The visible hand in economics

Archive for November 2007

So we won’t know whether the Warehouse is going to be sold until the High Court releases the details surrounding its ruling and the Commerce Commission decides whether to appeal.  Ultimately I hope the decision to allow a sale had something to do with the halo effect ;).

Something that did catch my eye is Steven Tindall’s claim that he will act with integrity when selling his shares.  For the life of me I don’t know what the hell he’s talking about.  My guess is that he is going to pretend to sell to the the bidder who offers to keep the community spirit of the Warehouse going.  Although to be fair to the man, he is strongly involved in charity, and I’m sure he’ll keep a stake in the company he spent so long creating.

Can anyone tell me what they think Mr Tindell’s integrity will involve, and do you think this ‘integrity’ will have a price?

The last 6 weeks have shown the New Zealand economy to be tight – but not to tight. Unemployment has fallen to a record low (3.5%), but at the same time the participation rate has fallen and employment growth has fallen to its lowest rate in a few years. Income growth was strong, but not out of control.

The QSBO indicated that capacity utilisation is still high, but not as high as it has been. Consumption imports are rising, but merchant stocks are high and retail sales growth is moderate at best, although off a high level.

House price growth is strong, but slowing. House sales are falling, but the average number of days to sell property remain short, implying that there is little pressure on highly leveraged home owners to sell property.

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Today on the bus the bus driver stopped to tell school kids to stand up. This happens on occasion, and generally the adults on the bus act like they think it is a complete joke. You can here comments like ‘this is ridiculous’ and ‘the bus driver just wants to feel important’ from adults/civil servants lounging around, but ultimately I think the bus drivers understand what is going on better than the group of civil servants on the bus.

Bus drivers are like the government, they are given a certain welfare policy that has to be followed on their bus. Although conditions such as standing up to let frail older people sit down are solved internally in the ‘marketplace’ of the bus, the condition of having all adults sitting while children stand is often violated. Now don’t get me wrong, I’m not saying that the rule is right, ultimately in social welfare terms I think there is no difference between me standing or some 14 year old boy is standing, but this is the rule that the bus driver has to enforce.

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flexible-family.gif

The flexible working hours bill aims to increase the degree of ‘flexibility‘ in the labour market for households with a child under the age of 5 or a disabled child under the age of 18. Now I’ve heard all sorts of complaints and complements about this bill, so I’ll try to talk about the way I see it.

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In the comments Kimble had a great point “long term estimates of the level of the dollar can be heavily influenced by the current level”. Although this may seem like economists being myopic, it has more to do with our extremely limited understanding of how the exchange rate works.

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What do we have here, the Fed has lowered growth and inflation forecasts, Freddie Mac (a US based mortgage finance company – think subprime mortgages) suffered record losses, Citibank and Bank of America struggle with credit concerns, and the MIT real estate center recorded a fall in commercial property prices (and the first fall in commercial property values since 2003). On the back of this, the Fed feels the decision to cut rates again is on a knife-edge, with market sentiment pointing to a fall.

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In a previous post we discussed the Halo effect, and how the Warehouse was trying to claim it was their own idea. Since then, the Halo effect has taken on special importance as Woolworths Ltd (Aus) and Foodstuffs decided to appeal the Commerce Commission’s decision to refuse to let one of these firms buy the Warehouse.

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bizarro.gif

This cartoon tells us a number of things about the situation. Firstly, for Walmart to put this mans firm out of business, Walmart must have been relatively more efficient (ie, its costs were either lower or the value they added to the product was greater). Secondly, it tells us that the person that used to have a firm is worse off than he was when he did have his firm (as he now only makes enough to shop at Walmart, when before he could afford to go to boutique stores).

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We’ve previously blogged about the potential for patent protections to restrict innovation when inventions are sequential. However, Sudipto Bhattacharya and Sergei Guriev suggest on VoxEU that the research we cited by Bessen and Maskin might be misleading. In particular they point out that there is a ‘third way’ that knowledge can be treated.

Rather than patent it or make it public, a firm may choose to simply keep the information private as a trade secret. It can then be licenced to a vendor in return for royalties. Unfortunately, this is less efficient than patents because the vendor will under-invest in development of the technology. Essentially this is because the vendor bears the whole cost of further development but is forced to pay a portion of the revenue generated from that investment to the original inventor in the form of royalties. The authors claim that decreasing patent protections could thus cause more inventions to be kept secret and inefficiently licenced, which reduces total welfare.

As a consequence is that the number of ideas available to firms to develop is probably a concave function of the level of patent protection, with an interior maximum! With no patent protections ideas are kept as trade secrets and handed out under exclusive licences. With full patent protection it is too costly to licence the patent and develop the idea. In both cases the level of innovation will be low. Somewhere in between is the ideal level of intellectual property rights enforcement. So even if innovation is sequential, reducing patent protections has the potential to stifle further invention, although not for the reasons usually cited.

NB. Besson and Maskin’s paper isn’t directly comparable with the Vox paper: the former use complementarities to drive their result while the latter exclude such complementarities and allow for private information. Bhattacharya and Guriev are therefore considering a more general problem than B & M, which is why I describe reliance on the B & M result as misleading: it doesn’t represent the vast majority of industries in which patents are used.

I was just reading the dirty old (note dirty old is a complement from me) Dilbert blog, when I happened upon a post he called Happiness smoothing. Now in this blog post he discusses how individuals choose to interact with people in a way that is inversely related to the persons current success. So if you see a successful person you rip them down, if you see a downtrodden person you help them out (all other things equal). This is similar to tall poppy syndrome and empathy all rolled into one.

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It will come as no surprise to anyone that the RBA lifted its cash rate to 6.75%. Glen Stevens statement was relatively hawkish, noting that underlying inflation would likely leave the target band and stating the growth would need to moderate before inflationary pressures would ease.

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Most debate surrounding climate change focuses on the best method of suppressing demand for carbon intensive technologies. However, as Hans-Werner Sinn points out at VoxEU, reductions in demand for carbon could result in perverse incentives on the supply side. In particular, the suppliers of oil, coal and other non-renewable, carbon rich resources could face an incentive to increase their rate of extraction.

This arises because of the special nature of exhaustible resources: since there is a finite quantity of the resource to make profits from, the extractor tries to sell it when the price is highest. If carbon reduction policies are successful then we should observe declining demand for these resources over time. Decreasing demand will cause prices to fall and, since the extractors of oil can anticipate the price drops, they’ll try to sell as much now as possible. The increase in supply will cause prices to drop straight away which will trigger countries who have not signed up to Kyoto to consume more carbon rich fuels now.

The two ways this could be avoided are to either force the entire world to conform to the same Kyoto-type standards, or to forcibly restrict the supply of carbon rich fuels. Failure to do either of these things could result in global carbon emissions actually rising as momentum builds behind the environmental movement. Sinn thinks that the only way to cope is to invest heavily in afforestation to offset the extra emissions. Given the rate of global deforestation it can only be hoped that political pressure and reputation effects will be enough to prevent cheap oil flooding the world market. Thankfully oil prices show no signs of diving since the advent of the Kyoto protocol. So far at least…

This is why I don’t believe people who claim that overcoming one’s biases isn’t important. David Romer gives a football coach solid evidence that he could win more games by running or passing on fourth down and what happens?

“It used to be that going for it on fourth down was the macho thing to do,” Romer said. But after his findings were widely publicized in sports circles, he said: “Now going for it on fourth down is the egghead thing to do. Would you rather be macho or an egghead?”

Yeah, they STOP running and passing because that would be the ‘geeky’ thing to do! Now that’s an example of a seriously costly bias if ever I heard one.

The article quotes Wayne Stewart, an associate professor of management at Clemson University, describing this as a principal-agent problem: the team owner wants to win games but the coach just wants to avoid risky plays that might make him look bad. Or geeky plays that might get him a ribbing at the bar after the game, apparently.

Cato’s Regulation magazine has a fairly detailed comparison
of cap-and-trade and carbon tax systems in their latest issue. A couple
of commentators have interpreted the article as supporting their preference for a cap-and-trade system. They say that the two greatest benefits of taxes are revenue recycling and price stability but claim that the money could be wasted by the government and so it’s better to set up a permits scheme that mimics the outcome of a tax. I don’t have a problem with their conclusions but I do have a quibble with their assessments of the relative merits of each system.

The root of this issue is the question of how much to trust the government. The biggest problem with carbon regulation schemes is
that they are regressive: the poorest tend to spend the largest proportion of their incomes on energy and are thus disproportionately
penalised (although perhaps not in developing countries). This happens under permit trading and taxation since both schemes essentially seek to raise the price of engaging in carbon intensive activities. A tax scheme raises revenues that can be used to redistribute wealth and offset the regressive nature of the carbon regulation. Permit schemes which involve grandfathering of permits do not raise any revenues and so cannot redistribute the burden of emissions reduction. Schemes which either lease or auction the permit rights should raise the same revenues as a taxation scheme; however, this makes them just as susceptible to the critique about government wastage as taxation. The only way to avoid the potential for pork barrel spending is to accept a scheme that hurts the poor.

The second issue is price stability. The problem with taxes is that it’s difficult to accurately set the tax in the first place, and the same holds true for setting the lease price permits. Of course it can be adjusted later but then one can hardly call price stability a benefit of taxation. On the other hand permits guarantee a reduction in emissions, which is after all the goal of any such regulatory scheme. If the market is fully informed about the number of permits available then it can price the permits based on all the available information. If the market is efficient then the price will accurately reflect the cost of reducing emissions to the target level. An accurate tax will settle at the same level but any error in the government’s calculations will result in either changing taxes or over-pollution.

This really all boils down to how much you trust the government to get things right. Attempting to design a permit scheme that mimics a tax scheme opens it up to the same criticisms that are made against taxes. Either the government is effective and can tax carbon at the right price and redistribute revenues efficiently, or it can’t and should leave things up to the market through a permit scheme but accept that the poor will suffer.

Matt and I recently discussed whether we thought the government should intervene to correct intra-personal externalities that arise from time inconsistency in peoples’ behaviour. We particularly talked about smoking: models of smoking which incorporate hyperbolic discounting predict that people will want to quit in the future but will never be able to quit when the time comes (and here I’ve horribly conflated two different causes of dynamic inconsistency in the interests of simplicity). I wasn’t able to persuade him that it is in the public interest to correct such externalities, but perhaps this paper(NBER) cited on MR provides a harsher example of the consequences of time inconsistency (and, yes, I know I’m horribly mangling together two different causes of dynamic inconsistency).

The authors find that

…women who are the victims of domestic violence often leave and return multiple times. … We present supporting evidence that women in violent relationships display time inconsistent preferences… We find that “no-drop” policies — which compel the prosecutor to continue with prosecution even if the victim expresses a desire to drop the charges — result in an increase in reporting. No-drop policies also result in a decrease in the number of men murdered by intimates suggesting that some women in violent relationships move away from an extreme type of commitment device when a less costly one is offered.

The problem here is that there is no device available to the women that allows them to commit to leaving the relationship and force their ‘future self’ not to return. A no-drop policy on the part of prosecutors gives them that precommitment power and prevents them from reneging on their desire to leave the abusive relationship. By restricting the womens’ future choice set the state can make them better off. I feel bad talking about domestic violence in such dry terminology, but I think this is a really good example of how economic theory can help understand important ‘real world’ problems. Policies such as taxation of smoking and no-drop prosecution of domestic violence are not examples of government interference in peoples’ lives: they are examples of the government helping people to help themselves.


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