Condliffe Lecture 2015

Dr Terry L. Anderson

Condliffe Lecture 2015

Environmental Markets:
Lessons from and for Fisheries Management

The Department of Economics and Finance is pleased to invite you to the 2015 Condliffe Lecture.

Dr Terry Anderson will discuss Free Market Environmentalism and the approach of using property rights and markets to address environmental problems, focusing on lessons from and for fisheries management in New Zealand.

Day:	Tuesday 17 November 2015
Time:	6pm –7pm
Venue:	LAWS 108 Lecture Theatre (Google map link)
RSVP:	By 5pm, Wednesday 11 November to meredith.henderson@canterbury.ac.nz

Abstract

Increased demand for environmental amenities and competition for scarce natural resources require rethinking how we manage our natural environment. The dominant management institutions have focused on top-down command-and-control regulations. Though some of these regulations have been successful in picking low hanging environmental fruit – especially in reducing air and water emissions – they have not harnessed private initiative by using property rights and markets. This approach under the banner of “free market environmentalism” shows remarkable promise for dealing with a variety of environmental problems. Fisheries management in New Zealand illustrates the potential for this approach if the necessary market institutions can be buttressed and improved. In short, environmental markets offer a promising alternative for the next generation of environmentalism.

About the speaker

Terry L. Anderson is the William A. Dunn Distinguished Senior Fellow at PERC—the Property and Environment Research Center, in Bozeman, Montana, and the John and Jean DeNault Senior Fellow at the Hoover Institution, Stanford University. He is the author or editor of 38 books, including most recently, Free Market Environmentalism for the Next Generation (2015 with Donald Leal) andEnvironmental Markets: A Property Rights Approach (2014 with Gary Libecap). He has published widely in professional journals and the popular press, including frequent editorials in the Wall Street Journal.

Dr Anderson has been a visiting scholar at Oxford University, Basel University, Clemson University, and Cornell as well as a Fulbright Fellow at the University of Canterbury.

In March 2011, he received the Liberalni Institute’s (Prague, CZ) Annual Award for his ideas promoting freedom and prosperity. Previous recipients of this award include Nobel laureates Milton Friedman, Gary Becker, and Vernon Smith. In 2015, Anderson received the “Gary Walton Award for Excellence in Economic Education” from the Foundation for Teaching Economics.

Dr Anderson received his BS degree from the University of Montana in 1968 and his MA and PhD degrees in economics from the University of Washington in 1972, after which he began his 25-year teaching career at Montana State University. There he has won several teaching awards and is now Professor Emeritus.

Terry is an avid outdoorsman who enjoys fly fishing, hiking, skiing, horseback riding, and archery hunting.

Venue and Car Parking

The lecture venue is LAWS 108 lecture theatre on main campus (Google map link) and there is no charge for parking after 5:00pm. The available car parking areas are the Science car park, Law car park or Clyde car park.

For more information

Department of Economics and Finance

Phone: +64 3 364 2631

Email: meredith.henderson@canterbury.ac.nz

EconTalk this week

Cesar Hidalgo of MIT and the author of Why Information Grows talks with EconTalk host Russ Roberts about the growth of knowledge and know-how in the modern economy. Hidalgo emphasizes the importance of networks among innovators and creators and the role of trust in sustaining those networks.

A direct link to the audio is available here.

TEC Lectureship on Europe and the World 2015

Here are two lectures given by Joel Mokyr, the Robert H. Strotz Professor of Arts and Sciences and Professor of Economics and History at Northwestern University.

The first is "Culture of Gowth: Origins of the Modern Economy"


The second is "Long-Term Economic Change in China and Europe: The Needham Paradox Revisited"

EconTalk last week

Yuval Harari of Hebrew University and author of Sapiens talks with EconTalk host Russ Roberts about the history of humanity. Topics discussed include the move from hunting and gathering to agriculture, the role of fiction in sustaining imagination, the nature of money, the impact of empires and the synergies between empires and science.

A direct link to the audio is available here.

Catching cheating students

There is a new NBER working paper out on Catching Cheating Students by Steven D. Levitt and Ming-Jen Lin. The abstract reads,

We develop a simple algorithm for detecting exam cheating between students who copy off one another’s exam. When this algorithm is applied to exams in a general science course at a top university, we find strong evidence of cheating by at least 10 percent of the students. Students studying together cannot explain our findings. Matching incorrect answers prove to be a stronger indicator of cheating than matching correct answers. When seating locations are randomly assigned, and monitoring is increased, cheating virtually disappears.

Econ exams at Canterbury, at least, are well monitored with random seat allocation, and have been so for a number of years. I wonder what the amount of cheating is.

EconTalk for three weeks

When Lewis and Clark crossed through Montana, they encountered an extraordinary cornucopia of wildlife. Most of that ecosystem and the animals that once thrived there are gone. But a non-profit wants to bring it all back. Pete Geddes, Managing Director of the American Prairie Reserve talks with EconTalk host Russ Roberts about creating the Serengeti of the Americas--a 3.3 million acre prairie that would allow bison, pronghorn antelope, prairie dogs and their friends to inhabit a Wildlife Reserve in Montana, the size of Connecticut. Geddes discusses the goals of the American Prairie Reserve and how they're using a for-profit company, Wild Sky Beef, to gather support and help from local ranchers for the project.

A direct link to the audio is available here.

Tim O'Reilly of O'Reilly Media talks with EconTalk host Russ Roberts about his career in technology and media and the challenges facing low-wage workers as technology advances. Topics include the early days of the Internet, the efficacy of regulation to protect workers, and the poetry of Elizabeth Bishop.

A direct link to the audio is available here.

Pete Boettke of George Mason University talks with EconTalk host Russ Roberts about the political and economic lessons he has learned as program director of research in the aftermath of Hurricane Katrina. In this wide-ranging conversation, Boettke discusses the role of civil society, the barriers to recovery that have hampered New Orleans and what worked well as people and institutions responded to tragedy and devastation.

A direct link to the audio is available here.

2015 Nobel Prize in economics

The Royal Swedish Academy of Sciences has decided to award The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for 2015 to

Angus Deaton
Princeton University, NJ, USA

"for his analysis of consumption, poverty, and welfare".
Angus Deaton, UK and US citizen. Born 1945 in Edinburgh, UK. Ph.D. 1974 from University of Cambridge, UK. Professor of Economics and International Affairs, Princeton University, NJ, USA, since 1983.

The work for which Deaton is now being honoured revolves around three central questions:

How do consumers distribute their spending among different goods? Answering this question is not only necessary for explaining and forecasting actual consumption patterns, but also crucial in evaluating how policy reforms, like changes in consumption taxes, affect the welfare of different groups. In his early work around 1980, Deaton developed the Almost Ideal Demand System – a flexible, yet simple, way of estimating how the demand for each good depends on the prices of all goods and on individual incomes. His approach and its later modifications are now standard tools, both in academia and in practical policy evaluation.

How much of society's income is spent and how much is saved? To explain capital formation and the magnitudes of business cycles, it is necessary to understand the interplay between income and consumption over time. In a few papers around 1990, Deaton showed that the prevailing consumption theory could not explain the actual relationships if the starting point was aggregate income and consumption. Instead, one should sum up how individuals adapt their own consumption to their individual income, which fluctuates in a very different way to aggregate income. This research clearly demonstrated why the analysis of individual data is key to untangling the patterns we see in aggregate data, an approach that has since become widely adopted in modern macroeconomics.

How do we best measure and analyse welfare and poverty? In his more recent research, Deaton highlights how reliable measures of individual household consumption levels can be used to discern mechanisms behind economic development. His research has uncovered important pitfalls when comparing the extent of poverty across time and place. It has also exemplified how the clever use of household data may shed light on such issues as the relationships between income and calorie intake, and the extent of gender discrimination within the family. Deaton's focus on household surveys has helped transform development economics from a theoretical field based on aggregate data to an empirical field based on detailed individual data.

Press Release

Advanced Information

EconTalk this week

There is only one country in the world where a person can sell a kidney to another citizen who buys it. That country is Iran. Tina Rosenberg of The New York Times talks with EconTalk host Russ Roberts about the Iranian kidney market--how it works, its strengths and weaknesses, and whether its lessons apply to the United States or elsewhere.

There is a direct link to the audio available here.

Questions on trade

Tyler Cowen – for his upcoming conversation at the Mercatus Center with Dani Rodrik – asked on his blog for suggestions of questions that he might put to Professor Rodrik. Don Boudreaux suggested that Tyler ask Professor Rodrik the following question:

Rodrik was quoted in a 2007 New York Times report as saying that, while he follows the methods of modern economics, he rejects the “faith” [his word] – that says, among other things, that free trade is always good. And, of course, Rodrik is known for his ‘heterodox’ refusal to join in mainstream economists’ embrace of free trade.

So, ask Rodrik if economists who embrace free trade within a country are guilty of faith-based policy recommendations in the same way that he thinks economists who embrace free trade between countries are guilty of faith-based policy recommendations? If he answers no, ask him to summarize the relevant differences that separate intranational from international trade, and press him explain why these differences are real or strong enough to shift the burden of persuasion away from those who oppose a general policy of free trade and onto supporters of free trade.

Rodrik's answer to this question is given here. While Boudreaux's response to this answer is here.

A discussion well worth following.

EconTalk last week

Ever wonder what goes on behind the scenes at a Broadway show? This week's EconTalk lifts the curtain on the magical world of Broadway: Mitch Weiss, co-author of The Business of Broadway, talks with EconTalk host Russ Roberts about his book and what it's like to manage the production of a blockbuster musical in New York City. Topics discussed include the eight-performance-per-week grind, the how and why of creating a Broadway set, the challenges of wardrobes (domestic and international) and the pluses and minuses of unions which are a central part of the Broadway workplace.

A direct link to the audio is available here.

Conversation on free banking theory between Larry White and Juan Ramón Rallo

Lawrence H. White is economics professor at George Mason University and Juan Ramón Rallo is also economist and director of Instituto Juan de Mariana.

EconTalk for two weeks

How much care do you take when you make a donation to a charity? What careers make the biggest difference when it comes to helping others? William MacAskill of Oxford University and the author of Doing Good Better talks with EconTalk host Russ Roberts about the book and the idea of effective altruism. MacAskill urges donors to spend their money more effectively and argues that the impact on human well-being can be immense. MacAskill wants donors to rely on scientific assessments of effectiveness. Roberts pushes back on the reliability of such assessments. Other topics include sweatshops, choosing a career to have the biggest impact on others, and the interaction between private philanthropy and political action.

A direct link to the audio is available here.

Are human beings naturally cooperative or selfish? Can people thrive without government law? Paul Robinson of the University of Pennsylvania and author of Pirates, Prisoners and Lepers talks with EconTalk host Russ Roberts the ideas in his book. Robinson argues that without government sanctions or legislation, there is an evolutionary drive to cooperate even in life-and-death situations. In such situations private punishment and norms play a crucial role in sustaining cooperative solutions. The last part of the conversation deals with the criminal justice system and how attitudes toward the system affect society-wide cooperation and crime.

A direct link to the audio is available here.

School vouchers: a survey of the economics literature

For those interested in the area there is a new NBER working paper out on School Vouchers: A Survey of the Economics Literature by Dennis Epple, Richard E. Romano and Miguel Urquiola.

Abstract:

We review the theoretical, computational, and empirical research on school vouchers, with a focus on the latter. In this substantial body of work, many studies find insignificant effects of vouchers on educational outcomes; however, multiple positive findings support continued exploration. Specifically, the empirical research on small scale programs does not suggest that awarding students a voucher is a systematically reliable way to improve educational outcomes. Nevertheless, in some settings, or for some subgroups or outcomes, vouchers can have a substantial positive effect on those who use them. Studies of large scale voucher programs find student sorting as a result of their implementation, although of varying magnitude. Evidence on both small scale and large scale programs suggests that competition induced by vouchers leads public schools to improve. Moreover, research is making progress on understanding how vouchers may be designed to limit adverse effects from sorting while preserving positive effects related to competition. Finally, our sense is that work originating in a single case (e.g., a given country) or in a single research approach (e.g., experimental designs) will not provide a full understanding of voucher effects; fairly wide ranging empirical and theoretical work will be necessary to make progress.

EconTalk this week

Thousands of bears in New Jersey. Humpback whales near New York City. Acres devoted to farming stable or declining even as food production soars. Jesse Ausubel of the Rockefeller University talks with EconTalk host Russ Roberts about the return of nature. Ausubel shows how technology has reduced many of the dimensions of the human footprint even as population rises and why this trend is likely to continue into the future. The conversation concludes with Ausubel's cautious optimism about the impact of climate change.

A direct link to the audio is available here.

Chris Trotter misunderstands economics

Over at the Offsetting Behaviour blog Eric Crampton notes that Chris Trotter has been writing In praise of Bryce Wilkinson. And justly so.

But at one point Trotter writes,

Economics II was staffed by young economists who had studied at universities in the United States where the monetarist theories of Milton Friedman, and the ideas of neo-classical economics generally, were already well-entrenched.

"[T]he ideas of neo-classical economics generally, were already well-entrenched". Is this in anyway surprising? This comment seems to show a rather large misunderstanding of the development of economics.

I mean neo-classical economics developed in the 1870s with the work of Carl Menger, William Stanley Jevons and Léon Walras. So by the 1970s and 1980s it had been around for 100 years. It had been the standard in economics textbooks since, at least, Alfred Marshall's Principles of Economics in 1890s. So I am confused as to why Trotter thinks its worth noting that Treasury economists were trained in it. Every economics student, then as now, is trained in it. Its the standard, there is nothing unusual or noteworthy about it.

What would be worthy of note is if they were using non neo-classical ideas. And it is, because they were. Many of the ideas introduced by treasury economists of this time where ideas which moved thinking outside of the purely neo-classical box. They were thinking Coaseian thoughts by applying ideas from the law and economics literature and the new institutional economics to the New Zealand policy scene. They also utilised ideas from contract theory, in the main principal-agent theory, and the transaction cost economies of Oliver Williamson,

This kind of thinking is non neo-classical thinking. It moves away from the ideas of perfect markets, perfect information, zero transaction costs and institution free worlds. So one of the most important things we should be grateful to Wilkinson et al for is the introduction of non neo-classical thinking into New Zealand policy making. It is a great and lasting contribution, a contribution for which they can be justly praised.

Hal Varian interviews Alvin Roth

Hal Varian interviews Alvin Roth about Roth's new book "Who Gets What — and Why," at Google.

EconTalk this week

Rachel Laudan, visiting scholar at the University of Texas and author of Cuisine and Empire, talks with EconTalk host Russ Roberts about the history of food. Topics covered include the importance of grain, the spread of various styles of cooking, why French cooking has elite status, and the reach of McDonald's. The conversation concludes with a discussion of the appeal of local food and other recent food passions.

A direct link to the audio is available here.

EconTalk this week

Summer Brennan, author of The Oyster War, talks with EconTalk host Russ Roberts about her book and the fight between the Drakes Bay Oyster Company and the federal government over farming oysters in the Point Reyes National Seashore. Along the way they discuss the economics of oyster farming, the nature of wilderness, and the challenge of land use in national parks and seashores.

A direct link to the audio is available here.

The "anti-commons" in intellectual policy

A common argument made with respect to intellectual property is that many countries innovation system provide excessively strong or numerous intellectual property rights that drown innovation in a “thicket” or “anti-commons” of overlapping legal rights. The majority view holds that anti-commons effects are a common occurrence that raises significant policy concerns about excessive intellectual property rights. A counter view to this line of argument is that market players have incentives and capacities to correct for anti-commons type effects through contract and other mechanisms.

In a paper, The Anti-Commons Revisited, forthcoming in the Harvard Journal of Law and Technology, Jonathan Barnett aggregates and critically reviews the diverse body of evidence on this issue. He independently replicates some of the most controversial results, surveying over a century’s worth of pooling arrangements, and providing additional evidence on potential anti-commons effects in certain markets. Two surprising and unusually consistent conclusions emerge. First, there is little concrete evidence that intensive levels of intellectual property acquisition and enforcement restrain innovation or output. Second, unless constrained by antitrust limitations, markets consistently exhibit capacities to devise transactional solutions that preempt or mitigate intellectual thickets. These conclusions erode confidence in the majority view, which in turn casts doubt on normative recommendations in favour of weakening intellectual property rights to preclude anti-commons effects.

The abstract reads:

Intellectual property scholars and policymakers often assert that technology and creative markets suffer from “anti-commons” (“AC”) effects that restrain innovation within a web of conflicting intellectual property claims. A minority view asserts that market players have incentives and capacities to correct for AC effects through transactional solutions. To assess the relative merits of each side of this debate, I review a large and diverse body of empirical evidence relating to AC effects in contemporary and historical markets. I independently replicate the most controversial empirical findings, supplement additional research on selected markets, and provide a survey of all documented IP-pooling arrangements in U.S. markets since 1900. The weight of the evidence strongly favors the minority view. Evidence for AC effects is scarce while evidence that markets correct for AC effects is abundant. AC effects are typically preempted or mitigated through cooperative arrangements among small numbers of IP holders or transactional solutions devised by entrepreneurial intermediaries for large numbers of IP holders. This pattern recurs over a diverse array of markets and periods, including automobiles, petroleum refining, aircraft, and radio communications in the early to mid-20th century, and information and communications technology markets from the late 20th century through the present. Contrary to standard assumptions, there is little evidence that these markets experienced reduced or delayed innovation or output despite intensive levels of patent issuance and litigation.

EconTalk this week

Seafood is highly perishable and supply is often uncertain. Roger Berkowitz, CEO of Legal Sea Foods talks with EconTalk host Russ Roberts about the challenges of running 34 seafood restaurants up and down the east coast. Berkowitz draws on his 22 year tenure as CEO and discusses how his business works day-to-day and the question of sustainability.

A direct link to thee audio is available here.

You REALLY know your economy is in trouble when .......

you start to run out of beer!!

From Vice News comes the news that Venezuela Faces Looming Beer Shortage in Dispute with Nation’s Biggest Brewer.

Venezuela's largest food distributor on Thursday denounced the government occupation of a Caracas warehouse amid accusations that the company is hoarding goods.

Soldiers took over the warehouse complex used by Empresas Polar late Wednesday just as Venezuela's federation of brewers announced that Polar's beer manufacturing subsidiary is shutting two of its six plants because of a lack of imported barley — a crucial ingredient in beer.

and

Earlier this month, the head of Venezuela liquor store federation warned that the nation was about to run out of beer because brewers had reached "zero hour" amid widespread shortages in raw materials. Days later, he was detained for reasons that remain unclear.

An economy without beer is an economy in need of reform, big time!

The history and future of workplace automation

There is much written about the effects that automation and robots will have on human employment and normally we are told it's all bad. The Luddites are still with us.

In a new article in the Journal of Economic Perspectives David H. Autor considers the effects on automation on jobs and asks Why Are There Still So Many Jobs? The History and Future of Workplace Automation. The abstract reads:

In this essay, I begin by identifying the reasons that automation has not wiped out a majority of jobs over the decades and centuries. Automation does indeed substitute for labor—as it is typically intended to do. However, automation also complements labor, raises output in ways that leads to higher demand for labor, and interacts with adjustments in labor supply. Journalists and even expert commentators tend to overstate the extent of machine substitution for human labor and ignore the strong complementarities between automation and labor that increase productivity, raise earnings, and augment demand for labor. Changes in technology do alter the types of jobs available and what those jobs pay. In the last few decades, one noticeable change has been a "polarization" of the labor market, in which wage gains went disproportionately to those at the top and at the bottom of the income and skill distribution, not to those in the middle; however, I also argue, this polarization and is unlikely to continue very far into future. The final section of this paper reflects on how recent and future advances in artificial intelligence and robotics should shape our thinking about the likely trajectory of occupational change and employment growth. I argue that the interplay between machine and human comparative advantage allows computers to substitute for workers in performing routine, codifiable tasks while amplifying the comparative advantage of workers in supplying problem-solving skills, adaptability, and creativity.

So machines are both a substitute and a complement to labour, and when thinking about the effects of automation on employment we need to keep both these factors in mind. Machines have not, so far, replaced all workers, in fact employment is growing, and it's unlikely that they will replace all jobs in the future. The complementarities between labour and machines are stronger than many people seem to realise.

Are NZ First really as xenophobic and economically illiterate as this makes them sound?

An article at Voxy.co.nz tells us that English concedes NZ farms better off in NZ ownership - NZ First. The article states,

The government has finally admitted its folly over foreign ownership of New Zealand’s farms, says New Zealand First.

"When questioned in Parliament yesterday, Finance Minister Bill English first parroted the government line that Landcorp buying Crafar farms is not an obvious advantage to Landcorp or the New Zealand economy," says Spokesperson for Primary Industries Richard Prosser.

"However, Mr English then confirmed what farmers know but the government would not admit, until yesterday. He compared foreign corporate ownership of NZ farms to a fashion trend that came and went, but then revealed his own view that the ‘New Zealand owner-operator model - those who live it and love it - tend to be the only ones who can make money out of NZ farmland’.

First, a little knowledge of economics would suggest that the fact that the owner-operator model, normally a family-owned model, tend to be the ones to make money out of framing should not surprise anyone.

In New Zealand, and most other places, it is obvious that family-based firms still dominate in agriculture. Which is odd if you compare agriculture with, say, manufacturing, investor-owned firms predominate in manufacturing, So why not farming?

The short answer given by Allen and Lueck (1998) and Allen and Lueck (2002) is "nature". They argue that farms operate in unique circumstances defined by nature, in particular seasonality. This is the main feature that distinguishes farm organisation from industrial organisation. For farmers a season is a distinct period of the year during which a given activity is optimally undertaken.

This is key to understanding the why the incentives generated within agriculture favour family farms. The two basic issues are opportunities for hired workers to shirk due to random production shocks from nature and the limits on the gains from specialisation and the timing problems caused by seasonality. The trade-off between effect work incentives and gains from specialisation help determine the costs and benefits of different farm organisational types.

The family farm model provides the best work incentives since the owner is the sole recipient of the benefits, but this model misses some benefits due to specialisation. This follows from the fact that the farmer must engage in numerous different tasks during each stage of production, and in addition, numerous production stages throughout the year.

On the other hand, large factory-style corporate farms gain from a specialised labour force and lower cost of capital, but suffer from bad worker incentives since hired workers, not being one of the owners, have an increased incentive to shirk.

To some degree all firms are governed by the trade-off between gains from specialisation and work incentives. For the case of farming it is the unique, large impact of nature that biases it towards family operations.

An obvious, but key, feature of agriculture is that it involves a living, growing product. In the case of livestock, for example, you have breeding, husbandry, feeding and slaughter. Such a cycle is largely governed by nature. In principle there is no reason that a different farmer could not own each stage. But timing difficulties between stages result in high costs of engaging in market transactions. Such timing issues are particularly severe in farming because the inventories of the intermediate goods cannot be held given the living nature of the product.

There are a number of factors, such as the number of crop cycles, the length of the production stages and the number of tasks within a stage, which also influence wage labour incentives. When cycles are few, stages are short, random shocks are large and the tasks are few, there is little to gain from specialisation and labour is especially costly to monitor. Thus family farms.

If these issues can be overcome, that is, if farmers can mitigate seasonality and random shocks to output, farm organisation starts to look much like that in the rest of the economy. Under such conditions farm organisation will gravitate towards factory process and develop the large-scale corporate forms of other sectors of the economy. But thus far this hasn't happened.

Given the nature of farming, corporate ownership, be it local or foreign, isn't yet the most efficient form of ownership and thus it hasn't penetrated agriculture to the degree it has in other sectors of the economy.

So farms being in family ownership is simply a result of the economics of farming. It is the fact that the owner-operator model is the most efficient that is important here, not the nationality of the owner.

The economics of farming will give the result that most farms are in New Zealand hands, since family-owned business are most likely New Zealand owned business. There is no need for any xenophobic ownership restrictions to keep farms in New Zealand hands, the market will achieve this.

Also putting restrictions on ownership can prevent foreign investment in the situations where it is needed.

The Voxy article continues,

"Ownership of New Zealand property, be it residential or farmland, needs to be restricted to New Zealand citizens and permanent residents only, the end," says Mr Prosser.

Such restrictions are not need since as noted above when local ownership is efficient you get it, and there are times when you want foreign ownership. The point is that New Zealand gains the most when you get assets into the hands of those you value them most, who will use them most efficiently, and the restrictions on ownership can prevent this.

References:

• Allen, Douglas W. and Dean Lueck (1998). "The Nature of the Farm", Journal of Law and Economics, 41: 343-86.
• Allen, Douglas W. and Dean Lueck (2002). The Nature of the Farm: Contracts, Risk, and Organization in Agriculture, Cambridge Mass.: The MIT Press.

EconTalk this week

How important are basic skills for economic success and growth? Eric Hanushek of Stanford University's Hoover Institution talks with EconTalk host Russ Roberts about the importance of basic education in math and literacy and their relationship to economic growth. Hanushek argues that excellence in educating people in basic skills leads to economic growth, especially in poorer countries where years of education may be a poor proxy for learning. He argues that the U.N.'s Millennium Development Goals should emphasize outputs rather than inputs--performance on skill-based exams rather than years of education.

A direct link to the audio is available here.

Housing and productivity

Up until now I have never really gotten the reason for people getting so excited about the effects of housing on productivity. When the Productivity Commission looked into the problems with housing in New Zealand it didn't seem to me to be the obvious factor explaining New Zealand's low productivity growth.

Well it turnouts I may have to rethink this issue. The Economist magazine has an article which explains How cheaper housing can boost productivity. They write,

To understand how cheap housing could boost productivity, consider the British economy. Inner London is by far the most productive region of the country, thanks to its clusters of finance, technology and nerds. More than one third of new jobs created in Britain since the recession have been based in the capital. London could create more still, but its lack of housing hems it in. The average house there now costs £370,000 ($577,000), nearly double the national average. Soaring demand has met stagnant supply. In the past decade the number of homes in London has grown by just 8%. The effect of high house prices is to push people out of London (or stop them moving in), and thus put them in less productive jobs. Others waste time on marathon commutes. From 2005 to 2014 the number of people commuting into London rose by 32%. One paper published in 2010 found that absenteeism among German workers would be 15-20% lower if they did not commute. If it were somehow possible to scrap commuting altogether, the British economy would see a productivity boost worth £12 billion a year, according to the Centre for Economics and Business Research, a think-tank.

Now if the effects of cheaper housing on productivity in New Zealand are of this order of magnitude then this is another big reason for doing something about freeing up the supply-side of the housing market. This makes reforming the local government regulation of building new homes or modifying existing ones look all that much more important. This is especially true of Auckland where the returns to reform will be the greatest since it has the greatest "clusters of finance, technology and nerds" in the country.

EconTalk this week

Wences Casares, bitcoin evangelist and founder and CEO of Xapo, talks with EconTalk host Russ Roberts about how bitcoin works, the genius of bitcoin's creator, and how Xapo is structured to create security for bitcoin banking.

A direct link to the audio is available here.

Government takes over Serco-run Mt Eden prison

That is the headline on an article at stuff.co.nz. In the article Aimee Gulliver writes,

Corrections Minister Sam Lotu-Iiga announces that the government is taking over Serco-run Mt Eden prison as of Monday.

The government is taking over the management of Mt Eden prison as of Monday, following serious allegations of prisoner mistreatment at the Serco-run facility.

Serco staff will remain on site but a management team will be put in place to oversee the day to day running of the facility.

The decision comes after a series of serious allegations at the Mt Eden prison, where inmates are claimed to have been thrown off balconies in a practice known as "dropping", and physically assaulted.

A question I would ask is, Should we be surprised at this outcome? One reason for saying no comes from the literature on privatisation, in particular the paper 'The Proper Scope of Government: Theory and an Application to Prisons' by Oliver D. Hart, Andrei Shleifer and Robert W. Vishny, "Quarterly Journal of Economics", 112(4) November: 1127-61, 1997. The paper considers the question as to which goods or services the government should provide, with an emphasis on prison services.

The HSV model considers the choice between in-house production and contracting out. The provider, government or private, can invest in improving the quality of service or reducing cost. Given incomplete contracts, the private provider has a stronger incentive to engage in both quality improvement and cost reduction than a government employee has. However, the private contractor's incentive to engage in cost reduction is typically too strong because he ignores the adverse effect on noncontractible quality. Cost are always lower under private ownership but quality may be higher or lower under a private owner.

Hence the focus of the HSV model is on quality. Here quality has a broad interpretation. It can stand for how well prisons treat prisoners, how clean utilities keep the water, how well schools educate their pupils, how long it takes for a letter to reach a remote area or how innovative car makers are etc. The basic idea is that the provider of the service, whether it be the government or a private firm, can made an investment to increase the quality of the service or a investment to reduce the cost of the service. It is important to note that quality is reduced by any cost reductions. Neither of these two investments are ex ante contractible. But to implement either of the innovations requires the agreement of the owner of asset. The asset can be thought of as, say, a school or a hospital or a prison. If the owner of the asset is the government then the provider of the service, who will be a government employee, requires the approval of the government to invoke either investment since, in this case, the residual control rights reside with the government. As a result, the employee will receive just a fraction of the returns to either innovation, even if implemented.

If on the other hand the provider is a private sector contractor, then the contractor has the residual control rights and thus does not need the government's agreement for a cost reduction. However, if the contractor wishes to improve the quality of the service and receive a higher price for it, then they have to renegotiate with the government since the government is the purchaser of the service. Under the assumption that the contractor is successful in obtaining an increase in price they capture all such gains. Thus a private contractor will generally face stronger incentives, than a government employee, to improve quality and reduce costs but the incentive to reduce costs can be too strong since the contractor ignores the negative impact this has on quality.

HSV examined the conditions that determine the relative efficiency of in-house provision versus outside contracting of government services. Their theoretical arguments suggest that the case for in-house provision is generally stronger when noncontractible cost reductions have large deleterious effects on quality, when quality innovations are unimportant, and when corruption in government procurement is a severe problem. In contrast, the case for privatisation is stronger when quality reducing cost reductions 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.

They then apply this analysis to several government activities using the available evidence on the importance of various factors. They conclude that the case for in-house provision is very strong in such services as the conduct of foreign policy and maintenance of police and armed forces, but can also be made reasonably persuasively for prisons. In contrast, the case for privatisation is strong in such activities as garbage collection and weapons production, but can also be made reasonably persuasively for schools.

With regard to prisons HSV write (p. 1152-4)

Prisons seem to fit reasonably well into our framework. Although in some respects prison contracts are very detailed, they are still seriously incomplete. There are significant opportunities for cost reduction that do not violate the contracts, but that, at least in principle, can substantially reduce quality. Moreover, from the available evidence we have the impression that the world may not be far from the assumptions of Proposition 4. First, the welfare consequences of quality deterioration might be of the same magnitude as those of cost reduction (b(e) and c(e) are comparable). Second, the opportunities for quality innovation are limited (beta(i) is small). Under these conditions, Proposition 4 suggests that public ownership is superior.

Would ex post competition between prisons for inmates strengthen the case for privatization? One possibility is that convicts themselves choose the prison in which to serve their sentences, but this is probably a bad idea, since prisoner choice would encourage contractors to attract customers by allowing gangs, drugs, and perhaps even easy escapes. A more plausible alternative is to have judges choose a private prison to send a convict to, with the idea that judges would send more inmates to higher quality prisons and fewer to lower quality prisons. Private contractors would then have the appropriate incentives to invest in quality improvements, and to avoid excessive cost reductions, to bring in more business. At the moment, such schemes have not been tried, in part because there is a shortage of prison capacity in the United States, but it is possible that they could be tried in the future. One potential disadvantage of such judge choice is that some judges might actually choose lower quality prisons because they want the inmates to get a stiffer penalty, whereas other judges might choose prisons that are soft on inmates. Contractors would then cater to the preferences of the judges, which need not coincide with social welfare.

Finally, the choice of whether to privatize prisons depends on the importance of corruption and patronage. Patronage does not appear to be a huge problem in prison employment in the United States, since the union premium as of this writing is not large. Corruption appears to be a greater concern, at least judging from the available anecdotal evidence. To begin, private prison companies are very active politically. For instance, ESMOR evidently lobbies politicians and makes political contributions to receive contracts {The New York Times, July 23, 1995}. The wife of Tennessee governor Lamar Alexander invested early and profitably in the stock of Corrections Corporation of America, which subsequently got involved very deeply in the privatization of Tennessee prisons with the governor’s endorsement {The New Republic, March 4, 1996, p. 9}.

A related problem is that contract enforcement cannot be taken for granted. The INS report concludes that ESMOR’s changes in policies “hindered INS ability to effectively perform its oversight functions.” The report also notes that ESMOR told its guards not to share information with the INS officials working on the premises, and in one instance encouraged the INS to reassign an officer who complained about the performance of the Elizabeth, New Jersey, facility several months prior to the riot. The report indicates that ESMOR violated the contract in some instances, and also pursued policies preventing the INS from enforcing the contract. But it is also clear from the report that the INS did not do what it could to enforce this contract. The INS report vividly illustrates how a government bureaucracy with relatively weak incentives has trouble enforcing a contract with a private supplier determined to reduce its costs, even if this involves violations of the contract and not just the issues on which the contract is silent.

In sum, our model suggests that a plausible theoretical case can be made against prison privatization. This case is weakened if competition for inmates can be made effective, but strengthened by the relevance of political activism by private contractors. One instance in which the case against prison privatization is stronger is maximum security prisons, where the prevention of violence by prisoners against guards and other prisoners is a crucial goal {The New York Times Magazine 1995}. In many cases, the principal strategy for preventing such violence is the threat of the use of force by the guards.We have shown that it is difficult to delineate contractually the permissible circumstances for the use of such force. Moreover, hiring less educated guards and undertraining them—which private prisons have a strong incentive to do—can encourage the unwarranted use of force by the guards. As a result, our arguments suggest that maximum security prisons should not be privatized so long as limiting the use of force against prisoners is an important public objective. Consistent with this view, only 4 of the 88 private prisons in Thomas’s {1995} census of private adult correctional institutions in the United States are maximum security. In contrast, private half-way houses and youth correctional facilities, where violence problems are less serious, are common {Shichor 1995}.

So there is a case to be made for private prisons, but it may not be as strong as for other services currently provided by the government, and it is at its weakest for the case of maximum security prisons. Thus seeing Mt Eden prison back under government management may not be that surprising. Maximum security prisons are an area where government provision can be more effective.

Why it is necessary to regulate doping in sports?

This is a question asked by Jeff Cisyk and Pascal Courty in a new column at VoxEU.org.

That performance-enhancing drugs are used and that this use is a controversial issue has been clear since competitive sports first began. You could argue that drugs are just another way of improving performance, like better training methods or improved nutrition, so what's the problem? The Cisyk and Courty column argues that of the three major rationales for regulation – athletes’ health, fairness, and audience losses – the damage to audiences is the most convincing rationale for regulation. The evidence they discuss shows that doping causes measurable economic damage. Teams and leagues competing for audience attention may not internalise all externalities associated with doping, and they face a time-inconsistency problem when they discover it.

Doping has been a controversial issue since competitive sports first began. There is even evidence of drug use by ancient Greek and Roman athletes. The first modern regulation of doping was instated in 1928. Since then, bans on performance-enhancing drug have received constant attention in the media. While most people believe doping should be regulated, few agree on why, where to draw the line, and how to manage enforcement.

• The main rationale offered by the medical community and some sports experts and ethics scholars is that constraining doping is necessary to protect the health of athletes.

However, many sports themselves are inherently dangerous. Taken literally, the protection argument would call for pro-safety interventions that go beyond regulating such drugs. This would not be supported by most people.

• Others argue that sports competition requires a level playing field.

However, doping is just another technology to improve performance and there are rules to deal with what contestants can and cannot do to win.

• A final rationale is that doping harms the public.

Broadly interpreted, this means that doping imposes a negative externality. A sport generally involves many stakeholders (athletes, teams, league, broader sports organisations, sponsors, and the public) who have vested interests in organised competitions. Fans commit to a sport and make specific investments to support a team. When doing so, they care about the quality of future events and may suffer a negative externality if they value the sport less when athletes do not comply with doping rules.

With prevailing large stakes, athletes and teams benefit from doping if it increases the chance of winning. A league may also benefit if doping increases the entertainment value; that is, as long as the public does not find out. The economic rationale for regulating drug-use rests on the assumption that fans value a sport less when athletes use them.

But is such an assumption reasonable?

The research that Cisyk and Courty discuss is the first work that offers definitive evidence that the demand for a sports event is negatively affected by news about drug use. The evidence is based on ticket sales (rather than random respondents interviewed in surveys) and measures actual demand responses instead of consumer opinions. A basic rule of economics is, take notice of what people actually do rather than what they say they will do.

Cisyk and Courty  leverage the 2005 introduction by Major League baseball of a new set of random tests for drug use. Under this new policy, a positive test is immediately announced publicly and the player is removed from the team. This policy yields unique data for investigating the impact of drugs violations on attendance.

Obviously if the public really cares about drug use, you would expect a decrease in attendance following a suspension and what we see in the data is such a decrease. Interestingly, there is no decline in attendance for injury announcements.

So a reason to enforce doping regulation is to protect consumer interest. But who should regulate doping? Cisyk and Courty comment,

Teams lack motivation to align with the public interest. The same holds for leagues. The incentives to self-regulate and honour the interests of fans are limited. Again, this is because leagues compete for audience attention and they may not internalise all externalities associated with doping. Leagues also face a time-inconsistency problem when they discover that doping takes place. Our work demonstrates that doping reduces fan interest, and players, teams, and leagues may not fully internalise these losses.

But what affect are the Chinese actually having on house prices?

With all the xenophobic rubbish we are getting from Labour and bizarre calls for bans on foreign ownership of housing by the likes of the BNZ's Tony Alexander I find myself asking, But what is the actual effect of foreign buyers on the prices of homes?

I mean if I go to a house auction and bid $X for the house then all a foreign buyer has to do to get the house instead of me is bid $X+1. So the actual effect on the sale price of the house of having a foreign buyer in the market could be very small. But everyone seems to be assuming that the effect of foreign buyers is huge, But is it? What do we actually know about the effect of foreign buyers on house prices? What studies have looked at this?

I'm guessing the answer to the question is we know nothing and thus we get the sort of mindless, ill-informed scaremongering we see from Labour.

From what studies I have seen about housing problems, in particular Auckland's housing problems, its the lack of supply that is the issue not demand. The likes of Labour and Alexander seem to want to fix a supply-side problem by affecting the demand-side. Well, that just won't work. To lower house prices we simply need more homes. No amount of demand-side tinkering will  increase the supply of housing.

EconTalk this week

Lee Ohanian, Arnold Kling, and John Cochrane talk with EconTalk host Russ Roberts about the future of freedom, democracy, and prosperity. Recorded in front of a live audience at Stanford University's Hoover Institution as part of a conference on Magna Carta, the three guests give their perspective on the future of the American economy and the interaction between politics and economics. Each guest makes a brief presentation at the start followed by a moderated conversation.

A direct link to the audio is available here.

EconTalk

Michael O'Hare of the University of California, Berkeley talks with EconTalk host Russ Roberts about the management of art museums. O'Hare suggests a number of changes that would allow museums to be more effective and to justify their non-profit status--lower admission prices, selling part of their substantial unseen inventory to other museums, and broadening the activities of the museum to include educational exhibits on the creation of art and the commercial side of art. He encourages trustees of museums to see their job more as tough-minded advisors and less as financiers of museum budgets.

A direct link to the audio is available here.

We're in the middle of a healthcare revolution but it's about more than marvelous life-saving and life-enhancing apps on our smartphone. Eric Topol of the Scripps Translational Science Institute and author of The Patient Will See You Now argues that the digital revolution will give us more control of our health information and data. More powerful patients will transform the doctor-patient interaction. Topol talks with EconTalk host Russ Roberts about his new book giving us a glimpse of the changes coming to medicine from the digital revolution.

A direct link to the audio is available here.

Did an 800-year old piece of parchment really change the world? Nicholas Vincent of the University of East Anglia talks with EconTalk host Russ Roberts about the Magna Carta, the founding document of English law and liberty. The Magna Carta was repudiated just ten weeks after King John issued it. Yet, its impact is still with us today. In this conversation, Vincent explains what led to the Magna Carta and how its influence remains with us today in England and elsewhere.

A direct link to the audio is available here.

Bent Flyvbjerg of Oxford University speaks with EconTalk host Russ Roberts about the political economy of megaprojects--massive investments of a billion dollars or more in infrastructure or technology. Flyvbjerg argues that such projects consistently end up costing more with smaller benefits than projected and almost always end up with costs that exceed the benefits. Flyvbjerg explores the reasons for the poor predictions and poor performance of giant investment projects and what might be done to improve their effectiveness.

A direct link to the audio is available here.

Is climate change the ultimate Black Swan? Martin Weitzman of Harvard University and co-author of Climate Shock talks with EconTalk host Russ Roberts about the risks of climate change. Weitzman argues that climate change is a fat-tailed phenomenon--there is a non-trivial risk of a catastrophe. Though Weitzman concedes that our knowledge of the climate is quite incomplete, he suggests that it is prudent to take serious measures, including possibly geo-engineering, to reduce the accumulation of carbon dioxide in the atmosphere.

A direct link to the audio is available here.

Nathaniel Popper of the New York Times and the author of Digital Gold talks with EconTalk host Russ Roberts about Bitcoin. Can Bitcoin make it? What went wrong with Mt. Gox? Why did Ross Ulbricht, the creator of Silk Road, just get sentenced to life in prison? Why are venture capital firms pouring millions of dollars into companies promising easier ways to use Bitcoin? Popper discusses these questions along with the technical side of Bitcoin to help listeners understand why so many investors are excited about the potential of Bitcoin.

A direct link to the audio is available here.

What's it like to hang out with Brad Pitt, Christian Bale, Ryan Gosling, and Steve Carell for two months? Adam Davidson, who writes for the New York Times Sunday Magazine, was the technical advisor to the upcoming movie, The Big Short. Besides rubbing shoulders with celebrities, he noticed what he calls the Hollywood model where highly talented workers come together temporarily in project-based employment. Davidson discusses the costs and benefits of this approach and its potential emergence as a more common phenomenon throughout the economy.

A direct link to the audio is available here.

Morten Jerven of Simon Frasier University talks with EconTalk host Russ Roberts about his new book, Africa: Why Economists Get It Wrong. Jerven, who will be joining Noragric at the Norwegian University of Life Sciences this fall, argues that economists have misread the economic history of Africa, ignoring successful episodes of economic growth while trying to explain a perpetual malaise that does not exist. Jerven is critical of many of the attempts to explain growth using econometric techniques and suggests that a richer approach is necessary that is aware of the particular circumstances facing poor countries.

A direct link to the audio is available here.

Science writer and author Matt Ridley discusses climate change with EconTalk host Russ Roberts. Based on his reading of the scientific evidence, Ridley describes himself as a "lukewarmer." While Ridley agrees that humans have made the climate warmer, he argues that the impact is small or positive over some temperature ranges and regions. He rejects the catastrophic scenarios that some say are sufficiently likely to justify dramatic policy responses, and he reflects on the challenges of staking out an unpopular position on a contentious policy issue.

A direct link to the audio is available here.

Nobel Laureate Alvin Roth of Stanford University talks with EconTalk host Russ Roberts about his work on matching markets. Examples include marriage, matching kidney donors to kidney recipients, and students to schools in cities that allow choice in their public school systems. Roth also discusses repugnance--the unease some people have with allowing buying and selling of some goods and what it's like to watch a kidney transplant knowing your research has helped make the surgery possible.

A direct link to the audio is available here.

The eternal economist

Competition and productivity

The Competition and Markets Authority (CMA) in the U.K. has produced a report (pdf) which looks at the the theoretical and empirical evidence on the relationship between competition and productivity. The report states that,

The evidence reviewed here addresses two separate but related questions: first, does stronger competition between firms lead to higher levels of productivity; and second, does competition policy and enforcement lead to stronger competition and hence higher productivity?

There is a strong body of empirical evidence showing that competition can drive greater productivity. Within-country studies demonstrate a positive relationship between strength of competition and productivity growth across sectors. Similarly, cross-country studies suggest that countries with lower levels of product market regulation, enabling stronger competition, tend to have higher levels of productivity growth.

There is also an extensive literature examining the impact on productivity of changes in competition over time, including as a result of deregulation. These studies show generally strong positive effects on productivity in sectors where deregulation has occurred, including transport and utilities.

There are three main mechanisms via which competition drives productivity. First, within individual firms managers are forced to become more efficient when facing competition from other firms. Secondly, competition means that the more productive firms increase their market share at the expense of those firms that are less efficient. The low productivity firms may, in the end, be forced out of the market having been replaced by more productive firms. Thirdly, and perhaps most importantly, competition drives firms to innovate, coming up with new products and processes which can lead to step-changes in efficiency.

These ideas kinda seems obvious when you see them but they are often forgotten when people talk about the advantages of deregulation and increased competition in markets.

Interesting papers forthcoming in NZEP

New Zealand Economic Papers has some interesting papers due to appear in future issues.

From complete to incomplete (contracts): A survey of the mainstream approach to the theory of privatisation.

Abstract
Privatisation is a common, yet controversial, policy in many countries around the world, including New Zealand. In this essay, we survey the literature on the theory of privatisation to see what insights it provides to the privatisation debate. We divide the literature into two periods defined by their relationship to the theory of the firm. In the period up to 1990, the literature followed the theory of the firm in using a complete or comprehensive contracting modelling framework. By the end of the 1980s, the ownership neutrality theorems highlighted a major weakness with this approach. The contemporary (post-1990) literature took advantage of incomplete contracting models to explain the difference in the behaviour of state and privately owned firms.

The effects of home heating on asthma: evidence from New Zealand

Andrea Kutinova Menclova and Rachel Susan Webb

Abstract
New Zealand, along with the USA and Australia, has one of the highest asthma rates among developed countries and previous analyses attribute this partly to insufficient home heating in certain neighbourhoods. International public health and medical studies corroborate this link but strong evidence of causality is lacking. In this paper, we empirically investigate the effect of home heating on hospital asthma admissions using panel data techniques and controlling for endogeneity. The hypothesis that higher electricity prices (via less adequate heating) increase hospital asthma admissions is tested and receives strong empirical support across a number of model specifications and datasets used.

Does stadium construction create jobs and boost incomes? The realised economic impacts of sports facilities in New Zealand

Samuel A. Richardson

Abstract
Government involvement in facility construction is typically justified on the basis of ex-ante predictions of economic impact resulting from events hosted at the new or upgraded facility. This paper examines the impact of facility construction on construction sector employment and real GDP across 15 New Zealand cities between 1997 and 2009. Results from static and dynamic models indicate that certain types of facilities had short-term (during construction) positive impacts on construction sector employment growth, although only stadium projects generated positive post-construction employment impacts. There is also little in the way of empirical evidence to suggest that new or upgraded facilities had any significant impact on local area real GDP either during or post-construction.

Cool book and website

There is a cool new book and website available on the work of F. A. Hayek designed for the general reader.

The book is the The Essential Hayek by Donald J. Boudreaux.

The chapters in the book are:

1. How we make sense of an incredibly complex world
2. Knowledge and prices
3. Individual flourishing and spontaneous order
4. The rule of law, freedom, and prosperity
5. Legislation is distinct from law
6. False economic security and the road to serfdom
7. Economic booms and busts
8. The curse of inflation
9. The challenge of living successfully in modern society
10. Ideas have consequences

The website is The Essential Hayek where you can download a free pdf of the whole book, read the chapters of the book and watch short videos which explain the ideas in the book.

Eminent domain (updated)

A couple of days back I downloaded the Kindle version of Ilya Somin new book on the problems with eminent domain, "The Grasping Hand: 'Kelo v. City of New London' and the Limits of Eminent Domain". This has turned out to be very timely given that The Productivity Commission has come up with the most appalling policy idea I have seen in I don't know how long, that is, the idea that there is a potential role for compulsory property acquisition in assembling large-enough land parcels for achieving proper economies of scale in construction of housing as a way of dealing with problems to do with the supply of land for homes.

Fortunately not all of New Zealand is as crazy as the Commission. Eric Crampton makes the case against the Commission's idea in an excellent post over at The Sand Pit blog.

Eric writes

Hold-out problems are the usual justification for use of eminent domain. Suppose that you’re a property owner. You get wind that a big developer is planning something substantial for the neighbourhood – and that it would include your property. If you know that everybody else has sold their rights to the developer, well, you could charge a price that would have you get a pretty substantial chunk of the developer’s profits. Or, suppose you got wind of where the government was planning on putting in a roading project. If you bought up the properties ahead of the government, and if you knew the government didn’t have other options for the route, you could hold the government to ransom for that property. And so the threat of eminent domain expropriation guards against this kind of strategic behaviour that can threaten the viability of beneficial projects.

But is it the only way of solving hold-out problems? And are hold-out problems even the binding constraint here?

I have been a fan of option contracting as a way around hold-out problems. Suppose you’re the same property owner above. The developer comes to you and offers you a deal. The deal is this. He’ll pay you $10,000, right now, for the option to buy your house in a year’s time at a price that looks fair to you. Whether or not he buys the house in a year, you get to keep the $10,000. He says he’s putting together land for a development but he isn’t quite sure where he wants to put it yet – it could be here, it could be someplace else. You can’t tell whether you’d be the hold-out as you neither know whether your neighbours have signed up, nor whether your property would wind up being used anyway. If the developer is clever, he’ll have identified a couple of sites that could work reasonably well for the project and would be buying options over both sites. You can’t do better than taking the $10,000 in hand, if you think the price is fair. If you don’t, the sale would be inefficient anyway.

Hold-out is pretty cheap in an environment with ever-escalating land costs due to stupid zoning rules. You lose nothing by just sitting on the land and waiting for the capital gains. Some developers have told me that, in hindsight, they should never have bothered trying to put housing up in some parts of Auckland – the costs of dealing with Council meant that they’d have earned a much better return by just landbanking rather than developing. But that changes where the other policy recommendations from ProdComm come into play. When far more land can be put to its most productive use, you can’t expect that your little plot will forever appreciate. Another offer to develop might not come because the development will have gone elsewhere.

Is land assembly through option contracting feasible? It worked where I grew up. Manitoba Hydro wanted to put in wind turbines. Before they did the wind mapping, they bought options from all the farmers where they might have wanted to place the turbines. Where they had options over a long enough ribbon of land where the wind turned out to be right, they exercised those options and put up the turbines. Nobody could hold-out because nobody knew where Hydro would want to put the turbines and because there were multiple potential options. Some people didn’t sell Hydro the option because they didn’t think that the price that Hydro was offering for access to the turbine site was worth the hassle it would cause in the field – and fair enough. But in an eminent domain version, every one of them would have been considered a hold-out and forced to sell.

Think about how this eminent domain proposal would pan out in New Zealand practice. ProdComm talks of using it in a Urban Development Agency (UDA) for Master-Planned developments. In practice, that would mean the UDA in partnership with a big developer strong-arming homeowners to sell out, on threat of forced sale, in order to put up a new subdivision or higher-density development.

Think too of all the land assembled under threat of compulsory purchase in Christchurch. How much of that is now in more productive use? Was small owner hold-out the main problem there? Really?

As alternative, the UDA could instead maintain a register of the owners of the fragmented property holdings and pass along option contract offers to the owners, lowering the transactions costs of assembling the land. They could also pass along declined offers to Council, that Council might update its land valuation figures. If you’ve turned down a million dollar offer on a site that’s rated at $500,000, well, the rating is probably too low.

A question I wonder about with eminent domain is, How do you know that a person who is not willing to sell is in fact holding-out? After all a refusal to sell could just mean they value their property more than the price they are being offered. There may be nothing strategic in what they are doing at all. Especially when it comes to homes or businesses. They may just want to live or work where they are. Consider that they could have sold their property for the market price at anytime but they haven't. I would assume this is because they don't think the market price is high enough to compensate them for the loss of the property. So how is forcing them out efficient?

Note: I have changed a number of "hold-ups" to "hold-outs" in the quote from Eric's post just because I'm a pedant!

Update: At the Not PC blog the point is made that the Productivity Commission pisses on property owners while Michael Reddell comments on The Productivity Commission on land supply.

The Austrian tradition in economics

From the Free Thoughts series at Libertarianism.org comes this interview with Professor Peter J. Boettke of George Mason University in which he talks about "The Austrian Tradition in Economics".

Boettke traces the school’s history from Carl Menger through Eugen Böhm-Bawerk and Joseph Schumpeter, Ludwig von Mises, Friedrich Hayek, and Murray Rothbard to contemporary economists such as Israel Kirzner, Vernon Smith, and Mario Rizzo. He explains what Austrian economics does and does not do, and distinguishes between what he calls “mainline” economics and “mainstream” economics.

What distinguishes Austrian economics from other schools of thought in economics? How did the Austrian school come to be known as the free market school?

Risk aversion and the firm

A bit over a week ago in the comments to a post James asked,

Can I make a request for a topic? Since you're the resident expert on the theory of the firm, can you write something about any work that's been done on risk averse firms? (I.e. in contrast to the standard assumption about risk neutral firms). Does the risk neutrality assumption have any major implications for standard economic theory?

I've been away but now I'm back at home I can attempt a rough answer. Better late than never, I hope.

Back in 1974 when discussing the topic of 'risk, uncertainty, and the firm' Michael Crew wrote,

Like growth theory of the firm, the theory of the firm under uncertainty is not highly developed. Much of it is speculative.

And not much has changed since then, the theory still isn't that well developed. Knightian uncertainty rather than risk has become more important to the modern theories of the firm.

While little has been written on the topic of risk and uncertainty to do with the firm, the amount is not zero. Back in 1970, for example, Lintner wrote a paper in which pricing decisions of the firm are made on a fully rational profit maximising basis subject to risk aversion with respect to the uncertain profits involved. Assume the uncertainty is due to uncertainty to do with demand. It is uncertainty about the quantity that will be sold. Under the assumptions Lintner makes he can show, not surprisingly, that for a given price change the higher the degree of risk aversion the greater is the increase in expected profits profits requires by a firm (decision maker) in order to induce it to accept greater profits uncertainty. Also the effects of risk aversion on price and output are such that prices are lower when (1) the greater the uncertainty and (2) the greater the risk aversion the closer the price gets to marginal cost and thus the further a firms gets from the monopoly outcome. In addition Lintner can show that the greater the uncertainty about sales and volumes and the greater the risk aversion of the decision maker the greater will be the expected quantity sold.

Different forms of uncertainty can deliver different results. If uncertainty is about realised prices, rather than quantities, then Day, Aigner and Smith show that price is set higher than the monopoly outcome, the greater the degree of risk aversion.

Marcus Asplund has a 2002 paper on 'risk-averse firms in oligopoly'. Does risk aversion lead to softer or fiercer competition? This paper provides a framework that accommodates a wide range of alternative assumptions regarding the nature of competition and types of uncertainty. It shows how risk aversion influences firms' best-response strategies. Only in the case of marginal cost uncertainty does higher risk aversion make competition unambiguously softer. The risk-averse best response strategies depend on the level of fixed costs. This fact is used to analyse strategic investments in capacity and the importance of accumulated profits. The paper concludes with a discussion of ways of empirically testing for risk-averse behaviour in oligopoly.

In more modern approaches to the firm the work of Frank Knight on risk and the firm has been developed. The standard view of Knight’s rationale for the existence of the firm doesn't depend on profit, but on risk, or more accurately, risk distribution. The entrepreneur forms a firm as a way of specialising in risk-taking. Employees receive a stipulated income and the entrepreneur takes the residual income of the firm and thereby bears most of the risk associated with uncertainty about the future. The advantage of the firm, according to the standard view, is that there are gains to be made from this distribution of risk between the entrepreneur and the firm’s employees. The profit and loss consequences of fluctuations in the business outcomes can be better absorbed by the entrepreneur than the employees. The entrepreneur contracts to pay a fixed wage to workers, thereby protecting them from the fluctuations in business outcomes. Knight sees this as efficient since the entrepreneur is less averse to bearing risk. Presumably, risk is not handled as well without firms.

Other views of Knight have been put forward in papers by Barzel and McManus. Each puts forward a moral hazard explanation for the Knightian firm. The firm arises here because, for certain kinds of risks, the functions of risk taking and management are inseparable due to the prohibitively high costs of enforcing constraints that would induce one individual, the manager, to maximise the wealth of another, the risk-taker. As noted in the distribution of risk story above, firms are one way of specialising in risk-taking. Knight was aware of contractual and insurance arrangements as alternatives to the firm as ways of specialising in risk-taking but thought, because of the moral hazard problems, they were particularly costly to enforce in the case of risks of enterprise and hence the need for the creation of a firm. Presumably monitoring the manager is easier for the risk-taker in a firm that it is on the market.

In 1991 Holmström and Milgrom made two observations to do with the firm and its (risk-averse) employees. First, they note that there are a number of ways that an employee can spend their time, many of which can be of value to an employer. But if these multiple activities compete for the worker’s attention then the incentives offered for each of the activities must be comparable. Otherwise, the employee will put most effort into those things that are most well compensated and put less effort into the others activities. The second observation relates to the provision of strong incentives to a risk-averse employee. Providing strong financial incentives is costly because it loads extra risk into the worker’s pay. In addition, the cost is greater the more difficult it is to measure performance. This means that, other things being equal, tasks where performance is hard to measure should not be given as intense incentives as ones that are more accurately observed. But having low-powered incentives means that the employer needs to be able to exercise authority over the use of the employee’s time, since the employee will not have the proper incentives to be productive.

The above are all partial equilibrium models but a general equilibrium approach is taken in a 1979 paper by Kihlstrom and Laffont. They construct a theory of competitive equilibrium under uncertainty using an entrepreneurial model with historical roots, again, in the work of Knight in the 1920s. Individuals possess labour which they can supply as workers to a competitive labour market or use as entrepreneurs in running a firm. All entrepreneurs have access to the same risky technology and receive all profits from their firms. In the equilibrium, more risk averse individuals become workers while the less risk averse become entrepreneurs. Less risk averse entrepreneurs run larger firms and economy-wide increases in risk aversion reduce the equilibrium wage. A dynamic process of firm entry and exit is stable. The equilibrium is efficient only if all entrepreneurs are risk neutral. Inefficiencies in the number of firms and in the allocation of labour to firms are traced to inefficiencies in the risk allocation caused by institutional constraints on risk trading. In a second best sense which accounts for these constraints, the equilibrium is efficient.

Well this will make things better .......... not!

Just when you thought things in Venezuela couldn't possibly get any worse, they do. This from Yahoo! News:

Caracas (AFP) - Venezuelan President Nicolas Maduro has promised to nationalize food distribution in the South American nation beset with record shortages of basic goods, runaway inflation and an escalating economic crisis.

During a rally Friday, on International Workers' Day, the socialist leader allowed a union activist to ask for the nationalization of food and essential-item distribution.

Citing new decree-making powers recently granted by the National Assembly, Maduro said he would carry out such a measure "in the coming days and weeks."

Maduro had pledged earlier in the week to announce economic reforms.

Various estimates suggest the government already controls about half of the country's food distribution, but that hasn't stopped record shortages in shops and markets.

Has no one in the Venezuelan government not looked around the world or looked at history and asked, Under what system does food distribution work best. Under a market system being the answer. Just think about the stories of shopping in the old Soviet Union to get the point.

On any given day, people in Venezuela can wait hours to get some subsidized milk, cooking oil, milk or flour -- if they can be found at all.

And does Madura really think nationalising the rest of the food distribution system will help. Market reforms are needed to get the economy going again. What is needed is the use of the price system to allocate resources giving consumers and producers the right incentives and information about scarcities. This would counter the black market and smuggling of goods out of the country.

Does vertical integration decrease prices?

The double marginalization problem is a classic problem with applications in industrial organization, innovation policy and development. The problem is what happens to social welfare, prices, and profits when one monopoly sells to another monopoly. Below is a video discussion of the double marginalization problem by Alex Tabarrok of George Mason University from MRUniveristy,


The double marginalization problem makes the (monopoly) producers worse off as well as making consumers worse off.

Now as noted in the video combining the seller monopoly with the buyer monopoly into one will, in theory, make both the producers and consumers better off. But does it do so in practise? At least as far as consumers are concerned.

This is where a new paper Does Vertical Integration Decrease Prices? Evidence from the Paramount Antitrust Case of 1948 by Ricard Gil in the American Economic Journal: Economic Policy, 2015, 7(2): 162–191, helps us. Gil finds, utilising data from the Paramount antitrust case of 1948, that vertical integration, i.e. combining the two monopolies, does in fact decrease prices, and thus increases consumer welfare, in a manner consistent with the elimination of the double marginalization problem.

The paper's abstract reads:

I empirically examine the impact of the 1948 Paramount antitrust case on ticket prices using a unique dataset collected from Variety magazine issues between 1945 and 1955. With information on prices, revenues, and theater ownership for an unbalanced panel of 393 theaters in 26 cities, I find that vertically integrated theaters charged lower prices and sold more admission tickets than nonintegrated theaters. I also find that the rate at which prices increased in theaters was slower while integrated than after vertical divestiture. These findings together with institutional details are consistent with the prediction that vertical integration lowers prices through the elimination of double marginalization.

Britain's housing crisis

This short video comes from The Economist magazine:


Rocketing prices and limited construction are putting home ownership out of reach for many young Britons. As the election nears, few politicians have a realistic solution.

Obviously the particulars in the video pertain to the situation in the U.K. but the general problems are more universal. Just think of the housing problems in Auckland.