Luther: Further Arguments on Government Regulation

Playing devils advocate, Ryan makes a case for government regulation. He claims that regulation can be beneficial when time inconsistency is inherent in the situation and feedback mechanisms are slow. Simply put, government can acquire information that individuals cannot and, therefore, can pass regulations that are in the actual best interests of individuals.

Ryan is correct to point out that there are "a number of unknown effects caused by everyday products we encounter throughout our normal lives." However, the solution he suggests makes several bold assumptions.

1. Government is more capable of acquiring information (specifically when there is a delay between choices and consequences) than individuals.
2. Once this information is acquired, government regulation is the best way of dealing with the problem.
3. Government officials are guided explicitly by what is best for individuals as a whole rather than what is best for themselves.

I am skeptical. I'll say that #1 is possible, but unlikely. I am just not convinced that a centralized bureaucracy is better at gathering information than decentralized market participants. It seems to me, though, that the argument for regulation falls apart at #2. If the market is superior in cases where accurate information is available, why not just collect and publish the relevant information? Why is it necessary to mandate (via regulation) how people should act with respect to that information? It is one thing to say that individuals make bad decisions because they do not have enough information. It is quite another to say that even in the face of information they continue to make bad decisions. I doubt politicians are better equipped than I am to make decisions regarding what is best for me. So give me the information (which I will discount accordingly) and let me decide.

So if publishing information is a better solution than regulating, why is it that government officials often choose to regulate? The answer concerns #3. Government officials are primarily guided by their own interests. In some cases, this refers to their own financial interests. They pander to a rentseeking minority at the expense of the majority in exchange for campaign contributions or under-the-table compensation. In other cases, this refers to their own psychic interests. They think you should live your life a certain way and will use the force of law to see to it that you do.

Now that sounds more like the regulation I see in the real world.

A slightly more technical response is under the fold.
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It is important to draw out another assumption Ryan implicitly makes. It is not merely that individuals have little information on the outcomes associated with a particular choice (Ryan uses salt and I will do the same). If it were, some would underestimate the harmful effects of salt while others overestimate. The amount of information would affect the variance but not the mean of the distribution of beliefs people hold about the effects of salt and, accordingly, the decisions they make regarding how much salt to consume. What is necessary, then, is a systematic bias to underestimate the harmful effects of salt. Maybe they are not forward looking enough. The specific reason is not too important in and of itself, so long as a reason exists.

Suppose that individuals are systematically biased to underestimate the harmful effects of salt. Can government improve upon this situation? Again, I am skeptical. It seems unlikely that those individuals in government (particularly in democracies) are exempt from the biases that plague the populace.

Interesting lines that spur my interest...

So far only Denmark has taken the radical step of indexing the pensionable age to life expectancy.

Say what you will about Scandinavian countries and their take on the government's role in the economy and its results-- and there's quite a lot to talk about-- but perhaps it is a greater reliance on the public sector that allows for more ingenuity in public programs? Does an economy more dependent on the private sector relegate itself to a more vanilla public sector?

That quote is from this week's Economist, in the intro to this week's section on ageing.

Terry Tate, Office Linebacker

Came across this classic economics lesson in monitoring and the principle-agent problem:

Professor Goes to Prison

I suspect his new colleagues will not be impressed with his CV:

OHN BZDIL, III, who worked as the Manager of the Pediatric Neurosciences Department of the Neurological Institute at Columbia University, was sentenced today by United States District Judge SIDNEY H. STEIN to 15 months in prison for defrauding Columbia of more than $180,000.

[He] submitted reimbursement requests to Columbia for spinal muscular atrophy studies purportedly performed by a medical professional affiliated with Columbia. In fact, the studies were never performed....submitted reimbursement requests for various items purchased from Amazon.com for his personal use... [and] also submitted reimbursement requests for expenses incurred at the Skytop Lodge, in Skytop, Pennsylvania, in connection with his wedding.

Ordinary Economics

As Emily mentioned earlier and Steve at TAE mentions today, I have a working paper with Pete Boettke on the recent financial crisis. The paper will be included in Steve Kates' edited volume The Meltdown of the World Economy: Alternative Perspectives on the Global Financial Crisis, published by Edward Elgar. It is also a part of the Mercatus Center Financial Markets Working Group.

Here's the punchline:

The financial fiasco that has followed the bursting of the housing bubble is not a consequence of market instability, but the inability of government to engage in apt intervention. Politicians presume they have the necessary knowledge to effectively tackle the problems that, ironically, they brought about. In reality, they do not possess this knowledge. They cannot possess this knowledge. This knowledge is dispersed throughout society, with each market participant holding information of a particular time and place that is often unknown to others and, in some respects, impossible to articulate. Even if politicians were capable of collecting the necessary knowledge—and, to reiterate, they are not—that knowledge would be outdated before it could be used. We live in a dynamic world where things are constantly in flux. And, to the dismay of politicians, the instantaneous collection of knowledge by one entity—which would be required for apt intervention—is beyond the realm of possibility. Breaking down the institutional structures of an economy to engage in apt intervention when it is impossible to aptly accomplish what is intended ends predictably in catastrophe.

Since we at TPS revel in shameless self-promotion, I'll throw up a link and suggest you read the whole article.

Ryan: Further Arguments on Government Regulation

Last week, Justin played devil's advocate with regards to government regulation. We here at TPS enjoyed the exchange that followed, so now it's my turn to step up to the plate, suppress the gag reflex and play the role of government supporter.

So here it goes...

Typically, when we think of harmful products hurting consumers, we describe a feedback mechanism that allows the market to correct the problem. A good example is when a restaurant doesn’t practice proper food preparation practices; as a result, food gets contaminated and makes people sick. This isn’t a problem because people aren’t going to a restaurant repeatedly that makes people sick, the restaurant will lose money, and there will be no more tainted food offered to the public. Problem solved.

But what if there’s a time inconsistency inherent in the situation? Let’s take the specific example of salt. Salt had a tremendous impact on society for years; in the past, it was used to keep meat edible longer, and therefore had great value. And while its preservation qualities are not as highly demanded as before, it is still (arguably) the most widely used spice in the world today. Salt has the unique quality of bringing out the flavor of other flavors, so no matter what you’re cooking, you’d be hard pressed to find a meal that couldn’t benefit from a little salt. Ceteris paribus, if you had the choice between two dishes, you’d likely choose the one with salt. This leads to the market result of salted dishes winning out in the competition game.

The problem is, eating a lot of salt isn’t the best for your health. It’s connected to a range of health problems (the specifics aren't important, though the list is here) that take years, if not decades, to experience. Many of these ailments are serious medical problems. Just as important, many of these effects are nonreversible.

With or without public health care, this is a problem. There exists no quick feedback mechanism in the market to help rectify this situation. Furthermore, since the process of feedback is particularly slow, without active medical research into the effects of salt, the problem is likely to linger, not unlike the situation of lead being used for pipes in the Roman Empire.

Granted, we know about salt, so its use here is just for example. However, there are certainly a number of unknown effects caused by everyday products we encounter throughout our normal lives. It is therefore the role of the government to actively search out goods that could have potentially harmful effects through medical research and, further, to remedy these harms via protective regulation.

What do you think?

Top 10 Best-Selling Albums of All Time

I love lists and rankings; here are the best selling LPs of all time. The margin by which Thriller leads is astounding. I had thought Rumours was higher on the list. Phantom of the Opera surprised me. Interestingly, only 6 of the 11 are traditional albums.

Fat, White Women with Low Self-Esteem Earn Less

NBER working paper finds that there is a wage penalty for being obese for both black and white women. According to the paper, "men's wages are not impacted by their body weight". The study examines the effect of obesity on self-esteem and finds that self-esteem impacts wages for whites (both men and women). The results of this study find that that obesity has the most serious impact on white women's wages, because of both the direct negative effect of obesity on wage and the indirect effect on self-esteem.

In other words, fat black people incur a wage penalty for obesity but not for "feeling bad" about being fat. Black people's change in self-confidence as a result of obesity does not economically affect their wage. White people, especially women, experience a wage penalty for being fat and for the effects being fat have on self-esteem.

We've still got a way to go

I've been having fun this morning with a website called "What Does the Internet Think?". It gives you a percentage of (un)-favorable internet hits on the subject you search. It's enjoyable for a few minutes-- most of your friend's names won't come up unless they're connected with someone else more well known (guilty). Then I did the following searches:

Adolf Hitler: 97.3% negative / 2.7% positive
Che Guevara: 0.2% negative / 99.8% positive

Kind of puts a damper on things, doesn't it?

Human Action: Chapters 12-15

Summaries for chapters 12, 13, 14, and 15 are available from the Mises Institute.

As usual, I will post some quotes in hopes of sparking conversation in the comment section.

Page 216:

The “materialism” of the stock exchange and of business accountancy does not hinder anybody from living up to the standards of Thomas a Kempis or from dying for a noble cause. The fact that the masses prefer detective stories to poetry and that it therefore pays better to write the former than the latter, is not caused by the use of money and monetary accounting. It is not the fault of money that there are gangsters, thieves, murderers, prostitutes, corruptible officials and judges. It is not true that honesty does not “pay.” It pays for those who prefer fidelity to what they consider to be right to the advantages which they could derive from a different attitude.

Page 219:

Shortcomings in the governments’ handling of monetary matters and the disastrous consequences of policies aimed at lowering the rate of interest and at encouraging business activities through credit expansion gave birth to the ideas which finally generated the slogan “stabilization.” One can explain its emergence and its popular appeal, one can understand it as the fruit of the last hundred and fifty years’ history of currency and banking, one can, as it were, plead extenuating circumstances for the error involved. But no such sympathetic appreciation can render its fallacies any more tenable.

Page 224:

The endeavors to expand the quantity of money in circulation either in order to increase the government’s capacity to spend or in order to bring about a temporary lowering of the rate of interest disintegrate all currency matters and derange economic calculation. The first aim of monetary policy must be to prevent governments from embarking upon inflation and from creating conditions which encourage credit expansion on the part of banks. But this program is very different from the confused and self-contradictory program of stabilizing purchasing power.

Page 240:

In his capacity as a businessman a man is a servant of the consumers, bound to comply with their wishes. He cannot indulge in his own whims and fancies. But his customers’ whims and fancies are for him ultimate law, provided these customers are ready to pay for them. He is under the necessity of adjusting his conduct to the demand of the consumers. If the consumers, without a taste for the beautiful, prefer things ugly and vulgar, he must, contrary to his own convictions, supply them with such things.

Page 258:

The market is not a place, a thing, or a collective entity. The market is a process, actuated by the interplay of the actions of the various individuals cooperating under the division of labor.

Page 279:

Yet such mentally and economically self-sufficient individuals or families, roaming about the country, were only free as long as they did not run into a stronger fellow’s way. In the pitiless biological competition the stronger was always right, and the weaker was left no choice except unconditional surrender. Primitive man was certainly not born free.

Page 282:

The essential task of government is defense of the social system not only against domestic gangsters but also against external foes. He who in our age opposes armaments and conscription is, perhaps unbeknown to himself, an abettor of those aiming at the enslavement of all.

Next Friday, we will cover chapter 16.

A Potpouri of Bests This Week

1. Productivity-Enhancing Dynamic Bibliography Software
   
2. Picture & Caption Combo
3. Field Trip
4. RV Park Makeover
5. An Otherwise Lost Memory circa 2003
   
6. New HBO Series

Courteous driving survey

With a claim like this, I just had to delve a bit deeper to see exactly what they did.

Evidently Portland has the most courteous drivers in America, snagging the title from Pittsburgh, last year's winner. Here's a summary of the report. The research methodology states the following:

"Prince Market Research, an independent marketing research company, was commissioned to conduct a nationally representative telephone study with consumers in 25 major metropolitan areas in the U.S. to learn more about consumer views on road rage."

Ahh, nothing like drawing conclusions based on phone surveys *cough*CardandKrueger*cough*.

Let's assume the claims put forth by the study are of merit; what could be the determinants of a city containing more or less courteous drivers?

1. I don't think overall time spent in the car matters, but time spent in traffic probably does, and in a negative way. I'd define traffic as a period of time where you're driving a certain amount of speed or percentage of speed lower than expected.

2. Independent of traffic issues, I'd say the slower average speed on the commute (i.e. freeway vs. surface streets) would lead to more aggressive driving, as shortcut attempts increase. Percent gains on travel time would be greater with behind the wheel entrepreneurship on a slow speed commute.

3. Higher income areas would have higher opportunity costs of being in the car, and hence may be more aggressive in trying to get to their destination faster.

4. 3 begs the question of whether commute time is a function of driving style; I'd say it probably is, though that would be pretty tough to isolate. I'd love to see a study on this. (Not by telephone.)

5. Previous experiences in driving create a feedback cycle on aggressive driving; expecting aggressive driving leads to more proactive aggressive driving.

What else is there?

Ultimately, is courteous driving a cause of and an effect of traffic conditions? I could be convinced of the former within legitimate evidence, and latter is probably true.

As an aside, there are two things about Pittsburgh driving that constantly confound me. First, people are prone to slowing and waiting for an opening on interstate traffic as opposed to merging. It's my general opinion that going slower is probably not the best option when entering a roadway where cars are going faster. Just throwing it out there. Yes, I'm aware that some places have stop signs that mandate this; we're talking where there's an open choice and plenty of room.

The second is that cars will stop at a green light and oncoming traffic to make left-hand turns in front of them. The spontaneous order of driving works well because people can coordinate around common procedures; one of them is right-of-way. This throws a wrench into the whole process. Courteous? Perhaps. Beneficial in the long run? I don't happen to think so.

Foxworthy on workplace behavior

Skimming through a Larry King/Jeff Foxworthy interview, I found this quote from the comedian on the incentives for-- and results from-- hard work:

"You don't really want to get fired; you want to have a job. But you don't want to do it well, because you're going to be promoted, and that's a lot of pressure. Who can have any fun with that kind of anvil hanging over your head?"

Sounds like Jeff experienced a pricing problem during his days at IBM!

Ross: Why Government Should Have Regulatory Powers II

First Post Here. In it, I play the Devil's Advocate and argue some regulations are ex-ante forms of protection of property rights. Two examples I use are mandating liability auto insurance and not regulating against the construction of private nuclear reactors.

Matt provides a good response here.

My response to Justin Ross the Devil's Advocate (JRDA) of regulation is "with all the concern over property rights, you forgot the economics!" Let's start with the example of mandating auto liability insurance as a form of ex-ante property right enforcement. In a world without such a mandate, what are the incentives? What are the trade-offs?

Put yourselves in the shoes of just such a person, who understands that he may not be compensated for damage in collisions where the other party is at fault. Their incentive is…to voluntarily buy insurance against it. Compared to a world of mandatory liability insurance, we will have a greater amount of full coverage purchased. Now, you would implicitly be selling your possible future claim against the perpetrator to the insurance company in exchange for guaranteed compensation.

JRDA: "But wait, you haven't corrected the externality! Uninsured drivers are shifting their costs onto the more responsible drivers, incentivizing them to buy more insurance than they otherwise would."

Okay, but this is simply a transfer, is it not? Instead of him buying liability you are now buying protection, and this is only as true to the extent at which they would buy more protection insurance than they would in the mandated world. After all, the world where liability insurance is mandated does not ensure 100% compliance, so there will still be uninsured drivers incentivizing the more risk-averse drivers to buy protection insurance against them. All we have done by dropping the mandate is affect the perception of risk in exchange for the opportunity for everyone involved to choose their own risk-reward structure. As Matt pointed out, the mandated world changes the drivers who run the risk of large property damages to a certainty of some smaller property damage, coercing some in the process.

Now, the private nuclear reactor example.

In one sense this is easier to defuse on the grounds of reality (why would anyone ever do that?) but harder to do in principle. In reality, people build nuclear reactors for the benefit of others, which entail large fixed costs. The only way to recover that cost is to build a reactor that will operate safely and long enough for you to recover those costs. In principle though, what if someone wanted to build a private nuclear reactor? My imagination can only see this playing out in a handful of ways.

One of the observable consequences of a person building their own personal nuclear reactor would be a swift decrease in the value of property. If this did not happen, then it would be because nobody would have issues with private nuclear reactors and hence there would be no reason to regulate it. Most likely, it would decrease the value of property, significantly.

I think that it would most likely be viewed by the legal system as a form of coercion. What is your neighbor the reactor owner doing? He is discouraging others from trading (property) with you out of fear for their safety. If you discourage others from trading by encouraging them to trade with you via competition, there is no problem. If you discourage others from trading by threatening them with physical harm, it is coercion. That form of coercion is reserved for government use only, so due compensation or restraint is in order. The private owner could probably get those reduced if they submitted to providing some proof that they were being sufficiently safe.

Ultimately, the private nuclear reactor forces us to think carefully about what constitutes theft and violence toward property, i.e. that we clearly define property rights.

Ryan: Why Government Should Have Regulatory Powers

(This is in response to Justin's original post.)

The idea of regulation helping mitigate a large scale failure in the ex-post protection of property rights is an interesting argument, but also realize that it’s not fundamentally different from the wide-ranging argument for regulation in the first place—namely, to improve upon market outcomes. The range of markets need not be narrow, either—labor markets (minimum wages, OSHA), financial markets (SEC, FDIC), toys market (child safety measures). We don’t like the fact that labor market outcomes could involve someone making a sufficiently low wage; therefore, we impose a minimum wage. We don’t like the fact that someone could get hurt at work; therefore, OSHA regulations. And so on and so forth.

People don’t generally speak of it in probability terms—at least not the things I’m reading—but I think that actually makes the argument for regulation a bit harder to make. I see it this way; there’s a probability that something drastic could happen, perhaps a hurricane impacting insurance contracts, or on a smaller level, a car wreck. (It needn’t be insurance related, though both of those examples are—perhaps you drank a bit too much, inflicted grave harm upon someone and you can’t pay a court-ordered restitution. The specifics of the examples aren’t the issue.) By extension, the probability of bad events happening translates to the probability that property rights will be compromised. Presumably, that probability is less than 1—and I’ll go a step further and assume it’s a lot less than 1.

But consider the solution—in exchange for our situation of a probability of infringing property rights being less than one, we’re incorporating a solution where the probability of compromising property rights is exactly 1. Imposing regulation at the outset necessarily infringes upon everyone's property rights. If the goal is to respect and reinforce property rights, regulation cuts immediately and significantly against that end. Requiring everyone to purchase liability insurance infringes on the property rights of every driver (whether they would have purchased said insurance anyway, it should be noted)—in the ex-post example above, we have property right infringement only in the case of a calamity.

Now, naturally, there is an argument of degrees here, and maybe the devil’s in the details here. We can see where the discussion goes. But, again, if the goal is to protect property rights, I could think of no worse stance to take from the onset than harming every single person’s property rights through regulation.

Justin, I appreciate the stance—next time, it’s my turn to play devil’s advocate! I think I may have an idea once this one runs its course—and giving the characteristics of summer blogging, that may be sooner rather than later.

Ross: Why Government Should Have Regulatory Powers

We're going to try something a little different for this TPS Discussion. I'm going to play devil's advocate and argue in favor of allowing governments to have regulatory authority over individual actions. Regular readers know this is generally against the grain for me, but I promise to put my best foot forward in debate with my fellow TPSers, no intentional straw men here. Here goes nothing:

To have a meaningful system of private property rights serve as the basis of an economy, they must have legal protection. As Gwartney et al (2008, p.33) puts it:

Legal protection against invasion from other individuals who would seek to use or abuse the property without the owner's permission.

Legal protection in common law typically deals with ex-post violations of property rights. If I damage your property, I am required to pay due compensation and perhaps face criminal charges (including negligence). Similarly, if we engage in a voluntary transaction, if I fail to come through on the terms of agreement I may be subject to similar civil or criminal charges. This incentivizes others to consider the wishes of others when choosing their action. It's okay to drink alcohol, but if you wind up hurting someone under the influence you will be punished. Legal protection dramatically increases the effectiveness of private property rights to create the incentives for efficient markets.

So we agree if people engage in behavior that damages others after the fact, is there any behavior that one might engage in that would have a high enough probability of damaging others that we would want to ban or regulate it ex-ante, if for no other reason than to provide confidence in others of the protection of their property? A few examples:

1. We mandate drivers purchase liability auto insurance, and driving without it is punishable even if you cause no harm. In the case of an accident, it is relatively easy for an at-fault driver to cause far more damage than they would be capable of compensating the damaged owners. Anyone can easily cause several hundred thousand dollars in damage, yet very few of us could repay a debt like that, and at the very least the legal claims of compensation would carry little credibility.
   
2. In cases of an institutional failure to adequately provide ex-post legal protection of property, ex-ante protection is a second best solution. For instance, we do not allow people to build nuclear reactors for their own private use. If something were to go wrong, there is no credible compensatory mechanism for those who are damaged. Until one is devised, regulations must do.
   

Not all regulations are property rights protection, but we don't fault markets for not achieving nirvana status, so we should afford regulations the same respect.

There you have it TPSers! Am I wrong? Why am I wrong?

Follow Up:
Matt Responds

HEA: Plato is a fascist

Schumpeter (1954: 55-56) -

"...Plato's influence is obvious in many communist schemes of later ages, there is little point in labeling him a communist or socialist or a forerunner of later communists or socialists. Creations of such force and splendor [The Republic] defy classification and must be understood in their uniqueness, if at all. The same objection precludes attempts to claim him as a fascist. But if we do insist on forcing him into a strait jacket of our own making, the fascist strait jacket seems to fit somewhat better than the communist one: Plato's 'constitution' does not exclude private property except on the highest level of the purest ideal; at the same time it enforces a strict regulation of individual life, including limitation of individual wealth and severe restrictions upon freedom of speech; it is essentially 'corporative'; and it recognizes the necessity of a classe dirigente - features that go far toward defining fascism."

Do some masterpieces defy classification? Moreover is this irrelevant because the nature and manner by which humans perceive the world necessarily involves classification, multiple classifications, and classifications which may overlap and not be mutually exclusive. In other words - we do it anyway. Case in point.

What do you think of the features by which Schumpeter characterizes fascism? The list is missing the obvious role of a strong state military, but the point about the relatively greater amount of allowable private property is well noted. What about the dangers of the "philosopher kings" ideal leading to fascist dictator in practice?

BTW - Schumpeter thinks that Aristotle's "criticism of Plato....is strikingly unfair and, moreover, misconceives completely the nature and meaning of Plato's creation" (1954: 59). Despite the fact that "the arguments he [Aristotle] adduced for private property and the family and against communism were all the more successful..." (1954: 59).

Collabrative Learning and a Luxurious Approach to the Mind of Schumpeter

There are various ways one goes about reading a text and even more ways to learn and digest material. I have a general technique involving a mechanical pencil and a set of markings I have developed to indicate various ideas and reactions as I move through the pages. Underlining sentences of importance, to give an obvious example.

When I read books that I have borrowed from others, I notice their system. I have adapted my approach once or twice in response to what I have learned. For instance, after seeing how Gordon Tullock marked the pages of texts he was reading by sliding his pencil off the page such that a marking was left on the fore edge of the book, I gave it a try. I can only assume this made it easy to flip through and see where you thought the important parts and notations were. I have since discarded this method - it doesn't seem to work well for me and the way in which my memory serves me. One technique I have adopted concerns a specific notation for identifying when an author states a definition; something I picked up from a fellow TPS blogger.

Don Lavoie was interested in the various methods by which people come to learn and understand -- curious about the role technology can play in coordinating knowledge. He worked on various projects inside the classroom and with the Program on Social & Organizational Learning during his time at George Mason University. In short, his ideas focused on the dialogue process that takes place between an author and the reader and the differences in conversation that take place with written word and verbal discussion. He experimented with his students using hypertext technology whereby different readers could mark a text, allowing various readers to engage with the text -- asking questions, posing challenges in margins, highlighting etc. Lavoie called this process collaborative learning.

I think there are collaborative learning aspects to blogging and I would like to try an experiment. I am currently reading Schumpeter's History of Economic Analysis for "summer enjoyment reading" (ie it is not directly related to any of my current working papers). I would like to blog my reading of this book and have thought about how I would do it. What one must first know about HEA is that the text is roughly 1200 pages, with endless footnotes in what could only be 6pt font. Moreover, the footnotes are where the action is, so they are not to be skipped over lightly. The book covers everything from Plato and Aristotle right up to contemporary economics around the time of Schumpeter's death in 1950.

The text is amazing and the story of its creation is incredible. Written over the course of a lifetime, the book was only in manuscript when Schumpeter passed. His wife edited the completed version (also dieing shortly after). Much of the text was in handwritten form, with several revised versions, no page numbers, and written in multiple languages. Put it this way: the Editor's Introduction reads like a bibliophile's romance novel.

After much consideration, I have decided to blog this book unsystematically. In other words, I will not summarize chapters or post consistently. I will however, post interesting ideas and claims that Schumpeter makes in the text. I may also post beautifully crafted sentences, as I believe Schumpeter to be one of the best writers economics has ever had. I will post my own thoughts on passages or related questions. I will be happy to elaborate on particular themes and will grant reasonable reader requests as I move slowly through the text. For all posts, I will include citations to the Oxford University Press 1954 Edition.

I have chosen to approach History of Economic Analysis in this manner for several reasons. First, the book is a work of art. A theme I will touch on in future posts. Second, it would be highly inefficient to attempt to summarize the chapters. Third, Schumpeter does make stimulating, concise claims that are provocative for discussion. The first reason is strictly utility enhancing for me, but for the third reason I hope that the readers of TPS chime into the discussion in the comments section. My hope is that there will be some positive amount of "collaborative learning" going on as I make my way through the book.

The Myth of "Made in China"

From Foreign Policy:

Since the economic crisis began, China's exports have dropped significantly, but the impact on its GDP growth, oddly, appears muted. What's going on? Given the low share of domestic value added in China's exports, the Chinese economy's true dependence on exports is only half as large as the headline trade data would lead one to believe. The pain of a reduction in China's exports is shared with other economies that supply components, such as Japan, Korea, Taiwan, Singapore and Hong Kong. For example, for every iPod that the United States decides not to import, the "decline" in recorded exports from China is $150 -- but only about $4 of that value was added in China. In other words, China's GDP declines just $4 for each lost $150 iPod. Japan, on the other hand, contributes about $100 to the $150 value and takes the far bigger GDP hit from "China's" decline in exports.

Is the Skyhook a Free Lunch?

From ESPN:

O'Neal calls the skyhook "one of the most effective shots" in the history of the game, which makes you wonder why he never adopted it himself.

"My father made me shoot it all the time," O'Neal said. "Being a hip-hop kid, I didn't want to do it.

"We're different. We like to be a lot cooler."

Abdul-Jabbar concedes "it's not a macho shot," and realized it was going out of style even when he first learned it in the 1950s. But he doesn't understand the reluctance of the modern-day player to incorporate it into his game.

"I used it to become the leading scorer in the history of the NBA," Abdul-Jabbar said. "There has to be something about it that works."

Policy is never so bad that it can't get worse

Want to know the sad part about this? I'm truly, honestly surprised that there isn't a provision in here that stipulates you get more money, or maybe only get money, if you buy an American car.

Though I love the following line:

The program lasts either one year or until the funding runs out.

If the federal government hasn't run out of funding yet, it's not going to happen for a good long while.

If this passes, or looks to pass through the Senate, we should expect to see a price spike in the used car markets for those varieties eligible for the rebate.

Efficient Financial Market Hypothesis

Over at ThinkMarkets, Mario Rizzo has a great exposition of what the efficient market hypothesis means in financial markets. As he puts it, the financial crisis is not a result of mortgage backed securities, credit-default swaps, or new financial instruments, per se -- but rather a result of a poor institutional context.

The argument relies on first making the point that markets work because of arbitragers (at the very least) -- implying that entrepreneurial action is necessary to discover what types of information are relevant and to whom. Without a grasp on how new information becomes injected into a competitive market, it becomes harder to understand the causes of the financial crisis. First, arbitragers and entrepreneurs must perceive profitable opportunities. Second, the ability to then act on those perceptions of profit is dependent on the incentives they face in assuming risk or acting under conditions of uncertainty.

Fed low interest rate policy set up counter-corrective incentives, encouraging investment in assets which did not reflect the true relative prices of those mortgages. It should also be noted that this was compounded by the regulatory and legislative environment, not assuaged by it (ie - Neighborhood Reinvestment Act etc). In terms of the market complications associated with the lattice work of the credit-default swaps and other novel instruments -- there are reasons to believe that it wasn't that market players failed to perceive such problems. Instead, the incentives to act on those perceptions were exceptionally weak. As Rizzo puts it:

"Most financial players realized that there was, as they thought, some extremely small probability that the highly leveraged complex of securities could blow up. But why worry about that? Under those circumstances bailouts would be highly likely, perhaps certain. That certainly was a good bet given recent events. And from this point on, it will be an even better bet."

In other words, the necessary incentives for a "well working" error correction mechanism are institutionally dependent and in this case were eroded by Federal Reserve actions and regulatory environment that encourages people to write checks they can't cash.

Rizzo began the post by mentioning that the NYT column that calls the EMH into question. I think its worth talking the relationship between the discussion of economics in the popular press and the discussion of ideas that take place in journals. For the popular press to suggest that the EMH is empirically no longer relevant opens up the discussion to various different avenues. Does the popular press get the theory right? Does the popular press ask the empirically relevant questions? Does the popular press understand the relationship between models and empirics? These questions spark debate among economists, much less between economists and non-economists.

Rizzo's post highlights an Austrian interpretation of the EMH, suggesting that a strict interpretation leaves the ideas of Keynes and Thaler much more attractive. Is the route to better everyday economics found in revising the common understanding of what efficiency in the market looks like?

On a related note, TPS blogger Will Luther has a paper coming out with Peter Boettke on the importance of ordinary economics in extraordinary financial times. A working paper version will hopefully be posted soon!

Becker and Posner on health care

Becker and Posner have had a nice conversation on health care; for those of you who, like myself, find the issue almost burdensome to become educated about, it's a nice jumping off point. I particularly like Becker's easy dismissal of looking at life expectancy as a metric for health care success, as well as the alternative of looking at disease survival rates. I would also agree with his implyied assertion that the best solution, in terms of solutions that might actually see the light of political day, would be some sort of health savings account, which aligns the proper incentives for economization on the demand side and efificiency on the supply side.

By the lofty standards provided by Becker and Posner, we here at TPS have quite a way to go with our "discusssions" threads!

File this under...voting outcomes you don't get in America

One of the lessons of winner-take-all American democracy is that extreme candidates don't have much of a chance. After all, if we stick to the median voter model, those that gravitate towards the middle have the most success. The median voter model, of course, misses a number of significant nuances of the American political process, but considering its simplicity, it's pretty descriptive of the goings on here, and is still a great jumping off point.

Now, the model describes American politics-- remember, winner-takes-all. What happens with proportional representative, i.e., a parliamentary system? Well, extreme parties can end up with some seats in the legislature. Extreme parties like the Pirate Party in big parliaments like the European Union.

Here's the Pirate Party's home page, and here are the Pirate Party's Declaration of Principles. I'm searching for some Pirate Party swag because this is a party I think I can get on-board with-- pardon the pun.

The real question, of course: Should Pete Leeson fill the seat?

Addendum: Here's the Pirate Party USA site.

Human Action: Chapters 8-11

Summaries for chapters 8, 9, 10, and 11 are available from the Mises Institute.
From page 182:

It is true that these programs are often recommended by reference to divine institutions, to the eternal laws of the universe, to the natural order, to the inevitable trend of historical evolution, and to other objects of transcendent knowledge. But such statements are merely incidental adornment.

From page 193 (and one of my favorite quotes thus far):

In calling a rise in the masses’ standard of living progress and improvement, economists do not espouse a mean materialism. They simply establish the fact that people are motivated by the urge to improve the material conditions of their existence. They judge policies from the point of view of the aims men want to attain. He who disdains the fall in infant mortality and the gradual disappearance of famines and plagues may cast the first stone upon the materialism of the economists. (emphasis added)

From page 202:

A serious blunder that owes its origin and its tenacity to a misinterpretation of this imaginary construction was the assumption that the medium of exchange is a neutral factor only. According to this opinion the only difference between direct and indirect exchange was that only in the latter was a medium of exchange used. The interpolation of money into the transaction, it was asserted, did not affect the main features of the business. One did not ignore the fact that in the course of history tremendous alterations in the purchasing power of money have occurred and that these fluctuations often convulsed the whole system of exchange. But it was believed that such events were exceptional facts caused by inappropriate policies. Only “bad” money, it was said, can bring about such disarrangements. In addition people misunderstood the causes and effects of these disturbances. They tacitly assumed that changes in purchasing power occur with regard to all goods and services at the same time and to the same extent. This is, of course, what the fable of money’s neutrality implies. The whole theory of catallactics, it was held, can be elaborated under the assumption that there is direct exchange only. If this is once achieved, the only thing to be added is the “simple” insertion of money terms into the complex of theorems concerning direct exchange. However, this final completion of the catallactic system was considered of minor importance only. It was not believed that it could alter anything essential in the structure of economic teachings. The main task of economics was conceived as the study of direct exchange. What remained to be done besides this was at best only a scrutiny of the problems of “bad” money.

I really like how Mises sets this up. In my opinion, the Austrian Business Cycle Theory is one of the strongest contributions made by Austrian scholars. Here, Mises explains why what the Austrians find so obvious has been largely overlooked by economists. I wonder if this is a bit of a straw man, however. Mises, writing in 1949, knows that money matters to a whole host of economists. In the traditional Keynesian framework, for example, monetary policy has a real effect on the economy. Of course, it might be fair to read Mises as saying money has been overlooked for so long and only recently--as in the last few decades--have economists started to question the real effects of money.

Maybe the more important question, though, is whether economists TODAY believe money matters. Money certainly mattered in the original Lucas Island model, where individuals (dubbed island dwellers) only observe nominal changes. However, Lucas eventually rejected this idea when rational expectations were incorporated. Similarly, money matters for New Keynesians who point to menu costs. I am sure we will talk more about the ABCT in the future. My question for now is this: If a random sample of economists were surveyed, what percent would say that money is neutral?

God bless Wal-Mart

Wal-Mart is pressing onwards!

I love stories like this-- they provide great barbs when people try to argue that Wal-Mart is anything other than one of the world's leaders in making people better off. Their support of the minimum wage is a great example, too-- and un-rebuttable (yes, I just made that word up), as anyone schooled in economics enough to explain why their minimum wage stance is a bad thing (considering the vast majority of wages they pay are above minimum wage) is similarly schooled enough to know that Wal-Mart isn't a bad thing at all.

As I stressed in the previous blog post, however, the debate over Wal-Mart, sadly, doesn't come down to economics. It comes down to:

Person 1: "Wal-Mart is bad! Lou Dobbs told me so!"
You: "But they hired more people when the economy wasn't in great shape."
*Person 1 searches for response, confounded by the apparent contradiction*

or

Person 2: "Wal-Mart is evil! Network news told me so!"
You: "But they support the minimum wage!"
*Person 2 searches for response, confounded by the apparent contradiction*

They're not economic arguments-- not in the least. But policy debate on Wal-Mart doesn't dwell in the land of economics, and if it did, the debate itself would exist for about 5 seconds.

Morgantown taxicabs

A great example of regulation to give in class-- at least in Morgantown-- is that of taxicab regulation. It is nearly impossible to hail a cab in Morgantown, and waiting for an hour or more on a weekend night is a fact of life. One co-blogger and I actually paid an individual we didn't know to give us a ride home one evening. The students know the cab situation so it's a very accessible part of the lecture.

Generally, I like to start with the hypothetical question: How many taxis are there in Morgantown? I was surprised this week when a student immediately replied: "Seven."

I thought it was a joke at first, but sure enough, he knows a taxi driver here in town and the last time he spoke with him, there were exactly seven taxis in Morgantown. As a point of reference, there are about 27,000 students at WVU, a comparable number of non-student residents of the town, and six or seven times a year, 70,000+ people come to watch football games here. After speaking more recently with the taxi driver, he got the update that there are now 11 taxis operating in Morgantown.

It turns out that there are three licenses to operate a taxicab company in Morgantown. Then why do we have only 11 cabs? The same person owns all three licenses-- which fed nicely into the next part of the lecture concerning concentrated vs. dispersed costs and benefits.

West Virginia: Where regulation is a way of life.

Determinants of Right-to-Work laws

I ran across an interesting paper today while reading about an unrelated topic, "The Determinants and Effects of Right-to-Work Laws: A Review of Recent Literature" by William J. Moore. It's from 1998, and the effects part of it doesn't interest me as much, but the determinants part was kind of fun. Poorer states are more likely to adopt right-to-work (RTW) laws, and that's a surprise to me. Typically, unions are a common (at least here in WV) solution to the relative status of poor states, which would make me think that RTW laws would be just that much harder to pass. More urban states are less likely to adopt these laws, and so are non-Southern states. The higher the percentage of female employment increases the chances of passing a RTW law. Education generally doesn't matter.

Right-to-work laws are a hot button topic no matter where or when they get brought up.

Addendum: Sad to hear that Moore passed away in 2006.

Optimal Sports Decisions

I hesitate to say that economic analysis has shed new light on decisions in the sports realm, but I will say that increased statistical analysis has had that effect.

The analysis in baseball has been perhaps most visible. The Bill James-led sabermetrics revolution has brought on-base percentage and OPS (on-base percentage + slugging percentage) into everyday conversation. Moneyball played a large role in making this well known, but the process started prior to its 2004 release. Typical baseball strategy involved bunting and stealing bases; sabermetrics highlighted the deficiencies in assuming this to be the goal at all times. The game is in transition at the time, and I'm eager to see where it goes-- both because of my personal interest in the sport and its possibility for continual evolution. I think where things sit now are not where they will be sitting in a few years; I'm eager to see where it goes next. I think the bunt/steal situation hasn't been flushed out fully-- at least not for public consumption, anyway.

Football's been analyzed statistically as well, though not quite to the extent of baseball, and I'm not certain that many of the recommendations have been incorporated. For example, statistical analysis shows that teams punt too often. And while some teams may choose to go for it on 4th down a bit more often now than, say, 10 or 15 years ago, I do know the estimates for how often they should go for it are still quite diverged from the rates they actually try it.

Basketball is moving down that path of statistical analysis, too. The question here was mainly what to measure; influential (and accurate) statistical analysis depends, naturally, on substantive statistics. There have been some posts at Freakonomics (and possibly Marginal Revolution) concerning this development, and there was also a New York Times article on Shane Battier concering the general trend of more statistics in basketball. I'd expect in the next 10-15 years a similar evolution along the lines of what happened in baseball to happen in basketball-- and given the state of the NBA right now, it couldn't happen soon enough.

All of this was brought about by watching the first two Stanley Cup Finals games over the last two nights. Hockey, it seems to me, has evaded any sort of statistical revolution. I'm not sure that any of the four sports are immune to gains from new insight-- obviously-- and I don't think hockey is immune to statistics either. What advances have been made that I've missed, or what areas could a team improve in order to enhance their chances of winning?

Part of me thinks that teams don't pull their goalie early enough. For the uninitiated, when a team in hockey is losing by one or two goals, they remove their goalie from the ice for an extra attacker to try and make up the difference. (The 1- and 2-goal lead is just my observation; it seems that a 3+ goal margin leads to a team ceding the victory.) Clearly, there's a tradeoff here-- if you pull your goalie, you have an increased chance in scoring (since you have an extra offensive player on the ice), but you also increase your chance in giving up a goal (since, well, you don't have a goalie). Statistical analysis can give some indication of a superior ex ante strategy, albeit through the analysis of ex post outcomes. If your team scores without a goalie, then ex post, it was a wise decision; if your team didn't score, or gave up an additional goal, then it wasn't wise.

The timing of when teams decide to pull their goalies is of interest to me. It would seem to me that the odds of giving up a goal without a goalie as compared to the odds of scoring without a goalie would be independent of the time the team spends without the goalie in net. Given that situation, it would also imply that the odds of giving up a goal were greater than scoring one-- otherwise, teams, in the long run, would score more goals playing the entire game without a goalie. As it sits now, teams generally pull their goalies with 1 minute left in the game if they're losing by 1 goal, 2 minutes if losing by 2 goals-- is this optimal? It just seems to me that a lot of game end without an additional goal one way or the other-- which means that there's probably some marginal adjustment to be made that could improve the welfare of the losing team.

Optimal shift length? Optimal number of lines? I think there's enough market feedback to hone these over time. The goalie issue still piques my interest.