Thursday, 11 December 2014

EconTalk for many, many weeks

Thomas Piketty of the Paris School of Economics and author of Capital in the Twenty-First Century talks to Econtalk host Russ Roberts about the book. The conversation covers some of the key empirical findings of the book along with a discussion of their significance.

Martha Nussbaum of the University of Chicago and author of Creating Capabilities talks with EconTalk host Russ Roberts about an alternative to GDP for measuring economic performance at the national level. She is a proponent of the capabilities approach that emphasizes how easily individuals can acquire skills and use them, as well as the capability to live long and enjoy life. Nussbaum argues that government policy should focus on creating capabilities rather than allowing them to emerge through individual choices and civil society.

David Autor of the Massachusetts Institute of Technology talks with EconTalk host Russ Roberts about the future of work and the role that automation and smart machines might play in the workforce. Autor stresses the importance of Michael Polanyi's insight that many of the things we know and understand cannot be easily written down or communicated. Those kinds of tacit knowledge will be difficult for smart machines to access and use. In addition, Autor argues that fundamentally, the gains from machine productivity will accrue to humans. The conversation closes with a discussion of the distributional implications of a world with a vastly larger role for smart machines.

EconTalk host Russ Roberts is interviewed by long-time EconTalk guest Michael Munger about Russ's new book, How Adam Smith Can Change Your Life: An Unexpected Guide to Human Nature and Happiness. Topics discussed include how economists view human motivation and consumer behavior, the role of conscience and self-interest in acts of kindness, and the costs and benefits of judging others. The conversation closes with a discussion of how Smith can help us understand villains in movies.

Luigi Zingales of the University of Chicago's Booth School of Business talks with EconTalk host Russ Roberts about Zingales's essay, "Preventing Economists' Capture." Zingales argues that just as regulators become swayed by the implicit incentives of dealing with industry executives, so too with economists who study business: supporting business interests can be financially and professionally rewarding. Zingales outlines the different ways that economists benefit from supporting business interests and ways that economists might work to prevent that influence or at lease be aware of it.

Robert Solow, Professor Emeritus at Massachusetts Institute of Technology and Nobel Laureate, talks with EconTalk host Russ Roberts about his hugely influential theory of growth and inspiration to create a model that better reflected the stable long-term growth of an economy. Solow contends that capital accumulation cannot explain a significant portion of the economic growth we see. He makes a critical distinction between innovation and technology, and then discusses his views on Milton Friedman and John M. Keynes.

Daron Acemoglu, the Elizabeth and James Killian Professor at the Massachusetts Institute of Technology, talks with EconTalk host Russ Roberts about his new paper co-authored with James Robinson, "The Rise and Fall of General Laws of Capitalism," a critique of Thomas Piketty, Karl Marx, and other thinkers who have tried to explain patterns of data as inevitable "laws" without regard to institutions. Acemoglu and Roberts also discuss labor unions, labor markets, and inequality.

Becky Liddicoat Yamarik, Hospice Palliative Care Physician, talks to EconTalk host Russ Roberts about the joys and challenges of providing care for terminally ill patients. The two discuss the services palliative care provides, how patients make choices about quality of life and when to stop receiving treatment, conflicts of interest between patients and families, and patients' preparedness to make these decisions.

Nobel Laureate Vernon L. Smith of Chapman University talks to EconTalk host Russ Roberts about how Adam Smith's book, The Theory of Moral Sentiments has enriched his understanding of human behavior. He contrasts Adam Smith's vision in Sentiments with the traditional neoclassical models of choice and applies Smith's insights to explain unexpected experimental results from the laboratory.

Emily Oster of the University of Chicago talks with EconTalk host Russ Roberts about why U.S. infant mortality is twice that in Finland and high relative to the rest of the world, given high income levels in the United States. The conversation explores the roles of measurement and definition along with culture to understand the causes of infant mortality in the United States and how it might be improved.

Nick Bostrom of the University of Oxford talks with EconTalk host Russ Roberts about his book, Superintelligence: Paths, Dangers, Strategies. Bostrom argues that when machines exist which dwarf human intelligence they will threaten human existence unless steps are taken now to reduce the risk. The conversation covers the likelihood of the worst scenarios, strategies that might be used to reduce the risk and the implications for labor markets, and human flourishing in a world of superintelligent machines.

James Otteson of Wake Forest University talks to EconTalk host Russ Roberts about his new book, The End of Socialism. Otteson argues that socialism (including what he calls the "socialist inclination") is morally and practically inferior to capitalism. Otteson contrasts socialism and capitalism through the views of G. A. Cohen and Adam Smith. Otteson emphasizes the importance of moral agency and respect for the individual in his defense of capitalism. The conversation also includes a discussion of the deep appeal of the tenets of socialism such as equality and the impulse for top-down planning.

Propriety and Prosperity: Adam Smith

A new collection of essays on Adam Smith has been announced. The following is from Gavin Kennedy at his Adam Smith's Lost Legacy blog:
Propriety and Prosperity

New Studies on the Philosophy of Adam Smith


ISBN 9781137320681

Publication Date December 2014

Palgrave Macmillan

This book is a collection of specially commissioned chapters from philosophers, economists and political scientists, focusing on Adam Smith's two main works Theory of Moral Sentiments and Wealth of Nations. It examines the duality which manifests itself as an apparent contradiction: that is, how does one reconcile the view of human nature expounded in Theory of Moral Sentiments (sympathy and benevolence) and the view of human nature expounded in Wealth of Nations (self-interest)? New work by philosophers has uncovered the complex and nuanced connections between Smith's account of economic and moral motivation. His economic theory has presented conceptual challenges: the famous 'invisible hand' has proved an elusive concept much in need of scrutiny.

'Prosperity' in the title captures the economic side of Smith's thought. 'Propriety' points to his ethics. In recent philosophical scholarship two major shifts have occurred. One is that the originality of Smith's moral theory has been rediscovered and recognised. His account of sympathy is significantly different from Hume's: his idea of the 'impartial spectator' is independent, rich and complex and he is alert to the phenomenon of self-deception. The second shift is that Smith's image as an economic liberal has been drastically revised, reclaiming him from current ideological use in defence of free markets and the minimal state. Smith links economics, politics and ethics through notions of justice and utility in subtle ways that make the labels 'economic liberal' and 'laissez-faire theorist' at best inadequate and at worst misleading.

This collection was put together with a view to bringing Smith to a mainstream philosophy audience while simultaneously informing Smith's traditional constituency (political economy) with philosophically finessed interpretations.

1. Introduction; David F. Hardwick and Leslie Marsh

2. Adam Smith as a Scottish Philosopher; Gordon Graham 

3. Friendship in Commercial Society Revisited: Adam Smith on Commercial Friendship; Spyridon Tegos

4. Adam Smith and French Political Economy: Parallels and Differences; Laurent Dobuzinskis

5. Adam Smith: 18th Century Polymath; Roger Frantz


6. Indulgent Sympathy and the Impartial Spectator; Joshua Rust

7. Adam Smith on Sensory Perception: A Sympathetic Account; Brian Glenney

8. Adam Smith on Sympathy: From Self-Interest to Empathy; Gloria Zúñiga y Postigo

9 . What My Dog Can Do: On the Effect of The Wealth of Nations I.ii.2; Jack Weinstein


10. Metaphor Made Manifest: Taking Seriously Smith's 'Invisible Hand'; Eugene Heath

11. The 'Invisible Hand' Phenomenon in Philosophy and Economics; Gavin Kennedy

12. Instincts and the Invisible Order: The Possibility of Progress; Jonathan B. Wight

13. The Spontaneous Order and the Family; Lauren K. Hall

14. Smith, Justice and the Scope of the Political; Craig Smith

Contributing Authors (In bold: scholars whom I know)
Laurent Dobuzinskis, Simon Fraser University, Canada

Roger Frantz, San Diego State University, USA

Brian Glenney, Gordon College, Massachusetts, USA

Gordon Graham, Princeton Theological Seminary, USA

Lauren K. Hall, Rochester Institute of Technology, USA

David F. Hardwick, The University of British Columbia, Canada

Eugene Heath, State University of New York at New Paltz, USA

Gavin Kennedy Heriot-Watt University, UK

Leslie Marsh, The University of British Columbia, Canada

Joshua Rust, Stetson University, USA

Craig Smith, University of Glasgow, UK

Vernon L. Smith
, Chapman University, USA

Spyridon Tegos, The University of Crete, Greece

Jack Weinstein, University of North Dakota, USA

Jonathan Wight, University of Richmond, USA

Gloria Zúñiga y Postigo, Ashford University, USA
This looks like a very interesting set of essays, but the price!! Demand curves do slope downwards. I sometimes wonder if publishers know this simple fact.

Book award to Foss and Klein

This is from the website of the Society for the Development of Austrian Economics
2014 FEE Prize for the best book in Austrian economics is awarded to Nicolai Foss and Peter G. Klein’s Organizing Entrepreneurial Judgment

Comments read by Virgil Storr, Vice President of the SDAE, during the presentation of the 2014 FEE Prize for the best book in Austrian economics:

In Organizing Entrepreneurial Judgment: A New Approach to the Firm, Nicolai Foss and Peter G. Klein bridge the gap between studies of entrepreneurship and the theory of the firm. Despite both concepts becoming increasingly appreciated and studied by contemporary scholars in economics and management, Foss and Klein show that the existing theoretical and practical literature too often fails to adequately connect these theories. Seeking to correct this failing and drawing on insights from Austrian economics, Foss and Klein examine entrepreneurship as judgment decisions made by management under conditions of uncertainty. They show that these judgments are drivers of the economy and keys to understanding firm performance and organization.

For meaningfully adding to the Austrian literature on entrepreneurship and applying Austrian insights about entrepreneurship to the theory of the firm, the prize committee determined that Organizing Entrepreneurial Judgment: A New Approach to the Firm is deserving of the 2014 FEE Prize for the best book in Austrian Economics.
In a working paper of mine I say this about the Foss and Klein book (footnotes removed),
Foss and Klein 2012

A second recent approach to the firm that doesn't fit well into the Foss, Lando and Thomsen classification, but which also emphasises the entrepreneur, is that of Foss and Klein (2012) (FK). FK see their work as offering a theory of the entrepreneur centred around a combination of Knightian uncertainty and Austrian capital theory. While such a basis places their work outside the conventional theory of the firm, FK see themselves ``not as radical, hostile critics, but as friendly insiders" (Foss and Klein 2012: 248).

To understand the FK theory first consider the one-person firm. For FK it is the incompleteness of markets for judgement that explains why an entrepreneur has to form their own firm. Here ``judgement" refers to business decision making in situations involving Knightian uncertainty, that is, circumstances in which the range of possible future outcomes, let alone the likelihood of any individual outcome, is unknown. Thus decision-making about the future must rely on a kind of understanding that is subjective and tacit, one that can not be parameterised in a set of formal, explicit decision-making rules. But then how can we tell great/poor judgement from good/bad luck? A would-be entrepreneur may not be able to communicate to others just what his ``vision" of a new way to satisfy future consumer desires is in such a manner that other people would be able to assess its economic validity. If the nascent entrepreneur can not verify the nature of his idea then they are unlikely to be able to sell their ``expertise" across the market - as an consultant or advisor - or become an employee of a firm utilising his ``expertise" due to adverse selection/moral hazard problems and thus he will have to form his own firm to commercialise this ``vision". This reasoning for the formation of a firm is not entirely without precedence. Working within a standard property rights framework Rabin (1993) and Brynjolfsson (1994) show that an informed agent may have to set up a firm to benefit from their information for adverse selection and moral hazard reasons respectively. In addition to this the inability to convey his ``vision" to capital markets will limit an entrepreneur's ability borrow to finance the purchase of any non-human assets the entrepreneur requires. This means the the entrepreneur can not be of the Kirznerian penniless type. Non-human assets are important because judgemental decision making is ultimately about the arrangement of the non-human capital that the entrepreneur owns or controls. Capital ownership also strengthens the bargaining position of the entrepreneur relative to other stakeholders and helps ensure the entrepreneur is able to appropriate the rents from his ``vision".

Turning to the multi-person firm FK argue that the need for experimentation with regard to production methods is the underlying reason for the existence of the firm. Given that assets have many dimensions or attributes that only become apparent via use, discovering the best uses for assets or the best combination of assets requires experimenting with the uses of the assets involved. Thus entrepreneurs seek out the least-cost institutional arrangement for experimentation. Using a market contract to coordinate collaborators leaves the entrepreneur open to hold-up, collaborators can threaten to veto any changes in the experimental set-up unless they are granted a greater proportion of the quasi-rents generated by the project. By forming a firm and making the collaborators employees, the entrepreneur gains the right to redefine and reallocate decision rights among the collaborators and to sanction those who do not utilise their rights effectively. This means that the entrepreneur can avoid the haggling and redrafting costs involved in the renegotiation of market contracts. This can make a firm the least-cost institutional arrangement for experimentation.

With regard to the boundaries of the firm, FK argue that when firms are large enough to conduct activities exclusively within its borders - so that no reference to an outside market is possible - the organisation will become less efficient since the entrepreneur will not be able to make rational judgements about resource allocation. When there are no markets for the means of production, there are no monetary prices and thus the entrepreneur will lack the information they need about the relative scarcity of resources to enable them to make rational decisions about resource allocation and whether entrepreneurial profits exists. This implies that as they grow in size, and thus do more internally, firms become less efficient due to the increasing misallocation of resources driven by the lack of market prices. But the boundaries of firms seem to be such that firms stop growing before outside markets for the factors of production are eliminated and market prices become unavailable. So while this idea can explain why one big firm can not produce everything it seems less able to tell us why the boundaries of actual firms are where they are. Real firms seem too small for the lack of outside markets and prices to be driving large efficiencies.

For FK the internal organisation of a firm depends on the dispersion of knowledge within the firm. The entrepreneur will typically lack the information or knowledge to make optimal decisions. So the entrepreneur has to delegate decision-making authority to those who have, at least more of, the necessary information or knowledge. In doing this the firm is able to exploit the locally held knowledge without having to codify it for internal communication or motivating managers to explicitly share their knowledge. But the benefits of delegation in terms of better utilising dispersed knowledge need to be balanced against the costs of delegation such as duplication of effort - due to a lack of coordination of activities, moral hazard, creation of new hold-up problems and incentive alignment.

The things that sets the FK apart from the mainstream is the importance given in their theory to the entrepreneur and that they develop their theory utilising a combination of Knightian uncertainty and Austrian capital theory. But, unlike Spulber (2009), the questions they set out to answer are standard in that they want to explain the existence, boundaries and organisation of the firm.
  • Brynjolfsson, Erik (1994). `Information Assets, Technology, and Organization', Management Science, 40(12): 1645-62.
  • Foss, Nicolai J. and Peter G. Klein (2012). Organizing Entrepreneurial Judgment: A New Approach to the Firm, Cambridge: Cambridge University Press.
  • Rabin, Matthew (1993). `Information and the Control of Productive Assets', Journal of Law, Economics and Organization, 9(1) Spring: 51-76.
  • Spulber, Daniel F. (2009). The Theory of the Firm: Microeconomics with Endogenous Entrepreneurs, Firms, Markets, and Organizations, Cambridge: Cambridge University Press.

Tuesday, 14 October 2014

2014 Nobel Prize in economics: Jean Tirole

A number of people seem more excited by this award than me, see for example, A Fine Theorem, Joshua Gans at Digitopoly and Tyler Cowen at Marginal Revolution. (Peter Klein at Organizations and Markets and Joseph Salerno at the Mises Economics Blog are less excited.)

Cowen does mention Tirole's survey article with Holmstrom on the theory of the firm which is well worth reading even if a few years old now. In a survey paper of mine on the theory of privatisation I say this about a paper by Laffont and Tirole (Jean-Jacques Laffont and Jean Tirole (1991). ‘Privatization and Incentives’, Journal of Law, Economics, & Organization, 7 (Special Issue) [Papers from the Conference on the New Science of Organization, January 1991]: 84-105.):
In the Laffont and Tirole (1991) model a firm is assumed to be producing a public good with a technology that requires investment by the firm’s manager. In the case of a public firm this investment can be diverted by the government to serve social ends. For example, the return on investment in a network could be reduced by the government if it were to allow ex post access to the general population. Such an action may be socially optimal but would expropriate part of the firm’s investment. A rational expectation of such an expropriation would reduce the incentives of a public firm’s manager to make the required investment. For a private firm, the manager’s incentives to invest are better given that both the firm’s owners and the manager are interested in profit maximisation. The cost of private ownership is that the firm must deal with two masters who have conflicting objectives: shareholders wish to maximise profits while the government purses economic efficiency. Both groups have incomplete knowledge about the firm’s cost structure and have to offer incentive schemes to induce the manager to act in accordance with their interests. Obviously the game here is a multi-principal game which dilutes the incentives and yields low-powered managerial incentive schemes and low managerial rents. Each principal fails internalise the effects of contracting on the other principal and provides socially too few incentives to the firm’s management. The added incentive for the managers of a private firm to invest is countered by the low powered managerial incentive schemes that the private firm’s managers face. The net effect of these two insights is ambiguous with regard to the relative cost efficiency of the public and private firms. Laffont and Tirole can not identify conditions under which privatisation is better than state ownership.
Cowen goes on to say,
It’s an excellent and well-deserved pick. One point is that some other economists, such as Oliver Hart and Bengt Holmstrom, may be disappointed they were not joint picks, this would have been the time to give them the prize too, so it seems their chances have gone down.
Hart and Holmstrom's chances may have gone up since they can now be given for their, separate and joint, work on different aspects of the theory of the firm.

Sunday, 28 September 2014

So what's "moral" funding?

From the New Zealand Herald comes this gem,
Research funding from the dairying and soft drink industries could be declined on ethical grounds under proposals being worked through by the University of Canterbury.

The university is in the midst of a wide-ranging debate about ethical research funding - who academics should and shouldn't accept money from, and for what research purpose.

Currently, research funding from the tobacco and armaments industries could be declined.

Some academics have argued that should extend to certain industry-funded alcohol, gambling, dairying, mining and soft drink research.
Who the hell cares who funds research? Surely the issue is the quality of the research, not who funds it. If research is able to be published in peer-reviews journals or books hasn't it meet the standards required of academic research? After all if someone thinks you have said or done something wrong in your paper they can write a response to your work pointing out the error. Such a thing is not unusual.
Others believed there should be no prohibition and that the acceptance of funding should be left to individual moral judgements.
Some sanity after all.

Later we are told,
Professor Sally Casswell, a Massey University public health researcher with a particular focus on alcohol, said she strongly believed research funding should not be accepted from the alcohol industry.
But let me guess, she has no problems whatsoever about researchers taking money from anti-alcohol groups.
Such funding was an attempt by the industry to position itself as a partner in policy research, Professor Casswell said, but only industry-friendly policies were supported.
And of course the anti-alcohol groups support all research on alcohol not just industry-unfriendly work. You may not like the conclusions reached by some research but you should play the ball not the man.

Eric Crampton makes good sense on this issue:
However, Dr Eric Crampton, head of research at the NZ Initiative think-tank, said industry-funded research could be extremely valuable, so long as funding arrangements were disclosed and unethical behaviour could be censured.

Dr Crampton previously worked at the University of Canterbury's economics department and was frequently critical of research on the societal harm from alcohol.

He maintains an adjunct senior fellow position with the department.

One-fifth of his university position was funded through a grant from the Brewers Association of Australia and New Zealand, he said, "and everything that I did was totally up for anybody to look at or comment on, or censure me if I was behaving badly".

"It is distortionary to automatically believe that industry funding is bad and evil and that government money comes with no strings and no agenda."
Yes indeed. All research money comes with strings attached, that's why you judge research not on the source of funding but on the quality of the output produced. Unless, of course, you want to make sure your views are the only ones heard.

Friday, 19 September 2014

The Economics of World War I. 4

Another in the series of posts from The Economics of World War I at
Endowments for war in 1914
Avner Offer 19 September 2014
Victory in World War I relied on three types of energy: renewable energy for food and fodder, fossil energy, and high explosive. This column argues that the Allies had a clear advantage in manpower, coal, and agriculture, but not enough for a quick decision. Mobilisation in continental economies curtailed food production, occasionally to a critical level. Technical competition was a matter of capacity for innovation, not of particular breakthroughs. Coercive military service and rationing of scarce energy and food had egalitarian consequences that continued after the war.

Tuesday, 16 September 2014

EconTalk this week

Elizabeth Green, author of the new book Building a Better Teacher: How Teaching Works (and How to Teach it to Anyone), talks with EconTalk host Russ Roberts about the art of teaching and the history of various reforms, mostly failed, trying to improve teaching in America. Specific topics include the theoretical focus of undergraduate education programs and various techniques being used in charter schools and elsewhere to improve teaching performance.

A direct link to the audio is available here.

Monday, 15 September 2014

This is simply a bad idea: Labour's asset buying fund.

From the Stuff website comes this news:
Labour is promising to create a new national asset buying fund, giving at least $100 million a year to help raise local ownership.

In the last major policy announcement before Saturday's election, leader David Cunliffe revealed the details of his planned sovereign wealth fund, NZ Inc.
Although Cunliffe said the fund would target strategic assets - such as port infrastructure or dairy processing plants - or invest in renewable energy companies, he agreed it could also buy farms or shares in privatised electricity companies.

Labour has said it would not rule out buying back the state assets partially sold in the current term, and the fund appears to be an attempt to court New Zealand First leader Winston Peters into coalition.

Peters has named foreign ownership as a key priority for coalition talks, promising a "buy back" programme of farmland during a speech in Tauranga this week.
While there are problems with the National government's partial "privatisation" policy (more on this below) the answer to these problems isn't to buy back the bits of the firms sold but rather to sell 100% of those SOEs. Also the government is very bad at picking winners to invest in. In addition xenophobia isn't a basis for determining what to invest in.

Why do we want  government ownership? If foreign ownership means a more efficient use of an asset then we want that asset to be in foreign hands. We get a more efficient, and wealthier, economy. If, on the other hand, "local ownership" is more efficient then local private investors will be able to buy and utilise the asset. to our advantage Thus there are either good efficiency reasons for foreign ownership or local ownership will occur without government ownership being necessary. Either way its not clear why we want government ownership.

The fundamental question to be asked is Where is the boundary between what activities the government should carryout and those the private sector should carryout? Insight into this question is provided in Hart, Shleifer and Vishny (1997). Here the issue examined is when should the government carryout production "in-house" and when should it contract out the production of a good or service. In this paper information problems are not the driving force of the analysis of contracting out. The provider of a service, either public or private, can invest his time in improving the quality of the service or reducing the cost of the service. Here quality has a broad interpretation. It can stand for how well prisons treat prisoners, how clean utilities keep the water, how well schools educate their pupils, how long it takes for a letter to reach a remote area or how innovative car makers are etc. The important assumption is that investments in cost reduction have negative effects on quality. Investments are non-contractible ex ante. For the case where the provider is a government employee he must obtain approval from the government to implement any innovation he has created. Given that the government has residual rights the employee will gain only a fraction of return on his investment. This gives him weak incentives to innovate. If the service provider in an independent contractor, i.e. the service has been contracted out, then he will have stronger incentives to both cut costs and improve quality. This is because he keeps the returns to his investment. The downside to private provision is that the incentives to cut costs are strong and the provider does not fully internalise the negative effects on quality of the reductions in cost. With public provision the incentive for excessive cost cutting are reduced as are the incentive for innovation and quality improvements. Costs are always lower under private ownership but quality may be higher or lower under a private owner. Hart, Shleifer and Vishny argue that the case for public provision is generally stronger when (i) non-contractible cost reductions have large deleterious effects on quality; (ii) quality innovations are unimportant; (iii) corruption in government procurement is a severe problem. On the other hand their argument suggests that the case for privatisation is stronger when (i) quality-reducing cost reductions can be controlled through contract or competition; (ii) quality innovations are important; (iii) patronage and powerful unions are a severe problem inside the government.

Hart, Shleifer and Vishny apply this analysis to several government activities using the available evidence on the importance of various factors. They conclude that the case for in-house provision is very strong in such services as the conduct of foreign policy and maintenance of police and armed forces, but can also be made reasonably persuasively for prisons. In contrast, the case for privatisation is strong in such activities as garbage collection and weapons production, but can also be made reasonably persuasively for schools.

So what assets does Labour think are "strategic"and thus should be used to produce in-house? And what is a "strategic asset" anyway? The term has no meaning within economics.

Its not clear that the government's past interventions have been in areas where the Hart, Shleifer and Vishny arguments would suggest the government should be involved. Banking, for example, is not a area where cost reduction come at the expense of quality, where innovation is unimportant or where there are any problem with government procurement. So why have the government owning a bank? Also government involvement in Air New Zealand is hard to justify on these grounds. As noted above, the case for private sector provision is stronger when quality reducing cost reduction can be controlled through competition, and the airline industry is very competitive, when quality innovations are important, and we want a high quality and innovative airline industry, and when patronage and powerful unions are a severe problem inside the government, which are things we wish to avoid with an airline. Here private provision makes sense.

So what will be invested in, and how will the assets be picked? And why should the government be involved in these businesses in the first place?

And what of governments, or their agents, picking winners? Some years ago economist Tim Harford had a piece up at in which he tries to unravel why governments so unerringly back losers. Harford points out that "[i]f you want to dismay an economist, just mention the phrase "national champion."" On hearing such a phrase economists automatically think of "wheezing corporate behemoths protected from domestic competition, propped up with generous government subsidies and shielded behind trade barriers." I suspect that the expression "strategic asset" would have much the same affect on economists. Not a pretty picture, it has loser written all over it. So, asks Harford, if governments want to back winners, Why are they so good at backing losers?. He answers,
Partly, it's because picking the winners is inherently a difficult job. Left alone, the market does a great job of rewarding the very best and cutting the rest down to size. Any corporation that gets big and stays big in a competitive environment is likely to be very good at what it does. A corporation that stays big only because of government backing probably won't be.
He then goes on to explain that government favouritism may have a somewhat more sinister logic behind it,
Namely, firms in emerging, competitive industries have virtually no incentive to lobby for government hand-outs, while firms in aging, shrinking industries have the most to gain.
The reason for this is simple he says,
Firms in an open, competitive, growing young industry have little to gain from government support. More government funding for, say, biotechnology, is going to mean more biotechnology companies, more competition and (perhaps) more innovation. That might be good for America, but probably not much good for any single biotech company. Sure, they'll all enjoy the government help, but each must weigh that assistance against the swarm of new competitors attracted by the handouts. No one firm would choose to hire top lobbyists and send them to D.C. to bring back the pork.

By contrast, firms in aging, shrinking, capital-intensive industries have everything to gain from government support. Because the industry is shrinking and it's expensive to enter--think steel mills--the government subsidies and tax breaks are probably not going to attract new competitors. If there are no new competitors, the old guard gets to pocket all the money.
D R Myddelton looked at a related question in his recent book They Meant Well: Government Project Disasters. In this work, published by the Institute of Economic Affairs in London, Myddelton asks How is it that so many major, government-sponsored projects can lose so much money? He points out that the the answer to this question does not lie with malign intentions on behalf of their promoters in government. On the contrary the supporters within government of such projects only have the best of motives, so why do these projects go so wrong?

Myddelton considers six projects covering a period of 80 years to find answers. He looks at The R. 101 airship, the groundnut scheme, nuclear power, Concorde, the channel tunnel and the infamous Millennium Dome. A recurring rationale for these grandiose projects has been to boost "national prestige", but this concept has little real value.

Myddelton's explanation for the continual failure of such projects is that failure results from mismanagement, lack of clear lines of responsibility and lack of accountability. The point is made that
[n]one of the six projects was well managed and many of the failures were down to politicians: installing inadequate or over-complex organisations, appointing incompetent managers, or insisting on excessive secrecy.
These problems have their roots in the wider economic problems of undertaking quasi-commercial ventures in the public, rather than in the private, sector. This results, argues Myddelton, in well-meaning politicians and government officials wasting huge sums of taxpayers' money.

The arguments of both Harford and Myddelton should make us apprehensive when governments start talking of "national champions" or "strategic assets" and starting want to back these notions with our money. Odds are things will end badly.

Folsom and Folsom (2014) looks at the history of government investments in the U.S. covering everything from beaver pelts to railroads to green energy, and again things ended badly.

In short, there are good reasons for thinking the government, or its agents, will pick losers rather than winners.

To return to the point made at the beginning that there are problems with the current government's policy of selling 49% of SOEs. To see the problems note that most of the privatisation programmes enacted around the world - including New Zealand, as well as the general political debates that have surrounded the sale of state assets, have taken place with little or no reference to the economic theory of privatisation. Taking a look at the literature on the contemporary incomplete contracts approach to privatisation we can conclude a number of things several of which are directly applicable to the 49% sale programme of the New Zealand government.

First, one of the most important results is what can be interpreted as ``existence results" that show that even in a world of totally benevolent governments privatisation can still be optimal. Secondly, it can be reasonably argued that the practice of selling less than 51% of an SOE does not constitute privatisation. Under such a plan the state remains the primary force responsible for deciding the outputs (and possibly the inputs) of the firm, rather than the market. This means that programmes such as the recent policy by the New Zealand government of selling just 49% of SOEs is not genuine privatisation. The results flowing from the papers utilising the British definition of privatisation implicitly assume that full control is transferred to the private sector. Thirdly some of the results above suggest that the government is involved in areas of the economy where private provision is more efficient. Sectors of the economy like banking, mining and airlines are examples of areas where innovation is likely to be important and competition can deal with any deleterious effects on quality, which suggests that public provision is less likely to be welfare enhancing. See the discussion of the Hart, Shleifer and Vishny paper above. Fourthly, a firm's ownership can depend on its investment requirements since different ownership structures result in different patterns of investment and thus depending on the desired nature of investments different forms of ownership can be optimal. Fifthly, an important driver of several of the results presented above is the degree to which politicians can interfere, ex post, with the operations of the firm. The lower the cost of interference the greater the likelihood of firms being induced to serve political rather than economic ends. This highlights the importance of post-privatisation regulation, and competition, to the outcome of an asset sales programme. Sixth there is an implicit assumption in the literature discussed above that economic efficiency is a major objective of privatisation but the, ex ante, conditions sometimes imposed by governments on the sale of assets often serve political rather than economic ends. Examples of such conditions are things like the New Zealand governments restrictions on foreign ownership and the desire to sell to ``Mums and Dads" which restricts the number of possible bidders. Such conditions also result in fragmented ownership making it difficult for owners to coordinate their efforts to effect the firm's behaviour. In addition given that each ``Mum or Dad" will own only a very small share of any of the firms, they have little incentive to become informed on the firm's activities since they will only capture a very small amount of any improvement in performance they could bring about. These factors suggest that in practice little will change in terms of the behaviour of the SOEs, they will remain, for all intents and purposes, government controlled entities. This contradicts the very reason for privatising SOEs in the first place.

The answer to the problems with the National government's asset sales programme is not a buy-back plan like that being suggested by Labour but rather the opposite: the sale of 100% of the SOEs in question.

  • Folsom Jr., Burton W. and Anita Folsoms (2014). Uncle Sam Can't Count: A History of Failed Government Investments, from Beaver Pelts to Green Energy, New York: Broadside Books.
  • Hart, Oliver D., Andrei Shleifer and Robert W. Vishny (1997). `The Proper Scope of Government: Theory and an Application to Prisons', Quarterly Journal of Economics, 112(4) November: 1127-61.

Saturday, 13 September 2014

How did the west get so rich?

In this audio Deirdre McCloskey is interviewed on the Tom Woods Show. Deirdre McCloskey, author of The Bourgeois Virtues, among many other books, discusses the real reason for why west got rich and why the traditional explanations fail.