Thursday, 16 November 2017

Book contract signed

I have just signed a contract with Routledge for them to publish my second book, "A brief prehistory of the theory of the firm". The manuscript is due first thing in December (I have much work to do over the next couple of weeks) and thus with luck the book will appear a few months later.

Keep an eye out and save up so you can be one of the first lucky people to own a copy!


    Preface and acknowledgements
    A note on the numbering of equations, tables and figures


    Chapter notes

The division of labour and the firm

    Ancient philosophers

    Medieval period

    Pre-classical economics period

    19th century

    20th century

    Chapter notes

Development of a theory of production or the firm

    Pre-classical economists

    The classical economics period

    The neoclassical era

        Behavioural and managerial models

        Contemporary criticisms of the neoclassical model

        Coase versus Demsetz on the neoclassical model

        Profit maximisation

    Malmgren (1961)

    Chapter notes

Possible reasons for the neglect of the firm

    Chapter notes


Monday, 13 November 2017

Common ownership, competition, and top management incentives

An interesting looking revised version of a working paper from the Cowles Foundation for Research in Economics at Yale University on "Common Ownership, Competition, and Top Management Incentives" (pdf). The paper is by Miguel Antón, Florian Ederer, Mireia Giné, and Martin Schmalz.

The abstract reads:
We show theoretically and empirically that managers have steeper financial incentives to expend effort and reduce costs when an industry’s firms tend to be controlled by shareholders with concentrated stakes in the firm, and relatively few holdings in competitors. A side effect of steep incentives is more aggressive competition. These findings inform a debate about the objective function of the firm.
The basic conclusion of the paper is,
We found that the sensitivity between top managers’ wealth and their firm’s performance is weaker when the firms’ largest shareholders are also large shareholders of competitors. The wealth-performance relation for managers is steeper when firms are owned by shareholders without significant stakes in competitors.
Thus you will get more competition when a firm is owned by shareholders without significant stakes in competitors.

Trade, merchants, and the lost cities of the Bronze Age

An interesting new NBER working paper on Trade, Merchants, and the Lost Cities of the Bronze Age by Gojko Barjamovic, Thomas Chaney, Kerem A. Coşar and Ali Hortaçsu.

NBER Working Paper No. 23992
Issued in November 2017
NBER Program(s): ITI
We analyze a large dataset of commercial records produced by Assyrian merchants in the 19th Century BCE. Using the information collected from these records, we estimate a structural gravity model of long-distance trade in the Bronze Age. We use our structural gravity model to locate lost ancient cities. In many instances, our structural estimates confirm the conjectures of historians who follow different methodologies. In some instances, our estimates confirm one conjecture against others. Confronting our structural estimates for ancient city sizes to modern data on population, income, and regional trade, we document persistent patterns in the distribution of city sizes across four millennia, even after controlling for time-invariant geographic attributes such as agricultural suitability. Finally, we offer evidence in support of the hypothesis that large cities tend to emerge at the intersections of natural transport routes, as dictated by topography.
Alex Tabarrok writes on this paper at Marginal Revolution:
In a stunningly original paper Gojko Barjamovic, Thomas Chaney, Kerem A. Coşar, and Ali Hortaçsu use the gravity model of trade to infer the location of lost cities from Bronze age Assyria! The simplest gravity model makes predictions about trade flows based on the sizes of cities and the distances between them. More complicated models add costs based on geographic barriers. The authors have data from ancient texts on trade flows between all the cities, they know the locations of some of the cities, and they know the geography of the region. Using this data they can invert the gravity model and, triangulating from the known cities, find the lost cities that would best “fit” the model. In other words, by assuming the model is true the authors can predict where the lost cities should be located. To test the idea the authors pretend that some known cities are lost and amazingly the model is able to accurately rediscover those cities.

Dennis Rasmussen on Hume and Smith and "The Infidel and the Professor"

In this audio from EconTalk Russ Roberts interviews Dennis Rasmussen about Rasmussen's new book "The Infidel and the Professor: David Hume, Adam Smith, and the Friendship that Shaped Modern Thought".
How did the friendship between David Hume and Adam Smith influence their ideas? Why do their ideas still matter today? Political Scientist Dennis Rasmussen of Tufts University and author of The Infidel and the Professor talks with EconTalk host Russ Roberts about his book--the intellectual and personal connections between two of the greatest thinkers of all time, David Hume and Adam Smith.
A direct link to the audio is available here.

Its a book that's well worth reading.

Claudia Goldin on the gender earnings gap

Claudia Goldin (Professor of Economics at Harvard University) writes, in the New York Times, on How to Win the Battle of the Sexes Over Pay (Hint: It Isn’t Simple.)

The executive summary
In sum, the gap is mainly the upshot of two separate but related forces: workplaces that pay more per hour to those who work longer and more uncertain hours, and households in which women have assumed disproportionately large responsibilities.
And now a bit more detail.
Yet it is also true that the time demands of many jobs can explain much of the pay difference, a finding that has sobering implications. Eliminating the gender earnings gap will require changes in millions of households and thousands of individual workplaces.
The gap is larger among more educated people, for example, and varies according to occupation, often in big ways. Among college graduates, it is far larger in business, finance and legal careers than in science and technology jobs. In health care, it is larger when self-employment is high (think dentists) and much lower when professionals are mainly employees (think pharmacists).

What’s more, the gap is a statistic that changes during the life of a worker. Typically, it’s small when formal education ends and employment begins, and it increases with age. More to the point, it increases when women marry and when they begin bearing children.
Similar patterns appear using data for women and men who have earned master’s degrees in business administration. Immediately after graduation, women earn 92 cents for each male dollar. A decade later they earn only 57 cents.

Correcting for time off and hours of work reduces the difference in the earnings between men and women but doesn’t eliminate it.

On the face of it, that looks like proof of disparate treatment. It may seem understandable that when a man works more hours than a woman, he earns more. But why should his compensation per hour be greater, given the same qualifications? But once again, the problem isn’t simple.
The data shows that women disproportionately seek jobs — including full-time jobs — that are more likely to mesh with family responsibilities, which, for the most part, are still greater for women than for men. So, the research shows, women tend to prefer jobs that offer flexibility: the ability to shift hours of work and rearrange shifts to accommodate emergencies at home.

Such jobs tend to be more predictable, with fewer on-call hours and less exposure to weekend and evening obligations. These advantages have a negative consequence: lower earnings per hour, even when the number of hours worked is the same.

Is that unfair? Maybe. But it isn’t always an open-and-shut case. Companies point out that flexibility is often expensive — more so in some jobs than others.

Certain job characteristics have a big impact on the gender earnings gap. I have looked closely at these issues, including the extent to which workers are:
  • Subject to strict deadlines and time pressure
  • Expected to be in direct contact with other workers or clients
  • Instructed to develop cooperative working relationships
  • Assigned to work on highly specific projects
  • Unable to independently determine their tasks and goals
Occupations with a lower level of these characteristics (like jobs in science and technology) show smaller gaps, corrected for hours of work. Occupations with a higher level (like those in finance and law) have greater gaps. Men’s earnings tend to surge when there are fewer substitutes for a given worker, when the job must be done in teams and when clients demand specific lawyers, accountants, consultants and financial advisers. Such differences can account for about half the gender earnings gap.
Ask yourself, do you really care who your pharmacist is versus do you care who your doctor or lawyer is? A particular pharmacist not having to be there to deal with customers mean greater flexibility in hours worked but this comes with lower pay while the fact that people want a particular doctor or lawyer to deal with them means long hours with little flexibility but with higher pay to compensate.
These findings provide more nuance in explaining why the gap widens with age and why it is greater for women with children. Whatever changes have already taken place in American society, the duty of caring for children — and for other family members — still weighs more heavily on women. And if you thought that moving to a more family-friendly nation would eliminate the gap, think again. In several nations, including Sweden and Denmark, a “motherhood penalty” in earnings exists, even though these nations have generous family policies, including paid family leave and subsidized child care.

Such considerations bring us to a very sensitive area: domestic arrangements at home, especially among couples with children. These are personal questions. In theory, gender earnings equality is possible when both parents take off the same amount of time and enjoy the same flexibility at work.
So domestic arrangement with a more equal distribution of childcare may reduce the wage gap but it may also make the family poorer.
From a classic economic standpoint, if one spouse or partner can earn more by working less flexible hours, as a family, the couple would earn more money by having that parent in that job, while the other partner accepts the more flexible one. A man can certainly be the more flexible member of this household — though he typically is not. Such decisions need to be made couple by couple.
So the answer to the pay gap may be in the choices made within the home. And that makes it difficult for public policy to deal with.

Thursday, 9 November 2017

Zingales, McCloskey, Karlson and Kuran on populism and the free society

What does populism mean? Why do people buy it? Is the critique against the established elites valid? What are the main causes of the populist threats to the free society? How can public discourse and liberal democracy be restored?

Deirdre McCloskey, Luigi Zingales and Timur Kuran are some of the sharpets minds in academia today. They have all written extensively on the foundations of liberal societies. In conjunction with a special meeting with the Mont Pelerin Society on the populist threats to the free society and the reconstruction of the liberal project hosted by the Ratio Institute in Stockholm Sweden, they got together for a dialogue on some of the most pressing issues of our time. Professor Nils Karlson, CEO of the Ratio Institute and author of the book Statecraft and Liberal Reform in Advanced Democracies (Palgrave Macmillan), was the chair of the discussion.

Sunday, 22 October 2017

Immigration with Art Carden

An interview from the Libertarian Christian Institute with economist Art Carden about immigration.


Saturday, 21 October 2017

The division of labour and the firm: Rauh (forthcoming)

An interesting new paper which develops a theory, incorporating the division of labour and specialisation and a stochastic ('O-ring') production function, to explain the incentive structure and size of the firm is The O-ring theory of the firm by Micheal T. Rauh, which is set to appear in the Journal of Economics & Management Strategy.

A note on the name 'O-ring'. The O-ring production function was introduced by Kremer (1993). The name comes from the fact that it was an O-ring failure that caused the space shuttle Challenger disaster. The basic idea is that the failure of a small component can have large adverse consequences. Here one part of the production process failing causes the whole process to fail.

Rauh assumes a production process that can be divided into a number of distinct tasks. This makes it possible for the tasks to be allocated across workers (the division of labour) and for workers to make investments in task-specific human capital (specialisation). This is the kind of situation just discussed in the Becker and Murphy paper. We saw that an increase in employment gave rise to a greater division of labour, that is, fewer tasks assigned to each worker, and greater specialisation and thus higher productivity. Importantly Rauh postulates an additional feature of the production process: a breakdown at any point in production, which could be due to shirking, poor decision-making or a negative shock, will have serious adverse consequences for the successful manufacturing of the product--this is the 'O-ring' type production function.

This second condition has important implications for the moral hazard problems that arise within a firm. In the first best case, the principal can directly monitor individual worker effort and thus will be able to identify and respond to any shirking by workers with probability one. In the second best case, individual output can be monitored and again shirking can be punished with probability one. Note that in this case a worker who experiences a negative shock will also be punished. In the third best case all workers will be punished, with probability one, if any single worker shirks. In each of the three cases there will be no free rider issues since shirkers cannot hide behind the efforts of their co-workers.

Rauh considers a production process where the set of tasks is the unit interval. The principal chooses the number of workers, and the set of tasks to be performed is divided equally across all workers. Each of the workers is able to choose their production effort and their level of investment in task-specific human capital for each task they are assigned. To produce one unit of output requires one unit of output of each task. This means that you get zero output if any of the workers shirks or suffers an adverse shock in any of their assigned tasks. In line with Becker and Murphy (1992) greater levels of employment implies fewer tasks being assigned to each worker, which in turn means the workers can increase their investments in human capital for each of their reduced set of assigned tasks. This results in greater productivity and thus increasing returns to employment.

The stochastic (O-ring) nature of the production function is thought about in the following way.
"In addition to production effort and investments in human capital, each agent monitors his assigned tasks and makes decisions about whether or not a problem has arisen, whether or not to halt production to fix it, whether he can fix it himself, and which potential solution is appropriate. When there is only one agent, there is a high probability that at least some of these decisions will be faulty because he has limited cognitive resources and performs all the tasks himself. When there are two agents, the probability that either one will make a mistake should be lower because each performs only half the set of tasks and can therefore devote more care and attention to each of them. On the other hand, we now have two probabilities instead of one, so the effect of an increase in employment is ambiguous" (Rauh forthcoming: 2).
More formally, the probability that a worker suffers a negative shock to at least one of the tasks they have been allocated is an increasing function of the proportion of tasks being performed by that worker. Under an assumption of independence, the probability of a product defect is the product of the individual probabilities. If the number of workers is increased this results in two effects. First, it will decrease the probability that each worker will suffer a negative shock. Secondly, it will increase the number of points in the production process at which a negative shock can occur. Rauh then defines a production process as satisfying the O-ring property if the probability of a defect occurring is increasing in the number of workers and converges to one as the number of workers goes to infinity.

Given this background, the main question for the paper is then considered: What limits the size of a firm? For Rauh the answer has to do with the effects (or lack of effects) of moral hazard. Since there is a one-to-one relationship between the division of labour and the level of employment in the paper, the question can be rephrased as, What limits the division of labour? As has been noted above Becker and Murphy (1992) see this limit as be determined not by the extent of the market, as Adam Smith argued, but rather by coordination costs, including agency costs.

When determining the relationship between moral hazard and the size of the firm, "[ ... ] the optimal employment level balances the following considerations: (i) the increasing returns to employment due to specialization and division of labor, (ii) the O-ring property of the production technology, where the probability of team failure increases with the size of the team, and (iii) the marginal cost of employment (the cost of hiring another agent)" (Rauh forthcoming: 2).

In the first best case of no moral hazard Rauh shows that the standard zero incentive, full insurance contract is employed. Effectively the firm is behaving as if it were a perfectly competitive wage-taker despite it being a monopolist. Since, in this case, each worker's payment is fixed, the firm's labour costs (the number of workers times the expected payment to each worker) are linear in workers and the marginal cost of a worker is constant. Importantly, however, given increasing returns to employment, which arises from specialisation and the division of labour, but only linearly increasing costs to employment, these costs cannot limit the extent of employment. Thus, in this case, the extent of the market for labour or the O-ring property must be limiting employment and thus the size of the firm. If it wasn't for these constraints the first best firm would be of infinite size since there are increasing returns to employment.

Next Rauh considers the second best contract. Here effort cannot be observed but individual output can. Rauh shows that the optimal (second best) contract involves awarding a bonus to a worker when their individual output is high, i.e., when the worker's effort is first best and there is a positive shock, and replacing the worker otherwise. Rauh shows that the worker’s bonus is decreasing in employment. This follows from the fact that as employment increases the proportion of tasks carried out by each worker falls which increases the likelihood of a positive shock. This increases the expected value of the worker’s payment if the worker selects the first best effect level. This means the principal can reduce the bonus paid to the worker. It is also shown that this reduction in the bonus reduces the expected payment to the worker and this implies that the payment is decreasing in employment as well. If this type of effect is large enough then the marginal cost of an extra worker can decline with employment and could even be negative. In this situation the second best cost of employment could be less than the first best (constant) marginal cost of employment. This would mean the second best firm could be larger than the first best firm. Thus, the second best firm would have weak incentives (low bonus), low expected pay (small worker payment) and an excessive division of labour (and an excessive amount of specialisation). Motivation is provided by the fact that shirking workers will be identified and fired, rather than through the use of incentive schemes. As before, as the level of employment increases fewer tasks are carried out by each worker and the probability of a positive shock converges to one. This means that the second best expected payment to a worker converges to the first best payment. In turn, this means that the second best cost function tends towards the (linear) first best cost function. Thus as with the first best case the increasing returns resulting to employment resulting from the division of labour and specialisation cannot be contained by an asymptotically linear cost of employment. Rauh concludes from this that when the principal can monitor individual output, even if not effort, the size of the firm under moral hazard is again limited by either the total number of workers available or the O-ring property .

Lastly, Rauh looks at the third best situation where the where the principal can observe only team output. Here the results are the opposite of the second best case. This is because the third best incentive relies on the probability that all workers experience a positive shock rather than depending on the probabilities that individual workers experience a positive shock. Given the O-ring property, an increase in workers increases the probability that an individual worker experiences a positive shock but reduces the probability that all workers experience a positive shock. In this case increasing the number of workers decreases the team probability of success and this decreases the expected payments made to workers when they put in the first best level of effort. This means that the principal will increase the third best bonus, which increases the third best expected payment to workers and the marginal cost of employment. From this it is clear that all of the third best bonus, expected payments and the marginal cost of a worker are increasing in the number of workers. This is the opposite of the second best case above.

As the number of workers employed continues to increase, the third best bonus, expected payments and the marginal cost of employment all explode. This is contrary to the second best case where all these variables tended to their first best levels. The third best marginal cost of employment is shown to always exceeds the first and second best marginal costs of employment. This means the third best firm is usually smaller than either the first or second best firms.

Thus for Rauh's model moral hazard concerns only limit the division of labour, and the size of the firm, when the principal can monitor just the output of the whole team. When either worker's effort or individual output can be observed either the extent of the labour market or the O-ring property limit the extent of the division of labour or the size of the firm.

Rauh's paper is interesting in part because it combines, in some ways, the older division of labour approach to the firm with the more modern principal agent approach to the firm. The more modern mainstream approaches to the firm don't emphasise the division of labour with their emphasis being more on incomplete contracts and agency problems. The division of labour approach has largely fallen out of favour.

Well worth a read if you are into the theory of the firm.

  • Becker, Gary S. and Kevin M. Murphy (1992). 'The Division of Labor, Coordination Costs, and Knowledge', Quarterly Journal of Economics, 107 (4) November: 1137-60.
  • Kremer, M. (1993). 'The O-ring theory of economic development', Quarterly Journal of Economics, 108(3) August: 551-75.
  • Rauh, Michael T. (forthcoming). 'The O-ring theory of the firm', Journal of Economics & Management Strategy.

Monday, 16 October 2017

Speaking truth to "power"

Bob McManus writes at the City Journal:
Stephen Colbert, with arguably the sharpest tongue among America’s late-night TV ankle-biters, made his bones at the 2006 White House Correspondents Dinner, laying a vile spiel on President George W. Bush and finding himself the man of the moment. How brave, to speak such truth to power, gushed the usual suspects, and Colbert has been riding that wave ever since.

But he had done no such thing. In the absence of personal risk, haranguing the powerful can be soul-satisfying, and sometimes it forges careers, but it isn’t brave by a long shot. Thomas More spoke truth to Henry VIII, and it cost him his head. Dietrich Bonheoffer spoke truth to Adolf Hitler and was hanged in a concentration camp. Aleksandr Solzhenitsyn spoke truth to the Soviet Union and suffered grievously for it. Stephen Colbert piddled on the president’s rug, and he’s been cashing big-bucks checks ever since. See the difference?
Statements have to be costly to be credible. Cheap talk is .... well .... cheap talk. Signals need to be costly if people are to believe them. And there is nothing costly or brave about just sounding off against "power" when that "power" will not respond.

Saturday, 14 October 2017

Palgrave studies in ancient economies

An interesting looking new book series from Palgrave.

Call for Proposals - Palgrave Studies in Ancient Economies

Announcing a new series

This series provides a unique dedicated forum for ancient economic historians to publish studies that make use of current theories, models, concepts, and approaches drawn from the social sciences and the discipline of economics, as well as studies that use an explicitly comparative methodology. Such theoretical and comparative approaches to the ancient economy promotes the incorporation of the ancient world into studies of economic history more broadly, ending the tradition of viewing antiquity as something separate or ‘other’.

The series not only focuses on the ancient Mediterranean world, but also includes studies of ancient China, India, and the Americas pre-1500. This encourages scholars working in different regions and cultures to explore connections and comparisons between economic systems and processes, opening up dialogue and encouraging new approaches to ancient economies.

Series Editors:
Paul Erdkamp, Vrije Universiteit Brussel, Belgium
Ken Hirth, Penn State University, USA
Claire Holleran, University of Exeter, UK
Chunyan Huang, Yunnan University, China
Michael Jursa, University of Vienna, Austria
J. G. Manning, Yale University, USA

Contact for Proposals
Submissions are ideally between 60,000 and 110,000 words, although shorter submissions (25,000-50,000 words) will be considered for our Palgrave Pivot publication format.

Authors interested in submitting a proposal should contact the series editors directly or Laura Pacey (

Civil asset forfeiture, crime, and police incentives

Yes the police, like criminals, respond to incentives.

A new NBER working paper makes this point.

Civil Asset Forfeiture, Crime, and Police Incentives: Evidence from the Comprehensive Crime Control Act of 1984

Shawn Kantor, Carl Kitchens, Steven Pawlowski
The 1984 federal Comprehensive Crime Control Act (CCCA) included a provision that permitted local law enforcement agencies to share up to 80 percent of the proceeds derived from civil asset forfeitures obtained in joint operations with federal authorities. This procedure became known as “equitable sharing.” In this paper we investigate how this rule governing forfeited assets influenced crime and police incentives by taking advantage of pre-existing differences in state level civil asset forfeiture law and the timing of the CCCA. We find that after the CCCA was enacted crime fell about 17 percent in places where the federal law allowed police to retain more of their seized assets than state law previously allowed. Equitable sharing also led police agencies to reallocate their effort toward the policing of drug crimes. We estimate that drug arrests increased by about 37 percent in the years after the enactment of the CCCA, indicating that it was profitable for police agencies to reallocate their efforts. Such a reallocation of effort, however, brought an unintended cost in the form of increased roadway fatalities, seemingly from reduced enforcement of traffic laws.
Enforcement goes where the money is, not where the need is.

Friday, 13 October 2017

Intellectual property rights: yay or nay?

From the IEA comes this podcast in which Kate Andrews and Steve Davies talk about the good and bad aspects of intellectual property rights.
The Institute of Economic Affairs's Dr Steve Davies joins Kate Andrews to discuss the arguments for and against intellectual property rights - a topic that which particularly divides the libertarian movement.

In the podcast, Steve explains the philosophical arguments both for and against, ultimately arguing that copyright law forms illogical conclusions when taken to the extreme.

However, Steve thinks certain forms of intellectual property are justifiable and helpful, like trademarks, often because they spring up organically, and recognised by courts rather than determined by state policy.

He also points out, that as it becomes increasingly more difficult to monitor copyright infringement, changes to law may be needed for the 21st century.

The Latest bad idea in town: economic nationalism

From the IEA comes this podcast in which Kate Andrews and Steve Davies talk about the rise of economic nationalism.
From the left-ward shift of the Conservative Party in Britain, to the rise of Donald Trump in America, there seems to be a growing appetite for protectionism and central planning in contemporary politics. Steve and Kate examine some of the reasons behind this trend - and whether advocates of free trade are losing the "Battle of Ideas" in the 21st century.

They also look at what protectionist governments hope to achieve from adopting these policies - and how likely they will be to succeed in "bringing back jobs" for declining domestic industries.

Thursday, 7 September 2017

Pigs don't fly: the economic way of thinking about politics

This essay, Pigs Don't Fly: The Economic Way of Thinking about Politics by Russ Roberts is well worth rereading, especially as we are only weeks away from the election.
Politicians are just like the rest of us. They find it hard to do the right thing. They claim to have principles, but when their principles clash with what is expedient, they often find a way to justify their self-interest. If they sacrifice what is noble or ideal for personal gain, they are sure to explain that it was all for the children, or the environment or at least for the good of society.

Pigs don't fly. Politicians, being mere mortals like the rest of us, respond to incentives. They're a mixture of selfless and selfish and when the incentives push them to do the wrong thing, albeit the self-interested one, why should we ever be surprised? Why should be fooled by their professions of principle, their claims of devotion to the public interest?
And yet voters are stupid enough to be fooled.

Roberts makes a nice point about bootleggers and Baptists,
The Baptists give the politicians cover for doing what the bootleggers want. No politician says we should ban liquor sales on Sunday in order to enrich the bootleggers who support his campaign. The politician holds up one hand to heaven and talk about his devotion to morality. With the other hand, he collects campaign contributions (or bribes) from the bootleggers.

Sunday, 13 August 2017

"Democracy in Chains" versus public choice

From the Cato Institute comes this Cato Daily Podcast audio in which Michael Munger is interviewed by Caleb O. Brown about Nancy Maclean's book Democracy in Chains. The book paints Nobel Laureate and Cato Distinguished Senior Fellow James Buchanan as the scholar who would help bring down democracy using the methods of public choice. Michael Munger of Duke University comments.

Is price gouging bad?


4.42 minutes stating the obvious.

Saturday, 12 August 2017

Why you want to keep politicians away from business

The ever disintegrating Venezuela gives us a great illustration of why politicians should be kept out of businesses. Trying to gain political support by interfering in the running of a business doesn't improve the business.
To survive months of street protests and an economy in tailspin, Venezuelan President Nicolas Maduro is trying to turn state oil company PDVSA into a bastion of support, further degrading an already vulnerable enterprise.

Political appointees are gaining clout at the expense of veteran oil executives, while employees are under mounting pressure to attend government rallies and vote for the ruling Socialists. The increasing focus on politics over performance is contributing to a rapid deterioration of Venezuela's oil industry, home to the world's largest crude reserves, and to a brain drain at the once world-class company.

Interviews with two dozen current and former employees, foreign oil executives, and contractors point to a PDVSA coming apart at the seams.

"Everything is a disaster and yet we have to clap," said a PDVSA employee, who asked to remain anonymous because she feared retaliation.
Now Venezuela's oil production is on track to end 2017 at a 25-year low, but the leftist government still relies heavily on PDVSA to be its financial motor.

That leaves management in a precarious balancing act and sources say political factions are increasingly locked in power struggles within the company.

A senior management team named in January that draws heavily on political and military appointees has left PDVSA's president, the Stanford-educated engineer Eulogio Del Pino, largely powerless, according to two high-level sources in PDVSA and the government who spoke on the condition of anonymity for fear of reprisals.

Meanwhile, the infrastructure of the company is crumbling, rig counts are at historic lows and refineries are working at a fraction of capacity.

Staff at PDVSA's once gleaming headquarters complain that many elevators are out of service, the bathrooms lack toilet paper, and their cars are broken into in the parking lot. Scarce paper and ink are diverted to make political posters.
Prominent new executives include trading division boss Ysmel Serrano, who used to work for current Vice President Tareck El Aissami, and finance vice president Simon Zerpa, a young ally of Maduro's.

The influx of inexperienced executives and middle managers is keenly felt by foreign oil executives, who say they sometimes spend hours waiting for PDVSA representatives and complain that simple decisions are inexplicably delayed.

"Most of the time executives don't answer phone calls or emails. It's surprising how young and unprepared some managers are," said a representative of a foreign firm holding a supply contract with PDVSA.

He said that managerial and operational chaos was worsening, with waiting time to load a tanker stretching to 30-40 days compared to 2-3 days a few years ago.
In short the business of politicians is politics, not business.

Thursday, 10 August 2017

George Selgin on "A Monetary Policy Primer, Part 11: Last-Resort Lending"

One of the few interesting bits of monetary policy is the central banks role as the lender of last resort.
For many, the "lender of last resort" role of central banks is an indispensable complement to their task of regulating the overall course of spending. Unless central banks play that distinct role, it is said, financial panics will occasionally play havoc with nations' monetary systems.
George Selgin's aim is to challenge this way of thinking. Its an interesting antidote to much of what you hear said about the importance of the lender of last resort role of central banks.

Worth a few minutes to read.

Wednesday, 2 August 2017

You know your country is in trouble when

you get these kind of things happening,
In a hastily organized plebiscite on July 16, held under the auspices of the opposition-controlled National Assembly to reject President Nicolás Maduro’s call for a National Constituent Assembly, more than 720,000 Venezuelans voted abroad. In the 2013 presidential election, only 62,311 did. Four days before the referendum, 2,117 aspirants took Chile’s medical licensing exam, of which almost 800 were Venezuelans. And on July 22, when the border with Colombia was reopened, 35,000 Venezuelans crossed the narrow bridge between the two countries to buy food and medicines.
Voting with your feet is a real thing.

The most frequently used indicator to compare recessions is GDP. According to the International Monetary Fund, Venezuela’s GDP in 2017 is 35% below 2013 levels, or 40% in per capita terms. That is a significantly sharper contraction than during the 1929-1933 Great Depression in the United States, when US GDP is estimated to have fallen 28%.

Friday, 21 July 2017

Mike Munger interview

Dr. Mike Munger (Professor, Political Science & Economics at Duke University) is interviewed by Dave Rubin to discuss political science, the importance of state’s rights, the Republican’s problem with social issues, fact checking in mainstream media, and more.

Tuesday, 18 July 2017

Towards a political theory of the firm

Towards a Political Theory of the Firm is a new NBER working paper by Luigi Zingales.

Neoclassical theory assumes that firms have no power of fiat any different from ordinary market contracting, thus a fortiori no power to influence the rules of the game. In the real world, firms have such power. I argue that the more firms have market power, the more they have both the ability and the need to gain political power. Thus, market concentration can easily lead to a "Medici vicious circle," where money is used to get political power and political power is used to make money.
I hope when I get the chance to read the paper that there is more to it than this abstract suggests. Many, most, organisations, be they firms, trade unions, churches, not-for-profits, universities, welfare groups, environmental groups etc, will try to get governments to do their bidding. It's just the nature of things and a really good reason for keeping firms etc as far away from government as possible. It is one reason why you want a limited role for government in the economy, the smaller the role, the less government can do to help firms and thus the less firms will try to influence governments. 'Positive non-interventionism' has a lot going for it.

In the neoclassical model its not that firms have no power to influence the rules of the game, its more that there are no firms, or government for that matter, to do the influencing or to be influenced. In a world of zero transaction costs there is no need for firms since consumers can carry out production themselves. "With perfect and costless contracting, it is hard to see room for anything resembling firms (even one-person firms), since consumers could contract directly with owners of factor services and wouldn't need the services of the intermediaries known as firms" (Foss 2000: xxiv).

If you want to see what letting governments and business get together results in check out the history of guilds, they provided money to governments and governments provided protection for them for 800 years! What suffered for this time was economic efficiency, the consumer (as usual) and the economy and society in general.

  • Foss, Nicolai J. (2000). 'The Theory of the Firm: An Introduction to Themes and Contributions'. In Nicolai Foss (ed.), The Theory of the Firm: Critical Perspectives on Business and Management (xv-lxi), London: Routledge.

Monday, 3 July 2017

Ronald Coase a socialist!

I have just come across an article by Per Bylund at the Mises Institute website on the question Was Ronald Coase an Austrian? At one point Bylund answers the question by saying,
He was hardly an Austrian economist. On the contrary, he was a self-declared socialist - at least in his youth.
Let me quote Coase himself on this,
One may ask how I reconciled my socialist sympathies with acceptance of [Arnold] Plant's [free market] approach. The short answer is that I never felt the need to reconcile them. I would only recall that a fellow student, Abba Lerner, who, in the preface to his Economics of Control, acknowledges Plant's influence in the development of his views, went to Mexico to see Trotsky to persuade him that all would be well in a communist state if only it reproduced the results of a competitive system and prices were set equal to marginal cost. In my case my socialist views fell away fairly rapidly without any obvious stage of rejection (Emphasis added).
So the description should be 'he was a self-declared socialist - ONLY in his youth'.  I'm sure that anyone who has read the older Coase will be surprised to see him call a socialist. If fact in an interview Coase tells a story about his wife going to a party while he was at the University of Virginia,
They thought the work we were doing was disreputable. They thought of us as right-wing extremists. My wife was at a cocktail party and heard me described as someone to the right of the John Birch Society. There was a great antagonism in the '50s and '60s to anyone who saw any advantage in a market system or in a nonregulated or relatively economically free system.
Perhaps being both a socialist and to the right of the John Birch Society is an accomplishment worthy of a Nobel Prize!

Tuesday, 27 June 2017

Minimum wage increases, wages, and low-wage employment: evidence from Seattle

A new NBER working paper looks at the effects of the first and second phase-in of the Seattle Minimum Wage Ordinance, which raised the minimum wage from $9.47 to $11 per hour in 2015 and to $13 per hour in 2016. The paper is

Minimum Wage Increases, Wages, and Low-Wage Employment: Evidence from Seattle
Ekaterina Jardim, Mark C. Long, Robert Plotnick, Emma van Inwegen, Jacob Vigdor and Hilary Wething
NBER Working Paper No. 23532.
The absract reads,
This paper evaluates the wage, employment, and hours effects of the first and second phase-in of the Seattle Minimum Wage Ordinance, which raised the minimum wage from $9.47 to $11 per hour in 2015 and to $13 per hour in 2016. Using a variety of methods to analyze employment in all sectors paying below a specified real hourly rate, we conclude that the second wage increase to $13 reduced hours worked in low-wage jobs by around 9 percent, while hourly wages in such jobs increased by around 3 percent. Consequently, total payroll fell for such jobs, implying that the minimum wage ordinance lowered low-wage employees’ earnings by an average of $125 per month in 2016. Evidence attributes more modest effects to the first wage increase. We estimate an effect of zero when analyzing employment in the restaurant industry at all wage levels, comparable to many prior studies.

Wednesday, 14 June 2017

Positive v's normative economics

This is a distinction every economics student knows. But where did it originate?

A clear distinction between positive and normative economics goes back at least as far as John Neville Keynes (father of Maynard). Keynes wrote,
"[a]s the terms are here used, a positive science may be defined as a body of systematized knowledge concerning what is ; a normative or regulative science as a body of systematized knowledge relating to criteria of what ought to be, and concerned therefore with the ideal as distinguished from the actual ; an art as a system of rules for the attainment of a given end. The object of a positive science is the establishment of uniformities, of a normative science the determination of ideals, of an art the formulation of precepts" (Keynes 1917: 34-5).
Carl Menger also saw a difference, with regard to ethical considerations, between theoretical economics (positive economics) and economic policy (normative economics). In Menger (1883: 235) Menger criticises what he calls the "ethical orientation" of the German historical school. He writes with regard to theoretical economics that
"[w]hat we should like to stress here particularly is the fact that we cannot rationally speak of an ethical orientation of theoretical economics either in respect to the exact orientation of theoretical research or to the empirical-realistic orientation". But normative consideration do enter into economic policy: ``Economic policy, the science of the basic principles for suitable advancement (appropriate to conditions) of ``national economy" on the part of the public authorities" (Menger 1883: 211).
The important word here is suitable. You can not determine what is suitable without value judgements.

John Stuart Mill makes a similar distinction when he differentiates between science and art.
"These two ideas [science and art] differ from one another as the understanding differs from the will, or as the indicative mood in grammar differs from the imperative. The one deals in facts, the other in precepts. Science is a collection of truths ; art, a body of rules, or directions for conduct. The language of science is, This is, or, This is not ; This does, or does not, happen. The language of art is, Do this ; Avoid that. Science takes cognizance of a phenomenon, and endeavours to discover its law ; art proposes to itself an end, and looks out for means to effect it" (Mill 1844: 124).
So 1844 is as far back as I've found the distinction going, so far.

  • Keynes, John Neville (1917). The Scope and Method of Political Economy 4th edition, New York: Augustus M. Kelley Publishers, 1986.
  • Menger, Carl (1883). Investigations into the Method of the Social Sciences with Special Reference to Economics, formerly published under the title: Problems of Economics and Sociology (Untersuchungen uber die Methode der Socialwissenschaften und der Politischen Oekonomie insbesondere), with a new introduction by Lawrence H. White, edited by Louis Schneider, translated by Francis J. Nock, New York: New York University Press, 1985.
  • Mill, John Stuart (1844). Essays on Some Unsettled Questions of Political Economy, London: John W. Parker.

Sunday, 14 May 2017

The emergence of the corporate form

An interesting new article from the Journal of Law, Economics and Organisation -- Volume 33, Issue 2 May 2017: 193-236.
The Emergence of the Corporate Form
Giuseppe Dari-Mattiacci; Oscar Gelderblom; Joost Jonker; Enrico C. Perotti
We describe how, during the 17th century, the business corporation gradually emerged in response to the need to lock in long-term capital to profit from trade opportunities with Asia. Since contractual commitments to lock in capital were not fully enforceable in partnerships, this evolution required a legal innovation, essentially granting the corporation a property right over capital. Locked-in capital exposed investors to a significant loss of control, and could only emerge where and when political institutions limited the risk of expropriation. The Dutch East India Company (VOC, chartered in 1602) benefited from the restrained executive power of the Dutch Republic and was the first business corporation with permanent capital. The English East India Company (EIC, chartered in 1600) kept the traditional cycle of liquidation and refinancing until, in 1657, the English Civil War put the crown under strong parliamentary control. We show how the time advantage in the organizational form had a profound effect on the ability of the two companies to make long-term investments and consequently on their relative performance, ensuring a Dutch head start in Asian trade that persisted for two centuries. We also show how other features of the corporate form emerged progressively once the capital became permanent. (JEL: G30, K22, N24).

Friday, 12 May 2017

Daniel Griswold on the basics of trade

From David Beckworth’s podcast series, Macro Musings comes this audio of an interview with Daniel Griswold on the Basics of Trade.
Daniel Griswold is a Mercatus Center Senior Research Fellow and Co-Director of the Program on the American Economy and Globalization at the Mercatus Center at George Mason University. He joins the show to discuss the theory of trade, dating back to Adam Smith, and his work on current US trade policy. Daniel and David discuss some of the misconceptions surrounding trade and why Americans should embrace free trade instead of protectionism.

Tuesday, 9 May 2017

How to make trouble

These guys really know how to make trouble .........

Replicating Anomalies
Kewei Hou, Chen Xue, Lu Zhang
NBER Working Paper No. 23394
Issued in May 2017
The anomalies literature is infested with widespread p-hacking. We replicate the entire anomalies literature in finance and accounting by compiling a largest-to-date data library that contains 447 anomaly variables. With microcaps alleviated via New York Stock Exchange breakpoints and value-weighted returns, 286 anomalies (64%) including 95 out of 102 liquidity variables (93%) are insignificant at the conventional 5% level. Imposing the cutoff t-value of three raises the number of insignificance to 380 (85%). Even for the 161 significant anomalies, their magnitudes are often much lower than originally reported. Out of the 161, the q-factor model leaves 115 alphas insignificant (150 with t < 3). In all, capital markets are more efficient than previously recognized.
The behaviourists will not be happy!

Wednesday, 3 May 2017

Oliver Hart, incomplete contracts and control

From the 2017 Royal Economic Society Conference comes this video of the talk by Oliver Hart, the Winner of the 2016 Nobel Prize in Economics, which is an extended version of his Prize Lecture.

Watch it and actually learn something worth learning!! An usual thing in economics these days. And no, not a regression anywhere.

Friday, 28 April 2017

Josh Zumbrun on the challenges and angst facing the economics profession

From David Beckworth’s podcast series, Macro Musings comes this audio of an interview with Josh Zumbrun on the challenges and angst facing the economics profession.
Josh Zumbrun is a national economics correspondent for the Wall Street Journal. David and Josh discuss what seems to be the diminished status of economists in a populist era and what role economists will play in the Trump Administration. Josh also shares his thoughts on life as an economics journalist in the digital age.

Wednesday, 26 April 2017

82 copies sold

Today I received a note from my publisher telling me that the greatest book ever written has sold a total of 82 copies! Ok a few fewer than you might expect from a new Harry Potter book, but a (small) step towards being a millionaire.

Thanks to the 82 of you out there.

As for the rest of you ...... shame!

Tuesday, 25 April 2017

Unpacked: President Trump’s border wall

This video comes from the Brookings Institution:
Vanda Felbab-Brown, senior fellow at the Brookings Institution, unpacks the security, economic and environmental impacts of President Trump’s proposed border wall. Felbab-Brown explains that the wall may accomplish very little and instead jeopardize Mexico-U.S. relations in addition to escalating issues with the existing fence, wildlife and the flow of drugs.

20% off

The publisher, Routledge, of my book "The Theory of the Firm: An Overview of the Economic Mainstream" is offering 20 percent off right now.

That means its just 76 pounds, so be in quickly!!

Those of you with a Kindle can get the Kindle edition for US$50.81 (no idea how they came up with that price!) from Amazon.

Sunday, 23 April 2017

Mental experiment on the effects of minimum wages

This thought experiment is from Don Boudreaux at Cafe Hayek.
Imagine that you’re given the option of buying ten-dollar bills for $5 a piece. How many will you buy? The answer is obvious: as many as the sellers of these discount-priced ten-dollar bills will sell to you. Of course, in reality $10 bills are never available for sale at $5 a piece. Or are they?! In a very real way, reality does indeed sometimes offer such deals. If a worker that can produce $10 per hour worth of output is currently paid by his or her employer only $5 per hour, a competing employer can profit by hiring, at some wage higher than $5 per hour, that worker away from his or her current employer. Indeed, employers will compete for this worker until this worker’s hourly wage is bid up to $10. (If you doubt this outcome, the burden is on you to explain why this worker’s wage will stop rising at some amount less than $10 per hour. It’s a surprisingly difficult burden to meet.)

Now imagine that you’re offered the prospect of buying five-dollar bills for $10 a piece. How many $5 bills will you buy? The answer again is obvious: none. Even if you’re a billionaire, you have no incentive to spend $10 to buy a $5 bill. The fact that you can “afford” to do so is irrelevant. If someone is asked to predict how many $5 bills, say, billionaire Nick Hanauer will buy if each of these bills is priced at $10, that someone would surely say “none.” And that someone would surely be correct.

The minimum wage is economically identical to a scenario in which government prohibits the sale of Federal Reserve notes at any price below $10 each. No bill worth less than $10 would be purchased. No one will knowingly buy something worth only $5 for a price higher than $5.

The above example involving Federal Reserve notes is easy to grasp. Yet change the item for sale from “five-dollar bill” to “low-skilled worker who can produce on average no more than $5 worth of output per hour,” and many people – including even some economists – somehow mysteriously find reason to believe that people will pay for $5 bills some price greater than $5.

Saturday, 22 April 2017

The drive to mandate paid family leave

From the Cato Institute comes this Cato Daily Podcast in which Vanessa Brown Calder talks to Caleb O. Brown about the effects of mandate paid family leave.
What can federally mandated unpaid family leave tell us about the likely impacts of a proposed mandate for paid family leave?

Thursday, 20 April 2017

Relative prices and inflation (updated)

A recent discussion on twitter went as follows:

The basic point is that relative prices changes and inflation are not the same thing despite the fact that the way we calculate inflation makes them look as though they are.

To quote the Federal Reserve Bank Of Cleveland
Relative Price Changes Are Not Inflation

Relative-price changes, like inflation, can cause price pressure in an economy. We experience them every day much like we experience inflation, and they cause changes in standard price indexes. But there the similarity ends. Relative-price changes are not a monetary phenomenon. They arise in market economies as individual prices adjust to the ebb and flow of the supply and demand for various goods. Relative-price movements convey important information about the scarcity of particular goods and services. A rising relative price indicates that demand is outstripping supply (or that supply is falling behind demand), while a falling relative price denotes just the opposite. A rising relative price induces consumers to conserve on the good in question and to look for substitutes. A rising relative price also, by increasing profit opportunities, entices producers to bring more of the good in question to market.

In this way, relative-price changes—no matter how uncomfortable they are for consumers or producers—transmit vital information necessary for the efficient allocation of resources throughout any market economy. Inflation, by contrast, contributes no information useful to our consumption, production, or labor choices. If anything, inflation can temporarily distort vital relative-price signals, leading people to make unsound economic choices. It can even cause people to shift their time and resources away from activities that foster production and long-term economic growth to activities intended to protect their wealth rather than expand it.

Recently, the relative prices of petroleum, agricultural goods, and some other commodities have risen sharply. One factor responsible for much of these increases is the world’s unprecedented economic performance in recent years. Between 2004 and 2007, world output expanded an average of 4.8 percent each year, according to IMF data. While emerging markets, notably China and India, appear to have led the way, nearly every nation on earth shared in the expansion. This growth and development, which itself stems from an increasing willingness of countries to embrace globally integrated markets, has placed greater demand on world resources, leading to sharp increases in the relative prices of commodities. Foods imported into the United States, for example, have increased 4 percent on average each year since 2002 relative to other goods, while the relative prices of imported industrial commodities have increased 17 percent over the same period. Meanwhile, the relative price of petroleum increased 28 percent each year on average—and because petroleum is required to produce food and industrial commodities, its hike fed into their prices as well.
What we need to keep in mind is the difference between what may be called "true or pure inflation" and "relative price changes". One thing that seems odd about much discussion of inflation is the failure to make this distinction.

As noted by the Cleveland Fed changes in relative prices are important because it is relative prices that direct resource allocation. These are the price signals that are important for the smooth functioning of the economy, they provide the incentives for people to change their behaviour. As Cowen and Crampton (2002: 5) put it [t]he Canadian plumber's knowledge of substitutes for copper piping influences the French electrician's choice of home wiring through its effect on the market price of copper. "Pure inflation", on the other hand, is signal jamming noise which can result in the misallocation of resources. One of the major problems with inflation is the fact that people can't tell the difference between changes in relative prices and pure inflation. This is, in part, because the standard measures of inflation, eg changes in the CPI, contain both components: relative price changes and "pure inflation". Sorting these two factors out however is far from easy.

But what exactly is meant when we talk about "true or pure inflation"? Imagine an economy in which every price exogenously doubled. What used to cost $1 now costs $2, those who were paid $10 per hour now are paid $20, and what was worth $100 now is worth $200 and so on. Note that there has been no relative prices changes here. Thus, because people care about trade-offs when making choices, no one will behave any differently in the new "high price" world than they did previously. We would say, there is no "money illusion" in that changes in the unit of account don’t change anything real at all. (In microeconomic theory you learn this when you are told that demand functions are homogeneous of degree zero in prices and income.) Such an equiproportional price level increase, in the example just given the price level has doubled, is what can be called pure inflation.

In a paper - Relative Goods' Prices and Pure Inflation by Ricardo Reis and Mark Watson, CEPR 6593, December 2007 - it is pointed out that central to the story told above is a measure of inflation which is defined by two properties:
  1. all prices increase in exactly the same proportion, and
  2. the change is unrelated to any relative-price movements.
Reis and Watson argue that the extent to which (2) holds is an inflation measure's "purity." A measure of inflation is purer the more it has been stripped from relative-price changes and so it is closer to the thought experiment carried out above. How then to purify a measure of inflation?

Reis and Watson note that,
[i]n our own work, we noticed that factor analysis also gave a natural way to purify the measure of inflation. Factor analysis produces a set of components (or factors) that explain why prices move together. One of these factors is the equiproportional change in prices that Bryan and Cecchetti emphasised. But the other factors are just as interesting. These factors are measures of relative-price changes due to some common source (say productivity, fiscal, or monetary shocks), and it turns out that a few of these alone account for a great deal of the variability of price changes. Therefore, we can use them to statistically purify our measure of inflation from these main sources of relative price movements.
Using US data Reis and Watson found that
... most of the movements in conventional measures of inflation like the Consumer Price Index (CPI), its core version, or the GDP deflator are due to relative-price changes. Only around 15-20% of the movements in these measures of inflation correspond to pure inflation.
Given that they had measures of relative price changes and pure inflation Reis and Watson could look for evidence of money illusion in their data. They found that once they controlled for relative price changes, the correlation between (pure) inflation and real activity is essentially zero. So,
... when we see that high inflation typically comes with low unemployment or high output, this is indeed driven by the change in relative prices hidden within the inflation measure. When there is pure inflation, that is when all prices increase in the same proportion independently from any relative price changes, nothing happens to quantities.
Update: In a related blog post Michael Reddell at the Croaking Cassandra blog asks What to make of the CPI?

Ricardo and comparative advantage (updated)

David Ricardo is probably most famous because of his introduction of the idea of comparative advantage into economics. Today comparative advantage is the standard reason given as to why countries gain from trade. And as noted in this twit by the great trade economist Doug Irwin, Ricardo's book "Principles of Political Economy" is 200 years old.

But is Ricardo the author of the famous pages in his "Principles of Political Economy"? Some have argued that James Mill is the true author.

In a footnote on page 132 of the fifth edition of his "Economic Theory in Retrospect" Mark Blaug writes
Ironically enough, it is now been shown that the famous pages on comparative advantage in the chapter on foreign trade were almost certainly written by James Mill. Moreover, Ricardo's own conception of foreign trade never effectively went beyond the idea of absolute advantage; in short, he does not deserve the credit he has been given for the theory of comparative advantage.
The basis for Blaug's claim is the paper, by William O. Thweatt, "James Mill and the Early Development of Comparative Advantage", History of Political Economy 8 (Summer 1976) 207-34.

A quick look at Douglas Irwin's book "Against the Trade: An Intellectual History of Free Trade" gives rise to another footnote, from page 91, which reads,
Thweatt's case is plausible because Mill worked closely with Ricardo on the Principles and commented extensively on drafts. Inconclusive evidence against his interpretation comes in a letter from Mill to Ricardo in which he states: "... that it may be good for a country to import commodities from a country where the production of those same commodities cost more, than it would cost at home: that a change in manufacturing sill in one country, produces a new distribution of the precious metals, are new propositions of the highest importance, and which you fully prove." See David Ricardo (1952, 7: 99). Further, in his article on colonies Mill also credits Ricardo with the theory.
It has also argued that Mill explained the idea of comparative advantage better in his "Elements of Political Economy", published after Ricardo's "Principles".

But whoever wrote about comparative advantage Ricardo's book is worth celebrating. So joint Irwin and many other economists in raising a glass of wine, from a country of your choice, to David Ricardo!

Updated: In the comments section to this posting Jorge Morales Meoqui writes,
The authorship debate about comparative advantage has mostly revolved about the relative merits of Ricardo's statement in the Principles and Robert Torrens’ statement in Essay on the External Corn Trade (1815). James Mill never claimed merit for it, and in the letter to his friend Ricardo he indicated unequivocally who should be credited for the insight.
For more on Morales Meoqui's work on the comparative advantage debate see here.

Sunday, 16 April 2017

When usury laws are counterproductive

Is it a good idea have a ceiling on the interest rate, be that zero or some positive rate.
We study the effects of interest rate ceilings on the market for automobile loans. We find that loan contracting and the organization of the loan market adjust to facilitate loans to risky borrowers. When usury restrictions bind, automobile dealers finance a greater share of their customers’ purchases, which allows them to price credit risk through the mark-up on the product sale rather than the loan interest rate. Despite having little effect on who receives credit, usury limits therefore have a substantial effect on who provides credit and on the terms of credit granted. Usury limits may harm defaulting borrowers, who face greater liabilities in default than they would if loan contracts were unconstrained.
This is the abstract of a new working paper, Loan Contracting in the Presence of Usury Limits: Evidence from Automobile Lending (Consumer Financial Protection Bureau Office of Research Working Paper No. 2017-02) by Brian Melzer and Aaron Schroeder.

Melzer and Schroeder explain,
Usury restrictions are often motivated by the argument that lenders, if unchecked, will exercise market power and raise interest rates on risky borrowers beyond the level required to compensate for credit losses, origination costs, and required capital returns. Supporters of usury limits thus argue that lenders will respond to interest rate caps by extending credit at lower prices. Opponents counter that price ceilings will cause credit rationing, which reduces access to credit and harms precisely the risky borrowers that supporters of usury limits intend to help. We propose and investigate an alternative view that applies to the large market for certain subprime automobile loans: vehicle sellers can creatively contract around binding usury limits by financing their customers’ purchases and pricing default risk through the mark-up on the vehicle sale rather than through the interest rate.

The strategy of automobile dealers is simple. Vehicle loans are structured as installment contracts that require constant monthly payments for a fixed maturity (typically 3-6 years) and allow the lender to repossess the vehicle if the borrower defaults. Holding fixed the collateral, loan maturity, and principal amount, a lender is typically constrained to adjust the price of credit by changing the interest rate specified in the contract. For a lender that also serves as the vehicle seller, however, there is an additional degree of freedom—marking up the sales price of the vehicle. When the usury limit binds, the integrated dealer-lender can subsidize a negative net present value loan with a higher-margin sale. Within the loan contract, this change amounts to increasing the stated loan amount (along with the sales price) rather than the interest rate, thereby achieving the desired monthly loan payment while still complying with usury law. To give an example, a $9,000 loan at 30% interest has the same required monthly payment as a $10,650 loan at 20% interest over a four-year, fully amortizing term.

While dealers’ contracting flexibility allows them to approximate an unconstrained loan, it does not completely eliminate the friction introduced by the usury limit. First, the constrained and unconstrained contracts are not identical. When a dealer raises the stated loan amount instead of the interest rate, the borrower’s loan balance starts higher and remains higher until the end of the contract. Borrowers who prepay or default thus owe more to the lender when they terminate the contract. Second, risky borrowers may pay higher prices for credit, as their purchases depend upon financing from automobile sellers rather than a broader, and potentially more competitive, universe of third-party lenders. In an equilibrium with usury limits and dealer financing, therefore, few borrowers are completely excluded from the market, but dealers provide captive financing for a larger share of purchases and borrowers that receive dealer financing face different loan terms—lower interest rates, larger loan-to-value ratios, and possibly higher loan payments—than they would in the absence of usury limits (pp. 2-3).

Saturday, 15 April 2017

The problem with "ban the box"

Often even well intentioned policies can have harmful unintended consequences. One such example is the "Ban the box" policies that are becoming more widely implemented in the US. Ban the box is a policy that prohibits employers from asking about criminal records. In the short video below, Amanda Agan (Assistant Professor of Economics at Rutgers University) discusses whether these policies affect racial disparities in the chance of getting a job interview.

Julian Simon's "Almost Practical Solution to Airline Overbooking"

The problem of airline overbooking has made headline over the last week. An obvious question this gives rise to is, how do we deal with the problem?

Timothy Taylor at the Conversable Economist blog gives us this explanation of economist Julian Simon's method for dealing with the problem of overbooking. Simon wrote a short note, "An Almost Practical Solution to Airline Overbooking" (pdf), in the May 1968 issue of the Journal of Transport Economics and Policy.
Here's how Simon described the idea in 1968:
Perhaps the reader has suffered a fit of impotent rage at being told that he could not board an aeroplane for which he held a valid ticket. The explanation is clear, and no angry letter to the president of the airline will rectify the mistake, for mistake it was not. The airline gambles on a certain number of cancellations, and therefore sometimes sells more tickets than there are seats. Naturally there are sometimes more seat claimants than seats.

The solution is simple. All that need happen when there is overbooking is that an airline agent distributes among the ticket-holders an envelope and a bid form, instructing each person to write down the lowest sum of money he is willing to accept in return for waiting for the next flight. The lowest bidder is paid in cash and given a ticket for the next flight. All other passengers board the plane and complete the flight to their destination.

All parties benefit, and no party loses. All passengers either complete their flight or are recompensed by a sum which they value more than the immediate completion of the flight. And the airlines could also gain, because they would be able to overbook to a higher degree than at present, and hence fly their planes closer to seat capacity. ...

But of course this scheme will not be taken up by the airlines. Why? Their first response will probably be "The administrative difficulties would be too great". The reader may judge this for himself. Next they will suggest that the scheme will not increase net revenue. But the a priori arguments to the contrary make the scheme worth a trial, and the trial would cost practically nothing and would require no commitment.

What are the real reasons why this scheme will not be adopted? Probably that "It just isn't done", because such an auction does not seem decorous; it smacks of the pushcart rather than the one price store; it is "embarrassing" and "crass", i.e., frankly commercial, like "being in trade" in Victorian England.
It does seem better than beating people up and dragging them off planes.

When business loves regulation

From NPR's Plant Money comes this audio on

A few years ago, Jestina Clayton started a hair braiding business in her home in Centerville, Utah. The business let her stay home with her kids, and in good months, she made enough to pay for groceries. She even put an ad on a local website. Then one day she got an email from a stranger who had seen the ad.

"It is illegal in the state of Utah to do any form of extensions without a valid cosmetology license," the email read. "Please delete your ad, or you will be reported."

To get a license, Jestina would have to spend more than a year in cosmetology school. Tuition would cost $16,000 dollars or more.

On today's show: Why it was illegal to braid hair without a license in Utah. And why hundreds of licensing rules in states all around the country are a disaster for the U.S. economy.
The good news in this story comes in the update at the end.

Thursday, 13 April 2017

Yes, a lot of economists do agree on somethings,

and one of those things is the benefits that immigrants to a country bring. The following is the text of An Open Letter from 1,470 Economists on Immigration (pdf).
Dear Mr. President, Majority Leader McConnell, Minority Leader Schumer, Speaker Ryan, and Minority Leader Pelosi:
The undersigned economists represent a broad swath of political and economic views. Among us are Republicans and Democrats alike. Some of us favor free markets while others have championed for a larger role for government in the economy. But on some issues there is near universal agreement. One such issue concerns the broad economic benefit that immigrants to this country bring.
As Congress and the Administration prepare to revisit our immigration laws, we write to express our broad consensus that immigration is one of America’s significant competitive advantages in the global economy. With the proper and necessary safeguards in place, immigration represents an opportunity rather than a threat to our economy and to American workers. We view the benefits of immigration as myriad:

  • Immigration brings entrepreneurs who start new businesses that hire American workers.
  • Immigration brings young workers who help offset the large-scale retirement of baby boomers.
  • Immigration brings diverse skill sets that keep our workforce flexible, help companies grow, and increase the productivity of American workers.
  • Immigrants are far more likely to work in innovative, job-creating fields such as science,
  • technology, engineering, and math that create life-improving products and drive economic growth.

Immigration undoubtedly has economic costs as well, particularly for Americans in certain industries and Americans with lower levels of educational attainment. But the benefits that immigration brings to society far outweigh their costs, and smart immigration policy could better maximize the benefits of immigration while reducing the costs. We urge Congress to modernize our immigration system in a way that maximizes the opportunity immigration can bring, and reaffirms continuing the rich history of welcoming immigrants to the United States.


Sonny Bill Williams has made the news over the last week for this objection to the BNZ logo on his Blue's jersey. My first reaction to hearing his news was, will he return that part of his salary that the BNZ pays? If the BNZ are the modern day version of the baby-eating Bishop of Bath and Wells then along with covering up the BNZ logo should SBW not, for the sake of consistency, also return whatever part of his salary the bank provides? Where does Williams think the money for his salary comes from if not the sponsors? Money made by charging interest.

At the Stuff website Tony Smith writes,
The practising Muslim issued a statement on Wednesday, saying his objection was "central to my religious beliefs". "As I learn more, and develop a deeper understanding of my faith I am no longer comfortable doing things I used to do. So while a logo on a jersey might seem like a small thing to some people, it is important to me that I do the right thing with regards to my faith and hope that people respect that."
But is this central to his religion? Yesterday I was reading, for other reasons to do with the Islamic approach to the corporation, Timur Kuran's (Professor of Economics and Political Science, and Gorter Family Professor in Islamic Studies at Duke University) book "The Long Divergence: How Islamic Law Held Back the Middle East" when I came across this comment,
In its strict interpretation, classical Islamic law requires every loan, regardless of size or purpose, to be free of interest. The principal justification is that the ban appears in the Quran. What the Quran explicitly prohibits is riba, an ancient Arabian practice whereby the debt of a borrower doubled if he failed to make restitution on time. Riba commonly resulted in confiscation of the borrower's assets, even in his enslavement. In banning the practice, Islam effectively prohibited immiserization and enslavement for debt (Kuran 2011; 144-5).
Sounds all fairly sensible. But then Kuran writes,
It is not self-evident that a ban on riba requires a general and timeless prohibition of interest (Kuran 2011; 145).
Thus how did we get the ban?

A little later Kuran sends a couple of pages (pp. 147-150) explaining how in practice people evaded the interest ban. Clearly interest free loans would diminish lenders incentive to lend. Thus borrowers often compensated their creditors through payments that amounted to interest, if not actually being interest. Kuran goes on to say,
All such firms of casuistry received religious stamps of approval, although the legality of any given form could very across Islam's schools of law (Kuran 2011: 150).
If Kuran is right and interest in general is not prohibited and the prohibition is honoured in the breach then how did Islamic law get from this to the position SBW is taking?

Also one has to ask if we accept SBW's objection to the BNZ logo where does this end? In his Stuff article Smith wants the All Blacks to lodge an objection to the sponsorship by AIG. And this raises the important point, if we accept SBW's objection, what objections to sponsors can be rejected?

If a player has strong environment beliefs can they object to a sponsor on that firm's environmental record? Does the firm pollute waterways? What if a player is a "social justice warrior" can they lodge an objection on the grounds of the social effects of a given firm's actions, say their use of "sweatshops" in other countries? What if someone is an economic nationalist, can they object to a sponsor on the grounds that that firm closed a New Zealand plant and "moved those jobs overseas"? Which objections are acceptable and which are not? And how is the difference to be determined?

Accepting any "conscientious objection" to a sponsor could be seen as opening a real can of worms for future sponsorship deals. If sponsors think they may not get the exposure they thought they would get do they cutback on the amount of money they offer or even pullout of sponsorship deals altogether. Either way this can't be good for professional sport.

  • Kuran, Timur (2011). The Long Divergence: How Islamic Law Held Back the Middle East, Oxford: Oxford University Press.

Tuesday, 11 April 2017

Why do financial institutions exist?

Financial institutions have made the news over the last few day, albeit for very strange reasons. But why, you could ask, do such institutions exist in the first place?

Professor Philip Booth argues the answer is very simple, they reduce transaction costs.
Financial institutions exist to reduce transactions costs. Without them, somebody saving money for a rainy day or for their pension would have to seek out and assess the creditworthiness of a vast number of individuals or companies before lending them money. And, without securities markets and banks providing on-demand deposits, the cost of individuals realising their investments at convenient times would be huge.
That firms exist since they reduce transactions costs is the point made by Ronald Coase way back in 1937. According to Coase we carry out a transaction within a firm when doing so costs less than carrying out that transaction across the market.

Of course this is dependent on technology. As technology changes so does the relative advantage of markets compared to firms. This is just as true in finance as anywhere else. For example:
Peer-to-peer lending radically simplifies the “middle-man” in credit transactions; and other innovations are on their way in finance. In China, 2,000 platforms intermediate £100bn of peer-to-peer lending.
Such changes in technology does mean that it is quite possible that banks will go the way of the dodo. The market may become cheaper than the firm. But it doesn't mean that charging interest will go the same way.

Rise the price, don't beat people up

From Stuff: Man dragged off overbooked United flight by police as fellow passengers look on in horror
Passenger Audra D. Bridges posted the video on Facebook. Her husband, Tyler Bridges, said United offered US$400 (NZ$574) and then US$800 vouchers and a hotel stay for volunteers to give up their seats. When no one volunteered, a United manager came on the plane and announced that passengers would be chosen at random.
I can't help but think the airline has missed the obvious here. The price offered was too low. If you want people to get off the flight then keep raising the price till its worth while for people to get off. Don't beat them up and drag them off the flight. There will be a price at which people will get off.

People will value a seat on a given flight in the same way they value any other good or service, what the airline has to do is workout what that value is. The easiest way is to keep raising the compensation offered until someone takes the offer. That way the passenger is happy, they voluntarily took the offer, and the airline is happy, the required number of people have left the flight. The price mechanism works better than violence. This removes the need to beat passengers up.

Could this get expensive for the airline, yes. But you want it to be expensive. If airlines are to be given the incentive not to remove people from flights then you want removal to be expensive, that way the airline will think twice before getting themselves into a position where they have to do it.

Ninja Economics twittered the new United Airlines setting plan.

Tyler Cowen on complacency, immobility, and stagnation

From David Beckworth’s podcast series, Macro Musings comes this audio of an interview with Tyler Cowen on complacency, immobility, and stagnation.
Tyler Cowen is a professor of economics at George Mason University as well as the general director of the Mercatus Center at George Mason University. He joins the show to discuss his new book, *The Complacent Class: The Self-Defeating Quest for the American Dream.* Tyler argues that restlessness and willingness to take risks have been key traits throughout American history. However, in the last few decades, American society has become more risk-averse. While we may have become more comfortable with less risk-taking, this complacency has led to less innovation and dynamism in the economy. Such stasis is causing economic stagnation and other woes throughout the United States.