A few interesting economics books of 2016

2016 was a good year for books in economics. Here are a few that I thought interesting.

To start with a New Zealand connection we have A Few Hares to Chase: The Life and Times of Bill Phillips by Alan Bollard. Phillips was a New Zealander most famous for the "Phillips Curve" which shows an inverse relationship between the level of unemployment and the rate of inflation..

Phillips experienced the rigours of the Great Depression on construction sites, and while still a young man he roamed the outback of Australia working in gold mines and sometimes crocodile hunting. In 1937 he set off to discover militarising Japan, a guerrilla war in Manchuria, Stalin's Soviet Union, and the tensions in Europe. On the outbreak of war, he joined the RAF and was sent to Singapore where he rearmed planes but was eventually incarcerated in a POW camp by the Japanese. In camp he learned languages, invented gadgets for the troops and built a clandestine radio. After the war, he scraped through a sociology degree at the LSE, before convincing a faculty to let him build a hydraulic model of the economy. This beautiful complex machine was a great success and put Bill Phillips on the track of serious economics. In the next few decades he developed new ideas for stabilising economies, was one of the first to use electronic computers, developed the Phillips Curve, showed ways to help an economy to grow, and developed new techniques to model economies.

Another book with a New Zealand connection is Was Communism Doomed?: Human Nature, Psychology and the Communist Economy by Simon Kemp, who is Professor of Psychology at the University of Canterbury.

Simon looks at whether the ideology of communism was doomed to failure due to psychological rather than structural flaws. Does communism fail because there is not enough individual incentive and does it discourage psychological ownership? If so, does it produce learned helplessness and therefore empower evil? Such questions are considered both with respect to how communism actually functioned and how it could have functioned using examples from Eastern Europe and the USSR itself. It reviews both the ideology of communism and its history, as well as the basic but difficult question of how one might decide whether an economic system can be defined as successful or not.

Two of the very best book of this year are to do with economic history. A Culture of Growth: The Origins of the Modern Economy by Joel Mokyr and Bourgeois Equality: How Ideas, Not Capital or Institutions, Enriched the World by Deirdre N. McCloskey are about how the rich got rich.

During the late eighteenth century, innovations in Europe triggered the Industrial Revolution and the sustained economic progress that spread across the globe. The big mystery with the industrial revolution is why it took place at all. Why did this revolution begin in the West and not elsewhere, and why did it continue making the rich countries rich in the process? Joel Mokyr argues that a culture of growth specific to early modern Europe and the European Enlightenment laid the foundations for the scientific advances and pioneering inventions that would instigate explosive technological and economic development. Mokyr argues that culture--the beliefs, values, and preferences in society that are capable of changing behavior--was a deciding factor in societal transformations. He looks at the period 1500-1700 to show that a politically fragmented Europe fostered a competitive "market for ideas" and a willingness to investigate the secrets of nature. At the same time, a transnational community of brilliant thinkers known as the "Republic of Letters" freely circulated and distributed ideas and writings. This political fragmentation and the supportive intellectual environment explain how the Industrial Revolution happened in Europe but not China, despite similar levels of technology and intellectual activity. In Europe, heterodox and creative thinkers could find sanctuary in other countries and spread their thinking across borders. In contrast, China's version of the Enlightenment remained controlled by the ruling elite.

Deirdre McCloskey points out that most humans today are better off than their forebears. In this book, the concluding volume of her trilogy celebrating the oft-derided virtues of the bourgeoisie, McCloskey argues that the poorest of humanity will soon be joining the comparative riches of Japan and Sweden and Botswana. Why? Not because of the accumulated capital but rather because of ideas. “Our riches,” she argues, “were made not by piling brick on brick, bank balance on bank balance, but by piling idea on idea.” Capital was necessary, but so was the presence of oxygen. It was ideas, not matter, that drove “trade-tested betterment.” Nor were institutions the drivers. McCloskey builds a powerful case for the initiating role of ideas—ideas for electric motors and free elections, of course, but more deeply the bizarre and liberal ideas of equal liberty and dignity for ordinary folk. Liberalism arose from theological and political revolutions in northwest Europe, yielding a unique respect for betterment and its practitioners, and upending ancient hierarchies. Commoners were encouraged to have a go, and the bourgeoisie took up the Bourgeois Deal, and we were all enriched.

A somewhat depressing and critical voice which argues that the level of economic growth that we have become to depend on will come to an end is raised in The Rise and Fall of American Growth: The U.S. Standard of Living since the Civil War by Robert J. Gordon

Economic growth is often seen as the norm for countries like the United States. Innovations such as electric lighting, indoor plumbing, motor vehicles, air travel, and television transformed households and workplaces. But has that era of unprecedented growth come to an end? The Rise and Fall of American Growth challenges the view that economic growth will continue unabated, and demonstrates that the life-altering scale of innovations between 1870 and 1970 cannot be repeated. Gordon contends that the nation's productivity growth will be further held back by the headwinds of rising inequality, stagnating education, an ageing population, and the rising debt of college students and the federal government, and that we must find new solutions.

Looking not at history but at current economies Per L. Bylund writes on The Seen, the Unseen, and the Unrealized: How Regulations Affect Our Everyday Lives.

This book illuminates the effects of regulations on people’s everyday lives. It traces the effects of regulations on an economy by working through the ripple effects of changes. Regulations, which are restrictions placed on the working of the economy, have consequences, both intended and unintended, direct and indirect. While the direct effects are well understood, the indirect effects are often overlooked because they don’t fit with the common understanding of the economy. More to the point, this book emphasises the real effects of regulation and market change on individual actors, thereby stressing how the economy works to provide an individual with the options that exist in choice situations. The book drafts a new definition of prosperity and well-being which focuses on the individual’s access to valuable alternatives. From this point of view, the real implications of regulation are traced step by step, following the logic of exchange and the effects on individual actors rather than the economy as a whole.

One of the more controversial books of the year is Illiberal Reformers: Race, Eugenics, and American Economics in the Progressive Era by Thomas C. Leonard

In Illiberal Reformers, Leonard reexamines the economic progressives whose ideas and reform agenda underwrote the Progressive Era dismantling of laissez-faire and the creation of the regulatory welfare state, which, they believed, would humanise and rationalise industrial capitalism. But not for all. Academic social scientists such as Richard T. Ely, John R. Commons, and Edward A. Ross, together with their reform allies in social work, charity, journalism, and law, played a pivotal role in establishing minimum-wage and maximum-hours laws, workmen's compensation, antitrust regulation, and other hallmarks of the regulatory welfare state. But even as they offered uplift to some, economic progressives advocated exclusion for others, and did both in the name of progress. Leonard meticulously reconstructs the influence of Darwinism, racial science, and eugenics on scholars and activists of the late nineteenth and early twentieth centuries, revealing a reform community deeply ambivalent about America's poor. Illiberal Reformers shows that the intellectual champions of the regulatory welfare state proposed using it not to help those they portrayed as hereditary inferiors but to exclude them. Leonard discusses his book with Russ Roberts at EconTalk here and with Glenn Loury on the Glenn Show at Bloggingheads.tv here.

For me one of the most interesting books of the year is Adaptation, Specialization, and the Theory of the Firm: Foundations of the Resource-Based View by Birger Wernerfelt.

The book sets out to provide a foundation for a new theory of the firm, drawing on Birger Wernerfelt's work on economic theory and the resource-based view of the firm. It addresses a vigorous and long-standing academic debate over what exactly a 'firm' is, both in the field of management and economics. Wernerfelt revisits his classic articles, including an extensively revised 'A Resource-Based View of the Firm' (1984), which have been updated and synthesised to provide precise and accessible concepts and predictions along with a discussion of two his more recent papers 'On the Nature and Scope of the Firm' (1997) and 'The Comparative Advantages of Firms, Markets, and Contracts' (2015). These papers form the foundations of the 'Adaptation Cost' approach to the theory of the firm.

I shall end with what I, obviously, think of as the greatest book of 2016, The Theory of the Firm: An overview of the economic mainstream by Paul Walker

Firms are a ubiquitous feature of the economic landscape, with much of the activity undertaken within an economy taking place within their boundaries. Given the size of the contribution made by firms to economic activity, employment and growth, having a theoretical understanding of the nature and structure of firms is crucial for understanding how an economy functions.The Theory of the Firm firstly offers a brief overview of the past of the theory of the firm/production. Next, the ‘present’ of the theory of the firm is discussed in three sections. The first section considers the post-1970 theory of the firm literature per se, while the second section scrutinises the relationship between the three most prominent of the modern sets of theories: the reference point, property rights and transaction cost approaches. The third section looks at the theory of privatisation. This volume offers an intuitive introduction to the theories of the firm as well as simple formal models of the most important contributions to the literature. It also outlines the historical evolution of the traditional and modern theories of the firm.

Staying safe this Christmas

Thanks to Ele Ludemann at the Homepaddock blog for advice on staying safe this Christmas:

Please be advised that all employees planning to dash through the snow in a one-horse open sleigh, going over the fields and laughing all the way are required to undergo a Risk Assessment addressing the safety of open sleighs.

This assessment must also consider whether it is appropriate to use only one horse for such a venture, particularly where there are multiple passengers. Please note that permission must also be obtained in writing from landowners before their fields may be entered.

To avoid offending those not participating in celebrations, we request that laughter is moderate only and not loud enough to be considered a noise nuisance.

Benches, stools and orthopaedic chairs are now available for collection by any shepherds planning or required to watch their flocks at night.

While provision has also been made for remote monitoring of flocks by CCTV cameras from a centrally heated shepherd observation hut, all facility users are reminded that an emergency response plan must be submitted to account for known risks to the flocks.

The angel of the Lord is additionally reminded that prior to shining his/her glory all around s/he must confirm that all shepherds are wearing appropriate Personal Protective Equipment to account for the harmful effects of UVA, UVB and the overwhelming effects of Glory.

Following last year’s well publicised case, everyone is advised that human rights legislation prohibits any comment with regard to the redness of any part of Mr. R. Reindeer.

Further to this, exclusion of Mr. R Reindeer from reindeer games will be considered discriminatory and disciplinary action will be taken against those found guilty of this offence.

While it is acknowledged that gift-bearing is commonly practised in various parts of the world, everyone is reminded that the bearing of gifts is subject to Hospitality Guidelines and all gifts must be registered.

This applies regardless of the individual, even royal personages.

It is particularly noted that direct gifts of currency or gold are specifically precluded under provisions of the Foreign Corrupt Practices Act. Further, caution is advised regarding other common gifts, such as aromatic resins that may initiate allergic reactions.

Finally, in the recent case of the infant found tucked up in a manger without any crib for a bed, Social Services have been advised and will be arriving shortly.

Compliance of these guidelines is advised in order for you to fully participate with the appropriate save level of festive spirit.

thxs
Risk Management Team

Is psychology education or indoctrination?

A new paper in Current Psychology asks this question, and the answer isn't completely reassuring. It appears that many first year psychology textbooks pass on falsities, half-truths and urban legends.

Education or Indoctrination? The Accuracy of Introductory Psychology Textbooks in Covering Controversial Topics and Urban Legends About Psychology by Christopher J. Ferguson, Jeffrey M. Brown and Amanda V. Torres

Abstract

The introductory psychology class represents the first opportunity for the field to present new students with a comprehensive overview of psychological research. Writing introductory psychology textbooks is challenging given that authors need to cover many areas they themselves may not be intimately familiar with. This challenge is compounded by problems within the scholarly community in which controversial topics may be communicated in ideological terms within scholarly discourse. Psychological science has historically seen concerns raised about the mismatch between claims and data made about certain fields of knowledge, apprehensions that continue in the present “replication crisis.” The concern is that, although acting in good faith, introductory psychology textbook authors may unwittingly communicate information to readers that is factually untrue. Twenty-four leading introductory psychology textbooks were surveyed for their coverage of a number of controversial topics (e.g., media violence, narcissism epidemic, multiple intelligences) and scientific urban legends (e.g., Kitty Genovese, Mozart Effect) for their factual accuracy. Results indicated numerous errors of factual reporting across textbooks, particularly related to failing to inform students of the controversial nature of some research fields and repeating some scientific urban legends as if true. Recommendations are made for improving the accuracy of introductory textbooks.

Interesting blog bits

1. Matt Ridley asks Why is the left reviving apartheid?
   

   Identity politics is taking us backwards to division and prejudice.

2. Tom G. Palmer on A New, Old Challenge: Global Anti-Libertarianism

   A spectre is haunting the world: the spectre of radical anti-libertarian movements, each grappling with the others like scorpions in a bottle and all competing to see which can dismantle the institutions of liberty the fastest. Some are ensconced in the universities and other elite centers, and some draw their strength from populist anger. The leftist and the rightist versions of the common anti-libertarian cause are, moreover, interconnected, with each fueling the other. All explicitly reject individual liberty, the rule of law, limited government, and freedom of exchange, and they promote instead radical, albeit aggressively opposed, forms of identity politics and authoritarianism. They are dangerous and should not be underestimated.

3. Russ Roberts on The Human Side of Trade

   Free trade is on the run. The president-elect of the United States calls the free market the “dumb market.” He wants to renegotiate past trade deals. The death spiral of manufacturing jobs makes people wonder if trade with China was really such a good idea. Some economists claim to have found evidence that increased trade with China causes an increase in suicide. It is tempting to argue then, that free trade, while good for the economy, is not so good for human beings.

4. Timothy Taylor on the Economics of Gentrification

   "Gentrification" arises when a neighborhood in a city that has in the past offered relatively low-cost housing to relatively low-income people experiences the entry of a wave of higher-income buyers. The new entrants often buy the older housing stock and rebuild or refurbish it, pushing up housing prices in the rest of the neighborhood. On one side, this process offers lower-income people who own their homes a chance for a financial windfall, and can also offer benefits to the neighborhood like improved local job opportunities, shopping options, and public safety. On the other side, gentrification also disrupts existing neighborhoods and can displace low-income residents, some of whom may have been living in the neighborhood for a long time.

5. Michael Reddell on Brexit, Trump and all that

   Last week, The Treasury hosted a guest lecture featuring two visiting academics under the heading Brexit, Trump & Economics: Where did we go wrong. When the invitation went out, I was rather puzzled by the title? Who was this “we” that apparently “got things wrong”?

6. Tyler Cowen on Prizes are flourishing.

   Stumped for solutions to hundreds of industrial and technical problems, businesses and governments alike are turning the search for innovative ideas into prize-worthy puzzles that capitalize on the ingenuity of the crowd.

Big corporations are powerful and long lasting?

From Mark Perry at his Carpe Diem blog

What do the companies in these three groups have in common?

Group A: American Motors, Brown Shoe, Studebaker, Collins Radio, Detroit Steel, Zenith Electronics and National Sugar Refining.

Group B: Boeing, Campbell Soup, Deere, General Motors, IBM, Kellogg, Procter and Gamble and Whirlpool.

Group C: Facebook, eBay, Home Depot, Microsoft, Google, Netflix, Office Depot and Target.

And the answer is:

All of the companies in Group A were in the Fortune 500 in 1955, but not in 2016.

All of the companies in Group B were in the Fortune 500 in both 1955 and 2016.

All of the companies in Group C were in the Fortune 500 in 2015, but not 1956.

It turns out that nearly 9 of every 10 Fortune 500 companies in 1955 are gone, merged, or contracted. Only 12% (and fewer than 1 in 8) of the Fortune 500 companies in 1955 were still on the list 61 years later in 2016, and more than 88% of the companies from 1955 have either gone bankrupt, merged with (or were acquired by) another firm, or they still exist but have fallen from the top Fortune 500 companies.

But we so often told about all powerful big corporations are, how the control markets and can force consumer to buy whatever products they sell. John Kenneth Galbraith is perhaps the most (in)famous economist who argued along these lines. He argued that in the industrial sectors of the economy, which are composed of the largest corporations - think Fortune 500 companies, the principal function of market relations is, not to constrain the power of the corporate behemoths, but to serve as an instrument for the implementation of their power. Moreover, the power of these corporations extends into commercial culture and politics, allowing them to exercise considerable influence upon popular social attitudes and value judgements. That this power is exercised in the shortsighted interest of expanding commodity production and the status of the few - the 1% - is, in Galbraith's view, both inconsistent with democracy and a barrier to achieving the quality of life that the "new industrial state" with its affluence could provide to the many. Galbraith argued that we find ourselves living in a structured state controlled by these large and all powerful corporations. Control over demand and consumers is exercised via the use of advertising which creates a never ending consumer "need" for products, where no such "need" had existed before. In addition, as Princeton University Press said in its advertising for a new edition of Galbraith's "The New Industrial State",

The goal of these companies is not the betterment of society, but immortality through an uninterrupted stream of earnings.

If all this is true why is it that so few have survived from 1955 to 2016?

Another hypothesis is that there’s been a lot of market disruption, churning, and Schumpeterian creative destruction over the last six decades. This suggests that no matter what some economists, and competition policy authorities, may want you to think, corporations are not all powerful and consumers are not just feeble minded puppets having their strings pulled by evil corporate executives. Yes, market competition and consumer sovereignty could actually be a thing.

Joseph Henrich on the difference between economics and psychology

Tyler Cowen interviews anthropologist Joseph Henrich. At one point they talk about the difference between economics and psychology:

COWEN: You’re an anthropologist. You’ve spent a lot of time with economists — coauthored, worked with Paul Romer, Colin Camerer, others. As an anthropologist, what do you find strange about the tribe known as econ? [laughs]

HENRICH: I had a real opportunity. I was very fortunate in my career to be a professor of psychology and a professor of economics at the same time but to be neither in some deep sense. I would get to go back and forth from seminars in economics and psychology.

In economics, there’s this really competitive culture. The way I like to describe it: If you’re giving a seminar in economics, the crowd — everybody’s trying to show who’s the smartest guy in the room. Just on your first slide, someone will raise their hand. (I’m like, I haven’t said anything yet!) Then they’ll try to ask the killer question which undercuts your whole talk so that they can get you right at the beginning.

[laughter]

HENRICH: Whereas psychologists, they’ll sit quietly. They watch your talk. You go through your whole PowerPoint. You probably touched a lot of different research projects.

Then there’ll be question time; at first no hands will go up. Then someone will be like, “I got a question.” Then they say, “I just have one small question. I mean, it was a great talk and this is just a very minor thing.”

Then it could be a killer question at that point when they’ve done the preface. It’s a very strong cultural difference between the econ tribe and the psychology tribe.

I’ve always wanted to write an ethnography: My Life among Two Strange Tribes: The Psychologists and the Economists.

Contracts are important and old ..... really old

From the Presentation Speech by Professor Per Strömberg, Member of the Royal Swedish Academy of Sciences, Chairman of the Nobel Committee for the Prize in Economic Sciences in Memory of Alfred Nobel, 10 december 2016.

At the edge of the Mediterranean − outside today's Izmir, Turkey − the Greek city of Teos was located in ancient times. During recent excavations of that city, archaeologists discovered a 1.5 meter high white marble stele, with a fifty line long chiselled inscription. The stele turned out to be a 2,200 year old lease agreement for a property including buildings, farmland and associated slaves.

A wealthy man in Teos had donated the property to a nearby gymnasium, but the students - who were busy with their studies and sports - leased it out to the highest bidder. One clause in the detailed agreement gave the owners the right to inspect yearly whether the tenant was keeping the buildings in good repair and taking good care of the farmland. More than half of the lines of the inscription listed the extra fees and penalties that could be charged to the tenant in case of a breach of contract. The agreement also gave the owners the right to hold religious ceremonies on the property three days per year; this not only provided the students with spiritual sustenance, but also made their rental income tax-free.

Nobel Prize lectures in economic sciences for 2016

From Nobelprize.org:

Oliver Hart: Incomplete Contracts and Control

Oliver Hart delivered his Prize Lecture on 8 December 2016 at the Aula Magna, Stockholm University.


Bengt Holmström: Pay for Performance and Beyond

Bengt Holmström delivered his Prize Lecture on 8 December 2016 at the Aula Magna, Stockholm University.

Oliver Hart on the good and bad in economics

From Hart's speech at the Nobel Banquet, 10 December 2016

After 47 years working in the area, I have learned that economics is both more and less powerful than people think. It is more powerful because it provides an indispensable set of tools for understanding human behavior. Whether we are talking about an individual's decision about how much education to get, a firm's decision about how much to invest, or a society's decision about how best to tackle global warming, economics can provide an invaluable perspective. In the context of the current prize my co-laureate and I have shown that economics can throw light on whether teachers should be rewarded according to their students' test scores; or whether prisons should be run by private companies or by the government.

This is the good news about economics. It can help us to understand many things. The bad news is that it is not the whole story. For understanding many questions other things matter too: psychology, history, sociology, politics. This is the sense in which economics is less powerful than people think. It provides only part of the answer.

And I would add that it is only part of the answer but it is the part that seems to be ignored in those very cases where it is most powerful and useful.

Oliver Hart interview

Guy Rolnik interviews this year's Nobel Prize in Economics co-winner Professor Oliver Hart about incomplete contracts and the theory of the firm.

Half an hour well spent.

1776 was more about representation than taxation

A question not often asked about the American Revolution, Did Monarchists resisting an incipient democracy movement in Britain prevent a compromise that could have placated the American colonists?

Jen Deaderick writes in the December 2016 NBER Digest:

"No taxation without representation" — the rallying cry of the American Revolution — gives the impression that taxation was the principal irritant between Britain and its American colonies. But, in fact, taxes in the colonies were much lower than taxes in Britain. The central grievance of the colonists was their lack of a voice in the government that ruled them.

The political underpinnings of the American Revolution have been discussed and debated for more than two hundred years, and there are multiple explanations of the causes and multiple analyses of the revolutionary dynamic. One question about the revolution that has remained difficult to answer is why, if a little representation in Parliament could have prevented a war for independence, did King George III not grant it?

This question is the motivation for Sebastian Galiani and Gustavo Torrens' study Why Not Taxation and Representation? A Note on the American Revolution (NBER Working Paper No. 22724). They note, in drawing attention to the role of representation as a spark for revolution, that the average British citizen who resided in Britain paid 26 shillings per year in taxes, compared with only one shilling per year in New England, even though the living standard of the colonists was arguably higher than that of the British.

Most accounts of the events that led to the American Revolution depict a conflict between the colonies and a unified British government. In fact, the researchers argue, the reality was more subtle. They draw on a variety of historical accounts to describe the tension between two rival British interest groups, the landed gentry and the democratically inclined opposition, and to explain the failure to reach a compromise that would have granted representation to the colonies. In particular, they focus on how extending representation would have affected the relative influence of these two groups.

The researchers consider events a century before the American Revolution to have set the stage for the domestic tensions in Britain at the time of the colonial protests. In 1649, during the English Civil War, a rebellion of Parliamentarians overthrew — and beheaded — King Charles I. Oliver Cromwell, who ruled for most of the subsequent decade, supported expanding representation in government beyond landowners, and his government was sympathetic to grievances like those raised by the American colonies many decades later. Following Cromwell's death in 1658, however, Royalists returned to power and sought to restore the historical ruling class.

When the colonies asked for representation in the middle of the 18th century, the monarchy was still recovering from its dethroning, and the landed gentry, now returned to primary power, still felt vulnerable. The researchers point out that the Royalists were contending with factions that sought to bring democracy to Britain. While these opposition groups did not hold significant power, if representatives from the American colonies were invited to join Parliament, they likely would have sympathized with the opposition and expanded their influence. The researchers see this tension as critical to understanding why Britain was so reluctant to enfranchise the colonists.

There were proposals to settle the colonial crisis peacefully, most notably by Thomas Pownall and Adam Smith. Smith, for example, proposed "a system in which the political representation of Great Britain and America would be proportional to the contribution that each polity was making to the public treasury of the empire." Such proposals were rejected by the ruling coalition in Britain. "The landed gentry, who controlled the incumbent government, feared that making concessions to the American colonies would intensify the pressure for democratic reforms, thus jeopardizing their economic and political position," the researchers find.

Ultimately, the opposition of the landed gentry to the demands for representation by the American colonies pushed the colonies to rebellion and independence, but helped to delay the development of the incipient democratic movement in Britain.

Is Trump's deal with Carrier a form of crony capitalism? (updated)

Short answer, yes.

Tyler Cowen, professor of economics at George Mason University, gives a longer and more sophisticated answer in an interview on npr. Cowen comes in about the 4 minute mark.



Update: John Cochrane gives this Carrier Commentary.

Glenn Loury talks to Thomas Leonard

On the Glenn Show at Bloggingheads.tv Glenn Loury (Brown University) interviews Thomas Leonard (Princeton University) about Leonard's recent book Illiberal Reformers: Race, Eugenics, and American Economics in the Progressive Era.

The division of labour and the firm: Robinson (1931)

This material relates to Robinson (1931).

One of the earliest attempts to relate the division of labour to the size of firms was Robinson (1931). In The Structure of Competitive Industry Robinson offered an analysis of the factors that determined the optimum size for a firm. For Robinson the interaction of five factors determined the size of the firm: technique, management, finance, marketing and risk of fluctuations. These various theoretical optima have then to be reconciled in the size or constitution of a real firm after allowing for difficulties and anomalies of growth. The division of labour has a role to play with regard to technique and management. Because of this we will concentrate on these two factors here.

For Robinson the optimum firm is that firm which in existing conditions of technique and organising ability produces at the minimum of long-run average costs. Under the conditions of perfect competition we would expect to see the optimum firm emerge but under conditions of imperfect competition, Robinson notes, it may not materialise. Consider, for example, the case of monopolistic competition in which a firm will be in equilibrium at less than the minimum of average cost.

The first application of the division of labour to the size of the firm that Robinson considers is the relationship between the division of labour and the optimum technical unit. Robinson follows Adam Smith in seeing three different reasons for the division of labour giving rise to more efficient production. First is the increase in dexterity of workmen; secondly, the saving of time which is commonly lost in passing from one type of work to another; and thirdly, the invention of a great number of machines which facilitate and abridge labour, and thus enable one person to do the work of many.

With regard to the issue of dexterity, Robinson notes Smith's observation that a person who works at a given task for some time is likely to develop a skill or knack for doing that task. In addition the division of labour can allow those people with a natural skill for carrying out a given task to specialise in that task.

Adam Smith (and Robinson) also saw an advantage in the division of labour in that specialisation at a task saved the time that would otherwise be spent on passing from one task to another. Time could be saved because workers do not have to move between machines or processes. Also time would be lost if machines had to be reset to perform a different function. The division of labour saves time by concentrating both workers and machine upon a given function, and a larger factory enjoys an advantage over a smaller one in so far as it makes this concentration possible.

The third economy Smith saw is due to the development of specialised equipment to carry out the tasks that the manufacture of an item is divided into. Separation of a process into its constituent parts makes development of machines to carry out those parts easier.

It is important to keep in mind when considering the size of a firm that the principle of the division of labour requires a firm of sufficient size to obtain the maximum profitable division of labour. This size will differ across industries depending on the nature of the production process for that industry and how detailed a division of labour can be implemented for that particular process. Larger firms will, often, have the capacity to implement a greater division of labour than a smaller firm, giving the larger firm an advantage in terms of efficiency.

The next issue discussed by Robinson is what he calls `the integration of process'. Robinson explains that often a large firm has fewer rather than more processes of manufacture. They can utilise a large machine which has been designed to takeover what would otherwise be a series of manual, or at least less completely mechanical, operations. A complicated machine can perform two or three or more consecutive processes and it can thereby eliminate the labour and time which would be required to up the work on each of the successive earlier machines. Only large firms can keep such a machine running at its full capacity and this fact gives the large firm an advantage over the smaller, and less mechanised, firm. But this difficulty can be overcome by the small firm as long as the size of the market for the process is large enough. If a given process requires a scale of production too great for a smaller firm the small firm can outsource the process to specialist firm. But such outsourcing if only possible if the extent of the market for a particular process is large enough to allow the division of labour to develop to the point where a specialist firm is viable. Robinson refers to this outsoucing as 'vertical disintegration'.

The second of the areas for which Robinson sees the division of labour having a role to play is with regard to management. A manager in a small firm will have multiple tasks to preform, some of which he will be good at, others that he will not be so good at. In a larger firm a division of labour can develop which allows managers to specialise on those function for which they are best suited. The larger firm gains in two ways from its division of managerial labour: 1) special abilities to be used to their fullest extent. Talents are not wasted by having managers carry out functions which could be better assigned to another manager with a particular ability at that function. 2) a manger who specialises in a given task will increase their knowledge of that task.

A potential downside of the managerial division of labour is the problem of coordination. As the division of labour becomes greater the problems associated with the coordination of the different parts of the production process also increases. As new tasks are created by dividing up the production process, new administrative functions are also created to coordinate the ever more disjoint production process. The advantage that a larger firm has over the smaller depends, in a large part, on how well it solves this coordination problem.

An additional theoretical problem with Robinson's discussion follows from the implicate assumption in the competitive model that complete contracts can be written. In such a world it is not clear why a firm is needed to carry out production at all. As Coase (1937) first highlighted in a world of complete contracts any organisation form can mimic any other meaning that production could be carried out via the market just as efficiently as within a firm.

Refs.:

• Coase, R. H. (1937). `The Nature of the Firm', Economica, New Series 4 No. 16 November: 386-405.
• Robinson, E A G. (1931). The Structure of Competitive Industry, Cambridge: Cambridge University Press.

Stories from the stone age First Farmers pt.2

Neolithic Revolution the Caucasian Resurrection.

Stories from the stone age First Farmers pt.1

Out of the Stone age and into the Neolithic one of human's most incredible accomplishments 6000 yrs before the pyramids. The story of Near Eastern "The First Farmers".

Can Trump make the U.S. a ‘global subsidy cop’?

Has Trump actually come up with something right to do with trade? Are global subsidies a bad thing? Should we complain if other countries subsidise their industries? If other countries want to subsidise our consumption of imports should we care? Scott Lincicome argues that if the U.S. wants to end the practice of other countries subsidising key industries, it would require the U.S. to clean up its own business giveaways.

Resource misallocation & productive growth

Chang-Tai Hsieh, IGC steering group member, explains why some firms are more successful than others, using Indian firms as a case study. The Indian example shows that entrepreneurs can find ways around inefficient regulation. The problem of course is that the workaround is not fully efficient, a better policy would be to remove the bad regulation in the first place. But as noted by Hsieh politicians aren't willing to go there. Another example of bad politics driving out good economics.

A challenge to mercantilists

A challenge from Don Boudreaux at the Cafe Hayek blog. Boudreaux issues the following challenge to any protectionist/mercantilist/economic-nationalist who might wish to take it on:

Identify one plausible economic problem caused by free trade that is unique to trade and commerce that spans political borders. Just one. That is, identify a problem with free trade that arises when people are free to buy and sell internationally but that does not arise when people are free to buy and sell intranationally.

In other words, what economic problems can we avoid by restricting international trade that we don't have to deal with in internal trade?  I've got to admit I've yet to think of anything even remotely plausible as an answer to this challenge.

The "Adaptation Cost" theory of the firm

This material is covers chapters 3 and 4 of Wernerfelt (2016). These chapters are, in turn, based on Wernerfelt (1997) and Wernerfelt (2015), respectively.

Wernerfelt considers two questions to do with the firm that he thinks important but go largely unanswered in the standard theory of the firm literature: What determines the choice between the use of the market, a firm or a contract? Why are all of these mechanisms so commonly used?

His answer to these questions is contained in the "Adaptation Cost" theory of the firm.

Start with a situation where a worker is providing a particular service to an entrepreneur. The entrepreneur's needs change so that the worker's service would have to also change if he is to stay with that entrepreneur. But the worker's productivity will suffer if he, either, changes the service he provides or changes to another entrepreneur and in either of these cases costs would have to be incurred due to the process of bargaining over the terms of a new agreement.

But the costs of worker adaptation are not just those of bargaining, there are also costs, in terms of lower productivity, if the worker has to change, either, to a new service or a new business. A worker is most efficient when he is "double specialised". That is, when he is continually providing the same service to the same business. If this "double specialisation" is not possible it is often second-best to specialise in one of the two dimensions and deal with occasional adaption in the other dimension. Some such adaptations, whether it be between two businesses or two services, are more costly than others.

The basic theory of the Adaptation Cost theory was developed in two papers by Wernerfelt, Wernerfelt (1997, 2015). To begin with the 1997 paper (chapter 3 of Wernerfelt 2016). The focus is on workers who supply businesses with services. The problem is that the needs of the businesses change. Three mechanism to deal with the changing needs are considered: employment, sequential contracting and price lists. In chapter 3 adaptation costs are mainly price determination costs only, since production costs are held constant.

Under the employment mechanism, workers and entrepreneurs negotiate on a once-and-for-all basis over the wage and a large set of services to be supplied on demand. This is similar to the situation in Simon (1951). Here a firm is made up of an entrepreneur and a number of workers who provide the entrepreneur with services via the employment mechanism while the scope of the firm is determined by set of workers thus employed by the entrepreneur. The downside of this is that since there are a large number of things to be bargained over the initial bargaining costs are large, but once agreement is reached there are no further costs incurred so the gains from trade are realised in each period.

Under the sequential contracting mechanism a new price gets negotiated whenever the business's requirements change and thus bargaining costs are incurred on each such occasion. However as the bargains are simpler than those required for the employment contract - the parties are bargaining over a single, known service - the per-occasion bargaining costs are lower.

With the price list, a set of price are agreed upon ex ante and then the list is referred to as needed. As with the case of sequential contracting the per-service bargaining costs are low but if the initial bargaining is over a very long list of prices those costs are high. Here the diversity of needs - how long the price list needs to be - is important to the relative attractiveness of the mechanism.

When the need for a change in service adaptation arise with sufficient frequency, the folk theorem allows us to assume that all trades are efficient under the employment and sequential contracting mechanisms, while under the price list mechanism all trades actually covered by the list are efficient. An implication of this is that there are no trading inefficiencies and thus the only bargaining costs involved are those associated with the mechanism process itself. Given this, the performance of each of the three mechanisms depends only on the costs of adapting to changes in the requirements of the businesses.

In the employment mechanism, costs are a one-time thing related to the negotiation of the wage agreement; for the sequential contracting mechanism the costs are the per-occasion costs of agreeing a price for that particular event; while for the price list mechanism the costs are those one-time costs involved in negotiating the price list plus the loss in the gains from trade for any situations not covered by the list.

Given that the employment mechanism has the lowest costs of adaption - just a verbal instruction - there exists a region in the parameter space, situations in which needs change frequently, in which the employment mechanism (weakly) dominates the other two mechanisms, see Figure 1.

From Figure 1 it is clear that price lists are good when they can be kept short, i.e. there a small number of services needed, sequential bargaining is good when changes are infrequent and employment is good when needs change frequently and many diverse adaptations are required.

Next consider the Wernerfelt (2015) paper (chapter 4 of Wernerfelt 2016). Importantly in this case adaptation costs are expanded to include the costs due to less efficient production. Specifically Wernerfelt assumes that there are gains from specialisation - where specialisation implies little in the way of adaptation - along two dimensions, first businesses and second, services. The former is modelled as an increase in adaptation costs for the worker each time he wants to service a different business. The latter is captured by assuming different workers are good at different things. In this situation three mechanisms are compared: employment, sequential contracting, as before, and markets. Again it is assumed that trade is ex post efficient in all three mechanisms. Wernerfelt concentrates on minimising adaptation costs.

Under the employment mechanism performance is delineated by the gains from trade in each period minus the one-off costs of negotiating the employment contract. The performance of sequential contracting is the gains from trade minus the bargaining costs incurred each period. The important thing about the market mechanism is that it allows workers to specialise in the services at which they are most efficient. "For example, instead of being superintendents they can be plumbers, carpenters, or electricians" (Wernerfelt 2016: 19). The advantage of this is that the gains from trade are increased but the disadvantage is that workers incur business adaptation costs (lose gains from specialisation) every time they switch businesses.

Wernerfelt shows that there are three regions in the parameter space in which each of the three mechanisms (weakly) dominates both of the two other mechanisms.

The relative performance of each of the three mechanisms depends on the frequency with which the needs of the businesses change, the gains from specialisation in an particular service, the business adaptation costs and bargaining costs. See Figure 2 and Figure 3.

Consider Figure 2. Markets are good when workers' between-business adaptation costs are low, that is, the gains from business specialisation are low and thus workers can cheaply switch between businesses; sequential contracting is good when changes in needs are infrequent; and employment is good when the cost advantage of service specialists are small and needs are changing quickly.

Another parameter is shown in Figure 3. Here "service specialisation" - the gains from specialisation in a particular service - is considered. Markets are good when service specialists are a lot more efficient than an employee carrying out many different tasks.

Wernerfelt (2016: 59) illustrates the effects of specialisation, switching costs and adjustment frequency with the example of the maintenance of a medium-sized apartment building,

The owner [of the building] will typically have an employee, the superintendent, perform minor repairs (``the toilet leaks"). The building generates a steady flow of small problems, they tend to be urgent, and the superintendent can solve each of them pretty well. On the other hand, certain minor renovations, such as those having to do with electricity (``install LED light bulbs in public spaces"), are normally done through the market. The jobs are often larger, service specialists can do them better, and the building does not need a full-time electrician. Major renovations, for which advance planning reduces the need for in-process changes, are typically governed by a bilateral contract subject to occasional, though typically costly, renegotiations.

The same example can illustrate the effects of size. A landlord who owns just one or two units will typically go to the market even for minor repairs because these units do not generate enough work to support a superintendent. On the other hand, very large landlords, such as universities, typically use specialist employees (their ``own" electricians) for both repairs and minor renovations.

The major prediction of this theory is that the more frequent are changes in needs the more attractive the employment contract becomes.

Refs.:

• Simon, Herbert A. (1951). "A Formal Theory of the Employment Relationship", Econometrica, 9(3) July: 293–305.
• Wernerfelt, Birger (1997). "On the Nature and Scope of the Firm", Journal of Business, 70(4): 489-514.
• Wernerfelt, Birger (2015). "The Comparative Advantages of Firms, Markets, and Contracts", Economica, 82 no. 236: 350-67.
• Wernerfelt, Birger (2016). Adaptation, Specialization, and Theory of the Firm: Foundations of the Resource-Based View, Cambridge: Cambridge University Press.

The division of labour and the firm: Stigler (1951)

"The division of labor is not a quaint practice of eighteenth-century pin factories; it is a fundamental principle of economic organization."
Stigler (1951: 193)
The following discussion covers material from Stigler (1951) which is one paper that offers a theory of the boundaries of a firm based on the division of labour. Interestingly Adam Smith, despite his famous discussion of the division of labour in the pin factory, did not develop a theory of the firm based on it.

Stigler begins his argument by saying that the division of labour, and its limit due to the extent of the market, lies at the core of a theory of the functions, and thus the boundaries, of a firm. Stigler outlines this theory in the second section of his paper.

In this theory a firm is seen as engaging in a series of distinct operations leading to the production of a final product. That is, the firm is partitioned not among its input markets but among the functions or process that determine the scope of its activities. And thus determine the firm's boundaries.

To allow the graphical representation of the firm's costs of production we will assume that the average costs of each activity depends only on the rate of output of the firm. In addition, if we assume that there is a constant proportion between the rate of output of each activity and the rate of output of the final product then all the cost functions can be drawn on the same diagram and the vertical sum of these costs will be the conventional average cost curve for the firm. With reference to the diagram below to produce q units of final output requires a given number of units of activity 1, costing C_1(q), a number of unit of activity 2, costing C_2(q), and a number of units of activity 3, costing C_3(q). These costs can be summed to give the average cost of production for q units of output, C_1(q)+C_2(q)+C_3(q).

With respect to the shape of the average cost curves for the various activities, some are increasing continuously (C_1), some are falling continuously (C_3) and some are conventionally U-shaped, (C_2).

Now consider the Adam Smith's idea that the division of labour is limited by the extent of the market. First take the activities for which there are increasing returns, Why doesn't the firm exploit the returns more fully and in the process become a monopoly in the output market? Because as the firm expands outputs other activities also have to be increased and some of these are subject to diminishing returns and these cost increases are such that they overwhelm the cost advantages of the increasing returns and increase the average cost of the final product. So why then does the firm not abandon these C_3-like activities and let some other firm (and thus industry) specialise in them to exploit the increasing returns fully? At a given time the market for these activities may be too small to support specialised firms. Given this firms must perform these activities for themselves.

But with an expansion of the market for the increasing returns activity firms specialised in that activity would develop. The firms currently carrying out this activity for its own consumption would forgo this activity and let it be taken over by a new (monopoly) firm. This monopoly could not fully exploit its market power however since it has charge a price which is less than the average cost of production for the firm abandoning the activity. As the market for this activity grows even larger the number of firms specialising in it grows. That is the industry becomes increasingly competitive.

The abandonment of this activity by the original firms will change the cost function for each firm. The cost curve, C_1, will be replaced by a horizontal line (the black dashed line in the diagram above) in the effective region. This also changes the average cost curve for the final product with the new curve (black dashed curve in the diagram above) being lower than the current curve.

What about the increasing cost case? Why not abandon or reduce use of those activities with increasing cost? Much of the previous discussion carries over to this case with the exception that as the market and the industry grows the original firms does not have to stop utilising that activity completely. Part of the needed use of that activity can still be produced in-house without high average (and marginal) cost, with the rest being purchased via the market.

Ref.:

• Stigler, George J. (1951). "The Division of Labor is Limited by the Extent of the Market", Journal of Political Economy, Vol. 59, No. 3 June, pp. 185-193.

Private funding of the Parker fight

Related to my previous posting on the withdraw of public funding for the Parker fight in Auckland comes this news from the New Zealand Herald on pay-for-view prices for the event.

Pay-per-view prices for Joseph Parker's heavyweight world title fight are set to go sky high, with punters and pubs expected to cop the fallout from Auckland Council's refusal on ratepayer funding.

The Herald on Sunday understands from a well-placed source that the pay-TV price for Parker's fight against Andy Ruiz Jr next month could now be set between $70 and $100.

The first point to make here is that this is one way for the event to be paid for by those who want to see the event.

The Herald also states,

The expected pay-TV spike comes after Auckland Council's events and economic development arm, Ateed, threw in the towel on funding the fight with ratepayer money.

Now for the bit I don't get about all of this, Why does the Herald journalist think that the pay-TV price has anything to do with public funding? I mean if the profit maximising price for screening the event is around $70 to $100 without public funding then why isn't this the profit maximising price with public funding?

If market conditions are such that the promoter can charge in the $70-$100 range for the fight when there is no public funding then those same conditions mean he can charge the same even with public funding. This basically just turns the public funding into a rent for the promoter.

It's a strange old world: good sense from JAFAland.

This bit of good news comes from nzherald.co.nz.

Just as they appeared set to announce Parker would fight Andy Ruiz Jr for the WBO title in the city on December 10, Auckland council's events arm Ateed have withdrawn their support for the event, leaving it in a state of limbo.

Ateed Chief Executive Brett O'Riley confirmed last night: "Ateed will not be providing financial sponsorship to Duco to stage the Parker/Ruiz fight."

and

O'Riley said it was not clear if staging the fight in Auckland would have "the desired outcomes of Auckland's Major Events Strategy" so the decision was made "not provide financial sponsorship for the fight."

It is understood Ateed's contribution was going to be "hundreds of thousands of dollars".

Looks like the ratepayers of Auckland have dodged a rather large bullet here.

From another Herald article comes this comment from Howick councillor Dick Quax who is opposed "throwing public money at a private event",

"Did anyone go to Zaire following the rumble in the jungle between George Foreman and Muhammad Ali. I don't think so," said Quax in a reference to the perceived benefits for Auckland.

Questions have to be asked as to whether the fight is a goer without some form of public money and if it isn't is there a justification for staging it in New Zealand. If there are real economic benefits to the fight being in Auckland why can't private funding be found to keep the fight there? If the private sector are not welling to back the event then does this tell us they really don't think they can capture (now or in the future) enough of the supposed benefits to justify backing the fight? Does this, in turn, suggest that the benefits aren't there? In which case why have the fight here?

Joel Mokyr interview

An interview of Joel Mokyr by Ana Swanson from the Washington Post.

Why did the industrial revolution start in Europe, rather than in China? In part because,

It isn’t just that China doesn’t have an Industrial Revolution, it doesn’t have a Galileo or a Newton or a Descartes, people who announced that everything people did before them was wrong. That’s hard to do in any society, but it was easier to do in Europe than China. The reason precisely is because Europe was fragmented, and so when somebody says something very novel and radical, if the government decides they are a heretic and threatens to prosecute them, they pack their suitcase and go across the border.

So exit options can matter. One government doesn't like your ideas, move onto the next.

Antitrust: where did it come from and what did it mean?

Is the title of a new working paper by Richard N. Langlois.

This paper is a draft chapter from an ongoing book project I am calling The Corporation and the Twentieth Century. In The Visible Hand, Alfred Chandler explained the rise of the large vertically integrated corporation in the United States mostly in terms of forces of technology and economic geography. Institutions, including government policy, played a quite minor role. In my own attempt to explain the decline of the vertically integrated form in the late twentieth century, I stayed true to Chandler’s largely institution-free approach. This book will be an exercise in bringing institutions back in. It will argue that institutions, notably various forms of non-market controls imposed by the federal government, are a critical piece of the explanation of the rise and decline of the multi-unit enterprise in the U.S. Indeed, non-market controls, including those imposed in response to the dramatic events of the century, account in significant measure for the dominance of the Chandlerian corporation in the middle of the twentieth century. One important form of non-market control – though by no means the only form – has been antitrust policy. This chapter traces the history of antitrust and argues that, far from being a coherent attempt to address an actual economic problem of monopoly, the Sherman Antitrust Act emerged from the distributional political economy of the nineteenth century. More importantly, the chapter argues that the form in which antitrust emerged would prove significant for the corporation, as the Sherman Act and its successors outlawed virtually all types of inter-firm coordinating mechanisms, thus effectively evacuating the space between anonymous market transactions and full integration.

The last couple of sentences of the abstract are interesting. An unintended(?) consequence of competition policy is an all-or-nothing approach to firm organisation. It's either a market transaction or a fully integrated organisation with little between them being legal. This removes many options in terms of organisational form for entrepreneurs to use to structure a transaction. This can result in an loss of efficiency in those cases where coordination of activity is most effectively carried out by an organisation that is not neither a fully integrated firms or a market transaction. Developments in competition policy in the US during the period around 1900 sent a clear signal that coordination through inter-firm agreements would surely face legal scrutiny whereas coordination within the boundaries of a single legal entity likely would not. This created a palpable incentive for firms to integrate.

Langlois notes an irony in all of this,

Here we begin to glimpse the great irony of American antitrust policy at the turn of the twentieth century: legislation pushed in part by small independent businesses to ward off the threat of the giant corporation actually harmed the small firms, which relied on coordination through contract, and reduced the relative cost of coordination within boundaries of large enterprises.

But such unintended consequences are so often the outcome of government intervention in economic activity.

Good and bad news on the Parker fight

From Sam Richardson's Fair Play and Forward Passes blog comes some good news and some bad news with regard to the Joseph Parker fight. It turns out that despite what we were hearing last week that the fight was most likely to go overseas it will in fact take place in Auckland. Duco withdrew their application for government funding and so no central government money will be put into the fight.

First up the bad news, Sam Richardson writes,

It is not 100% privately funded, though. One of the backers of the Parker camp is the Auckland City events arm ATEED, so there are already taxpayer dollars being funneled into the fight.

Auckland ratepayers will be the losers here. As Sam writes,

Now that the fight is taking place in Auckland, the question becomes whether the fight will generate economic benefits for the city and for New Zealand. In short, the benefits are likely to be confined to Auckland city and are not likely to spill over outside the city boundaries. The extremely short-term nature of the event itself will likely mean that any impact is short and sharp - don't expect longer-term economic impacts - even if Parker happens to win the fight.

Now for the good news,

In the Takam fight, Duco auctioned off 520 general admission tickets at $1 reserve on TradeMe. The intention of this experiment was an attempt to eliminate the possibility of scalping occurring with these tickets - people buying cheap and selling at higher prices.

With interest in this fight likely to be significantly greater than what it was for the Takam fight, it will be very interesting to see if Duco try it again. If anything, they have more to gain from giving it another go - one would expect the willingness to pay for a title fight to be much greater than for a build-up fight. Yet there is always a risk that they may not make the money that they are seeking - but they are likely to sell the tickets and fill the venue. At the same time, charging a fixed price is not a sure bet either - people might decide that the price is simply too steep and there could be empty seats as a result. There is also the possibility that the price might be set too low - and scalping could occur.

The use of an auction would be a great way to generate money for the promoter and deal with scalping. The reason for scalping is that tickets are, for whatever reason, priced at less than the market rate. Given that, it is obvious that money can be made by buying cheap and selling dear. That is, some people will be willing to pay a lot to get to go to the fight and scalpers who buy at the "official" price can resale to these high willingness to pay people at a much higher price. By auctioning off tickets Duco can capture most of the rents that the scalpers would otherwise get and in the process maximise the revenues they get from the fight. Note that this means there is less of a need for any public funding of the fight.

Basically what Duco would be doing is capturing the surplus that consumers would otherwise get if they were to buy at the lower "official" price - what economists call consumer surplus - via price discrimination. Duco can charge different people different prices. An auction is a way of getting people to reveal their willingness to pay.

Anti Trump letter from 370 economists

A group of 370 economists, including eight Nobel laureates in economics, have signed a letter warning against the election of Donald Trump. The letter calls him a "dangerous, destructive choice" for the country. And given his stated views on trade he is likely a "dangerous, destructive choice" for the rest of the world as well.

A few of the letter's statements on trade:

He has misled voters in states like Ohio and Michigan by asserting that the renegotiation of NAFTA or the imposition of tariffs on China would substantially increase employment in manufacturing. In fact, manufacturing’s share of employment has been declining since the 1970s and is mostly related to automation, not trade

He has falsely suggested that trade is zero-sum and that the “toughness” of negotiators primarily drives trade deficits.

He has misled the public with false statements about trade agreements eroding national income and wealth. Although the gains have not been equally distributed—and this is an important discussion in itself—both mean income and mean wealth have risen substantially in the U.S. since the 1980s.

Economist Letter 11012016 on Scribd

Is no competition policy the best competition policy?

Donal Curtin at the Economics New Zealand blog writes.

We had a session at last week's RBB Economics conference in Sydney on "How can a Chief Economist's team enhance competition law enforcement? - an examination of different approaches", with a panel made up of people who should know: Lilla Csorgo, chief economist on the competition side of our Commerce Commission; Graeme Woodbridge, chief economist for the whole caboodle at the ACCC; and RBB founding partner Simon Bishop to talk about the European Commission's experience.

One conclusion that emerged was that competition authorities had experimented over the years with various internal structures, ranging from a separate 'consultancy on call', through the EC's model of an internal quality check unit, through to integration (or at least close involvement in) the investigation teams. Of the various models, integration with the investigation teams, or, at a minimum, close and early involvement with the cases at hand, seemed to be working best.

I want to suggest a question that I'm sure no one at the conference would dare ask, Should there be competition policy in the first place? After all if you make a living out of competition policy, for your own good, you will concentrate on technical issues such as how should economists be integration into the enforcement process rather than suggesting putting yourself (and others) out of a job.

I'll guess that all those at the conference shared the view that a competition body is needed and that it should be a powerful player in its role as competition regulator. I would suggest that the first question the chief economist should ask is, Is this really right? May be competition policy 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 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.

Such questions and arguments will not win friends within the likes of the Commerce Commission but perhaps it would be good for the soul of those within such such bodies to sometimes think about these issues. And coming up with an answer may even be fun.

Refs.:
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.

Kevin Bryan on Oliver Hart and the nature of the firm

Kevin Bryan writes at VoxEU.org on Oliver Hart's contribution to the theory of the firm.

Bryan writes,

Grossman and Hart (1986) instead argue that the distinction that really makes a firm a firm is that it owns assets. Why does ownership matter? They retain the idea that contracts may be incomplete – at some point, I will disagree with my suppliers, or my workers, or my branch manager, about what should be done, either because a state of the world has arrived not covered by our contract, or because it is in our first-best mutual interest to renegotiate that contract.

They retain the idea that there are relationship-specific rents, so I care about maintaining this particular relationship. But rather than rely on transaction costs, they simply point out that the owner of the asset is in a much better bargaining position when this disagreement occurs. Therefore, the owner of the asset will get a bigger percentage of rents after renegotiation. Hence the person who owns an asset should be the one whose incentive to improve the value of the asset is most sensitive to that future split of rents.

Baker and Hubbard (2004) provide a nice empirical example: when on-board computers to monitor how long-haul trucks were driven began to diffuse, ownership of those trucks shifted from owner-operators to trucking firms. Before the computer, if the trucking firm owns the truck, it is hard to contract on how hard the truck will be driven or how poorly it will be treated by the driver. If the driver owns the truck, it is hard to contract on how much effort the trucking firm dispatcher will exert ensuring the truck isn’t sitting empty for days, or following a particularly efficient route.

The computer solves the first problem, meaning that only the trucking firm is taking actions relevant to the joint relationship that are highly likely to be affected by whether they own the truck or not. In Grossman and Hart’s ‘residual control rights’ theory, then, the introduction of the computer should mean the truck ought, post-computer, be owned by the trucking firm. If these residual control rights are unimportant – there is no relationship-specific rent and no incompleteness in contracting – then the ability to shop around for the best relationship is more valuable than the control rights provided by asset ownership.

Hart and Moore (1990) extend this basic model to the case where there are many assets and many firms, suggesting critically that sole ownership of assets that are highly complementary in production is optimal. Asset ownership affects outside options when the contract is incomplete by changing bargaining power, and splitting ownership of complementary assets gives multiple agents weak bargaining power and hence little incentive to invest in maintaining the quality of, or improving, the assets. Hart et al. (1997) provide a great example of residual control rights applied to the question of why governments should run prisons but not garbage collection.

As an aside Bryan writes,

[...] note the role that bargaining power plays in all of Hart’s theories. We do not have a ‘perfect’ – in a sense that can be made formal – model of bargaining, and Hart tends to use bargaining solutions from cooperative game theory like the Shapley value. After Lloyd Shapley’s Nobel prize alongside Alvin Roth in 2012, this makes multiple prizes heavily influenced by cooperative games applied to unexpected problems. Perhaps the theory of cooperative games ought still be taught with vigour in PhD programmes.

I have to agree with Bryan here, coopertive game theory should be taught to all students. The guy that taught me game theory in my honours degree covered cooperative as well as non-cooperative game theory and the cooperative stuff was interesting with more applied applications than you would think. One of my first publications was on the application of cooperative game theory to cost allocation problems. How do you allocate fixed ad joint costs of a project to those agents undertaking the project? Cooperative game theory gives some nice solution to this problem. It also comes in handy when dealing with bargaining problems like those utilised in Hart's work. The two most commonly use solutions concepts are the Nash bargaining solution and the Shapley Value.

Bryan continues by commenting on Hart's more recent work on the reference point approach to the firm,

[...] he has been primarily working on theories which depend on reference points, a behavioural idea that when disagreements occur between parties, the ex ante contracts are useful because they suggest ‘fair’ divisions of rent, and induce shading and other destructive actions when those divisions are not given. These behavioural agents may very well disagree about what the ex ante contract means for ‘fairness’ ex post.

The primary result is that flexible contracts (for example, contracts that deliberately leave lots of incompleteness) can adjust easily to changes in the world but will induce spiteful shading by at least one agent, while rigid contracts do not permit this shading but do cause parties to pursue suboptimal actions in some states of the world.

This perspective has been applied by Hart to many questions over the past decade, such as why it can be credible to delegate decision-making authority to agents: if you try to seize it back, the agent will feel aggrieved and will shade effort (Hart and Holmström 2010). These responses are hard, or perhaps impossible, to justify when agents are perfectly rational, and of course the Maskin-Tirole critique would apply if agents were purely rational.

So where does all this leave us concerning the initial problem of why firms exist in a sea of decentralised markets? We have many clever ideas, suitable for particular contexts, but still do not have a believable, logically ironclad theory.

A perfect theory of the firm would need to be able to explain why firms are the size they are, why they own what they do, why they are organised as they are, why they persist over time, and why inter-firm incentives look the way they do. It almost certainly would need its mechanisms to work if we assumed all agents were highly, or perfectly, rational – foolishness is not a good justification for institutions employed by millions of organisations.

Since patterns of asset ownership are fundamental, it needs to go well beyond the type of hand-waving that makes up many ‘resource’ type theories. (Firms exist because they create a corporate culture! Firms exist because some firms just are better at doing X and can’t be replicated! These are outcomes, not explanations.)

Byran is correct when he says we have, as yet, no "believable, logically ironclad theory". As I note in Walker (2016: 160)

While the post-1970 theory of the firm literature has began the task of developing a genuine understanding of the firm, and closely related issues, it has yet to coalesce around one model or even one group of models. Even within the contemporary mainstream there are a number of competing models, to say nothing of those we could add into the mix if we were to consider the heterodox literature.

As Bylund (2016: 1–2) explains,

[...] there are several notable theories that each provide a different explanation and rationale for the business firm. [...] [T]here are several different definitions of what the firm supposedly is. [...] But each one must necessarily be incomplete, since it doesn’t capture all of what the other definitions capture.

One can be forgiven for thinking that the current situation with regard to the modelling of the firm is much like a group of blind men trying to describe an elephant, each man can tell you about the part he can feel while remaining unaware of the rest of the animal. Each of the current theories tells us something about the firm, but none can tell us everything.

But if we had all the answers there would be no fun (or point) in working in the area.

Refs.:

• Baker, G, and T Hubbard (2004), ‘Contractibility and Asset Ownership: On-board Computers and Governance in US Trucking’, Quarterly Journal of Economics 119(4): 1443-79.
• Bylund, Per L. (2016). The Problem of Production: A New Theory of the Firm, London: Routledge.
• Grossman, S, and O Hart (1986), ‘The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration’, Journal of Political Economy 94(4): 691-719.
• Hart, O, and B Holmström (2010), ‘A Theory of Firm Scope’, Quarterly Journal of Economics 125(2): 483-513.
• Hart, O, and J Moore (1990) ‘Property Rights and the Nature of the Firm’, Journal of Political Economy 98(6): 1119-58.