesting. New Zealand is not in their data set and I wonder how flexible our labour markets would look internationally.

Urbanisation makes the world more unequal

A recent article, by Kristian Behrens and Frédéric Robert-Nicoud, at VoxEU.org deals with the above issue and argues that large cities are more unequal than the nations that host them. The article contends that this is because large cities disproportionately reward talented superstars and disproportionately 'fail' the least talented. Cities should thus be the primary focus of policies to reduce inequality and its adverse consequences for society. Now the obvious question is Why should there be policies to reduce inequality? Are the authors attacking inequality when their real concern is with poverty?

The basic argument of the article is,

Large cities are more unequal than the nations that host them. For example, income inequality in the New York Metro Area (MSA) is considerably higher than the US average and similar to that of Rwanda or Costa Rica. Large cities are also more unequal than smaller towns. Figure 1 plots the relationship between population size and the Gini index of income inequality for a 2007 cross-section of US MSAs (solid line). The relationship is clearly positive. This holds true even when considering that large cities host more educated people on average (dashed line); income inequality cannot be entirely explained by higher educational attainment in large cities.

How can we then explain the size-inequality nexus? Researchers have proposed two main explanations so far, both of which have to do with city composition.

First, large cities may differ systematically in their industrial structure and the functions they perform. Large cities host, for example, more business services and the higher-order functions of finance and R&D, whereas small and medium-sized cities host larger shares of lower-order services and manufacturing. Consequently, larger cities are more skilled. However, industry composition explains only about one fifth of the observed skill variation across cities (Hendricks 2011). Furthermore, that variation cannot fully account for observed income inequality.

Second, large cities attract a disproportionate fraction of households at the bottom and at the top of the income distribution [ ... ]. Central cities of US MSAs attract, for example, poor households because they offer better access to public transportation [ ... ]. Large cities also attract rich households because they reward their skills more highly than smaller cities – a ‘superstar effect’ in ‘superstar cities’ [ ... ].

This is the second potential source to the positive relationship in Figure 1: returns to skill are increasing in city size [ ... ].

The argument for the second issue is that while larger cities increase the income of everyone, the top 5% benefit substantially more than the bottom quintile. The article continues,

In a recent study we propose a simple theory to explain why this happens [ ... ]. In our theory, large cities are places that disproportionately reward the most talented people (the ‘superstars’) and that disproportionately fail the least talented (‘selection’). In a nutshell, larger cities provide incentives for the most able to self-select into activities that offer high payoffs to the successful. However, the risk of failure associated with those activities also increases because workers in larger cities compete against more numerous and better rivals.

Disproportionate rewards for the most skilled – and failure for the less skilled – then drives income inequality. Both channels are stronger in larger cities, thus establishing the positive link between city size and inequality, even when abstracting from differences in industry composition and educational attainment.

The theory also predicts that increasing globalisation among global cities will translate into larger urban income inequality. Just as large cities provide large local markets to reward skills, larger global markets serve the same function. One novel aspect of our analysis is to emphasise the existence of both a direct effect of increasing globalisation on inequality (the ‘superstar effect’) and an indirect effect that goes through increasing urbanisation and the growth of cities. Cities are more ‘valuable places’ in a globalised world, which may serve to explain increasing urbanisation. The latter is positively linked to inequality, an aspect that has not been much analysed until now.

But perhaps the most interesting bit of the article are the caveats they put at the end.

We conclude with two words of caution. First, nominal income inequality (which is measured) is not equivalent to real income inequality (which is not directly measurable). Insofar as large cities offer a wider range of cheaper goods and services than small cities do, and if this pattern is especially pronounced for the least well off, then actual real urban inequality may be less severe than nominal inequality [ ... ]. Actually, Harvard economist Edward Glaeser claims that the large poverty rates of central cities are a testimony of their success, not their failure: they attract poor households by catering better to their needs [ ... ].

Second, fighting (urban) inequality does not require aggressive local redistributive policies, for such policies attract the poor and repulse the rich, leading to the bankruptcy of local governments, such as the fiscal crisis that hit New York City in the 1970s.

If inequality really is the issue then you may ask, Inequality of what? Is nominal/real income inequality what we should be worried about or is consumption inequality the real issue?

Theoretical v. applied economics

"Then, as now, applied economists, “realitics”, as Sir John Clapham called them, and theoretical economists (‘analytics’) were often a race apart who neither properly understood nor appreciated each other’s roles and approaches. Then, as now, views differed on whether or not theory had to be directly applicable in explanations of ‘real world’ observations and much misunderstanding occurred because the separation between logically coherent ‘high theory’ in its own domain and, a separate issue, its direct applicability, was not made by protagonists in an argument. Or, if it were, one side would be concerned with the former, the other with the latter, without either making this understanding explicit."
(Stephanie Blankenburg and Geoffrey Harcourt (2007), ‘The Debates on the Representative Firm and Increasing Returns: Then and Now’ In Philip Arestis, Michelle Baddelely and John S. L. McCombie (eds), Economic Growth, New Directions in Theory and Policy, Cheltenham, UK and Northampton, MA: Edward Elgar Publishing, pp. 44–64.)

Housing affordability

Paul Cheshire - Professor Emeritus of Economic Geography at LSE, and twice visitor to the econ department at Canterbury - asks, What lies behind Britain’s crisis of housing affordability? His answer is that it is nothing to do with foreign speculators but decades of planning policies that constrain the supply of houses and land and turn them into something like gold or artworks. He also exposes myths about the social and environmental benefits of ‘greenbelts’.

Cheshire writes,

When things go wrong, it is always handy to blame foreigners and currently even the liberal press are blaming them for our crisis of housing affordability. The problem is not 50 luxury houses empty on London’s Bishops Avenue (as The Guardian reported in January) or foreign speculators buying luxury flats to keep empty in London. It is that we have not been building enough houses for more than 30 years – and those we have been building have too often been in the wrong place or of the wrong type to meet demand.

and

This is what explains the crisis of housing affordability: we have a longstanding and endemic crisis of housing supply – and it is caused primarily by policies that intentionally constrain the supply of housing land. It is not surprising to find that house prices increased by a factor of 3.36 from the start of 1998 to late 2013 in Britain as a whole and by a factor of 4.24 over the same period in London.

and he adds,

What also happens – and this is central to our ‘blame the foreigners and speculators’ scapegoating – is that houses are converted from places in which to live into the most important financial asset people have; and the little land you can build them on becomes not just an input into house construction but a financial asset in its own right.

In other words, what policy is doing is turning houses and housing land into something like gold or artworks – into an asset for which there is an underlying consumption demand but which is in more or less fixed supply. So the price increasingly reflects its expected value relative to other investment assets. In the world as it has been since the financial crash of 2007/08, with interest rates at historic lows and great uncertainty in global markets, artworks and British houses have been transformed into very attractive investment assets.

and

The more tightly we control the supply of land and houses, the more housing and housing land become like investment assets. In turn, the stronger the incentives for their owners to treat them as an option to hold in the expectation of future price rises.

So to blame speculators for housing shortages and rising prices is simply incorrect. It is our post-war public policy that has converted a good that is in principle in quite elastic supply into a scarce and appreciating asset.

And what of greenbelts?

Supporters of urban containment policies argue that Britain is a small island and we are in danger of ‘concreting it over’. But this is a myth: greenbelts in fact cover one and a half times as much land as all our towns and cities put together.

And

So the second myth about greenbelts is that they are ‘green’ or environmentally valuable. They are not because intensive farmland is not. Moreover, there is little or no public access to greenbelt land except where there are viable rights of way. Greenbelts are a handsome subsidy to ‘horseyculture’ and golf. Since our planning system prevents housing competing, land for golf courses stays very cheap. More of Surrey is now under golf courses – about 2.65% – than has houses on it.

The final myth about greenbelts is that they provide a social or amenity benefit. The reality is that a child in Haringey gets no welfare from the fact that five miles away in Barnet, there are 2,380 hectares of greenbelt land; or in Havering another 6,010 hectares.

What SERC research has shown is that the only value of greenbelts is for those who own houses within them. What greenbelts really seem to be is a very British form of discriminatory zoning, keeping the urban unwashed out of the Home Counties – and of course helping to turn houses into investment assets instead of places to live.

Solutions?

So the solution to our crisis of housing affordability is not to blame speculators or foreign buyers but to sort ourselves out. We need to allow more land to be released for development while protecting our environmentally and amenity-rich areas more rigorously than we do at present.

Building on greenbelt land would only have to be very modest to provide more than enough land for housing for generations to come: there is enough greenbelt land just within the confines of Greater London – 32,500 hectares – to build 1.6 million houses at average densities. Building there would also reduce pressure to build on playing fields and amenity-rich brownfield sites such as the Hoo Peninsula and improve the quality of housing.

Basic message: release more land for building houses. Now I wonder if any other country could learn from this idea.

Hmmmmmmmm

Investor-owned firms as cooperatives

Having written a couple of posts recently on cooperatives, see here and here, I thought to compare cooperatives with investor-owned firms, the main form of firm in the economy. While investor-owned firms dominate the economy what is not often realised is that they can be seen as a form of producer cooperative. This argument is due to Henry Hansmann, "Ownership of the Firm", Journal of Law, Economics, & Organization, Vol. 4, No. 2. (Autumn, 1988), pp. 267-304.

Hansmann begins by noting that

In the discussion that follows it will be helpful to have a term to comprise all persons who transact with a firm, either as purchasers of the firm's products or as suppliers to the firm of some factor of production, including capital. Such persons—whether they are individuals or other firms—will be referred to here collectively as the firm's "patrons."

Most firms are owned by persons who are also patrons. This is conspicuously true of producer and consumer cooperatives.

He then notes that this is also true of the standard business firm, which is owned by persons who lend capital to the firm. In fact, Hansmann argues, the standard investor-owned firm is in a sense nothing more than a special type of producer cooperative—a lenders' cooperative, or capital cooperative.

To show this Hansmann starts by looking at the structure of a typical producer cooperative.

A representative example is a dairy farmers' cheese cooperative, in which a cheese factory is owned by the farmers who provide the raw milk for the cheese. The firm pays the members a predetermined price for their milk on the occasion of each sale. (In keeping with conventional usage, the term "member" will be used here to refer to the patron-owners of cooperatives.) This price is usually set low enough so that the cooperative is almost certain to make a profit from its operations. Then, at the end of the year, profits that have been earned from the manufacture and sale of the cheese are distributed pro rata among the members according to the amount of milk they have sold to the cooperative during the year. Voting rights are held only by those who sell milk to the firm, either on the basis of one-member-one-vote or with votes apportioned according to the volume of milk each member sells to the firm. Some or all of the members may have capital invested in the firm. In principle, however, this is unnecessary: the firm could borrow all of the capital it needs. In any case, even where members invest in the firm, those investments typically take the form of preferred stock that carries no voting rights and is limited to a stated maximum rate of dividends. Upon liquidation of the firm, the net asset value—which may derive from retained earnings or from increases in the value of rights held by the firm—is divided pro rata among the members, usually according to some measure of the relative value of their cumulative patronage.

In short, ownership rights are held exclusively by virtue of the fact, and to the extent, that one sells milk to the firm. On the other hand, not all farmers who sell milk to the firm need be owners; the firm may purchase some portion of its milk from nonmembers, who are simply paid a fixed price and do not participate in net earnings or control. (Consumer cooperatives are set up similarly, with net earnings and votes apportioned according to the amounts that a member purchases from the firm.)

Now what of the standard business firm?

A business corporation is also organized in this fashion, except that it is owned not by persons who supply the firm with some commodity, such as milk, but rather by some or all of the persons who lend capital to the firm. To see the analogy clearly, it helps to characterize the transactions in a business corporation in somewhat stylized terms: The members each lend the firm a given sum. For this they are paid a fixed interest rate, set low enough so that the firm has a reasonable likelihood of running at a profit. Then at regular intervals, or upon liquidation, the firm's net earnings (after all contractual expenses, including wages and the cost of materials as well as the fixed interest rate on the capital borrowed from the members, have been paid) are distributed pro rata among the lender-members according to the amount they have lent. The firm may also have lenders who are not members. These lenders, commonly banks or bondholders, simply receive a fixed market interest rate and have no share in profits or participation in control.

As it is, in a business corporation the interest rate that is paid to lender- members (that is, shareholders) is generally set at zero for the sake of convenience. Moreover, the loans from members are not arranged annually or for other fixed periods, but rather are perpetual; the principal can generally be withdrawn only upon dissolution of the firm. In the typical cooperative, by contrast, members generally remain free to vary their volume of transactions with the firm over time, and even to terminate their patronage altogether. This distinction is not, however, fundamental. Investor-owned firms can be, and sometimes are, structured so that the amount of capital invested by each member can be redeemed at specified intervals or even (as in a simple partnership) at will. Conversely, cooperatives can be, and often are, structured so that members have a long-term commitment to remain patrons. Electricity generation and transmission cooperatives, for example, commonly insist that their members (which are local electricity distribution cooperatives) enter into requirements contracts that run for thirty-five years.

Indeed, we can view business corporation statutes as simply specialized versions of the more general cooperative corporation statutes. In principle, there is no need to have separate business corporation statutes at all; business corporations could just as well be organized under a well-drafted general cooperative corporation statute. Presumably we have separate statutes for business corporations simply because it is convenient to have a form that is specialized for the most common form of cooperative—the lenders' cooperative—and to signal more clearly to interested parties just what type of cooperative they are dealing with. (All quotes, Hansmann 1988: 270-2. Footnotes deleted.)

So the standard business firm can be seen as a form of cooperative, a capital cooperative. Not that it is often thought of in this way.

Do large modern retailers pay premium wages?

An important question given the grow we have seen in larger retailers in New Zealand and around the world. The question is studied in this new NBER working paper Do Large Modern Retailers Pay Premium Wages? by Brianna Cardiff-Hicks, Francine Lafontaine, Kathryn Shaw. The abstract reads,

With malls, franchise strips and big-box retailers increasingly dotting the landscape, there is concern that middle-class jobs in manufacturing in the U.S. are being replaced by minimum wage jobs in retail. Retail jobs have spread, while manufacturing jobs have shrunk in number. In this paper, we characterize the wages that have accompanied the growth in retail. We show that wage rates in the retail sector rise markedly with firm size and with establishment size. These increases are halved when we control for worker fixed effects, suggesting that there is sorting of better workers into larger firms. Also, higher ability workers get promoted to the position of manager, which is associated with higher pay. We conclude that the growth in modern retail, characterized by larger chains of larger establishments with more levels of hierarchy, is raising wage rates relative to traditional mom-and-pop retail stores.

So the short answer seems to be yes, at least for the U.S., but to me the interesting thing is the sorting effect with better working employed at the bigger retailers. Is this a version of the Henry Ford $5 a day idea?

Henry Ford’s friend and general manager, James Couzens, came up with the innovative idea of paying the workers enough to keep them from leaving. $5 a day, said Couzens. Henry, himself a multimillionaire, countered that $3 a day was more than enough, then a few days later he grudgingly agreed to $4 before eventually caving in to Couzen’s insistence. Finally, in January 1914, Ford doubled the wages of his workers to an unheard-of $5 a day. Ford was swamped with job applications and absenteeism dropped from 10% to 0.5%.

Worker (and other) cooperatives

As I have posted before on when worker cooperative may be a viable governance structure, and when they won't be, I thought I would take a look at just how large a force they are in the economy. Data is a bit hard to get but I did come across this from the US Federation of Worker Cooperatives

Though we lack comprehensive data on the nature and scope of worker cooperatives in the U.S., researchers and practitioners conservatively estimate that there are over 350 democratic workplaces in the United States, employing over 5,000 people and generating over $500 million in annual revenues.

Given the size of the US economy, 5000 people is not many.

However if you look at all cooperatives things look a bit different. The International Co-operative Alliance states that there are

30,000 co-operatives [which] provide more than 2 million jobs

Of course cooperatives being big employers is nothing new for New Zealand given the size of Fonterra (17,300 employees as at 2012). But to put this into perspective Wal-Mart alone employs around 2.2 million people world-wide.

EconTalk this week

Chris Blattman of Columbia University talks to EconTalk host Russ Roberts about a radical approach to fighting poverty in desperately poor countries: giving cash to aid recipients and allowing them to spend it as they please. Blattman shares his research and cautious optimism about giving cash and discusses how infusions of cash affect growth, educational outcomes, and political behavior (including violence). The conversation concludes with a discussion of the limits of aid and the some of the moral issues facing aid activists and researchers.

A direct link to the audio is available here.