Kling on non-profits

Arnold Kling writes,

James Piereson writes,

For much of U.S. history, nonprofits have operated as a check on government by providing private avenues to serve the public interest. Unfortunately, American charities—and more broadly, the entire nonprofit sector—have become a creature of big government…

The publication Giving USA, which tracks charitable spending, reports that the government now supplies one-third of all funds raised by not-for-profit organizations.

… According to a recent report by the Chronicle of Philanthropy, government funding of such charities grew by 77% between 2000 and 2010, while private support for such groups grew by just 47%.

I keep emphasizing that the main difference between non-profit and for-profit is that non-profits are accountable to donors and for-profits are accountable to customers.

While I agree that non-profits are not accountable to their "consumers" I don't agree that they are accountable to their donors. If they were for-profit status would work. In fact the use of non-profit status is largely because they are not accountable to donors, the non-profit status is a way of signalling to donors that they will not (or are less likely to) be ripped off.

Imagine that you are a possible donor to a firm the outputs of which you can't easily verify. If the firm is for profit then the profit maximising thing to do is take the donor's money and do nothing at all. Remember the donor can't verify what you have done with their money. The donor's money is then pure profit, you have no costs since you haven't actually done anything. You just tell the donor you have done lots of things. The revenue from the donor is then profit. If you are non-profit then you can't capture profit in this way since there are no profits to be distributed by definition. This gives a lesser incentive to rip a donor off since any rent seeking must be done via other higher costs methods

Now this is just stupid 2

A reading of Henry Hansmann's 1996 book "The Ownership of Enterprise" may be worthwhile for Geoff Bertram. When discussing the Spanish cooperative Mondragon Hansmann writes,

The wage structure has been among the most contentious issues at Mondragon. Initially, the systemwide top pay index-the maximum permissible ratio of highest to lowest rate of pay-was three to one. Over the years, this ratio has been increased to attract and hold talented executives.

Hansmann notes that the ratio had been increased to 4.5 to 1 and then to 6 to 1 in a effort to keep good managers.

A firm with a very constrained  pay scale will not be able to keep its "best and brightest". I used this basic argument in a paper to help explain why you don't see player-owned teams in professional sport,

Another (more usual) example of a human-capital based "firm", but one where labour-owned firms are seldom, if ever, found, due to the heterogeneity of the human-capital involved, is that of the professional sports team. Here we have a situation where human capital, talent at playing a particular sport, is the basis for the “firm” but ownership by the human capital, the players, is extremely rare since a worker-owned team would be at a disadvantage relative to a player-as-employee based team.

Heterogeneity among playing talent and thus earning potential acts as a disincentive to the formation of a worker cooperative, which involves (rough) equality in payment, since those players with the greatest earning potential, the largest outside options, will transfer away from the cooperative to maximise their income stream. Differential payment schemes can occur, especially within partnerships, but they require that the individual employee productivities are sufficiently easy to measure so that a relatively objective method of productivity related pay is possible. Given the team production nature of team sports productivities are difficult, if not impossible, to estimate and thus payment by productivity is not feasible, which argues in favour of equality in payments. Thus a worker-owned team would have few, if any, star players, a handicap in the winner-takes-all world of professional sports.

EconTalk this week

Michael Lind of the New American Foundation talks with EconTalk host Russ Roberts about two recent articles by Lind at Salon.com. In the first article, Lind argues that libertarians are wrong about how to organize a society because they embrace a philosophy that has never been tried. In the second article, Lind argues that the ideas taught in economics principles classes lead to bad public policy. Roberts challenges Lind and along the way they manage to find some areas of agreement.

Now this is just stupid (updated)

Kiwiblog writes,

Simon Collins reports:

The Government should stop giving contracts – and knighthoods – to companies that pay their bosses more than three times their lowest-paid workers, an economist has suggested.

Dr Geoff Bertram, a retired Victoria University economist who inspired a Labour Party plan to force down electricity prices, made the proposal at a conference on inequality in Wellington yesterday.

Seriously I find it hard to believe an economist could come out this such an idea, after all as Steven Landsburg pointed out back in 1993,

Most of economics can be summarized in four words: "People respond to incentives." The rest is commentary.

Has Bertram really thought about the incentives in his idea? If he had he would know that they are all bad. These ideas have been tried and failed. Many worker cooperatives have payment schemes which limit the ratio of the highest paid person to the lowest, e.g. 3 to 1, 6 to 1 etc, in an effort to create a more equal division of the firm's residual. Ricketts (1999: 20) outlines the general problem with this as '[...] to minimise antagonism a rough equality in the division of the residual will be necessary and this may conflict with outside opportunities. Those with high transfer earnings reflecting high productivity elsewhere will desert the co-operative. It is for these reasons that control of the firm by its labour force is usually found in circumstances which permit a high degree of common interest'. Jossa (2009: 709-10) explains the basic issue in terms of the management of capitalistic versus co-operative firms: '[g]iven the tendency of cooperatives to distribute their income equitably among all the members, it is difficult to deny that few cooperatives are in a position to pay the high salaries that able managers can expect to earn in capitalistic firms. Whenever a group of people resolve to work as a team-we may add-the member who outperforms the others in initiative and organizational skills will inevitably take the lead. The crux of the matter is that such a person has no incentive to establish a cooperative and share power and earnings with others. He or she will prefer to found a capitalistic firm, where he or she will hold all authority and, if sole owner, appropriate the whole of the surplus [references deleted]'.

In other words having a payment scheme which imposes a tight limit on the payments to the most able within the firm gives an large incentive for these people to leave. And these are the very people the firm needs to succeed.

Update: Eric Crampton also seems to see some problems with the Bertram suggestion while Matt Nolan thinks Bertram's being "reasonably disingenuous".

Big Mac index

A new interactive Big Mac index is available from the Economist magazine here.

THE Big Mac index was invented by The Economist in 1986 as a lighthearted guide to whether currencies are at their “correct” level. It is based on the theory of purchasing-power parity (PPP), the notion that in the long run exchange rates should move towards the rate that would equalise the prices of an identical basket of goods and services (in this case, a burger) in any two countries. For example, the average price of a Big Mac in America in July 2013 was $4.56; in China it was only $2.61 at market exchange rates. So the "raw" Big Mac index says that the yuan was undervalued by 43% at that time.

Burgernomics was never intended as a precise gauge of currency misalignment, merely a tool to make exchange-rate theory more digestible. Yet the Big Mac index has become a global standard, included in several economic textbooks and the subject of at least 20 academic studies. For those who take their fast food more seriously, we have also calculated a gourmet version of the index.

This adjusted index addresses the criticism that you would expect average burger prices to be cheaper in poor countries than in rich ones because labour costs are lower. PPP signals where exchange rates should be heading in the long run, as a country like China gets richer, but it says little about today's equilibrium rate. The relationship between prices and GDP per person may be a better guide to the current fair value of a currency. The adjusted index uses the “line of best fit” between Big Mac prices and GDP per person for 48 countries (plus the euro area). The difference between the price predicted by the red line for each country, given its income per person, and its actual price gives a supersized measure of currency under- and over-valuation.

By this measure the New Zealand dollar is undervalued by 5.7%.

EconTalk this week

Michael Clemens of the Center for Global Development talks with EconTalk host Russ Roberts about the effects of aid and migration on world poverty. Clemens argues that the effects of aid are positive but small. But emigration has the potential to have a transformative effect on migrants from poor countries who emigrate to richer ones. The discussion concludes with the impact of migrants on the host country.

Education and labour markets

Bill Kaye-Blake writes In praise of liberal arts:

One of the issues we examined was ‘mismatch’. With the NZ data, there wasn’t much we could do. There just isn’t enough information on what happens to students after they leave tertiary education. I know that the pay-off to a liberal arts education for me was a long time coming — it isn’t enough to follow people for two years or five years. To cite our conclusion:

Finally, mismatches between employment and field of study and/or qualification level are often cited as a possible driver of low returns. There is little evidence that observed mismatches are in fact mismatches at all. However, if persistent mismatching is going on due to policy or market failures, this could be having a significant impact on returns. Whether that is the case or not is an open question.

Mismatch actually refers to two separate things. One is qualification mismatch — people getting Bachelor’s degrees when employers really want trade qualifications. The second is subject-matter mismatch — university students studying French literature when employers want computer science grads.

But if there is a mismatch in either sense, isn't the real question, What are prices not adjusting? If there is an excess demand (supply) for a particular qualification/skill why are wages not increasing (decreasing)? Thus is the problem got more to do with labour markets, and their regulation, than it has to do with education as such?

Firms learning without markets

Being able to judge market signals and learn from what they are telling you is important for any firm operating within a market system. But what if your firm worked outside of a market system, Would it still have the skills to respond to market information? The answer appears to be no. A new NBER paper from Thomas Triebs and Justin Tumlinson argues that firms operating outside the market system — the former East Germany in this study — do not have the ability to judge market signals. Triebs and Tumlinson look at firms in East and West German, after unification had taken place, and they find that East German firms did not anticipate, or respond to, market information as well as their West German counterparts. This suggest that firms operating under the Communist system lost, or never had, the ability to function within a market setting.

See "Learning Capitalism the Hard Way—Evidence from Germany’s Reunification" by Thomas P. Triebs and Justin Tumlinson, NBER Working Paper No. 19209, July 2013:

Communism in East Germany sought to dampen the effect of market forces on firm productivity for nearly 40 years. How did East German firms respond to the free market after being thrust into it in 1990? We use a formal learning model and German business survey data to analyze the lasting impact of this far-reaching treatment on the way firms in former East Germany predicted their own productivity relative to firms in former West Germany during the two decades since Reunification. We find in confirmation of our formal model’s predictions, that Eastern firms forecast productivity less accurately, particularly in dynamic and uncertain markets, but that the gap gradually closed over 12 to 13 years. Second, by analyzing the direction of firm level errors in conjunction with contemporaneous market signals we find that, in the years immediately following Reunification, Eastern firms estimate the market’s role as generally less potent than Western firm do, an observation consistent with overweighting experiences from the communist era; however, over roughly 14 years both converge to the same (incorrect) overestimate of the market’s role on their productivity.

A less extreme example of the same issue is adjustment by New Zealand firms to the 1980s reforms. A point noted by Eric on twitter:

It took a long time for NZ firms to adjust to the 80s reforms. But look at East Germany... http://t.co/1C2spvxEcm
— Eric Crampton (@EricCrampton) July 16, 2013

Privatisation in New Zealand

This is a video of a presentation given by Sinclair Davidson a few weeks back at the New Zealand Initiative on privatisation and public choice.

MRUniversity on Edward Gibbon Wakefield

A name known to all in Canterbury since in 1848 Wakefield, with John Robert Godley, set up the Canterbury Association to plan a Church of England colony in New Zealand.

Alex Tabarrok on "How the Dismal Science Got Its Name"

Alex Tabarrok at Marginal Revolution University explains how the dismal science got its name.


Fans of Thomas Carlyle and John Ruskin will not happy to learn this story, but the dismal science no longer looks so dismal.

5 reasons price gouging should be legal

"Price gouging" is meant to describe something bad, something we don't want to see happen, especially in emergencies. But Peter McCaffrey argues that we should like price gouging and gives 5 reasons why:

So-called price gouging is a critical economic tool to ensure that supplies last and so can meet ongoing demand. Making it illegal is ridiculous, and here’s why:

1. Without price increases, many people buy extra supplies “just in case”, regardless of what they have tucked away at home already. If too many people do this, supplies run out and people who need them much more urgently miss out. With price increases, people who don’t really need supplies will leave them on the shelf, not out of the goodness of their heart, but out of concern for their wallet.
2. Price increases encourage conservation of resources people already have. Those who can most easily adjust their consumption will do so, leaving resources free for those who can’t. People might, for example, use their cars more sparingly to avoid having to fill up while prices are inflated.
3. The ability to raise prices encourages businesses to stock excess reserves. Space in stores and warehouses is limited and products (even water) go off over time. If they’re not allowed to raise prices on those items, they’ll use that limited space for other products that have higher profit margins the rest of the time.
4. Allowing price gouging actually encourages citizens to be more prepared for disasters. Do you have enough food and water and other essentials stored at home for you and your family if disaster strikes your town? Or do you just assume you’ll be able to go to the store and buy what you need when something goes wrong? Knowing that prices might double, triple, or more during a disaster is a pretty big incentive to go and stock up now instead of waiting — even for that person who lives right next door to the store!
5. Finally, rising prices attract more resources from outside of the disaster area, where prices are lower. Nearby businesses, small or large, can easily profit by shipping essential supplies in and selling them at a premium. Without the ability to charge that premium, they would actually end up losing money through shipping costs, overtime wages, and inherent risks of operating is a disaster area. Without the profit motive, many don’t take the risk.

McCaffrey suggest that we should use a different term for what is now called price gouging:

“Price gouging” is a derogatory term meant to belittle. A more accurate description would be “sustainable pricing” — pricing that ensures supplies are sustainable to meet the demand of future customers.

So, "price gouging" is dead, long live "sustainable pricing".

Economic freedom and labour market conditions

An interesting new paper on Economic Freedom and Labor Market Conditions: Evidence from the States by Lauren R. Heller and E. Frank Stephenson. The abstract reads:

Using 1981–2009 data for the 50 states, this article examines the relationship between economic freedom and the unemployment rate, the labor force participation rate, and the employment-population ratio. After controlling for a variety of state-level characteristics, the results from most specifications indicate that economic freedom is associated with lower unemployment and with higher labor force participation and employment-population ratios.

The conclusion to the paper states,

Our findings have clear implications for policymakers. Adopting policies that increase economic freedom by one point in the EFNA index would reduce the unemployment rate by as much as 1.3 percentage points. Likewise a one point increase in economic freedom would increase the labor force participation rate by up to 1.9 percentage points and the employment-population ratio by as much as 2.3 percentage points. Moreover, the estimation results for the EFNA sub-components offer policymakers some guidance about the most beneficial ways to improve state EFNA ratings. The effect of area 1 (size of government) is generally larger than the effect for areas 2 or 3. Hence, our results suggest that reducing the size of government would have the largest effect on labor market outcomes.

So economic freedom does decrease unemployment and increase the labour force participation rate but reducing the size of government is the big winner for reducing unemployment.

EconTalk for two weeks

Michael Munger of Duke University talks with EconTalk host Russ Roberts about the role of formal rules and informal rules in sports. Many sports restrain violence and retaliation through formal rules while in others, protective equipment is used to reduce injury. In all sports, codes of conduct emerge to deal with violence and unobserved violations of formal rules. Munger explores the interaction of these forces across different sports and how they relate to insights of Coase and Hayek.

Morris Fiorina, the Wendt Family Professor of Political Science and Hoover Institution Senior Fellow at Stanford University, talks with EconTalk host Russ Roberts about the state of the American electorate and recent election results. Fiorina argues that while the Republican and Democratic parties are more extreme than they were in the past, there has been only modest change in the character of the American electorate. Fiorina discusses these differences in light of recent election results which show an inability of either party to sustain control of the Presidency or the Congress.

The dark side of social capital

We hear much about the wonders of social capital - the dense network of associations facilitating cooperation within a community - of which there are many. It typically leads to positive political and economic outcomes, but is there a "dark side" to social capital? A new NBER working paper suggests there can be.

Bowling for Fascism: Social Capital and the Rise of the Nazi Party in Weimar Germany, 1919-33 by Shanker Satyanath, Nico Voigtlaender and Hans-Joachim Voth

Abstract:

A growing literature emphasizes the potentially "dark side" of social capital. This paper examines the role of social capital in the downfall of democracy in interwar Germany by analyzing Nazi party entry rates in a cross-section of towns and cities. Before the Nazi Party's triumphs at the ballot box, it built an extensive organizational structure, becoming a mass movement with nearly a million members by early 1933. We show that dense networks of civic associations such as bowling clubs, animal breeder associations, or choirs facilitated the rise of the Nazi Party. The effects are large: Towns with one standard deviation higher association density saw at least one-third faster growth in the strength of the Nazi Party. IV results based on 19th century measures of social capital reinforce our conclusions. In addition, all types of associations - veteran associations and non-military clubs, "bridging" and "bonding" associations - positively predict NS party entry. These results suggest that social capital in Weimar Germany aided the rise of the Nazi movement that ultimately destroyed Germany's first democracy.

Don't forget: Condliffe Lecture 2013

What if... Our cities vanished?
Wednesday, 10 July 2013 from 6:30 PM to 8:00 PM
Undercroft 101 Seminar Room, James Hight Building, University of Canterbury
Presenter: Professor Edward Glaeser, Harvard University

• What if humanity stopped urbanising?
• What is the role of cities in promoting economic growth?
• What are the lessons for the Christchurch rebuild from cities around the world?

Cities are often seen as the source of social problems such as poverty and crime, while we retain romantic notions of idyllic rural life. The truth is very different. In this lecture, Professor Edward Glaeser, the world’s leading expert in the economics of cities, will discuss why cities are crucial to economic development, why proximity has become ever more valuable as the cost of connecting across long distances has fallen and why, contrary to popular myths, dense urban areas are the true friends of the environment, not suburbia.

You can register for the lecture here: http://www.eventbrite.co.nz/event/7114849707/es2/?rank=1

EconTalk this week

Betsey Stevenson and Justin Wolfers, of the University of Michigan talk with EconTalk host Russ Roberts about their work on the relationship between income and happiness. They argue that there is a positive relationship over time and across countries between income and self-reported measures of happiness. The second part of the conversation looks at the recent controversy surrounding work by Reinhart and Rogoff on the relationship between debt and growth. Stevenson and Wolfers give their take on the controversy and the lessons for economists and policy-makers.

The rise and fall of the gold standard

There is a new Cato Policy Analysis piece out on The Rise and Fall of the Gold Standard in the United States (pdf) by George Selgin. The executive summary reads,

There is, in informal discussions and even in some academic writings, a tendency to treat U.S. monetary history as divided between a gold standard past and a fiat dollar present. In truth, the legal meaning of a “standard” U.S. dollar has been contested, often hotly, throughout U.S. history, and a functioning (if not formally acknowledged) gold standard was in effect for less than a quarter of the full span of U.S. history.

U.S. monetary policy was initially founded upon a bimetallic dollar, convertible into either gold or silver. Although officially committed to bimetallism, from 1792 to 1834 the United States was functionally on a silver standard. From the Civil War until 1879, a fiat “greenback” standard predominated with the exception of a few states, such as California and Oregon, where a gold standard continued to operate.

Between 1870 and 1879 numerous countries embraced gold monometallism. France ended the free coinage of silver in 1873, while the rest the Latin Monetary Union followed in 1876. But it was above all Germany’s switch to gold that prompted the United States to demonetize silver and embrace gold. Thus began the era of the Classical Gold Standard in the United States.

The Classical Gold Standard Era lasted until about War World I, when as common in times of war countries abandoned their commitment to convertibility. What followed World War I was the Gold Exchange Standard, whose failure resulted from its dependence upon central bank cooperation. Post World War II, the Gold Exchange Standard was replaced by the Bretton Woods System and its reliance on a fiat dollar. Bretton Woods finally came to an end when President Nixon closed the “gold window” on August 15, 1971.

This paper reviews the history of the gold standard in the United States, explaining both how that standard came into being despite having been neither formally provided for nor informally established at the nation’s inception, and how it eventually came to an end. It concludes that the conditions that led to the gold standard’s original establishment and its successful performance are unlikely to be replicated in the future.

EconTalk this week

Dan Pallotta, Chief Humanity Officer of Advertising for Humanity and author of Uncharitable talks with EconTalk host Russ Roberts about the ideas in his book. Pallotta argues that charities are deeply handicapped by their culture and how we view them. The use of overhead as a measure of effectiveness makes it difficult for charities to attract the best talent, advertise, and invest for the future. Pallotta advocates a new culture for non-profits that takes the best aspects of the for-profit sector to enhance the mission and effectiveness of charities.

A philosopher's objections to NSA surveillance

Philosopher, and Adam Smith scholar, James Otteson appeared on the Wall Street Journal's "OpinionLive" on the 13th of June to discuss his objections to the recently revealed activities of the NSA with regard to their surveillance of American Citizens.