The crash from an Austrian perspective

Steven Horwitz gave a talk at the Adam Smith Institute in London on "An Austrian perspective on the great recession of 2008-09". The following 6 points come from notes taken by a reporter from the Spectator and which appeared in their "Coffeehouse" column.

1. The Austrian Business Cycle Theory is necessary but not sufficient to explain the recession. Think of it as a car pile-up. Imagine we see an enormous rise in the number of traffic accidents in a major city. Cars keep colliding at intersections as drivers all seem to make the same sorts of mistakes at once. Is the most likely explanation that drivers have irrationally stopped paying attention to the road, or would we suspect that something is wrong with the traffic lights? Even with completely rational drivers, malfunctioning traffic signals will lead to lots of accidents. Keeping interest rates artificially low is like getting all the lights stuck on green.

2. The crash has nothing to do with greed. Or, rather, greed is no more to blame for these bad mortgages than gravity is to blame for plane crashes. Gravity is always present, just like greed.

3. Blame artificially low interest rates. They may create a feel-good factor, as people fill their homes with cheap stuff. But they wrongly incentivise borrowing, causing a boom followed by a bust.

4. Deregulation was not the culprit. From 1980-2009 in the US, there were 4 new regulatory policies for every 1 deregulatory policy.

5. Lessons for recovery. Bailouts and stimuli are not the answer. We need to let the healing take place and encourage savings that create capital and wealth. We do not need a “recovery plan” – recession is the recovery.

6. So what can we do? In the short-run: encourage hiring across the board (e.g. in the US, suspend payroll tax). We can suspend capital gains tax to encourage investment. We can sell off government stakes in GM and the banks, and stop bashing profit-seeking behaviour. And in the long-run: limit the powers of the central bank. Consider stronger thresholds for major fiscal policy decisions (e.g. supermajorities or balanced-budget requirements). And, finally, end subsidies.

What happens to R&D in domestic multinationals after foreign acquisition?

With foreign ownership of domestic companies becoming increasingly common, questions are mounting as to the what the consequences of said ownership are. One area of concern is the effect on research and development. This new column from VoxEU.org by Roger Bandick, Holger Görg and Patrik Karpaty presents new evidence from Sweden, where flagship firms such as Volvo and Saab are now foreign owned, that it hopes will reassure policymakers, and others.

The money quote from the article would be:

The key policy implication of the analysis is that foreign acquisitions can have beneficial effects for domestic R&D activity. Hence, there is no need for fears and therefore no need for policymakers to start thinking about limiting international merger and acquisition activity. Quite the contrary, foreign acquisitions may be an important way to generate new knowledge and contribute to boosting the level of technology in the domestic economy.

So them foreign types may not be so bad after all. Just don't tell Winston Peters.

Just for fun: reference points, property rights and transaction costs

Hart (2008: 406) argues that shading costs are akin to "haggling costs". The modelling of haggling costs can be seen as a move towards the modelling (however imperfectly) of transaction costs. Hart and Moore (2008: 4-5) argue that "[ ... ] the costs of flexibility that we focus on--shading costs--can be viewed as a shorthand for other kinds of transaction costs, such as rent-seeking, influence, and haggling costs." Exactly how similar the reference point and transaction-cost explanations are is, however, open to debate. There is also the question of the relationship between these two approaches to the firm and the property rights approach.

In a discussion of the differences between the Grossman-Hart-Moore (GHM) theory of the firm and the transaction-cost approach, Williamson (2000: 605-6) argues that the most important difference between them is that GHM introduce inefficiencies at the ex ante investment stage while the transaction-cost approach emphasises that ex post haggling and maladaptation drive inefficiencies. There are no ex post inefficiencies in GHM due to their assumption of common knowledge and ex post costless bargaining. Gibbons (2010: 283) explains it this way:

"[t]he model in question is Grossman and Hart's (1986), which explores an alternative to Williamson's (2000, p. 605) emphasis that "maladaptation in the contract execution interval is the principal source of inefficiency". Instead, in the Grossman-Hart model, there is zero maladaptation in the contract execution interval, and the sole inefficiency is in endogenous specific investments.

It is striking how different the logic of inefficient investment can be from the logic of inefficient haggling. In their pure forms envisioned here, the two can be seen as complements. For example, the lock-in necessary for Williamson's focus on inefficient haggling could result from contractible specific investments chosen at efficient levels. But by assuming efficient bargaining and hence zero maladaptation in the contract execution interval, Grossman and Hart focused attention on non-contractible specific investments and hence discovered an important new determinant of the make-or-buy decision: in the Grossman-Hart model, an important benefit of non-integration is that both parties have incentives to invest; in Williamson's argument, an important cost of non-integration is inefficient haggling. In short, the two theories are simply different."

This emphasis on ex post haggling and maladaptation can be interpreted as reflecting a view that internal organisation is better at reconciling the conflicting interest of the parties to a transaction and facilitating adaptation to changing supply and demand conditions when such cost are high.

The reference point approach can be seen as a movement away from the ex ante GHM approach and back towards transaction cost thinking in so much as contracting is not perfectly contractible ex post. This fact, as Hart (2008: 294) points out "[ ... ] is a significant departure from the standard contracting literature. The literature usually assumes that trade is perfectly enforceable ex post (e.g. by a court of law). Here we are assuming that only perfunctory performance can be enforced: consummate performance is always discretionary", and thus inefficiencies can arise ex post. The development of a tractable model of contracts and organisational form that exhibits ex post inefficiency is one of motivations for advancing the reference point approach in the first place. (Hart and Moore 2008: 4).

The reference point approach also highlights the importance of Williamson's notion of the "fundamental transformation". Hart and Moore argue that the move from an ex ante competitive market to an ex post bilateral setting--what Williamson (1985: 61-3) terms the fundamental transformation--provides a rationale for the idea that contracts are reference points. "A competitive ex ante market adds objectivity to the terms of the contract because the market defines what each party brings to the relationship. HM assume that the parties perceive a competitive outcome as justified and accept it as a salient reference point." (Fehr, Hart and Zehnder 2009: 562). This is an idea which finds experimental support: see Fehr, Hart and Zehnder (2008), Fehr, Hart and Zehnder (2009) and Hoppe and Schmitz (forthcoming).

But we must also be aware that important features of the transaction-cost theory may still have been left out. How fully shading costs capture the costs of ex post maladaptation and haggling is an open question. When discussing some opportunities for the future of transaction-cost economics, Robert Gibbons (2010: 283) notes that "[ ... ] it may be that Hart and Moore's (2008) "reference points" approach is a productive path. Time will tell [ ... ]".

• Fehr, Ernst, Oliver D. Hart and Christian Zehnder (2008). `Contracts as reference points - experimental evidence', National Bureau of Economic Research, NBER Working Paper: 14501, November.
• Fehr, Ernst, Oliver D. Hart and Christian Zehnder (2009). `Contracts, Reference Points, and Competition-Behavioral Effects of The Fundamental Transformation', Journal of the European Economic Association, 7(2-3) April-May: 561-72.
• Gibbons, Robert (2010). `Transaction-Cost Economics: Past, Present, and Future?', Scandinavian Journal of Economics, 112(2): 263-88.
• Grossman, Sanford J. and  Oliver D. Hart (1986). `The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration', Journal of Political Economy, 94(4): 691-719.
• Hart, Oliver D. (2008). `Economica Coase Lecture: Reference Points and the Theory of the Firm', Economica, 75(299) August: 404-11.
• Hart, Oliver D. and John Moore (2008). `Contracts as Reference Points', Quarterly Journal of Economics, 123(1) February: 1-48.
• Hoppe, Eva I. and Patrick W. Schmitz (forthcoming). `Can contracts solve the hold-up problem? Experimental evidence', Games and Economic Behavior.
• Williamson, Oliver E. (1985). The Economic Institutions of Capitalism, New York: The Free Press.
• Williamson, Oliver E. (2000). `The New Institutional Economics: Taking Stock, Looking Ahead', Journal of Economic Literature, 38(3) September: 595-613.

Interview with Professor Ronald Coase

Here is an interview by Wang Ning of Ronald Coase and his views on China.

An interesting question asked was about what separates good economics from bad. And it all comes down to the importance of transaction costs, which is the central message of  Coase's two most famous papers - The Nature of the Firm and The Problem of Social Cost:

WN: You mentioned many times that you do not like the term, "Coasean economics", and prefer to call it simply the "right economics" or "good economics". What separates the good from bad, the right from wrong?

RC: The bad or wrong economics is what I called the "blackboard economics". It does not study the real world economy. Instead, its efforts are on an imaginary world that exists only in the mind of economists, for example, the zero-transaction cost world.

Ideas and imaginations are terribly important in economic research or any pursuit of science. But the subject of study has to be real.

EconTalk this week

Bruce Caldwell of Duke University and the General Editor of the Collected Works of F. A. Hayek, talks with EconTalk host Russ Roberts about Hayek, his life, his ideas, his books, and articles. The conversation covers Hayek's intellectual encounters with Keynes, Hayek's role in the socialist calculation debate, Hayek's key ideas, and a discussion of which of Hayek's works are most accessible.

Why Not Socialism?

is the title of the last book by the late political philosopher G. A. Cohen. Adam Smith scholar James R. Otteson offers a review of the book in the Independent Review. He writes

Defending socialism is a tall order these days, so it is a bit surprising to see an unabashed attempt. The late G. A. Cohen was a distinguished political philosopher at All Souls College, Oxford, and an important critic of libertarianism. His 1995 book Self-Ownership, Freedom, and Equality, for example, is a challenging and searching Marxist criticism of Nozickean libertarianism. Distinguished philosophers such as Hillel Steiner and Jonathan Wolff have offered high praise for Why Not Socialism? Thus, if anyone can defend socialism successfully, perhaps Cohen can in this book.

The book’s brevity—only ninety-two very small pages—and its largely jargonfree writing suggest that it is meant for nonspecialist readers. One presumes that it is intended for classroom use, and for that purpose I suppose it can be useful. But Cohen’s argument in this book is so weak that the book’s main effect, I fear, would be to show that socialism has no plausible defense.

While I can't see an economic defense of socialism; Mises, Hayek, Robbins et al put paid to that, I am surprised/disappointed that Cohen can not offer a wider philosophic/moral/ethical defense. If only because of the standard of Cohen's past works.

Households as corporate firms

In this audio form VoxEU.org Robert Townsend talks about his recent book, co-authored with Krislert Samphantharak, that analyses household finance in developing countries using integrated household surveys. Townsend describes how to create new and more comprehensive household ‘accounts’, and use them to analyse productivity, capital structure and liquidity in households.

The General Theory after 75 years

There is a new NBER Working Paper out by Matthew N. Luzzetti and Lee E. Ohanian on "The General Theory of Employment, Interest, and Money After 75 Years: The Importance of Being in the Right Place at the Right Time".

The abstract reads:

This paper studies why the General Theory had so much impact on the economics profession through the 1960s, why that impact began to wane in the 1970s, and why many economic policymakers cling to many of the tenets of the General Theory. We discuss three key elements along these lines, including the fact macroeconomic time series through the 1960s seemed to conform qualitatively to patterns discussed in the General Theory, that econometric developments in the area of simultaneous equations made advanced the General Theory to a quantitative enterprise, and that the General Theory was published during the Great Depression, when there was a search for alternative frameworks for understanding economic crises.

Perhaps the sadist point Luzzetti and Ohanian make is

The GT [General Theory] will continue to have a large audience among policymakers as long as governments are pressed to boost nominal spending during periods of crisis, whether or not those efforts are effective.

EconTalk this week

Robin Hanson of GMU talks with EconTalk host Russ Roberts about the idea of a technological singularity--a sudden, large increase in the rate of growth due to technological change. Hanson argues that it is plausible that a change in technology could lead to world output doubling every two weeks rather than every 15 years, as it does currently. Hanson suggests a likely route to such a change is to port the human brain into a computer-based emulation. Such a breakthrough in artificial intelligence would lead to an extraordinary increase in productivity creating enormous wealth and radically changing the returns to capital and labor. The conversation looks at the feasibility of the process and the intuition behind the conclusions. Hanson argues for the virtues of such a world.

Two letters and a speech

Don Boudreaux writes to the New York Times on Packaging Insanity while Greg Mankiw goes further and writes to the President to give advice.

On the packaging issue, retired Coca-Cola executive Harry Teasley gives a great speech.

Alfred Kahn has died

Peter Cramton writes at his blog that

Alfred Kahn died on Monday, 27 December 2010, in his Ithaca home at the age of 93. Fred lived a wonderful life and contributed enormously to society and all those who knew him. As a market design he was a pioneer. It takes a special person to be named chairman of an organization, the Civil Aeronautics Board in his case, and eliminate it. Fred recognized that the CAB served only to insulate airlines from competition. Fred’s action led the way to a deregulation movement that introduced competition into many industries, reducing prices and spurring innovation.

Yes Kahn actually did away with a part of the US government! We need more such people.

The New York Times obituary is here, the Houston Chronicle's here, Cornell University's here.

EconTalk this week

Pete Boettke of George Mason University talks with EconTalk host Russ Roberts about the life, work, and legacy of Ludwig von Mises. Boettke outlines Mises's most important contributions to economics--business cycle theory, the socialism/calculation debate, and the application of economics to a wide range of behavior beyond the financial. Boettke discusses how Mises fits into the Austrian tradition and how he influenced scholars who came after him. The conversation closes with a discussion of Mises's most important works and suggests which books and articles are most accessible to a beginner who wants to explore Mises's ideas.

Happy birthday Ronald Coase

Coase was born at 3:25 p.m. on December 29th, 1910, which means he turns 100 today!

He has a new book, coauthored with Ning Wang an Assistant Professor at the School of Politics and Global Studies Arizona State University, coming out from Palgrave Macmillan and the Institute of Economic Affairs on How China Became Capitalist early next year.

Trade and farming

Which came first? In his book "The Rational Optimist: How Prosperity Evolves" Matt Ridley writes,

"One of the intriguing things about the first farming settlement is that they also seem to be trading towns. [ ... ] it is a reasonable guess that one of the pressures to invent agriculture was to feed and profit from wealthy traders - to generate surplus that could be exchanged for obsidian, shells or other more perishable goods. Trade come first." (Ridley 2010: 127).

The basic point here is that there is a conflict between the fact that we specialise in production but diversify in consumption. We produce, or help to produce, a very limited number of things but we consume a great many things. This conflict is reconciled by redistribution, i.e. via exchange/trade. Thus the first farmers who produced a limited number of goods, eg wheat or meat, but wished to consume more that just what they produced needed to be able to trade to expand their consumption set. Hence the necessity of trade for farming to survive.

EconTalk this week

Joe Nocera, New York Times columnist and co-author with Bethany McLean of All the Devils Are Here, talks with EconTalk host Russ Roberts about the origins of the financial crisis. Drawing on his book, Nocera identifies many people he considers devils for contributing to the crisis and a few angels who tried but failed to stop it. The discussion covers the history and development of securitization and the peculiar incentives created by securitization and the relative lack of regulation of the securitization process. The conversation also includes a discussion of whether past bailouts contributed to the crisis.

Boring headline of the day

Do We Need Google To Measure Inflation? Yes economists are coming up with new ways to measure changes in the CPI.


Zzzzzzzzzzzzzzzzzzzzzzzz .........................

EconTalk this week

Wafaya Abdallah of Oasis Hair Salon in Rockville, Maryland talks with EconTalk host Russ Roberts about the challenges and rewards of running a small business. Abdallah discusses her career path from would-be lawyer to owning her own salon with many employees and a management style that is different from the traditional one in her business. She discusses the economics of hair-cutting, how she motivates her employees to be part of the team, the openness of the salon's financial situation, the educational training she offers, and the ways she works with employees to motivate and inspire. You'll also learn how much her scissors cost.

Coase's big idea

The 2009 Nobel Prize in Economics co-winner Oliver Williamson has this to say about Ronald Coase

Ronald Coase is a seminal thinker and has a timeless message. On my reading, the essence of Coase is this: 1) push the logic of zero transaction costs to the limit; 2) study the world of positive transaction costs; 3) because hypothetical forms of economic organization are operationally irrelevant, and because all feasible forms of organization are flawed, assess alternative feasible forms of organization in a comparative institutional way; 4) because the action resides in the details, study the microanalytics of contract, contracting, and organization. That is a subtle and powerful combination of ideas and turns out to be difficult to implement. Although much of it goes against the main tradition, it has nevertheless made progressive headway in relation to, and parts have been incorporated within, orthodoxy.

For me the central message of Coase resides in the second of Williamson's points: study the world of positive transaction costs. It is only when we consider positive transaction costs that we can make sense of economic organisations. The firm is a product of having to deal with positive transaction costs. In a zero transaction cost world there would be no firms. As Foss, Lando and Thomsen (2000: 632) summarise it:

"The pure analysis of the market institution leaves almost no room for the firm (Debreu 1959). Under the assumption of a perfect set of contingent markets, as well as certain other restrictive assumptions, the model describes how markets may produce efficient outcomes. The question how organizations should be structured does not arise, because market-contracting perfectly solves all incentive and coordination issues. By assumption, firm behaviour (profit maximization) is invariant to institutional form (e.g. ownership structure). The whole economy can operate efficiently as one great system of markets, in which autonomous agents enter into very elaborate contracts with each other. However, by treating the firm itself as a black box, where internal structure, contracts, etc. disappear from the picture, there are many other issues that the theory cannot address. For example, the theory does not tell us why firms exist".

Coase changed the very way we see economic organisations. The theory of the firm for Ronald Coase, Oliver Williamson or Oliver Hart is a very different thing from that of Arthur Pigou, Lionel Robbins, Jacob Viner, Joan Robinson or Edward Chamberlin. The questions asked of the theory have changed from being about how the firm acts in the market, how it prices its outputs or how it combines its inputs, to questions about the firm's existence, boundaries and internal organisation. That is, there has been a movement away from the theory of the firm being seen as developing a component of price theory, namely issues to do with firm behaviour, to the theory being concerned with the firm as a subject in its own right.

This change in questions is Coase's great contribution to the theory of the firm. He changed the path analysis of the firm went down. Coase's 1937 paper "The Nature of the Firm" was, as Hal Varian puts it, a "Big Idea". In Coase's work we see most of the main issues of the modern theory of the firm being raised together for the first time. He sets out to "discover why a firm emerges at all in a specialized exchange" - a question about the existence of the firm; he also sets out to "study the forces which determine the size of the firm" - an issue to do with the boundaries of the firm; and he inquires into the reasons for "diminishing returns to management" - issues to do with the internal organisation of the firm. It was the efforts to answer these questions that initiated the charge from seeing the theory of the firm as just part of price theory to seeing it as an important topic in its own right. Coase also provides one of the main building block for answers to these issues, the "costs of using the price mechanism" or transaction costs.

The importance of Coase (1937) stems from the fact that it was the major catalyst, albeit with a long delay, for the modern theory of the firm and the theory of economic organisations more generally. Coase notes "[t]he article was not an instant success." (Coase 1988: 23). In fact it took nearly 40 years for it to become an overnight success.

Coase, who turns 100 on the 29th of December, has a new book coming out from Palgrave Macmillan and the Institute of Economic Affairs, How China Became Capitalist, early next year. It’s coauthored with Ning Wang, an assistant professor at Arizona State. Not bad for an old guy!

EconTalk for many weeks

Don Boudreaux of George Mason University talks with EconTalk host Russ Roberts about Chinese exchange rate policy and the claim that China keeps the value of its currency artificially low in order to boost exports to the United States and reduce U.S. exports. Boudreaux argues that regardless of whether China is manipulating its currency, inexpensive Chinese imports are generally good for the United States. He also points out that manufacturing output in the United States has been thriving despite claims that the United States is being "hollowed out." The conversation also includes a discussion of whether Chinese holdings of U.S. Treasuries threaten the United States.

Robert Frank of Cornell University talks with EconTalk host Russ Roberts about inequality. Is there a role for public policy in mitigating income inequality? Is such intervention justified or effective? The conversation delves into both the philosophical and empirical evidence behind differing answers to these questions. Ultimately, Frank argues for a steeply rising tax rate on consumption that would reduce disparities in consumption. This is a lively back-and-forth about a very timely topic.

Nicholas Phillipson, author of Adam Smith: An Enlightened Life, talks to EconTalk host Russ Roberts about the life of Adam Smith. Drawing on his recent biography of Smith, Phillipson discusses his intellectual roots, his intellectual journey, and what we know of his influences and achievements. Phillipson argues that Smith was shy, ambitious and very well-liked. He highlights the influence of Francis Hutcheson and David Hume on Smith's thinking. Phillipson gives his take on how the ideas of The Theory of Moral Sentiments mesh with The Wealth of Nations and argues that the Theory of Moral Sentiments was a response to Mandeville and Rousseau.

Kevin Kelly, author of What Technology Wants, talks with EconTalk host Russ Roberts about technology and the ideas in the book. Kelly argues that technology is best understood as an emergent system subject to the natural forces underpinning all emergent systems. He argues that any technology creates benefits and costs but that the benefits typically outweigh the costs (perhaps by a small amount) leading to human progress. This is a wide-ranging conversation that includes discussion of the Unabomber, the Amish, the survival of human knowledge, and the seeming inevitability of the advancement of knowledge. The conversation closes with a discussion of the potential for technology to make an enormous leap in self-organization.

George Selgin, of the University of Georgia, talks with EconTalk host Russ Roberts about whether the creation of the Federal Reserve in 1913 has been a boon or a bust for the U.S. economy. Drawing on a recent paper with William Lastrapes and Lawrence White recently released by the Cato Institute, "Has the Fed Been a Failure?" Selgin argues that the Fed has done poorly at two missions often deemed to justify a Central Bank: lender of last resort and smoother of the business cycle. Selgin makes the case that avoiding bank runs and bank panics does not require a central bank and that contrary to received wisdom, it is hard to argue that the Fed has smoothed the business cycle. Additional topics discussed include whether the Fed has the information to do its jobs well, the role of the Fed in moral hazard, and the potential for the gold standard to outperform the Fed.

Ministry's figures need analysis (updated)

so says Eric Crampton in this morning's Press here in Christchurch. And he is right. The figures in question are the Ministry of Health's estimates on the health costs of smoking - $1.9 billion. Eric writes,

You could be forgiven for thinking that the health system could save $1.9 billion if tobacco had never existed. That's what the Ministry of Health says smoking costs the public health system.

But, you'd be wrong.

Not that the ministry would correct your error. Eric goes on to make the real point about the ministry's numbers,

The ministry's latest estimate of the cost of smoking has nothing to do with the costs that smokers impose on taxpayers or the costs that could be avoided if smoking were to disappear.

Rather, it's a politically convenient number whose promotion has much to do with gaining voter support for anti-tobacco initiatives and nothing to do with real economic costs.

Interestingly the ministry's number

[...] was much higher than the previous estimate of $350 million dollars - a figure produced not by the Big Tobacco lobby but rather by Des O'Dea in a report commissioned by anti-tobacco crusaders Action on Smoking and Health.

So, you may ask, how did the ministry get their figure?

After sorting the population by age, gender, income, ethnicity and smoking status, they then compared the costs of providing health services to smokers as compared to nonsmokers for each group.

The excess costs of the smoking group were tallied up to produce the $1.9b figure.

But there are problems with such an approach. Eric deal with two of the big ones.

It's easiest to think of smoking as bringing forward a whole lot of end-of-life costs.

Smokers die earlier than nonsmokers.

We know that.

And the costs to the health budget of somebody who is dying are rather higher than the costs of somebody who is healthy.

But everybody dies sometime and most of us will incur end-of-life costs that will be paid for by the public health system.

Suppose that a smoker will die at age 65 and a nonsmoker will die at 75. Comparing 65-year-old smokers to 65-year-old nonsmokers and calling the difference the cost of smoking then rather biases upwards the measured costs of smoking.

We ought to be comparing the health costs of a smoker dying at age 65 with the health costs of a nonsmoker dying at age 75.

And, perversely, the deadlier cigarettes are, the greater will be this bias. The younger smokers are when they die of smoking-related illnesses, the greater will be the measured cost difference between smokers and non- smokers because a smaller proportion of comparable nonsmokers would be incurring end-of-life costs.

The figures assume that in the absence of smoking, smokers would never have imposed end-of-life costs on the health system. But for their smoking, all smokers in this scenario would have died of a sudden, and cheap, heart attack and would only have had average health costs up to that point. That's clearly nonsense, but the $1.9b figure only makes sense if it's true.

Further, we might well expect that there are differences between smokers and nonsmokers beyond those accounted for by income, gender, ethnicity and age.

Imagine a 45-year-old white female of average income who happens also to be an active jogger, moderate drinker and health food enthusiast. Is she more or less likely to be a smoker than a 45-year-old white female of average income who happens also to avoid the gym, drink too much and never touch a vegetable?

On average, we'd expect that folks who are more health conscious on other margins are also less likely to smoke.

But the ministry's method, which doesn't correct for those other health-related behaviours, necessarily lumps all of the differences between smokers and non- smokers into the cost of smoking rather than into the cost of having a generally unhealthy lifestyle that includes smoking.

It's only if smokers and nonsmokers are otherwise identical, on average, in their health-related behaviours - after correcting for income, gender and ethnicity - that the ministry's figure holds up. But that's also pretty clearly nonsense.

So the ministry may not be telling us the truth, the whole truth and nothing but the turth. Anyone surprised? As Eric notes we should

[...] be as sceptical of numbers coming from the Ministry of Health as you would be of numbers produced by the tobacco industry. Neither is a disinterested party.

Well said Crampo.

Update: Eric writes more on the matter here.