Macroeconomists do it with models

John Taylor has an interesting post - Measuring the Impact of the Stimulus Package with Economic Models - at his Economics One blog on the problems of evaluating the effects of the stimulus package of 2009 in the US. Taylor writes,

It's been nearly a year since the stimulus package of 2009 was passed. Unfortunately most attempts to answer the question “What was the size of the impact?” are still based on economic models in which the answer is built-in, and was built-in well before the stimulus. Frequently the same economic models that said, a year ago, the impact would be large are now trotted out to show that the impact is large. In other words these assessments are not based on the actual experience with the stimulus. I think this has confused public discourse.

In other words, should we be surprised that we see the rabbit come out of the hat given we saw it carefully put it there in the first place? Taylor continues,

An example is a November 21 news story in the New York Times with the headline “New Consensus Sees Stimulus Package as a Worthy Step.” Authors Jackie Calmes and Michael Cooper write that “the accumulation of hard data and real-life experience has allowed more dispassionate analysts to reach a consensus that the stimulus package, messy as it is, is working. The legislation, a variety of economists say, is helping an economy in free fall a year ago to grow again and shed fewer jobs than it otherwise would.”

As evidence the article includes three graphs, which are reproduced on the left of the chart below. Each of the three graphs on the left corresponds to a Keynesian model maintined by the group shown above the graph. All three graphs show that without the stimulus the recovery would be considerably weaker. The difference between the black line and the gray line is their estimated impact of the stimulus. But this difference was built-in to these models before the stimulus saw the light of day. So there are no new hard data or real life experiences here.

Taylor then makes the point that if the rabbit isn't put in the hat, it doesn't come out.

In fact, a number of other economic models predicted that the stimulus would not be very effective, and, using the same approach, those models now say that it is not very effective. To illustrate this I have added two other graphs on the right-hand side of the chart which did not appear in the New York Times article. The first one is based an a popular and well-regarded new Keynesian model estimated by Frank Smets, Director of Research at the European Central Bank, and his colleague Raf Wouters. Focus again on the difference between the black and the gray lines, which is what is predicted by that model, as shown in research by John Cogan, Volker Wieland, Tobias Cwik, and me. Note that the impact is very small. The second additional graph on the right is based on the research of Professor Robert Barro of Harvard University. As he explained last January, “when I attempted to estimate directly the multiplier associated with peacetime government purchases, I got a number insignificantly different from zero.” So according to that research, the difference between the black and the gray line should be about zero, which is what that graph shows. So there is no consensus.

There seems to be at least two basic messages that follow from this: one, when using models to evaluate policy outcomes it is important to go beyond the use of just a few select models, and check to see if the outcome is robust across a number of different models. Second, it is now time to start looking at the direct impacts of the stimulus by looking at the hard data.

Christians and capitalism

From the Cato Institute comes this video of a book forum on Money, Greed, and God: Why Capitalism Is the Solution and Not the Problem by Jay Richards. The forum features the author, Jay Richards, with comments by Doug Bandow, Senior Fellow, Cato Institute, and author, Beyond Good Intentions: A Biblical View of Politics. Moderated by Daniel Griswold, Director of the Center for Trade Policy Studies, Cato Institute, and author, Mad about Trade: Why Main Street America Should Embrace Globalization.

Defenders of the free market must often contend with accusations from Christians that capitalism is immoral despite its track record of delivering the goods. Jay Richards says there's no contradiction between Christianity and capitalism. He argues that markets, though imperfect, are a natural outgrowth of God's creation and an important tool for helping the poor and disadvantaged.

Markets fail. That's why we need markets

Or so says Arnold Kling and Nick Schulz in the Christian Science Monitor:

This view can be summarized as “Markets fail. That’s why we need markets.”

This seemingly paradoxical view is based on several overlapping strands of research in economics as it pertains to development, history, technology, business expansion, and new-firm formation. According to this view, entrepreneurs at work in the economy – in finance, high tech, manufacturing, services, and beyond – are constantly experimenting, creating new business models, techniques, and technologies that upend the established order of things.

Some new technologies and innovations are genuine improvements and are long-lasting welfare enhancers. But others are the basketball equivalent of pump fakes – they look like the real deal and prompt market actors to leap hastily into action, only to realize later that their bets were wrong.

Given this dynamic, markets are unpredictable, prone to booms and busts, characterized by bouts of exuberance that are rational or irrational only in hindsight.

But markets are also the only reliable mechanism for sorting out this messy process quickly. In spite of the booms and busts, markets drive genuine long-run innovation and wealth creation.

When governments attempt to impose order on this chaotic and inherently risky process, they immediately run up against two serious dangers.

The first is that they strangle new innovations before they can emerge. Thus proposals for a Consumer Financial Protection Agency, a systemic risk regulator, a public health insurance plan, a green jobs policy, or any attempt at top-down planning may do more harm than good.

The second danger has to do with the nature of political economy. Politics creates its own kind of innovators who can be as destabilizing to markets as market actors themselves – but in far more pernicious ways.

Economists call these political entrepreneurs “rent-seekers.” Rent-seekers gain wealth, not by creating it, but by channeling it through political favors. Examples include government-sponsored monopolies, “targeted” tax breaks for special industries, and legislative loopholes inserted by lobbyists.

The boom in housing and mortgage securities that ended so badly was fueled by government policies that were encouraged by rent-seekers in the real estate, home building, and mortgage finance industries.

Rent-seekers aren’t partisan. They used President Bush’s push for an ownership society to promote sketchy mortgage products. Before that, they used President Clinton’s push for a fairer economy to compel banks to make loans to poorer neighborhoods. In both cases, rent-seekers turned political slogans into profit, but at a steep cost to society when the boom ended.

The response to the current economic crisis has perpetuated and even intensified this process, as hundreds of billions of dollars of taxpayer funds have been used to prop up the very firms that took such reckless risks. The bigger the bad bet, the bigger the bailout.

This gets to the key difference between markets and governments. When innovation-driven excesses and imbalances are recognized in the marketplace, the system can correct itself quickly. This is less the case when government policy failure occurs.

Because political failure is less publicly tolerable than market failure, the temptation becomes for policymakers to avoid acknowledging their role in creating or perpetuating problems. Or they double down on bad bets. So rather than recognize the government’s central role in the housing boom and bust and quickly changing its ways, we see the federal policy apparatus continuing to throw good money after bad in the mortgage market and on Wall Street.

Markets fail; but they learn from their failures. That’s why we need markets. Government can promise to guarantee our prosperity; but only markets can really deliver.

Is an undervalued currency the key to economic growth?

The short answer seems to be no. A recent paper by Michael Woodford argues that the evidence in favour of an positive link between an undervalued currency and economic growth is less persuasive than some authors, Dani Rodrik being one, suggest. This is for two reasons. First, some papers exaggerate the strength and robustness of the association between the real exchange rate and growth in the cross-country evidence. And second, even granting the existence of such a correlation, a causal effect of real exchange rates on growth is hardly the only possible interpretation.

The abstract of the Woodford paper reads,

Dani Rodrik (2008) offers a provocative argument for policies that seek to maintain an "undervalued" exchange rate in order to promote economic growth. The key to his argument is the empirical evidence that he presents, indicating correlation of his measure of undervaluation with economic growth in cross-country panel regressions. Rodrik does not really discuss the measures that should be undertaken to maintain an undervalued exchange rate, and whether it is likely that a country that pursues undervaluation as a growth strategy should be able to maintain persistent undervaluation. For example, he remarks (as justification for interest in the question of a causal effect of undervaluation on growth) that "one of the key findings of the open-economy macro literature is that nominal exchange rates and real exchange rates move quite closely together." But while this is true, and while it is widely interpreted as indicating that monetary policy can affect real exchange rates (since it can obviously move nominal rates), it hardly follows that monetary policy alone can maintain a weak real exchange rate for long enough to serve as part of a long-run growth strategy. Indeed, conventional theoretical models with short-run price stickiness, that are perfectly consistent with the observed short-run effects of monetary policy on real exchange rates, imply that monetary policy should not have long-run effects on real exchange rates. Rodrik also cites evidence showing that sterilized interventions in the foreign-exchange market can affect real exchange rates. But economic theory suggests that interventions not associated with any change in current or subsequent monetary policy should have even more transitory effects. And the experiences of countries that have sought to use devaluation to boost economic growth have often found that the real exchange rate effect of a nominal devaluation is not long-lasting. Nonetheless, the point of the paper is to provide evidence that undervaluation favors growth, on the assumption that policies to maintain undervaluation are avail- able, and it is that central contention that I shall examine here. I find the evidence less persuasive than the paper suggests, for two reasons. First, I believe that the paper exaggerates the strength and robustness of the association between the real exchange rate and growth in the cross-country evidence. And second, even granting the existence of such a correlation, a causal effect of real exchange rates on growth is hardly the only possible interpretation.

The wages of sin ...

are high.

A new paper by Lena Edlund, Joseph Engelberg and Christopher A. Parsons, The Wages of Sin, looks at the high-end prostitution market, the so called escort market.

A standard argument for the high wages of prostitutes is that they compensate for risk and things like foregone marriage opportunities due to the stigma of prostitution. This new paper looks at the prostitution market where there is a lower risk, the high-end escort service industry. These workers do not work on the street and thus have a better control on who they do business with. Also, they are less visible, which should help a little with stigma issues.

It may be expected that the price paid for an escort would decrease with age. But it appears to do so very little. In fact, wages have a hump-shaped pattern, with a peak at the age bracket where the probability of marriage is the highest in the general population. This suggests that foregone marriage opportunities are important. Furthermore, Edlund, Engelberg and Parsons find that those escorts whose activity has no impact on the marriage market, those who, for example, do not offer sex or are transsexual, do not have such a hump. Finally, in places where most of the business is with travellers, the premium is lower.

The abstract reads,

Edlund and Korn [2002] (EK) proposed that prostitutes are well paid and that the wage premium reflects foregone marriage market opportunities. However, studies of street prostitution in the U.S. have revealed only modest wages and considerable risks of disease and violence, casting doubt on EK’s premise of an unexplained wage premium. In this paper, we present evidence from high-end prostitution, the so called escort market, a market that is, if not entirely safe, notably safer than street prostitution. Analyzing wage information on more than 40,000 escorts in the U.S. and Canada collected from a web site, we find strong support for EK. First, escorts in the sample earn high wages, on average $280/hour. Second, while looks decline monotonically with age, wages follow a hump-shaped pattern, with a peak in the 26-30 age bracket, which coincides with the most intensive marriage ages for women in the U.S. Third, the age-wage profile is significantly flatter, and prices are lower (5%), despite slightly better escort characteristics, in cities that rank high in terms of conferences, suggesting that servicing men in transit is associated with less stigma. Fourth, this hump in the age-wage profile is absent among escorts for whom the marriage market penalty is lower or absent: escorts who do not provide sex and transsexuals.

Happy birthday, Ronald

Happy Birthday to Ronald Coase who turned 99 years young today. He was born at 3:25 p.m. on December 29th, 1910.

Coase received the Nobel Prize in 1991 “for his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy.”

EconTalk this week

Clifford Winston of the Brookings Institution talks about the ideas in his book, Market Failure vs. Government Failure, with EconTalk host Russ Roberts. Winston summarizes a large literature on antitrust, safety regulation and environmental regulation. He finds that government regulation often fails to meet its objectives. While markets are imperfect, so is government. Winston argues that idealized theories of government intervention based on textbook theories of market failure are not the way regulation turns out in practice. He argues that special interest politics explains much of the disappointing outcomes of government regulation.

Attack of the utility monsters

The Cato Daily Podcast for the December 22, 2009 was "Attack of the Utility Monsters" featuring Jason Kuznicki.

The paper being discussed in the podcast is Attack of the Utility Monsters: The New Threats to Free Speech.

Freedom of expression is looking less and less like a settled issue. Challenges to it have lately arisen from the right, from the left, from Muslim perspectives, and even in the name of protecting children online. These challenges seem to share an underlying concern, namely that we must balance free expression against the psychic hurt that some expressions will provoke. Often these critiques are couched in language that draws or appears to draw, on the law and economics movement. Yet the cost-benefit analyses advanced to support restrictions on expression are incomplete, subjective, and self-contradictory.

Several examples help to illustrate this point, including flag-desecration laws, hate-speech laws in the United Kingdom and Canada, U.S. college and university speech codes, the Cairo Declaration on Human Rights in Islam, and the Megan Meier Cyberbullying Prevention Act, currently before the House Judiciary Subcommittee on Crime, Terrorism, and Homeland Security. Although seemingly unrelated, these measures rely on a common assumption, namely that governments should provide emotional well-being to their citizens, even at the expense of free expression. This assumption discounts the emotional well-being of other citizens, neglects countervailing social considerations, and hands arbitrary power to governments.

The result is not more happiness, but a race to the bottom, in which aggrieved groups compete endlessly with one another for a slice of government power. Philosopher Robert Nozick once observed that utilitarianism is hard-pressed to banish what he termed utility monsters—that is, individuals who take inordinate satisfaction from acts that displease others. Arguing about who hurt whose feelings worse, and about who needs more soothing than whom, seems designed to discover—or create—utility monsters. We must not allow this to happen.

Instead, liberal governments have traditionally relied on a particular bargain, in which freedom of expression is maintained for all, and in which emotional satisfaction is a private pursuit, not a public guarantee. This bargain can extend equally to all people, and it forms the basis for an enduring and diverse society, one in which differences may be aired without fear of reprisal. Although world cultures increasingly mix with one another, and although our powers of expression are greater than ever before, these are not sound reasons to abandon the liberal bargain. Restrictions on free expression do not make societies happier or more tolerant, but instead make them more fractious and censorious.

The relationship between capitalism and freedom

The Washington Post reports,

SEOUL -- North Korean leader Kim Jong Il moved early this month to wipe out much of the wealth earned in the past decade in his country's private markets. As part of a surprise currency revaluation, the government sharply restricted the amount of old bills that could be traded for new and made it illegal for citizens to have more than $40 worth of local currency.

It was an unexplained decision -- the kind of command that for more than six decades has been obeyed without question in North Korea. But this time, in a highly unusual challenge to Kim's near-absolute authority, the markets and the people who depend on them pushed back.

Grass-roots anger and a reported riot in an eastern coastal city pressured the government to amend its confiscatory policy. Exchange limits have been eased, allowing individuals to possess more cash.

The currency episode reveals new constraints on Kim's power and may signal a fundamental change in the operation of what is often called the world's most repressive state. The change is driven by private markets that now feed and employ half the country's 23.5 million people, and appear to have grown too big and too important to be crushed, even by a leader who loathes them.

While these events in no way guarantee that North Korea will soon become a freer place, they do suggest that economic freedoms can help constrain even the most oppressive of governments.

The Post continues,

Still, analysts say there has also been evidence of unexpected shifts in the limits of Kim's authority.

"The private markets have created a new power elite," said Koh Yu-whan, a professor of North Korean studies at Dongguk University in Seoul. "They pay bribes to bureaucrats in Kim's government, and they are a threat that is not going away."

Is this a case where corruption can be efficient? Being able to bribe the bureaucrats may not only undermine the power of the state, it may also lead to a more efficient outcome than if the bureaucrats where incorruptible.

Message on Offsetting Behaviour (updated x2)

If anyone is looking for Offsetting Behaviour, it is currently down due to GoogleFail: they think it's a spam blog. But it will be back soon.

Update: Eric comments

Correction: will be back when and if a human at google checks my blog and confirms that it isn't spam.

I had a page rank of 6 before take down for chrissakes. The whole University has only a PR of 7. How the hell does a spam blog get a PR of 6?

If you want to know what has been going on at Offsetting Behaviour here is the Google Cache as at 27 Dec 2009 06:21:26 GMT.

Update 2: Offsetting Behaviour is now back.

Economics as science

From Bloggingheads.TV comes this video of the Alex Rosenberg and David Levine discussing the topic of Economics as Science.

Five questions for a Keynesian

At at PBS's Nightly Business Report, Steven Horwitz has Five Questions for a Keynesian. Should you, over the Christmas period, be involved in a conversation at some social event with a Keynesian type, Horwitz suggests these five questions to get the argument really going:

1. Why did Keynes think savings was bad if when people save through financial intermediaries they give control over resources to the banking system, which in turn will lend that out to firms to create capital and new jobs?

2. How does government spending create jobs and wealth if the resources that government spends must ultimately come from the private sector, through taxes or reduced borrowing due to government borrowing more (or inflation), and the private sector would have spent it either on consumption directly or on investment through savings anyway?

3. If one of the problems of the housing boom is that we put too many resources into housing and finance, how will a Keynesian government spending package know where that spending should have gone instead?

4. Keynes frequently wrote about the importance of the uncertainty of the future and the way that made things difficult for private investors and for the connection between savings and investment. Why doesn't that same uncertainty prevent governments from knowing exactly how much and where they should be spending in a recession, especially because markets have prices and profits as signals to help entrepreneurs navigate that uncertainty while government bureaucrats do not have similar signals?

5. Given the enormous role that government interventions played in causing the current recession, from the expansionary policies of the Fed to GSEs like Fannie and Freddie, to misguided regulations in housing and banking, why should anyone believe that the same government actors will know how to solve it?

Feel free to report here any and all answers you receive to these questions.

The usefulness of the "Buy Kiwi Campaign" 2

Earlier I posted on The usefulness of the "Buy Kiwi Campaign", arguing that the campaign was useless. Now over at Offsetting Behaviour Eric Crampton take me, and NotPC, to task for this view. Eric argues that while it may have had no economic impact, the campaign was not in fact useless. He writes,

The biggest problem with MMP is the costly bargains main parties have to make with support partners. The more efficient that main parties are at creating symbols to placate support parties that have zero real world effect, the better. Yes, they can cost a bit of money in the budget; NotPC says the Buy NZ campaign cost somewhere around $10 million. But that's insanely cheap compared to other anti-trade policies. I cannot imagine a better piece of policy that buys off the Greens and the nationalists while having trivial deadweight costs. Yeah, so every tax dollar has a deadweight cost somewhere around thirty cents. So the policy cost $13 million all up, pure loss. But compared to hiking tariffs or abandoning the free trade deal with China? Priceless.

I guess part of the disagreement is due to me looking at the campaign from a economic point of view, rather a political point of view. Also Eric's argument only works if the alternative buy-off of the Greens was more expensive than the "buy New Zealand campaign", and we don't know what the alternative was. If we are to assume that the campaign buy-off was the cheapest option, then we live in the (2nd) best of all possible worlds. But it seems unlikely to me that, given we are talking politics, we would be in the best of all possible worlds. Just because it is doesn't mean it's best, or even 2nd best. Political markets are not as efficient as economics markets. Politicians are spending other people's money and as Milton Friedman put it "very few people spend other people's money as carefully as they spend their own." I think Eric is, implicitly, assuming we got the best deal possible, something which for me at least seems a little too Panglossian.

Smoot-Hawley tariffs and the Great Depression

A view common among economists is that the Smoot-Hawley tariffs of the 1930s in the US were a poor policy choice, but they were not a main reason for the severity of the Great Depression. With regard to the latter point in the previous sentence, Scott Sumner at the TheMoneyIllusion blog writes,

In the period around March and April 193o, there were a few “green shoots” in the economy. The stock market recovered a significant chunk of the huge losses in 1929. (I recall the Dow fell well below 200 during the famous crash, and got back up over 260 in April. The 1929 peak had been 381.) Then in May and June everything seemed to fall apart, and stocks crashed again. So what happened in May and June?

The headline news stories during those months were the progress of Smoot-Hawley through Congress. Each time it cleared a major legislative hurdle, the Dow fell sharply. This pattern was obvious to those following the markets, and was frequently commented upon. After it cleared Congress it went to Hoover. The President received a petition from over 1000 economists pleading with him to veto the bill. (A veto would not have been overridden.) Over the weekend Hoover decided to sign the bill, and on Monday the Dow suffered its biggest single day drop of the entire year.

Sumner argues that the Smoot-Hawley reduced investment not only in the US but all over the world and interest rates fell, the opportunity cost of holding gold fell, and the demand for gold rose. This caused deflation, which made the Depression even worse.

Implications of the crisis for introductory economics

This comes from Economics One the blog run by Stanford's John Taylor. It rises a number of interesting issues about the teaching of first year economics, in particular after the recent financial crisis.

So how should introductory economics teaching change as a result of the financial crisis? Talyor writes,

Clearly we need to include more on financial markets, but based on my experience teaching in the two-term introductory course at Stanford, I think the single most important change would be to stop splitting microeconomics and macroeconomics into two separate terms. The split has been common in economics teaching since the first edition of Paul Samuelson’s textbook, which put macro first. Many courses now have micro in the first term and then macro in the second.

But regardless of the order now used, I think a reform that integrates micro and macro throughout is worth considering. There were arguments for doing this before the crisis, including the fact that in research and graduate teaching the tools of micro have now been integrated into macro.

The financial crisis clinches the case for full integration in my view. The crisis is the biggest economic event in decades and it can only be understood with a mix of micro and macro. To understand the crisis one must know about supply and demand for housing (micro), interest rates that may have been too low for too long (macro), moral hazard (micro), a stimulus package (macro) aimed at such things as health care (micro), a new type of monetary policy (macro) that focuses on specific sectors (micro), debates about the size of the multiplier (macro), excessive risk taking (micro), a great recession (macro), and so on. It you look at the 22 items that the Financial Crisis Inquiry Commission has been charged by the Congress to examine, you’ll see that it is a mix of micro and macro. Defining the first term as micro and the second term as macro, or visa versa, is no longer the best way to allocate topics.

Austrian economics: recent work

Mario J. Rizzo has a new article, Austrian economics: recent work, available on The New Palgrave Dictionary of Economics, Online Edition, 2009. The abstract reads,

This article reviews research in Austrian economics over the last 25 years, relating it to (but not discussing in detail) earlier classic work in the Austrian tradition. Core issues are business cycle theory, entrepreneurship, market processes and economic institutions, the communication of knowledge in markets, spontaneous order, and issues related to law and economics.

The Introduction continues,

In the past 25 years, a large amount of new research in Austrian economics has developed and expanded the basic themes that are central to its unique identity (O'Driscoll and Rizzo, 1996). These highly interrelated themes are (1) the subjective, yet socially embedded, quality of human decision making; (2) the individual's perception of the passage of time (‘real time’); (3) the radical uncertainty of expectations; (4) the decentralization of explicit and tacit knowledge in society; (5) the dynamic market processes generated by individual action, especially entrepreneurship; (6) the function of the price system in transmitting knowledge; (7) the supplementary role of cultural norms and other cultural products (‘institutions’) in conveying knowledge; and (8) the spontaneous – that is, not centrally directed – evolution of social institutions. The specific ways in which these themes have recently manifested themselves is the subject of this article.

If you can't access the final version, there is an almost-final version available here.

The usefulness of the "Buy Kiwi Campaign"

The Importers Institute comments on the usefulness of the "Buy Kiwi Campaign":

The Greens and the last Labour government decided to fund a "Buy Kiwi Campaign". They spent $10.2 million from our taxes, most of it ($8.4m) with an advertising agency.

The Ministry of Economic Development has now commissioned a review from consultants MartinJenkins and Associates. The report is available from the Ministry's website: http://tinyurl.com/ydnorqw.

The report concluded "there was no convincing evidence of overall impact on consumer spending", "there was a lack of conventional policy analysis" and "there was no assessment of the likely impact or of the costs and benefits". In other words, Green and Labour politicians spent our money like confetti, spraying it against the Wellington wind - and achieved nothing of any use.

We could have told them all of that before they spent a single cent of our money. The only beneficiaries were some residents of Grey Lynn, who lined their pockets with the advertising extravaganza.

The uselessness of the campaign was very predictable. As Chris Worthington wrote back in 2007,

If you haven’t seen the new poster for the “Buy New Zealand made” campaign, it features an attractively attired woman, asking the question, “Does my economy look good in this?” The implication, of course, is that we should think carefully about the damage wrought when we purchase foreign-made goods.

As an economist, I am loath to criticise a campaign that features pretty models urging us to think more about the economy. But, to my great dismay, there simply isn’t any intellectual merit to the campaign’s message. Buy all the foreign products you want – it won’t hurt the domestic economy in the slightest.

Worthington continues,

If we think harder about the trade process, it becomes clear that there is an error in the intuition that when foreign goods are purchased, spending power (and thus jobs) vanish from the domestic economy.

The mistake begins with the terminology. We don’t “buy” imports, we swap for them. In order to purchase that Chinese-made dress, our poster-girl first needs to find someone willing to take her New Zealand dollars in exchange for Chinese currency. But New Zealand dollars serve only one purpose – you can buy New Zealand produced goods or services (exports), or you can lend them to New Zealanders who will in turn buy New Zealand produced goods or services.

So the money does not disappear – we can only buy imports if there is someone willing to accept our exports in return, either now or in the future (if the money is used for lending). And, indeed, imports and exports tend to closely balance over the long-run. Over the last 20 years New Zealand has had an average trade surplus of 0.9% of GDP.

So buy foreign, it makes not difference to the New Zealand economy.

The why of Boxing Day sales

For those of you who have been taking advantage of the Boxing Day Sales here is a question, Why do we see post-Christmas sales? Why are the sales right after Christmas and why do they happen every year?

There are a number of possible reasons. To get rid of all the unwanted merchandise is one, while to reduce inventories for tax purposes, is another. May be post-Christmas sales are a consequence of store buyers' misjudgements about the market demands for various goods and thus come down to mistakes in ordering.

But if such sales happen year after year after year can it really be chalked up solely to misjudgements and errors. If post-Christmas sales can be chalked up to misjudgments and mistakes, then you have to ask, Why are the store buyers at these stores retained, year after year after year? Shouldn't they be fired and replaced with buyers whose misjudgements and errors aren't as pervasive and persistent? After all, we are looking at stocking "mistakes" at Christmas that are systematic, that extend to all departments in the stores and result in "excess inventories" that are discounted by 50% or more. Also if stores have "excess inventories" why not sell them off at full price slowly over the next year, and order less next Christmas.

There must be a better explanation. And there is, price discrimination. This amount to saying that retail stores have post-Christmas sales (often deep ones) because the price-insensitivity of their customers takes a plunge between the day before Christmas and the day after. McKenzie (2008: 71) puts it this way,

Before Christmas, many customers need the goods they buy to be able to stand witness to the considerable (often only imagined) joy of their love ones and friends on Christmas morning receiving their gifts. Before Christmas, many customers are working and have high opportunity costs of their time; they also might have low storage costs. They have not yet filled their cabinets and closets with countless gifts, most wanted but some kept only out of respect for the givers. After Christmas, many buyers are often fully stocked with more goods than they need, or want. Many are often on holiday breaks at Christmas time, with low opportunity time costs.

More to the point, before Christmas, buyers' demands are highly inelastic. After Christmas, they are highly elastic because they have time to consider more carefully the prices charged by any number of sellers, and they have to see significant price reductions to stuff their cabinets and closets with more products. [...] firms can maximize profits only by playing to the different elasticities of demand, which means that they should charge relatively higher prices before Christmas in anticipation of charging relatively lower prices afterwards.

Stores order earlier in the year, and they order with both markets in mine. That is, they order with both the pre-Christmas and post-Christmas buyers in mind. What is tell us is that post-Christmas sales are planned for, they are not the result of mistakes. McKenzie again,

The higher before-Christmas prices fit the higher demand and lower price elasticities of demand that stores then face. The after-Christmas prices fit the then lower demand and higher price elasticities of demand. Christmas allows stores to segment their markets with the prices charged before Christmas being higher than it would be if a constant price for both market segments had to be charged. (McKenzie 2008: 72)

McKenzie goes on to note

Of course, the elevated before-Christmas prices, followed by expected after-Christmas sales, can cause many price-sensitive shoppers to postpone as many purchases as they can until after Christmas. But such postponements are not necessarily all bad for stores, since the postponements further segment their markets into price-insensitive and price-sensitive shoppers. Purchase postponements can leave the before-Christmas market dominated by highly price-insensitive customers, giving rise to some additional price increase tailored to the demands of the before-Christmas shoppers. Shoppers who delay their purchases can increase the after-Christmas demands for goods, thus tempering the extent of the after-Christmas price cuts. (McKenzie 2008: 72)

So post-Christmas sales are just a way for retailers to get you to reveal your price sensitivity, and then charge you accordingly.

• McKenzie, Richard B. (2008). Why Popcorn Costs So Much at the Movies: And Other Pricing Puzzles. New York: Copernicus Books.

Incentives matter: motor industry file

From a story in the Wall Street Journal,

Venezuelan President Hugo Chávez, beset by a recession that is hurting his popularity, has turned his sights on international car companies, threatening them with nationalization and pledging to ramp up government intervention in their local businesses.

The populist leader has threatened to expropriate Toyota Motor Corp.'s local assembly plant if the Japanese car maker doesn't produce more vehicles designed for rural areas and transfer new technologies and manufacturing methods to its local unit. He said other car companies were also guilty of not transferring enough technology, mentioning Fiat SpA of Italy, which controls Chrysler Group LLC, and General Motors Co.

What incentives does this give the car companies? Anyone what to take a bet on what will happen to rural Venezuelans’ access to automobiles and other automotive products? Anyone what to take a bet on what will happen to private foreign investment in Venezuela?

(HT: Cafe Hayek)

Peter Singer and William Easterly on Bloggingheads.tv

Bloggingheads.TV has put up a 45 minute video discussion between Peter Singer and William Easterly where Peter and William discuss imposing tough love on the global poverty charities who take your Christmas gifts and donations. The message that does come through loud and clear from both Singer and Easterly is; give, and, equally important, make sure your gifts reach the poor. Sounds so simple, and yet you have to work hard at the details to get it right.