Category Archive for: Market Failure [Return to Main]

Sunday, March 23, 2014

On Greg Mankiw's 'Do No Harm'

A rebuttal to Greg Mankiw's claim that the government should not interfere in voluntary exchanges. This is from Rakesh Vohra at Theory of the Leisure Class:

Do No Harm & Minimum Wage: In the March 23rd edition of the NY Times Mankiw proposes a 'do no harm' test for policy makers:

…when people have voluntarily agreed upon an economic arrangement to their mutual benefit, that arrangement should be respected.

There is a qualifier for negative externalities, and he goes on to say:

As a result, when a policy is complex , hard to evaluate and disruptive of private transactions, there is good reason to be skeptical of it.

Minimum wage legislation is offered as an example of a policy that fails the do no harm test. ...

There is an immediate 'heart strings' argument against the test, because indentured servitude passes the 'do no harm' test. ... I want to focus instead on two other aspects of the 'do no harm' principle contained in the words 'voluntarily'and 'benefit'. What is voluntary and benefit compared to what? ...

When parties negotiate to their mutual benefit, it is to their benefit relative to the status quo. When the status quo presents one agent an outside option that is untenable, say starvation, is bargaining voluntary, even if the other agent is not directly threatening starvation? The difficulty with the `do no harm’ principle in policy matters is the assumption that the status quo does less harm than a change in it would. This is not clear to me at all. Let me illustrate this...

Assuming a perfectly competitive market, imposing a minimum wage constraint above the equilibrium wage would reduce total welfare. What if the labor market were not perfectly competitive? In particular, suppose it was a monopsony employer constrained to offer the same wage to everyone employed. Then, imposing a minimum wage above the monopsonist’s optimal wage would increase total welfare.

[There is also an example based upon differences in patience that I left out.]

Thursday, March 06, 2014

'Why DRM'ed Coffee-Pods May be Just the Awful Stupidity We Need'

Speaking of anti-competitive behavior, here's Cory Doctorow:

Why DRM'ed coffee-pods may be just the awful stupidity we need, by Cory Doctorow: I've been thinking about the news that Keurig has added "DRM" to its pod coffee-makers since the story first started doing the rounds a couple of days ago. I've come to the conclusion that while the errand is a foolish one, and the company deserves nothing but contempt for such an anti-competitive move, that there might be a silver lining to this cloud. As I've written recently, there's not a lot of case-law on Section 1201 of the Digital Millennium Copyright Act (DMCA), the law that prohibits "circumventing...effective means of access control" to copyrighted works. In the past, we've seen printer companies and garage door opener manufacturers claim that the software in their devices was a "copyrighted work" and that anyone who made a spare part for their products was thus violating 1201. But that was 10 years ago, and it's been a while since there was someone stupid and greedy enough to try that defense.
I think Keurig might just be that stupid, greedy company. The reason they're adding "DRM" to their coffee pods is that they don't think that they make the obviously best product at the best price, but want to be able to force their customers to buy from them anyway. So when, inevitably, their system is cracked by a competitor who puts better coffee at a lower price into the pods, Keurig strikes me as the kind of company that might just sue. And not only sue, but keep on suing, even after they get their asses handed to them by successive courts. With any luck, they'll make some new appellate-level caselaw in a circuit where there's a lot of startups -- maybe by bringing a case against some spunky Research Triangle types in the Fourth Circuit.
Now, this is risky. Hard cases made bad law. A judge in a circuit where copyright claims are rarely heard might just buy the idea of copyright covering pods of coffee. The rebel forces that Keurig sues might be idiots (remember Aimster?). But of all the DRM Death Stars to be unveiled, Keurig's is a pretty good candidate for Battle Station Most Likely to Have a Convenient Thermal Exhaust Port.

[Boing Boing is licensed under a Creative Commons License permitting non-commercial sharing with attribution.]

'Did Robert Bork Understate the Competitive Impact of Mergers?'

I have argued again and again that we aren't concerned enough about the concentration of economic power:

Did Robert Bork Understate the Competitive Impact of Mergers? Evidence from Consummated Mergers, by Orley C. Ashenfelter, Daniel Hosken, and Matthew C. Weinberg, NBER: In The Antitrust Paradox, Robert Bork viewed most mergers as either competitively neutral or efficiency enhancing. In his view, only mergers creating a dominant firm or monopoly were likely to harm consumers. Bork was especially skeptical of oligopoly concerns resulting from mergers. In this paper, we provide a critique of Bork’s views on merger policy from The Antitrust Paradox. Many of Bork’s recommendations have been implemented over time and have improved merger analysis. Bork’s proposed horizontal merger policy, however, was too permissive. In particular, the empirical record shows that mergers in oligopolistic markets can raise consumer prices.

Friday, February 21, 2014

'What Do Obamacare and the EITC Have in Common with Cap-and-Trade?'

Jeff Frankel has a follow-up to a post I highlighted a few days ago:

What Do Obamacare and the EITC Have in Common with Cap-and-Trade?: My preceding blog post described how market-oriented mechanisms to address environmentally damaging emissions, particularly the cap-and-trade system for SO2 in the United States, have recently been overtaken by less efficient regulatory approaches such as renewables mandates. One reason is that Republicans — who originally were supporters of cap-and-trade — turned against it, even demonized it.
One can draw an interesting analogy between the evolution of Republican political attitudes toward market mechanisms in the area of federal environmental regulation and hostility to the Affordable Care Act, also known as Obamacare. ... One can trace through the parallels between clean air and health care. ... A third example is the Earned-Income Tax Credit. ...

Wednesday, February 19, 2014

'The Rise and Fall of Cap-and-Trade'

Jeff Frankel:

The Rise and Fall of Cap-and-Trade: ...the political tide on both sides of the Atlantic has been against “cap and trade” over the last five years. In the United States, the highly successful trading system for allowances in emissions of SO2 (sulfur dioxide) has all but died since 2012.  In the European Union as well, the Emissions Trading System was in effect overtaken by other kinds of regulation in 2013.
Cap-and-trade was originally considered a Republican idea.  Market-friendly regulation was pushed by those who thought of themselves as pro-market, rather than by those who thought of themselves as pro-regulation.  Most environmental organizations were opposed to the novel approach;  many of them thought it immoral for corporations to be able to pay for the right to pollute. The pioneering use of the cap-and-trade approach to phase out lead from gasoline in the 1980s was a policy of Ronald Reagan’s Administration.  Its successful use to reduce SO2 emissions from power plants in the 1990s was a policy of George H.W. Bush’s administration.  The proposal to use cap-and-trade to reduce SO2 and other emissions further was a policy of George W. Bush’s administration ten years ago under, first, the Clear Skies Act proposed in 2002 and then the Clean Air Interstate Rule of 2005. (See Schmalensee and Stavins, 2013, pp.103-113.) ... Senator John McCain, had sponsored US legislative proposals to use cap-and-trade to address emissions of carbon dioxide and other greenhouse gases responsible for global warming. ...
Republican politicians have now forgotten that this approach was ever their policy.  To defeat the last major climate bill in 2009, they worked themselves into a frenzy of anti-regulation rhetoric.  ... The Republican rhetoric successfully stigmatized cap-and-trade.  Schmalensee and Stavins (p.113) sum it up: “It is ironic that conservatives chose to demonize their own market-based creation.”
This stance left in its place alternative approaches that are less market-friendly (Stavins, 2011)... The non-market alternatives, such as “command and control” regulation requiring that particular energy sources or particular technologies be used, are less efficient.    Nonetheless they are again the dominant regime.   ...
There is nothing inevitable or irreversible about the recent trend away from cap-and-trade.  ... Even in the US, where it began, there is still grounds for hope. ...

Monday, February 17, 2014

Paul Krugman: Barons of Broadband

We should be more worried than we are about monopoly power:

Barons of Broadband , by Paul Krugman, Commentary, NY Times: Last week’s big business news was the announcement that Comcast ... has reached a deal to acquire Time Warner... If regulators approve the deal, Comcast will be an overwhelmingly dominant player in the business...
So let me ask two questions about the proposed deal. First, why would we even think about letting it go through? Second, when and why did we stop worrying about monopoly power?
On the first question, broadband Internet and cable TV are already highly concentrated industries... Comcast perfectly fits the old notion of monopolists as robber barons...
And there are good reasons to believe ... that monopoly power has become a significant drag on the U.S. economy as a whole.
There used to be a bipartisan consensus in favor of tough antitrust enforcement. During the Reagan years, however, antitrust policy went into eclipse, and ever since measures of monopoly power... have been rising fast.
At first, arguments against policing monopoly power pointed to the alleged benefits of mergers in terms of economic efficiency. Later, it became common to assert that the world had changed in ways that made all those old-fashioned concerns about monopoly irrelevant. Aren’t we living in an era of global competition? Doesn’t ... creative destruction ... constantly tear down old industry giants and create new ones?
The truth, however, is that many goods and especially services aren’t subject to international competition: New Jersey families can’t subscribe to Korean broadband. Meanwhile, creative destruction has been oversold: Microsoft may be ... in decline, but it’s still enormously profitable thanks to the monopoly position it established decades ago.
Moreover, there’s good reason to believe that monopoly is itself a barrier to innovation...: why upgrade your network or provide better services when your customers have nowhere to go?
And the same phenomenon may be ... holding back the economy as a whole. One puzzle ... has been the disconnect between profits and investment. Profits are at a record high..., yet corporations aren’t reinvesting their returns in their businesses. Instead, they’re buying back shares, or accumulating huge piles of cash. This is exactly what you’d expect to see if a lot of those record profits represent monopoly rents.
It’s time, in other words, to go back to worrying about monopoly power, which we should have been doing all along. And the first step on the road back from our grand detour on this issue is obvious: Say no to Comcast.

Saturday, February 15, 2014

'Time to Get Real on Comcast-Time Warner'

On the proposed Comcast Time-Warner merger:

Paul Krugman:

Monoposony Begets Monopoly, And Vice Versa: Nothing to see here, folks, says Comcast. The cable giant’s defenders insist that its already awesome market power won’t be increased if it acquires Time Warner, because they serve (i.e., are local monopolists in) different geographical areas...
But elsewhere in the business section, we see clear evidence that this is nonsense. Comcast’s size gives it monopsony as well as monopoly power — it is able to extract far more favorable deals from content providers than smaller rivals. And if it’s allowed to acquire Time Warner, it will be even more advantaged...
This would, in turn, make it even harder for potential competitors to enter markets served by ComcastTimeWarner, strengthening its monopoly position.
What possible justification could there be for approving this scheme?

Joshua Gans:

Time to get real on Comcast-Time Warner, by Joshua Gans: ... with every potential harm to the public benefit is also opportunity. What would happen if, as part of the conditions to approve this merger (a) content assets were divested; and (b) Net Neutrality was enshrined? That may remove more structural impediments to competition and guarantee that this is a long-term win for consumers. It would be nice if someone were to propose that.

In general, I don't think that we pay enough attention to the problems that are associated with market power.

Monday, February 03, 2014

'Silicon Valley Billionaires Believe in the Free Market, as Long as They Benefit'

Dean Baker:

Silicon Valley billionaires believe in the free market, as long as they benefit, by Dean Baker, theguardian.com: Last week, Mark Ames published an article ... on a court case that alleges that Apple, Google, and other Silicon Valley powerhouses actively conspired to keep their workers' wages down. According to documents filed in the case, these companies agreed not to compete for each others' workers dating at least as far back as 2005. ... This means not only that they broke the law, and that they acted to undermine the market, but that they really don't think about the market the way libertarians claim to think about the market. ...

The classic libertarian view of the market is that we have a huge number of people in the market actively competing..., there is so much competition that no individual or company can really hope to have much impact on market outcomes.

This point is central to their argument that the government should not interfere with corporate practices. For example, if we think our local cable company is charging too much..., our libertarian friends will insist that the phone company, satellite television or other competitors will step in to keep prices in line. They would tell the same story if the issue were regulating the airlines, banks, health insurance, or any other sector where there is reason to believe that competition might be limited. ...

The ... Silicon Valley non-compete agreements show that this is not how the tech billionaires believe the market really works. This is just a story they peddle to children and gullible reporters. ... The fact the Silicon Valley honchos took the time to negotiate and presumably enforce these non-compete agreements was because they did not think that there were enough competitors to hire away their workers. They believed that they had enough weight on the buy-side of the market for software engineers ... to ... keep their wages down. ...

Wednesday, January 22, 2014

'The Political Economy of Populism'

Paul Krugman:

A Note on the Political Economy of Populism: All indications are that President Obama will make inequality the central theme of his State of the Union address. Assuming he does, he will face two different kinds of sniping. One will come from the usual suspects on the right, shrieking “class warfare”. The other will come from a variety of people, some of them well-intentioned, arguing that while sure, inequality is an issue, the crucial thing now is to get the economy growing and create more jobs; these people will argue that populism is a diversion from the main issue.
Here’s why they’re wrong.
First of all, even on the straight economics inequality and job creation aren’t completely separable issues. ...
Beyond that, there’s the political economy.
It has been painfully obvious, to anyone willing to see (a group that unfortunately doesn’t include a large part of the press corps) that deficit obsession hasn’t really been about deficits — it has been about using deficits as a club with which to smash to welfare state, and hence increase inequality. ...
Conversely, talking about the need to help struggling families is ... a way to shift the focus away from deficit obsession, and pave the way at least for a relaxation of austerity, if not actual stimulus.
And I think we also have to face up to an awkward political reality: moderate populism has a broad popular constituency, Keynesian macroeconomics doesn’t..., the public doesn’t “get” macroeconomics; lines like “American families are having to tighten their belts, so the government should too” still resonate. You could blame Obama for not using the bully pulpit to teach the nation why this is wrong, and I wish he had made more of a stand. Still, the fact is that this is just a hard story to get across...
So if I were Obama, I’d do what he’s apparently doing: focus on inequality, which is a valid and popular issue, and use it indirectly to move macro policy in the right direction too.

To follow up on the previous post, capitalism is the best economic system yet discovered for producing economic growth, but it also concentrates risk and causes people to face hardship through no fault of their own (e.g. a recession that puts someone out of work, someone who shows up for work everyday and does their job well). The solution to this is for either the private sector or the government to provide insurance against these risks -- and market failures mean it is generally the government that must step in. Yes, that means transfers from the winners to the less fortunate, much as those with fire insurance who have good outcomes -- no fire -- find their insurance premiums transferred to those who do have the bad luck to experience a fire. But the risks inherent in the system that makes those at the top so wealthy, and those at the bottom so miserable must be attenuated through government provided insurance. Unemployment insurance is a good example of this, but more social insurance is needed to protect the vulnerable from risks they had no hand in creating (e.g. the financial crisis caused great pain for workers who had nothing at all to do with creating the problems that caused the Great Recession, while those who benefitted from the lead up to the crisis and had a hand in causing it, those who are doing very well now, whine incessantly if they are asked to help to reduce the hardship of the innocent).

'Inequality in Adam Smith’s World'

I like this as far as it goes, but why not make the point that there is a role for government in solving the market failures that lead to the lack of job insurance for vulnerable workers (and *perhaps* for solving the inequality problem as well if it progresses beyond some threshold)?:

Inequality in Adam Smith’s World, by Chris House: Inequality is a fact of economic life and it is becoming more and more pronounced over time. ...
There are many forces in our economy that create income inequality. The most basic of these forces however, is tied to the nature of trade itself and can be traced all the way back to Adam Smith and the division of labor. If you read the Wealth of Nations (something I told you not to do a few blog posts back …) you will find that Smith begins by marveling at the incredible increases in productivity that can be obtained by exploiting the division of labor, that is, by specializing. ... A jack-of-all-trades is simply not valued in a market system. ...
The way you get the division of labor to work is by combining it with trade. ... A physician cannot consume only her own medical advice – she must draw on the productivity of the many other specialists in society. If you are willing to do trade, you can, by specializing, reach incredible levels of productivity. As populations grow, and as the ability to trade grows, you should see more and more specialization and higher and higher productivity. (Obviously the division of labor is not the only source of increases in productivity.)
However, there is a downside... Adam Smith’s plan exposes people to incredible variations in income and thus a market system possesses and important force which causes inequality. Specialization ties your entire wellbeing to a single industry. If you decide that you are going to become a web designer, your fate is very closely tied to the market for web designers. As a result, while Smith’s plan dramatically increases overall productivity, it also exposes us to incredible risk.
Of course, markets do have responses to risk. The typical response is for the market to provide insurance contracts to reduce risk. In this case however, the type of insurance needed is actually income or job insurance. These types of insurance contracts are not typically available. ...
I don’t mean to imply that all or even most of the alarming increase in inequality is due to the division of labor and trade. I would guess that modern technology (which allows people to leverage luck to extreme degrees by cheaply reproducing and transmitting ideas and information) and inheritance, both play a significant role in creating inequality. However, living with income inequality is an implicit part of the deal we made with Adam Smith and it will be with us in some form for a long time.

Sunday, December 29, 2013

'Mixed Thinking about Markets'

John Quiggin:

Mixed thinking about markets: ... Chris Berg ... wants to argue that all the good things that have happened in the last two centuries are the product of the “market economy”, and that we should therefore scrap our existing social arrangements in favor of radical reforms in which market forces are given free rein.
In reality, modern society is characterized by a mixed economy, in which large components of economic activity take place outside the market, within households or through publicly funded and provided services. Even within the private business sector, the majority of activity takes place within corporations whose internal operations are characterized by central planning, not markets.
All of this reflects the fact that a pure market economy doesn’t work well. Rather than list all the problems which have led modern societies to constrain the role of markets (environmental pollution, inequality and so on), I’ll focus on the one discussed by Berg, that of technological innovation. Information is what economists call a public good... And while it’s possible to keep useful information secret for a while, it gets harder and harder over time. So, a pure market system often doesn’t provide much of a reward to people who come up with new ideas.
All sorts of solutions to the problem have been developed. They include patents (a temporary grant of government-enforced monopoly), prizes and awards, and publicly funded research institutions such as universities. ...
Berg’s argument is an example of a characteristic fallacy among advocates of market liberalism. Beginning with the fact that all modern societies are, in some sense, capitalist, they point to the successes of modern society to argue in favor of a particular version of capitalism (free markets, on the US model but taken even further) and against others that have been more successful in terms of human welfare (various forms of social democracy) or that might exist in the future. ...

Monday, December 09, 2013

'What Obama Left Out of His Inequality Speech: Regulation'

Thought I'd highlight this piece from today's links:

What Obama Left Out of His Inequality Speech: Regulation, by Thomas McGarity, Commentary, NY Times: President Obama’s speech on inequality last Wednesday was important in several respects. He identified the threat to economic stability, social cohesion and democratic legitimacy posed by soaring inequality of income and wealth. He put to rest the myths that inequality is mostly a problem afflicting poor minorities, that expanding the economy and reducing inequality are conflicting goals, and that the government cannot do much about the matter.
Mr. Obama also outlined several principles to expand opportunity: strengthening economic productivity and competitiveness; improving education, from prekindergarten to college access to vocational training; empowering workers through collective bargaining and antidiscrimination laws and a higher minimum wage; targeting aid at the communities hardest hit by economic change and the Great Recession; and repairing the social safety net.
But there’s a crucial dimension the president left out: the revival, since the mid-1970s, of the laissez-faire ideology that prevailed in the Gilded Age, roughly the 1870s through the 1910s. It’s no coincidence that this laissez-faire revival — an all-out assault on government regulation — has unfolded over the very period in which inequality has soared to levels not seen since the Gilded Age. ...[continue]...

See here for more.

Monday, November 04, 2013

'Why Doesn’t Competition Drive Out Inefficient Health Care Technology?'

Nicholas Bagley at The Incidental Economist:

Why doesn’t competition drive out inefficient health care technology?: So here’s a burning question. There’s a consensus that the primary driver of escalating health-care costs is the rapid adoption of new and expensive medical technology. Much of that technology is untested and of questionable medical value. Yet private insurance plans typically cover most any intervention that physicians say is medically necessary. ...
Why? Why don’t private plans compete on price by refusing to cover costly, unproven therapies? ... One answer you sometimes hear is that the law gets in the way. ... We want to contain costs, but the courts won’t let us do it.
The law can’t be the real story, however. As it stands, a federal statute—ERISA—gives employer-sponsored plans almost complete freedom to tailor their coverage packages as they like. ... ERISA even shields a plan from liability if it negligently refuses to authorize coverage for care that it (wrongly) thinks is medically unnecessary. As safe legal harbors go, it doesn’t get any better than ERISA.
Why, then, are private plans so cautious? I’m speculating a little here... For starters, it’s really hard to make good coverage decisions. The data for making them are usually quite poor... And, absent convincing data, a plan that excludes a promising treatment risks alienating physicians and hospitals (not to mention patients). No individual plan has the right incentives to generate that kind of convincing data because, once it does, its competitors will ... take advantage of the leading plan’s research investments.
What’s more, most coverage decisions aren’t crisp (“No proton-beam therapy, period.”). They’re qualified: if a patient has a certain risk-profile, or an identifiable need, then the intervention is covered. But once a plan has said that some patients are eligible for a particular treatment, it’s hard to stop those outside that group from getting the treatment, too. ...
Against this backdrop, piggybacking on Medicare’s coverage determinations makes good sense. Not only does it allow plans to sidestep the collective-action problem that plagues efforts to develop good coverage data. It also helps plans avoid public backlash because they can be confident that their competitors will also follow Medicare’s lead. The government’s seal of approval lends legitimacy to a coverage exclusion that might otherwise appear hard-hearted.
Employer-sponsored plans aren’t the only private plans around, of course. And, as it happens, the law has more bite outside of the employer setting. ... But for employer-sponsored plans, the law isn’t the problem. Far from restraining these plans, the law enables them to tackle the rising costs of technology. There’s just not a business case for it—at least not yet.

Thursday, September 19, 2013

Waste in the Private Sector

Antonio Fatás:

Does competition get rid of waste in the private sector?: It is very common to hear comments about the waste of resources when referring to governments and the public sector. Paul Krugman does his best to argue against this popular view by showing that most of what government do is related to services that we demand and value as a society (it is not about hiring civil servants that produce no useful service). As he puts it, the government is an "insurance company with an army". But critics will argue that even if this is the case, the functioning of that (public) insurance company is extremely inefficient. In fact, we all have our list of anecdotes on how governments waste resources, build bridges to nowhere and how politicians are driven by their own interest, their ambitions or even worse pure corruption. If only we could bring the private sector to manage these services!
In addition to the anecdotal evidence there is something else that matters: we tend to use framework that starts with the assumption that in the private sector competition will get rid of waste. An inefficient company will be driven out of business by an efficient one. An inefficient and corrupt manager will be replaced by one who can get the work done. And we believe that the same does not apply to governments (yes, there are elections but they do not happen often enough plus there is no real competition there).
But is competition good enough to get rid of all the waste and inefficiencies in the private sector? I am sure there are many instances where this is the case but I am afraid there are also plenty of cases where competition is not strong enough. And just to be clear, I am not simply talking about large companies that abuse monopoly power, I am thinking of all the instances where the competitive threat is not enough to eliminate inefficiencies. ...

He goes on to give two examples of private sector waste and inefficiency resulting from insufficient competetive forces, the large amount of waste, destruction, and inefficiency caused by the financial crisis and the large amount of waste in private sector healthcare markets (he shows one estimate that excess costs are 31% of total spending on health care). He concludes with:

But ...[when it comes to].. waste in other sectors, we simply do not know about it, we do not even attempt to measure it (at least at the macro level). And the reason why we do not bother measuring it is because we assume that markets and competition must make this number close enough to zero. Maybe it is time to challenge this assumption.

Saturday, September 14, 2013

'Ronald Coase, a Pragmatic Voice for Government’s Role'

Robert Frank:

Ronald Coase, a Pragmatic Voice for Government’s Role, by Robert Frank, Commentary, NY Times: ... Nobel Memorial Prize in Economic Science [winner] ... Ronald H. Coase ... spent most of his career at the University of Chicago, where he was revered by its many free-market enthusiasts as the world’s foremost authority on ... negative externalities... He became their champion because they thought his framework provided the most cogent arguments for limiting government’s role in economic life.
That belief was profoundly mistaken. In time, I predict, Mr. Coase’s framework will instead be seen as providing not only the best explanation for why governments regulate..., but also the best advice on how they might regulate more effectively. ...
Mr. Coase’s work cannot be read as a case for minimal government. On the contrary, his message was more purely pragmatic: Because we can’t negotiate efficient private solutions most of the time, we must ask whether laws and other institutions can help steer us toward solutions we would have chosen if negotiation had been practical. ...
Because population density has been rising, behaviors with harmful side effects have been growing steadily more important. Our continued prosperity ... will require thinking clearly about how to mitigate the resulting damage. Mr. Coase has pointed the way forward.

Thursday, September 12, 2013

'Remembering Ronald Coase’s Contributions'

In his post Remembering Ronald Coase’s Contributions, Robert Stavins notes a big surprise, the Wall Street Journal's editorial page being less than forthright (he is summarizing a statement in "an effective essay" by Severin Borenstein on "the effect that Coase’s thinking had decades ago on his own intellectual development"):

the Wall Street Journal in its ... tribute to Coase ... twisted the implications of his work to fit the Journal’s view of the world

Stavins goes on to discuss "The Coase Theorem and the Independence Property":

... In our article, “The Effect of Allowance Allocations on Cap-and-Trade System Performance,” Hahn and I took as our starting point a well-known result from Coase’s work, namely, that bilateral negotiation between the generator and the recipient of an externality will lead to the same efficient outcome regardless of the initial assignment of property rights, in the absence of transaction costs, income effects, and third party impacts. This result, or a variation of it, has come to be known as the Coase Theorem.
We focused on an idea that is closely related to the Coase theorem, namely, that the market equilibrium in a cap-and-trade system will be cost-effective and independent of the initial allocation of tradable rights (typically referred to as permits or allowances). That is, the overall cost of achieving a given emission reduction will be minimized, and the final allocation of permits will be independent of the initial allocation, under certain conditions (conditional upon the permits being allocated freely, i.e., not auctioned). We called this the independence property. It is closely related to a core principle of general equilibrium theory (Arrow and Debreu 1954), namely, that when markets are complete, outcomes remain efficient even after lump-sum transfers among agents.
The Practical Political Importance of the Independence Property
...The reason why this property is of such great relevance to ... public policy is that it allows equity and efficiency concerns to be separated. In particular, a government can set an overall cap of pollutant emissions (a pollution reduction goal) and leave it up to a legislature to construct a constituency in support of the program by allocating shares of the allowances to various interests, such as sectors and geographic regions, without affecting either the environmental performance of the system or its aggregate social costs. Indeed, this property is a key reason why cap-and-trade systems have been employed and have evolved as the preferred instrument in a variety of environmental policy settings.
...Does the Property Always Hold?
...Hahn and I ... carried out an empirical assessment of the independence property in past and current cap-and-trade systems...
I hope some of may find time to read our article, but a quick summary of our assessment is that we found modest support for the independence property in the seven cases we examined (but also recognized that it would surely be useful to have more empirical research in this realm).
Political Judgments
That the independence property appears to be broadly validated provides support for the efficacy of past political judgments regarding constituency building through legislatures’ allowance allocations in cap-and-trade systems. Governments have repeatedly set the overall emissions cap and then left it up to the political process to allocate the available number of allowances among sources to build support for an initiative without reducing the system’s environmental performance or driving up its cost.
This success with environmental cap-and-trade systems should be contrasted with many other public policy proposals for which the normal course of events is that the political bargaining that is necessary to develop support reduces the effectiveness of the policy or drives up its overall cost. So, the independence property of well-designed and implemented cap-and-trade systems is hardly something to be taken for granted. It is of real political importance and remarkable social value. It is just one of many lasting contributions of Ronald Coase.

Saturday, September 07, 2013

Where are the Women (in Economics)?

"It’s something systemic to the field"

Where are the Women?, by Jesse Romero, FRB Richmond: Women earned 34 percent of economics Ph.D.s in 2011... That might sound like a lot, but it’s much lower than the 46 percent of all doctorate degrees earned by women, and the smallest share among any of the social sciences. ...
The gender gap in economics gets larger at each stage of the profession, a phenomenon described as the “leaky pipeline.” In 2012, women were 28 percent of assistant professors, the first rung on the academic ladder; 22 percent of associate professors with tenure; and less than 12 percent of full professors...
In part, this might reflect the long lag between earning a Ph.D. and attaining the rank of full professor; if more women are entering the field today than 20 years ago, more women might be full professors in the future. But the share of new female Ph.D. students is actually lower than it was in 1997,... which means women’s share of economics faculty could actually shrink.
Donna Ginther of the University of Kansa s and Shulamit Kahn of Boston University also found leaks in the pipeline. In several studies, they have shown that women are less likely than men to progress at every stage of an academic career... Furthermore, women are less likely to be promoted in economics than in other social sciences, and even than in more traditionally male fields such as engineering and the physical sciences.
In part, the disparity between men and women could be due to different choices, such as having children or focusing more on teaching than on research. ...
But even after controlling for education, ability, productivity, and family choices, Ginther and Kahn found that a gap of about 16 percentage points persists in the likelihood of promotion to full professor in economics — a much larger gap than in other disciplines. “It’s something systemic to the field,” says economist Claudia Goldin of Harvard University.
Whatever that something is, ... the problem might be the way economics is taught, Goldin says. “... We’re teaching economics the same way we did when women didn’t matter. But now women do matter. So how do we translate economics into ‘girlish’?” ...
Does it actually matter how many female economists there are? Yes, says Susan Athey of Stanford University. “You just don’t get the best al location of human capital” when one category of people is excluded. “Losing out on a chunk of the population is wasteful.” (In 2007, Athey was the first woman to receive the John Bates Clark medal, given to the American economist under 40 who has made the greatest contribution to the field.) In addition, a survey by Ann Mari May and Mary McGarvey of the University of Nebraska-Lincoln and Robert Whaples of Wake Forest University found that male and female economists have significantly different opinions on public policy questions such as the minimum wage, labor regulations, and health insurance. As the authors concluded, “Gender diversity in policymaking circles may be an important aspect in broadening the menu of public policy choices.” ...

Saturday, August 31, 2013

A Carbon Tax That America Could Live With?

I expected Greg Mankiw's latest column to be about sales of his textbook. That's important news everyone should know about. But in a complete surprise, he talked about carbon taxes instead:

A Carbon Tax That America Could Live With: ... If the government charged a fee for each emission of carbon, that fee would be built into the prices of products and lifestyles. When making everyday decisions, people would naturally look at the prices they face and, in effect, take into account the global impact of their choices. In economics jargon, a price on carbon would induce people to “internalize the externality.”
A bill introduced this year by Representatives Henry A. Waxman and Earl Blumenauer and Senators Sheldon Whitehouse and Brian Schatz does exactly that. Their proposed carbon fee — or carbon tax, if you prefer — is more effective and less invasive than the regulatory approach that the federal government has traditionally pursued.
The four sponsors are all Democrats, which raises the question of whether such legislation could ever make its way through the Republican-controlled House of Representatives. The crucial point is what is done with the revenue raised by the carbon fee. If it’s used to finance larger government, Republicans would have every reason to balk. But if the Democratic sponsors conceded to using the new revenue to reduce personal and corporate income tax rates, a bipartisan compromise is possible to imagine. ...

Mankiw once said that economists shouldn't consider the political realities of policy, they should just recommend the best policy:

Politics aside: I have finally gotten around to reading the new Ebenstein biography of Milton Friedman. Here is a quotation from Milton that I particularly like:

“The role of the economist in discussions of public policy seems to me to be to prescribe what should be done in light of what can be done, politics aside, and not to predict what is ‘politically feasible’ and then to recommend it.”

So now, when I advocate raising gasoline taxes and cutting income taxes, and my conservative friends tell me that the plan is politically unrealistic, that the government will just keep the extra revenue instead of cutting income taxes, I can quote Milton....

I get that Mankiw really wants his personal taxes to be lowered, he seems to hate the idea of paying a fair share in taxes from what he makes from the textbook he hawks at every opportunity. But why, from an economic standpoint, is lowering his personal taxes (corporate taxes too) the best option (as opposed to simply trying to find something that is politically acceptable to the right)? Has he made that argument? The revenue could be used to help low income households that would be hurt by the tax, for deficit reduction without cutting programs, there are all sorts of ways the revenue could be used and it's not at all clear that his recommendation is, from an economic rather than a political view, the best way to use the revenue from a carbon tax.

Monday, August 26, 2013

Paul Krugman: The Decline of E-Empires

The biggest companies eventually become complacent and lose their leading role in the marketplace. Does that mean we shouldn't worry about their monopoly power?:

The Decline of E-Empires, by Paul Krugman, Commentary, NY Times: Steve Ballmer’s surprise announcement that he will be resigning as Microsoft’s C.E.O. ... has me thinking about network externalities and Ibn Khaldun. ...
First, about network externalities: Consider the state of the computer industry circa 2000... By all accounts, Apple computers were better than PCs... Yet the vast majority of desktop and laptop computers ran Windows. Why?
The answer, basically, is that everyone used Windows because everyone used Windows. ... Software was designed to run on PCs; peripheral devices were designed to work with PCs. That’s network externalities in action, and it made Microsoft a monopolist. ...
The trouble for Microsoft came with the rise of new devices whose importance it famously failed to grasp. “There’s no chance,” declared Mr. Ballmer in 2007, “that the iPhone is going to get any significant market share.”
How could Microsoft have been so blind? ... Ibn Khaldun ... was a 14th-century Islamic philosopher... Desert tribesmen, he argued, always have more courage and social cohesion than settled, civilized folk, so every once in a while they will sweep in and conquer lands whose rulers have become corrupt and complacent. They create a new dynasty — and, over time, become corrupt and complacent themselves, ready to be overrun by a new set of barbarians.
I don’t think it’s much of a stretch to apply this story to Microsoft, a company that did so well with its operating-system monopoly that it lost focus, while Apple — still wandering in the wilderness after all those years — was alert to new opportunities. And so the barbarians swept in from the desert. ...
Anyway, the funny thing is that Apple’s position in mobile devices now bears a strong resemblance to Microsoft’s former position in operating systems. ...Apple ... products ... are, by most accounts, little if any better than those of rivals, while selling at premium prices.
So why do people buy them? Network externalities: lots of other people use iWhatevers, there are more apps for iOS... Meet the new boss, same as the old boss.
Is there a policy moral here? ... Microsoft was a monopolist, it did extract a lot of monopoly rents, and it did inhibit innovation. Creative destruction means that monopolies aren’t forever, but it doesn’t mean that they’re harmless while they last. This was true for Microsoft yesterday; it may be true for Apple, or Google, or someone not yet on our radar, tomorrow.

Monday, August 19, 2013

The Polarized Economic Policy Debate: All Markets Fail, Some More Than Others

I make this point a lot, but it's worth emphasizing again given how polarized the debate over public policy has become. Here's the problem I see. I, and others like me, are more than willing to say that most of the time, markets work well and we ought to leave them alone. Government should stay out of the way. The right, of course, has no disagreement with that. But we on the left also recognize that sometimes markets can fail -- in fact all markets fail to some degree when measured against the requirements for the pure competitive markets found in textbooks -- and when those failures are severe enough, government intervention can make them work better, i.e. force them closer to the competitive ideal (or, when markets fail altogether, as with public goods, the government supplies them itself).

I could understand if the right wanted to debate where the line is between when we should intervene and when we shouldn't. For example, they likely view government as less effective than I do and hence would intervene only in the most severe cases of market failure. But to simply say that government should never intervene in any case at all gets us nowhere. As Jared Bernstein points out below, there is no advanced economy in which government doesn't play some role in shaping economic outcomes. I would love to be able to debate where the line between intervening, or not, ought to be, but that's a debate that doesn't seem possible right now due to the polarized, uncompromising position that one side has taken.

Here's Jared Bernstein:

Breaking Out of a Cramped Economic Policy Debate, by Jared Bernstein: The Justice Department’s decision to oppose the merger of American and US Airways caught a lot of people by surprise.  From the cruising altitude of 30,000 feet, it doesn’t look much different from previous airline mergers, so it’s not unreasonable for onlookers to wonder why this particular merger threatens consumers that much more than the others.
There are, in fact, some salient differences...
But what I found most interesting about this episode is what it says about the ways in which we shape economic outcomes.  This merger dust-up is a microcosm worthy of attention in an era wherein the debate over the scope of government intervention in the economy is confined, misleading, and uninformed.  The fact is we can and must shape outcomes—we do it all the time.  But because this fact is discomforting to the mythological ideology of “free markets,” we’re often in denial in ways that skew the debate and severely limit the scope of our policies.
If you dropped in from Mars and turned on cable news (though that in itself might lead you to hightail it back to Mars), you’d probably think that things break down like this.  On one side are those who want the government, the Federal Reserve, the Justice Department, the Environmental Protection Agency, Fannie and Freddie, Obamacare and all the rest of them to just get out of the picture and let the “free market” solve whatever problems those agencies and their interventions are misguidedly trying to fix.
On the other side are the interventionists, the tinkerers, the Bernankes and Obamas with their stimulus, their jobs programs, social insurance, safety nets, fuel standards, and so on, grabbing the “free hand” by the wrist and trying to move it this way and that.
Of course, reality is more complicated... Whether it’s Tea Partiers opposing Medicare cuts, politicians protecting tax-advantaged investment income, or the Justice Department intervening in such a way as to preserve market competition, you’d be very hard pressed to draw neat lines between those who seek more or less intervention.  When you drill down, it’s usually more a matter of who wins and who loses. ...
It’s a waste of time to argue about whether public policy is going to play a role in shaping market outcomes, from health care to airlines to stocks and bonds.  No advanced economies exist wherein policy does not play that role.  Adam Smith himself recognized that sometimes the “invisible hand” is all thumbs, and wrote incisively about the importance of distributional outcomes and regulating commerce (he might well have signed on with the Justice Department in opposition to the airline merger).
The question is whether the interventions will promote fairness, opportunity, and growth.  Too often, our political economy debate tries to preclude these choices in the defense of some pristine vision of unfettered markets.  We’re told we have to choose between growth and equity, innovation or regulation, factory jobs or globalization, budget deficits or private investment.  That’s all a ruse, and it has led to the cramped politics and limited policy debate in which we’re stuck today.  We can and must choose a better path.

Sunday, August 18, 2013

'Does the Government Stifle Innovation? I Don’t See It (To the Contrary…)'

Jared Bernstein responds to the Robert Shiller article I linked to yesterday:

Does the Government Stifle Innovation? I Don’t See It (To the Contrary…): I usually find economist Robert Shiller’s commentaries resonant and insightful, but this one seemed more confusing than enlightening. The thrust of the piece is the concern that government activities to promote innovation can just as easily stifle it.

The piece introduces the notion of corporatism, from a new book by Ed Phelps. What means “corporatism”? It’s:

…a political philosophy in which economic activity is controlled by large interest groups or the government. Once corporatism takes hold in a society…people don’t adequately appreciate the contributions and the travails of individuals who create and innovate. An economy with a corporatist culture can copy and even outgrow others for a while…but, in the end, it will always be left behind. Only an entrepreneurial culture can lead.

... I don’t get it. While “entrepreneurial culture” will always be essential, many innovations that turned out to be economically important in the US have government fingerprints all over them. From machine tools, to railroads, transistors, radar, lasers, computing, the internet, GPS, fracking, biotech, nanotech—from the days of the Revolutionary War to today—the federal government has supported innovation often well before private capital would risk the investment (read about it here).

Shiller’s critical, for example, of the manufacturing innovation institutes that the White House has been both touting and setting up. He’s certainly right to ask what it is these new creations do and why we need them... But most manufacturers I’ve spoken to about them tells me they fill an important niche, essentially building a path through the Death Valley between the university lab and the factory floor. If so, that’s a classic coordination failure in which markets have been known to underinvest. ...

To be clear, my argument is not at all that government efforts in this area are all successful or are somehow always free of the corruption that is too common when politics enters the fray. My points are that a) many important innovations have involved government support somewhere along the way, and b) while one could and should worry about waste in this area, I’ve not seen evidence, nor does Shiller provide any, of stifling. ...

So I’d suggest we be more careful in where we point the corporatist finger.

Sunday, August 04, 2013

'For Obamacare to Work, Everyone Must Be In'

I've made this point several times (e.g.), but it's worth highlighting again:
For Obamacare to Work, Everyone Must Be In, by Robert Frank, Commentary, NY Times: Two beliefs continue to shape debate on Obamacare. First, pre-existing medical conditions shouldn’t prevent people from obtaining affordable health insurance. And second, people who don’t want health insurance shouldn’t be forced by the government to purchase it.
These may seem to be reasonable positions. But they are incompatible. That’s been shown by historical events, and it’s now being strikingly confirmed by recent experience in the emerging Obamacare insurance exchanges.
The crux of the matter is what economists call the adverse-selection problem. ...
We must ask those who would repeal Obamacare how they propose to solve the adverse-selection problem. That problem is not an abstraction invented by economists to justify trampling individual liberties. As experience in most countries around the world has confirmed, it is a profound source of market failure that renders unregulated insurance markets a catastrophically ineffective way of providing access to health care.

Saturday, August 03, 2013

'A Republican Case for Climate Action'

Republican administrators of the E.P.A under Presidents Richard Nixon, Ronald Reagan, George Bush and George W. Bush try to convince other Republicans that climate change is real, and that we need to do something about it now, not later:

A Republican Case for Climate Action, by William D. Ruckelshaus, Lee M. Thomas, William K. Reilly, and Christine Todd Whitman, Commentary, NY Times: Each of us took turns over the past 43 years running the Environmental Protection Agency. We served Republican presidents, but we have a message that transcends political affiliation: the United States must move now on substantive steps to curb climate change, at home and internationally.
There is no longer any credible scientific debate about the basic facts: our world continues to warm... The costs of inaction are undeniable. ... And the window of time remaining to act is growing smaller: delay could mean that warming becomes “locked in.”
A market-based approach, like a carbon tax, would be the best path to reducing greenhouse-gas emissions, but that is unachievable in the current political gridlock in Washington. Dealing with this political reality, President Obama’s June climate action plan lays out achievable actions that would deliver real progress. He will use his executive powers to require reductions in the amount of carbon dioxide emitted by the nation’s power plants... The president also plans to use his regulatory power to limit the powerful warming chemicals known as hydrofluorocarbons...
Rather than argue against his proposals, our leaders in Congress should endorse them and start the overdue debate about what bigger steps are needed and how to achieve them — domestically and internationally.
As administrators of the E.P.A under Presidents Richard M. Nixon, Ronald Reagan, George Bush and George W. Bush, we held fast to common-sense conservative principles — protecting the health of the American people, working with the best technology available and trusting in the innovation of American business and in the market to find the best solutions for the least cost.
That approach helped us tackle major environmental challenges to our nation and the world: the pollution of our rivers... The solutions we supported worked, although more must be done. ...
We can have both a strong economy and a livable climate. All parties know that we need both. The rest of the discussion is either detail, which we can resolve, or purposeful delay, which we should not tolerate. ... The only uncertainty about our warming world is how bad the changes will get, and how soon. What is most clear is that there is no time to waste.

Sunday, July 28, 2013

'Advertising, Paternalism, Information and Plain Packaging of Cigarettes'

Simon Wren-Lewis on the economics of advertising for cigarettes. He asks, is banning advertising paternalistic, or does it enhance our freedom?:

Advertising, Paternalism, Information and Plain Packaging of Cigarettes: This is off the usual macro beat, so probably this point has been made in a much clearer way by others, but it is hardly ever made in the public debate, and I have read economists who argue the opposite. It was prompted by the UK government’s predictable decision to kick ‘plain packaging’ of cigarettes (example...) into the long grass. One of the arguments used against plain packaging is that it represents yet more paternalism by the government. My general thought is this: is banning advertising paternalistic, or is it enhancing our freedom? ...
The argument for advertising has to be that the benefits to the few in getting useful information outweighs the costs to the many in either avoiding it, or getting information they do not want. It is not paternalistic to ban advertising, just as it is not paternalistic to stop people being stalked.
That is the general point which hardly ever seems to be made. ... However the debate about ‘plain packaging’ is not about either packaging that is plain, or the pros and cons of advertising. The Australian version of plain packaging replaces the logo of the cigarette with a picture of one of the health risks if you smoke these cigarettes (see [here]). So it is not about banning advertising, but replacing one type of advertising with another.
Those who do not smoke and have no intention of smoking are not forced to look at these adverts, so banning this kind of advertising would not increase their freedom. For those who do not smoke but might smoke, and probably for those who do smoke, the information content of the ‘plain packages’ is clearly much greater than packages that were dominated by a logo. So this is one example where the information content of advertising does dominate any reduction in freedom that the advertising entails. ...

[I cut quite a bit from the original, particularly on the costs and benefits of advertising in general that set up the second paragraph above.]

Saturday, July 20, 2013

'Profits, Norms and Power'

Chris Dillow:

Profits, norms and power, by Chris Dillow: Jesse Norman says companies have a duty not just to obey the law but to follow an ethic of good stewardship. Andrew Lilico and Stephen Pollard disagree. Implicit in this debate is something that should be made explicit - the role of corporate power.
Lilico and Pollard are following the tradition of Milton Friedman, who argued that "the social responsibility of business is to increase its profits."
This principle is an expression of the first theorem of welfare economics ... which says that rational self-interest will lead to socially optimum outcomes.
However, this is only the case under a particular condition - that companies' economic and political power is limited. ...
Now, here's the thing. When Friedman advocated profit-maximization as a socially optimal strategy, he did so at a time when firms faced countervailing power. In a pre-globalized era of strong unions, they couldn't easily maximize profits by paying lousy wages or offering degrading conditions, and they couldn't so easily dodge taxes. With their power limited, it was at least possible that profit-maximization did increase aggregate welfare. Friedman acknowledged this when he said that firms should "[conform] to the basic rules of the society, both those embodied in law and those embodied in ethical custom."
But things have changed. Firms' bargaining power is now so great that there can be a tension between profit-maximizing and welfare. Maximizing profits now entails ducking taxes, paying wages which are regarded by many as unfair, and producing unpriced externalities such as risk pollution (pdf).This is exacerbated by the fact that "ethical custom", as perceived by capitalists and their apologists, tolerates such behaviour.
There are several possible responses to this:
- To ignore the role of power. Doing so, I suspect is an example of how beliefs, such as Friedman's, can persist after the conditions in which they were reasonable have disappeared.
- To think that power can be restrained by social norms, as Jesse does. It's a good conservative position, to think that free markets are welfare-enhancing if they operate within a particular moral code.
- To think legislation is necessary to rein in firms. This is the statist social democratic view.
There is, though, a fourth view - the Marxian one. This says that the tension between profit maximization and welfare hasn't increased simply because of a failure of law and morals, but because of a genuine shift in the balance of class power. Firms now have power and one thing we know about power is that it'll be used. Unless this changes, hopes of reconciling profit maximization with well-being might well prove mistaken.

Tuesday, June 25, 2013

'Highway Robbery for High-Speed Internet'

Why is internet service so expensive?:

Highway Robbery for High-Speed Internet, by Paul Waldman, American Prospect: If you're one of those Northeastern elitists who reads The New York Times, you turned to the last page of the front section Friday and saw an op-ed from a Verizon executive making the case that "the United States has gained a global leadership position in the marketplace for broadband"... "Hey," you might have said. "Didn't I read an almost identical op-ed in the Times just five days ago?" Indeed you did, though that one came not from a telecom executive but from a researcher at a telecom-funded think-tank. And if you live in Philadelphia, your paper recently featured this piece from a top executive at Comcast, explaining how, yes, American broadband is the bee's knees.
That smells an awful lot like a concerted campaign to convince Americans not to demand better from their broadband providers. ... The telecoms are right about one thing: In the last few years, broadband speeds have improved. ... But we're paying for what we get—oh boy, are we ever paying. ...
How did it come to this? ... Susan Crawford, a Harvard professor and author of Captive Audience: The Telecom Industry and Monopoly Power In the New Gilded Age, puts the blame on the situation that the cable and telecom companies have so purposefully engineered. "As things stand," she has written, "the U.S. has the worst of both worlds: no competition and no regulation." ... In many places, the local cable monopoly is the only realistic choice you have for internet service...
With growing demand for video, online games, and other bandwidth-sucking uses, ISPs have no choice but to keep increasing the speed of their service. But they're in a position to make sure that we keep paying through the nose for it. In other countries, costs have been kept down in large part because they treat broadband like a utility. We have special rules for things like water and electricity, both because they are absolutely vital to modern existence and because of the impracticality of having too many competing providers in any one geographical area. But in exchange for their monopoly position, companies like Pepco or Con Edison are subject to tight regulation to make sure they don't gouge their customers. Today's cable companies, on the other hand, enjoy all the benefits of their monopolies (or in some places, duopolies), with little of the regulatory oversight. As long as that's true, broadband won't get any cheaper.

Friday, June 21, 2013

Paul Krugman: Profits Without Production

The growing importance of monopoly rents:

Profits Without Production, by Paul Krugman, Commentary, NY Times: One lesson from recent economic troubles has been the usefulness of history. ... Yet economies do change over time, and sometimes in fundamental ways. So what’s really different about America in the 21st century?
The most significant answer, I’d suggest, is the growing importance of monopoly rents: profits that ... reflect the value of market dominance. ...
To see what I’m talking about, consider the differences between ... General Motors in the 1950s and 1960s, and Apple today.
Obviously, G.M. in its heyday had a lot of market power. Nonetheless, the company’s value came largely from its productive capacity: it owned hundreds of factories and employed around 1 percent of the total nonfarm work force.
Apple, by contrast, seems barely tethered to the material world..., it employs less than 0.05 percent of our workers. ... To a large extent, the price you pay for an iWhatever is disconnected from the cost of producing the gadget. Apple simply charges what the traffic will bear, and ... the traffic will bear a lot. ...
I’m not making a moral judgment here. You can argue that Apple earned its special position — although I’m not sure how many would make a similar claim for ... the financial industry... But here’s the puzzle: Since profits are high while borrowing costs are low, why aren’t we seeing a boom in business investment? ...
Well, there’s no puzzle here if rising profits reflect rents, not returns on investment. A monopolist can, after all, be highly profitable yet see no good reason to expand its productive capacity. ...
You might suspect that this can’t be good for the broader economy, and you’d be right. If household income and hence household spending is held down because labor gets an ever-smaller share of national income, while corporations, despite soaring profits, have little incentive to invest, you have a recipe for persistently depressed demand. I don’t think this is the only reason our recovery has been so weak — weak recoveries are normal after financial crises — but it’s probably a contributory factor.
Just to be clear, nothing I’ve said here makes the lessons of history irrelevant. In particular, the widening disconnect between profits and production does nothing to weaken the case for expansionary monetary and fiscal policy as long as the economy stays depressed. But the economy is changing, and in future columns I’ll try to say something about what that means for policy.

Thursday, June 20, 2013

'Corrupted Credit Ratings'

I was working on this post Tuesday morning when the phone rang and, to use Paul Krugman's phrase, life intervened. I had something to say about it, but I don't know what it was at this point. Anyway, may as well post it now (posts from me will continue to be sparse/absent for awhile -- immense thanks for the outpouring of support):

Corrupted Credit Ratings: S&P’s Lawsuit and the Evidence by Matthias Efing, Harald Hau, Vox EU: In its civil lawsuit against Sta)ndard & Poor's, the US Department of Justice accuses the credit-rating agency to have defrauded federally insured financial institutions... The US complaint alleges that Standard & Poor’s presented overly optimistic credit ratings as objective and independent when, in truth, Standard & Poor’s downplayed and disregarded the true extent of credit risk...

According to the plaintiff, Standard & Poor’s catered rating favors in order to maintain and grow its market share and the fee income generated from structured debt ratings. In support of these allegations, the complaint lists internal emails in which Standard & Poor’s analysts complain that analytical integrity is sacrificed in pursuit of rating favors for the issuer banks.

Standard & Poor’s files for dismissal of the case

Standard & Poor’s denies issuing inflated ratings and any possible conflict of interest... That some of Standard & Poor’s very own employees appealed to their colleagues and superiors to withdraw inflated ratings is dismissed as "internal squabbles" and interpreted as a "robust internal debate among Standard & Poor’s employees"...

Statistical evidence on rating bias in structured products

While the US Department of Justice did not give any statistical evidence in its deposition, our new research (Efing and Hau 2013) suggests that rating favors were indeed systematic and pervasive in the industry.

In a sample of more than 6,500 structured debt ratings produced by Standard & Poor’s, Moody's and Fitch, we show that ratings are biased in favor of issuer clients that provide the agencies with more rating business. This result points to a powerful conflict of interest, which goes beyond the occasional disagreement among employees.

The beneficiaries of this rating bias are generally the large financial institutions that issue most structured debt; they in turn provide the rating agencies with most of their fee income. Better ratings on different components (so-called tranches) of the debt-issue amount to a lower average yield at issuance – a cost reduction pocketed by the issuer bank. ...[presents evidence]...

The evidence also suggests that the two other rating agencies, Moody’s and Fitch were no less prone to rating favors towards their largest clients than was Standard & Poor’s. ...

Still more evidence on rating bias in bank ratings

Additional evidence for rating bias emerges for bank ratings. Hau, Langfield and Marques-Ibanes (2012) show in a paper forthcoming in Economic Policy that rating agencies gave their largest clients also more favorable overall bank credit ratings. ...

Hau, Langfield and Marqués-Ibañez (2012) also show that large banks profited most from rating favors. ... The rating process for banks may have contributed to substantial competitive distortions in the banking sector, thus fostering the emergence of the too-big-to-fail banks.

Ironies of the case

It is hard to read some of the legal arguments without being struck by a sense of irony.

In its defense, Standard & Poor’s argues (without admitting any rating bias) that it has never made a legally binding promise to produce objective and independent credit ratings. ... For an agency whose business model is based on its reputation as an impartial 'gatekeeper' of fixed income markets, this defense is most remarkable.

But the accusation has its own oddities: Standard & Poor’s argues that it is impossible to defraud financial institutions about "the likely performance of their own products". Standard & Poor’s points out the irony "that two of the supposed 'victims,' Citibank and Bank of America – investors allegedly misled into buying securities by Standard & Poor’s fraudulent ratings – were the same huge financial institutions that were creating and selling the very CDOs at issue"...

In many cases the victim-view on institutional investors may indeed be questionable: Large banks often issued complex securities and at the same time invested in them. It is hard to believe that the asset management division of a bank was ignorant of the dealings by the structured product division with the rating agencies. ... It is difficult to figure out where exactly the border between complicity and victimhood runs.

What could be done?

The lawsuit against Standard & Poor’s highlights the conflicts of interest inherent in the rating business, but can do little to resolve them. If new and complex regulation and supervision of rating agencies provides a remedy is unclear and remains to be seen. However, three alternative policy measures could make the existing conflicts much less pernicious:

  • Similar to US bank regulation under the Dodd-Frank act, Basel III should abandon (or at least decrease) its reliance on rating agencies for the determination of bank capital requirements.
  • As forcefully argued by Admati, DeMarzo, Hellwig and Pfleiderer (2011), much larger levels of bank equity as required under Basel III could reduce excessive risk-taking incentives and ensure that future failures in bank-asset allocation do not trigger another banking crisis.
  • More bank transparency in the form of a full disclosure of all bank asset holdings at the security level would create more informative market prices for bank equity and debt, with positive feedback effects on the quality of bank governance and bank supervision.

Our reliance on bank ratings could thus be greatly reduced. ...

Saturday, June 15, 2013

'What Sweden Can Tell Us About Obamacare'

Robert Frank:

What Sweden Can Tell Us About Obamacare, by Robert Frank, Commentary, NY Times: Last month, for the 37th time, the House of Representatives voted to repeal Obamacare, with many Republicans saying that its call for greater government involvement in the health care system spells doom. Yet most other industrial countries have health care systems with far more government involvement than we are ever likely to see under Obamacare. What does their experience tell us about Republican fears?
While in Sweden this month as a visiting scholar, I’ve asked several Swedish health economists to share their thoughts about that question. They have spent their lives under a system in which most health care providers work directly for the government. Like economists in most other countries, they tend to be skeptical of large bureaucracies. ...
Yet none of them voiced ... complaints about recalcitrant bureaucrats... Little wonder. The Swedish system performs superbly, and my Swedish colleagues cited evidence of that fact with obvious pride. ...
Congressional critics must abandon their futile efforts to repeal Obamacare and focus instead on improving it. Their core premise — that greater government involvement in health care provision spells disaster — lacks support in the wealth of evidence from around the world that bears on it.
The truth appears closer to the reverse: Because of pervasive market failures in private health care markets, this may be the sector that benefits most from collective action.

Wednesday, June 12, 2013

Hacker: Reinvigorate the Center-Left through Predistribution

Jacob Hacker:

How to reinvigorate the centre-left? Predistributionm by Jacob Hacker, guardian.co.uk: ... Center-left progressives seem to have lost their ability to provide a clear alternative to either current conservative nostrums, or the "third way" many of them staked out before the fall.
The only way out is a new governing approach – one that I have infelicitously called "predistribution", but which can be more simply summed up as "making markets work again for the middle class". Third way jujitsu rested on two maxims: let markets be markets, and use redistribution to clean up afterward. For the left, this has proved fatal... [explains why, describes predistribution]...
Predistribution may not be a catchy slogan, but the left does not need more slogans. It needs to take a cold, hard look at the concessions made to the rhetorical and political triumphs of the right. Yes, inequality is a global trend. Yes, globalization places real limits on economic strategies. Yes, labor is weaker, and must be retooled and supplemented. And yes, the state cannot do everything. But there is a vital place for active governance in the 21st century economy, and not just in softening the sharp edges of capitalism. Now more than ever, governments need to step in with boldness and optimism to make markets work for the middle class.

I don't quite agree with the description of the "third way" -- let markets work and clean up afterwards. For me, markets only work if they are reasonable approximations of the classic textbook case of "pure competition." The first step for the third way then is to correct market failures that cause significant departures from this ideal (including how income is distributed). I wish the article had done more to emphasize this aspect of the problem since it's an essential element of his call for "making markets work again for the middle class" (it does so indirectly, e.g. the call for worker organizations recognizes unequal market/negotiating power over wages, and the call for public goods and a reduction in carbon emissions, but it does not recognize this as part of the "'third way' many [center-left progressives] staked out before the fall" and I'd like to see the general market failure problem receive more emphasis).

The second thing to realize is that market outcomes depend upon the initial distribution of income and wealth. If initial allocations are highly unequal, as they are presently, the market outcome will reflect that.

How to correct this? One way is to equalize opportunity, and I fully agree with all his recommendations that push in this direction (this seems to be the essence of predistribution -- but you'll need to read the article for the full description of what predistribution means). But some correction of past inequities through post-distribution may be necessary to sufficiently equalize opportunity. Otherwise, those inequities will be perpetuated even with reasonably competitive markets and reasonably equal opportunity.

For a long time I believed that equal opportunity, sufficiently competitive markets, and equitable initial allocations of wealth would be enough. Everyone has a fair chance, so there was no reason to worry about inequality of outcomes. But it may be that even under those conditions rising inequality will continue. For example, if technology continues to wipe out the middle class even after we've provided education, health, and so on to everyone, then some degree post-distribution may be necessary to prevent an ever widening income gap. That's a position -- a fair start may still produce inequities that will subsequently be perpetuated if we don't intervene -- I've come to reluctantly.

I'm fully on board with predistribution, but the article seems to deemphasize post-distribution, in part because the wealthy have the political power to resist it:

Redistribution itself is never popular. Citizens want a job and opportunities for upward mobility more than a public cheque. Meanwhile, the super-wealthy loudly resent the increased tax bite they face – and have enormous political influence to back up their complaints.

But he does add:

Taxation and redistribution are cornerstones of progressive governance

Again, let's work on instituting the ideas behind the label "predistribution." But I think it would be a big mistake to, at the same time,  deemphasize the need for post-distribution. That day may come, but we aren't there yet.

Tuesday, June 11, 2013

'S&P Revises Up Its Outlook for US Debt: Markets Yawn'

Via Jared Bernstein:

S&P Revises Up Its Outlook for US Debt: Markets Yawn, by Jared Bernstein: Perhaps you recall back in August of 2011 when S&P’s credit rating agency downgraded US debt…no?? ... Markets shook it off, maybe because a) it didn’t make a lick of sense at the time, b) the credit raters hadn’t exactly distinguished themselves during the debt bubble.
Well today they revised their outlook from “negative” to “stable.” And again, I expect no one to notice.
In fact, here’s the trajectory of 10-year Treasury yields since the downgrade, wherein you see a conspicuous lack of reaction to the downgrade.  I often poke at financial markets for not being as all-knowing as assumed, but in this case, I gotta give it up: they correctly ignored non-information.

treas_10

Ratings agencies are supposed to solve an asymmetric information problem -- buyers are not as well informed about assets as sellers -- but if nobody trusts them (because the often add noise rather than clarity), what use are they?

Tuesday, May 28, 2013

'China and the Environmental Kuznets Curve'

Tim Taylor:

China and the Environmental Kuznets Curve: The original Kuznets curve posited, back in 1955, that inequality of incomes would follow an inverted-U pattern as a nation's economy developed, first rising, and then declining. In 1955, this looked reasonable! The "environmental Kuznets curve" suggests that pollution may follow an inverted-U pattern as a nation's economy develops. Pollution first rises as a low income nation industrializes with few limitations on pollution. But then the nation becomes better-off and more able and willing to pay the costs of limiting pollution, and the nation's economy shifts from industry to services, and pollution levels fall. For a useful overview article, Susmita Dasgupta, Benoit Laplante, Hua Wang, and David Wheeler wrote on "Confronting the Environmental Kuznets Curve" in the Winter 2002 issue of the Journal of Economic Perspectives. (Like all articles in JEP, it is freely available online compliments of the American Economic Association. Full disclosure: I've been the Managing Editor of JEP for the last 26 years.)
Of course, the environmental Kuznets curve is a theory that needs to be supported or refuted with evidence... And the experience of China, with its burgeoning economy and extraordinary environmental issues, is at the center of the debate. ...
The conventional environmental Kuznets is that emissions of pollutants rise up until some level between about $5000 and $8000 in per capita income, and then fall after that point. There is some historical evidence to support this claim. ...
According to the World Bank, China's per capita GDP was $5,445 in 2011, so it is just reaching the levels where its pollution should first start to level off, and then to decline. ...
Interestingly, there are signs that for some pollutants, the level of pollution is no longer rising with the growth of China's economy. For example, here's a figure about air pollution. The top line shows the growth of GDP. Emissions of sulfur dioxides and soot have not been rising with GDP, and even emissions of carbon dioxide have been lagging behind the rise in GDP in the last few years.
Here's a similar figure for water pollution. Chemical oxygen demand (COD) measures the level of organic pollutants in water. Both that measure and wastewater are at least not rising at the same pace as GDP.
It remains true that China's amount of pollution relative to its economic output is high by the standards of high income countries. ...
The policy prescription for reducing pollution in China is clear enough: close down older facilities, and make sure their replacements have up-to-date anti-pollution equipment; keep building sewage treatment facilities; put a price on polluting activities to encourage conservation; and so on. Sam Hill's paper has details.
But ultimately, China's path along the environmental Kuznets curve will be determined by politics and public pressure, and public pressure in China does seem to be building for stronger environmental protection. The (wonderfully named) Elizabeth C. Economy at the Council of Foreign Relations recently wrote a brief piece on "China’s Environmental Politics: A Game of Crisis Management," which notes the growing number of environmental public protests in China. In a society under such a high degree of government control, environmental protests can become a place where those discontented with government have a semi-safe space for dissent.

Tuesday, May 21, 2013

'The Climate Skeptics Have Already Won'

Martin Wolf:

Humanity has decided to yawn and let the real and present dangers of climate change mount. ... Judged by the world’s inaction, climate skeptics have won..., however rational it may be to seek to lower the risk of catastrophic outcomes, this is not what is happening now or seems likely to happen in the foreseeable future. ...

The attempt to shift our choices away from the ones now driving ever-rising emissions has failed. It will, for now, continue to fail. The reasons for this failure are deep-seated. Only the threat of more imminent disaster is likely to change this and, by then, it may well be too late. This is a depressing truth. It may also prove a damning failure.

As he says, it's not too late, "Unless the most apocalyptic scenario happens, humanity may be able to curb emissions and buy itself time," but the clock is running and it's hard to see how meaningful change will come about without substantial changes in the political environment. Gridlock favors the skeptics.

Sunday, May 19, 2013

'Keynes on Laissez-Faire'

Gavin Kennedy follows up on a recent post from Brad DeLong on Keynes and laissez faire:

Keynes on Laissez-Faire, by Gavin Kennedy: I read the Keynes quote below in Brad Delong’s Blog:
As John Maynard Keynes shrilly stated back in 1926:
“Let us clear… the ground…. It is not true that individuals possess a prescriptive 'natural liberty' in their economic activities. There is no 'compact' conferring perpetual rights on those who Have or on those who Acquire. The world is not so governed from above that private and social interest always coincide. It is not so managed here below that in practice they coincide. It is not a correct deduction from the principles of economics that enlightened self-interest always operates in the public interest. Nor is it true that self-interest generally is enlightened… individuals… promot[ing] their own ends are too ignorant or too weak to attain even these. Experience does not show that… social unit[s] are always less clear-sighted than [individuals] act[ing] separately. We [must] therefore settle… on its merits… "determin[ing] what the State ought to take upon itself to direct by the public wisdom, and what it ought to leave, with as little interference as possible, to individual exertion.
Comment
My “Collected Writings of John Maynard Keynes” are kept in France, so I was able to re-read “The End of Laissez-Faire” from Volume IX: “Essays in Persuasion” (pp 272-94. Macmillan).
The paragraph quoted by Brad Delong is fairly typical of the tone and language of the Essay. While Keynes’s main focus is on laissez-faire, it also strikes at the general proposition now widespread across the discipline, usually wrapped in the extreme neoclassical fable that:
[Adam] Smith proclaimed the principle of the ‘Invisible Hand’; every individual in pursuing his own selfish good was led, as if by an invisible hand, to achieve the best good for all, so that any interference with free competition by government was almost certain to be injurious (Samuelson, Economics: an introductory analysis, 5th edition, McGraw-Hill, p 39).
Keynes, rightly, points out that Adam Smith never used the words laissez-faire. And on the single occasion where he used the IH metaphor in Wealth Of Nations, it is a travesty to impute, let alone blatantly assert, that his words can be stretched to mean what Samuelson’s wild inference takes them to mean.
However, on this occasion I shall not develop that theme.
I want to return to laissez-faire, accepting how Keynes expresses his demolition of the popular idea that laissez faire has or ought to have traction in it. I completely agree. And before my libertarian friends jump on me, I should point out that the meaning drawn from the incident between the merchant, Legendre and the French Minister, Colbert, is not entirely innocent of a narrow self interest.
‘Laissez-nous faire’ is not advocated as a universal principle for merchants and their customers; it was a very partial principle for merchants only – “laissez-nous faire” cries Legendre (“leave us alone!”). And that is the point of my own libertarian reservations about the slogan itself and its origins.
French markets were highly regulated and supervised by government inspectors. Yes, I agree an abomination. This placed consumers at the mercy of the decisions of local magistrates. Freeing merchants from the administrative burdens of the inspectors could, indeed, be a tentative step forward but freeing merchants from interference from competing merchants puts consumers at the mercy of the intentions of the merchants, which, as experience shows, is a high-risk strategy and generally one that has woeful consequences. As it was, experience in England and Scotland had been deeply marked by the monopolizing consequences of merchant tradesmen free, under governments, through the dead-hand of the Guilds in towns where they held sway, and ruthlessly protected by the Apprenticeship Acts that virtually eliminated competition. No laissez-faire there!
Moreover, laissez-faire became the rallying cry for merchants and industrialists in the 19th century to rally support for resisting government legislation against the excessive hours in mills and mines and the employment of very young children and women. It was also the common slogan of the anti-corn law agitation aimed at lowering the wages of labourers under the guise of removing barriers to farm imports.
Neither of these laissez-faire campaigns were the disinterested motives of the beneficiaries. Mill owners preferred laissez-faire to protect themselves from interference in the arduous, unsafe employment conditions and long hours they imposed on the males, females and children whom they employed; Mine owners likewise employed women and children underground at lower wages than adult men. Both wrapped themselves in laissez-faire flags to wipe up the blood of their employees when they demanded their own freedoms and not those of their labourers or their customers.
On these issues I agree with Keynes.

Sunday, May 12, 2013

'Corporate Boards Are Still Failing'

Dean Baker:

Corporate Boards Are Still Failing: The median pay for a member of the board of a Fortune 500 company is almost $240,000 a year. This typically involves 4-8 meetings a year. One of the top priorities of the board is supposed to be ensuring that top management doesn't rip off the company. They have not been doing a very good job as Gretchen Morgenson points out in her column today. That raises the question of what exactly the get all this money for? ...

Gretchen Morgenson:

Directors Disappoint by What They Don’t Do: Directors of some high-profile public companies are coming under scrutiny this proxy season. Shareholder advocates say it’s about time.
The coming meeting of JPMorgan Chase shareholders, to be held in Tampa, Fla., on May 21, is a case in point. Directors on that board are under fire for not monitoring the bank’s risk management, a failure highlighted by last year’s $6 billion trading loss... Shareholder advisory firms have recommended voting against some of the directors on the risk policy committee and audit committee, so it will be interesting to see what kind of support those board members receive at the election.
The risk-management fiasco at JPMorgan was an obvious failing, but directors of public companies often let down their outside shareholders in ways that are more subtle, but equally important... Directors commonly neglect chief executive succession planning and inadequately analyze company performance as it relates to managers’ pay. ...

See also Lucian Bebchuk here (academic papers) and here (op-eds).

Saturday, May 04, 2013

Cowen: To Fight Pandemics, Reward Research

Tyler Cowen:

To Fight Pandemics, Reward Research, by Tyler Cowen, Commentary, NY Times: That frightening word “pandemic” is back in the news. A strain of avian influenza has infected people in China... The outbreak raises renewed questions about how to prepare for possible risks...
Our current health care policies are not optimal for dealing with pandemics. The central problem is that these policies neglect ... “public goods”: items and services that benefit many people and can’t easily be withheld from those who don’t pay for them directly.
Protection against communicable diseases is a core example of a public good, as is basic scientific research... Without government financing for such public goods, the capacity wouldn’t be there if a new pandemic produced a surge in demand. This would amount to an institutional failure.
The government could also take another, more unusual step: it could promise to pay lucrative prices for the patents on drugs and vaccines that prove useful in dealing with pandemics. ...
Over all, the American government seems to be turning its back on its traditional role of producing and investing in national public goods. ... Focusing government on the production of public goods may sound like a trivial issue... But, in fact, we have been failing at it, and the consequences could be serious indeed.

[This extract probably doesn't emphasize the idea in the second to last paragraph above -- offering prizes for ideas that prove useful in dealing with pandemics -- as much as Tyler would prefer.]

Thursday, April 04, 2013

Joel Waldfogel's Ambilavence about Amazon’s Acquisition of Goodreads

Joel Waldfogel on the economics of Amazon's purchase of Goodreads:

Am I the Only One Ambivalent about Amazon’s Acquisition of Goodreads?, by Joel Waldfogel: The New York Times reported recently that Amazon’s buying Goodreads, the largest book review site online. It’s easy to see the appeal of Goodreads to Amazon. Goodreads apparently has 10 million ratings and reviews of over 700,000 titles. ...
But when I think about Amazon’s sources of market power in book retailing, one of the first things that comes to mind is the indirect network effects: Amazon’s existing collection of user-contributed book ratings and reviews provide lots of information to potential buyers. The more customers who use Amazon, the more information they make available, and the higher the quality of subsequent customer experience at Amazon. In short, the more that people use Amazon, the more that additional people will want to use Amazon. This source of market power is fairly gained, I guess, although the customer/reviewers who create all of this information might want more compensation than the words “top-rated reviewer” after their names.
Buying Goodreads substantially increases the amount of information at Amazon’s disposal. Given how adroit Amazon is at using information, we can expect them to find a way to improve the customer experience. Some part of me is actually excited about that.
But Amazon’s acquisition of Goodreads will also enhance the market position of the market’s largest player. If Amazon owns Goodreads, then no other book retailer does. It seems entirely possible that some other book retailer could have combined with Goodreads to offer Amazon some serious competition. If this is a done deal, we’ll never know.

Friday, March 29, 2013

'Is 'Intellectual Property' a Misnomer?'

Tim Taylor:

Is "Intellectual Property" a Misnomer?, by Tim Taylor: The terminology of "intellectual property" goes back to the eighteenth century. But some modern critics of how the patent and copyright law have evolved have come to view the term as a tendentious choice. One you have used the "property" label, after all, you are implicitly making a claim about rights that should be enforced by the broader society. But "intellectual property"  is a much squishier subject than more basic applications of property, like whether someone can move into your house or drive away in your car or empty your bank account. ...
Is it really true that using someone else's invention is the actually the same thing as stealing their sheep? If I steal your sheep, you don't have them any more. If I use your idea, you still have the idea, but are less able to profit from using it. The two concepts may be cousins, but they not identical. 

Those who believe that patent protection has in some cases gone overboard, and is now in many industries acting more to protect established firms than to encourage new innovators, thus refer to "intellectual property as a "propaganda term." For a vivid example of these arguments, see "The Case Against Patents," by Michele Boldrin and David K. Levine, in the Winter 2013 issue of my own Journal of Economic Perspectives. (Like all articles in JEP back to the first issue in 1987, it is freely available on-line courtesy of the American Economic Association.)

Mark Lemley offers a more detailed unpacking of the concept of "intellectual  property" in a 2005 article he wrote for the Texas Law Review called "Property, Intellectual Property, and Free Riding" Lemley writes: ""My worry is that the rhetoric of property has a clear meaning in the minds of courts, lawyers and commentators as “things that are owned by persons,” and that fixed meaning will make all too tempting to fall into the trap of treating intellectual property just like “other” forms of property. Further, it is all too common to assume that because something is property, only private and not public rights are implicated. Given the fundamental differences in the economics of real property and intellectual property, the use of the property label is simply too likely to mislead."

As Lemley emphasizes, intellectual property is better thought of as a kind of subsidy to encourage innovation--although the subsidy is paid in the form of higher prices by consumers rather than as tax collected from consumers and then spent by the government. A firm with a patent is able to charge more to consumers, because of the lack of competition, and thus earn higher profits. There is reasonably broad agreement among economists that it makes sense for society to subsidize innovation in certain ways, because innovators have a hard time capturing the social benefits they provide in terms of greater economic growth and a higher standard of living, so without some subsidy to innovation, it may well be underprovided.

But even if you buy that argument, there is room for considerable discussion of the most appropriate ways to subsidize innovation. How long should a patent be? Should the length or type of patent protection differ by industry? How fiercely or broadly should it be enforced by courts? In what ways might U.S. patent law be adapted based on experiences and practices in other major innovating nations like Japan or Germany? What is the role of direct government subsidies for innovation in the form of government-sponsored research and development? What about the role of indirect government subsidies for innovation in the form of tax breaks for firms that do research and development, or in the form of support for science, technology, and engineering education? Should trade secret protection be stronger, and patent protection be weaker, or vice versa? 

These are all legitimate questions about the specific form and size of the subsidy that we provide to innovation. None of the questions about "intellectual property" can be answered yelling "it's my property." 

The phrase "intellectual property" has been around a few hundred years, so it clearly has real staying power and widespread usage  I don't expect the term to disappear. But perhaps we can can start referring to intellectual "property" in quotation marks, as a gentle reminder that an overly literal interpretation of the term would be imprudent as a basis for reasoning about economics and public policy. 

Wednesday, March 27, 2013

'Do Intellectual Property Rights on Existing Technologies Hinder Subsequent Innovation?'

Out and about today, so quickly:

Do intellectual property rights on existing technologies hinder subsequent innovation?, EurekAlert: A recent study (Journal of Political Economy 121:1 February 2013) suggests that some types of intellectual property rights discourage subsequent scientific research.
"The goal of intellectual property rights – such as the patent system – is to provide incentives for the development of new technologies. However, in recent years many have expressed concerns that patents may be impeding innovation if patents on existing technologies hinder subsequent innovation," said Heidi Williams, author of the study. "We currently have very little empirical evidence on whether this is a problem in practice."
Williams investigated the sequencing of the human genome by the public Human Genome Project and the private firm Celera. Genes sequenced first by Celera were covered by a contract law-based form of intellectual property, whereas genes sequenced first by the Human Genome Project were placed in the public domain. Although Celera's intellectual property lasted a maximum of two years, it enabled Celera to sell its data for substantial fees and required firms to negotiate licensing agreements with Celera for any resulting commercial discoveries. ...
Williams' conclusion points to a persistent 20-30 percent reduction in subsequent scientific research and product development for those genes held by Celera's intellectual property.
"My take-away from this evidence is that – at least in some contexts – intellectual property can have substantial costs in terms of hindering subsequent innovation," said Williams. "The fact that these costs were – in this context – 'large enough to care about' motivates wanting to better understand whether alternative policy tools could be used to achieve a better outcome. It isn't clear that they can, although economists such as Michael Kremer have proposed some ideas on how they might. ..."

Tuesday, March 19, 2013

The Freedom to Exert Economic and Political Power

I agree with some of this, and I definitely agree with the last sentence of the following "explanation" of inequality from John Taylor -- a "poor diagnosis of the [inequality] problem will lead us in the wrong direction":

Economic Freedom For All, by John Taylor: In talks..., I argue that shifts toward and away from the principles of economic freedom have had profound effects on economic performance. From the mid-1960s through the 1970s, deviations away from economic freedom were large, economic policy was bad, and economic performance was poor with rising unemployment and inflation and falling economic growth. During the 1980s, 1990s, and until recently, deviations were smaller, policy was better, and economic performance improved; unemployment and inflation declined and growth picked up. In recent years policy has been poor and so has economic performance with high unemployment and low economic growth.
Many ask about how changes in the distribution of income fit into this story...
A large body of research documents that returns to education started increasing in the 1980s as evidenced by the growing college and high school wage premium. ... The source of the income distribution problem is thus related to a poor education system. We are restricting educational opportunities, especially for those who are disadvantaged.
In other words the explanation for the widening inequality is the restriction of economic freedom rather than the promotion of economic freedom. Economic freedom did not mean economic freedom for all. ...
Not extending economic freedom to all in the area of education is only one example of how deviations from economic freedom can adversely affect the distribution of income. ...

Ironically some argue that moving further away from the principles of economic freedom—with higher marginal tax rates or more regulations on firms or more discretion for regulators or more interventionist macro policy—is the way to improve the economy and the distribution of income. That would be a great tragedy since history shows that over the long haul it has been more economic freedom that has pulled people out of poverty. The point is not that income distribution isn’t a problem; it is that a poor diagnosis of the problem will lead us in the wrong direction.

The increase in inequality occurred during an era of deregulation, so I can't agree with his basic premise. In any case, I am all for increasing opportunity, and for improving access to education. But the story that inequality is a result of education (and the freedom thing) doesn't hold up to closer scrutiny. It's a "poor diagnosis of the problem":

OK, I see that some people are doubling down on the claim that rising inequality is all about education — when what the CBO report drives home is that this is all wrong, the big increase has come from gains at the very top. ...
Yes, college grads have done better than non; but inequality in America is mainly a story about a small elite pulling away from everyone else, including ordinary college grads. And we’ve know this for a long time! There is no excuse for getting it wrong.

The "Regulatory capture by large firms, crony capitalism, deviations from the rule of law, [and] bailouts of the creditors of large financial firms" certainly contributed to inequality (though his comments about the Fed seem more like sour grapes than analysis). But the problems he describes such as regulatory capture, crony capitalism, etc. are largely about the economic and political power enjoyed by the wealthy. It's hard to see how having government step even further out of the way than it has since the 1970s -- less oversight, less regulation, lower taxes at the top, etc., etc. -- will solve these problems.

[Taylor also has an op-ed in the WSJ. Noah Smith responds.]

Wednesday, February 20, 2013

China Says It May Implement a Carbon Tax

China may implement a (modest) carbon tax:

Taxing Carbon, by Vikas Bajaj, NY Times: Long considered the biggest holdout in climate change negotiations, China said this week that the country would implement new taxes designed to curb greenhouse gas emissions. Officials in Beijing provided few details, but a report by the state-owned Xinhua news service suggested that the government is working on a relatively modest plan. ...
The Xinhua report ... did not say how big a tax the country would impose, but it pointed to a three-year-old proposal by government experts that would have levied a 10-yuan ($1.60) per ton tax on carbon in 2012 and raised it to 50-yuan ($8) a ton by 2020. Those prices are far below the $80 (500-yuan) a ton that some experts have suggested would be needed to achieve “climate stability,” and which would raise the cost of gasoline by about 70 American cents a gallon.
China’s plan will not make a serious dent in global warming, though the tax may still have some beneficial impact within the country, where air pollution is a serious problem. ...
Meanwhile, in the U.S., many members of Congress find the idea of carbon taxes totally anathema and think such taxes would wreck the economy. They might, however, want to consider a proposal promoted by Mr. Hansen that would take the money collected from carbon taxes — or carbon fees as he prefers to call them — and rebate it in full to individuals. That would help consumers pay for more expensive electricity and gasoline, while giving them an incentive to cut their use of energy and fossil fuels. It’s an elegant way to limit damage to the economy while giving people incentives to do what is right for the planet.

Contrary to what "many members of Congress" (i.e. many Republicans) claim, eliminating a market failure through a carbon tax moves the economy closer to the optimal growth path rather than further from it.

Tuesday, February 12, 2013

What Do Republicans Really Want?

My latest column begins with Eric Cantor's call for Republicans to talk about "helping folks":

For Obama, State of the Union Means State of the People, by Mark Thoma: House Majority Leader Eric Cantor believes that Republicans must show their concern for those struggling in this economy if they want to regain their political footing. “We’ve got to be talking about helping folks,” he said Sunday on Meet the Press, “You’ve got so many millions of Americans who feel that they have become an afterthought.”
There’s a reason people feel that way. Republicans have refused to support any of the jobs proposals president Obama has put forward...

What do Republicans really want?:

Pretending to be on the side of the middle class while enacting policies that help businesses and the wealthy has worked well in the past, so it shouldn’t be surprising to see Republicans try this again. Remember the failed promises of trickle-down economics?

But if Republicans -- and Obama -- want to steer the conversation away from the debt, I'm all for that:

President Obama also wants to change the conversation toward the needs of the millions of Americans who feel abandoned by politicians, and he intends to emphasize jobs and the economy in his State of the Union address. This is a welcome change. Instead of focusing on the debt, we should be discussing what we want the government to do. What are our priorities, what will they cost, and what can we, as a nation, afford? In the short-run, is there room for us to do more to help the unemployed? In the longer run, should government be bigger or smaller...? Can the composition of spending and taxes be improved? How fast does the debt need to be reduced, and should it be reduced through tax increase or spending cuts? As we get richer as a society – income doubles every thirty years or so – should the share of GDP devoted to helping people increase, or should government’s share of output be limited to historical averages as many conservatives argue?

As we discuss these important questions about the size and role of government, we need to remember something that has been forgotten too often amid Republican attempts limit government intervention into the economy. The government has an important role to play in overcoming market failures... The private sector, on its own, will not provide the correct amounts of infrastructure, retirement security, health care spending, protection against monopoly and corruption, unemployment insurance, national defense, environmental regulation, education, food and drug safety, bank regulation, innovation, anti-trust action, safe working conditions, support of basic research, stabilization policy, and so on. Fixing these market failures through government action does not distort private sector economic activity away from the optimal outcome as many on the right would have us believe, it moves us closer to the ideal textbook economy. ...

Full column here.

Wednesday, February 06, 2013

Jagdish Bhagwati Does Not Seem to Like Al Gore

Not sure where to start with this one other than to note that Jagdish Bhagwati does not seem to like Al Gore:

Futurama, by Jagdish Bhagwati: ...Al Gore ... surely succeeded beyond his wildest expectations as the author of An Inconvenient Truth. But his phenomenal success had little to do with science (which has remained somewhat controversial: many of us remember for instance the not-too-distant scare about global cooling, also from climate scientists) and much to do with the photographs of polar bears caught on drifting ice as glaciers melted. An image like that is what we all need when we push our pet agendas. Alas, none of us is so fortunate. Nor is Gore as he turns now to writing about our future. ...
The problem Gore faces in the bulk of this book therefore is that his identification of problems, and his proposed solutions, are not compelling. His erudition is considerable but is necessarily limited since he casts his net wide, and he is both unfamiliar with important issues pertinent to his analysis and also shallow in his prescriptions for remedial policies. ...
Given Gore’s justified reputation on climate change, a disappointing feature of Gore’s book is in the chapter titled “The Edge.” I agree with him that the evidence on climate change, and the contribution to it by man-made carbon emissions, is about as good as science can provide; and he is persuasive in his sketch of the scenario of the dangers that global warming, unchecked, hold for mankind. Where he fails is in the remedies that he discusses. To focus on just one issue: there is now agreement from the last meeting at Cancún on the attempted renewal of Kyoto Protocol that $100 billion be found annually to create new technologies of mitigation and adaptation to climate change. It is expected that a significant share of this will be public funds. We have the precedent that public monies should largely be used to create public good: thus the new seeds under the green revolution were publicly financed and they were available to everyone virtually for free. Should we then not expect the green technologies developed with public funds to be available for free to Mars, China, and India?
But, to my knowledge, Gore has not embraced this proposal, which would make, say, India accept more ambitious targets of carbon reduction because it would reduce the cost of doing so. I would not make the ferocious charges that Gore levels at the opponents of climate change (see page 283). But may I wonder whether the reason for Gore’s omission is that he is heavily invested in green-energy stocks and would like to see public funds to be used only for private payoffs by these firms?
The good in the book is therefore offset by the bad. But even the bad will produce good if it irritates us into thinking harder about the many issues that Gore correctly insists we must confront.

Gore's sin is not embracing a particular proposal, and it must be because "he is heavily invested in green-energy stocks?" Pretty thin charge, and pretty speculative -- I expected a more compelling complaint. (Bhagwati agress with Gore on the science, says he's persuasive, etc., and acts like the know-it-all judge of all things related to climate change, yet he tosses out the global cooling thing? There's a reason this is called the "global cooling myth.")

In another part, I was surprised to hear a call for unions:

...The problem in this world of competition among similar products is that comparative advantage is now fragile: it has a “knife-edge” quality. One day you have it; the next day you do not. Almost every entrepreneur has a rival breathing down his neck; and this need not be from China or India, with their “low wages”—what Gore frets about—but may be Poland or France or Sweden. There are three implications.
First, firms need flexibility in firing if they are to hire.
Second, we can no longer assure economic security for workers by giving them lifetime employment. The security has to be for the worker herself, unrelated to specific occupation and employment.
Third, the volatility also means that we can no longer expect firms to provide training and hence “human capital” to blue-collar workers who can be expected to leave at the next sign of trouble at their plant or firm. We therefore have to provide this human capital through efforts by unions, employers, community colleges, etc.
Gore also accepts uncritically the notion that we are doomed to greater inequality in a globalized world of trade and multinational investment. The evidence is more mixed than he reports...

I think it would only be fair to note the incentives work the other way as well. With firms willing to fire workers at the drop of a hat -- older social obligations to retain workers through tough times are largely gone -- there's no incentive for workers to invest in themselves if the human capital is unique to the particular firm. Why bother if you are unlikely to be there for very long? (That is, I don't think the problem is workers who "leave at the next sign of trouble." f course they'll leave for another opportunity if they fear they'll be fired in the near future due to the "trouble.")

Wednesday, January 30, 2013

'The Real, and Simple, Equation That Killed Wall Street'

I'm sympathetic to the argument that excess leverage was a problem in the financial crisis, but I don't see it the primal cause of the recession. Instead, leverage iss a magnifier that makes things much, much worse when problems occur:

The Real, and Simple, Equation That Killed Wall Street, by Chris Arnade, Scientific American: ...It ... is the overly simple narrative that many in the media have spun about the last financial crisis. Smart meddling kids armed with math hoodwinked us all.
One article, from the March 2009 Wired magazine, even pinpointed an equation and a mathematician. The article “Recipe for Disaster: The Formula That Killed Wall Street,” accused the Gaussian Copula Function.
It was not the first piece that made this type of argument, but it was the most aggressive. ...
This theme plays on the fallacy that danger always comes from complexity. ...
The reality is much simpler and less sexy. Wall Street killed itself in a time-honored fashion: Cheap money, excessive borrowing, and greed. And yes, there is an equation one can point to and blame. This equation, however, requires nothing more than middle school algebra to understand and is taught to every new Wall Street employee. It is leveraged return. ...
The Gaussian Copula Function, opaque to most, is convenient to blame. It allows us to shake off our collective sense of guilt. It obscures the real crime...

I'm willing to blame leverage for contributing to the magnitude of the crisis, and I've long-called for limits on leverage to mute the negative effects of the next financial recession, which will come no matter how hard we try to avoid it. But I don't think it's correct to blame leverage itself for our problems, i.e. that "there is an equation one can point to and blame."

[The article actually notes many other factors, e.g. bad incentives for ratings agencies, failures of regulation, easy moneary policy by the Fed, and so on, but still ends up focusing on the leverage component as the key factor. In any case, the article is directed squarely at Felix Salmon, and I'm posting this in the hope that it will help prod him into responding.]

Sunday, January 27, 2013

Climate Policy in Obama's Second Term

I think of Robert Stavins as being on the optimistic side when it comes to action on climate change, but even he seems discouraged despite Obama's mention of this issue in his inaugural address:

The Second Term of the Obama Administration, by Robert Stavins: In his inaugural address on January 21st, President Obama surprised many people – including me – by the intensity and the length of his comments on global climate change.  Since then, there has been a great deal of discussion in the press and in the blogosphere about what climate policy initiatives will be forthcoming from the administration in its second term. ...
Although I was certainly surprised by the strength and length of what the President said in his address, I confess that it did not change my thinking about what we should expect from the second term.  Indeed, I will stand by an interview that was published by the Harvard Kennedy School on its website five days before the inauguration (plus something I wrote in a previous essay at this blog in December, 2012).  Here it is, with a bit of editing to clarify things, and some hyperlinks inserted to help readers. ...
Q: In the Obama administration’s second term, are there openings/possibilities for compromises...?
A: It is conceivable – but in my view, unlikely – that there may be an opening for implicit (not explicit) “climate policy” through a carbon tax. At a minimum, we should ask whether the defeat of cap-and-trade in the U.S. Congress, the virtual unwillingness over the past 18 months of the Obama White House to utter the phrase “cap-and-trade” in public, and the defeat of Republican Presidential candidate Mitt Romney indicate that there is a new opening for serious consideration of a carbon-tax approach to meaningful CO2 emissions reductions in the United States.
First of all, there surely is such an opening in the policy wonk world. Economists and others in academia, including important Republican economists such as Harvard’s Greg Mankiw and Columbia’s Glenn Hubbard, remain enthusiastic supporters of a national carbon tax. And a much-publicized meeting in July, 2012, at the American Enterprise Institute in Washington, D.C. brought together a broad spectrum of Washington groups – ranging from Public Citizen to the R Street Institute – to talk about alternative paths forward for national climate policy. Reportedly, much of the discussion focused on carbon taxes.
Clearly, this “opening” is being embraced with enthusiasm in the policy wonk world. But what about in the real political world? The good news is that a carbon tax is not “cap-and-trade.” That presumably helps with the political messaging! But if conservatives were able to tarnish cap-and-trade as “cap-and-tax,” it surely will be considerably easier to label a tax – as a tax! Also, note that President Obama’s silence extends beyond disdain for cap-and-trade per se. Rather, it covers all carbon-pricing regimes.
So as a possible new front in the climate policy wars, I remain very skeptical that an explicit carbon tax proposal will gain favor in Washington. ...
A more promising possibility – though still unlikely – is that if Republicans and Democrats join to cooperate with the Obama White House to work constructively to address the short-term and long-term budgetary deficits the U.S. government faces,... then there could be a political opening for new energy taxes, even a carbon tax. ...
Those who recall the 1993 failure of the Clinton administration’s BTU-tax proposal – with a less polarized and more cooperative Congress than today’s – will not be optimistic. ... The key group to bring on board will presumably be conservative Republicans, and it is difficult to picture them being more willing to break their Grover Norquist pledges because it’s for a carbon tax.

Here's the surprising part (to me anyway), some optimism after all:

What remains most likely to happen is what I’ve been saying for several years, namely that despite the apparent inaction by the Federal government, the official U.S. international commitment — a 17 percent reduction of CO2 emissions below 2005 levels by the year 2020 – is nevertheless likely to be achieved!  The reason is the combination of CO2 regulations which are now in place because of the Supreme Court decision [freeing the EPA to treat CO2 like other pollutants under the Clean Air Act], together with five other regulations or rules on SOX [sulfur compounds], NOX [nitrogen compounds], coal fly ash, particulates, and cooling water withdrawals. All of these will have profound effects on retirement of existing coal-fired electrical generation capacity, investment in new coal, and dispatch of such electricity.
Combined with that is Assembly Bill 32 (AB 32) in the state of California, which includes a CO2 cap-and-trade system that is more ambitious in percentage terms than Waxman-Markey was in the U.S. Congress, and which became binding on January 1, 2013. ...  In other words, there will be actions having significant implications for climate, but most will not be called “climate policy,” and all will be within the regulatory and executive order domain, not new legislation. ...

Thursday, January 24, 2013

'Robots and All That'

Fred Moseley responds to my comments on his comments (I suggested that if he wants a theory of exploitation that is consistent, he should consider dropping Marx's Labor Theory of Value, which does not actually explain value, and instead explain exploitation in more modern terms, i.e. with reference to why workers have not received their marginal products in recent decades):

Thanks to Mark for posting my critical comment on Krugman’s explanation of stagnant real wages and declining wage share of income, and for his introductory comment, which raises fundamental issues.
A question for Mark: how do you know what the “MP benchmark” is that workers should have received. The MP benchmark is presumably the “marginal product of labor”, but how do you know what this is? I know of no time series estimates of the aggregate MPL (independent of income shares) for recent decades. If you know of such estimates, please send me the reference(s).
What you have in mind may be estimates like Mishel’s estimates of the “productivity of labor” and the “real wage of production workers”, which shows a widening gap in recent years (see Figure A in “The wedges between productivity and median compensation growth”; ). But these estimates of the “productivity of labor” are not of the MPL of marginal productivity theory, but are instead the total product divided by total labor. These estimates are more consistent with Marxian theory than with marginal productivity theory. And I agree that explaining this divergence is an important key to understanding the increasing inequality in recent decades. I think the explanation has to do with a number of factors that have put downward pressure on wages: higher unemployment, outsourcing and threat of more, declining real minimum wage, attacks on unions, etc. This is very different from Krugman’s “capital-biased technological change”.
A word on the labor theory of value: the LTV is not mainly a micro theory of prices, but is instead primarily a macro theory of profit. And I think that it is the best theory of profit by far in the history of economics (there is not much competition). It explains a wide range of important phenomena in capitalist economies: conflicts over wages, and conflicts over the length of the working day and the intensity of labor in the workplace, endogenous technological change, trends and fluctuations in the rate of profit over time, endogenous causes of economic crises, etc. (For further discussion of the explanatory power of Marx’s theory see my “Marx Economic Theory: True or False? A Marxian Response to Blaug’s Appraisal”, in Moseley (ed.) Heterodox Economic Theories: True or False?; available here:
Marginal productivity, in very unfavorable contrast, can explain none of these important phenomena.
Thanks again.
Fred

Just one comment. If the LTV cannot explain input or output prices, and it doesn't, how can it explain profit?

(Okay, two -- In defense of Krugman, his book Conscience of a Liberal was anything but a “capital-biased technological change” explanation of rising inequality, and he stated the “capital-biased technological change” explanation as something to look into rather than a conclusion he has drawn. For example, he says:

More on robots and all that ... there’s another possible resolution: monopoly power. Barry Lynn and Philip Longman have argued that we’re seeing a rapid rise in market concentration and market power. The thing about market power is that it could simultaneously raise the average rents to capital and reduce the return on investment as perceived by corporations, which would now take into account the negative effects of capacity growth on their markups. So a rising-monopoly-power story would be one way to resolve the seeming paradox of rapidly rising profits and low real interest rates. As they say, this calls for more research; but the starting point is to realize that there’s something happening here, what it is ain’t exactly clear, but it’s potentially really important.

So I don't think it's completyely fair to say that Krugman's explanation for rising inequality is "capital-biased technological change.")

Saturday, January 19, 2013

Financial Collapse: A 10-Step Prevention Plan

Alan Blinder lists "10 financial commandments, all of which were brazenly violated in the years leading up to the crisis":

Financial Collapse: A 10-Step Recovery Plan, by Alan S. Blinder: ...let me try to encapsulate what we must remember about the financial crisis...:
1. Remember That People Forget ...
2. Do Not Rely on Self-Regulation ...
3. Honor Thy Shareholders ...
4. Elevate Risk Management ...
5. Use Less Leverage ...
6. Keep It Simple, Stupid ...
7. Standardize Derivatives and Trade Them on Exchanges ...
8. Keep Things on the Balance Sheet ...
9. Fix Perverse Compensation ...
10. Watch Out for Consumers ...
Mark Twain is said to have quipped that while history doesn’t repeat itself, it does rhyme. There will be financial crises in the future, and the next one won’t be a carbon copy of the last. Neither, however, will it be so different that these commandments won’t apply. ...

Wednesday, January 09, 2013

The FTC and Google

Shane Greenstein:

The FTC and Google: What did Larry Learn?, by Shane Greenstein: The FTC and Google settled their differences last week, putting the final touches on an agreement. Commentators began carping from all sides as soon as the announcement came. The most biting criticisms have accused the FTC of going too easy on Google. Frankly, I think the commentators are only half right. Yes, it appears as if Google got off easy, but, IMHO, the FTC settled at about the right place.
More to the point, it is too soon to throw a harsh judgment at Google. This settlement might work just fine, and if it does, then society is better off than it would have been had some grandstanding prosecutor decided to go to trial.
Why? First, public confrontation is often a BIG expense for society. Second, as an organization Google is young and it occupies a market that also is young. The first big antitrust case for such a company in such a situation should substitute education for severe judgment.
Ah, this will take an explanation. ...

Monday, January 07, 2013

The Reason We Lose at Games: Implications for Financial Markets

Something to think about:

The reason we lose at games, EurekAlert: Writing in PNAS, a University of Manchester physicist has discovered that some games are simply impossible to fully learn, or too complex for the human mind to understand.
Dr Tobias Galla from The University of Manchester and Professor Doyne Farmer from Oxford University and the Santa Fe Institute, ran thousands of simulations of two-player games to see how human behavior affects their decision-making.
In simple games with a small number of moves, such as Noughts and Crosses the optimal strategy is easy to guess, and the game quickly becomes uninteresting.
However, when games became more complex and when there are a lot of moves, such as in chess, the board game Go or complex card games, the academics argue that players' actions become less rational and that it is hard to find optimal strategies.
This research could also have implications for the financial markets. Many economists base financial predictions of the stock market on equilibrium theory – assuming that traders are infinitely intelligent and rational.
This, the academics argue, is rarely the case and could lead to predictions of how markets react being wildly inaccurate.
Much of traditional game theory, the basis for strategic decision-making, is based on the equilibrium point – players or workers having a deep and perfect knowledge of what they are doing and of what their opponents are doing.
Dr Galla, from the School of Physics and Astronomy, said: "Equilibrium is not always the right thing you should look for in a game."
"In many situations, people do not play equilibrium strategies, instead what they do can look like random or chaotic for a variety of reasons, so it is not always appropriate to base predictions on the equilibrium model."
"With trading on the stock market, for example, you can have thousands of different stock to choose from, and people do not always behave rationally in these situations or they do not have sufficient information to act rationally. This can have a profound effect on how the markets react."
"It could be that we need to drop these conventional game theories and instead use new approaches to predict how people might behave."
Together with a Manchester-based PhD student the pair are looking to expand their study to multi-player games and to cases in which the game itself changes with time, which would be a closer analogy of how financial markets operate.
Preliminary results suggest that as the number of players increases, the chances that equilibrium is reached decrease. Thus for complicated games with many players, such as financial markets, equilibrium is even less likely to be the full story.

Thursday, January 03, 2013

Health Exchanges: Competition versus Standardization

Jonathan Gruber describes a "central tension" in online health exchanges: more choices and more competition versus standardization that makes choices between plans abundantly clear:

The health-insurance markets of the (very near) future, MIT News: An online health-insurance exchange is coming to your state. How effective will it be?

That is an increasingly important question in the United States. In June 2012, the Supreme Court upheld the legality of the country’s Affordable Care Act, passed by Congress and signed into law by President Barack Obama in 2010. The program mandates private-sector health insurance for all citizens, and provides subsidies for those who otherwise could not afford it. Insurance-plan choices will be available through exchanges, or marketplaces; most people will be able to study plans and sign up for one online. As of December, nearly 20 states have elected to run exchanges themselves; the federal government will run the exchanges in other states.

And therein lies a key issue: Creating a consumer-friendly exchange is no easy task. It is hard enough to know what kinds of foods we should eat, which cars to drive, or which apps to use. Selecting an insurance plan is a far more complex decision.

“Health insurance is a confusing and difficult choice,” says Jonathan Gruber, a professor of economics at MIT who specializes in health-care issues. “It’s important that people make decisions in an organized and effective market. In that way they can make the best choices, and we can ensure the best level of competition among insurers.” ...

Moreover, as Gruber readily acknowledges, state-run insurance exchanges must pull off a difficult balancing act. The point of markets is to provide competition, but academic research shows that when people are given too many choices, they struggle to select logical options for themselves.

“The tension that exchanges face,” Gruber says, “is [having] enough standardization to make choice and competition work effectively, but not so much standardization that people can’t find the plans that best fit their tastes. That’s absolutely a central tension.” To handle this challenge, policymakers and academic researchers will almost certainly have to collaborate in productive ways.

Indeed, plenty of research suggests that America’s existing health-care offerings are already too complex. ...[more]...