What is so terrible about this Mossack Fonseca thing?

I can't help thinking not much. One has to keep in mind there is a difference between tax avoidance and tax evasion. Eamonn Butler at the Adam Smith Institute blog makes the point,

The two are different, of course. Theft, fraud, tax evasion and money-laundering are rightly illegal: any firm or country that helps mafia bosses or dictators conceal stolen millions should be exposed and punished. But if you work within the rules and find ways to cut your tax bill, or invest your money in some place where it won’t be taxed within an inch of its life, that is legal and should remain so. Indeed, low-tax jurisdictions act as a safety valve that makes it harder for politicians to oppress their citizens with crippling taxes.

But it is too easy for those politicians to lump together the illegal evasion with the legal avoidance and say that both should be swept away.

And not just politicians, many commentators and journalists who are losing their collective minds over this whole issue make the same mistake.

Butler continues,

That is why politicians hate them. They know that if other places have lower taxes, people will move their money (or their businesses, or even themselves) abroad – so their citizens can no longer be taxed with impunity. It’s pure tax protectionism: governments don’t produce widgets, so they are all in favour of free trade in widgets; but they do produce taxes, so they want to keep out the competition.

So its competition for thee but not for me! Not that anti-competitive behaviour by governments in that unusual.

And if governments are so worried about tax havens then their is an obvious solution, lower their taxes.

Low taxes encourage enterprise, investment, growth and freedom. So low-tax jurisdictions don’t need to flout the rules, and it is insulting to suggest that they do: in fact, many have financial sectors that are better regulated than ours. Rather than try to bully them out of existence, the big countries should ditch their tax protectionism, square up to the competition, lower and simplify their own taxes.

What's the bit they won't?

Things Adam Smith got wrong

In short, not many and the things he got right far outweigh the things he got wrong, but as  James R. Otteson argues in his book "Adam Smith" there were some wrong steps.

In his book Otteson has a chapter on "What Smith Got Wrong". He suggests four things:

1. Labor Theory of Value,
2. Happiness and Tranquility,
3. Committing the Great Mind Fallacy? and
4. Smithian Limited Government and Human Prosperity.

I'm going to argue here for a fifth thing, Smith missed the opportunity to formulate a theory of the firm. He had building blocks on which to base such a theory, he just didn't develop them.

In particular I would argue he could have his expanded his discussions of specialisation and the division of labour and of joint-shock companies to formulate some version of a theory of the firm.

Smith who opens his magnum opus, An Inquiry into the Nature and Causes of The Wealth of Nations, with a discussion of the division of labour at the microeconomic level, the famous pin factory example, but 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 “micro-microeconomics”. [ ...] 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”.

Another missed opportunity is when, from the third edition on, Smith discusses ‘joint-shock companies’. When considering the internal organisation of such firms Smith raises, but does not develop a theory of, what we would call today, the principal-agent problems that arise from the separation of ownership from control. Perhaps his most famous remark is,

“[t]he directors of such companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master’s honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company” (Smith 1776: Book V, Chapter 1, Part III, p. 741).

But “[ ...] Smith neither used the modern terms, “agency” or “corporate governance,” nor developed a general theory−a fact that is often overlooked” (Fleckner 2016: 22).

Perhaps the most obvious reason for this is that Smith wasn't interested in the firm as such. He was, as the title of this book would suggest, interested in economic growth and its nature and causes. This didn't require a theory of the firm in terms of a theory explaining the existence, boundaries and internal organisation of the firm. There may also be an empirical reason for the firm being overlooked; the relative unimportance of the firm. Until relatively recently firms were simply not a large part of the economy. But it has been pointed out that such an explanation is not wholly convincing. Large firms have existed since before the time of Adam Smith and the classical economists knew this. A more precise, and more defensible, version of the argument would be that the large, vertically integrated and diversified firm was not empirically important until recently.

For whatever reason this line of thinking was followed by the classical economists resulting in a situation which Blaug (1958: 226) could summarise simply by noting that the classical economists “[ ...] had no theory of the firm”.

Refs.:

• Blaug, Mark (1958). ‘The Classical Economists and the Factory Acts-A Re-Examination’, The Quarterly Journal of Economics, 72(2) May: 211-26.
• Fleckner, Andreas Martin (2016). ‘Adam Smith on the Joint Stock Company’, Max Planck Institute for Tax Law and Public Finance Working Paper 2016-01 January.
• 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.
• Otteson, J. R. (2011). Adam Smith (Major Conservative and Libertarian Thinkers Volume 16, Series Editor: John Meadowcroft), New York: Continuum.
• Smith, Adam (1776). An Inquiry into the Nature and Causes of the Wealth of Nations, Volumes I and II, R. H. Campbell and A. S. Skinner (general eds.), W. B. Todd (textual ed.), Indianapolis: Liberty Classics, 1981.

Is general equilibrium dead?

As early as 1955 Milton Friedman was suggesting that to deal with "substantive hypotheses about economic phenomena" a move away from Walrasian towards Marshallian analysis was required. When reviewing Walras's contribution to general equilibrium, as developed in his Elements of Pure Economics, Friedman argued,

"[e]conomics not only requires a framework for organizing our ideas [which provides], it requires also ideas to be organized. We need the right kind of language; we also need something to say. Substantive hypotheses about economic phenomena of the kind that were the goal of Cournot are an essential ingredient of a fruitful and meaningful economic theory. Walras has little to contribute in this direction; for this we must turn to other economists, notably, of course, to Alfred Marshall" (Friedman 1955: 908).

By the mid-1970s microeconomic theorists had largely turned away from Walras and back to Marshall, at least insofar as they returned to using partial equilibrium analysis to investigate economic phenomena such as strategic interaction, asymmetric information and economic institutions.

If one takes the theory of the firm as an example (see here for an overview of this literature), all the models considered in the contemporary literature are partial equilibrium models. but in this regard the theory of the firm is no different from most of the microeconomic theory developed since the 1970s. Microeconomics such as incentive theory, incomplete contract theory, game theory, industrial organisation, organisational economics etc, has largely turned its back on general equilibrium theory and has worked almost exclusively within a partial equilibrium framework.

One major path of influence from the mainstream of modern economics to the development of the theory of the firm has been via contract theory. But contract theory is an example of the mainstream’s increasing reliance on partial equilibrium modelling. Contract theory grew out of the failures of general equilibrium. As Salanie (2005: 2) has argued,

“[t]he theory of contracts has evolved from the failures of general equilibrium theory. In the 1970s several economists settled on a new way to study economic relationships. The idea was to turn away temporarily from general equilibrium models, whose description of the economy is consistent but not realistic enough, and to focus on necessarily partial models that take into account the full complexity of strategic interactions between privately informed agents in well-defined institutional settings”.

When surveying theory of the firm literature Foss, Lando and Thomsen (2000) use a classification scheme which clearly illustrates the movement of the current theory of the firm literature away from general equilibrium towards partial equilibrium analysis. The scheme divides the contemporary theory into two groups based on which of the standard assumptions of general equilibrium theory is violated when modelling issues to do with the firm. The theories are divided into either a principal-agent group, based on violating the ‘symmetric information’ assumption, or an incomplete contracts group, based on the violation of the ‘complete contracts’ assumption.

Another recent challenge to standard general equilibrium as come from the introduction of the entrepreneur in the theory of the firm since, as William Baumol noted more than 40 years ago, the entrepreneur has no place in formal neoclassical theory.

“Contrast all this with the entrepreneur’s place in the formal theory. Look for him in the index of some of the most noted of recent writings on value theory, in neoclassical or activity analysis models of the firm. The references are scanty and more often they are totally absent. The theoretical firm is entrepreneurless−the Prince of Denmark has been expunged from the discussion of Hamlet” (Baumol 1968: 66).

The reasons for this are not hard to find. Within the formal model the ‘firm’ is a production function or production possibilities set, it is simply a means of creating outputs from inputs. Given input prices, technology and demand, the firm maximises profits subject to its production plan being technologically feasible. The firm is modelled as a single agent who faces a set of relatively uncomplicated decisions, e.g. what level of output to produce, how much of each input to utilise etc. Such ‘decisions’ are not decisions at all, they are simple mathematical calculations, implicit in the given conditions. The ‘firm’ can be seen as a set of cost curves and the ‘theory of the firm’ as little more than a calculus problem. In such a world there is a role for a ‘decision maker’ (manager) but no role for an entrepreneur.

The necessity of having to violate basic assumptions of general equilibrium theory so that we can model the firm, suggests that as it stands GE can not deal easily with firms, or other important economic institutions. Bernard Salanie has noted that,

“[ ...] the organization of the many institutions that govern economic relationships is entirely absent from these [GE] models. This is particularly striking in the case of firms, which are modeled as a production set. This makes the very existence of firms difficult to justify in the context of general equilibrium models, since all interactions are expected to take place through the price system in these
models” (Salanie 2005: 1).

This would suggest that to make general equilibrium models a ubiquitous tool of microeconomic analysis - including the analysis of issues to do with non-market organisations such as the firm - developing models which can account for information asymmetries, contractual incompleteness, strategic interaction, the existence of institutions and the like is not so much desirable as essential. One catalyst for the development of such a new approach to general equilibrium is that partial equilibrium models can obscure the importance of the theory of the firm for overall resource allocation, a point which is more easily appreciated in a general equilibrium framework.

General equilibrium is dead. Long live general equilibrium? We will see.

Refs.:

• Baumol, William J. (1968). `Entrepreneurship in Economic Theory', American Economic Review, 58(2) May: 64-71.
• Foss, Nicolai J., Henrik Lando and Steen Thomsen (2000). ‘The Theory of the Firm’. In Boudewijn Bouckaert and Gerrit De Geest (eds.), Encyclopedia of Law and Economics (vol. III, pp. 631-58), Cheltenham U.K.: Edward Elgar Publishing Ltd.
• Friedman, Milton (1955). ‘Leon Walras and His Economic System’, American Economic Review, 45(5) December: 900-09.
• Salanie, Bernard (2005). The Economics of Contracts: A Primer, 2nd edn., Cambridge, Mass.: The MIT Press.

Do minimum wages stimulate productivity and growth?

This question is asked in a new paper (pdf) under that title by Joseph J. Sabia (San Diego State University, USA, and IZA, Germany).

The basic finding from the paper is that minimum wage increases fail to stimulate growth and can have a negative impact on vulnerable workers during recessions.

The Pros and Cons of minimum wages are outlined as,

The author's main message is

Empirical evidence provides little support for claims that higher minimum wages will: (i) serve as an engine of economic growth by redistributing income to workers with a relatively high marginal propensity to consume; or (ii) alleviate poverty during economic downturns. Therefore, policymakers wishing to aid low-skilled workers during recessions, or to spur economic growth, should not look to the minimum wage as a policy solution. Rather, means-tested, pro-work cash assistance programs and negative income tax schemes can deliver income to the working poor far more efficiently.

Per Bylund on "The Problem of Production".

In this audio Per Bylund (Assistant Professor of Entrepreneurship and Records-Johnston Professor of Free Enterprise in the School of Entrepreneurship at Oklahoma State University) discusses his recent book, The Problem of Production: A New Theory of the Firm (Routledge, 2016).

Bylund's theory is rooted in Austrian economics and examines the firm as a part of the market, not as a free-standing entity. In this integrated view, a theory is offered which incorporates entrepreneurship, production, market process and economic development.

The digital revolution, the firm, and economic statistics

As has been noted previously the digital revolution has given rise to a number of problems to do with the measurement of economic statistics. One particular issue has to do with the effects of the digital revolution on firms and the measurement issues this gives rise to. One reason it is problematic to measure the "knowledge economy" at the national level is because it is difficult to measure knowledge at the level of the individual firm. Part of the reason for this is that none of the orthodox theories of the firm offer us a theory of the “knowledge firm” to guide our measurement. I wrote a section on the "The (non)theory of the knowledge firm" in Oxley, Walker, Thorns and Wang (2008).

As has been emphasised by Carter (1996) it is problematic to measure knowledge at the national level in part because it is difficult to measure knowledge at the level of the individual firm. Part of the reason for this is that none of the orthodox theories of the firm offer us a theory of the “knowledge firm” to guide our measurement.

The model of the “firm” found in most microeconomic textbooks does not incorporate knowledge - individual or institutional - or the knowledge worker; it can’t since it isn’t a “theory of the firm” in any meaningful sense. The output side of the standard neoclassical model is a theory of supply rather than a true theory of the firm. In neoclassical theory, the firm is a ‘black box’ there to explain how changes in inputs lead to changes in outputs. The firm is a conceptualisation that represents, formally, the actions of the owners of inputs who place their inputs in the highest value uses, and makes sure that production is separated from consumption. The firm in neoclassical theory is no more or less than a specialized unit of production, but it can be a one-person unit” (Demsetz 1995: 9).

Given there is no serious modelling of the firm in neoclassical theory, there is no way to deal with the knowledge firm within this framework. There are no organisational problems or any internal decision-making process, in fact, there is no organisational structure at all and thus the advent of the knowledge economy cannot alter this nonexistent structure. As there is no role for managers or employees there can be no knowledge workers in the firm. But the growth in knowledge workers is one of the most important aspects in the development of the knowledge society. And their advent will change the way we think about firms.

Knowledge creators\workers\owners have the potential to be highly internationally mobile (unlike the physical capital or land in the old economy) which has the capacity to either reduce the knowledge divide or increase it, but importantly at much higher speeds. Buying the necessary knowledge creators\assimilators is like buying physical capital except the ownership of the ‘means of production’ is now vested more with the capital itself (human) than in the past modes of production. This has a number of important implications including helping understand who wins and who loses from the knowledge economy and this has the potential to affect our understanding\modelling of the traditional ‘theory of the firm’ - in terms of the Grossman/Hart/Moore (GHM) approach - which is vested in the ownership of physical capital alone.

The modern theory of the firm is based on the work of Grossman and Hart, (1986, 1987) and Hart and Moore (1990). Within the GHM approach ownership is defined in terms of residual control over non-human assets, things such as machinery, inventories, buildings, patents, client lists, firm’s reputation etc. Owner-managers employ labour that cannot work without the physical capital these firms own. Dismissal\resignation of the labour requires them to find other physical capital owning organisations (firms) to employ them. On liquidation of the firm, physical capital can be sold and the proceeds disbursed to the owners (shareholders). The standard theory of the firm is based on the role of non-human capital in the firm. The definition of a firm, the determinants of the boundaries of a firm - that is, the determinants of vertical integration of firms, the meaning of ownership of the firm, the nature of authority within the firm are all functions of control rights over the firm’s non-human assets. Making non-human assets the centre of the theory means that questions to do with the ownership and control of the physical information technology can be addressed, but this concentration on non-human assets means that the theory doesn’t deal with firms based on human assets. However it had been noted from the beginning that the theory could beextended to include human capital. As Hart (1988: 151) argues:

“. . . one difference with previous work is the emphasis on how integration changes control over physical assets. This is in contrast to Coase’s 1937 paper which focuses on the way integration changes an ordinary contractual relationship into one where an employee accepts the authority of an employer (within limits). Note that these approaches are not contradictory. Authority and residual rights of control are very close and there is no reason why our analysis of the costs and benefits of allocating residual rights of control could not be extended to cover human, as well as physical, assets.”

Once we move to a situation where firms may own\need little physical capital, then the modern theory of the firm loses much of its main reason for being. Once human capital (labour) becomes the most important\sole creator of wealth\value added then modern economic theory is in need of modification. The theory does not, however, lose all relevance. As Hart (1995: 56-7) explains, at least some, nonhuman assets are essential to a theory of the firm. To see why this may be so consider a situation where ‘firm’ 1 acquires ‘firm’ 2, which consists entirely of human-capital. The question Hart raises is, What is to stop firm 2’s workers from quitting? Without any physical assets, e.g. buildings, firm 2’s workers would not even have to relocate themselves physically.

If these workers were linked by telephones or computers, which they themselves own, they could simply announce one day that they had decided to become a new firm. For the acquisition of firm 2 by firm 1 to make economic sense there has tobe a source of value in firm 2 over and above the human-capital of the workers. It makes little sense to buy a ‘firm’ if that ‘firm’ can just get up and walk away. Hart argues there must be some ‘glue’ holding firm 2’s workers in place.

The value which acts as this glue may consist of as little as a place to meet; the firm’s name, reputation, or distribution network; the firm’s files, containing important information about its operations or its customers; or even a contract that prohibits firm 2’s workers from working for competitors or from taking existing clients with them should they quit. The source of value may even just represent the difficulty firm 2’s workers face in co-ordinating a move to another firm. But, Hart points out, without something binding the firm together, the firm becomes a phantom, and as such we should expect that such firms would be flimsy and unstable entities, constantly subject to the possibility of break-up or dissolution.

Thus even a human-capital based firm will involve some nonhuman-capital, but the human capital will play the dominate role. The important characteristic of human-capital is that it embodies information and knowledge. A theory of the human-capital based firm has to model this co-existence of the human and nonhuman-capital. Brynjolfsson (1994) deals with the issue by extending the property rights approach to the firm to include information whether this information is embodied in humans, in the form of human-capital, or in artifacts. Rabin (1993) also works within the property rights framework, but extends it by assuming that an agent has information about how to make production more productive which they are willing to sell.

If the firm comprises human capital resources (eg., a legal or accounting firm) whose accumulated knowledge is the source of wealth creation, the balance of power stemming from the “ownership of the means of production”, has changed. Likewise predictions about what would happen at the dissolution of a knowledge-firm, is also unclear. Who has the rights to the sell-off of the assets, where these assets are embodied in human beings? How can these assets be sold-off? These issues, although important in the context of the economic theory of the firm may have less importance when trying to measure the size\scale of the knowledge economy. However they are likely to have profound effects on the idea f a Knowledge Society where the balance of (economic) power will change - owners of physical capital losing this to owners of human capital, which without slavery map one-to-one to each individual. An individual’s own economic power would likely vary with their different stocks of human capital as would the price they charge to hire it to others in the form of employment. This in turn affects who wins and who loses from the knowledge society.

While the Brynjolfsson model is distinct from the Rabin model, they are complementary. The relationship between information, ownership and authority is central to both papers. Rabin works within a framework of an adverse selection model and shows that the adverse selection problems can be such that, in some cases, an informed party has to take over the firm to show that their information is indeed useful. The Brynjolfsson model is a moral hazard type framework which deals with the issue of incentives for an informed party to maximise uncontractible effort.

As has been discussed Hart (1995: 17) noted that the neoclassical model tells us nothing about where a firm’s boundaries will lie or about the size or location of a plant or factory within a given firm. This approach is consistent with every existing firm being a plant or division of one huge firm which produces everything. It is also consistent with every plant or division of each existing firm being a separate and independent firm in their own right. Thus it is not clear in what organisational form production will occur. Will it be organised as a single large factory, several smaller factories or a household? The GHM approach does delineate the boundaries of the firm but still does not tell us anything about the location or size of a plant or factory which is part of the firm. Again the form of production organisation is indeterminate. What will be argued below is that the division of knowledge is one important influence on the form of organisation in which production takes place. The most obvious issue has to do with the determination of whether or not work occurs in a centralised factory or in separate households or some combination. This has been an issue since at least the industrial revolution.

The development of ICTs has meant that the costs of moving people as opposed to moving information have risen sharply. The costs involved in sending and receiving information have fallen thanks to technologies such as email and the Internet along with falls in the costs of long distance phone calls and the expanding use of cellular networks. The costs of people moving have not fallen however. Commuting to work via congested city and suburban streets, for example, is at least as difficult as it was two decades ago. The increasing interest in congestion pricing in many cities around the world suggests that traffic problems are not lessening. The ever increasing relative cost of moving people would suggest that the size of the “unit of production” should be moving away from the large factory, so dominant for the last two centuries, towards more home based production, as in the period before the industrial revolution.

The previous sections have briefly outlined the effects of the increasing importance of knowledge for the mainstream theory of the firm. It was argued that the neo-classical production function approach is not a true theory of the firm, but rather the firm is portrayed as a uninvestigated perfectly efficient ‘black box’ which simply turns inputs into outputs without organisation structure. The extensions of the GHM framework offered by Brynjolfsson (1994) and Rabin (1993) inherits the implicit owner\manager restriction of the original GHM framework and thus are of limited value when modelling the knowledge firm. When we turn to the location of production the models suggest that we should, in general terms, see a movement back towards home production but we are not given a specific relationship between knowledge and plant size or production location.

We are left with an unsatisfactory model of the (knowledge) firm and thus we are unable to give guidance on either empirical or policy questions that flow, via changes to the firm, from the development of the knowledge economy. Firm’s organisational structures are changing in response to the increased prominence of information and knowledge in the production process. In the new economy, not only will we see changes in the location of production, but even if production still takes place within a traditional firm, a factory or office, that firm may have a very different structure and organisation from that which we see today. Rajan and Zingales (2003: 87) argue that we are in fact seeing a new “kinder, gentler firm”. This is in response to the increase in the importance of human capital, along with increased competition and access to finance, all of which have increased the worker’s importance and improved the outside options for workers, thereby changing the balance of power within firms. In Rajan and Zingales’s view “[t]he single biggest challenge for the owners or top management today is to manage in an atmosphere of diminished authority. Authority has to be gained by persuading lower managers and workers that the workplace is an attractive one and one that they would hate to lose. To do this, top management has to ensure that work is enriching, that responsibilities are handed down, and rich bonds develop among workers and between themselves and workers” (Rajan and Zingales 2003: 87).

Cowen and Parker (1997) make a similar point about changing organisational structures. For them, “[i]nformation as a factor of production is making old functional structures and methods of organisation and planning redundant in many areas of business. The successful use of knowledge involves not only its generation, but also its mobilisation and integration, requiring a change in the way it is handled and processed.” (Cowen and Parker 1997: 12). Organisational change, as far as Cowen and Parker are concerned, is the consequence of the increasing need to make use of market principles within the firm and the growing importance of human capital. They note that as far as a firm’s labour force is concerned, “[t]he emphasis now is upon encouraging knowledge acquisition, skills and adaptability in the workforce as critical factors in competitive advantage.” (Cowen and Parker 1997: 32). Firms are obliged to rely more on market based mechanisms as the most efficient way of processing and transmitting information and giving the firm the flexibility and yet also focus it requires. Companies are decentralising their management systems as a way of coping with the uncertainty and pace of change in their markets. The aim is to ensure that those with the required knowledge and right incentives are the ones making the decisions and taking responsibility for the outcomes. Cowen and Parker (1997: 25-8) emphasise how advances in ICTs underlie the ability to be able to combine the advantages of this organisational flexibility with mass production.

But little of these types of changes are captured or explained by the mainstream theory of the firm. Expanding the orthodox view of the firm to include the new reality of the knowledge economy should be an urgent issue on the economic research agenda. It should be noted that such changes to the firm help determine who are the “winners and losers” from economic change in general. As in all previous “economic revolutions”, this is the ultimate issue to do with the knowledge economy.

All the references in the above can be found in Oxley, Walker, Thorns and Wang (2008).

• Oxley, Les, Walker, Paul, Thorns, David, Wang, Hong (2008). 'The knowledge economy/society: the latest example of “Measurement without theory”?', The Journal of Philosophical Economics, II:1 , 20-54.

A more detailed discussion of these issues can be found in Walker (2010).

• Walker, P. (2010). "The (non)theory of the knowledge firm". Scottish Journal of Political Economy, v57 no1, February 2010: 1-32.

The digital revolution, and economic statistics

Following on from the previous post, the problems for measuring economic activity bought about by the digital revolution that has given rise to the so-called "knowledge economy"  is an issue that I have written a little on. There is a section on this problem, called "Mr Bean(counter) measures the economy", in Oxley, Walker, Thorns and Wang (2008).

Much time and effort is expended by many national and international organisations in an attempt to measure the economy or economies of the world.

While the measuring of the “standard” economy is funny enough, when we move to the measurement of the “knowledge economy” measurement goes from the mildly humorous to the outright hilarious. Most attempts to measure, or even define, the information or knowledge economy border on the farcical: the movie version should be called, "Mr Bean(counter) Measures the Economy".

There are substantial challenges to be overcome in any attempt to measure the knowledge society\economy. These are at both the theoretical and the method level. A more consistent set of definitions are required as are more robust measures that are derived from theory rather than from what is currently or conveniently available. In order to identify the size and composition of the KBE one inevitably faces the issue of quantifying its extent and composition. Economists and national statistical organisations are naturally drawn to the workhorse of the ‘System of National Accounts’ as a source of such data. Introduced during WWII as a measure of wartime production capacity, the change in Gross Domestic Product (GDP) has become widely used as a measure of economic growth. However, GDP has significant difficulties in interpretation and usage (especially as a measure of wellbeing) which has led to the development of both ‘satellite accounts’ - additions to the original system to handle issues such as the ‘tourism sector’; ‘transitional economies’ and the ‘not-for-profit sector’ and alternative measures for example, the Human Development Indicator and Gross National Happiness . GDP is simply a gross tally of products and services bought and sold, with no distinctions between transactions that add to wellbeing, and those that diminish it. It assumes that every monetary transaction adds to wellbeing, by definition. Organisations like the ABS and OECD have adopted certain implicit\explicit definitions, typically of the Information Economy-type, and mapped these ideas into a strong emphasis on impacts and consequences of ICTs. The website (http://www.oecd.org/sti/information-economy) for the OECD’s Information Economy Unit states that it:

“. . . examines the economic and social implications of the development, diffusion and use of ICTs, the Internet and e-business. It analyses ICT policy frameworks shaping economic growth productivity, employment and business performance. In particular, the Working Party on the Information Economy (WPIE) focuses on digital content, ICT diffusion to business, global value chains, ICT-enabled off shoring, ICT skills and employment and the publication of the OECD Information Technology Outlook.”

Furthermore, the OECD’s Working Party on Indicators for the Information Society has

“. . . agreed on a number of standards for measuring ICT. They cover the definition of industries producing ICT goods and services (the “ICT sector”), a classification for ICT goods, the definitions of electronic commerce and Internet transactions, and model questionnaires and methodologies for measuring ICT use and e-commerce by businesses, households and individuals. All the standards have been brought togetherin the 2005 publication, Guide to Measuring the Information Society . . . “ (http://www.oecd.org/document/22/0,3343,en_2649_201185_34508886_1_1_1_1, 00.html)

The whole emphasis is on ICTs. For example, the OECD’s “Guide to Measuring the Information Society” has chapter headings that show that their major concern is with ICTs. Chapter 2 covers ICT products; Chapter 3 deals with ICT infrastructure; Chapter 4 concerns ICT supply; Chapter 5 looks at ICT demand by businesses; while Chapter 6 covers ICT demand by households and individuals. As will be shown below several authors have discussed the requirements for, and problems with, the measurement of the knowledge\information economy. As noted above most of the data on which the measures of the knowledge economy are based comes from the national accounts of the various countries involved. This does raise the question as to whether or not the said accounts are suitably designed for this purpose. There are a number of authors who suggest that in fact the national accounts are not the appropriate vehicle for this task. Peter Howitt argues that:

“. . . the theoretical foundation on which national income accounting is based is one in which knowledge is fixed and common, where only prices and quantities of commodities need to be measured. Likewise, we have no generally accepted empirical measures of such key theoretical concepts as the stock of technological knowledge, human capital, the resource cost of knowledge acquisition, the rate of innovation or the rate of obsolescence of old knowledge” (Howitt 1996: 10).

Howitt goes on to make the case that because we can not measure correctly the input to and the output of, the creation and use of knowledge, our traditional measure of GDP and productivity give a misleading picture of the state of the economy. Howitt further claims that the failure to develop a separate investment account for knowledge, in much the same manner as we do for physical capital, results in much of the economy’s output being missed by the national income accounts.

In Carter (1996) six problems in measuring the knowledge economy are identified:

1) The properties of knowledge itself make measuring it difficult,
2) Qualitative changes in conventional goods: the knowledge component of a good or service can change making it difficult to evaluate their “levels of output” over time,
3) Changing boundaries of producing units: for firms within a knowledge economy, the boundaries between firms and markets are becoming harder to distinguish,
4) Changing externalities and the externalities of change: spillovers are increasingly important in an knowledge economy,
5) Distinguishing ‘meta-investments’ from the current account: some investments
are general purpose investments in the sense that they allow all employees to be more efficient,
6) Creative destruction and the “useful life” of capital: knowledge can become
obsolete very quickly and as it does so the value of the old stock drops to zero.

Carter argues that these issues result in it being problematic to measure knowledge at the level of the individual firm. This results in it being difficult to measure knowledge at the national level as well since the individual firms’ accounts are the basis for the aggregate statistics and thus any inaccuracies in the firms’ accounts will compromise the national accounts.

Haltiwanger and Jarmin (2000) examine the data requirement for the proper measurement of the information economy. They point out that changes are needed in the statistical accounts which countries use if we are to deal with the information\knowledge economy. They begin by noting that improved measurement of many “traditional” items in the national accounts is crucial if we are to understand fully Information Technology (IT’s) impact on the economy. It is only by relating changes in traditional measures such as productivity and wages to the quality and use of IT that a comprehensive assessment of IT’s economic impact can be made. For them, three main areas related to the information economy require attention:

1) The investigation of the impact of IT on key indicators of aggregate activity, such as productivity and living standards,
2) The impact of IT on labour markets and income distribution and
3) The impact of IT on firm and on industry structures.

Haltiwanger and Jarmin outline five areas where good data are needed:

1) Measures of the IT infrastructure,
2) Measures of e-commerce,
3) Measures of firm and industry organisation,
4) Demographic and labour market characteristics of individuals using IT, and
5) Price behaviour.

In Moulton (2000) the question is asked as to what improvements we can make to the measurement of the information economy. In Moulton’s view additional effort is needed on price indices and better concepts and measures of output are needed for financial and insurance services and other “hard-to-measure” services. Just as serious are the problems of measuring changes in real output and prices of the industries that intensively use computer services. In some cases output, even if defined, is not directly priced and sold but takes the form of implicit services which at best have to be indirectly measured and valued. How to do so is not obvious. In the information economy, additional problems arise. The provision of information is a service which in some situations is provided at little or no cost via media such as the web. Thus on the web there may be less of a connection between information provision and business sales. The dividing line between goods and services becomes fuzzier in the case of e-commerce. When Internet prices differ from those of brick-and-mortar stores do we need different price indices for the different outlets? Also the information economy may affect the growth of Business-to-Consumer sales, new business formation and in cross-border trade. Standard government surveys may not fully capture these phenomena. Meanwhile the availability of IT hardware and software results in the variety and nature of products being provided changing rapidly. Moulton also argues that the measures of the capital stock used need to be strengthened, especially for high-tech equipment. He notes that one issue with measuring the effects of IT on the economy is that IT enters the production process often in the form of capital equipment. Much of the data entering inventory and cost calculations are rather meagre and needs to be expanded to improve capital stock estimates. Yet another issue with the capital stock measure is that a number of the components of capital are not completely captured by current methods, an obvious example being intellectual property. Also research and development and other intellectual property should be treated as capital investment though they currently are not. In addition to all this Moulton argues that the increased importance of electronic commerce means that the economic surveys used to capture its effects need to be expanded and updated.

In Peter Howitt’s view there are four main measurement problems for the knowledge economy:

1) The “knowledge-input problem”,
2) The “knowledge-investment problem”,
3) The “quality improvement problem”,
4) The “obsolescence problem”.

To deal with these problems Howitt makes a call for better data. But it’s not clear that better data alone is the answer, to both Howitt’s problems and the other issues outlined here. Without a better theory of what the “knowledge economy” is and the use of this theory to guide changes to the whole national accounting framework, it is far from obvious that much improvement can be expected in the current situation.

One simple question is to which industry or industries and\or sector or sectors of the economy can we tie knowledge\information production? When considering this question several problems arise. One is that the “technology” of information creation, transmission and communication pervades all human activities so cannot fit easily into the national accounts categories. It is language, art, shared thought, and so on. It is not just production of a given quantifiable commodity. Another issue is that because ICT exists along several different quantitative and qualitative dimensions production can not be added up. In addition if much of the knowledge in society is tacit, known only to individuals, then it may not be possible to measure in any meaningful way. If on the other hand knowledge is embedded in an organisation via organisational routines, see Becker (2004) for a review of this literature, then again it may not be measurable. Organisational routines may allow the knowledge of individual agents to be efficiently aggregated, much like markets aggregate information, even though no one person has a detailed understanding of the entire operation. In this sense, the organisation “possesses” knowledge which may not exist at the level of the individual member of the organisation. Indeed if, as Hayek can be interpreted as saying, much of the individual knowledge used by the organisation is tacit, it may not even be possible for one person to obtain the knowledge embodied in a large corporation.

There has also been considerable effort made to measure the information\knowledge society by national and international organisation such as UNESCO, the UN and the EU. That these efforts differ in their outcomes reflects, to a certain degree, different understandings of what the knowledge society is and thus different ways of modelling it. Some documents follow the process of knowledge production to sort out indicators, themes and tend to include measures on i) prerequisites for knowledge production (information infrastructure, knowledge, skill and human capital) and ii) knowledge production (R&D) itself. For example, in “Advancement of the Knowledge Society: Comparing Europe, the US and Japan” (European Foundation for the Improvement of Living and Working Conditions 2004), all indicators are sorted by whether they measure a prerequisite for the advancement of the knowledge society or whether they measure the outcomes of a knowledge society.

Other documents use different criteria to select indicators. The UN model initiated in “Understanding Knowledge Societies in Twenty Questions and Answers with the Index of Knowledge Societies” (Department of Economic and Social Affairs 2005), for example, categorises indicators along three dimensions: assets, advancement and foresightedness. When putting together its “Knowledge Society Barometer” (European Foundation for the Improvement of Living and Working Conditions 2004a), ‘The European Foundation for the Improvement of Living and Working Conditions’ considers notions such as information, knowledge, knowledge-value societies and sustainable development as parts of a ‘jigsaw puzzle’ which makes up their knowledge society framework. It seems to indicate that the knowledge society is viewed as a result of the integration of concerns of the previous conceptualisation of societies. Thus, the different frameworks also suggest the influence of organisational agenda\priorities in defining the knowledge society.

Despite the difference in frameworks and indicators, there are some common themes. These include human capital, innovation, ICT development and the context dimension. The human capital theme includes variables on the levels of people’s skills and education which reflect the size of the pool of educated people. Included in the innovation theme are variables showing innovation investment, procedures, capacities and networks. There are diverse indicators under the ICT theme; yet, they can be categorised as either resources or access. The former refers to the information infrastructure while the latter is related to the accessibility of information in people’s life and work. The context dimension always includes variables on socio-economic, political and institutional conditions for knowledge production.

Obviously, these themes are crucial for measuring the knowledge society. However, these measures are not without their pitfalls. One basic problem for these measures is caused by the “knowledge problem”. In some cases, knowledge is understood partially and information and knowledge are treated as exchangeable terms. As a result, some documents focused entirely on measuring the information economy while talking about the knowledge economy and society. Other documents mentioned the difference between tacit and explicit knowledge, the distinction between information and knowledge, and thus, the distinction between the information society and the knowledge society while they failed to employ appropriate variables to reflect the distinctions, due to data availability. Among these documents, we do see a gradually shifting understanding and discourse on the knowledge society. For example, “UNESCO World Report: Towards Knowledge Societies” could be seen as a leading document in initiating the paradigm shift from the information society to the knowledge one. It acknowledges that “the idea of the information society is based on technological breakthroughs. The concept of knowledge societies encompasses much broader social, ethical and political dimensions” (UNESCO 2005: 17). At the same time, another document prepared by UNESCO on statistical challenges shows difficulties in identifying the relevant data within the existing measurement frameworks.

In addition, the knowledge problem raises other issues to do with the choice of indicators in each of the major themes. For example, human capital is measured according to people’s formal education and skills based on human capital approaches. This inevitably ignores people’s tacit knowledge and knowledge between people. There are a number of sociological studies which show that even within the economic domain people are not rational actors but their economic performance is signicantly affected by social, cultural and political structures in which they are embedded.

Similarly, the measurement of innovation in these documents seems to focus mainly on the production of scientific knowledge in laboratories. This is inconsistent with the Mode-2 knowledge production initiated by Gibbons (1994) in the knowledge society in which science and society co-evolve. Also the measurement of innovation fails to distinguish the role of inventions from that of innovations. Consequently, it is difficult to see how they can measure the economic value of innovation and at the same time attach a social value to it. Regarding ICTs, it seems that the widely accepted practice is to enumerate the physical infrastructure or, at best, measure access to information. There is a misunderstanding on the relationship between technology and human beings here. It is not technology but human beings and their interactions that constitute so-called society and its institutions. Thus, the function of ICTs is not only their capacity to provide additional new connections but also their potential for opening or closing forms of personal, social and economic capacities, relationships and power-plays (Dutton,  2004). Mansell and Wehn’s (1998) INEXSK approach would be a valuable endeavour to integrate the dimension of human beings, their knowledge and ICTs in the knowledge society measurement (Mansell and Wehn 1998).

Another problem with measures of the knowledge society is confusing the knowledge economy with the knowledge society. Generally, there are two kinds of documents on the measurement of the knowledge society. One group focuses on measuring the knowledge economy although they mention the concept of the knowledge society. The foci of the measurement are human capital, innovation and ICT development. A representative document is “Measuring a Knowledge-based Economy and Society: An Australian Framework” prepared by the Australian Bureau of Statistics. The document’s author claims that this framework

“does not attempt to cover all knowledge in the economy and society . . . [and] offer a comprehensive treatment of a knowledge-based society although it does address those social elements which potentially affect economic change or are affected by it” (Australian Bureau of Statistics 2002: 15)

Another group of documents considers both economic and technological features and social conditions and outcomes of the knowledge society. Two representative documents here would be, “Advancement of the Knowledge Society: Comparing Europe, the US and Japan” (European Foundation for the Improvement of Living and Working Conditions 2004) and “Knowledge Society Barometer” (European Foundation for the Improvement of Living and Working Conditions 2004a) published by the European Foundation for the Improvement of Living and Working Conditions. There are some variables reflecting social issues such as social inclusion, quality of life and gender equality in the two documents. However, they failed to see that both the economic and the social are equally important and integrated components in the measurement frameworks. Instead, the social is still treated as the ‘leftover’ after having identified ‘significant’ and ‘measurable’ components for national accounting.

In light of these issues it would seem that a necessary first step along the path towards the correct measurement of the knowledge society\economy would entail the development of a theory of the knowledge society\economy. Such a theory would tell us, among other things, what the knowledge economy is, how - if at all - the knowledge economy\knowledge society differ, how they change and grow, and what the important measurable characteristics are. Based on this, a measurement framework could be developed to deal with, at least some of, the problems outlined above.

All the references in the above can be found in Oxley, Walker, Thorns and Wang (2008).

• Oxley, Les, Walker, Paul, Thorns, David, Wang, Hong (2008). 'The knowledge economy/society: the latest example of “Measurement without theory”?', The Journal of Philosophical Economics, II:1 , 20-54.

Independent review of UK economic statistics

Sir Charles Bean discusses the challenges of the digital revolution, the "knowledge economy",  in measuring economic statistics. The aim is to ensure that the statistics – and the methodologies used to construct them – evolve to better reflect Britain’s modern complex dynamics.


Of course the issues raised are not UK dependent, all countries face the same measurement problems.

Discussion of such problems is not new, For example Oxley, Walker, Thorns, Wang (2008) argued that a lack of good theory is holding back measurement. Just collecting more data is not enough. Many authors do not see that the problems measuring the "knowledge economy" brings can not be resolved by simply gathering better data. Without well thought out theory, the data we would be seeking to find would be yet another “known unknown”.

The abstract reads:

The world has embraced a set of concepts (knowledge driven growth) which are seen as the ‘core of future growth and wellbeing’ without any commonly agreed notion of what they are, how they might be measured, and crucially therefore, how they actually do (or might) affect economic growth and social wellbeing. The theory of how the mechanism works lacks important detail.

Ref.:

• Les Oxley, Walker, Paul, Thorns, David, Wang, Hong (2008) ‘The knowledge economy/society: the latest example of “Measurement without theory”?’, The Journal of Philosophical Economics, II:1 , 20-54

Economists on trade deals

This comes from Greg Mankaw's blog:

The new IGM Panel poll of prominent economists asks about this proposition:

An important reason why many workers in Michigan and Ohio have lost jobs in recent years is because US presidential administrations over the past 30 years have not been tough enough in trade negotiations.

Only 5 percent agree, while 64 percent disagree. (The rest were uncertain or did not answer.) A previous poll asked about this statement:

Past major trade deals have benefited most Americans.

On this one, 83 percent agreed, and zero percent disagreed.

With regard to the first poll mentioned, David Cutler, who "agreed" with the statement made an interesting comment,

The phrasing implies that any reduction in jobs is bad. Some shifts in employment are valuable (e.g., fewer sweatshop jobs in the US).

So there may be good even in the bad.

When the responses to this poll are weighted by each expert's confidence, those who "agree" falls to 3%. In both weighted and unweighted responses 0% "strongly agree". The weighted "disagrees" is 86%. So those who disagree are confident in their position.

So the vast majority of economists see advantages in trade deals, even if non-economists don't.

Do politicians affect economic outcomes?

For the US at least the answer, in one sense, is yes: the US economy has performed better under Democratic presidents than Republican ones.

But why?

A new paper in the American Economic Review (Vol. 106, Issue 4 -- April 2016 ) looks at this question.

Presidents and the US Economy: An Econometric Exploration
Alan S. Blinder and Mark W. Watson

The US economy has performed better when the president of the United States is a Democrat rather than a Republican, almost regardless of how one measures performance. For many measures, including real GDP growth (our focus), the performance gap is large and significant. This paper asks why. The answer is not found in technical time series matters 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 total factor productivity (TFP) performance, a more favorable international environment, and perhaps more optimistic consumer expectations about the near-term future. (JEL D72, E23, E32, E65, N12, N42)

When you look at the things that drive the Democratic advantage - benign oil shocks, superior total factor productivity (TFP) performance, a more favorable international environment and more optimistic consumer expectations - apart from may be the more optimistic consumer expectations, it is not obvious how the current term president could affect the other drives of economic performance.

So in this sense the answer to the question is no. It looks more like luck than good management on the part of politicians that drives economic success.

Israel Kirzner on the history and importance of the Austrian Theory of the Market Process

Mercatus Center Academic & Student Programs recently hosted the 2016 Advanced Austrian Seminar at which Dr. Israel M. Kirzner, Professor Emeritus of Economics at New York University, delivered the keynote lecture, “The History and Importance of the Austrian Theory of the Market Process.” In this talk, Professor Kirzner examines the history of thought in Austrian economics, specifically focusing on the developments in the 20th century, to develop a link between the Austrian theory of the market process and the notion of subjectivism as the central idea in Austrian economics.

David Friedman & Bob Murphy - The Chicago Vs. Austrian School Debate

David Friedman and Robert Murphy will compare and contrast the different principles and methods of the Chicago and Austrian schools of economics -- and their impact on ethics and other social sciences.

Peter Boettke on Austrian Economics in the 21st Century at the Legatum Institute

The Legatum Institute's Economics of Prosperity programme hosted a breakfast discussion with Peter Boettke, one of the world’s most prominent Austrian economists. In this short video, the Legatum Institute's Shanker Singham, Boettke discusses the US elections (in particular, the rise of populist candidates such as Bernie Sanders and Donald Trump), the issue of inequality and economic distortion, which Boettke believes has come about because of the crony capitalism that has been spawned by a regulatory system that is captured by the elites, and why 'innovation' could be the 'magic bullet' for improving human capital.

Climate shock: the economic consequences of a hotter planet

See here for a short audio, from VoxEU.org, of Gernot Wagner being interviewed by Romesh Vaitilingam on "Climate shock: the economic consequences of a hotter planet".

At the heart of policy debates about our collective responses to climate change is the issue of risk and uncertainty - ‘unknown unknowns’ about the impact of global warming. In this Vox Talk, Gernot Wagner - co-author with Harvard’s Martin L. Weitzman of 'Climate Shock: The Economic Consequences of a Hotter Planet’ - argues for Pigovian taxes and carbon pricing, against geoengineering solutions, and why 'we need to stick it to CO2, not to capitalism’.

The 2015 Vincent and Elinor Ostrom Memorial Lecture

In February 2015 the Indiana University Maurer School of Law Bloomington hosted the Vincent and Elinor Ostrom Memorial Lecture with Barry R. Weingast (Ward C. Krebs Family Professor, Dept. of Political Science, Stanford University and a Senior Fellow, Hoover Institution) who spoke on “The Violence Trap: Why Democracy and Rule of Law Fail in the Developing World.”

Managers and productivity differences

Productivity, and the reasons why some countries are more productive than others is an issue of long-standing interest to economists. Cross-country differences in productivity are pondered over and worried about in the policy circles of most countries, including New Zealand. A new column at VoxEU.og, by Nezih Guner, Andrii Parkhomenko and Gustavo Ventura, attempts to dig a little deeper in to the issue, looking into differing managerial quality between different nations. In high-income countries, the mean earnings of managers tend to grow faster than for non-managers and the earnings growth of managers relative to non-managers corresponds to output per worker. To understand why countries like Italy (and New Zealand?) lag behind the US in terms of output per worker, they argue we should take into account that there are more incentives to invest in managerial skills in the US.

The modelling approach taken in the column is described as

In order to understand and draw implications from our empirical findings, we study a span-of-control model with a life-cycle structure. Every period, a large number of finitely lived agents are born. These agents are heterogeneous in terms of their initial endowment of managerial skills. The objective of each agent is to maximise the lifetime utility from consumption. In the first period of their lives, agents make an irreversible decision to be either workers or managers. In the model economy, differences in managerial quality emerge from differences in selection into management work, along the lines of Lucas (1978), and differences in skill investments, as we allow for managerial abilities to change over time as managers invest in their skills. Hence, we place incentives of managers to invest in their skills and the resulting endogenous skill distribution of managers at the centre of income and productivity differences across countries.

In the model economy, skill investment decisions reflect the costs (resources that have to be invested rather than being consumed) and the benefits (the future rewards associated with being endowed with better managerial skills). Since consumption goods are an input for skill investments, a lower level of aggregate productivity results in lower incentives for managers to invest in their skills. Furthermore, managers face potential size-dependent distortions as in the literature on misallocation in economic development. We model size-dependent distortions as progressive taxes on the output of a plant, and do so via a simple parametric function that was proposed originally by Benabou (2002).

Size-dependent distortions have two effects in our setup.

• First, a standard reallocation effect, as the introduction of distortions implies that capital and labour services flow from distorted (large) to undistorted (small) production units;
• Second, a skill accumulation effect, as distortions affect the incentives for skill accumulation and thus, the overall distribution of managerial skills – which manifests itself in the distribution of plant level productivity.

Overall, under higher exogenous productivity and smaller distortions, managers invest more in their skills in equilibrium and operate larger and more productive plants. As a result, both output per worker and the gap between the earnings of managers to non-managers become larger, in line with the cross-country evidence presented in Figure 1

Figure 1. Cross-country relationship between output per worker and lifetime growth of managers’ earnings relative to non-managers

Guner, Parkhomenko and Ventura conclude,

[...] we contend that in order to understand why countries like Italy and others lag behind the US in terms of output per worker, we should take into account that in the US, the incentives to invest in managerial skills are not as distorted. A young person who contemplates a managerial career takes into account distortions (regulations and other factors that act as implicit size-dependent taxes) that he or she will face when earning a higher compensation as a manager. In economies with larger distortions, individuals will either invest less in their managerial skills or choose a non-managerial career. In equilibrium, these reactions lead to lower managerial quality and output per worker, and to lower earnings growth of managers relative to non-managers, as the data indicates.

Apple vs the feds: fhe facts

All this article from NetGuide makes interesting reading. But the most relevant point made is I think this one:

So Apple’s strongly worded response to the court order could have more to do with public relations and commercial fallout as it does with customer protection.

This isn't all that surprising as none of this is likely to be terribly palatable for Apple who’ll foot the bill for complying with the court order. While the costs of doing so are likely to be peanuts in the grand scheme of things, it’ll also do Apple no favours In an ultra-competitive smartphone marketplace, where any perceived weakness such as the feds being able to snoop through a phone could be exploited by competitors to turn potential buyers away from IOS.

In short, consumers don't want a phone from a company which will help the Feds break into it. Consumers value privacy and Apple have worked this out and responded accordingly. Competition, if not a genuine belief in liberty, forced Apple to the right decision.

The funniest papers in the history of economics

Worth watching.

Competition policy, again (updated)

In the latest Insights newsletter at the New Zealand Initiative Oliver Hartwich discusses the recent decision by the government not to criminalise cartel behaviour. Hartwich writes,

On Tuesday, Minister of Commerce Paul Goldsmith decided not to proceed with the long debated criminalisation of cartel behaviour.

The Minister’s explanation was telling: “In weighing up the benefits of criminalising cartel activity, the government had to consider the significant risk that cartel criminalisation would have a chilling effect on pro-competitive behaviour between companies.”

As Hartwich notes it may sound strange that pro-competitive behaviour of companies could ever be confused with anti-competitive behaviour. Hartwich writes,

The problem lies in the nature of competition law. It is an area of law which is prone to arbitrariness. Practically everything is a matter of interpretation.

William Landes summaries the point in the following quote on why Coase gave up antitrust,

Ronald [Coase] said he had gotten tired of antitrust because when the prices went up the judges said it was monopoly, when the prices went down they said it was predatory pricing, and when they stayed the same they said it was tacit collusion. (William Landes, “The Fire of Truth: A Remembrance of Law and Econ at Chicago”, Journal of Law and Economics (1981) p. 193.)

If everything is illegal what is a firm to do?

Hartwich continues,

Similarly, the benchmark of “competition” is vague. For what should it mean? Is it the theoretical but unrealistic state of so-called “perfect competition” taught in many economics textbooks? Or is it the process of companies actually competing with each another? And if so, how do you measure that?

Then there is the difficulty in finding proper definitions. To quote the late economist Murray Rothbard, “there is nothing anticompetitive per se about a cartel, for there is conceptually no difference between a cartel, a merger, and the formation of a corporation: all consist of the voluntary pooling of assets in one firm to serve the consumers efficiently.” Indeed. Yet somehow the formation of a corporation is fine whereas a merger or a cartel might be illegal.

Rothbard's point about cartels being illegal while mergers which can achieve the same result being legal is comment on a relatively recent change in thinking on competition policy. If you go back to, say, the 1950s integration was looked at with just as much suspicion as cartels are today. Recently I came across an interesting comment on the old view on integration and antitrust policy by Joseph J. Spengler

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

This was written in 1950 and things have changed since it is now accepted that there are often efficiencies that result from integration and now the US Antitrust Division typically requires a showing of market power before it considers whether a such arrangement poses serious competitive concerns.

At least part of the reason for the change in view is due to the work of Oliver Williamson, Williamson was sceptical of the conventional wisdom of the time (1960s), which presumed that the purpose and effect of many integration practices was the enhancement of market power and the erection of entry barriers. Contrary to this view, which was widely adopted by antitrust lawyers and courts in the 1960s, Williamson could see rationales for various integration practices that were based instead on economic efficiency.

If we accept that integration can have efficiency justifications then why not cartels? At least we should ask what the reasons for the formation of the cartel are and not just assume that cartels are evil per se. The government's decision can be seen as a small step in this direction.

Update: Donal Curtin at the Economics New Zealand blog takes a more traditional (and anti) view of the government's decision when he argues "Hard core" cartelists are criminals.

Do we need competition policy?

On twitter Vanilla Thrilla asked,

NZ - the weakest competition law regime in the developed world? https://t.co/t2H2NOGBj5

— Vanilla Thrilla (@Vanilla_Thrilla) December 8, 2015

I replied,

@Vanilla_Thrilla no competition policy the best policy?

— Paul Walker (@psw1937) December 8, 2015

then Vanilla Thrilla said,

@psw1937 interesting question. pretty sure self-licensing professional guilds, labour unions and large corporates would all say yes

— Vanilla Thrilla (@Vanilla_Thrilla) December 8, 2015

and then I said,

@Vanilla_Thrilla Companies can use competition law to protect their position and harm competitors

— Paul Walker (@psw1937) December 8, 2015

Let me expand a bit on my general point with an argument from a previous post on this topic.

Many people seems to think that a body such as the Commerce Commission is needed and that it should be a powerful player in its role as competition regulator. I ask why? May be the commission does more harm than good. Would it be better to do away with it?

The idea behind competition law in New Zealand is, according to the Act, “to promote competition in markets for the long-term benefit of consumers”. This is to say, it is believed, by the Act's supporters, that markets left to themselves, without any oversight from regulators, without any regulation of prices, quantities, or structure, would be harmful to consumers. Such a view rests on the notion that there is a large danger of monopoly power being used to harm consumers and, therefore, competition is a state of affairs which must be regulated and managed by the authorities because undesirable situations of monopoly can emerge all the time.

Frederic Sautet, ex-economist at NZ Treasury and the Commerce Commission, makes the point that this thinking is wrong headed:

At the end of the day, the problem assumed by competition law is only exacerbated by regulation, while economics shows that the entrepreneurial process solves it. So while there may be situations where competition law may seem warranted, in fact there is no crime at the crime scene. While competition law aims to protect consumers, the danger is that it may affect the self-correcting properties of the market system — an outcome worse than the disease it tries to cure.

Much of the problem is due to the fact that competition law was established on an misunderstanding of the nature of competition. The law in New Zealand aims to achieve "workable competition" but the practice of competition law relies on the view of competition as a static (equilibrium) state of affairs - derived from the idea of perfect competition. However, actual competition is a rivalrous entrepreneurial process by which the knowledge enabling a better coordination of individual plans is discovered over time. Again, as Frederic Sautet points it

[...] it must be understood that the competitive process takes place within a set of institutions that guarantee the functioning of entrepreneurial discovery and the exploitation of business opportunities over time. These institutions and regulation must guarantee entry into any market to anyone desiring to compete.

Sautet goes on to make the important point that

Under the disguise of consumer protection, competition law has in fact protected some producers from the greater efficiency of their potential competitors. Indeed, competition can be difficult for some incumbents who run the risk of being outcompeted. However, this process is necessary if the ultimate goal is to let consumers (indirectly) dictate the allocation of resources according to their preferences. The danger with competition law is that it interferes with the entrepreneurial process — a cure worse than the disease.

Thus the danger of the Commerce Commission is that it may so damage or restrict the true competitive process that it harms the very people it set out to help, consumers, but helps the people it wished to control, producers. The law of unintended consequences strikes again.

As far as empirical evidence goes it tends to suggest that competition policy does not improve consumer welfare by much. Robert W. Crandall and Clifford Winston look at the effects of antitrust enforcement in the US and ask Does Antitrust Policy Improve Consumer Welfare? And the short answer is, not much. Crandall and Winston write,

In this paper, we argue that the current empirical record of antitrust enforcement is weak.

and they add

We then synthesize the available research regarding the economic effects of three major areas of antitrust policy and enforcement: changing the structure or behavior of monopolies; prosecuting firms that engage in anticompetitive practices, namely, price fixing and other forms of collusion; and reviewing proposed mergers. We find little empirical evidence that past interventions have provided much direct benefit to consumers or significantly deterred anticompetitive behavior.

Overall I'm not sure that we really do want a strong interventionist Commerce Commission.

At the very lest we should start a discussion about the nature of the Commerce Act and the role of the Commerce Commission by asking questions about what form of competition policy we really want.

References:

The Sautet paper, which is well worth reading, is "The Shaky Foundations of Competition Law", New Zealand Law Journal, pp. 186-190, June 2007.

The Robert W. Crandall and Clifford Winston paper is "Does Antitrust Policy Improve Consumer Welfare? Assessing the Evidence", Journal of Economic Perspectives, 17(4) Fall 2003.

Worstall on Davies on Coase on housing

In a previous post I commented on the idea of Steve Davies to apply Coaseian thinking to solving the British (and other countries) housing problem. In part Davies wrote

For Coase the solution was to assign a property right to one of the two sides and then allow a process of bargaining to take place. If the first group have the right then those who do not want development would have to pay them not to do it. If the second, then the developers (and ultimately the buyers) have to pay for the right to develop. Crucially it does not matter which of these two we go for: in either case we will end up with the outcome that maximises total welfare so long as the bargaining process itself is not too costly.

Now at the Adam Smith Institutes's blog Tim Worstall comments on this idea. He writes

We have no doubt this would work and that should be good enough as a solution. However, while it would work we’re really not convinced that it is the correct solution. For what it is saying is that those who wish to prevent building upon land that they do not own have some form of right to say or insist so. That’s why they might be due some compensation from those who do build. And we rather reject that basic contention.

Property ownership does mean that one should be able to dispose of the property as one wishes. Consistent with this is that other people do not have the right to impose their views upon you of how you should dispose of that property. Thus we’re uncomfortable with the idea of creating a right which can then be subject to such Coasean bargaining.

Tim has a point, sorting out who has what rights to object to a housing development could raise the transaction costs of Coaseian type bargaining to such a degree that it would become impractical. And if multiple people or groups claim said rights negotiating with each of them could be expensive and time consuming. However if it is clear who the parties involved are and there are only a few of them, ie transactions costs really are low, then the Coaseian solution could be an improvement over the current situation.

EconTalk this week

If you have 250 million tons of food to give away every year to local food banks how should you do it? Canice Prendergast of the University of Chicago's Booth School of Business talks with EconTalk host Russ Roberts about how he and a team of economists created an artificial currency and a daily auction for the national food bank Feeding America so that local food banks could bid on the types of food that were the most valuable to them. Prendergast explains the results of the new system and the cultural and practical challenges of bringing prices, even artificial ones, to a world accustomed to giving things away.

A direct link to the audio is available here.

Efficiency of female leaders in family and non-family firms

There has been recent discussion of the idea that economic research shows that companies that have a balanced representation of women and men on their boards perform better, a claim made by the Treasury Secretary Gabriel Makhlouf . Eric Crampton at the Offsetting Behaviour blog has pointed to research that shows this is not the case.

Today I came across this working paper - Efficiency of Female Leaders in Family and Non-Family Firms by Per-Olof Bjuggren, Louise Nordström and Johanna Palmberg - that draws a distinction between family-owned and non-family owned firms when looking at the performance effects of female leadership. In their conclusion the authors write,

Our study shows that female leadership is more common in family than non-family corporations. This female leadership has also a strong positive impact on performance in family firms while the performance impact is surprisingly strongly negative in non-family firms.

Insofar as Makhlouf's comments were about non-family owned firms, and most large firms are of this form, then the above comment doesn't offer much support for his claim. When considering family-owned firms however, he may be on stronger ground.

The paper's abstract reads:

Female leadership is an expanding area of research. It is a popular topic discussed frequently in both academia and in the popular press. Despite this, comparative studies of the impact of female leadership on firm level performance between family and non-family firms are rare. The present study has the ambition to fill this gap. This paper investigates female leadership in family firms and how it affects firm profitability. A unique database of ownership and leadership in private Swedish firms makes it possible to analyze difference in firm performance due to female leadership in family and non-family firms. Even though much has been written regarding the role of women in family firms we do not know so much about how female leadership in family firms affect the profitability of the firm. The analysis indicates that female leadership makes much more of a positive difference for performance in family firms. The effect is negative in non-family firms.

This leaves open the question as to what drives the difference in leadership performance between the two types of firms.

AFA Lecture: Andrei Shleifer

"The Transformation of Finance" an address to The American Finance Association by Andrei Shleifer, January 2011.

The 20 most influential books in history

From the World Economic Forum comes a list of The 20 most influential books in history. The top ten are,

Davies on Coase on housing

At the LSE's British Politics and Policy blog Steve Dacies writes that low house-building levels and the unaffordability of existing homes are problems that have been plaguing Britain for decades. And this is true not just in the UK but most other countries, like New Zealand, as well.

Davies writes,

There is now something of a consensus among academics and commentators that the shortage of housing (and buildings of all kinds) is one of our most pressing problems. Many others such as welfare costs and low productivity are at least partly caused by the lack of house building and the consequent high price of housing. However, this has not as yet led to any political action. The problem of course is the conflict of interest between people who want to build, buy or rent new houses on the one hand, and people who do not want new development on greenfield sites on the other. The second group have so far been able to block any action and this does not seem likely to change.

But the work of Coase shows that this deadlock is quite simply unnecessary and avoidable if we only think about it in the right way, as Mark Pennington explains. Current policy on development is shaped by conventional welfare economics, where two people engaging in a transaction can impose costs on bystanders. So a developer and a house buyer can impose costs on existing home owners and people who wish to preserve the rural environment. This is dealt with by regulations through planning laws.

As Pennington explains, Coase rejects this model. For him the costs are reciprocal – there are two sides each of whom is potentially imposing costs on the other. One wants to build houses, the other to preserve space. To the extent that one side gets its way the other suffers a loss. What we actually have is not an externality or pollution but a conflict over how to use land.

For Coase the solution was to assign a property right to one of the two sides and then allow a process of bargaining to take place. If the first group have the right then those who do not want development would have to pay them not to do it. If the second, then the developers (and ultimately the buyers) have to pay for the right to develop. Crucially it does not matter which of these two we go for: in either case we will end up with the outcome that maximises total welfare so long as the bargaining process itself is not too costly.

Fortunately, in the case of land use the cost of negotiation is low. If we applied this model instead of a complex and costly planning procedure we would simply have a default right, either to build or not, which would have to be bought out. We could make one default apply in some parts of the country and the other in the rest (although this should not matter, it might be politically astute). There would then be a process of bargaining and through this we would actually find out how much people really valued one alternative or the other (as opposed to their asserting it – words are cheap).

The result would be development in some areas but not in others and this would reflect the actual value that people collectively placed on the two competing uses and the associated moral values. This would be different in different places (unlike the inflexible present system). As Pennington points out this would also be an ethically superior outcome because it would reflect ethical and value pluralism rather than having one group’s values imposed on the rest through the political process which is what we have now.

For Coase the world of positive transaction costs is the world we should consider when thinking about policy. High transactions costs can prevent otherwise efficient trades from taking place. But if we can structure things so that transaction costs are low then bargaining between parties will lead us to efficient outcomes. Thus as Davies notes if we assign property rights to either developers or to those who wish to prevent new development and let them bargain the two groups can work the problem out for themselves. Bureaucrats not needed.

Such an approach to housing really would be RMA change!

Do people maximise their well-being?

As a followup to the last posting on Coase v. Becker on utility theory I came across this new working paper by Marc Fleurbaey and Hannes Schwandt which asks Do People Seek to Maximize Their Subjective Well-Being?

The abstract reads,

In a new survey we ask respondents, after a standard Subjective Well-Being (SWB) question, if they can think of changes in their lives that would improve their SWB score. If the SWB score is just one argument among others in the respondents’ goals in life, they should easily find ways to improve it, at the expense of other dimensions they care about. Our results suggest that close to 90% of the respondents actually seek to maximize their SWB. The life satisfaction question appears the best contender as the “maximand” in the contest, before the ladder-of-life question and felt happiness. Among the other goals that people pursue and for which they are willing to sacrifice some of their SWB, the prominent appear to be about their relatives and about their future self.

So 90% of us seem to want to maximise our subjective well-being. One interesting question is what does this tell us about assuming utility maximisation as a starting point for modelling consumer behaviour?

Coase v. Becker on utility theory

An interesting, and all too short, exchange between Ronald Coase and Gary Becker on utility theory. Coase was not much of a believer in the usefulness of utility theory whereas Becker was.


The video comes from freetochoose.tv.

Why politics and business should not mix

In a new column at VoxEU.org Jiangtao Fu, Daichi Shimamoto and Yasuyuki Todo discuss Politically connected lending and economic development.

A long held view of many economists is that firms with good political connections obtain loans with more relaxed terms than those who are not politically connected. The Fu, Shimamoto and Todo column presents evidence from Indonesia that firms whose owners or directors have a personal relationship with a politician are more likely to have their loans approved by state-owned banks, and are more likely to receive the full amount applied for. However, the labour productivity of such firms is on average lower. This suggests that in some cases, politically connected lending may distort the efficiency of resource allocation and be detrimental to economic development.

Fu, Shimamoto and Todo write,

The Indonesian government implements policies to facilitate credits to SMEs with growth potential. However, our results suggest that such public credits are most likely to be given to unproductive but politically connected firms. The distorted allocation of resources may harm the economic growth of Indonesia and lead the economy into a middle-income trap. Possible solutions to this problem include reducing the political influence in state-owned banks (e.g. their privatisation), building SMEs’ credit information sharing system, and strengthening the ability of financial institutions to evaluate loan applications.

These results highlight, if such highlighting is really needed, why politics and business should never mix. Some countries are better at separating business from politics but all countries need to be aware of the dangers of the mixing of the two. Those dangers include reducing much needed economic growth. The column also points to one advantage of privatisation, in this case of state-owned banks, it helps depoliticise business decisions.

EconTalk this week

Are we on the verge of driverless cars and other forms of autonomous robots and artificial intelligence? David Mindell of MIT and the author of Our Robots, Ourselves talks with EconTalk host Russ Roberts about the robotic revolution. Mindell argues that much of the optimism for autonomous robots ignores decades of experience with semi-autonomous robots in deep-sea operation, space, air, and the military. In all of these areas, the role of human supervision remains at a high level with little full autonomy. Mindell traces some of the history of the human interaction with robots and artificial intelligence and speculates on what the future might hold.

A direct link to the audio is available here.