Monday, 6 July 2015

Interesting papers forthcoming in NZEP

New Zealand Economic Papers has some interesting papers due to appear in future issues.

From complete to incomplete (contracts): A survey of the mainstream approach to the theory of privatisation.

Privatisation is a common, yet controversial, policy in many countries around the world, including New Zealand. In this essay, we survey the literature on the theory of privatisation to see what insights it provides to the privatisation debate. We divide the literature into two periods defined by their relationship to the theory of the firm. In the period up to 1990, the literature followed the theory of the firm in using a complete or comprehensive contracting modelling framework. By the end of the 1980s, the ownership neutrality theorems highlighted a major weakness with this approach. The contemporary (post-1990) literature took advantage of incomplete contracting models to explain the difference in the behaviour of state and privately owned firms.

The effects of home heating on asthma: evidence from New Zealand

Andrea Kutinova Menclova and Rachel Susan Webb

New Zealand, along with the USA and Australia, has one of the highest asthma rates among developed countries and previous analyses attribute this partly to insufficient home heating in certain neighbourhoods. International public health and medical studies corroborate this link but strong evidence of causality is lacking. In this paper, we empirically investigate the effect of home heating on hospital asthma admissions using panel data techniques and controlling for endogeneity. The hypothesis that higher electricity prices (via less adequate heating) increase hospital asthma admissions is tested and receives strong empirical support across a number of model specifications and datasets used.

Does stadium construction create jobs and boost incomes? The realised economic impacts of sports facilities in New Zealand

Samuel A. Richardson

Government involvement in facility construction is typically justified on the basis of ex-ante predictions of economic impact resulting from events hosted at the new or upgraded facility. This paper examines the impact of facility construction on construction sector employment and real GDP across 15 New Zealand cities between 1997 and 2009. Results from static and dynamic models indicate that certain types of facilities had short-term (during construction) positive impacts on construction sector employment growth, although only stadium projects generated positive post-construction employment impacts. There is also little in the way of empirical evidence to suggest that new or upgraded facilities had any significant impact on local area real GDP either during or post-construction.

Thursday, 18 June 2015

Cool book and website

There is a cool new book and website available on the work of F. A. Hayek designed for the general reader.

The book is the The Essential Hayek by Donald J. Boudreaux.

The chapters in the book are:
1. How we make sense of an incredibly complex world
2. Knowledge and prices
3. Individual flourishing and spontaneous order
4. The rule of law, freedom, and prosperity
5. Legislation is distinct from law
6. False economic security and the road to serfdom
7. Economic booms and busts
8. The curse of inflation
9. The challenge of living successfully in modern society
10. Ideas have consequences
The website is The Essential Hayek where you can download a free pdf of the whole book, read the chapters of the book and watch short videos which explain the ideas in the book.

Eminent domain (updated)

A couple of days back I downloaded the Kindle version of Ilya Somin new book on the problems with eminent domain, "The Grasping Hand: 'Kelo v. City of New London' and the Limits of Eminent Domain". This has turned out to be very timely given that The Productivity Commission has come up with the most appalling policy idea I have seen in I don't know how long, that is, the idea that there is a potential role for compulsory property acquisition in assembling large-enough land parcels for achieving proper economies of scale in construction of housing as a way of dealing with problems to do with the supply of land for homes.

Fortunately not all of New Zealand is as crazy as the Commission. Eric Crampton makes the case against the Commission's idea in an excellent post over at The Sand Pit blog.

Eric writes
Hold-out problems are the usual justification for use of eminent domain. Suppose that you’re a property owner. You get wind that a big developer is planning something substantial for the neighbourhood – and that it would include your property. If you know that everybody else has sold their rights to the developer, well, you could charge a price that would have you get a pretty substantial chunk of the developer’s profits. Or, suppose you got wind of where the government was planning on putting in a roading project. If you bought up the properties ahead of the government, and if you knew the government didn’t have other options for the route, you could hold the government to ransom for that property. And so the threat of eminent domain expropriation guards against this kind of strategic behaviour that can threaten the viability of beneficial projects.

But is it the only way of solving hold-out problems? And are hold-out problems even the binding constraint here?

I have been a fan of option contracting as a way around hold-out problems. Suppose you’re the same property owner above. The developer comes to you and offers you a deal. The deal is this. He’ll pay you $10,000, right now, for the option to buy your house in a year’s time at a price that looks fair to you. Whether or not he buys the house in a year, you get to keep the $10,000. He says he’s putting together land for a development but he isn’t quite sure where he wants to put it yet – it could be here, it could be someplace else. You can’t tell whether you’d be the hold-out as you neither know whether your neighbours have signed up, nor whether your property would wind up being used anyway. If the developer is clever, he’ll have identified a couple of sites that could work reasonably well for the project and would be buying options over both sites. You can’t do better than taking the $10,000 in hand, if you think the price is fair. If you don’t, the sale would be inefficient anyway.

Hold-out is pretty cheap in an environment with ever-escalating land costs due to stupid zoning rules. You lose nothing by just sitting on the land and waiting for the capital gains. Some developers have told me that, in hindsight, they should never have bothered trying to put housing up in some parts of Auckland – the costs of dealing with Council meant that they’d have earned a much better return by just landbanking rather than developing. But that changes where the other policy recommendations from ProdComm come into play. When far more land can be put to its most productive use, you can’t expect that your little plot will forever appreciate. Another offer to develop might not come because the development will have gone elsewhere.

Is land assembly through option contracting feasible? It worked where I grew up. Manitoba Hydro wanted to put in wind turbines. Before they did the wind mapping, they bought options from all the farmers where they might have wanted to place the turbines. Where they had options over a long enough ribbon of land where the wind turned out to be right, they exercised those options and put up the turbines. Nobody could hold-out because nobody knew where Hydro would want to put the turbines and because there were multiple potential options. Some people didn’t sell Hydro the option because they didn’t think that the price that Hydro was offering for access to the turbine site was worth the hassle it would cause in the field – and fair enough. But in an eminent domain version, every one of them would have been considered a hold-out and forced to sell.

Think about how this eminent domain proposal would pan out in New Zealand practice. ProdComm talks of using it in a Urban Development Agency (UDA) for Master-Planned developments. In practice, that would mean the UDA in partnership with a big developer strong-arming homeowners to sell out, on threat of forced sale, in order to put up a new subdivision or higher-density development.

Think too of all the land assembled under threat of compulsory purchase in Christchurch. How much of that is now in more productive use? Was small owner hold-out the main problem there? Really?

As alternative, the UDA could instead maintain a register of the owners of the fragmented property holdings and pass along option contract offers to the owners, lowering the transactions costs of assembling the land. They could also pass along declined offers to Council, that Council might update its land valuation figures. If you’ve turned down a million dollar offer on a site that’s rated at $500,000, well, the rating is probably too low.
A question I wonder about with eminent domain is, How do you know that a person who is not willing to sell is in fact holding-out? After all a refusal to sell could just mean they value their property more than the price they are being offered. There may be nothing strategic in what they are doing at all. Especially when it comes to homes or businesses. They may just want to live or work where they are. Consider that they could have sold their property for the market price at anytime but they haven't. I would assume this is because they don't think the market price is high enough to compensate them for the loss of the property. So how is forcing them out efficient?

Note: I have changed a number of "hold-ups" to "hold-outs" in the quote from Eric's post just because I'm a pedant!

Update: At the Not PC blog the point is made that the Productivity Commission pisses on property owners while Michael Reddell comments on The Productivity Commission on land supply.

Wednesday, 3 June 2015

The Austrian tradition in economics

From the Free Thoughts series at comes this interview with Professor Peter J. Boettke of George Mason University in which he talks about "The Austrian Tradition in Economics".

Boettke traces the school’s history from Carl Menger through Eugen Böhm-Bawerk and Joseph Schumpeter, Ludwig von Mises, Friedrich Hayek, and Murray Rothbard to contemporary economists such as Israel Kirzner, Vernon Smith, and Mario Rizzo. He explains what Austrian economics does and does not do, and distinguishes between what he calls “mainline” economics and “mainstream” economics.

What distinguishes Austrian economics from other schools of thought in economics? How did the Austrian school come to be known as the free market school?

Sunday, 3 May 2015

Risk aversion and the firm

A bit over a week ago in the comments to a post James asked,
Can I make a request for a topic? Since you're the resident expert on the theory of the firm, can you write something about any work that's been done on risk averse firms? (I.e. in contrast to the standard assumption about risk neutral firms). Does the risk neutrality assumption have any major implications for standard economic theory?
I've been away but now I'm back at home I can attempt a rough answer. Better late than never, I hope.

Back in 1974 when discussing the topic of 'risk, uncertainty, and the firm' Michael Crew wrote,
Like growth theory of the firm, the theory of the firm under uncertainty is not highly developed. Much of it is speculative.
And not much has changed since then, the theory still isn't that well developed. Knightian uncertainty rather than risk has become more important to the modern theories of the firm.

While little has been written on the topic of risk and uncertainty to do with the firm, the amount is not zero. Back in 1970, for example, Lintner wrote a paper in which pricing decisions of the firm are made on a fully rational profit maximising basis subject to risk aversion with respect to the uncertain profits involved. Assume the uncertainty is due to uncertainty to do with demand. It is uncertainty about the quantity that will be sold. Under the assumptions Lintner makes he can show, not surprisingly, that for a given price change the higher the degree of risk aversion the greater is the increase in expected profits profits requires by a firm (decision maker) in order to induce it to accept greater profits uncertainty. Also the effects of risk aversion on price and output are such that prices are lower when (1) the greater the uncertainty and (2) the greater the risk aversion the closer the price gets to marginal cost and thus the further a firms gets from the monopoly outcome. In addition Lintner can show that the greater the uncertainty about sales and volumes and the greater the risk aversion of the decision maker the greater will be the expected quantity sold.

Different forms of uncertainty can deliver different results. If uncertainty is about realised prices, rather than quantities, then Day, Aigner and Smith show that price is set higher than the monopoly outcome, the greater the degree of risk aversion.

Marcus Asplund has a 2002 paper on 'risk-averse firms in oligopoly'. Does risk aversion lead to softer or fiercer competition? This paper provides a framework that accommodates a wide range of alternative assumptions regarding the nature of competition and types of uncertainty. It shows how risk aversion influences firms' best-response strategies. Only in the case of marginal cost uncertainty does higher risk aversion make competition unambiguously softer. The risk-averse best response strategies depend on the level of fixed costs. This fact is used to analyse strategic investments in capacity and the importance of accumulated profits. The paper concludes with a discussion of ways of empirically testing for risk-averse behaviour in oligopoly.

In more modern approaches to the firm the work of Frank Knight on risk and the firm has been developed. The standard view of Knight’s rationale for the existence of the firm doesn't depend on profit, but on risk, or more accurately, risk distribution. The entrepreneur forms a firm as a way of specialising in risk-taking. Employees receive a stipulated income and the entrepreneur takes the residual income of the firm and thereby bears most of the risk associated with uncertainty about the future. The advantage of the firm, according to the standard view, is that there are gains to be made from this distribution of risk between the entrepreneur and the firm’s employees. The profit and loss consequences of fluctuations in the business outcomes can be better absorbed by the entrepreneur than the employees. The entrepreneur contracts to pay a fixed wage to workers, thereby protecting them from the fluctuations in business outcomes. Knight sees this as efficient since the entrepreneur is less averse to bearing risk. Presumably, risk is not handled as well without firms.

Other views of Knight have been put forward in papers by Barzel and McManus. Each puts forward a moral hazard explanation for the Knightian firm. The firm arises here because, for certain kinds of risks, the functions of risk taking and management are inseparable due to the prohibitively high costs of enforcing constraints that would induce one individual, the manager, to maximise the wealth of another, the risk-taker. As noted in the distribution of risk story above, firms are one way of specialising in risk-taking. Knight was aware of contractual and insurance arrangements as alternatives to the firm as ways of specialising in risk-taking but thought, because of the moral hazard problems, they were particularly costly to enforce in the case of risks of enterprise and hence the need for the creation of a firm. Presumably monitoring the manager is easier for the risk-taker in a firm that it is on the market.

In 1991 Holmström and Milgrom made two observations to do with the firm and its (risk-averse) employees. First, they note that there are a number of ways that an employee can spend their time, many of which can be of value to an employer. But if these multiple activities compete for the worker’s attention then the incentives offered for each of the activities must be comparable. Otherwise, the employee will put most effort into those things that are most well compensated and put less effort into the others activities. The second observation relates to the provision of strong incentives to a risk-averse employee. Providing strong financial incentives is costly because it loads extra risk into the worker’s pay. In addition, the cost is greater the more difficult it is to measure performance. This means that, other things being equal, tasks where performance is hard to measure should not be given as intense incentives as ones that are more accurately observed. But having low-powered incentives means that the employer needs to be able to exercise authority over the use of the employee’s time, since the employee will not have the proper incentives to be productive.

The above are all partial equilibrium models but a general equilibrium approach is taken in a 1979 paper by Kihlstrom and Laffont. They construct a theory of competitive equilibrium under uncertainty using an entrepreneurial model with historical roots, again, in the work of Knight in the 1920s. Individuals possess labour which they can supply as workers to a competitive labour market or use as entrepreneurs in running a firm. All entrepreneurs have access to the same risky technology and receive all profits from their firms. In the equilibrium, more risk averse individuals become workers while the less risk averse become entrepreneurs. Less risk averse entrepreneurs run larger firms and economy-wide increases in risk aversion reduce the equilibrium wage. A dynamic process of firm entry and exit is stable. The equilibrium is efficient only if all entrepreneurs are risk neutral. Inefficiencies in the number of firms and in the allocation of labour to firms are traced to inefficiencies in the risk allocation caused by institutional constraints on risk trading. In a second best sense which accounts for these constraints, the equilibrium is efficient.

Well this will make things better .......... not!

Just when you thought things in Venezuela couldn't possibly get any worse, they do. This from Yahoo! News:
Caracas (AFP) - Venezuelan President Nicolas Maduro has promised to nationalize food distribution in the South American nation beset with record shortages of basic goods, runaway inflation and an escalating economic crisis.

During a rally Friday, on International Workers' Day, the socialist leader allowed a union activist to ask for the nationalization of food and essential-item distribution.

Citing new decree-making powers recently granted by the National Assembly, Maduro said he would carry out such a measure "in the coming days and weeks."

Maduro had pledged earlier in the week to announce economic reforms.

Various estimates suggest the government already controls about half of the country's food distribution, but that hasn't stopped record shortages in shops and markets.
Has no one in the Venezuelan government not looked around the world or looked at history and asked, Under what system does food distribution work best. Under a market system being the answer. Just think about the stories of shopping in the old Soviet Union to get the point.
On any given day, people in Venezuela can wait hours to get some subsidized milk, cooking oil, milk or flour -- if they can be found at all.
And does Madura really think nationalising the rest of the food distribution system will help. Market reforms are needed to get the economy going again. What is needed is the use of the price system to allocate resources giving consumers and producers the right incentives and information about scarcities. This would counter the black market and smuggling of goods out of the country.

Friday, 1 May 2015

Does vertical integration decrease prices?

The double marginalization problem is a classic problem with applications in industrial organization, innovation policy and development. The problem is what happens to social welfare, prices, and profits when one monopoly sells to another monopoly. Below is a video discussion of the double marginalization problem by Alex Tabarrok of George Mason University from MRUniveristy,

The double marginalization problem makes the (monopoly) producers worse off as well as making consumers worse off.

Now as noted in the video combining the seller monopoly with the buyer monopoly into one will, in theory, make both the producers and consumers better off. But does it do so in practise? At least as far as consumers are concerned.

This is where a new paper Does Vertical Integration Decrease Prices? Evidence from the Paramount Antitrust Case of 1948 by Ricard Gil in the American Economic Journal: Economic Policy, 2015, 7(2): 162–191, helps us. Gil finds, utilising data from the Paramount antitrust case of 1948, that vertical integration, i.e. combining the two monopolies, does in fact decrease prices, and thus increases consumer welfare, in a manner consistent with the elimination of the double marginalization problem.

The paper's abstract reads:
I empirically examine the impact of the 1948 Paramount antitrust case on ticket prices using a unique dataset collected from Variety magazine issues between 1945 and 1955. With information on prices, revenues, and theater ownership for an unbalanced panel of 393 theaters in 26 cities, I find that vertically integrated theaters charged lower prices and sold more admission tickets than nonintegrated theaters. I also find that the rate at which prices increased in theaters was slower while integrated than after vertical divestiture. These findings together with institutional details are consistent with the prediction that vertical integration lowers prices through the elimination of double marginalization.

Britain's housing crisis

This short video comes from The Economist magazine:

Rocketing prices and limited construction are putting home ownership out of reach for many young Britons. As the election nears, few politicians have a realistic solution.

Obviously the particulars in the video pertain to the situation in the U.K. but the general problems are more universal. Just think of the housing problems in Auckland.

Thursday, 30 April 2015

Pope Francis says it's 'scandalous' that women earn less than men for the same job

From Fox News Latino,
Pope Francis has added his voice to the feminist anthem of equal pay for equal work, saying it's "scandalous" that women earn less than men for doing the same job.

Francis also lambasted the attitude of some who blame the crisis in families on women getting out of the house to work. He says such attitudes are a form of "machismo" that shows how men "want to dominate women."
Francis says husband and wife must be complementary: "We should support with decisiveness the right to equal pay for equal work. Why is it a given that women must earn less than men?"
Good to see him making a stand. After all if there is one job with complete equality of the sexes its that of being Pope!

Peer review in one picture

We all know how this feels

(HT: Organizations and Markets)

Venezuela powers down

Things just keep on getting worse in Venezuela. From the BBC we get this bit of news,
Venezuela says it will cut the working day for public sector workers to five-and-a-half hours to conserve energy, down from eight to nine hours.

The initiative is part of a nationwide electricity rationing plan.

Vice-President Jorge Arreaza said there had been a surge in energy demand due to extremely hot weather. He said state employees would now work from 07:30-13:00 to save on air conditioning.On Monday, local media reported blackouts across the country.

Mr Arreaza said private companies would be asked to use their own generators to reduce pressure on the national grid.

But he said it was private homeowners who consumed the most energy, and he called for everyone to turn the dial down on their air conditioners.

"We are appealing to everyone's conscience, to use energy efficiently."

Last week the government claimed that energy problems were due to maintenance issues, but the opposition criticised the government for not investing enough in the energy sector, BBC Venezuela correspondent Daniel Pardo reports.

Power outages are common in Venezuela, which is a big oil producer but depends heavily on hydro-electric power.
More evidence that command and control equals chaos when implemented at the macro level. Why not let prices adjust to reflect increased demand? Higher prices would give consumers an incentive to reduce quantity demanded while the revenues generated could help provide funds to invest in the energy sector.

Wednesday, 29 April 2015

Harford on inequality

At his blog Tim Harford has been writing on The truth about inequality. He says,
How serious a problem is inequality? And if it is serious, what can be done about it?

Myths abound. Many people seem to believe that Thomas Piketty’s Capital in the Twenty-First Century showed that wealth inequality is at an all-time high; instead, his data show that wealth inequality has risen only slowly since the 1970s, after falling during the 20th century. In Europe we are thankfully nowhere near the wealth inequality of the past.

Another common belief is that the richest 1 per cent of the world’s population own half the world’s wealth (almost true) and that their share is inexorably increasing (not true). The richest 1 per cent had 48.2 per cent of the world’s wealth in the year 2014, according to widely cited research from Credit Suisse, but that share has fallen and risen over the past 15 years. It is lower now than in 2000 and 2001.

Neither is it clear that global inequality is rising. Average incomes in China and India have risen much faster than those in richer countries; this is a powerful push towards equality of income. But inequality within many countries is rising. Research from Branko Milanović, author of The Haves and the Have-Nots, suggests that the two forces have tended to balance out roughly over the past generation.

One final myth is that inequality in the UK has risen since the financial crisis. In fact, it has fallen quite sharply. “Inequality remains significantly lower than in 2007-08,” said the Institute for Fiscal Studies last summer. That conclusion is based on data through April 2013. The IFS did add, though, that “there is good reason to think that the falls in income inequality since 2007-08 are currently being reversed.”
Harford then makes an important point about the need to take income redistribution into account when looking at inequality.
The UK already redistributes income extensively. As Gabriel Zucman of the London School of Economics points out, the UK’s richest fifth had 15 times the pre-tax income of the poorest fifth, but after taxes and benefits they had just four times as much.
I would think that if we were to look at consumption, which to me seems the important thing, the gap between "rich" and "poor" would decrease even more.

Of course there are those who would have the government redistribute even more but my previous post on To eat the rich, first they must stay still should act as a warning as to what could happen when the top income rates are raised.

I would suggest there is one addition question Harford did not ask: Is inequality a problem at all? Only after having answered that question yes should we ask how big the problem is and what can we do about it.