Tuesday, 27 September 2016

Well done John Minto and Lianne Dalziel

Yes you read that right! Even Minto and Dalziel can be right sometimes.

Minto and Dalziel have come out against a new sports stadium in Christchurch. This morning The Press is reporting that
Minto questioned whether it [the stadium] was needed, while Dalziel labelled it as "waste of time".
According to The Press Jerry Brownlee has said the stadium is on hold until the city council clearly commits to funding it. Well all we need now is for all the other mayoral candidates to back Minto and Dalziel's position. The sooner the council refuses to fund the stadium the better.

As I have argued many times on this blog the economics of sports stadiums are just awful and its good to see some good sense from a couple of our mayoral candidates.

Incentives and ethics in the economics of body parts

Repugnant markets are an relatively new area of economics - associated with the work of Nobel winner Alvin Roth - and one that many people find strange and unsettling but it is also one that has very important implications for people's welfare. And there is no more important area than the "market" for human body parts. This is an area where demand outstrips supply in a big way and we need ways to get more people to donate. But many people don't like the idea of using monetary incentives to increase donations.

In this new NBER working paper Nicola Lacetera looks at some of the economic and moral issues involved in organ markets.

The abstract of the paper reads:
Research shows that properly devised economic incentives increase the supply of blood without hampering its safety; similar effects may be expected also for other body parts such as bone marrow and organs. These positive effects alone, however, do not necessarily justify the introduction of payments for supplying body parts; these activities concern contested commodities or repugnant transactions, i.e. societies may want to prevent certain ways to regulate a transaction even if they increased supply, because of ethical concerns. When transactions concern contested commodities, therefore, societies often face trade-offs between the efficiency-enhancing effects of trades mediated by a monetary price, and the moral opposition to the provision of these payments. In this essay, I first describe and discuss the current debate on the role of moral repugnance in controversial markets, with a focus on markets for organs, tissues, blood and plasma. I then report on recent studies focused on understanding the trade-offs that individuals face when forming their opinions about how a society should organize certain transactions.

Sunday, 25 September 2016

GBBO and the nature of the firm

For those not in the know GBBO stands for the Great British Bake Off which is a very popular (not at all sure why) television programme in the UK which until recently as on the BBC but has now been bought by Channel 4.

What has this to do with the theory of the firm? Chris Dillow at the Stumbling and Mumbling blog writes,
As you all know, Mary, Mel and Sue [3 of the 4 presenters of the show] will not be joining the show when it moves channel, which has prompted everyone to claim that Channel 4 have spent £75m on a tent and a fat scouser – something they could have got in Millets Liverpool’s branch for rather less.

This highlights a general fact – that firms are often not merely collections of physical assets, intellectual property and explicit contracts. Their value often lies in key employees, and if these leave they can take a lot of corporate value with them. If viewers boycott the new GBBO because there’s no Bezza, then the GBBO is indeed not as valuable as Channel 4 thought.
While it it clearly true that many firm have employees who are of great value to them its not clear that this fact changes the theory of the firm. Even when workers/managers are of value to a firm non-human assets (physical assets, intellectual property rights, location etc) still play a role.

One of the problem with developing a theory of the firm for firms based on human capital is that human capital can not be owned by the firm. Employees can always walkout the door in a way that non-human capital can not. This means that human capital firms can be very unstable with workers leaving anytime they want. Hart (1995: 56-7) goes so far as to argue that, at least some, nonhuman assets are essential to a theory of the firm. To see why this may be so consider a situation where 'firm' 1 acquires 'firm' 2, which consists entirely of human-capital. The question Hart raises is, What is to stop firm 2's workers from quitting? Without any physical assets - e.g. buildings - firms 2's workers would not even have to relocate themselves physically. If these workers were linked by telephones or computers, which they themselves own, they could simply announce one day that they had decided to become a new firm. For the acquisition of firm 2 by firm 1 to make economic sense there has to be a source of value in firm 2 over and above the human-capital of the workers. It makes little sense to buy a 'firm' if that 'firm' can just get up and walk away. Hart argues there must be some 'glue' (non-human assets) holding firm 2's workers in place. A firm which is made up of only human capital would be flimsy and unstable, subject to the possibility of break-up or dissolution.

For GBBO while presenters are important there is also the need for non-human capital - cameras, sound equipment, editing equipment, ovens etc - which are not owned by the presenters. These non-human assets can keep the firm together.

Whether these are enough to keep GBBO together, or will it go the way of Top Gear after its three presenters left, only time will tell. But if human capital is super important to the show, as it seems to have been for Top Gear, and it fails then this would just make Hart's point, human capital only (or largely human capital) firms are unstable.

  • Hart, Oliver D. (1995). Firms, Contracts, and Financial Structure, Oxford: Oxford University Press.

When antitrust runs amok: bulletin board material

Timothy Taylor at the Conversable Economist blog posted this cartoon from Dale Everett at the Anarchy In Your Head website in 2008:

An interesting cartoon given this quote from 1981 about why Ronald Coase gave up teaching antitrust:
“Ronald [Coase] said he had gotten tired of antitrust because when the prices went up the judges said it was monopoly, when the prices went down they said it was predatory pricing, and when they stayed the same they said it was tacit collusion.”

–William Landes quoted in Edmund W. Kitch, “The Fire of Truth: A Remembrance of Law and Economics at Chicago, 1932-1970”, Journal of Law and Economics 26(1) (Apr., 1983) p. 193.

Saturday, 24 September 2016

Why you shouldn't take economic advice from a comedian.

From CBCNews.ca comes this news story:
One of the hottest comedians in show business is warning fans not to buy or resell overpriced tickets to his upcoming shows — because he might just cancel the tickets.

Louis C.K. announced Tuesday that the West Coast city would be the only Canadian stop so far on his forthcoming North American tour.

The award-winning funny man will play the 6,000 seat Thunderbird Arena for two nights on Dec. 7 and 8. And once again he was capping prices well below average for a top notch show.

"As always, I'm keeping the price of my tickets down to an average of $50, including all charges," he said in an email blasted out to fans to announce the dates. "I know that's not nothing. But it's less than more than that."

Somewhat predictably, tickets were sold out with minutes, leaving desperate fans searching online for seats at the show.

And that's where the warning comes in.

It turns out C.K. has a long-standing beef with scalpers and resellers, and he takes personal pride in jamming their attempts to profit from his shows.

"Regarding ticket resale: we take great efforts and have many methods of finding out what inventory is being sold on broker sites like Stubhub and Vivid Seats and immediately invalidating those tickets," he declared on his website.
Now this guy may be great at being a comedian but he is a crap economist. If the quantity demand is greater than the quantity supplied the price rises to clear the market. Now Louis C.K. may not like this bit of basic economics but that doesn't stop it from being true. The reason that you see scalpers is simply that the ticket price is below the market equilibrium price. So if he wants to prevent scalping he just needs to increase the price of tickets.

But from the above you see that he wants to keep "the price of my tickets down to an average of $50". Low price implies below equilibrium pricing which in turn implies scalping to get tickets into the hands of those who value them most. That is, his own pricing policy creates scalping. An insolvable problem?

What to do? If he won't increase the ticket price does he have live with scalping? Actually no, there is a very obvious solution to this. All he has to do is increase supply. As supply increases the price will be driven down. So to get a $50 price with no scalping all he has to do with play a bigger venue or put on more shows, or both. These things will increase the supply of tickets which will decease the price until, if he gets the supply just right, the equilibrium price is $50. And, of course, there will be no scalping. Problem solved!

Is California's $15 minimum wage law a good idea?

California has passed a law that will raise the state's minimum wage to $15/hr by 2022. Does this law make economic sense? Is it a sound policy in pursuit of social justice? Don Boudreaux, Professor of Economics at George Mason University, and Mike Konczal, fellow at the Roosevelt Institute debate the issue at an event sponsored by the University of San Diego's Center for Ethics, Economics, and Public Policy.

Which countries have the greatest economic freedom?

From the Economic Freedom of the World: 2016 Annual Report comes these rankings of economic freedom. The ratings are for 2014, the most recent year for which comprehensive data are available.

New Zealand is in at 3. Hong Kong is at 1 and Singapore 2.
For the record the 10 lowest-rated countries, not shown, are: Iran, Algeria, Chad, Guinea, Angola, Central African Republic, Argentina, Republic of Congo, Libya, and lastly Venezuela. Yes the Socialist paradise that is Venezuela made it to 159 out of 159. But to be fair to Venezuela, North Korea is not in the rankings and if they were Venezuela may only be second to bottom.

Friday, 23 September 2016

How to regulate CEO pay (and how not to do it)

In the good old days political campaigns were about silly things like taxes, government spending, and foreign policy etc whereas today there about important things like CEO compensation and how government can regulated it to make the world a better place. In a column at VoxEU.org Alex Edmans considers the various arguments for regulating CEO pay and questions whether it is a legitimate target for political intervention. Some arguments for regulation are shown to be erroneous, and some previous interventions are shown to have failed. While regulation can address the symptoms, only independent boards and large shareholders can solve the underlying problems.

A obvious first question to ask is, Is regulation necessary? Our politicians don't ask this question they just assume it is. After all there are votes in say regulation is needed.
A contract is a private agreement between an employer and an employee. It is shareholders who bear the direct costs of the contract, and so it’s unclear whether the government should intervene.

A common argument is that pay has indirect costs – it causes CEOs to take actions (such as risk-taking) that affect society. However, there is very limited causal evidence that pay does have these effects. Even if it did, it is not clear why the government should regulate pay rather than these actions themselves. Firms take many other decisions that have far larger effects on society – firing workers, restructuring, or making large investments – which are rarely regulated. Thus, calls to regulate pay may be driven by envy, rather than pay actually being a critical social decision (Murphy 2012).

Moreover, we have remedies for bad decisions – private equity firms and hedge funds take large stakes in underperforming companies. They are certainly not in the CEO’s pocket, and they’re not afraid to make major changes – they even fire the CEO in many cases. But, they very rarely cut CEO pay (Brav et al 2008, Cronqvist and Fahlenbrach 2013). Thus, while large investors see many things to fix in a firm, the level of pay doesn’t seem to be one.
If we do what politicians don't and look at all the evidence, what do we find?
Public opinion is typically informed by a few high-profile examples of egregious compensation. The media will only report the worst cases because these are the most newsworthy. But, it is important to assess all the evidence – and that’s the role of academic research. Indeed, the large-scale evidence is that pay is highly linked to performance:
  • A 1% fall in the stock price reduces CEO wealth by $480,000 (Murphy 2013);
  • CEOs with high stock compensation deliver superior long-run stock returns of 4-10% per year (von Lilienfeld-Toal and Ruenzi 2014);
  • Firms with high income inequality exhibit superior operating and stock performance (Mueller et al 2016).
So what is the role of the policymaker?
A policymaker should exhibit similar caution to a doctor. The Hippocratic oath is "first, do no harm", i.e. to ensure that any intervention doesn’t worsen the problem. Murphy (2012) describes how the entire history of compensation regulation is filled with unintended consequences. The forced disclosure of perks in 1978 increased perks as CEOs could see what their peers were receiving; the 1984 law on golden parachutes catalysed the adoption of golden parachutes by alerting some CEOs to their existence; and Bill Clinton’s $1 million salary cap led to CEOs below the cap raising their salaries to above it, and those above merely reclassifying salary as a bonus.

Indeed, regulation is often driven by political agendas – by politicians’ desire to be seen as tough, rather than to create social value. Far more important than taking action is taking the right action.
What to do? Two common ideas are pay ratios and employee voting. But
The motivation behind capping pay ratios is sound – to ensure the CEO is not paid for poor performance, and to improve equality. But, to ensure the CEO is paid for performance, we should compare pay to her performance, not the pay of the median employee. One argument is that a well-performing CEO should share the spoils with her workers – she wasn’t the only one responsible for her firm’s success. But, the flipside of bonuses for good performance is they allow punishments for poor performance – former JC Penney CEO, Ron Johnson, suffered a 97% pay cut when the stock price tumbled. Workers pay didn’t fall – and it shouldn’t have.

Moving to equality concerns, a focus on pay ratios can actually increase inequality. A CEO can lower the pay ratio by firing low-paid workers, converting them to part time, or increasing their cash salary but reducing their non-financial compensation (such as on-the-job training and working conditions).
Employees rarely wish to weigh in on a pharma company’s R&D policy, since this should be left to the experts – the scientists. But everybody believes that they are an expert on CEO pay, even though economics and finance requires as much expertise as science.

An employment contract is an extremely complex issue and cannot be whittled down to a simple number such as a pay ratio. How should we best filter out industry performance? Indexed options? Indexed stock? Options on indexed stock? Stock with indexed performance vesting thresholds? Confused? Well, so might the general public be – as they were during the UK’s EU referendum, so the debate was narrowed to simple dimensions and driven by misinformation.

To get past a vote, a board may focus on the ‘optics’ of pay (e.g. a low ratio) and ignore more important dimensions, such as performance targets being long-term rather than short-term. The median size of a Fortune 500 firm is $20 billion, and median pay is $10 million. Thus, even if a CEO was paid double what she deserves, that costs 0.05% of firm value. If a CEO’s pay is tied to short-term performance, she might take myopic actions that reduce firm value by several percentage points (Edmans et al. 2015).

Employees often come up with ingenious ideas. But, companies already have incentives to consult workers – without any need for regulation – and many often do. In Edmans (2011), I find that firms with high employee satisfaction – for which consultation is key – beat their peers by 2-3% per year. Even if boards only cared about shareholder value, they should consult employees. We want to push the message that employees and executives are in partnership, rather than employee consultation destroying value so we have to pass laws to ensure it happens.

And, there is a big difference between consulting employees and putting them on the board. Firms do market research by consulting customers, but don’t put them on the board. Otherwise, every corporate decision would become a political process. Indeed, Gorton and Schmid (2004) found that worker representation on German boards is associated with lower profitability and firm value.
So the big question, What should be done?
Should we do nothing? Far from it. But we should leave the decisions to major shareholders, who have the expertise and incentives to get these decisions right. High CEO pay comes straight out of shareholder returns, and if the contract causes the CEO to take bad decisions – or demoralises employees and customers – shareholders suffer the consequences. Unlike regulation, which is one-size-fits-all, shareholders can decide what the optimal pay package is for that particular firm.

And things are being done. Eleven countries have passed ‘say-on-pay’ legislation since 2002; Correa and Lel (2016) show that it reduces pay and increases pay-performance sensitivity. Interestingly, advisory votes are more effective than binding votes – in contrast to politicians’ desire to take the toughest possible action. We have also seen innovation in other dimensions of pay, such as lengthening vesting horizons to encourage the CEO to think long-term (Gabaix and Edmans 2009), and paying with debt rather than just equity to dissuade excessive risk-taking (Edmans 2010).

Moreover, when pay is inefficient, it is often a symptom of an underlying governance problem brought on by conflicted boards and dispersed shareholders. Addressing pay via regulation will solve the symptoms; encouraging independent boards and large shareholders will solve the problem. That will improve not only pay, but other governance issues.

What about equality? Kaplan and Rauh (2010) showed that high CEO pay has actually not been a major cause of the rise in inequality – it has risen much more slowly than pay in law, hedge funds, private equity, and venture capital. If inequality is truly the concern, it may be better addressed by income tax. This will address inequality resulting from all occupations (including sports, entertainment, and trust funds); it is not clear why CEOs should be singled out.

The bottom line is that, to the extent that pay is a problem, it should be shareholders, not politicians or employees, who fix it. The electorate will be more impressed by a politician halving pay than extending the vesting horizon from three to seven years, even though the latter will have greater impact. The goal of policy shouldn’t be to write headlines, but to create long-term value for society.
We can conclude that one size does not fit all and the shareholders of a firm have the best information and incentives to get CEO pay right. So why not let them?

Thursday, 22 September 2016

How computer automation affects occupations: technology, jobs, and skills

James Bessen deals with this issue in a new column at VoxEU.org. A common argument you see with regard to computers and employment is that computer automation leads to major job losses. A modern version of the Luddite story. Bessen argues that this line of argument, however, ignores the dynamic economic responses that involve both changing demand and inter-occupation substitution. Using US data, he explores the effect of automation on employment growth for detailed occupational categories. Computer-using occupations have had greater job growth to date, while those using few computers suffer greater computer-related losses. The major policy challenge posed by automation is developing a workforce with the skills to use new technologies.

Bessen looks at estimates of employment demand growth.
Taking these considerations into account, I estimate a simple model of occupational demand across industries that allows for changing demand and inter-occupation substitution within industries. As my key independent variable, I measure the extent of computer use by workers in each occupation and industry. These data come from supplements to the Current Population Survey. I assume that occupations that use more computers will have a higher degree of task automation, all else equal. The dependent variable is the relative growth of employment in occupation-industry cells.

The estimates contradict popular assumptions about the impact of computer automation. First, computer-using occupations tend to grow faster, not slower. At the sample mean, computer use is associated with a 1.7% increase in occupational employment per year. In other words, the bank teller example may be typical rather than exceptional.

Second, there is a strong substitution effect between occupations. Occupations tend to have declining growth to the extent that other occupations in the same industry use computers. That is, the story is not about machines replacing humans; rather it is one of humans using machines to replace other humans, as graphic designers with computers replaced typesetters.

The substitution effect largely offsets the growth effect. Counting both, at the sample mean, computer use is associated with positive employment growth but the effect is small, 0.45% per year. This association is not necessarily causal—perhaps some other factor caused computer-using occupations to grow. But this finding does show that computer automation is not associated with major job losses.
The last sentence is the takeaway result. Computer automation is not associated with major job losses meaning our modern day Luddites have less to worry about than they first thought.

A downside to increasing computer use is that while the evidence suggests that computers are not causing net job losses, low wage occupations are losing jobs, likely contributing to economic inequality. The policy problem is how to get the workers effected the new skills they need in order to transition to new, well-paying jobs. Developing a workforce with the skills to use new technologies is the real challenge posed by computer automation.

Are firms that discriminate more likely to go out of business?

This question is asked in a paper by Devah Pager at Sociological Science. The answer is yes.

Alex Tabarrok explains the basic logic of the argument that discrimination will be punished by the market and discriminating firms will be driven under.
Discrimination is costly, especially in a competitive market. If the wages of X-type workers are 25% lower than those of Y-type workers, for example, then a greedy capitalist can increase profits by hiring more X workers. If Y workers cost $15 per hour and X workers cost $11.25 per hour then a firm with 100 workers could make an extra $750,000 a year. In fact, a greedy capitalist could earn more than this by pricing just below the discriminating firms, taking over the market, and driving the discriminating firms under.
Pager's article is one of the first to test this idea directly. The paper's abstract reads:
Economic theory has long maintained that employers pay a price for engaging in racial discrimination. According to Gary Becker’s seminal work on this topic and the rich literature that followed, racial preferences unrelated to productivity are costly and, in a competitive market, should drive discriminatory employers out of business. Though a dominant theoretical proposition in the field of economics, this argument has never before been subjected to direct empirical scrutiny. This research pairs an experimental audit study of racial discrimination in employment with an employer database capturing information on establishment survival, examining the relationship between observed discrimination and firm longevity. Results suggest that employers who engage in hiring discrimination are less likely to remain in business six years later.
The results of the paper show that 36% of the firms that discriminated in hiring failed but only 17% of the non-discriminatory firms failed over the six year time period studied. So if you discriminate the market will comeback and bite you.

One up for Becker.

Tuesday, 20 September 2016

How copyright improved Italian opera

Petra Moser explains that copyright protection for 19th century Italian operas led to more and better operas being written, but the evidence also suggests that intellectual property rights may do more harm than good if they are too broad or too long-term.

So the takeaway from this video is that intellectual property rights should be narrow and short-lived. Unfortunately when you look around you you see that there is increasing pressure, mainly from the US, for copyrights to be extended and made wider. Its not clear that such expansions are socially beneficial.

The video come from The CORE Project (http://core-econ.org).

NZ as Olympic host? No!

For some very strange reason Laura McQuillan, at Stuffdiscuses the idea of New Zealand hosting the Olympics. So much stupid here.
Nothing says "we're a world-class city" like hosting the Olympic Games - but could New Zealand ever do the honours?

Pulling off the world's largest sporting event - whether the Summer or Winter Games - is a lot of hard slog that brings mountains of debt, international criticism, and often not a lot of benefit.

But International Olympic Committee boss Thomas Bach reckons New Zealand has what it takes to play host.

In anticipation of that day arriving, here's a look at the New Zealand cities and councils best equipped to host the Olympics.
The most important thing in the above quote is "often not a lot of benefit" bit. The research on hosting events like the Olympics tells us the costs are much greater than the benefits.

In a recent issue of the Journal of Economic Perspectives (Vol. 30, Issue 2 Spring 2016) Robert A. Baade and Victor A. Matheson discuss Going for the Gold: The Economics of the Olympics.

The abstract reads,
In this paper, we explore the costs and benefits of hosting the Olympic Games. On the cost side, there are three major categories: general infrastructure such as transportation and housing to accommodate athletes and fans; specific sports infrastructure required for competition venues; and operational costs, including general administration as well as the opening and closing ceremony and security. Three major categories of benefits also exist: the short-run benefits of tourist spending during the Games; the long-run benefits or the "Olympic legacy" which might include improvements in infrastructure and increased trade, foreign investment, or tourism after the Games; and intangible benefits such as the "feel-good effect" or civic pride. Each of these costs and benefits will be addressed in turn, but the overwhelming conclusion is that in most cases the Olympics are a money-losing proposition for host cities; they result in positive net benefits only under very specific and unusual circumstances. Furthermore, the cost–benefit proposition is worse for cities in developing countries than for those in the industrialized world. In closing, we discuss why what looks like an increasingly poor investment decision on the part of cities still receives significant bidding interest and whether changes in the bidding process of the International Olympic Committee (IOC) will improve outcomes for potential hosts. (Emphasis added)
So no, New Zealand should never even think about doing something as stupid as trying to host the Olympics.

Kevin Murphy interviews Edward Lazear

Edward P. Lazear is a labour economist and a founder of the field known as personnel economics. His research centers on employee incentives, promotions, compensation and productivity in firms. In this episode, Lazear and Kevin Murphy talk about the legacy of human capital and labor economics at the University of Chicago, as well Lazear’s experience crossing from academia to the Council of Economic Advisers

The Kindle edition of the greatest book ever written is now available

I have just noticed that the Kindle edition of the greatest book ever written, aka The Theory of the Firm: An overview of the economic mainstream, is now available.

The big advantage of this edition is the price, US$43.53 compared to US$135.20 for the hardback. Still not exactly cheap but it is cheaper, by a reasonable amount, than the hardback.

I have also, unfortunately, had to update the errata section on the webpage for the book.

Monday, 19 September 2016

Why you shouldn't copy your classmates

Students beware, if you rely too much on your classmates, you all suffer.

The takeaway for students is stick together, but not for too long.

Does the division of labour matter?

The short answer is yes.

Adam Smith argued that the an increasing division of labour was a driver of technological improvement, increases in output and reductions in the prices of goods and services. But was Smith right?

According to a paper recently accepted by the Quarterly Journal of Economics the answer is yes.

The paper Adam Smith, Watch Prices, and the Industrial Revolution is by Morgan Kelly and Cormac Ó Gráda. They set out to evaluate Smith's claim that watch prices - watches were one of the first mass produced consumer goods and were Smith's prime example of technological progress - may have fallen by up to 95 per cent over the century preceding Smith.

The paper's abstract reads:
Although largely absent from modern accounts of the Industrial Revolution, watches were the first mass produced consumer durable, and were Adam Smith’s pre-eminent example of technological progress. In fact, Smith makes the notable claim that watch prices may have fallen by up to 95 per cent over the preceding century; a claim that this paper attempts to evaluate. We look at changes in the reported value of over 3,200 stolen watches from criminal trials in the Old Bailey in London from 1685 to 1810. Before allowing for quality improvements, we find that the real price of watches in nearly all categories falls steadily by 1.3 per cent per year, equivalent to a fall of 75 per cent over a century, showing that sustained innovation in the production of a highly complex artefact had already appeared in one important sector of the British economy by the early eighteenth century.
The authors also note that,
If we assume modest rises in the quality in silver watches, so that a watch at the 75th percentile in the 1710s was equivalent to one of median quality in the 1770s, we find an annual fall in real prices of 2 per cent or 87 per cent over a century, not far from what Adam Smith suggests.
One wonders how Smith obtained his estimate. He didn't have right fancy econometrics to help him.

Saturday, 17 September 2016

Rent controls have always and everywhere ended in failure

Or so argues Kristian Niemietz at the IEA blog. He writes,
No doubt, the issue of escalating rents is real. UK rents are the highest in Europe, both in absolute terms and relative to incomes. On average, private tenants in the UK pay between 40 and 50 per cent more than their counterparts in the Netherlands, Belgium, Germany and France. It is only when we include Monaco in the rent level rankings that the UK is pushed into second place, and even then, Inner London is in the same league as that playground of the rich and famous.

So clearly, there is a problem here, and this is not just a problem for tenants. It is a problem for taxpayers, employees, employers and consumers as well.

High rent levels beget high levels of spending on housing benefit, which costs the taxpayer £24.3bn every year – that is £870 per household. Then, since the problem is worst in those parts of the country which have the best jobs and earnings prospects, high rents reduce labour mobility, and thus economic productivity. Further, the problem is not limited to residential property, but affects commercial property no less, adding to the cost of doing business. This is the main reason why grocery prices in the UK are about a fifth higher than in comparable countries. The list goes on.

Rent controls, however, are not the solution. In a market economy, prices, including rents, are just messengers of scarcity. Rents are high in the UK because rental properties are in high demand and in short supply. Controlling rents, then, is like shooting the messenger – just far worse. It is more like hijacking the messenger and forcing him to tell a comforting lie. A controlled rent is a messenger who tells us, at gunpoint, that there are plenty of rental properties to go round.
This is just Econ 101. If you force the price of housing below the market equilibrium - and there is no point in rent controls if they aren't below equilibrium - then the quantity demanded goes up and the quantity supplied goes down, relative to equilibrium, and thus the excess demand gets even larger. An excess demand that there is no incentive for people to remove because prices can not adjust.

A simple question to ask is, What would happen if rent controls were introduced?
On the supply side, London, in particular, is full of what we could call “reluctant landlords”. These are people who did not purchase a property with the express intention of becoming landlords. They became landlords when they realised that, in London, every underused room represents foregone income. This is why London has so many basement flats and converted studio flats.

If rents were capped at a level noticeably below market rates, a lot of these reluctant landlords would be among the first to take their properties off the market, and simply use them for themselves and their families. On the demand side, a lot of people who live in shared accommodation would look for a place of their own. More people would chase fewer properties, making the gap between supply and demand even wider.
The basic takeaway on rent controls is
Rent controls have a terrible track record. They have always and everywhere ended in failure, which is why over nine out of 10 economists oppose them.
Swedish economist Assar Lindbeck's famous quip should not be ignored.
next to bombing, rent control seems in many cases to be the most efficient technique so far known for destroying cities

Douglas Irwin on free trade, the gold standard, and American economic history

From David Beckworth’s new podcast series, Macro Musings comes this audio of an interview with Doug Irwin:
Douglas Irwin, professor of economics at Dartmouth College and author of Free Trade Under Fire (Princeton University Press, 2015), joins the show to discuss the economic arguments for free trade and the reasons for the heated politics surrounding trade. He describes the history of U.S. trade policy from the Embargo Act of 1808 to the Smoot-Hawley Tariff of 1930 to the North American Free Trade Agreement (NAFTA). Finally, he and David discuss the role of the inter-war gold standard during the Great Depression.

A libertarian debates a marxist on what makes a free society

From Per Bylund at the Mises Institute:
In a live and streamed debate on 9/14 in Stockholm, Sweden, Per Bylund of Mises Institute debated Andrew Kliman from the Marxist-Humanist Initiative (MHI). The topic for the debate was "What makes a free society?" and the purpose was to raise two often overlooked perspectives on society and the economy: libertarianism and marxism.
With the debaters being economists, the debate focused on economic issues. The primary discrepancy is the one between views on property, where the marxist Kliman proposed "individual property," or ownership only of what one uses for personal needs but with communal ownership of the means of production, whereas I, as libertarian, argued for private property and free markets of the means of production. It is interesting to note that the Kliman relies on a division of property that is divided along economic categories: consumer and production goods (or goods of lowest and higher orders).

While this distinction makes sense theoretically, and for the purpose of economic analysis, it is confusing and unintuitive in practice. You can use your house as both dwelling and office, your car for both personal transportation and business, and so on. The error by the marxists is here of the same type (though opposite) as that of environmentalists, who do not recognize the difference between natural/physical resources and economic resources. Kliman, in distinguishing between practical ownership of individual and private property (where only the latter may include the means of production), makes a theoretical distinction between consumption and production that he claims must be upheld exclusively also in practice. Kliman's argument, it follows, requires clear-cut differences where those differences may sometimes only be existing in theory. In practice, as we know, a physical resource may be used interchangeably as production and consumption goods — or both at the same time.

Thursday, 15 September 2016

Two opposing literary critiques of socialism

You can be forgiven for thinking that most authors of novels are supports of some form or another of socialism. But not all authors are mindlessly pro-socialism/anti-capitalism, a few have offered literary criticisms of socialism.

The most famous may be Orwell's famous books, Animal Farm and Nineteen Eighty-Four which criticised the totalitarian forms of socialism. But he is not the only one.

A new working paper looks at the critiques of socialism offered by George Orwell, Eugen Richter and Henry Hazlitt. The abstract of the paper, Two Opposing Literary Critiques of Socialism: George Orwell Versus Eugen Richter and Henry Hazlitt by Michael Makovi, reads:
Orwell's famous fictions, Animal Farm and Nineteen Eighty-Four criticized totalitarian forms of socialism from a Public Choice perspective, assuming that socialism would work as an economic system as long as the proper political institutions were in place to curb the potential for the abuse of power. This is contrasted with two novels by others who took the opposite approach: Richter's Pictures of the Socialistic Future and Hazlitt's Time Will Run Back. These two assumed that the political implementation of socialism would be perfect but that socialism would necessarily turn totalitarian because of the problem of economic calculation. These novels assumed away the Public Choice problem of institutions and the abuse of power and focused on the political implications of socialism as a purely economic system. Contrasting these two sets of novels shows how the Austrian and Public Choice schools criticize socialism in two entirely different ways.

Wednesday, 14 September 2016

If you build it .......

Spending on infrastructure is an idea that you often hear put forward as a way the government can help the economy. In the Summer 2016 issue of the City Journal economist (he is a professor of economics at Harvard University) Edward L. Glaeser takes a look at the costs and benefits of infrastructure spending in the USA. He notes that
The progressive romance with infrastructure spending is based on three beliefs. First is that it supercharges economic growth. As President Obama put it in his 2015 State of the Union address: “Twenty-first century businesses need twenty-first century infrastructure.” Further, by putting people to work building needed things, infrastructure spending is an ideal government tool for fighting unemployment during recessions. Infrastructure should also be a national responsibility, progressives believe, led by Washington and financed by federal tax revenues.
None of this is right. While infrastructure investment is often needed when cities or regions are already expanding, too often it goes to declining areas that don’t require it and winds up having little long-term economic benefit. As for fighting recessions, which require rapid response, it’s dauntingly hard in today’s regulatory environment to get infrastructure projects under way quickly and wisely. Centralized federal tax funding of these projects makes inefficiencies and waste even likelier, as Washington, driven by political calculations, gives the green light to bridges to nowhere, ill-considered high-speed rail projects, and other boondoggles. America needs an infrastructure renaissance, but we won’t get it by the federal government simply writing big checks. A far better model would be for infrastructure to be managed by independent but focused local public and private entities and funded primarily by user fees, not federal tax dollars.
Glaseser looks at the myths and realities of infrastructure spending noting that the realities do not live up to the myths. The whole article, while not short, is well worth the time needed to read.

Glaeser concludes by making a basic but important point,
Economics teaches two basic truths: people make wise choices when they are forced to weigh benefits against costs; and competition produces good results. Large-scale federal involvement in transportation means that the people who benefit aren’t the people who pay the costs. The result is too many white-elephant projects and too little innovation and maintenance.

Tuesday, 13 September 2016

Interesting blog bits

  1. Lynne Kiesling on Pharmaceuticals and multi-layered government-granted monopoly
    Kiesling looks at Mylan’s price increase of the EpiPen in late August that has caused consternation and a lot of debate about the reasons why Mylan has been able to increase the EpiPen price so dramatically above its production cost.
  2. Timothy Taylor on China's Insufficient Investment in Education
    Can China maintain its rapid pace of economic growth in the decades ahead? The argument discussed here suggests that one substantial hindrance may be China's education system is not keeping up.
  3. Tim Worstall on How to make public policy these days
    Ride hobby horse, spout piffle, invent targets then shout loudly. Sounds about right.
  4. Susannah Kahtan on Re-dressing old wounds: The unintended consequences of NHS prescription regulations
    The current system for exempting certain patients from paying for their NHS prescriptions is discriminatory, unjust and unfit for purpose. The high cost of prescription medication deters many patients from engaging consistently with treatment, increasing their risk of adverse outcomes such as strokes and heart attacks.
  5. Bryan Caplan explans Why I Don't Vote: The Honest Truth
    My honest answer begins with extreme disgust. When I look at voters, I see human beings at their hysterical, innumerate worst. When I look at politicians, I see mendacious, callous bullies. Yes, some hysterical, innumerate people are more hysterical and innumerate than others. Yes, some mendacious, callous bullies are more mendacious, callous, and bully-like than others. But even a bare hint of any of these traits appalls me. When someone gloats, "Politifact says Trump is pants-on-fire lying 18% of the time, versus just 2% for Hillary," I don't want to cheer Hillary. I want to retreat into my Bubble, where people dutifully speak the truth or stay silent.
  6. Tyler Cowen tells us Facts about Jane Jacobs
    Just 8, but I'm going to guess you don't know any of them
  7. Matt Ridley on Invasion of the alien species
    In July, the New Zealand government announced its intention to eradicate all rats, stoats and possums from the entire country by 2050 to save native birds such as the kiwi. It’s an ambitious plan, perhaps impossible to pull off with the methods available today, but it’s a stark reminder that invasive alien species today constitute perhaps the greatest extinction threat to animal populations world-wide.
  8. Steven Kaplan on (God Knows) Wall Street Isn’t Perfect, But It Has Helped Make the World A Lot Better Off
    There is a large academic literature on the effect of financial markets. A great deal of that research finds that countries with thriving financial sectors experience greater growth in GDP. Countries that restrict their financial sectors grow less.

Sunday, 11 September 2016

Did he really think before writing?

I'm almost halfway through Neil Oliver's A History of Ancient Britain. It is an interesting and readable account of the (pre)history of Britain from the arrival of first people up until the Romans. But it is, unfortunately, marred by some absolute clangers.

Perhaps my favourite so far is about the size of the population of the world.
But for all that, we are finally and undeniably too many. The day will surely come, and soon, when the latest empty mouths and naked backs demand food and clothes from the world - and the world will have nothing more to give (p. 66).
I mean hasn't the whole Club of Rome/Population Bomb stuff died already?

One could go all Julian Simon here but a couple of obvious points should made one think about Oliver's claim: 1) we have over time become more productive in agriculture as in other areas and 2) population growth rates decline as people become richer; and people are becoming richer. Together both these points argue that the world will have enough to give to future mouths and backs.

To me it is far from "undeniable" that we are too many.

Saturday, 10 September 2016

The economics of the reformation

are considered in a new working paper, Malthus Meets Luther: The Economics Behind the German Reformation, by Malik Curuk and Sjak Smulders

The abstract reads:
The Reformation provided a powerful source of legitimacy for secularization of governance and enabled the regional authorities to change the institutional structure to eliminate the inefficiencies under the prevailing (Catholic) regime. We investigate this idea in a simple model of regime change and show that the regions where the prevailing institutions are less appropriate, i.e. poorer regions with greater economic potential, should have been more likely to adopt the Reformation. Using detailed data on religious denominations, city characteristics and exogenous measures of agricultural potential, we empirically confirm this hypothesis for the cities in the 16th century Holy Roman Empire. This finding points to an economic rationale of the adoption of Protestantism as a vehicle of institutional change. 
So changing religion changes institutions which effects growth rates via  a move towards more efficient structures.

Friday, 9 September 2016

Learning across disciplines and perspectives

In this conversation Jayme Lemke and Peter Boettke discuss the commonalities between three approaches to understanding the social world: Austrian economics, public choice economics, and the Bloomington School’s multiple-methods, real-world approach to institutional analysis.

Thursday, 8 September 2016

Another advantage of legal medical marijuana

Another post at the ProMarket blog highlights the cost advantages of medical marijuana, at least in the institutional framework for healthcare currently in use in the US.
A new working paper by University of Georgia researchers shows that medical marijuana leads to sharp drops in the number of prescriptions for branded drugs.The paper estimates savings of up to $1.5 billion per year in Medicaid spending if medical marijuana was legalized in all 50 states.
The blog post goes on to argue that the ideas of George Stigler might offer a potential explanation as to why the countrywide legalisation of medical marijuana has not happened yet.

One possible reason:
Some, including journalist Lee Fang and the Washington Post’s Christopher Ingraham, have suggested that this might have something to do with resistance from pharmaceutical companies, longtime rivals of marijuana reforms. Pharmaceutical companies have lobbied against marijuana legalization on both the state and federal level, and spent millions on anti-legalization campaigns and funding for academic research that presented marijuana as dangerous.
What the research discussed in the blog post shows is that in states that instituted medical marijuana programs, legalisation was followed by a sharp drop in the number of prescriptions for branded drugs for which marijuana could be used as an alternative. Pharmaceutical companies would not be too happy about this.
In July, the Bradfords [authors of the research] published a first-of-its-kind paper that examined the effects of legalized medical marijuana on doctors’ prescribing patterns by examining data from the Medicare Part D database between 2010 and 2013.1) Their paper focused on nine categories of drugs: pain (sales-wise, the most lucrative category for pharmaceutical firms), anxiety, depression, glaucoma, nausea, psychosis, seizures, sleep disorders, and spasticity. They found that the 17 states that had medical marijuana programs in 2013 have seen a sharp drop in the number of prescriptions, particularly for painkillers. In states where medical marijuana was legal, doctors prescribed 1,826 fewer daily doses of painkillers per year, 562 fewer daily doses of anti-anxiety drugs, and 265 fewer daily doses of antidepressants.

The Bradfords have since utilized the same methodology and applied it to Medicaid, where the population is younger and therefore more prone to use medical marijuana.2) In a new working paper, they find that the trends they observed in their previous paper were much more pronounced, and that medical marijuana was followed by a drop of 3-5 percent in the number of prescription in seven of the nine categories they examined.3)

The Bradfords’ research also indicates that legalizing medical marijuana could benefit taxpayers, in the form of reduced spending on health care. States that legalized medical marijuana by 2013 saved $165.2 million per year on Medicare spending alone, according to their research. If all states had implemented medical marijuana laws in 2013, they estimated, overall savings to Medicare would have been $468 million—just under 0.5 percent of all Medicare Part D spending in 2013. When it comes to Medicaid, the savings are much larger, and could be as high as $686 million.4) If all 50 states had legalized medical marijuana by 2014, according to their estimates, that could translate to savings of $1.5 billion per year in Medicaid spending.
What part does George Stigler's idea of regulatory capture play in the pharmaceutical companies opposition?
In a recent conversation with ProMarket, W. David Bradford said that while he and his daughter didn’t write their initial paper with regulatory capture in mind, they have “come around” to the view that pharmaceutical companies are opposed to reforming marijuana laws.

“The biggest reaction we’ve gotten to this paper, that I hadn’t anticipated, was that people interpreted our results as if we were providing evidence for why pharmaceutical companies would oppose the legalization of marijuana. Having now looked at the issue more since our paper came out, I do think we are seeing activities on the part of the pharmaceutical industry to protect their interest in mostly-branded drugs that treat these conditions,” he said.

The Bradfords’ two papers show that people use marijuana as medicine, and not just recreationally. They also seemingly show that pharmaceutical firms have a reason to worry about further liberalization of marijuana laws. Yet initially, Bradford said, he was “really skeptical” of the notion that the pharmaceutical industry would oppose legalization.

“I thought ‘why would pharmaceutical companies oppose this? If they could get a new drug approved based on whole-plant marijuana, and it was a blockbuster, they could get at least five years of exclusivity out of it, and lots of patent protection if it was a patentable product.’ But after thinking about it more, and being made aware of the amount of money that pharmaceutical companies are spending to lobby against marijuana legalization, I’ve come around to the view that it’s not likely that whole-plant could be patentable, or gain any kind of market exclusivity from the FDA. Even if you could somehow short-circuit some of the trials, it’s still going to cost hundreds of millions of dollars to get a drug through the FDA approval process. And if it’s a whole-plant product, and it is proven to work, and it gets approved and is rescheduled somehow, and then people could just grow it in their backyards, what’s their incentive?” said Bradford.
If you have regulators, you will have regulatory capture and current market players will use their influence to keep competitors out.

The interesting question is given New Zealand's health care framework, what are the cost advantages of legalised medical marijuana? If the results outlined above carryover to the New Zealand case then the cost savings could be large and thus well worth looking into.

Can you regulate your way to lower costs?

The answer, at least in some cases, is no. This is an example were regulations were put in place in the hope of restraining the growth of health spending, but failed.

In most states in the US, health care providers who seek to open a new hospital must obtain a "certificate of need" (CON) from a state board certifying that there is an "economic necessity" for their services. A new working paper, by James Bailey, published by the Mercatus Center at George Mason University, finds that states with CON laws spend 3 percent more on health care than other states.

Bailey discusses his work in a blog post at the ProMarket blog. He writes,
What does it take to open a new hospital or health facility? Certainly a building, equipment, supplies, and a staff of trained medical professionals. But in most states, this is not enough. Health care providers must also obtain a “certificate of need” from a state board certifying that there is an “economic necessity” for their services.

Certificate of need (CON) laws were passed rapidly between 1964 and 1980 in the hope of restraining the growth of health spending. By 1980, every state but Louisiana had a CON program, and the federal government was pushing states to adopt CON by threatening to withhold Medicare funds from states without it.

But by 1986, the feds were no longer convinced that this approach to keeping costs down was working, and they stopped pushing CON onto states. Since then 15 states have repealed their CON laws, allowing healthcare providers to make their own decisions about how to expand.
Bailey's research investigates how health care spending has changed in the 15 states that repealed CON compared to the 35 states that have not. The punchline from his study is,
I find that CON laws have not led to lower spending. In fact, states with CON laws actually spend 3 percent more on health care than other states.

In other words, not only have CON laws failed in their goal of reducing health care spending, they have backfired and driven spending upward.
An obvious question to ask is, Why? A bit of simple economic theory explains the result.
High spending can be driven by two factors: a high quantity of sales, or high prices. By restraining the supply of new health care, CON laws try to push quantities down. But with fewer competitors entering the market, existing providers find themselves able to raise prices without jeopardizing their market. Because the demand for health care is relatively inelastic, supply restrictions like CON increase prices more than they decrease quantities, leading to an increase in total spending. While data on health care prices are notoriously difficult to acquire, my paper shows that hospital charges fall by 1 percent per year over 5 years in CON-repealing states relative to CON-maintaining states.
The moral of the story is, regulating your way to lower costs need not work.

Wednesday, 7 September 2016

Did a legal ivory sale increase smuggling and poaching?

Short answer, yes. But the answer is a bit counter-intuitive.

Below is an interesting piece from the NBER Digest, September 2016 Issue.
After the experimental 2008 sale, there was a discontinuous jump in the proportion of wild elephants poached and in seizures of contraband ivory leaving Africa.

Advocates of legalizing the purchase of goods sold in black markets argue that allowing legal trade will displace illegal buying and selling, reduce criminal activity, and permit greater control of the previously illegal goods. New research indicates that this is not always the case.

In Does Legalization Reduce Black Market Activity? Evidence from a Global Ivory Experiment and Elephant Poaching Data (NBER Working Paper No. 22314), Solomon Hsiang and Nitin Sekar show that the production of black market elephant ivory expanded by an estimated 66 percent following a one-time legal sale in 2008. Seizures of contraband ivory leaving African countries also increased, from 4.8 to 8.4 seizures per country per year. The weight of ivory in the seizures increased by an average of 335 kilograms per year.

In 1989, the Convention on the International Trade of Endangered Species (CITES) banned international trade in ivory in order to protect the wild African elephant. Individual countries continued to regulate their domestic ivory trade. Poaching slowed, and elephant populations began to recover. African governments kept stockpiles of ivory harvested from animals that died naturally.

Poaching began increasing again in the mid-1990s. Following a single legal sale from stockpiles to Japan in 1999, China and Japan requested the right to make an additional purchase. After years of debate, the governments of those countries were able to purchase 62 and 45 tons of legal ivory, respectively, at auction in 2008. The governments continue to resell that ivory in their domestic markets.

After the legal sale in 1999, CITES established the Monitoring the Illegal Killing of Elephants (MIKE) program at 79 sites in 40 countries in Africa and Asia. Preliminary data collection began in mid-2002. The Proportion of Illegally Killed Elephants (PIKE) Index is the fraction of "detected elephant carcasses that were illegally killed," a measure designed to correct for fluctuating elephant populations and field worker effort.

The researchers examine how poachers responded to the 2008 sale by studying annual PIKE data from 2003 to 2013. They find a clear discontinuous increase in the index after the 2008 sale. They cannot explain this increase with changes in natural elephant mortality rates, or with economic variables such as China's or Japan's per capita GDP, Chinese or Japanese trade with elephant range countries, measures of China's physical presence in range countries, or per capita GDP in PIKE-reporting countries.

The researchers conclude that the legal sale of ivory "triggered an increase in black market ivory production by increasing consumer demand and/or reducing the cost of supplying black market ivory." Supplier costs may be reduced if legalization of a product makes it more difficult to detect and monitor illegal provision of that product. Consumer demand may rise because legalization may reduce the stigma around a previously banned product.

An interview with Deirdre McCloskey

Here is the text of a short conversation with renowned economist and economic historian Deirdre McCloskey.

A couple of interesting questions:
Gustavus: Let’s start with the million-dollar question. Does economics matter?

Professor McCloskey: Yes, alas. I would prefer to live in Eden, but as long as we don’t, we have to face up to scarcity, and that’s a big part of the lessons of economics.

Gustavus: What is the biggest problem in economics in today’s global economy? Income inequality?

McCloskey: Let me start by saying economic equality is a silly thing to want. Do you want .325 hitters for the Twins to earn the same at .150 hitters? If you have a higher IQ than I have (a good bet, by the way), should we pound nails into your head to bring us down to equality? We can’t—and largely shouldn’t—achieve equality. But we can—and should—achieve a decent income for everyone. The biggest economic problem today is not inequality, despite what you read in the newspaper. It’s the remnants of poverty. World poverty has fallen in the past 40 years—and the past 200—like a stone.

Tuesday, 6 September 2016

The Maori Party needs to do Econ 101

Thanks to Mark Hubbard on twitter
I was alerted to this NewsHub article: Maori Party calls for immediate rent freeze.
The Maori Party is calling for a rent freeze to stop struggling families being forced onto the streets.

Co-leader Marama Fox has spent the past couple of weeks at the cross-party inquiry into homelessness, listening to hundreds of "absolutely heartbreaking" tales of how Kiwi families ended up without a roof above their heads.

"These are not people who are just desperate dropkicks. They are just struggling to meet the rent," Ms Fox told Paul Henry on Tuesday morning.
While the idea may make for a great headline, it sounds all very nice, Econ 101 tells us it would help. In fact it would make things worse.

Rent controls are just a big amount of stupid. As Swedish economist Assar Lindbeck once quipped
"next to bombing, rent control seems in many cases to be the most efficient technique so far known for destroying cities"
Increasing rents are just a sign that there is a problem on the supply side of the market. The question to ask is Why? And the people to ask the question of are, usually, the local (and national) government. The problem here is that the market can not adjust, largely due to local and central government interventions in the market. Prices are raising and thus we would expect the quantity supplied to increase. An increase in supply would over time reduce the excess demand in the market and thus reduce price increases.

Except this isn't happening since it's too difficult for the supply to expand in face of the constraints on land supply and building controls.

Putting rent controls in place will only make this problem worse. It will mean there is even less incentive for people to expand the housing supply. If you force the price of housing below the market equilibrium - and there is no point in rent controls if they aren't below equilibrium -  then the quantity demanded goes up and the quantity supplied goes down, relative to equilibrium, and thus the excess demand gets even larger. An excess demand that there is no incentive for people to remove because prices can not adjust.

If the Maori Party really is interested in helping the disadvantaged, rather than just producing nice sounding PR, then it should call for these people to be simply given money. Increasing their "income" so they can pay market rents and letting the market mechanism work for them is way better to deal with the problem than preventing the market from working at all.

In addition the Maori Party should be working to remove the constraints that prevent the supply of houses from growing enough to satisfy demand.

But this doesn't simply involve creating nice headlines and 60 second sound bytes so there isn't much chance of any politician being interested in doing it.

Sunday, 4 September 2016

2016 Condliffe Memorial Lecture

This is the video of the 2016 Condliffe Memorial Lecture given at the University of Canterbury 4 July 2016 by Janet Currie, Henry Putnam Professor of Economics and Public Affairs at Princeton University and the Director of Princeton’s Center for Health and Well Being. The topic of the lecture was "Early Life and the Roots of Economic Inequality".

Saturday, 3 September 2016

Limits of general equilibrium

In a recent EconLog piece Emily Skarbek writes,
A recent piece by Raphaële Chappe discusses the uses and limitations of general equilibrium theorizing. The post is a long-read, but Chappe briefly summarizes the point when she writes:
...the theory lacks explanatory relevance, providing instead a language through which one can say both too much and too little. The theory's abundance of riches within its own multiverse is to be contrasted with its complete neglect of some important aspects of real-world markets, such as for example the presence of increasing returns to scale, the role of institutions and their effects (including money), and the place of innovation, all of which are difficult to model within the theory.
This neglect of real-world institutions is very well illustrated by current, mainly partial-equilibrium, approach to the theory of the firm. As I have written in chapter 5 of The Theory of the Firm, the current theoretical approaches to the firm highlight a general issue to do with post-1970 microeconomics; namely, the retreat from the use of general equilibrium (GE) models. I argue,
As early as 1955 Milton Friedman was suggesting that to deal with ‘substantive hypotheses about economic phenomena’ a move away from Walrasian towards Marshallian analysis was required. When reviewing Walras’s contribution to GE, as developed in his Elements of Pure Economics, Friedman argued,
Economics not only requires a framework for organizing our ideas [which Walras provides], it requires also ideas to be organized. We need the right kind of language; we also need something to say. Substantive hypotheses
about economic phenomena of the kind that were the goal of Cournot are an essential ingredient of a fruitful and meaningful economic theory. Walras has little to contribute in this direction; for this we must turn to other economists, notably, of course, to Alfred Marshall.
(Friedman 1955: 908)
By the mid-1970s microeconomic theorists had largely turned away from Walras and back to Marshall, at least in so far as they returned to using partial equilibrium analysis to investigate economic phenomena such as strategic interaction, asymmetric information and economic institutions.
In fact to model economic institutions like the firm it is necessary to violate basic assumptions of GE theory which suggests that as it stands GE cannot deal easily with firms, or other important economic institutions. Bernard Salanié has noted that,
[...] the organization of the many institutions that govern economic relationships is entirely absent from these [GE] models. This is particularly striking in the case of firms, which are modeled as a production set. This makes the very existence of firms difficult to justify in the context of general equilibrium models, since all interactions are expected to take place through the price system in these models.
(Salanié 2005: 1)
All this would suggest that to make GE models a ubiquitous tool of microeconomic analysis – including the analysis of issues to do with non-market organisations such as the firm – developing models which can account for information asymmetries, contractual incompleteness,strategic interaction,the existence of institutions and the like is not so much desirable as essential.

One catalyst for the development of such a new approach to GE is that partial equilibrium models can obscure the importance of the theory of the firm for overall resource allocation, a point which is more easily appreciated in a GE framework.

Friday, 2 September 2016

Measuring global hunger: the importance of variances

is the title of a new column at VoxEU.org by some guy John Gibson, from some out fit called the University of Waikato. Gibson argues that different survey methodologies are typically employed to produce estimates of global hunger. His column considers some of the methodological issues that arise. Short reference periods for each household lead to overstated variances and the confounding of chronic and transient welfare components. The column goes on to present a new approach to measuring chronic hunger which tackles this sampling problem by employing an intra-year panel.

About the new approach to measuring chronic hunger Gibson writes,
In a recent paper, I propose a new way to measure chronic hunger from surveys, which accounts for excess variability from just observing a snapshot of diets (Gibson 2016). This method also can identify the transient component of hunger, which is a type of welfare fluctuation that is neglected in the literature compared to the emphasis placed on transient poverty (and a type of hunger neglected by the FAO).

The proposed method needs surveys to see the same households in at least two, non-adjacent periods in the year. This survey design is rare. Dupriez et al. (2014) survey statistics offices in 100 low- and middle-income countries to obtain metadata on their food consumption surveys and find just two that use this type of intra-year panel. Many more surveys in their sample use revisits for short, adjacent, periods (e.g. every second day) to check on diary-keeping by respondents; the median diary-keeping survey has interviewers make five visits in two weeks.

However, seeing the same household repeatedly for, say, two weeks to implement a diary is less informative than seeing it for a week, and then again for another week, six months later. Seeing the same household at two or more times of the year reveals more about outcomes with low auto-correlation since a snapshot of these mis-measures their long-run average. The benefit from repeated observations has previously been noted for incomes, expenditures, and microenterprise profits, which have low auto-correlations (McKenzie 2012), and the new results show that calories are another outcome of interest with low auto-correlations.

To get a correct estimate of annual variances from snapshot surveys, the correlations between values of a living standards indicator in separate periods for the same households are needed. These correlations are implicitly assumed to be 1.0 if short reference period survey data are treated as equivalent to annual data. If correlations are only 0.7, monthly reference period surveys overstate annual variances by 40%, and by 80% if the correlations are as low as 0.5. The correlation-based method has been found to almost exactly replicate what benchmark annual data from year-long diaries show, for variance-based statistics such as inequality and poverty indices (Gibson et al. 2003) but has not previously been used to measure hunger.

Reinhard Selten has died

Thanks to the A Fine Theorem blog I have just learnt that the economist and game theorist Reinhard Selten, a recipient of the 1994 Nobel Prize in economics, has died at the age of 85. He died August 23 in the Polish city of Poznan.

Kevin Bryan writes,
Selten’s most renowned contribution came in the idea of perfection. The concept of subgame perfection was first proposed in a German-language journal in 1965 (making it one of the rare modern economic classics inaccessible to English speakers in the original, alongside Maurice Allais’ 1953 French-language paper in Econometrica which introduces the Allais paradox).
In the 1965 paper, on demand inertia (paper is gated), Selten wrote a small game theoretic model to accompany the experiment, but realized there were many equilibria. The term “subgame perfect” was not introduced until 1974, also by Selten, but the idea itself is clear in the ’65 paper. He proposed that attention should focus on equilibria where, after every action, each player continues to act rationally from that point forward; that is, he proposed that in every “subgame”, or every game that could conceivably occur after some actions have been taken, equilibrium actions must remain an equilibrium. Consider predatory pricing: a firm considers lowering price below cost today to deter entry. It is a Nash equilibrium for entrants to believe the price would continue to stay low should they enter, and hence to not enter. But it is not subgame perfect: the entrant should reason that after entering, it is not worthwhile for the incumbent to continue to lose money once the entry has already occurred.
And this idea started a whole industry of finding other ways to refine Nash Equilibria.

Thursday, 1 September 2016

North v's South

GDP or GDP per person may not be a perfect measure of welfare but sometimes it does tell a story.

The graph below is of GDP per person for North and South Korea, and it does tell a story about peoples' welfare. And economic systems.

The myth of neoliberalism

Colin Talbot writes on The Myth of Neoliberalism. Not everyone will agree with Talbot but his piece is worth talking a few minutes to read. And think about.

First he makes the point that,
Neoliberalism is a myth. It’s a pervasive myth on one side of politics – the left. But it is nevertheless a myth.
and he adds
Let’s start with one simple and obvious fact – no-one claims to be a neoliberal.
Which, as he says, is rather odd. I know libertarians and I know classical liberals but I'm not sure I know anyone who does claim to be a "neoliberal". I know people who have been called "neoliberal" by others but they themselves don't use the term.

Talbot goes on to note
‘Neoliberalism’ has become a term of abuse and an obstacle to serious thinking about what is, and is not, happening in politics and public policy.
and he ends by saying,
Neoliberalism is a convenient myth invented by opponents of any type of pro-market reform or political position that recognizes markets may – in the right circumstances – be a good thing. Everyone from moderate social democrats to the most lurid free-marketeers gets lumped together under a convenient ‘neoliberal’ label. I suppose it saves the bother of actually thinking, but otherwise it is not helpful.
After reading much stuff written by those who oppose "neoliberalism", I still don't know what those who use the term actually mean by it. It seems to mean different things to each user of the term. It would be better if someone could come up with a discussion of just what its characteristics are and how it differs from ideas like libertarianism and classical liberalism.