People respond to incentives ...

really they do.

At FT.com Tim Harford asks Does the altruism theory help anyone at all?

He writes,

[...] many policy wonks believe not just that there are some things that money can’t buy, but that cash incentives are counterproductive and even morally corrosive. The touchstone of this school of thought is Richard Titmuss’s book The Gift Relationship, published in 1970.Titmuss’s most memorable and influential claim was that the British system of voluntary blood donation led to better outcomes – healthier blood, supplied in a more timely fashion – than the American system of paying blood donors.

and

As for blood donation, Titmuss’s thesis is far less pressing now that better blood-screening techniques have been developed. It is not clear how solid the idea was, since he himself complained about the lack of good data. But perhaps he was right that paying for blood was counterproductive.

Still, it is interesting to see a new study by the economists Nicola Lacetera, Mario Macis and Robert Slonim concluding that paying for blood increases the quantity donated without lowering the quality. Distasteful it may be, but sometimes the way to get results is to pay for them.

The study Harford mentions is one I blogged on last December. As I wrote then: "But it has been argued that this is not entirely true [that incentives matter] for some areas of social activity where "intrinsic" motivation is important, such as blood donation. A number of contributions in both the psychology and economics literatures have argued that when people are "intrinsically" motivated to perform a task, as in activities such as blood donation, adding an extrinsic incentive could reduce supply of the activity because the extrinsic incentive might undermine the intrinsic motivation and also attract the "wrong" types of agents to perform the activity. Surveys and laboratory experiments lend support to this non-standard response to economic incentives for the provision of pro-social behaviour. But new research shows that blood donors responding to incentives in the "standard" way; offering donors economic incentives significantly increases turnout and blood units collected, and more so the greater the incentive’s monetary value." So Tim Harford has a point, no matter how distasteful we may find it, sometimes the way to get results is to pay for them. Incentives really do matter.

Economics of digital media

From VoxEU.org comes this audio in which Joel Waldfogel of the University of Pennsylvania’s Wharton School talks to Romesh Vaitilingam about the economics of digital media, including: music file sharing (both illegal and legal) and the impact on artists and record labels; the threat that intellectual property piracy poses to the movie business; and the future of books and newspapers in the digital age.

Podcast: an economist gets stoned

From npr's Planet Money comes this podcast of Harvard economist, Jeffrey Miron, talking about what happens when drugs move from the black market to the open market. Do they get 100 times cheaper? Or instead, more expensive? Miron talks about the economics of prohibition, and reveals his drug of choice (which is legal) and one he would like to try (which is not).

The discussion is based on Miron's paper The Effect of Marijuana Decriminalization on the Budgets of Massachusetts Governments, With a Discussion of Decriminalization’s Effect on Marijuana Use An Update of Miron (2002a).

You know the recession is bad when ....

the sex trade is in trouble.This comes from the Toronto Star:

The vices – smoking, drinking, sex – are usually bulletproof during a recession, says economist Perry Sadorsky, who teaches at York University's Schulich School of Business. So if the sex trade is hurting, "we are in the most serious depression since the 1930s. This shows the magnitude of the decline. It is deep and it is problematic."

Sex workers say their incomes began plummeting last fall, with johns pleading poverty and haggling over prices, and prostitutes bidding against each other.

"There are 60 people on the street, but they are all sex workers and there's no money for anybody," says Ray, who, like other prostitutes, did not want his real name used. "This economy is causing a lot of misery."

If prices are dropping is it a decrease in demand or an increase in supply or both?

Sadorsky wonders if the economic crisis is forcing more people into sex work, thereby increasing competition on the street. Toronto police, who use a community complaints system to keep track of prostitution, report no increase in complaints, though they suggest this may mean sex workers are trolling in non-residential areas.

...The recession has seen the street price of oral sex, the most common service, plummet from $60 last fall to $20 today. "Full service" involving intercourse has dropped from $150 to $80.

Econ 101 tells us that a decrease in demand will decrease price and decrease the quantity traded. An increase in supply also decreases price but increases the quantity traded. If both are happening then price will drop but the effect on quantity is indeterminate. The article also says,

Escort workers, both those with agencies and independents, report a 15 per cent decline in clients, says Valerie Scott, executive director of Sex Professionals of Canada, a volunteer group working toward the decriminalization of sex work.

which would suggest that the demand effect is dominating.

(HT: Market Power)

Price gouging in Haiti

You will find many reports in the media suggesting that prices for many useful and necessary goods have jumped considerably since the earthquake in Haiti. I'm sure you will also find many reports saying that these price increases are examples of "price gouging" and that such activity is unethical and thus ought to be condemned, if not prosecuted.

One of the better responses to such reasoning comes from Michael Giberson at Knowledge Problem blog. He writes,

But I find it hard to condemn these actions, which generally appear to be pro-social commercial responses to abnormal social and economic conditions. Higher prices motivate more careful use of existing supplies as well as extraordinary efforts to secure additional supplies. Changing relative prices help guide the efforts of suppliers and merchants to the most vitally needed items. Both the incentive and information aspects of prices are critical to guiding decentralized responses to human needs in this rapidly changing situation.

The New York Times article observes that, “Haiti’s huge informal sector reacted faster to the quake than did established companies and banks. Outdoor markets like La Saline are already filled with goods from the countryside, including salt, cornmeal, fruits like mangoes and used clothing from the United States.” How fast would that informal sector have reacted if the government felt an obligation to enforce some notion of anti-price gouging policy?

Markets work, even in extreme circumstances, if you let them.

Hayekian comments on student papers

Peter Klein at Organizations and Markets says that a grad student inspired these Hayekian Comments on Student Papers,

"The writer clearly suffers from a fatal conceit."

"Reading this proposal helps me understand the knowledge problem."

"Your paper appears to be the result of human action, but not human design"

"The proposed outline reveals how little people really know about what they imagine they can design."

In the comments section two additional comments were suggested,

"Spontaneous order does not apply to writing."

"Time spent on this paper was a malinvestment?"

Anything better?

Schools of thought and influence on policy making

Relying on the interpretations of opinions of people is one way to characterise a school of thought and measure its influence. But John Taylor at Economics One asks if there is a less inherently subjective way to characterise a school of thought or to measure the extent of its influence on policy making. He writes

Are there more objective, perhaps quantitative, ways? Consider, for example, measuring influence by the representation of members of a school in top economic positions in government where there is an opportunity to influence policy. And consider as a measure of an economist’s school, the university where he or she received the PhD. The data in the chart follows this approach. It shows the university PhD percentages of appointees to the President’s Council of Economics Advisers (CEA).

The blue line shows the percentage of presidential appointees to the CEA who have a PhD from Chicago. The red line shows the same for MIT or Harvard (Cambridge), one possible definition of an alternative to the Chicago school. The years from the creation of the CEA in 1946 until 1980 are shown along with each presidential term thereafter. Observe that the peak of the Chicago school influence was in the Reagan administration; it then dropped off markedly. In contrast Cambridge reached a low point of zero appointees to the CEA during the Reagan administration and then rose slightly to 20 percent in Bush 41, to 82 percent in Clinton, and to 100 percent in both Bush 43 and in Obama.

Blaming the financial crisis on the free-market influence of the Chicago school is certainly not consistent with these data. There were no Chicago PhDs on the President’s CEA leading up to or during the financial crisis. In contrast there was a great influx and then dominance of PhDs from Cambridge. And also notice that there were plenty of Chicago PhDs on the CEA at the time of the start of the Great Moderation—20 plus years of excellent economic performance. These data are more consistent with the view that the waning of the free-market Chicago school and the rise of interventionist alternatives was largely responsible for the crisis. But the main point is that there is no evidence here for blaming the influence of Chicago.

Taylor goes on to note,

The data are robust when you look beyond the CEA to other top posts normally held by PhD economists. All assistant secretaries of Treasury for Economic Policy appointed during the Bush 43 and Obama Administrations had PhDs from Harvard. During the same period, all chief economists appointed to the IMF had PhDs from MIT, and, except for Don Kohn, who was promoted from within and Susan Bies who was appointed as a banker, all PhD economists appointed to the Federal Reserve Board were from Cambridge MA.

So do free market supporters really have influence on policy making these days?

Quote of the day

From Don Boudreaux at Cafe Hayek:

I’m at a conference in south Florida with Paul Rubin, a superb scholar of law and economics. Paul just observed that whenever there’s a corporate scandal, it’s typically blamed on an increase in greed, but when there’s a sex scandal, it’s never blamed on an increase in lust.

Words fail me

and now apparently also some school students in the US. Alex Tabarrok at Marginal Revolution points us to this:

The 9,000-student K-8 district this week pulled all copies of Merriam-Webster's Collegiate Dictionary after an Oak Meadows Elementary School parent complained about a child stumbling across definitions for "oral sex."

The decision was made without consultation with the district's school board and has raised concerns among First Amendment experts and some parents.

Other parents and Menifee residents, though, have praised the district's decision, saying a collegiate-level dictionary is inappropriate for younger children.

So now dictionaries are only allowed to have "approved words" in them?

Productivity and wages

In an earlier posting I wrote that Trevor Mallard had been blogging his support for an increase in the minimum wage. Mallard wrote

Business NZ would squeal. But most employers know that lifting wage rates encourages investement in capital equipment and training to make their labour force more productive. It is all part of the movement to a high skill, high wage economy.

I also noted that, yes, there is a relationship between productivity and wages but it runs the opposite way to what Trevor claims. Over time if you make people more productive, wages will increase.

Following up this, the information below comes from a paper by Martin Feldstein (George F. Baker Professor of Economics at Harvard University and President Emeritus of the National Bureau of Economic Research) given to the American Economic Association on January 5, 2008. The paper is entitled "Did Wages Reflect Growth in Productivity?" Feldstein writes,

The level of productivity doubled in the U.S. nonfarm business sector between 1970 and 2006. Wages, or more accurately total compensation per hour, increased at approximately the same annual rate during that period if nominal compensation is adjusted for inflation in the same way as the nominal output measure that is used to calculate productivity.

More specifically, the doubling of productivity represented a 1.9 percent annual rate of increase. Real compensation per hour rose at 1.7 percent per year when nominal compensation is deflated using the same nonfarm business sector output price index.

In the period since 2000, productivity rose much more rapidly (2.9 percent a year) and compensation per hour rose nearly as fast (2.5 percent a year).

and later he says

The relation between wages and productivity is important because it is a key determinant of the standard of living of the employed population as well as of the distribution of income between labor and capital. If wages rise at the same pace as productivity, labor’s share of national income remains essentially unchanged. This paper presents specific evidence that this has happened: the share of national income going to employees is at approximately the same level now as it was in 1970.

So when measured correctly, productivity and wage do roughly move together over time. For the US at least.

Keynes vs. Hayek rap video

This is a a rap video developed by Russ Roberts, of Cafe Hayek and EconTalk fame, and John Papola.

More resources including lyrics and a free download of the song are here.

(HT: Cafe Hayek)

EconTalk this week

Nobel Laureate Michael Spence of Stanford University's Hoover Institution and the Commission on Growth and Development talks with EconTalk host Russ Roberts about the determinants of economic growth. Spence discusses the findings of the Commission's recent report and how it compares to earlier attempts to uncover the sources of growth and the lack of growth such as the Washington Consensus. Spence makes the case for government provision of infrastructure including education and the problems of corruption and governance. The conversation closes with a look at Spence's career and the lessons of that experience.

Just let them in

The following is from a post at Aid Watch by Michael Clemens, a research fellow at the Center for Global Development in Washington, DC, and an affiliated associate professor of public policy at Georgetown University.

The best thing the United States could do for Haitians would be to let them in, either temporarily or permanently. We are now accepting about 21,000 permanent Haitian immigrants per year, and just a few hundred temporary workers per year. If we really wanted to raise Haitians out of destitution, we could absorb many times more than this.

Water economics and management: lessons from Australia’s drought

In thsi audio from VoxEU.org Mike Young, executive director of the Environment Institute at the University of Adelaide, talks to Romesh Vaitilingam about how Australia has responded to the big shock to its water supply – through new regulations, through technological solutions, through public education and through the introduction of market mechanisms. Water and its management is a big issue not only in Australia, New Zealand has issues with this as well and may be can learn something from across the Tasman.

Econ 101 and the minimum wage

In a posting about the minimum wage Eric Crampton, at Offsetting Behaviour, quotes the National Business Review as saying

When the 2025 Taskforce made its controversial list of proposals for increasing New Zealand’s economic performance to catch up to Australia’s, it missed an obvious one.

The only way to really lift New Zealand’s woeful economic performance is to smack every New Zealander over the head with a textbook of “Economics 101”.

This nation-wide lack of financial common sense was reflected in a poll by the NZ Herald that found 61% of respondents want the minimum wage lifted to $15 an hour.

Of course, the Herald didn’t ask the follow-up question- “do you support higher unemployment, particularly among groups vulnerable to labour market changes such as young people and Maori, as well as the possible collapse of many businesses already burdened by ever-increasing government-imposed costs?”

One of those who needs a smack 'over the head with a textbook of “Economics 101” ' is Marty G at The Standard.

In a comments to a posting about the minimum wage at The Standard I made the point that most economists would argue that an increase in the minimum wage would increase unemployment among those at the bottom end of the wage distribution. When asked for empirical evidence to back up my claim I referred to the book, “Minimum Wages” by David Neumark and William L. Wascher, Cambridge: MIT Press, 2008. To counter my claim Marty G wrote

One book by two no name US neoliberal economists, whose 2007 paper says:

“We review the burgeoning literature on the employment effects of minimum wages – in the United States and in other countries – that was spurred by the new minimum wage research beginning in the early 1990s. Our review indicates that there is a wide range of existing estimates and, accordingly, a lack of consensus about the overall effects on low-wage employment of an increase in the minimum wage.”

This quote interested me since it seems to undermine the Economics 101 idea that demand curves slope downwards, so I went looking for the quote. The "two no name US neoliberal economists" are David Neumark - Professor of Economics, University of California, Irvine - and William L. Wascher - Senior Associate Director, Division of Research and Statistics, Federal Reserve Board - and I found the 2007 working paper that Marty G seems to be referring to, see here. The working paper was published in Foundations and Trends in Microeconomics, 2007, Vol. 3, Nos. 1-2, pp. 1-182. The quote that Marty G gives comes from this abstract to this paper.

Now let me quote the sentence that come directly after the quote that Marty G gives,

“However, the oft-stated assertion that recent research fails to support the traditional view that the minimum wage reduces the employment of low-wage workers is clearly incorrect.”

So in other words, the very next sentence after the quote Marty G gives, counters the very point that Marty G seems to have been trying to make by using the quote, and in fact support my claim. Marty G was being selective, shall we say, with the use of his quote.

Neumark and Wascher go on to say,

“A sizable majority of the studies surveyed in this monograph give a relatively consistent (although not always statistically significant) indication of negative employment effects of minimum wages. In addition, among the papers we view as providing the most credible evidence, almost all point to negative employment effects, both for the United States as well as for many other countries. Two other important conclusions emerge from our review. First, we see very few – if any – studies that provide convincing evidence of positive employment effects of minimum wages, especially from those studies that focus on the broader groups (rather than a narrow industry) for which the competitive model predicts disemployment effects. Second, the studies that focus on the least-skilled groups provide relatively overwhelming evidence of stronger disemployment effects for these groups.”

Thus the 2007 paper that Marty G quotes in fact supports my contention that the minimum wage reduces the employment of low-wage workers.

Liberalism v's liberalism

George Will on (American) liberalism:

The essence of contemporary liberalism is the illiberal conviction that Americans, in their comprehensive incompetence, need minute supervision by government, which liberals believe exists to spare citizens the torture of thinking and choosing.

Joseph Schumpeter on (Classical) liberalism:

Still more important, they did so in a spirit of laissez-faire, that is to say, on the theory that the best way to promote economic development and general welfare is to remove fetters from the private-enterprise economy and to leave it alone. This is what will be meant in this book by Economic Liberalism. The reader is requested to keep this definition in mind because the term has acquired a different– in fact almost the opposite– meaning since about 1900 and especially since 1930: as a supreme, if unintended, compliment, the enemies of the system of private enterprise have thought it wise to appropriate its label. (emphasis added) [ Joseph Alois Schumpeter, History of economic analysis, p.372]

(HT: Cafe Hayek)

The World Bank and how many people in the world are in extreme poverty

At the Aid Watch blog Bill Easterly point us to the AEA Presidential Address that Angus Deaton (see right) gave recently at the AEA meetings. Deaton discussed the measurement of world poverty and inequality, with particular attention to the role of PPP (purchasing power parity) price indexes from the International Comparison Project. Global inequality increased with the latest revision of the ICP, and this reduced the global poverty line relative to the US dollar. The recent large increase of nearly half a billion globally poor people came from an inappropriate updating of the global poverty line, not from the ICP revisions. Even so, Deaton explained, PPP comparisons between widely different countries rest on weak theoretical foundations. Deaton argued for a wider use of self-reports from international monitoring surveys, and for a global poverty line that is truly denominated in US dollars.

Easterly tells us that the lecture

will not let you ever trust the World Bank again on how many people in the world are in extreme poverty.

Easterly gives four examples as to why this is so:

1) “India has become poorer because India has become richer!”

The World Bank’s recent 40 percent upward revision of the global poverty number was based on an absurd procedure that led to the paradox in the quote.

To make a long story short, the World Bank decided to boot richer India out of the group of poorest countries used to determine the poverty line, which made the poverty line higher, which made Indian (and global) poverty higher – all because India was richer. This misguided revision of the poverty line, which accounted for virtually all of the upward revision, was not clear to virtually anyone until this new paper by Deaton.

2) Adjusting for purchasing power (how cheap the goods are) across countries is complex and probably impossible.

The details are as incredibly boring as they are hugely consequential.

As only one tiny example, the poverty count is sensitive to a mostly-made-up number that is incomparable across countries: the imputed rent to housing.

Then there is the “index number problem,” which only is of great fascination to 2 people, but unfortunately can change the ratio of US/Tajikstan incomes by a factor of 10. The trouble is that rich people and poor people consume very different things. For example, poor people may consume a lot of something that is cheap in the poor country, which is not consumed much and is expensive in the rich country. Similarly, rich people consume a lot of something else that is cheap in the rich country and expensive in the poor country. If you use rich country prices, you exaggerate poor people’s consumption basket value (they are given a lot of credit for consuming a lot of something very expensive, but it isn’t that expensive in the poor country and if it were, they would consume a lot less of it). Conversely, if you use poor country prices, you exaggerate rich people’s consumption basket value. There are possible intermediate solutions but no complete solutions to this intractable problem.

Deaton muses: “perhaps we are aiming too high when we try to construct a real income scale on which every country in the world can be placed.”

3) Why don’t you just ask people if they think they are poor?

World Gallup Poll does.

In contrast to the World Bank global poverty rate of 25 percent (around which there were those misguided revisions and many other uncertainties on the order of 40 percent of the original estimate):

33 percent worldwide say they don’t have money for food,
38 percent say their living standards are poor, and
39 percent say they are “in difficulty.”

So you are on safe ground saying, “there are lots of people in poverty.” But don’t insult our intelligence with an exact number.

4. Deaton offers consolation: you don’t really need a global poverty number.

In spite of the attention that they receive, global poverty ... measures are arguably of limited interest. Within nations, the procedures for calculating poverty are routinely debated by the public, the press, legislators, academics, and expert committees, and this democratic discussion legitimizes the use of the counts in support of programs of transfers and redistribution. Between nations where there is no supranational authority, poverty counts have no direct redistributive role, and there is little democratic debate by citizens, with discussion largely left to international organizations such as the United Nations and the World Bank, and to non-governmental organizations that focus on international poverty. These organizations regularly use the global counts as arguments for foreign aid and for their own activities, and the data have often been effective in mobilizing giving for poverty alleviation … It is less clear that the counts have any direct relevance for those included in them.

The moral of the story: don’t cite global poverty numbers unless you know they’re trustworthy, and most of the time they aren’t.

The 2010 index of economic freedom

The 2010 Index of Economic Freedom is now available. New Zealand comes in at number 4 with a score of 82.1, up by 0.1 compared to last year. Australia is one place ahead of New Zealand at number 3. New Zealand is also ranked 4th out of 41 countries in the Asia–Pacific region.

The index says

The economy has an impressive record of market reforms and benefits from its openness to global trade and investment. The banking sector is characterized by sound regulations and prudent lending practices, and well-implemented structural reforms have allowed the New Zealand economy to weather the recent global financial and economic crisis relatively unscathed.

The index's top ten countries areInterestingly the US score has fallen by 2.7 and the UK has fallen out of the top ten completely. The UK's score fell by 2.5, leaving it at number 11 in the rankings. Commenting on the fall in the US score Terry Miller at the Wall Street Journal writes,

The U.S. lost ground on many fronts. Scores declined in seven of the 10 categories of economic freedom. Losses were particularly significant in the areas of financial and monetary freedom and property rights. Driving it all were the federal government's interventionist responses to the financial and economic crises of the last two years, which have included politically influenced regulatory changes, protectionist trade restrictions, massive stimulus spending and bailouts of financial and automotive firms deemed "too big to fail." These policies have resulted in job losses, discouraged entrepreneurship, and saddled America with unprecedented government deficits.

The bottom two countries, for which data are available, are, at 178, Zimbabwe with a score of 21.4 which has fallen by 1.3 since last year and at 179, North Korea with a score of 1.0 which has fallen by 1. No real surprises with the bottom two.

Unemployment insurance and moral hazard

Moral hazard is a well known problem in all forms of insurance, unemployment insurance being no exception. The problem being that unemployed workers who are insured may not do enough in the way of searching for a job or may turn down job offers that they do receive. But trying to get a handle on how large this effect is very difficult. This is an area where field experiments can help: randomly assign people to treatment groups where there is an increased level of the monitoring of claimants relative to the control group. Claimants in the treatment group have to make more frequent visits to the employment office and face questioning about their search behaviour. And see what happens.

Such an experiment was carried out in Hungary in 2003. The results are reported in a paper, The e ffect of monitoring unemployment insurance recipients on unemployment duration: evidence from a field experiment by John Micklewright and Gyula Nagyy. The paper reports results which show marked differences between the sexes in the effect of treatment on benefit duration and outflows to employment. Treatment has quite a large effect on women aged 30 and over, especially for those married with a working husband, while they typically find no effect for younger women or for men.

Micklewright and Nagyy note that,

There are (at least) two alternative explanations for the experiment’s results (‘explanations’ in the sense of descriptions of the observed behaviour). First, search effort of men and younger women is already high and the marginal return to additional effort encouraged by the treatment is zero. Men and younger women in the control group make frequent visits to employment offices to access vacancies of their own volition, so their contact with the offices is no lower than for their counterparts in the treatment group. For the older women, treatment does bring more contact in practice with the offices’ vacancies compared to the control group, and there is a positive return to additional search stimulated by treatment in terms of job offers generated.

Second, search effort of men and younger women is not high in the absence of treatment but the treatment does not produce additional search. The questions faced by the treatment group during visits to the employment office are answered with equanimity, with no disutility resulting. Treatment does mean in practice that additional visits are made to the employment offices but these visits do not result in better contact with vacancies. Only the women aged 30+ take advantage of the increased access to information on vacancies through the office visits. And only these women experience disutility from the additional visits and the questioning about job search, which increase the cost of leisure while unemployed, and react to a threat of sanctions if they do not increase their search activity.

Unfortunately Micklewright and Nagyy do not have the detailed information on actual search activity of both the treatment group and the control group that would allow them to judge between the competing explanations.

Investment and regime uncertainty

In an earlier posting on government actions in Venezuela to take over a French-owned retail chain I wrote,

I'm guessing foreign investment isn't at the top of Hugo Chavez's list of must haves for economic development. I'm also guessing that Robert Higg's idea of regime uncertainty isn't something Chavez is too concerned about. One wonders what effect all this will have on private investment, both foreign and local, in Venezuela.

Now this story from Reuters UK tells us

Venezuela's Mariscal Sucre project, which has estimated reserves of 14.7 trillion cubic feet of gas, has failed to attract private interest after the government invited firms to make offers last week.

Offers were to be made on Friday until midnight.

The government this month improved the conditions it was offering companies to help develop the project, but in the end nobody came forward, private sector sources close to the process said on Monday.

Given past actions, such as the nationalisation of the French-owned retail chain and the threatening of international car companies with nationalization, it is hardly surprising that foreign firms don't want to invest in Venezuela. They too, rationally, fear seizure of their assets at some future date. The possibility of hold-up in the future reduces firms willingness to invest today. A point lost, it would appear, on Hugo Chavez.

Maybe there is more to this story than is obvious from the news report, but the argument above seems sufficient to explain the lack of interest in investing in Venezuela.

(HT: Knowledge Problem)