Politicisation of provision

That the government isn't the best provider of many goods and services is a common enough argument, with plenty of empirical evidence to back it up. The (theoretical) question is, Why? I'm increasingly thinking that the answer is simply the incentives that government ownership or provision entail, or in short, the politicisation of provision.

It could be argued that it is an issue of corporate governance and that the problem with government-owned firms is poor selection and motivation of managers and workers. That within the bureaucracy government managers and workers just need the correct incentives and all will be well. But what underlies bad corporate governance and incentives?

I noted in the posting on Last Rites for the Cullen Fund? the comment by Roger Kerr on the politicisation of decisions to do with the fund,

Moreover, there was never any chance that the Guardians of the Fund would remain free from political interference in their job of maximising its returns (for a given level of risk). Predictably, in a few short years we have seen political parties variously proposing to bias the Fund’s investments towards infrastructure, green projects, venture capital and investment in New Zealand.

I also noted in the posting on Public-private partnerships one of the reasons that PPPs have not worked as expected was

[...] the operation and outputs of PPP schemes have often been subject to substantial political and bureaucratic intervention. As seen with some of the public transport PPPs, a hostile relationship may develop between the counterparties. There can even be politically-motivated attempts to subvert the viability of projects. This makes it more difficult both to raise private finance and transfer risk. Investors are more likely demand a premium and contractual guarantees if they perceive political risks as high.

When applying their grabbing hand theory of government to privatisation Shleifer and Vishny write,

Unlike the helping hand perspective, it suggests that the key problem of state firms is government interference in their activities to direct them to pursue political rather than economic goals, such as excess employment. [...] Indeed, assigning to the government the role of actively finding better managers or of restructuring monopolies contradicts the essential premise of the grabbing hand approach: that government control is itself the fundamental problem.

In their discussion of New Zealand's SOEs, Spicer, Emanuel and Powell (1996) warned that there are two pressures on SOE's: the first being towards privatisation since the productivity and efficiency gains achieved by SOE are in danger of being eroded over time due to political pressure and the second being towards a return to being part of the public sector where social and political objectives can be more readily be meet. Most interventions in SOE's operations seemed to be more politically motivated.

If this is right and the fundamental problem with state ownership is the politicisation of provision, then it suggests that any reform of the public provision of goods and services has to be aimed at reducing as much as possible the ability of politicians and the bureaucracy to intervene. This is far from easy. Privatisation, for example, is often seen as one way to depoliticise a firm. But governments often keep "golden shares" in the privatised firm just so they can intervene when it is politically advantageous to do so. Shleifer and Vishny argue that

[...] the design of privatization must focus on restricting the possible future influence of the state on privatized firms, through subsidies, regulations, or even minority ownership.

But the compete avoidance of government influence on firms is impossible. However the above does suggest that for the example of privatisation, the sale of the total government interest in a firm is needed along with no use of residual control via things like "golden shares".

Other approaches to the depoliticisation problem have been tried in other areas of the economy. New Zealand tried to make its SOEs work like private business by writing this requirement into the SOE Act. But as Spicer, Emanuel and Powell (1996) make clear this hasn't been totally successful, political interference can still take place. Depoliticisation of the operation of monetary policy is attempted in New Zealand via the Reserve Bank Act which gives the Reserve Bank instrument independence, but not goal independence. But there is also debate as to how successful this has been. The Kerr quote above suggests that the independent Cullen Fund may not be so independent and the problems of the PPP schemes noted above also suggests that these approaches to political free investment may not be as successful as they could be.

So the politicisation of provision may be an obvious problem but it doesn't seem to have an obvious solution.

Incentives matter: cash for clunkers file

Will Wilkinson on the recently passed "cash for clunkers" legislation in the US:

OK. Let me get this straight. I can get $4500 toward a new car as long as my old car gets terrible gas mileage. Well, I’ve got a 1996 Civic, which gets 30-something MPG. But it’s worth less than $4500. So I guess I should sell it for what it’s worth ($2-3000) maybe, buy a total piece of shit for as cheap as possible, and then exchange that for $4500 off a new car? I’d be several grand ahead. Of course, most of the models of new car I’ve got my eye on get worse mileage than a 1996 Civic. So if this plan induced me to buy a new car when I wasn’t going to, which it might, and I get the kind of car I think want, taxpayers will have paid me $4500 to drive a nicer but less fuel efficient car than I’ve got.

Or maybe I should just buy a clunker, get the trade-in, then instantly sell the brand new car for $2000 off sticker and pocket the rest. Anyway, better move quick. Lemons go fast when everybody’s thirsty for lemonade.

Acemoglu on growth

The "Epilogue: Mechanics and Causes of Economic Growth" from Introduction to Modern Economic Growth by Daron Acemoglu is available as a pdf file here.

He gives a brief discussion of what you hopefully will have learned from the models in his book and how they offer a useful perspective on world growth and cross-country income differences. He then provides a quick overview of some of the many remaining questions.

There is an interesting section on "A Possible Perspective on Growth and Stagnation over the Past 200 Years" in which Acemoglu gives some tentative answers to three questions:

1. Why did the world economy not experience sustained growth before 1800?
2. Why did economic takeoff start around 1800 and in Western Europe?
3. Why did some societies manage to benefit from the new technologies and organizational forms that emerged starting in 1800, while others steadfastly refused or failed to do so?

All good stuff.

EconTalk this week

Riccardo Rebonato of the Royal Bank of Scotland and author of Plight of the Fortune Tellers talks with EconTalk host Russ Roberts about the challenges of measuring risk and making decisions and creating regulation in the face of risk and uncertainty. Rebonato's book, written before the crisis, argues that risk managers often overestimate the reliability of the measures they use to assess risk. In this conversation, Rebonato applies these ideas to the crisis and to the challenges of designing effective regulation.

Last Rites for the Cullen Fund?

Roger Kerr has a piece in the Business Forum column that appeared in the Dominion Post, 10 June 2009 in which he asks, Last Rites for the Cullen Fund?

He writes,

Commentators have suggested that the government’s decision to suspend automatic contributions to the New Zealand Superannuation Fund (the socalled Cullen Fund) may spell its eventual demise.

and then asks,

Should we mourn that outcome? Would it have any implications for future superannuation benefits, as some have suggested?

His answer to both these questions is no.

An important point that Kerr makes later in the article is a version of a problem that appears with many cases of government provision of goods or services: politicisation of provision,

Moreover, there was never any chance that the Guardians of the Fund would remain free from political interference in their job of maximising its returns (for a given level of risk). Predictably, in a few short years we have seen political parties variously proposing to bias the Fund’s investments towards infrastructure, green projects, venture capital and investment in New Zealand.

All moves which will not maximize the return to the fund.

Kerr goes on to note that instead of putting money into a ‘jam jar’, a more prudent policy to provide for the future would be to continue to repay debt and focus on boosting productivity and growth.

It also has to be asked if borrowing to grow the Super Fund is a sound investment strategy? Kerr writes

But returns above risk-free rates can only be achieved by taking on more risk. Sharemarkets could easily fall by 30-50% again when the Fund is at its peak. If it made sense to fund future pensions by risky investments it would make sense to do the same for future health costs and other government programmes.

There is the additional problem that by contributing to a high tax burden in the build-up period, the Super Fund impedes economic growth and risks discouraging private savings. Kerr goes on to say that an additional reason for Cullen Fund to be wound up,

[...] is to ‘deleverage’ the Crown balance sheet. Finance minister Bill English has argued that assets should be managed as actively as liabilities. Facing growing debt, a household or a company looks to realise assets to reduce its exposure, and the same principle applies to the Crown.

It is also worth noting that at its best the Super Fund amounted to a tax-smoothing scheme which was estimated at its inception to cover only 14% of NZS, with the balance coming from current taxation at the time. With the suspension of contributions for a decade, the Treasury estimates that the amount of NZS covered will drop to only 8%.

The budget decision to suspend contributions should be taken as an opportunity to open the debate on how we should deal with superannuation. What role is there for government and what role for private savings? And how best are we to achieve whatever role we assign to the public and private sectors?

An exam question I would like to ask

Indeed in the absence of transactions costs there seemed to be no reason why firms should exist at all.

Martin Ricketts, "The Use of Contract by Government and its Agents", 2009.

Discuss with reference to the neoclassical theory of the firm and the Coaseian approaches to the firm.

Public-private partnerships

Public-private partnerships (PPPs) seem to offer a solution to a common problem for economies which have been hampered by the poor quality of their infrastructure. PPPs mean, it is argued, that private capital would be used to fund much-needed projects, whether it be in transport, education, health or whatever. Better still, it was further argued, private companies could build and operate the new infrastructure, bringing large cost savings.

At the IEA website Richard Wellings discusses the British experience with PPPs. He explains Why PPPs may offer poor value for money.

Wellings writes that in the UK,

The first modern PPPs were began in the 1980s under what became known as the Private Finance Initiative (PFI). Their numbers grew during the early-mid 1990s, with several design, build, finance and operate (DBFO) road schemes, as well as the construction of a number of privately-operated prisons. These projects were generally viewed as successful within government - a higher proportion were delivered on time and on budget than would have been expected using traditional procurement methods.

Building on these foundations, the election of a New Labour government saw a rapid expansion in the number of PPPs. The model fitted well with Labour’s ‘Third-Way’ approach to the economy. Instead of outright nationalisation, with its well-documented ineffiencies, the dynamism of the private sector would be harnessed for social objectives.

By 2003/04 PPP schemes accounted for 39% of capital spending by UK government departments. And by January 2008 there were over 500 operational PPP projects with a total capital value of around £44 billion and a further number in the pipeline. Their scope was also widened, with a higher proportion used to build new schools and hospitals. Public transport became a major investment priority rather than roads.

But Wellings argues this expansion of PPPs may have been misguided. Indeed, it was arguably when partnerships started to go wrong. In particular, unlike the earlier schemes, the new projects were more likely to be in fields marked by a high level of political sensitivity. Wellings gives as an example of the problems, the London Underground PPP. He writes,

This huge project, designed to upgrade the Tube, required an annual subsidy of £1 billion. Fiercely resisted by the Greater London Authority under Ken Livingstone, who favoured an alternative bond finance scheme, it was imposed on the capital by central government with heavy Treasury backing. So even before it started the process was marked by a high level of controversy.

Extremely complex 30-year contracts were drawn up, at a cost of £455 million in consultancy fees, and the Rail Regulator was appointed as ‘PPP Arbiter’ to adjudicate any disputes. Two consortiums were selected to upgrade and maintain different sections of the network.

In 2003 the Metronet consortium began a £17 billion project covering nine out of twelve tube lines. It soon got into difficulties. In April 2004 it was fined £11 million for poor performance, but this was just the start.

Further fines followed and in June 2007 Metronet, concerned about cost escalation, requested an extraordinary review by the PPP Arbiter. A short-term cost overrun of £551 million was predicted, rising to £2 billion by 2010, and this was blamed on additional demands made by Transport for London.

But the Arbiter had a different view – most of the cost escalation could be explained by Metronet’s inefficiency and only a small fraction of the requested extra payments would be forthcoming. Faced with huge losses, the company went into administration.

The government tried to find private bidders for the Metronet contracts but failed – unsurprisingly given the uncertainty concerning costs. The public sector then became responsible for the upgrades and maintenance. Taxpayers would now pick up the bill for any cost overruns.

The events just described illustrate a key weakness of PPPs. When they involve essential infrastructure that government will not allow to fail (too big to fail?), it is clear that a high proportion of a project’s risk remains with the public sector. But such an acknowledgment undermines one of the major rationales for having PPPs in the first place, that they are good value for money despite apparently higher financing costs, because of their ability to transfer risk to private investors. A transfer that doesn't appear to have taken place.

Wellings goes on to explain that the UK experience thus far suggests that PPP schemes have failed to live up to their early promise. He offers several explanations for this:

Firstly, comparisons with public finance may understate the true cost of government funding. While it may be possible to borrow at low interest rates this is only because potential risks and losses have been offloaded on to taxpayers.

Secondly, a high proportion of recent PPPs have been plagued by high ‘transaction costs’. They have involved tortuous bidding processes and the creation of complex contractual agreements and regulatory frameworks, which have created additional costs and risks for the private-sector partners involved. Value for money has been reduced as a result.

Finally, the operation and outputs of PPP schemes have often been subject to substantial political and bureaucratic intervention. As seen with some of the public transport PPPs, a hostile relationship may develop between the counterparties. There can even be politically-motivated attempts to subvert the viability of projects. This makes it more difficult both to raise private finance and transfer risk. Investors are more likely demand a premium and contractual guarantees if they perceive political risks as high.

Wellings concludes by saying,

Accordingly, PPPs may not be a suitable funding model for some projects. The risks are particularly high in situations when government is unwilling to take a ‘hands-off’ approach. At the same time, if government will stand aside, perhaps after setting a loose regulatory framework, then depoliticisation through full-blooded privatisation may be the best option.

There are warnings from the UK experience of PPPs for other countries, New Zealand?, thinking of going down this route. Hopefully these warnings will be heeded.

Bill Easterly on "rights" at the UN

At his blog Aid Watch Bill Easterly comments on "rights" at the UN. He writes

But let’s talk about rights at the UN. The UN publicizes such positive rights as “right to water,” “right to housing,” “right to health”, etc. These rights sound wonderful, while not imposing any specific obligation whatsoever on any specific actor to do any specific thing for any specific poor person. It is impossible for the UN or any other body to allocate responsibilities for observing the “right to water,” and also decide who will be first in line among the 884 million people now without clean water. So even if the UN creates international pressure to observe these “rights,” the pressure is diffused across so many potential actors with unclear responsibility that it has no effect, accomplishing nothing for poor people.

What about the UN’s record on the more traditionally defined “negative” human rights, like freedom from state killings and torture? These human rights are a lot easier to specifically address – the UN could denounce human rights violations, identifying the violator and the victim each time. Here international pressure could have more of an effect, because it is applied to very specific wrong-doers to stop very specific actions against specific victims [...]

So such victims could appeal to the UN Human Rights Council for their rights vis-à-vis the governments of Cameroon, China, and Egypt – except that the governments of Cameroon, China, and Egypt are MEMBERS of the UN Human Rights Council. The UN is perpetrating a sick joke on such victims, by filling the Human Rights Council with human rights violators. This travesty is already well known, but that doesn’t mean anyone who cares should stop talking about it.

Easterly end by noting

So here’s the scorecard on UN human rights. On something like “the right to water,” where it is impossible to identify who is violating such “rights,” the UN talks big. On human rights violations like killings and torture, where the UN knows precisely who is the violator, the UN sometimes shows up on the violator's side.

The UN is willing to talk big when words are meaningless, and unwilling to take action when actions could actually achieve something. If (costly) actions are taken as the measure of true intention-costless actions are just cheap talk , signals must be costly to be credible-then the UN comes up looking very lame when it comes to human rights.

Does climate change affect economic growth?

A question I'm sure you ask yourself several times a day. Well the answer according to Melissa Dell, Benjamin F. Jones, and Benjamin A. Olken in their paper “Climate Shocks and Economic Growth: Evidence from the Last Half Century,” NBER Working Paper 14132, 2008 comes in three parts:

First, higher temperatures have large, negative effects on economic growth, but only in poor countries. In poor countries, we estimate that a 1ºC temperature increase in a given year reduced economic growth in that year by about 1.1 percentage points. In rich countries, changes in temperature had no discernable effect on growth. Changes in precipitation had no substantial effects on aggregate output in either poor or rich countries. When we examine the impact of changes in average temperatures lasting a decade or more rather than annual changes, we find very similar results.

Second, one can distinguish two potential ways temperature could affect economic activity:

1. influencing the level of output, for example by affecting agricultural yields, or
2. influencing an economy’s ability to grow, for example by affecting investments or institutions that influence productivity growth.

The difference between these two types of effects matters when one starts to contemplate permanent changes to temperature: would a 1ºC permanent increase in temperature reduce per-capita GDP by 1.1 percentage points, or would it reduce the growth rate by 1.1 percentage points year after year? We find that higher temperatures reduce the growth rate in poor countries, not simply the level of output. Since even small growth effects have large consequences over time, these growth effects – if they persist in the medium run – imply very large impacts of permanent temperature increases.

Third, we find that temperature affects numerous dimensions of poor countries’ economies in ways consistent with an effect on the growth rate. While agricultural output contractions appear to be part of the story, we find adverse effects of hot years on industrial output and aggregate investment. Moreover, we document that poor countries produce fewer scientific publications in hot years, which suggests that higher temperatures may impede innovative activity. Higher temperatures lead to political instability in poor countries, as evidenced by irregular changes in national leaders. Many of these effects sit outside the primarily agricultural focus of much economic research on climate change and underscore the challenges in building aggregate estimates of climate impacts from a narrow set of channels. These broader relationships also help explain how temperature might affect growth rates in poor countries, not simply the level of output.

For a longer summary of the paper see the column, Does climate change affect economic growth?, at VoxEU.org.

Strange vote buying

Eric Crampton at Offsetting Behaviour reports on vote buying in Tanzania. It looks likely that both the government and the opposition bought voter cards in areas where they were likely to face greater opposition. Nothing strange in this in many parts of the world. But what is strange is the going currency: Mattresses!

Mattresses? Why Mattresses? These are not the most obvious choice for a medium of exchange for any transaction. To be widely marketable, a medium of exchange should possess the following characteristics:

1. transportability
2. divisibility
3. high market value in relation to volume and weight
4. recognizability
5. resistance to counterfeiting

Apart from, may be, item 4 I don't see mattresses as have any of these characteristics. So how is it that you can buy votes for them? There are some very strange markets out there!

What would Menger's theory of money look like if the medium of exchange was mattresses?!

Oh dear, its now Buy Australian

A posting at the Homepaddock blog lead me to this very strange article, by one Martin Feil, in The Age: 'Buy Australian' and free market theory are not in conflict. Feil writes,

Buy American, Buy Australian or Buy Any Nation campaigns work on the basis of a simple, first principle concept. Consumers do not know the country of origin of the products they are buying. The first principle of a Buy My Country's products campaign is to tell the consumer at the retail outlet where the produce or consumer products come from.

A free market economist would say that this is part of the preconditions of perfect consumer knowledge, which is one of the assumptions of the dominance of free markets. A rational consumer acting in their own interest with perfect market knowledge will make consumption decisions that, when aggregated, create economic decisions superior to any decision that could be made by an intervening government

The assumption of perfect information is one of assumptions made for a perfectly competitive market. In free markets consumers have complete knowledge of the conditions of the market. In particular they know the quality and price of the good they are buying.

Now note another assumption of the very same model: product homogeneity. The industry is defined as a group of firms producing a homogeneous product. The technical characteristics of the product as well as the services associated with its sale and delivery are identical. There is no way in which a buyer could differentiate among the products of different firms. If the product were differentiated the firm would have some discretion in setting its price. This is ruled out in perfect competition. What matters here is that you don't know what firm is making the good and, of course, you don't know what country the good is made in-which is what Mr Feil wants.

Also note that imperfect information can result in product differentiation. If all firms produce the same (undifferentiated) product but consumers, wrongly, think they are different, then the products are differentiated. Also if the products really are different but consumers don't know this, then there is no product differentiation.

Thus if Mr Feil's is arguing that better information will move as towards a more efficient, more perfectly competitive like outcome, then he has to give up on product differentiation.

But what Martin Feil wants is not perfect competition, because he wishes to differentiate goods by the country they are made in. He is an economic xenophobic. But the reasons for rejecting such mercantilist like arguments are well known and go back as least as far as Adam Smith. In short, free trade makes consumers better off. They get cheaper, better quality goods and services.

If people really do value the information about where goods are made then why is this information not already available? Someone could make a killing by just putting "made in Australia" stickers on Australian products. Or by opening stores which sell only Australian made products.

But why stop at "Buy Australian"? Why not "Buy New South Wales" campaigns? Or even "Buy Sydney" campaigns? If you accept the logic at the level of Buy Australian then you also have to accept the logic at the level of Buy New South Wales and Buy Sydney. Is Mr Feil really willing to go this far? And if not, why not?

To go to the extreme let us assume that Mr Feil gets his wish and Australians only buy local goods and services, that is, imports are zero. But if imports are zero then exports are also zero since, roughly, imports have to equal exports so that the balance of payments is zero. Is Australia really going to be better off in this case?

So I'm not really sure what Mr Feil's argument is, other than he wants Australians to make themselves worst off by buying (local) goods they otherwise won't buy.

Who knows best?

Over at the ThinkMarkets blog Gene Callahan asks does Daddy Knows Best? He writes

Does economics have to assume that Daddy (or anyone else) knows what’s best form himself? I’m reading Dan Klein’s Libertarian Essays, in which he asserts “that the individual knows best in matters that concern her alone” is “one of the most basic precepts of economics.”

Callahan is not happy with this analysis, he argues that all that economics needs assume to explain, say, market prices, is that the individual, if left free to do so, will choose based on what she thinks is best for her, regardless of whether or not anyone knows better.

However, there is the point that to say someone knows better, by some objective measure, what is good for us is to abandon the subjective theory of value. You could reply that whether or not our subjective valuations are right does not matter for prices, since even if wrong, they still form the basis for market trading.

But if we don't know what's best for ourselves then should this not lead to "advice markets"? We are able to shop for advisors who can correct any errors of judgment we may make. Or at least, increase the probability of making the right decision. And I have the strongest incentives to correct errors, to search for good advice, since I pay the costs of wrong decisions.

But I'm not sure that the difference between the Callahan and Klein positions has empirical relevance. How could you ever test which of them is right?

A politician thinks up an economic plan ...

(HT: Carpe Diem)

Excuse me while I puke

This comes from a group of second-year Harvard MBAs: The MBA Oath.

As a manager, my purpose is to serve the greater good by bringing people and resources together to create value that no single individual can create alone. Therefore I will seek a course that enhances the value my enterprise can create for society over the long term. I recognize my decisions can have far-reaching consequences that affect the well-being of individuals inside and outside my enterprise, today and in the future. As I reconcile the interests of different constituencies, I will face choices that are not easy for me and others.

Therefore I promise:

* I will act with utmost integrity and pursue my work in an ethical manner.
* I will safeguard the interests of my shareholders, co-workers, customers and the society in which we operate.
* I will manage my enterprise in good faith, guarding against decisions and behavior that advance my own narrow ambitions but harm the enterprise and the societies it serves.
* I will understand and uphold, both in letter and in spirit, the laws and contracts governing my own conduct and that of my enterprise.
* I will take responsibility for my actions, and I will represent the performance and risks of my enterprise accurately and honestly.
* I will develop both myself and other managers under my supervision so that the profession continues to grow and contribute to the well-being of society.
* I will strive to create sustainable economic, social, and environmental prosperity worldwide.
* I will be accountable to my peers and they will be accountable to me for living by this oath.

This oath I make freely, and upon my honor.

There can be little more dangerous to success of a company than mangers who think social responsibility is their responsibility-using other peoples money, of course. This makes me feel that we need Milton Friedman even more today. Friedman has long suggested that the social responsibility of business is to maximize profits. As Friedman wrote,

But the doctrine of "social responsibility" taken seriously would extend the scope of the political mechanism to every human activity. It does not differ in philosophy from the most explicitly collectivist doctrine. It differs only by professing to believe that collectivist ends can be attained without collectivist means. That is why, in my book Capitalism and Freedom, I have called it a "fundamentally subversive doctrine" in a free society, and have said that in such a society, "there is one and only one social responsibility of business–to use it resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud."

I'm with Friedman.

Words to ponder

Raising taxes on alcohol to prevent problem drinking is akin to raising the price of gasoline to prevent people from speeding.

Edward Peter Stringham, "The Catastrophe of What Passes for Alcohol Policy Analysis". Reason Foundation, Policy Brief no. 78, 2009.

Economists talking about who knows what

The link below is to a video of Maroš Servátka of the University of Canterbury, Rudolf Sivák of Ekonomická univerzita and Mary M. Shirley of the Ronald Coase Institute talking about God knows what since the discussion is in the Slovak language.

But to be fair, Maroš makes about as much sense to me in the video as he does talking to him in English. But I have never seen him in a suit before! Click here.

Buy British ... or not

Homepaddock has an interesting post on British dairy co-op in receivership. In part she writes

Dairying in Britain is not in a healthy state. Production and cow numbers have fallen prompting farming leaders to urge retailers to pay a fair price for milk.

Organisations including the NFU, NFU Scotland, NFU Cymru and the FUW have written to retailers and food service industry to call for action to secure Britain’s milk supplies.

In the letter, the organisations said retailers, discounters and the food industry need to help increase confidence among dairy farmers to stop them leaving the sector.

Everyone in the milk supply chain needs to make a fair profit and retailers needed to stop gambling with the security of milk supplies, it said.

“Our message is very simple. If you want to guarantee a supply of quality British milk, cheese and dairy products you must take steps to secure it,” it added.

New Zealand producers may be concerned that the industry-wide group asked retailers and food service companies to commit to sourcing British dairy products because that will be direct competition for our milk and cheese.

Anyone who thinks promoting Kiwi-made is still a good idea should take note of this because if we urge domestic consumers to buy local, we can’t argue when overseas competitors urge their domestic consumers to buy local too.

Homepaddock is right in that this is just a "Buy British" campaign, which is just as dumb as "Buy New Zealand" or "Buy American".

But what got me about the message quoted is the logic they seem to be using. Or rather the lack of logic. For a start they want retailers to pay a fair price for milk. And what is a "fair price"? I'm guessing they mean a higher price than they are paying now. But if retailers pay a higher price then consumers pay a higher price. But demand curves slope downwards. If the price goes up, the quantity demanded goes down. These two effects work against each other in determining revenues. Or do milk producers think the demand for milk is totally inelastic? Add to this the fact that if consumers pay more for milk they may end up buying less of other goods. How would this help the UK economy?

They also want "retailers and food service industry to call for action to secure Britain’s milk supplies". What actions? Retailers are there to provide what their customers want. What are they to do, force consumers to buy British milk at gun point? If consumer don't want to buy British, what are the retailers and food service industry to do?

And what is a "fair profit"? Profit is a residual, its what is left over, if anything, after costs have been subtracted from revenues. What is fair or unfair about this? Or it is believed that everyone in the milk supply chain can just specify this "fair profit" and all will be well. If it is the case that these business can specify a profit why don't they, and all other business, specify an infinite profit, that seems fair.

But there seems to be a more basic issue here, that of resource allocation. May be the fact that dairying in Britain is not in a healthy state is telling farmers that they do not have a comparative advantage in dairying, that other countries, like New Zealand, can do the job better and that consumers will gain if dairy products are imported. The message being sent to dairy farmers is that they have misallocated resources, the resources they are using in this form of farming would be better used in some other activity.

I guess the basic question is, Why should anyone take actions to secure Britain’s milk supplies? The best suppliers may be foreigners. That's what the gains from trade are all about.

The effects of the Buy American campaign

This comes from an article in the Economist magazine:

Canadians are already worried at signs of rising protectionism in their neighbour’s Democrat-led Congress, in the form of Buy American provisions in the economic-stimulus package and proposals in a new environmental bill to impose trade sanctions on countries with high levels of greenhouse-gas emissions. Their indignation has been heightened by two unfortunate incidents. A contractor at the Camp Pendleton Marine base in California ripped out a section of sewerage pipe because it was Canadian-made; and a Canadian salesman travelling to an equestrian-products trade show was turned back at the Washington state border on the ground that he was “stealing” American jobs.

Child care subsidies and childhood obesity: part 2

I blogged earlier on a NBER working paper by Chris M. Herbst and Erdal Tekin that looks at Child Care Subsidies and Childhood Obesity (NBER Working Paper No. 15007, May 2009). Since then the Economist magazine has commented here, Kiwiblog commented here and Homepaddock commented here.

I have now come across a longer summary of the paper from the Population Association of America (PAA) 2009 Annual Meeting Program Website:

The 1996 overhaul of the U.S. welfare system introduced important changes to the way that federal and state governments provide child care assistance to low-income families. The Welfare Reform Act consolidated the child care subsidy system into a single Child Care and Development Fund (CCDF) and increased funding to facilitate the movement of welfare recipients into employment. States were also granted increased flexibility in program design and implementation. In 2005, states spent about $9.4 billion on child care subsidies and served an average of 1.7 million children per month.

Although a large number of studies examine the impact of subsidies on low-income mothers’ employment and child care utilization, researchers have largely ignored the question of whether subsidies have implications for child development, including obesity. There are two primary channels through which child care assistance policies can influence child outcomes. First, mothers must be employed to be eligible for a subsidy, and research evidence points to a negative relationship between maternal employment and childhood obesity. Second, there are a number of design features associated with the CCDF that have implications for the quality of care purchased with subsidies. Indeed, a sizable literature finds that subsidized children receive lower quality care than unsubsidized, low-income children.

In this paper, we explore the relationship between child care subsidy receipt and obesity. Our analysis draws from the Early Childhood Longitudinal Study-Kindergarten cohort (ECLS-K), a nationally representative sample of 21,260 children attending kindergarten in the fall of 1998. Children in the ECLS-K are followed through the eighth grade, with detailed parent, child, and teacher interviews conducted in the fall and spring of kindergarten (1998 and 1999) and the spring of first (1999), third (2002), fifth (2004), and eighth (2007) grade. This study is based on the fall and spring of kindergarten waves of data collection, in which children’s height and weight measurements were taken and parents were asked questions about child care attendance in the year prior to kindergarten entry. We limit our sample to 3,186 children who lived with a single mother as of the fall of kindergarten interview.

Two key outcomes are explored in this study: an indictor for whether a given child is overweight and an indictor for whether the child is at-risk of being overweight. These variables are derived from the child’s Body Mass Index (BMI), which is ascertained during the fall and spring interviews. BMI is defined as weight in kilograms divided by height in meters squared (kg/m2). Although BMI is a standard measure for defining excess weight among adults, the Centers for Disease Control (CDC) recently approved its use for children as well. We follow the CDC guidelines for age- and gender-specific BMI cut-offs to define overweight children as those with a BMI at or greater than the 95th percentile of the age- and gender-specific distribution. Children who are at-risk of being overweight have a BMI that is at or greater than the 85th percentile of the distribution. Approximately 13 percent of children in both surveys are overweight, and 30 percent are at-risk of being overweight.

The primary independent variable in our analysis is a dummy variable indicating whether a given child received subsidized, non-parental child care in the year prior to kindergarten. Parents were asked a series of questions about child care use during the past 12 months, including the number of arrangements, the amount of time that each arrangement was used, whether there was a cost associated with each arrangement, and if so, the amount paid for care. Regarding subsidy receipt, parents were asked the following: “Did any of the following people or organizations help to pay for this … provider to care for {CHILD} the year before {he/she} started kindergarten?” Four possible choices were then presented to parents, and we code those answering “a social service agency or welfare office” as receiving a child care subsidy. ( Similar questions appear in several nationally representative surveys (e.g., National Survey of America’s Families and the Survey of Income and Program Participation), and other researchers have constructed indicators of subsidy receipt based on them.) Approximately 15 percent of children are coded as receiving subsidized care in the year before kindergarten.

The key empirical problem is that child care subsidies are not randomly assigned to families; in fact, states use a number of strategies to ration subsidies according to specific child/family characteristics. If there are unobserved characteristics related to both the propensity to receive a subsidy and the outcomes, the coefficient on subsidy receipt will be biased. Therefore, we take a number of steps to minimize this bias. We utilize the richness of the ECLS-K dataset and control for an extensive set of characteristics to mitigate the influence of omitted variables. A potential concern is that even our extensive set of controls may not fully account for unobserved heterogeneity. Therefore, we include in our models county fixed effects as a second attempt to eliminate unobserved heterogeneity. Finally, we estimate models with Two Stage Least Squares (TSLS), relying on exclusion restrictions to identify the impact of child care subsidies. Specifically, we use variables that determine how subsidies are rationed under the assumption that childhood obesity does not depend on the rationing mechanism, conditional on subsidy receipt. Furthermore, we assume (and provide substantial evidence) that rationing is determined at the county-level and therefore use county of residence as the identifying instruments.

Preliminary results suggest that child care subsidy receipt during the year before kindergarten increases the likelihood that children are overweight and at-risk of being overweight. These findings are robust across the various estimators. Although the magnitude of the subsidy effect attenuates somewhat between the fall and spring of kindergarten, the basic results persist over time. Our results at this point indicate that participation in center-based child care appears to be driving the impact of subsidies.

How not to do antitrust (updated)

George L. Priest writes in the Wall Street Journal on The Justice Department's Antitrust Bomb. He says

As if commandeering the banking, finance and auto industries weren't enough, a couple of weeks ago the Obama administration decided to throw a bomb at modern antitrust law.

Assistant Attorney General for Antitrust Christine Varney claims that the Justice Department can aid economic recovery by prosecuting businesses that have been successful in gaining large market shares.

I spent two hours in tutorials yesterday pointing out that size in and of itself is not a problem. Bigness, in terms of a large market share, may be necessary for market power but it is not sufficient. The most obvious counter example is a contestable natural monopoly. To be efficient you want only one provider, but because the market is contestable the monopolist would not have market power.

Priest continues

In her announcement last month she argued that "many observers agree" that our current recession reflects "a failure of antitrust" and "inadequate antitrust oversight."

This is news to most economists. The cause of the recession is not easy money by the Fed, or the bursting of the housing bubble, or excessive risk-taking through complicated financial instruments? It's insufficient antitrust prosecution? The claim is hardly plausible. Prosecuting successful businesses will help the recovery? Again, hard to believe

Priest then asks

Why prosecute firms whose products large majorities of consumers have found most valuable?

and notes

Ms. Varney gives no principled reason.

The idea seems to be to move the US antitrust laws to more closely resemble that of Europe. Not a good idea. The basic reasons that the two approaches to antitrust diverge is that the operative legal standards are different and that the Europeans have not adopted a tradition of rigorous economic analysis. Priest notes

U.S. antitrust laws condemn practices that are "in restraint of trade," which has been interpreted to mean harm to competition. The European Union, in contrast, condemns practices that constitute "abuse of a dominant position."

Priest discusses the recent $1.45 billion fine levied by the EU against Intel.

Although the EU has not released its full report documenting what violations it found, it appears that the principal concern was Intel's practice of giving "loyalty discounts" to repeat customers, presumably increasing Intel's dominance in the microprocessor business.

Should a firm be punished for giving discounts? A discount to a repeat customer is a ubiquitous business practice from local delis to auto repair shops, hardly monopolists in any sense. At various points in her presentation Ms. Varney stated that the ambition of antitrust law is to secure low prices for consumers.

Intel, of course, operates on a different scale than a deli. But the fact that it has been able to maintain roughly an 80% market share for decades provides strong evidence that it is producing a valuable product. The antitrust questions with regard to dominant firms should be: What is the source of dominance and how has it survived over time?

The EU complaint claims that Intel has practiced a variation of predatory pricing. As is well-established in U.S. law, predatory pricing claims are highly questionable in the intellectual property field.

Priest continues by noting that the antitrust problem is likely to become increasingly troublesome over time.

In a dynamic economy we should expect the development of novel business practices as firms attempt to attract consumers in order to maximize product sales. In the U.S. -- Ms. Varney's views aside -- success in competition is rewarded. In Europe it is suspect, a particularly perverse presumption given that national and international competition has been increasing and will continue to increase.

We need competition policy which recognises that competition is the major force leading to outcomes which maximie consumer welfare. Let us not follow Europe, and here's hoping the US doesn't as well.

Update: Don Boudreaux comments on the Priest article as only he can,

In today's Wall Street Journal, George Priest argues that it's a mistake for the Obama administration to change antitrust policy from one that, at least allegedly, is focused on protecting competition to one focused on restricting large and successful - "dominant" - entities from competing vigorously with less-successful rivals. Priest is right: this policy will help only weaker rivals as it harms consumers.

But if the administration insists on resurrecting this old-fashioned (and intellectually discredited) policy, it should do so consistently. It can begin by blocking the Democratic Party from taking advantage of its dominance over its much-weaker rivals. Given President Obama's apparent understanding of the competitive process, he must know that the G.O.P. and other minor parties can compete against the Democrats only if government prevents the Democrats from exploiting their current market dominance.