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Archive for the ‘Economics’ Category

At e3ne.org, I have posted some reflections on my last discussion with the Ethics & Economics Challenge students, on the topic of private property rights. The work of Acemoglu, Johnson, and Robinson on how property rights support high levels of development plays a prominent role. Here’s a scatter plot from their famous 2001 paper:

property rights and development

Source: Acemoglu, Johnson, and Robinson (2001)

Economies with greater protection from expropriation have higher per capita incomes. There are plausible reasons to think the relationship is causal. As I note in the post,

If I have a stock of lumber in a warehouse in Oregon, and I hear that a hurricane in New Jersey is causing prices to spike there, I have an incentive to ship lumber there only if I can enjoy the profits of doing so. If the government taxes my profits at 100%, I have no incentive to ship the lumber where it’s needed most. Even if the tax is only 70% or 60%, it reduces my incentives enough that I’m not going to incur a lot of time, effort, and cost to ship the lumber. Similarly, if the government owns the lumber, or no one does, then no one earns the profit from shipping the lumber where it’s needed, and so no one wants to ship the lumber where it’s needed.

Still, private property rights are not sufficient for development:

If private property rights are so great for the economy, why didn’t the economy grow tremendously during the age of classic feudalism, when aristocrats held absolute property rights in their land, and serfs had to work on their estates for low pay? It should be clear that just as prices without property rights do little good, so do property rights without real markets. When a small group of people own vast quantities of land and use their ownership of land to oppress everyone else, you won’t get economic progress. We need private property rights, but they need to be dispersed enough to prevent the biggest property owners from converting their wealth into effectively absolute political power.

For that reason, I’m willing to consider comprehensive redistribution of land in former conquistador states, where owners of the great latifundias work the land inefficiently with hired laborers and convert their market power in the rental market into political power.

The other benefit of private property rights I talked about with the students was environmental. Private property rights can solve the “tragedy of the commons,” whereby people tend to overuse and deplete open-access resources. In that vein, I shared with them this very interesting article on different property regimes in the Maine lobster fishery. Where (communal) property rights are strictly defined and enforced, lobster are not overfished: lobster caught are larger and more mature, and lobstermen earn higher wages.

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This week’s post at e3ne.org is about the miracle of the price system:

Natural disasters harm people’s standard of living by destroying resources, but in a free marketplace, rising prices and profits in scarce goods give both buyers and sellers an incentive to heal the economic wound. Drawn by the possibility of making good profits at high prices, sellers bring the scarce goods to market from afar. Facing high prices, buyers demand less of the scarce goods than they would if prices were not allowed to rise.

For this reason, George Mason University economist Alex Tabarrok calls a price a “signal wrapped up in an incentive”…

Read more.

As it happens, I’ve also assigned this week F.A. Hayek’s article, “The Use of Knowledge in Society,” in my Dartmouth course this term, American Political Economy. Hayek’s article is itself a kind of minor miracle, in that it was published in the world’s top economic journal, The American Economic Review, despite having no equations in it and a grand total of one cited reference.

Hayek’s point is that the free market’s price system aggregates and condenses distributed, particular information unknown to most market actors. No one has to know where all the stocks of a scarce resources are located, and what the relative valuations of that resource are to all possible consumers, for the market to allocate the resource to the highest-valuing users from the lowest-cost producers. A price is a signal wrapped up in an incentive.

At the end of Hayek’s article there is a wee bit of gloating about how he and Mises had persuaded the rest of the profession that economic calculation is impossible without prices. The state of the debate ended as a sort of compromise between the two original positions. The socialists had conceded that economic calculation was impossible without market prices, and the free-marketeers had conceded that, in principle, a decentralized socialist economy could generate market prices.

The problem for even a decentralized socialism is that while it can have price signals, it lacks the virtue of the “incentive” feature of prices. I might know that the price of lumber is high in New Jersey after a hurricane, but if I’m sitting on a warehouse full of lumber in Oregon, I won’t necessarily ship that lumber to New Jersey unless I can reap the extra-normal profits afforded by those high prices. If I’m not the “residual claimant” on the value of the lumber, I might as well send it to my political cronies, or not do anything with it at all, which might be the easiest course of action. Even decentralized socialism with price signals, for instance as attempted in Yugoslavia in the 1970s and 1980s, fails on account of its poor incentives.

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The theory of comparative advantage shows how voluntary exchange benefits both parties and encourages specialization. You don’t need to possess an absolute advantage in any particular productive activity to enjoy a comparative advantage. Your comparative advantage is whatever you can do relatively cheaply compared to everything else and everyone else. For instance, Haiti still trades with the U.S. even though it’s a much poorer economy. The reason is that the U.S. worker focuses on her/his comparative advantage – making stuff like microchips, software, financial services, houses, retail, design, engineering services, accounting services, higher education services, wheat, corn, soybeans, apricots, and airplanes – and leaves other stuff for workers in other countries, like making t-shirts, steel, rubber, bananas, coconuts, furniture, and toys. Haiti, in particular, specializes in making t-shirts. An American worker could probably make more t-shirts than a Haitian one – we have better tools (more capital) – but it doesn’t pay for us to spend our time on that when we could be doing on the things aforementioned. So we buy t-shirts from Haiti instead.

At e3ne.org I have a new post up explaining the theory and offering a short quiz. I’ve copied it below. Feel free to take your shot at the answers in the comments!

1. Imagine you’re the chief executive of a successful information technology business. You rose through the ranks as a graphic designer and are very good at that, but you’re also a good manager and fundraiser. Your task now is to write up an annual report for the shareholders. Should you use your graphic design skills to format an excellent annual report, or should you simply type up the information and delegate the formatting of the report to one of your employees?

2. Imagine the U.S. opens up to imports of clothing from China. What happens to the price of clothing in the U.S. and in China?

3. Does opening up to Chinese clothing affect the quantity of U.S. exports, say, of microchips?

4. Does opening up to Chinese clothing affect the price of microchips in the U.S. and in China?

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The economic thinking behind “buy local” campaigns is typically terrible. One such example is the claim that a dollar “circulates more” when you spend it locally. The rate of circulation of a dollar doesn’t create any wealth. Try it out: circulate a dollar among a group of friends and feel your standard of living stay the same. In general, “buy local” activism commits the broken-window fallacy: ignoring opportunity costs. Spending more on the same product because it’s local means you can’t spend on other things that make you happy. And you are part of the local economy!

At e3ne.org, I have a longer critique of the fallacies behind “buy local” and “buy American” campaigns. An excerpt:

[I]magine that everyone bought local, all the time. Cars, airplanes, software, clothing, food… everything would have to be made and exchanged in the town where you live. What would happen to everyone’s standard of living? It would fall dramatically. (How many skilled airplane manufacturers does your town have?) The same principle applies at the national level, or any other geographic level you choose. If you buy everything within that circumscribed area and exclude everything outside it, your community will be worse off than it would be if it bought from any willing seller.

Now, that’s an extreme example, but it illustrates the principle. Some things are impossible to make locally (airplanes). Other things are difficult and costly to make locally (shipping and retailing of plastic bins). A few things will be most efficiently and affordably made locally, and you will want to buy them locally without having to be goaded into doing so – they’ll simply be the best products for the price. Goading your community into buying shoddier or more costly products just because they’re local or American or whatever just makes your community poorer.

Read more.

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Critics of the President’s State of the Union address noted it did little to promote bipartisanship. Yet, it has already stimulated bipartisan agreement on one of the President’s education proposals.

In the State of the Union, President Obama proposed free community college:

“I am sending this Congress a bold new plan to lower the cost of community college—to zero.

…Whoever you are, this plan is your chance to graduate ready for the new economy, without a load of debt. Understand, you’ve got to earn it—you’ve got to keep your grades up and graduate on time. Tennessee, a state with Republican leadership, and Chicago, a city with Democratic leadership, are showing that free community college is possible. I want to spread that idea all across America, so that two years of college becomes as free and universal in America as high school is today.”

One detail that failed to make it into the State of the Union address: The funding for the program would come by effectively killing the 529 college savings accounts, that exempt earnings from taxation if used for educational expenses.

This fact stimulated bipartisanship, albeit not the kind the President anticipated. As Jonathan Weisman (New York Times) explains:

President Obama, facing angry reprisals from parents and from lawmakers of both parties, will drop his proposal to effectively end the popular college savings accounts known as 529s, but will keep an expanded tuition tax credit at the center of his college access plan, White House officials said Tuesday.

The decision came just hours after Speaker John A. Boehner of Ohio demanded that the proposal be withdrawn from the president’s budget, due out Monday, “for the sake of middle-class families.” But the call for the White House to relent also came from top Democrats, including Representatives Nancy Pelosi of California, the minority leader, and Chris Van Hollen of Maryland, the ranking member of the Budget Committee.

Although this means of funding the community college proposal seemed particularly tone deaf, it does illustrate that bipartisanship is possible when protecting tax expenditures. Imagine if reformers focused on even larger tax expenditures (e.g. the $212 billion exclusion of employer-provided health insurance, the $176 billion expenditures for pensions and 401(k)s, or the $101 billion deduction of mortgage interest)? A new era of bipartisanship might bloom.

Related: See Josh Kraushaar in National Journal for an interesting piece on the SOTU and the implications for Hillary Clinton 2016.

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The Hagedorn, Manovskii, and Mitman working paper on the effect of unemployment insurance (UI) on employment has been getting a lot of press lately. In brief, they find that the end of the federal unemployment insurance extension accounts for about 1.8 million new jobs in 2014.

Mike Konczal does a useful deep dive on the paper here and is very skeptical of the result. In particular, he criticizes as implausible and empirically inaccurate labor market search models that imply employer monopsony power, which are essential to the plausibility of the result. These models are also essential to the revisionist literature on the minimum wage, holding that minimum wage increases do not reduce low-productivity workers’ employment. Curiously, Mike Konczal has defended search models in this aspect. He’s a smart guy and clearly thinks that applications of search theory to macroeconomic variables have problems that the application to the minimum wage doesn’t – but if search theory badly explains one phenomenon, it’s unlikely to do well explaining another. There’s a clear tension between claiming simultaneously that employer monopsony power explains why raising the minimum wage doesn’t reduce employment and that ending UI can’t have increased employment so much because employers don’t have that much monopsony power, even if the latter claim is limited to slack periods in the business cycle. (Why wouldn’t employer monopsony power be greater during slack periods in the business cycle? The Marxist concept of the “reserve army of the unemployed” comes to mind here.)

Another interesting parallel between the UI and minimum wage research is that the famous Dube et al. paper in Review of Economics and Statistics relied heavily on matched-border-county estimates, as does the Hagedorn et al. paper. Having looked at these data, I actually agree with Konczal that these models are inappropriate. The logic behind using matched border counties is that contiguous counties are alike in every relevant way other than the policy discontinuity associated with the state border (say, one county has a high minimum wage and the other does not). But border counties are actually usually quite dissimilar. Take Camden, N.J. and Philadelphia, Penn. These two counties are vastly different in size, so if Camden creates jobs at a higher rate than Philadelphia, Camden’s new jobs might still be a tiny percentage of Philadelphia’s. Yet the Dube/Hagedorn approach considers these counties to be equivalent, and takes the larger percentage increase in jobs for Camden as an indication of superior New Jersey employment policy. (See also David Neumark on empirical evidence that border counties are not appropriate control groups.)

In summary, if you are skeptical of the empirical strategy and theoretical justification of the literature saying the minimum wage has no negative employment effects, you should also be skeptical of the empirical strategy and theoretical justification of the new paper showing that unemployment insurance has big disemployment effects. If you like the Dube et al. minimum wage work, you should like the Hagedorn et al. UI paper. How many wonks are intellectually honest enough to adopt one of these two, ideologically inconvenient pairs of positions?

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Dragnet’s Joe Friday may have never uttered those words, but he would be impressed nonetheless by the facts on crime. There was a fascinating piece by Erik Eckholm in yesterday’s New York Times on the Drop-in-crimedramatic reductions in crime over the past several decades. Overall, crime peaked in 1991 and has fallen steadily since then.

 

All of this leads to the big question: why? Is it a change in tactics (e.g., aggressive policing, the “broken window” theory)? Is it a product of an increase in the costs of criminality (e.g., mandatory sentencing and the decision to keep 1.5 million people in prison)? Is it a product of good economic times? Perhaps it simply reflects demographics (e.g., the aging of the population, the decline in teenage pregnancy)? In the end, law professor Franklin E. Zimring (UC-Berkeley) is quoted as describing the search for an explanation as “criminological astrology.”

 

Max Ehrenfreund (Washington Post Wonkblog) has designated the above “chart of the day” as “something of a Rorschach test. Everyone sees what they want to see in it.” That may be something of an overstatement. Certainly, the advocates of the war on drugs, police militarization, aggressive policing and harsh sentencing laws will view it as evidence that their strategies have worked. They will have the challenge of explaining why similar trends are evident elsewhere, including Canada, that have not embraced the US model. And I am not at all certain of how the Left would make sense of the fact that crime has fallen as inequality has increased.

Will the decline in crime have an impact on public policy? Will it lead to a rethinking of police militarization and mass incarceration? I hold little hope given that public opinion seems immune to the facts.

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Even if crime has fallen dramatically, according to Gallup the majority of Americans in most years on record believe that crime is getting worse. As Gallup observes: “federal crime statistics have not been highly relevant to the public’s crime perceptions in recent years.” A public concerned with crime and (willfully) ignorant of the long-term trends will continue to demand an aggressive police presence. And that demand will be met.

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